# IMMC.COM%282021%29511%20final.ENG.xhtml.1_EN_ACT_part1_v5.docx

european flagEUROPEAN COMMISSION Brussels, 2.6.2021 COM(2021) 511 final Recommendation for a COUNCIL RECOMMENDATION delivering a Council opinion on the 2021 Convergence Programme of Croatia {SWD(2021) 501 final}
Recommendation for a COUNCIL RECOMMENDATION delivering a Council opinion on the 2021 Convergence Programme of Croatia THE COUNCIL OF THE EUROPEAN UNION, Having regard to the Treaty on the Functioning of the European Union, Having regard to Council Regulation (EC) No 1466/97 of 7 July 1997 on the strengthening of the surveillance of budgetary positions and the surveillanc e and coordination of economic policies 1 , and in particular Article 9(2) thereof, Having regard to the Recommendation of the European Commission, Having regard to the resolutions of the European Parliament, After consulting the Economic and Financial Committee, Whereas: (1) On 20 March 2020, the Commission adopted a Communication on the activation of the general escape clause 2 of the Stability and Growth Pact. 3 In its Communication, the Commission set out its view that, given the expected severe economic do wnturn resulting from the COVID-19 outbreak, the conditions to activate the general escape clause were met. On 23 March 2020, the Ministers of Finance of the Member States agreed with the assessment of the Commission. The general escape clause has granted Member States budgetary flexibility to deal with the crisis. It has facilitated the coordination of budgetary policies in times of severe economic downturn. Its activation allows for a temporary departure from the adjustment path towards the medium-term bu dgetary objective of each Member State, provided this does not endanger fiscal sustainability in the medium term. On 17 September 2020, in its Annual Sustainable Growth Strategy, the Commission announced that the general escape clause would remain active i n 2021. 4 (2) On 20 July 2020, the Council recommended Croatia to take all necessary measures, in line with the general escape clause, to effectively address the pandemic, sustain the economy and support the ensuing recovery. 5 It also recommended Croatia t o pursue, when economic conditions allow, fiscal policies aimed at achieving prudent medium-term fiscal positions and ensuring debt sustainability, while enhancing investment. (3) Next Generation EU, including the Recovery and Resilience Facility, will ens ure a sustainable, inclusive and fair recovery. Regulation (EU) 2021/241 establishing the Recovery and Resilience Facility 6 came into force on 19 February 2021. This Facility will provide financial support for the implementation of reforms and investment, entailing a fiscal impulse financed by the EU. It will contribute to the economic recovery, to the implementation of sustainable and growth-enhancing reforms and investment, notably to promote the green and digital transitions, and it will strengthen the e conomies’ resilience and potential growth. In turn, it will also help public finances to return to more favourable positions in the near term and will contribute to strengthening sustainable public finances, growth and job creation in the medium and long t erm. (4) On 3 March 2021, the Commission adopted a Communication providing further policy orientations to facilitate the coordination of fiscal policies and the preparation of Member States’ Stability and Convergence Programmes. 7 The overall fiscal stance, taking into account national budgets and the Recovery and Resilience Facility, should remain supportive in 2021 and 2022. At the same time, given the expectation of economic activity gradually normalising in the second half of 2 021, Member States’ fiscal policies should become more differentiated in 2022. Member States’ fiscal policies should take into account the state of the recovery, fiscal sustainability and the need to reduce economic, social and territorial divergences. In view of the need to support a sustainable recovery for the EU, Member States with low sustainability risks should gear their budgets towards maintaining a supportive fiscal policy in 2022, taking into account the impact of the Recovery and Resilience Facil ity. Member States with high debt levels should pursue prudent fiscal policies, while preserving nationally financed investment and making use of grants under the Recovery and Resilience Facility to fund additional high-quality investment projects and stru ctural reforms. For the period beyond 2022, fiscal policies should continue to take into account the strength of the recovery, the degree of economic uncertainty and fiscal sustainability considerations. A refocusing of fiscal policies towards achieving pr udent medium-term fiscal positions, including by phasing out support measures in due course, will contribute to ensuring fiscal sustainability in the medium term. (5) The Communication of 3 March 2021 also announced the Commission’s view that the decision on the deactivation or continued application of the general escape clause should be taken as an overall assessment of the state of the economy, with the level of economic activity in the EU or euro area compared to pre-crisis levels (end-2019) as key quan titative criterion. On the basis of the Commission’s 2021 spring forecast, on 2 June the Commission considered that the conditions to continue to apply the general escape clause in 2022 and to deactivate it as of 2023 were met. Country-specific situations will continue to be taken into account after the deactivation of the general escape clause. 8 (6) On 29 April 2021, Croatia submitted its 2021 Convergence Programme, in line with Article 8 of Regulation (EC) No 1466/97. (7) In 2020, based on data validated by Eurostat, Croatia’s general government deficit was 7 .4 % of GDP, while general government debt increased to 88.7 % of GDP. The annual change in the primary budget balance amounted to -8.1 % of GDP, including discretionary budgetary measures of 3.8% of GDP in support of the economy and the operation of automatic stabilisers. Croatia also provided liquidity support to companies and households (such as guarantees and tax deferrals, which do not have a direct and immediate budgetary impact), estimated at 4.6% of GDP.
