SOVEREIGN AND SUPRANATIONAL ISSUER IN-DEPTH Government of Honduras – B1 stable 28 May 2018 Annual credit analysis OVERVIEW AND OUTLOOK The credit profile of Honduras (B1 stable) balances the economy's resilient growth and RATINGS improving fiscal profile against its small scale and very low GDP per capita, weak institutions Honduras and high proportion of foreign currency debt. The economy exceeded 3.5% annual growth Foreign Local Currency Currency over the last three years, benefiting from strong remittances flows and public investment Gov. Bond Rating B1/STA B1/STA projects. Over the same period, the fiscal framework improved significantly as the authorities Country Ceiling Ba2 Ba2 implemented significant institutional enhancements to increase discipline in the budgeting Bank Deposit Ceiling B2 Ba2 process, tighten controls on expenditures and improve tax administration. TABLE OF CONTENTS Credit challenges include very low national income measured by GDP per capita in PPP terms OVERVIEW AND OUTLOOK 1 of $5,562 in 2017, which is lower than the B median of $9,456 and the lowest level in Latin CREDIT PROFILE 2 America, as well as very weak Worldwide Governance Indicator rankings, particularly for Economic strength: Low (+) 2 Rule of Law and Government Effectiveness. Over 70% of the government's debt is in foreign Institutional strength: Very Low (+) 6 Fiscal strength: Moderate (-) 9 currency exposing the government's balance sheet to currency fluctuations. Susceptibility to event risk: Moderate Upward pressure on the credit profile could be considered if continued fiscal consolidation (-) 13 Rating range 18 supports a significant and sustained drop in debt ratios. Successful implementation of Comparatives 19 increased public investment that supports higher growth, which in turn supports fiscal DATA, CHARTS AND REFERENCES 20 improvements could also lead to a positive rating action. Conversely, negative pressure could result if future policy behavior is not consistent with Contacts newly created institutional arrangements, thus preventing additional progress on fiscal Gabriel Torres +1.212.553.3769 consolidation and stalling the positive trends observed in recent years. VP-Sr Credit Officer [email protected] This credit analysis elaborates on Honduras’ credit profile in terms of economic strength, institutional strength, fiscal strength and susceptibility to event risk, which are the four main Calyn Gelinas +1.212.553.5195 Associate Analyst analytic factors in Moody’s Sovereign Bond Rating Methodology. [email protected] Mauro Leos +1.212.553.1947 Associate Managing Director [email protected] CLIENT SERVICES Americas 1-212-553-1653 Asia Pacific 852-3551-3077 Japan 81-3-5408-4100 EMEA 44-20-7772-5454 MOODY'S INVESTORS SERVICE SOVEREIGN AND SUPRANATIONAL CREDIT PROFILE Our determination of a sovereign’s government bond rating is based on the consideration of four rating factors: economic strength, institutional strength, fiscal strength and susceptibility to event risk. When a direct and imminent threat becomes a constraint, that can only lower the preliminary rating range. For more information please see our Sovereign Bond Rating Methodology. Economic strength: Low (+) Factor 1: Overall score Scale VH+ VH VH- H+ H H- M+ M M- L+ L L- VL+ VL VL- + Final - Factor 1: Sub-scores Honduras Low (+) Score for Honduras Median of countries with B1 rating SCALE OF THE GROWTH DYNAMICS ECONOMY NATIONAL INCOME weight 50% weight 25% weight 25% Average real GDP (% change) Volatility in real GDP growth (ppts) Global Competitiveness index Nominal GDP (US$ bn) GDP per capita (PPP, US$) VERY HIGH HIGH MODERATE LOW VERY LOW Economic strength evaluates the economic structure, primarily reflected in economic growth, the scale of the economy and wealth, as well as in structural factors that point to a country’s long-term economic robustness and shock-absorption capacity. Economic strength is adjusted in case excessive credit growth is present and the risks of a boom-bust cycle are building. This ‘credit boom’ adjustment factor can only lower the overall score of economic strength. Note: In case the Indicative and Final scores are the same, only the Final score will appear in the table above. We assess Honduras’ economic strength as “Low (+),” which balances the economy's resilient growth against its small scale and very low GDP per capita. Honduras' nominal GDP of $23 billion in 2017 is the median for “Low (+)” peers whereas 2017 GDP per capita (PPP) of $5,562 is below the “Low (+)” median of $9,826. Other sovereigns with the same score for economic strength include Albania (B1 stable), Armenia (B1 positive) and Bolivia (Ba3 stable). Exhibit 1 Peer comparison table factor 1: Economic strength Honduras L+ Median Albania Armenia Ethiopia Tanzania Montenegro Bolivia B1/STA