Recommendation for a COUNCIL RECOMMENDATION on Croatia's 2014 national reform programme and delivering a Council opinion on Croatia's 2014 convergence programme
Date: 2014-06-02
Institutions: European Commission
Subjects: Croatia, budget deficit, competitiveness, economic convergence, economic disparity, economic growth, economic stabilisation, financial control, job creation, macroeconomics, multilateral surveillance, public debt, stability programme













EUR-Lex - 52014DC0412 - EN











|



52014DC0412

Recommendation for a COUNCIL RECOMMENDATION on Croatia's 2014 national reform programme and delivering a Council opinion on Croatia's 2014 convergence programme /* COM/2014/0412 final - 2014/ () */









 
 
Recommendation for a
COUNCIL RECOMMENDATION
on Croatia's 2014 national reform
programme
and delivering a Council opinion on Croatia's 2014 convergence programme

THE COUNCIL OF THE EUROPEAN UNION,
Having regard to the Treaty on the
Functioning of the European Union, and in particular Articles 121(2) and 148(4)
thereof,
Having regard to Council Regulation (EC) No
1466/97 of 7 July 1997 on the strengthening of the surveillance of budgetary
positions and the surveillance and coordination of economic policies[1], and in particular
Article 9(2) thereof,
Having regard to Regulation (EU) No
1176/2011 of the European Parliament and of the Council of 16 November 2011 on
the prevention and correction of macroeconomic imbalances[2], and in particular
Article 6(1) thereof,
Having regard to the recommendation of the
European Commission[3],
Having regard to the resolutions of the
European Parliament[4],
Having regard to the conclusions of the
European Council,
Having regard to the opinion of the
Employment Committee,
Having regard to the opinion of the
Economic and Financial Committee,
Having regard to the opinion of the Social
Protection Committee,
Having regard to the opinion of the
Economic Policy Committee,
Whereas:
(1)                   
On 26 March 2010, the European Council agreed to
the Commission’s proposal to launch a new strategy for growth and jobs, Europe
2020, based on enhanced coordination of economic policies, which will focus on
the key areas where action is needed to boost Europe’s potential for
sustainable growth and competitiveness.
(2)                   
On 13 July 2010, the Council, on the basis of
the Commission's proposals, adopted a recommendation on the broad guidelines
for the economic policies of the Member States and the Union (2010 to 2014)
and, on 21 October 2010, adopted a decision on guidelines for the employment
policies of the Member States, which together form the ‘integrated guidelines’.
Member States were invited to take the integrated guidelines into account in
their national economic and employment policies.
(3)                   
On 29 June 2012, the Heads of State or
Government decided on a Compact for Growth and Jobs, providing a coherent
framework for action at national, EU and euro area levels using all possible
levers, instruments and policies. They decided on action to be taken at the
level of the Member States, in particular expressing full commitment to achieving
the objectives of the Europe 2020 Strategy and to implementing the
country-specific recommendations.
(4)                   
Croatia participated in the 2013 European
Semester on a voluntary and informal basis by submitting an economic programme;
there were no country-specific recommendations. On 21 June 2013, the Council
adopted conclusions welcoming Croatia's economic programme, emphasising that
Croatia is expected to progress towards meeting the requirements of the
Stability and Growth Pact and that it needs to embark on a credible
consolidation path, whilst safeguarding growth-enhancing expenditure and
ensuring room for co-financing the inflow of EU funds. 
(5)                   
On 13 November 2013, the Commission adopted the
Annual Growth Survey[5],
marking the start of the 2014 European Semester of economic policy
coordination. On the same day on the basis of Regulation (EU) No 1176/2011, the
Commission adopted the Alert Mechanism Report[6],
in which it identified Croatia as one of the Member States for which an
in-depth review would be carried out. 
(6)                   
On 20 December 2013, the European Council
endorsed the priorities for ensuring financial stability, fiscal consolidation
and action to foster growth. It underscored the need to pursue differentiated,
growth-friendly fiscal consolidation, to restore normal lending conditions to
the economy, to promote growth and competitiveness, to tackle unemployment and
the social consequences of the crisis, and to modernise public administration.
(7)                   
On 5 March 2014, the Commission published the
results of its in-depth review for Croatia[7],
under Article 5 of Regulation (EU) No 1176/2011. The Commission's analysis leads
it to conclude that Croatia is experiencing excessive macroeconomic imbalances,
which require specific monitoring and strong policy action. In particular,
policy action is required in view of the vulnerabilities arising from sizeable
external liabilities, declining export performance, highly leveraged firms and
fast-increasing general government debt, all within a context of low growth and
poor adjustment capacity. 
(8)                   
On 24 April 2014, Croatia submitted its 2014
national reform programme and its 2014 convergence programme. In order to take
account of their interlinkages, the two programmes have been assessed at the
same time.
(9)                   
The objective of the budgetary strategy outlined
in the 2014 Convergence Programme is to correct the excessive deficit by 2016,
whilst at the same time moving back to a path of sustainable economic growth.
This is projected to be achieved by a continuous reduction in the deficit from
4.9% of GDP in 2013 to below 3% of GDP by 2016, the deadline for the correction
of the excessive deficit. The programme projects that government debt will peak
at around 72% of GDP in 2014, slightly drop in the following year and level off
thereafter. The macroeconomic scenario underpinning the budgetary projections
in the programme is optimistic over the entire programme period. According to
the programme scenario, GDP would stagnate in 2014, whilst moderate growth of
1.2% is projected in 2015; against a decline of 0.6% and growth of 0.7%,
respectively, in the Commission 2014 Spring Forecast. The programme's budgetary
forecast figures deviate from the standards of the European System of National
and Regional Accounts (ESA), giving rise to inconsistency with past data and
the macroeconomic scenario and hindering an appropriate comparison with the
Commission 2014 spring forecast. Moreover, the programme does not provide a
sufficient level of detail on the consolidation measures for 2015 and 2016, in
particular on the expenditure side. According to the Commission 2014 spring forecast,
the headline balance is expected to reach 3.8% and 3.1% of GDP in 2014 and
2015. After the necessary adjustment to make these projections comparable to
the targets set in the context of the Excessive Deficit Procedure (i.e.
excluding the impact of the transfer of second pillar pension assets) the
Commission projection for the deficit in 2014 would be 4.6% of GDP and 3.8% in
2015. As the Convergence Programme constitutes the first report on the action
taken by the authorities following the opening of the Excessive Deficit
Procedure on 28 January 2014, the Commission assessed the action taken by
Croatia in a Communication published on 2 June 2014. In particular, the
headline target is projected to be met in 2014, while the deficit is expected
to be somewhat above target in 2015. The improvement in the structural
government balance falls marginally short of what is required both in 2014 and
2015. Finally, while the change in the adjusted structural balance is below the
recommended effort, the effort measured by the underlying amount of
discretionary measures is estimated to be delivered both in 2014 and 2015. In
order to reduce the negative impact on growth and enhance the sustainability of
the consolidation, greater attention to the quality of the measures and a
transition to expenditure based measures are warranted. Based on its assessment
of the programme and the Commission forecast, pursuant to Council Regulation
(EC) No 1466/97, the Council is of the opinion that, while Croatia has taken
effective action by 30 April 2014 to correct its excessive deficit as
recommended, additional efforts are needed in order to comply with the recommendation
under the Excessive Deficit Procedure to correct the excessive deficit by 2016
and ensure the credibility of the correction.
(10)               
Budgetary consolidation measures should be
geared towards enhancing the quality of public finances, with a view to achieving
efficiencies notably in wage, social security and subsidy outlays and to
providing sufficient fiscal space for prioritising growth-enhancing expenditure
and investments, including in projects funded by the Union. Croatia has
implemented significant reforms in its fiscal framework in recent years.
However, weaknesses remain in relation to budgetary planning, effective control
over expenditure and consistent application of budgetary constraints, which
negatively impact on fiscal policy-making. Although recently changed, the
design of the fiscal rules should be further improved. Notably, the
effectiveness of the fiscal framework is undermined by the absence of
preventive mechanisms and weak compliance with the debt rule, and an ambiguous
formulation of the structural balanced-budget rule. While the establishment of
the Fiscal Policy Commission is welcome, additional measures are deemed
necessary to strengthen its position in the budget planning and monitoring, most
notably its independence from all budgetary authorities.
