Implications of Kosovo’s initial credit rating
For the first time in the country’s history, Kosovo has received a sovereign credit rating. The rating agency Fitch assigned an Issuer Default Rating (IDR) of BB- to Kosovo in April this year. Before then, Kosovo was the only country in the Western Balkans without a sovereign credit rating. Therefore, the rating represents a milestone for the country. The BB- rating is in line with expectations and closely resembles those of its Western Balkan peers. As such it bears no surprises, but has important implications, nonetheless.
By presenting and assessing a host of relevant aspects of Kosovo’s economy and administration, the rating reduces uncertainty for investors. In turn, it facilitates taking on new debt from international financial institutions and reduces the cost of borrowing on international commercial markets. Although no plans to tap international markets for credit exist at the moment, obtaining the rating provides the country with additional fiscal flexibility in the medium term. Moreover, the rating contributes to the development of Kosovo’s financial sector and facilitates FDI attraction.
Introduction
On April 19th this year, Kosovo has received its first-ever credit rating. Upon request by Kosovar authorities, Fitch Ratings assigned a Long-Term Foreign-Currency (LTFC) Issuer Default Rating (IDR) of ‘BB-‘ with a stable outlook.
This newsletter explains what the rating means and which implications it entails.
Issuer Default Ratings
Issuer Default Ratings (IDRs) are forward looking assessments/opinions about the likelihood that an issuer of securities defaults. As such, they do not concern any specific security, but an entity that can issue securities, in this case the Republic of Kosovo. Instead of indicating a percentage likelihood of default, IDRs assign grades based on an issuer’s relative default risk compared to that of other issuers.
Implications of obtaining an Issuer Default Rating
Receiving its first-ever sovereign credit rating entails three main implications for Kosovo. First, it improves the country’s conditions for issuing securities on international markets, thereby increasing its fiscal flexibility. Second, the rating can contribute to the development of the financial sector in Kosovo. And last, it can be expected that the rating will make it easier for the country to attract foreign direct investment (FDI).
Access to international capital markets
Obtaining an IDR before issuing securities on international markets is strongly recommended, because it significantly enhances borrowing conditions, as numerous studies have shown.
Obtaining a credit rating prior to emitting securities increases demand, because many institutional investors have policies that prohibit their fund managers from investing in securities from unrated issuers.
Those international investors that invest in securities from unrated issuers typically charge a higher risk premium to compensate for accepting the increased uncertainty that comes along with unrated issuers.
Current debt structure
Lacking a credit rating, Kosovo so far relied mainly on domestic bonds, which accounted for 57% of the debt stock in 2023. The second biggest source of debt-financing are loans from multilateral creditors (38% in 2023), primarily from the World Bank.
Interestingly, Kosovo’s diaspora is also a source of debt-financing, albeit negligible in size so far. Emigrants can invest in their country of origin by buying so-called diaspora bonds, which are available exclusively to Kosovar citizens residing abroad.
Kosovo’s domestic sovereign bonds are emitted by the Central Bank of Kosovo (CBK) on behalf of the Ministry of Finance. They are issued regularly through primary auctions and are held predominantly by local banks, the Kosovo Pension Savings Trust and the Central Bank itself.
Increased fiscal flexibility
According to the IMF, the Kosovar administration currently has no concrete plans to issue securities on international markets. This is unsurprising, since the domestic market has allowed for very cheap borrowing so far. The yields of Kosovo’s domestic bonds are much lower than what international investors would most likely be willing to accept, gauged from the yields of bonds from similarly rated countries such as Albania.
Nonetheless, relying exclusively on domestic lenders and international financial institutions places constraints on Kosovo’s fiscal flexibility in the long run. The country’s debt-levels are very low in international comparison, ranging at 17.4% of GDP in 2023. This is substantially below the legal limit of 40% of GDP that the country has given itself. One explanation for this could be that domestic demand for sovereign debt may not allow for higher debt-levels. According to the IMF, it is unlikely that local banks and the Kosovo Pension Savings Trust have sufficient additional demand for Kosovar sovereign debt to sustain significantly higher public debt levels.
Moreover, many international financial institutions require a sovereign credit rating to approve larger loans, representing another limitation to fiscal flexibility. The newly obtained credit rating helps to relax both constraints to borrowing.
Financial sector development
Another important implication of the new credit rating concerns the development of Kosovo’s financial sector.
It can strengthen the capacity of local financial institutions to provide financing to Kosovar businesses through two channels. First, the new rating improves access to international markets for Kosovar financial institutions, by reducing uncertainty for investors. Through the new rating, Kosovo’s domestic banks are better equipped to issue own securities internationally, which can help to provide them with the means necessary to increase financing to local businesses.
If the Kosovar state diversifies its creditor-base by issuing debt internationally, it will be less reliant on borrowing from local financial institutions. Reduced demand from government incentivizes these institutions to increase lending to local businesses. Accordingly, Luitel and Vanpée (2018) have found that the asset portfolio of local banks changed to reflect increased lending to businesses after their host country entered international capital markets.
FDI attraction
Another finding of Luitel and Vanpée’s working paper for the European Capital Market Institute was that obtaining a sovereign credit rating typically increases a country’s FDI inflows. Although ratings only concern a country’s ability and willingness to fulfil its obligations to lenders, they can nonetheless reduce uncertainty for potential investors. This is because rating agencies scrutinize many aspects of the sovereign’s economy that are also relevant for direct investments. Among other aspects, credit ratings offer an independent and concise assessment of a country’s governance, fiscal stance and growth prospects. Having the rating as reference point thus facilitates decision-making for potential investors.
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The rating in regional comparison
As mentioned, IDRs ordinally rank issuers in reference to other issuers. With its BB- rating, Fitch considers Kosovo to exhibit “an elevated vulnerability to default risk, particularly in the event of adverse changes in business or economic conditions over time”.
This assessment is in line with the rating of Kosovo’s neighbours in the Western Balkans. Kosovo and Albania are rated very similarly and are considered to possess a slightly higher default-risk than Serbia and North Macedonia, and a slightly lower default risk than Bosnia and Herzegovina and Montenegro.
Kosovo’s sovereign credit rating thus bears no surprises to observers acquainted with its economy. Nonetheless, having one benefits the country.
