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Rating Action:

Moody's changes outlook on Montenegro's rating to positive, affirms B1 rating

21 Sep 2018

Frankfurt am Main, September 21, 2018 -- Moody's Investors Service ("Moody's") has changed the outlook on the Government of Montenegro's B1 long-term issuer and senior unsecured debt ratings to positive from stable. Concurrently, Moody's has affirmed the B1 long-term ratings as well as Montenegro's Not Prime (NP) short-term issuer rating.

The key drivers for the change in the rating outlook to positive from stable are:

(1) Montenegro's favourable medium-term growth outlook, supported by structural reforms, progress with respect to the country's EU accession negotiations and significant investment projects in transportation, tourism and energy sectors.

(2) The government's consolidation measures that improve Montenegro's fiscal position.

(3) Moreover, the government took effective actions to significantly lower Montenegro's medium-term refinancing risks.

The affirmation of Montenegro's B1 sovereign ratings balances its relatively high wealth compared to similarly rated peers with the economy's very small size and low diversity. The rating reflects also the country's moderate institutional strength supported by EU accession prospects and its moderate event risk, driven by banking sector risk and to a lesser extent by external vulnerability risk.

Montenegro's long-term foreign currency bond and deposit ceilings remain at Ba1 and B2, respectively. The short-term foreign currency bond and deposit ceilings remain Not Prime.

RATINGS RATIONALE

RATIONALE FOR POSITIVE OUTLOOK

FIRST DRIVER: MONTENEGRO'S FAVOURABLE MEDIUM-TERM GROWTH OUTLOOK, SUPPORTED BY STRUCTURAL REFORMS, EU ACCESSION PROSPECTS AND SIGNIFICANT INVESTMENT PROJECTS

The first driver for changing Montenegro's rating outlook to positive relates to Montenegro's medium-term growth outlook, supported by structural reforms, the country's EU accession prospects and significant investment projects. With respect to structural reforms, the new labour and pension laws are expected to address mismatches in the labour market and improve the sustainability of the pension system which has a relatively large funding gap. Overall, Moody's expects potential growth to rise to about 3.5%, an acceleration from the average growth rate of 2.0% between 2008 and 2017.

Montenegro's growth prospects are also supported by further progress made on strengthening institutions in the EU accession process. While Moody's does not expect Montenegro to join the EU in the foreseeable future, the ongoing success achieved in bringing the legal and operational framework into line with EU norms enhances local operating conditions and the country's attractiveness to foreign direct investment (FDI). Montenegro is the front-runner in EU accession negotiations compared to peers such as Serbia (Ba3 stable) and Albania (B1 stable).

In addition, Montenegro benefits from EU assistance amounting to around 1% of GDP per year under the Second Instrument for Pre-Accession (IPA2) for the period 2014-2020, which aims to support the implementation of key reforms. Moreover, following the European Commission's publication of its strategy towards the Western Balkans in May 2018 which reaffirmed the enlargement perspective, the Western Balkan Summit in London in July 2018 saw the commitment to a new guarantee instrument with an initial EU commitment of up to €150 million in 2019-2020 that could be leveraged to up to €1 billion in investments in sustainable socio-economic development and regional integration.

Significant investment projects in the tourism, construction and energy sectors currently underway are also supporting Montenegro's growth perspectives. The expansion of capacity in the tourism sector continues with new flight routes being opened to additional Western European locations. The Bar-Boljare highway project will further improve Montenegro's economic prospects by facilitating access to main coastal hubs and diversifying the tourist sector by opening up links to the mountainous north of the country. While Moody's expects more substantial gains once the entire highway and corresponding links from other countries are complete, the priority section of the Bar-Boljare highway being in full operation probably in the second half of 2019 will already have some positive spill-over effects on the economy.

Moreover, large energy projects will support investment and Montenegro's export potential. The most important of these is an undersea power cable connecting Montenegro and Italy -- a link of the 400 kV Trans-Balkan Electricity Corridor connecting Serbia, Bosnia and Herzegovina, Romania and Montenegro to the EU grid -- that is expected to be in full operation in 2019. The entire corridor linking all four countries to the EU grid is expected to come on stream in 2022. This project is expected to make Montenegro an important energy hub in the region, increasing the country's competitiveness and encouraging investments in new energy sources, particularly renewables.

SECOND DRIVER: CONSOLIDATION MEASURES IMPROVE FISCAL POSITION

The second driver for changing the outlook to positive from stable relates to Moody's assessment that the authorities' fiscal consolidation measures will improve the government's debt metrics starting in 2018. The authorities made progress on the implementation of significant fiscal consolidation measures comprising higher revenue generation and expenditure cuts as well as measures taken to tackle pension and public-sector wages since end-2016.

On the revenue side, the main measures have been an increase in the standard VAT rate to 21% from 19% at the beginning of 2018 and higher excises on, for example, sugary drinks (January 2018) and coal (planned for January 2019). Spending measures include reduction in social welfare benefits, cuts in capital expenditure outside of the Bar-Bolijare highway, reduction in payments to redundant workers. Those fiscal adjustments translate into a counter-cyclical fiscal policy which is in contrast to the pro-cyclical fiscal policy that had eroded the government's fiscal space in the past.

In combination with solid average economic growth of 3.2% over 2018/20, Moody's expect the fiscal balance to turn into a surplus of 2% of GDP by 2020 from an average deficit of -2.4% of GDP in 2018/19. After peaking at 69% in 2018, the debt-to-GDP ratio is expected to decline to below 50% by 2022. In Moody's view, regaining fiscal space is especially important in Montenegro's case due to the full euro-ization of the economy, which leaves fiscal policy as its main macro tool. Moody's expects the fiscal policy actions and the commitment of the government to reduce government debt as well as contingent liabilities. The accumulated fiscal consolidation measures taken together will amount to almost 3% of GDP between 2017 and 2020, with the largest effect in 2018.

