EIZ: Numerous Risks Ahead, Two-Year GDP Slowdown

Researchers from the Economic Institute of Zagreb (EIZ) expect GDP growth to slow to 2.7 percent this year, and further slightly slow to 2.6 percent next year, EIZ announced on Thursday in the latest issue of the publication Croatian Economic Outlook.

This reduces the GDP growth estimate for this year by 0.6 percentage points, considering that EIZ analysts estimated in September last year that growth in 2018 could be 3.3 percent. The slowdown in GDP growth to 2.7 percent this year and further slight slowdown to 2.6 percent in 2019 is explained by EIZ analysts as being due to the low growth rate of real GDP in the last quarter of 2017, the recovery of imports, and uncertainties related to the restructuring process of Agrokor.

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– This year, the structure of GDP growth will largely resemble that of the previous year, meaning that domestic demand will provide the largest contribution to growth. Of the 2.7 percent projected growth, 3.6 percentage points will relate to domestic demand, while net external trade will have a negative contribution of 0.9 percentage points, thanks to the recovery of commodity imports, as stated in the publication Croatian Economic Outlook.

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EIZ analysts also estimate that nearly two-thirds of GDP growth this year will be generated by real household consumption, which will continue to grow, primarily due to rising employment and wages, as well as low inflation.

– Taking into account the increase in transfers to veterans, real household consumption this year could rise by 3.1 percent year-on-year. However, with the fading effects of wage and employment growth next year, consumption growth will also slow to 2.7 percent, EIZ states.

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They also estimate that, given the strong growth of tax revenues, especially VAT revenues, the stabilization of public finances, but also partly due to more successful drawing of funds from EU funds, state consumption in 2018 could accelerate growth to 2.2 percent. Considering the announced abolition and/or reduction of certain parafiscal levies as well as the announcement of a reduction in the VAT rate, in 2019, the decline in tax revenues could affect the slowdown of the growth rate of state consumption to 0.9 percent.

Low Investment Rate and Uncertainties Around Agrokor

EIZ analysts also remind that the low investment growth rate of only 1.7 percent in the fourth quarter of last year led to an unexpectedly low investment growth rate for the entire 2017. The reasons for the slowdown, as they state, primarily lie in the absence of important reforms and unfavorable business conditions, somewhat slower realization of previously announced investment projects, and a decline in investment activity in companies burdened by Agrokor’s settlement and restructuring process.

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– Given that the deadline for the settlement for Agrokor has been pushed to mid-year, the full potential of investments will be reduced this year as well. However, the investment growth rate this year could be slightly higher, at 3.9 percent, as it will be supported by the reduction of parafiscal levies, low financing costs, and high profit rates from last year, which could at least partially be reinvested, EIZ states.

In 2019, they expect investment growth of 4.3 percent, assuming the implementation of Agrokor’s restructuring, the realization of announced public investments, and the acceleration of the use of EU funds.

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In the upcoming period, export growth will be stimulated by strong tourism and the growth of demand from the most important foreign trading partners, so EIZ analysts expect export growth of 5.6 percent this year and 5.3 percent in 2019. However, thanks to the recovery of disposable incomes and the large import component of consumer goods, imports could further accelerate to 7.4 percent this year and 7.5 percent in 2019.

Changes in the Budget for This Year Are Merely Cosmetic

Noting that they still do not have consolidated data for the general government budget in 2017, EIZ analysts estimate that the budget could end with a small deficit of around 0.4 percent of GDP.

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– As for the budget for this year, the announced changes are merely cosmetic in fiscal terms, EIZ states. They remind that the threshold for entering the VAT system has been raised, as well as the highest annual amount of in-kind donations, while as a relief for the tourism sector, the cost of accommodation for seasonal workers has become a non-taxable item. On the expenditure side, allowances for unemployed veterans and their family members are being introduced, and the minimum veteran pension is also increasing.

Revenue growth is expected primarily due to GDP growth, and due to somewhat restrained expenditures that will grow at a rate lower than the GDP growth rate, fiscal consolidation will continue this year and next year, EIZ emphasizes, which is why they expect a surplus of 0.2 percent in the general government budget this year, which could increase to 0.5 percent of GDP next year.

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– Numerous risks such as the expansion of existing veterans’ rights, potentially lower tax revenues from profit tax related to the crisis in Agrokor, as well as possible state obligations from future lawsuits related to Agrokor could jeopardize the currently favorable state of public finances. In addition, it is difficult to expect that the planned functional integration of hospitals this year will succeed in resolving the accumulated 8 billion kuna debts in healthcare, which makes this sector the biggest threat to the stable trajectory of public finances, EIZ warns.

They also believe that in the upcoming period, the decline in unemployment will significantly slow down, primarily due to the reduction in the intensity of emigration, so they expect that the unemployment rate in 2018 could be 10.5 percent, and further decrease to 9.7 percent in 2019.

– Unemployment could be higher if there are significant layoffs due to the restructuring of Agrokor as well as the public administration reform announced for next year, EIZ states.

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It is added that net wages will continue to grow this year, primarily due to the increase in the minimum wage and the growth of labor productivity, while in 2019 a slight increase in public sector wages is possible, which, along with a moderate inflation rate, will keep real disposable income stable.

EIZ analysts estimate that the inflation rate this year could be 1.6 percent, and next year price growth could accelerate to 1.8 percent. Robust export growth, stable public finances, a recent upgrade in credit rating, and preparations for Croatia’s entry into the European exchange rate mechanism favor further appreciation of the kuna. With expectations of another successful tourist season, EIZ believes that the kuna/euro exchange rate could fall to 7.42 this year and to as low as 7.40 kuna next year.