Croatia: Risk Assessment
Country Risk Rating
Business Climate Rating
- 50% of electricity produced by dams; 20% imported
- Tourism appeal and long coastline
- Oil and gas potential
- Kuna pegged to the euro (60% of bank deposits in euros), with a view to participating in ERM II
- High-quality infrastructure
- High private and public debt
- Inefficient administration and justice system; inadequate regulation
- Weak industrial development; lack of competitiveness
- High long-term and youth unemployment
- Emigration taking away skilled workforce
Activity supported by domestic demand
The economy is expected to record a fourth consecutive strong year in 2019, driven by domestic demand. Because of the labor shortage, household consumption (58% of GDP) will continue to benefit from wage growth, the impact of tourism (25% of GDP, one in ten jobs), expatriate remittances, and the VAT reduction from 25% to 13% on food products on January 1. In addition, inflation is expected to remain low, with energy prices evening out and the pending arrival of a discounter in the food retail sector. When combined with the stability of the kuna, this should allow the central bank to maintain an accommodative policy. Investors, meanwhile, will be heartened by the resolution of the Agrokor case and credit growth, particularly for SMEs. Work on the Peljesac bridge – which will span Bosnia's maritime access to provide a road connection between the north and south of the Croatian coastline – resumed in the summer of 2018. Implementation of European funds is also set to increase, benefiting construction. Exports will get a boost from market share gains in the EU, particularly in the oil, food, medical, lingerie, and control instruments segments. Tourism revenue should remain on a positive trend, although competition from Turkey, Egypt and Tunisia may cast a shadow. However, as imports will be boosted by domestic demand at the same time, trade’s contribution to growth should remain slightly negative.
Fiscal consolidation to continue
The public accounts are expected to be in balance in 2019, and might even show a surplus if interest on debt is excluded. The improvement is based largely on the beneficial effect of growth in revenues, notably from consumption via VAT and employment via social security contributions. Reduced debt service linked to low interest rates and better use of European funds are also playing a part. However, the contribution of economic conditions to performance puts the good result in perspective – a fact that is corroborated by the persistence of the structural deficit, which ignores this aspect. Government wage and procurement bills remain high (18% of GDP between them). Similarly, social transfers (which are not sufficiently targeted), pensions, defense and healthcare spending will continue to weigh heavily on the budget. However, the primary surplus, growth, and low interest rates will be sufficient to provide some relief on the debt, 70% of which is denominated in euros and much of which is held by domestic banks, which are predominantly (90%) subsidiaries of Austrian and Italian groups. The authorities will have to consider the future of the struggling Uljanik shipyards, whose state guarantees are equivalent to more than 1% of GDP and whose 4,500 jobs might justify intervention. State-owned companies, with assets representing 80% of GDP and employing 5% of the labor force, are often low-profit or unprofitable operations, with revenues equivalent to 15% of GDP.
Tourism’s essential role
The current account has been in surplus since 2013. This covers a large deficit (18% of GDP in 2018) in the trade of goods offset by tourism income (19%). In addition, the sum of remittances from expatriates and European funds (about 4% of GDP) exceeds net outgoing dividend and interest payments. Nevertheless, the decline in the current account surplus that began in 2018 is expected to continue in 2019. Strong export and tourism performances are being outweighed by vigorous imports due to the difficulties faced by local industry in meeting demand and the high import content of exports. FDI (3% of GDP in 2018) meets the development needs of tourism and energy resources and compensates for the reduction in external debt. Mostly denominated in euros, external debt (75% of GDP at the end of 2018) represents a risk for non-financial companies (51% of the outstanding amount, including one third for intra-group loans under FDI), the state (39%) and banks (10%). However, the risk is mitigated by the central bank's tight control of the kuna/euro exchange rate. The bank’s interventions to counter kuna appreciation have increased foreign exchange reserves to more than a year of imports.
Fragile government and opposition to reforms
Less than a year after the previous elections, early elections in September 2016 handed power back to the coalition formed by the center-right Democratic Union (HDZ) and the reformist MOST (The Bridge) Party. This coalition soon broke up over the reform agenda. Prime Minister Andrej Plenkovic, who leads the HDZ, has managed to form a new one with liberals from the People's Party (HNS). With 78 seats (including 61 for the HDZ) out of 151, it is weakened by disagreement between the Prime Minister and the nationalist wing of the HDZ. The reform programme is opposed, not only by the main opposition, the Social Democratic Party (SDP), but also within the HDZ. At the international level, relations with Serbia are tense. It is also worth noting the Croatia’s refusal to accept the Permanent Court of Arbitration’s ruling that Slovenia should have access to the sea through the Bay of Piran.