Republic of Croatia: Selected Issues and Statistical Appendix
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International Monetary Fund
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Publication Date:
03 Mar 2000
eISBN:
9781451817300
Language:
English
Keywords:
ISCR; CR; Croatia; bank; short-term debt; current account; General government subsidy; sick pay; net wage; government cash payment; wage bill; Pensions; Aging
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The development of the Croatian financial sector has faced many of the difficulties experienced by other transition countries. Recent troubles have exacted a significant macroeconomic price but the strategy implemented by the Croatian National Bank (CNB) since the approval of the new banking law promises the early resolution of the more immediate problems. GDP at constant prices, trends in total labor costs, price developments, retail inflation rates, agricultural production, consolidated central government fiscal accounts, government employment, health insurance, disability and retirement insurance, and so on are presented in detail.

Abstract

The development of the Croatian financial sector has faced many of the difficulties experienced by other transition countries. Recent troubles have exacted a significant macroeconomic price but the strategy implemented by the Croatian National Bank (CNB) since the approval of the new banking law promises the early resolution of the more immediate problems. GDP at constant prices, trends in total labor costs, price developments, retail inflation rates, agricultural production, consolidated central government fiscal accounts, government employment, health insurance, disability and retirement insurance, and so on are presented in detail.

Croatia: Basic Economic Indicators, 1994-1999

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Sources: Croatian authorities; Information Notice System; and IMF staff estimates.

Registered average unemployment rate. According to the Labor Force Survey (based on ILO standards), the unemployment rate was 10.0 percent in November 1996 and 12.6 percent in the first half of 1999.

Including extrabudgetary funds.

On a remaining maturity basis; limited to debt contracts registered with the CNB.

In October 1999.

In January-August 1999.

In September 1999.

I. Trends in Croatia’s Government Sector: A Cross-Country Perspective1

A. Size of the Government Sector

1. Consolidated general government expenditure and net lending (ENL), on a cash basis, has risen steadily since the mid-1990s, to 52 percent of GDP in 1998, reflecting in part the cost of post-war reconstruction and compensation, and transition- and demography-induced changes in labor force participation.2 In periods of budgetary pressure, expenditures have also been financed by non-cash methods, including arrears accumulation and issuance of shares in state-owned companies. This would imply that cash-based measures tend to understate the true level of expenditures in such periods.3

2. Total revenue of the consolidated general government has tended to keep pace with expenditure and, on average, revenues provided full coverage of budgetary cash expenditures.4 Excluding the proceeds from privatization, however, the consolidated general government recorded an average cash deficit of more than 1 percent of GDP during 1994–98, while the primary balance (which excludes interest payments) averaged a surplus of 1.4 percent of GDP. This performance compares favorably with that in other Central and Eastern European (CEE) and EU countries (see Table 1).

Table 1.

General Government Balance and Expenditure and Net Lending in CEE and EU Countries, 1994-98

(In percent of GDP)

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Sources: WEO and IMF staff estimates.

Cash basis.

3. In relation to GDP, Croatia’s general government expenditure is large relative to EU and CEE countries. Moreover, one would expect that the fiscal sector would contract during the transition process as state subsidies to enterprises and consumers are reduced and the range of services provided by the state is scaled back. This tendency is evident in most other transition countries, but has not been observed in Croatia, where the state has increased its role in the economy in most functional and economic categories (see below and Figure 1).

Figure 1.
Figure 1.

General Government Expenditure and Net Lending in Selected CEE and EU Countries, 1994-98 1/

(In percent of GDP)

Citation: IMF Staff Country Reports 2000, 022; 10.5089/9781451817300.002.A001

Source: WEO.1/ Central and Eastern European countries include: Bulgaria, Czech Republic, Hungary, Poland, Romania, Slovakia, and Slovenia.2/ Cash basis.

B. Composition of Expenditure

Economic classification

4. The major expenditure items in the 1998 consolidated general government budget were transfers to households, nonprofit institutions and abroad (15.7 percent of GDP), goods and nonlabor services (12.7 percent of GDP), wages and salaries (11.8 percent of GDP), and capital expenditure (6.9 percent of GDP). These categories were also the four largest in 1994, but were ranked as follows: goods and nonlabor services (15.6 percent of GDP), transfers (11.2 percent of GDP), wages and salaries (10.4 percent of GDP), and capital expenditure (3.1 percent of GDP). Reflecting the relatively low level of public sector debt (see below), interest payments accounted for only about 1.5 percent of GDP on average since 1994. Moreover, a shift from domestic debt to cheaper external borrowing helped to farther contain interest costs during the period.

