S&P lowers Croatia's credit rating to BB from BB+, outlook stable

By bne IntelliNews January 24, 2014

Standard & Poor's Ratings Services said on Jan 24 it has lowered its long-term foreign and local currency sovereign ratings on Croatia to 'BB' from 'BB+' on weak economic growth and budgetary prospects.

Furthermore, the agency said it now expects the five-year recession to continue in 2014 after previously believing the economy might recover this year.

"The short-term benefits of EU accession are being constrained by a lack of internal growth drivers stemming from ongoing policy inertia and policy constraints to fiscal and structural reforms, and leveraged public- and private-sector balance sheets," the S&P said in a statement, adding the government's economic and budgetary policy measures so far "have been insufficient".

At the same time, the S&P affirmed the short-term ratings at 'B'. The outlook is stable, the rating agency said in a statement.

The S&P estimates that Croatia's real GDP contracted by about 1% in 2013 and forecast it will further decline by 0.5% in 2014, which means a sixth consecutive year of recession for the newest EU member state. According to the agency, the economic competitiveness remains weak due to labor market rigidities and a complicated business environment.

The recovery of the economy is expected in 2015, when it is seen growing 0.8%, and speeding up to a 1.7% expansion in 2016. The Croatian government still expects 0.2% GDP growth in 2013 and hopes for a 1.3% increase in 2014.

"In the absence of policy measures that will materially improve labor market rigidities, as well as unlock Croatia's export potential beyond the tourism sector, we expect only slight economic growth from 2015," the statement said.

Still, S&P expect a modest recovery in exports and investment in 2014. The recovery in the sectors will be due to regulatory and legislative changes such as the law on strategic investments, the access to EU funds, and the government's public investment program.

At the same time, however, it expects that consumption, which has already contracted 12% since 2008, will continue to decline on still-rising unemployment, a low employment rate, falling real disposable income, continued deleveraging, and expected fiscal tightening.

Regarding the EC's excessive deficit procedure Croatia is about to enter this year, S&P expects the government to present annual deficit-reduction measures of at least 0.5% of GDP in structural terms over 2014 and 2015. Still, the measures to be implemented might not be enough to stabilize the government debt burden over the forecast horizon considering the weakening political support and the lasting recession.

Here are some of the other highlights from the S&P's statement:

- The inclusion of outstanding state guarantees for the state motorways in government debt--expected as part of the motorway concession tender approved in 2013--will exacerbate the overall increase in general government debt. We estimate this will average 6% of GDP annually in 2013-2016. As a result, we expect the net general government debt burden to continue rising to about 70% of GDP by 2016, and the interest payments to 9.4% of revenues.

- Croatia might not fully use the EU funds available to it from the 2014-2020 EU budget (amounting to 3% of Croatia's GDP, annually). Failure to draw on these funds could render Croatia a net contributor to the EU budget.

- Net foreign direct investment (FDI) declined to an estimated 1% of GDP in 2013. We don't expect a significant recovery without material improvements in the investment climate, for example by reducing red tape, removing administrative barriers for investment, and updating product and service market regulations.

- Bank financing from abroad will continue to fall in 2014 as the private sector deleverages and the recession continues. The improved current account balance and banking- and private-sector deleveraging has helped stabilize a high net external liability position, but the economy still depends on external financing to service its high external debt.

- The predominantly foreign-owned Croatian banking system will continue to report low profitability, in our view, given weak economic prospects that are being constrained by depressed domestic demand, as well as moderate credit growth.

- The stable outlook reflects our view that we currently see less than a one-in-three probability that we will raise or lower the ratings over the next year.

Croatia - Selected Indicators 2013 estimate 2014 forecast   2015 forecast  2016 forecast
Real GDP growth (%)  -1 -0.5 0.8 1.7
Change in general govt debt /GDP (%)  5.7 7 6.5 4.5
Net general govt debt/GDP (%) 58.9 64.9 69.4 70.7
General govt interest expenditure/revenues (%) 8 8.7 8.9 9.4
CPI growth (%) 2 2 3 3
Gross external financing needs*/CARs** +use. res (%) 105.3 104.3 104.1 106
Current account balance/GDP (%) 0.8 0.5 -0.3 -1.3
Source: S&P      

* Gross external financing needs are defined as current account payments plus short-term external debt at the end of the prior year plus nonresident deposits at the end of the prior year plus long-term external debt maturing within the year.

** CARs - Current account receipts

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