OECD Economic Outlook, Volume 2023 Issue 2

Croatia

Output growth is expected to remain broadly resilient, picking up slightly from 2.5% in 2023 to 2.6% in 2024 and 2.7% in 2025. Rising public sector investment and resilient private consumption are projected to support demand, offsetting subdued exports. Inflation, which remains high, will decline gradually as labour inputs and excess capacity will remain relatively scarce.

Tighter euro area monetary policy is tempering lending growth and raising interest rates. A small government budget deficit is expected in 2023 but plans for tax cuts and higher spending on investment, wages and pensions are expected to contribute to a wider deficit in 2024. Rising revenues are projected to enable a modest improvement in the budget balance in 2025. Public debt is expected to fall below 60% of GDP by 2025. Ending poorly-targeted price caps and energy and home loan subsidies would help growth to remain sustainable, improve the economy’s efficiency and build fiscal buffers for future shocks.

Robust services exports and rising real incomes are buttressing growth

Output growth has been buoyed this year by recovering consumer spending, as rising wages and employment lifted households’ incomes. Robust tourism activity, boosted in part by integration into the euro and Schengen areas, has supported demand in employment-intensive services, helping to reduce the unemployment rate. This has offset weaker industrial production and goods exports, which have been affected by higher energy and other input costs and softer external demand, as well as slowing construction activity. After strong house price rises in 2022 and the first half of 2023, housing demand has moderated with higher borrowing costs and the expiry of a government home-loan subsidy.

Croatia: Fiscal and activity indicators

1. The fiscal balance corrected for the business cycle measures the government’s fiscal stance once cyclical variation in revenues and spending are taken into account.

Source: OECD Economic Outlook 114 database; and Eurostat.

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Croatia: Demand, output and prices

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The rise in international energy prices has slowed the fall in headline inflation, which reached 6.7% in the year to October. Falls in other international, upstream prices and softening global demand have eased the inflation momentum. International tourism, particularly within Europe, is a key influence on Croatia’s economy. Demand plateaued in the third quarter of 2023, albeit still near historic highs, as conditions weakened in key regional markets.

Fiscal policy will be stimulatory in the near term

Tighter euro area monetary policy is feeding into Croatia’s financial sector, with higher borrowing costs and tighter lending conditions contributing to lower growth in lending to businesses. Lending to households is more robust, led by home loans, which had been supported by a temporary government home loan subsidy. The government’s budget position has been supported by robust growth in activity and prices lifting revenues, and is expected to record a small deficit in 2023. In 2024, a wider deficit is expected due to higher public-sector pay and pensions, increases in public and defence investment, alongside cuts in household income tax and social contribution rates. The government has extended energy and food price caps and tax reductions to April 2024 and is providing one-off cash transfers. Spending on public investments and transfers for Recovery and Resilience plan projects, largely funded by EU programmes, are projected to rise slightly between 2023 and 2024. In 2025, the fiscal stance is projected to broadly neutral, with higher revenues expected to modestly reduce the budget deficit. Despite the near-term expansion of deficits, public debt is expected to fall below 60% of GDP by 2025.

Growth is expected to remain resilient

Output growth is projected to moderate in the second half of 2023 before firming slightly in 2024 and 2025. Weaker external demand will be the main drag on growth. Robust private consumption, as the tight labour market supports households’ real incomes, and rising investment as the government advances with its Recovery and Resilience Plan will support domestic demand. Nonetheless, capacity constraints will ease. Employers’ difficulties recruiting workers with relevant skills will be eased by reduced growth and by immigration. Inflation will continue to gradually abate with lower upstream prices and softer external demand, but remain above the euro area target due in part to strong wage growth. If wages continue to rise rapidly into the medium-term, inflation will remain well above other euro-zone countries and Croatia’s competitiveness will be weakened. Achieving planned increases in public investment remains a challenge. If investment falls short of plans, domestic activity would be weaker than projected. The capacity for further strong growth in tourism is uncertain. There is also risk of under-performance of industrial production and exports if energy or other input prices rise further or geopolitical uncertainty amplifies.

Building fiscal buffers and investing in the green and digital economy will help sustain growth

Ending poorly-targeted energy price caps and home loan support, fully implementing planned investments, and saving any windfall revenues would improve the sustainability of growth. Ensuring that the budget stance reduces demand pressures while inflation is high, and enables public debt ratios to fall, will help Croatia to face future shocks and looming challenges from the green transition and as the workforce declines and health and other care costs rise with the population ageing. Further expanding adult education and developing a more responsive skilled immigration programme can ease labour market pressures and improve access to higher productivity, higher income jobs.