Standard & Poor’s Global Ratings revised Croatia’s outlook as positive on the back of improving wealth with economic convergence with the eurozone over the past decade. The positive outlook indicates that S&P could raise the ratings if Croatia achieves faster integration into the wealthier eurozone economy.
Standard & Poor’s Global Ratings revised Croatia’s outlook as positive on the back of improving wealth with economic convergence with the eurozone over the past decade. Revision is supported by steady expansion in tourism, increasingly complemented by investments in the economy’s productive capacity & GDP per capita strengthening to 73% of the EU average in 2022 from 60% in 2013. The positive outlook indicates that S&P could raise the ratings if Croatia achieves faster integration into the wealthier eurozone economy.
The agency said that Croatia’s forecasted economic growth is expected to continue in 2023. According to the agency, strong wage growth owing to a tight labor market has kept gross real wage growth in positive territory this year, boosting private consumption beyond the agency’s previous expectations. The agency now forecasts real GDP growth at 2.5% for 2023, up from the initial 1.7% that was anticipated in March, supported by private consumption, especially as inflations decelerate; investments; and dynamic tourism activity. They believe Croatia’s recent eurozone entry and accession to the Schengen Area will support the economy’s long-term growth by fostering investments and facilitating tourists’ entry. Also, the agency expects Croatia to maintain a solid growth trajectory over the medium term, with real growth averaging 2.6% yearly through 2026.
The agency also commented on expected investments. Backed by EU financing, investments should anchor Croatia’s growth in 2024-2026 and cushion any potential volatility stemming from year-on-year variations in tourism flows. In addition, the agency considers opportunities for strengthening the economy’s resilience and productive capacity that could result from the successful implementation of Croatia’s National Recovery and Resilience Program. Institutional progress could facilitate improvements in productivity, the business environment, and the efficiency of the public sector and judiciary and further amplify income convergence with the EU average.
The government is expected to remain committed to its reform program, receive significant EU financing, and maintain fiscal prudence to gradually rebuild the fiscal space it lost as a result of the pandemic. Gross general government debt is expected to be reduced to lower than 60% of GDP by 2026, with net government debt settling below 55% of GDP throughout 2023-2026.
Further, the agency also provided upside & downside scenarios. In the upside scenario, the agency could raise the ratings over the next 12 months if Croatia’s economic resilience is sustained, supported by the country’s deepening integration with Europe, and facilitated institutional improvements, for example within the judiciary, education, and broader business environment. The downside scenario is based on Croatia’s outlook if economic performance does not improve as expected. Such weakening could come about if the Russia-Ukraine conflict led to increasingly severe economic consequences across Europe or if inflationary conditions significantly worsened. Net emigration trends and an aging population also represent a long-term risk to Croatia’s growth and public finances. Near-term risks would result from worsening consumer sentiment in continental Europe. Croatia directs about 25% of its goods exports to Germany and Italy, making it vulnerable to the economic developments of these key EU trading partners.
External and fiscal deleveraging should continue through 2025
The agency expects Croatia to post a modest budget deficit of 0.7% of GDP in 2023, despite cost-of-living pressures and increased costs due to the indexation of current spending items, notably pensions and social transfers.
Moreover, it is anticipated that fiscal consolidation will be spurred by Croatia’s alignment with the Maastricht criteria from 2023 onward. Net general government debt is expected to gradually reduce and approach 54% of GDP by 2026 from 60% in 2022, thanks to stringent fiscal management and the nominal growth of the economy.
Regarding the inflation development, Croatia’s inflation rate of 7.8% in August was the second highest in the eurozone that month, when it averaged 5.3%. Inflation is set to fuel price increases after shifting from commodities to the labor market as nominal wage growth is a brisk 12% for 2023. Croatia’s tourism sector will also act as a key driver of overall price hikes, in particular, because it is pivoting toward more affluent tourists. This resulted in a services inflation rate of 11% in August, which is notably above headline inflation. Croatia’s inflation is expected to be moderate over 2023-2024 but remain higher than the eurozone average over the medium term, reflecting the economy’s convergence as prices and wages catch up with the more mature eurozone economies. Finally, the impact of monetary policy tightening has been reduced by Croatia’s adoption of the euro.
