COMMISSION STAFF WORKING DOCUMENT In-Depth Review for Croatia in accordance with Article 5 of Regulation (EU) No 1176/2011 on the prevention and correction of macroeconomic imbalances Accompanying the COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE COUNCIL, THE EUROPEAN CENTRAL BANK, THE EUROPEAN ECONOMIC AND SOCIAL COMMITTEE, THE COMMITTEE OF THE REGIONS AND THE EUROPEAN INVESTMENT BANK Economic policy coordination in 2021: overcoming COVID-19, supporting the recovery and modernising our economy
Date: 2021-06-02
Institutions: European Commission, Secretariat-General
Subjects: Croatia, EU employment policy, European Semester, coronavirus disease, economic recovery, epidemic, fiscal policy, investment policy, macroeconomics, structural adjustment

EN 

  EN 

   EUROPEAN COMMISSION  Brussels, 2.6.2021  SWD(2021) 406 final  COMMISSION STAFF WORKING DOCUMENT In-Depth Review for Croatia                in accordance with Article 5 of Regulation (EU) No 1176/2011 on the prevention and correction of macroeconomic imbalances  Accompanying the COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE COUNCIL, THE EUROPEAN CENTRAL BANK, THE EUROPEAN ECONOMIC AND SOCIAL COMMITTEE, THE COMMITTEE OF THE REGIONS AND THE EUROPEAN INVESTMENT BANK Economic policy coordination in 2021: overcoming COVID-19, supporting the recovery and modernising our economy {COM(2021) 500 final} - {SWD(2021) 401 final} - {SWD(2021) 402 final} - {SWD(2021) 403 final} - {SWD(2021) 404 final} - {SWD(2021) 405 final} - {SWD(2021) 407 final} - {SWD(2021) 408 final} - {SWD(2021) 409 final} - {SWD(2021) 410 final} - {SWD(2021) 411 final} - {SWD(2021) 412 final}  
 
 
CONTENTS 

Executive summary 

1.  Assessment of Macroeconomic Imbalances 

2.  Thematic Issue: External Imbalances 

3.  Thematic Issue: Private Debt 

LIST OF TABLES 

Table 1.1: 

Assessment of Macroeconomic Imbalances Matrix - Croatia 

Table 1.2: 

Selected economic and financial indicators, Croatia 

Table 2.1: 

Selected external indicators, Croatia 

Table 3.1: 

Private debt indicators, Croatia 

LIST OF GRAPHS 

Graph 1.1: 

Contribution to potential growth 

Graph 2.1: 

Thematic Graphs: External imbalances 

Graph 2.2: 

NIIP scenarios 

Graph 3.1: 

Thematic Graphs: Household debt 

Graph 3.2: 

Thematic Graphs: Non-financial corporate debt 

Graph 3.3: 

Thematic Graphs: Non-performing loans 

1 

2 

10 

15 

7 

9 

12 

18 

5 

13 

14 

19 

20 

20 

 
 
 
 
 
 
 
EXECUTIVE SUMMARY 

The  2021  Alert  Mechanism  Report  concluded  that  an  in-depth  review  should  be  undertaken  for 
Croatia  to  examine  further  the  persistence  of  imbalances  or  their  unwinding.  In  February  2020, 
under  the  previous  annual  cycle  of  surveillance  under  the  Macroeconomic  Imbalances  Procedure,  the 
Commission identified macroeconomic imbalances in Croatia. These imbalances related to high levels of 
external, private and government debt in a context of low potential growth. The analysis shows that these 
vulnerabilities  remain.  It  should  be  noted  that  the  context  of  the  assessment  of  vulnerabilities  in  this 
year’s in-depth review (IDR) for Croatia is markedly different from last year. Also, the evolution of the 
COVID-19 pandemic, the strength of the recovery, and possible structural implications of the crisis are all 
still surrounded by high  uncertainty, requiring caution in the  assessment. In general, policy action over 
the past year focused on cushioning the impact of the COVID-19 shock and facilitating the recovery. This 
has  added  to  indebtedness  but  should  support  adjustment  in  the  medium-term.  Looking  forward,  the 
Recovery and Resilience Facility provides an opportunity to address imbalances, investment and reforms 
needs.  

Main observations and findings of this IDR analysis are: 

  This IDR is informed by the 2021 spring forecast, which expects a recovery in economic activity 
in Croatia with the easing of the COVID-19 crisis. After the steep drop of 8% in 2020, real GDP is 
projected to increase by 5% this  year and 6.1% next  year,  allowing the economy to recover its pre-
pandemic level by the end of 2021 (in quarterly terms).  

  The COVID-19 pandemic exposed vulnerabilities linked to the composition of Croatia’s current 
account flows as Croatia’s sizeable tourism sector was severely hit. The current account balance 
turned negative in 2020, with a deficit equal to 1.1% of GDP, due to a sharp deterioration in the trade 
balance largely driven by the decline in tourism. The current account balance as a whole is expected to 
mildly worsen in 2021 before recovering somewhat in 2022. The negative net international investment 
position (NIIP) declined slightly to -52% of GDP in 2020, but should resume its pre-pandemic upward 
trajectory already in 2021, reaching the prudential benchmark in 2022. The composition of Croatia’s 
external  liabilities  remains  favourable  as  the  NIIP  excluding  non-defaultable  instruments  (NENDI) 
has been close to balance in 2020.  

  After declining for five years, the public debt  ratio rose  by 16 percentage points to its highest 
level on record (88.7% of GDP) in 2020. The increase is due to the combined effect of the  fall in 
economic activity (GDP fell by 8% in 2020) and the measures put in place to address the COVID-19 
pandemic and support the economy (resulting in a deficit of 7.4% of GDP in 2020). The debt ratio is 
expected  to  start  declining  already  in  2021  and,  as  economic  output  recovers,  fall  to  slightly  below 
83% of GDP in 2022. 

  2020  marked  a  turnaround  as  private  sector  debt-to-GDP  increased  after  several  years  of 
improvements. Private sector debt increased by 10 percentage points to 101.4% of GDP in 2020. This 
reversal  came  as  a  result  of  a  sharp  drop  in  GDP,  accompanied  by  higher  borrowing  needs  of 
corporates  in  light  of  the  COVID-19  crisis.  The  banking  sector  remains  well  capitalised  and  has 
become  more  resilient  since  Croatia  joined  the  Single  Supervisory  Mechanism  as  part  of  its  euro 
adoption  process,  but  challenges  remain.  Increased  bank  provisioning  suggests  an  expected  rise  in 
non-performing loans going forward. An increase in the number of insolvencies, particularly those in 
sectors severely hit by the COVID-19 pandemic, could increase the banks’ already high levels of non-
performing loans. 

  Reforms  and  investments  addressing  structural  rigidities  in  Croatia’s  economy  should  lift  the 
growth  potential.  Croatia’s  low  growth  potential  remains  an  obstacle  for  a  swift  recovery  after  the 
COVID-19  pandemic  and  for  its  catching  up  with  the  EU.  Reforms,  particularly  those  to  improve 
labour  productivity,  reduce  the  complexity  of  the  business  environment,  improve  efficiency  of  the 
public  sector,  will  contribute  to  increase  the  pace  of  Croatia’s  convergence  process  towards  the  EU 
average.  

1 

 
1.  ASSESSMENT OF MACROECONOMIC IMBALANCES 

Introduction 

In  February  2020,  over  the  previous  annual  cycle  of  surveillance  under  the  Macroeconomic 
Imbalances Procedure, the Commission identified “macroeconomic imbalances” in Croatia. These 
imbalances related to high levels of government, private and external debt in a context of low potential 
growth. The 2021 Alert Mechanism Report published in November 2020 concluded that a new in-depth 
review  (IDR)  should  be  undertaken  for  Croatia  with  a  view  to  assess  the  persistence  or  unwinding  of 
imbalances.  

The  context  of  the  assessment  of  vulnerabilities  this  year  is  markedly  different  from  last  year's 
IDRs, which took place before the COVID-19 pandemic. The evolution of the pandemic, the strength 
of the recovery, and possible structural implications of the crisis are still surrounded by high uncertainty 
requiring caution in the assessment. Policy action over the past year focused on cushioning the impact of 
the COVID-19 shock and on facilitating the recovery. While this supports adjustment in the medium-term 
through  stronger  fundamentals,  it  also  has  added  to  indebtedness.  Follow-up  to  country-specific 
recommendations  from  2019  and  2020,  including  those  that  are  MIP-relevant,  is  taking  place  in  the 
context of the assessment of the Recovery and Resilience Plans (RRPs). The analysis of policies in the 
present  report  was  finalised  before  the  formal  submission  of  RRPs  and  does  not  draw  on  information 
included  in  RRPs.  It  is  therefore  without  prejudice  to  the  Commission’s  assessment  of  RRPs,  which  is 
ongoing at the time of publication of this report. 

