Despite Political and Economic Instability, Croatia Garners Ratings Higher Than Other Emerging Markets

But even with European ties and agency ratings, it can't generate support from the investor community.
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Russia dove. Kosovo erupted. Recession looms. Not exactly an ideal recipe for boosting investor confidence in the Balkans.

And yet Croatia, where President Franjo Tudjman is being investigated for possible war crimes in Bosnia-Herzegovina, garners investment-grade ratings from big international credit agencies like

Moody's Investors Service

and

Standard &Poor's

. True, the agencies might maintain negative outlooks, but the country still gets a higher rating than many other emerging economies.

The case for Croatia got a little better on Tuesday. Economy Minister Nenad Porges announced his country would follow all regulations covering trade in audio-visual services observed by the

European Union

members. Audio-visual services is the last sector hurdle in Croatia's

WTO

bid.

With yields of 13.33% on bonds due 2006 and 13.05% on the 2010s, Croatia's floating-rate notes are generally considered cheap. By comparison, Mexican junk-rated global bonds due 2007 trade at 9.86%.

Even with the backing of the powerful ratings agencies and its tighter ties with Europe, however, Croatia can't win meaningful support from the investment community.

"In my opinion, the ratings agencies are way out of line," said Natalie Dempster, an analyst at

Chase Securities

in London who maintains an underweight position on Croatia.

The key to Croatia's enviable investment-grade ratings -- Moody's gives it a Baa3, while S&P gives it BBB- -- is its relatively low external debt burden, says Moody's. S&P estimates general government debt and net public external debt totals 30% of GDP, in line with triple-B category sovereigns.

Detractors, however, point out that similarly rated countries, like Lithuania, have significantly lower debt-to-GDP ratios and that Croatia's debt is rising. The country's postwar reconstruction bill is estimated at $37 billion by the government, but it could be much higher, according to Croatian economist Branimir Lokin.

To finance this Goliath undertaking, Croatia has tapped the international capital markets. And in addition to its own debt offerings, Croatia is responsible for 29.5% of former Yugoslavia's commercial bank debt which was proportionally split among the successor states.

Recent history has also helped abrade the Croatian economy. Another war -- this time in neighboring Kosovo -- hit the vital tourism sector, which accounted for 15% of GDP before April. By some estimates, tourism income has dropped by as much as 50%.

While Croatia's closer ties with the West and possible integration into the global economy should, in the clean books of theory, bring about greater pro-market reforms, investors remain skeptical.

With the popularity of Tudjman's party, the nationalist

Croatian Democratic Union

(HDZ), dipping to its lowest ever, with about a 20% approval rating, economic reforms might pick up domestic support if the opposition wins December's parliamentary elections. Even with a victory, however, Tudjman, whose presidential mandate doesn't run out until 2002, might shut the opposition down. As recently as 1995, Tudjman used his office to block the confirmation of an opposition mayor in Zagreb who was deemed a national security risk.

In the short term, investors should anticipate a continued economic downturn as reforms take a backseat to postelection power struggles.

"Despite being an investment-grade credit, I much prefer the single-B

rated Bulgaria," said Andrew Kenningham, senior economist at

Merrill Lynch

in London.

Buyers of Croatia, however, will need patience and hope that, come December, Croatia can move from Tudjman's control into an era of integration and prosperity -- ultimately, into proper investment-grade status.