ZAGREB, March 24, 2018 - The Standard & Poor's (S&P) agency reported on Friday that it had raised its long-term foreign and local currency sovereign credit ratings on Croatia to 'BB+' from 'BB'.
The outlook is stable. The agency affirmed the short-term foreign and local currency sovereign credit ratings at 'B'.
The government's debt ratio has fallen below a still high 80% of GDP. "In line with our fiscal and growth forecasts, the ratio could drop another 10 percentage points by 2021 to just below 70% of GDP," S&P said.
In 2017, Croatia achieved its first ever general government surplus of 0.6% of GDP, supporting the downward trend in the government debt ratio. "Over our forecast horizon, we expect Croatia will continue incurring small deficits averaging 0.8% of GDP over 2018-2021, as accelerated pick-up of EU structural and cohesion funds should drive up capital
expenditures," the agency said.
The upgrade reflects Croatia's improved external position, which benefits from growing current account receipts on the back of strong tourism-related inflows, continued external deleveraging of the economy, and rapid growth of foreign currency reserves.
Moreover, the ratings are supported by Croatia's improved fiscal picture, benefiting in part from the ongoing economic recovery, but also from structural reform efforts, such as the income tax reform that took effect in 2017. This in turn is helping accelerate the reduction of Croatia's high government debt burden, which still constrains the ratings.
In addition, the ratings remain constrained by Croatia's relatively shorter track record of implementing structural reforms amid bouts of political volatility and low per capita wealth levels in the context of the 28 EU member states.
A favourable external environment and another record tourism season supported Croatia's recovery, which is entering its fourth year. The ongoing restructuring of retail conglomerate Agrokor dampened domestic demand somewhat, though consumption and investment growth were still robust, the agency said. Structural challenges to the economy are apparent in the labour market and in the large role the public sector plays in the economy, and the government's reform efforts are only gradual.
At 2.8%, the initial real economic growth data for 2017 shows a slightly weaker picture than in the September report. However, part of the weakness in the fourth quarter was driven by one-off factors. For example, the announcement of a new excise tax system and revised calculation for value-added tax (VAT) payments for companies on car purchases pushed car sales from December into January 2018 when sales surged by 30% year-on-year.
Overall, Croatia's economy continued to be supported by external and domestic demand in 2017. A further reduction in the unemployment rate, as well as wage growth in the public and private sector, supported additional pick-up in consumption growth. Export growth benefited from another record tourism season, but importantly, goods exports showed strength, as well. Investments slowed somewhat as Agrokor-related uncertainties took their toll on business and consumer confidence over the course of the year.
Croatia's National Reform Programme spells out several reforms that the government wants
to implement, though progress is only gradual. In addition, the Croatian government has already implemented structural reforms to the VAT and income tax that took effect in 2017. Moreover, parafiscal fees, fees and taxes not directly payable to the government, were reduced by 30% in 2017 and the restructuring of the highway and motorway companies, including their debts, is progressing. Still, more sustained and robust reform efforts will be needed to entrench some of the fiscal gains the ongoing recovery has brought about, S&P said.
"After repeated bouts of political volatility, the current government of the centre-right HDZ and the liberal HNS, in power since June 2017, appears to be on a more stable footing. The previous coalition of HDZ and MOST collapsed when some MOST party members did not support the finance minister in a parliamentary vote of no confidence after the collapse of Croatia's retail conglomerate Agrokor. The restructuring of Agrokor is continuing, despite a setback in February 2018 when the initially appointed restructuring advisor resigned. Nevertheless, Agrokor intends to complete the restructuring terms according to the initial plan by April 10, 2018. To that end, the company continues its frequent meetings with representatives from the creditor groups. Our base-case scenario remains that of an orderly restructuring process," the agency said.
Downside risks to the economy could emerge if a disorderly restructuring of Agrokor were to negatively affect its suppliers, mostly small and midsize enterprises and farms, and resulted in their coming under financial pressure, the agency said.
The stable outlook balances Croatia's improved external and fiscal balances against still high government debt levels and structural rigidities weighing on Croatia's growth outlook over the next 12 months.
"We could raise our ratings on Croatia if the government implements structural reforms that would more sustainably entrench fiscal consolidation and raise the economy's long-term growth potential. Moreover, in such a scenario, a stronger-than-expected reduction in Croatia's still high government debt levels would support a positive rating action," the agency said.
Conversely, the ratings could come under downward pressure if structural reform efforts slowed, leading to lower economic growth and higher-than-forecast fiscal deficits. "Moreover, we are closely monitoring the restructuring efforts at Agrokor and could consider a negative action if a disorderly restructuring undermines economic performance or leads to significant fiscal costs. This is not our base-case scenario, however," the agency said.
