(The following statement was released by the rating agency)
Dec 28 -
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Summary analysis -- Montenegro (Republic of) ---------------------- 28-Dec-2012
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CREDIT RATING: BB-/Stable/B Country: Montenegro
Primary SIC: Sovereign
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Credit Rating History:
Local currency Foreign currency
13-Jun-2012 BB-/B BB-/B
31-Mar-2010 BB/B BB/B
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Rationale
The ratings on Montenegro balance our view of its economic potential, anchored by the prospect of EU accession, against the country's weak external position and limited administrative capacity, as well as its lack of monetary flexibility. We believe that the government is facing increased challenges to its efforts to stabilize public debt levels given the weakening economic environment, pressures arising from contingent liabilities, and diminishing external bank financing.
We project that GDP growth will decelerate in 2012 to an estimated 0.5%, after a moderate recovery during 2010-2011. Domestic demand remains subdued due to anaemic credit growth and the large private sector debt overhang. At the same time, the weak external environment and repeated delays on 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 continues to deleverage as foreign banks' local subsidiaries increasingly rely on domestic deposits to fund their loan books. At the end of November 2012, the stock of external banking sector debt had declined by 48% to EUR726 million from its peak in April 2009, implying a reduction in the loan-to-deposit ratio (excluding non-resident deposits) to 118% from 223%.
Financial sector deleveraging has been largely offset by a rapid rise in public sector external debt to 83% of current account receipts (CARs) in 2012, from 33% in 2008. Montenegro's net external liability position has risen sharply over the same period to 336%, from 208%, but still-substantial foreign direct investment (FDI) inflows have cushioned the impact on debt. External debt (net of liquid assets) remained at a relatively high 74% of CARs in 2011. However, we believe the denominator could be understated, possibly by about 10%, as a large proportion of tourism receipts remain unrecorded. This is visible in the large number of positive errors and omissions (E&O), which despite the balance of payments data revision in 2012, is still estimated at 5.9% of GDP on average between 2009 and 2011.
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 also hinders the government's ability to consolidate public finances. At the end of September 2012, tax arrears was 6.5% of GDP, a net increase of 1% of GDP compared with end-December 2011. In our opinion, the general government will not be able to meet its revised deficit target of 2.8% of GDP in 2012. We expect the full-year deficit to reach 3.3% of GDP.
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 that 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 may be required to assume 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 44% 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 act as a buffer against the effects of cyclical downturns on the public sector balance sheet.
Our 'AAA' transfer and convertibility (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.
Outlook
The stable outlook reflects 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 believe that external refinancing needs are 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 that are not consistent with our current fiscal assessment.
We could raise the ratings if the government implements labor market and business environment reforms that improve economic competitiveness, diversify the economy, and increase capacity in key sectors, while external and fiscal imbalances unwind.
Related Criteria And Research
-- Ratings On Montenegro Lowered To 'BB-' On Weakening Economic Environment; Outlook Stable, June 13, 2012
-- Sovereign Government Rating Methodology And Assumptions, June 30, 2011
-- Criteria For Determining Transfer And Convertibility Assessments, May 18, 2009
-- Introduction Of Sovereign Recovery Ratings, June 14, 2007
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