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Moody's downgrades Bosnia and Herzegovina to B3; on review for further downgrade

April 04, 2012 | Moody's Investors Service

New York, April 03, 2012 -- Moody's Investors Service has today downgraded to B3 from B2 the government bond rating of Bosnia & Herzegovina and commenced a review for further possible downgrade, reflecting a deterioration in the country's public-sector budget and external financing. The outlook had been negative since May 2011.



The key drivers for the downgrade to B3 and review for further possible downgrade of Bosnia & Herzegovina's government ratings are:



1) The deteriorating fiscal position of the general government, including the emergence of large structural deficits at the sub-national level and limited access to external financing.



2) The increased susceptibility of the country's debt-service management to antagonistic political dynamics, as evidenced by the brief interruption of payments to several multilateral financial institutions and on one commercial bank loan earlier this year.



3) Poor growth prospects in light of Bosnia & Herzegovina's high unemployment rate, the slowing economic growth of its major trading partners and its limited progress to date on structural economic reforms.



RATING RATIONALE



The first consideration driving Moody's one-notch downgrade of Bosnia & Herzegovina is the weakening of the general government's financial position. The trend is partly the result of an expensive multi-layered government as well as unaffordable, politically-driven decisions related to pensions and other social transfers in years past. Official financial support for Bosnia & Herzegovina had been shrinking for several years before the global crisis, and private investment largely dried up after 2008 when the global financial crisis intensified.



An effective freeze in Bosnia's 2009-12 stand-by arrangement with the International Monetary Fund occurred prior to the October 2010 national elections. The lack of such funding has forced the two sub-national entities -- Republika Srpska (RS) and the Bosnian Muslim-Croat Federation (FBiH) -- to rely more heavily on shorter-term Treasury bills to finance relatively large structural deficits. Higher debt-service costs by themselves could further widen the budget gaps in 2012-13 unless fresh spending cuts and revenue measures are implemented.



The Bosnian authorities recently approached the IMF about a successor program to the interrupted stand-by arrangement. However, the negotiations over any such new agreement are likely to be arduous given the number of incomplete tasks left over from the 2009 program and the complex decision-making processes in Bosnia's various levels of government. Still, recent agreements in the Council of Ministers to shrink the national (or State)-level budget and on a distribution of indirect tax receipts should help to overcome two key obstacles to an accord.



The second driver for the downgrade and rating review is weakened government effectiveness, as illustrated most clearly by the 16-month delay in forming new State-level institutions following the 2010 election and the missed foreign debt payments. An agreement to form a State government was finally reached in late December 2011, likely motivated by the need to sign a 2011 budget in order for government spending to be re-authorised in 2012. Nonetheless, Moody's notes that political disagreements over the legality of that budget agreement continued into the new year, holding up the authorisation of payments owed to several multilateral financial institutions and one commercial bank in January to early February. The delay in payments was short-lived, in some cases just a day or two, but Moody's expects the antagonistic political dynamics responsible for the interruption to persist.



The third reason for Moody's rating action on Bosnia & Herzegovina is the economy's low growth prospects, which are being exacerbated by the slow progress on structural economic reform. Growth had been averaging at around 5% per annum prior to the global crisis, buoyed by rapid credit growth and foreign direct investment (FDI). With FDI abating, the European sovereign debt crisis and the lengthy political uncertainty, Bosnia & Herzegovina's economy has grown slowly since coming out of recession and now seems to be re-entering recession. Weak growth will aggravate efforts to consolidate public finances and could also exacerbate political tensions, given the high unemployment levels.



Moody's has unified at B3, with continued review for possible further downgrade, all of Bosnia & Herzegovina's country ceilings, i.e. its ceilings for local- and foreign-currency debt and for local- and foreign-currency deposits. These ceilings reflect Moody's decision to equate all such risks to that of the government's own default risk due to the country's currency board arrangement.



RATIONALE FOR REVIEW FOR DOWNGRADE



Moody's will be examining these issues in more detail during its ratings review in order to determine whether additional downward rating action should be taken.



The principal focus of the review will be: (1) whether the government can take adequate precautions to avoid a recurrence of debt-service delays; (2) whether fiscal consolidation measures are implemented that will assure debt sustainability and reduce reliance on short-term financing, at both the national and sub-national level; (3) whether any progress is made on political and constitutional reform that would streamline decision processes between and among various levels of government; (4) whether the key steps needed to qualify for EU candidacy will be taken; and (5) whether the economy and the general government budget deficit can prove resilient to the slowdown in European growth in 2012.

Company: Bosnia and Herzegovina

Full company nameBosnia and Herzegovina
Country of riskBosnia and Herzegovina
Country of registrationBosnia and Herzegovina

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