## 1. Selected Real Sector Indicators, 2012–2017

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### Context and main challenges
- Croatia’s recovery continued into a third year after a prolonged recession; over 2015-16, real GDP growth averaged 2.5 percent.
- Drivers of recovery: strong tourism and private consumption, trade partners’ growth, higher absorption of EU funds, and improved confidence.
- Sizable fiscal consolidation since 2014 allowed exit from the EU’s Excessive Deficit Procedure (EDP) in June 2017.
- Croatia’s GDP per capita: about 60 percent of the EU average.
- Main challenge: transform current momentum into high sustainable medium- and long-term growth; output, employment, and total factor productivity remain below pre-2008 levels.
- Required: growth-friendly fiscal measures and productivity-enhancing structural reforms.

### Recent developments — real, fiscal, monetary, external
- Output and labor markets:
  - Economy estimated to be operating close to potential; output gap appears to be closing.
  - Unemployment: 11.6 percent at end-October 2017 (staff view: mostly structural).
  - Wage pressures moderate and inflation low.
- Fiscal performance and public debt:
  - Fiscal outturn 2016: deficit 0.9 percent of GDP vs budget target 2.6 percent.
  - Structural deficit improved by close to 2 percent of potential GDP.
  - Public debt fell to about 83 percent of GDP (Annex II).
  - Eurobond note: interest rate on a large Eurobond (€1.25 billion in 2017) cut from 6.25 to 3 percent in 2017.
- Monetary and banking:
  - Domestic monetary conditions accommodative; intrabank liquidity ample.
  - Negative overall credit growth due to deleveraging; bank lending began to pick up in mid-2016.
  - Share of kuna lending, particularly to households, increasing since 2015.
  - Banking sector: on average well capitalized and liquid; profitability bolstered by lower provisions and modest net interest income increase.
  - NPL-to-total loans ratio remains high but declining; NPLs well-provisioned; un-provisioned part on average fully covered by capital above minimum requirement.
  - Agrokor crisis slowed but did not reverse improving bank trends.
- External sector:
  - External position broadly in line with fundamentals.
  - Tourist arrivals increasing steadily; merchandise export growth moderated but remained buoyant.
  - External debt declined further; real exchange rate broadly in line with fundamentals.
  - CNB foreign exchange purchases in 2016; gross international reserves declined slightly by year-end due to abolishment of requirement for banks to maintain part of statutory reserves in FX with the CNB.
  - At end-September 2017:
    - Share for FX deposits in broad money (M4): about 55 percent.
    - Share of FX placements to total placements: about 55 percent.
    - Difference between banks’ FX deposits and FX loans to other domestic sectors: 12 percent of GDP.
    - Difference between banks’ FX deposits and total FX loans: 1.5 percent of GDP.

### Outlook and risks — growth, composition, and balance of risks
- Growth projections:
  - Growth projected to reach 3.1 percent in 2017 (strong tourism and private consumption).
  - Investment lagging but expected to increase as EU fund absorption improves and deleveraging eases.
  - Current account surplus projected at 3.7 percent of GDP in 2017; expected to steadily decline as export and tourism growth moderates.
  - Inflation expected to slowly pick up but remain low and in line with regional trends.
  - Growth projected to converge towards 2 percent by 2022, mostly due to structural impediments.
- Balance of risks: improved but tilted to the downside over the medium term.
  - Upside risks:
    - More favorable conditions in trading partners could raise exports.
    - Recent fiscal overperformance may boost confidence and activity.
  - Downside domestic risks (notably Agrokor):
    - Baseline incorporates a 0.3-0.5 percent of GDP decline in growth due to Agrokor for 2018.
    - Risk that Agrokor restructuring in 2018 could have higher-than-expected impact on investment, export capacity, and consumption.
    - Private consumption could slow with significant layoffs, reducing tax revenue and increasing unemployment benefits.
    - Public debt at 80 percent of GDP remains high and vulnerable to currency and interest rate risks.
  - Downside external risks:
    - Sudden tightening in global financial conditions could press public finances and borrowers with variable-rate loans.
    - Corporate balance sheet FX mismatches highest in the region; vulnerability of unhedged borrowers could be substantial with significant exchange rate volatility.

### Authorities’ views on Agrokor and growth
- Authorities project slightly stronger short- and medium-term growth, assuming higher private consumption and investment; assess risks as broadly balanced.
- Regarding Agrokor, authorities expect orderly restructuring due to a new law on systemic companies; caretaker management plans minimal employment impact and debt-to-equity swaps for creditors.
- Authorities believe banking system has withstood the Agrokor crisis and can withstand further write-offs as indicated by CNB stress tests.

### Key statistics (selected time series and projections)
- Real GDP growth (annual): 2012 -2.2, 2013 -1.1, 2014 -0.5, 2015 2.2, 2016 3.0, 2017 3.1, 2018 (Proj.) 2.8.
- Medium-term baseline real GDP (percent change): 2018 2.8, 2019 2.6, 2020 2.4, 2021 2.3, 2022 2.2.
- General government revenue (percent of GDP, ESA 2010): 2012 41.8, 2013 43.0, 2014 43.1, 2015 45.0, 2016 46.8, 2017 46.6, 2018–2022 projected 46.8–46.9.
- General government expenditure (percent of GDP): 2012 47.1, 2013 48.3, 2014 48.5, 2015 48.4, 2016 47.6, 2017 47.2, 2018–2022 projected 47.3–46.3.
- Overall general government balance (percent of GDP): 2012 -5.3, 2013 -5.3, 2014 -5.4, 2015 -3.4, 2016 -0.9, 2017 -0.6, 2018 (Proj.) -0.5, 2019 (Proj.) -0.3, 2020 (Proj.) 0.2, 2021 (Proj.) 0.4, 2022 (Proj.) 0.6.
- Structural balance (percent of potential GDP): 2012 -3.4, 2013 -3.0, 2014 -2.8, 2015 -2.1, 2016 -0.4, 2017 -0.6.
- General government debt (percent of GDP): 2012 70.7, 2013 82.2, 2014 86.6, 2015 86.3, 2016 83.7, 2017 80.4, 2018 (Proj.) 77.5, 2019 (Proj.) 74.1, 2020 (Proj.) 71.0, 2021 (Proj.) 67.7, 2022 (Proj.) 64.4.
- Gross official reserves (billions of euros): 2012 11.2, 2013 12.9, 2014 12.7, 2015 13.7, 2016 13.5, 2017 15.5, 2018 (Proj.) 16.2.
- Current account (percent of GDP): 2012 -0.1, 2013 1.0, 2014 2.0, 2015 4.6, 2016 2.5, 2017 3.7, 2018 (Proj.) 2.8, 2019 (Proj.) 2.0, 2020 (Proj.) 1.5, 2021 (Proj.) 0.9, 2022 (Proj.) 0.4.
- External debt (percent of GDP): 2012 103.1, 2013 105.3, 2014 108.0, 2015 103.0, 2016 90.9, 2017 84.3, 2018 (Proj.) 78.7, 2019 (Proj.) 75.0, 2020 (Proj.) 71.0, 2021 (Proj.) 67.8, 2022 (Proj.) 65.8.
- Unemployment rate (percent): 2012 18.9, 2013 20.2, 2014 19.6, 2015 17.0, 2016 14.8.
- CPI inflation (avg.): 2012 3.4, 2013 2.2, 2014 -0.2, 2015 -0.5, 2016 -1.1, 2017 1.1, 2018 (Proj.) 1.5.
- Nominal GDP (billions of euros): 2012 43.9, 2013 43.5, 2014 43.0, 2015 44.1, 2016 45.8, 2017 47.8, 2018 (Proj.) 49.8.

### Policy discussions and IMF staff recommendations — Fiscal policy: utilizing the upturn
- Staff assessment:
  - Staff projects 2017 general government deficit at about 0.6 percent of GDP (below budget target of 1.6 percent).
  - Cyclically-adjusted balance estimated to have deteriorated by about 0.2 percent of potential GDP (mildly procyclical stance).
  - 2018 budget targets a deficit of 0.5 percent of GDP; authorities plan consolidation towards a small surplus starting in 2019.
  - Staff believes a small surplus could be achievable starting 2020, reducing public debt to about 65 percent of GDP under current policies, contingent on resisting pressures for rapid tax cuts or expenditure increases.
  - Wage agreement: increase in three steps by a total of 6 percent in nominal terms in 2017-18.
  - From 2018, personal income tax revenues to be collected by local governments to strengthen financing capacity to co-finance EU projects.
- Staff recommendation: faster reduction in public debt over the medium term.
  - Recommended additional cumulative measures: 1.5 percent of GDP during 2018-22.
  - Expected result: reduction in debt over 5 years of around 20 percent of GDP; bring debt below 60 percent of GDP by end of medium term.
  - Guidance: adopt a mildly counter-cyclical fiscal policy that preserves recovery while reducing debt.
- Specific recommended consolidation measures (to achieve 1.5 percent of GDP, 2018-22):
  - Revenue-side:
    - Adopt a modern real estate tax estimated to generate additional revenue of around 1 percent of GDP.
    - Use real estate tax revenue to allow further reduction in less growth-friendly taxes, such as income taxes.
    - Room for streamlining VAT rates in line with original VAT reform proposal, ensuring measures are revenue neutral.
  - Expenditure-side:
    - Implement measures in the Convergence Program and the NRP.
    - Social benefits: possible reduction by 1 percent of GDP while protecting vulnerable groups.
      - Current social benefits provision: provided by 7 different ministries; fiscal cost of Croatia’s social benefits about 1 percent of GDP higher than peers.
      - Poverty rate: 8 percent and declining.
      - World Bank estimates only 10 percent of Croatia’s social programs are well-targeted.
    - Compensation of employees: reduce the growing wage bill by 0.5 percent of GDP, including streamlining public administration and making compensation more performance-based.
- Two additional necessary reforms for fiscal sustainability:
  - Healthcare sector:
    - Legacy arrears about 2 percent of GDP; new arrears estimated at 110 million kuna per month.
    - Half of new arrears could be eliminated by removing exemptions and enforcing collection of premiums for supplementary health insurance.
    - Premium of supplementary benefits: 70 kuna per month (about €10).
    - Consider raising premiums and introducing co-payments for supplementary benefits; centralize procurement; consider moving health insurance fund back under the Treasury.
  - Pension system:
    - Put pension system on sustainable path via: (i) tightening early retirement rules, (ii) accelerating transition to higher statutory retirement age, and (iii) expediting convergence of special regimes and privileged pensions with the general system.