Government Employment and Wages

During 1994–98, the total wage bill of the general government increased by 80 percent, while employment (excluding the police and army) is estimated to have declined by 3½ percent.1 Moreover, while no data is available for previous years, it is thought that employment in the ministry of defense and the police was substantially higher than the 72,600 reported in 1998. This implies that average public sector wages rose by at least 84 percent during 1994–98. Despite the decline in the level of government sector employment (excluding the police and army), its share of total employment has risen slightly from 20 percent in 1994 to 21½ percent in 1998, reflecting the larger decline in economy-wide employment during the period. Including security forces, the general government accounted for 26 percent of total employment in 1998.

Public administration at the central government, EBFs and local governments accounted for 16 percent of total government employment in 1998, while the police and armed forces, health and social services, and education each accounted for just over a quarter of total government employment. Gross earnings in public administration were 22 percent higher than the national average in 1998, while in health and education they were 20 percent above and 2 percent below the national average, respectively.2

1/ Public sector employment is defined as the sum of employment in public administration, compulsory social security, education, health and social work, and sanitation. 2/ Large wage increases granted in 1999 have raised wages in public administration and health care further above the national average. Following the 12 percent increase granted in December 1999, wages in public administration are expected to exceed even those in the financial services sector (which previously had the highest level of gross wages) by nearly 7 percent.

5. An indication of the redistributive nature of budgetary spending is given by the sum of subsidies and current and capital transfers (which is defined as all unrequited government cash payments). This item increased from 13.8 percent of GDP in 1994 to 20.8 percent of GDP in 1998, when it accounted for nearly two-fifths of total general government ENL (see Table 2).5 Spending in this category includes support to industry, various segments of the domestic population, and foreign governments and residents. Support to public and private enterprises through these channels in 1998 was 2.8 percent of GDP, up from 2.2 percent of GDP in 1996.6 The main beneficiaries during 1994–98 were the publicly owned Croatian Railways (averaging 1.2 percent of GDP), the agricultural sector (averaging 0.6 percent of GDP), the maritime industry (averaging 0.2 percent of GDP) and, more recently, the tourism sector. Subsidies and transfers to support the restructuring and rehabilitation of enterprises adversely affected by the transition process and the war amounted to 0.5 percent of GDP in 1997 and 1998.

Table 2.

Croatia: General Government Subsidies and Transfers, 1994-99

(In percent of GDP)

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Sources: Ministry of Finance and IMF staff estimates.

For 1994-96, excludes transfers to veterans and the Croatian array by the pension fund, which are included under other current transfers.

Estimate based on subsidies and current transfers of the central government and extrabudgatary funds.

Consolidated central budget only.

Not separately identified in the 1994-98 budget presentations.

6. Post-war related spending accounts for a large part of total subsidies and transfers and encompasses reconstruction of housing and infrastructure (averaging 1.1 percent of GDP during 1995–98), and transfers to veterans, invalids and civil war victims (averaging 1.5 percent of GDP during 1995–98).7 However, this understates the full extent of unrequited cash spending for post-war related purposes since transfers to veterans from the pension fund were not separately identified during 1994–96. Post-war related transfers are budgeted to increase to 3.1 percent of GDP in 1999.

7. The Croatian budget also provides financial support to the government and residents of Bosnia and Herzegovina, primarily to finance pensions of war veterans and to underwrite the Croat component of the Federation army. The amount of this support in 1999 is budgeted at 0.4 percent of GDP. Other types of transfers and subsidies include pensions, sick pay and maternity pay (see below), as well as consumer subsidies.

Functional classification

8. A functional classification is prepared by the Ministry of Finance only for unconsolidated central government expenditure. An estimate of consolidated central government expenditure (including the extrabudgetary funds, but excluding local governments) by function was prepared by IMF staff by netting out intragovernmental transactions and allocating expenditures of the EBFs to various functional categories on the basis of available information regarding the purpose of the spending.8 The resulting functional breakdown of expenditures is shown in Table 3 and Figure 2.9

Table 3.

Croatia: Consolidated Central Government Expenditure by Function, 1994-99

(In percent of GDP)

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Sources: Ministry of Finance; and IMF staff estimates.
Figure 2.
Figure 2.

Croatia: Consolidated Central Government Expenditure by Function, 1994-99

Citation: IMF Staff Country Reports 2000, 022; 10.5089/9781451817300.002.A001

Sources: Ministry of Finance and IMF staff estimates.1/ Revised budget.

9. The largest components of consolidated central government expenditure in 1998 were social security and welfare (16.3 percent of GDP), health (6.5 percent of GDP), defense (4.5 percent of GDP), and education (3.0 percent of GDP). This compares with the following structure of spending in 1994: social security and welfare (12.2 percent of GDP), defense (8.0 percent of GDP), health (5.6 percent of GDP), and education and public order and safety (each 2.9 percent of GDP). Total spending for social purposes (defined as social security and welfare, health and education) increased from 51.1 percent of total consolidated central government expenditure (20.6 percent of GDP) in 1994 to 56.4 percent of total spending (25.7 percent of GDP) in 1998. A further increase of 2½ percentage points of GDP is budgeted for 1999.

