Republic of North Macedonia 'BB-/B' Ratings Affirmed; Outlook Stable

  • The Republic of North Macedonia's resolution of the long-lasting name dispute with Greece in January 2019 is a major milestone, but we do not expect to see an immediate material effect on North Macedonia's economy.
  • We expect North Macedonia to formally begin EU accession talks this year. This could accelerate a number of structural reforms as part of the negotiations, although EU membership is unlikely in the near future.
  • We are affirming the 'BB-/B' long- and short- term sovereign ratings on North Macedonia. The outlook is stable.
On March 8, 2019, S&P Global Ratings affirmed its long- and short-term foreign 
and local currency sovereign credit ratings on the Republic of North Macedonia 
at 'BB-/B'. The outlook is stable.

The stable outlook reflects the balance between the risks from North 
Macedonia's rising public debt and still comparatively modest income levels, 
and its favorable economic prospects alongside the potential for institutional 
settings to strengthen over time.

We could raise our ratings on North Macedonia if timely reform implementation, 
for instance as part of EU accession negotiations, strengthened North 
Macedonia's institutional arrangements and improved its economic prospects. We 
could also consider an upgrade if North Macedonia displayed a stronger fiscal 
performance that placed net general government debt firmly on a downward path. 

We could lower the ratings if major political tensions returned or reform 
momentum waned, impairing growth and foreign direct investment (FDI) and 
undermining the country's longer-term growth prospects. We could also lower 
the ratings if large fiscal slippages or off-budget activities were to call 
into question the sustainability of North Macedonia's public debt, raise the 
sovereign's borrowing costs, and substantially increase its external 
obligations, given the constraints of the exchange-rate regime.

The ratings on North Macedonia reflect our view of the country's relatively 
low income levels; still comparatively weak institutional settings despite 
some recent improvements; and limited monetary policy flexibility arising from 
the country's fixed-exchange-rate regime. The ratings are primarily supported 
by moderate--albeit rising--external and public debt levels and favorable 
growth potential.

Institutional and Economic Profile: Name dispute resolution and restored 
political stability underpin a return of growth
  • Following stagnation in 2017, we estimate that the North Macedonian economy grew by 2.5% in real terms last year.
  • The resolution of the name dispute with Greece opens the door to NATO membership and the formal start of EU accession talks.
  • We do not expect any notable policy changes after the April 2019 presidential elections, given the largely ceremonial function of president in North Macedonia.
In January 2019, a long-standing dispute between Greece and North Macedonia 
over the latter's name was finally resolved. The disagreement had stemmed from 
Greece's objection to North Macedonia calling itself Republic of Macedonia 
because there is a similarly named region in Greece. Under the solution 
unveiled for the first time in June 2018, the country's name has changed to 
Republic of North Macedonia. After decades of gridlock, it took less than a 
year to agree and implement the newfound solution. It has already been 
ratified in both countries' parliaments and entered into force in February.

The resolution of the name dispute is an important positive milestone that we 
expect will reduce North Macedonia's past isolation and contribute to regional 
stability. More specifically, the agreement paves the way for North 
Macedonia's NATO membership and the start of formal EU accession talks in the 
coming months. Although North Macedonia has been an EU candidate since 2005, 
no progress on membership talks has been achieved due to being blocked by 

In addition to a number of important reforms adopted recently, North Macedonia 
still needs to implement some changes before EU negotiations can begin. We 
understand that these include undertaking a public administration reform, 
passing a new anti-corruption law, and adopting legislation to strengthen the 
judicial system. Potential hurdles could also stem from the European 
Parliament elections this year owing to growing EU skepticism and enlargement 
fatigue. Nevertheless, we believe these will be overcome given the 
already-substantial progress achieved to date. Our baseline expectation now is 
that North Macedonia's accession talks will start in the coming months.

In our view, the start of EU accession talks could accelerate reform momentum 
as North Macedonia implements the changes required to align it with Acquis 
Communautaire, the body of EU law. Nevertheless, we consider that it will take 
time before any adopted reforms bear fruit and become firmly entrenched within 
the institutional framework. We do not expect North Macedonia to join the EU 
in the short-to-medium term, based primarily on the experience of other 
countries in the region in recent years. For example, Montenegro and Serbia 
started accession negotiations in 2012 and 2014, respectively. The European 
Commission last year stated that they could join the EU by 2025 provided that 
required reforms are implemented. Assuming a similar timeframe, North 
Macedonia is unlikely to join the EU before 2030, in our view.

