S&P affirms Macedonia at BB-/B, outlook stable

S&P affirms Macedonia at BB-/B, outlook stable gary yim/Shutterstock.com

SKOPJE (Macedonia), March 17, (SeeNews) - Standard & Poor's said on Friday it affirmed Macedonia's long-term and short-term foreign and local currency sovereign credit ratings at BB-/B with a stable outlook.

"The stable outlook reflects the balance between the risks from Macedonia's rising public debt and heightened political uncertainty over the next 12 months, and the country's favorable economic prospects," S&P said in a statement.

Macedonia's institutional landscape remains weak and the political crisis is continuing even after the December 2016 early general election, the global rating agency added.

S&P also said in the statement:

"The ratings on Macedonia reflect our view of the country's relatively low income levels; weak checks and balances between state institutions, exacerbated by the prolonged political crisis; and limited monetary policy flexibility arising from the country's fixed-exchange-rate regime. The ratings are primarily supported by moderate--albeit rising--external and public debt levels.

Macedonia has been locked in a political crisis for the last two years. Following a very narrow win in the December 2016 early general election, VMRO-DPMNE failed to reach an agreement with its previous coalition partner Democratic Union for Integration (DUI), which represents the Albanian minority. Subsequently, the main opposition party SDSM has secured enough support from Albanian minority parties on the condition that Albanian language is recognized across the country. However, public protests against the proposal took place and president Gjorge Ivanov refused to grant SDSM a mandate to form a government.

We believe that the current political stalemate portends heightened uncertainty in the absence of a clear way out. In our view, Macedonia's weak institutional arrangements--characterized by the lack of effective checks and balances between government bodies and limited independence of the judiciary--hamper an effective resolution of the present impasse. Another early election remains a possibility but it is unclear whether it could lead to a conclusive outcome. Moreover, absent a grand coalition between VMRO-DPMNE and SDSM--which currently seems improbable--any future government is likely to have an only narrow majority. This will diminish its ability to pass reforms and tackle long-standing issues such as the ongoing dispute with Greece over Macedonia's constitutional name.

In our view, the protracted political crisis could pose risks to the country's economic performance. Although headline growth appears to have already been affected, it has not been too severe so far. We estimate that the Macedonian economy grew by 2.5% in 2016 on the back of strong private consumption and export performance. That said, we estimate that investment dynamics were considerably weaker than in 2014-2015.

We forecast headline growth will slow down further to 2% in 2017 before recuperating closer to 3% once the political uncertainties subside. However, there are downside risks to these forecasts. With GDP per capita estimated at just $5,200 in 2016, Macedonia remains a low income economy. In recent years, the government has attempted to attract foreign direct investment (FDI) to special free economic zones, capitalizing on the country's comparatively favorable tax regime, low labor costs, and proximity to European markets. In our view, persisting political uncertainty could weigh on growth if a substantial portion of these foreign investments are cancelled or postponed. So far, net FDI has held up well at around 4% of GDP last year.

Political risks aside, we believe there is upside potential for the economy's long-term growth prospects from the free zones expansion. Full benefits to growth would only materialize, however, if companies within the zones become better integrated into the local economy by using local suppliers. We note that so far most inputs for goods assembled by foreign companies have been imported. Consequently, the free zones' impact on the rest of the economy has been less than might be expected and largely confined to employment.

Although Macedonia has been running persistent budget deficits, we believe its fiscal profile still leaves some space for policy flexibility, which supports the ratings. We estimate that the general government deficit amounted to 2.8% of GDP last year--lower than the authorities' revised target of 4%. Importantly, however, this has largely happened against the background of underspending, partly attributable to the ongoing political stalemate. At present, the government targets gradual consolidation with deficit declining to 2.2% of GDP by 2019. In our view, however, the consolidation plan lacks concrete measures and could fall short of target if growth or revenue collection underperform. Consequently, we forecast deficits averaging 3% of GDP over the next four years.

We also believe that while net general government debt remains comparatively low, it will continue to rise to 47% of GDP in 2020 from an estimated 39% of GDP at end-2016. Our general government debt calculation includes the increasing debt of The Public Enterprise for State Roads (PESR). This is because we believe PESR will need to rely on government transfers to service its debt in the future. In particular, a €580 million loan from the Export-Import Bank of China (and for which the government provided a guarantee), contracted in 2013 for the construction of two highway sections, will continue to contribute to the increasing debt burden.

Macedonia has repeatedly been able to tap the Eurobond market. This has made the government's balance sheet more vulnerable to potential foreign-exchange movements, as close to 80% of government debt is denominated in foreign currency (including part of domestic debt). The authorities plan to expand their domestic issuance but also maintain regular foreign capital market borrowing.

With the public sector increasingly borrowing abroad, the Macedonian economy's external debt has been rising, despite some deleveraging in the banking sector. In 2016, we estimate that gross external debt net of liquid financial and public sector assets increased to about 35% of current account receipts. We forecast that Macedonia's external debt metrics will remain broadly stable over the next four years. Last year's current account deficit turned out to be wider than we projected, at 3.1% of GDP. This is largely explained by the weaker performance of current transfers and larger primary income deficit. Nevertheless, we anticipate the current account deficit will gradually tighten and reach 1.2% of GDP in 2020, partly owing to the positive impact from the expansion of foreign companies in the free zones. We project these deficits will be financed by a combination of borrowing and net FDI inflows.

The Macedonian denar is pegged to the euro and we believe the existing foreign exchange regime restricts monetary policy flexibility. However, central bank measures, such as lower reserve requirements for denar-denominated liabilities, have lowered overall euroization in Macedonia, with foreign currency-denominated deposits and loans remaining around 40% of total deposits and loans in recent years. This affords the National Bank of the Republic of Macedonia (NBRM) some room for policy response. Rather exceptionally for the region, bank lending in Macedonia has also continued to increase in recent years. That said, even though the overall stock of domestic credit expanded by an estimated 4% last year, lending to corporates contracted in year-on-year terms.

Macedonia's banking system has seen several bouts of volatility in recent years. For example, political developments caused deposit outflows from Macedonia's banking sector last April, although the majority of funds have since flowed back into the system. In general, the banking system appears well capitalized and profitable, and it is largely funded by domestic deposits. Macedonia's regulatory and supervisory framework under the NBRM has proven resilient to past episodes of volatility; the NBRM reacted swiftly to the volatility in April by raising interest rates and intervening in the foreign exchange market to support the currency peg as well as deploying several other measures. In addition, the NBRM has introduced macroprudential measures such as higher capital requirements for consumer loans longer than eight years and is moving ahead with the implementation of Basel III principles. At the end of 2016, nonperforming loans in the system amounted to about 7% of the total.


The stable outlook reflects the balance between the risks from Macedonia's rising public debt and heightened political uncertainty over the next 12 months, and the country's favorable economic prospects.

We could raise our ratings on Macedonia if reforms directed toward higher broader-based growth led to a faster increase in income levels than in our base-case scenario, alongside improved effectiveness and accountability of public institutions.

We could lower the ratings if the protracted political uncertainty substantially impaired growth and FDI inflows, undermining the country's longer term prospects. We could also lower the ratings if large fiscal slippages or off-budget activities were to call into question the sustainability of Macedonia's public debt, raise the sovereign's borrowing costs, and substantially increase its external obligations, given the constraints of the exchange-rate regime. In addition, if the parent companies of systemically important banks operating in Macedonia were to cut their exposure to subsidiaries, we could consider a negative rating action."

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