November 8 (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 and human development, as well as a credible and coherent macroeconomic and fiscal policy in line with 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 others, including the economy's small size and high exposure to exchange rate risk, for example due to the banking sector's euroisation and a high share of government debt denominated in foreign currency, and high structural unemployment, reflecting skill mismatches and a large informal economy," Fitch added.
The negative outlook reflects continued downside risks to growth, including the evolution of the pandemic, and path of public debt, together with uncertainty regarding the consistency of the government's fiscal consolidation strategy and growth targets in the context of the delayed approval of new fiscal rules.
Fitch also said in the statement:
"North Macedonia's ratings are supported by favourable governance and human development indicators relative to the 'BB' median, and a credible and coherent macroeconomic and financial policy mix consistent with 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 others, including the economy's small size and high exposure to exchange rate risk, for example due to the banking sector's euroisation and a high share of government debt denominated in foreign currency, and high structural unemployment, reflecting skill mismatches and a large informal economy.
The Negative Outlook reflects moderating but still material downside risks to the growth outlook, including the evolution of the pandemic, and path of public debt, together with uncertainty regarding the consistency of the government's fiscal consolidation strategy and growth targets in the context of the delayed approval of new fiscal rules.
Political uncertainty has recently increased due to the resignation of Prime Minister Zoran Zaev as head of government and leader of the governing SDSM party after significant losses in the second round of local elections. Parliament will consider the PM's resignation, and if accepted, move on with the formation of a new coalition government that has a narrow majority in parliament.
Although we do not expect a significant departure from long-standing economic policies and commitment to EU integration, the new coalition government will likely re-assess its policy priorities and its political space for reaching a negotiated solution to Bulgaria's EU accession veto given the new political scenario. Nevertheless, the main opposition party, VMRO-DPMNE, has called for early elections; the last elections were held in July and the next elections are not scheduled until 2024.
The dispute with Bulgaria (partly over the account of historical figures and of North Macedonia's language) continues to delay the agreement on the framework for EU negotiations and it is not clear when formal negotiations could start. Resolution remains dependent on Bulgarian domestic politics, but also on current political developments in North Macedonia. A protracted delay will not only likely lead to reduced reform momentum but could also weigh on support for EU accession.
Fitch forecasts that growth will reach 4.1% in 2021 and 4.3% in 2022 before easing to 3.9% in 2023, slightly above the projected 3.5% for the 'BB' median, as still favourable economic conditions in key export markets and host countries of overseas workers will benefit exports and remittances. Domestic credit availability, continued wage growth, albeit at a more moderate pace, and public investment will support domestic demand.
The still uncertain evolution of the pandemic in North Macedonia and key trading partners as well as global supply disruptions impacting the car industry, among others, could represent challenges to the recovery. The government has secured vaccine supply from a variety of sources but its vaccination campaign, as in many other countries in the region, has run against vaccination hesitancy. At the end of October, 38% of the target population was fully vaccinated.
We have not significantly upgraded our view on medium-term growth prospects based on the recently launched Growth Acceleration Plan (GAP). The impact of the plan will depend on sustained improvements in meeting public investment targets, the government's ability to crowd in private investment and the development of institutional capacity and coordination mechanisms to support timely, transparent and efficient execution of investment projects.
Although the government revised up its 2021 budget deficit to 6.5% of GDP (from 4.9%), we have only moderately increased our deficit forecast to 6.1% of GDP (from 5.8% in May) due to strong revenue growth and the expectation of some level of expenditure under-execution as in previous years. The government's 2022 budget proposal is in line with the 2022-2026 fiscal strategy, which projects the budget deficit declining to 4.3% and 3.5% of GDP in 2022-2023, before reaching 2.2% of GDP by 2026. The risks to the government strategy are derived from lower growth than the government's forecast (averaging 5.3% between 2022-2026) and failure to contain current spending.
