Excessive Deficit Procedure and Macroeconomic Imbalances Procedure

Requirements for Croatia and current state of play

Servaas DEROOSE

Deputy Director-General

European Commission, DG Economic and Financial Affairs

Challenges of budget management in Croatia – Zagreb, 11 December 2014

EU accession did not act as a growth trigger and medium-term growth prospects remain bleak

2

95

100

105

110

115

120

2013 2014 2015 2016 2017 2018 2019

2013=

100

Potential output

2004 accession 2007 accession SI HR

Source: European Commission estimates (2014 Autumn Forecast)

Protracted recession has contributed to further deterioration of Croatia's public finances

3

6

7

8

9

10

11

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

HR

K b

n,

ave

rage f

or

the p

ast 12M

Consolidated central government revenue and expenditure, Croatia

Revenue Expenditure

Source: Ministry of Finance of Croatia. Commission services calculations.

-6

-5

-4

-3

-2

-1

0

BG CZ EE LV LT HU PL RO SI SK HR

% G

DP

General government structural balance

2010-14 2015-16

2010-14 CEE10 2015-16 CEE10

Source: European Commission 2014 Autumn Forecast; AMECO.

Treaty-based limits (in % of GDP)

General government budget deficit

Gross government debt, or diminishing by at least 1/20 p.a.

How the Stability and Growth Pact works

4

Preventive arm

Corrective arm: Excessive Deficit Procedure (EDP)

3%

60%

Flexibility • Negative

growth • Major

structural reforms

Balanced-budget rule Structural

deficit <0.5% of GDP

Deadline of up to 6 months

to comply

with time-bound

recommendation

Expenditure benchmark To prevent

net spending from rising faster than

potential GDP

Putting the procedure on hold

Deadline extension, revised recommendation

Stepping up, possibly sanctions (0.2% of GDP), ESI

fund suspension

Medium-term objective

Country-spec. reference value in

structural terms

Effective action

Events outside govt. control

No effective action

What have been the main milestones for Croatia under the EDP so far?

21 Jan Launch of the

procedure

Correction by 2016

Effective action by 30 Apr 2014

2 Jun Assessment of effective action

2014 delivered

2015 not ensured

31 Oct Reporting on progress made

Every six months

5

What is expected of Croatia?

-5,2%

-4,6%

-3,5%

-2,7%

-6%

-5%

-4%

-3%

-2%

-1%

0%

2012 2013 2014 2015 2016

Headline deficit (% GDP) EDP & EC 2014 Autumn Forecast

Forecast -3,6%

-3,1%

-2,2%

-1,5%

-5%

-4%

-3%

-2%

-1%

0%

2012 2013 2014 2015 2016

Structural balance (% GDP) EDP & EC 2014 Autumn Forecast

Forecast

Consolidation measures of 2.3% of GDP in 2014, 1 % of GDP in 2015 and 2016

6

Source: European Commission

Where does Croatia stand in 2014 and 2015? EDP Recommendation and Commission 2014 Autumn Forecast (% GDP)

2014 2015

EDP Forecast EDP Forecast

Headline budget deficit

4.6% 5.6% 3.5% 5.5%

Corrected change in structural balance

0.5% 0.0% 0.9% 0.3 %

Bottom-up assessment

2.3% 2.4% 1.0% 0.7%

Need to complement the 2015 budget with a detailed specification of concrete measures underpinning the fiscal targets

7

Source: European Commission

Main discretionary measures underpinning the Commission assessment

Increase in health contributions Increase in the lower VAT rate Increase in fuel taxes Increase in pension contributions

Drop in investment Savings in intermediate

consumption Reduction in subsidies Decrease in the wage bill Savings in health care

2014 2015

Most of the 2014 measures impact fiscal effort in 2015 positively (adopted in the middle of the year)

No further measures were known

at the cut-off date of the forecast

Deficit-increasing PIT reform New deposit interest tax Broadening of the lottery tax Qualitative expenditure cuts

2015 Budget

8

Alert Mechanism Report (AMR)

(Scoreboard and thresholds)

November 2014

Programme countries their own enhanced

surveillance

No problem Procedure stops

In-Depth Reviews (IDRs)

Commission prepares in-depth country reviews,

using a wide set of indicators and analytical tools

March 2015

No problem

Procedure stops

Imbalances Recommendations integrated

under European Semester May 2015

Excessive imbalances Recommendations and Specific Monitoring or Corrective Action Plan

May 2015 and continuous monitoring

9

Macroeconomic Imbalances Procedure

The scope of the AMR's scoreboard

+ auxiliary indicators and auxiliary social indicators (no thresholds)

