Recommendation for a COUNCIL RECOMMENDATION on the 2016 national reform programme of Croatia and delivering a Council opinion on the 2016 convergence programme of Croatia
Date: 2016-05-18
Institutions: European Commission, Secretariat-General
Subjects: Croatia, budget deficit, early retirement, economic reform, judicial reform, public administration, public debt, public sector, stability programme, unemployment

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   EUROPEAN COMMISSION  Brussels, 18.5.2016  COM(2016) 331 final   Recommendation for a COUNCIL RECOMMENDATION on the 2016 national reform programme of Croatia  and delivering a Council opinion on the 2016 convergence programme of Croatia  
 
Recommendation for a 

COUNCIL RECOMMENDATION 

on the 2016 national reform programme of Croatia 

and delivering a Council opinion on the 2016 convergence programme of Croatia 

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 
policies1, 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 
imbalances2, and in particular Article 6(1) thereof, 
Having regard to the recommendation of the European Commission3, 
Having regard to the resolutions of the European Parliament4, 

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  November  2015,  the  Commission  adopted  the  Annual  Growth  Survey5, 
marking  the  start  of  the  2016  European  Semester  of  economic  policy 
coordination.  The  priorities  of  the  Annual  Growth  Survey  were  endorsed  by  the 
European Council on 17-18 March 2016. On 26 November 2015, on the basis of 
Regulation  (EU)  No  1176/2011,  the  Commission  adopted  the  Alert  Mechanism 
Report6 , in which it identified Croatia as one of the Member States for which an 
in-depth review would be carried out.   

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OJ L 209, 2.8.1997, p. 1. 
OJ L 306, 23.11.2011, p. 25. 
COM(2016) 331 final. 
P8_TA(2016)0058, P8_TA(2016)0059, and P8_TA(2016)0060. 
COM(2015) 690 final. 
COM(2015) 691 final. 

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(2) 

(3) 

(4) 

(5) 

The  2016  country  report  for  Croatia7  was  published  on  26  February  2016.  It 
assessed  Croatia’s  progress  in  addressing  the  country-specific  recommendations 
adopted  by  the  Council  on  14  July  2015  and  Croatiaʼs  progress  towards  its 
national Europe 2020 targets. It also included the in-depth review under Article 5 
of Regulation (EU) No 1176/2011. On 8 March 2016, the Commission presented 
the results of the in-depth review.8 The Commission’s analysis leads it to conclude 
that Croatia is experiencing excessive macroeconomic imbalances. In particular, it 
is essential to address vulnerabilities linked to high public, corporate and external 
debt in the context of high unemployment. Further weaknesses requiring specific 
policy  action 
the  governance  of  state-owned 
enterprises,  the  efficiency  of  public  administration,  and  the  resolution  of  non-
performing loans.  

include  fiscal  governance, 

On 28 April 2016, Croatia submitted its 2016 national reform programme and its 
2016  convergence  programme.  To  take  account  of  their  interlinkages,  the  two 
programmes  have  been  assessed  at  the  same  time.  The  National  Reform 
if  fully 
Programme  presents  a  fairly  ambitious  reform  agenda,  which, 
implemented  within 
its 
indicated 
macroeconomic  imbalances.  It  outlines  relevant  measures  to  improve  the 
management  of  public  finances,  the  health  sector  and  the  business  environment 
and  commits  to  ambitious  reforms  in  the  public  administration,  the  pension 
system,  social  protection  and  the  improvement  of  governance  in  state-owned 
enterprises. Based on the assessment of Croatia's policy commitments, there is no 
need at this stage for a stepping-up of the macro-economic imbalances procedure 

timelines,  would  help  address 

the 

Relevant  country-specific  recommendations  have  been  addressed 
the 
programming of the European Structural and Investment Funds for the 2014-2020 
period.  As  foreseen  in Article  23  of  Regulation  (EU)  No  1303/2013,  where  it  is 
necessary  to  support  the  implementation  of  relevant  Council  recommendations, 
the Commission may request a Member State to review and propose amendments 
to  its  Partnership  Agreement  and  relevant  programmes.  The  Commission  has 
provided further details on how it would make use of this provision in guidelines 
on  the  application  of  the  measures  linking  the  effectiveness  of  the  European 
Structural and Investment Funds to sound economic governance9.  

