Hungary gets a ratings upgrade, Croatia should be next

Increasing demand for beach holidays in Croatia is contributing to the country’s economic growth

This week’s news of Standard & Poor’s upgrading its sovereign borrower rating of Hungary came as little surprise.

Although economic growth is expected to slow down – plus EU funding will decline and there are other concerns for political risk and high public debt – the higher risk rating is justified by a range of macro-fiscal metrics. They include an expanding exports capability, high private savings, real wage growth, low private debt and a flexible exchange rate that can absorb shocks.

The upgrade puts the sovereign borrower on a par with the Philippines and it arrives after a solid upward trend in Euromoney’s country risk survey.

But it also begs the question as to when another star performer in the survey, Croatia, will be next.

The case for Croatia

Euromoney’s crowd-sourced survey has shown improvement to Croatia’s risk profile over time as analysts have upgraded various factors affecting its creditworthiness. That doesn’t mean all risk factors are constantly uprated, but weighting them together to provide a measure of total risk reveals consistent improvement.

The sovereign borrower gained 1.7 points in the survey in 2018, extending a longer-term gradual upward trend, and rose to 59^th in the global rankings to go almost level with Hungary one place above:

Economic growth was robust last year, despite weaker patterns across western Europe, and the latest (interim) forecasts released by the European Commission this week describe how growth in private consumption has not only counteracted the effect of slowing exports, it will continue to do so.

Subdued inflation, low interest rates and an improving labour market should all support consumer confidence to maintain high spending this year.

The country is also witnessing expansion in the tourism industry as demand for beach holidays and city breaks increases, notably with Dubrovnik high on most people’s wish-list, contributing to economic growth and employment.

Consequently, despite slowing, as in other countries across the region, real GDP growth should remain favourable, the Commission predicts, coming in at around 2.7% in 2019 and 2.6% in 2020.

This will further reduce unemployment, while helping to improve the public finances, given lower outlay on benefits and higher tax revenue from those in work.

The harmonized unemployment rate declined to a seasonally adjusted 7.7% at the end of 2018, according to Eurostat, representing a drop of two percentage points in a year.

Meanwhile, Eurostat reports the gross debt burden (EU measure) fell to 74.5% of GDP at the end of September 2018, and the downward trend seems likely to continue in response to the substantial improvement in fiscal management in recent years.

In 2017, Croatia recorded its first budget surplus in 26 years, and the IMF is expecting the budget to be in balance this year, with the debt burden shrinking.

The country has favourable external economic risk indicators, too, including a current account surplus and ample foreign exchange reserves covering more than 160% of maturing short-term liabilities, or up to eight months of import payments, with the external debt-to-GDP ratio also receding.

Plus, the political environment is stable, with the HDZ-led coalition in control facing few opposition threats and favouring closer European integration since Croatia joined the EU in 2013.

It plans to lodge a formal application to join ERM2 – the successor regime to the European Exchange Rate Mechanism – in 2020, cementing pre-existing currency stability. This also provides a waiting room for a couple of years to achieve the convergence criteria for euro membership, although first the country must join the EU’s banking union (a new precondition of membership).

ECR survey contributor, Aljoša Šestanović, a professor at Effectus, a university college for law and finance in Zagreb, recognizes the risks and opportunities offered by Croatia. For example, demographic changes are a key structural risk (a risk factor included in Euromoney’s survey), noting the dangers posed by emigration and negative ageing dynamics.

There are also fiscal risks tied to government guarantees issued for the shipyards facing financial distress.

If the restructuring plan is accepted by the EU “the costs will be borne mainly by the Croatian government,” Šestanović says.

He nevertheless foresees Croatia gaining an investment grade rating: “The public debt is under control and projected to be 70% of GDP in 2019. Consumer price inflation is relatively low, and GDP growth is projected to be the same level as in 2018.”

Šestanović also reiterates the fact there is strong political will for implementing the euro as the national currency in the next few years: “This strategic goal already determines the current monetary policy of the Croatian National Bank (the central bank), with the HRK/EUR exchange rate moving in a very narrow range.”

The banking sector, he adds, is “relatively healthy, with a decent amount of capitalization”.

Other survey contributors tend to agree with this assessment.

And while Croatia is clearly not without its risks, an investment grade rating seems entirely justified.

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