IMPACT OF THE PUBLIC DEBT OF THE REPUBLIC OF CROATIA ON THE CROATIAN EXPORT SECTOR

Transcription

1 IMPACT OF THE PUBLIC DEBT OF THE REPUBLIC OF CROATIA ON THE CROATIAN EXPORT SECTOR Helena Miloloža Marina Šunjerga: IMPACT OF THE PUBLIC DEBT OF THE REPUBLIC OF CROATIA ON THE CROATIAN EXPORT SECTOR Abstract Helena MILOLOŽA, M.A. Faculty of Economics & Business Zagreb, Republic of Croatia Marina ŠUNJERGA, M.A. Vecernji list, Zagreb, Republic of Croatia The competitiveness of the Croatian export must be observed in the context of public and external debt of the Republic of Croatia. Increased government spending generates public debt on domestic and foreign markets. State debt on the domestic market limits the private sector s access to capital. With high amounts of debt on foreign markets, the state affects the increase in the risk premium for Croatia at the national level, which increases the price of money and reduces the return on investment. This in turn significantly affects the export sector and limits the financial capacity for technological innovation. Exposure of the state to the debt in foreign currencies causes a restrictive exchange rate policy based on a fixed exchange rate. This prevents economic operators from using exchange rate policy as leverage. For an EU economy outside the euro zone, such as Croatian, this could play a key role in the battle for price competition on the EU market. Public debt has been growing fast since 1999, and rapidly since the crisis began in Borrowing is financing public spending not covered by revenue budget, which serves to maintain the current economic model based on state and para-state sector, existing from the expansion phase of the economy up until 2008, which relied on large infrastructure projects financed with public money. The decline in budget revenues during the crisis was tried to be replaced with higher tax burden, which resulted in a drop of competitiveness of the private sector and disturbances on the money markets. The high cost of government 478

2 borrowing has resulted in high interest costs that, in the medium term, will amount to about 3 percent of GDP, which will adversely affect the competitiveness of the economy. Keywords: public debt, export, competitiveness JEL Classification: F34, H6, E6 1. INTRODUCTION General government debt of Republic of Croatia and its rapid growth in the years of the financial crisis, significantly affected the access to and cost of capital for other sectors of the economy, especially for the sector of the economy abroad and on the domestic market. Refinancing obligations at the beginning of the crisis especially in 2009 and 2010 took place on the international and domestic market at very unfavorable conditions with yields higher than the 6 percent as in the medium term significantly increased expenditures for settling interest. Consequence of government spending to pre - crisis level was the rapid growth of general government debt and the growth of government debt part in external debt, which by the end of 2014 exceeded the level of 100 percent of GDP. External debt in the years of crisis stagnated as a result of deleveraging of the private sector and monetary institutions, while the amount of external debt is growing. On the domestic market government is borrowing more and faster and the share of external debt in general government debt during the crisis fall from more than 41 percent to a level of 37 percent. The fall in tax revenues, which occurred due to the crisis and decline in business volume and lack of liquidity, which is enhanced due to the crisis shock, the government attempted to substitute with the reduced allocations for investment. After a decade of intense government investment in infrastructure, savings in public spending are generated in the period from 2009th to 2014th mainly in the capital investment. The public sector tried to compensate the drop in tax revenues, with higher tax rates and new forms of para-fiscal levies. In circumstances where the local economy is highly dependent on government spending and public procurement which amounts to more than 40 billion, it takes about 15 percent of GDP, and the high cost of capital, which is difficult to access private companies, the competitiveness of export and investment in the development of technologies is extremely volatile and dependent on exter- INTERDISCIPLINARY MANAGEMENT RESEARCH XI 479

