May 18 (SeeNews) - Fitch Ratings said it has revised the outlook on North Macedonia's long-term issuer default ratings (IDR) to negative from stable.
The IDRs have been affirmed at 'BB+', Fitch Ratings said in a statement on Friday.
Fitch also said in the statement:
"KEY RATING DRIVERS
The revision of the Outlook reflects the following key rating drivers and their relative weights:
HIGH
Fitch forecasts the North Macedonian economy contracts by 4.2% in 2020 (a downward revision of 7.7pp since our last review six months ago) following growth of 3.6% in 2019. This is driven by the impact of lockdown measures on domestic demand, the sharp fall in eurozone demand and disruption to supply chains particularly in the auto sector. Some support is provided by moderate fiscal stimulus, the benefits of lower energy prices, the capacity of the banking sector to continue lending, and scope for further monetary policy easing. We project GDP growth of 5.1% in 2021 (1.8pp higher than our previous forecast) due to some investment catch-up, and revival of private consumption and external demand. There are sizeable downside risks to our forecasts, and to the external demand that has underpinned Macedonia's FDI-driven economic model, should the COVID-19 pandemic not be contained in 2H20 in line with Fitch's current baseline assumption.
The general government deficit is set to widen sharply this year, to a forecast 6.6% of GDP from 2.1% in 2019. The announced fiscal response totals 1.8% of projected GDP, around 60% of which is wage subsidies (at the level of the minimum wage). Other measures include covering 50% of employer social security contributions, and corporate and income tax deferrals for three months. The government has announced offsetting expenditure cuts of 1.1% of GDP, which we assume will be greater due to under-execution of capital projects. The full economic support package is still being developed, including proposals to provide transfers that have greater reach to North Macedonia's large informal economy, and possible introduction of a credit guarantee scheme and extension of existing measures over a longer period. We forecast the general government deficit will narrow to 3.7% of GDP in 2021, in line with economic recovery and the unwinding of fiscal support, which is below the projected 'BB' median of 4.6% of GDP. However, there are downside risks and it may prove difficult to implement post-crisis consolidation measures that stabilise public debt.
North Macedonia faces a heavier debt repayment schedule of EUR837 million, including interest (7.7% of projected GDP) in 2020 and EUR836 million in 2021 (2019: EUR398 million), adding to financing needs. For 2020, the government intends to draw down available IFI financing of EUR316 million (IMF COVID-19 Rapid Financing Instrument facility, and World Bank) and EUR200 million of EU finance. Planned net domestic issuance totals a further EUR200 million (70% of which has already been executed) and the government is considering a Eurobond. Fitch assumes higher domestic issuance, and a 0.5pp drawdown of fiscal reserves to 4.3% of GDP, reflecting more difficult external financing conditions. There is also sizeable concessional financing available using World Bank MIGA guarantees available to North Macedonia.
Fitch forecasts general government debt will rise to 47.9% of GDP at end-2020, from 40.3% at end-2019, 6.9pp higher than at our previous forecast. Government guarantees of public entities total a further 8.6% of GDP (almost three-quarters of which are roads projects) but none of these have previously been called. General government debt is projected to stabilise in 2021, at 48.2% of GDP, below the projected 'BB' median of 56.3%. In our medium-term debt dynamics, which assume the primary deficit steadily recovers to the 2019 level of -0.9% of GDP by 2023, and GDP growth averages 3.6% in 2022-2024, debt edges down to 47.4% at end-2024. Fiscal discipline in recent years enhances confidence in a post-coronavirus fiscal adjustment but there is added policy risk due to this year's election. A higher share of North Macedonia's debt is FX-denominated than the 'BB' median (73%, versus 56%) but this is predominately in euros and the exchange rate risk is mitigated by the longevity and credibility of the exchange rate peg.
MEDIUM
External financing risks have increased somewhat due to challenging financing conditions and an expected reduction in net FDI inflows to 1.5% of GDP this year, from 2.5% in 2019 (and 5.6% in 2018). We forecast a 0.2pp increase in the current account deficit in 2020 to 3.0% of GDP, driven by weaker remittances, narrowing to 2.1% in 2021. The benefit of lower energy prices more than offsets the cost of the collapse of tourism (the net energy deficit has averaged 6.1% of GDP since 2015, compared with net tourism of 1.0%), and lower exports, FDI, and domestic demand will also contribute to a sharp fall in imports. There have been moderate balance of payments pressures since the beginning of March, with FX interventions totaling EUR115 million (3% of FX reserves). We forecast a further EUR200 million fall in FX reserves this year, but recovering next year to 4.4 months of current external payments, compared with the 'BB' median of 4.2 months. Net external debt is projected to increase from 22.1% of GDP in 2019 to 25.5% in 2021, which is in line with the peer group median of 25.4%.
