Multilateral investment guarantee agency performance and learning review



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Document of

The World Bank Group
Report No. 106507-HR


INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT
AND INTERNATIONAL FINANCE CORPORATION
AND MULTILATERAL INVESTMENT GUARANTEE AGENCY
PERFORMANCE AND LEARNING REVIEW
OF
THE FY14-17 COUNTRY PARTNERSHIP STRATEGY FOR
THE REPUBLIC OF CROATIA


Croatia Country Office

Central/Southern Europe and Baltics

Europe and Central Asia Region
The International Finance Corporation

Europe and Central Asia
The Multilateral Investment Guarantee Agency

CURRENCY EQUIVALENTS

(Exchange Rate as of June 30, 2016)

Currency Unit = Croatian Kuna (HRK)

US$1.00 = 6.75355 HRK



FISCAL YEAR

January 1 – December 31



ABBREVIATIONS AND ACRONYMS

ASA

Advisory Services and Analytics

LROs

Land Registration Offices

COs

Cadastral Offices

M&E

Monitoring & Evaluation

CLR

Completion and Learning Review

MOST

Bridge of Independent Lists

CPF

Country Partnership Framework

MSMEs

Micro Small and Mediums Sized Enterprises

CPS

Country Partnership Strategy

NPL

Non-Performing Loan

CSR

EU Country Specific Recommendations

PCG

Partial Credit Guarantee

CHF

Swiss Francs

RF

Results Framework

DH

District Heating

R&D

Research and Development

DLI

Disbursement Linked Indicator

SCD

System Country Diagnostic

DPO

Development Policy Operation

SDP

Social Democratic Party

DPL

Development Policy Loan

SPSMP

Social Protection System Modernization Project

EBRD

European Bank for Reconstruction and Development

SME

Small and Medium Enterprise

EC

European Commission

SOEs

State Owned Enterprises

EDP

Excessive Deficit Procedure (EDP)

M&E

Monitoring and Evaluation

EFIL

Export Finance Intermediation Loan

PforR

Program for Results

ERDPL

Economic Recovery Development Policy Loan

PPP

Public Private Partnership

EU

European Union

RAMP

Revenue Administration Modernization Project (RAMP)

FDI

Foreign Direct Investments

RAS

Reimbursable Advisory Services

GDP

Gross Domestic Product

R&D

Research and Development

GHG

Green House Gas

SCD

Systematic Country Diagnostic

GEF

Global Environment Facility

STP2

Second Science and Technology Project

HBOR

Croatian Bank for Reconstruction and Development

TA

Technical Assistance

HERA

Croatian Energy Regulating Agency

WBG

World Bank Group

HDZ

Croatian Democratic Union

WPP

Wind Power Plant

HRK

Croatian Kuna







IBRD

International Bank for Reconstruction & Development







ICRR

Implementation Completion and Results Report







ICR

Implementation Completion Report







ICT

Information and Communication Technology







IFC

International Finance Corporation







IOTA

International Organization of Tax Administrators







JPR

Joint Portfolio Review
















IBRD

IFC

MIGA

Vice President:

Director:

Regional Manager:

Task Team Leader:

Cyril Muller

Arup Banerji


Andrea Kucey/Carlos Pinerua

Dimitris Tsitsiragos

Tomasz Telma

Thomas Lubeck

George Konda/Magdalena Soljakova



Karin Finkelston (VP & COO)

Dan Biller (Acting)


Gianfilippo Carboni









PERFORMANCE AND LEARNING REVIEW

OF THE COUNTRY PARTNERSHIP STRATEGY

OF THE REPUBLIC OF CROATIA
TABLE OF CONTENTS


I.Introduction 1

II.Main Changes in Country Context 1

III.Summary of Program Implementation 4

IV.Emerging Lessons 11

V.Adjustments to CPS and Future Engagement 12

VI.Risks to CPS Program 14

Annex 1: Updated CPS Results Matrix 16

Pillar I: Fiscal Adjustment through Reforms at the Sector Level 16

Annex 2: Matrix of changes to original CPS Results Matrix 19

Pillar I: Fiscal Adjustment through Reforms at the Sector Level 19

Annex 3: Matrix summarizing progress towards CPS Objectives 23

Pillar I: Fiscal Adjustment through Reforms at the Sector Level 23



  1. Introduction




  1. The World Bank Group (WBG) endorsement of the Country Partnership Strategy (CPS) in June 2013 coincided with Croatia’s membership as the 28th country to join the European Union. (EU). The program supported Croatia’s efforts to maximize the benefits of EU accession, including access to European Structural and Investment Funds and opportunities to strengthen institutions. The FY14-17 CPS focused squarely on the most pressing challenges to improving the country’s growth prospects: the need for fiscal adjustment and to enhance competitiveness. These themes remain strategically relevant today.




  1. At the time of the CPS, the challenges facing the Croatian economy required a strong structural reform agenda and ownership, including to meet EU Country Specific Recommendations (CSR), which proved to be increasingly difficult in the lead up to the political transition. The WBG program supported government efforts first with the ERDPL2, and also through analytical work. Croatia’s economic fundamentals have improved since the approval of the CPS and economic growth returned in 2015 for the first time since the 2008 crisis. The expectation is that growth will continue at a gradual pace, however advances on structural reforms will depend on political developments, including the results of upcoming snap elections, called for by the Croatian Parliament.



  1. The WBG program articulated in the CPS is on track to deliver results by the end of the FY14-17 period. The Performance Learning Review (PLR) introduces some modest adjustments to define expected outcomes with greater precision. Given a thorough understanding of development challenges and constraints could help Croatia unleash its full growth potential, the WBG will focus efforts during the remaining year of implementation on the preparation of the Systemic Country Diagnostic (SCD). The SCD will provide an input for informing national policies, lay the foundation for the future Country Partnership Framework (CPF), and allow for a tighter alignment of the WBG program with the Twin Goals.




  1. Main Changes in Country Context




  1. Accession to the EU implied additional responsibilities that tested the capacity of government to deliver. At the time of CPS delivery, the country was led by the Social Democratic Party (SDP) in a coalition Government with a stable majority. After an active reform effort, with WBG support, the administrative capacity for effective policy design and implementation of complex reforms came under stress from a difficult political environment and the demands of trying to absorb a seven-fold increase in EU funds. While there were notable successes, the Government’s ability to build the consensus needed to accelerate the pace of reforms proved more challenging than expected, and continues to be challenging given political uncertainty.




  1. CPS implementation was affected by political developments related to an intense pre-electoral period and change of Government. Following elections in November 2015, further political uncertainty persists. A coalition government was voted in on January 22, 2016, consisting of two main partners, the center-right coalition led by HDZ (Croatian Democratic Union) and MOST, the Bridge of Independent Lists. The Government, led by the Prime Minister, Tihomir Oreskovic, formulated a national reform program that defines key strategic actions for this administration, including to promote macroeconomic stability, improve the business environment and investment climate, and to achieve public sector efficiencies and greater transparency. However, the Parliament was dissolved effective July 15, 2016, following a breakdown in the coalition. A technical government remains in place until a new Government is established after elections due in early September.




  1. Economic developments, while not as positive as anticipated in the CPS, reflect an improvement in fundamentals that are underpinning the modest recovery in growth. Post accession Croatia has improved its fiscal position, the current account balance, and maintained a stable financial sector. In 2015, following a six-year recession, the country began its gradual recovery with an annual growth rate of 1.6 percent. Growth was led by external demand, helped by the EU recovery, and revived private consumption boosted by oil and food price declines, income tax changes and an improving labor market.




  1. Fiscal vulnerabilities declined in 2015 as a result of concerted efforts in 2014, including on tax collection and the public sector wage bill. The general government deficit in 2015 declined to 3.2 percent of GDP (on an accrual basis) from 5.5 percent in 2014. Public debt rose further to 86.7 percent of GDP. The fiscal situation remains an important concern, and in combination with low potential growth rates has been one force behind the downgrades of the sovereign credit rating to two notches below investment grade status. The European Commission (EC) maintains a close oversight on fiscal outcomes, and is working with the Government to meet Excessive Deficit Procedure (EDP) targets over the medium-term.




  1. The financial sector remains stable, despite high Non Performing Loans (NPLs) and an environment of corporate and domestic deleveraging. Lending activity declined by 2.9 percent in 2015 led by accelerated corporate deleveraging in the non-financial sector which reduced domestic borrowing. Households reduced their liabilities to the banking sector as well by 1.5 percent, after the conversion and partial write-offs of Swiss Francs (CHF) loans. In September 2015, the Government adopted a law on the conversion of CHF loans to euro denominated loans, which is estimated to result in bank losses in 2015 and fiscal revenues foregone in 2016 of 1.41 and 0.2 percent of GDP, respectively. NPLs at 16.6 percent slightly declined compared to 2014 as the sale of non-performing assets to factoring companies took off. According to Central Bank stress tests, the domestic banking sector is resilient to external shocks. The capital adequacy ratio, at 19.9 percent in September 2015, is well above the regulatory minimum of 10 percent, although the high NPL overhang has an impact on economic growth.




  1. The external position has been in surplus since 2012. The current account balance recorded a surplus of 5.2 percent of GDP in 2015. The largest contribution came from a reduced deficit on the income account. Strong tourism sector performance that underpinned a large surplus on services, while EU transfers further strengthened the external position of the country. The trade balance deteriorated despite a strong export growth in pharmaceuticals, ships, car parts, foods and electricity, led by the recovery of EU demand and Croatia’s integration into global supply chains.

Table 1. Macroeconomic Indicators2



  1. The combination of high labor costs and stagnant productivity is limiting the growth potential of the economy. The increase in labor costs has been largely driven by collective bargaining in a disproportionately large public sector, including public enterprises. While productivity has been largely stagnant since 2006, the unit labor costs increased substantially up until 2009 and culminated in job destruction and higher unemployment rates, in addition to the cyclical factors. Despite moderation since 2010, the average wage level in 2014 is still misaligned with productivity performance and is higher than in its EU peers (like Hungary and Poland, for example). At 16.3 percent in 2015, unemployment remains relatively high. Addressing structural reforms for a well-functioning labor market, as well as public sector, are likely to emerge as a high priority for new administration.




  1. Growth and job creation will be the prime determinant for poverty reduction and shared prosperity. Poverty hit a high of close to 10 percent in 2014, as measured at $5 PPP a day. As growth gradually recovers, poverty is expected to decline to 8.4 percent in 2017 and further to 7.7 percent in 2018, based on current growth projections. Labor market improvements have helped reduce poverty, in particular through the service sectors (tourism, construction and professional services). Still labor force participation at 52.7 percent in 2015 is among the lowest in the EU, and presents a strong determinant of low household incomes and greater vulnerability to poverty3. Further labor market improvements should improve unemployment rates, which is affecting disproportionately the bottom 40 percent4.




