Press Release: IMF Executive Board Approves 20-Month Stand-By Arrangement for the Republic of Croatia

August 4, 2004

The Executive Board of the International Monetary Fund (IMF) has approved a 20-month Stand-By Arrangement in an amount equivalent to SDR 97 million (about US$141.3 million) for the Republic of Croatia to support the country's economic program. The Croatian authorities intend to treat the arrangement as precautionary and are not planning to draw funds under the credit.

The previous Stand-By Arrangement, which was also treated as precautionary, was approved on February 3, 2003 (see Press Release No. 03/13). It expired on April 2, 2004.

Following the Executive Board discussion of the Republic of Croatia on August 4, 2004, Mr. Takatoshi Kato, Deputy Managing Director and Acting Chair, said:

"Croatia's economic growth and inflation performance since the mid-1990s compares well with the Central and Eastern European countries (CEECs), the economy is open, and structural reform is advanced. But this good performance has been accompanied by a worsening of Croatia's external current account deficit and rising external debt. These trends accelerated since the turn of the decade and have made Croatia vulnerable to external shocks. The authorities have recognized the extent of the external imbalance and should be commended for designing a set of policies to address it that emphasizes fiscal consolidation and supporting structural measures.

"The total fiscal and quasi-fiscal adjustment of 2¾ percentage points of GDP targeted for 2004-05 is ambitious. The government has shown its commitment by the decision to postpone the planned VAT rate reduction. But given the uncertainties surrounding the short-term outlook, the authorities should stand ready to adjust fiscal targets as needed to secure the macroeconomic objectives of the program.

"The measures to enhance transparency, control quasi-fiscal activities, and improve expenditure and debt management are welcome. To sustain the fiscal adjustment, the government will need to undertake significant expenditure reforms in the context of a medium-term expenditure plan. This would also enable it to achieve its goals of reducing the tax burden and adjusting spending priorities in order to meet EU accession-related needs. To achieve these goals, the government should focus on reducing the share of current spending, which is relatively high in Croatia.

"Exchange rate stability has worked well as the basis for monetary policy in Croatia. Although this choice constrains monetary policy, managing bank liquidity is still important in a bank-dominated financial sector. The Croatian National Bank (CNB) should continue to allow short-term exchange rate fluctuations and stand ready to take measures to safeguard its international reserves target. The plans to introduce open market operations and the commitment to close cooperation between the CNB and the Ministry of Finance are welcome.

"The financial sector seems to be in good health and supervision has been improved, but gaps remain. The CNB needs to increase the focus on the foreign exchange exposure of banks' customers. The authorities should also close gaps in nonbank financial supervision and improve cooperation between supervisors at home and abroad, considering the significant risk transfers from banks to other financial institutions and the high degree of financial integration with the rest of the world," Mr. Kato said


Recent Economic Developments

Since the mid-1990s, Croatia has recorded satisfactory GDP growth averaging 4.5 percent and inflation in the low single digits. These numbers compare well with the EU-15 and Central and Eastern European countries (CEECs).

However, a persistent gap between savings and investment since the mid-1990s has led to high current account deficits and a gradual build-up of foreign debt-trends that were fueled by a credit boom in 2001-02. Macroeconomic policies did not manage to contain the credit-financed surge in domestic demand and the external position deteriorated sharply during this period. The fiscal consolidation underway was not sufficient to offset the growth in private consumption and investment; and monetary policy was constrained by the Croatian National Bank's preference for nominal exchange rate stability and a very open capital account. As a result, the current account deficit rose sharply to 8.4 percent.

Private sector activity started moderating in the second half of 2003, but there was a sharp reversal of fiscal policy in the run-up to the November elections. As a result, the deficit jumped to 6.3 percent of GDP, derailing the last Stand-By Arrangement. Although the current account improved in 2003 due to large tourism receipts, external debt continued to rise reflecting strong capital inflows.

Program Summary

The government's program is designed, in the short term, to restore order in Croatia's public finances and limit the vulnerability arising from the high current account and external debt burden, and in the medium term, to modernize and reduce the role of the state, promote private sector activity, and prepare Croatia to compete within the EU.

