February 14 (SeeNews) - S&P Global Ratings said it has affirmed its 'B' long-term issuer credit rating on one of Bosnia's Serb Republic entity, with a stable outlook.
Slower economic growth, inflation-driven spending and rising interest costs will affect the entity's budgetary performance in the next two years, but tax-supported debt is expected to remain below 120% of consolidated operating revenue, the global ratings agency said in a statement last week.
S&P added it expects the Serb Republic to maintain satisfactory access to international capital markets and multilateral funding through the sovereign, Bosnia and Herzegovina.
The Serb Republic is one of the two autonomous entities that form Bosnia and Herzegovina. The other one is the Federation.
S&P also said:
"Overview
We expect that Republika Srpska will maintain satisfactory access to international capital markets and multilateral funding through the sovereign, Bosnia and Herzegovina (BiH).
Republika Srpska operates under complex and volatile political and financial arrangements with the central government of BiH. Although we expect that subdued economic growth, inflation-driven spending, and rising interest costs will affect Republika Srpska's budgetary performance in the next two years, we forecast tax-supported debt will remain below 120% of consolidated operating revenue.
We affirmed our 'B' long-term issuer credit rating on Republika Srpska with a stable outlook.
Rating Action
On Feb. 10, 2023, S&P Global Ratings affirmed its 'B' long-term issuer credit rating on Republika Srpska (RS), a constituent region of Bosnia and Herzegovina (BiH; B/Positive/B). The outlook is stable.
Outlook
The stable outlook reflects our view that contained political tensions between RS and the central government of BiH will allow RS to maintain satisfactory access to external sources of funding. It also reflects our view that weaker economic growth and inflation-driven expenditure will affect RS's budgetary performance.
Downside scenario
We could lower the rating if intergovernmental relations became more tense in BiH, for instance, if the authorities took concrete steps toward secession. This could lead to disruptions in its access to external funding sources. We could also lower the rating if RS's budgetary performance weakens, and in such a case its management does not take measures to prevent RS's debt burden increasing.
Upside scenario
We could raise the rating on RS if we upgrade BiH and coordination between the different levels of government in BiH improves. More visibility on long-term fiscal planning could also be supportive for the ratings, particularly if this leads to significantly better budget performance than expected.
Rationale
We expect that RS will maintain access to international capital markets and multilateral funding through the sovereign, particularly since we do not expect its political leaders to take concrete action toward secession from state level institutions. RS operates under complex and volatile political and financial arrangements with the central government of BiH. Although we expect that subdued economic growth, inflation-driven spending, and rising interest costs will affect RS's budgetary performance in the next two years, we also forecast tax-supported debt will remain below 120% of consolidated operating revenue.
RS's economy is weak in an international context, and it operates within complex and volatile political and financial arrangements
Weak global economic conditions will affect BiH, with low real GDP growth of 1% by 2023, before picking up slowly in 2024 and 2025. We expect RS to expand broadly in line with the national trend. The region accounts for about one-third of national GDP and, at $7,700, its expected GDP per capita in 2023 is slightly under the national average, which itself is well below that of most other European countries. BiH's population is aging due to younger people leaving the country, which will increase pressure on RS's expenses. However, BiH is only partly exposed to hikes in energy prices given that it produces most of its electricity via thermal or hydro generation.
RS operates under complex and volatile political and financial arrangements with the central government. The institutional framework in BiH is hampered by a lack of coordination between the different levels of government, and disagreements among the country's ethnicities. Although policymakers at the different government levels broadly agree on the need for some institutional and economic reforms, implementation is slow due to diverging views and interests between the different ethnicities. Confrontations between the entities and the high representative of BiH frequently occur following his decisions and powers over state politics, as defined by the Dayton agreement.
Although RS's political leadership sometimes uses secession rhetoric in relation to three state-level institutions (the Indirect Tax Authority; High Judiciary; and the defense and security services), particularly in pre-election periods such as autumn 2022, we continue to consider the likelihood of concrete steps toward secession low. Furthermore, we note some signals for better cooperation between the different government levels, including the relatively smooth formation of a central government at the BiH state level. We continue to believe that the international community will not support political escalation from RS, including traditional allies such as Serbia, which is trying to avoid harming its path to EU accession. Moreover, RS is highly dependent on financing from international financial institutions like the IMF and European Bank for Reconstruction and Development, which could be significantly reduced in such a case, weakening its liquidity position.
The very volatile institutional framework is partially offset by the autonomy that entities in BiH hold in terms of managing their own fiscal policies and setting direct tax rates. RS's government sets the rates for half of its revenue, including direct taxes, social security contributions, and other charges and fees. However, the central government sets and collects indirect taxes. It allocates part of this revenue for financing central government institutions and retains sufficient funds to service the external debt issued on behalf of the constituent entities. The rest is distributed to the three Bosnian entities.
We regard RS's financial management as weak in an international context, lacking reliable long-term planning and a formal liquidity policy, and with weak control of government-related entities compared to peers. RS's financial planning is limited to headline figures, investment plans, and debt issuance needs over a three-year horizon, and typically those plans are updated significantly and frequently. In addition, we note that effective implementation often deviates from budget planning. We understand that reforms in terms of public enterprise management and public investment programs are still in an implementation phase and have not yet led to major changes.
We do not expect RS's financial policies to change over the next few years under the coalition in place since the 2022 elections in the region. The Alliance of Independent Social Democrats (SNSD) party, headed by Milorad Dodik, won the majority of votes. A coalition government based on a comfortable majority in the state parliament has already been formed from eight parties and is not significantly different from the previous government.
Satisfactory access to liquidity helps to refinance loans and cover deficits, but an increasing interest bill will continue to burden RS
We expect RS's budgetary performance to weaken in 2023 due to inflation-related spending growth and the implementation of election promises. For example, we expect expenditure pressure from wages and pensions increases, social benefits, and subsidies to households and companies. We also expect higher prices will affect investment costs.
In the next few years, we expect a mild improvement in budgetary performance, although we anticipate the deficit after capital spending will still be about 6% of total revenue by 2025. We believe budgetary performance will be supported by higher economic growth and receding inflation, leading to less pressure on expenditure growth. In addition, we think RS has higher flexibility, if needed, than other local and regional governments to raise revenue or contain spending, due to its relatively high fiscal autonomy within BiH.
Despite budget deficits over the next few years, we expect tax-supported debt, which includes government debt, social security, and the highways public enterprise, to remain below 120% of consolidated operating revenue. We note that 70% of tax-supported debt is external and the rest is domestic, while 78% is at fixed interest rates and the rest at floating rates. We expect interest spending to increase significantly due to rising interest rates and exceed 5% of operating revenue this year, given new gross borrowing in 2023 will represent 30% of outstanding debt. In our view, RS's contingent liabilities are limited, notably including the debt of municipalities and public enterprises.
RS's liquidity position is weak and depends on its access to external sources. In our view, RS has relatively low cash reserves, far below levels sufficient to cover the next 12 months' debt service, which includes a €200 million Eurobond maturing in summer 2023. We understand RS expects to refinance this by issuing long-term bonds in external or domestic markets. For investment projects or other budgetary needs, it may borrow from domestic or nonresident banks and multilateral lending institutions. Temporary or short-term liquidity needs could also be met by issuing treasury bills to local banks. Based on its track record of borrowing from a diversified pool of investors, we think RS has satisfactory access to external liquidity sources."