Croatia has many tasks to finish

The EU economy is continuously showing good economic performance but few members including Croatia are still facing considerable problems. What’s worse is that the Croatian progress in the implementation of EC recommendations is either limited or in some areas no progress has been noted.

Each year, the European Commission undertakes a detailed analysis of each country’s plans for budget, macroeconomic and structural reforms. In the previous years, many countries waited for the news with lot of nervousness as the Commission’s recommendations meant a lot of sweat for those which economies were doing badly. However, the scenery have gradually changed, although not for everybody, says  Manica Hauptman, Senior economic advisor, European Commission Representation to Croatia. 

  1. How the EU has fared in general?

The EU economy has been doing well, expending robustly with the positive macroeconomic outlook being matched by improved labour market and social situation. However, not everyone is benefiting equally from the economic growth and there is still a lot to be done in terms of structural reforms and convergence in some of the EU member states. Unemployment and the number of people at risk of poverty are still too high. Social protection systems remain a challenge, since increasing labour mobility and new forms of employment are not easily matched by adequate changes and reforms.

Despite policy areas where there is work to be done, the overall news in the EU remains positive. The number of countries facing difficulties in public finances has been steadily declining and we are left with only France and Spain in the corrective arm of the excessive deficit procedure. The number of countries facing macroeconomic imbalances has also fallen and thus we have only three countries facing excessive imbalances, Cyprus, Italy and Croatia.

Economic growth in the EU continues with positive economic sentiment, improvement in labour markets and increased global economic activity and trade. Overall, EU member states have made progress in reform implementation over the past years with the support of the European Commission.

  1. The Commission will present the in-depth reviews as part of its annual Country Reports in early 2018. How in terms of structural reforms as well as situation in public finance Croatia used previous EC recommendations?

Country specific recommendations are adopted every year by the Council of the EU on the basis of the Commission proposals, which means that they are supported by the member states.

In 2016 Croatia made significant progress in the quality of the public finances, with marked deficit reduction and a declining trend of the debt ratio. Last year the Council of the EU abrogated excessive deficit procedure for Croatia on the basis of improvements in public finance in the prior year largely due to economic growth resulting in higher tax revenue and contained expenditure growth. Despite the positive trend, however, the debt ratio remains high especially when compared to peers (other CEE EU member states).

Country specific recommendations for Croatia do not tackle fiscal policy only of course, but a number of other policy areas. The Recommendations have remained very similar over the years, meaning that Croatian progress in its implementation is either limited or in some areas no progress has been noted; such as in pension system or public administration reform.

  1. On the basis of the analysis in the Alert Mechanism Report Croatia became one of 12 countries that have been proposed to be covered by an in-depth review in 2018. What role such reviews have on government policies?

Identifying member states for an in-depth review aims to prevent the emergence and build-up of harmful macroeconomic imbalances, which could affect not only the economic stability in a certain member state but also in the euro area and the EU as a whole.

Our macroeconomic imbalances scoreboard points to vulnerabilities such as excessive public and/or private debt, unemployment and employment levels and net foreign liabilities among others. In-depth review then tackles the drivers of these imbalances, which is crucial for future policy choices. For a member state facing excessive macroeconomic imbalances the European Commission can propose the activation of the macroeconomic imbalances procedure to the Council which entails agreement on a corrective action plan for the member state in question including a timeline with planned specific policy actions. Such procedure has so far not been activated for any member state.

Analysis of macroeconomic imbalances is not the only subject of the country reports. Apart from this, Commission services are also analyzing developments in the domain of structural policies as well as assessing progress in the implementation of country specific recommendations over the years tackling structural reforms. The most successful policy areas for reforms across the EU have been financial services, fiscal policy and fiscal governance but there has been less evident progress in terms of fiscal sustainability of pension systems, reform in services markets as well as persistently weak access to venture capital for companies.

  1. Among the EU members which yet have to reach European average, Croatia had one of the largest slumps in the level of public investments. Did that significantly change as the economy recovered?

Following a sharp decline in public and private sector investments, investment started slowly rebounding in 2015 with growth rate of 3.8%. The latter reached 5.3% in 2016 and decelerated to 3.4% in 2017, partly depressed by Agrokor crisis. In addition, business environment remains burdened with inefficiencies and lack of access to diversified sources of finance.

As for public investment, it lagged behind and began to grow in 2016 with a rate of 4%. Given its budgetary constraints, Croatia is reliant on the European Structural and Investment Funds (ESI funds or so called “EU funds”). In the period 2015 – 2017, the share of ESI Funds in public investment stood at 80 % and is the second highest in the EU after Portugal. Overall levels of public investments remain modest, especially in sectors such as R&D which is one of the reasons for low performance in terms of quality of scientific output and more generally, limited cooperation between research and business sectors, which prevents successful commercialisation of scientific research.

The European Commission initiated the European fund for strategic investments (EFSI) providing financial guarantee for public or private sector projects and supporting private investment in member states. After three years of operations, EFSI is backing several projects in Croatia and we hope for further financing agreements to be signed in the future, particularly in terms of combining public and private investment, building investment platforms and establishing links with ESI funds.

  1. The pick-up in economic growth and domestic policy actions have helped put the level of nonperforming loans in Croatia in 2017 on a decreasing path. Do you expect EC to confirm the same trend this year?

The quality of bank assets in Croatia have been improving and the banking sector remains well capitalized, with notable improvements of profitability and solvency since 2015. In the third quarter of 2017, the NPL rate declined to 10.8 %, mainly due to NPL sales as well as restructuring, which led to more performing loans. The EU average of NPLs for the same period was 4.4%.

Despite the positive declining trend, the overall level of NPLs in Croatia remains high, especially in the corporate sector. The net inflow of NPLs related to the exposure of banks to Agrokor had a negative effect on the NPLs level, however it was less than initially expected.

To tackle the problem of persisting NPLs in several EU member States, the EU ministers of finance agreed on an action plan in July last year. In March this year, the Commission presented its second progress report in this regard, showing that the continuous decline of NPLs, albeit unevenly across the member States. Together with the report, the Commission proposed a new package of measures to tackle NPLs, including further development of a secondary NPL market in the EU as well as enabling accelerated out-of-court settlement for loans granted to businesses and secured by collaterals. However, the primary responsibility for tackling high NPL levels remains with affected banks and ultimately, with the member states.

6. EC has formed a specialized service as a sort of support to the countries in drafting structural reforms. How much is that support used in Croatia?

The Structural Reform Support Service (SRSS) is a new service of the Commission, available to the member states at their request to assist in the design, implementation and evaluation of structural reforms. The member states submit projects to the Commission annually according to their priorities. Depending on the available budget, a list of projects across the EU is selected each year. In 2017, SRSS supported 150 projects in 15 member states. The initial success of the service is reflected in the fact that demand outweighed the available budget fivefold this year and ultimately 140 projects in 24 member states were chosen for support, with seventeen in Croatia alone.

Given the demand at hand, the Commission is proposing to increase funding for the 2018-20 period and intends to propose a follow up under the post 2020 multiannual financial framework. Within the latter the Commission has also foreseen a dedicated convergence facility for member states in the euro adoption process, which in itself opens new opportunities for technical and financial assistance for Croatia. Before the adoption of the new financial framework, there will be a dedicated work stream within SRSS to assist countries on their way towards joining the euro area.