in 

Croatia is currently in the corrective arm of the Stability and Growth Pact. In its 
2016  convergence  programme,  the  government  expects  that  the  headline  deficit 
will  be  below  3%  of  GDP,  at  2.6%  of  GDP,  in  2016  and  will  fall  further 
thereafter, reaching 1.0% of GDP by 2019. Moreover, the government expects to 
reach  its  medium-term  budgetary  objective  —  a  deficit  of  1.75  %  of  GDP  in 
structural  terms  –  throughout  the  programme  period.  The  government  debt-to-
GDP  ratio  peaked  at  86.7%  in  2015  but,  according  to  the  convergence 
programme,  is  projected  to  gradually  decline  to  80.0%  in  2019.  Taken  at  face 
value,  the  debt-to-GDP  projections  in  the  programme  comply  with  the  debt 
reduction benchmark. However, while the macroeconomic scenario underpinning 
these  budgetary  projections  is  plausible  in  real  terms,  nominal  GDP  growth  is 
higher  than  projected  in  the  Commission  forecast,  especially  for  2016.  The 
projected reduction in the debt ratio therefore relies on favourable nominal growth 
projections;  in  addition,  it  factors  in  significant  debt-reducing  stock-flow 

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SWD(2016) 80 final/2. 
COM(2016) 95 final. 
COM(2014) 494 final. 

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adjustments from the sale of financial assets, which are not sufficiently specified. 
Furthermore,  the  measures  needed  to  support  the  planned  deficit  targets  from 
2017  onwards  are  mostly  unspecified.  Based  on  the  Commission  2016  spring 
forecast,  the  general  government  deficit  is  projected  to  reach  2.7%  of  GDP  in 
2016,  in  line  with  the  headline  deficit  target  included  in  the  Council 
recommendation  under  Article  126(7)  TFEU.  The  recommended  fiscal  effort 
under the excessive deficit procedure is projected to be achieved. By contrast, the 
Commission forecast does not point to compliance with the forward-looking debt 
reduction  benchmark.  Whereas  a  structural  adjustment  of  0.2%  of  GDP  in  2017 
would  be  sufficient  to  reach  the  medium-term  budgetary  objective,  a  higher 
structural  adjustment  would  be  needed  to  ensure  compliance  with  the  debt 
reduction  benchmark.  In  particular,  an  adjustment  above  the  0.5%  of  GDP 
benchmark  would  seem  appropriate  given  the  high  debt  and  current  cyclical 
conditions in Croatia. Currently, the structural balance is projected to deteriorate 
by 0.2% of GDP in 2017. Based on its assessment of the convergence programme 
and  taking  into  account  the  Commission  2016  spring  forecast,  the  Council  is  of 
the opinion that there is a risk that Croatia will not comply with the provisions of 
the  Stability  and  Growth  Pact.  Therefore,  further  measures  will  be  needed  to 
ensure compliance in 2017. 

Croatiaʼs  budgetary  planning  continues  to  suffer  from  major  weaknesses  despite 
some  improvements  made  by  the  2015  amendment  of  the  Budget  Act.  Linkages 
between the multiannual budgetary framework and annual budgets remain weak, 
and  there  are  no  clear  rules  on  changing  budgetary  plans  within  the  year.  The 
strategic  planning  of  individual  budgetary  units  is  not  subject  to  systematic 
scrutiny and does not sufficiently support the alignment of policy priorities with 
medium-term fiscal targets. The budgetary process gives little consideration to the 
sizeable  off-budget  transactions  and  accounting  adjustments  impacting  general 
government  deficit  and  debt.  Numerical  fiscal  rules  are  currently  being  revised. 
One of the main challenges is to make them more operational and better aligned 
with  the  Stability  and  Growth  Pact.  Efforts  are  also  needed  to  improve  the 
statistical basis of budgetary planning. 

