Morningstar DBRS Assigns "A" Credit Rating to Republic of Croatia, Stable Trend

DBRS Ratings GmbH (Morningstar DBRS) assigned Long-Term Foreign and Local Currency - Issuer Ratings of "A" to the Republic of Croatia. At the same time, Morningstar DBRS assigned Short-Term Foreign and Local Currency - Issuer Ratings of R-1 (low). The trend on all credit ratings is Stable.

KEY CREDIT RATING CONSIDERATIONS
Croatia's credit ratings are underpinned by its credible policy framework and membership in the European Union (EU) and the Euro Area. The credit ratings assigned also reflect Croatia's robust economic growth performance, its strong fiscal track record, and comparatively low and declining public debt. These strengths are balanced against the country's small economy with heavy reliance on tourism, its declining and aging population, and labour productivity well below the EU average. Croatia's low GDP-per-capita and the small and open nature of its economy exposes the country to external shocks, though its strong economic prospects will likely continue to enable wealth and productivity convergence with EU peers.

The Stable trend reflects Morningstar DBRS' view that Croatia's strong economic growth outlook, and its prudent fiscal policies and low public debt mitigate risks stemming from a potential temporary increase in fiscal deficits amid a challenging macroeconomic and geopolitical environment. The economy is expected to continue to outperform regional peers. The IMF forecasts Croatia's real GDP to grow on average by roughly 3% each year, well above the euro area average. The main downside risk to Croatia and to the EU stems from the barriers to global trade that result from U.S. tariff policy. Although Croatia's direct trade exposure to the U.S. is low, the economy is still exposed to indirect effects from slower aggregate demand across Europe.

CREDIT RATING DRIVERS
The credit ratings could be upgraded if income-per-capita in Croatia materially converges with the EU average. A significant reduction in the public debt-to-GDP ratio would also be credit positive. The credit ratings could be downgraded if a worsening of the medium-term growth outlook or weaker fiscal discipline result in a sustained increase in the public debt ratio.

CREDIT RATING RATIONALE
Croatia's Economy Expected to Continue to Outperform European Peers

The Croatian economy grew by 3.8% in 2024, well above average euro area expansion of 0.7% and above Croatia's 3.4% average annual growth rate each year since 2015. The performance has been bolstered by strong domestic demand and healthy tourism receipts. Growth momentum will likely slow over the next few years due to still above target inflation and weaker income growth. That said, the Croatian Central Bank (CNB) expects economic activity in Croatia to remain comparatively strong, expanding by 3.0% on average from 2025-2027. Strong tourism flows, healthy employment conditions, still positive real wage growth, and continued investments linked to the Recovery and Resilience Plan (RRP) are the main economic drivers.

Recent reforms help alleviate the economy from structural features that constrain output potential and restrain even faster economic convergence. These includes the country's declining population and sluggish productivity growth, with output per capita at roughly 54% of the EU average in 2024. Croatia's 3.9 million population in 2023 declined by roughly 15% since 2000. However, the number of investments and reforms linked to RRP could support medium-term growth. Total funding from RRP of roughly 13% of GDP represents the second largest investment envelope among EU member states (after Greece). Croatia has a strong record absorbing EU funds. The money is linked to energy investments, key reforms to the education sector, and labour market reform meant to liberalize regulated professions. These efforts combined with growing labour immigration are aimed to strengthen growth potential and encourage growth prospects. This supports the positive adjustment in the "Economic Structure and Performance" building block assessment.

Persistent Geopolitical Tension and Global Trade Uncertainty Would Indirectly Affect Croatia's External Sector

The primary downside external risk to the Croatian economy stems from geopolitical tension and uncertainty around changes in global trade. Croatia's direct trade relationship with the U.S. is low, though the economy would be affected by the indirect effects from a worsening of consumer sentiment in continental Europe. This could strain Croatia's important tourism sector, which accounts for roughly one-fifth of total economic output. Likewise, roughly one-quarter of Croatia's goods exports are directed to Germany and Italy. This makes Croatia vulnerable to an economic downturn among its larger European partners. Nevertheless, the economy has reduced its external debt. Croatia's net international investment position improved to 23% of GDP as of the third quarter 2024, from 80% in 2015, and the IMF forecasts the country's current account will remain in modest surplus over the duration of its forecast period. The expansion of an LNG terminal and its connectivity to central Europe is expected to advance energy exports.

