TRANSITION REPORT 2014 Innovation in Transition

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Highlights

  • The five-year recession has continued into 2014. This is despite Croatia becoming a European Union (EU) member in July 2013, which should have boosted investor confidence. Reforms remain hesitant and economic recovery has been further delayed.
  • Privatisation of the country’s leading insurance company was successful. However, several other privatisation attempts have failed in the past year. The state’s efforts to sell key assets in the transport, natural resources and banking sectors have been unsuccessful, largely due to a lack of investor interest.
  • Transport sector reforms have advanced. The process of monetising the motorways is ongoing and a more commercialised approach to road maintenance has been introduced.

Key priorities for 2015

  • Business environment reforms need to be accelerated. Croatia’s economic stagnation in the past five years has been partly due to a failure to implement necessary reforms. Priorities include cutting back on the size of the state and accelerating the reduction of red tape on businesses.
  • The fiscal deficit should be reduced. Public debt has reached worrying levels. The focus should be on an efficient use of EU structural funds along with cuts in government spending, rather than an increase in taxes, as the size of the state must be reduced to ensure better long-term growth.
  • The high level of non-performing loans (NPLs) continues to rise and needs to be tackled. A comprehensive approach to NPL resolution is needed in order to free up resources for new lending.

THE FIVE-YEAR RECESSION HAS CONTINUED INTO 2014

PRIVATISATION OF THE COUNTRY’S LEADING INSURANCE COMPANY WAS SUCCESSFUL

TRANSPORT SECTOR REFORMS HAVE ADVANCED

2014 sector transition indicators
Corporate Energy Infrastructure FI

Source: EBRD.
Note: FI – Financial institution; ICT – Information and communication technology; Water – Water and wastewater; IAOFS – Insurance and other financial services; PE – Private equity.


Main macroeconomic indicators %

  2010 2011 2012 2013 2014
          proj.
GDP growth -2.3 -0.2 -2.2 -0.9 -0.5
Inflation (average) 1.0 2.3 3.4 2.2 0.5
Government balance/GDP -4.5 -4.6 -3.3 -5.5 -4.7
Current account balance/GDP -1.1 -0.9 -0.1 0.9 2.2
Net FDI/GDP 1.1 2.3 2.5 1.6 1.8
External debt/GDP 105.2 96.4 105.4 110.6 n.a.
Gross reserves/GDP 24.0 25.3 25.7 29.6 n.a.
Credit to private sector/GDP 74.9 77.1 72.4 71.7 n.a.

Macroeconomic performance

Croatia’s economy remains stalled in recession. Croatia has been in recession for the past five years. Over this period, its GDP contracted by a cumulative 12 per cent. In 2013 GDP fell by 0.9 per cent on the back of continued declines in household consumption and investment, as well as a drop in exports. GDP dropped a further 0.6 per cent year-on-year in the first quarter of 2014 and 0.8 per cent in the second quarter. Although the country suffers from deep structural problems, reforms remain hesitant. Upward pressures on prices subsided for over a year and Croatia experienced three months of deflation at the beginning of 2014. However, prices rose again by 0.4 per cent year-on-year in May 2014, as measured by the harmonised index of consumer prices. Pressure on the kuna in the past year has led the Croatian National Bank to intervene several times on foreign exchange markets to prop up the currency.

In January 2014 Croatia entered the EU’s excessive deficit procedure. The economic difficulties of the past five years have taken a toll on public finances. In January 2014 Croatia entered the EU’s excessive deficit procedure due to persistent government deficits above 3 per cent of GDP and a rising level of consolidated general government debt that had reached almost 70 per cent of GDP by mid-2014. This implies that the authorities have committed to a gradual fiscal consolidation, including further austerity measures in line with EU requirements. So far, the government has undertaken measures both on the revenue side of the budget (raising the intermediate value added tax rate from 10 per cent to 13 per cent and abolishing certain tax reliefs) and on certain spending reductions. In addition, the government is planning to introduce taxes on savings and real estate, and to increase the residence tax for tourists. The weakening fiscal position also resulted in the downgrade of Croatia’s sovereign debt rating to non-investment grade by all three main credit agencies.

