Country risk: Croatia is heading for investment grade

Croatia was downgraded to sub-investment grade by S&P towards the end of 2012, when declining GDP and large budget deficits caused its sovereign debt burden to climb above 80% of GDP.

Fitch and Moody’s followed the lead in 2013.

Fast forward to 2016, and GDP increased in real terms for a second successive year, by an estimated 2.8%, says the Institute of Economics, Zagreb.

There has been a concerted attempt to consolidate the public finances, resulting in the deficit improving more than expected, to 1.7% of GDP, the authorities claim, stabilizing the debt ratio.

Government stability has also improved since the elections in September handed victory to the Croatian Democratic Union (HDZ), led by Andrej Plenkovic, which formed a coalition with the Bridge of Independent Lists (Most).

Croatia’s 10-year benchmark bond yield has fallen to 3% and is threatening to break through that barrier. The five-year CDS spread of 195 basis points has room to tighten based on a 147-point spread for Indonesia, less than a point higher in Euromoney’s country risk survey.

Scores for Croatia’s regulatory and policymaking environment, and government stability, improved in the final months of 2016, alongside most economic risk indicators and debt ratings.

Its total risk score responded accordingly, rising to almost 50 points (out of 100), pushing the country higher in the global rankings, to 65th, meaning it is less risky than Namibia, a country the rating agencies regard as investment grade.

The picture for 2017 remains bright, despite the external risks.

The government has approved a budget for 2017 targeting a deficit of 1.6% of GDP, which will begin to lower the debt burden, in addition to refinancing part of the debt on more favourable terms.

And there are widespread expectations of a stronger economic expansion in 2017.

Aljosa Sestanovic, professor at Effectus, the university college for law and finance in Zagreb, puts this down to four main factors.

“First, at the end of 2016 the non-competitive and complex tax system was reformed,” he says.

The corporate tax rate was reduced from 20% to 18%, and to 12% for small businesses. Personal tax rates were lowered and thresholds raised.

“[Second,] better public debt management started to be the narrow focus of the government to limit public debt to 75.3% of GDP in 2019, which is 10 percentage points lower than the current level.”

Third, the government is using EU structural funds. This is improving investment, and the competitiveness of small and medium-sized enterprises. A fourth factor, says Sestanovic, is the more active use of state property, with sales of minority shares in certain, non-strategic enterprises taking place.

Tourism receipts are benefiting from the perception of safety from terrorism, and the unemployment rate is expected to come down from a high of 17% in 2013-14 to below 11% this year.

Croatia’s fortunes are improving, reversing the higher risk image depicted last year. It might not be long before the credit rating agencies sit up and take notice.

This article was originally published by ECR. To find out more, register for a free trial at Euromoney Country Risk.