July 9 (SeeNews) - Fitch Ratings said it has affirmed Croatia's long-term foreign- and local-currency issuer default ratings (IDRs) to 'BB+' and revised the outlook to positive from stable.
The revision of Croatia's outlook reflects, among other things, the country's balanced budget and current account surplus, the ratings agency said in a statement late on Friday.
Fitch also said:
"Fitch forecasts Croatia to run a budget surplus of around 0.4% of GDP in 2018, following a surplus of 0.8% in 2017. This would be an outperformance of the government's own target of a deficit of 0.5% of GDP, owing to the favourable 2017 starting point, commitment to expenditure targets, falling interest costs and strong revenue growth. The European Commission (EC) forecasts a 2018 surplus of 0.7% of GDP. Croatia outperformed its 2017 budget target by 2.1% of GDP and its 2016 target by 1.5% of GDP.
For 2019, Fitch forecasts a balanced budget, compared with the government's target of a deficit of 0.4% of GDP in its Convergence Plan (CP), based on similar dynamics as in 2018. Statements by government ministers suggest likely cuts in VAT, personal income tax or social contributions in 2019. However, these are already included in the CP base line. The CP envisages a deficit of 0.4% in 2019, a balanced budget in 2020 and a surplus of 0.5% in 2021.
Fitch expects the combination of persistent primary budget surpluses (2.9% of GDP in 2018), low interest rates and healthy GDP growth to contribute to a continued marked reduction in gross general government debt. Public debt/GDP fell by 2.7pp to 77.5% at end-2017, from a peak of 84% at end-2014, and Fitch projects it to fall to around 71% by end-2019. Nevertheless, it remains well above the current 'BB' range median of 45% at end-2017.
Medium
Continuing current account surpluses, supplemented by net equity FDI and EU capital inflows, are leading to a decline in Croatia's net external debt (NXD) and an increase in foreign exchange reserves. Fitch forecasts current account surpluses to average 2% of GDP over 2018-2020, after 4.3% in 2017, supported by continuing record tourist arrivals.
Fitch forecasts NXD/GDP to fall to around 22% at end-2018, from 33% at end-2017 and 62% at end-2013, driven by the current account surplus as well as some write-down of the foreign bank debt of Agrokor. The balance of payments in combination with the central bank's managed exchange rate regime against the euro is leading to a rise in foreign exchange reserves, which Fitch forecasts to reach around USD20 billion (33% of GDP) by end-2018.
Croatia's 'BB+' IDRs also reflect the following key rating drivers:
Croatia's structural features are a key rating strength. GDP per capita, human development and governance indicators are all stronger than the current 'BBB' medians, supported by EU membership, while the business environment is more favourable than in 'BB' range peers according to the World Bank.
The overall economy is highly leveraged. As well as high government debt, corporate and household debt in total exceeds 100% of GDP. NXD at 33% of GDP at end-2017 is well above the current 'BB' median of 12% of GDP. Exposure of balance sheets to exchange risk is material, albeit predominantly in euro, against which the kuna has a long track record of stability. Some 77% of bank deposits were in foreign currency in March 2018 (including foreign currency indexed), while 76% of general government debt is denominated in foreign currency.
Pension reform has led to the accumulation of assets equivalent to 25% of GDP in mandatory 'second pillar' funds, including 18% of GDP in government debt, increasing public debt sustainability and fiscal financing flexibility. The EC estimates annual ageing-related government spending will be 3.4% of GDP lower by 2070, the second-most favourable position in the EU. The government plans to lower the structural budget deficit Medium-Term Objective to 1% of GDP next year from 1.75% and to pass a new fiscal responsibility law this year, which would add deficit and debt targets to its fiscal rules, aligning them with the EU Stability and Growth Pact.
The Croatian economy and banking sector are proving resilient to the financial problems at Agrokor, the country's largest company, which was placed into administration in April 2017, although some downside risks remain. An agreement to restructure Agrokor's debt was approved by a quorum of 80% of creditors. Bank profits have been hit by provisioning against Agrokor-related exposures. Nevertheless, the sector has remained profitable, and risk-weighted capital adequacy is strong at 23.8% at end-2017. Non-performing loans have declined to 11.4% at end-March, from a peak of 17.3% in mid-2015, helped by economic recovery and NPL sales.
The Agrokor case has created some political fallout, with the resignation in May of Deputy PM and Minister of Economy Martina Dalic over an alleged conflict of interest related to the drafting of Lex Agrokor and debt restructuring plans. The HDZ-led government coalition has proved resilient since July 2017, despite a slim majority with 77 out of 151 seats in parliament, but structural reforms may be challenging and a change in its composition cannot be ruled out.
GDP growth slowed sharply to 0% in 4Q17 and 0.2% in 1Q18 (qoq seasonally adjusted) after averaging 0.7% (qoq) over 2015-2017. This reflects the EU-wide soft patch, base effects from a strong 1Q17, Agrokor and weak public investment. However, private consumption and investment growth has remained robust, and latest indicators point to a rebound in 2Q18. Fitch forecasts GDP growth of 2.6% in 2018 and 2.5% in 2019, supported by strong tourist arrivals, rising real earnings, tax cuts, accommodative monetary policy and a pick-up in EU project execution. Nevertheless, potential growth of around 2% is lower than peers' and a rating weakness.
In May, the government formally adopted a strategy to join the euro, agreed with the central bank. Although there is no formal target date, PM Andrej Plenkovic said he hoped to enter the ERM II by 2020, which could be consistent with joining the euro in 2023, if all convergence criteria are met and the ECB, EC and euro member states agree."