April 2 (SeeNews) - Fitch Ratings said it has revised its outlook on Croatia's long-term foreign-currency Issuer Default Rating (IDR) to stable from positive, affirming the IDR at 'BBB-'.
Croatia is highly dependent on tourism and tourism-related activities, with these sectors accounting for an estimated 25% of GDP and a similar share of total employment, Fitch said in a statement late on Wednesday.
The ratings agency added that it expects an aggregate fall in tourism of some 50% for the whole of 2020 in Croatia, as a result of widespread domestic and international travel restrictions amid the coronavirus outbreak, as well as due to weak economic conditions in Croatia's key tourist markets of Germany, Italy, Austria and Slovenia.
At the same time, Fitch has also revised its 2020 GDP forecast for Croatia, now expecting a 5.5% contraction, due to the impact of the COVID-19 pandemic, which is a drop of 8 percentage points from its previous forecast made in December 2019
Here is what else the rating agency said:
"The hit to tourism and other services will have a significant effect on employment, consumption, investment and exports. This should be partly mitigated by the authority's relief measures targeting businesses and individuals, and potentially by higher public investment. Measures so far include the deferral of tax payments for affected companies, wage support for affected workers, targeted sector aid, increase in state guarantees and options to defer loan payments, which combined could total over HRK30 billion (7.5% of 2019 GDP). Although additional measures are likely, downside risks to our growth forecast for 2020 are significant given the uncertainty around the duration of the COVID-19 pandemic (the tourism season is concentrated in 3Q).
We expect the economy to recover in 2021, expanding by close to 3% on the back of service sector growth and a pick-up in exports as global demand resumes. This baseline rests on the assumption that tourism recovers quickly and that macro-fiscal stability is maintained. Fitch expects the unemployment rate to jump to 9% in 2020 but then rise only slowly to 9.5% in 2021 and ease in 2022. This would be significantly below the 17.4% rate reached in 2013, the peak during six years of economic contraction. We maintain our medium-term growth forecast of 2.2%, reflecting adverse demographics and slow progress implementing structural reform (which hinders economic diversification).
MEDIUM
Croatia´s current account and net external debt position will deteriorate in 2020 following six years of rapid improvement, as exports of goods and services contract sharply owing to the COVID-19 pandemic. Income from travel and transport services account for about 35% of total current account receipts, contributing to a large services surplus (21% of GDP in 2019). We expect this income to fall by over 45% in US dollar terms this year, with some of it being offset by a drop in goods and services imports (helped by lower oil prices). As a result, the current account will move from an estimated 2.7% of GDP surplus in 2019 to a deficit of 3.2% in 2020. Combined with an expected increase in net official foreign borrowing, this will lift net external debt to 17.4% of GDP. Fitch expects these trends to reverse in 2021 and for the country´s external position to remain broadly resilient, but risks are on the downside.
Sound fiscal performance in the last four years, underpinned by prudent policy, provides the authorities some policy flexibility and supports confidence in medium-term fiscal stability. Fitch expects the budget deficit to rise to over 5% of GDP in 2020, from an estimated surplus of 0.2% in 2019, as the authorities step up fiscal efforts to boost the economy. We forecast a sharp fall in revenue as most economic sectors suffer and unemployment rises, as well as a significant increase in expenditure outlays, driven by automatic stabilisers. A sharper economic contraction represents a key downside risk. The government has a variety of financing options including ample fiscal savings—central government deposits stood at 7.4% at end 2019—good market access and EU grant support (potentially up to EUR1.3 billion for 2020; 2.5% of GDP). We forecast public debt to jump to 77.7% of GDP in 2020, compared with our previous forecast of 68.1%.
Under our baseline assumption that the economy will recover in 2021, the deficit should fall under 3% of GDP and public debt stabilise at 77% of GDP, still well above the current 'BBB' median of 42% of GDP. The current shock to both supply and demand will likely continue to affect revenue and put pressure on expenditure over the medium term, but there is scope for either expenditure restraint in some areas or additional EU financing that would prevent a long-lasting hit to the public finances. Moreover, despite high public sector debt levels, medium-term funding needs are modest, reflecting long maturities (close to six years) and sound public debt management.
Fitch expects GDP per capita to fall sharply in 2020 before rising modestly in 2021, to USD14.700 at market exchange rates. This would be the same level as in 2019 and only 90% of the level of our previous forecast. Nonetheless, it will remain 30% above the `BBB´ median, supporting the rating.
