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COUNTRY REPORT

Bosnia and Hercegovina

Croatia

1st quarter 1998

The Economist Intelligence Unit15 Regent Street, London SW1Y 4LRUnited Kingdom

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ISSN 1366-4123

Contents

3 Summary

Bosnia and Hercegovina4 Political structure6 Outlook for 1998-999 Review9 The political scene

14 Economic policy16 The economy

Croatia20 Political structure21 Economic structure22 Outlook for 1998-9926 Review26 The political scene29 Economic policy31 The economy34 Foreign trade and payments36 Business news

37 Quarterly indicators and trade data

List of tables8 Bosnia and Hercegovina: forecast summary9 Republika Srpska: National Assembly election results, Nov 1997

17 BiH Federation: industrial output, 199717 BiH Federation: average net monthly wages, 199717 BiH Federation: employment, 199718 Republika Srpska: unemployment, 199718 BiH Federation: consumer prices, Jan-Nov 199725 Croatia: forecast summary30 Croatia: quarterly budget data31 Croatia: gross domestic product32 Croatia: industrial output32 Croatia: construction33 Croatia: inflation34 Croatia: foreign trade37 Croatia: quarterly indicators of economic activity38 Croatia: foreign trade39 Croatia: foreign trade

1

EIU Country Report 1st quarter 1998 © The Economist Intelligence Unit Limited 1998

List of figures10 Republika Srpska: National Assembly election results, 1996-9725 Croatia: gross domestic product25 Croatia: retail prices32 Croatia: industrial output33 Croatia: monthly retail prices

2


January 30th 1998 Summary

1st quarter 1998

Bosnia and Hercegovina Outlook for 1998-99: The renewed international commitment to rebuildinga united Bosnia and Hercegovina (BiH), and the likelihood that the mandate ofNATO forces in BiH will be extended beyond the current June 1998 deadline,improve the prospects for the country’s reintegration and make a resumptionof war less likely. Progress in securing refugee returns will be limited, despitemore robust international efforts. Resistance from hardliners will continue,and the new, moderate prime minister in the Republika Srpska (RS) will dependon international support. Potential flashpoints remain, notably over the futureof Brcko. Economic activity will pick up this year, mainly thanks to greaterflows of international aid.

Review: A moderate prime minister, Milorad Dodik, has been appointed in theRS, following the defeat of hardliners in November’s parliamentary election.After initially refusing to recognise Mr Dodik’s appointment, the hardlinersagreed to participate in the new parliament. The powers of the internationalhigh representative for BiH, Carlos Westendorp, were increased at an inter-national meeting on BiH in Bonn, enabling him to impose decisions on BiH’sauthorities. The US president, Bill Clinton, has indicated that NATO-led forcesshould stay in BiH as long as they are needed. Mr Westendorp has imposed newbanknote designs for the joint currency, which should soon be in circulation.GDP growth estimates for 1996 and 1997 are likely to be revised downwards.

Croatia Outlook for 1998-99: Politics is becoming more focused between the SocialDemocratic Party of Croatia (SDP) on the left and the ruling Croatian Demo-cratic Union (HDZ) on the right. The HDZ is trying to transform itself into amodern centre-right party, as emerging new leaders position themselves for thesuccession to the president and party leader, Franjo Tudjman. Continued inter-national pressure will hamper Croatia’s international integration efforts. Atighter economic policy is likely to be pursued in 1998. This will contribute toslower GDP growth, compared with 1997, of around 4.2%. The tourism re-covery will continue, narrowing the current-account deficit in 1998-99. Pres-sure for a currency devaluation may become irresistible, although thegovernment will be keen to avoid it.

Review: Eastern Slavonia has passed into Zagreb’s control. The peaceful returnof refugees presents a major challenge; the international community is closelymonitoring the treatment of the region’s Serbs. The Croatian Social Liberal Partyhas split, leaving the SDP as the main opposition party.The introduction of VAT,at a flat rate of 22%, has sparked controversy and led to initial price rises. GDPgrowth was about 5.3% in 1997, as industrial output picked up and tourismcontinued its strong recovery. Monetary policy has been tightened. Importsgrew more strongly than exports in 1997, and in dollar terms exports stagnated.

Editors:All queries:

Peter Palmer; Joan HoeyTel: (44.171) 830 1007 Fax: (44.171) 830 1023

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Bosnia and Hercegovina

Political structure

Official names Bosnia and Hercegovina (BiH) has legal existence within the boundaries of thehomonymous republic of former Yugoslavia. It comprises two entities: the Federationof Bosnia and Hercegovina, set up by the Washington Treaty of March 18th 1994, andthe Republika Srpska (RS)

Form of state Bosnia and Hercegovina has the following limited responsibilities under the BasicPrinciples agreed in Geneva and New York in September 1995, and confirmed atDayton, US, on November 21st: the establishment of a Constitutional Court, aCommission for Displaced Persons, a Human Rights Commission, a central bank,public corporations to manage and operate transport and telecommunications, aCommission to Preserve National Monuments, and a system of arbitration betweenthe two entities. Foreign trade is also supposed to be managed by the government ofBosnia and Hercegovina

Legislatures The Federation and the RS have their own assemblies. Bosnia and Hercegovina has atwo-chamber parliament: the House of Representatives and the House of Peoples,two-thirds elected from the Federation and one-third from the RS. A valid majorityrequires the support of at least one-third of the members representing each entity

National elections September 14th 1996; next elections due by end-1998

Head of state Bosnia and Hercegovina has a collective presidency of three, elected on September 14th 1996: Alija Izetbegovic, Momcilo Krajisnik and Kresimir Zubak

National government There is a small Council of Ministers with two co-chairmen (prime ministers) and adeputy prime minister chosen by the presidency on December 18th 1996. Threedepartmental ministers, each with two deputies, were elected by parliament onJanuary 3rd 1997

Main political parties Croatian Democratic Union of BiH (HDZ); Party of Democratic Action (SDA); Party forBiH; Serbian Democratic Party (SDS); Serbian People’s Alliance (SNS); Serbian RadicalParty of the RS (SRS); Socialist Party of the RS (SPRS); Social Democrats of BiH; Unionof BiH Social Democrats

National government Co-chairmen Haris Silajdzic; Boro BosicCivil affairs & communications Spasoje AlbijanicEconomic relations & foreign trade Hasan MuratovicForeign affairs Jadranko Prlic

Central bank governor Peter Nicholl

Federation President Ejup GanicPrime minister Edhem BicakcicDeputy prime minister & finance Drago Bilandzija

4 Bosnia and Hercegovina


Key ministers Agriculture & forestry Ahmed SmajicDefence Ante JelavicEnergy, mining & industry Izudin KapetanovicEnvironment Ibrahim MorankicInterior Mehmed ZilicJustice Mato TadicScience, culture & sports Fahrudin RizvanbegovicSocial affairs, refugees & displaced persons Rasim KadicTrade Ige Krezo Transport & communications Rasim Gacanovic

RS President Biljana PlavsicVice-president Dragoljub MirjanicPrime minister Milorad Dodik

Key ministers Agriculture Milenko SavicDefence Manojlo MilovanovicEducation Nenad SuzicEnergy & mining Vladimir DokicFinance Novak KondicHealth & social security Zeljko RodicIndustry & technology Djuradj BanjacInformation Rajko VasicInterior Milovan StankovicInternational economic relations Savo LoncarJustice Petko CancarTrade & tourism Nikola KraguljTransport & communications Marko Pavic

Bosnia and Hercegovina 5


Outlook for 1998-99

The robust internationalstance will continue—

Recent events have made the prospects for peace and further reintegration inBosnia and Hercegovina (BiH) look better than at any time since the Daytonpeace agreement was reached in 1995. The key factor in bringing this aboutover the last year has been the more robust stance taken by the internationalcommunity. Although the military aspects of Dayton were quickly and fairlysuccessfully implemented, progress on the political front was initially slow. Itfrequently appeared that there was little international will to bring about thereal reintegration of the country, and that little was expected beyond a de factoseparation of the former warring parties. However, the international powersinvolved in BiH seem to have accepted by early 1997 that such a partial imple-mentation of Dayton merely maintained an unstable status quo. The risk of areturn to war remained and the prolonged—perhaps indefinite—presence ofinternational forces would be required if further fighting was to be avoided.Unwillingness to allow such a “Cyprus scenario” to develop led to a morerobust approach, in which aid is used as a lever to secure compliance withDayton’s provisions and military force is applied to deal with those obstructingDayton’s implementation, especially in the Republika Srpska (RS).

The renewed international commitment to rebuilding a united BiH was statedeven more forcefully in December at the Peace Implementation Council meet-ing in Bonn (see The political scene). The new powers granted to the inter-national high representative, Carlos Westendorp, to impose measures designedto build the institutions of a functioning state have provided the local partieswith an incentive to be more co-operative before Mr Westendorp resorts tosuch coercion. The likelihood that the international military presence willcontinue beyond the current mid-1998 deadline (see The Political scene)reinforces the international commitment to BiH and significantly reduces thechances of a return to war.

—and prospects forfurther reintegration are

improved—

The installation of a moderate prime minister in the RS, Milorad Dodik, hasenhanced the prospects for further reintegration. Mr Dodik has signalled hisdesire to co-operate in implementing Dayton, and there is likely to be furtherprogress in establishing the central institutions that bind the country together.

However, building these institutions, which are intended to have only limitedpowers, does not by itself bring real reintegration on the ground. Mr Dodik hasalso indicated that he will facilitate the return of refugees. There have beensuggestions that NATO troops will be more energetic in implementing provi-sions of Dayton such as enforcing freedom of movement, protecting returningrefugees and arresting indicted war criminals. Some progress in this direction islikely, but its extent is uncertain. Hostility towards returning refugees is wide-spread, and confidence among most refugees in their ability to rebuild their livesin areas controlled by another ethnic group remains low. Even if it were possiblefor refugees to return, there is in many cases little for them to return to.

—although resistance willcontinue—

For the time being Mr Dodik’s power in the RS rests on slim foundations. Likethe RS president, Biljana Plavsic, during her recent power struggle with the RS’shardline former leaders, he will have to rely for some time on international



support. Much will depend on whether the RS receives the necessary financialaid to make a tangible difference to the Bosnian Serbs. For the moment he andMrs Plavsic seem to be in a strong position. Under sustained internationalpressure, and deprived of support from Belgrade, the hardliners are in retreat.However, they will still seek to thwart the new government, especially in theeastern half of the RS, where the hardline nationalist parties still dominate. Amajor challenge for Mr Dodik in the coming weeks will be the need to establishcontrol over the police in the east. It is also uncertain how far he will besupported by Mrs Plavsic, who has not given up her nationalist views and forwhom compliance with international demands is primarily a way of gainingaid and obtaining international support against her rivals. For the moment,given the continuing fragility of her position in the RS, Mrs Plavsic can beexpected to co-operate with the international community.

Resistance to the integration of the BiH Federation will also continue as theBosnian Croats, in particular, seek to preserve the structures of their para-state,Herceg-Bosna. Here much will depend on Croatia. Despite heavy internationalpressure in recent months to bring its influence to bear on the Bosnian Croats,Croatia continues to demonstrate a lack of commitment to the unity of BiH.Croatia is likely to continue to undermine Bosnian unity as long as its aged andsick president, Franjo Tudjman, remains at the helm. The Bosnian Muslims,too, are likely to persist in attempting to preserve their predominance in struc-tures in which power is now supposed to be shared, to the chagrin of bothCroats and Serbs.

—and there are potentialflashpoints

Potential flashpoints remain which could derail the peace process. Mostimmediately, the decision on the future of the disputed town of Brcko couldcause a serious rupture (see The Political scene). The international arbitratorsmay try to find a compromise, but it remains to be seen whether the BosnianSerbs, in particular, can accept a compromise, given the strategic importance ofthe town to them. There is also a severe risk that the more forceful inter-national stance could at some time provoke a backlash, for example if NATOtroops move to arrest senior Serbs indicted for war crimes, such as the formerRS president, Radovan Karadzic.

