HNB: In 2010, GDP to fall by up to 1.6 percent

The Croatian National Bank predicts that GDP in Croatia will fall by up to 1.6 percent this year, and the central bank warns that the crisis in the eurozone government debt market increases the risk of weakening the recovery of the international economy, which undermines the prospects for the recovery of the Croatian economy based on export growth and further emphasizes the need to direct economic policy towards strengthening the competitiveness of the economy and ensuring the solvency of the public sector.

Assuming the absence of significant growth dynamics in the eurozone and, as a consequence, the absence of export demand, the HNB’s publication "Financial Stability" assesses that, according to the baseline scenario, GDP growth in Croatia in 2010 will be in a moderately negative zone, with a decline of up to 1.6 percent. At the same time, they expect that the external imbalance in the form of a smaller deficit on the current account of the balance of payments (around 4 percent of GDP) and slower growth of foreign debt will continue to decrease. The necessity of changing the previous growth pattern based on domestic demand towards export-led growth is emphasized, which imposes a redirection of activities from the non-tradable sectors to the tradable goods sectors or export sectors. It is highlighted that economic policy should be directed towards strengthening international competitiveness and ensuring the solvency of the public sector. To strengthen competitiveness, the HNB states that it is important to increase labor market flexibility and ensure a decrease in unit labor costs relative to the EU through wage policy. At the same time, the investment climate should be improved so that the necessary rebalancing of the economy towards export sectors occurs as smoothly and quickly as possible. To ensure the solvency of the public sector, fiscal policy should continue consolidating towards achieving a sustainable level of public debt. This requirement, it is noted, gains additional weight in the context of expectations of higher capital costs and lower potential growth rates compared to the previous period.

This requires reducing the overall structural deficit of the general government to zero, which implies a surplus in the primary balance. In addition to ensuring fiscal solvency, such a rule would allow for moderate deficits to help stabilize the economy in recession conditions, and in conditions of above-average growth, surpluses would be formed to prevent ‘overheating’ of the economy, the HNB explains. For this, a clear medium-term strategy for expenditures and revenues is needed to transparently assess all risks and ensure broader public support, taking into account the intergenerational distribution of the consolidation burden. In this regard, the HNB believes that it is necessary to consider the fact that high volatility of tax revenues reduces the credibility of fiscal policy, and thus the capacity for borrowing, so the existing dominant reliance on more stable consumption taxes should be maintained in the tax system. It is noted that reforms of the pension and health systems are also of great importance for the credibility of fiscal policy, which should ensure a long-term sustainable level of deficits in these systems, and thus implicit public debt. Furthermore, the restructuring policy of public enterprises needs to ensure the stability of potential public debt arising from state guarantees to these enterprises. The HNB assesses that the Government’s economic recovery program contains good guidelines, while also emphasizing that consistent implementation of the program will be important for the perception of financial markets. They add that prudent fiscal policy opens up space for relatively relaxed monetary policy, which maintains a high level of liquidity in the banking sector without pressure on the exchange rate of the kuna against the euro. (H)