August 5 (SeeNews) - Standard & Poor's maintained on Friday its long- and short-term foreign and local currency sovereign credit ratings on Albania at B+/B with a stable outlook.
"We believe that Albania's steady economic performance and ongoing improvement in its fiscal consolidation are likely to continue, despite the risk of fiscal slippages due to the 2017 general elections or external financing pressures," S&P said in a statement.
"The stable outlook reflects our view of balanced risks to the ratings on Albania over the next 12 months, since we anticipate that Albania will continue the fiscal consolidation that is anchored by its IMF arrangement, while containing potential risks to its economy and policymaking," it added.
S&P also said in the statement:
"RATING ACTION
On Aug. 5, 2016, S&P Global Ratings affirmed its 'B+/B' long- and short-term foreign and local currency sovereign credit ratings on the Republic of Albania. The outlook is stable.
RATIONALE
The affirmation reflects our view that Albania's steady economic performance and ongoing improvement in its fiscal consolidation are likely to continue despite the risks of fiscal slippages due to the 2017 general elections or external financing pressures. In our view, the risk that Albania could potentially face refinancing pressures of its still-high government debt is mitigated by its compliance with the existing International Monetary Fund Extended Fund Facility (IMF EFF or the arrangement) in place until early 2017, and by reducing refinancing risks through the lengthening of the government's debt maturity structure. Moreover, we think that economic growth is likely to be supported by institutional improvements, such as the implementation and full compliance with the July 2016 parliamentary approval of the judicial reform package, the absence of which has been a key deterrent for more significant foreign investments.
We believe that a successful track record of implementing reform in the country's judicial institutions, besides improving the business climate, could drive Albania's progress toward opening EU accession negotiations over the coming 12 months. This would, however, not only hinge on Albania itself but also on political developments regarding the EU. The government has already tackled several reform areas over the past years, such as pensions, local governments, and energy supply.
We expect that Albania's economy will grow by an annual average of 3.7% over 2016-2019, with domestic demand contributing more strongly to growth performance over the next couple of years, which represents a shift from recent years when net exports were the primary growth engine.
In that regard, we expect that net foreign direct investment (FDI) inflows, especially in the hydropower sector and the Trans-Adriatic Pipeline project in 2016-2018, will likely fund most of Albania's large current account deficit, projected at about 13% of GDP on average during 2016-2018. In order to improve the trade balance, which has been adversely affected by low commodity prices in 2015 and 2016, and shift to more export-oriented economic growth, FDI will remain key over the coming years and could be supported by the above-mentioned judicial reform. Albania's gross external financing needs, which we estimate at 116% of current account receipts in 2016, are significant. Its external indebtedness is relatively low as financing for the current account deficit has historically been more in the form of net foreign investment, particularly in the energy sector, rather than debt-creating inflows. While narrow net external debt, by our measures, increased in 2014-2015, we project that it will remain rather stable relative to current account receipts in 2016-2019.
Given Albania's links with Greece, home to a substantial Albanian population, the Greek crisis has structurally reduced remittances to Albania as workers returned, although remittances flared up before the capital controls in Greece were established last summer. We currently project remittances to remain subdued at about 7% of GDP in the next few years (compared with an average 13% of GDP over 2004-2008), but migration of Albanians to other countries will contribute to further diversify remittance sources.
We expect Albania's fiscal performance will remain solid over 2016-2019 as authorities continue to make progress under an IMF program that targets fiscal and structural reforms. As a result, we expect general government debt will decline to 62% of GDP in 2019 from about 72% of GDP in 2015. We include in our calculation of general government debt also debt issued mainly by the electricity sector and guaranteed by the government (nearly 4% of GDP) to reflect our view that the probability of these guarantees being called is high. Our measure of net general government debt is set do decline to 60% of GDP by 2019 from just under 70% in 2015. Our expectation of future general government deficit reduction to 1.5% of GDP in 2018 from 4% in 2015 is based on the government's plan to increase revenues through increased efficiency on tax and customs revenue collection and compliance while broadening the tax base. We observe that tax collection in Albania is challenged by evasion and administrative deficiencies, and we therefore believe that recent measures to improve tax compliance will aid an improvement in government finances, albeit gradually.
The main near-term threat to Albania's public finances would be an increasing fiscal deficit due to the general elections in 2017, potentially coupled with arrears accumulation and an economic slowdown due to increased political uncertainty. We understand that the government is better positioned to avoid such a situation than in the last general election year in 2013, when financing pressures for the government emerged. This is in part due to provisions of the new budget law that are explicitly designed to avoid spending slippages ahead of elections and a new fiscal rule aims to anchor the downward trajectory of public debt toward a long-term target of 45% of GDP. We note, however, that the robustness of fiscal rules remains to be tested. At the same time, the government itself is structurally in a better fiscal position with significant reserves ($3.1 billion at year-end 2015) and has successfully improved the structure of public debt.
The government has extended its debt maturity profile considerably over the past three years. However, for the domestic portion of debt, average maturity remains short, at 741 days as of June 30, 2016. Domestic debt currently accounts for over 50% of the total. Albania markedly reduced its financing in the domestic market in 2015-2016 in favor of external borrowing. However, we still view the links between the government and the country's financial sector as a potential refinancing risk. For example, Albania's banking system still holds the largest share of domestic debt, and over 20% of the banking system's assets are government securities.
Potential improvements in the legal system are also important in order to reduce nonperforming loans (NPLs). The high level of NPLs in the financial sector hampers lending and constrains faster economic growth. The government is making strides in tackling NPLs comprehensively through legal changes that aim at improving collateral execution, for example by strengthening bankruptcy and private bailiff laws. NPL levels were still high at about 18% at end-2015. We project that the deposit-funded financial sector will remain in a net external creditor position over the next few years. Capital buffers in the banking system are well above minimum capital requirements. The increase of the financial sector's net foreign assets--in part the reflection of high liquidity--mirrors the country's weak growth performance and limited lending opportunities for banks in recent years, but also deleveraging of foreign banks' subsidiaries and high risk aversion that can in part be attributed to weaknesses in the legal framework for collateral execution. We estimate bank credit to the private sector to have grown at slightly over 2% in the first half of 2016. Subsidiaries of Greek banks maintain a sizable presence in Albania and the authorities have taken measures to limit exposure to their parents and prevent contagion risks to the rest of the sector.
The Albanian central bank's policy of monetary easing will continue throughout 2016--as inflation will likely remain well below the 3% target. However, the high share of foreign currency loans (at about 60%) and deposits (at about 50%) is hindering the effectiveness of Albania's monetary policy, as it does in several economies across the region.
We note that Albania's central bank intervened only marginally in the foreign exchange market in 2014-2016 to increase its foreign currency reserves in line with its targets. Otherwise it maintains a free-floating exchange rate regime. Although Albania's monetary flexibility benefits from this regime, it is challenged by the relatively shallow foreign exchange and capital markets.
OUTLOOK
The stable outlook reflects our view of the balanced risks to the ratings on Albania over the next 12 months, since we anticipate that Albania will continue the fiscal consolidation that is anchored by its IMF EFF program, while containing potential risks to its economy and policymaking.
We could raise the ratings if structural reforms established a track record of improved institutions, strengthened investment, and lifted income levels. The significant reduction of government debt beyond our current forecasts, potentially alongside higher-than-expected economic growth, would also be positive for the ratings.
We could lower the ratings if the government's finance position deviated significantly from our current projection, along with potential financing pressures. We could also lower the ratings if we saw a significant deterioration in Albania's external position and ability to fund its current account deficit, which could also occur if the availability of external official support were uncertain."