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Rating Action:

Moody's affirms Bosnia and Herzegovina's B3 issuer rating; Outlook stable

16 Feb 2018

London, 16 February 2018 -- Moody's Investors Service, ("Moody's") has today affirmed Bosnia and Herzegovina's B3 long-term issuer ratings. The outlook is stable.

The factors supporting today's affirmation are:

(1) Bosnia and Herzegovina's (Bosnia) resilient economic growth supports its credit profile, although structural challenges, including very high unemployment, weigh on economic strength;

(2) Ongoing political volatility impairs effective policy-making and keeps susceptibility to political event risk high; and

(3) A moderate debt burden, mainly due to concessional creditors, supports fiscal strength, although limited access to external financing keeps Bosnia reliant on official support.

The stable outlook on Bosnia's B3 rating reflects Moody's expectation that Bosnia will continue to meet the conditions for concessional external financing, albeit with delays, which would provide the needed financial and technical assistance to continue to gradually progress the reform agenda.

However, significant reform progress will be hampered by ongoing political disagreements which distract from a country-wide reform focus and limit Bosnia's ability to address the notable structural constraints needed to improve its credit profile, including material improvements to the business environment, a strengthening of institutions and addressing risks to debt sustainability at all levels of government.

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 are also unaffected by this rating action and remain Not Prime (NP).

RATINGS RATIONALE

RATIONALE FOR RATING AFFIRMATION

FIRST FACTOR: BOSNIA AND HERZEGOVINA'S RESILIENT ECONOMIC GROWTH

The first factor for Moody's decision to affirm the B3 rating on Bosnia and Herzegovina (Bosnia) is the country's resilient economic performance despite a number of headwinds in recent years, including unfavourable weather conditions and the country's volatile political dynamics.

Real GDP has grown by an estimated average 3.2% over the past three years, with household consumption benefitting from remittance inflows, an acceleration in bank lending and modest employment gains. Furthermore, improved access to the European Union (EU) market, through higher quotas for tariff-free exports including in the agricultural sector, has supported double-digit goods export growth in 2017. Similar to other Balkan countries, tourism has been a bright spot with the number of foreign arrivals growing by around 19% in 2017. Moody's expects real GDP growth to continue to remain robust in the coming years (3.7% in 2018) supported by private consumption and improving regional growth prospects, although the economy will still continue to grow below pre-crisis rates.

However, there remain significant impediments to generating the higher growth needed to help close the income gap with EU peers. In particular, Bosnia's large and inefficient public sector undermines the development of a competitive private sector. Importantly, foreign direct investment, which remains below pre-crisis levels, will continue to be restrained by the weak business environment, reflected in Bosnia's scores on the World Bank Doing Business Survey which are lower than regional peers, acting as a limit on potential growth.

These factors partly explain the persistently high unemployment rate which stood at 20.5% in 2017 according to the Labour Force Survey, although local unemployment offices point to a much higher rate of around 39% as of November 2017. Employment gains, supported by past labour reforms, have helped to reduce the very high unemployment rate although this also reflects the substantial emigration of the working age population, which declined by 3.3% in 2017 alone.

SECOND FACTOR: ONGOING POLITICAL VOLATILITY WEIGHS ON INSTITUTIONAL STRENGTH

The second factor supporting the affirmation is the ongoing political volatility which impairs the effectiveness of policy formation and implementation in Bosnia, reflecting the complex structure of the government created to protect the interests of the three major political groupings. This is reflected in Bosnia's ranking in the bottom 25% among Moody's rated universe on the Worldwide Governance Indicator for effective functioning of the government.

Importantly, weak government effectiveness is reflected in Bosnia's ongoing delays in complying with the requirements under International Monetary Fund (IMF) programmes. For example, Bosnia did not complete its 2012-2015 IMF agreement and the completion of the first review under its follow-up Extended Fund Facility was delayed by more than 12 months largely due to political disagreements around excise tax rises. Moody's notes that legislative bottle-necks hinder the necessary approvals to release funding for budget support or investment projects. In contrast, Bosnia's currency board arrangement, supported by significant reserve coverage of Bosnia's monetary liabilities, enjoys a high level of confidence and credibility, providing stability to monetary policy and support to Moody's assessment of institutional strength.

Furthermore, Moody's expects Bosnia's weakness in policy implementation will slow its progress on the path of EU accession, which would provide a framework to align the country's judicial, institutional and policy environment closer to EU norms. In this regard, Bosnia continues to lag behind regional peers, such as Serbia (Ba3 Stable) and Montenegro (B1 Stable), which have seen faster progress towards EU accession in light of their stronger reform momentum.

At the same time, the very challenging political landscape keeps susceptibility to political event risk high. The crystallisation of these political risks have had damaging consequences, for example the substantial delay in forming a government following elections in 2010 and again in 2014, and further challenges to government formation cannot be excluded for the upcoming election period. Moody's expects a focus on policies to promote entity interests or challenge the legitimacy of state level institutions will continue to foster divisive politics and strain relations with international partners, such that domestic political risk acts as an overall constraint on the government's rating.

THIRD FACTOR: MODERATE DEBT BURDEN SUPPORTS FISCAL STRENGTH

The third factor for Moody's decision to affirm Bosnia's B3 issuer rating is the moderate and relatively affordable debt burden, although government finances continue to be reliant on IMF programme disbursements.

