[pic] | COMMISSION OF THE EUROPEAN COMMUNITIES |

Brussels, 6.11.2007

SEC(2007) 1431

COMMISSION STAFF WORKING DOCUMENT

CROATIA 2007 PROGRESS REPORT accompanying the COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT AND THE COUNCIL Enlargement Strategy and Main Challenges 2007-2008

{COM(2007) 663 final}

TABLE OF CONTENTS

COMMISSION STAFF WORKING DOCUMENT Croatia 2007 Progress Report 5

1. Introduction 5

1.1. Preface 5

1.2. Context 5

1.3. Relations between the EU and Croatia 6

2. Political criteria 7

2.1. Democracy and the rule of law 7

2.2. Human rights and the protection of minorities 10

2.3. Regional issues and international obligations 15

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 21

4. ABILITY TO ASSUME THE OBLIGATIONS OF MEMBERSHIP 24

4.1. Chapter 1: Free movement of goods 24

4.2. Chapter 2: Freedom of movement for workers 26

4.3. Chapter 3: Right of establishment and freedom to provide services 27

4.4. Chapter 4: Free movement of capital 27

4.5. Chapter 5: Public procurement 28

4.6. Chapter 6: Company law 29

4.7. Chapter 7: Intellectual property law 30

4.8. Chapter 8: Competition policy 31

4.9. Chapter 9: Financial services 32

4.10. Chapter 10: Information society and media 33

4.11. Chapter 11: Agriculture 35

4.12. Chapter 12: Food safety, veterinary and phytosanitary policy 35

4.13. Chapter 13: Fisheries 37

4.14. Chapter 14 Transport policy 37

4.15. Chapter 15 - Energy 39

4.16. Chapter 16: Taxation 40

4.17. Chapter 17: Economic and monetary policy 41

4.18. Chapter 18: Statistics 42

4.19. Chapter 19: Employment and social policy 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 53

4.25. Chapter 25: Science and research 56

4.26. Chapter 26: Education and culture 57

4.27. Chapter 27: Environment 58

4.28. Chapter 28: Consumer and health protection 60

4.29. Chapter 29: Customs union 61

4.30. Chapter 30: External relations 62

4.31. Chapter 31: Foreign, security and defence policy 63

4.32. Chapter 32: Financial control 64

4.33. Chapter 33: Financial and budgetary provisions 65

STATISTICAL ANNEX 66

COMMISSION STAFF WORKING DOCUMENT

Croatia 2007 Progress Report

INTRODUCTION

Preface

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

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

- briefly describes the 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.

The period covered by this report is from 1 October 2006 to 3 October 2007. Progress is measured on the basis of decisions taken, legislation adopted and measures implemented. As a rule, legislation or measures which are under preparation or await parliamentary approval have not been taken into account. This approach ensures equal treatment across all reports and permits an objective assessment.

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

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

Context

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

Relations between the EU and Croatia

Accession negotiations with Croatia have continued. Following the conclusion of the screening process in October 2006, all 33 screening reports have been submitted by the Commission to the Council.

So far, negotiations have been opened on fourteen chapters (science and research, education and culture, economic and monetary policy, industrial policy, customs, intellectual property rights, services, company law, statistics, financial services, financial control, information society and media, consumer and health protection, as well as external relations) and provisionally closed on two (science and research, education and culture)

On ten chapters (public procurement; competition policy; justice, freedom and security; social policy/employment; capital; goods; agriculture; environment; food safety; regional policy) opening benchmarks were agreed by Council and communicated to Croatia. At this stage, the Commission considers only the opening benchmark on justice, freedom and security to be met.

The political and economic dialogue between the EU and Croatia has continued . Political dialogue meetings were held in Brussels in April at ministerial level and in June 2007 at senior official level. Economic dialogue meetings were held in Brussels in April at ministerial level and in July 2007 at senior official level. These meetings focused on the main challenges faced by Croatia under the Copenhagen political and economic criteria and reviewed progress being made towards fulfilment of Accession Partnership priorities.

Implementation of the Stabilisation and Association Agreement (SAA) has largely continued without major difficulty. The main exception is continued non- compliance with state aid provisions, in particular the need to present acceptable restructuring plans in the shipbuilding and steel sectors. Important efforts have been made to improve implementation of SAA provisions on access to real estate.

The EU provides guidance to the authorities on reform priorities through the Accession Partnership . Progress on these reform priorities is encouraged and monitored through the bodies of the SAA. The SAA Association Council met in April 2007 and the SAA Association Committee in December 2006. Seven sectoral sub-committees have been held since November 2006. Based on the Accession Partnership, Croatia adopted its national programme for EU accession in January 2007.

Financial assistance is provided under the new Instrument for Pre-accession Assistance (IPA) from 2007. The 2007-2009 Multi-Annual Indicative Planning Document (MIPD) for Croatia was adopted in June. The 2007 IPA national programme amounted to € 141 million. This assistance is concentrated on institution building and preparation for the implementation of the EU's common agricultural policy and cohesion policy. In addition, Croatia continued to benefit from regional and horizontal programmes. The management of pre-accession aid was decentralised to Croatian authorities in 2006, with ex-ante approval of files by the Commission. However, Croatia has exhibited in 2007 some important weaknesses in its implementation of EU assistance under DIS which requires urgent attention.

As regards financial support to civil society, a € 3 million grant scheme will be launched to support civil society projects in the following sectors: environment and sustainable development, democratisation and human rights and youth. In addition, a € 12 million contribution for cross border cooperation with Italy, Slovenia and Hungary will promote dialogue between local and regional authorities. Cross border cooperation will also continue under IPA and will be expanded to neighbouring countries.

Participation of Croatia in Community programmes is also an important tool to implement civil society dialogue.

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 respect for international obligations, such as cooperation with the UN International Criminal Tribunal for the former Yugoslavia.

Democracy and the rule of law

Parliament

The parliament has dealt with an increased volume of EU-related legislation over the past year. Parliament also adopted a number of laws addressing outstanding issues related to electoral legislation. In February 2007, the new Law on voters' registers introduced improvements in the maintenance of voter lists. These changes strengthen the legal basis for the proper conduct of elections. However, it is not yet ensured that data on permanent residence, which is the basis for registration in the voters' list, are correct. The current Law on permanent and temporary residence does not provide for an adequate checking and updating of residence records.

Members of the new State Election Commission (SEC) were sworn in March 2007 and the Commission is now operational. However, given difficulties finding adequate staff, a temporary solution was found, whereby the president and two vice-presidents of the Supreme Court were appointed to the SEC. A more permanent solution is needed to allow the Supreme Court to focus more fully on the functioning of the judiciary.

In December 2006, the parliament adopted a Law on the financing of political parties. This is an important step towards transparency and the fight against corruption. Proper implementation will be crucial, including with respect to financing of election campaigns and monitoring and adequate sanctions where breaches are found.

Government

There have been no changes in the structure of the government . With regard to local governance , there has been some progress in addressing weaknesses in the functioning of local government. Amendments to legislation concerning local and regional self government and the election of local officials were adopted in October 2007 with the aim of defining clearly the relations between directly elected prefects or mayors and local assemblies and addressing the issue of blank resignations of local councillors.

Public administration

Limited progress has been made on public administration reform. In January 2007, the government adopted a policy paper covering the underlying principles for the planned new Law on general administrative procedures (GAPA). A project (Hitrorez) aimed at simplifying or removing certain regulatory procedures has been launched. Four further implementing regulations for the Civil Service Law were adopted.

However, two of the thirteen regulations necessary for full implementation of the Civil Service Law remain to be adopted, despite this law being adopted in January 2006. There is still no overall comprehensive strategic framework for public administration reform, which continues to be implemented only in a piecemeal manner. Management and administrative capacity of institutions in charge of public administration reform, particularly the Central State Office for Administration (CSOA), remains weak.

Under the existing GAPA, there are numerous special administrative procedures regulated through sectoral legislation. The wide discretionary scope in legislation has lead to inefficiency and legal uncertainty and facilitates corruption. The Administrative Court is unable to cope with its present workload of reviewing administrative decisions. The European Court of Human Rights (ECtHR) ruled in late 2006 that there is no effective remedy for overly lengthy administrative procedures.

There has been some improvement in human resource management in state administration, notably through training and better centralised coordination and guidance. However, widespread weaknesses remain. In many state institutions there is still general resistance towards merit-based personnel policy and career planning. The civil service continues to be politicised. Policy implementation often remains in the hands of political advisors. Undue political influence, even in the recruitment of technical staff, continues.

Concerning the training of civil servants, the Civil Service Training Centre started to implement horizontal training programmes at the beginning of 2007. Sufficient funding was secured for training of civil servants in 2007. Overall, the civil service continues to suffer from high staff turnover and a lack of qualified personnel.

There have been no particular developments in the decentralisation process, which is important in the context of preparing local authorities for their responsibilities under the acquis . Police reform has continued. Further improvements are needed, however, especially in terms of career management and the development of a professional, citizen-oriented service.

