As tportal/Maruska Vizek writes on the 26th of March, 2020, following the transition from socialism to a market economy, the Homeland War and the great financial crash of 2008, the coronavirus epidemic is the fourth structural breakdown that has hit the Croatian economy, according to a major analysis by the Zagreb Institute of Economics director Maruska Vizek.
As such, she proposes sixteen anti-crisis measures that should be taken in addition to those already presented by the Government to save the Croatian economy.
Economists have a special name for events like the coronavirus epidemic; we call them structural fractures. A structural breakdown is an unexpected change in an economy that fundamentally changes the behaviour of citizens, businesses and the entire state, which makes economic models and forecasts unreliable. The relatively young country of Croatia had the unfortunate fate of experiencing four massive structural breakdowns in its relatively short history: the transition from socialism to a market economy, the Homeland War, the Great Financial Crisis of 2008, and now the coronavirus pandemic.
In moving to a market economy, Croatia gave up central planning and adopted the practice that the market should be the one to offer insurance for different types of events. So, you can buy insurance in case your pet becomes unwell, in case of a natural disaster, and in case of bankruptcy of the country. However, the market cannot offer insurance against collective global risks such as the effects of climate change or a global pandemic. For such naturally colossal structural breakdowns, the only insurer that can offer insurance is the state itself. And the state, with the help of people well-known for their skills in central planning, needs to offer this insurance as quickly, efficiently and abundantly as possible to prevent a complete economic setback that can also result in wider social collapse.
The pandemic as a litmus paper for the effectiveness of the Croatian Government
The crisis caused by the coronavirus pandemic can also be seen as an indicative test of how not only the Croatian Government, but how all countries and their governments function. Every government faces the same questions about the pandemic and the high risk of economic crisis that accompanies a pandemic, and their answers tell us a lot about how they govern the countries they lead. In this sense, the response of the Croatian Government to the deep recession that could well be ahead is very indicative: there are seemingly many measures to create the impression of substance, most of which with a little political will mixed in, and they should’ve been introduced even without the appearance of coronavirus.
In all of that, there are only a few substantive measures that are pre-bureaucratically defined, all accompanied by chaotic communication that brought additional nervousness and uncertainty to the already neglected future beneficiaries of these measures, which have fundamentally changed their lives and businesses in just a few weeks. Of course, it should be borne in mind that not all governments have the same arsenal of measures at their disposal and not all governments face the same set of constraints when defining these measures (we’ll touch a little more on that later), but it cannot be denied that our measures have the classic Croatian a signature of prescription and a big lack of courage.
What can be done at all to protect national economies, intensely globalised and economically interdependent, from the effects of a pandemic that happens (hopefully) once every 100 years? How do you help in a situation where, in order to reduce the health consequences of a pandemic, countries are literally forced to break their national economies? The state can do a lot and the market does practically nothing. However, it’s first necessary to diagnose the problem and list the limitations that countries face in finding a solution, and only then can adequate solutions be offered.
Three economic shocks because of the epidemic
So, let’s start with the diagnosis. The peculiarity of the economic crisis caused by the coronavirus epidemic is that the structural fracture that has hit us can be broken down into three components. Due to the closure of the borders and the introduction of quarantine, companies are unable to continue with their normal operations, resulting in a decrease in the production of goods and services. It’s a supply-side shock. Consumers, however, cannot buy the products and services they normally buy because they either can’t, as producers cannot deliver them, or because of quarantine they cannot physically reach them. We’ll call it demand-side shock. The collective psychosis that arises from the preoccupation with news of a pandemic and its aftermath creates a third kind of shock, a shock of confidence. For fear of an uncertain future, people lose confidence in the economy and stop buying anything but essential products, and businesses, for the same reason, even if they have liquidity, stop producing and investing.
All three shocks cause a significant decline in economic activity as measured by gross domestic product (GDP), while their impact on prices is ambivalent. Supply shock produces inflation and demand and expectation shocks have a deflationary effect, so, it’s ultimately more certain as a result of this pandemic (especially if it is short-lived) to expect a decrease in the general price level, that is, deflation. The aforementioned shocks are mutually supportive and like a ball that increases in size as it descends down the snowy slope it spreads very quickly across the whole economy, which is why the ultimate impact of the pandemic on GDP could be really huge.
Furthermore, due to the fact that the pandemic has spread in the G7 countries and of course in China, to which 60 percent of world’s GDP and 65 percent of world’s production are related, it’s clear that only a few countries will avoid undesirable economic consequences, even if the epidemic itself doesn’t actually touch them at all.
