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ZAGREB, May 7, 2022 – Fitch Ratings has confirmed Croatia’s investment rating at “BBB” with a positive outlook, believing that the country’s tourism industry recovery will support the economy at a time when the exports are slowing and that entry into the euro zone will reduce risk financing.

Fitch revised down its Croatian growth projection for 2022 from 4.4% to 3.3%, citing base effects and a sharp slowdown in household consumption, with high inflation hurting consumer spending.

“A slowdown in major trading partners, primarily the Eurozone, will affect the performance of goods exports this year, but we expect key service sectors such as tourism to continue to recover given the structural benefits of the country,” the agency said.

“We forecast an acceleration in GDP growth in 2023 (3.7%) assuming a reduction in external risks and a recovery in investment momentum, driven by EU programs. We estimate that transfers of the EU could reach 5 pp of GDP per year over the next four years, which will support economic momentum,” he added.

Limited links to Russia and Ukraine

Croatia is less exposed to the adverse macroeconomic consequences of the Russian-Ukrainian conflict than other countries in the region. “Direct connections with Russia and Ukraine are very limited in terms of exports (less than 1.5% of the total), investments and tourism (1%).”

Although energy import dependency is similar to the EU average (56%), Croatia has invested to diversify away from Russian energy sources, opening an LNG terminal last year that allows it to reduce its exposure to Russian gas to zero. Nevertheless, the country is highly exposed to higher energy costs, as well as potential further disruptions to supply chains.

Deficit and debt reduction

Croatia’s budget deficit has narrowed rapidly in 2021, to 2.9% of GDP, thanks to solid revenue growth and spending containment, Fitch said, revising down its November deficit forecast last by 1.4 percentage points.

“While we expect revenue growth to remain strong this year, demands for higher spending to tackle rising inflation – beyond the 1.1% of GDP that has already been approved – are expected to continue. This will limit scope for further improvement in the overall deficit in 2022, although outperformance in 2021 means a good starting position. We expect a headline deficit of 2.8% in 2022, before reduce to 1.9% in 2023 with modest downside risks, given the strong commitment to fiscal prudence,” the agency said.

The public debt-to-GDP ratio fell to 79.8% in 2021, a reduction of 7.8 pp compared to 2020, thanks to the improvement in the budgetary situation and rapid economic expansion. It is expected to decline further to reach 75.5% in 2022 and 72.6% in 2023.

“Modest primary deficits and high nominal growth (particularly in 2022) support our forecast of an average debt stock reduction of 3 pp per year over the next five years (similar rates to 2016-2019) This trend would be consistent with meeting the convergence criteria, despite the fact that public GDP/debt will remain above the Maastricht debt ceiling of 60% (and compared to the current BBB median of 55%). we expect funding costs to rise gradually, in line with global trends, but the euro adoption process and sound debt management are reducing funding risks,” Fitch said.

Adoption of the euro

Croatia has met all the structural reform criteria required under the ERMII and currently meets most of the convergence criteria, including interest rate, exchange rate and public finances. Questions remain about compliance with price stability criteria, particularly in the context of rising inflation in recent months. It reached 7.3% in March, the highest level since 2008, and averaged 4.07% in April 2021-March 2022.

Given that inflation has increased across the EU, Fitch believes that “the EU will use the flexibility provided for in the convergence criteria (by removing the inflation rates of certain Member States which it considers to be outliers of the calculation) when assessing Croatia in May, with a likely positive result by July.”

“At present, we do not expect a delay of more than a year in joining the euro if the country does not meet the inflation criteria this year, because we consider that there is a clear commitment at EU level to speed up the process,” he added.

The agency said it could downgrade Croatia’s rating in the event of a significant delay in the timetable for eurozone membership or a further increase in public debt in the medium term.

On the other hand, the score would be raised if the Economic and Business Council of the EU confirms that Croatia has fulfilled its criteria for joining the euro zone.

Another factor that could lead to an upgrade is “evidence of improved medium-term growth prospects, for example through the implementation of structural reforms or EU-led investments, which could lead faster than expected public debt/GDP reduction.

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