ZAGREB, 22 May 2021 - Fitch Ratings on Friday affirmed Croatia's rating at 'BBB-', with a stable outlook, saying that pressure on state finance linked to the pandemic should be neutralised by economic recovery on the back of tourism and EU support.
The 'BBB-' rating balances strong structural features, the agency says, singling out better indicators of human development and governance in comparison with countries with a similar rating and higher GDP per capita.
The rating is restricted by a high public debt and periods of weak economic growth, in part due to the slow adoption of structural reforms.
The stable outlook "weighs large short-term downside risks related to pandemic developments against stronger medium-term growth prospects linked to substantial EU fund support and our fiscal consolidation and debt reduction baseline that is underpinned by the authorities' commitment to fulfilling convergence criteria under the Exchange Rate Mechanism (ERMII)."
"Fitch expects the economy to expand by 5.5% in 2021, from a combination of base effects (growth was stronger than expected in 2H20), the resilience of sectors such as construction and goods exports, and a gradual recovery in consumption," the agency says.
"Our forecasts rest on an improved tourism sector outlook (at around two-thirds of 2019 levels), assuming a pick-up in summer tourism as the health crisis in Europe continues to abate. However, renewed travel restrictions due to the still uncertain evolution of the pandemic, including the spread of new variants, cannot be discounted."
European support
Fitch expects the economy to grow this year, "even if tourism levels remained at 2020 levels (50% of 2019), but the weaker recovery could increase the risk of longer-term scarring and put pressure on public and external finances."
Fitch forecasts GDP growth to accelerate to 6.1% in 2022 before averaging 4% in 2023-25, driven largely by investment and notes that Croatia will receive around €6.3 billion in grants from the Recovery and Resilience Facility (RRF), in addition to €1 billion from the EU Solidarity Fund for earthquake reconstruction and €12.6 billion in the 2021-27 Multi-Annual Funding Facility.
Work force problem
According to those projections, Croatia will likely reach pre-crisis output in early 2022, "limiting the risks of labour market hysteresis and corporate sector bankruptcies."
Rapid labour tightening in sectors such as construction could delay some of the investment momentum, as could the need to pass a large number of reforms, in a short timeframe in order to get RRF fund disbursement.
"Croatia's absorption capacity lags the EU average and the sheer size of funds accentuates the implementation challenges."
"If the authorities are successful at adopting long-standing reforms, this could mitigate major growth challenges such as adverse demographics. According to the EU Commission, the working age population could contract by 26% by 2050."
Deficit forecast raised
Fitch raised the public deficit forecast from 3.5 to 4% of GDP in 2021 and forecasts a fall to 3% in 2022, up by 0.8 percentage points from the forecast made last December.
"The authorities put in place relatively generous and effective pandemic support measures that are gradually being wound down, with very limited direct budget costs expected beyond 2Q21."
That will help bring public spending/GDP down from a record 55.4% of GDP in 2020, while revenue should benefit from strong nominal growth, but recovery in certain segments could be jeopardised if tourism activity disappoints.
Eurozone entry in 2024
Public debt/GDP should fall to 82.7% of GDP in 2022 from 88.7% in 2020, Fitch said, reducing the forecast from December by 2.8 percentage points.
Croatia benefits from favourable financing conditions and deposits, reducing liquidity pressures.
"Over 75% of public debt is foreign currency-denominated (almost all in euros), but there are few concerns about exchange rate stability and this long-standing vulnerability will dissipate once Croatia joins the eurozone."
The authorities continue to target euro adoption by early 2023, but the biggest challenge remains fulfilling the public finance convergence criteria targets, as the government deficit and debt reduction strategy could face challenges in the near term if macroeconomic conditions do not improve as expected.
Fitch maintains its forecast that Croatia should enter the eurozone in 2024.
Consolidation
The agency says that it could upgrade Croatia's rating if near-term macroeconomic risks dissipate and if criteria are met and eurozone accession goes as planned. A stable reduction of the public debt and budget deficit through budget consolidation would also have a favourable effect.
The rating could be downgraded in case of failure to reduce general government debt over the medium term, "for example due to a more pronounced and longer period of fiscal loosening and economic contraction," as well as in case of deterioration in macroeconomic prospects, for example through a setback to the tourism sector.
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