Public Finances Benefit from a Track Record of Fiscal Prudence and Compliance with EU Guidance

Croatia's general government fiscal deficit has slightly deteriorated since it posted a balanced position in 2022. The deficit widened from its 0.9% of GDP result in 2023 to 2.1% in 2024. The fiscal result balances strong revenue generation from healthy economic growth against remaining cost-of-living support measures to offset the lingering effects from the 2022 energy price shock - including the electricity price cap and lower excise duties on fuel and toll roads - and the costs associated with wage bill reform implemented last year. According to its 2025 Budget, the government targets net expenditure growth of 6.3% in 2025 and for the fiscal deficit to remain at 2.1% of GDP. This is compliant with the new EU economic governance framework and the medium-term fiscal structural plan. Defence spending is set to increase from 2.0% of GDP in 2024 to 2.5% by 2027. The budgetary plan also includes policy changes to gradually improve on fiscal outcomes, including additional revenue (taxes on property and changes to personal income and value added taxes) and contained expenditure (increased pension indexation). The IMF expects the deficit to narrow to 1.5% of GDP by 2027.

The country's public debt to GDP ratio remains on a downward path over the next few years thanks to expected strong nominal economic growth and contained primary deficits. Despite higher interest rates in recent years, the IMF forecasts debt servicing costs to average 1.3% of GDP over its five-year horizon. Contained debt affordability is the result of effective debt management. General government gross debt is set to decline from 61.8% of GDP in 2023 to 57.3% last year and 56.0% next year, according to the EC forecasts. If achieved, this would constitute nearly 30 percentage points decline in the debt ratio since the 2020 peak of 86.1%, and roughly 14 percentage points below the pre-pandemic high of 70.4% in 2019.

The Banking Sector's Record Profits and Capitalisation Support Financial Sector Resilience

Banks operating in Croatia booked record-high profits in recent years and remain highly capitalised and liquid. This has increased financial sector resilience at a time when Croatia's strong economic fundamentals are being stressed by heightened geopolitical uncertainty. The main risks to the financial sector stem from a deterioration in economic conditions and the prospect of elevated inflationary pressures. Persistently high interest rates could have an adverse effect on domestic private sector debt servicing that would weigh on bank asset quality. The rapid rise in real estate prices, up 56% from Q3 2020 to Q3 2024, points to vulnerability to price reversals. The Financial Action Task Force (FATF) placed Croatia on its `Grey List' of enhanced monitoring in 2023 to reflect deficiencies in the country's prevention of money laundering and terrorism financing. This increases financial sector reputational risk and supports the negative adjustment to the "Monetary Policy and Financial Stability" building block assessment.

However, various factors enhance the resiliency of the financial sector. These include robust domestic economic growth, low debt levels among households and non-financial corporates, a propensity of fixed rate bank lending, ample capital buffers, and a strong starting position on bank asset quality. Non-performing loans declined to 1.8% at end-2024, down from 4.3% at end-2019. Further boosting the resilience of the banking sector is the Croatian National Bank's (CNB) macroprudential policy. With its gradual build-up of counter-cyclical capital buffer since 2022, the CNB has created room to execute counter-cyclical action to support the banking sector in the event of a sudden economic shock.

