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OPINION June 14, 2021

Opportunities for Croatia Have Never Been Clearer and More Vibrant

Interview with Elisabetta Capannelli, World Bank Country Manager for Croatia, as originally published in the online edition of Poslovni dnevnik, , June 14, 2021.

Elisabetta Capannelli’s four years in Zagreb will stand out in her thirty-year career at the World Bank. After finishing the new strategy for Croatia and just as the hectic tempo was easing, the pandemic, devastating earthquakes, and the economic crisis hit Croatia. As a result, her  mandate took an unexpected turn.

POSLOVNI DNEVNIK: Your four-year term in Croatia is coming to an end. How do you assess the progress of Andrej Plenković’s Government in the implementation of reforms? In your opinion, what are the biggest successes, where did it fail? 

Elisabetta Capannelli: The past four years were very eventful, and I would say they were positive. During my time here, Croatia has built on its membership of the European Union, entered the Exchange Rate Mechanism II (ERM II), and set the basis to become a member of the euro area and of Schengen. These are all major successes. Personally, I have also been especially impressed by Croatia’s economic response to the COVID-19 pandemic.

Worldwide, COVID has caused the largest economic contraction since World War II and global poverty increased for the first time in 20 years. In 2020, Croatia was one of the hardest hit countries in the EU and Croatia’s GDP contracted by 8 percent. The two devastating earthquakes of March and December 2020 added combined damages estimated at almost 30 percent of its GDP.

After the 2009 crisis, Croatia could not afford a big fiscal stimulus package and endured the longest recession in the EU. Croatia’s unemployment rate more than doubled, reaching 17.3 percent. Croatia was prepared to face this crisis due to its solid macro-economic fundamentals. The country had been running budget surpluses for three consecutive years, with public debt firmly on a downward path. This allowed the government to design an adequate intervention package to support the private sector and workers. Almost 600,000 workers were covered by employment protection schemes at some point in 2020 and by now more than 10 billion Kuna has been paid out to employers, which along with liquidity loans and tax forgiveness and deferrals, helped the private sector stay afloat. Such interventions prevented a deeper recession.

If the vaccination program expands further and no new restrictions are reintroduced after the summer, Croatia could achieve an even stronger recovery (we estimated GDP growth of 5.5% in 2021 and 6.2% in 2022), and Croatia’s real GDP should return to pre-pandemic levels already in 2022, at the same time as for other EU member states.

But Croatia can do better. The convergence with the rest of the EU has been slow, reflecting the composition of Croatia’s economy and structural bottlenecks. The export sector, which should be the engine of growth in a small open economy such as Croatia, is still too small. The pace of implementation of difficult reforms has been slow, sometimes despite Government’s best efforts. The country will need to significantly accelerate its implementation of key reformsif it wants to move into the group of advanced European economies.

I cannot think of a better time for Croatia than now for faster actions and aiming higher.

PD: In a column for Poslovni dnevnik 2 years ago, you portrayed Croatia as a sleeping beauty waiting for Prince Charming. What are your impressions today?

EC: That was only in December 2018, but it feels almost like a world apart. When I was discussing the opportunities and challenges for Croatia then, we could not even fathom the difficulties the world would soon face. When you consider that Croatia entered a strict lockdown in March 2020, had a major earthquake some days afterwards and another one 9 months later, and that the government has been providing support to employees, the private sector, handling the healthcare crisis, and ensuring that pupils could continue their education, I believe Croatia did rather well in this challenging environment. This confirms my impression that Croatia does well when faced with major crises, but encounters resistance when it needs to tackle the deep transformation of its economy. So while there are reasons for optimism, the real awakening is yet to happen and we are still waiting for that kiss.

As I mentioned, the opportunities for Croatia have never been clearer and more vibrant. I would highlight three important ones. First, Croatia is now fully anchored in the EU and soon will enter the euro area, allowing for even stronger economic integration. Second, Croatia’s political stability can make it easier to take bold decisions and fully address some of its governance issues. There is stronger involvement of citizens and a new generation of national and local leaders across the political spectrum demanding change and faster actions. Third, Croatia will soon have access to the Next Generation EU Funds. The grant allocation from the Recovery and Resilience Facility alone adds up to around 12 percent of Croatia’s GDP (2019), which is by far the largest amount among the Central and Eastern European countries.