The allocation of funds for the Ombudsman has been increased. However, the Ombudsman's office still lacks adequate premises and its work continues to be limited by a lack of funding and personnel. In particular, it is difficult to ensure a presence outside Zagreb. The Ombudsman for Children and the Gender Equality Ombudsman have also encountered similar difficulties.

Overall, limited progress has been achieved in the area of public administration reform. It continues to represent a major challenge for Croatia. A clear political commitment and sustained and serious efforts are needed.

Civilian oversight of the security forces

Reform of the security and intelligence system has continued. After much delay, a new head of the Council for civilian supervision of the intelligence services was appointed in July. Laws on data secrecy and on information security were adopted in July 2007, the former having first been withdrawn from parliamentary procedure and revised due to heavy criticism from NGOs. However, while both laws improve the legal framework, some shortcomings remain and the legitimate interest of the state to protect certain information and the right of the public to have access to it are not yet properly balanced.

The question of the intelligence services' conduct and scope of control was again raised when the Government dismissed the Head of the Government's Office for NGOs. Both the Head of the Government's Office for NGOs and the Security and Counter-Intelligence Agencymade procedural errors resulting in the violation of human rights of the person checked. The case highlighted shortcomings in the existing legal framework.

Overall, civilian control of the security services is generally assured. However, gaps in the existing legal framework need to be addressed to prevent inappropriate surveillance and security checks and to ensure adequate access to information for citizens.

Judicial system

Some progress has been made implementing the judicial reform strategy. Legislative and organisational steps have been taken to improve the functioning of the judiciary. Further progress has been made in reducing the case backlog. However, these improvements are as yet insufficient. Limited progress has been made on improving the accountability, impartiality professionalism and competence of the judiciary. The case backlog remains large. Limited progress has been made on the rationalisation of the court network.

With regard to domestic prosecutions for war crimes , Croatia continues to be active in trying war crimes cases on its own initiative, with around 20 ongoing trials. A more balanced approach seems to be slowly emerging. However, a common standard of criminal accountability is not being applied irrespective of ethnicity. There remains widespread impunity for war crimes committed against ethnic Serbs.

Despite some exceptions, there is a continued need to establish accountability for crimes committed by members of the Croatian armed forces. Many crimes remain unprosecuted, often due to a combination of a lack of evidence, unwillingness of witnesses to come forward and less than proactive approach of police and prosecutors.

A number of cases have thrown light on weaknesses in the system, most frequently concerning equality before the law. Procedural shortcomings and administrative confusion surrounding the lifting of one war crimes suspect's parliamentary immunity as well as the reaction to his hunger strike, underlined weaknesses in the institutional basis for the sound, politically impartial prosecution of war crimes in Croatia.

The confidentiality of witness statements and details of witnesses is not always maintained. As a result, there has been witness intimidation and the integrity of proceedings has been violated. To ensure integrity of the judicial process, protection should be extended beyond the trial period for witnesses and informants, as well as to other sources of information in the pre-trial or investigative phase. There continue to be difficulties with the provision of an adequate defence by court-appointed counsel. A mechanism to review the verdicts of in absentia trials which are based on poor evidence has not yet been established.

Overall, judicial reform is moving forward but considerable efforts are needed to overcome the weaknesses in the judicial system. The performance as regards war crimes' trials also needs further improvement in a number of areas. To ensure progress continues, continued close monitoring will be required.

(See also Chapter 23 - Judiciary and fundamental rights).

Anti-corruption policy

Some first results are appearing in the fight against corruption. The anti-corruption programme 2006-2008 is being implemented. The legal framework to combat corruption has been further improved. The Office for the Fight against Corruption and Organised Crime (USKOK) has become more active and become involved in the investigation of some important corruption cases. However, corruption remains widespread. There is a need for greater efforts to prevent, detect and prosecute corruption. No indictment or verdict has been issued in any high-level corruption case. The concept of conflict of interest is little understood. Implementation of the anti-corruption programme lacks strong coordination and efficient non-partisan monitoring.

(See also Chapter 23 - Judiciary and fundamental rights)

Human rights and the protection of minorities

Observance of international human rights law

The European Court of Human Rights (ECtHR) issued 31 judgements against Croatia. As in previous years, the majority of judgments are related to the violation of the right to a fair trial and the length of the proceedings under Article 6 of the European Convention for the Protection of Human Rights (ECHR).

In two cases of particular note, the ECtHR ruled that a delay of several years in returning private property allocated by the state to third persons during the armed conflict violated the owners' rights to property. The Court also found that the administrative and judicial remedies for repossession were not adequate.

As regards promotion and enforcement of human rights, measures have been taken by the authorities to raise awareness of various human rights issues in Croatia. However, enforcement of rights continues to be negatively affected by a poorly functioning judiciary. More efforts are needed to embody education of human rights in the school system.

Civil and Political Rights

As regards prevention of torture and ill-treatment and the fight against impunity , increasing public attention is being paid to questions of impunity for corruption and organised crime, including cases going back to the 1990s. Some steps have been taken to cooperate regionally on war crimes cases to tackle impunity caused by legal obstacles to extradition and the transfer of cases. Limited steps have been taken by the authorities to investigate and prosecute war crimes against Serb civilians. Concerns also remain about the right to a fair trial as regards war crimes, in particular given the continued presence of ethnic bias in cases and difficulties regarding witness protection.

Access to justice is still hampered by the lack of a comprehensive system of legal aid. It is also obstructed by high fees for legal services.

As regards the prison system , there continues to be room for improvement in prison conditions. There is a lack of prison staff and capacity. Overcrowding continues, with on average a prison population 20% above capacity. The ECtHR ruled in July in a case against Croatia that the plaintiff had been subject to inhuman and degrading treatment given the poor prison conditions and inadequate medical treatment he received.

Freedom of expression including freedom and pluralism of the media continue to be provided for in Croatia. Some progress has been made in following up the recommendations of the 2004 joint expert mission for changes to the laws on electronic media and on Croatian radio and television (See also Chapter 10- Information society and media) . Following a renewed public tender, parliament appointed the remaining four members of the State news agency HINA management board. However, the public broadcaster HRT continues to be subject to occasional political pressure, raising concerns about freedom of expression. There are possibilities for undue political influence on the media at the local level, with much of the media at this level in public hands.

There have been no major difficulties as regards freedom of assembly and association .

Civil society organisations continue to play an important role in the promotion and protection of human rights and democracy.

There have been no particular difficulties as regards the freedom of religion .

Overall, with some specific exceptions, civil and political rights are reasonably well respected in Croatia. However, shortcomings as regards impunity for war crimes, prison conditions and access to justice require further attention.

Economic and Social Rights

As regards gender equality and women's rights , the government has taken measures to raise general awareness as part of the national policy for the promotion of gender equality, of which implementation has begun. 33 of 150 members of parliament are women (22%). Four of fifteen Government ministers are women.

However, the gender equality policy needs more effective implementation. The Ombudsman for gender equality has pointed to an increase of complaints regarding family violence. While a working group has been established to draw up an action plan to tackle violence against women and police performance has improved especially in bigger cities, centres for social welfare have not made progress in dealing with family violence. Public awareness is rising but the judiciary is still slow in reacting, especially with regard to enforcing verdicts. An inefficient judicial system and labour inspection department remain important obstacles to exercising women's rights. The main problems women encounter in the labour market relate to child care and maternity care. These rights are guaranteed by law but are not consistently enforced. Further efforts are needed as regards human trafficking.

As regards children's rights, the national plan for the benefit of the rights and interests of the child 2006-2012 is being implemented. However, there has been little follow-up of cases of ill-treatment of children in institutions. Better coordination among homes, families and centres for social welfare is needed. The centres for social welfare often lack proactive staff to respond to the needs of children and to ensure their adequate protection.

There has been some progress as regards socially vulnerable and/ or persons with disabilities . In March 2007, Croatia signed the UN Convention on the rights of persons with disabilities. In June, a national strategy on equal opportunities for persons with disabilities was adopted. A pilot project to introduce a system of personal assistants to support persons with disabilities and their families is ongoing. Some advanced models of community services are also being piloted. However, continued efforts are needed in this field. Budgetary constraints also continue to limit the scope of their rights to health and special care and their social integration. Despite the government's de-institutionalisation policy, the number of persons with mental disabilities in institutions has not decreased in the past year. Community-based services are not sufficiently developed as an alternative to institutionalisation, and financial resources allocated to mental health care are scarce. The priorities set out in the joint inclusion memorandum signed in March 2007 need now to be effectively implemented.

There has been limited progress in the area of non-discrimination policies . A national strategy and action plan on preventing all forms of discrimination has not yet been adopted. The level of protection against discrimination in practice and its judicial prosecution is still not in line with EU standards. The existing anti-discrimination legislation is not being applied vigorously. Only four cases have been pursued under the hate crime provisions of the criminal code. Measures encouraging tolerance and reconciliation, especially among citizens of the region, should be pursued. A number of homophobic incidents were recorded. Support to the victims of discrimination is marginal.

With regard to labour and trade union's rights , there has been limited progress ( See also Chapter 19 – Social policy and employment ). Workers’ rights are still negatively affected by weak public administration and the poorly functioning judiciary.

