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S&P downgrades Montenegro to B, outlook stable

Author Radomir Ralev
S&P downgrades Montenegro to B, outlook stable gary yim/

PODGORICA (Montenegro), March 10 (SeeNews) - Standard & Poor's (S&P) lowered Montenegro's long-term foreign and local currency sovereign credit ratings to 'B' from 'B+', with a stable outlook, it said.

The short-term foreign and local currency sovereign credit ratings of Montenegro were affirmed at 'B', with stable outlook, S&P said in a statement last week.

"We estimate that Montenegro's tourism-based economy contracted 15.5% in 2020 and its balance-of-payments and fiscal positions weakened in tandem, with tourism-sector recovery expected to be only gradual based on global vaccination progress," S&P said.

Standard & Poor's also said in the statement:

"Rating Action

On March 5, 2021, S&P Global Ratings lowered its long-term foreign and local currency sovereign credit ratings on Montenegro to 'B' from 'B+'. At the same time, the short-term foreign and local currency sovereign credit ratings were affirmed at 'B'. The outlook is stable.


The stable outlook reflects our view that, despite the erosion of Montenegro's fiscal space from the pandemic, there are no immediate pressures from higher debt levels over the next 12 months. Montenegro has accumulated sizable cash buffers through prefunding and we estimate that these are enough to cover all upcoming government debt payments in 2021. The stable outlook also assumes that successful vaccine distribution in Montenegro and in Europe in 2021 will allow for a gradual re-opening of Montenegro's tourism industry, which should support economic recovery over the medium term.

Downside scenario

The ratings could come under pressure if Montenegro's economy does not rebound as we expect over 2021-2022, in turn further straining the already weak fiscal position. We could also lower the ratings if the fiscal position continues to deteriorate for other reasons, resulting in net general government debt continuing to rise in contrast with our current expectations that it will stabilize at under 80% of GDP. This could be the case if the government is unable to control current spending over the medium term or undertakes large additional debt-financed projects. That said, we currently view imminent pressures on Montenegro's debt sustainability as unlikely.

Upside scenario

We could raise the ratings if Montenegro's fiscal prospects improve compared with our baseline expectations. This could be the case if the tourism sector stages a faster comeback and underpins higher growth, in turn supporting Montenegro's budgetary performance and balance-of-payments position.


Montenegro's tourism-dependent economy has been hit hard by the COVID-19 pandemic and related containment measures. With tourist arrivals down 80% year on year in 2020, we estimate the economy contracted by 15.5%. In parallel, we estimate that Montenegro's current account deficit surpassed 25% GDP on account of the associated collapse in service receipts.

We believe the fallout from the COVID-19 pandemic has caused lasting damage to Montenegro's already weak fiscal position. We now estimate that Montenegro's net general government debt will average just under 80% of GDP over the medium term, which is almost 20 percentage points higher than our pre-pandemic projections. We consider this level elevated, particularly given the lack of monetary policy flexibility stemming from the unilateral adoption of the euro.

We estimate that Montenegro's general government deficit amounted to 10.5% of GDP last year but should gradually reduce toward 3% of GDP in 2023. Even so, there are risks that the authorities might not be able to control the level of current spending, given a history of lax spending control and especially the heterogeneous nature of the new governing coalition and its slim parliamentary majority.

Positively, through pre-funding the authorities have accumulated substantial cash buffers, which we estimate at 27% of GDP at year-end 2020. These mainly stem from a successful €750 million Eurobond placement in December 2020 and are enough to cover all upcoming debt payments in 2021.

The COVID-19 pandemic has triggered an economic shock that is more pronounced in tourism-dependent countries like Montenegro, with the country's important tourism sector largely at a standstill over most of 2020. The loss of tourism revenue has worsened an already strained external position, resulting in a material loss of economic output and significant fiscal damage. The country's high fiscal debt burden limits its ability to absorb shocks, in particular because Montenegro's currency regime limits monetary policy flexibility.

Institutional and economic profile: Only partial recovery following a large 15.5% economic contraction in 2020

We estimate that Montenegro's GDP contracted 15.5% in 2020 as tourist arrivals almost dried up.
We believe the strength of the country's economic rebound is subject to numerous risks as the pandemic lingers, while the domestic vaccination program is off to a slow start.
The August 2020 elections ended the Democratic Party of Socialists' (DPS') three-decade rule, bringing a new diverse coalition of parties with a slim parliamentary majority into power.

