Fitch Ratings-London-20 August 2008: Fitch Ratings has today affirmed the Republic of Croatia's ratings at Long-term foreign currency Issuer Default (IDR) 'BBB-' (BBB minus), Long-term local currency IDR 'BBB+' and Short-term foreign currency IDR 'F3'. The Outlooks for Croatia's Long-term IDRs are Stable. The Country Ceiling is 'BBB+'.
"Croatia's ratings balance its relatively rich economy and solid governance indicators against a high, albeit declining, government debt burden and weak external finances," said David Heslam, Director in Fitch's Sovereign team. At USD11,600, its per capita income compares well against the 'BBB' range median of USD6,800. Balancing this support is Croatia's large and widening current account deficit (CAD), which is driving the growth of an already high level of external debt. Fitch is forecasting a widening of Croatia's CAD to over 10% of GDP in 2008, from 8.6% in 2007, owing to a slowdown in Croatia's key euro area trading partners and higher energy prices.
The size of Croatia's CAD is modest when compared with some new EU member states such as the Baltic countries, Bulgaria and Romania, many of which have experienced double-digit CADs for a number of years. However, most of these countries have been running a tighter fiscal policy and have a lower government debt burden than Croatia. Moreover, Croatia's external debt stock is already high relative to levels in most of these countries and compares poorly against the broader 'BBB' group. Croatia's gross external debt (GXD) was equivalent to 168% of external receipts (CXR) in 2007, up from 156% in 2006. The median level of GXD for the peer group is 104% of CXR. On a net basis, Croatia's external debt stands at 80% of CXR compared with a group median of 7%.
Despite an improvement in the budget deficit, fiscal policy has not been ambitious in the context of the economy's growing external liabilities and peak of the economic cycle. The general government deficit narrowed to 3.5% of GDP in 2007 from over 6% in 2003, while general government debt has fallen by 3 percentage points of GDP over the same period, to 38% in 2007. The stock of general government debt is high relative to the peer group when expressed as a percentage of GDP, although it is in line with the group median as a share of revenues - reflecting Croatia's large government sector. The government has announced its intention to balance the general government budget by 2011, although concrete policies to meet this target have yet to be detailed. A fall in repayments of pensioners' debt will contribute to a narrowing of the general government deficit to a forecast 2.5% in 2008 and a further fall in general government debt. Beyond 2008 the government will have to address its high social spending if it is to continue to narrow the budget deficit.
Combined with weaker external demand, measures by the Croatian National Bank (CNB) to restrict the pace of credit growth and tighter fiscal policy are expected to contribute to a slower rate of economic growth this year, with Fitch forecasting real GDP growth to fall to 4.1%, from 5.6% in 2007. This should help to ease inflationary pressure in the Croatian economy, which has been hit by food and fuel price shocks common to many countries in central and eastern Europe. Annual inflation stood at 8.4% in July 2008, its highest level in over a decade.
Progress with EU-related reforms has the potential to address some of Croatia's credit weaknesses and increase upward rating pressure. Reforms would help to strengthen Croatia's business environment which, despite improvements over the past year, continues to compare poorly with rated peers'. A stronger business environment could encourage greater inflows of green-field foreign direct investment and improve the economy's capacity to generate export receipts. An acceleration of negotiations with the EU over the past year is an encouraging sign that these reforms are progressing, although they will take time. Fitch's central scenario is for EU accession to take place in 2012, recognising domestic political challenges in complying with EU laws and the potential for developments within the EU itself to contribute to delays in Croatia's membership. |