(11)               
Croatia faces the challenge of pursuing fiscal
consolidation without harming competitiveness and prospects of economic
recovery. Against such background, the revenue side of public finances is
constrained by a narrow definition of the bases for taxes that offer a stable
tax yield and have little distortionary impact on growth. In this context, the
national reform programme announces a plan to introduce a recurrent property
tax in 2016 but its operational design, including that of the tax base, is yet
to be specified. Croatia is also determined to take measures to improve tax
compliance by reducing the grey economy. Steps have been taken on this front. The
gradual introduction of fiscal cash registries has increased tax receipts by
enhanced oversight of transactions. The reorganisation of the tax
administration is expected to improve the efficiency and effectiveness of tax
collection while lowering compliance burdens for taxpayers. However, in light
of fiscal consolidation needs, and also taking into account data pointing to
significant amounts of uncollected taxes, there seems to be scope to increase
further the efficiency of tax collection and continued efforts are needed to
improve tax compliance by providing more e-services to taxpayers. 
(12)               
Croatia has taken measures with a view to
improving the sustainability and adequacy of pensions: since November 2010, the
statutory retirement age, the early retirement age and the qualifying period
for women have been gradually increased and are set to be fully harmonised by
2030. The amendments to the Pension Insurance Act adopted in December 2013
raise the statutory retirement age from 65 to 67 and the early retirement age
from 60 to 62. However, this increase will become effectiveonly as of 2031,
which is insufficiently ambitious taking account of  demographic trends. Despite
reforms implemented over recent years, various possibilities for early
retirement still exist. Considering the extent of exemptions, the penalties for
early retirement and the late retirement bonus create little incentive to work to
the statutory retirement age, impacting negatively on labour supply and the
sustainability of the pension system. The Act on the Single Forensic Expertise
Body was adopted in 2013 to help limit the inflow of disability pensioners and
reduce fraud by unifying disability assessments. Together with increased
inspections, this addresses a definite need but the effect on expenditure will
depend on how measures are implemented and the extent to which decisions are enforced.
Pensions under special schemes that were above a certain threshold were cut by
10%, albeit on a temporary basis, while their indexation has been tied to a GDP
trigger. Despite recent attempts to curb expenditure and increase transparency,
the pace and extent of convergence of pensions under special schemes towards
general rules are slow and overall progress is still limited.  
(13)               
The health sector achieves reasonably good
health outcomes and, with some regional variation, services are accessible, but
the system contributes significantly to pressure on the public finances. The
authorities identified remediable inefficiencies in the hospital network. The
master plan presented in March 2014 for the reorganisation of hospital care
provides for measures that would improve cost-effectiveness, such as
rationalisation of the hospital network, reduced average lengths of hospital
stays, a better allocation of hospital beds, including for long-term care, and
further changes in hospital financing. Strong monitoring and implementation
capacities in both hospitals and central government should be ensured to put
the plan into practice. Long-term care is characterised by dispersed services
between the health and the social welfare systems, low coverage rates and
formal care, high costs of provision and long waiting lists.
(14)               
Employment and activity rates are amongst the
lowest in the EU, and are particularly low for young people and older people.
Beyond cyclical developments, these labour market outcomes are partly related
to institutional and policy settings. Croatia has embarked on labour market
reforms to increase flexibility on the labour market. A first phase of the
reform, was completed in 2013, focused on regulation of fixed-term employment
contracts. The government adopted a second legislative proposal in January 2014
which provides for reducing dismissal costs by shortening and simplifying
procedures and increasing working-time flexibility. In addition, more flexible
forms of employment such as part-time contracts would be introduced. These
changes would put Croatia broadly on a par with its peers, as far as the
employment protection index is concerned. Although these reforms are expected
to have a positive effect on overall employment, they also entail an increased risk
of labour market segmentation, including the development of fixed-term
contracts. Meanwhile, no changes are foreseen to the wage-setting institutions
despite Croatia's particular combination of relatively high average wages and
very low employment. Despite further rising unemployment, spending and coverage
of active labour market policy measures to enable improved access to, and
longer stay in, the labour market are still below average, especially as
regards young people, long-term unemployed and older workers. The
administrative capacity of the Croatian public employment service is under
severe pressure, including at regional level. An overall system to monitor and
evaluate developments on the labour market and labour market needs including
skills forecasting does not exist nor is there a regular evaluation of active
labour market policy measures. There is high proportion of undeclared paid
activity. 
