May 10 (SeeNews) - Fitch Ratings said it has affirmed North Macedonia's long-term issuer default ratings (IDR) at 'BB+ with a negative outlook.
The rating reflects the country's favourable governance, human development, and ease of doing business indicators, backed by a track record of coherent macroeconomic and fiscal policy that underpins the longstanding exchange rate peg to the euro, the global ratings agency said in a statement on Friday.
"The EU accession process helps to anchor policy and support exports and FDI inflows. These factors are balanced against high exposure of public debt to exchange rate risk, banking sector euroisation and high structural unemployment, reflecting skill mismatches and a large informal economy," Fitch added.
The negative outlook reflects continued downside risks to near-term growth and public finances from the coronavirus pandemic as the number of Covid-19 cases remain high and the vaccination campaign has faced delays.
Fitc also said in the statement:
"KEY RATING DRIVERS
North Macedonia's ratings are supported by favourable governance, human development, and ease of doing business indicators, and a track record of coherent macroeconomic and fiscal policy that underpins the longstanding exchange rate peg to the euro. The EU accession process helps to anchor policy and support exports and FDI inflows. These factors are balanced against high exposure of public debt to exchange rate risk, banking sector euroisation and high structural unemployment, reflecting skill mismatches and a large informal economy.
The Negative Outlook reflects continued downside risks to near-term growth and public finances from the coronavirus pandemic. The number of new cases in the country remains high and the vaccination campaign has faced delays (3% of the population vaccinated at end-April) due to global supply constraints, which could weigh on the economy's recovery. The potential need for additional fiscal support measures and lack of detail regarding the government's fiscal consolidation plans create risks to our fiscal baseline and the medium-term stabilisation of government debt.
Although restrictions remained in place in the first months of 2021 due to the high number of Covid-19 cases, we forecast growth to reach 3.9% in 2021 and 4.3% in 2022, after a 4.4% contraction in 2020 and close to the forecast for the 'BB' median, reflecting a negative output gap, recovering domestic demand and exports. The growth outlook remains dependent on the evolution of the pandemic in North Macedonia and key export markets.
The general government deficit rose to 8.2% of GDP in 2020 due to revenue underperformance and four anti-crisis packages worth USD1 billion (9% of GDP), including social transfers, wage support mechanisms and tax relief measures. Fitch forecasts the general government deficit will decline to 5.8% of GDP, higher than the 2021 budget of 4.9% and the 5.2% median forecast for 'BB' peers, assuming implementation of two additional support packages worth 1.6% of GDP.
We expect fiscal consolidation to continue in 2022, with a deficit of 4.7% of GDP, largely based on our expectation of withdrawal of anti-crisis spending and revenue growth supported by the economic recovery. The government is preparing the 2022-2026 fiscal strategy. The previous plan (2021-2025) targeted deficits falling below 3% by 2024, although this was partly supported by optimistic growth assumptions.
A new budget law under discussion in parliament aims to introduce a revamped fiscal framework including a formal fiscal rule and the formation of a fiscal council. The adoption of the rule could provide an anchor for fiscal consolidation, but Fitch considers that its credibility will depend on its capacity to improve policy predictability, stabilise government debt over the medium term, and its consistency with the government's announced Growth Acceleration Plan.
General government debt rose by 9.5pp to 51.2% of GDP in 2020, below the estimated 'BB' median of 59%. Government guarantees account for a further 8.6% of GDP (the majority are road projects), none of which have previously been called. Under our baseline scenario, we forecast debt to increase to 54% by 2022, still lower than the forecast 59% 'BB' median. Although 76% of government debt is foreign currency denominated, it is predominantly in euros (69% of total) and exchange rate risk is mitigated by the credibility of the exchange rate peg.
Near-term financing risks are manageable in 2021-2022. The sovereign returned to international markets in March with a EUR700 million issuance at historically low rates to repay its EUR500 million July amortisation. The next external market amortisation is in 2023. The local market has accommodated increased government issuance (net 3.2% of GDP in 2020) and we expect local liquidity conditions to continue to provide some flexibility. The Treasury cash buffer stood at EUR237 million (2.2% of GDP) at end-2020.
Improved international reserves levels, external financing availability and low current account deficits, declining to 3% of GDP in 2021-2022, mitigate near-term external risks. International reserves rose to EUR3.4 billion in 2020 and we forecast these will remain stable, averaging EUR3.5 billion in 2021-2022, maintaining adequate reserve coverage (4.7 months of CXP in 2022 in line with the peer group median of 4.8 months). External liquidity risks are further mitigated by the extension of the EUR400 million repo facility with the ECB until March 2022.
