Croatia Must Continue Overhaul to Keep Recovery Alive, IMF Says

Croatia’s government should finish overhauling its finances before global credit tightens or risk undermining the country’s first growth since 2008, an International Monetary Fund official said.

Johannes Wiegand, the IMF head of mission for Croatia, warned that a plan to cut the country’s fiscal deficit to below 5 percent of gross domestic product this year needed to be more specific. The Washington-based lender sees the Adriatic country of 4.2 million people growing 0.5 percent this year, and accelerating to as much as 2 percent in subsequent years, boosted by external factors.

“Low commodity prices, a weaker euro, stronger growth in the European Union, and very accommodating financing conditions, these are the tailwinds for the Croatian economy,” Wiegand said in an interview in Zagreb on Tuesday. “But the tailwinds may change, and to support durable growth, determined reform efforts remain critical.”

Croatia’s economy has plunged more than 12 percent over the past six years, the European Union’s third-worst contraction after Greece and Cyprus. The country is under pressure from the European Commission, which said in March the newest member must address “excessive macroeconomic imbalance” stemming from low growth, high public debt, declining exports and an indebted private sector.

Decisive Action

After the commission called for “decisive policy action” in March, the Social-Democrat-led government announced spending cuts and tax increases aimed at reducing budget gap by 2 billion kuna ($295 million), or 0.6 percent of GDP, from 5.7 percent last year. Wiegand urged the government to focus on spending with the aim to reduce the deficit by 3 percent of GDP in the next three to four years.

While fiscal consolidation is “absolutely critical” to reduce high debt and deficit levels, he said the Washington-based lender had “some sympathy” so as “not to overdo fiscal adjustment while the economy is still weak.”

The government’s current plan looks “appropriate regarding the amount of proposed consolidation measures,” but Wiegand said he had “misgivings” about its composition.

“Along with some good but low-yielding revenue measures, such as increased excise taxes, most of the rest are ad-hoc cuts spread across ministries and state companies, not clearly specified and in some cases affecting public investment,” he said.

‘Big If’

Without the measures, Croatia may struggle to grow when global credit conditions eventually tighten, Wiegand said. The junk-rated nation, whose public debt is estimated at 85 percent of gross domestic product, sold 1.5 billion-euro ($1.7 billion) of bonds in March with a 3 percent coupon, compared with 3.875 percent for eight-year debt sold a year ago.

“The question will be, is Croatia growing, and does it look like it has its fiscal problems under control?” Wiegand said. “If these two things are in place, I wouldn’t be too worried about tightening of financial conditions. But that’s a big if.”

Wiegand also urged the government to continue selling or overhauling state-owned companies to remove non-expert political party members from management and supervisory boards. He also said Croatia must find “adequate and fair” solution for its 60,000 Swiss-franc borrowers, whose mortgage payments soared as the Swiss national currency appreciated against the Croatian kuna, which is pegged to the euro.

The Finance Ministry, the central bank, commercial banks and borrowers are trying to hammer out a long-term solution for about 21.8 billion kuna ($3.2 billion) of Swiss-franc mortgages. Several thousand borrowers protested last month in front of the central bank in Zagreb, demanding Governor Boris Vujcic resign.

“The debate in recent weeks got a little bit out of hand,” Wiegand said. “Calls for resignation of the central bank governor threaten to undermine the independence of the central bank, and I would caution against taking the debate in this direction.”

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