IMF Executive Board Concludes 2021 Article IV Consultation with Croatia

Washington, DC: On August 30, 2021 the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation [1] with Croatia.

The Croatian economy has been subjected to severe stress, but is showing its resilience. The pandemic and two devastating earthquakes led to a 8.0 percent drop in activity in 2020, reflecting lower domestic and external demand-particularly, a drop of some 60 percent in tourism receipts (yoy). Ample support of fiscal and monetary policy, coupled with appropriate relaxation of supervisory requirements, helped to contain the effects of the pandemic. The financial position of the government was somewhat alleviated by the EU funds (loans, transfers) that have financed most of the fiscal support measures. The CNB intervened in the currency market and mitigated tensions in the domestic bond market through purchases of government securities (about 5.5 percent of GDP). It also lowered reserve requirements and conducted repo operations. Markets calmed, not least after a €2 billion SWAP arrangement with the ECB was announced in mid-April 2020. External indicators held up relatively well, the current account posted a small 0.4 percent deficit in 2020, despite the collapse in tourism receipts. However, gross public and external debt climbed by almost 16 and 6 percentage points, respectively, causing a reversal of earlier gains. Inflation has remained benign, despite a recent uptick.

A robust bounce back is projected for 2021 and 2022, of 5.4 and 5.8 percent growth respectively driven by a rebound in the services sector (assuming ⅔ and nearly full recovery of tourist arrivals in 2021, and 2022 respectively), and investment which will be bolstered by large EU investment grants over the medium-term. Over the medium term, growth is projected to ease closer to 3 percent. Inflation is projected to pick up and stay at 2 percent through 2023, in line with the ECB inflation target. There are large risks on both sides, including from virus mutations in the near-term which could result in significant economic scarring. Medium-term growth would be substantially lower if the pace of recovery in EU trading partners is lower than expected, if EU funds are not effectively absorbed and/or if promised complementary reforms remain challenging to deliver. On the upside, a more rapid and successful vaccination campaign would enable a quicker return to the health of the population and the economy. Over the medium-term, the positive effects of green investments and digitalization may be greater than projected.

Executive Board Assessment [2]

Executive Directors welcomed the swift measures taken to combat the COVID-19 pandemic thus building the foundations for the projected recovery, underpinned by tourism and investment.

Directors welcomed the authorities’ efforts to balance the pandemic recovery with fiscal prudence while remaining vigilant to support the nascent recovery as needed. They stressed that it will be important to avoid further tax cuts to conserve fiscal resources and to firmly place public debt levels on a downward trajectory over the medium term.

Directors called for an accelerated implementation of structural reforms and the need to increase the capacity to absorb EU structural funds, in particular in the area of public investment management. Such reforms are essential to make progress toward the goal of closing the income gap to the EU average and to achieve the desired decarbonization, digitalization, and diversification of the economy. In this context, they also welcomed the authorities’ plans to implement a civil service remuneration system that rewards productivity, as well as the merging of healthcare services across sub-national governments.

Directors considered that monetary policy had been appropriately accommodative within the limits of the exchange rate anchor and ample global liquidity. They welcomed ERM II membership in July 2020, in the context of the authorities’ strategic priority of euro adoption. Noting the benefits of euro adoption, Directors welcomed the authorities’ strong commitment to observe the convergence criteria and to improve the AML/CFT framework and SOE governance.

Directors stressed the need to remain vigilant to financial and banking sector risks with the expiration of the regulatory easing introduced in line with the European Banking Authority guidelines to mitigate the impact of the pandemic. They welcomed the decision to facilitate write-offs of NPLs and efforts to strengthen the insolvency framework. Directors urged the authorities to remain particularly vigilant over credit developments in the real estate market and stand ready to absorb excess liquidity and impose adequate macroprudential measures if needed.