OREANDA-NEWS. Fitch Ratings has affirmed Lesotho's Long-term foreign and local currency Issuer Default Ratings (IDR) at 'BB-'and 'BB', respectively. The Outlooks are Stable. The Country Ceiling has been affirmed at 'A-' and the Short-term foreign currency IDR at 'B'.

KEY RATING DRIVERS
Lesotho's 'BB-' rating is supported by the local currency's peg against the South African rand, which has contributed to macroeconomic stability. GDP growth in the year to March 2016 (FY2015) is forecast to recover to 4.8%, above the 'BB' median, supported by improved political stability and infrastructure investment. Dependence on volatile South African Customs Union (SACU) revenues remains a weakness. Large government deposits at the central bank, equivalent to 23% of GDP in 2014/15, support Lesotho's official foreign reserves and ensure the country remains a net external creditor.

The political situation has normalised following the standoff in 2014. Following general elections held in February 2015, described as free and fair by independent observers, a new coalition led by Pakalitha Mosisili, of the Democratic Congress party, was formed. The challenge to ensure political stability will be maintaining working relations between political constituents, and also between the military and security forces. Fitch expects stability to prevail in the medium term, although Lesotho's history suggests that bouts of political instability remain possible, which could trigger new interventions by South Africa.

Fitch expects growth to increase to 4.8% in 2015 following a weak 2.5% in 2014, which reflected the political crisis. The agency expects the Liqhobong mine and construction of the Lesotho Highlands Water Project phase II to support growth in the medium term. Growth is expected to slow to 4% in 2016, due to a fall in SACU revenues. The largest component of GDP, government spending, relies on SACU revenues that are largely dependent on South African economic growth. Weak South African growth, due to long-term structural issues, remains the main risk to Lesotho's growth.

Fitch forecasts a fiscal deficit of 3.9% of GDP in FY16, up from an estimated 2.2% of GDP in FY15 as SACU revenues fall from 29.3% of GDP in FY15 to 26.1% of GDP in FY16 and both capex and wage expenditure, as a % of GDP, remain stable. The agency expects a much larger deficit of 7.3% of GDP in FY17 due to an expected sharp 20% drop in SACU revenues, as the latest South African budget documents suggest. Due to limited flexibility to reduce wages, Fitch expects the authorities to respond by cutting capital expenditure with the deficit partly financed by drawing down of government deposits.

Fitch forecasts the current account deficit will widen to 6.8% of GDP in 2015, from 4.5% of GDP in 2014, before widening further to 10.8% of GDP in 2016. Construction of the LHWP dam and water transfer component will continue to drive the deficit, together with weak South African growth. The LHWP component will be funded by South African funds with the rest of the deficit funded by government external borrowing. Remittances have been on a downward trajectory for the last decade with weak South African growth likely to mean this trend continues.

Fitch assumes the African Growth and Opportunity Act (AGOA), expiring September 2015, will be renewed. The policy is popular on both sides of the Atlantic. US congress is expected to vote on the renewal in 2H15. However, uncertainty is affecting investment at a time of increasing competition from producers in south-east Asia and limited demand from other markets to pick up the slack. Non-renewal would affect the macro outlook, public finances and external accounts, placing negative pressure on the rating.

RATING SENSITIVITIES
The Stable Outlook reflects Fitch's assessment that upside and downside risks to the rating are currently well-balanced. The main factors that individually or collectively might lead to rating action are as follows:

Negative:
- Renewed political turmoil could lead to negative rating pressure if it affects macro stability, GDP growth and potentially external financial support from the international community.
- Deterioration in the budget balance due to pressure from non-capital spending and/or a SACU revenue shock, leading to a material weakening of debt ratios and an erosion of government deposits.
- Deterioration in the current account balance due to a fall in SACU revenues leading to a decline in foreign reserves.

Positive:
-Sustained high GDP growth, supported by an improvement in the business environment and political stability and favouring diversification in the economy.
- Further progress in diversifying the revenue base and growing tax receipts that lessen the dependence on SACU revenues.

KEY ASSUMPTIONS
Fitch assumes that economic growth in Lesotho will be supported by a gradual recovery in its key economic partners, namely the US, Europe and South Africa.

Fitch assumes there will be no major revision to the SACU revenue-sharing formula that could negatively affect SACU revenues to Lesotho. Fitch also assumes the AGOA will be renewed in 2015.