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OPINIONNovember 9, 2023

Interview with World Bank Country Manager Jehan Arulpragasam: Croatian Economy Far More Resilient Now than 10 Years Ago

This interview with Jehan Arulpragasam, World Bank Country Manager for Croatia, was originally published in the print edition of Novi ListGlas Istre and Zadarski List on November 4, 2023.

Novi List: At a recent event of the American Chamber of Commerce in Zagreb, it was spoken highly of the Government's efforts in the crisis. How much does the fact that Croatia is a member of the EU affect this general assessment?

Jehan Arulpragasam: The Government's response to the COVID crisis was largely focused on preserving jobs, which was critical in supporting the rapid recovery that followed already in 2021. This is in stark contrast to the period after the Global Financial Crisis of 2008-2009. which caused a six-year recession in Croatia and an unemployment rate of more than 17 percent. Of course, it was a different kind of shock and the reaction that followed was significantly different, both at the national level and at the European Union level. In any case, the Croatian economy is much more resilient today than a decade ago. Likewise, the state provided comprehensive assistance during the energy crisis and continues to subsidize the price of energy for households and businesses.  and still managed to achieve significant decrease in public debt.

Energy Prices/Costs

NL: A new phase is coming now?

JA: Although in the short term it is understandable to focus on a quick response and ensure broad support to all layers of society, in the medium term this becomes too high of a cost and does not meet the objectives.

Therefore, it is important to create the preconditions so that the assistance can be targeted to and reach the most vulnerable members of society and allow the price of energy, at least to a certain extent, to contribute to a change in behavior of consumers and to stimulate more investments in energy efficiency. Therefore, we commend the Government's efforts in creating a household register which should enable exactly this type of better targeting of assistance during challenging periods. As for the strategic direction of the country, we believe that the key challenges are well identified, an ambitious plan of reforms and investments has been put forth in the National Recovery and Resilience Plan, and now it is crucial to continue with efficient implementation. This demonstrates how much membership in the European Union means to Croatia, not just in terms of funding but also in the implementation of reforms that can increase the country's growth potential.

NL: What is your assessment, how is Croatia dealing with the "shock" of suddenly having a large amount of money available from the NRRP and the Next Generation EU funds - does your assessments support the fact that Croatia has sufficient absorption capacity, and if not, is the problem in human resources, project preparation or something else? Do you have an estimate to what extent Croatia will be able to use these funds?

JA: These are indeed huge amounts. Croatia has almost 50 percent of its 2019 GDP at its disposal until the end of this decade. Absorption and effective use of such a large amount would be a challenge even for much more developed countries.

We are not referring here only to the administrative capacities of the authorities, but also about the actual capacities of the economy itself. We know that Croatia is facing labor shortages, especially in service industries such as construction, but also in the highly qualified labor pool such as designers and architects who prepare documentation before work can even begin.

So we have to be prepared that things will not always go smoothly. However, Croatia has learned a lot during the first programming period from 2014 to 2020, from the use of funds from the Solidarity Fund as well as during the preparation, and now also the implementation of the NRRP. We are truly seeing great progress.

What we consider very important is to shift the focus from the absorption to the effectiveness of the EU funds.  It will be important not just to use the funds, but to use them well. We have to decide not only what we want to achieve with these funds but also what kind of Croatia we would like to envisage in 2030.  And we also all need to prepare for the period when free funds will no longer be so abundant.

NL: Among other things, it was also mentioned that the World Bank carried out research which found that companies with more than 10 percent of foreign ownership shares generate as much as a third of Croatian GDP, employ a quarter of employees, and account for almost 50 percent of Croatia's exports. In this sense, is Croatia sufficiently open to investors, or are there still some obstacles that it should work on. We know that the problem is the judiciary, as well as the land registry system. What are some other issues?

JA: Foreign direct investments generally have significant positive effects on the domestic economy, and Croatia has room to play a more active role in this. This is very important in terms of attracting investors, especially in the context of the surrounding countries which are all competing for new investments. Investors look at the quality of the judiciary, the level of bureaucracy, the stability of the regulatory framework, the availability of labor. These are areas in which Croatia still has a lot of room for improvement. But on the other hand, Croatia has a very competitive investment promotion law. It is a member of the Eurozone and the Schengen area, and in addition, the COVID-19 pandemic has encouraged certain trends such as regionalization and shortening of supply chains. This creates a very good opportunity for Croatia to integrate itself more strongly into European value chains.

Foreign Investments

Nl: What is the structure of these investments?

JA: If we look at the structure of foreign investments in Croatia today, we see that a significant part of equity investments relates to investments in real estate rather than in more productive sectors such as manufacturing or other services. That is why the recent large investment of the American company Jabil in Osijek is very important. The significance of this investment is not only because of the creation of a large number of jobs in Slavonia, but also because it puts Croatia back on the map of regions that are of interest to foreign investors.  And I really believe that such an investment can help steer the situation in the desired direction.

NL: When it comes to productivity, can you detect the characteristics of the Croatian economy, or its shortcomings?

