SKOPJE (North Macedonia), February 22 (SeeNews) – Standard&Poor's said it has affirmed its 'BB-/B' long-term and short-term foreign and local currency sovereign credit ratings on North Macedonia, with a stable outlook.
The ratings agency expects the country's economy to grow by 3.6% in 2021, whereas its current account and fiscal deficits are seen narrowing gradually by 2024 as net government debt rises to about 57% of GDP, it said in a statement last week.
S&P added it could lower North Macedonia's ratings if fiscal and current account deficits are higher than expected, net government debt continues to rise, external stress grows or the domestic financial system weakens materially.
"We could raise the ratings if continued reforms strengthened the sovereign's institutional arrangements while preserving sustainable fiscal policies. North Macedonia's EU accession aspirations could remain an anchor for institutional improvements and structural reform progress," the ratings agency also said.
Here's what else S&P said in the statement:
"Outlook
The stable outlook reflects our expectation that North Macedonia's projected economic recovery will help rein in fiscal and external deficits over the coming year.
Upside scenario
We could raise the ratings if continued reforms strengthened the sovereign's institutional arrangements while preserving sustainable fiscal policies. North Macedonia's EU accession aspirations could remain an anchor for institutional improvements and structural reform progress.
Downside scenario
We could lower the ratings if fiscal and current account deficits are higher than we project over the next one-to-two years, coupled with a continuous rise in net government debt or the buildup of external stress. The ratings could also come under pressure if the domestic financial system stability were to weaken materially in a hypothetical scenario of sustained asset quality deterioration and persistent deposit conversion to foreign currency.
Rationale
We expect North Macedonia will weather the pandemic-induced shock to its economy, as well as its external and fiscal metrics. To mitigate the impact of the containment measures and the reduced foreign demand for the country's exports, the government has deployed substantial stimulus to preserve employment and productive capacity in the country's economy. As a result, net general government debt will increase to 53% of GDP in 2021 from 41% in 2019.
We expect North Macedonia's economic growth to accelerate over 2021, particularly through public investment spending, private consumption, and recovering exports. The long-term growth outlook underpins our expectation that debt accumulation will slow to still-moderate levels over the coming two-to-three years. At the same time, access to funding from official and market sources underpin the ratings.
Our ratings on North Macedonia remain constrained by our view of the country's comparably low income levels; still-developing institutional settings, despite recent improvements; and monetary policy flexibility that is limited by the fixed exchange-rate regime.
Institutional and economic profile: Growth is set to resume in 2021
We project that North Macedonia's economy will expand by 3.6% in 2021 after contracting by over 4% in 2020.
The Bulgarian veto blocked the start of North Macedonia's EU accession talks in late 2020.
Nonetheless, we think that the Social Democratic Union of Macedonia (SDSM)-led government will keep its Euro-Atlantic orientation.
We estimate that North Macedonia's economy contracted by 4.4% in 2020. After the 15% decline in second-quarter 2020, the deepest on record, we expect that the economy gradually recovered toward the end of 2020. Short-term indicators point to a very moderate contraction, if any, in the fourth quarter. In December, industrial production recorded the first positive monthly growth rate since February. North Macedonia is integrated in global supply chains, especially in the auto sector, and less reliant on the services sector--for example tourism--than regional peers. This integration, along with the impact of domestic containment measures, explains the pandemic's significant impact in spring 2020 through the trade channel.
We expect that the revival of the global auto sector over the past few months will underpin North Macedonia's economy recovery in 2021. We project 3.6% real GDP growth this year, but the country's economic perspectives depend on developments in key trading partners--for example, Germany accounts for about 50% of the country's exports.
At the same time, domestic demand will underpin growth in 2021. The government's fiscal stimulus of around 4% of GDP in 2020, in various sets of support measures, helped preserve employment and cushion the pandemic's economic impact. We expect that support measures will gradually be withdrawn, depending on the recovery, or replaced by other measures such as the fifth support package announced in February 2021. Broadly constant employment and sound wage growth in 2020 are supporting disposable incomes and the recovery of private consumption into 2021. Conversely, private consumption suffered notably in 2020 through declining worker remittances from abroad. We estimate private transfers to have declined by 20%-25% in 2020 due to adverse economic developments in the workers' (mostly European) host countries and travel restrictions.
We expect sizable government infrastructure investment to fuel growth over 2021-2024. Public investment will be one focus of the SDSM-led government formed in fall 2020. This aims, for example, at improving North Macedonia's physical infrastructure in transport, health, and education, and a total of €3.2 billion (almost 30% of 2021 GDP) is projected for capital investment from 2021-2025. In that regard, we note the government's efforts to improve the execution of capital expenditure plans.
Other domestic policy priorities include ensuring fiscal sustainability and implementing growth-supportive structural reforms. We note the importance of preserving North Macedonia's competitiveness in the context of rising labor costs and falling productivity in 2020. We view positively the government's sustained efforts to attract foreign direct investment (FDI) into the free economic zones, which it has expanded in recent years and have boosted the country's goods exports. Nevertheless, the economic structure remains fairly basic, with a prevalence of lower-value-added goods exports. Companies in the free economic zones are concentrated in the electronics and auto sectors, but a large proportion of inputs are still imported, rather than sourced domestically, which limits the free zones' wider integration into the domestic economy.