The right to property is guaranteed. However, there are certain difficulties in exercising this right. The process of restitution of property that was confiscated after World War II continues to proceed slowly. Provisions discriminating on grounds of nationality have not been removed from the law on t he restitution of nationalised property. Weaknesses have also been highlighted both by the Ombudsman and the ECtHR in the compensation scheme for owners of property temporarily taken under legislation in force during the 1991-1995 war.

Overall, legal protection for economic and social rights is partially guaranteed. Implementation of women's and children's rights and protection against all forms of discrimination needs to be improved in practice.

Minority rights, cultural rights and protection of minorities

Some progress has been made with regard to the implementation of the Constitutional Law on national minorities (CLNM). The Central State Administration Office prepared for the first time a recruitment plan for minorities in the state administration. In 2007, it is planned to employ 286 minority members in the bodies of the state administration at the central level and 50 members at the regional level. In 2007, the State council for national minorities received around € 5 million from the state budget for national minority associations, up by 25% compared to 2006.

However, implementation of the CLNM's provisions in practice presents a mixed picture, some provisions are implemented well, others only to a limited extent. There is no overall action plan covering all bodies concerned by the CLNM to ensure its full implementation. Problems persist, particularly in terms of under-representation of minorities in state administration, the judiciary and the police. A long-term strategy to implement the CLNM's minority employment provisions is lacking. Detailed recruitment plans are missing at all levels of state administration. Some steps have been taken to collect data on ethnic affiliation. However, a civil servants' registry to allow for systematic statistics collection has still to be set up.

Elections for the local councils of national minorities (CNMs) were held in June 2007. The number of candidates increased considerably compared to the 2003 elections. However, voter turn-out was again very low. The government financed the organisation of the elections but made a limited effort to promote them. Moreover, the provisions of the CLNM were not respected in that the elections were called one month later than stipulated and for fewer councils than minorities are eligible to vote for. The capacity of the CNMs to advise local government in relation to minority issues – as provided for under the CLNM – goes unrecognised by the majority of local authorities and many local councils struggle to obtain premises and funding.

With regard to cultural rights , education provisions of the CLNM and other laws relevant to minorities are generally being implemented satisfactorily. With regard to the perception of national minorities in the media, negative stereotyping has decreased. However, there has been little progress with regard to the production and/or broadcasting of programmes for minorities in their languages by public radio and TV stations, as envisaged under the CLNM. Also, in many cases bi-lingual rights guaranteed in municipalities and towns where a minority constitutes at least one third of the population are not exercised. Initiatives promoting greater integration, reconciliation and tolerance as well as joint activities within the current system should be further encouraged.

With regard to the Serb minority , there have been mixed developments. Generally, the mood in the country continues to move forward, albeit slowly. There have been fewer reports of apparently ethnically motivated attacks against the Serb minority and the Orthodox Church.

However, there are still shortcomings in police investigation and limited prosecutions when such attacks occur. Members of the Serb minority, including those who remained in Croatia during the war, face major difficulties concerning access to employment, especially in the war affected areas. Discrimination continues particularly in the public sector. More efforts are needed to tackle ethnic bias with regard to war crimes.

There has been limited progress on the various outstanding issues regarding refugees . Around 3,500 refugees returned to Croatia over the past year. The total number of Croatian Serbs registered as returnees to Croatia increased to 130,000, although the estimated level of actual return could be less than 60% of this figure. Reconstruction of housing has continued. The programme to reconnect public infrastructure in certain return villages is ongoing without major difficulties. Mine clearance operations have continued.

However, a number of obstacles to sustainable return of Serb refugees remain, principal among them being housing, particularly for former tenancy rights holders. Implementation of the Croatian government's housing care programmes within and outside the areas of special state concern (ASSC) for the former tenancy rights holders who wish to return to Croatia continues to be extremely slow. Outside the ASSC, only around 2% of the 4,500 applications for accommodation have been definitively resolved, four years after the programme was launched. Processing of applications is subject to significant delay. Of 8,320 applications inside ASSC, some 3,736 (44%) families have been allocated an apartment, up just 6% from last year. Croatia has indicated that the current target date of 2011 for full implementation outside the areas of special state concern will be brought forward to 2009. However, political will and a concerted effort from responsible authorities is clearly needed if this deadline is not to be missed.

As regards reconstruction of housing, some 2,000 units were reconstructed leaving perhaps some 2,500 housing units still to be reconstructed. There remain over 10,000 outstanding appeals against negative eligibility decisions, many of which have been pending for four years. There has been almost no progress on the approximately 200 houses/flats that remain to be repossessed and handed over to their rightful owners. There is still no movement on occupied agricultural land. A repair programme covering some 400 houses which were damaged or looted prior to repossession is slowly getting underway. There is limited progress dealing with cases of claims for unsolicited investments in occupied properties. There is a backlog in paying compensation for delays in repossession of properties. Account will need to be taken of the recent ECtHR verdicts.

Apart from housing, other key concerns facing returnees are employment, enduring hostility in certain localities and "convalidation", or the validation of certain documents and rights, including pension rights, of those residing in the parts of Croatia not under Croatian government control during the 1990s. No substantive decision has been taken to settle this issue. Returnees also continue to face difficulties re-establishing their status of permanently residing foreigner.

The position of the Roma minority in Croatia is slowly improving and the administration is developing a more positive approach. Progress is being made on the pre-school education of Roma under the government’s action plan for the “Decade of Roma Inclusion 2005-2015”. Funding is also increasing.

However, overall implementation of the action plan needs to be speeded up. Funding is still not adequate to address the challenges of the action plan if real improvements in the Roma’s position are to be achieved. Most Roma remain excluded from mainstream Croatian society and face difficult living conditions. Only 25% of all Roma children complete primary education. Unemployment remains endemic. Discrimination of Roma continues, whether in terms of access to employment, adequate housing, in schooling, or in general attitudes in society. Many obstacles still exist, especially at grass roots level with various efforts aimed at desegregation often met by opposition from the parents of non-Roma children. No solution has yet been found to address the issue of lack of legal status of Roma without citizenship.

There is also a continued unwillingness or inability of some local authorities to finance Roma programmes. Coordination among Roma groups is weak and expertise for effective implementation lacking. The Roma community also needs to make a greater effort to participate in the programmes for education.

Overall, the position of minorities in Croatia continues to improve slowly. Legal provisions for protection of minority rights are in general adequate, but a number of important challenges remain in terms of implementation, especially as regards employment. Croatia also needs to encourage a spirit of tolerance towards the Serb and Roma minorities in particular and take appropriate measures to protect persons belonging to these minorities who may be subject to threats or acts of discrimination, hostility or violence. Progress on important outstanding refugee return issues has been limited. A more comprehensive policy addressing disadvantage and social exclusion is necessary.

Regional issues and international obligations

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

Croatia continues to cooperate with the International Criminal Tribunal for the former Yugoslavia (ICTY) . Some difficulties arose during the year in the preparations of one case before the ICTY, but these have been resolved. No particular developments took place on the freezing of assets of those indicted by ICTY; there are no Croatian residents on the current Council lists.

The trial in The Hague of Generals Čermak, Markač and Gotovina has been delayed following the disqualification of three defence attorneys for conflicts of interest. Croatia's requests to act as a "friend of the Court" were rejected by the ICTY. The trial against Rahim Ademi and Mirko Norac, the only war crimes case transferred from ICTY to Croatian jurisdiction, started at the Zagreb County Court in June 2007. The indictment was prepared in cooperation with the ICTY prosecution. Impartial prosecution of this case and other cases conducted in Croatia needs to be ensured.

Croatia has not concluded any bilateral immunity agreements granting exemptions from ICC jurisdiction and its policy regarding the International Criminal Court (ICC) is fully aligned with the EU Common Positions on the integrity of the Rome Statute as well as related EU guiding principles.

No decisive progress on implementation of the Sarajevo Declaration , aimed at finalising the return process by the end of 2006, has been achieved. The process remains blocked by the lack of political consensus between the signatories. Further efforts are urgently needed to resolve the outstanding issues, namely how to deal with compensation claims of those who lost occupancy and tenancy rights (OTRs) in Croatia, and recognition of pensions and other rights for years spent working in Serb-controlled areas of Croatia during the war.

Regional cooperation , a number of bilateral visits, agreements and continued engagement by Croatia in regional initiatives have contributed towards the aim of further improvement of relations between Croatia and its neighbours.

Croatia's chairmanship of the South East Europe Cooperation Process (SEECP) was successful, allowing good progress to be made in transition from the Stability Pact to a more regionally owned framework with a strengthened SEECP and the new Regional Cooperation Council. Croatia actively participates also in other regional initiatives as the Adriatic-Ionian Initiative (chairmanship since June 2007) and the Migration, Asylum and Refugees Regional Initiative - MARRI (presidency since April 2007). Croatia is a party to the Energy Community Treaty and a signatory of the Agreement on the European Common Aviation Area (ECAA). The expanded and modernised Central European Free Trade Agreement (CEFTA) has been ratified by Croatia.

