Cause and Effect in European Politics and Law

Croatia Is Looking for Investors

Adelina Marini, August 10, 2012

Ever since the government officially admitted that its forecast 2012 to be the year when the recession will end and the country will come up with positive growth of 0.8% would not come true, the tension in Croatia started growing together with the summer temperatures. Will the debt of 48.5% of GDP approach the 60 per cent EU threshold this year thus leading to the necessity of asking for external financing, or how much farther can the austerity policy continue, are only few of the questions that have been in the Croatian public domain in recent weeks. And last week the government presented a revised version [in Croatian] of its economic guidelines as for this year but also for the period 2013-2015.

For the first quarter of 2012 the gross domestic product dropped by 1.3% on a year-on-year basis. The greatest decline is of gross investments and fixed capital (-2.8%), which is a continuation of the negative trend from 2011 when these two components were the main ones to pull growth downward. The government's revised forecast is Croatia to conclude 2012 with stagnation, same as last year, and in 2013 to register growth of 1.8%, in 2014 of 3.0% and 3.5% in 2015. All this, however, given that domestic demand increases as in the past few years it has been constantly shrinking.

Together with the uncertain economic environment, decline is registered in employment too, as this year the unemployed are expected to reach 14.4% of the labour force. The hopes of Zoran Milanovic's cabinet are in 2013 the negative trends to be over and unemployment to start gradually decreasing and be 14.1% in 2013, 13.3% in 2014 and 12.2% in 2015.

The unfavourable economic developments have an impact on the country's indebtedness too. In its economic guidelines, the government points out that in the end of 2011 the public debt grew (y-on-y) by 18 bn kunas (2.4 bn euros) and reached a total amount of 156 bn kunas (20.8 bn euros) which is 46.7% of gross domestic product. The cabinet's explanation is that the growing public debt is due to the general government deficit but also to the kuna depreciation against the euro and the dollar, because 70 per cent of the debt is in these two currencies. The Croatian Finance Ministry's forecast is the debt to reach this year 51.7% and in 2013 to grow to 52.9 per cent and then start gradually declining as of 2014 onwards, when it is expected to be 52.6%.

According to the government's analyses, the economic situation in Croatia is developing against the backdrop of highly unfavourable macro economic environment globally but especially in the euro area. An important element of the assessment in the analysis is that the current model of economic growth, based on individual consumption, is exhausted and a transition to growth based on investments in production is needed. With its entry into the EU next year Croatia will start paying public money into EU's budget, as well as to set aside money to co-finance projects funded mainly by EU funds. For the purpose the government intends to further tighten spending beyond what is envisaged in the Law on Financial Responsibility, according to which every year spending must be cut by 1% of GDP until the budget is balanced, which means some 3.5 bn kunas to be cut every year.

But in the same time it is pointed out that success cannot be pursued only with fiscal consolidation. What is necessary is economic growth to be boosted by stimulating investments as well, especially in the industry. For the purpose the government will seek simplification of administrative procedures, better protection of property by enhancing the efficiency of the judiciary, including through solving disputes related to unsettled payments, but also fiscal alleviations for business activity. It is planned the transfer from direct to indirect taxes to continue. Special attention the government intends to pay on investors who contribute to the opening of new jobs. For them it is foreseen, depending on the number of new jobs, to receive money prizes but tough fines are also envisaged if abuses are found.

In July, the analytical Economic Institute Zagreb also reviewed its economic forecast, claiming that there will be recession of -1.3% instead of the expected negative growth of -1.0%. The institute's expectations for next year's economic growth diverge from those of the government. If the cabinet expects positive growth of 1.8%, the institute is more sceptic and foresees positive growth of 0.8%, same as earlier government expectations for 2012. According to the analysts of the institute, the positive growth is expected to come from Croatia's accession to the EU next year, which is planned for mid-2013 - on July 1st. An increase of tax revenues is also expected, combined with reduced spending, which will lead to gradual budget consolidation.

But the biggest fear this autumn stems from the country's credit rating. The expectations are that if the public debt continues to grow, together with the economic uncertainty, the credit rating agencies could throw Croatia to the "junk", giving it the lowest grade possible (junk), which is a signal for investors to run away. At the moment Croatia's rating is: BBB- (Fitch), Baa3 (Moody's), BBB- (Standard & Poor's). And all this in spite of the extremely good preliminary data for the touristic season this year, indicating growth compared to last year. The topic of credit rating became especially hot after neighbouring Slovenia has been dramatically downgraded - another eurozone country - from an excellent rating of A2 to a level of Baa2.

The subject is on the first page of the Globus weekly, titled "Junk" with a subtitle "We open the last battle to rescue the rating". Although Croatia does not have Slovenia's banking problems, the risks, according to the magazine, simply have a different address and they are: incomplete or totally not implemented planned reforms. According to the edition, the rating can be saved only if the biggest structural problems of Croatia's economy - the railways and the shipyards - are finally resolved. A problem, of which the EU has been constantly warning in every report during the pre-accession, including the latest one, already part of the monitoring after the country signed the accession treaty.

Globus writes that with years the problems in these two state-owned areas were not being solved and also that the smallest change there could bring huge benefits for Croatia, as well as a positive assessment by the credit rating agencies. The problem with the railways is that there is a plan for restructuring which, however, "still is 100% on paper". There is also a plan for restructuring the shipyards - there is a selected buyer (from July this year) of Brodotrogir. Brodosplit is also sold, while Kraljevica will be let to default. But still this plan is implemented only partially. Reforms in the health care system are also late, where a reform has been launched of the public procurement in state-owned hospitals but there 70% of the implementation is still on paper, the magazine has calculated.

Another area for restructuring, which draws public attention lately is leasing part of the already built motorways in Croatia, which is expected to lead to the layoff of several hundred people.

In October, it is expected experts of credit rating agencies to arrive in Croatia and this is when pressure on the government is expected to increase as a possible throwing of Croatia to the junk is envisaged to happen precisely then - in October or November. Unless, reforms that have remained on paper are not implemented. Because, as the magazine writes, Slovenia has the advantage of being able to ask the EU for help, while Croatia will have to turn to the International Monetary Fund, which the highly respected here Finance Minister Slavko Linic is trying to avoid or at least to postpone. All eyes are now focused on him, hoping that the worst would be avoided. He is also the focal point of all ministers, who have to undertake the unpleasant task of cutting flesh in their areas.

In other words, in Croatia the autumn is expected to be hot too, especially against the backdrop of forecasts for a price hike of fundamental goods because of the drought this summer.

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