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- The 2021 revised budget highlights a financing crunch that is likely to intensify in the absence of reforms and an IMF deal.
- We see an external funding gap of US$1.9bn (4.3% of GDP) for 4Q21, which could lead to arrears and shortages.
- Monetizing this gap would double the pace of central bank financing versus 2020 and accelerate the drawdown in Fx reserves.
By Jean-Michel Saliba
Tunisia in Focus
Tunisia - hallmarks of a fiscal crisis
The 2021 supplementary budget highlights to us a fiscal financing crunch that is likely to intensify in the absence of a bold 2022 budget and an International Monetary Fund (IMF) program. We see an external funding gap of US$1.9bn (4.3% of GDP) for 4Q21, which could lead to arrears and shortages. Monetizing this gap would likely double the pace of central bank financing versus 2020 and accelerate the drawdown in Fx reserves.
Cabinet formed, but no political roadmap yet
The Cabinet formed in early October by Prime Minister (PM) Bouden faces large challenges going forward, in our view. A timetable for the political transition sought by President Kais Saied has not yet been made public, although preparations for an electronically-conducted dialogue appear to be in the works. The opposition to President Saied's moves has increased. This has been reflected in official statements from a number of political parties and civil society groups.
IMF program and regional financial support face long odds
In our view, the lack of a clear economic policy anchor diminishes the chance of an International Monetary Forum (IMF) program near-term. While it is positive that President Kais Saied appears to have given a green light to formally initiate program talks with the IMF, the government's room to manoeuvre remains unclear, in part due to the ongoing political transition. Technical talks with the IMF resumed in early November.
President Kais Saied's 22 September Decree makes the Cabinet subordinate to him. Fiscal reforms linked to an IMF program are likely to go against President Kais Saied's political instincts. While he has talked of austerity in official pronouncements, we interpret his comments as focused on reducing luxury imports. A 2023-25 economic recovery program is in the works and could be announced by the 100-day mark for the Cabinet (i.e. mid-January 2022), according to the Minister of Economy and Planning.
Regional financial support for Tunisia appears unlikely near-term. This is highlighted by the lack of announcements post-visit of PM Bouden to Saudi Arabia, in our view. Any bilateral support provided to the central government may get caught in any future potential restructuring conducted under the Paris Club process. This could thus act as an economic disincentive, in our view.
A debt audit is in the works
President Kais Saied instructed the Ministry of Finance to conduct a debt audit, reflecting his claims that debt proceeds were misspent. For now, we expect this could be to settle political scores with the previous administrations. However, the risk is that, if the economic situation deteriorates further, the debt audit could serve as a negotiation tactic with creditors and reflect an erosion in the willingness to pay, in our view.
Ongoing negotiations with the labour union complicate IMF talks
The first round of negotiations in mid-November between the Cabinet and the UGTT labour union signals a higher wage bill, in our view. While UGTT's rank-and-file members may be supportive of President Saied's political moves so far, fiscal austerity is likely to be opposed by the labour union going forward, in our view. UGTT's official pronouncements suggest it is likely to resist price hikes, subsidy removals and economic reforms by the current 'temporary government in exceptional circumstances'. (Politically, UGTT is opposed to the resumption of the current parliament's activities, and called for electoral law reform and early elections).
PM Bouden agreed to honour the agreements UGTT reached with previous governments. 6,000 temporary workers will integrate formal civil service employment by 15 December according to the accord, and we understand further temporary workers may also have their situation regularized next year. UGTT stated the government will codify the agreements by publishing them in the Official Gazette. These agreements include raising the national minimum wage (agreed in May 2019) and the payment of the last tranche of the February 2019 UGTT-government wage settlement (worth c0.3% of GDP and scheduled for payment in January 2020).
We understand the implementation of the previous agreements was effectively "suspended" through the lack of publication in the Official Journal. We suspect the government may have sought to align its policies with IMF conditionality as it was negotiating a program over 1H21. The IMF's view in previous programs suggest its starting position could be a nominal wage bill freeze, and it is more likely to hold the line in ongoing talks given debt sustainability and financing concerns, in our view.