Further political changesare in store

New elections at the central, BiH level are due by the end of this year. They willprovide an opportunity for another trial of strength between moderates andhardliners in the RS. In addition Alija Izetbegovic, the Muslim representative inthe joint presidency and leader of the main Muslim party, the Party of Demo-cratic Action (SDA), has announced that he will not stand for the presidencyagain. This will mark another break with the wartime period, although its effecton SDA politics, and on Muslim politics generally, is hard to gauge. Politics inthe main Croat party, the Croatian Democratic Union (HDZ), may also start toadapt to post-war realities, following the same trend as its mother party, theHDZ in Croatia; there are already signs of a purge of Croat hardliners in Mostar.Breaking the monopoly of power of the wartime Serb, Muslim and Croatleaderships, which has already happened in the RS, may thus also occur in theFederation in 1998.



Economic reform willcontinue slowly—

Economic restructuring has yet to get under way, but it is vital if the initialrecovery, driven by international aid, is to be translated into sustained longer-term growth. Progress in building common institutions will help advance eco-nomic reforms, but will be slow as it is tied to progress on the political front.The new common currency is expected to be in circulation by April, and a newcustoms tariff law is due to be passed soon. These two measures should helpstimulate trade, and payments between the entities should be facilitated. Fur-thermore, the customs tariff law is an important step in reforming publicfinances and should help to strengthen the revenue base of both entities’budgets. A law removing legal obstacles to the inflow of foreign direct invest-ment is to be adopted in the Federation. Privatisation in the Federation is alsoset to get under way this year.

—which will hamperrecovery

The slowness of economic reform will hamper the revival of industries whichwere previously the backbone of the Bosnian economy, such as the metals andelectrical engineering industries. Besides many other problems, these industriesare import-dependent and acutely short of finance. Investment needs are great,but the weak and underdeveloped financial sector will not be able to providethe finance until it is restructured and recapitalised.

Economic activity willpick up

Economic recovery will continue to be driven mainly by the reconstructionprogramme financed with international donor aid. Given that internationalaid flows slowed last year, as aid was used as a lever to enforce compliance withthe Dayton agreement, the EIU expects that the World Bank projection of 35%GDP growth in 1997 will have to be revised downwards, and that 1997 wit-nessed a slowdown in GDP growth in comparison with 1996 (see The eco-nomy). The very high World Bank estimates and projections of the past twoyears were based in part on excessive local official estimates. However, we stillexpect that there will be a pick-up in economic activity in 1998, as the flow ofdonor aid increases and the RS, at last benefiting from international aid, beginsto experience a more significant recovery. Having concluded that the WorldBank’s estimates of GDP growth for 1996 and 1997 are likely to require down-ward revision, we also project that such high levels in 1998 are unlikely. We do,however, expect growth in 1998 to be very strong, and have revised our fore-cast to 20%. Provided that peace is maintained and that foreign aid, which ispolitically determined, continues to flow, strong growth from the still lowpost-war levels can be expected to continue in 1999.

Bosnia and Hercegovina: forecast summary(% change, year on year unless otherwise indicated)

1995a 1996b 1997b 1998c

Real GDP 33 28d 15d 20

Industrial output n/a 87 40 30

Trade balance ($ m) –930 –1,546 –2,000 –2,500

a World Bank estimates. b EIU estimates. c EIU forecasts. d World Bank estimates: 1996: 50%; 1997:35%.



Review

The political scene

Moderates gain in theRepublika Srpska’s

elections—

In the parliamentary election in the Republika Srpska (RS) on November 22nd-23rd, hardline nationalist parties lost their majority in the entity’s NationalAssembly. The election had been called by the RS president, Biljana Plavsic, inan effort to resolve her struggle with Pale-based leaders gathered around herpredecessor, Radovan Karadzic, and Momcilo Krajisnik, the RS’s representativein the joint Bosnia and Hercegovina (BiH) presidency (4th quarter 1997, pages10-12). With strong international support, Mrs Plavsic conducted a concertedcampaign against her rivals in which they lost exclusive control over the me-dia. Mrs Plavsic accused the leadership of the ruling party, the Serbian Demo-cratic Party (SDS), including Mr Karadzic and Mr Krajisnik, of working againstthe interests of the RS by their non-compliance with the Dayton peace agree-ment for BiH, while personally benefiting from large-scale illegal activities. Thisstruck a cord with a part of the RS’s impoverished and disillusioned population,especially in the western half of the entity around Banja Luka, the RS’s largestcity and Mrs Plavsic’s powerbase.



The publication of the election results was delayed for a couple of weeks. Theyrevealed that the SDS remained the largest party with 24 of the Assembly’s 83seats. However, even with its allies in the Serbian Radical Party of the RS (SRS),the sister party in the RS of Vojislav Seselj’s extreme nationalist party in Yugo-slavia (Serbia and Montenegro), the SDS could not muster a majority in parlia-ment. Mrs Plavsic’s new party, the Serbian People’s Alliance (SNS), won 15seats, while the Socialist Party of the RS (SPRS), the sister party of Serbia’s rulingparty, the Socialist Party of Serbia, won nine seats and two small parties wontwo seats each. With the two hardline nationalist parties having failed toachieve an absolute majority, the balance of power in the Assembly potentiallyrested with the 16 deputies of the Coalition for a Single and Democratic BiH,which represents Muslim and Croat voters, most of whom are refugees in theBiH Federation and voted in absentia.

Republika Srpska: National Assembly election results, Nov 1997

Party No. of seats

Serbian Democratic Party (SDS) 24

Coalition for a Single and Democratic BiH 16

Serbian People’s Alliance (SNS) 15

Serbian Radical Party (SRS) 15

Socialist Party of the RS 9

Party of Independent Social Democrats 2

Social Democratic Party (SDP) 2

Total 83Source: Organisation for Security and Co-operation in Europe.

—and a moderate RSprime minister is

appointed—

It was almost two months before a new RS government could be appointed.Mrs Plavsic’s first choice for prime minister, Mladen Ivanic, an economist atBanja Luka university, proposed forming a national unity government ofexperts. However, his efforts were blocked by the SDS and the SRS, despite hisoffer of cabinet seats to the SDS. The SDS and the SRS objected that Mr Ivanicwas not affiliated to any of the parties and insisted that the new governmentshould include an equal number of party representatives and experts.Mr Ivanic received backing from the international community as well as from

Republika Srpska: National Assembly election results, 1996-97% of total

Source: Organisation for Security and Co-operation in Europe.

Serbian RadicalParty (SRS) 7.2Serbian RadicalParty (SRS) 7.2Serbian RadicalParty (SRS) 7.2Serbian RadicalParty (SRS) 7.2Serbian RadicalParty (SRS) 7.2Serbian RadicalParty (SRS) 7.2Serbian RadicalParty (SRS) 7.2Serbian RadicalParty (SRS) 7.2

Serbian DemocraticParty (SDS) 54.2

Alliance for Peaceand Progress 12.0Alliance for Peaceand Progress 12.0Alliance for Peaceand Progress 12.0

Serbian RadicalParty (SRS) 7.2


Alliance for Peaceand Progress 12.0

Party of DemocraticAction (SDA) 16.9

Party of DemocraticAction (SDA) 16.9

Others 9.6


Serbian RadicalParty (SRS) 18.1

Socialist Party ofthe RepublikaSrpska 10.8

Serbian People'sAlliance 18.1Coalition for a

Single and DemocraticBiH19.3

Coalition for aSingle and Democratic

BiH19.3

Others 2.4

Party of IndependentSocial Democrats 2.4

Sep 1996Total seats: 83

Nov 1997Total seats: 83



the Yugoslav president, Slobodan Milosevic, but having failed to receive parlia-ment’s endorsement, he resigned his mandate on January 16th.

Milorad Dodik

A businessman from north-west Bosnia, Mr Dodik made money during the warexporting timber to Serbia and importing fuel and coffee. He has been a notableopponent of the nationalist RS authorities for the past couple of years. During thewar he was one of a handful of RS politicians who were in contact with theircounterparts in the Federation, and he was chairman of the Club of IndependentDeputies in the RS Assembly. He has been involved in the shadow government, agrouping of opposition politicians in both entities opposed to the narrowlynationalistic policies of the hitherto ruling parties. He now leads the small Party ofIndependent Social Democrats.

Mr Dodik favours the implementation of the Dayton agreement for BiH. As such, hiscredentials as a true moderate are much more genuine than those of Mrs Plavsic, astaunch nationalist who, until she became estranged from other SDS leaders lastyear, was a loyal follower of Mr Karadzic and a firm supporter of the SDS’s wartimepolicies. Mr Dodik is regarded as a pragmatist, but his record demonstrates agenuine aversion to the violently exclusive nationalism which has dominated RSpolitics until now.

Mrs Plavsic next nominated the leader of the small Party of Independent SocialDemocrats. Milorad Dodik, a long-standing moderate who had opposed thenationalistic policies of the wartime leadership, secured parliamentary en-dorsement of his nomination on January 17th, relying on the support of theMuslim and Croat representatives of the Coalition for a Single and DemocraticBiH. Outraged, the SDS and SRS stormed out of the Assembly before the votewas taken. Mr Dodik’s new government does not include any SDS, SRS mem-bers or Muslim or Croat members.

—signalling a majorshake-up in RS politics

Mr Dodik quickly announced that the seat of government would be movedfrom Pale, a village close to Sarajevo, in the eastern half of the RS, where theSDS-hardliners are based, to the politically more moderate Banja Luka. SDS andSRS leaders initially insisted that the new government was illegitimate and thatthey would not recognise it. Warning that the new government would lead toa final split in the RS, SDS and SRS deputies threatened to hold a parallelparliamentary session on the same day as the meeting of the official parlia-ment. However, as the Belgrade authorities welcomed Mr Dodik’s appoint-ment, the SDS backed down. The outgoing prime minister, Gojko Klickovic,announced that he would hand over peacefully to Mr Dodik, and at a meetingin Banja Luka on January 24th the Assembly speaker, Dragan Kalinic, agreedwith Mrs Plavsic that a full session of the new parliament would go ahead. Itwas further agreed that the session would be held in Banja Luka, which the SDShad initially resisted.

Mr Dodik faces severe challenges in his attempt to assert his authority over thewhole RS territory, and his opponents will try to thwart him. Nevertheless, hisappointment marks an extraordinary break for the RS and for BiH as a whole.



Mr Dodik, the first BiH leader not to come from one of the wartime nationallybased parties, has signalled his intention to implement the Dayton agreement,to shake up government, root out corruption and press ahead with economicreform. He has moved to block former ministers’ access to state funds andinsisted that all government records be handed over to the new ministers. Hehas sacked several officials in the customs service and the police, as well as thedirectors of state-owned utilities and other state-owned companies and theeditor of the state-owned daily, Glas Srpski. Taking control of customs posts—and the funds they collect—is also one of Mr Dodik’s priorities. He has en-dorsed moves aimed at reintegrating BiH, such as the introduction of commonpassports, a common currency and common vehicle licence plates, and haspromised to ease the return of refugees to the RS.

International support ispromised

After the long experience of obstruction by the RS leaders to the implement-ation of Dayton, international officials are determined to give Mr Dodik everysupport in facing down his hardline opponents. Because of its leaders’ lack ofco-operation in implementing Dayton, the RS has so far received much less aidthen the Federation. Economic aid is now vital to the new government in itsefforts to consolidate its position, demonstrating to the population that co-operation with international demands brings rewards. The EU moved quicklywith Ecu6m ($6.7m) for the payment of back wages to public servants such asthe police and teachers. The World Bank has promised aid for reconstructionand the repair of the power and water utilities.

Mr Westendorp’s powersare increased—

At the meeting of the Peace Implementation Council on December 9th-10th inBonn, the powers of the international high representative for BiH, CarlosWestendorp, were increased to allow him to impose binding decisions in caseswhere the leaders of BiH’s three constituent nations are unable to reach agree-ment. Thus he will be able to impose the decisions needed to establish theinstitutions of a functioning state, as required by Dayton. Mr Westendorp wasalso empowered to punish officials who block the functioning of joint institu-tions or who violate Dayton.

—and he quickly uses them Mr Westendorp has not hesitated to use his new powers. In a number of caseshe has imposed, or threatened to impose, decisions, and he promptly threat-ened to sack Mr Krajisnik unless he becomes more co-operative. Progress inestablishing joint institutions and advancing reintegration has been made inthe following areas.

