ZAGREB, Nov 14 (Hina) – Moody’s credit rating agency has upgraded Croatia’s rating to Ba1 from Ba2 and changed the outlook to stable from positive, citing enhanced institutional capacity and policymaking as the country enters a critical phase of euro area accession and reduced exposure to foreign-currency debt risk.
In July, amid the coronavirus disruption, Croatia was admitted into the EU’s Exchange Rate Mechanism II (ERM II), one of the final steps prior to becoming a member of the euro area, thanks to its comprehensive reform programme.
“Moody’s believes that Croatia’s policy effectiveness has strengthened over the recent years. The government and the central bank have provided a more predictable and stable framework for economic activity in a very uncertain environment. The policy response to mitigate the impact of the coronavirus pandemic has been timely and efficient,” the credit agency said in a report.
“Moody’s expects Croatia to continue to pursue sound economic and financial policies, as entering the euro area will require both sustainable economic convergence and readiness to participate in the banking union. On economic convergence, compliance with the convergence criteria is already advanced, as noted in the ECB’s 2020 convergence report.
“From a macroprudential and banking perspective, Moody’s believes that the close cooperation between the ECB (European Central Bank) and the CNB (Croatian National Bank) and the inclusion of eight of the largest banks operating in Croatia under the ECB’s supervision will further enhance the system’s regulatory environment and promote the adoption of best practices,” the credit agency said.
Croatia’s fiscal credit profile has improved despite the negative impact of the coronavirus pandemic.
Under Moody’s methodology, a high share of foreign currency denominated debt lowers fiscal strength considering the currency-depreciation risk that would trigger a sudden rise in interest costs and debt stock relative to GDP.
Last year 71.4% of Croatia’s general government debt was denominated in euros, down from 73.8% in 2016. By contrast, the share of kuna-denominated bonds rose from 22% to 28.4%.
“Given the very uncertain environment and the need for Croatia to implement post-ERM II reforms, Moody’s believes Croatia could join the euro area towards 2025.”
“Regarding the government’s balance sheet, 2020 will mark a reversal in the declining debt trend against the backdrop of the coronavirus pandemic. Moody’s expects Croatia’s real GDP to contract by 8.6% this year, as both domestic and external demand are affected by the coronavirus pandemic. Accounting for 25% of GDP when considering direct and indirect effects, the Croatian tourism sector is strongly being affected by travel restrictions.
“As a result, Moody’s expects the fiscal deficit to reach 7.5% of GDP in 2020. This, in turn, is expected to push the debt-to-GDP ratio to 88.5% in 2020 and debt-to-revenues to 192.5%.
“However, Moody’s expects the sharp deterioration in the debt metrics to be temporary and forecasts a gradual decline starting in 2021, when debt-to-GDP is expected to reach 86.7%, followed by 85.9% in 2022.
“The gradual reduction in public debt will be supported by a gradual economic recovery and a prudent fiscal stance as the government targets convergence towards the Maastricht criteria.
“Furthermore, the higher debt load will be partly offset by strong and improving affordability metrics, as Moody’s forecasts a decline in interest payments-to-GDP from 2.2% in 2019 to 2.0% in 2021. Similarly, interest payments-to-revenues are expected to fall from 4.7% in 2019 to 4.2% in 2021,” the report said.
Moody’s said that the stable outlook reflects stronger- than-peers’ institutions and low susceptibility to risk. Croatia’s fiscal strength combines a higher debt load compared to peers, while debt affordability is strong and foreign currency debt risk is declining with ERM II entrance, it added.
“In terms of economic strength, Croatia’s much higher-than-peers’ wealth per-capita is somewhat offset by the country’s relatively smaller size, slower growing and more volatile economy,” the credit agency said.
“At the same time, the stable outlook captures heightened risks for permanent scars with respect to Croatia’s economic and fiscal strength against the backdrop of the coronavirus’ new infection wave, with potentially a negative impact on both domestic and external demand,” it added.
Moody’s had maintained Croatia’s credit rating at Ba2, two notches below investment grade, since March 2016, only changing the outlook from stable in March 2016 to positive in March 2017 and to positive in April 2019.
Two other major credit rating agencies, Standard & Poor’s and Fitch, keep Croatia’s credit rating at investment grade. S&P affirmed its rating of ‘BBB-/A-3’ with a stable outlook in September, while Fitch did so in June.