Standard & Poor’s Global Ratings raised its long and short-term foreign and local currency sovereign credit ratings on Croatia to ‘BBB+/A-2’, with a stable outlook.
Following Fitch’s announcement of an increase to Croatia’s credit rating, Standard & Poor Global Ratings is the second agency to upgrade Croatia’s rating ahead of schedule. This would mean that Croatia’s short and long-term foreign and local currency sovereign credit rating has been raised from ‘BBB – /A-3’ to ‘BBB+/A-2’, with a stable outlook.
The agency said that the stable outlook reflects their expectation that Croatia’s economic growth would remain consistent over the coming two years, despite the inflationary pressure and the economic consequences of the current Russia-Ukraine conflict. They also expect the government to remain committed to the reform program, receive significant EU financing, and gradually rebuild the fiscal space lost in the aftermath of the pandemic.
The agency also commented on the potential for upgrades or downgrades to their rating. In terms of receiving an upgrade, the agency considers it plausible if Croatia’s economic growth accelerates beyond the agency’s current expectations, which would lead to an increase in economic wealth. In this case, fiscal consolidation and declining net general government debt is expected. Further European integration for Croatia, for example, through institutional improvements, within the judiciary, education, and business environment could also lead to an upgrade.
On the flip side, a downgrade could be considered if there is a considerably weaker fiscal position and structurally weaker economic growth than what the agency projects. This could come from the prolonged conflict in Ukraine, which would have increasingly severe pan-European economic consequences, or if there is a complete half of the European energy supply, which would surely increase the risk of a recession throughout the continent. Finally, high levels of emigration and an aging population represent a long-term risk to Croatia’s growth and public finances.
Moving on, the agency commented on the benefits of from ECB’s monetary policy.
According to the agency’s analysts, Croatia as a member of the eurozone will benefit from the monetary policy flexibility of the ECB, while the foreign exchange risks will decline in the heavily euro-based economy. Economic prospects are also positive if we consider the strong estimated tourism flows and solid near-term execution of EU-funded investments. At the same time, the agency considers that Croatia has a limited direct dependence on Russian hydrocarbon imports, especially because of the recent expansion of the Krk LNG terminal and advanced sea-borne oil supply substitution.
The accession should also eliminate any remaining exchange rate risks in the heavily euro-based economy, where about 75% of the banking sector assets and 67% of liabilities are denominated in euros. This will also reduce the foreign currency risks on the government’s balance sheet, which should in turn reduce Croatia’s share of govt. debt denominated in foreign currency from app. 70% to close to zero (it should be noted that even now, this debt is exclusively denominated in euros).
There were also comments on the growth projection, which got revised to 3.5%.
The agency revised its growth projection for the Croatian economy in 2022 from 2.5% to 3.5% on the back of resilient dynamics in H1 2022 and the expected strong tourism season, on par with pre-pandemic levels. In the medium term, the agency expects Croatia’s economy to settle on a solid growth path, backed by investments supported by EU financing and rebounding tourism. At the same time, the repercussions from the Russian invasion of Ukraine and inflationary pressures represent risks to the forecast. There are also some pandemic risks, as less than 60% of Croatia’s population was fully vaccinated against COVID-19, (as of 7 July 2022), compared with the EU average of 76%.
The agency also commented on the average inflation forecast for 2022, which currently stands at 8%.
This is due to the fact that the Russia-Ukraine conflict has added pressure on energy prices, which will have a strong impact on Croatia’s inflation outlook for 2022. The agency expects a considerable increase in inflation, with the CPI averaging at 8%, due to rising energy prices, increasing wages, and rising hospitality sector costs.
Lastly, S&P projects general govt. deficit at 3% of GDP in 2022. As the govt. has already introduced subsidy schemes to alleviate price pressures on fuel and energy, which will add 1.1% of GDP to the expenditure bill. Considering the current energy crisis, additional govt. subsidy schemes might be required in the 2nd half of 2022.