Now that the Government had some time to settle in, we believe it is time to do some stock taking. In measuring how far the Government got by now, we might be able to see how far it is likely to go over the next couple of months. About a month ago, PM Plenkovic said “if this was honeymoon, nobody will want to get married any more”. This was apparently in reference to all the perceived abuse his cabinet was subject to while trying to tackle their first big projects – the budget and the tax reform package.
In the end, the budget was adopted without much trouble although some questioned its optimism since it was based on higher than expected growth. In the meantime, latest figures seem to have justified the optimism and the World Bank and the EC have joined in adjusting their growth forecasts upwards.
The tax reform caused a bit more stir. The Government claimed it would relieve the businesses from much unnecessary burden and, in particular with the income tax changes, enable the employers to keep the best and the brightest. But the critics claimed that took from the poor to give to the wealthy, and effects of the most controversial part are yet to be seen as the VAT on tourism increases from 13% to the full 25%. In a country where tourism accounts from between 18%-20% of the GDP, this is a significant figure which could heal the budget or sink the most important branch of economy.
Then came the neighbors. Under the legacy of the previous two governments and various veteran issues, the relatively new Government did not manage to significantly improve relations with any neighbors, and relations with Bosnia and Serbia seem decidedly worse. On the credit side, relations with Slovenia and Hungary do not appear any worse than before. But most concerning in the immediate surroundings are the clearly deteriorating relations with the Federation of Bosnia and Herzegovina, where Croat cries for the “third entity” continue to alienate the Bosniaks to the loud cheering from Banja Luka. In addition, the Government seems to have mishandled the arrest of HVO soldiers, where it oscillated between cries “you cannot treat us this way” and claims that Croats liberated Bosnia, without any clear political response in sight. In the end, things went the expected way – the HVO soldiers will stand trial, and Croatia will continue to insist it was not the aggressor in the Bosnian war. But the whole episode was unnecessary and should not have been allowed to reach such proportions.
Relations with Serbia seem to have bottomed out for now as both sides for now seem content with “peaceful coexistence”. Historical precedents indicate that this will change for the worse when needed by either side (for purposes of elections, for instance).
From the outset it seemed that the Government’s biggest problem will be lack of political experience, and some tainting by association by the sitting President who keeps running into unnecessary gaffes. This seems to be a particular problem when it comes to dealing with far-right extremism. Currently, two main streams are running prominent in the Croatian political space – the anti-choice catholic conservatives, and the devotees of the World War II Nazi puppet regime of Independent Croatia (NDH). So far, it seems that the first group enjoys at least some support from the current cabinet as at least the MFA Stier appeared as speaker at some Christian conservatives’ events. Normally, this would not be a problem that requires particular mention but in this case it seems to be shaping a large portion of the Government’s political agenda so it bears watching in the near future, together with the Government’s relations with the Catholic Church in Croatia.
But the NDH devotees are a more important problem that won’t go away as much as the Government keeps burying its head in the sand. There are plaques, inscriptions, stadium chants and other attempts to introduce NDH symbolism into the political mainstream, and it seems to have encouraged at least some violence so far (one person was killed in Zagreb by a veteran allegedly for being a minority and a former communist, and there have been several serious incidents involving minorities). Combination of these two seems to have raised the political temperature significantly, if not yet to the boiling point. The GoC decided to get rid of the later problem by establishing a Committee, which should recommend a position on “all totalitarian regimes”. We believe this response to be inadequate, and see this as evidenced by the recent march of neo-Nazis in Zagreb who swore allegiance to the US President Trump, and other minor events occurring daily. This will be a topic of further comments later in the week.
And then came the economy: First the body blow of the INA ruling, with the Government losing the case against MOL. The case basically said that MOL acquired more rights in INA through corruption of the former PM Sanader, and that therefore contracts allowing that should be considered null and void. The Court of Arbitration did not agree with the GOC, and thus the INA saga started. Although it is unclear how much the damages would be, some articles in 2014 spoke of 3-4 billion Kuna that the GoC might have to pay to MOL under two other disputes where MOL’s standing has just improved greatly with this rulling. And the GoC decided, with no apparent reasoning behind it, that the way out of this predicament is to buy out MOL whatever the cost. The only publicly available justification is the one the GoC provided to the Parliament when the opposition demanded an explanation. And this justification quotes the SDP data for 2011-2015 where INA lost 37% of its revenue, processed 21% less oil, EBITDA went down by 60% and from Kn 1.8 billion in net profits in 2011 went to Kn 4.8 billion in losses, its fixed assets lost 30% of their value, and the appreciation exceeds investment. So the GoC decided to buy back INA to stop this process of deterioration.