North Macedonia's 'BB+' IDRs also reflect the following key rating drivers:
North Macedonia's governance, human development, and ease of doing business indicators compare favourably with the 'BB' medians, and there is a track record of coherent macroeconomic and financial policy, which underpins the longstanding exchange rate peg to the euro. The EU accession process helps to anchor policy and support exports and solid FDI inflows, albeit concentrated in Development Zones that are not well integrated with the rest of the economy. Set against these factors are the greater exposure of public debt to exchange rate risk than the peer group median, banking sector euroisation, and still-high structural unemployment, partly reflecting a large informal economy and skills mismatches, together with weak productivity growth.
The European Council decision in March to open EU accession negotiations, and NATO membership, which was agreed last year, have provided a boost to investor confidence and FDI prospects. It is a multi-year process, taking eight years to complete in the case of the previous EU accession country, and there has since been a general weakening in appetite for enlargement, which could translate into more stringent requirements to align standards. Solid public support in North Macedonia for EU membership and ongoing economic integration will help bind the process. The EU is likely to agree the detail of the negotiating framework in 2H20 and we anticipate the initial focus of reforms will remain on issues of rule of law in the judiciary and freedom of expression, tackling corruption, and improving public administration, and that the new government will continue to make steady progress.
The general election, which has been pushed back from April and is now expected in late June or early July, somewhat increases policy uncertainty. In the latest polls, the ruling centre-left SDSM has a narrow lead over the more nationalist centre-right VMRO-DPMNE and the outcome could depend on coalition agreements struck with pro ethnic-Albanian parties. Although the opposition has been critical of elements of the EU process, particularly on the Prespa Agreement name change, we anticipate a broad continuation of current policies on EU accession and macroeconomic management should they be elected. The election process will constrain implementation of new measures between the expiry of the COVID-19 State of Emergency (due on 16 May) and the formation of a new government (potentially around one month after the elections depending on coalition negotiations), which could impede the near-term policy response to the crisis.
The banking sector has sound credit fundamentals and is well placed to weather the coronavirus crisis and provide credit support. A majority of the sector is controlled by foreign-owned institutions, which also reduces contingent liability risk. The sector Tier 1 capital ratio was 14.8% at end-2019 and the NPL ratio has been broadly stable, at 5.0% in 1Q20. Profitability is relatively high, with a return on equity of 12.8% in 2019, helping to absorb credit losses, but we nevertheless expect a marked increase in the NPL ratio next year after recent regulatory forbearance measures (including lengthening the NPL classification from 90 to 150 days) are removed.
The coronavirus shock has had a moderate impact on bank deposits, which slowed to 0.1% month-on-month in March. The share of local-currency deposits in total deposits increased to 59.1% at end-March from 57.9% six months earlier but compares unfavourably with the 'BB' median of 75.2%. Banking sector liquidity is high, and the Central Bank has cut interest rates by 50bp since the beginning of March to 1.5% and reduced the amount of central bank bills auctioned but not the reserve requirements. Together with government measures to subsidise lending through the Development Bank of North Macedonia and a potential government credit guarantee scheme, this underpins our expectation for mildly positive credit growth for 2020 as a whole.
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.
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 did not adjust the output from the SRM to arrive at the final Long-Term Foreign-Currency IDR.
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.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to negative rating action/downgrade:
- Failure to put government debt/GDP on a downward trajectory over the medium term for example due to a more severe or prolonged recession, greater structural fiscal loosening, or crystallisation of contingent liabilities.
- 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.
- Adverse political developments that affect governance standards and the economy.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
- Greater confidence that general government debt/GDP will stabilise from next year, for example due to economic recovery and a post-coronavirus-shock fiscal consolidation.
- Further improvement in governance standards, reduction in political and policy risk, and progress towards EU accession.
- An improvement in medium-term growth prospects, for example through implementation of structural economic reform measures.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Public Finance 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 https://www.fitchratings.com/site/re/10111579.
KEY ASSUMPTIONS
- Fitch assumes that the global economy develops in line with our Global Economic Outlook published on 22 April.
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 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(ies), either due to their nature or to the way in which they are being managed by the entity(ies). For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg."