TABLE OF CONTENTS

1........... Introduction.................................................................................................................... 3

1.1........ Preface........................................................................................................................... 3

1.2........ Context.......................................................................................................................... 3

1.3........ Relations between the EU and Croatia............................................................................ 3

2........... Political criteria............................................................................................................... 5

2.1........ Democracy and the rule of law........................................................................................ 5

2.2........ Human rights and the protection of minorities................................................................... 5

2.3........ Regional issues and international obligations..................................................................... 9

3........... Economic criteria.......................................................................................................... 17

3.1........ The existence of a functioning market economy.............................................................. 17

3.2........ The capacity to cope with competitive pressure and market forces within the Union........ 24

4........... Ability to assume the obligations of membership............................................................. 24

4.1........ Chapter 1: Free movement of goods............................................................................. 27

4.2........ Chapter 2: Freedom of movement for workers.............................................................. 28

4.3........ Chapter 3: Right of establishment and freedom to provide services................................. 29

4.4........ Chapter 4: Free movement of capital............................................................................. 30

4.5........ Chapter 5: Public procurement...................................................................................... 31

4.6........ Chapter 6: Company law.............................................................................................. 32

4.7........ Chapter 7: Intellectual property law............................................................................... 32

4.8........ Chapter 8: Competition policy....................................................................................... 33

4.9........ Chapter 9: Financial Services........................................................................................ 34

4.10...... Chapter 10: Information society and media.................................................................... 35

4.11...... Chapter 11: Agriculture and rural development.............................................................. 36

4.12...... Chapter 12: Food safety, veterinary and phytosanitary policy......................................... 37

4.13...... Chapter 13: Fisheries.................................................................................................... 38

4.14...... Chapter 14: Transport policy........................................................................................ 39

4.15...... Chapter 15: Energy....................................................................................................... 40

4.16...... Chapter 16: Taxation.................................................................................................... 41

4.17...... Chapter 17: Economic and Monetary policy.................................................................. 42

4.18...... Chapter 18: Statistics.................................................................................................... 42

4.19...... Chapter 19: Social policy and employment.................................................................... 43

4.20...... Chapter 20: Enterprise and industrial policy................................................................... 45

4.21...... Chapter 21: Trans European Networks......................................................................... 46

4.22...... Chapter 22: Regional policy and coordination of structural instruments........................... 47

4.23...... Chapter 23: Judiciary and fundamental rights................................................................. 48

4.24...... Chapter 24: Justice, freedom and security...................................................................... 56

4.25...... Chapter 25: Science and research................................................................................. 60

4.26...... Chapter 26: Education and culture................................................................................. 61

4.27...... Chapter 27: Environment.............................................................................................. 62

4.28...... Chapter 28: Consumer and health protection................................................................. 64

4.29...... Chapter 29: Customs Union.......................................................................................... 65

4.30...... Chapter 30: External relations....................................................................................... 66

4.31...... Chapter 31: Foreign, Security and Defence Policy......................................................... 67

4.32...... Chapter 32: Financial control........................................................................................ 68

4.33...... Chapter 33: Financial and budgetary provisions............................................................. 69

Statistical Annex......................................................................................................................... 71

1. Introduction 1.1. Preface

Since March 2002, the Commission has reported regularly to the Council and Parliament on the progress made by the countries of the Western Balkans region.

This report on progress made by Croatia on preparing for EU membership largely follows the same structure as in previous years. The report:

– briefly describes relations between Croatia and the Union;

– analyses the situation in Croatia in terms of the political criteria for membership;

– analyses the situation in Croatia on the basis of the economic criteria for membership;

– reviews Croatia's capacity to assume the obligations of membership, that is the acquis expressed in the Treaties, the secondary legislation and the policies of the Union.

This report covers the period from October 2010 to September 2011. Progress is measured on the basis of decisions taken, legislation adopted and measures implemented. As a rule, legislation or measures which are being prepared or awaiting parliamentary approval have not been taken into account. This approach ensures equal treatment across all reports and enables an objective assessment.

The report is based on information gathered and analysed by the Commission. Many sources have been used, including contributions from the government of Croatia, the EU Member States, European Parliament reports[1] and information from various international and non-governmental organisations.

The Commission has drawn detailed conclusions regarding Croatia in its separate communication on enlargement[2], based on the technical analysis contained in this report.

1.2. Context

The June 2004 European Council granted the status of candidate country to Croatia. Accession negotiations with Croatia were opened in October 2005 and closed in June 2011. The Stabilisation and Association Agreement between Croatia and the EU was signed in October 2001 and entered into force in February 2005.

1.3. Relations between the EU and Croatia

Croatia is participating in the Stabilisation and Association Process.

Following the closure of the remaining chapters, accession negotiations with Croatia were closed by a Ministerial Accession conference on 30 June 2011. The Commission has received a strong mandate to closely monitor Croatia's fulfilment of the commitments undertaken. Work on the finalisation of the Treaty of Accession with Croatia is about to be finished and should allow its signature before the end of the year, as provided for by the June 2011 European Council. At the same time as this report is published, the Commission will give its formal favourable Opinion on Croatia's accession, in line with Article 49 of the Treaty on European Union. After the European Parliament has given its consent, Council will take a decision on the admission of Croatia. After signature, the treaty will need to be ratified by the present Member States and Croatia, in line with their constitutional requirements. The target date for Croatia's accession to the EU, as agreed by Member States and included in the Accession Treaty, is 1 July 2013.

The political and economic dialogue between the EU and Croatia has continued. Political dialogue meetings were held in Brussels in April at ministerial level. Economic dialogue took place in a bilateral meeting with the Commission and Croatian senior officials in May. Moreover, the multilateral economic dialogue between the Commission, EU Member States and Candidate Countries in the context of the pre-accession fiscal surveillance continued, including a meeting at Ministerial level in May in Brussels. These meetings focused on the main challenges posed to Croatia by the Copenhagen political and economic criteria and reviewed the progress made towards fulfilling the Accession Partnership priorities.

Implementation of the Stabilisation and Association Agreement (SAA) improved markedly. Croatia brought its tax regime on coffee into line with its SAA obligations (see also Chapter 16 - Taxation) and complied with State aid rules in relation to the shipyards in difficulty. Croatia should also further reduce import tariffs for its agricultural sector to pave the way for integration into the EU internal market upon accession.

The EU is providing guidance to the authorities on reform priorities under the Accession Partnership. Progress on these reform priorities is encouraged and monitored by the SAA bodies. The SAA Council met in April 2011 and the SAA Committee in December 2010. Six sectoral sub-committee meetings have been held since November 2010. Based on the Accession Partnership, Croatia adopted its national programme for alignment with the acquis in February 2011.

Financial assistance is provided under the Instrument for Pre-accession Assistance (IPA). The 2011 IPA programmes totalled €156.5 million. This assistance is focused on institution-building and preparing for implementation of the EU's common agricultural policy and cohesion policy. In addition, Croatia continued to benefit from regional and horizontal programmes. Overall, Croatia has demonstrated a satisfactory functioning of the decentralised implementation system under IPA, although some delays were encountered in implementation. The institutional framework for the implementation of EU cohesion policy will build directly on the existing implementation structures of IPA. Follow-up audits on IPA conferral of management confirmed that internal control procedures are broadly satisfactory. The recommendations made have been or are being properly addressed. In order to prepare for the next phase of decentralisation of management powers, namely the waiver of the EU Delegation's ex ante controls for IPA by the date of accession, the country continued to implement roadmaps with indicative benchmarks.

EU financial support has been provided for the development of civil society under the Civil Society Facility. Croatia's participation in an increasing number of EU programmes (15) is also a valuable opportunity to put civil society dialogue into action.

Croatia participates in the following EU Programmes: 'Seventh Research Framework Programme'; 'Competitiveness and Innovation Framework Programme' (including 'Entrepreneurship and Innovation Programme', 'Information Communication Technologies Policy Support Programme' and 'Intelligent Energy Europe Programme'); 'Progress'; 'Culture'; 'Europe for Citizens'; 'Fiscalis 2013'; 'Customs 2013'; 'Civil Protection Financial Instrument'; 'MEDIA 2007'; 'Community action in the field of health'; 'Marco Polo II'; 'Civil Protection Mechanism', 'Life Long Learning, Youth in Action' and 'ISA - Programme on Interoperable Solutions for Public Administrations'.

2. Political criteria

This section examines the progress made by Croatia towards meeting the Copenhagen political criteria, which require stability of institutions guaranteeing democracy, the rule of law, human rights and respect for and protection of minorities. It also monitors regional cooperation, good neighbourly relations with enlargement countries and Member States, and compliance with international obligations, such as cooperation with the International Criminal Tribunal for the former Yugoslavia (ICTY).

2.1. Democracy and the rule of law

Parliament

Parliament continued to function in accordance with its constitutional role. However, there is scope for the Parliament to improve its scrutiny of the legislative process. In late October 2010, the Parliament adopted the legislation necessary for the implementation of the changes to the Constitution voted in July 2010.

Government

The government continued to function effectively. A cabinet reshuffle took place in December 2010.

Public administration

Progress can be reported in the field of public administration reform. The Ministry of Public Administration (MoPA) continued to implement the State Administration Reform Strategy (2008-2011). The Civil Service Human Resources Development Strategy (2010-2013) is being implemented and a new Code of Ethics was adopted regulating the role and responsibilities of the ethics units and commissioners within the state administration. The Civil Service Training Centre under MoPA organised continuous training of civil servants at all levels. A State School for Public Administration was established. However, it is not yet fully operational as the necessary human resources have not yet been provided. Amendments to the Civil Service Act were adopted in April 2011: MoPA's authority in the implementation of recruitment procedures has been broadened and civil servants' liability for minor and serious violation of official duties has been extended. In order to allow full application of the General Administrative Procedures Act (GAPA), the process of harmonising the relevant sectoral legislation has continued, with the majority of acts now adopted by the Croatian Parliament.

However, the legal framework for developing a merit-based professional civil service has still to be completed. The drafting of the law on salaries in the public sector, which is expected to cover the public service, state bodies and local and regional self-government, has been further delayed. Dismissal procedures need to be further developed. The administrative capacity of MoPA to implement and monitor the complex and demanding public administration reform still remains insufficient. Although new staff has been recruited across the entire administration to prepare for EU accession, persistent structural problems of turnover and retention were reported. High level political support has to be maintained for the successful implementation of the reform.

Measures have been taken to strengthen the position of the Ombudsman's Office including creation of a mechanism for improved follow-up of his recommendations. Greater attention should therefore be paid to the Ombudsman's recommendations to further enhance his role as an institutional counterweight defending the rights of citizens and combating maladministration.

Overall, progress can be reported in the area of public administration reform. Further efforts are needed in improving professionalism and ensuring efficient implementation of the relevant legal framework in order to build a modern, reliable, transparent and citizen-oriented public service.

Judicial system (see also Chapter 23 – Judiciary and fundamental rights)

Good progress was achieved in the area of the judiciary. Implementation of the judicial reform strategy and action plan has continued, with a large volume of legislation adopted. The Ministry of Justice underwent a major reorganisation with the aim of improving efficiency and making decision-making less politicised. However, Croatia needs to improve human resources planning, including for the long term needs of the judiciary, taking into account the impact of many on-going and planned reforms.

Numerous measures have been taken to strengthen the independence, accountability, impartiality and professionalism of the judiciary, in particular through the implementation of amendments to the Constitution in July 2010 and further amendments to the relevant legislation. As regards independence of the judiciary, Croatia has reformed and strengthened the State Judicial Council (SJC) and State Prosecutorial Council (SPC). Other measures have been taken to allow these bodies to function professionally, impartially and without political or other interference. A new system for recruiting and appointing judges and state prosecutors has been established. Systems for the professional evaluation of judges and prosecutors have been introduced to improve career management. As regards accountability of the judiciary, legal changes adopted in May 2011 provide for improvements in the disciplinary system for judicial officials. There has been some progress as regards the impartiality of the judiciary, with the SJC becoming responsible for the system of assets declarations of judges.

Croatia needs to continue to build up a track record that demonstrates the recruitment and appointment of judicial officials based on merit. The SJC and SPC should also pro-actively apply the improved disciplinary rules and procedures that have been put in place in an efficient, objective and transparent manner. The systematic and accurate checking of judicial officials' declarations of assets also needs to be assured.

Croatia has taken and implemented various measures leading to improved efficiency of the judiciary. The merger of courts as part of the court rationalisation process is enabling more efficient allocation of resources for handling case backlogs. A number of measures were adopted to improve the system of enforcement. Croatia has made progress with the physical infrastructure and computerisation of courts. Between December 2009 and December 2010, the overall number of pending cases before the courts fell from 795,722 to 785,561 cases (-1.3%) and to 781,323 by 31 March 2011 (-1.8%). The backlog of old criminal cases was reduced by 10.6%. However, the backlog of old civil cases increased by 3.8%. The number of pending enforcement cases, including old enforcement cases, increased in 2010 and showed a slight decline in the first quarter of 2011.

Croatia has continued to improve the handling of domestic war crimes cases. A new strategy on impunity was adopted. Priority cases are being identified at the national and regional level. Approximately two dozen trials were on-going in 2010, similar to the situation in 2009. A more balanced approach to trials has continued. Measures have been taken to protect witnesses with improved witness support services at certain courts. Croatia has continued to implement its action plan for the review of in absentia cases. Revised legislation has made the four specialised war crimes chambers competent for all new cases, and also facilitates the use in Croatian court cases of evidence collected by the ICTY.

The issue of impunity for war crimes needs to be thoroughly addressed in Croatia, especially where victims were ethnic Serbs or where alleged perpetrators were members of the Croatian security forces. The majority of crimes have not been pursued in court. Implementation of the new Strategy on impunity will be key, as well as the systematic and effective use of the specialised war crimes chambers.

Overall, Croatia has made good progress regarding judicial reform. The adoption of new legislation further strengthened judicial independence and the overall case backlog was further reduced. Some challenges remain, especially relating to the further increase of judicial efficiency, and to the practical implementation of new measures relating to independence, impartiality and accountability of the judiciary, especially in terms of judicial appointments as well as disciplinary matters. Croatia has continued to improve the handling of domestic war crimes cases. The issue of impunity needs to be thoroughly addressed.

Anti-corruption policy (see also Chapter 23 – Judiciary and fundamental rights)

Good progress can be reported in the prevention of corruption. Croatia has taken a number of measures to strengthen the legal and institutional framework. Measures are being implemented in accordance with Croatia's anti-corruption action plan. Croatia has increased transparency and integrity in its public administration and state owned companies. Amendments to the law on access to information were adopted, which introduce clearer procedures and deadlines for information requests and supervision of the implementation of the law by the Data Protection Agency. Croatia adopted a new law on the financing of political activities and election campaigns, which improves transparency and independent oversight and increases the penalties for non compliance with the law. Changes to the Conflict of Interest Act provide for the depolitisation of appointments to supervisory boards of state-owned companies, as well as of the membership of the conflict of interest commission itself. Sanctions in cases of conflict of interest have also been strengthened. Measures were taken to raise awareness of potential conflicts of interest, in particular at the local level. Amendments to the Labour Act have enhanced protection for whistleblowers.

Further progress is needed to implement the newly adopted legislation in practice. The implementing structures still have to be further strengthened. Given the recent adoption of the law on access to information, particular vigilance is required in terms of its effective implementation. Further strengthening of the State Electoral Commission, which is in charge of the supervision and control of the regular financing of political parties and of election campaigns, is required in order to ensure full and effective implementation of the new legislation. Effective implementation of the legislation on conflict of interest should be ensured, including more proactive checking of declarations of assets, application of dissuasive sanctions in case of irregularities and greater awareness of conflicts of interest in practice.

As regards the fight against corruption, the operational capacity of the Office for the Fight against Corruption and Organised Crime (USKOK) has been reinforced and the Police National Office for the Suppression of Corruption and Organised Crime (PNUSOK) is now fully staffed. Interagency cooperation has improved, including through the implementation of memoranda of understanding, which has contributed to improved financial expertise. The new Police Act was adopted in March 2011 which aimed at making the police a more professional service and introducing some depoliticising measures. There are a number of mid and high-level corruption cases which are currently being investigated or where indictments have been issued, including against a former Prime Minister. There have also been court rulings in higher level cases, including in cases involving a former Deputy Prime Minister as well as a former Minister of Defence.

However, for most high level corruption and public procurement cases the proceedings are still on-going and they have not yet reached the stage of court rulings. The track record of effective handling of organised crime and corruption cases needs to continue to be built up, especially in respect of high level corruption, local level corruption and including cases related to public procurement and the judiciary.

Overall, substantial progress can be reported in the field of anti-corruption, especially as the law enforcement bodies are addressing the widespread corruption in Croatia. The track record of effective handling of organised crime and corruption cases needs to be further developed, especially in relation to high level corruption, local level corruption and including cases related to public procurement and the judiciary. Further experience is needed in implementing the newly adopted preventive legal framework in practice and the implementing structures remain to be further strengthened.

2.2. Human rights and the protection of minorities (see also chapter 23 - Judiciary & fundamental rights)

Observance of international human rights law

Overall, Croatia continued to observe international human rights law.

During the reporting period, the European Court of Human Rights (ECtHR) delivered 22 judgments finding that Croatia had violated rights guaranteed by the European Convention on Human Rights (ECHR). A total of 987 new applications were allocated to ECtHR decision bodies since October 2010. In September 2011, a total of 1,726 allocated applications regarding Croatia were pending before the ECtHR. Cases continued to mainly concern the length of proceedings claims, under Article 6 of the Convention. Most of those cases were concluded by an amicable settlement between the government and applicants. The Court also found violations of Article 8 (right to respect for private and family life), Article 46 (binding force and execution of judgements) and article 14 (prohibition of discrimination) in conjunction with article 9 (right to freedom of thought, conscience and religion). In the case of the disappearance of a person of Serbian ethnicity taken by the Croatian police to the premises of a local police station in late 1991, the Court found a violation of Article 2 of the ECHR (right to life).

As regards promotion and enforcement of human rights, Croatia has continued to take various steps to raise public awareness and improve the protection of human rights. Measures to raise awareness of police, prosecutors and courts about human rights law are ongoing. However, enforcement of rights requires continued attention, including in terms of judicial efficiency and access to justice.

