MACRO MONITORING REPORT September 2016 CROATIA In the first half of 2016 growth strengthened to 2.75 percent thanks to exports growth, accelerating private consumption, and a rebound of investment. The labor market continued to improve, with unemployment falling to 13 percent, the lowest level since summer 2008. Higher profits of foreign-owned companies and lower absorption of EU funds widened the current account deficit in Q1, while recovery of imports completely offset solid growth of exports. Despite continuing household and corporate deleveraging, there are mild signs of a bottoming-up in lending to corporate sector. Growth-supported fiscal consolidation brought the fiscal deficit down to 2 percent of GDP, which in turn brought public debt below 83 percent of GDP. New elections were set for September 11 as the political crisis ended with collapse of the government and dissolution of Parliament. Recognizing the downside risks to growth, rating agencies confirmed the current non-investment grade credit rating of BB with negative outlooks, as country plans refinancing of more than 13 percent of its external debt in 2017. In Q2 growth strengthened further, to 2.8 percent, for the employment fell to 43.2 percent, far below the EU average. seventh consecutive quarter. The stronger than expected The administrative unemployment rate, however, continued increase in GDP was a result of somewhat slower growth in declining, reaching 13 percent led by increased demand in the exports of goods and services (4 percent y-o-y) and recovery tourism sector, as well as employment in trade, of domestic demand. Accelerating household consumption manufacturing, and other service activities. More than 95 (3.1 percent y-o-y), the highest investment growth in seven percent of new contracts are fixed-term employment. By June years (over 6.3 percent y-o-y), and a rise in general real gross wages had grown by 1.7 percent, partly because government consumption (2.6 percent y-o-y) more than offset emigration of workers speeded up (over 9 percent of the the negative contribution from rising imports. Compared to unemployed left the country for jobs abroad). There are the previous quarter, seasonally adjusted real GDP increased already shortages of low-skilled workers in construction, by 0.6 percent. Growth was broad-based, with encouraging tourism, and other seasonal sectors. performance from industrial production, retail trade, and The current account surplus, on a four-quarter basis, robust tourist and construction activity. declined, but to a still high 4.3 percent of GDP. In Q1 2016 Deflationary pressures have persisted in 2016 due to cuts the current account deficit increased by 25 percent y-o-y, in administrative prices. The strong annual decline of affected by a strong seasonal trade pattern and deterioration of consumer prices by July (at 1.5 percent y-o-y) was the primary income balance due to the higher profits of foreign considerably affected by the government cutting the natural owned companies (especially those active in financial gas price by 19 percent late last year; the cut could not be intermediation, hotels, and food and beverage production). In offset by the recovery of prices of services (in particular health addition, inability to absorb all available EU funds was and tourist services, responding to higher demand). Core reflected in a worsening of the secondary income balance and inflation was again negative (at 0.1 percent y-o-y), for the also made significant contribution to the widening of the second month in a row. deficit. Robust growth of export of goods (6.6 percent y-o-y) was completely offset by rising imports of goods (4.3 percent Figure 1. Growth in Real GDP, 2012 – 16, Percent) y-o-y). In Q2 the trade balance continued to deteriorate as 3 imports recovered despite stronger exports; however, the 2 robust performance of tourism will help mitigate the widening trade deficit. 