Press Release No. 20/360

IMF Staff Concludes Virtual Visit to Croatia

November 30, 2020

• The Croatian authorities and the IMF team discussed the importance of balancing short-term priorities of economic support with medium-term priorities of restoring fiscal space and raising productivity and growth through green and digital public investment.
• The IMF team expects GDP growth to rebound to about 6 percent in 2021, driven by higher public investment and a partial rebound in tourism assuming the effects of the pandemic fade. This forecast is subject to significant pandemic-related uncertainty.
• Over the medium-term, implementation of the long-standing agenda on structural and fiscal reforms remain essential to reaping the maximum benefits of forthcoming euro adoption and restoring the economy to a path that ushers greater convergence of living standards with the EU.

Washington, DC: An International Monetary Fund (IMF) team led by Mr. Srikant Seshadri conducted virtual discussions with the Croatian authorities during November 16-25, 2020 on how to balance short-term priorities of economic support in the face of a resurgence in infections against medium-term priorities of restoring fiscal space, and raising productivity and growth through improved public investment and greening of the economy.

At the end of the visit, Mr. Seshadri issued the following statement:

“The Croatian people have shown great resilience in coping with the Covid-19 crisis, and the earthquake. This year, the economy is expected to contract between 8-10 percent reflecting lower domestic and external demand, and in particular, a 50 percent decline in tourism volumes (year-on-year). Despite the difficulties of this year, Croatia is faring better than many other countries with a similar degree of tourism-dependence. Rises in unemployment have been contained thus far thanks to strong policy support. Yet, significant challenges persist due to the resurgent pandemic. Public debt is expected to rise back up to 88 percent of GDP this year, with a forecast of the general government deficit of 8 percent of GDP due to lower tax revenues, and fiscal support measures provided to support those impacted by the shocks. Growth in credit to the private sector has held its ground, partly supported by a temporary debt service moratorium. Economic growth is expected to rebound to about 6 percent in 2021, driven by a partial recovery in tourism and higher public investment, but it is subject to significant pandemic-related uncertainty.

"Finding a balance between short and medium-term priorities is challenging. In the short-term, the priorities are to ensure that (1) economic support due to the Covid-19 crisis is not withdrawn until the recovery is well entrenched; (2) the measures enacted remain effectively targeted in reaching viable sectors of the economy to minimize scarring; (3) resources for potentially higher healthcare expenses can be met, particularly if the epidemiological situation gets worse. These have to be balanced against medium-term goals of once again increasing fiscal space ahead of euro adoption, guiding budgets back towards balance, enacting structural reforms to fix healthcare and pensions, streamlining the role of the state-prominently through improved SOE governance, as well as an enhanced business climate.

"Policy measures should evolve in tandem with the crisis. Active training and reskilling should take place in areas with excess capacity such as tourism and hospitality and into areas like greening the economy and construction. Measures need to be constantly monitored to ensure that economic support is targeted to viable firms. Further, Covid-19-related support measures should be designed to remain in place as long as the pandemic has not abated; this will remove any uncertainty regarding the duration for which they will be needed. In addition, taking the economy to the next level over the medium-term would be better facilitated by investments in technological and human capital, as we recommended in the 2019 Article IV consultations. Once recovery is entrenched, the fiscal framework needs to be steered closer to the medium-term objectives of lowering debt and balancing the budget. The Croatian authorities would be well advised to actively communicate their medium-term fiscal strategy that covers medium-term financing needs and includes an assessment of the fiscal risks. Fiscal stimulus designed to raise growth would be more effective if delivered as spending increases than further tax cuts. At this stage, in our view, further reductions in VAT are not advisable without adequate offsets that guard against permanent revenue losses.

"The generous allocation of Next Gen EU Funds represents a unique opportunity for Croatia. Averaging 5 percent of GDP over the next several years starting in 2021, these funds are substantial and can be utilized to raise public investment in physical, digital, green, and soft infrastructure for years to come. If properly absorbed and utilized, these funds could meaningfully raise productivity and growth, whilst shielding the ability to meet crucial current expenditure needs in areas such as healthcare, in the near-term. In this regard, the Croatia 2030 National Development Strategy is encouraging and broadly lays out the right priorities. It is crucial to develop a concrete investment plan and follow through with strong implementation.

"The Croatian National Bank (CNB) has been proactive in responding to the crisis and the banking sector has thus far withstood pressures well. The CNB had to aid the currency at the outset of the pandemic, provide additional liquidity, support the government securities market, and temporarily eased the regulatory burden on banks. The European Central Bank (ECB) and the CNB agreed on a €2 billion swap line on April 15. The CNB conducted five purchases of government securities, for about 5.5 percent of GDP by end-June. Domestic financial markets quickly stabilized, and Croatia took another step forward in its integration with European Union partners, by joining ERM II and establishing close cooperation with the ECB on banking supervision as well as by joining the Single Resolution Mechanism on July 10.

“The mission held fruitful discussions with the Deputy Prime Minister and Minister of Finance Marić; Governor of the Croatian National Bank Vujčić, and other government officials, and representatives from the private sector. The mission thanks the authorities and all interlocutors for the frank and constructive dialogue. The IMF looks forward to the upcoming 2021 Article IV Consultations, scheduled for next Spring.”