Nicholas Watson in Prague -

The key factors for improving Croatia's economic performance and creditworthiness are creating a stronger fiscal position and downsizing the role of the government in the economy, Moody's Investors Service said in its annual report on the country, released Monday.

Moody's says the country's 'A1' foreign currency ceiling for bonds and stable outlook reflect the country's progress in stabilizing and modernizing the economy since the end of the Balkan War in 1995 and its designation as a EU candidate country, with negotiations for membership expected to conclude by the end of the decade."

However, on the negative side, "Croatia's ratings also reflect its lagging performance relative to many of the other transition economies in establishing a modern market economy, and its relatively higher fiscal and external debt burden compared to recent EU admits, Bulgaria and Romania," said Moody's associated vice-president Joan Feldbaum-Vidra, author of the report.

To improve those ratings, Croatia needs to strengthen its fiscal position and reduce the government's role in the economy, which would curb the build-up of public sector debt, help contain the expansion of the external current account deficit and help fuel more dynamic private-sector-led growth, Moody's said.

"Continued fiscal restraint has helped offset the demand pressures emanating from loose monetary conditions in Croatia," the report said.

Croatia's main fiscal vulnerability, the report details, is resistance to reforms in the pension and healthcare areas, which account for 60% of government spending, while healthcare sector arrears continue to climb.

With regards to the EU accession talks, Feldbaum-Vidra said negotiations are proceeding smoothly and fears over any delay in membership as a result of the bloc's internal reform issues have been allayed by repeated favourable statements from the EU. In addition, the news on possible NATO entry is also favourable, Moody's said.

Croatian Prime Minister Ivo Sanader said in May that his country would receive an invitation for NATO membership at its Bucharest summit in 2008.

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