IMF Executive Board Concludes 2023 Article IV Consultation with Croatia
June 29, 2023
Washington, DC: The Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation [1] with Croatia on a lapse-of-time basis. [2]
On January 1, 2023, Croatia became the 20th member of the eurozone, a testament to the significant progress achieved since joining the European Union in 2013. The euro adoption has improved sovereign ratings, eased access to capital markets, and significantly reduced exchange rate risks.
Croatia posted another year of strong economic growth in 2022, among the highest in the eurozone. Output expanded by 6.2 percent in 2022, driven by domestic demand and tourism. The fiscal position improved considerably to a small surplus and the public debt declined significantly to about 69 percent of GDP, below pre-pandemic levels. However, surging energy and food prices drove headline inflation to a multi-decade high at year end. The largely foreign-owned banking system has remained profitable, well-capitalized, and extremely liquid.
Economic growth is expected to moderate to 2.4 percent in 2023. Weak external demand, tightening financial conditions, and still high global uncertainty are expected to dampen growth, partially offset by a decline in global commodity prices, resilient tourism, and a buoyant labor market. Growth is projected to gradually recover from 2024 towards its potential. Inflation is projected to recede to an average of 7½ percent in 2023 and fall towards the ECB’s 2 percent target in late 2025. The adoption of euro has had a very limited impact on inflation.
The outlook remains subject to significant uncertainty, but risks to growth are broadly balanced. Downside risks include intensification of Russia’s war in Ukraine, a renewed surge of commodity prices and inflation, a sharper global or regional recession, and tighter-than-expected financial conditions. On the upside, the euro adoption and entry into the Schengen area could provide a stronger boost to tourism, trade, and investment. Risks to inflation are tilted to the upside.
Executive Board Assessment
The euro adoption marks a momentous milestone for Croatia and is a testament to diligent policymaking and concerted efforts. The economy has also proven resilient in the face of the pandemic and the war in Ukraine and recorded another year of strong growth in 2022. However, surging global energy and food prices pushed headline inflation to a multi-decade high towards year end. While inflation has peaked, it remains elevated and broad-based. The 2022 external position was broadly in line with the level implied by fundamentals and desirable policies.
Growth is set to moderate in 2023. Weak external demand, tightening financial conditions, and still elevated global uncertainty would weigh on growth, partially offset by a decline in global commodity prices, resilient tourism, and a buoyant labor market. Higher growth is anticipated from 2024, underpinned by a recovery in the global economy and reforms under the NRRP. Inflation is expected to be sticky, averaging about 7½ percent in 2023, and to gradually fall towards the ECB's target of 2 percent by late 2025. The outlook remains subject to significant uncertainty.
The near-term fiscal policy needs to complement monetary tightening and avoid adding to aggregate demand. The labor market is tight, core inflation remains elevated, and the euro adoption has mitigated the impact of ECB’s tightening. Therefore, an expansionary fiscal stance risks fueling domestic demand and inflation and hurting Croatia’s competitiveness. Broad-based support measures—notably energy price caps and tax cuts—need to be reversed.
Maintaining a growth-friendly fiscal consolidation over the medium-term is paramount, by improving tax policy, reducing spending rigidity, and enhancing spending efficiency. Given Croatia’s high budget spending rigidity and the need to further reduce public debt, any tax reforms should preserve revenue resources while improving the tax system structure to reduce distortions and support fairness and growth. Modernizing the property tax and reducing favorable taxation on short-term rental income would help dampen housing demand, boost supply, and encourage labor participation. A simplified and transparent public sector pay system that rewards merit and productivity would enhance public services and make the sector more efficient. Worsening healthcare and pension costs due to an aging population call for renewed efforts to lengthen the working life and decisively address healthcare arrears. In addition, enhancing the monitoring and corporate governance of SOEs will reduce potential fiscal risks and maximize their contribution to growth. Efforts to strengthen the public investment management system, including establishing a strong central coordination function in the MOF, should continue.
