Newsletter article

Currency Report - November 2013

Little more than four months after joining the European Union Croatia is discovering that membership carries responsibilities as well as rewards.  Eurostat, Brussels' statistical agency, notes in a recent report that Croatia's budget deficit peaked two years ago, at 7.8% of gross domestic product, and has since fallen back to 5.0%.  That is still too high though. The EU's ceiling is 3% of GDP for the annual deficit and total public debt is not supposed to exceed 60% of GDP.  Whilst Croatia is probably not far adrift of the 60% debt limit, its budget deficit is moving higher again as a result of EU membership costs and interest on previous borrowings.  To bring the numbers into line with EU policy it looks as though Zagreb will have no option but to fill the gap with higher taxes.  Finance Minister Slavko Linic hinted last week that VAT, at 25% already among the highest in the EU, might have to go up.  He appeared to rule out a cut in state pensions.

The move is the latest in a series of tacit admissions that Croatia's fiscal wicket is a little sticky.  Local economists believe there is an evens chance that Zagreb will have to arrange a credit facility with the International Monetary Fund within two years.  The situation is not as damaging to the kuna as similar news in, say, Italy would be to the euro because the kuna is too small to attract the attention of speculators.  However, the currency's gently weakening trend implies that the euro is seen as a safer bet than the Croatian currency.

That weakness is only relative though.  The kuna has not moved far and remains well above the low point it touched at the end of 2004.  It is impossible to dismiss the possibility that the Croatian National Bank is deliberately allowing the kuna to depreciate but that is not the way it looks at the moment.  Rather, the kuna is roughly steady against the euro with a slight tilt towards weakness.

That link to the euro took the kuna higher against sterling in the last month as the pound declined from 9.1kn to 8.95kn.  It was less a matter of investors shifting out of the pound and into the euro, more that they had run out of fresh reasons to buy sterling.  Although the UK economy is, by almost every measure, performing better than Euroland, investors are no longer content with UK economic data that are merely good, they want to see excellent figures.  They demonstrated this recently when it was announced that Britain's economy had grown by a provisional 0.8% in the third quarter of the year.  It was a good figure and it was exactly in line with analysts' forecasts but investors had been hoping for a positive surprise.  When they got no more than they had been promised they were disappointed and the pound came under pressure.

Sterling's setback is undramatic and probably temporary.  The kuna's weakness against the euro is even more modest but it might last longer.

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