Croatia Premier Touts Mild Keynesian Policy Amid EU Entry

Europe’s sovereign-debt crisis has shown that blindly following austerity prescriptions leads to failure, said the premier of Croatia, the former Yugoslav republic that joins the European Union on July 1.

“Austerity no, but a rational approach to the budget,” Prime Minister Zoran Milanovic, 48, said yesterday in an interview in his office in central Zagreb. “You can run some constructive -- so to speak -- deficits, in a very mild, constrained Keynesian way, but not too much.”

Croatia will become the EU’s 28th member next week as the world’s largest trading bloc expands for the first time since Bulgaria and Romania entered in 2007. The ex-communist nation is seeking to end what threatens to be a five-year run without economic growth as it joins a club radically altered by the global financial crisis compared with when it started accession talks in 2005.

Having gone without economic growth since 2008, the Balkan country that emerged from the bloody breakup of Yugoslavia will face immediate pressure to contain a widening budget deficit. The lack of expansion also curtails Milanovic’s room to narrow the shortfall by cutting government jobs, which would further depress domestic demand, he said.

‘Under Pressure’

“We’re under pressure as the first government in Croatia’s history to undertake some bold measures -- by Croatian standards -- to downsize spending and explain to people there are no entitlements for life,” said Milanovic, who’s been in office since 2011. “I don’t believe in cuts, I believe in rational restructuring. Massive layoffs also lead to a contraction in consumption and that’s something you don’t need.”

The budget deficit will widen to 4.7 percent of gross domestic product this year and to 5.6 percent in 2014 from 2.4 percent in 2012, the European Commission forecasts. The government’s 2013 target is 3.4 percent. The economy will contract 1 percent this year after a 2 percent decline in 2012, according to the commission.

GDP will shrink 0.9 percent this year before growing 1.2 percent in 2014, according to central bank Governor Boris Vujcic, who cut a December forecast for 2013 expansion of less than 0.3 percent. Foreign direct investment is “particularly important” as Croatia enters the EU and can help restart economic growth, he told an economic conference in Vienna today.

Bob Dylan

Vujcic advocates euro adoption as soon as possible because much of the economy is already based around the common currency, making it difficult for the central bank to use the exchange rate as a monetary-policy tool.

“I like to cite Bob Dylan here,” he said. “When you got nothing, you got nothing to lose.”

The kuna traded 0.1 percent higher at 7.4543 per euro at 2:33 p.m. in Zagreb, its strongest since Oct. 2. It’s gained 1.9 percent this quarter, the fourth-best performance among about 170 currencies tracked by Bloomberg. The yield on the government’s 2023 dollar bond fell to 5.954 percent from 6.030 percent yesterday.

The kuna exchange rate, blamed by some companies including the exporter lobby group, Klub Izvoznika, for worsening their competitiveness against European rivals, will “probably” stay stable against the euro as there’s “no reason” for appreciation after EU entry, Milanovic said.

While Milanovic said Croatia as a small open economy is destined to eventually adopt the euro, he declined to give a date for the changeover.

Euro Endgame

“It’s been said that our currency is too expensive, but that is dubiously so,” Milanovic said. “If you are not productive, not good, no currency fluctuation will help you. As far as the euro is concerned, that should be the endgame.” Setting a date “matters, but it’s not essential.”

Even without the euro, EU membership by itself may help attract foreign direct investment by providing “psychological” assurance that the country’s legal system offers enough protection for businesses, according to Milanovic, who described himself as a “social democrat, free marketer, libertarian.”

The government is also seeking to pass a new law on strategic investments to help large-volume projects, he said. That may also help lure buyers to state-owned companies such as Croatia Osiguranje d.d., the nation’s largest insurer, and Hrvatska Postanska Banka d.d. The Cabinet wants to complete the Osiguranje sale by year-end and has “good interest” in the company, Milanovic said.

EU Funds

The nation is counting on as much as 10 billion euros ($13 billion) of EU funds through 2020 to help finance investment as budget constraints prevent the government from stimulating growth by public spending. The Cabinet plans to channel the grants toward infrastructure and energy projects.

Croatia’s ability to absorb those funds and to spend them wisely will determine the country’s path after EU entry, Milanovic said.

“There will be plenty of possibilities, a plethora of possibilities, a new market, new chances,” Milanovic said. “You might get them if you work hard, if you prepare well, but you can also end up as a loser, as a net contributor, which would be a curse, which would be the opposite of what we intended. And I’m hell-bent on” success.

Milanovic said he intends to use some of those funds to help diversify the economy further. The country of 4.2 million people is focused on the services industry and tourism, which take advantage of its 5,800 kilometers (3,600 miles) of coast along the Adriatic, including more than 1,000 islands.

“Isn’t that enough?” Milanovic said when asked what the country brings to the EU. “It brings rational people. A former socialist country, which went through a very destructive war and finally emerged as a stable democracy and market economy.”

Before it's here, it's on the Bloomberg Terminal.