Croatia faces important challenges in finding a balance between boosting economic growth and opening new jobs while ensuring that fiscal consolidation remains on track, the European Commission reported on Wednesday in its assessment of the government's 2013 economic programme and planned reforms as part of the current European Semester.
After five years of recession, that challenge is the key for Croatia in the short term. In the medium term, it is crucial to improve competitiveness and strengthen confidence in the financial sector, the Commission notes.
The Commission recalls that in its spring outlook it forecasted a contraction of the economy of one per cent. The Croatian government however expects that GDP will grow by 0.7%.
Croatia will need to make further efforts to reduce the high budget deficit and to resolve the liabilities carried by state-owned enterprises while safeguarding investment and other growth-enhancing expenditure.
In mid-April, Croatia sent its economic programme to the Commission for assessment in which it forecasted a deficit at 3.6% of GDP and that it would reduce this to below the maximum allowable value in the European Union of 3% of GDP by 2016.
The Commission, however, considers that there is scope to increase the efficiency of taxation and that it was urgent to resolve the rigid labour market and unfavourable business environment.
In its review of public finances, the Commission warns that a high deficit contributes to a rapid build-up of public debt which the Commission forecasts will soon exceed the reference value of 60% of GDP on unchanged policies.
Therefore, it is key to implement a clear and sustainable consolidation strategy, the Commission said, noting that on the revenue side, there is scope to broaden tax bases, given that the tax-to-GDP ratio was 32% in 2011, much lower than the EU average of nearly 40%.
The Commission suggests stepping up the fight against tax fraud and evasion.
On the expenditure side, the challenge is to embark on a credible consolidation path while safeguarding growth and enhancing expenditure and leaving sufficient room for co-financing from the EU funds, Brussels points out.
There is also scope to review the effectiveness, sustainability and adequacy of expenditure on social protection and pensions, the assessment goes on.
Finally, the state maintains an important role in a large number of companies, many of which are loss-making and highly indebted, posing risks to public finances.
Reflecting on the financial sector, the Commission notes that the economy is saddled with a large share of non-performing loans (14% at the end of 2012) and the private sector is exposed to currency risk as a high share of its debt is denominated in or indexed to foreign currency (75.3% in February 2013).
Making provisions for these risks would enhance the soundness of the financial sector but may curb credit growth in the medium term.
The Commission warns that job creation is hindered by an inflexible labour market and by the disincentives embedded in the benefit system. Dismissals are complex and costly and can run in court for several years.
This has led to a large grey economy which is estimated to account for up to 40% of GDP. That negatively affects public finances, the Commission warns.
The unemployment rate has almost doubled since 2008 and in 2012 reached 15.9%, hitting younger workers hardest and exposing a third of the population to the risk of poverty.
The quality of the business environment is low, as indicated by Croatia’s unfavourable ranking in international surveys.
The low efficiency of the judiciary and a high perception of corruption is worrying, the Commission underscores.
Enhancing administrative capacity will be particularly important for investments to be successfully implemented if co-financed by the EU, the Commission concludes.