3 Helena Miloloža Marina Šunjerga: IMPACT OF THE PUBLIC DEBT OF THE REPUBLIC OF CROATIA ON THE CROATIAN EXPORT SECTOR nal shocks, and is further threatened by the fact that of the goverment taxes increase the cost of the product and further lower its competitiveness in the regional and European level. As a result, the dynamics and structure of public debt is inseparable from the debate on the competitiveness of the export sector. Correlation between public debt and economic growth is an issue that divided economic policy at the two poles: first part of economic science advocated the growth of the fiscal deficit in favor of boosting economic growth, while on the opposite side advocated the view according to which growth in the debt limit economy. The financial world crisis, especially Europian debt crisis has given the right to economists who advocate fiscal balance and a moderate deficit. Braeuninger (2002) used Romer-Lucas model of endogenous growth coming to the conclusion that after a certain public debt to GDP ratio, the growth of public debt negatively affects economic growth. Kumar and Woo (2010) explain that based on empirical results, we can prove that the growth of public debt to GDP ratio of 10 percentage points, slowing GDP growth at an annual rate of 0.2 percent even with the impact on the less developed economies somewhat modest. Cost of interest also negatively affects the development of the economy, and Clements, Bhattacharya and Nguyen (2005) argue that growth allocations for the payment of interest by 1 percent of GDP reduces public investment by 0.2 percent of GDP. They stress, however, that borrowing on the international market does not exclusively have negative consequences including the external debt lower than 35 percent of GDP and the external capital generally leads to increased competitiveness, however, if the external debt increased, as in the case of Republic of Croatia and if exceeds choice for 170 percent, Pattillo, Poirson and Ricci (IMF 02/69) show that rapid growth reduces the expansion of the economy almost to a 1 percent of the gross national product. In the first part of the paper, we process the structure and growth of public and external debt from 1999 to 2014, while in the second part of the paper we analyze the impact of debt on economic competitiveness, with an emphasis on the export sector and the impact of excessive deficit procedures and procedures of macroeconomic balance to the load of the export sector in the medium term. 480

4 2. THE GROWTH AND STRUCTURE OF PUBLIC AND EXTERNAL DEBT 2.1. GENERAL GOVERNMENT DEBT FROM 1999TH TO 2014TH Croatian Public Debt over 15 years has increased 5.5 times. Its growth should be divided in two cycles: the cycle of borrowing to finance infrastructure projects from 2000 to 2008, and the cycle of borrowing in times of economic crisis of 2009 th th Most of the total public debt refers to central government while local units participate with less than 5.5 billion of the total amount of debt, that at the end of 2014 exceeded 265 billion. Intensive government borrowing begins with undertaking major infrastructure projects in late 2000 and in the period before the crisis, despite the relatively high rates of economic growth, general government debt has doubled to billion. Given the growth rates of more than 3 percent a year, public debt during this period was sustainable. The global financial crisis and recession adversely affected the fiscal balance in Croatia. In six years the debt has increased 212 percent, to billions kuna, with nearly 140 billion invested in the renovation of the deficit in the state treasury caused by a fall in tax revenues, despite changes in tax policy during which the tax rate increased as the general tax burden of the economy. The dynamics of growth of public debt of Croatia, follows the economic theory that investment in debt encouraging public investment brings a positive effect in the short to medium term while in the long term has negative implications for economic growth and competitiveness of the economy. INTERDISCIPLINARY MANAGEMENT RESEARCH XI 481

5 Table 1. General government debt Republic of Croatia in the period 1999 th th Helena Miloloža Marina Šunjerga: IMPACT OF THE PUBLIC DEBT OF THE REPUBLIC OF CROATIA ON THE CROATIAN EXPORT SECTOR Year General government domestic debt General government external debt Total Domestic warranty of Central Goverment Foreign warranty of Central Government , , ,9 26, , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,8 Source: Croatian National Bank General government debt of Republic of Croatia grew faster than the expansion of the economy. Infrastructure investments were accelerated economic growth in the short term in the mid-2000s, but the allocation of public funds, financed by borrowing on domestic and foreign market in public investment, took away funding the real sector, while the redistribution of public debt in favor of investments in infrastructure resulted directly in lower rate of economic growth after the mid - term increase in GDP driven by personal consumption. High growth rates of GDP in the period from late 2005 to 2007 can be correlated with the increase in disposable income part of citizens, and which is directly related to the money invested in public investment, but it is partly due to the acceleration of foreign demand for goods and services from Croatian. The period of high growth rates in Europe and other export markets of the Croatian economy withdrew production in Croatia. The public sector was unprepared for the financial crisis to customize personal consumption and for the reforms, so it is evident that the negative GDP growth rates and increased need for financing the deficit resulting with rapid growth of public debt. 482

