TEXT-Fitch revises Croatia's outlook to stable; affirms rating at 'BBB-'
Wed Sep 5, 2012 7:16am EDT
(The following statement was released by the rating agency)
Sept 05 -
Fitch Ratings has revised the Republic of Croatia's Outlook to Stable from Negative and affirmed its Long-term foreign and local currency Issuer Default Ratings (IDR) at 'BBB-' and 'BBB' respectively. The agency has also affirmed the Short-term foreign currency IDR at 'F3' and the Country Ceiling at 'BBB+'.
The Outlook revision reflects the government's progress in developing a medium-term plan to address the country's fiscal challenges. Implementation risks are nevertheless high and the GDP growth outlook is weak. The key challenge facing the government will be to further reduce its deficit and implement structural reforms against a backdrop of prolonged low economic growth.
The public finances remain a key rating driver and Fitch considers Croatia's public debt dynamics to be unsustainable without a credible medium-term fiscal consolidation plan. The revision to a Stable Outlook is therefore based on the government maintaining a tight medium-term fiscal stance in line with the requirements set by the fiscal responsibility law.
The government is on track to meet the 2012 general government deficit target of 3.8% of GDP in 2012, down from 5% in 2011, despite the recessionary environment. Revenue growth has over-performed Fitch's baseline mainly owing to improvements in tax compliance. A reduction in government expenditure, particularly related to the public sector wage bill, should play a bigger role in the H212 and in 2013 as a result of changes to labour laws.
Fitch views positively the government's efforts to improve tax compliance and to fight tax avoidance. Such efforts have been well-targeted and have borne fruit in a short-time frame. Fitch also believes that the changes to the labour laws and collective agreements would make the public sector wage bill more flexible and responsive to the economic cycle.
The stock of public debt increased from 38% of GDP in 2005 to 45.7% in 2011 (63.5% including guarantees). Under its baseline fiscal projections, Fitch assumes that the government will reduce expenditures by 1% of GDP each year until a primary balance is achieved in line with the fiscal responsibility law. Under this scenario public debt peaks at 58% of GDP in 2015 and declines from 2016.
A light sovereign amortisation schedule will keep borrowing needs modest in the short-term.
The sovereign has no external bonds maturing until April 2014. Financing capacity is supported by a domestic market underpinned by pension funds and a liquid banking sector.
Domestic banks are becoming increasingly inter-dependent with the sovereign due to their increased holdings of T-Bills and loans to central government. This inter-dependence puts greater emphasis on the government's ability to consolidate the public finances and maintain market confidence. In this respect, the government meeting its budget deficit target and the stabilisation of the public debt ratios are key to preserving the investment grade rating.
The Croatian economy is facing a growth problem. The country has been unable to return to growth since the 2008 crisis. On Fitch's latest forecasts, Croatia faces the prospect of a real GDP contraction of 1.7% in 2012, followed by anaemic growth of 1.5% in the medium-term. Weakness in Italy and other key EU export markets are a drag on export growth. This poses a threat to the country's fiscal adjustment and its debt dynamics.
In Fitch's view comprehensive labour market reform which tackles rigidities in both private and public sector is important to improve competitiveness, support medium-term GDP growth potential and preserve Croatia's investment grade rating. The government has carried out changes to the labour laws which tackle the flexibility of wages in the public sector. Nevertheless, in Fitch's view, the low labour participation rate in the economy is a key structural bottleneck.
Croatia's sharp current account adjustment, to 0.7% of GDP in 2011 from a deficit of 9% of GDP in 2008, has helped to ease external financing concerns. Rollover rates on external debt have held up well so far and Croatia has managed to
finance external deficits without IMF support.
However, Croatia's external financing requirements remain substantial, owing to a heavy external debt amortisation schedule. This leaves the country exposed to changes in investor sentiment and the willingness of parent banks (mainly Italian and Austrian) and companies to continue to roll-over funding.
Croatia is set to join the EU in July 2013. EU accession will strengthen the country's governance and, over the medium-term, unlock substantial external financing sources. EU membership is also supportive of an increase in inward foreign direct investment and will provide an anchor for fiscal policy as future governments will have to submit Convergence Programmes and National Reform Programmes annually to the EU
In terms of potential rating triggers, significant slippage against fiscal targets would lead to a negative rating action. Balance of payment pressures that led to a sustained fall in foreign exchange reserves, for example triggered by an intensification of the eurozone crisis, would also put downward pressure on the rating.
Conversely, the government meeting its budget deficit targets, stabilisation of the public debt ratios and return to sustainable GDP growth would stabilise the rating. Progress on structural reforms would also be rating positive.
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