DEVELOPMENTAL PRIORITIES OF THE REPUBLIC OF CROATIA

GOVERNMENT OF THE REPUBLIC OF CROATIA DEVELOPMENTAL PRIORITIES OF THE REPUBLIC OF CROATIA 2002-2004 GROWTH OF EMPLOYMENT AND STANDARD OPENNESS COMPETITIVENESS STABILITY Zagreb, November 12, 2001

BACKGROUND Republic of Croatia stands at a key turning point: during the course of 2000-2001, the economy has been consolidated and a critical mass of support has been harnessed for the acceleration of the reforms which will lead to sustainable growth. Thus, the Government can cease to direct all of its efforts towards a rudimentary struggle with everyday problems, and focus its attention on long-term solutions to structural problems and future growth and development. The global economic recession has intensified and spread in the course of this year. However, despite the unfavorable environment of the global economy slow-down, Croatia managed to achieve an annual growth of around 4,5%. Without a consensus regarding key development priorities, it will be impossible to make long-term and consistent political decisions required for changing the economic and social circumstances, and achieving sustainable growth. The following developmental priorities ensue from the " Development Guidelines of the Republic of Croatia", and 19 integral studies that make up the strategic project "Croatia in the 21 st century." Taking the capacity of and the overall situation in the Republic of Croatia into consideration, the Government has selected, within the framework of its four-year programme, the developmental priorities which represent the basis of key policy reforms and changes in the upcoming period. This document contains the most important tasks and measures which have to be undertaken in order to achieve key objectives set out by the Government, and which can ensure positive outcomes in Croatia's economic and social sphere. 2/13

KEY FINDINGS AT THE BEGINNING OF 2000 negative economic growth coupled with regression of industry high and wide-spread illiquidity large government debts towards budget beneficiaries, the economy and the population very high budget deficit amounting to 7,4% of GDP negative employment trend with an accelerated increase in unemployment rates high degree of political as well as economic and financial isolation inefficient rule of law with wide-spread corruption tycoon based privatization support by the government structures absence of economic restructuring resulting in low competitiveness of the economy RESULTS ACHIEVED IN 2000-2001 dynamised economic growth; GDP growth increased from -0,4% in 1999 to 3,7% in 2000 and 4,5% in 2001, growth of investments and preconditions for more active entrepreneurship and employment have been achieved, old government debts, which have blocked the economy, have been serviced, liquidity has improved considerably, savings have increased and interest rate has declined, the revenue-generating capacity (profits in relation to losses) has increased as well as overall profitability of the economy a multi-annual plan for public finances stabilisation was launched aimed at decreasing the share of government expenditures in GDP from approximately 50% to 37-38% in 2004; in a two-year period, from 2000-2001, this share has fallen to 44%, and the budget deficit has declined from 7,4% of GDP in 1999 to 5,7% in 2000 and 5,3% in 2001, long-term reforms have been initiated in the field of state and public administration, health and pension system, and social policy, 3/13

Republic of Croatia has been accepted into international organizations and associations, international credit rating has improved, with manifold effects on the economy, Republic of Croatia has become a full member of WTO, it has joined CEFTA, the Stand-by Arrangement with the IMF has been signed, the World Bank Structural Adjustment Loan (SAL) has been approved, and many bilateral agreements, which will enable the broadening of economic cooperation and exports, have been signed, Stabilization and Association Agreement with EU has been signed. CONTINUING PROBLEMS AT THE END OF 2001 high unemployment rate low competitive capacity of the Croatian economy growth of the public debt slow implementation of reforms insufficient rule of law with deep-reaching corruption present in the society CROATIAN PERSPECTIVE In addition to natural wealth, two key factors on which the Republic of Croatia bases its perspective are: preserved nature (natural resources of unpolluted soil and water, its geographical location, beauty of its landscapes, indigenous cultural heritage) and quality human potential, which, in the long-term, can ensure: an economy based on new skills and technologies (establishment of R&D technological centers of European significance, regional centers for the production of software), Croatia becoming a prestigious tourist destination with its specific regional, national and international features, the production and export of high-quality natural and healthy food, a new quality of traditional products (ships, grafted wood, textiles etc.). 4/13

