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WorldAugust 1 2012

Croatian National Bank holds its course

The abrupt departure of the Croatian National Bank governor laid bare tensions over conditions in the country’s financial sector, but his successor looks set to bring continuity rather than change.
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Croatian National Bank holds its course

At the beginning of June 2012, the unexpected news came that the governor of the Croatian National Bank (HNB), Zeljko Rohatinski, was leaving his post in July at the end of his second six-year term of office. Dr Rohatinski stated the main reason behind his decision was his inability to co-operate with the new government of Zoran Milanovic, which has been in power since December 2011.

This was another blow to the public’s perception of the Croatian government and its economic policy, as Mr Rohatinski – widely credited as having preserved the country's banking system when the current crisis broke out – consistently figured very highly in public approval ratings, in sharp contrast to the government’s two ministers mostly responsible for economic policy.

The change at the top of the HNB comes at a time when Croatia is in its fourth year of recession – the HNB forecasts gross domestic product (GDP) to shrink by 1.6% in 2012. The government is seen by many as not doing enough to reverse the situation, while pushing through unpopular measures such as increases in energy costs and in value-added tax.

The change of governor also prompted the airing of some criticism of the HNB’s policies, particularly those related to the exchange rate (saying that the kuna is too strong) and liquidity (that there is not enough of it).

Meet the new boss

However, any thoughts that Mr Rohatinski’s announcement might lead to changes in the HNB’s policies were immediately suppressed with the news that he would be succeeded by Dr Boris Vujcic, Mr Rohatinski’s deputy of 12 years. Mr Vujcic was duly appointed governor by the Croatian parliament from July 8, 2012.

“General monetary policy will stay the same,” Mr Vujcic tells The Banker. “Exchange rate policy will remain the same, [meaning] a stable exchange rate, and we will do what we can to support the growth of the economy. However, there is only so much we can do and at the moment one cannot expect the central bank to do much more than we are doing currently, running an expansionary policy for the fourth year in a row.”

Mr Vujcic emphasises the continuation of the HNB’s exchange rate policy as the natural consequence of the euroisation of the Croatian economy, which is about 80%.

“Because of the high level of currency substitution, the exchange rate is the key tool for financial stability,” he says. “In that sense the freedom for a different type of monetary policy is severely reduced. That means that the economy must adjust, you have to watch your productivity increases, your wage increases, your unit labour costs.” 

Even before European monetary union, he notes, a number of countries in Europe had a de facto peg to the deutschmark. These are exactly the countries that now have the best productivity and are the largest exporters in Europe, rather than the countries that devalued frequently.

“It is not the exchange rate, it is what you do given what the exchange rate policy is that determines how successful you will be,” he says.

Seeking investment

In order to achieve the desired productivity gains, Croatian business needs to make more capital investment, and to do this it mostly needs to borrow. However, HNB figures show that bank lending to the business sector fell by Hrk5.6bn ($916m) in the six months to the end of June, although this is almost fully explained by the transfer of more than Hrk5bn of shipyard debt to the government in the process of privatisation.

The lack of lending is not a consequence of a lack of funds to lend, according to Mr Vujcic. “We have a structural surplus of liquidity in the domestic money market, with very low interest rates in the interbank market, and banks keeping Hrk6bn to Hrk7bn surplus liquidity on their account at the central bank. That there is not even the need for repo operations at the central bank tells you how expansionary our policy is,” he says.

An important factor that constrains both lending growth and investment activity is the stagnant revenues of the corporate sector

Hrvoje Dolenec

To help tackle the lending problem, the HNB has reduced reserve requirements to release Hrk6.8bn of liquidity, which is being offered in conjunction with the Croatian Bank for Reconstruction and Development (HBOR) at low interest rates to commercial banks to lend to Croatian business. Mr Vujcic says that part of the reason for lower lending by the commercial banks is their increased risk aversion in the crisis. He hopes that this scheme, following earlier similar schemes, will help partly overcome this hurdle by sharing the risk between HBOR and the commercial banks, and that positive results will become visible by the end of the year.

Hrvoje Dolenec, chief economist of Croatia’s largest bank, Zagrebacka Banka, agrees that the main reasons behind the low lending are correlated with the economic environment in which the banks conduct their business. He says Croatian banks pursued sound business practices that helped the Croatian economy weather the world financial crisis. They now have to work in an environment where lending depends on corporate demand and the quality of projects prepared for financing.

“Banks are prepared to support all projects and sectors in line with sound business practices, with high standards of assessment on risks and on projects’ economic feasibility and justifiability. However, the current market is characterised by a lack of adequate [projects in the] pipeline and lack of investment activity. An important factor that constrains both lending growth and investment activity is the stagnant revenues of the corporate sector,” says Mr Dolenec.

He believes that the HNB/HBOR scheme has created more favourable lending conditions, and points out that the banks have started lending under the scheme, but says that more is needed for it to succeed. The demand size and quality of projects nominated for financing will be the most important factors, he says. 

Structural reform needed

Mr Vujcic also recognises that the Croatian economy faces other problems that lie beyond the remit of monetary policy. He lists a series of structural problems ranging from "non-restructured public companies, to the labour market and the investment climate overall, with all kinds of barriers for investment and entrepreneurship. Just look at Ease of Doing Business league tables and you can see that Croatia is not faring very well there, actually it is faring below what you would expect from our GDP per capita and economic development.”

Damir Novotny, a economic and management consultant and a former member of the HNB council, says the Croatian government does not appear to share the central bank’s appreciation of the need to address the country’s structural economic challenges. “The Croatian economy is faced with huge problems in its structure. The public sector is very strong, and the private sector unfortunately is very weak. Without a strong private sector, private companies, strong households, you cannot have economic recovery. That is the problem,” he says.

The government’s first significant attempt to tackle some of the institutionalised costs in the public sector came in its endeavour to cut Christmas bonuses and other benefits from public sector workers’ pay packages. However, this ran into union opposition and has had to go to arbitration in light of the failure to come to a negotiated settlement.

Mr Novotny is not impressed by the government’s efforts to date, and is pessimistic about the government carrying out more meaningful reforms. He sees no major policy-making changes on the horizon, but believes it is crucial to reform the Labour Act. “I know of hundreds of cases where companies have to finance employees to do nothing. Their contracts are expensive and companies are simply waiting for the recovery, but the recovery is not coming and companies are devastating their capital,” he says.

Sitting tight

However, the prime minister, who famously signed a union-sponsored petition for a referendum against attempts by the previous government to amend Croatia's Labour Act, has categorically stated that his government will not touch it.

Mr Vujcic diplomatically says that the government is right to emphasise investment as the best means of growth for Croatia, against a backdrop of fiscal consolidation, deleveraging in the household sector and a decline in external demand. But he emphasises that investment is a process that will probably show results later than the government expects. “This year is lost for growth; 2013 is the year where things will start to happen,” he says.

He also points out that structural reforms have in fact started, with actions such as union negotiations and plans to restructure public companies such as Croatian Railways. But he acknowledges that the government can do more, and encourages bolder moves in terms of structural reforms. "Some are coming but not enough yet, more needs to be done in the near future,” he says.

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Read more about:  Central & Eastern Europe , Croatia