The assessment follows a similar structure  as the IDRs that were included in Country Reports in 
recent  annual  cycles.  This  chapter  presents  the  main  findings  for  the  assessment  of  imbalances,  also 
summarised in the MIP assessment matrix. The assessment is backed by selected thematic chapters that 
look  more  at  length  at  the  external  position  and  private  debt  developments,  both  of  which  have  been 
specifically  hard  hit  by  the  pandemic.  Spillovers  and  systemic  cross-border  implications  of  imbalances 
are also taken into account. In addition, also assessments of structural issues made in previous IDRs and 
in the context of fiscal assessments are considered if relevant.  

Macroeconomic context 

Real GDP is forecast to grow strongly after the COVID-19 crisis, surpassing its pre-crisis annual 
level in 2022. Growth in Croatia rebounded strongly in the third quarter of 2020, after the unprecedented 
contraction in the first half of the year. Overall GDP fell by 8% in 2020 and growth is forecast at 5% in 
2021 and 6.1% in 2022, by then surpassing the 2019 level by 2.4%. Potential growth is forecast to recover 
from the sharp drop in 2020 and reach 2.6% in 2022. The negative output gap is set to close by 2022. The 
current account balance is forecast to gradually improve, but remain mildly negative (-0.7% of GDP) in 
2022,  and  still  well  below  the  surplus  registered  in  2019 (2.7%). The  unemployment  rate  is  forecast  to 
return to its 2019 level of 6.6% by 2022 on the back of job creation. HICP-measured inflation is expected 
to pick up mildly, reaching 1.3% in 2020, driven by energy and processed food prices. 

The  economic  recovery  is  expected  to  be  broad-based  as  private  consumption  gets  a  boost  from 
pent-up demand while tourism starts to recover from a steep drop. The lifting of pandemic-related 
constraints on consumption in combination with pent-up demand and accumulated involuntary savings is 
set to boost private consumption, which is performing rather well as the labour market has been relatively 
shielded from the crisis. The gradual recovery of tourism from a steep drop is forecast to add strongly to 
economic  growth,  even  though  tourism  is  not  expected  to  reach  its  2019  levels  by  2022.  Having 
recovered much faster than services, going forward exports of goods are projected to add to growth more 
mildly. Investment is set to benefit from the increased absorption of European Structural and Investment 
Funds  and  from  the  RRF.  The  vaccination  pace  in  Croatia  initially  lagged  behind  the  EU  average, 
hindered by delays  in deliveries and organisational issues,  but it has  since picked  up pace. Restrictions 
and containment measures have been less severe than in most countries and were lifted relatively early. 

2 

 
1. Assessment of Macroeconomic Imbalances 

Policy  measures to protect jobs  were  extended and  modified regularly in order to keep  in line  with the 
imposed restrictions. They are projected to be phased out by end-2021. Downside risks to growth  most 
notably relate to the extent to which the pandemic is curbed in both Croatia and its key emissive tourist 
markets  in  time  for  the  tourist  season.  Low  administrative  capacity  also  presents  a  risk  for  a  swift 
absorption of the EU funds available to Croatia.  

Imbalances and their gravity 

After  five  years  of  declining,  the  high  public  debt  ratio  rose  markedly  in  2020  as  a  result  of  the 
COVID-19 pandemic. In the period 2015-2019, Croatia’s public debt ratio decreased by 12 percentage 
points  driven  by  both  nominal  GDP  growth  and  prudent  fiscal  policies,  which  resulted  in  three 
consecutive  government  surpluses  from  2017  to  2019.  In  2020,  the  COVID-19  pandemic  reduced 
economic  output  by  8.0%.  In  addition  to  the  direct  impact  on  the  debt  ratio  through  the  denominator 
effect,  the  policy  response  to  the  pandemic  resulted  in  a  deficit  of  7.4%  of  GDP  which  needed  to  be 
financed  by  new  borrowing.  As  a  result  of  these  two  effects,  the  debt  ratio  increased  by  almost  16 
percentage points to 88.7% of GDP, the highest on record. The latest debt sustainability analysis confirms 
that the country faces medium risk in the medium term (1). The gravity of the imbalance represented by 
the elevated public debt ratio is mitigated by the fact that both the debt that was refinanced in recent years 
and  the  newly  accumulated  debt  in  2020  have  been  issued  at  very  low  rates  and  with  relatively  long 
maturities. As a result, in spite of the growing stock of public debt, the cost of its servicing has declined 
substantially. On the other hand, the newly accumulated debt was largely issued or denominated in euro, 
increasing exposure to foreign exchange risks. However, given the historic stability of the exchange rate, 
the  high  degree  of  euroisation  of  the  economy,  stable  external  competitiveness  and  Croatia’s  entry  in 
ERM2, foreign exchange risks are expected to be contained. 

Croatia’s  financial  sector  is  exposed  to  the  lingering  effects  of  the  COVID-19  outbreak,  in 
particular  due  to  its  direct  linkages  with  the  country’s large  tourism  sector.  The  Croatian  banking 
sector has one of the highest exposures within the EU to sectors that are most vulnerable to the outbreak 
and  the  containment  measures.  Nevertheless,  the  banking  system  has  ample  absorption  capacity,  with 
high  regulatory  capital  (CET1:  22.4%  in  Q3  2020,  among  the  highest  within  the  EU)  and  provisioning 
levels (coverage ratio: 66.2%, the highest within the EU). Banking sector profitability has been moderate 
and declined in light of the COVID-19 crisis but remained positive in Q2 2020. The banking system has 
also  improved  its  asset  quality  significantly  in  recent  years,  driven  partly  by  effective  supervisory 
pressure.  As  part  of  Croatia’s  entry  into  the  ERM2,  the  authorities  have  also  successfully  amended  the 
legal  framework and engaged in necessary assessments,  which paved the  way  for the banking system’s 
accession  into  the  Single  Supervisory  Mechanism  (SSM)  as  well  as  the  Single  Resolution  Mechanism 
(SRM). From October 2020, the ECB exercises direct supervision over significant institutions in Croatia. 
In  particular,  the  ECB’s  comprehensive  assessment,  which  was  finalised  in  June  2020,  resulted  in  no 
additional capital needs.  

2020  marked  a  turnaround  as  private  sector  debt-to-GDP  increased  after  several  years  of 
improvements. The consolidated corporate and household debt levels for 2020 are estimated at 63% and 
38% of GDP respectively. Despite this increase in debt levels, both household and corporate debt levels 
remain  below  their  respective  prudential  thresholds (2).  Nevertheless,  both  debt  levels  remain  high 
compared  to  their  thresholds  based  on  fundamentals.  The  increase  in  household  debt  can  largely  be 
attributed  to  an  increase  in  long-term  debt  resulting  from  increased  mortgage  lending  which  was 
supported by the government’s housing loans subsidy programme. The loan subsidy programme has also 
been found to further stoke strong house price increases. To combat the negative effects of the COVID-19 
pandemic,  two  programmes  of  government  guarantees  were  approved  on  the  basis  of  the  temporary 
framework  for  state  aid  measures:  one  supporting  liquidity  of  exporters  and  another  programme  of 
favourable loans  for SMEs.  A  minimum three-month  moratorium to clients hit by the  pandemic on the 

(1)  See Article 126(3) report (June 2021) and the Debt Sustainability Monitor 2020 for detailed methodological explanations.  
(2)  Fundamentals-based benchmarks are derived from regressions capturing the main determinants of credit growth and taking into 
account  a  given  initial  stock  of  debt.  Prudential  thresholds  represent  the  debt  threshold  beyond  which  the  probability  of  a 
banking crisis is relatively high, minimising the probability of missed crisis and that of false alerts. Methodologies are described 
in  European  Commission  (2017), Benchmarks  for  the  assessment  of private  debt.  Note  for  the  Economic  Policy  Committee, 
European Commission, Brussels; and updates to the methodology have been subsequently proposed in European Commission 
(2018),  Fundamentals-based  private  debt  benchmarks:  enhanced  sample  and  robustness  checks.  Note  to  LIME,  European 
Commission, Brussels. 

