Fitch expects Croatian economy to expand by 5.5% in 2021.
On Friday, Fitch Ratings has, as expected by the market, affirmed Croatia’s Long-Term Foreign-Currency Issuer Default Rating (IDR) at ‘BBB-‘. The Outlook is Stable.
Croatia’s ratings balance strong structural features, including higher human development, governance indicators and GDP per capita than peers, with high public sector debt and a record of low GDP growth, partly due to the slow adoption of structural reforms. The Stable Outlook weighs large short-term downside risks related to pandemic developments against stronger medium-term growth prospects linked to substantial EU fund support and Fitch’s fiscal consolidation and debt reduction baseline that is underpinned by the authorities’ commitment to fulfilling convergence criteria under the ERMII.
Fitch expects the economy to expand by 5.5% in 2021, from a combination of base effects (growth was stronger than expected in 2H20), the resilience of sectors such as construction and goods exports, and a gradual recovery in consumption. Fitch’s forecasts rest on an improved tourism sector outlook (at around two-thirds of 2019 levels), assuming a pick-up in summer tourism as the health crisis in Europe continues to abate. However, renewed travel restrictions due to the still uncertain evolution of the pandemic, including the spread of new variants, cannot be discounted and constitute a key short-term downside risk, given the importance of the sector to the economy.
Fitch would still expect some growth in 2021, even if tourism levels remained at 2020 levels (50% of 2019), but the weaker recovery could increase the risk of longer-term scarring and put pressure on public and external finances.
The rating agency forecasts GDP growth to accelerate to 6.1% in 2022 before averaging 4% in 2023-25, driven largely by investment. Croatia will receive around EUR 6.3bn (12.8% of 2020 GDP) in grants from the Recovery and Resilience Facility (RRF), in addition to EUR 1bn (2% of GDP) from the EU Solidarity Fund for earthquake reconstruction and EUR 12.6bn (25.6%) in the 2021-27 Multi-Annual Funding Facility (MFF). Annual EU fund inflows could reach up to 5% of GDP, with the authorities calculating an additional growth impact from RRF of 0.5-1.5pp of GDP per year.
If Fitch’s growth projections materialise, Croatia will likely reach pre-crisis output in early 2022 (as opposed to the eight years it took after the global financial crisis), limiting the risks of labour market hysteresis and corporate sector bankruptcies. Nevertheless, rapid labour tightening in sectors such as construction could delay some of the investment momentum, as could the need to pass a large number of reforms, including some politically sensitive, in a short timeframe in order to get RRF fund disbursement. Moreover, Croatia´s absorption capacity lags the EU average and the sheer size of funds accentuates the implementation challenges. However, if the authorities are successful at adopting long-standing reforms, this could mitigate major growth challenges such as adverse demographics.