Croatia Cut to BB by S&P on Policy Inertia Amid Recession

Croatia’s credit rating was cut one step by Standard & Poor’s to BB, two levels below investment grade, on signs the government is failing to narrow the budget deficit and the economy faces a sixth year of recession.

S&P raised the outlook on the long-term debt of the European Union’s newest member to stable from negative, the company said today in a statement. Croatia’s short-term ratings were affirmed at B with a stable outlook.

“The short-term benefits of EU accession are being constrained by a lack of internal growth drivers stemming from ongoing policy inertia and policy constraints to fiscal and structural reforms, and leveraged public- and private-sector balance sheets,” analysts led by London-based Ana Jelenkovic said in the report.

Croatia, whose $63 billion economy hasn’t grown since 2008, is facing rising borrowing costs after public debt reached 64 percent of economic output last year. The government is struggling to rein in a bloated public payroll while reducing unemployment that reached 21.6 percent last month.

The yield on Croatia’s dollar-denominated Eurobonds due in 2023 rose to 5.93 percent at 2 p.m. in Zagreb from yesterday’s 5.82, the highest since Dec. 31. The country’s five-year debt yields 303 basis points, or 3.03 percentage points, more than U.S. Treasuries, compared with an average of 302 basis points during the last three months, according to data compiled by Bloomberg.

‘Bit Harsh’

The decision was “a bit harsh,” Timothy Ash, chief emerging-markets economist at Standard Bank Group Ltd in London, said in an e-mail. “While the fiscal side is not improving at a rapid enough pace I tended to think that at BB+ the risks were already in the rating.”

Croatia, rated one step below investment grade at Moody’s Investors Service and Fitch Ratings, may see its gross domestic product expand 1.3 percent this year after a 0.2 percent contraction in 2013, according to the government. Last month, the central bank projected a 0.7 percent acceleration for 2014, driven by investment and exports.

“Croatia’s recession is likely to continue for a sixth consecutive year,” S&P said. “Limited fiscal consolidation efforts and an upward revision in fiscal statistics are underpinning a rapid increase in government debt and interest burdens.”

The government plans to submit a revised 2014 budget draft to lawmakers in the coming weeks that would narrow the 5.5 percent deficit forecast in November. That month, the European Commission recommended Croatia take measures to reduce the “excessive deficit” to 4.6 percent.

‘Big Blow’

The rating cut is “a big blow for Croatia,” Abbas Ameli-Renani, an economist at Royal Bank of Scotland Group Plc in London, said in response to Bloomberg questions. “There just doesn’t seem to be any momentum behind structural reforms, without which growth remains stagnant, and the fiscal situation remains on a deteriorating footing.”

Croatia plans to meet about half its financing needs abroad this year and won’t seek aid from the IMF, Finance Minister Slavko Linic said in a Bloomberg interview in November. The country needs to borrow 44 billion kuna ($7.88 billion) this year to refinance debt and service a budget gap of 16 billion kuna, he said.

“I believe the measures the government is undertaking haven’t been studied enough,” Linic told reporters in Zagreb after the rating cut was published today. “With our work on reforms, this year we will be able to stop the ratings from sliding, and maybe even to improve them.”

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