ZAGREB (Reuters) ? Croatia's new centre-left government must focus on reforms to save the country's credit rating and boost the economy before joining the European Union in July 2013, after two-thirds of voters backed EU membership on Sunday, analysts said.
They said there was some relief at the 66 percent referendum "yes" vote, but it was already broadly priced in, and investors wanted to see a viable reform program, possibly backed by a precautionary deal with the International Monetary Fund.
"Investors are likely to be ready to buy Croatia's debt this year as long as they see some form of more comprehensive reform program from the government - perhaps helped by an IMF program," said Timoty Ash of the Royal Bank of Scotland.
"Now, with the EU referendum successfully behind, it might be easier for the government to pursue necessary reforms," he told Reuters.
A pressing task for Prime Minister Zoran Milanovic is to draft a tight budget and avert a credit rating downgrade which would put Croatia in the lowest, speculative investment grade, hike borrowing costs and complicate economic recovery.
"EU membership will boost investment and have a positive impact on growth in a medium- to long-term. However, on a short-term horizon there might be hiccups in economic policies ... a downgrade may follow if the new government fails to implement structural reforms," J.P. Morgan said in a research note.
Last year Croatia's budget deficit exceeded five percent of gross domestic product, the highest level in eight years.
This year the small Adriatic country of 4.3 million tentatively sees the gap at around 3.5 percent of GDP and to cover it the government may combine issuing debt and selling non-strategic assets in the banking and insurance industry.
BUDGET KEY TEST FOR RATING
The government, which wants to pursue reforms on its own and sees an IMF deal as a last resort, has already announced a hike in value added tax to 25 from 23 percent, and a budget draft is expected to be ready by the time Fitch rating agency arrives to assess Croatia's economy on February 1-3.
Moody's and Standard and Poor's are due in the second half of February.
Fitch rates Croatia BBB-, with a negative outlook.
"I think our chances to rescue the rating are a touch above 50-50. There is political will, everyone has acknowledged that spending must be cut, but there is not a lot of time," said Hrvoje Stojic, an analyst at Hypo Bank Alpe Adria.
He said Croatia could even post mild growth this year, despite a bleak outlook for the euro zone's economy, if it goes for "a radical overhaul of the business climate, spending cuts, tax and labor market reforms, public tenders, concessions."
"But we just don't have experience with quick implementation," he said.
The World Bank has forecast a mild economic decline of up to one percent this year.
Raffaella Tenconi of Bank of America-Merrill Lynch also said a stand-by deal with the IMF would be very welcome although Croatia probably would not need to draw any money.
"I think they only need it as an insurance, I don't think they actually need the money. Their issuance needs (this year) are relatively low," she said.
The 2012 budget is likely to be approved by the parliament in February or early March.
(Reporting by Igor Ilic and Zoran Radosavljevic, additional reporting by Sujata Rao in London)
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