Civil and political rights

With regard to prevention of torture and ill-treatment, the Croatian Ombudsman continued to receive complaints about police treatment of citizens including excessive use of force. Under the new Law on Police transparent procedures for establishing police responsibility and regulating police activities will be put in place. Implementation of this law will depend on the secondary legislation which has yet to be adopted.

As regards the issue of impunity, there is progress to report in the domestic handling of war crimes cases. However, the issue of impunity for war crimes needs to be thoroughly addressed. The majority of crimes have not been pursued in court (see under Judicial system above).

With regard to the prison system, work related to the expansion of existing detention and treatment facilities has continued and will be finalised in 2012. In the meantime, problems of overcrowding and inadequate health protection persist.

As regards access to justice, there is progress to report with the amendment of implementing legislation that will simplify procedures for legal aid. Legislation was amended in July 2011, following revocation of provisions of the law by the Constitutional Court. Applications forms have been made more user friendly and fees for lawyers to take on legal aid cases have increased. A further review of legal aid procedures is ongoing with the aim of reducing bureaucracy. The approval rate of legal aid applications is increasing.

Freedom of expression, including freedom and pluralism of the media, is provided for in Croatian law and is generally respected. A new Media Law provides for greater transparency in media ownership. There has been limited progress with investigating cases from previous years of intimidation of journalists working on cases of corruption and organised crime. Few new cases have been reported, however. Economic pressures in particular are hampering the development of investigative reporting. Problems with political interference at local level remain. The public broadcaster HRT continued to face serious difficulties in spite of having selected a new supervisory board and programme council, which has been unable to appoint a new director general.

With regard to freedom of assembly and association, the overall situation continued to be satisfactory but requires continued attention, including in terms of the handling of demonstrations by the authorities, to prevent violent incidents such as those occurred during the Gay Pride demonstration in Split.

Civil society organisations (CSOs) are playing an important role for the promotion and protection of human rights, democracy and minorities. An umbrella network of 15 NGOs has been very active in monitoring and reporting on the state of affairs regarding justice and fundamental rights. However, in particular at the local level, the analytical and financial capacities of CSOs, for monitoring political developments and government decisions continue to be weak. CSOs tend to remain excluded from the policy-making process. Despite the legislation on access to information, CSOs report continuing difficulties in obtaining public documents. Greater efforts are needed to ensure the independence and sustainability of CSOs.

There have been no particular problems with exercising the freedom of thought, conscience and religion. The ECtHR has ruled that Croatia violated article 14 in conjunction with article 9 of the ECHR in one case filed by three religious communities in 2007, concerning religious education in public schools and nurseries and state recognition of religious marriages.

Overall, civil and political rights continue to be generally well respected in Croatia. Croatia has made progress in the area of civil and political rights. There are some remaining shortcomings around impunity for war crimes, access to justice and freedom of expression.

Economic and social rights (see also Chapter 19 – Social policy and employment)

There has been some progress with women's rights and gender equality. Provisions on maternity and parental benefits were amended to bring them into line with EU gender equality provisions. The institutional mechanisms for gender equality at central and local government levels are developing. The Ombudsperson for Gender Equality continued to implement the Gender Equality Act. The office has received additional staff members. Legislation adopted in September foresees the merger of the Ombudsperson for Gender Equality with the Office of the Ombudsman.

The legislative framework against domestic violence is being implemented. The police continued to strengthen its capacity to act appropriately in cases of family violence. The work of social welfare centres has improved slightly. However, the protection of women against all forms of violence needs to be strengthened. The number of registered cases of domestic violence has decreased slightly. Victims of family violence continue to have insufficient access to information on their rights and entitlements.

There has been no significant change in the position of women on the labour market. The percentage of unemployed women remains high and wage differences due to gender persist. Fixed-term contracts for women on the labour market remain widespread. Women remain under-represented in economic and political decision-making bodies.

There has been limited progress with children's rights. The Ombudsperson for Children became more active in promoting and protecting children's rights. 2,409 new cases were dealt with in 2010, predominantly concerning family violence and violence against children. The Ombudsperson for Children has obtained sufficient office space and has developed regional offices in three counties. Legislation adopted in September foresees the merger of the Ombudsperson for Children with the Office of the Ombudsman. Cases of peer violence and violence against children in educational institutions continued to increase and are not being adequately addressed by the relevant authorities. There is still a lack of prevention programmes and of professional training for educators. Shortcomings in the judicial and social welfare systems continue to contribute to the poor enforcement of children's rights.

There has been some progress on advancing the social inclusion of socially vulnerable persons and/or persons with disabilities, notably through the adoption of a new Social Welfare Act. The capacity of the Office of the Ombudsman for Persons with Disabilities has been strengthened. Legislation adopted in September foresees the merger of the Ombudsman for Persons with Disabilities with the Office of the Ombudsman. There is a lack of information on social welfare, health care and pension insurance rights and entitlements. Application of criteria for the establishment of entitlements remains uneven. The legislation regulating specific rights is fragmented. A National Plan for de-institutionalisation and transformation of social welfare homes has been enacted. The transition from institutional care to community-based care services continues to be slow.

There is low public awareness of the rights of people with disabilities, especially in rural areas. Regulations ensuring physical access to public buildings for people with disabilities are not adequately enforced.

In general, children with developmental difficulties remain excluded from educational institutions. Support in the form of access, transport and teaching assistants remains insufficient. Discrimination against people with disabilities continues on the labour market. The quotas laid down in the Professional Rehabilitation and Employment Act for people with disabilities are not met by the public sector. Marginalisation is even greater in the private sector with employers lacking information, in particular on the incentives that are available.

People with mental health problems generally remain in psychiatric institutions which are not professionally regulated or adequately equipped. Assistance to enable a greater number of patients to stay with their families or live independently is lacking.

Croatia has begun developing a track record of implementing the Anti-Discrimination Law and legislation on hate crimes. Various steps have been taken to raise awareness of this legislation among both the public and law enforcement bodies. The Office of the Ombudsman, which plays a key role in implementing anti-discrimination legislation, is being reinforced. A new mechanism was introduced, giving responsibility to the Government Office of Human Rights to monitor follow-up by the administration of the Ombudsman's recommendations. Legislation adopted in September foresees the merger of the specialised Ombudspersons functions with the Office of the Ombudsman. Law enforcement bodies have started a number of cases under hate crime legislation.

The track record of implementing anti-discrimination and hate crime legislation needs to be further developed. Public awareness regarding the scope of the anti-discrimination law and proposed remedies has not increased significantly. There is still a small number of discrimination complaints, few of which have so far reached the courts. Lesbians, gays, bi-sexual and trans-gender people (LGBT) have continued to face threats and attacks, in particular during the gay pride event in Split, with limited follow-up by the authorities. More needs to be done to address homophobic and xenophobic sentiment in society. The process of merging the specialised Ombudspersons functions with the Office of the Ombudsman will need to be carefully managed to ensure a more effective system of human rights protection in practice.

With regard to labour and trade unions rights, the establishment of a specialised court for work-related disputes in Zagreb represents significant progress towards a more efficient resolve of labour conflicts. Following the renewed participation of trade union organisations, the Economic and Social Council has resumed its work after ten months. Strengthening social dialogue within the decision-making process and in policy design, as well as capacity-building of social partners, remain key issues to be addressed.

Property rights are generally protected. However, there remain some cases of delayed repossessions and problems with compensation for the use of private property confiscated under the war legislation from the 1990s.

Overall, legal protection for economic and social rights is widely guaranteed. Croatia has made some progress in the area of economic and social rights. However, implementation of women's and children's rights and protection against all forms of discrimination demand further attention.

Respect for and protection of minorities, cultural rights

There has been progress as regards the protection of minorities and cultural rights. The commitment to the rights of minorities, reaffirming their place in Croatian society, continues to be expressed at the highest level. Cooperation between the political representatives of minorities and the government remains good. The level of funding available for minority organisations has been decreased by only 1.25%, despite more extensive cuts elsewhere. Conditions for the effective implementation of the constitutional act on the rights of national minorities (CARNM) have improved. A plan for minority employment for the period 2011-2014 under the CARNM was adopted in May 2011. Financial support to the local Councils for National Minorities increased and training was provided for local authorities. Awareness of the extent of rights stemming from the CARNM has been raised among civil servants, law enforcement officials and minorities. The number of reported racist or xenophobic incidents has been fairly limited, in particular compared to previous years. Where incidents have occurred, the response at the political and law enforcement level has generally been adequate.

In July 2011 elections to the advisory minority councils took place in 187 counties and municipalities. Voter turn-out was very low.

Despite the ongoing effort to improve conditions for minorities, some persistent problems remain. The CARNM and minority action plans need to be implemented. Due largely to the general ban on recruitment in the civil service, there has been no tangible improvement in the level of employment of national minorities in public sector employment. Significant further strengthening of the monitoring of the employment action plan is required. Further work is needed in the area of schooling, including implementation of planned general human rights education and in particular a review of the role of schooling in reconciliation efforts through reviewing teaching material and the portrayal of minorities.

