S&P expects that Croatia’s economy will expand by 2.5% in 2022, supported by the recovery in the tourism sector and a pick-up in investments.
On Friday, Standard & Poor’s agency affirmed its ‘BBB-A-3’ ratings for Croatia, with a stable outlook, on the expectation that Croatia’s economic growth will remain steady in the coming two years despite inflationary headwinds and the pan-European macroeconomic consequences from the conflict in Ukraine. They also expect that the govt. will remain committed to its reform program, successfully absorb EU financing, and gradually rebuild the fiscal space it lost in the aftermath of the pandemic.
Upside scenario
The agency could raise the ratings if Croatia satisfies the remaining ascension requirements for euro adoption, setting the economy for a speedy entry into the European Monetary Union. An upgrade would also find support if the economic growth were to accelerate beyond the agency’s expectations, leading to a step-up in economic wealth.
Downside scenario
The agency would consider a downgrade if the economic growth was materially lower than in their forecast, which would result in significantly higher fiscal deficits.
Rationale
S&P projects that the Croatian economy will expand by 2.5% in 2022, as the country benefits from higher investment and tourism activity close to pre-pandemic levels. This follows a strong GDP rebound of 10.4% in 2021, which enabled Croatia’s GDP to exceed its pre-pandemic level following the 8% decline in 2020. This rebound was supported by the tourism sector, which benefitted from a reduction of COVID-19 cases during the summer months.
The agency estimates that the tourism and hospitality sectors will account for almost 20% of value-added in Croatia and about 1/3 of its current account receipts, exposing the country to swings in tourism flows. Private consumption should also be an important growth driver in 2022, although to a lesser degree since elevated prices will likely curb consumer spending.
The economic growth should remain strong in 2023-2025, supported by investment spending. This is supported by significant EU funds over the coming years; EUR 10bn under the Next Generation EU program 2022-2024, of which about EUR 6bn is in the form of grants, as well as EUR 10bn under the EU’s new Multiannual Financial Framework 2022-2029. Additional funds are available from various other programs.
The agency projects a general govt. Deficit of 3.5% of GDP in 2022, with expenditure benefitting from roll-back of pandemic support programs, while subsidy schemes alleviate price pressures on fuel and energy (which should add 1.1% of GDP to the expenditure bill).
They also expect the fiscal deficit to narrow over 2022-2025, to about 2% of GDP by 2025, due to the prudent fiscal policies from the govt.
The central bank also remains committed to stabilizing HRK to EUR exchange rate, including via foreign exchange interventions in 2020 and 2021. At the end of 2021, the central bank’s FX reserves stood at USD 28.3bn or 42% of GDP.
Croatia aims for eurozone ascension by 1 January 2023. In July 2022, Croatia will have completed the two years within the European Exchange Rate Mechanism (ERM) II framework, the precursor to euro ascension.
Moving forward to the Russian invasion of Ukraine, the agency says it has added pressure on energy prices, which will have an impact on inflation in 2022. Because of this, they expect CPI to average at 6%, due to the rising energy prices, increasing wages, and rising hospitality sector costs.
The agency also anticipates that asset quality will remain a key issue for the Croatian banking sector. Private-sector debt remains among the highest of Central and Eastern European peer countries. Nevertheless, nonfinancial entities are less indebted than they were 10 years ago, during the last financial crisis. The agency also believes that the recent takeover of the Croatian subsidiary of Sberbank by HPB will not cause any disruptions to the country’s financial system, which remains profitable, well-capitalized, and well-funded by domestic customer deposits.
