Croatia: Government targets 1.9% deficit in pre-election socially-sensitive 2024 budget
Metodi Tzanov
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The government approved a draft budget for 2024 targeting a general government budget deficit of 1.9% of GDP, which is 1.6pps higher than the 0.3% fiscal gap planned for this year under the latest, October revision. The marked widening of the gap is due to the fact that spending is to increase by more than 11%, which runs contrary to PM Plenkovic assurances that the budget is ambitious. In fact, it rather speaks of a pre-election spending boost as 2024 is a super-election year - elections for president, parliament and European Parliament are to be held next year. Despite the planned increase in the deficit next year, the government is fully committed to keeping the public finances on a sustainable path - therefore, it will continue to pursue a medium-term fiscal strategy of gradual and sustainable consolidation, combined with investments and reforms conducive to higher sustainable growth, to achieve a prudent medium-term fiscal position. Accordingly, fiscal deficit in 2025 is forecasted to decrease to 1.6% of GDP, while the general government-to-GDP ratio will continue to fall to 56.6% at the end of the forecast horizon. Therefore, the general government deficit is planned to remain well below 3% of GDP and the general government debt-to-GDP ratio to further drop and remain below 60% over the medium-term horizon.
Fiscal policy to remain expansionary to support incomes, but deficit to remail well below SGP threshold
In 2024, the state budget revenues are planned at EUR 28.5bn, up by 3% compared to the planned revenues in the October revision of the 2023 budget, while state budget expenditures - at EUR 32.6bn, up by 11.2% compared to the planned expenditures in the October revision of the 2023 budget. Thus, the state budget is to run EUR 4.1bn or 5.1% of GDP deficit.
The general government budget deficit is planned at 1.9% of GDP, which is much higher than the planned in the revised 2023 budget plan deficit of only 0.3% of GDP. Despite the deterioration, the fiscal gap will be well below the Maastricht criterion of 3% of GDP. The fiscal gap is to decrease to 1.6% of GDP in 2025 and 1.5% of GDP in 2026.
Budget plan aimed to align income of households with rising cost of living
PM Andrej Plenkovic described the budget plan as socially-sensitive as it continues to be the basis for the implementation of aid packages for citizens and the economy and for salary increases in public and state services, as well as for payments to pensioners and other social benefits. According to him, the budget is also sustainable because it respects the fact that Croatia is a member of the euro area and responsibly manages public finances, and creates a stimulating economic environment and increases Croatia's investment attractiveness. He views the budget also ambitious as it also provides funds for the continuation of reconstruction after the earthquake, for reforms from the Government Programme -in education, healthcare, implementation of demographic measures, strengthening of defence capabilities and further investments in the field of green and digital transition and energy security.
Of the total expenditures worth EUR 32.6bn, the largest share have spending on the pension system - EUR 8.4bn, followed by economy and business environment (EUR 3.2bn), healthcare (EUR 2.3bn), balanced development, transport and decentralisation (EUR 2.2bn), social security (EUR 1.8bn), education and research as well as safety of citizens (EUR 1.2bn each). The increase in total expenditures for 2024 by EUR 3.3bn compared to their level in 2023 is the result of large social benefits, whereby public sector employees and pensioners should benefit the most. In particular, EUR 1.5bn more are planned for workers in the education system and public institutions, and EUR 1.1bn more than this year will go to pensioners. In addition, significant increases in expenditure, in the amount of EUR 723mn, are planned for the implementation of projects financed from the EU's Recovery and Resilience Facility, EUR 418mn will go to earthquake reconstruction, while EUR 273mn will go to HEP to compensate it for the costs of filling gas storage Okoli. On the other hand, the most significant expenditure cuts - EUR 1.4bn, reflect the completion of EU projects; the cost of paying the arbitration procedure according to the INA-MOL ruling is also reduced by HRK 229mn, EUR 153mn less should be spent due to the end of measures to eliminate disturbances on the domestic energy market, pensioners will no longer receive one-time supplements due to high inflation, which will reduce budget expenditures by EUR 136mn.
