"Croatia's economic performance has been weak compared to its central and southern European peers, especially since 2009. This reflects its competitiveness challenges, which will also mute this year's recovery from the past six years of recession," said Atsi Sheth, Senior Vice President and co-author of the report released on Thursday.
The credit rating agency says the report is an update to the markets and does not constitute a rating action.
Moody's expects Croatia's GDP to grow by 0.3% in 2015, after an annual average growth of -2.1% between 2009 and 2014.
The report notes that high external debt is also a sovereign credit constraint, although the improved current account balance coupled with the central bank's management of reserves and the exchange rate mitigate balance of payments risks.
"Government's finances have deteriorated over the last six years. Weak government revenues, rigid expenditures and costs associated with unprofitable state-owned enterprises have raised government debt to 85% of GDP in 2014, from 36% in 2008, as fiscal deficits averaged about 6% of GDP annually between 2009 and 2014, from under 3% in 2008. The negative outlook on Croatia's rating is based on Moody's view that low GDP growth will impede efforts to meet the government's fiscal targets, which have been set in line with the EU's Excessive Deficit Procedure. Consequently, fiscal metrics may stabilise over the medium term at weaker levels than its peers," Moody's says, adding that a worsening in Croatia's fiscal, growth and external vulnerability metrics could put downward pressure on the rating.
"On the other hand, the rating outlook could return to stable if economic recovery strengthens and is accompanied by narrower fiscal deficits and falling government debt ratios," the agency concluded.