RECENT ECONOMIC DEVELOPMENTS
Growth strengthened in 2016 to 2.9% on the back of accelerated private consumption and a rebound of investment after six years of decline. The recovery was broad based, with a surge in industrial production and construction and record-high tourism contributing the most to the accelerated growth.
Labor market performance improved, with a decline of unemployment to 13.8% by September. A high level of emigration (around 54,000 people left the country) and continued outflows from inactivity into early retirement led to declines in labor force participation. Thus, the employment rate remained at a low 44.5%, far below the EU average. Real net wages increased by 3% due to the deflationary and labor market pressures in sectors that face skill shortages.
Fiscal consolidation continued in 2016, with the general government deficit (European System of Accounts methodology) narrowing to below 2% of GDP from 3.3% in 2015. Revenues increased substantially, led by rising tax revenues (especially corporate tax, value added tax, and excises), while spending was restrained due to the temporary financing in effect throughout the first quarter after the general elections and because the government was only provisional until the snap elections in September 2016. Given the robust primary surplus, public debt decreased to 85% of GDP from 86.7% at end-2015. Croatia will likely exit the Excessive Deficit Procedure with the EU in 2017.
Sustaining the fiscal consolidation going forward to reduce public debt will remain challenging. The Government adopted the 2017 budget with a deficit of 2.1% of GDP, relaxing both revenue as well as spending to cater to pre-election promises, amid an optimistic growth projection of over 3%. Debt refinancing needs remain high at 12% of GDP, or 27% of general government revenues over the next three years, requiring tight fiscal policy.
The economy is expected to grow by 2.9% in 2017 and around 2.6% in 2018–19. Growth will be led by strengthened personal consumption, service exports, and investments, benefiting from the EU funds absorption. Personal consumption is expected to intensify, reflecting personal tax reform, the labor market recovery, and a pickup in lending activity. The current account surplus will decline, however, to 1.6%, given the high import reliance of the growth model.
Public finances are projected to continue to improve, with the headline fiscal deficit amounting to 1.7% of GDP in 2017–19, although the structural deficit could grow to 3% of GDP. Positive labor market developments and an increase in real pensions are expected to support the growth of disposable income for all segments of the welfare distribution.
A tax reform package that includes personal tax cuts, with income brackets changed from 12, 25, and 40% to 24 and 36%, along with an increase in non-taxable income of 46%, is expected also to support income growth.
Risks are still skewed to the downside. Although fiscal outcomes are better than expected, the new fiscal expansion and domestic policy uncertainty add to the risks related to slowing the pace of structural reforms and achieving the sustainability of public debt.
Still, high levels of private and public sector indebtedness amid the upcoming monetary tightening and the increased volatility on the financial market are set against the country’s borrowing requirements. Sustained fiscal consolidation and competitiveness reforms are needed to reduce macroeconomic imbalances and protect the nascent recovery.
Last Updated: Apr 20, 2017