We expect net FDI to recover to 3.1% of GDP by 2022, fully financing the current account deficit. North Macedonia's competitive labour costs (despite rising real wages) and government policies aimed at attracting investment and progress in the negotiation towards EU accession could also favour foreign investment prospects.
The National Bank of North Macedonia (NBRNM) has eased policy rates by 75bp since March 2020 and provided additional liquidity to the economy to support resilient credit growth (4.7% in 2020). The stability of the exchange rate peg and gradual domestic demand recovery will allow the central bank to maintain an accommodative policy stance. Banks have maintained adequate capitalisation (16.7% at end-2020) and profitability (11.3% return on equity). Asset quality has yet to reflect the impact of the crisis, as non-performing loans (NPL) declined to 3.3% in February 2021. NPL provisions remain high (73.2%) and the NBRNM has advised banks to temporarily delay dividend payments. The share of foreign currency deposits has been stable (42% at end-2020) but remains higher than peers.
The dispute with Bulgaria (partly over the account of historical figures and of North Macedonia's language) continues to delay agreement on the framework for EU negotiations and the resolution remains partly dependent on the Bulgaria's domestic politics. We still expect North Macedonia to formally start the negotiation process for full-membership, but we anticipate full accession will take a minimum of the eight years it took the previous EU accession country.
ESG - Governance: North Macedonia has an ESG Relevance Score of '5' for both Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption, as is the case for all sovereigns. These scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model. North Macedonia has a medium WBGI ranking, at the 50th percentile, reflecting a moderate level of rights for participation in the political process, moderate institutional capacity, established rule of law and a moderate level of corruption.
North Macedonia has an ESG Relevance Score of '5' for Political Stability and Rights as World Bank Governance Indicators have the highest weight in Fitch's SRM and are highly relevant to the rating and a key rating driver with a high weight.
North Macedonia has an ESG Relevance Score of '5' for Rule of Law, Institutional & Regulatory Quality and Control of Corruption as World Bank Governance Indicators have the highest weight in Fitch's SRM and are therefore highly relevant to the rating and are a key rating driver with a high weight.
North Macedonia has an ESG Relevance Score of '4' for Human Rights and Political Freedoms as voice and accountability is reflected in the World Bank Governance Indicators that have the highest weight in the Sovereign Rating Model (SRM). They are relevant to the rating and a rating driver.
North Macedonia has an ESG Relevance Score of '4' for Creditor Rights as willingness to service and repay debt is relevant to the rating and is a rating driver for North Macedonia, as for all sovereigns.
Except for the matters discussed above, the highest level of ESG credit relevance, if present, is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or to the way in which they are being managed by the entity.
RATING SENSITIVITIES
FACTORS THAT COULD, INDIVIDUALLY OR COLLECTIVELY, LEAD TO NEGATIVE RATING ACTION/DOWNGRADE:
-Public Finances: Materially higher than forecast general government debt/GDP over the medium term, for example due to a weak economic recovery or greater structural fiscal loosening.
-External Finances: An increase in external vulnerabilities, for example due to a larger widening of the current account deficit net of FDI exerting pressure on foreign currency reserves and/or the currency peg against the euro.
-Structural: Adverse political developments that affect governance standards and the economy.
FACTORS THAT COULD, INDIVIDUALLY OR COLLECTIVELY, LEAD TO POSITIVE RATING ACTION/UPGRADE:
- Public Finances: Greater confidence that general government debt/GDP will stabilise in the medium term, for example due to economic recovery and post-coronavirus-shock fiscal consolidation.
-Macro: An improvement in medium-term growth prospects, for example through implementation of structural economic reform measures.
- Structural: Further improvement in governance standards, reduction in political and policy risk, and progress towards EU accession.
SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)
Fitch's proprietary SRM assigns North Macedonia a score equivalent to a rating of 'BB' on the Long-Term FC IDR scale.
Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows:
- Macro: +1 notch: the positive notch adjustment offsets the deterioration in the SRM output driven by the pandemic shock, including from the growth volatility variable. The deterioration of the GDP growth and volatility variables reflects a very substantial and unprecedented exogenous shock that has hit the vast majority of sovereigns, and Fitch currently believes that North Macedonia has the capacity to absorb it without lasting effects on its long-term macroeconomic stability.
Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance."