Press Release No. 25/417

Washington, DC: The Executive Board of the International Monetary Fund (IMF) completed the 2025 Article IV consultation for Republic of Croatia,^[1] considered and endorsed the staff appraisal without a meeting on a lapse-of-time basis.[2] The authorities have consented to the publication of the Staff Report prepared for this consultation.

The economy has continued to grow rapidly, still among the highest in the euro area, but imbalances are emerging. The increases in fiscal deficit driven by spending during strong economic growth have exacerbated demand pressures, contributing to higher inflation and current account deficits. Credit growth has been rapid and housing prices have increased strongly. Against a weak external environment and elevated global uncertainty, staff projects growth to moderate to a still solid pace of around 3 percent in 2025–26 with inflation moving toward the ECB’s target in late 2026 or early 2027. The current account deficit is expected to widen in the short run before improving while the fiscal deficit is projected to average marginally below 3 percent of GDP during the projection horizon.

Risks to growth are broadly balanced while risks to inflation are tilted to the upside. Growth would be weaker if external demand, particularly in the tourism sector, were to weaken considerably, including because of worsening geopolitical or trade tensions, or lower growth of major trading partners. Global shocks could also result in higher inflation, notably through energy and food prices. Domestically, there is a risk of protracted overheating, as continuation of accommodative fiscal policy and higher-than-expected wage and credit growth could fuel domestic demand and stall disinflation. On the upside, faster implementation of reforms could ease supply side constraints, raising actual and potential growth.

Executive Board Assessment

The economy has continued to grow strongly but imbalances are emerging, which need to be curtailed. The procyclical fiscal policy driven by expenditure has exacerbated aggregate demand pressures, contributing to higher inflation and worsening the current account. The external position in 2024 is assessed to be moderately weaker than the level implied by fundamentals and desirable policies. Against a weak external environment and elevated global uncertainty, growth is projected to moderate to a still solid level of about 3 percent in 2025–26, supported by private consumption and EU-funded investment. Inflation is projected to move towards the ECB’s target in late 2026 or early 2027 and the current account deficit is expected to widen in the short run before improving. Risks to the growth outlook are broadly balanced while risks to inflation are tilted to the upside.

Stronger and faster fiscal consolidation is key to dampening domestic demand pressures and reducing inflation, thereby addressing the emerging imbalances early on. It is also essential for strengthening the country’s competitiveness and building buffers against future shocks and large spending needs. In the short term, restraint in public salary growth, improving VAT compliance, ending the remaining cost of living support measures, and strengthening fiscal discipline at local government units can underpin the consolidation. Over the medium term, there is considerable scope to broaden the tax base and improve the tax system, notably through reviewing and rationalizing VAT exemptions and reduced rates and moving to value-based taxation on property. On expenditure, measures should focus on (i) reducing the high wage bill building on a review of public sector employment; (ii) improving the efficiency of spending, notably healthcare and education spending, and better targeting social spending; and (iii) ensuring pension sustainability, notably by extending the effective retirement age. The authorities should continue to strengthen corporate governance of SOEs and enhance public investment management.

Heightened risks call for continued vigilance and close monitoring to preserve financial stability. Cyclical systemic risks have risen but remain moderate and manageable, as the banking system remains highly profitable, well capitalized, and highly liquid. Stress tests suggest that it would remain overall resilient under adverse scenarios. Further vigilance remains nonetheless warranted given the buildup of vulnerabilities and risks, particularly in the housing sector, as well as structural risks including relatively high sovereign-bank nexus and concentration of corporate loans. The authorities appropriately tightened macroprudential policy through capital and borrower-based measures. As macro-financial conditions evolve, they should continue to monitor the macroprudential stance and adjust if warranted. In particular, tightening of the BBMs might be needed in case cyclical risks persist. Given the high share of cash-financed property acquisition and foreign demand, complementary measures to boost housing supply and reduce speculative demand, notably through strengthening taxation on property and short-term rental income, are highly recommended.

Fostering potential growth in the context of population aging, labor shortages and skill mismatches, as well as subdued productivity, calls for healthcare and education reforms to boost human capital without increasing costs. Healthcare reform needs to reduce geographical inequality in healthcare access, promote prevention and healthy living, review the central role of hospitals in the system, and improve the use and distribution of pharmaceuticals. Education reform should aim at reducing skills mismatches, complemented by measures to increase participation in adult learning. Better integration of foreign labor would magnify its role in supporting growth and welfare.

