Croatia: Staff Concluding Statement of the 2021 Article IV Mission
IMF News, June 23, 2021
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- Published: June 23, 2021
Summary
- Between the pandemic and two large earthquakes, Croatia was severely tested; resilience has come through.
- Economic contraction in 2020: 8 percent.
- Recovery outlook 2021: growth between 5 and 6 percent, driven by rebound in services and investment, conditional on pandemic developments.
- Recovery caveats: tourism and directly related sectors not fully recovered; full recovery likely to take another year or two.
- Best-case 2021 scenario: with successful vaccination drive and favorable tourism outcomes, growth could exceed 6 percent.
Near-term economic developments and labor market
- Q1 2021: recovery picked up noticeably; construction and manufacturing activity already above 2019 levels.
- Registered unemployed persons: fallen by nearly 13 percent since a year ago.
- Tourism-related recovery: likely to take another year or two.
- If the pandemic fades by end of this year, growth could remain high over the next few years, provided timely and full use of forthcoming EU funds.
Fiscal priorities in 2021
- Support measures enacted in 2020 included subsidy and job retention schemes, tax relief and deferrals, opt-in limited time debt service moratorium, guarantees and grants to businesses.
- IMF staff view: most important fiscal goal in 2021 is to focus on spending available resources wisely to restore the economy to health.
- Support measures should:
- Remain in place until health of population and economy fully restored.
- Be better targeted to lagging sectors as conditions improve.
- Rotate toward preparing the workforce for the post-pandemic world and facilitating balance sheet repair of viable businesses.
- Healthcare priorities:
- Vaccination drive must be as successful and widespread as possible.
- Extra healthcare costs should be fully met and arrears in the healthcare system reduced to the maximum possible extent.
- Revenue stance:
- Authorities need to conserve all available resources to meet unexpected expenditures into 2022 and beyond.
- IMF staff: not the right time for further tax cuts or weakening of the tax base; frequent tax changes create uncertainty.
Public investment and EU funds (opportunity and absorption)
- Recovery and Resilience Fund (RRF) grants: amount to 10.6 percent of GDP to be utilized by 2026.
- Taken together with regular structural EU funds: total inflows could be 35.7 percent of GDP over the next six years.
- IMF staff assessment: RRF funds alone could add as much as 2.9 percentage points to real GDP over the next twenty years (estimate relative to a policy neutral real GDP baseline).
- Potential outcomes if investments and reforms are implemented:
- Significant upgrade of public capital stock, decarbonization, digitalization catch-up, improved maritime and rail transport.
- Narrowing of a 35% gap in per capita income with respect to the EU average, over time.
- Reduced outward migration and lowered risks to sustainability of healthcare and pensions systems.
- IMF recommendation: fully absorb funds efficiently and in a timely manner, accompanied by needed reforms.
Public investment management and IMF support
- Need to strengthen public investment management practices: planning, selecting, budgeting, and implementation to meet international best practice across the public sector.
- Authorities requested a Public Investment Management Assessment (PIMA) from the IMF for August 2021 to prepare an action plan ensuring effective and climate-sensitive investment spending.
- NRRP (National Recovery and Resilience Plan) commitments across five components: green and digital economy; public administration and judiciary; education, science and research; labor market and social protection; and healthcare. The plan is “front-loaded” with a significant share of reforms slated for completion over the next three years.
Structural reforms and fiscal-strengthening measures (priority areas)
- Civil service and administrative reforms, including:
- Modernization of the public salary system.
- Improving territorial organization of sub-national governments.
- Healthcare reforms:
- End stop-gap measures for healthcare arrears by overhauling cost structure (centralize procurement of medicines, merge medical services to exploit economies of scale).
- Explore a more sustainable revenue base to preserve healthcare quality standards.
- State-owned enterprises (SOEs):
- Develop and implement a full-fledged SOE strategy: separate core from non-core businesses, strengthen oversight for core SOEs so they remain financially durable after public service obligations.
- Authorities’ commitments to sell some non-core SOEs over the next few years noted as promising.
- IMF stands ready to provide capacity development for SOE oversight if desired.
- Pensions: ensure long-term sustainability given population aging.
- Competitiveness: continue improving competitiveness via active dialogue with the private sector; recent proposed improvements for tourism and non-tourism sectors are steps in the right direction.
- Business environment: reforms to debt restructuring, insolvency, and legal predictability/efficiency are central to unlocking private investment.
Monetary and financial sectors: vigilance recommended
- Monetary policy: remains highly expansionary within the exchange rate anchor in place since 1993; stance considered appropriate to nurse the economy back to health.
- Liquidity: more than ample funds in the banking system to meet credit demand.
- Inflation: recent pick-up likely transitory (energy prices and nascent recovery); if inflation proves more persistent than in the euro area, the CNB may consider reducing excess liquidity while maintaining exchange rate stability.
- Banking system: liquid and on average well capitalized.
- Credit dynamics:
- Restoration of credit register welcomed to help banks’ risk management.
- Bank lending to companies initially strong but recently tapered off; bank lending for housing remains firm.
- Uncollateralized retail cash loans have fallen—considered a healthy development.
- Asset quality:
- Ratio of non-performing loans (NPLs) to total loans has remained stable.
- Stage II loans (forward-looking indicator of future asset quality problems) have risen, particularly for non-financial corporations — warrants continued close monitoring.
- Housing market:
- Upward trend in house prices in Zagreb and coastal areas continues.
- If housing purchases are not driven by excessive household borrowing, they do not constitute an immediate financial stability risk, but require continued CNB monitoring.
- CNB could consider more formal macro-prudential measures if circumstances require (beyond the current implicit debt-service-to-income ratio in the Foreclosure Act).
Conclusion and policy message
- Croatia faces a rare opportunity over the next five years to restore its people and economy to health by ramping up public investments with EU funds.
- Success requires:
- Timely and efficient absorption of EU funds.
- Broad stakeholder support for vital reforms.
- Re-energizing private investment and innovation.
- Strong focus and preparation for euro adoption to reap full benefits of the currency union.
- The time to act is now.
Source: Croatia: Staff Concluding Statement of the 2021 Article IV Mission, June 23, 2021.
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