10. Among the expenditure functions, the largest increases during 1994–98 were recorded in social security and welfare (4.1 percentage points of GDP) and housing and community amenities (1.7 percentage points of GDP), while the largest decline (3.4 percentage points of GDP) occurred in defense spending. These shifts reflect the improved security situation during the period that permitted a redistribution of expenditure from defense purposes to social outlays arising from post-war related priorities (including housing for veterans) and demographic shifts in the population. Significant increases are budgeted for 1999 in the categories “mining, manufacturing, construction” reflecting an increase in budgetary assistance to public and private enterprises,10 in “transport and communications” due to the initiation of an extensive road construction program, and in “expenditures not classified” reflecting the payout of insured deposits in failed banks financed from the budget and part of the transfer to Bosnia-Herzegovina.

11. The majority of spending for social security and welfare is devoted to retirement, invalidity, widows’ and veterans’ pensions, sickness and maternity benefits, unemployment benefits, and child benefits.11 With the exception of sick pay, which has risen sharply reflecting the liberal use of these benefits as an alternative form of unemployment relief, spending on benefits has remained stable since 1994 at around 2¾ percent of GDP. In contrast, expenditure for pensions rose by more than 4 percentage points of GDP between 1994–98, to nearly 12 percent of GDP, and is budgeted to increase further in 1999 to nearly 14 percent of GDP.

12. Government social spending is relatively high by international standards (see Table 4). Spending on health, education, and social security and welfare by the consolidated central government in 1998 was equal to 25.7 percent of GDP in Croatia, compared with an average of 23.4 percent of GDP in CEE countries.12 This reflects spending on social security and welfare and health that was 2 percentage points of GDP and 1.5 percentage points of GDP, respectively, above the regional average, whereas education spending was 1.2 percentage points of GDP below the regional average.

Table 4.

Government Sector Social Spending in CEE Countries, 1997-98

(In percent of GDP)

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Sources: Government Finance Statistics and IMF country desks.

13. However, in order to assess whether Croatia’s social spending is out of line with that of other countries, adjustment should be made for the additional burden imposed on social spending by post-war obligations. Non-war related social expenditure (proxied by total social spending excluding expenses for refugees and others affected by civil war, and pensions for veterans, survivors and the disabled) totaled 19.5 percent of GDP in 1998, which is well below the regional average. However, non-war related social spending is budgeted to increase rapidly in 1999 to 23.1 percent of GDP, close to average social spending in CEE countries.13

Expenditure for specific purposes

14. A functional classification based on the GFS methodology provides a sectoral breakdown of government expenditure. However, the classifications used by the authorities is quite broad, while expenditures which benefit some groups fall under different functional categories, making it difficult to identify total benefits for specific purposes. In this section, an attempt is made to identify and consolidate total budgetary resources devoted to three key policy priorities: post-war related purposes; road infrastructure and maintenance; and bank rehabilitation.

Trends in Pension Expenditure

The expansion in pension expenditures since 1994 largely reflects population aging, the increase in the minimum guaranteed pension in 1996, legislated and constitutional court mandated retroactive indexation of pensions to wages,1 and the granting of pensions to war veterans and invalids, as well as to families of war victims. In addition, reintegration into Croatia of Eastern Slavonia and other regions in 1997 substantially increased pension obligations by increasing the number of beneficiaries.2

Between 1993 and 1999, the total number of pension beneficiaries grew by more than 26 percent, to just under one million (21.7 percent of the population). Since 1993, the number of old-age, disability, and survivors’ pensioners increased by 23 percent, 27 percent, and 7 percent, respectively (Table 5). However, since veterans receiving pensions were recorded until 1999 according to the type of pension they received, the change in the number of recipients of old-age, disability, and survivors benefits in 1999 understates the actual increase in the number of non-veteran beneficiaries.3 More than half of all beneficiaries were old-age pensioners in 1999, while disability and survivors pensioners each accounted for more than a fifth of all pensioners.

The rapid increase in the number of pensioners generated a sharp rise in the dependency ratio (defined as the ratio of pension beneficiaries to total employment) from 63 percent in 1993 to 96 percent in 1999. Also contributing to the increase in the dependency ratio—and to the financial burden on the current PAYG pension system—was a rapid decline in the number of contributors to the pension fund, reflecting lower overall employment and a shift of workers from an employment to a contractual relationship in order to avoid social security contributions.

Croatia: Dependency Ratio

(Period average)

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Despite a fourfold increase in average pension benefits, replacement rates fell sharply between 1993 and 1999, from 58 percent to 41 percent, as pension levels failed to keep pace with the growth in net wages. The old-age replacement rate (defined as the ratio of the average old-age pension to the average net wage) declined even faster during this period, from 67 percent to 43 percent, reflecting the compression of benefits across different pension types, as the old-age benefit slipped from 1.45 to 1.15 times the pension with the lowest average benefit level (which was the survivors benefit in most years). This narrowing of old-age disability and survivors’ benefits was fully reversed in 1999, owing to the separate identification of benefits paid by the pension fund to veterans and members of the Croatian army, which were more than 175 percent of the average net wage and nearly six times the average old-age benefit level in 1999. In addition, veterans receive transfers from the central budget amounting to 0.6 percent of GDP.

