MACRO MONITORING REPORT December 2015 CROATIA \ After six years of economic contraction, Croatia started a gradual recovery in 2015. Continued recovery in the EU and events in competing tourism markets boosted Croatia’s exports of goods and services, while oil and food price declines and income tax changes contributed to a rebound in private consumption. Although the trade balance improved, pushing the current account surplus to a record high, external debt reached 109 percent of GDP by August 2015, indicating still high external vulnerability. The general government deficit is expected to be around 5 percent of GDP in 2015, increasing public debt to close to 90 percent of GDP. The Excessive Deficit Procedure (EDP) target budget deficit of 4.6 percent of GDP is out of reach. Despite the modest recovery in 2015, the economy requires urgent reforms to consolidate its finances, increase competitiveness and boost employment. After parliamentary elections in early November, Croatia faces difficult negotiations to form a government. Growth strengthened in Q3 and was relatively broad and youth that prevented further deterioration. Croatia has based. After real annual growth of 0.8 percent in the first half doubled the amount of employment subsidies supported by the of the year, growth accelerated to 2.8 percent in the third EU Youth Guarantee Scheme in 2015. quarter of 2015. This was the fourth consecutive quarter of The current account balance recorded a surplus for the positive GDP growth and the highest since the second quarter first-time in the second quarter of 2015. This was mainly of 2008. Growth was broad based, with income tax changes due to improvements in the trade balance, as exports grew by and growing consumer confidence supporting real growth of 14.2 percent y-o-y on the back of ships, motor vehicles, 1.4 percent in private consumption, while investments picked fabricated metal and food products. A solid tourist preseason up for the second quarter in a row, by 2.2 percent. High (revenues up by 6.4 percent y-o-y) increased the services frequency data point to continued positive growth in the last surplus, while an additional contribution to the current account quarter. Driven by increased external demand, industrial surplus came from the rise in compensation of employees and production surged in October, by 6.4 percent y-o-y, especially doubled transfers from the EU. Cumulatively, in the last four in food, chemical, wood and pharmaceutical industries. quarters, the current account surplus reached a record high of Higher household disposable income boosted retail trade 2.1 percent of GDP. Goods exports continued to increase in growth to 1.5 percent in October, while tourist arrivals and the third quarter, which combined with decelerating import night stays benefitted from the extended tourist season. growth led to a narrowing of the trade deficit to 15.2 percent Real GDP, annual growth rates of GDP in September, 0.7 percentage points below the same (Percent) period last year. 3 Foreign direct investment (FDI) decreased in the first half 2 of 2015. This was mainly due to profit transfers abroad, 1 especially in telecommunications, and losses in foreign- owned banking sector affected by the mandatory conversion % 0 of the CHF-denominated loans. About 18 percent of total FDI -1 in the first half of the year went to chemical industries and nearly 15 percent to construction. -2 -3 External debt is still on rise led by public sector debt. Still Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 in relative terms, by August 2015, it reached 108.9 percent of 2012 2013 2014 2015 GDP in gross terms, only 0.5 percentage points of GDP above Source: CBS. the end-2014. A rise of external debt is to be attributed to public sector (i.e. March bond issue of EUR1.5 bn) as well as The labor market improved slightly as growth prospects the central bank repo-auction related debt growth. The net recovered and employment support measures international investment position remained largely strengthened. The survey-based unemployment rate declined unchanged, at 89 percent of GDP, compared to end-2014. to 16.9 percent in the first half of 2015 (a four-quarter average), 0.5 percentage