With regard to the Serb minority, reports of ethnically motivated attacks have decreased. However, cases of vandalism against monuments for war victims have continued. Police investigations into such incidents have improved, but few cases have ended in a prosecution. Many cases remain unreported due to lack of confidence in the authorities. Members of the Serb minority, both returnees and those who remained in Croatia during the war, face difficulties in gaining access to employment, especially in the war-affected areas. Cases of discrimination continue, particularly in the public sector at local level.

As for the Roma minority, there have been some further improvements in education, particularly in pre-school education. Improvements to the infrastructure of some Roma settlements have continued. However, the Roma still face discrimination, particularly regarding access to education, social protection, health, employment and adequate housing. Segregation persists in some schools. Progress towards ensuring that Roma children complete primary and secondary education has been modest. Extremely high unemployment persists, despite measures such as adult vocational training for young Roma women. There is scope for improved take-up by the Roma of measures in their favour. For many Roma there is the persistent problem of their unresolved status (residence and citizenship), which creates difficulties when it comes to the provision of services, notably access to education, health care and free legal aid.

There has been good progress on refugee return issues. Refugees continued to return to Croatia, with the Croatian authorities having registered over 132,872 returnees in total belonging to the Serb minority, which corresponds to approximately half of those who fled the country up until 1995. It is estimated that 54% of returnees have remained in Croatia. Progress was made with regard to housing issues. Housing care programmes for returnees are being implemented. A purchase option under favourable conditions for housing care beneficiaries and the possibility of new applications in areas not directly affected by the war have been introduced. Regional cooperation under the Sarajevo process has been reinvigorated. Croatia has implemented its Action Plan on the Housing Care Programme for returning refugees/former tenancy rights holders. It has met the target for 2008. The target for 2009 under the action plan for the provision of 2,070 flats has also been met. Croatia has strengthened the administrative capacity for handling rejected applications for housing reconstruction, principally by recruiting legal experts. The backlog of appeals has been reduced. Progress has been made in reconstructing the remaining properties. Implementation of the decision on validating pension rights has continued.

Croatia needs to make continued progress in providing accommodation to other successful applicants beyond the 2009 target. A plan was prepared in March 2011 setting out, inter alia, the financial requirements necessary to deal with the remaining 2,500 or so applications. Efforts to create the economic and social conditions necessary for sustainable returns of refugees need to be accelerated.

Overall, the position of minorities in Croatia is continuing to improve, although problems remain for the Serb and Roma minorities. Good progress was made on outstanding refugee return issues, but the efforts to provide housing and ensure the sustainability of returns need to continue.

2.3. Regional issues and international obligations

Compliance with the Dayton/Paris and Erdut Peace Agreements has been ensured overall.

Croatia continues to cooperate with the International Criminal Tribunal for the former Yugoslavia (ICTY). The government's inter-agency task force has explored important new avenues in its investigations aimed at locating or determining the fate of missing military documents requested by the Office of the ICTY Prosecutor. Croatia has been unable to fully account for the missing documents; its efforts should continue. The verdicts of the ICTY of 15 April 2011 against Croatian Generals Gotovina and Markač led to protests in the major Croatian cities. There have been a number of occasions in which public declarations in Croatia, including on a high political level, have not been conducive to the efforts to create a climate in Croatia more fertile for reconciliation and dealing with the legacy of the 1990s.

Croatia's policy regarding the International Criminal Court (ICC) is aligned with the EU's Common Positions on the integrity of the Rome Statute and related EU guiding principles.

Croatia continued to engage in cooperation on war crimes cases at the bilateral and regional levels. Good cooperation between judicial authorities, in particular prosecutors, continued. Although there are continuing problems with the extradition of own nationals in the region, practical steps have been taken to overcome them. Cases have been transferred between Croatia and Serbia so that both Croatia and Serbia have been able to pursue cases against their own citizens sought under war crimes charges originally brought in the other country. However, draft legislation proposed by the government in September 2011, if adopted by parliament, would complicate further cooperation with Serbia in this area. The first cases have been pursued under an agreement with Bosnia and Herzegovina whereby persons sentenced for war crimes in Croatia who fled to Bosnia and Herzegovina can serve their sentence there.

Significant progress was made with regard to the Sarajevo Declaration Process, launched through the Sarajevo Declaration of 31 January 2005. Bosnia and Herzegovina, Croatia, Montenegro and Serbia cooperate within this process to find solutions for refugees who were displaced as a result of the armed conflicts in ex-Yugoslavia between 1991 and 1995. Countries have continued to make progress on a number of outstanding issues such as data exchange, civil documentation, public information, pensions and trust fund mechanisms, in the framework of the established regional working groups. Following the meetings of June and September 2011, Bosnia and Herzegovina, Croatia, Montenegro and Serbia agreed on a number of issues, including on the text of a joint declaration to be signed at a ministerial conference in November 2011 in Belgrade. A regional multi-year programme aimed at addressing the needs of the most vulnerable refugees, has also been agreed, together with a donors' conference to be held in the first half of 2012 in Sarajevo.

As regards missing persons, as of September 2011, there were still approximately 14,000 people missing from the conflicts in the region. Of these, some 10,000 were related to the conflict in Bosnia and Herzegovina, 2,000 to the conflict in Croatia and over 1,800 to the conflict in Kosovo. Positive developments were noted in relation to the process of resolving the cases of missing persons in Croatia. During this reporting period, around 40 cases were solved, some 35 bodies were exhumed from these gravesites and other such exhumations were announced which could result in resolving over 300 cases. However, there still a large number of unidentified human remains in the morgues. A comprehensive process to review these cases needs to be carried out so as to enable identification and closure. Solving the remaining missing cases in an expeditious manner is important for the reconciliation process in the region.

Regional cooperation and good neighbourly relations form an essential part of Croatia's process of moving towards the European Union. In July, the Croatian government adopted and transmitted to Parliament for adoption a declaration on promoting European values in Southeast Europe stating a firm commitment from Croatia that bilateral issues, such as border issues, must not obstruct the accession of candidate countries to the EU from the beginning of the accession process until the Accession Treaty comes into effect.

Croatia continued to participate actively in regional initiatives, including the EU Strategy for the Danube Region, the South-East European Cooperation Process (SEECP), the Regional Cooperation Council (RCC), the Central European Free Trade Agreement (CEFTA), the Energy Community Treaty and the European Common Aviation Area Agreement. In March, within the framework of the SEECP, Croatia endorsed the Regional Strategic Document and Action Plan on Justice and Home Affairs 2011-2013. Croatia continues to actively support the Igman initiative on reconciliation, which brings together NGOs from Bosnia and Herzegovina, Croatia, Serbia and Montenegro, and the RECOM initiative.

Bilateral relations with other enlargement countries and neighbouring EU Member States are continuing to improve.

Croatia continues to have good relations with Albania and the former Yugoslav Republic of Macedonia.

Relations with Bosnia and Herzegovina intensified. President Josipovic and PM Kosor adopted a joint statement on Croatia's support for Bosnia and Herzogovina's European integration. The Presidency of Bosnia and Herzegovina visited Croatia in January 2011. Croatia and Bosnia and Herzegovina signed an agreement on police cooperation in combating cross-border crime which provides for the exchange of information on investigations and the appointment of police liaison officers. However, limited progress was achieved regarding the outstanding issues (border demarcation, the use of the port of Ploce, refugee return, property relations, dual citizenship). The inter-state Commission for Borders continued to meet but failed to agree on the outstanding border demarcation issues. Two agreements linked to the Sava river were signed. A readmission agreement with a shorter procedure, which replaced the previous agreement from 2002, was signed. The first meeting of a joint working group was held in April 2011 in Sarajevo to discuss the revision of the Local Border Traffic Agreement and the Agreement on free transit through the port of Ploce and the coastal town of Neum in Bosnia and Herzegovina.

Croatia continues to have good relations with Montenegro. Croatia and Montenegro signed an agreement on the extradition of citizens sentenced for corruption and organised crime. A number of technical meetings have been held to prepare the joint submission of the Prevlaka border delimitation to the ICJ, but no substantial progress has been achieved to date. The temporary agreement on Prevlaka continues to function smoothly, but achieving a permanent solution is necessary.

Relations with Serbia have further improved. The respective visits of the Presidents of Serbia and Croatia opened a new page in Croatian-Serbian relations. However, the issue of investigation and prosecution of war crimes against citizens of the other country have periodically burdened bilateral relations. There have been no tangible results with regard to border demarcation concerning the Danube. The Serbian government's counter-suit against Croatia before the International Court of Justice on genocide allegations remains pending.

Relations with Kosovo[3] have been further developed. Visits took place at different levels, including at the level of Prime Minister and Foreign Minister. Croatia and Kosovo signed agreements on cooperation regarding European integration and road transport.

Relations with Turkey continue to be good and high-level meetings between the two countries were held.

Croatia continues to have good relations with neighbouring EU Member States Hungary and Italy.

Relations with Slovenia have improved further. The Arbitration Agreement on the border entered into force on 29 November 2010 and was jointly submitted for registration with the Secretariat of the UN on 25 May 2011. Concerning the Ljubljanska Banka/SFRY Succession Agreement (guarantee of foreign currency deposits), Croatia agreed to continue negotiations on the issue at the Bank of International Settlements in Basel. Croatia and Slovenia have agreed on a solution for the future exchange of fishing rights in coastal waters.

