hrvatska banka za obnovu i razvitak 500,000,000 euro medium term

Offering Circular

∆

Hrvatska banka za obnovu i razvitak(The Croatian Bank for Reconstruction and Development, a statutory entity established under the Law on

Hrvatska banka za obnovu i razvitak (The Croatian Bank for Reconstruction and Development) published in theofficial gazette of the Republic of Croatia (Narodne novine) No. 33/92, 76/93, 108/95 and 8/96)

g500,000,000Euro Medium Term Note Programme

unconditionally and irrevocably guaranteed byTHE REPUBLIC OF CROATIA

Under the euro medium term note programme described herein (the “Programme”), Hrvatskabanka za obnovu i razvitak (The Croatian Bank for Reconstruction and Development, the “Issuer”or “HBOR”), subject to compliance with all relevant laws, regulations and directives, may from timeto time issue guaranteed euro medium term notes (the “Notes”) guaranteed by the Republic ofCroatia (the “Guarantor”, the “Republic” or “Croatia”) pursuant to Article 3, paragraph 2 of the Lawon Hrvatska banka za obnovu i razvitak (The Croatian Bank for Reconstruction and Development),published in the official gazette of the Republic of Croatia (Narodne novine) (the “Official Gazette”)No. 33/92, 76/93, 108/95 and 8/96 (the “HBOR Law”) and the Decision of the Government of theRepublic of Croatia dated 26th July 2000 in the form of guarantee set out under “The Guarantee”below (together, the “Guarantee”) and denominated in any currency agreed between the Issuerand the Relevant Dealer(s) (as defined below). The Issuer is authorised to issue and haveoutstanding at any one time Notes, with the benefit of the Guarantee, up to an aggregate principalamount authorised by the Government of the Republic of Croatia for each fiscal year. For the fiscalyear 2004 a total principal amount of e355,000,000 has been authorised by the Government of theRepublic of Croatia. Any issuance over such amount must be separately approved by theGuarantor.

Application has been made to list the Notes issued under the Programme on the LuxembourgStock Exchange. However, Notes issued under the Programme may also be listed on an alternativestock exchange (including the Zagreb Stock Exchange) or may not be listed.

For a discussion of certain factors that should be considered in connection with an investment inthe Notes see “Investment Considerations”.

ArrangerDeutsche Bank

DealersABN AMRO Alpha BankBank Austria Creditanstalt CitigroupDeutsche Bank Dresdner Kleinwort Wasserstein JPMorgan Privredna banka Zagreb UBS Investment Bank UniCredit Banca Mobiliare

This Offering Circular is dated 23rd January 2004 and is valid for the period of one year from thedate hereof. It replaces the Offering Circular dated 15th January 2002.

Each of the Issuer and the Guarantor, having made all reasonable enquiries, confirm that thisdocument contains all information with respect to the Issuer, the Guarantor and the Notes that ismaterial in the context of the issue and offering of the Notes, the statements contained in it relatingto the Issuer and the Guarantor are in every material particular true and accurate and notmisleading, the opinions and intentions expressed herein with regard to the Issuer and theGuarantor are honestly held, have been reached after considering all relevant circumstances andare based on reasonable assumptions, there are no other facts in relation to the Issuer, theGuarantor or the Notes the omission of which would, in the context of the issue and offering of theNotes, make any statement herein misleading in any material respect, and all reasonable enquirieshave been made by the Issuer and the Guarantor to ascertain such facts and to verify the accuracyof all such information and statements. Each of the Issuer and the Guarantor accepts responsibilityaccordingly.

No person has been authorised to give information or to make any representation other than thosecontained in this Offering Circular or in any Pricing Supplement relating to a Series or Tranche inconnection with the issue and sale of the Notes and, if given or made, such information orrepresentation must not be relied upon as having been authorised by the Issuer, the Guarantor,the Arranger or any of the Dealers (each as defined in “Summary of the Programme”). Neither thedelivery of this Offering Circular nor any sale made in connection herewith shall, under anycircumstances, create any implication that there has been no change in the affairs of the Issuer orthe Guarantor since the date of this Offering Circular or the date upon which this Offering Circularwas most recently amended or supplemented or that there has been no adverse change in thefinancial position of the Issuer or the Guarantor since the date of this Offering Circular or the dateupon which this Offering Circular was most recently amended or supplemented or that any otherinformation supplied in connection with the Programme is correct as of any time subsequent to thedate on which it is supplied or, if different, the date indicated in the document containing the same.

The distribution of this Offering Circular and the offering or sale of the Notes in certain jurisdictionsmay be restricted by law. Persons into whose possession this Offering Circular comes are requiredby the Issuer, the Guarantor, the Arranger or the Dealers to inform themselves about and toobserve any such restriction. The Notes have not been and will not be registered under the UnitedStates Securities Act of 1933, as amended (the “Securities Act”) and include Notes in bearer formthat are subject to United States tax law requirements. Subject to certain exceptions, Notes maynot be offered, sold or delivered within the United States or to US persons (as defined in theSecurities Act). For a description of certain restrictions on offers and sales of Notes and on thedistribution of this Offering Circular and other documents, see “Subscription and Sale”.

This Offering Circular does not constitute an offer of, or an invitation by or on behalf of the Issuer,the Guarantor, the Arranger or the Dealers to subscribe for, or purchase, any Note.

None of the Arranger or the Dealers has separately verified the information contained in thisOffering Circular. None of the Arranger or the Dealers makes any representation, express orimplied, or accepts any responsibility, with respect to the accuracy or completeness of any of theinformation in this Offering Circular or any Pricing Supplement relating to any Series or Tranche orany further information, notice or other document which may at any time be supplied in connectionwith Notes or their distribution. Neither this Offering Circular nor any other documents incorporatedby reference herein are intended to provide the basis of any credit or other evaluation and shouldnot be considered as a recommendation by any of the Issuer, the Guarantor, the Arranger or theDealers that any recipient of this Offering Circular or any other documents incorporated byreference herein should purchase the Notes. Each potential purchaser of Notes should determinefor itself the relevance of the information contained in this Offering Circular and its purchase ofNotes should be based upon such investigation as it deems necessary. None of the Arranger orthe Dealers undertakes to review the financial condition or affairs of the Issuer or the Guarantorduring the life of the arrangements contemplated by this Offering Circular nor to advise anyinvestor or potential investor in the Notes of any information coming to the attention of any of theArranger or the Dealers.

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In connection with the issue and distribution of any Tranche of any Series of Notes, theDealer, if any, disclosed as a stabilising agent (the “Stabilising Agent”) in the PricingSupplement relating to such Notes may over-allot or effect transactions with a view tosupporting the market price of the Notes at a level higher than that which might nototherwise prevail. However, there may be no obligation on the Stabilising Agent to do this.Such stabilising, if commenced, may be discontinued at any time and must be brought toan end after a limited period. Such stabilising shall be carried out in accordance withapplicable laws and regulations.

In this Offering Circular, unless otherwise specified or the context otherwise requires, referencesto “HRK” and “Kuna” are to the currency of the Republic of Croatia, references to “euro”, “euros”and “f” are to the currency introduced at the start of the third stage of European economic andmonetary union pursuant to the Treaty establishing the European Community (as amended fromtime to time) (the “Treaty”), references to “US$” and “US dollars” are to the currency of the UnitedStates of America and references to “DM”, “DEM” and “Deutsche Mark” are to the nationalcurrency unit of the Federal Republic of Germany (being a non-decimal denomination of the euro).As at 30th September 2003, the exchange rate between euro and Kuna was f1.00 = HRK7.57137and between US dollars and Kuna was US$1.00 = HRK6.630502.

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TABLE OF CONTENTS

Documents Incorporated by Reference.......................................................................... 5∆

Supplemental Offering Circular ...................................................................................... 6∆

Investment Considerations ............................................................................................ 7∆

Summary of the Programme .......................................................................................... 10∆

The Guarantee .............................................................................................................. 16∆

Terms and Conditions of the Notes................................................................................ 20∆

Global Notes and Global Certificates ............................................................................ 43∆

Form of Pricing Supplement .......................................................................................... 49∆

Use of Proceeds ............................................................................................................ 56∆

Hrvatska banka za obnovu i razvitak (The Croatian Bank for Reconstruction andDevelopment) ................................................................................................................ 57∆

Overview of the Republic of Croatia .............................................................................. 81∆

The Economy ................................................................................................................ 89∆

Recent Economic Trends................................................................................................ 93∆

Foreign Trade and International Balance of Payments .................................................. 110∆

Public Finance................................................................................................................ 131∆

Public Debt .................................................................................................................... 139∆

Taxation .......................................................................................................................... 153∆

Subscription and Sale .................................................................................................... 154∆

General Information........................................................................................................ 157∆

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DOCUMENTS INCORPORATED BY REFERENCE

This Offering Circular should be read and construed in conjunction with each Pricing Supplement(as defined herein) relating to any Notes, any amendment or supplement to this Offering Circularprepared from time to time, the most recently published audited non-consolidated annual accounts(being as at the date hereof the accounts for the years ended 31st December 2001 and 2002) andany interim accounts (whether audited or unaudited) published subsequently to such annualaccounts, of the Issuer, which shall be deemed to be incorporated in, and to form part of, thisOffering Circular and which shall be deemed to modify or supersede the contents of this OfferingCircular to the extent that a statement contained in any such document is inconsistent with suchcontents.