6 Table 2. Croatian public debt to GDP movements Year Growth of public debt GDP Growth billion HRK % ,2 3, ,2 3, ,0 5, ,2 5, ,7 4, ,2 4, ,8 4, ,8 5, ,3 2, ,9-7, ,9-1, ,3-0, ,8-2, ,8-0,9 Source: Croatian National Bank and the Central Bureau of Statistics, author s adaptation 2.2. EXTERNAL DEBT OF THE REPUBLIC OF CROATIA IN THE PERIOD FROM 1999TH TO 2014TH The external debt of the Republic of Croatia at the end of 2014 reached the level of percent of GDP, according to the forecasts of international financial institutions by the end of 2016 will bring a level of 115 percent of GDP. Since the beginning of the financial crisis, foreign debt has stagnated at about 46 billions of euros as a result of two opposing processes. The public sector, with an emphasis on the central government, increased external debt intensively while the real and financial sector during the crisis continuously discharged. Government increased foreign borrowing during the entire period and as from 2004, more faces to domestic money market, share of general government in external debt was maintained at a moderate level until the beginning of the financial crisis of In the period from 2009 th to 2014 th, the structure of external debt was changed and the state was becoming a generator of foreign debt. During the six years the government has increased the external part of the debt for 5.4 billions of euros, and 2014 ended with a share in the external debt of percent. INTERDISCIPLINARY MANAGEMENT RESEARCH XI 483

7 Table 3. External debt in the period from 1999th to 2014th Year General Goverment Central Bank Financial Institutions Other Sectors Foreign Direct Investment Total Helena Miloloža Marina Šunjerga: IMPACT OF THE PUBLIC DEBT OF THE REPUBLIC OF CROATIA ON THE CROATIAN EXPORT SECTOR ,9 219, , ,4 297, , ,9 216, , ,6 578, , ,8 215, , ,0 534, , ,9 23, , ,4 672, , ,9 365, , ,4 905, , ,6 2, , , , , ,5 2, , , , , ,8 2, , , , , ,8 2, , , , , ,5 2, , , , , ,9 332, , , , , ,0 357, , , , , ,9 360, , , , , ,9 351, , , , , ,9 421, , , , , ,4 444, , , , ,5 Source: Croatian National Bank, the author s adaptation The real sector and financial institutions, after a cycle of intensive financing, is gradually discharged. Domestic banks have stimulated economic growth with intensive financing from the beginning of 2004, when they began to borrow more on foreign markets. Debt of the financial institutions culminated in 2011, when a strong deleveraging of the financial sector started. Foreign sources of capital in total liabilities, climax had in 2006, when they amounted to 29% in April 2006, but by 2012 the share of foreign capital began to decline. In the first months of 2013 they fell to a level of less than 18% and in August 2014 reached a historic low level of 15.1%. This was a result of the continued deleveraging of domestic banks and reduced need to find resources to fund new loans, which will continue throughout the medium-term period ahead. The real sector was also in the process of deleveraging, and since the beginning of the financial crisis has reduced the exposure to debt by 10 percent. The private sector is still in the process of deleveraging, and the expectation of slow economic recovery and further growth of unemployment, further discourage investment and consumption, and the demand for credit Therefore, in the next year, we can expect weak lending activity and continued deleveraging of credit institutions abroad. 484

8 Deleveraging companies may be due to the contraction of the economy and reduced personal spending, which discourages the private sector from further investment, but in Croatia is closely linked with the conservative policy of the banking sector, caused by the degree of difficult collectible receivables, amount of that in the last quarter of 2014 stopped at 30.3 percent of loans. Deleveraging may be the result of government borrowing if the growth of public debt is unsustainable. If the private sector is financially limited, as it was the case because of problems in banks in developed countries in the last crisis, the government s borrowing and prudent fiscal adjustment that avoids expenditures cuts will have a positive impact on the economic recovery (Baldacci, 2013). On the other hand, if private financial constraints are not strong, sharper fiscal adjustment on the expenditure side, can restore fiscal credibility and encourage the private sector to increase demand. This will replace a government savings with new cycle of private debt (Alesina and Ardagana, 2010). Croatia has a stable banking system and high capitalization of banks, but to trigger a new cycle of indebtedness of the real sector it is necessary fiscal adjustment of public finances, which is deferred over four years. 3. THE IMPACT OF PUBLIC DEBT ON ECONOMIC GROWTH AND EXPORT Economic science has identified that public sector borrowing as a result of the allocation of public funds in the investment, can have a positive impact on the competitiveness of the economy in the circumstances of sustainable public debt. Maastricht criteria suggest that the amount of public debt above 60% of GDP and public sector deficit above 3.5%, require a response from the goverment in the direction of consolidation of public finances. The Croatian government in the current year is planning deficit at the level of more than 5.2 percent, while the public debt will exceed 83.5 percent of GDP Croatian accession to the excessive deficit procedure and the procedure of macroeconomic balance will enhance the external pressure on the significant reduction in public spending, which would in 2015 have to be reduced to a minimum of 0.5 percent of GDP in order to regulate the deficit of the state treasury. The circumstances in which the fiscal adjustment takes place, that are mostly affected by the parliamentary elections, suggest that the government will another year keep public spending INTERDISCIPLINARY MANAGEMENT RESEARCH XI 485

