Croatia Economy Profile 2012

Rating agency S&P affirmed at the beginning of April its long- and short-term foreign and local currency ratings on Croatia at 'BBB-/A-3' inclunding their negative outlook. The ratings reflect the political stability in the country, the relative prosperity measured with per capita GDP of additional than USD 13,000 and the moderate net general government debt burden. High euroization, sizable external debt burden and lack of substantial structural reforms, however, indicate weak increase prospects and S&P sees the Croatian economy shrinking 1% this year.

Most Croatian citizens as well believe the economic situation in the country will deteriorate in the coming year, according to a public opinion survey. In 2011, the GDP contracted only marginally, by a real 0.04%, after shrinking 1.2% in 2010. The fourth-quarter GDP shrank by 0.4% after expanding by 0.7% in the previous quarter.

Croatia's consumer price inflation accelerated to 2% in March from 1.3% in February. Retail sales rose by a real 1.1% on the year in February, slower than the 1.9% increase recorded a month before . Industrial production shrank an annual 5.2% in February after dropping 4.9% in the previous month.

The government revealed plans to stimulate employment in the country as registered unemployment rate reached 20.1% in February. Economy minister Radimir Cacic said the jobless rate will continue rising in April to reach a peak in early May and start declining by the end of the month and in June. Labour productivity went down by 0.7% on the year in the first months of 2012 after dropping by 1.3% in January alone.

Croatia's current account gap contracted 5.5% to EUR 446mn in 2011. FDI inflow jumped to over EUR 1bn last year from EUR 295mn in 2010 thanks to higher volume of net equity investment. The country's foreign trade deficit climbed by an annual 20.3% to EUR 564mn in February after rising 25.5% in January.

Croatia Business Forecast 2012

We expect economic growth in Croatia to weaken in 2012 owing to the country's high degree of exposure to the ongoing eurozone sovereign debt crisis. We expect exports to continue falling as external demand dries up and domestic consumption to remain under pressure because of a lack of credit extension and a difficult environment facing consumers.

We believe the new centre-left coalition government, the Kukuriku (cock-a-doodle-do), will seek financial backing from the IMF at some point in 2012. The new government faces the daunting task of reining in the fiscal deficit against the backdrop of stagnating economic growth. Further exacerbating the situation is a high level of external debt in the economy, the burden of which has increased as the Croatian kuna has come under heavy selling pressure.

We believe exchange rate stability will prevail in 2012 and expect a steady depreciation of the kuna against the major currencies on the back of a weak economic growth outlook and wider risk aversion towards frontier market assets. Given the aforementioned high degree of external obligations in the economy, we believe the stability of the kuna, especially against the euro, will remain a key policy objective of the central bank.

Major Forecast Changes

We have revised down our forecast for Croatian real GDP growth to come in at 0.1% in 2012 and caution that risks to this outlook are skewed firmly to the downside. The country's high exposure to the eurozone sovereign debt crisis poses significant macroeconomic and financial headwinds to the Balkan economy via lower export growth and bank lending. Moreover, our conviction that the new Kukuriku government will pursue heavy spending cuts, likely with the aid of the IMF, means a positive government contribution to growth is off the cards.

We have revised our forecast for Croatia's fiscal deficit to come in at 5.9% of GDP in 2011 and 5.6% in 2012, from previous expectations of 5.4% and 4.8% in 2011 and 2012 respectively. We expect the weak domestic environment to strain revenue growth in 2012 despite proposed measures from the new government to boost revenues. Our view that the new government is likely to seek IMF backing underpins our forecast for expenditure to fall by 1.5% in 2012. Fiscal expenditure had increased towards the end of 2011 in the run-up to parliamentary elections held December 4.

We have revised our forecast for Croatia's current account deficit, to 0.7% of GDP in 2011 and 1.2% in 2012, from 1.0% and 1.5% respectively previously. We expect the large services surplus - the result of a bumper tourist season - to continue to widen, albeit at a slower rate in 2012 than in 2011. However, with export growth set to slow markedly in 2012 as the eurozone sovereign debt crisis squeezes external demand, we expect the widening merchandise trade deficit to drag the current account deeper into the red.

Key Risks To Outlook

The main risk to our macroeconomic and financial market forecasts remains a more pronounced slowdown in the eurozone than we currently have pencilled in; we forecast the bloc to contract by 0.3% in real terms this year. A more severe slowdown in the eurozone would have a highly deleterious effect on Croatia's economy, which is small and highly exposed to the eurozone sovereign debt crisis by way of trade, investment and banking links.

One upside risk to our fiscal and investment forecasts would be the government's ability to find a buyer for the country's beleaguered shipyards. While this target remains a key chapter in the EU accession process, a lack of interest has meant the government has been unable to sell the shipyards. In the event that the new government finds a buyer, it would take a significant strain off public finances and could increase investor interest in the country, thereby improving Croatia's investment outlook.