It is the first increase of Croatia’s credit rating since 2004. Then, Standard & Poor’s increased BBB- to BBB, after which it was repeatedly downgraded by all three of the world’s leading rating agencies (Moody’s being the third).
In the new report, Fitch points out that economic growth remained at three per cent in 2017, as Croatia benefited from a strong cyclical position, increased EU funding from funds, strong tourism and tax reforms. Growth should remain around this level over the next period due to solid labor market dynamics and increase of EU funds’ disbursement. Fitch expects that there will be no signs of overheating and that inflation should remain low. This agency points out that, despite improvements, the growth of the economy is still slow compared to the similar countries in the EU, which reflects the structural economic weaknesses, high private indebtedness, low investment levels and unfavorable demographic trends.
Financial problems in Agrokor, the largest private company in the country according to the income and employment, did not have a significant macroeconomic impact, and the banking sector overwhelmed them, although some risks remain, suggests the rating agency. Fitch expects that Agrokor’s restructuring will not cause major disturbances in the economy and the financial sector, but challenges remain, including legal ones. The profit of the banks, Fitch believes, was hit by Agrokor’s credit facilities. However, this sector, which is 90 per cent foreign owned, has remained profitable, and its capital adequacy remains strong. At the end of September 2017, it was 22,6 per cent. NPLs to the corporate sector remains high at 28,3 per cent. Overall, NPLs amounted to 13,2 per cent. Consumer crediting grows after a several years decline and corporate lending is expected to rise after the uncertainty surrounding Agrokor’s diminish.
Fitch analysts point out that the tourism strengthening provided revenues supporting the improvement of the Croatian foreign position. The 2013 payment balance was in surplus, and Fitch forecasted that it will remain the same in the period until 2019. The record tourist season and the withdrawal of smaller profits by foreign banks resulted in surplus in the balance of payments reaching 3,9 per cent of GDP in 2017, after 2,7 per cent in 2016. The import dependence of most economic activities means that the growth of consumption and investment expected during the forecast period will reduce this surplus to 2 per cent of GDP in 2019, notes Fitch.
The surpluses in the balance of payments and the solid flow of capital support a significant reduction in net external debt. Fitch estimates that net external debt will fall to 16 per cent of GDP by the end of 2019, with an estimated 26 per cent at the end of 2017, or whooping 52 per cent at the end of 2014. According to this indicator, Croatia is moving to a group of average countries that have the BB rating. It is expected that the non-banking private sector will be the main source of debt solving in 2018, reflecting the use of rising corporate profits for the repayment of external debts, as well as the restructuring of Agrokor.
Fitch also states that the fiscal performance of the country surpassed expectations for the second consecutive year, with a surplus of state in 2017 (first by ESA 2010 methodology), while targeting a 1,3 per cent of GDP deficit. Cyclical improvements in revenue and the continuation of spending limits were complemented by tax reform, which reduced the complexity of the tax system. Fitch is expecting a deficit back in 2018 (the Croatian government projected it at 0,5 per cent of GDP) as a reflection of moderate wage increases in the public sector, greater co-financing of projects by EU money and less probabilities than positive surprises on revenue side of the budget. Still, they say, fiscal performance is much stronger than in the past years. In Fitch, the government deficit is projected on average 0,4 per cent of GDP in the period between 2016 and 2019, compared to 4,7 per cent of the average in the previous four years.
Primary surpluses and the return of economic growth have also reduced the share of government debt to GDP, from its peak of 85.8 per cent recorded by the end of 2014 to approximately 78 per cent by the end of 2017. Exchange rate fluctuations have contributed to a 6-percentage point decrease in this share in 2017, but exchange rate fluctuations remain the source of the country’s vulnerability, according to the rating agency, as roughly 75 per cent of the government debt is denominated in foreign currency, although government’s commitment to the euro introduction strategy partially reduces some of these risks. Debt management operations have reduced the cost of debt servicing, as noticed at Fitch. With the primary surpluses expected in 2018 and 2019, the debt-to-GDP ratio will continue to fall to the projected 70.9 per cent by the end of 2019, but as such remains significantly higher than the projected average of 45 per cent for countries with a ‚BB’ rating. By contrast, the ratio of indebtedness and income is now consistent with comparable countries, with an average of 166 per cent at the end of 2017.
The agency says that further improvement in Croatia’s rating could be achieved if public debt-to-GDP cuts continue and strengthen prospects for economic growth and competitiveness, including the implementation of structural reforms. On the other hand, rating deterioration would follow if it would reverse fiscal consolidation, which would lead to an increase in public debt-to-GDP ratio, and if the prospect of economic growth is weakened. Of the three leading rating agencies, now Fitch holds the Croatian rating one degree below the investment level, while S&P and Moody’s hold two degrees below. While doing so, Moody’s has a stable outlook for Croatia and S&P positive, which means that only one step is needed to increase the rating itself.
The Croatian government is in a positive mood. Minister of Finance Zdravko Marić (once the CFO of Agrokor) said that, as Fitch’s credit rating has been lifted, the government’s goal was to return to the country’s investment rating as soon as possible and announced that the financial restructuring of the road sector should be completed in the first quarter, adding to that goal. At the end of last year, the government issued EUR1.275bn worth of bonds intended to refinance part of the debt of the road system. These funds will be directed to refinancing part of the EUR5.1bn worth debt of Croatian Roads, Croatian Motorways and Motorway Rijeka-Zagreb. The bonds are due in 2030, and the terms of issue were the most favorable until now.
Vedran Obućina is an analyst and a journalist specializing in the Croatian and Middle East domestic and foreign affairs. He is the Secretary of the Society for Mediterranean Studies at the University of Rijeka and a Foreign Affairs Analyst at The Atlantic Post.