The stable outlook reflects the ratings agency's expectation that Skopje municipality will manage its temporary budgetary performance deterioration and return to a stable debt-reduction path once the pandemic subsides, S&P said in a statement on Friday.
However, S&P noted it could downgrade Skopje's rating in the following year if the long-term rating of North Macedonia is lowered or if Skopje's liquidity or budgetary performance weakens materially.
The global ratings agency also said in the statement:
We could lower our rating on Skopje within the next 12 months if we lowered our long-term rating on North Macedonia (BB-/Stable/B), or if Skopje's liquidity or budgetary performance weakens materially. In addition to the risks associated with a more prolonged economic impact from the pandemic, relaxed control over operating expenditure and increased capital investments could result in weaker budgetary performance that pushes up deficits after capital accounts structurally to high levels.
Any ratings upside is contingent on us raising our rating on North Macedonia. Given a higher sovereign rating, we could raise our rating on Skopje if the central government steps in to provide additional support to the city's finances, including its related companies, and if management strengthens its long-term planning and budgeting, resulting in sustained improvement in its budgetary performance and a reduction in debt.
Skopje entered 2020 with a strong fiscal position of high operating surpluses and low debt (below 20% of operating revenue). Due to the pandemic, we anticipate tax revenue losses and additional expenditure will lead to deficits after capital accounts of 15.2% of total revenue in 2020, and direct debt of 24% of operating revenue by 2021. Municipal companies' additional planned debt issuance would push up expected tax-supported debt to close to 40% of consolidated revenue, and we expect it will start declining gradually from 2022. We also expect that Skopje will partly finance its deficits by depleting previously accumulated high cash reserves over our forecast horizon through 2022. Uncertainties about medium-term investment spending could further deplete the municipality's cash levels. Our rating on Skopje remains constrained by the volatile and unbalanced institutional framework under which the municipality operates in North Macedonia.
Skopje's performance remains supported by its status as economic center of the country, despite the pandemic-induced recession
Although we expect a sharp contraction in North Macedonia's real GDP of 6.0% in 2020, we believe Skopje's economic fundamentals will remain solid, given its status as the country's financial and administrative center. In an international comparison, however, Skopje's population has relatively low income and wealth levels. We project national GDP per capita will average $6,300 over 2020-2023. The city hosts well-diversified production facilities of export-oriented foreign companies, as well as national headquarters of domestic companies. We expect the local economy will gradually recover in line with the national economy, achieving average real GDP growth of about 3.3% over 2021-2023. This is based on our assumption that the pandemic will subside in 2021, allowing the economy to recover. With steady growth in 2021-2023, we expect Skopje's budgetary performance will return to a healthy position, with contained deficits after investment expenditure.
The predictability of North Macedonia's institutional setup is affected by the central government's fiscal policy. Plans for further decentralization continue with a focus on policing and tax collection. Effective implementation remains uncertain and we understand that discussions were paused in light of the pandemic. Skopje receives funds for services provided through earmarked transfers from the central government's budget. During the pandemic, the central government did not distribute extraordinary support to the local tier, as seen among some international peers. Similar to other local governments in the region, Skopje has very limited autonomy to divert received funds to other uses.
We consider financial management a key 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 diverge materially from the budget. Although management has taken some steps toward more realistic planning, execution both for capital revenue and capital expenditure (capex) continue to be unpredictable. For example, in 2019, capital revenue was more than double the budgeted amount. We understand capex overestimation, to some extent, reflects considerations outside of Skopje administration's direct control, such as delays owing to lengthy public procurement procedures. The city produces multiyear forecasts, but the achieved figures continue to vary considerably from forecasts. That said, the city government has a relatively tight grip on operating expenditure, and regularly reevaluates 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 accountable to parliament.
Local elections are scheduled for 2021, but following the smooth transition following the prior electoral change and stability in the management team, we anticipate continuity post-election. In the final year of the current mandate, we expect some investment projects to be pushed toward finalization.
The pandemic will increase spending and hurt balances after capital accounts, but Skopje will remain in an operating surplus
Similar to other local and regional governments, we expect Skopje's tax base will worsen significantly in 2020 and moderately recover in 2021, on the back on an economic recovery. Half-year results show a very low collection of municipal and property taxes as well as nontax items, while transfers from the central government, accounting for 45% of operating revenue, are in line with standard year-on-year growth expectations. Additional subsidies to municipal companies will also increase local government spending. For example, the transportation company already received 95% of its budgeted amount by midyear and might require additional support in the second half of 2020. Therefore, we project the municipality's operating surplus will decline to 9.9% of revenue in 2020 and average 12.0% over 2021-2023 compared with 20.4% in 2019. We anticipate management will implement measures to strengthen revenue collection and adequately control expenditure, which could prevent further deterioration over the medium term.
We believe capex will remain at its historical average in 2020, but will return to higher levels because of the city's large infrastructure gap from 2021. According to management, investment projects were not delayed materially due to the pandemic. The project pipeline is dense and involves investments mainly in roads, bridges, and public transportation. Capital revenue is likely to remain volatile and be significantly lower than budgeted in 2020. Half-year 2020 figures indicate no real estate sales. Overall, this leads us to forecast deficits after capital accounts of close to 5% of revenue over 2021-2022, after a peak deficit of 15% in 2020.
In our view, Skopje's budgetary performance continues to be volatile due to its exposure to the real estate market, especially construction taxes and land sales. The city derives about 30% of its revenue from real estate-related development, both directly and indirectly.
We believe Skopje has limited revenue and expenditure flexibility. 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 for central government transfers. We continue to believe that scaling down capital spending might be challenging, given the city's infrastructure gap.
The large deficits after capital in 2020 are likely to lead to a reduction in Skopje's accumulated liquidity reserves and increase debt. A contracted loan facility will be drawn upon until year-end 2021, partially covering deficits and investment needs. Skopje will nevertheless continue to conform with the central government borrowing limits. Post-pandemic, we continue to believe that the city will resume its deleveraging plan, supported by improvements in operating performance. We forecast tax-supported debt will peak at just below 40% of consolidated operating revenue, including additional borrowing by the municipal companies, before declining again in 2022.
We also view Skopje's exposure to its municipal companies as a key credit weakness. Several municipal companies have investment needs and large payables that ultimately dependent on the city's support. Additional contingent liabilities may come from the municipality's plans to foster infrastructure development through public-private partnerships.
Skopje's debt service coverage ratio remains 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 will decrease to finance part of pandemic-related tax shortfalls and related expenditure, as well as upcoming investment projects. We anticipate a gradual weakening of the municipality's strong liquidity to adequate levels by year-end 2023. Skopje holds its cash in several accounts at the state treasury. These positive factors are balanced by the city's limited access to external liquidity, owing to North Macedonia's relatively underdeveloped local banking system and capital markets for municipal debt."
