Bolivia: Downgrade from category 5/7 to 6/7 for the MLT political risk

• Political tensions have been increasing in this highly polarised country since 2019.
• The economy has recovered in 2021 by an expected 5%, but real GDP will only reach pre-Covid-19 levels by the end of 2022.
• The external debt-to-GDP ratio is on the rise and is now at its highest level since 2005, when the country benefited from debt relief.
• The fixed exchange rate and decreasing foreign exchange reserves elevate the risk of capital controls or foreign exchange shortages.

Rising political tensions and unrest in a highly polarised country

In the past decades, Bolivia has been prone to political instability, mainly due to domestic tensions between the elite and poor indigenous communities (about two thirds of the population). However, the rule of Evo Morales and his MAS party (Movimiento al Socialismo) – mainly supported by the indigenous people – did bring relative political stability between 2005 and 2019. Nevertheless, political tensions have been rising ever since Morales decided to run for re-election in 2019, despite a referendum rejecting (another) proposal of Morales, for a consequential fourth presidential term. Although Morales was elected during the 2019 elections, the results were annulled on fraud allegations, and Morales fled the country while it was experiencing violent unrest. A caretaker government of the centre-right (elite) opposition ran the country until new elections took place in 2020. Luis Arce, of the MAS party, became president in November 2020 after an overwhelming election victory. Yet, political tensions have only increased in the highly polarised country. Since returning to power, the MAS have been taking severe measures against opponents and the president of the caretaker government, and several key members are being held in jail. Furthermore, ever since the 2019 elections, the country has been prone to bouts of prolonged and violent unrest.

Economic growth has been declining since 2016

During Morales’ rule, the country surfed on a commodity boom with high mineral and hydrocarbon prices. Bolivia exports gold, silver, zinc and tin, and mainly gas. Indeed, between 2005 and 2016, average real GDP growth stood around 5%. However, since 2016, real GDP growth has been declining due to the country’s high reliance on commodity exports (mainly explained by lower gas prices). An average real GDP growth of 3.7% was recorded between 2016 and 2020. The Covid-19 crisis and low commodity prices hit Bolivia’s economy hard, resulting in a deep recession of 8.8% in 2020. Even though the economy has been recovering in 2021, by an expected 5%, thanks to higher gas and mineral prices, real GDP will only reach pre-Covid-19 levels by the end of 2022. Looking forward, economic growth forecasts are expected to remain below the 2005-2019 average with an expected average real GDP growth of 3.7% in 2022-2025. The expected fiscal consolidation and low levels of private investment are projected to curtail economic growth in the medium term. Bolivia is among the slowest-vaccinating countries in Latin America and is not expected to reach herd immunity before 2023. Therefore, downside risks prevail, as the country will remain vulnerable to Covid-19 waves in the coming years, and to natural disasters (droughts, floods, wildfires, etc.). At the same time, global reliance on fossil fuels is expected to lessen in the longer term, which could affect Bolivia’s gas exports.

Lower commodity prices have led to current account deficits

Until 2014, Bolivia posted a decade of current account surpluses thanks to the commodity boom. However, between 2015 and 2020 the current account balance turned into a deficit of an average 5% of GDP. On the export side, current account revenues dropped by a quarter in 2015 and have never recovered to their 2014 levels ever since. An important reason is, that since their peak in 2014, hydrocarbon exports have decreased by almost 60% in dollar value, and by a third in volume in 2020. Moreover, Argentina and Brazil, the sole importers of Bolivian natural gas, are actively seeking to reduce those imports in favour of domestic production, while landlocked Bolivia has been unsuccessful in securing alternative markets. In addition, the regulatory regime introduced by President Morales, incorporates administrative controls over prices and exports (mainly of agriculture products) which also hurt current account revenues. On the import side, oil, capital and consumer goods are the main drivers of current account payments. In 2020, the current account deficit narrowed down to a modest 0.5% of GDP amid large import compression (as witnessed in all of Latin America due to lockdown measures). In 2021, the current account deficit is expected to widen to 2.2% of GDP as import payments increase quickly when an economy normalises. In the coming years, the current account deficit is expected to gradually widen to 3.8% of GDP in 2025, because higher gas and mineral prices will only bring temporary relief. In the past, current account deficits have been financed mainly by drawing down foreign exchange reserves and by issuing external debt (mainly concessional multilateral debt, and to a lesser extent by external bonds). In the past years, FDI inflows have been a rather volatile source to fund current account deficits, while large FDI outflows occurred in 2019 and 2020 (which was not a general trend in Latin America). In the coming years, FDI inflows are forecast to be a relatively small source to fund the expected current account deficits, given that the government’s interventionist policies are making FDI unattractive. Hence, further running down of foreign exchange reserves and external debt issuance will be necessary to fund the current account deficits in the coming years. On the upside, Bolivia’s vast and underdeveloped lithium deposits – the world’s largest – hold the greatest potential seeing the current context of a global green transition, if the country is able to attract investments.