### Structural reform priorities and rationale
- Diagnosis:
  - Potential growth, competitiveness, and job creation hampered by low investment, low productivity, and adverse demographics since the GFC.
  - Low FDI and slow EU fund absorption limited technological advances; emigration of high-skilled workers reduced labor force.
- Staff-recommended areas:
  - Public administration:
    - Streamline complex multilayered administration; reduce para-fiscal fees; increase use of electronic hubs; simplify administrative processes.
  - Labor market:
    - Ease regulations on temporary and part-time employment and on hiring and retrenchment to increase flexibility.
    - Better-target social benefits; increase childcare facilities; enhance education and vocational training aligned with NRP.
  - SOE reform:
    - Improve efficiency; divest scattered and underutilized state assets; reduce number of enterprises classified as strategic.
  - Corporate governance and legal process:
    - Address gaps in corporate governance; speed judicial proceedings; digitalize court procedures; modernize land registry and cadaster.

### Monetary, financial sector, and macroprudential guidance
- Monetary policy:
  - Given benign inflation outlook, CNB appropriately kept interest rates low and ensured ample liquidity; staff encourages maintaining accommodative stance within limits of exchange rate and financial stability.
- Financial sector:
  - CNB’s conservative prudential policies helped banks withstand Agrokor; stress tests show system can absorb significant write-offs (a couple of banks may need modest capital increases in worst-case).
  - NPL measures: facilitation of write-offs of fully provisioned NPLs via amended tax legislation; banks prefer market-based NPL sales.
- Macroprudential measures:
  - No immediate need to tighten MPMs absent real estate market overheating.
  - Current MPMs include capital conservation buffer, structural systemic risk buffers, higher capital charge on O-SII, strict residential property definition, and higher risk-weights on commercial real estate exposures.
  - Revisit MPMs should real estate price increases accelerate.
- Euro adoption:
  - Public debate launched; government aims to enter ERM II in 2020.
  - Staff emphasized need to increase dynamism and resilience of economy and rapidly reduce public debt to create fiscal space before joining the currency union.

### Public debt sustainability — baseline, risks, and stress tests (Annex II highlights)
- Public debt:
  - Projected around 80 percent of GDP at end-2017.
  - Gross financing needs about 13 percent of GDP in 2017.
  - Under baseline, debt gradually declines over medium term.
- Baseline projections (selected):
  - Real GDP growth: 2015 -0.1, 2016 2.2, 2017 3.0, 2018 3.1, 2019 2.8, 2020 2.6, 2021 2.4, 2022 2.3.
  - Effective interest rate (percent): 2015 5.1, 2016 4.2, 2017 3.8, 2018 3.2, 2019 3.1, 2020 3.0, 2021 3.0, 2022 2.9.
  - Nominal gross public debt (percent of GDP, reported series): 2015 58.7; 2016 86.3; 2017 88.7; 2018 80.4; 2019 77.5; 2020 74.1; 2021 71.0; 2022 67.7; later 64.4.
  - Public gross financing needs (percent of GDP): 2015 19.4; 2016 16.1; 2017 11.1; 2018 12.8; 2019 11.5; 2020 8.7; 2021 6.6; 2022 4.2.
- Stress test scenarios:
  - Real GDP growth shock (one standard deviation): primary deficit deteriorates to about 1.9 percent of GDP and public debt rises sharply to over 90 percent in 2019 before improving.
  - Combined macro-fiscal shock: public debt could approach close to 100 percent of GDP at peak; gross financing needs near 17 percent of GDP in 2019.
- Policy implications:
  - Accelerate fiscal adjustment to support debt reduction consistent with Debt Management Strategy (reduce debt-to-GDP ratio by 10 percentage points by 2020).
  - Further reduce short-term debt, mitigate currency and interest rate risks, increase transparency, and pursue longer-maturity refinancing at favorable rates.
  - Consider divestment of state assets with proceeds used for public debt reduction.
  - Maintain vigilance on contingent liabilities (e.g., guarantees to SOEs, highway companies’ debt).

### External sector assessment and competitiveness (Annex IV highlights)
- Current account:
  - Substantial surplus since 2013; tourism receipts averaged 18 percent of GDP in 2015-16.
  - Current account surplus declined in 2016 to 2.6 percent of GDP from 4.8 percent in 2015; projected 3.7 percent in 2017 (one-off bank provisioning effect).
  - Medium-term projection: surplus gradually moves toward balance as tourism moderates and imports rise with investment and consumption.
- External position:
  - Gross external debt declined from 108.0 percent of GDP in 2014 to 84.3 percent in 2017.
  - NIIP improved from -90 percent of GDP in 2009 to -67 percent in 2016; remains worse than Euro Area average (-13 percent).
  - Reserve adequacy: gross official reserves 2016 €13.5 billion; projected to exceed ARA metric starting 2017.
- Competitiveness:
  - Non-price indicators show broader competitiveness challenges despite relative declines in ULC.
  - Doing Business ranking: 51st in 2018 (fell 8 spots).
  - Wages high relative to per capita income; productivity uneven across sectors.
- Policy implication: advance deep structural reforms to raise potential growth; baseline (slow reform) projects potential around 2 percent.

### Risk Assessment Matrix — selected entries (Annex VI)
- Global risks:
  - Tighter global financial conditions (Time Frame: Short term; Relative Likelihood: High; Impact: Medium to High).
    - Recommended policy response: Growth-friendly fiscal consolidation; FX intervention to smooth volatility; accelerate private sector debt restructuring; encourage shift of unhedged borrowers to kuna fixed-rate loans; ensure availability of kuna liquidity; develop hedging markets.
- Domestic risks:
  - Disorderly Agrokor restructuring (Time Frame: Short to medium; Relative Likelihood: Medium; Impact: Medium to High).
    - Recommended policy response: Align expectations; work with creditors on viable solutions; strengthen corporate governance.
  - Further reform standstill (Time Frame: Medium; Relative Likelihood: High; Impact: Medium to High).
    - Recommended policy response: Strengthen national commitment to reform; seek consensus and target "low hanging fruit" first.

### Data, governance, and institutional developments
- Fiscal governance:
  - Fiscal Responsibility Law being finalized includes creation of a Fiscal Council with seven non-political members and staff.
  - Budget Act to include contingent liabilities analysis and a three-year spending limit.
  - Updated 2017 Debt Management Strategy encourages expanding kuna-based borrowing to reduce FX exposure and develop local bond market.
- Data adequacy for surveillance (as of September 30, 2017): broadly adequate with some shortcomings (e.g., breakdown of GFCF into private/public not published; coverage gaps in earnings data).
- IMF staff and authorities statements (January 10, 2018):
  - Authorities revised 2017 fiscal projection from deficit of 0.6 percent of GDP to surplus of 0.6 percent; public debt projected to be 78 percent of GDP at end-2017.
  - Authorities aim to gradually decrease public debt to close or below 60 percent of GDP and committed to start official process of euro adoption.

*Source: cr1805 — International Monetary Fund staff summary and annexes contained in the provided content.*

### 1. Selected Real Sector Indicators, 2012–2017 ___________________________________________________ 18

### 1. Selected Real Sector Indicators, 2012–2017

### Context
- Croatia’s recovery continued into a third year after a prolonged recession. Over 2015-16, real GDP growth averaged 2.5 percent, reflecting strong tourism and private consumption, trade partners’ growth, higher absorption of EU funds, and improved confidence.
- Sizable fiscal consolidation since 2014 allowed Croatia to exit the EU’s Excessive Deficit Procedure (EDP) in June 2017.
- Croatia’s GDP per capita now stands at about 60 percent of the EU average.
- Main challenge: transform current momentum into high sustainable medium- and long-term growth. Output, employment, and total factor productivity remain below their pre-2008 levels; income convergence with the EU has slowed after the global financial crisis (GFC) for various reasons, including delays in implementing structural reforms (Annex I).
- Supporting faster income convergence while reducing vulnerabilities will require growth-friendly fiscal measures and productivity-enhancing structural reforms.

### Recent developments
- The economy is estimated to be operating close to potential; the output gap appears to be closing.
- Unemployment: 11.6 percent at end-October 2017; staff view it as mostly structural. Labor supply affected by unfavorable demographics, emigration, untargeted social benefits, and labor market rigidities.
- Wage pressures are moderate and inflation is low.
- Fiscal performance and public debt:
  - Fiscal overperformance in 2016: deficit at 0.9 percent of GDP compared to the budget target of 2.6 percent.
  - Structural deficit improved by close to 2 percent of potential GDP.
  - Public debt fell to about 83 percent of GDP (Annex II).
  - Refinancing needs were met on very favorable terms as Croatia’s risk premium declined significantly.
  - Note on Eurobond: In 2017, the interest rate on a large Eurobond (€1.25 billion in 2017) was cut by more than half (from 6.25 to 3 percent).
- Monetary and banking:
  - Domestic monetary conditions remain accommodative; intrabank liquidity is ample and money market rates are modest.
  - Continuing deleveraging resulted in negative overall credit growth, but transaction data indicate bank lending began to pick up in mid-2016.
  - Share of kuna lending, particularly to households, has been increasing gradually since 2015.
  - Banking sector: on average well capitalized and liquid; profitability bolstered by lower provisions, one-off items, and a modest increase in net interest income.
  - NPL-to-total loans ratio remains high but has been declining. NPLs are well-provisioned; the un-provisioned part is, on average, fully covered by capital exceeding the minimum requirement.
  - The Agrokor crisis has not reversed the improving trend in bank positions but slowed it down.
- External sector:
  - External position broadly in line with fundamentals.
  - Tourist arrivals increasing steadily; merchandise exports growth moderated but remained buoyant.
  - Croatia continued to gain market share in the EU since its entry in mid-2013.
  - External debt declined further; real exchange rate broadly in line with fundamentals (Annexes III and IV).
  - Non-price indicators suggest broader competitiveness challenges.
  - CNB made foreign exchange purchases in 2016; gross international reserves declined slightly by year-end due to abolishment of the requirement for banks to maintain part of statutory reserves in FX with the CNB.
  - Moderate upward exchange rate pressures continued throughout most of 2017; CNB accumulating sizable reserves.

### Outlook and risks
- Growth projections and composition:
  - Growth projected to reach 3.1 percent in 2017, mostly due to strong tourism and private consumption.
  - Investment has been lagging but envisaged to increase in the near term as absorption of EU structural and investment funds improves and overall deleveraging gradually comes to an end.
  - Current account surplus projected at 3.7 percent of GDP in 2017; expected to steadily decline as export and tourism growth moderates.
  - Inflation expected to slowly pick up but remain low and in line with regional trends.
  - Growth projected to converge towards 2 percent by 2022, mostly due to structural impediments (Annex V).
- Balance of risks: improved but tilted to the downside over the medium term (Annex VI).
  - Upside risks:
    - More favorable conditions in trading partners, possibly higher exports.
    - Lower GDP and employment compared to pre-2008 levels may point to more cyclical slack.
    - Recent history of fiscal overperformance could contribute to increased confidence and activity.
  - Downside domestic risks (mostly related to Agrokor):
    - Risk that in 2018 Agrokor restructuring could have higher-than-expected impact on domestic investment, export capacity, and consumption (Annex VII).
    - Private consumption may slow if significant layoffs occur in affected companies, reducing tax revenue and increasing unemployment benefits.
    - Public debt at 80 percent of GDP remains high and subject to currency and interest rate risks; financing needs remain elevated.
    - Debt path vulnerable to growth shocks and materialization of contingent liabilities (Annex II).
    - Baseline incorporates a 0.3-0.5 percent of GDP decline in growth due to Agrokor for 2018 (Annex VI).
  - Downside external risks:
    - Sudden tightening in global financial conditions could press public finances and borrowers with variable-rate loans.
    - Corporate balance sheet FX mismatches are the highest in the region.
    - Despite progress, euroization of banks’ balance sheets remains high.
      - At end-September 2017, share for FX deposits in broad money (M4) and share of FX placements to total placements amounted to about 55 percent each.
      - Difference between banks’ FX deposits and FX loans to other domestic sectors and total FX loans amount to 12 and 1.5 percent of GDP, respectively at end-September 2017.
    - Vulnerability of unhedged borrowers could be substantial with significant exchange rate volatility.

