The global financial crisis and fiscal policy in Central and Eastern Europe: the 2009 Croatian budget odysey

This paper addresses two main questions: first, what is the scope for domestic and external market-based financing of Croatia’s government budget deficit; and second, what is the scope for expansionary fiscal policy in Croatia. Both questions are addressed from a broader Central and Eastern European perspective, in the context of the economic and financial crisis unfolding in the region since October 2008. The paper analyses how the crisis had spread through financial markets in the region and how it affected the cost and availability of budget financing. It shows that the reliance on market-based financing increased significantly in successive revisions of the 2009 budget despite rising bond yields and interest rates; that government borrowing from domestic banks led to a severe crowding-out of the private sector; and that the sovereign eurobond placement in 2009 was costlier than earlier placements in similar circumstances and other sovereign debt issues in CEE in the first half of 2009. On this basis, the paper argues that expansionary fiscal policy in Croatia would not be effective and would undermine fiscal sustainability and financial stability.