Overall, Croatia is continuing to cooperate with the ICTY as well as to play an active part in regional cooperation. At the same time, political leaders should avoid statements and measures that could call into question the importance of reconciliation and the need to serve justice through the prosecution of war crimes. Relations with neighbouring countries have improved, although outstanding issues in particular settlement of border disputes, property issues and return of refugees remain to be solved.

3. Economic criteria

In examining economic developments in Croatia, the Commission's approach was guided by the conclusions of the European Council in Copenhagen in June 1993, which stated that membership of the Union requires the existence of a functioning market economy and the capacity to cope with competitive pressure and market forces within the Union.

3.1. The existence of a functioning market economy

Economic policy essentials

Croatia is participating in the EU pre-accession fiscal surveillance procedure. The Pre-accession Economic Programme (PEP) for 2011-2013, submitted in January 2011, presented a sufficiently comprehensive and consistent macroeconomic and fiscal framework for economic policies. Progress was achieved in some of the main areas of the 'Economic Recovery Programme', a package of fiscal measures and comprehensive structural reforms launched in April 2010. Overall, consensus on the fundamentals of a market economy was maintained, but efforts need to be intensified to implement the necessary structural reforms.

Macroeconomic stability

The global financial and economic crisis caused a protracted recession in Croatia which continued through the first quarter of 2011. In 2010 as a whole, real GDP declined by 1.2% after a 6.0% contraction in 2009. GDP per capita in purchasing power terms fell from 65% of the EU-27 average in 2009 to 61% in 2010. Investment continued to fall at a double-digit rate (-11.3%) while the decline in private consumption diminished markedly (by -0.9% compared with -8.5%). Public consumption also declined (-0.8%) in contrast to a small increase in 2009 (0.2%). In the context of the economic recovery in the EU and in other export markets, export volumes increased by 6.0% in 2010 following the sharp contraction in the preceding year (-17.3%). The decline in import volumes, however, continued, albeit at a much slower speed (-1.3% in 2010 against -20.4% in 2009). The contribution by net exports to real GDP growth remained at 3.0%. The mild decline in economic activity continued throughout the winter of 2010/11 and output was 0.8% lower, year on year, in the first quarter of 2011. Available data indicate a slight upturn of economic activity in the second quarter. GDP was 0.8% higher year on year according to the preliminary estimate. Industrial production started to trend upward and its volume level was 0.9% higher year on year in July. Retail sales have increased consistently on a year-on-year basis since April and were 0.9% higher in July. Exports of goods were 6.3% higher in nominal terms in April-July compared to the corresponding period in 2010. Physical indicators of tourism have increased significantly in the first seven months of 2011 compared to the previous year. Overall, economic recovery had not yet taken hold in early spring 2011, but there are indications that economic activity has started to increase since April.

The government launched the Economic Recovery Programme in April 2010, when the economy was not yet recovering from the recession and fiscal trends were more unfavourable than expected. Apart from some fiscal measures which were quickly adopted, the programme is a package of structural reforms seeking to address the structural weaknesses of the economy and create an environment encouraging sustainable economic growth. It encompasses basically all existing strategy papers and development documents and provides a new basis for economic policy in the country. The programme includes 131 measures in ten areas to be implemented over ten years. Among other things, it aims at reducing the number of public-sector employees, privatising State-owned enterprises and cutting non-tax fees, but it also includes a vast number of measures in other fields such as labour market policy, education and science policy, social security, export and investment promotion, government asset management, environmental protection, etc. Progress has been made on implementing the planned structural reforms in some of the main areas like pension laws, unemployment benefits, civil service employment and non-tax fees. But fundamental structural reforms have not been achieved so far. Overall, the measures which have been taken under the Economic Recovery Programme so far have not contributed decisively to improving the growth potential and international competitiveness of the economy.

The current account deficit narrowed to 1.2% of GDP in 2010 from 5.3% in 2009 continuing a cyclical trend which started with the onset of the recession. As in the preceding year, it was again driven by an improving balance of trade in goods. Imports of goods and services declined, but at a much slower rate than in 2009. At the same time, the trade balance benefited from a turnaround to growth in exports, as the recovery took hold in major foreign markets. As a consequence, the trade deficit in goods fell from 16.2% of GDP in 2009 to 12.9% in 2010. The trade surplus for services (mainly tourism and transport) increased slightly from 12.6% of GDP in 2009 to 12.8% in 2010. The deficit on income and transfer payments fell from 1.7% of GDP in 2009 to 1.2% in 2010. The improvement in the current account was sustained in the first quarter of 2011 as continued subdued domestic demand prevented imports from rising more markedly. Overall, the current account deficit has been narrowing, mainly as a result of subdued demand for imported goods, but also thanks to rising exports.

Net capital inflows receded in 2010 as a corollary of the declining current account deficit. Excluding changes in international reserves, they fell from 9.6% of GDP in 2009 to 3.3% in 2009. More than half of this decline is accounted for by a sharp fall in inward foreign direct investment (FDI). FDI fell to 0.9% of GDP in 2010 from 4.6% in 2009. After net FDI flows had financed only half of the current account deficit in 2009, they covered close to 100% of the much smaller deficit in 2010 despite dropping sharply. The total stock of FDI in Croatia stood at €24.5 billion (around 53% of GDP) at the end of 2010, about 1 percentage point higher than at the end of 2009. Overall, in the context of a declining current account deficit, sufficient external financing was secured by net FDI inflows.

The heavy external debt burden continued to increase in 2010. The stock of gross external debt went up by €1.2 billion to €46.5 billion, which amounts to 102.6% of GDP.[4] The general government increased its foreign debt by around €0.8 billion in the course of 2010 to €6 billion which is equivalent to about 13% of Croatia's gross external debt. The fact that the non-tradable sector accounts for around 40% of gross foreign debt remains a cause for particular concern. Overall, the high and growing level of external debt and the relatively large exposure of the non-tradable sector to currency risks remain key external vulnerabilities of the Croatian economy.

On the labour market the average annual unemployment rate increased from 9.1% in 2009 to 11.8% in 2010 according to the labour force survey. The rising trend of unemployment continued into 2011. In the first quarter the unemployment rate rose to 14.3% which is 3.1 percentage points higher, year on year. The registered unemployment rate was 0.4 percentage points higher in July 2011 than a year earlier, but this year-on-year increase has declined from 2% last winter. Annual average employment was 4.0% lower in 2010 after a 1.8% decline in 2009. The Croatian labour market continues to suffer from major structural weaknesses, such as low employment and participation rates along with high rates of youth and long-term unemployment. In 2010 the employment and participation rates declined to 54.1% and 61.5% respectively, while youth unemployment surged to 34.4% from 25.1% in 2009. The effective retirement age remained low as there are transitional arrangements on equalising pensionable age. Significant labour supply disincentives persisted. Employment has been negatively affected by Croatia's limited progress on effectively implementing the objective of the Economic Recovery Programme to make the labour market more dynamic and by the lack of incentives structures and the combination of flexibility and security on the labour market. As a result, labour turnover remained low, suggesting limited reallocation of labour resources. Wage movements reflected the weakening of the labour market to some extent. Average gross wages increased by 1.1% year on year in the first half of 2011 in nominal terms and were 1.2% lower in real terms. Overall, the labour market situation continued to deteriorate. Major structural weaknesses persist in the labour market (see also Chapter 19).

Monetary policy continued to be directed towards a tightly managed kuna/euro exchange rate with little variability, but without a formal peg to the euro. This monetary policy framework anchors inflation expectations and reduces exchange rate-related credit risks in a highly euroised economy. In spite of a slight downward trend of the kuna against the euro, monetary policy was able to maintain an accommodating stance in persisting recessionary conditions. As an additional incentive to bank lending, the central bank released €850 million worth of additional euro liquidity into the banking system in early March 2011 by lowering the minimum reserve requirement on banks' foreign exchange liabilities from 20% to 17%. In the foreign exchange market the kuna depreciated 2.9% against the euro between the beginning of October 2010 and mid-September 2011, viz. from 7.30 to 7.52 kuna per euro. The central bank intervened on four occasions to counter depreciation pressures, twice in November 2010, once in July 2011 and once in September 2011, selling a total of €770 million. Nevertheless, overall foreign exchange operations increased gross international reserves from €11,154 million at the end of September 2010 to €11,233 million at the end of July 2011 which is equivalent to around seven months of imports of goods and services. Overall, the central bank maintained an accommodating monetary policy stance in the context of subdued economic activity, while maintaining exchange rate and financial stability.

Following a slight contraction in 2009 domestic credit to the private sector increased by 6.9% in 2010 (or 3.6% excluding exchange rate effects primarily arising from the sharp appreciation of the Swiss franc). This credit expansion was roughly maintained in the first five months of 2011 with an annualised increase of 6.6%. It was exclusively driven by bank lending to the corporate sector which expanded by 9.6% in the course of 2010 and accelerated to an annualised rate of 11.8% in the first five months of 2011. By contrast, lending to private households (adjusted for exchange rate effects) fell by 1.4% in 2010 and this decline continued into 2011. Bank credit to general government increased by 13.8% in the course of 2010 and accelerated to 27.0% in the first five months of 2011. The government's programme to stimulate corporate financing via the State Development Bank (HBOR) had only a limited impact on bank lending. Overall, credit to private households has contracted slightly, lending to the corporate sector has recovered moderately, and the structure of credit has continued shifting towards government financing.

