Rating action

Scope Ratings GmbH (Scope) has today affirmed the Republic of Croatia’s (Croatia) long-term issuer and senior unsecured debt ratings at BBB+, in local and foreign currency, and revised the Outlooks to Positive, from Stable. The short-term issuer ratings have been affirmed at S-2 in both local and foreign currency, and the Outlooks revised to Positive, from Stable.

The revision of the Outlooks to Positive on Croatia’s ratings reflects the country’s favourable public debt-to-GDP trajectory, anchored by a strong track record of fiscal prudence, favourable growth prospects and robust debt affordability. After increasing temporarily following the Covid-19 shock, the debt-to-GDP ratio has been declining robustly since the second quarter of 2021 to 63% by YE 2023. Scope forecasts the debt ratio to edge just below the 60% Maastricht criterion by the end of this year. The expected, steady decline in the debt ratio is driven by continued high nominal growth, moderate primary surpluses and a relatively low interest burden. Second, Croatia’s economic outlook remains very strong, benefitting from structural improvements derived from an ambitious reform agenda and sizable EU-funded public investments. These will allow for a continued convergence towards euro area income levels and enhance the country’s resilience to external shocks.

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Key rating drivers

Steady improvement in fiscal metrics. The first driver of the revision of the Outlook to Positive on Croatia’s ratings reflects a robust fiscal outlook with a firmly declining public debt trajectory, anchored by a commitment to fiscal discipline, strong debt affordability and favourable dynamics in economic growth.

Croatia’s general government fiscal balance recovered swiftly from a Covid-19 induced 7.3% of GDP deficit in 2020, narrowing to 2.5% of GDP in 2021, and turning to a temporary surplus of 0.1% of GDP in 2022. In 2023, the fiscal balance turned negative to -0.7% of GDP, reflecting normalising revenue growth, temporary outlays on energy support measures and higher wage and social expenditures relating to the inflationary shock since end-2021, with HICP inflation averaging 9.6% over 2022-23. Scope expects the fiscal deficit to widen to 1.9% of GDP in 2024, in line with persistent inflation-related spending pressures and as a result of the impact of recent policy changes weighing on revenue growth, including revaluations in personal income tax brackets and reductions in pension contributions.

Scope expects the fiscal deficit to stabilise at around 1.0% in coming years until 2029. This projected trajectory accounts for expectations of robust revenue growth and is underpinned by the Croatian government’s strong track record of fiscal prudence, as reflected in pre-pandemic primary surpluses (of 2.5% of GDP on average over 2016-19). After turning to moderate deficits in 2024/25 (-0.5% of GDP on average) the primary balance should remain in surplus over the rest of the forecast horizon (averaging at +0.2% of GDP over 2026-29).

In addition, the interest burden is expected to remain low, after having declined markedly in the years leading up to the pandemic (from 3.4% in 2015 to 1.4% of GDP in 2022). This improving trend reversed somewhat last year, in line with the tightening of global funding conditions, resulting in a slight increase in interest payments as a share of GDP (1.7%). Nevertheless, Scope expects net interest payments to remain broadly stable over the medium term at around 2.7% of revenue and thus to remain well-below pre-pandemic averages (4.8% over 2017-19). This is also driven by the positive effects of Croatia’s euro area accession in January 2023 which helped to lower the sovereign’s borrowing costs.

Scope projects that modest primary surpluses, strong debt affordability and robust nominal growth (expected to average 6% per year over 2024-29) will support a steady decline in the general government debt-to-GDP ratio over coming years. The debt ratio declined to 63.0% by YE 2023, down from 67.8% in 2022 and 86.1% in 2020, its recent peak. It expected to decline to 59.4% this year, and thus below the 60% Maastricht criterion, and to conclude the forecast horizon at around 53% at YE 2029. Croatia’s projected debt-to-GDP ratio thus outperforms that of ‘BBB’ rating category sovereign peers, for which Scope projects more moderate declines in the debt ratio on average over the same period to an average of around 80% of GDP.

Robust medium-term economic outlook. The second driver of the revision of the Outlook to Positive on Croatia’s ratings relates to the country’s robust medium-term growth prospects, supported by the government’s commitment to structural reforms and sizable EU fund inflows.

Croatia’s post-pandemic economic growth performance compares favourably to peers, with real GDP in Q4 2023 standing around 16% above its Q4 2019 level, against 3.5% for the euro area. Real GDP growth remained strong last year, at 3.1%, one of the highest rates in the EU. The economic momentum benefited from very strong tourism exports, supported by the country’s recent euro and Schengen area accessions. Private consumption remained robust, driven by a significant rebound in real wages (up 6.4% in 2023) and a resilient labour market (total employment up by 2.5% in 2023). These factors, combined with high EU-funded public investment, outweighed pressures related to weak growth among Croatia’s main trading partners (among which Germany and Italy) and tighter funding conditions, in line with euro area peers. Growth outperformance has significantly accelerated the country’s convergence to EU wealth levels, with its GDP per capita (in purchasing power parity terms) increasing to around 76% of the EU average as of end-2023, up 10pps from 2019.

