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Rating Action:

Moody's changes outlook on Croatia's Ba1 government bond rating to negative from stable

21 Mar 2014

New York, March 21, 2014 -- Moody's Investors Service has today changed the outlook on Croatia's Ba1 government bond rating to negative from stable. Concurrently, Moody's has affirmed Croatia's Ba1 rating.

The key drivers of today's outlook change are as follows:

(1) Croatia's impaired medium-term economic outlook, owing to competitiveness challenges, continued deleveraging and the growth-dampening effect of fiscal consolidation efforts.

(2) The slow pace of fiscal deficit reduction, which will keep government debt ratios and annual financing needs above those of many similarly rated peers.

(3) Large external debt-servicing requirements that keep Croatia's external liquidity position tight.

The key drivers for Moody's affirmation of Croatia's Ba1 government bond rating are:

(1) Anticipated policies adopted under the European Union (EU)'s Excessive Deficit Procedure (EDP), which are likely to keep fiscal metrics from deteriorating as rapidly as they have in the last two years.

(2) Croatia's improved current account balance and foreign-exchange reserves, which will cushion its balance of payments from global financial volatility.

(3) Croatia's relatively high per-capita incomes compared to similarly rated peers, as well as the economic benefits from Croatia's entry into the EU in 2013.

Croatia's local-currency country risk ceilings remain at A3, the long-term foreign-currency debt ceiling remains Baa1, and the short-term foreign-currency debt ceiling is P2. The long-term foreign-currency bank deposit ceiling remains Ba2 and the short-term foreign-currency bank deposit ceiling is Not Prime.

RATIONALE FOR OUTLOOK CHANGE

--FIRST DRIVER: CROATIA'S IMPAIRED MEDIUM-TERM ECONOMIC OUTLOOK

The first driver of the outlook change is Croatia's impaired medium-term economic outlook, owing to competitiveness challenges, continued deleveraging and the growth-dampening effect of fiscal consolidation efforts. In this context, Croatia is having a weak recovery from recession, with positive real GDP growth having eluded the economy since 2009.

Moreover, in the past five years, Croatia's growth has been weaker than that of similarly rated peers. In addition to the investment, export and banking sector effects from the euro area debt crisis, Croatia has suffered from a number of shocks to the economy, including the restructuring of the shipyard sector and the loss of export markets following the country's exit from the Central European Free Trade Agreement due to EU entry.

Croatia's GDP growth is estimated at -1.0% in 2013, and Moody's expects 2014 growth to remain weak as private sector deleveraging as well as public sector consolidation efforts keep domestic demand subdued. The rating agency notes that weak growth lowers Croatia's resilience to future economic shocks, and complicates the government's efforts to reduce fiscal deficits and debt.

--SECOND DRIVER: SUBSTANTIAL RISE IN GOVERNMENT DEBT LEVELS

The second driver of the outlook change are Croatia's high levels of government debt ratios and annual financing needs which are higher than those of many similarly rated peers. Moody's estimates that Croatia's general government debt has risen to approximately 66% of GDP by the end of 2013 (2008: 29%), owing to an increase in fiscal deficits as well as the costs of restructuring certain state owned enterprise debts and calls on government guarantees.

Despite the government's recently proposed measures to increase revenues and curtail expenditures, the fiscal deficit is unlikely to decline rapidly over the next two years from an estimated 6.1% of GDP in 2013. As a result, government debt and deficits are likely to remain above the 2013 Ba median level of 45.5% and 3.7% of GDP, respectively.

--THIRD DRIVER: LARGE EXTERNAL DEBT-SERVICE REQUIREMENTS WILL KEEP CROATIA'S EXTERNAL LIQUIDITY POSITION TIGHT

The third driver of the outlook change is Croatia's substantial external debt-service requirements. External debt rose to an estimated 107% of GDP by the end of 2013, from 68.6% in 2005. The bulk of the increase was due to private sector borrowing prior to 2009. Although the private sector has reduced its external borrowing since 2010, the government has continued to borrow externally.

