May 4 (SeeNews) - Standard & Poor's (S&P) affirmed Montenegro's B+/B rating, but revised its outlook to negative from stable, as the pandemic of the novel coronavirus (COVID-19) may send the tourism-dependent economy of the country into a deep recession in 2020, it said.
"Although we assume growth will rebound in 2021, a protracted standstill in economic activity could inflict permanent damage to Montenegro's productive capacity, materially weaken its fiscal position, and negatively affect its domestic banking sector," S&P said in a statement late on Friday.
Earlier government prefunding activities and established relationships with international financial institutions (IFIs) mitigate short-term refinancing risks, S&P added.
Standard & Poor's also said in the statement:
"RATING ACTION
On May 1, 2020, S&P Global Ratings revised its outlook on Montenegro to negative from stable. At the same time, we affirmed our long- and short-term foreign and local currency sovereign credit ratings at 'B+/B'.
As "sovereign ratings" (as defined in EU CRA Regulation 1060/2009 "EU CRA Regulation"), the ratings on Montenegro are subject to certain publication restrictions set out in Art. 8a of the EU CRA Regulation, including publication in accordance with a pre-established calendar (see "Calendar Of 2020 EMEA Sovereign, Regional, And Local Government Rating Publication Dates," published Dec. 20, 2019, on RatingsDirect). Under the EU CRA Regulation, deviations from the announced calendar are allowed only in limited circumstances and must be accompanied by a detailed explanation of the reasons for the deviation. In this case, the reason for the deviation is the rising
risk of a protracted standstill in the domestic economy due to the direct and indirect effects from the SARS-CoV-2/COVID-19 pandemic and the adverse impact it could have on productive capacity, fiscal revenue intake, and banking sector stability.
The next scheduled rating publication on Montenegro will be on Sept. 4, 2020.
OUTLOOK
The outlook is negative because we see risks that a standstill in Montenegro's tourism sector and the wider economy, should it become protracted, could erode the country's already weak fiscal position, reduce its growth potential, and/or negatively affect the banking sector, for example, due to deterioration in asset quality.
Downside scenario We could lower our ratings on Montenegro within the next 12 months if the economic fallout of the COVID-19 pandemic becomes more severe than we
currently expect, leading to an erosion of fiscal performance, or resulting in a material deterioration in asset quality or heightened liquidity constraints in Montenegro's banking sector.
Upside scenario We could revise the outlook to stable if Montenegro's economic and fiscal prospects stabilize, putting its fiscal debt trajectory back on a downward path.
RATIONALE
We note that Montenegro remains particularly exposed to a protracted lockdown and travel restrictions, given that its tourism sector plays a key role in domestic economic activity. A protracted recovery from COVID-19 risks eroding Montenegro's already weak fiscal position. We estimate that the net general government debt at year-end 2019 amounted to 62% of GDP, which we consider elevated for a country with no monetary policy flexibility (given the unilateral euro adoption). We also consider that the COVID-19 pandemic could pose risks for the country's banks, for instance, if asset quality were to deteriorate notably.
The ratings are supported by government's cash reserves accumulated during previous pre-funding exercises alongside established arrangements with the IFI community, which ease the public sector's short-term financing needs.
S&P Global Ratings believes the global spread of COVID-19 will have significant implications for tourism-dependent sovereigns globally. In addition to the human costs, we expect the pandemic, together with travel restrictions both within Montenegro and in other tourist source markets, will have a significant impact on GDP, fiscal accounts, and foreign exchange inflows in 2020. While the timing of the peak of the pandemic will differ across sovereigns, the global peak will inform governments' decisions regarding travel restrictions and border closings, as well as tourists' propensity to travel.
Institutional and economic profile: Near-term economic contraction driven by dependence on tourism
-- Montenegro's tourism-dependent economy is vulnerable to a protracted global lockdown in response to COVID-19.
-- We expect it will contract by 7.8% in 2020 as domestic and external demand weaken because of the pandemic.