On 2 June 2021, the Commission issued a report under Article 126(3) TFEU. This report discusses the budgetary situation of Croatia, as its general government deficit in 2020 exceeded the 3% of GDP Treaty reference value, while its general government debt exceeded the 60% of GDP Treaty reference value and did not diminish at a satisfactory pace. The report concluded that the deficit criterion was not fulfilled and the debt criterion was not complied with. (8) The macroeconomic scenario underpinn ing the Convergence Programme’s budgetary projections is realistic in 2021 and favourable in 2022. Most notably, it projects somewhat stronger growth than the Commission’s spring forecast in 2021 (5.2% compared to 5%) and in particular in 2022 (6.6% compar ed to 6.1%). This is most notably due to the more positive projections of household consumption and investment, while the Commission’s forecast is slightly more optimistic on the contribution of exports. (9) In its 2021 Convergence Programme, the governme nt plans a decrease in the general government deficit from 7.4% of GDP in 2020 to 3.8% of GDP in 2021, while the debt ratio is planned to decrease to 86.6% of GDP in 2021. According to the programme, the change in the primary budget balance in 2021 compare d with the pre-crisis level (2019) is set to amount to -4.6% of GDP, reflecting the discretionary budgetary measures in support of the economy and the operation of automatic stabilisers. In comparison, the Commission’s 2021 spring forecast does not project the deficit to narrow as much in 2021 (4.6% of GDP). The differences are most pronounced on the revenue side, which the Convergence Programme projects to rebound well in excess of the nominal GDP growth rate. Meanwhile, reconstruction following the 2020 e arthquakes in Zagreb and Petrinja is expected to have an impact, although exceptional, on expenditure. (10) In response to the COVID-19 pandemic and related economic downturn, Croatia has adopted budgetary measures to strengthen the capacity of its health system, contain the pandemic and provide relief to those individuals and sectors that have been particularly affected. This forceful policy response has cushioned the contraction in GDP, which, in turn, curtailed the increase in government deficit and publ ic debt. Fiscal measures should maximise support to the recovery without pre-empting future fiscal trajectories. Therefore, measures should avoid creating a permanent burden on public finances. When Member States introduce permanent measures, they should p roperly fund them to ensure budgetary neutrality in the medium term. The measures taken by Croatia in 2020 and 2021 have been in line with the Council Recommendation of 20 July 2020. The discretionary measures adopted by the government in 2020 and 2021 are mostly temporary or matched by offsetting measures. Beyond the horizon of the Commission’s forecast, in 2023, the remaining impact of those non-temporary measures is preliminarily estimated at around 0 .3 % of GDP, mainly consisting of income tax cuts. (11) The 2021 Convergence Programme assumes investment and reforms financed by grants under the Recovery and Resilience Facility amounting to 0.4% of GDP in 2021, 1.9% in 2022, 2.4% in 2023, 2.3% in 2024, 1.7% in 2025 and 1% in 2026. The Commission’s spring fo recast includes these grants in its budgetary projections at a broadly similar pace in 2021 and 2022. (12) The established indicators of fiscal adjustment set out in Regulation (EC) No 1466/97 need to be considered in the context of the current circumstan ces. First, there is significant uncertainty surrounding output gap estimates. Second, there is a need for fiscal policy to stand ready to rapidly adapt to the evolution of the pandemic, shifting from emergency relief to more targeted measures once health risks diminish. Third, the current context is characterised by a significant policy response to support economic activity. In the presence of sizeable transfers from the EU budget (such as those from the Recovery and Resilience Facility), the established i ndicators do not capture the full impulse provided by fiscal policies to the economy. Against this background, the structural balance does not appear adequate in the current circumstances. The expenditure benchmark, in