SKOPJE (North Macedonia), October 24 (SeeNews) – Standard&Poor's said it has affirmed its 'BB-' long-term issuer credit rating on the municipality of Skopje, the capital of North Macedonia, with a stable outlook.
Skopje's transition to the current administration after the 2017 elections was smooth and we expect to see stability in policy implementation, S&P said in a statement last week.
"We anticipate that Skopje's operating performance will weaken in 2019-2021, but the margin will remain at about 20%," S&P said, adding that because of a considerable infrastructure gap, capital expenditure (capex) will keep absorbing a large amount of resources, despite reduced capex in 2018.
According to S&P, the stable outlook reflects its view that Skopje will maintain a healthy operating performance with declining debt and adequate liquidity balances. “Furthermore, in our base-case scenario, we assume stability in the management team and its policies and practices.”
S&P also said in the statement:
The rating on Skopje is constrained by the volatile and unbalanced institutional framework under which the municipality operates in North Macedonia. The city's financial management policies have remained stable over the past two years following the local elections. The city reduced its debt in 2018, and we forecast debt will remain below 20% of operating revenue. Ongoing operating expenditure controls are likely to result in positive operating balances. Uncertainties around future and medium-term investment project spending remain, however, which could weigh on the city's cash levels.
Solid growth prospects from a low economic base and stability in the current city government pave the way for steady financial performance
Following tensions at the central government level in 2017, and the subsequent delay in local elections, administrative power was smoothly transferred to a coalition led by the Social Democratic Union (SDSM). There was no turnover in technical personnel, and we see consistency of financial management policies under the new mayor, which we consider an indication of political stability. The current administration has closer ties with the central government than the prior one, particularly as the mayor is also vice secretary of SDSM.
The predictability of North Macedonia's institutional set-up is affected by the central government's fiscal policy. We note that there are plans for further fiscal decentralization, to transfer more responsibility to North Macedonian municipalities for policing, health care, and tax collection. However, this has not progressed markedly in recent years, although it remains an agenda item for the current government. Skopje funds most services through earmarked transfers from the central government's budget. Like other local governments, it has very limited autonomy to divert funds to different uses.
The city's financial management is a weakness for the rating. The municipality lacks tested medium-term financial planning for the core budget and its enterprises, and outcomes on annual budgets very often differ markedly from planned volumes. While we see initial steps toward more realistic planning of capital revenue in the 2019 budget, capex is still routinely overestimated. We understand that, to some extent, this reflects considerations outside of the Skopje administration's direct control, such as delays owing to lengthy public procurement procedures. Half-year 2019 figures still indicate low volumes of real estate sales executed. The margin of execution appears on better footing though, with 20% already achieved, versus 2018 full-year execution hardly reaching this level. Additionally, with the amended law on local government finances, a ceiling has been placed on total budget size, set at a maximum of the past three years' average budget volume and a 10% allowance for an increase. Regardless of this institutional measure, greater budgetary precision would enhance Skopje's planning capabilities. The city produces multiyear forecasts, but the achieved figures differ considerably from the forecasts. On the positive side, the city government has a relatively tight grip on operating expenditure and is closely reevaluating its investment program. Moreover, it arranges funding for capital projects in advance from multilateral financial institutions, both directly and via the state treasury. Skopje's accounts are audited by an independent government body reporting to parliament.
Skopje has low income and wealth levels in an international comparison. We project national GDP per capita will average just US$6,700 over 2019-2021. The city is the center of the country's economy, hosting manufacturing facilities of export-oriented foreign companies, as well as headquarters of national companies. We expect the local economy to gradually expand in line with the national economy, achieving annual GDP growth of about 3% over 2019-2021. We believe that these steady economic developments are likely to buoy the city's budget performance.
Financial performance is strong, but the infrastructure gap remains high
Skopje's financial performance in 2018 exceeded our base-case expectations, thanks to higher revenue and a slowdown in capex. A strong underlying economy and higher transfers from the central government drove the increase in tax revenue. At the same time, capex was contained through cancellation of some of the "Skopje 2014" projects to build monuments and renovate facades. Despite a further decline in the amount of land sales, the balance after capital accounts remained positive, leaving more room for deleveraging. We expect revenue growth to maintain its momentum, expanding in line with the economy. Half-year numbers indicate good execution of property taxes and non-tax items, with some underexecution on transfer service taxes. Strong pressures from salaries and subsidies to municipal companies will also absorb more funds, with both items already at an execution rate of 45% and above. We think this will moderately reduce the operating margin to 18% in 2021. In addition, we believe capex will return to higher levels because of the city's large infrastructure gap. The project pipeline is dense and involves investments in roads, schools, and public transportation. Half-year execution has surpassed 2018 levels already. Capital revenue is likely to remain volatile and to be lower than budgeted. Overall, this leads us to expect deficits after capital accounts under our forecast through 2021 at an average of 2.0%.
Volatility of the real estate market further constrains the predictability of the municipality's budgetary performance, especially regarding construction taxes and land sales. Skopje derives about one-fourth of its revenue from real estate-related development, both directly and indirectly.
Our view of Skopje's limitations regarding revenue and expenditure flexibility remains unchanged. A high proportion of revenue depends on central government decisions, such as setting the base or range for most local tax rates, as well as the distribution coefficients. In addition, despite a slowdown of capex in 2018, we believe scaling down capital spending may be challenging, given the city's infrastructure gap.
The above mentioned deficits, coupled with a persistent reduction of the city's debt burden, are likely to lead to a reduction in Skopje's accumulated liquidity reserves. The central government has only in recent years allowed municipalities in North Macedonia to take on debt, and borrowing limits are gradually being relaxed. However, these limits are essentially not rigid for Skopje, whose stock of debt reduced to just 17% of operating revenue in 2018. In addition, we believe that the city will continue with its deleveraging plan, supported by high cash balances and strong operating performance. As a result, we forecast tax-supported debt will remain roughly stable at around 20% of consolidated operating revenue by year-end 2021.
We see Skopje's municipal company sector as a credit weakness. Several municipal companies have investment needs and large payables. Additional contingent liabilities may come from the municipality's plans to foster infrastructure development through public-private partnerships.
Skopje's debt service coverage ratio is high, with cash holdings--adjusted for the deficit after capital accounts--substantially exceeding 200% of debt service falling due over the coming 12 months. Nonetheless, we believe this ratio is volatile and inflated by cash accumulated through 2015 asset sales and fees from land sales. With normalized asset sales and a pickup in infrastructure investment, we anticipate a gradual reversal of the municipality's strong liquidity position to adequate levels. We believe that the city will be able to manage the cash balance at a minimum of Macedonian denar 200 million (about US$3.9 million). Skopje holds its cash in an account at the state treasury. These positive factors are countered by the city's access to external liquidity, which we view as limited, owing to the relatively immature local banking system and capital markets for municipal debt.