ZAGREB, December 16, 2019 - The existing gap between Croatians and other residents in the EU in terms of the average income per capita can be narrowed by higher and better investments of the public sector alongside investments of the private sector, according to conclusions made by the International Monetary Fund (IMF).

"If, for example, Croatia were to aspire to bridge 15 percentage points of the current average per person income gap with the EU by 2030, the economy would need to grow at 1.5 percentage points more rapidly than the EU average, over this period. To maintain such higher relative growth rates, in addition to higher private investment, Croatia needs to raise its public sector investment as well—both in quantity and quality," reads the conclusions of the IMF mission which has recently visited Croatia.

The conclusions, published on Monday, praise Croatia for having come a long way over the last five years.

"Growth is strong, inflation is subdued, and unemployment has been significantly reduced. Public debt is steadily declining and external reserves are healthy."

"Following a protracted and painful recession, the last five years have seen the Croatian economy become stronger and healthier. Some of this can be attributed to 'good fortune', that is to say favourable global conditions, helping a tourism boom. However, a significant share is due to good policies—strong budget management and skilful policies by the Central Bank," say the conclusions praising the central bank (HNB).

"As long as the authorities maintain prudent policies and global conditions remain supportive, this picture is likely to continue next year. Looking further ahead, Croatia must rise to the significant challenge of successfully deepening integration with Europe—including through future Euro adoption—during a period of rapid technological change."

Croatia is urged to make prudent investments so as to to catch up with other countries that have made greater progress.

The IMF also calls for measures so as to ensure that the economic expansion can be felt more broadly across the population.

"The share of the workforce between the ages of 20 and 64 that is employed is only slightly above 60 percent. And the share of the population at risk of poverty and social exclusion is estimated at 25 percent. The country’s most vital resource—its youth—remain concerned about their long-term prospects. This has spurred emigration and a hollowing out of the internal regions of the country. In the short-term, the obvious symptom has been labor shortages in areas like construction and tourism. However, the more insidious problems are those of 'brain drain', and challenges to the sustainability of pension and healthcare systems," the Fund warns.

According to current official figures, the income per person of Croatia stands at 63 percent of the EU average.

Higher wages must be supported by higher productivity that grows the economy and to this aim, the IMF suggests three steps: maintaining macroeconomic and financial stability; making the state a source of greater dynamism through reforms; and, investing resources wisely to raise productivity.

Regarding the first step, the IMF praises the authorities for "considerable success" attained with the first step and it "needs to be carefully preserved."

"However, without more significant progress on the second step, the right climate and needed resources for the third step will prove difficult to realize."

Concerning the reforms of the public sector, Croatia is praised for increasing public investments in accordance with continued debt reduction which do not call for any austerity measures.

"Yet, they do require strong public sector reforms and a shift of some share of current spending to capital spending. Over the last decade, whether compared to the EU, or to other emerging economies, the balance of public spending in Croatia has tilted considerably toward spending on items like non-investment goods and services, subsidies, compensation of employees, and other social benefits, and away from public investment. This has reduced the flexibility of the budget and its capacity to spark economic growth."

The country is called to implement active employment policies "to facilitate smooth transfers of public sector workers with suitable skills to the private sector" now when the economy as a whole is doing relatively well.

"State-owned enterprise management and performance need to continue on the path of more modernization, so that enterprises in core areas support the productivity of the economy. It is noteworthy that this year they will meet or exceed the initial target of 0.4 percent of GDP contribution to the budget."

The government is advised to optimise social benefits system through better targeting of benefits to those who are most vulnerable and in need.

"The government should also continue social dialogue to come up with measures that mitigate the effects of the recent roll-back of pension reforms."

"Improving the territorial organization of local governments would significantly improve their capacity to invest and deliver uniform high-quality public services," says the IMF.

The Fund also estimates that if "around 4 percent of overall government revenues were gradually and efficiently reallocated to smart investments, the Croatian economic growth rate can be raised sufficiently as to bridge a significant portion of the gap with the EU over the next decade." These investments should be conducted in parallel with public sector reforms "that are supposed to enable savings in current spending that can be redeployed to capital spending, without the need to raise taxes, or cut the overall level of government spending. These adjustments, if properly executed and implemented, will repay the Croatian people handsome returns in the future."