1 Net inflow of foreign direct investment (FDI) almost % 0 doubled. Net FDI increased to 0.7 percent of GDP on a 4- quarter basis, mainly because of higher retained profits by -1 foreign-owned companies, especially banks. Over €503 mn -2 more (27 percent y-o-y) was invested in Croatia in Q1 2016, the highest quarterly value since mid-2014. More than three- -3 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 fourths of the FDI came from Austria, Luxembourg, and 2012 2013 2014 2015 2016 Germany. Source: CBS. External debt has stayed on its downward path in 2016: by As the economy recovered, the labor market continued to May it had declined from 103.7 percent of GDP at the end of improve. The survey-based unemployment rate dropped to 2015 to 97.5 percent because of both deleveraging in the 15.4 percent in Q1 2016 (from 16.1 percent in Q4 2015). financial and other sectors and a reduction in government However, the activity rate went down to 51.1 percent and foreign liabilities. The net international investment position continued to improve, reaching 75.6 percent of GDP in Q1 improving the quality and efficiency of judicial system and the 2016, down from its peak of 93 percent in 2010. tax treatment of NPLs. Despite continuing household and corporate deleveraging, Figure 2. General Government Deficit and Debt, 2011–16, there are some early signs of bottoming out in 2016. Percent of GDP Compared to end-2015, in the first half of 2016 loans to 100 0 corporations stagnated; with two-thirds of loans denominated 82.2 86.5 86.7 83.0 -1 in foreign currency, once corrected for the kuna’s appreciation 80 70.7 65.2 -2 against the euro by 0.7 percent and against the Swiss franc (CHF) by 5 percent, corporate lending has picked up. -2.1 -3 60 -3.2 % of GDP Household loans, still largely influenced by the conversion -4 % of GDP and a partial write-off of CHF loans, decreased by 5 percent 40 -5.3 -5 -5.5 by June. Deposits grew by 4.5 percent. -5.3 -6 20 -7 Nonperforming loans (NPLs) continued to decline in 2016; -7.8 -8 dropped from 16.6 percent in December 2015 to 15 percent in June, mainly because of continued sale of NPLs to factoring 0 -9 companies and their write-offs. The largest impact on the 2011 2012 2013 2014 2015 4/16. Domestic debt Foreign debt Guarantees decline came from a reduction in corporate NPLs, followed by Total public debt Fiscal deficit (rhs) loans to households. Credit stagnation and NPLs will continue to weigh on the profitability of banks, as will the costs of Source: MoF, CBS, WB calculations. conversion of CHF-pegged loans to euros. The EC has requested a response to the EC-initiated proceedings against The political crisis caused by the weakness of the Croatia by warning that its legislation enabling the conversion governing coalition ended in July with the collapse of the of loans indexed to the CHF to euros was in violation of EU government and dissolution of Parliament. Conflicts law—the grounds are that it jeopardizes the principle of free between ruling parties ended with the Parliament’s vote of no- movement of capital, enabling universal conversion of loans confidence in the Prime Minister. Early elections took place regardless of individuals’ ability to repay, and the fact that the on September 11 suggesting another coalition government law is retroactive puts at risk legal security and predictability. would need to be formed. Fiscal consolidation continued in 2016. The general Although the government turmoil delayed a Eurobond, government deficit narrowed to 2.1 percent of GDP by March Croatia managed to raise funds locally