Press Release No. 01/10

The Executive Board of the International Monetary Fund (IMF) today approved a 14-month stand-by credit for SDR 200 million (about US$255 million) for Croatia. The decision will enable Croatia to draw SDR 40 million (about US$51 million) from the IMF immediately. However, in view of the comfortable reserve level, good access to capital markets, and the positive external outlook, the authorities do not intend to make purchases and will treat the arrangement as precautionary.

Following the Executive Board discussion on Croatia, Stanley Fischer, First Deputy Managing Director and Acting Chairman, said:

"The Croatian authorities are commended for adopting a three-year economic program for 2001-03 that seeks to achieve sustainable high rates of economic growth with price stability and external viability through fiscal adjustment, wage discipline and structural reforms in the context of continued exchange rate stability. Reduced government spending, a lower tax burden, wage restraint throughout the economy as well as economic liberalization, restructuring, and privatization will help boost productivity—the basis for future real wage increases and higher living standards—and employment. The program is ambitious, as is necessary for Croatia's economic stability and development, and its successful implementation will require firmness on the part of the authorities and support by parliament and the public at large.

"The authorities have acted forcefully to implement their program for 2001 by adopting a restrained budget, introducing a new treasury system, and laying the foundations for a tight wage policy in the public sector. The full implementation of this policy is crucial for attainment of the government's deficit target and for the adoption of a social pact that establishes responsible wage guidelines in the rest of the economy. It is therefore urgent for the government to translate its legislative authorization into actual wage scales for civil servants and other government workers, and to adopt and start implementing specific employment reduction plans. The finances of the pension and health funds should be firmly controlled while more fundamental reforms are being prepared with the assistance of the World Bank. If slippages in the fiscal area were to materialize despite these efforts, the authorities should not hesitate to activate the contingency measures identified in their program.

"The 2001 budget's heavy reliance on privatization receipts makes it essential for the authorities to press ahead with their privatization plans. Prompt and decisive action in this area will inspire confidence in the authorities' economic program and improve economic efficiency over time.

"With improved access to foreign markets, continued regional stability, and full implementation of the program, the present level of the exchange rate should remain appropriate, thus maintaining Croatia's external competitiveness during the program period. The Croatian National Bank's (CNB) monetary program for this period is consistent with a stable exchange rate, but the CNB should not resist any unexpected large or persistent exchange market pressures," Mr. Fischer said.

ANNEX

Program Summary

Croatia's economy has pulled out of the 1998/99 recession and the banking system has recovered from its recent crisis. Consumption was boosted in 2000 by large wage increases granted during 1999, the lifting of political uncertainties, and monetary easing, while exports benefited from the recovery in Europe, past real effective depreciation, and a strong tourist season. Real GDP growth is likely to accelerate to 4 percent in 2001 from an estimated 3.5 percent in 2000. However, this moderate acceleration is still too little to make a dent in unemployment at a time of planned public sector layoffs. Although both its headline and core rates have risen in 2000, the outlook for inflation remains benign, with retail price inflation subsiding to 4.5 percent during 2001 from 7.4 percent in 2000 as a result of wage restraint, exchange rate stability, and oil price moderation.

The authorities are committed to slashing the size of government and its financial imbalance, while maintaining price stability on the basis of a broadly stable exchange rate. The new government has made a good start in 2000 in reducing government spending, tax pressure, and the fiscal imbalance. Concurrently with fiscal adjustment, the CNB has eased monetary conditions. Under its fiscal framework for 2001-03, the government intends to reduce consolidated central government spending from 46.2 percent to 37.6 percent of GDP and the fiscal deficit to 1.3 percent of GDP from 6.5 percent.

The authorities' program for 2001 is based on further fiscal adjustment, wage restraint, and structural reform. The policies are designed to ensure the desired stability of the exchange rate under the chosen managed float regime. But the CNB will not resist persistent or large exchange market pressures or tolerate endangering achievement of its quarterly international reserve targets.

Fiscal policy aims to reduce the consolidated central government deficit to 5.3 percent of GDP in 2001 from an expected 6.5 percent in 2000, implying a 4.3 percentage point reduction of expenditure in light of tax reductions and court-mandated additional pension spending. The required expenditure savings will result mainly from cuts in the wage bill, purchases of goods and services, investment and social transfers. The deficit is expected to be financed mainly with privatization receipts, without recourse to domestic bank financing. The program contains contingency measures to offset wage policy implementation and other fiscal slippages and an adjuster for delays in privatization. Wage restraint is to be achieved by a reduction of the government sector wage bill, a freeze of average wages in public enterprises, and a social pact that limits wage increases in the rest of the economy to somewhat below productivity gains.