turn, needs to be adapted 9 and comple mented with additional information in order to fully gauge the fiscal policy orientation. First, similarly to the approach pursed in the assessment of the 2021 Draft Budgetary Plans, temporary emergency measures have been excluded from the expenditure aggregate. These crisis-related temporary emergency measures support health systems and compensate workers and firms for the losses in income due to lockdowns and supply chain disruptions; their reversal by the public authorities is contingent on the return of the public health and economic situation to normality. Second, to assess the overall fiscal stance at the current juncture, the sizeable transfers from the EU budget (such as those from the Recovery and Resilience Facility) should be included in the relevant expenditure aggregate. Therefore, the fiscal stance is then measured by the change in primary expenditure (net of discretionary revenue measures and excluding crisis-related temporary emergency measures) including expenditure financed by grants under the Recovery and Resilience Facility and other EU funds. Going beyond the overall fiscal stance, the analysis also aims at assessing whether national fiscal policy is prudent and its composition is conducive to a sustainable recovery consistent with the green and digital transitions. For that reason, particular attention is paid to the evolution of nationally financed primary current expenditure and investment. (13) In its 2021 Convergence Programme , Croatia’s general government deficit is planned to de crease to 2 .6 % of GDP in 2022, mainly due to strong revenue growth and a discontinuation of the temporary support measures adopted in 2020 and 2021. The general government debt ratio is planned to decrease to 82 .5 % of GDP in 2022. The Commission’s 2021 spr ing forecast projects a higher deficit and debt ratio in 2022, at 3.2% of GDP and 82.9% of GDP, respectively, the difference being largely due to the base effect from 2021. Based on the Commission’s forecast, overall fiscal stance as defined above – also i ncluding the impact on aggregate demand in 2022 from investment financed by both the national and the EU budgets, notably the Recovery and Resilience Facility – is estimated at - 2.4 of GDP 10 . The positive contribution of expenditure financed by Recovery and Resilience Facility grants and other EU funds is projected to increase by 1.5 percentage points of GDP. N ationally financed investment is projected to provide an expansionary contribution of 0 .1 percentage points of GDP . 11 Nationally financed primary current expenditure (net of discretionary revenue measures) is projected to provide an expansionary contribution of 0.8 percentage points of GDP. (14) The quality of Member States’ budgetary measures appear particularly impo rtant. Fiscal structural reforms aimed at improving the composition of national budgets can support potential growth, create much-needed fiscal space and help ensuring fiscal sustainability over the longer term, including in view of climate change and heal th challenges. On the revenue side, the COVID-19 crisis has reinforced the importance of reforms for more efficient and fairer public revenue systems. On the expenditure side, it has made even more crucial to increase the level and quality of sustainable a nd growth-enhancing investments, consistent with serving the objectives of enhancing growth potential, economic and social resilience and the green and digital twin transition. The Recovery and Resilience Plans will allow to improve the composition of nati onal budgets. (15) According to the programme’s medium-term budgetary plans, the general government deficit is planned to decrease from 1 .9 % of GDP in 2023, to 1 .5 % of GDP in 2024. Based on the programme, the overall fiscal stance – also including the imp act on aggregate demand from investment financed by both the national and the EU budgets, notably the Recovery and Resilience Facility – is estimated at -0.1% of GDP in 2023 and 2024 on average . Expenditure financed by Recovery and Resilience Facility gran ts and other EU funds is projected to provide a contractionary contribution of 0.6 percentage points of GDP. Nationally financed investment is projected to provide a contractionary contribution of 0.1 