Croatia has solidified its position as one of the fastest-growing economies in the European Union and is projected to maintain steady GDP growth of around 3% annually from 2024 to 2026, according to a new report by Capital Economics.

After a significant downturn during the global financial crisis, which saw GDP decline by 11% between 2008 and 2014 and unemployment peak at 17%, Croatia's economy has rebounded strongly. Since 2015, the country has experienced a decade of robust economic expansion, averaging 3% growth per year. In 2023 Croatia's GDP grew by 2.8%, making it the second-fastest growing economy in the EU, just behind Malta. Unemployment dropped to a record low of 6.2% in 2023.

At the same time, “Croatia has experienced the fastest pace of income convergence in the EU since 2019,” said the report. 

Several factors have driven this growth. Tourism, which accounts for approximately 25% of GDP, has been a significant contributor. Tourist arrivals in 2023 surpassed pre-pandemic levels, providing a substantial boost to the economy. Additionally, Croatia has seen one of the largest increases in employment rates in the EU since 2019, with wage growth hitting a multi-decade high of 14% year on year, further supporting domestic demand.

EU funds have also played a critical role, amounting to 25% of GDP over the past decade. These funds have fuelled investments in infrastructure, digitalisation and the green transition, significantly enhancing the country's economic landscape.

Improvements in public finances have paralleled economic growth. Croatia's government debt burden, long a significant issue, has seen a dramatic reduction from 86% of GDP in 2020 to 63% in 2023. "No EU country other than Greece has experienced such a large decline in its debt ratio during this time," Capital Economics pointed out. The general budget was broadly balanced over 2022-23, contrasting sharply with an average deficit of 4% of GDP in Central and Eastern Europe (CEE).

Looking forward, the outlook remains positive, according to Capital Economics analysts. While scope for a further recovery in tourism is limited, domestic demand should drive the economy,” the report says. 

The European Commission's economic sentiment indicator is near multi-year highs, and consumer credit growth is running at more than 10% y/y. Real wages are growing at 8% annually, and employment levels are likely to stay robust, bolstered by non-EU migration inflows from Serbia, Bosnia & Herzegovina and parts of Asia. The central bank estimates that foreign workers could raise GDP growth by 0.4 percentage points this year alone.

Capital Economics' newly launched EM financial risk indicators reveal that financial risk in Croatia is at its lowest level in over two decades, reflecting stronger public finances and a healthier banking system. "This provides a foundation to achieve strong and sustainable growth in the coming years," the report asserted.

Despite these optimistic projections, challenges remain. Demographic trends pose a significant constraint, with Croatia having one of the oldest populations in Europe. The working-age population is projected to decline by a further 7.7% by 2030. Structural reforms are needed to reduce labour market inefficiencies and enhance participation rates, but the current business environment continues to hinder foreign investment.

The re-election of the Croatian Democratic Union (HDZ) in the April general election also promises continuity including on Zagreb’s strong pro-EU stance. 

Overall, according to Capital Economics, Croatia’s medium-term economic outlook remains positive, driven by continued EU fund inflows and improved productivity. However, sustaining high growth rates will require addressing demographic challenges and implementing meaningful economic reforms.

The report concludes that while GDP growth may slow to 2.0-2.5% by the end of the decade, it will still be sufficient to support ongoing income convergence, albeit at a slower pace. "Our baseline view is that GDP growth slows to 2.0-2.5% by the end of this decade. This will be strong enough to support further income convergence, but it will progress at a slower pace," the report stated.