  1. Investment in Croatia continues to contract as a result of structural constraints. Since 2009, the share of domestic investment in GDP dropped from 25 percent to 19 percent in 2015, although it is expected to recover in the next several years underpinned by greater EU fund absorption. While the level of exports has been increasing, Croatia remains a relatively low intensity export economy (48 percent of GDP, compared to 77.8 percent in Slovenia). Before the global crisis, the country relied heavily on domestic consumption and public sector investments. Corporate investment has still not recovered, as companies struggle with high debt levels (despite efforts to deleverage) and the business environment and high labor costs imply a high cost of operation, hurting their competitiveness and capacity to increase their exports in markets with growth potential. State-Owned Enterprises (SOE) tie up a disproportionate part of economic resources and operate at lower productivity and higher cost than private companies, spreading inefficiencies through trade linkages and through a distortion in wage levels. It would seem that there is still significant untapped potential in the private sector, which bears further exploration.




  1. The modest economic recovery is expected to continue in 2016-2018 with growth averaging 2.1 percent a year. This estimate is based on assumptions of stronger private consumption, export growth and investment due to improved absorption of EU funds. Private consumption is expected to grow reflecting labor market recovery, increased consumer confidence and a slowdown in deleveraging. Stronger utilization of EU funds, along with recovered FDI in tourism and car supply value chain industries and service sectors (expected at the level of 3 percent of GDP on average per year in 2016-18) will boost investment. Government consumption is projected to remain subdued in light of the need for fiscal consolidation under the Excessive Deficit Procedure (EDP) with the EC. Future growth prospects will be further explored as part of the SCD, which will identify reforms with the potential to increase resilience, reduce vulnerabilities and accelerate the pace of the convergence process.




  1. Summary of Program Implementation




  1. The proposed CPS program presented a unique opportunity to maximize the benefits of Croatia’s EU membership to develop the country’s economic potential. The two major constraints to development identified in the CPS, notably the need for fiscal consolidation and to stimulate economic growth, remain relevant today.




  1. Three thematic areas comprise the strategic pillars and form the basis of the CPS Results Framework (RF): (i) fiscal adjustment through reforms at the sector level; (ii) innovation and trade competitiveness for growth and shared prosperity; and (iii) helping maximize the economic benefits of becoming an EU state.


Pillar I. Fiscal adjustment through reforms at the sector level


  1. Activities within this pillar targeted primarily measures to improve efficiency within tax administration, targeting of social assistance programs and rationalization of the health sector. Progress has been made in this pillar, particularly as many outcomes were frontloaded and are now being monitored for sustainability.




  1. The Government has made good progress in revenue mobilization with the contribution of the Bank’s Revenue Administration Modernization Project (RAMP) centered on tax efficiency and improved compliance. The indicator for the RF was the tax gap as a percent of total GDP, and at the end of 2014 this had improved to 2.5 percent from 2.7 percent in 2012. Improvements in revenue mobilization will continue to be monitored, but in the absence of a tax administration project, another credible alternative source is needed to track progress.5 The Bank will remain engaged in a dialogue on taxation to ensure gains made by the government during the first half of the CPS are sustained.




  1. The Government is seeking to improve efficiency in its social programs. This includes more robust targeting of social assistance programs, including expanding the share of mean-tested programs. Bank support has been through ERDPL2 and will continue through a Social Protection System Modernization Project (SPSMP) approved in September 2014. Good progress has been made to date. The share of means-tested social programs in overall central government social spending increased from 16.1 percent in 2012 to 17.2 percent in 2014. The SPSMP operation primarily focuses on realizing administrative efficiencies in the social sector.




  1. The CPS identified improving the quality and efficiency of health spending as a critical goal to ensure sustainability of the sector. Croatia’s public health spending is relatively high compared to the EU average, and the country’s ageing population will mean higher demand for health services while a decrease in the working age population will decrease revenues for health given a payroll-based financing system. This means Croatia must deliver better value from its health spending by improving quality and efficiency. Persistent hospital arrears are a manifestation of the inefficiencies embedded in the current system of service delivery. In 2015, overall liabilities of the health sector grew and hospitals generated new arrears accounting for about 0.6 percent of GDP.



  1. The CPS Results Framework (RF) monitors progress towards rationalization and efficiency of the health sector with two indicators. The first was supported by the ERDPL2 and monitors total reduction in public accrued health spending. The CPS foresaw a drop of .5 percent of GDP in health spending on an accrual basis and this has been achieved.6 The Bank will continue to monitor sustainability during the remainder of the CPS period, including efforts to contain hospital arrears. To support efficiency improvements in the health sector, the Bank approved a Health PforR in May 2014. . This PLR proposes to replace the RF indicator on rationalization of hospital beds, an indicator that is not being monitored, with the Disbursement Linked Indicator monitored under the project, i.e., a reduction in the total number of acute care beds by 20 percent from 15,930 (2012) to 12,800 (2017). The first stage of the DLI was achieved and the 2017 target is expected to be reached by CPS completion. IFC has offered its help to the government to structure and implement PPP in the health sector to finance, plan, construct and maintain 6 new hospital buildings in one of the oldest university hospitals in Croatia. The Government decided to keep the project on hold due to early 2015 elections. After elections, the Government has reiterated its interest in the PPP in the health sector and asked for more time to assess the project.




