Croatia: Risk Assessment
Country Risk Rating
Business Climate Rating
- 35% of electricity from renewable sources, 40% imported
- Tourism appeal and long coastline
- Oil and gas potential
- Kuna pegged to the euro (76% of bank deposits in euro or indexed to the euro), with a view to ERM II participation in 2020
- EUR 12.6 billion of European structural funds over the 2014-2020 period, or 22% of GDP 2018
- High-quality infrastructure
- Private and public debt still high: public debt service accounts for 14% of GDP
- Institutional gaps: inefficient administration, health and justice, overlapping administrative levels, corruption
- Time-consuming and inefficient insolvency treatment
- Low industrial diversification/lack of competitiveness
- High youth unemployment (23% in January 2019), low participation of women
- Emigration taking away skilled labor, population decline
Activity supported by domestic demand
Despite a slight slowdown, the economy is expected to enjoy satisfactory growth in 2020, driven by domestic demand. With a labor shortage emerging in some sectors and continued growth in employment, household consumption (58% of GDP) is benefiting from wage growth. In addition, the standard VAT rate has been reduced from 25% to 24%, the VAT rate on catering has been cut to 13%, income tax for those under 30 has been reduced or eliminated, and public sector pensions and salaries have been increased. Inflation is expected to remain low. When combined with the stability of the kuna, this should encourage the central bank to maintain its accommodative policy. This, alongside the fall in impaired loans (9.4% in October 2019) and the resolution of the Agrokor bankruptcy, will contribute to the continued recovery of credit. Public consumption should also remain lively. Conversely, investment (21% of GDP) could weaken. However, the implementation of European structural funds is increasing (76% of the 2014-2020 budget used by October 2019), benefiting both the private and public sectors. 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, is continuing with a view to delivery in 2022. Finally, the contribution of trade to growth could turn negative again due to the poor economic performance of the main export markets (oil products, wood, machinery and electrical equipment) and increased competition from other Mediterranean tourist destinations. Medication sales should not be affected. Meanwhile, imports will be boosted by domestic demand.
Debt relief and the essential role of tourism
The public accounts are expected to remain close to balance in 2020 and will be in surplus if interests on the debt are excluded. There is a small risk of slippage due to the holding of parliamentary elections in December 2020. The risk is linked to pressure on wages, particularly for police officers, teachers and carers, as well as to possible support for (highly indebted) railways and hospitals. Use of the state guarantees provided to the Uljanik shipyards (4,500 jobs, 25% state-owned), which are bankrupt and looking for a partner, should not upset the situation, as the largest of these guarantees have already been activated. In addition, the country, which holds the European Presidency in the first half of 2020, will be thinking about entry into the ERM II exchange rate mechanism, the banking union and the Schengen area. Under these conditions, the primary surplus (i.e. excluding interest), sustained growth and low interest rates (spread of 0.8% to 1.2% over the Bund in October 2019) will be sufficient to provide an additional reduction in debt, 65% of which is euro-denominated and of which the domestic share (63%) is held largely by the subsidiary banks of European groups. However, the improvement is heavily based on the beneficial effect of growth on revenues, in particular consumption via VAT and employment via social contributions. The role played by economic conditions in the performance puts the good result in perspective, a fact that is corroborated by the persistence of the structural deficit (0.8% in 2019), which excludes this aspect.
The current account surplus will continue to decline in 2020 in line with the widening goods trade deficit (19% of GDP in 2019). Brisk export and tourism performances are being surpassed by the strength of imports due to the difficulty for local industry to meet domestic demand and the high import content of exports. The services surplus linked to tourism revenues (20%) is no longer expected to be able to compensate for this. In addition, the sum of expatriate remittances and European funds (4% of GDP) approximately equals net outflows of dividends and interest. Foreign direct investment (3% of GDP) meets the development needs of tourism and energy resources, while replenishing foreign exchange reserves (8 months of imports). The latter, together with the kuna’s peg to the euro, which will be strengthened by ERM II membership, reduce the exchange rate risk associated with external debt. Mostly denominated in euros, external debt (70% of GDP at the end of 2019 compared with 75% a year earlier) represents a risk for non-financial companies (53% of the outstanding amount, including 1/4 for intra-group loans), the State (38%), as well as for banks (9%).
Fragile government and strained relations with neighbors
Following the break-up of the coalition formed with the reformist and centrist MOST (“Bridge”) Party, Andrej Plenkovic, prime minister and leader of the center-right Democratic Union (HDZ) managed to form a new coalition with the liberals from the People’s Party (HNS) and the support of independent elected representatives in June 2017. With 82 seats (including 55 for the HDZ) out of 151, it has been weakened by the disagreement between the prime minister and the HDZ’s nationalist wing, and by the HNS’s desire to leave (4 seats). The victory of the social democrat Zoran Milanovic in the presidential election of January 2020 against the outgoing candidate from the ruling party is an important signal in the run-up to the legislative elections scheduled for December 2020.
At the international level, relations are strained with Serbia and also with Bosnia over its Croatian component and the Peljesac bridge. We also note the refusal to accept the ruling of the Permanent Court of Arbitration granting Slovenia access to the sea through the Bay of Piran, which the latter could use to refuse access to the Schengen area.