1 As part of the stabilization program of October 1993, the automatic indexation of pensions to wages was suspended through annual decree, and enshrined in law in February 1997, when the principle of price indexation of pensions was adopted. A 1998 ruling judged as unconstitutional the suspension of wage indexation of pensions and, in order to partially redress the fell in the replacement rate, the government decided to pay out an additional HrK 7.5 billion (5¼ percent of 1999 GDP) in pensions during 1998–2001. Of this total, HrK 590 million was paid in 1998, and HrK 1.75 billion is to be paid in 1999. 2 Reintegration also added to the deficit of the pension system since the increase in benefit payments was not matched by contribution receipts from the war-affected areas. 3 The number of old-age pensioners increased by 10 percent in 1999, as many workers opted for early retirement in order to receive benefits they were entitled to under the pre-reform pension system. However, official data indicate a smaller increase in the number of old-age pensioners, once veterans receiving old age pensions are separately identified The jump in the total number of pensioners accounts for a significant part of the increase in pension expenditure projected for 1999. 4 Since a proportionately larger number of veterans are eligible for disability and survivors benefits, the average level of these benefits dropped sharply in 1999 once veterans were removed from those groups of beneficiaries.
Table 5.

Croatia: Number of Beneficiaries and Pension Payments by the Croatian Pension Institute

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Sources: Pension Insurance Fund, Bureau of Statistics, and IMF staff calculations.

Before 1999 Croatian army and war veterans were not separately identified. According to the Ministry of Finance, pension payments to war veterans were Hrk 1.1 billion and Hrk 1.4 billion in 1997 and 1998, respectively, and the number of beneficiaries increased significantly over time.

Before 1996 the number of beneficiaries from other former SFRY republics were not separately identified.

Average pension divided by average net wage.

Old age pension divided by average net wage.

Post-War Expenditure

15. Post-war spending encompasses expenditure for reconstruction (primarily housing), and cash and in-kind benefits in support of veterans, invalids, refugees and others affected by civil war. Between 1995 and 1999, identifiable post-war budget expenditure totaled Hrk 21.7 billion (15.3 percent of 1999 GDP). Aid to veterans and invalids accounted for more than half of budgetary post-war spending, while reconstruction and refugees accounted for 30 percent and 17 percent, respectively. Reflecting their subsequent resettlement, spending for refugees declined over time, whereas spending in support of veterans and invalids increased more than three-fold between 1995 and 1999.

Road construction and maintenance

16. In support of the authorities’ policy to improve cross-border and internal transport links, government expenditure for the construction and maintenance of roads accounted for 4.1 percent of 1999 GDP on a cumulative basis between 1996 and 1999, much of it financed by earmarked foreign loans. In addition, the government provided guarantees on foreign loans to private road construction companies in the amount of HrK 1,960 million (US$260 million or 1.4 percent of GDP), and has granted VAT-exempt status to one such company, thereby raising the fiscal cost of road construction through foregone tax revenues.

Banking sector rehabilitation

17. The fiscal cost of bank rehabilitation is the sum of cash payments to troubled banks and the bank rehabilitation agency (to finance payouts of insured deposits in failed banks), and newly issued public sector debt to recapitalize banks that entered the rehabilitation program.14 During 1996–99, total cash injections amounted to HrK 2.6 billion (1.8 percent of 1999 GDP), while debt issues totaled HrK 5.3 billion (3.7 percent of 1999 GDP).

C. The Structure of General Government

18. The general government is divided into three parts: the central government, the extrabudgetary funds; and the local governments. The first two parts combine to form the consolidated central government. There are currently five extrabudgetary funds (pension, health, employment, child, and water).15 The local government level is further divided into counties, cities, and municipalities, of which there are several hundred (see footnote 1).

19. A complex system of grants, revenue-sharing arrangements, and social security contributions connects the different levels of government, while smaller transfers also link branches within the same level of government. Transfers from the central budget to other parts of government—which are the largest type of intragovernmental transfer—totaled HrK 6.5 billion (4.7 percent of GDP) in 1998, compared with HrK 2.0 billion (2.0 percent of GDP) in 1994. Of these, HrK 220 million and HrK 6.2 billion went to the EBFs in 1994 and 1998, respectively. Transfers from the central budget to other parts of government are budgeted to rise further to HrK 11.1 billion (7.8 percent of GDP) in 1999, of which HrK 10.5 billion is slated for the EBFs.

