Credit Profile and Rating Migration of Diamond Industry in Africa

Prepared By:PRANITA MEHTA

Roll No. 962

Credit Rating

Definition of 'Credit Rating'

An assessment of the credit worthiness of a borrower in general terms or with respect to a particular debt or financial obligation. A credit rating can be assigned to any entity that seeks to borrow money – an individual, corporation, state or provincial authority, or sovereign government. Credit assessment and evaluation for companies and governments is generally done by a credit rating agency such as Standard & Poor’s or Moody’s. These rating agencies are paid by the entity that is seeking a credit rating for itself or for one of its debt issues. For individuals, credit ratings are derived from the credit history maintained by credit-reporting agencies such as Equifax, Experian and TransUnion.

• Credit rating agencies typically assign letter grades to indicate ratings. Standard & Poor’s, for instance, has a credit rating scale ranging from AAA (excellent) and AA+ all the way to C and D. A debt instrument with a rating below BBB- is considered to be speculative grade or a junk bond. Credit rating changes can have a significant impact on financial markets. A prime example of this effect is the adverse market reaction to the credit rating downgrade of the U.S. federal government by Standard & Poor’s on August 5, 2011. Global equity markets plunged for weeks following the downgrade.

Diamond Industry in Africa

• Among all the major natural resources on earth, diamonds have often been considered the most mysterious.

• For centuries they have been prized for their extraordinary brilliance and hardness. Battles have been fought over diamonds, fortunes have been won and lost.

• A third of the country's gross domestic product (GDP) flows from diamonds, and the gemstones account for 80 percent of all export earnings and about 39 percent of public revenue.

• "For our people, every diamond purchase represents food on the table, better living conditions, better healthcare, potable and safe drinking water, more roads to connect our remote communities, and much more."

BOTSWANA

• WITH A TRACK RECORD OF sound macroeconomic policies, good governance, reliable institutions and political stability, Botswana remains one of the top performing economies in Africa.

• The country has managed its diamond wealth efficiently, in stark contrast to the widely cited cases of natural resource curse experienced by many developing countries.

• Largest exporter of diamonds• Botswana also has the reputation of being the least

corrupt country in Africa and has the highest sovereign credit rating on the continent.

Map of Botswana’s diamond mines

Botswana’s Credit Profile by Moody’s

• Moody's notes that Botswana's key credit strengths include the government's robust balance sheet, as highlighted by its fiscal surplus of around 1% of GDP in 2012 (compared with a deficit of -12.3% in 2009) and its low debt levels of around 18.5% of GDP in 2012. These results reflect the government's prudent approach to fiscal policy and the effectiveness of its consolidation measures to date

• Diamond-rich Botswana has so far managed to avoid Africa's "resource curse" - a term for conflicts sparked or maintained by commodities - but is unlikely to escape the global recession unscathed.

The country relies heavily on diamonds for its development, but in tough economic times, deriving most of your revenue from a single resource can sour reputations. In March credit agencies downgraded Botswana's rating.

• Kristin Lindow, senior vice-president and regional credit officer for Africa at Moody's, a well-known international credit rating agency, said in a statement that Botswana's lower rating was a result of the current economic crisis representing a "serious risk for Botswana's diamond-dependent economy."

Botswana’s Credit Rating by Moody’s

• Botswana's A2 government bond rating by Moody’s• Moody's says that Botswana's heavy reliance on the

diamond industry is a key credit weakness. Despite the government's efforts to diversify the economy, the mining industry's share of gross value added remains high at around 20% in 2012, albeit down from 29% in the 2000s.

• As a result of this narrow economic base, the economy is highly susceptible to shocks, as reflected in the 7.8% contraction in GDP during the global financial crisis in 2009.

• Moody's notes that upward pressure on Botswana's A2 rating could develop as a result of a successful implementation of the economic diversification strategies over the medium term, coupled with the accumulation of an even larger net financial position.

• Moody's expects to see fiscal consolidation and economic diversification becoming more crucial to preserving the country's economic strength given that its diamond mine resources will begin to deplete in 2030.

