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Standard & Poor’s Ratings Services has affirmed all its ratings on the Republic of Croatia, including its ‘BBB-/A-3’ foreign currency and ‘BBB+/A-2’ local currency sovereign credit ratings. The outlook remains stable.

“The ratings on Croatia are supported by planned fiscal deficit reduction and privatisation, which should stem the rise in the moderate government debt burden,” says Standard & Poor’s credit analyst Kristel Richard. “The ratings also draw support from improved prospects for EU membership, and a modestly diversified economic base with good growth expectations.”

Croatia has introduced politically sensitive measures to reduce wage bill growth and reform its pension and health care systems. These reforms will help to reduce Croatia’s consolidated general government deficit to about 3.5% of GDP in the medium term, from an estimated 4.8% in 2002 and 2003. In turn, this will help to slow the growth of general government debt, which is estimated to reach 52% of GDP in 2003.

The government has also taken major steps to advance the restructuring of large enterprises and to strengthen the economic base. The upcoming general election, which is likely to be held in the fall of 2003, is expected to return a similar coalition to power. The new government is then expected to build on its predecessor’s successes.

Regional stability has also improved over recent years. Most importantly, the country has applied for EU membership, thereby furthering its international integration.

“Nevertheless, the ratings are constrained by a deteriorating net external debt position, and the need to modernize the country’s legal, regulatory, and judicial systems,” adds Richard.
The country’s net external debt has recently surged, reaching an estimated 53% of current account receipts, from about 24% in 2001. This results from rapid borrowing by the banking sector and large current account deficits (estimated at 7% of GDP in 2003 and 2004), while equity inflows (particularly foreign direct investment) have fallen and are expected to be about 2.5% of GDP in 2003 and in 2004. In line with growing net external debt levels, Croatia’s external borrowing requirement as a percentage of reserves is again estimated to exceed 100% in 2003, and is expected to remain substantially above that level in the years to come.

Finally, creating conditions conducive to stronger economic growth will require the establishment of fully functioning legal, regulatory, and judiciary systems, as well as considerable improvements to corporate governance standards and the payment culture.

“Going forward, there are uncertainties linked to the rapid increase in the net external debt burden, in particular banking sector net external debt, which is resulting in deteriorating external liquidity ratios,” says Richard. “These are balanced by the recent and expected improvements in the country’s fiscal stance, progress with structural reforms, and the country’s ongoing international integration. Nevertheless, the ratings and outlook could be negatively affected should the net external debt continue to grow rapidly in the short term and should liquidity ratios show a further substantial deterioration.”