3 

                                                           
1. Assessment of Macroeconomic Imbalances 

repayment of credit liabilities was agreed with the banking sector. The amount of loaned  funds covered 
by the moratorium peaked in mid-2020 (when it covered 15% of all loaned funds) and has halved by the 
end of Q1-2021. The bulk of the remaining moratoria is expected to expire by the end of Q2-2021. There 
was  also  a  moratorium  on  enforcement  on  accounts  of  natural  persons,  along  with  a  suspension  of 
accruing of interest in this period. Corporate debt remains high relative to gross financial assets or equity, 
signalling a persistently high debt overhang and solvency risks for the corporate sector. The private-sector 
debt  profile  has  continued  to  improve.  The  share  of  debt  exposed  to  foreign  exchange  risk  has  been 
reducing  in  recent  years,  reaching  63%  for  businesses  and  45%  for  households,  respectively,  in 
2020,reflecting  the  increasing  propensity  of  both  businesses  and  households  to  borrow  in  domestic 
currency  and  repay  their  foreign-currency-denominated  debt.  While  exposure  to  foreign  currency  risks 
remains  relatively  high,  the  risks  themselves  seem  contained  in  the  context  of  stable  competitiveness 
outlook  and  the  historical  stability  of  the  kuna  vis-à-vis  the  euro,  which  has  been  affirmed  by  its 
participation in the Exchange Rate Mechanism (ERM2) as of July 2020 as part of Croatia’s intention to 
adopt the euro. Businesses and households also benefitted from low interest rates and a tendency towards 
fixed interest rates. 

The pandemic exposed vulnerabilities due to the composition of Croatia’s current account flows as 
it severely hit Croatia’s sizeable tourism sector. In 2020, a steep decline in output exceeded the fall in 
aggregate  demand,  which  has  led  to  a  substantial  widening  of  the  trade  deficit.  After  six  years  of 
recording a surplus, the current account turned negative in 2020, with a deficit equal to  -1.1% of GDP, 
due to a sharp deterioration in trade balance largely driven by decline in travel income. Despite the crisis, 
foreign direct investment kept flowing into the economy during 2020. After improving by 45 percentage 
points over nine years, the net international investment position declined by 2 percentage points in 2020 
to -52% of GDP, largely due to the contraction in nominal GDP. The composition of Croatia’s external 
liabilities remains favourable as the NIIP excluding non-defaultable instruments (NENDI) stood at only -
3.4% in 2020, well above its prudential benchmark. Central bank reserves remained sizeable, at 38.5% of 
GDP end of 2020, despite several substantial foreign exchange interventions to counter kuna depreciation 
pressures in the first half of 2020. 

Croatia’s  potential  growth  remains  among  the  lowest  in  Central  and  Eastern  Europe,  despite 
having increased over the past few years. Low potential growth hinders Croatia’s convergence capacity 
towards  the  EU  average.  Low  allocative  efficiency,  a  cumbersome  business  environment  and  an 
inefficient public sector weigh on total factor productivity (TFP) (Graph 1.1). Labour productivity growth 
is low, especially  for a converging economy. The labour  market reaction to the  disruption in economic 
activity was quick, but contained, as the government’s wage and liquidity support measures mitigated the 
fall  in  employment.  The  evolution  of  the  COVID-19  pandemic  and  the  associated  lockdown  measures, 
including travel restrictions, will be a key determinant in Croatia regaining growth momentum.  

4 

 
Graph 1.1:  Contribution to potential growth 

1. Assessment of Macroeconomic Imbalances 

Source: European Commission Services 

Evolution, prospects, and policy responses 

The public debt ratio is expected to start declining already in 2021. As economic output recovers, the 
public debt ratio is set to resume its decline through the denominator effect, dipping below 83% of GDP 
in 2022. This decline is not expected to be as pronounced as in the pre-pandemic period, as the general 
government balance is not expected to recover as fast as economic output in the medium term. A positive 
circumstance  is  that  both  the  maturing  debt  in  recent  years,  but  also  the  newly  accumulated  debt,  have 
been refinanced at very low rates,  which means that the increased stock of debt will not be reflected in 
rising debt servicing costs for now. 

Increased bank provisioning suggests an expected rise in non-performing loans going forward. The 
withdrawal  of  government  support  schemes  (most  notably  loan  repayment  moratoria)  may  lead  to  an 
increase  in  the  share  of  bad  debt.  Coupled  with  an  overall  increase  in  debt,  this  could  give  rise  to 
insolvencies in sectors severely hit by the pandemic, which could in turn increase banks’ non-performing 
loan  portfolios.  On  the  other  hand,  favourable  developments  will  help  suppress  the  private  debt  ratio 
driven mainly by the positive denominator impact of the strong economic growth projected for 2021 and 
2022. Lending to corporations is likely to remain at moderate levels, given tightening of lending standards 
as well as the already existing high levels of debt and non-performing loans. 

After taking a hit in 2020, external imbalances should start to recover as of 2021. The trade balance 
is  expected  to  start  improving  already  as  of  2021  as  tourism  begins  to  recover.  However,  the  current 
account  balance  as  a  whole  is  expected  to  dip  to  -2%  of  GDP  in  2021  before  recovering  somewhat  in 
2022. The net international investment position should resume its pre-pandemic upward trajectory already 
in 2021, rising to around -45% of GDP in 2022, and thus reaching the prudential benchmark for the first 
time. 

Reforms  and  investments  addressing  structural  rigidities  in  Croatia’s  economy  should  lift  the 
growth potential. The unemployment rate reversed its rapid fall seen over recent years with an increase 
to  7.5%  in  2020.  While  strong  government  support  mitigated  the  impact  of  the  crisis  on  the  labour 
market,  enhancing  the  labour  contribution  to  potential  growth  will  require  increasing  Croatia’s 
chronically low activity rate. In addition, Croatia is facing a shrinking labour force due to aging and net 
emigration. The unemployment rate is forecast to start declining at a moderate pace to 7.2% in 2021 and 
6.6% in 2022. Croatia’s large tourism sector (which used to account for 17% of GVA) was hit particularly 
hard by the pandemic in 2020 and is expected to operate below capacity also in 2021 due to longer lasting 
disruptions in international travel and changes in consumer preferences. 

Croatia  joined  the  Exchange  Rate  Mechanism  (ERM2)  in  July  2020  as  part of  the  euro  adoption 
process. Whilst there are numerous benefits to euro area membership, being part of the currency area also 
entails  responsibilities  to  its  members.  Most  notably,  pursuing  a  sound  fiscal  policy  and  an  ambitious 
structural reform agenda are core responsibilities to prevent the build-up of imbalances and rendering the 
country uncompetitive under a fixed exchange rate regime. As part of Croatia’s ERM2 process, Croatia 

5 

-3.0-2.0-1.00.01.02.03.0081012141618202224Rate of change y-o-y (%)Total Labour (Hours)ContributionTFP ContributionCapital AccumulationContributionPF Potential Growth  
1. Assessment of Macroeconomic Imbalances 

committed  to  implement  measures  to  strengthen  the  anti-money  laundering  framework,  reduce  the 
administrative and financial burden on the economy, improve governance of state-owned enterprises and 
strengthen  the  national  insolvency  framework.  Furthermore,  Croatia  joined  the  Single  Resolution 
Mechanism  in  2020.  The  Croatian  National  Bank  became  part  of  the  Single  Supervisory  Mechanism 
(SSM)  with the ECB exercising direct supervision over significant institutions in  Croatia from October 
2020.  

Overall assessment 

2020 was an exceptional year, which put a sudden halt to the positive trajectory of correcting the 
Croatia’s  imbalances  built  up  over  the  past  number  of  years.  Though  vulnerabilities  will  remain, 
Croatia’s  debt  imbalances  are  expected  to  subside  somewhat  in  the  near  term  given  the  more  positive 
economic outlook. Public debt rose to a new high in 2020, using up the substantial buffer created over the 
past  five  years.  However,  it  is  expected  to  resume  its  downward  trajectory  already  as  of  2021  as  the 
economy  starts  to  recover.  The  current  account  balance  turned  into  deficit  in  2020  due  to  significant 
deterioration in the trade balance amid a strong decline in international travel. While the current account 
is not expected to improve quickly, the net lending position is projected to stay positive, supported by the 
capital account surplus. Along with nominal GDP growth, this is forecast to lead to improvements also in 
the NIIP. The Croatian banking sector remains well capitalised, while becoming more robust and resilient 
since  joining  the  Single  Supervisory  Mechanism.  At  the  same  time,  increased  provisioning  seems  to 
reflect the heightened risk of many Croatian firms facing difficulties as the crisis measures are wound up. 
Non-performing loans rose marginally in 2020.  

Croatia’s low growth potential remains an obstacle for a swift recovery after the pandemic and for 
its  economic  convergence  with  the  EU.  Increasing  the  labour  contribution  to  potential  growth  will 
require  raising  the  low  activity  rate,  which  requires  strong  measures,  particularly  given  Croatia’s 
demographic  challenges.  Productivity  growth  remains  curtailed  by  weak  allocative  efficiency,  a 
cumbersome  business  environment,  and  an  inefficient  public  sector,  prompting  the  need  for  ambitious 
structural  reforms.  The  Recovery  and  Resilience  Facility  presents  Croatia  with  the  opportunity  to 
implement  many of the  needed reforms and investments. A productive  use of  funds  from the  Recovery 
and Resilience Facility (the assessment of which lies outside the scope of this report) will help create jobs 
and  sustainable  growth,  while  modernising  the  economy,  and  allowing  it  to  recover  in  a  balanced, 
resilient, forward-looking and sustained manner. 

