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Croatia Enters the European Semester with Huge Problems

Published on , , Zagreb, Twitter: @AdelinaMarini
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"An IDR [in-depth review] is also warranted for Croatia, a new Member of the EU, given the need to understand the nature and potential risks related to its external position, trade performance and competitiveness, as well as internal developments". This is written in the Alert Mechanism Report of the European Commission. With it Zagreb will make its debut in the European Semester, separately from another debut - the inclusion into the excessive deficit procedure (EDP).

As the country joined the EU in the middle of the year - July 1st - which is also the end of the European Semester for 2013, Zagreb participated in the exercise on a voluntary basis by presenting its economic programme in April. But the programme proved completely sufficient to trigger Brussels's alarm bells. According to the Commission, several indicators are with levels above the indicative thresholds, like, for instance, the net international investment position. This, by the way, is one of the problems for Bulgaria as well. A loss of market shares, high unemployment, negative net international investment position nearing 90 per cent of the gross domestic product for 2012, growing unit labour costs, accompanied by unfavourable product specialisation and geographic export orientation.

Brussels did not miss also the fast growth of the public debt as well as the lack of a "significant" fiscal consolidation which Finance Minster Slavko Linic has been calling for since the beginning of his term and recently clearly demonstrated his desperation. He even suggested that it was high time to ask the International Monetary Fund for help, a notion firmly rejected by Prime Minster Zoran Milanovic. The situation is further deteriorating by the fact that the regulatory burden and the insufficient competition in many sectors of the economy remain "serious impediments to growth and job creation". Moreover, the data show that there is structural unemployment. The number of people facing the risk of poverty is among the highest in the EU.

Concern in Brussels, optimism in Zagreb

The autumn forecast of the European Commission shows that the real Croatian gross domestic product will contract by 0.7% this year due to the weak demand at major export markets, the bad conditions at the labour market and the indebtedness of the private sector. According to Croatia's Minster of Finance Slavko Linic, however, the contraction will only be -0.2%. He said this during the presentation of the draft bill amending this year's budget which is necessary precisely because of too optimistic expectations for growth. The weak net wage growth, the declining employment, the weak domestic demand and continuous bank deleveraging, coupled by uncertainty, are all preconditions for the European Commission's conservative expectations for the Croatia's economic growth in the next two years.

For 2014, Brussels's expectations are that the Croatian economy will return to the positive zone by 0.5%. But the risks are very serious and are stemming from enhanced competition pressures in the EU and also from the exit from the Central European Free Trade Area (CEFTA). Besides, the capacity for absorption of EU funds is also expected to be limited. The budget deficit is forecast to increase to 5.4% in 2013 as well as the public debt which next year will trespass the limit of 60% of GDP. And if the Commission's forecast before it has started the in-depth review of the Croatian economic indicators sounds too conservative, some optimism can be felt in Zagreb's expectations. Minister Linic forecasts economic growth of 1.3 per cent next year, 2.2% in 2015 and 2.5% in 2016. He justifies his expectations with increase in revenues to a large extent due to the fiscalisation that started earlier this year and the improved tax discipline.

And although taking into account that the government had done all the possible and necessary cuts, the budget deficit is expected to grow because of the Croatian contribution to the common EU budget, which in 2014 will be full and not half in size as this year's. The spending next year will increase also because of the continuous reforms of the healthcare system, including through debt payments. In general, the visions of Zagreb and Brussels coincide as regards the relatively low absorption of EU funds. The government expects in 2014 4.5 billion kunas to be injected into the Croatian economy (some 590 million euros) which, however, also means more costs for co-financing. The more the projects, the bigger the spending for co-financing. But in the same time the EU funds will be more, the finance minister explained. For 2014 the general government deficit is expected to be 5.5% of GDP, in 2015 4.6% and only in 2016 it is expected to fall within the 3% limit as prescribed in the Stability and Growth Pact of the EU.

Having in mind the tradition of Zoran Milanovic's cabinet to make budget reviews every year, Slavko Linic's forecasts should be viewed as rather short-term and too optimistic. He himself pointed out that from now on everything will depend on economic growth because no more spending cuts can be made, especially against the backdrop of the ongoing for two months doctors' strike because of a lack of a collective bargaining. Slavko Linic has warned that the reform in the health care sector will be the toughest next year. "Every new reform, every structural change brings new losses and means new costs for the budget", he added.

But Brussels believes that the economic growth requires much more than what the cabinet in Zagreb is doing. The Commission assessment is that the low quality of business environment and the low efficiency of the judiciary, as well as the lack of competition on key markets suppress growth perspectives of the Croatian economy. Apart from that, the investments in research and development are also few. On Friday, the Commission is to present its report on whether Croatia should be included in the excessive deficit procedure. Zagreb is ready for tough negotiations with the Commission on how exactly should the statistical data be interpreted and what measures should be undertaken to reduce the budget deficit and the debt. At this stage, the Croatian attitude is to throw all the blame onto the EU because of which, practically, the budget deficit jumps over the allowed 3 per cent of the GDP. Zagreb has in mind the Croatian contribution to the EU budget which will be 3.6 billion kunas (473 million euros) next year. Without it, the government says, the budget deficit would be in line with the indicative threshold.

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