IMF Welcomes Economic Reforms in Croatia

The International Monetary Fund (IMF) on Tuesday praised the Croatian authorities for their ‘skillful navigation of the economy through the global financial and economic crisis’ and welcomed the implementation of reforms under the government’s economic recovery program, stating that these will strengthen market confidence and help Croatia enter the European Union in a strengthened position.

‘The IMF Executive Board commended the authorities for their skillful navigation of the economy through the global financial and economic crisis, as their swift interventions helped preserve financial stability, curb the fiscal deficit, and maintain investor confidence and access to international capital markets,’ the statement from the IMF Executive Board meeting, which concluded consultations on Article IV with Croatia on Monday, noted.

This is a regular bilateral discussion on economic development and policy that the IMF conducts annually with all member countries. The conclusions of the IMF Executive Board state that the global crisis significantly affected the Croatian economy, limiting capital inflows, causing a decline in exports, making domestic credit more difficult, a real GDP decline of 5.8 percent in 2009, and a sharp rise in unemployment to 17 percent. Economic activities also declined at the beginning of 2010, while a gradual return to positive growth is expected in the second half of 2010. The IMF forecasts zero growth for Croatia in 2010 and two percent in 2011.

The IMF praised the authorities’ rapid response to the crisis, particularly the Croatian National Bank (HNB), which addressed liquidity issues in the banking sector in 2009 with appropriate measures. Strong fiscal measures in 2009 were also highlighted to compensate for declining revenues and to keep the budget deficit in financially sustainable levels. The IMF noted that three supplementary budgets and numerous short-term measures were adopted in Croatia, including expenditure cuts, freezing salaries and pensions, increasing the VAT rate, and introducing a temporary ‘solidarity tax’ on incomes and pensions. These measures are deemed to have helped, although the budget deficit increased to 4 percent of GDP and public debt rose to 50 percent of GDP.

IMF directors emphasize that ‘the initial recovery is accompanied by significant risks’ given the uncertain global outlook, underdeveloped regional financial markets, and significant domestic economic weaknesses. ‘Well-focused medium-term fiscal consolidation and ambitious structural reforms will be necessary to increase competitiveness and attract investment, which can bring about stronger and more balanced growth,’ the conclusions of the IMF Executive Board stress.

The IMF directors state that the main burden lies on fiscal policy, given the stable exchange rate of the kuna. They agreed that a cyclically balanced budget provides the necessary political space and debt sustainability. Croatia’s total external debt, according to the IMF, is expected to reach 99.9 percent of GDP this year. Fiscal adjustments, in the opinion of the Executive Board, are best achieved through ‘limiting consumption, including reducing public sector wages, rationalizing pension and healthcare expenditures, and better targeting social assistance costs.’

The IMF directors welcomed the inclusion of many of these measures in the government’s economic recovery program, with the recommendation that ‘the reform of consumption should also foresee tax reductions.’ The Executive Board also assessed that maintaining a stable exchange rate of the kuna provides an appropriate anchor given market instability and high financial euroization. The directors emphasized the importance of ‘structural reforms to strengthen competitiveness, including removing inefficiencies in the labor market and business environment, and implementing appropriate income and wage policies to achieve internal economic adjustment.’

They recommended greater flexibility in employment and social benefits policies to eliminate disincentives for employment. To improve the business environment in Croatia, they recommended continuing privatization, limiting parafiscal levies, and simplifying conditions for starting businesses. The IMF directors welcomed the recent ‘initiation of reforms in many of these areas under the economic recovery program, emphasizing that swift and full implementation of the program will contribute to strengthening market confidence and help Croatia enter the EU from a position of strength.’

The IMF Executive Board called for vigilance in monetary and fiscal policy, as banks remain vulnerable to credit and liquidity risks. They consider moderate easing of monetary policy appropriate but warn against further easing due to uncertain financial prospects. They also recommended close monitoring of the quality of loans issued under credit support measures. The IMF directors expressed concern about the refinancing of public banks from the deposit insurance fund.  (H)