30 October 2006

Star entrepreneurs but an unreformed state sector

By Eric Jansson
Published by Financial Times, 30 October 2006

This summer's bidding war for Pliva, a generic drug maker, marks how Croatia's top companies have attained global standards.

The rival bidders, Barr Pharmaceuticals of the US and Actavis of Iceland, pushed the price to $2.5bn before Barr won this month.

Bruce Downey, chairman and chief executive of Barr, spoke of the combination of "two great companies". Rarely do western investors describe acquisitions in central Europe or the Balkans in such glowing terms.

But Croatia is an exception, with several large comapnies.

Pliva, listed on the London and Zagreb stock exchanges, boasts the largest turnover of any drug maker in central and eastern Europe.

Podravka, a food pro- cessor, claims a hefty market share in eastern Europe, where its Vegeta brand spice is a household name. State-owned Uljanik, a shipyard, claims a significant share of the world market for car- transporters.

The growth of such companies, backed by strong performances by small and medium sized businesses, helped gross domestic product rise 6 per cent in the first half of 2006, up from by 4.2 per cent in 2005.

Unemployment remains uncomfortably high at 14.3 per cent, but is falling and is at its lowest level since 2000. Central bankers are keeping inflation low, despite soaring oil prices.

New arrivals are surprised at the appearance of wealth in a country whose economic reality has normalised faster than its international reputation.

World Bank economists say the country has adopted a genuine reform path, as indicated by a raft of legislation adopted to cut administrative hassles.

In a survey last month, they rated Croatia seventh in a list of the world's top reforming economies. The former Soviet republic of Georgia was placed first.

But difficulties persist. The same World Bank survey included a list of "countries where doing business is easiest", in which Croatia came 124th, just five places above dictatorial Belarus.

This state of affairs is generally blamed on an early wave of privatisation in the 1990s, when the government sold state assets to known loyalists in a process now known as "tycoonisation".

Many "tycoons" were newcomers to business, who sapped the capacity of their companies or sold them off in parts, while amassing private fortunes.

Where the state chosenot to privatise, as withthe shipyards, subsidies often insulated lacklustre management from com- petition. Large portions of the economy are still unrestructured as a result.

That may change. The era of private disinvestment is over, replaced by a spending spree. Credit is readily available amid frantic competition in a financial sector dominated by western banks, and private investment is soaring.

Investment as a share of GDP grew 10 per cent over the past five years, "and most of this increase came from the private sector," says Zarko Miljenovic, chief economist at Zagrebacka Bank, which is owned by Italy's Unicredito.

At the same time, the government has moderated its spending habits, cutting back on infrastructure investments and slowing the growth of pensions, while stabilising the country's external debt.

Athansios Vamvakidis, resident representative for the International Monetary Fund, praises Mr Sanader's government for halving the annual budget deficit over three years, from 6.1 per cent in 2003 to 2.8 per cent, the figure projected by policymakers in 2006.

Goran Saravanja, senior economist in Croatia for Austria's Creditanstalt Investment Bank, says the picture is not quite as pretty as the IMF paints it: "If you include debt to pensioners, the budget deficit goes up to 4 per cent.

"It's not included in the IMF-sanctioned numbers, but it is significant," he says. "The headline figures look good, but when you cut beneath the surface there has not been much reform."

Private indebtedness is increasingly a greater concern than public indebtedness.

Another risk is posed by politics. With parliamentary elections due next year, some economists, including Mr Vamvakidis of the IMF, wonder aloud whether the government will maintain fiscal responsibility.

But he adds thatthe political temptation to scrap restructuring and privatisation plans forthe critically important shipyards will be tempered by economic reality.

"The situation is so bad" that commercial banks have begun denying some shipyards credit needed to cover operational costs, he says. "The pinch is here."

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