• DTC Botswana announced a few days ago that it shall suspend its diamond projects from March 2 toMarch 13, 2009 to preserve employment and conserve cash. Debswana, the company jointly owned byBotswana’s government and diamond giant De Beers, recently announced the termination of its twoBotswana operations; Damtshaa and Orapa’s Plant 2 projects.

• Mining projects are not the only victims of this crisis. The job market has sustained a blow as well. In January DTC Botswana and sightholders announced that thousands of people might lose their jobs if diamond sales do not revive. Faced with the new circumstances, companies have cut down on diamond purchases and several sightholders refrained from participating in the November sight altogether. The company estimates that large scale dismissal of employees this year is inevitable.

• Furthermore, in December diamond giant De Beers decided to postpone the relocation of its aggregation from London to Botswana, due to the company’s forecast of extremely sluggish sales as a result of the liquidity crisis in the diamond market. Despite what the Botswana government described as its “shock,” De Beers did not reconsider its decision.

South Africa’s poor Performance• South Africa’s diamond sector is as shaken as Botswana’s. • De Beers recently declared its intention to dismiss around 3,500 of

its South African employees due to the weakening demand for luxury products. The company is in the process of formulating the terms and steps to be taken as part of the cutback in its South African operations.

• A few days ago South Africa announced the postponement of its diamond royalties’ policy to 2010. This decision is projected to generate assistance amounting to 1.8 million ZAR forSouth Africa’s diamond and gold industries, a step which could potentially reduce dismissals. This is part of the government’s efforts to help the domestic mining sector, which has been badly hit by plummeting prices, diminishing global demand and lack of liquidity.

Angola• Last year Angola was Africa’s third largest diamond producer,

with Botswana and South Africa ranked as first and second, respectively. Nevertheless, even Angola has seen better days. Alrosa, the Russian diamond giant and the largest foreign shareholder of the Catoca mine, recently announced that the production of the world’s fourth largest diamond mine will decrease this year due to the global financial crisis. Catoca’s other shareholders are Endiama - Angola’s national diamond company, the Israeli owned Daumonty and the Brazilian Odebrecht company.

• As a means to deal with the crisis, Angola’s Mining Minister Makenda Ambroise recently called on local diamond mining companies to cut the number of expatriates on their payroll.

• Endiama is reportedly on the lookout for partners in diamond explorations at 100 sites throughout the country. It aims to expand its diamond production from 9.7 million carats in 2007 to 10.5 million carats this year despite the global recession.

• Endiama is reportedly considering the relinquishment of its national Angolan diamond mining shares as part of the current reformulation of the country’s diamond regulations, a process which is expected to be finalized shortly.

Zimbabwe

• Zimbabwe has fared far worse than any of its neighbors. About a month ago the World Diamond Council (WDC) demanded an immediate examination of Zimbabwe’s diamond industry, following reports of violent incidents at the state’s diamond fields, diamond smuggling to other countries such as South Africa, and the use of income from illegal diamond sales to fund the regime of Robert Mugabe, Zimbabwe’s President. If these reports are verified, Zimbabwe risks the loss of its status as a legal diamond trader in accordance with the Kimberly Process. The country produces less that 0.4% of the world’s total diamonds although the volume of illegal diamond mining in its alluvial mines witnessed a sharp increase in 2008.

Diamond Offshore

• Diamond Offshore is a leader in offshore drilling, providing contract drilling services to the energy industry around the globe with a total fleet of 44 offshore drilling rigs, including five rigs under construction.

Conclusion

• Indeed, the major African diamond producing states are experiencing difficult times. Mining companies are withdrawing from projects, cutting down on production, sending workers home and thinking twice before entering new projects. While diamond mining companies are suffering the most from the industry’s current crisis, the African countries, where diamond mining constitutes the bulk of their income, are being forced to come to terms with a new and disturbing reality including the impact on the states themselves as well as on the immediate value of their natural resources.