Moody's affirms Albania's B1 rating with stable outlook

April 10 (SeeNews) - Moody's Investors Service said it has affirmed Albania's B1 long-term foreign and local currency issuer ratings and the B1 foreign currency senior unsecured debt rating, with a stable outlook. Moody's expects Albania's economy to continue to show resilience in 2023 and 2024, as the EU accession process advances and the country balances its public debt ratio by weakening debt affordability metrics, Moody's said in a statement on Friday. The global rating agency also said in the statement:

"The key drivers for affirming the B1 ratings of Albania are the following: (1) Moderate economic strength which combines a robust economic growth outlook with structural weaknesses and economic exposure to physical climate risks. (2) Moderate fiscal strength with weakening debt affordability metrics balanced by a falling debt burden.

(3) Susceptibility to event risks is elevated driven by government liquidity risks and banking sector risks. The stable outlook reflects Moody's view that risks to Albania's credit profile are balanced at the B1 level. Moody's expects Albania's economy to continue to show resilience in 2023-24.

The EU accession process as the key external anchor for reforms will result in a further gradual implementation of structural economic and institutional reforms. The improvement in the country's public debt ratio will be balanced by weakening debt affordability metrics. The local currency country ceiling remains unchanged at Baa3.

The four-notch gap with the sovereign rating reflects predictable institutions, a contained government footprint in the economy and financial system, manageable political risk, and moderate external imbalances. The foreign currency country ceiling remains unchanged at Ba2. The two-notch gap to the local currency ceiling reflects relatively weak, albeit improving, policy effectiveness and moderate external indebtedness.

RATINGS RATIONALE RATIONALE FOR THE AFFIRMATION OF THE B1 RATINGS FIRST DRIVER: MODERATE ECONOMIC STRENGTH WHICH COMBINES A ROBUST ECONOMIC GROWTH OUTLOOK WITH STRUCTURAL WEAKNESSES AND ECONOMIC EXPOSURE TO PHYSICAL CLIMATE RISKS

The first driver of today's affirmation relates to the Albanian economy's robust economic growth outlook with Moody's estimate of potential growth of around 3% which combines with structural weaknesses and exposure to physical climate risks to result in moderate economic strength. The medium-term growth perspective is supported by solid foreign direct investments particularly in the tourism and energy sector, further development of the tourism and agricultural sector - including prolonging the tourism season and increasing the importance of high-end tourism and agritourism - as well as competitiveness enhancing reforms attached to the reforms for further advancing on the EU accession process. It is noteworthy that the Albanian economy has shown significant resilience to the triple shocks since late 2019, namely the earthquake in late 2019, the coronavirus pandemic which pushed the Albanian economy in a recession in 2020 and the European energy crisis that started in 2022 caused by the war in Ukraine (Ca stable).

Despite the sizeable tourism sector, which had an overall contribution to GDP of more than 20% in 2019[1], the economy recovered quickly already surpassing the 2019-pre pandemic level in 2021 and the GDP growth momentum remained with 4.8%[2] strong in 2022 with the number of tourist arrivals climbing to a new record high. Moody's forecasts a slowdown of GDP growth to 2.5% and a moderate acceleration to 3.2% in 2024 which is in line with the trend growth over 2017-2026. However, the income gap of Albania with the EU remains larger compared to most Western Balkan countries and the catch-up with the EU levels is only gradual.

Per capita GDP (PPP basis, £) was only 34% of the EU's population-weighted average in 2022[3]. With potential growth of around 3% it would take more than 30 years to align the country's per-capita GDP with the EU's population-weighted average. Over the medium-to-long term, the ability of the Albanian economy to sustain income convergence process with the EU countries will depend on the government's success in implementing structural reforms and gaining competitiveness relative to other countries in the region.

Progressing on the EU accession process - the formal accession negotiations started in July 2022 -, making ongoing process on the associated fundamental reforms and benefitting from the capacity building support from the European Commission will be crucial. The economic strength of Albania is constrained by its small size, its large informal sector, a limited economic diversification in combination with a narrow export base and low competitiveness. Albania's economy is also moderately negative exposed to environmental risks because of the country's exposure to physical climate risks.

