Croatia: Staff Concluding Statement of the 2024 Article IV Consultation Mission
IMF News, June 7, 2024
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- Published: June 7, 2024
Outlook and Risks
- Growth moderated to 3.1 percent in 2023, still among the highest in the euro area (EA).
- Staff projections:
- Real growth of 3.4 percent in 2024.
- Real growth of 2.9 percent in 2025.
- Growth approaching potential of 2½ percent over the medium term.
- Inflation and disinflation:
- Inflation averaging about 4.2 percent in 2024.
- Inflation approaching the European Central Bank’s target of 2 percent only in late 2025.
- Services inflation expected to remain sticky due to strong wage increases and tourism demand.
- Output gap:
- Estimated to narrow but remain positive during 2024-26.
- Risks:
- Downside: intensifying regional conflicts, commodity price volatility, global or regional recession, domestic wage growth exceeding productivity.
- Upside: faster implementation of reforms raising actual and potential growth.
- Supply shocks could push inflation either up or down.
Fiscal Policies — Current Assessment and Recommendations
- Fiscal stance:
- Overall deficit rose from 0.7 percent of GDP in 2023 to a projected 2½ percent of GDP in 2024, driven by generous increases in social payments and compensation of public employees.
- Expansionary and procyclical fiscal stance risks fueling domestic demand, hampering disinflation, and undermining competitiveness.
- Priority recommendations for 2024:
- Reduce the fiscal stimulus in 2024.
- Promptly reverse broad-based cost-of-living measures (notably tax cuts and price controls) to yield about ⅓ percent of GDP in savings while restoring price signals.
- Any remaining support measures should be temporary and targeted to the most vulnerable.
- Save revenue over-performance.
- Where feasible, raise revenue and/or cut discretionary non-priority current spending to reduce the stimulus.
- Medium-term fiscal path:
- Support for the Ministry of Finance’s plan to meaningfully reduce the overall deficit starting from 2025 and return to a structural primary balance by 2027.
- Planned reduction of the headline deficit by about ⅔ percent of GDP in 2025 is achievable.
- Under this fiscal consolidation path, public debt projected to decline to 55 percent of GDP in 2029.
- Assessment: Croatia’s sovereign stress risk is low under this path.
- Raising revenue and spending efficiency:
- Tax policy reforms:
- Introduce a modern value-based property tax.
- Remove excessively favorable taxation on short-term rental income.
- Remove explicit and implicit subsidies on fossil fuels (estimated around 2 percent of GDP annually in revenue) to raise revenues and promote the green transition.
- Public wage bill:
- Continue reforms to reduce the size of the public wage bill over coming years.
- Rationalize the public workforce based on a functional review; enforce an attrition rule except for essential functions.
- Develop the internal market to improve mobility.
- Pensions and healthcare:
- Pension measures could include: (i) increasing statutory retirement age and/or increasing minimum contribution years and indexing retirement age to life-expectancy; (ii) strengthening the second pillar pension by expanding coverage and building trust while improving PAYG adequacy.
- Healthcare: consider co-payments designed to directly reduce fiscal costs while seeking to broaden access, which may save costs by providing less expensive primary care or reduce reliance on old-age homes.
- Public investment management (PIM):
- Move towards a more centralized framework for appraisal, processing, and monitoring of all public investments.
- Implement the recently drafted PIM manual and action plan.
State-Owned Enterprises and Fiscal Risk Management
- SOE reforms:
- Continue strengthening corporate governance, ownership, monitoring, and oversight practices.
- A new single law on SOEs expected to be adopted by end-2024.
- Introduce regular assessment, reporting, and disclosure of fiscal risks of SOEs.
- Medium-term fiscal framework:
- Strengthen the medium-term fiscal framework to prepare and implement the structural fiscal plan required by the new EU fiscal rules.
- Consider preparing and publishing a Fiscal Risk Statement covering all aspects of risks to the budget.
- Improve the role and capacity of the Fiscal Policy Commission to assess macroeconomic and fiscal forecasts, contingent liabilities, and long-term fiscal sustainability including aging and climate costs.
Financial Sector Policies
- Current stability assessment:
- Financial sector has weathered monetary tightening; systemic risks broadly unchanged and manageable.
- Improved household and corporate balance sheets, but higher financing costs could challenge repayment capacity for some borrowers.
- Supervisory recommendations:
- Ensure banks maintain adequate capital buffers and diligently monitor credit risks.
- Continue scrutiny of the real estate market for signs of overheating and risk buildup.
- Investigate indirect exposures to commercial real estate and manage potential spillovers and inter-linkages.
- Given significant intercompany loans, gather more granular information and step up monitoring of associated vulnerabilities.
- Macroprudential policy:
- Continue to assess the need for explicit borrower-based macroprudential limits (BBMs) and stand ready to introduce them if warranted.
- Maintain a tight stance of capital-based macroprudential measures during the maturing expansionary phase of credit and housing cycles.
- Reassess the adequate level of the counter-cyclical capital buffer and consider a positive neutral framework to facilitate communication.
- If housing market momentum resumes, be prepared to introduce BBMs to preempt financial stability risks.
- Consider differentiated BBM thresholds for first-time house buyers and couple BBMs with targeted measures to improve housing affordability.
- Note: expiration of housing loan subsidies and decline of foreign demand have eased structural obstacles for implementing effective BBMs.
Structural Policies — Labor, Housing, Productivity, and Green Transition
- Labor market and productivity:
- Address multidimensional labor shortages with coordinated policies to foster higher labor participation, reduce skills mismatch, facilitate labor mobility, and integrate foreign workers.
- Targeted interventions:
- Strengthen vocational education and training to ease school-work transition.
- Expand adult learning opportunities to facilitate re-skilling and up-skilling.
- Improve domestic labor mobility.
- Boost productivity through comprehensive reforms to encourage innovation, strengthen business dynamism, and facilitate access to financing.
- Facilitate firm entry and exit by removing regulatory barriers in services and improving business insolvency procedures.
- Increase public financing for research and development, develop capital markets, encourage equity financing, and strengthen institutions to improve the business environment.
- Maintain momentum in strengthening the effectiveness of the AML/CFT regime to exit the Financial Action Task Force’s grey list.
- Housing affordability:
- Tackle the underlying supply gap rather than supporting demand.
- Boost supply by better using the sizable existing vacant stock and modernizing and streamlining regulations.
- Reduce or remove favorable tax treatment of residential real estate investment and short-term rental to reduce speculative demand and activate idle housing.
- Modernize the legal cadaster, develop longer-term rental market, and invest in infrastructure and green social housing for low-income households.
- Caution: demand-side measures such as subsidies to home buyers tend to be effective only in the short term and can contribute to higher house prices or rental costs over the medium term.
- Green transition:
- Accelerate the green transition using the National Energy and Climate Plan (NECP) as a starting point; integrate it with other strategic documents and subject it to public consultation.
- Achieving EU climate mitigation goals requires economy-wide carbon pricing, reinforced by sectoral policies (notably feebates for power, transport, and building heating) and targeted support to vulnerable households.
Mission Note
- The mission thanks the Croatian authorities and other stakeholders for excellent cooperation and open and constructive discussions, with special gratitude to the Croatian National Bank and Ministry of Finance for assistance with meetings and logistical arrangements.
IMF Communications Department — Croatia: Staff Concluding Statement of the 2024 Article IV Consultation Mission