Following a move by S&P late in 2012, Moody’s has also cut Croatia’s government bond rating to Ba1 from Baa3.
The move is not expected to roil markets but at the same time it does not bode well for the country, which is due to join the EU in July and has enjoyed “plentiful of good will in much of 2012,” Demetrios Efstathiou, head of CEEMEA Strategy at RBS, said.
The Croatian coalition government, which won the elections in December 2011, was praised by international and local pundits alike as “the best in a decade,” Efstathiou noted.
But “although the government has come up with all the right rhetoric and even intentions on structural reform, progress has been slow to come, and has proved fairly immaterial in the face of internal opposition,” he added.
Moody’s said the rating cut had been prompted by the absence of an economic recovery in Croatia, insufficient fiscal consolidation and the country’s external vulnerability and relatively high debt to gross domestic product compared with countries rated Baa3.
Croatia’s economic model, which has “historically relied heavily on private consumption and construction fuelled by external credit”, is no longer working properly, the rating agency said.
The government cannot rebalance the economy towards exports because of a lack of productive investments before the crisis, a business environment less attractive than that in regional peers as measured by the World Bank’s Ease of Doing Business Indicators, an “oversized and dated public sector” and lack of labour flexibility, with high costs for firing and hiring, according to Moody’s.
In the World Economic Forum’s Global Competitiveness report, Croatia dropped to 81 out of 144 countries in 2012-2013, from 76 in the previous period.
CROATIAN BONDS
Croatia’s debt-to-GDP ratio was 54% at the end of last year, closer to the 58% average ratio of countries rated Ba1 than to the 38% of GDP seen in countries rated Baa3, Moody’s said.
“We see this as a reiterated message to the government to examine the 2013 budget, bolster fiscal discipline and accelerate very much needed structural reforms. The short-term market impact may be limited, but we see pronounced risks down the road,” Erste Bank analyst Alen Kovac said. Kovac said the S&P took the first step to downgrade Croatia last year and market sentiment towards emerging markets was still strong.
“Nevertheless we see fundamental weakness gaining in importance, especially if global sentiment becomes less supportive, thus anticipating upward risks from current yield levels later in 2013,” he warned.
Efstathiou says that crucial for Croatia is the fact that, with Moody’s the second rating agency to deliver the downgrade, the composite credit rating of the sovereign was taken down to junk for the first time in the country’s history.
“This will force funds with investment-grade only mandates to drop Croatian bonds from their portfolio.”
Kovac believes the Croatian Ministry of Finance should take advantage of the supportive market conditions which make financing for the fiscal deficit for this year viable, and “seek to utilize this and already alleviate a significant proportion of the financing risks for 2013 early in the year.”
Efstathiou points out that external financing needs for this year are “very modest” as there are no international bonds maturing in 2013 and the government has “substantial deposits with the banking sector” which it can draw on if it needs to.
The government has already suggested it may refrain from tapping international markets this year, given the credit rating cuts, and Efstathiou says Croatia can stay on the sidelines if it wants.
“Having said that, we don’t think the markets would prohibit the sovereign from placing an international bond should it wish to do so, especially given the continued strength of appetite for new issues.”