Croatia

The economic outlook for Croatia has markedly deteriorated as a result of the war in Ukraine. The economy is highly dependent on exports, especially the export of services (tourism), which makes it vulnerable to external shocks. Croatia is also a large net importer of energy and food and thus has been hit by the surge in global prices for these goods in 2022. However, the country’s direct trade relations with Russia have been small so it has been less impacted by the European energy-supply crisis and EU trade sanctions against Russia than other countries in the Emerging Europe region. Following a strong post-Covid-19 recovery, with real GDP growth of around +13% in 2021 and over +8% y/y in the first half of 2022, economic activity began to cool in the second half of that year amid higher inflation, rising interest rates, softening external demand and declining business confidence. Growth came in at +6.3% in 2022 as a whole and decelerated further to an average +2.3% y/y in the first three quarters of 2023, as the economic slowdown in Western Europe, Croatia’s main export destination, weighed on trade and tourism in the country. Domestic fiscal stimulus has been moderate due to rising financing costs. Going forward, EU funding inflows should somewhat mitigate the impact on growth. We forecast annual real GDP to expand between +2.5% and +3% in 2024-2025.

Croatia joined the Eurozone at the start of 2023, marking an important milestone in the process of integration with the EU a decade after it joined the bloc. While monetary policy is now conducted by the European Central Bank (ECB), membership of the Eurozone provides for low transfer and convertibility risk and has substantially decreased external vulnerabilities related to exchange-rate risk. The backing of the ECB should strengthen the banking and financial system in Croatia and increase the economy’s resilience to external economic shocks. Investor confidence should rise as well and overall Eurozone membership should provide a medium-term boost to the economy.

Inflation has moderated to 4.5% y/y at end-2023, after it had risen to a peak of 13.5% y/y in November 2022, driven by interrupted supply chains and surging energy and food costs. We project it to remain somewhat elevated in 2024 owing to strong wage growth, persistent, though slowing, price increases in services and the likely phase out of measures to mitigate the impact of high energy prices. We forecast annual average inflation of around 3.5% in 2024 and 2.5% in 2025.

The business environment in Croatia is generally adequate though spots of weaknesses remain. The World Bank Institute’s annual Worldwide Governance Indicators surveys suggest that the regulatory framework is generally business-friendly while weaknesses remain with regard to perceived corruption and the legal framework. The Heritage Foundation’s Index of Economic Freedom survey 2023 ranks Croatia 46 out of more than 180 economies, a significant improvement from rank 79 in the 2021 survey. The country gets strong scores with regard to the tax burden, trade freedom, investment freedom, property rights and judicial effectiveness (with the latter two items reflecting the improvement since 2021) while weaknesses remain in the areas of government integrity, labor freedom and financial freedom. Our proprietary Environmental Sustainability Index assigns Croatia is a strong rank of 13 out of 210 economies, reflecting high scores for energy use and CO2 emissions per GDP, renewable electricity output, water stress and general vulnerability to climate change. However, the recycling rate is the one weakness.