10

External positions: current accounts, net international investment positions

Competitiveness developments : real effective exchange rates, unit labour costs

Export performance: export market shares

Private sector indebtedness: credit, debt

Public sector indebtedness

Assets markets: housing

Financial sector developments: financial sector liabilities

Unemployment

EXTERNAL IMBALANCES

INTERNAL IMBALANCES

Croatia's performance in 2015 AMR's scoreboard

11

Indicator Threshold 2012 2013

Exte

rnal

Current Account Balance (% GDP) 3Y average -4%/6% -0.8 -0.1

Net Internat. Investment Position (% GDP) -35% -89.9 -88.7

Change in Real Effective Exchange Rate (%) 3 years ±5% & ±11% -8.3 -4

Change in Export Market shares (%) 5 years -6% -22.8 -20.9

Change in Nominal ULC (%) 3 years 9% & 12% -1.6 0.9

Inte

rnal

Change in Deflated House Prices (%) y-o-y 6% -2.2 -18.1

Private Sector Credit Flow (% GDP) consolid. 14% -3.3 -0.2

Private Sector Debt (% GDP) consolid. 133% 123.4 121.4

General Government Sector Debt (% GDP) 60% 64.4 75.7

Unemployment Rate (%) 3Y average 10% 14.1 15.8

Change in Total Financial Sector Liab. (%) % y-o-y 16.5% 0.8 3.4

Source: European Commission

12

16 Member States will be analysed in-depth

Reflected in eroding export market shares Competitiveness

1

Adjustment capacity

2

De-leveraging

3

Financial stability

4

Public finances

5

The 2014 In-Depth Review highlighted five major risks and imbalances for Croatia

Weaknesses in the labour market and the business environment have amplified the impact of the crisis

Private sector entered the crisis highly indebted External financing risks

Banking system has shown resilience Still, non-performing loans very high

Pro-cyclical fiscal policies have fuelled deficit and debt

13

14

2014 country-specific recommendations for Croatia

Addressing fiscal imbalances

Sound public

finances

Sustainable pensions

and healthcare

Unlocking the employment

potential

High employ-

ment

Effective social

protection

Bank asset

quality

Safeguarding financial stability

Reviving business and investment

Efficient insolvency

& de-leveraging

Business-friendly environ-

ment

Smarter state

involve-ment

1 2 3 4

5 6

7

8

Specific MIP monitoring in Croatia reveals highly uneven progress since June

Progress on fiscal structural reforms piecemeal, facing implementation risks

Only limited steps to align budgetary projections to ESA standards

Expenditure review preparation in motion but no implementation timeframe

Recurrent property tax being prepared but timing unclear

Measures to improve pension sustainability yet to be outlined

Limited ambition of measures to improve cost-effectiveness of health care

Progress in improving the functioning of labour markets, labour law reform

Further measures to tackle obstacles to job creation still to be defined

Plan for social benefit consolidation needs full political endorsement

Business climate likely to benefit from planned enhancements of early rescue framework and reform of regional state administration

Progress on removing para-fiscal levies slower than expected

SOE governance improvements limited, restructuring behind plans

Public admininstration and anti-corruption reforms risk being delayed

QUALITY AND SUSTAINABILITY OF PUBLIC FINANCES

LABOUR MARKET & EFFECTIVENESS OF SOCIAL PROTECTION

PROMOTING GROWTH & COMPETITIVE-NESS

15

Government deficit is projected to remain high and government debt has risen quickly

-6%

-5%

-4%

-3%

-2%

-1%

0%EE LV LT CZ RO HU SK PL BG SI HR

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

EE BG RO LV LT CZ PL SK HU HR SI

16

Source: European Commission

General government balance, 2014 (% GDP) General government debt, 2014 (% GDP)

Source: European Commission

What main measures should be taken to address fiscal imbalances?

» Get quality of fiscal projections up to EU standards

» Reinforce expenditure control

» Review expenditure

» Strengthen budgetary planning & fiscal rules

» Optimise revenue & tax administration

» Reform recurrent property taxation

» Address weaknesses in pensions & healthcare 17

18

Diverging labour market trends but major opportunities to mobilise employment exist

50

55

60

65

70

75

80

2004 2007 2010 2013*

Employment rate 20-64 (%)

EU2020 target

EU28

Croatia

* 2013 Croatia: break in the series

18 Source: European Commission Source: European Commission

» Review wage setting framework

» Strengthen active labour market policies

» Address undeclared work

» Review tax/benefit system to make work pay

What main measures should be taken to unlock employment potential?

19

Productivity growth was low before the crisis and is not picking up strongly despite large job losses

Growth accounting, 2002-2008 (%) GDP growth decomposition, 2008-13 (%)

20

0 1 2 3 4 5 6

GDP

Labour market

Demography

Productivity

GDP

Labour market

Demography

Productivity

HR

CEE10

1.8

0.0

2.4

4.2

4.4

-0.3

1.5

5.7

90

100

110

120

80 90 100

Gro

ss v

alu

e a

dded p

er

em

plo

yee (

2008=

100)

Employment (2008 = 100)

HR

PL

SK

BG LV

LT

SI

Source: European Commission Source: European Commission

» Lower administrative burdens

» Make the best use of EU funds

» Improve governance of state-owned enterprises

» Zero in on corruption and public procurement

» Get pre-insolvency & insolvency procedures right

» Strengthen efficiency of courts

What main measures should be taken to revive business activity and investment?

21

0

5

10

15

20

BG SI RO HU HR LT PL LV SK EE

Non-performing loans (% total) June 2014

While the banking sector remains well capitalised the long recession justifies supervisory vigilance

» The central bank is now

undertaking a tailor-made

portfolio screening exercise

» Focus is on important

portfolios not covered by

the ECB and on mid-size

and smaller banks

22 Source: ECB

23

November 2014

European Semester resumed with the AGS

The AMR identified countries for in-depth review

EDP implementation was assessed, following the Autumn Forecast

Spring 2015

2nd Monitoring Report reviews progress of reforms in Croatia

Commission publishes In-Depth Reviews

Member States present their National Reform Programmes and Stability/Convergence Programmes

Commission proposes Country-Specific Recommendations

Recent and next steps for the EU and Croatia