Next year is gearing up to be an important one for Croatia’s economy after EU finance ministers gave the approval for Croatia’s membership of the eurozone. Kit Gillet reports.

Earlier this summer, Croatia was given the green light to join the eurozone after EU officials were satisfied the country met the economic criteria to adopt the single currency, with formal approval given on July 12 to commence eurozone membership on January 1, 2023.

While countries such as Bulgaria and Romania have long discussed joining the euro, Croatia will become the first new member of the eurozone since Lithuania joined in 2015. It has been a relatively quick journey for Croatia, which only joined the EU in 2013.

Euro adoption 

Adopting the single currency is both a symbolic as well as a practical move for Croatia, one of the smallest countries in the EU, with a population of just under four million.

“Joining the euro will provide a boost to economic growth by way of creating a more competitive environment for the corporate sector, as well as citizens,” says Dinko Lucić, president of the management board of Privredna banka Zagreb, part of Intesa Sanpaolo Group. “It will positively impact goods and services exports, facilitating doing business, reducing transaction costs and improving the country’s sovereign rating and perception for investors.”

By joining the single currency, Croatia will also be able to apply for European Stability Mechanism assistance and have access to European Central Bank funds.

Croatia’s economy is already highly integrated into the euro area. The country has maintained a managed float of its domestic currency against the euro for years. In addition, 87% of household savings deposits are currently in euros, as well as more than 90% of foreign debt.

“Croatia was more or less set up to join the eurozone structurally decades ago,” says Goran Šaravanja, chief economist at Hrvatska gospodarska komora, the Croatian Chamber of Commerce. “We’ve been saving in euros for the past 20 years and before that, in German marks. To formalise our relationship with the eurozone by joining and getting all the benefits is completely logical.”

Mr Šaravanja adds that joining the eurozone will also reduce the risk perception of doing business in Croatia, which should give a further boost to the economy.

To formalise our relationship with the eurozone by joining and getting all the benefits is completely logical

Goran Šaravanja

Schengen push

In addition to joining the single currency, Croatia is on track to join the Schengen group of countries in the near future.

Croatia’s entry into the Schengen zone – the passport-free area stretching across 26 countries – is also likely to provide a boost to the country’s economy and offer a further sign of full integration with much of the rest of the EU. While its entry date is less clear than for the eurozone, it could also be next year.  

“Schengen membership is one of the factors for optimism – as a car-dominated destination, removing additional obstacles to fully free travel boosts the attractiveness of Croatia as a tourist destination,” says Christoph Schoefboeck, CEO of Erste Bank Croatia.

Another boost to Croatia’s economy will come from access to NextGenerationEU (NGEU) funds, part of the EU-wide post-pandemic recovery effort that will see more than €800bn invested across the bloc, with a particular focus on areas like clean technology and digital initiatives. NGEU funds are likely to have a big impact on the Croatian economy, with Recovery and Resilience Facility grants of roughly €6.3bn earmarked for the country, equivalent to around 12% of its gross domestic product (GDP).

Hrvoje Dolenec, head of macroeconomic and market analysis at Zagrebačka banka, says that access to the funds could create around 1.5 percentage points of GDP growth per year when fully absorbed, though he adds that there will be a bigger economic impact this year and next created through spending remnants of the 2014-2020 budget allocations of structural instruments.

Others also see a big opportunity from NGEU funds. “Clearly EU funds are going to give a boost to the economy,” says Mr Šaravanja. “We’re getting 10 times more per capita than the western Balkans, so you are going to see that over the next seven or eight years in GDP growth. For me, it’s the dynamic impact of being a member of the biggest, wealthiest club on Earth, and you can see that in the way the economy is changing.”

Post-pandemic growth

Croatia entered 2022 on a strong footing. After a real GDP contraction of 8.6% in 2020, the Croatian economy rebounded by 10.2% in 2021, in part due to the return of the tourism industry. The economy is expected to grow by 3.4% in 2022, according to the European Commission, down from an early forecast of 4.8%, due to direct exposure to the conflict in Ukraine. This will be followed by growth of 3% in 2023, it said, down slightly on a forecast of 3.4%.

In May, Fitch Ratings affirmed Croatia’s long-term credit rating at BBB with a positive outlook, pointing to strong structural features including higher human development and governance indicators, anchored by membership of the EU and GDP per capita roughly 40% higher than the BBB median. Growth, however, is being held back by high public sector debt and a weak record of structural reform implementation, Fitch found.

Croatia’s public debt-to-GDP ratio fell to 79.8% in 2021, down 7.8% year-on-year. Fitch expects this to fall to 72.6% in 2023, aided by an improved fiscal position and rapid economic expansion.

However, inflationary pressures are rising. Average annual inflation is expected to peak at around 9.3% this year, according to Privredna banka Zagreb’s Mr Lucić, driven mainly by energy and food price increases linked in part to the conflict in Ukraine. Others predict that inflation will hit double digits, with the introduction of the euro potentially leading to a one-off price increase.

Croatia also still relies heavily on Russian gas for most of its energy needs, adding a further layer of uncertainty. Though on a positive note, after peaking at 7.6% in 2021, Croatia’s unemployment rate is declining steadily and is expected to fall below 6.5% by the end of 2023.

Croatian exports of goods are also expected to be affected by weaker demand across the country’s main trading partners, but there should still be growth of around 5%.

Tourism still king

While there is increasing hype around areas like the Croatian IT industry, with a growing start-up scene and two unicorns (a company valued at $1bn plus) minted in the past couple of years, tourism is still the key industry for Croatia. Tourism generates roughly 11% of the country’s GDP and indirectly that could be closer to 17%.

The Covid-19 pandemic had a big impact on tourism and while the country outperformed many of its Mediterranean peers, about half of its tourism activity was lost. However, 2021 saw a return to form, with the sector recording almost 80% of its pre-Covid output, with 2022 likely to be an even stronger year.

Foreign direct investment (FDI) into Croatia, meanwhile, stood at €38m in 2021, largely coming from other EU nations like the Netherlands, Austria, Italy and Germany. FDI’s impact on the Croatian economy has ranged from between 2-6% of GDP over the past few years, says Mr Dolenec. He adds that while “missing purely greenfield investments, existing investments have brought in new technologies and know-how to some sectors, especially telecommunications and the financial sector”.

The tech scene is also thriving. “We’ve got two unicorns in this country [software developer Infobip and electric car manufacturer Rimac Group],” says Mr Šaravanja. “For a place this small to have two unicorns shows that there’s plenty of talent. You can see a more than tripling of ICT revenues. Clearly there are technical skills in terms of digitisation.”

Going forward, other sectors are also set to grow, driven by investments in areas like renewable energy.

“We see exporters and the renewable energy sector as a propulsive part of the economy,” says Balázs Békeffy, CEO of OTP Banka.

However, Mr Békeffy adds that persisting supply chain disruptions and the risk of a recession within the EU are weighing on Croatia’s upcoming economic performance. “Weaker domestic and external demand will affect the outlook,” he says. “This might also keep the current account in a small deficit, via  a heavier import bill, as Croatia is a net fuel importer, before returning to surplus from 2023.”

Looking ahead, the next 12 months are likely to be challenging for the Croatian economy, dealing with the dual demands of rising costs of living and global uncertainty, as well as teething issues that will naturally come with introducing a new currency.

Still, most are looking ahead with confidence. “We’ll have to wait and see how the outlook for 2023 would evolve, as certain headwinds are likely to remain in place, but overall, we remain optimistic,” says Erste Bank’s Mr Schoefboeck.

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