COMMISSION STAFF WORKING DOCUMENT Country Report Croatia 2017 Including an In-Depth Review on the prevention and correction of macroeconomic imbalances Accompanying the document COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE COUNCIL, THE EUROPEAN CENTRAL BANK AND THE EUROGROUP 2017 European Semester: Assessment of progress on structural reforms, prevention and correction of macroeconomic imbalances, and results of in-depth reviews under Regulation (EU) No 1176/2011 {COM(2017) 90 final} {SWD(2017) 67 final to SWD(2017) 93 final}
Date: 2017-02-22
Institutions: European Commission, Secretariat-General
Subjects: Croatia, EU employment policy, EU investment, economic development, economic recovery, euro area, fiscal policy, macroeconomics, multilateral surveillance, structural adjustment

EN 

   EN 

   EUROPEAN COMMISSION  Brussels, 22.2.2017  SWD(2017) 76 final   COMMISSION STAFF WORKING DOCUMENT Country Report Croatia 2017 Including an In-Depth Review on the prevention and correction of macroeconomic  imbalances Accompanying the document COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE COUNCIL, THE EUROPEAN CENTRAL BANK AND THE EUROGROUP  2017 European Semester: Assessment of progress on structural reforms,  prevention and correction of macroeconomic imbalances, and results of in-depth reviews under Regulation (EU) No 1176/2011  {COM(2017) 90 final} {SWD(2017) 67 final to SWD(2017) 93 final}    
 
 
CONTENTS 

Executive summary 

1. 

Economic situation and outlook 

2. 

Progress with country-specific recommendations 

3. 

Summary of the main findings from the MIP in-depth review 

4. 

Reform priorities 

4.1.  Public finances 

4.2.  Private sector debt and financial sector 

4.3. 

Labour market, social policies and education 

4.4.  Business environment and investment 

4.5.  Public sector governance 

A.  Overview table 

B.  MIP Scoreboard 

C. 

Standard tables 

References 

1 

4 

10 

13 

19 

19 

24 

31 

39 

48 

56 

61 

62 

67 

 
 
 
 
LIST OF TABLES 

1.1. 

2.1. 

Key economic, financial and social indicators — Croatia 

Summary table on 2016 CSR assessment 

3.1.  MIP Matrix 

4.1.1. 

Tax brackets in PIT (HRK / month) 

4.2.1.  Financial soundness indicators, all banks 

B.1. 

The MIP Scoreboard for Croatia 

C.1. 

Financial market indicators 

C.2. 

Labour market and social indicators 

C.3. 

Labour market and social indicators (continued) 

C.4. 

Product market performance and policy indicators 

C.5.  Green growth 

LIST OF GRAPHS 

1.1. 

1.2. 

1.3. 

1.4. 

Real GDP growth by demand component 

Structure of employment (lhs) and unemployment rate (rhs) 

Contributions to rate of change in yearly unit labour costs (ULC) 

Current account composition, gross external debt and net international investment 

position 

1.5. 

Inflation dynamics and main components in Croatia and in the euro area and money 

market interest rates 

Average cost of MFI euro-denominated loans for non-financial corporations, new business 

Debt and debt servicing burden to GDP for non-financial corporations , households and 

general government sector 

Actual and potential output growth 

Level and change in net international investment position 

1.6. 

1.7. 

1.8. 

3.1. 

4.1.1.  General government debt by currency and market of issuance 

4.1.2.  Contributions to yearly change in debt to GDP and total debt to GDP 

4.1.3.  Expenditure on the wage bill and intermediate consumption compared to peers 2016 

4.1.4.  Budget revenue from EU grants: projections, revisions and execution 2014-2017 

4.1.5.  Gross public debt under different scenarios 

4.2.1.  Contributions to changes in total corporate debt 

4.2.2.  Proportion of debt by risk class and industry (2010 and 2015) 

4.2.3.  Currency composition of corporate debt 

4.2.4.  Contributions to change in total households debt 

4.2.5.  Key indicators of the Croatian banking sector 

4.2.6.  Non-performing loans developments 

4.3.1.  Change in the unemployment rate: contribution of employment and participation 

4.3.2.  Change in activity rate by age and skill level (Q3-2015 and Q3-2016) 

9 

11 

17 

22 

28 

61 

62 

63 

64 

65 

66 

4 

5 

5 

6 

6 

7 

7 

8 

15 

19 

20 

20 

21 

21 

24 

25 

25 

26 

27 

28 

31 

31 

 
 
 
4.3.3.  Composition of new retirees by type of pensions 

4.3.4. 

Temporary employment by labour market status 1 year before, and share of temporary 

contracts in total employment 

4.4.1.  Potential output in Croatia and in Central Eastern European peer economies 

4.4.2. 

Investment by sectors, cumulative growth 

4.4.3. 

Investment across sectors: 2009 versus 2015 

4.4.4.  Sources of investment financing by sectors (2015) 

4.4.5.  Productivity in Croatia and CEE peers by industry (2014, CEE total=100) 

4.4.6.  Change in average productivity by industry (2010-2014) 

4.4.7.  Restrictiveness indicator 

4.4.8.  Broadband connectivity in Croatia by speeds (% of households) 

4.5.1.  Aggregate local government unit expenditure in 2015 by function 

4.5.2.  Municipalities and towns (*) current revenue and expenditure in 2015 by size class 

4.5.3.  Productivity gap of SOEs by ownership 

LIST OF BOXES 

2.1. 

Contribution of the EU budget to structural change in Croatia 

4.3.1. 

Impact of personal income tax reform on inequality and work incentives 

4.4.1. 

Investment challenges and reforms in Croatia 

32 

33 

39 

41 

41 

42 

42 

43 

44 

46 

48 

49 

51 

12 

34 

40 

 
 
 
 
EXECUTIVE SUMMARY 

This report assesses Croatia’s economy in light 
of the European Commission’s Annual Growth 
Survey  published  on  16 November 2016.  In  the 
survey,  the  Commission  calls  on  EU  Member 
States  to  redouble  their  efforts  on  the  three 
elements  of  the  virtuous  triangle  of  economic 
policy — boosting investment, pursuing structural 
reforms and ensuring responsible fiscal policies. In 
so  doing,  Member  States  should 
focus  on 
enhancing  social  fairness  in  order  to  deliver  more 
the 
inclusive  growth.  At 
the 
Commission  published 
the  Alert  Mechanism 
Report (AMR) that initiated the sixth round of the 
macroeconomic  imbalance  procedure.  The  in-
depth  review,  which  the  2017  AMR  concluded 
should be undertaken for the Croatian economy, is 
presented in this report. 

same 

time, 

The recovery picked up steam in 2016. In 2015, 
GDP  had  expanded  modestly,  marking  the  end  of 
one  of  the  longest  and  deepest  recessions  in  the 
EU.  The  recovery  accelerated  in  2016,  at  a 
projected  rate  of  2.8 %.  An  improving  labour 
market, low energy prices and the personal income 
Investment 
tax 
started to finally recover, thanks partly to a pick-up 
in the use of EU Funds. Croatian goods continued 
to gain export market shares, while soaring tourist 
arrivals boosted the export of services.  

reform  spurred  consumption. 

to 

improve 

in  2017  and  2.5 % 

Economic growth is projected to remain robust 
and  broad-based  in  the  short  term,  and  the 
further.  As 
labour  market 
favourable  new  developments  replace  the  fading 
tailwinds that have aided the recovery for the past 
two  years,  GDP  growth  is  forecast  at  a  relatively 
robust  3.1 % 
in  2018. 
Consumption  is  expected  to  be  bolstered  by  the 
newly  adopted  tax  reform,  with  lower  personal 
income  taxes  more  than  compensating  for  the 
impact  of 
inflation  on  household  disposable 
income. A further increase in the absorption of EU 
funds and still favourable credit conditions are set 
to support investment. Growth of exports is set to 
moderate,  while  imports  are  projected  to  keep 
growing,  leading  to  a  gradual  fall  in  the  current 
account surplus. The labour market is projected to 
continue  improving,  with  activity  rates  stabilising 
and the unemployment rate declining further.  

The  economic  recovery  is  helping  to  reduce 
domestic  and  external  debt,  but  vulnerabilities 
is 
persist.  Private 

sector  debt 

reduction 

1 

progressing, and the general government debt ratio 
moved  onto  a  declining  path  in  2016.  External 
liabilities  are  contracting,  as  the  current  account 
in  solid  surplus.  An  overall  sound 
remains 
financial  sector  lays  the  ground  for  continued 
macro-financial 
Nevertheless, 
stability. 
vulnerabilities persist, in particular related to high 
levels of debt denominated in foreign currency. 

Modest  growth  prospects  remain  a  key 
challenge  for  the  economy.  Protractedly  slow 
productivity  growth  and 
low  and  declining 
utilisation  of  human  capital  reduce  the  economy's 
long 
term  growth  prospects.  At  about  1 %, 
Croatia's  currently  estimated  potential  growth  rate 
is  low  compared  to  other  catching  up  economies. 
Real  GDP  has  been  growing  above  this  rate  over 
the past two years and the economy is projected to 
keep  growing  above  potential  over  the  forecast 
period. In the medium term, however, the economy 
is set to return to its long-term potential. This will 
slow  down  the  convergence  process  and  the 
unwinding 
imbalances. 
of  macroeconomic 
Improving  this  long-term  scenario  will  require 
determination in carrying out structural reforms.   

the 

have 

reform 

programme 

the  multi-annual 

recurrent  property 

limited  progress 
2016 

in 
Croatia  has  made 
implementing 
country-specific 
recommendations, in the context of two general 
elections  in  less  than  a  year.  Only  a  few  of  the 
policy  commitments  put  forward  in  the  2016 
national 
been 
implemented  to  date.  Croatia  has  made  limited 
progress  in  reinforcing  numerical  fiscal  rules  and 
strengthening  the  Fiscal  Policy  Commission,  as 
improving  budgetary  planning  and 
well  as 
strengthening 
budgetary 
framework.  Some  progress  has  been  made  in 
reforming 
and 
improving  debt  management.  There  has  been  no 
progress 
retirement, 
accelerating  the  transition  to  the  higher  statutory 
retirement age and aligning pension provisions for 
specific  categories  with  the  rules  of  the  general 
scheme.  Limited  progress  has  been  made  in 
providing appropriate up- and re-skilling measures, 
while  there  has  been  no  progress  in  consolidating 
social  protection  benefits.  Limited  progress  has 
been  made  in  reducing  the  fragmentation  and 
of 
functional 
improving 
competencies  in  the  public  administration.  There 
has  been  no  progress  in  harmonising  the  wage-
public 
setting 

in  discouraging 

frameworks 

distribution 

taxation 

across 

early 

the 

the 

 
 
of 

state-owned 

and  public 

in  reinforcing 

service.  Limited 
administration 
the 
progress  has  been  made 
monitoring 
enterprises’ 
performance and boards’ accountability, as well as 
advancing  the  listing  of  their  shares  and  the 
divestment process of state assets. There has been 
limited progress in reducing parafiscal charges and 
the administrative burden on businesses, as well as 
removing  unjustified  regulatory  restrictions  on 
regulated  professions.  Limited  progress  has  been 
made in to improving the quality and efficiency of 
the 
and 
administrative courts. Finally, there has been some 
progress  in  facilitating  the  resolution  of  non-
performing loans. 

commercial 

judicial 

system 

in 

Regarding progress in reaching the national targets 
under the Europe 2020 strategy, Croatia’s record is 
mixed. It is on track in terms of energy efficiency, 
reducing greenhouse gas emissions, increasing the 
share  of  renewable  energy  (except  in  transport), 
reducing early school leaving and reducing poverty 
and social exclusion. However, this is less the case 
for  targets  on  tertiary  education  attainment  and 
employment rates, R&D investment and renewable 
energy in transport. 

findings  of 

The  main 
review 
contained  in  this  report,  and  the  related  policy 
challenges, are as follows:  

in-depth 

the 

onto 

  In  2016,  the  general  government  debt  ratio 
a  declining  path,  but 
moved 
sustainability  risks  have  not  been  fully 
overcome.  After  having  more  than  doubled 
during  the  six-year  recession,  the  general 
government debt is expected to have shrunk to 
84.1 %  of  GDP  in  2016  and  to  continue 
declining  in  the  short  term.  Several  factors 
contributed  to  this  outcome.  They  include  the 
achievement  of  a  primary  surplus  in  2015  and 
its  increase  in  2016,  declining  debt  servicing 
costs, higher GDP and a slight appreciation of 
the  kuna  against  the  euro  in  2016,  which 
reduced  the  value  of  outstanding  government 
liabilities  denominated  in  foreign  currency. 
However,  public  debt  remains  high  —  well 
above its pre-crisis levels — and much of it is 
denominated  in  foreign  currency,  and  thus 
exposed  to  currency  risk.  Moreover,  while 
sustainability  risks  are  low  in  the  long  term, 
they remain high in the medium term. They are 
fiscal 
by  weaknesses 
compounded 

in 

Executive summary 

governance, including in strategic planning and 
in the debt management framework. 

  Private  sector  debt 

is  decreasing,  but 
remains  high,  especially  in  the  corporate 
sector, and heavily exposed to currency risk.  
The  pace  of  corporate  and  household  debt 
reduction  picked  up  speed  in  2015  and  2016. 
This  was  due  to  higher  growth  as  well  as  the 
slight  appreciation  of  the  national  currency 
towards the euro, as a significant proportion of 
private  debt  is  also  denominated  in  foreign 
currency.  However,  in  the  corporate  sector, 
debt  remains  high  and  concentrated  in  a  few 
sectors  and  a  handful  of  companies.  The 
legislated 
franc-
of  Swiss 
loans  also  helped 
denominated  household 
reduce  household  indebtedness  in  2016,  but 
resulted  in  significant  losses  for  the  banking 
sector. 

conversion 

  The  financial  sector  is  set  to  support  the 
recovery,  but  remains  exposed  to  indirect 
credit  risk.  The  financial  sector  remains  well 
capitalised, despite the losses incurred with the 
conversion  of  the  Swiss  franc  loans,  and  its 
profitability  recovered  in  the  course  of  2016. 
Improving  economic  conditions  and 
low 
interest  rates  are  expected  to  support  credit 
demand. Combined with the improving quality 
of  banks'  assets,  this  is  set  to  result  in  mildly 
positive  net  credit  flows.  However,  the  non-
in 
ratio 
performing 
comparison  to  other  Member  States.  The  new 
provisions on the treatment of writing off non-
performing  loans,  as  part  of  the  tax  reform, 
may give impetus to their swift resolution. The 
banking  sector,  nevertheless,  remains  exposed 
to indirect credit risks through the large foreign 
currency  exposure  of 
its  corporate  and 
household  clients.  The  central  bank's  tight 
management of the exchange rate significantly 
reduces these risks. 

remains  high 

loans 

force. 

labour 

  The  unemployment  rate  is  falling  rapidly, 
thanks  to  moderate  job  creation  but  also  a 
shrinking 
the 
unemployment  rate  fell  to  12.8 %,  over  3.5 
percentage points below the rate a year earlier. 
force 
contracting 
However, 
accounted for more than half of this reduction, 
while  most  of  the  new  jobs  were  created  on 

In  2016, 

labour 

the 

2 

 
 
Executive summary 

the reduction of regional disparities. The wage 
setting framework still lacks consistency across 
the  public  administration  and  public  services. 
Improving  the  efficiency  and  quality  of  the 
justice  system  remains  a  challenge,  despite 
reduced  backlogs.  Health  outcomes  remain 
below  EU  average.  Although 
the  sector 
continues  to  generate  arrears,  no  action  has 
been  taken  to  promote  a  more  sustainable  and 
efficient  financing  of  health  care.  Finally,  the 
new  ministry  in  charge  of  managing  public 
assets  could 
foster  a  more  coordinated 
approach and give impetus to restructuring and 
privatisation.  The  Croatian  Bank 
for 
Reconstruction  and  Development  still  appears 
to  lack  the  high  standards  of  transparency  and 
accountability  that  are  needed  to  fulfil  its 
mission. 

to 

long-term 
temporary  contracts.  Youth  and 
unemployment 
Limited 
high. 
remain 
availability  of  attractive  job  opportunities  may 
have  discouraged  labour  market  participation 
and  contributed 
increasing  migration 
outflows.  Skill  gaps  among  the  working  age 
population and multiple pathways to early exit 
compound  the  problem.  The  employment  rate 
remains amongst the lowest in the EU, as early 
retirement 
care 
for 
responsibilities, drive a high share of prime-age 
potential  workforce  out  of  the  labour  market. 
Despite  the  low  utilisation  of  the  labour 
potential,  the  steep  decline  in  the  number  of 
jobseekers  is  expected  to  give  rise  to  renewed 
wage  pressure,  following  years  of  wage 
moderation.    

women, 

and, 

in 

the 

transitions 

skills  makes 

labour  market 

  The education and social protection systems 
still suffer from structural weaknesses. Lack 
of  basic 
into 
employment  difficult.  The  awaited  reform  of 
the  education  system  has  been  delayed,  and 
efforts  to  equip  the  workforce  with  the  skills 
needed 
remain 
insufficient. Croatia still exhibits high levels of 
poverty  and  social  exclusion,  and  the  two 
successive  personal  income  tax  reforms  have 
reduced  the  tax  system's  capacity  of  tackling 
income inequality. Inconsistencies, fragmented 
coverage  and  lack  of  transparency  in  the 
its 
system  of  social  protection  weaken 
effectiveness and fairness. Finally, both current 
and  future  adequacy  of  pensions  is  low  and 
creates  high  risks  of  poverty  in  old  age, 
especially for those with shorter working lives. 

  A 

of 

productive 

investment 

improved 
allocation 

cumbersome  business 

environment 
depresses 
and 
productivity  growth.  Croatia’s  productivity 
growth  lags  behind  that  of  its  central  and 
eastern  European  peers  in  all  sectors  of  the 
economy. The average productivity of Croatian 
in  recent  years,  but 
firms  has 
inefficient 
has 
resources 
prevented  productive  businesses  from  growing 
faster  than  their  less  productive  competitors. 
Productivity  is  particularly  weak  in  state-
owned  enterprises  and  in  heavily  regulated 
sectors such as energy, and to a lesser extent in 
transport.  The  high  level  of  the  administrative 
burden  in  the  provision  of  services  and  of 
parafiscal  charges  continues 
to  constrain 
investment in business creation and expansion. 
Furthermore,  the  regulatory  environment  for 
service  providers  and  regulated  professions 
in 
remains 
accessing  finance  are  preventing  small  and 
medium-sized  enterprises 
from  expanding 
more rapidly.    

restrictive.  The 

difficulties 

Other key economic issues analysed in this report 
which  point 
facing 
Croatia’s economy are as follows:  

to  particular  challenges 

  The 

fragmented  public  administration 
weighs  on  the  effective  delivery  of  public 
services. 
territorial 
Croatia’s  marked 
fragmentation  and  complex  fiscal  relations 
across levels of government  are not conducive 
to  an  efficient  delivery  of  public  services  and 

3 

 
 
1.  ECONOMIC SITUATION AND OUTLOOK 

GDP growth  

Croatia  came  out  of  its  six  year  recession  in 
2015  and  a  strong  recovery  is  now  underway. 
The  2008  economic  and  financial  crisis  has  had  a 
profound  and  long  lasting  impact  on  the  Croatian 
economy,  as  it  brought  to  the  fore  important 
and  macroeconomic 
structural  weaknesses 
imbalances  accumulated  in  the  pre-crisis  years. 
Between  2008  and  2014,  real  GDP  contracted  by 
more  than  12  %.  Following  EU  accession  in  July 
2013, export of goods started to provide a positive 
contribution to growth, followed, one year later, by 
the  strong  rise  in  the  contribution  of  export  of 
services,  especially  tourism.  As  falling  energy 
prices and the income tax cuts implemented in late 
2015  boosted  household  disposable  income,  2015 
finally  saw  a  return  to  positive  real  GDP  growth, 
by 1.6 %. Investment also started to rebound in the 
course  of  2015  and  picked  up  momentum  the 
following  year.  Overall,  in  2016  GDP  growth  is 
expected 
to  2.8 %  (see 
Graph 1.1)  while  turning  broader-based  across 
demand components and sectors.   

to  have  accelerated 

No 

further 

significant 

Growth is expected to remain robust until 2018, 
but the volume of output is set to remain below 
pre-crisis  levels.  The  favourable  conditions  that 
supported  the  recovery  in  the  last  two  years  are 
abating. 
cost-
competitiveness gains are expected as productivity 
growth 
remains  subdued  and  wage  growth 
resumes. After three years of sizeable gains, export 
market  shares  are  projected  to  gradually  stabilise 
by  2018.  As  import  growth  remains  robust,  net 
external  demand  is  projected  to  have  detracted 
from  growth  in  2016  and  continue  to  do  so  over 
the forecast period. At the same time, the recovery 
of  employment  and  wages  and  the  stipulated 
reduction  in  the  personal  income  tax  (see  Section 
4.1)  are  expected  to  support  consumption,  while 
investment 
to  benefit  from  continued 
favourable  financing  conditions  and  increased 
absorption of EU funds.  Against this background, 
the Commission 2017 winter forecast expects GDP 
growth  to  accelerate  to  3.1  %  in  2017  and  slow 
down to 2.5 % in 2018. Yet, by 2018 real GDP is 
projected to remain about 3 % lower than the peak 
attained in 2008. 

is  set 

Graph 1.1: 

Real GDP growth by demand component 

(1) Year-on-year contributions are obtained as the moving 
average of four quarters GDP component compared to the 
moving average of the respective components in the same 
quarters of the previous year. 
Source: Eurostat 

Labour market 

in  output 

is  boosting 
The  acceleration 
employment, but job creation has relied mainly 
on  fixed-term  contracts.  During  the  crisis,  slow 
wage adjustment exacerbated labour shedding (see 
Graph 1.2).  The  unemployment  rate  peaked  at 
18 % in mid-2013. In 2013 and 2014, two reforms 
were  implemented  to  make  the  labour  market  — 
especially  the  temporary  contracts  segment  — 
more  flexible,  while  wages  started  to  adjust. 
Employment  began  to  expand  at  the  end  of 
2013 (1). It is projected to have increased by 1.9 % 
in 2016. Job creation has relied almost exclusively 
the 
on 
expansion  of 
tourism-related 
industries.  Employment  growth  is  expected  to 
strengthen 
this  year  and  slightly  decelerate 
thereafter.  

temporary  contracts  —  also  due 

seasonal 

the 

to 

(1)  Employment statistics stemming from different sources do 
not  always  provide  a  consistent  picture  for  Croatia  (see 
Croatia:  2016  Country  Report,  box  2.4.1).  The  above 
statistics refer to the Labour Force Survey.  

4 

-15-10-50510152006200820102012201420162018pps.ImportsInvestmentPublic consumptionPrivate consumptionExports of servicesExports of goodsGDPforecast 
 
 
                                                           
1. Economic situation and outlook 

Graph 1.2: 

Structure of employment (lhs) and 
unemployment rate (rhs) 

Graph 1.3:  Contributions to rate of change in yearly unit 

labour costs (ULC) 

(1) The figures related to the structure of employment are 
based on moving averages for four quarters. The 
unemployment rate is seasonally adjusted. 
Source: Eurostat, LFS 

The  unemployment  rate  has  been 
falling 
rapidly,  partly  due  to  a  marked  contraction  of 
the  labour  force,  and  wages  have  started 
growing  again.  The  unemployment  rate  fell  to 
12.8 % in 2016. This rapid decrease is only partly 
due  to  employment  growth.  The  labour  force 
continued  to  shrink  throughout  2016,  also  due  to 
net  migration  outflows.  In  the  third  quarter,  the 
activity  rate  was  down  to  65.6 %  (age  group  15-
64), some 8 pps below the EU average. No further 
major  declines  of  the  labour  force  are  expected 
going  forward.  Consequently,  the  unemployment 
rate  is  set  to  contract  at  a  more  moderate  pace, 
falling  to  9.3 %  by  the  end  of  2018.  The  steep 
decline in the number of jobseekers is contributing 
to  renewed  wage  pressure.  After  years  of  wage 
moderation,  in  2016  wages  are  expected  to  have 
increased  by  roughly  1.7 %,  (i.e.  2.3 %  in  real 
terms).  In  turn,  unit  labour  costs  are  projected  to 
have  started  increasing  again  in  2016,  and  are 
forecast to keep growing in line with developments 
in  the  euro  area  (see  Graph 1.3).  The  outcome  of 
the ongoing wage negotiations in the public sector 
(see  Section  5.1)  may  add  wage  pressure  in  the 
through  demonstration  effects. 
private  sector 
Overall,  compensation  of  employees  is  projected 
to  increase  by  around  2.5 %  in  both  2017  and 
2018. 

Source: Eurostat, European Commission winter 2017 forecast 

Social developments 

Income  inequality  has  remained  broadly  stable 
and  close  to  the  EU  average  since  the  crisis.  In 
2014 the richest 20 % of households had 5.3 times 
more income than the poorest 20 %, broadly in line 
the  EU  average  (2)  However, 
with 
income 
inequality  in  Croatia  is  driven  by  the  poorer 
households having a lower share of income than in 
other  European  countries (3).  Income  inequality 
before  taxes  and  benefits  —  "market  income 
inequality"  —  was  66 %  higher  than  after  taxes 
and  benefits.  This  indicates  that  Croatia's  tax-
benefit  system  reduces  inequality  by  around  the 
same  extent  as  the  EU  average.  The  tax  reforms 
implemented  recently  (at  the  end  of  2015  and 
again  on  1st  January  2017)  are  set  to  slightly 
weaken  the  system's  redistributive  capacity  (see 
Box 4.3.1).  

(2)  EU-SILC 2015 data. Note that these data refers to the 2014 
situation  (first  year  of  recovery)  for  the  income  and  work 
intensity  components,  while  material  deprivation  refers  to 
2015. 

(3)  The  share  of  income  received  by  the  richest  10%  of 
households  in  Croatia  (22.8%  in  2015)  is  lower  than  the 
EU average (of 24.1%), suggesting that rich households are 
not  contributing  to  inequality  in  Croatia  as  much  as 
elsewhere. On the other hand, the share of income received 
by  the  poorest  20%  of  households  in  Croatia  (7.3%  in 
2015) was below the EU average (of 7.7%), suggesting this 
is  increasing  inequality  more  in  Croatia  than  elsewhere  in 
Europe. 

5 

0246810121416182002004006008001,0001,2001,4001,6001,8002,00007080910111213141516%thousandsSelf-employedEmployees (temporary contracts)Employees (open ended contracts)Unemployment rate (rhs)-8-6-4-202468101201020304050607080910111213141516*17*18*y-o-y %Inflation (GDP deflator growth)Real compensation per employeeProductivity contribution (negative sign)Nominal unit labour cost 
 
 
                                                           
1. Economic situation and outlook 

Graph 1.4:  Current account composition, gross external 

Inflation and interest rate developments 

debt and net international investment position 

through 

Following two years of deflation, the rebound in 
energy  prices  and  wage  increases  is  driving  a 
turnaround  in  price  dynamics.  In  2015,  the 
collapse  in  energy  prices  on  international  markets 
fed 
to  domestic  energy  prices  and 
contributed to negative inflation, at -0.3 % in 2015 
and -0.6 % in 2016. Prices started to increase again 
towards  the  end  of  2016  and  the  rising  trend  is 
expected  to  strengthen  over  the  forecast  horizon, 
sustained  by  a  rebound  in  energy  prices  (partly 
offset  by  VAT  cuts)  and,  to  a  lesser  extent,  wage 
growth. Inflation is therefore projected to rise back 
to 1.7 % in 2017 and slightly decelerate in 2018, as 
the recovery in energy prices slows down. 

Graph 1.5: 

Inflation dynamics and main components in 
Croatia and in the euro area and money 
market interest rates 

Source: Eurostat 

is 
The  accommodative  monetary  policy 
resulting in lower interest rates, but the spread 
between  the  local  and  euro  area  rates  remains 
high.  The  combination  of  the  economic  recovery, 
stronger  demand  for  kuna  loans  and  solid  current 
account  surplus  has  allowed  the  central  bank  to 
pursue  an  even  more  expansionary  monetary 
policy.  Abundant  kuna  liquidity  was  released 
through  several  refinancing  operations  during 
2016.  Despite  the  traditionally  weak  transmission 
mechanisms of domestic monetary policy, the loan 
rates  for  newly  granted  loans  have  decreased  (see 
Graph 1.6), more so in the euro segment. However, 
the  spread  between  the  average  interest  rates  on 
newly  granted  euro  denominated  loans  to  non-
financial  corporations  in  Croatia  and  in  the  euro 

6 

Source: Eurostat, NCB 

External position  

As  domestic  savings  continue 
to  outstrip 
investment,  the  current  account  remains  in 
surplus,  and  external  liabilities  are  abating. 
After a record deficit of 9 % of GDP in 2008, the 
current account balance turned into a small surplus 
position  in  2013.  The  improvement  was  initially 
driven by a contraction of imports, but as of 2013 
the main driver has been the positive performance 
of  exports  of  goods  and,  more  recently,  services. 
The  surplus  has  progressively  strengthened, 
reaching  a  record  5.0 %  of  GDP  in  2015  (see 
Graph 1.4).  As  the  impact  of  temporary  factors 
fades-out  (4),  export  market  shares  stabilises  and 
oil  prices  increase  again,  the  current  account 
surplus  is  expected  to  shrink  to  1.3 %  of  GDP  by 
2018.  The  improvement  in  the  current  account 
balance  helped  reverse  the  trend  of  growing 
external 
liabilities 
indebtedness.  Net  external 
improved  from  the  record  negative  position  of 
about  -98 %  of  GDP  in  early  2011  to  -75.8 %  of 
GDP  in  mid-2016.  Similarly,  gross  external  debt 
fell  from  106 %  to  97 %  of  GDP  over  the  same 
period.  The  ratio  of  external  liabilities  is  set  to 
continue  falling  in  the  short  term  as  continued 
surpluses combine with stronger growth.  

(4)  Temporary  factors  also  contributed  to  the  high  surplus, 
including  falling  energy  prices  and  losses  suffered  by  the 
mainly  foreign-owned  banking  sector  in  the  wake  of  the 
legislated  conversion  of  Swiss  franc  loans,  which  resulted 
in  a  negative  flow  of  retained  earnings  of  about  1.5 %  of 
GDP in 2015. 

-120-100-80-60-40-200-15-10-50510200820092010201120122013201420152016% of GDP% of GDPBalance of primary and secondary incomes (other)Net investment incomeBalance of trade (goods and services)Current account balanceNIIP (rhs)Gross external debt (rhs)-1%0%1%2%3%4%5%6%20082010201220142016OtherFoodEnergyHICP HRHICP EA 
 
                                                           
 
area  remains  high,  occasionally  surpassing  200 
basis points. 

Graph 1.6:  Average cost of MFI euro-denominated loans 

for non-financial corporations, new business 

1. Economic situation and outlook 

in  mid-2015, 

for  households  and  firms  (defined  as  interest  paid 
to GDP ratio), as most loans to households are on 
flexible  interest  rates  and  corporate debt has  been 
terms.  This, 
rolled-over  on  more  favourable 
combined  with 
the  acceleration  of  economic 
activity,  is  expected  to  stimulate  credit  demand. 
After  peaking  at  17.3 % 
the 
proportion  of  non-performing  loans  fell  below 
15 %  in  mid-2016,  due  to  a  large  extent  to 
accelerated sales and write-offs of impaired assets. 
The  freeing-up  of  reserves  and  abundant  kuna 
liquidity  are  set  to  ease  supply  constraints.  Credit 
is therefore projected to resume expanding already 
in  2017.  Currency  and  maturity  mismatches 
between new credit  demand  (long-term  kuna)  and 
deposits (short-term kuna or long-term EUR) may 
nevertheless  turn  out  to  be  a  limiting  factor,  if 
households  maintain  their  preference  for  foreign 
currency deposits.  

(1) Weighted averages 
Source: Croatian National Bank, European Central Bank, 
own calculations 

Graph 1.7:  Debt and debt servicing burden to GDP for 

non-financial corporations , households and 
general government sector 

Private indebtedness  

Businesses  and  households  continue  to  reduce 
their  high  debt  and  foreign currency  exposure. 
During  the  recession,  corporate  and  household 
deleveraging progressed slowly, as negative credit 
flows were partially offset by contracting income. 
By  mid-2016  corporate  debt  is  estimated  to  have 
fallen  to  72 %  of  GDP  (of  which  about  55 %  is 
external  liabilities  and  22 %  is  domestic  debt 
contracted in foreign currency). Household debt is 
estimated  to  have  decreased  to  about  36.5 %  of 
GDP  (of  which  just  above  60 %  contracted  in 
euros, down from 68 % at the end of 2015) (5). The 
recent  reduction  was  largely  driven  by  higher 
growth, the conversion of Swiss franc loans (which 
in  some  cases  resulted  in  accelerated  re-payment) 
and  currency-related  valuation  effects,  while  the 
contribution of net credit flows has turned broadly 
neutral.  

Easing  deleveraging  pressures  and  improving 
financing  conditions  are  laying  the  basis  for  a 
new  credit  expansion  phase.  Debt  levels  remain 
relatively  high.  Yet, 
rate 
environment has reduced the debt servicing burden 

interest 

low 

the 

(5)  Debt  is  defined  as  the  sum  of  loans  and  debt  securities  in 

sector accounts.  

Source: European Commission, DG ECFIN 

Public finances 

finances  deteriorated 

Public 
substantially 
during the recession, but as of 2016 the general 
government debt ratio is set to decline.   During 
the  crisis,  the  accumulation  of  high  deficits  and 
transactions  related  to  state-owned  enterprises 
(SOEs)  were 
the  main  drivers  of  general 
government debt. Budgetary targets set through the 
excessive  deficit  procedure  (EDP)  have  provided 
an  anchor  to  fiscal  policy.  After  hitting  a  record 
high  of  7.8 %  of  GDP  in  2011,  the  deficit 
contracted  to  3.3 %  of  GDP  in  2015  and  is 

7 

0123456720122013201420152016%SpreadCorporate interest rates - CroatiaCorporate interest rates - Euro area01122334405010015020025020052006200720082009201020112012201320142015% of GDPNFC debtHH debtGG debtNFC debt burden (rhs)HH debt burden (rhs) 
 
                                                           
 
1. Economic situation and outlook 

expected  to  have  reached  1.8 %  of  GDP  in  2016. 
The  combination  of  these  factors  with  the  more 
benign growth outlook is expected to have put the 
public debt to GDP ratio onto a declining path. The 
ratio  is  projected  to  have  declined  to  84.1 %  in 
2016 and to shrink further to 81.3 % in 2018.  

Potential growth  

The  sustainability  of  the  adjustment  process 
rests  on  lifting  the  low  potential  growth.  The 
rebound in internal demand is driving GDP above 
its  potential  growth  rate.  In  the  medium  term, 
however,  output  growth  is  set  to  revert  to  its 
potential,  which  is  currently  estimated  at  around 
1 %. The on-going recovery of capital expenditure 
is lifting the long term growth outlook, but it will 
take  years  of  sustained  investment  growth  before 
the  contribution  of  capital  deepening  to  potential 
GDP growth returns to pre-crisis levels. Moreover, 
adverse  developments  in  the  labour  force  and 
subdued  total  factor  productivity  (TFP)  still  limit 
Croatia's 
(see 
Graph 1.8).  A  pre-condition  for  the  abatement  of 
accumulated  domestic  and  external  debt  largely 
relies  on  a  prolonged  period  of  sustained  growth. 
This,  in  turn,  hinges  upon  the  implementation  of 
structural policies to lift TFP growth and increase 
the utilisation of labour potential. 

term  growth  prospects 

long 

Graph 1.8:  Actual and potential output growth 

(1) Potential output: production function approach 
Source: European Commission, DG ECFIN 

8 

-8.0-6.0-4.0-2.00.02.04.06.0200220042006200820102012201420162018pps.Total factor productivityContribution from capital deepeniningContribution from labourPotential outputActual growth 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
1. Economic situation and outlook 

Table 1.1: 

Key economic, financial and social indicators — Croatia 

(1) Sum of portfolio debt instruments, other investment and reserve assets  
(2,3) domestic banking groups and stand-alone banks. 
(4) domestic banking groups and stand-alone banks, foreign (EU and non-EU) controlled subsidiaries and foreign (EU and 
non-EU) controlled branches. 
(*) Indicates BPM5 and/or ESA95 
Source: European Commission,  ECB 

9 

2004-20082009201020112012201320142015201620172018Real GDP (y-o-y)4.0-7.4-1.7-0.3-2.2-1.1-0.51.62.83.12.5Private consumption (y-o-y)3.8-7.4-1.50.3-3.0-1.8-1.61.23.03.43.0Public consumption (y-o-y)3.52.1-1.6-0.3-1.00.3-0.8-0.31.41.01.0Gross fixed capital formation (y-o-y)7.2-14.4-15.2-2.7-3.31.4-2.81.64.25.25.8Exports of goods and services (y-o-y)4.1-14.16.22.2-0.13.17.610.04.94.74.3Imports of goods and services (y-o-y) 5.8-20.4-2.52.5-3.03.14.59.46.15.25.8Output gap3.6-1.3-1.8-1.6-3.1-4.0-4.3-2.6-1.11.32.8Potential growth (y-o-y)2.8-0.2-1.1-0.5-0.7-0.2-0.2-0.11.30.71.0Contribution to GDP growth:Domestic demand (y-o-y)4.7-7.9-5.0-0.4-2.7-0.7-1.71.02.93.23.1Inventories (y-o-y)0.3-3.50.20.3-0.7-0.3-0.20.20.40.00.0Net exports (y-o-y)-1.04.13.1-0.11.20.01.40.5-0.4-0.1-0.6Contribution to potential GDP growth:Total Labour (hours) (y-o-y)0.6-0.2-0.9-0.5-0.7-0.5-0.4-0.70.4-0.4-0.2Capital accumulation (y-o-y)2.01.50.80.70.60.70.60.60.70.80.9Total factor productivity (y-o-y)0.1-1.5-1.0-0.7-0.6-0.4-0.4-0.10.10.20.3Current account balance (% of GDP), balance of payments-6.5-5.3-1.2-0.8-0.21.02.15.0...Trade balance (% of GDP), balance of payments-6.9-3.7-0.4-0.40.50.42.02.8...Terms of trade of goods and services (y-o-y)1.31.20.60.2-0.6-0.10.40.71.8-1.70.0Capital account balance (% of GDP)0.00.10.10.10.10.10.20.6...Net international investment position (% of GDP)-68.0-86.9-94.3-91.7-90.8-88.9-86.8-77.7...Net marketable external debt (% of GDP) (1)-31.1-46.5-49.5-52.1-49.1-47.8-45.1-42.0...Gross marketable external debt (% of GDP) (1)70.288.591.893.791.193.394.191.7...Export performance vs. advanced countries (% change over 5 years)29.22.8-6.0-8.5-15.0-15.9-12.5-1.50...Export market share, goods and services (y-o-y)-1.1-0.7-12.7-6.0-7.52.54.73.5...Net FDI flows (% of GDP)-4.9-2.9-1.8-2.5-2.8-1.9-1.8-0.5...Savings rate of households (net saving as percentage of net disposable income)2.06.77.47.07.46.17.3....Private credit flow, consolidated (% of GDP)15.02.64.9-2.4-3.0-0.60.4-1.4...Private sector debt, consolidated (% of GDP)90.7118.6125.2122.6119.8118.3119.6115.0...of which household debt, consolidated (% of GDP)33.840.042.041.541.240.440.439.0...of which non-financial corporate debt, consolidated (% of GDP)56.978.683.281.178.677.979.276.0...Corporations, net lending (+) or net borrowing (-) (% of GDP)-3.5-3.00.22.30.73.41.04.1-0.4-1.2-1.5Corporations, gross operating surplus (% of GDP)20.619.218.119.218.518.417.417.516.316.216.6Households, net lending (+) or net borrowing (-) (% of GDP)0.63.94.84.65.13.75.16.96.96.75.9Deflated house price index (y-o-y)8.7-8.0-7.8-2.2-4.6-5.7-1.1-2.4...Residential investment (% of GDP)...........GDP deflator (y-o-y)4.22.80.81.71.60.80.00.10.70.91.8Harmonised index of consumer prices (HICP, y-o-y)3.42.21.12.23.42.30.2-0.3-0.61.71.6Nominal compensation per employee (y-o-y)4.9-0.32.24.40.1-0.6-5.4-0.31.72.42.5Labour productivity (real, person employed, y-o-y)0.2-6.72.13.81.41.7-3.10.1...Unit labour costs (ULC, whole economy, y-o-y)3.16.90.10.6-1.3-2.3-2.4-0.50.91.41.5Real unit labour costs (y-o-y)-1.04.0-0.8-1.0-2.8-3.0-2.4-0.60.20.6-0.3Real effective exchange rate (ULC, y-o-y)2.41.7-1.0-1.9-5.8-2.5-3.4-2.91.00.9-0.3Real effective exchange rate (HICP, y-o-y)1.41.5-3.4-2.7-2.51.20.4-1.51.1-1.6.Tax rate for a single person earning the average wage (%).....30.330.329.1...Tax rate for a single person earning 50% of the average wage (%).....23.123.121.9...Total Financial sector liabilities, non-consolidated (y-o-y)14.15.33.72.31.93.11.02.2...Tier 1 ratio (%) (2).....18.619.417.7...Return on equity (%) (3).....0.63.9-6.8...Gross non-performing debt (% of total debt instruments and total loans and advances) (4).....11.812.912.5...Unemployment rate11.49.211.713.716.017.317.316.312.810.89.3Long-term unemployment rate (% of active population)6.45.16.68.410.211.010.110.3...Youth unemployment rate (% of active population in the same age group)28.525.232.436.742.150.045.543.030.5..Activity rate (15-64 year-olds)64.365.665.164.163.963.766.166.8...People at risk of poverty or social exclusion (% total population)..31.132.632.629.929.329.1...Persons living in households with very low work intensity (% of total population aged below 60)..13.915.916.814.814.714.4...General government balance (% of GDP)-3.5-6.0-6.2-7.8-5.3-5.3-5.4-3.3-1.8-2.1-1.8Tax-to-GDP ratio (%)36.736.436.135.235.936.436.437.337.637.036.6Structural budget balance (% of GDP)..-5.3-7.1-3.8-3.2-3.6-2.1-1.4-2.8-3.2General government gross debt (% of GDP)39.649.058.365.270.782.286.686.784.183.081.3forecast 
 
 
 
 
 
 
2.  PROGRESS WITH COUNTRY-SPECIFIC RECOMMENDATIONS 

in 

with 

implementing 

Progress 
the 
recommendations addressed to Croatia in 2016 
(6)  has  to  be  seen  as  part  of  a  process  which 
started  with  the  introduction  of  the  European 
Semester. Most country-specific recommendations 
have  remained  unchanged  since  2014  when 
Croatia  was  first 
the  European 
included 
Semester  cycles.  The  most  notable  areas  of 
progress have been ensuring a lasting correction of 
the  excessive  deficit  and  reducing  the  general 
government  debt  ratio.  The  general  government 
deficit  shrank  markedly  in  2016,  although  this 
owed  more  to  windfall  gains  and  under-execution 
of  expenditure  than  to  structural  consolidation 
that  would  ensure  sustained  fiscal 
measures 
fiscal 
to 
discipline.  Measures 
framework  are  still  pending,  while  a  public  debt 
management  strategy  was  adopted  in  January 
2017. 

improve 

the 

in  order 

to  enhance 

implemented 

labour  market  more 

In  2014  Croatia  implemented  reforms  to  make 
the 
flexible,  but 
weaknesses in the pension and social protection 
system  have  not  been  addressed.  Two  reforms 
were 
the 
flexibility  of  the  labour  market.  The  quality  of 
services  offered  by  the  Croatian  employment 
service  was  improved  and  active  labour  market 
policy  measures  were  re-designed  with  a  focus 
towards  the  young  without  working  experience, 
including  those  who  are  not  in  employment, 
education  or  training.  The  comprehensive  reform 
of the education system is being reassessed and its 
implementation is delayed. The authorities adopted 
a  plan  for  reforming  the  vocational  education 
system 
that  should  improve  the  quality  and 
relevance  of  education  for  the  labour  market. 
However,  the  challenge  of  low  labour  utilisation 
has  still  not  received  an  adequate  response,  as 
measures  encouraging  longer  working  lives  and  a 
streamlining  of  pension  provisions  have  not  yet 
been  carried  out.  On 
the 
assessment  of  disability  claims  was  harmonised 
and  moved  to  a  new  Single  Expert  Evaluation 
Body. Finally, weaknesses in the social protection 
system have not been addressed. 

the  positive  side, 

Policy  actions  aimed  at  improving  the  business 
environment  and  the  public  administration 

have been largely delayed. This includes the main 
pillars of the public administration reform and the 
law on public sector wages, now planned for 2019. 
Several  para-fiscal  charges  were  abolished  or 
to  reduce 
reduced  and  an  action  plan 
the 
administrative 
adopted.  The 
burden  was 
management  of  public  assets  was  transferred  to  a 
newly  established  ministry.  The  divestment  of 
state-owned  companies  has  not  proceeded  in  line 
with the announced plans, and the adoption of the 
corporate governance code has been delayed.  

Reforms of healthcare and EU funds absorption 
have  progressed  slowly,  while  steps  have  been 
taken  to  improve  the  judiciary  system.  There 
was  limited  progress  in  implementing  structural 
measures  in  the  healthcare  sector  and  addressing 
the accumulation of arrears. The absorption of EU 
funds  remains  hindered  by  limited  administrative 
Insolvency 
capacity  and 
procedures  have  been  thoroughly  revised,  and  the 
reformed judicial map has improved the efficiency 
of the system. However, the quality and efficiency 
of  the  judiciary  continue  to  pose  challenges,  with 
large backlogs and long disposition times. 

strategic  planning. 

Implementation of the recommendations on the 
financial  sector  came  with  some  drawbacks.  In 
2014, the comprehensive portfolio screening of the 
banking  sector  confirmed  its  robustness,  and  the 
some  identified  weaknesses  have  been  addressed. 
The  share  of  non-performing 
loans  remains 
relatively high, but they are well provisioned, and 
their sale has accelerated lately. The conversion of 
Swiss franc loans into euros hit the profitability of 
the  banking  sector,  and  may  have  damaged  legal 
certainty. 

Overall,  Croatia  has  made  limited  (7)  progress 
in addressing the 2016 recommendations. In the 
context of two parliamentary elections in less than 
one  year,  Croatia  undertook  limited  policy  action. 
There  has  been  some  progress  with  public  debt 
management and the introduction of a simple form 
of  recurrent  property  taxation,  envisaged  as  of 
2018.  Furthermore,  the  2017  tax  reform  included 
provisions on tax deductibility for writing off non-
performing loans, which is expected to help banks 
improve their asset quality. 

(6)  For  the  assessment  of  other  reforms  implemented  in  the 

past, see in particular section 4.  

(7)  Information  on  the  level  of  progress  and  actions  taken  to 
address  the  policy  advice  in  each  respective  subpart  of  a 
CSR is presented in the overview table in the Annex.  

10 

 
 
                                                           
                                                           
2. Progress with country-specific recommendations 

Table 2.1: 

Summary table on 2016 CSR assessment 

* This overall assessment of CSR1 does not include an assessment of compliance with the Stability and Growth Pact. 
Source: European Commission 

11 

Croatia Overall assessment of progress with 2016 CSRs:  Limited CSR 1: 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. (MIP relevant)` Limited progress*   Limited progress in reinforcing fiscal rules and strengthen the Fiscal Policy Commission.  Limited progress in improving budgetary planning and the multi-annual framework.  Some progress in reforming recurrent taxation.  Some progress in reinforcing the public debt management framework and adopting a debt management strategy. CSR 2: 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. (MIP relevant) No progress  No progress in reforming the pension system.  Limited progress in providing up- and re-skilling measures  No progress in improving the social protection system.  CSR 3: 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 social partners, harmonise the wage-setting frameworks across the public 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. (MIP relevant) Limited progress  Limited progress in reforming the public administration.  No progress in harmonising the wage-setting frameworks.  Limited progress in improving the corporate governance of SOEs and the divestment process of state assets. CSR4: Significantly reduce parafiscal charges. Remove unjustified regulatory restrictions hampering access to and the practice of regulated professions. Reduce the administrative burden on businesses. (MIP relevant) Limited progress  Limited progress in reducing parafiscal charges.  Limited progress in removing regulatory restrictions.  Limited progress reducing administrative burden. CSR 5: 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. (MIP relevant) Limited progress  Limited progress in improving the justice system.  Some progress in facilitating the resolution of NPLs.   
 
 
 
 
 
2. Progress with country-specific recommendations 

12 

 
 
 
 
 
 
3.  SUMMARY OF THE MAIN FINDINGS FROM THE MIP IN-

DEPTH REVIEW 

The  2017 Alert  Mechanism  Report  called  for  a 
new  in-depth  analysis  to  monitor  progress  in 
unwinding  the  excessive  imbalances  identified 
in previous years. In March 2016 the Commission 
concluded that Croatia was experiencing excessive 
macroeconomic  imbalances  and  called  for  a  new 
in-depth review to examine further the persistence 
of  macroeconomic  risks  and 
its 
progress 
imbalances. 
These  are  mainly  related  to  the  high  levels  of 
external 
largely 
and  domestic  debt,  both 
denominated  in  foreign  currency,  in  a  context  of 
low potential output growth. 

in  unwinding  excessive 

to  monitor 

identified 

This report provides the in-depth review of how 
the 
imbalances  have  developed. 
Analysis  relevant  to  the  review  is  found  in  the 
following sections:  

  government debt is analysed in section 4.1;  

  private  sector debt and  the  financial  sector are 

discussed in section 4.2;  

 

labour market is analysed in section 4.3;  

  business  environment  and  investment,  and 
public sector governance — all issues relevant 
to  addressing  the  low  productivity  growth  — 
are  discussed 
in  chapters  4.4  and  4.5 
respectively. 

3.1. 

IMBALANCES AND THEIR GRAVITY 

are 

challenges 

After  6  years  of  rapid 
increase,  general 
government debt is projected to have shrunk to 
in  2016.  Long-term  debt 
84.1 %  of  GDP 
sustainability 
considered 
manageable,  but  vulnerability  remains  substantial 
in the medium term. The debt ratio has diminished 
in  the  last year, but it  does not decrease  under  all 
envisaged  scenarios  and  debt  levels  are  likely  to 
remain high in the coming years. Moreover, a large 
share  of  the  public  debt  is  exposed  to  currency 
risks.  This  concerns  both  the  part  of  public  debt 
held  by  foreign  investors  (35 %  of  GDP)  and  the 
domestic  debt  denominated  or  indexed  in  EUR 
(37 % of GDP).  

Private sector debt is projected to have shrunk 
to  115 %  of  GDP  by  mid-2016,  but  it  remains 
heavily  exposed  to  currency  risks.  A  number  of 
sectors 
(notably  construction)  appear  over-
indebted. More than half of corporate debt is cross-
border  lending,  thus  subject  to  currency  risk.  On 
the  other  hand,  part  of  cross-border  debt  (about 
13%  of  GDP  in  2015)  consists  in  inter-company 
loans,  typically  less  exposed to  re-financing  risks.  
Moreover, at least 18% of the remaining domestic 
corporate  debt  is  also  exposed  to  currency  risks. 
While  household  debt  stood  at  a  moderate  36.5% 
of  GDP  by  mid-2016,  more  than  half  of  it  was 
contracted  domestically  but  in  foreign  currency, 
mostly euros.  

The financial system has withstood the financial 
crisis  and  the  rapid  accumulation  of  non-
performing  loans,  but  remains  exposed  to  the 
credit  risks  of  its  unhedged  borrowers.  By 
September  2016,  the  share  of  non-performing 
loans remained at 14.7 % but impaired assets were 
well  covered.  Direct  exposure  of  the  financial 
sector  to  currency  risk  was  limited,  although  the 
largely unhedged  foreign  currency  exposure  of  its 
household and corporate clients represents a source 
of  vulnerability.  The  tight  management  of  the 
exchange  rate  has  been  successful  in  managing 
these risks. 

High  corporate  and  government  debt  are 
reflected  in  a  high  level  of  external  debt  and  a 
negative  net  international  investment  position. 
The  excess  of  investment  over  domestic  savings 
has  resulted  in  the  accumulation  of  sizeable 
external  liabilities.  However,  by  mid-2016  gross 
external  debt  had  shrunk  to  about  97 %  of  GDP, 
while  the  net  international  investment  position 
stood  at  -75 %  of  GDP.  Risks  related  to  the  high 
share  of  external  liabilities  are  mitigated  by  the 
significant share of inter-company lending; on the 
other  hand  almost  one  third  of  external  debt  is  in 
the form of government securities.   

Potential  output  growth  remains  low  due  to 
weak labour utilisation and subdued growth in 
productivity. At the end of 2015, the participation 
rate  of  66.8 %  (age  group  15-65)  was  one  of  the 
lowest  in  the  EU.  This  is  mostly  due  to  low 
activity rates among prime-age men. In spite of the 

13 

 
 
3. Summary of the main findings from the MIP in-depth review 

investment,  but  is  not  targeted  at  low  income 
households,  nor  at  making  work  pay  for  the  low 
skilled. 

in  kuna 

loans.  By  mid-2016 

Household  deleveraging  picked  up  steam  in 
2016  on  the  back  of  higher  growth,  valuation 
effects and the legislated conversion of the Swiss 
the 
franc  mortgage 
household  debt  was  estimated  to  have  further 
contracted by some 2.5 pps of GDP. The impact of 
transactions  turned  broadly  neutral  due  to  a  slight 
pick-up 
loans.  The  strong  growth 
performance  in  the  first  half  of  the  year  also 
contributed  to  the  acceleration  of  deleveraging. 
The main driver, nevertheless, was the reduction in 
debt  owed  to  credit  institutions  arising  from  the 
statutory  conversion  of  Swiss  franc-indexed  loans 
to  euro-denominated  loans.  The  impact  on  banks' 
balance  sheets  was  estimated  at  roughly  2.3 %  of 
GDP  up  to  the  first  quarter  of  2016  (see  below), 
but  this  figure  also  includes  the  sale  of  non-
performing loans. The impact on household debt is 
therefore  lower.  The  appreciation  of  the  kuna 
exchange  rate  also  helped  households  with  euro 
denominated  debt  by  reducing  the  value  of  their 
outstanding liabilities. 

The  total  indebtedness  of  the  non-financial 
corporate sector continued to decline in the first 
half of 2016. By mid-2016, consolidated corporate 
debt  is  estimated  to  have  further  contracted  by 
around  2.5  pps  of  GDP.  The  contribution  of 
transactions was broadly neutral. Valuation effects, 
largely  driven  by  the  appreciation  of  the  kuna 
against  the  euro  played  a  significant  role,  but  the 
bulk  of  the  reduction  was  delivered  by  the 
acceleration  of  growth.  The  reduction  in  external 
debt, partly driven by debt-to-equity swaps was the 
main driver of the reduction in indebtedness. In the 
the 
current 
repayment  burden  has 
considerably. 
fluctuations 
to 
Exposure 
nevertheless  remains  high  as  external  debt  still 
amounts  to  39.8 %  of  GDP  and  domestic  debt 
contracted  in  foreign  currency  amounts  to  at  least 
16.2 % of GDP.  

rate  environment, 

eased 
rate 

exchange 

interest 

low 

In  2015,  banks’  profitability  was  severely 
affected by the conversion of Swiss franc loans, 
but  it  has  now  recovered.    The  aforementioned 
conversion  of  the  Swiss  franc  loans  resulted  in 
bank  losses  that  are  estimated  at  HRK  7.6  billion 
(or  2.3%  of  GDP).  The  banks  nevertheless 

has 

productivity,  TFP) 

low participation, the unemployment rate was still 
high  at  16.5 %,  particularly  for  young  people 
(43 % in the age bracket 15 to 24) and for the low 
skilled  (22.8 %).  Productivity  (measured  as  total 
factor 
contributed 
negatively  to  growth  over  the  past  6  years,  but  it 
was  registering  rather  sluggish  growth  rates  even 
productivity 
crisis.  Adverse 
before 
developments  are 
in  weak  business 
rooted 
environment  and  public  sector  governance,  which 
prevent  a  more  efficient  allocation  of  resources 
throughout  the  economy.  Croatia’s  low  potential 
resolution  of  stock 
the 
growth 
imbalances and amplifying related vulnerabilities.  

is  slowing 

the 

3.2. 

EVOLUTION, PROSPECTS, AND POLICY 
RESPONSES  

The  general  government  deficit  is  projected  to 
have shrunk further in 2016, while the debt-to-
GDP ratio has moved onto a declining path. In 
2015, Croatia significantly cut the headline deficit. 
The strengthening of the recovery in 2016 resulted 
in  windfall  revenue  gains  which,  together  with 
contained  expenditure  growth,  resulted 
in  a 
projected headline deficit of just above 2 %.  This 
lower  deficit,  combined  with  the  acceleration  of 
growth and exchange rate-related valuation effects, 
is  projected  to  have  led  to  a  slight  decline  in  the 
debt-to-GDP  ratio  to  84.1  %.  This  trend  is 
expected  to  continue  thanks  to  the  improved 
macroeconomic  situation.  Moreover,  the  current 
low 
lowering 
rate  environment 
refinancing costs. Vulnerabilities linked to the high 
currency exposure of public debt remain. The debt 
sustainability  analysis  reveals  that  short  and  long 
term sustainability risks are low, but the medium-
term  risk  is  high,  albeit  with  some  improvements 
since  2015.  The  outlook  of  the  sovereign  credit 
rating  has  improved,  but  retains  a  non-investment 
grade. 

interest 

is 

The  recently  adopted  tax  reform  will  boost 
investment  and  consumption,  but  will  also 
result  in  a  deterioration  of  the  public  finances. 
The  reform  lowers  the  corporate  and  personal  tax 
rates  and  aims 
to  simplify  procedures  and 
modernise  the  tax  administration.  The  expected 
direct  budgetary  effect  of  the  reform  is  a  revenue 
reduction  of  0.6  %  of  GDP  in  2017  and  an 
additional  0.2  %  in  2018.  The  reform  is  expected 
to  have  a  positive  impact  on  consumption  and 

14 

 
3. Summary of the main findings from the MIP in-depth review 

regional peers remains wide in almost all sectors of 
the  economy.  The  main  difference  is  related  to 
poor  allocative  efficiency,  as  the  less  productive 
firms  appear  to  be  growing  faster  than  the  more 
productive  ones.  Excessive  red 
tape,  sector-
specific  bottlenecks  and  limited  access  to  finance 
for  small  firms  constrain  the  free  flow  of  labour 
and  capital  to  where  they  could  be  used  most 
efficiently. 

Graph 3.1: 

Level and change in net international 
investment position 

by 

the 

progressive 

remained  well  capitalised  and  the  quality  of  their 
assets  is  improving.  Overall,  proportion  of  non-
performing  loans  fell  to  below  15%  by  Q3-2016, 
the  lowest  in  3  years.  Accelerated  sale,  also 
motivated 
automatic 
provisioning  imposed  by  the  Central  Bank,  is  the 
key  driver  behind  this  sharp  reduction.  The  tax 
reform  includes  provisions  on  tax  treatment  of 
writing off such loans, and this may help improve 
the  quality  of  banks’  assets  further.  The  amended 
corporate and personal insolvency frameworks are 
starting to deliver results, but in the absence of an 
adequate  monitoring  system  it  is  difficult  to 
quantify  to  which  extent  they  are  contributing  to 
the deleveraging process. 

The  simultaneous  deleveraging  of  households, 
government and businesses is resulting in large 
current  account  surpluses  and  the  progressive 
reduction  of  external  liabilities.  The  current 
account is set to deteriorate slightly in 2016 due to 
a  surge  in  profits  in  the  largely  foreign-owned 
banking  sector,  while  still  maintaining  a  solid 
surplus (2.8 % of GDP). By mid-2016, the external 
debt  had  decreased  by  about  6.5 %  of  GDP.  The 
deleveraging  was  mainly  intermediated  by  the 
financial  sector,  but  was  also  driven  by  the  direct 
external  deleveraging  of  the  government  and  the 
corporate  sector.  The  valuation  effects  mentioned 
above,  largely  related  to  the  appreciation  of  the 
kuna,  reduced 
the  outstanding 
the  value  of 
liabilities. These improvements carried over to the 
investment  position,  which 
net 
improved by a broadly similar magnitude. The net 
international  investment  position  to  GDP  ratio 
nevertheless  remains  far  more  negative  than  the 
prudential threshold level (-35 % of GDP).  

international 

Unemployment  has  declined  sharply,  although 
mostly due to the shrinking labour force. In the 
fourth quarter of 2016, the unemployment rate fell 
to  11.4 %,  from  15.6 %  in  the  previous  year. 
Whereas job creation intensified, more than half of 
the contribution to this decline came from a further 
contraction  of  the  labour  force  caused  by  adverse 
demographic  dynamics,  reduced  activity  and  net 
migration outflows.  

The  contribution of total  factor  productivity  to 
potential  growth  has  turned  slightly  positive  in 
2016,  but  market  inefficiencies  still  constrain 
Croatia’s potential growth. On average, firms are 
improving  their  productivity,  but  the  gap  with 

(1) Net transaction effect corresponds to Financial Account 
balance, net of investment income, i.e. the sum of trade 
balance and capital transactions. 
Source: CNB, Eurostat 

to 

Structural  reforms  are  needed  to  tackle  the 
bottlenecks  in  productivity  growth,  but  the 
reform  agenda  has  broadly  stalled.  The 
withdrawal  of  parliamentary  support 
the 
government in the summer 2016 was followed by a 
new  general  election  in  September  2016.  This 
prolonged  the  standstill  in  reforms  that  started  in 
the  run-up  to  the  parliamentary  elections  of 
November 2015. As a result, few of the ambitious 
policy  commitments  put  forward  in  the  national 
reform  programme  submitted  by  the  Croatian 
authorities  in  April  2016  have  been  implemented 
to  date.  The new  government  has  yet  to  present  a 
detailed structural reform programme.  

3.3.  OVERALL ASSESSMENT 

The  unwinding  of  debt  related  sources  of 
imbalances  is  accelerating  on  the  back  of 
stronger  economic  growth,  but  vulnerabilities 
persist.  Robust  growth  in  2016  is  helping  the 

15 

-120-100-80-60-40-200-40-30-20-10010203004050607080910111213141516Change in pp. of GDP (y-o-y)Valuation changesNet transaction effect (rest FA bal.)Investment income effectNominal growth effectChange in NIIPNIIP 
 
3. Summary of the main findings from the MIP in-depth review 

to  ensure  a  durable  adjustment  of  debt-related 
imbalances.  

investment 

deleveraging  and  both  public  and  private  debt  is 
now  on  a  declining  path.  As  a  large  share  of  the 
debt is denominated in foreign currency, the kuna's 
ongoing appreciation is also reducing the value of 
the  outstanding 
liabilities.  The  simultaneous 
deleveraging  of  the  private  and  public  sector  is 
reducing external liabilities and improving the net 
position.  Whereas 
international 
valuation  effects  are  currently  helping 
the 
deleveraging  process,  they  also  point  to  the 
economy’s 
rate 
fluctuations.  This  reinforces  the  need  for  the 
central  bank  to  pursue  its  policy  of  tightly 
managing  the  exchange  rate.  It  also  calls  for 
policies  aimed  at  maintaining 
regained 
competitiveness,  while  avoiding  macro  and  fiscal 
measures that could undermine the current account 
balance. 

sensitivity 

exchange 

the 

to 

The  financial  sector  is  well  capitalised  and  the 
quality  of  banks’  assets  is  improving,  but 
exposure  to  indirect  credit  risk  remains.  Banks 
are  accelerating  the  resolution  of  impaired  assets, 
and  improving  the  quality  of  their  portfolios. 
Profitability  indicators  are  also  improving.  The 
financial  sector  remains  indirectly  exposed  to 
currency  risk  due  to  loans  contracted  in  foreign 
currency  in  the  household  and  corporate  sector. 
The  indirect  risks  are  mitigated  by  the  tightly 
managed rate of the kuna against the euro. 

In  the  long  run  the  resolution  of  stock-related 
imbalances  is  threatened  by  the  low  potential 
growth. A lasting adjustment, however, requires a 
prolonged  period  of  sustained  economic  growth. 
Growth  is  projected  to  remain  robust  over  the 
forecast  period,  at  well  above  the  economy’s 
the  long  run,  however, 
current  potential.  In 
maintaining  current  growth  rates  will  require  the 
root causes of the low growth potential — namely 
the 
sluggish 
productivity growth — to be tackled. 

shrinking 

labour 

force 

and 

Progress  with  implementing  growth  enhancing 
structural reforms has been limited. The core of 
Country  Specific  Recommendations  addressed  to 
Croatia  was  aimed  at  boosting  employment  and 
productivity  by  removing  disincentives  to  labour 
supply  and  improving  the  business  environment. 
As  discussed  in  the  previous  section,  there  has 
been  only  limited  progress  in  implementing  the 
policies. Resuming the reform agenda will be key 

16 

 
3. Summary of the main findings from the MIP in-depth review 

Table 3.1: 

MIP Matrix 

(Continued on the next page) 

17 

 Gravity of the challenge Evolution and prospects Policy response Imbalances (unsustainable trends, vulnerabilities and associated risks) Public debt Between 2008 and 2015 public debt rose from 39.6 % to 86.7 % of GDP due to the large government deficit and the materialisation of contingent risks related to state-owned enterprises.  A large share of the government debt is denominated or indexed to foreign currency (mostly euro), entailing exchange rate risk.  In line with the large public debt, debt sustainability analysis indicates that risks will remain high in the medium term (see Section 4.1). The general government deficit has contracted substantially in 2015 and again in 2016, but the adjustment has relied strongly on lower public investment, with possible impact on long-term growth. Public investment rebounded in 2016 in line with better absorption of EU funds. The debt-to-GDP ratio is projected to have declined to about 84.1 % of GDP in 2016 due to the lower deficit, a rebound in the growth and favourable valuation effect resulting from the kuna appreciation, and is set to further decline over the forecast period. The authorities have completed a new draft of the Fiscal Responsibility Act. In addition, the amendments to the Budget Act in relation to the revision and execution of the budget are being prepared, including rules on reallocating funds within or across budget lines.  The previous debt management strategy that expired in 2013 is now replaced by a new one for the upcoming 2017-2019 period. No other measures have been taken to strengthen the debt management function or improve the framework. Steps were taken to reduce compliance risks related to VAT refunds and the application of the reverse charge mechanism. A compliance risk management system is being developed. The reform of personal income tax was implemented. It is set to further reduce the already small share of personal income tax revenue. Household and corporate debt and the financial sector Household and corporate debt increased rapidly in the previous decade reaching a peak of 42% and 83.2% of GDP by the end of 2010. By the end of 2015, corporate and household debt stood at 76 % and 39.0 % of GDP, respectively.  The banking sector has suffered significant losses due to the conversion of Swiss franc household loans into euros, but bank profitability is recovering and the sector remains relatively well capitalised and liquid.  At around 15 %, the rate of non-performing-loans is still relatively high. It stems mainly from the corporate debt (especially construction sector).  Around 63 % of household debt and almost 80 % of corporate debt is denominated in euro. Both corporate and household deleveraging accelerated during 2016, mainly thanks to higher growth and the conversion of Swiss franc loans. Deleveraging pressures in both the household and corporate sector are set to abate in the context of low interest rates. Credit is projected to enter a mild expansionary phase.  Non-performing loans of corporates are decreasing mostly because of the marked sell-off.   The authorities plan to facilitate the write-off of non-performing loans through the tax deductibility provisions. The implementation of the revised corporate insolvency legislation resulted in the bankruptcy of thousands of illiquid companies without assets. The authorities also plan to step up the monitoring of the reformed corporate and personal insolvency framework in order to assess its effectiveness.   
 
 
 
 
3. Summary of the main findings from the MIP in-depth review 

Table (continued) 

Source: European Commission 

18 

External liabilities and trade performance The current account improved from a record deficit of 9 % of GDP in 2008 to surplus in 2013. Gross external debt continued to increase up to mid-2015 due to government borrowing, reaching 114 % of GDP.  In 2015 the net international investment position decreased to around 76 % of GDP, while gross external debt declined to 104 % of GDP. External debt is almost exclusively foreign denominated (in euro), which adds to the currency risk exposure of domestic debt. The trade performance has improved significantly following EU-accession. Croatia has regained most of its previously lost market shares (+8 % between 2013 and 2015). The export of services has also been very strong due to solid growth in the tourism sector.  The current account is projected to record a solid surplus position over the forecast period, partly due to increasing absorption of EU funds.  The net international investment position is projected to further improve over the forecast period, thanks to falling external debt liabilities, the improved macroeconomic scenario and the appreciation of the kuna. Further reduction in external debt is also projected over the forecast period, but external sustainability remains vulnerable to shocks in exchange and interest rates The simplification of administrative procedures for imports and exports is helping reduce transaction costs, though Croatian firms are still burdened by costly administrative procedures.  Weaknesses in the business environment remain, limiting Croatia' attractiveness for foreign direct investment and increasing the costs of doing business for Croatian firms. Most reform initiatives aimed at improving the business environment have been largely delayed due to the political instability in 2016.    Potential output The low potential growth has contributed to exacerbate the challenges linked to the high debt in the public and private sector.  The contribution of total factor productivity has remained negative. Low labour utilisation and sluggish productivity are weighing on potential growth, undermining the durability of the adjustment process.  The crisis led to intense shedding of labour and the unemployment rate reached 18 % towards the end-2013. At 15.7%, the unemployment rate in 2015 was well above the EU average, and it combined with one of the highest inactivity rates in the EU. Low labour utilisation is weighing on potential growth, undermining the durability of the adjustment process.  The contribution of total factor productivity is set to return to positive, remaining however low for a catching-up economy. The unemployment rate fell by about 3.5 pps in 2016. Employment grew by an estimated 1.8 %, but new jobs are mostly on temporary basis. Most of the drop in the unemployment rate, however, was driven by a contraction of the labour force. Activity rates continue to decline fast after the age of 50 as recourse to early retirement is still widespread.  Over the past few years wages have reversed the rapid growth seen before the crisis. They are now projected to start growing again, though so far broadly in line with productivity increases.  The labour market has been made more flexible by the 2013 and 2014 reforms, but the increasing weight of temporary employment is a source of concern. The government had undertaken a review of wage-setting in the broader public sector (including state-owned enterprises), but has so far failed to propose reform measures. The adoption of the new Act on Public Sector Wages has been postponed by more than 2 years.  Some steps have been taken in simplifying the business environment, including the reduction of parafiscal charges. The implementation of most of the related measures, however, registers significant delays (see Section 4.4).    Conclusions from IDR analysis  The economy is burdened by a high stock of public and private sector debt that is constraining investment and the ability of fiscal policy to respond to cyclical downturns. The large share of foreign currency-denominated debt amplifies vulnerability to financial markets' volatility. Despite the recent losses, the financial sector remains well capitalised, although the rate of non-performing loans remains high. The net international investment position and the external debt are high, contributing to the vulnerability of the economy. Persistently low activity rates and the high unemployment rate are holding back the growth potential, while the high share of temporary employment exposes the economy to large fluctuations in employment levels.  Deleveraging pressures are set to abate and credit is expected to start growing again, partly due to the declining rate of non-performing loans.  The acceleration of the economic recovery is nevertheless expected to contribute to a further mild reduction in the private debt-to-GDP ratio, while as of 2016 the ratio of public debt to GDP is on a declining path. The current account is expected to remain positive and to support further reduction in external debt.   The Central bank's policies have contributed to preserving macro-financial stability and – together with the reform of insolvency procedures – accelerating the resolution of banks' impaired assets. Enhanced labour market flexibility is underpinning a relatively job-rich growth. Policy action is needed in order to ensure a lasting correction of the primary balance. With investment growing again, an increase in potential growth could be supported by improving the business environment and addressing the low activity rates.   
 
 
 
4.  REFORM PRIORITIES 

4.1.  PUBLIC FINANCES 

for 

Until  2015,  widening  general  government 
deficits led to a substantial increase in the stock 
of  public  debt.  With  cyclically-adjusted  deficits 
averaging  above  5 %  of  GDP  in  the  period  2004-
2009,  Croatia  entered  the  recession  with  limited 
room 
fiscal  manoeuvre.  The  protracted 
recession  depressed  revenue  collection,  which 
resulted  in  soaring  deficits  in  the  period  2009-
2014.  In  addition  to  deficits  in  the  state  budget, 
public  debt  was  significantly  affected  by  off-
budget 
the  rising  net 
borrowing  of  SOEs  classified  in  the  general 
government  sector  and  the  take-up  of  debt  by  the 
state  upon  repeated  calls  on  guarantees  to  public 
corporations  (together  averaging  1.4 %  of  GDP 
annually  in  this  period)  (European  Commission, 
2016, p. 14). As a result, general government debt 
rose  from  39.6 %  in  2008  to  86.7 %  of  GDP  in 
2015. 

transactions, 

including 

The  increase  in  debt  contributed  to  a  build-up 
the 
of  foreign  currency  exposure.  Against 
background  of  limited  absorption  of  debt  by  the 
domestic market, almost 40 % of the debt that was 
accumulated  during  the  crisis  was  issued  abroad. 
Furthermore,  the  most  of  the  general  government 
debt held domestically was issued in or indexed to 
the  euro,  reflecting  the  high  euroisation  of  the 
economy.  This  resulted  in  growing  exposure  of 
public finances to foreign exchange risks. 

to 

The  general  government  deficit  decreased 
markedly  in  2015-2016  on  the  back  of  strong 
economic  growth  and  expenditure  restraint. 
Between  2014  and  2015,  the  general  government 
deficit decreased from 5.4 % to 3.3 % of GDP and, 
according 
the  Commission's  2017  winter 
forecast,  improved  further  to  1.8 %  of  GDP  in 
2016. The deficit reduction was achieved through a 
combination  of  windfall  revenues  stemming  from 
stronger-than-expected  economic  growth  and 
expenditure restraint facilitated by the presence of 
caretaker  governments  with  no  legislative  powers 
during  much  of  the  year.  The  restraint  no  longer 
affected  public 
the  contrary, 
investment.  On 
backed  by  a  stronger  uptake  of  EU  funds 
(estimated at +20 %), public investment rebounded 
by  an  estimated  16 %  after  it  was  heavily  cut  in 
2010  (by  almost  40%)  in  an  effort  to  contain 

soaring  public  spending,  and  increasing  only 
moderately thereafter.  

Graph 4.1.1:  General government debt by currency and 

market of issuance 

(1) FC = foreign currency, of which most is in EUR 
Source: Croatian National Bank, European Commission 

effect. 

Furthermore, 

The  reduction  in  deficit  and  strong  growth 
drove  the  debt  ratio  to  decrease  for  the  first 
time since 2007. In addition to low deficits, which 
reduced  the  need  to  issue  new  debt,  strong  GDP 
growth  helped  decrease  the  debt  ratio  through  a 
denominator 
the 
aforementioned  high  exposure  of  Croatia's  public 
debt  to  the  euro  had  a  positive  effect,  as  the 
appreciation of the kuna (slightly above 1 %, from 
end-2015 
the 
reduction of the debt ratio (by an estimated 0.7 % 
of GDP in 2016) (see Graph 4.1.2). Thus, general 
government debt is estimated to have decreased to 
84.1 % of GDP in 2016 and is projected to decline 
further to 81.3 % of GDP by 2018. 

to  end-2016),  also  supported 

The  structure  of  public  expenditure  does  not 
provide  sufficient  support  to  growth  and  jobs. 
A  comparatively  high  intermediate  consumption 
and  wage  bill  add  up  to  almost  one  fifth  of  the 
country's GDP, which makes the functioning of the 
government  costly  in  comparison  to  comparable 
countries in the region, as well as the EU average 
(see Graph 4.1.3). Considering in addition the still 
high costs of debt servicing, this leaves little fiscal 
space  to  finance  productive  investment,  education 
or  social  spending,  which  is  facing  demographic 

19 

01020304050607080901000304050607080910111213141516*% of GDPDomestic debt in HRKDomestic debt in FCExternal debt in FC 
 
 
4.1. Public finances 

pressures.  Therefore,  improving  the  efficiency  of 
spending  through  structural  measures  remains  a 
challenge for fiscal policy in the near term. 

although  this  does  in  principle  not pose  a  risk  for 
the deficit as they tend to be matched by a similar 
overestimation on the expenditure side. 

Graph 4.1.2:  Contributions to yearly change in debt to GDP 

Graph 4.1.3:  Expenditure on the wage bill and intermediate 

and total debt to GDP 

consumption compared to peers 2016 

(1) * based on European Commission's winter forecast 
Source: Eurostat, CNB and Winter Forecast  

Source: Eurostat, European Commission winter forecast  

on 

for 

The  medium  term  budgetary  framework  is 
expected  to  be  strengthened  soon,  while  the 
credibility  of  budgetary  targets  varies  across 
items.  The  new  fiscal  responsibility  act  should 
soon be adopted. It is intended to transpose the EU 
Directive 
budgetary 
requirements 
frameworks of the Member States (Council, 2011), 
including  the  strengthening  of  the  autonomy  and 
role  of  the  Fiscal  Policy  Commission.    The 
adoption of a new budget act is also expected, with 
the aim of making the budgetary framework of the 
central  and 
local  government  more  binding, 
namely by qualifying the conditions under which a 
departure  from  the  set  deficit  target  is  permitted. 
This  is  set  to  help  reduce  the  frequency  and 
significance  of 
targets 
the  revisions 
throughout the year that was observed in the past. 
Still, in order to enhance the robustness of annual 
and multiannual budgetary planning and execution, 
ensuring  the  quality  of  the  underlying  projections 
remain important pre-requisites. In 2015 and 2016, 
the 
the  growth  surprise  explains  much  of 
discrepancies  between  projections  and  execution 
on 
side.  However,  budgetary 
projections  for  items  like  corporate  income  tax 
revenues  (underestimated  by  16 %)  and  dividends 
from  entities  within  the  public  sector  could  be 
improved.  Revenues 
from  EU  grants  are 
continuously  over-estimated  (see  Graph  4.1.4), 

revenue 

the 

the 

to 

income 

in  shared  personal 

The  expansionary  2017  state  budget  relies  on 
strong  take-up  of  EU  funds.  In  spite  of  strong 
growth,  the  budget  projects  modest  growth  in  tax 
revenues  (ca.  1.5 %),  largely  due  to  the  negative 
impact of the tax reform, estimated at HRK 2 bn in 
2017  (this  represents  0.6  %  of  GDP  or  2.8 %  of 
2016  tax  revenues).  Meanwhile,  the  budgeted 
expenditure - net of increases in transfers from the 
central to the local government to compensate for 
tax  revenue 
loss 
resulting  from  the  tax  reform  -  is  planned  to 
increase  by  6 %.  Approximately  half  of  the 
projected increase is expected to be deficit-neutral 
as  it  is  intended  to  be  conditional  upon  financing 
from  external  sources  (largely  EU  funds).  The 
wage  bill  is  set  to  grow  by  3.7 %  as  the  terms  of 
the  collective  agreement  were  renegotiated  with  a 
part  of  public  sector  employees.  Intermediate 
consumption is also projected to grow substantially 
(ca.  14 %),  although  much  of 
the  projected 
increase should be deficit-neutral as it is projected 
to  be  financed  from  EU  funds.  Sources  of  risk  to 
the budget include the estimation of the impact of 
the  tax  reform  and  a  further  increase  in  the  wage 
bill resulting from the possible renegotiation of the 
collective  agreement  with 
the 
employees  in  the  public  sector.  The  coverage  of 
the state budget was expanded to include two more 
agencies, with a minor and largely equal impact on 

rest  of 

the 

20 

-6-4-20246810120304050607080910111213141516*17*18*pps.Primary deficitInterestReal growthInflationStock-flow adjust.Debt/GDP, change02468101214161820HRHUSIPLEU28CZSKBGRO% of GDPWage billIntermediate consumption 
 
 
4.1. Public finances 

Graph 4.1.5:  Gross public debt under different scenarios 

both revenue and expenditure. This is welcome as 
it  brings  the  coverage  closer  to  that  of  central 
government in ESA 2010 terms. Nevertheless, the 
budget  still  does  not  feature  an  ESA-based  target 
(neither  for  the  central  government  nor  for  the 
general government as a whole).  

Graph 4.1.4:  Budget revenue from EU grants: projections, 

revisions and execution 2014-2017 

(1) Last budget revisions were in November (2014 & 2016) 
and September 2015 
Source: Official gazette, European Commission estimate (for 
2016 execution) 

The 

for 
government 

Refinancing risks in the short term appear low. 
Although public debt moved onto a declining path 
in  2016,  at  a  projected  84.1 %  of  GDP  it  still 
the  Croatian 
represents  a  vulnerability 
economy. 
borrowing 
requirements  were  met  without  major  difficulties 
in  2016,  partly  thanks  to  ample  liquidity  in  the 
financial  sector  coupled  with  the  current  low 
interest  rate  environment.  Overall,  short-term 
fiscal  risks  stemming  from  the  fiscal  and  broader 
macro-financial  conditions 
in  Croatia  have 
significantly  decreased  since  the  aftermath  of  the 
crisis, and appear now contained. Similarly, two of 
the leading rating agencies have recently improved 
the  outlook  for  Croatia's  sovereign  credit  rating, 
which  might  imply  lower  financing  costs  in  the 
near  future.  However,  with  refinancing  needs  due 
to  maturing  debt  being  higher  in  2017,  risks  may 
increase  if  the  interest  rate  and  exchange  rate 
environment becomes more adverse. 

(1) Baseline scenario: no policy change  
Interest rate shock scenario: Standardised (permanent) 
positive shock to the short- and long-term interest rates on 
newly issued and rolled over debt 
Inflation/GDP growth scenario: Standardised (permanent) 
positive shock on inflation or GDP growth yield the same 
outcome 
kuna depreciation scenario: Sensitivity test on the HRK 
depreciation vis-à-vis euro (-5% in 2017 and 2018) 
Source: European Commission 

Croatia’s fiscal sustainability risk is expected to 
remain high in the medium term. The improved 
budgetary position implies that the improvement in 
the  structural  primary  balance  over  2019-2023 
needed to reduce the debt-to-GDP ratio to 60 % of 
GDP  by  2031  has  significantly  declined  (from  a 
cumulative  4.5 %  of  GDP  last  year  to  3.2 %  of 
GDP).  However,  sensitivity  analysis  of  the  public 
debt  trajectory  under  alternative  scenarios  (see 
Graph 4.1.5) still points to high sustainability risks 
in  the  medium  term.  Based  on  the  Commission's 
2017  winter  forecast,  and  under  normal  economic 
conditions with no change of fiscal policy after the 
forecast period, the public debt ratio is projected to 
fall until 2018 but start increasing again after that, 
reaching  93 %  of  GDP  in  2027.  Assuming  full 
compliance with the fiscal effort recommended by 
the Council and achievement of Croatia’s medium-
term  objective  of  a  structural  balance  of  -1.75 % 
thereafter, the debt ratio would continue falling, to 
78.5 %  of  GDP  in  2027.  By  contrast,  under  more 
unfavourable  assumptions  on  interest  rates  and 
exchange  rates,  the  debt  ratio  would  increase  to 
over 90 % of GDP, which is the critical threshold 
for considering a certain scenario to be high risk. 

Currency  risk  exposure  is  mitigated  by  the 
monetary  policy  implemented  by  the  Croatian 

21 

0246810122014201520162017bn HRKExecutionInitial budgetLast revision758085909510010520142017202020232026% of GDPBaselineSGP scenarioInterest rate shock (+1p.p.)Inflation or GDP growth (+0.5p.p.)Kuna depreciation 
 
 
4.1. Public finances 

rationalisation  of  corporate  income  tax  (CIT),  a 
one-off  incentive  for  the  writing-off  of  non-
performing  loans,  changes  in  the  VAT  categories 
and  the  basis  for  the  future  introduction  of  the 
recurrent property taxation. 

income 

tax  reform 

The  personal 
further 
narrows  the  tax  base.  As  described  in  Table 
4.1.1,  the  brackets  of  the  personal  income  tax 
(PIT)  were  reduced  from  three  (12%,  25%,  40%) 
to two (24% and 36%) and the personal allowance 
was  significantly  increased  (from  a  threshold  of 
HRK  2 600  to  HRK  3 800).  Other  changes  in  the 
PIT 
for 
include  a  more  progressive  scale 
expanding  the  personal  allowance  for  dependent 
children and the narrowing of eligibility criteria for 
other  supported  family  members.  Social  security 
contributions for “other income” – i.e. non regular 
income  from  employment  and  self-employment  – 
have also been cut. As a consequence, the number 
of  persons  that  will  no  longer  pay  any  PIT  will 
increase  by  560 000,  reaching  1.5  million  (more 
than  half  of  all  persons  with  income),  while 
higher-income  earners  will  face  a  significantly 
lower tax liability (further discussed in box 4.3.1). 
According  to  the  authorities,  the  PIT  reform 
reduces  tax  revenue  by  0.4 %  of  GDP  in  2017 
(which represents the bulk of the overall effect of 
the  reform  of  -0.6 %  of  GDP)  and  somewhat 
increases income inequality (see Chapter 4.3). The 
budgetary  impact  of  the  cuts  in  social  security 
contributions  is  expected  to  be  marginal,  as  they 
apply  only  to  second  incomes,  which  represents 
less than 2 % of employment and self-employment 
income.  

Table 4.1.1: 

Tax brackets in PIT (HRK / month) 

(1) The general personal allowance before the reform was 
HRK 2 600, while the higher allowances applied to 
pensioners and citizens in supported areas 
Source: Ministry of finance 

Reductions  in  the  corporate  income  tax  rates 
are designed to be broadly compensated by the 
abolition  of  costly  exemptions  and  tax  breaks. 
The  general  CIT  rate  was  cut  from  20 %  to  18 % 
and  a  new,  reduced  rate  of  12 %  was  introduced 

- 

National  Bank  (Graph  4.1.1).  The  large  share  of 
public  debt  that  is  indexed  or  denominated  in 
foreign  currency  –  mostly  euros 
implies 
substantial currency risk, as was also demonstrated 
by  its  materialisation  in  2016,  when  the  slight 
appreciation  of  the  kuna  against  the  euro  helped 
reduce  the  debt-to-GDP  ratio  (see  above).  In  a 
the  kuna 
assumes 
simulation  which 
depreciates  against  the  euro  in  2017  and  2018, 
public debt would rise to 101.2 % of GDP in 2027. 
However,  exchange  rate  risk  is  greatly  mitigated 
by  the  central  bank's  tightly  managed  float  of  the 
kuna's exchange rate against the euro. 

that 

In the long run, in an unchanged policy setting, 
Croatia  faces  low  fiscal  sustainability  risk.  A 
still unfavourable initial budgetary position and the 
projected  increase  in  healthcare  costs  are  more 
than  offset  by  a  substantial  projected  drop  in 
pension  spending  as  a  result  of  previous  reforms. 
These  include  the  introduction  in  2002  of  a 
mandatory  fully  funded  pillar,  which 
is  not 
included  in  the  projections.  However,  the  pension 
system gives rise to strong adequacy concerns (see 
Section 4.3.3), which make it susceptible to policy 
reversals. 

The  authorities  have  finally  adopted  a  public 
debt management strategy for the period 2017-
19,  but  the  debt  management  framework  has 
not  been  strengthened.  The  government’s  high 
financing  needs  and 
the  high  exposure  of 
sovereign  debt  to  currency  risk  highlight  the 
importance of developing and maintaining reliable 
financing  sources  that  are  subject  to  prudent  risk 
management.  After  a  gap  of  three  years  from  the 
last  strategy  (which  covered  the  period  2011-
2013),  a  new  strategy  for  the  management  of 
public debt over the next three years was adopted 
in January 2017. It focuses on the debt of the state 
sector only, thus excluding the financing needs of 
extra-budgetary  entities  and  local  governments. 
The  former  have  contributed  to  a  large  extent  to 
the build-up of debt in past years. In the meantime 
though,  no  steps  have  been  taken  to  reinforce  the 
framework for debt management or strengthen the 
debt  management  function  within  the  Ministry  of 
Finance. 

A  comprehensive  tax  reform  has  just  entered 
into  force.  The  tax  reform  package  includes 
several  elements,  namely  a  simplification  and  a 
(PIT),  a 
reduction 

in  personal 

income 

tax 

22 

  Pre - reform Post - reform Personal allowance 2 600 - 3 800 (1) 3 800 1st bracket 0 - 2 200 0 - 17 500 rate 12% 24% 2nd bracket 2 200 - 13 200 > 17 500 rate 25% 36% 3rd bracket > 13 200 - rate 40% -   
 
 
 
4.1. Public finances 

(the  monument 

and  then  a  value-based  property  tax  in  2020.  The 
simple  version  of  the  tax  will  entail  an  enhanced 
version  of  the  existing  utility  fee  and  will  also 
replace  the  tax  on  holiday  homes  as  well  as  one 
parafiscal  charge 
fee).  The 
calculation of the tax base will be the same as for 
the  utility  fee,  with  the  addition  of  two  new 
coefficients  (age  and  condition  of  property, 
respectively). Exemptions that are in place will be 
abolished.  Local  government  units  will  be 
responsible for  providing  data  on  the  coefficients. 
The first stage of this process is progressing well, 
with  96 %  of  local  government  units  having 
conducted the necessary recording of properties by 
November  2016.  The  real  estate  transfer  tax  rate 
was  cut  from  5 %  to  4 %,  with  the  entire  amount 
local  government  units 
now  earmarked 
(compared to 80 % before). 

for 

as 

investment,  against 

for small businesses and farmers (with revenue up 
to  HRK  3m).  At  the  same  time,  the  authorities 
broadened  the  base  by  removing  some  of  the 
exemptions  applied  to  companies  in  supported 
(underdeveloped)  geographical  areas  and  by 
abolishing  the  tax  break  for  reinvested  earnings. 
This  tax  break  was  introduced  in  2012  to  help 
the 
revive  plummeting 
background  of  negative  credit  growth  and  slow 
deleveraging.  However, 
circumstances 
improved  and  the  design  of  the  tax  break  was 
changed,  it  became  costly  to  implement,  while 
providing  benefits  to  few  companies.  Reducing 
rates  while  simultaneously  abolishing  the  tax 
breaks  and  exemptions  is  expected  to  result  in  a 
broader-based freeing up of investment capital at a 
cost  for  the  budget  of  just  above  0.1 %  of  GDP, 
accompanied by a simplification of the framework. 
Additional  simplifications  include  the  possibility 
given  to  small  businesses  to  choose  between  two 
methods for calculating their CIT liabilities and the 
introduction  of  a  system  of  warnings  and 
recommendations instead of punitive measures for 
minor  offences.  However,  the  substantial  gap 
between  the  general  and  the  reduced  rate  (6  pp.) 
risks creating disincentives for companies to grow.  

VAT rates remained unchanged, but categories 
of goods and services were shifted across rates. 
In  a  move 
farmers  and 
to  support  small 
households, the reduced rate of 13 % is now being 
applied  to  inputs  in  agriculture,  electricity  and 
utility services. On the other hand, food and drink 
services  were  moved  from  the  reduced  to  the 
general  rate.  In  2018,  the  authorities  plan  to  raise 
the  threshold  for  entry  into  the  VAT  system  by 
30 %  and  reintroduce  a  deduction  of  input  tax  on 
vehicles at a rate of 50 %. The authorities estimate 
the  net  effect  of  these  measures  on  budget 
revenues at around −0.1 % of GDP in 2017 and an 
additional  −0.1 %  of  GDP  in  2018.  If  this  VAT 
reform  translates  into  lower  prices  of  electricity 
and inputs in agriculture, the purchasing power of 
households  and  the  competitiveness  of  small 
farmers and businesses will be supported. 

The introduction of a recurrent property tax is 
scheduled for 2018, while the property transfer 
tax rate is being reduced. The authorities remain 
committed  to  introducing  a  recurrent  property  tax 
as laid out in the 2016 national reform programme. 
This  long  process  is  envisaged  to  result  in  the 
introduction of a simple property tax first (in 2018) 

23 

 
4.2.  PRIVATE SECTOR DEBT AND FINANCIAL SECTOR 

A  sizeable  part  of  private  debt  is  largely 
financed  externally  and  in  foreign  currency.  In 
the  run-up  to  the  crisis,  the  excess  of  investments 
over domestic savings was partly financed through 
direct  external  borrowing  by  large  corporations, 
including  inter-company  lending,  and  via  the 
financial  sector.  The  resulting  surge  in  domestic 
bank  lending  was  also  partially  financed  from 
abroad, so that external indebtedness grew rapidly 
(8). In  2010,  corporate  debt  peaked  at  83.2 %  of 
GDP,  while  household  debt  stood  at  42.0 %  of 
GDP. In addition, a substantial part of the domestic 
lending  took  place  also  in  foreign  currency, 
amplifying exposure to currency risk (9).  

Deleveraging  of  the  private  sector  has  gained 
momentum,  while  the  financial  sector  remains 
robust.  In 2016 the overall level of private debt is 
expected  to  have  declined  markedly.  Household 
increasing  and  disposable 
deposits  continued 
the 
income  grew  as  well.  Benefiting  from 
improved  economic  conditions,  corporate  sector 
profitability  has  recovered  and  investment  credit 
demand  has  started  to  increase.  The  financial 
sector  recovered  the  profitability  that  had  been 
dented  by 
franc-
denominated loans, and it remains well capitalised, 
liquid and stable. 

the  conversion  of  Swiss 

4.2.1.  CORPORATE DEBT 

High  investment  rates  in  the  pre-crisis  years 
resulted  in  a  steep  accumulation  of  corporate 
debt. With investment growing at an average rate 
of  over  10 %  between  2002  and  2008,  the 
non-financial 
aggregate 
of 
to  2010. Partly 
corporations  rose  sharply  up 
because 
constraints,  Croatian 
corporations often by-passed the domestic banking 
sector  to  obtain  cross-border  loans  directly  from 
foreign  banks  and,  to  a  lesser  extent,  from  parent 

indebtedness 

supply 

of 

(8)  Between  2000  and  2010,  external  debt  increased  by 
roughly  52 %  of  GDP,  of  which  roughly  half  was 
intermediated  by  the  broader  financial  system  (about  15 
pps  by  deposit  taking  institutions  and  9  pps  by  non-
monetary  financial  institutions).  The  rest  of  the  increase 
was  due  by  direct  inter-company  lending  (about  11  pps) 
and direct lending from foreign credit institutions (about 15 
pps). 

(9)  Domestic  lending  in  foreign  currency  results  from  high 
euroisation  of  local  deposits,  also  due  to  existing  macro-
prudential 
limiting  banks'  open  currency 
position. 

regulation 

companies. In 2010, more than 50 % of the of non-
financial corporations' total debt was external debt, 
mostly  in  euro  area  countries.  Moreover,  two 
thirds  of  domestic  debt  was  also  denominated  in 
foreign currency, essentially the euro.  

Graph 4.2.1:  Contributions to changes in total corporate 

debt 

Source:  European Commission (Eurostat) 

from 

stemmed  mostly 

Corporate debt has decreased by approximately 
7 percentage points between 2010 and 2015. The 
reduced 
reduction 
investment. As net credit flows turned negative, by 
2015  the  debt-to-GDP  ratio  was  down  to  75.8 %, 
while  corporate  external  debt  fell  to  around 
42.5 %.  The  ratio  is  projected  to  have  further 
decreased by about 2.5 pps by mid-2016. This is a 
result of the acceleration of economic activity, but 
also of valuation effects, as a slight appreciation of 
the  kuna  reduced  the  value  of  outstanding  debt 
denominated in euro. 

The  deleveraging  process  went  hand  in  hand 
with reallocation of resources across industries. 
Whereas  the  stock  of  debt  decreased  in  aggregate 
terms,  evidence  from  corporates’  balance  sheets 
suggests  that  the  distribution  of  debt  also  shifted 
across 
industries.  Between  2010  and  2015, 
transportation  and 
agriculture,  manufacturing, 
storage,  and  accommodation  and  food  increased 
their  proportion  of  total  debt.  These dynamics  are 
consistent  with  the  evidence  showing  that  in  the 
recession  productive  resources  shifted  towards 
sectors that are more exposed to external demand. 
Conversely,  the  proportion  of  debt  decreased 

24 

-10-5051015020304050607080910111213141516*y-o-y changeCredit flowReal growthInflationOther changesD/GDP, change 
 
                                                           
 
4.2. Private sector debt and financial sector 

sharply  in  the  wholesale  and  retail  sector  and 
utilities.  An  increased  proportion  of  debt  in  the 
already  highly  indebted  construction  sector  can 
probably  be  related  to  the  persistent  involvement 
of domestic banks in real estate lending, expecting 
that the real estate market will eventually recover. 

Graph 4.2.2:  Proportion of debt by risk class and industry 

(2010 and 2015) 

(NACE  codes  M-S) (11). The 
and  wholesale 
absolute level of high-risk debt in the construction 
sector  remains  high  but  the  average  has  recently 
been decreasing, reaching 27 %. However, the risk 
profile  of  debt  in  construction  and  the  real  estate 
sector may be underestimated to the extent that the 
stock of unsold properties might still be valued at 
pre-crisis  prices (12). Furthermore,  debt 
the 
construction sector has become more concentrated 
than  before  the  crisis  since  the  total  number  of 
construction  firms  fell  by  about  a  quarter  during 
the recession. 

in 

Graph 4.2.3:  Currency composition of corporate debt 

(1) Sectors: A — Agriculture, forestry and fishing; B — Mining 
and quarrying; C — Manufacturing; D — Electricity, gas, 
steam and air conditioning supply; E — Water supply; 
sewerage, waste management and remediation activities; F 
— Construction; L — Real estate activities; G — Wholesale 
and retail trade; repair of motor vehicles and motorcycles; H 
— Transportation and storage; I — Accommodation and 
food service activities; M — Professional, scientific and 
technical activities; N — Administrative and support service 
activities; S — Other service activities. 
Source: Orbis, European Commission 

The  sustainability  of  corporate  debt  keeps 
improving,  but  risks  are  concentrated  in  a  few 
sectors  and  a  handful  of  companies.  Between 
2010  and  2015,  the  share  of  corporate  debt 
considered  high-risk  decreased  from  39% 
to 
31% (10).  This  improved  risk  profile  is  essentially 
linked to higher profits, which led to a significant 
reduction  in  the  debt-to-earnings  ratio  —  one  of 
the  key  metrics  for  assessing  debt  sustainability. 
High-risk  debt  nevertheless 
remains  highly 
concentrated in a few sectors — including utilities 
(NACE codes D&E), and services other than retail 

(10)  For  details  on 

methodology,  please 
performed 
Commission, 2015a).  

in 

the  definitions  of 

refer 

to 
the  2015  Country  Report 

risk  class  and 
the  analysis  already 
(European 

(1) Foreign currency-denominated debt is estimated. 
Source: Croatian National Bank, European Commission (use 
of stat) 

Whereas  the  stock  of  corporate  debt  appears 
moderate,  exposure  to  currency  risk  remains 
high.  Despite  an  increase  in  domestic  currency 
lending, over 85% of corporate debt (total external 
debt and part of domestic debt) is denominated in 
foreign  currency.  Importantly,  the  stability  of  the 

(11)  The higher share of (high-risk) debt in the utility industry is 
partially  related  to  the  high  capital  intensity  —  which 
typically requires  higher than average leverage ratios.  The 
risk  assessment  takes  into  account  this  aspect,  since  debt 
levels are assessed also in terms of the debt to capital ratio. 
Yet,  critical  thresholds  are  not  industry  specific,  thus 
penalising  utility  industry.  However,  the  stability  of  the 
revenue  streams  and  quasi-monopoly  position  enjoyed  by 
most  corporations  largely  mitigates  risks  stemming  from 
excessive leverage ratios. 

(12)  Again, this is mainly related to the debt to capital ratio (see 
previous footnote). If firms have not yet marked to market 
the  value  of  the  stock  of  unsold  properties,  capital  can  be 
overestimated. Therefore an artificially low debt to capital 
ratio and an underestimation of the risk profile of the debt 
held by construction and real estate. 

25 

-5051015202530A&BHF&LICM&SJD&EG% of total debtChange in share of high risk debt (2010-2015)Change in share of low to medium risk debt (2010-2015)Share of high risk debt (2010)Share of low to medium risk debt (2010)Change in share of total debt (2015)0102030405060708090020304050607080910111213141516*% of GDPDomestic (HRK)External (f/c)Domestic (f/c) 
 
                                                           
 
                                                           
4.2. Private sector debt and financial sector 

Graph 4.2.4:  Contributions to change in total households 

debt 

the 

foreign exchange rate reduces the risk of currency 
shock.  Risks  are  also  mitigated  by  the  currency 
matching  of  revenue  and  expenditure  flows  in 
tradable  sector. 
in 
companies  operating 
Nevertheless,  some  non-tradable  industries  (such 
as  construction)  have  a  higher-than-average 
currency  mismatch  (Croatian  National  Bank, 
2015a,  p.  32).  Exposure  to  interest  rate  risk  is 
mitigated  by  longer  debt  maturities  and  the  share 
of  contracted  fixed  interest  rates.  Although  the 
likelihood  of  shocks  appears  low  in  the  current 
context,  the  assessed  impact  is  substantial  and 
requires close monitoring. 

4.2.2.  HOUSEHOLD DEBT 

strong  expansion 

A  housing  boom  and  expectations  of  rapid 
convergence  of  income  levels  with  the  EU 
average  fuelled  the  past  household  debt  surge. 
Between 2002 and 2008, real household disposable 
income increased by 20% underpinned by dynamic 
wage  growth  and  a 
in 
employment.  Real  estate  prices  soared  while 
fuelled 
expectations  of 
demand  for  durable  goods.  The  prospect  of  high 
returns  invited  the  banks  —  mostly  foreign –
owned  —  to  increase  the  supply  of  credit  — 
in  foreign  currency.  As  a  result, 
including 
household  indebtedness  reached  42 %  of  GDP  by 
2010  –  still  low  in  the  EU  wide  perspective,  but 
one of the highest amongst catching-up economies.   

income  convergence 

Households  started  deleveraging  in  2011,  but 
progress  was  slow  due  to  long  loan  maturities 
and  a  rising  debt  repayment  burden.  As  real 
estate prices started to adjust, credit growth to the 
household  sector  fell.  As  almost  half  of  the  loans 
extended  were  granted  for  real  estate  purchases, 
the average duration of the outstanding household 
debt remains high. A sharp deterioration in labour 
market  conditions  and  decreasing  disposable 
income  hindered  swift  debt 
repayment  and 
increased  the  household  debt  burden. As  in  the 
corporate  sector,  the  recession  also  contributed  to 
slow  deleveraging  process.  Aggregate 
the 
household debt therefore contracted by only about 
3 pps between 2010 and 2015, with 1.4 pps of the 
change in 2015 alone.  

(1) Foreign currency denominated debt is estimated. 
Source: Croatian National Bank, European Commission 
(Eurostat) 

The  legislated  conversion  of  Swiss  franc  loans 
into  euros  accelerated  household  deleveraging 
in  2016.  The  conversion  of  Swiss 
franc-
denominated  loans  into  euro-denominated  loans, 
stipulated  in  September  2015,  has  significantly 
reduced household debt as it reduced principal and 
future  instalments  of  the  vast  majority  of  the 
relevant borrowers. Moreover, data suggest that in 
some cases households opted for refinancing along 
with  the  conversion  of  their  loans,  by  taking  out 
kuna-denominated loans. Despite a feeble increase 
in the demand for new loans, due to the conversion 
of the Swiss franc loans and the appreciation of the 
kuna,  the  household  debt-to-GDP  ratio  is  set  to 
have fallen by 2.5 pps in 2016. 

Pressures 
to  reduce  household  debt  are 
subsiding as labour market conditions improve, 
real  estate  prices  stabilise  and  interest  rates 
remain  at  historically  low  levels.  Lower  debt 
levels  and,  even  more  importantly,  low  interest 
rates have pushed down households' debt servicing 
burden  (i.e.  the  interest  paid  on  outstanding  debt) 
to 0.4 % of GDP in 2015, well below the record of 
1.8 % of GDP reached in 2009. As the situation on 
the labour market keeps improving and real estate 
prices  show  signs  of  bottoming  out,  residual 
pressure  to  reduce  debt  level  appears  contained 
(Croatian  National  Bank,  2014,  p.  27-30). 
According 
the  Commission's  2016  winter 
forecast,  households’  saving  rate  is  set  to  decline 

to 

26 

-6-4-202468020304050607080910111213141516*y-o-y changeCredit flowReal growthInflationOther changesD/GDP, change 
 
4.2. Private sector debt and financial sector 

to  just  above  11 %  over  2017-2018  period.  It  is 
therefore  unlikely  that  the  debt-to-GDP  ratio  will 
see similar sharp reductions.  

Graph 4.2.5:  Key indicators of the Croatian banking sector 

low 

rate 

is  no 

interest 

longer  dragging 
The  debt  burden 
household  consumption,  but  exposure 
to 
interest  and  currency  risk  remains  high.  In  the 
environment, 
current 
macroeconomic  risks  stemming  from  high  debt 
levels appear contained. The sinking debt burden is 
contributing  to  the  recovery  in  consumption. 
Nonetheless,  household  bank  loans  exposed  to 
currency  risk  still  amounted  to  around  22 %  of 
GDP 
in  mid-2016,  albeit  a  small  share  of 
households  is  likely  hedged  through  their  foreign 
currency-denominated  financial  assets  or  revenue 
streams.  Household  borrowers  in  Croatia  who 
contracted  variable  interest  rate  loans  are  also 
exposed 
in 
rate 
mortgages, due to the loans' long duration. As with 
corporate  debt,  risks  currently  appear  limited  and 
have further decreased over the last year. 

risk,  especially 

interest 

to 

4.2.3.  FINANCIAL SECTOR 

The  profitability  of  the  banking  sector  was 
affected  by  the  conversion  of  Swiss  franc  loans 
into  euros,  but  the  sector  has  been  recovering 
since  then.  The  conversion  legislation  allowed 
Swiss  franc  borrowers  to  convert  their  loans  into 
euros at historical currency and interest rates. This 
resulted  in  a  gross  loss  estimated  at  HRK  7.6 
billion  (Ministry  of  Finance,  2016) for  the  banks 
—  roughly  2.3 %  of  GDP  —  which  hit  their 
profitability immediately in 2015 and subsequently 
weakened  their  capital  positions.  The  conversion 
insulated Swiss franc borrowers from the effects of 
the franc's appreciation, but the government took a 
blanket  approach  and  did  not  specifically  target 
distressed  borrowers.  In  addition,  it  may  have 
damaged  legal  certainty  and  investor  confidence. 
The  measure 
legal 
proceedings,  which  may  eventually  result  in  a 
substantial liability for the state budget.  

is  currently  subject 

to 

(1) Total loans comprise government, corporate and 
household sector 
Source: Croatian National Bank 

Asset  quality  has  been  improving  since  mid-
2015  thanks  to  the  acceleration  of  sales  of 
impaired  assets.  The  ratio  of  non-performing 
loans  (according  to  the  national  definition (13))  to 
gross  loans  declined  from  16.6 %  at  end-2015  to 
14.6 % in September 2016, the lowest level in the 
last  3  years.  The  ratio  of  non-performing  housing 
loans  in  all  currencies  fell  from  9.8 %  to  8.5 % 
over the same period. Similarly, the share of non-
performing  loans  to  non-financial  corporations 
dropped  from  34.7 %  to  30.0 %  over  the  period. 
Preliminary  analysis  suggests  that  sales  of  non-
performing  loans  have  been  a  principal  driver 
behind  these  improvements.  The  increase  in  sales 
was  probably  driven  by  both  supply  and  demand 
factors;  parent  banks  have  more  actively  reduced 
their  portfolios  of  such  loans,  while  buyers  have 
recognised  the  potential  of  the  Croatian  market. 
The  progressive  and  automatic  provisioning 
requirements  introduced  by  the  central  bank  in 
2013  could have been  an  important driver,  as  this 
policy  has  continuously  increased  the  coverage of 
the  non-performing 
(see  Graph 4.2.6). 
loans 
Section 4.5.3 explains why it is difficult to monitor 
the impact of the revised insolvency regulation on 

(13)  The non-performing loans definition relies on granular risk 
category  data  provided  by  the  Croatian  National  Bank 
which  is  based  on  the  local  loan  classification  rules. 
Accordingly, they cover partly recoverable loans (i.e. loans 
for  which  there  exists  objective  evidence  of  partial 
impairment)  and  fully  irrecoverable  loans  (i.e.  loans  for 
which  there  exists  objective  evidence  of  full  impairment). 
As  a  general  rule,  the  local  figures  are  broader  than  those 
cited by the European Central Bank.  

27 

-10-505101517181920212223201020112012201320142015H12016%%Total capital  ratioProfitability, RoAE (rhs)Total loan growth rates (rhs) 
 
                                                           
4.2. Private sector debt and financial sector 

banks has increased due to the marked increase in 
kuna  deposits  by  both  households  and  corporates. 
In  contrast,  deposits  by  households  in  foreign 
currency have fallen since 2015. 

Graph 4.2.6:  Non-performing loans developments 

(1) NPL: Non-performing loans, according to local definition 
Source: Croatian National Bank 

the 

improved 

A  pick-up  in  deposits,  coupled  with  continuous 
deleveraging,  has 
financial 
sector's  external  position.  As  deposit  growth 
outpaced  credit  growth  and  domestic  market 
experienced  ample  liquidity,  the  financial  sector 
started  reducing  its  external  debt.  Between  2011 
and  2015  the  external  debt-to-GDP  ratio  dropped 
by more than 16 pps. Banks intermediated the bulk 
of  this  reduction  and  consequently  now  have 
positive net  external  position (15). However, gross 
external  debt  remains  at  very  high  levels,  as  does 
the  net  international  investment  position.  In  June 
2016  gross  external  debt  and  the  net  international 
investment  position  were  at  97 %  and  -75 %  of 
GDP, respectively. 

Banks remain exposed to currency- and interest 
rate-induced  credit  risk.  The  Croatian  economy 
remains heavily euroised, due to historical mistrust 

increase  the  risk-weights  on  foreign  currency  loans  for 
almost all banks with substantial foreign currency lending. 
Also,  in  2016,  the  CNB  provided  around  HRK 1 bn 
additional  domestic  currency  liquidity  through  structural 
repo  auctions,  which  typically  provide  medium  to  long-
term kuna funding for banks. 

(15)  The reduction in net external liabilities was even higher as 
the  excess  of  deposits  was  also  used  to  increase  foreign 
assets. 

the process of resolving non-performing loans. At 
this  stage,  it  is  also  difficult  to  assess  the  role 
played by the conversion of Swiss franc loans into 
euro loans in helping reduce non-performing loans. 
Despite  recent  improvements,  the  proportion  of 
such 
remains  high,  both 
historically  and  in  comparison  with  the  EU 
average. 

in  Croatia 

loans 

Table 4.2.1: 

Financial soundness indicators, all banks 

 *Aggregate balance sheet data, excl. government and 
MFIs 
Source: European Central Bank 

The  recently  adopted  tax  reform  may  provide 
further  incentives  to  the  banks  to  write  off  the 
non-performing loans and provide a fresh start 
to  borrowers.  Until 
recently,  banks  have 
reportedly been discouraged from writing off their 
non-performing  loans  because  of  ambiguities  in 
tax  deductibility  rules.  The  recent  tax  reform  (see 
chapter  4.1)  allows  banks  to  treat  the  provisions 
related 
tax-
deductible expenses when writing it off. This could 
shift  the  resolution  strategy  from  sales  towards 
writing  off.  However,  deductibility  would  be 
recognised  only  during  2017  for  non-performing 
loans  and  related  provisions  that  were  booked  as 
such,  according  to  the  Croatian  National  Bank's 
definition,  in  the banks’ balance  sheets  as of  end-
2015. 

the  non-performing 

loan  as 

to 

loans 

for  households  has 

There  are  signs  of  a  recovery  in  new  domestic 
currency  lending  and  in  domestic  currency 
deposits. The share of domestic currency loans in 
increased 
total 
substantially, from 28 % at end-2014 to over 40 % 
by  September  2016.  This  is  due  to  increased 
demand for kuna loans, either through new lending 
or  through  the  refinancing  of  existing  foreign 
currency  loans.  It  may  also  reflect  prudential 
measures  that  encourage  banks  to  provide  more 
domestic  currency  loans (14).  Kuna  lending  by 

(14)  In  accordance  with  local  rules,  banks  now  have  to  offer 
each  client  a  comparable  kuna  loan  whenever  a  foreign 
currency  loan  (or  a  currency-indexed  loan)  is  requested. 
The supervisors have also maintained Pillar 2 measures to 

28 

(%)2013201420152016Q2Non-performing loans11.812.912.511.2Coverage ratio48.159.164.169.5Loan to deposit ratio*95.691.083.781.7Tier 1 ratio18.619.417.718.4Return on equity0.63.9-6.8-Return on assets0.10.5-0.9-01020304050607020102011201320142016%Total NPL rateCorporate NPL rateHousehold NPL rateCoverage ratio (rhs) 
 
 
 
                                                           
 
                                                                                   
financial 

limited,  with 

in  the  domestic  currency  as  a  store  of  value  after 
frequent  episodes  of  hyperinflation  in  the  1980s 
and early 90s. The direct exposure of the financial 
sector  to  currency  risk  is  —  and  has  always  been 
relatively  small  unhedged 
— 
positions.  The 
sector  nevertheless 
remains exposed to indirect (i.e. currency-induced) 
credit risk due to the largely unhedged position of 
households (16)  and  non-financial  corporations. 
High exposure to indirect credit risk became clear 
in the wake of the depreciation of the kuna against 
the  Swiss  franc.  However,  the  system  is  currently 
exposed  to  currency-induced  credit  risk  only 
regarding  the  euro,  against  which  the  domestic 
currency has a proven track record of stability due 
to the Croatian National Bank’s firm commitment 
in  managing  the  float.  The  future  transposition  of 
the  Mortgage  Credit  Directive  and  its  foreign 
currency 
provide 
additional  protection  of  the  borrowers  in  foreign 
currency,  allowing  them  to  convert  the  loan  into 
domestic  currency  at  the  market  exchange  rates, 
while also ensuring they are informed of the risks 
that such loans entail. 

provisions  would 

loans 

The  independence  of  the  central  bank  could 
potentially  be  undermined  by  pending 
amendments to the Central Bank Act. The draft 
amendments  would  strengthen  public  authorities' 
powers  of  scrutiny  of  the  Croatian  National  Bank 
in a way that may infringe the principle of central 
bank  independence  and  the  ECB's  confidentiality 
rules.  The  ECB  expressed  these  concerns  in  two 
successive  opinions,  in  June  and  October  2016 
(European  Central  Bank,  2016).  Its  concerns 
mainly  relate  to  the  remit  of  the  State  Audit 
Office’s 
to 
confidential information, and Parliament’s right to 
vote  on  the  National  Bank’s  reports.  The  ECB 
points out that national central banks and members 
of  their  decision-making  bodies  are  prohibited 
from  seeking  or  taking  instructions  from  EU 
institutions,  bodies  or  agencies, 
from  any 
government of a Member State and from any other 
body.  Parliament  has  adopted  a  conclusion  on 
accepting the draft law without taking on board the 
ECB’s concerns. The law still has to go through its 

audit  powers,  notably 

access 

(16)  According to the CNB, the share of unhedged loans in total 
loans exposed to the currency-induced credit risk was close 
to  66.2 %  in  September  2016  (Croatian  National  Bank 
database). 

4.2. Private sector debt and financial sector 

second reading in Parliament before it is formally 
adopted. 

4.2.4.  ACCESS TO FINANCE 

Access  to  bank  loans  for  small  and  medium 
sized enterprises is gradually improving. Banks 
are  the  main  source  of  external  financing,  in 
particular  for  small  and  medium-sized  enterprises 
(SMEs).  Although  their  access  to  finance  is 
improving,  the  latest  survey  on  the  access  to 
finance  of  enterprises  indicates  that  this  remains 
more  of  a  problem  for  Croatian  SMEs  than  for 
their  EU  peers.  In  2016,  61 %  of  the  SMEs 
surveyed that applied for a bank loan were granted 
it,  a  decline from  77 %  the  year  before.  For  26 % 
the application was rejected, the loan offer was too 
expensive or they received a smaller loan than they 
had  applied  for.  This  was  an  increase  from  23 % 
the  year  before.  The  remaining  13 %  were  still 
awaiting  the  outcome  of  their  application.  The 
impact  of  rejected  loan  applications  on  SMEs 
could be further mitigated, and repeated rejections 
avoided,  through  activities  aimed  at  mandating 
financial  intermediaries  to  provide  feedback  to 
SMEs  on 
loan  applications (European 
Commission,  2016b;  ECB,  forthcoming).  Apart 
from  direct  bank  lending,  other  major  sources  of 
financing are loans and credit lines with subsidised 
for 
interest 
rates 
Reconstruction 
(HBOR) 
implemented  through  counties  and  commercial 
banks. 

the  Croatian  Bank 

and  Development 

from 

their 

European Structural and Investment Funds are 
expected  to  improve  SME  financing  but  other 
largely 
potential  sources  of  financing  are 
untapped.  A  set  of  new  financial  instruments 
supported by the European Regional Development 
Fund and European Social Fund (ESF) to the tune 
of  EUR 310 million  are  expected  to  considerably 
ease access to finance with an expected leverage of 
over  3.6.  The 
small 
development 
loans,  guarantees,  subsidies  for 
guaranteed loans, and growth and expansion loans. 
The 
to 
entrepreneurship  and  SME  activity.  It  should  also 
lead  to  measures  that  encourage  the  creation  of 
businesses  and  enable  the  financing  of  newly 
established  companies  (European  Commission, 
2016b;  ECB,  forthcoming).  In  2016  a  seed  co-
investment  fund  worth  EUR  2.5  million  was 

instruments  comprise 

funding 

should 

boost 

give 

a 

29 

 
                                                           
4.2. Private sector debt and financial sector 

launched 
financing for innovative SMEs (IBRD, 2015). 

to  strengthen  risk  capital 

in  order 

Ongoing  reforms  in  the  capital  markets  could 
improve  access  to  finance,  but  challenges 
remain.  After  the  acquisition  of  Ljubljana  Stock 
Exchange by Zagreb Stock Exchange in 2015 and 
the recent activities undertaken to support the SEE 
(south-east  Europe)  Link  and  the  regional  Central 
Counterparty (CCP) service, Croatia has developed 
the  potential  to  become  an  important  regional 
capital market player. Other initiatives, such as the 
development  of  a  domestic  covered  bond 
instrument  and  market,  are  also  progressing.  The 
remaining  challenges  could  be  addressed  by 
measures  such  as  increasing  the  number  of  initial 
public  offerings  by  SOEs  on  the  Zagreb  Stock 
Exchange  and  further  initiatives  to  boost  local 
currency financing (17). 

(17)  Other measures suggested by international entities like the 
European Bank for Reconstruction and Development could 
also prove useful. 

