Croatia on track for 2023 eurozone entry, public debt seen below 3% by end-2021

By Nevena Krasteva

Zdravko Maric,
Croatian finance
minister and deputy
prime minister

Prime minister Andrej Plenkovic has said that Croatia would be ready to join the eurozone in January 2023. What risks do you see in this process and how do you plan to offset them?

The adoption of the euro is one of our key strategic orientations towards further integration into the European institutions.

Croatia is a highly euroised economy. We made a lot of quantitative analyses, calculating what are the pros and cons of us joining the euro area and the benefits, such as the elimination of ethics risk, reduction of private transaction risk and related risk, which are long-lasting, are much bigger than the potential threats. However, we also need to be very much focused on potential threats. We asked our citizens what are the key challenges that they see for us in introducing the euro, and the number one they mentioned was the possibility of inflation pressures because of retailers rounding up the prices. We also did an analysis of the situation in the newest members of the Euroland – the Baltic and Central and Eastern European countries – and on the average the inflation effect was just 0.2% for one year only as it is a one-off effect.

A lot of work remains to be done on the technical and on the operational level, and a lot of individual steps have to be taken. Very recently, for example, we had a public debate and made a decision how our coins will look. We want to use this time on two fronts and fulfil all the criteria that we should. On the one hand, these are the post-ERM-2 commitments in anti-money laundering, better public administration and better management of public assets, improved judiciary system, in particular pre-bankruptcy and bankruptcy procedures. On the other hand, these are the Maastricht criteria. Our interest rates and prices, as well as ethics, have been for years in line with the Maastricht criteria. In terms of fiscal criteria, prior to Covid, Croatia was lowering its public debt three times faster than required. We have been running a budgetary surplus three years in a row. So, we could tick each of these boxes.

However, Covid had implications on our fiscal stance. Our deficit went above 3%. This year it is projected to be 3.8% but next year it will be back within the Maastricht limit. Even this year, we are planning to decrease our public debt to fulfil the Maastricht criteria.

At the same time, in this process until 2023, we want to inform, to educate, to pass all these messages to every single citizen in Croatia because the euro adoption is literally affecting every single citizen. We want to run the whole process very, very transparently. We appreciate also the contribution of the European institutions. We also see strong support from individual member states. As was the case with our entry into the European Union, the better prepared we are, the larger the benefits and smaller the threats.

Currently, what we are seeing is better than expected execution of our revenues due to better than expected GDP. Originally, we planned GDP growth for the year as a whole in the area of around 5%. Latest data for the second quarter and some other macroeconomic indicators are suggesting that it could be even in the area of 7%, which I would say is quite good.

Do you have plans to tap the international markets with a bond to finance public debt?

In general, what we do is that we finance and refinance international maturities on the international markets. By the end of this year we are not planning any international issuances, nothing apart from the regular Treasury bill auctions on the domestic market. However next year, when we have a few maturities in the euro bond market, we will do it there. The domestic market is also very strong, very liquid, with big interest for our bonds, not only on the part of the banking industry but the pension funds, insurance companies and investment funds, as well.

In the beginning of this year the government cut income tax and profit tax. Is the finance ministry considering any further tax changes?

The focus of our tax reform was predominantly on direct taxes – on corporate and personal income tax. Of course, citizens are very much focused on how we are planning to move forward with the indirect taxes, particularly with excise duties and VAT. We lowered VAT in some areas such as fresh meat, fresh fish, vegetables and electricity. However, everything is subject to the fiscal space that we create.

So far, there have been positive effects of the lowering of taxes. In the first year of application of the corporate tax reduction we had more revenues than the year before. With the personal income tax, our idea was to directly stimulate an increase in incomes a component of the overall demographic recovery.

It would be great if we could resolve all our issues with tax changes but taxes are also a support for certain contributions to the overall plan. Our plan is by the end of our mandate to continue to lower taxes and I really hope that we will be able to find adequate maneuver space to further reduce some of the social contributions. But we are talking about the health sector and the pension system and these two sectors are already suggesting that maneuver space is very limited.

However, the focus of our attention lies on the expenditure side. That’s where we can find a solution to the long-term sustainability of public finances.

For next year, our fiscal guidelines are suggesting a budget deficit within the 3% ceiling, 2.5% is the target, then falling below 2% in the following years.

We see public debt management as a three pillar strategy – one pillar is GDP growth, the other one is fiscal consolidation, and the third one is activation of state assets including privatisations.

Regarding the activation of state assets and privatisations, this is a process that we want to reemphasize. We will start with different firms where the state holds minority stakes, cleaning the balance sheets. Hopefully and subject to further developments, some of the potentially bigger state-owned enterprises (SOEs) will also be put up for sale. This all will have an effect on our public debt which we see already going down this year by roughly 2 – 2.2 pp of GDP and in the next three year on the average annual basis by 3 pp, which is at least two times faster than the Maastricht criteria.

You have said that Croatia currently does not have the firepower to carry out privatisations. When do you think this process could resume?

We didn’t have the firepower to sell anything neither in 2016, nor in 2021. However, we believe that the introduction of any form of private capital could contribute to the so called hidden reserves of the state-owned enterprises and the elements of corporate management. When you improve that, the value of the company and its contribution to the overall economic situation is increasing. At the end of the day, some decisions in the privatisation area are also political ones. These are to be thoroughly analysed, examined and eventually a decision is to be taken. There are a few segments of our economy which will be treated as strategically important, like waters, forests and the likes, and there the state-owned enterprises will remain in government hands. All the others are subject to different developments that we will be putting in place.

Does Croatia’s national plan under the EU’s Recovery and Resilience Facility (RRF) mention privatisations?

In a way, yes, not only the national plan under the EU’s RRF, but also the post-ERM-2 and other strategic documents talk in general of this process but without at this stage naming specific areas or companies. They have one generic point which says better management of the public entities and this would be positioned under it.

What are the key areas in Croatia’s national plan that will receive support under the RRF?

In a nutshell, the RRF and this grant scheme of 6.3 billion euro to Croatia is meant to stimulate reforms supported by the public and private investments in various areas. More than half of the total envelope is business related, both on the private and public side, and there is an infrastructure part, as well. The plan is about how to pass these funds on towards better economic performance, how to stimulate the economy and improve the business climate and the overall environment for the business community to invest and to employ.

A very important chapter is education. Education and R&D is something that we see as a long-term process, as a better linking between the education system and the labour market. We lack labour force in certain sectors of our economy and these potential mismatches can become even bigger if we don’t change. That is why we recognise this area as very, very important. The education system will be further improved and this is a very clear message to our younger population, it is an investment in their future.

We are also planning to cover through this scheme certain areas like the public administration, health sector, the social security segment, SOE, the usual suspects where we are constantly trying to find ways for further improvement and reform.

Finally, there is the recovery from the earthquake, both in Zagreb and in Banovina region. In the city of Zagreb, we are talking predominantly about physical infrastructure recovery. In Banovina, as it is economically among the least developed areas of Croatia, we are talking about an overall recovery, including its economic, social and demographic aspects.

The programme is horizontal but you can definitely see support for specific sectors of our economy, particularly the ones that are quite prospective. I would like to mention one, the IT sector. In the whole EU Next Generation plan, ‘digital’ and ‘green’ are the buzz words. The IT sector is definitely very much recognised not only because of its activity per se but because of its very strong relationship with the other activities across our economy.

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