28th April 2021 - Approximate reading time, 7 minutes.
MONTENEGRO:
The Curious Case of the "Highway to Nowhere"
A small mountainous Balkan country with a population of just over 600,000 owes China approximately USD 1 billion for a highly controversial and technically complex highway project that has brought with it looming financial peril.
Montenegro sometime during the past two weeks reportedly asked the European Union for assistance in repaying its huge Chinese obligation - the first highway loan payment comes due in July. China presently holds about one quarter of Montenegro's debt total with much of it resulting from throughway financing. Fears of Montenegro possibly defaulting on the road construction loan (owed to China's Import-Export Bank) and / or other external debt triggered a market sell-off of its two eurobond issues, with the 2029 maturity in particular dropping dramatically (from the low 90s to near 80 in just a matter of days). The country's bonds have since recovered somewhat but market sentiment remains clearly negative, particularly since the EU has stated that it does not get involved in repaying loans to third parties, although some notable figures in Brussels have expressed concerns about "the socioeconomic and financial effects some of China's investments can have [on Montenegro]", along with economic imbalance risks and "debt dependency."
China sees Montenegro as pragmatically attractive because it gives Beijing a European presence in the Adriatic and closer political ties, and heightened influence in the country may prove beneficial if Podgorica gains European Union membership.
Montenegrin officials deny that a "formal request" for assistance was ever communicated to the E.U. and they claim that the country has the capacity to service all its debts "without unusual difficulty." A rather bold statement given that, according to recent Standard and Poor's projections, Montenegro's debt-to-GDP metric will exceed 82 percent by end 2021. Balance of payments pressures also remain seriously high with the current account deficit standing at 26 percent of of GDP, at the present time (SeeNews: S&P downgrades Montenegro to B, outlook stable. 10th March 2021). Moreover, the tourism-reliant Montenegrin economy has been especially hard hit by Covid-19. All things considered, the former Yugoslav state is hardly in a position to assume any further borrowings to complete the last three stages of its problematic highway venture (in actuality, the first stage has yet to be finished. "Official first-stage completion" was recently rescheduled for end 2021). The IMF in a recent Montenegro economic assessment estimated that at least an additional USD 1.2 billion will be needed to complete all four highway stages (International Monetary Fund, Montenegro: Request for Purchase Under the Rapid Financing Agreement - Press Release Staff Report, and Statement by the Executive Director for Montenegro. June, 2020).
The country had been fast-tracked for European Union membership in 2022. However, during 2018, growing unease regarding the pace of social and fiscal reforms plus the government's ineffectiveness in tackling widespread corruption pushed Montenegro's approximate accession date to 2025, at the earliest.
Montenegro's massive highway undertaking was substantially troublesome from origination and it has suffered extended delays with no fixed timetable for completion. "The Highway to Nowhere", as the venture is commonly referred to nowadays, was conceptually billed by the government as a critical part of Montenegro's modernization program, emphasizing that the roadway offered a rapid, more direct connection to neighboring Serbia, facilitating commerce, diplomacy and socio-cultural exchanges. The inceptive project blueprint was designed to link Montenegro's Adriatic port of Bar to landlocked Serbia. However, studies conducted as far back as 2006 (and again in 2012) reached the conclusion that the roadway was not economically feasible, and it was only after European sources refused to provide financing that the powers in Podgorica approached China - the highway construction loan was executed in 2014. "There is a big question of how they complete it", voiced an anonymous E.U. official sometime around the loan's official signing. "[Montenegro's] fiscal space has shrunk enormously. They have strangled themselves [with the highway financing]." (Reuters: Chinese highway to nowhere haunts Montenegro. 16th July 2018).
In 2014, shortly before Chinese funding was secured, an E.U. anti-corruption monitor, MANS, repeatedly requested that the central government provide legislators with data buttressing the project's early period income generation forecasts. But Podgorica was not forthcoming and numerous details regarding accounting procedures, technical aspects of the project and a variety of loan agreement elements remain off limits.
The "Highway to Nowhere" is at the center of a vigorous debate concerning Chinese influence in the European Union as well as some eastern neighbors with ambitions of joining the E.U. - Albania, North Macedonia and Serbia. There is growing disquiet that, potentially, China's footprint could expand throughout the Balkans via its aggressive infrastructure and energy lending programs, giving rise to unwanted regional financial dependence on Beijing.
So, how can Montenegro navigate its way out of this "nowhere highway" financial quandary? Its options are rather unclear as of now but two possibilities - although far from certain or ideal - come to mind:
1) Podgorica could appeal to the E.U. as a NATO member and the Balkan region's dominant investor for assistance through its multi-billion euro Economic and Investment Plan for the Western Balkans.
The E.U. investment plan might also encourage funding from other investors - both public and private - including the European Investment Bank - at favorable rates. The problem is that this particular tactic is unlikely to quickly bring about a satisfactory solution. Unfortunately, the reality is that Montenegro's need is most immediate since, as mentioned, the initial payment on the highway loan comes due in July.
2) Another approach would be for Montenegro to leverage its historical relationship with Russia and negotiate a financing structure designed to cover the highway loan payments that fall in the short-term, allowing it additional time to arrange a more long-term solution through the E.U. or possibly other avenues. However, any deal with Moscow would, in all probability, not sit well with Brussels primarily for geopolitical reasons.
Examining things strictly from an investment perspective. going forward, volatility in Montenegro's eurobonds is to be expected, especially as we move closer to the first highway loan payment date. In the coming weeks, we are likely to encounter a slew of both positive and negative news concerning Podgrocia's maneuvers to achieve a satisfactory resolution to the Chinese loan quagmire. Surely, its bond prices will be moved by developments.
Possible Market Plays:*
Surveying the current Montenegro bond trading landscape for possible opportunities (with volatility in mind), one quick profit gambit could be to buy into Montenegro debt (bonds) when there are major price dips and cash out at the first sign of upward movement - a pure, very short-term capital gains play. Rinse and repeat at the next chance.
A second strategy entails taking a more medium-to-long-term view: Buy on a pronounced price drop and take a calculated risk that the Balkans are too politically and economically important to the E.U. for it to not pursue timely action against a potential Montenegrin default. A greater temporal risk to be sure but, at the right purchase price, yields in the short-term could be highly attractive and, if default is avoided, one will be in a position to accomplish some solid capital gains down the road.
WesBruin Capital
28th April 2021
*DISCLAIMER:
Must not be construed in any way as a recommendation to buy, sell or trade any Montenegrin bonds or other assets. Comments are opinions, not advice, and provided strictly for research purposes.