March 7 (SeeNews) - Standard & Poor's (S&P) affirmed Montenegro's long- and short-term foreign and local currency sovereign credit ratings at 'B/B', with a stable outlook, it said.
Montenegro's real gross domestic product (GDP) is expected to grow 5.5% in 2022 after rising by estimated 13% last year, S&P said in a statement on Friday.
"We believe the ambitious economic and budgetary reform package the government recently launched could face execution risks and lead to fiscal slippages in the context of political uncertainty. That said, we forecast that the government's cash reserves will cover the bulk of the government's financing needs in 2022," the global rating agency said.
S&P also said in the statement:
"On March 4, 2022, S&P Global Ratings affirmed its 'B/B' long- and short-term foreign and local currency sovereign credit ratings on Montenegro. The outlook is stable.
Outlook
The stable outlook reflects our view that Montenegro's economic growth will remain solid and support a gradual consolidation of public finances. We expect economic activity in Montenegro will stay largely unaffected by its political uncertainty.
Upside scenario
We could raise our rating on Montenegro in case of a consistently strong economic growth and faster-than-expected budgetary consolidation. In this scenario, we would expect the net government debt as a share of GDP to chart a clear trajectory to below 60% of GDP, supported by recurring primary surpluses.
Downside scenario
We could lower the ratings if Montenegro's economic growth proved materially weaker than we forecast. Pressure could also emerge if the budgetary position deviates significantly and negatively from our forecast. This could, for example, occur if the government were unable to control spending over the medium term, if execution of key fiscal reforms resulted in wider budgetary imbalances, or if authorities undertake large additional debt-financed projects.
Rationale
Our ratings on Montenegro reflect the country's developing institutional arrangements together with the government's relatively sizable government debt, monetary policy constraints, and an external position that renders the sovereign vulnerable to external shocks. The ratings also take into account the investible and open nature of the economy and our expectation that recurring and sizable foreign direct investment (FDI) inflows will continue give rise to imports and increase the country's current account deficit.
Institutional and economic profile: Montenegro's economic performance will likely again be supported by the rebounding tourism activity
We estimate that Montenegro's GDP expanded by 13% in 2021, underpinned by a strong pick-up in tourism.
We expect tourism will reach pre-pandemic levels this summer, supporting growth of 5.5% for the full year.
The recent collapse of the coalition government raises uncertainty and poses questions on economic and budgetary reform.
Montenegro's tourism-dependent economy bounced back strongly in 2021 after being hit hard by the pandemic in 2020 on the back of a strong revival in tourism that proved resilient to recurring COVID-19 waves over the year. In particular, Montenegro attracted a significant number of regional tourists. We estimate that real GDP expanded by 13% in 2021, largely restoring the 15.3% decline recorded in 2020.
We expect the economy will expand by 5.5% in 2022 and 4.5% in 2023 on the back of a continued improvement in tourism, in tandem with strengthened public and private demand and a continuation of investment, predominantly related to real estate and the utility sector. We understand that there is a significant number of advance bookings for the upcoming summer season. That said, geopolitical tensions following Russia's military intervention against Ukraine could dampen Montenegro's tourism this summer. In addition, low immunization levels constitute further risk. As of Feb. 22, 2022, 45% of Montenegro's population was fully vaccinated against COVID-19, compared with the EU average of 72%.
Despite tourism being severely hit in the pandemic, we believe the Montenegrin economy has maintained its investible nature. We forecast FDI inflows will remain solid across our forecast horizon, with inward FDI at about 10% of GDP annually--supporting several ongoing hospitality-related projects alongside investment in the energy transition to solar and wind power generation. That said, following the international sanctions imposed on Russia, we note the risk of lower investment inflows from Russia, which we estimate contributed about 20% of inward FDI to Montenegro in 2021. Other than that, we anticipate that remittances, which remained uninterrupted at about 8% of GDP in 2020 and 2021, will continue to support the purchasing power of Montenegrin households.
While the tourism sector is the key impetus behind Montenegro's economic recovery, we observe an asymmetry in the sectoral rebound that adds fragility to the near-term growth context. In particular, the pandemic has increased the structural unemployment level, which together with low labor market participation remains a key structural impediment to Montenegro's longer term growth prospects. We estimate unemployment of 19% at year-end 2021 and expect it will only gradually moderate over the coming years as government reforms progress.