6 

Table 1.1: 

Assessment of Macroeconomic Imbalances Matrix - Croatia 

1. Assessment of Macroeconomic Imbalances 

Table (continued) 

(Continued on the next page) 

7 

 Gravity of the challenge Evolution and prospects Policy response Imbalances (unsustainable trends, vulnerabilities and associated risks) Public debt Public debt ratios declined for several years from a peak of 84.8% in 2014 to 72.8% in 2019. In 2020 however, as a result of COVID-19 pandemic, the public debt ratio increased by almost 16 percentage points to reach 88.7% of GDP, the highest on record. This jump came on the back of a GDP drop of 8% during the year, coupled with a government deficit of 7.4% of GDP.  As economic output recovers, the public debt ratio is set to resume its decline through the denominator effect already in 2021, dipping below 83% of GDP in 2022. This is despite the forecast government deficits of 4.6% and 3.2% of GDP in 2021 and 2022 respectively.  The 2021 Convergence Programme aims to reduce the deficit below 3% of GDP in 2022, but current forecast is somewhat more negative.  New debt issuance increased exposure to foreign exchange risks, but the risk remains low. In spite of the increase in the stock of debt, improved financing conditions lower the cost of debt servicing. The new Budget Act is set to be adopted by the end of 2021, bringing about improvements to budgetary projections and planning and the issuance and monitoring of contingent liabilities. Household and corporate debt and the financial sector After nearly a decade of rather steady and gradual decline, consolidated corporate and household debt to GDP increased in 2020 to 63.1% and 38.3% respectively. Both ratios stood below prudential thresholds, but remained above levels suggested by fundamentals. Foreign currency risks related to the high shares of household (45%) and corporate debt (63%) denominated in foreign currency (mainly euro) persist.  The NPL rate in the Croatian banking sector dropped to 5.1% in the first quarter of 2020, but increased subsequently to 5.4% over the next two quarters. The rate for non-financial corporations remains high at 11.9% in the third quarter of 2020, despite reducing significantly over the past few years. The private sector debt is expected to return to a downward trajectory in 2021, supported by the strong rise in nominal GDP. However, challenges persist given the expected increase in corporate insolvencies after the ending of governments’ business support measures and policies introduced in the context of COVID-19 crisis. The level of NPLs is expected to rise going forward. Croatia’s steps towards adopting the euro and joining ERMII should help easing the currency related risks in the corporate and household sectors.  To combat the negative effects of COVID-19, two programmes of government guarantees were approved on the basis of the temporary framework for state aid measures: one supporting liquidity of exporters and another programme of favourable loans for SMEs. There was also a moratorium on enforcement on accounts of natural persons, along with a suspension of accruing of interest in this period. A minimum three-month moratorium to clients hit by the pandemic on the repayment of credit liabilities was agreed with the banking sector. The government’s housing loan subsidy programme, that contributed to house price growth, continued to support household borrowing. External liabilities and trade performance Steady improvements in the net international investment position ended in 2020 due to the strong contraction in nominal GDP. The NIIP stood at -52% of GDP in 2020. The composition of Croatia’s external liabilities remained favourable as the NIIP excluding non-defaultable instruments (NENDI) stood at only -3.4% in 2020. Gross external debt picked up to 82.6% of GDP, up from 75.4% in 2019. The current account turned negative in The NIIP is projected to rise sharply, reaching for the first time its prudential benchmark in 2022 at around -45% of GDP. Medium-term NIIP projections show that Croatia could come close to a balanced NIIP by 2030. The current account is projected to further decline to -2% of GDP in 2021, despite some improvement in the trade balance. In 2022, the current account should improve again, to slightly over 2020 values, on the account Significant reforms to address weaknesses in the business environment, namely the high costs of doing business, slow judiciary, and weak public governance, would be supportive also for exports of goods.   
      
 
 
 
1. Assessment of Macroeconomic Imbalances 

Source: European Commission Services 

8 

2020, with a deficit equal to -1.1% of GDP, driven by a sharp fall in the trade balance due to tourism decline. The recorded current account balance is only mildly below the current account norm, which is estimated at -0.5% of GDP. of further improvements in the trade balance, driven by the continued gradual recovery in exports of services. Potential output The unemployment rate increased to 7.5% in 2020 as the labour market responded to the onset of the COVID-19 pandemic. Activity and employment rates in Croatia remain among the lowest in the EU. Potential growth remains low relative to that of peer countries, thus slowing Croatia’s convergence with the EU. The contribution of total factor productivity to potential growth remains low for a catching-up economy. The labour market recovery is expected to be slow, with neither employment nor unemployment likely to reach their pre-crisis levels until 2022. A complex and restrictive business environment and an inefficient public sector continue to depress the total factor productivity contribution to potential growth. Government wage and liquidity support measures mitigated the fall in employment in some sectors. Challenges persist related to raising the low activity rate, addressing labour shortages, and tackling undeclared work. Progress is being made in reforming the education system. Action plans aimed at reducing the financial and administrative burden on businesses continue, though the pace of implementation is slow.  Main takeaways  The public debt ratio jumped in 2020 due to a sharp contraction in nominal GDP. A sharp rebound in GDP will support a resumption of the downward trajectory in debt-to-GDP ratios in the near term. The current account as a whole is expected to dip to -2% of GDP in 2021 before recovering somewhat in 2022. The net international investment position should resume its pre-pandemic upward trajectory already in 2021, rising to around -45% of GDP in 2022, and thus reaching the prudential benchmark for the first time.   The government’s housing loan subsidy programme, that contributed to rising house prices, will continue to support household borrowing for housing loans in 2021. Lending to corporations is likely to remain at moderate levels, given tightening of lending standards as well as the already existing high levels of debt and non-performing loans. An expected rise in the number of insolvencies after the withdrawal of government support measures has the potential for a significant rise in non-performing loans.   Croatia’s low growth potential remains an obstacle for its catching up with the EU. Persistently low activity rates and a shrinking labour force hold back the growth potential. The Recovery and Resilience Facility presents Croatia with the opportunity to implement many of the needed reforms and investments that will help create jobs and sustainable growth, while modernising the economy, and allowing it to recover from the pandemic in a balanced, resilient, forward-looking and sustained manner.        
 
  
Table 1.2: 

Selected economic and financial indicators, Croatia 

1. Assessment of Macroeconomic Imbalances 

(1) NIIP excluding direct investment and portfolio equity shares         
(2) domestic banking groups and stand-alone banks, EU and non-EU foreign-controlled subsidiaries and EU and non-EU 
foreign-controlled branches.         
(3) The tax-to-GDP indicator includes imputed social contributions and hence differs from the tax-to-GDP indicator used in the 
section on taxation         
(4) Defined as the income tax on gross wage earnings plus the employee's social security contributions less universal cash 
benefits, expressed as a percentage of gross wage earnings  
Source: Eurostat and ECB as of 2021-05-05, where available; European Commission for forecast figures (Spring forecast 2021)  

