S&P said it affirmed on Friday, Aug 2, Croatia’s 'BB+/B' long- and short-term foreign and local currency sovereign credit ratings but revised the rating outlook to negative from stable, anticipating structural challenges might constrain growth more than previously expected. 

S&P said in a statement the weak economic performance and lack of impetus are the main reasons for the shift. The S&P analysts see a more than one-in-three chance for fiscal or external outcomes that are worse than their current projections.

They might lower the ratings on Croatia over the next year if the economy deteriorates beyond their current expectations for a mild GDP recovery in 2014, and if deficits widen, or external financing becomes more challenging.

Croatia entered its fifth consecutive year of recession in 2013, as real GDP has lost 12% since 2008 due to declines in real consumption and real investment. S&P projects a further 1% GDP drop this year.

Furthermore, the Croatian government is expected to exceed the 3%/GDP deficit limit and the 60%/GDP debt limit set by the Maastricht Treaty - which will trigger an excessive debt procedure (EDP) since Croatia already became part of the EU in July 2013.

In addition, if the government does take over the debt of the Croatian Road Authority company, which equals 7.5% of GDP, as part of a planned concession contract, S&P warns this would lift higher the general government debt.

Croatia’s accession to the EU is seen as an opportunity but the lack of government reforms could impede the full absorption of EU funds allocated to the country from the 2014-2020 EU budget (amounting to 3%/GDP annually). On the other hand, too much attention is paid to the revenue side of the government’s balance sheet, while expenses should be addressed as well in order to provide possibility for growth in the private sector. Still, S&P believes the European Commission could put some pressure on the Croatian government to focus more on consolidating the fiscal expenditure side.

Non-performing loans continue to increase and are expected to reach 18% of total loans by the end of 2013, signaling high credit risk coming from the poor shape of the real estate and construction sectors, the report added.