Overall, we think that the budget plan is strongly a pre-election one, a view shared by the opposition parties as well, as the spending is projected to increase quite sharply, which coupled with planned only moderate revenue growth, results in the fiscal gap increasing by 1.6pps against the October revision of the 2023 plan.
Generous social payments
Social payments (without social transfers in kind) make the most important expenditure category of the general government, amounting to 12.7% of GDP. They are mostly determined by the pensions (in the amount of 9.9% of GDP, which represents the increase by 0.7pps compared to 2023). This is the result of pension indexation based on the legislation defining general and special pensions, the accumulated effect of changes in the number and structure of pensioners as well as pension indexation from 2023. The projection also includes the fiscal effect of the new model for family (survivors') pensions, which enables pensioners to use part of the family pension with the simultaneous use of their own old age/early/invalidity pension. Finally, this expenditure category incorporates the effect of the amendments to the pension supplement law that enables pensioners, eligible for the pensions from both pension pillars and entitled to the basic pension from the first pillar to get a 27% pension supplement instead of the previous one at 20.25%. The calculations also take into consideration the increase in the minimum pension by 3% in real terms. All these measures are undertaken in the framework of National Recovery and Resilience Plan (NRRP) in order to increase the pension adequacy in Croatia, especially in the context of inflationary pressures and demographic challenges.
Furthermore, maternity allowances will amount to 0.6% of GDP, while child allowances and unemployment benefits will amount to 0.2% of GDP. Social security benefits are projected at 0.9% of GDP (increasing by 0.4pps compared to 2023) and include the payment of social benefits stipulated by the social welfare law from 2022. In this context, the personal assistance law, which came into force on Jul 1, 2023 and improved the services of personal assistance for disabled persons in their daily lives, also increase spending. Lastly, this expenditure category also includes the fiscal effect of the inclusivity supplement law, which should come into force on Jan 1, 2024 and will introduce the inclusivity supplement, pooling together personal disability allowance, assistance and care allowance, child allowance and financial allowance for unemployed persons with disability. These measures are also an integral part of the NRRP with the aim of improving coverage, adequacy and targeting of social benefits.
Compensation of employees
The second largest expenditure category refers to compensations of employees and amounts to 12.1% of GDP. The increase by 0.7pps compared to 2023 results from a series of factors: increase in the wage base established by the collective agreements for public and state employees, annual effect of wage supplements and wage coefficients increased during 2023, years-of-service bonus of 0.5%, and the envisaged dynamics of public and civil service employment. The agreed wage coefficients will be incorporated in the new wages law and the accompanying bylaws, which should come into force next year as a part of the comprehensive wage reform for civil and public servants as one of the key milestones in NRRP.
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The key factor driving the increase of social payments and compensation of employees is the necessity to align the income of households, especially the most vulnerable ones, with the rising cost of living, mostly stemming from food prices given that food is one of the main items in households' consumption baskets, the government explained. This is why, the government introduced the abovementioned measures regarding increase in the social payments as well as the compensation of employees, especially those in the civil and public service (219,000 out of 250,000) with the lowest wage coefficients (from 0.63 to 1.87) who got temporary wage supplements. Still, the 4th and the 5th package of anti-inflationary measures, which were adopted during 2023, are to be phased out at the end of March 2024, in line with the Country Specific Recommendations from June 2023, the government assured.
Investments
The next important expenditure category is gross fixed capital formation that is projected at 4.5% of GDP and is determined by the expected investment dynamics of the central and local (regional) government. To a great extent, these investments are to be financed from EU ESI funds and RRF loans. This category entails investment in education, transport and utility infrastructure, the delivery of 6 new trains to Croatian Railways Passenger Transport as well as the delivery of fighter jets and weapons to the defence ministry in order to strengthen geo-political position of Croatia. Considerable resources will continue to be invested in the reconstruction of public infrastructure in the areas hit by the earthquake (Zagreb and Banovina region) exclusively from national resources and new RRF loans. The renovation of public buildings to improve energy efficiency is planned to be financed largely from the REPowerEU chapter of the NRRP, more specifically from new RRF loans.