In order to achieve higher future living standards, in terms of transportation infrastructure, the country "already has a good network of roads. Investment in ports on the coast are also underway. However, to make these ports fully productive, investment in railways—particularly for freight purposes—also needs to occur." Investments in both solid waste and waste-water treatment are also high priority areas.

"Aside of 'physical' infrastructure, Croatia also needs to upgrade its technological infrastructure. The overall strategy and responsibility for digitalization of the country would benefit from having a single independent entity with a long-term perspective.

"Although connectivity with regard to existing fixed broadband and mobile technologies is good, Croatia significantly lags behind advanced European peers and many other New Member States when it comes to leading edge fast and ultra-fast digital technology," says the IMF.

"Croatia has made some progress in the availability of digital public services for individual citizens. More progress is needed when it comes to the availability and use of digital services for businesses. The recently launched “START” initiative which allows for simple electronic procedures to start a business is a welcome development in this regard."

"The IMF supports the government’s decision to withhold the reduction in the overall VAT rate from 25 to 24 percent, given recent demands for higher wages. Indeed, we would recommend holding back on any other tax reductions at this stage, as they could return the fiscal balances to deficits, and undermine the reduction in public debt which is still elevated.

"For the same reason, we also strongly urge restraint with regard to any further wage demands, until a thoroughly analytically researched new public sector wage grid and coefficients are developed."

The IMF also praises the Croatian banking system as "profitable, liquid, and well-capitalized."

The conclusions describe the preliminary findings of IMF staff at the end of their official staff visit to Croatia earlier this month.

More economic news can be found in the Business section.

ZAGREB, October 15, 2019 - The International Monetary Fund (IMF) has revised upward the projection of Croatia's real Gross Domestic Product for this and next year, saying that Croatia's GDP growth in 2019 is likely to be twice as strong as the growth of a group of countries which the Washington-based fund calls "Emerging and Developing Europe".

Croatia's economic growth is projected to revive to 3% in 2019, according to the IMF Winter Economic Outlook (WEO), which is 0.4 percentage points higher than the Fund's estimate released in April.

In 2020, Croatia's economy is expected to grow by 2.7%, which is 0.2 percentage points more than in the previous projection.

The IMF also estimates that Croatia's economy grew by 2.6% in 2018, which is 0.1 percentage point lower than in its previous forecast.

Croatia's economic growth of 3% in 2019 is twice as high as the projection for "Emerging and Developing Europe" which, apart from Croatia, includes Russia, Turkey, Poland, Romania, Ukraine, Hungary, Belarus, Bulgaria and Serbia.

The aggregate economic growth of that group is estimated by the IMF at 1.8% in 2019, and in 2020 the group's growth rate is set at 2.5%.

The main reason for the slower economic growth in "Emerging and Developing Europe" is Turkey's economic stagnation this year, which neutralises Hungary's 4.6% growth projection and Poland and Romania's growth projection of 4%.

The IMF also projects Croatia's unemployment rate of 9.0% this year to further fall to 8% in 2020, after it stood at 9.9% in 2018.

Croatia's consumer prices index is put at 1% in 2019 and 1.2% in 2020.

Croatia's current account balance surplus, expressed as a percentage of GDP, stands at +1.7% and +1% in 2020, after it stood at +2.5% in 2018.

More GDP growth news can be found in the Business section.

ZAGREB, May 3, 2019 - Macroeconomic conditions in Croatia continue to be positive and fiscal performance is good despite sizable recent shipyard guarantee payments, but a possible slowdown in main trading partners may affect these benign conditions, reads a statement by the International Monetary Fund (IMF) team released on Thursday, after the team's recent visit to Zagreb.

"Macroeconomic conditions have remained positive. Growth is gradually moderating from its recent highs, inflation remains subdued, international reserves have increased, and public debt has been declining," reads the statement.

The IMF expects Croatia's GDP growth rate this year to be at 2.6% and inflation at 1.5%.

"Fiscal performance has been strong despite sizable recent shipyard guarantee payments. Private demand and tourism continue supporting economic activity which is also underpinned by the CNB's (Croatian National Bank) continued accommodative monetary policy. Overall, the banking sector is liquid, profitable, and well-capitalized."

