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S&P cuts Albania's long-term ratings to B, outlook negative

TIRANA (Albania), December 6 (SeeNews) - Standard & Poor's Ratings Services said on Friday it has lowered its long-term foreign and local currency sovereign credit ratings on Albania to B from B+ while affirming the country's short-term ratings at B.

The outlook on the rating is negative, Standard & Poor's said in a statement.

The ratings agency also said in the statement:

"RATIONALE

The rating action follows a significant unanticipated increase in the general government debt burden. We now expect this to reach nearly 67% of GDP in 2013 (or 66% of GDP on a net basis), where previously we projected general government debt at 58% of GDP at year's end, a large and unexpected deviation. Important in this increase is the recent recognition of arrears worth an estimated 4% of GDP. The general government deficit has also widened significantly in 2013. The ratings remain constrained by low GDP per capita estimated at $4,000 and significant structural difficulties related to weak institutions and governance (in particular, weak rule of law and high levels of corruption). The ratings are supported by significant future growth potential, underpinned by Albania's ongoing efforts toward EU integration.

The negative outlook reflects the risk that Albania may struggle to continue to roll over its expanded debt stock at sustainable rates.

After winning the June 2013 parliamentary elections, the Alliance for a European Albania, a coalition led by the Socialist Party, took office in September. We expect the new administration will pursue electoral, judicial, parliamentary, and public administration reforms. These reforms would help Albania satisfy the conditions of EU candidate status, possibly by the end of this year or in early 2014.

However, Albania's public finances deteriorated markedly during 2013, partly linked to the expansionary fiscal policy ahead of the elections. We now expect the general government deficit to rise to 6.5% of GDP in 2013 from 3.5% in 2012, based on poorer growth performance than expected, a statistical revision to GDP and, crucially, the recognition of a stock of arrears currently estimated at 4% of GDP. Of the arrears, 30% relate to unpaid value-added tax (VAT) reimbursements and the rest to unpaid infrastructure bills, likely relating to road construction. It is unclear how long these arrears took to build up but we have added them into our debt estimates. Clearing the arrears is a priority for the new authorities and financing them could become part of an official assistance program.

In our view, the bulk of the increase in the 2013 deficit stems from decisions related to the electoral cycle. In the run up to the June 2013 elections, the government increased current expenditures (personnel-related expenditure increased by 3%) and collected less tax (there was an 8% decline in VAT collection). Data for January to October show that total year-on-year revenues fell by 3% and total expenditures rose by about 7%.

During the election campaign, uncertainty regarding the security of public sector employment and changes to the business environment discouraged investment and consumption, which had a knock-on effect on the related tax revenues. We have assumed that the underlying deficit will narrow to close to 3% of GDP in 2014 as tax collection resumes its normal, albeit low, pattern and the government implements expenditure cuts, including likely cuts to public sector pay and headcount. However, we also include the clearance of arrears worth 2% of GDP per year in our estimates for 2014 and 2015 and therefore expect the average deficit to be closer to 4% of GDP over the next three years.

As a result, we predict that general government debt will increase to an estimated 67% of GDP in 2013; our previous estimate was 58% of GDP. We expect the government's net debt burden to total 66% of GDP, and anticipate that general government interest payments will average over 14% of revenues over the next three years.

Over 40% of the money the government owes is due to nonresidents. Although its average debt maturity has increased, it remains short at 510 days (up from 386 at the end of 2012). In 2014, debt redemptions total approximately 22% of GDP. Approximately 20% of the government's debt stock is concessional debt from multilateral creditors. However, Albania's domestic debt comprises about 60% of total debt, and its banking system holds most of the domestic debt. Over 30% of loans in the banking system are to the government. Domestic banks that have traditionally lent to the government have been gradually reducing their exposures since the 2008 crisis, despite having excess liquidity.

We therefore view rollover risk as high and expect that further appetite for government paper at sustainable prices would be limited without official financial assistance from an international organization. A bespoke retail off-balance-sheet fund has played an important role in absorbing government debt through 2013, although we consider the fund unlikely to increase its exposure to the government further.

Real GDP growth over 2012 and 2013 has slowed to the lowest rates in over a decade, and is expected to be 1.2% in 2013. Official historical assumptions on energy subsidies have also lowered previous GDP levels by approximately 16 billion lek or 1% from 2011. Since 2008, remittances from Albanians living in Italy and Greece have fallen to a still-significant 6%-7% of GDP from 12%-13%. Although the country has become less dependent on remittance-funded consumption, we expect lower remittances to limit consumption growth and import demand.

Weak enforcement of contract rights and high levels of corruption have long been a significant structural barrier to investment that might lead to stronger domestic demand. Growth is also impaired by a lack of credit, as arrears have weakened banks' asset quality. Although we anticipate that net exports will support growth, real GDP growth is likely to average around 2.5% between 2013 and 2016, compared to estimated potential growth of 4%.

Up to a quarter of nonperforming loans (NPLs) in the banking system are estimated to be related to the government's recently recognized arrears. Removing these NPLs could reduce the strain on the businesses affected, particularly those in the construction sector, and boost confidence. In turn, this could lead to the resumption of credit growth.

We forecast that the financial sector will retain its small net external creditor position over the medium term. The banking system is largely funded by domestic deposits; we estimate loans to deposits at about 60%, and capital adequacy at about 17%. Over 50% of loans and deposits are denominated in foreign currency, a characteristic which we see as reducing monetary flexibility. The high level of NPLs (about 24% of total loans) in the system could also constrain economic growth. Although the Albanian subsidiaries of Greek parent banks appear well-capitalized, their external funding positions could weaken in future.

OUTLOOK

The negative outlook reflects the one-in-three chance that we could lower the ratings on Albania over the next year due to the high rollover risk on its increased debt stock. We could lower the ratings if the government recognized further arrears or increased its debt stock, given the potential difficulty of financing them.

We could revise the outlook to stable if pressures on government finances abate, through higher-than-expected growth combined with a reduction in the budget deficit. Progress on removing long-standing structural impediments to sustained growth would also be positive for the ratings."
 

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