May 3 (SeeNews) - Fitch Ratings has affirmed North Macedonia's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'BB+' with a negative outlook, it said.
The negative outlook reflects continued material downside risks to growth and public finances following the significant pandemic shock and the indirect effects of the war in Ukraine, the global ratings agency said in a statement last week.
Fitch also said in the statement:
"KEY RATING DRIVERS
Credit Fundamentals, Negative Outlook: North Macedonia's ratings are supported by favourable governance relative to the 'BB' median, and a credible and consistent policy mix underpinned by the longstanding peg to the euro. The EU accession process helps to anchor policy and support exports and FDI inflows. These factors are balanced against the economy's small size and high exposure to exchange rate risk, for example due to the banking sector's euroisation and a high share of government debt denominated in foreign currency, and high structural unemployment. The Negative Outlook reflects continued material downside risks to growth and public finances following the significant pandemic shock and the indirect effects of the war in Ukraine.
Recovery Takes a Hit: Higher energy and food prices and slowdown in the EU (70% of exports) will lead growth to decelerate to 2.8% in 2022, from 4% in 2021. The negative impact of net trade will be partly balanced by private consumption, cushioned by government support measures and wage increases, and investment. We expect a modest pick up to 3% in 2023, reflecting some easing of geopolitical risks and energy price pressures, and gradual fiscal consolidation with continued emphasis on public investment. The risk of a prolonged conflict in Ukraine, continued problems of global manufacturing supply chains or the fallout from abrupt energy supply disruptions from Russia (100% of gas imports), such as recently announced for Poland and Bulgaria, represent key downside risks to our growth outlook.
Macro-Financial Stability, Higher Inflation: The long-standing 'de facto' peg to the euro is well-anchored, despite the almost consecutive shocks of the pandemic and war in Ukraine. Annual inflation rose to 8.8% in March pushed by supply side factors, and we expect inflation to average 6.3% in 2022, above the forecast 5.4% 'BB' median, before easing to 3.9% in 2023. After raising its policy rate by 25bp to 1.5% in April, we believe that the National Bank will continue normalisation of monetary policy to anchor inflation expectations and keep FX pressures in check. The banking sector maintains strong fundamentals. Capitalisation (17.3% at end 2021 with Tier 1 capital of 15.8%) is adequate and non-performing loans declined to 3.1% at end-March (end-2021: 3.2%). However, deposit euroisation remains high (45%) relative to peers.
Higher External Deficits: We forecast the current account deficit to widen to 5.7% of GDP in 2022, up from 3.5% in 2021, the highest since 2004 and above the forecast 3% deficit for the 'BB' median, due to reduced export demand and higher energy import costs. We view the increased external deficit as temporary and the current account deficit should ease to 4.7% of GDP, still above peers, in 2023, in line with reduced energy imports and weaker fiscal impulse.
Contingent External Liquidity Support: After FX interventions in 1Q22, Fitch forecast international reserves at EUR3.4 billion (3.4 months of current external payments for 2022), as increased external borrowing will support external buffers. Near-term external liquidity risks are mitigated by the extension of the EUR400 million temporary repo facility with the ECB until January 2023 and the recent announcement that North Macedonia has requested a Precautionary and Liquidity Line (PLL) to the IMF, which could help channel additional official and external market financing.
Temporary Reversal of Fiscal Consolidation: Fitch forecasts the general government deficit to increase to 6.5% 2022, from 5.4% in 2021 and above the 4.3% of the 2022 budget, reflecting measures to mitigate rising food and energy prices (EUR400 million or 3.2% of GDP March package), demand for higher public sector wages, higher pension spending and government support for key sectors including energy and agriculture. We forecast the general government deficit to decline to 4.8% in 2023, as temporary measures such as lowering VAT rates and support for the electricity sector are withdrawn. Fitch considers that the requested IMF PLL programme could boost the credibility of authorities' commitment to fiscal consolidation by outlining a realistic fiscal strategy including specific measures to support tax revenue growth and keep current spending in check, thus reducing the fiscal deficit and supporting debt stabilisation.
