COMMENT: Croatia – new era, new challenges

COMMENT: Croatia – new era, new challenges
Zagreb, where a new government is looking to give the country a political fresh start.
By Nicolas Adamovich of Commerzbank February 8, 2016

Moving into 2016, there are signs that Croatia is entering a new era.

The political deadlock from a hung parliament after November’s elections seems to have been solved with the swearing-in of a new technocrat prime minister and coalition government. And following a six-year recession – which cost the country as much as 13% of its output – Croatia’s economy last year showed some signs of life. Driven by an increase in exports and the recovery of domestic demand, GDP growth was in the positive in 2015 for the first time since the global financial crisis.

Yet the Croatian economic recovery will not be without its challenges. The 2008 crisis hit the country hard, the realities of EU membership have required the country to implement significant structural reforms, and a lack of investment has had lasting economic consequences.

Attracting investment to develop trade is crucial to Croatia’s progress, encouraging the domestic production and exports that will drive the economy. The local financial sector – aided by the reach of global banks – will be vital in achieving this goal.

Challenges of EU membership

Challenges lie ahead for Croatia. Certainly, the transition since joining the EU in 2013 – a milestone after a decade of talks – has not been smooth. Croatian borders have been opened up to stronger, more competitive economies to the west, while at the same time traditional export markets in the east – such as Russia and the Balkans – have become less attractive due to various tariff barriers.

Meanwhile, Croatia still has work to do to improve its economic situation: the country has been placed under the ‘Corrective Arm’ of the European Commission’s Stability and Growth Pact, recognising the country’s need to address its public finances, deficit and debt, raise competitiveness, tackle unemployment, and improve public sector governance. Indeed, although not a priority, should Croatia want to adopt the euro in future, it would need to meet the EU’s stability criteria.

In particular, Croatia has not done enough in recent years to clamp down on high public spending – at the end of 2015, public debt stood at nearly 90% of GDP. Thus, further fiscal reforms are now needed. The tax system has been targeted as a way of increasing revenues, while the country will need to look to privatisation as a way of reducing the large public-sector presence in the economy, and boosting competitiveness.

Growth figures for Croatia are at least now positive, and set to accelerate. For instance, 2015 GDP showed 1.1% growth, with 1.4% expected in 2016 and 1.7% forecast for 2017. Yet such figures remain modest, meaning more ways must be found to drive the Croatian recovery.

Attracting investment and building trade

One priority is to attract foreign direct investment (FDI). This will boost production and create the jobs essential to motivating Croatia’s economic growth.

Political uncertainty remains as the country acclimatises to its new government. But Croatia’s recent track record of political stability and social peace should nevertheless stand it in good stead. Meanwhile, businesses can look forward to a prime minister with a background in industry: prior to being sworn in, Tihomir Oreskovic met with international investors and stressed the need to prioritise attracting investment in Croatia’s future.

In fact, the country can build on good experience with attracting FDI. Investment in Croatia picked up after 2000, with the result that tourism expanded, consumer demand picked up and GDP grew at sustained rates of around 4-6%. Of course, the global financial crisis saw FDI flows slacken: ramping them up again is thus a vital step towards recovery.

Increasing FDI flows will also help the expansion and diversification of Croatia’s export trade – key to building a stable, resilient economic future. Yet making up only 21.6% of the country’s GDP, Croatia’s share of exports stands below the EU’s average of over 30%. Without doubt, Croatia cannot provide long-term economic security with its traditional overreliance on tourism.

Promisingly, the country has the potential to attract investment, counting on a highly skilled, multilingual and productive workforce, as well as a coastal central European location and efficient transport infrastructure that can drive integration into the common market. Indeed, Croatia’s return to growth last year was driven in large part by growing stability in neighbouring markets and modest growth in Europe, stimulating exports.

There are budding opportunities in various sectors: from intensive agriculture and timber production, to high-tech and pharmaceuticals, as well as renewable energy production. Notably, Croatia boasts a strong legacy in shipbuilding, having inherited most of the shipyard infrastructure, docks and advanced technological know-how from Yugoslavia – once the world’s third most significant player in the industry.

Banks crucial to driving progress

As Croatia explores these new trading opportunities, the financial sector will be instrumental. Working as important intermediaries, banks can support Croatia’s growing industries, facilitating commerce on regional and international levels by mitigating risk – important, given the country’s relatively high non-performing loan ratio of 17%.

Promisingly, the banking sector represents one of the standout industries in the country. Local banks in Croatia have emerged from the recession well-capitalised, well-regulated and well-supervised by the Croatian National Bank, offering the resilient environment necessary for facilitating trade, and attracting FDI.

Meanwhile, the prevalence of international banks in the local financial landscape contributes the requisite know-how, expertise and global reach. Croatian banks can work with such institutions to leverage their global networks and access to exotic markets far beyond the country’s – or indeed Europe’s – borders.

In fact, global banks’ work in supporting Croatian trade extends beyond letters of credit: they can provide guarantees, secure credit lines, and enable global payment processing between Croatia and the wider world, as well as offering advisory services.

Given the tendency of many banks to scale back their operations after the recession and retrench from certain markets, the ability to facilitate important trade links for companies between Croatian local banks and foreign markets is all the more crucial.

Last year, presidential and parliamentary elections pushed the country’s economic fightback into the background. This year, with the right foundations, Croatia’s economic resurgence may take centre stage.

Nicolas Adamovich is Senior Representative at Commerzbank’s Zagreb office and President of the German Croatian Chamber of Industry and Commerce.