20. These transfers distort the magnitude of underlying revenues and expenditures recorded by the donor and the recipient. Based on consolidated data (i.e., excluding intragovernmental transactions), the central budget and the EBFs accounted for 47 percent and 42 percent, respectively, of general government expenditure in 1998 (see Table 6). The share of the central government in total expenditure (and in GDP) declined sharply since 1994, due to spending increases by the pension and health funds, and the local governments.16

Table 6.

Consolidated General Government Revenue and Expenditure by Level of Government, 1994-9

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Source: Ministry of Finance.

Includes the central budget, the extrabudgetary funds and local governments.

Included in the central budget since 1995.

21. As a share of consolidated revenue, in 1998 the central government collected 60 percent of the total, while the EBFs collected 29 percent. The larger revenue-earning capacity of the central government reflects its ability to levy taxes on goods and services and income, as well as privatization receipts. The EBFs’ main revenue source is wage-based contributions, while the local governments rely mainly on surcharges on income taxes collected by the central budget.17

22. Excluding intragovernmental transactions, the central government budget has consistently run a surplus, which rose to a level of 7.4 percent of GDP in 1998 and is expected to increase further in 1999. This has been offset by persistent deficits in the extrabudgetary funds (primarily the pension and health funds), which also reached a new high in 1998 at 6.5 percent of GDP. The consolidated net position of the local governments has remained near balance during 1994–98.

D. Comparative Tax Rates

23. Compared with other transition countries, Croatia’s tax system imposes a heavy burden on the economy. Tax collections by the general government totaled 46.6 percent of GDP in 1998, 10 percentage points above the average of other CEE countries (Table 7). This was due primarily to VAT revenues, which were 6 percentage points of GDP above the average collected in other CEE countries, and to social security contributions, which were 1.7 percentage points higher than the cross-country average.

Table 7.

Comparison of General Government Revenues in Selected CEE Countries, 1998

(In percent of GDP)

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Source: IMF country desks.

Excluding privatization.

Revenue from goods and services tax.

24. The strong revenue-generating capacity of Croatia’s VAT reflects its relatively high rate and limited exemptions (Table 8).18 Apart from Bulgaria, Croatia is the only CEE country with a uniform rate and, at 22 percent, its level is also comparatively high. Croatia’s large share of VAT revenues may also reflect significant underreporting of GDP in official statistics. Replacement of the sales tax with the VAT in 1998 boosted Croatia’s indirect tax revenue by 3.8 percentage points of GDP compared to 1997. However, a contraction in private consumption, together with reduced compliance, is expected to reduce sharply the revenue yield from the VAT in 1999. On the other hand, Croatia’s direct tax rates are not substantially out of line with those in other CEE countries, and this is reflected in personal and corporate income tax collections that are close to the CEE average.19 Moreover, Croatia’s personal and corporate income tax systems appear to be simpler than in most other transition countries, having fewer tax brackets and a limited number of exemptions. Nonetheless, after raising the rate from 25 percent to 35 percent in 1997, Croatia’s corporate tax rate is almost double that in Hungary, which cut its tax rate in a revenue-neutral manner by eliminating a wide variety of exemptions. However, owing to the exclusion of dividends and the “normal” return on equity from the taxable base and reduced rates in the war-affected areas, the effective corporate tax rate was 22.8 percent in 1998. Unlike most other CEE countries, Croatia does not yet offer investment incentives in the form of corporate tax holidays, but the Ministry of Economy is working on a proposal to do so in the near future.

Table 8.

Selected Tax Rates in CEE Countries in 1999

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Source: International Bureau of Fiscal Documentation, “Taxation and Investment in Central and East European Countries,” various editions.

From January 1, 2000.

Applies only to exports.

Separate schedules apply to wages and other sources of income. Both schedules have the same tax rates, but the wage tax is more progressive.

Including zero bracket.

An additional 10 percent municipal tax is also levied.

Lower rate applies to companies with taxable profit of less than BGL50 million.

Applies to financial and medical services, and real estate transactions and, since November 1999, to books, milk, bread, and prescription drugs provided by the health fund.

Excluding income tax surcharges levied by cities (up to 60 percent in Zagreb and 30 percent in other cities). Actual rates are currently between 6 and 18 percent

Applies to enterprises in war affected regions.

Applies to basic foodstuffs, all services, real estate and construction works.

Applies to profits of investment and pension funds.

Applies to basic foodstuffs and household electricity.

Applies to textbooks, certain medicines and medical products, and construction.

Dividend withholding tax.

Applies to building materials, pharmaceuticals, medical devices, tourism.

Applies to Basic foodstuffs and health services.

Interest income is tax exempt.

Withholding tax applies to dividends and interest.

Applies to bread.

Household consumption of electricity and gas exempted.

Wage tax. Different schedules (with different tax rates) apply to other sources of income.

On dividends and interest. Income from services is taxed at 15 percent.

Applies to basic foodstuffs, pharmaceuticals, electricity, and legal services.

Postal, financial, education and health services.

Capital income is not taxed.

Withholding tax applies to royalties, rental income, and income of independent artists.