However, in December 2006 the Croatian Parliament decided that the Croatian ecological and fishing protection zone would be applied to EU Member States as from 1 January 2008. This decision deviates from the political agreement reached between the countries concerned in June 2004, referred to in the European Council conclusions of 16-17 June 2004; this issue remains to be resolved. Efforts are needed to further develop regional cooperation and good neighbourly relations, which form an essential part of the process of moving towards the European Union.

The implementation of the succession Agreement on the former Socialist Federal Republic of Yugoslavia and efforts aimed at reconciliation among citizens in the region have been limited. Croatia has not seized the opportunity to benefit from a system of diagonal cumulation of origin with the EU and its neighbours in the region.

Bilateral relations with other enlargement countries and neighbouring member states continue to develop. However, there has been limited progress towards finding definitive solutions to various open bilateral issues between Croatia and its neighbours, particularly as regards borders.

Relations with Serbia have continued to improve. The provisional visa-free regime remains in force. The Croatian State Prosecutor and the Serbian War Crimes Prosecutor signed an agreement on cooperation on war crimes prosecution. There has been some progress in cooperation on missing persons. There has been no progress in delimiting the border at the Danube river. Other open matters include property related issues, in particular claims for compensation for lost occupancy and tenancy rights, refugee return, and Croatia’s claim for compensation for war damages.

Relations with Montenegro have been developing well. High level visits have taken place and diplomatic representations opened. Both sides have indicated a willingness to move towards resolution of outstanding issues. These concern primarily property, refugees and missing persons. Agreement on the border at Prevlaka is still outstanding, although the temporary border regime is running smoothly.

Bilateral relations with Bosnia and Herzegovina remain stable and bilateral contacts have been increasing. Bilateral agreements on dual citizenship and border control have been signed. Croatia has submitted a proposal for a new Agreement on the Port of Ploče. However, there has been no progress on border issues. Ratification of the 2005 Agreement on Demarcation of the Land and River Borders remains on hold and the dispute over Veliki Skoj and Mali Skoj remains unresolved, as does the issue of the Una river border. The Peljesac bridge project remains an open political issue. Other unresolved issues include property, refugees and trade.

Relations with Slovenia , while generally well developed, continue to be affected periodically by difficulties linked to outstanding border issues. Both sides have begun tentative discussions on various issues which had been stalled for some time, such as the maritime and land borders, Ljubljanska Banka/SFRY Succession Agreement (guarantee of foreign currency deposits), Krško nuclear power plant and the implementing rules for the fisheries aspects of the Border Traffic and Cooperation Agreement. The informal agreement between the Prime Ministers of Croatia and Slovenia to request third party involvement on open border issues constitutes progress and needs to be followed up. Further concrete steps towards reaching permanent solutions are still needed on all these issues. The issue of the non-application of the ecological and fishing protection zone in the Adriatic to EU Member States needs to be resolved.

Relations with Italy are good. Temporary disputes such as on different interpretations of World War II events are being settled in the spirit of good neighbourly relations. The issue of the non-application of the ecological and fishing protection zone in the Adriatic to EU Member States needs to be resolved.

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

ECONOMIC CRITERIA

In examining the 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.

The existence of a functioning market economy

Economic policy essentials

The country participates fully in the EU Pre-Accession Fiscal Surveillance procedure. The third Pre-accession Economic Programme 2007-2009, submitted in December 2006, presents a coherent fiscal framework and an ambitious agenda for structural reforms. If fully implemented, it would further improve the functioning of markets and support sustainable growth and real convergence. The programme with the International Monetary Fund (IMF) was successfully completed in November 2006 and the authorities did not request a successor arrangement. Cooperation with the World Bank remained an important anchor for structural reforms. However, economic policy coordination between various parts of the government was sometimes insufficient. The economic rationale of reforms has not always been communicated effectively to the general public. At times, the limited impact of existing economic expertise on government decision making reduced the scope and pace of structural reform, in particular prior to the 2007 general elections. Overall, consensus on the fundamentals of a market economy has been maintained, but the government has not taken full advantage of its economic expertise.

Macroeconomic stability

In 2006, real GDP growth accelerated to 4.8% year on year, up from 4.3% in 2005. Growth continued to be largely driven by strong domestic demand. Stronger private investment contributed to an acceleration of total real investment growth to 10.9%, up from 4.8% in 2005. Private consumption grew by around 3.5% in real terms. The growth of exports of goods and services accelerated to 6.9%, but was lower than the increase in imports (7.3%). Economic growth remained robust in 2007. Real GDP growth accelerated further to 6.8% in the first half and industrial production went up by 7% year on year in the first eight months of 2007. Overall, the economic performance remained strong, with real growth rates above potential growth.

Domestic demand and growth led to stronger imports and a slight widening of the trade deficit to 24.4% of GDP. As in previous years, this deficit was only partly offset by the surplus in the trade in services, mainly tourism, which was down slightly at 16.6% of GDP. Moreover, the balance of net factor income fell owing to strong increases in dividend and interest payments as well as higher retained earnings. Also, transfer payments to Croatia from abroad declined as a percentage of GDP. As a result, the current account deficit widened significantly from 6.4% of GDP in 2005 to 7.8% in 2006 and in the 12 months to June 2007, with no major changes in its composition. External deficits have continued to widen.

Net inflows of foreign direct investment (FDI) almost doubled as a percentage of GDP to 7.4% in 2006 and to 9.2% of GDP in the 12 months to June 2007. Thus, net FDI flows largely financed and recently even exceeded the current account deficit. Due to strong and persistent capital inflows, official foreign reserves increased to around € 9.2 billion, or by 6.5% year on year in July 2007. Gross external debt continued to grow, although at a slower pace, to EUR 30.4 billion in August 2007 or to around 83 of the GDP expected for 2007. At end-2006, the external debt to GDP ratio stood at 84.7%, up from 82.6% in 2005. In sum, capital inflows remained strong, and external debt continued to rise, albeit at a slower pace.

Employment growth accelerated markedly to 3.4% in 2006, up from 0.8% in 2005. Provisional data for 2007 point to a slowdown in employment growth, but subsequent upward revisions are likely. The officially registered unemployment rate showed a marked decline to 13.8% in August 2007, the lowest rate since end-1995, compared to 15.7% in August 2006. Labour force survey data recorded a fall in the unemployment rate to 10.5% in the second half of 2006, from 12.3% a year ago. It declined for all age groups, but still remained high for the young population (29%). The long-term unemployment rate decreased to 5.6% (2005: 6.7%). Overall, the labour market performance improved, but the relatively high unemployment rate and limited job turnover remained a concern.

A sound monetary policy framework of a “managed float” with the primary objective of maintaining price stability remained in place. The Central Bank continued to target broad stability in the kuna/ euro exchange rate without any commitment to a particular exchange rate level or band. A number of factors contributed to significant foreign exchange inflows and a persistently strong demand for kuna. Among those, continued foreign borrowing by banks and enterprises, a government bond issue, the take-over of a domestic company by a foreign investor and increases of capital in some foreign-owned banks played a major role. In an effort to alleviate persistent appreciation pressures, the central bank intervened several times on the foreign exchange market during 2006 as well as in July 2007 to purchase a net total of around EUR 1.3 billion from commercial banks. In 2006, the kuna appreciated by 0.5% against the euro in nominal terms, followed by a slight year-on-year depreciation of 0.8% in August 2007. Overall, exchange rate stabilisation has been successful and remains a key policy priority.

The central bank re-instated, and subsequently tightened, direct administrative credit controls in order to discourage foreign borrowing by commercial banks and to contain domestic credit growth. These took effect in early 2007, in addition to already adopted regulations which had been only partially effective in containing credit growth. Annual growth of broad money accelerated from 16.6% in September 2006 to 19% in August 2007. In the same period, annual domestic credit growth slowed somewhat from 22.4% to 18.7%. Recently, bank credit to households grew stronger then credit to enterprises, but the corporate sector continued to revert to direct external and non-bank sources of financing. Overall, in an attempt to contain credit growth, monetary policy also continued to rely on administrative measures, including additional credit control.

Average annual consumer price inflation declined slightly from to 3.3% in 2005 to 3.2% in 2006. Higher prices for agricultural goods led to an increase of year-on-year consumer price inflation from 2% in December 2006 to 2.6% in August 2007. Annual average inflation declined further to 2% in the first eight months of 2007. Lower price rises for energy, a stable exchange rate and increased competition in retail trade have contributed to price stability. Core inflation, which excludes agricultural products, energy and other administrative prices, dropped from 3.1% in 2005 to 2.5% in 2006 and slightly increased to 2.6% in annual average terms in the first eight months of 2007. Overall, price stability has been maintained.

