Despite the increasing recovery of economic activity, the systemic risk exposure of the domestic financial system remains elevated, the Croatian Central Bank (HNB) Council said in a statement on Wednesday.

The HNB Council met to discuss current economic and financial developments and the latest analysis of financial stability.

The recovery of economic activity might pick up in the first quarter of 2021 as a result of a break in the second and the third wave of the coronavirus pandemic in Croatia, the HNB said in a statement.

Labour market indicators show the weakening of momentum at the end of the quarter, probably as a result of the mild strengthening of seasonal activities in the circumstances of the renewed deterioration of the epidemiological situation. The rise in oil prices in March, combined with the base effect, pushed the annual inflation rate to 1.2% from 0.3% in February.

In such circumstances, monetary policy remained highly accommodative, and the banks’ free funds continued to grow in April as well, mostly due to a decrease in government kuna deposits with the central bank, reaching their highest level yet. However, credit activity remained subdued as the annual rate of bank lending slowed to 2.3% in March from 3.0% in February.

The growth rate of corporate lending slowed from 4.1% in February to 1.0% in March on account of strong lending in March last year. On the other hand, growth in household lending picked up thanks to marked growth in housing loans, with the volume of general-purpose cash loans dropping slightly.

The pick-up in the recovery of real activity also had a positive impact on budget revenue, which rose by 10% in the first quarter of 2021 compared with the same period in 2020. Expenditure also rose, leaving a budget gap of HRK 3.5 billion. The deficit was slightly lower than in the first quarter of 2020, which was also partly affected by the pandemic.

The central bank warned of strong public debt growth. While fiscal policy helped mitigate the consequences of the pandemic, lower revenues and substantial fiscal support drove up public debt. Also, the already strong exposure of credit institutions to the state strengthened further. However, the country’s low risk premium and favourable financing terms, as well as substantial funds available from the EU budget, facilitated government financing and mitigated these risks over the short term, the statement said.