How much of a decline in GDP awaits us?
At the moment, it isn’t very wise make any estimates of the expected fall in Croatian GDP in the second and third quarters of this year, but this estimate is still necessary because the estimated magnitude of the economic damage caused by the epidemic also necessitates the speed and magnitude of the country’s response. The specificity of the structure of the Croatian economy thus makes the negative economic effects of the pandemic potentially significantly more dangerous. Namely, Croatia doesn’t have a diversified economy based on productive activities, but instead is focused on tourism, and with abundant tax policy assistance to tourism, which, with transport, hospitality and personal services, is the most affected economic sector. As tourism alone generates 11.4 percent of GDP directly, and we can declare this year’s tourist season a failure, the annual decline in GDP coming from this activity alone will be very painful.
It’s worth keeping in mind that an epidemic that directly affects the tourism industry is likely (at least in the first strike) to do the most damage to small tourism-focused economies such as Croatia, Malta and Cyprus, than to the economies that are much more affected at the moment, even those who also see a lot of tourism like Italy and Spain, but in which tourism generates only a few percent of GDP.
Although data is currently not available to estimate the expected GDP decline, it can be expected that Croatia will enter into a recession securely and officially in the third quarter, although it is possible for it to enter a recession in the second quarter.
Due to its reliance on tourism and Croatia’s recovery from the crisis, it’s likely to be different from economies that rely on industry. In contrast to the manufacturing sector, where production was lost due to a lack of raw materials or quarantine, which can be partially or fully compensated when an epidemic passes, services don’t have this capability. This means that manufacturing-based economies can expect a V or U recession (hence a decline in activity and either an immediate or very rapid full recovery), while service-based economies can expect an L recession (a decline in activity and a prolonged period of stagnation).
Extraordinary times call for extraordinary measures
An upcoming recession is therefore a certain result of the coronavirus epidemic. GDP decline is likely to be higher than that recorded in 2008 and 2009, while there is no guarantee of a speedy recovery, even if the pandemic is over quickly. The longer this epidemic lasts, the greater the possibility of economic depression. Depression is an economic situation in which GDP decline is long-lasting, accompanied by high unemployment rates and the declining prices of products and services.
Therefore, the Croatian Government’s response to this situation must be decisive, prompt, well coordinated, innovative and financially very generous. These are extraordinary times that require extraordinary measures. Measures that will at least partially restore the confidence of both citizens and business owners in the Croatian economy and will entrench the Croatian state in its current place – the place of insurers of its citizens and businesses against collective global risks.
The preservation of company viability and jobs
What are the priority objectives of these anti-crisis measures? Firstly, to provide sufficient liquidity to businesses and citizens affected by the coronavirus crisis to overcome this temporary economic disruption (while hoping for the epidemic that caused this disruption to be a short-lived one). Without providing additional liquidity to citizens and businesses affected by this crisis, Croatia will face a new wave of unpaid claims, pre-bankruptcy settlements, bankruptcies and unfortunate foreclosures.
The peculiarity of the coronavirus recession is that in the long run, we know that in a few months, when the pandemic is over, the economy will indeed return to normal, but for these few months, in combination with the earthquake that struck Zagreb on Sunday, they look like the end of the world to many businesses. Standard recessions are usually the opposite; we don’t see the end of them, but we know that for a few months we can surely push through without giving up our usual lifestyle. And that’s why it’s important for the state to enable businesses and citizens to bridge this very deep (but hopefully short-lived) economic crisis that lies ahead of us. If the Croatian Government fails to do that, or if they delay the implementation of the necessary measures, a recession is more likely to turn into an economic depression.
Another objective of anti-crisis measures is to preserve jobs. As with the first objective, it is the state that must make a short-term bypass in the labour market so that unemployment doesn’t rise massively overnight and lead to a secondary shock in demand.
Maintaining the country’s foreign exchange liquidity
The third objective of the necessary anti-crisis measures is to ensure sufficient foreign currency liquidity for the government to continue to repay its outstanding debts. Why is this important? Otherwise, we might have trouble finding the foreign exchange needed to pay for imports and servicing by the end of the year. In other words, if we don’t do this – the state could go bankrupt. These currencies are secured from tourism revenue in normal, non-crisis times, but as we can forget this year’s season, the 10 billion euros in foreign currency inflows will have to be offset somehow. The fact that we have 18 billion euros in foreign exchange reserves at our disposal is somewhat reassuring, but it will be necessary to provide some more foreign exchange to prevent any speculative attacks on the exchange rate.