KEY OBJECTIVES TO INCREASE EMPLOYMENT AND EMPLOYABILITY OF THE LABOUR FORCE An absolute priority of the economic policy is to increase employment, in particular to create favorable conditions for the employment of young people, women, and people living on islands and areas of special state concern, In order to enhance employability, the education system needs to be reformed and the permanent education of employees made possible, Extensive support to entrepreneurship must be available as the basis of progress and employment. PERMANENT MACROECONOMIC STABILITY AND SUSTAINABLE GROWTH to strengthen political and social safety, macroeconomic stability and economic growth in order to overcome negative world-wide impacts brought about by the global economic recession, to intensify, in line with the above said, the orientation of the Croatian economy towards improving its overall competitiveness and openness of with a view to achieve sustainable export-based growth, to ensure social and political stability. EXPORTS, COMPETITIVENESS AND INVESTMENTS economic policy will support new projects that are based on the exploitation of national resources, manpower and exports, which meet the trends and criteria of the world market (such as: production of organic healthy food, selective forms of tourism, wood and timber products, quality drinkable water), to further encourage domestic and foreign investments in the course of 2002 and to implement administrative and legislative changes in order to eliminate administrative barriers to foreign direct investments and more intense domestic investments. 5/13

MORE EFFICIENT ENFORCEMENT OF THE RULE OF LAW AND COMPREHENSIVE DECENTRALIZATION fast decision-making in the judiciary, efficient government administration, provision of quick and quality services in the public sector, strengthening of legal institutions and significant improvements in the efficiency of the bankruptcy procedure, the regularity of the payment of invoices and the settlement of liabilities as well as the resolution of criminal activities related to privatization, acceleration of the decentralization process in education, health, social welfare, local self-government units and state administration. THOROUGH REFORM OF THE EDUCATION SYSTEM reform of the overall education system focusing on the intensification of acquisition of new skills and the introduction of a flexible system for educating the work force, establishment of a life-long education system which relates to new technologies, products and business procedures, taking into account the alarming need for skilled personnel of an entrepreneurial and managerial, as well as economic and analytical, profile business schools will be set up at both state and regional level, reform of the University into a modern and integrated institution. INTENSIFIED HARMONISATION ACTIVITIES AND ACCEPTANCE OF EUROPEAN UNION STANDARDS In order to prepare for accession to the EU in a timely manner, all of the already proposed activities for the government institutions have to be implemented, amongst which are: implementation of measures set out in the Stabilization and Association Agreement between the Republic of Croatia and the European Communities and their member states, approximation of legislation with the acquis communitaire, implementation of macroeconomic policy measures aimed at achieving fastest possible fulfillment of EU conditions in terms of the Copenhagen criteria, 6/13

reform of state and public administration directed at establishing a system which can be the proponent of EU integration, development of human potential which can carry out the EU integration process. MACROECONOMIC ECONOMIC POLICY MEASURES 2002-2004 taking into account global circumstances, it is realistic to expect that GDP growth in 2002 will amount to 3-4%, while budget expenditures and other spending are expected to be on a lower end of that projection, social partners will agree a wage policy whereby wages will grow slower than labour productivity, foreign and domestic investments will be directed towards export-oriented entrepreneurs. ECONOMIC PLANNING MODELED AFTER EU AND TRANSITION COUNTRIES by June 30, 2002, the Government will develop a system of economic planning at state level and will set up a competent institution based on the practice of EU and other transition countries, securing the optimum of national interests in the course of development at large, relying on the "Development Guidelines of the Republic of Croatia" and 19 sectoral strategy documents, by the end of 2002, the Government will prepare an economic programme and plan of action which will serve as the basis for Croatia's EU accession process. FISCAL by 2004 the overall deficit will be decreased to comply with EU standards, with current deficit and borrowing also continuing that trend, the share of government expenditure shall further decrease in budgets for 2002, 2003 and 2004 from around 44% in 2001 to 37-38% in 2004, concurrently the budget deficit will decline from 5,3% in 2001 to 4,25% in 2002 and 1,4% in 2003, the 2002 budget will generate an increase of tax revenues of 4,5% to 5% i.e. 2,5-3 basis points less than GDP growth, and budgets for 2003 and 2004 will continue that trend of reducing the tax burden, 7/13

