Political pitfalls for Croatia's economy

Zagreb may look prosperous, but it contains much hidden poverty

Croatia's current political turmoil, sparked by demonstrations against the extradition of war-crimes suspects, looks likely to dent the economy.

The Croatian economy has been growing strongly in recent years, driven by a post-war bounce-back in the tourism sector, which now accounts for about 15% of gross domestic product (GDP).

But any indication of instability - and in particular any hint that pan-Balkan unrest might resurface - could set the tourist industry back years.

Croatian economic indicators

GDP growth, 2000: 3.7%

GDP per head, 2000: $4,180

Annual inflation, June 2001: 4.9%

Unemployment, May 2001: 22%

Exports, Jan-May 2001: $1.8bn

Imports, Jan-May 2001: $3.7bn

The Croatian economy, which was relatively prosperous even under communism, should have sufficient reserves to weather a temporary tourist downturn.

Economist warn, however, that political factors could derail the government's already halting progress in vital reforms.

The coalition government of prime minister Ivica Racan is facing a week of street demonstrations, a no-confidence vote in parliament, and the need to rebuild itself after the resignation of four ministers at the weekend.

Tourist trap

Croatia's tourist industry, based around the sun-soaked islands of its long Adriatic coast, has boomed since the end of the Bosnian war in the mid-1990s.

Revenues are now growing at an annual rate of 15-20%, according to official estimates.

This has helped Croatia achieve annual GDP growth of 4-5% over the last couple of years.

But the tourist business - particularly in the war-torn Balkans - is notoriously sensitive to perceptions of instability.

Fighting in Kosovo last year, and the flare-up this year in Macedonia, have both had an impact on Croatia.

Slower tourism traffic is among the causes of a likely slowdown in the Croatian economy this year, with GDP growth predicted to ease to 2.7%.

Rich promises

Even if the slowdown gathered pace, it should not prove fatal to the Croatian economy, which has long been among the most prosperous in Eastern Europe.

Under communism, Croatia enjoyed average incomes on a par with Spain's.

And while the collapse of communism and the Bosnian war together knocked 40% off Croatian GDP, the country is still richer than most of its neighbours.

Optimism about the Croatian economy reached a new height last year, when Stipe Mesic, a centrist, took over as president after the death of nationalist strongman Franjo Tudjman.

Observers hoped that Mr Mesic, and prime minister Ivica Racan, would have the zeal to push through long-delayed free-market reforms.

Idle hands

But Mr Racan's fractious coalition government has been beset by infighting, and little has been done to tackle Croatia's underlying economic woes.

Many Croatians prefer to do their shopping abroad

The most crucial of these is chronically high state spending: as a proportion of GDP, state expenditure in Croatia is the second-highest in Europe, beaten only by Sweden.

This means high taxes, and cripplingly high prices in Croatian shops.

Petrol prices in Croatia are nearly as high as in Germany, and double the levels in most ex-communist countries.

Many Croatians travel across the border into Hungary to buy even the most basic goods.

Despite the high state spending, poverty is still widespread.

Unemployment is currently running at 22%, well above the East European average.

Private problems

The second key problem is a reluctance to push through privatisation.

Under the relatively liberal Yugoslav economic system, most industry was in private hands during the communist period.

But the Croatian government has persistently delayed the crucial privatisation of utilities, despite the urging of lenders such as the International Monetary Fund.

Selling off inefficient state firms would free up state funds, allowing the government to reduce overall spending while putting more money into welfare programmes.

Achieving consensus on this has never been easy, said Gavin Gray, an expert on Croatia at the Economist Intelligence Unit.

"The government has the right idea, but implementation has always been somewhat lacking."

With the government currently more concerned about its own survival than long-term economic policymaking, these problems are unlikely to be resolved quickly.