Moody’s downgrades Montenegro, outlook remains negative

Moody's Investors Service has downgraded Montenegro's government bond rating to Ba3 from Ba2, reflecting the country's deteriorating economic environment. The outlook remains negative.
"The economic recession will likely cause a decline in government revenues, leading to higher debt that will persist over time," said Kenneth Orchard, Vice-President/ Senior Analyst in Moody's Sovereign Risk Group. "Moreover, problems in the manufacturing and banking sectors could lead to higher debt as the government supports troubled companies."
Moody's forecasts that the Montenegrin economy will contract by 4%, although there is considerable uncertainty surrounding the forecast. "Montenegro will be badly affected by the recession in the rest of Europe, the end of the global property boom and the lack of liquidity in the banking sector," explained Orchard.
"Given the past surge in credit and asset prices, there is potential for the upcoming recession to be even more severe than forecast," cautioned Orchard. "However, the small size of the Montenegrin economy means that growth could be swayed upwards by progress on one or two large investment projects."
Moody's expects that the government will be forced to provide financial support to important companies in the private sector. It made an emergency loan to the second-largest bank in late 2008, which may be converted into equity. The global economic crisis is also threatening the viability of the two largest exporters in the country, KAP (aluminium smelter) and Niksic (steel mill).
"The government may struggle to fund its entire borrowing requirements from private creditors in the current international environment. Unless there is a significant improvement in the European banking sector over the next six months, the government may be forced to seek financial support from official sources, such as the IMF," cautioned Orchard.
Moody's notes that an IMF programme would open up the possibility of supplementary macro-fiscal support from the European Union (EU). Thus, the recent decision by the EU to commence an evaluation of Montenegro's readiness to become an official candidate country is positive.
Moody's estimates that the Montenegrin government's debt/GDP ratio could increase to almost 50% in 2010 from under 30% in 2007-08, while future economic growth rates will probably be lower than recently experienced.
The recession is also likely to perpetuate problems in the banking sector. Moody's has further concerns that the country could experience a liquidity crunch unless additional foreign capital is secured.
Ongoing structural reform and further European economic integration should also sustain gradual income convergence towards the EU average, although this process could take several decades.