March 25 (SeeNews) - Standard & Poor's said it has raised its long- and short-term foreign and local currency sovereign credit ratings on Croatia to 'BBB-/A-3' from 'BB+/B', with a stable outlook, mostly due to the country's improving fiscal metrics.
"Croatia's recent economic performance has been solid and balanced. Growth has been accompanied by recurring current account surpluses, driven by buoyant tourism-related inflows, allowing net external leverage to reduce severalfold to just 13% of GDP in 2018," S&P said in a statement late on Friday.
The ratings agency also said that macroeconomic risks related to the crisis in Croatia's food-to-retail concern Agrokor have abated, while the additional fiscal cost of supporting the country's struggling shipyards will likely remain low.
Standard & Poor's also said in the statement:
"We project net general government debt will decline to just below 60% of GDP by 2022 from the 75% peak in 2015. According to the authorities, expected improved budget performance will likely be used to further reduce debt, which should help reduce vulnerabilities related to Croatia's government debt profile. More specifically, over 70% of public debt is denominated in foreign currency and the domestic banking sector's government debt holdings are about 20% of assets. Croatian road companies' liability management exercise of last year has supported interest cost reduction and could serve as model for similar exercises for other government-owned sectors."
"Croatia's current account remains in surplus thanks to a large service-balance surplus stemming from the tourism sector. We expect the external surplus will moderate to below 1% on average in 2019-2022 from about 4% in 2017, a figure that was inflated by Agrokor-related bank provisioning that lowered foreign-owned banks' profits."
Institutional and economic profile: Growth is moderating and structural challenges persist
- Croatia's economic growth will moderate to around 2.5% on average in 2019-2022.
- The government has implemented tax and pension reform this year, but demographic trends will continue to weigh on the public purse.
- Despite recent political volatility, we expect the government will serve its full term.
Croatia's economy has seen resilient growth since emerging from recession in 2015. Tourist arrivals have almost doubled since 2010, at around 20 million visitors in 2018, in its flagship tourism sector. Manufacturing as well as other services, like transportation significantly contribute to the GDP, although tourism-related revenues amount to almost 20% of GDP. Several sectors of Croatia's economy have shown increased dynamism in recent years.
The rating agency expects the country's economic growth, which reached 2.6% in 2018, to moderate slightly in 2019 to 2.5%. Rise in employment, wages and tax reforms will support private consumption, as increased EU funds absorption should benefit investments. Goods exports should decelerate while imports are pulled by domestic demand, as tourism services exports are expected to expand, due to various investments in the sphere.
Progress has been made on important structural reforms. The thirds round of the taxation reform market its effect in January 2019, as it reduced VAT rates for certain items. This should stimulate disposable incomes, while investment activity can be supported via reduced labor costs. Croatia's brain drain issue can get help with the tax policies. Net emigration of some 3% over the past five years is a key structural obstacle, normal for new EU member states. Labor immigration quotas have been raised in Croatia, as unemployment decreased to below 8%.
In the recent years, Croatia has seen political volatility, but the risk of a government breakdown seems to have been abated. The thirst for early elections among the political spectrum seems to be lower than in the previous years, as the new parliamentary elections are due in 2020 under the regular electoral cycle.
Moreover, risks related Croatia's Agrokor have decreased, while the probability of fiscal slippages from payments of state guarantees against troubled shipyard Uljanik's debt liabilities are diminished. Croatia's largest food retailer restructuring programme has progressed, as majority of creditors approved the settlement deal last year. Croatia's economic, fiscal, and political outlooks have thus been reduced. This could lead to an economic opportunity in the long run, since competition will be increased and market-entry barriers will be removed, which could possibly attract foreign investments.
Flexibility and performance profile: Public debt is on a downward path while the external current account remains in surplus
- Croatia has achieved marked fiscal consolidation, with debt declining by 10 percentage points between 2015-2018.
- Despite some erosion, the current account surplus is likely to stay.
- Croatia intends to join Exchange Rate Mechanism II (ERM II), the precursor for euro adoption, in 2020.
Croatia marked a general government surplus for a second year in a row in 2018. This was mostly supported by higher tax revenues as well as expenditure savings, such as the interest bill. We believe that the Fiscal Responsibility Act adopted in 2018 will likely anchor recent fiscal prudence. Such a legislation sets requirements for structurally balanced budget and we think it will limit the probability of pronounced fiscal slippages. However, we also expect a return to a modest general government deficit in 2019-2022, to 20.5% in 2019 from 2.6% in 2018.
The 2018 fiscal results could have been even better if the government's activation of the guarantee for the troubled Uljanik shipyards has not taken place.
"We understand that total guarantees outstanding for Uljanik were Croatian 4.5 billion kuna (about 1.2% of GDP) of which about 3.1 billion kuna has been paid by the government so far. Of the remaining 1.4 billion kuna, the effect on the 2019 budget depends on the ships under construction being finished. The amount falling on the government's balance sheet could ultimately be lower. In the search for a strategic investor, we understand that the government's position is to avoid incurring any future contingent liabilities."
The general government is expected to go into deficits in the period from 2019 to 2022, after two consecutive years of surplus. The net government debt is expected to fall below 60% of the GDP by 2022, from 75% in 2015. Over 70% of the public debt is foreign currency denominated as the domestic banking sector's government debt holdings are some 20% of the assets.
Thanks to the large service-balance surplus coming out of the tourism sector, Croatia's current account is still in surplus. The external surplus is expected to moderate to an average of below 1% in 2019-2022 from some 4% in 2017, a figure that was inflated by Agrokor-related bank provisioning that lowered foreign-owned banks' profits. Brisk household consumption is also expected to accelerate import growth expand the goods trade deficit to over 18% of the GDP by 2022. Services exports will continue to practice strong performance although the growth rates might moderate as a result of three record tourist seasons in a row. Following the EU accession, it is acknowledged that Croatia's goods exports have strengthened significantly , especially in pharmaceuticals, metal products, scientific and control instruments, and food.
The Croatian National Bank's interventions, due to appreciation pressure on the kuna, helped the reserves to grow. Gross international reserves increased by 1.7 billion euro to 17.4 billion euro as of December 2018. This, together with strong current account receipts (CARs), has strongly diminished Croatia's external debt net of liquid external assets. The agency forecasts a further decline to some 23% of CARs by end of 2022, due to recurring, albeit shrinking, current account surpluses and continued deleveraging, as well as Agrokor-related debt write-offs. Deleveraging will also continue to strengthen Croatia's net international investment position. Still, gross external financing needs of about 84% of CARs on average over 2019-2022 are forecast.
The central bank is committed to the quasi-peg of the kuna to the euro. Monetary policy flexibility is thus limited as does the euroised economy. The foreign currency has over 50% of loans and deposits denominated in or linked to it. Usually, this is the euro. Inflation is expected to be contained at some 1.5% on average over the following two or three years. Croatia also hopes it will ented ERM II, which is the precursor to the euro adoption in 2020.
The disposal of distressed assets is believed to remain a key driver of domestic banks' asset quality recovery from 2019 to 2021, but to a lesser extent than the last four years. Croatian banks' nonperforming exposures (NPE) workout will facilitate the more favourable economic environment. Domestic banks' credit growth picked up in 2018, as the fastest growing sector is the general purpose cash loans to households.