“However, a possible slowdown in main trading partners may affect these benign conditions. If a slowdown were to emanate from Europe, the authorities are encouraged to let the social safety net work, before considering fiscal stimulus," reads the statement, published on the Croatian National Bank's website.

“For the last three years, macroeconomic imbalances and vulnerabilities have been steadily declining. The recently approved Convergence Program for 2019-22 projects further reduction of public debt, which is welcome. Achievement of the underlying surpluses will require continued restraint with current expenditures. EU funds need to be increasingly utilized to ramp up public investment.

“Yet, reducing macroeconomic vulnerabilities is only half the task. There is another equally important half on which significantly greater progress is called for - to raise living standards durably and make the economy more dynamic through structural reforms... These reforms must be pursued while favourable economic conditions last, to derive the maximum benefits of Euro adoption," IMF officials say.

In that regard, they consider as being of central importance efforts to streamline the state, increase labour force participation, improve business conditions, preserve the sustainability of the pension system and make the healthcare system financially self-sufficient.

As for making state administration more efficient, the IMF team says that merit-based civil servant compensation complemented by an appropriate reduction in total public employment expenditures could create room for higher public sector wages.

It also notes that decisive action is needed to divest non-essential state assets and strengthen the financial management of essential ones.

As regards an increase in labour force participation, IMF officials say that modernizing labour contracts would improve employment prospects for the young and reduce the incentive to emigrate.

"Improved child care access would facilitate higher participation from women. Reforms in education and training policies would alleviate skills’ mismatches, reduce labour shortages, and generate more jobs," reads the statement.

"It is encouraging to note recent initiatives to reduce parafiscal fees and simplify the process of starting a business. However, uncertainties and back-logs associated with legal processes are impediments to enhancing the business climate," the team says with regard to the recommendation on improving business conditions.

As for the pension system, the IMF team says that longer life-spans come with inescapably higher pension costs and that the recently passed pension reform was a vital step in acknowledging realities that cannot be put off any longer.

"Without an increase in retirement age, the State would incur sizable debts, for which the youth of today will have to pay. Alternatively, the elderly would be consigned to living on lower pensions. If the pension system is not aligned with today’s life expectancy, the range of the country’s choices will be limited between these two outcomes."

As for making the healthcare system financially self-sufficient, IMF experts say that despite increasing healthcare contributions, the build-up of arrears continues. "Concerted actions to increase cost efficiency are compatible with maintaining the existing quality of the healthcare system and need to be pursued with urgency."

The IMF team, headed by Srikant Seshadri, visited Croatia on April 23-30 for regular talks on the latest macroeconomic and political developments. They met with Finance Minister Zdravko Marić, Croatian National Bank Governor Boris Vujčić and other state officials, representatives of the private sector and civil society organisations.

The next round of consultations on Article IV of the IMF Statute for 2019 is scheduled for this autumn.

More news about Croatia and the IMF can be found in the Business section.

ZAGREB, April 10, 2019 - Croatia's economic growth will slow down mildly in 2019 and 2020, the International Monetary Fund (IMF) said in its spring forecast confirming Croatia's GDP growth forecast however, it significantly changed its forecast of unemployment.

Croatia's economy this year is expected to increase by 2.6%, which was also forecast in the IMF's World Economic Outlook last autumn. According to its forecast for 2020, Croatia's growth will decelerate slightly to 2.5%.

IMF's forecast to 2018 however has been downgraded by 0.1 percentage points to 2.7%, with Croatia recording four years of growth in a row.

IMF significantly upgraded its forecast of Croatia's unemployment, noting that in 2018 unemployment decreased to 10% from 12.4% in 2017.

Unemployment is expected to continue to fall to 9% this year, reducing the autumn projection by 2.2 percentage points. That would mean that it would remain above the average eurozone forecast of 8%.

The IMF expects Croatia's unemployment rate to continue falling in 2020 by one percentage point to 8%. That would mean that it would be somewhat higher than the 7.7% forecast for the eurozone and above the 6.9% projected for the group of developed European economies.

The inflation rate for 2018 was mildly decelerated by 0.1 percentage point compared to the autumn outlook to 1.5% whereas for 2019 consumer prices are projected to rise at that same rate as projected in the autumn outlook.