  1. There is a strong dialogue on public finance. The Public Finance Review (2014) provided an analysis of options for fiscal consolidation. The Government followed up with a request for a Spending Review in 2015 to respond to EC Country Specific Recommendations. The Spending Review focused on five sectors and had a positive impact on the dialogue with respect to EDP, and remains a valid document to inform future efforts at the sector spending level. Seeking greater public sector efficiencies and opportunities for consolidation remains a relevant priority going forward, and the WBG is using a combination of its own-managed resources to continue the dialogue on macro structural adjustments.


Pillar 2. Innovation and trade competitiveness for growth and shared prosperity


  1. Objectives in this area include promoting public enterprise restructuring, strengthening the business environment and private sector led growth. Progress as measured by the Results Framework indicators is good; however expectations of a broader engagement, particularly in the area of State Owned Enterprises (SOEs), have not materialized to the extent articulated in the main text of the CPS.




  1. The CPS outlined an intention to promote public enterprise restructuring with an initial focus on transport and energy. Progress has been made on transport with WBG support. On energy, the Government has advanced the original CPS agenda in the right direction mostly on its own with institutional reforms, building on analytical work by the Bank; IFC has supported private sector investments in the renewable energy and transport sectors.




  1. The work on railways has the support of a newly approved project which will have its impact in the following CPF. During the remaining year of this CPS the delivery will focus primarily on the restructuring plans for the three railway companies and a medium-term strategy for the sector, linked to the funding from the EU. The indicator of a multi Modal Strategy is on track to be met by CPS completion.




  1. Achieving energy security and reducing greenhouse emissions, in support of the wider European climate objectives, are key priorities in the Government’s energy strategy. The CPS objective to contribute to diversity and security of energy supply is considered achieved. Specifically, an action plan for feed-in tariffs for renewable energy resources and for improving the efficiency of the district heating (DH) sector was adopted in 2013, with amendments in 2014 and 2015. Through its work on the Energy System Review, the WBG took stock of the methodology for feed-in tariffs, especially for district heating sector, and provided recommendations to HERA – Croatian Energy Regulating Agency. Some recommendations were accepted and adopted in the new tariff system, in particular for the DH. This included decoupling of establishing prices for DH – to be market-oriented and not to be government-influenced. A Note on Energy Vulnerability and ways how to mitigate the impact of potentially rising energy prices on the energy vulnerable was delivered. The Government is moving forward with positive improvements to rebalance energy tariffs and strengthen institutions, building on work the Bank prepared, but without direct Bank support. In a complementary manner, IFC supported Croatia’s climate change objective by investing $25 million and mobilizing $31 million from other financial institutions to finance a Wind Power Plant (WPP), which has been commissioned in 2016. This brings the total wind power generation capacity installed with IFC’s support—through its three active portfolio projects—to 108 MW, which constitutes a 50 percent increase in Croatia’s total wind power capacity since 2012. These IFC projects also contribute to the reduction of greenhouse gas (GHG) emissions with estimated 75,000 tCO2 avoided every year. This is below the original CPS target because an anticipated US$75 million sustainable energy finance project with a Croatian bank focused on renewable energy, has not materialized; the respective target has been revised accordingly.




  1. The CPS will retain its focus on the transport sector. The railway agenda remains highly relevant to ensure the financial viability of the sector. In the road sector, although facing challenges, IFC stays committed to support PPPs in the transport sector with its ongoing work in Bina Istra road concession and Dubrovnik Cruise Passenger Terminal concession. Since the Government plans changed, IFC will not provide PPP advisory services for the Brijuni National Park concession. Realization of IFC advisory and investments in PPP will depend on Government commitment to full implementation. In air transport, IFC has invested US$73 million in the Zagreb airport, aiming to expand the airport capacity by about 35% by the end of the CPS period, hence contributing to the development of the tourism sector, one of the major drivers of Croatia’s GDP and employment. More broadly, given the strong link between the restructuring agenda on transport and fiscal consolidation, this theme will be moved to the first Pillar to ensure a better fit.




  1. The CPS envisioned a strong role for IFC and the Bank in strengthening the business environment. In Croatia, the World Bank and the Agency for Investment and Competitiveness organized a workshop to present the key findings of the Doing Business Memorandum for Croatia. The Bank’s advisory services to improve the investment climate and decrease the costs of doing business are being discussed for the remaining CPS period. Croatia is also included in a list of countries where a Sub National Doing Business survey will be done with support of the EC. IFC’s regional Corporate Governance project promoted better corporate governance practices in the business sector, working closely with the Zagreb Stock Exchange on development of a corporate governance manual.



  1. The agenda on improving the efficiency and reducing the backlog of cases in the judicial system is on track. Such cases have been reduced from a baseline of around 437,892 in 2012 to 349,051 by April 2016, which exceeds the target in the project document of 394,103 by 2017.7 Disposition times for cases have also shortened. Significant contributions have been made to improving the pace and quality of work in courts, by automating and streamlining case processing. The Justice Sector Support Project is due to close in June 2016, but project activities should continue to have positive impacts after project closure, and the Ministry of Justice and courts remain committed to the reform agenda. The WBG will monitor progress towards the CPS target. The Integrated Land Administration System Project is also contributing to improving efficiency. Significant progress has been made in reducing transaction processing times in land registry and cadaster: from 46 to 17 days for land registries; and from 30 to 5.7 days for cadastres. The Real Property Registration and Cadastre Joint Information System is under implementation in 108 Land Registration Offices (LROs) and 112 Cadastral Offices (COs), and is expected to be rolled-out to the City of Zagreb Office for Cadastre and Geodetic Activities in 2016. Through the ERDPL2 the Bank has supported the reform of business registration as well as the construction permitting reform that led to an important improvement of the Croatia’s ranking on the Doing Business list.




