Croatia Got Lucky with Tourism

Excerpts from an interview with Carlos Piñerúa, World Bank Country Manager for Croatia and Slovenia for Nacional weekly, published on September 27, 2016.

Nacional: Another election is behind Croatia. The former government only lasted six months and did not manage to implement any of the announced reforms. Nonetheless, numbers are telling us that the economy is moving in a positive direction and after six years the country is slowly getting out of a recession, GDP is growing, imports are up, the tourism season is at record level, deficit is decreasing and public debt is falling. Does this mean that Croatia functions best without a government?

Carlos Pinerua: Before I respond, I need to emphasize that there are a few things people need to think about very well and not get too complacent about things and that is my key message. You mentioned the tourism season. There are geopolitical reasons for such good results, irrespective of economic policy. Fear of terrorism for example, in the region, Turkey. Clearly the country benefited from this. Americans have an expression which says, better be lucky than good and in this case this country has been privileged. It is a safe country and it is a beautiful country, so why not come here.

So that affects the GDP, the budget revenues from tourism increase and there is a multiplier effect.

There are a couple of other factors. Obviously, oil prices have come down significantly and that has an impact on consumption which has been one of the drivers of growth in Croatia. The third factor is policy driven. There were cuts in personal income taxes last year and that has had an effect on consumption. So the three things put together produced positive results.

Also, after six years of recession the economy is bound to rebound by itself. This is a capitalist system after all. That’s the way the capitalist system works. If prices are down, the demand will pick up eventually. It does not mean that you are better off without a government and people should not get too complacent. Geopolitics change very quickly, tourism is very sensitive. Croatia is a very safe country and safety is an essential element of tourism. This does not mean that you should relax.

Nacional: What do you expect from those who will form the next government? Can this positive trend continue without real structural reform and what would those reforms be?

CP: We, ourselves are embarking on the design of a new country partnership framework. We are trying to define areas we should focus on with the new government. We hear a lot about these structural reforms and we would like to know in particular which reforms. We have been discussing in general terms and that is why I asked my team, which started to work on this this week, to look deeper into what are the constraints for the economy to grow. Is it the business environment since people are not investing enough in Croatia? Why are people not employing enough?

I talk a lot with private sector representatives and ask them what it is that bothers them most. Usually they say – regulations. Yes, but which particular one?  Some of them are very dramatic and say let’s get rid of ninety percent of regulations. But that is not possible.

That’s why we will have consultations throughout the country and do a thorough diagnostic of the economy, trying to find what are the policies the government should focus on. We want to go from generalities to specificity. For example, why is it necessary for business registration to go through the court system which is already overwhelmed. Maybe we can bring expertise and experience from other countries in this case. A good example is the Netherlands, or Singapore. But it is not possible to apply exactly the same measure to the Croatian situation.  For example, here we have the local governments involved and are they on board to do these things.

Nacional: Are the positive indicators presented recently by Minister Marić results of Tihomir Oresković’s government’s budget and measures or is it only now that we see the results of the previous government headed by Zoran Milanović?

CP: It is very difficult to separate all these measures from each other. Like I said, when you have growth, you have higher tax revenues and when you have more tax revenue, fiscal accounts improve. To say that it is the result of one or the other is impossible.

There is a continuity in economic policies. With Minister Marić, we started a dialogue the second day after he took office and I believe that his attitude about decreasing expenditures and not increasing taxes went in the right direction and was successful. The moves were viewed positively by the international community. Both governments took the importance of fiscal consolidation very seriously. Of course they were under pressure from the European Commission to do something. So both of them deserve credit. In addition to focusing on the expenditures, it is very important that Minister Marić made it clear that they will not create more uncertainty by changing taxes, which is one of the biggest complaints by foreign investors. 

Nacional: By the Constitution Croatia is a welfare state. There is a prevailing opinion in the public that international institutions like the IMF and the World Bank are reducing social rights, in health, education, pensions to improve the state of public finances. Is this correct?

CP: We are, first of all, invited to find answers to a challenge that a government has. Which is – can we keep delivering the same quality of services with the resources that we have. I always tell my children – I would love to drive a Ferrari, but I cannot afford it. We don’t come in and say – the health system is too nice, take it down. So, the question is – can we put in place protocols that would save resources, for example, in procurement of medicines or medical devices? We probably can. Can we think of specializing hospitals? Do all hospitals have to provide all services?

So it is not a question of cancelling services, rather rationalizing them, since somebody has to pay for them.

I’ll tell you a story about a colleague, who travelled here for work and he fainted. The ambulance came, they did all the tests and he spent a night in the hospital. He told me that he had never been treated so well and he is not part of the health insurance system. After everything he got a bill for 900 kunas. He could not believe it. He asked me – why would they only charge so little? I know what people will say – Croatia is not the US, we do not have the same level of income. But at the end of the day, it is the same service. So the biggest challenge that we are presented with and which should be part of a public discussion, is that the system cannot pay its bills, it is accumulating debt. So one day, we are going to wake up and we are not going to be able to deliver the services. Our job is to find a way to avoid such a scenario in the future. It is the question of addressing the need now rather than later. From our experiences, if it comes later it is a disaster.

It is the same with the pensions. I was talking the other day with the Polish Ambassador. He told me: Carlos we have a 4:1 ratio of employed persons to pensioners and we are worried. Here in Croatia the ratio is 1:1 and nothing is being done. We are very concerned about this situation. Very concerned. Because, ten years from now what kind of pensions are you going to offer to people, if the system is broken.