In line with policy targets, the budget deficit[3] in 2006 was markedly reduced to 2.2% of GDP (3.9% in 2005). Total revenues rose 9% on the back of particularly strong growth in direct taxes, VAT and social contributions. Current spending (government consumption, subsidies and social transfers) rose by 7.1%, but its share of GDP fell by 1.4 percentage points to 44.8% of GDP. Capital spending as a share of GDP declined by 0.4 percentage points, albeit from the relatively high level of 4% of GDP in 2005. Strong economic performance contributed to favourable fiscal developments in the first half of 2007. Revenue growth exceeded expectations and accelerated to 13.1% year-on-year, with total spending growing by 6.8%[4]. A supplementary budget for 2007 with major revisions was adopted in July. It includes additional revenues of 2% of GDP, part of which is to be used to settle financial obligations, particularly in the health sector. The revision also allowed for an increase in current spending, including for education, subsidies, and social benefits. The deficit was reduced only slightly, to 1.6% of GDP, from the 1.8% planned in the original budget. There was a marked slowdown in the growth of general government debt and the debt ratio fell to 40.7% at the end of 2006 (from 43.7% in 2005). Overall, fiscal consolidation continued as planned, while recent levels of revenue above expectations have led to an expansion of current spending.

The rationalisation of public spending remained a key public finance objective. The government adopted a social welfare reform to streamline numerous benefits and achieve a better targeting of social assistance through the wider application of means-testing. However, a new population policy adopted in late 2006 partly contradicts these objectives. Initial reforms to the financing of health care, which were adopted in mid-2006, have so far not been complemented by more ambitious steps to fully address the sector's financial difficulties. Recent increases in pensions and the lowering of the early retirement "discount" partly reversed earlier important parametric reforms of which aimed at improving the financial sustainability of the "pay as you go" system. Important quasi-fiscal operations added uncertainties to the overall fiscal stance. These included debt repayments to pensioners, debt write-offs in the context of privatisations, state guarantees for restructuring companies and the operations of the State Development Bank. Public finances continued to be faced with significant risks, and ensuring lasting fiscal consolidation remains an important challenge.

Progress has been made in enhancing analytical capacity for setting up medium-term fiscal frameworks. Budget planning capacity and procedures have improved, with wider use being made of fiscal impact assessments. The link between strategic planning and the budget process remained generally weak. The reform of the treasury system continued, but a number of extra-budgetary funds still remain outside the single treasury account, undermining effective budget control. Although efforts have been made to reconcile fiscal statistics with ESA 95, local governments were still only partially included in fiscal reporting . Procedures for recording public debt have improved and become more transparent. However debt management continues to be beset by considerable operational shortcomings, weak segregation of duties and a significant key person risk. Overall, there has been a further strengthening of analytical and institutional capacity in some important areas of the Ministry of Finance.

Stabilisation of the high and rising external debt has remained an important policy target. The general orientation of macroeconomic policies has, on the whole, been appropriate to contain potential external vulnerabilities. Given the limited scope for monetary policy discretion under the circumstances of currency substitution, fiscal policy continued to play an important role in containing the savings-investment balances in the economy. So far the authorities have not taken advantage of the generally benign economic environment to pursue a more ambitious path of fiscal consolidation. However, there may be a strong argument for such consolidation as a way to reduce external risks, increase the flexibility of fiscal policy and make more room for greater private sector initiative. In sum, the macro-economic policy mix has generally been appropriate, but there is still scope for a more ambitious fiscal policy.

Interplay of market forces

The private sector’s share of output has continued to rise, to an estimated 70% of GDP. The private sector's share of total employment grew from 67.8% in 2005 to 68.8% in 2006. At the same time, state intervention and ownership remained significant in important industrial sectors, such as in the shipbuilding industry.

The State's 17% shareholding in the national oil company INA was successfully sold in late 2006. Recently, the government decided to sell a further 7% of shares to the company's former and current employees at a reduced price. More than half of the remaining government shares in the telecommunication company (32.5%) were sold off through public tendering at the end of September 2007. Up to September 2007, the State Privatisation Fund had sold a total of around 100 companies; however, the remaining portfolio still comprised around 880 companies, and the State had a majority holding in 100 of them. A major corruption investigation led to the dismissal of the Fund's management in June 2007 which affected the pace of privatisation. Overall, the privatisation process has been uneven and sometimes hampered by legal problems, institutional weaknesses and unrealistic conditions of sale.

Market entry and exit

Company registration procedures have been further simplified through the gradual establishment of additional one-stop shops throughout the country. The average time and number of procedures needed to set up a business, as well as average registration costs, have been reduced. New company registrations grew by 7% year on year in the first half of 2007 and the stock of active businesses increased by 7.4% year-on-year in June. Following earlier changes to the law, business exits benefited from more efficient and simplified bankruptcy procedures. Preparatory steps were taken to reduce the burden of legislation in the context of the "Regulatory Guillotine" project, however its implementation has not yet started. Procedures for obtaining licences and building permits remain cumbersome. Overall, there has been some progress in removing bureaucratic obstacles to market entry and exit, but significant administrative inefficiencies remain.

Legal system

Some progress was made in reducing the backlog of cases before Croatian courts. However, the backlog is still a large one and the judicial system has continued to suffer from slow and inefficient court proceedings, poor case management and low professional capacity. These circumstances may discourage economic actors from taking cases to court and undermine effective enforcement of creditor and property rights.

Financial sector development

The banking sector represented slightly more than three quarters of total financial sector assets in mid-2007. Some 96% of banks are privately owned and the share of foreign ownership remained high at 91%. In 2006, the number of banks fell by one to 33, which is still high in relation to the overall market size. The degree of market concentration remained moderate and generally has not been an impediment to market competition. The five largest banks together accounted for a market share of around 72% at the end of 2006, slightly down on 2005. The spread between average kuna lending and deposit rates fell by 1.2 percentage points during 2006 and an additional 0.4 points in the first seven months of 2007. Domestic private credit rose to 71.5% of GDP in 2006, up from 62.9% in 2005. The share of non-performing assets declined further to 3.2% in 2006 (from 4% in 2005), although this indicator may understate portfolio risks during periods of strong asset growth. The banking system still has to contend with foreign-exchange induced credit risks arising from un-hedged balances in the non-financial sector. Overall, the largely privately-owned banking sector remained generally sound, amid a rapid credit expansion.

The share of non-banking financial sector assets in total financial sector assets increased from 21.4% at end-2005 to 23.6% at end-2006 and above 26 % by mid-2007. This was primarily due to strong asset growth of investment funds, leasing companies and mandatory pension funds. The shares of other market segments (voluntary pension funds, saving cooperatives, housing savings banks, insurance) have not changed significantly. There has been a further increase in bond market capitalisation, which rose to around 17% of GDP by end-2006 (2005: 14.3%), owing to a large number of new emissions, primarily by the corporate sector. Stock market capitalisation rose markedly - to around 80% of GDP - at the end of 2006, but this was more a reflection of the big increases in share prices rather than of an expansion of the stock market. In general, equity and bond markets remained relatively shallow.

A number of measures have been taken to strengthen the supervision of the financial sector, in particular with a view to closer monitoring of currency-induced credit risk. Reserves for the fastest growing banks were also increased. Prudential regulation led to a stronger recapitalisation of banks, which has been conducive to financial sector stability in general.

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

Existence of a functioning market economy

Macroeconomic stability has been maintained and has allowed economic agents to make decisions in a climate of stability and predictability, thus supporting the functioning of market mechanisms. However, external imbalances and fiscal risks bring vulnerabilities, and private sector development has been rather slow.

Human and physical capital

Reforms in the education sector continued. Further steps were taken to improve the quality of education at all levels. Attempts were made to enhance the scope and quality of adult education, but participation rates in life long learning remained low, at 2.5% in 2006 (2005: 2.3%). The education sector generally still suffers from out-dated curricula and poor equipment. Students as a percentage of the population stayed low, at 3%, and only a small proportion of students are graduating in science and research. The government adopted an annual programme for employment promotion in 2007, which plans to continue the active labour market policy measures introduced in 2006. The programme includes training and employment subsidies for young people without work experience, the long-term unemployed, older persons and vulnerable groups. However, although there was a slight increase in employment and participation rates, the levels remained relatively low - at 56.6% and 63.5% respectively in the second half of 2006. Overall, the labour market continued to suffer from a mismatch between supply and demand.

Investments - driven in particular by stronger private investment - continued their strong growth in 2006 and early 2007, and the fixed investment ratio reached 30% of GDP in 2006 (2005: 28.6%). Total spending on research and development remained relatively high, at around 1% of GDP. Public investment in transport remained strong. It resulted in a further expansion of the extensive motorway network by some 100 km to over 900 km. However, the road network continued to suffer from a significant maintenance backlog. The core main lines of the rail network are sufficiently well maintained to allow a competitive freight transport business.

Net inflow of foreign direct investment (FDI) almost doubled as a percentage of GDP to 7.4% in 2006; this growth was mostly due to direct equity investments. The takeover of a pharmaceutical company, recapitalisation of some foreign-owned banks and the acquisition of two domestic banks contributed significantly to this. The financial sector accounts for the largest share of cumulative FDI inflows (31.1%), followed by manufacturing (27.2%), then post and telecommunications (13.5%). There has still been little greenfield investment, and private investments in the processing and manufacturing industry have remained relatively low, limiting technological change and export potential. To conclude, strong levels of investment continued to be largely concentrated in transport infrastructure and the services sector.