Lack of Law 38/2020 implementation litmus test for stability
The planned lack of implementation of Law 38/2020 by the government likely reduces pressures on the public wage bill. However, this may prove a rallying point for protestors, especially in the lead-up to regularly occurring demonstrations in January of each year. Subsequent to the Cabinet-UGTT meeting, President Kais Saied announced he is opposed to the implementation of Law 38/2020 (which would allow direct hiring into the public sector of higher degree holders that have been unemployed for ten years or more). We note that the Cabinet-UGTT agreement does not appear to have formally endorsed implementation of Law 38/2020.
Fiscal trends year-to-date appear unsustainable
Deep cuts to capital expenditures, spending prioritization and likely accumulation of arrears have minimized the fiscal deficit year-to-date, reflecting external funding constraints. As of August 2021, the fiscal balance and primary balance (IMF GFS presentation) stood at -TND3.0bn (US$1.1bn, 2.4% of GDP) and -TND1.7bn (US$0.6bn, 1.3% of GDP) respectively. The fiscal deficit (IMF GFS presentation) thus annualizes at TND4.6bn (US$1.7bn; 4.1% of GDP), compared to TND11.2bn (US$4.0bn, 9.5% of GDP) in 2020.
Net fiscal funding over 8m21 originated fully from domestic sources as net external borrowing was negative over the same period. Investment spending was flattish on a yoy basis over 8m21, running at 80% of the budgeted amount on an annualized basis. While this has helped keep overall spending flat over the same period, the local press suggests anecdotal evidence of government arrears to its suppliers as well as some shortages in sectors dominated by government-sourced imports,
2021 supplementary budget highlights financing crunch
The 2021 supplementary budget decreed in mid-November underlines the material fiscal financing challenges in 4Q21. This reflects the relative inflexibility in the composition of government spending, a higher subsidy bill (with the budgeted oil price assumption hiked from US$45//bbl to US$70/bbl), and the drying out of foreign financing in the absence of an IMF program. We flesh out the budget details in the fiscal accounts and fiscal financing needs and sources in the two tables below.
The 2021 supplementary budget expects a widening in the fiscal balance (IMF GFS presentation) to -TND10.4bn (US$3.7bn, 8.3% of GDP) on a full-year basis. This would lead to the budget deficit doubling over a single quarter (4Q21), This is primarily due to spending pressures as expenditures of TND20.7bn (US$7.4bn) are pencilled in for the last four months of 2021, largely on the back of the revision to the fuel subsidy bill and the lack of the implementation of the automatic adjustment to administered domestic fuel prices.
The central government expenditure composition suggests that the higher spending budgeted for 4Q21 is largely incompressible in nature. A comparison to a similar situation last year at the time of the publication of the 2020 supplementary budget (which coincided with the release of the 8m20 fiscal accounts) suggests that the bulk of the spending planned for the last four months of 2020 did take place (TND17.9bn realized versus TND18.7bn planned). In the extreme, if the government only executed 50% of the budgeted capital expenditures and good and services over 4Q21, we estimate this would provide savings of only TND1.7bn.
External financing budgeted for 4Q21 unlikely to fully materialize
We see an external funding gap of TND5.3bn (US$1.9bn; 4.3% of GDP) for 4Q21. Monetizing the gap would double the pace of central bank financing versus 2020. The 2021 supplementary budget implies an increase in the gross fiscal financing needs by TND10.9bn (US$3.8bn; 8.6% of GDP) to TND21.5bn (US$7.7bn; 17.2% of GDP) for the full year. Authorities expect to raise TND1.9bn (US$2.8bn; 6.2% of GDP) externally and TND3.0bn (US$1.0bn; 2.4% of GDP) domestically. Authorities only raised US$0.8bn externally in September, making use of the US$0.7bn IMF Special Drawing Rights (SDR) allocation and receiving a likely previously approved US$0.1bn World Bank project financing budget support loan.
The remaining external financing sources appear unlikely to fully materialize in the absence of an IMF program. We note that authorities incorporate TND2.8bn (US$1bn; 2.4% of GDP) in unspecified bilateral funding. We expect this to reflect two US$0.5bn budget support loans being negotiated with Saudi Arabia and Libya, according to the local press, but regional financial support has not been forthcoming so far.