30 

 
 
                                                           
4.3.  LABOUR MARKET, SOCIAL POLICIES AND EDUCATION 

4.3.1.  LABOUR MARKET 

The  labour  market  is  recovering  but  continues 
to face challenges. The unemployment rate soared 
from less than 9 % in 2008 to 18 % in August 2013 
and,  according  to  both  national  accounts  and  the 
Labour  Force  Survey,  the  rate  of  job  destruction 
peaked  at  the  end  of  2013.  The  labour  market 
started  to  recover  in  2014  and  in  2016  the 
unemployment  rate  declined  to  12.8 %,  from 
16.3 %  in  2015.  The  unemployment  rate  among 
people  aged  15-24  also  fell  significantly,  from 
41 % in Q3-2015 to 28 % a year after. The share of 
young  people  who  were  not  in  employment, 
education or  training, fell  from  19.6 %  in 2013  to 
just  over  18.5 % 
these 
remains 
improvements, 
significantly  above  the  EU  average,  including  for 
young  people,  and  almost  two  thirds  of  the 
unemployed have been without a job for more than 
a year. Moreover, a significant drop in the activity 
rate  explains  more  than  half  of  the  overall 
reduction 
(see 
in 
Graph 4.3.1).  

the  unemployment 

in  2015.  Despite 

unemployment 

rate 

Graph 4.3.1:  Change in the unemployment rate: 

contribution of employment and participation 

(1) The 'employment effect' reflects the change in the 
number of employed while the 'participation effect' reflects 
the change in the labour force. 
Source: Eurostat, Commission calculations  

The  still  high  unemployment  in  combination 
with  persistently  low  and  declining  activity 
points  to  a  large  untapped  labour  potential.  In 
2016, the activity rate (age 15-64) declined by 2.5 
pps., to 65.6 %, with particularly large falls among 
the  low  skilled,  especially  those  of  prime  age  (25 

the 

attractive 

to  5 %  of 

to 55 years) (see Graph 4.3.2). Limited availability 
job  opportunities  may  have 
of 
labour  market  participation  and 
discouraged 
increasing  migration  outflows. 
to 
contributed 
Indeed, the share of 'discouraged' workers (jobless 
to  work  but  not  seeking 
people  available 
employment)  amounted 
total 
population  (15-74)  in  2015,  which  is  more  than 
double  compared  to  the  EU  average  and  has 
increased  significantly  since  2008  (3 %).  Skills 
deficiencies,  care  responsibilities  as  well  as 
multiple  pathways  to  early  exits  represent  further 
barriers  to  labour  market  participation.  Going 
forward,  the  still  high  number  of  the  long-term 
unemployed  poses  an  additional  risk  to  labour 
market  participation  rates  due  to  their  declining 
employability  over  time.  Some  steps  have  been 
taken 
term 
unemployed  to  make  them  more  employable  and 
help  them  get  back  into  work.  However,  there 
appears  to  be  no  policy  focus  on  bringing  more 
people into the labour market. 

improve  support 

long 

the 

to 

to 

Graph 4.3.2:  Change in activity rate by age and skill level 

(Q3-2015 and Q3-2016) 

(1) Bars indicate group-specific activity rates in Q3 2015 and 
diamonds the corresponding rate in Q3 2016.  
Source: European Commission (Eurostat) 

The working-age population is shrinking due to 
both ageing and emigration. Data for 2015 point 
to  an  acceleration  of  the  negative  demographic 
trends  recorded  in  Croatia  over  the  past  two 
decades. Those have been driven both by negative 
natural population growth and migration outflows, 
which intensified following EU accession in 2013. 
Official 
substantially 
underestimate  the  real  size  of  emigration,  given 

figures  are 

likely 

to 

31 

-5-4-3-2-101215Q115Q215Q315Q416Q116Q216Q3Difference from previous year rateParticipation effectEmployment effectTotal reduction in unemployment rate0102030405060708090100YoungPrimeageElderlyYoungPrimeageElderlyPrimeageElderlyLow skilledMedium skilledHighly skilledActivity rate (%)MalesFemales 
 
 
 
4.3. Labour market, social policies and education 

favourable  conditions  –  like  lower  retirement  age 
or  higher  pension  accruals  –  to  categories  of 
workers  in  occupations classified  as  arduous  and 
hazardous (18), in specific sectors like security and 
defence,  and  for  war  veterans (19).  If 
these 
categories  were  included  in  the  share  of  those 
retiring earlier, this share would be even higher. 

Commitments  to  reform  the  pension  system 
have  not  been  carried  out.  The  design  of  the 
pension  system  and  the  lack  of  policy  progress 
raise  serious  concerns  regarding  future  pension 
adequacy, as discussed in Section 4.3.3. Measures 
aimed at discouraging and reducing access to early 
retirement (20)  and  redefining  pension  provisions 
for  specific  categories  are  on  hold.  In  2016  the 
authorities completed a review of the arduous and 
hazardous  professions  benefiting 
from  more 
generous  pension  provisions.  The  planned 
streamlining  of  the  provisions  has  not  yet  taken 
place,  however.  The  same  applies  to  the  planned 
acceleration of the gradual increase in the statutory 
retirement  age  (currently  due  to  be  completed  by 
2038)  and  of  plans  to  make  the  retirement  age 
equal  for  men  and  women.  Efforts  on  reforming 
the  methodology  and  assessment  framework  for 
disability  pensions  are  ongoing.  Other  measures 
enabling 
tax 
incentives  and  increasing  the  coverage  of  labour 
market 
been 
implemented yet.  

policy  measures 

longer  working 

including 

lives, 

have 

not 

Care  responsibilities  are  an  additional  barrier 
to women's participation in the labour market. 
Croatia lags behind the EU target on the provision 
of formal  childcare,  though the  situation seems  to 
be  improving  slowly,  especially  for  full-time 
childcare  for  children  under  three.  The  lack  of 
nation-wide  policies  has 
large 
disparities across municipalities in available places 
and costs. As discussed in previous year's country 
report, care responsibilities particularly affect elder 
women, who consequently retire prematurely from 

resulted 

in 

(18)  This  group  benefits  from  a  lower  statutory  retirement  age 
and up to 25 % higher pension accruals compared to other 
pensioners.  There  are  currently  30.000  insured  people 
under  this  scheme  (ca  2.1 %  of  all  insured);  since  2009 
their share has been increasing. 

(19)  War  veterans  from  Croatia  and  Bosnia  and  Herzegovina, 
among  which  about  80  000  have  been  already  retired, 
mainly on disability pensions. 

(20)  Including on the basis of Article 35, the current gap of five 
years  between  early  and  statutory  retirement  age,  and  the 
current levels of bonuses/penalties. 

that  many  do  not  notify  the  national  authorities 
when  leaving  the  country.  Better  labour  market 
situation and living conditions in host countries are 
strong  pull-factors  for  migration.  The  bulk  of 
migrants are aged 25-50 years, which relates to the 
above mentioned developments in the labour force. 
Data 
that 
recipient  countries 
Germany  has  been  by  far  the  most  popular 
destination,  followed  by  Austria  and  Ireland.  The 
authorities  have  announced  greater  efforts  in 
tackling the demographic challenge.  

indicate 

from 

Graph 4.3.3:  Composition of new retirees by type of 

pensions 

(1) Retirement without penalty for people having 
completed minimum 41 years of contributions who are at 
least 60 years old. Data related to early retirement with no 
penalty due to employer's bankruptcy (regulated under Art 
36) was not included as it is negligible (about 0.1 % in 2016). 
Source: European Commission based on data from Croatian 
Pension Insurance Institute from September 2016 (and 
projections for the remaining months of 2016).  

Low  employment  among  older  workers  is  still 
mainly  due  to  the  availability  of  various 
pathways  to  early  labour  market  exits.  In  2016 
the  proportion  of  new  retirees  exiting  the  labour 
market  at  the  statutory  retirement  age  is  expected 
to  have  increased  marginally.  However,  the  share 
of 
the  statutory 
retirement age increased, if the different pathways 
to  early  retirement  (early  old  age,  long-career 
pensions – the so called Article 35 pensions – and 
disability pensions) are combined. In addition, the 
Croatian  pension  system  still  features  numerous 
to  more 
special  rules 

that  give  entitlement 

retiring  earlier 

those 

than 

32 

0510152025303540Old ageEarly oldageArt. 35*DisabilitySurvivors%201420152016 
 
                                                           
4.3. Labour market, social policies and education 

around  1.8  %.  Due  to  negative  inflation,  this 
implies  a  2.4  %  growth  rate  in  real  terms.  Wages 
are  projected  to  increase  above  productivity  in 
2017  and  2018,  causing  a  small  increase  in  unit 
labour costs. 

Graph 4.3.4:  Temporary employment by labour market 

status 1 year before, and share of temporary 
contracts in total employment 

Source: Eurostat 

There have been no reforms of the wage setting 
framework.  The  adoption  of  new  legislation  on 
public  sector  wages,  aiming  to  better  harmonize 
wages  across  the public administration  and  public 
services  (23),  has  been  postponed  by  more  than  2 
years,  to  2019.  A  common  methodology  and 
for  negotiating,  coordinating  and 
guidance 
monitoring  collective  agreements  in  the  public 
administration has been developed and adopted by 
the  government  in  February  2017.  The  two  basic 
collective agreements regulating the rights of civil 
servants and public servants expired in 2016. They 
temporarily  extended  and  re-
will  both  be 
negotiated 
to 
increasing  synchronisation  of  bargaining  cycles 
(24).  The  government  negotiated  a  6 %  wage 
increase for civil servants under a 2009 agreement  

in  2017,  partly  with  a  view 

(23)  By  introducing  common  wage  grids  and  job  complexity 
job  descriptions  and 

coefficients,  more  consistent 
competences frameworks. 

(24)  It  is  worth  noting  that  the  delayed  adoption  of  the  law  on 
public  sector  wages,  which  was  meant  to  also  regulate 
aspects of working conditions and rights that are currently 
negotiated  under  the  collective  agreements,  creates  a  time 
inconsistency,  in  that  the  two  basic  agreements  will  be 
negotiated before the new law comes into force. 

the labour market: in the broad age bracket 45-59, 
care responsibilities explain about one third of the 
inactivity among Croatian women (well above the 
EU average). In addition, Croatia is one of the few 
EU  countries  where  paternity  leave  is  unpaid. 
Regarding  care  for  dependant  relatives,  in  most 
cases  the  rights  of  carers  are  not  recognised  in 
Croatia  (21).  Work  contracts  allow  little  flexibility 
in terms of reduced hours, leave arrangements and 
sharing  of  rights  to  enable  carers,  mostly  women, 
to balance work and care responsibilities.  

Job  creation  has  mostly  relied  on  temporary 
contracts.  Following  the  2013  and  2014  labour 
market  reforms,  which  increased  the  flexibility  of 
the  labour  market,  there  has  been  a  surge  in 
temporary  contracts.  This  is  especially  the  case 
among young people: for those aged 15-29, 47.1 % 
of  contracts  in  2015  were  temporary,  compared 
with  an  EU  average  of  32.2  %  for  the  same  age 
group.  The  share  of  fixed-term  contracts  in  total 
employment grew from 15.6 % in Q3-2013 to 24.2 
% in Q3-2016. The trend is visible in all sectors of 
the economy but especially in construction, private 
services and tourism, due to the high seasonality of 
their activity. The 2016 country report showed that 
these  trends  have  been  underpinned  by  both 
increased 
into 
employment and a higher probability of temporary 
employment  for  all  categories  of  workers  (see 
graph  4.3.4) (22) 
.  In  addition,  some  atypical 
contracts  that  are  designed  only  for  specific 
circumstances  –  professional  contracts  ("ugovor  o 
djelu")  and  student  contracts  –  appear  to  be 
increasingly  used (CELSI,  2016).  On  a  positive 
note,  recent  data  show  that  an  increasing  share  of 
temporary  employees  (37.8 %  in  2015)  did  make 
the transition to permanent employment. 

inflows  of  people  moving 

to 

increase 
Labour  costs  are  projected 
marginally.  Despite 
productivity 
subdued 
developments,  nominal  unit  labour  costs  fell  by 
almost 5 % in 2013-2016 in response to the labour 
market  slack.  The  steep  decline  in  the  number  of 
jobseekers, despite low and declining participation, 
is expected to stimulate renewed wage pressure. In 
2016,  wages  are  expected  to  have  increased  by 

(21)  Rights  are  only  recognised  in  the  case  of  parents  taking 

care of their disabled children. 

(22)  However, the surge in transitions from self-employment to 
temporary employment that was observed in 2014 data was 
probably  linked  to  a  one-off  policy-induced  effect,  as  it 
appears to have faded out the following year. 

33 

101214161820050100150200250300201320142015%Student (and other inactive)UnemployedSelf-employedEmployeesShare of temp. emp. (EU, rhs)Share of temp. emp. (HR, rhs) 
                                                           
 
                                                           
4.3. Labour market, social policies and education 

34 

 Box 4.3.1: Impact of personal income tax reform on inequality and work incentives Personal income taxes were reduced in 2015 and a further cut entered into force in January 2017. The details of the two reforms are discussed in last year’s Country Report and in chapter 4.1 of this report, respectively. The graphs below illustrate the impact of the two reforms on income distribution and work incentives (1). Graph 1a shows that disposable income of the first and second deciles remained broadly unaffected by both the two reforms. The 2015 reform delivered a broadly uniform increase, of about 0.5 %, in disposable income of households in the third to the sixth deciles. Thereafter the gains in disposable income increased almost linearly, from 1.1 % in the seventh decile to 2.3 % in the 10th decile. The 2017 reform only slightly increases disposable income in the third and fourth deciles (by less than 1 %) and in the next two deciles (by less than 2 %). Most of the gain is concentrated in the top two deciles (more than 3 %). As a result, both reforms somewhat increase income inequality. Accordingly, the Gini coefficient increases by 0.4 pps with the 2015 reform and by an additional 0.3 pps with the 2017 reform (2).   Graph 1b shows the composition and distribution of effective marginal tax rates before and after the reforms. For households in the first three income deciles, the effective marginal rates are hardly affected. However as from the fourth decile and up to the eighth the rates are reduced by some 4 pps on average. This is likely to have a positive impact on labour supply of households already in employment.  Changes in labour supply, however, are mainly driven by transitions from unemployment or inactivity to employment. The financial incentive to move to employment is typically measured by the net gain obtained when moving from inactivity or unemployment into employment. Total taxes paid by workers up to the third decile are not affected by the reform. After deducting employees’ social security contributions (20 %) and the personal allowance, a single person working at the minimum wage was already not paying any personal income tax before the 2015 reform. Hence, both the 2015 and 2017 reforms appear to do little to give low-skilled workers stronger incentives to work.                                                            (1) Simulations have been conducted by the Joint Research Centre of the European Commission to analyse the fiscal and distributional impact of the reforms using EUROMOD, the tax-benefit microsimulation model for the European Union. EUROMOD simulates benefit entitlements and tax liabilities (including social security contributions) of individual and households according to the tax-benefit rules in place in each Member State. The simulations are based on representative survey data from the European statistics on income and living conditions (EU-SILC) and cover the main elements of direct taxation and social contributions as well as non-contributory benefits. (2) The index is based on disposable income and ignores the role of indirect taxes such as value added tax. As highlighted in the 2016 country report, Croatia relies more than other EU Member States on indirect taxation, which typically has a regressive effect. Ignoring TVA typically leads to under-estimating overall inequality. 0%1%2%3%4%010002000300040005000600012345678910Disposable income (monthly average)2015 Reform (% change, rhs)2017 Reform, cumulative (% change, rhs)Graph 1a: Average individual disposable income by decile and percentage change following the reforms (rhs)0%5%10%15%20%25%30%35%40%45%12345678910Benefit component (baseline)SIC component (baseline)Tax component (baseline)2015 Reform2017 Reform (cumulative)Graph 1b: Composition and distribution of effective marginal tax rates by income decile under the baseline and 2015 and 2017 reforms 
 
 
 
 
 
with  the  trade  unions  (see  chapter  4.1).  It  is  still 
due  to  negotiate  the  wage  increase  for  the  public 
servants.  This  may  add  to  wage  pressure  in  the 
private  sector  through  demonstration  effects.  As 
for  SOEs,  no  further  steps  have  been  taken  to  set 
up a coordinated system for collective bargaining. 

Changes  to  the  minimum  wage  are  under 
consideration.  The  minimum  wage  currently  in 
force in Croatia is on the lower end of the EU rank 
(25). In 2016, the authorities commissioned a study 
on  the  institutional  design  and  impact  of  the 
minimum wage in Croatia (Institute of Economics 
Zagreb,  2015).  The  study  highlights  significant 
variations  in  the  coverage  and  level  of  the 
minimum  wage  (relative  to gross  earnings) across 
regions  and  sectors  within  Croatia.  Employees 
earning  the  minimum  wage  are  predominantly 
women,  people  with  relatively  lower  education, 
working  in  services  and  in  rural  areas.  Young 
people are also concerned. The study recommends 
reviewing the definition of the minimum wage, in 
consultation  with  the  social  partners,  and  making 
the  annual  revision  process  more  predictable  and 
transparent.  It  also  recommends  the  establishment 
of  an  independent  expert  body  to  inform  the 
discussions  of  social  partners  and  the  authorities. 
In 2017, the government announced an increase in 
the  minimum  wage  of  5  %  but  it  is  not  clear  to 
what  extent  the  recommendations  from  the  study 
will be taken on board.  

tax 

personal 

The 
reductions 
income 
implemented recently decrease the progressivity 
of  the  tax  system.  The  reform  of  the  personal 
income tax that entered into force in January 2017 
(see  Section  4.1)  (26)  comes  on  top  of  a  previous 
PIT  reform,  in  force  since  2015.  The  latter  had 
already increased the tax allowance and broadened 
the  intermediary  tax  bracket  (the  upper  limit  was 
raised  from  HRK  8 000  to  13 000).  The  tax  cuts 
are  expected  to  mainly  benefit  higher  incomes, 
without increasing work incentives for low skilled 
workers. See Box 4.3.1. 

(25)  Both  expressed  as  purchasing  power  standard  (663  in 

2017) and as a share of mean gross earnings (43 %). 

(26)  The  reform  was  part  of  a  broader  package  including  a 
reform of corporate income tax (CIT) and a reshuffling of 
categories of goods across preferential VAT rates. 

4.3. Labour market, social policies and education 

4.3.2.  EDUCATION AND SKILLS 

The  low  and  deteriorating  basic  skills  of  many 
pupils  will  eventually  lead  to  skills  gaps  in  the 
labour market. In the 2015 OECD Programme for 
International  Student  Assessment  (PISA)  of  15 
year-olds, Croatia recorded one of the worst results 
in  the  EU  in  applied  science  and  mathematics. 
Compared to 2012, the proportion of low achievers 
increased in mathematics (from 30 % to 32 %) and 
most significantly in science (from 17 % to 25 %), 
undoing  the  progress  made  up  to  2012  (OECD, 
2016).  The  proportion  of  top  performing  students 
is on average below  5 %, demonstrating a lack of 
focus  on 
talented 
identifying  and  supporting 
students.  However,  the  Trends  in  International 
Mathematics and Science Study (2015) shows that 
younger  pupils  (10  year  olds)  are  significantly 
better 
in 
mathematics and science than in 2011, and that the 
best  and  poorest  performers  are  fairly  evenly 
distributed (IEA, 2015). As far as digital skills are 
concerned Croatia remains below the EU average, 
but  there  has  been  improvement  compared  to  last 
year  with  27.9  %  of  individuals  having  no  digital 
skills,  17.4  %  low  skills,  21.3  %  basic  skills  and 
33.3 % above basic skills (European Commission, 
2017a).  The  national  ʻe-Schools’  project  aims  at 
ensuring  that  digitally  competent  teachers  have 
access  to  adequate  ICT  equipment  and  that  they 
develop and use e-content in classrooms.  

theoretical 

exercises 

solving 

at 

its 

and 

implementation 

The  reform  of  the  education  system  is  being 
reassessed 
is 
significantly delayed. Over the past 2 years policy 
developments  in  the  education  system  have  been 
dominated  by  the  implementation  of  the  strategy 
for  education,  science  and  technology.  A  part  of 
the  strategy  is  a  comprehensive  and  ambitious 
curricular  reform.  Since  the  beginning  of  2015, 
school  curricula  have  been  revised  and  refocused 
on  improving  content  and  better  incorporating 
transferable  skills (27).  While 
teacher  unions, 
parents and the non-governmental sector expressed 
support for the reform, strong criticism was voiced 
by  some  parts  of  academia.  As  a  result,  the 
coordination body in charge of the reform resigned 
and the pilot implementation was delayed, though 
a public consultation on the final draft of curricular 

(27)  Learning  to  learn,  entrepreneurship,  personal  and  social 
development, health, sustainable development, ICT use and 
citizenship education. 

35 

 
 
                                                           
                                                           
4.3. Labour market, social policies and education 

programmes.  This  has  contributed  to  a  better 
common  understanding  among  key  actors  of 
sectoral  human  resources  needs.  To  improve  the 
employment  outcomes  of  vocational 
poor 
education  graduates  (discussed  in  earlier  country 
reports),  Croatia  adopted  a  vocational  education 
and training development plan in September 2016 
the  CROQF 
that  will  guide, 
methodology,  the  update  of  the  VET  curricula, 
increase  the  share  of  work-based  learning  and 
improve the quality of teaching.  

line  with 

in 

the  generally 

attainment  of 

Croatia  is  lagging  behind  in  upgrading  skills 
and  re-skilling  the  working  age  population.  In 
2015, only 3.1 % of adults (25-64) reported having 
participated  in  lifelong  learning.  Even  though  this 
is  slightly  higher  than  previous  years,  it  is  far 
below  the  EU  average  of  10.7  %.  This  is  a 
particular  concern  given 
low 
educational 
the  working-age 
population,  and  especially  given  that  50  %  of  the 
unemployed are long-term unemployed who run a 
higher  risk  of  becoming  inactive  due  to  their 
obsolete or eroded skills. New legislation is under 
preparation  with  the  aim  of  improving  the  quality 
of institutions, programmes and teaching for adult 
learning.  However  there  has  been  no  significant 
progress  with  the  system  for  recognising  and 
validating non-formal and informal learning as it is 
dependent  on  progress  made  in  updating  the 
CROQF  standards.  The  Public  Employment 
Service  is  currently  reviewing  its  active  labour 
market  policy  measures  in  order  to  take  into 
account 
the  2016  external 
evaluation.  Nevertheless,  resources  for  re-training 
programmes,  and  life-long  learning  in  general  as 
well as employer engagement remain insufficient.  

findings  of 

the 

rather 

Tertiary  education  outputs  and  labour  market 
needs are not sufficiently aligned. More students 
in  Croatia  choose  to  study  social  sciences  and 
humanities  than  in  EU  peer  countries,  leaving 
science,  technology,  engineering  and  mathematics 
(STEM)  graduates 
supply 
in 
(CEDEFOP,  2016).  The  lack  of  basic  skills  in 
mathematics  and  science  leads  to  low  interest  in 
STEM  subjects  and  high  dropout  rates.  To  better 
align  the  education  outputs  with  labour  market 
needs,  the  National  Council  for  Development  of 
Human Potential recommends setting up a rigorous 
methodology  for  establishing  enrolment quotas. 
This  would  be  based  on  labour  market  needs  and 
would  regulate  enrolments  through  more  strategic 

short 

documents  went  ahead  between 
June  and 
November  2016.  The  lack  of  consensus  on  some 
key  aspects  of  the  reform  and  the  ways  forward 
ultimately  led  to  a  loss  of  momentum,  although 
there  appears  to  be  political  will  to  restart  the 
process in 2017.  

construction, 

transportation, 

labour  market  recovery  has  revealed 
The 
shortages in the supply of labour at both ends of 
the  skill  spectrum.  Despite  Croatia's  still  high 
unemployment  and  level  of  inactivity,  employers 
in 
shipbuilding, 
tourism  and  other  seasonal  sectors  continue  to 
report  shortages  of  low  and  medium  skilled 
workers  and  call  for  increased  import  quotas  for 
foreign  workers.  The  limited  attractiveness  of 
seasonal jobs certainly explains part of this, while 
for  other  sectors  shortages  are  partially  linked  to 
outmigration.  A  recent  study  (CEDEFOP,  2016) 
shows  there  are  also  shortages  in  professions 
(ICT  professionals, 
requiring  higher 
mechanical  engineers  and  secondary  mathematics 
teachers)  mainly  due  to  shortcomings  in  the 
education  system.  For  medical  doctors,  vacancies 
are  difficult  to  fill  in  rural  and  underdeveloped 
areas  due  to  general  unwillingness  to  relocate  in 
the  country.  At  the  same  time,  higher  skilled 
professionals  are  mobile  internationally,  as  they 
tend  to  find  more  job  opportunities  with  better 
working  conditions  abroad.  In  2017,  the  Public 
Employment  Service plans  to  gather  more  precise 
and  timely  evidence  from  employers  on  their 
labour force needs.  

skills 

Croatia  is  updating  its  qualification  standards 
to  bring  them  into  line  with  the  needs  of  the 
labour  market.  Implementation  of  the  Croatian 
Qualification  Framework  (CROQF)  picked  up 
speed in 2016, yielding first results. These include 
the introduction of new qualifications (28), surveys 
of  graduate  employment  outcomes,  and  a  better 
alignment of enrolment criteria with labour market 
needs.  These  were  all  conducted 
in  close 
cooperation  with  employer  associations.  At  the 
same  time,  the  sectoral  councils  established  to 
coordinate this process are revising the occupation 
classification system in line with the labour market 
analyses.  Once  approved,  all  standards  will  be 
entered  into  the  so  called  CROQF  Register  to 
guide  a  continuous  process  of  updating  study 

(28)  Agro  tourism  managers,  social  entrepreneurs,  energy 
efficient building technicians and palliative care nurses. 

36 

 
                                                           
4.3. Labour market, social policies and education 

subsistence  needs  and  has  very  low  coverage 
(European  Commission,  2016a).  It  has  been 
estimated that about 5 % of the state budget (or ca 
1.8 % of GDP) is devoted to the specific group of 
war  veterans (32)  and  their  families,  with  the 
highest  share  spent  on  pensions (33).  Given  that  a 
range  of  legal  provisions  govern  the  rights  and 
cash  benefits  of  this  group,  the  functioning  of  the 
system  is  not  very  clear.  For  the  time  being,  the 
fiscal impact and the dedicated resources have not 
been  assessed  in  the  context  of  other  social 
expenditure  items,  nor  in  terms  of  labour  market 
effects.  At  the  same  time,  significantly  higher 
budgetary  resources  have  been  allocated  in  2017 
for this group and a new law is under preparation 
with the aim to extend the rights to a larger number 
of beneficiaries. 

The  consolidation  of  social  benefits  and  the 
establishment  of  'one-stop  shops'  have  not 
advanced  according  to  plan.  The  draft  action 
plan  outlining  the  reform  of  the  social  protection 
system  has  not  yet  been  adopted (34).  The 
authorities  have  completed  the  analysis  of  almost 
50 benefits granted at the central government level 
with  a  view  to  categorising  them,  agreeing on  the 
institutional  division  of 
responsibilities  and 
harmonising  the  eligibility  criteria.  To  date  the 
consolidation  plans  regarding  local  and  regional 
benefits  and  those  granted  on  the  basis  of  special 
rules have not been outlined by the authorities. The 
establishment of one-stop shops as the single point 
of  contact  with  the  administration  for  various 
benefits and social services was postponed for the 
second  time  in  a  year.  This  has  had  the  effect  of 
delaying  the  implementation  of  other  related 
reform  measures  which  could  help  improve  the 
transparency of the system and design an adequate 
minimum  benefit  scheme.  A 
tool  has  been 
developed  to  enable  poverty  mapping  (35),  which 

(32)  There are about 500 000 people registered with war veteran 
status.  The  majority  are  in  their  prime  age,  and  the 
dedicated expenditure is likely to remain considerable for a 
long time. 

(33)  Both  disability  and  old-age  pensions  in  these  cases  are 
higher  than  for  the  general  population  due  to  more 
generous pension provisions. 

(34)  The  plan  does  not  cover  the  war  veteran  related  benefits 

discussed above.   

(35)  The  tool  ranks  small  geographic  areas  based  on  the 
multiple  (income  and  consumption)  deprivation  index.  It 
allows  the  identification  of  high  poverty  concentration 
areas 
and 
differentiation 
consumption-based poverty.  

between 

income- 

and 

of 

and 

subsidies 

use 
accreditation 
instruments. However,  the  lack  of  relevant  labour 
market  data  makes  it  difficult  to  implement  these 
types  of  recommendations  yet.  A  recent  pilot 
graduate  tracking  project  revealed  that  especially 
professional  higher  education  programmes,  as 
opposed 
the  academic  programmes,  were 
unsuccessful  at  teaching  the  practical  skills  and 
competencies 
employment 
(Mrnjavac and Pivac, 2015). However, surveys of 
graduates’ 
(European 
Commission/EACEA/Eurydice, 2014) which could 
help  align  education  policy  with  labour  market 
needs are not run systematically. 

employment 

necessary 

paths 

for 

to 

4.3.3.  SOCIAL PROTECTION SYSTEM  

In 2014 Croatia exhibited high levels of poverty 
and social exclusion. The risk of relative poverty 
(AROP)  remained  above  the  EU  average  and 
increased  somewhat  in  2014  (see  footnote  2). 
Social  transfers  are  less  effective  in  Croatia  in 
reducing  poverty  than  in  other  EU  Member 
States (29). Absolute poverty measured as the share 
of those suffering from severe material deprivation 
and  those  living  in  (quasi)  jobless  households  (30) 
is  still  considerably  higher  than  the  EU  averages, 
to  quality  and 
though  decreasing.  Access 
affordable  housing 
remains  difficult,  partly 
because  the  social  housing  sector  is  small  (less 
than  2  %  of  all  housing  stock).  Overcrowding 
rates (31)  are  high  both  among 
the  general 
population (42.1 % v 16.9 % EU average) and the 
poor (47.1 % vs 30.1 % EU average). 

The  design  of  the  social  protection  system 
weakens  its  effectiveness  and  fairness.  Previous 
analysis concluded that there are inconsistencies in 
eligibility  criteria  at  the  central  level,  substantial 
regional  disparities 
social 
in 
protection  benefits  and  that  only  a  marginal  share 
of the budget is spent on the poorest (ca 0.6 % of 
the  GDP).  The  Guaranteed  Minimum  Benefit 
the  basic 
(GMB) 

scheme  does  not  meet 

spending  on 

(29)  For 2014 data, social transfers including pensions reduced 
the poverty rate in Croatia by 17.1 percentage points. This 
was the second lowest poverty reduction effect in the EU. 
(30)  Share of people aged 0-59 living in a household where the 
working age population worked no more than 20 % of their 
potential during the previous year. 

(31)  Percentage  of  the  population  living  in  a  household  that 
does not have at its disposal a minimum number of rooms 
as defined for that household size. 

37 

 
                                                           
                                                           
4.3. Labour market, social policies and education 

should  help  the  authorities  better  target  policy 
interventions and the allocation of EU funds. 

to 

Pension  adequacy  is  low  for  most  of  the 
population,  also  reflecting 
short  working 
careers.  This  creates  a  high  risk  of  poverty  and 
social  exclusion  in  old  age,  especially  for  women 
(36). Not only are today's pensioners experiencing a 
significant  drop  of  their  earnings  (37),  but  a 
significant  further  reduction  in  income  is  also 
expected  due 
lower  projected  pensions 
(European  Commission,  2016a).  The  pension 
system  is  characterised  by  a  duality  stemming 
from its combination of more generous retirement 
rules for certain categories of workers (see section 
on early retirement) and above-average benefits for 
some  groups.  This  has  led  to  relatively  high 
income  inequality  among  pensioners,  makes  the 
system  fragmented  and  raises  questions  about  its 
fairness. To improve future pension adequacy, the 
authorities  introduced  voluntary  pension  schemes 
in  2002  and  have  been  encouraging  voluntary 
savings through tax exemptions and subsidies (38). 
While  the  overall  take-up  of  these  schemes  is  on 
the rise, this is likely not the case among people on 
lower  incomes.  Furthermore,  the  very  early  pay-
out  age  (50  years)  of  these  schemes  undermines 
their role in providing better retirement income in 
old-age.  