-- Political uncertainty also remains high as the country gears for general elections later this year and underlying tensions remain.
We expect that, similar to most other countries, the COVID-19 pandemic will have notable negative repercussions for Montenegro's economy. We expect the lockdown measures the government implemented on March 30, which currently extend to mid-May, will have a material negative impact on domestic demand. Furthermore, with the tourism sector accounting for about 30% of GDP and being a source of 40% of current account receipts, Montenegro's economy is highly vulnerable to external developments, as well. We believe that European economic activity is unlikely to stabilize by the end of the second quarter, and individual countries' borders might not fully reopen in time for the summer tourist season.
Our forecast that Montenegro's economy will contract by 7.8% in 2020 is based on the following assumptions:
-- Domestic consumption will suffer from two full months of lockdown measures, including closed borders. Over this period, we anticipate that service industry-related activity will be substantially diminished, and that May and June will be lost as tourism months.
-- We expect that there will be a gradual resumption of economic activity in the second half of 2020 as border restrictions and broader containment measures are lifted.
-- We foresee that a large part of private investment will be put on hold, given that much of it relates to the tourism sector. We understand that some public sector investments are ongoing, albeit at a subdued pace.
-- The falloff in recorded economic activity will similarly hit the purchasing power of the unofficial economy, further dampening activity.
Montenegro's tourism receipts are highly seasonal, with July and August accounting for almost 80% of tourist activity and suggesting there is still time for things to improve. Furthermore, we note that tourists from Russia and Serbia combined account for roughly two-thirds of tourist arrivals in Montenegro. Given the geographic proximity, tourism from Serbia could prove more accessible if borders open soon. We believe, however, that even if travel restrictions are removed, an important component will relate to the behavioral effects the pandemic will have on the propensity to travel. As such, we consider that substantial parts of Montenegro's 2020 tourist season could be
lost, with a more solid recovery only commencing in 2021.
In our view, Montenegro has only limited policy headroom to offset the short-term economic impact of COVID-19. The country has no monetary flexibility because it has unilaterally adopted the euro, while the fiscal space has been eroding in recent years, partly due to the ongoing debt-financed construction of a highway to link the coastal port of Bar with the Serbian border. Although the completed portion of the road has boosted growth in recent years, the cost of the first section also added about 20% of
GDP to debt over the past three years. The timeframe and financing arrangements for the additional sections of the highway in the current environment are even more uncertain as the fiscal space further narrows in 2020.
We consider Montenegro's institutional settings to be comparatively strong in a regional context. The country remains an EU candidate with upside potential from implementation of reforms that will align it with the EU's Acquis Communautaire (although we consider the announced possible accession in 2025 optimistic). Further progress could be hampered both by domestic developments and rising euroskepticism among the existing member states, which--under EU rules--will ultimately have to unanimously approve Montenegro's membership bid. Nevertheless, the ongoing EU accession negotiations strengthen the country's policy frameworks. The country is gearing up for general elections later this year and we expect the political uncertainty to remain elevated in the run-up.
Flexibility and performance profile: Montenegro's unilateral euro adoption and limited fiscal space constrain the country's ability to absorb shocks
-- We expect the fiscal deficit to reach 8% of GDP in 2020.
-- Previously accumulated cash and established relationships with IFIs mitigate short-term refinancing risks.
-- The banking sector will likely face challenges from a ramp-up in nonperforming loans (NPLs).
We forecast that Montenegro's general government deficit will reach 8% of GDP in 2020 with pressures predominantly coming from an expected reduction of fiscal revenue. We understand that the government aims to prepare a revised state budget in May to address the expected revenue shortfall. The budget will likely also include further, as yet unspecific, support measures for the private sector. Already, the government has announced two support packages to secure 70% of the minimum wage for all registered employees in sectors that had to close due to the pandemic-related lockdown. Further measures include a commitment to pay 50% of the gross minimum wage to workers in companies, whose work is at risk due to the lockdown and to people that have to stay home and take care of children under 11 or otherwise have been subject to quarantine measures."