Moody’s: Bosnia and Herzegovina’s B3 long-term issuer rating

SARAJEVO, WASHINGTON, 29.02.2016 – Moody’s Investors Service, (“Moody’s”) has affirmed Bosnia and Herzegovina’s B3 long-term issuer rating and senior unsecured debt ratings. The outlook is stable.The factors supporting today’s affirmation are:
(1) Bosnia and Herzegovina’s low economic strength, reflecting slow progress in addressing structural impediments to growth, which keeps income levels well below the EU average;
(2) The country’s complex political system which impacts on the effectiveness of the government, keeping institutional strength low;
(3) A moderate debt burden, mainly due to concessional creditors, supports fiscal strength although limited access to external financing keeps Bosnia reliant on further official support; and
(4) Continued political instability which keeps susceptibility to political event risk high.
The stable outlook reflects Moody’s expectation that some of the recent progress on implementing the government’s Reform Agenda will help to unlock much needed financial and technical assistance from the IMF, but that high implementation risks, particularly from the challenging political environment, will hinder significant further reforms. Bosnia and Herzegovina’s local-currency bond and deposit ceilings and 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).
RATIONALE FOR THE AFFIRMATION:
FIRST FACTOR — Bosnia and Herzegovina’s low economic strength – The first factor for Moody’s decision to affirm the B3 rating on Bosnia and Herzegovina (Bosnia) is the country’s low economic strength, with slow progress in addressing structural impediments to growth. Bosnia’s economy has grown slowly since emerging from recession in 2010, averaging a lackluster 0.8% per year to 2014, far below the pre-crisis average growth of around 5% per annum buoyed by rapid credit growth and foreign direct investment (FDI). Nevertheless, the economy demonstrated resilience in the face of heavy flooding in May 2014, with growth reaching 1.1% that year despite the significant impact of the natural disaster on all aspects of the economy. Furthermore, the economic recovery that was underway in 2013 has continued in 2015, with annual growth estimated at 2.1% and increasing to 3% in 2016 helped by the reconstruction efforts and improved growth in the European Union, its main trading partner. However, despite some recent progress on reforms, significant impediments to higher growth, such as the large and inefficient public sector as well as very low levels of competitiveness, are expected to continue. FDI will remain below pre-crisis levels, continuing to limit potential output and private sector job creation, holding back a meaningful reduction in unemployment. As a result, there will be no significant improvement in income levels, which have remained around 30% of the EU average since 2009.
SECOND FACTOR — Weak government effectiveness keeps institutional strength low – The second factor supporting the affirmation is the government’s poor effectiveness in policy formation and implementation, reflecting the complex structure of the government created to protect the interests of the three major political constituencies.In particular, Bosnia’s low institutional strength is reflected in its ranking in the bottom 20% among our rated universe on the Worldwide Governance Indicator for effective functioning of the government, similar to the median of B3-rated peers. In addition, weak government effectiveness impacted on Bosnia’s compliance with its 2012-2015 IMF agreement, which did not complete due to the lack of fiscal and financial sector reform. Furthermore, Moody’s expects Bosnia’s weakness in policy implementation will continue to hinder its progress on the path of EU accession, which would provide a framework to conform the country’s judicial, institutional and policy environment closer to EU norms. In contrast, Bosnia’s currency board arrangement, supported by significant reserves, enjoys a high level of confidence and credibility, providing stability to monetary policy and support to Moody’s assessment of institutional strength.
