Standard & Poor's Ratings Services affirmed its 'BB+' long-term and 'B' short-term sovereign credit ratings on the Republic of Montenegro

Published date: 24.11.2008 12:42 | Author: KREDITNI REJTING CRNE GORE

Print

On Nov. 10, 2008, Standard & Poor's Ratings Services affirmed its 'BB+' long-term and 'B' short-term sovereign credit ratings on the Republic of Montenegro. The outlook remains negative and the Transfer & Convertibility assessment on Montenegro remains 'AAA'.

The rating on Montenegro is constrained by vulnerabilities emanating from the countrys very high current account deficit and narrow economic base. External imbalances have been fuelled by robust growth of domestic demand amid the fastest credit growth among all rated sovereigns. Domestic credit has increased to 86% in 2007 from 20% of GDP in 2005, and is likely to reach 100% in 2008, although the pace of growth has slowed significantly this year. The ratings are supported by a strong budgetary position, the use of the euro as legal tender, and improved prospects for EU accession relative to other countries in the region.

Foreign investment inflows into Montenegro's property and tourism sectors since independence in May 2006 have been very high at an average net FDI-to-GDP ratio of 20%. Together with rapid credit expansion, this has kept imports high. That said, we expect the very high current account deficit of above 30% of GDP in 2007 and in 2008 to fall significantly as the investment and credit booms reverse in light of the economic slowdown in Europe. Net FDI covered around 60% of the current account deficit in 2007 and similar coverage is expected in 2008. The remainder is financed through bank borrowing from abroad, particularly parent bank funding, rather than through wholesale markets. The use of the euro as domestic currency eliminates the risk of a currency sell-off and the accompanying household and corporate balance sheet effects that many of Montenegros peers face. However, the diminished availability of external funding will eventually require a potentially painful correction in the real economy as the current account deficit is forced to narrow. Montenegro's real GDP growth is estimated at 7.6% in 2008, but the medium-term growth trajectory is highly uncertain due to the openness of the economy, the rigidity of the monetary regime, and the downturn in external demand.

The general government surplus stood at 6.3% of GDP in 2007 and a surplus is expected in 2008. However, government finances are likely to come under increasing pressure as the economy is affected by lower external financing and FDI flows. Debt has not declined commensurately because of the governments policy of building reserves for future infrastructure projects. We estimate gross government debt at around 30%, with concessional loans keeping the interest burden low.

An application for EU membership is forthcoming and the accession process is providing a strong impetus for further reforms.

The negative outlook reflects Montenegro's large macroeconomic imbalances, the dangers associated with a sudden withdrawal of external financing, and the consequent risk to economic performance and public finances. The rating could be lowered in the event of a hard economic slowdown following an adjustment of the current account and credit growth that would lead to a steep deterioration in bank asset quality and in public finances. Pressure on the rating could also come from the need for significant capitalizations of the banks by the government. If imbalances unwind in an orderly fashion and the economy slows in an orderly manner, the process of deleveraging could proceed relatively smoothly and the outlook would likely be revised back to stable.