In 2020, inflation is expected to be somewhat higher at 1.6% similar to the outlook for developed European economies and the eurozone with the exception of Slovenia.

The latest forecast of Croatia's current account balance surplus for 2018 is slightly higher (0.2 pp) to 2.9% of GDP. The forecast of the current account balance surplus for 2019 however is 2.2 pp less to 2.1% of GDP.

The surplus is expected to continue sliding in 2020 to 1.6% of GDP.

More news about Croatia’s economic growth can be found in the Business section.

ZAGREB, February 13, 2019 - The International Monetary Fund's (IMF) executive directors have established that in 2018 Croatia continued its fourth year of positive economic growth as well as its fiscal consolidation albeit at a slower rate, and they also call for improving the business climate in Croatia and rationalisation of the public companies' sectors as well as improvements in bankruptcy legislation.

"The economic expansion continues, driven primarily by private consumption and exports of goods and services," the IMF says in a press release after the conclusion of 2018 Article IV Consultation, on 8 February.

The fund's Executive Directors welcome "Croatia’s continued economic recovery, which has helped further reduce indebtedness and build external buffers," according to the press release issued on the IMF website on Wednesday. "Directors commended the attainment of the first fiscal surplus in 2017 since independence.

"They encouraged the authorities to seize the opportunity presented by favourable macroeconomic conditions to advance the reform agenda by stimulating more inclusive growth, persevering with fiscal consolidation and debt reduction, and fully implementing structural reforms."

The report reads that in Croatia "wages are growing, employment is rising, and inflation remains benign."

"Over the next few years, growth is expected to moderate, as the economy moves closer to its potential. The current account is projected to decline but remain in surplus, while external indebtedness is expected to continue to decline."

After the 2.7% growth in 2018, Croatia's economy is likely to grow by 2.6% in 2019, according to the IMF estimates.

"Fiscal performance has been strong, but the materialization of contingent liabilities from government guarantees is likely to reduce the overall surplus. Low public and private investment, and continued emigration weigh on medium-term growth prospects. Downside risks in the near-term stem from possible changes in regional or global economic and financial conditions, and the further realization of contingent liabilities," reads the press release.

Directors welcomed the Croatian authorities’ commitment to fiscal discipline, and "stressed the importance of pursuing growth-friendly fiscal consolidation, while improving the structure of revenues and the quality of expenditure.

"To this end, they encouraged the authorities to broaden the tax base and take measures to reduce the informal economy."

Directors welcomed the passage of the Fiscal Responsibility Law, and encouraged the authorities to enact the Budget Act which would integrate the analysis of contingent liabilities as part of the budget process and facilitate medium-term planning.

The IMF highlights "the need to improve the business environment by further reducing administrative and tax burdens, and welcomed recent initiatives to reduce parafiscal fees."

The IMF directors advise "rationalizing the state-owned enterprise sector, divesting under-utilized state assets, and improving the efficiency of legislative and judicial processes."

According to the press release, "directors called for more ambitious restructuring of public administration including by reducing high public employment outlays and reducing the fragmentation in sub-national levels of government."

While welcoming the passage of pension reform, as well as recent measures to improve the efficiency of the healthcare system, they underscored that the elimination of the healthcare system’s arrears as well as ensuring long-term sustainability of the pension system would require further reforms," reads the assessment made by the IMF directors.

More news on Croatia’s economy can be found in the Business section.

ZAGREB, December 11, 2018 - The Croatian authorities have skilfully utilised the economic upturn to reduce indebtedness and further build external buffers but important challenges remain for the Croatian economic policies such as the need to restructure public administration and make the pension and healthcare systems sustainable, a delegation of the International Monetary Fund (IMF) said on Monday, noting that the current economic situation provided a good basis for the necessary structural reforms.

The IMF staff were recently on a visit to Croatia as part of regular consultations under Article IV of the IMF's Articles of Agreement. Their closing statement was published on the IMF and Croatian National Bank's (CNB) websites on Monday.

"Macroeconomic developments have been positive. Growth continues to be strong, inflation benign, and unemployment has steadily declined. However, the labour participation rate remains low. The Croatian authorities have skilfully utilized the economic upturn to reduce indebtedness and further build external buffers. Yet, important challenges remain," IMF delegation says.