We estimate Montenegro's economy contracted by 15.5% in 2020, with output suffering from substantially diminished service-industry-related activity due to social-distancing measures and closed borders. Notably, given Montenegro's tourism sector accounts for an estimated 30% of GDP and 40% of current account receipts, the COVID-19 pandemic has exposed the economy's vulnerability to external developments.

In our view, Montenegro has only limited policy headroom to offset the economic effects of COVID-19. The country has no monetary flexibility because it has unilaterally adopted the euro, while 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. The cost of the first section has 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 given the country's strained fiscal stance.

Positively, while tourism remained mostly absent in 2020, foreign direct investment (FDI) inflows were unexpectedly positive. In particular, FDI flows into the utility and real estate sectors remained dynamic, with inward FDI at about 10% of GDP--supporting several ongoing hospitality-related projects alongside investment in energy transition to solar and wind power generation. Furthermore, an uninterrupted flow of remittances, at about 7% of GDP in 2020, supported current account receipts.

We expect the pace of economic recovery in Montenegro to be only gradual. We forecast that Montenegro's economy will expand by 6% in 2021 and return to 2019 levels of output in real terms only in 2024. The forecast remains sensitive to the uncertain situation regarding the pandemic and the risk of fresh containment measures and possible delays in vaccination roll-out. In particular, success in administering immunization programs, both domestically and abroad, will determine the extent to which Montenegro's economy can re-open for the important upcoming summer tourist season.

The parliamentary election, held on Aug. 30, 2020, brought an end to the longstanding parliamentary rule of the DPS. Instead a three-block coalition, the blocks in themselves coalitions, was formed in the election aftermath. Even though the three blocks are united in their opposition to the DPS, they hold diverging views on a range of policy priorities and have instated a technocratic government to overcome partisan politics. Although the coalition government has voiced plans to streamline public administration and enhance transparency of budgetary allocation, execution could prove difficult amid existing power structures and vested interests.

Given its fragmented nature and diverging policy views, together with its thin majority in parliament, we believe the current coalition could prove unstable. The new government is yet to release its 2021 budget and concretize its economic policy objectives, including the outline of a budgetary consolidation agenda. Currently, the government is executing the 2021 budget on a temporary financing basis expected to last at least through first-quarter 2021.

In our view, overall, Montenegro's institutions can be characterized as developing. We consider that the orderly power transfer in the aftermath of the 2020 parliamentary elections represents an important precedent. That said, instances of corruption and irregular adherence to rule of law have been reported in the past and we believe they will continue to hamper the business environment. Still, Montenegro's institutional setting benefits from the country's status as an EU candidate. Reforms implemented as part of the accession negotiations have the potential to strengthen the country's policy frameworks and align Montenegro with the EU's Acquis Communautaire. The incumbent government has reiterated its commitment to Montenegro's EU path following the election.

We consider Montenegro's plan for EU accession in 2025 as optimistic. This is because we believe both domestic developments and Euroscepticism among the existing member states could hamper the process, since--under EU rules--member states will ultimately have to unanimously approve Montenegro's membership bid.

Flexibility and performance profile: A surge in public debt has eroded policy space, especially given the lack of independent monetary policy

We assess the pandemic fallout as having caused lasting damage to Montenegro's public finances, since net general government debt exceeds 80% of GDP in 2020-2021.
Balance-of-payments vulnerabilities remain elevated given the current account deficit reached almost 26% of GDP in 2020, while monetary flexibility is almost nonexistent.
The placement of a €750 million Eurobond in December 2020 reduces short-term refinancing concerns.

We estimate that Montenegro's general government deficit reached 10.5% of GDP in 2020 due to a marked decline in government revenue alongside discretionary spending initiatives. Through 2020, the government deployed four fiscal support packages aimed at helping households and the private sector survive COVID-19-induced liquidity pressure. The chief measure includes the securing of 70% of wages for all registered employees in sectors that had to close due to the pandemic-related lockdown.