The Issuer will, at the specified office of the Paying Agents (as defined herein), provide, withoutcharge, to each person to whom a copy of this Offering Circular has been delivered, upon the oralor written request of any such person, a copy of any or all of the documents incorporated hereinby reference. Written or oral requests for such document should be directed to the specified officeof any Paying Agent or the specified office of the listing agent in Luxembourg or, in respect of Noteslisted on the Zagreb Stock Exchange, at the specified office of the listing agent in Zagreb.

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SUPPLEMENTAL OFFERING CIRCULAR

The Issuer has agreed to comply with the undertakings given by it from time to time to theLuxembourg Stock Exchange in connection with the Notes and, without prejudice to the generalityof the foregoing, shall furnish to the Luxembourg Stock Exchange all such information as the rulesof the Luxembourg Stock Exchange may require in connection with the listing on the LuxembourgStock Exchange of the Notes. In respect of Notes to be listed on the Zagreb Stock Exchange, theIssuer has agreed to furnish to the Zagreb Stock Exchange all such information as the rules of theZagreb Stock Exchange may require and to otherwise comply with such rules in connection withthe listing of such Notes on the Zagreb Stock Exchange.

The Issuer has undertaken in the Programme Agreement (as defined herein) to the Dealers thatif, at any time during the duration of the Programme there is a significant change affecting anymatter contained in this Offering Circular whose inclusion would reasonably be required byinvestors and their professional advisers, and would reasonably be expected by them to be foundin this Offering Circular, for the purpose of making an informed assessment of the assets andliabilities, financial position, profits and losses and prospects of the Issuer, and the rights attachingto the Notes, the Issuer shall prepare an amendment or supplement to this Offering Circular orpublish a replacement Offering Circular for use in connection with any subsequent offering of theNotes and shall supply to each Dealer such number of copies of such amendment, supplement orreplacement hereto as such Dealer may reasonably request. Any such amendment or supplementor replacement Offering Circular shall be available at the specified office of the listing agent inLuxembourg.

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INVESTMENT CONSIDERATIONS

In addition to the other information contained in this Offering Circular, prospective investors shouldconsider carefully the information set forth below before making an investment in the Notes.

The Republic of Croatia

General

Since gaining its independence in 1992, Croatia’s political, legal, judicial and regulatory structureshave undergone extensive changes with a view to Croatia joining the European Union by 2007. Tothe extent that such structures have been changed, they have not been fully tested. As aconsequence, investment in Croatia carries risks which are not typically associated with investingin more mature markets.

Political Considerations

Since 1993, Croatia has been pursuing a programme of economic structural reform which hasresulted in the establishment of a free market economy through privatisation of state enterprisesand deregulation of the economy. The recently elected Government has reaffirmed its intention tocontinue the strategy in favour of a pro-European, mainstream conservative orientation that iscommitted to democracy, the rule of law, human rights and minority rights. It is expected that thepolitical initiatives necessary to achieve Croatia’s transformation and that such economic reformsdescribed elsewhere in this Offering Circular will continue with a view to achieving their intendedaims.

Economic Infrastructure

Since independence, Croatia has invested in repairing and modernising its infrastructure. Roads,railways, seaports and airports have been a particular focus for the Government and futureinvestments are expected to continue. The rebuilding of Croatia’s infrastructure to WesternEuropean levels still requires further investment and may take some years to complete.

Official Economic Data

The Croatian Central Bureau of Statistics (the “CBS”), the Ministry of Finance and the CroatianNational Bank (the “CNB”) regularly publish statistics on Croatia and its economy. There can be noassurance that the statistics are as accurate as those compiled by statistics bureaus in developedcountries, but in recent years major adjustments have been made to the balance of payments(“BOP”), System of National Accounts (“SNA”) and Government Finance Statistics (“GFS”) in linewith international methodologies. Croatia also signed an agreement with the IMF to publish certainkey economic data on the IMF web site. Data now adheres to Special Data DisseminationStandards (“SDDS”).

Economic Development

Since 2000, economic growth has increased, with recorded GDP growth of 2.9% in 2000, 3.8% in2001, 5.2% in 2002 and 5% in first half of 2003. In 2002, GDP growth was influenced by anincrease in personal consumption which rose by 6.6% in 2002 and gross capital formation whichwas due to a wage bill increase caused by average wage growth, increased employment and newhousehold borrowing from deposit taking banks. The growth continued in early 2003 with GDPestimated at 4.9% and 5.0% for the first and second quarters, respectively, higher than thecorresponding periods in 2002. This growth was influenced by investment activity and an increasein the foreign goods and services trade. However, there can be no assurance that the favourablefactors which influenced the growth rates and positive growth trend will continue.

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The 2000 current account deficit was the lowest since 1994 at US$438.8 million (2.4% of GDP).Improved tourist revenues and increased transfers and a fairly stable merchandise trade deficitaccount for the improvement. In 2001, the current account deficit increased to US$741.2 million(3.8% of GDP) mainly due to an increase in imports. As a result of deterioration of the merchandisetrade balance and due to pronounced cross-currency changes of the US dollar against the euroand Kuna, the current account deficit in 2002 increased to 7.2% of GDP. Deficit growth was causedby foreign trade liberalisation together with consumption increase triggered by credit expansion. In2003, tourism revenues contributed to moderating the external account deficit. Based onpreliminary data, the 2003 current account deficit is expected to decline to 5.9% of GDP.

Settlement of Outstanding Debt

After independence, Croatia, along with some of the other successor republics of the SocialistFederal Republic of Yugoslavia (“SFRY”), entered into negotiations with the SFRY’s creditors inrespect of outstanding SFRY debt. Agreements were concluded during 1995 and 1996 withinternational institutions such as the Paris Club (in respect of public creditors) and the London Club(in respect of commercial banks), as well as with foreign suppliers. These agreements wereconcluded on the general basis of Croatia assuming responsibility for 28.49% of unallocatedoutstanding SFRY debt, with the Paris and London Club agreements resulting in a rescheduling ofprincipal over extended periods of up to 14 years.

The London Club agreement releases Croatia from joint and several liability in respect of theexternal debt of the SFRY to foreign commercial banks. Croatia has honoured all its assumedobligations under its rescheduling agreements.

Privatisation Programme

Restructuring of the Croatian economy is not complete. Croatia commenced its privatisationprogramme in 1991, with the aim of privatising some 3,000 “socially owned” companies.

The vast majority of companies in the former SFRY were “socially owned”, i.e. owned andmanaged by the employees. Under the main privatisation law, the Law ∆on Transformation ofSocially Owned Companies, published in the Official Gazette, No. 19/91, 83/92, 84/92, 94/93, 2/94∆and 9/95 and the Law on Privatisation, published in the Official Gazette, No. 21/96, shares in eachcompany were offered to employees and former employees before being offered to individualsoutside the company. The take up rate was high, given that these shares were offered at discountsto their market value (20% plus 1% for each year of employment in Croatia), and consequently littlechange in the ownership structures resulted. This effectively ruled out large scale restructuring orredundancies in many companies. In addition, actual cash raised from privatisations has beenminimal, due to the fact that most shares were offered to employees at a discount, or were freewithin the voucher scheme described below. Until 1999, Croatia did not rely upon privatisationreceipts to fund budget expenditures. In 1999, the privatisation proceeds of the strategic sale of35% and in 2001 of another 16% of Croatian Telecom shares to Deutsche Telekom contributedsignificantly to the budget revenues in such years.

The continued reform of the Croatian economy depends in part upon the successful privatisationof the utilities and the largely completed privatisation of the banking sector. Any significantdisruption in the privatisation process may adversely affect the reforms currently being undertaken.The first phase of the privatisation of the Croatian oil and gas company, Industrija Nafte d.d.,(“INA”) was completed in July 2003 with the sale of an interest representing 25% plus 1 share toHungarian oil and gas company, Magyar Olaj-és Gázipari (“MOL”) which invested US$505 million.

The approach to privatisation by the former centre-left Government saw all government holdings(other than in banks, insurance companies and utilities) consolidated into the Croatian PrivatisationFund (“CPF”) portfolio. At the beginning of 2000, the CPF’s share portfolio consisted of stakes in1850 companies. In the first six months of 2000, holdings in almost 450 companies were divestedby CPF. CPF has undertaken an analysis of each company to develop a restructuring programme

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for it which forms the basis of negotiations with creditors and potential buyers. The principle ofusing market value rather than book value as the basis for price negotiations has now beenadopted. As of 1st October 2003, CPF’s portfolio comprised 1133 companies, 854 of which areeligible for privatisation. See “Economy - The Privatisation Programme - Approach to Privatisation”,below.

Croatia’s Legal System

Croatia has taken, and continues to take, steps to move towards a mature legal system which iscomparable to the legal systems of the EU countries. New laws have been introduced and revisionshave been made with respect to company, property, bankruptcy, competition, securities, labour,taxation, mutual funds and telecommunications laws to harmonise them with EU laws. Such newlaws and revisions remain untested in the courts and do not have a long history of interpretation.In some circumstances, therefore, it may not be possible to obtain swift enforcements of judgmentsin Croatia.

