David Tomašek (HPB): Excessive Public Spending Loses Meaning After Exiting the Crisis

The credit leverage for entrepreneurs will be lower due to stricter bank standards and the availability of funds from the European Union for quality projects.

When I graduated at the end of 2007 and soon got a job, I was not aware of how lucky I was. Like many more experienced colleagues, I did not expect that the crisis which began to loom over the EU and the US would hit Croatia even harder. The crisis that started here at the end of 2008 turned into stagnation over the years, and the generations that entered the labor market from 2009 to 2014 faced much tougher conditions. Moreover, students who enrolled in college in 2008 or 2009 have already graduated, while the recession was still ongoing. Croatia’s economy lost 200,000 jobs from the beginning of the fourth quarter of 2008 to the end of the third quarter of 2015. Some sectors that were drivers in the previous expansion cycle, such as construction, trade, and transport, lost a third or more of their revenue compared to the pre-crisis period, and the number of employees in those industries decreased in the same proportions.

Export Contributes to Growth

At the end of 2014, changes began to be felt, with quarterly GDP growing on a year-on-year basis, and for the third quarter of 2015, it was 2.8 percent higher compared to the same period in 2014. Finally, after six long years, Croatia exited the recession in 2015.

The expected annual GDP growth rate of around 1.5 percent in 2015 may be slimmer than in the pre-crisis years, but the trend is positive – GDP has been growing for four consecutive quarters. According to surveys by the Croatian National Bank (HNB), consumer confidence has significantly improved and is almost at the pre-crisis level of 2007. Inflation has not only been contained, but deflationary movements have been imported due to falling energy prices, which also positively affects disposable income. The combination of these factors has created momentum for continued real GDP growth in 2016 between one and two percent.

Unlike the pre-crisis period, the largest contribution to growth is no longer provided by personal consumption of imported goods but by exports. Shipbuilding, which was a major export factor, is now, apart from a few restructured shipyards that have adapted to the market, just a memory. With the entry into the EU, access to a large market has been facilitated for smaller and often private companies, which are the engine of export activities. This is particularly important as they are adaptable, flexible, and more resilient to shocks.

The credit boom in Croatia between 2003 and 2007 was largely used for investments in unproductive assets and for consumption of goods that could not realistically be afforded. Therefore, the crisis hit us longer and harder than countries in the region, but it also positively influenced the awareness of company management and more responsible consumer behavior. Personal consumption began to recover steadily in 2015 due to falling price levels and rising income following the tax reform at the beginning of the year. In recent years, household balances have also significantly improved through simultaneous debt repayment and increased savings. A slight increase in disposable income and a lower level of net debt have created the preconditions for a trend reversal in 2016 and growth in household credit at moderate rates of one percent.

Citizens are much more hesitant to purchase real estate, and demand has significantly decreased. However, the need for real estate has not disappeared, and residential properties are now much cheaper than before the crisis. If employment rises in parallel with the expected GDP growth through the creation of new jobs, inflationary expectations will also rise. In that case, an increase in demand for residential properties would be logical. Given the stock of unsold properties, I do not see opportunities for price growth in the short term.

We Will Not Be Millionaires

Companies have also improved their financial position in recent years by repaying debt and accumulating their own resources. However, they have achieved the capital goods necessary for production and service provision, which will need to be replaced to increase labor productivity and competitiveness in the EU market. Therefore, I expect investment growth in 2016, primarily in the manufacturing industry and tourism, our export anchors. Along with the growth in demand for tourist services, I also see potential for the recovery of agricultural production. Unlike in the past, the credit leverage that entrepreneurs will use will be lower due to stricter bank credit standards and the availability of funds from the EU for quality projects.

Although it could be argued that government spending saved GDP from collapse, excessive public spending loses meaning after exiting the crisis. Therefore, fiscal consolidation should begin in 2016 to reduce public debt. Its current level of 90 percent of GDP is not sustainable in conditions where GDP growth is lower than the interest we pay on the debt. Given that the state’s expenditure is not what it collects in taxes but its consumption, I expect that reforms will begin in 2016 that will result in at least a balanced budget in the long term, perhaps even a slight surplus. This would reduce the ratio of public debt to GDP with a smaller numerator and a larger denominator.

The HNB has preserved the value of our currency and confidence in the monetary and credit system through its counter-cyclical monetary policy. Unlike other monetary systems, in Croatia, public debt has not been financed by money issuance, yet monetary expansion has occurred through other – regulatory – measures. In this way, inflation has not been fueled, and nominal debt and savings in the domestic currency have not been devalued. I do not expect monetary policy to change, and the kuna should remain stable against the euro.

‘Next year at this time we will be millionaires’ (Derek Del Boy Trotter, ‘Only Fools and Horses’). We will not. The idea that wealth and prosperity come without work has disappeared with the bursting of bubbles in the capital and real estate markets since 2008. Nevertheless, 2016 in our homeland can be a year of optimism, responsible behavior, and new opportunities. I expect that we will know how to seize it.