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TEXT - S&P cuts Croatia's ratings; revises outlook to stable
Fri Dec 14, 2012 12:21pm EST
Overview
-- In our opinion, the Croatian government's reforms have so far been insufficient to eliminate the structural rigidities that hamper the country's growth potential.
-- We believe that the government's fiscal resolve has weakened, leaving structural budgetary weaknesses, such as high personnel and social expenditures, which together make up just under three quarters of central government spending, unaddressed.
-- We are therefore lowering our long- and short-term sovereign credit ratings on Croatia to 'BB+/B' from 'BBB-/A-3'.
-- The outlook is stable, reflecting our view that Croatia's wealth levels, relatively diversified economy, and future receipt of EU funds could help stabilize external imbalances and government finances while improving growth prospects.
Rating Action On Dec. 14, 2012, Standard & Poor's Ratings Services lowered its long- and short-term sovereign credit ratings on Croatia to 'BB+/B' from 'BBB-/A-3'.
The outlook is stable. The T&C assessment remains 'BBB+'.
We assigned a recovery rating of '4', reflecting our view of a 30%-50% recovery in the event of default.
Rationale The downgrade reflects our view that structural and fiscal reforms implemented so far have been insufficient to foster economic growth and place public finances on a more-sustainable path.
Because Croatia's economy is highly euroized, with a semi-fixed exchange rate regime, we consider flexible labor and product markets and the maintenance of external and fiscal buffers to be of greater importance to offset possible external shocks than for sovereigns with floating exchange rate regimes.
In our opinion, labor and product market flexibility in Croatia is lacking. Policy inertia and opposition from vested interests that benefit from long-entrenched entitlements have contributed to wage and price rigidities, the low participation rate, and loss of economic competitiveness.
Croatia's public sector employs about one-third of the workforce.
The budget is dominated by personnel and social expenditure: together nearly three-quarters of central government spending, leaving little room for public investment. Given the strength of incumbents inside and outside the public sector, Croatia's unsustainably high entitlement spending--in light of economic drift, low labor participation, and population aging--will be politically challenging to cut back, in our view. As a consequence, we no longer consider Croatia to possess the economic flexibility and policy resolve of an investment-grade sovereign.
Revenue-based fiscal consolidation, driven by a 2% increase in the VAT rate and improved tax collection, saw the fiscal position improve modestly in 2012 compared to 2011. Nevertheless, the recently adopted supplementary budget for 2012 underlines the challenge the government faces in adhering to its own spending plans for the wage bill, subsidies, and social transfers: all were revised upward.
The government's medium-term fiscal framework indicates a continued preference for revenue-based budgetary consolidation rather than current expenditure cuts to meet what we view as unambitious fiscal goals. This includes the widening deficit in 2013, a deviation from the previous government plans and from our expectations, and growing nominal expenditure, based on what we believe to be overly optimistic growth assumptions. We see risks of expenditure slippages despite amendments to the collective bargaining agreements with trade unions, which the government expects will deliver 0.6% of GDP in savings on the wage bill during 2013.
Since 2009, the Croatian economy has been either in recession or stagnant. We estimate about a 2% contraction for 2012, despite a strong tourism season. Private-sector deleveraging, high unemployment, rising inflation, low credit growth, and a VAT increase are all weighing on domestic demand. During 2013, we expect the economy to stagnate, and then recover only gradually to trend growth of 2% by 2015, well below the pre-crisis average.
We believe that the government's growth program--mainly increasing investment by state-owned enterprises, backed by external funding from international financial institutions--may temporarily boost domestic demand. In our opinion, however, this will be offset by weak private demand, given high unemployment and unfavorable credit conditions. The growth program is also likely to exacerbate high external vulnerabilities, pushing up investment and external debt.
At just under 200% of current account receipts (CARs), Croatia's net external liability position is already substantial, albeit it marginally declined from 2009, as the current account deficit has dropped to less than 1% of GDP (excluding errors and omissions). While the current account is expected to remain close to balance in 2012-2013, the economy will continue to depend heavily on external financing to rollover the high stock of liabilities to nonresidents. External debt service (including the rolling over of short-term debt) is about 75% of CARs. Foreign banks account for 90% of bank assets in Croatia and external bank financing has contracted moderately in 2012, although we expect external bank support to remain strong.
Outlook
The stable outlook balances our expectation of Croatia's EU accession, which would see the country benefit from EU structural and cohesion funds and higher foreign direct investment, against our view of limited prospects for major growth- and competitiveness-enhancing reforms.
Strong progress in reducing economic imbalances, particularly the reliance on external financing, and the implementation of growth-enhancing structural reforms could lead us to consider raising the ratings.
Conversely, we could consider lowering the ratings if the government fails to reduce the structural rigidities in the economy, external imbalances widen, or there is significant deviation from budgetary targets, which could increase the risk of sudden deterioration in the economy's funding position.
Related Criteria And Research
-- Sovereign Government Rating Methodology And Assumptions, June 30, 2011
-- Criteria For Determining Transfer And Convertibility Assessments, May 19, 2009
-- Introduction Of Sovereign Recovery Ratings, June 14, 2007
Ratings List
Downgraded To From Croatia (Republic of) Sovereign Credit Rating BB+/Stable/B BBB-/Negative/A-3 Senior Unsecured BB+ BBB- Recovery Rating 4 Affirmed Transfer & Convertibility Assessment BBB+
Fri Dec 14, 2012 12:21pm EST
Overview
-- In our opinion, the Croatian government's reforms have so far been insufficient to eliminate the structural rigidities that hamper the country's growth potential.