(15)               
The situation on the labour market is of
particular concern for young people as their unemployment increased drastically
and reached almost 50% in 2013, while the proportion of
young people not in education, employment or training
keeps increasing. Important challenges include outreach
to non-registered youth and mobilisation of the private sector to offer more
apprenticeships, in line with the objectives of a youth guarantee. Croatia also
faces serious challenges in education as regards labour-market relevance and
quality of provision across all educational sectors. Work-based
learning and career guidance across secondary and tertiary education are
lacking while employers' engagement with vocational education and training, and
secondary and tertiary education is low. Employment
rates among recent graduates are significantly lower than in the rest of the EU.
The outdated vocational education and training system is undergoing a reform in
the form of piloting new school curricula. The implementation of the Croatian Qualifications Framework and the
Strategy on Education, Science and Technology is pending but should improve
educational outcomes and align them with labour market needs.
(16)               
High unemployment and low labour market
participation have led to a deterioration of the social situation in Croatia.
The proportion of persons at risk of poverty and social exclusion has increased
in recent years and is significantly above the EU average. The design of the
social benefit system makes it possible for recipients to accumulate
overlapping cash transfers. When recipients move into work, they lose the
benefit of some of these social transfers, thereby creating disincentives for them
to enter the labour market. There is scope to make the social protection system
more efficient and transparent: currently, the allocation of income support
schemes and benefits is scattered across many institutions and levels of
government, with inconsistent application of criteria and overlaps. The 2013
Social Welfare Act introduced stricter means-testing and merged four of more
than 70 benefits at national level, including some targeting specific groups, into
the General Minimum Income. A national ‘one-stop shop’, through which all national level cash benefits will be administered, is being implemented gradually until 2016. However, systematic
monitoring and evaluation will be difficult as the income support schemes and
programmes at local and regional levels and the various non-means tested cash
benefits targeting specific categories of the population, have not been
integrated. Despite several legislative reforms since 2011, the design of the
social benefit systems failed to effectively target, people most in need. 
(17)               
The current regulatory framework for doing
business in Croatia imposes a high burden on businesses, including lack of
legal certainty, untransparent decision-making in particular at local level,
and numerous para-fiscal charges. Moreover, high fragmentation of public
administration responsibilities at regional and local level and a complex split
of competencies between ministries and agencies at central level complicate
business decisions and lengthen administrative procedures. A structured
approach has been put in place at central government level to identify
obstacles for business; however, a consistent methodology for measuring
administrative burden is not applied, which decreases the effectiveness of
measures already taken. The existing one-stop shop for businesses covers
limited functionalities only. There is a need to rationalise and improve
control over public subsidies and guarantees; a central register of supported
companies and individuals would represent a first step in this area. Croatia
has initiated reforms of the public administration to strengthen its
administrative capacities and to improve the client-orientation of public
services for citizens and businesses. However, the quality of public governance
remains low, with weak coordination across different levels of government and
little or overformalistic use of evidence-based policy-making and assessment.
The adoption of the public administration reform strategy is a step in the
right direction; the strategy should be thoroughly implemented at all levels of
government.  The experience of the implementation of the pre-accession funds
points to deficiencies in terms of strategic planning and institutional
capacity and weaknesses in project elaboration and follow-up.
(18)               
State-owned or state-controlled companies are
negatively affected by weak governance while the implementation of the new
strategy for the management of public assets and enterprises has encountered
delays. Currently, there is no competitive selection procedure for supervisory
board members and management, and appointments are not published. While
measures have been taken to improve the anti-corruption framework, more efforts
are required in the prevention of corruption, at all layers of government. The
key elements currently missing in the anti-corruption framework include
effective verification mechanisms for conflict of interest and asset disclosure
of public officials, as well as specific safeguards for state-owned and
state-controlled enterprises. The verification powers of the Commission for the
Resolution of Conflict of Interest rely on the competences and pro-activeness
of other authorities. Despite the progress made to increase transparency of
public procurement procedures, risk assessment tools are not being
systematically used and vulnerable sectors appear to be insufficiently
prioritised. The oversight over the effective implementation of public
procurement rules needs to be reinforced, also in view of the allocation of EU
funds in the coming years.  
