CNB Council: Inflation is expected to slow down to 2.1% in 2022

Published: 13/10/2021

At its session today, the CNB Council discussed current economic and financial developments and examined the latest trends in the banking system, macroeconomic and financial risks as well as monetary policy projections. The Council also adopted several decisions on matters falling within its competence.

As regards current economic developments, the GDP nowcast shows that economic activity accelerated in the third quarter from the previous quarter, mainly as a result of a very good tourist season. Real GDP is expected to grow at an annual rate of 8.5% in 2021, driven by the strong growth of goods and services exports as well as of domestic demand. Given that economic activity is expected to reach its pre-pandemic levels already this year, the growth rate may slow down to 4.1% in 2022. The strong growth of goods and services exports is expected to continue and inflows from EU funds will boost domestic demand.

Labour market developments remained positive: the number of employed persons exceeded the pre-crisis level at mid-2021, while the number of unemployed persons remained slightly above that level. Employment is expected to grow annually and the unemployment rate is expected to decrease in 2021 and 2022. Labour productivity growth and strong demand are anticipated to support continued wage growth, especially in the dynamic segments of the economy. The annual consumer price growth accelerated from 2.8% in July to 3.1% in August, primarily due to the accelerated annual growth of food prices. Core inflation also edged up in August, but remained relatively low at 1.8%. Consumer price inflation could accelerate temporarily from 0.1% in 2020 to 2.3% in 2021 due to an increase in the annual rate of change of energy prices, especially those of refined petroleum products. Inflation is expected to edge down to 2.1% in 2022 as a result of the lower projected growth of energy prices. However, there are major downside risks to the inflation projection, indicating that inflation could be higher than projected.

Favourable trends in tourism and goods exports as well as strong inflows from EU funds could cause the surplus in the current and capital account of Croatia’s balance of payments to increase to 4% of GDP in 2021 and remain elevated in the following year. The increase in the current and capital account surplus has lent support to expansionary monetary policy, a trend that is expected to continue in the following year. Banks’ free reserves reached HRK 62.4bn in September, which is an increase of HRK 21.3bn from the same month in the previous year. Despite continuing very favourable financing conditions, lending has remained subdued in all segments, except in the segment of housing loans. The growth of household loans continued to accelerate, reaching 4.6% annually in August, although at a slackened pace, due to the completion of the new round of housing loan subsidies. Housing lending has remained strong and general-purpose cash loans have been recovering gradually. In contrast, lending to non-financial corporations continued to stagnate at a slightly decelerated annual growth rate of 1.2% in August. The annual growth rate of banks’ total placements (excluding placements to the government) could slow down to 3.4% in 2021, but it is expected to pick up in 2022, especially when it comes to lending to non-financial corporations.

Total systemic risk exposure decreased from high to moderate at the end of the third quarter of 2021. Economic recovery has strengthened on the back of rising consumer and business optimism, reducing short-term risks in the non-financial sector. However, structural vulnerabilities, which increase the intensity of disturbance if an adverse shock materialises, have remained heightened. They primarily derive from the high level of general government debt and external debt, the still high unemployment rate and low labour market activity as well as from a relatively high non-financial corporate debt. 

Significant medium-term risks to financial stability include trends in the real estate market and the corporate sector. Given the continued growth of real estate prices it is very important to monitor developments in the market of real estate and housing loans and to ensure that prudent standards are maintained for loan approval in the whole system. In addition, a deceleration in the corporate dynamics can adversely impact the corporate sector’s performance and its ability to mitigate potential shocks in the future, which also increases risks for the financial sector. Another possible trigger for risk materialisation in the sector of non-financial corporations is the potential significant worsening of the pandemic situation, with slowed down or disrupted supply chains additionally weighing on macroeconomic developments. 

Total assets of credit institutions increased by HRK 15.5bn (3.4%) in the first half of 2021, standing at HRK 478bn, with the bulk of the growth accounted for by an increase in household current account deposits. As a result of this and a drop in non-performing loans (NPLs), the quality of total exposure continued to improve and the share of NPLs in total loans dropped slightly from 5.4% to 5.1%. Loans that are not yet in default, but for which a significant increase in credit risk has been identified, have stopped growth. However, their remaining at an increased level reflects an increase in lending risk compared with the pre-crisis period. Due to the absence of risky investments and the maintained level of total capital, capital adequacy indicators have remained very high, with the total capital adequacy ratio of the banking system standing at 25.4%. At the end of the first half of 2021, credit institutions reported profit amounting to HRK 2.6bn, which is HRK 0.9bn (51.3%) more than at the end of the same period in the previous year. The increase in profit resulted from considerably lower impairment allowances for credit losses and, to a lesser extent, from a slight increase in net operating income. Profitability indicators thus grew from the previous period: ROA increased from 0.8% to 1.1% and ROE went up from 5.6% to 8.1%.