The rating is supported by the Balkan country’s low and stable debt-to-gross domestic product (GDP) ratio, prudent fiscal policy, stable revenue base, its external creditor position and a healthy banking sector, combined with its economy’s size, informality, lack of institutional recognition and risks from a tense relationship with Serbia, as well as diaspora reliance and a large structural trade deficit, Fitch said in a statement last week.
Fitch further elaborated:
Credible Fiscal Policy: Kosovo's general government deficit improved an estimated 0.4pp in 2023 to 0.3% of GDP, which compares favourably with the 'BB' median deficit of 3.1%. A 13% increase in tax revenues, helped by improved compliance, and a sharp rise in grant assistance, offset 13% expenditure growth including from a 33% surge in capex. The fiscal deficit recovered quickly from the pandemic shock, narrowing 6.6pp in 2021 to 1.2% of GDP and has gradually improved since. A record of strong compliance with national fiscal rules and the IMF stand-by arrangement, which the authorities plan to maintain as a precautionary programme, augments our confidence in fiscal policy.
Small Fiscal Deficits: Fitch forecasts general government deficits of 0.7% of GDP in 2024 and 0.9% in 2025, comfortably complying with Kosovo's fiscal rule deficit ceiling of 2% of GDP (excluding donor financed investment, and privatisation revenues). Concessional finance drove net external financing of EUR64 million in 2023, allowing for a sharp reduction in domestic financing. Fitch projects a further increase in concessional finance in 2024-2025, partly reflecting the availability of USD100 million of World Bank funds this year, and an initial payment from the EU Western Balkans Growth Plan. New external borrowing requires a two-third parliamentary majority, which typically has been secured.
Low and Stable Public Debt: General government debt (including guarantees) declined to 17.5% of GDP at end-2023 from 22.4% at end-2020, close to its pre-pandemic level and well below the 'BB' median of 53.1%. Fitch treats this debt as 100% foreign-currency denominated, consistent with Kosovo's adoption of the euro as its currency. However, the absence of pressure on the exchange rate regime mitigates currency risk on Kosovo's debt, around 95% of which is euro-denominated. We forecast public debt/GDP to end 2025 at 17.4%, and fiscal reserves (including Privatisation Agency holdings) to rise 0.1pp in 2024-2025 to 5.7% of GDP. Debt interest/revenue, at 1.5%, is well below the 'BB' median of 9.6%.
Ongoing Tensions with Serbia: We see weak prospects for a legally binding agreement with Serbia that leads to full normalisation of relations between the two countries. Relations have worsened over the last year, with violent protests in May 2023 around mayoral positions in northern Kosovo, an armed siege by ethic-Serb militants in September, and recent prohibition on the use of the Serbian dinar outside of the Kosovan banking sector. However, we view the risk of outright military conflict as low, given costs to EU finance and accession prospects, and ongoing NATO presence.
Limited Impact on Financing Sources: Progress has been made towards the lifting of punitive measures introduced by the EU in June that restrict funds from the Western Balkans Investment and Pre-Accession Frameworks. This includes reducing police presence in northern Kosovo and advancing new mayoral elections. We do not expect these measures to have a sizeable effect on overall availability of financing over our forecast horizon. Kosovo continues to pursue bilateral dialogues to address its lack of full international recognition, including by five EU countries.
Large Current Account (CA) Deficit: The CA deficit narrowed to 7.7% of GDP in 2023 from a 10-year high of 10.3% in 2022, on strong growth in remittances and services. Structurally large CA deficits have been fully met by diaspora-supported financial inflows and FDI (around 60% of which is into real estate) and international reserves were largely unchanged at USD1.26 billion in March 2024 from USD1.25 billion at end-2022. Fitch forecasts the CA to narrow to 6.9% of GDP in 2025 and international reserves to rise to 2.1 months of current external payments, from 1.9 months at end-2023, but still well below the 'BB' median of 4.4 months.
Net External Creditor Position: We project a slight improvement in Kosovo's net external creditor position to 11% of GDP at end-2025, which compares favourably with the peer group median of a debtor position of 17% of GDP. Vulnerability to a sharp fall in diaspora inflows is a risk, but we consider this unlikely given their relative stability over a long period, underpinned by expatriates' maintenance of strong social and economic ties with Kosovo. The Central Bank of Kosovo's (CBK) temporary EUR100 million repo line with the ECB has been extended to end-January 2025.