(36)  34.4 % of women aged 65+ are in a situation of poverty or 
social  exclusion  compared  to  28.2 %  for  men  and  the  EU 
average rate for women 65+ of 19.6 % (Eurostat. 2015) 
(37)  The aggregate replacement ratio is 40 %, the lowest in the 

EU (European Commission, 2015b). 

(38)  A partial tax exemption is available to employers matching 
contributions  to  the  voluntary  individual  account  up  to 
HRK 500 per month (ca EUR 65) or a total of HRK 6 000 
per  year  (ca  EUR  800).  The  state  is  also  subsidising 
voluntary  contributions  by  15 %  of 
the  amount  of 
contributions actually paid (maximum HRK 5 000 per year 
or ca EUR 660). Membership has grown from 13 % of the 
working-age population in 2010 to 19 % in 2015. 

38 

 
                                                           
4.4.  BUSINESS ENVIRONMENT AND INVESTMENT 

Slow  productivity  growth  and  weaknesses  in 
investment act as a drag on Croatia's potential 
growth.  A  lasting  adjustment  of  macroeconomic 
imbalances  and  the  achievement  of  sustained 
economic  and  social  convergence  towards  higher 
standards  all  depend  on  lifting  Croatia's  potential 
output.  Potential  output  is  currently  estimated  at 
1 %,  and  has  been  well  below  that  of  other 
catching-up  economies  in  Central  Eastern  Europe 
(CEE) for the past 15 years. The previous chapter 
discussed 
to  high  potential 
growth  stemming  from  labour  –  due  to  both  high 
unemployment  and  a  shrinking  labour  force.  The 
other  drivers  of  potential  output  are  capital 
deepening,  which  is  determined  by  productive 

impediments 

the 

investments, and total factor productivity (TFP). In 
the  aftermath  of  the  crisis,  investment  contracted 
sharply  in  most  EU  economies,  but  the  slower 
recovery of Croatian investment has translated into 
the contribution of capital deepening falling below 
the  level  in  many  other  EU  countries,  including 
Croatia's  peers.  Even  more  striking  is  the  dismal 
performance  of  TFP.  Its  contribution  to  potential 
growth  gradually  declined  during  the  pre-crisis 
years,  until  it  became  negative  and  reached  a 
trough  in  2009;  it  is  expected  to  have  turned 
positive only in 2016. 

Graph 4.4.1:  Potential output in Croatia and in Central Eastern European peer economies 

(1) CEE Peers in this analysis include Czech Republic, Hungary, Poland, Slovenia and Slovakia.  
Source:  Ameco 

39 

-3.0-2.0-1.00.01.02.03.04.05.06.020022004200620082010201220142016Contribution of labour inputMinimum and maximum(CEE peers)CEE peers averageHR-3.0-2.0-1.00.01.02.03.04.05.06.020022004200620082010201220142016Contribution of capital deepening-3.0-2.0-1.00.01.02.03.04.05.06.020022004200620082010201220142016Contribution of Total Factor Productivity-3.0-2.0-1.00.01.02.03.04.05.06.020022004200620082010201220142016Potential real output growth 
 
 
 
4.4. Business environment and investment 

Investment 
is  picking  up,  but  structural 
bottlenecks hamper a more sustained recovery. 
Since the crisis, the decline in investment has been 
sharper  than  in  most  other  catching-up  CEE 
economies.  The  fall  in  public  investment  was 
particularly  sharp,  with  a  cumulative  drop  by 
almost 46 % between 2008 and 2015. 

The  contraction  in  private  investment  was  more 
gradual,  but  still  in  the  order  of  33 %  between 
2008  and  2014,  when  Croatia  finally  came  out  of 

the  recession  (39).  Investment  picked  up  again  in 
2016  and  is  set  to  accelerate  moderately  over  the 
forecast  period,  but  structural  weaknesses  still 
prevent a more sustained recovery (see Box 4.4.1). 

(39)  Arguably,  however,  public  investment  started  from  a 
comparatively  high  level,  due  to  a  prolonged  public 
infrastructure boom. 

40 

 Box 4.4.1: Investment challenges and reforms in CroatiaInvestment activity was hit hard by the economic crisis: from a peak of 28 % of GDP in 2008, investment plummeted to 21 % in 2010 and then stagnated. Private investment was mainly affected by weak domestic demand and the debt overhang, since corporations struggled to reduce their debt exposure. Supply conditions also played a role, as a high country risk pushed up firms' financing costs. Investment rebounded in 2016 and is expected to continue recovering over the forecast period, facilitated by a new credit expansionary phase and a pick-up in the absorption of European Structural and Investment Funds.  Despite the more favourable macroeconomic and financing conditions, as confirmed by the European Commission assessment, a number of bottlenecks still weigh on a more sustained recovery and investment (1). Some reforms have been adopted, in particular in the areas of employment protection legislation and insolvency frameworks, but significant barriers remain to be addressed.  In particular, (1) the still high number of para-fiscal charges levied on firms complicates the business environment. Frequent changes in regulation, substantial inconsistency in how they are interpreted and the recourse to urgent legislative procedures weaken legal certainty and the predictability of the business environment. The perceived low quality of regulation, including the degree of interference with market mechanisms in some sectors, depresses the business climate. The administrative weaknesses and the fragmentation of the public administration weigh on service delivery for businesses.   (2) Restrictive regulation in the energy and railways sector limits competition, favouring incumbent firms and stifling investment. (3) Gas and electricity prices remain regulated, creating a barrier to market entry, while the lack of regulatory requirements for cooperation between state-owned enterprises, private operators and infrastructure managers prevents market contestability.                                                             (1) See SWD (2015) 400 final.   
                                                           
 
 
 
 
 
4.4. Business environment and investment 

investment 

The  sources  of 
funding  vary 
significantly  across  sectors.  While  the  growing 
ICT  sector  finances  investment  almost  entirely 
from  own  sources,  the  transport  and  tourism-
related  industries  rely  more  on  bank  loans.  This 
reflects the fact that investment in these sectors has 
been growing most strongly in the recent years, at 
a  pace  difficult  to  sustain  through  own  sources 
alone.  Public  funding  is,  as  might  be  expected, 
prevalent in water supply and waste management. 
In  the  (public)  construction  sector  and  in  water 
supply  and  waste  management,  EU  funds  have 
played a big role. 

Graph 4.4.3:  Investment across sectors: 2009 versus 2015 

(1) For definition of sectors refer to Graph 4.4.2. 
Source: Croatian Bureau of Statistics 

and 

investment 

The  efficient  use  of  the  European  Structural 
and  Investment  Funds  (ESIF)  is  vital  for 
conducting 
supporting 
structural  reforms  in  key  areas.  As  the  sectoral 
strategies  and  plans  are  the  precondition  for 
receiving  the  funds,  they  are  beneficial  for  both 
funding 
structural 
improvements  in  key  sectors.  At  the  end  of  the 
programming  period  2007-13,  the  rate  of  use  of 
ESIF  climbed  up  to  78 %  (40),  coming  from 
slightly  below  50 %  in  2015.  The  real  challenge 
currently  lies  in  the  use  of  the  funds  allocated  in 
the programming period 2014-20, which have vast 
potential  but  so  far  have  been  used  up  to  6.32 % 

projects 

and 

key 

of 

(40)  Cut-off  date  31  December  2016, 

including  advance 
payments.  Per  Fund:  77.4 %  for  the  European  Regional 
Development  Fund  (ERDF),  71 %  for  the  Cohesion  Fund 
(CF) and 93% for European Structural Fund (ESF). 

4.4.1.  INVESTMENT AND EU FUNDS 

As  Croatia  has  emerged  from  the  recession, 
investment  has  picked  up  in  most  sectors. 
Investment  has  been  growing  most  steadily  in 
transport,  tourism  and  ICT.  It  also  continues  to 
grow  in  manufacturing,  which  was  among  the 
sectors  hardest  and  earliest  hit  by  the  investment 
slump.  The  uptake  of 
these 
industries  reflects  growing  industrial  production 
and  the  strong  performance  of  exports  of  goods 
and  services.  At  the  same  time,  the  correction  of 
investment  in  construction  and  trade  was  still 
underway in 2015. 

investment 

in 

Graph 4.4.2:  Investment by sectors, cumulative growth 

(1) Sectors: A — Agriculture, forestry and fishing; B — Mining 
and quarrying; C — Manufacturing; D — Electricity, gas, 
steam and air conditioning supply; E — Water supply; 
sewerage, waste management and remediation activities; F 
— Construction; G — Wholesale and retail trade; repair of 
motor vehicles and motorcycles; H — Transportation and 
storage; I — Accommodation and food service activities; J 
— Information and communication. 
Source: Croatian Bureau of Statistics 

The  positive  trends  in  investment  contribute to 
a  more  balanced  allocation  of  capital  across 
sectors.  Investment  in  the  tradable  sectors  seems 
to  have  squeezed  out  a  lot  of  the  investment  that 
was  previously  concentrated  in  the  non-tradable 
sectors,  mainly  construction  and  trade.  Between 
2009  and  2015,  investment  in  manufacturing 
significantly increased its share in total investment, 
followed 
and 
accommodation  and  food  service  activities  (see 
Graph  4.4.3). A  similar  shift has  been  seen  in  the 
distribution of corporate debt (see Graph 4.2.2).  

transport 

storage 

and 

by 

41 

-30%-20%-10%0%10%20%ABCDEFGHIJ2008-20122013-20157%9%7%10%9%16%16%10%25%9%4%7%6%10%14%20%8%4%3%4%0%10%20%30%40%50%60%70%80%90%100%20092015ABCDEFGHIJ 
 
 
                                                           
4.4. Business environment and investment 

Graph 4.4.5:  Productivity in Croatia and CEE peers by 

industry (2014, CEE total=100) 

(41). In some investment-intensive sectors, such as 
environment  and  transport,  the  need  for  strong 
delivery capacities is particularly pronounced. The 
prioritisation  of  the  projects  and  the  use  of  well-
targeted  selection  criteria  are  key  to  ensuring  an 
optimal leverage of the innovation and competitive 
advantage (see Box 2.1). 

Graph 4.4.4:  Sources of investment financing by sectors 

(2015) 

(1) Sectors: B — Mining and quarrying; C — Manufacturing; 
D — Electricity, gas, steam and air conditioning supply; E — 
Water supply; sewerage, waste management and 
remediation activities; F — Construction; G — Wholesale 
and retail trade; repair of motor vehicles and motorcycles; H 
— Transportation and storage; I — Accommodation and 
food service activities; J — Information and communication 
Source: European Commission, based on Orbis database  

(1) For definition of sectors refer to Graph 4.4.2. 
Source: Croatian Bureau of Statistics 

4.4.2.  PRODUCTIVITY DEVELOPMENTS 

In  most  industries,  Croatiaʼs  productivity  is 
well  below  that  of  its  peers.  In  2014,  Croatiaʼs 
TFP was about 10 % lower than that of peer CEE 
economies. The gap was highest in manufacturing 
(almost  20 %),  mining  and  quarrying  and 
construction.  The  only 
in  which 
productivity  was  above  the  peer  average  was 
energy (see Graph 4.4.5). Provisional data suggest 
that  in  2015  productivity  in  the  food  and  hotel 
industry was above peers (42).  

industry 

(41)  Cut-off  date  31  December  2016, 

including  advance 
payments.  Per  Fund:  4,70%  for  the  ESF,  ERDF,  CF, 
EMFF, 9% for the EAFRD and 29% for the YEI. 

(42)  Data for 2015 are not presented, since limited coverage of 
firms'  accounts  does  not  yet  allow  for  a  fully  comparable 
picture.  

competitors. 

In  2010-2014, 

A  cumbersome  business  environment  prevents 
more  productive  firms  from  growing  faster 
than 
average 
productivity of firms increased in most industries, 
with  the  significant  exception  of  energy  utilities 
and mining and quarrying (43). Productivity growth 
was  sustained  in  the  tourism-related  industry  of 
accommodation  and  food.  Strong  demand  and  the 
upgrading  of  infrastructure,  in  terms  of  both 
capacity  and  quality,  have  resulted  in  better 
productivity 
trade  and 
manufacturing also registered significant increases, 
comparable  to  or  above  those  in  other  CEE 
economies  (see  Graph  4.4.6).  However,  allocative 
efficiency  (44),  defined  as  the  extent  to  which  the 

indicators.  Firms 

in 

(43)  The  firm  level  analysis  focuses  on  firms  active  in  the  real 
sector only and excludes the public sector, financial sector 
and  part  of  the  services  sector  (i.e.  business  services). 
Moreover the macroeconomic derivation of TFP relies on a 
concept  of  potential  output,  whereas  micro-level  TFP 
estimates  assume  that  each  company  is  at  its  potential 
output  level.  Finally  TFP  derived  from  macro  data  is 
estimated on the basis of aggregate labour statistics, which 
present  significant  shortcomings  (European  Commission, 
2016a). For all these reasons, macro and micro based TFP 
can show partially different evolutions.   

(44)  Average productivity in an industry increases if the average 
productivity  of  firms  increases  and/or  if  capital  is  shifted 
towards the most productive firms, meaning that the weight 

42 

0%20%40%60%80%100%ABCDEFGHIJOwn fundsCreditEU fundsPublic fundsOther020406080100120140BCDEFGHIJTotCEEHR 
 
                                                           
 
                                                           
driving 

productivity 

most productive firms also have the highest market 
shares,  has  been  weak  or  negative,  partially 
offsetting  the  substantial  improvement  in  firm-
aggregate 
in 
level 
productivity. With the significant exception of the 
energy  sector,  more  productive  firms  appear  to 
have  grown  more  slowly  than  less  productive 
firms.  Overall,  whereas  aggregate  productivity 
increased by 4 % and 8 % between 2010 and 2014 
in  the  CEE  economies  and  Croatia,  respectively, 
the contribution of the allocation of resources was 
positive in CEE economies (9 % growth), whereas 
it slightly detracted from aggregate growth in TFP 
in the case of Croatia (-7 %) (45). Such sub-optimal 
allocation of resources is typically associated with 
a  weak  functioning  of  markets,  rigid  regulation 
(often  in  specific  sectors)  and  the  widespread 
presence of large state owned enterprises. 

4.4.3.  SECTOR-SPECIFIC ISSUES 

The  liberalisation  of  the  energy  markets  is 
progressing  but  there  remain  some  restrictive 
regulations.  Obligations  requiring  gas  producers 
to offer the gas primarily to  the wholesale market 
supplier and the supplier of last resort, and to sell 
any remaining gas quantities in Croatia, are still in 
place. These provisions practically prevent energy 
exports  to  other  Member  States.  Additionally, 
public  service  suppliers  and  the  supplier  of  last 
resort  must  purchase  gas  for  the  needs  of  retail 
customers  from  the  supplier  on  the  wholesale 
market.  Croatia  is  currently  in  the  process  of 
revising the legislation. 

Competition  is  developing,  although  gas  and 
electricity  prices  remain  heavily  regulated. 
Competition  is  slowly  developing  in  the  retail 

of  more  productive  firms  increases.  In  particular,  if  we 
define  aggregate  productivity  as  the  average  of  individual 
firm  productivity  weighted  by  the  share of  value  added  in 
the  industry,  at  any  time  t,  then  it  can  be  shown  that 
aggregate  productivity  is  the  sum  of  the  simple  mean  of 
productivity  across  firms  and  a  measures  of  how  larger 
than  average  share,  correlates  with  higher 
(smaller) 
i.e. 
(respectively 
,  
Pjt = ∑ pitϑit =
iϵjt
(45)  While this could in theory result from  slower productivity 
growth  in  a  few  very  large  companies  the  data  shows  a 
weak  correlation  between  growth  and  productivity  across 
all classes of enterprises. 

∑ (ϑit − ϑj̅ )(pit − pj̅ ) 

than  average  productivity, 

∑ pit 
iϵjt

lower) 

Njt

+

iϵjt

1

4.4. Business environment and investment 

market  for  households  (46).  Furthermore,  although 
legislation has been transposed, electricity and gas 
transmission  system  operators  (TSOs)  have  still 
in  Croatia.  Additionally, 
not  been  certified 
licensing 
remain 
rights 
cumbersome,  and  the  separation  of  tasks  between 
the  transmission  system  operators,  the  national 
is 
regulatory  authority  and  market  operators 
incomplete. 

procedures 

and 

Graph 4.4.6:  Change in average productivity by industry 

(2010-2014) 

(1) Sectors: B — Mining and quarrying; C — Manufacturing; 
D — Electricity, gas, steam and air conditioning supply; E — 
Water supply; sewerage, waste management and 
remediation activities; F — Construction; G — Wholesale 
and retail trade; repair of motor vehicles and motorcycles; H 
— Transportation and storage; I — Accommodation and 
food service activities; J — Information and communication 
Source: European Commission, based on Orbis database 

recent 

improvements, 

Despite 
restrictive 
regulations  and  policies  still  dominate  some 
transport 
rail.  The 
sectors,  particularly 
dominant market position of the existing three rail 
SOEs  (HŽ  Infrastruktura,  HŽ  Putnički  prijevoz, 
HŽ  Cargo)  prevents  the  development  of  private 
rail enterprises in Croatia. For example, HŽ Cargo 
accounted  for  around  91 %  of  freight  transport  in 
the first three quarters of 2016, while in passenger 
rail  transport  the  incumbent  continues  to  hold 
100 % of the market. In this latter segment, Croatia 
does  not  make  use  of  competitive  tendering,  but 
only of direct award to the state-owned incumbent 
lack  of  cooperation 
passenger  operator.  The 

(46)  There  are  currently  more  than  40  retailers  and  the 
incumbent’s share (40 %) is below EU average (50 %) 

43 

-0.5-0.4-0.3-0.2-0.100.10.20.30.40.5HRCEEHRCEEHRCEEHRCEEHRCEEHRCEEHRCEEHRCEEHRCEEHRCEEBCDEFGHIJTotalChange in allocative efficiencyChange in firm level average productivityChange in industry average productivity 
                                                                                   
 
                                                           
4.4. Business environment and investment 

steadily  rising  trend  in  the  number  of  tourist 
arrivals  and  overnight  stays  has  continued 
throughout  2016,  with  revenues  exceeding  pre-
crisis  levels  and  positively  contributing  to  the 
current  account  surplus.  Tourism  boasted  record 
investments  in  2013-2015  (see  Graph  4.4.2), 
resulting  in  an  increase  in  both  capacity  and 
quality.  The  sector  benefits  from  the  country's 
increasingly recognised status of a safe and easily 
accessible  tourist  destination  with  a  preserved 
environment.  The  large-scale  investment  in  roads 
over  the  last  decade  has  made  most  Croatian 
tourist  destinations  more  accessible  to  tourists 
from  the  main  European  markets.  Unlike  several 
other 
competing  Mediterranean  destinations, 
Croatia  has  so  far  avoided  excessive  construction 
and  devastation  of  its  coast.  These  advantages,  if 
preserved and further developed, have the potential 
to bring increasing benefits to the sector. 

Graph 4.4.7:  Restrictiveness indicator 

further  hampers 

between SOEs and private operators, and between 
infrastructure  managers, 
the 
competitiveness  of  the  rail  sector  in  Croatia.  The 
infrastructure manager  HŽ  Infrastruktura  does  not 
have  an  asset  register  which  forms  the  basis  of 
efficient  asset  management  strategies.  On  the 
positive  side,  Croatian  ports  have  lifted  a  major 
barrier  by  publishing  complete  lists  of  access 
conditions and prices of rail-related services.  

Services  are  still  hampered  by  red  tape,  but 
there  are  some  improvements.  The  regulatory 
environment  for  business  services  in  Croatia 
remains  restrictive,  as  confirmed  by  a  new 
indicator  developed  by  the  Commission  (47).  This 
is  particularly  evident  in  legal  services,  where 
fixed tariffs and a marketing ban are still in force. 
The  recently  adopted  action  plan  for  reducing  the 
administrative  burden  envisages  the  abolition  of 
some  of  such  restrictions  (Ministry  of  Economy, 
2017).  In  December  2016  the  authorities  adopted 
legislation  that  brings  tax  advisers'  activities  into 
line with the Services Directive. The slow pace of 
legislative  changes  hampers  the  development  of 
new business models. This  has a negative impact 
on  consumers  and  investors,  especially  in  the 
collaborative  economy  sector,  in  spite  of  the  fact 
that Croatian consumers appear to be well aware of 
the  services  on  offer  and  are  keen  to  use  them 
(European Commission, 2016e). 

There  has  been  little  progress  in  reforming 
regulated  professions.  Croatia's  list  of  regulated 
professions 
includes  architects,  certified  civil 
engineers, tax advisers, lawyers, patent agents, real 
estate agents and tourist guides. The restrictiveness 
indicator shows that in six of the seven professions 
analysed,  regulation  in  Croatia  is  more  restrictive 
than  on  average  in  the  EU  (see  Graph 4.4.7).  In 
July 2016 the government submitted an action plan 
outlining  plans  to  replace  and  modernise  unfit 
the  plan  contains  only 
regulation.  However, 
limited  reform  proposals  or  does  not  provide 
details  on 
the  planned 
amendments. 

substance  of 

the 

Tourism  continues  to  be  a  key  driver  of 
Croatiaʼs  strong  economic  performance.  The 

(47)  The Commission has developed a new composite indicator 
on the restrictiveness of most existing barriers to the access 
to  and  exercise  of  regulated  professions,  based  on  data 
collected from  Member States and complemented by desk 
research (European Commission, 2016c and 2016d).  

Source: European Commission 

in 

Arrivals  are  progressing 
line  with  the 
national  strategy  for  tourism  but  revenue 
remains  relatively  low.  The  goals  of  increasing 
the  number  of  tourist  arrivals  and  overnight  stays 
set  out  in  the  tourism  development  strategy  up  to 
2020  seem  within  reach.  However,  achieving  the 
revenue  growth  target  will  require  a  substantial 
boost 
tourists'  average  expenditure.  The 
implementation  in  2016  of  the  ‘eVisitor’  and 
‘eCrew’ systems, which are  aimed at simplifying 
check-in  and  check-out  procedures  and  reducing 
the  sector's  shadow  economy,  was  a  positive 
development. The bulk of investment in the sector 
is  geared  toward  upgrading  existing  hotels  (to  4 

in 

44 

012345AccountantArchitectCivil engineerLawyerPatent agentReal estate agentTourist guideEUHR 
                                                           
 
4.4. Business environment and investment 

insufficient  incentives  to  manage  waste  according 
to  the  waste  hierarchy,  lack  of  co-ordination 
between  the  different  administrative  levels,  and 
insufficient  enforcement  capacity  are  the  main 
factors  impeding  a  faster  transition  to  a  circular 
economy. 

The Green Book published in October 2015 sets 
the technical basis for developing a low carbon 
strategy. This strategy sets out the path towards a 
competitive  low-carbon  economy  for  the  period 
until  2030,  with  an  outlook  to  2050.  It  applies  to 
all  sectors  of  the  economy  and  human  activities, 
industry, 
but  particularly 
concerns 
transport, 
and  waste 
management.  It  supersedes  the  sectoral  strategies, 
although  operationally  implemented  through  the 
individual sectors.  

agriculture, 

forestry 

energy, 

4.4.4.  CROSS-CUTTING ISSUES 

is 

to 

to 

reduce 

expected 

authorities'  plans 

The 
the 
administrative  burden  are  now  resuming.  The 
implementation of the action plan for reducing the 
administrative  burden 
cut 
administrative  costs  by  30 %  (commensurate  to 
0.4 %  of  GDP)  in  eight  areas  by  end-2017 
(Ministry  of  Economy,  2017).  The  plan  sets  out 
104  measures  to  achieve  the  reduction.  The  cost 
was  measured  using  the  standard  cost  model 
methodology  (SCM).  There  are  plans  to  enlarge 
the  model  measurement  to  all  economically-
relevant  regulation,  including  services,  but  so  far 
no decision has been taken. The SCM will also be 
used  in  the  regulatory  impact  assessment  of  new 
regulation,  together  with  the  SME  test.  National 
companiesʼ 
rules 
registered  offices  into  and  out  of  Croatia  are  not 
yet in place. 

transferring 

directly 

for 

tax 

the 

reform 

long-standing 

Progress  on  removing  parafiscal  charges  is 
lagging.  The  authorities  did  not  use 
the 
to  systematically 
comprehensive 
address 
issue  of  parafiscal 
charges, many of which are statistically treated as 
taxes,  regardless  of  their  legal  title.  However,  the 
government  adopted  a  decision  in  July  2016  to 
abolish  13  and  reduce  11  parafiscal  charges  in 
2016-2017, amounting to HRK 250 million (25 % 
lower 
reform  programme 
commitment).  To  date,  five  of  these  charges  have 
been  abolished  and  five  reduced  (amounting  to  a 

its  national 

than 

and  5  stars).  While  this  may  help  to  extend  the 
peak  season  and  increase  revenues,  hotels  still 
account for just around one third of Croatia's total 
accommodation  capacity  (with  the  rest  largely 
being  residential  accommodation).  However,  the 
extremely high seasonality of the tourism industry 
remains a key challenge, however. 

The  ever-growing  importance  of  tourism  has  a 
twofold effect — it boosts the economy and puts 
strains  on  the  environment.  In  2016,  revenues 
from  tourism  accounted  for  almost  one  fifth  of 
GDP,  higher  than  in  any  of  the  competing 
European  countries  in  the  Mediterranean.  During 
the  crisis,  tourism  curbed  the  country's  trade 
deficit,  helped  to  maintain  currency  stability  and 
cushioned  the  rising  unemployment.  However, 
such a heavy reliance on one single sector exposes 
the (entire) economy to a considerable risk. Other 
adverse effects are seen in waste management and 
water  supply,  traffic  congestion,  pollution  and 
pressures on natural resources.  

resources 

Croatia’s  transition  from  a  linear  to  a  circular 
economy is just beginning. Six years of economic 
recession,  a  general  lack  of  adequate  policies  and 
competences  and  a  regulatory  framework  that  is 
still  not  in  line  with  EU  regulations  have  all 
contributed  to  the  lag  in  Croatia’s  transition 
towards a circular economy. Resource productivity 
(which measures how efficiently the economy uses 
material 
to  produce  wealth)  has 
improved slightly over the last ten years, but at 1.1 
EUR/kg is still significantly below the EU average 
of 2  EUR/kg. Lack  of  investment,  in  particular  in 
the waste management sector is the main driver of 
the  slow  transition  to  a  circular  economy.  Croatia 
is  still  far  from  meeting  the  EU  targets  on 
recycling.  Recycling  of  municipal  waste  (48) 
remains low (17 % compared to the EU average of 
44 %).  At  the  same  time,  landfilling  of  municipal 
waste  accounts  for  83 %,  compared  to  the  EU 
average of 28 %. Croatia has recently adopted the 
national  waste  management  plan  and  the  waste 
prevention  programme,  both  required  to  develop 
the  existing  policies  and  strategies  aimed  at 
achieving  the  EU  waste  management  targets. 
instruments, 
Suboptimal  use  of 

economic 

(48)  Municipal waste consists of waste collected by or on behalf 
of  municipal  authorities,  or  directly  by  the  private  sector 
(business or private non-profit institutions) not on behalf of 
municipalities. 

45 

 
                                                           
total  of HRK 130  million),  and  amendments  have 
been prepared to reduce four more. The register of 
parafiscal charges has not been updated. 

Croatia  lags  behind  other  Member  States  in 
broadband  connectivity  and  coverage.  While 
there  is  some  progress  in  improving  connectivity 
(European  Commission,  2017),  Croatia  is  still  far 
below  the  EU  average  (see  Graph  4.4.8).  The 
National  Programme  for  the  Development  of 
Broadband  Backhaul 
Infrastructure  has  been 
notified to the Commission end of December 2016. 
It aims at building the infrastructure for better and 
nationwide high-speed broadband connections.  By 
2020  the  country  should  be  covered  by  next-
generation  access  networks  enabling 
internet 
access at speeds over 30 Mbit/s across the country, 
and  at  least 50 % of  households  shall have access 
at  100 Mbit/s  or  greater.  Rural  broadband 
connectivity  and  fast  broadband  coverage  remain 
limited.  The  expected  transposition  of  the  Cost 
Reduction  Directive 
(European  Commission, 
2014) should help speed up infrastructure coverage 
and broadband roll-out. 

Graph 4.4.8:  Broadband connectivity in Croatia by speeds 

(% of households) 

4.4. Business environment and investment 

EU average and the national R&D intensity target 
of  1.4 %.  Public  R&D  intensity  stagnated  in  the 
last  5  years  at  around  0.4 %  of  GDP.  Business 
R&D  intensity  has  increased  between  2009  and 
2015  from  0.34 %  to  0.44 %,  but  remains  far 
the  EU  average  of  about  1.3 %.  In 
below 
innovation,  Croatia  performs  above 
the  EU 
average  only  in  human  resources,  a  result  of 
having  an  above-average  proportion  of  young 
people  with 
education. 
Notwithstanding the high number of graduates, the 
education  system  faces  challenged  (see  section 
4.3.2).  

secondary 

upper 

is 

The  low  level  of  R&D  spending  is  one  of  the 
reasons for the low quality and efficiency of the 
R&I  system.  The  quality  and  efficiency  of  the 
R&I system as measured by the quality and impact 
low (49).  Several 
of  scientific  publications 
factors  continue  to  hinder  the  development  of  a 
strong  science  base  in  Croatia  with  improved 
connections  to  the  economy.  They  include  sub-
critical  scale,  fragmentation,  lack  of  international 
integration  and  a  below  EU  average  rate  of  new 
graduates  in  science  and  engineering (50).  Public-
private cooperation in R&I remains at a relatively 
low  level,  as  shown  by  the  level  and  decline  in 
public-private co-publications (51) and the share of 
public research financed by business (52).  

technology  and 

Croatia  has  recently  introduced  some  policy 
responses  to  foster  innovation.  Several  national-
level strategies to support R&I have recently been 
developed  to  complement  the  2014  strategies  for 
for 
education,  science  and 
fostering  innovation.  In  particular,  the 
'smart 
specialisation'  strategy  adopted  in  March  2016  is 
an  important  framework  for  implementing  ESIF 
that  R&I 
funding  effectively  and  ensuring 
activities  are  fostered 
thematic 
priorities  (health  and  quality  of  life;  energy  and 
sustainable  environment;  transport  and  mobility; 
security;  food  and  bio-economy).  There  was 

in  five  key 

Source: DESI 2016 

4.4.5.  RESEARCH AND INNOVATION 

Croatia has the fifth lowest R&D intensity level 
in  the  EU  and,  as  a  moderate  innovator, 
performs below average in nearly all innovation 
dimensions.  R&D  intensity  amounts  to  only 
0.85 %  of  GDP,  significantly  below  both  the  2 % 

(49)  Only  4.5 %  of  Croatian  publications  were  within  the  top 
10 % most cited publications in 2013, compared to an EU 
average of 10.5 % 

(50)  New  graduates  in  science  and  engineering  per  thousand 
population  aged  25-34  in  Croatia  represent  14.4  (EU 
average 17.6).  