• After Serb deputies in the BiH parliament repeatedly rejected citizenship andcommon passport laws which failed to recognise a dual citizenship agreementbetween the RS and Yugoslavia that the international community regards asinvalid, Mr Westendorp imposed the laws on December 16th.

• At the end of December he threatened to impose a common design forvehicle licence plates unless agreement was reached by the end of January. Thismeasure is regarded as crucial in anabling freedom of movement. Mr Dodikreached agreement with his Federation counterparts on January 23rd.



• When an end-December deadline for agreement on a new BiH flag went bywithout a decision, he appointed a committee of intellectuals to make recom-mendations to him by mid-February.

• Early in January he threatened to take “appropriate measures” if an RSgovernment was not quickly appointed. Mrs Plavsic took this as a threat thathe himself would appoint a prime minister.

• In mid-January, after heavy international pressure, the joint presidencyagreed on the appointment of 32 new ambassadors, but failed to agree on anambassador to the United States.

• In January Mr Westendorp imposed a design for the new common currency(see Economic policy).

Mr Westendorp’s readiness to use his extended powers may persuade repre-sentatives of the three constituent peoples that co-operation is in their interestif they wish to retain control of their own affairs.

US troops may stay longer The US president, Bill Clinton, visited American troops in Bosnia in December.Shortly before his departure he stated for the first time that a continued USpresence, as part of the NATO-led force in BiH, would be required beyond theend of the current mandate in June. He noted the vital role of the NATO forcein building and preserving peace. He added that the force would probably bescaled down, but that it would still be capable of defending itself. Crucially hesaid that, in contrast to previous mandates, while the mission should have cleargoals, it should not have a deadline for withdrawal. NATO is considering thefuture of the force in BiH and has various options. President Clinton’s com-ments weigh powerfully in favour of the continued presence of a substantialforce. The US decision is key. Both the UK and France, the other leading powersin the force, have indicated that if US forces were withdrawn, theirs would go aswell. In addition, a leading US role has proved vital in giving the militarypresence and international efforts credibility among the Bosnian parties.

There has been great reluctance in the US Congress and within the adminis-tration—notably on the part of the defence secretary, William Cohen—toextend the mandate. Mr Clinton may have a difficult task persuading oppo-nents of an extension to accept his view. He has tried to assuage doubts bycalling on European countries to take on a greater share of the burden and bypointing out the successes of the force’s more robust stance in 1997. These haveincluded the prising away of media control from hardline opponents ofDayton in the RS and helping to bring moderates to power there; NATO troopshave made the first arrests of suspected war criminals; and the establishment ofjoint institutions has been speeded up. Such achievements would probably belost if the NATO force were to be withdrawn prematurely.

The future of Brckoremains contentious

Arbitration on whether the disputed town of Brcko will be in the RS or theFederation is due by March 15th. The town is strategically vital, lying in thecorridor which links the eastern and western halves of the RS. It was the oneoutstanding issue left to be settled at the time of the Dayton agreement, and adecision on its future was again postponed in February last year. After that, aninternational supervisor for Brcko, Robert Farrand, was appointed, with the



task of promoting the town’s recovery and facilitating the return of Muslimand Croat refugees before a final decision is taken (2nd quarter 1997,pages 11-12). Mr Farrand’s mission has scored notable successes in a number ofareas. A multi-ethnic local government and judiciary have been set up, and atthe beginning of January a multi-ethnic police force began to operate—success-fully, according to Mr Farrand.

However, the key issue of the town’s disposition remains extremely divisive.The successful implementation of many of the special provisions for Brckoprobably reflects the fact that compliance with Mr Farrand’s decisions is likelyto weigh heavily when the final decision is made. Both entities consider Brckoto be of vital strategic importance. There were rumours at the beginning of lastyear that Brcko was to be granted to the RS, before vigorous Muslim objectionsled to the decision’s postponement. The Serb claim is based on the absoluteneed for the RS to be united, while the Muslims base their claim on the factthat Serbs were a minority in the town before the war, so that awarding it to theRS would reward “ethnic cleansing”. Mrs Plavsic repeated in January that Brckomust be awarded to the RS, or else Dayton will be dead. On this issue Mr Dodikis in agreement with Mrs Plavsic, and he announced shortly after the confirma-tion of his appointment that a government session would be held in Brcko,reinforcing the RS’s claim.

Tensions ease in theFederation

Progress has been made recently in establishing functioning local authorities incities which have witnessed disputes between the Federation’s Muslim andCroat partners. After nearly two years of stalemate, Rasim Gacanovic of theleading Muslim party, the Party of Democratic Action (SDA), was elected mayorof Sarajevo on January 8th; his deputy is Ante Zelic of the main Croat party, theCroatian Democratic Union. Agreement had been held up by the SDA’s unwill-ingness to share power in the capital.

In the divided city of Mostar, the scheduled rotation of the office of mayorproceeded peacefully in early December, as the former deputy mayor, SafetOrucevic, a Muslim, became mayor, and the former mayor, Ivan Prskalo, aCroat, became deputy mayor. In Mostar county, too, a Muslim-Croat balancewas maintained, as a Croat, Zelko Obradovic, became mayor, and Fatima Leho,a Muslim, became his deputy. However, this apparent observance of the prin-ciple of power-sharing has so far not brought about a real unification of the city.

There is no agreement onthe entities’ constitutions

The Bonn conference underlined the international commitment to BiH as asingle state with two multi-ethnic entities. However, the conference did notbring about progress in harmonising the constitutions of the two entities withthe constitution of BiH so that the three constituent nations can be recognisedas such in each entity. According to Dayton, this should have been donewithin three months of the signing of the peace agreement. However, nat-ionalist opposition to this change remains strong: in Bonn, the Bosnian Croatsrefused to give their support.



Economic policy

A new currency design isimposed

Mr Westendorp used the new powers granted to him in Bonn to imposedesigns for the new common currency, the convertible marka (KM). Althoughthe marka is already legal tender, banknotes have not yet been issued becauseof a long-standing dispute over their design—the Bosnian Serbs and theBosnian Croats wanted designs incorporating their national symbols. To breakthe impasse, Mr Westendorp presented the new designs, which include nonational symbols, on January 21st. They feature prominent Bosnian writersand poets, are in both the Latin and Cyrillic scripts, resemble the D-markbank-note designs and are slightly different in the two entities (although all arevalid throughout the country). It is expected that the notes will be ready byApril.

The new currency should encourage trade across the country (until now theD-mark has been the only common currency), and it is hoped that it willgradually replace the other currencies in circulation: the Croatian kuna, theYugoslav dinar and the Bosnian dinar (BiHD). Banks holding assets and liabil-ities in Bosnian dinars (which have been used in Muslim-controlled areas) hadto denominate them in markas by August 1st 1997, at a rate of BiHD100:KM1.The 1997 BiH budget was also calculated in markas.

The marka will follow a currency board regime, backed up by D-mark reserves.It is intended to be an interim currency while a permanent arrangement isdrawn up over the next 18 months.

Agreement with theLondon Club is finalised—

Agreement with the London Club of commercial creditors was finalised inDecember 1997, following an agreement in principle reached in June (3rdquarter 1997, page 13). The total London Club debt stands at $394m—downfrom the $404m agreed in June due to exchange-rate movements. Of the total,$147.8m is to be paid over 20 years, after a seven-year grace period. Repaymentof the remaining $246.2m is to begin once BiH’s GDP reaches an annual levelof $2,800 per head for two consecutive years—GDP per head was estimated ata little over $800 in 1996.

Negotiations with the Paris Club should follow once a deal with the IMF isreached. The IMF has made its $100m stand-by facility conditional on agree-ment on the implementation of a series of measures to establish functioningcentral state institutions: the central bank; the state budget; arrangements forrepaying debt to the World Bank; and a joint currency.

—but servicing foreigndebt is problematic

Establishing a mechanism for meeting other foreign debt obligations is a prior-ity in drawing up the 1998 state budget. External debt servicing has proved tobe a problem. The state of BiH is the sole guarantor of the country’s foreigndebt, but it has no independent source of revenue and is dependent on contrib-utions from the two entities. An ad hoc debt-servicing arrangement wasworked out in 1997, but the delay in settling the country’s obligations held upaid from the World Bank and other international organisations (3rd quarter1997, page 13). The World Bank recently delayed the approval of a $27m loanfor reconstruction of the Federation’s gas system and for several projects in theRS until the RS had paid the IMF an outstanding $288,000. The uncertainty



regarding the country’s ability to meet its foreign obligations is harmful to itscredibility and detracts from its appeal to potential foreign investors.

A new law enablesprivatisation to proceed—

After several months’ delay, the Federation parliament passed a law in Januaryfacilitating the valuation of enterprises and banks prior to privatisation and sale(4th quarter 1997, page 15). This legislation was needed to get the privatisationprogramme under way, as a prerequisite for the arrival of significant foreigndirect investment. Preparation of the law, which was drafted in December, hadcaused fierce disagreement between the Federation partners. According to thelaw, old debts are to be transferred from the banks to the finance ministry. TheBosnian Croats claimed that this would place a disproportionate burden onCroat taxpayers, alleging that the larger portion of the debt would be transferredfrom enterprises in territories with a Muslim majority.

In the meantime there have been reports of secret privatisation deals goingahead in some parts of the Federation. This has been possible because there isstill no unified legal system and powerful local figures continue to deny theFederation’s authority. Such deals will complicate the implementation of theprivatisation programme once it gets under way.

—and bank restructuringgets under way

A bank privatisation law has also been framed for the Federation, providing forinsolvent banks to be closed down and for others to be prepared for privatis-ation. The law envisages the creation of a team within the finance ministry,including international experts, to oversee the bank privatisation process. Ithas recently been announced that one of the largest state-owned banks oper-ating in the Federation, Privredna banka, is to be liquidated. While the state-owned banks continue to struggle with the burden of non-performing assets,smaller private banks have on the whole done better. However, they are not yetcapable of supplying credit on the scale that the economy needs.

In an effort to strengthen the sector as a whole, the European Bank forReconstruction and Development (EBRD) has recently bought a stake in anumber of private banks in both entities and, together with the World Bank’sInternational Finance Corporation, set up a micro-Credit Bank to stimulatemicro- and small businesses.

The economy

GDP growth is slowerthan expected

According to the latest World Bank estimates, real GDP grew by 35% in 1997,following growth of 50% in 1996. The official estimate of the FederationStatistics Bureau puts 1997 GDP growth in the Federation at 37%, while thefigure for the RS is not available. These estimates need to be interpreted withconsiderable caution. GDP figures are very tentative and have been subject tosubstantial revision. Figures provided at the entity level are based on differentmethodologies, and the coverage is patchy; in both entities much activity goesunrecorded. The World Bank estimate for 1996 used as a starting point officialreal GDP growth figures of 55% for the Federation and 19% for the RS. How-ever, the official estimate for the Federation has recently been revised down to30%. On the basis of this figure, a 1996 real GDP growth figure for the countryas a whole might be around 28%.



The Word Bank’s initial projection of 1997 growth was based on the assump-tion that substantial amounts of donor aid would be flowing steadily into theeconomy, so that BiH would reach its pre-war GDP level by 2002. Economicrecovery still depends largely on the injection of international aid. However,the release of donor funds, which have largely been aimed at the rebuilding ofinfrastructure, has been impeded by political obstacles, thus slowing down therecovery process. In the absence of more concrete information, the WorldBank’s estimates remain the best available. However, it is probable that the earlyWorld Bank projection of 1997 GDP growth will be revised downwards. Theofficial estimate of 1997 GDP growth in the Federation stands at 37%, but it seemslikely that this will be subject to a downward revision, as with the 1996 figure.

Recovery has mainly been driven by reconstruction-related activities, com-bined with a slow recovery of local industry. Industries requiring relatively lowcapital investment (such as textiles, footwear and food processing) and thoseusing local inputs (such as wood processing) have grown most strongly.

