On Friday, Fitch affirmed Croatia’s credit rating at BBB-, remaining in investment grade territory.
Croatia’s ratings balance strong structural features, including higher human development, governance indicators and GDP per capita than peers, with weak growth potential and high public sector debt. The Stable Outlook reflects Fitch´s view that the economy will recover gradually from the coronavirus pandemic without significant imbalances and the authorities will achieve medium-term fiscal consolidation, underpinned by substantial EU fund support and a recent track record of fiscal prudence.
Fitch expects GDP to contract by a record 9% of GDP in 2020, as the resurgence of the coronavirus pandemic in 2H 2020 offsets a slightly better performance of the tourism sector (annual tourism arrivals are expected to contract by 50% versus their previous forecast of 75%). Despite a large fiscal support package (above 10% of GDP in 2020 in both direct and indirect measures) household consumption and service exports have been badly affected by the pandemic, with the short-term outlook remaining weak as new restrictions are implemented. On the upside, goods exports have proven more resilient to coronavirus-related pressure, preventing a sharper GDP contraction.
Fitch forecasts a moderate economic expansion of 3.8% in 2021 (compared with their previous 4.5% forecast and BBB peer median growth of 4.9%), given weaker carry-over effects and still subdued demand in the services sector. Investment will recover more rapidly thanks to increased public investment driven largely by earthquake reconstruction projects in Zagreb. Fitch expects growth to accelerate to 6% in 2022 as the pandemic effects wane and demand is boosted by the gradual implementation of projects tied Next Generation EU (NGEU, for which Croatia is set to receive EUR 5.9 billion in grants, or 12.2% of GDP, which needs to be spent by 2026). Fitch assumes that EU funds will boost growth by 2pp in 2022.
Fitch adds that it is clear that EU funds will be a supportive macro factor for the rating, limiting negative spill-overs from sectors that could see some long-term scarring (such as tourism, which is unlikely to fully recover by end-2022) and underpinning fiscal and external financing flexibility.
The rating agency expects the budget deficit to narrow to 3.5% of GDP in 2021, following a projected deficit of 8% in 2020 and compared with the 2021 budget target of 2.9%. According to Fitch, the authorities are likely to maintain some sectoral support (in addition to guarantee schemes) through at least 1H 2021, but they still expect budget spending to fall in nominal and real terms as automatic stabilisers elapse and other expenditure is streamlined. The government approved a tax reform in November that will reduce personal income tax rates and VAT loopholes starting next year. Although there are risks that this could weaken revenue growth in 2021, the current government has implemented similar reforms in recent years where the net effect was revenue neutral to positive.