Scope forecasts real GDP growth will remain robust this year, at 3%, reflecting significant positive carry-over effects and strong consumption, underpinned by continued employment growth and improvements in purchasing power. Growth should gradually converge to its medium-term potential in subsequent years, estimated at 2.8% annually.

Over the forecast horizon, Croatia’s economic outlook benefits from structural improvements related to reforms and public investments, including policies outlined under Croatia’s National Recovery and Resilience Plan (NRRP). The country’s total allotment under the EU Recovery and Resilience Facility (RRF) amounts to EUR 10bn (around 13% of 2023 GDP, of which EUR 5.8bn in grants and EUR 4.2bn in loans). Croatia had received EUR 3.5bn in RRF grants (more than half of its allocation), following a fourth disbursement in April 2024, placing it as one of the best performers in terms of RRF absorption. This contrasts with the country’s previously relatively moderate track record in EU funds absorptions and signals significant progress made in public procurement.¹ Croatia’s growth outlook will also benefit from sizable funding under various other EU programmes, including EUR 8.7bn in cohesion policy funding (11.4% of 2023 GDP) earmarked under the EU’s 2021-27 Multiannual Financial Framework.²

Following April 2024 legislative elections, Scope expects broad policy continuity and continued ambitious structural reforms over coming years. Planned policies cover measures aimed at bolstering Croatia’s business and regulatory environment, improving the efficiency and transparency of the public administration system, and implementing active labour market policies. Investments planned under the NRRP will support the digitalisation of the economy and the development of key physical infrastructure, in particular fostering the decarbonisation of the Croatian economy and reducing its reliance on fossil fuels.

Rating challenges: moderate economic diversification; adverse demographic trends; and relatively high public debt, although with a firmly declining trend. Croatia’s BBB+ credit ratings remain constrained by: 1) the economy’s low degree of diversification, in particular related to its relatively high reliance on tourism revenues (amounting to about 19% of GDP), making it more vulnerable to adverse external developments and creating constraints to its convergence to euro area income levels; 2) adverse demographic trends, resulting in pressures on potential growth via growing labour supply constraints and additional fiscal costs, which are expected to increase by 0.8pps of GDP over 2022-30 according to the European Commission’s latest Ageing Report³; and 3) relatively high public debt levels versus peers, albeit with a robust, declining trajectory since end-2020.

Outlook and rating sensitivities

The Positive Outlook reflects Scope’s view that risks to the ratings are skewed to the upside over the coming 12 to 18 months.

Upside scenarios for the ratings are (individually or collectively):

1. Croatia’s growth outlook remained strong, for example reflected by improvements in economic diversification, and/or productivity and wealth levels;
    
2. Fiscal dynamics remain favourable, driving a sustained decline in the general government debt-to-GDP ratio.

Downside scenarios for the rating and Outlooks are (individually or collectively):

1. The economic outlook weakened materially, due to, for example, a negative external shock with negative repercussions on key trading partners;
    
2. Fiscal dynamics deteriorated significantly.

Sovereign Quantitative Model (SQM) and Qualitative Scorecard (QS)

Scope’s SQM, which assesses core sovereign credit fundamentals, signals a first indicative credit rating of ‘a-’ for Croatia. Under Scope’s methodology, the indicative rating receives 1) a one-notch positive adjustment from the methodological reserve-currency adjustment; and 2) no negative adjustment from the methodological political-risk quantitative adjustment. On this basis, a final SQM quantitative rating of ‘a’ is reviewed by the Qualitative Scorecard (QS) and can be changed by up to three notches depending on the size of Croatia’s qualitative credit strengths or weaknesses compared against a peer group of sovereign states.

Scope identified the following QS relative credit weaknesses for Croatia: 1) macro-economic stability & sustainability; 2) current account resilience; 3) environmental factors; 4) social factors; and 5) governance factors. Conversely, Scope did not identify QS relative credit strengths for Croatia. On aggregate, the QS generates a two-notch negative adjustment for Croatia’s credit ratings, resulting in final BBB+ long-term ratings. A rating committee has discussed and confirmed these results.

Environment, social and governance (ESG) factors

Scope explicitly factors in ESG issues in its ratings process vis-à-vis the sovereign-rating methodology’s stand-alone ESG sovereign-risk pillar, which holds a significant 25% weighting under the quantitative model (SQM) and 20% weight under the methodology’s qualitative overlay (QS).

