Real GDP growth could be 5.5 percent this year and 2.5 percent in 2023, while inflation could slow down from this year's 9.4% to 4.6% in 2023, the Croatian Central Bank (HNB) said on Wednesday.

According to the HNB’s summary of macroeconomic trends and estimates, the economic repercussions of the Russian invasion of Ukraine, the continued rise in energy and raw material prices, and the disruption of global supply chains have not seriously affected Croatia’s economic growth outlook.

However, unfavourable global circumstances and pronounced inflationary pressures could have a bigger impact on domestic economic trends in 2023, when real domestic activity growth is expected to slow down to 2.5 percent.

The risks remain pronounced in the projected period 2022-23, with the prevalence of risks that could have a negative impact on economic growth, such as a gas embargo, food and energy price hikes, tighter financing conditions than expected, and a deterioration of the COVID situation.

HNB governor Boris Vujcic told the press that growth in Q2 this year was expected to be stronger than in Q1, when it was 7 percent, the tourism season was expected to make a very strong contribution in Q3, and “solid growth” was expected in Q4.

He said Q4 was much more uncertain and that for the most part, it depended on developments on the energy market, and whether there would be a gas embargo for Europe, which would significantly change the economic outlook for Q4 and 2023.

Vujcic said a recession was possible next year, mainly due to a stoppage in gas deliveries to Europe. The recession could first occur in Croatia’s main trade partners, Germany and Italy, and then spill over to Croatia, he added.

As for this year’s tourism season, he said arrivals were almost the same as in 2019, while accommodation and hospitality prices increased by 20 to 30 percent, which would point to a record tourism season financially.

Inflation in June surpasses 11 percent

This year’s inflation of consumer prices could accelerate to 9.4 percent, first and foremost as a result of considerably higher global energy and raw material prices, the HNB said. On the domestic market, energy and food prices continue to increase the most, but the increase in prices of other goods and services is gradually accelerating, too.

Vujcic said inflation was expected to increase to over 11 percent in June, that during the summer it should be at 11 percent or 12 percent, while it was expected to start slowing down at the end of this year and especially at the start of 2023.

The growth of the main inflation sub-components is expected to slow down in 2023 and total inflation as well, to 4.6 percent. However, this forecast hinges on the stabilisation and, later this year, the gradual decrease in energy and raw material prices on the global market, according to the HNB.

Inflation projections for this year and the next are dominated by risks that could increase it further, including higher energy and raw material prices and a more pronounced salary growth.

Vujcic said the fight against inflation envisaged higher interest rates and that the European Central Bank announced that this could begin this month already. “I expect this to continue in the autumn.”

The goal is for HNB and ECB interest rates to be the same as of 1 January 2023 and Croatia’s accession to the euro area, he said.

Mandatory reserves to be reduced to 1 percent

The HNB Council decided today to reduce banks’ rate for calculating mandatory reserves from 9 percent to 5 percent this August and from 5 percent to 1 percent in December, which is the mandatory reserve rate in the euro area, Vujcic said.

He also decided that the minimum amount of foreign currency claims be reduced from 17 percent to 8.5 percent in August and abolished in December.

The effect of the first measure will be the release of 34.2 billion kuna in mandatory reserves, while the second will allow banks to release or differently dispose of €5 billion, Vujcic said.

Historically low interest rates

He said today’s decisions would also affect interest rates by making financing cheaper for banks, so they would have fewer reasons to raise them, notably on new loans. They can reduce them further, depending on their business policy, he added. “But we’ll see where we are at the start of next year.”

Vujcic said interest rates in Croatia were historically low, while those in EU countries outside the euro area were considerably higher, twice as high for housing loans.

Decrease in real and increase in nominal pay

This year, employment is expected to continue to grow and unemployment to fall, with an increase in nominal and a decrease in real pay.

Vujcic said the current situation on the labour market was unusual, given that the private sector was recording a strong rise in nominal pay, about 10 percent, mainly due to the difficulty to find qualified labour, while wage increases in the public sector were slower.

Looking at the two sectors together, the growth in wages is somewhat lower than that of inflation, and this year real pay is expected to drop 1.5-2 percent, Vujcic said, adding that wage increases were expected to be at the level of inflation growth only in the private sector.

Euro area and Schengen additional incentive to foreigners to buy real estate

Speaking of the real estate market, Vujcic said property prices in Q1 were 13.5 percent higher year on the year and that the increase was also due to very low interest rates on savings, which are even negative in neighbouring countries, prompting foreigners to buy due to the higher yield.

The increase in property prices is also due to the government’s subsidised housing scheme as well as the acceleration of inflation.

Vujcic said Croatia’s accession to the euro and Schengen areas would be an additional incentive to buy real estate. On the other hand, if the rise in ECB interest rates also affects those on deposits, this rise should also reduce the incentive to buy real estate, but this can’t happen overnight, he added.

Market activity could slow down due to the expected tightening of financing conditions and unfavouable income trends.