"Montenegro's economy grew by an estimated 6% in real terms in 2023, bolstered by a strong tourism season, and we forecast growth will slow in 2024, but remain favorable at 3.6%," S&P said in a statement on Friday.
The ratings agency noted it projects Montenegro's economic growth to further slow to 3.2% in 2025, 3.1% in 2026 and 3.0% in 2027.
"Resilient nominal GDP growth and lower fiscal deficits helped reduce net general government debt over 2021-2023 to 54% of GDP, down from 58% of GDP before in 2019," the agency said, adding that net debt-to-GDP is seen lingering at 54.4% in 2024, and gradually rising to 55.2% in 2025, 56.3% in 2026 and 57.5% in 2027.
The agency expects that Montenegro's general government budget will turn to 3.3% of GDP deficit this year from 0.4% of GDP surplus in 2023. The budget deficit-to-GDP ratio is seen slowly declining to 3.0% in 2025, and 2.8% in each of 2026 and 2027.
S&P projects consumer prices growth will slow to 4.3% this year from 8.6% in 2023, and will further cool down to 2.8% in 2025, and 2.3% in each of the following two years.
S&P also said in the statement:
"Outlook
The positive outlook primarily reflects the potential for Montenegro's fiscal and balance-of-payments performance to prove stronger than we currently forecast over the next year, further reducing the level of net general government debt as a share of the economy following an already consistent decline over 2021-2023.
Upside scenario
We could raise our ratings on Montenegro in the next 12 months if its fiscal performance proves stronger than we currently forecast, continuing the downward trend in net general government debt. This could be the case as a result of stronger economic growth or fiscal consolidation measures adopted by the authorities. We could also raise the ratings if Montenegro's external position strengthens beyond our current base-case forecast.
Downside scenario
We may revise the outlook to stable or lower the ratings in the next 12 months if Montenegro's fiscal performance proves materially weaker than we expect. For instance, this could happen if additional debt-financed infrastructure projects led to a sharp increase in public debt, eroding Montenegro's fiscal headroom.
Rationale
The outlook revision to positive primarily reflects the potential for Montenegro's fiscal performance to strengthen further over 2024-2025. Although we currently forecast an average general government budget deficit of 3% of GDP over the next two years, Montenegro ran a balanced budget in 2023, largely supported by stronger revenue outturns, but also some one-off factors such as revenue from the now-terminated citizenship-by-investment program and EU grants. In our view, further growth in tourism and domestic consumption, improvements in tax administration, and additional revenue-accruing measures could underpin a stronger budgetary performance for Montenegro.
We note that Montenegro's fiscal position has already improved significantly since its small and tourism-dependent and open economy took a severe hit from the COVID-19 pandemic shock in 2020. A combination of resilient nominal growth averaging 17% over 2021-2023 and stronger budgetary performance underpinned a steady reduction in net general government debt. At an estimated 54% of GDP at end-2023, Montenegro's net general government debt was below the end-2019 pre-pandemic level of 58%.
Nevertheless, despite the mentioned improvements, risks to the fiscal outlook remain. These primarily stem from the government potentially deciding to fund the completion of the remaining sections of a major highway project through public debt. The first section of the highway, Bar-Boljare, has already been completed.
Our current projections do not incorporate additional funding for highway construction because the government has not yet taken the final decision on further phases for the project, while the full cost remains unclear. There is an ongoing EU-sponsored feasibility study to determine the cost, but uncertainties persist regarding the ultimate funding mechanism if the project were to go ahead. We understand Montenegro has the potential to secure some financing from international financial institutions on favorable terms and access small grants through the Western Balkans Investment Framework.
Our ratings on Montenegro are underpinned by the country's strong growth prospects, long-term benefits from structural reforms tied to the EU accession process, and modest costs of servicing general government debt (we expect interest spending to average about 6% of revenue through 2027).
Our ratings on Montenegro are constrained by the moderate stock of general government debt, a lack of independent monetary policy, and a still weak external balance sheet, despite recent improvements.
