IMF Executive Board Concludes the 2012 Article IV Consultation with the Republic of Croatia

Public Information Notice (PIN) No. 12/123
November 13, 2012

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2012 Article IV Consultation with the Republic of Croatia is also available.

On November 7, 2012, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Republic of Croatia.1

Background

Sustained recovery from the economic crisis in 2009 remains elusive. Growth stagnated in 2011 after two years of contraction. With unfavorable external conditions and subdued domestic demand, GDP is expected to contract further by 1½ percent in 2012, only modestly picking up by ¾ percent in 2013. Further on, barriers to investment and employment growth, if not forcefully addressed, will keep potential growth modest.

Despite a significant narrowing of the current account deficit, external vulnerabilities remain high, with gross external debt above 100 percent and an external financing requirement of about 30 percent of GDP. Competitiveness is hampered by substantial non-price weaknesses, which have severely limited export growth performance.

To address these weaknesses and restart growth, the authorities adopted a comprehensive structural reform program in August 2012. The program aims to improve the business climate and competition and foster labor force participation by reducing administrative barriers to investment, speeding up restructuring and privatization of state-owned enterprises, and reforming pensions and health care systems. While some measures have already been taken, many important reforms remain to be developed in terms of specific policies and desired effects.

To restore fiscal sustainability, the authorities have launched a significant consolidation in 2012, aimed at reducing the deficit from 5.2 percent of GDP in 2011 to 4 percent of GDP in 2012 under staff’s macroeconomic projections. The adjustment has focused on better targeting of subsidies, restraints on expenditures of goods and services, and improved tax collection. Reforms in public sector workers’ remuneration and further rationalization of health expenditures have also been initiated, with results expected from 2013 on.

Within their framework centered on a broadly stable exchange rate, the Croatian National Bank has allowed in recent years increased two-way exchange rate flexibility, which has facilitated macroeconomic adjustment and limited speculation. Despite official credit support schemes, credit growth slowed down markedly in 2012 reflecting weak demand. The largely foreign-owned banking system remains well capitalized, although growing non-performing loans have started eroding profitability.

Executive Board Assessment

Executive Directors noted that Croatia is experiencing a prolonged recession reflecting subdued domestic demand, lackluster competitiveness, and a difficult external environment. Short-term growth prospects remain weak and downside risks prevail, while structural impediments hamper medium-term growth. Directors underscored the importance of advancing with policies and structural reforms to boost growth and reduce vulnerabilities.

Directors welcomed the authorities’ commitment to fiscal consolidation and the expenditure retrenchment that has taken place in 2012. While they recognized that fiscal consolidation is particularly challenging at the current juncture, they underscored its necessity to restore debt sustainability, satisfy the requirements of the Fiscal Responsibility Law, and retain market access. Directors therefore saw a need to continue a gradual but steady expenditure-based consolidation in 2013 and well into the medium term, while protecting capital spending. Directors also encouraged the authorities to persevere with their efforts to rebalance the tax structure away from labor in a revenue-neutral way.

Directors welcomed the recent adoption of the government’s structural reform program, which makes a good start on the road to restore competitiveness and spur growth. Strengthening EU funds absorption capacity would allow Croatia to take full advantage of EU accession by supporting growth-enhancing investments. Directors encouraged the authorities to develop specific policies and prioritize measures, focused on raising labor force participation, enhancing labor market flexibility, reducing barriers to market entry, and fostering competition.

Directors welcomed the increased exchange rate flexibility of recent years, as it has improved the economy’s resilience to shocks and aided macroeconomic adjustment. They generally agreed, however, that the broadly stable exchange rate framework has served Croatia well and that excessive exchange movements would be harmful given the high degree of euroization and the sizeable external debt. In order to build further an important buffer against external shocks, Directors recommended that the central bank continue to gradually accumulate international reserves.

Directors noted that the financial sector appears well-capitalized and resilient to shocks, but faces risks related to potential further deterioration of asset quality, indirect credit risk stemming from vulnerable borrowers, and sizeable dependence on parent banks for funding. They stressed the importance of maintaining high statutory capital buffers, ensuring adequate provisioning for non-performing loans, further strengthening financial supervision and regulation and cross-border supervisory cooperation, and closely monitoring liquidity and credit developments.


Croatia: Selected Economic Indicators, 2007–13 1/
 

 

2007 2008 2009 2010 2011 2012 2013

 

        Est. Proj.  
 

Output, unemployment, and prices

(Percent change, unless otherwise indicated)

Real GDP

5.1 2.1 -6.9 -1.4 0.0 -1.5 0.7

Contributions:

             

Domestic demand

6.6 3.4 -11.2 -4.0 -0.3 -2.6 0.6

Net exports

-1.5 -1.3 4.2 2.6 0.3 1.1 0.1

Unemployment (labor force survey, percent)

9.4 8.3 9.1 12.2 13.7 14.2 13.8

CPI inflation (average)

2.9 6.1 2.4 1.0 2.3 3.0 3.0

Average monthly nominal wages

6.2 7.1 2.2 -0.4 1.5 ... ...