  1. The WBG has been supporting successfully the financing of exports, including through the approval of additional financing of €50 million in 2013. Under the Export Finance Intermediation Loan (EFIL), the volume of medium-to long-term lending to firms under the project has increased, and it is expected to achieve the final targets by the closing date in August 2016. The level of exports of beneficiary companies under the EFIL rose by 20 percent, whereas employment rose by 4.5 percent in 2015, meeting the CPS target. Sustainability will be monitored going forward. The WBG also supported HBOR through the first ever Partial Credit Guarantee for a Financial Intermediation Project. The Guarantee project attempts to enable access to commercial markets by HBOR at more favorable terms including reduced lending rates and longer tenure. The first tranche of EUR 50 million was withdrawn in May 2016.




  1. IFC supported competitive local companies through investments in the financial sector, agribusiness and retail. In the financial sector, IFC has been implementing its strategic approach to support systemic banks to expand on-lending to SMEs. IFC provided US$68 million long-term finance to one of Croatia’s systemic banks to help target largely underserved markets such as the agri-sector and micro, small and medium enterprises (MSMEs). Through this bank, IFC has reached 5,400 MSMEs, which as of the end of 2014 had an outstanding balance of loans totaling to US$370 million; the relevant indicator was added to the results matrix. IFC has not seen opportunities for local currency finance as the Croatian economy remained heavily euro-ized and this is unlikely to change in the foreseeable future given the anticipated introduction of the Euro. In agribusiness, through the portfolio project committed during the previous CPS period, IFC continued supporting one of the leading domestic producers of food and personal care products and a leading distributor of consumer goods in South-Eastern Europe. In retail, IFC supported the regional expansion of one of the leading German retailers to Croatia. Both companies procure about 50 percent of their domestic purchases from MSMEs, which totaled about US$200 million in 2014.




  1. The WBG also continued work on enhancing the landscape for research, development and innovation in Croatia. Technical assistance contributed to the Government’s Smart Specialization Strategy, an ex-ante conditionality for the use of EU funds for research and development. The Government also signed a RAS agreement in April 2016 focusing on increasing competitiveness of clusters. Additionally the Innovation and Entrepreneurship Venture Capital Project was approved and aims to strengthen risk capital financing for innovative SMEs and startups in Croatia. This is with the overall aim of making the private sector more dynamic and competitive.



Pillar 3. Helping maximize the economic benefits of becoming an EU state


  1. The third pillar includes two objectives to support greater absorption of EU funds by enhancing the coherence of national strategies and by building solid project pipelines for EU financing. This Pillar reinforces the first two pillars, in that stronger national strategies contribute to fiscal consolidation, which enables the absorption of EU funds; and a strong project pipeline centered on areas related to competitiveness brings resources for the private sector to invest and contribute to growth. This is particularly relevant in science and technology, where there has been a sustained engagement.




  1. Good progress has been made on formulating sector strategies, with most completed at the time of this PLR. Sector strategies include: (i) National Education, Science and Technology Strategy – supported under the Second Science and Technology Project (STP2) and adopted by the Government and the Parliament in October 2014 – this is an ex-ante conditionality for the use of EU funds; (ii) National Innovation Strategy - prepared with contribution from STP2 and adopted in December 2014—responds to the Europe 2020 Strategy which sets clear targets for EU Member States for innovation agenda; (iii) Research and Innovation Strategy for Smart Specialization—, key ex-ante conditionality for the use of EU funds in R&D sector; (iv) National Research Infrastructure Roadmap—a document required by all EU Member States and an input for the Smart Specialization Strategy; and (iv) policy advice/recommendations provided under the EU Preparedness TA in the areas of public administration, irrigation, rural development, transport, SME and water/environment sector—e.g., peer review and analysis of the Partnership Agreement and Operational Program Cohesion and Competitiveness 2014-20; (v) National Technical and Economic Study for Management of Wastewater Treatment Sludge—prepared under the Coastal Cities Pollution Control Project 2 and an EU requirement under EU Landfill Directive and under the Sludge Waste Directive, adopted in 2014. A draft of the National Waste and Leachate Management Plan was also prepared under the Regional GEF Adriatic project which is a requirement under the EU Waste Management Directive. Under the National Reform Plan Technical Assistance, the Bank assisted in reviewing and providing recommendations for strengthening the policy coordination under the European Semester, designing reform proposals for strengthening social benefits targeting, as well as assessing fiscal, economic and social impacts of the national reform plans.




  1. The CPS indicators set with regard to building a pipeline of projects have been met by the time of this PLR. Specifically, at least 6 projects are on track for financing in R&D and innovation, in excess of €50 million. In nature protection, 15 projects for €50 million have been prepared to date. In judiciary, the Justice Sector Support Project prepared technical documentation for ICT projects to be funded using EU structural funds, as well as courthouse designs and technical documentation for the rehabilitation of four courthouses in the lagging regions. This will make an important contribution towards absorption of EU funds in the next programming cycle. The relevant instruments include the Second Science and Technology Project and the EU Natura 2000 Integration Project.