(51)  Croatia  in  2014  had  11  public  private  co-publications  per 
million population, compared to an EU average of 34. 
(52) In  Croatia  public  expenditure  on  R&D  financed  by 
business  enterprise  amounted  to  0.034 %  of  GDP  in  2015 
compared to 0.052 % in the EU 

46 

020406080100Fixed broadbandFast broadband(>30 Mbit/s)Ultra-high speedbroadband (>100Mbit/s)%Subscription - EUSubscription - HRAvailability - EUAvailability - HR 
 
                                                           
4.4. Business environment and investment 

scientific  excellence  and  industry  clusters  under 
the smart specialisation strategy. 

progress  in  improving  governance  by  merging 
existing  R&I  institutions  —  the  National  Science 
Council  and  the  National  Council  for  Higher 
Education;  the  Business  and  innovation  agency 
BICRO  and  the  Agency  for  Small  Business  and 
Investments, HAMAG. In November 2015 six new 
centres of research excellence were established and 
additional  resources  for  them  are  planned  from 
ESIF funding.  

Changes  have  been  made  with  the  aim  of 
introducing  competitive  funding  of  R&D,  but 
with  low  impact.  These  changes  include  funding 
research  and  higher  education,  and  awarding 
project-based  R&D,  on  the  basis  of  performance; 
allocating  new  institutional  responsibilities;  and  a 
more  rigorous  evaluation  process.  Although  these 
reforms  can  help  to  strengthen  the  accountability 
of public research organisations, the percentage of 
public funding allocated on this basis remains low. 
Public  spending  on  R&D  as  a  share  of  GDP  in 
2015 reached only 59 % of the EU average. 

environment 

The  'smart  specialisation'  strategy  addresses 
the need to strengthen the private sector's R&I 
to  create  an 
capacity.  The  strategy  aims 
innovation-friendly 
for  SMEs, 
strengthen  the links between science  and business 
and  develop  smart  skills  to  meet  business  needs. 
This  initiative  follows  the  National  Innovation 
Strategy (of December 2014) and a programme for 
technology  transfer  at  universities  launched  in 
February  2015.  Additional  grant  schemes  for 
SMEs  were  launched  in  2016  to  complement  the 
R&D 
ensure 
schemes 
sequencing of innovation policy instruments aimed 
supporting 
the  commercialization  phase  of 
innovation projects. The new tax reform maintains 
the existing tax incentives for R&D. The National 
Information  System  in  Science,  launched  in  2014 
to  improve  programme  evaluation,  has  yet  to  be 
completed. 

investment 

and 

to 

Croatia  can  build  on  the  use  of  EU  funds  to 
meet  its  challenge  of  increasing  investment  in 
R&D&I.  Croatia  is  eligible  for  a  substantial 
amount  of  funding  for  R&D  from  EU  funds  over 
2014-2020,  including  a  contribution  of  around 
EUR 665 million  from  the  European  Regional 
Development  Fund.  These  resources  have  a  key 
role 
towards  a 
the 
knowledge-intensive  economy  through  targeted 
capacity building and by bringing together areas of 

in  stimulating 

transition 

47 

 
 
 
 
4.5. PUBLIC SECTOR GOVERNANCE 

4.5.1.  PUBLIC ADMINISTRATION 

to 

of 

for 

the 

doing 

reform 

business 

A  weak  public  administration  holds  back  the 
agenda. 
implementation 
According 
the  World  Economic  Forum 
Competitiveness  Report  2016-2017,  an  inefficient 
government  bureaucracy  is  by  far  the  biggest 
in  Croatia. 
problem 
Furthermore, Croatia scores much lower than other 
EU  members  on  the  government's  capacity  to 
deliver  sound  policies  (‘executive  capacity’)  as 
the  participatory  and  oversight 
well  as  on 
(‘executive 
actors 
social 
of 
competencies 
accountability’)  (53).  The  lack  of  evidence-based 
policymaking  and  monitoring  of  policy  impact 
affects  most  areas,  and  the  perceived  quality  of 
public  services  in  Croatia  is  also  predominantly 
bad (European Commission, 2016f).  

Graph 4.5.1:  Aggregate local government unit expenditure 

in 2015 by function 

Source: Ministry of Finance and Croatian National Bank 

At  the  sub-national  level,  municipalities  and 
towns are in charge of the majority of spending. 
The  2016  country  report  analysed  the  financing 
the  distribution  of  competences 
system  and 
between 
level 
and 
administration. 
(municipalities 

central, 

towns) 

county 

local 

and 

the 

law 

Although 
in  principle  distinguishes 
between  towns  and  the  municipalities,  they  have 
the  same  competencies.  In  particular,  they  are 
responsible  for  the  bulk  of  spending  at  the  sub-
national  level,  mainly  on  pre-primary  education, 
housing,  road  and  transport,  and  recreational 
activities  (including  religion).  At  the  level  of 
counties,  the  share  of  spending  is  higher  on  non-
pre-primary  education  and  healthcare  (see  graph 
4.5.1).  

broadened 

to  extend 

amendments 

the  possibility 

The  high  level  of  territorial  fragmentation 
contributes  to  a  complex  state  administration 
and weighs on efficiency. The current institutional 
design emerged from the 1992 Law on Local Self-
Government  and  Administration.  Between  1992 
and today, the number of towns and municipalities 
has  increased from  102  to  555,  mainly  as  a  result 
of villages claiming autonomous jurisdiction. This 
has  led  to  a  large  number of  small  municipalities, 
with  the  majority  having  a  population  between 
2 000  and  3 000.  The  2001  constitutional  and 
legislative 
the 
responsibilities  of  towns  and  municipalities.  They 
their 
were  granted 
competencies  in  the  provision  of  public  services, 
without  however  adequate  consideration  of 
capacity  constraints  induced  by  the  increasing 
fragmentation of municipalities. Many units do not 
have  the  adequate  financial,  administrative,  and 
personnel  resources,  and  the  range  and  quality  of 
functions  performed  varies  significantly  across 
municipalities  and  towns.  Moreover,  the  increase 
in 
towns 
contributed  to  increased  costs  and  an  inefficient 
utilisation of resources (UNDP, 2005; Ministry of 
Public  Administration,  2015).  This  trend  is  still 
continuing:  between  2010  and  2015  the  staff  of 
sub-national  units  has  increased  by  almost  7 % 
(World  Bank,  2016).  This  has  been  accompanied 
by  a  steady  increase  in  the  wage  bill  but  no 
noticeable  improvement  in  the  quality  of  local 
services.  

the  number  of  municipalities  and 

(53) The  Sustainable  Governance  Indicator  (SGI)  combines 
analysis of policy performance, democracy and governance 
for  41  EU  and  OECD  countries.  Executive  capacity 
includes factors such as strategic capacity, inter-ministerial 
coordination,  societal  consultation,  policy  communication, 
effective  implementation,  adaptability,  and  organisational 
reform  capacity.  Executive  accountability  includes  factors 
such as citizens' participation, legislative actors' resources, 
the role of media, political parties and interest associations 
(Bertelsmann Stiftung, 2016). 

Per-capita  expenditure  tends  to  be  higher  for 
smaller  municipalities,  partly  on  account  of 
higher  operational  costs.  Administrative  and 
general public services absorb more than one third 
of  current  expenditure,  and  in  some  cases  the 
financing  of  the  administration  itself  takes  up  to 
half  of  the  units’  budgets.  The  population  size  of 
towns and municipalities influences their financing 
costs  and  the  efficiency  of  spending.  Per-capita 

48 

0.00.51.01.52.02.53.03.5Municipalities andtownsCountiesZagrebInfrastructure, EnvironmentSocial, Health, EducationAdministrative, general public services 
 
 
                                                           
4.5. Public sector governance 

financial 

intervenes 

the  extent 

standards, 
through 

The system of sub-national financing relies on a 
complex  system  of  revenue  sharing  and 
transfers.  The  core 
resources  of 
municipalities  and  towns  comes  from  a  revenue 
sharing  arrangement  of  the  personal  income  tax 
levied on residents. Towns and municipalities that 
have  taken  on  decentralised  functions  are  entitled 
to  a  higher  share  of  the  personal  income  tax, 
irrespective  of 
to  which  service 
provision  goes  beyond  residents.  This  financing 
system  implies  that  most  units  are  not  able  to 
provide  services  with  own 
resources  alone, 
particularly in the least developed parts of Croatia. 
When  shared  revenue  is  not  sufficient  to  cover 
the  central 
established  minimum 
government 
‘fiscal 
its 
equalisation fund’. The financial standards for the 
decentralised  functions  appear  to  be  mostly  based 
on  past  expenditure,  though  this  is  not  clearly 
specified  (European  Commission,  2016a).  As  can 
be  seen  in  the  graph  4.5.2,  these  transfers  are 
significant  only  for  larger  municipalities  and 
towns,  as  indeed  these  are  providing  the  bulk  of 
the  decentralised  functions.  These  transfers  are 
relatively  modest  when  compared  with  other 
transfers  from  the  central  budget,  ministries  and 
other  central  institutions,  and  which  are  not 
directly  linked  to  the  decentralised  functions. 
Furthermore,  municipalities  and  towns  belonging 
to  areas  of  special  national  concern,  benefit  from 
additional  transfers,  as  well  as  a  privileged  tax-
sharing  arrangement.  The  multitude  of  special 
rules and criteria for the allocation of transfers and 
grants  ultimately  result  in  a  non-fully  transparent 
financing system. 

it 

in 

varies 

towns,  and 

considerably 

Transfers  do  not 
fully  address  regional 
service 
disparities  and  heterogeneity 
provision.  The  per-capita  cumulative  distribution 
across 
of 
transfers 
municipalities  and 
is  weakly 
correlated  with  the  fiscal  capacity  of  local  units 
and scope of services provided Per-capita transfers 
tend  to  be  much  larger  in  smaller  municipalities 
than  in  larger  ones.  As  a  large  share  of  transfers 
ultimately  seems  to  address  the  higher  costs  of 
smaller  local  units,  their  redistributive  impact  in 
terms  of  service  provision  is  impaired.  Moreover, 
following the 2017 tax reform, and the further cut 
in  personal  income  taxes,  the  share  of  transfers 
from  central 
local  government  units  has 
increased  by  around  17 %.  Meanwhile,  disparities 
in  per-capita  expenditures  across  the  territory 

to 

spending  is  highest  in  the  smallest  municipalities 
(with  less  than  1 000  inhabitants),  partly  on 
account  on  the  higher  administrative  costs,  but 
possibly  also  due  to  the  higher  cost  of  providing 
services.  Per-capita  expenditure  drops  by  more 
than  50 %  in  units  between  1 000  and  2 000 
residents,  and  further  declines  thereafter.  The 
a 
smaller  municipalities 
minimum set of tasks. This also explains why per-
capita  administrative  expenditure  makes  up  for  a 
higher share of their total expenditure. 

typically  perform 

Graph 4.5.2:  Municipalities and towns (*) current revenue 

and expenditure in 2015  by size class 

(*) Simple average within each size class. Zagreb has not 
been included.  
Source: Ministry of Finance and Croatian National Bank 

Larger  municipalities  and  towns  also  feature 
higher  average  expenditure,  but  this  partly 
reflects  a  broader  range  of  provided  services. 
Larger municipalities and towns  appear to achieve 
economies  of  scale  in  terms  of  administrative 
costs, but they also incur higher average per-capita 
spending on services. Municipalities above 10 000 
inhabitants and towns spend a greater share of their 
revenues  on  education,  healthcare  and  social 
services,  compared  to  smaller  units.  This  is  also 
related to the fact that they tend to provide services 
for  citizens  residing  outside  their  borders  (which 
distorts the figure for per-capita expenditure). The 
role  of  major  centre  for  service  provision  is 
recognised  through  special  status  to  the  town-
county  of  Zagreb,  for  which  an  ad-hoc  system  of 
revenue  sharing  and  grants  is  in  place.  However, 
other  large  municipalities  and  towns  do  not  enjoy 
similar special status.   

49 

01000200030004000500060007000HRK per capitaOwn revenueEnvironment, community services, otherSocial, Health, EducationAdministrative, general public servicesTransfers - decentralised functionsTransfers - other 
 
4.5. Public sector governance 

remain marked, ranging from as low as 1 700 HRK 
(around  225  EUR)  per  year  in  the  Brod-Posavina 
county  to  6 250  HRK  (around  825  EUR)  in  Istria 
county.  

as  well  as  merging  the  existing  agencies.  The 
planned  streamlining  of  public  sector  wages  has 
been postponed to the end of 2019 (Section 4.3). 

in 

the 

weaknesses 

Recent years have seen no concrete progress in 
tackling 
public 
administration.  In  general,  the  adoption  and 
implementation  of  the  ambitious  reform  plans  in 
this  area  has  not  been  supported  by  firm  political 
commitment.  Upon  accession  to  the  EU,  Croatia 
allocated a significant share of the European Social 
Fund  for  the  period  2014-2020  to  improving  the 
quality and efficiency of its public administration. 
In  order  to  meet  the  ex-ante  conditionalities 
required  for  the  release  the  funds,  in  2015  the 
ambitious  public  administration  development 
strategy for 2015-2020 was adopted. However, due 
to  several  revisions  of  its  action  plan,  adopted  in 
December  2016,  the  actual  implementation  of  the 
strategy could not start. The action plan for 2017-
2020  tackles  three  very  relevant  policy  areas: 
efficiency of the public administration system, de-
politicisation  and  efficient  human 
resource 
management, and digitalisation of public services. 
The success of this reform will very much depend 
on 
the 
the  extent  of  political  backing  and 
administrative capacities to implement it.  

the 

and 

administration 

conditional 
upon 
information  system 

The  three  pillars  of  the  public  administration 
reform  face  delays.  Analytical  work  has  been 
undertaken  on  the  territorial  fragmentation  of  the 
functional 
public 
distribution  of  competencies,  but  no  measure  has 
been  adopted.  The  authorities  have  decided  to 
the 
make 
reform 
the 
establishment  of  an 
that 
records  local  units'  spending  by  beneficiary.  This 
may prove challenging and thus risks significantly 
delaying  the  reform  process.  New  legislation  on 
the  public  administration  which  redefines  the 
division of tasks between the central and local state 
administration  offices  is  still  under  preparation. 
There  is  no  clear  timetable  for  the  plan  to  reduce 
the  over  1 200 
local  branches  of  central 
administration  offices  by  20 %.  In  early  2017  the 
government announced the establishment of a task 
force  to  draw  up  a  new  law  on  the  financing  of 
sub-national  government  units.  The  planned 
streamlining  of  the  state  agencies  system  has  also 
been  put  on  hold.  This  includes  legislation  aimed 
at regulating their establishment and introducing a 
higher  degree  of  homogeneity  across  the  system, 

4.5.2.  STATE-OWNED ENTERPRISES 

to 

impetus 

The recent creation of a Ministry of State Assets 
could  foster  a  more  coordinated  approach  and 
restructuring  and 
give 
the 
privatisation  of  SOEs.  Until 
recently,  49 
companies  of  strategic  and  special  interest  for  the 
state  were  coordinated  by  the  central  state  office 
for  state  asset  management  (SDUUDI).  Recently, 
this  role  has  been  taken  over  by  the  newly 
established  Ministry  of  State  Assets.  The 
ownership  function  for  another  500  companies 
owned by the central government but whose public 
shares are intended to be privatised stays with the 
Centre  for  Restructuring  and  Sale  (CERP).  Some 
of these companies operate in industries where the 
presence of SOEs is typically large, whereas others 
operate in sectors such as manufacturing, trade and 
accommodation.  Other  SOEs  are  owned  by  local 
government  units,  mostly  utility  companies  in  the 
energy and water distribution sector. 

Corporate  governance  of  enterprises  owned  by 
local  government  units  appears  to  be  weak.  In 
recent  reports,  the  State  Audit  Office  identified 
various  shortcomings  in  local  government-owned 
enterprises  (State  Audit  Office,  2015  and  2016). 
These  include  the  lack  of  a  clear  specification  of 
the  duties  and  responsibilities  of  Supervisory 
Boards, as well as unclear rules of appointment for 
board  members  and  on  conflict  of 
interest. 
Supervisory boards do not appear to be involved in 
strategic planning. In some companies, supervisory 
boards  are  not  given  the  chance  to  discuss  the 
business  results  and  management  performance. 
Independent  external  auditors  were  occasionally 
selected without following the public procurement 
rules.  Overall,  in  many  such  companies,  internal 
control systems appear inadequate. As regards real 
estate management, it is seen as inadequate in most 
of the local government-owned enterprises. This is 
due to outdated catalogues of their real estate and a 
lack of strategies for optimal utilisation, and to the 
poor  maintenance  of  the  registers  of  lessees  and 
respective income. 

The  government  has  taken  some  steps  towards 
the privatisation of national assets but progress 

50 

 
is  stalling.  The  2016  national  reform  programme 
launched  an  ambitious  privatisation  agenda  for 
Croatia  and  identified  some  potential  candidates 
for  divestment.  Eight  SOEs  have  been  removed 
from  the  list  of  strategic  companies,  opening  up 
the  way  for  their  privatisation.  The  government’s 
share  in  one  of  those  companies,  Koncar  electric 
industry,  has  already  been  successfully  sold 
through  a  bid  on  the  Zagreb  Stock  Exchange. 
Other companies that have been removed from the 
strategic  list  are  Croatia  Airlines  (98 %  state 
owned), Podravka (20 % state owned), ACI (79 % 
state  owned),  port  Rijeka  (33 %  state  owned), 
Croatia  Banka  (100 %  state  owned),  Petrokemija 
(80 %  state  owned)  and  Croatia  Osiguranje  (31 % 
state owned). In 2016 the state sold shares in a few 
companies besides Koncar, yielding total revenues 
of  around  0.2 %  of  GDP.  However,  the  draft 
operational  plan  for  2017  does  not  spell  out  a 
detailed strategy to achieve the remaining goals of 
assets 
the 
management,  and  no  concrete  future  steps  for 
privatisation have been outlined yet. 

2013-2017 strategy 

public 

for 

Graph 4.5.3:  Productivity gap of SOEs by ownership 

(1)  SOEs, including minority stakes. 
(2) Histogram shows the estimated productivity gap and 
vertical bars represent the standard error. 
Source: European Commission, Orbis and SDUUDI 

The  available  evidence  suggests  that  Croatian 
SOEs have particularly weak productivity. The 
productivity  gap  between  state-owned  and  private 
enterprises  is  higher  in  Croatia  than  in  peer  CEE 
economies  (after  controlling  for  sector,  size,  state 

4.5. Public sector governance 

ownership  and  a  country-specific  effect) (54).  The 
productivity  gap  was  estimated  at  about  54 %  in 
firms coordinated previously by SDUUDI (now by 
the  Ministry of  State  Assets).  It  was  around  32 % 
in  firms  in  CERP's  portfolio  with  a  majority 
ownership  and  about  12 %  in  those  with  minority 
ownership.  Interestingly,  in  the  remaining  SOEs 
the gap does not appear to be significant. This may 
be due to the fact that utilities also tend to be state 
owned  in  the  other  countries  examined.  Overall, 
the  evidence  shows 
that  central  government 
ownership  in  Croatia  entails  a  ‘productivity  gap’, 
which  appears  to  be  greater  in  firms  subject  to 
tighter public control. 

The presence of large, unproductive SOEs may 
affect  overall  productivity  in  the  industries  in 
which  they  operate,  as  they  hamper  allocative 
efficiency.  The  European  Commission  has 
published  an  analysis  of  the  impact  of  state 
ownership  on  allocative  efficiency (European 
Commission, 2016g) which finds that the presence 
of  SOEs  significantly  reduces  sectoral  allocative 
efficiency. This is likely to be driven by the lower 
productivity  of  typically  large  SOEs  and  the 
potentially  negative  spillover  effects  on 
the 
allocation of productive resources. The presence of 
SOEs  can  hamper  the  reallocation  of  labour  and 
capital  to  more  efficient  firms,  for  example 
because  private  firms  face  more  difficulties  to 
engage in public procurement or obtain bank loans, 
or  because  of  higher  wages  in  SOEs  (European 
Commission, 2015a). It may take some time before 
the  benefits  of  privatisation 
terms  of 
productivity gains materialise, and complementary 
policy measures could be necessary to reap the full 
benefits.  Accompanying  measures, 
such  as 
retraining the workforce, would also need to be put 
in  place  to  mitigate  the  potential  social  costs  of 
restructuring  SOEs.  Similar  caveats  also  hold  for 
the  firm-level  productivity  gap  referred  to  above. 
Whereas  these  limitations  call  for  caution  in 
projecting  potential  gains 
from  privatisation, 
including  the  timeline  for  the  positive  effects  to 

in 

(54) Specifically, firm level total factor productivity (TFP) was 
estimated  at  the  level  of  NACE  2  industries  with  pooled 
data  for  Croatia  and  other  Central  Eastern  European 
economies  (namely  CZ,  SK,  PL  and  HU).  TFP  was  then 
regressed  on  size,  time,  industry-related  dummies,  and 
additional  dummies  controlling  for  lower  TFP  in  Croatia 
overall  and  lower  TFP  in  SOEs  overall  in  Croatia  and  in 
peer  countries.  Finally,  for  Croatia,  we  included  four 
specific 
specific 
ownership structure. 

indicator  variables  capturing 

the 

51 

-10010203040506070SDUUDICERP -majoritypackagesCERP -minoritypackagesOther SOEs 
 
                                                           
4.5. Public sector governance 

courts),  on  average.  However,  there  are  signs  of 
improvement,  as  courts  have  resolved  more  cases 
than  they  have  received.  In  2016,  the  number  of 
pending  civil,  commercial,  enforcement  and 
administrative  cases  at 
instance  courts 
dropped  by  10 %  (against  2015).  This  was  partly 
due  to  a  lower  caseload  as  fewer  cases  were 
resolved. The backlog of criminal cases increased. 

first 

cases 

public 

Electronic  communication  with  courts  remains 
underdeveloped.  The  electronic 
filing  and 
delivery of court documents could bring significant 
the  court  staff’s 
savings  and  would  relieve 
workload.  However,  the  electronic  delivery  is  not 
in  place  regarding  insolvency  cases  (for  FINA), 
enforcement 
notaries), 
(for 
administrative cases (for the tax administration) or 
regarding  civil  and  commercial  cases 
(for 
lawyers). Commercial judges lack online access to 
registers  (e.g.  for  vehicles,  boats),  which  would 
reduce costs and improve efficiency in insolvency 
cases.  The  online  availability  of  first  and  second 
instance court judgments remains low and there is 
no  management  tool  to  indicate  the  timeframes 
(the rate of cases to be resolved in a court within a 
given  time).  The  High  Commercial  Court  has 
successfully  joined  the  ICT  case-management 
system;  the  Supreme  Court  will  be  the  last 
remaining  court  to  join  in  2017.  While  the  partial 
introduction  of  case  management  reform  appears 
to  have  brought 
the  High 
Commercial  Court  (around  30%  more  resolved 
cases,  around  20%  lower  backlog),  such  reforms 
have  not  been  implemented  at  first  instance 
commercial courts. An evaluation of the effects of 
the implemented judicial map reform that has been 
implemented 
is  being  prepared,  drawing  on 
experience from Member States.  

improvements 

to 

judicial 

The 
involvement  of  the  National  Security 
Agency  in  the  appointment  of  first  time  judges 
remains  under  constitutional  review.  This  issue 
raises  concerns  about 
independence, 
particularly in the light of the on-going procedure 
to  appoint  new  Supreme  Court  judges  (European 
judicial 
Commission,  2016c,  p.76).  Perceived 
independence remains particularly low. Despite the 
fact  that  the  Council  for  the  judiciary  plays  a  key 
role  in  safeguarding  judicial  independence,  its 
administrative capacity remains low. 

While  the  corporate  and  personal  insolvency 
framework  has  been  improved,  a  system  for 

they  clearly  suggest 

occur, 
large 
proportion  of  SOEs  contributes  to  the  overall  low 
productivity growth. 

that 

the 

and 

independently 

The  Croatian  Bank  for  Reconstruction  and 
Development  (HBOR)  will  be  subject  to  an 
independent  asset  quality  review  in  2017.  With 
the financial crisis, the role of national promotional 
banks  in  the  EU  economy  has  become  more 
prominent,  and  they  take  prominent  place  in 
implementing  the  EU  financial  instruments  and, 
more  recently,  the  Investment  Plan  for  Europe 
(‘Juncker Plan’). To play this role without causing 
distortions  to  the  economy  (such  as  misallocation 
of  investment  and  the  crowding  out  of  private-
sector financing alternatives) national promotional 
banks  need  high  standards  of  transparency  and 
accountability 
exercised 
prudential  supervision,  in  line  with  best  practices 
prevalent 
in  most  Member  States  (European 
Commission,  2015c).  Such  high  standards  do  not 
appear  to  be  met  by  the  Croatian  Bank  for 
Reconstruction  and  Development,  and  this  gap 
appears greater in view of the fact that HBOR has 
a high share of direct lending in its assets (in 2014 
around  60 %  of  its  total  loans),  a  relatively  large 
market  share  (its  assets  would  approximately 
correspond  to  the  assets  of  the  sixth  largest 
Croatian  bank)  and  it  assumes  a  high  level  of 
credit  risk.  The  authorities  plan  to  decide  on 
possible  changes 
regulatory 
framework and governance structures on the basis 
of  the  findings  of  the  upcoming  asset  quality 
review. The methodology for this review has been 
developed  by  the  Croatian  National  Bank  and 
tailored  to  the  characteristics  of  a  promotional 
bank.  The  review  is  envisaged  for  the  second 
quarter of 2017 (on the basis of end-2016 data) by 
external  auditors.  The  results  and  final  reporting 
are planned for the second half of 2017.   

the  Bank's 

to 

4.5.3.  JUSTICE SYSTEM 

Despite  reduced  backlogs,  court  proceedings 
remain  long.  The  number  of  pending  cases  and 
disposition  time  in  litigious  civil  and  commercial 
cases  remained  among  the  highest  in  the  EU  in 
2015 (European Commission, 2017b). Proceedings 
in first instance courts remain slow, with civil and 
commercial  cases  taking  889  and  724  days, 
respectively,  and  criminal  cases  taking  594  days 
(at  municipal  courts)  and  988  days  (at  county 

52 

 
4.5. Public sector governance 

monitoring its effectiveness in practice is not yet 
in  place.  Despite  a  continued  large  influx  of 
liquidation  cases  for  companies  (18 432  in  2016; 
mostly  without  assets),  the  average  length  of 
insolvency  cases  fell  to  190  days  from  327  in 
2015.  The  length  of  pre-insolvency  cases  rolled-
out  according  to  the  new  law  was  158  days.  In 
2016,  the  first  year  the  personal  insolvency  law 
was  in  force,  claims  worth  over  EUR  56  million 
were  submitted  to  the  financial  agency  that 
operates  the  out-of-court  resolution  procedure.  Of 
these, only 321 personal insolvency cases have so 
far reached the municipal courts, where it took 66 
days  on  average  to  resolve  them.  The  number  of 
company  pre-insolvency  cases  slightly  decreased 
(589  cases  in  2016,  compared  to  724  in  2015). 
There  is  a  need  for  continued  training  of  judges 
and of restructuring/insolvency practitioners if the 
new  insolvency  laws  are  to  be  implemented 
effectively.  A  quarterly  insolvency  framework 
effectiveness  report  is  in  preparation,  drawing  on 
experience from Member States (55).  

of 

and 

sanctions 

Supervision 

investigations  ex  officio  by 

considered  vulnerable  to  corruption.  A  recent 
Commission  study  recommended  that  Croatia 
the  State 
allow 
Public 
Commission 
for 
increase  protection  for  whistle-
Procurement, 
blowers 
for 
implement 
infringements  of  the  procurement  rules  (European 
Commission,  2016h).  A  study  for  the  European 
Parliament  estimated  a  potential  gain  of  just  over 
EUR 10 million per year from reducing corruption 
in  public  procurement  once  Croatia 
fully 
implements e-procurement (RAND, 2016). A new 
Public  Procurement  Act,  transposing  Directives 
2014/24/EU and 2014/25/EU, entered into force on 
January 1 2017. The new Act should help address 
corruption 
and 
procedures. 
transparency 
Introduced  in  Croatia  in  2008,  the  use  of  e-
procurement  is  mandatory,  including  (since  July 
2016) the legal obligation to allow e-submission of 
tenders  for  all  contracting  authorities,  above  as 
well as below EU thresholds. 

through  higher 

procurement 

traceability 

of 

4.5.4.  FIGHTING CORRUPTION  

4.5.5.  HEALTHCARE SYSTEM  

The  implementation  of  the  important  anti-
corruption  strategy  and  action  plan  has  been 
delayed.  The  implementation  of  Croatia's  anti-
corruption  strategy  for  2015-2020  and  the  action 
plan  for  2015-2016  has  stalled. The  commitments 
contained  in  the  action  plan  (Ministry  of  Justice, 
2015)  and  more  broadly  in  the  2016  national 
reform programme have not yet been confirmed by 
the new government. The new government has put 
the effective fight against corruption, in particular 
in  public  procurement,  among  its  priorities,  but 
concrete  steps  have  yet  to  be  taken.  The  limited 
progress  in  this  area  is  reflected  in  the  results  of 
the  Executive  Opinion  Survey  2016  of  the  World 
Economic  Forum:  from  2015  to  2016  corruption 
climbed to fifth place among the most problematic 
factors  for  doing  business  in  the  country  as 
identified by Croatian executives (WEF, 2016). 

corruption 

public 
Addressing 
procurement could have a significant impact on 
public  spending  efficiency.  Public  procurement 
is 
accounts  for  around  13 %  of  GDP  and 

risks 

in 

(55) Workshop in Slovenia (Oct 2016) funded by the technical 
the  European  Commission 

assistance  programme  of 
operated by the Structural Reform Support Service 

The  fiscal  sustainability  of  the  healthcare 
system appears to be at high risk in the medium 
in  2015,  health 
term.  At  6.7  %  of  GDP 
expenditure  in  Croatia  remains  below  the  EU 
average of 9.5 %. Spending on medical goods as a 
proportion  of  total  health  expenditure  and  on 
pharmaceuticals  in  relation  to  GDP  are  both 
significantly higher than the EU average (29.3 % v 
17.1  %,  and  2.0  %  against  1.3  %).  According  to 
the Ageing Report 2015, healthcare expenditure is 
projected  to  increase  by  1.7  pp.  of  GDP  (in  the 
Age Working Group reference scenario, compared 
to  0.9  pp.  EU  average),  driven  by  population 
ageing.  Healthcare  in  Croatia  is  largely  financed 
through  social  security  contributions.  In  the  short 
term,  the  still  weak  labour  market  constrains  the 
system’s  revenue-generating  potential.  Currently 
only one third of the population is liable to pay full 
contributions,  and  high  contribution  rates  may 
have a detrimental impact on the labour market.   

