"This is the first year of a pronounced economic recovery since 2008, with an increase recorded in all aggregate demand components", said the Croatian National Bank Governor Boris Vujčić at the CNB management's meeting with media representatives on 20 December 2016. The Governor then proceeded to say the following: "After growing steadily in the first half of the year, economic activity strengthened further in the third quarter, when GDP increased annually by 2.9%. This growth was mainly driven by strong tourism performance, but also by a recovery in personal consumption, accelerated by positive labour market developments, including a continued rise in the number of employed persons and a steady fall in registered unemployment, which was down to close to 13% in September, a level last observed at the end of 2008. Nevertheless, despite these positive labour market trends, concerns have been raised over a steady decline in the labour force, partly caused by the outflow of working age population, as it diminishes long-term growth potentials.
 
The available data for the last quarter point to a relatively high growth rate at the end of the year as well, supporting CNB estimates of a 2.8% real GDP growth in 2016. As regards the expectations for the next year, CNB projections show that real growth will accelerate slightly to 3.0% in 2017 with foreign demand again being the biggest contributor. The projected growth acceleration reflects the effects of the tax reform on household consumption and, to a smaller extent, on gross fixed capital formation, which should also be boosted by a better use of EU funds. Favourable trends in tourism industry are also expected to continue.
 
Real economic trends have generated a slight increase in inflation pressures, with the annual price decline decelerating substantially towards the end of the year from the summer months, to a large extent due to energy price trends. Inflation is therefore expected to increase to 1.6% in 2017, compared with a negative 1.2% estimated for 2016, primarily as a result of rising imported inflation pressures, including an expected increase in the prices of crude oil and other raw materials, the acceleration of the eurozone's inflation rate and the strengthening of the US dollar against the euro (and, in turn, against the kuna), as well as because of changes in the indirect tax system. CNB current estimates are that the risks of the GDP growth rate and the inflation rate falling short of or exceeding the projections are balanced.
 
As regards foreign economic relations, despite the strong performance of the tourism industry, the several-year upward trend in the current account surplus came to an end in 2016. Although to some extent caused by the deepening of the deficits in trade in goods and the primary income account (with the latter due to increased profits of foreign-owned banks and enterprises), this primarily resulted from a considerable impact that the conversion of Swiss franc loans had on the surplus growth in 2015. In addition, all domestic sectors continued to deleverage abroad, a trend predominantly driven by credit institutions, which reduced their foreign liabilities and increased foreign assets, thus considerably improving their net external positions. The deleveraging of domestic sectors led to a sharp decrease in gross external debt, which stood at 94.2% of GDP at the end of September 2016, down by almost 10 percentage points from the end of 2015. The current account surplus is expected to narrow further in 2017 as a result of the oil price growth and the strengthening of the US dollar as well as due to an ongoing economic recovery that accelerates export growth. Net foreign liabilities are expected to decrease further and, supported by the nominal GDP growth, lead to a marked improvement in relative gross and net external debt indicators.
 
As favourable fiscal developments continued in 2016, the general government debt to GDP ratio for 2016 is expected to decrease. Accordingly, should there be no substantial budget revisions aimed at increasing the planned deficit and no shocks to revenues, Croatia could exit the excessive deficit procedure in 2017.
 
In this macroeconomic environment, the CNB pursued an expansionary monetary policy, continuing to support the recovery of the domestic economy and maintain the stability of the kuna to euro exchange rate. In the Croatian monetary system a stable exchange rate is a prerequisite for the preservation of financial stability and an anchor for expectations of future price developments. In early 2016 the CNB introduced structural repo operations, which provide banks with long-term kuna liquidity, allow for a long-term decrease in interest rates and stimulate lending in the domestic currency (this topic is dealt with in more detail in a separate box of a new CNB publication). At the four reverse repo auctions held so far, the CNB placed a total of close to HRK 1bn for a period of four years, reducing the interest rate at the last two auctions from 1.8% to 1.4%. The interest rate for regular weekly reverse repo operations was cut to 0.3% in mid-September and the amount of funds placed increased from the previous part of the year.
 
Due to high liquidity in domestic and foreign financial markets and the narrowing of sovereign CDS spreads, short-term and long-term financing conditions for the domestic private sector continued to improve. This, together with positive business and household expectations of future economic trends and improved lending standards, caused an increase in both corporate and household loan demand and a recovery in lending activity. The annual growth rate of placements to non-financial corporations rose (transaction based), standing at 2.7% at the end of October, and household placements recorded a positive growth rate of 0.3% in October, for the first time since 2009.
 
The monetary policy stance will remain unchanged in 2017. While fiscal policy is expected to change and become slightly expansionary in the following year, monetary policy should remain expansionary because of a relatively low expected inflation rate and the still relatively slow recovery in lending to the private sector. Domestic interest rates will remain low on the back of surplus kuna liquidity, which is expected to spur placement growth and favourably influence economic developments in general. In addition, the removal of non-performing placements from banks' balance sheets is expected to continue in 2017, along with one-time write-offs of non-performing placements, which, encouraged by the government through income tax changes, could create a sound basis for accelerating lending growth in the medium term. The main negative risks include a high level of corporate sector debt, an increased volatility in international financial markets stemming from numerous political risks, and a significant shift of the corporate sector towards foreign sources of financing.
 
Maintaining a stable kuna to euro exchange rate remains the main monetary policy objective. The CNB stands ready to respond to potential foreign or domestic shocks that might result in a high exchange rate volatility by means of foreign exchange interventions and/or by introducing changes to monetary policy instruments. This was confirmed last week, when the CNB intervened in the foreign exchange market, purchasing EUR 278m to prevent appreciation pressures on the domestic currency."