Standard & Poor’s Cuts Croatia’s Rating to Junk

Croatia had its sovereign debt rating cut to junk by Standard & Poor’s, which said the country’s structural and fiscal overhaul is insufficient to promote growth and make government finances more sustainable.

Croatia’s long-term credit rating was lowered one step to BB+, the highest non-investment level, and its short-term grade also fell one level to B, stated S&P in a statement. The ratings carry a stable outlook, balancing the positive effects of Croatia’s EU accession, benefiting from EU structural, cohesion funding and expecting FDI influx, against S&P’s view of limited “major growth” and “competitive-enhancing reforms.

The country will review its 2013 budget, call off plans for a debt sale early next year and will consider working with the International Monetary Fund, Finance Minister Slavko Linic (SDP) said in a press conference after the S&P announcement. “This will make a difficult situation worse,” Linic said.

Given Linic’s strong political influence regarding national fiscal policy, concentration on fiscal discipline, and determination to stabilise the country’s finances, his immediate reaction to the S&P decision can be viewed as a sign that the government will quickly review its 2013 State Budget soon after the New Year, regardless of the political ramifications of such a decision. Also, it can serve as additional external pressure in the government’s negotiations with public services unions to significantly reduce the salary and benefits guaranteed by national collective bargaining agreements.

As expected, opposition parties have used the decision to strongly attack the coalition government. The reaction from the government coalition partner, the Croatian People’s Party (HNS), who publicly criticised the government regarding the continued support of monopolies in the public sector and focus on the increase of tax burdens, was somewhat unexpected. This criticism by the HNS expresses a serious disconnect between the ruling coalition regarding economic policy between Linic’s fiscal consolidation and government economic control through state-owned companies vs. the HNS’ more liberal economic policies of the promotion and incentives towards the private sector. President Ivo Josipovic stated that this was a serious warning to the government that structural reforms must be quickly implemented.

The S&P statement ended with a synopsis of what would influence their future decision for raising their rating, meaning “strong progress in reducing economic imbalances, particularly the reliance on external financing, and the implementation of growth-enhancing structural reforms”. Practically, this means that the government needs to cut government/public spending, especially to non-growth areas, quickly “jump-start” state growth focused projects and privatisations (e.g. Croatia Osiguranje, HPB, PlominC, Zagreb Airport Terminal, etc.), and reduce tax and Para fiscal taxes towards the private sector. Conversely, S&P also stated that they would consider lowering the ratings if the government failed to reduce the structural rigidities in the economy (e.g. high taxes on private sector, extensive bureaucracy, inflexible labour legislation, etc.), external imbalances widen (i.e. external debt, stagnant EU economic recovery), or there is a significant deviation from budgetary targets. Given the government’s focus on fiscal consolidation, they should be able to control budgetary targets.

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