points down to the same period last The budget deficit and fiscal vulnerabilities remain high. year. Further, activity and employment rates increased (to 52.8 The general government deficit reached 4.5 percent of GDP percent and 43.9 percent, respectively), although remaining by June 2015 (at ESA2010), having recorded 5.6 percent of well below the EU average. The administrative unemployment GDP in 2014. Revenue growth was supported by an increase data continued its year and a half long downward trend in social contributions and stronger VAT collection (8.1 supported by public sector and service sector employment, as percent y-o-y), thanks to the recovery of private consumption well as active labor market programs for vulnerable groups and pre-season tourism. At the same time expenditures stagnated as increases in intermediate consumption and The central bank continued to ensure liquidity and interest payments were offset by a decline in social security stabilize interest rates. Following the enactment of the CHF- benefits. Transfers from the EU budget doubled, contributing denominated loans conversion act, the central bank intervened to improved revenues. However, general government debt in September for the third time this year in the FX market by continued rising, reaching 85.7 percent of GDP by August selling EUR268.3 million to withdraw HRK2.05 bn (after 2015, up from 85.1 percent of GDP in 2014 and is expected to withdrawing HRK3.8 bn in January and February). This reach 89.8 percent of GDP in 2015 and stabilize only in 2018. prevented a kuna depreciation, stabilized interest rates, and provided liquidity for banks. Additionally, to ensure kuna In its 2015 Convergence Program, the Government liquidity, the central bank revoked compulsory purchases of planned to correct the excessive deficit by 2017. The Fiscal CB bills and recommenced (after October 2009) reverse deficit is projected at 5 percent of GDP in 2015, 3.9 percent in repurchase (repo) auctions every week from end-September. 2016, 2.7 percent in 2017 and 2.4 percent in 2018 (at ESA2010). However, this is not in line with the Despite increased liquidity, deflationary pressures recommendation by the European Council to have the deficit intensified in the second half of 2015. Led by declining oil below 3 percent of GDP by 2016. Nonetheless, in June 2015 and gas prices, the annual CPI declined by 0.8 percent in decided not to activate corrective action against Croatia, but October and 0.4 percent in the first ten months of 2015 (having pointed out that the "level of ambition remains below declined 0.2 percent in 2014). expectations in a number of areas". Croatia was also given six After parliamentary elections on November 8 Croatia new recommendations for reforms in 2015 and 2016. faces difficult negotiations to form a government. With General government deficit and debt turnout of about 61 percent, the Croatian Democratic Union (Percent of GDP) (HDZ)-led Patriotic Coalition won more votes (59 MPs) in the 100 0 151-seat parliament, but not enough to form a government on 85.1 85.7 its own. The Social Democratic Party (SDP)-led Croatia is -1 80 80.8 -2 Growing Coalition got 56 seats, while amongst the biggest -2.7 63.7 69.2 -3 surprises was the party ‘Most’ (the Bridge), winning 19 seats 60 % of GDP 57.0 -4.5 -4 in the Parliament thus playing a crucial role in the government % of GDP 48.0 40 38.9 -5.4 -5 formation. After the inaugural session of Parliament’s -5.9 -5.3 -5.6 -6 assembly ended without electing a speaker, discussions -5.8 20 -7 between HDZ, SDP and Most will continue. -7.8 -8 0 -9 In November, through the Alert Mechanism Report, the 2008 2009 2010 2011 2012 2013 2014 Aug-15 EC requested another in-depth review (IDR) for Croatia, Domestic debt Foreign debt Guarantees Total public debt Fiscal deficit (rhs) as part of the Macroeconomic Imbalance Procedure (MIP). In the updated MIP scoreboard, a number of indicators Note: Fiscal deficit in 2015 refers to H1. are beyond their indicative thresholds, namely the negative net Source: MoF, CBS, WB staff calculations. international investment position (NIIP), there have been Deleveraging continued in 2015 on the back of corporate substantial losses