Croatian Debt Becoming More Interesting to EU Investment Funds, American and British Investors Turning Away

Credit rating agencies are increasingly favorably viewing the borrowing (and debt repayment) potentials of Croatia. With the entry into the eurozone, this has significantly increased global investors’ interest in Croatian bonds issued on the foreign market (eurobonds). It should be noted that comprehensive data on the liquidity of Croatian government bonds on a global level is lacking. Otherwise, Croatian eurobonds have not been particularly traded for many years, and the situation is generally similar today, especially in comparison to countries close to us.

However, in recent years, positive shifts have been observed, as we learned in the financial industry. The picture of interest in eurobonds is particularly interesting in the context of the state’s shift towards borrowing from citizens, at the beginning of the year through the people’s bond, and now also through treasury bills. This is intended by the Ministry of Finance to introduce more “color” into the structure of investors in Croatian debt, which until recently consisted exclusively of large domestic and foreign institutional investors – pension and investment funds, banks, and insurance companies.

Without Much Change

Kristina Pukšec, head of trading at InterCapital, emphasizes that the liquidity of Croatian eurobonds on the foreign market is not particularly good. – Given that bonds are mainly traded on the so-called OTC (Over-The-Counter) market characterized by bilateral agreements, trading data is extremely scarce and incomplete. It is therefore impossible to substantiate claims about average daily turnovers. However, from practice, we can say that not all Croatian eurobonds are traded every day. Typically, the highest liquidity is in ten-year issues that serve as benchmarks, and these are currently Croatian eurobonds maturing in 2033 and 2035 – explains Pukšec.

According to her, entry into the eurozone has brought us a narrowing of the risk premium, but it has not changed much regarding the liquidity of our bonds. – If anything, it has brought us new natural buyers for our bonds, which could make them even scarcer and actually less liquid over time – says Pukšec.

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Kristina Pukšec, Voditelj odjela trgovanja InterCapital

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On the other hand, analysts at Raiffeisen Bank emphasize that entry into the eurozone has positively reflected on Croatian eurobonds and that liquidity has significantly improved. – This also corresponds to local institutional investors, primarily pension funds that trade significant amounts. Approximately, annual turnovers for Croatian eurobonds were five billion euros in 2021, six billion euros in 2022, and seven billion euros in turnover so far this year. Absolute amounts should be taken with caution – they emphasize from RBA. Compared to comparable countries (Slovakia, Slovenia, Baltic states), liquidity is still relatively weaker, they add from RBA.

However, positive ratings and improved outlooks from leading rating agencies positively affect the prices of Croatian eurobonds, which generally achieve better price performance compared to comparable countries, claim analysts at Raiffeisen Bank. – Therefore, there is also greater interest from investment funds from the EU, index funds that have included these bonds in their assets, while there is currently less interest generally among banks from the EU and American and British investors – they emphasize from RBA.

Kristina Pukšec explains how the improvement in credit rating and outlook attracts new buyers for Croatian debt, which is most clearly visible in the narrowing of the premium that Croatian bonds yield compared to German bonds. – In this context, we could say that it has acted in the direction of reducing liquidity as demand for bonds has increased while supply has not changed – says Pukšec.

In the ‘Lower House’

According to comparative data from the Croatian National Bank, after Moody’s improved the outlook for our credit rating at the end of last week, Croatia currently enjoys positive rating outlooks for long-term borrowing in foreign currency from all three leading global rating agencies. However, we are still in the “lower house” in terms of rating quality among the 27 member states of the European Union. Moody’s rates our rating at Baa2, and only Romania and Italy (both rated Baa3) have a worse rating in the investment grade. Greece, according to Moody’s, remains in the speculative grade with a rating of Ba1 and is only one level away from entering the investment grade.

Standard & Poor’s and Fitch have assigned Croatia a better rating than Moody’s. Croatia enjoys a rating of BBB+ from Fitch. In the investment grade, Bulgaria, Cyprus, Italy, and Hungary (all rated BBB) have a worse rating than us, while Romania is rated BBB-. Greece has a rating of BB+ from Fitch. Standard & Poor’s (S&P) also rates Croatia at BBB+, making us better than Bulgaria, Cyprus, and Italy, which have a rating of BBB, while Greece, Hungary, and Romania have a rating of BBB-.

However, there is still plenty of room for improvement, and for comparison, we do not need to look far, just to neighboring Slovenia. Slovenia has a rating of AA- from S&P, four levels better than Croatia, rated A3 by Moody’s (two levels better), and enjoys an A rating from Fitch (also two levels higher). Accordingly, the yield on the Slovenian 10-year bond is 3.457 percent, while a month ago it was at 3.70 percent.

When we talk about Slovenian bonds, some solutions on how to increase trading in these securities could be mirrored from our neighbors. As Pukšec says, Slovenia has a system of primary dealers created specifically to maintain and create better liquidity, which is also the practice in most of Europe. This solution could be particularly significant in the domestic bond market, which also lacks much vibrancy. As Pukšec says, trading in government bonds on the domestic market has been quite weak in recent years. There are several reasons for this.

Action on Multiple Fronts

– Maintaining the market for local bonds operates on a voluntary basis, so there is no contract with the state as is the case, for example, in the system of primary dealers. Local banks have reduced limits for the inventory of bonds intended for trading in recent years and have withdrawn from the role of more active market maintenance, which has lost a very important prerequisite for good liquidity. Additionally, after the Covid episode, some natural buyers have almost completely withdrawn from local issues due to illiquidity, primarily investment funds – says Pukšec.

Moreover, entry into the eurozone has brought some changes, adds Pukšec. – Insurers no longer have a regulatory incentive to invest in local issues as was previously the case due to lower capital requirements, and pension funds may also become less active in local issues as they have opened up a wider range of investment products. We could say that illiquidity feeds illiquidity, and to change this, action on multiple fronts will be necessary. As a first step, it would certainly mean a lot to allow the settlement of local bonds through global custodians, not just through SKDD, which would bring the local market closer to foreign investors and potentially lead to new activity – believes Pukšec.

A significant drop in yields on bonds, especially American ones, which has been exciting leading stock markets for about ten days, has also reflected on our debt securities. The yield on the 10-year Croatian bond currently stands at 3.821 percent, while a month ago it was 4.118 percent. As is known, yield and bond prices move in opposite directions, so the lower the yield, the higher the price.

When asked how the yield on Croatian debt might move next year, Raiffeisen analysts emphasize that our eurobonds move in line with the movements of bonds in the SIE region, following the pattern of movements of benchmark issues, reflecting Croatia’s membership in the euro area.

– With the achievement of the terminal level of reference interest rates of the European Central Bank, we believe that yield levels have reached or are close to their peaks. In the year ahead, especially in the second half, we expect a gradual downward movement of yields, although with a very mild dynamic. Regarding spreads (the difference in yield between Croatian and German bonds taken as a benchmark, ed.), even the announcement and then entry into the euro area has reflected in the movement (narrowing) of spreads compared to benchmark issues, so the room for further narrowing is limited – assess RBA analysts.