Abstract
This paper assesses the Republic of Croatia’s Second Review Under the Stand-By Arrangement, and Requests for Waiver of Performance Criteria and for Modification of a Performance Criterion. Although there were continuing delays in structural reforms, the main performance criteria for end-2001 were observed. The IMF staff supports waivers for the nonobservance of these performance criteria on the grounds that the nonobservance is likely to be largely temporary in the light of an unchanged privatization program, and that there is no evidence that it caused a crowding out of the private sector.
March 29, 2002
The following information, which does not change the substance of the staff appraisal, has become available since the staff report was issued.
1. As noted in EBS/02/47, three prior actions remained to be completed before the Board’s consideration of the second review under the stand-by arrangement with Croatia. These actions have now been completed. On March 19, parliament approved the privatization laws for HEP and INA. On March 21, parliament approved the new employment law. On March 7, the government decided to appoint the consortium CA-IB, Zagreb and Deloitte ∓ Touche, Budapest as its advisor for the privatization of HPB. On March 27, the Agency for Deposit Insurance and Bank Rehabilitation (DAB) signed a contract with the consortium to prepare proposals for the privatization of 25 percent plus two shares in 2002. According to information received by the staff on March 28, this contract will be modified as soon as possible to provide for the privatization of another 50 percent in the bank in 2003. On the basis of this information, the staff considers that the third prior action has been met, but it regrets that the five-day rule for the completion of prior actions has been breached.
2. Tensions in the government have been resolved following the March 15 agreement within the five-party coalition on the appointment of two new ministers (Economy and Transport). The agreement is based on a renewed commitment towards macroeconomic stability and structural reforms.
3. Economic activity remains strong. Real retail sales grew by 10.9 percent year on year in January and manufacturing production increased by 5.7 percent year on year in January-February. Retail price inflation in February was 2.8 percent year on year, after a temporary increase to 3.3 percent in January due to increases in road tolls and excise taxes on fuel. Core inflation remained roughly flat at 1.8 percent, while producer prices continued falling.
4. Large foreign currency inflows connected with euro conversion continued in January, and, according to preliminary data, in February. Most of the inflows have remained in the banking system, giving rise to a further net addition to bank deposits. Credit growth continues to be strong, both for households and businesses. Appreciation pressures on the kuna continued, and the CNB intervened again on March 15 selling domestic currency. The end-March target on international reserves seems easily attainable. So does the end-March target on the CNB’s net domestic assets, despite the extension of emergency liquidity credit to Rijecka Banka (see below).
5. On March 14, concerns about significant currency trading losses led to deposit withdrawals from Riječka Banka, the third largest bank. The CNB promptly assisted the bank with emergency liquidity and any systemic impact was averted. On March 20, the CNB board approved the acquisition of an up to 90 percent stake in the bank by the State Agency for Deposit Insurance and Bank Rehabilitation (DAB), after Bayerische Landesbank Girozentrale München (BLB) had agreed to surrender to DAB its 59.9 percent shareholding. Since then, new management has been appointed and the government has announced its intention to resell the bank as soon as possible.
6. On March 21, the government approved a privatization program for INA, which is a structural benchmark for March 31, 2002 under the stand-by arrangement. As for structural measures not subject to Fund conditionality, on March 19 parliament approved the defense sector reform laws, which will enable a substantial reduction of government employment. On the other hand, parliamentary approval of the new banking law and of the law on industrial parks is now expected during the parliamentary session that starts in mid-April 2002, and the draft law on bankruptcy trustee services is still being discussed among experts in government procedure.
7. The draft report for the off-site safeguards assessment of the CNB is currently being reviewed by Departments. The assessment, which included a review of the 2000 financial statements that had been restated under international accounting standards and audited under international standards of auditing, did not find significant vulnerabilities. The draft report, however, makes a series of recommendations in the areas of internal and external audit systems of the CNB and its system of internal controls. The staff found the CNB very cooperative throughout the assessment process.