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Rating Action:

Moody's changes outlook on the Government of Croatia's Ba2 rating to stable from negative; affirms ratings

10 Mar 2017

Frankfurt am Main, March 10, 2017 -- Moody's Investors Service ("Moody's") has today changed Croatia's outlook to stable from negative and affirmed its Ba2 senior unsecured bond and Ba2 long-term issuer ratings.

The key drivers for changing the outlook to stable and affirming the Ba2 rating:

(1) Croatia's stronger than expected medium-term economic growth following its emergence from a six-year recession in 2015, with growth of around 2.5% on average in coming years.

(2) The reversal in the upward trajectory of Croatia's public sector debt burden as a result of improved growth.

(3) In spite of these positive economic and fiscal trends, the rating continues to be constrained at the Ba2 level by structural weaknesses in Croatia's economy in the absence of a structural reform agenda.

Croatia's long-term and short-term foreign-currency bond ceilings remain unchanged at Baa3/P-3, the long-term foreign-currency deposit ceiling remain unchanged at Ba3. The short-term foreign-currency deposit ceiling remain unchanged at Not Prime (NP). At the same time, the local-currency bond and deposit country ceilings were unchanged at Baa1.

RATINGS RATIONALE

FIRST DRIVER: CROATIA'S STRONGER THAN EXPECTED MEDIUM-TERM ECONOMIC GROWTH

Moody's expects Croatia's economy to grow by 2.5% per annum on average over the next few years, which is much lower growth than the pre-crisis average of 4.5% between 2000 and 2007 but is only slightly weaker than the average 2.8% expected for its Central and Eastern European (CEE) peers over the same period. Moody's believes that the improved growth prospects will have a positive impact upon budgetary performance and contribute to a reduction in general government debt. These credit trends are materially different to what Moody's had assumed a year ago when it assigned a negative outlook on the government rating.

Croatia's economic momentum has strengthened, after the economy emerged from a six-year recession in 2015. Real GDP growth accelerated to an estimated 2.9% (year-on-year) in 2016, significantly exceeding growth in 2015 (1.6%) as well as our forecast of 2.1%. Growth has become broad based, reflected by a good performance in exports of goods and services, a pick up in household consumption and investments, as well as public consumption. Particularly notable is the rise in government consumption (above 2% in Q2/Q3) -- the highest rise since 2009, which comes in spite of spending restraint and political events that resulted in early elections.

We expect Croatia's economic growth to expand further this year, with additional support provided by the government's more accommodative fiscal policy. Private consumption will probably expand further on the back of tax cuts introduced by the government from 2017 as well as further improvements to the labour market.

At the same time private investment will benefit from ample liquidity in the Croatian banking system as well as good financing conditions which are both likely to have a positive impact upon credit expansion. Credit growth began to recover in mid-2016 and it is expected to enter positive growth territory this year. Economic growth will also be supported by public investment which will benefit from increased absorption of EU funds. A reduction in domestic political uncertainty, after the formation of a new government in the second half of 2016, will also probably have a positive impact upon the economy.

On the external side, we expect exports of goods and services to remain strong at 4%, although they will be somewhat weaker as compared with 2016 and 2015 given the moderation in tourist growth. That said, the political uncertainty in competing tourist destinations, such as North Africa and Turkey, will continue to benefit Croatia. We expect strengthening domestic demand to drive import growth, which will offset export growth resulting in a negative contribution of net exports to overall real GDP growth.

SECOND DRIVER: THE REVERSAL IN THE UPWARD TRAJECTORY OF CROATIA'S DEBT BURDEN

Croatia entered the global financial crisis with a modest debt burden of around 39% of GDP in 2008, but this rose rapidly to an estimated 86.7% of GDP in 2015 due to low nominal growth, high budget deficits, and the assumption of state-owned enterprise debt, as well as costs related to the restructuring of state enterprises. However, against a backdrop of better-than-expected public finance performance, Croatia's debt-to-GDP ratio is likely to have declined to around 84% of GDP at year-end 2016, and we expect a further gradual decline in Croatia's debt-to-GDP burden, to 82.9% of GDP in 2017 and to 81.4% in 2018.

