Introduction

The Croatian authorities would like to thank staff for their fair assessment of the economic performance, and for their continuous efforts in helping them to steer through the complex economic reform course. After successful completion of the previous precautionary SBA in May last year, which was beneficial for the country in many ways, the authorities decided to request another precautionary SBA, with an aim to confirm their decisiveness regarding the reform process. This time, to demonstrate even more the precautionary nature of the program, the authorities repaid all their obligations towards the Fund ahead of schedule (in late December 2002), and they requested the lowest possible access (less then 30 percent of their quota) under the new arrangement.

General Outlook

Last year’s economic growth could be as high as 5 percent (according to preliminary estimates), which is well above all previous projections. Let me recall that the authorities entered into the last year with a conservative growth projection of 3.5 percent, and then accepted a 4.0 percent projection after the first quarter data became available. However, the good tourist season, and very strong industrial production seem to have accelerated real growth even further, which is especially satisfactory in light of the less favorable external environment and the ongoing (considerable) fiscal consolidation. Good growth prospects are expected for this year too (above 4 percent for GDP), and the latest figures on the industrial production (which indicated an acceleration in the last quarter of 2002) are encouraging in this respect.

Turning back to last year’s strong economic growth, it is noteworthy that this growth was mainly an outcome of the impressive performance of the private sector. For the first time since transition started, the aggregate net profit/loss balance of the Croatian enterprises turned to positive values last year. Furthermore, unemployment statistics improved, despite significant lay-offs in the public sector. Unemployment still remains high in Croatia, roughly 15 percent on an ILO basis, but it fell by a full percentage point last year.

Fiscal Policy

Perhaps the main accomplishment over the past few years was in the fiscal area. The fiscal adjustment has been considerable in every aspect (well-presented in the table on page 12 of the staff report) - the fiscal deficit has been lowered by some 2–3 percentage points of GDP, and the government expenditures by some 5 percentage points of GDP. At the same time, the tax burden has been lowered too, and almost all government arrears (which amounted to some 5 percent of GDP at end-1999) have been paid. However, despite strong consolidation efforts, the public debt continued to climb (although at a much slower pace than before). Hence, the authorities’ strong aim under the proposed new arrangement is to reverse the debt dynamics, and to make further progress towards the medium-term soundness of the public finances.

Against this background, the authorities are committed to reduce the consolidated general government deficit to 5 percent of GDP in 2003. Although this figure still looks high, it represents a significant adjustment effort (1.4 percentage points of GDP), which comes in the pre-election period. It is also worth noting that the figure includes highway construction (an annual cost of approximately 2 percentage points of GDP), which has the characteristics of a self-financing investment project. In any case, the latter fact at least adds to the medium-term debt sustainability. In addition, let me underscore that beside the authorities’ strong intention to reduce the deficit this year, they are fully committed to further fiscal consolidation. The track record they have established over the past three years speaks the best for their determination to put the public finances on a sound footing.

Monetary and Exchange Rate Policy

Monetary policy successfully continues to be focused on low inflation, while keeping an eye on exchange rate developments. Last year’s inflation was 2.3 percent, with core inflation about 1 percent. It is noteworthy that this year - 2003 - is the 10^th anniversary of the stabilization program (implemented in Fall 1993), during which Croatia has been experiencing very low inflation rates. On average, annual headline inflation has been roughly 3.3 percent, and core inflation has remained below 2.5 percent. With such a performance, Croatia is an excellent performer among CEE transition countries, and there is little need to stress how eager the central bank is to continue to perform well on the inflation front.

The role of exchange rate stability should not be underestimated in considering the outstanding inflation performance. This is especially true in light of Croatia’s monetary history, which provides an explanation for the high level of euroization in the economy. Hence, the monetary authorities intend to continue to rely on foreign exchange interventions at their discretion, with an aim to preserve the price stability objective, but also to discourage any potential one-way bets on the foreign exchange market. To this end, such a policy is entirely consistent with the authorities’ aspirations to join the EU and to introduce the euro as legal tender in a manner consistent with practices that are applicable to the economies embarking on an accession path, and consistent with the recommendations of the EU and the ECB.

Separately, with regard to strong growth of bank credit to the private sector, let me note that the monetary authorities have already adopted measures to discourage excessive commercial banks’ lending. Given the fact that the recent growth in bank placements has been based on the growth in foreign liabilities rather than on domestic deposits, the adopted measures tend not only to preserve a quality of commercial banks loan portfolio, but also to reduce pressures on the balance of payments and the external debt.

Structural Reforms

Without any doubt, the structural agenda continues to be complex, given the wideranging nature of reforms. To provide some sense of its complexity, let mc shortly outline some of the most important actions planned for this year. In the context of fiscal sector reforms, the authorities intend to adopt a new budget law and to strengthen their debt management. Then, to improve the functioning of markets and support employment, the authorities plan to adopt new company, competition, bankruptcy and labor laws. Furthermore, health sector reform, as well as judicial reform will proceed. Finally, regarding privatization, beside further divestiture programs in public enterprises (from the privatization fund’s portfolio), the authorities plan to privatize 25 percent plus one share of the oil and gas company (INA), and also to start privatizing the only remaining bank in state hands. It is noteworthy that the last state-owned bank is relatively small in size (3–4 percent of total banking assets), and that it is well-capitalized. In addition, preparatory work for potential privatization of power plants (after 2003), within the electricity company, will also be completed in the course of the year.

All in all, despite the demanding structural agenda, and the fact that some reforms might not be politically popular, the authorities are determined to finish the job. That said, they are well aware that only successful implementation of these reforms could pave the way towards a full-fledged and stable market economy.

Conclusion

The Croatian authorities would like to underscore the very fruitful cooperation with staff. They consider the proposed arrangement as a help to address various challenges that are on the way ahead, particularly in the area of public finances and structural reform. At the same time, they are of the opinion that such a program is the best way to confirm their strong reform orientation.