Rating Action: Moody's affirms Bosnia and Herzegovina's B3 issuer rating; outlook stable
Global Credit Research - 21 Aug 2020
London, 21 August 2020 -- Moody's Investors Service, ("Moody's") has today affirmed Bosnia and Herzegovina's B3 long-term issuer ratings. The outlook remains stable.
The decision to affirm the ratings and maintain the stable outlook balances the following key rating factors:
(1) Persisting structural challenges continue to weigh on Bosnia and Herzegovina's medium-term growth prospects, constraining the country's economic strength;
(2) Moderate debt levels and fiscal restraint in recent years provide fiscal space to respond to economic shocks like the coronavirus pandemic;
(3) Weak institutions, in part reflecting a complex governance system and a divisive political environment, continue to hamper effective policymaking. Moody's considers institutional strength a governance factor under its ESG framework.
Bosnia and Herzegovina's local-currency bond and deposit ceilings and long-term foreign-currency bond and deposit ceilings are unchanged at B3. The short-term foreign currency bond and deposit ceilings remain Not Prime (NP).
FIRST DRIVER: PERSISTING STRUCTURAL CHALLENGES CONSTRAIN ECONOMIC STRENGTH
The first driver for the rating affirmation at B3 is Bosnia and Herzegovina's limited economic strength, constrained by its small economic size, relatively weak competitiveness and business environment, lack of a dynamic private sector and high unemployment that weighs on its economic potential. Nominal GDP, at $20.5 billion in 2019, is below the median for B-rated peers ($27 billion). GDP per-capita in purchasing power parity (PPP) terms, which was estimated at around $14,220 in 2019, is higher than the B-rated median of $7,703 but remains substantially below regional peers. Despite some convergence in recent years, progress in closing the income gap with the EU remains limited.
A business environment characterized by complex bureaucracy weighs on the country's economic strength, with Bosnia and Herzegovina ranking unfavorably compared to regional peers according to international surveys. According to the IMF estimates, Bosnia and Herzegovina's public sector accounts for almost half of total employment and plays a large role in the economy. The public sector displays low efficiency levels due to the country's institutional fragmentation that results in the duplication of functions among the various levels of government.
The lack of a dynamic private sector and labour market rigidities have contributed to high unemployment rates, in particular among the youth. According to the statistics agency's Labour Force Survey, unemployment stood close to 16% in 2019 (ILO methodology). The lack of job opportunities leads to persistent emigration, with much-needed skills leaving the economy. According to the Labour Force Survey, Bosnia and Herzegovina's working age population has shrunk by 7.8% between 2013 and 2018. Moody's expects structural challenges to persist, as the reform drive will likely remain very gradual due to the challenging political environment, weighing on medium term growth prospects.
Moody's expects Bosnia and Herzegovina's economy to be significantly impacted by the coronavirus pandemic this year due to the effect of the domestic measures to contain the spread of the coronavirus, decline in trade (in particular with the EU), and a reduction in workers' remittances. In 2019, remittances accounted for about 11% of GDP and are an important driver of private consumption. Tourism has also been severely affected, with foreign tourist arrivals falling by 77% annually in the first half of this year. That said, despite the industry's rapid growth in recent years, tourism's economic importance is lower than in a number of regional peers, with travel export receipts accounting for more than 5% of GDP.
Moody's projects Bosnia and Herzegovina's real GDP to contract by 5.5% in 2020, after 2.9% growth in 2019, followed by a relatively mild rebound of 3.5% in 2021. While the measures to contain the spread of the coronavirus have been effective at the early stage of the pandemic, their gradual relaxation since mid-May has been accompanied by a significant increase in cases, and a potential further worsening of the country's epidemiological situation with a potential reintroduction of containment measures poses a downside risk to the current growth projections.
SECOND DRIVER: MODERATE DEBT LEVEL AND FISCAL RESTRAINT OVER RECENT YEARS PROVIDE FISCAL SPACE
The second factor underpinning the rating affirmation is Bosnia and Herzegovina's fiscal strength supported by a moderate debt burden that was -- prior to the coronavirus outbreak -- on a gradually declining trend. General government debt stood at an estimated 32.5% of GDP at the end of 2019, well below the median of B-rated peers (52.4% of GDP in 2019). In recent years, Bosnia and Herzegovina maintained a prudent fiscal stance, registering a small budget surplus since 2016, mainly reflecting sustained growth in indirect tax revenue but also spending restraint, in particular under-execution of capital expenditure.