2022 budget is likely to be a key signal
In the lack of financing avenues or consensus over a bold, reformist, 2022 budget, we expect increased fiscal stress next year. This is likely to lead to further accumulation of arrears, resort to direct or indirect central bank monetization, a further drawdown of Fx reserves, and increased sovereign debt restructuring risks, in our view. With the share of net external borrowing in gross fiscal financing sources hovering around 50%, the drying out of external funding for 2022 could lead to a fiscal funding gap of TND12bn (US$4.3bn; 9.7% of GDP).
in the lack of alternative funding sources, this funding gap is likely to lead to a combination of arrears, import shortages, and accelerated central bank monetization and drop in Fx reserves. The scale of the monetization required to fully fill the gap, in the absence of other measures, is four times that of 2020 and potentially double that of 2021. We do not expect the banking sector to be able to adequately fully bridge a gap that large. This is reflected in its structural liquidity shortage versus the central bank (BCT). Indeed, the overall volume of BCT refinancing has averaged TND10.6bn (US$3.8bn; 8.4% of GDP) over July-November, a 24% increase versus 1H21.
Increasing financial risks from SOE debt
A build-up of short-term trade credits has helped to boost gross Fx reserves pre-pandemic, in our view. However, a potential inability to rollover maturing trade credit lines given the deteriorated economic situation and sovereign rating is likely to weigh on Fx reserves going forward, in our view. Corporate defaults could disrupt imports and increase contingent liabilities on the sovereign. The IMF reports that the 30 largest State-Owned Enterprises (SOEs) had debt of 40% of GDP in 2019, and SOE-guaranteed debt stood at 15% of GDP in mid-2020.
The large US$3.2bn pick-up in short-term external debt (mostly unguaranteed trade credits) by SOEs over 2019 raises near-term rollover risks. This has come against flat import growth that year, boosting Fx reserves then. The need to increase the share of SOEs imports being financed through trade credits could suggest a weakening financial profile for SOEs. Many SOEs face financial difficulty, as per local press reports. Furthermore, they are exposed to exchange rate risk and many of them likely sell imported products at subsidized prices locally, in our view.
BCT net FC assets weaker than headline gross Fx reserves level suggests
BCT reported its net foreign currency (FC) assets at US$7.1bn on 24 November (4 months of import cover), which we estimate translates to gross international reserves of US$7.7bn (adjusting for holdings of gold, SDRs and IMF reserve position). However, we estimate the BCT presentation of its net FC assets does not account for a number of its foreign currency liabilities. Examining the BCT's balance sheet (last reported for end-September), we estimate the BCT net FC assets on 24 November stood at US$3.6bn.
Our presentation for net FC assets excludes foreign-currency liabilities irrespective of residency. We thus exclude the Fx share of government central and special accounts (calibrated at the end-year share stated in the BCT annual reports), Fx liabilities to the resident financial sector and Fx liabilities to non-residents. We note the latter include US$250mn in deposits by the Bank of Algeria (three tranches deposited in April 2011, May 2014 and March 2015) and a EUR0.5bn deposit by the Central Bank of Libya made in July 2019. The breakdown of BCT's external debt suggests the bulk of its liabilities to non-residents are long-term in nature, and the IMF suggest only US$0.1bn in medium- and long-term debt amortizations for BCT in 2022.
The long-term nature of the BCT liabilities to non-residents and associated amortization schedule provide comfort that there is no near-term call from them on BCT's liquid foreign assets. However, the large overall stock of foreign currency liabilities of the CBT (c50% of the gross international reserves position) suggests that the build-up in gross Fx reserves pre-June 2021 moves was partly boosted by Fx borrowing, in our view.
News and Views
Mexico: Headline inflation reached 7.05% yoy, the highest since 2001.
Biweekly headline inflation in 1H November surprised to the upside at 0.69% (E. 0.51%, BofA 0.56%). Core inflation also surprised to the upside at 0.15% (E. 0.07%, BofA 0.11%). The surprise in core inflation is mostly explained by food merchandise at 0.28% (tortilla and beer) and other services at 0.42% (hotels and airfares). Non-core inflation was mostly driven by fruits and vegetables at 3.49% (green tomato) and energy prices at 3.32% (mostly due to the end of summer subsidy for electricity). On annual terms, headline inflation is now at 7.05% yoy up from 6.36% yoy, the highest since 2H April 2001, while core inflation is now at 5.53% yoy from 5.26% a fortnight ago, the highest since 2H April 2009.
- To follow: Inflation continues to surprise to the upside and Banxico will have to continue hiking. We have Banxico hiking in the next six meetings, 25bp on each one, to put the overnight rate target at 6.5%. The risk is that Banxico accelerates the pace. The other risk is the uncertainty regarding Banxico's next governor over inflation, growth and financial stability.