The recent downgrade of Montenegro’s credit rating, bringing it deeper into junk status, highlights the structural challenges the tiny country’s economy faces.
It has had impressive success in putting itself on the global tourism map, which has also attracted investment in real estate, but financial sector difficulties and fiscal imbalances, as well as exposure to the eurozone crisis, are a drag on growth.
Standard & Poor’s downgraded Montenegro’s long-term foreign and local currency sovereign credit rating from BB to BB-, three steps below investment grade, on June 13. The rating has stable outlook.
The agency said that its decision was based on the “increasing challenges” to the government’s debt stabilisation efforts due to the “weakening economic environment, pressures arising from contingent liabilities, and diminishing external bank financing”.
S&P expects growth to be an anaemic 0.5 per cent in 2012, and notes that the country is suffering from the “continuous withdrawal of credit from [the] private sector”. Montenegro may not be able to meet its revised budget deficit target of 2.5 per cent. An IMF report in May forecast a primary balance (the fiscal balance before the payment of interest) of -3.3 per cent, and improvement on -4.6 per cent in 2011, as the government pursues fiscal consolidation. This has become a pressing priority – public debt as a percentage of GDP rose to 47 per cent at end-2011, from 28 per cent in 2007.
After several years of buoyant growth, driven by high levels of foreign direct investment, the economy hit a wall in 2009, contracting by 5.7 per cent. Recovery has been respectable, if by no means stellar, with two successive years of 2.5 per cent growth. But that recovery is now stalling.
The crisis in the eurozone is certainly partly to blame for the slowdown. As a tiny and open economy, Montenegro can scarcely hide from external conditions. The country continues to attract high levels of FDI relative to its GDP (11.9 per cent in 2011 and a forecast 11.4 per cent this year, says the IMF) a sign of its advantages as an investment destination. FDI per head was €860 in 2011, according to official figures, high by regional standards. International investors and institutions including the World Bank are upbeat about the country’s long-term potential.
But there are structural issues holding the country back. The government’s indebtedness has been increased by the burden of its support for the country’s crucial metals industry, particularly KAP, a heavily-indebted and loss-making aluminium plant, Zeljezara Niksic, an insolvent steel mill. Inefficient tax collection also depresses government revenues.
While the financial sector may be stabilising, a rapid drawdown in liquidity since the crash is stifling private sector growth, and banks are hampered by high levels of non-performing loans. The World Bank has praised the government’s reform efforts, but urged further improvements to the business climate, particularly greater labour market flexibility. Diversification could also help: in 2009, KAP accounted for more than half the country’s export earnings, and more recently tourism has been the main growth driver. Montenegro has certainly done well at developing its tourism industry and related real estate business, but the glitzy resorts of the coast contrast with poverty in the mountainous north.
The message from the downgrade is that more must be done to get public finances on an even keel and the broader economy back on its feet. The good news is that Montenegro has shown itself able to punch above its weight, which should stand it in good stead in the long term.