MACRO MONITORING REPORT March 2016 CROATIA \ After six years of recession, Croatia started a gradual recovery growing by 1.6 percent in 2015 on the back of external demand and private consumption. The labor market improved, although the unemployment rate at 16.3 percent remained high compared to peers. A surge in tourism receipts, transfers from the EU and income surplus as parent banks reduced profit withdrawal due to CHF-loans conversion losses pushed the current account surplus to a record high. The general government deficit is expected to have declined to 4 percent of GDP in 2015, with public debt to GDP reaching 87 percent. After parliamentary elections in early November and difficult negotiations to form a government, the new government got confirmed in January. Two months later, the Parliament adopted the 2016 budget that aims to reduce the deficit below 3 percent of GDP. The Economy grew by 1.6 percent in 2015 following six unemployed continued to decline by 11.6 percent on annual years of contraction. After 1.5 percent in the first three basis due to early labor demand by tourist sector ahead of quarters, real GDP recorded an increase of 1.9 percent y-o-y Easter, as well as employment in trade and other services in the last quarter with an acceleration of consumption and activities. Additionally, there was a lower inflow of investment. This was the fifth consecutive quarter of positive unemployed from work, education and inactivity. Vacancies annual real growth. For 2015 as a whole, the largest positive surged by 20.1 percent yoy, while registered unemployment contribution to growth came from export of goods that surged rate declined to 17.8 percent in February, 1.8 percentage by 12.1 percent, led by ships, pharmaceuticals and food points below the same period of last year. products. Both personal and government consumption Current account balance (CAB) recorded a surplus of 5.2 continued growing in 2015, while investments recovered after percent of GDP in 2015. The largest contribution came from six years of decline by 1.6 percent yoy. Manufacturing a surplus on the income account for the first time in 15 years industry continued growing at the beginning of 2016 (by 8.4 as parent banks did not withdraw profits due to CHF-loans percent yoy by February) mostly on the back of manufacturing conversion losses (accounting for 2 percentage points of of food, chemical and fabricated metal products. Retail trade GDP). However, strong tourism performance (revenues up by surged by 4.1 percent yoy by February, also supported by 10.2 percent) increased surplus on services, while positive double-digit car sales. contribution came also from the rise in transfers from the EU Deflationary pressures persisted at the beginning of 2016. reflecting gradual strengthening of the absorption capacity. On After average decrease of 0.5 percent in 2015, consumer the other side, trade balance deteriorated despite growth in prices declined in the first two months by 1.1 percent y-o-y goods export (9.9 percent) led by pharmaceuticals, ships, driven by declining oil prices. motor vehicles, fabricated metal, food products and electricity. Real GDP, annual growth rates Foreign direct investment (FDI) declined to its historical (Percent) low in 2015. Despite overall close to EUR1.9 bn in new FDI, 3 net FDI declined to 0.3 percent of GDP due to 2 telecommunications profit transfer abroad, and losses in foreign-owned banking sector, affected by the mandatory 1 conversion of the CHF-denominated loans. % 0 At the same time, external debt declined to 103.7 percent -1 of GDP in 2015, on the back of financial sector deleveraging. External debt declined from 108.4 percent of -2 GDP at end-2014, despite a rise in government debt due to -3 bond issue of EUR1.5 bn as well as the central bank through Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 repo-auction related debt. The net international investment 