Industrial output picks upin the Federation—

In the Federation, official figures recorded a pick-up in industrial outputgrowth in the second half of 1997, after a disappointing performance and sharpfluctuations earlier in the year. Industrial output in 1997 was 35% up on 1996,and at the end of the year amounted to about 20% of the Federation’s 1991level. In September 1997 the industries that currently constitute the backboneof BiH’s industrial activity—electrical power, mining, construction material,food processing and textiles—reached around 40-50% of their average 1991output. As reconstruction-related activities picked up in the course of the year,following the delayed third donors’ conference in July (4th quarter 1997, pages13-14), so did output in the Federation’s construction sector.

BiH Federation: industrial output, 1997(% change)

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Month on month –3.3 –3.9 12.3 –7.5 –1.3 10.9 –10.6 10.1 5.9 7.2 0.3 9.5

Year on year 66.7 42.2 52.9 38.6 33.6 40.5 13.4 28.7 29.5 35.8 29.3 27.9Source: The Statistics Bureau of the BiH Federation.

—and in the RepublikaSrpska

A similar pattern of fluctuating industrial output, with an improved perform-ance in the second half of 1997, was reported in the RS. The highest increasesin the third quarter were recorded in the textiles, chemicals, and leather andfootwear industries. However, it is not clear to what extent these data reflectreal changes in production levels rather than problems with data collection,which appear to be particularly serious in the RS.

Wages growth hasslowed—

After strong growth in 1996, wages in both entities grew at a much lower ratein 1997. From January to September 1997 wages in the RS and the Federationgrew by 10% and 13% respectively. The level of wages is low by any measurethroughout the country. In addition, especially in the RS, wages are paid irregu-larly and with long delays. Strike activity by workers in both industry andservices has risen in areas of the Federation with a Muslim majority and in theRS. Areas of the Federation with a Croat majority continue to have the highestwages in the country.



BiH Federation: average net monthly wages, 1997(KM)

Jan Feb Mar Apr May Jun Jul Aug Sep

238 244 251 258 261 258 267 268 270Source: The Statistics Bureau of the BiH Federation.

—and employment levelsremain low

Official figures show that employment in the Federation was fairly staticthroughout most of 1997. Oscillations in the employment figures are also con-nected with the flow of foreign aid. There was a slight pick-up in September, to339,792—a marginal increase on the peak in employment recorded inNovember 1996. Sectoral movements in employment levels are difficult to iden-tify, as statistics are not available for the whole territory of the Federation.

BiH Federation: employment, 1997


338,181 338,681 337,860 336,030 336,876 337,273 337,384 337,431 339,792Source: The Statistics Bureau of the BiH Federation.

Official 1997 employment figures for the RS are unavailable. According to oneunofficial local estimate, the total number of employed in the RS was around170,000 last year, which is lower than the official December 1996 figure of193,574. According to the same source, the number of unemployed in 1997was around 200,000—much higher than the latest officially reported figure.Official figures show unemployment in the RS increasing steadily during theyear, from 121,306 in January to 142,699 in September.

The number of people working in the grey economy is believed to be signif-icant in both entities. However, even taking that into consideration, given theslow process of job creation, the unemployment rate for BiH as a whole may beas high as 50%.

Republika Srpska: unemployment, 1997


121,306 134,812 133,387 138,435 138,335 139,143 140,781 141,633 142,699Source: The Republika Srpska Statistics Bureau.

The inflation rate remainssteady

In the Federation, following a sharp 1.7% month-on-month increase inSeptember, caused by a 6% rise in prices for imported food products, the rate ofretail price inflation slowed in the fourth quarter. January-November retailprices were up by 12% year on year. Data from the Central Bank of BiH, whicheffectively cover only areas under Muslim control, where the Bosnian dinarcirculates, indicate that a fairly tight monetary policy was pursued in both 1996and 1997, keeping inflation under control. A World Bank representative in BiH,Graeme Hunter, recently commented that prices are fairly stable given the con-ditions in Bosnia, and he said that the risk of higher inflation was low.

In the RS, after an increase at the beginning of 1997, growth in retail pricesslowed, with most prices stable during the rest of the year. Services prices,which increased by almost 10% between June and September 1997, were anotable exception.



BiH Federation: consumer prices, Jan-Nov 1997(% change, year on year)

Total 12.4

Food (total) 6.5

Agricultural products 18.9

Industrial food products 3.5

Industrial non-food products 4.5

Beverages –8.6

Tobacco –5.1

Services 43.4Source: The Statistics Bureau of the BiH Federation.

Foreign trade data areincomplete

Great caution needs to be exercised when interpreting the available foreigntrade statistics. Reliable data are lacking and the country’s division along ethniclines means that the territorial coverage of the collected data is incomplete. Inaddition, given the country’s porous borders and the extent of unreportedtrade, only a fraction of the actual foreign trade transactions is captured. TheWorld Bank provides the best possible estimates in the circumstances, andaccording to its figures, exports from the Federation in 1996 were, at $336m,twice the officially reported figure.

The trade deficit hascontinued to widen

The locally produced official figures can do little more than provide a very roughindication of trends. These suggest that the volume of trade continued toincrease in 1997, but at a slower rate than in 1996. Decelerating growth ineconomic activity in 1997 appears also to have been reflected in slower importgrowth. However, given that export growth appears to have remained verymodest, the trade deficit will have continued to widen. According to officialdata, food and beverages accounted for over one-quarter of the Federation’s totalimports, followed by manufactured metal products, chemicals and machinery.Wood products, iron and steel, transport equipment and manufactured metalproducts accounted for over 60% of total exports. The official figures show aslight shift in the territorial composition of foreign trade in 1997, with Italyovertaking Croatia as BiH’s most important trading partner. This should betreated with caution, however, as there is much unrecorded crossborder tradebetween Croatia and the Croat-controlled areas of the Federation. BiH officialswould like to diversify the country’s trade away from the strong bias towardsCroatia; they have voiced dissatisfaction with the higher costs of imports chan-nelled through Croatia, as well as with the discrimination shown by Croatiatowards BiH’s main exports, such as salt, timber and wood products.

1997 current-account dataare unavailable

World Bank estimates of the current-account balance are the best available andshow a rapidly widening deficit in 1996, up to $1.6bn from $134m in 1995.The central bank has begun to produce current-account information, althoughit faces the same problems as the Federation’s Statistics Bureau in collectingreliable data. The widening of the current-account deficit is likely to haveslowed in 1997, as import growth has decelerated owing in part to delays earlierin the year in foreign inflows. It is likely to widen as economic activity picks upin 1998. For the time being it will be financed by donor loans, but the extentof the deficit will become more of a concern in the medium term if exports donot start to pick up to close the gap.



Croatia

Political structure

Official name Republic of Croatia

Form of state Democratic republic

Legal system Based on constitution of December 1990, amended in 1992

National legislature There is a bicameral parliament (Sabor): the lower house is the Chamber ofConstituencies (Zastupnicki dom); the upper house is the Chamber of Regions(Zupanijski dom)

National elections October 1995 (Chamber of Constituencies); April 1997 (Chamber of Regions) and June1997 (presidential); next elections due by the end of 1999 (Chamber ofConstituencies), by 2001 (Chamber of Regions) and by June 2002 (presidential)

Head of state President of the republic, currently Franjo Tudjman, last elected June 1997

National government Appointed by the president and confirmed by parliament. There is currently asingle-party (Croatian Democratic Union) government, appointed on November 7th 1995

Main political parties Croatian Democratic Union (HDZ); Social Democratic Party of Croatia (SDP; formercommunists); Croatian Social Liberal Party (HSLS); Croat Peasant Party (HSS);Independent Democratic Serb Party (SDSS); Istrian Democratic Parliament (IDS);Liberal Party (LS)

Leading members of thegovernment

Prime minister Zlatko MatesaDeputy prime ministers Jure Radic; Mate Granic;

Borislav Skegro; Ivica Kostovic; Ljerka Mintas Hodak

Key ministers Agriculture & forestry Zlatko DominikovicCulture Bozo BiskupicDefence Gojko SusakDevelopment & reconstruction Jure RadicEcology, construction & housing Marko SiracEconomy (industry, shipbuilding & energy) Nenad PorgesEducation & sport Ljilja VokicFinance Borislav SkegroForeign affairs Mate GranicHealth Andrija HebrangImmigration & repatriation Marijan PetrovicInternal affairs Ivan PenicJustice Miroslav SeparovicLabour & social welfare Joso SkaraLocal government Davorin MlakarPrivatisation Milan KovacScience & technology Ivica KostovicTourism Sergej MorsanTransport, shipping & communications Zeljko Luzavec

Central bank governor Marko Skreb

20 Croatia


Economic structure

Latest available figures

Economic indicators 1993 1994 1995 1996 1997a

GDP at current prices ($ bn) 11.7 14.2 18.1 19.1 18.5

Real GDP growth (%) –0.9 0.6 1.8 4.3 5.3

Retail price inflation (av; %) 1,518 98 2.0 3.5 3.6b

Population (m; mid-year) 4.64 4.65 4.67 4.49 4.5

Exports fob ($ m) 3,904 4,260 4,633 4,512 4,500

Imports cif ($ m) 4,666 5,229 7,510 7,788 8,700

Current account ($ m) 104 103 –1,712 –1,452 –1,600

Total external debt ($ m; Dec) 2,523c 2, 995c 3,662c 4,847 6,000

Government balance (% of GDP) 0.2 0.6 –0.9 –0.1 1.0

Foreign exchange reserves ($ m; Dec) 617 1,410 2,036 2,440 2,650

Exchange rate (av; HRK:$)d 3,577 5.99 5.23 5.43 6.10b

January 30th 1998 HRK6.44:$1; HRK3.52:DM1

Origins of gross domestic product 1996 % of total

Agriculture, forestry & fishing 10.2

Manufacturing & mining 20.3

Construction 3.2

Trade, tourism & catering 20.4

Transport & communications 6.4

Crafts, services & others 39.5

Total 100.0

Principal exports 1996 % of total Principal imports 1996 % of total

Chemicals 15.1 Chemicals 12.9

Textiles products 14.5 Electrical equipment 10.4

Shipbuilding 9.0 Machinery & engineering 10.0

Food products 7.6 Petroleum products 9.5

Total incl others 100.0 Total incl others 100.0

Main destinations of exports 1996 % of total Main origins of imports 1996 % of total

Italy 21.0 Germany 20.6

Germany 18.6 Italy 18.2

Slovenia 13.5 Slovenia 9.9

Bosnia and Hercegovina 12.2 Austria 7.7

Austria 4.4 UK 2.9

Russia 2.9 US 2.7

a EIU estimates. b Actual. c These figures do not include the $1.45bn Croatian share of unallocated debt inherited from former Yugoslavia. d OnMay 31st 1994 the kuna (HRK) was introduced, worth CRD1,000. The 1994-97 figures are HRK:$; the figure for 1993 is CRD:$.

Croatia 21


Outlook for 1998-99

Vulnerability tointernational pressure

remains

In an end-of-year interview the foreign minister, Mate Granic, said that follow-ing the reintegration of Eastern Slavonia, the last Serb enclave in Croatia (seeThe political scene), concrete progress could be expected in moving towardsintegration in international structures such as NATO, the EU, the CentralEuropean Free Trade Agreement (CEFTA) and the World Trade Organisation(WTO). Western integration remains Zagreb’s key foreign policy objective, butit is likely to face continuing international suspicion. Croatia’s behaviour willcontinue to be closely monitored, especially regarding the following issues:

• its policy towards Bosnia and Hercegovina (BiH)—Zagreb’s proposals forspecial ties with the BiH federation (4th quarter 1997, page 26) are regardedwith considerable suspicion;

• the treatment of its Serb minority, including the extent to which Serb refu-gees are able to return to their homes; and

• the treatment of the independent media and non-governmental organis-ations in Croatia (see The political scene).

It remains to be seen how successfully Croatia can reintegrate Eastern Slavonia,but hopes of early progress towards an EU association agreement or joiningNATO’s Partnership for Peace (PfP) programme are likely to be disappointed.The NATO supreme commander, General Wesley Clark, was non-committal onCroatia’s PfP prospects during a meeting with the defence minister, GojkoSusak, in January, stressing that Croatia needed to fulfil its obligations underthe Dayton agreement for BiH first. The government has high hopes of joiningCEFTA this year, but the reservations of some CEFTA members, in response tothe tougher stance on Croatia adopted by international organisations andother governments since early 1997, casts doubt on this. WTO membershipthis year is a more realistic goal.

