OECD Economic Outlook, Volume 2022 Issue 2

Croatia

The energy and price shocks are projected to sharply slow Croatia’s growth from 6.4% in 2022 to 0.8% in 2023. Rising exports, employment and wages are projected to support incomes as energy prices and supplies stabilise, lifting output growth to 1.5% in 2024. Faster implementation of EU‑funded projects and Croatia’s integration into the euro and Schengen visa areas will encourage investment. Labour market tightness, especially for specialised skills, and scarce spare capacity risk amplifying wage and cost pressures.

Substantial fiscal measures offset the drag of scarce and more expensive energy on household well‑being, production and exports, mostly by limiting price rises, but could add to demand pressures. Making support measures more targeted towards vulnerable consumers and designing them so as to maintain incentives for energy savings would improve fiscal sustainability and raise Croatia’s lagging energy efficiency. Continuing fiscal consolidation would reduce demand pressures and free resources to address other challenges to sustained growth, such as skills shortages.

Surging energy prices and uncertainty are stalling the strong rebound

GDP grew strongly in the first half of 2022, supported by the rebound in tourism and other exports, and strong household consumption. Tourist receipts in the year to August 2022 exceeded the previous record in 2019. High-frequency indicators suggest that this momentum stalled in the third quarter of 2022, as heightened international uncertainty amplified the drag from surging energy and other prices and supply disruptions. By August 2022, industrial production had retreated from the historic highs achieved earlier in the year. Retail spending also fell, as slowing employment growth and strong consumer price inflation, reaching 12.6% in September 2022, compressed households’ real incomes. Inflation, initially led by energy and food prices, has broadened into other goods and services, lifting core inflation above the headline rate.

Croatia

Source: OECD Economic Outlook 112 database.

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Croatia: Demand, output and prices

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Croatia sourced a modest share of its energy from Russia prior to 2022, thanks to extensive renewable energy capacity and its expanding energy import infrastructure. Nonetheless Croatia is exposed to surging European wholesale energy prices. To offset these, it has introduced measures worth at least 3.7% of annual GDP, including: tax relief and excise rate cuts (2.6% of GDP); income support for vulnerable groups (0.8% of GDP); and support for energy renovations (0.3% of GDP). In addition, support for loans and grants to businesses is valued at 1.7% of GDP. It has increased social benefits for pensioners and other vulnerable groups, and is raising civil servants’ wages. Most of these measures are scheduled to expire in March 2023, but are expected to be extended for an additional 12 months as the energy crisis persists.

Fiscal and monetary conditions will remain supportive

Strong growth in activity and prices in 2022 buoyed revenues, enabling the government to increase transfers and other spending. The government expects the budget deficit to be near 2.4% of GDP in 2023, as it expects revenue growth to slow while it maintains increased spending on energy support measures and public investment. However, the carry-over in revenues from stronger growth in 2022, and rising construction costs which add to the challenges of implementing planned investment projects, may lead to a smaller deficit. Croatia’s integration into the euro area on 1 January 2023 will support access to finance and reduce its cost, eliminating the exchange rate risk of euro-denominated loans. Rating agencies are upgrading Croatia’s sovereign debt rating and spreads on public debt may fall further. For private borrowers, this could partly offset rising euro area interest rates.

Rising investment will rekindle growth

Weaker external conditions, the loss of real incomes, shortages and uncertainty are projected to slow consumption, investment and exports in the near-term. With reduced pressures on capacity and recruitment, inflation should ease. From 2023, supplies and prices of energy are expected to stabilise, while increased public spending and substantial wage rises help to rebuild households’ real incomes. Investment is projected to lead the pick-up, supported by European funds disbursements, and as Croatia attracts greater financing and foreign direct investment following its integration into the euro and Schengen visa areas. The expiry of energy support measures, expected in 2024, will lift headline inflation temporarily. Inadequate energy supplies, especially over the coming winters, would risk deeper contractions in activity and spending. Improving competitiveness, fiscal credibility, and the full implementation of Croatia’s recovery and resilience plan are central to raising investment. This would be imperilled if wage or price growth outpace peers, fiscal consolidation falls short of medium‑term objectives, or the planned improvements to the business environment are not achieved.

Addressing skills shortages and improving the economy’s resilience will help sustain growth

As Croatia integrates into the euro area, further reductions of the fiscal deficit would improve the sustainability of growth and reduce the risks from capacity constraints and declining competitiveness. Shifting from fiscal measures that cap energy prices to targeted help for households and firms to reduce their energy needs – such as renovating buildings or improving the efficiency of transport and other equipment – would reduce exposure to energy price fluctuations, reduce the fiscal costs of support measures and improve environmental quality. Raising participation in quality active labour market programmes, and reforming pension and retirement arrangements to encourage older workers to continue contributing to the workforce, would help address labour market pressures. In the longer term, raising participation in high-quality vocational education programmes would help to ensure that adults have the skills to benefit from emerging, higher productivity opportunities.