9 

2004-072008-122013-182019202020212022Real GDP (y-o-y)4.6-1.90.92.9-8.05.06.1Potential growth (y-o-y)3.7-0.40.51.80.31.71.1Private consumption (y-o-y)3.9-1.81.03.5-6.24.93.4Public consumption (y-o-y)4.60.11.03.43.42.51.5Gross fixed capital formation (y-o-y)6.6-5.73.37.1-2.97.310.2Exports of goods and services (y-o-y)6.2-1.76.36.8-25.016.312.2Imports of goods and services (y-o-y) 6.2-4.36.46.3-13.811.08.2Contribution to GDP growth:Domestic demand (y-o-y)5.0-2.50.74.1-3.55.14.7Inventories (y-o-y)0.2-0.70.4-1.51.3-1.50.0Net exports (y-o-y)-0.61.1-0.20.2-5.81.41.4Contribution to potential GDP growth:Total Labour (hours) (y-o-y)1.2-1.0-0.30.5-0.30.5-0.2Capital accumulation (y-o-y)1.91.10.41.00.60.70.7Total factor productivity (y-o-y)0.6-0.60.30.30.00.50.5Output gap3.3-0.4-0.63.8-5.5-3.10.1Unemployment rate11.911.813.66.67.57.26.6GDP deflator (y-o-y)3.72.50.71.50.41.71.7Harmonised index of consumer prices (HICP, y-o-y)2.82.90.90.80.01.31.3Nominal compensation per employee (y-o-y)4.82.0-0.41.52.11.40.9Labour productivity (real, person employed, y-o-y)2.60.10.1-0.2-6.9..Unit labour costs (ULC, whole economy, y-o-y)2.11.9-1.01.79.7-2.9-3.5Real unit labour costs (y-o-y)-1.6-0.6-1.70.29.3-4.5-5.1Real effective exchange rate (ULC, y-o-y)1.6-1.0-1.6-1.4...Real effective exchange rate (HICP, y-o-y)0.8-0.70.7-1.5-0.50.1-0.7Net savings rate of households (net saving as percentage of net disposable income)-0.7-1.10.02.9...Private credit flow, consolidated (% of GDP)14.83.60.71.7...Private sector debt, consolidated (% of GDP)86.8118.5106.391.1...of which household debt, consolidated (% of GDP)32.640.737.034.6...of which non-financial corporate debt, consolidated (% of GDP)54.277.869.256.5...Gross non-performing debt (% of total debt instruments and total loans and advances) (2)..10.04.6...Corporations, net lending (+) or net borrowing (-) (% of GDP)-5.30.12.50.6...Corporations, gross operating surplus (% of GDP)17.919.820.319.7...Households, net lending (+) or net borrowing (-) (% of GDP)1.81.42.34.2...Deflated house price index (y-o-y)9.8-4.90.38.17.4..Residential investment (% of GDP).......Current account balance (% of GDP), balance of payments-7.4-4.71.12.7-1.1-2.0-0.7Trade balance (% of GDP), balance of payments-8.6-4.2-0.7-0.2-7.2..Terms of trade of goods and services (y-o-y)1.40.60.20.8-1.6-0.40.2Capital account balance (% of GDP)0.00.10.82.12.6..Net international investment position (% of GDP)-69.5-89.1-74.8-50.3-52.0..NENDI - NIIP excluding non-defaultable instruments (% of GDP) (1)-32.4-49.2-32.0-5.5-3.4..IIP liabilities excluding non-defaultable instruments (% of GDP) (1)74.893.985.864.669.8..Export performance vs. advanced countries (% change over 5 years)30.7-3.71.220.32.8..Export market share, goods and services (y-o-y)-0.1-5.81.64.3-16.87.86.5Net FDI flows (% of GDP)-4.7-2.9-1.8-2.0-2.1..General government balance (% of GDP)-3.5-5.8-2.50.3-7.4-4.6-3.2Structural budget balance (% of GDP)..-2.2-1.4-5.0-3.2-3.3General government gross debt (% of GDP)39.456.079.472.888.785.682.9Tax-to-GDP ratio (%) (3)36.736.237.438.738.037.937.1Tax rate for a single person earning the average wage (%) (4)..29.429.929.5..Tax rate for a single person earning 50% of the average wage (%) (4)..21.320.020.0..forecast 
        
 
2.  THEMATIC ISSUE: EXTERNAL IMBALANCES 

In  2020,  a  steep  decline  in  output  exceeded  the  fall  in  aggregate  demand,  which  has  led  to  a 
substantial widening of the trade deficit. After a period of roughly matched output and demand, a trade 
deficit re-emerged in 2018, as the increase in domestic demand outpaced the rise in output (Graph 2.1(a)). 
Following a slight narrowing of the trade deficit in 2019, it widened strongly due to developments in the 
current  crisis,  characterised  mainly  by  the  strong  decline  in  exports,  primarily  of  services,  and  a  small 
increase  in  government  consumption  that  helped  cushion  the  decline  in  domestic  demand.  Gradual 
improvements in the trade balance are projected over the forecast period. 

Increase  in  government  borrowing  has  led  to  decline  of  the  economy’s  net  lending/borrowing 
position last year, while private sector maintained its savings surplus. Gradually improving from the 
trough  in  2011,  general  government  reached  small  savings  surpluses  between  2017  and  2019  (Graph 
2.1(b)).  In  2020,  government  recorded  large  net  borrowing  related  to  the  crisis  and  the  fiscal  support 
programs.  While  other  sectors  increased  their  saving  surpluses  on  aggregate,  the  overall  economy’s 
position  worsened  to  1.5%  of  GDP,  down  from  4.7%  in  2019.  Government’s  position  is  forecast  to 
improve  in  2021,  while  private  sector  is  expected  to  reduce  its  surplus,  leading  to  a  lower,  but  still 
positive net lending of the overall economy in 2021, that should increase slightly in 2022.  

In  the  six  years  leading  up  to  2020,  the  Croatian  economy  recorded  strong  current  account 
surpluses  (Graph  2.1(c)). These  were  mainly  related  to  the  continued  deleveraging  of  both  private  and 
public sectors, as well as a decline in construction investment. The contribution of the economic cycle has 
been negative  since 2016. Compared to the preceding boom-bust period, the  trade balance significantly 
improved, even turning positive in a few years, owing to the strong tourism sector and continued export 
market share gains observed since Croatia joined the EU in 2013. Over the same period, capital account 
surpluses expanded as well. Since 2015, the current account consistently and considerably exceeded the 
level explained by fundamentals, as well as the levels needed to reach the prudential NIIP threshold in 10 
years  (Table  2.1).  Consequently,  external  stock  imbalances  narrowed  markedly  supported  also  by 
relatively strong nominal GDP growth with NIIP standing at -52% of GDP in 2020.   

The  COVID-19  pandemic  exposed  vulnerabilities  due  to  the  composition  of  Croatia’s  current 
account flows as it severely hit Croatia’s sizeable tourism sector. The current account turned negative 
again in 2020, with a deficit equal to -1.1% of GDP, due to a sharp deterioration in trade balance largely 
driven  by  decline  in  travel  income  (Graph  2.1(c)).  These  negative  trends  were  partly  offset  by 
improvements in both, primary and secondary income accounts. The recorded current account balance is 
only  mildly  below  the  current  account  norm,  which  is  estimated  at  -0.5%  of  GDP  (Table  2.1). 
Surprisingly,  exports  of  goods  contracted  only  slightly  in  2020.  The  current  account  is  projected  to 
decline by another 0.9 percentage points of GDP in 2021, despite some improvement in the trade balance. 
In  2022,  the  current  account  should  improve  again,  to  slightly  above  the  2020  level,  on  the  account  of 
further  improvements  in  the  trade  balance,  driven  by  the  continued  gradual  recovery  in  exports  of 
services. Growing capital account balance, supported by stronger uptake of EU funds, helped mitigate the 
rise in external imbalances in 2020, providing a substantial contribution to net lending position of 1.5% of 
GDP. While no large change in the capital account balance is projected for 2021, in 2022 it is projected to 
further strengthen by the expected new inflows from the Recovery and Resilience Fund.   

Despite  the  crisis,  foreign  direct  investment  kept  flowing  in  the  economy  during  2020.  This  was 
largely  driven  by  an  increase  in  FDI  equity  liabilities,  equal  to  2.4%  of  GDP,  coupled  with  a  small 
increase in Croatian residents’ FDI equity assets abroad, by 0.4%, while net flows of intercompany debt 
were  of  negligible  size.  There  was  a  net  outflow  in  portfolio  equity  amounting  to  1%  of  GDP,  a  three 
quarters of which was due to Croatian residents’ investment in foreign portfolio equity. As for the debt 
instruments, net outflows have been recorded, with net incurrence in external liabilities of 1.6% of GDP 
for portfolio debt. Central bank further increased its holdings of the reserve assets. Interestingly, despite 
some  atypical  developments  in  the  first  half  of  2020,  in  net  terms,  across  the  main  types  of  financial 
instruments  (Graph  2.1(d)),  and  for  2020  as  a  whole,  the  financial  flows  broadly  followed  the  same 

10 

 
2. Thematic Issue: External Imbalances 

pattern that has been observed over the last few years before the current crisis. Overall, in 2020, Croatian 
residents acquired foreign asset  worth 3.8% of GDP across all instruments, and incurred new liabilities 
towards non-residents in the amount equal to 2.1% of GDP. 