It should be noted that there are also goals that aren’t complementary to the three goals I’ve mentioned above. The first such objective is the introduction of the euro (whereby it remains to be seen whether the euro, after all that is currently happening in Italy, Spain and France, has any viable future whatsoever), and the second such aim is to win the next parliamentary elections (whenever they’re held). This is definitely a miserable time to be a politician, because this extreme crisis will very accurately detect all the dysfunctionalities of both the state apparatus and the political system, as well as separate the true leaders from those who didn’t step up in terms of public service when it was necessary to do so.
Three dances down the wire
The fundamental limitation that the Croatian Government faces in adopting measures to meet the three objectives outlined above is – where can we find the resources to take the necessary measures? Namely, we don’t have our own obvious stocks (I’ll talk more about less obvious stocks a little later), and at the same time, with each delay day, the likelihood that we can borrow funds on international capital markets decreases.
Furthermore, ideally, the entire state budget expenditure needed for assistance should be monetised. The government would therefore have to issue domestic bonds in order to borrow money for the necessary measures, and these bonds would then be bought directly or indirectly by the Croatian National Bank. However, this ideal case scenario is appropriate and fully enforceable only in large and more developed countries because they don’t face capital flight during times of crisis, instead, investors with surplus savings want to ”park” their capital in those countries.
Small and underdeveloped economies such as Croatia, with the lack of their own resources to combat the crisis, are already facing the outflow of foreign capital, which can significantly weaken the exchange rate and thus further destabilise the economy. This ultimately means that the Croatian economy and other economies like it, in the fight against the crisis will have to, figuratively speaking, dance a monetary dance along a very thin wire – on the one hand, the state must pump money into the system with extravagant measures, and on the other hand, it must ensure that these same measures don’t cause the exchange rate to collapse.
The second dance on wire, which is needed because of the constraints we face, is a fiscal dance. It consists of balancing the need for a very large stimulus package from the state budget.
The third dance down the wire is the austerity dance, which consists of balancing the need to soak up some of the funds for anti-crisis measures through budgetary savings, without exaggerating in order not to deepen the already described demand shock and to prevent the country from really ending up in a truly deep economic depression.
Let’s now look at the anti-crisis measures proposals that should be taken in addition to those currently proposed
1. The establishment of a crisis headquarters to defend against the coronavirus recession
Judging by the list of measures currently proposed, the government has seriously underestimated the magnitude of the problem it is facing. When you read the proposed measures, you get the impression that they were made so that a circular was sent to all ministries to suggest what each of them could do. As a result, we’ve been given a lengthy list that will require a large number of changes to laws and regulations, without the measures themselves being financially generous enough to address the problem we’re facing whatsoever.
In a situation where it is necessary to respond quickly, precisely, efficiently, very concretely and convincingly, such a bottom-up approach makes no sense at all. The measures should be designed and coordinated by a centralised expert body with adequate expertise and with all relevant information on the table. This isn’t a moment for some sort of spontaneous trial and error method, but for a responsible and competent central planner capable of perceiving both the global situation and national specificities. This situation is very serious, there is very little time to react and the time we do have must be used in an optimal way.
2. The withdrawal of income tax advance payment
In a situation where we can be overjoyed if Croatia’s GDP declines in the second and third quarters, this is ambiguous. Only a few companies will make a profit this year. Paying an advance on corporate income tax is therefore meaningless and only exacerbates the already deeply impaired liquidity of companies. The cancellation of this down payment doesn’t apply to public companies.
3. VAT deferral from March onwards for all affected businesses
Quarantine has been in force in Croatia for a week now, which means that many sectors affected by the crisis are no longer generating any revenue at all, while they are expected to pay taxes such as VAT on invoices issued in February, which are paid in March, and most of the affected companies pay it from the revenue generated in March. If these revenues are absent or substantially reduced due to the quarantine imposed by the state, the question arises as to how the entrepreneurs will pay this tax at all. In other words, those entrepreneurs who were forced to sink their business completely due to quarantine in March should be allowed to postpone their VAT due in March and for all subsequent months. If that doesn’t happen, the state will actually turn the liquidity problem – which it’s claiming it wants to solve – into a wider economic one, thus causing the illiquidity spiral Croatia has already seen back in the 1990s.
