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Rating Action:

Moody's affirms Bosnia and Herzegovina's B3 ratings; outlook stable

22 Jul 2022

London, July 22, 2022 -- Moody's Investors Service ("Moody's") has today affirmed Bosnia and Herzegovina's B3 long-term local and foreign currency issuer ratings. The outlook remains stable.

The decision to affirm the B3 ratings balances Bosnia and Herzegovina's limited economic strength and significant structural challenges with fiscal metrics that are stronger than its peers, reflecting moderate debt levels and high debt affordability. The ratings are also constrained by weak institutions and governance strength, in part reflecting a very complex governance system, and extremely high political risk that hampers effective policymaking and reform implementation.

The stable outlook reflects Moody's expectation that the negative economic and fiscal impact of the spillovers related to the Russia-Ukraine military conflict will remain manageable and that Bosnia and Herzegovina's fiscal metrics will remain stronger than those of most of its peers. Furthermore, despite persistent internal political dissent, Moody's views the risk of a de-facto secession of the Republic of Srpska (RS, B3 stable) as low given signs of resuming cooperation in decision-making at state-level and demonstrated commitment of the international community to the country's economic and political stabilization.

Bosnia and Herzegovina's local- and foreign-currency ceilings remain unchanged at B1 and B3, respectively. The two-notch gap between the local-currency ceiling and the sovereign rating reflects the elevated political risks from the volatile domestic politics, low predictability of government and institutions and moderate government's footprint in the economy. The two-notch gap between the foreign-currency ceiling and the local-currency ceiling balances limited capital account openness and weak policy effectiveness against contained external indebtedness and the presence of a credible currency board arrangement.

RATINGS RATIONALE

FIRST DRIVER: SIGNIFICANT STRUCTURAL CHALLENGES WEIGH ON ECONOMIC STRENGTH

The affirmation of Bosnia and Herzegovina's B3 ratings reflects its limited economic strength, given its relatively small size and structural challenges that constrain its growth potential including the presence of a large and inefficient public sector, high unemployment and persistent emigration. That said, the economy has proved relatively resilient to the pandemic, with real GDP growth rebounding by 7.5% in 2021 from a contraction of 3.1% in 2020 supported by the recovery of domestic demand and strong export growth, in particular base metals and mineral products, exceeding pre-pandemic levels.

The economy is also less exposed than some regional peers to the economic effects of the military conflict in Ukraine (Caa3 negative), particularly given its relatively limited trade and financial linkages with Russia and Ukraine. While gas is imported from Russia, it accounts for a very small share of the energy mix. Nevertheless, Moody's expects a significant deceleration of economic activity this year with real GDP projected to grow only by around 2.5% in 2022 and 2023, with risks tilted on the downside due to the deteriorating economic environment of trading partners, in particular within the EU that accounts for around 70% of Bosnia and Herzegovina's exports.

Progress in closing the income gap with the EU countries has lagged compared to regional peers and Moody's expects Bosnia and Herzegovina's structural challenges to continue to weigh on growth potential, which is estimated at around 3%. The lack of a dynamic private sector, which reflects relatively weak business environment characterized by complex bureaucracy, has contributed to a low level of labour force participation and persistently high unemployment rates, in particular of long term nature and among the youth. Limited job opportunities have contributed to continuous emigration of workers, exacerbating pressures on labour supply and accelerating ageing, as emigrants tend to be younger and more educated. Moody's expects these structural challenges to persist, given low appetite for reforms, which in part reflects the difficult political environment.

SECOND DRIVER: STRONGER-THAN-PEERS FISCAL METRICS REFLECTING MODERATE DEBT BURDEN AND HIGH DEBT AFFORDABILITY

The second driver of the rating affirmation is Bosnia and Herzegovina's stronger fiscal metrics compared to both regional and rating peers. This in part reflects the track record of small budget surpluses accumulated pre-pandemic, mainly driven by sustained growth in indirect tax revenue and spending restraint (in particular, capital expenditure), although the latter is mainly a reflection of weak public investment management and limited institutional coordination.

