At its session today, the CNB Council discussed current economic and financial developments and the latest financial stability analysis. The Council also adopted a number of decisions falling within its field of competence.

The flash estimate of GDP shows that economic recovery could pick up in the first quarter of 2021, which can among other things be attributed to the hiatus between the first and the second wave of the pandemic. Labour market indicators lost momentum at the end of the quarter, probably due to seasonal activities strengthening at a slower pace amid the renewed deterioration of epidemiological situation. The rise in oil prices, coupled with the base effect, pushed the annual inflation rate to 1.2% in March from 0.3% in February. In such circumstances, monetary policy remained highly accommodative and banks’ free reserves continued to grow in April, reaching their all-time highs, primarily as a result of a decrease in government kuna deposits with the central bank. However, lending activity remained subdued, with the annual rate of bank placements down to 2.3% in March from 3.0% in February. The growth rate of corporate lending slowed down particularly, from 4.1% in February to 1.0% in March, as a result of strong corporate lending in March last year. In contrast, household lending accelerated due to an increasingly high growth in housing loans, with the volume of general-purpose cash loans dropping slightly. The accelerated recovery of real activity had a positive impact on budget revenues, which rose by 10% in the first quarter of 2021 from the same period in 2020. Expenditures also increased, with the result that budget deficit stood at HRK 3.5 billion. The first-quarter deficit was thus slightly lower than the one in the first quarter of 2020, which was also partly affected by the pandemic.

Despite the accelerating recovery, the domestic financial system's total exposure to systemic risks has remained elevated. Under conditions of continued uncertainty, emphasis should be put on several categories of risks to financial stability.

Public debt grew strongly, solidifying the sovereign-bank nexus. Fiscal policy, supported by other economic and regulatory policy measures, contributed to the mitigation of the effects of the pandemic. However, a drop in revenues and substantial fiscal support resulted in a sharp increase in public debt. The already high credit institutions' exposure to the government increased further. Still, the country's low risk premium and favourable financing terms, coupled with substantial EU funding, facilitate government financing and mitigate these risks in the short-term.

The high and rapidly rising prices of residential real estate are moving further away from their economic fundamentals. Although the number of transactions in the real estate market decreased in the pandemic, the growth of residential real estate prices decelerated only slightly. On the back of favourable financing conditions, continued government subsidies as well as employment and income stability maintained by fiscal support, housing loans have continued to grow at an accelerated pace. Even though most such loans are granted under prudent lending conditions, some of them have seen an increase in the service-to-income ratio, which may exacerbate the impact of turmoil in the real estate market in adverse conditions.

The prolongation of the pandemic and fiscal incentives also raises the risk of zombification of the corporate sector. Despite a recovery in aggregate economic activity, some segments of the economy have remained affected by social distancing measures. On the one hand, a premature withdrawal of support measures may put at risk the operation of sound enterprises. On the other hand, the number of enterprises entering and exiting the market decreased despite the pandemic. A too lengthy use of support measures may therefore allow enterprises with unsustainable business models to stay in the market, which would reduce available resources for the growth of healthy enterprises and could, in turn, diminish corporate dynamics and zombify the corporate sector, with adverse implications for economic growth and financial stability.

Pressures on credit institutions’ earnings will continue to grow, which may have an adverse impact on loan availability in the medium term. With considerable heterogeneity among credit institutions, the system is well capitalised and liquid, and is capable of absorbing considerable credit risk costs. These costs have already grown sharply as a result of the economic slump, while regulatory relief measures have partly postponed their full materialisation. The steady decline in interest rates and the rise in the share of placements with lower yields will further limit opportunities to improve earnings. Credit institutions will therefore not only have to increasingly rely on digital sales channels to lower costs and preserve profitability to some extent, but will also have to adjust to the transition to a green economy, examining and taking into account climate risks in their overall risk assessments.

The CNB Council issued approval to the Supervisory Board of Raiffeisenbank Austria d.d. for the appointment of Liana Keserić as Chairwoman of the Management Board of Raiffeisenbank Austria d.d. and granted authorisation to Raiffeisenbank Austria d.d. to merge by acquisition Raiffeisen stambena štedionica d.d.