HNB: Exposure to systemic imbalances at a moderate level

Risks in the financial system of the Republic of Croatia in the first half of 2023 have not significantly changed, and exposure to systemic imbalances has remained at a moderate level, as stated in the latest issue of the HNB publication Macroprudential Diagnostics.

Alongside a tightened geopolitical situation, the main risks to financial stability are the slowdown of the economy in Croatia and the euro area, as well as persistent core inflation, which would require maintaining monetary policy in a restrictive area for an extended period, highlighted in a statement from the Croatian National Bank (HNB) on Friday.

However, the adverse effects of the slowdown in economic activity, elevated inflation, rising interest rates, and stricter financing conditions for households are mitigated by a still strong labor market characterized by robust growth in real wages, and there are also solid business results from non-financial companies in the past year, they noted.

The HNB assessed that the growth of the Croatian economy in the first half of 2023 remained relatively robust, thanks to strong service activities, while the growth of industrial activity remained subdued.

They believe that the weakness of industrial production in Croatia can be linked to the slowdown in the growth of commodity exports, driven by weaker economic activity from major foreign trade partners.

On the other hand, exceptionally good tourism results at the beginning of the year, along with available monthly indicators for the second quarter, herald a continuation of strong demand for services.

In line with this, the HNB expects that the real growth rate of the Croatian economy in 2023 could be 2.9 percent, which is significantly above the euro area average.

Household resilience supported by a significant share of fixed-rate loans

The central bank emphasized that interest rates on loans have only moderately increased, and so far, no stronger effects of tightening monetary policy on increasing household vulnerability are visible.

Household resilience to the adverse effects of rising interest rates is supported by a significant share of loans contracted at a fixed interest rate, while consumers with long-term loans at a variable interest rate are primarily exposed to rising interest risk, which is temporarily mitigated by the widespread use of the National Reference Rate (NRS) as a reference parameter, which has only slightly increased so far, the legal limit on variable interest rates, as well as the actions consumers take to protect themselves.

“However, in the medium term, loans linked to the NRS are also exposed to interest rate risk, the increase of which would raise the legal upper limit of variable interest rates and further emphasize interest rate risk for loans linked to Euribor,” warned the HNB.

They reported that during 2022, approximately one-fifth of housing loans (5,500 loan parties) with a variable interest rate linked to Euribor, and only a smaller number of loans linked to other parameters, consumers accepted offers from banks to fix the interest rate on the loan or independently requested the fixing of interest rates.

Inflation shows signs of slowing down

They stated that inflation shows signs of slowing down in Croatia, primarily influenced by falling energy prices and slower growth in food prices, but core inflation has only slightly slowed.

Among other things, strong demand for services contributes to the persistence of core inflation, with the upcoming peak of the tourist season potentially stimulating additional price increases for certain services, they assessed.

The attempt to compensate for the loss of purchasing power in conditions of a strong labor market, accompanied by low unemployment and widespread labor shortages, has spurred an acceleration in the growth of nominal wages, which further contributes to inflationary pressures, noted HNB analysts, adding that the persistence of core inflation requires maintaining monetary policy in a restrictive area.

Housing prices continued to rise, but the number of transactions decreased

They also highlighted that housing prices continued to rise, while the number of transactions decreased, which, along with worsening financing conditions, could trigger a reversal of the cycle in the housing market, especially if economic activity significantly weakens.

– Although such an unfavorable scenario could increase credit risk and reduce the value of collateral instruments on banks’ balance sheets, the banking system is assessed as resilient to such risks due to high capitalization and liquidity and rising profitability – they wrote.

Considering the elevated cyclical risks, primarily in the form of strong growth in bank loans to the non-financial private sector and rising housing prices, the HNB has raised the countercyclical capital buffer rate for the third time in less than a year and a half, contributing to strengthening the resilience of banks, they noted from the central bank.