Moody's projects the fiscal balance to record a deficit of 4.6% of GDP this year, compared with a surplus of 2.2% in 2019. The deterioration reflects the impact of the economic contraction on the revenue side and the fiscal measures adopted by the authorities to mitigate the effect of the coronavirus with respect to expenditures.
Moody's expects the resulting higher financing needs of around 8.7% of GDP in 2019 to be covered by an increase in domestic borrowing and by international financial institutions' financing, mainly the already disbursed IMF's Rapid Financing Instrument and the EU's Macro-Financial Assistance under negotiation.
The fiscal expansion in 2020 will lead to a temporary reversal of the public debt downward trajectory. Moody's expects the general government debt to exceed 38% of GDP by the end of 2020 and to decline gradually thereafter. However, the increase in the debt level is expected to be smaller compared to that registered by most sovereigns in the region and B-rated peers: general government debt-to-GDP is forecast to increase by about 6 percentage points in 2020 compared with an expected more than 10-percentage-point increase for the median of B-rated peers.
Bosnia and Herzegovina also benefits from a high degree of debt affordability. That said, it is predominantly a reflection of the country's large official creditor base which provides funding at below-market rates. Interest payments absorbed around 1.7% of general government revenue in 2019, comparing favorably to the B-rated median (8.0% in 2019). Hence, favorable fiscal metrics compared with rating peers and the past track record of small budget surpluses provide Bosnia and Herzegovina with the fiscal space to respond to the coronavirus shock without incurring a material weakening of its fiscal strength despite the significant deterioration in general government debt to GDP foreseen in 2020.
THIRD DRIVER: WEAK INSTITUTIONS AND DIVISIVE POLITICAL ENVIRONMENT CONTINUE TO HAMPER EFFECTIVE POLICYMAKING
The third driver for the rating affirmation is based on Bosnia and Herzegovina's institutional constraints. A complex governance system and a divisive political environment hamper effective policymaking. Bosnia and Herzegovina's long-standing institutional fragmentation, decentralized government structure and a lack of internal political consensus have hindered significant progress in terms of economic and institutional reforms, including the last IMF program that saw only one review completed, as well as timely adherence to recommendations set out by international partners and prevented a rapid and coordinated fiscal response to the coronavirus shock. The country's institutional fragmentation reflects the provisions established by the Peace Agreement to end the war in Bosnia and Herzegovina in 1995.
At the same time, the currency-board arrangement provides an effective anchor for macroeconomic stability and enjoys a high level of credibility. Despite the central bank coming under some political pressure to use its reserves for fiscal purposes at the onset of the pandemic, Moody's expects Bosnia and Herzegovina to remain committed to its currency board, as such an intervention would undermine the credibility of the currency board and potentially jeopardize future IMF assistance.
Moody's expects the engagement with the IMF, EU and other international partners to continue. That said, the country's limited institutional effectiveness will likely result in a continuation of very gradual reform progress. The IMF and the authorities are discussing a new multi-year arrangement and a successful re-engagement in a new program would provide a key policy anchor. At the same time, Moody's expects the progress in fulfilling the criteria on the EU membership path to remain slow. Bosnia and Herzegovina's has lagged behind regional peers and limited progress has been achieved so far in addressing the identified 14 priorities to be granted the official EU candidate status.
In response to the outbreak, the two entities -- the Federation of Bosnia and Herzegovina and the Republika Srpska -- have, albeit to different extents, implemented measures to mitigate the socioeconomic impact of the pandemic. Measures included support to employees of companies affected by the coronavirus and guarantee schemes to support the liquidity of companies. Moreover, the two entities' respective banking agencies have introduced the possibility of a six-month moratorium on loan repayments for businesses and individuals.
However, the delay of the disbursement of the IMF emergency assistance due to the lack of an agreement on the funds allocation between the two entities exemplified the weak government effectiveness on the back of the fragmented institutional structure.
RATIONALE FOR STABLE OUTLOOK
The stable outlook on Bosnia and Herzegovina's B3 rating reflects Moody's expectations that the country's credit profile will remain consistent with the current rating over the next 12 to 18 months despite the expected economic and fiscal deterioration due to the coronavirus pandemic. Moody's expects that liquidity and external risks will be effectively mitigated by the support of international financial institutions, and in particular by the financial assistance from the IMF and the EU. At the same time, Moody's expects the volatile political environment to continue to hamper effective policy response and significant reform progress, potentially delaying international assistance.
ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
Moody's takes into account the impact of environmental (E), social (S) and governance (G) factors when assessing sovereign issuers' economic, institutional and fiscal strength and their susceptibility to event risk. In the case of Bosnia and Herzegovina, the materiality of ESG to the credit profile is as follows.
Environmental considerations are relevant to Bosnia and Herzegovina's credit profile given the economy's reliance on agriculture, exposing it to weather-related events and trends. According to ILO estimates, the agricultural sector accounts for around 15% of employment as of 2019.
Social factors are material to Bosnia and Herzegovina's credit profile. Long-standing considerations relate to the sovereign demographic challenges and very high unemployment rates, in particular among the young segment of the population, with limited job opportunities which led to high emigration. Moody's regards the coronavirus outbreak as a social risk under its ESG framework, given the substantial implications for public health and safety, and the adverse economic and fiscal impact Moody's anticipates.
Governance considerations are material to Bosnia and Herzegovina's credit profile which is reflected in the country's weak rankings in the Worldwide Governance Indicators (WGIs), particularly around the effective functioning of the government. The country's highly complex political structure and a lack of internal consensus undermine the political and economic reform process, as well as governance more generally.
GDP per capita (PPP basis, US$): 14,220 (2019 Actual) (also known as Per Capita Income)
Real GDP growth (% change): 2.9% (2019 Actual) (also known as GDP Growth)
Inflation Rate (CPI, % change Dec/Dec): 0.3% (2019 Actual)
Gen. Gov. Financial Balance/GDP: 2.2% (2019 Actual) (also known as Fiscal Balance)
Current Account Balance/GDP: -3.5% (2019 Actual) (also known as External Balance)
External debt/GDP: 76.4% (2019 Actual)
Economic resiliency: b2
Default history: At least one default event (on bonds and/or loans) has been recorded since 1983.
On 18 August 2020, a rating committee was called to discuss the rating of the Bosnia and Herzegovina, Government of. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have not materially changed. The issuer's institutions and governance strength, have not materially changed. The issuer's fiscal or financial strength, including its debt profile, has not materially changed. The issuer's susceptibility to event risks has not materially changed.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
WHAT COULD CHANGE THE RATING - UP
Material progress in implementing reforms that help to strengthen the country's governance and institutional profile and address long-standing structural economic challenges enhancing medium-term growth prospects would place upward pressure on the rating. This progress would likely be supported by a more conducive and stable political environment resulting in a greater policymaking effectiveness. Furthermore, continuous cooperation with IMF and EU leading to structural reform progress would contribute to the emergence of upward pressure on the rating.
WHAT COULD CHANGE THE RATING - DOWN
Bosnia and Herzegovina's rating could be downgraded in the event of a material weakening in the government fiscal metrics and an increase of liquidity risk, due for example to severe and lasting economic consequences of the pandemic that required additional significant fiscal measures. In addition, any halt or setback in the reform agenda, including to deepen Bosnia and Herzegovina's integration with the EU, could also be credit negative. Furthermore, a marked escalation in political volatility resulting in a weakening of the state level institutions or putting into question the country's future as one sovereign nation could also lead to downward rating pressure.
The principal methodology used in these ratings was Sovereign Ratings Methodology published in November 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1158631. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.
The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.
For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.
For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.
For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.
The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.
These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.
Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.
Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1133569.
At least one ESG consideration was material to the credit rating action(s) announced and described above.
Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.
Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.
Daniela Re Fraschini Asst Vice President - Analyst Sovereign Risk Group Moody's Investors Service Ltd. One Canada Square Canary Wharf London E14 5FA United Kingdom JOURNALISTS: 44 20 7772 5456 Client Service: 44 20 7772 5454 Yves Lemay MD-Sovereign/Sub Sovereign Sovereign Risk Group JOURNALISTS: 44 20 7772 5456 Client Service: 44 20 7772 5454 Releasing Office: Moody's Investors Service Ltd. One Canada Square Canary Wharf London E14 5FA United Kingdom JOURNALISTS: 44 20 7772 5456 Client Service: 44 20 7772 5454
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