Croatia Watch: The sun is still up in the skies, BUT….

According to the latest seasonally adjusted data, economic activity in Q322 printed -0.4% qoq decline and 5.5% yoy real growth, confirming that the expected slowdown of economic activity has arrived. Namely, despite the continuation of excellent tourist results, other high-frequency indicators suggested a decline in economic activity in comparison to the previous quarter, thus resulting in a slowdown in economic growth on an annual level. Industrial production, real retail trade turnover and construction fell on a quarterly level while the consumer confidence index stayed steadily below the long-term average. Nevertheless, comparing the updated results, Croatia still stands as the top performer among the European countries.

All domestic components have continued to grow, the biggest contribution coming from household consumption that, in real terms was higher by 5.6% yoy. Obviously, strong tourism data (tourist overnights were +9.9% yoy in the period Jul-Sep) and a tight labour market managed to curb the strong decline in consumer confidence and optimism. Investment grew by 8% yoy, partially due to the base effect, but still reflecting positive annual development in the construction sector, both in civil engineering and building works. The latest component of domestic demand, government consumption, after the decline in Q222, reported positive but mild real growth rates (1.3% yoy) thus supporting the overall GDP development. Eventually, net foreign demand was negative as exports grew less than imports (23.3% vs 30.5%) whereas the latter is obviously a reflection of the still high import dependency of the Croatian economy.

In our view, the impressive recovery of more than 13% yoy in 2021 will be followed by another “impressive figure” for 2022. The GDP results confirmed that Croatia will report at least 5.8% yoy real GDP growth rate, even in the case of a more evident slowdown in the last quarter. Moreover, with the updated increase of economic activity of 7.2% yoy, our estimate is exposed to a slight upside risk. On the other hand, there is no time to relax as the already present slowdown, together with the external environment, calls for caution. Therefore, we stress that our 2023 GDP forecast (1.8% yoy) is subject to significant downside risks, in particular tied to European energy developments, the length and depth of a potential recession in the euro area, as well as the success of curbing inflation in the most important emission markets. The deepening of the energy crisis in Europe, along with prices rising, would greatly burden European economies and ultimately reduce disposable income noticeably, which would inevitably have a stronger impact on Croatia as well. Of the local factors, the ability to withdraw and use European funds will be particularly important, not only in the short term but also to achieve stronger resilience and sustainability of growth. We see investment funded by EU funds as a driver of growth both short- and mid-term as withdrawal is preconditioned by fulfilling very important specific reforms. Of course, the special focus is on inflation which is forecasted at 6.7% yoy for 2023, but the higher perception of inflation is weighing on consumption optimism and could jeopardize household consumption.