The political scene willbecome more focused—

A trend in which the political scene becomes more focused, with one mainopposition party on the left—the former communist Social Democratic Party ofCroatia (SDP)—competing with the ruling Croatian Democratic Union (HDZ)is likely to continue (see The political scene). Other opposition parties will playa more modest role on the political stage. Following the split in the CroatianSocial Liberal Party (HSLS), the newly formed Liberal Party under the formerHSLS leader, Vlado Gotovac, is unlikely to make a big impact; the continuingHSLS under its new leader, Drazen Budisa, has damaged its credibility as a resultof its recent disarray and in-fighting, and has ceded its place as the mainopposition party to the SDP. Prospects of co-operation among the oppositionparties are circumscribed by the refusal of the Croat Peasant Party to counte-nance any co-operation with the SDP.

—as the HDZ seeks todefine its profile

The HDZ convention, which was postponed from November (4th quarter 1997,page 25) has been scheduled for mid-February. The convention is expected tointroduce a new programme designed to adapt the party’s profile to normal,peace-time conditions. It is also expected to make leadership changes. Variousfactions and personalities within the party have been jockeying for position for

22 Croatia


some time, and the party is anxious to avoid any public show of disunity. Anyleadership changes will indicate the party’s likely future direction.

Analyses of internal HDZ politics have tended to concentrate on a strugglebetween two wings: a moderate, technocratic wing which, with the support ofthe president, Franjo Tudjman, has consolidated its position since the end ofthe war; and a hardline, nationalist right, which is committed to supportingBosnia’s Croats and resists compliance with international demands. However,it has become increasingly apparent that this characterisation is too simplistic.

Hardline HDZ nationalistshave few prospects

As the war has receded, the hardline wing has increasingly lost its purpose,although it retains strong support in the party. Its former leading exponent,Gojko Susak, is ill and has softened his nationalist stance, perhaps in order tobroaden his base in the HDZ; the prospects for the other leading figures on theright have faded over the past year.

The technocratic wing includes several politicians, notably Hrvoje Sarinic,whose powerbase is within the presidential administration, who have no inde-pendent powerbase in the party and whose influence depends almost solely onthe support of the president. For the moment Mr Tudjman’s health appears tobe holding out, despite persistent rumours that he has terminal cancer and ismerely in a period of remission. As long as he is in control, the practice ofbalancing different groupings within the HDZ is likely to continue.

However, at least two figures with strong political support in their own righthave emerged who may compete for the Tudjman succession over the comingyear: the foreign minister, Mate Granic, and the president’s adviser on internalaffairs, Ivic Pasalic. Both are relatively moderate, and both want to transform theHDZ into a modern, democratic party, as opposed to the broad political move-ment it has been under Mr Tudjman. Mr Granic is more inclined to co-operatewith the international community in order to advance Croatia’s integrationinto Western structures, while Mr Pasalic favours a somewhat more assertivedefence of Croatian national interests. Mr Granic is popular in the country atlarge and highly regarded abroad, while Mr Pasalic is stronger within the HDZ.

Thus the key contest in the battle for the HDZ succession is no longer likely tobe between moderates and hardliners. While breakaways cannot be ruled outduring the process of adjustment, a more focused right-of-centre political partyis likely to emerge as Mr Tudjman’s rule draws to a close.

A turbulent 1998 is inprospect

The introduction of a 22% value added tax (VAT), replacing the turnover tax atthe beginning of January, is one factor making for an uncertain and potentiallyturbulent year for the economy. It will affect the economy in various ways.Prices will rise initially but may fall later. Imports will be made more expensive,reducing the trade deficit, but higher prices might have a negative impact ontourism, reducing services income. As VAT will be charged to public institu-tions on goods and services which were previously exempt from tax, the appar-ent increase in the budget in line with GDP growth masks a substantial fiscalcontraction in real terms, but a budget based on an unrealistically low inflationforecast might prove difficult to implement.

Croatia 23


Inflation is likely to rise An initial boost to inflation from the introduction of VAT in January is ex-pected, but the government argues that ultimately the tax should not be infla-tionary and that the elimination of the turnover tax should bring a fall inprices (see The economy). Thus, the authorities maintain, inflation of aroundthe 1997 level of 3-4% should be achieved this year too. The EIU expects thatafter an initial sharp rise in prices in January things will settle and that pricesmight fall back a little later in the year. However, the impact of January’s pricerises has led us to raise our forecast for average inflation in 1998 to 6%. Giventhe expectation of a continued tightening of economic policy this year, weexpect that inflation will fall in 1999 to an annual average of 4%.

The currency outlook isuncertain

The outlook for the kuna remains uncertain. The widening current-accountdeficit, combined with the real appreciation of the kuna in recent years, makesa devaluation this year a distinct possibility. Although the kuna is largelyshielded from outside speculative attacks (see Foreign trade and payments), therising pressures on exporters and on the tourism industry owing to the over-valued kuna may make devaluation unavoidable, no matter how firm thegovernment’s denials. While formally the central bank allows the value of thekuna to be determined by the market (ie by commercial banks), its influence insetting the exchange rate is considerable. Safeguarding the value of the kuna isa key feature of the government’s policy of maintaining macroeconomic stabil-ity, and it would be extremely reluctant to abandon it. However, intensifyingdiscussions about a possible devaluation in January 1998, with a succession ofstatements from key officials denying that such a step was imminent, point tothe politicisation of exchange-rate policy and the pressure on the authoritiesfrom key lobbies.

Tighter monetarydiscipline is expected—

The tightening of monetary policy towards the end of 1997 (see Economicpolicy) is expected to continue, as the authorities seek to dampen consumptiongrowth, reduce imports to narrow the current-account deficit, and counterinflationary pressure associated with the introduction of VAT. The governmentregards such a policy as more effective in tackling the external imbalance thana currency devaluation. The widening of the trade deficit is expected to slowover the next two years, while the continued recovery of the tourism sector willincrease invisible income, causing the current-account deficit to narrow. How-ever, even if imports for consumption are scaled back over the next two years,demand for imports will be spurred by an increase in the demand for importedcomponents, materials and investment goods as industry is privatised andforeign direct investment picks up. At around 7-8% of GDP the current-accountdeficit will remain a cause for some concern. Tighter policies may also lead to afurther appreciation of the kuna, placing more pressure on exporters and pro-viding a stronger argument to those who say that the kuna is overvalued andthat an adjustment is due.

—which will dampengrowth somewhat

The predicted tighter monetary policy will contribute to a slowdown in the rateof real GDP growth this year. The knock-on effects of the Asia crisis have alsoled us to be more circumspect about global prospects and to lower our growthforecast for the EU to 2.6% per year in 1998-99. The poorer prospects forCroatia’s key European markets may result in lower exports and reduced for-

24 Croatia


eign direct investment in Croatia. Following estimated real GDP growth of5.3% in 1997, we have revised down our forecast of 1998 GDP growth to 4.2%.Industrial output, which began to pick up significantly only last year, willcontinue to grow strongly. Following the reintegration of Eastern Slavonia, andthe need for reconstruction that this brings, the construction boom is expectedto continue apace. The services sector, especially tourism, is forecast to con-tinue its strong expansion of the past two years.

These sectoral trends are expected to continue into 1999, with services drivingthe economic recovery. Growth in both industry and services will be sustainedby productivity and investment gains from newly privatised and restructuredindustries. Tighter policies are expected to lead to a slowdown in the rate of realwages growth in 1998-99, but private consumption will remain buoyant. Fixedinvestment growth will be spurred by post-war reconstruction and the re-equipment of privatised enterprises by domestic and foreign investors.Croatia’s prospects for continued strong growth of around 5% in 1999 thusappear fairly solid.

Croatia: forecast summary(% change year on year unless otherwise indicated)

1996a 1997b 1998c 1999c

Real GDP 4.3 5.3 4.2 5.0

Gross industrial production 3.1 6.8a 5.5 5.0

Retail prices (av) 3.5 3.6a 6.0 4.0

Merchandise exports fob ($ m) 4,512 4,500 4,850 5,300

Merchandise imports fob ($ m) –7,009 –7,800 –8,600 –9,200

Current-account balance ($ m) –1,452 –1,600 –1,500 –1,400

a Actual. b EIU estimates. c EIU forecasts.

0

1

2

3

4

5

6

1995 96 97(b) 98(c) 99(c)

Croatia

East Europe (a)

Croatia: gross domestic product% change, year on year

(a) Excluding former Soviet Union. (b) EIU estimates. (c) EIU forecasts.Source: EIU.

0

20

40

60

80

100

120

140

1995 96 97 98(c) 99(c)

Croatia

Eastern Europe (a)

Croatia: retail prices% change, year on year

Croatia 25


Review

The political scene

Eastern Slavonia revertsto Zagreb’s control—

Eastern Slavonia, the last Serb-controlled enclave in Croatia, formally passedinto Zagreb’s full control in January, after two years of UN control during whichthe region has been gradually reintegrated into Croatia. In a report in Octoberthe UN secretary-general, Kofi Annan, said that Croatia had not yet fulfilled allof its obligations towards the region’s Serbs, and that more needed to be donebefore he could recommend that the UN’s mandate be ended (4th quarter 1997,page 25). In December, however, Mr Annan recommended that the mandate beterminated as planned, paving the way for UN withdrawal. At the government’srequest, a UN civil police presence will be maintained for the time being in amonitoring role, but full responsibility for the further peaceful reintegration ofthe region has passed to the Croatian authorities.

—leaving significantremaining challenges—

The manner in which Croatia exercises control over the enclave is being closelywatched, and Croatia’s international standing depends in large measure onhow it copes with the remaining, considerable challenges. Key among these ismanaging the two-way return of refugees: Croats to Eastern Slavonia, and Serbsnow residing in Eastern Slavonia to other regions of Croatia from which theyare themselves refugees.

Some Croats have already returned to reclaim their homes, and there havebeen numerous instances of harassment, threats and even violence towards theSerbs currently living in them. There have also been instances of intimidationand violence against Serbs by Croats seeking revenge. After one Serb was shotdead, a Croat suspect was charged with murder; he had earlier been convictedof “endangering public safety with fatal consequences” after he threw a gre-nade into a cafe, killing another Serb. Since the region reverted to Croatiancontrol, several Croats have been arrested for violent attacks.

—as refugees begin toreturn

The authorities are under pressure to do all they can to prevent such occur-rences, and Zagreb has received international appeals to restrain the thousandsof Croat refugees from the region from returning at once, so that alternativeaccommodation can be provided for the Serbs currently occupying theirhomes, either in the region or in those parts of Croatia from which theyoriginally came. In order to return, Croat refugees are supposed to apply for a“green card” granting them the status of returnee. The government announcedin January that applications from 78,355 people wishing to return had beenreceived, 4,449 of whom had received the green card. However, some havereturned without waiting for the green card.

In early December reports of an increase in the number of Serbs departing fromthe region raised fears of a mass exodus of the type seen earlier in Bosnia andfrom the Croatian Krajina region. However, following the introduction of anew border control agreement between Croatia and Yugoslavia (Serbia andMontenegro) in the middle of that month, the numbers dropped; the UNreported that in many cases the head of the household remained while family

26 Croatia


members moved out. It appears that at present the majority of Serbs are waitingapprehensively to see how things develop, while Croat refugees, themselvesuncertain of the situation, prepare to return.

Some Serb refugees returnhome

Meanwhile, Serb refugees have slowly been returning from Eastern Slavonia tothe regions from which they fled, mostly during the Croatian military oper-ations of 1995. According to the government, applications have been receivedfrom 17,389 Serbs in Eastern Slavonia wishing to return home. The authoritiesin Karlovac recently reported that nearly 5,000 Serb refugees had returned totheir area, while the number of returnees in the Vojnic area was reported at alittle over a thousand. Some have come in organised returns, and the arrivalshave caused some strain, as in most cases Croat refugees from other parts ofCroatia and BiH are now in their former homes. Serb leaders in Croatia haveexpressed great dissatisfaction at the conditions in which many Serb returneesare living while waiting to recover their property. The test will be whether theirresettlement is given the same urgent attention as that of Croat refugees inEastern Slavonia.