Nacional: This seems to be an issue which is asking for a consensus between the two biggest parties. On their own they will not be able to implement the necessary reforms.

CP: Absolutely. I am a guest in this country. However, political decisions are political decisions. I think there has to be a broad public discussion whether these reforms are needed or not needed. If people decide, we are going to continue with this level of services and we don’t care what happens, then fine. But make your decisions on the basis of full information.

Nacional: What are your views on the tax cuts, that is, changes to the tax policies which were promised by almost all political parties during the election campaign? Can this boost the economy or will it have negative effects on the budget? Is it doable?

CP: My reaction to this was – great, but how will you pay for it? I am not against any tax reduction but I am against any irrational tax reduction that doesn’t say how we are going to compensate for this. And this is the thing that is missing from those promises. You can take the voodoo economics position, which says, if you lower taxes growth will come but things do not function like that. And to be very frank – populism is alive and well. Not only in Croatia but in many other countries, including mine. These things are easy to promise but difficult to deliver. Again, you have come out of a recession after six, almost seven years and there is a recovery.

But the recovery is not enough as you are not back to where you were in the beginning and unemployment is coming down but it’s not nearly enough for the people to really start feeling well. I keep reminding people that you have a recovery at a time when interest rates are very, very low, historically. This is going to change at some point and you have to be ready, because this change is a reality of economics.

Nacional: What are your views on the monetization of the highways which are, due to their loans a big burden on the state budget?

CP: We are trying to help and this has already been publically mentioned by Minister Marić, as well as, Minister of transport Butković. The reality is that the debt of highways and roads companies is growing year by year. So we are trying to do some kind of financial architecture and trying to move the payments into the future. That would require some kind of financial engineering, including providing a partial guarantee from the Bank.

The other aspect is the operational restructuring of the companies and it will require some degree of political support. My team tells me that the cost of maintenance is very high and we need to see why this is the case. There may also be changes in employment. This does not mean that the World Bank says you need to fire an x number of people. We need to look into how to decrease costs and if there are mechanisms that would increase revenues. Can we introduce a payment system like in Greece, which is also a tourist country and it introduced some kind of a seasonal charge?

Nacional: How is the World Bank helping Croatia? What projects are you planning to support in the future?

CP: In terms of planning, our relationship is changing a little bit, as three years ago Croatia became an EU member and has access to EU funds. We still have infrastructure projects and we recently completed the Ploče Terminal. We have another terminal project in Rijeka. We just completed the Coastal Cities Pollution Control Project in 22 municipalities which among others constructed wastewater treatment plants. Those are projects from the past.

We are moving away from infrastructure into more policy driven projects. That’s the reason why we have under discussion this roads and highways management project. We are involved in venture capital financing, research and development, health, social protection. Our funding will eventually come down, because of the role of EU funds and it is also the question of the political maturity of the country.

Nacional: Has the World Bank advised on policies that would increase employment, the key to economic growth and something that is clear to those who are not economic experts?

CP: As I mentioned earlier, we will be starting the process on diagnostics this week. But my own instinct tells me – if we are able to do something significant about the business environment, changing the way investors look at Croatia, employment would follow. The most difficult things that I have is when I talk to kids at universities, and I love to visit universities and hear the kids’ opinions. Most of them tell me that all they want to do is leave. It is very sad. This is not my country, it makes me very sad to hear that educated young people want to leave because they have no job prospects.

It is critical to change that and we really want to help the government to improve the business environment. I know that many investors from many countries just gave up because they did not have enough money to wait for the bureaucracy. Here I am talking about small investors, small companies and they are the ones that generate the most employment.

Nacional: In 2017, Croatia is expected to repay HRK 27 billion. How can this be repaid without a big economic earthquake?

CP: I don’t think there will be an earthquake. Without sounding too much like a big supporter of Minister Marić, he has the right attitude. You have to signal to the markets that you are doing the right thing. Because it is a matter of credibility. Rolling over debt when you have a lot of liquidity and very low interest rates is not a problem. It is not a problem in the short term. It could become a problem in the long term.

But the government has to be mindful that they are setting the expectations at such a level that they have to deliver. If they do not deliver then things will change and interest rates will go up. It will become harder and harder to roll over that debt. I hope that the coalition will be agreed very quickly so that the new government can start dealing with the budget for next year. That budget needs to be credible and that the ground is set for the reduction of debt to keep things under control. The rest will come.

Nacional: You are also the World Bank Country Manager for Slovenia. Can you make a comparison between the two countries economically? Slovenia also went through a crisis and how did the Slovenes overcome the crisis?

CP: They don’t give me a lot of work to do. Slovenia came out of a recession because it, as an older member of the EU, took advantage of EU funds very efficiently. They were able to handle the recession much better than many other European countries, not only Croatia. The World Bank has no lending in Slovenia but we have a couple of technical assistance projects with them. Their remaining weakness is the financial sector, where there are still a lot of state owned entities and we are helping them deal with these issues.

Nacional: Since you mentioned SOEs, does the World Bank have a position on INA or such big companies owned by the state? Should governments pull out of big companies?

CP: We do not have a unified position on this. But we usually – like we have done with railways and roads – recommend to improve the management of operations in such companies. We have for many years promoted privatization of everything, but it has been shown, that if you can put in place the right corporate governance, it does not matter in the end who owns the company. If the state plays by the same corporate governance rules of the private sector, and if the companies are led by professionals who are not politically appointed, they can be very successful.