Average annual inflation fell from 2.4% in 2009 to 1.1% in 2010, continuing the trend from the preceding year. The disinflationary process was driven primarily by the growing slack in use of resources transmitted to price- and wage-setting. Since late 2010, however, disinflation has been replaced by a mild upturn in inflation. Higher energy and food prices pushed up headline inflation from 1.2% in November to 2.0% in August. Higher commodity prices have spilled over into areas like transport and, particularly, processed food. Consequently, the central bank's measure of core inflation increased from -0.2% year on year last November to 1.8% in May. Overall, the recession-induced decline in inflation has been followed by a mild upturn stemming mainly from rising commodity prices.

Public finances worsened again in 2010 mainly as a consequence of the continuing recession. A budget revision in August 2010 lowered projected general government revenue by 4.5% of GDP and increased expenditure by 0.3% of GDP compared with the original budget. The projection for the general government deficit in 2010 was raised by 1.9 percentage points to 5.2% of GDP compared with a deficit of 4.1% of GDP in 2009. The preliminary outturn shows a lower than planned deficit of 4.9% of GDP. This has only been made possible by keeping public investment expenditure some 0.5 percentage points of GDP below budget appropriations. The stock of general government consolidated gross debt increased significantly from 35.2% of GDP at the end of 2009 to 41.2% at the end of 2010. Adding outstanding State guarantees and the debt of the State Development Bank (HBOR), the level of public debt totalled 57.1% of GDP at the end of 2010. The 2011 budget is based on the assumption of 1.5% real GDP growth and 2.1% inflation in 2011. Revenue is projected to decline by 0.8% in nominal terms compared with 2010. This is primarily a consequence of the phased repeal of the special crisis tax on salaries, pensions and other receivables which had been imposed in mid-2009. Another reason is last year's change in income tax rates and tax brackets which lowered annual revenue by an estimated 0.3% of GDP. Expenditure is budgeted to stay at the same level in nominal terms in accordance with a decision adopted by parliament in August 2010. The overall deficit is projected at 5.5% of GDP. According to the Ministry of Finance, the deficit equalled 2.6% of annual GDP in the first six months of 2011. In an ad hoc response to rising oil prices, the government reduced excise taxes on petrol and diesel fuel in March 2011, which will lower revenue by close to 0.1% of GDP on an annual basis. The contraction in output in the first quarter implies a risk of lower-than-projected economic growth and tax revenue and, therefore, a higher-than-projected deficit in the 2011 budget. Overall, the authorities made efforts on the expenditure side of the budget to contain the continuing rise of the fiscal deficit. Ensuring medium-term fiscal sustainability remains a key challenge.

Limited progress has been made on rationalisation of public spending. Some further health reforms have been adopted as a major step towards addressing the sector's financial difficulties. These include streamlining of the administration of the hospital network and of the supplementary health insurance system. Some cuts to privileged pensions have been adopted, but in general little progress has been made towards better targeting of social support in spite of the action announced in the Economic Recovery Programme. Overall, little progress has been made towards increasing the efficiency of public spending.

Strategy-based budget planning has improved with the adoption of a Fiscal Responsibility Law on 23 November 2010. This law, which came into force on 1 January 2011, aims to ensure medium- and long-term sustainability, transparency and discipline for public finances and applies to all general government bodies. It contains fiscal rules aiming to stabilise and reduce the ratio of public debt to GDP. They stipulate that total general government expenditure will be reduced by a minimum of 1% of GDP annually. Once the primary fiscal balance has been brought back to zero, it has to be kept in balance (or in surplus) in cyclically-adjusted terms. The fiscal rules have to be applied for the first time in the public budgets for 2012. The law also contains general provisions on financial control, including presentation of annual statements of fiscal accountability. Responsibility for enforcement of the law lies mainly with the Ministry of Finance, but in March 2011 the government established a Fiscal Policy Committee, consisting of non-governmental experts, to monitor implementation of the fiscal rules. Overall, the Fiscal Responsibility Law has improved strategy-based budget planning and can be used as an instrument to rein in the high budget deficit.

Implementation of a comprehensive treasury reform strategy has continued with a view to further improving expenditure management and budget control systems. In February 2011 the government adopted the Public Debt Management Strategy for 2011-2013. Its objectives are to stabilise the share of public debt to GDP, to extend the repayment period (currently averaging around five years), to introduce a currency risk protection clause especially for debt denominated in US dollars, to develop the domestic securities markets and to achieve a balanced distribution of public debt between foreign and domestic markets. Fiscal transparency remains a concern, due to the non-inclusion in the general government accounts of some quasi-fiscal operations (the State Development Bank and the Motorway Company) and a large number of municipalities. More progress is required to bring fiscal reporting closer into line with ESA95 standards. Further progress is also required on linking policy priorities to the budget planning process more effectively. Overall, analytical and institutional capacity on public finance has continued to improve, but strategy-based budget planning could be strengthened further.

Overall, the macroeconomic policy stance has, by and large, been appropriate to address the macro-economic challenges given the existing constraints. Monetary policy maintained exchange rate and financial stability while remaining appropriately accommodating in a context of subdued economic activity. Fiscal policy has, to some extent, contained the negative budgetary consequences of the continuing recession. To achieve medium-term fiscal sustainability, key challenges remaining are to improve the budgetary process further, to strengthen fiscal discipline and to enhance the efficiency of public spending.

Interplay of market forces

The private sector's share of employment has remained at around 70% and its share of GDP is also estimated at around 70%. Only limited progress was made with privatisation of publicly-held assets. In the period between 15 September 2010 and 30 June 2011 a total of 83 companies were privatised, including through bankruptcy and winding-up procedures. The proceeds of the sales were relatively modest (about €11 million) since many of the companies were liquidated in the process. The remaining portfolio comprises 693 companies, with the State holding majority ownership of 92 of them. The portfolio's nominal value was set at around €7.7 billion at the end of June 2011, up by about 3% since mid-September 2010. Since the remaining holdings consist predominantly of highly indebted and often loss-making companies, finding strategic partners is a lengthy process, requiring several stages prior to declaring bankruptcy or liquidation. As regards the shipbuilding sector, which generates revenue equivalent to about 2.5% of GDP, restructuring and privatisation continued (See also Chapter 8). In December 2010 parliament adopted a Law on State property management which created the Government Asset Management Agency by merging the Croatian Privatisation Fund with the Central Administrative Office for State Property Management. This consolidation should allow better management of all State property and easier access to State property for potential investors by allowing new sales models. Overall, very limited progress has been made towards reducing the large role of the State in the economy.

Market entry and exit

The legal framework for companies entering and leaving the market was improved by the adoption of a number of laws (on forfeiture, litigation procedures, bankruptcy and court registering). Preliminary data indicate that the number of newly registered companies declined by 8.6% in 2010, year on year, and the total number of registered businesses declined by 1.9%. A bill on regulatory impact assessment has been enacted by parliament in July 2011. A regulatory impact assessment strategy has been drafted and three pilot projects are under way. The investment climate still suffers from difficulties in obtaining the necessary licences, building permits and other authorisations, as well as from the unpredictability of administrative decisions, in particular at local level. A large number of non-tax fees at national and local levels still burden entrepreneurs although they have been reduced, on average, by about 25% as part of the Economic Recovery Programme. Overall, further progress has been made on simplifying company registration, but the investment climate continues to suffer from a heavy regulatory burden, unpredictability of administrative decisions and numerous non-tax fees.

Legal system

Further progress was made in speeding up court procedures. However, the length of proceedings before the courts remains generally excessive and problems persist with enforcement of court decisions. The weaknesses of the judicial system continue to undermine effective enforcement of creditor and property rights. Land registration has improved, but remains incomplete in parts of the country. Investors still suffer from lengthy procedures to register property. Corruption is being tackled more vigorously but is still affecting the business environment, which also continues to suffer from inefficiencies in the public administration. Foreign direct investment is held back by the various shortcomings in the business environment. Overall, the judicial system has been improved, although enforcement of property rights is still weak. Improving the business environment should remain a priority in the accession process.

Financial sector development

The financial sector continued to be dominated by banks, which held 75.3% of the total assets of financial intermediaries at the end of 2010. The foreign-owned banks had a market share (i.e. share of total banking assets) of 90.5%. The banking sector is almost completely privatised with only two out of 32 banks remaining State-owned, together holding a combined market share of 4.2%. There were 23 small banks with market shares below 1%, three medium-sized banks with a share of between 1 and 5% and six large banks with market shares above 5%. The market share of the four largest banks remained practically unchanged and added up to 65.6% at the end of 2010. Market concentration has remained moderate and has generally not hindered market competition.

Banking sector assets increased by 5.2% in 2010 compared with only 2.7% in 2009. About half of the rise was due to increased lending to the private corporate sector and about one third stemmed from increased lending to the government sector. The rise in household lending was due solely to the rising value of the Swiss franc which increased the size of residential loans to the household sector. In terms of GDP, total bank lending rose from 75.8% at the end of 2009 to 81.3% at the end of 2010. Overall, the largely private and foreign-owned banking sector remained the dominant part of the financial sector as a whole, with a moderate degree of market concentration.

