Croatia Watch: Past C/A surplus drivers are losing steam

According to the latest data from the Croatian National Bank (HNB), the usual current account surplus in Q3 2024 decreased by 5.1% compared to the same period in 2023, amounting to EUR 4.8 bn. In the same quarter, the capital account reported a surplus of EUR 361 mn, which was almost 25% or EUR 119.1 mn lower than in the same quarter of 2023. The fall in the positive balance of the capital account is mainly the result of smaller distributions of EU funds in the form of capital transfers to end users.

Overall, in Q3 2024, the current and capital accounts ran a combined surplus of EUR 5.14 bn, which is a decrease of EUR 377.3 mn yoy.

Observing the last four quarters, the cumulative balance in the current account has remained in a small deficit of 0.5% of GDP, while the combined surplus of the current and capital accounts decreased to EUR 1.04 bn or 1.2% of GDP (1.2pp lower compared to the same period a year before).

As said, the shrinking CA surplus during Q3 2024 was primarily due to the services sub-account, where the positive balance decreased by EUR 390.9 mn (-4.1% yoy). This was driven by double-digit growth in service imports (+21.2%) and a slight decline in exports (of 0.3% or EUR 32.3 mn). During the peak tourist season revenues from tourism edged down from EUR 9.12bn in Q3 2023 to EUR 9.06 bn likely reflecting the guests' restrained spending due to inflationary pressures from previous periods, as well as relatively stronger price increases in the Croatian market vs the Mediterranean peers.

A significant portion of the growth in service imports can be attributed to tourism, specifically the travel of domestic residents who are currently experiencing strengthened purchasing power. Although the difference between the export and import of services can be partially explained by the noticeable difference in domestic economic activity (strong domestic demand) compared to that in important emitting markets in the euro area, the central bank states that the stagnation in exports was also influenced by the loss of price competitiveness. Despite still relatively high annual changes in prices in some tourism-related activities (for example, in the CPI Services sub-aggregate — Restaurants and Hotels), nominal revenues from tourism-related travel decreased by 0.7% or EUR 64.3 mn in the July-September 2024 period yoy.

Although the overall tourism season in 2024 is still successful, especially due to trends outside the peak tourist season, Croatia recorded fewer overnights of foreign guests in Q3 compared to last year (-0.6% yoy). It should also be mentioned that the structure of foreign guests has changed. In line with the relatively difficult economic environment, the number of overnight stays by guests from some of Croatian most important markets (and those with high spending power), such as Germany or Italy, decreased noticeably. We can conclude that although last year the strong growth in the overall current account surplus in the third quarter was the result of international trade in services, which was driven by a still solid tourist season and rising prices in service-related activities, the (service) inflation has started to take its toll. Therefore, the further growth and development of the for Croatia so important tourism sector can be based only on further improvements to quality as well as extending the season (i.e. reducing seasonality). Otherwise, further room for strong revenue growth in the current economic environment seems limited.

It is not surprising, that the highest growth in tourism revenue is seen in the months before and after the peak tourist season. Namely, looking at the first nigh months of 2024 revenues from tourism-related travel increased by 1.7% yoy.

Regarding the goods sub-account, both revenues and expenses increased compared to the same period last year, consistent with the modest growth in goods exports and imports during the observed period. Moreover, revenues grew more strongly (+7.6% or EUR 354.2 mn) than expenses (+2.8% or EUR 257.8 mn), so despite the high base in imports, the deficit on an annual basis decreased by 2.2% or EUR 96.5 mn (to -4.3 bn). The growth in goods imports is not surprising, but the relatively strong revenues from exports are rather interesting, especially considering that the industry will mark the second consecutive year of a decline in production on an annual level and is essentially in recession. A potential explanation may lie in the volatility of energy production. Despite the noticeable difference between strong domestic and subdued foreign demand, movements in the goods sub-account signal that Croatia could maintain a stable market share in global goods exports.

In Q3, the positive balance of capital transactions (EUR 361 mn) decreased by almost 25% or EUR 119.1 mn compared to the same quarter of the previous year. The reduction in the capital account balance is not surprising and reflects the cyclical decrease in the use of EU funds. Namely, 2023 was the last year in which it was possible to draw funds from the previous EU financial envelope (for the period from 2014 to 2020), thus marking the peak of disbursements. Moreover, the use of funds from the European Solidarity Fund for earthquake reconstruction has also been completed.

The importance of mentioning EU funds in the context of the balance of payments can be justified by the fact that the surplus in economic relations with abroad is increasingly determined by the positive balance of the secondary income account and the capital account, regardless of the potential deterioration in the balance of international goods and services. Therefore, the balance is “artificially” improved by transfers, and there is temporarily no accumulation of debt; in other words, transfers finance the difference between the export and import of goods and services. It is sufficient to say that the usual cycle of inflows of the observed funds significantly affects the account balance, which clearly indicates that macroeconomic relations that are unsustainable in the long term should be a concern.