The financial system is currently stable; continued vigilance is needed given ongoing challenges. The banking system has remained profitable, well-capitalized, and extremely liquid. Although household and corporate vulnerabilities have moderated since the pandemic, a deeper economic slowdown amidst higher interest rates could pose new challenges. In addition to the announced increases of the counter-cyclical capital buffer, explicit borrower-based measures could be considered to contain potential future financial stability risks of housing market pressures, taking into consideration measures already in place and other risk mitigating factors. A comprehensive review of housing support measures should be considered to address the housing affordability challenge.
Advancing structural reforms is key to reap the full benefits of euro adoption and sustaining income convergence. The authorities should continue their commendable and steadfast implementation of the NRRP. Raising productivity, advancing the green and digital transition, and making the best of an aging and declining population are priorities. The currently tight labor market offers an opportunity to carry out further labor market reforms. More ambitious reforms, along with the EU funds, are warranted to address relatively low firm-level productivity and inefficient resource allocation. A comprehensive climate strategy, beyond the NRRP and fully aligned with the energy strategy, will help diversify the energy mix, promote energy savings, improve energy efficiency, and accelerate the green transition. In particular, an economy-wide carbon pricing accompanied by sectoral policies and targeted support to the vulnerable can help promote cost-effective emissions reductions and ensure adherence to the EU-wide targets.
[1] Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.
[2] The Executive Board takes decisions under its lapse-of-time procedure when the Board agrees that a proposal can be considered without convening formal discussions.
|
Table 1. Croatia: Selected Economic Indicators, 2019-2028 |
|||||||||||
|
2019 |
2020 |
2021 |
2022 |
2023 |
2024 |
2025 |
2026 |
2027 |
2028 |
||
|
Prel. |
Projections |
||||||||||
|
Output, unemployment, and prices |
(Percent change, annual average, unless otherwise indicated) |
||||||||||
|
Real GDP growth |
3.4 |
-8.5 |
13.1 |
6.2 |
2.4 |
2.4 |
2.7 |
2.9 |
2.8 |
2.8 |
|
|
Contributions: |
|||||||||||
|
Domestic demand |
2.4 |
-3.1 |
6.0 |
5.4 |
3.5 |
2.6 |
2.2 |
1.9 |
2.1 |
2.1 |
|
|
Net exports |
1.0 |
-5.4 |
7.1 |
0.9 |
-1.1 |
-0.2 |
0.5 |
1.0 |
0.7 |
0.7 |
|
|
Unemployment rate |
7.8 |
9.0 |
8.1 |
6.8 |
6.3 |
5.9 |
5.6 |
5.6 |
5.6 |
5.6 |
|
|
CPI inflation (avg.) |
0.8 |
0.0 |
2.7 |
10.7 |
7.5 |
3.8 |
2.5 |
2.2 |
2.2 |
2.1 |
|
|
Saving and investment (percent of GDP) |
|||||||||||
|
Domestic investment |
22.9 |
24.2 |
21.9 |
25.8 |
25.9 |
26.1 |
25.9 |
25.0 |
24.5 |
24.0 |
|
|
Domestic saving |
25.8 |
23.6 |
23.6 |
24.2 |
25.6 |
25.7 |
25.2 |
24.7 |
24.5 |
24.3 |
|
|
Government |
6.8 |
-2.0 |
1.8 |
4.3 |
2.5 |
3.0 |
3.6 |
4.0 |
4.1 |
4.2 |
|
|
Nongovernment |
18.9 |
25.6 |
21.8 |
19.9 |
23.1 |
22.6 |
21.5 |
20.7 |
20.4 |
20.2 |
|
|
