The Croatian National Bank (HNB) has revised upward its GDP growth projection for 2016 to 2.3% because of the faster-than-expected increases in domestic consumption and investments, but the high levels of public and foreign debt still pose the largest downside risk to the country, HNB Governor Boris Vujcic said on Thursday.

"The HNB estimates that the GDP growth rate this year will be 2.3%, which is a considerable increase compared with the previous projection (of 1.8%), while in 2017 the rate is expected to be 2.5%. The main reason for the upward revision is the faster growth of domestic aggregate demand, that is of personal consumption and investments, in relation to the previous period. Data for the first five to six months of this year show that personal consumption increased considerably, as did investments in the first quarter of the year, partly thanks to the use of EU funds," Vujcic told a press briefing on current economic trends and projections.

The central bank expects personal consumption to grow at a rate of 2.9% in 2016, following 1.2% growth in 2015, while the investment growth rate is projected at 2.9%, after 1.6% in 2015.

Foreign direct investment in Croatia was EUR 503 million in the first quarter of 2016, an increase of EUR 107.4 million or 27.1% over the same period last year, the HNB's preliminary data show.

Noting that the recovery of the national economy was primarily spurred by increased exports which occurred as soon as Croatia joined the EU, Vujcic said this also had helped improve the business environment and increase business optimism.

At the same time, imports mostly consisted of capital investment equipment, which shows that export enterprises are also increasing their investments. The HNB estimates that this year exports will have gone up by 5.7%.

The most important GDP component, personal consumption, is also increasing as a result of real income growth. With an expected negative inflation rate of 0.9% and the decreasing burden of debt repayment, disposable income is increasing. 

The main risk to the Croatian economy still comes from high public and foreign debt because of susceptibility to a possible deterioration of the situation on foreign financial markets. The HNB projects this year's foreign debt at 96.9% of GDP and public debt at about 85% of GDP.

"The fundamental risk of the present level of foreign and public debt is a change in financing conditions on the market. With the last issue of state treasury bond we saw that the financing conditions on the domestic market were far better than ever before and we have that situation on the international market too. However, that situation will certainly not last forever and this period of favourable financing conditions needs to be utilised so that debts can be decreased because due to the high level of public and foreign debt when financing conditions change, Croatia is still vulnerable to such negative shocks," the governor said.

He said that the central bank too for now does not see any negative impact of the political instability on all positive trends, particularly because there are no indications of the budget being amended.

"Let's wait for the (early) election and then see how the government will be formed. What is clear and what is important for forecasts is that the budget remains as it was adopted and this GDP growth rate enables the deficit to fall below 3% of GDP. In addition, our forecast is that as of next year the debt-to-GDP ratio will begin to fall," Vujcic said, underscoring that that would open the opportunity to begin talks on Croatia exiting the European Union's Excessive Deficit Procedure (EDP).

The HNB considers unemployment to be the greatest problem for Croatia's economy, emphasising that Croatia has the highest unemployment rate (17% in 2015, and an expected 15.6% in 2016) compared with other countries in central and eastern Europe.

Speaking about financial stability in Croatia, Vujcic said that it was very high and that the Croatian banking system was highly capitalised and stable.

The capital adequacy of banks, he recalled, decreased last year by 3 percentage points as a consequence of converting loans pegged to the Swiss franc, but now it is again at 22%, he said.

He underscored that bank adequacy was such that even if none of the bad loans were to be settled, for which reserves were not set, their capital adequacy rate would still be above the current legally prescribed level which means that the Croatian banking system continues to be very stable.

He reflected on the problems facing Italian banks in consideration that two-thirds of Croatian banks are owned by Italian banks and said that for the time being there is no indication of any problems arising.

"What is certain is that Zagrebacka Banka and Privredna Banka Zagreb are very highly capitalised and stable financial institutions. At the moment, because they have come under monitoring by the European Central Bank (ECB), we have continual cooperation within supervisory meetings with the ECB and there is absolutely no outstanding issues in that regard, that I would certainly be informed of," Vujcic said.

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