We must confess that to us, this reasoning seems somewhat opaque. It seems from the above and some public comments that INA requires quite a bit of handling, including possibly a sizeable investment. The GoC intended to find the money by selling 25% of the HEP, as started by the previous government. But when it became clear that the money that could be obtained for HEP would be nowhere near sufficient just for the purchase, let alone the investment, the whole issue dropped from the public eye.
In the meantime, the GoC further hit HEP by deciding it must bear the costs of maintaining the price of gas for households at the 2016 level. The GoC explained that the price of gas should rise because the price of gas rose in the European market. But as any energy-related web site shows, this is not quite true. Prices did rise slightly over the past couple of months but remain significantly lower than, for instance, two years ago. So it seems that the price hike is more closely related to some deregulation efforts that recently came into force. Be that as it may, the GoC asked the HEP to maintain prices, and HEP negotiated lower prices with INA, its main supplier. However, HEP’s market position was damaged by this move as it is estimated that it will have to cover anything between EUR 30 and EUR 70 million in losses on gas sales this year alone.
Coupled with the INA problem, the GoC seems to have inherited a sizeable health sector bill estimated up to two billion Kuna. A cursory glance at the budget does not reveal where this loss would be covered from, so any number of scenarios seem possible including running more debt and possibly returning the national health insurance back under the treasury. This would be seen as a step back in consolidating the notoriously leaky health sector.
And on top of all that came the Agrokor issue. A few weeks after PM Plenkovic returned from Ukraine, where he caused protests from the Russian Federation for his offer to help Ukraine reintegrate its eastern territories on the basis of Croatian experience, the RF ambassador to Zagreb came out with an eyebrow-raising statement. He claimed that Sberbank, the RF Government-owned bank, supported Agrokor so far but is well aware of troubles the company is facing and will no longer continue to fund it except under extraordinary circumstances. About a month later, his Pythian words became clearer as the press started claiming that Agrokor owes some EUR 2.5 billion to Sberbank alone, and maybe up to Kn 50 billion in total to various creditors and suppliers. The GoC resorted to its standard rhetoric of “we are following the situation closely, no need to panic”, and in the meantime the Russian creditors came to Zagreb to demand control of the company or their money back. And backed this up with further EUR 300 million emergency loan to give Agrokor some breathing space until it consolidates.
The main trouble there is that Agrokor alone accounts for about 15% of the Croatian GDP, employs anywhere between 35,000-45,000 people and keeps an estimated total of some 150,000 breadwinners gainfully employed. Of course, collapse of a company that big would cause a major crash with unforeseeable consequences for the entire Croatian economy. This was demonstrated at the end of last week when several Agrokor companies (normally considered blue chip at the ZSE) dropped 10% or more dragging the market index 3% down in a single day.
To us, this looks like someone with a foresight used the gargantuan need of a particular company for money to create a position from which to dictate terms to that company and all depending on it. Consequently, Sberbank is now in a position to dictate terms to most of the Croatian economy. As it is owned by the Russian Government, and as the Russian Government has previously shown a penchant for using economic leverage for political purposes, it seems that Mr Todoric managed to get the Croatian Government in a fix. And this might have a bearing on a number of issues where Croatia and the RF don’t see eye to eye, including Croatian position on some multilateral matters. We believe political stability to be more important, but on that opinions will certainly differ. We also believe this demonstrates how dangerous it is to allow a company to grow too big to fail. Why exactly Croatia’s market and financial regulators did not react when the company was growing this big, and when a bank got so exposed to a single client, is a different issue.
Although INA’s stake in the GDP is currently hard to estimate, it seems that at stake are tourism, with a minimum of 18% of the GDP, Agrokor with further 15% of the GDP, and INA. If INA is anywhere near Agrokor, those two companies alone could affect a quarter of Croatian fragile economy in a blink. This is not a good prospect.
On the bright side, most of the rating agencies have finally raised Croatian ratings and changed the outlook to stable. This enabled the MoF to quickly refinance EUR 1.3 billion at 3.2%, saving hundreds of million on interest payments. And the Croatian economy continued to grow at an unexpected rate, with everyone and their brother claiming credit for increased investment, consumption and other good things that come to those who wait for cycles to turn. Although it is impossible to say whose achievement this growth is, it is an achievement nevertheless. But it is yet to be seen if the Croatian economy is on a general path to recovery and INA, Agrokor and the like are just final coughs after a long cold, or if the bubble of optimism can burst when hit by such heavy blows.
So in conclusion, the first couple of months seem to be colored by the GoC looking for its political sea legs, and taking some serious body blows on economy and dealing with political legacy issues. But the situation keeps getting more complicated, and it will become increasingly hard to navigate between various rocks. The GoC so far has proven itself steady, if not a particularly inspired (or inspirational) helmsman. Whether that will be enough is anybody’s guess.