in export market shares, steadily increasing sector domestic deleveraging. Lending activity declined by government debt, high unemployment (as well as the increase 2.7 percent y-o-y in October led by accelerated corporate in long-term and youth unemployment). The EC will present deleveraging (4.5 percent), which turned to direct foreign the conclusions of the IDRs in February 2016. borrowing. Deposits increased by 3.4 percent, while NPLs Economic activity is expected to increase by 1.5 percent in remained unchanged in September 2015, compared to end- 2015, with risks skewed to the downside. The recovery is 2014, at 17.1 percent, with corporates and households at 31.1 expected to continue in 2016-17 at on average 1.6 percent, led percent and 12.1 percent, respectively. by strengthening domestic demand, exports and investment In September, Parliament enacted the law to convert all while unemployment continues to gradually decline. CHF-loans to EUR-loans. The Constitutional Court rejected However, external factors, like a slowdown in Croatia’s main the banks’ call to suspend regulations on CHF-loan trading partners, the Fed’s tightening monetary policy and a conversion. Both disputed laws regulating the conversion of surge in emerging market risk premium, could undermine CHF-loans (on credit institutions and consumer credit) will Croatia’s fragile recovery, affecting exports and raising remain in force until a final ruling on their constitutionality is financing costs of an already highly indebted government and made. The banks were given a deadline until November 15 to other domestic sectors. On the domestic side, difficulties in send their clients amended loan contracts, after which time forming a new government, and uncertain scope of fiscal loans holders have one month to decide on the conversion— consolidation measures for 2016 and 2017 could hamper the this refers to about 4 percent of households and will result in growth outlook. To ensure macroeconomic stability and bank losses and fiscal revenues foregone of around 2.1 and 0.3 growth, addressing fiscal vulnerabilities as well as high percent of GDP, respectively. inactivity and unemployment rates, and a commitment to implement long-lasting structural reforms remains crucial. High frequency data, trend-cycle adjusted Current account balance and net foreign direct series investments (Index) (Percent of GDP) 130 8 7.1 125 6.0 5.5 6 120 115 4 2.9 2.6 2.7 3.0 1.9 index, 2011=100 2.1 2.1 2.4 110 2 1.0 0.8 105 in % of GDP 100 0 -0.1 95 -2 -0.7 -1.1 90 Industry 85 -4 Construction 80 -5.1 Retail trade -6 75 CAB Net FDI Tourism last obs.: 10/15 (except Constr) -8 -6.5 70 -7.1 -8.8 2010/1 2010/4 2010/7 2011/1 2011/4 2011/7 2012/1 2012/4 2012/7 2013/1 2013/4 2013/7 2014/1 2014/4 2014/7 2015/1 2015/4 2015/7 2010/10 2011/10 2012/10 2013/10 2014/10 2015/10 -10 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 H1 Source: CBS, WB staff calculations. Source: CNB, CBS, WB staff calculations. Business and consumer confidence Loans, annual growth (Three-member moving averages) (Percent) 150 12 140 10 Domestic credit 130 8 Corporate credit 120 6 Households credit 110 %, yoy 4 100 2 90 0 80 last obs.: 11/15 -2 70 2008 2009 2010 2011 2012 2013 2014 2015 -4 Construction business confidence indicator -6 last obs.: 10/15 Industry business confidence indicator 2010/12 2011/3 2011/6 2011/9 2011/12 2012/3 2012/6 2012/9 2012/12 2013/3 2013/6 2013/9 2013/12 2014/3 2014/6 2014/9 2014/12 2015/3 2015/6 2015/9 Retail trade business confidence indicator Long-run average = 100 Services business confidence indicator Consumer confidence indicator Economic Sentiment Index (ESI) Source: EC, WB staff calculations. Source: CNB, WB staff calculations. Labor market, administrative data Non-performing loans (Thousands) (Percent) 1500 410 35 Corporate Households Total loans 1450 30 370 1400 25 thous. thous. % of total loans 330 1350 20 290 1300 15 last obs.: 10/15 1250 250 10 2010/1 2010/4 2010/7 2011/1 2011/4 2011/7 2012/1 2012/4 2012/7 2013/1 2013/4 2013/7 2014/1 2014/4 2014/7 2015/1 2015/4 2015/7 2010/10 2011/10 2012/10 2013/10 2014/10 2015/10 5 Employment (lhs) Employment_tc (lhs) 0 Unemployment (rhs) Unemployment_tc (rhs) 2008 2009 2010 2011 2012 