The measures and guidelines for the drafting of the budget which the government adopted on Thursday envisage cuts worth HRK 4.6 billion, whereby expenditures would amount to HRK 117.6 billion, revenues to HRK 108 billion, and the deficit to HRK 9.6 billion or 2.8 per cent of GDP.

The general value added tax rate will be increased from 23 to 25 per cent, while VAT on children's food, oils, fats, and water bills will be reduced to 10 per cent, which is expected to increase annual revenue by about HRK 2.5 billion. The government will also extend the deadline for paying VAT to 45 days.

The contribution rate on mandatory health insurance will be reduced from 15 to 13 per cent, which is expected to reduce the annual budget revenue by about HRK 2.4 billion.

Non-taxable income will be increased. The basic standard deduction will be increased from HRK 1,800 to 2,000, tax categories will be changed but the tax rates will remain 12, 25 and 40 per cent. These measures are expected to reduce annual revenues by about HRK 250 million in total.

Prime Minister Zoran Milanovic said the budget must be realistic and ambitious so as to stimulate growth, because the benefit of fiscal stability was small if the country stood still.

Export growth and new investments must generate growth, he said, adding that coming out of the crisis was possible only with growth that facilitated job creation.

The government plans to achieve 0.8 per cent growth this year through higher state investments. After gross investments dropped 11.3 per cent in 2010 and 7.3 per cent in 2011, the government plans to increase them by 7.4 per cent.

The government envisages a 1.5 per cent real GDP increase in 2013 and 2.5 per cent in 2014, while inflation would stay at 2.5 per cent.

The 'holy trinity' of the government's policy in that period is sustainability of public finance in accordance with the Fiscal Responsibility Act, creation of prerequisites for growth, and protection of vulnerable groups of citizens, said Milanovic.

Economy Minister Radimir Cacic said the plan was very optimistic but that the government had a backup plan if the situation deteriorated, namely more radical spending cuts.

He announced talks with representatives of the International Monetary Fund, the World Bank and credit rating agencies over the next week.

Over the next three to four weeks, the government must define all investment projects, which are expected to reach HRK 8 billion this year, said Cacic.

Finance Minister Slavko Linic said most of the investments would be made in projects that replaced imports with domestic output, adding that investment in electricity, gas, ports and railways would finally kickstart real sector growth.

Regional Development and European Union Funds Minister Branko Grcic warned about an additional deficit that was not part of the guidelines, HRK 3 billion that would have to be paid for some guarantees, the debt to pensioners, and the deficit of some state-owned companies.

This means that the total deficit will actually account for four per cent of GDP, 2.1 percentage points less than last year, said Grcic.

The government plans to save HRK 550 million annually by rescinding the tax refund on expenses and the use of official cars.

It also plans to reduce VAT on some services in tourism and hospitality as of 1 January 2013.

The government predicts that the VAT increase will result in a 1.4 per cent price increase, which it will try to compensate by introducing lower VAT rates, increasing the non-taxable income, indexing pensions, and stimulating employment.

Milanovic said there was no reason for the VAT increase to result in higher prices, adding that a higher VAT was imperative in the current situation and that the government would try to help the middle class, those earning between HRK 3,500 and 8,000 a month.

The amount required for pensions and interest rates will be increased (HRK 500 million and 1.2 billion respectively), expenses for government employees will be cut (about HRK 2 billion) as will material expenses (HRK 350 million), expenses for subventions (HRK 1.4 billion), households (HRK 500 million), and other expenses (about HRK 2 billion).

The government said the budget revenues were not at risk, as the prediction was made very conservatively, without inflation, the higher VAT and the expected GDP growth.