Exposure to physical climate risks is exacerbated by having one of the highest economic dependences on climate-sensitive sectors - namely tourism and agriculture - among the Western Balkans. Albania is also almost entirely reliant on hydropower for electricity generation; power shortages because of drought can weaken economic growth and add to government expenditure by increasing electricity imports at times when prices are elevated. In addition, demographic trends, which are part of Moody's assessment of social risk being highly negative for Albania, are adverse and will slow potential growth over the medium-to-long term unless softened by economic reforms or increasing productivity growth.

Continued outward migration intensifies the adverse demographic trends and in the three decades to 2050 the population and prime working age population will likely decrease by 0.5% and 0.6% per year, respectively. SECOND DRIVER: MODERATE FISCAL STRENGTH WITH WEAKENING DEBT AFFORDABILITY METRICS BALANCED BY A FALLING DEBT BURDEN The second driver of today's rating action relates to the government's stable fiscal strength at moderate levels, with weakening debt affordability metrics being balanced by a falling public debt ratio.

While general government debt-to-GDP (including guarantees) increased by almost 9 percentage points between 2019-21 peaking at 74.5% in 2021[4] (which was below the B1-rated median of 79.1%), the public debt ratio turned on a downward trend in 2022 and decreased by almost 10 percentage points falling below the 2019 pre-pandemic level.[5] Moody's expects Albania's public debt ratio to fall in absolute and relative terms. By 2024, Moody's projects Albania's debt-to-GDP ratio to be 61.2%, 13.8 percentage points below the B1-rated median. While public debt burden metrics will improve, debt affordability will weaken as a result of higher interest rates.

Moody's forecasts general government interest payments-to-revenue to increase to 10.6% in 2024 from a low of 6.9% in 2022[6], the highest level since 2013 and bringing Albania roughly on par with the B1-rated median. Contingent liability risks remain elevated, mainly related to electricity imports. The country is almost entirely reliant on hydropower for electricity generation and power shortages because of drought can weaken economic growth and can increase electricity imports that pose quasi-fiscal risks to the government's budget.

In addition, the authorities' increasing reliance on public-private partnerships (PPPs) to scale up investment coupled with the lack of a robust regulatory framework and the practice of receiving unsolicited proposals also presents fiscal risks. The IMF estimates the contract value of PPPs (including existing projects and projects being in the pipeline) at around 40% of GDP in 2022, significantly above 33% of GDP in 2018. However, the authorities are planning to enhance their public investment management (PIM), to align the PIM and PPP processes over the coming years and to integrate those into the budget cycle to improve investment selection and minimize fiscal risks stemming from investment projects.

Moreover, Albania's stock of foreign currency debt in relation to its GDP of 38% in 2021 exposes the country's fiscal strength to a currency depreciation. THIRD DRIVER: SUSCEPTIBILITY TO EVENT RISKS IS ELEVATED DRIVEN BY GOVERNMENT LIQUIDITY RISKS AND BANKING SECTOR RISKS Albania's government liquidity risks are elevated.

Amid a very volatile market environment and a material increase in interest rates, the government is exposed to roll-over risk of maturing debt given the relatively low average maturity of domestic debt - accounting for 54% of total debt - of 2.1 years as of end-2022, its sizeable gross borrowing requirements of an average 19% of GDP in 2023-24, which is higher than the B1-rated median of 15%, and its funding reliance on the domestic banking system. Depending on market conditions, Albania plans to issue its sixth Eurobond later in 2023 and to use parts of the proceeds from this issuance to smooth the debt maturity profile via an active liability management of buying back part of the EUR500 million (or 2.2% of 2025 GDP), seven-year 2018 Eurobond maturing on 9 October 2025, which has a coupon of 3.5%. Banking sector risks are elevated and driven by the relatively weak intrinsic strength of the highly euroized banking system.

The Albanian banking system is exposed to credit risks, exchange rate risks and interest rate risks. Asset quality improved with the NPL ratio decreasing to a low of 5.0% at end-2022 which is below the 8.4% at end-2019.[7] Nonetheless, asset quality concerns persist related to a still large proportion of foreign-currency loans including to "unhedged" borrowers and the share of bank loans with variable interest rates. In addition, the linkage between the sovereign and the banking system is relatively high as banks hold almost 63% of domestic public debt which accounted for around 24% of the banking system's assets.[8]

That said, capitalization of the banking system is above regulatory requirements as highlighted by the Capital Adequacy Ratio (CAR) of 18% at end-2022 which is above the 12% regulatory minimum across all banks. RATIONALE FOR STABLE OUTLOOK The stable outlook reflects balanced risks at the B1 level.

