‘The main task of Zagreb is to strengthen trust in the financial sector’

Croatia is facing a significant challenge in finding a balance between stimulating economic growth and creating new jobs while concurrently continuing the process of fiscal consolidation, the European Commission stated today in its assessment of the government’s economic program and planned reforms within the framework of the European Semester.

After five years of recession, this challenge is crucial for Croatia in the short term. In the medium term, Zagreb’s main task is to improve competitiveness and strengthen trust in the financial sector, the Commission emphasizes.

They remind that in the spring forecasts, they estimated that the Croatian economy would shrink by one percent this year. The Croatian government, on the other hand, expects GDP growth of 0.7 percent this year.

Croatia will need to make additional efforts to reduce the high budget deficit and address the debts of state-owned enterprises while ensuring investments and other forms of spending that stimulate growth.

In mid-April, Croatia submitted an economic program for assessment to the Commission, in which it estimated the general government deficit for this year at 3.6 percent of GDP and its reduction below the maximum allowable value in the EU of three percent of GDP only in 2016.

The Commission notes that there is room for improving the efficiency of the tax system and highlights the urgent task of addressing the issues of a rigid labor market and an unfavorable business environment for companies.

In its review of public finances, the Commission warns that the high deficit contributes to a rapid accumulation of public debt, which it forecasts will soon exceed the EU reference value of 60 percent of GDP.

Therefore, the application of a clear and sustainable consolidation strategy is crucial, according to the Commission, noting that on the revenue side there is room to broaden the tax base since in 2011, the share of taxes in GDP in Croatia was 32 percent, significantly below the EU average of nearly 40 percent.

They also suggest additional intensified efforts to combat tax evasion and tax fraud.

On the budget expenditure side, the challenge is credible consolidation that will not jeopardize growth-oriented spending and leaves enough room for co-financing from EU funds, they emphasize in Brussels.

There is also room for reconsidering the efficiency, sustainability, and appropriateness of resources reserved for the social protection system and pensions, they believe.

They also note that the state continues to play an important role in a large number of companies, many of which accumulate losses and record high levels of debt, thus posing a risk to public finances.

In its review of the financial sector, they note that the economy is pressured by a significant share of non-performing loans (14 percent at the end of last year), and the private sector is also exposed to currency risk since a large part of its debt (75.3 percent in February 2013) is denominated in foreign currency or has a currency clause.

Provisions to cover these risks would strengthen the stability of the financial sector, but in the medium-term perspective, they could limit credit growth, they estimate.

They also warn that the opening of new jobs is hindered by an inflexible labor market and incentives that, in their view, discourage citizens from seeking employment. Dismissing workers is simultaneously complex and costly, and accompanying legal processes can last several years, they note.

This has led to a boom in the informal economy, whose share in GDP is estimated to be up to 40 percent. This negatively affects public finances, they warn.

The unemployment rate has nearly doubled since 2008 and reached 15.9 percent in 2012 (according to ILO methodology), which hardest hits younger workers and exposes a third of the population to the risk of poverty, they emphasize.

They consider the quality of business regulation to be weak, supporting this with Croatia’s poor ranking on the lists of relevant international institutions. They are also concerned about the low level of efficiency of the judiciary and the perceived high level of corruption in public administration.

Improving administrative capacities will be particularly important to successfully realize investments that will be co-financed from European funds, the Commission estimates.