### Authorities’ views
- Authorities project slightly stronger growth over short- and medium-term, assuming higher private consumption and investment; they consider risks broadly balanced.
- Regarding Agrokor, authorities expect restructuring to proceed in an orderly manner due to a new law on systemic companies.
- Caretaker management’s plan envisages minimal impact on employment; intends to offer creditors debt-to-equity swaps rather than cash repayment from sales.
- Authorities believe banking system has withstood Agrokor crisis and can withstand further write-offs, as indicated by CNB stress tests.

### Policy discussions — A. Fiscal Policy: Utilizing the Upturn
- Staff projection and assessment:
  - Staff projects 2017 general government deficit at about 0.6 percent of GDP, well below the budget target of 1.6 percent.
  - Overperformance due to robust cyclical revenues, lower than budgeted interest payments, and ongoing tax administration reforms that mobilized revenues and contained expected losses from recent tax cuts (Annex I).
  - Virtually all expenditures were executed as planned, including wage increases.
  - Staff estimates cyclically-adjusted balance deteriorated by about 0.2 percent of potential GDP, indicating a mildly procyclical fiscal stance.
  - 2018 budget targets a deficit of 0.5 percent of GDP. Authorities plan further consolidation towards a small surplus starting in 2019.
  - Staff believes 2018 target is feasible and a small surplus could be achievable starting 2020, which would lead to a reduction in public debt to about 65 percent of GDP; scenario feasible within current policies but contingent on resisting pressures for rapid tax cuts or expenditure increases (including war veterans’ benefits and public wages).
  - Wage agreement: increase in three steps by a total of 6 percent in nominal terms in 2017-18.
  - From 2018, personal income tax revenues to be collected by local governments to strengthen financing capacity to co-finance EU-financed projects.
  - Increase in veteran benefits per War Veterans Act (November 2017) is incorporated in the baseline.
- Staff recommendation: faster reduction in public debt over the medium term to reduce financing needs, cushion against tighter global financial conditions, and create fiscal space for downturns.
  - Recommended additional cumulative measures: 1.5 percent of GDP during 2018-22.
  - Expected result: reduction in debt over 5 years of around 20 percent of GDP; bring debt below 60 percent of GDP by end of medium term, aligning with Stability and Growth Pact threshold.
  - Guidance: adopt a mildly counter-cyclical fiscal policy that preserves recovery while reducing debt.
- Specific measures recommended to achieve 1.5 percent of GDP consolidation (2018-22):
  - Revenue-side:
    - Adoption of a modern real estate tax estimated to generate additional revenue of around 1 percent of GDP. A well-designed real estate tax based on objective criteria would be more equitable and yield more revenue than existing communal fees.
    - Use real estate tax revenue to allow further reduction in less growth-friendly taxes, such as income taxes.
    - Room for further streamlining VAT rates in line with original VAT reform proposal, ensuring measures are revenue neutral.
  - Expenditure-side:
    - Implement measures contained in the Convergence Program and the NRP.
    - Social benefits: possible reduction by 1 percent of GDP while protecting vulnerable groups. Current social benefits provision:
      - Provided by 7 different ministries and vary between municipalities; lack of coordination and need to improve targeting.
      - Fiscal cost of Croatia’s social benefits about 1 percent of GDP higher than peers.
      - Poverty rate is 8 percent and declining.
      - World Bank estimates only 10 percent of Croatia’s social programs are well-targeted.
      - Recent measures, including expansion of veteran benefits, are not means-tested.
      - Assessment of disability claims harmonized and moved to new Single Expert Evaluation Body.
    - Staff recommended social benefits reform be designed in consultation with the World Bank and focus on better targeting and monitoring, including reviving plan to introduce a one-stop shop for benefits.
    - Compensation of employees: reduce the growing wage bill by 0.5 percent of GDP, including through streamlining public administration and government agencies; advance plans to make compensation more performance-based to improve public service delivery.
- Two additional necessary reforms for fiscal sustainability:
  - Healthcare sector reforms:
    - Stop perpetual accumulation of arrears: legacy arrears about 2 percent of GDP; new arrears estimated at 110 million kuna per month.
    - Half of new arrears could be eliminated by removing exemptions and enforcing collection of premiums for supplementary health insurance.
    - Consider raising premiums and introducing co-payments for supplementary benefits.
    - Improve efficiency by reducing number of specialized centers and centralizing procurement.
    - Consider moving health insurance fund back under the Treasury to strengthen monitoring and control of expenditures.
    - Premium of supplementary benefits is 70 kuna per month (about €10).
  - Pension system reforms:
    - Put pension system on a sustainable path via: (i) tightening early retirement rules, (ii) accelerating transition to higher statutory retirement age, and (iii) expediting convergence of special regimes and privileged pensions with the general system.

*International Monetary Fund staff summary based on the Republic of Croatia country report content provided.*

### 14.      Staff supported the authorities’ recent effort to strengthen fiscal governance and

### 14.      Staff supported the authorities’ recent effort to strengthen fiscal governance and 

### Fiscal governance and debt management
- The Fiscal Responsibility Law, which is being finalized, includes the creation of a Fiscal Council with seven non-political members and its own staff.
- The Budget Act, also to be approved soon, will include an analysis of contingent liabilities as part of the budget process as well as a three-year spending limit, while ensuring appropriate flexibility.
- Staff welcomed measures to reduce debt vulnerabilities in the updated debt strategy, published in 2017, and especially encouraged further expansion of kuna-based borrowing to reduce FX exposure and develop the local bond market (Annex II).

### Authorities’ fiscal and health sector intentions
- Authorities intend to continue to improve tax administration and are contemplating reforms to further alleviate the high tax burden.
- Yearly fiscal savings are intended to be used to pay off some of the health sector arrears.
- Planned health sector efficiency measures include:
  - functional integration of hospitals in 6 pilot cases,
  - reduction of the excessive number of inpatient procedures,
  - consolidation of procurement.
- Currently there is no intention to raise contributions to the supplementary insurance; authorities prefer to make it attractive for a larger pool of healthy participants.
- Public administration reform is being phased in through mid-2018 to allow for careful preparation.
- Negotiations on changes in the pay grade system have started; the reform will first encompass civil servants.
- With respect to social benefits:
  - plan to implement the virtual one-stop shop by 2020,
  - no plans at this point to reduce the number of benefits.
- The change in the retirement age could be brought forward after other elements of the reform are worked out.

### Removing impediments to growth: diagnosis
- Since the global financial crisis, Croatia’s potential growth, competitiveness, and job creation have been hampered by low investment and productivity as well as adverse demographics.
- Past overleveraging and a low level of absorption of EU funds resulted in subdued domestic investment and especially FDI, thereby limiting technological advances (Annex VIII).
- Emigration of high skilled workers has led to a declining labor force and lower productivity.
- Indicators of competitiveness and the ease of doing business suggest significant room to raise potential growth by improving productivity, attracting investment, and increasing employment through implementing structural reforms (Annexes IV, V and VIII).

### Staff-recommended structural reforms (areas and rationale)
- Public administration:
  - Croatia has a very complex and multilayered public administration with a high number of counties, municipalities, and public agencies relative to population and administrative capacity.
  - Staff recommended streamlining to reduce red tape and disparities in regulation and in scope and quality of public services.
  - Further reducing para-fiscal fees, increasing use of electronic hubs, and simplifying administrative processes and required documentation were encouraged.
- Labor market:
  - Participation rate remains one of the lowest in the EU and structural unemployment, especially among youth and women, is high.
  - Staff encouraged easing regulations on temporary and part-time employment, and on hiring and retrenchment of labor to increase flexibility and bring jobs out of the informal sector.
  - Incentives to accept jobs could be increased by streamlining and better-targeting social benefits and by increasing the number of child care facilities.
  - Enhancing education and vocational training in line with the NRP was recommended to improve productivity and employment, especially among youth and war veterans.
- SOE reform:
  - State-owned enterprises operate in almost all sectors, suffer from low efficiency, and generate substantial fiscal costs and contingent liabilities.
  - Too many enterprises are classified as strategic, impeding privatization.
  - Staff welcomed engagement with the World Bank on operational restructuring of the highway companies after part of their old debt was refinanced (Annex II).
  - Divesting scattered and underutilized state assets, such as real estate and minority shares, was recommended.
- Corporate governance:
  - Recent improvements in bankruptcy legislation (post-Agrokor) and the 2015 Bankruptcy law amendments were noted.
  - Staff recommended identifying and addressing remaining gaps in corporate governance, including supervisory boards’ roles, ownership consolidation trends, accounting and auditing standards, payment culture, and insolvency and creditor rights.
- Legal process and property rights:
  - Judicial proceedings remain very lengthy and there is scope to improve consistency in court rulings.
  - Staff encouraged digitalization of court procedures, streamlining procedures for small claims, facilitating out-of-court settlement, and enhancing dispute resolution mechanisms.
  - Modernization of land registry and the cadaster was recommended to enhance property rights.

### Monetary and financial sector policies
- Given the benign inflation outlook, the CNB has appropriately kept interest rates low and ensured ample liquidity.
- Staff encouraged the CNB to maintain an accommodative monetary stance within the limits of preserving exchange rate and financial stability.
- Existing CNB lending facilities are adequate and should remain available, especially given lingering uncertainties surrounding the restructuring of Agrokor.
- Recent changes permit banks to pool collateral for the CNB’s various lending facilities, including the long-term structural kuna funding facility.
- CNB’s conservative prudential policies helped banks withstand the Agrokor crisis; stress-testing showed the banking system could absorb significant write-offs of Agrokor’s debt due to high capital buffers (a couple of banks might have to modestly increase their capital in the CNB’s stress test’s worst-case scenario).
- NPL measures: facilitation of write-offs of fully provisioned NPLs during 2017 via amended tax legislation; market-based solutions such as NPL sales are preferred by banks.
- Macroprudential measures (MPMs):
  - No immediate need to tighten MPMs absent signs of overheating in the real estate market.
  - Current main MPMs include the capital conservation buffer, structural systemic risk buffers, higher capital charge on other systemically important institutions (O-SII), strict definition of residential property, and higher risk-weights on exposures secured by mortgages on commercial real estate.
  - Vital to maintain conservative prudential policies and supervisory vigilance; consider revisiting MPMs should real estate price increases accelerate.
- Euro adoption debate:
  - Authorities launched a public debate about pros and cons of euro adoption; government aims to enter ERM II in 2020.
  - Croatia’s monetary policy is already closely linked to the Euro Area given exchange rate movements and high euroization.
  - Euro adoption would eliminate the current limited monetary policy independence and allow full participation in EA decision making; it would reduce exchange rate risk and transaction costs.
  - Staff emphasized the need to increase dynamism and resilience of the economy by accelerating structural reforms and to rapidly reduce public debt to create fiscal space before joining the currency union.