After a pandemic-induced deficit of 4.7% of GDP in 2020, the fiscal balance achieved again a small surplus in 2021. The overperformance of indirect tax revenue so far has afforded the authorities the fiscal room to introduce a number of measures in response to increasing inflationary pressures, including rises in wages and pensions, and the setup of commodity reserve funds while other measures, including the introduction of differentiated VAT rates, are under consideration. Moody's projects that the fiscal balance will record a small deficit this year, although risks are tilted to the downside given the possibility of additional measures introduced ahead of the elections scheduled for October. While fiscal consolidation is expected to resume in 2023, repeated salary and pensions increases rise the budget rigidity and pose a risk to fiscal sustainability over the longer term as they are unlikely to be reversed.

General government debt stood at 35.4% of GDP at the end of 2021 and Moody's expects the general government debt to gradually decline in 2022-2023, reaching about 31% of GDP at the end of 2023. The debt burden remains well below the median of B-rated peers (60% of GDP in 2021), but fiscal risks arise also from arrears in the health sector and SOEs liabilities, with the latter estimated at about 25% of GDP.

Bosnia and Herzegovina's fiscal strength is also supported by favorable debt affordability metrics, although this mainly reflects the country's large reliance on concessional financing from international financial institutions. Interest payments absorbed around 1.7% of general government revenue in 2021, comparing very favorably to the B-rated median (9.5% in 2021). Nevertheless, increasing reliance on commercial sources and less favorable market conditions will weigh on debt affordability over the medium term unless additional financing is secured from official sources.

THIRD DRIVER: DIVISIVE POLITICAL ENVIRONMENT WEIGHS ON POLICY EFFECTIVENESS AND HINDERS REFORM IMPLEMENTATION

The third driver for the rating affirmation at B3 is Bosnia and Herzegovina's very high political risk, which is the key driver of the country's susceptibility to event risk. Political risk has increased over the past year, with the lack of cooperation at state-level culminating in a political crisis that only recently has showed signs of de-escalation.

The political environment deteriorated last year when the RS, one of the two entities that comprise Bosnia and Herzegovina, decided to withdraw its representatives from state-level institutions and subsequently launched a process to setup parallel institutions in areas currently managed by the state such as indirect taxation, defence and security as well as judicial institutions. The lack of political consensus has not only resulted in a political paralysis that adversely affected the implementation of economic and institutional reforms, but risks undermining some of the key institutional frameworks at the state level.

The highly divisive political environment has exacerbated the challenges posed by Bosnia and Herzegovina's institutional fragmentation and complex governance structure. Fiscal policy effectiveness has also been undermined by political dissent. Political disagreements and legislative bottlenecks constrain budget formation and the release of concessional external financing for budget support and investment from official creditors. Furthermore, progress in fulfilling the criteria on the EU membership path to be granted the official candidate status have been elusive so far.

While Moody's continues to view the central bank as effective in managing a credible currency board arrangement, politically-driven initiatives challenging this framework may have the potential to undermine the country's monetary and financial stability.

Partially due to the engagement of the international community, which included the imposition of targeted sanctions and the suspension of part of official financing to RS, recently there have been signs of de-escalation of the political crisis, with evidence of increased cooperation at state level, including the approval of the 2022 state budget and a political agreement on the EU reforms path. While the risk of a de facto secession has effectively receded, Moody's expects that the very high political risk will continue to weigh on policy implementation and reforms progress, constraining our assessment of susceptibility to event risk.

RATIONALE FOR STABLE OUTLOOK

The stable outlook reflects Moody's view that the B3 rating captures the balance of risks to Bosnia and Herzegovina's credit profile. Moody's expects that the negative economic and fiscal impact from spillovers from the Russia-Ukraine military conflict will remain manageable for Bosnia and Herzegovina and that its fiscal metrics will remain stronger than those of most of its peers.

