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 +10% in 2021 and over +8% y/y in the first half of 2022, economic activity began to cool in the second half of the year amid higher inflation, rising interest rates, softening external demand and declining business confidence. Real GDP shrank in Q3 2022 and we expect a mild technical recession lasting into early 2023. The projected economic slowdown in Western Europe, Croatia’s main export destination, will weigh on trade and tourism in the country. Domestic fiscal stimulus will be moderate due to rising financing costs. However, EU funding inflows should somewhat mitigate the impact on growth. We expect full-year real GDP to expand by around +1.7% in 2023. Our tentative forecast for 2024 is an acceleration to growth of about +2.5%.

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.

In the near term, inflationary pressures will remain elevated. Consumer price inflation turned positive in early 2021 and rose to more than 13% y/y in Q4 2022, driven by interrupted supply chains and surging energy and food costs. We expect it to remain in the double digits in the first half of 2023 before a gradual decrease is likely towards the end of the year, in part due to base effects, the ECB's tighter monetary policy and slowing domestic demand.

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 2022 ranks Croatia 45 out of 184 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 in 2022) while weaknesses remain in the areas of government integrity and labor 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.

As of January 2023, Croatia has been admitted to the Schengen zone by the EU. As a result, passengers passing through land crossings and sea borders will no longer be required to show a passport, and Croatia itself will be able to issue Schengen visas. From 26 March 2023 onwards, passport checks will be ended for passengers arriving from other Schengen member states. Moreover, Croatia will end the last of the controls on its border with Slovenia and Hungary, easing the movement of people and goods between the country and the rest of the EU. Among other things, this will bring an end to the long queues that form on Croatia's borders each summer as millions of tourists enter and leave the country. However, the increase in irregular immigration via the Balkans, with arrivals into the EU rising by over +150% in 2022, has led Slovenia to warn it may continue to conduct spot patrols on its border with Croatia, deferring the point of completely free passage across the latter's land border with the rest of the EU.