S&P places Skopje rating on watch negative on institutional uncertainty

S&P places Skopje rating on watch negative on institutional uncertainty gary yim/Shutterstock.com

SKOPJE (Macedonia), May 15 (SeeNews) - Standard&Poor's said it has placed its BB- rating on the municipality of Skopje on CreditWatch negative due to the political turbulence at the Macedonian parliament and local government elections not being initiated country-wide. 

The latest puts local governments' mandates into question, S&P said in a statement on Friday.

"We are placing our 'BB-' rating on the Municipality of Skopje on CreditWatch negative because of the uncertainty surrounding municipality councils' and mayors' legal ability to perform their obligations over the coming months," S&P said.

The CreditWatch placement reflects the agency's view that there is a heightened risk that over the coming three months, the central government will be unable to find a solution to the current uncertain situation at the local government tier, putting into question Skopje's ability to function professionally.

According to S&P, Skopje municipality will be able to maintain annual operating surpluses of nearly 20%, on average, over 2017-2019.

S&P also said in the statement:

"The rating on the Municipality of Skopje is constrained by a volatile and unbalanced institutional framework under which the municipality operates in Macedonia. The current ambiguous situation at the central government has increased the risks to Skopje's operations--as it has for all local governments across the country. Despite this, the rating continues to be supported by the city's relatively low, albeit increasing, debt levels and its steady economic growth prospects--which are likely to be reflected in a reasonable pace of growth in the municipality's operational revenues. This should allow Skopje to maintain solid budgetary results with sustainable operating balances. The city's liquidity position remained strong in 2016, but as the size and timing of future sales is hard to predict given low visibility on unsold office space and likely sales prices, we anticipate a gradual weakening of the municipality's liquidity position over 2017-2019, alongside lower associated operating and capital revenues.

Institutional set-up is not preventing uncertainties, but not yet affecting economic prospects 

Following the December 2016 elections, Macedonia has, to date, failed to put in place a functioning government. With this, the deadline for initiating local elections has passed without action. The Macedonian Law on Local Governments stipulates that local elections are to be held every four years, with the Macedonian Electoral Code specifiying that they should fall into the first half of May. As the Electoral Code does not contain any rules pertaining to the continuation of local governments' mandates until new elections are upheld, there now appears to be a policital vacuum. This puts into question the legal validity of decisions and operations undertaken at the municipal level over the coming weeks and potentially months. The Macedonian parliament could in theory call local elections and with this also change the Electoral Code to extend municipal level council members and mayors mandates. However, so far this has not occurred. Similarly we understand the Ministry of Local Governments is seeking a solution for the situation but has not yet concluded upon a resolution. We believe this imposes political and operational risks to the municipal tier overall as well as for the particular case of the city of Skopje. In addition, political division in the country may weigh further on the intergovernmental relationship, in particular should local and central government composition differ. Going foward, we may reflect this by revising our institutional framework assement for local governments in Macedonia or implementing a qualifier for the increased risks of rapidly rising political uncertainty.

Our view of Skopje's limited revenue and expenditure flexibility is due to the central government's control over municipalities' finances within the context of the Macedonian municipal framework. Furthermore, the predictability of Macedonia's institutional set-up is affected by the central government's fiscal policy. A high proportion of revenues depends on central government decisions, such as setting the base or range for most local tax rates. We note that further fiscal decentralization to transfer more responsibility to Macedonian municipalities for policing and health care has not progressed markedly in recent years. The provision of most services is funded with transfers from the central government's budget, and local governments have very limited autonomy in managing their revenues and expenditures.

The transparency of medium-term plans is weak, in our opinion. The audits for Skopje's accounts are mandated by an independent government body reporting to parliament, not by independent audit firms. The volatility of the real estate market further constrains the predictability of the municipality's budgetary performance. Historically, about one-third of Skopje's revenues is derived, both directly and indirectly, from real estate sales.

Our view of the city's financial management is weak because the municipality lacks medium-term financial planning for the core budget and its enterprises, and outcomes very often differ markedly from annual budgets. Capital revenues are often overestimated while capital expenditures are routinely well below the budgeted amount. 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. Nevertheless, the city government has a tight grip on operating expenditure. Moreover, it arranges funding from multilateral financial institutions directly and via the state treasury in advance for capital projects.

Skopje has low income and wealth levels compared to internationally. We project national GDP per capita to average just US$5,500 over 2017-2019. Nevertheless, we acknowledge the relative strength of the city's economy within the country, hosting the manufacturing units of export-oriented foreign companies as well as national companies that tend to be headquartered in Skopje. We also expect the local economy to gradually expand in line with the national economy, achieving annual GDP growth of about 2.5% over 2017-2019. We believe that these steady economic developments are likely to buoy the city's budget performance. We project the operating surplus to gradually narrow toward 21% of operating revenues by 2019 from exceptional 28% in 2016.

Budget execution remains strong, but possible volatility still a concern 

Skopje has shown another strong budgetary year in 2016, surpassing our last review expectations on stronger revenue intake and lower expenditure growth. With this, the city posted not only a sound operating surplus, but also maintained a positive balance after capital accounts, though at decreased levels compared with 2015 due to investments increasing. While tax revenues showed year-on-year growth, non-tax items underperformed both budget and year-end 2015 results. We expect tax revenues to stablize in 2017 and beyond and with this overall revenue growth to slow down. Operating expenditures have developed in line with expectations, while some underspending on goods and services can be observed for 2016. We expect 2017 expenditures to increase at a higher pace than last year. Similarly, we believe investment expenditures will increase, whereby capital revenues should remain volatile and are likely to underperform the city's budget. Overal this leads to deficits after capital accounts under our forecast through 2019, while roughly stable with our previous view.

These deficits after capital accounts average about 6% over 2017-2019 and lead to steady debt accumulation going forward, and in our base-case scenario. The central government has allowed Macedonian municipalities to take on debt only in recent years, and borrowing limits are gradually being relaxed. We forecast that Skopje's tax-supported debt will increase to 25% of consolidated operating revenues by year-end 2017 and over 30% by year-end 2019 in our base-case scenario.

Skopje's municipal company sector constitutes a credit weakness, in our view. 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 falling due over the coming 12 months. Nonetheless, we believe this ratio to be volatile and inflated by 2015 sales of office income and fees from land sales. Going forward, with limited visibility on the potential sales of commercial space, we anticipate a gradual reversal of the municipality's strong liquidity position to previously adequate levels. Nonetheless, the city's internal cash flow-generating capability remains strong, with an operating balance before interest exceeding annual debt service by 4x. Skopje holds its cash in an account at the state treasury.

These positive factors are mitigated 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."

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