Croatia´s IDRs also reflect the following key rating drivers:
The National Bank of Croatia (HNB) has taken a number of steps to support the currency regime, maintain liquidity in the financial system, and provide some relief to the corporate sector. Key measures include reducing the minimum reserve requirement from 12% to 9%, intervening in the FX market to stabilise the currency (EUR1.6 billion since early March), purchasing government bonds in the secondary market for the first time (over HRK4 billion) and announcing a loan moratorium for existing loans and better financing conditions for new loans. The HNB has abundant foreign reserves (USD21 billion in January; 35% of 2019 GDP) and a long-track record of maintaining exchange-rate stability to help the economy withstand shocks. Moreover, inflation is low (1.5% in February) and will remain very low this and next year (averaging 0.7%).
Fitch believes the financial sector is in a better position to weather a crisis than in 2008-09, supported by a liquid, profitable and highly capitalised banking sector that is less reliant on cross-border lending. The capital adequacy ratio was 23.2% at end-2019 versus 15.1% at end-2008, while liquid assets to total assets were close to 35% at end-Q319. The ratio of non-performing loans had been on a clear downward trend (reaching a 10-year low of 7.5% at end-2019) but the projected sharp economic slowdown will likely lead to increased number of loan restructurings and borrower defaults, particularly in tourism and tourism-related segments. Credit growth, which was rising moderately, is expected to slow sharply as demand dries up. Combined with increased loan impairment charges, this will impact profitability.
The COVID-19 shock risks delaying Croatia's entry into the Exchange Rate Mechanism (ERM II) and the Banking Union, ultimately postponing euro-adoption beyond 2024. The authorities are making substantive efforts to complete all agreed commitments by the original deadline of end-June 2020, while the ECB was preparing to finalise an asset-quality review of five banks by end 2Q. However, even if the process carries on as planned, it is unclear whether European institutions will agree to move forward given other priorities, or whether Croatia will fulfil the euro-convergence criteria required under ERM II given the outlook and risks to growth and public finances. If concerns about risks ease and the process resumes, this would be supportive for the rating, as underlined by our view that all things being equal, we would upgrade Croatia Long-Term Foreign-Currency IDR by two notches between admission to the ERM II to joining the euro.
Croatia's structural features are generally more favourable than 'BBB' peers and the country scores better than peers in governance and human development indicators, thanks in part to EU membership. The coalition government installed in June 2017 has been able to implement its agenda relatively smoothly despite its small majority (evidenced most recently by adoption of support measures to tackle the COVID-19 crisis). Nonetheless, political tensions could increase somewhat as parties gear up towards the presidential elections by end-2020, reducing visibility of medium-term policies.
ESG - Governance: Croatia has an ESG Relevance Score of 5 for both Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption, as is the case for all sovereigns. Theses scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model. Croatia has a high WBGI ranking at 66.5 percentile, reflecting its track record of stable and peaceful political transitions, well established rights for participation in the political process, moderate institutional capacity, effective rule of law and a moderate level of corruption.
SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)
Fitch's proprietary SRM assigns Croatia a score equivalent to a rating of 'BBB' on the Long-Term Foreign-Currency (LT FC) IDR scale.
Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows:
-Macroeconomics: -1 notch, to reflect weak medium-term growth potential relative to peers and a lack of flexibility in the economy, owing to adverse demographic trends and supply side constraints.
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.
RATING SENSITIVITIES
The main factors that may, individually or collectively, lead to an upgrade or other positive rating action are:
- General government debt/GDP returning to a firm downward path over the medium-term, for example due to a post-coronavirus-shock fiscal consolidation.
- Progress toward eurozone accession.
-Strengthening of growth prospects and competitiveness, including through the implementation of structural reform.
The main factors that may, individually or collectively, lead to a downgrade or other negative rating action are:
-Persistent increase in general government debt, for example due to a more pronounced and longer period of fiscal loosening and economic contraction.
-Sharp worsening of Croatia's external position leading to rising external vulnerability.
-Deterioration in medium-term growth prospects.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Public Finance issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings click here.
KEY ASSUMPTIONS
-Fitch assumes that the global tourism industry experiences a gradual recovery extending into 2021 after the initial, sharp shock from the COVID-19 pandemic this year.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG CONSIDERATIONS
Croatia has an ESG Relevance Score of 5 for Political Stability and Rights as World Bank Governance Indicators have the highest weight in Fitch's SRM and are highly relevant to the rating and a key rating driver with a high weight.
Croatia has an ESG Relevance Score of 5 for Rule of Law, Institutional & Regulatory Quality and Control of Corruption as World Bank Governance Indicators have the highest weight in Fitch's SRM and are therefore highly relevant to the rating and are a key rating driver with a high weight.
Croatia has an ESG Relevance Score of 4 for Human Rights and Political Freedoms as the Voice and Accountability pillar of the World Bank Governance Indicators are relevant to the rating and a rating driver.
Croatia has an ESG Relevance Score of 4 for Creditor Rights as willingness to service and repay debt is relevant to the rating and is a rating driver for Croatia, as for all sovereigns."