Unless Croatia takes far-reaching action the country is headed for crisis, Standard Bank analysts have warned, despite the sovereign’s tentative return to growth after a six year recession.
The country is on track to post positive yearly economic growth this year, with the EBRD expecting a 0.5% increase in GDP in 2015, according to EBRD forecasts published this week.
But the recovery could be too late. The combination of a vast debt pile, large fiscal deficit and recent lack of growth has pushed Croatia’s debt profile precariously close to unsustainable levels, according to Demetrios Efstathiou, head of CEEMEA strategy at ICBC Standard Bank. Croatian government debt reached 85% of GDP in 2014, according to the IMF.
“Unless something dramatic happens we will be talking about the Croatian crisis in three to four years’ time,” Efstathiou said. “The country is in desperate need of structural reforms to wake up the economy and generate growth.”
The modest 0.5% the EBRD expects Croatia to post is aided by economic recovery in the EU, quantitative easing in the eurozone and lower oil prices, said Peter Tabak, lead economist for Croatia, Serbia and Russia at the EBRD’s office of the chief economist. But the country is also under great pressure from the European Commission to meet a 2016 deadline under an Excessive Deficit Procedure (EDP). Croatia’s government deficit was 5% of GDP in 2014, and EDP wants the sovereign to knock this down to 2.7% by 2016.
FISCAL REFORM
But even if the deficit is lowered to around 3%, with low economic growth and inflation the debt will continue to mount, added Tabak. Croatian finance minister Boris Lalovac needs to stop the debt pile mounting, and find ways to start reducing it. But past Croatian governments have proved unequal to the task.
“Successive administrations have laboured under the misapprehension that the economy could grow its way out of its difficulties,” said Fitch analysts, who are all the more sceptical of the government’s ability to deliver a “tough fiscal reform agenda” given the government budget deficit. Parliamentary elections due to take place by late February 2016 only complicate matters.
“The country is facing a lot of structural issues that have to be tackled in the short to medium term,” said Tabak. “But we can’t expect large adjustments until after the elections, so it’s something the new government will have to deal with.”
The efficiency of the public sector, labour market flexibility and governmental red tape needs to be addressed, said Tabak. This would help free banks from funding the deficit and provide more funding to the private sector. But cutting public investment is something Croatian governments have been guilty of in the past, noted Efstathiou.
Heaped on top of this already daunting list of demands, the new administration will also have to address the Swiss franc problem. The sharp appreciation of that currency earlier this year has hit Croats indebted in Swiss francs. The government’s one year freeze of the kuna/Swiss franc exchange rate is by definition a temporary relief measure. The IMF wants Croatia to avoid “across the board bailouts,” which would mean a de facto conversion of Swiss francs loan into kuna. Croatia’s lower level of FX reserves means this is unlikely to be an option.