Applies to food, transport, printed material, medical services and public hygiene.

Applies to insurance and financial services.

Applies to interest from securities issued by state or local governments or public companies, and other exemptions.

25. Croatia’s payroll taxes to finance social security and other benefits are not out of line with other CEE countries (Table 9). Contributions are levied at a rate of nearly 42 percent of gross wages and, consistent with trends in several neighboring countries, this rate has declined somewhat in recent years in order to stimulate employment and reduce incentives for evasion.20 Nonetheless, sharply lower collections in 1999 are due in large part to a drop in payroll tax compliance.

Table 9.

Payroll Taxes in Selected CEE Countries in 1999

(In percentage points)

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Source: International Bureau of Fiscal Documentation, “Taxation and Investment in Central and East European Countries,” various editions.

From January 1, 2000. Reduced rates apply to employment in specific industries.

For work-related illness and maternity benefits.

Sickness and other benefits.

From January 1, 1999.

An additional lump sum health care levy of HUF 3,600 per month paid by employers applies.

Contributions for injury insurance vary by type of employment.

Contribution to fund to pay wages in the event of insolvency of employer.

For standard working conditions. A 10 percentage point premium is added for arduous labor conditions.

Contribution to the Chamber of Commerce.

Maternity benefits.

E. Public Sector Debt

26. Debt of the central government (excluding domestic arrears) stood at HrK 42.1 billion (30.5 percent of GDP) in September 1999, of which two-thirds was external debt (Figure 3).21 22 This represents a 6 percentage point increase over the level at end-1998, owing to new foreign borrowing and the depreciation of the kuna during 1999, which increased the kuna equivalent of both external and domestic debt since the latter is mostly denominated in, or indexed to, foreign exchange.

Figure 3.
Figure 3.

Croatia: Structure of Public Sector Debt in September 1999

(In percent of total; total debt: Hrk 42.1 billion)

Citation: IMF Staff Country Reports 2000, 022; 10.5089/9781451817300.002.A001

Sources: Ministry of Finance, Croatian National Bank, and IMF staff estimates.

27. Croatia’s public sector debt is the result of several factors: the assumption of debt as part of the succession process since independence; the transition process; and multilateral lending.

  • As a result of succession to the Socialist Federal Republic of Yugoslavia (SFRY), Croatia inherited in 1995 a part of the debt owed by the SFRY to creditor governments and banks under the terms of Paris and London club agreements. Of this debt, part was assumed by the enterprises and banks that received the original loan proceeds, while the remaining, unallocated portion was assumed by the Republic of Croatia. The government’s London and Paris club debt accounted for 31 percent of total public debt in September 1999.23

  • Succession to the SFRY was also responsible for the buildup of debt arising from the confiscation by the National Bank of Yugoslavia of banks’ foreign exchange reserves. These reserves, which amounted to about US$3 billion, were the counterpart assets to the private sector’s foreign currency deposits. In 1991, the Republic of Croatia assumed responsibility for these claims against the former SFRY; however, since the fledgling state had little foreign exchange reserves, the government issued to the commercial banks deutsche mark denominated “counterpart” bonds.24 The government also issued bonds (called JDA and JDB bonds) to finance the first two installments of principal of the counterpart bonds. Public debt associated with the frozen foreign exchange deposits accounted for 13 percent of total public debt in September 1999.

Reconstruction bonds, which were almost fully amortized by September 1999, were issued during 1992 and 1993 in an amount of about US$80 million to finance the reconstruction of war-damaged property.

  • Bonds to finance the rehabilitation and restructuring of enterprises (called “big bonds”) were issued in 1991 in an amount of DM 1,550 million. They were used by the enterprises to clear their obligations to domestic banks. Outstanding public debt from this source stood at 7 percent of total public debt in September 1999.

  • Official multilateral lending (primarily from the IBRD), to finance structural adjustment and sectoral projects, accounts for about 9 percent of the September 1999 public debt stock.

  • The rehabilitation of five state-owned and renationalized banks during 1996–99 was associated with an increase in public debt (called bank rehabilitation agency (BRA) bonds) to recapitalize the banks and provide needed liquidity. Debt from this source accounted for 11 percent of public debt in September 1999, but the rehabilitation of an additional bank in October 1999 added a further HrK 550 million to the stock of outstanding BRA bonds.

  • The remaining 29 percent of public debt, which is largely foreign debt, has been used to refinance more expensive domestic debt.

28. Despite the recent increases, public sector debt has declined slightly from US$5.9 billion in 1991 to US$5.8 billion in September 1999 and remains relatively low in comparison to other transition countries,25 even though—unlike some other transition countries—Croatia has not seen the real value of its obligations eroded by rapid inflation (Table 10). The relatively low level of Croatia’s public debt reflects moderate fiscal cash 26 deficits, and the redemption of a significant part of domestic debt in exchange for state-owned assets, including housing and enterprise shares.27

Table 10.

