Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized World Bank – Croatia Partnership Country Program Snapshot September 2011 Public Disclosure Authorized RECENT ECONOMIC 2011. Capital adequacy remains high (at at 19 DEVELOPMENTS percent in June 2011) and continues to safeguard the banking sector soundness. Growth and External Performance 8 in % The crisis has taken a severe toll on Croatia, 6 with the economy contracting by 7.2 percent 4 in 2009-2010. A return to positive but subdued 2 growth was noted in Q2 of 2011 of 0.8 percent. 0 The 2011 growth is projected at below 1 -2 percent. The recovery is based on a modest -4 Domestic demand upturn in exports and consumption spending, if -6 Real GDP external conditions, improvements in corporate -8 credit growth and the recent rise in consumer -10 confidence are sustained. The slow rebound led to 2004 2005 2006 2007 2008 2009 2010 2011e a temporary recovery of labor market conditions reducing the official unemployment rate below 17 A sustainable recovery depends on the percent in July 2011, down from the peak of emergence of a more dynamic private sector almost 20 percent in early 2011. However, the supported by an investment-friendly climate. informal sector remains large misreporting the The private sector’s share of GDP amounts to growth and employment performance. only 70 percent and is low compared to other EU peers. Croatia’s performance in terms of Nevertheless, prospects for economic recovery enterprise restructuring, privatization, and creating remain fragile, suggesting the need to accelerate an enabling investment climate has been mixed. reforms across public administration, social Improving the business environment – such as sectors, and the business environment. The creating efficient government institutions and ongoing spending freeze from mid-2009 helped predictable legal framework, more flexible and stabilize public finances. Significant adjustments skilled labor force, and improved access to finance on the spending side equal to 5 percentage points – would bring many benefits. of GDP had to be undertaken (including a Estonia reduction in public sector wages, suspension of Latvia Lithuania Doing business 2011 pension indexation, cuts in categorical social Macedonia (185 countries) benefits and privileged pensions) to protect Slovakia Slovenia macroeconomic stability with keeping the general Bulgaria Hungary government deficit at 5 percent of GDP in 2009 Romania and 2010. A half-year government deficit in 2011 Montenegro Czech … stood at 2.6 percent of GDP. The newly approved Turkey Poland 2012-2014 Budget Guidelines aim to achieve a Croatia primary balance by 2013 and stem further public Serbia BiH debt growth through one percentage point of EU 10 GDP in spending reduction per year. EU 15 0 20 40 60 80 100 120 140 The current account deficit narrowed to around one percent of GDP in 2010 and 2011 due to a To support recovery and mitigate social fall in imports and exports recovery, down from impacts, the Croatian Government adopted over 6 percent of GDP from the pre-crisis period. the Economic Recovery Program (ERP) in The external debt continued to increase in 2009- April 2010. However, after the launch of reforms 2011 period, although at an increasingly slower across social sectors as well as reforms to improve rate, maintaining external debt to GDP around the investment climate, the reform pace slowed 100 percent. The financial sector remained stable, down as general elections are approaching. In May although the non-performing loans at 11.5 percent 2011 the World Bank supported the of total in March 2011 prevent faster credit implementation of the ERP by approving EUR recovery which remained anemic in 2010 and early 150 million of budget support loan (ERDPL). Earlier the World Bank’s Fiscal, Social, and established under the negotiations, and project Financial Development Policy Loan (DPL), preparation for post-accession funds. By using approved in January 2010, contributed to IPA funds, Croatia is also building its capacities Government efforts to maintain macroeconomic and resources for the absorption of significant stability and protect the most vulnerable groups of Structural and Cohesion Funds that will be made society. Through the Export Financial available upon membership. IPA procedures for Intermediation Loan to the Croatian Bank for selection of projects, tendering and contracting are Reconstruction and Development, the Bank similar to the procedures under the Structural supported access to long-term working capital for Funds – and the use of IPA funds are providing export companies. In terms of analytical and invaluable experiences for the country’s advisory activities, the Bank conducted a 2008 institutions as they prepare for future use of much Public Finance Review and produced Policy Notes on larger post-accession funds. Fiscal Responsibility, Pensions and Labor Market in 2011 to help the authorities in designing reforms The Bank has aligned its program with for structural challenges. The Bank also produced Croatia’s EU accession needs and the 2009 