The Fitch Ratings agency has affirmed Croatia's long-term foreign and local currency issuer default ratings at 'BB' with negative outlooks.
"The ratings balance Croatia's high government and external debt loads and weak growth performance, against favourable governance indicators and relatively high per capita GDP," the agency said in a statement on Friday.
It said that last year's budget deficit of 3.2% of GDP was better than expected, underpinned by improved tax compliance and the economy's return to positive growth. This year the deficit is expected to narrow further to 2.6% of GDP.
However, public debt remains very high and is forecast to reach 86.3% of GDP in 2018.
The agency noted that political risk had risen since its last review in January 2016.
"Some progress on the planning of key reforms was made by the Oreskovic government, which could allow a new government to take action quickly. However, regional elections scheduled for May 2017 may delay politically difficult reforms. Moreover, an outright victory for either the HDZ or SDP is highly unlikely. Fitch expects the next government to be a coalition between one of the two largest parties and MOST. This could achieve significant reforms, but it may not prove durable, as demonstrated by the previous HDZ-MOST administration," the statement said.
The growth outlook, in the near and long term, remains a rating weakness. Last year's growth rate of 1.6% was quite weak, and this year it is forecast to reach 1.8% and average 1.9% in 2017-18.
"Potential growth is estimated at 1%-2% per year, a very low rate for a country at Croatia's income level," the agency said, warning that Croatia might fall further behind better-performing Central and Eastern European countries.
"Croatia's low potential growth rate reflects a large and inefficient public sector, slow resolution of bad loans, weak progress on structural reform and a challenging demographic outlook."
The negative outlook reflects the agency's view that the rating might be downgraded if the public debt-GDP ratio is not put on a sustained downward path, as a result of policy direction, fiscal underperformance, rising financing costs, or weaker nominal GDP growth.
On the other hand, the outlook might be revised to stable if progress on fiscal consolidation leads to greater confidence that public debt/GDP will decline over the medium term and in the case of strengthening growth prospects and competitiveness, particularly through the implementation of structural reforms.
Two weeks ago, the Standard & Poor's rating agency also affirmed Croatia's credit rating with a negative outlook. All three leading rating agencies -- S&P, Moody's and Fitch -- keep Croatia's rating two notches below investment grade with a negative outlook.