Institutional and economic profile: We expect growth to moderate following brisk tourism-driven growth of about 6.1% in 2023
- Growth will moderate to 3.6% in 2024, mainly due to a slowdown in consumption.
- Montenegro continues its negotiations on EU membership, but the progress is slow, with only three out of 33 chapters provisionally closed since negotiations began in 2012.
- Risks to the stability of the coalition government centered around Europe Now party (PES) have increased in the aftermath of the resignation at the end of February of Montenegro's president Jakov Milatovic, founding member of PES.
After achieving an estimated growth rate of 6.1% in 2023, we expect that growth will moderate to 3.6% in 2024. This deceleration is primarily driven by a moderation in consumption, stemming from reduced tourism activity and a decline in consumption associated with the decline in foreign visitors from Ukraine and Russia. However, we anticipate that investments will remain a key driver of growth, supported by ongoing projects in the real estate, energy, and hospitality sectors. Additionally, we expect net exports to have a slight negative impact on growth, due to an increase in investment-related imports.
Beyond 2024, we anticipate growth will average about 3% annually through 2027. We expect that Montenegro's growth prospects will remain closely tied to developments in the country's tourism sector, which accounted for an estimated 27% of nominal GDP as of 2022 (this ratio increases when factoring in indirect economic effects). Heavy reliance on tourism renders the Montenegrin economy particularly susceptible to external shocks, exemplified by the sharp decline in tourism levels in 2020 due to the COVID-19 pandemic. Nevertheless, the government is actively pursuing efforts to diversify the economy, with a specific emphasis on renewable energy sources such as wind, solar, and hydroelectric.
In the past, Montenegro experienced several episodes of political instability. Specifically, two governments lost no-confidence votes in 2022 and the country has been overseen by a technical administration. In a significant political shift during the April 2023 presidential elections, Jakov Milatovic from the PES party emerged as the winner, marking the end of Milo Djukanovic's long tenure. Following this, the June 2023 parliamentary elections also saw PES, led by Milojko Spajic, capture the largest portion of the vote, pushing Djukanovic's traditionally influential Democratic Party of Socialists into second place. The subsequently formed PES-centered government represents a diverse political spectrum. Despite internal disagreements, the coalition successfully adopted the 2024 budget and a new supreme state prosecutor has been appointed, following two years during which the role remained unfilled. Nevertheless, Jakov Milatovic's resignation in the latter part of February has introduced a degree of political uncertainty, leaving the impact on the current governing coalition's stability and future direction unclear.
Beyond recent political developments, Montenegro's institutional framework has a number of shortcomings, including reduced predictability of policy responses due to frequent changes in government and a comparatively high perception of corruption, both of which weigh on the country's business environment. As an EU candidate country, Montenegro is actively engaged in reforms as part of its accession negotiations, aiming to strengthen its policy frameworks and align it with the EU acquis (EU law). Nevertheless, progress on membership negotiations has been slow since beginning more than 10 years ago in 2012 with only three out of 33 accession chapters closed to date. Although achieving EU membership by 2030 appears unlikely, the government coalition has made joining the EU a top priority, signaling its continued commitment to the process.
Flexibility and performance profile: Moderate public debt levels and no monetary policy flexibility, given the unilateral adoption of the euro
- Montenegro's net general government debt steadily trended downward over 2021-2023 and reached an estimated 54% of GDP at end-2023, which was below the 58% of GDP pre-pandemic level.
- We forecast an average fiscal deficit of 3.0% of GDP over 2024-2027, following a 0.5% surplus in 2023, bolstered by one-off revenue.
- Montenegro has no independent monetary policy, due to its unilateral adoption of the euro.
