Croatia Business Forecast Report Q3 2009

Tourism To Take A Severe Hit

Supporting our long-held downbeat view for the Croatian economy, the latest GDP data for the fourth quarter of 2008 confirm that the economy is teetering on the edge of recession. Real GDP growth slowed to 0.2% year-on year (y-o-y) during Q408, down from 1.7% in Q308 and marking the fourth consecutive quarter of slowing growth. With domestic demand conditions set to deteriorate further this year, framed by a similarly bleak global economic backdrop, a full-year recession is looking unavoidable for the Croatian economy. Moreover, given that tourism accounts for around 20% of nominal GDP, a marked decline in tourism revenues will hit the local economy hard this year and will further compound Croatia's economic downturn.

The ongoing stalemate between Slovenia and Croatia over disputed land continues to threaten the ability of the latter to conclude EU accession talks this year, further jeopardising the government's 2010-2011 target date to join the bloc. While we believe that Slovenia's political clout as an EU member (which gives Ljubljana power to block Croatia's EU progress) will mean that Zagreb will most likely need to concede in order to proceed with accession talks, the specific outcome that will transpire still remains very uncertain. Furthermore, that Croatia has also indicated that it wants the dispute taken to the International Court of Justice in the Hague does not bode well for a timely or amicable resolution to the dispute.

Croatia's gross external debt pile continued to creep higher through the tail end of 2008 according to the latest data provided by the Croatian National Bank. Indeed, in a sign that the deleveraging process is still yet to get off the ground, total gross external debt swelled to EUR39.1bn at end-2008, marking a 17.7% increase on the same period a year earlier, and equivalent to 96.5% of GDP. Going forward, we hold to our view that given the acute shortage of global credit, which we expect to persist for some time yet, combined with the distinct lack of refinancing opportunities, Croatia's gross external debt load will need to deflate over the medium term. Specifically, we forecast external debt reaching 90.5% of GDP in 2009, falling further to 75.1% by end-2013.

Though the Croatian kuna will likely be caught up in regional volatility, we believe that the unit will continue to underperform most floating currencies in the region. To be sure, the moderate degree of liquidity and limited volume continue to deter a significant speculative element, as building up a sufficient position in kuna remains a major obstacle for institutional investors. Evidence from trading data for the previous few months is certainly supportive of this projection. Indeed, though the Polish zloty, Hungarian forint and Czech koruna, in particular, fell a cumulative 55%, 40% and 30% respectively against the euro over the July 2008-February 2009 period, the kuna has only depreciated around 6% since its 2008 peak (in September) to its February low. As such, going forward we believe that the unit will remain largely range bound between HRK7.2000/EUR and HRK7.40000/EUR.