Higher Debt, Composition Reduces Risks: The general government debt declined slightly to 51.8% of GDP due to high nominal GDP growth, lower-than-budgeted deficit and the use of the majority of the IMF's SDR allocation (1.4% of GDP). Nevertheless, higher deficits will push general government debt up to 55.2% of GDP in 2022 and 56% in 2023, in line with the projected 'BB' median. Government guarantees of public entities (8.6% of GDP end-2021) are mainly related to road projects (6.1% of GDP). The majority of foreign currency debt (75% of total) is euro-denominated and currency risks are mitigated by the longevity and credibility of the exchange rate peg.
New Government, Uncertain EU Negotiations Start: After the resignation of Prime Minister Zoran Zaev in December 2021, the new SD SM-led coalition government led by Prime Minister Dimitar Kovačevski has a 63 MPs (out of 120) majority, but high political polarisation and legislative gridlock remain challenges. Both new governments in Bulgaria and North Macedonia have expressed increased goodwill towards achieving a solution, the feasibility of a breakthrough in the near term is uncertain, as political space seems limited due to coalition politics in Bulgaria, increased support for the opposition and growing disillusionment with the delay in the start of the EU negotiation process in North Macedonia.
ESG - Governance: North Macedonia has an ESG Relevance Score (RS) of '5[+]' for both Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption. Theses scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model. North Macedonia has a medium WBGI ranking at 53 reflecting a recent track record of peaceful political transitions, a moderate level of rights for participation in the political process, moderate institutional capacity, established rule of law and a moderate level of corruption.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to negative rating action/downgrade:
-Public Finances: Materially higher than forecast general government debt/GDP over the medium term, for example, due to weaker growth prospects or expectations of a more prolonged fiscal loosening.
-Macro & External Finance: Persistently high inflation and increased external vulnerabilities, for example due to a sustained period of large current account deficits net of FDI, which could exert pressure on foreign currency reserves and/or the currency peg against the euro.
Structural: Adverse political developments that affect governance standards, the economy and EU accession progress.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
- Public Finances: Greater confidence that general government debt/GDP will stabilise in the medium term, for example, due to economic recovery and fiscal consolidation.
-Structural: Further improvement in governance standards, reduction in political and policy risk, and progress towards EU accession.
-Macro: An improvement in medium-term growth prospects, for example through implementation of structural economic reform measures.
SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)
Fitch's proprietary SRM assigns North Macedonia a score equivalent to a rating of 'BB' on the Long-Term Foreign-Currency (LT 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 SRM data and output, as follows:
- Macro: +1 notch, the positive notch adjustment offsets the deterioration in the SRM output driven by the pandemic and war in Ukraine shock, including from the growth volatility variable and high inflation. The deterioration of the GDP growth and volatility variables reflects a very substantial and unprecedented exogenous shock that has hit the vast majority of sovereigns, and Fitch currently believes that North Macedonia has the capacity to absorb it without lasting effects on its long-term macroeconomic stability.
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.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG CONSIDERATIONS
North Macedonia has an ESG Relevance Score of '5[+]' for Political Stability and Rights as World Bank Governance Indicators have the highest weight in Fitch's SRM and are therefore highly relevant to the rating and a key rating driver with a high weight. As North Macedonia has a percentile rank above 50 for the respective Governance Indicator, this has a positive impact on the credit profile.
North Macedonia has an ESG Relevance Score of '5[+]' for Rule of Law, Institutional & Regulatory Quality and Control of Corruption as World Bank Governance Indicators have the highest weight in Fitch's SRM and are therefore highly relevant to the rating and are a key rating driver with a high weight. As North Macedonia has a percentile rank above 50 for the respective Governance Indicators, this has a positive impact on the credit profile.
North Macedonia has an ESG Relevance Score of '4[+]'for Human Rights and Political Freedoms as the Voice and Accountability pillar of the World Bank Governance Indicators is relevant to the rating and a rating driver. As North Macedonia has a percentile rank above 50 for the respective Governance Indicator, this has a positive impact on the credit profile.
North Macedonia has an ESG Relevance Score of '4[+]' for Creditor Rights as willingness to service and repay debt is relevant to the rating and is a rating driver for North Macedonia, as for all sovereigns. As North Macedonia has a track record of 20+ years without a restructuring of public debt and captured in our SRM variable, this has a positive impact on the credit profile.
Except for the matters discussed above, the highest level of ESG credit relevance, if present, is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or to the way in which they are being managed by the entity."