Italian recession and its influence over Croatian economy

Krk, Croatia (Yacht Rent, CC BY)

Pessimistic economic news from Italy and Germany are starting to have a negative effect in Croatia. In the Q4’18, Italy went into recession, and Germany lowered its economic growth forecast for 2019.

The importance of these two countries for Croatia is significant: exports to them account for almost 28 per cent of total Croatian exports (in the first ten months of 2018 it amounted to EUR12.1bn).

The German government downgraded the economy’s growth this year to 1 per cent due to uncertainty caused by Brexit, trade conflicts and tax competition. Until now, Berlin expects 1.8 per cent of growth in 2019. Following a 2.2 per cent growth in 2017 and 1.5 per cent in 2018, Economy Minister Peter Altmaier predicts slower activity “mainly due to the international environment”. According to first results of the Q4’18, the economy of the country has come into a slowdown. The IMF and other world financial institutions have already made estimates of global slowdown, all of which for a small Croatia means the deterioration of the conditions in the environment on which it depends. The mentioned industrial decline has already been shown to be a weaker performance for these important economies.

Italian economy fell 0.2 per cent in the Q4’18, after falling by 0.1 per cent in the Q3. Recession in Italy is certainly not good news for Croatia, as Italy is Croatian main trading partner, and data show that the value of Croatian exports to Italy in the first ten months of last year was EUR1.74bn, which is 11 per cent more than in the same period a year earlier. From Italy, however, Croatia imported goods worth EUR2.63bn or 10.7 per cent more than in the first 10 months of 2017. Therefore, Italy accounts for more than 20 per cent of Croatian exports to the EU and almost 15 per cent of its total exports.

Taking into account that Germany, Croatian second largest trading partner, also achieved quarterly drop in the Q3 of last year and hardly achieved growth in the Q4, then perhaps it is necessary to measure a decline in Croatian industrial production in 2018 by 1 per cent compared to 2017. Croatia is also strongly linked to Italy through finance sector, as the largest domestic banks are owned by Italians and the weakening of their domicile economy is always a danger in terms of capital inflow and interest growth.

It is good news that a fall in economic activity could have an adverse effect on exports, but not on tourism which is still more resistant to such movements, because people are reluctant to give up traveling. The importance of German and Italian tourists for Croatia is enormous and tourism would actually seize to exists if these guests would suddenly choose not to travel any more.

The Croatian National Bank (CNB) in its latest publication Macroprudential Diagnosis identifies the main potential sources of risks associated with the external environment, namely “growing geopolitical uncertainty and possible strengthening of protectionism, which could result in worsening financing conditions and further increase in uncertainty”. Risks related to the political situation in Italy and the need to implement additional fiscal consolidation have so far no significant impact on other European countries, including Croatia.

However, after an agreement between the Italian government and the European Commission (EC) on the implementation of additional fiscal measures, the risk premium for Italy has only slightly decreased and has not returned to earlier levels. Re-raising the risk premium could result in rising interest rates in Italy, further slowdown in economic activity and lower profitability of their banks. This could have an adverse effect on the Croatian economy. The CNB writes and explicitly says that “possible disturbances in the operation of Italian banks could impact domestic banks”. Nevertheless, the likelihood of such a scenario is small, as the current exposure and the volume of financing that can be provided by domestic banks is relatively low. Domestic subsidiaries are highly capitalized and their activity is financed from domestic deposits. Negative consequences for the financial sector would also have a stronger slump in global economic activity than expected, which would be particularly pronounced in terms of possible strengthening of protectionism and its impact on the slowdown in world trade.

Unfortunately, the recession in Italy may be a long-term one, as there are structural problems in the public sector. It is difficult to expect GDP growth over a longer period. The recession will have the so-called L form, i.e. decline in economic activity and long-term stagnation.

Croatian economic relations with Italy are strong and any disturbances affecting purchasing power or consumer sentiment in Italy will certainly affect Croatia’s economy. It is yet another proof that Croatian economic system is vulnerable to external shocks, as there are rare companies that are well positioned on the wider European market to disperse market risks.

The Croatian Chamber of Commerce emphasizes that for many years Italy has traditionally been the first Croatian foreign trade partner until 2015, when it was overtaken by Germany. Italy, in the total commodity trade of Croatia, occupies the second place but still remains the most important country for Croatian exports.

Italian entrepreneurs have established in Croatia a large number of companies in total or mixed ownership. In the period from 1993 to the end of the Q3’18, Italian investors invested EUR3.6bn in Croatia, making Italy the third most significant investor in Croatia having a great impact on the increase of trade.

Vedran Obućina is an analyst and a journalist specializing in the Croatian and Middle East domestic and foreign affairs. He is the Secretary of the Society for Mediterranean Studies at the University of Rijeka and a Foreign Affairs Analyst at The Atlantic Post.

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