(19)               
The wide-spread application of the
pre-bankruptcy procedure in 2013 met with some success in addressing debt-servicing
problems faced by companies in the context of complex, expensive and lengthy
bankruptcy procedures. However,
there is scope to considerably strengthen the instrument by addressing various
shortcomings, such as insufficient clarification of the role of the state in
the process, strengthening the role of commercial courts in validating claims
and sound restructuring plans, extending the scope of the procedure to allow
for effective restructuring before the debtor becomes insolvent, and addressing
deficiencies in implementation of the law. Despite a number of reforms to
improve the effectiveness of the justice system, judicial proceedings in
litigious civil, commercial and administrative cases are unduly long,
particularly in first instance. The backlog of cases increased in 2013 and is
very high, particularly as regards civil and commercial proceedings. Continued
effort to create and enforce the right incentives to resolve proceedings in a
timely manner and to promote out-of-court settlements, especially in the case
of small claims, is needed to address these issues, as they hamper business
activity and reduce Croatia's attractiveness for foreign direct investment.
(20)               
 The conservative approach adopted by the
Croatian National Bank to  macro-prudential regulation, notably in relation to
capital levels, has meant that banks have built up a degree of  resilience that
has proven to be useful given the challenges they now face from the weak
economy. However, with the economy entering its sixth year of recession and
increasing non-performing loans, there are risks to banks' asset quality. It is
welcome that certain portfolios of the four largest Croatian banks, which are
foreign-owned, will be covered by the euro area asset quality review/stress
test of the new Single Supervisory Mechanism. Nevertheless, the exercise
excludes some materially important portfolios from a Croatian perspective, as
portfolios are selected based on their relevance at a banking group level. Furthermore,
the exercise does not cover mid-size and smaller banks, which may have lower
capital levels and less robust asset quality, and which are potentially
important for financial stability. Complementing the Single Supervisory
Mechanism exercise by an additional supervisory diagnostic exercise designed
specifically for the Croatian financial system (and which would cover
significant portfolios of Croatian subsidiaries that are not part of the Single
Supervisory Mechanism exercise, as well as key mid-size and smaller banks)
would improve the overall understanding of banks' loan classification and the
adequacy of their loan loss provisions.
(21)               
In the context of the European Semester, the
Commission has carried out a comprehensive analysis of Croatia’s economic
policy. It has assessed the convergence programme and the national reform
programme. It has taken into account not only their relevance for sustainable
fiscal and socio-economic policy in Croatia but also their compliance with EU
rules and guidance, given the need to reinforce the overall economic governance
of the European Union by providing EU-level input into future national
decisions. Its recommendations under the European Semester are
reflected in recommendations (1) to (8) below.
(22)               
In the light of this assessment, the Council has
examined Croatia’s convergence programme, and its opinion[8] is reflected in
particular in recommendation (1) below.
(23)               
In the light of the Commission's in-depth review
and this assessment, the Council has examined the national reform programme and
the convergence programme. Its recommendations under Article 6 of Regulation
(EU) No 1176/2011 are reflected in recommendations (1) to (8) below.
HEREBY RECOMMENDS that Croatia take
action within the period 2014-2015 to:
1.                      
Fully implement the budgetary measures adopted
for 2014. Reinforce the budgetary strategy, further specifying announced
measures for 2015 and 2016, and considering additional permanent,
growth-friendly measures in order to ensure a sustainable correction of the
excessive deficit by 2016. At the same time, ensure that the structural
adjustment effort as specified in the Council recommendation under the Excessive
Deficit Procedure is delivered. Align programme projections with ESA standards
and Stability and Growth Pact requirements. Take measures to reinforce control
over expenditure. By March 2015, carry out a thorough expenditure review. Reinforce
the budgetary planning process, in particular by improving the accuracy of
macroeconomic and budgetary forecasts and strengthening the binding nature of
the annual and medium-term expenditure ceilings and improve the design of
fiscal rules. By October 2014, ground in law the newly established Fiscal
Policy Commission, strengthen its independence from all budgetary authorities,
broaden its mandate, notably with respect to monitoring of all fiscal rules and
the ex-ante and ex-post assessment of forecasts, and ensure adequate resourcing.