Saving and investment

(Percent of GDP)

Domestic investment

31.4 33.4 27.6 24.3 23.3 23.0 24.2

Of which: fixed capital formation

26.2 27.4 24.5 20.6 18.8 18.2 18.9

Domestic saving

24.2 24.5 22.4 23.2 22.4 21.7 23.0

Government

3.9 3.2 0.2 -1.5 -1.8 -1.0 -0.4

Nongovernment

20.3 21.2 22.3 24.7 24.2 22.8 23.5

Government sector 2/

 

General government revenue

39.8 39.2 39.0 37.8 36.8 37.5 37.7

General government expenditure

41.9 40.5 43.1 42.9 42.0 41.5 41.0

General government balance

-2.1 -1.3 -4.2 -5.1 -5.2 -4.0 -3.3

General government balance (broad definition) 3/

-3.1 -2.3 -5.5 -5.3 -5.2 -4.9 -4.2

HBOR balance (net of budget transfers)

-0.5 -0.1 -0.6 -0.1 0.1 -0.8 -0.8

Cyclically adjusted balance

-3.5 -3.0 -2.9 -3.8 -4.5 -3.2 -2.8

General government debt

32.9 29.3 35.8 42.2 46.7 53.8 55.4

Money and credit 4/

(End of period, change in percent)

Bank credit to the nongovernment sector

15.0 10.6 -0.6 6.8 5.4 -1.6 ...

Broad money

18.3 4.3 -0.9 4.4 3.5 3.2 ...

Interest rates 4/ 5/

(Period Average, percent)

Average kuna deposit rate (unindexed)

2.3 2.8 3.2 1.8 1.7 1.9 ...

Average kuna credit rate (unindexed)

9.3 10.1 11.6 10.4 9.7 9.5 ...

Average credit rate, foreign currency-indexed loans

6.3 7.5 8.1 8.1 7.3 7.1 ...

Balance of payments

(Millions of euros, unless otherwise indicated)

Current account balance

-3,151 -4,258 -2,408 -582 -437 -591 -528

Percent of GDP

-7.3 -9.0 -5.1 -1.3 -1.0 -1.3 -1.1

Capital and financial account

5,159 5,444 4,418 1,804 1,877 1,654 1,373

FDI, net (percent of GDP)

7.9 6.8 3.4 1.3 2.3 2.1 2.0

Overall balance

722 -330 896 84 401 24 -113

Errors and Omissions (percent of GDP)

-3.0 -3.2 -2.6 -2.5 -2.3 -2.3 -2.1

Debt and reserves

(End of period, millions of euros, unless otherwise indicated)

Gross official reserves

9,307 9,060 10,376 10,660 11,187 11,211 11,098

Percent of short-term debt (by residual maturity)

109 70 94 88 80 87 89
  • Months of following year's imports of goods and
    nonfactor services

4.7 6.1 7.0 6.8 7.0 6.7 6.2

Net international reserves

7,349 7,967 9,365 9,644 10,374 10,476 10,363

Reserves (Fixed, percent of RAM)

85.4 74.3 86.0 84.7 85.6 88.5 84.7

Reserves (Float, percent of RAM)

125.1 105.5 124.0 121.5 120.8 126.7 122.7

External debt service to exports ratio (percent)

58.4 53.3 85.3 68.7 77.1 83.1 72.0

Total external debt (percent of GDP)

77.7 85.0 99.1 101.1 101.9 101.6 98.8

Net external debt (percent of GDP)

40.6 51.4 62.7 65.6 65.3 65.0 62.3

Exchange rate

 

Kuna per euro, end of period 6/

7.3 7.4 7.3 7.4 7.5 7.4 ...

Kuna per euro, period average 6/

7.3 7.2 7.3 7.3 7.4 7.5 ...

Real effective rate (CPI, percent change) 4/

0.7 4.6 1.2 -2.6 -2.1 -2.8 ...

Memorandum items:

 

Nominal GDP (millions of euros)

43,380 47,537 44,770 44,864 44,896 45,006 46,693

Output gap (percent of potential)

3.4 4.3 -2.8 -3.0 -1.6 -2.3 -1.7

  Per capita GDP (2011, WEO): $13,999

  Percent of population below poverty line (2004): 11.1

Quota (2010): SDR 365 million (563 million U.S. dollars)

 

Sources: Croatian authorities; and IMF staff estimates.

1/ Under the new ESA95 methodology, revised data include estimates for the "gray economy," imputed dwelling rates, and financial intermediate services indirectly measured (FISIM). National account data for 1995-2008 were revised in 2009 and data for 2008–2011 were revised in 2012. Revised nominal GDP figure for 2011 is about 2.7 percent lower than the previous estimate.

2/ ESA 95 presentation.

3/ Includes the balances of HBOR and HAC (net of budget transfers).

4/ Latest data as of end July 2012 

5/ Weighted average, all maturities. Foreign currency-indexed loans are indexed mainly to euros.

6/ Latest data as of end September 2012 


1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. An explanation of any qualifiers used in summings up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.



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