The likelihood of fresh elections is delaying the structural reforms necessary to prevent the debt burden from snowballing.
The prospect of a technocrat caretaker administration and fresh elections added to the sovereign’s waning score trend when the Croatian parliament reconvened last week without a government being formed after the inconclusive elections in November.
Croatia has shed 16 points in Euromoney’s country risk survey since 2010 and fallen 13 places in the global rankings to 68th out of 186 countries.
Provisional results compiled for the fourth quarter of 2015 – to be released in early January – signal a further downgrade, pushing Croatia even lower in the fourth of ECR’s five tiered categories, synonymous with a B- to BB+ sub-investment-grade rating.
Croatia is presently ranked a BB credit by Fitch and Standard & Poor’s, and Ba1 by Moody’s. All three agencies have the borrower on standby for a downgrade.
Anxiety creeps into debt metrics
At the heart of its problems is a gross debt burden still climbing in the absence of deeper austerity and structural reform, which is set to reach 92% of GDP, according to European Commission programme projections through to 2017.
Benchmark five-year CDS spreads, floating higher, albeit on an uneven trend this year, are presently around 287 basis points, signalling a medium-to-high risk of default.
The return to economic growth after six years of recession is to be welcomed, and is a broad-based recovery of domestic demand and exports, aided by tourism keeping the current account in surplus.
Yet the cyclical upturn is vulnerable to a relapse, especially since harsh austerity is still required to narrow a general government deficit which is likely to come in around 5% of GDP at the end of this year and includes a pre-election easing of the consolidation effort.
Adding to the risks, in September the Croatian parliament passed legislation allowing €3 billion-worth of Swiss franc-denominated loans to be converted to euros.
This addresses the soaring repayment costs borrowers were facing caused by the decoupling of the Swiss franc from its pegged euro exchange rate earlier this year.
However, with the costs now to be borne by the lenders, it will weaken corporate income-tax revenue from the banks in 2016.
Key to squaring the political divide is the aptly named kingmaker Bridge (or Most), a party of independents seeking reforms, but vainly in search of a coalition of national unity, which the two largest parties HDZ and SDP appear to reject.
Alen Kovac, Erste Bank Croatia's chief economist, believes the risk of a repeated election is on the rise, which implies “a further delay of the budget and fiscal agenda that in our view only adds to the weak fundamental profile in that segment”.
Euromoney’s survey has already shown risk-indicator scores falling for bank and currency stability, transparency and government stability this year, and more revisions are expected.
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