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The Financial Times, March 03, 2013
Croatia likely to be in recession as it joins the EU this year

by Andrew MacDowall

This might have been a triumphant year for Croatia. Less than a decade and half after its war of independence, the country will join the EU in July, symbolically returning to the mainstream European fold after decades of authoritarianism and conflict.

But 2013 could well be yet another year in recession for the troubled Croatian economy. A flash estimate published on Thursday suggested that GDP had shrunk 2.0 per cent in the full year 2012 – and prompting forecasts of a grim 2013.

Hypo Alpe Adria, a bank, said in a note that it now expects a further decline of 1.5 per cent in 2013, which would make the fourth year in five of recession. The exception was 2011, but then the economy grew by only 0.25 per cent – at most.

The eurozone crisis, and a sharp correction after Croatia’s belt-loosening boom years of the middle of the last decade, have pulled the country into a negative spiral. According to Hypo, “deepening GDP contraction largely owed to weaker household expenditure, with rising unemployment, real disposable income decline, retail deleveraging and utility price hikes as the key suspects therein”.

“Likewise pulling GDP headline lower was a deepening industrial decline courtesy of deteriorating foreign demand, competitiveness problems and local capacity shut downs,” the note continued.

The outlook for 2013 looks not dissimilarly grim, with unemployment, weak demand from the EU and continued deleveraging weighing heavily. The downgrade of Croatian debt to junk status by Moody’s and Standard & Poor’s in recent months is also likely to push up borrowing costs. And there’s a risk things could be even worse, including a deterioration of the eurozone crisis (Croatia will be looking across the Adriatic at Italy with concern) and shocks to the financial sector.

A statement issued by the IMF on Monday highlighted these difficulties and recommended a predictable three-pronged strategy to restore economic health; structural reform (particularly of labour legislation), continued fiscal consolidation, and careful calibrating of the financial sector to promote both stability and a recovery in lending.

The Fund praised the government’s progress in starting to bring the budget under control (it targets a deficit of 4 per cent of GDP in 2013) and “objectives” on financial regulation. But there is a long way to go on both, during an uncertain economic climate. And the government shows little enthusiasm to grasp the nettle of structural reform.

“The IMF report addressed all concerns that are well known to the Croatian business community,” says Vedran Antoljak, a Croatian business consultant. “These recommendations have been repeated a number of times in meetings between the government and real sector representatives.Businessmen, foreign and domestic commercial associations and investors have warned the government that the combination of higher taxes, more surtaxes, delayed payments by the state; an inefficient and over-protected state administration, and the government’s hesitation for “real” reforms such as a reduction of administrative barriers and investor attraction meant that Croatia is reaching a “real sector cliff”… If the government wants to avoid this, it has to make serious and painful reforms – to bite the bullet.”

Rather than providing the fillip that many expect, Antoljak warns that EU accession may make life more difficult for Croatian companies, as they are increasingly exposed to foreign competition. Not all would agree: Croatia’s market has been fairly open for many years, and EU funding should provide both stimulus and the opportunity to develop infrastructure and other sectors.

Amid the gloom, it’s worth considering Croatia’s strengths, including a flourishing tourism sector, and the distance it has come since the troubled times of the early 1990s. It will be the last country in its region to join the EU for many years, which shows how far it is ahead of many of its neighbours in the Balkans. But with the economy still tanking, this may be cold comfort to Croats.
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