The Croatian economy made an impressive recovery from the coronavirus pandemic in 2021 and its growth prospects depend on the efficient use of EU funds, the International Monetary Fund (IMF) said in its end-of-mission statement.

“Croatia’s 2021 economic rebound from the pandemic has been impressive. The economy has significantly outperformed earlier expectations with 2021 growth at 10.4 percent. For context, it was not until 2018, that the economy had fully recovered from the 2008 shock of the global financial crisis. The fact that, on aggregate, the economy is now already back to 2019 real income levels testifies to the importance of fiscal buffers and improved macroeconomic management,” the IMF mission led by Srikant Seshadri said following a virtual staff visit to Croatia between 28 February and 7 March 2022.

The IMF team met with Finance Minister Zdravko Maric, Croatian Central Bank Governor Boris Vujcic, and other government officials, as well as with representatives from the private sector.

The IMF mission found that the conflict in Ukraine “is casting a shadow over an otherwise strong economic outlook.”

“In the short run, macroeconomic policymaking will need to stay very nimble in a world with elevated uncertainty. With respect to medium-run challenges, Croatia must efficiently utilize the generous allocation of EU funds allocated to recover from the recent earthquakes, transition to a greener and more digitalized post-pandemic reality and strengthen the cohesion of the EU,” it said.

It noted that the authorities had made a commendable start on the reforms associated with the Next Generation EU funds, and that this reform momentum should be sustained.

“Vested interests holding back reforms that make the Croatian economy more efficient—including on pensions, healthcare, and public administration—must be challenged. These reforms will allow Croatia to reap the full benefits of euro adoption and sustainably raise living standards,” the IMF said.

Energy prices to remain elevated for a longer time

“Near-term inflationary risks continue to tilt higher as energy and commodities markets price in the consequences of the conflict in Ukraine. Energy prices—and therefore inflation—will also remain higher for longer,” the IMF mission said.

It recalled that the authorities had recently unveiled a package of measures to alleviate some of the burden on the population after last year’s stronger than expected growth performance had provided a cushion to help absorb the fiscal costs of these measures.

“However, to conserve the state’s revenues for possible future shocks, these measures should be allowed to lapse once they have served their purpose. Moreover, domestic inflationary factors need to be kept in check. Public sector wage increases should therefore be carefully measured and combined with efficiency enhancing public sector reforms that benefit the taxpayer,” the IMF said.

Efficient use of EU funds to increase growth prospects

“Future growth prospects hinge on the efficient utilization of EU funds. ‘Next-Gen’ and structural EU funds (totaling some 30 percent of GDP over the next five years) must play a greater role in generating economic growth. If the absorption of these funds and the quality of public investment were to significantly improve, so would the economy’s growth potential, as well as its ability to catch up with EU peers,” the statement said.

“Increases in public investment need to be matched by a labor force well-prepared to thrive in an economy that is greener and more digitized. The authorities’ policies to promote reskilling and retooling of the workforce should be supplemented by measures to support job creation in green and digital transitions,” it added.

The IMF pointed out that a strong public investment management system was needed to maximize the benefits of EU funds.

The IMF provided capacity development through a Public Investment Management Assessment (PIMA) in 2021. In accordance with the PIMA’s recommendations, it welcomed the creation of a strong central coordination function in the Ministry of Finance, tasked with appraising and supervising investment projects consistently from a national perspective.

Decarbonizing Croatia’s economy will require major policy reforms and significant public and private investment in all sectors, and Croatia has access to considerable EU resources to help support this transition.

“The necessity of adapting to climate change and mitigating its impacts should be embedded as a fundamental consideration in public investment projects. The authorities are urged to develop national guidelines to facilitate this process,” the IMF said.

Banking system remains well-capitalized and liquid

Commenting on Croatia’s banking system, the IMF mission said that “the banking system remains well-capitalized and liquid, yet continued vigilance is essential.”

“Profitability indicators of the banking system have strengthened in tandem with the ongoing economic recovery. The share of non-performing loans (NPLs) has declined since the beginning of the pandemic (from 5.5 percent at end-2019) to 4.3 percent end-2021, due to NPL sales and the economic recovery. Although the stock of general-purpose cash loans has declined since Q1 2020, the NPLs in this sector have increased. House prices have continued to grow, particularly in Zagreb. This may be related to a myriad of factors, such as foreign investor purchases, and rising construction costs. Against a general backdrop of rising global risks, the authorities are urged to remain vigilant,” the IMF said.