Croatian Investors

The Notes, Receipts and Coupons (each as defined herein) are governed by English law and theIssuer has submitted to the non-exclusive jurisdiction of the courts of England to settle anydisputes that may arise out of or in connection with any Note, Receipt or Coupon (see “Terms andConditions of the Notes - 17. Governing Law, Jurisdiction, Service of Process and Waiver ofImmunity”, below). In respect of any proceedings between the Issuer and a Croatian natural orlegal person to which a non-Croatian natural or legal person is not also a party, a Croatian courtmay refuse to recognise and give effect to the choice of English law as the law governing theNotes, Receipts and Coupons and may also refuse to recognise and enforce an English courtjudgment awarded in connection therewith in the Republic of Croatia.

Guarantee

The Guarantee is contained in Article 3, paragraph 2 of the HBOR Law and also in a contractualguarantee executed by the Ministry of Finance on behalf of the Republic of Croatia. The Guaranteeis, therefore, governed by Croatian law. See the text of the Guarantee executed by the Ministry ofFinance under the heading “The Guarantee” set out in the Offering Circular.

The Issuer

Risks specific to the Issuer are closely linked to the general risks faced by investors in Croatia.Among other risks, HBOR as a state-owned development finance bank depends on the structuralsoundness of fiscal policy in Croatia. In terms of foreign exchange risk, HBOR like all Croatianbanks depends on exchange rate stability between the Kuna and the Euro as lending is primarilymade in Kuna and own borrowing is primarily Euro denominated. In these circumstances HBORhas to hedge its foreign exchange risk which it does through the use of foreign exchange clausesin its loan agreements.

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SUMMARY OF THE PROGRAMME

The following summary does not purport to be complete and is taken from, and is qualified in itsentirety by, the remainder of this Offering Circular and (in relation to the terms and conditions ofany particular Tranche of Notes) the Pricing Supplement. Words and expressions defined or usedin “Terms and Conditions of the Notes” below shall have the same meanings in this summary. TheIssuer may agree with any Dealer that Notes may be issued in a form other than that contemplatedin “Terms and Conditions of the Notes” herein, in which event a supplement to the Offering Circular,if appropriate, will be made available which will describe the effect of the agreement reached inrelation to such Notes.

Issuer Hrvatska banka za obnovu i razvitak (The Croatian Bankfor Reconstruction and Development)

Guarantor The Republic of Croatia

Description Guaranteed Euro Medium Term Note Programme.

Programme Size Up to e500,000,000 aggregate principal amount of Notesoutstanding at any one time (or the equivalent in othercurrencies at the date of issue).

Arranger Deutsche Bank AG London (the “Arranger”)

Dealers ABN Amro Bank N.V., Alpha Bank, Bank AustriaCreditanstalt AG, Citigroup Global Markets Limited,Deutsche Bank AG London, Dresdner Bank AG, J.P.Morgan Securities Ltd., Privredna banka Zagreb d.d., UBSLimited, UniCredit Banca Mobiliare S.p.A.

The Issuer may from time to time terminate theappointment of any dealer under the Programme or appointadditional dealers either in respect of one or more Seriesor Tranches or in respect of the whole Programme.References in this Offering Circular to “Permanent Dealers”and to “Relevant Dealers” are to the persons listed aboveas Dealers and to such additional persons as areappointed as dealers in respect of the whole Programme(and whose appointment has not been terminated) andreferences to “Dealers” are to all Permanent Dealers andall persons appointed as a dealer in respect of one or moreSeries or Tranches.

Fiscal Agent Deutsche Bank AG London

Registrar Deutsche Bank Luxembourg S. A.

Method of Issue The Notes will be issued on a syndicated basis (each a“Syndicated Issue”) or on a non-syndicated basis (each a“Non-Syndicated Issue”). The Notes will be issued in serieseach, a “Series”) having one or more issue dates and onterms otherwise identical (or identical other than in respectof the first payment of interest), the Notes of each Seriesbeing intended to be interchangeable with all other Notesof that Series. Each Series may be issued in tranches(each, a “Tranche”) on the same or different issue dates.The specific terms of each Tranche (which will besupplemented, where necessary, with supplemental terms

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and conditions and, save in respect of the issue date, issueprice, first payment of interest and principal amount of theTranche, will be identical to the terms of other Tranches ofthe same Series) will be set out in a pricing supplement (a“Pricing Supplement”) relating thereto.

Issue Price Notes may be issued at their aggregate nominal amount orat a discount or premium to their aggregate nominalamount. Partly Paid Notes may be issued, the issue priceof which will be payable in two or more instalments.

Form of Notes The Notes may be issued in bearer form only (“BearerNotes”) or in registered form only (“Registered Notes”).Each Tranche of Bearer Notes will initially be representedby a Note in temporary global form (a “Temporary GlobalNote”) if (1) definitive Notes are to be made available toNoteholders following the expiry of 40 days after their issuedate or (2) such Notes have an initial maturity of more thanone year and are being issued in compliance with the DRules (as defined in “Summary of the Programme – SellingRestrictions”). Otherwise such Tranche will be representedby a Note in permanent global form (a “Permanent GlobalNote” and, together with the Temporary Global Note, the“Global Notes”. Registered Notes will initially berepresented by interests in a Global Certificate which maybe exchanged for Certificates (as further described under“Global Notes and Global Certificates” below), oneCertificate being issued in respect of each Noteholder’sentire holding of Registered Notes of one Series.Certificates representing Registered Notes that areregistered in the name of a nominee for one or moreclearing systems are referred to as “Global Certificates”.

Clearing Systems Euroclear Bank S.A./N.V., as operator of the EuroclearSystem (“Euroclear”) and Clearstream Banking, sociétéanonyme (“Clearstream, Luxembourg”), and, in relation toany Series or Tranche, such other clearing system as maybe agreed between the Issuer and the Relevant Dealer.

Initial Delivery of Notes On or before the issue date for each Tranche, the GlobalNote representing Bearer Notes or the Global Certificaterepresenting Registered Notes may be deposited with acommon depositary for Euroclear and Clearstream,Luxembourg. Global Notes or Global Certificates may alsobe deposited with any other clearing system or may bedelivered outside any clearing system provided that themethod of such delivery has been agreed in advance bythe Issuer, the Fiscal Agent and the Relevant Dealer.Global Certificates representing Registered Notes, that areto be credited to one or more clearing systems on issue willbe registered in the name of nominees or a commonnominee for such clearing systems.

Currencies Subject to compliance with all relevant laws, regulationsand directives, Notes may be issued in any currencyagreed between the Issuer and the Relevant Dealer(s).

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Issues of Notes denominated in Swiss francs or carrying aSwiss franc related element with a maturity of more thanone year (other than Notes privately placed with a singleinvestor with no publicity) will be effected in compliancewith the relevant regulations of the Swiss National Bankbased on article 7 of the Federal Law on Banks andSavings Banks of 8th November 1934 (as amended) andarticle 15 of the Federal Law on Stock Exchanges andSecurities Trading of 24th March 1995 in connection witharticle 2, paragraph 2 of the Ordinance of the FederalBanking Corporation on Stock Exchanges and SecuritiesTrading of 2nd December 1996. Under the said regulations,the relevant Dealer or, in the case of a syndicated issue thelead manager (the “Swiss Dealer”), must be a bankdomiciled in Switzerland (which includes branches orsubsidiaries of a foreign bank located in Switzerland) or asecurities dealer duly licensed by the Swiss Federal BankCommission as per the Federal Law on Stock Exchangesand Securities Trading of 24th March 1995. The SwissDealer must report certain details of the relevanttransaction to the Swiss National Bank no later than therelevant issue date for such a transaction.

Maturities Subject to compliance with all relevant laws, regulationsand directives, such maturity as may be agreed betweenthe Issuer and the Relevant Dealer(s) and as indicated inthe Pricing Supplement.

Denominations Definitive Notes will be in such denominations as may bespecified in the Pricing Supplement, save that the minimumdenomination of each Note will be such as may bepermitted or required from time to time by any relevantcentral bank (or equivalent body) or any laws or regulationsapplicable to the relevant currency. Unless permittedotherwise by then current laws and regulations, Notes(including Notes denominated in Sterling) which have amaturity of less than one year and in respect of which theissue proceeds are to be accepted by the Issuer in theUnited Kingdom or whose issue otherwise constitutes acontravention of section 19 of the Financial Services andMarkets Act 2000 (the “FSMA”) will have a minimumdenomination of £100,000 (or its equivalent in othercurrencies).

Fixed Rate Notes Fixed interest will be payable in arrear on the date or datesin each year specified in the Pricing Supplement.

Floating Rate Notes Floating Rate Notes will bear interest at a rate determined:

(i) on the same basis as the floating rate under anotional interest rate swap transaction in the relevantSpecified Currency governed by an agreement in theform of the Interest Rate and Currency ExchangeAgreement incorporating the 2000 ISDA Definitions,published by the International Swaps and DerivativesAssociation, Inc. and as further amended and/or

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supplemented as at the Issue Date of the relevantSeries; or

(ii) on the basis of a reference rate appearing on anagreed screen page of a commercial quotationservice; or

(iii) on such other basis as may be agreed between theIssuer and the relevant Dealer,

as indicated in the Pricing Supplement.

