- draft prepared for CNB Survey edition -
by
Velimir Sonje,
email:
Velimir.Sonje@rba-zagreb.raiffeisen.at
December 1996
Croatia accomplished the most remarkable stabilization record among transition economies in the last three years. The exchange rate has fluctuated within a narrow band since the end of 1993 and the rate of comsumer price inflation was -3% in 1994 and 3.7% in 1995 (December level). However, the unfavourable war-time and political environment was an obstacle to growth and deeper capital market development although economic activity is picking up since 1994 (real GDP growth was 1% in 1994 and 2% in 1995). The signing of the Dayton Agreement for neighbouring Bosnia and Herzegovina, the peaceful reintegration of Eastern Slavonia (the only remaining occupied region, on the Eastern border with Serbia), and Croatia's full membership in the Council of Europe (November 1996) will undoubtedly enhance the economic effects of stabilization and reforms carried out in the period 1992 - 1995.
The purpose of this survey is to cover the most important issues related to
capital market development. The first section is on monetary policy and deals
with problems of the institutional role of the central bank, exchange rate
policy, interest rates, as well as financial market instruments and open market
operations. The second section covers the banking sector. It contains a brief
review of the history, prudential regulations and bank rehabilitation. The third
section is on privatization. Both privatization techniques and results are
discussed. The fourth section is on organised exchanges, with special emphasis
on equity markets development. The fifth section discusses external sources of
finance.
1 This survey is based on the author’s contribution
to the book “Capital Markets in Emerging Economies” edited by Christian
Helmenstein. The book will be published in Spring 1997 by Edward Elgar.
Despite the great success of a macroeconomic stabilisation program, capital markets in Croatia developed relatively slowly due to war-time and regional security risks. However, despite war-time, significant financial structural reforms were undertaken in 1993 - 1995. Hence, a favourable political environment in 1996 started to bear fruit in 1996 in terms of financial deepening and real economic growth.
The first section on monetary policy focuses on the monetary aspects of the stabilization program. Emphasis is put on the role of an independent central bank which carried out substantial reforms of instruments that helped the development of financial markets. Special comment is given on high interest rates and interest spreads which are explained by supply side factors: bad assets in large banks and weak competitive pressures coming from newly established private banks.
The structure of the banking system is the focus of section two. Relations between ownership concentration, size and interest spreads are examined and it is stressed that larger banks with lower ownership concentration have the strongest competitive potential, but their balance sheets are burdened with bad assets. Hence, bank rehabilitation is a powerful policy tool which can increase competition in the short run even if foreign banks hestitate to penetrate the market. The rehabilitation procedure is described briefly and it is stated that the beginning of credible bank rehabilitation procedures in 1996 can explain the decline in interest rates that occurred recently.
The techniques and results of privatisation are elaborated in section three. Although Croatia did not employ mass privatization scheme, the results are positive: more than 50% of nominal equity in enterprises that entered the procedure is privately owned. However, large public utilities are entirely state owned. There was no political consensus on privatization strategy for the public sector enterprises and institutions, so this remains the main policy issue till the end of the century.
Exchanges are described in section four. Special emphasis is put on equity market development. Equity markets developed strongly in 1994 due to swaps of shares held by the Croatian Privatization Fund for public debt instruments. This was a successful operation which simultaneously enhanced the size of the private sector, decreased the public debt and helped the development of the secondary markets for public debt instruments. In 1995, markets suffered from pessimistic expectations due to war-times during liberation military actions, but they have recovered strongly in 1996, driven mainly by the successful privatisation of pharmaceutical company Pliva and Zagrebacka bank, one of the most successful emerging market banks.
Finally, external sources of funds are the focus of the concluding section five. Reasons for optimistic expectations related to FDI are elaborated. It is stressed that Croatia has regularized its relations with all international creditors. A current account deficit of 5%-6% of GDP is sustainable till the end of the century in light of the very low international indebtness and good links with international financial institutions.