International Monetary Fund officials have said that due to the resurgence of the pandemic, significant challenges continue to exist for Croatia, that economic policy needs to be adjusted to the crisis and that further VAT cuts are not advisable without measures to offset permanent revenue losses.

In the period from November 16 to 25, members of an IMF team led by Srikant Seshardi held online consultations with Croatian Finance Minister Zdravko Maric, Croatian National Bank (HNB) Governor Boris Vujcic and other state officials and representatives of the private sector, as part of regular consultations based on Article IV of the IMF Statute.

The Croatian authorities and the IMF team discussed ways to balance short-term priorities of economic support in the face of a resurgence in infections against medium-term priorities of restoring fiscal space, and raising productivity and growth through improved public investment and greening of the economy, reads a press release made public on the IMF’s and HNB’s websites on Monday.

This year, the economy is expected to contract between 8-10 percent reflecting lower domestic and external demand, and in particular, a 50 percent decline in tourism volumes (year-on-year), reads the press release.

“Despite the difficulties of this year, Croatia is faring better than many other countries with a similar degree of tourism-dependence. Rises in unemployment have been contained thus far thanks to strong policy support.

“Yet, significant challenges persist due to the resurgent pandemic. Public debt is expected to rise back up to 88 percent of GDP this year, with a forecast of the general government deficit of 8 percent of GDP due to lower tax revenues, and fiscal support measures provided to support those impacted by the shocks.”

“Growth in credit to the private sector has held its ground, partly supported by a temporary debt service moratorium. Economic growth is expected to rebound to about 6 percent in 2021, driven by a partial recovery in tourism and higher public investment, but it is subject to significant pandemic-related uncertainty.

“Finding a balance between short and medium-term priorities is challenging. In the short-term, the priorities are to ensure that (1) economic support due to the Covid-19 crisis is not withdrawn until the recovery is well entrenched; (2) the measures enacted remain effectively targeted in reaching viable sectors of the economy to minimize scarring; (3) resources for potentially higher healthcare expenses can be met, particularly if the epidemiological situation gets worse.

“These have to be balanced against medium-term goals of once again increasing fiscal space ahead of euro adoption, guiding budgets back towards balance, enacting structural reforms to fix healthcare and pensions, streamlining the role of the state-prominently through improved SOE governance, as well as an enhanced business climate,” the IMF team says in the press release.

Active training and reskilling in tourism, hospitality into green economy

“Policy measures should evolve in tandem with the crisis. Active training and reskilling should take place in areas with excess capacity such as tourism and hospitality and into areas like greening the economy and construction.

“Measures need to be constantly monitored to ensure that economic support is targeted to viable firms. Further, Covid-19-related support measures should be designed to remain in place as long as the pandemic has not abated; this will remove any uncertainty regarding the duration for which they will be needed.

“Once recovery is entrenched, the fiscal framework needs to be steered closer to the medium-term objectives of lowering debt and balancing the budget. The Croatian authorities would be well advised to actively communicate their medium-term fiscal strategy that covers medium-term financing needs and includes an assessment of the fiscal risks.

“Fiscal stimulus designed to raise growth would be more effective if delivered as spending increases than further tax cuts. At this stage, in our view, further reductions in VAT are not advisable without adequate offsets that guard against permanent revenue losses,” the IMF officials say.

Commenting on funds from the Next Generation EU facility, the IMF officials say that it represents a unique opportunity for Croatia.

“If properly absorbed and utilized, these funds could meaningfully raise productivity and growth, whilst shielding the ability to meet crucial current expenditure needs in areas such as healthcare, in the near-term. In this regard, the Croatia 2030 National Development Strategy is encouraging and broadly lays out the right priorities. It is crucial to develop a concrete investment plan and follow through with strong implementation.”

Members of the IMF team also believe that the HNB has been proactive in responding to the crisis and the banking sector has thus far withstood pressures well.

They recall that the HNB had to aid the currency at the outset of the pandemic, provide additional liquidity, support the government securities market, and that it temporarily eased the regulatory burden on banks.

The European Central Bank (ECB) and the HNB agreed on a €2 billion swap line on April 15.

The HNB conducted five purchases of government securities, for about 5.5 percent of GDP by end-June. Domestic financial markets quickly stabilised, and Croatia took another step forward in its integration with European Union partners, by joining ERM II and establishing close cooperation with the ECB on banking supervision as well as by joining the Single Resolution Mechanism on July 10, the IMF says.

The IMF expects the upcoming 2021 Article IV consultations to be held next spring.