Economic Analysis - C/A Surpluses Reducing External Vulnerability - OCT 2017


BMI View: While higher global oil prices and strong domestic demand will see Croatia's current account narrow over the next two years, robust external demand and a booming tourism sector will keep the external balance in positive territory. Croatia ' s large net international investment deficit is set to narrow, reducing external vulnerabilities.

After Croatia's current account surplus narrowed to 2.6% of GDP in 2016, from 4.8% in 2015, we expect the country's external surplus to further narrow over the next two years. The significant surplus reduction in 2016 was primarily due to a one-off increase of the primary income deficit (from EUR0.28bn in 2015 to EUR1.75bn in 2016), as a forced conversion of Swiss franc loans in 2015 slashed foreign bank profits and thus significantly reduced the scope for repatriation. Over the next two years, the narrowing of Croatia's current account surplus will stem from higher global oil prices and strong domestic demand which will increase the country's import bill.

Nevertheless, a positive economic growth outlook across the country's main trading partners and a booming tourism industry will bolster Croatian goods and services exports. As such, we forecast Croatia's current account to remain in surplus of 2.4% in 2017 and 1.9% of GDP in 2018, which will improve the country's net international investment position and thus reduce external vulnerabilities.

Surplus To Narrow
Croatia - Current Account Balance, EURmn, 4qma
Source: CNB, BMI

Import Bill To Increase

We see two factors that will increase Croatia's import bill over the next two years, namely, higher global oil prices and strong domestic demand. Regarding the former, our Oil and Gas team forecasts average Brent crude oil prices to increase from USD45.13/bbl in 2016 to USD57.00/bbl and USS60.00/bbl in 2017 and 2018, respectively. As a result, the value of oil imports, which accounted for 12.3% of total imports in 2016, will increase over the coming quarters and thus drag on the country's trade balance.

Higher Oil Prices Increasing Import Bill
Croatia - Energy Imports
Source: Trademap, BMI

In addition to higher oil prices, a strong outlook for domestic demand, aided by household consumption and rebounding European Union (EU) structural fund inflows ( see 'Recovery On Firm Footing', June 22), will drive up Croatian imports over the next two years. With regards to household consumption, a rapidly falling unemployment rate (having reached its lowest level since March 2010 in April 2017) and labour market shortages will exert upwards pressures on wages, thus boosting household purchasing power and aggregate demand. Additionally, we expect to see an uptick in EU co-financed infrastructure projects, which will support demand for capital goods imports.

Robust External Demand And Booming Tourism Sector To Bolster Exports

We also believe that exports will remain on an upward trajectory, as a strong economic growth outlook for the country's main trading partners and another bumper year for tourism suggest heightened external demand over the next two years. To begin with, amid improving macroeconomic conditions in the eurozone ( see 'Quick View: Q1 GDP Paints Bright Picture', June 8), we have revised up the currency union's real GDP growth forecast from 1.7% to 1.8% in 2017 and from 1.6% to 1.7% in 2018. This is a net positive for Croatian exporters, as more than 60.0% of the country's goods exports are historically destined for markets in the EU. In addition to this uptick in goods export growth, we maintain a bullish outlook for Croatian services exports, as we expect 2017 to produce another record year of foreign tourist arrivals. In 2016 tourism accounted for nearly two-thirds of all services exports and the 20.0% y-o-y uptick in foreign tourist arrivals over the first two months in 2017 comes as a strong indication of yet another bumper year for tourism.

Looking ahead, we see significant investment potential for the country's tourism sector, which apart from showing strong annual visitor growth rates, still remains highly underdeveloped, thus representing a target for foreign direct investment.

Limited Threats To Financial Account Stability
Croatia - Financial Account, EURmn, 4qma
Source: CNB, BMI

Finally, the accumulation of account surpluses will improve the country's large NIIP (net international investment position) deficit, thus reducing vulnerability to external shocks. The last two years of surplus generation saw the country's NIIP deficit narrow from 86.5% of GDP in 2014 to 77.1% and 70.6% in 2015 and 2016, respectively. Although this is still considered a macroeconomic imbalance (the European Commission sees a NIIP of more than 60% of GDP as an imbalance), the composition of the NIIP has been improving in recent years, as the share of portfolio and other investment liabilities ('hot money' liabilities) to total liabilities has fallen from 65.2% in Q413 to 57.9% in Q416. Looking ahead, we anticipate that portfolio and other investment liabilities will continue to unwind and the share of FDI in total liabilities to rise, thus reducing external vulnerabilities.