9 Helena Miloloža Marina Šunjerga: IMPACT OF THE PUBLIC DEBT OF THE REPUBLIC OF CROATIA ON THE CROATIAN EXPORT SECTOR at the same levels despite pressure from the European Commission. Paper on the political and economic impacts on the state budget in the industrial democracies (Roubini, Sachs 1989) says that the growth in the deficit has been caused by a problem in the political management in coalition governments. The biggest problems arise in governments where junior coalition partner has a veto power over changes, said the researchers. The problem which was detected on the basis of empirical research can be seen in Croatia. Continued government spending without structural reforms will continue to have a negative impact on economic growth and on investment. The continued decline in private consumption and the expectation of continued consumption of the public sector at a level that is above the income capacity, strengthens the role of export activities in the context of economic recovery and exit from the perennial crisis cycle. Export characteristics of the Croatian economy are not satisfactory as illustrated by the continuing trade deficit. Table 4. Foreign trade of the Republic of Croatia Source: YEAR FOREIGN EXCHANGE The share of imports in GDP millions of USD (%) ,9 41, ,3 41, ,9 36, ,0 39, ,7 41, ,4 43, ,4 44,3 Croatian exporters are the healthiest segment of the Croatian economy. Yet, only 13 percent of companies in Croatia are exporters, they employ half of all employees in businesses, generate 65 percent of total sales revenue, and they invest as much as 70 percent of total investment funds in development. The last twenty years Croatia has witnessed a steady trade deficit, and the share of Croatian exports of goods and services in GDP in ranged percent. In the countries of Central Europe, which are in direct competition to domestic 486

10 exporters, share of exports in GDP ranged percent, in the Czech Republic percent, and in Hungary percent. Croatia is quite behind in relation to the Baltic countries, which are in 2012 exported an average of 80 percent of GDP. The dynamics of growth of Croatian exports is lowest of all EU countries. Croatian products are mainly with low added value and can not be compared with the products of technologically developed countries, that have had a lot more knowledge and technology (Kovač, 2012). Croatia is located on the 37th place according to the production complexity among 124 countries, and only 6.4 percent of Croatian exports are in the first, the most complex category of production, while 65 percent are categorized in the lowest level of production complexity - the fourth, fifth and sixth stands in the Action Plan for the promotion of exports adopted by the Croatian Government in May For comparison, the share of products of secondary and higher degree of processing in 1987 amounted to 67 percent, and in 2010 only 28 percent of total exports. Domestic companies have failed to take a strong position on foreign export markets. Croatia expressed extremely negative trends in exports of goods and by the end of 2012 managed to return only at the level of merchandise exports recorded before the global crisis, which points to the continuing problem of competitiveness. Croatian share of merchandise exports in GDP was in 2012 just 22.8 percent, while the average of EU - 27 amounted to 33.8 percent. In the structure of Croatian exports there is only a small proportion of high complexity products and prevailing unfavorable ratio of the share of industrial products and the share of primary products. The low level of processing in this category leads to a lower contribution or participation in the gross domestic product, which now stands at 19 percent - which is considerably less than the average in Central Europe by 55 percent and South - Eastern Europe by 34 percent. Weak industrial production, low level of technology and innovation and low spending on research and development are the main causes of this situation. The reasons for the weakness of the Croatian exports are manifold, and the consequences of de - industrialization of the economy, lack of competitiveness INTERDISCIPLINARY MANAGEMENT RESEARCH XI 487