We forecast the government deficit to decline to 5.0% of GDP in 2022 and 4.1% in 2023, above the 4.0% and 3.5% forecast for the 'BB' median. Our forecast assumes lower revenue growth in in line with our growth forecast, as well as under-execution in planned public investment. The government expects public investment to increase from 2.4% of GDP in 2020 to 6% by 2026, a challenging task despite the recent improvements in expenditure monitoring and execution.
The new organic budget law has yet to be approved by parliament. The adoption of the law could provide an anchor for fiscal consolidation through the introduction of a revamped fiscal framework including a formal fiscal rule and the formation of a fiscal council. Nevertheless, Fitch considers that its credibility will depend on its capacity to improve policy predictability (including the application of escape clauses), stabilise government debt over the medium term, and its consistency with the government's GAP.
Having risen by 10pp in 2020, the general government debt ratio will increase to 53% of GDP in 2021 and to 55.3% by 2023, close to the projected 'BB' median of 57%. Government guarantees account for a further 8.2% of GDP (the majority are road projects), none of which have previously been called. Although 76% of government debt is foreign-currency denominated, it is predominantly in euros (73% of total) and exchange rate risk is mitigated by the credibility of the exchange rate peg.
Near-term external risks are mitigated by improved international reserves levels, external financing availability and moderate current account deficits. We expect the current account deficit to equal 3.4% of GDP, as stronger domestic demand recovery and higher energy imports will be partly balanced by a strong export rebound and continued strength in remittances. The deficit will ease to 3% of GDP by 2023 and we expect net FDI to recover to 3.1% of GDP by 2022, fully financing the current account deficit.
International reserves reached EUR3.7 billion in September, and we forecast them to remain relatively stable in 2022-2023, maintaining adequate reserve coverage (average 4.7 months of CXP) although lower than peers (6.9 months). North Macedonia's external liquidity, measured by the ratio of the country's liquid external assets to its liquid external liabilities, forecast at 204% in 2022, is stronger than peers (173%) and risks are further mitigated by the extension of the EUR400 million repo facility with the ECB until March 2022.
Inflation has increased to 3.7% in September, while the National Bank of North Macedonia maintains an accommodative monetary stance with a policy rate at 1.25%. Monetary policy will likely remain accommodative in the absence of increased inflation expectations translating into increased FX demand in the local market. The 'de facto' peg to the euro remains well-entrenched.
The banking sector has maintained strong fundamentals despite the pandemic shock and the phasing out of financial sector relief measures. It is adequately capitalised (total capital ratio of 17.3% and common equity Tier 1 ratio of 15.9% at in mid-2021) and profitability (return on average equity of 12.6%) as well as low non-performing loans (3.4%), despite almost complete withdrawal of the payment moratorium. Deposit dollarisation remains relatively high at 42%, but the pandemic shock has not reversed the declining trend over the past decade.
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 53rd 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.
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.
- Structural: Adverse political developments that affect governance standards, the economy and EU accession progress.
- 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.
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.
- Structural: Further improvement in governance standards, reduction in political and policy risk, and progress towards EU accession
- Macro: An improvement in medium-term growth prospects, for example through implementation of structural economic reform measures.
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 Foreign-Currency (LT 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 SRM data and output, 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. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit [...].
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG CONSIDERATIONS
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 therefore highly relevant to the rating and a key rating driver with a high weight. As North Macedonia has a percentile rank above 50 for the respective Governance Indicator, this has a positive impact on the credit profile.
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. As North Macedonia has a percentile rank above 50 for the respective Governance Indicators, this has a positive impact on the credit profile.
North Macedonia has an ESG Relevance Score of '4[+]'for Human Rights and Political Freedoms as the Voice and Accountability pillar of the World Bank Governance Indicators is relevant to the rating and a rating driver. As North Macedonia has a percentile rank above 50 for the respective Governance Indicator, this has a positive impact on the credit profile.
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. As North Macedonia has track record of 20+ years without a restructuring of public debt and captured in our SRM variable, this has a positive impact on the credit profile.
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. For more information on Fitch's ESG Relevance Scores, visit [...]."