On the eve of Croatias EU accession, scheduled for mid-2013, the economy is lacking growth drivers, with its economic model impaired and export sector constrained by the weak regional growth outlook. Croatia (Baa3 negative) is likely to be the first Eastern European country to join the Union with a deteriorating economic situation and limited prospects for returning to a healthy growth trajectory in the near term. In the absence of pro-growth reforms and improvements in the countrys institutional capacity, the anticipated benefits normally expected from EU accession are unlikely to fully materialise. As a result, the negative outlook remains unchanged.

This Special Comment examines the significant short and medium-term economic and creditworthiness challenges Croatia faces. We note in particular that:
--The prevailing Croatian economic model, which had relied heavily on private consumption and construction fuelled by external credit, has reached its limit. Domestic demand prospects are weak and the economy is struggling to rebalance towards the export sector, whilst the challenging external environment is undoubtedly an aggravating factor.
--Despite a recent and noticeable policy shift, key bottlenecks to investment and export- led growth persist. Authorities efforts to implement reforms that would support internal devaluation and unlock Croatias growth potential have been so far insufficient. Further reforms are necessary in particular in interconnected areas such as (1) the business environment; (2) the role and efficiency of the public sector; and (3) the rigidities in the labour market.
--Croatia faces considerable challenges in implementing the pre-requisites for the country to fully leverage the benefits normally expected from EU membership as access to the EU market promises expanded trade and investment relationships. In addition to implementing the above mentioned reforms, an improvement in the authorities ability to absorb EU funds together with the consolidation of public finances are also necessary. These are all the more crucial for restoring steady growth levels and investor confidence given that Croatia is entering into the EU at a time of heightened scrutiny of public finances and with an overall economic and fiscal position particularly weak in comparison with that of other countries that joined the EU in 2004 and 2007.

Source: bne