Croatia’s 2016 budget, adopted by the government on March 10, is targeting a general budget deficit of 2.7% of GDP. This would bring Croatia back below the 3% threshold demanded by the European Union, but deeper reforms are still needed to tackle public debt and reform the cumbersome state sector.

Zagreb expects HRK114.9bn (€15.2bn) worth of revenues and expenditures of HRK122.4bn, resulting in a budget gap of HRK7.5bn, though this will rise to HRK9.2bn when state agencies and municipal authorities are taken into account. The new budget is based on a GDP growth forecast of 2% this year, as Croatia continues to expand after emerging from a six-year recession.

"This is the lowest targeted budget gap since 2008. If we apply European Union methodology, the gap still remains below 3% of GDP which is our goal," Finance Minister Zdravko Maric told a cabinet session on March 10, according to Reuters.

The announcement of the budget follows pledges from Prime Minister Tihomir Oreskovic’s government to bring the deficit below 3% of GDP. It comes two days after the European Commission announced it would not take corrective measures against Zagreb over excessive macroeconomic imbalances. Maric said on March 8 that the budget would send a “clear message” to Brussels of the government’s intention to carry out reforms, a government statement said.

The 2% growth projection “seems realistic”, according to Raiffeisen financial analyst Tomislava Ujevic, even though Raiffeisen has a more conservative forecast of 1.5%. However, Ujevic points out that the forecast is “primarily based on domestic demand, mostly thanks to household consumption, which is forecast to grow by 1.8% in 2016 and 2017, and 2% in 2018. We see the risk might come from a potentially less favorable external environment and still weak labor market.”

She adds that there is also a risk of overestimated receipts from the EU, which are set at HKR9.4bn in the 2016 budget, a considerable increase since 2015, when Croatia planned to use around HKR 7bn - though the actual amount utilised could be considerably lower.

On the other hand, between 2016 and 2018, Zagreb is hoping to receive HRK1.6bn a year from privatisations, an estimate Ujevic believes is conservative.

Data on the 2015 budget deficit has not yet been published, but it is expected to be around 4% of GDP, down from 5.6% of GDP in 2014, according to the International Monetary Fund (IMF). This is attributed both to the cyclical upturn in revenues and government steps such as tighter spending control and an increase in fuel and tobacco excises.

Seething troubles

In addition to the budget deficit, Croatia also has extremely high public debt, at around 90% of GDP, though Oreskovic’s government says it will bring the ratio down to 80% by 2020.

This may not be easy to achieve. Gunter Deuber, head of CEE research at Raiffeisen Bank International in Vienna, warned in an interview with bne IntelliNews on March 25 that addressing Croatia’s financial ills would not be quick. “Fundamentally it will require years of consolidation. This is the only country in the region where we have never seen fiscal consolidation.”

Khaled Sakr, who led an IMF mission to Croatia, said in a February 24 statement that, “Further fiscal consolidation is required to reduce the large public debt, and should be designed to be growth friendly to the extent possible.”

Led by Oreskovic, a former pharmaceuticals executive, the new government is considered to be business friendly. Maric, who worked at regional food and retail giant Agrokor for the last four years, after serving as state secretary under a previous government, is also well respected. Ujevic says that “In 2016 no tax changes are predicted, pointing to a more stable business environment.”

However, there have been some teething troubles in the relationship between coalition partners the right-wing Croatian Democratic Union (HDZ), one of Croatia’s two main parties, and the Bridge of Independent Lists (Most), a relative newcomer to the political scene, which insisted on a technocratic prime minister. Given that Oreskovic and Maric are working alongside many of Croatia’s political old guard, Deuber warns, “It will be very tough for those guys to succeed.”

It is early days for a verdict on the government’s effectiveness; the new cabinet was only voted in by the parliament on January 22. Timothy Ash of Nomura International wrote in a March 1 note he was “encouraged” by announcements so far from the government, and by its “understanding of the key issues and the need for fiscal consolidation ... [and] broader structural reform.”

However, he adds that that the government “needs to be detailed and specific in terms of its reform plans”. “The agenda thus far looks like something of a hotch-potch of plans rather than a fully coordinated programme, which will hopefully come with time.”

The government is already planning to embark upon structural reforms to Croatia’s cumbersome public administration, which is likely to prove politically sensitive. The IMF’s Sakr said that, “Steps are ... needed to streamline the multiple layers of government and public agencies, enhance the targeting of social benefits, and improve the efficiency of the public sector and administration.”

The government reforms will include a review of employment and salaries, though detailed plans have not yet been revealed. Administrative reforms in the heathcare sector are expected to save around HRK400mn. There are also plans to reform the pensions system, including to extend the retirement age and penalise early retirement, following concerns voiced by the EC.

Initiating these reforms will be a test for the government, but the example from neighbouring Serbia is quite encouraging. In 2014, Serbian Prime Minister Aleksandar Vucic’s government embarked upon an ambitious programme of fiscal consolidation, starting with a 10% public sector wage and pension cut. A year later, Serbia’s consolidated budget deficit for 2015 stood at RSD148.6bn (€1.2bn), significantly shrinking from RSD258.13bn in 2014, according to the ministry of finance’s preliminary data.

Vucic is now taking Serbia to an early election in order to gain a renewed mandate to forge ahead with more reforms including the restructuring of major state owned enterprises - with consequent job losses. However, fiscal consolidation does not appear to have hurt Vucic’s standing; the latest poll from Faktor Plus shows his Serbian Progressive Party is backed by 58% of the population.

Oreskovic has a similarly high level of popular support - a poll by broadcaster RTL published in February showed that 52.9% of Croatians “completely” or “mostly” supported the new prime minister so far.