Election Results Last Year Mostly Offers Governing Continuity

The centre-right conservative Croatian Democratic Union (HDZ) emerged victorious again from the parliamentary election in April 2024, winning a 61-seats plurality of the 151-seat unicameral assembly. By May 2024, Prime Minister Andrej Plenkovi¿ and his ruling HDZ agreed on a governing coalition with the far-right nationalist Homeland Movement (DP), which won 14 seats and played the role of coalition kingmaker. Plenkovi¿ will serve as PM for the third consecutive time, which allows a degree of policy continuity despite the inclusion of the DP in the current government. The DP campaigned on an anti-immigration platform, as defender of traditional family values, and against allowing the minority Serb party from joining any future coalition. The new coalition's governing program focuses on macroeconomic stability, addressing depopulation, key capital investment such as rail infrastructure, securing the border, and tackling corruption. While World Bank governance scores for Croatia on Government Effectiveness (75.5 percentile rank score in 2023) and Voice and Accountability (65.7 percentile rank score in 2023) have gradually increased in recent years, the percentile rank score on Rule of Law (59.4 in 2023) has gradually declined.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
ESG considerations had a significant effect on the credit analysis.

Social (S) Factor
The following Social factor had a significant effect on the credit analysis: Human Rights and Human Capital. Croatia's GDP per capita, at USD 23,380 in 2024, remains relatively low compared with its European peers. Despite the comparatively lower economic productivity, respect for human rights is high. Morningstar DBRS has taken this factor into account in the Economic Structure and Performance building block.

The following Governance factor had a significant effect on the credit analysis: Institutional Strength, Governance, and Transparency. In the World Bank's Worldwide Governance Indicators (WGI), Croatia's percentile rank score for Rule of Law deteriorated to 59.4 in 2023 from 61.9 in 2019. Morningstar DBRS has taken this factor into account in the Political Environment building block.

There were no Environmental factors that had a relevant or significant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (13 August 2024) at https://dbrs.morningstar.com/research/437781.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments at: https://dbrs.morningstar.com/research/452584.

EURO AREA RISK CATEGORY: LOW

Morningstar DBRS notes that the above press release was amended on 30 April 2025 to include the disclosure on a newly rated issuer and update the title of the ESG methodology.

Notes:
All figures are in euros unless otherwise noted. Public finance statistics reported on a general government basis unless specified.

The principal methodology is the Global Methodology for Rating Sovereign Governments (15 July 2024) https://dbrs.morningstar.com/research/436000. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings, https://dbrs.morningstar.com/research/437781 in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

The sources of information used for this credit rating include the Ministry of Finance (2025 Draft Budget; National Medium Term Fiscal Structural Plan, Investor Presentation February 2025), National Bank of Croatia (Bulletin March 2025; Spring 2025 Macroeconomic Projections; Financial Stability Report June 2024), Croatia Bureau of Statistics, European Commission (Autumn 2024 Economic Forecast; 2024 Country Report - Croatia; Opinion on Draft Budgetary Plan 2025), European Central Bank, European Banking Authority, Eurostat, Bank of International Settlements, Organisation for Economic Co-operation and Development, IMF (WEO and IFS), World Bank, the Social Progress Imperative (2024 Social Progress Index), and Macrobond. Morningstar DBRS considers the information available to it for the purposes of providing this credit rating to be of satisfactory quality.

This credit rating concerns a newly rated issuer. This is the first Morningstar DBRS credit rating on this issuer.

With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, this is an unsolicited credit rating. This credit rating was not initiated at the request of the issuer.

With Rated Entity or Related Third-Party Participation: NO
With Access to Internal Documents: NO
With Access to Management: NO

Morningstar DBRS does not audit the information it receives in connection with the credit rating process, and it does not and cannot independently verify that information in every instance.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS' outlooks and credit ratings are under regular surveillance.

For further information on Morningstar DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication. For further information on Morningstar DBRS historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

The sensitivity analysis of the relevant key credit rating assumptions can be found at: https://dbrs.morningstar.com/research/452579.

This credit rating is endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Jason Graffam, Senior Vice President, Global Sovereign Ratings and Financial Institutions Group
Rating Committee Chair: Nichola James, Managing Director, Global Sovereign Ratings
Initial Rating Date: 25 April 2025
Last Rating Date: Not applicable as there is no last rating date

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