On Friday, Fitch Ratings released an updated review of its credit rating for Croatia. In the report, they affirmed Croatia’s status at ‘BBB+’, with a stable outlook. In this brief summary, we’ll go through the main points of the report.

Fitch Ratings has affirmed Croatia’s Long-Term Foreign-Currency (LTFC) Issuer Default Rating (IDR) at ‘BBB+’, with a stable outlook. The key factors influencing their report are the following: credit fundamentals, the conclusion of the euro adoption, deterioration of the fiscal position, a decline in the public debt, slowdown in economic growth, EU funds supporting growth, a gradual easing of inflation, deficit in the current account, stable banking sector, and ESG.

In terms of the credit fundamentals, Fitch notes that Croatia’s ratings are supported by strong structural features, including higher governance indicators than peers’, EU, and eurozone membership, as well as a 35% higher GDP per capita compared to the ‘BBB’ median. On the other hand, they note a high, but decreasing public sector debt, as well as a weak record of structural reform implementation, which when combined with an adverse demographic profile, has held back Croatia’s potential growth in the past. Fitch also notes that the stable outlook is due to their expectation of Croatia’s economy remaining resilient to external shocks.

In terms of the euro adoption, they expect that it will further enhance Croatia’s integration with core eurozone countries and boost its institutional capacity. Furthermore, access to ECB’s credible monetary policy framework and liquidity facilities for banks will significantly reduce external and financial vulnerabilities, as the currency risk is removed. Lastly, they also expect Croatia to benefit from lower transaction costs and greater price transparency.

Moving on to the fiscal position, they forecast that the budget will turn into a deficit in 2023, at 2.4% of GDP, from an estimated surplus in 2022, due to slower economic growth and increased expenditures. This includes the recently announced aid package of EUR 1.7bn (2.9% of GDP) for electricity and gas price subsidies. Furthermore, they have also included the effect of the recapitalization of HEP (state-owned power utility company) of EUR 900m, as well as the effects of the 2022 extra profit tax.

In terms of the public debt, they expect it to keep declining to 65.2% in 2023, from an estimated 68.3% in 2022, and almost 20 p.p. lower than the pandemic peak in 2020. They expect the debt reduction to continue in the coming period, albeit at a slower 2-3 p.p. YoY, due to the slowdown in nominal GDP growth.

They also expect economic growth to slow down, with GDP growth expected at 1.7% in 2023. They note that private consumption will likely ease to around 1% as inflation continues to impact disposable incomes, and consumer confidence remains dampened. On the other hand, Fitch expects that investments should be the main driver of growth, as EU funds absorption should peak in 2023. This would mean that investment should grow at around 5.5% in 2023. In 2024, GDP growth should recover to app. 3% due to the private consumption recovery.

In terms of the EU funds supporting growth, they note that Croatia is a front-runner in the absorption of Recovery and Resilience Facility grants, as EUR 2.2bn (out of EUR 5.5bn allocated) has been successfully disbursed by the end of 2022. Together with other funds, Croatia could receive up to EUR 20.3bn in the next 5-7 years, representing 34.9% of 2023 GDP).

Moving on to inflation, Fitch expects it to gradually ease, with HICP inflation averaging 6.8% in 2023, due to base effects, slowing inflation at main trading partners and cooling domestic demand. They also note that the impact of the euro inflation on inflation has been limited, and amounts to app. 0.4 p.p., which is in line with other countries which adopted the currency.

Fitch also expects Croatia to post a small current account deficit in 2023/2024, due to weaker demand from main trading partners, and an increase in import-intensive investments. They also note that euro adoption and the Schengen area entry could further support the tourism industry.

Next up, Fitch notes that the Croatian banking sector remains stable, with a solid capitalization of 24.6% at the end of 2022, and improving asset quality. NPL ratio stood at 3% at the end of 2022, down 1.3 p.p. YoY. Further synchronization of the monetary policy with the ECB resulted in a significant reduction in some regulatory requirements in the banking sector and an increase in liquidity buffers.

Finally, Fitch also provided us with factors that could lead to an upgrade or a downgrade.

Starting off with the downgrade, Fitch notes that if the public finances deteriorate, for example, due to a sustained increase in general govt. debt in the medium term, due to longer periods of fiscal loosening could lead to this outcome. A deterioration in the macroeconomic situation, due to lower growth stemming from structural shocks to key sectors or weaker demographics could also lead to this outcome.

Moving on to the upgrade, this outcome could be achieved if the public debt continues to decline, through for example fiscal consolidation. Furthermore, the implementation of structural reforms, or positive spillovers from the euro adoption, leading to the convergence of GDP per capita with higher-rated peers could also lead to this outcome.

The entire report can be accessed here.

As of March 2023, Fondul’s NAV reached RON 14bn, which would translate into a NAV per share of RON 2.5823, an increase of 10.1% YoY and a flat MoM development.

According to the latest Fondul Proprietatea’s NAV report (31 March 2023), Fondul reported a total NAV of RON 14bn (EUR 2.83bn), which translates into a NAV per share of RON 2.5823 (EUR 0.5218).

Comparing it on a YoY basis, the total NAV recorded an increase of 10.1%. Nevertheless, compared to February, NAV remained flat.

Fondul Proprietatea’s portfolio structure still remains focused on the power utility generation sector (79.6% of NAV) with Infrastructure (7.6%) and Power & Gas supply and distribution (7.4%) following. This is also why the three most significant holdings, Hidroelectrica, Aeroporturi Bucuresti, and Engie Romania amount to 87.9% of the total NAV of the Fund. However, most of those come only from Hidroelectrica with 79.6% as the biggest holding. Finally, regarding the whole power utility generation sector, we emphasize that Fondul increased its exposure to the power utility generation sector by 3.1 p.p. on a monthly basis, which came on the back of a higher share of Hidroelectrica compared to the whole portfolio.

 In terms of the Fund’s portfolio structure, unlisted equities accounted for the vast majority of NAV, standing at 96.6%. Following unlisted equities, there is Net Cash & Receivables with 2.1% and finally listed equities with only 1.2%. Further, we note that during March, no other significant changes in Fondul’s portfolio occurred. Also, we remind and emphasize that at the start of this year, Fondul liquidated its position in OMV Petrom, which was previously the second biggest holding after Hidroelectrica with 5.6% of the fund’s NAV in the latest data available for November.

Turning our attention toward the share price’s performance, during the month, the Company’s share price noted a flat development with 0.2% share price increase, ending the month at RON 2.105 per share. The current discount to NAV per share stands at 21.8%.

Fondul Share Price & NAV per Share

Source: Bloomberg, InterCapital