Croatia Debt Rating Cut to Junk by S&P

Croatia had its sovereign debt rating cut to junk by Standard & Poor’s, which said the country’s structural and fiscal overhaul is insufficient to promote growth and make government finances more sustainable.

Croatia’s long-term credit rating was lowered one step to BB+, the highest non-investment level, and its short-term grade also fell one level to B, S&P said today in a statement. The ratings carry a stable outlook, indicating that S&P is more likely to keep them unchanged than cut or raise them.

The country will review its 2013 budget, call off plans for a debt sale early next year and will consider working with the International Monetary Fund, Finance Minister Slavko Linic said in a press conference.

“This will make a difficult situation worse,” Linic said of S&P’s action.

Croatia, which is set to become the European Union’s 28th member in July 2013, is struggling to return to growth, after the economy shrank in four consecutive quarters. The government on Nov. 19 said the budget deficit will widen as the Cabinet repays debt and begins contributing to EU coffers after entry in July. It also cut the 2012 forecast to a 1.1 percent contraction, citing an investment drought due to Europe’s debt crisis.

“Reforms did not materialize, and neither did the initial plan to cut public spending,” Zdeslav Santic, chief economist at Societe Generale SA (GLE)’s local unit Splitska Banka d.d., said today by phone.

Increasing Revenue

The government will seek to increase revenue from the “gray economy,” Linic said, while avoiding cuts in pensions, public-sector wages and social benefits.

The kuna was 0.1 percent lower at 7.5248 per euro at 8:53 p.m. in Croatia. The yield on Croatian government bonds due July 2022 rose to 4.5195 percent from 4.4369 percent.

The downgrade puts Croatia’s credit rating on par with Romania and Indonesia. Fitch Ratings on Nov. 29 lowered its outlook for the former Yugoslav country’s debt, which it now rates at the lowest investment grade, to negative from stable.

The economy will contract 2 percent this year and stagnate in 2013, recovering gradually to trend growth of 2 percent by 2015, according to S&P.

The 11-month-old Cabinet of Prime Minister Zoran Milanovic, which has vowed to reduce public spending and remove obstacles to investment to speed up the sale of state companies, predicts the budget deficit will widen to 3.1 percent of gross domestic product next year, while the economy will grow 1.8 percent.

‘Policy Inertia’

“Structural and fiscal reforms implemented so far have been insufficient to foster economic growth and place public finances on a more sustainable path,” S&P said in the statement. “Policy inertia and opposition from vested interests that benefit from long-entrenched entitlements have contributed to wage and price rigidities, the low participation rate, and loss of economic competitiveness.”

After joining the EU, Croatia will benefit from structural and cohesion funds from the bloc, along with higher foreign- direct investment, S&P said. Still, prospects “for major growth- and competitiveness-enhancing reforms” are limited, it said.

Almost half the time, government bond yields fall when a rating action suggests they should climb, or they increase even as a change signals a decline, according to data compiled by Bloomberg on 314 upgrades, downgrades and outlook changes going back as far as 38 years.

The rates moved in the opposite direction 47 percent of the time for Moody’s and S&P. The data measured yields after a month relative to U.S. Treasury debt, the global benchmark.

To contact the reporter on this story: Balazs Penz in Budapest at bpenz@bloomberg.net

To contact the editor responsible for this story: Balazs Penz at bpenz@bloomberg.net

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