Croatia's annus laboriosus

By bne IntelliNews March 28, 2012

Guy Norton in Zagreb -

Barring a last-minute hitch - something that can never be discounted in the Balkans - Croatia will become the 28th member of the EU on July 1, 2013. On that fateful day, the country will finally achieve its long-cherished dream of joining Europe's elite politico-economic bloc, ushering in an unparalleled era of economic prosperity.

That at least is marketing spin propagated by local politicians who in the two decades since Croatia gained independence from the former Yugoslavia have pursued the goal of EU accession with an almost monomaniacal zeal. The economic reality promises to be somewhat different, warn both domestic and international observers who feel that Croatia is still poorly prepared to meet the challenges of competing in the single European market it will join next year.

While the previous rounds of EU enlargement involving states from Central and Southeast Europe in 2004 and 2007 were conducted in the midst of a global economic boom, Croatia will join the EU in 2013 against a backdrop a global economic slowdown, if not outright recession.

As such, the recently installed left-wing coalition government in Croatia has its work cut out if is to resuscitate the country's moribund economy. As Fitch Ratings recently noted: "Croatia's poor growth performance (0.1% average in the five-years to 2011) weighs on its rating." Nevertheless, Fitch affirmed Croatia's 'BBB-' investment grade rating, with the caveat that it retained its negative outlook. "Despite some positive initial policy steps by the new government, further fiscal consolidation measures and structural reforms will be required to boost economic growth and stabilise the public finances," it said.

UK investment bank Barclays Capital too remains sceptical about whether the government has the wherewithal to push through potentially painful social reforms that can improve the country's creditworthiness. In a recent trip report entitled, "A start... but still too little, too slow", it welcomed the fact that the government had promised to cut spending by HRK4bn (€530m) - roughly 1% of GDP - but queried whether its actions went far enough. "While the first nominal expenditure reduction in Croatian history is perceived as an achievement by the authorities, we think the proposed measures are not overly ambitious and represent largely a one-off solution."

As such, it went on to warn: "We think the risks of a downgrade to non-investment status over the next months are very real."

Critics of the government's economic policies are not only to be found abroad. In a damning indictment of the current state of play in the economy, the Croatian employers' association Hrvatska Udruga Poslodavaca (HUP) in a recent statement complained: "Labour and capital in Croatia are overtaxed, labour legislation is bad and inflexible, the education system is not coordinated with labour market needs, the justice system is slow and ineffective, and the state and local administration is inefficient."

The HUP went on to bemoan a lack of real and fundamental reforms that would create conditions for economic recovery and long-term sustainable growth. "What has been done so far is not and will not be enough to stimulate growth and improve the investment and business climate. Quite the contrary, some steps are having a negative effect on the investment climate and economic growth, such as higher taxes that create additional risks and legal insecurity," it said.

Growth gap

There's also widespread doubt about whether the government's GDP forecasts for this year - it is targeting growth of 0.8% of GDP – is even remotely achievable. Most local economists believe that the economy will instead shrink by 0.5-2.0%.

Alen Kovac, chief economist at Erste Bank in Zagreb, believes that the government's growth forecasts understates the impact that the recessionary conditions in the Eurozone will have on Croatia this year. "Our baseline scenario of GDP shrinking by 1% this year is based on the slowdown in the Eurozone which will have a negative impact on tourism revenues and investment activity," he says. "Nobody except the government is looking at positive GDP growth in 2012 because of the weak external and domestic economic environment."

He also believes that planned investments in roads, railways and the energy sector that the government hopes will boost growth this year will only have a positive impact in the medium term. "They're a good idea, but they won't really have an economic impact until 2014-15."

Kovac believes that the most pressing challenge facing the government this year is to get agreement with the country's powerful public sector trade unions on changes to collective bargaining agreements, which are seen as key to improving the efficiency and profitability of the country's numerous state-owned enterprises that account for roughly 25% of Croatian GDP. "If there is no agreement on labour market reforms, the government will not meet its fiscal targets for 2012. Changes need to be made this year so as to have a positive impact on Croatia's competitiveness when it joins the EU in 2013."

Analysts say that the government's ability to push through changes on the labour front will also have an important impact on its efforts to attract much-needed foreign direct investment which has dropped dramatically in recent years. To reverse this decline, the authorities in Zagreb are creating a special agency to promote foreign investment, taking over these functions from local authorities, which are largely blamed for deterring investors by erecting numerous bureaucratic hurdles. "The government is working hard to get foreign investors to look at Croatia again," says Kovac, adding that it is hoping that the prospect of EU accession in July 2013 which will bring in €3.5bn funds for infrastructure and development projects in the first two years of membership.

This, it is hoped, will prove to be a deal clincher when it comes to the government attracting foreign participation in a slew of public-private partnership projects that it's looking toward in order to make Croatia's EU membership an economic dream rather than a nightmare.

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