Fitch Affirms Croatia at 'BB'; Outlook Negative

Fitch Ratings has affirmed Croatia's Long-term foreign and local currency Issuer Default Ratings (IDRs) at 'BB' and 'BB+' respectively.

The Outlooks on the IDRs are Negative.

Two weeks ago Standard &Poor's issue the same rating.

The issue ratings on Croatia's senior unsecured foreign and local currency bonds are also affirmed at 'BB' and 'BB+' respectively. The Country Ceiling is affirmed at 'BBB-' and the Short-term foreign-currency IDR at 'B'.

Explaining its decision, Fitch said the ratings balance Croatia's high public and external debt burdens, large fiscal deficits and weak growth performance against fairly favourable structural features. General government gross debt rose to an estimated 89% of GDP in 2015, well above the 'BB' median of 43.6%, and is only expected by Fitch to peak in 2017, at 92.4%. Gross and net external debt reached an estimated 110% and 55.3% of GDP, respectively, in 2015. However, structural features including per capita income, human development and governance indicators score well above peer medians.

The ratings agency also noted that a new coalition government including the centre-right Croatian Democratic Union (HDZ) and a new pro-reform party, Bridge, took power in January 2016.

"The new administration aims to bring down public debt and implement reforms that would address many of the structural impediments to growth identified by the European Commission. However, there are doubts about the ability of the government to achieve these objectives and about the unity of the coalition as a whole. In addition, the new technocratic Prime Minister, Tihomir Oreskovic, has no experience in Croatian politics," Fitch said.

Fitch estimates that the general government deficit narrowed to 5% of GDP in 2015 (BB median: 3.5%) from 5.6% in 2014, mostly reflecting stronger revenue growth on the back of an economic recovery. There is a high degree of uncertainty around fiscal forecasts for 2016-17 given the arrival of the new government. At present there is no full 2016 budget; a draft is expected to be presented to parliament by end-March. Under the most recent Convergence Programme (April 2015), Croatia is committed to correcting its excessive deficit (bringing the shortfall to below 3% of GDP) by 2017. The new government has announced plans to shave 1.5pp off the deficit ratio this year, but this appears optimistic. Fitch's baseline scenario is for the fiscal deficit to narrow to 4.5% of GDP in 2016 and 4% in 2017. 

Fitch estimates that the economy expanded 1.7% in real terms in 2015, following six consecutive years of contraction. Growth was underpinned by a strong tourism season and a boost to real net incomes from an income tax cut and low oil prices. Fitch expects the economy to grow 1.4% in 2016, rising to 1.8% in 2017. Tourism should remain an important driver of growth, helped by heightened political and security risks in many competitor markets. Oil prices will remain low, underpinning real income growth, and the labour market should continue to recover. However, the high level of corporate debt, at over 100% of GDP, is preventing a recovery of investment growth and is hindering the reallocation of resources to more productive parts of the economy. 

The current account surplus rose to an estimated 4.3% of GDP in 2015, from 0.7% a year ago. The increased surplus in 2015 reflected the impact of the conversion of Swiss franc retail loans into euros, which saw debits on the primary income account fall sharply in 3Q15. However, a rise in the services surplus as a result of the strong tourism season was also a contributor. Fitch forecasts a current account surplus of 2.3% of GDP in 2016. 

The conversion of Swiss franc retail loans imposed one-off losses on the banking sector estimated at HRK8bn (just over 2% of GDP). However, the impact was cushioned by sizeable capital buffers, with the regulatory capital adequacy ratio at a still robust 19.9% at end-3Q15. The conversion could help prevent a further deterioration of loan portfolios. Non-performing loan (NPLs) totalled 17.1% of total gross loans at end-3Q15. High foreign ownership (over 90%) in the banking sector mitigates contingent liabilities to the sovereign balance sheet. 

The exchange rate was fairly stable in 2015, appreciating by 0.3% against the euro for the year as a whole. The Croatian National Bank seeks to limit fluctuations in the kuna-euro exchange rate, given the economy's high level of euroisation, and has adequate reserves to do so.

The ratings agency also said that the Negative Outlook reflects risk factors that may, individually or collectively, result in a downgrade, such as continued escalation of the public debt/GDP ratio, whether through fiscal underperformance, rising financing costs, or weaker nominal GDP growth; future developments that may, individually or collectively.

Fitch also noted progress on fiscal consolidation leading to greater confidence that public debt/GDP will stabilise over the medium term, as well as better growth prospects and competitiveness, particularly through the implementation of structural reforms.

Last update: Sat, 30/01/2016 - 13:42

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