The HSLS splits— On November 30th the long-standing conflict in one of the main oppositionparties, the Croatian Social Liberal Party (HSLS), finally came to a head as theparty’s congress elected Drazen Budisa as leader in place of Vlado Gotovac.Mr Budisa, who had led the party before Mr Gotovac, had been at loggerheadswith the departed leader for some time over the party’s direction: Mr Budisaasserts that while the HSLS, as an opposition party, will not make pre-electionpacts with the ruling Croatian Democratic Union (HDZ) at the national level,and will keep its options open after an election, at the local level pacts could bemade with the HDZ. Mr Gotovac has rejected any co-operation with the HDZ.Following his defeat, he announced hat he was leaving the HSLS to form a newparty, to be known as the Liberal Party.

—and the SDPstrengthens—

On the same day as the HSLS congress, a coalition (which included the HSLS) ledby the former communist Social Democratic Party of Croatia (SDP), emergedvictorious from repeat elections to the assembly of Primorsko-Goranja, whichincludes the city of Rijeka. It won 29 seats, compared with eight for the HDZ andallied parties. While the HDZ has in the past been relatively weak in Rijeka, thisresult was nevertheless a significant victory for the SDP.

The SDP has gained strength steadily since the parliamentary election ofOctober 1995. It has managed better than all the other parties to develop acoherent political stance adapted to the conditions of post-war political andeconomic normalisation. As a centre-left party it emphasises the social griev-ances of a population which has been impoverished (official data showunemployment in December at 17.6% of the workforce), while an elite close tothe HDZ has been enriched. Its support has been concentrated in the mainurban centres, including Zagreb, and until recently it had tended to be ass-sumed that its prospects would be limited because of its previous communistand Yugoslav associations. Indeed, as the other main opposition parties fellinto disunity and disarray, it appeared that the HDZ favoured a bipolaritybetween itself, perhaps with allied parties, on the right, and the SDP on the left,

Croatia 27


believing that because of its roots the SDP could not overcome a ceiling ofabout 20% of the vote.

—as Croatian politicsbecomes increasingly

bipolar

This analysis is now being called into question as the SDP’s electoral successescontinue and opinion polls show the popularity of its leaders, including IvicaRacan, Croatia’s last communist leader, to be high. As the war recedes intohistory, nationalism as a key factor determining voting patterns is becomingless important, while difficult social conditions are helping the SDP to presentitself as a plausible alternative to the HDZ. In addition, as the other mainopposition parties (notably the HSLS) lose credibility, the SDP is increasinglysuccessful at portraying itself as the principal party of opposition. The weeklycurrent affairs magazine Globus has speculated that the HDZ, recognising thegrowing threat from the SDP, has been courting former senior, but now polit-ically marginal, communists in an attempt to prise communist die-hards awayfrom the SDP. Mr Budisa, in an interview with Globus, acknowledged that theCroatian political scene has changed as the SDP has grown in strength, andthat the HSLS will not be able to regain the levels of support (up to around 25%of the vote) that it previously enjoyed.

The media and NGOs comeunder fire

The authorities have come in for new criticism over the treatment of theindependent media and non-governmental organisations (NGOs) in Croatia.On December 18th the European Parliament adopted a resolution condemningattacks on NGOs, media and their staff, through legal and other means, inCroatia. The move was partly in response to a draft law on humanitarianorganisations that could facilitate increased government interference in theactivities of NGOs which have been critical of the government, such as theOpen Society Institute.

The resolution also noted recent trials involving journalists at two independentweeklies, Feral Tribune and Globus. Legal proceedings against the editor andanother journalist of Feral Tribune were thrown out by the Zagreb MunicipalCourt in September 1996. They had been accused of defaming the president inarticles and a photo-montage which compared him to the former Spanishdictator, General Franco, and which condemned a government plan to burysoldiers of the second world war Nazi puppet state in Croatia alongside itsvictims at the former death camp at Jasenovac. However, following an appealby the state prosecutor, a new trial was ordered by a higher court and openedin December 1997. In another case, the editor of Globus, Davor Butkovic, isbeing sued by the entire cabinet for publishing a US report alleging govern-ment corruption. Mr Butkovic is also facing charges over an article claimingthat the HDZ has a blacklist of “state enemies”, including most senior oppos-ition politicians. The European Commission announced that it was suspendinga $2.4m technical aid package as an expression of dissatisfaction with Croatiaover its the harassment of independent media and NGOs.

Relations with Sloveniaand Bosnia are strained

Recent constitutional amendments (4th quarter 1997, page 26) have causedanger in Ljubljana and Sarajevo as a new list of Croatia’s minorities, whichincludes Serbs, Italians, Hungarians and other very small minorities, did notcontain either Slovenes or Muslims. Zagreb claimed that neither was an indige-nous minority, both having arrived in recent times, and asserted that Croatia’s

28 Croatia


international undertakings in any case included full respect for all minorities.The significance of the point lies in the heritage of Tito’s Yugoslavia, where thestatus of national groups was very precisely defined, so that any apparentdowngrading remains sensitive.

Relations with both Ljubljana and Sarajevo have often been difficult since theend of former Yugoslavia. The dispute with Ljubljana in particular could bedamaging, as Croatia needs Slovenia’s support in its efforts to integrate intowestern Europe, Zagreb’s key foreign policy goal. There were hints in Ljubljanathat the upgrading of transport links, which are important for Croatia’s tour-ism industry, might be delayed, while Slovene support for Croatia’s bid to jointhe Central European Free Trade Agreement (CEFTA) may be in doubt. Thislatest dispute has now been added to other, long-standing ones over Slovenesea access in the bay of Piran, the jointly owned nuclear plant at Krsko inSlovenia, and bank deposits and property rights.

Economic policy

VAT is introduced amidcontroversy

The long-planned introduction of a value-added tax (VAT) came on January 1stat a flat rate of 22%. The measure has been very controversial, sparking fears ofprice rises and adverse social consequences. The introduction of VAT bringsCroatia into line with most other European countries, and it is simpler than theprevious turnover tax, which could be applied at various stages before a goodreached the final consumer. However, the government has been criticised forthe manner in which VAT was introduced. Many businesses were uncertain ofthe implications of the new tax and poorly prepared for it. Especially contro-versial was the decision to introduce VAT at a uniform rate, including suchbasic goods as food, fuel and medicines. This found wide support among econ-omists for its simplicity and for avoiding wrangling among different interestgroups for preferential treatment. It is, however, unusual in Europe, and thegovernment was criticised for placing an undue burden on the poor, who aremost likely to bear the brunt of price increases for basic goods, and for riskinghitting certain sectors—notably tourism—particularly hard.

The government remained unmoved, but conceded that there was a need toprovide some protection for the poor. Just before the introduction of VAT itreached an agreement with dairies, millers and bakers to guarantee that pricesfor fresh milk and semi-white bread would not rise (prices for other sorts ofbread and other dairy products were not affected); similar measures for cookingoil and sugar were promised. When prices rose sharply in January (see Theeconomy), the government set up a Consumer Support Commission to moni-tor prices and to draw attention to increases considered to be unjustified.

The 1997 budget deficitwas lower than planned—

The government announced in early January that the central governmentbudget deficit for 1997 was HRK1.1bn ($173m). This is around 1% of estimatedGDP, compared with the budgeted deficit of 2.6% of GDP. According to thegovernment, expenditure was 3.9% lower than planned. While tax revenuewas up in 1997 (although revenue from income tax was slightly down), thelevel of budget expenditure was affected by lower than planned revenue fromprivatisation.

Croatia 29


Croatia: quarterly budget data(HRK m)

1995 1996 19971 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr

Revenue 6,035.7 6,872.1 7,080.5 7,396.5 6,767.0 8,316.7 7,877.2 7,852.3 6,695.1 8,617.7 8,890.7

Expenditure & lending 5,912.4 6,997.4 7,037.5 8,253.2 7,161.7 7,890.3 7,850.4 8,044.5 8,021.5 8,587.1 8,930.1

Balance 123.3 –125.3 43.0 –856.7 –394.7 426.4 26.8 –192.2 –1,326.4 30.6 –39.4Source: IMF, International Financial Statistics.

—and a tight 1998 budgetis planned

On December 19th the lower house of parliament passed the 1998 centralgovernment budget which had been presented by the government inNovember (4th quarter 1997, page 27), with amendments to increase expend-iture by HRK300m to HRK39.1bn ($6.2bn). The increased expenditure willmainly go on a planned increase of 27% in civil servants’ wages, which havelagged behind in recent years. The pay award follows an agreement in Decem-ber with trade unions representing state sector employees; teachers’ unions didnot sign the agreement, considering the offer to be insufficient.

Planned revenue has also been increased by HRK300m, leaving the projecteddeficit unchanged at 1.6%. The planned deficit is based on the assumption of asignificant increase in revenue from privatisation. It is envisaged that the intro-duction of VAT should reduce the overall tax burden on the country; projectedrevenue increases from the tax are expected to lag well behind nominal GDPgrowth.

Monetary policy istightened

A tightening of monetary policy by the National Bank of Croatia (NBH, thecentral bank) began during the last quarter of 1997. This had been expected,given the widening trade deficit and the rise in consumer credit that wasfuelling rising imports (4th quarter 1997, page 23). The NBH had intervened inthe foreign-exchange market during the height of the tourist season; as foreigncurrency inflows increased and demand for the kuna rose, the bank bought upforeign-exchange. This prevented the kuna from appreciating but increased themoney supply (4th quarter 1997, pages 31-32). Following this, the NBH has notbeen active in the foreign exchange market, thus tightening the money supply;this led to a slight appreciation of the kuna against the D-mark and a modestincrease in interbank interest rates at the end of the year. This slight monetarytightening reverses the looser monetary policy that had been pursued sincemid-1996.

Mass privatisation getsunder way

Mass voucher privatisation finally got under way in January with the distrib-ution of vouchers to the 225,000 beneficiaries—victims of the war and of com-munism (4th quarter 1997, page 28). The final list of 450 companies was issuedin mid-December and includes stakes in the food group Podravka, the chocolatemaker Kras, two electrical companies, Koncar and Elka, and the Adriatic crudepipeline operator Janaf. The vouchers can be exchanged for shares in the com-panies at a series of three auctions or entrusted to seven approved investmentfunds, which will bid for shares on behalf of the beneficiaries.

Increased pensions arepromised

An increase of 4.4% in the state pension was promised by the state pensionfund in December, in part prompted by the price rises associated with the

30 Croatia


introduction of VAT. Pensioners have suffered a significant drop in livingstandards in recent years, and have not shared in the benefits of the upturn inthe economy. As a means of improving the lot of pensioners, the governmenthas for some time been planning to reform the pension system. The labour andsocial welfare minister, Joso Skara, again referred to the urgency of the matterin December. World Bank support for the reforms is expected.

The economy

GDP growth picks up— GDP growth accelerated in the third quarter of 1997, reaching 7%, comparedwith the year-earlier period. With second-quarter growth revised upwards to4.6%, the first nine months of the year showed GDP growth of 5.2% over thesame period in 1996. The acceleration of growth in the third quarter followsthe same pattern as in 1996 and reflects this year’s continuing recovery of thetourism industry, which has been more rapid than expected. Given the stronggrowth recorded in the first three quarters and figures suggesting that industrialactivity remained strong in the fourth quarter, we have revised our estimate of1997 growth upwards to 5.3%.

Croatia: gross domestic product(constant 1990 prices)


HRK m 47.6 49.3 50.0 49.6 48.4 50.6 54.0 51.9 50.2 53.0 57.8 % change, year on year 5.5 4.2 –2.0 –0.3 1.7 2.7 7.9 4.6 3.6 4.6 7.0Source: Croatian Statistical Office, Mjesecno Statisticko Izvjesce.