Index Linked Notes Payments of principal in respect of Index LinkedRedemption Notes or of interest in respect of Index LinkedInterest Notes will be calculated by reference to such indexand/or formula as the Issuer and the relevant Dealer mayagree (as indicated in the Pricing Supplement).

Floating Rate Notes and Index Linked Interest Notes mayalso have a maximum rate of interest, a minimum rate ofinterest or both (as indicated in the Pricing Supplement).

Interest on Floating Rate Notes and Index Linked InterestNotes in respect of each Interest Period, as selected priorto issue by the Issuer and the relevant Dealer, will bepayable on such Interest Payment Dates specified in, ordetermined pursuant to, the Pricing Supplement and will becalculated on the basis of such Day Count Fraction as maybe agreed between the Issuer and the relevant Dealer.

Dual Currency Notes Payments (whether in respect of principal or interest andwhether at maturity or otherwise) in respect of DualCurrency Notes will be made in such currencies, andbased on such rates of exchange, as the Issuer and therelevant Dealer may agree (as indicated in the PricingSupplement).

Zero Coupon Notes Zero Coupon Notes will be offered and sold at a discountto their Aggregate Nominal Amount and will not bearinterest other than in the case of late payment.

Redemption The Pricing Supplement relating to each Tranche of Noteswill indicate either that the Notes of such Tranche cannot beredeemed prior to their stated maturity (other than inspecified instalments (see below), if applicable, or fortaxation reasons or following an Event of Default) or thatsuch Note will be redeemable at the option of the Issuerand/or the Noteholders upon giving not less than 15 normore than 30 days’ irrevocable notice (or such other noticeperiod (if any) as is indicated in the Pricing Supplement) tothe Noteholders or the Issuer, as the case may be, on adate or dates specified prior to such stated maturity and ata price or prices and on such terms as are indicated in thePricing Supplement.

Unless otherwise permitted by then current laws andregulations, Notes (including Notes denominated inSterling) which have a maturity of less than one year and

Other provisions in relation toFloating Rate Notes and IndexLinked Interest Notes

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in respect of which the issue proceeds are to be acceptedby the Issuer in the United Kingdom or whose issueotherwise constitutes a contravention of section 19 of theFSMA must have a minimum redemption amount of£100,000 (or its equivalent in other currencies).The PricingSupplement may provide that Notes may be redeemable intwo or more instalments of such amounts and on suchdates as are indicated in the Pricing Supplement.

Status of the Notes The Notes will constitute unsubordinated and unsecuredobligations of the Issuer and the Guarantor, respectively, asdescribed in “Terms and Conditions of the Notes – Statusof the Notes”.

Status of the Guarantee The due repayment of all sums expressed to be payable bythe Issuer under the Notes and the related Coupons andReceipts is unconditionally and irrevocably guaranteed bythe Guarantor pursuant to the HBOR Law, as described in“Terms and Conditions of the Notes – Guarantee”. TheIssuer is authorised to issue and have outstanding at anyone time Notes, with the benefit of the Guarantee, up to anaggregate principal amount authorised by the Governmentof the Republic of Croatia for each fiscal year. For the fiscalyear 2004 a total principal amount of e355,000,000 hasbeen authorised by the Government of the Republic ofCroatia. Any issuance over such amount must beseparately authorised by the Guarantor.

Cross Default See “Terms and Conditions of the Notes – Events ofDefault”.

Negative Pledge See “Terms and Conditions of the Notes – NegativePledge”.

Withholding Tax All payments of principal and interest in respect of theNotes will be made free and clear of withholding taxes ofthe Republic of Croatia, subject to customary exceptions,all as described in “Terms and Conditions of the Notes –Taxation”.

Governing Law English law, save that the Guarantee shall be governed byCroatian law.

Listing The Luxembourg Stock Exchange, the Zagreb StockExchange or as otherwise specified in the PricingSupplement. As specified in the Pricing Supplement, aSeries need not be listed on the Luxembourg StockExchange, the Zagreb Stock Exchange or any other stockexchange.

Listing Agent Deutsche Bank Luxembourg S.A. (in respect of Notes to belisted on the Luxembourg Stock Exchange) andInterCapital Securities Ltd (in respect of Notes to be listedon the Zagreb Stock Exchange).

Ratings The Programme has been rated BBB- by Standard &Poor’s Ratings Group, a division of the McGraw-Hill groupof companies. Tranches of Notes may be rated or unrated.

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Where a tranche of Notes is rated, such rating will notnecessarily be the same as the rating assigned to theProgramme. A security rating is not a recommendation tobuy, sell or hold securities and may be subject tosuspension, reduction or withdrawal at any time by theassigning rating agency.

Selling Restrictions United States, United Kingdom, the Republic of Croatia,the Federal Republic of Germany, Japan and such otherrestrictions as may be required in connection with aparticular issue. See “Subscription and Sale”.

Each of the Issuer and the Guarantor is Category 1 for thepurposes of Regulation S under the Securities Act.

Notes having a maturity of more than one year will besubject to the United States Tax Equity and FiscalResponsibility Act of 1982 (“TEFRA”) and will be issued incompliance with US Treas. Reg. § 1.163-5(c)(2)(i)(D) (the“D Rules”) unless (1) the Pricing Supplement states thatNotes are issued in compliance with US Treas. Reg. §1.163-5(c)(2)(i)(C) (the “C Rules”) or (2) the Notes areissued other than in compliance with the D Rules or the CRules but in circumstances in which the Notes will notconstitute “registration required obligations” under TEFRA,which circumstances will be referred to in the PricingSupplement as a transaction to which TEFRA is notapplicable.

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THE GUARANTEE

The Issuer is authorised to issue and have outstanding at any one time Notes, with the benefit ofthe Guarantee, up to an aggregate principal amount authorised by the Government of the Republicof Croatia for each fiscal year. For the fiscal year 2004 a total principal amount of f355,000,000has been authorised by the Government of the Republic of Croatia. Any issuance over suchamount must be separately approved by the Guarantor.

The following is the text of the guarantee of the Republic of Croatia:

THIS DEED OF GUARANTEE is given on 9 November 2000 by THE REPUBLIC OF CROATIA(the “Guarantor”) in favour of the Holders (as defined below).

WHEREAS

(A) Pursuant to the Law on The Croatian Bank for Reconstruction and Development (Narodnenovine) 33/92, 76/93, 108/95 and 8/96) (the “HBOR Law”) THE CROATIAN BANK FORRECONSTRUCTION AND DEVELOPMENT (“HBOR”, “Hrvatska banka za obnovu irazvitak”, the “Issuer”) may procure funds by, inter alia, issuing bonds domestically andinternationally, and any such liability of the Issuer is stated to be guaranteed by theGuarantor under Article 3, paragraph 2 of the HBOR Law.

(B) The Issuer has agreed to issue Notes from time to time under its e500,000,000 Euro MediumTerm Note Programme (the “Programme”) in accordance with their terms and conditions (the“Conditions”), and the Guarantor is obliged under the terms of the HBOR Law tounconditionally and irrevocably guarantee such obligations of the Issuer under the Notes. Forthe avoidance of doubt, the Guarantor has agreed to execute this separate Guarantee for thebenefit of the Holders of such Notes.

1. INTERPRETATION

1.1 Definitions. In this Guarantee:–

“Coupon” means an interest coupon appertaining to an interest bearing Definitive Note.

“Holder” means, at any time, the person who is the bearer of a Note, Coupon or Receipt.

“Note(s)” means a note issued or to be issued by the Issuer pursuant to the ProgrammeAgreement, which Note may be represented by a temporary Global Note, a permanentGlobal Note or a Definitive Note as defined in the Programme Agreement.

“Receipt” means a receipt for the payment of an instalment of principal in respect of a Noteof which the principal is repayable in instalments.

1.2 Construction. Clause headings are for ease of reference only and shall not affect theconstruction of this Guarantee. Other capitalised terms not defined in this Guarantee areidentical to those terms as defined in the Conditions of the Notes.

2. GUARANTEE AND INDEMNITY

2.1 Guarantee. The Guarantor hereby unconditionally and irrevocably guarantees to eachHolder of the Notes that if the Issuer does not pay any sum payable by it under the AgencyAgreement, the Notes, the Receipts or the Coupons by the time and on the date specifiedfor such payment (whether on the normal due date, on acceleration or otherwise), theGuarantor shall pay or procure to be paid that sum to or to the order of such Holder in suchplace and manner as the Holder shall specify. All payments under this Guarantee by theGuarantor will be made subject to Condition 7 (Payments) of the Notes.