Montenegro's 2021 budget execution is on a temporary financing basis for the first quarter, and as such budgetary allocations are equivalent to those in 2020, while awaiting the finalization of the new administration's budget plan and medium economic priorities. We anticipate that the government will aspire to consolidate its weakened fiscal position but forecast the fragility of the economic recovery will require substantial fiscal support in 2021. Consequently, we forecast the fiscal deficit will reach 7% of GDP this year, gradually tightening toward 3% of GDP in 2023, supported by the rebounding economy and the government's consolidation efforts.

In turn, we now forecast Montenegro's net general government debt will reach 82% of GDP in 2021, up from 58% in 2019, adding pressure to its already constrained fiscal position. As the government increasingly relies on net borrowing from the rest of the world, the sustainability of Montenegro's external financing is increasingly a function of the public sector's access to external capital markets. A sudden loss of access to foreign financing (which we currently do not project) would not only create a fiscal cliff for public finances, but also likely drain foreign reserve levels, and tighten overall financial conditions in a euroized economy that lacks a lender of last resort.

Montenegro's government debt is primarily owed to foreign creditors, with only a limited amount of domestic securities issued. Associated risks are partially mitigated by the fact that about 40% of government external debt is to official lenders under generally favorable conditions. However, the debt-redemption profile remains rather uneven, which is a function of the small size of the government budget and Montenegro's economy. Authorities issue benchmark-size instruments that are comparatively large as a percentage of GDP, meaning repayments are high for those years with Eurobond maturities.

We consider that Montenegro's favorable relationship with the international financial institutions and its currently ample liquidity are keeping short-term pressures in check in the context of its widening financing needs. The proceeds of a Eurobond issuance in December 2020 increased the government's cash position to 27.5% of GDP at year-end 2020. We expect this will cover borrowing needs for 2021, which include a €227 million Eurobond redemption in March 2021. We also note that despite higher leverage, Montenegro's interest expenditures will remain more contained, averaging about 6% of government revenue through 2024.

Montenegro also remains vulnerable to balance-of-payment risks, with a large net external liability position and persistent current account deficits. Historically, the economy has relied substantially on net inflows of foreign FDI into tourism and associated real estate. We observe that FDI flows showed resilience in 2020, with inward FDI in the region of 10% of GDP, supporting ongoing investments, particularly within the utility sector. In our base-case scenario, we expect FDI to be the key driver in Montenegro's import bill, supporting the resumption of several ongoing hospitality projects. We expect FDI will average 10% of GDP annually in 2021-2023, broadly in line with historical trends, fueling rising imports. With current account receipts from tourism only gradually returning to 2019 levels, we estimate that the country's current account deficit will remain elevated at about 20% of GDP in 2021-2023, moving toward its historical average of about 15% of GDP during the latter part of the forecast horizon.

As a response to COVID-19, the Central Bank of Montenegro extended a 90-day loan payment moratorium to borrowers affected by containment measures. Montenegro's unilateral adoption of the euro, however, prevents its central bank from setting interest rates and controlling the money supply, and restricts its ability to act as a lender of last resort. Although the central bank has some options to provide liquidity support to domestic banks, in our view, its inability to create additional liquidity in a stress scenario effectively prevents it from fulfilling the function of lender of last resort.

We also consider that the aftermath of the COVID-19 pandemic could pose risks for the country's banks, for instance, if asset quality notably deteriorates when various support schemes are gradually phased out. Positively, Montenegro's banking system has entered the pandemic in a relatively strong position, with solid capital levels, nonperforming loans (NPLs) at a low 5%, and ample liquidity. The system is dominated by subsidiaries of foreign banking groups, which typically have financial positions exceeding those of solely domestic banking groups. In December 2020 the two largest banks, CKB and Podgoricka Banka, completed their anticipated merger, with the combined entity now accounting for about 40% of sector assets. The banking system is largely funded by domestic deposits providing some stability.

We have so far observed no notable deposit flight and in our base-case scenario we expect the situation will remain stable. We still anticipate an increase in the level of NPLs as households and corporates are affected by the economic fallout of the pandemic. The rise in NPLs is likely to be felt with a lag as fiscal support and loan moratoria are phased out. The central bank is in the process of preparing an asset-quality review for all 13 banks with the results due to be published by April 2021."

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