WBG Portfolio and Implementation Performance


  1. In terms of instruments, the CPS envisaged a maturing of the WBG program in the form of a smaller investment lending portfolio, a gradual increase in Reimbursable Advisory Services (RAS), and DPLs as the main instrument to support the structural reform agenda. As anticipated, new investment lending was frontloaded in the first half of the CPS period, with approximately $600m delivered. The RAS program has gradually increased to above €5.7 million, although not at the rate envisioned in the CPS. This is, in part, due to the timing of CPS approval towards the end of one EU programming cycle where Croatia had to manage several EU programming and accreditation processes in parallel.




  1. Most of the Planned Lending materialized as expected (see Table 2). However, following ERDPL2, which closed in FY15, opportunities for subsequent DPOs did not materialize, primarily as a results of political uncertainty in a pre-electoral period. The WBG remained engaged through dialogue and analytical work, like the National Reform Program Technical Assistance or the Macro-Fiscal Structural Dialogue TA, and is well-positioned to support critical fiscal issues. The DPL is an instrument that is appropriate for Croatia as it can help bring sectors together around common objectives (see Lessons Learned). Government also appreciates the role of the Bank as an honest broker to facilitate moving a complex agenda forward across Ministries and agencies. The new Government has expressed interest in a development policy operation which would likely build on progress achieved during the previous series.

Table 2: Planned vs. Actual Lending

Planned Lending8

(no volume forecast)



Actual Lending

(FY; $US Million)



Policy Support

ERDPL2

DPL *


Economic Recovery Development Policy Loan 2


2014

206.8

Program Support

Health Sector

Improving Quality and Efficiency of Health Services (Program for Results)

2014

103.5

Social Protection

Social Protection System Modernization

(IPF with results-based disbursement)

2015

95.55

Project Support

Railways

Sustainable Croatian Railways in Europe

2015

183.4

Venture Capital

Innovation and Entrepreneurship Venture Capital

2016

21.92

GEF Adriatic Sea

GEF Adriatic Sea Environmental Pollution Control Project (1) Croatia and Bosnia and Herzegovina

2014

4.3

Guarantee

PCG

Croatian Export Financing Guarantee Project

2013

256.4

Total

871.87

* DPL was envisaged contingent on continued reforms implementation.

  1. Since the beginning of the CPS period, IFC’s committed portfolio has grown by almost 40 percent while outstanding exposure almost tripled, pointing to the acceleration of disbursements. In total, IFC long-term finance commitments totaled US$ 200 million of which about US$30 million were mobilized from other financial institutions. In the financial sector, IFC committed a US$68 million loan to one of the main banks in the country to support its lending to the agribusiness companies and SMEs. In the infrastructure sectors, IFC provided US$130 million in financing, including funds mobilized from partners, to support the construction of new renewable energy capacity and the modernization/expansion of the main airport in the country. IFC portfolio in Croatia is performing well, with no NPLs. Still, it has been under constant pressure of being prepaid due to a low interest rate environment in the EU member countries. Although IFC has been trying to renegotiate the rates with some of its clients, two companies prepaid IFC loans for an amount of US$14.3 million.




  1. IBRD portfolio performance is uneven and project restructuring is common, with multiple extensions of closing dates and delayed achievement of results. In 2015, seven projects were restructured, resulting in six extensions. The implementation period of a Bank-financed project is on average six to seven years. The delays are sometimes project-specific; however, there are often crosscutting issues including: poor implementation readiness which results in low disbursements in the first years; ambitious infrastructure projects that face problems with large civil works components, and governance sector projects that struggle with design and implementation of complex information systems, such as in tax and land registry projects. The success of addressing issues is correlated with strong ownership within Government and with the Bank proactivity.



  1. MIGA’s (historical) exposure in Croatia was in the financial sector, supporting Western parent banks’ shareholder loans to their Croatian subsidiaries, thus addressing country risk management constraints of the parent banks and enabling continued availability of working capital for on-lending by their Croatian subsidiaries. Going forward, MIGA looks to re-engage in opportunities in the financial sector as well as various real sectors including, potentially, in the Croatian transportation sector.



  1. The CPS continues to feature a gender focus in implementation. The Bank’s Export Finance Intermediation Loan, the Second Science and Technology Project and the Partial Guarantee Project all include gender monitoring indicators. The most recently approved Innovation and Entrepreneurship Venture Capital Project (2016) is also gender-informed and includes disaggregated targets. An assessment of overall portfolio results related to gender will feature as part of the Completion and Learning Review (CLR).



  1. The WBG takes full advantage of citizen engagement opportunities. In terms of potential new lending, Croatia’s legislation requires any potential DPO follow a structured consultation process. The preparation of a potential transport project would also include a citizen engagement process. All of Croatia’s Implementation Completion and Results Reports (ICRR) include a stakeholder workshop and consultations to assess impact for beneficiaries, including surveys to capture broader results. Going forward the Country Partnership Framework (CPF) would be informed by a Country Opinion Survey and include broad in-country consultations among all groups of key stakeholders.




