In the opinion of S&P analysts, "competitiveness challenges constrain Croatia's economic growth potential. These stem in part from a rigid labor market and a large public sector, which both contribute to persistent current account deficits."
"However, the new government formed after the December 2011 elections appears committed to accelerating fiscal consolidation and structural reforms, and we expect these to help improve Croatia's growth prospects," S&P said in a statement on Tuesday.
"The negative outlook reflects our view that there is a one-in-three chance of a downgrade during the next year if the scope and pace of implementation of the reform efforts, particularly in the labor market and public sector, are insufficient to facilitate sustainable economic growth."
The transfer and convertibility (T&C) assessment remained unchanged at 'BBB+', which is the lowest category of ratings at which the agency recommends investments In early March the Fitch agency also affirmed the existing credit rating for Croatia at 'BBB-'.
"The ratings on Croatia are supported by its political stability, its relative prosperity reflected in its per capita GDP of more than US$13,000, and its moderate, though rising, net general government debt burden of just under 50% of GDP."
"The ratings are constrained by weak growth prospects in the absence of more substantial structural reforms, its sizable net (of liquid assets) external debt burden, and high euroization that, along with a rigid monetary regime, constrains monetary flexibility and renders Croatia more vulnerable than peers to external shocks."
The agency forecast Croatia's real economy to shrink by about 1% in 2012.
"This follows two years of economic contraction in 2009 and 2010, before stagnation in 2011. Unlike regional peers that have benefitted from recovery in eurozone trading partners, Croatia's lack of competitiveness and its relatively small non-tourism export base is preventing the economy from recovering."
The agency says that "this is compounded by weak domestic demand, and further exacerbated by its high unemployment rate (the labor survey unemployment rate is around 14%; the registered unemployment rate was about 20% at end-2011)."
"Croatia's competitiveness and its growth potential have been eroded by its large inefficient public sector (which includes many state-owned enterprises), labor market rigidities, and a difficult business environment, along with a prolonged absence of structural reforms due to political maneuverings by consecutive governments."
In the view of S&P analysts "the new government's efforts to improve Croatia's economic competitiveness may fall short if it does not accelerate additional supply-side reform measures."
"We believe that the government's growth strategy--to increase investment by state-owned enterprises backed by external funding from international financial institutions--may temporarily boost domestic demand."
The agency expressed concern, however, that "the government may not address underlying structural weaknesses sufficiently such that investment in the tradable sector is increased in the medium term and the economy's growth potential is restored and fully realized."
"In this context, the government is aiming to increase the current low employment rate of 54% (people aged 15-64) and reduce the high labor-cost burden to the private sector by reviewing Croatia's collective bargaining framework. This will be key to achieving the budgeted savings in the public sector wage bill and to meeting the 2012 budget deficit target."
"We believe failure to frontload structural reforms could soon lead to reform fatigue as recession bites into public support for the government. This may weaken its commitment to policy implementation, especially in the more politically contentious areas of public sector, labor market, and social security reform," the agency said in its report.
It expects the Croatian economy "to grow again in 2013 if the government addresses main economic challenges, if foreign capital inflows strengthen along with Croatia's EU accession scheduled in 2013--which should also serve as an external policy anchor--and if the external environment improves."
"Revenue-side policies include tax reform. One aim is to reduce the cost of labor by a 2% cut to employer health contributions, while increasing the general VAT to 25% from 23%."
"In 2012, in order to boost revenues, the government is planning to privatize two financial sector institutions--a bank and an insurance company--and is also contemplating a property tax. If the budgeted savings are fully executed, we expect the government will meet the minimum requirements of the Fiscal Responsibility Act, which include reducing spending by 1.0% of GDP and narrowing the general government deficit to 4.5% of GDP in 2012 and to 3.0% once Croatia joins the EU. We estimate general government debt of 54% of GDP by end-2012," the agency said, among other things.
(HINA)