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Zagreb Got a Good Assessment from the Outside but Challenges Lie Ahead

Published on , , Zagreb
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Last week brought a lot of good news for the government of Zoran Milanovic who desperately needed them because of the tough economic situation of Croatia, enhanced additionally by the biggest drought in decades. The first swallow to bring good news was the decision of the Fitch credit rating agency to upgrade its outlook for Croatia from 'negative' to 'stable'. This was accepted as a very good news by the government, the media, experts and by a large part of society because for the coalition government the judgement of the credit rating agencies this autumn emerged as the biggest threat. It was even talked about the need Croatia to resort to the International Monetary Fund if the rating of the country was downgraded.

The second good news came from the tourism where the country scored new records. For the first eight months of the year the number of visitors in Croatia has increased by 5.6% compared to 2011. But the calculations what the financial contribution for the treasury this news will bring are not ready yet. However, the first news has a much bigger significance and is an external assessment for the government and all the measures it undertook in the past months. In its motives for the upgrade of Croatia's outlook, Fitch points out that the assessment reflects the government's progress in developing a medium-term plan to address the country's fiscal problems in a situation where public finances remain a key rating driver.

The Achievements

The first step toward the change of Croatia's assessment is the entering into force in the beginning of this year of the Fiscal Discipline Act which forces the government to limit its spending by 1% of GDP every year until a balanced budget is achieved or a surplus. According to Fitch, the government is on track with the reduction of the budget deficit and will meet its fiscal targets to reduce the budget deficit this year to 3.8% from 5% in 2011, in spite of the recessionary environment. The second reason for the positive outlook of Fitch is the relentless war Slavko Linic, the minister of finance, waged against tax debtors. In the peak of the summer the ministry of finance launched a special web page where it published the names of all the big debtors to the treasury - an act that led to overimplementation of the plans for tax revenues.

As the credit rating agency notes, the efforts for improvement of tax collection are well targeted and have started to deliver in a very short-term.

The challenges

But the good news end here because the challenges the Adriatic country is facing are many and all of them big - something which Milanovic's cabinet seems to be aware of. The biggest risk for the country, as the agency and the government itself point out, remains economic growth. The perspectives for the gross domestic product to grow remain weak. Croatia has been failing to return to positive growth since 2008. Fitch's expectations are the GDP to contract by 1.7% in 2012, followed by anaemic growth of 1.5% in the mid-term. The weak economies of Italy and other key export countries of the EU will be a heavy burden for Croatia's efforts to achieve positive growth. This is a threat for the fiscal adjustments and for the debt dynamics, the agency notes.

Ultimately, the country will receive a strong boost for the economy in the second semester of 2013 when it will join the EU. But this can have only short-term benefits if the opportunity is not seized properly, Fitch warns. What the government has to do and already is working on is to reform the labour legislation in order to improve competitiveness, especially after its entry into the highly competitive market of the EU next year. At the moment there are public discussions on the proposed by the government changes in the Labour Act. Mirando Mrsic, minister of labour and pensions, said on September 10th after almost 4-hour long session of the trilateral social and economic council that the act is to be divided into two - a Labour Act and an act on social rights. The purpose of the reforms is to increase the flexibility of the labour market, which however poses a risk of an increase of unemployment which already is growing.

Expectedly, the trade unions reacted sharply to the proposed amendments calling for a change of the model. Currently we have an austerity policy but this cannot last forever, Kresimir Sever, representative of the trade unions in the trilateral council said. In his words, most affected by the changes will be the workers in the public sector. Minister Mrsic assured, though, that the most important priority of the left-liberal coalition was to protect jobs. Most happy with the proposed changes seem to be the employers. According to their representative Damir Kustak, the draft legislation is a good attempt of the government which they support. "With our entry into the EU we have to keep our competitiveness", he recalled. The cabinet's intention is the amendments to enter into forces as of July 1st next year when Croatia's EU accession is planned.

Croatia urgently needs foreign investments for which, however, it needs to create the necessary flexible and with a minimum state participation business environment. In other words, the autumn for the government of Zoran Milanovic seems to be tough and intense, as will be all over Europe. According to Vecernji List, a Croatian daily, 10 are the challenges for the coalition government, created by the Social-Democratic Party of Milanovic and the Croatian People's Party of Radimir Cacic, the first deputy premier.

Overcoming the consequences of the drought for which farmers ask for compensations from the government, which says are not available in the budget; the unfinished process of privatisation of the Brodosplit shipyard, which is one of the constant requirements of the European Commission; reduction of the workers in the public sector; the border disputes with Bosnia and Herzegovina, which the construction of the strategically important bridge Peljesac depends on, aimed at connecting Croatia with its south interrupted by a five kilometre long outlet of Bosnia and Herzegovina to the Adriatic sea. The construction of the Plomin heating plant is another challenge, the newspaper writes.

Another problem that looms up as a very important issue by the day is the serious divergences between the goals of the government and the ministries. For two of them it has become clear recently that they had spent their budgets for this year and will be unable to pay wages. Those are the ministries of justice and education. There is a real danger the teachers' wages to be reduced by 10%. Financial problems has the Ministry of the Interior too. Minister Linic, however, is determined that no compromises should be made because in order to meet the fiscal targets for 2012 another 700 million kunas (93 million euros) will have to be cut from the budget.

Linic is against seeking external help because the debt of the country has already grown dramatically in the past years. According to the Fitch agency, the public debt has grown from 38 per cent of GDP in 2005 to 45.7% in 2011. The expectations are the debt to reach a peak of 58% of GDP in 2015 and then to begin declining from 2016 onwards which is slightly different from the government's forecast the debt to peak to 52.9% in 2013 and to start declining in 2014.

In spite of the tough situation in Croatia, good opportunities will open after its accession to the EU with the structural funds that could compensate the lack of foreign investments and help overcome the recession as Poland has done, becoming the only EU country to weather the crisis. The government in Zagreb has a choice for which it has vivid examples in the EU: to continue the tough structural reforms but to take advantage as much as possible of the possibilities of the single market and the structural funds or to continue the austerity policy without serious economic achievements and low absorption of EU funds, as Bulgaria does with which recently Vecernji List made a comparison. It is evident that the government has chosen the first option. It now remains for the society to be ready to continue to tighten the belt.

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