GDP growth is projected to moderate from 3.7% in 2024 to 3.0% in 2025 and 2.8% in 2026. Investment will be supported by the use of EU structural and Recovery and Resilience funds, along with more favourable financing conditions. Private consumption growth will slow as real income growth moderates. Risks are related to geopolitical tensions, global energy price rises and weakening demand from key trading partners.

Fiscal prudence is needed to rebuild fiscal buffers, support disinflation and prepare for the challenges of population ageing. Untargeted energy support measures should be phased out as soon as possible. Increasing labour force participation of underutilised groups would help to address chronic labour shortages, and boost growth.

Short-term indicators point to sustained but slowing growth in the second half of 2024. Retail sales growth remains robust but continued to slow in the second half of the year, and consumer confidence is further weakening. Industrial manufacturing production remains subdued due to weak foreign demand. Harmonised headline consumer price inflation has been falling since 2023 thanks to declining energy price inflation but remains elevated and rose to 3.6% in October, driven by rising food prices. Core inflation, at 4.5% in October, is sticky, reflecting high services inflation due to strong wage growth and robust tourism demand. The labour market is tight, and nominal wage growth remains strong (14% year-on-year in August). The unemployment rate, at 4.8% in September, is historically low. A high number of firms across all sectors, with especially strong increases in manufacturing and services, considers labour shortages as a factor limiting production.

Weaker external demand has moderated exports of goods and services. Tourist stays during the peak season increased at a lower rate than a year earlier. Easier financial conditions in the euro area have not yet passed through to borrowing costs in Croatia. Nevertheless, bank lending to households has been rising strongly, by around 11% (year-on-year) in September. On the other hand, growth in lending to firms has been declining in 2024, to around 4.7% in September, down from 12% in 2023.

The government deficit is projected to reach 2.1% of GDP in 2024, up from 0.9% of GDP in 2023. The fiscal deterioration in 2024 is due to increased energy support to households and businesses, increases in public wages and social benefits as well as spending on earthquake damage repair. The fiscal stance will become moderately restrictive in 2025 due primarily to the phasing out of energy subsidies by March 2025. Further structural consolidation of 0.25% of GDP is projected for 2026, in line with the medium-term fiscal plans.

Growth will be supported by domestic demand. Private consumption growth will be robust, albeit slower in 2025 and 2026, as slower wage growth and the phasing out of energy subsidies moderate real disposable incomes and labour shortages limit further employment gains. Investment growth will be supported by the absorption of the remaining EU Recovery and Resilience funds in 2025 and 2026 (around 6% of GDP) and the easing of financial conditions in the euro area. Exports will increase in line with the recovery of external demand, and imports will remain strong due to the high import content of investments financed by EU funds. Headline inflation will continue to gradually slow to 2% by the end of 2026. Core inflation will decline more slowly due to persistent services inflation and the effects of nominal wage increases. Risks are skewed to the downside. Strong wage growth, if not matched by productivity gains, would put upward pressure on inflation and weaken trade competitiveness. A lack of fiscal consolidation would slow disinflation.

The poorly targeted energy price subsidies should be discontinued as planned, which would help build fiscal buffers and support disinflation. Strengthening incentives for older workers to remain in work, and raising efforts to integrate and attract immigrants and mothers of young children to the labour market would help increase labour force participation and boost long-term growth. Reforms to both the education system and active labour market policies, such as improving vocational education and training and targeted upskilling and reskilling programmes, would help workers adapt to the evolving demand for skills and foster productivity growth.