Sovereign Analysis /

Senegal: Notes from the 2022 IMF Annual Meetings

  • Senegal has been buffeted by a number of shocks, growth is lower, inflation higher

  • Fiscal policy is main concern amid soaring energy subsidies and slower plans for fiscal consolidation as debt rises

  • Presidential election in 2024 may impact decision making while IMF programme is coming to an end; downgrade to Hold

Senegal: Notes from the 2022 IMF Annual Meetings
Stuart Culverhouse
Stuart Culverhouse

Chief Economist & Head of Fixed Income Research

Tellimer Research
21 October 2022
Published byTellimer Research

We set out our thoughts on Senegal following our discussions with the IMF team during the recent IMF/World Bank Annual Meetings. We would like to thank IMF staff for their time. The views we set out here are our own. We downgrade our recommendation on Senegal's dollar bonds to Hold from Buy with a yield of 10.8% (price US$73.5) on the SENEGL 2033s and 11.6% (price US$60.8) on the SENEGL 2048s on a mid-price basis as of cob 20 October on Bloomberg.

Senegal’s IMF programme is coming to an end. The relatively short joint SBA/SCF, for a duration of only 18-months, was only approved in June 2021. The most recent review, the second, was approved in June (along with an augmentation of access under the programme, as well as the fifth review of the PCI dating back to 2019, and which has run in parallel, and – not uncoincidentally – is also due to expire at the end of the year). There is only one review left of the SBA/SCF (the third and final review), due by year-end. Discussions for the final review are planned for early November, we assume ahead of an anticipated board review in December.

But while performance at the time of the second review was broadly satisfactory, we think the IMF statement published on 6 October following the conclusion of the recent staff visit signals a different tone. Reading between the lines, we think it provides a clear warning to the authorities that they need to do more and act more quickly on the fiscal position at a time when conditions have become more challenging. What happens next therefore has taken on greater significance.

Yield on Senegal dollar bonds (%)

Real economy

The economy has been hit by multiple shocks, external and domestic, with Covid, the food and energy price shock, security issues around Senegal's borders, and ECOWAS sanctions on Mali (its main trading partner), as well as a heavy election calendar. The latter has seen mayoral elections in January this year and legislative elections in July – which led to unrest after a clampdown on the opposition and which saw President Macky Sall's ruling coalition narrowly come first but lose its majority – ahead of the big one, the next presidential election in 2024, under which President Sall may controversially be seeking a third term. All of which has hamstrung decision making and impacted policy making.

The IMF note that the impact of the war in Ukraine and higher commodity prices are taking their toll on the economy. The forecast for real GDP growth has been revised down from 5.0% to 4.7% this year, while inflation has been increased from 5.0% to 7.5% for this year (on an average basis). Inflation was 11.2% yoy in August, driven by food inflation, running at 17% yoy.

Next year, the economy will be boosted by hydrocarbons, with the expected onset of O&G production, with GDP growth forecast at 8.1% (and growth excl. hydrocarbons of 5-6%), while medium-term growth prospects look favourable (averaging 10% over 2023-24). Inflation is seen gradually falling over the medium term to 2-3%. Meanwhile the current account deficit is large, about 13% of GDP this year in the WEO, due to energy investment related imports, although this will fade in time and the external deficit will narrow to 5% over the medium term.

Going off the fiscal rails

But it is fiscal policy where the main concern lies as the government seeks to contain further slippage in the overall deficit in the face of “soaring energy subsidies”. The government remains committed to its revised deficit target of 6.2% of GDP for this year, as per its supplementary budget in May, which it revised up from 4.8% in its initial budget due to new spending needs. But while revenues have performed strongly, and have been boosted by one-off proceeds from an asset sale, the government has since been forced to cut investment spending to accommodate higher subsidies and higher spending on public sector wages in order to stick to the 6.2% target.

Still, even if it meets the revised target, that would make it three consecutive years of a fiscal deficit of 6% of GDP or more, as previous plans for fiscal consolidation have fallen by the wayside and post-pandemic fiscal laxity continues (not quite Ghana proportions, but still potentially a worrying trend if not tackled). This is in contrast to the budget discipline that was seen before the pandemic and the controlled fiscal loosening in the initial response to it.

Senegal's fiscal deficit (% of GDP)

Meanwhile, the programme targets a gradual narrowing in the fiscal deficit in 2023 to 4.5% of GDP, and to 3% by 2024, consistent with the WAEMU convergence criteria.

Energy subsidies (electricity and fuel) are now the key issue. They have increased significantly, we understand from around 1% of GDP in the initial 2022 budget allocation to now over 4% (about 20% of revenue). This is high compared to the region and crowds out investment. Moreover, while one might argue this is temporary and will be reversed if fuel prices fell (ie if the war in Ukraine ends tomorrow and/or due to the global slowdown), therefore "solving" the fiscal problem, the overall deficit may not drop 1:1 with a decline in the subsidy bill if other spending is increased in response.

Hence, the IMF encourages the authorities to phase out energy subsides, eliminate costly tax exemptions and implement a medium-term revenue strategy. However, we haven't been able to quantify the expected fiscal gains from these measures.