In February 2022, Montenegro's technocrat-led coalition government, which held diverging views on a range of policy priorities, collapsed following a vote of no confidence. This put an end to its less than 18 months in office. Its entry into office had marked the end of a three-decade-long rule of the Democratic Party of Socialists. We consider that the orderly power transfer in the aftermath of the 2020 parliamentary elections represents an important precedent. While discussions on the formation of a new government are ongoing, we believe the fragmented and contentious political landscape will provide for a substantial degree of political uncertainty for the remainder of this legislative period.
Montenegro's policy headroom to offset shocks is constrained by its fiscal position and its limited monetary flexibility (having unilaterally adopted the euro in 2002). In particular, its fiscal space remains constrained by the debt contracted for the construction of a highway to link the Port of Bar with the Serbian border. The cost of the first section of highway added about 15% of GDP to debt over the past three years. This section is scheduled to become operational in first-quarter 2022, after numerous delays and cost overruns. We understand that government remains adamant in pursuing the subsequent sections of the highway, but consider the timeframe unclear given the current political environment.
The strong economic recovery supported a significant reduction in Montenegro's public finances in 2021. In late 2021, the ruling coalition introduced an ambitious economic and fiscal reform program, Europe Now, under which it introduced a string of tax measures that aim to increase the standard of living, improve the investing environment, and reduce the size of the grey economy. It also almost doubled the monthlyminimum net wage to €450 from €250 as of January 2022. While the currently unclear political situation clouds the predictability of reform implementation, we recognize broad political agreement around the chief elements of the Europe Now program and believe the efforts will proceed, albeit likely at a more subdued pace.
In our view, overall, Montenegro's institutions can be characterized as developing. Also, instances of corruption and irregular adherence to rule of law have been reported, and we believe they will continue to hamper the business environment. Montenegro's institutional setting benefits from the country's status as an EU candidate. Reforms implemented as part of the accession negotiations have the potential to strengthen the country's policy frameworks and align Montenegro with the EU's Acquis Communautaire. That said, we consider Montenegro's plan for EU accession in 2025 optimistic. This is because we believe both domestic developments and Euroscepticism among the existing member states could hamper the process, since--under EU rules--member states will ultimately have to unanimously approve Montenegro's membership bid.
Flexibility and performance profile: Budget deficit to widen in 2022 due to the Europe Now budgetary measures, followed by a gradual consolidation thereafter
We expect the general government deficit will widen to 6.0% of GDP in 2022, from an estimated 2.3% in 2021, as front-loaded spending under the Europe Now program weighs on public finances.
Nevertheless, substantial cash holdings alleviate short-term refinancing risks.
Montenegro has a fragile external position, with persisting high current account deficits and strong reliance on external financing availability.
We estimate that Montenegro's general government deficit reached 2.3% of GDP in 2021 due to a strong pickup in government revenue on the back of economic recovery, alongside a decline in discretionary spending. Moreover, the 2021 decline in the budget deficit reflects that budget execution was on a temporary financing basis for the first half-year, since persisting disagreements in government delayed its adoption. This situation curbed government spending initiatives over the first half of the year. Government revenue, on the other hand, surged to an estimated 45% of GDP, surpassing even the 2019 level in nominal terms, due to an improvement in tax collections, especially value-added tax, which accounts for nearly 60% of total tax revenue and benefitted from a pickup in tourism. Excluding interest payments, we estimate that Montenegro recorded a primary surplus of 0.4% of estimated GDP in 2021.
In December 2021, the Montenegrin government adopted a package of economic and budgetary measures titled Europe Now to incentivize more people to join the formal economy, support economic growth, and reverse emigration trends. The reform program includes several front-loaded expenditure items among others an increase of the minimum wage, in addition to a host of tax-related measures and abolishment of the obligation to pay contributions toward compulsory health insurance. In our view, the unclear political situation has amplified the challenges related to the program's implementation.
