On 9th March 2016, following the address of the Croatian National Bank Governor, Boris Vujčić, Croatian Parliament members discussed the Croatian National Bank' Semi-annual information on the financial condition, degree of price stability and monetary policy implementation for the first half of 2015.

Participating in the discussions were Goran Marić (HDZ), Ivan Lovrinović (Most), Gordan Maras (SDP), Anka Mrak-Taritaš (HNS), Miro Bulj (Most), Ivan Šuker (HDZ), Ružica Vukovac (Most), Boris Lalovac (SDP), Milorad Pupovac (SDSS), Irena Petrijevčanin Vuksanović (HRID), Ivica Mišić (Most), Željko Glasnović (HDZ), Josip Leko (SDP), Radimir Čačić (Reformisti), Goran Dodig (BM 365), Giovanni Sponza (IDS), Ingrid Antičević Marinović (SDP), Maro Kristić (Most), Miroslav Šimić, Josip Križanić (HDZ) and Branimir Glavaš (HDSSB).

In response to the comments of Parliament members, the Governor stressed that the proposal for a monetary reform was the most important and practically the only substantial criticism of monetary policy and then proceeded to elaborate on the stance of the Croatian National Bank.

The Governor explained the problems inherent in the inflation targeting regime, stressing that: "a precondition for an inflation targeting policy, which may be conducted and which some countries conduct, is a flexible exchange rate policy. In other words, under such a monetary policy regime, the exchange rate of the kuna versus the euro would no longer be used as an anchor for inflation expectations and depositors' expectations."

He added that the proposal for inflation targeting complemented and was consistent with the proposal for gradual depreciation, explaining that Croatian citizens would convert their savings deposits from the kuna to the euro should the Croatian National Bank announce such a change in its monetary policy stance.

"The international reserves of the Republic of Croatia are the only source of the euro in a situation when people start converting their kuna to the euro – because it pays and because the euro will be worth more than the kuna in the future. This means that in such a case we should start selling the international reserves of the Republic of Croatia. A reduction in the international reserves would lead to a reduction in the Republic of Croatia's rating, with the international reserves, as you know, having already been assessed as marginally sufficient, and even insufficient, by the IMF. A rating drop would lead to an interest rate increase."

The Governor concluded that a depreciation policy would boost interest rates, warning that loans would then become more expensive and less accessible.

"What would banks do? Well, they would say, given the new monetary policy stance of the Croatian National Bank, announced by the Governor, why don't we also shorten the kuna position; banks would start selling the kuna and buying the euro. From whom? From the Croatian National Bank, as only the central bank could sell, that is, protect the kuna exchange rate against a sudden devaluation, using the international reserves, which would eventually also cause interest rates to increase."

The Governor gave an example of what a 10% depreciation of the kuna would mean, using data for 2014. "With all the other conditions unchanged, goods and services exporters would receive an extra HRK 15.2bn, while all economic entities would have to pay an extra HRK 14.5bn for the existing goods and services imports. This would mean a positive difference of HRK 1 300 000 000. Foreign currency depositors, including the central government, would earn a nominal amount of HRK 18.3bn. The kuna equivalent of external debt of all sectors would rise by HRK 35.6bn, whereas domestic foreign currency denominated and foreign currency indexed debt would increase by HRK 25.3bn. Therefore, the net effect of a 10% depreciation of the kuna would be sharply negative, HRK 41.9bn. This is almost HRK 42bn, or 12.8% of GDP. That is why, in my opinion, such a policy would lead to a recession, rather than improve the Croatian economy and bring well-being to Croatian citizens."

"A decision to revoke the currency clause can be adopted only by the Parliament and not by the Croatian National Bank", said the Governor and added: "Should you opt for revoking the currency clause, without abolishing foreign currency savings deposits – what would happen? Banks would all of a sudden have huge open foreign exchange positions, as savings deposits would be euro dominated and loans kuna denominated. There would be no way for them to close their open foreign exchange positions, which would leave them fully exposed to foreign currency risk, so that interest rates would grow and loans would become less accessible."

"Domestic external debt of all sectors totalled EUR 103bn at the end of June 2015, EUR 81.3bn (78.7%) of which was denominated in or indexed to foreign currency. Should credit institutions' foreign currency indexed claims against all domestic sectors, excluding the central government, be revoked, the portion of total debt affected by the exchange rate would decrease to a still sizeable EUR 62.6bn, amounting to 60.6% of total debt. Should the currency clause for credit institutions' claims against the central government also be revoked, the exchange rate would be influencing EUR 60bn, or 58.4% of total debt. That is what I had to say a monetary reform and the effects it would produce in Croatia."

As regards the reserve requirement rate, the Governor agreed that it was too high, adding that the Croatian National Bank was reducing it because of that reason.

"By doing this we are reducing the regulatory burden for banks after the crisis, which is one of the main sources of the expansionary stance of monetary policy; let me remind you that the reserve requirement rate has been reduced from 30.5% to the current 12% and that we will continue to reduce it."

The Governor pointed out that the reserve requirement rate will be further reduced, but he also said that the reduction cannot be performed at once, lest a speculative attack on the kuna be provoked.