B1/STA B1/POS B1/STA B1/NEG B1/STA Ba3/STA Final score L+ L+ L+ M- M- L L+ Indicative score L+ M- L+ M- M- L L- Nominal GDP (US$ bn) 21.6 21.6 11.9 10.6 70.4 47.7 4.4 33.9 GDP per capita (PPP, US$) 5,288.0 9,375.3 11,820.5 8,643.2 1,945.3 3,087.4 16,730.7 7,228.6 Average real GDP (% change) 3.7 3.7 2.9 4.5 9.0 6.7 2.6 4.6 Volatility in real GDP growth (ppts) 2.2 2.8 2.1 7.1 1.2 1.1 4.5 1.0 Global Competitiveness Index 3.9 3.9 4.2 4.2 3.8 3.7 4.2 3.5 Source: Moody's Investors Service Honduras' small, open economy remains highly dependent on the US Honduras is a small, open economy whose growth is derived from manufacturing (mostly maquila), agriculture and, more recently, financial intermediation and telecommunications. The economy relies on the US as its main source of remittances and its principal export destination. With a nominal GDP of $23 billion recorded last year, the economy is much smaller than the $75.6 billion economy 2 28 May 2018 Government of Honduras – B1 stable: Annual credit analysis MOODY'S INVESTORS SERVICE SOVEREIGN AND SUPRANATIONAL of Guatemala (Ba1 stable) but larger than the $13.8 billion economy of Nicaragua (B2 positive). Despite the resiliency shown over the last five years, real GDP growth has slowed relative to the period prior to the global financial crisis and the Honduran political upheaval in 2009. During the period 2004-08, real GDP growth averaged 5.9%, it contracted by 2.4% in 2009, and has now averaged 3.6% growth during the past five years (see Exhibit 2). Nevertheless, economic growth has remained solid in recent years despite being lower than the pre-crisis average, at around 4.1% annually between 2015-17. Real GDP grew a robust 4.8% in 2017, driven by public investment, a very strong coffee harvest that increased exports and record-breaking remittances flows that fueled private consumption. Relatively low oil prices and strong US economic performance were positive external tailwinds that also contributed to boosting growth. We forecast real GDP growth of 3.8% and 3.5% in 2018 and 2019, respectively, such that growth reverts to levels more in line with historical trends. All growth components positively contributed to the economy in 2017. Government consumption slowed significantly but was compensated by private consumption and more robust exports (see Exhibit 3). Private investment returned to positive growth of 3.1% after a substantial decline in 2016, which was attributable to a very high level of private capital formation recorded in 2015. Public investment grew 37.7% last year, following an increase in infrastructure spending, which will continue to support economic activity over the coming years. The government is currently executing its plan to invest $957 million (about 4% of GDP) in the 2015-20 period in roads, ports and airport projects. About 50% of the public investment program will be destined to highway and road projects. The infrastructure program will be partially financed by private investors using public private partnerships (PPP). Exhibit 2 Exhibit 3 Real GDP growth Real GDP growth by components (% yoy) (2016-17 yoy%) 7.0 6.2 2016 2017 6.0 50.0 4.8 5.0 4.2 4.1 40.0 3.7 3.8 3.8 3.8 3.75 4.0 3.5 3.1 2.8 30.0 3.0 20.0 2.0 1.0 10.0 0.0 0.0 -1.0 -10.0 -2.0 -20.0 -3.0 -2.4 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017E2018F 2019F Private Public Private Public Exports Consumption Consumption Investment Investment Sources: Haver Analytics; Central Bank of Honduras; Moody's Investors Service Sources: Haver Analytics, Central Bank of Honduras, Moody's Investors Service Domestic consumption has remained a key economic growth driver, bolstered by remittances coming from the US. Current remittances fell after the financial crisis in 2009 but have steadily recovered since 2012, growing at a five-year average of 8.3% year- over-year and reaching 18.7% of GDP in 2017 (see Exhibit 4). According to government estimates, remittances finance more than 20% of private consumption over a year. We expect remittances to continue to support domestic consumption in 2018-19 based on our expectation of strong US economic performance and also taking into consideration the delayed termination of Honduras' Temporary Protected Status that expires on 5 January 2020. 3 28 May 2018 Government of Honduras – B1 stable: Annual credit analysis MOODY'S INVESTORS SERVICE SOVEREIGN AND SUPRANATIONAL Exhibit 4 Workers’ current remittances (% of GDP) 25 21.3 20.9 20.2 20 18.7 17.4 17.8 16.9 16.5 16.7 17.0 15.8 15.6 15 10 5 0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Source: Central Bank of Honduras, Moody's Investors Service High poverty rate and low education levels hamper long-term growth prospects A high rate of poverty, low education levels and widespread crime hinder Honduras’ long-term growth outlook.