—as tourism recoversstrongly

The number of tourist nights in the first ten months of the year, which in-cludes the whole of the peak summer season, was 43% up on the same periodin 1996, while the number of nights spent by foreign tourists was up 50%. Thenumber of tourist nights is still more than 50% below the level of the late1980s, leaving considerable scope for further growth in the sector. Long-termgrowth will also require investment in rebuilding and improving tourism infra-structure. The largest numbers of foreign tourists came from Germany, Italy,the Czech Republic, Slovenia and Austria.

Industrial output growthaccelerates—

Another key factor behind the accelerating growth rate in 1997 has been thestrong pick-up in industrial output which, according to official data, was up byaround 6.8% compared with 1996. There was particularly sharp growth inenergy production (up 17%), with the electricity sector registering evenstronger growth. Unlike the previous two years, there was no sharp seasonaldrop in output in December 1997. The respected chief economist of Zagrebackabanka, Zarko Miljenovic, explained that this “seasonal oscillation” was a distor-tion caused by the impact of the holiday season and suggested that eventuallythe seasonal effect could be excluded from the data. In any case, the picture forlast year of an industrial sector finally experiencing significant recovery andbenefiting from higher levels of investment seems clear.

Croatia 31


Croatia: industrial output(% change)

1995 1996 1997 Month Year Month Year Month Yearon month on year on month on year on month on year

Jan –5.7 6.2 4.8 4.3 4.3 0.8

Feb 0.7 5.8 –0.6 3.0 0.9 2.3

Mar 11.3 2.1 1.0 –6.6 3.9 5.3

Apr –8.0 2.1 0.8 2.4 2.0 6.5

May 2.5 2.0 2.5 2.4 1.2 5.2

Jun 1.4 3.8 –1.5 –0.7 1.5 8.4

Jul –7.6 –1.2 –1.0 6.5 –1.4 8.0

Aug –3.8 –1.9 –1.2 8.6 –6.8 1.8

Sep 7.7 –7.7 3.2 4.9 10.4 8.9

Oct 8.4 –2.2 13.2 9.4 10.2 6.0

Nov 3.1 0.5 –3.6 2.3 –3.1 6.6

Dec –13.3 –6.2 –14.1 1.3 –1.4 22.4Source: Croatian Statistical Office, Mjesecno Statisticko Izvjesce.

—and construction booms Construction activity continued to grow strongly in 1997, with large invest-ments in infrastructure and house-building. The sector will continue to be astrong motor for growth, although there have been warnings that it may soonface shortages of skilled labour: the average age of construction workers is highand recruitment is too slow to meet the expected demand.

Croatia: construction


Value of work put in place (HRK m) 0.78 1.04 1.20 1.37 0.87 1.63 1.87 2.19 1.37 2.14 2.38

Workers on building sites (av) 23,109 23,984 23,842 23,829 21,685 25,765 26,433 26,270 26,379 29,696 31,026Source: Croatian Statistical Office, Mjesecno Statisticko Izvjesce.

The rate of inflationpicks up—

A slight increase in the inflation rate at the end of 1997 raised the year-on-yearrate to 3.8% in December, giving an average rate of 3.6% for the year as awhole, which is well within the government’s target of 3-4%. The slight pick-up in December may have been caused in part by price increases in anticip-ation of the introduction of VAT on January 1st (see Economic policy).

Although official data are lacking, it appears that there has been a sharpincrease in prices for many goods in January. Prices in the grocery chainKonzum, for example, are reported to have gone up by an average 5.4% inJanuary. These include increases for bread and milk—other than semi-whitebread and fresh milk, whose prices are controlled (see Economic policy)—cooking oil (by 20-22%), sugar (16.3%), and milk products, meat, eggs, fruit,vegetables and detergents (5.7%). Konzum’s prices for beer, wine and coffeehave fallen. A rough estimate produced by the Split daily, Slobodna Dalmacija,based on a basket of goods and services, found that an average family faced anoverall price rise of around 5.3%. A similar study carried out by an independenttrade union organisation in Karlovac reckoned on a rise of 7-8%.

0

2

4

6

8

10

12

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

Croatia: industrial output% change, year on year

Source: Croatian Statistical Office, Mjesecno StatistickoIzvjesce.

1996199619961996199619961996199619961996199619961996199619961996199619961996199619961996 9797

nilnil

1996 971996 9797

nilnilnilnil

1996 971996 971996 971996 971996 971996 971996 971996 971996 971996 97971996 97

nil

32 Croatia


—to the government’sannoyance—

The Ministry of Finance reacted angrily to reports of sharp price increases,complaining that companies were transferring part of the burden of the newtax to consumers while neglecting to take into account the savings from theabolition of the turnover tax. The government had expected a rise in the retailprice index at the beginning of the year as a result of the introduction of VAT,but hoped that it would be slight and temporary.

The overall effect of the change should, in theory, be slight, given the elimin-ation of the turnover tax. Indeed, the finance ministry argued that over thecoming months the overall result should be a slight reduction in many prices.This is because of the elimination of the “cascade effect” of the turnover taxbeing applied at several points before reaching the final consumer. It wasexpected that it would take several months of adjustment before prices camedown, but the government argued strongly that this effect should be taken intoaccount before prices were adjusted for VAT. However, uncertainty and fearabout the impact of the change seem to have been more powerful than thegovernment’s reasoned arguments in determining the behaviour of many com-panies in setting prices.

—although the extent isuncertain

Although the evidence would seem to point to a sharp rise in prices in January,the extent is uncertain and the rough estimates cited may turn out to havebeen exaggerated. Not all prices have risen, as some have sought to set the kindof example that the government wanted: the state electricity company HEP, forexample, has said that electricity prices will not change. Some companies haveannounced price reductions as a result of the introduction of VAT: in Januarythe state oil company INA announced price reductions of 4.5%; the pharma-ceuticals company Pliva cut some prices by 5-10%; the confectionery companyKras and the food company Podravka announced some price cuts of 4-4.6%.

Croatia: inflation(% change)

1995 1996 1997 Month Year Month Year Month Yearon month on year on month on year on month on year

Jan 0.7 –2.2 0.2 3.2 1.0 4.2

Feb 0.1 –0.8 0.4 3.5 0.0 3.7

Mar 0.1 0.4 –0.1 3.3 0.1 3.9

Apr 0.7 2.5 –0.3 2.3 0.1 4.4

May 0.2 2.8 1.1 3.2 0.4 3.6

Jun –0.4 2.6 0.4 4.1 0.2 3.4

Jul 0.0 1.9 0.4 4.5 –0.3 2.7

Aug –0.1 1.9 0.0 4.6 0.8 3.5

Sep 1.6 2.9 0.1 3.0 0.3 3.7

Oct 0.5 3.5 0.6 3.1 0.2 3.3

Nov 0.1 3.7 0.5 3.5 0.4 3.1

Dec 0.2 3.7 0.0 3.3 0.7 3.8Source: Croatian Statistical Office, Mjesecno Statisticko Izvjesce.

The kuna remains stable The kuna has remained stable against the D-mark at HRK3.52:DM1. Against thedollar it strengthened slightly towards the end of 1997, as the NBH tightenedmonetary policy (see Economic policy). Since then it has fallen slightly, as the

3.0

3.2

3.4

3.6

3.8

4.0

4.2

Mar Jun Sep Dec Mar Jun Sep Dec

Croatia: monthly retail prices% change, year on year

Source: Croatian Statistical Office, Mjesecno StatistickoIzvjesce.

1996199619961996199619961996199619961996199619961996199619961996199619961996199619961996 97971996 971996 97971996 971996 971996 971996 971996 971996 971996 971996 971996 971996 97971996 97

Croatia 33


dollar itself strengthened. The question of whether the value of the kuna canbe maintained remains contentious. The NBH insists that the kuna will hold itsvalue without the need for intervention on its part.

Nevertheless, the real appreciation of the kuna against the D-mark in recentyears casts doubt on these assertions. As a consequence of this real apprec-iation, wage costs have risen ahead of improvements in productivity, leavingCroatia increasingly at a competitive disadvantage internationally. Croatia,with its low short-term debt and still fairly low portfolio investment, is rela-tively shielded from the type of speculative attacks lately witnessed in South-east Asia. However, taken together with the recent VAT-inspired inflation fears,some concern about the country’s economic stability remains.

Foreign trade and payments

The current-accountdeficit has widened

The trade deficit widened considerably in 1997, to an estimated $3.3bn, upfrom $2.5bn in 1996 (based on imports fob—initial official estimates puttingthe trade deficit at $4.1bn are based on imports cif). Imports have flooded insince the NBH loosened monetary policy in the second half of 1996, leading toa boom in consumer credit. Exports have also increased, picking up in thesecond half of the year but lagging well behind import growth. Exports to theEU have picked up, with Germany and Italy remaining the country’s mostimportant export markets. Elsewhere, exports to Bosnia and Hercegovina haveincreased substantially, and Slovenia remains an important trading partner.However, the strengthened dollar in 1997 has meant that the exports figureremained stagnant in dollar terms.

Croatia: foreign trade(% change, year on year)

Exports (fob) Imports (cif) HRK $ HRK $

19961 Qtr –7.2 –7.1 –4.0 –4.22 Qtr –1.6 –9.9 4.6 –4.33 Qtr –7.8 –10.4 –0.3 –3.64 Qtr 21.6 18.3 26.3 23.0

19971 Qtr 18.5 10.4 33.3 22.82 Qtr 4.0 –5.9 28.2 15.83 Qtr 18.5 –0.9 35.8 13.2Oct-Nov 10.0 –3.5 19.6 4.9Source: Croatian Statistical Office, Mjesecno Statisticko Izvjesce.

Balance-of-payments data for the first nine months of the year show thecurrent-account deficit widening to $1.41bn. The continuing strong recoveryin the tourism sector—the season peaks in the third quarter—resulted in thecurrent-account deficit for the year as a whole being narrower than it wouldotherwise have been (the deficit for the first six months was $1.6bn). Weestimate that the current-account deficit was around 9% of GDP in 1997.

This compares with a figure of 7.6% in 1996, according to the official data.However, the NBH has indicated that it is making substantial downward

34 Croatia


revisions of the current-account deficit for 1995 and 1996. A full report is to bepresented in February, but it seems that the 1996 deficit will be revised to alittle under $1bn, down from $1.45bn, and the 1995 figure will be revised from$1.71bn to $1.21bn. The revision follows IMF suggestions that the current-account deficit had been overstated in those two years, linking this to the highfigures for net errors and omissions (4th quarter 1997, page 32).

The external debt has risen According to the NBH, Croatia’s total external debt stood at $5.9bn (includinginterest arrears) in late October, up from $4.9bn at the end of 1996. Theincrease was almost entirely accounted for by medium- and long-term creditsfrom private lenders. While Croatia’s debt to official creditors declined slightlyover this period, its debt to private creditors increased by $1.1bn to $3.6bn(excluding interest arrears). Croatia’s short-term debt, which is very small, fellslightly to just below $400m. Although the external debt is rising fairly fast, thetotal foreign debt burden is still rather light at around 32% of GDP, and otherdebt indicators give no cause for alarm. However, financing its deficits andservicing its debt will require the government to borrow heavily on the inter-national capital markets in 1998-99. This is one area in which Croatia may beadversely affected by the fallout from the Asia crisis, as lenders take a generallymore cautious approach to emerging market risks, especially in the context ofconcern about the current-account deficit, the value of the currency and infla-tionary pressures in Croatia.

New profit tax rules scareinvestors

According to new profit tax rules published at the end of December, gains frommultiple trades in a security in the same year are be subject to the tax, which ischarged at 35%. The change caused consternation among investors; Croatiahad attracted increased portfolio investment over the past year, partly becauseof the absence of a tax on capital gains or on dividends and partly because ofthe lack of restrictions on the repatriation of funds. As investment has flowedin, the stockmarket has boomed, providing very large returns on investment inwhich the authorities seem to have wanted to have a share. The lack of detailedinformation about how the rule would be applied led to uncertainty and fallsin stock prices. The finance ministry quickly moved to calm worried investors,especially foreign ones. It said that there was no intention of applying a capitalgains tax; “normal” investors, especially foreigners, would not be affected.However, despite these assurances the legal position remains unclear and for-eign investors remain wary.