The banking sector remained well capitalised as a result of previous prudential and supervisory measures to address potential macro-financial vulnerabilities. The capital adequacy ratio remained high at 18.4% at the end of 2010, only slightly down from 19.2% in mid-2010. Subsequently it has climbed back up to 19.1% at the end of March 2011. The profitability of banks recovered somewhat in 2010 after the deterioration in the previous year. The return on average equity increased to 7.0% after having declined from 9.9% in 2008 to 6.4% in 2009. High provisioning costs continued to weigh on banks' profits. The share of non-performing loans continued to increase rapidly in 2010 reaching 11.2% at the end of the year, up from 7.8% at the end of 2009. In the course of the first quarter of 2011 it increased further to 11.5%. The main driving force behind this rise was the deteriorating quality of household loans against the background of deteriorating labour market conditions and the Swiss franc's appreciation against the kuna.[5] The upward trend in the share of non-performing loans continued into 2011 (11.5% as of 31 March 2011) as the banking system continued to face considerable interest- and currency-related credit risks since the majority of loans are based on variable interest rates and denominated in (or indexed to) foreign currencies, predominantly the euro. Developments affecting the stability of the financial sector have been kept under close watch by the central bank, which built up its institutional and analytical capacity to produce assessments of the stability of the sector. Overall, the banking sector remained relatively resilient to shocks, but significant risks are posed by largely unhedged liabilities of the non-financial private sector.

The share of non-banking financial sector assets in total financial sector assets remained largely unchanged in 2010 on 23.3% at the end of the year. The stock market index rose by 5.3% over the year 2010, following a gain of 16% in 2009, but was still about 60% below the peak in 2007. Market capitalisation of shares listed on the Zagreb stock exchange increased from 40.9% at the end of 2009 to 42.1% at the end of 2010. Market capitalisation of all listed bonds rose from 11.0% of GDP at the end of 2009 to 15.8% in the course of 2010, mainly due to the new domestic bonds issued by the Croatian government. Overall, notwithstanding the growth of some market segments, financial intermediation by the non-banking sector remained relatively modest. The stock market has only partially recovered from the heavy losses during the financial crisis.

3.2. The capacity to cope with competitive pressure and market forces within the Union

Existence of a functioning market economy

Croatia is a functioning market economy. The macro-economic policy stance to cope with the continuing recession has, by and large, been appropriate given the constraints on both fiscal and monetary policy. Prudent measures by the monetary authorities and efforts, albeit limited, to contain the fiscal deficit have helped to anchor the expectations of economic operators and supported market mechanisms.

Endowment with human and physical capital

Educational reforms have continued under the 2005-2010 development plan for the education system. Further steps were taken to improve the quality of education at all levels, including in the form of training of teachers. The process of referencing the Croatian Qualifications Framework to the European Qualification Framework is ongoing. Higher education has been further aligned with the principles of the Bologna process, although tertiary education generally continues to suffer from inefficiencies, poor governance and lack of funding. The ICT infrastructure is relatively well developed, with high internet and broadband penetration rates.

The government continued to implement labour market policies on the basis of the Economic Recovery Programme and the National Employment Promotion Plan. Measures include training and employment subsidies for young people without work experience, the long-term unemployed, older persons and vulnerable groups. Structural problems persisted on the labour market, as indicated by the high youth unemployment and low employment and participation rates. Overall, structural weaknesses in the labour market remain major challenges.

Investment continued to fall sharply in 2010, mainly due to a drop in construction activity. As a share of GDP, investment fell from 24.9% in 2009 to 21.6% in 2010. The decline in investment in processing and manufacturing industry has harmed the prospects for faster technological change, a more diversified production structure and higher export potential. Public investment slowed down a little, but remained significant, in particular in the motorway network. The largest share of cumulative FDI inflows (over the period 2003-2010) is accounted for by the financial sector (37%), followed by manufacturing (21%) and wholesale and retail trade (17%). The long-standing shortage of greenfield FDI continues. In October 2010 the government put forward a catalogue of 30 public-sector investment projects worth €13.85 billion. The projects should be carried out by public companies and local authorities in the areas of energy, tourism, water management and transport infrastructure. It remains unclear when work on these projects will begin, since the government has secured only a small amount of the financing needed. Overall, investment declined in the context of the recession and continued to concentrate on transport infrastructure and the services sector.

Sector and enterprise structure

Restructuring the shipyards in difficulty is a key priority in the accession process. The privatisation of the yards is in its final stage. One shipyard out of five reimbursed the State aid received since March 2006 and is no longer considered a shipyard in difficulty under State aid rules. Implementation of the National Restructuring Programme (NRP) for the steel sector was disrupted by the global economic crisis and is no longer needed. One of the steel mills is currently subject to a bankruptcy procedure. The private investor in the other steel mill has decided to reimburse the aid (See Chapter 8). There has been only limited progress on restructuring the State-owned railway company (staff reductions) and privatising its subsidiaries. The railways continue to receive high levels of budget support. Overall, although privatisation of the shipyards has proceeded, further efforts are now required to complete the process. Sustained efforts are required to complete the restructuring of the railways to secure their long-term viability and competitiveness.

The telecommunications industry was further liberalised. The Croatian Telecommunications Agency continued activities with the aim of stimulating competition by improving market access for new service-providers. This led to further price reductions and to a larger choice of tariff packages for customers. Liberalisation of the energy sector continued gradually and rules for the gas transport and distribution network have been enacted. However, gas and electricity markets remain dominated by single suppliers, preventing effective competition. The restructuring of the large electricity company has not advanced. Overall, despite further legal and regulatory adjustments, competition in network industries remains constrained by dominant incumbent suppliers.

The already dominant services sector increased its share of total gross value added from 68.2% in 2009 to 68.8% in 2010. The share of industry rose from 18.4% to 19.0% and the share of agriculture, forestry and fishing from 5.4% to 5.5%. These gains were made at the expense of construction whose share of total gross value added declined from 8.0% in 2009 to 6.7% in 2010. The share of construction in total employment decreased from 8.8% in 2009 to 7.5% in 2010 and the share of industry from 19.5% to 19.0%, whereas agriculture's share increased from 13.9% to 14.9%.

In the first three quarters of 2010, small and medium-sized enterprises (SMEs) accounted for 67.2% of total employment and 52.2% of total investment. SMEs generated 51% of gross profit and more than 45% of total exports. Except for gross profits, where their share declined, all their indicators improved compared with the previous year. The State Development Bank (HBOR) was further strengthened financially to enable it to increase lending to SMEs on more favourable terms. Still, the sector continued to suffer from the cumbersome regulatory framework and inefficiencies in public administration. Access to longer-term financing remained difficult, particularly for newly established businesses. Overall, the government continued to support the SME sector, whose relative share in the overall economy increased.

State influence on competitiveness

The Competition Agency has been given a stronger role in the antitrust and mergers field. Administrative capacity and enforcement of competition policy continued to improve. Public subsidies remained unchanged at the high level of 2.4% of GDP in 2010 and a large share still went to loss-making companies. Horizontal aid continued to account for only a small share of total subsidies, although it increased relative to sector-specific aid. Overall, State intervention in the enterprise sector remained substantial.

Economic integration with the EU

Croatia is an open economy with total trade in goods and services accounting for around 77% of GDP in 2010. Although this ratio is 2 percentage points higher than in 2009, it is still significantly below the level of 92% in 2008. Apart from exports of machinery and transport equipment (mainly ships), tourism remained the biggest source of export revenue, generating an unchanged 14% of GDP in 2010. The EU has continued to be Croatia's largest trading partner. Its shares of total Croatian exports and imports remained relatively stable in 2010 at 61% and 60% respectively. CEFTA countries accounted for 10.3% of all Croatian trade in 2010, slightly below their share in 2009. 94% of all FDI stocks stemmed from EU Member States. Overall, integration with the EU in the areas of trade and investment remained high.

The average real effective exchange rate deflated by consumer prices fell by 1.4%, year on year, in 2010, mainly due to the nominal depreciation of the kuna against a basket of currencies of major trading partners and partly to a smaller increase in domestic than in foreign consumer prices. However, the average real effective exchange rate deflated by producer prices increased slightly year on year (0.2%), despite the nominal effective depreciation. Using unit labour costs as the deflator, the kuna depreciated by 4.9% year on year in real effective terms in the first three quarters of 2010. Unit labour costs decreased due to the stronger fall in employment than in GDP and falling compensation per employee. Overall, standard indicators point, on balance, to some improvement in Croatia's international price competitiveness in 2010.

4. Ability to assume the obligations of membership

This section examines Croatia's ability to assume the obligations of membership – that is, the acquis as expressed in the Treaties, the secondary legislation and the policies of the Union. It also analyses Croatia's administrative capacity to implement the acquis. The analysis is structured in accordance with the list of 33 acquis chapters. In each sector, the Commission's assessment covers progress achieved during the reporting period, and summarises the country's overall level of preparation.