Croatia is expected to exit the EU's Excessive Deficit Procedure at the end of this year, given that the government managed to reduce its fiscal deficit significantly to an estimated 1.8% of GDP last year, below the EU's Maastricht 3% threshold and thus in line with the EU's recommendation from 2014. The fiscal deficit declined from 3.3% in 2015, with the reduction in the 2016 deficit being driven by the restraint in public spending as well as windfall revenues resulting from a more buoyant economy.

We expect the general government deficit to widen this year, following a significant reduction in 2016. The deficit should increase to 2.1% of GDP against the background of tax reforms introduced by the new government. The tax reforms will lower personal income tax as well as corporate taxation, a measure that is intended to stimulate consumption and economic growth. At the same time, the government made changes to VAT rates, by reshuffling groups of goods and services between existing rates.

THIRD DRIVER: RATING CONSTRAINED AT THE Ba2 LEVEL BY STRUCTURAL WEAKNESSES IN CROATIA'S ECONOMY IN THE ABSENCE OF A STRUCTURAL REFORM AGENDA

Various structural weaknesses in Croatia's economy remain unaddressed given the absence of a comprehensive reform agenda from the government. For example, the decline in the country's unemployment rate is driven by an ageing population and emigration, leading to a decline in the labour force. Also, Croatia's current high budgetary spending and rigid expenditure structure remain credit weaknesses -- with social benefits, pensions and wages accounting for around 60% of total expenditure -- and this results in limited flexibility to adjust public finances.

Croatia's debt affordability has improved in 2016, reflected in a declining interest to revenue ratio estimated to be 7.6% from just above 8% in 2015, but it is still significantly higher than the 2008 level of 4.6%. The high cost of servicing the debt takes a toll on the economy, as it squeezes out other government expenditure and constrains the ability of fiscal policy to respond to cyclical downturns. Furthermore, in spite of a projected decline over the next few years, Croatia's debt-to-GDP burden will remain above the median for Ba-rated countries.

WHAT COULD RESULT IN AN UPGRADE

Upward pressure upon Croatia's Ba2 rating might arise if the coalition government formed in October 2016 were to utilise the current more stable political environment in order to advance its programme of economic and fiscal reforms in a way that would further the country's long-term economic potential and secure the downward trajectory in public indebtedness beyond the next few years.

WHAT COULD RESULT IN A DOWNGRADE

Croatia's rating might be downgraded if, in the coming years, the country proves unable to implement a comprehensive structural reform programme, given that such failure would be likely to lead to weaker growth and to increases in Croatia's public debt in the long term. Given the lack of fiscal space, a weakening in the growth outlook based upon both domestic and external factors would be credit negative. Downward pressure upon the rating might also result from an assessment that Croatia's external vulnerability metrics have deteriorated to an extent that they fall significantly below those of Ba2-rated peers.

GDP per capita (PPP basis, US$): 21,625 (2015 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 2.9% (2016 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): -0.3% (2016 Actual)

Gen. Gov. Financial Balance/GDP: -1.8% (2016 Estimate) (also known as Fiscal Balance)

Current Account Balance/GDP: 2.8% (2016 Estimate) (also known as External Balance)

External debt/GDP: 91.5% (2016 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.

On 07 March 2017, a rating committee was called to discuss the rating of Croatia, Government of. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have increased. The issuer's fiscal or financial strength, including its debt profile, has increased.

The principal methodology used in these ratings was Sovereign Bond Ratings published in December 2016. Please see the Rating Methodologies 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 credit 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 credit rating action on the support provider and in relation to each particular credit 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 credit rating action, and whose ratings may change as a result of this credit 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.

Simon Griffin
Vice President - Senior Analyst
Sovereign Risk Group
Moody's Deutschland GmbH
An der Welle 5
Frankfurt am Main 60322
Germany
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Yves Lemay
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Releasing Office:
Moody's Deutschland GmbH
An der Welle 5
Frankfurt am Main 60322
Germany
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

No Related Data.
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