Croatia's central bank HNB said on Tuesday that economic indicators pointed to slower GDP growth in Q3 2022 and in 2023, and warned that the local banking system's exposure to systemic risks in the second half of 2022 increased "due to geopolitical and economic uncertainty, inflation, and changed financing conditions."

Business and consumer sentiment have worsened in this period, industrial production in July and August also dropped from Q2 2022 levels, and retail trade is stagnating.

Although the economy is adding new jobs at a slower rate, the official unemployment rate in July and August was somewhat lower than in Q2 2022. The nominal rise gross wages also slowed down in July and August, while real-term wages continued to decrease. Exports are also expected to slow down.

Due to this worsening economic outlook, strong inflationary pressures and uncertainties related to prices and availability of energy, GDP growth could drop from the projected 5.5 percent in 2022 to just 1.0 percent in 2023. In September, year-on-year inflation accelerated to 12.8 percent from the already record-high 12.3 percent in August. However, inflation rate is expected to drop by the end of the year.

The HNB said they expected inflation to average 10.3 percent this year and fall to 6.7 percent in 2023 due to the gradual fall in global prices of raw materials, resolved supply chain disruptions, and weaker market demand.

Despite strong growth in this year’s tourism revenue, which might turn out to be 20 percent up from the record-high year of 2019, the surplus on the current and capital accounts this year could fall to 3.6 percent of GDP due to a larger trade deficit. This surplus could continue to decrease next year.

The tightening of financing conditions in global financial markets in recent months is spilling over to interest rates on domestic household and corporate loans. The annual increase in lending to domestic sectors – excluding the central government – continued to accelerate, mostly due to corporate lending, notably in the energy sector, while household lending increased only marginally.

Croatia is set to join the euro zone on 1 January, during a tightening of the European Central Bank’s monetary policy, which is expected to have a negative impact on domestic economy financing. However, a reduction in the rate of mandatory reserve requirements and the abolition of the minimum mandated foreign currency liquidity will strongly increase available bank funds and mitigate the deteriorated financing conditions on the domestic market.

The global tightening of monetary policies has increased borrowing costs for most governments and the increase in the yield on Croatia’s bonds was markedly lower compared to central and eastern European countries outside of the euro zone.

Bank interest rates have not increased, but the repayment cost on loans with floating interest rates could gradually increase due to higher Euribor rates, which will be mitigated in the short term by the capping of interest rates on consumer loans. The likely rise in interest rates on new housing loans, alongside uncertainty and lower real-term wages means higher risks on the housing market, where average prices and activity continued to strongly increase over the first half of 2022.

Despite good business results in the first nine months of 2022, corporate reliability is decreasing as companies have to borrow more to finance higher operating costs, notably in energy-heavy businesses. However, the share of non-performing loans has continued to decrease, from 4.3 percent to 3.8 percent.

The banking system is still very resilient thanks to the expected increase in profitability and the effects of introducing the euro and the alignment of the central bank’s monetary instruments with those of the ECB. The main threats to financial stability are possibly stronger disruptions on the energy market and high inflation rate, which might result in faster and stronger increases of key interest rates and higher financing costs for the private and public sectors.