Croa­tia

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Af­ter sev­eral years of eco­nomic con­trac­tion, Croa­tia should see very fee­ble growth in 2014. With con­sumer spend­ing con­strained and pub­lic fi­nances stretched, most of the growth im­pe­tus will have to come from ex­ports and in­vest­ment. A pickup in in­vest­ment will be driven by the pub­lic sec­tor thanks to greater ac­cess to EU funds. The re­cov­ery should gather mo­men­tum in 2015 as the im­pact of pri­vate sec­tor delever­ag­ing be­gins to re­cede. The po­ten­tial growth is about 2.0% per year. Croa­tia is open to trade and cap­i­tal flows, and pri­vati­sa­tion is well ad­vanced, al­though un­even. Croa­tia's open­ness left the coun­try es­pe­cially vul­ner­a­ble dur­ing the Great Re­ces­sion. Pri­vate sec­tor credit de­clined sharply while weak­nesses in con­sump­tion and in­vest­ment out­weighed gains in ex­ports. Later, be­cause of its nar­row ex­port base and weak com­pet­i­tive­ness, Croa­tia was un­able to take full ad­van­tage of the eco­nomic re­bound among its trad­ing part­ners. In 2013, real GDP was ap­prox­i­mately 12% be­low the level in 2008.

The econ­omy has con­tracted over the past five years. In­vest­ment has weak­ened while the large pub­lic sec­tor im­posed an added drag on growth. Pub­lic agen­cies and en­ter­prises were not sub­ject to strict fi­nan­cial dis­ci­pline and state aid in var­i­ous forms has ex­ceeded that from other fi­nan­cial sources. Do­mes­tic de­mand has re­mained de­pressed as cor­po­ra­tions and house­holds fo­cus on re­duc­ing their ex­cess debt lev­els.

Eco­nomic out­look

Af­ter five con­sec­u­tive years of con­trac­tion, Croa­tia should see a fee­ble turn­around in 2014 when real GDP is ex­pected to rise by 0.5%. With con­sumer spend­ing con­strained and pub­lic fi­nances stretched, most of the growth im­pe­tus will have to come from ex­ports and in­vest­ment. A pickup in in­vest­ment will be driven by the pub­lic sec­tor thanks to greater ac­cess to EU funds.

In­fla­tion is pro­jected to be 2.2% in 2014 but a hike in the VAT rate could push up prices. Un­em­ploy­ment was 17.1% in 2013 and it will fall to 15.5% in 2014. The job­less to­tal will grad­u­ally fall in the medium term. Youth un­em­ploy­ment is still ex­ceed­ingly high. Re­stric­tions on hir­ing were eased in 2013.

Con­sump­tion is held back by house­hold debt which, as a share of GDP, is one of the high­est in the re­gion. A weak labour market also de­presses growth of dis­pos­able in­come. The real value of pri­vate fi­nal con­sump­tion con­tracted by 1.3% in 2013 and growth of 0.1% is ex­pected in 2014. Do­mes­tic de­mand should im­prove in the medium term as pri­vate sec­tor debt is scaled back.

Un­like most other re­cent EU en­trants, Croa­tia has not ex­pe­ri­enced a boom due to ac­ces­sion. Progress is lim­ited by struc­tural chal­lenges, po­lit­i­cal con­straints to fis­cal re­forms and highly lever­aged pub­lic and pri­vate sec­tor balance sheets.

Eval­u­a­tion of market po­ten­tial

A grad­ual re­cov­ery is ex­pected to gather mo­men­tum be­gin­ning in 2015 as the im­pact of pri­vate sec­tor delever­ag­ing be­gins to re­cede. How­ever, pri­vate sec­tor delever­ag­ing could con­tinue to de­press de­mand for longer than pro­jected. Croa­tia's Eco­nomic Re­cov­ery Pro­gramme is aimed at ad­dress­ing deep-rooted

struc­tural prob­lems and weak­nesses in com­pet­i­tive­ness but crit­ics call for a more de­ci­sive ef­fort. The IMF es­ti­mates that the coun­try's long-term po­ten­tial growth is about 2.0% per year.

The gov­ern­ment has adopted a plan to re­solve its long-stand­ing debt to cur­rent pen­sion­ers which amounts to about 1.2% of GDP. The bulk of this debt will be paid off com­pletely in the near fu­ture. Mean­while, pen­sion laws have been amended to equalise the statu­tory re­tire­ment age of women and men by 2030, penal­ties for early re­tire­ment have been in­creased and in­cen­tives in­tro­duced to de­lay re­tire­ment.

For­eign trade

Croa­tia's ex­ports rep­re­sent a smaller por­tion of GDP than is true for most of its neigh­bours. The share has also been rel­a­tively sta­ble over time. In 2013, ex­ports were the equiv­a­lent of 20.7% of GDP. In dol­lar terms, ex­ports fell by 3.6% in 2013 and gains of 9.6% are ex­pected in 2014. In ad­di­tion to weak ex­ter­nal de­mand, Croa­tia's ex­port per­for­mance is lim­ited to some ex­tent by labour force rigidi­ties and high wages.

In 2013, 58.4% of the coun­try's ex­ports went to mar­kets in the EU. Croa­tia has a nar­row ex­port base in terms of the com­modi­ties it ex­ports. Ma­chin­ery and trans­port equip­ment ac­counted for 26.6% of to­tal ex­ports in 2013 fol­lowed by ba­sic man­u­fac­tures (14.2%).

The gov­ern­ment is pur­su­ing a strat­egy of trade lib­er­al­i­sa­tion at the bi­lat­eral and re­gional lev­els, and ne­go­ti­at­ing free trade agree­ments with Turkey and the Euro­pean Free Trade As­so­ci­a­tion (EFTA). These agree­ments have con­trib­uted to the ex­pan­sion of ex­port mar­kets. These moves, how­ever, are un­der­mined to some ex­tent by Croa­tia's wan­ing com­pet­i­tive­ness in in­ter­na­tional mar­kets.

The cur­rent ac­count sur­plus was 1.2% of GDP in 2013. A cur­rent ac­count sur­plus equal to 1.1% of GDP is ex­pected in 2014.

Busi­ness en­vi­ron­ment

Croa­tia lags be­hind its neigh­bours in cre­at­ing an ap­peal­ing busi­ness en­vi­ron­ment. Ma­jor bar­ri­ers are a bur­den­some reg­u­la­tory en­vi­ron­ment and a slow-mov­ing ju­di­ciary. There are also sig­nif­i­cant “unofficial” re­stric­tions on for­eign in­vest­ment which add to the over­all cost of do­ing busi­ness. Sub­si­dies to state-owned firms fur­ther dis­tort the econ­omy and mo­nop­o­lies dom­i­nate most mar­kets. To at­tract more for­eign in­vest­ment, the gov­ern­ment has in­tro­duced in­cen­tives such as 10-year tax hol­i­days, sub­si­dies and state as­set sales.

The gov­ern­ment hiked the VAT from 23% to 25% in 2012 to boost rev­enues. In 2014, the in­ter­me­di­ate VAT rate was raised from 10% to 13%. Tar­iffs on gas and to­bacco were also hiked. Delin­quent taxes owed by cor­po­ra­tions and in­di­vid­u­als to­tal more than 6.0 bil­lion euro. To boost pro­duc­tiv­ity, the gov­ern­ment passed new in­vest­ment pro­mo­tion laws and scaled back reg­u­la­tory re­stric­tions in 2013.

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