Debt Levels and Developments

The process of fiscal consolidation which started in 2004 resulted in positive effects on public debt to GDP ratio which declined by 9.1 percentage points towards the end of 2008 compared to the end of 2005 and stood at 29.3% of GDP. However, as the effects of the global economic and financial crisis began to be felt in Croatian economy in early 2009, budget revenues declined, deficit widened and GDP fell, resulting in an increase in the nominal amount of public debt and its share in GDP. Thus, at the end of 2009, total public debt reached HRK 117.8 billion, or 35.4% of GDP. In the previous period, financing relied mainly on domestic sources. As a result, the domestic component of public debt rose from 55.3% in 2005 to 68.2% of the total public debt stock in 2009. During the same period, the foreign component of public debt fell from 44.7% to 31.8% of the total public debt stock.

Figure 6: Public Debt 2005-2009 0 20.000 40.000 60.000 80.000 100.000 120.000 140.000 2005 2006 2007 2008 2009 H R K m il li o n 0 5 10 15 20 25 30 35 40 45 % G D P

Foreign public debt - left Domestic public debt - left Public debt (% GDP) - right

Source: MF

The bulk of the public debt was associated with borrowing based on securities, followed by loans and T-bills issues. Looking by levels of government authority, the central government accounted for 93.6%, or the largest share of public debt towards the end of 2009. Extra-budgetary users accounted for 4.7% and local government units for 1.8% of the public debt. With central government borrowing taking place mostly on the domestic market, the domestic component of its debt accounted for 67.5% of the total central government debt. The local government also borrowed mainly in the country, and its domestic debt component accounted for 99.6% of the total local government debt. As regards extra-budgetary users, the domestic component of the debt also prevailed and accounted for 68.9% of the total debt of extra-budgetary users.

As regards public debt currency structure, it should be noted that a significant part of the debt is denominated in foreign currency, with euro-denominated debt accounting for the bulk of this amount.

With a view to creating additional room for private sector financing on the domestic financial market, after a five-year break, in 2009 the government again issued bonds on the foreign financial market. Thus, in 2009, the government met part of its financing needs by issuing two Eurobonds, the first in May 2009 in the amount of EUR 750 million and the second in November 2009 in the amount of USD 1.5 billion. With a view to reprogramming liabilities falling due, in March 2010 the Republic of Croatia issued ten-year bonds on the domestic market in the amount of HRK 3.5 billion with an annual interest rate of 6.75%, and EUR 350 million in kuna equivalent value with an annual interest rate of 6.50%. Furthermore, in July 2010 two more ten-year bonds were issued on the domestic market, the first in the amount of HRK 1.5 billion with a fixed interest rate of 6.75%, and the second in kuna equivalent value of EUR 650 million value with an interest rate of 6.50%, in addition to which a Eurobond was issued in the US market in the amount of USD 1.25 billion with an interest rate of 6.625% and a maturity period of 10 years. In November 2010, for the purpose of changing the existing debt maturity and structure, the government issued a seven year bond on the domestic market worth HRK 4.0 billion at a fixed interest rate of 6.25%. A part of the total financing needs in 2010 was also met by means of short-term financing instruments, most notably syndicated loans of domestic banks and T-bills.

As regards overall public debt management, it is extremely important to define plans and direction of public debt management that builds on previous years’ achievements and is closely correlated with the plan of developments in fiscal and other economic policies. Debt management is a process where main efforts are focused towards debt structure assessment and analysis with the aim of reducing generated risks, in view of their direct impact on the state budget, the financial system, and the capital market and thereby on the fiscal and macroeconomic stability of the country. The Budget Act prescribes the institutional framework for borrowing and public debt management in a way that ensures that the financial needs of the government are met at the lowest medium-term and long-term financing costs and optimum level of risk, in accordance with the given conditions. Prudent risk management is essential for the achievement of the optimum structure of debt and adequate debt management strategy.

The Fiscal Responsibility Act, as one of the key measures of the Economic Recovery Programme that introduces clear fiscal rules, is of great importance for public debt management. This Act is an instrument which ensures public finances sustainability as the use of fiscal rules will lead to necessary fiscal adjustments and ensure positive effects on public debt development.

In the forthcoming three-year period, total budget deficit and due liabilities financing needs will be met both on the domestic and foreign financial markets with the main aim of adjusting future maturities in terms of amount and due dates and at the same time creating additional space for other sectors financing.

The developments in total general government budget deficit and liabilities maturing in the forthcoming three-year period will result in higher financing needs relative to historical averages and will also have an impact on the public debt to GDP ratio.

The bulk of liabilities maturing in the 2011-2013 period relates to three bond maturities of which two are domestic bonds, one denominated in euro, worth EUR 500 million and second denominated in kuna, worth HRK 4.0 billion, and one foreign bond, worth EUR 750 million.

In accordance with the planned financing and macroeconomic and fiscal projections, in 2011 we expect to see a further increase in the public debt to GDP ratio that started in 2009 under the influence of the global economic crisis. The implementation of fiscal consolidation in the forthcoming years will result in a slower growth trend in the public debt to GDP ratio in 2012 with projected stabilisation in 2013. Further fiscal consolidation that will result from the implementation of the principles and mechanisms laid down in the Fiscal Responsibility Act will ensure a trend of steady decline in the public debt to GDP ratio, the beginning of which is expected to take place in 2014. Changes will also be seen in the levels of foreign and domestic component of public debt expressed as a share of GDP as a result of liabilities maturing during the observed period and the planned realisation of new borrowing both on the domestic and foreign financial markets.

Table 2: Projections of Public debt developments

% of GDP 2009 2010 p 2011 p 2012 p 2013 p

Public debt 35.4 41.6 44.2 46.3 46.7

Foreign 11.3 14.3 15.9 18.2 20.0

Domestic 24.1 27.3 28.2 28.1 26.7