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2.2 Guarantor as Principal Debtor. As between the Guarantor and the Holders but withoutaffecting the Issuer’s obligations, the Guarantor shall be liable under this Clause as if it werethe sole principal debtor and not merely a surety. Accordingly, it shall not be discharged, norshall its liability be affected, by anything that would not discharge it or affect its liability if itwere the sole principal debtor (including (1) any time, indulgence, waiver or consent at anytime given to the Issuer or any other person, (2) any amendment to any other provisions ofthis Guarantee or to the Conditions or to any security or other guarantee or indemnity, (3)the making or absence of any demand on the Issuer or any other person for payment, (4)the enforcement or absence of enforcement of this Guarantee, the Notes, the Receipts orthe Coupons or of any security or other guarantee or indemnity, (5) the taking, existence orrelease of any security, guarantee or indemnity, (6) the dissolution, amalgamation,reconstruction or reorganisation of the Issuer or any other person or (7) the illegality,invalidity or unenforceability of or any defect in any provision of this Guarantee, the Notes,the Receipts or the Coupons or any of the Issuer’s obligations under any of them).

2.3 Guarantor’s Obligations Continuing. The Guarantor’s obligations under this Guaranteeare and shall remain in full force and effect by way of continuing security until no sumremains payable under the Notes, the Receipts or the Coupons. Furthermore, thoseobligations of the Guarantor are additional to, and not instead of any security or otherguarantee or indemnity at any time existing in favour of any person, whether from theGuarantor or otherwise and may be enforced without first having recourse to the Issuer, anyother person, any security or any other guarantee or indemnity. The Guarantor irrevocablywaives all notices and demands of any kind.

2.4 Exercise of Guarantor’s Rights. So long as any sum remains payable by the Issuer underthe Notes, the Receipts or the Coupons, no right of the Guarantor, by reason of theperformance of any of its obligations under this Clause, to be indemnified by the Issuer or totake the benefit of or to enforce any security or other guarantee or indemnity in respect ofthe obligations of the Issuer shall be exercised and enforced by the Guarantor.

2.5 Avoidance of Payments. The Guarantor shall on demand indemnify each Holder againstany cost, loss, expense or liability sustained or incurred by it as a result of it being requiredfor any reason (including any bankruptcy, insolvency, winding-up, dissolution or similar lawof any jurisdiction) to refund all or part of any amount received or recovered by it in respectof any sum payable by the Issuer under any Note, or the Receipts or Coupons relating to thatNote, and shall in any event pay to it on demand the amount as refunded by it.

2.6 Indemnity. As separate, independent and alternative stipulations, the Guarantorunconditionally and irrevocably agrees (1) that any sum that, although expressed to bepayable by the Issuer under the Notes or the Receipts or the Coupons, is for any reason(whether or not now existing and whether or not now known or becoming known to theIssuer, the Guarantor or any Holder) not recoverable from the Guarantor on the basis of aguarantee shall nevertheless be recoverable from it as if it were the sole principal debtor andshall be paid by it to the relevant Holder on demand and (2) as a primary obligation toindemnify each Holder against any loss suffered by it as a result of any sum expressed to bepayable by the Issuer under the Notes or the Receipts or the Coupons not being paid on thedate and otherwise in the manner specified therein or any payment obligation of the Issuerunder the Notes or the Receipts or the Coupons being or becoming void, voidable orunenforceable for any reason (whether or not now existing and whether or not now known orbecoming known to the Issuer, the Guarantor or any Holder), in any case the amount of thatloss being the amount expressed to be payable by the Issuer in respect of the relevant sum.

3. TAXES AND WITHHOLDINGS

All payments under this Guarantee shall be made free and clear of, and without withholdingor deduction for, or on account of, any taxes, duties, assessments or governmental charges

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of whatever nature imposed, levied, collected, withheld or assessed by or within the Republicof Croatia or by any authority therein or thereof having power to tax, unless such withholdingor deduction is required by law. In that event, the Guarantor shall pay such additionalamounts to the Holder as shall result in receipt by that Holder of such amounts as wouldhave been received by it had no such withholding or deduction been required, except that nosuch additional amounts shall be payable with respect to any Note, Receipt or Coupon orany payment under this Guarantee:

(a) presented for payment by or on behalf of a Holder which is liable to such taxes, duties,assessments or governmental charges in respect of such Note, Receipt or Coupon byreason of his having some connection with the Republic of Croatia other than the mereholding of the Note, Receipt or Coupon;

(b) presented (or in respect of which the Certificate representing such Note, Receipt or Couponis presented) for payment more than 30 days after the Relevant Date (as defined in Condition8), except to the extent that the Holder of it would have been entitled to such additionalamounts on presenting it for payment on the thirtieth such day.

4. NOTICES

4.1 Communication Details. Any demands or other communications by any Holder upon theGuarantor shall be deemed to be given to the Guarantor if in writing and delivered in person,sent by certified or registered airmail or the equivalent (with return receipt requested) or byfax or telex (with answerback received) addressed to the Guarantor at:

Address: Katančićeva 510000 Zagreb

Fax Number: + 385 1 4591 388Attention: Mr. Hrvoje Radovanić, Assistant to the Minister

4.2 Effectiveness. Any demand made of the Guarantor shall specifically identify the obligationto which this Guarantee relates. A notice or communication will be effective, if delivered byhand, on the day it is delivered, if sent by facsimile or telex, on the day the recipient’sanswerback is received or if sent by airmail or the equivalent (return receipt requested),seven days after dispatch.

5. PARTIAL INVALIDITY

If, at any time, any provision hereof is or becomes illegal, invalid or unenforceable in anyrespect under the law of any jurisdiction, neither the legality, validity or enforceability of theremaining provisions hereof nor the legality, validity or enforceability of such provision underthe law of any other jurisdiction shall in any way be affected or impaired thereby.

6. TRANSFERS

6.1 Benefit and Burden of this Guarantee. This Guarantee shall be binding on the Guarantorand shall benefit each Holder, their transferees, assignees and successors. Any reference inthis Guarantee to any Holder shall be construed accordingly.

6.2 Guarantor. The Guarantor may not transfer all or any part of its obligations under thisGuarantee.

7. RIGHTS OF HOLDERS

The rights of the Holders are several. The amount of any time owing by the Guarantor to anyHolder under this Guarantee shall be a separate and independent debt from the amountowing to any other party.

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8. MISCELLANEOUS

8.1 Certificate. A certificate from the Fiscal Agent as to the amounts at any time payable by theGuarantor under this Guarantee shall be prima facie evidence of the existence and amountsof the specified obligations of the Guarantor stated therein.

8.2 English language. The Guarantor hereby agrees that each communication or otherdocument to be delivered hereunder, including without limitation this Guarantee shall be inthe English language or accompanied by an English translation thereof certified as a trueand accurate translation thereof by an officer of the Guarantor and, in the case of conflict theEnglish version shall prevail.

8.3 Payments. All payments to be made by the Guarantor under or in connection with thisGuarantee shall be made in the currency and funds and otherwise in the manner in whichand at the places where the Issuer is required to make payments from time to time under theConditions.

9. GOVERNING LAW

This Guarantee is governed by, and shall be construed in accordance with, Croatian law.

IN WITNESS whereof the Guarantor has caused this Guarantee to be executed as a deedon the date stated at the beginning.

THE REPUBLIC OF CROATIA

represented by the Minister of Finance

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TERMS AND CONDITIONS OF THE NOTES

The following is the text of the terms and conditions that, subject to completion and amendmentand as supplemented or varied in accordance with the provisions of the Pricing Supplement, willbe applicable to the definitive Notes of each Series or Tranche. Either (i) the full text of these termsand conditions together with the provisions of the Pricing Supplement or (ii) these terms andconditions as so completed, amended, supplemented or varied (and subject to simplification by thedeletion of non-applicable provisions) shall be endorsed on such Bearer Notes or on theCertificates relating to such Registered Notes (excluding the italicised paragraphs). References inthese terms and conditions to “Notes” are to the Notes of one Series only, not to all Notes that maybe issued under the Programme.

This Note is one of a Series of Notes issued pursuant to an agency agreement dated 6th October2000, as amended and restated on 23rd January 2004 (as further amended, restated and/orsupplemented as at the Issue Date, the “Agency Agreement”) between the Issuer, Deutsche BankAG London as fiscal agent and the other agents named in it and with the benefit of a deed ofcovenant dated 6th October 2000 as amended and restated on 23rd January 2004 (as furtheramended, restated and/or supplemented as at the Issue Date, the “Deed of Covenant”) executedby the Issuer in relation to the Notes. The fiscal agent, the paying agents, the registrar, the transferagents and the calculation agent(s) for the time being (if any) are referred to below, respectively,as the “Fiscal Agent”, the “Paying Agents” (which shall include the Fiscal Agent), the “Registrar”,the “Transfer Agents” (which shall include the Registrar) and the “Calculation Agent(s)”. In theseterms and conditions (the “Conditions”), references to “Agents” shall mean the Fiscal Agent, thePaying Agents, the Registrar, the Transfer Agents and the Calculation Agent or any of them, andshall include such further or other Agent or Agents as may be appointed from time to time underthe Agency Agreement.

The Pricing Supplement for this Note (or the relevant provisions thereof) is attached to or endorsedon this Note and supplements these Conditions and may specify other terms and conditions whichshall, to the extent so specified or to the extent inconsistent with these Conditions, replace ormodify these Conditions for the purposes of this Note. References herein to the “PricingSupplement” are to the Pricing Supplement (or the relevant provisions thereof) attached to orendorsed on this Note.

