As Croatia eyes the Eurobond market, fixed income investors should not overlook the fact that the country faces heightened political risks that threaten to harm its already insubstantial attempts at economic reform.
The sovereign mandated Deutsche Bank, JP Morgan, Société Générale and Banca IMI last week for a euro transaction, the same week that prime minister Zoran Milanovic dismissed finance minister Slavko Linic over alleged misconduct in the pricing of land sales. The former finance minister, like Milanovic a member of the ruling coalition government’s largest party the Social Democratic Party, has denied fault.
Local observers have suggested the dismissal is linked to tensions between the ex-finance minister and the prime minister. As the former retains strong grassroots support within the party, the danger is that a power struggle ensues, Tim Ash, Standard Bank’s head of emerging market strategy excluding Africa, told Emerging Markets.
“The assumption is that Linic is unlikely to go quietly after being so publicly humiliated by his party leader,” said Ash. If the SDP performs poorly in the European Parliament elections later this month, Linic could present a challenge to Milanovic, and this has the potential to split the party, potentially bringing down the government and forcing early parliamentary elections, he added.
Political volatility and worsening debt levels have pushed Croatia’s bond spreads wide of peers like Serbia. But with bond markets in general rallying, investors have not fully priced in the dangers Croatia is facing, Ash said. Croatia’s political scene is already splintered, but more political tension risks distracting politicians from the more important task of reforming the country’s ailing economy.
The country has been suffering from the worst growth dynamics in the CEE region. RBS analysts expect the debt to GDP ratio to reach 65.3% this year from 55.5% in 2012. The government ran a deficit of 5.5% of GDP in 2013, according to the European Commission, which does not expect this to change in 2014.
“Debt and fiscal issues ultimately get resolved by growth and in this respect there’s not enough big picture strategy,” said Ash. Croatia is an expensive and difficult place to do business, and this has hurt foreign investment. Meanwhile, the government’s high deficit means it has limited ability to stoke growth on its own.
“The country received almost no foreign direct investment last year,” said Ash. “They don’t have the domestic capital to spur growth and not enough of a radical reform and investment strategy to sell the country abroad.”
This in is contrast to countries like Serbia, which signed a $1bn loan with Abu Dhabi in March as part of an effort to bring in UAE investors.
"Serbia is going out of its way to attract other sources of investment, and you just don't see that happening in Croatia," Ash said.
Croatia is not short of options. It has a large public sector; some of which could be privatised to raise cash. Bureaucracy and administrative reform would help secure more foreign investment and realistic growth assumptions would prevent serial revisions to spending plans and taxes.