proceeds from the privatization will not be spent on the budget, but will entirely be directed towards stimulating development and growth, decentralisaton of public services and affirmation of local and regional governments will be intensified. MONETARY, CREDIT AND BANKING Government will ensure macroeconomic and price stability. Prices are expected to grow by approximately 5% in 2001, 4% in 2002, and 3,8% in 2003, while a 3% price growth is targeted for 2004, which will enable Croatia to comply with European standards, internal and external liquidity, and the stability of the Kuna exchange rate will be ensured, Croatian National Bank and Ministry of Finance will continue to harmonise monetary and fiscal policies and their instruments, policy of further lowering interest rates and of gradually conforming to EU standards will be pursued, the system of supervision and control of the operation of banks and the overall financial and banking system will be upgraded by encouraging savings and developing the system of insured savings in line with European standards, continuation of the pension reform, as well as other social reforms, will have an impact on the acceleration of the development of financial markets. EMPLOYMENT - INCENTIVE POLICIES Government of Croatia will further elaborate and implement an active employment policy, in particular in the scope of employment of young people, women and people who live on islands and areas of special government concern, relevant institutions will develop annual employment plans which constitute an obligation of each EU member state since 1998 (in the future, the development of such plans will represent a framework through which Croatia will utilise the European Social Fund), implementation of targeted regulations and activities will ensure the development of institutions and the flexibility of the labour market, relevant Ministries (Ministry of Labour, Ministry of Science and Ministry of Education) and the Employment Bureau will: systematically analyse the pattern of skills of the work force and its employability; asses the professional needs for 8/13

a competitive work force, particularly when it comes to new products and technologies, focusing on its implications for the education system and the enrollment policy of the universities. This will directly affect new proposals for changes in the organisational structure of the labour market, education programmes, programmes for additional training and acquisition of new skills and qualifications. Trade unions and associations of employers will play an active role in this process, organizational structure and functions of the Employment Bureau will be reformed: the Bureau will engage in mediation, consultancy and the preparation of annual employment plans, whereas the aspect of social policy, thus far performed by the Employment Bureau, will fall under the domain of the Ministry of Labour and Social Welfare. The role and status of the Employment Bureau will be brought into conformity with the EU system, and the regulatory framework will be set up in such a manner that the Employment Bureau will not have any institutional advantages in relation to other agents, in particular private employment agencies. The Employment Fund will be encouraged to gradually transform itself into a self-financing institution. COMPLEMENTARITIES BETWEEN EDUCATION AND EMPLOYMENT complementarities between the education system, science and employment will be developed in line with the EU norms and standards to ensure that education and science are steered in a direction that matches the needs of a modern labour market, as well as future labour forecasts. technological incubators will be established for the purpose of developing new technologies, patents and business solutions. Such incubators will partly be financed by the private sector and will serve as a location for the development of new technologies, as well as acting as a direct competition to state scientific institutions, adequate and stimulating working conditions will be provided for our most promising scientists in order for their knowledge to be used in Croatia. 9/13

COMPETITIVENESS AND EXPORTS Main economic priority of the Republic of Croatia is increased growth based on the export of goods and services, as well as increased competitiveness of Croatia and Croatian products. Therefore, a plan of action containing proponents and deadlines will be designed for enhancing the competitive capacity of the Croatian economy. The improved financial rating of the country, the reduction of investment capital related expenses, greater possibilities of raising capital under more favorable conditions, economic associations with other countries and integration within CEFTA, the EU and NATO all are important prerequisites for more successful exports. However, export-related problems are complex, systemic and soluble only over a longer period of time. Croatian economy is still a relatively closed economy and insufficiently competitive on the global market in terms of price and quality. Small and medium sized enterprises have not yet become the engine of an economic success together with the big, successful companies. Large state-owned companies are still not privatized and restructured. Imports of goods highly exceed exports. These facts underlie the following set of measures and policies. PRIVATIZATION AND RESTRUCTURING privatization and intensification of the structural adjustments of Croatian enterprises for achieving international market competitiveness will continue at a faster pace, preparation of large public enterprises for privatization will accelerate, which will have a two-fold effect: it will increase the profitability of public enterprises and will render them capable to adjust to modern market economy practices, in addition to privatization, systemic restructuring of public enterprises will play a key role in the overall strengthening of the national economy, with increased investments in acquisition of new skills and technologies made, and broadening of activities onto numerous sub-contractors takes place, support will be given to the development of entrepreneurship, entrepreneurial organizations and the utilization of potentials of certain sectors (industry, tourism, agriculture and other activities) and the strengthening of the role of certain cutting-edge companies on wider markets. 10/13