THIRD FACTOR — A moderate debt burden but funding reliant on new IMF agreement- The third factor for Moody’s decision to affirm Bosnia’s B3 government bond rating is the moderate and relatively affordable debt burden, although government finances continue to be reliant on a new programme with the IMF. Despite the significant rise in its debt burden, Bosnia’s estimated general government debt to GDP ratio of 44.6% in 2015 remains in line with the median of its B-rated peers (48% in 2014). Furthermore, Bosnia’s large concessional creditor base has extended funding on favourable terms. As a result, Bosnia benefits from a high degree of debt affordability compared to most sovereigns, with its interest expense to general government revenue ratio close to 2% in 2015, well below the median of its B-rated peers of around 10%. Nevertheless, given Bosnia’s limited access to private external capital, the government’s ability to roll over large repayments due to the IMF over the next three years relies on securing new external financial support, most likely in the form of a new IMF programme. In the interim, the entity level governments have relied on domestic debt to meet short term liquidity needs while negotiations are ongoing. Moody’s notes that domestic issuances have continued to be comfortably met by domestic demand such that both entities have been able to refinance themselves successfully through 2015 and 2016 to date, limiting the immediate risk to government liquidity until a new IMF agreement is finalised.
FOURTH FACTOR — Continued political instability keeps susceptibility to event risk high – The fourth factor is the divisive political landscape which 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. Moody’s notes that the formation of a government within the Federation entity in late 2015 together with an improvement in inter-entity relations allowed for the adoption of the broad Reform Agenda, written in conjunction with international partners, by all three of the main political entities, which marked a rare success in reaching a difficult-to-achieve consensus. However, political infighting will continue to pose credit risks. In particular, Moody’s believes that the government in Republika Srpska will likely continue to foster uncertainty in light of its announcement to suspend co-operation with state-level judiciary institutions and recent disagreements around the adoption of a co-ordination mechanism between the various levels of government. Moody’s expects these developments 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. Furthermore, progress on the path to EU accession will likely be accompanied by an increase in political tensions. RATIONALE FOR STABLE OUTLOOK – The stable outlook reflects Moody’s expectation that some of the recent progress on implementing the government’s Reform Agenda will help to unlock much needed financial and technical assistance from the IMF in the coming months, but that high implementation risks, particularly from the challenging political environment, will hinder further reforms that would have a material impact on our assessment of Bosnia’s economic, institutional and fiscal strength. Recent reform progress, in particular the passing of the long-delayed labour market reforms in the face of significant protests as well as the new fiscal responsibility law in Republika Srpska, indicates there could be a sound basis for concluding negotiations on a new IMF programme in the near term. An agreement would allow the country to regain access to external finance at concessional rates, allowing for the refinancing of the roughly $500 million in repayments due over the next three years from previous IMF Stand-By Agreements. Furthermore, a revised approach by the EU to focus on economic and social reforms allowed for Bosnia’s 2008 Stabilisation and Association Agreement to come into force in 2015 and Bosnia’s recent candidacy application demonstrates the authorities’ commitment to progress EU integration. However, Moody’s expects reforms will continue to be hampered by political infighting and face opposition from vested interests, while local elections scheduled in late 2016 pose a significant risk to reform momentum. As a result, more fundamental progress on the path of EU accession will continue to remain halting and slow. In particular, EU integration will continue to meet resistance from some sub-national governments challenging the consensus for stronger central government powers that better positions the country to overcome political deadlock.
WHAT COULD CHANGE THE RATING UP/DOWN – A strengthening of institutions through the implementation of structural reforms (independently or as part of the EU accession process) and/or streamlining of the policymaking process in light of a significant improvement in inter-entity relations could place upward pressure on the rating. Continuous compliance with a new IMF agreement that addresses fundamental aspects of fiscal/pension reforms to ensure debt sustainability at all levels of government would also be credit positive. A negative rating action could occur in the event the country is unable to reach (or fails to comply with) a new IMF agreement, which would further disrupt disbursements and put concessional external financing out of reach, increasing uncertainty about the government’s ability to roll over the large IMF repayments due over the next three years. In addition, an ongoing failure to implement the reforms needed to deepen Bosnia’s integration with the EU would also be credit negative. Furthermore, inaction from the international community which allows the divisive actions of the Bosnian communities to persist, resulting in a pessimistic outlook for the country’s future as one sovereign nation, could also lead to downward rating pressure.