Croatia

Details

Country assessments

Highlights

• Croatia became a member of the European Union (EU). The country joined the Union as the twenty-eighth member state on 1 July 2013, after fulfilling all necessary pre-accession requirements, and following ratification of the Accession Treaty by all member states.
  
• Key large-scale privatisations were completed this year. The government sold the Brodosplit, Brodotrogir and 3 Maj shipyards, and earlier in the year launched the privatisation of the freight railway operator, HZ Cargo.
  
• The economy remains in recession. Last year GDP declined by 2 per cent on the back of a decline in domestic demand, and there are no signs of recovery in the first half of 2013.

Key priorities for 2014

• The government needs to accelerate reforms to strengthen the business environment and to boost the economy’s competitiveness. Progress on these fronts has been limited in recent years, although some concrete measures have been implemented. The recent EU accession and the continued slump in economic activity have added urgency to further actions on these issues.
  
• Labour market reforms are needed in order to reduce unemployment, especially among the youth. Unemployment rose sharply during the recession, and currently stands at close to 20 per cent of the labour force (and more than 40 per cent for those under 25). Measures to reduce hiring and firing costs are urgently needed.
  
• Private sector involvement in the infrastructure sector should be enhanced. Efforts to reduce the role of the state and enhance commercialisation in key transport and energy companies should be stepped up.

Macroeconomic performance

The economy is back in recession. Croatia experienced one of the most protracted recessions in the region as a result of the global financial crisis. After two years of declining output in the period 2009-10, and zero growth in 2011, the country is now back in recession. GDP fell by 2 per cent in 2012, as a result of a decline in domestic demand. These figures reflect both spillovers from the eurozone crisis and deep structural problems. These weaknesses have persisted into 2013. GDP fell by 1.5 per cent year-on-year in the first quarter, on the back of a continued decline in household consumption, and further falls in investments and a drop in exports of goods were experienced. According to official estimates, the recession moderated in the second quarter, with GDP declining by 0.7 per cent year-on-year. Upward pressures on prices have been subsiding in recent months, and inflation stood at 1.9 per cent year-on-year in July 2013. Pressure on the kuna in 2012 led the Croatian National Bank to intervene several times on foreign exchange markets to prop up the currency.  

The 2013 budget was revised in March, and the deficit target was reduced slightly to 3 per cent of GDP, from the original 3.2 per cent, due mainly to expenditure adjustments. However, the general government deficit is higher when measured by ESA95 standards. It is likely that the government wished to reassure markets that its fiscal resolve had not weakened, and to alleviate concerns over the sustainability of its public debt. This follows the downgrading of Croatia’s sovereign debt rating to junk by two of the three main credit agencies (S&P in late 2012 and Moody’s in early 2013), notwithstanding Croatia’s pending EU membership, which normally pushes up ratings. S&P has subsequently revised its outlook on Croatia to negative, indicating possible further downgrades, while Fitch also downgraded its rating of Croatia’s sovereign debt to junk status in September 2013.   

The prospects for recovery are gloomy.  The economic outlook is very uncertain, given the protracted crisis in the eurozone, and downside risks are high. Under current baseline projections the recession will continue this year, although the decline in GDP will be smaller than in 2012. Over the medium term, Croatia’s economy could see a boost as a result of its EU accession, but prospects for growth will depend on the extent to which long-awaited reforms to public administration and the labour market are implemented.

Major structural reform developments

Croatia joined the EU on 1 July 2013. Following the completion of the EU accession talks, Croatia was subject to a special pre-accession monitoring mechanism focusing on a number of priority reform areas, including public administration, the judiciary and the business environment. The European Commission’s final monitoring report, published in March 2013, confirmed that Croatia had completed the priority actions identified in previous reports, and that it had demonstrated its ability to fulfil the remaining obligations prior to the accession date. Following ratification of the Accession Treaty by all member states, Croatia was able to join the Union as planned on 1 July 2013.  

Some key, large-scale privatisations took place in the lead-up to EU accession. The government had experienced considerable difficulty in restructuring and selling the loss-making shipyards. However, incentivised by the EU accession deadlines, the government accelerated efforts to sell the remaining state-owned shipyards in the first half of 2013. Brodosplit and Brodotrogir were both sold to local enterprises, and 3 Maj was sold to the shipyard, Uljanik. In August 2013 the government launched tenders for the privatisation of Hrvatska postanska banka and the Croatia Osiguranje insurance company. At the end of July 2013 the government accepted an offer for 75 per cent of the cargo railway company HZ Cargo by Romania’s GFR Group.

Limited progress has been achieved in strengthening the business environment over the past year. Croatia’s ranking in the World Bank 2014 Doing Business report declined by one place, relative to the previous year, from eighty-eighth to eighty-ninth, of 189 countries. The World Bank noted positive developments, in the areas of tax reform, trading across borders, contract enforcement and resolving insolvency. The largest gaps remain in the areas of construction permits, investor protection, trading across borders and property registration. Progress has been made with respect to land registry reform, but some restrictions still exist for the purchase of land by foreign persons or legal entities. The government has intensified efforts to improve the business environment in other areas, but progress in achieving concrete results is slow.

Railway reforms are advancing. In July 2012 the government decided on a major restructuring of the national railway company, Hrvatske Zeljeznice (HZ). At the end of last year three independent companies were established: HZ Cargo, HZ Passenger and HZ Infrastructure, while HZ Holding and HZ Traction ceased to exist. Various measures, including major labour force shedding, are under way as part of a longer term restructuring programme for the sector. A new Law on Railways was approved by the parliament in July 2013 to underpin this process.

The financial sector is strained by weak credit demand and a rising proportion of non-performing loans (NPLs). Credit growth has been negative since August 2012, and the decline intensified this year (over 3 per cent year-on-year). Meanwhile, the proportion of NPLs has risen to 15.1 per cent of total loans, as at the end of July 2013, and provisions are low, at about 43 per cent, although the system-wide capital adequacy remains at 20.8 per cent as at June 2013.

Non-bank financial institutions (NBFIs) and private equity are increasing in importance, from a low base. Standard NBFI products are well established in Croatia, including a three-pillar pension system. Competition has increased in the insurance sector in the past year, with a decrease in market share for the top three companies. With regard to private equity, while there have been few meaningful private equity transactions historically, active capital and capital available for investment both increased over the last year, estimated at approximately 0.5 and 0.6 per cent of GDP, respectively (up from 0.4 and 0.5 per cent of GDP in 2011). In 2012 there were four identified country-dedicated fund managers, and 17 identified regional fund managers, up from two and 15, respectively, in 2011.

Efforts are under way to improve labour market flexibility. Unemployment in Croatia has increased sharply during the recession of recent years, standing at 18.6 per cent as at June 2013. The rate of youth unemployment is particularly high, reaching 43 per cent at the same point in time. The country has, for many years, carried the burden of relatively inflexible rules regarding the employment and dismissal of workers, and these rules have hindered the economic recovery. In an effort to reform the system, in August 2013 the government proposed a number of amendments to the Labour Law, including measures to allow for more flexible working hours, and for lower severance payments in the event of termination of contract.

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