Boris Vujčić reiterated that structural repo auctions had been launched due to the high current account surplus, coupled with an excess of banks' foreign assets over foreign liabilities, a gross domestic product recovery and a consequent increase in demand for kuna loans. However, he stressed that structural repo auctions would not solve Croatia's economic problems because of the unresolved issue of the pass through of funding to the economy. He also mentioned his proposal of several years ago to introduce a guarantee scheme to offset the lack of collateral and capital in Croatian enterprises.

The Governor replied to the comments that the CNB presented an overly optimistic picture of economic conditions in Croatia by saying that they were completely false and misguided. On the contrary, the CNB has over the years constantly warned of the structural weakness of the Croatian economy, including the high deficit levels and public debt growth, as well as of the need to speed up the pace of reform implementation. If any of the objections were in place, those would be the objections to the contrary: the CNB revised upwards its GDP growth projections several times over the previous year, which means that it has been, like other forecasters, including international financial institutions, overly pessimistic, rather than overly optimistic.

In response to the objections that the Croatian National Bank had not put sufficient effort into de-euroisation, the Governor indicated a series of measures aimed at the "re-kunisation" of the economy implemented by the CNB. "The strongest and most efficient measure was the requirement imposed on banks to hold additional capital buffers for lending in foreign currency to borrowers without a natural hedge, that is, those with no income in that currency," said the Governor.

He pointed out that these measures: "had succeeded in reducing euroisation to some extent, from 78% to approximately 63%; however, after the onset of the crisis, within three months everyone once again resorted to the euro as people got scared." "The Croats turn to the euro when they get scared, as they used to turn to the German mark, this is a psychological category no monetary policy can change," said the Governor, adding that: "the regulatory burden on the euro is at the moment twice as high as the one placed on the kuna, but it is still not helping much."

The Governor replied to criticism of the CNB's treatment of small banks by saying that: "the regulatory treatment of small banks is exactly the same as that of large banks. Small banks' placements are subject to the same regulatory treatment as large banks' placements."

The Governor also referred to the method of submission of the Annual Report and described the European Central Bank's method of reporting to the European Parliament on its operations.

"We submit financial statements to the Parliament. We submit financial statements to the Ministry of Finance on a monthly basis, it is common practice. I come here, I will answer your questions on a quarterly basis, instead of semi-annually or annually, if you want; I hope, and I am glad about that, that we can continue our discussion at the Croatian National Bank, we are going to organise a panel discussion as soon as possible, seeing there is interest in these topics, after this Parliament session."

Parliament members also directly asked questions about Croatian National Bank's operations, expenditures and employee expenses. The Governor replied that: "Croatian National Bank expenditures were HRK 341.5m in 2010 and HRK 309m in 2014, whereas for 2015 we do not have an audit report yet, but HRK 319m are planned. Accordingly, Croatian National Bank expenditures have decreased, rather than grown, dropping, according to audit reports, by 10% until 2014, and by 8% until 2015."

Governor Vujčić reiterated that the Croatian National Bank was not responsible for the supervision of Austrian savings banks.

In response to the question on Credo banka, Boris Vujčić explained that: "Credo banka was undergoing a compulsory winding-up procedure, which means that it had lost its licence and was therefore no longer allowed to provide services it had been licensed for, including payment services. The execution of its payments was suspended in our payment systems, the CLVPS and NCS, i.e. the large-value payment system and the small-value clearing system; however, according to law, winding up does not mean the dissolution of a company, so that execution proceedings had to be conducted." The Governor pointed out that an investigation on this matter had been carried out, establishing no regularities.

Responding to the objections related to Swiss franc indexed loans, the Governor pointed out that the Croatian National Bank, acting in the best interest of Croatian citizens: "proposed a solution, that is, solutions, to help those who needed help, borrowers with Swiss franc loans, without imposing legal and financial risks to the Croatian budget, i.e., to all taxpayers."

In response to the questions regarding the degree of protection for banks in Croatia from crises in their respective parent countries, the Governor said: "They are well protected. Why? Because these are Croatian banks. This should be kept in mind. So, Zagrebačka banka is a Croatian bank, established in Croatia, with the capital in Croatia." The Governor added that the bank: "can now be transformed into a branch under European laws and we cannot prevent that, but in that case deposits would be insured by the Italian government, and not by the Croatian government.'' The Governor stressed that the capital adequacy of banks in Croatia was very high. ''The capital adequacy of Croatian banks considerably exceeds that of their parent banks, so that their safety is ensured, which is a crucial factor for Croatia's financial stability." Replying to the questions on the EURIBOR, the Governor said that the Croatian National Bank had warned of the use of the EURIBOR in credit contracts and that its use was enabled by the Parliament's adopting the Consumer Credit Act, and not by the CNB. The CNB has put forward and is still putting forward proposals for the resolution of the problem, some of which have been accepted, with the result that kuna loans with a fixed interest rate are now widely available on the domestic market; the CNB will continue to propose solutions to this problem to the new Government.

Governor Vujčić pointed out that: "the CNB has been buying time for the governments to implement structural reforms aimed at stimulating the economy. Monetary policy can do this, not only the monetary policy of the Croatian National Bank, but the monetary policy of, for example, the European Central Bank as well. However, if these reforms fail to be implemented, monetary policy cannot increase productivity."