Bosnia's general government debt to GDP ratio, at an estimated 42.5% in 2017, remains moderate and is below the median of B-rated peers (57% in 2017). Importantly, the debt burden has been on a gradually declining path since 2015 and Moody's expects that modest budgets, helped by continued wage restraint, as well as robust economic growth will support a further debt reduction in 2018 to below 41% of GDP. However, Moody's notes that arrears from the health sector and state-owned enterprises pose material contingent liability risks.

Bosnia's fiscal strength also benefits from a high degree of debt affordability compared to most sovereigns, with its interest expense to general government revenue ratio estimated at around 2.4% in 2017, well below the median of its B-rated peers of around 10%. This reflects Bosnia's large concessional creditor base, which has extended funding on very favourable terms.

However, Bosnia's limited access to private external capital means it remains reliant on external financing support from multilateral institutions such as the IMF. Indeed, recent delays in meeting IMF conditionality has meant entity level governments have increasingly relied on more costly domestic debt to meet short term liquidity needs. Nevertheless, Moody's notes that financing conditions for the entity level governments have remained manageable in 2017, helped by strong growth in tax revenues and alternative sources of finance. Furthermore, domestic issuances, when needed, have continued to be comfortably met by domestic demand.

RATIONALE FOR STABLE OUTLOOK

The stable outlook on Bosnia's B3 rating reflects Moody's expectation that Bosnia will continue to meet the conditions for concessional external financing, albeit with delays, which would provide the needed financial and technical assistance to continue to gradually progress the reform agenda. However, significant reform momentum will be hampered by ongoing political disagreements which distract from a country-wide reform focus and limit Bosnia's ability to address the notable structural constraints needed to improve its credit profile.

For example, there has been a marked slowdown in progressing the country's reform agenda in 2017, evidenced by the delay in completing the first IMF programme review, and Moody's expects the prospects for further important legislative achievements, demonstrated during the early part of the reform agenda, to remain limited. Notably, the political discourse in 2017 has likely been impacted by the forthcoming October elections and Moody's expects this will continue to pose a significant risk to reform momentum in the near term.

Nevertheless, Moody's expects the authorities' commitment to progress EU integration, reflected in the EU candidacy application in early 2016, will continue to provide an anchor for the country's reform direction, supported as well by the European Commission's (EC) recent adoption of its engagement strategy for the Western Balkan states. However, Moody's expects progress on the path of EU accession will continue to remain halting and slow given ongoing political challenges to central government powers. For example, the EC's technical questionnaire, a pre-requisite for candidacy status, which is expected to be delivered to the EC by the end of February 2018, has progressed far slower than for other potential EU candidacy countries.

At the same time, Moody's expects that government financing, an ongoing credit concern, will continue to remain manageable in 2018. Notably, the financing of entity level budgets will benefit from the build-up of savings in 2017, ongoing expenditure constraint as well as continued strong proceeds from indirect tax revenues due to ongoing improvements in tax collection and robust economic growth.

Moreover, recent progress in mobilising significant funding opportunities for Bosnia provide some upside risk to Moody's medium term growth assessment. In particular, the recent agreement to raise excise duties on fuels could allow significant funding directed to road infrastructure investment. For example, the €70 million (0.4% of GDP) already committed by the European Bank for Reconstruction and Development (Aaa stable) for supporting the Bosnian leg of the trans-European Corridor Vc road network, helping to improve the road links within the country and with the EU. Furthermore, recent foreign investments in the energy sector could help to stimulate this important export sector. However, Moody's expects ongoing capacity constraints and the very challenging business environment will serve to limit the potential to leverage these opportunities over Moody's rating horizon.

On the other hand, Bosnia's credit rating faces material downside risks from the crystallisation of high political event risks, particularly in an election year. For example, disagreements around amendments to the Bosnia and Herzegovina Election Law in compliance with Constitutional Court decisions could potentially hamper the implementation of the 2018 general elections and lead to a longer than expected delay in government formation, halting progress on the reform agenda and placing concessional external funding at risk.

WHAT COULD CHANGE THE RATING UP/DOWN

A streamlining of the policymaking process resulting from greater internal consensus, improving Moody's political risk assessment, would place upward pressure on the rating. In particular, a more stable policy making environment resulting in a stronger reform momentum that helps to strengthen institutions and address significant economic constraints leading to a material increase in medium term growth prospects, would be credit positive. Furthermore, ongoing timely compliance with the IMF agreement, helping to addresses fundamental aspects of fiscal reforms to ensure debt sustainability at all levels of government, would be credit positive.

A negative rating action could occur in the event the country is not able to meet the conditions to release concessional external financing disbursements, increasing risks to government financing and its ability to roll over forthcoming IMF repayments. In addition, a halt in the reform agenda, including to deepen Bosnia's integration with the EU, would also be credit negative, which may result from a longer than expected delay in forming a government following the forthcoming elections. Furthermore, a marked escalation in political volatility resulting in increased concern for the country's future as one sovereign nation, could also lead to downward rating pressure.

GDP per capita (PPP basis, US$): 10,908 (2016 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 3.2% (2016 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): -0.3% (2016 Actual)

Gen. Gov. Financial Balance/GDP: 0.4% (2016 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: -5.1% (2016 Actual) (also known as External Balance)

External debt/GDP: [not available]

Level of economic development: Low level of economic resilience

Default history: At least one default event (on bonds and/or loans) has been recorded since 1983.

On 13 February 2018, a rating committee was called to discuss the rating of the Government of Bosnia and Herzegovina. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have not materially changed. The issuer's institutional strength/ framework, 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.

The principal methodology used in these ratings was Sovereign Bond Ratings published in December 2016. 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.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt 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.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

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.

Evan Wohlmann
Vice President - Senior 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 Risk
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

No Related Data.
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