Fitch Says Croatia EU Entry Benefits Limited Without Reforms

Croatia, the next European Union member, will reap limited benefits from the entry to the world’s largest trading bloc unless it improves its labor market and removes obstacles to investments, Fitch Ratings said.

“While accession to the EU in July should be positive for the growth outlook, benefits will be limited in the absence of a credible medium-term fiscal consolidation program and convincing movement on the structural reforms agenda,” Michele Napolitano, director of global sovereigns and supranational at Fitch, said in an e-mailed response to Bloomberg questions.

Fitch, the only major credit rating company that judges Croatia’s debt at investment level, in November changed its outlook for Croatia to negative from stable, while maintaining the lowest investment grade of BBB-.

The Adriatic nation’s economy is in its second recession in two years after contracting for five consecutive quarters. The government on Feb. 20 reduced its 2013 forecast to a 0.7 percent growth, from an earlier estimate of 1.8 percent growth, citing investment drought. The International Monetary Fund said Jan. 21 that Croatia’s economy will stagnate this year.

The yield on Croatia’s dollar-denominated bond climbed to 4.921 percent at 1:50 p.m. in Zagreb, the highest since Sept. 6. The cost of insuring the debt with five-year credit-default swaps, which rise as perceptions of creditworthiness worsen, dropped to 287.5 from 292.6.

The country’s credit rating was cut to junk by Standard & Poor’s in December, followed by a similar cut by Moody’s Investors Services in February. Both credit rating companies cited a stalled recovery, lack of budget discipline and vulnerability to external shocks as reason for downgrade.

EU Grants

Croatia stands to receive about 10 billion euros ($13 billion) in EU grants through 2020, and the Social-Democrat-led government of Prime Minister Zoran Milanovic wants to attract investors by channeling these funds into infrastructure and energy projects.

Milanovic last month announced a 3 percent wage cut for government employees, after repeated calls by the IMF and the World Bank to reform the bloated public sector in the country of 4.2 million.

“Despite the recent cut in public wages, the government appears to lack the appetite for bolder structural reforms, particularly in the labor market,” Napolitano said. “Timely implementation of structural reforms would support Croatia’s economy and underpin its credit rating,” he said.

The government forecast in November the budget deficit to widen this year to 3.5 percent of gross domestic product as the country repays debt and begins contributing to EU coffers. The IMF said on Feb. 27 the budget gap will widen to 4.25 percent of GDP in 2013, before widening further to 4.5 percent in the medium term.

Vulnerability

The government’s fiscal financing needs for this year seem “manageable,” while public and external debt ratios remain high and increase the country’s vulnerability to external shocks, Napolitano said.

Croatia’s public debt is expected to exceed 60 percent of economic output by late 2014, according to the IMF’s report on Feb. 27.

“A fundamental advantage of EU accession is access to structural funds, but in the absence of structural reforms, Croatia will likely fall amongst the countries that have the lowest absorption of EU funds,” Abbas Ameli-Renani, emerging markets strategist at Royal Bank of Scotland Group Plc in London, said in an e-mailed response to questions.

To contact the reporter on this story: Jasmina Kuzmanovic in Zagreb at jkuzmanovic@bloomberg.net

To contact the editor responsible for this story: James M. Gomez at jagomez@bloomberg.net

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