Other expenditures
The other expenditure category mainly includes current and capital transfers and is projected at 4.2% of GDP. It mostly refers to the Croatian contribution to the EU budget and the projects financed from EU funds, particularly in the water-management and utility sector. This category also takes into consideration subsidies for the price of gas for households until the end of March 2024 and the continuation of the project that will enable women, who are relatively less employable on the labour market, to work as caretakers for the elderly (over-contracted EU project of 0.1% of GDP). Capital transfers mostly refer to capital transfers to public companies and other legal entities; renovation of residential houses to improve energy efficiency and the reconstruction of residential buildings hit by the earthquake' financed through the national sources. This category also includes resources invested with the aim of increasing the capacity of the LNG terminal and improving the gas infrastructure, financed through RRF loans (as a part of the REPowerEU chapter) in order to strengthen the security of energy supply for Croatia as well as Central and Southeast Europe.
Some 0.3% of the gross fixed capital formation as well as capital transfers projected in 2024 refers to the national financing of the over-contracted EU projects, mostly part of the environment protection and water-management sector aimed to meet Croatia's obligations stemming from the EU acquis.
2024 borrowing plan higher than that for 2023
The government plans to borrow EUR 8.16bn via government bonds, which is up by 9.1% against the revised 2023 budget plan, but has not specified how much it will borrow via T-bills and government bonds. Further EUR 2.5bn is to be borrowed via loans. The planned repayment on government securities is set at EUR 3.16bn or 4.4% higher than in 2023, while that on loans - at EUR 774mn, down by 36.3%. Thus, the general government debt is projected to decrease to 58% in 2024 from 60.7% in 2023.
Budget based on overall plausible but slightly more upbeat macroeconomic projections
The budget plan for 2024 is based on the assumption of 2.8% GDP growth next year, despite the recessionary trends in many developed economies and a slight slowdown in expected global growth and foreign trade. Thus, the economy is to expand at the same pace as this year, with GDP growth to be driven solely by domestic demand. On the labour market, the government expects positive trends, so survey unemployment should fall to 5.7% in 2024 from 6.1% this year. Gross wages should increase by 9% in nominal terms, which is a slowdown compared to 2023 (14.6%). Inflation should slow down more markedly, from 8% this year to 3.1% in 2024.
The forecast for GDP growth is by far the most upbeat from among those of the central bank and IFIs, meaning that the revenue forecast may be underperformed. In particular, the government's forecast for household consumption is rather upbeat as compared to those of other institutions, which means that the tax revenue forecast for 4.2% increase compared to this years may not be reached - note that VAT revenues are forecast to grow by the robust 6.9%, while excise taxes are projected to grow by 3.9%. The projected to moderate wage growth is also unlikely to support strong personal income revenues (they are entirely to the benefit of local governments). Furthermore, the projected to strongly increase social security contributions also do not bode well with the expected to moderate employment and wage growth in 2024. Given the expected to decrease unemployment rate, the strong increase of social spending (apart from the abovementioned increase due to policy changes) is also dubious.
Conclusion
Overall, the budget plan for 2024 is rather expansionary as it targets much higher fiscal deficit target, which however reflects generous social and wage spending in the run-up to the super-election year. Some of the projected revenues and expenses does not seem quite realistic in view of the expected macroeconomic developments, meaning that the fiscal target may be overshoot, i.e. the deficit may appear be higher. Yet, the planned deficit is much lower than the 3% of GDP Maastricht reference value as the rules of the Stability and Growth Pact are to become obligatory next year, meaning that the government willl still have sufficient room for manoeuvre in case of new extraordinary circumstances and need to spend even more than planned without breaching the SGP rules.