Moody’s assigns ‘positive’ outlook to Croatia’s rating

Moody’s Investors Service has improved the outlook to ‘positive’ from ‘stable’ on the Republic of Croatia’s Baa3 foreign currency government bond rating in light of the strides made in aligning its institutions with the European Union and its eventual membership possibly by the end of the decade.

The outlook has also changed to ‘positive’ from ‘stable’ the ceilings for foreign currency bonds (A1) and bank deposits (Ba1/NP). The government’s Baa1 local currency bond rating remains ‘stable’.

November’s parliamentary elections are not expected to derail significantly the medium term pro-EU policy thrust, which aims at European Union entry by around the end of the decade, although there could be some slippage this year, said Moody’s Assistant Vice President Joan Feldbaum-Vidra.

“The government has been focusing on reducing the high level of euroization of its debt stock by refinancing foreign currency-denominated debt with long-term kuna-denominated instruments,” said the Moody’s analyst. “The high level of euroization of the economy and government debt is a key rating constraint as it renders the country highly vulnerable to exchange rate shocks.”

As part of EU accession, she said, Croatia will be required to control the size of its deficits, continue to reduce subsidies and guarantees on debt issuance, reform public administration and the judiciary, restructure loss-making public sector companies such as the shipyards, reform the public healthcare sector, which continues to amass arrears, and make other structural reforms to enhance the competitiveness of the
economy and state of public finances.

“Improving the business climate will help encourage FDI and export growth which has lagged behind other transition economies,” said Feldbaum-Vidra, explaining that Croatia has a bloated public sector, high levels of bureaucracy, red tape, corruption, a weak judicial system and inflexible labor laws.

Croatia‘s large current account deficit (about 8% of GDP) and external debt (about 85% of GDP) continue to constrain its credit ratings. She said one main risk to Croatia‘s rating outlook stems from the increasing availability of liquidity to the country in part because of its EU prospects, and the possible economic excesses high levels of liquidity may cause.
“This heightened risk underscores the need for a considerable restructuring of the economy to ensure faster-paced sustainable growth in order to contain balance of payments pressures,” Feldbaum-Vidra explained. “Tighter fiscal policy will likely be necessary to offset rising demand pressures especially in the context of a tightly managed exchange rate regime and large capital inflows.”