Croatia: Selected Economic Indicators, 2020–30

2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030             Projections                         Output, unemployment, and prices (Percent change, annual average, unless otherwise indicated) Real GDP growth -8.3 12.6 7.3 3.8 3.8 3.1 2.7 2.6 2.6 2.5 2.5 Contributions:                       Domestic demand -2.9 7.5 7.9 2.0 7.4 5.3 3.2 2.9 2.9 2.9 2.9 Net exports -5.4 5.1 -0.6 1.7 -3.6 -2.2 -0.5 -0.2 -0.3 -0.4 -0.4 Unemployment rate 9.0 8.1 6.8 6.2 5.3 4.7 4.7 4.7 4.7 4.7 4.7 HICP inflation (avg.) 0.0 2.7 10.7 8.4 4.0 4.4 2.8 2.5 2.5 2.5 2.5                         Saving and investment (Percent of GDP) Domestic investment 23.5 21.8 26.2 24.7 24.4 25.1 24.7 24.7 24.9 24.9 25.0 Domestic saving 21.6 22.1 22.7 24.8 22.2 22.3 21.5 21.9 22.6 23.1 24.0 Government -1.9 1.9 5.0 4.5 4.0 3.5 3.2 2.6 2.4 2.3 2.3 Nongovernment 23.5 20.2 17.7 20.2 18.2 18.8 18.3 19.3 20.2 20.8 21.7                         Government sector (ESA 2010 definition)   General government revenue 46.5 45.6 45.2 45.5 46.1 47.2 48.0 47.1 46.6 46.5 46.6 General government expenditure 53.8 48.2 45.0 46.3 48.0 50.2 50.9 50.0 49.4 49.1 49.1 General government balance   -7.2 -2.6 0.1 -0.8 -1.9 -2.9 -2.9 -2.9 -2.8 -2.6 -2.5 Structural balance 1/ -5.7 -3.2 -1.1 -1.8 -3.0 -3.7 -3.5 -3.2 -2.9 -2.7 -2.5 Structural primary balance 1/ -3.8 -1.9 0.1 -0.5 -2.0 -2.8 -2.4 -2.1 -1.9 -1.7 -1.5 Structural primary balance excl. net EU grants 1/ -7.2 -5.5 -2.8 -4.3 -4.4 -5.2 -5.2 -4.4 -3.9 -3.5 -3.5 General government debt 2/ 86.5 78.2 68.5 60.9 57.4 56.9 57.3 58.0 58.6 59.1 59.5                         Balance of payments (Percent of GDP) Current account balance -1.9 0.3 -3.6 0.1 -2.2 -2.8 -3.2 -2.8 -2.3 -1.8 -1.0 Capital account 2.1 2.4 2.5 2.8 1.4 2.2 2.3 2.1 1.4 1.2 1.0 Financial account -0.1 -1.6 2.3 -5.1 0.2 0.7 0.9 0.7 0.9 0.6 0.0                         Debt and reserves     Gross official reserves (billions of euros) 18.9 25.0 27.9 2.9 3.2 … … … … … … In months of imports in goods and services (based on next year level) 9.3 9.8 7.5 0.8 0.8 … … … … … … Total external debt (percent of GDP) 3/ 81.3 81.1 73.8 76.9 66.4 63.1 60.7 58.3 56.6 54.9 53.2 Total external debt excl. CNB share (percent of GDP) 79.6 75.0 67.5 55.7 56.9 54.3 52.3 50.3 48.9 47.6 46.2                         Money and credit (End of period unless otherwise indicated, change in percent) Broad money (M3) 11.5 15.0 10.7 21.3 4.5 … … … … … … Claims on other domestic sectors 4/ 3.3 2.6 10.0 7.7 9.1 … … … … … …                         Interest rates     12-month average T-bill rate (in kuna until 2023, then euros)  0.1 0.0 0.1 3.1 3.5 … … … … … … 10-year government bond yield 0.6 0.1 2.8 3.7 4.0 … … … … … …                         Exchange rate   Real effective exchange rate (percent, "-" = appreciation) -0.8 0.7 0.8 3.1 0.5 … … … … … …                         Memorandum items:                       Nominal GDP (billions of euros) 50.7 58.3 67.6 79.2 85.9 92.2 97.5 102.3 107.3 112.3 117.6 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 in 2020-2021 and the energy crisis in 2022-2024. 2/ Gross debt as defined by the EU under the Maastricht Treaty. 3/ With the entry of Rep. of Croatia into the euro area in January 2023, there was an increase in gross foreign debt for the amount of liabilities related to the distribution of euro banknotes within the Eurosystem. 4/ Comprises claims on households and non-financial corporations.

 

[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.