"Moody's action on the City of Zagreb reflects the close financial and operational linkages between the state and local governments in Croatia. Zagreb is highly dependent on intergovernmental revenues in a form of shared taxes and central government transfers, representing around 70% of operating revenues in 2011", said Gjorgji Josifov, Assistant Vice President and lead analyst for this credit.

Despite having planned with more conservative budget assumptions, if Croatia's macroeconomic conditions deteriorate, this would impact the revenues of the City of Zagreb and will make its fiscal consolidation goals more difficult to achieve, Moody's said.

This action follows Moody's decision to change the outlook of the sovereign bond rating of Croatia to negative from stable on 31 May 2012.

The agency also said that any deterioration of Croatia's rating would determine a downward change of Zagreb's rating. Further downward pressure could be also influenced by a deterioration in the city's operating performance and growth in overall debt exposure, the agency said.

On the other hand, any stabilisation or positive change of the sovereign rating could determine upward pressure on the City of Zagreb, only if associated with a significant improvement in the city's budgetary performance and liquidity position combined with sustained decrease in net direct and indirect debt, the agency said.