A recovery supported by robust domestic demand

The Croatian economy will record a solid growth rate in 2022, albeit slower than in 2021, as the base effect fades. Domestic demand is expected to remain robust, with household consumption and fixed asset investments contributing to GDP growth. An improved labor market, accumulated savings, and the development of consumer loans will support private consumption. Households’ spending and employment are already benefitting from the strong recovery in the Croatian tourism industry (20% of GDP) in 2021. Indeed, while it remains 22% below 2019 levels, the country recorded a 46% increase in overnight stays from January to August 2021 compared to last year. As a result, the vital summer season decreased the unemployment rate from 8.6% in mid-2020 to 7.3% in September 2021. The 2022 summer season should also support the Croatian economy, especially as the government will likely continue opening the country to foreign tourists. Net exports’ contribution to GDP growth should remain positive, albeit lower because imports increase faster than exports. Nevertheless, the risk of containment measures should be considered for 2022. The vaccination rate lags behind the EU average (46% of the Croatian population is fully vaccinated compared to 66% of the EU average in November 2021). Moreover, the acceleration of household consumption could be limited by a surge in inflation, which hit an eight-year high in September 2021 at 3.3% year-over-year. Increased energy and food prices and pandemic-related supply-chain disruptions have led to growing consumer inflation. While inflationary pressures could ease in 2022, these effects will continue to be felt in the coming months.

The inflow of EU funds will boost investments and, in turn, economic growth. It includes both ‘traditional’ funds from Multiannual Financial Frameworks and the Recovery and Resilience Facility (RRF). Regarding the latter, in July 2021, the European Commission approved a EUR 6.3 billion grant (12.8% of Croatia’s 2020 GDP) for 2021-2026, with Croatia receiving the first payment (EUR 818 million) of this recovery package in October 2021. Funded projects include research and development of self-driving vehicles, investment in broadband access - including infrastructure to develop a 5G network -, energy efficiency and renewable energy projects, and decarbonization initiatives.

Improving public finances amid upcoming euro adoption

Both public deficit and debt are expected to decline in 2022 after an improvement already recorded in 2021. Croatia is focusing on fiscal consolidation to facilitate the euro adoption by 2023. Therefore, the state deficit will drop below 3% as early as 2022. Revenues, especially value-added tax, are expected to grow thanks to rising household and tourist consumption. Expenditures will increase in line with higher public investments co-financed by RRF funding. Nevertheless, while Croatia is among the biggest net beneficiaries of such funding, the effectiveness of EU funds will ultimately depend on the country’s absorptive capacity.

The current account balance is expected to remain in a slight surplus in 2022 after temporarily turning negative in 2020. Merchandise exports will closely follow the economic activity of Croatia’s main trading partners, while the tourism sector will strongly support services export growth. Indeed, the surplus in the services balance will continue to offset the merchandise trade balance deficit resulting from the country’s high import dependence.

Political stabilization but strained relations with its neighbor

The Croatian Democratic Union (HDZ) won the July 2020 parliamentary election. It formed a government coalition with two liberal parties - namely the Croatian People’s Party (HNS) and the Reformists - and the support of eight ethnic minority members of parliament. The coalition has a majority by just one in the 151-seat Hrvatski Sabor (parliament). Before that, in the January 2020 presidential election, former prime minister and center-left candidate Zoran Milanovic defeated the conservative incumbent, Kolinda Grabar-Kitarovic, by winning 52.7% of the vote. The opposition Social Democratic Party (SDP) backed Mr. Milanovic. International relations with Bosnia and Herzegovina strained over several political and geostrategic issues, like the Peljesac bridge. The latter, which will span Bosnia’s maritime access to provide a road connection between the north and south of the Croatian coastline, is continuing and scheduled to be opened in 2022. Nevertheless, economic ties between the two nations remain strong with high trade volumes, while Croatia is the second-largest foreign investor in Bosnia and Herzegovina.