Standard & Poor's has revised its outlook to stable from negative and affirmed its 'BB-' long-term issuer credit rating on Zagreb, estimating that the capital city will benefit from the recovery of Croatia's economy from the COVID crisis and budget consolidation.

The reflects “the city’s strained liquidity, moderately high tax-supported debt burden, and volatile policy environment. These weaknesses are partly mitigated by the support Zagreb will receive from the EU and the central government to rebuild infrastructure after earthquakes in 2020,” the agency said.

“We believe that the ongoing reconstruction of earthquake-devasted areas should not lead to significant funding gaps for the city,” it added.

Zagreb is dependent on EU support and has good cooperation with the government, S&P said, but noted that it “remains to be seen how the cooperation between the city administration and central government will develop over the next four years, especially because Zagreb is now ruled by parties which are in opposition role at the national level.”

The agency said it expected “a sound rebound of the national economy with real GDP expanding by 6.5% in 2021, which should create additional tax revenue for Zagreb.”

“We base the stable outlook on our expectation that Zagreb will continue to consolidate its budgetary performance with the help of increased revenue collection and a tight grip on expenditure,” the agency said.

Post-earthquake reconstruction will be long-term burden

“Drawings on Zagreb’s share in reconstruction costs after devastating earthquakes are very low so far, but will continue to weigh on the city’s financial situation for years,” it said, adding, “Although the city is likely to face fewer costs than initially thought, we continue to include in our assessment that Zagreb will have to cover some reconstruction costs, which will fall due over years, if not decades.”

According to S&P, “continued investment needs will continue to create pressures on Zagreb’s budgetary performance.”

First positive steps

“We note a policy shift in the city administration following municipal elections in spring 2021. The new mayor, supported by a two-party coalition with the majority of seats in the city council, initiated consolidation measures in summer 2021, including the merger of city departments and reduction in salaries,” the agency said.

“We view positively as first steps to consolidating city finances” the new management’s “steps to increase the transparency of city financials and decisions” and to install new management boards at the main city companies, including Zagrebački Holding.

Unpredictable framework

“The rating on the city also considers our view of the unpredictable institutional framework for Croatian local and regional governments….”The framework changes frequently, and the distribution of resources is unbalanced and insufficiently aligned to tasks delegated to municipalities. This is highlighted by Zagreb’s accrued deficit, which reflects the funds the city expects to receive from the central government to compensate for delegated tasks.”

S&P also said that “multiple changes to the tax system make financial planning difficult, citing the example of “tax cuts at the central government level, aimed at supporting the local economy after the COVID-19 shock.”

Consolidation and support

“We could lower the rating if, contrary to our expectation, the financial pressure on Zagreb and its companies would rise, for example if additional payables are accumulated and the cash holdings deteriorate. In addition, fading government support in channeling funds to the city to finance major investment projects could weigh on the rating,” S&P said.

“We see upward potential for the rating if Zagreb further reduces its contingent liabilities and increases transparency about the city’s financial planning. In addition, an improving budgetary performance, further increased cash holdings, and the debt burden staying at current levels could provide uplift to the ratings,” it added.