London, 18 August 2009 -- Montenegro's Ba3 government bond rating and country ceilings are primarily based on an assessment of its low level of economic and institutional strength, limited by the country's small size and the concentrated nature of its economy, says Moody's Investors Service in its new annual sovereign credit report on Montenegro.

Montenegro is a relatively newly established country. Its economy is very small compared with the economies of other countries both in the region and globally: with a population of fewer than 600,000, and a moderate level of average income, nominal GDP is forecast at only $4.2 billion in 2009, making the country one of the smallest rated by Moody's.

The small size of its economy means that Montenegro's output is concentrated in a few sectors and, as such, is likely to suffer greater volatility over time. It also makes the economy much more vulnerable than larger economies to sector-specific and company-specific shocks.

Montenegro applied to the EU in December 2008. It is expected to become a candidate country in 2010 and, depending on negotiations, to follow the accession of Croatia around 2017.

"The country's institutional development is still in its early stages and needs significant improvement to bring it up to EU standards," explains Kenneth Orchard, a Vice President-Senior Analyst in Moody's Sovereign Risk Group. "The EU accession process should propel this convergence in a number of ways, since adoption of the EU acquis requires a significant overhaul of a country's laws, regulations, public sector and associated bodies."

Montenegro's financial strength and susceptibility to event risk are assessed to be moderate.

"The country's fiscal policy has been fairly prudent and the government's debt affordability is high. The ratio of interest payments to government revenue is forecast at only 2% in 2009, compared with the Ba rating category median of 12%," says Orchard. "However, access to finance is partly constrained in the current environment, and the government was forced to inject most of the budgetary surpluses it accumulated in
2006-08 into the banking system in late 2008 to support liquidity."

Although event risk is mitigated by the country's euroisation, there are several other risks remaining, including the risk that the economic slowdown could be exacerbated by deflating asset prices and the existence of large external imbalances.



"The government could be forced to enter into a stand-by arrangement with the IMF if the economic situation continues to deteriorate," says Orchard.

In April 2009, Moody's downgraded Montenegro's government bond rating by one notch and retained the negative outlook. The rating action was in response to the deteriorating economic environment, which was expected to put significant pressure on the government's budget and to generate contingent liabilities on its balance sheet. Since then, the situation has generally evolved in line with Moody's expectations.

The issuance of this credit report by Moody's Investors Service is an annual update to the markets and is not a formal action to alter the credit rating of the issuer.