The National Recovery and Resilience Plan (NRRP) that the Government has recently adopted includes a bold reform agenda for the next 6 years and presents a unique opportunity to close some of the reform and investment gaps that are still holding the country back. If this plan is fully and efficiently implemented, Croatia can accelerate its convergence to the EU, create better foundations for long term growth, and create a more resilient, greener, and equal society.

PD: Before the pandemic, the World Bank calculated that Croatia, if it were to maintain growth rates of 3 percent, would catch up with Slovakia in 9 years and with Austria in 26 years (levels prior to COVID-19 outbreak). How much has the pandemic swayed that calculation, where are we today compared to the neighboring countries?

EC: The COVID-19 pandemic has not significantly altered Croatia’s catch up dynamics with the other EU member states and hence Croatia’s convergence remains slow. Poor productivity growth remains a long-standing issue and one of the main reasons why Croatia is at the lower end of the EU in terms of GDP per capita. I was hence happy to see that Croatia’s National Development Strategy (NDS) declared the acceleration of convergence as one of its priorities. The Bank produced a series of analyses to help inform this document. Achieving convergence will require dealing with structural bottlenecks, including strengthening government institutions, especially public administration, the judiciary, and further improving the business environment. More investment on research and development, support for young, innovative firms, and the transformation of some large firms are also needed to stimulate the growth of the private sector and to make the country less dependent on tourism. Policy actions focused on equity, the role of women, and education are very important for long term growth.

Meanwhile Croatia’s negative demographic trends may further constrain its growth potential. Before this crisis, Croatia was already facing labor shortages in certain sectors, like tourism and construction, and in some high-skilled occupations that will be vital for improving productivity and competitiveness. I expect Croatia will face similar challenges in the next years. There is some recognition that actions are needed. Croatia was one of the first countries in the world to regulate the work of digital nomads in an effort to attract young, educated professionals, and it has made it easier to hire foreign workers. But such actions will not be enough. Croatia will also need to increase the participation rate of its working age population, especially women whose labor market participation rate is significantly lower than for men and will also need to develop active policies for in-migration.

PD: In your opinion, has the Government charted a good path with the National Recovery and Resilience Program (NRRP/NPOO). Entrepreneurs (and some economists) criticize that there is too little funding for the private sector, and warn that infrastructure cannot create a multiplier effect or long-term GDP growth, not to mention corruption...

EC: The Recovery and Resilience Facility (RRF) is a new instrument. It is the main and the largest part the EU’s response to the crisis called Next Generation EU.  NGEU was developed with lots of ambition to help EU member states deal with the economic and social repercussions of the COVID pandemic. It comes with its own regulations, rules, and benchmarks. The intention of the RRF is to foster the actions that address long standing reform challenges, including those that were highlighted in the ‘country specific recommendations’ (CSR). In the case of Croatia, the CSRs were developed by successive governments and range from reforms of education and social services, to privatization, prevention of corruption and improving the efficiency of judiciary, and so on. Therefore, it is in the nature of the RRF instrument for the public sector to be the main direct beneficiary of the funds. But let us not forget that there are grant schemes, through the Ministry of Economy and Sustainable Development as well as the Ministry of Tourism and Sports, and other financial instruments offered through HABOR and HAMAG-BICRO, that will enable the private sector to access free or cheap funding for green and digital investment.

My plea is for the private sector to focus on (and monitor) the Plan in its entirety, in particular how fast and how reforms included in the NRRP - related to ease of doing business, cutting red tape, improving the efficiency of the judiciary, improving the skills of students, and introducing flexibility in the labor market - will be implemented by the authorities. These are key features of the Plan that will make lives of entrepreneurs much easier, enabling them to seize new market opportunities, grow, employ, and ultimately thrive.