As used herein and in the Pricing Supplement, “Tranche” means Notes which are identical in allrespects (including as to listing) and “Series” means a Tranche of Notes together with any furtherTranche or Tranches of Notes which are expressed to be consolidated and form a single series andidentical in all respects (including as to listing) except for their respective Issue Dates InterestCommencement Dates and/or Issue Prices (as indicated in the Pricing Supplement).

Copies of the Agency Agreement are available for inspection and copies of the Pricing Supplementapplicable to this Note may be obtained free of charge, in each case during normal business hoursat the specified office of each of the Agent and the other Paying Agents (including, for theavoidance of doubt, the Paying Agent in Luxembourg) save that, if this Note is an unlisted Note ofany Series, the Pricing Supplement will only be available for inspection by a Noteholder holdingone or more unlisted Notes of that Series and such Noteholder must produce evidence satisfactoryto the relevant Paying Agent, as the case may be, as to identity.

The Noteholders (as defined in Condition 1(c) below), the holders of the interest coupons (the“Couponholders”) relating to interest-bearing Notes in bearer form (the “Coupons”) and, whereapplicable, in the case of such Notes, talons for further Coupons (the “Talons”) and the holders ofthe receipts for the payment of instalments of principal (the “Receipts”) relating to Notes in bearerform of which the principal is payable in instalments are deemed to have notice of the provisionsof the Agency Agreement applicable to them.

Words and expressions defined in the Agency Agreement or used in the Pricing Supplement shallhave the same meanings where used in these Conditions unless the context otherwise requires or

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unless otherwise stated and provided that, in the event of inconsistency between the AgencyAgreement and the Pricing Supplement, the Pricing Supplement will prevail.

1. Form, Denomination and Title

(a) Form

The Notes are issued in bearer form (“Bearer Notes”) or in registered form (“Registered Notes”).

This Note is either (i) a Fixed Rate Note, a Floating Rate Note, a Zero Coupon Note, an Index-Linked Interest Note or a combination of the foregoing, depending upon the Interest Basis specifiedin the Pricing Supplement, and (ii) a Redemption at par Note, an Index Linked Redemption Note,an Instalment Note, a Dual Currency Note or a Partly Paid Note, depending upon theRedemption/Payment Basis shown in the Pricing Supplement.

Bearer Notes are serially numbered and issued with Coupons (and, where appropriate, a Talon)attached, save in the case of Zero Coupon Notes in which case references to interest (other thanin relation to interest due after the Maturity Date), Coupons and Talons in these Conditions are notapplicable. Instalment Notes are issued with one or more Receipts attached.

Registered Notes are represented by registered certificates (the “Certificates”) and, save asprovided in Condition 2(c), each Certificate shall represent the entire holding of Registered Notesby the same holder.

(b) Specified Denomination and Specified Currency

The Notes are issued in the Specified Currency or Currencies and the Specified Denomination(s)specified in the Pricing Supplement. Bearer Notes of one Specified Denomination may not beexchanged for Bearer Notes of another Specified Denomination. Bearer Notes may not beexchanged for Registered Notes and vice versa. All Registered Notes shall have the sameDenomination.

(c) Title

Title to the Bearer Notes, the Coupons, the Receipts and the Talons passes by delivery. Title to theRegistered Notes shall, subject to mandatory rules of law, pass by registration in the register thatthe Issuer shall procure to be kept by the Registrar in accordance with the provisions of the AgencyAgreement (the “Register”). Except as ordered by a court of competent jurisdiction or as requiredby law, the holder (as defined below) of any Note, Certificate, Receipt, Coupon or Talon shall bedeemed to be and may be treated as its absolute owner for all purposes, whether or not it isoverdue and regardless of any notice of ownership, trust or an interest in it, any writing on it (or onthe Registered Certificate representing it) or its theft or loss (or that of the related RegisteredCertificate) and no person shall be liable for so treating the holder.

In these Conditions, “Noteholder” means the bearer of any Bearer Note and the Receipts relatingto it or the person in whose name a Registered Note is registered, as the case may be, “holder” (inrelation to a Note, Receipt, Coupon or Talon) means the bearer of any Bearer Note, Receipt,Coupon or Talon or the person in whose name a Registered Note is registered, as the case maybe, and capitalised terms have the meanings given to them in the Pricing Supplement, the absenceof any such meaning indicating that such term is not applicable to the Notes.

2. Exchange and Transfers of Notes

(a) Exchange of Notes

Registered Notes may not be exchanged for Bearer Notes and vice versa. Bearer Notes of oneSpecified Denomination may not be exchanged for Bearer Notes of another SpecifiedDenomination.

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(b) Transfer of Registered Notes

Registered Notes may be transferred upon the surrender (at the specified office of the Registrar orany Transfer Agent) of the Certificate representing the Registered Notes to be transferred, togetherwith the form of transfer endorsed on such Certificate duly completed and executed and any otherevidence as the Registrar or Transfer Agent may reasonably require. In the case of a transfer ofpart only of a holding of Registered Notes represented by one Certificate, a new Certificate shallbe issued to the transferee in respect of the part transferred and a further new Certificate in respectof the balance of the holding not transferred shall be issued to the transferor.

(c) Exercise of Options or Partial Redemption in Respect of Registered Notes

In the case of an exercise of an Issuer’s or Noteholders’ option in relation to, or a partial redemptionof, a holding of Registered Notes represented by a single Certificate, a new Certificate shall beissued to the holder to reflect the exercise of such option or in respect of the balance of the holdingnot redeemed. In the case of a partial exercise of an option resulting in Registered Notes of thesame holding having different terms, separate Certificates shall be issued in respect of thoseRegistered Notes of that holding that have the same terms. New Certificates shall only be issuedagainst surrender of the existing Certificates to the Registrar or any Transfer Agent. In the case ofa transfer of Registered Notes to a person who is already a holder of Registered Notes, a newCertificate representing the enlarged holding shall only be issued against surrender of theCertificate representing the existing holding.

(d) Delivery of New Certificates

Each new Certificate to be issued pursuant to Conditions 2(b) and 2(c) shall be available fordelivery within five business days in the location of the specified office of any Transfer Agent or theRegistrar after receipt of the request for exchange, form of transfer or Exercise Notice (as definedbelow) or surrender of the Certificate for exchange. Delivery of the new Certificate(s) shall be madeat the specified office of the Transfer Agent or of the Registrar, as the case may be, to whomdelivery or surrender of such request for exchange, form of transfer or Exercise Notice or surrenderof such Certificate shall have been made or, at the option of the holder making such delivery orsurrender as aforesaid and as specified in the relevant request for exchange, form of transfer,Exercise Notice or otherwise in writing, be mailed by uninsured post at the risk of the holder entitledto the new Certificate to such address as may be so specified, unless such holder requestsotherwise and pays in advance to the relevant Agent the costs of such other method of deliveryand/or such insurance as it may specify. In this Condition 2(d), “business day” means a day, otherthan a Saturday or Sunday, on which banks are open for business in the place of the specifiedoffice of the Registrar or the relevant Transfer Agent.

(e) Exchange and Transfer Free of Charge

Exchange and transfer of Notes and Certificates on registration, transfer, partial redemption orexercise of an option shall be effected without charge by or on behalf of the Issuer, the Registraror the Transfer Agents, but upon payment of any tax, duty or other governmental charges that maybe imposed in relation to it (or the giving of such indemnity as the Issuer, the Registrar or therelevant Transfer Agent may require).

(f) Closed Period

No Noteholder may require the transfer of a Registered Note to be registered (i) during the periodof 15 calendar days ending on the due date for redemption of, or payment of any InstalmentAmount in respect of, that Note, or (ii) during the period of 15 calendar days before any date onwhich Notes may be called for redemption by the Issuer at its option pursuant to Condition 6(d), or(iii) after any such Note has been called for redemption in whole or in part or (iv) during the periodof seven days ending on (and including) any Record Date (as defined in Condition 7(b)(ii)).

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3. Status and Guarantee

(a) Status

The Notes and the Coupons and Receipts relating to them constitute (subject to the provisions ofCondition 4) unsecured and unsubordinated obligations of the Issuer and shall at all times rank paripassu and without any preference among themselves. The payment obligations of the Issuer underthe Notes and the Coupons and Receipts and of the Guarantor under the Guarantee (as definedbelow) shall, save for such exceptions as may be provided by applicable legislation and subject tothe provisions of Condition 4 shall at all times rank at least equally with all other unsecured andunsubordinated indebtedness of the Issuer and the Guarantor, respectively, present and future.

(b) Guarantee

The due payment of sums expressed to be payable by the Issuer under the Notes and the relatedCoupons and Receipts is unconditionally and irrevocably guaranteed by the Guarantor pursuant toArticle 3, paragraph 2 of the Law on the Croatian Bank for Reconstruction and Development,published in the official gazette of the Republic of Croatia (Narodne novine) No. 33/92, 76/93,108/95 and 8/96 and the Decision of the Government of the Republic of Croatia dated 26th July2000 in the form of the deed of guarantee executed by the Guarantor dated 9th November 2000(together, the “Guarantee”). The Guarantor has confirmed that the Guarantee covers all paymentand monetary obligations and/or liabilities of the Issuer under any issues of notes by the Issuer,including the “Notes”.

