IMF says national reform programme encouraging, sees public debt as big risk

An International Monetary Fund (IMF) Mission said on Tuesday that the Croatian government's national reform programme was encouraging, warning however about the existing risks to the national economy.

IMF Mission head Khaled Sakr told a news conference, held at the end of the mission's two-week visit, that Croatia's public debt posed a great risk, as interest rates at international financial markets were currently exceptionally low, adding that those rates would grow once the global economy was stabilised.

They now create a manoeuvre space for the government as there are no problems in refinancing, but this is not a normal situation, he added. Once the global economy recovers, interest rates will go back to being higher which is why Croatia needs to try to reduce its public debt as soon as possible, Sakr said, presenting the IMF Mission's Concluding Statement of the 2016 Article IV.

A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’), in most cases to a member country. Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, or as part of other staff monitoring of economic developments.

Sakr underscored that the implementation of the government-sponsored reforms would have a positive impact on the public debt as it would improve the perception of Croatia on international financial markets, reduce the risk and enable more favourable financing conditions not only for the state but for the private sector and general population, too.

In its Concluding Statement, the IMF Mission recalls that the recovery gained traction during 2015 and real growth registered 1.6 percent, notwithstanding a slowdown in the fourth quarter.

IMF staff projects a further strengthening of growth to about 1.9 percent in 2016, aided by strong exports of goods and services and a continued pick-up in private consumption. 

Over the medium term, economic growth is therefore projected to stabilise at around 2–2.25 percent. Inflation is projected to return to positive territory in 2016 and to remain low over the medium term.

However, there are substantial downside risks, including a slowdown in external demand due to remaining uncertainties in the EU economic outlook, a normalization of global monetary conditions, which could lead to higher costs for the large public financing needs, and border disruptions associated with the refugee crisis, the Concluding Statement read.

"Furthermore, domestic political conditions remain challenging with possible adverse implications for reform implementation and the economic policy-making environment. To mitigate this risk it would be important to finalize and communicate the remaining details of the national reform program, adhere to the budget process outlined in Budget Law and Fiscal Responsibility Law, and preserve the independence of the central bank in line with the Statute of the European System of Central Banks," read the Statement.

IMF staff says that the announced national reform program is encouraging but will require decisive implementation of concrete measures in order to achieve its objectives.

Speaking of the government reform programme, Sakr commented on the announced introduction of a real estate tax, saying that the mission welcomes the plan to introduce a modern real estate tax that is appropriately phased-in, building on the existing communal fees system. 

Creating the fiscal space to reduce the high tax on labour would also help in this regard. 

Sakr also said that the decline in the general government deficit in 2015 was stronger than expected. The overall deficit is estimated at 3.2 percent of GDP, compared to 5.5 percent in 2014.

IMF staff said that the 2016 budget targets a deficit of 2.6 percent of GDP. This further decline of the deficit is based on a combination of a cyclical revenue upturn and a freeze of the overall “nationally-financed” expenditures, i.e., non-EU funded expenditures.

"There is a risk that there will be higher public investment this year, especially in view of last year's reported decline in public enterprises' investment. This risk could lead to a slightly higher deficit of 2.8 percent of GDP," the IMF said.

The mission also notes that the national reform plan aims at a further steady ambitious fiscal consolidation over the medium term, which includes both tax and expenditure reductions. "The authorities have expressed their determination to achieve the planned reforms. However, given the various downside risks, the mission is projecting a somewhat slower pace of expenditure and thus fiscal consolidation compared to the national plan. It would therefore be important to make sure that any reduction in taxes go hand in hand with other reforms that would create the fiscal space for such reductions. It would also be useful to finalize the remaining details of the planned reforms, with a view to enhance efficiency, growth, and equity." 

The mission welcomes the containment of the large wage bill and the plan to make part of compensation performance-based in order to enhance incentives to improve efficiency and the quality of public service.

The mission welcomes the intention to improve the absorption of the EU structural and investment funds, which would contribute to growth with relatively modest fiscal impact.

The mission believes it would be desirable to strengthen public expenditure monitoring and control, and to put in place a contingency plan to guard against fiscal slippages should downside risks materialise.

The mission encourages the authorities to continue to smooth sharp exchange rate fluctuations, while expediting structural reforms in order to enhance competitiveness. The mission believes it would also be useful to take advantage of the strong balance of payments position to further bolster international reserves.

IMF staff encourages the Croatian National Bank (HNB) to continue to adopt an accommodative monetary policy stance within the limits set by the exchange rate anchor and financial stability objectives. 

"Ambitious structural reforms remain essential to enhance Croatia's growth potential. Business environment indicators suggest significant room for improvement," the Concluding Statement said. The mission therefore encourages the authorities to reduce bureaucratic impediments to doing business, improve policy transparency and predictability, enhance the judiciary process, and strengthen anti-corruption efforts.

The high unemployment and low labour participation rates highlight the need for further reforms of the labour market and benefit systems. It would be important to make the regulations on temporary employment, severance payments and the hiring and retrenchment of employees less restrictive in order to encourage employment creation. Creating the fiscal space to reduce the high tax on labour would also help in this regard. A better targeting of unemployment and veterans benefits and implementation of the planned pension reforms, would help improve participation rates.

A determined effort to strengthen public sector management and advance the planned privatization in a transparent and fair fashion would help improve the efficiency of the economy and also put the large public debt on a faster downward path, IMF staff said.

Last update: Tue, 10/05/2016 - 19:32


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