  1. Emerging Lessons




  1. The WBG is particularly well-positioned as a strategic partner in supporting structural reforms and as a source of technical assistance, which is confirmed by the client survey results. The Government continues to value the WBG as a knowledge provider, a source of international best practices, and advocate for change. In this context, the Government requested the Bank’s advisory services for the higher education finance reform aimed to support the line ministry and the higher education institutions to introduce the performance based budgeting, which has set forth the first RAS engagement in Croatia. Addressing constraints to growth and working towards fiscal consolidation, has been a long-term agenda for the country which the WBG has supported through DPOs and targeted analytical work. The WBG is also well-positioned to provide support at regional and local levels to help in EU Funds absorption and institutional capacity building. This focus should continue, with the Systematic Country Diagnostics (SCD) as an opportunity to provide valuable input on future directions for the WBG partnership and sharpen priorities to make the most of limited IBRD resources.




  1. High level ownership and strong coordination are critical for accelerating the pace of reform. Implementation of reform policies requires a high degree of coordination and a high level of joint ownership across government institutions. This has proven challenging in the past, and is likely to continue to be so for the remainder of the CPS period. While the WBG has played a successful role in bringing various government agencies around a common set of national priorities, in some cases this has taken longer than expected and calls for caution and a realistic approach in designing the scope of development reforms supported by the WBG.




  1. Strong ownership is also critical to improve and accelerate implementation of the Bank’s lending portfolio. Experience has demonstrated that ownership can be fostered through use of a project steering committee with high-level officials to actively provide strategic advice to project managers and serve as a decision-making body with a mandate to improve implementation and increase the likelihood of achieving development objectives. It can also be a useful tool to promote transparency, involve stakeholders and improve results for beneficiaries. The joint portfolio review (JPR) is another tool that could be used more strategically to address imminent project issues by adopting strict action plans and close monitoring. Finally, there are lessons to be learned in specialized government agencies, which tend to rely less on bureaucratic structures and have stronger accountability frameworks – which are conducive to resolving problems early on with involvement of relevant stakeholders.




  1. Adjustments to CPS and Future Engagement




  1. The pillars and objectives of the CPS remain valid and relevant, and the PLR proposes only modest adjustments. There are a few selected indicators which have been amended to reflect changes in instruments, the pace of implementation and/or availability of relevant data.




  1. Going forward, given the CPS refers to the strategic pillars with different formulations, for ease of reference and clarity the PLR proposes the following common language:

Pillar I. Fiscal Adjustment through Reforms at the Sector Level

Pillar II. Innovation and Trade Competitiveness for Growth and Shared Prosperity

Pillar III. Helping Maximize the Economic Benefits of Becoming an EU Member State


The paragraphs below summarize proposed amendments and additions to the FY14-17 CPS.
Pillar I. Fiscal Adjustment through Reforms at the Sector Level


  1. Within this Pillar the WBG focus on fiscal consolidation will continue to emphasize improving efficiency in public administration, revenue collection and social assistance and health expenditures, and to contain the fiscal pressure from SOEs in the transport sector. These are critical objectives to meet critical macroeconomic goals such as reducing the level of public debt. Efforts to improve absorption of EU funds, in Pillar 3, also benefits from fiscal consolidation given the need to secure fiscal resources for co-financing of EU-funded projects. Given the objectives, the Pillar has been reformulated to better reflect efforts to enhance efficiency.




  1. Some modest amendments to indicators are proposed within this Pillar. Given the Project in support of improving tax administration (RAMP) has closed, support for maintaining the gains in the efficiency of revenue collection will continue through policy dialogue. In order to monitor sustainability of results already achieved the PLR proposes tracking progress for the remainder of the CPS period through the recurrent reporting of the Croatia Tax Administration to International Organization of Tax Administrators (IOTA) on tax effort.




  1. There is no adjustment needed with respect to the Social Assistance objective.




  1. The Bank remains deeply committed to increasing the efficiency of the health sector and will continue to work through The Health System Quality and Efficiency Improvement PforR, whose focus is on the efficiency of the existing health network and improving the health of all of the population, with special attention of the bottom 40 percent. The CPS results framework indicator has been replaced with the comparable DLI of the project, related to the number of acute care beds. Given the focus on efficiency during the remaining years of implementation, the objective has been revised to “introducing cost rationalization and efficiency measures in the health sector”. The Bank will continue to monitor arrears in the sector and support sustaining gains related to reducing health expenditures as a percentage of GDP.


Pillar II. Innovation and Trade Competitiveness for Growth and Shared Prosperity


  1. The WBG will remain active on the themes and objectives outlined in the CPS under the competitiveness pillar, which remain relevant to promote growth. The PLR proposes to sharpen the results in this area during the remaining CPS period.




  1. Work on promoting public enterprise restructuring during the remainder of the CPS period will focus exclusively on strengthening the performance of the railway sector, and not tackle other public sector enterprises. Given the project supporting this objective seeks to improve the financial sustainability and operational efficiency of the public rail sector, it is proposed that this objective be moved under Pillar 1. Fiscal Consolidation. On energy, no new additional support is envisioned at this time, and the objective related to energy is considered achieved. The Government continues to advance reforms of the sector which have been informed by analytical work developed in collaboration with the Bank.




  1. Given the low growth environment and a very slow recovery of the corporate sector investments, as well as Croatia's access to the EU Structural and Investment Funds for municipal infrastructure investments, IFC projections for an increased engagement in Croatia will not materialize. Therefore, IFC is revising the expected investment program during the CPS cycle, from up to US$600 million to up to US$400 million. IFC will continue to look for opportunities to support solid local export oriented companies, to increase SME access to financing, to promote foreign investors and transfer of know-how and technologies, to support private sector investments in the infrastructure sectors, and to help Croatian companies to expand their market and invest in the region. IFC will also be open to explore opportunities in municipal finance, but only if they are not being targeted through the EU Structural and Investment Funds.