It notes that relatively low levels of public and private investments and the emigration of young people hamper medium-term growth prospects. "Emigration and population aging are generating labour shortages. They also challenge the long-term sustainability of the pension and the healthcare systems. This calls for a smartly focused transformation to a more dynamic economy, and a more efficient state," the IMF officials say, underlining as the most important "a sizable restructuring of public administration".

Durable fixing of the healthcare and pension systems are two of the other important issues to tackle, the IMF delegation says, noting that some welcome progress is being made on those fronts, but the momentum needs to be sustained. “Acting decisively now—under favourable conditions—would ensure higher living standards in the future," the IMF delegation says.

The IMF expects Croatia's economic growth to moderate gradually over the next few years, as the economy moves closer to its potential. However, there are negative risks to this outlook, mainly due to possible changes in regional and global economic and financial conditions. "Sustained strong growth is needed to catch up to the income levels of wealthier EU countries. Achieving this requires an infusion of greater dynamism and resilience to the economy."

Further integration into Europe via the entry into ERM II and the banking union will set the stage for the envisaged adoption of the euro. Yet, to enjoy the full benefits of the currency union, deeper structural changes are essential, as is continued careful management of the country's public finances, the IMF says.

"Today's economic conditions provide fertile ground for the needed structural changes. Such changes require up-front compromises from all stakeholders and the rewards are harvested with time, once the efforts bear fruit. Therefore, they have greater chances of success if initiated when economic conditions are improving, as they are currently. The authorities have made some progress with respect to the National Reform Programme, which covers a wide area of structural reforms. While welcoming this progress, we encourage the authorities to push forward a focused structural agenda with stronger impetus."

A more dynamic state can facilitate durable growth, the IMF officials say.

Compared with regional peers, Croatia currently has one of the largest expenditures on total public employment proportional to the size of its economy. Furthermore, many municipalities do not have sizable populations, making the scope significant to merge services thereby generating greater efficiencies. "Decisive progress with reforms in this area will free up funds for investment in infrastructure and workers. It will also lead to better services for households and businesses."

The new draft law on merit-based civil service employee compensation is a first step towards a more efficient public service. "If complemented with an appropriate reduction in total public employment expenditure, it could open the space for high performing public employees to enjoy higher wages."

New public employees can be hired where they are needed, for example to enhance administrative capacity to absorb EU funds.

The further easing of administrative, tax, and parafiscal fees, will also produce collateral benefits by improving the business climate, enabling higher private investment and more job creation, the IMF officials say, noting that reforms to judicial and legal processes are important to keep on the agenda.

The recently passed pension reform is an important step in putting the system more in tune with the reality of increasing life-spans, and to make it more sustainable and equitable across generations, says the IMF delegation.

"Reinforcing measures that discourage early retirement, increasing the statutory retirement age, and eliminating group-specific pension provisions sets the stage for further measures to improve the system's viability. Examining the underlying weaknesses of the second pillar of the pension system is rightly on the authorities' agenda. Without such measures, pensions are likely to decrease, directly affecting the standard of living of the elderly," the delegation says in its statement.

Employment has picked up notably over the last two years and the challenge is to sustain this expansion, says the delegation. Yet, the labour market participation rate remains one of the lowest in the EU. "Structural unemployment, especially among youth and women, is high. This calls for steps to improve education and training."

Labour market flexibility needs to be enhanced, but this needs to be done carefully. "It should not lead to a two-tiered system, wherein employers invest significantly less in workers on temporary contracts and offer them less security relative to those on open-ended contracts. Such a situation could encourage further emigration of the young, to the detriment of medium-term growth prospects. This situation would benefit neither employees nor employers."

Solutions that better balance the considerations of both employers and employees are needed. This requires innovative thinking and compromises from all stakeholders.

A solution could take the form of a "hybrid" between the current fixed and open-ended contracts for an initial probationary period, to be followed by mandatory conversion to the full open-ended contract, upon completion of the probation.

It could also take the form of encouraging qualified public-sector workers who are interested in private sector employment, but fear losing the relative safety of their jobs to try their hand in the private sector with suitable but temporary safeguards to induce some risk-taking, the IMF officials say.

"To be clear, any solution needs to be thought through in detail, but the scope for innovation exists. Given that currently there are labour shortages, this would be a good time to work on suitable solutions."