Total Debt of the Consolidated Central Government in Selected CEE Countries, 1994-98 1/

(In percent of GDP)

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Source: WEO and IMF country desks.

Excluding government guarantees.

At end September 1999, Croatia’s government debt increased to 30.5 percent of GDP.

At end September 1999, the sum of Croatia’s government debt and public guarantees was 45.2 percent of GDP.

29. While the level of debt contracted by the government remains moderate, public guarantees provided to loans from domestic and foreign sources have grown rapidly. Total outstanding public guarantees increased by HrK 4.6 billion from end-1998 to August 1999 to reach HrK 20.9 billion (14.7 percent of GDP). About 37 percent of guarantees are performance related, covering, inter alia, the on-time delivery of ordered goods, mostly ships.

30. External guarantees accounted for 47 percent of total outstanding guarantees in August 1999, and were equivalent to US$1.4 billion or 6.9 percent of GDP. Major beneficiaries of external guarantees are Croatian Airlines, road construction companies, the shipbuilding industry, the state-owned Croatian Bank for Reconstruction and Development (HBOR), and Croatian Railways. External guarantees increased by HrK 3.5 billion (US$475 million) during the first eight months of 1999, primarily in support of road construction and shipyards.

31. Regarding domestic guarantees, a large share is associated with lending by HBOR in support of various sectors of the economy, including shipbuilding, small enterprises, and tourism, as well as reconstruction of war-damaged industry and infrastructure. This lending is financed by government-guaranteed foreign borrowing, grants from the central budget and, until mid-1997, earmarked privatization receipts. To the extent that onlending by HBOR is financed by publicly guaranteed foreign borrowing, the state guarantees both the source and the use of the loan funds. Other publicly guaranteed domestic lending is undertaken by commercial banks and primarily supports public enterprises and tourism facilities.

F. Conclusions

32. Croatia’s fiscal position appears relatively sound when measured by the overall balance and the public debt ratio. However, when compared with other CEEs and what would be expected during the transition process, Croatia’s experience appears less favorable. In particular, the increase in the size of the government sector since the mid-1990s to more than 52 percent of GDP in 1998 reflects structural pressures on spending—including a rapidly increasing dependency ratio and an overly generous health and social transfer system—as well as excessive public sector wages and heavy spending in a number of areas.

33. A number of temporary budgetary obligations—including the cost of bank resolution and court-mandated supplementary pension payments—is expected to further increase general government expenditure in 1999 and 2000. Privatization receipts from state-owned utilities and banks will provide one-off coverage for these, while presenting a short window of opportunity in which to address the underlying structural deficiencies in the fiscal sector. However, the bulk of the privatization receipts is likely to be exhausted by 2002, by which time the temporary budget obligations will also have been completed. Nonetheless, the structural problems will persist unless decisive measures are implemented early on. Resolving these problems will be complicated by the absence of an adequate public sector expenditure oversight and control mechanism. Moreover, the recent rapid increase in contingent government liabilities could lead to a substantial additional fiscal burden in light of the weak economic performance of several of the industries that received government guarantees.

34. Expenditure cuts will also be needed in response to the recent erosion in tax compliance, which experience from other countries suggests will be very difficult to reverse. Moreover, tax rates in several areas remain high in comparison to neighboring countries. In order to support increased compliance while improving external competitiveness and increasing Croatia’s attractiveness to foreign investors, taxes on employment and profit should be reduced. However, given the uncertainties involved in projecting the likely savings from structural expenditure reforms, it is advisable that tax cuts be introduced only once expenditure savings have been realized. In addition, given the potentially significant revenue losses that could result from the planned introduction of corporate tax holidays, Croatia is advised to limit the breadth and duration of these incentives.

1

Prepared by Rachel van Elkan.

2

The general government consists of the central government, five extrabudgetary funds (EBFs), and local governments (421 municipalities, 122 cities and 21 counties).

3

When repayment of arrears is recorded above the line (as occurred in 1999), the use of arrears does not affect the overall level of cash spending, but postpones the recording of the expenditure.

4

The cumulative deficits of between ½ and 1¼ percent of GDP recorded in 1995–97 were exactly offset by surpluses in 1994 and 1998.

5

Moreover, this item is budgeted to increase further in 1999 to 23.3 percent of GDP. All references to the 1999 budget refer to the revised budget.

6

Additional budgetary support to industry is provided through the payment of interest and principal on guaranteed loans and, in 1999, through the cancellation of debt (primarily of the shipyards) to the pension and health funds for unpaid contributions. In the first nine months of 1999, payments on guaranteed loans financed from the current budget were nearly HrK 470 million (0.3 percent of GDP), but total payments for this purpose—which are financed from past budgetary contributions to the guarantee reserve fund—are thought to have been significantly greater.

7

This category excludes in-kind benefits (including to refugees) and capital goods acquired for reconstruction purposes.

