Croatia: Staff Concluding Statement of the 2016 Article IV Mission
IMF News, May 10, 2016
Source details
- Canonical URL
- Croatia: Staff Concluding Statement of the 2016 Article IV Mission
Other formats
Bibliographic details
- Published: May 10, 2016
Recent developments and outlook
- Since late 2014, the Croatian economy has been gradually recovering from a six-year long recession, mostly on the back of strong exports, tourism activity, and consumer confidence.
- Real growth in 2015 registered 1.6 percent, notwithstanding a slowdown in the fourth quarter.
- IMF staff projects:
- Growth of about 1.9 percent in 2016, aided by strong exports of goods and services and a continued pick-up in private consumption.
- Medium-term growth stabilizing at around 2–2¼ percent.
- Inflation projected to return to positive territory in 2016 and to remain low over the medium term.
- External sector:
- The current account registered a record surplus of 5.2 percent of GDP in 2015, partly explained by a one-off cost of foreign-owned banks related to the Swiss franc loan conversion (about 2 percent of GDP).
- External debt declined to about 104 percent of GDP in 2015 and is expected to fall further over the medium term with ongoing deleveraging and fiscal consolidation.
- Risks and scenarios:
- Downside risks predominate, including a slowdown in external demand, normalization of global monetary conditions increasing public financing costs, and border disruptions associated with the refugee crisis.
- Domestic political conditions could impede reform implementation and economic policy-making.
- Upside influences include persistently lower energy prices (favorable for production costs and purchasing power) and accelerated reforms improving growth and competitiveness.
- Policy priorities to mitigate risks:
- Finalize and communicate remaining details of the national reform program.
- Adhere to the budget process outlined in Budget Law and Fiscal Responsibility Law.
- Preserve the independence of the central bank in line with the Statute of the European System of Central Banks.
Fiscal policy
- 2015 fiscal outcomes and drivers:
- Overall general government deficit in 2015 is estimated at 3.2 percent of GDP, compared to 5.5 percent in 2014.
- Contributing factors: cyclical upturn in revenues, consolidation efforts, and a substantial decline in general government investment.
- Consolidation measures included increases in excises on fuel and tobacco, full-year effect of the 2014 increase of health insurance contributions, and improved tax administration.
- Expenditure containment included measures on the wage bill (mainly seniority bonuses) and subsidies; some agricultural subsidies now paid directly by the EU Agricultural Guarantee Fund.
- Preliminary data indicate a one-off decline in public enterprise investment equivalent to about 0.8 percent of GDP, possibly due to lack of execution during the caretaker government’s term in Q4.
- As final financial statements become available, estimated investments could be revised upwards, with implications for the size of the 2015 deficit depending on financing.
- 2016 budget and near-term risks:
- The 2016 budget targets a deficit of 2.6 percent of GDP.
- Risk of higher public investment could lead to a slightly higher deficit of 2.8 percent of GDP.
- Authorities indicated close monitoring and control of expenditure, with compensatory measures as needed to achieve the budget target.
- Acceleration of reform implementation, including in the health sector (large arrears and inefficiencies), would ensure faster deficit reduction and improve quality of consolidation, which is currently focused on an across-the-board expenditure freeze.
- Medium-term reform and consolidation:
- The national reform plan aims at a further steady ambitious fiscal consolidation over the medium term, including both tax and expenditure reductions.
- Mission projects a somewhat slower pace of expenditure and thus fiscal consolidation compared to the national plan, given downside risks.
- Important complementarities:
- Any reduction in taxes should go hand in hand with other reforms that create fiscal space.
- Finalize remaining reform details to enhance efficiency, growth, and equity.
- Specific policy recommendations:
- Streamline social benefits and reform the health sector in cooperation with the World Bank to reduce costs and enhance efficiency and equity; accelerate the one-stop shop for numerous benefits and increase means-testing to improve targeting.
- Contain the large wage bill and make part of compensation performance-based to enhance incentives and public service quality.
- Introduce a modern real estate tax appropriately phased-in, building on the existing communal fees system; timely modernization of the land registry and cadastre is necessary, and exemptions should be very limited to enable a low rate that yields substantial revenue.
- Improve absorption of EU structural and investment funds, contributing to growth with modest fiscal impact.
- Strengthen public expenditure monitoring and control and put in place a contingency plan to guard against fiscal slippages.
Monetary policy and banking sector
- Exchange rate and monetary stance:
- Given the high degree of euroization, there is no viable alternative to the quasi-peg to the euro at this juncture.
- Mission encourages authorities to continue smoothing sharp exchange rate fluctuations while expediting structural reforms to enhance competitiveness.
- Use the strong balance of payments position to further bolster international reserves.
- Staff encourages the CNB to continue an accommodative monetary policy stance within limits set by the exchange rate anchor and financial stability objectives.
- Liquidity and instruments:
- Ample liquidity has been ensured, including through the recent introduction of a four-year structural reverse repo facility that helped provide stable long-term kuna funding.
- Availability of such funding should help gradually reduce high euroization and increase monetary policy traction.
- Banking sector soundness:
- The banking sector has remained robust despite difficult economic conditions during the recession; continued conservative prudential policies and supervisory vigilance are needed.
- On average, the system is liquid and well-capitalized.
- Banks remained profitable in recent years except for 2015 due to costs from the Swiss franc loan conversion.
- Mission’s view: a linear bailout without any social criteria should had been avoided, as it increased the risk of moral hazard.
- Non-performing loan (NPL) ratio seems to have stabilized but remains high at 16.6 percent.
- NPLs are fairly provisioned at 56.6 percent.
- Anecdotal information suggests some banks may begin to lend more with the improved outlook for non-financial enterprises and households.
- In 2015, one small, but regionally important bank began the resolution process in accordance with the EU Bank Recovery and Resolution Directive.
Structural reforms
- Growth potential and business environment:
- Ambitious structural reforms are essential to enhance Croatia’s growth potential.
- Business environment indicators suggest significant room for improvement.
- Recommendations: reduce bureaucratic impediments to doing business, improve policy transparency and predictability, enhance the judiciary process, and strengthen anti-corruption efforts.
- Labor market and benefits:
- High unemployment and low labor participation call for further labor market and benefit system reforms.
- Make regulations on temporary employment, severance payments, and hiring and retrenchment of employees less restrictive to encourage employment creation.
- Create fiscal space to reduce the high tax on labor.
- Better targeting of unemployment and veterans benefits and implementation of planned pension reforms would help improve participation rates.
- Public sector management and privatization:
- Strengthen public sector management and advance planned privatization in a transparent and fair fashion to improve efficiency and put large public debt on a faster downward path.
- Government bodies and decentralization:
- Plans to streamline the large number and multiple layers of government bodies should be ambitious, in line with initial announcements, to reduce fiscal cost, red tape, and improve regional equity and quality of public services.
Mission details
- An IMF mission led by Khaled Sakr visited Zagreb during April 27 – May 10, 2016.
- Meetings included: Prime Minister Orešković; Deputy Prime Minister Petrov; Minister of Finance Marić; Minister of Social Policy and Youth Juretić; Minister of Health Nakić; Minister of Tourism Kliman; Governor of the CNB Mr. Vujčić; President of The Commission on Fiscal Policy and Chairman of Finance and Central Budget Committee of the Parliament, Mr. Marić; other officials and representatives of the business community, labor unions, and academia.
- The mission is grateful to the authorities and other counterparts for their excellent cooperation and constructive discussions.
IMF staff concluding statement, May 10, 2016.