### STAFF APPRAISAL — key points and quantitative targets
- Croatia’s economic recovery continues at a brisk pace; Real GDP growth is expected to reach about 3 percent for a second year in a row, supported by strong tourism and private consumption.
- Output remains below its 2008 level, and per capita income is only at about 60 percent of the EU’s average.
- Unemployment has declined substantially but remains in double digits.
- Labor participation is low and demographic trends are unfavorable; private investment is recovering but still subdued.
- Fiscal position:
  - Fiscal accounts continued to strengthen; exit from the Excessive Deficit Procedure in June 2017.
  - Public debt remains high; it is important to adopt additional measures to reduce public debt below 60 percent of GDP by 2022.
  - Reducing debt below 60 percent of GDP by 2022 would reverse the currently procyclical stance, reduce government financing cost, and create fiscal space for future downturns.
- Recommended fiscal reforms should be growth-friendly and improve expenditure and revenue structure:
  - Introduce a modern real estate tax and streamline VAT rates to allow for a revenue-neutral further reduction in the income tax burden.
  - Rationalize current expenditure by advancing civil service reform, better-targeting social benefits, and reducing early retirement incentives.
  - Improve sustainability of the healthcare system by enhancing efficiency, centralizing procurement, removing exemptions for subscribers to supplementary insurance, and raising co-payments for its added services.
- Monetary policy:
  - Has remained appropriately accommodative within the limits of the exchange rate anchor; maintaining such stance would support growth as long as risks to financial stability and inflation remain low.
  - Authorities’ detailed studies on euro adoption are welcome and point to the need to expand fiscal space and advance structural reforms to maximize benefits and minimize risks of joining the currency union.

*International Monetary Fund staff summary from the provided content.*

### 28.      Conservative macroprudential policies and effective bank supervision have helped

### 28.      Conservative macroprudential policies and effective bank supervision have helped

### Financial sector stability and supervision
- Conservative macroprudential policies and effective bank supervision have helped preserve financial sector stability.
- Progress has been made in reducing NPLs, and the financial system remains generally sound despite the Agrokor crisis.
- Maintaining effective supervision and a robust macroprudential framework will continue to be critical as the economy recovers fully.
- It is also important to build on recent improvements in bankruptcy legislation for large corporations by identifying and addressing any remaining gaps in corporate governance.

### Structural reforms to sustain and broaden the upswing
- The current upswing should be used to advance structural reforms in order to remove impediments to sustained growth.
- It is critical to improve the business environment by streamlining the complex and overlapping levels of public administration, and by enhancing the legal process and property rights.
- To maximize the impact on job creation:
  - Make the regulations on temporary employment and the hiring and retrenchment of labor less restrictive.
  - Increase the availability of childcare centers.
- Raise the efficiency of SOEs and divest scattered and underutilized state assets to improve productivity and resource allocation.

*Source: cr1805 - 28.      Conservative macroprudential policies and effective bank supervision have helped*

### 30.      It is recommended that the next Article IV consultation be held on the standard 12-

### It is recommended that the next Article IV consultation be held on the standard 12-month cycle.

### Real sector: recent performance and projections
- GDP continues to recover, driven by tourism and strong export growth.
- Real GDP growth (annual): 2012 -2.2, 2013 -1.1, 2014 -0.5, 2015 2.2, 2016 3.0, 2017 3.1, 2018 (Proj.) 2.8.
- Contribution breakdown (2012–2017): Domestic demand and Net exports noted; Domestic demand (2017) 3.1; Net exports (2017) -0.3.
- Retail trade, manufacturing production, construction, and consumer confidence indicators show improvement through 2017Q2/2017Q3.
- Medium-term baseline real GDP (percent change) projections: 2018 2.8, 2019 2.6, 2020 2.4, 2021 2.3, 2022 2.2.

### Fiscal developments and projections
- General government revenue and expenditure (percent of GDP, ESA 2010):
  - Revenue: 2012 41.8, 2013 43.0, 2014 43.1, 2015 45.0, 2016 46.8, 2017 46.6, 2018–2022 projected 46.8–46.9.
  - Expenditure: 2012 47.1, 2013 48.3, 2014 48.5, 2015 48.4, 2016 47.6, 2017 47.2, 2018–2022 projected 47.3–46.3.
- Overall general government balance (percent of GDP): 2012 -5.3, 2013 -5.3, 2014 -5.4, 2015 -3.4, 2016 -0.9, 2017 -0.6, 2018 (Proj.) -0.5, 2019 (Proj.) -0.3, 2020 (Proj.) 0.2, 2021 (Proj.) 0.4, 2022 (Proj.) 0.6.
- Structural balance (percent of potential GDP): 2012 -3.4, 2013 -3.0, 2014 -2.8, 2015 -2.1, 2016 -0.4, 2017 -0.6, 2018–2022 projected -0.6 to 0.6.
- General government debt (percent of GDP): 2012 70.7, 2013 82.2, 2014 86.6, 2015 86.3, 2016 83.7, 2017 80.4, 2018 (Proj.) 77.5, 2019 (Proj.) 74.1, 2020 (Proj.) 71.0, 2021 (Proj.) 67.7, 2022 (Proj.) 64.4.
- Selected expenditure items (percent of GDP) indicate room for further fiscal savings; borrowing expected to be met to a large extent from domestic sources.
- Public debt amortization and refinancing needs remain sizable over 2018–2021.

### Monetary and banking sector
- Deposit trends: Bank deposit growth (y-o-y percent change) shows moderate growth; FX deposits adjusted for exchange rate and kuna deposits tracked separately through Oct-17.
- Long-term interest rates on private loans have continued to decline (data through Oct-17).
- Excess reserves (billions of kuna): Banks' excess reserves remained high as of Oct-17.
- Domestic credit growth: lending remains subdued; contributions by Government, Enterprises, Households varied with residuals.
- Financial soundness indicators (selected):
  - CAR (Regulatory capital to risk-weighted assets): 2012 20.9, 2013 20.9, 2014 21.8, 2015 21.0, 2016 22.5, 2017 Q1–Q3 23.3–22.7.
  - Nonperforming loans to total gross loans (percent): 2012 13.8, 2013 15.4, 2014 16.7, 2015 16.3, 2016 13.6, 2017 Q1–Q3 13.7–12.5.
  - Return on assets: 2012 0.9, 2013 0.3, 2014 0.6, 2015 -1.2, 2016 1.8, 2017 Q1–Q3 0.5–0.7.
- Monetary aggregates (billions of kuna, selected):
  - Broad money (M4): 2012 254.6, 2013 264.8, 2014 273.2, 2015 287.3, 2016 300.9, 2017 Q3 309.6.
  - Gross official reserves (billions of euros): 2012 11.2, 2013 12.9, 2014 12.7, 2015 13.7, 2016 13.5, 2017 15.5, 2018 (Proj.) 16.2.

### Financial markets and risk pricing
- Lending and deposit rates have continued to decline through Oct-17.
- EMBI Eurobond spreads and 5-Year CDS spreads for Croatia have significantly come down by Nov-17; Croatia’s risk priced closer to peers.
- Bond yields: domestic and international bond yields remained low with ample liquidity (Nov-17).
- Stock market affected by Agrokor developments; kuna per euro fluctuated in a narrow range (kuna per euro around 7.3–7.8 in series shown).

### Balance of payments and tourism
- Current account (millions of euros): 2012 -514, 2013 158, 2014 622, 2015 2,019, 2016 1,159, 2017 1,770, 2018 (Proj.) 1,406, 2019 (Proj.) 1,012, 2020 (Proj.) 792, 2021 (Proj.) 505, 2022 (Proj.) 229.
- Current account (percent of GDP): 2012 -0.1, 2013 1.0, 2014 2.0, 2015 4.6, 2016 2.5, 2017 3.7, 2018 (Proj.) 2.8, 2019 (Proj.) 2.0, 2020 (Proj.) 1.5, 2021 (Proj.) 0.9, 2022 (Proj.) 0.4.
- Services trade balance (millions of euros): positive and large (2012 6,490; 2016 8,684; 2017 9,486).
- Exports of services and tourism are significant: exports of services (2017) 13,238; travel/tourism contributes importantly to GDP and current account; foreign tourists by origin in Jan–Sept. 2017: Germany 32.4, Austria 10.0, UK 7.2, Slovenia 4.8, Italy 3.1, Other 42.4 (percent of total nights).
- Tourism indicators: arrivals and receipts grew, hospitality sector absorbed larger arrivals; travel receipts per million visitors (percent of GDP) and employment in accommodation and food service activities rose through 2016.

### Short-term vulnerabilities and external position
- Reserve coverage (ratio of reserves to short-term external debt, percent, 2016) improved: examples cited with Croatia relative to Emerging Europe and other regions; specific ratios displayed in charts.
- External debt (percent of GDP): 2012 103.1, 2013 105.3, 2014 108.0, 2015 103.0, 2016 90.9, 2017 84.3, 2018 (Proj.) 78.7, 2019 (Proj.) 75.0, 2020 (Proj.) 71.0, 2021 (Proj.) 67.8, 2022 (Proj.) 65.8.
- Net external debt (percent of GDP): 2012 65.7, 2013 64.5, 2014 65.1, 2015 57.6, 2016 48.7, 2017 39.2, 2018 (Proj.) 33.4, 2019 (Proj.) 29.8, 2020 (Proj.) 26.1, 2021 (Proj.) 23.4, 2022 (Proj.) 22.2.
- Financing requirements (percent of GDP) and amortization schedules indicate sizable but declining refinancing needs; external debt levels remain high albeit declining through projected period.
- FX lending share has been declining, particularly to households (Oct-17).