ENCOURAGING SMALL AND MEDIUM SIZED ENTREPRENEURSHIP institutions and activities which will provide quality infrastructure and support for medium and small sized enterprises will be developed and upgraded, and the coordination between these institutions and activities will be established, a system of financial support and stimulation (credits, subsidized interest) will be put in place, craftsmen and small and medium sized entrepreneurs will be enabled to operate under favorable conditions in unused business premises, central government, counties, cities and municipalities will develop a system of favorable conditions (surtax, payment for municipal services, access to unused business premises); furthermore, they will compete in attracting developmental programmes and entrepreneurs, establishment of developmental centers, free zones, business zones, technological incubators and business parks will be encouraged by the local authorities; these efforts will be financially and politically supported by the central government Ministry for Crafts and SME s will establish a system of market-oriented institutions which will mediate between banks and entrepreneurs, provide consultancy services, elaborate business plans, provide assistance in searching for investment funds, mediate in marketing related activities, conditions will be created in the overall entrepreneurial system which will enable individuals and companies with ideas and projects to successfully compete at all times for financial support for the realization of those projects, new Development and Employment Fund will be established which will, in addition to other sources of funds, be sponsored by the proceeds acquired through privatisation ENCOURAGING FOREIGN INVESTMENTS Ministry of Economy will establish a "one-stop-shop" agency for foreign investors which will provide all the legal and technical information to foreign and domestic investors; local self-government units will be encouraged to establish regional "one-stop-shop" institutions, this agency will urgently design an adequate guide to investing in Croatia which will familiarize the foreign investor with the investment process in Croatia, the investors' realistic possibilities, time limits for the duration of particular procedures, the system of appeals and procedures in acquiring licenses. The process of designing and collecting information for such a guide will also serve 11/13

as an insight into the conditions and circumstances for investing in the Republic of Croatia in order to safeguard us from those investments which are not in line with national interests. REGIONAL DEVELOPMENT regional differences in economic development will be reduced, in that in the period until 2010 differences between the most and the least developed regions will not exceed the proportion 2:1 (measured GDP per capita), during the same period, national policy will ensure the improvement of employment conditions and conditions in the health and education sector in less developed regions and will reduce present-day differences in comparison with developed regions by at least 25%, economic and social conditions in specific regions: border-areas, under populated areas with unused natural resources, islands, and areas which were particularly affected by the consequences of war, will be improved a new regional system, including the establishment of regional units and new institutions for regional planning which would become operational in 2003, will be established new-established regional system will be brought into conformity with the EU system, and the institutions for regional planning will be utilised to the greatest extent possible for the implementation of the regional employment policy, the regional policy will be structured and carried out in a manner which will enable Croatia to start using EU regional development funds as soon as possible, Croatian Government will establish a Commission for regional development and policy making. Together with the institutions for regional planning the Commission will, amongst other tasks, propose economic policy measures aimed at fulfilling regional policy objectives, counties, cities and municipalities will be active agents in implementing regional policies and will encourage accelerated development by means of various incentives. State-level support will be provided to those regional self-government units which themselves make investments in order to encourage growth and development, in proportion with their realistic capabilities. 12/13

RULE OF LAW social and political stability, as well as the efficient protection of proprietary rights and contractual relations, are prerequisites for an advanced society, Croatia as a modern and successful society means an open, civil society with know-how, personal initiatives and accountability as the foundation of a socially responsible state that is governed by the rule of law ensuring ecologically sustainable economic growth within a global context, however, without efficient rule of law it is impossible to strengthen market economy, to ensure positive privatization effects, to achieve full international integration, long-term development is not possible, nor is the resolution of economic problems, the Parliament and the Government will undertake measures by the end of 2001 and onwards which will improve the judiciary system, and make the state and public administration more efficient in relation to both the private and public sector. Some of these key policies will include: redistribution of specific workloads from some courts to others, as well as the demarcation of court cases from judicial cases which would entail the reduction of the workload and cases which require the engagement of judges, and can therefore be carried out by persons with a university degree in law and persons with an associate degree in law, updating and harmonisation of land books and cadastral books which constitutes a key process for the economic growth. For this purpose a special division within the Ministry of Justice will be established to deal exclusively with these issues, bankruptcy procedures will be simplified and shortened as a way of preventing those enterprises that have no perspective of becoming profitable and efficient from receiving subsidies and slowing down the economic reform process. 13/13