Croatia Cut to Junk by Moody’s on Fiscal, External Risks

Croatia’s credit rating was cut to junk by Moody’s Investors Service, which cited a stalled recovery, lack of budget discipline and vulnerability to external shocks by the European Union’s next member.

The Balkan country’s government bond rating was lowered to Ba1 from Baa3, the same level as Hungary and Ireland, Moody’s said in a statement released in London today. Standard & Poor’s cut Croatia to junk in December. Moody’s also changed Croatia’s outlook to stable from negative, saying the risk the government’s fiscal position and debt will “materially deteriorate any further” is limited.

“The government’s capacity to re-balance the economy toward exports is intrinsically limited,” Moody’s said in the statement. “The country’s expected forthcoming EU accession in July 2013 is a positive development; however, the European environment and the government’s reform inertia are likely to limit the benefits normally expected to arise.”

Croatia, a former Yugoslav republic set to join the EU in July, is in its second recession in two years amid austerity measures and an investment drought sparked by Europe’s debt crisis. The government said Dec. 19 that the budget deficit will widen this year to 3.1 percent of economic output as the country repays debt and begins contributing to EU coffers.

Dropping Croatia

“The downgrade will undo any good will that the EU accession would have generated amongst investors,” Abbas Ameli-Renani, emerging-market strategist at Royal Bank of Scotland Group Plc in London, said in an e-mailed response to questions. “Croatia’s composite rating has now been lowered to sub-investment,” which “will force a lot of investment funds that have a mandate for investment-grade only bonds to drop Croatia from their portfolios.”

The third major credit rating company, Fitch Ratings, in November changed its outlook for Croatia to negative from stable, while maintaining the lowest investment grade, BBB-.

Prime Minister Zoran Milanovic’s Cabinet, which has vowed to reduce public spending and remove obstacles to investment, forecasts the economy will grow 1.8 percent this year as an expected 10 billion euros ($13.6 billion) in EU grants through 2020 boost investment. The International Monetary Fund in November said the economy will grow 0.75 percent this year, after shrinking 1.5 percent in 2012.

Budget Review

Finance Minister Slavko Linic said the the downgrade was not “malicious judgment,” but a wakeup call for the government.

He pledged to review the budget in the spring and seek to raise revenue levels with “improved tax policies” and introduction of a property tax. he Cabinet also needs to continue state-asset sales and strengthenngthen industrial production, he said.

“This is a very clear message,” Linic said today in Zagreb, adding that his economic forecasts for the country will remain unchanged. “We hope that this second downgrade will convince the public we need reforms.”

The yield on dollar-denominated notes due in March 2021 rose to 4.611 percent today from 4.512 percent yesterday, according to data compiled by Bloomberg.

Croatia’s weak economy, external vulnerability and relatively high debt will make fiscal consolidation harder, Moody’s said. “The government’s fiscal metrics are also weaker, with general government debt exceeding those of Baa3-rated countries,” the company said.

Bond-market history indicates that the utility of sovereign ratings may be limited. Almost half the time, yields on government bonds fall when a rating action by S&P and Moody’s suggests they should climb, according to data compiled by Bloomberg last year on 314 upgrades, downgrades and outlook changes going back as far as the 1970s.

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