11 Helena Miloloža Marina Šunjerga: IMPACT OF THE PUBLIC DEBT OF THE REPUBLIC OF CROATIA ON THE CROATIAN EXPORT SECTOR arising from higher cumulative increase in prices of domestic inputs, low rates of investment in research and development work, a large number of smaller companies that rarely associate in the appearance on the market, more difficult access to capital and unfavorable cost of financing in credit institutions, and the lack of infrastructure or the practice of alternative forms of financing investments, and in many ways it is derived from the high public debt, which results in high cost of capital and squeezing out private sector credit activities. Despite the historical period of low interest rates in the global capital markets, Croatia is still paying a high price of a debt above 3 percent as a result of the high risk premium for the whole country. In countries that compete with domestic exports, such as the Czech Republic, that risk premium is much lower and that draws the interest of public debt below 1.5 percent. Thus the Czech economy, only through the price of financing, gets precedence over the Croatian products, and additional gap creates differences between the tax burden and the numerous incentives that Croatia does not have the fiscal capacity. Table 5. Movement of investments and tax revenue budget YEAR TAX REVENUES INVESTMENTS billion HRK billion HRK ,14 56, ,68 59, ,47 71, ,23 78, ,57 83, ,68 67, ,95 48, ,42 46, ,69 44, ,04 45,14 Source: Croatian Chamber of Economy, Ministry of Finance, the author s adaptation Investments of companies in fixed assets for the first time fell below the level of tax revenue during 2010, after the state began to substitute the loss of revenue with the new tax levies and thus reduce consumer spending and demand for the products in times of intense financial crisis that affected the decrease foreign demand. 488

12 Strengthening the revenue side of the budget continued throughout the crisis, so that VAT increased twice, 2009 and 2012, with a final rate of 25 percent, narrowing the tax brackets in the income tax, introduced and abolished the crisis tax, telecommunication operators in more repeatedly paying additional levies as a contribution to the crisis, and companies are directly loaded with new tax form - tax on dividend and payments of profit and rigorous control of the collection of tax liabilities that marked 2012 and CONCLUSION Countries with high public debt to - GDP ratio and the high rate of interest payments in the medium term can stimulate the economy, but in the long term such a model negatively affects the competitiveness of the domestic economy, in particular, its export sector. Kumar and Woo (2010) demonstrated that the growth of public debt to GDP ratio of 10 percentage points slowing GDP growth on an annual basis by as much as 0.2 percent while the impact on the less developed economies is somewhat modest. Interest rates also negatively affects the development of the economy, and Clements, Bhattacharya and Nguyen (2005) argue that growth allocations for the payment of interest by 1 percent of GDP reduces public investment by 0.2 percent of GDP, which is visible in Croatian example. Increasing the tax burden in the short term leads to generous tax revenues, but in the medium term and especially the long run, causes a reduction in the tax base and the taxation of consumption is eroding domestic demand, as in the case of Croatian resulted in continuous budget deficit above 5 percent and recover about 3 percent of GDP for the interest payments. The withdrawal of the public sector from infrastructure projects and reducing public spending, frees up capital for the private sector, on the basis of which the growth of investments in technological equipment which leads to the growth of competitiveness and long - term economic growth. The reduction of public spending in the short term can lead to restriction of access to public services or smaller employee benefits in the public sector, but in the medium term, sustainable economic growth increases the fiscal capacity of the state. INTERDISCIPLINARY MANAGEMENT RESEARCH XI 489

13 Helena Miloloža Marina Šunjerga: IMPACT OF THE PUBLIC DEBT OF THE REPUBLIC OF CROATIA ON THE CROATIAN EXPORT SECTOR LITERATURE Aizenman, J.; Kletzer, K.; Pinto, B. (2007), Economic Growth with Constraint on Tax Revenues and Public Debt, University of California, Santa Cruz Damir Novotny: Public and External Debt of Republic of Croatia EKONOMIJA / ECONOMICS, 14 (2) pages (2008) Ivan Kovač: Analysis of International Trade in Goods of Republic of Croatia , Economic review, Vol. 63, No 1, february the 2nd 2012 Braeuninger, M. (2002), The Budget Deficit, Public Debt and Endogenous Growth, Universitaet der Bundeswehr Hamburg. Kumar and Woo July 2010 Public Debt and Growth, IMF Clements, Bhattacharya i Nguyen Can Debt Relief Boost Growth in Poor Countries?, IMF Pattillo, C.; Ricci, L.; Poirson, H. (2002), External Debt and Growth Finance and Development, A Quarterly Magazine of the IMF, Vol. 39, No 2. Baldacci, Gupta, Mulas - Granados Fiscal Affairs Department Debt Reduction, Fiscal Adjustment, and Growth in Credit-Constrained Economies November 2013 Alesina, Ardagna, Large Changes in Fiscal Policy: Taxes Versus Spending, Roubini, Sachs, Government Spending and Budget Deficits in the Industrial Countries, Economic Policy, Vol. 4, No. 8 (Apr., 1989), pp