### Key indicators (selected table highlights)
- Unemployment rate (percent): 2012 18.9, 2013 20.2, 2014 19.6, 2015 17.0, 2016 14.8.
- CPI inflation (avg.): 2012 3.4, 2013 2.2, 2014 -0.2, 2015 -0.5, 2016 -1.1, 2017 1.1, 2018 (Proj.) 1.5.
- Domestic investment (percent of GDP): 2012 19.3, 2013 19.1, 2014 18.6, 2015 19.8, 2016 19.8, 2017 19.7, 2018 (Proj.) 20.2.
- Gross official reserves (millions of euros): 2012 11,236; 2017 15,483; 2018 (Proj.) 16,244.
- Nominal GDP (billions of euros): 2012 43.9, 2013 43.5, 2014 43.0, 2015 44.1, 2016 45.8, 2017 47.8, 2018 (Proj.) 49.8.

### Policy recommendation
- It is recommended that the next Article IV consultation be held on the standard 12-month cycle.

*International Monetary Fund. Croatia: selected figures, fiscal and macro-financial projections, and vulnerability indicators (source: IMF staff estimates and Croatian authorities).*

### Annex I. Reform Implementation

### Annex I. Reform Implementation

### A. Progress in Implementation of IMF Recommendations
- Overall assessment
  - Croatia has made substantial progress in fiscal consolidation and debt reduction.
  - Pace of structural reforms moderated since EU accession in 2013 and reforms have more recently been largely paused due to political challenges.
  - Two governments formed in 2015-16; HDZ assembled two coalitions and secured only a thin majority.
  - Structural reforms since the 2016 Article IV have been only partially aligned with the authorities’ National Reform Program (2016 Article IV report, Annex V) and Fund advice.

- Fiscal consolidation
  - 2016 Article IV advice: Continue fiscal consolidation but make it more growth-friendly.
  - Action: Achieved. Annual fiscal consolidation in 2015-17 exceeded staff advice although partly due to strong economic recovery.

- Structural tax reform
  - 2016 Article IV advice: Reduce income tax rates and implement off-setting revenue, including eliminating one of the two preferential VAT rates. Introduce in 2018-19 a modern real estate tax.
  - Action: Limited progress. Improvements introduced to VAT and income tax systems, but original tax reform proposal was somewhat more ambitious. Introduction of the real estate tax was postponed.
  - Specific tax changes noted in the source:
    - General corporate (profit) tax rate reduced from 20 to 18 percent (for small businesses to 12 percent) while corporate tax exemptions were reduced.
    - For personal income tax, the minimum tax-exempt income was increased from 2,600 to 3,800 kuna and the tax rates were changed from 12, 25 and 40 percent to 24 and 36 percent.
    - Proposed VAT Act reduced number of tax rates from three (25 percent, 13 percent and 5 percent) to two (25 percent and 13 percent), but the adopted Act maintained the three rates.
    - Period for voluntary registration in the VAT system decreased from five to three years, and the threshold increased to 300,000 Kuna (about €40,000).
    - It will be possible to apply a tax deduction of 50 percent to advance VAT payments for the acquisition or lease of motor vehicles when the value does not exceed HRK 400,000.
    - Other VAT modifications relate to real estate transactions, import and customs operations, reciprocity in refunding VAT to third parties, and new measures to deter VAT ID fraud, including important changes in penalties.

- Streamlining public expenditures
  - 2016 Article IV advice: (a) Contain growth of the wage bill by linking remuneration to performance, introducing a single salary framework, and streamlining public administration. (b) Better target social expenditures by accelerating the one-stop shop for benefits while enhancing means testing.
  - Actions:
    - (a) Delayed. Decision prohibiting new recruitment of civil servants and employees in special administrative units, professional services and offices of the government was adopted in July 2016. Action Plan for Public Administration Development 2017-20 envisages establishing a unified competence framework; a pilot project to be launched in five ministries.
    - (b) No progress on one-stop shop; postponed to 2020. A new allowance for parents of small children starting at six months after birth was introduced; allowances from 6 to 12 months after birth were increased by 5 percent.

- Improving absorption of EU funds
  - 2016 Article IV advice: Improve implementation capacity, simplify administrative procedures, expedite transposition of the procurement directive.
  - Action: Limited progress. Croatia has contracted 29 percent from the €10.7 billion EU funds available under the 2014-20 programming period. National priority Action Plan for Increasing the Efficiency of EU Fund Use for 2016-2018 was adopted in June 2016.

- Strengthening public sector management
  - 2016 Article IV advice: (a) Advance privatization especially of inactive assets in a transparent way. (b) Amend the Fiscal Responsibility Law to strengthen the link between annual budget planning and the multi-year fiscal strategy.
  - Actions:
    - (a) Limited progress. Eight SOEs were divested in 2016. Methodological operational guidelines to make SOEs more efficient are underway. Some non-core assets have been sold but behind schedule. A draft proposal on further sales of state-owned apartments (about 4,000 apartments) has been drafted.
    - (b) Some progress. A new draft of the Fiscal Responsibility Act, being finalized, aims to enhance the autonomy and role of the Fiscal Policy Commission.

- Reducing administrative procedures to improve business environment
  - 2016 Article IV advice: (a) Reduce parafiscal fees. (b) Enhance the judiciary framework.
  - Actions:
    - (a) Some progress. January 2017 Action Plan for Reduction of Administrative Burden on the Economy adopted; identified 104 measures creating most administrative burden (health and safety at work, trade, energy efficiency in construction, business registration, real estate trade). Para-fiscal fees reduced by 30 percent in 2017. In May 2017, mandatory application of the SME test introduced for primary and secondary legislation.
    - (b) Limited progress. Court case backlog remains very high despite some improvement.

### B. Progress in Domestic Revenue Mobilization
- Overall revenue profile
  - Croatia’s public revenues are at the level of advanced European countries.
  - Croatia raises almost 46 percent of GDP in public revenues.
  - It has the highest indirect tax (on goods and services) ratio among European countries, at 20 percent of GDP.
  - Direct taxes raise barely 5.5 percent of GDP.
  - Tax collection through social contributions was almost 12 percent of GDP in 2016.

- Tax administration reforms and organization
  - CTA restructured over the past decade with World Bank assistance; major reforms occurred in 2013.
  - CTA opened a Large Taxpayers Office, a Taxpayer’s Service Unit, and a unit for Sector Strategy and Development.
  - Introduction of taxpayer identification number (OIB) central to e-citizen initiative.
  - CTA introduced fiscal registers for cash-based services and a public listing of tax delinquents.
  - Strengthened tax administration code expanded powers to collect tax-related information and enforce payment of tax arrears.

- Outcomes and performance metrics
  - Croatia is the EU country with the third smallest VAT tax gap (difference between expected VAT revenue and amount actually collected) per the cited European Commission source.
  - CTA reorganization approved in July 2017 included:
    - Empowering regional offices with legal departments for audit, enforcement, and other support.
    - Increasing automation of tasks.
    - Introducing a special Taxpayer Information and Education Department.
  - Growing use of technology:
    - Percentage of e-filing by the corporate sector increased from less than 3 percent in 2007 to more than 99 percent in 2016.
    - CTA website had nearly 30 million visits per year.
    - 2017 reforms introduced personal tax cards for e-filing; until June 2017 only businesses could file electronically, but upgrades funded by EU programs enabled all citizens to interact electronically.
    - New electronic services in 2017 include: user mail box, tax payer profile, and e-requests.
    - CTA’s strategy for 2016-20 aims at achieving paperless tax administration by the period-end.

- Remaining challenges
  - Slow implementation of a risk-based management system (risk management module, data warehouse, audit support) which should select taxpayers for audit based on risk analysis.
  - Need to build capacity in the Large Taxpayers Office; continuous training emphasized, including 12 e-learning modules developed with the World Bank.
  - Additional efforts required to reduce the number of transactions/administrative steps taxpayers must complete before settling obligations with the CTA.
    - Croatia ranks well on number of transactions and time required to pay corporate and income taxes alone, but when other taxes are included Croatia averages 35 transactions per tax payment compared to the European average of 12 transactions per payment (PwC, 2018).

*Source: cr1805 - Annex I. Reform Implementation*

### Annex II. Public Debt Sustainability Analysis

### Annex II. Public Debt Sustainability Analysis

### Overview
- Public debt has been declining since 2014, although it remains high.
- It is projected to be around 80 percent of GDP at end-2017.
- Gross financing needs remain elevated at about 13 percent of GDP in 2017.
- Under the baseline, debt will continue to gradually decline over the medium term.
- Projections are vulnerable to growth prospects and materialization of contingent liabilities, such as guarantees to SOEs, which are not included in the public debt statistics.
- The analysis includes a conservative estimate for privatization proceeds.

### Definitions, debt profile, and vulnerabilities
- Definitions and coverage:
  - Croatia’s gross debt statistics cover the general government (central, local, social security funds, and state-owned enterprises).
  - Liabilities included: cash and deposits, debt securities, and credits and loans.
- Debt profile and developments:
  - Central government debt accounts for 80 percent of general government gross debt.
  - About half of public debt is denominated in foreign currency (mostly euro).
  - More than 90 percent of outstanding debt matures beyond one year.
  - Since its peak in 2014, public debt has declined more than 5 percentage points, but remains high at almost 80 percent of GDP.
  - Gross financing needs have been high, but met on favorable terms due to lower risk premia because of the pick-up in economic activity and better than expected fiscal performance.
  - Debt denominated in euro has increased gradually due to issuance of domestic and foreign bonds denominated in or indexed to euro, borrowing in the domestic market via syndicated loans, and use of project loans from international financial institutions.
- Debt management strategy:
  - Authorities published an updated Debt Management Strategy (2017-2019) that emphasizes the need to accelerate fiscal adjustment and aims at reducing the debt-to-GDP ratio by 10 percentage points by 2020.
  - Key objectives: further reduce short-term debt, mitigate currency and interest rate risks, and increase transparency of public debt and borrowing.
  - Staff supported this strategy, while recommending additional adjustment to expedite the reduction in public debt.
- Realism of projections:
  - Croatia’s projected fiscal adjustment of about 2.5 percentage points in the cyclically-adjusted primary balance over the medium term is similar to other countries’ past adjustments.
- Vulnerabilities (heat map summary):
  - Stock of debt remains high.
  - Gross financing needs are no longer above the 15 percent high-risk threshold.
  - Debt profile has improved in terms of longer maturity, but external financing requirements remain high.
- Note on contingent liabilities:
  - In November 2017, Croatia refinanced part of the debt of highway companies through issuing a Eurobond (€ 1.3 billion bond with a 12-year maturity at a yield of 2.95 percent) under a state. The total debt of the road companies is €5.2 billion, or 11.2 percent of GDP.

