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End of recession in sight

D&T
May 14, 2015

A mild recovery is forecast for 2015, with growth set to reach 1% in 2016, spurred by EU-funded investments. Fiscal consolidation needs and limited structural reforms, however, continue to hold back potential growth. Employment is still expected to stagnate in 2015 - according to the analysis and forecast of the European Commission.

Croatia’s economy contracted for a sixth consecutive year in 2014, but the pace of the recession weakened over the course of the year, bringing real GDP growth for the year to an estimated -0.5%. According to the analysis and forecast of the European Commission (published in February, 2015) positive demand from abroad was not enough to offset the effect of weak domestic demand, which fell as a result of a 3.6% fall in investment and decreases in private and public consumption of 0.6% and 2.1% respectively.

A muted recovery expected to start in 2015...

Croatia’s recession is forecast to come to an end in 2015, but real GDP is forecast to grow only moderately by 0.2%. Domestic demand growth is set to remain negative, as a result of a further contraction of investment and government consumption. Private consumption is now forecast to stagnate as the negative impact of the weak labor market and uncertainties related to the final settlement of Swiss-franc indexed loans is broadly offset by the positive impact of the income tax reform and of lower oil prices.

Although indicators suggest that the labor market may have bottomed out in 2014, employment is still expected to stagnate in 2015, due to adverse demographic trends, while the unemployment rate is set to decrease to 16.8%, on the back of the contracting labour force. Wages are expected to grow moderately, due to the strong deceleration of inflation in 2014 and the negative price dynamics expected for 2015.

The feeble growth set to be achieved in 2015 is set to come exclusively from net exports. After the strong performance in 2014, partly reflecting large one-off effects related to Croatia's accession to the EU, the restoration of trade links with former partners from the CEFTA and the recovery of the neighboring Slovenian economy, exports of goods and services are set to increase at a more moderate rate of 2.8%. At the same time, imports are forecast to increase by 1.8%. Overall, the current account surplus is set to expand to 2.4% of GDP.

…and gain ground in 2016.

In 2016, recovery is expected to attain a tepid 1.0% thanks to an increase in domestic demand, driven largely by EU-linked investments. Private consumption should also add to growth as the labor market stabilizes. In particular, employment is expected to increase on the back of a rise in the activity rate and a decrease in the unemployment rate to 16.4%. As a result of acceleration in core inflation and attenuating private sector deleveraging pressures, inflation is forecast to pick-up to 1.0%.

Relatively stronger growth in the EU should further stimulate exports, which are expected to grow by 4.7%. Imports, meanwhile, are set to rise by 4.5%, leading to a mild deterioration of the trade balance, although the current account will continue to improve on the back of current transfers from the EU budget. Risks to growth projections are mainly negative and related to uncertainties about fiscal policy and structural reforms.

Consolidation efforts hindered by personal income tax rebate

The general government deficit in 2014 is expected to stand at 5.0% of GDP. Expenditure appears to have evolved mostly in line with the authorities’ plans, but some additional outlays from flood-related reconstruction costs materialized in the second half of 2014. The downward revision from the previous forecast is mainly the result of a better revenue outturn (in particular VAT).

In 2015, changes to the personal income taxes are expected to push the budget deficit up to 5.5% of GDP, as potential offsetting measures are still largely unknown. In 2016, the deficit is forecast to remain at around the same level, in spite of the moderate pick-up in growth expected. The structural deficit is expected to have reached 3,5 % of GDP in 2014, and to deteriorate in 2015 and 2016, by about 1,5 % of GDP respectively.

The ratio of general government debt to GDP is expected to have reached 81.4% in 2014, mainly as result of the achieved budget deficit, continued subdued nominal GDP growth and a pre-financing operation planned before the end of the year. In 2015 and 2016 public debt is forecast to increase to 84.9% and 88.7% of GDP as a result of the underlying deficit trends.

Negative fiscal risks are still present, including from the accumulation of arrears in the hospital sector and possible additional expenditure slippages in 2015 in some other sectors, such as education and transport. On the other hand, the general government deficit forecast could be revised downward if the government substantiates its fiscal deficit targets by credibly announced and sufficiently detailed measures.

D&T

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