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The Sixteenth Dubrovnik Economic Conference Croatian National Bank (Dubrovnik, June, 2009) Discussion of the paper: “Growing Together: Croatia and Latvia” Zuzana Murgasova International Monetary Fund The views expressed herein are those of the author and should not be attributed to the IMF, its Executive Board, or its management. Outline • The focus of the paper is on long-term growth trends and underlying factors • This presentation is complementary—the focus is on the boom-bust cycle and policy challenges going forward to achieve sustainable growth Different Pre-crisis Macro Developments Pre-Crisis Macro Developments Average 2002–07 Real GDP (year-on-year percent change; geometric mean) Real domestic demand (year-on-year percent change; geometric mean) Credit to the private sector (year-on-year percent change; geometric mean) Current account balance (percent of GDP; arithmetic mean) Net FDI (percent of GDP; arithmetic mean) External debt (percent of GDP; end-2007) Exports of goods and services (percent of GDP; arithmetic mean) Net exports (contribution to real GDP growth; arithmetic mean) Inflation (annual average; geometric mean) General government balance (percent of GDP; arithmetic mean) Croatia Latvia 4.8 6.1 19.0 -6.2 4.7 83.4 42.7 -1.8 2.5 -2.9 9.2 11.4 44.9 -14.2 4.5 127.7 43.1 -4.0 5.7 -1.1 Sources: IMF, World Economic Outlook ; IMF, International Financial Statistics ; and IMF staff calculations and estimates. The Boom-Bust Cycle Different Magnitudes 15 15 Real GDP Growth (Year-on-year percent change) 10 10 5 5 0 0 -5 -5 -10 -10 -15 -15 Croatia Latvia -20 -20 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Need to Change the Growth Model • Capital inflows unlikely to resume to pre-crisis levels, hence credit driven domestic demand expansion not sustainable. • Rebalance growth from non-tradables to tradables Improve competitiveness How to Boost Competitiveness? Cost side • With stable/fixed exchange rate, internal adjustment (depreciation) needed; wage and incomes policies; government to take the lead. Productivity side • Structural measures to address productivity and improve business environment. • ULC adjustment Also, if tax burden high, create fiscal space through expenditure reduction for tax cuts (Croatia). Unit Labor Costs and Wages Different need for and pace of adjustment 275 275 300 Croatia: public 275 Croatia (manufacturing sector) 300 Average Wages, SA (2002=100) Nominal Unit Labor Cost (2005=100) 275 Croatia: private Latvia (entire economy) 225 225 175 Latvia: public 250 250 Latvia: private 225 225 200 200 175 175 150 150 125 125 100 100 175 125 125 75 75 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 75 75 2002 2003 2004 2005 2006 2007 2008 2009 2010 Wages and Productivity Wage level higher in Croatia 60 60 20000 Average Gross Monthly Wages vs Per Capita GDP , 2008 (In euros) Wages and Labor Productivity, 2008 18000 CZE 50 50 18000 SVN 16000 HRV SVK 40 POL HUN EST LTU 30 BIH 40 30 LVA 20 20 MKD BGR 10 UKR ROM RUS SRB 500 CZE 14000 SVK 12000 RUS LTU 8000 10 Average monthly gross wages, in euros 0 1,500 HRV POL ROM 6000 MKD SRB 2000 0 0 500 8000 4000 BIH UKR 10000 6000 MNE 4000 2000 1,000 HUN 14000 12000 EST LVA 10000 BGR 0 0 Per captia nominal GDP Labor productivity, Euro Area=100 16000 20000 1000 Average monthly gross wages, in euros 0 1500 Recovery in Trading Partners Matters 5 Real Domestic Demand Growth of Trading Partners (Year-on-year percent change) 5 4 4 3 3 2 2 1 1 0 0 -1 -2 -3 -4 Croatia's Top Five Trade Partners: Italy Germany Russia Slovenia Bosnia and Herzegovina Croatia Latvia -1 Latvia's Top Five Trade Partners: Lithuania Russia Estonia Germany Poland -5 -2 -3 -4 -5 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Business Environment Scope for improvement in Croatia Ease of Doing Business Croatia Overall Starting a Business Dealing with Construction Permits Employing Workers Registering Property Getting Credit Protecting Investors Paying Taxes Trading Across Borders Enforcing Contracts Closing a Business Source: World Bank, Doing Business. Latvia 2010 Rank 2005 Rank Change in Rank 2010 Rank 103 101 144 163 109 61 132 39 96 45 82 134 112 171 131 109 117 156 72 140 28 76 +31 +11 +27 -32 0 +56 +24 +33 +44 -17 -6 27 51 78 128 58 4 57 45 22 15 88 Croatia: Economic Recovery Program How will it promote growth? • A home-grown comprehensive reform program. • Excellent diagnosis of problems and challenges. • Tackles key reforms needed to improve competitiveness and increase policy space (fiscal consolidation, wage and incomes policies, reduction in pension and health expenditure, labor market flexibility, privatization and reduction of business costs; • Success depends on its decisive and well-sequenced implementation (Pursue expenditure cuts and privatization to ensure lower taxes do not compromise fiscal consolidation; an ambitious Fiscal Responsibility Law is key); • Implementation progress is encouraging (Within weeks of adoption, the authorities are proposing amendments to politically sensitive areas) • If properly implemented, it will instill market confidence and enable Croatia to enter the EU from a position of strength. Speedy Implementation Hvala