Guy Norton in Zagreb -

It's been a glorious summer in Croatia, with many parts of the country enjoying months of unbroken sunshine - a blessing for the country's tourism industry, but a curse on its agricultural sector. With the peak holiday season now over, Croatians are now steeling themselves for what could be a winter of discontent, given the parlous state of the country's economy.

According to the Central Bureau of Statistics, the country is still firmly stuck in recession, with preliminary figures for the second quarter showing that GDP shrank by 2.1% on an annual basis - the biggest fall in the last two years after GDP fell 2.5% in the second quarter of 2010.

The second quarter fall in economic activity indicates an acceleration in the decline in Croatia's financial fortunes compared with the first three months of the year when GDP fell by 1.3%. Although it's probably cold comfort to the vast majority of Croatians, the fall in GDP was actually lower than most local analysts had predicted. In a survey conducted by state news agency Hina, eight Croatian macroeconomists had predicted a 2.3% fall in economic activity on a consensus basis.

Nevertheless it confirms that the country is still struggling to find its way out of a recession that hit at the start of 2009. Since then the economy has only registered three quarters of positive growth, in the third quarter of 2010 and the second and third quarters of 2011. Commenting on the latest GDP number, Zdeslav Santic, chief economist at Splitska Banka, says that although a detailed breakdown of second-quarter GDP won't be available until late September, recent indicators point to an across-the-board fall in economic activity. "Most likely all categories of GDP recorded a decline on an annual basis. Retail trade was 5.6% lower in real terms, while industrial production contracted by 6.7%."

Santic adds that the country's trade balance also deteriorated in the second quarter, with a 7.7% increase in the trade deficit on the back of falling exports to the EU, the country's main trading partner.

Looking ahead to the rest of the year, there is unlikely to be a major turnaround in the economy in the near term, argues Erste Bank's chief economist, Alen Kovac. "I still see a negative GDP figure for the third quarter, less pronounced, but still negative."

Santic at Splitska Banka says that while foreign tourism revenues from the peak holiday season of July and August may mitigate some of the decline in economic activity in the third quarter, that positive effect will be absent in last three months of the year. "In the fourth quarter, GDP might again contract at a somewhat stronger pace as economic activity at the end of year relies mostly on domestic growth factors, such as household consumption and capital investments."

Commenting on the weak GDP data, Prime Minister Zoran Milanovic admitted that it was clear that Croatia would not achieve the 0.8% growth in GDP the government had forecast at the start of the year when it came to power, but that he firmly believed that Croatia would emerge from recession in 2013 when it is due to join the EU. Asked by reporters if he was thinking about resigning because of the poor state of the economy, Milanovic said the government was not asking for sympathy or mercy but a little patience and that after half a year in office, it was perfectly clear that miracles were not possible in six months. "If there is headway next year, that will not be a miracle but the result of this government's work, because good measures and laws are being adopted, he said. "The government is not crying because of the difficult situation."

That prompted a bitter response from Dragutin Lesar, leader of the leftwing Hrvatska Laburista (Croatian Labour) party, who told Hina: "Maybe the government is not crying because of the difficult situation and the fall in GDP, but the Croatian people are crying. We can not just expect a further decline in GDP... but also a decline in production, higher prices, declining incomes, rising unemployment... It is

an never-ending spiral. I can not believe that they [the government] cannot see the spiral and that they do not see that their actions are only deepening the crisis."

Meanwhile, Goran Maric, an economic strategist for the HDZ, the main opposition party in Croatia, said that the weak GDP data was no surprise given the tax hikes implemented by the centre-left government. "In such a recession, you cannot impose such high taxes and expect economic growth. With such a tax burden the government has pushed Croatia from recession into depression."

On the international front all eyes will now be on the credit rating agencies, which at the start of the year were widely seen as giving the newly installed government the chance to prove its economic credentials when they retained their 'BBB' investment grade ratings for Croatia, albeit with a negative outlook.

Santic at Splitska Banka says that the government will now quickly need to convince the rating agencies it is able to rein in public spending and push through long overdue economic reforms if the country is to avoid being relegated to so-called junk status. "In comparison with the start of the year we expect that the rating agencies might be less willing to provide a grace period for the government to tackle these two issues."