on favorable (on a 12-month basis) because of rising tax revenues conditions. The government postponed a bond issue abroad (especially corporate tax and excises) and social contributions because of the high risk premium, but in June was able to sell and lower expenditures supported by temporary financing in locally five-year bonds amounting to HRK6 bn with a yield of effect in Q1 after the general elections. The fiscal position had 2.85 percent, supported by strong domestic liquidity. This is again improved by July, pushing the general government the lowest yield on Croatian government bonds since the 2001 deficit to around 2 percent of GDP as direct taxes and inaugural bond issue on domestic capital market. absorption of EU funds improved. At the end of May, public Growth is expected to remain solid in 2016-18, averaging debt further declined to 83 percent of GDP. 2.3 percent. Risks are still skewed to the downside. Along EC decided not to step up the Macroeconomic Imbalance with risks related to the fiscal consolidation and the Procedure for Croatia. The decision was based on a positive sustainability of public debt, high levels of private sector assessment of Croatia’s National Reform Plan (NRP) and indebtedness and the possibility of a further rise in the risk Convergence Program, which the EC regarded as an ambitious premium for emerging markets has arisen as the country plans agenda with measures that are relevant for addressing its its refinancing strategy for redeeming three sovereign bonds macroeconomic imbalances. However, the EC strongly in 2017. A protracted formation of the new government after recommended five measures: (1) reducing the general September elections may lead to more delays in absorption of government debt ratio, with a fiscal adjustment of at least 0.6 EU funds and another year of delays in the structural reforms pp of GDP in 2017, and introducing a property tax and a debt announced in the NRP. Furthermore, financial volatility management strategy; (2) penalizing early retirement, following Brexit and monetary tightening in the USA could accelerating the transition to full retirement age, and have negative effects on the borrowing costs of domestic consolidating social benefits; (3) reducing fragmentation and sectors. While with the current pace of consolidation Croatia harmonizing wage-setting systems across the public sees the possibility of exiting the Excessive Deficit Procedure administration, reinforcing the monitoring of SOEs, and in 2017, its macroeconomic imbalances will require a robust speeding up the process of divesting state assets; (4) reducing response by the new government. parafiscal charges and administrative burdens on businesses and removing regulatory restrictions on professions; and (5) Figure 3. High-frequency Real Sector Data, Trend- Figure 4. Current Account Balance, 2011–16, cycle Adjusted Series (Index) Percent of GDP Source: CBS, WB staff calculations. Source: CNB, CBS, WB staff calculations. Figure 5. Business and Consumer Confidence, Figure 6. External Debt and Net International 2011–16, Three-month Moving Averages Investment Position, 2011–16, Percent of GDP 110 108.4 -70 108 105.6 -75 106 103.7 103.7 -75.6 104 103.0 -77.6 -80 102 100 97.5 -85 98 -88.2 -86.4 96 -90.4 -90.3 -90 94 92 -95 2011 2012 2013 2014 2015 5/16. External debt, % of GDP (lhs) NIIP, % of GDP (rhs) Source: EC, WB staff calculations. Source: CNB, CBS, WB staff calculations. Figure 7. Labor Market, 2011–16, Administrative Figure 8. Nonperforming Loans, 2011–16.,Percent) Data, Thousands Source: CBS, WB staff calculations. Source: CNB. Figure 9. Labor Market, Survey-based Data, 2011– Figure 10. CPI and PPI, Annual Growth Rates, 2011– 16, Percent 16, Percent Source: CBS. Source: CBS. Croatia