In addition to resolving the name dispute, North Macedonia has recently 
undergone an orderly power transfer that we believe has set an important 
precedent given that the country's political stage had been dominated by the 
VMRO-DPMNE party for more than 10 years previously. Despite the close 2016 
election outcome, SDSM ultimately succeeded in forming a government in May 
2017 and has now been in office for almost two years. We consider that the 
power transfer and the subsequent ability of SDSM to govern goes some way 
toward strengthening various public institutions, even though checks and 
balances and policy predictability still remain weak. To this end, we note the 
high levels of perceived corruption and the difficulties in enforcing some 
judicial decisions seen, for instance, in the escape of former prime minister 
Nikola Gruevski abroad, despite facing charges domestically. 

North Macedonia is currently gearing up for presidential elections scheduled 
for April 2019, but we expect limited policy changes in the aftermath. This is 
primarily because the presidential post is largely ceremonial in North 
Macedonia. The incumbent president Gjorge Ivanov supports the main opposition 
VMRO party but he is due to step down in May 2019 given the end of his second 
term in office.

In line with our previous expectations, North Macedonia's economy returned to 
growth last year, following stagnation in 2017. We estimate that output 
expanded by 2.5% in real terms in 2018. Although we view the resolution of the 
name dispute as an important development, we consider that the return of 
political stability has been at least as important in helping accelerate 
economic dynamics. We currently do not expect the resolution of the name 
dispute to substantially alter North Macedonia's growth performance in the 
short term.

We project that the economy will grow by 3% on average over the next three 
years. Domestic consumption and exports will remain important growth drivers. 
Meanwhile, we expect a stronger outturn for investments after an estimated 8% 
real contraction in 2018. This will happen on account of both rising private 
investments owing to improved political stability, as well as accelerating 
public capital expenditure (capex) following the substantial under-use of the 
capex budget last year on delays in a publicly-funded road construction, among 
other things.

We currently view risks to our economic projections as broadly balanced. There 
is upside potential from faster government reform implementation, which could 
ultimately improve the business environment and subsequently lead to larger 
FDI inflows. At the same time, there are risks from softening growth in 
Europe, where most of North Macedonia's trade partners are. To this end, there 
are also some risks from the U.S. introducing tariffs on car imports, which 
could indirectly affect North Macedonia mainly via its exposures to other 
European economies. Overall, at around $6,000, North Macedonia's per capita 
income remains modest in a global comparison, and substantially faster 
economic growth is needed to ensure convergence with average EU income levels. 

We continue to believe that the economy's long-term growth prospects could 
benefit from the expansion of free economic zones and their better integration 
into the local economy by using local suppliers. We note that, so far, most 
inputs for goods assembled by foreign companies have been imported. 
Consequently, the free zones' effect on the rest of the economy has been less 
than might be expected and largely confined to employment. That said, there 
are examples of some companies increasingly using domestic suppliers.

Flexibility and Performance Profile: After a period of growth, we expect 
public debt to GDP to gradually stabilize from 2020
  • North Macedonia's public debt burden remains moderate in a global context, but there has been an erosion of fiscal space in recent years.
  • Although downside risks remain, we expect net general government debt to gradually stabilize at about 45% of GDP in 2021-2022 after a prolonged period of growth.
  • North Macedonia's monetary flexibility is higher than that of other Balkan states, but the denar's peg to the euro still constrains the central bank's policies.
North Macedonia has historically run fiscal deficits. While indebtedness is 
still favorable compared globally, fiscal space has somewhat eroded in recent 
years. This is particularly important given that North Macedonia runs a fixed 
exchange rate regime and, as such, fiscal policy is the main lever by which 
the government can influence domestic economic developments.

Despite the 2018 fiscal deficit being lower than we previously projected, this 
was mainly a result of much lower capex, including delays in several 
construction projects. We understand this under-execution was caused by some 
difficulties in procurement procedures.

We expect the fiscal deficit to expand in 2019, partially from accelerating 
capex following last year's delays. Current expenditures, namely salaries and 
transfers, will continue to account for the lion's share of government 
spending, as is typical for other countries in the region. The government 
introduced progressive personal income tax but we expect the effect to be 
limited (<0.5% of GDP). Overall, we expect the general government deficit will 
expand to 3% of GDP this year, in line with the government's projection. 
Deficits should then slightly moderate, averaging close to 2.5% of GDP over 

We view positively the recent pension system reform. Currently North Macedonia 
spends about 10% of GDP on pensions, among the highest in the region, while 
the pension deficit amounts to about 4% of GDP, according to IMF estimates. 
The changes removed the double-indexation system (50% CPI/50% wage growth) for 
pensions, anchoring growth to CPI only, and increased contributions to the 

The authorities also aim to continue public financial management reform with a 
focus on improved transparency, budgeting, and oversight. We understand that 
work is ongoing to clear the arrears outstanding at various levels of 
government. In the supplementary 2018 budget, €50 million (0.5% of GDP) was 
allocated to municipal entities to clear past obligations. 

