March 18 (SeeNews) - S&P Global Ratings said it has affirmed its 'BB-' long-term issuer credit rating on North Macedonia's capital Skopje, with a negative outlook.
"The negative outlook reflects the risks of Skopje's operating revenue being weaker than we currently project, which, coupled with elevated spending on public services and subsidies to municipal companies, could lead to further depletion of cash and accumulation of overdue payables," S&P said in a statement on Friday.
The credit rating agency added it could lower its rating on Skopje in the next year if the municipality posted weaker-than-anticipated budgetary results or if political fragmentation continues to hinder Skopje's ability to borrow and leads to further accumulation of overdue payables and erosion of its liquidity.
S&P also said in the statement:
"Rating Action
On March 15, 2024, S&P Global Ratings affirmed its 'BB-' long-term issuer credit rating on the Municipality of Skopje, the capital of North Macedonia. The outlook on the rating remains negative.
Outlook
The negative outlook reflects the risks of Skopje's operating revenue being weaker than we currently project, which, coupled with elevated spending on public services and subsidies to municipal companies, could lead to further depletion of cash and accumulation of overdue payables.
Downside scenario
We could lower the rating in the next 6-12 months if Skopje posts weaker-than-projected budgetary results or if political fragmentation continues to hinder Skopje's ability to borrow and leads to further accumulation of overdue payables and erosion of its liquidity. If we downgraded North Macedonia (BB-/Stable/B), it would also lead to a downgrade of Skopje.
Upside scenario
We could revise the outlook to stable if Skopje's liquidity strengthened while accumulated overdue payables reduced. This could be the case, for example, if tax revenue strengthened, bolstered by higher economic growth and a recovery in real estate activities, taxes on which are an important source of own revenue for Skopje.
Rationale
The rating reflects our expectation that Skopje's revenue performance will strengthen, driven by an acceleration in economic growth and easing financial conditions that should support a recovery in real estate activity. We also expect a much lower execution of capital expenditure in 2024 as compared with the adopted budget, which should support the municipality's liquidity position.
Nevertheless, we continue to see risks that Skopje's revenue will turn out weaker should a recovery in real estate activities or efforts to collect past taxes due underwhelm. Several key municipal companies also remain loss-making and could require the provision of additional support from Skopje.
At the same time, Skopje was not able to borrow in 2022-2023, largely due to complex approval processes, as well as the highly fragmented city council, with the two main political parties, VMRO and SDSM, each lacking a majority in the 45-seat chamber. We expect political uncertainty to remain elevated in the run-up to and after the April-May 2024 parliamentary and presidential elections. North Macedonia is scheduled to hold the next local elections in 2025.
The rating is constrained by Skopje's low wealth levels in an international comparison, lack of firm financial policies, and challenging political environment, both at the local and central government level in North Macedonia.
The rating on Skopje is weighed down by shortcomings in North Macedonia's institutional framework for municipalities, as well as limited adherence to financial policies and weak oversight of municipal companies
We expect North Macedonia's economy will grow by 2.9% in 2024, accelerating from 2.0% in 2023, supported by a rebound of domestic consumption and exports stemming from the projected stronger trade partner growth. However, we still view such growth rates as modest for an emerging market economy with per capita income levels of a comparatively low $9,000 in an international context. We expect growth in the capital city to be in line with the national growth trend. Skopje is the country's financial and administrative center, contributing to more than 40% of North Macedonia's total GDP. It also hosts a range of production facilities and the national headquarters of foreign companies. The demand for real estate activities has somewhat declined over the past year, due to high interest rates, limited construction capacity, and political volatility that increases uncertainties regarding future property tax policy. We nevertheless expect a gradual recovery in this sector, supported by stronger economic growth and looser financial conditions, given that we think inflation has peaked. This should also ultimately support an increase in Skopje's tax revenue.
Our rating on Skopje remains constrained by the shortcomings of the institutional framework under which the municipality operates. Discussions for further decentralization continue, with the focus on broadening local and regional governments' responsibilities and increasing their fiscal autonomy, but progress remains slow and uneven. Effective implementation of changes to the municipal system remains limited, owing to political fragmentation at the central level, in particular since most of the elected mayors in North Macedonia since 2021 belong to the opposition party, VMRO.
Municipalities are not allowed to set the main tax rates (such as property taxes) but can choose the rate from a given range, which allows them to increase their revenue. Other communal fees can be set individually. That said, fees and tax rates are typically set at the lower end of the range due to political considerations.
Under the existing arrangements, North Macedonian municipalities receive a fraction of the personal income and value-added tax (VAT) across the country. Based on prior decisions, the percentage of VAT collections allocated to municipalities will rise to 6.0% in 2024 from 5.5% in 2023 while for personal income tax it will increase to 6.0% from 5.0% last year. We don't expect these changes on their own to have a pronounced impact on Skopje's revenue performance.