The outlook for the next year is uncertain. The economy continues to face long-standing problems of weak competitiveness, a large public sector and difficulties in the business environment. Under the current projections, GDP would moderately fall this year – the sixth consecutive year of contraction for the Croatian economy – returning to mild growth only in 2015. Over the medium term, Croatia’s economy could see a boost from improved regional and global conditions, as well as from the efficient use of EU cohesion funds, but growth prospects will depend on the extent to which long-awaited reforms to public administration and economic governance are implemented.


Major structural reform developments

The privatisation programme has achieved mixed success in the past year. The government successfully sold the country’s largest insurance company, Croatia Osiguranje, to the local Adris Group, which is listed on the Zagreb Stock Exchange. Also, there was substantial investor interest in Kupari – a hotel resort ruined and abandoned in the 1990s – for which the privatisation process is under way. However, the government received no bids for the purchase of 49 per cent of Croatia Airlines in November 2013. In March 2014 the government’s attempts to sell a stake of 25 per cent plus one share in the fertiliser producer, Petrokemija, failed to attract any binding offers, even though several foreign companies had expressed an interest. Furthermore, in December 2013 the government rejected a bid by Erste Bank for a 99.1 per cent stake in the state-owned postal bank, Hrvatska Postanska Banka (HPB), because the offer, including the proposed price, was considered unacceptable. Erste Bank was the only bidder as OTP Banka, which had participated in the first round of tendering, subsequently dropped out. Meanwhile, the government is currently working on its 2015 privatisation agenda, which will most likely once again include Croatia Airlines, HPB, Croatian Railways Cargo and ACI, a chain of national marinas.

A new Act on Strategic Investments has been enacted. The Act, which entered into force in November 2013, is designed to speed up the implementation of projects deemed to be of strategic importance. Despite this measure, in the World Bank Doing Business 2015 report, Croatia’s score for ease of doing business remains relatively low in comparison with other EU countries. Out of 189 countries in the index, Croatia ranked 65th, still scoring the lowest in dealing with construction permits. In the agricultural sector, a draft law has been prepared to provide the legal framework and support needed to facilitate consolidation of fragmented farmland.

Natural resource tender attracts significant private interest. Following the enactment of the new Hydrocarbons Exploration and Exploitation Act in July 2013, the authorities opened the first offshore bidding round in April 2014 for 29 exploration blocks in the Adriatic Sea, with bids to be awarded by early 2015. The tender attracted considerable interest, with more than 30 oil and gas companies reportedly present at the launch. If successful, this will be Croatia’s first licensing of its natural resources in a competitive bidding process. In addition to the offshore bidding, in July 2014 the Ministry of Economy issued a tender for onshore licensing. The application deadline is February 2015, and the maximum exploration and production period envisaged in the tender is 30 years.

Transport sector reforms are advancing. In October 2013 the Ministry of Transport launched an international tender to monetise operating motorways, which are currently under the management of two state-owned companies, HAC and ARZ. Five bidders have come forward and the selection process is ongoing. Financial closure is envisaged for 2015. In addition, performance-based maintenance contracts were introduced in April 2014 by Croatian Roads, the company responsible for local and regional roads. In December 2013 the French Zagreb Airport International Company (ZAIC) signed a 30-year concession deal for Zagreb Airport. Under the terms of the contract, ZAIC will invest around €300 million in the construction of a new terminal. In the railways sector, two new cargo operators entered the market – local Adria Transport d.o.o. and Rail Cargo Carrier from Hungary. There are no new operators in passenger services. However, the planned sale of a 75 per cent stake in Croatian Railways Cargo has been abandoned following the collapse of negotiations with Romania’s Grampet Group in January 2014.

Deleveraging and the rising level of NPLs reflect vulnerabilities in the financial sector. The banking system is well developed by regional standards, with one of the highest capital adequacy ratios in Europe, at 20.8 per cent as of June 2014. The banking sector is highly euroised with over 70 per cent of loans and deposits denominated or indexed to foreign currency. However, monthly year-on-year private sector credit growth has been negative since mid-2012. In addition, the level of non-performing loans has been rising steadily, reaching 16.6 per cent by June 2014.

A new labour law has been passed. The new law, approved by parliament in July 2014, aims to make hiring and firing in the labour market more flexible. It builds on previous reforms to the labour market introduced in 2013. However, the five-year recession in Croatia has taken its toll on labour market performance. Unemployment increased sharply over that period, standing at more than 20 per cent in the first quarter of 2014, with a particularly high rate of youth unemployment.