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Croatian GDP grows by 2.8% in second quarter

05.09.2016  10:39

In the second quarter the economy grew by 2.8% year on year, matching the figure of the third quarter of 2015—the fastest rate of expansion since 2008. Growth in the second quarter of 2016 was driven by continued private spending growth and an expansion in gross fixed capital formation and public consumption. Given the strength of data in the first half of this year, we will revise up our full-year growth forecast to about 2.3%, from 2% currently. However, due to major structural issues, poor growth prospects in Croatia's major trading partners and the dissipation of supportive cyclical factors, we maintain our medium-term forecast of 2% average growth in 2016-20—one of the slowest real GDP growth rates in the region.

The economy grew by 2.8% year on year in the second quarter, according to a first estimate released by the Croatian Bureau of Statistics (CBS). In seasonally adjusted terms, output grew by 0.6% quarter on quarter.

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Household spending rose by 3% year on year, maintaining the strong growth of 3.1% in the first quarter. Government spending accelerated to 2.6%, a sharp uptick from a growth range of 0.4-0.8% in previous quarters. Gross fixed capital formation, the component of GDP that has fallen most since the global financial crisis of 2008, continued to improve and rose by 6.3% year on year. Continuing the trend that began in the fourth quarter of 2015, net exports detracted from growth. Export growth slowed significantly, from 7.1% in the first quarter to 4.1%, whereas import growth rose from 6.1% to 6.7%. The CBS also released a breakdown of growth by gross value added. This showed that the two main sectors driving growth were manufacturing (up by 5.7%) and construction (by 4.3%).

Household spending rose by 3% year on year, maintaining the strong growth of 3.1% in the first quarter. Government spending accelerated to 2.6%, a sharp uptick from a growth range of 0.4-0.8% in previous quarters. Gross fixed capital formation, the component of GDP that has fallen most since the global financial crisis of 2008, continued to improve and rose by 6.3% year on year. Continuing the trend that began in the fourth quarter of 2015, net exports detracted from growth. Export growth slowed significantly, from 7.1% in the first quarter to 4.1%, whereas import growth rose from 6.1% to 6.7%. The CBS also released a breakdown of growth by gross value added. This showed that the two main sectors driving growth were manufacturing (up by 5.7%) and construction (by 4.3%).

The latest data confirm three trends in Croatia's growth profile:

  • Consumption has recovered, owing to the a sustained improvement in the labour market and earnings growth, although falling consumer confidence provides reason for caution.
  • Investment is continuing to pick up, from a low base.
  • Net exports have turned negative, resuming their position in the country's growth profile in the years before the global financial crisis.
Consumption has recovered, but sentiment has fallen

The outlook for private consumption has significantly improved. The labour market has recovered, and although still high, the seasonally adjusted unemployment rate fell to 15.1% in July—the lowest level since August 2009. Combined with strong real earnings growth (driven by faster nominal wage growth and oil-induced consumer price deflation), this has created a supportive environment for private consumption growth. However, European Commission sentiment surveys indicate that major purchase intentions and consumer confidence, although close to their highest levels since 2007, peaked in the first quarter of this year and have fallen since.

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 pick-up in investment

Despite the Croatian economy's return to growth in 2015, investment grew by just 1.6% last year, contributing only 0.3% to real GDP growth. However, in each of the past six quarters year-on-year investment growth has improved, reaching 6.3% in the second quarter of this year—the strongest output since the third quarter of 2008. This has probably benefited from supportive conditions for borrowing and fewer concerns about demand weakness. However, similarly to private consumption, the outlook is uncertain. Public investment will continue to suffer from fiscal austerity and remain dependent on planned improvements in the country's weak EU fund absorption capacity. Despite five consecutive quarters of improved growth, investment remains at around two-thirds of its 2008 level in real terms.

Negative contribution from net exports

With four consecutive quarters of year-on-year real GDP growth ranging between 1.9% and 2.8%, it is clear that Croatia's recovery has consolidated. However, the structure of growth has changed. In 2015 net exports and private consumption were the main drivers of growth, but in the first half of 2016 private consumption and gross capital formation drove growth whereas net exports turned negative. This points to a more broad-based recovery, and the country's growth rate is catching up with most of its trading partners this year.

Medium-term growth of 2% with risks to the downside

In the second half of 2016 growth will continue to rely on private consumption and investment, with investment boosted by loose monetary policy and improved lending conditions. This will help to offset a negative external balance brought on by increased import demand. The services component of Croatian exports will remain a crucial driver of growth, and all indicators point to another record year for the tourism sector. However, we do not expect goods exports to significantly improve, with major export partners—Germany and Italy—likely to show slightly slower growth in the second half of the year. As a result we will revise up our current forecast of 2% growth in 2016, to about 2.3%.

In the medium term private consumption will slow as consumer price deflation recedes and confidence worsens. The weakness of the euro—against which the kuna is heavily managed—will make exports to countries outside the bloc more competitive. Meanwhile, investment should continue to pick up, helped by low borrowing costs, a moderately better outlook for demand and improved EU fund absorption.

There are several downside risks to the country's renewed growth. First, the economy continues to benefit from favourable base effects. Second, cyclical factors—notably the plunge in the price of oil and the weakness of the euro (along with the resulting weakness of the kuna)—are acting as important stimulants to growth. It is not yet clear what will drive growth when these factors fade. Demographic trends—in particular a worsening of the dependency ratio and high levels of emigration—in the medium and long term will provide greater headwinds to growth. If any of these risks materialise earlier or more sharply than expected, this could hold back any component of Croatia's growth profile.

Source: The Economist Intelligence Unit (02-09-2016)