4. Negative Pledge

(a) Negative Pledge

So long as any of the Notes, Coupons or Receipts remains outstanding (as defined in the AgencyAgreement) the Issuer is obliged to ensure that:

(i) no current or future International Issues (as defined below) of the Issuer and no guaranteegiven by the Issuer in respect of any International Issue by any third party is secured bymeans of any encumbrance (except an encumbrance pursuant to law), mortgage or anyother interest over the current or future assets or income of the Issuer, unless at the sametime or prior thereto, the Notes, Coupons and Receipts (i) are secured equally and rateablytherewith or (ii) benefit from a guarantee or indemnity in substantially identical terms thereto,or (iii) have the benefit of such other security, guarantee, indemnity or other arrangement asshall be approved by an Extraordinary Resolution (as defined in the Agency Agreement) ofthe Noteholders; and

(ii) its payment obligations under the Notes rank at all times pari passu with all other ForeignCurrency Obligations of the Issuer except for (i) secured Foreign Currency Obligations in remwhich were or will be entered into for the acquisition of real estate, and (ii) secured ForeignCurrency Obligations with a maturity of one year or less and which have been or will beentered into in the ordinary course of the Issuer’s business.

(b) Definitions

For the purposes of these Conditions:

“Foreign Currency Obligation” means any credit obligations denominated in any currency otherthan the legal currency for the time being of the Republic of Croatia provided that, if at any timethe lawful currency of the Republic of Croatia is the euro, then any credit obligations denominatedin euro shall be included in “Foreign Currency Obligations”;

“guarantee” and “to guarantee” include every guarantee or other agreement, which results in therelevant party becoming liable for the obligations of another party.

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“International Issue” means every current or future obligation which is represented by promissorynotes or other securities:

(i) which were, pursuant to their conditions or at the option of the creditors, repayable in acurrency other than the legal currency for the time being of the Republic of Croatia providedthat, if at any time the lawful currency of the Republic of Croatia is the euro, then anypromissory notes or other securities repayable, pursuant to their conditions or at the optionof the creditors, in euro shall be included in “International Issue” ; and

(ii) which were at the relevant time quoted, listed, dealt in or traded or intended to be quoted,listed, dealt in or traded on a stock exchange, over-the-counter or other security market.

5. Interest

(a) Fixed Rate Notes

Each Fixed Rate Note bears interest on its outstanding Aggregate Nominal Amount (or if it is aPartly Paid Note, on the amount paid up) from, and including, the Interest Commencement Dateat the rate per annum (expressed as a percentage) equal to the Rate(s) of Interest, such interestbeing payable in arrear on each Interest Payment Date and on the Maturity Date if that date doesnot fall on an Interest Payment Date.

If a Fixed Coupon Amount or a Broken Amount is specified in the Pricing Supplement, the amountof interest payable on each Interest Payment Date will amount to the Fixed Coupon Amount or, ifapplicable, the Broken Amount so specified and in the case of the Broken Amount will be payableon the particular Interest Payment Date(s) specified in the Pricing Supplement.

If the Maturity Date is not an Interest Payment Date, interest, from, and including, the precedingInterest Payment Date (or the Interest Commencement Date, as the case may be) to, butexcluding, the Maturity Date will amount to the final Broken Amount.

If interest is required to be calculated for a period ending other than on an Interest Payment Date,such interest shall be calculated by applying the Rate of Interest to each Specified Denomination,multiplying such sum by the Day Count Fraction (as defined below and as specified in the PricingSupplement), and rounding the resultant figure to the nearest sub-unit of the Specified Currency,half of any such sub-unit being rounded upwards or otherwise in accordance with applicablemarket convention.

(b) Floating Rate Notes and Index-Linked Interest Notes

(i) Specified Interest Payment Dates

Each Floating Rate Note and Index-Linked Interest Note bears interest on its outstandingAggregate Nominal Amount from, and including, the Interest Commencement Date at the Rate ofInterest, such interest being payable in arrear on either:

(A) the Specified Interest Payment Date(s) specified in the Pricing Supplement; or

(B) if no express Specified Interest Payment Date(s) is/are specified in the Pricing Supplement,each date (each a “Specified Interest Payment Date”) which falls the number of months orother period specified as the Interest Period in the Pricing Supplement after the precedingSpecified Interest Payment Date or, in the case of the first Specified Interest Payment Date,after the Interest Commencement Date.

(ii) Business Day Convention

If any Specified Interest Payment Date that is specified in the Pricing Supplement to be subject toadjustment in accordance with a Business Day Convention would otherwise fall on a day that is nota Business Day, then, if the Business Day Convention specified is:

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(C) the “Floating Rate Convention”, such date shall be postponed to the next day which is aBusiness Day unless it would thereby fall into the next calendar month, in which event:

(1) such date shall be brought forward to the immediately preceding Business Day (asdefined in Condition 5(j)); and

(2) each subsequent such date shall be the last Business Day in the month in which suchdate would have fallen had it not been subject to adjustment; or

(D) the “Following Business Day Convention”, such date shall be postponed to the next daywhich is a Business Day; or

(E) the “Modified Following Business Day Convention”, such date shall be postponed to the nextday which is a Business Day unless it would thereby fall into the next calendar month, inwhich event such date shall be brought forward to the immediately preceding Business Day;or

(F) the “Preceding Business Day Convention”, such date shall be brought forward to theimmediately preceding Business Day.

(iii) Rate of Interest for Floating Rate Notes

The Rate of Interest in respect of Floating Rate Notes for each Interest Period (as defined inCondition 5(j)) shall be determined in the manner specified in the Pricing Supplement, and theprovisions below relating to either ISDA Determination or Screen Rate Determination shall apply,depending upon which determination is specified in the Pricing Supplement.

(A) Screen Rate Determination

Where Screen Rate Determination is specified in the Pricing Supplement as the manner in whichthe Rate of Interest is to be determined, the Rate of Interest for each Interest Period will, subjectas provided below, be either:

(1) the offered quotation (if there is only one quotation on the Relevant Screen Page) or;

(2) the arithmetic mean of the offered quotations,

for the Reference Rate in each case appearing on the Relevant Screen Page at the Relevant Timeon the Interest Determination Date (as defined in Condition 5(j)) in question, subject to anyadjustment required to be made pursuant to Condition 5(g), as determined by the CalculationAgent.

If paragraph (1) of Condition 5(b)(iii)(A) applies and no Reference Rate appears on the RelevantScreen Page at the Relevant Time on the Interest Determination Date or if paragraph (2) ofCondition 5(b)(iii)(A) applies and fewer than two offered quotations appear on the Relevant ScreenPage at the Relevant Time on the Interest Determination Date, subject as provided below, the Rateof Interest shall be the arithmetic mean of the offered quotations that each of the Reference Banks(as defined in Condition 5(j)) is quoting (or such of them, being at least two as are so quoting) toleading banks in the Relevant Financial Centre (as defined in Condition 5(j)) at the Relevant Time(as defined in Condition 5(j)) on the Interest Determination Date in question, subject to anyadjustment required to be made pursuant to Condition 5(g), as determined by the CalculationAgent.

If the paragraph above applies and the Calculation Agent determines that fewer than twoReference Banks are so quoting the Reference Rate, subject as provided below, the Rate ofInterest shall be the arithmetic mean of the rates per annum (expressed as a percentage) that theCalculation Agent determines to be the rates (being the nearest equivalent to the Reference Rate)in respect of the Specified Currency that at least two out of five leading banks selected by theCalculation Agent in the principal financial centre of the country of the Specified Currency or, if theSpecified Currency is euro, in the euro-zone (as defined in Condition 5(j)), (the “Principal Financial

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Centre”) are quoting at the Relevant Time for a period commencing on the Effective Date (asdefined in Condition 5(j)) for a period equivalent to the relevant Interest Period to leading bankscarrying on business in (i) Europe, or (if the Calculation Agent determines that fewer than two ofsuch banks are so quoting to leading banks in Europe) (ii) the Principal Financial Centre on theInterest Determination Date in question, subject to any adjustment required to be made pursuantto Condition 5(g), as determined by the Calculation Agent. If fewer than two of such leading banksare quoting at such time, the Rate of Interest shall be the Rate of Interest determined on theprevious Interest Determination Date (after readjustment for any difference between any Margin,or Maximum or Minimum Rate of Interest applicable to the preceding Interest Period and to therelevant Interest Period).

If the Reference Rate from time to time is specified in the Pricing Supplement as being other thanLIBOR or EURIBOR, the Rate of Interest in respect of such Notes will be determined as providedin the Pricing Supplement.

(B) ISDA Determination

Where ISDA Determination is specified in the Pricing Supplement as the manner in which the Rateof Interest is to be determined, the Rate of Interest for each Interest Period will be determined bythe Calculation Agent as a rate equal to the relevant ISDA Rate, subject to any adjustment requiredto be made pursuant to Condition 5(g). For the purposes of this Condition 5(b)(iii)(B), “ISDA Rate”for an Interest Period means a rate equal to the Floating Rate that would be determined by theCalculation Agent under a Swap Transaction under the terms of an agreement incorporating theISDA Definitions (as defined in Condition 5(k)) and under which:

(3) the Floating Rate Option is as specified in the Pricing Supplement;

(4) the Designated Maturity is a period specified in the Pricing Supplement; and

(5) the relevant Reset Date is either (i) if the applicable Floating Rate Option is based on LIBORor EURIBOR for a currency, the first day the first day of that Interest Period or (ii) in any othercase, as specified in the Pricing Supplement.

