The new outlook is the result of "the strides made in aligning (Croatia's) institutions with the European Union and its eventual membership possibly by the end of the decade," said Moody's Assistant Vice President Joan Feldbaum Vidra.
At the end of 2001 Moody's awarded Croatia Baa3 credit rating, and it has not changed since.
Parliamentary elections scheduled for November this year are not expected to significantly affect the medium-term pro-EU policy thrust, although there could be some slippage this year, the agency said.
"The government has been focusing on reducing the high level of euroization of its debt stock by refinancing foreign currency-denominated debt with long-term kuna-denominated instruments," said Feldbaum Vidra.
The high level of euroization of the economy and government debt is a key rating constraint as it renders the country highly vulnerable to exchange rate shocks, the analyst said.
As part of EU accession, Croatia will be required to control the size of its deficits, continue to reduce subsidies and guarantees on debt insurance, reform public administration and the judiciary, restructure loss-making public sector companies such as the shipyards, reform the public health care sector, and make other structural reforms to enhance the competitiveness of the economy and state of public finances, Feldbaum Vidra said.
"Improving the business climate will help encourage FDI and export growth which has lagged behind other transition economies," Feldbaum Vidra said, explaining that Croatia has a bloated public sector, high levels of bureaucracy, red tape, corruption, a weak judicial system and inflexible labour laws.
Croatia's large current account deficit (about 8% of GDP) and external debt (about 85% of GDP) continue to constrain its credit ratings, she said, adding that one main risk to the country's rating outlook stems from the increasing availability of liquidity to the country in part because of its EU prospects and the possible economic excesses high levels of liquidity may cause.
"This heightened risk underscores the need for a considerable restructuring of the economy to ensure faster-paced sustainable growth in order to contain balance of payments pressures," the analyst said.