The fall in stock values resulting from the lack of clarity over the new tax rulesfollowed a sharp fall in the last quarter of 1997, which reflected the volatilityin world share prices caused by the recent Asian crisis, as many investorsreassessed the risks of emerging markets. From the end of September to mid-January the Crobex index of eight leading stocks lost 21% of its value. Never-theless, in January Austria’s investment bank, Creditanstalt, gave a verypositive outlook for growth in the Croatian market, which it saw as performingfavourably in comparison with the markets of other transition countries.

Croatia 35


Business news

Bank profits are up Croatia’s two largest banks have recently reported their profits for the first ninemonths of 1997. Zagrebacka banka, now the largest bank, reported group netprofits of HRK223m ($35m), up 35% on the same period in 1996, with theprofits of the parent bank up 31% at HRK187m. However, the bank’s shareprice fell towards the end of last year, reflecting not only a global fall in stockprices but also greater nervousness about emerging markets. The bank cut itsbad loan provision from HRK1.86bn to HRK1.79bn, asserting that its loanprofile was more diversified, thus lowering the overall risk. This decisioncaused some concern among analysts, but the overall assessment of the bankremains positive. The US rating agancy Thomson Bankwatch in Decemberupgraded the bank’s inter-country issuer rating to IC-B/C, from IC-C, pointingto its “dynamic management”, stable financial position and sound risk cover-age. Its short-term local currency debt rating was reaffirmed at LC-1, the high-est rating.

Privredna banka Zagreb (PBZ) has been undergoing rehabilitation since the endof 1996. Previously the country’s largest bank, its balance sheet has been cutfrom HRK20bn to HRK14bn ($82.2bn) as part of this process, as bad loans werewritten off and the bank was recapitalised by the government. In January thebank announced a return to profit (of HRK15.7m) in the first nine months of1997. The finance minister, Borislav Skegro, announced that a stake of 25% ormore in the bank may soon be sold off, amid speculation that the EuropeanBank for Reconstruction and Development (EBRD) has shown an interest.Thomson Bankwatch recently assigned an IC-C/D inter-country issuer rating toPBZ, which means that while it is regarded as an acceptable credit risk, it stillhas important deficiencies. Its short-term local currency debt rating is LC-1.

Iran orders new ships As part of a programme to replace ageing ships, Iran announced in January thatit would buy four 22,000-tonne container ships from Croatia, at a cost of $29meach. Shipbuilding has been a major though erratic component of Croatianexports in recent years, accounting for 9% of exports in 1996. A serious declinein the exports of the shipbuilding industry has been reported in 1997, and theIranian order therefore represents an important boost.

36 Croatia


Quarterly indicators and trade data

Croatia: quarterly indicators of economic activity

1995 1996 1997

3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr

Industrial production Monthly av

General index 1995=100 95 104 100 102 101 109 103 109 108 122a

Durable consumer goods “ 98 95 97 97 104 103 124 148 123 135a

Non-durable

consumer goods “ 97 110 89 90 93 103 94 104 110 114a

Employment

Employedb ’000 1,027 1,007 1,018 1,022 1,014 996 980 974 970 963c

Wages & prices

Net wages, real 1996=100 94.5 95.0 95.0 99.0 101.6 104.3 107.3 111.2 113.7 115.3c

Consumer pricesd: 1995=100 100 102 99d 100 100 101 103 103 104 105a

change year on year % n/a n/a 3.0 3.0 4.0 2.9 4.0 3.0 4.0 n/a

Producer prices, indd 1995=100 100 101 100d 100 100 101 102 102 103 103a

Money End-Qtr

M1: HRK m 8,363 8,275 8,601 9,396 10,326 11,409 10,995 12,018 13,267 13,273e

change year on year % 28.8 24.6 26.0 21.3 23.5 37.9 27.8 27.9 28.5 n/a

Foreign trade Qtrly totals

Exports fob $ m 1,177 1,091 1,082 1,080 1,058 1,291 1,196 1,016 1,045 762f

Imports cif ” 1,979 1,891 1,662 1,893 1,907 2,326 2,040 2,193 2,157 1,632f

Exchange holdings End-Qtr

Foreign exchange $ m 1,943.8 1,895.2 1,890.8 2,019.1 2,295.1 2,314.0 2,252.4 2,326.5 2,487.8 2,515.6g

Exchange rate

Official rate HRK:$ 5.255 5.316 5.458 5.443 5.426 5.540 5.466 6.167 6.239 6.225g

Note. Annual figures of most of the series shown above will be found in the Country Profile.a Average for October-November. b Excluding employees at internal and defence ministries, and independent farmers. c October only. d From1996, 1996=100. e End-October. f Total for October-November. g End-November.

Sources: Republic of Croatia Central Bureau of Statistics, Monthly Statistical Report; IMF, International Financial Statistics.

Quarterly indicators and trade data 37


Croatia: foreign trade($ m)

Total Germany Italy Slovenia Austria

Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec

Imports cif 1995 1996 1995 1996 1995 1996 1995 1996 1995 1996

Food 780.4 767.4 87.8 83.9 112.6 108.3 86.8 73.9 67.1 74.1

of which:

meat & preparations 114.4 98.0 2.4 1.9 8.0 9.6 20.3 15.0 10.6 5.8

fruit & vegetables & prods 222.0 193.8 6.9 6.0 58.8 49.6 15.3 13.1 18.2 18.0

coffee, cocoa, tea & spices 98.2 89.0 3.9 2.6 7.8 9.5 2.8 1.9 7.5 8.2

Mineral fuels 871.1 857.5 10.4 16.5 5.0 11.4 2.1 2.4 39.9 11.8

of which:

petroleum, crude 674.9a 635.2b 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Chemicals 810.3 848.6 153.5 155.2 132.3 129.1 159.5 154.0 68.8 73.6

Paper & manufactures 235.6 249.1 30.4 35.7 37.5 40.7 70.9 58.1 34.1 35.2

Textile yarn, cloth & mnfrs 209.8 203.2 34.6 27.5 46.6 45.2 28.8 26.7 13.8 10.3

Non-metallic mineral mnfrs 123.7 141.5 15.5 16.5 53.0 59.4 20.6 20.2 9.9 9.5

Iron & steel 243.2 256.9 52.2 46.0 43.4 42.6 21.8 19.6 14.0 14.2

Non-ferrous metals 137.0 133.5 15.0 18.1 26.5 29.5 10.1 9.0 4.8 6.6

Metal manufactures 203.4 234.9 34.1 41.7 67.8 81.2 38.5 39.5 20.0 22.2

Machinery & transport eqpt 2,008.6 2,129.2 606.1 668.2 334.9 340.8 185.6 170.6 168.9 181.3

of which:

road vehicles 438.5 477.0 200.9 236.4 72.3 61.4 34.9 29.4 18.9 16.6

other transport equipment 122.6 143.2 15.6 20.8 15.0 13.3 4.2 3.2 11.2 7.0

Clothing 271.2 285.6 105.2 109.3 82.9 103.0 17.3 18.9 11.0 7.9

Footwear 214.4 240.4 50.6 47.7 94.2 106.6 15.6 10.9 31.7 48.0

Scientific instruments etc 159.0 194.2 52.3 56.0 22.4 25.3 11.8 14.6 16.7 24.2

Total incl others 7,509.2 7,787.8 1,509.0 1,601.8 1,366.0 1,421.6 804.8 769.2 574.1 597.4

Total Italy Germany Slovenia Bosniac

Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec

Exports fob 1995 1996 1995 1996 1995 1996 1995 1996 1995 1996

Food 395.2 410.8 45.2 43.6 18.7 16.3 67.6 67.1 101.0 122.2

Wood & cork 160.9 166.3 103.2 115.6 3.7 2.3 16.3 15.9 1.0 1.4

Petroleum & products 366.1 370.7 116.1 43.7 1.3 1.1 124.8 191.9 28.8 72.0

Chemicals 813.6 643.0 299.7 189.6 83.5 62.6 138.2 89.9 40.4 57.2

Paper & manufactures 107.5 62.2 17.1 7.6 5.4 5.4 23.8 16.9 6.1 7.8

Textile yarn, cloth & mnfrs 123.8 110.4 38.1 40.5 27.5 21.7 10.5 7.4 16.4 12.2

Non-metallic mineral mnfrs 126.2 135.3 36.1 39.4 18.4 15.7 18.4 13.8 16.6 36.2

Metals 132.4 113.1 28.6 25.4 25.8 19.0 13.8 13.9 6.0 11.5

Metal manufactures 92.5 99.6 11.3 14.0 19.9 21.2 14.2 16.8 12.7 20.8

Machinery & transport eqpt 777.6 964.3 82.0 124.7 150.8 127.5 62.2 67.8 39.3 66.7

Furniture 151.3 120.0 16.9 7.4 56.9 37.0 5.5 3.6 8.3 10.0

Clothing 672.9 632.7 110.5 101.0 422.1 381.2 17.5 30.9 15.7 13.9

Footwear 233.7 235.2 76.3 83.6 71.8 64.1 24.4 9.3 4.4 7.3

Total incl others 4,632.7 4,511.7 1,098.2 949.7 996.9 839.5 607.8 611.4 383.2 548.5

a Of which UK, 310.4. b Of which Libya, 239.4. c Including Hercegovina.

Source: UN, External Trade Statistics, series D.

38 Quarterly indicators and trade data


Croatia: foreign trade($ m)

Exports fob Imports cifJan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec

1994 1995 1996 1994 1995 1996

Manufactured food 324.0 320.2 344.3 330.6 499.7 502.7Petroleum & natural gas 22.3 38.0 46.1 476.7 708.6 742.2Petroleum products 337.0 350.2 352.7 50.5 57.7 68.9Chemicals 605.6 849.8 682.0 629.7 952.5 1,008.2Wood & manufactures 313.6 335.7 296.0 83.1 133.5 171.0Paper & manufactures 105.5 119.1 70.7 130.9 231.1 237.8Textile fibres & manufactures 734.1 785.1 732.1 369.0 463.4 471.6Metals & manufactures 240.5 269.7 255.9 417.5 691.4 737.7Machinery 156.3 166.1 170.1 447.0 665.8 775.1Electrical equipment 252.6 312.0 338.5 512.8 815.4 812.8Transport equipment 350.2 332.9 480.6 460.1 604.2 654.0 of which: ships 302.8 260.4 409.6 20.9 82.3 98.2Leather footwear & accessories 310.2 254.3 252.9 221.7 244.1 271.8Total incl others 4,260.4 4,632.7 4,511.8 5,229.3 7,509.9 7,787.9

Exports fob Imports cif

Jan-Dec Jan-Dec Jan-Dec Jan-Nov Jan-Nov Jan-Dec Jan-Dec Jan-Dec Jan-Nov Jan-Nov

1994 1995 1996 1996 1997 1994 1995 1996 1996 1997

EU 2,531 2,672 2,303 2,066 2,081 3,096 4,664 4,625 4,143 4,760

Austria 149 200 198 176 205 353 575 597 538 631

France 111 110 84 75 75 116 188 199 178 255

Germany 941 997 839 764 724 1,110 1,509 1,602 1,417 1,571

Italy 910 1,098 949 838 851 994 1,366 1,421 1,275 1,536

UK 68 57 70 63 63 179 455 225 209 163

EFTAa 65 59 41 38 41 112 219 179 166 193

Switzerland 60 52 37 35 34 101 169 144 133 166

Other developed countries 133 131 134 126 136 317 417 412 415 506

US 88 83 89 85 91 172 201 213 194 223

Developing countries 1,531 1,771 2,034 1,781 1,760 1,704 2,210 2,572 2,293 2,564

Bosnia & Hercegovina 338 383 549 481 600 4 9 63 56 123

Czech Republic 34 36 40 36 45 92 147 207 168 185

Hungary 68 71 55 52 44 100 158 193 175 217

Russia 146 152 131 110 130 148 157 214 201 390

Slovenia 556 608 611 532 497 541 805 769 713 691

Total 4,260 4,633 4,512 4,011 4,018 5,229 7,510 7,788 7,017 8,023

a Iceland, Liechtenstein, Norway and Switzerland.

Source: Republic of Croatia Central Bureau of Statistics, Monthly Statistical Report.

Quarterly indicators and trade data 39


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