The CNB's monetary policy for 2001 is based on a stable exchange rate and seeks to reduce retail price inflation to 4.5 percent by year-end. The CNB expects the demand for broad money to grow further—although at a reduced rate—in 2001, reflecting faster growth in economic activity and strengthening confidence in the banking system, especially after repayment of the balance of insured deposits in failed banks at the end of 2000. The CNB will use part of the rising demand for base money during the tourist season to accumulate international reserves so as to keep their gross level at about 4.25 months of imports.

Meanwhile, banks that survived the 1998/99 banking crisis have attracted new deposits and rebuilt their capital base, reflecting strengthened confidence in the banking system. While banks now have long foreign exchange positions, foreign currency lending to potentially unhedged borrowers is likely to involve substantial indirect exchange rate risk. Ownership concentration is expected to continue within a strengthened regulatory and supervisory framework

Structural reforms aim at economic liberalization, restructuring, and privatization. The authorities intend to improve the finances of the pension and health funds and the competitiveness of the economy to attract foreign investment, directly through privatization and indirectly through a more welcoming institutional and regulatory framework. They view these measures as necessary to achieve their growth and employment objectives. Measures to strengthen the pension and health fund finances, safeguard the confidence in the banking system, increase the flexibility of labor markets, and improve enterprise efficiency are important to the present program.

Croatia joined the IMF on December 14, 1992, and its quota¹ is SDR 365.1 million (about US$465 million). Its outstanding use of IMF financing currently totals SDR 121 million (about US$155 million).

Croatia: Selected Economic Indicators             1995 1996 1997 1998 1999   2000   2001 Real economy (percentage change)                       Real GDP           6.8 6.0 6.6 2.5 -0.4   3.5 1/ 4.0 Unemployment rate (average; percent of labor force) 2/ n.a 10.0 9.9 11.4 13.6   15.1 3/ 14.5 Nominal net wages (percentage change; period average) 17.7 14.8 15.4 11.2   9.0 4/ ... Retail prices (e.o.p.)         3.7 3.4 3.8 5.4 4.4   7.4   4.5 Gross domestic saving (percent of GDP)   9.9 16.1 18.2 17.2 18.7   20.2 1/ 22.0 Gross domestic investment (percent of GDP)   17.6 21.9 29.8 24.3 26.3   24.8 1/ 25.8                               Public finance (percent of GDP)                       Consolidated central government (cash basis) 5/   -0.9 -0.4 -1.3 0.6 -2.0   -5.1 1/ -0.8 Consolidated central government (accrual basis)   ... ... -2.0 -3.0 -7.4   -6.5 1/ -5.3                               Money and credit (e.o.p.; percentage change)                     Broad money           40.4 49.1 37.6 13.0 -1.1   26.5 1/ 15.3 Credit to consolidated central government   -3.0 -3.4 -49.9 -2.7 41.1   19.2 1/ 0.0 Other credit 6/           18.9 3.1 44.1 22.4 -6.5   4.4 1/ 15.9                               Interest rates (e.o.p.; percent)                         Average deposit rate         6.1 4.2 4.4 4.1 4.3   3.6   ... Average credit rate         22.3 18.5 14.1 16.1 13.5   10.5   ...                               Balance of payments (percent of GDP)                       Trade balance           -17.3 -18.2 -25.8 -19.2 -16.4   -17.9 1/ -17.3 Current account balance       -7.7 -5.5 -11.6 -7.1 -7.6   -4.6 1/ -3.9 Total external debt (e.o.p.) 7/       20.8 23.2 31.9 40.3 44.5   53.2 1/ 50.4 Gross official reserves (USD million; e.o.p.)   1,895 2,314 2,539 2,816 3,025   3,423   3,663 Reserve cover (months of imports of goods and services) 2.4 2.8 2.7 3.2 3.7   4.2   4.3 Short-term debt in percent of gross usable official reserves 5/ 31.6 40.7 45.6 75.1 77.3   96.3 1/ 75.7                               Exchange rate                             Exchange rate regime         Other managed floating       Croatian kuna per US$ (January 31, 2001)   8.37687 Nominal effective rate (1995=100; p.a.)     100.0 100.3 101.0 100.4 94.7   94.4 8/ ... Real effective rate (1995=100; p.a.)     100.0 99.3 99.6 101.3 97.1   98.8 8/ ... Sources: Croatian authorities; Information Notice System; and IMF staff estimates. 1/ Estimate. 2/ Labor Force Survey (based on ILO standards). 3/ January-June. 4/ November. 5/ National presentation, with privatization receipts above the line. 6/ After inclusion of arrears repayment, credit expansion would be 15.3 percent in 2000 and 18.5 percent in 2001. 7/ Does not include debt that was excluded from the London Club agreement. 8/ October. 1 A member's quota in the IMF determines, in particular, the amount of its subscription, its voting weight, its access to IMF financing and its share in the allocation of SDRs.