Peer Comparison:

Infrastructure Development Holds The Key To Two African Sovereigns' Resource-Led Futures
Primary Credit Analyst: Gardner T Rusike, Johannesburg +27 (11) 214 1992; gardner.rusike@standardandpoors.com Secondary Contacts: Ravi Bhatia, London (44) 20-7176-7113; ravi.bhatia@standardandpoors.com Christian Esters, CFA, Frankfurt (49) 69-33-999-242; christian.esters@standardandpoors.com

Table Of Contents
Long-Term Benefits, Short-Term Vulnerabilities Weakening Fiscal Positions Triggered Recent Ratings Actions Continued Growth And Investments Should Lead To Steady Progress Over The Next 12 Months Related Criteria And Research

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Peer Comparison:

Infrastructure Development Holds The Key To Two African Sovereigns' Resource-Led Futures
The downgrade, earlier this year, of Uganda and Mozambique by Standard & Poor's Ratings Services throws into sharp relief the similarities that these sovereigns share. From a credit perspective, their common characteristics include relative political stability since the end of civil wars; weak institutional and governance strength; low GDP per capita (both less than $1,000); a dependence on donor funding, albeit to varying degrees; structural trade deficits; and significant infrastructure and development needs. What's more, the countries' economies are dominated by the size of their service sectors (trade, finance, tourism, transport, and communication) relative to GDP, and the size of their agriculture sectors in terms of both employment and exports. However, both countries are also going through transformative economic periods following the discovery of natural resources--oil in Uganda and coal and gas in Mozambique. Uganda discovered oil in 2006, while Mozambique, which is already producing and exporting coal, discovered gas reserves in 2011. Overview The discovery of oil, coal, and gas reserves is transforming the economies of Uganda and Mozambique. Both countries are developing their infrastructure to take advantage of these natural resources. Ongoing economic growth, coupled with infrastructure investments, should continue to support the creditworthiness of Uganda and Mozambique over the near term.

Mozambique started producing coal in 2010, but has only been exporting it in small quantities (less than 10 million tonnes per year) due to infrastructure bottlenecks. We understand that the country's gas reserves should come onstream from 2018. Uganda has mapped out a plan for utilizing its crude oil production, estimated to be at least 100,000 barrels per day, over next three years. This includes: power generation, which could commence within two to three years using existing power plants; the construction of a refinery for Uganda and the East African Community (EAC) region; and the construction of a pipeline from Uganda to Kenya for crude oil exports. Recognizing that they have infrastructure bottlenecks, both countries have fast-tracked their infrastructure development. Uganda is focusing on its transport and energy sectors. Road construction, upgrading, and maintenance are going ahead since most freight is transported by road. The country is also improving its power supply through the construction of two hydroelectric power plants--Bujagali (250 megawatt [MW] capacity), which came onstream in 2013, and Karuma (600 MW capacity), which is currently under construction. Mozambique, meanwhile, is improving its ports, rail, and road infrastructure. It is refurbishing the existing port of Beira and planning to build a port in Nacala along with a new railway line through the Nacala corridor to improve capacity and increase coal exports. These improvements are being undertaken by both private sector companies and the government. Other significant projects

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Peer Comparison: Infrastructure Development Holds The Key To Two African Sovereigns' Resource-Led Futures

in Mozambique include the Mozal aluminum smelter, Cahora Bassa hydroelectric plant, Sasol gas pipeline to South Africa, Vale and Benga coal mines, and liquefied natural gas projects of Anadarko and ENI.

Long-Term Benefits, Short-Term Vulnerabilities

While the aforementioned projects provide long-term benefits, they also lead to short-term vulnerabilities in the two sovereigns' fiscal and external accounts. Principally, the governments--alone, or in partnership with the private sector--have to pay for the infrastructure developments. In addition the developments themselves are import-intensive. Strong import growth has led the sovereigns to post weaker current account balances in recent years. Uganda's current account deficit, for example, is more than 10% of GDP (see chart 1). Oil accounts for about 20% of total imports, with capital and consumer goods making up the remainder. At the same time, there has been no significant uptick in exports. Exports have largely been agricultural, with coffee, tea, cotton, tobacco, flowers, and fish making up 65% of total exports. The trade and income deficits are partly offset by a surplus on Uganda's transfer account thanks to official development assistance and private remittances.
Chart 1

In Mozambique, the current account balances have weakened significantly since 2011 and we estimate that they will

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Peer Comparison: Infrastructure Development Holds The Key To Two African Sovereigns' Resource-Led Futures

average 35% of GDP over the medium term. Growth in imports has outpaced that for exports, which center on aluminum, coal, and agriculture. This surge in imports, however, reflects the huge projects in the coal and gas sectors, where large foreign direct investment (FDI) inflows are followed by imports of capital goods and services, the latter predominantly in the gas sector. It also partly reflects the still-limited domestic supply of goods and services. On service and income balances, receipts have benefited from investments in port and railway services related to large projects and the growth in tourism. However, this has been more than offset by project-related service imports and the increased repatriation of FDI profits. Mozambique's donor receipts partly offset the deficits in its trade, service, and income accounts. Nevertheless, a combination of these factors has led the current account deficit to widen to about 35% of GDP.

