Inflation on the Threshold

AIM Zagreb, 16 February, 1999

Is inflation coming back to Croatia? Five years after it successfully stopped it in autumn 1993, the regime is investing great effort to prove that such danger does not exist. "There is no reason for further decline of the kuna", Marko Skreb, governor of Croatian National Bank persistently repeats. It seems, however, that life is denying him day after day. At the most inconvenient moment for the ruling Croat Democratic Community (HDZ), in the election year, the exchange rate of the national currency started to weaken, while at the same time prices are hurruedly going up.

This is all far from the former hyperinflation which at the end of 1993 had reached more than 30 per cent a month with a corresponding decline of the exchange rate of the then Croatian dinar. Nevertheless, in the past few months even official statistics shows that the situation has been profoundly disturbed. In January, retail prices were already by 2 per cent higher than the 1998 average. At the same time, the exchange rate of kuna in relation to the German mark started to go down practically every day. Kuna is now worth less than ever in its short history since its introduction in spring 1994. It seems to people that only yesterday the exchange rate written on street tablets of numerous exchange offices was 3.5 kunas for one German mark. Nowadays, it is already 3.9 kunas.

The exchange rate is determined solely on the foreign currency market: higher demand than supply. At least for six months already, the National Bank is selling foreign currency reserves and thanks to that managed to keep up the appearance of stability until the end of last year. According to the data of known American Merill Lynch Bank, just in the second half of last year and just abroad, Croatian National Bank sold 330 million dollars. At the same time, the National Bank imposed the obligation on commercial banks to bring their foreign currency funds back into the country, so its foreign currency reserves formally remained the same. In this way, the supply on the foreign currency market is increased almost by sums of 50 to 75 million dollars each week, which slowed down the decline of the kuna, but it could not be stopped.

Increased demand of foreign currency is only the result of payments of large instalments of foreign loans, and not of revival of industries. This year's instalment is 850 million dollars of principal and 400 million of interest. Inflow of new loans has at the same time been diminished, so for the first time Croatia is in the position that instalments of old loans are higher than the inflow of new ones. The total debt now exceeds eight billion dollars which means that, per capita, it is twice higher than the former Yugoslav debt from the time of the greatest indebtedness crisis in the beginning of the eighties. Of course, this figure refers only to the principal. With interest, experts report, the debt exceeds 15 billion dollars.

Reservation of foreign creditors is explained primarily by political reasons the essence of which was manifested in a detail of recent talks between a joint delegation of the UN, the European Union and OSCE, which studied the problems of human rights in Croatia, and president Franjo Tudjman. To his tirade customary for such occasions about Croatia having been in Europe from times immemorial, one of the members of the delegation, German Freimuth Duve, bluntly replied: "My country has also always been in Europe, but during 12 years during which Nazis were in power, it was not!" Within living memory in Croatia, nobody from abroad has ever uttered such sharp criticism of the regime, that is so openly compared it with Nazism. After that, nobody in Croatia should be surprised by a change in the attitude of foreign financiers.

But along with political, there are also serious economic reasons for that. Foreign creditors not without reason fear that Croatia soon will not be able to pay back its enormous debts. The problem is not only in high indebtedness, but even more in the manner in which the loans received so far have been spent. They were not invested into production which could create an income for returning them. They are invested only in roads and tunnels, and everything else is spent on enormous military and other state expenditures.

In the past few months, Croats employed abroad have been sending less money, too. Normally, the inflow amounted to about 1.7 billion marks a year, partly from foreign pensions and partly from workers' remittances. However, after seven Croatian banks have already run into great difficulties - but especially after a large sum of money from Croatian diaspora has remained frozen in one of them, Glumina Bank - confidence in domestic banking system is quickly melting. When there is no certainty, even interest, though higher than anywhere else in Europe, means nothing. Money is kept abroad, only aid is sent to families in Croatia. Why should Croatian workers abroad, who have earned every penny they have with great effort, act differently than Croatian tycoons who have taken great sums of money out of the country.

As soon as the foreign currency exchange rate of kuna has started to go down, the prices in this country have started to soar into the air. Their rise was mostly checked by competition of imported goods, cheap because they used to be bought with cheap foreign currency. Inflation was also slowed down by the citizens who directly do their shopping abroad, and Croatia has such borders that shops are close to almost everybody: in Italy, Austria, Hungary, B&H, and lately even in Yugoslavia. That this hindered inflation was clearly shown by price movements of services which had gone up by 20 to 30 per cent even without foreign competition. For example, television subscription has gone up by 120 per cent since inflation has been checked, and so did the toll on highways. Prices of public services and certain power sources, gas, for example, have also gone up quickly.

It is interesting that weakening of the kuna has concerned even the Croatian economists, bankers, entrepreneurs and opposition politicians who had been trying to prove that the exchange rate had been unrealistic; that overestimated kuna was convenient only for importers and smugglers, while it was disastrous for export and therefrom for production. It is clear to everybody that change of foreign currency rate in itself would not increase Croatian export, because after a number of years during which production has been systematically destroyed, nothing could help it any more. Years would be needed in more favourable conditions for the export industries to recover. But all negative effects of devaluation of the domestic currency would show immediately.

Apart from inflation, business operation of the already badly shaken banks would be seriously disturbed because they would not be able to collect most of the given loans. Almost every one of them includes the provision on foreign currency, meaning that in conditions of accelerated inflation and even faster rise of the price of foreign currency, repayment of loans would become practically impossible. This would not destroy only enterprises and banks, but also majority of the citizens who had purchased their housing units in instalments or took loans for cars and other commoidities. All that with the provision on foreign currency, of course.

That is why nowadays, in politically sharply divided Croatia - in which the sharpest and the most obvious conflict between the ruling HDZ and the opposition since introduction of the multiparty system is going on right now - there is full agreement concerning one point. Foreign currency rate must be defended no matter at what price. But that price is the change of policy which would enable Croatia to show to the international community and foreign investors that Croatia has become a country worth dealing with. The price is also reduction of excessive state taxes levied on the economy which are nowadays the main motive forces of inflation. The current regime, burdened by its nationalistic, expansionist aspirations, and at the same time deeply sunk in bureaucracy, luxury and corruption, has neither the force nor the will to do it. That is why independent political analysts in Croatia nowadays believe that change of the regime is not just the question of democracy, but that of very survival.

MILAN GAVROVIC