Standard & Poor's on Friday raised its sovereign credit ratings on Croatia to 'BBB-/A-3' from 'BB+/B', putting the country's rating after six years back into the investment category owing to an improved situation in the budget and economic recovery.

The BB+/B rating describes a country’s debt securities as speculative investment, while BBB-/A-3 is an investment category.

In December 2012, S&P downgraded Croatia’s rating to a non-investment category.

The outlook now is stable.

Improved fiscal metrics

“The upgrade reflects Croatia’s improving fiscal metrics, underpinned by its recent economic recovery thanks to tax-rich domestic demand, but also fiscal consolidation measures implemented by the authorities.

“The general government has run primary fiscal surpluses since 2015, including of 3 percent of GDP on average in 2017-2018, with public debt as a share of GDP declining by 10 percentage points between 2015 and 2018.

“Risks to GDP performance, public finance, and financial stability emanating from the bankruptcy of Croatia’s largest food retailer Agrokor have abated. We also view the likelihood of fiscal
slippages–from the payment of state guarantees against Uljanik shipyard’s debt liabilities–as reduced,” S&P says.

Economic performance solid and balanced

“Croatia’s recent economic performance has been solid and balanced. Growth has been accompanied by recurring current account surpluses, driven by buoyant tourism-related inflows, allowing net external leverage to reduce severalfold to just 13 percent of GDP in 2018.

“The stable outlook balances the potential for a reform-driven faster income convergence with wealthier trading partners against risks emanating from external uncertainties.

“We could raise the ratings over the next two-to-three years if Croatia’s economic growth proves resilient to Europe’s cyclical slowdown, allowing continued convergence with EU average income levels and possibly aided by removing structural impediments to growth. If public debt reduced faster than we currently anticipate, this could also prove positive for the ratings.

“We could lower the ratings if we observed a material economic downturn, possibly driven by a significant weakening in the external environment, which would reverse recent fiscal gains. An emergence of higher-than-expected contingent liabilities could also put pressure on the ratings if such liabilities caused a sizable fiscal drain or a drag on the economy.

“External debt has declined amid ongoing export growth and persistent current account surpluses. Recent fiscal improvements also support the ratings,” S&P says.

Growth moderating

After in 2018 Croatia’s economy grew by 2.6 percent, S&P expects economic growth to moderate to around 2.5 percent on average in 2019-2022.

“The government has implemented tax and pension reform this year, but demographic trends will continue to weigh on the public purse.”

“Croatia’s economy has seen resilient growth since emerging from recession in 2015. In its flagship tourism sector, tourist arrivals have almost doubled since 2010 to around 20 million visitors in 2018.

“While tourism-related revenues amount to almost 20 percent of GDP, manufacturing as well as other services such as transportation are also important contributors to GDP,” S&P says, noting that personal consumption will remain strong, helped by rising employment and wages as well as tax reforms.

Investment growth

“Investment should benefit from increasing EU fund absorption, public infrastructure investments such as the Peljesac bridge, soaring construction activity generally, and the effects of recent tax reforms.

“Net exports will detract from growth in 2019-2022 as domestic demand pulls in imports. Goods exports already started decelerating in 2018, which could worsen if there is a sizable and protracted slowdown in key trading partners such as Italy or Germany.”

“Croatia has made progress on important structural reforms. The third round of taxation reform took effect in January 2019, among other things reducing the VAT rate for certain items. This, in turn, is set to stimulate disposable incomes, while reduced labour costs for employers could support investment
activity.”

“According to preliminary estimates, Croatia posted a general government surplus in 2018 for the second year in a row. This was supported by higher tax revenues but also expenditure savings, for example on the interest bill.”

“The 2018 fiscal results could have been even better if the government guarantee for the struggling Uljanik shipyards had not been activated,” says S&P.

Public debt on downward path

S&P analysts estimate that the net general government debt will decline to just below 60 percent of GDP
by 2022 from the 75 percent peak in 2015.

They also estimate that inflation will be contained at about 1.5 percent on average over the coming two to three years.

They note that Croatia will be chairing the Council of the EU in the first half of 2020 and that it hopes to join the Exchange Rate Mechanism (ERM II) that same year.

Since early 2018 the country’s rating or outlook have been upgraded by the world’s three leading rating agencies, with S&P now having raised the country’s rating to the investment category.

Fitch is keeping Croatia’s rating one grade below and Moody’s two grades below the investment category, with Fitch describing the country’s outlook as positive and Moody’s as stable.