During the IMF mission's visit to Zagreb, undertaken as part of regular consultations under Article IV of the IMF's Articles of Agreement, the CNB and the mission exchanged opinions on both the economic situation in the country and monetary policy. In the course of discussions, a substantial degree of agreement was reached on most issues. However, on two issues, divergent views were expressed. As the Concluding Statement presents only the views of one side, which could raise questions in the public's mind about monetary policy in the forthcoming period, the CNB believes it necessary and proper to make a public statement on these issues.

The International Monetary Fund and the Croatian National Bank both assessed that for a faster real sector recovery and sustained GDP growth, which would be mainly driven by external demand and exports growth and much less dependent on foreign financing of domestic consumption, it is necessary to enhance the competitiveness of the Croatian economy by more decisive structural reforms.

Also, the CNB and the IMF agreed it is necessary to continue the implementation of policies aimed at reducing the country's external vulnerabilities and mitigating the impact of possible new external shocks, particularly given that structural adjustment of the real sector is not sufficiently rapid. One of the central bank policies is to continue with the gradual strengthening of currently record high foreign exchange reserves and to maintain prudential measures to ensure banking sector resilience. The CNB has been pursuing this objective up to now and will continue to use the entire set of available foreign exchange, kuna and prudential instruments, including foreign exchange interventions, when appropriate, regardless of the direction of exchange rate pressures, as well as kuna liquidity management. As before, it will thereby ensure sustainable growth in the country's foreign exchange reserves and exchange rate stability. In the period to come, the CNB will continue to conduct foreign exchange interventions by using the same technique. The CNB assesses that the change in the technique for foreign exchange interventions, as suggested in the Concluding Statement, would not only be unnecessary but also risky and counter-productive, as its effects could be exactly opposite to those both the IMF and the CNB agreed on as necessary.

In view of the above, we believe it useful to inform the public about some views the CNB expressed to the IMF mission, which diverge from the views given in paragraphs 12 and 13 of the IMF mission's Concluding Statement.

First, saying that foreign exchange reserves are relatively low requires a more detailed assessment, which was not made in this particular case, as well as inclusion in the analysis of country-specific factors, such as the high share of foreign banks in the Croatian market.

From the technical point of view, there are three usual ways to assess the adequacy of reserves: (a) the level of international reserves relative to the value of imports in a certain period; (b) the level of international reserves relative to the value of the total money supply; and (c) the level of international reserves relative to short-term external debt. Croatia's international reserves cover roughly as much as seven months of imports; they are higher than total demand deposits and currency in circulation and are somewhat lower than external debt maturing in the next 12 months. Hence, two out of the three usual assessment criteria show that Croatia's international reserves are more than adequate, while the third criterion shows that they are at a lower level of adequacy. However, it would be methodologically correct to exclude from the assessment those categories of short-term external debt that, in our opinion, cannot be included in the categories to be covered by official international reserves and that largely arise from the specific high presence of foreign banks in the domestic market. For example, this implies short-term debt of Croatian banks to foreign parent banks and short-term liabilities of foreign-owned enterprises to their parents (these liabilities are included in foreign direct investments). In line with this, the amount of domestic banks' foreign currency claims on non-residents could also be included in the function of international reserves. With all this in mind, it is without doubt that the adequacy of international reserves is appropriate even under the third criterion.

Furthermore, the methodology on which the mission primarily relies has received very different assessments from within the IMF itself, by its analysts and management, including the one saying that there should be no "one-approach fits all". It would, therefore, be quite premature and inappropriate to make such explicit judgements on the adequacy of international reserves of the Republic of Croatia based exclusively on that methodology.

This is even more inappropriate bearing in mind that Croatia is one of a very few countries whose international reserves more than comfortably cover its money supply.

Second, the Croatian National Bank sees merit in continuing the policy aimed at a gradual strengthening of international reserves. This has been the policy implemented by the CNB so far. Bearing in mind the background in which our foreign exchange market operates and its sensitivity to exchange rate developments, the existing system of foreign exchange interventions has proved to be functional and effective. This shows that the suggested changes in the technique for conducting foreign exchange interventions are unnecessary. The proposed technique could adversely affect exchange rate expectations and market confidence, leading up to completely different (undesired) results, such as the loss of international reserves, instead of their increase, and/or hikes in interest rates and lower credit growth, with a negative impact on the fragile economic recovery in progress.