In 2023, Montenegro achieved a budget surplus of 0.5% of GDP, largely due to one-off revenue items, including grants and fees from the now-phased-out golden visa scheme whereby citizenship could be obtained through investments of €250,000-€450,000. For 2024, the budget approved by parliament projects a deficit of 3.1% of GDP (in line with our forecasts). Revenue is forecast to rise to €2.7 billion (38.7% of GDP), marking a roughly 15% increase versus previous years. The government has introduced increased excise duties, including on tobacco and gasoline products, having not extended the reduction for the latter. Current expenditure is projected to grow by 12% to €2.96 billion (42% of GDP). Notable increases include transfers for social protection. Additionally, €240 million (3.4% of GDP) will be allocated for capital expenditure. Depending on costs, we expect the budget to be funded through a combination of deposits, international or domestic bond markets, international financial institutions, or bilateral lending channels.
Beyond 2024, we anticipate an average general government budget deficit of 3% of GDP over 2025-2027, in line with the current fiscal framework and our growth projections. However, fiscal performance could surpass our expectations, bolstered by factors like potential overperformance in tourism revenue, EU grants accompanying Montenegro's accession process, and initiatives to broaden the tax base by reducing the informal economy, which constitutes approximately 30% of Montenegro's GDP.
Despite the potential for the underlying budgetary performance to prove stronger than we currently project, there are also fiscal risks. In particular, we understand that the government is exploring options to complete construction of a large highway project, following the recent completion of the first phase (the Bar-Boljare section of the motorway). The cost of constructing additional sections is currently unconfirmed, but they could weaken Montenegro's fiscal profile if the government decides to finance them with debt. We understand that the government is exploring using loans and grants through the EU's Western Balkans Investment Framework to cover a portion of the construction costs. Our fiscal forecasts for Montenegro currently do not include additional debt for constructing further sections of the highway.
Other risks to the country's debt profile include the fact that approximately 90% of its debt is owed to foreign creditors, making the country heavily reliant on external financing. Moreover, state guarantees contribute to fiscal risks, totaling approximately €769 million (10.6% of GDP). Notably, in the 2024 budget, the government has issued guarantees to projects it deems necessary, particularly those related to infrastructure. However, fiscal risks are somewhat offset by the fact that approximately 40% of the government's external debt is to official lenders under generally favorable terms.
Montenegro's economy depends significantly on tourism, which accounts for an estimated 43.5% of total goods and services exports. Tourist numbers hit a new high in 2023, with 1.4 million arrivals, which is an 11% increase over 2019 pre-pandemic figures. We expect growth in tourism arrivals to moderate over the next two to three years following very rapid post-pandemic recovery. The 25% of GDP services surplus in 2023 was more than offset by a large 44% of GDP trade deficit, underpinning a large full-year 2023 current account deficit of 11.6% of GDP. We expect the current account deficit will average a similar 12% of GDP annually over the medium term.
In our view, headline current account deficits somewhat overstate Montenegro's balance-of-payments vulnerabilities as they are predominantly financed by net inflows of foreign direct investment (FDI) rather than debt. For instance, over the last three years FDI funded over 90% of the cumulative current account deficit and we expect a similar funding mix to remain in place over the next few years. FDI primarily flows into tourism, real estate, and energy. We also note that Montenegro persistently posts large positive net errors and omissions in its reporting. These averaged 9% of GDP over 2021-2023, likely reflecting unrecorded tourism receipts and inflows from Russian and Ukrainian immigrants.
Inflationary pressures in Montenegro have begun to subside. Inflation decreased to 4.4% in January 2024, down from 16.2% a year earlier. This decrease in inflation is mainly due to falling food and utility prices. For 2024, we project inflation to stabilize at an average of 4.3%, supported by base effects and further reductions in food prices. Nonetheless, upward pressure on inflation could emerge, particularly from the tight labor market.
Montenegro's decision to unilaterally adopt the euro limits the Central Bank of Montenegro's ability to set interest rates or control the money supply, thereby also hampering its ability to act as a lender of last resort for the domestic financial sector. The banking sector in Montenegro currently demonstrates strong capital adequacy and liquidity. Nonperforming loans stood at under 5.9% as of third-quarter 2023, reflecting a declining trend, with the ratio of Tier 1 capital to risk-weighted assets close to 20%. Montenegro's banking landscape is predominantly characterized by branches of international banking groups."
