Foreign Debt, C/A Deficit Pose Risks for Croatia, Fitch Says

According to Fitch, Croatia has so far been sheltered from the impact of the global financial crises, reflecting its relatively strong economic and credit fundamentals - including a banking system that is not over-leveraged or exposed to international capital markets.

The agency forecasts Croatia's current account deficit to fall to 4.1 billion euro ($5.29 billion), or 9.0% of GDP in 2009, from a 2008 forecast for 4.5 billion euro, or 10.9% of GDP. Croatia’s current account gap in 2007 was 8.6% of GDP, according to central bank figures.

Assuming net foreign direct investment (FDI) covers 40% of the 2009 deficit, this leaves a deficit on the basic balance of 2.5 billion euro, which will need to be funded by other capital inflows or a rundown in Croatia's international reserves and/or non-sovereign external assets, Fitch said.

In addition, maturing medium- and long-term debt is estimated by Fitch to stand at 6.0 billion euro in 2009, bringing the 2009 gross external financing requirement, less net FDI, to 8.5 billion euro. This compares with official foreign exchange reserves of 10.9 billion euro  in November 2008.

In its report, Fitch presents three scenarios (central, optimistic and pessimistic) for FDI coverage of the current acoount deficit and rollover rates on amortising medium- and long-term debt in 2009. In these scenarios, the subsequent 'ex ante financing gap' ranges from 2.5 billion euro to 7.1 billion euro, with Fitch's central scenario at 4.9 billion euro.

Fitch notes that the Croatian National Bank (CNB) is unlikely to want to run down its official reserves too far given the tightly managed exchange rate regime and foreign currency exposure on private sector balance sheets. “Moreover, there is considerable uncertainty related to the global financial environment, including potential funding and capital pressures at foreign parent banks,” Fitch said. Pressure could be greater if there is an increase in "euroisation" or capital flight, while a sharper downward adjustment of the deficit could lessen pressure, it added.

In addition to official reserves, deposit money banks' foreign assets stood at 8.0 billion euro in August, with bank foreign currency reserves deposited at the central bank  standing at 4.3 billion in September. Non-bank private sector assets are estimated at a further 1.8 billion euro. Fitch notes that use of these assets would take pressure off official reserves in meeting next year's financing needs.

However, risks are tilted to the downside. Evidence that rollover rates are low, any signs of a material decline in foreign exchange reserves or other signs of financial stress could lead to a negative rating action, the agency said. “To lessen the likelihood that these negative pressures materialise, the sovereign authorities could take measures to further bolster investor confidence,” it added.

These measures could include seeking a precautionary programme from the IMF and continuing to pursue structural reforms to ensure an invitation to join the EU. Moreover, frontloading measures to balance the general government budget before the government's 2012 target would aid a sharper fall in the current account deficit and lessen the economy's external financing needs, Fitch added.

Croatia's sovereign Issuer Default Ratings are: Long-term Foreign currency 'BBB-' (BBB minus); Short-term Foreign currency 'F3'; Long-term Local Currency 'BBB+' (BBB plus); The Outlook on the IDRs is Stable. Croatia's Country Ceiling is 'BBB+' (BBB plus).

Croatia started accession talks with the EU in 2005 and hopes to join the bloc around 2011.

($ = 0.7750 euro)

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