EU 11 R EGULAR E CONOMIC R EPORT M ACROECONOMIC R EPORT : F OCUS ON C ROATIA

Entering the fifth year of recession Croatia : Quarterly GDP growth, y / y EU 11 and EU 15: GDP growth, y / y Source : Eurostat, CROSTAT, World Bank staff calculations

Deteriorating Labor Market Conditions Sour labor market developments, Croatia, in % Less opportunities ( or incentives ) even in the informal sector Source : CROSTAT, World Bank staff calculations

External Debt (% of GDP ) CAD and Net FDI (% of GDP ) External Position Slightly Improved  External debt although high, shrank slightly due to bank deleveraging – some 20 pp of GDP above EU 11  CAD turned positive in Q while net FDI inflow improved Source : CNB, CROSTAT, World Bank staff calculations

Public Debt and Deficit (% of GDP ) Public Debt on Rise  Stronger fiscal consolidation required, especially on the expenditure side  2013 plans hardly achievable Note : Fiscal deficit assessed for as per the required ESA 95 coverage Source : MOF, CROSTAT, World Bank staff calculations

Weak Signs of Bottoming Out ? Tourism recovered to pre - crisis levels, but low impact on trade… High frequency indicators Source : CNB, CROSTAT, World Bank staff calculations

Some Softening of the Labor Market Source : CROSTAT, HZZ, World Bank staff calculations

However, Structural Problems Deepened Labor market entry for youth particularly constrained Source : CROSTAT, HZZ, World Bank staff calculations Job destruction in industry continued ; public sector employment dominated

Reform agenda – seizing opportunities  84 th in the World Bank ’ s Doing Business rankings or 81 st on the Global Competitiveness rankings  Challenging competition after July 1 with many of the world ’ s best nations for doing business.

What To Do – Fiscal Consolidation 10  Need to regain the investment credit rating before the capital market deteriorates ( again )  Interest payments at 3% of GDP already at the capital spending level  Expenditure - based consolidation remains a priority – public spending at around 45% of GDP as opposed to 40% of GDP of EU 10  Fiscal space exists in the area of the wage bill, subsidies and consumption  Social spending requires redistribution from categorical to targeted social programs and a separation from contribution - based benefits from categorical benefits  Capital spending needs to be EU - funded and to take into consideration future maintenance cost

What To Do – Investment Climate 11 Disclosure Time / Cost Strengthen the business environment in the areas of : insolvency proceedings ; issuance of construction permits ; registering property ; and transparency of related - party transactions. Open up the network industries such as energy, railways, postal services and telecoms to competition to deliver better services at better prices for business and citizens. Deepen the governance reform in the areas of : e - governance, performance - based public sector pay ; territorial reorganization ; review business necessity of quasi - fiscal institutions Source: World Bank

What To Do – Labor Market and Social Sectors 12  Demand and supply side issues, no quick wins :  EPL still highly rigid in stimulating employment and accelerating restructuring  Skill mismatches  Low labor participation  Which reforms :  Increasing hiring flexibility ( a good set of proposals submitted by the government )  Reducing rigidity of collective firing  Improving VET education and providing incentives for LLL  Reducing incentives for early retirement, consolidating social benefits and improving their targeting

What To Do - EU Funds 13 July 1, 2013 Croatia Becomes 28 th EU Member State EU Structural Funds : – 1.2% of GDP available for absorption in 2013 or 0.8% of GDP in payments. –Around 3.5% of GDP per year over the next programming period in commitments –Ease the external balance position and improve debt sustainability  What needs to be done ?  Create fiscal space in the order of 1 percent of GDP per year as counterpart funds and for pre - financing  Develop sector and regional development strategies linked to sustainable fiscal frameworks

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