Croatia to slash bank reserve rate, eye ERM-2 in 2012

Reuters

1/26/2010

Croatia`s central bank plans to cut banks` reserve requirements by up to three percentage points this 
year, releasing funds worth $1.75 billion to boost lending and growth, Vice-Governor Boris Vujcic told 
Reuters on Tuesday.

In a rare interview, Vujcic also urged the government to move straight into the pre-euro exchange rate 
mechanism if Croatia joins the European Union as expected in 2012 -- likely signalling an early bid for 
euro membership.

He said the bank would slash the required reserves its mostly foreign-owned banks must hold from the 
current 14 percent during 2010, boosting an economy that shrank around 6 percent last year and is expected 
to contract another 0.5 pct in 2010.

Governor Zeljko Rohatinski had hinted in December at possible cuts in the rate to boost lending but 
policymakers had given no indication of the scope being considered.

"We are ready to gradually cut the reserves requirement by up to three percentage points, which amounts 
to 9 billion kuna ($1.75 billion)," Vujcic told Reuters in an interview.

The government, hoping for mild growth this year, has set up special funds to help businesses get loans 
at lower interest rates, with risk shared by the state and the private sector. More than 90 percent of 
Croatia`s banks are foreign-owned, most notably by Unicredit, Banka Intesa SP , Societe Generale and 
Raiffeisen.

"The key condition is that the loans are not used for retail consumption or fixing banks` balance sheets 
but for the corporate sector," Vujcic said.

"We have to see how this will develop and we`ll revise our growth forecast accordingly. We should see 
some effects already this year and even more in 2011."

At a time when many EU states have run up huge budget shortfalls, most notably in nearby Greece, the 
Balkan state`s budget gap is just 2.5 percent of gross domestic product and public debt only 33 percent 
of GDP by EU standards.

Vujcic said the government should have little trouble refinancing its debt this year, but its public 
and private sectors have together run up foreign debt worth almost 100 percent of Croatia`s GDP, making 
overall indebtedness and funding for further loans a bigger issue.

EURO ZONE BENEFITS
Vujcic said the government should not seek to raise the budget deficit to boost the economy as some 
central and eastern European states have done to take advantage of Brussels structural funds around EU 
entry.

"We already have a high tax bite, high subsidies, high public spending. So the government should seek 
to decrease state spending and refinancing needs in the medium term," he said.

The former Yugoslav republic aims to complete talks on joining the EU this year and join at the start 
of 2012.

Vujcic said the country, where most local loans are indexed to the euro, should stick with its current 
managed float of the kuna currency before applying to join ERM-2 immediately upon EU entry. Countries 
have to spend at least two years in the currency grid before being assessed for euro membership.

"The stable exchange rate has served us well. It will not change and should enable us to join the ERM-2 
without problems. How fast we apply is up to the government but I see no reason for Croatia to delay," 
he said.

Of the 12 mostly ex-communist states that have joined the EU in the past decade, only Slovenia, Slovakia, 
Cyprus and Malta have adopted the single currency.

Baltic states Estonia, Latvia and Lithuania joined the ERM-2 immediately after EU entry. Estonia is 
expected to be the first of them to adopt the euro in 2012 and is seen as a test case for other hopefuls 
like Poland, Hungary and the Czech Republic.

Most analysts say Croatia will not adopt the euro until 2015 or 2016. Joining ERM-2 in 2012 would put 
it on track to be approved for membership in 2014 and join in 2015.

"After joining the eurozone, currency risk is eliminated and borrowing costs are substantiallly reduced. 
Credibility effect, as witnessed in previous cases, is very strong," Vujcic said.