We expect that the Europe Now program will weigh on Montenegro's budget balance in 2022 and estimate that the budget deficit will widen to 6% of GDP, compared with the government's target of 5%. After the rationalization achieved in 2021, the government will increase its current spending due to a higher wage bill, social protection transfers, and increase in pension spending. We forecast the deficit will gradually narrow toward 3% of GDP in 2024, supported by economic growth and the government's consolidation efforts.
We forecast Montenegro's net general government debt will stand at 69.3% of GDP in 2022, at about the same level as 2021, before gradually declining to 65% by the end of 2025. As the government increasingly relies on net borrowing from the rest of the world, the sustainability of Montenegro's external financing is increasingly a function of the public sector's access to external capital markets. A sudden loss of access to foreign financing (which we currently do not project) would not only create a fiscal cliff for public finances, but also likely drain foreign reserves and tighten overall financial conditions in a euroized economy that lacks a lender of last resort.
Montenegro's government debt is primarily owed to foreign creditors, with only a limited number of domestic securities issued. Associated risks are partially mitigated by the fact that about 40% of government external debt is to official lenders under generally favorable conditions. However, the debt-redemption profile remains rather uneven, which is a function of the small size of the government budget and Montenegro's economy. Authorities issue benchmark-size instruments that are comparatively large as a percentage of GDP, meaning repayments are high in years with Eurobond maturities.
We consider that Montenegro's favorable relationship with international financial institutions and its currently ample liquidity will allow it to secure financing in the context of its financing needs. The proceeds of a €750 million Eurobond in December 2020 went toward bullet maturities in March 2021 and left a cash cushion at about 10% of GDP as of December 2021.
In July 2021, the Montenegrin government put in place a hedging arrangement on its Chinese highway loan, which represents about 15% of the government's debt stock, effectively reducing currency risks and the interest rate to 0.88% in euros from 2.00% in U.S. dollars. Also, despite higher leverage, Montenegro's interest expenditures will remain more contained, averaging about 5.8% of government revenue through 2025.
Montenegro's external accounts have benefitted from a strong rebound in tourism, enabling it to reign in its current account deficit quite significantly last year. Service surplus has boomed, thanks to a rapid pickup in travel related revenue. This, coupled with resilient remittance inflows as well as a surplus on the primary balance have helped the country improve its current account receipts. We estimate the current account deficit to have narrowed to 13.5% of GDP in 2021, down by about 12 percentage points compared to 2020. We also forecast tourism sector to recover fully and reach or even slightly exceed 2019 levels in 2022, after reaching nearly 60% of pre-pandemic levels in 2021.
However, the persistence of current account deficits and a large net external liability position keeps Montenegro vulnerable to balance-of-payment risks. Historically, the economy has relied substantially on net inflows of FDI into tourism and associated real estate. We observe that FDI flows showed resilience in 2021, with inward FDI at about 10% of GDP, supporting ongoing investments, particularly within the utility sector. We see significant risks to FDI flowing in particularly from Russia this year, in the light of international sanctions. In our base-case scenario, we expect FDI to be the key driver in Montenegro's import bill, supporting the resumption of several ongoing hospitality projects. We expect FDI will average 10% of GDP annually in 2022-2025, broadly in line with historical trends, fueling rising imports. Nonetheless, we have improved our forecast of tourism receipts and estimate that the country's current account deficit will now average 13.7% of GDP over 2022-2025.
Montenegro's unilateral adoption of the euro prevents its central bank from setting interest rates and controlling the money supply and restricts its ability to act as a lender of last resort. Although the central bank has some options to provide liquidity to domestic banks, in our view, its inability to create additional liquidity in a stress scenario effectively prevents it from fulfilling the function of lender of last resort.
Montenegro's banking system entered the pandemic in a relatively strong position, with solid capital levels, nonperforming loans (NPLs) at a low 5%, and ample liquidity. The central bank completed an asset-quality review for all banks in the country and concluded basis preliminary results that the financial system is stable. NPLs have remained broadly stable but a rise is likely to be felt as fiscal support and loan moratoria are phased out. The banking system is dominated by subsidiaries of foreign banking groups, which typically have financial positions exceeding those of solely domestic banking groups. It is largely funded by domestic deposits, providing some stability. In December 2020, the two-largest banks, CKB and Podgoricka Banka, completed their anticipated merger, with the combined entity now accounting for about 40% of sector assets."