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Croatia: IMF Warns Against Large Deficit

Washington, 28 July 1998 (RFE/RL) -- Croatia has been given a sharp warning to deal quickly and decisively with its ballooning current account deficit.

The Executive Directors of the International Monetary Fund (IMF) told the government in Zagreb earlier this month that they were "seriously concerned" about Croatia's unsustainable large deficit which has risen to 12.5 percent of GDP.

The current account is the balance between all funds going into and out of a country other than capital investments.

Croatia's deficit has been growing because strong consumer demand, fueled by rapid wage growth and a surge in bank credit, has pushed imports up nearly 33 percent in the past year while exports remained static.

The deficit has also been growing because of an underlying easing of the government's fiscal policy -- allowing the budget deficit to grow -- and because of a deterioration in the balance between savings and investment of large state enterprises, reflecting large wage increases last year.

The 24 Executive Directors, representing the 183 member nations of the IMF, gave their assessment of Croatia's situation in their annual review of the country. The review, called an article four consultation, was released Monday.

In it, the Executive Directors said that among the measures Croatia must take quickly are restraining government worker's pay raises, freezing wages in state enterprises and limiting those enterprises' borrowing

Large state enterprises have been showing "poor financial discipline, " both in unrestrained and uneconomic borrowing carried out without explicit government guarantees, and in awarding large wage increases, keeping surplus labor on the books, and not pressing for payment for services or goods delivered.

The directors underscored the need for Croatia to get a "firm grip" on wage policy, both in the budget and in the state enterprise sector. They noted that wage restraint for public workers is important not only for its "demonstration effects" to private sector workers, but also because there is no room in an already tight state budget for higher wages, especially considering the heavy demands for social spending and reconstruction of the country.

The government's 1999 wage bill will cause serious problems, the directors said, which can only be avoided through meaningful civil service reform and retrenchment.

The directors commended Zagreb for its fiscal consolidation efforts, but noted that the policy package for 1998 does not go far enough to return the current account balance to a sustainable level. The government must also cut the budget deficit immediately and implement reforms of the banking and financial sectors now or face far higher costs later.

In addition to government fiscal tightening, the IMF's directors said the best way to achieve greater financial discipline in the public enterprise sector is to move faster on privatization as the best way to improve corporate governance.

The directors also expressed concern about stresses in the banking sector in Croatia and advised authorities to close unviable banks as quickly as possible. For healthy banks, the directors urged better government supervision because of a rapid expansion in bank credit, which when coupled with large scale foreign borrowing, makes the bank's and the country vulnerable to shifts in global market sentiment.

Sudden withdrawal of short-term foreign money has been at the heart of the Asian and Russian financial crises.

At the same time, the directors praised Croatia for its exchange-rate-based stabilization efforts, it's robust real growth and its low inflation.

In a background report prepared by the IMF staff, the fund noted that Croatia has made advances in the past year in introducing a single-rate VAT, commencing a voucher privatization scheme, preparing for reform of the pension system, and for approving legislation to separate the post and telecommunications functions of Croatian Post and Telecom.

Real GDP growth was recorded at 6.5 percent in 1997, inflation remained moderate at 3.9 percent, and tourism continued to rebound, rising by almost 30 percent in 1997, the staff said.

However, IMF staff also noted that the very strong growth of private consumption in 1997 was fueled partly by rapid wage growth, but also in larger measure by one-time factors of buyers advancing purchases into 1997 to avoid higher taxes which took effect in 1998.