Fitch cuts Macedonia's ratings, GDP outlook as political crisis bites

Fitch has cut Macedonia’s long-term foreign currency and local currency issuer default ratings (IDR) by one notch to to BB, citing the prolonged political crisis in the country, which underlines shortcomings in standards of governance and affects negatively the economy.

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The rating agency slashed its 2016 economic growth forecast for Macedonia to 2.5% from 3.6% following a sharp drop in annual GDP growth to 2% in the first quarter from 3.7% in 2015.

Economic growth was “dragged down by a large contraction in investment activity, likely affected by the uncertain political environment,” Fitch said in a statement late on Friday.

“GDP growth should recover to 3.4% in 2017 based on recovery in investment activity, but the risk of a deeper political crisis could negatively impact FDI inflows, a key driver of Macedonia’s economic model,” it warned.

The outlook on the ratings is negative, with a further downgrade possible in case of an escalation in political instability or pressures on public finances, the currency peg or foreign exchange reserves that could stem from potentially widening fiscal and current account gaps.

After the downgrade, Fitch’s rating on Macedonia is still one notch higher than that of Standard & Poor’s, which rates the country at BB- with stable outlook, three steps below investment grade.

Fitch’s full statement follows:

“Fitch Ratings has downgraded Macedonia’s Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) to ‘BB’ from ‘BB+’. The issue ratings on Macedonia’s long-term senior unsecured foreign and local currency bonds have also been downgraded to ‘BB’ from ‘BB+’. The Outlooks on the Long-Term IDRs are Negative. The Country Ceiling has been revised down to ‘BB+’ from ‘BBB-‘. The Short-Term Foreign Currency and Local Currency IDRs have been affirmed at ‘B’. The issue ratings on Macedonia’s short-term senior unsecured local currency bond have been affirmed at ‘B’.

KEY RATING DRIVERS

The downgrade of Macedonia’s Long-Term IDRs to ‘BB’ from ‘BB+’ with Negative Outlook reflects the following key rating drivers and their relative weights:

HIGH

Macedonia’s political crisis, which started following the emergence of major corruption allegations in February 2015, remains unresolved, underlining shortcomings in standards of governance. A roadmap brokered by the European Commission under the Przhino agreement in July last year broke down after failed attempts to hold early parliamentary elections in April and June this year. Protests have continued, the main opposition party has resumed its boycott of parliament and the special prosecutor’s investigation into the high-level corruption allegations has been hindered, according to independent observers.

In July, under EU and US mediation, the main political parties made some progress on agreeing the conditions for a new election and setting an election date. However, it remains uncertain whether parliamentary elections will actually take place, and if so, whether they will lead to a stabilisation of the political situation and ease political tensions.

MEDIUM

The political crisis has started to adversely affect the economy. Real GDP growth slowed sharply to 2% yoy in 1Q16 from 3.7% in 2015, dragged down by a large contraction in investment activity, likely affected by the uncertain political environment. We have revised our real GDP growth forecast for 2016 to 2.5%, from 3.6% previously. The new forecast is in line with Macedonia’s five-year average growth, but it is below the 3.5% five-year average of the ‘BB’ median. GDP growth should recover to 3.4% in 2017 based on recovery in investment activity, but the risk of a deeper political crisis could negatively impact FDI inflows, a key driver of Macedonia’s economic model.

The political situation also contributed to a ‘mini-panic’ in April that triggered a fall in household bank deposits. It also led the central bank to raise interest rates and intervene in the foreign exchange rate market to support the currency peg to the euro.

In reaction to weaker economic growth, the government adopted a supplementary budget in July. Largely due to lower revenues, the fiscal deficit target for 2016 was revised to 3.6% of GDP from 3.2% in the original budget. Fitch’s deficit forecast is slightly higher, at 3.8% of GDP, reflecting the expectation of higher than planned expenditures related to large investment projects and costs associated with the political and migrant crisis, as well as the recent floods. The latest supplementary budget follows a history of overshooting of fiscal targets that has contributed to a substantial rise in debt to 40% of GDP by the end of 2016, from 34% of GDP in 2012. This is still well below the ‘BB’ median of 51% of GDP, but debt is expected to remain on an upward trend.

Macedonia’s ‘BB’ IDRs also reflect the following key rating drivers:

Annual government debt maturities are high, at 10.8% of GDP in 2016 which is double the median of 4.9% for the ‘BB’ category. Macedonia issued a EUR450m Eurobond in July 2016, but the political crisis meant a higher cost of borrowing for the sovereign. 74% of government debt is in foreign currency, albeit mainly in euros. The sovereign’s contingent liabilities in the form of guarantees to state-owned enterprises are expected to rise to 9.7% of GDP in 2016, adding to upward risks to the public debt stock.

External finances are broadly in line with ‘BB’ category peers. Net external debt at 23% of GDP at end-2015 is above the ‘BB’ median of 16%, but is entirely accounted for by the private sector, where half the debt is intercompany lending. Fitch expects the current account deficit in 2016 to be moderate, at 1.9% of GDP in 2016.

The authorities’ strong commitment to maintaining the stability of the denar-euro peg is an important anchor of macroeconomic and financial stability. Political uncertainty in April 2016 forced the central bank to intervene in foreign exchange markets due to a sudden drop in denar-denominated deposits, but the level of foreign reserves remains adequate. Fitch estimates they covered 4.5 months of current external payments as of July 2016.

Levels of GDP per capita are in line with the ‘BB’ range median. Progress towards higher levels of income remains constrained by structural bottlenecks in the economy.

SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)

Fitch’s proprietary SRM assigns Macedonia a score equivalent to a rating of ‘BB+’ on the Long-term FC IDR scale.

Fitch’s sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows:
– Structural Features: -1 notch, to reflect Fitch’s assessment that the political risks are higher and levels of governance are weaker than what is captured by the SRM.

Fitch’s SRM is the agency’s proprietary multiple regression rating model that employs 18 variables based on three year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch’s QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.

RATING SENSITIVITIES

The main risk factors that, individually or collectively, could trigger negative rating action are:
– An escalation in political instability, particularly if it leads to a breakdown in ethnic relations or adversely affects the economy and public finances.
– Fiscal slippage or the crystallisation of contingent liabilities that jeopardise the stability of the public finances or currency peg.
– A widening of external imbalances that exerts pressure on foreign currency reserves and the currency peg.

The main factors that could, individually or collectively, result in a stabilisation of the Outlook include:
– A marked easing in political tension and uncertainty, including the completion of free and fair elections.
– Implementation of a credible medium-term fiscal consolidation programme consistent with a stabilisation of the public debt/GDP ratio.

KEY ASSUMPTIONS

Fitch assumes that Macedonia will continue to pursue monetary and fiscal policy measures consistent with its currency peg to the euro.

Fitch assumes there is no near-term resolution of the “name issue” with Greece that could unlock the path towards NATO and EU accession.”

SEE News
22 August, 2016