Fitch Downgrades Croatia to 'BB'; Outlook Stable

Fri Aug 8, 2014 4:26pm EDT

(The following statement was released by the rating agency) Link to Fitch Ratings' Report: Croatia - Rating Action Report here LONDON, August 08 (Fitch) Fitch Ratings has downgraded Croatia's Long-term foreign currency Issuer Default Rating (IDR) to 'BB' from 'BB+' and local currency IDR to 'BB+' from 'BBB-'. The Outlooks are Stable. The issue ratings on Croatia's senior unsecured foreign and local currency bonds have also been downgraded to 'BB' from 'BB+' and 'BB+' from 'BBB-', respectively, while the Country Ceiling has been lowered to 'BBB-' from 'BBB'. The Short-term foreign currency IDR has been affirmed at 'B'. KEY RATING DRIVERS The downgrade of Croatia's Long-term IDRs reflects the following factors and their relative weights: High: Fitch believes there are increasing risks regarding Croatia's ability to stabilise its high public debt/GDP ratio over the medium term. Substantive revisions to the 2014 budget in April appeared to set Croatia on a deficit reduction path sufficient to cut the general government deficit (GGD) from 4.9% of GDP in 2013 to 3.8% in 2014 (including the transfer of pension assets), in line with the targets outlined in the European Commission's Excessive Deficit Procedure (EDP), which was initiated in January. However, the government recently pointed to fiscal slippage in 1H14 and publicly acknowledged that the chances of it meeting the EDP target for 2014 were slim, notwithstanding a supplementary budget in the autumn. Fitch forecasts a GGD of 4.5% of GDP in 2014, declining to 3.8% in 2015. Preservation of sovereign creditworthiness depends on the government's willingness and ability to deliver 3%-5% of GDP of fiscal adjustment that would put public debt on a sustainable downward path and restore budget balance. However, declining revenue and rising expenditure generated a consolidated central government deficit of 2.9% of GDP in January-May and the government now expects the full year outturn to be 4.3%-4.6%, compared to a target of 4.1%. Prolonged recession continues to impair the prospects for fiscal consolidation and public debt sustainability. Croatia is facing a sixth consecutive year of recession, albeit shallower (-0.5%) than 2013 (-1%), as the economy labours under the twin pressures of private sector deleveraging and fiscal consolidation. Weak domestic demand is courting mild deflation, which could accelerate private sector deleveraging and complicate public debt sustainability. Identifying future drivers of growth in this environment is challenging: monetary/exchange rate policy is constrained by extensive euroisation, fiscal policy faces growing limitations and hesitant structural reforms continue to cloud the investment climate. Concerted fiscal consolidation and accelerated structural reforms could result in material gains in sovereign creditworthiness and unlock up to EUR11.7bn of structural and cohesion funds in 2014-20. However, at present Croatia's absorption rate remains at the bottom of the league table for EU member states, while the approach of elections in 2015 is likely to constrain the pace of structural reforms in the near term. Croatia's gross general government debt (GGGD) has more than doubled since 2008 to 67% of GDP at end-2013, while fiscal financing needs are high at 18.5% of GDP. However, 80% of fiscal financing needs are met from the domestic market and borrowing costs have fallen to record lows. Nonetheless, public debt sustainability is far from secure: debt/GDP is unlikely to peak until 2015-16, when Fitch estimates that it will exceed 70%, while weak fiscal outcomes and/or continued recession could easily undermine our base case. Croatia's ratings and Stable Outlooks also reflect the following factors: Per capita income is high relative to 'BBB' and 'BB' peers, contributing to greater debt tolerance, matched by superior human development and governance indicators. The domestic capital market is well developed and coupled with a strong, majority foreign-owned banking system enhances fiscal financing flexibility. Conversely, banks' exposure to the broader public sector (ie: general government and state-owned enterprises) has been rising in the absence of alternative lending opportunities in the private sector. Externally, Croatia remains highly leveraged relative to peers: net external debt (NXD) stood at over 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 NXD and it is now falling, assisted further by a current account surplus of 1.2% of GDP in 2013. This represents a swing of around 10% of GDP compared with a peak deficit of 8.8% of GDP in 2008. RATING SENSITIVITIES The Stable Outlook reflects Fitch's view that upside and downside risks to the rating are evenly balanced. The main risk factors that, individually or collectively, could trigger negative rating action are: - Significant fiscal slippage leading to escalating public debt/GDP ratios - Prolonged recession, potentially accompanied by deflationary pressures, which would further weaken the prospects of securing public debt sustainability. - Increased contingent liabilities, or further crystallisation of these liabilities on the government's balance sheet. Government-guaranteed debt currently amounts to 16% of GDP. Conversely, the following factors, individually or collectively, could result in positive rating action: - Greater progress on deficit reduction in line with the EDP, leading to a declining public debt/GDP ratio over the medium term. - Clear signs of economic recovery, underpinned by greater structural reforms. 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. The incoming ESA2010 system of accounts is likely to increase the reported headline general government debt and deficit figures as a result of reclassifications. Given the scale of the public sector currently outside the general government perimeter, the revisions are expected to be material, although still uncertain. Contact: Primary Analyst Paul Rawkins Senior Director +44 20 3530 1046 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Amelie Roux Director +33 1 44 29 92 82 Committee Chairperson Douglas Renwick Senior Director +44 20 3530 1045 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: Additional information is available on Applicable criteria, 'Sovereign Rating Criteria' dated 13 August 2012 and 'Country Ceilings' dated 09 August 2013, are available at Applicable Criteria and Related Research: Sovereign Rating Criteria here Country Ceilings here Additional Disclosure Solicitation Status here ALL 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'. 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