The debt-repayment needs arising from a high level of external debt constrain the country's external liquidity position. Coupled with a high degree of euroisation within the country, this leaves Croatia's economy vulnerable to global financial volatility.

RATIONALE FOR AFFIRMING THE Ba1 RATING

-- FIRST DRIVER: FISCAL CONSOLIDATION EFFORTS UNDER EXCESSIVE DEFICIT PROCEDURE

The first driver of the affirmation of Croatia's Ba1 government bond rating is the country's entry into the EU's EDP in 2014, which mandates policy action to lower fiscal deficits and debt ratios. The institutional vigilance associated with the EDP is likely to support policy efforts that keep fiscal metrics from deteriorating at the pace at which they have done in the past few years.

-- SECOND DRIVER: IMPROVEMENTS IN CURRENT ACCOUNT AND FOREIGN-EXCHANGE RESERVES

The second driver of the affirmation is the improvement in Croatia's current account balance to an estimated surplus of 0.5% of GDP in 2013 from a deficit of 8.7% of GDP in 2008, owing to lower domestic demand for imports and robust tourism export receipts. Moody's expects the current account balance to remain in surplus this year, lowering the country's external financing needs. While external debt repayment needs are high, a significant portion is owed as intra-company debt, which limits roll-over risks.

Moreover, the rating agency expects foreign-exchange reserves, estimated at $17.3 billion at year-end 2013, to remain adequate to protect against global financial volatility.

-- THIRD DRIVER: RELATIVELY HIGH PER-CAPITA INCOMES, AS WELL AS THE ECONOMIC BENEFITS FROM CROATIA'S 2013 EU ENTRY

Croatia's sovereign credit profile is supported by its relatively high per-capita incomes compared to similarly rated peers globally, as well as the economic benefits of EU entry.

Relatively high incomes are reflected in Croatia's private sector savings rate, which supports the sovereign credit profile by providing a domestic market for government debt. Croatia's income and savings levels are also expected to cushion, to some extent, the effect of fiscal consolidation on consumption.

In 2013, the first year of Croatia's EU entry, Croatia's manufacturing export performance was weak due to the loss of traditional Central European Free Trade Agreement (CEFTA) export markets and relatively subdued growth in the EU. However, we expect that Croatia's integration with the EU, in conjunction with policies to address domestic competitiveness challenges, will support exports, investment and growth over the medium to long term. Moreover, as has been the case with prior EU entrants, institutional developments in Croatia are also likely to benefit from EU entry.

WHAT COULD MOVE THE RATING UP/DOWN

The rating outlook could return to stable upon signs that a sustained economic recovery was on the horizon, reflecting an improved medium-term economic outlook. Materially narrower fiscal deficits and falling government debt ratios would also exert upward pressure on the outlook. On the other hand, a downgrade could follow from an assessment that Croatia's fiscal, growth and external vulnerability metrics will continue to deteriorate for an extended period and to an extent that they will fall significantly below those of Ba1 rated peers and to levels inconsistent with a Ba1 rating.

GDP per capita (PPP basis, US$): 17,753 (2013 Actual) (also known as Per Capita Income)

Real GDP growth (% change): -1% (2013 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 0.3% (2013 Actual)

Gen. Gov. Financial Balance/GDP: -6.1% (2013 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: 0.5% (2013 Actual) (also known as External Balance)

External debt/GDP: 107% (2013 Estimate)

Level of economic development: Moderate level of economic resilience

Default history: At least one default event (on bonds and/or loans) has been recorded since 1983.*

*Events related to the debts of the Former Yugoslavia.

On 18 March 2014, a rating committee was called to discuss the rating of the Croatia, Government of. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have materially decreased. The issuer's fiscal or financial strength, including its debt profile, has materially decreased.

The principal methodology used in this rating was Sovereign Bond Ratings published in September 2013. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in this rating action, if applicable.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this rating action, and whose ratings may change as a result of this rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Atsi Sheth
VP - Senior Credit Officer
Sovereign Risk Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Bart Oosterveld
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's changes outlook on Croatia's Ba1 government bond rating to negative from stable
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