IMF urges Croatia to increase public sector investments

NEWS 16.12.201919:10
REUTERS/Yuri Gripas

The existing gap between Croatians and other residents in the EU in terms of the average income per capita can be narrowed by higher and better investments of the public sector alongside investments of the private sector, according to conclusions made by the International Monetary Fund (IMF).

“If, for example, Croatia were to aspire to bridge 15 percentage points of the current average per person income gap with the EU by 2030, the economy would need to grow at 1.5 percentage points more rapidly than the EU average, over this period. To maintain such higher relative growth rates, in addition to higher private investment, Croatia needs to raise its public sector investment as well—both in quantity and quality,” reads the conclusions of the IMF mission which has recently visited Croatia.

The conclusions, published on Monday, praise Croatia for having come a long way over the last five years.

“Growth is strong, inflation is subdued, and unemployment has been significantly reduced. Public debt is steadily declining and external reserves are healthy.”

Croatian economy has become stronger in last 5 years

“Following a protracted and painful recession, the last five years have seen the Croatian economy become stronger and healthier. Some of this can be attributed to ‘good fortune’, that is to say favorable global conditions, helping a tourism boom. However, a significant share is due to good policies—strong budget management and skillful policies by the Central Bank,” say the conclusions praising the central bank (HNB).

“As long as the authorities maintain prudent policies and global conditions remain supportive, this picture is likely to continue next year. Looking further ahead, Croatia must rise to the significant challenge of successfully deepening integration with Europe—including through future Euro adoption—during a period of rapid technological change.”

Croatia is urged to make prudent investments so as to to catch up with other countries that have made greater progress.

The IMF also calls for measures so as to ensure that the economic expansion can be felt more broadly across the population.

“The share of the workforce between the ages of 20 and 64 that is employed is only slightly above 60 percent. And the share of the population at risk of poverty and social exclusion is estimated at 25 percent. The country’s most vital resource—its youth—remain concerned about their long-term prospects. This has spurred emigration and a hollowing out of the internal regions of the country. In the short-term, the obvious symptom has been labor shortages in areas like construction and tourism. However, the more insidious problems are those of ‘brain drain’, and challenges to the sustainability of pension and healthcare systems,” the Fund warns.

According to current official figures, the income per person of Croatia stands at 63 percent of the EU average.

Higher wages must be supported by higher productivity that grows the economy and to this aim, the IMF suggests three steps: maintaining macroeconomic and financial stability; making the state a source of greater dynamism through reforms; and, investing resources wisely to raise productivity.

Progress in maintaining macroeconomic and financial stability

Regarding the first step, the IMF praises the authorities for “considerable success” attained with the first step and it “needs to be carefully preserved.”

“However, without more significant progress on the second step, the right climate and needed resources for the third step will prove difficult to realize.”

Public sector needs to be overhauled

Concerning the reforms of the public sector, Croatia is praised for increasing public investments in accordance with continued debt reduction which do not call for any austerity measures.

“Yet, they do require strong public sector reforms and a shift of some share of current spending to capital spending. Over the last decade, whether compared to the EU, or to other emerging economies, the balance of public spending in Croatia has tilted considerably toward spending on items like non-investment goods and services, subsidies, compensation of employees, and other social benefits, and away from public investment. This has reduced the flexibility of the budget and its capacity to spark economic growth.”

The country is called to implement active employment policies “to facilitate smooth transfers of public sector workers with suitable skills to the private sector” now when the economy as a whole is doing relatively well.

“State-owned enterprise management and performance needs to continue on the path of more modernization, so that enterprises in core areas support the productivity of the economy. It is noteworthy that this year they will meet or exceed the initial target of 0.4 percent of GDP contribution to the budget.”

The government is advised to optimise social benefits system through better targeting of benefits to those who are most vulnerable and in need.

“The government should also continue social dialogue to come up with measures that mitigate the effects of the recent roll-back of pension reforms.”

“Improving the territorial organization of local governments would significantly improve their capacity to invest and deliver uniform high-quality public services,” says the IMF.

IMF calls for investing in railways, waste and waste-water treatment and do “smart investments”

The Fund also estimates that if “around 4 percent of overall government revenues were gradually and efficiently reallocated to smart investments, the Croatian economic growth rate can be raised sufficiently as to bridge a significant portion of the gap with the EU over the next decade.” These investments should be conducted in parallel with public sector reforms “that are supposed to enable savings in current spending that can be redeployed to capital spending, without the need to raise taxes, or cut the overall level of government spending. These adjustments, if properly executed and implemented, will repay the Croatian people handsome returns in the future.”

In order to achieve higher future living standards, in terms of transportation infrastructure, the country “already has a good network of roads. Investment in ports on the coast are also underway. However, to make these ports fully productive, investment in railways—particularly for freight purposes—also needs to occur.” Investments in both solid waste and waste-water treatment are also high priority areas.

“Aside of ‘physical’ infrastructure, Croatia also needs to upgrade its technological infrastructure. The overall strategy and responsibility for digitalization of the country would benefit from having a single independent entity with a long-term perspective.

“Although connectivity with regard to existing fixed broadband and mobile technologies is good, Croatia significantly lags behind advanced European peers and many other New Member States when it comes to leading edge fast and ultra-fast digital technology,” says the IMF.

“Croatia has made some progress in the availability of digital public services for individual citizens. More progress is needed when it comes to the availability and use of digital services for businesses. The recently launched “START” initiative which allows for simple electronic procedures to start a business is a welcome development in this regard.”

Government’s decision to keep standard VAT rate at 25% supported

“The IMF supports the government’s decision to withhold the reduction in the overall VAT rate from 25 to 24 percent, given recent demands for higher wages. Indeed, we would recommend holding back on any other tax reductions at this stage, as they could return the fiscal balances to deficits, and undermine the reduction in public debt which is still elevated.

“For the same reason, we also strongly urge restraint with regard to any further wage demands, until a thoroughly analytically researched new public sector wage grid and coefficients are developed.”

The IMF also praises the Croatian banking system as “profitable, liquid, and well-capitalized.”

The conclusions describe the preliminary findings of IMF staff at the end of their official staff visit to Croatia earlier this month.