-- We believe that the government's fiscal resolve has weakened, leaving structural budgetary weaknesses, such as high personnel and social expenditures, which together make up just under three quarters of central government spending, unaddressed.
-- We are therefore lowering our long- and short-term sovereign credit ratings on Croatia to 'BB+/B' from 'BBB-/A-3'.
-- The outlook is stable, reflecting our view that Croatia's wealth levels, relatively diversified economy, and future receipt of EU funds could help stabilize external imbalances and government finances while improving growth prospects.
Rating Action On Dec. 14, 2012, Standard & Poor's Ratings Services lowered its long- and short-term sovereign credit ratings on Croatia to 'BB+/B' from 'BBB-/A-3'.
The outlook is stable. The T&C assessment remains 'BBB+'.
We assigned a recovery rating of '4', reflecting our view of a 30%-50% recovery in the event of default.
Rationale The downgrade reflects our view that structural and fiscal reforms implemented so far have been insufficient to foster economic growth and place public finances on a more-sustainable path.
Because Croatia's economy is highly euroized, with a semi-fixed exchange rate regime, we consider flexible labor and product markets and the maintenance of external and fiscal buffers to be of greater importance to offset possible external shocks than for sovereigns with floating exchange rate regimes.
In our opinion, labor and product market flexibility in Croatia is lacking. Policy inertia and opposition from vested interests that benefit from long-entrenched entitlements have contributed to wage and price rigidities, the low participation rate, and loss of economic competitiveness.
Croatia's public sector employs about one-third of the workforce.
The budget is dominated by personnel and social expenditure: together nearly three-quarters of central government spending, leaving little room for public investment. Given the strength of incumbents inside and outside the public sector, Croatia's unsustainably high entitlement spending--in light of economic drift, low labor participation, and population aging--will be politically challenging to cut back, in our view. As a consequence, we no longer consider Croatia to possess the economic flexibility and policy resolve of an investment-grade sovereign.
Revenue-based fiscal consolidation, driven by a 2% increase in the VAT rate and improved tax collection, saw the fiscal position improve modestly in 2012 compared to 2011. Nevertheless, the recently adopted supplementary budget for 2012 underlines the challenge the government faces in adhering to its own spending plans for the wage bill, subsidies, and social transfers: all were revised upward.
The government's medium-term fiscal framework indicates a continued preference for revenue-based budgetary consolidation rather than current expenditure cuts to meet what we view as unambitious fiscal goals. This includes the widening deficit in 2013, a deviation from the previous government plans and from our expectations, and growing nominal expenditure, based on what we believe to be overly optimistic growth assumptions. We see risks of expenditure slippages despite amendments to the collective bargaining agreements with trade unions, which the government expects will deliver 0.6% of GDP in savings on the wage bill during 2013.
Since 2009, the Croatian economy has been either in recession or stagnant. We estimate about a 2% contraction for 2012, despite a strong tourism season. Private-sector deleveraging, high unemployment, rising inflation, low credit growth, and a VAT increase are all weighing on domestic demand. During 2013, we expect the economy to stagnate, and then recover only gradually to trend growth of 2% by 2015, well below the pre-crisis average.
We believe that the government's growth program--mainly increasing investment by state-owned enterprises, backed by external funding from international financial institutions--may temporarily boost domestic demand. In our opinion, however, this will be offset by weak private demand, given high unemployment and unfavorable credit conditions. The growth program is also likely to exacerbate high external vulnerabilities, pushing up investment and external debt.
At just under 200% of current account receipts (CARs), Croatia's net external liability position is already substantial, albeit it marginally declined from 2009, as the current account deficit has dropped to less than 1% of GDP (excluding errors and omissions). While the current account is expected to remain close to balance in 2012-2013, the economy will continue to depend heavily on external financing to rollover the high stock of liabilities to nonresidents. External debt service (including the rolling over of short-term debt) is about 75% of CARs. Foreign banks account for 90% of bank assets in Croatia and external bank financing has contracted moderately in 2012, although we expect external bank support to remain strong.
Outlook
The stable outlook balances our expectation of Croatia's EU accession, which would see the country benefit from EU structural and cohesion funds and higher foreign direct investment, against our view of limited prospects for major growth- and competitiveness-enhancing reforms.
Strong progress in reducing economic imbalances, particularly the reliance on external financing, and the implementation of growth-enhancing structural reforms could lead us to consider raising the ratings.
Conversely, we could consider lowering the ratings if the government fails to reduce the structural rigidities in the economy, external imbalances widen, or there is significant deviation from budgetary targets, which could increase the risk of sudden deterioration in the economy's funding position.
Related Criteria And Research
-- Sovereign Government Rating Methodology And Assumptions, June 30, 2011
-- Criteria For Determining Transfer And Convertibility Assessments, May 19, 2009
-- Introduction Of Sovereign Recovery Ratings, June 14, 2007
Ratings List
Downgraded To From Croatia (Republic of) Sovereign Credit Rating BB+/Stable/B BBB-/Negative/A-3 Senior Unsecured BB+ BBB- Recovery Rating 4 Affirmed Transfer & Convertibility Assessment BBB+
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