2012 2013 2014 2015 position improved in 2015 reaching 78.7 percent of GDP, Source: CBS. compared to 88 percent at end-2014. Growth recovery underpinned by employment support Households and corporates continued to deleverage at the measures led to labor market improvement in 2015. beginning of 2016. From November 2015 to January 2016 Survey-based unemployment rate dropped to 16.3 percent in households’ loans were largely influenced by the conversion 2015, from 17.3 percent recorded in year before. Further, (HRK2.8 bn or 0.8 percent of GDP) and a partial write-off of activity and employment rates increased (to 52.7 percent and CHF loans (HRK6.6 bn or 2 percent of GDP). In January, 44.1 percent, respectively), although remaining well below the loans to households dropped by 5.7 percent yoy or 1.6 percent EU average. In the first two months of 2016, number of excluding the exchange rate and one-off effects. Together with corporate sector deleveraging, total loans declined by 2.1 set to decline further by 0.7 percentage points of GDP in 2017 percent. and another 0.3 pp of GDP in 2018. With real growth forecast at 2 percent in 2016, tax revenues are likely to be Despite negative credit growth, non-performing loans conservatively 1.2 percent above the 2015 level, while there is dropped to 16.6 percent in 2015. A sale of nonperforming an expectation that EU funds will double to HRK9.7 bn. loans to factoring companies and the write-offs which tripled Expenditures are higher by 1.1 percent of GDP (HRK3.8 bn) in 2015, led to a decline in the share of NPLs from 17.1 percent compared to the 2015 preliminary outcome (and higher than from a year ago. According to the stress test conducted by the in the guidelines published earlier due to larger expected central bank in January 2016, the domestic banking system is disbursements of EU funds). able to withstand potential shocks. Under the shock scenario, the share of NPL’s would reach 26 percent by 2017 mostly The government plans to tap the international market in driven by corporates with banks’ earnings declining further in mid-2016. In March, the government issued a domestic bond 2016 and 2017. The capitalization of the system would remain worth HRK4 bn, maturing in 2026 and carrying a yield of 3.99 above the regulatory minimum--at 13 percent on average. percent (down from 4.4 percent for the last issue in December). Credit default swap spreads are still at 270 basis The central bank launched long-term liquidity operations. points, some 100 bp above the EU peer countries, and aligned The current account surplus, coupled with the strengthening with Turkey and Portugal. Therefore, the fiscal consolidation of banks’ external positions and announced fiscal path the new government will pursue will very much consolidation opened the room for the central bank to determine the next pricing. introduce structural repo operations aimed at ensuring long- term liquidity, decreasing the financing costs for domestic Credit rating agencies rate Croatia two notches below sectors and, with strengthened domestic demand, boosting investment grade. In January 2016, following Fitch, the S&P lending in local currency to corporates and households. affirmed BB/'B credit rating on Croatia with the outlook remaining negative, while in March, Moody’s downgraded Growth supported fiscal consolidation in 2015. The central Croatia's rating to Ba2 from Ba1 and maintained the negative government cash deficit declined to 2.9 percent of GDP in outlook. Two main reasons for this decision were the already 2015 from 4 percent in 2014. VAT collection and doubled high and increasing level of public debt which greatly exceeds transfers from the EU budget contributed to a 7.8-percent the average of comparable countries with a Ba1 rating, and the increase in revenues, while expenditures rose by 3.5 percent continued weak prospects for stronger economic growth in the underpinned by