Steady improvements in the net international investment position ended in 2020 as NIIP declined 
by 1 percentage point, to  -52% of GDP (Graph 2.1(e)). The decline  was due to strong contraction in 
nominal GDP. Despite the projected current account deficits, with the recovery of the nominal GDP, and 
with the solid and increasing capital account surplus, the NIIP is projected to rise sharply, reaching for the 
first  time  its  prudential  benchmark  in  2022  at  45%  of  GDP  (Table  2.1).  The  composition  of  Croatia’s 
external liabilities remains favourable as the NIIP excluding non-defaultable instruments (NENDI) stood 
at only -3.4% in 2020, well above its prudential benchmark (Table 2.1). Central bank reserves remained 
sizeable,  at  38.5%  of  GDP  end  of  2020,  despite  several  substantial  foreign  exchange  interventions  to 
counter kuna depreciation pressures in the first half of 2020 (Graph 2.1(f)). While monetary and financial 
institutions  have  had  a  small  positive  NIIP  since  2016,  general  government  and  private  sector  display 
negative NIIP values, though with a significant share of equity for the private sector. Gross external debt 
picked up markedly to 82.6% of GDP by end of 2020, compared to 75.4% of GDP end of 2019, mainly 
on the account of declining nominal GDP. Rise in government borrowing in external markets to finance 
economic support measures also contributed to higher gross external debt.  

Medium-term NIIP projections show that Croatia could come close to a balanced NIIP position by 
the 2030 (Graph 2.2). This holds true under the baseline scenario. (3) Under a more adverse illustrative 
scenario describing a hypothetical slower tourism recovery than in the baseline (see the footnote to Graph 
2.2  below),  the  NIIP  should  also  approach  zero  by  2030  and  exceed  the  prudential  and  fundamental 
benchmarks  in  2023  and  2028,  respectively.  A  more  optimistic  illustrative  scenario,  assuming  higher 
capital  account  balances  than  in  the  baseline  (see  the  footnote  to  Graph  2.2)  results  in  slightly  positive 
NIIP in 2029. 

External risks are further mitigated with Croatia’s entry into the ERM2 in July 2020. 

Joining ERM2 in 2020 is an important milestone in Croatia’s efforts to join the euro area. Croatia must 
now  participate  in  the  mechanism  without  severe  tensions,  in  particular  without  devaluing  the  kuna’s 
central  rate  against  the  euro,  for  at  least  two  years  in  order  to  fulfil  the  exchange  rate  convergence 
criterion. For a country joining the euro area, the benefits are diverse and felt on a broad scale. Besides 
stable prices,  a more transparent and competitive  market, and better access to capital,  they include  also 
reduced  transaction  costs  in  foreign  trade  and  the  elimination  of  the  currency  risk  for  intra-euro  area 
transactions.  

(3)  The baseline scenario is based on the Commission services’ forecast for the period covered in the most recent vintage, and on 

the DG ECFIN t+10 forecast framework as well as debt sustainability monitor for subsequent years. 

11 

 
                                                           
Table 2.1: 

Selected external indicators, Croatia 

2. Thematic Issue: External Imbalances 

NA=National Accounts, BoP=Balance of Payments, CA=Current Account, NENDI= NIIP excluding non-defaultable 
instruments,TB= Trade Balance 
(1) Flow data refer to national account concept, unless indicated otherwise. 
(2) Cyclically adjusted Current Account is the Current Account adjusted for the domestic and foreign output gaps, taking 
into account trade openness. 
(3) The average Current Account needed in order to stabilise the NIIP is based on T+10 ECFIN projections.  
(4) The Current Account explained by fundamentals refers to the expected Current Account given the level of its 
fundamentals with respect to world average.  
(5) The Current Account or Trade Balance needed either to halve the distance to fundamental NIIP benchmark, or to reach 
the prudential NIIP benchmark in 10Y, whichever is higher. Based on T+10 ECFIN projections. 
(6) The country-specific prudential benchmark denotes the NIIP level beyond which the probability of an international 
economic and financial crisis becomes higher. The NIIP level explained by fundamentals (‘NIIP norm’) represents the NIIP that 
would result if a country had run its current account in line with fundamentals since 1995. For details see Turrini and Zeugner 
(2019), "Benchmarks for Net International Investment Positions", European Economy, Discussion Paper 097/2019. 

Source: (a) Eurostat, (b) AMECO, (c) European Commission calculations, (d) WIOD database 

12 

2003-072008-122013-172018201920202021f2022fFlows (1)Source:CA balance as % of GDP, NA(b)-7.5-4.61.9|2.43.1-1.1-2.0-0.7CA balance as % of GDP, BoP(a)-7.7-4.71.5|1.82.7-1.1-2.0-0.7Cyclically adj. CA balance as % of GDP (2)(c)-6.1-4.31.5|3.85.1-1.9-2.6-0.3CA req. to stabilize NIIP above -35% (3)(c)-0.51.5-0.7|-2.2-2.7-3.0-3.4-3.3CA explained by fundamentals (CA norm) (4)(c)-1.9-1.1-0.7|-0.4-0.5-0.5-0.5-0.6Required CA for specific NIIP target (5)(c)0.43.50.8|-1.1-1.6-1.8-2.1-2.0Trade bal. G&S, % of GDP, NA(b)-9.0-4.2-0.1|-0.8-0.2-7.2-5.7-4.0Required TB for specific NIIP target (5)(c)-0.22.9-2.5|-5.7-6.3-7.1-7.7-7.8Capital account bal. as % of GDP, NA(b)0.10.30.9|1.42.12.62.53.5StocksNIIP as % of GDP(a)-63-89-78|-58-50-52-49-44Prudential NIIP/NENDI benchmark (6) (c)-40-40-39|-43-44-42-44-45Fundamentally expl. NIIP benchmark (NIIP norm) (6) (c)-13-17-23|-21-22-24-22-21NENDI as % of GDP(a)-31-49-36|-14-6-3 
      
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Graph 2.1: 

Thematic Graphs: External imbalances 

2. Thematic Issue: External Imbalances 

Source: European Commission Services 

13 

3003203403603804004200809101112131415161718192021*22*Constant 2015 EUR mn(a) Demand, Output, Trade BalanceTrade balanceAgg. demandOutput (GDP)Source: Ameco-15-10-5051008091011121314151617181920*21*22*% of GDP(b) Net Lending/Borrowing by sectorHouseholds and NPISHGeneral governmentCorporationsTotal economySource: Ameco-140-120-100-80-60-40-20020406008091011121314151617181920% of GDP(e) Decomposition of NIIP by instrumentDirect investmentPortfolio inv, equityPortfolio inv, debtOther investmentFin derivatives and ESOReserve assetsNENDINIIPNIIP normSource: Eurostat-140-120-100-80-60-40-20020406013Q113Q314Q114Q315Q115Q316Q116Q317Q117Q318Q118Q319Q119Q320Q120Q3% of GDP(f) Decomposition of NIIP by sectorCentral bank (incl reserves)MFI (excl central bank)Private sectorGeneral governmentNet int'l investment position (NIIP)Source: Eurostat-10-50510151314151617181920% of GDP(d) Financial FlowsNet errors and omissionsReserve assetsNet debt flows (NENDI excl reserves)Net portfolio investment, equityNet direct investmentNet lending/borrowingSource: Eurostat-25-20-15-10-505101520253013141516171819202122% of GDP(c) Current Account DecompositionGoods, fcstServices, fcstGoods excl energyEnergy balanceServices excl travelTravel balancePrimary inc balanceSecondary inc balanceCurrent account balanceNet lending/borrowingSource:Eurostat and Ameco.  
 
Graph 2.2:  NIIP scenarios 

2. Thematic Issue: External Imbalances 

Scenario 1: 2.5pp negative shock to trade balance and 1pp negative shock to real GDP growth in 2021, that fade away over 
5 years (slow tourism recovery).  
Scenario 2: higher capital account balance (by 1pp of GDP), real GDP growth (by 0.5pp) and lower trade balance (by 
0.1pp) in 2021-2026 than in the baseline. 

Source: ECFIN Staff calculations 

14 

-60-50-40-30-20-10010192021*22*23*24*25*26*27*28*29*30*Net IIP, % of GDPNet IIP for HR, BaselineNet IIP for HR, Scenario 1Net IIP for HR, Scenario 2  
 
3.  THEMATIC ISSUE: PRIVATE DEBT 

After  several  years  of  decreasing  private  debt  levels,  2020  marked  a  turning  point  as  private  debt 
increased by 10 percentage points to stand at 101% of GDP. This reversal came as a result of a sharp drop 
in  GDP,  accompanied  with  higher  borrowing  needs  of  corporates  in  light  of  the  COVID-19  crisis.  To 
combat the negative effects of COVID-19, two programmes of government guarantees were approved on 
the  basis  of  the  temporary  framework  for  state  aid  measures:  one  supporting  liquidity  of  exporters  and 
another programme of favourable loans for SMEs A minimum three-month moratorium to clients hit by 
the  pandemic  on  the  repayment  of  credit  liabilities  was  agreed  with  the  banking  sector.  The  amount  of 
loaned funds covered by the moratorium peaked in mid-2020 (when it covered 15% of all loaned funds) 
and has halved by the end of Q1-2021. The bulk of the remaining moratoria is expected to expire by the 
end  of  Q2-2021.  Private  sector  credit  flows,  in  %  of  GDP,  decelerated  from  1.7%  in  2019  to  1.3%  in 
2020.  During  the  second  half  of  2020,  growth  of  private  sector  borrowing  slowed  as  banks  tightened 
credit standards for corporate loans. The non-performing loans ratio slightly increased in 2020 to 5.4%. 
However, there is a risk that NPLs will increase sharply once temporary policies to protect borrowers that 
were introduced to combat the negative effects of COVID-19 crisis are phased out. High levels of kuna 
liquidity in the banking sector continued to grow, supporting the favourable financing environment. Over 
the past number of years, the exposure of private-sector debt to foreign exchange risk has been reduced 
substantially, though the level remains high. 