percentage points of GDP. 12 Nationally financed primary current expenditure (net of discretionary revenue measures) is projected to provide an expansionary contribution of 0.6 percentage points of GDP. The current estimate of the 10-year average nominal potential growth is 3 1/4 % 13 . However, this estimate does not include the impact of the reforms that are part of the Recovery and Resilience Plan and can boost Croatia ’s potential growth. (16) The general government debt ratio is planned to decrease from 79.5% of GDP in 2023 to 76.8% of GDP in 2024. Croatia is c onsidered to face medium fiscal sustainability risks o ver the medium term, as per the latest debt sustainability analysis 14 . (17) In view of the currently still exceptionally high degree of uncertainty, the fiscal policy guidance should remain predominantly qualitative. More precise quantified guidance for the later years should be provided in 2022, if the degree of uncertainty has s ufficiently declined by then. The Council has assessed the 2021 Convergence Programme and the follow-up by Croatia to the Council Recommendation of 20 July 2020. HEREBY RECOMMENDS CROATIA TO:
1. In 2022, maintain a supportive fiscal stance, including the impulse provided by the Recovery and Resilience Facility, and preserve nationally financed investment. Keep the growth of nationally financed current expenditure under control . 2. When economic conditions allow, pursue a fiscal policy aimed at achieving p rudent medium-term fiscal positions and ensuring fiscal sustainability in the medium term. At the same time, enhance investment to boost growth potential 3. Pay particular attention to the composition of public finances, both on the revenue and expenditure sides of the budget, and to the quality of budgetary measures, to ensure a sustainable and inclusive recovery. Prioritise sustainable and growth-enhancing investment , notably supporting the green and digital transition . Give priority to fiscal structural reforms that will help provide financing for public policy priorities and contribute to the long-term sustainability of public finances, including by strengthening the coverage, adequacy, and sustainability of health and social protection systems for all. Done at Brussels, 2.6.2021 For the Council The President
(1) OJ L 209, 2.8.1997, p. 1.
(2) The clause, as set out in Articles 5(1), 6(3), 9(1) and 10(3) of Regulation (EC) 1466/97 and Articles 3(5) and 5(2) of Regulation (EC) 1467/97, facilitates the coordination of budgetary policies in times of severe economic downturn.
(3) Communication from the Commission to the Council on the activation of the general escape clause of the Stability and Growth Pact, Brussels, 20.3.2020, COM (2020) 123 final.
(4) Communication from the Commission on Annual Sustainable Growth Strategy 2021, Brussels, 17.9.2020, COM(2020) 575 final.
(5) Council Recommendation of 20 July 2020 on the National Reform Programme of Croatia and delivering a Council opinion on the 2020 Convergence Programme of Croatia , OJ C 282, 26.8.2020, p. 68
(6)
OJ
L57, 18.2.2021, p.17.
(7) Communication from th e Commission to the Council on one year since the outbreak of COVID-19: fiscal policy response, Brussels, 3.3.2021, COM(2021) 105 final.
(8) Communication from the Commission on Economic policy coordination in 2021: overcoming COVID-19, supporting the recove ry and modernising our economy, Brussels, 2.6.2021, COM(2021)500 final.
(9) In particular, the 4-year smoothing of investment used in the expenditure benchmark does not allow assessing properly the fiscal support to the recovery provided by nationally financ ed investments.
(10) A negative sign of the indicator corresponds to an excess of the primary expenditure growth compared with medium-term economic growth, which indicates an expansionary fiscal policy.
(11) Other nationally financed capital expenditure is proje cted to provide a neutral contribution.
(12) Other nationally financed capital expenditure is projected to provide an expansionary contribution of 0.2 percentage points of GDP.
(13) Estimated by the Commission, following the commonly agreed methodology.
(14)
See C
ommission Staff Working Document – Statistical Annex providing background data relevant for the assessment of the 2021 Stability and Convergence Programmes