June 13, 2012 |
|Rapid deleveraging of Montenegro's financial sector continues, and we |
estimate GDP growth will decelerate to 0.5% this year.
In our view, Montenegro's fiscal consolidation program is at risk due to
the protracted economic slowdown and the continuing accumulation of tax
and other arrears in the economy.
We also believe that contingent liabilities will likely crystallize on
the government's balance sheet due to payments due on state guarantees.
We are therefore lowering our long-term foreign and local currency
sovereign credit ratings on Montenegro to 'BB-' from 'BB'.
The stable outlook balances our view of risks from any further
deterioration in the external environment against the government's
general willingness to pursue reforms that address economic weaknesses.
LONDON (Standard & Poor's) June 13, 2012--Standard & Poor's Ratings Services
today lowered its long-term foreign and local currency sovereign credit
ratings on the Republic of Montenegro to 'BB-' from 'BB'. At the same time we
affirmed our short-term foreign and local currency ratings at 'B'. The outlook
on the long-term ratings is stable.
Montenegro's '3' recovery rating reflects our opinion of a 50%-70% recovery in
the event of a default. The transfer and convertibility (T&C) assessment
remains at 'AAA'.
The rating action reflects our view that the government is facing increasing
challenges to its efforts to stabilize public debt levels given the weakening
economic environment, pressures arising from contingent liabilities, and
diminishing external bank financing. Constraining the ratings are our view of
Montenegro's weak external position and limited administrative capacity, as
well as its lack of monetary flexibility. Our view of the country's economic
potential, anchored by the prospect of EU accession, is a ratings strength.
We project GDP growth will decelerate in 2012 to 0.5%, after a moderate
recovery during 2010-2011. Domestic demand remains subdued due to anemic
credit growth and the large private sector debt overhang. At the same time,
the weakening external environment and repeated delays on key supply-side
reforms--which, if implemented, could materially increase capacity in the
transport, tourism, and hydro-energy sectors--are hampering Montenegro's
export and overall growth performance, in our view.
The financial sector has continued to deleverage as foreign banks' local
subsidiaries increasingly rely on domestic deposits to fund their loan books.
At end-2011, the stock of external banking sector debt had declined by 40%
from its peak in 2008, implying a reduction in the loan-to-deposit ratio
(excluding non-resident deposits) to 135% in April 2012, from 223% in April
The financial sector deleveraging has been largely offset by a rapid rise in
public sector external debt to 80% of current account receipts (CARs) in 2012,
from 34% in 2008. Montenegro's net external liability position has risen
sharply over the same period to 335%, from 212%, but still-substantial FDI
inflows have cushioned the impact on debt. External debt (net of liquid
assets) stayed at a relatively high 77% of CARs in 2011. However, we believe
the denominator could be understated, possibly by about 20%, as a large
proportion of tourism receipts remain unrecorded. This is visible in sizeable
positive errors and omissions (E&O) of 11.8% of GDP on average between 2009
The continuous withdrawal of credit from Montenegro's private sector has
interrupted the flow of working capital into the economy. As a consequence,
several companies have accumulated arrears to both private and public sector
agents. Arrears accumulation is also hindering the government's ability to
consolidate public finances.
While reducing its deficit to 4.0% of GDP in 2011, from 4.9% in 2010, the
government was unable to meet its original 2011 cash-based budgetary target of
2.3% of GDP. This failure was due to:
An accumulation of tax arrears at about 0.7% of GDP during 2011; and
The impact of rising unemployment and one-off early retirement
commitments on social security transfers, which increased from 11.4% of
GDP in 2008 to 13.9% in 2011 (offsetting cuts to public capital
In our opinion, the general government may not be able to meet its revised
deficit target of 2.5% of GDP in 2012. In January-April 2012, the general
government deficit had already reached 2.5% of projected full year GDP, due to
the VAT collection shortfall.
Parliament passed a supplementary budget in May, which assumes additional
consolidation measures of about 1.2% of GDP, including a 7% wage cut for
high-ranking public employees and further cuts in capital spending. However,
we think these measures alone are not likely to reduce the cash deficit if
companies continue to accumulate tax arrears and/or the tourism sector
underperforms. Social transfers and gross salaries dominate government
spending (26% of GDP), and the government has so far been reluctant to make
cuts to these politically sensitive areas. Give this lack of flexibility
around reducing entitlement spending, we continue to see risks to the
sustainability of public finances over the medium term.
The government has also had to honor some of its guarantees, which has damaged
its fiscal position. It repaid the debt of steel mill, Zeljezara Niksic, at a
cost of 1% of GDP in 2011 (under an agreement that also required it to fund
the early retirement of its employees). In February 2012, it also decided to
assume the debt aluminum producer, Kombinat Aluminijuma Podgorica (KAP) owes
to Deutsche Bank, which cost the government 0.6% of GDP. KAP's total debt is
about 10% of Montenegro's GDP. We understand that the government is thinking
about assuming a further 3.1% of GDP of state-backed debt owed by KAP to
international lenders. If the government takes this onto its balance sheet,
general government debt net of liquid assets could increase to 49% of GDP in
2012, from 43% in 2011.
Montenegro unilaterally adopted the euro as its currency in 2002. It is not
part of the European Economic and Monetary Union (eurozone), and so has no
voice in the European Central Bank's (ECB) monetary policy deliberations and
no access to ECB liquidity facilities. Although using the euro has facilitated
large inflows of FDI and tourism, it also limits monetary policy flexibility.
This increases the importance of building up fiscal reserves to buffer against
the effects of cyclical downturns on the public sector balance sheet.
In our opinion the government has made some progress on structural reforms,
including the implementation of new pension legislation aiming to raise the
retirement age to 67 years from the current 65 for men and 60 for women. That
said, we believe further structural and microeconomic reforms would improve
Montenegro's long-term growth prospects. Despite the adoption of a new labor
law, which reduces the cost of using permanent labor by reducing redundancy
payments, labor market rigidities persist. Furthermore, restrictive collective
bargaining covers a large part of the labor force. An unintended consequence
is that youth unemployment remains high at about 30%.
Another structural weakness includes ongoing power subsidies to KAP, which we
estimate consumes about 30% of total domestic electricity capacity. EPCG, the
national energy company, has to pay a higher price for imported electricity to
cover KAP's needs. If KAP ceased operation, Montenegro would become a net
exporter of electricity, which would also help to improve the country's
The 'AAA' T&C assessment reflects our opinion of the extremely low likelihood
of the sovereign restricting nonsovereign access to foreign currency needed
for debt service, while the local currency remains the euro.
The stable outlook balances our view of risks from any further deterioration
in the external environment against the government's general willingness to
pursue reforms that address economic weaknesses.
We could lower the ratings if we believed that external refinancing needs were
placing more-intense pressure on the Montenegro economy than we currently
expect. Under such a scenario, government debt and deficit levels could rise
to levels inconsistent with our current fiscal assessment.
We could raise the ratings if the government implemented labor market and
business environment reforms that improved economic competitiveness,
diversified the economy, and increased capacity in key sectors, while external
and fiscal imbalances unwound.
|Full company name||Republic of Montenegro|
|Country of risk||Montenegro|