4. The ”forgiveness” of the payment of income tax and surtax for all taxpayers in the private sector for the duration of Croatia’s quarantine
Delaying tax payments doesn’t make sense in a situation where the coronavirus epidemic will permanently reduce revenues for all businesses (except for the few who produce goods and services for which demand during the crisis has increased). In order to avoid the deep shock of severely diminished demand and create a spiral of illiquidity, one should first select a tax form for which this ”forgiveness” will apply. If employment in the private sector is to be maintained, it may be the most prudent decision to exempt income tax and the corresponding surtax for the duration of quarantine. Additional tax exemptions are possible if the measures to improve the liquidity of the state bear fruit, but at present, and with limited information available to the expert public, that can’t really be discussed.
5. Prepare a new issue of government bonds on the international and domestic markets
International bond issuance can take place within just one month, and it’s necessary to provide additional foreign exchange liquidity for the country and reduce the mounting pressure on the exchange rate. This should start immediately; the more difficult it becomes, the less likely it is that such bonds will be issuable, especially since credit rating agencies will certainly return Croatia’s credit rating back doen to a non-investment grade (or, colloquially, a junk rating). At the same time as the issuance of foreign bonds, the issue of bonds on the domestic market should be prepared immediately and without delay, which can then be purchased from banks, investment funds and insurers, the most visible buyers of such securities, by the Croatian National Bank.
6. Use the Croatian Presidency of the Council of the European Union to abolish export restrictions on certain goods and services and to agree financial assistance measures for particularly affected member states
Getting the European Union out of the crisis will require coordinated action at European level and the solidarity of the less affected member states towards those who, like Croatia, will be more affected by the crisis. Croatia has the opportunity to impose this narrative during its Presidency of the Council of the European Union and propose a platform and some measures for coordinated economic action. The European Union should, in theory, be similar to marriage and its core values should absolutely refer to ”in sickness and in health”. If the Union abandons the principle of solidarity in this situation, in only makes the question of what purpose such a union serves at all even louder.
7. Examine the possibility of opening a credit facility with the European Central Bank
Such a credit line would have been available to us if Croatia had entered the European Exchange Rate Mechanism, but only in the case of serious disturbances in the exchange rate. However, as the crisis hit us shortly before joining the mechanism, and as our banking system is predominantly owned by banks in the Eurozone, we need to try to arrange a line of credit that would allow us to access these badly needed foreign currencies.
8. The reinforcement of the Croatian National Bank’s government bond repurchase programme
The primary source of financing for the stimulus package to help the Croatian economy and citizens will have to come through the purchase of government bonds and treasury bills by the central bank. Given that the stimulus package must be financially more generous than the one currently proposed, the buyout will need to be multiplied by an enormous four billion kuna. No private lender can swallow the amount of debt needed to stabilise economies in this state and help them avoid collapse. Only central banks’ balance sheets, and then the CNB’s balance sheet, can swallow that amount of cash.
9. Look for a stand-by arrangement with the IMF
There’s no shame, nor should there be a sense of failure in seeking an arrangement with the IMF at a time like this if you’re a small and underdeveloped economy like Croatia, which is already facing or will be facing a shortage of foreign exchange to finance its obligations. Eighty countries have already been in this order since the epidemic began, and we need to line up, too. If for no other reason, then as a precautionary measure should measures 5, 6 and 7 fail. IMF resources are also limited, which once again means that there is no time to waste and that we must immediately seek a stand-by arrangement.
10. The reduction of salaries in public and utility companies and payment of advance payments to the state budget
This would be the first of the austerity and diversion measures from the public sector to the private sector. Public companies have an average of one third higher salaries for the same jobs compared to government and public services. It is one of the less obvious ”stocks” of funding needed to fund anti-crisis measures. Collective agreements in public companies should be cancelled (for which all the conditions are now due to these extraordinary circumstances), salaries should be reduced and all excess liquidity transferred to the state budget through corporate income tax advance (and, if necessary, other creative measures).
11. The reduction of salaries in local self-government units
This segment of the public sector also has significantly higher salaries than state and public services do. Wages will need to be reduced to a lesser extent than those in public companies in order to stabilise the budgets of local government units, which will bear the burden of income tax ”forgiveness”. The proposal applies to other public authorities, such as tourist boards whose salaries also differ from the rest of the public sector.
12. The reduction of salaries in the civil and public service
Collective agreements for state and public services should be cancelled. Salaries should be linearly reduced in all services except for those in the health system and the police. For all three proposed pay cuts, the constraints should all be taken into account, because pre-term savings in the form of public sector pay cuts in these conditions are counterproductive, especially if they’re of a more lasting nature. Temporary significant cuts, especially if well motivated and adequately presented to public sector employees, could be much more effective. It isn’t possible to say in advance how much the proposed pay cuts would need to be in the three categories of the public sector, as this requires a little more detailed analysis and verification of the feasibility of the remaining proposed measures intended to improve domestic and international liquidity, but it will definitely be needed.