2013 2014 Q3/15 Source: CBS, WB staff calculations. Source: CNB. Labor market, survey-based data CPI and PPI, annual growth rates (Percent) (Percent) 10 Activity rate Employment rate Unemployment rate - rhs 8 60 20 6 50 4 15 40 2 % % 30 10 % 0 20 -2 5 -4 CPI 10 -6 PPI 0 0 last obs.: 10/15 -8 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 2015/10 2010/10 2011/10 2012/10 2013/10 2014/10 2010/1 2010/4 2010/7 2011/1 2011/4 2011/7 2012/1 2012/4 2012/7 2013/1 2013/4 2013/7 2014/1 2014/4 2014/7 2015/1 2015/4 2015/7 2011 2012 2013 2014 '15 Source: CBS. Source: CBS. Croatia Selected Indicators Avg. '00-14 2011 2012 2013 2014 2015 E 2016 F Income and economic growth GDP growth (annual %) 1.7 -0.3 -2.2 -1.1 -0.4 1.5 1.7 GDP per capita growth (annual %, real) 2.2 2.9 -1.9 -0.8 0.0 1.7 2.0 GDP per capita (US$, nominal) 11128.4 14542.3 13236.1 13574.9 13475.4 12715.5 13043.6 GDP per capita, PPP (current international $) 17231.8 20571.2 21113.6 21350.5 21252.3 21710.2 22177.9 Private Consumption growth (annual %) 1.6 0.3 -3.0 -1.8 -0.7 0.8 1.0 Gross Investment ( % of nominal GDP) 23.1 20.3 19.6 19.8 19.1 19.1 19.4 Gross Investment - Public ( % of nominal GDP) 1 4.9 3.5 3.5 3.7 3.7 3.6 3.5 Money and Prices Inflation, consumer prices (annual %, end of period) 2 2.6 2.1 4.7 0.3 -0.5 0.9 1.7 Inflation, consumer prices (annual %, period average) 2 2.7 2.2 3.4 2.2 -0.2 -0.2 1.0 M2 ( % of GDP) 67.8 76.4 79.3 82.2 85.0 86.0 87.0 Domestic Credit to the Private Sector ( % of GDP) 1 59.8 75.8 71.5 71.0 69.9 69.0 68.8 10 year interest rate (annual average) 2 .. .. .. .. .. .. .. Nominal Exchange Rate (local currency per USD) 6.2 5.3 5.9 5.7 5.8 6.2 6.2 Real Exchange Rate Index (2010=100) 101.4 97.9 96.6 97.3 96.2 101.8 103.2 Fiscal Revenue (% of GDP) 42.1 41.0 41.7 42.5 42.6 42.2 42.3 Expenditure (% of GDP) 46.5 48.8 47.1 47.8 48.2 47.1 46.3 Interest Payments (% of GDP) 2.3 3.0 3.4 3.5 3.5 3.6 3.6 Non-Interest Expenditure (% of GDP) 44.3 45.7 43.7 44.3 44.7 43.5 42.7 Overall Fiscal Balance (% of GDP) -4.4 -7.8 -5.3 -5.4 -5.6 -4.9 -3.9 Primary Fiscal Balance (% of GDP) -2.1 -4.7 -2.0 -1.9 -2.1 -1.3 -0.3 General Government Debt (% of GDP) 49.6 63.7 69.2 80.8 85.1 89.8 92.0 External Public Debt (% of GDP) 1 23.4 25.4 27.9 33.3 34.7 37.4 41.1 External Accounts Export growth, f.o.b (nominal US$, annual %) 10.0 13.5 -7.8 6.4 7.0 -1.3 3.1 Import growth, c.i.f (nominal US$, annual %) 8.4 12.1 -8.8 5.9 3.4 -2.3 4.7 Merchandise exports (% of GDP) 17.1 19.6 19.7 20.5 22.7 23.8 24.0 Merchandise imports (% of GDP) 35.5 33.9 34.0 35.6 37.5 38.9 39.8 Services, net (% of GDP) 14.3 14.1 14.6 15.5 16.9 17.7 17.7 Current account balance (current US$ millions) -1754.9 -316.6 -168.8 559.5 415.2 2057.3 524.1 Current account balance (% of GDP) -3.7 -0.5 -0.3 1.0 0.7 3.8 1.0 Foreign Direct Investment, net inflows (% of GDP) 3.6 2.7 2.7 1.9 3.0 3.2 3.4 External debt, total (% of GDP) 1 81.5 103.7 103.0 105.6 108.4 107.5 109.2 Multilateral debt (% of total external debt) 1 6.3 7.3 8.3 9.0 9.8 11.0 11.7 Debt service ratio (% of exports goods and non-factor services) 1 42.3 66.1 63.6 51.4 52.9 51.7 44.1 Population, Employment and Poverty Population, total (millions) 4.4 4.3 4.3 4.3 4.2 4.2 4.2 Population Growth (annual %) -0.5 -3.1 -0.3 -0.3 -0.4 -0.2 -0.3 Unemployment Rate 1 13.5 13.7 15.9 17.3 17.3 16.9 16.5 Poverty headcount ratio at national poverty line (% of population) 1 20.2 20.9 20.4 19.5 19.4 .. .. Poverty headcount ratio at US$5 a day (PPP) (% of population) 1 8.4 8.4 9.4 9.7 9.8 9.3 9.0 Inequality - Gini Coefficient1 31.1 31.2 30.9 30.9 30.2 .. .. Life Expectancy1 75.6 76.8 76.9 77.1 .. .. .. Other GDP (current LCU, millions) 285601.4 332587.0 330456.0 329571.3 328430.5 335166.6 342937.2 GDP (current US$, millions) 48711.8 62249.9 56485.6 57770.4 57113.9 53798.8 55046.1 GDP per capita LCU (real) 71692.4 76418.3 74975.5 74384.7 74419.1 75668.0 77151.4 Doing Business Rank3 39 .. .. .. 39 40 .. Human Development Index Ranking4 46 45.0 47.0 47.0 .. .. .. 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. Methodological enhancements in HDI calculations have resulted in notable improvements in the countries' rankings. Sources: MFMOD Database, World Bank WDI, GEM databases, IMF and national sources.