Croatia EU Convergence Report Reaching requirements. Given that IPA funds represent a and Sustaining Higher Rates of Economic Growth and small portion of resources required for the 2010 Social Impact of the Crisis and Building investments to meet acquis requirements, the Resilience report to assess the efficiency of the labor current Bank strategy is centered on supporting market and social safety net programs. Croatia’s pre-accession reforms through projects and analytical and advisory activities that Croatia and the European Union complement the EU accession agenda. The Bank has particularly supported Croatia’s investments in On June 24, 2011, the European Council gave the environment and water sectors and public the green light for Croatia to become the 28th administration reforms. Croatia introduced some member state to join the European Union on key EU legislative and institutional changes with July 1, 2013. The demanding and difficult Bank support, for instance in the agricultural negotiations, which were launched in 2005, were sector. Through investment operations, the Bank officially concluded on June 30, 2011, with the has provided technical assistance for project closing of the four outstanding policy chapters out preparation for IPA-funding, but more so for of a total of 35. Two chapters, in particular, had post-accession funds. Technical assistance is also posed the biggest challenge – Chapter 23 on critical in preparing the institutions for better judiciary and fundamental rights and Chapter 11 absorption of EU funds. In the selection and on competition. The EU accession process design of operations, primary consideration is provided Croatia with a strong incentive to adopt given to how the proposed project supports reforms and harmonize its legislation with the EU Croatia’s EU accession agenda. In the case of acquis communautaire. The European Commission social sectors where there is no EU acquis, will continue to monitor Croatia’s reform progress consideration will also be given to how projects during the ratification process, in particular those complement the EU accession efforts. related to the judiciary and fundamental rights. Poverty and Social Protection Croatia is preparing for future access to the Structural and Cohesion Funds through the The crisis has increased poverty in Croatia to implementation of the Instrument for Pre- over 10 percent. Before the crisis, poverty Accession Assistance (IPA). Croatia has been (defined as HRK 2063 per month for an adult), in using IPA – the EU financing program to support Croatia was below 10 percent. Simulations of the the country’s preparation for membership, since crisis impact indicate that between 2008 and 2010, 2007. More than EUR 1 billion, or about EUR poverty increased by 4 percentage points. Prior to 150 million a year, has been available through IPA the crisis, poverty was mostly associated with for the period 2007-2013. The IPA programs are those without a job for more than three years and closely linked with the accession process, with low-skilled workers. Now the profile of the poor projects addressing specific benchmarks has changed, with economically active, better educated, younger people, living in richer urban Centers of Social Welfare and the introduction of areas being most affected. The fall in employment a unique personal identification number will give coupled with the fall in real wages has pushed social workers access to data from other agencies, many unemployed workers into poverty. The such as the unemployment bureau and the tax policy priority should focus on preventing short- administration, helping them to assess the needs term unemployment turning into long-term of the claimants faster with less administration for unemployment, and temporary poverty into all parties. chronic poverty. The World Bank’s Social Welfare Development Croatia’s social assistance system provides a Project supported the development of an integrated generous safety net to the poor and social welfare MIS, modernization and quality vulnerable, but at a high cost administered improvement of social services, including the through a complex and inefficient system. reduction of institutionalized care and improved Social assistance reaches around 57 percent of the provision of community-based care. A series of poorest 20 percent of the population. However, policy-based loans supported the improved the number of programs on offer, the number of targeting and consolidation of categorical social institutions involved, and the lack of benefits, contributing to the government’s Social harmonization on eligibility criteria lead to a costly Welfare Reform Strategy 2011-2016 and the new system, which is not well targeted and treats May 2011 Social Welfare Act. claimants unequally. Very little of the money spent on social protection is based on the actual Health financial situation of a person (means-tested programs accounted for 8 percent of total Croatia fares well in the provision of health spending in 2010 or less than 0.4 percent of care and healthcare results, but spends 7.8 GDP).