Moody's downgrade of Croatia's credit rating is no surprise because this agency kept its ratings one notch above the ratings of the other two leading ratings agencies, analysts say, adding however that this is not a positive sign because of Moody's suspicions regarding the announced implementation of government reforms.
Moody's Investors Service, a ratings agency, on Friday downgraded Croatia's long-term issuer and senior unsecured debtratings to Ba2 from Ba1 and maintained the negative outlook, explaining that the main rationales for the downgrade are a large and increasing public debt and weak medium-term growth prospects.
"This is in fact the adjustment of Moody's ratings with the ratings of the other two agencies. It is not a positive sign, but it is not unexpected either, given that last year Moody's skipped the ratings," said Zrinka Zivkovic-Matijevic, economic research director in Raiffeisenbank Austria.
Now, all three leading ratings agencies -- Moody's, Fitch and Standards&Poor's -- keep Croatia's rating two notches below the investment level with the negative outlook.
Moody's said that one of the key reasons for the lowering was the government's large and increasing debt burden which stood at around 86% of GDP at year-end 2015. Moody's expects it will increase to above 90% by 2018. The government, however, projected in its draft budget that this year's share of the public debt in GDP would be stabilise and it would go down in the following years.
Moody's believes that the process of fiscal consolidation will be slow and halting, and expects a fiscal deficit of around 3.9% of GDP this year, weaker than the 3% of GDP criteria required to exit the European Union's (EU) excessive deficit procedure.
"Reasons for the lowered ratings are a high public debt, the general area of the fiscal policy and a weak economic recovery. Moody's underscored that Croatia needs structural reforms which would encourage economic growth and lower the deficit and the public debt," Zivkovic-Matijevic said.
Moody's expects the new government to face significant challenges in implementing its reform agenda, which is designed to arrest the debt increase and to improve growth prospects. The agency also notes that Croatia is faced with continuing weak medium-term economic growth prospects, which derive from historically low investment and structural rigidities, including a low labour force participation rate, as well as bottlenecks in the absorption of EU funds.
In 2016, the agency expects growth of around 1.5%, while the government's draft budget is based on a 2% GDP growth.
"Projections regarding the 2% GDP growth and twice as high absorption of money from EU funds are pretty optimistic. The budget does not show that this government is prepared to implement reform moves which would enable the solving of deficit and public debt problems, as well as other structural disproportions, primarily the labour marker and the education system," said Luka Brkic, a professor at the Faculty of Political Sciences.
He stressed that the latest Moody's ratings did not make Croatia's position any worse than it had been several months ago.
"We are definitely below the investment ratings and this will not easily be changed," Brkic said.
Apart from reducing Croatia's ratings, Moody's has also kept the negative outlook.
In particular, Moody's notes that the current coalition in parliament between the Patriotic Coalition (led by the Croatian Democratic Union, HDZ) and the newly-formed party MOST (which translated as "Bridge") holds only a slim majority, especially following the latter's loss of four MPs.
"The wide range of political views within the coalition and the relative inexperience of MOST's MPs at the central government level increase the risk that the new government will be unable to sustain majority support in parliament for economic and fiscal reforms. While the new government has popular support for reforms as MOST campaigned on a pro-reform platform, some of the proposed reforms (such as the rationalization of the public administration) already face resistance from different parts of the coalition."
Zivkovic-Matijasevic however said that the government had recently announced its plan aimed at eliminating macroeconomic imbalances because of which Croatia risked corrective action from the European Commission. She added that the plan included measures and deadlines by which the government planned to carry out reforms and reduce the deficit and the public debt.
"If the government implements this plan, Moody's said it could upgrade the country's outlook from negative to stable," Zivkovic-Matijevic said.