The Fiscal Policy Commission, which is in charge of monitoring compliance with 
fiscal rules  at the national level,  is closely linked with  national fiscal authorities 
and  is  understaffed.  Under  these  conditions,  its  political  and  functional 
independence is not ensured. A revision of the institutional setup and the mandate 
of the Fiscal Policy Commission has been announced for the third quarter of 2016.  

Croatia has started to reform the system of communal charges, presented as a step 
in  a  broader  reform  of  immovable  property  taxation.  Combined  revenue  from 
recurrent taxes on immovable property and communal charges is relatively low as 
a proportion of GDP. 

A  high  level  of  tax  arrears,  VAT  fraud  and  the  shadow  economy  are  key 
challenges.  Measures  are  being  taken  to  improve  tax  compliance,  including  the 
development  of  a  compliance  risk  management  system.  Yet,  evidence  on  the 
effectiveness of the measures taken is still limited.  

The  stock  of  public  debt  is  high  and  still  increasing,  making  it  indispensable  to 
adopt  a  forward-looking  proactive  approach  to  public  debt  management.  A  debt 
management  strategy  for  2016-2018  is  planned  to  be  adopted  soon.  However, 
Croatia  is  still  lacking  a  more  comprehensive  approach  to  debt  management 

(6) 

(7) 

(8) 

(9) 

(10) 

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(11) 

(12) 

(13) 

(14) 

(15) 

comprising inter alia annual revisions that take account of market developments, 
an appropriate risk management strategy, and the strengthening of the function to 
carry out the associated tasks.  

A  large  proportion  of  the  working  age  population  does  not  participate  in  the 
labour  market.  One  of  the  main  reasons  for  this  is  early  retirement,  also  among 
prime-aged men. Early retirement is possible a full five years before the statutory 
retirement  age  and  financial  incentives  to  work  until  (and  beyond)  that  age  are 
weak.  In  addition,  the  pension  system  is  characterised  by  a  number  of  special 
provisions  for  specific  categories  of  workers  and  generous  early  retirement 
options for certain occupations. Statutory retirement ages for men and women are 
being brought into line and increased to 67, but only slowly. Both the current and 
future  adequacy  of  pensions is  low  and  creates  high  risks of  poverty  in  old  age, 
especially for those with short working lives.  

The  problem  of  high  inactivity  is  compounded  by  high  unemployment;  the  low 
utilisation  of  the  labour  potential  holds  back  growth.  Youth  unemployment 
remains a key concern, pointing to weaknesses in the education system, and there 
is still room to improve the effectiveness, monitoring and evaluation of the Youth 
Guarantee. Long-term unemployment rates have fallen recently but are still about 
twice the EU average. Participation in lifelong learning remains very low, due to 
an underdeveloped adult education system.  

There  are  regional  differences  in  per  capita  spending  on  social  protection,  and 
inconsistencies  as  regards  the  eligibility  criteria  for  general  social  protection 
schemes  and  those  targeting  special  categories.  Moreover,  only  a  small  share  of 
the overall social protection budget is spent on the nation-wide minimum income 
scheme.  This  results  in  inefficiencies  and  provides  insufficient  protection  to  the 
poorest.  The  reform  of  the  social  protection  system  suffered  delays  in  terms  of 
consolidating  various  benefits  and  establishing  one-stop  shops  as  single 
administrative points for the delivery of social protection services.  

