RECENT ECONOMIC DEVELOPMENTS
Growth strengthened to 3% in 2016 on the back of a record high tourist season, accelerated private consumption, and a rebound of investment after six years of decline. Growth continued in the first half of 2017 at 2.7% on a four-quarter basis. The recovery was broad based, with a surge in industrial production and construction and record-high tourism contributing the most to the accelerated growth.
The performance of the labor market improved and unemployment declined to 10.8% in July 2017, due both to job creation and also higher net migration outflows. A high level of emigration and continued outflows from inactivity into early retirement led to declines in labor force participation. Thus, the participation and employment rates remained low at 51 and 45%, respectively, far below the EU average. Real net wages increased by 3.9% by June 2017 due to personal income taxation reliefs, a 2% rise in public sector wages, and increased labor market pressures within? from? the hospitality sector.
Fiscal consolidation continued in 2016 with the general government deficit (European System of Accounts [ESA] methodology) narrowing to below 0.8% of GDP from 3.4% in 2015. Due to the robust primary surplus, public debt decreased to 83.7% of GDP from 86.7% at end-2015. Croatia exited the Excessive Deficit Procedure (EDP) in June 2017.
Despite recent fiscal consolidation efforts, fiscal debt and risks remain high. Public sector wages are set to increase by 6% in 2017, and a mini tax reform adopted in late 2016, while contributing to a rise in disposable incomes, also reduced the revenue base. Delayed social sector reforms and the planned expansion of veterans benefits will continue to create spending pressures on social sectors. Debt refinancing needs remain high at 11% 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 2.7% in 2018–19. Growth will be led by strengthened personal consumption, tourism, service exports, and investments, all benefiting from EU funds absorption. Personal consumption is expected to intensify, reflecting personal tax reform, a labor market recovery, and a pickup in lending activity.
The fiscal deficit is expected to increase to 1.3% in 2017, as fiscal easing with tax reliefs and spending relaxation comes to fruition. The deficit should decline afterward to an average of 1.0% in 2018–19, which would lead to a further gradual public debt decline to 76.4% of GDP by 2019. Positive labor market developments are expected to support the growth of disposable income for all segments of the welfare distribution. The continued recovery of the economy, including a decline in the share of the long-term unemployed and NEETs (young people between 15 and 24 not in employment, education, or training), supports the overall decline in unemployment, and it is expected that the absolute poverty rate, measured at the US$5.5 at PPP 2011, will decline to 5.2% in 2019.
Downside risks have moderated but are still present. Although fiscal outcomes are better than expected, the new fiscal expansion and domestic policy uncertainty add to the risks associated with slowing the pace of structural reforms and achieving the sustainability of public debt. Remaining high levels of private and public sector indebtedness, the ongoing pre-bankruptcy proceeding of Croatia’s largest firm Agrokor, and the possibility of a further rise in the risk premium for emerging markets are all mounting concerns as the country faces the large refinancing of its public debt. Sustained fiscal consolidation and competitiveness reforms are needed to reduce macroeconomic imbalances and protect the nascent recovery.
Last Updated: Oct 13, 2017