The stable outlook also reflects Moody's expectation that the risk of a de-facto secession remains low given signs of resuming cooperation in decision-making at state-level and limited progress by RS in setting up parallel institutions. In Moody's view, the strong commitment of the international community will continue to help to mitigate domestic political tensions and preserve the integrity of the country, although politics will remain divisive, in particular ahead of elections. This environment will likely continue to hinder progress in strengthening Bosnia and Herzegovina's institutions and the implementation of reforms on the path toward EU accession.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

Bosnia and Herzegovina's credit profile is moderately exposed to environmental risks, reflected in its E-3 issuer profile score. Exposure to environmental risks is moderate, in particular to physical climate risk given the economy's high reliance on agriculture that exposes it to weather-related events and trends.

Exposure to social risks is high (S-4 issuer profile score), and it is mainly driven by demographic challenges and very high unemployment rates, in particular among the young segment of the population, with limited job opportunities which have led to high emigration. Access to basic services is also relatively weak, while health outcomes and education are also a source of risk, although moderate.

Governance considerations are material to Bosnia and Herzegovina's rating and a driver of today's action. Bosnia and Herzegovina has a highly negative governance profile score (G-5 issuer profile), reflecting the country's highly complex political structure and a lack of internal consensus undermine the political and economic as well as fiscal reform process, hence governance more generally. This also explains low resilience to E and S risks stemming from governance.

GDP per capita (PPP basis, US$): 16,010 (2021) (also known as Per Capita Income)

Real GDP growth (% change): 7.5% (2021) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 6.4% (2021)

Gen. Gov. Financial Balance/GDP: 0.8% (2021) (also known as Fiscal Balance)

Current Account Balance/GDP: -2.1% (2021) (also known as External Balance)

External debt/GDP: 63.4% (2021)

Economic resiliency: b2

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

On 19 July 2022, 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 RATINGS UP

A strengthening of the country's governance and institutional profile thanks to the implementation of reforms that address long-standing structural challenges and lead to tangible progress on the EU accession path would place upward pressure on the rating. This progress would be supported by a more cooperative political environment resulting in a greater policymaking effectiveness. Furthermore, close cooperation with the IMF and EU leading to structural reform progress would contribute to the emergence of upward pressure on the rating.

WHAT COULD CHANGE THE RATINGS DOWN

Bosnia and Herzegovina's outlook could be changed to negative and the rating eventually be downgraded in the event of political actions resulting in a material weakening of the state institutions (including for example the dismantling of the Indirect Taxation Authority) or a marked escalation in political or social tensions jeopardizing the country's future as single sovereign nation. More specifically, the creation of parallel institutions by RS in key areas currently managed by the state would be a key driver of a negative outlook as it will undermine the ability of state institutions to operate effectively, and the country's path toward the EU accession, threatening social stability. In addition, any major reform reversals, including to deepen Bosnia and Herzegovina's integration with the EU, could also lead to downward rating pressure. A significant weakening in the government fiscal metrics, due for example to a change in the fiscal policy stance would also be credit negative.

The principal methodology used in these ratings was Sovereign Ratings Methodology published in November 2019 and available at https://ratings.moodys.com/api/rmc-documents/63168. Alternatively, please see the Rating Methodologies page on https://ratings.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 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 on https://ratings.moodys.com/rating-definitions.

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 issuer/deal page for the respective issuer on https://ratings.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 https://ratings.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://ratings.moodys.com/documents/PBC_1288235.

At least one ESG consideration was material to the credit rating action(s) announced and described above.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the EU and is endorsed by Moody's Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on https://ratings.moodys.com.

Please see https://ratings.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 issuer/deal page on https://ratings.moodys.com for additional regulatory disclosures for each credit rating.

Daniela Re Fraschini
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

Alejandro Olivo
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

No Related Data.
© 2022 Moody’s Corporation, Moody’s Investors Service, Inc., Moody’s Analytics, Inc. and/or their licensors and affiliates (collectively, “MOODY’S”). All rights reserved.

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