Because of limited direct exposure to the Russia-Ukraine military conflict, a comparatively low energy imports dependency and ongoing solid foreign direct investment flows, Moody's expects Albania's economy to continue to show resilience in 2023-24. In addition, Moody's expects Albania to advance with the gradual implementation of structural economic and institutional reforms being driven by the EU accession prospects though the actual positive impact of those reforms will take some time to materialize. As explained, the further improvement in the country's public debt ratio will be balanced by weakening debt affordability metrics caused by higher funding costs.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS Albania's ESG Credit Impact Score is highly negative (CIS-4), reflecting moderate exposure to environmental risks, high exposure to social risks and moderately weak governance profile, the latter - along with weak fiscal metrics - also pointing to relatively low resilience. Albania's credit profile is moderately exposed to environmental risks, reflected in its E-3 issuer profile score.

Exposure to environmental risk is low or moderately negative across all categories, apart from physical climate risk which is highly negative. Albania is sensitive to environmental risks because increased temperatures and precipitation variability will have a negative impact on the large agriculture sector (16% of real GDP in 2022[9]). In addition, the sizeable tourism sector (overall contribution to GDP of about 20% in 2022) and the coastal population will be adversely affected by sea level rise.

Moreover, Albania is almost exclusive reliance on hydropower for electricity generation. Power shortages as a result of drought can weaken economic growth and increase electricity imports that pose quasi-fiscal risks to the government's budget. Exposure to social risks is high (S-4 issuer profile score), and it is mainly related to the low quality of basic service and unfavourable demographics, given high emigration and an ageing population, which will weigh on growth over the long term.

Health outcomes, housing, education and labour and income are also a source of credit risk, although to a moderate extent. Albania has a moderately negative governance profile score (G-3 issuer profile), reflecting significant improvements in strengthening its institutions, though its performance in respect of rule of law and control of corruption remains relatively weak. The EU's recent decision to launch accession talks with Albania is likely to support progress in these areas.

GDP per capita (PPP basis, US£): 15,995 (2021) (also known as Per Capita Income) Real GDP growth (% change): 8.9% (2021) (also known as GDP Growth) Inflation Rate (CPI, % change Dec/Dec): 3.7% (2021)

Gen. Gov. Financial Balance/GDP: -4.5% (2021) (also known as Fiscal Balance)

Current Account Balance/GDP: -7.5% (2021) (also known as External Balance) External debt/GDP: 60.5% (2021) Economic resiliency: ba2

Default history: At least one default event (on bonds and/or loans) has been recorded since 1983. On 04 April 2023, a rating committee was called to discuss the rating of the Albania, Government of. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have not materially changed.

The issuer's institutions and governance strength, have not materially changed. The issuer's fiscal or financial strength, including its debt profile, has not materially changed. The issuer's susceptibility to event risks has not materially changed.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS FACTORS THAT COULD LEAD TO AN UPGRADE An improvement in fiscal strength related to a faster decline in the debt burden than Moody's currently expects, a more limited deterioration in debt affordability and/or a reduction in contingent liability risks would create upward pressure on the rating.

A material improvement in Albania's institutions and governance strength - possibly in the context of the EU accession process - because of an improvement in fiscal policy effectiveness or further significant reform progress, for example, in the area of rule of law and the control of corruption that would go along with an improvement of the business environment and competitiveness would also be credit positive. FACTORS THAT COULD LEAD TO AN DOWNGRADE The outlook would move to negative if fiscal consolidation and debt reduction turn out materially weaker than Moody's expects in its baseline scenario and result in a reversal of the downward trajectory of the public debt ratio, for example, caused by a materialization of contingent liabilities or a sizeable and long-lasting economic shock.

An increase in government liquidity risks would also be credit negative. In addition, emerging challenges in funding the structural current-account deficit because of a significant decline in FDI or remittances would be credit negative. An abating political commitment to further institutional and economic reforms going along with a move away from the EU accession process would also be credit negative.

Although not Moody's baseline assumption, an escalation of the Russia-Ukraine military conflict into a war involving NATO members would also exert downward rating pressure."