Press Release No. 06/66

Press Release No. 06/66

The Executive Board of the International Monetary Fund (IMF) today completed the second review under an SDR 97 million (about US$139.9 million) Stand-By Arrangement for the Republic of Croatia, approved on August 4, 2004 for 20 months (see Press Release No. 04/170). The authorities are treating the arrangement as precautionary.

In completing the review, the Executive Board also granted an extension of the arrangement until November 15, 2006 as well as an augmentation of access to an amount equivalent to SDR 99 million (about US$142.7 million). The Executive Board also granted a waiver for the nonobservance of the end-December 2005 quantitative performance criterion pertaining to the stock of general government arrears.

Following the Executive Board's discussion on the Republic of Croatia, Ms. Anne O. Krueger, First Deputy Managing Director and Acting Chair, stated:

"Croatia's economy has experienced steady growth, external vulnerabilities have been reduced, inflation remains low, and key structural reforms have moved forward. This good performance has been underpinned by an impressive combined fiscal adjustment attained mainly through expenditure reductions. At the same time, much larger than expected private borrowing caused the external debt-to-GDP ratio to increase slightly in 2005-although at a slower pace than in previous years-and the level of debt remains high.

"Continuing the fiscal consolidation efforts and the implementation of key structural reforms are prerequisites for making further progress in reducing vulnerabilities. In that light, the 2006 budget target, which implies a further combined fiscal effort on top of the adjustment achieved in 2004-05, is welcome. The authorities intend to limit budgetary expenditures to the level provided for in the budget, even if the revenue outturn is better than expected. This is appropriate to address risks to domestic demand, including the impulse to domestic demand from the government's payment of "pensioners' debt" starting in the second half of the year. Holding the line on public spending will also reinforce the credibility of the medium-term plans for expenditure reduction in the Pre-Accession Economic Program.

"Structural reforms have advanced, notably in the pensions and healthcare areas, although further reforms will be needed to enable Croatia to keep pace with other central European countries and pave the way for eventual EU accession. Timely implementation of the health sector reforms should start yielding budget savings from mid-2006, but further measures to encourage more efficient use of health care services may be necessary in the medium term. The authorities are encouraged to persevere with their privatization agenda and their plans to reduce subsidies and state aid. In this context, an important element will be the reform of the shipyard industry.

"The Croatian National Bank (CNB) continues to play its part in mitigating vulnerabilities by keeping inflation low, maintaining exchange rate stability, and addressing the prudential risks associated with higher bank foreign borrowing and rapid credit growth. The CNB has raised the marginal reserve requirement on new foreign borrowing by banks and introduced a series of measures to help them mitigate foreign-currency-related credit risk. The creation of a single nonbank financial regulator at the start of 2006 is a welcome step. The CNB and the nonbank regulator will need to work together closely in monitoring the financial system," Ms. Krueger said.