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.
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.
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.
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.