grants to other general government units, medium term due to historically low investment rates and maintenance costs and interest payments. According to the structural inflexibility, as well as a low workforce ESA2010, the general government deficit reached 4.2 percent participation rate and bottlenecks in the absorption of EU of GDP by September 2015, down from 5.6 percent in 2014, funds. on the back of rising revenues, while expenditures remained flat. However, general government debt continued rising both Economic activity is expected to continue recovering in in nominal and relative terms reaching 86.7 percent of GDP, 2016-18 with growth averaging 2.1 percent a year. Risks compared to 86.5 percent of GDP in 2014, after the are still skewed to the downside. External factors, such as a methodological adjustment for the inclusion of another slowdown in Croatia’s main trading partners, the Fed’s highway concessionaire. tightening monetary policy and increased emerging market risk premium, could undermine Croatia’s fragile recovery, General government deficit and debt affecting exports and raising financing costs. On the domestic (Percent of GDP) side, high government and private debt will continue to 100 0 constrain investment and household consumption. Debt 86.5 86.7 -1 sustainability analysis indicates high risks in the medium term, 80 82.2 -2 70.7 while the scope of fiscal consolidation measures for 2016 and -2.7 -3 65.2 2017 is still uncertain. A wage increase of 6 percent planned 60 % of GDP 58.3 -4.2 -4 % of GDP 49.0 for 2016 as per the 2009 wage agreement and the delayed -5.4 -5 40 39.6 -5.3 -5.6 cancelation of the loyalty bonuses would add additional 0.65 -5.9 -6 -5.8 percent of GDP to spending in 2016 that could hamper the 20 -7 fiscal consolidation plans. The continued arrears creation in -7.8 -8 the health sector will also require additional savings measures. 0 -9 2008 2009 2010 2011 2012 2013 2014 2015 Lifting potential growth from the current 1 percent requires Domestic debt Foreign debt Guarantees sustained investment and deep structural reforms in labor and Total public debt Fiscal deficit (rhs) product markets to support full utilization of the labor force, Note: Fiscal deficit in 2015 refers to Q1-Q3. while ensuring robust productivity growth. Source: MoF, CBS, WB staff calculations. The parliament approved the 2016 budget with the general government deficit at 3 percent of GDP. The fiscal deficit is 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 5.2 120 115 4 2.9 2.7 3.1 2.5 index, 2011=100 1.9 110 1.8 105 2 1.0 0.9 in % of GDP 0.3 100 0 95 -0.7 0.0 90 -2 -1.1 Industry 85 -4 Construction 80 -5.1 Retail trade -6 75 CAB Net FDI Tourism last obs.: 2/16 (except Constr and Tour) -6.5 70 -8 -7.1 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 2016/1 2010/10 2011/10 2012/10 2013/10 2014/10 2015/10 -8.8 -10 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source: CBS, WB staff calculations. Source: CNB, CBS, WB staff calculations. Business and consumer confidence External debt and net international investment (Three-member moving averages) position (NIIP), Percent of GDP 150 120 -70 140 -72.7 105.6 108.4 101.1 104.2 103.7 103.0 103.7 130 100 -75 120 84.3 110 80 -78.7 -80 100 60 90 -85 80 40 -87.0 -88.0 last obs.: 3/16 70 -88.5 -90 2008 2009 2010 2011 2012 2013 2014 2015 2016 20 Construction business confidence indicator -90.6 -90.6 -93.0 Industry business confidence indicator Retail trade business confidence indicator 0 -95 Long-run average = 100 2008 2009 2010 2011 2012 2013 2014 2015 Services business confidence indicator Consumer confidence indicator External debt, % of GDP (lhs) NIIP, % of GDP (rhs) Economic Sentiment Index (ESI) Source: EC, WB staff calculations. Source: CNB, CBS, WB staff calculations. Labor market, administrative data Non-performing loans (Thousands) (Percent) 1500 410 35 Total loans 1450 30 370 Corporate 25 Households % of total loans 1400 thous. thous. 