The government's foreign policy priorities received a setback when Bulgaria vetoed the negotiating framework and effectively blocked the start of EU accession talks late last year. We do not think this will change the Euro-Atlantic course of North Macedonia, but disappointment with recurring roadblocks despite the country's efforts in recent years (among others, the change of name to North Macedonia following the Prespa agreement with Greece to resolve the long-standing name dispute) could tilt foreign policy sentiment in the population.
At the same time, domestic political polarization between SDSM and nationalist VMRO-DPMNE remains high. Close election outcomes have occurred many times, including 2020, and often resulted in a parliamentary gridlock, with neither side easily securing a working majority. However, SDSM and the ethnic Albanian party DUI agreed on continuing their coalition government. Despite reforms in recent years, we think North Macedonia's institutions have shortcomings, which the government will aim to address. If EU accession negotiations were to open, this could be an important anchor for these reforms.
Flexibility and performance profile: Government debt is inching upward, following the pandemic-induced surge
North Macedonia's fiscal deficits will average almost 4% in 2021-2024, consequently raising net general government debt to 57% of GDP by 2024.
The recent widening of the current account deficit will reverse over the forecast horizon through 2024.
We expect the peg of the Macedonian denar to the euro to continue.
North Macedonia's general government deficit widened to 8.1% of GDP in 2020 due to the effect of automatic stabilizers and fiscal measures in response to the pandemic. These comprised support to affected sectors, social security contribution subsidies to preserve employment, employment support to affected companies, and were accompanied by an accommodative monetary policy stance. For 2021, we expect the general government deficit to narrow to 4.9% of GDP and then further to 3.1% by 2024. Our forecast assumes deficits will decrease more gradually compared to the government's projections, which reflects our lower economic growth estimate.
We understand that the government aims to strengthen the fiscal framework. The government adopted the tax system reform strategy in December 2020, aiming for, among other goals, improving revenue collection and ultimately at supporting economic growth. The Organic Budget Law is in the legislative process and contains, among other provisions, the introduction of fiscal rules (which in essence mirror the eurozone's Maastricht criteria), and establishing a fiscal council. We also understand that improving revenue collection plays an important role in the government's consolidation plans, as revenue in relation to GDP lags that of higher-income European peers.
North Macedonia has significantly dipped into its fiscal space in 2020 and net general government debt is rising substantially to 53% of GDP in 2021 from 41% in 2019. With our projection of an average increase in net debt of over 4% in 2021-2024, net debt to GDP will gradually increase to 57% of GDP by 2024. This underlines that some of the pre-pandemic fiscal buffers have eroded. In 2020, the deficit was partially financed with international financial institutions facilities, such as from the IMF's Rapid Financing Instrument and an EU Macro-Financial Assistance facility. North Macedonia also issued a €700 million Eurobond in June 2020.
We estimate that the current account deficit widened to 3.7% of GDP in 2020. While exports declined broadly in tandem with imports, we expect remittances to have dropped by 20%-25% in 2020. In 2021-2024, we expect the current account deficit to narrow, particularly as exports recover in line with global auto demand, and private transfers increase. Government external borrowing partly replaced private external inflows in 2020. We project narrow net external debt to have increased to 29% of current account receipts in 2020 from 23% in 2019, and expect it to average 23% over our 2021-2024 forecast horizon.
In mid-August, the regulator revoked a license from a small domestic bank, Eurostandard. We understand that the bank had been vulnerable and undercapitalized. Its share in total domestic credit and deposits was small at below 2% and the license withdrawal did not have any systemic repercussions. The government is not involved in its resolution, and the deposit guarantee fund will assume insured deposit payouts with no government budget involvement. However, we understand that parties adversely affected by the license withdrawal voiced concerns in the media regarding banking sector surveillance and performance. While this was refuted by relevant authorities and international observers (such as the IMF) in North Macedonia, these episodes highlight the importance of maintaining trust in banking sector and exchange rate stability to avoid sudden volatility in deposits. There were some deposit withdrawals and conversions to foreign currencies briefly throughout April 2020 and some withdrawals following the Eurostandard bank license revocation. However, the overall rise in the deposit base in 2020 underpins that confidence was maintained.
In our view, North Macedonia's banking system is stable, but asset quality will likely weaken once the currently granted regulatory flexibility expires. However, the nonperforming-loan ratio was low at 3.4% as of third-quarter 2020. At year-end 2020, central bank reserves were 3% higher from year-end 2019, reflecting foreign borrowing.
We anticipate inflation will remain low, but increase to 1.7% by 2024, slightly above our projections for the eurozone.
We expect the pegged denar-euro exchange rate to continue for the foreseeable future. The absence of large-scale portfolio flows into North Macedonia somewhat relieves immediate risks related to the weaker outlook for remittances and FDI. Our baseline expectation is that there will be no large-scale resident conversion to foreign currencies, so the exchange rate will remain intact. The National Bank of the Republic of North Macedonia also recently agreed a €400 million repo line with the European Central Bank, which could be deployed in a downside scenario but has not been used so far."