Standard & Poor's on Friday affirmed its 'BBB-/A-3' long- and short-term foreign and local currency sovereign credit ratings on Croatia, with a stable outlook, saying economic recovery thanks to tourism has created conditions for reducing public debt this year from a record-high in 2020.

“Our ratings are still supported by Croatia’s modest net external leverage and the incumbent administration’s record of prudent fiscal policies,” the agency said. “The ratings are constrained by Croatia’s moderate income levels and its high public debt. Furthermore, Croatia has less flexible monetary settings than its peers, although these anchor its stability.”

“The stable outlook indicates that we expect Croatia’s strong economic recovery prospects, combined with its government’s commitment to reform, to help it gradually rebuild the fiscal space it lost in the aftermath of the pandemic. The stable outlook also assumes that vaccine distribution in Croatia will progress and continue to support activity in the country’s hospitality industry.”

“The Croatian tourism sector staged a strong comeback this summer, exceeding our previous expectations. We now estimate Croatia’s GDP will grow by 6.5% in 2021,” the agency said.

A solid investment agenda financed by substantial EU financing envelopes, a recovery of private consumption and unhindered tourism activity will lead to continued growth of 5% in 2022, it added. Until now, the agency forecast a 3.5% growth.

The forecast “is still sensitive to the lingering nature of the pandemic, the progress of immunization programs, and the risk of unchecked virus variants emerging. Croatia’s vaccination campaign has to date inoculated 44% of the population, below the EU average of 61%.”

In 2023, growth is forecast to slow down to 3%.

“Because Croatia entered the pandemic with an improved fiscal balance sheet, the government was able to deploy strong fiscal support measures to mitigate COVID-19 fallout on the labor market. This caused government debt to surge to a record high of 88.7% of GDP in 2020, although the government’s debt profile benefits from historically low funding costs and extended debt maturities.”

The agency projects that the debt will start to fall this year to 84.1%, “based on the government’s fiscal consolidation efforts amid a rebounding economy.”

It is projected to fall to 81.2% in 2022 and then to 79.1%, reaching the pre-crisis level by 2025.

“Croatia’s government aspires to adopt the euro quickly, giving it an incentive to reduce the fiscal deficit to below the Maastricht reference level of 3% of GDP in 2022-2024.”

The agency projects a general government deficit of 3.5% of GDP in 2021, down from 7.4% in 2020, “with expenditures still affected by ongoing pandemic-support programs, together with rising health care costs. On the other hand, fiscal revenue, in particular VAT receipts, have performed favorably over the summer and could counterbalance the increase in rigid spending items.”

The agency expects the fiscal deficit to gradually reduce to 2.5% by 2022 and to 2% in 2023.

“We could raise the ratings if Croatia’s economy stabilized and the medium-term growth trajectory strengthened so that the country’s wealth levels improved notably. In this scenario, the government would make effective and timely use of its EU funds allocation and move forward with its fiscal consolidation agenda. In the longer term, all else being equal, the country’s accession to the eurozone would also benefit its credit quality.”

On the other hand, the agency said it “could consider a downgrade if Croatia’s economic rebound proved underwhelming; it demonstrated an institutional inability to absorb EU financing for investments; or the pace of vaccination slowed, putting its service sector at risk from unchecked virus variants.”