Fiscal policy is the main instrument to achieve the objective of narrowing the gap between domestic savings and investment so as to reverse the trend of the external debt-to-GDP ratio over the medium term. On the assumption that non debt-creating capital flows would gradually decline over the medium term as privatization is completed, staff projects that a current account deficit of 5-5.5 percent of GDP in 2004-05 will gradually decline to about 4 percent in the medium term. This would first stabilize and then start reducing the external debt burden. The authorities also expect foreign direct investment unrelated to privatization, to get a boost from the prospects of EU accession.

In the short term, the government will aim at resuming fiscal consolidation and restoring transparency. The 2004 budget, including a supplementary budget approved by parliament in mid-July, targets a general government deficit of 4.5 percent to be achieved through an increase in revenues and, to a lesser extent, a reduction in investment. In 2005, the emphasis will shift to expenditure measures to reduce the deficit to 3.7 percent of GDP. Current spending will decrease by 1 percentage point of GDP, reflecting a lower wage bill as a result of ongoing reductions in personnel (mainly defense sector) and cost savings it the administration of public services. Budget financing will gradually shift to domestic sources, which will help reduce the government's exposure to exchange rate risk, boost the development of the domestic capital market, and help absorb excess liquidity in the private sector in the short run. In addition, the authorities intend to limit the issuance of new government debt guarantees, strengthen financial discipline, and improve the performance of public enterprise.

The government also sees the need for fiscal consolidation in a broader context. Restoring discipline and transparency in the public finances after 2003 is important not only from a macroeconomic point of view, but also for the accountability and credibility, domestically and abroad, of the state. For this reason, the consolidation effort would not only focus on reducing the government deficit, but also encompass quasi-fiscal operations, debt management, and the wider public sector. The government also sees consolidation in 2004-05 as the foundation for future measures to reduce the high tax burden in Croatia.

In regard to monetary policy, the CNB intends to pursue its price stability mandate by keeping the exchange rate of the kuna broadly stable agains the euro. It will pursue its 2004 targets for reserve and broad money growth at about 8-9 percent. To achieve these targets and signal its commitment to the external objectives of the program, the CNB introduced on July 1 a new marginal reserve requirement on foreign borrowing, and intends to maintain its Net Domestic Assets (NDA) below the level of negative HRK 3 billion for the remainder of the year. Further, the CNB plans to start open market operations (OMOs) with government paper to enhance liquidity management and facilitate the shift in government financing toward domestic sources.

On public sector reforms, the government is planning to take steps to enhance fiscal transparency and improve expenditure and debt management based on recent IMF and World Bank findings on major weaknesses in these areas. Further, the government plans to set annual budgets in the context of a medium-term fiscal policy framework, and ensure the long-term sustainability of the pension system. The authorities intend to restore momentum in the privatization process. The Privatization Fund (HFP) will aim at privatizing all companies in which the government holds a share of up to 25 percent by year-end and all remaining holdings in its portfolio by end-June 2005. Outside HFP's portfolio, the government will resume efforts to restructure and privatize large state enterprises. Finally, the government will take steps to improve the business environment, financial sector supervision, and statistics.

Croatia: Key Macroeconomic Indicators, 2001-05
















Output, unemployment, and prices


Real GDP








Unemployment (survey based, in percent)








CPI inflation (average)









General government and HBOR operations 1/


General government revenues








General government expenses and net lending








Overall general government balance








Overall HBOR balance (net of budget transfers)








Fiscal and quasi-fiscal balance








General government debt









Money and credit


Credit to the nongovernment sector








Broad money








Base money









Interest rates


Average deposit rate








Average credit rate









Balance of payments and external debt


Current account balance 2/








Total external debt (end of period)








Net external debt (end of period) 3/









Sources: Croatian National Bank, World Economic Outlook, and IMF Staff estimates.


1/ Prior to 2002 on GFS 1986 basis and from 2002 on GFS 2001 basis with net lending and government-guaranteed loans to the railway company included in expenses and all privatization in financing.

2/ Break in the series in 2002 due to a change in methodology of estimating the costs of insurance and freight, which led to an upward revision of the current account deficit by 1.3 percent of GDP.

3/ Net of gross official reserves and commercial bank assets.

4/ As of April 2004.


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