13. The use of funds from the second pension pillar to keep the economy alive
I have to admit that I never thought I’d ever advocate buying CNB government bonds or encroaching on another pillar. But according to the legendary statement of the great English economist John Meynard Keynes, when the facts change, I change my mind. In other words, if things get really nasty and if the epidemic persists, retirement savings will have to be put on the table as an option to fund economic rescue measures. In other words, pension funds are also another less obvious stock for anti-crisis funds. Pension funds are holding government bonds in their portfolio(s) anyway, and it’s certain that their share in the portfolio will need to increase in order to reduce the need for borrowing from abroad. It is disturbing that we have to sacrifice the future in order to save the present, but if we were to rationalise budget spending, such solutions wouldn’t be necessary today. Many economists have been warning us about this for decades, and no one has taken it seriously.
14. Ensure that the excess liquidity pumped by the CNB into the system reaches the private sector, ie – that it doesn’t end up in the public sector
The Croatian National Bank is following the steps it has taken to date. Delaying the possibility of a moratorium and rescheduling past due liabilities to maintain the stability of the banking system, while reducing the reserve requirement and expanding the bond repurchase programme in order to stabilise the bond market and increase the liquidity of the banking system. The real challenge is yet to come because it will have to ”dance” a monetary dance along that proverbial wire; therefore multiplying the bond repurchases while defending the exchange rate at the same time. At the moment, however, it’s crucial to conclude that this increased new liquidity doesn’t just remain with the banks because they will be prone to uncertainty regarding the situation in which we find ourselves ”storing” that liquidity in our giro accounts.
In other words, it makes no sense to flood the banking system with new money if that money just ends up staying with the banks. This money is needed by and for the Croatian economy, whether it is transferred through the banking system or through state support measures. It is even more crucial to conclude that this new excess liquidity of the banking system doesn’t serve for the direct financing of the public sector, which banks will also be inclined to, because at this moment in time, placing loans in the public sector is a much safer option than lending them to the private one.
Thus, excess liquidity should be channeled through the redemption of new government bonds into the state budget solely to offset the tax revenue lost by introducing tax relief and deferrals and financing minimum wages for crisis-hit companies and businesses. Part of the money should also be diverted to the reprogramming of existing loans and the granting of new, very cheap loans to businesses. Given the ”reduced risk appetite” of commercial banks, it would be advisable to devise a joint lending programme for commercial banks and for HBOR.
15. If the epidemic doesn’t last for more than a few months, introduce a tourist voucher programme
The sectors most affected by the crisis will need a highly specific support programme. The tourism sector deserves special attention because it generates eleven percent of Croatia’s GDP, and this year it has no chance of generating any revenue in a normal way. So, if we’re lucky and the epidemic ends quickly, vouchers can save that sector from collapse.
16. Review the necessity of the existence of individual state bodies and institutions
This coronavirus crisis can also be an opportunity for reform. In view of the fact that excessive cutting of public expenditure in such a situation is counterproductive, the possibility of restructuring and abolishing certain public authorities which are not expedient for the purpose of achieving further savings should definitely be examined. A wide variety of options are available, and only actual political will for such a move is needed.
In the end, it should be borne in mind that these are only umbrella macroeconomic measures that need to be accompanied by additional sectoral policies. In such volatile times, the situation may change overnight (for the worse or for the better), and that will require the constant adjustment of the measures already adopted and the introduction of more new ones. It is quite certain that, as a consequence of these measures, both the deficit and public debt will explode, which is acceptable to the European Commission at the moment, and with them, the balance sheet of the central bank will explode. But at this point there’s no other choice.
Furthermore, one should be aware that measures 2, 3, 4, 14 and 15 may also save a lot of those who have long been in bankruptcy, among others. Now is not the time, however, for these insights to be a pretext for hesitation. More substantial measures than those currently proposed must be enacted as soon as possible. Speed is now necessary.
The whole world is currently swimming through economically unfamiliar waters and no one knows the right way to the shoreline. However, staying out in the middle of a storm like this and not doing things properly cannot be an acceptable solution. The comparative advantage of Croatia is that in the last three and a half decades, it has successfully survived the socialist shortages, the collapse of the former Yugoslavia and its economic system, the Homeland War and the devastation that came with it, the care of a large number of displaced persons, international sanctions, as well as the financial crash. We will survive this, too.
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