Embracing Eurozone: Croatia's Resilient Path to Integration
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The Eurozone and Schengen entrance on 1 January 2023 sealed the completion of Croatia’s EU integration story. The economy has shown a remarkable resilience through the pandemic and RussiaUkraine conflict, marking a striking difference compared to the 2008-09 global financial crisis.
While there is a long way to go in terms of catching-up with the Eurozone average in almost all aspects, the authorities seem quite determined to make good use of the EU’s Recovery and Resilience Facility, increasing fixed investments while keeping public deficits within very reasonable levels. Better terms of trade compared to 2022 and a tourism boost from Schengen entry might rebalance the external sector earlier than expected while quasi-balanced budgets could push the public debt ratio below the dreaded 60% of GDP over the next couple of years.
Forecast summary
At the right speed given the context
Unlike most of its main EU partners that are experiencing mediocre growth at best, Croatia still managed to produce above potential growth rates in 2022. Momentum looks good in 2023 as well. Trends are clearly moderating in industry, construction and retail trade, with retail exposed to a generally weaker consumer confidence.
However, this is likely to change for the better as real wage growth has already turned positive in 1Q23 but it will take a couple of quarters for consumers to start noticing the wage dynamics. All aside, the prospects for the tourist season look very good, authorities expecting a record year both in terms of number of tourists and revenues. We therefore reinforce our above-consensus GDP growth estimate of 2.7% for 2023 with upside risk.
Real GDP (YoY%) and contributions (ppt)
On the right track
The revised official targets for the 2023 budget gap point to a 0.7% of GDP deficit, compared to an initial deficit estimate of 2.3%. In essence, as in 2022 that ended with a 0.4% of GDP surplus, the government is partly using the better-than-anticipated budget revenues to improve its budget metrics. In this context, the country has already returned to running primary balance surpluses which are expected to continue in the coming years.
We estimate that this will enable the debt-to-GDP ratio to dip below the dreaded 60% of GDP in 2025, having exceeded this level for 15 years. Looking forwards, we still anticipate the country to run small negative fiscal balances, as the phasing out of energy support measures will overlap increased social spending.
Public debt and fiscal balance (% of GDP)
Inflation is coming down but wage pressure remains
After marking the top at 13.0% back in November 2022, the harmonised index of consumer prices (HICP) inflation has continually slowed to reach 8.5% in May, mostly on the back of energy price base effects. As the import price pressure starts to fade as well, the producer price growth is also visibly - though not as rapidly - decelerating. Core inflation, on the other hand, is reacting with lagged effects and we expect it to stay roughly 0.5ppt above headline inflation for the rest of the year.
The clear upside risks stem from wage pressures, as the purchasing power loss from 2H21 and 2022 now needs to be compensated. This comes on the back of an already tight labour market as the unemployment rate might hit record lows this year.
HICP inflation and wage rates
