Deflation Continues in Croatia

By 16 August 2016

Contrary to expectations, deflation seems to have a stimulating effect on GDP growth.

Although this year inflation was expected, after two consecutive years of declining prices, the initial data indicate that deflation in Croatia could continue for the third consecutive year, reports Jutarnji List on August 16, 2016.

In December last year, a decline in consumer prices stood at 0.6 percent, and in June of this year it reached the level of 1.6 percent. This is mainly a result of lower prices of energy and processed food, and to a lesser extent, of industrial products and services. The average price of gasoline, for example, was 27.3 percent lower in the first half of the year than in the same period last year, while gas prices declined by 14.1 percent. According to the Central Bureau of Statistics data, food prices were lower by 1.4 percent, transportation by 5.9 percent, and education by 0.9 percent.

All central banks, including the Croatian National Bank, usually fear deflation because it can be devastating to the economy. Consumers put off buying products hoping they will become even cheaper, which leads to a decrease of production and firing of employees, and finally to an increase in the level of indebtedness. However, it seems that this time there is no fear of deflationary spiral. Actually, the fall in prices has a positive effect on the economic recovery by offloading incomes, with citizens spending the newly-available money on buying products and services.

“The decrease in the cost of energy and food, which are the main causes of low inflation rates, has led to growth in household disposable income. Consumers cannot delay the consumption of food and energy, which is why there has been no negative impact on consumer spending due to the decrease of prices in these two segments, which is usually a characteristic of deflation”, explains the Croatian National Bank. Positive developments in private consumption and investments confirm this.

In addition, there is no debt deflation. On the contrary, according to the central bank, since interest expenses are becoming less of a burden for consumers and construction industry, they have more funds to spend elsewhere. Finally, deflation has had a positive effect on production costs.

Among a few who currently suffer the negative consequences of deflation is the state budget because lower prices mean lower tax revenues. Data for the first six months show that VAT revenues are slightly below expectations.

Compared with other EU member states, Cyprus and Bulgaria are the only two countries with larger annual decrease in prices than Croatia. One explanation of this is certainly the structure of Croatian consumer basket in which food and energy components are over-represented.

However, the Croatian National Bank expects that the annual inflation rate by the end of the year could still be positive and amount to 0.4 percent, primarily due to expected growth in prices of oil and food products on world markets.