Selected Indicators Avg. '00-14 2012 2013 2014 2015 2016 E 2017 F Income and economic growth GDP growth (annual %) 1.7 -2.2 -1.1 -0.4 1.6 2.4 2.0 GDP per capita growth (annual %, real) 2.2 -1.9 -0.8 0.0 2.8 2.7 2.3 GDP per capita (US$, nominal) 11129 13236 13575 13481 11629 12012 12473 GDP per capita, PPP (current international $) 17232 21114 21351 21252 21709 22176 22653 Private Consumption growth (annual %) 1.6 -3.0 -1.8 -0.7 1.2 2.0 1.4 Gross Investment ( % of nominal GDP) 23.1 19.6 19.8 19.1 19.1 19.5 20.2 Gross Investment - Public ( % of nominal GDP)1 5.0 3.5 3.7 3.7 2.9 3.2 3.1 Money and Prices Inflation, consumer prices (annual %, end of period)2 2.6 4.7 0.3 -0.6 -0.5 1.0 1.5 Inflation, consumer prices (annual %, period average)2 2.7 3.4 2.2 -0.2 -0.5 0.9 1.5 M2 ( % of GDP) 64.6 74.6 77.7 80.7 83.6 84.2 84.8 Domestic Credit to the Private Sector ( % of GDP)1 59.8 71.5 71.0 69.9 66.6 66.0 65.8 10 year interest rate (annual average)2 .. .. .. .. .. .. .. Nominal Exchange Rate (local currency per USD) 6.2 5.9 5.7 5.7 6.9 6.8 6.8 Real Exchange Rate Index (2010=100) 103.1 105.3 104.2 105.4 109.9 110.1 110.2 Fiscal Revenue (% of GDP) 42.1 41.7 42.5 42.6 43.7 44.0 43.7 Expenditure (% of GDP) 46.6 47.0 47.8 48.1 46.9 46.7 45.8 Interest Payments (% of GDP) 2.3 3.4 3.5 3.5 3.6 3.6 3.6 Non-Interest Expenditure (% of GDP) 44.3 43.6 44.3 44.6 43.3 43.1 42.2 Overall Fiscal Balance (% of GDP) -4.5 -5.3 -5.3 -5.5 -3.2 -2.7 -2.1 Primary Fiscal Balance (% of GDP) -2.2 -1.9 -1.8 -2.0 0.4 0.9 1.4 General Government Debt (% of GDP) 50.4 70.7 82.2 86.5 86.7 86.0 84.9 1 External Public Debt (% of GDP) 24.2 29.3 34.7 36.0 35.4 36.6 36.7 External Accounts Export growth, f.o.b (nominal US$, annual %) 10.0 -7.8 6.4 6.7 -8.2 5.8 4.7 Import growth, c.i.f (nominal US$, annual %) 8.3 -8.8 6.1 3.0 -9.5 5.9 5.1 Merchandise exports (% of GDP) 17.1 19.7 20.5 22.7 24.4 24.6 24.9 Merchandise imports (% of GDP) 35.5 34.0 35.6 37.5 39.5 40.1 40.5 Services, net (% of GDP) 14.3 14.6 15.5 16.9 18.0 18.4 18.4 Current account balance (current US$ millions) -1705 -167 566 1123 2603 1595 1568 Current account balance (% of GDP) -3.6 -0.3 1.0 2.0 5.3 3.2 3.0 Foreign Direct Investment, net inflows (% of GDP) 3.5 2.7 1.9 1.9 0.4 2.7 3.2 1 External debt, total (% of GDP) 81.5 103.0 105.6 108.4 103.7 97.1 89.1 Multilateral debt (% of total external debt)1 6.3 8.3 9.0 9.8 11.2 12.6 14.3 Debt service ratio (% of exports goods and non-factor services)1 42.4 63.6 51.4 53.0 51.4 46.7 49.1 Population, Employment and Poverty Population, total (millions) 4.4 4.3 4.3 4.2 4.2 4.2 4.2 Population Growth (annual %) -0.5 -0.3 -0.3 -0.4 -1.1 -0.3 -0.3 1 Unemployment Rate 13.5 15.9 17.3 17.3 16.3 16.0 15.6 Poverty headcount ratio at national poverty line (% of population)1 20.2 20.4 19.5 19.4 20.4 .. .. 1 Poverty headcount ratio at US$5 a day (PPP) (% of population) 8.5 9.4 9.8 9.8 9.0 8.7 8.4 Inequality - Gini Coefficient1 31.1 30.9 30.9 30.2 30.9 .. .. Life Expectancy1 75.7 76.9 77.1 77.6 .. .. .. Other GDP (current LCU, millions) 285601 330456 329571 328431 334219 343537 353231 GDP (current US$, millions) 48713 56486 57770 57137 48732 50173 51928 GDP per capita LCU (real) 71692 74976 74385 74419 76504 78598 80434 Doing Business Rank3 39 .. .. 39 40 .. .. Human Development Index Ranking4 46 47 47 47 .. .. .. Notes: ".." indicates not available. E = estimate, F = forecast. Data from MFMOD unless otherwise noted. 1/ World Development Indicators Database 2/ World Bank GEM database 3/ This indicator is ranked out of 175 countries in 2007, 178 in 2008, 181 in 2009, and 183 in 2010 and 2011. 4/ The HDI ranking in 2001 is in relation to 175 countries and in 2010 in relation to 169 countries. Sources: MFMOD Database, World Bank WDI, GEM databases, IMF and national sources.