Building on plans outlined in the national reform programme, present a concrete
strategy to reform recurrent property taxation. Initiate a process of reporting
and reviewing of tax expenditures. Improve tax compliance, in particular by
further enhancing the efficiency of the tax administration; present an action
plan to this end by the end of 2014.
2.                      
Adopt legislation by March 2015 to accelerate
the planned harmonisation of statutory retirement ages of women and men and to
advance the planned increase of the statutory retirement age to 67 years. Reduce
access to early retirement. Ensure enforcement of tighter disability pensions
assessments and controls and accelerate the integration of pensions under
special schemes into the general pension system. Strengthen the
cost-effectiveness of the healthcare sector, including in hospitals. 
3.                      
Implement the second phase of the labour law
reform, following consultation with the social partners, notably as regards
conditions for dismissals and working time, and with a view to preventing
further labour market segmentation including for young people, by March 2015.
Review the wage-setting system with a view to better aligning productivity
developments and wage conditions. Present the conclusions of this review by the
end of 2014. Strengthen the effectiveness and reach of active labour market
policies by reinforcing the administrative capacities of the public employment
services, including at regional level, and by increasing the coverage of the young,
long-term unemployed and older workers.  Prioritise outreach to non-registered
youth and mobilise the private sector to offer more apprenticeships, in line
with the objectives of a youth guarantee. Outline plans, by the end of 2014, to
address undeclared work. Implement measures to improve the labour market
relevance and quality of education outcomes by modernising the qualification
systems, by putting in place quality assurance mechanisms and by improving
school-to-work transitions, notably through strengthening vocational education
and work-based learning. 
4.                      
Review tax and benefits systems by the end of
2014, and present an action plan to improve the reactivation of inactive and
unemployed persons. Strengthen the effectiveness and transparency of the social
protection system by further consolidating benefits, unifying eligibility
criteria and linking data from all relevant levels and government entities in
the "one-stop shop". Improve the effectiveness and adequacy of social
assistance benefits through their better targeting.
5.                      
Take further measures to improve the business
environment. Notably, by March 2015 set a target for considerably lowering
administrative requirements, including para-fiscal charges. Address the high
level of fragmentation and overlapping responsibilities by streamlining
administrative processes and by clarifying the decision-making and
accountability framework across various levels of government and at central
government level between ministries and agencies. Improve administrative
capacity and strategic planning of units entrusted with the management of
European Structural and Investment Funds and provide them with adequate and
stable staffing levels. 
6.                      
Present, by October 2014, a detailed plan for
public property management for 2015. Ensure that companies under state control
are governed in a transparent and accountable manner, in particular, strengthen
the competency requirements for members of management and supervisory boards
nominated by the state and introduce a public register for appointments. Reinforce
prevention of corruption in public administration and state-owned and
state-controlled enterprises, including by increasing the verification powers
of the Conflict of Interest Commission. Strengthen transparency and efficiency
of public procurement at both central and local levels, and the capacity to monitor
implementation and to detect irregularities. 
7.                      
By the end of 2014 reinforce the role of
commercial courts in the monitoring of transparency and legality in the
application of the corporate pre-bankruptcy procedure. Review the compulsory
test of insolvency/illiquidity to access pre-bankruptcy settlement proceedings
and streamline the insolvency/liquidation process to reduce its length. Improve
the quality and efficiency of the judicial system, in particular by providing incentives
to resolve proceedings in litigious civil and commercial cases and in
administrative cases in a timely manner and to resort to out-of-court
settlement especially for smaller claims.
8.                      
Complement the 2014 European Central Bank's
asset quality reviews and stress test exercises, undertake a comprehensive
portfolio screening exercise designed specifically for the Croatian financial
sector, with a focus on important portfolios that are not covered by the
European Central Bank exercise and including key mid-size and smaller banks.
Done at Brussels,
                                                                       For
the Council
                                                                       The
President
[1]               OJ L 209, 2.8.1997, p. 1.
[2]               OJ L 306, 23.11.2011, p. 25.
[3]               COM(2014) 412 final.
[4]               P7_TA(2014)0128 and P7_TA(2014)0129.
[5]               COM(2013) 800 final.
[6]               COM(2013) 790 final.
[7]               SWD(2014) 82 final.
[8]               Under Article 9(2) of Council Regulation (EC) No
1466/97.