The  functional  distribution  of  competences  of  public  administration  between 
central and local levels is complex, and the system is fragmented. The allocation 
of decentralised administrative functions is not in line with the fiscal capacity of 
the  local  units  in  charge.  This  makes  the  local  units  strongly  reliant  on  central 
government  transfers  while  leaving  considerable  regional  disparities  in  the 
provision  of  public  services.  The  fragmentation  of  public  administration  weighs 
on  service  delivery,  the  business  environment  and  the  efficiency  of  public 
expenditure.  The  reform  of  public  administration  has  not  been  taken  forward  in 
substance.  A  legal  framework  was  introduced  for  the  voluntary  merger  of  local 
government  units,  but  incentives  to  take  up  this  option  were  not  provided.  The 
rationalisation of the system of state agencies is proceeding slowly.  

Public  sector  wages  are  regulated  by  inconsistent  provisions  across  public 
institutions  in  the  definition  of  job  complexity,  fringe  benefits  and  wage 
supplements. This limits the government's control over the wage bill and weighs 
on the efficiency of the public sector. Due to the relatively high proportion of total 
employment  accounted  for  by  the  public  sector,  public  wage  developments  are 
also relevant to the wider economy. 

(16) 

State  ownership  of  companies  is  highly  present  in  the  economy.  Weaknesses  in 
governance,  including  the  lack  of  appropriate  performance  monitoring,  continue 
to  result  in significantly lower profitability of state-owned enterprises relative to 

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(17) 

(18) 

(19) 

(20) 

(21) 

(22) 

(23) 

comparable private corporations, with negative impacts on public finance. Listing 
shares  of  state-owned  enterprises  on  the  stock  exchange  can  help  improve  their 
corporate  governance,  notably  by  fostering  reporting  and  internal  control 
mechanisms. In the past year, steps to open up state-owned enterprises to private 
ownership advanced slowly. 

The  national  promotional  bank  "Croatian  Bank  for  Reconstruction  and 
Development (HBOR)", a state-owned entity, could play a crucial role in Croatia's 
recovery.  Its  lending  activity  could  have  a  substantial  impact  on  promoting 
investment  while  addressing  market  failures.  An  appropriate  regulatory 
framework  and  sound  corporate  governance  are  needed  to  contain  the  risk 
associated  with  its  activity,  especially  since  HBOR  is  increasingly  engaging  in 
direct lending. 

The  independent  asset  quality  review  of  HBOR's  credit  portfolio  that  the 
authorities  are  planning  to  carry  out  in  2017  is  one  step  in  addressing  these 
challenges.  In  the  meantime,  it  is  necessary  to  strengthen  the  monitoring  and 
accountability mechanisms applying to HBOR.  

The absorption rate of European Structural and Investment Funds has so far been 
low  due  to  factors  such  as  insufficient  administrative  capacity,  burdensome 
procedures and the limited number of ready-to-implement projects.  

Croatiaʼs business environment continues to suffer from major shortcomings that 
weigh  on  the  investment  climate.  Many  parafiscal  charges  levied  on  firms  still 
hamper  the  business  environment.  The  regulatory  environment  for  service 
providers  and  regulated professions remains  restrictive.  There  are  restrictions  on 
access  to  and  the  conduct  of  certain  regulated  professions,  including  legal 
professions  and  tax  advisors.  Croatia  has  been  reviewing  the  need  for  and  the 
proportionality  of these  restrictions, but  the delivery of action has  been  delayed. 
Furthermore, regulated professions and businesses suffer from high administrative 
burdens.  

Regulatory instability and a perceived low quality of legislation also weigh on the 
business  environment.  With  lengthy  proceedings,  significant  backlogs  and 
inconsistent  case  law,  the  quality  and  efficiency  of  the  judicial  system  and  of 
commercial  courts  in  particular  are  facing  challenges.  ICT  systems  are  under-
developed  notably  in  the  communication  with  parties  in  court  proceedings  and 
electronic delivery of court documents.  

