January’s re-election of president Stjepan Mesic, with two-thirds of the votes, is more proof that the overwhelming majority of Croatia’s 4.4 million people want to see their country become a member of the EU as soon as possible. The government’s task is to create political and economic conditions for accession talks, continue reforms and strengthen the country’s financial balances.
Croatia’s EU accession process accelerated after the death of president Franjo Tudjman in 1999, who was much out of favour with the union. After signing a Stabilisation and Association Agreement in February 2003, the country applied for EU membership, and in June 2004 the European Council decided to accept Croatia as a candidate country. The next decisive date is March 17, when accession talks are due to start.
Integration target
Since his appointment as prime minister in December 2003, Ivo Sanader, leader of the Croatian Democratic Union, the late Mr Tudjman’s party, has proved a fully-fledged supporter of EU integration. He has been promoting co-operation with the International Criminal Tribunal for Former Yugoslavia in The Hague, a pre-condition for accession negotiations.
EU membership has become a common unifying goal for most of Croatia’s political forces and is widely supported by the general population. Under this umbrella, the government should intensify reform efforts, continue privatisation, pursue a more strict economic and monetary policy, cut the budget deficit and improve the country’s external imbalances.
In its Pre-Accession Economic Programme (PEP) for 2005-2007, which was submitted to the EU in November 2004, the government listed ambitious medium-term targets. For the next three years, it is aiming for: an average GDP growth of 4.5% per year; inflation in the range of 2.2%-2.5%; a reduction in unemployment from 14.9% to 12.1%; and a cut in the general government budget deficit from 4.5% to 2.9%. By 2007, public debt must be reduced to 51% of GDP.
In the external sector, the PEP foresees improvement of the current account deficit to 3.8% of GDP, fully covered by foreign direct investment (FDI), which is projected to reach 3.9% of GDP in 2007. As a result of corrective measures, Croatia’s external debt should fall to less than 80% of GDP and be maintained at that level.
According to this ambitious plan, by 2007 Croatia should fulfill the Maastricht criteria in terms of government balance, inflation, external and public debt, and join the European Monetary Union as soon as possible after EU accession. If it succeeds in reaching these goals, it will be one of the most successful convergence stories among the transition economies of central and eastern Europe.
Promising indicators
Boris Vujcic, deputy governor of the Croatian National Bank, said that 2004 was expected to be a good starting point for the planned convergence and stabilisation. Last year’s economic indicators are promising: estimated GDP growth was about 4%, inflation decreased to 2.1% and, according to International Labour Organization figures, the unemployment rate fell to 13.8%. The general government budget deficit was cut from 6.3% of GDP in 2003 to 4.5% and the current account situation has also improved.
In 2004, a new, more favourable trend was recorded in Croatia’s merchandise trade: for the first time in a long period, exports were growing quicker than imports. In the first 11 months of the year, the annual growth rate of goods exports reached 20.1% and imports grew by 8.8%. Mr Vujcic says this tendency is the result of the positive, although somewhat delayed, effect of trade liberalisation and the increased amount of FDI directed into the export sector.
Croatia joined the World Trade Organization (WTO) in 2000 and the liberalised environment initially resulted in a jump in imports. Substantial exports growth started last year and there are strong hopes that the trade balance will further improve, says Mr Vujcic. Nevertheless, further efforts will be needed to improve the low export/import coverage ratio, which after the first 11 months of 2004 was 48.2% (compared with 44% a year earlier).
The central bank continued its tight monetary policy, thanks to which low inflation in 2004 remained one of Croatia’s main economic achievements. In a framework often called “quasi currency board”, 99.7% of domestic money was created through the purchase of foreign currency.
As in the past few years, the value of the kuna has remained at a fairly stable level (in 1998 the average €/Hrk rate was 7.14, in 2003 it was 7.56 and in December 2004 it was 7.55).
The successful tourist season last year was, once again, a main contributor to the country’s foreign exchange income. In the first 11 months of the year, tourist arrivals increased by 6.1% compared with the previous year and overnight stays grew by 2.5%. In the period 1999-2003, €950m was invested in the Croatian tourist sector and in 2004 a further €360m was invested. As a result, the share of low-grade (one-star and two-star) hotels fell to 34.2% and under new regulations all new hotels that open should be at least three-star. This is a clear sign that the country is moving away from mass tourism to a more demanding market segment. The goal is for about 50% of all Croatian hotels to be in the four-star and five-star category by 2010.
Tourism represents 10.6% of Croatia’s GDP and 13.0% of employment but with indirect impacts taken into consideration, the sector produces 22.4% of GDP and provides 27.4% of total employment. With a direct income of $6bn-$7bn and $9.1bn worth of total economic activity generated, tourism remains a decisive factor in Croatia’s convergence with the EU and a main stabilisation factor in its external balance.
Domestic finances
In public finances, parallel to the reduction of government deficit in the medium term (2005-2007), the Ministry of Finance will focus its attention on financing the budget deficit through domestic sources. The shift to domestic financing is expected to reduce exposure to exchange rate risk, foster domestic market development and help to absorb liquidity in the private sector. In 2005, more than the half of the budget’s financing needs – Hrk8.8bn ($1.5bn) of Hrk16.6bn – will be covered by securities issues, Hrk4.4bn by privatisation revenues and Hrk3.4bn by loans from international financial institutions and development banks.
This will help to reduce Croatia’s foreign debt to less than 80% of GDP (in 2004 it stood at 80.5%), which together with other favourable indicators may result in further sovereign rating upgrades. In December 2004, Standard and Poor’s upgraded Croatia’s long-term foreign currency rating by one notch to BBB. And the start of accession talks with the EU may trigger more favourable rating moves.
