Fitch Revises Macedonia's Outlook to Negative, Affirms at 'BB '
KEY RATING DRIVERS
The revision of Outlook to Negative reflects the following key rating drivers and their relative weights:
Risks to political stability have increased this year as Macedonia has been hit by two major political shocks, which could also have spill-over effects onto the economy. Revelations of and from an alleged illegal wiretap programme triggered demonstrations and hardened political polarisation in the country, which has seen the main opposition party boycott parliament since elections in April 2014; and in May a fire-fight in the town of Kumanovo between police and heavily armed ethnic Albanians left 18 dead. Although an agreement in July by the main political parties, brokered by European Commissioner Johannes Hahn, provides a road map for easing tensions, implementation risks are significant and events have revealed that governance is weaker than previously believed.
Public debt, which includes government guarantees, increased to 45.6% of GDP at end-2014, from 22.7% at end-2008, and Fitch forecasts it to reach around 50% by end-2017. Rising debt/GDP is the result of persistent slippage against fiscal targets. In July, parliament approved a supplementary budget, which increases expenditure by 0.9% of GDP, consistent with a budget deficit of 3.6%, compared with a target of 3.4% of GDP in the original 2015 budget. In 2014 the outturn for the consolidated general government deficit was 4.2% of GDP, well above the original budget target of 3.4%, following overshoots averaging 0.8% of GDP in 2012 and 2013.
Government guarantees to state-owned companies, mainly for infrastructure investment, increased sharply to 7.7% of GDP at end-2014, from 3.2% at end-2010. A heavy pipeline of projects means this is likely to increase further to around 10% at end-2015. This represents both a form of quasi-fiscal activity and pro-cyclical policy loosening, and a rising contingent liability for the government.
Macedonia's 'BB+' IDRs also reflect the following key rating drivers:-
Macedonia has a track record of low inflation, which averaged 2.2% in the five-years to 2014, and low macroeconomic volatility, supported by a longstanding exchange rate peg to the euro. However, unemployment is high at 27%, albeit down from 37% in 2005.
GDP per capita and levels of human development are above the 'BB' range median. The business climate is highly favourable - the 30th best in the world according to the 2015 World Bank Ease of Doing Business survey.
A high investment ratio of over 30% of GDP, supported by high public infrastructure investment and FDI-friendly free economic zones, augurs well for medium-term growth potential. Fitch forecasts GDP growth to ease somewhat from 3.8% in 2014 to 3.3% in 2015 and 2016, before strengthening to 3.7% in 2017. However, political uncertainty may delay some investment decisions. Greece is another downside risk, although its share of Macedonia's export markets shrank to 4.5% in 2014 from 13.4% in 2008. Recent growth performance and prospects compare favourably with regional peers.
The Medium Term Fiscal Strategy 2015-17 envisages a narrowing in the budget deficit to 3.2% in 2016 and 2.9% in 2017, which would involve a reduction in government expenditure to 33.3% of GDP in 2017 from Fitch's estimate of 35.7% of GDP in 2015. The worse 2015 starting point, security situation, the electoral cycle and the recent record of missed targets pose downside risks. Fitch forecasts the budget deficit to narrow more slowly to 3.4% in 2016 and 3.1% in 2017.
The government plans to introduce fiscal rules, which would limit the budget deficit to 3% of GDP (subject to over-ride in the event of a severe economic downturn or natural disaster) and public debt (including guarantees) to 60% of GDP from 2017. General government debt was 38% of GDP at end-2014, in line with the 'BB' range median. Interest costs are low at just 1% of GDP. However, some 78% of government debt is denominated in foreign currency, albeit over 70% of which is in euros.
Net external debt was 17% of GDP at end-2014 and above the 'BB' range median of 7%. Fitch forecasts a current account deficit of 1.4% of GDP in 2015 as workers' remittances and a surplus on services broadly offset a large trade deficit. Most of the current account deficit is financed by equity FDI.
The banking sector had a robust capital adequacy ratio of 16% at end-1Q15, and is profitable and highly liquid. Two Greek-owned subsidiaries account for 24% of the banking system by assets. However, the banks are well-capitalised and liquid and do not depend on their parents for financing or have any significant exposure to Greek assets. They suffered only minor temporary deposit withdrawals at the height of the recent Greek crisis, but a loss of public confidence in the event of a 'Grexit' represents a downside risk, albeit one that the central bank has the powers and capacity to address.
Future developments that could individually or collectively result in a downgrade include:
-Heightened or prolonged political instability, for example if there is a failure to implement the agreement brokered by European Commissioner Johannes Hahn or a breakdown in ethnic relations;
-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.
Future developments that could individually or collectively result in the Outlook being revised to Stable include:
- A marked easing in political tension and uncertainty, for example if there is an independent investigation into the wiretap allegations and holding of free and fair elections (scheduled for April 2016);
- Implementation of a credible medium-term fiscal consolidation programme consistent with a stabilisation of the public debt/GDP ratio.
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.
Fitch assumes that the EU economy, Macedonia's largest trade partner, will continue to recover gradually.