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Croatia May Seek IMF Cooperation After S&P Cut Debt to Junk

Croatia may seek cooperation with the International Monetary Fund and abandon a debt sale abroad next year to avoid rising borrowing costs after Standard & Poor’s cut the country’s sovereign debt rating to junk.

“We will not proceed with the plan to issue bonds abroad in early 2013, and we will review plans to sell any debt abroad in entire year,” Finance Minister Slavko Linic told reporters in Zagreb late yesterday. “The government will also seriously consider cooperation with the IMF.”

Croatia’s long-term credit rating was lowered one step yesterday by S&P to BB+, the highest non-investment level, and its short-term grade also fell one notch to B. The credit rating company said Croatia’s structural and fiscal overhaul is insufficient to promote growth and make government finances more sustainable. The ratings carry a stable outlook, indicating that S&P is more likely to keep them unchanged than cut or raise them.

The Adriatic Sea nation, 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 its entry It also cut the 2012 forecast to a 1.1 percent contraction, citing an investment drought due to Europe’s debt crisis.

Rising Debt

Croatian public debt will increase to 55 percent of gross domestic product next year, while state borrowing will total 27 billion kuna ($4.7 billion). The government expected to sell about $2.5 billion of debt in January on the U.S. and European markets, with a second round later in 2013 on Asian markets.

The rating cut will “make an already difficult situation worse,” Linic said. “Conditions of doing business will be harder for all, not only for the government.”

Linic said the rating downgrade will prompt the government to review its 2013 budget. He reiterated the government will not cut pensions and welfare payments or reduce public-sector wages, as that would “lead to impoverishment for many people.”

The government will boost revenue by curbing the shadow economy, and it will borrow money on the domestic market, relying on cooperation with the central bank, Linic said.

Romania, Indonesia

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 rates at the lowest investment grade, to negative from stable.

“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.”

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 GDP next year, while the economy will grow 1.8 percent.

Weak Dynamics

“The most disappointing element in the budget is not that it targets a wider deficit, but that it abandons the government’s commitment to the fiscal responsibility law,” Abbas Ameli-Renani, emerging markets strategist at Royal Bank of Scotland Group Plc, said by e-mail.

“Growth dynamics in Croatia are among the poorest in the region, and the economy is unlikely to fare much better next year,” Ameli-Renani said.

The yield on Croatian government bonds due July 2022 rose to 4.5195 percent from 4.4369 percent.

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.

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