330 20 1350 290 15 1300 10 last obs.: 2/16 (except Empl). 1250 250 5 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 2016/1 2010/10 2011/10 2012/10 2013/10 2014/10 2015/10 0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Employment (lhs) Employment_tc (lhs) Unemployment (rhs) Unemployment_tc (rhs) 2009 2010 2011 2012 2013 2014 '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 -8 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2011/10 2010/10 2012/10 2013/10 2014/10 2015/10 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 2016/1 2011 2012 2013 2014 2015 Source: CBS. Source: CBS. Croatia Selected Indicators Avg. '00-14 2012 2013 2014 2015 E 2016 F Income and economic growth GDP growth (annual %) 1.7 -2.2 -1.1 -0.4 1.6 1.9 GDP per capita growth (annual %, real) 2.2 -1.9 -0.8 0.0 1.8 2.2 GDP per capita (US$, nominal) 11128.7 13236.1 13574.9 13480.7 11554.1 11879.7 GDP per capita, PPP (current international $) 17231.8 21113.6 21350.5 21252.3 21709.2 22176.0 Private Consumption growth (annual %) 1.6 -3.0 -1.8 -0.7 1.2 1.2 Gross Investment ( % of nominal GDP) 23.1 19.6 19.8 19.1 19.0 19.5 1 Gross Investment - Public ( % of nominal GDP) 4.9 3.5 3.7 3.7 3.4 3.3 Money and Prices Inflation, consumer prices (annual %, end of period)2 2.6 4.7 0.3 -0.5 0.9 1.7 Inflation, consumer prices (annual %, period average)2 2.7 3.4 2.2 -0.2 -0.5 0.9 M2 ( % of GDP) 67.8 79.3 82.2 85.0 86.0 86.9 1 Domestic Credit to the Private Sector ( % of GDP) 59.8 71.5 71.0 69.9 69.0 68.6 2 10 year interest rate (annual average) .. .. .. .. .. .. Nominal Exchange Rate (local currency per USD) 6.2 5.9 5.7 5.7 6.9 6.9 Real Exchange Rate Index (2010=100) 101.4 96.6 97.3 96.2 101.8 103.2 Fiscal Revenue (% of GDP) 42.1 41.7 42.5 42.6 42.6 42.3 Expenditure (% of GDP) 46.5 47.1 47.8 48.2 46.8 45.5 Interest Payments (% of GDP) 2.3 3.4 3.5 3.5 3.6 3.6 Non-Interest Expenditure (% of GDP) 44.3 43.7 44.3 44.7 43.3 42.0 Overall Fiscal Balance (% of GDP) -4.4 -5.3 -5.4 -5.6 -4.2 -3.2 Primary Fiscal Balance (% of GDP) -2.1 -2.0 -1.9 -2.1 -0.6 0.3 General Government Debt (% of GDP) 50.4 70.7 82.2 86.5 86.7 86.8 1 External Public Debt (% of GDP) 24.2 29.3 34.7 36.0 36.4 37.8 External Accounts Export growth, f.o.b (nominal US$, annual %) 9.9 -7.8 6.4 6.7 -8.1 3.9 Import growth, c.i.f (nominal US$, annual %) 8.4 -8.8 6.1 3.0 -9.4 4.5 Merchandise exports (% of GDP) 17.1 19.7 20.5 22.7 24.3 24.6 Merchandise imports (% of GDP) 35.5 34.0 35.6 37.5 39.4 40.1 Services, net (% of GDP) 14.3 14.6 15.5 16.9 17.9 18.1 Current account balance (current US$ millions) -1750.1 -167.3 566.1 453.9 2539.5 1468.7 Current account balance (% of GDP) -3.7 -0.3 1.0 0.8 5.2 2.9 Foreign Direct Investment, net inflows (% of GDP) 3.6 2.7 1.9 3.1 0.3 0.4 1 External debt, total (% of GDP) 81.5 103.0 105.6 108.4 103.7 100.2 Multilateral debt (% of total external debt)1 6.3 8.3 9.0 9.8 11.2 12.5 1 Debt service ratio (% of exports goods and non-factor services) 42.4 63.6 51.4 53.0 51.4 47.5 Population, Employment and Poverty Population, total (millions) 4.4 4.3 4.3 4.2 4.2 4.2 Population Growth (annual %) -0.5 -0.3 -0.3 -0.4 -0.2 -0.3 Unemployment Rate1 13.5 15.9 17.3 17.3 16.3 16.0 Poverty headcount ratio at national poverty line (% of population)1 20.2 20.4 19.5 19.4 .. .. 1 Poverty headcount ratio at US$5 a day (PPP) (% of population) 8.5 9.4 9.8 9.8 9.0 8.7 Inequality - Gini Coefficient1 31.1 30.9 30.9 30.2 .. .. Life Expectancy1 75.7 76.9 77.1 77.6 .. .. Other GDP (current LCU, millions) 285601.4 330456.0 329571.3 328430.5 335266.6 343537.2 GDP (current US$, millions) 48713.3 56485.6 57770.4 57136.6 48884.8 50134.4 GDP per capita LCU (real) 71692.4 74975.5 74384.7 74419.1 75742.6 77379.2 Doing Business Rank3 39 .. .. 39 40 .. Human Development Index Ranking4 46 47 47 .. .. .. 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. Sources: MFMOD Database, World Bank WDI, GEM databases, IMF and national sources.