The debt of the Health Care Fund sank the state coffers, tourism is not threatened

Outstanding debts of the Health Insurance Fund (FZO), higher spending on salaries, social protection and pensions are the key reasons that will increase the budget deficit this year to around 6,5 percent of gross domestic product (GDP), revenues from tourism will be level of 85 percent in the record year 2019, while inflation due to the increase in the prices of imported food and fuel will be 12,5 percent, and if the Ukrainian-Russian conflict intensifies, it may be even higher.

These are the key assessments of the American rating agency Standard and Poor's (S&P), which at the end of last week confirmed the credit rating of Montenegro 'B/B' and maintained a stable outlook.

It was especially emphasized that the budget deficit will increase in 2022 due to the fiscal efforts of the Government to deal with the cost of living crisis (lower excise duties on fuel, VAT on groceries and real estate tax) and arrears in the health sector.

The health care fund requested 65 million euros in the budget review to pay its debts.

Tourism is not threatened

"We predict that the real GDP of Montenegro will increase by 4,5 percent in 2022, supported by income from tourism and the inflow of foreign direct investments (FDI), while the outlook for 2023 is more uncertain because rising inflation reduces household consumption. Additionally, we predict that the government's cash reserves will cover most of its financing needs in 2022, and we expect the country's constructive relations with international financial institutions to balance any shortfalls in external financing in 2023." it was assessed in the report, which added that the expectation is that tourists from other countries will replace any decline in Russian and Ukrainian tourists in Montenegro this year.

It was indicated that the stable outlook reflects their expectations that tourism will continue to support the economic growth of Montenegro, as well as that tourism has held up in the face of the conflict between Russia and Ukraine.

"Our basic scenario is that Montenegro will overcome the economic obstacles of the Russian-Ukrainian conflict, including the short-term impact on tourist arrivals and FDI flows. However, the indirect consequences of the conflict, especially the tightening of monetary policy by global central banks, including the European Central Bank (ECB), are likely to affect the economic and fiscal results of Montenegro. We are projecting an average inflation of 12,5 percent and an expansion of the current account deficit to around 14 percent of GDP in 2022," is the agency's position.

S&P estimates that investment inflows will continue to remain strong, and this conclusion is based on the data that foreign direct investments in six months were 355 million, which is 73 percent more than in the comparable period last year.

"Positively, the Montenegrin economy continues to attract FDI inflows in several sectors, especially the real estate market and hospitality. However, we expect a structurally smaller inflow of investments from Russia after the international sanctions imposed on that country," the report stated.

A highway study is pending

The agency estimated that the rise in prices of imported food and fuel will lead to inflation of 12,5 percent this year, limiting medium-term private consumption and some investments. It was assessed that there is a risk that inflation could be even higher in the event that further escalation of the Russian-Ukrainian conflict causes an even greater rise in commodity prices, as well as due to the tightening of the ECB's monetary policy.

"The possibilities of Montenegrin politics to neutralize shocks are limited by its fiscal position and the complete absence of monetary flexibility (since it unilaterally adopted the euro in 2002). In particular, its fiscal space remains limited by the debt contracted for the construction of the highway that would connect the Port of Bar with the Serbian border town of Boljare, which will eventually connect Bar with Belgrade. The costs of the first section of the highway have added to the debt of about 15 percent of GDP in the last three years. This section became operational in July 2022, after numerous delays and cost overruns. We understand that the government remains committed to the continuation of the next sections, but we think that the time frame is unclear, given the current political environment. The conclusion of the feasibility study of the European Bank for Reconstruction and Development, which is expected in the second half of this year, will be crucial, because a positive conclusion on economic profitability would be a condition for financing arrangements with the wider community of international financial institutions," the report stated.

It is estimated that there will be no problem in securing the missing money in the coming year because the Government can rely on its relations with official lenders.

Central bank unable to create additional liquidity

The report assessed that the unilateral adoption of the euro prevents the Central Bank (CBCG) from setting interest rates and controlling the money supply.

"In addition, it limits its ability to act as a lender of last resort." Although CBCG has some options to provide liquidity to domestic banks, in our opinion, its inability to create additional liquidity in a stressful scenario effectively prevents it from fulfilling the function of lender of last resort", the agency stated.

It was indicated that the Montenegrin banking system has solid levels of capital, non-performing loans of seven percent and sufficient liquidity.

"We understand that the conflict in Ukraine and the associated sanctions regimes have not led to a deterioration in the liquidity parameters of the banking system. It is largely financed by domestic deposits, which provides a certain stability," the report says.