In the sovereign ESG pillar’s environmental risk sub-category, Croatia’s performance compares broadly favourably with that of indicative sovereign peers. This is due to positive scores concerning the Croatian economy’s carbon intensity (as measured by CO2 emissions per units of GDP), and above average marks as regards its exposure to natural disaster risk, its footprint of consumption relative to available biocapacity and the country’s level of greenhouse gas emissions per capita. The government is aiming for a 45% reduction in carbon emissions by 2030 relative to 1990 levels and net carbon neutrality by 2050. Croatia’s share of renewable energy in final energy consumption stood at 29% in 2022, higher than the EU’s 23%. A full phase-out for coal is planned by 2033. Nearly 70% of Croatia’s electricity is generated from renewables, mainly from hydropower. Environmental policies and challenges are considered under a QS assessment of ‘environmental factors’, which is evaluated as ‘weak’ versus the sovereign peer group, to account for the Croatian economy’s higher exposure to climate risks, resulting from a comparatively higher importance of agriculture, tourism and energy sectors.

The country’s performance across key social factors is weak relative to peers. Croatia’s SQM score reflects an ageing society via an elevated and increasing old-age dependency ratio compared to peer economies. Croatia experienced positive net migration in 2022 (+11,685 persons), following a protracted period of significant outflows (averaging around 12,000 persons annually over 2013-21). Income inequality – captured by the ratio of the income share of the 20% of persons with the highest household incomes to the 20% of persons in society with the lowest household incomes – is low in an international comparison and similar to that of Croatia’s sovereign peer group. Labour force participation of around 70% of the active labour force (ages 15-64) is below the euro area average of around 75% and the peer group average. The EC’s Digital Economy and Society Index 2022, which ranks the EU-27 countries according to digital competitiveness, puts Croatia in 22nd place (below average), highlighting challenges in developing the labour force’s digital skills. Overall, the ‘social factors’ component of the QS assessment is evaluated as ‘weak’ to account for the country’s weak social outcomes relative to its sovereign peers.

Finally, under governance-related factors, Croatia has average performance compared to peer member states in Central and Eastern Europe as assessed under the World Bank’s Worldwide Governance Indicators. Croatia’s EU and euro area memberships enhance credible macroeconomic policymaking and a stable governance framework. The ‘governance factors’ component of the QS is assessed as ‘weak’, to account for rating challenges associated with a moderate institutional capacity, including limits to judicial system efficiency. This is reflected in comparatively lengthy legal resolution processes for commercial and civil cases (twice the EU average) and low levels of trust in judges’ independence (the lowest in the EU).⁴ The country compares unfavourably to sovereign peers as regards the primacy of the rule of law and the persistence of corruption, as reflected in weak rankings in the World Justice Project’s Rule of Law index (25th in the EU) and Transparency International’s Corruption Perceptions Index (57th globally).^5,6

Rating committee
The main points discussed by the rating committee were: i) Croatia’s economic outlook and medium-term growth potential; ii) fiscal and debt-sustainability developments; iii) external-sector vulnerabilities; iv) banking-sector and non-financial private sector balance sheet developments; v) ESG considerations; and vi) peer comparisons.

Rating driver references
1. European Parliament, Policy Department for Structural and Cohesion Policies – Absorption rates of Cohesion Policy funds
2. European Commission – Cohesion Open Data Platform, Croatia
3. European Commission – 2024 Ageing Report
4. OECD - Economic Surveys: Croatia 2023
5. World Justice Project – Rule of Law Index 2023
6. Transparency International – Corruption Perceptions Index 2023

Methodology
The methodology used for these Credit Ratings and/or Outlooks, (Sovereign Rating Methodology, 29 January 2024), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The model used for these Credit Ratings and/or Outlooks is (Sovereign Quantitative Model Version 3.0), available in Scope Ratings’ list of models, published under https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. Also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Credit Ratings were not requested by the Rated Entity or its Related Third Parties. The Credit Rating process was conducted:
With Rated Entity or Related Third Party Participation     NO
With access to internal documents                                   NO
With access to management                                            NO
The following substantially material sources of information were used to prepare the Credit Ratings: public domain.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting these Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and/or Outlooks and the principal grounds on which the Credit Ratings and/or Outlooks are based. Following that review, the Credit Ratings and/or Outlooks were not amended before being issued.

Regulatory disclosures
These Credit Ratings and/or Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlooks are UK-endorsed.
Lead analyst: Julian Zimmermann, Associate Director
Person responsible for approval of the rating: Eiko Sievert, Director
The Credit Ratings/Outlooks were first released by Scope Ratings in January 2003. The Ratings/Outlooks were last updated on 26 May 2023.

Potential conflicts
See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings.

Conditions of use / exclusion of liability
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