Standard & Poor’s (S&P) raised Croatia’s rating on Friday from ‘BB’ to ‘BB+’, with stable outlook, thanks to further reduction in public debt and improved fiscal position of the country due to the ongoing economic recovery.
As noted by S&P, Croatia’s public debt fell below 80 percent of gross domestic product (GDP) at the end of 2017, and by 2021, further reduction below 70 percent of GDP is expected.
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Last year, S&P states, Croatia likely achieved a general government budget surplus for the first time, amounting to 0.6 percent of GDP, thanks to stronger-than-expected revenues, partly due to cyclical factors, but also due to tax reform.
In the period until 2021, the agency expects low general government budget deficits, averaging 0.8 percent of GDP.
Good Fiscal Results
As highlighted by S&P, the rating was improved due to an enhanced external position thanks to, among other things, strong inflows from tourism, further foreign debt repayment, and rapid growth of foreign exchange reserves.
The rating was also raised due to improved fiscal position, supported by economic recovery, as well as structural measures such as the tax reform implemented in 2017. This helps in the faster reduction of the high burden of public debt, which still limits the rating.
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Additionally, the rating is constrained by the relatively short history of implementing structural reforms due to political upheavals and low per capita wealth compared to other EU member states.
Gradual progress in structural reforms helps maintain the sustainability of the economic recovery. A favorable external environment and another record tourist season have supported the economic recovery, which is entering its fourth year, the agency states.
The restructuring of Agrokor has somewhat dampened domestic demand, but consumption and investment growth has remained strong, analysts from the agency note.
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They also add that structural challenges for the economy are visible in the labor market and in the large role of the public sector in the economy, while the government’s reform efforts are only gradual.
GDP Growth is Expected to Slow
S&P analysts indicate that the end of 2017 was marked by somewhat weaker economic growth than expected, partly due to one-off effects.
For instance, the announcement of changes in excise duties and the amendment of VAT calculations for companies when purchasing vehicles delayed vehicle sales from December to January 2018, during which sales jumped by 30 percent year-on-year.
S&P states that the Croatian economy continued to benefit from strong foreign and domestic demand in 2017. Further reduction in the unemployment rate, as well as wage growth in the public and private sectors, supported the strengthening of consumption. However, they note that investments have somewhat weakened as uncertainties related to Agrokor affected the confidence of entrepreneurs and consumers.
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S&P analysts expect Croatia’s economy to grow by 2.7 percent this year, following last year’s 2.8 percent, and by 2021, they expect a gradual slowdown in economic growth to around 2.5 percent.
Gradual Progress in Reforms
The agency assesses that the government is gradually progressing towards addressing structural issues. Thus, S&P states that the National Reform Program contains several reforms that the government wishes to implement, but they assess the progress in this regard as gradual.
They emphasize that the government has already implemented structural reforms in the VAT and income tax systems, which have been in effect since 2017. Additionally, parafiscal levies, fees, and taxes not paid directly to the state have been reduced by 30 percent in 2017, and the restructuring of companies in the road sector is also progressing.
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However, S&P assesses that more sustainable and stronger reform efforts are needed to preserve some fiscal gains brought by the current recovery.
After political instability, the current government composed of HDZ and HNS, in power since June 2017, appears to be more stable, they assess.
The restructuring of Agrokor continues, despite some problems in February when the extraordinary commissioner Ante Ramljak resigned. Nevertheless, they emphasize that Agrokor intends to complete the restructuring according to the initial plan by April 10 of this year.
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According to the baseline scenario, S&P expects an orderly restructuring process. They see negative risks for the Croatian economy if there is uncontrolled restructuring of the group that would negatively affect its suppliers, mainly small and medium-sized enterprises and family farms.
However, they state that they currently see only limited negative risks for the economy from the turmoil in Agrokor, but continue to monitor the situation, including financial and operational restructuring and its impact on the Croatian economy.
What Does the Rating Depend On?
Stable outlook, S&P explains, reflects improved external and fiscal balances, while still high public debt and structural rigidities threaten the prospects for rating growth in the next 12 months.
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As they further state, Croatia’s credit rating could be increased if the government implements structural reforms that would enable more sustainable fiscal consolidation and increase potential economic growth.
In that case, a stronger reduction in public debt than expected would positively affect the rating.
However, they also add that the rating could be lowered if the implementation of structural reforms slows down, which would lead to lower economic growth and a higher fiscal deficit than projected.
Additionally, efforts regarding the restructuring of Agrokor will be closely monitored, and a negative action regarding the rating will be considered if the disorderly restructuring of Agrokor undermines economic performance or leads to significant fiscal costs. However, they note that they do not expect this in their baseline scenario.
S&P Followed Fitch’s Move
With this move, S&P followed Fitch’s decision, which in January raised Croatia’s credit rating by one notch, marking the first increase in Croatia’s rating since 2004.
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Of the three leading global rating agencies, S&P and Fitch now hold Croatia’s rating one notch below investment grade, while Moody’s is two notches below. All three agencies maintain stable outlooks.