Sector and enterprise structure

Progress was made in the restructuring and privatisation of the two loss-making, state-owned steel mills and the aluminium company (TLM). Following repeated tendering procedures, the two steel mills were sold and an investor for TLM was chosen. In the area of shipbuilding, draft restructuring plans for each shipyard were submitted to the European Commission, but these – together with a national restructuring strategy for shipbuilding - have still to be finalised by the government. The privatisation of the first shipyard has been further delayed. The government's commitment to a comprehensive restructuring of the sector to ensure its long-term economic viability remained rather low. The remaining agricultural conglomerate subject to a tendering process, but has not yet been sold. Overall, progress with the restructuring and privatisation of large loss-making state-owned companies has been rather slow ( See also Chapter 20-Enterprise and industrial policy and Chapter 8- Competition) .

The restructuring of the large railway carrier by separating its subsidiaries continued, creating scope for further staff reductions and efficiency gains. However, the railway sector continued to consume high levels of budget support, amounting to around 1.3% of GDP in 2006. Relatively low productivity and high unit labour costs are undermining its long-term viability, in particular once the network is opened up to competition. Five railway subsidiaries have been tendered for privatisation, but have not yet been sold. The liberalisation of the telecommunication industry continued, but network access needs to be further improved. Croatian Telecom continued to be the dominant supplier. New fixed line operators entered the market, raising their market share from 4% to a - still modest - 13%. Stronger competition in the mobile phone sector led to significantly lower prices. The restructuring and liberalisation of the energy sector is advancing gradually. Preparations for the privatisation of the large electricity company have made no progress. Overall, the reform of network industries made headway, but the railway sector needs much deeper restructuring to ensure its long-term viability and competitiveness.

The already large service sector maintained its share of total output at around 61%. Agriculture's share of output declined further to 7.4% in 2006 (from 7.6% in 2005). The construction sector increased to 7.1% (6.8%), while industry's share dropped to 24.5% (from 24.8%). Agriculture's share of employment showed a marked fall to 14% (2005: 17%), while industry rose slightly to 29% (2005: 28%) and the services sector posted a more pronounced rise to 57% (2005: 55%). Given the already large service sector, there were only marginal shifts in the sector structure of the economy.

The small and medium-sized enterprise (SME) sector continued to grow in 2006, representing 40% of the corporate sector's total assets, 98.5% of the total number of firms and 55% of total employment. SMEs generated more than 44% of GDP and almost one quarter of total exports. SMEs continued to benefit from support initiatives and subsidy schemes at various government levels. However, the sector continued to suffer from a cumbersome regulatory framework and inefficiencies in public administration. Access to longer-term financing remained difficult, particularly for newly established businesses. Overall, the SME sector has gained in importance, despite the remaining administrative obstacles.

State influence on competitiveness

There has been further progress in strengthening the role of the Competition Agency in monitoring and controlling state aid. Communication and cooperation with potential state aid providers, including national and regional administrations, has improved. However, the relatively low levels of staffing and budgetary resources allocated to the Agency, somewhat hindered a more effective state aid control. Total state aid reportedly increased, from around 2.3% of GDP in 2005 to 3.4% in 2006. In 2007, restructuring aid to loss-making enterprises increased significantly, which may undermine the implementation of the government's subsidy reduction plan. The latter provides for the gradual reduction of subsidies as a share of GDP. A large share of subsidies continued to go to specific sectors, such as the railways and the shipbuilding, steel and aluminium industries. Horizontal aid accounts for only a small share of state 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 representing more than 100% of GDP. In 2006, there was a further increase in both imports and exports as a percentage of GDP. Apart from the export of transport equipment (mainly ships), tourism continued to be the biggest source of export revenue, representing almost 18% of GDP in 2006. In 2006, the EU has continued to be the most important trading partner with a slightly higher share of around 63.5% in Croatian exports (from 62% in 2005) and an unchanged share of 65% in imports. At the same time, Croatia has expanded its trade with neighbouring countries as well as with Russia and China. Around 95% of FDI inflows originate from EU Member States. Overall, integration with the EU in the areas of trade and investment is very high, and trade with neighbouring countries has grown.

The 2.9% growth in real wages was less than that of average labour productivity (3.9%), with the result that real unit labour costs fell by 1%. The nominal effective exchange rate of the kuna appreciated by 3.4% in 2006, largely due to strong upward movement of the kuna against the US dollar. In real effective terms[5], the Kuna appreciated at a lower rate (2%), as producer prices rose faster abroad than on the domestic market. Overall, standard indicators suggest no significant changes in export price competitiveness.

Average per-capita income in 2006 rose to 50% of the EU-27 average[6] from 47% in 2005.

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.

Chapter 1: Free movement of goods

Some progress can be reported regarding alignment on general principles . Croatia needs to continue its efforts to ensure that its legislation is compatible with Articles 28 to 30 of the EC Treaty and the related case law, including both distinctly and indistinctly applicable measures. An Action Plan for compliance with Articles 28 to 30 including milestones for revising domestic legislation and administrative practices as well as for introducing mutual recognition clauses, remains to be adopted. This is one of the key elements for the accession negotiations on this chapter.

As regards horizontal measures , progress can be reported with the revision of the framework Act on technical requirements for products and on conformity assessment, which was adopted in July 2007.

As regards standardisation , the Standards institute (HZN) had transposed 8,933 harmonised European standards (of CEN and CENELEC by August 2007. By mid-June 2007, the number of HZN staff stood at 54. HZN is an affiliate member of the European Committee for Standardisation (CEN) and the European Committee for Electro-technical Standardisation (CENELEC). The reorganisation of the technical committees' infrastructure is underway

Concerning conformity assessment , no progress can be reported on the establishment of a network of independent certifying bodies and laboratories

In the area of accreditation , the Croatian Accreditation Agency (HAA) has continued to promote accreditation among governmental institutions responsible for harmonisation under the new and old approach directives. The HAA has made progress on developing new accreditation schemes in various sectors. By September 2007, it employed 21 staff and had accredited a total of 95 conformity assessment bodies. In March 2007, the HAA applied for signatory status of the multilateral agreement of the European Cooperation for Accreditation (EA) in the fields of calibration laboratories, testing laboratories, certification bodies for quality management systems, products, personnel and bodies and certification bodies for environmental management systems and inspection bodies.

As regards metrology , an amended Law on metrology was adopted by Parliament in October 2007. This lays the basis for developing and reorganising Croatia's metrology infrastructure. Pursuant to this law, legal and scientific metrology would be separated by establishing two institutions, the State Office for Metrology (DZM) and the Croatian Metrological Institute (HMI). All EU directives on metrology have been transposed, but their alignment with the acquis remains to be confirmed. The DZM is preparing a strategy for metrology which will lay the basis for investing in metrology infrastructure and for financing its development. In 2007, the DZM became an associate member of the European Cooperation in Legal Metrology (WELMEC) and signed the European Collaboration in Measurement Standards Mutual Recognition Agreement with EUROMET.

Regarding market surveillance , some progress can be reported on the State Inspectorate's administrative capacity and enforcement measures. Preparations are being made for an internal reorganisation of the State Inspectorate.

In terms of administrative capacity, the Department for internal market coordination within the Directorate for trade and the internal market in the Ministry of Economy, Labour and Entrepreneurship (MELE) has been reorganised and now employs six persons in 2 separate sections. This level of staffing is insufficient, particularly because the department is responsible for overall policy coordination with other ministries and agencies and for application of Articles 28 to 30 of the EC Treaty as well as for the introduction of the mutual recognition principle in the Croatian legal system.

Overall, as regards horizontal measures, basic structures for harmonisation with EU legislation are in place. Further, adequate capacity building measures are required to enable Croatian institutions to become full members of the relevant European organisations. Adoption and implementation of the revised horizontal framework legislation is a key element of the accession negotiations on this chapter, along with segregation of tasks between the various functions.

There has been some progress in sectors covered by the old approach product legislation. In 2006, Croatia adopted fifteen new ordinances meant to provide for alignment with four type-approval directives on motor vehicles, two- or three-wheeled motor vehicles and agriculture or forestry tractors. Measures meant to align with twelve directives were adopted in 2007. However, further progress is needed in the legislative alignment with old approach acquis . Substantive efforts are required on chemicals, pharmaceuticals, cosmetics, legal metrology and the remaining motor vehicles directives.

With regard to pharmaceuticals , a new Law on medicinal products entered into force in October 2007. This aims at transposing the Community acquis on medicinal products for human use, on implementation of good clinical practice in clinical trials on medicinal products for human use, on traditional herbal medicinal products, and on orphan medicinal products. Its alignment with the acquis remains to be confirmed. Work on new ordinances related to transparency of measures regulating reimbursement decisions and pricing of medicinal products is well advanced. Moreover, the veterinary Law, adopted in May 2007, has introduced changes with regard to imports of veterinary medicinal products.

As regards the new and global approach product legislation , progress can be reported on legislative alignment.

Progress can be reported with regard to recreational crafts. Amendments to the Ordinance on boats and yachts and to the Rules for statutory certification of boats and yachts have been prepared. Progress can be noted with the Ordinances on measuring instruments and non-automatic weighing instruments. Preparatory work for further alignment in the field of cableway installations, radio and telecommunications terminal equipment and electromagnetic compatibility, is well advanced.