Keeping the boliviano pegged to the US dollar comes at a price

Since November 2011, Bolivia has had a fixed exchange rate of 6.9 boliviano per US dollar, which resulted in low and stable inflation and a reduction in dollarisation. However, due to the current account deficits since 2015, foreign exchange reserves have been falling, and have downsized by almost 85% since the 2014 peak. They covered 2.6 months of imports in October 2021 (including the SDR allocation of USD 326 million, disbursed in August). This is a low level to defend the peg, especially as foreign exchange reserves are expected to decline in the coming years due to large, forecasted financing gaps in the balance of payments. Indeed, elevated mineral and gas prices and the IMF’s SDR provide additional reserve cushioning in 2021, but do not materially alter the current downward trajectory. This makes the peg of the boliviano to the US dollar no longer sustainable in the medium term. A devaluation is possible and the IMF stated in its August 2021 report that the real exchange rate is overvalued by around 10-15%. However, the combination of the current administration’s ideological and interventionist policy, its constant commitment to the current exchange rate (given a devaluation would hurt, especially, poor households), and the lack of an independent central bank elevate the risk of capital controls or foreign exchange shortages in the medium term. Furthermore, the declining foreign exchange reserves will keep Credendo’s ST political risk rating (4/7) under pressure in the one-year outlook.

Highest debt ratios since 2005

The recent current account deficits have led to a buildup in external debt. The latter rose to almost 42% of GDP at the end of 2020, coming from almost 27% of GDP at the end of 2014. Although in theory, the current level is still manageable, the country’s debt ratio is clearly on the rise and is now at its highest level since 2005, when the country benefited from debt relief under the HIPC and MDRI frameworks. In the coming years, the external debt-to-GDP ratio is not likely to come down, while depreciation could push up debt-to-GDP levels. On the upside, debt is mainly long-term debt, as short-term debt only accounts for about 7% of total external debt levels. Furthermore, Bolivia has been mainly relying on multilateral debt (for around half of its external debt) and bilateral debt (around a tenth of its total external debt). However, recently the Andean country has been relying more on commercial debt and has placed several bonds on the financial markets, for example in 2013 (to mature in 2023) and 2017 (to mature in 2028). Looking forward, the reliance on financing from international markets exposes Bolivia to a possible shift (tightening) in external financing conditions.

Large spending cuts and less public investments are key but might trigger political instability

Even if the figures are not worrying yet, public finances are weak. Since 2014, the persistent primary deficit (of around 6% of GDP) has led to a steady rise in the public debt-to-GDP ratio. The Covid-19 pandemic pushed public debt levels to an elevated 79% of GDP, as the government posted a large fiscal deficit of almost 13% of GDP in 2020. Looking forward, fiscal deficits are expected to only gradually decrease. As a result, public debt is expected to continue to rise to a high level of almost 90% of GDP by 2025. On the upside, though interest payments to public revenues are on the rise, the level is relatively low (expected to be below 10% of public revenues in 2021) as multilaterals funded the fiscal deficits in the past. Nevertheless, in the past year, additional financing has been necessary and the central bank has clearly increased the share of public debt on its balance sheet. In the future, large spending cuts and decreased public investments (the motor of domestic economic growth in the past) will be necessary but could lead to more political instability.

MLT political risk rating downgraded from category 5/7 to 6/7

Credendo’s decision to downgrade Bolivia’s medium-term to long-term political risk rating at the end of November 2021, from category 5/7 to 6/7, can be explained by various factors. There is the peg that was unsustainable in the medium term, decreasing foreign exchange reserves, rising political instability, and the buildup of external debt with an increasing commercial share, combined with the deterioration of public finances.

Analyst: Jolyn Debuysscher – J.Debuysscher@credendo.com