  1. Regarding the support for SMEs through access to finance, the work under the Export Finance and Intermediation Loan will be closing in August 2016. The Bank will monitor the performance of the exports of beneficiaries and use the lessons of the long-term engagement in supporting the export sector through available financing to inform the design of the next CPF. The Croatia Export Financing Guarantee project although approved in 2013 has taken time to take off, due to the novelty of the instrument. Immediate efforts will go into finalizing all of the requirements so that these guarantees are available to private exporters in Croatia. As noted, unless market conditions change, IFC will not offer products in domestic currency. Therefore, no changes in the original indicators are warranted.




  1. The “Innovation and Entrepreneurship Venture Capital” project was approved in 2015 for the purpose of strengthening the risk capital financing for innovative SMEs and startups. The project will provide financing for sequential stages of the innovation life cycle – both at the seed stage, through a co-investment fund, and at the following stage of early commercialization, through a public-private venture capital fund. These two components will be complemented with a technical assistance aiming at capacity building and networking activities in support of the key stakeholders identified in the project (HAMAG-BICRO staff, investors, entrepreneurs and experts). The expected closing date of the project is September 30, 2021. Results are expected to materialize in during the next CPF.




  1. In addition, the RAS “Cluster’s Competiveness in Croatia” at a value of €4,9 million that was signed with the Ministry of Economy is expected to commence June 01, 2016. It aims at strengthening the country’s competitiveness in selected Global Value Chains, assisting in the implementation of Competitiveness Cluster Initiative in selected Priority Thematic Areas and Sub-thematic Priority Areas as defined under the Croatia’s Smart Specialization Strategy (S3), adopted by the Government in March 2016. Activities under total of five components will be carried out: Strengthening the capacity of beneficiaries and partners; Strategic analysis and competitive positioning; Action plans and policy design; Design of Academy for Industrial Development; Monitoring and Evaluation of Clusters Initiatives implementation. Further, with the Justice Sector Support Project due to close in June 2016, the Ministry of Justice has expressed interest in a follow-up RAS to build on the project’s results and continue targeted reforms that improve efficiency of justice, particularly for SMEs.



Pillar III. Helping Maximize the Economic Benefits of Becoming an EU Member State


  1. The focus on absorption of EU funds remains a priority, particularly to enhance growth prospects and improve service delivery for the bottom 40 percent. Efforts will continue for preparation of sector strategies, meeting EU ex-ante conditionality and identifying a strong pipeline of projects. The RAS instrument has proven to be a relevant tool in this respect in other EU member countries. The Poverty Mapping RAS (EUR0.6 million) will develop small area poverty data as well as develop indicators of material deprivation for small areas that would help in identifying local regional development projects for EU funding under the Operational Program for Competitiveness and Cohesion. The EU Water Sector Project, foreseen under the CPS, will not be delivered in the CPS period.




  1. The SCD will serve as the basis for the WBG’s future engagement in Croatia. The preparation of the SCD will identify key constraints for Croatia to reach its growth potential and advance towards the Twin Goals. Shared Prosperity will remain elusive without higher levels of growth to launch employment generation and create opportunities for the bottom 40 percent. Greater clarity on the actions needed to stimulate the economy in a tight fiscal environment will facilitate this process. The findings of the SCD will be leveraged for greater impact and results through a tight alignment with the next Country Partnership Framework (CPF).




  1. Risks to CPS Program




  1. The macroeconomic risks identified at the time of the CPS are still valid and are rated substantial. External factors such as the slowdown in the world economy or tightening of the capital markets could still undermine the country’s fragile economic recovery. Domestic vulnerabilities, although not specifically highlighted in the CPS, remain significant as well. There are also some perceptions that political uncertainties, including calling for early elections, could impact the macroeconomic framework. Potential DPO support for public finance reforms which has been discussed, could help mitigate macro-fiscal risks. The WBG is engaging with the authorities on its reform program and could consider scaling-up support with DPO financing in the future, if appropriate. Since the CPF program was front-loaded, the expected delivery of CPS results is not substantially affected. The emphasis on public sector efficiency remains an important agenda and the Bank will continue to provide support through dialogue and technical assistance.




  1. Implementation risks identified at the time of the CPS are valid and rated substantial. Risks to the outcomes relate to capacity for implementation. As mentioned in the CPS, delivery of the WBG program, particularly in supporting sector reforms, requires coordination across sectors, ministries, with the private sector and among various levels of government. As noted in Section III. Emerging Lessons, implementation delays related to portfolio performance will require close monitoring and high level ownership. Mitigation measures will focus on improving portfolio performance and monitoring sustainability. The latest political developments which include dissolution of Parliament and a technical government in place until September elections, do not pose a substantial risk to the implementation of the WBG program. The CPS has less than one year left of implementation, and most of the progress towards objectives has been achieved. In particular, several outcomes related to the structural reform agenda were front-loaded as part of the DPL and will continue to be monitored for sustainability.



  1. Overall risk to CPS outcomes is assessed as moderate.


Annex 1: Updated CPS Results Matrix


Pillar I: Fiscal Adjustment through Reforms at the Sector Level


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