Mission Concluding Statement 

Croatia: Staff Concluding Statement of an IMF Staff Visit

May 23, 2018

Croatia’s economic growth continues to benefit from record-high tourism activity, solid merchandize exports, and strong domestic consumption. Growth is expected to remain at about 2.8 percent in 2018, before decelerating gradually over the medium term toward 2 percent in the absence of substantial structural reforms. Although moderating, unemployment is still high, at around 10 percent. This highlights the need for structural reforms to improve the business environment in order to boost growth and create more jobs. Inflation is projected to remain within 1.5-2 percent range over the medium term. Thanks to strong tourism receipts, the external position will remain in substantial surplus despite imports’ growth.

Continued significant fiscal overperformance has resulted in a general government surplus in 2017 for the first time since independence. The 0.8 percent of GDP surplus was the result of strong revenue collection, general spending restraint, and moderate public investment, and across-the-board reduction in current expenditure, with the exception of the wage bill. Consequently, public debt declined by almost 5 percentage points, to reach about 78 percent of GDP by end-2017. Significant progress has also been made in restructuring the debt of public highway companies. Operational restructuring of these, and the railway, companies should also be advanced.

Given the favorable cyclical position, the fiscal gains should be preserved in order to reduce the still high public debt and create space that can be used in future downturns. Maintaining a small surplus over the medium term and resisting pressures to increase expenditure are also warranted in view of the various fiscal risks, including the contingent liabilities of the public sector and the persistent arrears in the health sector. It is also critical to improve the structure of spending by reducing current expenditure while increasing quality public investment and accelerate utilization of EU funds. Public wage increases should be accompanied by civil service reform to improve efficiency and the provision of services to citizens. The pension system also needs to be reformed to ensure sustainability and support the effort to increase the low participation in the labor market. In addition, better targeting social benefits would help in this regard and enhance equity and social protection. On the revenue side, it would be important to offset any further reduction in taxes by introducing a modern real estate tax. With regards to the medium-term budget framework, adopting the Fiscal Responsibility Law and the Budget Act will help align Croatia’s fiscal rules and institutions with European standards.

The Croatian National Bank ( CNB) has maintained a monetary stance in line with the accommodating conditions in the euro area, while taking advantage of the strong external position to build up reserves. Overall, the banking sector continues to be in good health despite the Agrokor crisis. Deleveraging is slowing down and new lending is picking up. Continued vigilant monitoring of the banking sector is warranted in view of the expected tightening in global financial conditions, and the overall credit risk arising from any remaining uncertainties related to Agrokor and the still high level of variable interest rate and forex-indexed debt. It would also be important to preserve the independence of the CNB in line with best international practices.

Accelerating convergence to EU income levels and supporting Croatia’s ambition to join the euro area necessitate a revitalization of structural reforms . It is critical in this regard to build on the effort to improve the business environment by reducing of para-fiscal costs. Such efforts need to be complemented by essential reforms aimed at streamlining the extensive public administration structure and reducing red tape, enhancing the legal process and property rights, reducing labor market rigidities, and improving the efficiency of state-owned enterprises and divesting the underutilized state assets. Advancing the above reforms and enhancing the education and vocational training would help Croatia meet its national reform objectives of more jobs and higher income and prosperity for its citizens.

An IMF mission led by Khaled Sakr visited Zagreb during May 14-18, 2018, and met with, Minister of Finance Zdravko Marić, Croatian National Bank Governor Boris Vujčić, other senior officials, and representatives of academia and the business community.