4.1. Chapter 1: Free movement of goods

Good progress can be reported towards alignment on general principles. Although Croatia has made headway in the implementation of its action plan for compliance with Articles 34 to 36 of the Treaty on the Functioning of the European Union (TFEU), reporting to the Commission needs to be improved.

In the area of horizontal measures, good progress can be reported. The human resources of the Internal Market Co-ordination Department of the Ministry of Economy, Labour and Entrepreneurship have been strengthened with two additional employees. A further revision of the Act on technical requirements for products and on conformity assessment is under preparation in order to align the Croatian legal framework fully with the new horizontal acquis.

As regards standardisation, good progress can also be reported. The Croatian Standards Institute (HZN) has transposed nearly all European standards. HZN was chosen as the notifying authority referred to in the Agreement on Technical Barriers to Trade (WTO/TBT).

In the field of conformity assessment, some progress can be reported in adopting the relevant ordinances on the CE marking and designation of conformity assessment bodies.

In the field of accreditation, there has also been good progress. The Croatian Accreditation Agency (HAA) has prepared all necessary documents required for the regular re-evaluation by the European co-operation for Accreditation (EA) which will be taking place during 2011. So far the HAA has accredited a total number of 247 conformity assessment bodies.

Alignment with the acquis in the area of metrology is advanced. Transferring responsibility for scientific metrology to the National Metrology Institute (NMI) is still the main outstanding issue in this field. The Statute of the Croatian Metrology Institute (HMI) was adopted in March 2011, but the Director has not been appointed yet.

Regarding market surveillance, there has been further progress with the State Inspectorate's administrative capacity and enforcement measures. Alignment in the field of market surveillance is advancing.

Overall, as regards horizontal measures, adequate structures for harmonisation with EU legislation are in place.

There has been good progress in relation to the 'Old Approach' product legislation, with a number of regulations being adopted. Further efforts are needed in order to achieve full alignment and implementation of the legislation, in particular in the fields of data exclusivity and absence of financial interest in the pharmaceutical industry by the employees of the Agency for medicinal products and medical devices; clinical trials for medicinal products for human use; good laboratory practice and aerosol dispensers.

Alignment with the 'New and Global Approach' product legislation is well on track. New or revised transpositions have been adopted in many product sectors (e.g. electromagnetic compatibility, explosive substances, machinery and safety of toys). However, further efforts are still needed, particularly on construction products, medical devices, pressure equipment, simple pressure vessels and gas appliances.

Some progress has been achieved on procedural measures, where alignment is advanced. The central contact point, established within the Ministry of Economy, Labour and Entrepreneurship to facilitate cooperation between the Ministry and other central State departments and operators, needs to be reinforced. Further efforts are still needed in order to transpose fully the acquis governing acquisition and possession of weapons.

Conclusion

Good progress has been made in the field of free movement of goods. Alignment with the acquis in this chapter is well advanced. However, further efforts are necessary, particularly on the remaining revisions of the horizontal legislation, as well as the 'New' and 'Old Approach' product legislation, in order for the national legislation to be fully in line with the acquis.

4.2. Chapter 2: Freedom of movement for workers

Croatia largely fulfils the acquis requirements on access to the labour market.

Continued progress can be reported towards future participation in the EURES (European Employment Services) network. The organisational structure of the Croatian Employment Service (CES) has been adjusted, its administrative capacity strengthened and its IT system adapted to connect to the European Job Mobility Portal upon accession. Various training activities for EURES advisers have been organised. The CES has opened two new Migrant Information Centres in cross-border regions and is intensifying their activities. In this area, preparations are nearing completion.

Good progress has continued in the area of coordination of social security systems. Further efforts have been made to strengthen the administrative capacity to apply the acquis in this field. The inter-institutional working group meets on a monthly basis. Croatia continues to participate as an observer in the preparations for the EESSI project (on electronic exchanges of data under the new EU regulations) and has taken the necessary technical decisions to be able to join the EESSI as from accession. Training is systematically provided to staff from the State administration. The required estimate of the additional financial costs of health care to be taken into account in the internal budgetary planning is still expected. Preparations in this area are well advanced.

Preparations continue for the introduction of the European health insurance card upon accession.

Conclusion

Continued progress has been made in the field of freedom of movement for workers, and preparations to apply the acquis are on track. Continued attention must be paid to the strengthening of administrative capacity with regard to the coordination of social security systems.

4.3. Chapter 3: Right of establishment and freedom to provide services

Some progress can be reported in the area of right of establishment and freedom to provide cross-border services. In particular, work on transposition of the Services Directive into national legislation is progressing according to the related Action Plan, although further efforts on the implementation of the Directive are still needed.

The preparation of a horizontal law transposing the main principles of the Services Directive is completed. The Services Act was adopted and entered into force in July 2011. The screening of national legislation is completed, although several legislative amendments on sector-specific legislation to the Services Directive are still pending. Preparations for the establishment of the Point of Single Contact (PSC) required by the Services Directive have been initiated.

The administrative capacity of institutions working on the implementation of the Services Directive and cooperation need constant upgrading and strengthening respectively. Most of the competent authorities have appointed delegated coordinators for services. As regards the administrative capacity of the Department for Internal Market Service Development, it is fully staffed in accordance with the current organisational structure of the Ministry of Economy, Labour and Entrepreneurship (MELE). The Department is making efforts to train its own personnel and the personnel of other relevant institutions working on services, in particular those of the Croatian Chamber of Economy, i.e. staff working on the PSC.

As regards the alignment of sector-specific legislation with Articles 49 and 56 TFEU (and with the Services Directive when relevant), some measures have been taken by Croatia. The Law on the Legal Profession has been amended, regulating in more detail the special responsibility of members of a company of attorneys when it is established as a limited liability company. The Amendments to the Law on the Legal Profession also redefine the article regulating cross-border provision of attorney's services. Those provisions apply as of the EU accession. However, several restrictions affecting the exercise of the legal profession for both established and cross-border lawyers remain in the final text adopted, such as requirements of legal form and the six-months and the one-office rules. The Law on Private Protection was also amended.

Some progress has been made as regards postal services, where legislative alignment with the acquis continues to be well advanced. Although the Croatian Parliament has ratified several international agreements in the area of postal services, further legislative efforts are still needed in order to complete alignment with the acquis, especially in relation to amendments introduced by the Third Postal Directive. Furthermore, there is a need for legal certainty as regards the application of the existing national legislation for the benefit of licensed postal services.

Based on its strategic framework, the Croatian Post, which is the designated universal service-provider, adopted a new business plan for 2011, aimed at preparing for full liberalisation of the postal services market. Administrative capacity, in terms of the number and qualifications of personnel, of the Postal Services Department within the Croatian Post and Electronic Communications Agency (HAKOM) is at satisfactory level. However, further training of HAKOM staff is necessary, in particular on very specific regulatory issues such as cost accounting separation and cost allocation.

Good progress has been observed in the field of mutual recognition of professional qualifications. Several Acts have been amended in order to align them with the acquis, including the Act on Regulated Professions and Recognition of Foreign Professional Qualifications, the Midwifery Act, the Nursery Act and the Legal Professions Act. Furthermore, considerable progress has been made with respect to training curricula, in particular by the University of Zagreb. However, other training programmes need further work. The Act on Architectural and Engineering Tasks requires further amendments.

Conclusion

Further progress has been made in this chapter, where, in general, alignment with the acquis is satisfactory. Continued work is needed in the area of mutual recognition of professional qualifications and on transposition of the Service Directive in order to reach full alignment. Continued strengthening of administrative capacity of the postal services regulator and all institutions implementing the Services Directive is required.

4.4. Chapter 4: Free movement of capital

Further progress has been made on the free movement of capital, where Croatia's legislation is already largely aligned with the acquis. Croatia liberalised deposit transactions by residents abroad as of January 2011. However, restrictions remain on acquisition of agricultural land and land in protected nature reserves by EU nationals, and on special government rights.

Good progress can be reported as regards payment systems. The new Payment Systems Act and implementing legislation entered into force in January 2011, with the exception of provisions regulating the functioning of the Croatian payment system as an EU Member State, which will apply as of accession. The new Electronic Money Act transposing the Electronic Money Directive (Directive 2009/110/EC) entered into force in January 2011. Relevant secondary legislation was adopted in March 2011.

Some progress can be reported on anti-money-laundering measures. Cooperation between the Croatian Financial Intelligence Unit (FIU) and reporting entities has been increased. Joint training activities with the reporting entities continued. (See also Chapter 24— Justice, freedom and security)

Conclusion

Further progress has been made in the field of free movement of capital as regards payment services, the liberalisation of capital movements and anti-money-laundering. Overall, legislative alignment is almost complete. Continued efforts are needed to complete liberalisation of capital movements and to further consolidate the enforcement of anti-money-laundering legislation.

4.5. Chapter 5: Public procurement

Some progress has been achieved as regards general principles. In July 2011 Croatia adopted the new Public Procurement Law (PPL) completing its alignment to the relevant acquis. Apart from the Act on the Maritime Domain and Seaports, all the necessary sector regulating acts in the area of concessions have been adopted.

With regard to administrative capacity, the Department for the Public Procurement System (DPPS) at the Ministry of Economy, Labour and Entrepreneurship (MELE) together with the other key institutions continued to efficiently implement the p