### Baseline scenario: staff medium-term deficit and growth projections
- Fiscal path:
  - Preliminary data put the 2017 general government deficit at around 0.6 percent of GDP.
  - The deficit is projected to register -0.5 percent of GDP in 2018, and to move towards a small surplus in the medium term.
- Growth:
  - Real GDP growth is estimated at 3.1 percent for 2017.
  - Going forward, growth is expected to converge towards its potential rate of about 2 percent.
- Selected baseline projection table excerpts (percent of GDP unless indicated):
  - Nominal gross public debt: 2015: 58.7; 2016: 86.3; 2017: 88.7; 2018: 80.4; 2019: 77.5; 2020: 74.1; 2021: 71.0; 2022: 67.7; later: 64.4.
  - Public gross financing needs: 2015: 19.4; 2016: 16.1; 2017: 11.1; 2018: 12.8; 2019: 11.5; 2020: 8.7; 2021: 6.6; 2022: 4.2; later: 3.3.
  - Real GDP growth (percent): 2015: -0.1; 2016: 2.2; 2017: 3.0; 2018: 3.1; 2019: 2.8; 2020: 2.6; 2021: 2.4; 2022: 2.3; later: 2.2.
  - Inflation (GDP deflator, percent): 2015: 2.4; 2016: 0.0; 2017: -0.1; 2018: 1.1; 2019: 1.4; 2020: 1.4; 2021: 1.5; 2022: 1.7; later: 1.8.
  - Nominal GDP growth (percent): 2015: 2.3; 2016: 2.3; 2017: 2.9; 2018: 4.2; 2019: 4.2; 2020: 4.0; 2021: 4.0; 2022: 4.0; later: 4.1.
  - Effective interest rate (percent): 2015: 5.1; 2016: 4.2; 2017: 3.8; 2018: 3.2; 2019: 3.1; 2020: 3.0; 2021: 3.0; 2022: 2.9; later: 2.9.
  - Change in gross public sector debt (percent of GDP): 2015: 5.0; 2016: -0.3; 2017: -2.6; 2018: -3.3; 2019: -2.9; 2020: -3.4; 2021: -3.1; 2022: -3.2; later: -3.3; cumulative: -19.3.
  - Identified debt-creating flows (percent of GDP): cumulative: -16.5.
  - Primary deficit (percent of GDP): 2015: 2.7; 2016: 0.1; 2017: -2.0; 2018: -2.1; 2019: -2.0; 2020: -2.1; 2021: -2.4; 2022: -2.4; later: -2.5; cumulative: -13.6.
  - Automatic debt dynamics (percent of GDP): cumulative: -4.7.
  - Residual, including asset changes (percent of GDP): cumulative: -2.8.
  - Sovereign spreads (EMBIG bp): 189; 5Y CDS (bp): 106.
  - Ratings: Moody's Ba2/Ba2; S&Ps BBBB; Fitch BBBB.

### Risks to the baseline and mitigating factors
- Main downside risk: slower output growth.
  - Growth shock sources: uncertainties with the restructuring of Agrokor and abrupt changes in the external environment.
  - Risk has diminished as Croatia and external partners have regained growth momentum.
- Historical forecast performance:
  - Croatia’s real GDP growth forecast has been optimistic since 2009, but errors have diminished in magnitude in recent years, and growth has surprised on the upside.
- Fiscal overperformance:
  - Past track record of fiscal overperformance mitigates the balance of risks.
- Interest rate-growth differential:
  - A neutral interest rate-growth differential and consolidation efforts will result in much faster debt contraction than previously projected.
  - Gross financing needs are projected to decline due to lower deficits and recent refinancing at longer maturities and favorable interest rates, resulting in lower effective rates, even after assuming gradual increases in international interest rates.

### Shocks and stress tests: scenarios and impacts
- Real GDP growth shock:
  - Underperformance of real GDP growth by one standard deviation results in the primary deficit deteriorating to about 1.9 percent of GDP and public debt sharply increasing to over 90 percent in 2019, before improving thereafter.
  - Gross financing would approach the 15 percent of GDP mark in 2019.
- Combined macro-fiscal shock:
  - Assuming shocks to real GDP growth, the primary balance, real exchange rate, and real interest rate occur simultaneously, public debt would increase sharply and become close to 100 percent of GDP at its peak.
  - Gross financing needs would become close to 17 percent of GDP in 2019.
- Stress-test scenarios presented (selected underlying assumptions, percent):
  - Baseline: Real GDP growth 2017: 3.1; 2018: 2.8; 2019: 2.6; 2020: 2.4; 2021: 2.3; 2022: 2.2. Inflation 2017: 1.1; 2018: 1.4; 2019: 1.4; 2020: 1.5; 2021: 1.7; 2022: 1.8. Primary Balance 2017: 2.1; 2018: 2.0; 2019: 2.1; 2020: 2.4; 2021: 2.4; 2022: 2.5. Effective interest rate 2017: 3.2; 2018: 3.1; 2019: 3.0; 2020: 3.0; 2021: 2.9; 2022: 2.9.
  - Primary Balance Shock: Primary balance falls to 1.0 in 2018 then 1.1 in 2019 before returning to baseline.
  - Real GDP Growth Shock: Real GDP growth path includes 2018: -0.7 and 2019: -0.9 in the shock scenario.
  - Real Interest Rate Shock: Effective interest rate increases to 3.4 in 2018, 3.7 in 2019, 3.8 in 2020, 4.1 in 2021.
  - Real Exchange Rate Shock and Combined Shock assumptions also specified in the stress test matrices.
- Distributional and percentile projections:
  - Evolution of predictive densities of gross nominal public debt presented via percentiles (10th-25th, 25th-75th, 75th-90th) for 2015–2022 under baseline and restricted distributions.

### Quantitative indicators and external context
- External debt and external financing (Annex III excerpts):
  - Baseline: external debt (percent of GDP): 2012: 103.1; 2013: 105.3; 2014: 108.0; 2015: 103.0; 2016: 90.9; 2017: 84.3; 2018: 78.7; 2019: 75.0; 2020: 71.0; 2021: 67.8; 2022: 65.8.
  - Change in external debt (percent of GDP): 2012: -0.7; 2013: 2.2; 2014: 2.7; 2015: -5.0; 2016: -12.1; 2017: -6.6; 2018: -5.6; 2019: -3.7; 2020: -3.9; 2021: -3.2; 2022: -1.9.
  - Gross external financing need (billions of Euros): 2012: 14.1; 2013: 12.6; 2014: 12.8; 2015: 12.2; 2016: 13.6; 2017: 12.6; 2018: 15.9; 2019: 16.4; 2020: 16.7; 2021: 16.8; 2022: 16.4.
  - Gross external financing need (percent of GDP): 32.1; 29.0; 29.7; 27.8; 29.6; 26.4; 32.0; 31.6; 30.9; 30.0; 28.1 (2012–2022 series).
  - External debt-to-exports ratio (percent): 2012: 251.6; 2013: 246.6; 2014: 235.9; 2015: 211.4; 2016: 183.0; 2017: 161.5; 2018: 147.5; 2019: 137.4; 2020: 127.4; 2021: 118.9; 2022: 112.7.
- Key macro assumptions underlying baseline (selected):
  - Real GDP growth (percent): series from 2012 to 2022: -2.2; -1.1; -0.5; 2.2; 3.0; 3.1; 2.8; 2.6; 2.4; 2.3; 2.2.
  - Nominal external interest rate (percent): 2012: 3.4; 2013: 3.2; 2014: 3.3; 2015: 3.3; 2016: 0.8; 2017: 0.9; 2018: 0.9; 2019: 1.0; 2020: 1.1; 2021: 1.1; 2022: 1.2.
  - Growth of exports (Euro terms, percent): 2012: 1.1; 2013: 2.5; 2014: 4.8; 2015: 9.1; 2016: 6.1; 2017: 9.5; 2018: 6.5; 2019: 6.4; 2020: 6.3; 2021: 6.4; 2022: 6.6.

### Policy implications and recommendations
- Accelerate fiscal adjustment to support public debt reduction in line with the Debt Management Strategy objective to reduce the debt-to-GDP ratio by 10 percentage points by 2020.
- Further reduce short-term debt, mitigate currency and interest rate risks, and increase transparency of public debt and borrowing.
- Continue efforts to lower gross financing needs through durable fiscal consolidation and by pursuing longer-maturity refinancing at favorable rates.
- Consider divestment of state assets with proceeds used for public debt reduction; analysis includes a conservative estimate for privatization proceeds.
- Maintain vigilance on contingent liabilities (including guarantees to SOEs and highway companies’ debt) and ensure adequate monitoring and coverage in public debt statistics where appropriate.

*Prepared by IMF staff. Source: IMF staff estimates and projections contained in Annex II. Public Debt Sustainability Analysis.*

### Annex IV. External Sector and Competitiveness Assessment

### Annex IV. External Sector and Competitiveness Assessment

### Current account
- Croatia’s current account has been in substantial surplus since 2013.
- Tourism receipts averaged 18 percent of GDP in 2015-16 and have more than offset the traditional goods trade deficit.
- Exports of goods have grown strongly, especially since accession to the EU in 2013.
- The current account surplus declined in 2016 to 2.6 percent of GDP from a record high 4.8 percent a year earlier.
- The projected increase in the current account in 2017 is due to banks’ increased provisioning (losses) related to Agrokor, viewed as a one-off event that will reverse as banks absorb losses.
- Medium-term projection: current account projected to remain in surplus but gradually move towards balance as tourism revenue growth moderates and imports remain buoyant in line with investment and consumption projections.
- Staff adjustments and estimates:
  - Staff estimates the CA level effect of external deleveraging to be between 1 and 2 percent of GDP, implying an adjusted CA-balance of 1.1 percent of GDP.
  - Adjusting for EU accession effects (exports grew 35 percent cumulatively between 2013 and 2016; imports grew 21 percent over the same period) and low foreign value added share of Croatian exports (23.2 percent in 2014), staff estimates an effect of about 2.2 percent of GDP and an adjusted CA norm of 0.9 percent of GDP, implying a slight REER undervaluation of -0.5 percent.

### Capital and financial flows
- Outflows largely reflect:
  - Repayment of external public debt facilitated by rapid progress in fiscal consolidation.
  - Continued deleveraging by the banking sector, which is tapering off.
- The government has been obtaining part of its financing needs externally at favorable rates.
- Downside risk: tightening global monetary conditions.
- Policy implication: continued progress in fiscal consolidation would provide a useful cushion; advancing structural reforms would further improve market perception.

### Foreign assets and liabilities; external indebtedness
- Gross external debt declined over 2009-16 by 10 percentage points to 91 percent of GDP.
- External financing needs declined but remained elevated around 16 percent of GDP in 2016.
- Net international investment position (NIIP) improved from -90 percent of GDP in 2009 to -67 percent of GDP in 2016, largely reflecting deleveraging.
- NIIP remains much worse than the Euro Area average of -13 percent of GDP.

### Reserve adequacy
- Gross official reserves grew slowly in recent years but declined slightly in 2016 to €13.5 billion, in part due to abolishment of the requirement to maintain part of banks’ required reserves in FX with the CNB.
- Official reserves were moderately below the ARA metric in 2016 but comfortably above the benchmark of 100 percent of short-term debt.
- The ARA metric excludes banks’ obligation to maintain liquid FX assets (minimum 17 percent of FX liabilities), which serve as an additional buffer.
- Official reserves are projected to exceed the metric starting in 2017 due to strong current account surpluses and EU funds inflows.

