Rating action

Scope Ratings GmbH (Scope) has today upgraded the Republic of Croatia’s (Croatia) long-term issuer and senior unsecured debt ratings to A- from BBB+ in local and foreign currency, and revised the Outlooks to Stable, from Positive. The short-term issuer ratings have been upgraded to S-1 from S-2 in both local and foreign currency, and the Outlooks revised to Stable, from Positive.

The upgrade of Croatia’s ratings reflects the country’s robust fiscal fundamentals, which are expected to remain on a steady improving trajectory over coming years. The public debt-to-GDP ratio is forecast to edge below the 60% Maastricht criterion in 2024 and to remain on a declining trend over the rest of a forecast horizon ending in 2029.

The upgrade furthermore accounts for Croatia’s strong medium-term growth prospects. The implementation of reforms and investments agreed under the country’s Recovery and Resilience Plan (RRP) support near-term economic momentum and are set to yield significant structural improvements. These should allow a continued convergence towards euro-area wealth and productivity averages over coming years and enhance the country’s resilience to external shocks.

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Key rating drivers

Declining public debt levels, track record of fiscal prudence, and strong debt affordability.

Scope expects Croatia’s general government debt-to-GDP ratio to decline to 59.9% by YE 2024, just below the 60% Maastricht criterion, from 63.0% at YE 2023, and further to 59.4% in 2025, before converging to around 55% by end-2029. The debt ratio has declined rapidly from its Covid-19 peak of 86.1% at YE 2020. This favourable trend is underpinned by moderate expected primary deficits, strong debt affordability and a robust nominal growth outlook, with annual growth rates projected at 5.5% over 2024-29.

Scope expects the general government fiscal deficit to widen to 2.6% of GDP this year, from 0.7% of GDP in 2023, due to reduced personal income tax and pension contributions following recent policy changes, along with continued spending pressures from energy-support measures and social transfers. Notably, this also includes an increase in spending following a public sector wage reform under Croatia’s RRP.

Croatia's fiscal deficit is expected to remain broadly stable in 2025 and to improve to around 1.9% of GDP in 2026, driven by the phase out of remaining energy support measures, the restoration of healthcare contribution rates for younger workers, and still-solid revenue growth. This trajectory is underpinned by Croatia’s commitment to fiscal discipline, evidenced by pre-pandemic primary surpluses averaging 2.5% of GDP between 2016 and 2019. Scope notes that Croatia intends to introduce a value-based property tax, although the scope and timing of its implementation is uncertain.

The interest burden is expected to stay broadly stable at around 2.6% of general government revenue until 2029, remaining well below its pre-pandemic level of 4.4% in 2019. Favourable financing rates following euro area accession anchor interest payments at a low level over the forecast horizon.

Robust medium-term growth prospects.

Following a very strong post-pandemic recovery, real GDP growth moderated to 3.1% in 2023, still among the highest in the euro area, despite an unfavourable external environment, a sharp hike in inflation and associated rapid tightening of monetary policy. Growth is expected to remain robust at 3.4% in 2024 and 2.8% in 2025, thus remaining significantly above the euro area aggregate (forecast at 1.0% and 1.6%, respectively).

Domestic demand continues to be the key driver of output growth, reflecting expanding household consumption, amid declining consumer price pressures, dynamic job creations and high wage growth. Business investment is also expected to pick up next year amid gradually loosening funding conditions, while tourism continues to underpin service exports. Scope estimates medium-term potential growth 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 RRP. These measures are expected to drive further convergence in productivity towards the euro area average. In 2023, labour productivity, measured as output per person employed, reached 48% of the euro area average, although it was slightly ahead of some peers in Central and Eastern Europe, including Lithuania (A/Positive, 45%) and Latvia (A-/Stable, 46%).

The country’s total allotment under the EU Recovery and Resilience Facility (RRF) amounts to EUR 10bn (13.2% of 2023 GDP, of which EUR 5.8bn in grants and EUR 4.2bn in loans). Croatia has received EUR 3.7bn in RRF grants, following a fifth disbursement in July 2024, placing it as one of the best performers in terms of RRF absorption, indicating 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 (11.5% of 2023 GDP) earmarked under the EU’s 2021-27 Multiannual Financial Framework.²

Labour participation (at 72% of people aged 15-64 as of Q2 2024, up 6pps from 2019) has grown markedly over recent years, especially among women and older workers. The unemployment rate has continued to decline steadily to 4.9% in August 2024, reflecting strong job creation, with the employment rate standing at record high levels (68.7% as of Q2 2024). Scope expects activity and employment rates to continue converging towards euro area averages, supporting the medium-term growth outlook.

Labour shortages, related to skill mismatches and adverse demographic trends, remain a constraint on the medium-term growth outlook. Scope notes positively that after a protracted period of sizable population outflows, net migration turned positive in 2022, in part thanks to the inflows of Ukrainian refugees. Recent labour market reforms support a smoother integration of foreign workers and have helped alleviate labour shortages in some sectors.

Rating challenges: moderate economic diversification and wealth levels; adverse demographic trends. Croatia’s A- credit ratings remain constrained by: i) the economy’s moderate diversification, particularly its heavy reliance on tourism revenues (approximately 19% of GDP), and moderate wealth levels, with GDP per capita equivalent to about 48% of the euro area average in 2023, making it more vulnerable to external shocks; and ii) 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 Report.³

Outlook and rating sensitivities

The Stable Outlook reflects Scope’s view that risks to the ratings are balanced over the coming 12 to 18 months.

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

1. Croatia’s growth outlook remained strong, leading to structural improvements in the country’s productivity and wealth levels;
    
2. Fiscal dynamics improved at a faster rate than presently forecast, driving an accelerated decline in the public 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 A- 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. Croatian authorities aim to reduce carbon emissions by 45% by 2030 relative to 1990 levels, and to reach 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 compares rather unfavourably 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 2022-23 (+41,863 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. Despite having improved markedly in recent decades, labour market inclusivity remains weaker than peers, as reflected in lower employment rates (65.8% of population aged 15-64, 4.4 percentage points below the EU 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, 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 The ruling Croatian Democratic Union (HDZ) secured a renewed mandate following the April 2024 parliamentary elections, thanks to the support of the Homeland Movement. Scope expects Croatian authorities’ macro-fiscal policy stance to remain broadly unchanged, in particular as regards its commitments to fiscal prudence and to the implementation of structural reforms included in the NRRP.

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 Commission - Recovery and Resilience Scoreboard, Croatia
2. European Commission – 2024 European Semester: Country Reports, 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 4.0), 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 Credit Ratings: Eiko Sievert, Senior Director
The Credit Ratings/Outlooks were first released by Scope Ratings in January 2003. The Credit Ratings/Outlooks were last updated on 3 May 2024.

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, as well as a list of Ancillary Services and certain non-Credit Rating Agency services provided to Rated Entities and/or Related Third Parties.

Conditions of use / exclusion of liability
© 2024 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Ratings UK Limited, Scope Fund Analysis GmbH, and Scope ESG Analysis GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided ‘as is’ without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or other damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party as, opinions on relative credit risk and not a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstraße 5, D-10785 Berlin.