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FEDERATION OF EURO-ASIAN STOCK EXCHANGES SEMI ANNUAL REPORT OCTOBER 2006 ZAGREB STOCK EXCHANGE ECONOMIC AND POLITICAL DEVELOPMENTS Politic and Economic Environment Croatia's coalition government, led by the centre-right HDZ, is currently under no significant threat from the parliamentary opposition, although it faces a challenging year ahead of the general election expected in late 2007. The EU's October 2005 decision to start membership negotiations with Croatia means that the HDZ will have to turn its attentions to a range of difficult political and economic reforms that are required as part of the accession process. These include the liberalization of agriculture, the upgrading of environmental protection and the strengthening of competition policy (which will entail politically sensitive cuts in state aid). By the time campaigning for the 2007 general election gets under way, the government's management of this process, and its approach to economic reform more broadly (which has been somewhat mixed), will take centre-stage. The EU's intention to look more closely at "fundamental rights", including the treatment of minorities and the way that war crimes are addressed, is likely to make some elements of the negotiations more difficult. Significant progress will need to be made in strengthening the judiciary and improving administrative capacity, and the latter in particular will necessitate the creation of a number of new government agencies at a time when the coalition is under pressure from the IMF to exercise fiscal restraint. At the same time, the European Commission will monitor the implementation of reforms much more closely in Croatia than it did in the countries that joined in the previous round of enlargement, which will also prolong the negotiations. On March 29th the IMF's executive board completed the second review of Croatia's SDR97m (US$143m) stand-by arrangement, and approved the extension of the agreement until November 15th 2006. The government is working through a series of reforms to the healthcare system that will see a greater role for the private sector in health insurance and a reduction in payment exemptions. The completion of healthcare reform is not expected before 2007. The IMF is also pressing for more rapid restructuring of two of the largest recipients of state subsidies, the country's shipyards and the railway system (state aid in Croatia as a percentage of GDP is well above both the EU average and the average within the EU's new member states). Over the medium term, the reforms required to complete EU negotiations and the targets of the government's Pre-accession Economic Programme (PEP) will increasingly take precedence in the economic policy agenda. Especially with an election in prospect, it appears that the government will not seek another IMF programme following the completion of the current stand-by arrangement. Economic Performance Real GDP growth in 2005 was higher than expected, at 4.3%. Public consumption will be constrained in 2006 by pressure to reduce the general government deficit. The one-off income effect of the government's decision to pay out pension arrears in 2006 will support healthy growth in private consumption, despite the central bank's attempts to limit the rate of credit growth this year. The Croatian National Bank (CNB, the central bank) is committed to maintaining the nominal stability of the kuna against the euro, which has helped to counteract upward pressure on inflation stemming from high oil prices. The CNB estimates that the primary and secondary effects of high oil prices contributed as much as 1 percentage point to the growth of the consumer price index in 2005. The government moved to cap increases in fuel prices by INA, the partly state-held oil and gas concern, in April, but we continue to expect average annual inflation to remain above 3% this year. Consumer price inflation in the twelve months to March 2006 was 3.4%. In 2007 falling oil prices will attenuate a significant source of inflationary pressure. The CNB intervenes regularly in the localcurrency market, mostly purchasing foreign currency in order to ease upward pressure on the kuna. The introduction of regular repurchase agreement auctions by the central bank has improved management of liquidity and reduced interest rate volatility, helping the CNB to counter pressures on the Croatian currency from investment- and tourism-related foreign exchange inflows. In the first three months of 2006 the kuna strengthened to an average of HRK7.34:[euro]1, compared with a firstquarter average of HRK7.51:[euro]1 in 2005. With the US dollar set to weaken against the euro in 2007, and inflation in Croatia still running above price growth in the euro zone, we forecast a mild real effective appreciation of the kuna in 2006-07.* * Economic Intelligence Unit Ltd., May 2006 Key Information Contacts Croatian Agency for Supervision of Financial Services www.crosec.hr Ministry of Finance www.mfin.hr Croatian Government www.vlada.hr 2005-ORIGIN OF GROSS DOMESTIC PRODUCT (%) 2005-COMPONENTS OF GROSS DOMESTIC PRODUCT (%) Manufacturing & mining Public services Transport & trade Private consumption General government consumption Gross fixed investment Agriculture, forestry & fishing Construction Other services Change in stocks Exports of goods & services Imports of goods & services 20.1 10.2 7.0 60 50 57.0 47.1 55.8 24.2 6.6 40 30 28.6 32.0 20 10 0 20.4 2.7 PAGE 146
FEDERATION OF EURO-ASIAN STOCK EXCHANGES SEMI ANNUAL REPORT OCTOBER 2006 ZAGREB STOCK EXCHANGE CROATIA ECONOMIC CHARTS AND TABLES 2001 (a) 2002 (a) 2003 (a) 2004 (a) 2005 (a) GDP at market prices (HRK billions) 165.6 181.2 198.4 212.8 229.0 GDP (US$ billions) 19.9 23.0 29.6 35.3 38.5 Real GDP growth (%) 4.4 5.6 5.3 3.8 4.3 Retail price inflation (av; %) 4.9 1.7 1.8 2.1 3.3 Population (millions) 4.5 4.5 4.5 4.5 4.6 (b) Exports of goods FOB (US$ millions) 4,759 5,004 6,308 8,210 8,992 Imports of goods FOB (US$ millions) -8,860 -10,652 -14,216 -16,560 -18,283 Current account balance (US$ millions) -727 -1,917 -2,132 -1,895 -2,541 Foreign exchange reserves excl gold (US$ millions) 4,703 5,885 8,191 8,758 8,800 Total external debt (US$ billions) 12.0 15.6 23.5 28.4 (b) 30.6 (b) Debt-service ratio, paid (%) 31.0 25.8 20.6 20.9 (b) 27.9 (b) Exchange rate (av) HRK:US$ 8.34 7.87 6.70 6.04 5.95 (a) Actual. (b) Economist Intelligence Unit estimates. 2005-PRINCIPAL EXPORTS (%) 2005-PRINCIPAL IMPORTS (%) Machinery & transport equipment Classified manufactures Machinery & transport equipment Mineral fuels & lubricants Chemicals Mineral fuels & lubricants Chemicals Food & live animals Other Food & live animals Raw materials (excl fuels) Other 13.6 9.9 15.1 11.1 14.7 9.9 32.9 7.9 2.0 29.6 22.3 31.0 2005-MAIN DESTINATIONS OF EXPORTS (%) 2005-MAIN ORIGINS OF IMPORTS (%) Italy Bosnia & Hercegovina Germany Italy Germany Russia Slovenia Austria France Other Slovenia Austria France Other 14.3 10.6 9.1 6.8 14.8 5.7 21.4 8.1 4.2 7.1 2.3 16.0 43.4 36.2 Source: Economist Intelligence Unit ViewsWire PAGE 147
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