Earlier this year, Croatia’s construction industry at last seemed on track for recovery after many dismal years of negative growth. 2015 saw a number of construction sectors moving into positive figures for the first time since 2009, but the recovery really took hold last year with all construction sectors likely to show positive growth once complete data for the year are available. Now, though, the Agrokor crisis has thrown this rosy picture into doubt.
Written by Michael Glazer, SEE Regional Advisors and Tatjana Halapija, Nada Projekt – EECFA Croatia
First, some background. The Agrokor Group is by far ex-Yugoslavia’s largest business conglomerate, with EUR6.4 billion in sales in 2015. Indeed, it is one of Central Europe’s largest companies (11th, according to Deloitte’s Central Europe’s Top 500 2016) and its second largest retailer (behind Poland’s Jeronimo Martins Polska, also according to Deloitte). Among other things, Agrokor owns the biggest retail grocery chains in Croatia, Slovenia, Serbia and Bosnia-Herzegovina (BiH), several large Croatian agricultural producers, important Croatian resort projects, significant travel agencies and major distribution companies for the wholesale and HoReCa sectors in Croatia and BiH.
Agrokor is now in serious trouble. It is having difficulty finding liquidity, a government administrator has been appointed for it by the Croatian government, the Slovenian and Serbian governments are considering similar measures and it is making only limited payments to its suppliers, on its taxes and to its lenders.
In theory, the consequences of an Agrokor Group collapse could be grave for all of the economies in which the Group operates, particularly Croatia, where it represents as much as 15% percent of GDP measured by revenues and 2-2.5% by value added. The collapse of Agrokor’s tourism agencies, for example, could damage the Croatian tourism season at least somewhat. The withdrawal from the market, even temporarily, of its distribution subs would be very disruptive for HoReCa players in Dalmatia, where there are no adequate existing alternatives. If Agrokor is unable to finance its resort projects, construction on them could stall. And suppliers, particularly SMEs, are already in crisis because Agrokor’s failure to pay them means that they cannot fulfill their own obligations to their employees, suppliers, lenders and governments.
The knock-on effects for government revenues in Croatia could also be quite severe: workers fired by Agrokor Group members or their business partners would not only no longer pay taxes but would drain government resources through health and unemployment payments, VAT and corporate income tax revenues would drop dramatically and agricultural activity in a number of important regions could decline radically. Indeed, the Croatian central bank has warned that Agrokor’s problems could noticeably reduce Croatian GDP.
In the circumstances, it seems wise to ask what might be the consequences of the Agrokor crisis for the Croatian construction sector? In our view, the crisis need not affect Croatian construction output severely if dealt with wisely by Croatia and the other countries involved, but could cause a short-term slowdown of the sector’s recovery if it is not.
First, it is important to note that the situation created by the Agrokor crisis is serious, not dire. Even if Agrokor were to collapse completely, other players would purchase its assets and enter its markets. There would be disruption, but only for a year or so and then only in certain business areas. The impact on government expenditures and private investment, and so on the construction sector, would be significant but recovery would be relatively swift as other firms filled the gaps left by Agrokor’s disappearance.
Second, Agrokor is unlikely to collapse. The two most probable outcomes of the crisis are a rapid sale of the Group as a whole or the rapid divestiture of some of its major subsidiaries to pay off Group liabilities. If either occurs, certain supply chains will be disrupted for a time and the current tourism season will be somewhat negatively affected, but construction activity will likely continue at close to the pace that we’ve predicted, since any economic disruptions will be recognized as being only short term.
In the medium to long run, resolution of the Agrokor crisis will probably benefit regional economies, especially Croatia’s. The concentration of economic power in the poorly managed Agrokor Group limited the ability of better run, more agile competitors to grow. They will now have that chance. The distortions to government policies that the Group’s economic significance and political power created will be eliminated, improving governance region-wide. Both effects will likely benefit the Croatian construction sector, as will the improved economic growth that Agrokor’s demise or rehabilitation will likely produce once the current crises has run its course.
There are two important caveats to this somewhat sanguine view. For one thing, a positive outcome to the crisis depends on regional governments’ acting prudently and in concert. It is by no means guaranteed that they will. The Croatian government may collapse as a result of internal disputes relating to the Agrokor crisis. If the government does fall, it is not clear to whom the government-appointed administrator for Agrokor will answer, or how he will conduct the Group’s rehabilitation, until a new government is formed, a process that could take months. And there is a real possibility that the Croatian and Slovenian governments will clash as a result of a pending arbitration entirely unrelated to the Agrokor problem that has already created great discord between the two countries.
A second potential source of problems are the Croatian construction firms directly affected by the Agrokor crisis. The construction of many of Agrokor’s facilities was financed by the companies that built those facilities. The companies did so by guarantying loans extended to special purpose vehicles (SPVs) formed to undertake the facilities’ construction. These SPVs frequently retained ownership of the facilities, leasing them to Agrokor after their completion. This kept the facilities and their financing costs off of Agrokor’s balance sheet, a critical advantage for the highly leveraged group. Unfortunately, now that Agrokor is in deep trouble, payments on its leases are in doubt. So the construction firms that guaranteed loans to the SPVs that lease facilities to Agrokor may soon find themselves in grave financial difficulty.
How this second problem will be resolved is not obvious. The fact that the government’s administrator has not addressed the issue and that there has been relatively little discussion of it in the press compared to the plight of suppliers and banks suggests that construction companies will get no assistance. How serious a problem this will create for the Croatian construction sector is unclear as well, since the identity of the construction firms involved and the extent of their risk is not yet known.
Bottom line: the Croatian construction sector will probably experience a slight hiccup in output as a result of the Agrokor crisis. If regional governments mishandle the crisis, the sector could feel significant effects for a year or so. But Agrokor’s problems are likely to be resolved relatively quickly and are very unlikely to disrupt the sector dramatically even while they last unless regional governments make major mistakes, which, unfortunately, is a possibility that cannot be excluded.