Fitch Revises Croatia's Outlook to Negative; Affirms at 'BB+'

Fri Feb 14, 2014 12:07am EST

Link to Fitch Ratings' Report: Croatia - Rating Action ReportLONDON, February 14 (Fitch) Fitch Ratings has revised Croatia's Outlook to Negative from Stable. Its Long-term foreign and local currency Issuer Default Ratings (IDR) have been affirmed at 'BB+' and 'BBB-' respectively. The issue ratings on Croatia's senior unsecured foreign and local currency bonds have also been affirmed at 'BB+' and 'BBB-' respectively. The Short-term foreign currency IDR has been affirmed at 'B' and the Country Ceiling at 'BBB'. KEY RATING DRIVERS The affirmation and Negative Outlooks reflect the following factors and their relative weights: High: Croatia's fiscal outcomes have deteriorated further since Fitch's last sovereign rating review in September which resulted in a downgrade of the Long-term foreign currency IDR from investment grade to 'BB+'. Prolonged recession continues to impair the prospects for fiscal consolidation and public debt sustainability, while the government has displayed markedly less appetite for hard budget constraints than some of its central and east European peers, opening up a policy credibility gap. The 2014 budget, handed down to parliament in November, confirmed additional fiscal slippage in 2013 with the general government deficit (GGD) widening to 5.5% of GDP from an original target of 3.8%, and envisaged little fiscal consolidation before 2015. Fitch estimates that gross general government debt (GGGD) surpassed 60% of GDP at end-2013, notwithstanding some pre-financing of 2014 obligations, and the agency does not expect it to peak before 2016 at the earliest. Likewise, fiscal financing needs are expected to remain high at over 18% of GDP in 2014 and 2015. Fitch acknowledges that Croatia's formal submission to the European Commission's Excessive Deficit Procedure (EDP) on 28 January 2014, following its accession to the EU in July 2013, could provide a firmer policy anchor for fiscal consolidation and inject greater realism into official macroeconomic projections. However, policy reversals in 2013 imply that Croatia now faces much harsher fiscal consolidation in 2014-16 than would otherwise have been the case to meet an EDP GGD target of 2.9% of GDP by 2016. The government has begun to spell out the revenue and expenditure measures necessary to meet EDP goals and a revised budget should be sent to parliament by end-February. Revenue enhancements include the transfer of funds from some second to first pillar pension plans and retention of state enterprise profits. Expenditure cuts equivalent to around 1.1% of GDP are less well specified. Fitch is sceptical about the government's ability to deliver on expenditure cuts of this magnitude, particularly ahead of elections in 2015, and forecasts only a modest narrowing of the GGD to 5% of GDP in 2014. Medium: Past budgetary forecasts have been undermined by misplaced optimism on economic recovery, casting doubts on policy coherence and credibility, which have been borne out by early revisions to the 2014 budget and growth expectations. Real GDP growth has significantly underperformed 'BBB' and 'BB' peers over an extended period: the economy has been mired in recession since 2009, contracting by a cumulative 12%, while unemployment of almost 18% (Eurostat) far exceeds peers. The government recently downgraded its growth forecast for 2014 to 0.2% from 1.2%, but the ability of the economy to adjust and recover in the face of EDP-recommended fiscal tightening of 2.3% of GDP in 2014 and 1% of GDP in each of 2015 and 2016 remains highly uncertain. Consequently, a further year of recession cannot be ruled out in 2014. Croatia's IDRs also reflect the following key rating drivers:- Income per capita is high relative to 'BBB' and 'BB' peers, matched by superior human development and governance indicators. Consistent monetary and exchange rate policies continue to deliver markedly lower and less volatile inflation than peers, while a well-developed domestic capital market and a strong, majority foreign-owned banking system enhance fiscal financing flexibility. Externally, Croatia remains highly leveraged relative to peers: net external debt (GXD) stood at almost 60% of GDP at end-2013, giving rise to large gross external financing needs. However, household, corporate and bank deleveraging have begun to make inroads into GXD, which is now on the decline, assisted further by an estimated current account surplus of around 1% of GDP in 2013. RATING SENSITIVITIES The following risk factors could individually or collectively, trigger a negative rating action: - Failure to implement a credible medium-term fiscal consolidation strategy that is broadly in line with the EDP-recommended road map - Failure of the economy to recover over the medium term, leading to further strains on public finances and debt - Crystallisation of additional liabilities on the government's balance sheet. Government- guaranteed liabilities currently amount to 16% of GDP, while ESA95 data revisions could put further upward pressure on public debt/GDP ratios Conversely, the following factors could, individually or collectively, result in a positive rating action: - Greater progress on fiscal reform and deficit reduction in line with the EDP, leading to a declining public debt/GDP ratio - A stronger economic recovery than Fitch currently expects, potentially underpinned by greater structural reforms. Privatisation has made some progress, but Croatia's poor business climate and rigid labour market undermine competitiveness and remain a drag on growth. KEY ASSUMPTIONS The ratings and Outlooks are based on the following key assumptions: -Croatia's track record of monetary and exchange rate stability remains intact, minimising the risks to household, corporate and public sector balance sheets, all of which are heavily euroised -Fitch assumes the gradual progress in deepening fiscal and financial integration at the eurozone level will continue, key macroeconomic imbalances within the currency union will be slowly unwound, and eurozone governments will tighten fiscal policy over the medium term. It also assumes that the risk of fragmentation of the eurozone remains low Contact: Primary Analyst Paul Rawkins Senior Director +44 20 3530 1046 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Michele Napolitano Director +44 20 3530 1536 Committee Chairperson Douglas Renwick Senior Director +44 20 3530 1045 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Additional information is available on www.fitchratings.com Applicable criteria, ‘Sovereign Rating Criteria', dated 13 August 2012, and ‘Country Ceilings’, dated 9 August 2013, are available at www.fitchratings.com. Applicable Criteria andALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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