Cause and Effect in European Politics and Law

EC Expects Croatia To Complete All Failed Reforms

Adelina Marini, May 19, 2016

Croatia suffers from severe structural problems, which add to the acute political crisis. In this year’s country-specific recommendations the European Commission continues to demand that the country completes all the reforms that had been proposed by the government up to now, but failed due to resistance in parliament or by the unions. The EC, however, is of the opinion that without these reforms Croatian economy has no chance of walking out of the swamp that it got stuck into during the 6-year long recession. Contrary to claims by media and politicians in Zagreb that Brussels’ analysis is extremely positive, which is seen as an assessment to the quality of the national reforms programme, sent on April 28, the text of the document uncovers a different, far bleaker picture. Despite some similarities, this picture is not as discouraging as the Bulgarian one. 

The country has been in an excessive deficit procedure (EDP) for the last several years. Expectations are that this year budget deficit will be lowered to 2.6% of GDP and will reach 1.0% of GDP in 2019. Besides, the government of Prime Minister Tihomir Orešković hopes to lower the already dangerously high public debt from 86.7% in 2015 to 80.0% in 2019. The EC believes that, at this stage, there are favourable conditions present for reaching this goal. At the same time, additional fiscal effort is required. The structural correction of 2.0% of GDP in 2017, provided for in the government’s plan, would be sufficient in the current macroeconomic conditions to reach the mid-term budget goal, but much more will be required to achieve the demanded debt reduction.

The EC believes a 0.5% structural effort is more appropriate, having in mind the size of the debt and the current conditions in the country. In its country-specific recommendations, the Commission suggests an annual fiscal adjustment of “at least” 0.6% of GDP for next year. It is also said that there is a risk that Croatia will be unable to meet the requirements of the Stability and Growth Pact, so further efforts are required. Moreover, the provided measures for lowering debt by selling financial assets are not specific enough. The reason being this is also a very sensitive subject. The publishing of the list of companies for sale has already caused serious discontent in Croatia. 

What is the problem?

We are not talking just numbers here, but much more serious structural problems, which the EC has been repeating ever since Croatia entered the European semester by joining the EU in 2013. Budget planning continues to be poor. This is a problem, shared by all countries from the former Yugoslavia and the wider Balkans region. Links between the multi-annual budgetary framework and annual budgets are weak, states the EC, with clear rules for budget revisions missing. This, by the way, repeats every year, sometimes more than once a year. Another problem that the Commission talks about every year is that the Fiscal Policy Committee, whose aim is to monitor whether the government adheres to the fiscal rules on national level, continues to be dependent on the authorities. The EC recommends every year that the necessary changes are made to grant its independence from government. 

A large challenge are VAT frauds and the shadow economy, although it is acknowledged that measures are taken in this direction, but as of yet there is no evidence if they are working well. The EC sticks a finger into one of the most sensitive issues in Croatian society – labour market. A very large portion of the active population is left outside it. One of the main reasons is the option for early retirement. Twice already there have been attempts to push through a pension reform, which would increase retirement age and install more order, but these efforts are met with hostility by the entire community, including media. 

The problem is further complicated by high unemployment, especially among young people. According to the spring economic forecast of the EC, unemployment in Croatia this year will be 15.5%. By level of youth unemployment the country ranks right behind Greece and Spain. Actually, there are often talks in the country that Croatia is going towards the realisation of the Greek economic scenario, meaning default. Some indicators do actually point in this direction. One of them is employment in the public sector. Besides having a “relatively high” share of total employment in the public sector, wages there are based on controversial provisions. In fact, the government has no full control over wages and thus it is difficult for it to control the efficiency of the public sector. 

State ownership in companies too continues to be relatively high, coupled with poor management. One of the recommendations of previous years was to end the practise of political appointments in state-owned companies, but this reform is also quite difficult to push through. Business environment in Croatia is unfavourable. There are too many parafiscal charges for companies, regulation is too strong, access to some professions is restricted. 

Croatia suffers from another problem as well – regulatory instability and low quality lawmaking. Like in many countries in the EU, there is a large problem with non-performing loans in Croatia, weighing on the financial sector. The European Commission’s recommendations this year are five. Some media in Croatia interpreted this fact as good news and proof that the country is improving. There is another reason for the lowered number of recommendations. It is the wish of the EC, as part of its efforts to improve the work of the European semester, to make recommendations much more focused and much more specific. Their number is lowered for all member states and not from this year either. 

The first recommendation traditionally is on fiscal rules. Besides the additional structural effort by Zagreb, it is expected that by September the independence of the Fiscal Policy Committee will be increased, and by the end of the year budget planning will be improved and the multi-annual budgetary framework will be reinforced. The second recommendation deals with the pension system. The EC demands that steps are taken to discourage people from early retirement, conditions are provided for late education and consolidation of social payments. By the end of the year it is recommended that Croatia completes the administrative reform, planned by the previous government, which includes substantial changes in local authorities like closing down of municipalities and decentralisation. Those are measures that the ruling majority dislikes. This third recommendation includes an increase of the accountability by state-owned businesses.

The fourth recommendation is for reduction of parafiscal charges, removal of unjustified regulatory restrictions, and decreasing the administrative burden. At fifth place is the improvement of quality and efficiency of the judicial system regarding commercial and administrative courts and facilitating the resolution of non-performing loans. All this, however, needs a working government, stable parliamentary majority, and strong popular support. Neither of these conditions is present at the moment. Government and parliament are totally stalled by political quarrels and there is intensive talk of preliminary elections or government reshuffle, as euinside already reported. Huge resistance by unions and interested groups against certain reforms is another similarity to Greece.

Translated by Stanimir Stoev

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