8

For example, sickness and maternity benefits paid by the health fund are recorded as social welfare spending, rather than health spending.

9

This approach excludes net lending and local government expenditure, which together amount to about 5 percent of GDP.

10

The revised 1999 central budget includes capital transfers to the pension and health funds in exchange for shares acquired by the funds through debt-equity swaps with the shipyards. In its functional classification, the Ministry of Finance (MoF) includes these capital transfers as manufacturing expenditure (which would be consistent with the central budget transferring the funds directly to the shipyards which, in turn, would then pay their obligations to the EBFs). However, in its calculation of total consolidated central government expenditure, the MoF treats these capital transfers as an intragovernmental transaction, implying that total consolidated expenditure would be lower than if the government transferred the funds directly to the shipyards.

11

Also included in this category are the costs associated with administering the welfare system and transfers in kind, including to veterans.

12

The figures for Bulgaria, Hungary, Romania, and Slovakia relate to general government expenditure. To the extent that local governments undertake social spending, the comparable figures would be larger in Croatia, the Czech Republic, and Poland.

13

However, 1.2 percentage points of this increase reflects temporary factors associated with the retroactive indexation of pensions.

14

Since the Croatian National Bank (CNB) is not permitted to carry over any government debt from one calendar year to the next, an additional fiscal cost associated with the banking sector arises from the need to repay ahead of schedule government debt used by failed banks as collateral to secure liquidity loans from the CNB. The amount of early repayment in 1999 is about HrK 130 million (0.1 percent of GDP).

15

The road fund was absorbed into the central budget in 1995. The general government does not include the Croatian Privatization Fund or the Croatian Bank for Reconstruction and Development (HBOR).

16

This decline is measured after correcting for the absorption of the Croatian Road Fund into the central budget in 1995.

17

Cities with populations in excess of 40,000 may impose a surcharge on the personal income tax collected by the central government. In the case of Zagreb, the permitted rate is up to 60 percent, while in other cities the ceiling is 30 percent. In addition, income taxes collected from individuals living outside Zagreb are shared between the state budget (70 percent), counties (5 percent), and cities (25 percent). In the case of income taxes collected from individuals living in Zagreb, 55 percent goes to the central budget and 45 percent is allocated to the city. A summary of the Croatian tax system is given in Appendix II of this report.

18

The zero rating for bread, milk, books, and prescription drugs was introduced only in November 1999.

19

This excludes, however, surtaxes of up to 60 percent levied by local governments on personal income taxes collected by the central government.

20

Since mid-1998, the child benefit fund has been financed by the central budget, permitting a reduction in payroll contributions.

21

Debt data for the general government is not available, but borrowing opportunities for the EBFs and the local governments (except for the city of Zagreb) are small and limited primarily to domestic bank credit.

22

Domestic arrears of the consolidated central government are not included in official debt statistics, and the Ministry of Finance does not have accurate information on their level. Staff estimates that at end-1999, the stock of domestic arrears was equal to some 6 percent of 1999 GDP.

23

The government also inherited some multilateral debt, primarily from the IBRD, amounting to nearly US$130 million.

24

In order to prevent the withdrawal of these deposits from the domestic banking system—which would have precipitated the failure of the banks—these deposits were blocked for a period of three years (until July 1995), and thereafter unblocked at the minimum rate of 20 equal semi-annual installments.

25

Data on public sector debt excludes the stock of arrears of the central government and the extrabudgetary funds.

26

The cash deficits remained moderate, in part, because of the sale of state-owned assets.

27

Public debt will increase by DM 120 million (0.3 percent of GDP) in early 2000 reflecting a bond issue to individuals whose property was confiscated during the previous regime.

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Cover IMF Staff Country Reports
Republic of Croatia: Selected Issues and Statistical Appendix
Author:
International Monetary Fund
Volume/Issue:
Volume 2000: Issue 022
Publisher:
International Monetary Fund
ISBN:
9781451817300
ISSN:
1934-7685
Pages:
145
DOI:
https://doi.org/10.5089/9781451817300.002
  • Figure 1.
    View in gallery
    Figure 1.

    General Government Expenditure and Net Lending in Selected CEE and EU Countries, 1994-98 1/

    (In percent of GDP)

  • Figure 2.
    View in gallery
    Figure 2.

    Croatia: Consolidated Central Government Expenditure by Function, 1994-99

  • Figure 3.
    View in gallery
    Figure 3.

    Croatia: Structure of Public Sector Debt in September 1999

    (In percent of total; total debt: Hrk 42.1 billion)

Figure 1.

General Government Expenditure and Net Lending in Selected CEE and EU Countries, 1994-98 1/

(In percent of GDP)
Figure 2.

Croatia: Consolidated Central Government Expenditure by Function, 1994-99
Figure 3.

Croatia: Structure of Public Sector Debt in September 1999

(In percent of total; total debt: Hrk 42.1 billion)