Household debt  

In 2020, household debt increased to 38.3% of GDP up from 34.6% at the end of 2019. The increase 
in  household  debt  can  largely  be  attributed  to  an  increase  in  long-term  debt  resulting  from  increased 
mortgage lending (Graph 3.1(a) and Graph 3.1(b)). In 2020, the household debt ratio remained almost 17 
percentage points below the prudential threshold for Croatia (55%), but 18 percentage points above the 
fundamentals-based benchmark (20%) (Graph 3.1(c)). 

Households continued to borrow despite the economic uncertainty brought about by the COVID-19 
pandemic. The year-on-year growth of bank loans to households as a percent of GDP slowed in 2020 to 
0.8%  from  2.4%  in  2019  (Graph  3.1(d)).    Despite  credit  standards  tightening  in  the  first  half  of  2020, 
banks  eased  credit  standards  for  households  in  the  second  half  of  the  year  thanks  to  a  more  optimistic 
economic  outlook  and  buoyant  property  market.  The  annual  growth  of  general-purpose  cash  loans 
decelerated  substantially  in  2020.  This  decrease  came  after  the  CNB  in  2019  recommended  that  banks 
level out the conditions for assessing the creditworthiness of housing and non-housing loans with longer 
maturities.  

The  government’s  housing  loans  subsidy  programme  fuelled  the  annual  growth  of  housing  loans, 
which  accelerated  from  6.4%  in  2019  to  7.7%  in  October  2020  (Graph  3.1(b)).  That  loan  subsidy 
programme has been found to further stoke the strong house price increase. (4) Real house price growth 
continued to increase in 2020 rising by 7.4%, slightly down from 8.1% in 2019, but still far above the EU 
median. While the house price valuation indicators that use comparison with historical averages suggest 
that  the  overall  valuation  gap  is  still  negative  (Graph  3.1(e)),  housing  affordability  in  Croatia  has  been 
quite low for a longer period of time, when compared to other countries. (5) 

Interest rates on long-term household borrowing remained almost unchanged in 2020 on the back 
of  expansionary  monetary  policy  pursued  by  the  Croatian  National  Bank.  Household  exposure  to 
interest rate  risks continue to decline, as  fixed-rate  loans become increasingly common. Almost  half of 
household  loans  granted  in  2020  were  with  fixed  interest  rates.  The  share  of  loans  granted  with  fixed 
interest rates has almost doubled since 2015 (from 25% to 49%).   

(4)  Kunovac and Žilić (2020). Home sweet home: The effects of housing loan subsidies on the housing market in Croatia. Croatian 

National Bank Working Papers W-60, Zagreb, October 2020. 

(5)  Bricongne, J-C, A Turrini, and P Pontuch, 2019, "Assessing House Prices: Insights from HouseLev, a Dataset of Price Level 

Estimates", Discussion Paper 101, European Commission. 

15 

 
                                                           
3. Thematic Issue: Private Debt 

Corporate debt  

Consolidated non-financial corporate sector debt reached 63.1% of GDP in 2020, up from 56.5% a 
year earlier. The increase in the debt ratio was driven by the sharp contraction in GDP in 2020 (Graph 
3.2(a)).  In  2020,  the  corporate  debt  ratio  was  some  5  percentage  points  below  the  prudential  threshold 
estimated  for  Croatia,  but  was  significantly  (22  percentage  points)  above  what  the  fundamentals  would 
suggest, which indicates scope for further debt reduction (Graph  3.2(b)). Despite declining over the past 
few years, corporate debt remains high relative to gross financial assets or equity, signalling a persistently 
high debt overhang and  solvency risks for  the corporate  sector (Graph  3.2(c)). Overall,  corporate  loans 
remain  characterized  by  a  strong  cross-border  component  (Graph  3.2(d)):  loans  by  domestic  banks 
account for roughly a third of corporate debt (23% of GDP in 2020). Cross border loans to NFCs were at 
similar scale in 2020, of which half were intra-company loans. The remaining 14% of GDP of NFC debt 
is accounted for by other loans, the bulk of which seems owed to foreign banks in foreign currency. (6)   

Total loans to the non-financial corporate sector increased by 5.6% in 2020, largely due to lending 
in the first months of 2020. Loans to non-financial corporations hit a new five year high in April 2020 as 
corporations  renegotiated  investment  loans  and  rolled  over  working  capital  loans.  Given  the  economic 
uncertainty  and  increased  risk  environment  after  the  COVID-19  pandemic  hit  in  March  2020,  banks 
tightened credit standards. The pace of lending growth slowed in the second half of 2020, but continued 
to tick upwards towards the end of the year.  

Borrowing  costs  remained  low  thanks  to  expansionary  monetary  policy,  while  the  interest  rate 
exposure of corporates continued to abate with higher take up of fixed-rate loans. Interest rates on 
short-term  borrowing  in  kuna  by  non-financial  corporations  remained  stable  in  the  first  half  of  2020, 
while interest rates on long-term corporate  loans  with a currency clause increased by approximately 80 
basis  points  compared  to  end  2019  levels.  Interest  rates  on  renegotiated  loans  increased,  while  interest 
rates  on  new  loans  decreased  over  the  same  period.  Interest  rates  were  slightly  higher  in  the  second 
quarter of 2020, when the share of renegotiated loans increased considerably due to the granting of the 
deferral of payment. In addition, as liquidity financing associated with the COVID-19 crisis was granted 
at  fixed  interest  rates,  the  share  of  corporate  loans  with  variable  interest  rates  fell  by  two  additional 
percentage points. The share of fixed interest rate loans for non-financial corporations increased to 45% 
by the end of March 2020. 

Currency risks  

Currency related risks reduced somewhat in 2020 as Croatia  moved a step closer to adopting the 
euro as it joined the Exchange Rate Mechanism (ERM2) in July. Croatia’s steps towards adopting the 
euro  help  to  ease  currency  related  risks.  Croatia’s  adherence  to  ERM2  means  that  the  ECB  firepower 
assists the CNB in stabilizing the euro-kuna exchange rate. Since foreign currency exposures are by now 
almost exclusively to the euro, joining the euro area is bound to nearly eliminate the exchange rate risks 
to private-sector balance sheets.  

The exposure of private-sector debt to foreign exchange risk has been reduced substantially, though 
the  level  remains  high.  Currency  risk  in  the  corporate  sector  remains  high  with  the  share  of  domestic 
loans denominated in or indexed to a foreign currency increasing slightly in 2020 to 63% up from 62% at 
the  end  of  2019  (see  Table  1).  The  share  of  kuna-denominated  debt  in  total  household  loans  rose 
marginally in 2020 with 55% of household loans denominated in kuna, up from 54% at end 2019. Almost 
half  of  Croatian  household  loan  liabilities  are  thus  still  denominated  in  foreign  currency,  by  far  the 
highest level in the EU. Yet the level of kuna-denominated household debt still marks a turnaround since 
2012, when 80% of households’ outstanding loans were denominated in or indexed to a foreign currency. 
To  some  extent  though,  the  exposure  to  foreign  exchange  loans  may  be  explained  by  the  exposure  of 
households  to  euro–denominated  revenue.  In  this  vein,  private-sector  loans  denominated  in  currencies 
other  than  kuna  or  euro  have  virtually  vanished  over  the  past  decade. (7)  In  addition,  households  hold 

(6)  According to Eurostat BoP data, NFC cross-border loan liabilities other than direct investment amounted to 13.8% of GDP in 
2020.  BIS  locational  banking  statistics  suggest  that  half  this  amount  was  classified  as  cross-border  bank  loans  from  BIS-
reporting banks to Croatian NFCs, of which 99% were denominated in EUR and USD.  

(7)  Loans to the non-bank sector denominated in currencies other than euro or kuna declined from 13% of total loans in 2010 to 2% 

in 2016, and reached 0.7% in 2020.  

16 

                                                           
3. Thematic Issue: Private Debt 

significant  foreign-currency  deposits,  representing  nearly  80%  of  total  outstanding  deposits,  which,  if 
matched, could significantly mitigate risk. 

