Croatia Business Forecast Report Q1 2008

Election Run-Up Whatever the outcome in the tightly run November 2007 elections, the policies of both major parties for 2008 and beyond are strikingly similar. Both are campaigning on improving public administration efficiency and continuing the reform of the judiciary to better tackle corruption. The incumbent Croatian Democratic Union (HDZ) has mentioned investing more in health and continuing the privatisation process, whereas the Social Democratic Party (SDP) is focusing more on 'social justice' and the redistribution of wealth. Key goals such as EU and NATO membership, as well as reducing the country's foreign debt pile and large current account deficit are shared. Perhaps even more surprisingly, the broadly left-leaning SDP is also supportive of HDZ's plans to reduce the tax burden for business, in order to help boost productivity and economic growth. In this sense, for foreign investors, neither an HDZ nor an SDP victory would be a major disappointment.

While the Croatian government is still officially hoping for 2009 EU entry, we believe that 2011 is a more realistic date, with 2010 still technically possible. A priority of the current rotating EU presidency - held by Portugal - is to finalise the European Treaty. One of its aims is to slim-down bureaucracy and institutions, facilitating further enlargement. However, agreement on the Treaty by the respective 27 member states is a thorny issue, with many likely to hold national referenda, and a rejection cannot be ruled out. Existing provisions by the Treaty of Rome, which is legal until a new document is agreed, curb the bloc to its existing complement of members.

An expected gradual change in debt dynamics towards kuna-denominated borrowing makes good sense for Croatia. The IMF has warned that the country ranks second globally in share of loans in foreign currencies in total indebtedness. On the positive side, BMI believes gross external debt reached a peak at the end of 2006, at a massive 89.8% of GDP, and is set to fall to 86% of GDP in 2007, and 75% of GDP by 2012. Yet in the wake of a likely global tightening of financing conditions, Croatia could face problems rolling over maturing debt and raising funds to part-finance a current account deficit in the magnitude of 8% of GDP.

Economic migration looks set to pose a huge problem for Croatia, should EU accession occur as planned around the turn of the decade. This may sound illogical given current 14% unemployment, but it has already posed similar problems in Poland, which had a parallel double-digit unemployment rate. Arguably, Croatia already suffers from such problems. Data from the World Bank cite a national migration rate of 29.4%, with every third highly educated Croatian living abroad. Even if post-accession labour market restrictions were imposed on Croatian workers (as they were in the case of Bulgaria and Romania in many countries) the existing problem would be severely exacerbated.