Moody’s Confirms Croatia’s Rating ‘Baa2’, Upgrades Outlook to Positive

Moody’s agency confirmed on Friday Croatia’s credit rating ‘Baa2’ and upgraded the outlook from stable to positive, highlighting the reduction of public debt, economic growth significantly above the eurozone average, and more efficient institutions.

Moody’s raised Croatia’s credit rating to investment grade in July last year, following the formal completion of the process of entering the eurozone.

On Friday, they confirmed the rating ‘Baa2’, which indicates moderate credit risk, and changed the outlook from ‘stable’ to ‘positive’.

– The confirmation of the ‘Baa2’ rating reflects Croatia’s fiscal strength and the strength of institutions and governance systems that are significantly stronger than those of other countries with the same rating – they explained at Moody’s.

They emphasize, however, that the economy continues to be constrained by a strong reliance on tourism and structural challenges arising from an aging population. Credit constraints also remain, as does Croatia’s moderate exposure to geopolitical and banking sector risks, they add.

They have changed the outlook to positive, signaling that they could raise the rating, as they assess that there are increasing chances that public debt will decrease more significantly than previously expected.

They also highlighted the possibility of strengthening the growth potential of the Croatian economy, which, according to their estimates, should grow significantly stronger than the eurozone average and most similar countries in Central and Eastern Europe in the coming years.

They also point out the efficient implementation of an extensive investment and reform program under the Recovery and Resilience Plan, which testifies to the improved efficiency of institutions and governance systems as a whole, they conclude.

Favorable Refinancing

Croatia’s public debt expressed as a share of GDP is expected to be 61.1 percent by the end of the year, Moody’s estimates, and will decrease to 58.3 percent in 2024, they calculated. By 2025, it should further decrease to 56.3 percent, which would mean it would be nearly 15 percentage points lower than it was before the pandemic.

– The projected decline in the debt-to-GDP ratio is still stronger and deeper than Moody’s has previously expected – they added.

The relatively high debt has so far been the main weakness of Croatia’s credit profile, and continuous reduction will significantly bring Croatia closer to countries with a Baa rating, they emphasize.

They simultaneously expect that the ‘debt affordability metric’ will be significantly stronger than in most countries in that group, as the government, despite sudden changes in interest rates worldwide, still refinances a significant portion at lower interest rates than it was issued.

The sharp decrease in the debt-to-GDP ratio partly rests on the exceptionally strong growth of real GDP in 2021 and 2022 when the economy was recovering from the pandemic shock and strong growth of nominal GDP in an environment of high inflation in 2022 and 2023.

Real GDP is expected to grow solidly in both this year and next, they estimate, which means that public debt expressed as a share of GDP will continue to decrease.

Modest Deficit

The continuous reduction of public debt will also be supported by a generally balanced primary budget position in the coming years, Moody’s notes.

This year, the budget is expected to record a deficit of 0.4 percent of GDP due to support measures that the government is implementing to mitigate the inflationary shock to households and companies.

In the following year, the deficit is expected to rise to 1.9 percent of GDP due to demands for higher nominal spending on pensions and public sector wages to alleviate the inflationary shock, as well as increased investments financed by loans under the recovery and resilience program. By 2025, it should decrease to one percent of GDP.

Services and Consumption

The Croatian economy is expected to grow at rates just below three percent in this and the coming years, Moody’s estimates. This is significantly stronger growth than Moody’s forecasts for the eurozone, whose economy is expected to grow by 0.7 percent this year and by 1.1 percent in 2024. Croatia’s growth rate should also surpass that of most similar countries in Central and Eastern Europe, the agency notes.

The relatively high growth rates can partly be attributed to the structure of the Croatian economy, which mainly relies on services, especially tourism. This has spared Croatia in 2022 and 2023 from the blows of high energy prices and slowdowns in the broader European economy that have hit the industry harder, Moody’s explains.

They see a possible reason in strong household consumption due to wage increases that, as they state, have generally kept pace with inflation due to tight labor market supply.

The room for further growth in tourism in the coming years will be smaller, but the outlook for the economy should still be supported by moderate growth in exports and consumption, Moody’s estimates.

‘Smooth’ Implementation

The main reason for the improved economic outlook is, however, the ‘very significant’ amount of EU funds for investments that will be available to Croatia in the coming years, they emphasize. Moody’s expects that money from the Recovery and Resilience Fund will reach about 13 percent of GDP in 2023, with about half of the amount consisting of grants rather than loans, they note.

The implementation of reform and investment projects under the Recovery and Resilience Plan is currently proceeding ‘very smoothly’, and the efficiency of the authorities leads to the conclusion about the improved efficiency of institutions and governance systems as a whole, an important factor in the assessment of debt securities, they emphasize.

Focus on Lower Debt

They note that they could raise Croatia’s credit rating if public debt expressed as a share of GDP continues to decrease more strongly than they expected, while maintaining debt affordability. They would also positively assess the continuous effective implementation of the Recovery and Resilience Plan.

However, they will again change the outlook for the rating from positive to stable or signal a downgrade if the trend of debt reduction changes, along with significant easing of fiscal policy.

Significantly weaker economic outlook than Moody’s currently expects and weakened capacities of Croatia for effective implementation of the Recovery and Resilience Plan would also negatively impact the rating.

Increased geopolitical risks that could negatively affect the Croatian economy and public finances could also put the rating in question, they warn.