Unexpected budget overruns related to judicial claims, SOEs or ad-hoc decisions of the government to increase spending could lead to a weaker than expected fiscal consolidation. Moody's expects an average fiscal balance of -1% of GDP over 2018-2020 compared to the government's forecast of a balanced budget and a fiscal surplus of 4.4% by 2020.

The main risk to the fiscal outlook relates to the costs of the Bar-Boljare highway. The completion of the priority section is expected for the second half of 2019. The overall costs of that section are estimated at €929 million (based on the EUR/USD exchange rate as of 19 September 2018), equivalent to 20.7 % of GDP. The risks include possible delays with cost overruns as well as foreign currency risks associated with the dollar-denominated loan taken from the Export-Import Bank of China (A1 stable) in 2014. Additionally, while the authorities hope to attract private investors to build the three remaining sections of the highway project, Moody's believes that risks persist that the government would eventually be exposed to some form of risk sharing to complete the project. The overall costs for those sections are roughly estimated at around €1.2 billion or 25% of GDP.

THIRD DRIVER: THE GOVERNMENT'S EFFECTIVE MEASURES TO LOWER MONTENEGRO'S REFINANCING RISKS

The third rating driver is based on a significant mitigation of Montenegro's refinancing risks over coming years. While the government faced refinancing risks amounting to almost €1.1 billion or 22% of GDP against the backdrop of three maturing Eurobonds over 2019-2021 (notably €280 million in 2019, €500 million in 2020 and €300 million in 2021), the authorities have taken effective actions to improve the debt maturity profile and to lower large refinancing risks.

Firstly, with the support of a World Bank Policy-Based Guarantee amounting to €80 million, a consortium of international banks provided a €250 million loan to Montenegro in May 2018 with a maturity of 12 years and a 4-year grace period on principal and an amortizing payment structure. This loan will help to amortize the Eurobond maturing in 2019.

Secondly, the government issued a €500 million Eurobond with a 7-year maturity period in April 2018 and implemented a liability management operation including the exchange of €362.35 million of Eurobonds coming to maturity over 2019-2021. Overall these measures improved the debt maturity profile and significantly reduced the medium-term refinancing risks. The government's cash balance stood at €345 million at the end of 2018 Q2 up from €72 million at the end of 2018 Q1. Leveraging a second World Bank Policy-Based Guarantee and issuing a Eurobond smaller than the 2018 Eurobond would likely fully take away refinancing needs for 2019-2021.

RATIONALE FOR AFFIRMATION OF THE B1 RATING

The factors supporting the rating affirmation include Montenegro's elevated wealth and strong institutions compared to similarly rated peers. Montenegro's position in the Worldwide Governance Indicators compares favorably to regional peers: Montenegro fares better compared to Serbia, Albania, Bosnia and Herzegovina (B3 stable) and Moldova (B3 stable) in the key categories, including rule of law, government effectiveness and control of corruption. Balanced against these strengths are Montenegro's small scale and limited economic diversification, the government's relatively high debt-to-GDP levels and the economy's heavy reliance on foreign funding.

WHAT COULD CHANGE THE RATING UP/DOWN

The rating would likely be upgraded if there would be full or close to full implementation of the government's consolidations measures showing up in improving government's debt metrics placing the government's debt trajectory on a sustainable downward path in combination with Moody's heightened confidence that the highway-related fiscal risks are contained.

Also credit positive would be the completion of a majority of the EU's acquis communautaire, which would support progress towards EU accession. Equally, a reduction in contingent liabilities, stemming from a combination of materially lower government guarantees and lower risks posed by banks and SOEs, would also be credit positive.

Finally, further improvements in external competitiveness gained from the implementation of FDI-funded projects in the tourism and renewable energy sectors, as well as a material reduction in external vulnerability, would support Montenegro's sovereign credit profile.

The positive outlook signals that a downgrade is currently very unlikely. However, downward pressure on Montenegro's credit profile would develop should the government's debt metrics and contingent liabilities would deteriorate substantially. Other negative factors include a weakening of Montenegro's external position, likely reflecting the failure of efforts to gain competitiveness in the areas of tourism and other export-oriented industries.

GDP per capita (PPP basis, US$): 17,996 (2017 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 4.3% (2017 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 1.9% (2017 Actual)

Gen. Gov. Financial Balance/GDP: -5.4% (2017 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: -16.3% (2017 Actual) (also known as External Balance)

External debt/GDP: 159.7% (2017 Actual) (also known as Foreign Debt)

Level of economic development: Moderate level of economic resilience

Default history: No default events (on bonds or loans) have been recorded since 1983.

On 19 September 2018, a rating committee was called to discuss the rating of the Government of Montenegro. The main points raised during the discussion were: The issuer's economic strength have increased. The issuer's institutional strength/framework have improved being supported by the EU accession process. Montenegro's refinancing risks were lowered by the government's effective measures. The issuer's fiscal or financial strength including its debt profile will probably improve starting in 2018, but risks related to the Bar-Bolijare highway remain.

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.

Heiko Peters
Asst Vice President - Analyst
Sovereign Risk Group
Moody's Deutschland GmbH
An der Welle 5
Frankfurt am Main 60322
Germany
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 Deutschland GmbH
An der Welle 5
Frankfurt am Main 60322
Germany
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

No Related Data.
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