"In 2017 we expect a further acceleration of Gross Domestic Product growth to about 3%, thanks among other things to the tax reform, which should shortly result in increased domestic consumption," says Zdeslav Santic, chief economist at Splitska Banka.
After growth accelerated to about 2.7% in 2016 from 1.6% in the previous year, many analysts expect GDP to rise to about 3% in 2017, which would be the highest growth since the pre-recession 2007, when it reached 5.2%.
Growth is expected to receive a boost from domestic demand, notably personal consumption and investments, both public and private.
"Both of the GDP components will feel positive effects of the tax reform, which enters into force at the beginning of 2017. The aim has been to create a stable, simple and sustainable tax system, while at the same time unburdening businesses and households," says Zrinka Zivkovic-Matijevic, Director for Economic Research at Raiffeisenbank Austria (RBA).
She expects that the reform will result in reducing the tax burden by about one percentage point to below 37% of GDP and increasing GDP by about 0.6 percentage points.
New tourism records
GDP growth is projected to receive a positive impact from yet another record tourist season. Over 91 million overnight stays are expected to be recorded in 2016, about 10 million more than in 2015, while in 2017 their number could exceed 93 million on the back of positive demand trends and planned investments.
Revenues from foreign tourists in 2016 are expected to exceed EUR 8 billion for the first time, and a new record is expected in 2017.
The tourism records have been achieved in part thanks to investments. An estimated EUR 670 million worth of investments were made in the tourism sector in 2016, while investments of between EUR 500 million and 800 million have been announced for 2017.
"Investments in expanding the services and raising their quality are key if we want the growth trend to continue," Santic said.
Fall in unemployment, return of inflation expected
After three years of deflation, mostly due to imported deflation as a result of a fall in oil prices, inflation is expected to return in the new year.
"After three years of deflation, 2017 might see a rise in consumer prices by slightly over 1% on average," Zivkovic-Matijevic said.
This is mainly due to an expected increase in oil prices on global markets after the members of the Organisation of the Petroleum Exporting Countries (OPEC) and some non-members, such as a Russia, have decided to reduce oil production to mitigate the imbalance between excessive supply and inadequate demand.
Croatia is also expected to see a further drop in unemployment owing to economic and investment growth, and to some extent as a result of negative demographic and migration trends.
The European Commission has forecast that the average unemployment rate in Croatia may decrease to 11.7% in 2017, from about 13.4% in 2016.
Possible exit from EDP
The European Commission expects Croatia's public debt to continue to fall, following its first drop since 2007 to about 85% of GDP in 2016 from 86.7% in 2015.
Analysts at the Zagreb Institute of Economics (EIZ) believe that the budget deficit will continue to decrease over the next two years, to 1.9% of GDP in 2017 and further to 1.7% in 2018.
"Croatia might exit the Excessive Deficit Procedure (EDP) in mid-2017 given that already now the deficit is below 3% of GDP. However, in respect of the structural deficit, Croatian public finances are still not aligned with EU recommendations, which requires further fiscal consolidation," EIZ analysts said.
Credit rating upgrade possible
Thanks to the positive trends in the economy and public finances, Croatia's credit rating could be upgraded in 2017. The three major rating agencies, Standard & Poor's, Moody's and Fitch, keep Croatia's rating two notches below investment grade. While Moody's and Fitch keep the outlook negative, S&P upgraded it to stable in mid-December, assessing that economic growth was intensifying and that public finances were consolidating much faster than previously forecast.
The S&P outlook upgrade was the first improvement regarding Croatia's credit rating in nine years. S&P said it could upgrade the rating if economic recovery continued and the government continued to show capability and willingness to carry out structural reforms and stuck to its fiscal consolidation agenda.
"When we look at the other rating agencies, it's to be expected that their next step will be an outlook upgrade, while for the credit rating to be upgraded, one should very likely wait to see how the 2017 budget will be executed and to what extent the positive economic growth trends will continue," says Erste bank macroeconomist Alen Kovac.
He believes it is too early to talk about a potential credit rating upgrade before the second half of 2017.
Government, banks to agree on Swiss franc loan conversion?
As for the banking sector, analysts expect the continuation of high liquidity, an expansionary monetary policy by the central bank, and the stability of the kuna-euro exchange rate.
"Loan demand could markedly increase in the corporate sector and somewhat more mildly in the retail sector. Demand for kuna loans will prevail and the tendency of lower interest on deposits and loans will continue," says Zrinka Zivkovic-Matijevic.
The issue of the conversion of Swiss franc loans into those denominated in euro or kuna, carried out in 2016, could be solved in 2017. Because of the conversion, several banks sued Croatia, claiming they lost billions of kuna.
Central bank governor Boris Vujcic has said recently that he believes banks and the government will reach an agreement on a conversion law, expected to be passed in 2017.
Biggest challenges in 2017
According to Zdeslav Santic, the biggest challenge in 2017 will be refinancing the public debt, notably in light of increasing interest rates in the US and decreasing unconventional monetary incentives in the euro area.
In 2017, the financing account will include HRK 27.2 billion from the state budget and HRK 7.5 billion owed by road and rail companies.
The government will certainly meet its refinancing needs on the domestic and European markets, most likely in the first quarter of 2017, says Zivkovic-Matijevic. She too believes the government should continue with reforms.
"The problems are mainly structural in nature, such as the expensive and inefficient public administration which, together with the too frequent changing of regulations, hinders the functioning of the market economy. Together with a stronger rule of law, big public systems - health care, education and welfare - should be the government's key moves in the first year in office," says Zivkovic-Matijevic.
According to Santic, this period of relatively dynamic economic activity, alongside historically low interest rates on international financial markets, could easily have a demotivating effect on the implementation of the necessary reforms.
"The most important thing is not to repeat past mistakes," he says, adding that basing economic growth on domestic consumption and investments in construction again could be very easy but totally wrong. "Without an essential change to its economic policy, Croatia remains extremely sensitive to possible change globally."
Government-MOL negotiations on INA
In 2017, public attention will certainly focus on negotiations between the government and the Hungarian energy group MOL on Croatia's INA, after Prime Minister Andrej Plenkovic said on Christmas Eve that the government had decided to regain ownership of INA by buying MOL's entire stake in it.
Negotiations on the price will certainly not be easy, but the buyout could finally put an end to years of disputes between Croatian governments and MOL on management rights in INA, the gas business and the Sisak refinery.
But that is just one of the challenges awaiting the government. However, the situation is made somewhat easier by the positive economic trends.
"Croatia has finally caught up with the pace of recovery in central and eastern Europe and chances are that the same pace will continue in 2017. In conditions of markedly better fiscal indicators, the government has a chance to make growth more stable and more sustainable in 2017," says Zivkovic-Matijevic.