Health  sector  arrears,  mainly  related  to  the 
hospital organisation structure, remain a source 
of  concern.  The  stock  of  arrears  increased  from 
HRK  1.8  billion  (roughly  0.5 %  of  GDP)  in  2015 
to HRK 2.7 billion (roughly 0.8 % of GDP) in Q3-
largely  comprise  hospital 
2016.  The  arrears 

53 

 
                                                           
4.5. Public sector governance 

income  quintile  of  the  population  and  the  higher 
quintile  remains  higher  than  the  EU  average. 
While  the  gap  narrowed  between  2005  and  2012, 
inequities  are  on  the  rise  again  since  then.  The 
provision  of  healthcare  services  remains  over-
reliant  on  hospitals  as  the  primary  healthcare 
system  is  not  developed  enough.  The  overall 
efficiency  of  the  system  is  hampered  by  a  heavy 
reliance  on  hospitals.  Implementing  the  planned 
reorganisation  of  primary  healthcare  could  reduce 
the number of referrals to specialists, and the cost 
of specialist and hospital treatments. 

Croatia has not yet developed a comprehensive 
strategy on  long-term  care.  The  system  of  long-
term  care  is  spread  across  different  health  and 
social-welfare  institutions.  The  fragmentation  of 
the  system  often  leads  to  inefficiencies  which, 
combined  with  a  rapidly  ageing  population,  are 
likely  to  pose  increased  financial  burdens.  The 
scarce  availability  of  community  based  services 
leads  to  a  situation  where  women  take  on  the 
burden  of  care  provision,  which  reduces  their 
availability on the labour market. 

While  the  planned  reforms  in  healthcare  are 
being  reconsidered,  no  specific  measures  have 
been  taken  to  address  the  accumulation  of 
arrears  in  the  health  sector.  A  number  of 
structural 
reforms,  among  others,  aimed  at 
increasing the fiscal sustainability of the healthcare 
system  have  been  abandoned.  These  include: 
increasing  the  basic  insurance  payment  to  the 
Croatian health insurance fund (HZZO); increasing 
the  cap  on  patients’  co-payment;  reforming  the 
‘additional  insurance’  scheme;  and  introducing 
new  rules  for  emergency  services.  The  long-
awaited  reorganisation  of  the  hospital  system  is 
stalling,  and  the  reform  of  hospital  financing  has 
also  been  halted (58).  To  reduce  pharmaceutical 
expenditure,  the  list  of  benchmark  countries  has 
been  updated  and  the  authorities  also  envisage 
cost-containment measures in primary care and the 
establishment of a central commission to distribute 
particularly  expensive  medicines  to  hospitals.  In 

(58) The  latter  was  intended  to  gradually  reduce  the  share  of 
hospital funding based on ex ante spending limits in favour 
of  funding  based  on  the  amount  of  care  provided.  The 
authorities  are  preparing  a  central  information  system 
collecting  data  on  the  medical  services  provided  to  each 
patient  by  all  the  hospitals  in  the  country,  which  would 
allow  better  control  excessive  costs  and  possible  abuse  in 
the system. 

arrears,  in  particular  in  clinical  centres,  although 
the proportion of arrears from the Croatian Health 
Insurance  Fund  has  been  rising  strongly  (from 
27 %  to  41 %  in  the  same  period).  The  constant 
flow  of  arrears  calls  for  systematic  injections  of 
public  funds,  which  points  to  the  unsustainability 
of  the  current  system  and  could  generate  further 
financing instability. The problematic performance 
of  hospitals  is  partly  due  to  their  funding  and 
reimbursement  model, 
advance 
payments.  Funds  are  rarely  returned,  even  when 
they  are  not  used  for  the  intended  purpose  or 
amount. Hospital capacity is unequally distributed 
and  concentrated  in  metropolitan  areas,  and  the 
governance system does not provide incentives for 
quality  or  cost-efficiency.  Reorganising 
the 
fiscally 
and 
hospital 
responsible  hospital  management  could  help 
achieve a more sustainable system. 

promoting 

network 

based 

on 

to  a  challenge 

(chronic)  diseases 

Health outcomes are below the EU average, and 
in  preventing  non-
point 
(56).  Life 
communicable 
expectancy  at  birth  for  both  women  and  men  has 
increased  over  the  last  decade  but  remains  below 
the EU average (for women 81.0 v 83.6 years, for 
men  74.7  v  78.1  years)(57).  Infant  mortality  is  5.0 
per thousand live births, above the EU average of 
3.7, while perinatal mortality is 4.2 against the EU 
average  of  6.1.  Both  represent  a  short  term  proxy 
for  health  system  performance.  In  Croatia  non-
communicable  diseases  account  for  93 %  of  all 
deaths, affecting mainly the population of working 
age,  with  an  18 %  probability  of  premature 
mortality  from  four  leading  non-communicable 
diseases (World Health Organization, 2015). 

in 
Unmet  needs  for  medical  examination 
Croatia  remain  below  EU  average,  but  rising 
inequalities  in  access  to  healthcare  pose  a 
challenge.  The  total  unmet  needs  reported  for 
financial, geographical and waiting time reasons is 
below the EU average. However, a relatively high 
unmet  need  for  medical  examination  due  to 
distance (1.1 %  of  the population, vs 0.1 %  in  the 
EU) reflects challenges posed by the geographical 
specificities of Croatia, notably the high number of 
islands. The gap in unmet needs between the lower 

(56) The  four  main  types  are  cardiovascular  diseases,  cancer, 

chronic respiratory and diabetes. 

(57) Healthy  life  years  at  birth  amount  to  60.0  (women)  and 
58.6  years  (men)  and  are  below  the  EU  average  as  well 
(61.8 and 61.4). 

54 

 
                                                           
                                                           
4.5. Public sector governance 

recent  months  the  authorities  have  enlarged  the 
network  of  emergency  medicine.  However,  there 
are  still  no  concrete  plans  in  the  short  term  to 
address the accumulation of arrears in healthcare. 

55 

 
ANNEX A 

Overview table 

Commitments 

Summary assessment (59)  

2016 Country-specific recommendations (CSRs) 

CSR 1 

  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  Fiscal  Policy 
Commission.  

the  mandate  of 

  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. 

Croatia  has  made  limited  progress  in  addressing 
CSR 1  (this  overall  assessment  of  CSR1  does  not 
include  an  assessment  of  compliance  with  the 
Stability and Growth Pact): 

  Limited progress in reinforcing numerical fiscal 
rules and strengthening the independence and the 
mandate of the Fiscal Policy Commission. While 
a  new  draft  of  the  fiscal  responsibility  act  and 
budget act were prepared, they have still not been 
adopted. 

  Limited  progress 

planning 
budgetary framework.  

and 

in 
strengthen 

improving  budgetary 
the  multi-annual 

  Some  progress  in  reforming  recurrent  property 
taxation. The authorities have introduced a simple 
recurrent  real  estate  tax  through  amendments  to 
the  law  on  local  taxes.  The  tax  will  enter  into 
force as of 2018. 

  Some 

progress 

debt 
public 
management, 
the  adopted  debt 
management  strategy,  which  covers  the  2017-
2019 period. 

regarding 
to 

related 

CSR 2 

Croatia has made no progress in addressing CSR 2  

  By  the  end  of  2016,  take  measures  to 

  No  progress  in  reforming  the  pension  system. 

(59) The  following  categories  are  used  to  assess  progress  in  implementing  the  2015  country-specific  recommendations: 
No progress: The Member State has not credibly announced nor adopted any measures  to address the CSR. Below a number of 
non-exhaustive typical situations  that could be covered under this, to be interpreted on a case by case basis taking into account 
country-specific conditions: 

•  no  legal,  administrative,  or  budgetary  measures  have  been  announced  in  the  National  Reform  Programme  or  in  other  official 
communication  to  the  national  Parliament  /  relevant  parliamentary  committees,  the  European  Commission,  or  announced  in 
public (e.g. in a press statement, information on government's website);  
• no non-legislative acts have been presented by the governing or legislator body;   
•  the  Member  State  has  taken  initial  steps  in  addressing  the  CSR,  such  as  commissioning  a  study  or  setting  up  a  study  group  to 
analyse possible measures that would need to be taken (unless the CSR explicitly asks for orientations or exploratory actions), 
while clearly-specified measure(s) to address the CSR has not been proposed. 

Limited progress: The Member State has: 
• announced certain measures  but these only address the CSR to a limited extent;    
and/or 
• presented legislative acts in the governing or legislator body but these have not been adopted yet and substantial non-legislative 

further work is needed before the CSR will be implemented;  

• presented non-legislative acts, yet with no further follow-up in terms of implementation which is needed to address the CSR. 
Some progress: The Member State has adopted measures that partly address the CSR  
and/or  
the Member State has adopted measures that address the CSR, but a fair amount of work is still needed to fully address the CSR as 
only  a  few  of  the  adopted  measures  have  been  implemented.  For  instance:  adopted  by  national  parliament;  by  ministerial 
decision; but no implementing decisions are in place. 

Substantial progress: The Member State has adopted measures that go a long way in addressing the CSR and most of which have 

been implemented. 

Full implementation: The Member State has implemented all measures needed to address the CSR appropriately. 

56 

 
 
                                                           
A. Overview table 

Announced measures encouraging longer working 
lives  and  streamlining  pension  provisions  have 
not  been  implemented.  The  authorities  have 
completed  a  review  of  the  arduous  or  hazardous 
from  more  generous 
professions  benefiting 
pension  provisions.  However, 
the  planned 
streamlining has not yet taken place. 

  Limited progress in providing up- and re-skilling 
measures.  The  programme 
for  developing 
vocational  education  training  has  been  adopted 
and new legislation is being prepared to improve 
adult  learning.  However,  the  scope  of  training 
actions  provided  by  the  Public  Employment 
Services  seems  inadequate  in  view  of  the  size  of 
the 
significant 
recognition  of  skills  and 
developments  on 
validation of non-formal and informal learning.  

challenge.  There 

are  no 

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 
long-term 
and 
unemployed.  

low-skilled 

the 

  Consolidate 

social  protection  benefits, 
including  special  schemes,  by  aligning 
eligibility  criteria  and 
their 
administration,  and  focus  support  on  those 
most in need. 

integrating 

  No  progress  in  improving  the  social  protection 
system.  The  action  plan  setting  out  the  reform 
priorities  has  not  yet  been  adopted.  The 
authorities  have  completed 
the  analysis  of 
benefits granted at central government level with 
a  view  to  categorising  them  and  harmonising 
eligibility  criteria.  The  planned  introduction  of 
means-testing for the child allowance is currently 
being  reviewed.  The  establishment  of  one-stop 
shops to administer and provide social services is 
being  postponed  for  the  second  time  in  a  year. 
This  has  delayed  the  implementation  of  all  the 
related reform measures. 

Croatia  has  made  limited  progress  in  addressing 
CSR 3  

CSR 3 

  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.  

 

consultation  with 

social  partners, 
In 
harmonise 
frameworks 
the  wage-setting 
across  the  public  administration  and  public 
services.  

  Advance  the  divestment  process  of  state 
assets and reinforce the monitoring of state-
owned enterprises’ performance and boards’ 
accountability,  including  by  advancing  the 

  Limited  progress 

in 

for 

reforming 

the  public 
administration.  The  main  pillars  of  the  reform 
have  all  been  postponed  due  to  lack  of  political 
commitment.  In  December  2016  the  government 
adopted  a  new  version  of  the  2017-2020  action 
the  public 
the  modernisation  of 
plan 
administration.  New  legislation  redefining  the 
division  of  tasks  between  the  central  and  local 
state administration offices was due to be adopted 
in  December  2016  but  is  still  under  preparation. 
There is no clear timetable for the plan to reduce 
the  over  1 200 
local  branches  of  central 
administration  offices  by  20 %.  The  planned 
harmonisation  and  rationalisation  of  the  state 
agencies system has been put on hold.  

57 

 
 
A. Overview table 

listing of shares of state-owned companies. 

CSR 4 

  Significantly reduce parafiscal charges.  

  Remove  unjustified  regulatory  restrictions 
hampering  access  to  and  the  practice  of 
regulated professions.  

  Reduce 

the  administrative  burden  on 

businesses. 

  No  progress  in  harmonising  the  wage-setting 
frameworks.  The  adoption  of  new  legislation  on 
public  sector  wages  has  been  postponed  by  two 
years,  to  the  end  of  2019.  Preparatory  work  has 
been  carried  out  to  develop  an  IT  system  to 
support  the  introduction  of  a  universal  system  of 
wage grades. The authorities have also developed 
negotiation, 
common 
coordination  and  monitoring  of  collective 
agreements in the public administration. As far as 
state-owned enterprises are concerned, no further 
steps have been taken in setting up a coordinated 
system for collective bargaining. 

guidelines 

the 

for 

  Limited  progress  in  improving  performance 
monitoring  and  corporate  governance  of  state 
owned  enterprises,  and  in  divestment  from  state 
assets.  Eight  companies  were  removed  from  the 
government's  list  of  companies  and  other  legal 
entities  of  strategic  and  special  interest,  whereas 
the  sale  of  stakes  in  non-strategic  companies 
yielded income of 0.2 % of GDP in 2016. 

Croatia  has  made  limited  progress  in  addressing 
CSR 4  

  Limited progress in reducing parafiscal charges. 
The  authorities  have  decreased  or  cut  only  five 
parafiscal  charges,  with  an  impact  significantly 
lower 
the  national  reform 
in 
programme.  

than  planned 

  Limited  progress 

removing 

regulatory 
in 
restrictions  in  regulated  professions.  An  action 
plan  was  submitted  in  July  2016,  but  it  entails 
only  limited  reform  proposals  and  does  not 
the 
the 
provide  details  on 
amendments.  For  a  number  of  professions,  the 
action  plan  states  that  current  regulation  is 
adequate and no modification is needed. 

substance  of 

CSR 5 

  Limited  Progress  in  reducing  the  administrative 
burden.  An  action  plan  for  the  reduction  of 
administrative  burden  was  adopted  by 
the 
government. 

Croatia  has  made  limited  progress  in  addressing 
CSR 5  

  Take  measures  to  improve  the  quality  and 
in 

the 
efficiency  of 
commercial and administrative courts.  

judicial 

system 

  Limited  progress 

justice 
system. The number of pending cases and length 
of court proceedings remain among the highest in 

improving 

the 

in 

58 

 
 
 
A. Overview table 

  Facilitate  the  resolution  of  non-performing 
loans,  in  particular  by  improving  the  tax 
treatment  of 
resolution  of  non-
performing loans. 

the 

Europe 2020 (national targets and progress) 

Employment rate target: 65.2 %. 

R&D target: 1.4 % of GDP  

Greenhouse gas emissions, national target: + 11 
% 

the EU. Few measures have been implemented to 
improve  the  efficiency  of  justice  (e.g.  limited 
introduction  of  case  management  reforms)  and  it 
will  take  time  for  the  implemented  judicial  map 
reform to show effects.  Improving the quality of 
the 
challenge, 
particularly  the  electronic  communication  with 
been 
courts,  where 
implemented  that  would  allow  public  bodies, 
parties and legal professionals to send and receive 
court documents in electronic form. 

no  measures 

remains 

system 

justice 

have 

a 

  Some  progress  in  facilitating  the  resolution  of 
non-performing  loans,  as  sales  accelerate.  The 
recent tax reformʼs provisions on deductibility of 
non-performing  loan  write-offs  may  facilitate  a 
faster resolution in 2017. 

The employment rate in Croatia is one of the lowest 
in  the  EU  but  it  increased  from  57.2  %  in  2013  to 
60.5 % in 2015. In 2016 the unemployment rate fell 
to 12.8 %. Croatia may achieve its national target for 
employment,  but  this  is  still  far  below  the  level  in 
other EU countries. 

Limited  progress  towards  the  target.  In  2007-2015 
R&D  intensity  slightly  increased.  The  decline  of 
public  expenditure  on  R&D  as  %  of  GDP  was 
compensated  by  an 
increase  of  private  R&D 
intensity.  However,  based  on  current  trends  Croatia 
will not reach its R&D target. 

Based on the latest national projections submitted to 
the  Commission,  and  taking  into  account  existing 
measures,  it  is  expected  that  the  target  will  be 
achieved:  -8.9  %  in  2020  as  compared  to  2005  (a 
margin of 19.9 percentage points) 

Non-ETS 2015 target: +5.9 % 

The  latest  proxy  data  for  2015  show  that  Croatia 
reduced  its  emissions  by  -25.3  %.  This  sharply 
contrasts  with  the  increase  of  up  to  6%  that  was 
allowed by the annual allocation interim target under 
the Effort Sharing Decision for 2015. 

59 

 
 
 
 
A. Overview table 

2020 renewable energy target: 20 % 

With a renewable energy share in gross final energy 
consumption  of  27.9 %  in  2015  (60),  Croatia  has  for 
the time being achieved the 2020 target. Over 2014-
2020,  EU  cohesion  policy  will  invest  some  EUR  95 
million in renewable energy in Croatia. 

Share  of  renewable  energy  in  all  modes  of 
transport: 10 % 

Energy  efficiency,  2020  energy  consumption 
targets: 

  11.2 Mtoe (primary energy consumption); 

  7 Mtoe (final energy consumption). 

Early school leaving (ESL) target: 4 %. 

Tertiary education target: 35 %. 

Target for reducing the number of people at risk 
of  poverty  or  social  exclusion,  expressed  as  an 
absolute number of people: by 150 000 

Croatia increased its primary energy consumption by 
4.4 %  from  7.66  Mtoe  in  2014  to  8  Mtoe  in  2015. 
Final  energy  consumption  increased  by  6 %  from 
6.24  Mtoe  in  2014  to  6.59  Mtoe  in  2015.  Even  if 
Croatia  has  already  achieved  levels  of  primary  and 
final  energy  consumption  which  are  below  the 
indicative  national  2020  targets  (11.2  Mtoe  in 
primary  energy  consumption  and  7 Mtoe  in  final 
energy consumption) it would need to make an effort 
to keep these levels until 2020.  

The proportion of early school leavers aged 18-24 in 
Croatia is 2.8 %. This is the lowest rate in the EU and 
significantly  below  the  EU  average  of  11%  and  the 
EU target of 10 %. The rate has fluctuated slightly in 
recent  years  but  has  always  remained  close  to  the 
national target of 4 %. 

Tertiary attainment of 30-34 year olds has been on a 
generally upward trend since 2012, increasing by 7.8 
percentage  points  since  2012  —  the  third  largest 
positive  change  in  the  EU.  However,  the  drop  from 
32.2 %  to  30.9 %  between  2014  and  2015  caused 
Croatia  to  slip  further  away  from  meeting  its  35 % 
national  target  by  2020,  as  well  as  from  the  EU 
average of 38.7 %. 

The  number  of  people  at  risk  of  poverty  fell  from 
1.384 million  in  2011  to  1.216 million  in  2014. 
Croatia  is  likely  to  meet  its  national  target  of 
reducing  the  number  of  people  at  risk  of  poverty  or 
social exclusion by 150 000.  

(60) Renewable energy shares for 2015 are approximations and not official data, reflecting the available data (04.10.2016). See the 
the  2016  Report  on  Renewable  Energy,  

in  Realisation  of 

Öko-Institut  Report:  Study  on  Technical  Assistance 
http://ec.europa.eu/energy/en/studies 

60 

 
 
 
 
                                                           
ANNEX B 

MIP Scoreboard 

Table B.1: 

The MIP Scoreboard for Croatia 

Flags: e: estimated. i: see metadata. 
1) Unemployment rate: for 2006 i = Eurostat back-calculation to include 2011 Population Census results.  
2) Youth unemployment rate: for 2006 i = Eurostat back-calculation to include 2011 Population Census results. 
Source: European Commission, Eurostat and Directorate General for Economic and Financial Affairs (for real effective 
exchange rate), and International Monetary Fund. 

61 

Thresholds201020112012201320142015Current account balance, (% of GDP) 3 year average-4%/6%-5.2-2.4-0.70.01.02.7-35%-94.3-91.7-90.8-88.9-86.8-77.7Real effective exchange rate - 42 trading partners, HICP deflator3 years % change±5% & ±11% 2.0-4.4-8.3-4.0-1.00.1Export market share - % of world exports5 years % change-6%-12.9-15.8-23.5-22.8-18.6-3.5Nominal unit labour cost index (2010=100)3 years % change9% & 12% 12.57.6-0.6-3.0-5.8-5.06%-7.8-2.2-4.6-5.7-1.1-2.414%4.9-2.3-3.0-0.60.4-1.3133%125.2122.6119.7118.4119.5115.060%58.365.270.782.286.686.7Unemployment rate3 year average10%9.811.513.815.716.917.016.5%3.32.41.72.80.92.1-0.2%-0.6-1.7-1.7-1.42.02.90.5%0.63.15.14.41.70.12%7.213.016.917.68.80.9Activity rate - % of total population aged 15-64 (3 years change in p.p)Long-term unemployment rate - % of active population aged 15-74 (3 years change in p.p)Youth unemployment rate - % of active population aged 15-24 (3 years change in p.p)External imbalances and competitivenessNew employment indicatorsNet international investment position (% of GDP)Deflated house prices (% y-o-y change)Total financial sector liabilities (% y-o-y change)Private sector credit flow as % of GDP, consolidatedPrivate sector debt as % of GDP, consolidatedGeneral government sector debt as % of GDPInternal imbalances 
 
 
 
 
ANNEX C 

Standard tables 

Table C.1: 

Financial market indicators 

(1) Latest data Q2 2016. 
(2) Quarterly values are not annualised 
(*) Measured in basis points. 
Source: European Commission (long-term interest rates); World Bank (gross external debt); Eurostat (private debt); ECB (all 
other indicators). 

62 

201120122013201420152016Total assets of the banking sector (% of GDP)131.4132.2133.2134.5132.0128.1Share of assets of the five largest banks (% of total assets)-73.972.972.372.7-Foreign ownership of banking system (% of total assets)--79.378.365.2-Financial soundness indicators:1)              - non-performing loans (% of total loans)--11.812.912.511.2              - capital adequacy ratio (%)--19.620.419.219.8              - return on equity (%)2)--0.63.9-6.85.9Bank loans to the private sector (year-on-year % change)1.8-6.2-0.1-1.7-2.40.7Lending for house purchase (year-on-year % change)-0.3-0.9-2.0-2.8-1.9-2.4Loan to deposit ratio111.2100.595.691.083.778.1Central Bank liquidity as % of liabilities0.00.00.00.00.10.4Private debt (% of GDP)122.6119.7118.4119.5115.0-Gross external debt (% of GDP)1) - public24.728.132.735.936.333.1    - private50.751.751.052.949.947.0Long-term interest rate spread versus Bund (basis points)*393.1463.4311.1288.8305.5345.9Credit default swap spreads for sovereign securities (5-year)*322.5382.9303.7276.1273.1240.1 
 
 
 
 
 
 
C. Standard tables 

Table C.2: 

Labour market and social indicators 

(1) The unemployed persons are all those who were not employed but had actively sought work and were ready to begin 
working immediately or within 2 weeks.       
(2) Long-term unemployed are those who have been unemployed for at least 12 months.       
(3) Not in education employment or training.       
(4) Average of first three quarters of 2016. Data for total unemployment and youth unemployment rates are seasonally 
adjusted.       
Source: European Commission (EU Labour Force Survey). 

63 

201120122013201420152016 4Employment rate(% of population aged 20-64)59.858.157.259.260.561.5Employment growth (% change from previous year)-3.9-3.5-2.72.71.51.3Employment rate of women(% of female population aged 20-64)53.652.652.854.255.856.9Employment rate of men (% of male population aged 20-64)66.163.761.664.265.266.1Employment rate of older workers (% of population aged 55-64)38.237.537.836.239.037.9Part-time employment (% of total employment, aged 15-64)7.25.65.45.35.95.9Fixed-term employment (% of employees with a fixed term contract, aged 15-64)13.513.314.516.920.322.6Transitions from temporary to permanent employment43.739.223.7:37.8:Unemployment rate1 (% active population, age group 15-74)13.716.017.317.316.313.2Long-term unemployment rate2 (% of labour force)8.410.211.010.110.36.7Youth unemployment rate (% active population aged 15-24)36.742.150.045.543.031.2Youth NEET3 rate (% of population aged 15-24)16.216.619.619.318.5:Early leavers from education and training (% of pop. aged 18-24 with at most lower sec. educ. and not in further education or training)5.05.14.52.72.8:Tertiary educational attainment (% of population aged 30-34 having successfully completed tertiary education)23.923.125.632.230.9:Formal childcare (30 hours or over; % of population aged less than 3 years)12.011.010.017.0:: 
 
 
 
 
C. Standard tables 

Table C.3: 

Labour market and social indicators (continued) 

(1) People at risk of poverty or social exclusion : individuals who are at risk of poverty and/or suffering from severe material 
deprivation and/or living in households with zero or very low work intensity.       
(2) At-risk-of-poverty rate : proportion of people with an equivalised disposable income below 60 % of the national 
equivalised median income.        
(3) Proportion of people who experience at least four of the following forms of deprivation: not being able to afford to i) pay 
their rent or utility bills, ii) keep their home adequately warm, iii) face unexpected expenses, iv) eat meat, fish or a protein 
equivalent every second day, v) enjoy a week of holiday away from home once a year, vi) have a car, vii) have a washing 
machine, viii) have a colour TV, or ix) have a telephone.       
(4) People living in households with very low work intensity: proportion of people aged 0-59 living in households where the 
adults (excluding dependent children) worked less than 20 % of their total work-time potential in the previous 12 months.       
(5) For EE, CY, MT, SI and SK, thresholds in nominal values in euros; harmonised index of consumer prices = 100 in 2006 (2007 
survey refers to 2006 incomes)       
Source: For expenditure for social protection benefits ESSPROS; for social inclusion EU-SILC. 

64 

 
 
 
 
 
 
C. Standard tables 

Table C.4: 

Product market performance and policy indicators 

(1) The methodologies, including the assumptions, for this indicator are shown in detail at : 
http://www.doingbusiness.org/methodology .        
(2) Average of the answer to question Q7B_a. '[Bank loan]: If you applied and tried to negotiate for this type of financing over 
the past six months, what was the outcome?'. Answers were scored as follows: zero if received everything, one if received 
most of it, two if only received a limited part of it, three if refused or rejected and treated as missing values if the application is 
still pending or if the outcome is not known.       
(3) Percentage population aged 15-64 having completed tertiary education.       
(4) Percentage population aged 20-24 having attained at least upper secondary education.       
(5) Index: 0 = not regulated; 6 = most regulated. The methodologies of the OECD product market regulation indicators are 
shown in detail at :  http://www.oecd.org/competition/reform/indicatorsofproductmarketregulationhomepage.htm   
(6) Aggregate OECD indicators of regulation in energy, transport and communications.       
Source: European Commission; World Bank — Doing Business (for enforcing contracts and time to start a business); OECD (for 
the product market regulation indicators); SAFE (for outcome of SMEs' applications for bank loans). 

65 

 
 
 
 
 
 
C. Standard tables 

Table C.5:  Green growth 

All macro intensity indicators are expressed as a ratio of a physical quantity to GDP (in 2005 prices)         
          Energy intensity: gross inland energy consumption (in kgoe) divided by GDP (in EUR)         
          Carbon intensity: greenhouse gas emissions (in kg CO2 equivalents) divided by GDP (in EUR)         
          Resource intensity: domestic material consumption (in kg) divided by GDP (in EUR)         
          Waste intensity: waste (in kg) divided by GDP (in EUR)         
Energy balance of trade: the balance of energy exports and imports, expressed as % of GDP           
Weighting of energy in HICP: the proportion of 'energy' items in the consumption basket used for the construction of the HICP         
Difference between energy price change and inflation: energy component of HICP, and total HICP inflation (annual % 
change)         
Real unit energy cost: real energy costs as a percentage of total value added for the economy         
Environmental taxes over labour taxes and GDP: from European Commission's database, ‘Taxation trends in the European 
Union’         
Industry energy intensity: final energy consumption of industry (in kgoe) divided by gross value added of industry (in 2005 EUR)          
Real unit energy costs for manufacturing industry excluding refining : real costs as a percentage of value added for  
manufacturing sectors         
Share of energy-intensive industries in the economy: share of gross value added of the energy-intensive industries in GDP         
Electricity and gas prices for medium-sized industrial users: consumption band 500–20 00MWh and 10 000–100 000 GJ; figures 
excl. VAT.         
Recycling rate of municipal waste: ratio of recycled and composted municipal waste to total municipal waste         
Public R&D for energy or for the environment: government spending on R&D for these categories as % of GDP         
Proportion of GHG emissions covered by EU Emissions Trading System (ETS) (excluding aviation): based on greenhouse gas 
emissions         
(excl land use, land use change and forestry) as reported by Member States to the European Environment Agency.         
Transport energy intensity: final energy consumption of transport activity (kgoe) divided by transport industry gross value 
added (in 2005 EUR)         
Transport carbon intensity: GHG emissions in transport activity divided by gross value added of the transport sector         
Energy import dependency: net energy imports divided by gross inland energy consumption incl. consumption of 
international bunker fuels         
Aggregated supplier concentration index:  covers oil, gas and coal. Smaller values indicate larger diversification and hence 
lower risk.         
Diversification of the energy mix: Herfindahl index over natural gas, total petrol products, nuclear heat, renewable energies 
and solid fuels         
(*) European Commission and European Environment Agency         
Source: European Commission (Eurostat) unless indicated otherwise. 

66 

 
 
 
 
REFERENCES 

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