### Assessment of external position (EBA-lite / ES / REER)
- EBA-lite yields mixed results:
  - One approach indicates a slight exchange rate undervaluation; two approaches indicate a slight overvaluation.
  - The current account (CA) approach unadjusted suggests an undervaluation of about 11 percent but leaves a residual up to 5 percent unexplained by policy variables.
- External Sustainability (ES) approach:
  - Suggests exchange rate is in line with fundamentals.
  - Staff targets a gradual strengthening of Croatia’s NIIP by roughly 3 percent of GDP per year to about -52 percent of GDP (the long-run average NFA of peer countries) in the medium term, with an underlying current account surplus of 0.5 percent.
- Real Effective Exchange Rate (REER) approach:
  - Points to a slight overvaluation of less than 2 percent.
- Overall staff assessment: Croatia’s external position is broadly in line with medium-term fundamentals.

- Reported model results, 2016 (as presented):
  - Adjusted CA norm0.9
  - Cyclically Adjusted CA balance1.1
  - CA - stabilizing NIIP at 52 percent in 5 years0.5
  - CA gap /10.20.1
  - REER gap (in percent) /2-0.50.31.8

### Competitiveness and business environment
- Non-price indicators point to broader competitiveness challenges despite recent relative declines in unit labor costs (ULC).
- ULC has declined relative to peers and trading partners, partly due to restrained compensation and some productivity growth.
- Business environment indicators:
  - Croatia’s overall Doing Business ranking fell 8 spots to 51st in the 2018 DB report.
  - Considerable deterioration in the "Paying Taxes" category (note: recent tax reforms were not covered by the report's cut-off date).
  - Increased administrative fees for building and occupancy permits have raised the cost of construction permits.
  - Improvement in registering property due to lower real estate transfer tax (from 5 percent to 4 percent).
  - Recent steps: introduction of a regulatory impact assessment pilot with SMEs; removal of the requirement of stamps on all documents.
  - Starting a business remains cumbersome.
- Competitiveness indicators and labor market:
  - Wages remain high relative to per capita income; average monthly gross wage and nominal GDP per capita comparisons show wages high relative to income.
  - Labor productivity versus wages: productivity not uniformly high across sectors.
  - Export growth has been low compared to peers; average export growth metrics show weakness.
- Policy implication: structural reforms are needed to address non-price competitiveness shortcomings and improve the business environment.

### Structural drivers of potential growth and policy recommendations
- Potential growth developments:
  - Estimated potential growth declined significantly after the GFC from around 4-4.5 percent in the mid-2000s to around 1–2 percent in recent years.
  - Disentangling cyclical and structural components of growth is difficult after prolonged subdued growth.
- Contributing factors:
  - Prior to the GFC, capital accumulation drove potential growth; post-crisis capital contribution fell but rebounded somewhat after EU accession.
  - FDI inflows have averaged only 3.4 percent of GDP since 2000.
  - Labor contributions turned negative in 2008 due to the crisis, demographic trends, falling participation rates, and emigration.
  - Participation rate was 65.6 in 2016; activity rate after age 50 declines rapidly due to loopholes in the social benefit system and early retirement.
  - TFP growth stalled after the crisis; country-specific obstacles include red tape, weak business environment, skills mismatches, deteriorating healthcare quality, and institutional weaknesses.
- Policy recommendations and scenarios:
  - Deep structural reforms would help raise potential growth.
  - In the baseline (slow reform) scenario, staff projects Croatia’s potential growth to hover around 2 percent.
  - Policies focusing on identification and elimination of structural problems (improving institutions, aligning education with labor market needs, encouraging lifelong learning, addressing social benefit incentives) may favorably impact long-term growth.
  - Continued fiscal consolidation provides cushion against external risks; advancing structural reforms would improve market perception and growth prospects.

*Prepared by Olamide Harrison.*

### Annex VI. Risk Assessment Matrix

### Annex VI. Risk Assessment Matrix

### Global risks
- Retreat from cross-border integration
  - Time Frame: Short to medium term
  - Relative Likelihood: Medium
  - Impact if realized: Medium to Low
    - "A fraying consensus about the benefits of globalization leads to protectionism and economic isolationism, affecting trade and investment. However, merchandise trade is not large and therefore the impact of this risk would not be as high as in countries with larger exports."
  - Recommended policy response:
    - "Growth-friendly fiscal consolidation; continue to reduce non-price competitiveness costs."

- Tighter global financial conditions
  - Time Frame: Short term
  - Relative Likelihood: High
  - Impact if realized: Medium to High
    - "Higher debt service and refinancing risks could stress leveraged firms, households, and the sovereign."
  - Recommended policy response:
    - "Growth-friendly fiscal consolidation; use FX intervention to smooth excessive exchange rate volatility. Accelerate private sector debt restructuring.  Encourage unhedged borrowers to shift to kuna loans at fixed rates, and ensure availability of kuna liquidity from the central bank. Encourage further development of a market for hedging instruments."

- Structurally weak growth in key advanced economies
  - Time Frame: Medium term
  - Relative Likelihood: High
  - Impact if realized: Medium
    - "Weaker export performance would weigh on economic growth and perpetuate macroeconomic vulnerabilities."
  - Recommended policy response:
    - "Accelerate private sector debt restructuring and structural reforms."

### Domestic risks
- Disorderly Agrokor restructuring
  - Time Frame: Short to medium term
  - Relative Likelihood: Medium
  - Impact if realized: Medium to High
    - "Creditor law suits, 'surprises' identified in the audit, abrupt closure of companies and the created uncertainty will affect companies’ profitability and domestic activity, including through higher unemployment."
  - Recommended policy response:
    - "Continue communication to align expectations; work with creditors on viable solutions; strengthen corporate governance."

- Lower and ineffective absorbtion of EU funds
  - Time Frame: Medium term
  - Relative Likelihood: Medium
  - Impact if realized: Medium
    - "A lower level of investment would affect growth negatively."
  - Recommended policy response:
    - "Accelerate reforms to improve absorption by improving processes and cutting red tape."

- Further reform standstill
  - Time Frame: Medium
  - Relative Likelihood: High
  - Impact if realized: Medium to High
    - "Thin majority of the coalition government pose additional challenges for the reform efforts. Lack of reforms will affect growth in the medium term through lower investment, further decline in TFP, and lower labor productivity."
  - Recommended policy response:
    - "Strengthen national commitment to reform by creating consensus. Reach for 'low hanging fruit' first."

*Source: Annex VI. Risk Assessment Matrix*

### Annex IX. Euro Adoption Considerations

### Annex IX. Euro Adoption Considerations

### Overview
- Croatia has benefited from EU membership, including through trade, the EU funds, and reforms that improve governance.
- The convergence criteria play an important role in encouraging the adoption of sound macroeconomic and financial policies and frameworks.
- Both theory and country experience suggest that it would be important to increase the dynamism and resilience of the economy in order to facilitate internal adjustment and to reap the full benefits of joining the currency union.

### Structural policies
- Structural reforms have both growth and stability objectives and should make the economy more efficient and thus support sustainable growth.
- Structural reforms are critical to facilitate smooth internal adjustment to cushion shocks, particularly those that affect Croatia and the Euro Area in asymmetric ways.
- This becomes particularly important when even modest exchange rate flexibility is no longer available.
- Given the delays in structural reforms, Croatia will need to revitalize them and expedite their implementation to make the economy more efficient, dynamic, and ready to withstand future shocks.

### Fiscal policies
- The EU’s Stability and Growth Pact (SGP) has been gradually strengthened to build adequate buffers during good times, but recently also to permit some country-specific flexibility.
- Croatia already exited from the EDP in June 2017.
- If the envisaged fiscal reforms are implemented, euro adoption could further boost confidence and reduce public financing costs.
- The strategy highlighted the need to prepare well for eventual euro adoption by:
  - creating fiscal space,
  - further reducing the high public debt, and
  - advancing structural reforms to accelerate convergence and facilitate internal adjustment in case of external shocks.

### Banking union and financial policies
- Croatia, like all other non-euro EU countries, has so far decided not to join the banking union before adopting the euro.
- More than ⅔ of the assets of Croatian banks are owned by parent banks in the Euro Area.
- Potential benefits from euro adoption and related integration:
  - more uniform, and hence smaller, regulatory costs for banks;
  - stronger competition that should, in principle, benefit customers;
  - substantial backing in case of a systemic crisis;
  - capital market harmonization would also likely be facilitated by euro adoption.

### Monetary and exchange rate policy
- Croatia’s monetary policy is already closely linked to the ECB due to the quasi-peg to the euro and a high degree of euroization.
- Biggest benefits of euro adoption would include:
  - elimination of currency mismatches;
  - lower interest rates and elimination of the exchange rate risk;
  - lower cost for kuna/euro transactions;
  - ECB support of the anchor;
  - potential influence on euro group decisions.
- The euro premium disappeared in 2010, but has recovered to about half its crisis level since 2015.

### Timing, decision process, and preparations
- The timing for applying for ERM II membership and eventual euro adoption ultimately depends on domestic preferences and must be done in consultation with EU institutions.
- In the case of Croatia, ERM II and Banking Union membership will be decided by the government in consultation with Parliament, since some legislation will likely need to be amended.
- Euro adoption does not formally require a referendum and will be decided by Parliament.
- The CNB has prepared a comprehensive report on the pros and cons of euro adoption as well as some technical background studies to inform the debate.
  - The report is available on: http://euro.hnb.hr; and the background papers on the possible impact on trade, inflation, and costs of borrowing are available on: https://www.hnb.hr/en/analyses-and-publications/occasional-publications/surveys.

*Source: Annex IX. Euro Adoption Considerations, Republic of Croatia — Staff Report for the 2017 Article IV Consultation.*

### 4.      In FY17, the Bank’s Board approved a loan and a guarantee for the Modernization and

### cr1805 - 4.      In FY17, the Bank’s Board approved a loan and a guarantee for the Modernization and Restructuring of the Road Sector amounting to US$23.3 million and US$370.7 million respectively.

### Multilateral financing and development partner engagement
- World Bank (FY17):
  - Approved a loan of US$23.3 million and a guarantee of US$370.7 million for the Modernization and Restructuring of the Road Sector.
  - Currently finances 8 investment projects and one regional GEF grant, totaling US$605 million.
  - Provides two guarantees amounting to US$627.1 million, with a large portion in the transport sector.
- International Finance Corporation (IFC):
  - Investments portfolio consists of 7 projects amounting to approximately US$153 million.
  - Sectors: financial sector, renewable energy, infrastructure, agribusiness, food retail, and general manufacturing.
  - Investment priorities: Croatia’s less-developed regions, projects contributing to economic diversification and regional integration.
- Multilateral Investment Guarantee Agency (MIGA):
  - As of June 30, 2017, MIGA has no outstanding gross exposure in Croatia.