Overall, major efforts are still required to ensure further alignment with the new approach acquis, both through framework legislation and through sector alignment measures.

Concerning procedural measures , the EU directive on the control of the acquisition and possession of weapons has been transposed by the new weapons Act, although its alignment with the acquis remains to be confirmed.

Conclusion

Some progress has been made on alignment of legislation with the acquis on free movement of goods. Still, many elements of the acquis are not yet in place. Adjusting the conformity assessment infrastructure and market surveillance activities to the requirements stemming from the new and global approach remains a major challenge. Alignment with the acquis in this chapter is underway. Considerable efforts are still required to align legislation with the acquis and to implement and enforce it effectively.

Chapter 2: Freedom of movement for workers

Some progress has been made in the area of access to the labour market . In July 2007, Parliament adopted amendments to the Act on Foreigners which aim, inter alia , at abolishing work permits as a condition for EU nationals and their family members to work in Croatia. These amendments will enter into force by accession.

No specific progress can be reported on future participation in the EURES network. Gaps remain especially in the language skills of potential EURES advisers and, with a view to the required connection to the EURES Job Mobility Portal upon accession, in ensuring that all job vacancies of the Public employment services are displayed on its public website and can therefore be made available for publication on the Portal. In this area, Croatia is already moderately advanced.

There has been no progress on coordination of social security systems . Sufficient administrative capacity has not yet been developed to apply the acquis in this field.

No progress can be reported with introduction of the European health insurance card in Croatia. Preparations in this area are at an early stage.

Conclusion

Some progress has been made on this chapter. A satisfactory level of legal alignment has been reached. However, Croatia’s legislation is not yet fully in line with the EU rules on access to the labour market, and the administrative capacity for coordination of social security systems is not yet sufficiently developed. Increased efforts are required to align legislation with the acquis and to implement and enforce it effectively.

Chapter 3: Right of establishment and freedom to provide services

Limited progress can be reported on the right of establishment . In the tourism sector, nationality restrictions for bed-and-breakfast operators were repealed by the new Hospitality and Catering Industry Act adopted in December 2006. The Act on the Provision of Tourism Services and the Act on Amendments to the Sojourn Tax Act were adopted with the aim of reaching further compliance with the acquis . However, numerous restrictions on the right of establishment remain in many sectors, the main obstacles being citizenship and residence requirements, disproportionate language requirements, the requirement that certain economic activities need to be carried out without an interruption longer than six months and the one-office rule. Furthermore, the Law Practice Act has not yet been brought in line with Croatia's commitments under Article 49 of the Stabilisation and Association Agreement (SAA) so as to unambiguously allow for the establishment of branches of Community law firms providing those legal services to which Croatia under international agreements committed to grant market access.

There has been some progress regarding the freedom to provide cross-border services . Croatia adopted a new Aliens Act in July 2007 ( See also Chapter 24 – Justice, freedom and security ), under which upon Croatia's accession to the EU citizens of EEA Member States and their family members may work and provide services in Croatia without a work permit or operating licence. However, several restrictions that hamper cross-border provision of services still remain in both horizontal and sectoral acts.

No further progress has been made towards legislative alignment in the field of postal services, where the level of alignment is already relatively high. Despite the recruitment of two additional staff during the reporting period, the level of funding and administrative capacity of the Council for Postal Services (the national regulatory authority) is still low.

Some progress has been made on mutual recognition of professional qualifications . The amendments to the Act on the Recognition of Foreign Educational Qualifications adopted in December 2006 introduced a distinction between recognition of academic and professional qualifications. However, several sectoral acts still impose citizenship and disproportionate language requirements in order to gain access to regulated professions, both of which are incompatible with the acquis.

Conclusion

Some progress has been made on this chapter, particularly regarding freedom to provide cross-border services and mutual recognition of professional qualifications. However, further work is required in order to fully align Croatia's legislation with the acquis in these areas. Substantial obstacles to the right of establishment and freedom to provide services remain in both horizontal and sectoral legislation. Overall, alignment with the acquis is at a reasonable level, although considerable efforts are still required in some areas.

Chapter 4: Free movement of capital

Good progress can be reported concerning capital movements . The amendments to the Foreign Exchange Act that entered into force in December 2006 fully liberalise portfolio investment. Changes the same month to the Securities Market Act and the Savings and Loan Cooperatives Act further liberalised the capital market for institutional investors. Some provisions discriminating between investment into domestic and foreign assets remain in Croatian legislation, however.

The administrative capacity of the Ministry of Justice has been reinforced in order to expedite the processing of applications for the purchase of real estate by foreigners. This is starting to have a noticeable impact and the backlog of cases is being reduced. Good progress is thus being made towards streamlining of procedures for the authorisation on a non-discriminatory basis of real estate purchases by EU nationals. Croatia was also able to determine that its nationals are free to acquire real estate in Italy and Slovenia, thereby facilitating the application of reciprocity when processing applications from these Member States. The number of backlog cases remaining to be definitively settled remains high however. Croatia has not yet been able to ensure applications are generally dealt with in line with the target turn-around time of 30-60 days.

There has been no progress in the area of payment systems .

As regards the fight against money laundering and combating terrorist financing (AML/CTF), the Croatian government has still to adopt a comprehensive action plan aimed at reinforcing the national AML/CTF legal and institutional framework, which is a key element for the accession negotiations in this chapter. An Inter-Institutional Working Group was established in March 2007 bringing together representatives from 11 governmental institutions and agencies involved in AML/CTF. Its aim is to contribute to fulfilling the strategic and operational goals in the prevention of money laundering and terrorist financing, through, inter alia, identifying weaknesses and risks and removing obstacles to progress. The Croatian FIU concluded bilateral agreements with its Georgian and Moldovan counterparts.

There has been no progress on further legislative alignment with the AML directives as well as the standards of the Financial Action Task Force. Institutional capacity needs to be strengthened. Monitoring and supervision of reporting entities remains inadequate, especially outside the banking sector, and the enforcement record (including convictions, confiscations, seizures and asset freezing) is still weak. Moreover, further efforts are required in improving anti-money laundering legislation, ensuring effective implementation, strengthening the FIU and improving inter-agency cooperation.

Conclusion

There has been some progress in this chapter, mainly as regards liberalisation of the capital account, including with respect to SAA obligations on the acquisition of real estate by EU nationals. Further progress is necessary to align legislation, improve administrative capacity and strengthen enforcement concerning the fight against money laundering and combating terrorist financing. Overall a reasonable level of alignment has been achieved.

Chapter 5: Public procurement

Little progress can be reported in the areas of general principles and award of public contracts . A new Public Procurement Act was adopted in October 2007. However, work is continuing with a view to adoption of a new Concessions and Public-Private Partnerships Act.

Regarding administrative capacity , the Public Procurement Office (PPO) slightly increased its staff in 2007, which still falls short of the target of 24. The PPO has stepped up its efforts on training for contracting authorities and published a procurement manual in February 2007. Following the recruitment of a training coordinator in January 2007, the PPO delivered various training programmes as well as awareness-raising activities for their staff and contracting authorities. Expert support and training for contracting authorities, also in relation to practical implementation of the Act on public procurement, remains weak.

The Ministry of Finance has been designated as the focal point for concessions policy. In March 2007, the Croatian government adopted guidelines on the development of concessions policy for 2007-2009. The Trade and Investment Promotion Agency remains the focal point for public-private partnerships. In February 2007, the government adopted a regulation on issuing pre-approvals for public-private partnership contracts.

A single leading body for procurement responsible for coherent policy-making, coordination and implementation in all areas related to public procurement, which is a key element for accession negotiations in this chapter, has not been established. Croatia has not yet adopted a national strategy on development of the procurement system. Moreover, in view of the PPO's potential role as the focal point for procurement policy, its staffing levels are insufficient both quantitatively and qualitatively, including at managerial level.

Major gaps in the application of the basic principles and the overall legal framework on public procurement, particularly on concessions, remain.

There have been no developments on legislative alignment in the area of remedies .

The State Commission has continued to demonstrate a solid track-record of dealing with complaints from tenderers, although their staff recruitment target has not been achieved. Nevertheless, the State Commission managed to significantly reduce the average duration of review procedures (from 40 days in 2005 to 15 days in 2006). The State Commission enhanced the transparency of its work and improved the system of legal protection in public procurement, including publication of two manuals, one targeted at contracting entities, the other one at tenderers.

Conclusion

Some limited progress can be reported on this chapter. However, administrative capacity remains inadequate at all levels of the procurement system. Overall, alignment is underway, but very considerable efforts are needed to design a comprehensive strategy covering all areas of the procurement system, including concessions and public-private partnerships, and to task an organisation responsible for coherent policy-making and implementation in all these areas.

Chapter 6: Company law

Further progress has been recorded in the field of company law , where the Croatian legislation is largely aligned with the acquis. A Corporate Governance Code was issued in April 2007, based on the "comply or explain" approach, which covers many aspects of good corporate governance based on OECD principles. The amendments to the Court Register Act, adopted in March 2007, partly align Croatian legislation with the disclosure rules foreseen in the First Company Law Directive, including introduction of electronic procedures plus sanctions for late or non-disclosure of financial reports.