The resolution of non-performing loans is critical in addressing the debt overhang 
in the economy. In this regard, important steps have been made by reinforcing the 
pre-insolvency and insolvency frameworks for businesses and adopting a personal 
insolvency  procedure.  The  impact  of  the  new  frameworks  requires  detailed 
monitoring.  However,  legal  uncertainty  in  the  tax  treatment  of  write-offs  still 
constitutes  a  barrier  to  the  swift  unwinding  of  banks’  stocks  of  non-performing 
loans.  

In  the  context  of  the  European  Semester,  the  Commission  has  carried  out  a 
comprehensive analysis of Croatia's economic policy and published it in the 2016 
country report. It has also assessed the convergence programme and the national 
reform programme and the follow-up given to the recommendations addressed to 
Croatia  in  previous  years.  It  has  taken  into  account  not  only  their  relevance  for 
sustainable fiscal and socioeconomic policy in Croatia but also their compliance 

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with  EU  rules  and  guidance,  given  the  need  to  strengthen  the  EU's  overall 
economic governance by providing EU-level input into future national decisions. 
The 
in 
recommendations  under 
recommendations 1 to 5 below. 

the  European  Semester  are 

reflected 

(24) 

(25) 

In  the  light  of  this  assessment,  the  Council  has  examined  the  convergence 
programme,  and  its  opinion10  is  reflected  in  particular  in  recommendation  1 
below. 

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 5 below, 

HEREBY RECOMMENDS that Croatia take action in 2016 and 2017 to: 

1. 

2. 

3. 

4. 

5. 

Ensure a durable correction of the excessive deficit by 2016. Thereafter, achieve an 
annual fiscal adjustment of at least 0.6% of GDP in 2017. Use any windfall gains to 
accelerate  the  reduction  of  the  general  government  debt  ratio.  By  September  2016, 
reinforce numerical fiscal rules and strengthen the independence and the mandate of 
the Fiscal Policy Commission. By the end of 2016, improve budgetary planning and 
strengthen the multi-annual budgetary framework. By the end of 2016, start a reform 
of  recurrent  taxation  of  immovable  property.  Reinforce  the  framework  for  public 
debt  management.  Adopt  and  start  implementing  a  debt  management  strategy  for 
2016-2018. 

By  the  end  of  2016,  take  measures  to  discourage  early  retirement,  accelerate  the 
transition  to  the  higher  statutory  retirement  age  and  align  pension  provisions  for 
specific categories with the rules of the general scheme. Provide appropriate up- and 
re-skilling  measures  to  enhance  the  employability  of  the  working-age  population, 
with  a  focus  on  the  low-skilled  and  the  long-term  unemployed.  Consolidate  social 
protection  benefits  by  reducing  special  schemes,  aligning  eligibility  criteria, 
integrating their administration, and focus support on those most in need.  

By  the  end  of  2016,  start  reducing  fragmentation  and  improving  the  functional 
distribution  of  competencies  in  public  administration  to  improve  efficiency  and 
reduce  territorial  disparities  in  the  delivery  of  public  services.  In  consultation  with 
the  public 
social  partners,  harmonise 
administration  and  public  services.  Reinforce  the  monitoring  of  state-owned 
enterprises’ performance and boards’ accountability. Advance the listing of shares of 
state-owned companies and the divestment process of state assets. 

the  wage-setting  frameworks  across 

Significantly  reduce  parafiscal  charges.  Remove  unjustified  regulatory  restrictions 
hampering  access  to  and  the  practice  of  regulated  professions.  Reduce  the 
administrative burden on businesses. 

Take  measures  to  improve  the  quality  and  efficiency  of  the  judicial  system  in 
commercial  and  administrative  courts.  Facilitate  the  resolution  of  non-performing 
loans,  in  particular  by  improving  the  tax  treatment  of  the  resolution  of  non-
performing loans. 

10 

Under Article 9(2) of Council Regulation (EC) No 1466/97. 

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Done at Brussels, 

For the Council 
The President 

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