Yet, tellingly, the IMF noted in its press release – in unusually stark language, in our opinion – that fiscal consolidation efforts are insufficient; implying that the government needs to do more. This suggests to us that the 4.5% deficit target next year will be difficult to achieve, especially as we understand the government is seeking to loosen it to 5.5%, while the 3% target by 2024 therefore also looks unrealistic, too. A more gradual (slower) consolidation path therefore looks likely, especially with an election approaching, which could unsettle creditors and leave Senegal more exposed to external conditions.

And, as a result, the recent persistent and sizeable fiscal deficits have led to a sharp rise in public debt, which could begin to threaten debt sustainability. Public debt has increased over the last three years, from around 60% of GDP pre-Covid to 77% now (2022 WEO projection). Debt is, however, sustainable and assessed to be at moderate risk of debt distress, while maintaining an overall deficit of 3% of GDP, as per the medium term forecast in the WEO, is seen as enough to reduce the debt burden (which falls to 65% by 2027 in the baseline, although this may be achieved later if the projected fiscal consolidation ends up being more gradual than planned). In addition, the public debt ratio should fall as O&G comes on-stream because of the rise in the denominator.

However, we see the debt sustainability assessment as increasingly borderline as the margin between moderate and high risk has been eroded. This leaves little or no fiscal space, and any adverse shock will push them over.

Financing issues

Financing the deficit could also become harder. Senegal has relied on concessional financing from the official sector and the regional domestic market to meet most of its funding needs in recent years. However, the regional market could reach capacity limits and struggle to absorb greater issuance caused by expansionary policies across the region while borrowing costs rise as the regional central bank hikes rates. Meanwhile, prospects for eurobond issuance have dimmed as Senegal faces yields of c10% on existing dollar bonds.

As for the official sector, Senegal has a strong relationship with the World Bank, and usually has good standing with bilaterals. However, European aid for Ukraine may mean less for others, while the energy crisis and fiscal pressures may see a cut in Western aid budgets.

Indeed, in an environment of a more gradual fiscal consolidation, implying higher financing needs, with public debt at over 70% of GDP, and no IMF programme, and amid political uncertainty as elections approach, does that reduce MDB’s lending appetite?

Future IMF engagement

Much therefore rides on the government taking prompt action, in our view, in order to arrest adverse debt dynamics and reassure official creditors and investors, but while it may recognise the situation, there may be a question mark over its willingness and ability to do something about it, given its wafer-thin majority (now reliant on other parties and independents), while the less its incentive will be as we get closer to the election.

Moreover, with the IMF programme due to expire shortly, investors may be concerned whether the government will do enough if the Fund is no longer involved (and even if there is a new programme, the authorities will have to deliver, and implement it). However we understand the authorities have not yet expressed any interest in a successor arrangement. But the window to get a new programme will narrow the closer the election gets. Perhaps, instead, the authorities may seek a programme extension, taking them through next year and closer to the election.

We expect the Fund would like to see action taken in the next and final review; but it has little leverage as the current programme comes to an end and if there is no new programme or extension. Energy subsidies and the DSA would surely be the corner stone of any new programme.

But a new programme may present a political challenge for the government facing declining popularity. Senegal's current programme was approved under different circumstances, which was more due to regional policy coordination than its own BOP need (the joint SBA/SCF was only 140% of quota), and otherwise it could have graduated away from the Fund. But the macro situation and global context have changed.

That said, the other source of policy discipline is provided by the CFA-bloc currency union and the WAEMU, with the 3% deficit target providing a regional policy anchor, although there might also be calls across the region to relax this too, in the face of fiscal pressures emerging from higher global food and energy prices.

Investment conclusion

We downgrade our recommendation on Senegal's dollar bonds to Hold from Buy with a yield of 10.8% (price US$73.5) on the SENEGL 2033s and 11.6% (price US$60.8) on the SENEGL 2048s on a mid-price basis as of cob 20 October on Bloomberg.

The bonds have performed poorly this year, albeit broadly in line with the index, with prices down 30pts on the '33s ytd (and a total return in the index of -28% vs -26% for the Bloomberg EM Sovereign USD index), due to the impact of the war in Ukraine and the tightening in global financial conditions. The '33s have reversed nearly all their gains after the summer bounce, having fallen by c17pts and are now just 2pts off their post-issue low in mid-July (and are 15pts below their Covid-low). The yield has risen 500bps this year. The longer duration '48s have fallen by c40pts this year, although at a cash price of US$60, may begin to look attractive.

We have previously been attracted to Senegal's (Ba3/B+/-) strong fundamentals, with high growth and policy discipline, reinforced by its CFA membership, which – coming into the pandemic – helped it (along with Cote d'Ivoire and Benin) weather the shock better than many other frontiers, giving it a safe haven status. Investors have probably also welcomed the closer IMF engagement in recent years, through the PCI (2019), RCF/RFI (2020) and joint SBA/SCF (2021), with both the financing and policy discipline it has provided, during what has been a turbulent time, and may prefer that this continues (although it is not clear it will).

However, despite the onset of O&G production, given the rise in public debt and question marks about the willingness and ability to deliver an effective fiscal consolidation we turn cautious pending better visibility on the fiscal policy outlook ahead of the presidential election and future engagement with the Fund. That said, the debt service profile on bonded debt remains favourable, with no substantive amortisation until 2028 (the '24s are now only US$163mn outstanding), while a strong reserves position, in the context of the regional central bank's pooled official reserves, and a deep regional domestic market provide credit positives.

Price of Senegal dollar bonds (US$)