PD: In the corona crisis, Croatian economy experienced one of the largest falls in the EU due to tourism dependence, but a recovery is forecast with among the highest rates in the EU. Can (and should) Croatia break free from the embrace of dependence on tourism, and in which direction should it build a sustainable economic policy to catch up with Europe?

EC: The nature of the COVID-19 pandemic and the measures that were introduced by national health authorities to try to protect lives also had a serious impact on the hospitality industry. Croatia is heavily depended on tourism, with around 20 percent of economic activity directly or indirectly linked to tourism. Croatia suffered a 55 percent drop in export of travel services in 2020 which obviously caused a major hit to the entire economy. Croatia is not an isolated case in the EU. Countries like Greece, Spain, Italy, and Portugal experienced a severe recession too.

Croatia’s strong reliance on one sector, makes the country vulnerable to external shocks and limits overall productivity growth. However, tourism will remain one of Croatia’s most important economic sectors. It has also helped the country grow faster and has provided an income cushion during the previous crisis. But there are lessons to be learned from this experience and a change in the composition of the economy towards higher value-added sectors and knowledge-based activities would be beneficial for Croatia.

PD: Some economists consider the implementation of the euro to be ‘the last ship from the desert island’ in terms of prosperity, what is your view?

EC: Croatia belongs squarely in the EU and in the euro area. I am very positive about the Euro area entry. The question of when exactly this will happen is less important than ensuring that it does happen at the right time. If a bit more time than originally envisaged is needed, considering the imbalances created by the earthquakes and COVID, that too is fine. There is no doubt that the euro will help Croatia. It will almost fully eliminate currency risks, lower transaction and operating costs, particularly for exporters, foster external trade and reduce the cost of borrowing. But entering the euro area is not the panacea, nor by itself the euro will bring prosperity.

PD: To what extent was the World Bank able to support Croatia over the last four years?

EC: I came to Croatia after several challenging assignments in various continents thinking my four years in Zagreb would be relatively easy. Nothing could be further from the truth. I spent the first part of my mandate consulting intensively with stakeholders and government to design a new strategy to reflect a changed relationship for the World Bank to operate in a high-income EU country. This set a new course of actions for us. We launched new instruments of engagement, including less lending but broader Technical Assistances programs, as we employ in other EU Member States and in more developed countries worldwide. We focused on a broader range of issues, from structural reforms pertaining to euro adoption, to strategic efforts related to Slavonia/Pannonia, Science and Technology, the development of a new strategic planning system and support to the NDS2030, and new strategic directions in agriculture and fisheries. We also continued to work in areas supporting investments and government’s reform efforts in land administration, railways, roads, judiciary, business environment, health, and education. During my mandate I also focused on making the World Bank better known in Croatia and on changing my own team, recruiting younger Croatian talents, more women, bringing into the team a variety of skills and expertise to respond to the sophisticated challenges of Croatia.

And when I was ready to slow down a bit, the COVID pandemic and the earthquakes happened, Croatia entered a new economic crisis, and the World Bank was called in for help. We listened, assessed, designed, and acted quickly. By June 2020 we had already approved two new Loans (for the Zagreb earthquake and to mitigate the effects of the economic crisis) totaling about Euro 411 million or 0.9 percent of Croatia’s GDP. In May 2021, we approved a new EUR 200 million loan to HBOR providing liquidity to firms from less developed regions, firms owned or managed by women and young enterprises. During the last 18 months, we also prepared two Rapid Damage and Needs Assessments for both Zagreb and Petrinja earthquakes to help quantify the impact of the earthquakes and access EU Solidarity Fund. In addition, we supported the preparation of a coherent package of reforms and public investment projects for the Croatian National Recovery and Resilience Plan.

So, as this is not just the end of my four-year mandate in Croatia but will also be my last assignment for the World Bank after working almost 30 years in development, I wish things would have been easier and that I could have had more time to relax, travel, and enjoy this beautiful country of yours, rather than focusing on challenges and crises. But I have learned a lot from Croatia and I will bring with me many unique memories of generosity and dedication of my own colleagues, of how the Croatian people came together to help out during the Petrinja earthquake, and of the country’s ability to endure and respond in time of crisis.