Cause and Effect in European Politics and Law

Croatia Is at Crossroads - Painful Reforms or Sinking

Adelina Marini, December 18, 2013

Croatia has a deadline until April 2014 to decide what it should do with itself in the upcoming decades. If so far the Zoran Milanovic's government has been claiming that it is completely aware of the situation, the European Commission's decision to launch an excessive deficit procedure (EDP) against Croatia is the catalyst that would demand real actions from the country, not only words. April 30 is the deadline until when Croatia has to undertake efficient actions to correct its excessive deficit and to report in detail on a strategy for budget consolidation. Zagreb is expected to publicly announce or to undertake measures that will lead to effective reduction of the deficit to 4.6% of GDP in 2014, 3.5% in 2015 and 2.7% in 2016. As the Croatian public debt has neared the critical threshold of 60% of the gross domestic product the government will get one additional year to handle this problem too.

In this way, Croatia has a deadline until 2016 to come out of the EDP. This, however, is not that simple as it seems. Firstly, the country must achieve a difficult balance between filling in a sustainable way the budget gap and not to deteriorate or even improve the severe economic situation in the country. Croatia's Minister of Finance Slavko Linic was warning about what was coming for months, but in the end was forced to give up and admit that everything was in the hands of the government which has already approved the budget for 2014, adopted an economic plan in September to boost growth and currently is urgently selling huge and indebted state-owned companies like the insurance company Croatia Osiguranje, the Croatian freight railway company, and is giving under concession key companies like Zagreb airport and the motorways.

The problem is, though, that the situation does not require simply some measures that would bring one or two investors who wonder where to put their money. Neither is this about keeping some jobs or open some jobs. It is about a deep change. Moreover, this is about a change of mentality, as you can read in Croatian media more often recently.

In Bulgaria, this process is known as a change of the chip and has completely failed. Croatia should undertake severe structural reforms, which means to turn the education, pension and healthcare systems upside down, to take them out of the mentality of collective irresponsibility. Another thing the country needs to change is to delete from the collective Croatian mind that the state is a last resort saviour and that when we fail to reach the targets the state will borrow again and will handle the situation. For the purpose, though, indeed a nation-wide consensus is necessary and calls for such can be heard more and more often. "A radically severe situation requires radical measures", wrote Darko Pajic in the blog of the Rijeka based Novi list daily. "The situation is such that it is not unjustified to ask the government to initiate national unity, although this is politically unreal in a situation whereby the rulers have a majority in parliament".

This is the reason why early elections are asked, he commented. On the occasion of the call of one of the influential members of the opposition Croatian Democratic Union (HDZ), MEP Davor Ivo Stier, for a third national consensus on structural reforms that need to be done in Croatia, the government answered to euinside by pointing out that in any case it is good to have national consensus to conduct reforms. But when saying national consensus the cabinet means a majority in Parliament. In the first two years of this government's term, structural reforms are being implemented. In their answer from the government, is cited the example with the reform of the labour legislation, the law on financial services or consumer credit which have been unanimously approved by the parliament. This means that these pieces of legislation were supported by HDZ MPs, the government says.

In his commentary, Darko Pajic agrees that the parliament is the only logical place to build consensus on economic issues, but that the MPs rather deal with themselves than with more general issues. According to Jutarnji list, however, there is consensus. On Friday, HDZ presented their long-awaited and considered imaginary economic plan, which, according to the daily, resembles very much plan of Zoran Milanovic's Social Democrats. The two biggest Croatian parties want, practically, the same things: fiscal consolidation, reforms, investments. The two parties' plans, however, suffer from the same flaws as well. They lack priorities and specific deadlines in urgent, medium and long term. It is not clear what is a goal and what a tool to reach the goal. Both parties want to remedy the healthcare system, to transform the education, the public administration to become more efficient, public property to start working for development, to eradicate corruption.

This, however, Jutarnji commented, are public phenomena that can be corrected in generations and centuries, "which require a mentality change, to show readiness to accept change, etc."

The EU accelerates evolution

The European Union will very soon get involved deeper in the search of a national consensus. Hitherto it has only been showing the problems and did not point to any specific measures, but in the spring this will happen. What remains is Croatia to implement these recommendations because, otherwise, there is a risk of becoming like Bulgaria - a country with a close to the excellent fiscal discipline, but weak growth, seduced and abandoned by investors and with growing poverty. Until it waits for the government in Zagreb to come up with concrete visions to fight the excessive deficit and indebtedness, the EU will follow closely how the EU legislation is being transposed in the economic area. At its last week's meeting, the government approved and sent to Parliament a key piece of legislation which concerns financial stability. The draft legislation introduces macro prudential supervision of the financial system and creates conditions for the work of the European Systemic Risk Board (ESRB).

The draft law envisages also the establishment of a financial council which will look for systemic risks. The council will conduct Croatia's macro prudential policy, it will identify, assess and review systemic risks. A very important part of the Council's tasks will be to issue warnings and recommendations to the relevant bodies to correct systemic risks. These recommendations will be mandatory for all bodies. In case a body is incapable to apply the guidelines it will have to explain in written why. Depending on the case, this explanation could be published. The council will consist of ten members - four representatives of the Croatian central bank (HNB), two of the agency for supervision of financial services, two of the ministry of finance and two of the state agency for deposit insurance and resolution of banks.

An analogue of this draft law in Bulgaria is the law on the commission for financial supervision. Unlike the Croatian draft the Bulgarian law creates a rather loose organisation. Its decisions have only consultative powers and are not mandatory. Moreover, the chairman of the commission is elected by the parliament which makes that body another political institution that will deal with politics thus making its decisions doubtful. It has to be said, however, that a major role to secure Bulgaria's macro prudential security is played by the central bank and especially the monetary board. But the fact that the financial supervision commission is a highly politicised institution prevents it from identifying problems like, for instance, the piling up of huge public funds in only one bank, which could create a serious systemic risk.

The Croatian draft legislation has to be approved by the end of the year because it is planned to be enforced on January 1st. In this way, the Croatian new year will start with a bit more prudential security for the financial system, but with a lack of clarity how will the country build up national consensus on the future reforms. Reforms that will be very painful and will cause a new wave of protests and strikes. As Darko Pajic writes, Croatia is in an even worse situation than Greece because Greece, at least, has reformed its expensive public sector. But it has Ireland as a guiding light which has officially exited its adjustment programme and was called by the chairwoman of the European Parliament's economic committee, Sharon Bowles (ALDE, UK), a "newly freed" country.

So, Croatia has to decide will it strive for "freedom" or will it continue sinking shouting the EU is to blame. And the consensus needs to be longer than a parliamentary term because, otherwise, it could come to, again, the Bulgarian situation, whereby a reform is launched later cancelled by the next government. The experience with the eurozone crisis, by the way, shows that reforms are guaranteed only when they are signed by all major political forces. Such a consent was secured in Portugal, it was much harder to secure it in Greece and came quite naturally in Ireland.

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