JA: For a long time, there was a perception that the cause of low productivity of the Croatian economy was too much reliance on tourism because of its labor-intensive nature with lower added value and few spillover effects to other sectors of the economy. Our analysis has shown that the structure of the economy explains only a small portion of Croatia's lag in productivity. In Croatia, entire sectors such as the processing industry lag behind advanced European economies in labor productivity. It is impossible to find only one cause of such trends. This is partly a consequence of the low capital labor ratio, insufficient investment in research and development and slow adoption of new technologies and processes, but also insufficient competition on the market and often challenging procedures for firms to enter, and especially exit, the market. In the last two years, we have seen a certain acceleration of a positive trend, but for it to continue, and perhaps intensify, both the public and private sectors must take on their share of responsibility.

NL: To what extent is corruption still a problem?

JA: Good governance practices in public and private sectors are important for building trust in a society. The quality and efficiency of public services, transparency, efficiency of the judiciary, digitalization to streamline government services and procedures as well as provision of e-services are some of the important pieces contributing to this agenda. I am glad that the Bank has been working with the authorities on several of these aspects. For example, the Bank is involved in the modernization of the land administration system improving the efficiency and transparency of government services and reducing the costs to businesses and citizens. Faster services and increased access to information are contributing to private sector development, productivity and competitiveness of Croatia. We are also working on projects that are aiming to make the interaction with courts faster and more responsive for businesses and citizens so that all citizens benefit from more effective, efficient and reliable administration of justice and rule of law.

NL: Croatia also has a problem with the inflationary spiral with inflation still above the EU average. What are the main reasons for this – the introduction of the euro, price hikes by retailers trying to make a profit and the services industry, tax policy or something else?

JA: Consumer price inflation has been slowing down in recent months, but not as fast as we would like and significantly slower than in the rest of the eurozone. In September, Croatia had the second highest inflation rate in the Eurozone. In part, this reflects differences in the consumer basket with Croatia's containing a larger share of food and weaker competition on the domestic market. This was followed by a strong growth in tourist consumption of foreign visitors with higher purchasing power than the local population which is also creating pressures on price increases. Also, the relatively strong growth of the economy in the last three years also had the same effect. Let’s not forget that since the period before the COVID-19 caused recession, Croatia has had the strongest cumulative economic growth of all countries in the European Union. With expected slower economic growth towards the end of the year, inflationary pressures are also expected to ease, if there are no significant disruptions in energy supply. Finally, we see signs of weaker competition on the domestic market which makes it even more important to enable easy entry and exit from the market, and to continuously strengthen the national competition agency.

NL: What is your view of the labor market in Croatia, will it have to rely on "imported" labor or could part of the working population start to return from the countries of Western Europe?

JA: Foreign workers and retirees who use the options to return to the labor market while retaining their pension insurance rights make up almost 10 percent of total employment in Croatia today. We expect that this percentage will continue to grow and it is important that Croatia starts better managing immigration flows. There is a need for an immigration policy, that will also focus on attracting migrants with a higher level of education and on the integration of foreign workers and their families into Croatian society, as well as the protection of the dignity of foreign workers. As for the return of Croatian emigrants, especially those who emigrated in the last ten years, we expect that such trends will intensify in the coming years, especially as the income gap between Croatia and the rest of the EU will decrease. Today, Croatia is at 73% of the average EU income, measured by purchasing power parity. By the end of this decade, it could reach 80%, which is considered, in literature, to be the level after which emigration flows weaken significantly.

Financing Conditions

NL: In Europe, interest rates are rising significantly, resulting in much greater caution on the part of investors from countries that are traditionally focused on Croatia, such as Germany, Austria, etc. What can we expect on the global scene, when it comes to interest rates?

JA: We saw that last Thursday the European Central Bank kept key interest rates unchanged.  This is the first time in 15 months that interest rates have not been increased. On the one hand, this reflects a certain weakening of inflationary pressures, but also the fact that past increases in interest rates continue to spill over strongly into higher financing conditions on the market. In Croatia, interest rates for companies have risen strongly, while those for households, at least when it comes to housing loans, have remained relatively stable at low levels. We do not expect a further significant increase in interest rates, however, whether current interest rates will significantly affect the investment activity of companies will depend to a great extent on the expectations about future economic trends and the level of uncertainty on the market.

NL: At the same time, what is the trend in the loans that the World Bank itself approves?

JA: The World Bank (International Bank for Reconstruction and Development) has maintained a triple-A rating since 1959, and this high credit rating allows us to borrow at low cost and offer middle-income developing countries access to capital on favorable terms. This goes a long way in helping ensure that development projects go forward in a more sustainable manner, while often complementing or catalyzing private financing. IDA (International Development Association) resources are highly concessional and are provided to world’s poorest countries in the form of grants and zero to low-interest credits (loans). IBRD flexible loan interest rates are based on the reference rates (e.g. EURIBOR) on which a spread is added depending on the country’s pricing group and the loan maturity. While we see reference rates going up, our spreads have remained stable, and we continue to offer to our client countries access to capital on favorable terms. In the previous fiscal year, 2023, the World Bank (IBRD/IDA) committed $72.8 billion to partner countries, distributed in credits, loans, and grants.

