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Republic of Croatia - Cruising as a second wave leader

11 Sep 2003

Once the first wave of EU enlargement is completed next May, investors will focus on second wave countries like Croatia. Assistant finance minister Hrvoje Radovanic talks to Kathryn Wells.

On February 21 2003, Croatian leaders presented Greece's prime minister with a formal application for EU membership, just three months after the historic Copenhagen negotiations that paved the way for the first wave of EU accession in May 2004.

One week earlier, Croatia's funding chiefs moved to take advantage of the positive sentiment that expectation of the application was already creating with the launch of a Eu500m seven year Eurobond via lead managers Citigroup and Deutsche Bank.

The leads were able to price the bond at 111.5bp over the 2010 Bund, to give a spread of 95bp over swaps. This was nearly 40bp inside its Eu500m seven year bond that Croatia launched at the beginning of 2002, which was priced to give a spread at launch of 137bp over swaps.

"Funding conditions have improved since news of Croatia's official EU application was announced, enabling us to issue both in euros and in the Samurai market with much tighter spreads than we have achieved before," says Hrvoje Radovanic, the assistant Croatian minister of finance.

The book was four times oversubscribed, with 140 accounts participating. Nearly 15% of the issue went to accounts that buy EU government bonds and have only recently been moving into the EU first wave sovereigns.

Croatia hopes to join the EU in 2007, along with fellow second wave candidates Bulgaria and Romania. As the higher rated first wave sovereigns move into the EU fold, the extra attention that Croatia, Bulgaria and Romania are attracting is helping their spreads tighten.

Beyond emerging market status
A further sign of Croatia's growing stature was its ability to cut fees to 17bp, from the 25bp it paid last year for the same maturity. Along with the first wave accession economies, Croatia can no longer justifiably be classed as an emerging market credit, because with its investment grade ratings the universe of buyers is much wider than it used to be.

The sovereign's long term foreign currency ratings were Baa3/BBB-/BBB- at the beginning of September, several notches higher than its fellow second wave accession economies. Bulgaria is rated Ba2/BB+/BB+, while Romania is at B1/BB-/BB-. By choosing to become an annual visitor to the Samurai market, Croatia has benefited from the loyalty that Japanese bankers tend to show to regular issuers.

The republic completed its foreign funding programme for 2003 with its fifth visit to the Samurai market in June with a ¥25bn six year offering, which was priced via lead managers Daiwa Securities SMBC and Nomura at par with a 1.23% coupon.

"There has not been too much issuance in the Samurai market in past years by other EMEA sovereigns, mainly as a result of the market's reaction to both internal and external shocks," says Radovanic. "Having been active in the market for five years has helped to establish our name there, and with each issue we have succeeded in achieving better terms and in broadening our investor base. At the beginning, retail investors mainly bought our paper. Slowly but noticeably we have managed to penetrate the institutional sector."

Bankers said at the time that while Croatia had always stressed its links with the European Union, the concrete 2007 date, coupled with the reality of eight eastern European countries joining in 2004, made the topic particularly relevant for Japanese investors this year.

Alongside the traditional strong support from retail investors, a number of new institutional accounts participated, including one large Tokyo life insurance company.

"We are likely to continue the policy of accessing the Samurai market once a year, especially given the time and money that we have invested into it," says Radovanic. "Over the last five years the Samurai market has not always been that interesting an option for some countries in our region, as the amounts achievable there are smaller than those that can be issued in the euro or dollar markets. But the Samurai market fits well with our strategy." To this end, Croatia is not at present looking at any other markets.

As well as the EU negotiations, investors of both the euro and the yen bonds focused on Croatia's accession to the Central European Free Trade Agreement (CEFTA) earlier in the year, its stance over the conflict in Iraq and topics such as its debt ratios, the level of its short term debt and its import cover, which now stands at around six months.

The government also plans to raise Eu200m equivalent in the local markets in 2003. It issued a K1bn 2008 bond in May, its debut kuna denominated issue. Local firms Rijecka banka and Splitska banka lead managed the bond for the republic, which pays a semi-annual coupon of 6.125%.

More kuna to come
"Most of the kuna denominated bonds have been linked to the euro, which is the market's preference," explains Radovanic. "The K1bn fixed rate bond in May was our first such longer bond, and we will definitely try to develop the market further in the future.

"Traditionally it has been constrained by the banking sector, but structural reforms in the last 18 months have seen the advent of pension funds and such which need sufficient supply."

Croatia is not expected to return to market until early 2004, when it will pursue its usual strategy of front loading. While next year's borrowing requirements are still to be fixed in the 2004 budget, Radovanic says that the target is likely to be equal to or marginally less than it borrowed this year - in other words, a maximum of around Eu700m.

Radovanic is hopeful that by next May, Croatian bonds might benefit from added interest from both dedicated emerging market as well as cross-over investors even more than it has to date. "The accession of the eight first wave central European economies next year might have a positive effect and help to develop Croatia's profile further in the markets," he says. "Investors who traditionally looked at these markets might now look further afield for good opportunities."

11 Sep 2003