Government sector (ESA 2010 definition) |
|||||||||||
|
General government revenue |
46.5 |
46.8 |
46.2 |
45.5 |
45.7 |
45.2 |
45.2 |
45.3 |
44.8 |
44.7 |
|
|
General government expenditure |
44.3 |
54.1 |
48.7 |
45.1 |
46.5 |
46.9 |
46.3 |
46.1 |
45.6 |
45.2 |
|
|
General government balance |
2.2 |
-7.3 |
-2.5 |
0.4 |
-0.8 |
-1.8 |
-1.1 |
-0.8 |
-0.8 |
-0.6 |
|
|
Structural balance 1/ |
2.1 |
-5.7 |
-3.2 |
-0.5 |
-1.3 |
-2.0 |
-1.2 |
-0.8 |
-0.8 |
-0.6 |
|
|
Structural primary balance |
4.2 |
-3.7 |
-1.8 |
0.7 |
0.3 |
-0.2 |
0.3 |
0.6 |
0.4 |
0.5 |
|
|
General government debt 2/ |
71.0 |
86.9 |
78.3 |
68.8 |
63.7 |
62.5 |
60.9 |
59.2 |
57.6 |
55.9 |
|
|
Balance of payments (percent of GDP) |
|||||||||||
|
Current account balance |
2.9 |
-0.5 |
1.8 |
-1.6 |
-0.3 |
-0.5 |
-0.7 |
-0.3 |
0.0 |
0.4 |
|
|
Capital account |
1.6 |
2.1 |
2.4 |
2.6 |
3.0 |
2.5 |
2.5 |
2.2 |
2.0 |
1.7 |
|
|
Financial account |
-4.5 |
-1.0 |
-3.3 |
1.2 |
-2.7 |
-2.0 |
-1.8 |
-2.0 |
-2.0 |
-2.1 |
|
|
Debt and reserves |
|||||||||||
|
Gross official reserves (billions of euros) |
18.6 |
18.9 |
25.0 |
27.9 |
… |
… |
… |
… |
… |
… |
|
|
IMF metric 3/ |
13.6 |
10.8 |
12.7 |
14.9 |
… |
… |
… |
… |
… |
… |
|
|
IMF metric (percent) 3/ |
136.2 |
175.0 |
197.6 |
187.1 |
… |
… |
… |
… |
… |
… |
|
|
In months of imports in goods and services (based on next year level) |
7.8 |
9.3 |
9.8 |
7.6 |
… |
… |
… |
… |
… |
… |
|
|
Total external debt (percent of GDP) |
74.1 |
81.8 |
81.1 |
74.0 |
66.4 |
63.3 |
60.9 |
59.0 |
57.3 |
55.5 |
|
|
Money and credit |
(End of period unless otherwise indicated, change in percent) |
||||||||||
|
Broad money (M4) |
2.9 |
9.3 |
10.7 |
8.4 |
… |
… |
… |
… |
… |
… |
|
|
Claims on other domestic sectors 4/ |
2.6 |
3.3 |
2.6 |
10.0 |
… |
… |
… |
… |
… |
… |
|
|
Interest rates |
|||||||||||
|
12-month average T-bill rate (in kuna until 2023, then euros) |
0.1 |
0.1 |
0.0 |
0.1 |
… |
… |
… |
… |
… |
… |
|
|
10-year government bond yield |
0.7 |
0.6 |
0.1 |
2.8 |
… |
… |
… |
… |
… |
… |
|
|
Exchange rate |
|||||||||||
|
Real effective exchange rate (percent, "-" = appreciation) |
-1.3 |
-1.3 |
-0.1 |
0.2 |
… |
… |
… |
… |
… |
… |
|
|
Memorandum items |
|||||||||||
|
Nominal GDP (billions of euros) |
54.8 |
50.5 |
58.2 |
66.9 |
73.8 |
78.1 |
82.3 |
86.5 |
90.9 |
95.5 |
|
|
Sources: Croatian authorities; and IMF staff estimates. Unemployment rate is from Croatian Bureau of Statistics and Haver Analytics. |
|||||||||||
|
1/ Based on a simplified approach to the cyclically-adjusted balance, in percent of potential GDP. Includes the one-offs related to the COVID-19 package of -3.8 percent of GDP in 2020 and -2.3 percent of GDP in 2021. Includes the one-offs related to the energy crisis of 1.4 percent of GDP in 2022 and 1.6 percent of GDP in 2023. |
|||||||||||
|
2/ Gross debt as defined by the EU under the Maastricht Treaty. |
|||||||||||
|
3/ IMF, 2015, “Assessing Reserve Adequacy-Specific Proposals” IMF Policy Paper, Washington: International Monetary Fund. |
|||||||||||
|
4/ Comprises claims on households and non-financial corporations. |
|||||||||||
IMF Communications Department
MEDIA RELATIONS
PRESS OFFICER: Camila Perez
Phone: +1 202 623-7100Email: MEDIA@IMF.org