Beyond the slightly higher allocation of nationwide taxes, further steps in the decentralization process remain unclear. This is particularly so in the context of upcoming presidential and parliamentary elections in North Macedonia in April-May 2024. In February 2024, Skopje's current mayor, Danela Arsovska, was appointed leader of the small "New Alternative" party, which plans to contest the upcoming general election. In our view, the outcome of the ballot at the national level could influence the relations between the city administration and central government, as well as political dynamics within the city council, given that the two main North Macedonian parties currently hold most seats locally but lack a majority: SDSM (11 of 45 seats) and VMRO (16 of 45 seats).
Skopje lacks reliable long-term financial planning and effective liquidity and debt policies, which we consider a rating weakness. While budget approval is relatively smooth, annual budget outcomes, especially on the capital side, often differ markedly from plans. The municipality's efforts to expand its property tax base and to better control operating expenses have gained only mild success so far, partly because of political disagreements. The mayor faces obstacles in approving policy decisions within the city council, including debt intake, which further reduces the predictability of the city's budgetary trajectory, in our view. We believe that the absence of formal debt and liquidity policies has contributed to the city's increasing amount of payables and reduced cash levels. Meanwhile, we consider the oversight and management of the municipal companies sector as loose.
We also note some shortcomings in data disclosures and budgetary accounting. In particular, taking into account debt issuance and repayment, historical reported budgetary outcomes do not fully match the movements in the city's cash position.
Skopje has a low debt level in an international comparison, but weaker post-pandemic budgetary performance and inability to borrow strain liquidity
According to the estimated outcome for 2023, Skopje recorded an operating surplus equivalent to about 18% of operating revenue, which is slightly higher than our September 2023 projections. Accounting for capital spending, the city also posted a slight overall surplus after capital accounts, broadly in line with our previous base-case forecast. Compared with the 2023 budget, both revenue and expenditure were significantly lower than originally planned, a frequent outcome in Skopje.
Over the forecast horizon through 2026, we expect the operating surplus to remain at about the same levels as in 2023, which is nevertheless weaker than budgetary outcomes recorded before the pandemic. We believe that stronger economic growth in 2024 and 2025 and easing financial conditions should support recovery in revenue related to the real estate market, including construction fees and property tax receipts. The administration also banks on improving collections of the mentioned taxes, a process which was previously halted due to more strained household and corporate financial positions stemming from the impact of the pandemic.
We also expect a continued increase in central government transfers, driven by the amended law to distribute more personal income tax and VAT revenue to municipalities, and compensation for wage and cost increases for decentralized functions that are fully funded by the central government. Additionally, we believe expenditure will increase at a slower pace, thanks to cost-saving measures and lower energy-related costs. Substantial pressure stems from subsidies granted to the municipal companies, particularly for public transportation. At the same time, we believe there is a risk that the city will continue to defer some of its due obligations to keep expenditure lower. This would indicate that actual expenditure is higher than the published cash-based accounts show.
In our base-case scenario, we expect only a mild deficit after capital accounts on average through 2026, given that we expect the capital spending to pick up at a much slower pace than budgeted. In our view, the municipality has the flexibility to postpone some projects if funding is not secured or if there are capacity delays. We note, however, that this could come at the expense of the city's economic development, especially given the existing infrastructure gaps. Skopje is focusing on projects associated with the green transition that would lower pollution, such as building wastewater facilities and other recycling plants. Other projects are aimed at improving mobility, including road repairs and the construction of roads, sidewalks, bicycle paths, and bridges. Although capital expenditure is relatively flexible, capital revenue is more rigid as it consists largely of central government transfers and asset sales that are not fully controlled by the city. We think the municipality's asset disposals are likely to remain volatile and lower than budgeted. However, we expect central government and EU-related funds to support the municipality and contain borrowing needs.
Despite low cash reserves, we expect the municipality to resume borrowing only toward the end of 2024. New borrowing is subject to lengthy approval processes, and authorizations to borrow appear unlikely until after the general election. We expect further debt intake from 2025 to finance capital projects and help restore liquidity levels. We forecast Skopje's tax-supported debt will remain close to 20% of consolidated operating revenue through 2026, which is low in an international comparison, thanks to revenue increases and contained debt issuance. The city has started repaying its largest commercial loan of about Macedonian denar (MKD) 700 million (about €11 million) from a local commercial bank. Apart from that, the city has only two other active loans from the World Bank (onlent via the Ministry of Finance). The city's debt is long term and amortizing, in local currency, and carries a floating interest rate. We also factor in the city's exposure to contingent liabilities, mainly stemming from its municipal companies' payables and lawsuits against the city that could materialize at some point, such as in 2023 when the city had to pay MKD100 million related to a 10-year-old overdue obligation and that temporarily led to the blocking of Skopje's liquidity account.
We view Skopje's liquidity position as weak. Given reduced cash holdings, the municipality's estimated available cash covers less than 100% of the cost of debt servicing for the next 12 months, after accounting for the forecast budgetary results. We expect Skopje will accumulate additional cash, both through better budgetary performance and debt intake. We consider the municipality's access to external liquidity limited by the comparatively underdeveloped local banking system and capital markets for municipal debt."