Non-performing loans 

The  level  of  non-performing  loans  (NPL)  in  Croatia  ranks  high  among  EU  Member  States  and 
above  the  EU  average. The  Croatian  banking  sector  has  made  great  progress  over  the  past  number  of 
years in reducing the level of NPLs from 13.6% in 2014 to 5.2% end of 2019. The level increased slightly 
to  5.4%  in  the  third  quarter  of  2020.  Despite  the  downward  trajectory  before  2020,  the  level  remained 
considerably  higher  than  the  EU  average  of  2.7%.  In  addition,  in  case  of  an  increase  in  corporate 
insolvencies following the ending of governments’ business support measures and policies introduced in 
the  context  of  the  COVID-19  pandemic,  the  level  of  NPLs  could  rise  going  forward.  NPLs  of  non-
financial corporations remained broadly unchanged during 2020, reaching 11.9% of corporate loans at the 
end  of  the  third  quarter  of  2020  (Graph  3.3(a)). The  rise  of  NPLs  for  households  has  been  much  more 
pronounced in 2020, with the ratio of NPLs increasing to 6.3% at the end of the third quarter, from 5.5% 
at  the  end  of  2019  (Graph  3.3(b)).  Nevertheless,  the  banking  sector  remains  well  capitalised  with  high 
regulatory  capital  (CET1:  22.4%  in  the  third  quarter  of  2020,  among  the  highest  within  the  EU)  and 
provisioning levels (coverage ratio: 66.2%, the highest within the EU). 

17 

 
 
Table 3.1: 

Private debt indicators, Croatia 

3. Thematic Issue: Private Debt 

(f) European Commission forecast. (1) Benchmarks for flows (% of GDP) are estimated on the basis of non-consolidated flows. 
(2) Gross non-performing bank loans and advances to Households and non profit institutions serving households (% of total 
gross bank loans and advances to Households and non profit institutions serving households). (3) Gross non-performing bank 
loans and advances to Non-financial corporations (% of total gross bank loans and advances to Non-financial corporations). 
(4) Quarterly data is annualized. 
Source: (a) Eurostat, (b) Ameco, (c) European Commission calculations, (d) ECB 

18 

2003-072008-122013-18201920202021f|20Q220Q320Q4SourceStocksDebt, consolidated (% of GDP)(a,d)8311810791101|Debt, consolidated (% of potential GDP)(a,b,d)861181069596|Prudential threshold (% of GDP)(1)(c)114119116127123124|Fundamental benchmark (% of GDP)(1)(c)305058546161|FlowsPrivate credit flows (transactions, % of GDP) (4)(a)14.13.60.21.71.30.5|-1.01.43.1Private credit flows (transactions, % of potential GDP) (4)(a,b)14.53.80.21.81.20.5|-1.01.32.9Benchmark for flows (% of GDP)(1)(c)|Households (HH)StocksDebt, consolidated (% of GDP)(a,d)3141373538|Debt, consolidated (% of potential GDP)(a,b,d)3240373636|Prudential threshold (% of GDP)(1)(c)525050575555|Fundamental benchmark (% of GDP)(1)(c)61720182020|Debt (% of gross disposable income)(a,b,d)48655956|Interest paid (% of gross disposable income) (4)(a,b)1.52.81.10.3|Debt (% of gross financial assets)(a,d)38.742.130.827.2|Share of variable rate loans for house purchase (%)(d)60.553.613.120.2|Domestic  loans in forex (% of dom. loans)(d)75.561.945.544.8|FlowsCredit flows (transactions, % of GDP) (4)(a)5.40.70.42.40.80.3|-0.21.31.0Credit flows (transactions, % of potential GDP) (4)(a,b)5.60.70.42.40.70.3|-0.21.20.9Benchmark for flows (% of GDP)(c)1.92.20.10.40.70.9|Savings rate (% gross disposable income)(b)5.85.46.78.6|Investment rate (% gross disposable income)(b)5.46.05.25.6|p.m. Bank HH NPLs (% of HH loans)(2)(d)9.5|Non-financial corporations (NFC)StocksDebt, consolidated (% of GDP)(a,d)5278705663|Debt, consolidated (% of potential GDP)(a,b,d)5477695960|Prudential threshold (% of GDP)(1)(c)616966706869|Fundamental benchmark (% of GDP)(1)(c)243338364141|Debt, consolidated (% of value added)(a,b,d)107155138112|Interest paid (% of gross operating surplus) (4)(a,b)14.618.912.45.8|Debt, consolidated (% of gross financial assets)(a,d)131176152114|Domestic  loans in forex (% dom. Loans)(d)72.266.561.863.4|61.361.563.4FlowsCredit flows (transactions, % of GDP) (4)(a)8.63.0-0.2-0.70.50.1|-0.80.12.1Credit flows (transactions, % of potential GDP) (4)(a,b)8.93.1-0.1-0.70.50.1|-0.80.12.0Benchmark for flows (% of GDP)(1)(c)|Investment (% of value added)(b)37.529.127.929.6|Savings (% of value added)(b)24.226.930.627.0|p.m. Banks NFC NPLs (% of NFC loans)(3)(d)25.012.0|Total private sector (Households and Non-financial corporations) 
   
 
 
Graph 3.1: 

Thematic Graphs: Household debt 

3. Thematic Issue: Private Debt 

Source: European Commission Services 

19 

051015202530354045% of GDP(a) Household debt liabilities by creditorLong-term bank loansshort-term bank loansloans by OFIsOther domestic debt liab.Foreigntotal consolidatedSource: Calculations based on Eurostat and ECB0.010.020.030.040.050.060.070.080.0980002040608101214161820%GDP(c) Household debt and benchmarksHousehold debt, %GDPFundamentals-based benchmark, household debtPrudential benchmark, household debtSource: Eurostat and European Commission020406080100120140160-20-15-10-505101506Q207Q208Q209Q210Q211Q212Q213Q214Q215Q216Q217Q218Q219Q220Q22015=100Rate of change y-o-y (%)(b) House prices and mortgage credit growthMFI loans for house purchase (y-o-y growth rate)Real House Price Index (2015=100), right axisNominal House Price Index (2015=100), right axisSource: ECB Bank Lending Survey-1.5-1-0.500.511.522.511Q412Q413Q414Q415Q416Q417Q418Q419Q420Q4% of GDP (over last 4 quarters)(d) Bank loans to households (net flows)Source: ECB BSI-30-20-100102030400002040608101214161820% deviation of current price(e) House prices valuation gapsModel-based valuations gapPrice to income vs. hist. avg.Price to rent vs. hist. avg.Overall valuation gapSource: ECB Bank Lending Survey.        
 
Graph 3.2: 

Thematic Graphs: Non-financial corporate debt 

3. Thematic Issue: Private Debt 

Source: European Commission Services 

Graph 3.3: 

Thematic Graphs: Non-performing loans 

Source: European Commission Services 

20 

0.020.040.060.080.0100.00506070809101112131415161718192021*% of GDP(d) Non financialcorporations debt liablities by creditorDomestic loans from banksDomestic loans from other fin.Domestic loans from gov't & HH   domestic bond holders   foreign bond holdersDebt security liabilities:Unallocated loans  Foreign arms-length loans:  FDI loans & unallocForeign loan liabilities:Debt assets, F2-F4 ex FDI debtDebt assets incl FDI debtGross debt liabilities (cons.,Estat)Source: Calculations based on Eurostat and ECB020406080100120140160180200040608101214161820*Ratios of debt to equity, GDP and total financial assets (%)(c) Non financial corporate debt in relation to equity and financial assetsDebt / GDPDebt / equityDebt / financial assetsSource: Eurostat0102030405060708090030507091113151719% GDP(b) Fundamental-based and prudential benchmarks and NFC debt NFC debt, consolidated,  % of GDPFundamentals-based benchmark, % of GDPPrudential benchmark, % of GDPSource: Calculations based on Eurostat and ECB-8-6-4-202468101214070809101112131415161718192020Q4y-o-y change(a) Decomposition of non financial corporations debt flows Credit flowReal growthInflationOther changesD/GDP, changeSource: Eurostat05101520253017Q117Q217Q317Q418Q118Q218Q318Q419Q119Q219Q319Q420Q120Q220Q3(a) Non performing loans -Non financial Corporations % of NFCs loans and advancesSource:ECB consolidated banking data, incl. foreign-controlled branches and subsidaries02468101217Q117Q217Q317Q418Q118Q218Q318Q419Q119Q219Q319Q420Q120Q220Q3(b) Non performing loans -Households% of household loans and advancesSource:ECB consolidated banking data, incl. foreign-controlled branches and subsidaries