At its session today, the CNB Council discussed current economic and financial developments and examined the most recent assessment of risks to financial stability and the new macroeconomic outlook. The items on the agenda included the report on the banking system condition for the second quarter of 2020. The CNB Council also adopted several decisions on matters falling within its competence.

Economic activity partially recovered in the third quarter after a strong contraction in the second quarter caused by the pandemic and the restrictive measures introduced to contain it. The labour market was also marked by positive developments where the monthly rise in employment and the decline in the number of unemployed persons continued in July and August. Despite the recent favourable developments, the values of the indicators of real activity and the labour market continue to be noticeably less favourable than in the period before the outbreak of the pandemic. Also, in the third quarter, parallel with the deterioration in the epidemiological situation, the signs of a slowdown in recovery became visible and consumer expectations and business expectations in services and industry deteriorated in September. The annual total inflation rate remained in negative territory (–0.1%) in August due to a considerable negative contribution from the prices of energy, while core inflation stood at 1.2%. The current and capital account of the balance of payments deteriorated in the second quarter following a noticeable decrease in the net exports of services, primarily caused by the strong fall in revenues from tourism. Domestic financial system liquidity remained very high under the impact of the CNB’s highly expansionary monetary policy. However, the annual growth of total placements slowed down in August, reflecting a slowdown in the growth of placements to corporates and, to a lesser degree, to households. The central government deficit increased by some HRK 2.9bn in July on an annual level, which is an improvement relative to the very unfavourable developments in the second quarter that, at the end of June, increased the general government debt to the level of 85.3% of GDP, up 12.1 percentage points from the end of 2019.

According to the CNB’s new macroeconomic projections, a somewhat faster recovery is expected, relative to the July projection, on the back of the more favourable export performance. Thus, currently in 2020, the annual fall in real GDP is expected to stand at 8.0% (relative to the fall of 9.7% estimated in July) and growth at 5.2% in 2021 (from the previously projected 6.2%). The projection is based on the assumption that the epidemiological situation is not going to require much more restrictive social distancing measures that might have negative effects on economic activity. Negative risks for the realisation of the projection still prevail due to the possible worsening of the epidemiological situation before an effective medical solution is found. Despite only a gradual recovery, the consumer price inflation rate might accelerate to 1.1% in 2021 following a deceleration at a very low 0.2% in the current year, largely driven by the cheaper prices of refined petroleum products. Despite the currently favourable estimates when compared with the expectations from July, tourism revenues will decline significantly in 2020, which will reflect unfavourably in the current and capital account that might decrease moderately to 3.7% of GDP in 2020, and the same surplus level is also expected in 2021. The growing inflows from EU funds make a significant contribution to the current and capital account balance, which will also drive investment activity and facilitate the financing of part of the extraordinary government expenses.  In such a macroeconomic environment, the CNB will maintain the expansionary character of its monetary policy, which will contribute to maintaining favourable financing conditions in addition to a relatively moderate growth in bank placements.

The CNB Council also examined the most recent assessment of risks to financial stability and concluded that despite the more favourable expectations in terms of economic developments, the overall exposure to systemic risks remained high. A series of measures taken by the Government, the CNB and HANFA in the period from March until present, significantly mitigated the effects of the pandemic on the economy and maintained the stability of the financial system and the relatively favourable financing conditions and reduced short-term risks to financial stability. However, the materialisation of certain risks might be postponed.

Credit institutions continued to report high levels of capital and liquidity, although their profitability decreased markedly in the first half of the current year. While all operating income components decreased in an environment of unfavourable economic movements, higher impairment expenses had an even stronger impact on the fall in profitability. Although the share of non-performing loans in total loans held steady, thanks to the adjustment of the rules on classification relating to granted moratoria and the growth of total loans, banks reclassified a part of performing loans without credit risk to loans with an increase in credit risk. The risk of the banking system’s high exposure to the government through granted loans and investments in securities increased additionally, following a strong fiscal response to the crisis, which was largely financed in the domestic market.

Risks to financial stability might increase in the event of a stronger worsening of the epidemiological situation and the imposition of more stringent social distancing measures with an unfavourable effect on the economy. Slower economic recovery and growing private sector debt would reduce debt repayment capacity, i.e. its solvency. This would additionally jeopardise the quality of the corporate and household sectors that has already started to deteriorate in the segment of riskier non-collateralised general-purpose cash loans granted to households.

Finally, at today’s session, the CNB Council agreed with the proposal of the Supervisory Board of Raiffeisenbank Austria d.d. to appoint Georg Feldscher as a new member of the bank’s Management Board and with the proposal of Imex banka d.d. to appoint Boris Peko as a member of the bank’s Management Board.