Fitch affirms Croatia at 'BB', outlook stable

Fitch affirms Croatia at 'BB', outlook stable gary yim/Shutterstock.com

ZAGREB (Croatia), July 15 (SeeNews) - Fitch Ratings said it has affirmed Croatia's long-term foreign- and local-currency issuer default ratings (IDR) at 'BB' with a stable outlook. 

The issue ratings on Croatia's senior unsecured long-term foreign- and local-currency bonds have also been affirmed at 'BB', Fitch said late on Friday.

The short-term foreign- and local-currency IDRs have been affirmed at 'B'; the issue ratings on the senior unsecured short-term bonds have also been affirmed at 'B'; while the country ceiling has been affirmed at 'BBB-', the ratings agency noted.

Fitch also said:

Croatia's 'BB' IDRs reflect the following key rating drivers:

The Croatian economy is benefiting from favourable cyclical conditions. Strengthening growth in regional trading partners, favourable wage and employment dynamics, robust tourism receipts and improved absorption of EU funds, resulted in real GDP growth rising to 3% in 2016 (the fastest since 2007), and are likely to support performance in 2017. However, economic performance will be affected by the restructuring of the country's largest private company, Agrokor. Agrokor was placed into state administration in April and had debt of around 12% of GDP at end-1Q17. Fitch expects the Agrokor fallout will extend to the company's suppliers and banks and that it will impact employment, investment and credit growth, and cause real GDP growth to slow to 2.6% in 2017 in the event of an orderly restructuring. A further slowdown is projected for 2018. 

Potential growth remains weak relative to peers, at 1%-2%, due to adverse demographics, structural rigidities, on-going external deleveraging and low investment during the 2009-2014 recession. Growth volatility is higher than 'BB' peers, as is unemployment, which was 13.1% at end-2016.

Public finances have improved, leading to the lifting of the Excessive Deficit Procedure by the EU in June. After a sharp narrowing in the budget deficit in 2016 to 0.8% of GDP, the deficit is forecast to widen to an estimated 1.4% of GDP in 2017 as revenues are affected by recent tax reform and the 2016 spending freeze ends. Fitch anticipates moderate deficits to 2019 as the authorities stick to their medium-term target of a structural deficit of 1.75% of GDP in line with the EU Growth and Stability Pact, commensurate with a primary surplus.

Primary surpluses will keep debt/GDP on a downward trend. Nonetheless, at a forecast 82.5% of GDP at end-2017 it will remain well above the 'BB' median of 49.5%. Materialisation of contingent liabilities, including from arrears in the healthcare sector or adverse litigations, poses a risk, as do exchange rate fluctuations, given that 76.5% of public debt was foreign-currency denominated at end-2016. Refinancing needs are high, exceeding 15% of GDP in 2017.

Net external debt is high, at a projected 32.4% of GDP at end-2017, compared with a 'BB' median of 19.3% of GDP, and the external debt service ratio is nearly 3x the peer median. Risks are mitigated by the strength of the peg to the euro, supported by strong reserves. Fitch projects a decline of external indebtedness over the forecast horizon as robust tourism revenues support continued current account surpluses.

The banking sector's strong capitalisation (the capital adequacy ratio was 22.5% at-end 2016), high liquidity and net external creditor position will help absorb spillover effects from Agrokor. However, the restructuring will likely put an end to the recent downward trend in NPLs and could reverse the uptick in new lending after years of domestic deleveraging. Fitch expects monetary policy to be accommodative as inflation remains moderate (1.1% yoy at May 2017), which could help stimulate credit. 

There is uncertainty over the longevity of the current ruling coalition. Following the fall of a coalition government in April, the dominant party of the coalition, the HDZ, avoided early legislative elections by forming a new coalition with the centrist HNS in June. However, the coalition's majority is only two and tensions could arise on some key legislative bills. Fitch's baseline scenario is that of economic policy continuity, but the fragility of the government and the risk of early elections may slow down the pace of structural reforms.

Croatia's structural features compare very favourably with 'BB' medians. GDP per capita is more than twice the median; governance indicators, human development index and doing business indicators are also stronger than peers, reflecting the membership in the EU.

Fitch's proprietary SRM assigns Croatia a score equivalent to a rating of 'BBB' on the Long-Term FC IDR scale. 

Fitch's sovereign rating committee adjusted the output to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows:
- Macro: -1 notch to reflect weak growth potential and potential spillovers from the Agrokor restructuring on the economy and the banking sector
- Public Finances: -1 notch, to reflect non linearity of public debt at high levels not captured in the SRM and the high related refinancing needs
- External Finances: -1 notch, to reflect the high net external debt (which is not captured in the SRM)

Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.

The main factors that, individually or collectively, could trigger positive rating action are:
- Continued reduction in net external debt 
- Continued fiscal consolidation ensuring a material and sustained reduction in the public debt ratio
- Strengthening of growth prospects and competitiveness, including through the implementation of structural reforms

The main factors that, individually or collectively, could trigger negative rating action are:
- Deterioration in growth prospects
- A reversal of fiscal consolidation leading to unfavourable public debt dynamics

Fitch assumes that world growth will reach 2.9% in 2017 and 3.1% in 2018, and that the eurozone will grow by 2% in 2017 and 1.8% in 2018.

Fitch expects Croatia's track record of monetary and exchange rate policy stability to continue, minimising the risk of household, corporate and government balance sheets, all of which are heavily euroised."

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