Measures to increase child care access would incentivize greater participation from women. Improved targeting of all social benefits to those who are most in need is also likely to induce greater labour force participation, reads the statement.

In a comment on Croatia's fiscal policy, the IMF delegation says that recent budget performance has been commendable. The first surplus since independence was achieved in 2017. A small surplus might also materialize in 2018, depending on the size of one-off expenditures related to shipyard guarantees, says the delegation.

It notes that its fiscal recommendations are motivated by two equally important medium-term goals—to rebuild room for fiscal policy manoeuvre that can be used in the event another recession hits the economy and to improve medium-term growth prospects.

"To achieve these results, we recommend steadily increasing the fiscal surplus towards 1 percent of GDP over the next five years, and thereby accelerating the reduction of public debt to below the Stability and Growth Pact (SGP) threshold of 60 percent of GDP by 2023. This would help to reduce the vulnerability to potentially negative changes in regional and global conditions. Our recommendations to strengthen the budget include a more growth-friendly composition of public expenditures, and a gradual shift to more stable revenue collection from a broader set of sources."

On expenditures, increasing public investment, reducing the total expenditure on public employment, and reforming social benefits to better target the most vulnerable in society, are the top priorities.

On the revenue side, recent gains need to be preserved, the IMF says.

"At the appropriately receptive time and with careful design and communication, the introduction of a modern property tax merits reconsideration. It can provide a more stable revenue base, make the system more progressive and fairer, and create room to reduce higher and distortionary taxes elsewhere. Yet, it needs to ensure that it does not place an undue burden on individuals who are cashflow constrained, such as those on a limited pension. Preparatory steps for possible future reconsideration dovetail with other reforms such as the ongoing modernization of the land registry and the cadastre."

As regards the health sector, the IMF delegation believes that health spending needs to be made more efficient, that administrative costs should be reduced and the quality of health services provided to citizens improved.

There is also a need to reduce the drain on the budget caused by health sector arrears, which the authorities are working towards.

It is encouraging to note the number of new entrants contributing to the healthcare system, and the reduction in the numbers of non-paying participants for supplementary benefits, although some of this is also due to emigration.

"Still, a more comprehensive transformation requires a more rational premium and co-payment structure, ensuring that exceptions are minimized to protect only the most vulnerable. As IT system improvements and more rigorous income-testing come onstream, more improvements should be possible."

The IMF also calls for enhancing governance and performance of state-owned enterprises (SOE).

"Persistent loss-making SOEs are a drain on the budget, taking up more in subsidies than they pay back to the state... Strengthening SOE governance and increasing accountability to their budgets would help improve their efficiency and discipline."

The IMF delegation concludes its statement by noting that the Croatian National Bank (CNB) continued to deftly navigate the environment of low interest rates and ample liquidity. "Going forward, the CNB will need to pursue policies, which will allow the economy to accommodate potentially tighter external conditions and harness inflation expectations."

The banking system is, on average, very liquid, well capitalized and profitable, the delegation says.

The non-performing loan ratio is declining, in part due to their sales to third parties. "Additional measures to prevent excessive household borrowing, e.g., more comprehensive debt service-to-income based measures, could be considered for introduction at the appropriate time, if real estate prices accelerate or high growth of cash loans persists."

Further corporate sector deleveraging would be welcome, including through making the bankruptcy procedures even more efficient, e.g., by facilitating out-of-court settlements.

"Despite recent changes in the bankruptcy legislation, consideration could be given to conducting a comprehensive review to ensure that the insolvency framework aligns with best practices," the IMF says.

More news on Croatian economy can be found in our dedicated section.

ZAGREB, June 9, 2018 - The Constituency Group of the International Monetary Fund and the World Bank, comprising central bank governors and finance ministers of 15 countries, met near Split on Saturday and mostly discussed financial technology.

ZAGREB, April 19, 2018 - A Croatian delegation, consisting of representatives of the Finance Ministry and the Croatian National Bank, will attend the spring meetings of the World Bank and the International Monetary Fund (IMF) in Washington from 19 to 22 April, the Finance Ministry announced in a press release on Thursday.

The International Monetary Fund has just concluded a week-long visit to Croatia and issued a concluding statement on December 19, 2016.