In March, the Croatian government issued only its second ever kuna-denominated bond, a K3 billion, five-year note with a 6.75% coupon. This issue meets Croatia's strategy of building a yield curve in its domestic
currency but also helps curb its reliance on foreign debt, which rose to €22.7 billion at the end of 2004. Emerging Markets talks to Martina Dalic, secretary of state at Croatia's ministry of finance, about her government's strategy.
EM: What is Croatia's funding strategy in relation to both international and domestic markets?
MD: The funding strategy this year has been driven by two factors of wider macroeconomic importance. It has been determined in the light of the level of foreign debt and also by our intention to develop the domestic capital markets. However, there is a danger in simply moving the growth of external debt to other sectors.
Therefore a significant part of the government deficit this year will be financed through non-debt transactions, namely privatization: we have planned to raise about K5 billion through privatization revenues. We also expect to see foreign inflows from the international financial institutions and we have a special programme with the World Bank, which is a structural loan worth $150 million.
EM: So you are not planning any issuances on the international markets this year?
MD: We do not plan any foreign issuance this year. Any possible changes depend on the timing of the privatization revenues. If these take place this year as planned then I do not see the government [borrowing] in the international capital markets this year.
EM: In terms of the consolidated government deficit this year, what figures are you basing your plans on?
MD: The consolidated deficit this year was planned for 3.7% of GDP. This plan was made in October and this is the plan we are still working with. However, there are some significant challenges to our fiscal policy and budget. Primarily I am talking about the revenue outcome for 2004.
We didn't receive all of the revenues we were expecting in 2004 and also our tax revenue intake was a little lower than we expected. This, by definition, creates a challenge for this year. We are still assessing the budget and in the next few months it will be quite clear whether there is any need to make adjustments, but as of now our target is still 3.7%, which is an important reduction in the deficit.
EM: What challenges are the Croatian economy facing?
MD: I expect Croatian economic policy, and fiscal policy in particular, to be more and more driven by the EU accession process. Therefore economic policy will have to answer a few issues, which by the nature of the accession talks will come in the first plan: state aid, subsidies to enterprises, general restructuring to allow Croatia to be more competitive after the accession.
The second challenge is to make the government sector smaller and more efficient. I expect that during the next few years the size of the government sector will stabilize and slowly decline. The sustainability of the budget, the ability to reduce the deficit further and to consolidate public finances is linked to the ability of the country to achieve the macroeconomic indicators to enter the ERM2 to join the euro area in the future. These are the two most challenging tasks.
EM: The task of restructuring the government sector is potentially very difficult politically and unpopular with parts of the Croatian public. How strong is the government to tackle such issues?
MD: Well, you are right. It is quite clear that it is politically unpopular. This could be the most challenging task. These changes are necessary not just to ensure a quick accession but also so that the Croatian economy can grow in the future. It will take skill to find the match between the reforms needed and their political acceptance. As a government official I would say that I believe the government has enough experience.
EM: Moving on to the capital markets, how would you assess the success of Croatia in developing a capital market culture?
MD: The situation in the capital markets, its turnover, liquidity and capitalization are satisfactory in the area of the debt instruments that are traded on the Zagreb Stock Exchange. Since the 2000/2001 euro campaign, we have seen the deepening of the financial markets and the growth of the financial capacity of the markets. This deepened market has been able to absorb our government debt. The development of institutional investors also clearly contributed to the demand side. Investment funds as well as the pension funds are an important element in that respect. So in the area of bonds and debt instruments there has been good development.
As for the equity market, we are still faced with the same problems and these are related to the lack of stocks in the first quotation, and from this all other problems arise. There is still a certain
unwillingness of companies to list themselves in the market for several reasons: the lack of understanding on the part of companies of the possibilities of raising funds in the market is one; probably this is also linked to corporate governance issues as a listing requires
some scope of disclosure and certain rules to be applied inside the organization.
In addition, listing shares on the stock market has not been the main model for privatization for the past 10 years. However, as I always like to point out, the capitalization on the Zagreb Stock Exchange last year was close to 20% in shares and the capital markets of some developed economies do not have a much higher capitalization. There will be room for further development of the capital markets during the accession process and there will be investor interest in this market. But the future of the market will crucially depend on the medium-sized enterprises and their willingness to go and place funding in this way and not just raise money through banks.