Weakening Fiscal Positions Triggered Recent Ratings Actions

We lowered to 'B/Stable' from 'B+/Negative' our long-term foreign and local currency sovereign credit ratings on Uganda and Mozambique in January and February 2014, respectively. Besides weak external positions, the two sovereigns have weakening fiscal positions, but for different reasons. For Uganda, we project fiscal deficits averaging 5.6% of GDP in 2014-2016, compared with an average of 3.4% in 2011-2013 (see chart 2). The higher fiscal deficits stem from a combination of the suspension of general budget support in late 2012 by donors and expenditure increases to meet some of the infrastructure needs in power and transport. In November 2012, donor grants to Uganda were suspended by several bilateral donors, including Germany, Ireland, the U.K., and some Scandinavian countries, pending a full investigation into allegations of the misappropriation of $20 million of donor support (see "Donor Grant Cuts To Rwanda, Uganda, And Mozambique Create Financial Uncertainty But May Prompt Move Toward Increased Self-Sufficiency," published Jan. 29, 2013, on RatingsDirect). As a result, budget grant support has declined to 10% of total revenue in 2013 from about 20% in 2009. We also estimate that gross general government debt will rise from 29% of GDP in 2013 to close to 35% in 2016. In addition, government expenditure in Uganda has increased, partly because a hydroelectric power project starting earlier than planned and partly because of the overall increase in capital spending over the medium term to support economic development around the nation's big projects. However, some of these projects are partly financed from the government's oil savings account, which reduces the extent of borrowing. Consequently, we now project fiscal deficits averaging 5.0% of GDP in 2014-2016, compared with 3.6% over 2010-2013. Higher fiscal deficits and faster-than-expected debt accumulation lay behind our downgrade of Mozambique. As chart 2 shows, Mozambique's fiscal deficit in 2014 is set to rise to more than 12% of GDP this year in our estimation, before moderating to about 6% in 2015 and 2016. Prior to 2013, Mozambique's fiscal funding needs were to a great extent covered by external concessional loans and grants from multilaterals and bilaterals. Although no donor grants were suspended in the past two years, the share of donor grants to total revenue has gradually declined to about 20% in 2013 from about 30% in 2010. On the expenditure side, the Mozambique government is increasing its spending on infrastructure, the wage bill, and maritime security and development, none of which were fully factored into earlier budgets. Thus we estimate that Mozambique's expenditure-to-GDP ratio will increase to 40% in 2014 from 34% in

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Peer Comparison: Infrastructure Development Holds The Key To Two African Sovereigns' Resource-Led Futures

2012.
Chart 2

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Peer Comparison: Infrastructure Development Holds The Key To Two African Sovereigns' Resource-Led Futures

Chart 3

In 2013, Mozambique issued a guarantee for external commercial borrowing in the international markets through its government agency, EMATUM. The guarantee was for up to $850 million to fund the building of a tuna fishing fleet and other marine-related activities. Mozambique did not factor the guarantee into its 2013 borrowing plan. We treat this borrowing as government borrowing and include it in our general government debt measure. Overall, Mozambique's gross general government debt levels as a percentage of GDP are high relative to peers--we estimate 47% of GDP in 2014 and 50% by 2017, compared with about 35% of GDP for Uganda (see chart 3). This debt is predominantly external and vulnerable to exchange rate risks. In addition, the country's expansionary fiscal stance leads to a much weaker fiscal position, with deficits averaging 8.8% of GDP over 2014-2017 compared with 5.0% over 2010-2013.

Continued Growth And Investments Should Lead To Steady Progress Over The Next 12 Months
Looking ahead, we've assigned stable outlooks to both Uganda and Mozambique, indicating that we currently do not foresee further changes within the next 12 months. Continued infrastructure investments and solid medium-term

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Peer Comparison: Infrastructure Development Holds The Key To Two African Sovereigns' Resource-Led Futures

growth prospects should support our 'B' ratings on Uganda, despite the risks arising from fiscal and external imbalances. Mozambique's high economic growth is supported by the huge investment projects in the mining and gas sectors. The completion of the ports and rail improvements could in our view lead to much higher coal exports in the medium term and, over time, should support the gradual narrowing of the country's current account deficit. In addition, both countries are receiving resource-related one-off revenues from intercompany sales of equity stakes, the proceeds of which are being saved for future infrastructure spending. For example, Uganda is in the process of establishing a Petroleum Fund, managed by the central bank, that will hold all tax-related receipts from the oil sector.

Related Criteria And Research

Mozambique Long-Term Rating Lowered To 'B' On High Debt Accumulation; 'B' Short-Term Rating Affirmed; Outlook Stable, Feb. 14, 2014 Uganda Long-Term Ratings Lowered To 'B' On Weakening Fiscal Position; Outlook Stable, Jan. 17, 2014 Donor Grant Cuts To Rwanda, Uganda, And Mozambique Create Financial Uncertainty But May Prompt Move Toward Increased Self-Sufficiency, Jan. 29, 2013
Under Standard & Poor's policies, only a Rating Committee can determine a Credit Rating Action (including a Credit Rating change, affirmation or withdrawal, Rating Outlook change, or CreditWatch action). This commentary and its subject matter have not been the subject of Rating Committee action and should not be interpreted as a change to, or affirmation of, a Credit Rating or Rating Outlook.

Additional Contact: SovereignEurope; SovereignEurope@standardandpoors.com

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