NL: Looking at the global picture, the world is in a big crisis. In addition to the war hotspot in Ukraine, there is also a new problem in the Middle East. Can you estimate in which direction these conflicts will go, how long they may last, and with what consequences on the global, Croatian, and also the economy of the least developed countries? Will the role of the World Bank grow again, due to these crises?

JA: The world economy is, indeed, in a precarious position, threatened by a toxic trio: elevated debt levels, tighter financial conditions, and weak growth. This is all made worse by war and conflict. A human tragedy is unfolding in the poorest countries, where the prospects for development are the bleakest they’ve been in a generation. To put the global economy back on track, policymakers must step up with significant reforms that spur growth, restore fiscal sustainability, alleviate debt distress, and prevent financial contagion.

We do not have a crystal ball to see how these events will develop but the World Bank works closely with countries in Europe and Central Asia, the region Croatia is part of, to eliminate poverty and promote shared prosperity, through boosting human capital, facilitating green transitions, enabling markets and building and strengthening institutions. Unprecedented shocks and uncertainty have hit our region in recent years – from COVID-19 and the impacts of climate change through to the catastrophic human tragedies from Russia’s invasion of Ukraine and the earthquakes in Türkiye. Looking forward, crisis response and boosting resilience are likely to remain near-term priorities for the region as well as for Croatia.

So far, 6 and a half billion dollars for Projects in Croatia

NL: What is the focus of WB program and support to Croatia? How does the World Bank support Croatia and its goals and priorities?

JA: As already mentioned, the World Bank’s has embarked on a new mission which is described in detail in a document entitled the Evolution Roadmap. This is a new playbook that will guide the institution on a journey to create a World free of poverty on a livable planet. It is important to highlight that this new mission is inclusive of everyone, including women and young people. It will focus on building resilience to shocks, including against climate and biodiversity crises, pandemics and fragility. And it will promote sustainability, through growth and job creation, human development, fiscal and debt management, food security and access to clean air, water, and affordable energy.

The World Bank in Croatia is actively transposing the new playbook rules to the Croatian context.  Soon my team and I will start preparing a new Country Partnership Framework with the Government which will define the Bank’s program in Croatia until the end of the decade. The strategy will be based on a comprehensive country diagnostic which is identifying key constraints and priority actions for Croatia to achieve inclusive, resilient and sustainable growth.

In line with the new global mission of the institution and the country context, the program will focus on improving the effectiveness of the public service delivery; providing equal opportunities for all in education, health, labor market and social protection; increased productivity and better paid jobs, and improved environmental sustainability and resilience to climate change and natural disasters. Getting to this stage has been especially rewarding as the diagnostic work also involved talking and listening to many stakeholders across Croatia, including central and local government, the parliament, the private sector, civil society organizations, academia and youth.

The World Bank program currently provides knowledge, technical assistance and financing in the areas of transport, justice service delivery, business environment, land administration, primary education, science and technology, post-earthquake reconstruction of key health and education facilities, deinstitutionalization, pension system sustainability, and public administration.

As a final point, allow me to highlight that the World Bank Group has been a development partner to Croatia over thirty years. During these three decades we have supported more than 100 projects worth US$6.5 billion and provided knowledge and technical assistance to help strengthen institutions and support policymaking through more than 330 reports and studies.

Livable Planet – New Mission

NL: The World Bank is often criticized by green and environmental activists - their policy is usually, roughly speaking, anti-investment.  Have parts of the World Bank's investments now turned to sustainable projects, and in which sectors, and in which countries the most?

JA: The World Bank Group has a clear role to play in supporting our client countries to prepare for the low-carbon, resilient transition, enabling them to build climate-smart economies that are green, resilient and inclusive. As you may have seen, the World Bank recently expanded its mandate to emphasize that our goal is a World Free of Poverty – on a Livable Planet. That last phrase is new and reflects a mission to drive impactful development and lead to a better quality of life – which includes, access to clean air, clean water, education, and decent health care.

NL: In this regard, where does Croatia stand with "green" investments?

JA: Since the green transition is also at the core of the EU's ambition to be climate-neutral by 2050, the importance and relevance of this topic is getting more and more attention in Croatia. More than 40 percent of the investment in Croatia financed from the Recovery and Resilience Facility were green tagged meaning they are supporting climate objectives. In the recent period, the focus has been leaning primarily on the need to increase investments into renewable energy production and to improve energy efficiency in the buildings sector. However, it will also be important to advance investments in solid waste and wastewater management, and increase the circular material use rate, where Croatia is lagging behind the majority of EU peers. In addition, green transport is also an essential pillar of the green transition, and I am glad to see the recent announcements on investments that are planned in the railways sector. We expect that additional investments will also be needed in green, innovative and multimodal transport solutions to be able to reach ambitious carbon emission reduction targets.




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