A project is underway to implement the IT infrastructure necessary for electronic filing and availability of documents and particulars in the Court Register. The amendments to the Court Register Act also introduce the possibility – upon the accession of Croatia to the EU – to register as a European company or European economic interest group (EEIG). In October 2007, the Parliament adopted the Act on the Take-over of Joint Stock Companies as well as the Act on the Introduction of the European Company and of the EEIG. However, some amendments to Croatian legislation remain necessary.

There has been some progress in the field of corporate accounting . The new Accounting Act was adopted in October 2007. Croatia's legislation is not yet aligned with the acquis on, inter alia, layouts, preparation of annual reports and consolidated accounts. Publication of financial reports is mandatory for public limited liability companies only. Disclosure of financial reports by Croatian companies and enforcement thereof by the competent authorities, remain weak.

There has been limited progress in the field of auditing . Work is underway to prepare amendments to the Audit Act. The Chamber of Auditors adopted the ordinance on external quality assurance and the Code of Ethics as planned in June 2007, which aim to further align with the acquis. Further efforts are required to establish an effective external quality assurance system and public oversight of the auditing profession.

Conclusion

Overall, some progress can be reported in this chapter. Alignment with the acquis is on track, but continued efforts are required for implementation of the recently adopted amendments and for corporate compliance with the requirements concerning the disclosure of financial reports.

Chapter 7: Intellectual property law

There has been good progress in the field of intellectual property rights . Amendments to the Copyright and Related Rights Act, adopted in July 2007, have filled the key remaining gaps in the legislation, which is a key element for the accession negotiations in this chapter. This concerns also the exhaustion of rights, and implies that Community exhaustion will apply from the date of Croatia's accession to the EU. However, some further adjustments are necessary to align with the acquis .

There has been good progress on industrial property rights . Amendments to the Patent Act, the Designs Act and the Trademark Act have filled the key remaining gaps in Croatia's legislation, including on exhaustion of rights, compulsory licensing of pharmaceutical patents and the availability of special protection certificates. They also provide for extension of the Community trademark and of the Community design in Croatia following its accession to the EU.

Some progress can be reported on enforcement . The abovementioned amendments to the substantive acts almost fully align Croatia's legislation with the Enforcement Directive, although some further minor adjustments are required. The report on implementation of the national strategy was adopted by the government in April 2007. Over the reporting period, some 260 misdemeanour trials were requested on the basis of investigations by the State Inspectorate. The role of the judiciary in handling IPR cases and systematic collection of statistics are addressed in the national strategy but specialised training for the judiciary and overall commitment remains at a low level.

As regards administrative capacity, the abovementioned amendments to the substantive acts introduce from June 2008 an internal appeal board within the State Intellectual Property Office (SIPO), empowered to hear appeals against all administrative decisions taken by SIPO. The coordination between the enforcement bodies at central and regional levels has improved but remains weak, particularly in terms of policy. Light sanctions for criminal offences in the field are also a cause for concern, since they have little or no deterrent effect in terms of preventing crime. In addition, they are evidence of a rather low recognition of the economic and social effects of counterfeiting. A sufficient administrative capacity and a satisfactory track record of implementation are key elements for the accession negotiations in this chapter.

Conclusion

Good progress can be reported both on legislative alignment and on enforcement. Alignment with the acquis is well on track, but continued efforts are required regarding administrative capacity to enforce rights in the fight against piracy and counterfeiting and to establish an enforcement track-record.

Chapter 8: Competition policy

In the area of anti-trust , including merger control , the shortcomings identified in 2006 have not been addressed. Announced legislative changes needed to make anti-trust control more effective have not been adopted. In particular, an efficient system for imposing fines to allow CCA decisions to have a deterrent effect, but also leniency and judicial control have not been remedied. Also, Article 266 of the General Administrative Procedure Act (GAPA), which allows the government to overturn anti-trust decisions, has not been repealed. There is also a need to ensure uniform application of the Croatian Competition Act by bodies other than the CCA which have powers with respect to anti-trust and mergers in specific sectors.

As regards administrative capacity, the CCA continues to make progress with its case-management and analysis. However, this progress is being slowed down by the low budget allocated to the CCA and the absence of tools such as the power to set fines,, leniency and effective appeal mechanisms which hamper its overall effectiveness.

As regards the anti-trust enforcement record, the Competition Agency (together with the Croatian National Bank in the case of the banking sector) adopted 93 substantive decisions in 2006, including 5 on restrictive agreements, 3 on abuse of a dominant position, 26 on merger control and 59 advocacy decisions. The enforcement record should increasingly focus on preventing the most serious distortions of competition, in particular restrictive horizontal agreements and abuses of a dominant position.

In the field of state aid , some progress can be noted. Changes to the State Aid Procedural Bylaw adopted in 2006 provide a satisfactory basis for implementation. The main legislative and administrative challenges for aligning with the acquis now lie in related fields of legislation (fiscal and sector specific legislation) and require active cooperation from the grantors of aid and strong political support, thus ensuring that the CCA is involved early on in the alignment of all existing aid schemes and the design of new aid schemes.

The CCA is Croatia's national authority for monitoring and controlling state aid. In terms of administrative capacity, the CCA has made progress on the dialogue with grantors of state aid, with the national administration and with regional governments. Further significant improvements are nevertheless hindered by the low staffing levels and budgetary resources allocated to improving control of state aid.

There has been some progress on the state aid enforcement record. In 2006, the CCA handled 91 state aid cases (decisions and opinions). The majority of cases either were not considered state aid as defined in the Law or were approved as compatible aid. Only four cases were found to be incompatible with the Law.

Some progress can be reported in the area of fiscal aid , which is a key element of the accession negotiations. The draft Free Zones Act has not been aligned with the acquis. A new Investment Promotion Law and its implementing provisions, aligned with the acquis, entered into force in 2007. However, the actual disbursement of aid under this type of schemes requires the adoption of a regional aid map, which is missing.

As regards the shipbuilding sector , which is a key element of the accession negotiations, Croatia has made moderate progress. The major shipyards are experiencing difficulties and benefit from state aid in the form of debt write-offs, operating aid and extensive guarantees, in breach of Article 70 of the SAA. In February 2007, the Ministry of Economy and Labour (MELE) notified the CCA about restructuring aid for five shipyards in difficulty. Drafts of individual restructuring plans for the shipyards were also sent to the European Commission for information. These restructuring plans should identify the measures needed to restore long-term viability,, the undertakings' own contributions to the restructuring and measures compensating for the aid received. In view of the fact that the shipyards are in difficulty and are kept afloat thanks to operating aid, these plans remain to be finalised as soon as possible and integrated in a national restructuring programme approved by the government.

In the case of the steel industry , some progress has been achieved. The National Restructuring Programme for the steel industry, which is a key element for the accession negotiations, was adopted by the government in February 2007. Although this meets the formal requirement of the SAA, insofar as it includes final restructuring aid for the steel sector within the deadline, some elements remain to be finalised following the privatisation in July 2007 of the Split and Sisak steel mills. This includes the finalisation of their respective individual business plans and the updating of the National Restructuring Programme for the steel industry, leading to long-term viability under normal market conditions without distortions of competition.

Conclusion

Some progress has been achieved on this chapter, both as regards anti-trust and state aid. However, there is a need for further legislative alignment and for strengthening administrative capacity. Alignment with the acquis in this chapter is underway, but considerable efforts are still required, in particular in relation to the restructuring of the steel sector and of the shipyards in difficulty.

Chapter 9: Financial services

There has been some progress in the field of banks and financial conglomerates . The Credit Unions Act and the related amendments to the Banking Act adopted in December 2006 paved the way for turning savings and loans cooperatives into either credit unions or savings banks, both of which fall under the supervision of the National Bank (HNB). So far, 43 savings and loans cooperatives have announced plans to turn into savings banks and 36 into new credit unions, while 18 have announced that they are winding up. The process should be completed by the end of 2007. Some adjustments have been made to the capital adequacy requirements for credit institutions and investment firms. The National Bank is continuing to work towards adopting a new Credit Institutions Act and to draft necessary secondary legislation with the aim of fully transposing the new capital requirements framework. A new Leasing Act was adopted in December 2006, bringing leasing companies under the supervision of the Financial Sector Supervisory Authority (HANFA). Inter alia , it forbids leasing companies from granting credits on their own account.

As regards administrative capacity , the National Bank's Banking Supervision and Regulation Department hired six additional staff in April 2007. The National Bank also continued to develop its cooperation with foreign and domestic supervisors.

There has been some progress on financial market infrastructure . Croatia adopted and published a new Financial Collateral Act.

Limited progress can be reported in the field of insurance , where Croatia's legislation already largely complies with the EU acquis . Some implementing measures have been adopted by HANFA, notably concerning supervision of insurance groups, establishment of a guarantee fund and calculation of solvency margin and technical reserves. In the field of occupational pensions, legislative amendments were adopted in June 2007 with the aim of aligning the pension system with the IORP Directive.

Some progress can be reported in the area of securities markets and investment services . The amendments to