Reflecting our budgetary forecasts, North Macedonia's net general government 
debt will continue to rise until 2022, although it should stabilize at close 
to 44% of GDP thereafter. This compares to net general government debt of just 
21% of GDP in 2010. Our calculation includes the increasing debt of the Public 
Enterprise for State Roads (PESR), because we believe PESR may need to rely on 
government transfers to service its debt in the future. In particular, a 
government-guaranteed €580 million loan from the Export-Import Bank of China, 
contracted in 2013 for the construction of two highway sections, will keep 
contributing to the increasing debt burden.

In the past, North Macedonia has repeatedly tapped the Eurobond market. This 
has made the government's balance sheet more vulnerable to potential 
foreign-exchange movements, because close to 80% of government debt is 
denominated in foreign currency, predominantly euros (including part of 
domestic debt). Last year, the authorities increased their borrowing in the 
domestic market, but they also issued a €500 million Eurobond in January 2018 
at a historically low interest rate, benefiting from the European Central 
Bank's loose monetary policy. We believe the favorable terms have also been 
helped by the improved domestic political stability. The government plans to 
maintain a regular presence in the international financial markets.

With the public sector increasingly borrowing abroad, the economy's external 
debt has been rising. In 2018, we estimate that gross external debt, net of 
liquid financial and public-sector assets amounted to 27% of current account 

We forecast that North Macedonia's external indebtedness metrics will slightly 
decline over the next four years. We project the current account deficit will 
widen in 2019 to 2.5% of GDP as delayed investments take place, resulting in 
higher imports while current transfers moderate after an unusually strong 
outturn in 2018. The current account deficit will then gradually tighten and 
reach 1% of GDP in 2022, partly owing to the positive impact of the expansion 
of foreign companies in the free economic zones, including their closer 
integration with the domestic economy. We project these deficits will be 
financed by a combination of borrowing and net FDI inflows. 

The denar of North Macedonia is pegged to the euro, and we believe the 
existing foreign-exchange regime restricts monetary policy flexibility. 
However, central bank measures, such as lower reserve requirements for 
denar-denominated liabilities, have lowered overall euroization in North 
Macedonia, with foreign currency-denominated deposits and loans remaining at 
around 40% of total deposits and loans in recent years. We note that this is a 
lower proportion than in other Balkan economies and affords the National Bank 
of the Republic of North Macedonia (NBRM) additional room for policy response.

The central bank's gross foreign exchange reserves have been on the rise in 
2018. While the Eurobond issue in January gave an initial uplift, upward 
pressure on the denar of North Macedonia led the bank to purchase more than 
€350 million in foreign currency to maintain the existing exchange rate. 
Nevertheless, we believe there are vulnerabilities that could put some 
pressure on the existing peg in the unlikely event of confidence in the 
banking system taking a turn for the worse and prompting conversion of local 
currency deposits into euros. This is particularly so as North Macedonia runs 
a pegged exchange rate arrangement while being in a net external liability 
position vis-à-vis the rest of the world, at 60% of GDP.

North Macedonia's banking system, which is predominantly foreign owned, has 
seen several bouts of volatility in recent years. For example, political 
developments caused deposit outflows from North Macedonia's banking sector in 
April 2016, although the majority of funds quickly returned in the aftermath. 
In general, the banking system appears well capitalized and profitable, and it 
is largely funded by domestic deposits. Positively, North Macedonia's 
regulatory and supervisory framework under the NBRM has proven resilient to 
past episodes of volatility; the NBRM reacted swiftly to the volatility in 
April 2016 by raising interest rates and intervening in the foreign exchange 
market to support the currency peg, as well as deploying several other 
measures. At present, we estimate that nonperforming loans in the system 
amount to about 5% of the total, which compares favorably with other countries 
in the region.

Bank lending in North Macedonia has continued to increase in recent years. 
Compared to the past, trends are becoming more even: even though household 
lending remains higher than corporate, the two rates have been recently 
converging. We expect the overall stock of domestic credit to grow by an 
annual average of 7% over the next four years.
We work across the world

From London to San Francisco, to our home base in (Saint Helier) Jersey, we’re looking for extraordinary and creative scientists to help us drive the field forward.

AC Investment Inc. currently does not act as an equities executing broker or route orders containing equities securities. If AC Invest’s business model were to change and it begins routing non-directed orders in NMS securities, it will comply with the disclosure requirement of Rule 606.

77 Massachusetts Avenue Cambridge, MA 02139 617-253-1000