Yesterday, Fitch Ratings announced the upgrade of Croatia’s credit rating to ‘BBB+’, with a positive outlook. The main drivers of the upgrade refer to the approval of Croatia’s application to adopt by Euro by the European Council’s Economic and Financial Affairs Council (Ecofin).
As Croatia received approval to join the eurozone by the various EU committees/organizations (European Commission, European Central Bank, and finally, the Ecofin), the upgrade to Croatia’s credit rating by Fitch ratings was expected. This is because one of the main drivers of the upgrade by the agency, as outlined in their last report published in May (which we already covered in our news, and you can find here).
The approval by the Ecofin is the final step to the eurozone ascension process, a process that lasted since July 2020 when Croatia joined the Exchange Rate Mechanism II and fulfilled all convergence and reform criteria within the shortest possible timeframe. The currency conversion rate has also been set at EUR 1:HRK 7.5345.
Fitch notes that the euro adoption had a positive impact on the rating, as it would reduce transaction costs, limit exchange-rate risk to corporate and household balance sheets, and provide the country with a reserve-currency status. Since the euro adoption had a direct positive impact on Fitch’s Sovereign Rating Model (SRM) output, mainly through the reserve-currency flexibility, this led to Croatia’s credit rating upgrade. The upgrade also follows the plan laid out by Fitch according to which, at the time when Croatia joined the ERM II with a credit rating of ‘BBB-‘, adoption of the euro would lead to a two-notch upgrade, and thus an upgrade to ‘BBB+’.
The agency also commented on Croatia’s ESG Relevance Score, of which it has ‘5[+]’, for both political stability and rights, as well as for the rule of law, institutional and regulatory quality, and control of corruption. These scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in Fitch’s SRM calculation. Croatia has a high WBGI ranking in the 66th percentile, reflecting the track record of stable and peaceful political transitions, well-established rights for participation in the political process, moderate institutional capacity, effective rule of law, and a moderate level of corruption.
Fitch also commented on factors that could lead to a downgrade or an upgrade of the rating.
In regards to things that could lead to a downgrade, in terms of the public finances, if there is a sustained increase in general government debt over the medium term, for example, due to a more pronounced and longer period of fiscal loosening. In terms of the macro situation, a deterioration in international competitiveness or structural shocks to key sectors result in lower trend growth.
In terms of factors that could lead to an upgrade, in terms of public finances, a sustained decline in general government debt/GDP to levels closer to peer medians, via for example, continued fiscal consolidation. In terms of the macro situation, if there is an improvement in medium-term growth prospects, via implementation of structural reforms or EU-led investment, that supports the convergence of GDP per capita with higher-rated peers.
Fitch also commented on the fact that the next scheduled review date for Croatia is 28 October 2022, but they believe that developments in the country warrant a deviation in the calendar, and as such, the review might happen earlier.