### Assessment of data adequacy for surveillance (As of September 30, 2017)
General: Data provision is broadly adequate for surveillance, with a few shortcomings related to data coverage.

- National Accounts:
  - CBS publishes constant and current price data compiled in accordance with the ESA 2010 standard.
  - A breakdown of gross fixed capital formation into private and public components is not published (not required by Eurostat).
  - Minor discrepancies between nominal government consumption in national accounts and government consumption reported in government ESA 2010 accounts; being resolved.
- Wages and Employment:
  - CBS produces average net and gross earnings per person and employment by sector; currently reviewing the data series.
  - Earnings data include bonuses (in sums that are subjects to contributions, taxes, and surtaxes), sick pay, and meal allowances.
  - Earnings are based on monthly surveys covering 70 percent of workers in permanent employment in each division of NKD 2007 (NACE Rev. 2).
  - Coverage excludes a significant part of the working population: persons employed in trade and crafts, contract workers, and farmers.
  - Registered unemployed overstates actual unemployment; discrepancy significantly diminished in 2014.
  - Labor Force Survey: first conducted in 1996 on 7,200 households; expanded, semi-annual results since 1998, quarterly since 2007, with a lag of about four months.
- Price Statistics:
  - CBS produces monthly CPI with expenditure weights updated every five years; weights price-updated annually to December of the previous year.
  - Price collection timing varies by product; indices released around the fifteenth day of the following month.
  - Price collection confined to nine towns; weights based on a sample of households nationwide.
  - HICP calculated in line with Eurostat methodology.
  - Core CPI calculated based on methodology developed by the Croatian National Bank (CNB).
  - Monthly PPI released usually on the eighth day of the following month; weighting system based on the 2000 Annual Report of Industry and changed every five years with partial annual corrections.
- Government Finance Statistics:
  - Authorities have started presenting some budget plans based on ESA 2010; State Budget and local budgets remain based on national Chart of Accounts.
  - Historical general government data based on ESA 2010 are published nationally and by Eurostat but frequently revised.
  - Additional analysis to assess inclusion of some local government–owned enterprises in the government sector per ESA 2010 criteria.
  - Budget execution (cash) data produced monthly on the GFSM framework (GFS 2001); available in the Monthly Statistical Review of the Ministry of Finance (MOF) and time-series database.
  - Central government data normally lag about six weeks; end-of-year data often have much longer lags.
  - Revenue data reliable; expenditure data on a cash basis available according to GFS classifications for central budget and extra-budgetary funds.
  - Changes in institutions included in central government not always clearly indicated, affecting comparability over time.
  - Cash data for local governments and consolidated general government available quarterly; end-of-year data with long lags.
  - From January–March 2015, local and regional self-government unit data include all 576 local units and local units' extra-budgetary users (county road administrations).
  - Agreement (July 31, 2013) transferred responsibility for compilation of general government debt statistics to CNB; CNB compiles general government debt according to ESA 2010 and EDP definitions and publishes in CNB Monthly Bulletin.
  - Data showing central government guaranteed debt presented in CNB Monthly Bulletin reporting table.
- Monetary and Financial Statistics:
  - From 2015, CNB published monetary statistics using ESA 2010 framework with some backward revisions.
  - Since June 2013, IMF’s Statistics Department receives monetary statistics on Croatia directly from the European Central Bank.
  - For December 2001–June 2013, monetary statistics in IFS were based on IMF Standardized Report Forms per Monetary and Financial Statistics Manual, 2000.
  - For December 2010–June 2013, CNB reported revised data for other depository corporations covering money market funds in addition to licensed banks, savings banks, and housing savings banks.
- Financial Sector Surveillance:
  - CNB is banking supervisor; publishes selected financial soundness indicators (FSI), reports to IMF’s FSI Database, and provides IMF staff with broad range of FSIs.
  - Stress testing methodologies described in CNB Financial Stability Report (published twice a year).
  - Summary balance sheets and profit and loss statements of individual banks reported in Banking Bulletin (twice a year) with a lag of six to nine months.
  - Croatian Financial Services Supervisory Agency (HANFA) publishes monthly reports and summary statistics on regulated sectors.
- External Sector Statistics:
  - Quarterly balance of payments and international investment position data compiled broadly in accordance with BPM6.
  - Data generally available with a lag of three months and subject to revisions.
  - Net errors and omissions have ranged from 1 to 3½ percent of GDP since 2005, and are negative.
  - Coverage and quality of portfolio investment data reasonably complete and accurate.
  - Croatia participates in CDIS and plans to participate in CPIS after new security database is operational.
  - International Reserves and Foreign Currency Liquidity (Reserve Data Template) available with lag of one to two months.
  - External debt compiled according to External Debt Statistics: Guide for Compilers and Users, 2013.

### Data standards and dissemination
- Croatia has been a subscriber to the Fund’s Special Data Dissemination Standard (SDDS) since May 1996.
- Met all SDDS requirements in March 2001.
- No data ROSC has been published.

### Table of Common Indicators Required for Surveillance (excerpted dates and frequencies; as of December 7, 2017)
- Exchange Rates: Date of latest observation 12/05/17; Date received 12/07/17; Frequency D and M.
- International Reserve Assets and Reserve Liabilities of the Monetary Authorities: latest Oct. 2017; Date received 11/15/17; Frequency M.
- Reserve/Base Money: latest Oct. 2017; Date received 11/30/17; Frequency M.
- Broad Money: latest Oct. 2017; Date received 11/30/17; Frequency M.
- Central Bank Balance Sheet: latest Oct. 2017; Date received 11/30/17; Frequency M.
- Consolidated Balance Sheet of the Banking System: latest Oct. 2017; Date received 11/30/17; Frequency M.
- Interest Rates: latest Oct. 2017; Date received 11/30/17; Frequency M.
- Consumer Price Index: latest Oct. 2017; Date received 11/15/17; Frequency M.
- Revenue, Expenditure, Balance and Composition of Financing—General Government: latest 2017:Q3; Date received Nov. 2017; Frequency Q.
- Revenue, Expenditure, Balance and Composition of Financing—Central Government: latest 2017:Q3; Date received Nov. 2017; Frequency M.
- Stocks of Central Government and Central Government-Guaranteed Debt: latest 2017:Q3; Date received Nov. 2017; Frequency M.
- External Current Account Balance: latest 2017:Q3; Date received Nov. 2017; Frequency Q.
- Exports and Imports of Goods and Services: latest 2017:Q3; Date received Nov. 2017; Frequency Q.
- GDP/GNP: latest 2017:Q3; Date received Nov. 2017; Frequency Q.
- Gross External Debt: latest 2017:Q3; Date received Nov. 2017; Frequency M.
- International Investment Position: latest 2017:Q3; Date received Nov. 2017; Frequency Q.

### Statement by the IMF staff representative (January 10, 2018)
- Authorities revised preliminary projection for 2017 fiscal balance from a deficit of 0.6 percent of GDP to a surplus of 0.6 percent.
- Public debt projected to be 78 percent of GDP at end-2017.
- Preliminary stronger fiscal outcome attributed to higher-than-expected revenues and enhanced expenditure control; detailed data not yet available.
- Recent revisions of real GDP data for 2015 and 2016: 2.3 percent and 3.2 percent, respectively.
- Survey data indicate unemployment declined to a single digit for the first time since 2008.
- Inflation in November was 1.4 percent, y-o-y.

### Statement by Croatian authorities (January 10, 2018) — key developments, outlook, and policy priorities
Recent economic developments and outlook:
- Real GDP growth reached 3.3 percent y-o-y in the third quarter of 2017.
- Credit growth projected to be 3.0 percent y-o-y in 2017 (based on transactions).
- Medium-term real GDP projected to slow to 2.8 percent, reflecting expected lower tourism revenue growth and slower personal consumption; investments expected to pick up with stronger use of EU funds.
- Authorities emphasize need for further structural reforms via National Reform Programme (NRP) for 2018.

Fiscal policy and debt management:
- Strong fiscal adjustment in last two years: overall budget deficit was -0.9% of GDP in 2016; preliminary 2017 data point to a surplus of 0.6% of GDP.
- Public debt to GDP ratio shrank from 85.4% in 2015 and is projected to be around 78% by end-2017.
- Croatia exited Excessive Deficit Procedure (EDP) in June 2017.
- State budget for 2018-2020 and NRP envisage continued prudent fiscal policy and additional reduction in public finance imbalances (revenue and expenditure measures; improved tax administration and collection).
- Authorities aim to gradually decrease public debt to close or below 60% of GDP and committed to start official process of euro adoption.
- Four pillars for medium-term public finance sustainability:
  1. Strengthen public financial management framework and continue fiscal consolidation.
  2. Reduce healthcare arrears and ensure healthcare system sustainability.
  3. Improve efficiency of social benefits system.
  4. Ensure long-term sustainability of the pension system.
- New Public Debt Management Strategy for 2017-2019 adopted in January 2017, combined with favorable market conditions, brought savings in interest rate payments of close to 0.3% of GDP.
- Financial and operational restructuring of highway companies guided by World Bank; further productivity and efficiency improvements in SOEs needed.
- New Fiscal Responsibility Act planned for adoption in 2018 after consultations.
- Introduction of real estate tax planned for January 2018 will be postponed for further design work.

Monetary policy and financial stability:
- Monetary authorities to continue accommodative policy while anchoring exchange rate stability and monitoring financial stability risks.
- Kuna liquidity strengthened in 2017 via foreign exchange interventions to alleviate appreciation pressures.
- Eased access to favorable kuna funding for banks, enabling a pool of eligible assets for collateral in central bank operations.
- Authorities encourage kuna-based lending and caution against euro-denominated variable-rate lending.
- Banking system remained well capitalized, profitable, and liquid.
  - Total capital ratio mildly increased to above 23% by end-June 2017.
  - NPLs to total loans stood at 12.5%, the lowest level in six years.
  - Provisioning for possible losses associated with the Agrokor Group had a significant impact on bank results; stress tests showed strong resilience.

Competitiveness and structural reforms:
- Authorities prioritize structural reforms to improve business environment, labor market conditions, and public administration quality.
- Tax reform introduced in 2017 aimed at reducing total tax burden, developing stable and predictable tax system, and simplifying tax administration.
- Action plan for administrative relief (adopted January 2017) yielded 104 measures; implementation in 2017 allowed for administrative savings to the economy of up to HRK 1.5 billion or 30%.
- Draft Law on the Management of State Assets introduced end-2017 to exploit vacant state-owned real estate, particularly in tourism, to attract FDI.
- Divestment of state assets continued (example: Port of Rijeka sold to private investors).
- Revision of salary determination system in public administration and public services envisaged for 2018 to stimulate expertise and reward performance.
- Large-scale reform of social benefits postponed; authorities plan coordination and centralization by 2020 with a one-stop shop; aim to streamline benefits to those in need while addressing demographic challenges.

*Source: Croatia—Statistical Issues and statements (as provided in the supplied content).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2018/cr1805.pdf_