Inflation Falls to Target: Inflation fell to 2.3% in March 2024, from 12.1% at end-2022, driven by food and energy prices, with core inflation also slowing to 3.6% from 6.8%. Fitch projects inflation to average near 2.5% in 2024 and 2025, within the 2%-3% target. CBK estimates around 80% of inflation is imported, and its policy framework (of which reserve requirements are most prominent) has yet to be fully tested against a strong domestically-driven inflationary spike.
Diaspora-Fuelled GDP Growth: GDP growth moderated to 3.3% in 2023 from 4.3% in 2022, and a strong pandemic rebound of 10.7% in 2021. Fitch forecasts growth to average 4% in 2024-2025, slightly above the trend rate, fuelled by ongoing strong remittances and diaspora real-estate investment. A very young population (average age 30) supports labour demographics, but emigration of skilled workers weighs on growth, and there are structural challenges from a fairly low capital stock and a sizeable informal economy.
Steady Reform Progress: The administration of Prime Minister Kurti appears well-placed to serve a full term with elections due by March 2025. All structural benchmarks were met in the first review of the IMF SBA in November, and progress has been made on strengthening tax compliance, public investment management and the regulatory framework to boost investment in renewable energy. The administration continues to place a strong emphasis on reducing corruption but public sector administrative bottlenecks remain a key challenge to policy implementation.
Sound Banking Sector Fundamentals: The banking sector is well-capitalised, with Tier 1 capital at 13.9% of risk weighted assets at end-2023, has a high return on equity of 19.9%, and liquidity coverage ratio of 2.8. Eighty-four per cent of the sector (by assets) is foreign-owned, with EU banks accounting for just over half, supporting prudential standards. The NPL ratio fell further to 1.9% at end-2023 and is fully provisioned. Nominal credit growth averaged nearly 15% over the last two years, and there has been only a partial pass-through from ECB policy hikes to deposit and lending rates.
ESG - Governance: Kosovo 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, respectively. Theses scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model (SRM). Kosovo has a medium WBGI ranking at the 42nd percentile, broadly in line with the 'BB' median of 44. This reflects a moderate level rights for participation in the political process, moderate institutional capacity, established rule of law, a moderate level of corruption and political risks associated with relations with Serbia.
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
- Structural: Escalation of tensions with Serbia that have a materially negative impact on macro-fiscal metrics
- External Finances: A marked increase in external financing risk, for example due to a sizeable drop in the availability of external concessional financing, remittances, or FDI
- Public Finances: Deterioration in debt interest/revenue, the availability of finance, or the fiscal balance - for example due to marked fiscal loosening, an economic shock, or greater funding stress potentially due to political gridlock in securing the two-thirds parliamentary approval required for external borrowing
Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade
- Structural: Sustained improvement in relations with Serbia, reducing political risks, and underpinning faster international recognition and integration with EU economies
- External: Reduction in external finance risk, for example due to a marked rise in international reserves, potentially reflecting stronger and more diversified capital inflows and further progress with structural reforms boosting trade competitiveness
- Macro: Evidence of an increase in trend GDP growth, potentially supported by faster economic diversification, leading to greater income convergence with higher-rated peers
SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)
Fitch's proprietary SRM assigns Kosovo a score equivalent to a rating of 'BB' on the LTFC 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:
- Structural: -1 notch, to reflect risks from unresolved tensions with Serbia, which also constrain full international recognition, adding to political risk and adversely affecting the business environment.
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 LTFC 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.
The Country Ceiling for Kosovo is 'BBB-', three notches above the LTFC IDR. This reflects very strong constraints and incentives, relative to the IDR, against capital or exchange controls being imposed that would prevent or significantly impede the private sector from converting local currency into foreign currency and transferring the proceeds to non-resident creditors to service debt payments.
Fitch's Country Ceiling Model produced a starting point uplift of +3 notches above the IDR. Fitch's rating committee did not apply a qualitative adjustment to the model result.