For the purposes of this Condition 5(b)(iii)(B), (i) “Floating Rate”, “Calculation Agent” where usedin the eighth line only, “Floating Rate Option”, “Designated Maturity”, “Reset Date” and “SwapTransaction” have the meanings given to those terms in the ISDA Definitions and (ii) the definitionof Banking Day in the ISDA Definitions shall be amended to insert after the words “are open for” inthe second line the word “general”.

(iii) Rate of Interest for Index-Linked Interest Notes

The Rate of Interest in respect of Index-Linked Interest Notes for each Interest Period shall bedetermined by the Calculation Agent in the manner specified in the Pricing Supplement andinterest will accrue by reference to an index or formula specified in the Pricing Supplement

(c) Interest on Zero Coupon Notes

Where a Zero Coupon Note is repayable prior to the Maturity Date and is not paid when due, theamount due and payable prior to the Maturity Date shall be the Early Redemption Amount of suchNote (as defined in Condition 6(b)(ii)). As from the Maturity Date, the Rate of Interest for anyoverdue principal of such a Zero Coupon Note shall be a rate per annum (expressed as apercentage) equal to the Amortisation Yield (as described in Condition 6(b)(i)).

(d) Dual Currency Notes

In the case of Dual Currency Notes, if the Rate of Interest or Interest Amount (as defined inCondition 5(j)) falls to be determined by reference to a Rate of Exchange or a method of calculating

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a Rate of Exchange, the Rate of Interest or Interest Amount payable shall be determined by theCalculation Agent in the manner specified in the Pricing Supplement.

(e) Partly Paid Notes

In the case of Partly Paid Notes (other than Partly Paid Notes which are Zero Coupon Notes),interest will accrue as aforesaid on the paid-up Aggregate Nominal Amount of such Notes andotherwise as specified in the Pricing Supplement.

(f) Accrual of Interest

Interest shall cease to accrue on each Note on the due date for redemption unless, upon duepresentation, payment is improperly withheld or refused, in which event interest shall continue toaccrue (after as well as before judgment) at the Rate of Interest in the manner provided in thisCondition 5 to the Relevant Date (as defined in Condition 7).

(g) Margin, Rate Multiplier, Maximum/Minimum Rate of Interest, Instalment Amounts andRedemption Amounts and Rounding

(i) Margin and Rate Multiplier

If any Margin or Rate Multiplier is specified in the Pricing Supplement (either (x) generally, or (y) inrelation to one or more Interest Accrual Periods), an adjustment shall be made to all Rates ofInterest in the case of (x) or the Rates of Interest for the specified Interest Accrual Periods, in thecase of (y), calculated in accordance with Condition 5(d) above by adding (if a positive number) orsubtracting the absolute value (if a negative number) of such Margin or multiplying such RateMultiplier, subject always to the next paragraph.

(ii) Maximum/Minimum Rate of Interest, Instalment Amount and Redemption Amount

If any Maximum or Minimum Rate of Interest, Instalment Amount or Redemption Amount isspecified in the Pricing Supplement, then any Rate of Interest, Instalment Amount or RedemptionAmount shall be subject to such maximum or minimum as the case may be.

(iii) Rounding

For the purposes of any calculations required pursuant to these Conditions (unless otherwisespecified), (x) all percentages resulting from such calculations will be rounded, if necessary, to thenearest one hundred-thousandth of a percentage point (with halves being rounded up), (y) allfigures will be rounded to seven significant figures (with halves being rounded up) and (z) allcurrency amounts which fall due and payable will be rounded to the nearest unit of such currency(with halves being rounded up), save in the case of yen, which shall be rounded down to thenearest yen. For these purposes “unit” means, with respect to any currency other than euro, thelowest amount of such currency that is available as legal tender in the country of such currencyand, with respect to euro, means 0.01 euro.

(h) Calculations

The amount of interest payable in respect of any Note for any Interest Period shall be calculatedby multiplying the product of the Rate of Interest and the outstanding Aggregate Nominal Amountof such Note by the Day Count Fraction, unless an Interest Amount (or a formula for its calculation)is specified in the Pricing Supplement in respect of such period, in which case the amount ofinterest payable in respect of such Note for such period will equal such Interest Amount (or becalculated in accordance with such formula). Where any Interest Period comprises two or moreInterest Accrual Periods, the amount of interest payable in respect of such Interest Period will bethe sum of the amounts of interest payable in respect of each of those Interest Accrual Periods.

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(i) Determination and Publication of Rates of Interest, Interest Amounts, Final RedemptionAmounts, Early Redemption Amounts, Optional Redemption Amounts and InstalmentAmounts

As soon as practicable after the Relevant Time one each Interest Determination Date or such othertime on such date as the Calculation Agent may be required to calculate any rate or amount or anyInstalment Amount due, obtain any quotation or make any determination or calculation, it willdetermine such rate and calculate the Interest Amounts in respect of each Specified Denominationof the Notes for the relevant Interest Accrual Period, calculate the Final Redemption Amount, EarlyRedemption Amount, Optional Redemption Amount or Instalment Amount, obtain such quotationor make such determination or calculation, as the case may be, and cause the Rate of Interest andthe Interest Amounts for each Interest Period and the relevant Specified Interest Payment Dateand, if required to be calculated, the Final Redemption Amount, Early Redemption Amount,Optional Redemption Amount or any Instalment Amount to be notified to the Issuer, each of thePaying Agent, the Noteholders, any other Calculation Agent appointed in respect of the Noteswhich is to make a further calculation upon receipt of such information and, if the Notes are listedon a stock exchange and the rules of such exchange so require, such exchange as soon aspossible after their determination but in no event later than (i) the commencement of the relevantInterest Period, if determined prior to such time, in the case of notification to such exchange of aRate of Interest and Interest Amount, or (ii) in all other cases, the fourth Business Day after suchdetermination, in accordance with Condition 15. Where any Specified Interest Payment Date orSpecified Interest Period is subject to adjustment pursuant to Condition 5(b)(ii), the InterestAmounts and the Specified Interest Payment Date so published may subsequently be amended (orappropriate alternative arrangements made) by way of adjustment) without notice in the event ofan extension or shortening of the Interest Period. If the Notes become due and payable underCondition 10, the accrued interest and the Rate of Interest payable in respect of the Notes shallnevertheless continue to be calculated as previously in accordance with this Condition but nopublication of the Rate of Interest or the Interest Amount so calculated need be made. Thedetermination of any rate or amount, the obtaining of each quotation and the making of eachdetermination or calculation by the Calculation Agent(s) shall (in the absence of manifest error,wilful default or bad faith) be final and binding upon all parties.

(j) Definitions

In these Conditions, unless the context otherwise requires, the following defined terms shall havethe meanings set out below:

“Business Day” means a day that is both:

(i) either (i) in relation to interest payable in a Specified Currency other than euro, a day (otherthan a Saturday or Sunday) on which commercial banks and foreign exchange marketssettle payments in the principal financial centre of the country of Specified Currency (if otherthan London and any Business Centre) or (2) in relation to any sum payable in euro, a dayon which the Trans-European Real-time Gross Settlement Express Transfer (TARGET)System (the “TARGET System”) is open (a “TARGET Business Day”); and/or

(ii) a day on which commercial banks and foreign exchange markets settle payment in Londonand in any Business Centre.

“Day Count Fraction” means, in respect of the calculation of an amount of interest on any Note forany period of time (from and including the first day of such period to but excluding the last) (whetheror not constituting an Interest Period, the “Calculation Period”):

(i) if “Actual/365” or “Actual/Actual-ISDA” is specified in the Pricing Supplement, the actualnumber of days in the Calculation Period divided by 365 (or, if any portion of that CalculationPeriod falls in a leap year, the sum of (x) the actual number of days in that portion of the

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Calculation Period falling in a leap year divided by 366 and (y) the actual number of days inthat portion of the Calculation Period falling in a non-leap year divided by 365);

(ii) if “Actual/365 (fixed)” is specified in the Pricing Supplement, the actual number of days in theCalculation Period divided by 365;

(iii) if “Actual/360” is specified in the Pricing Supplement, the actual number of days in theCalculation Period divided by 360;

(iv) if “30/360”, “360/360” or “Bond Basis” is specified in the Pricing Supplement, the number ofdays in the Calculation Period divided by 360 (the number of days to be calculated on thebasis of a year of 360 days with 12 30-day months (unless (a) the last day of the CalculationPeriod is the 31st day of a month but the first day of the Calculation Period is a day otherthan the 30th or 31st day of a month, in which case the month that includes that last day shallnot be considered to be shortened to a 30-day month, or (b) the last day of the CalculationPeriod is the last day of the month of February, in which case the month of February shallnot be considered to be lengthened to a 30-day month));

(v) if “30E/360” or “Eurobond Basis” is specified in the Pricing Supplement, the number of daysin the Calculation Period divided by 360 (the number of days to be calculated on the basisof a year of 360 days with 12 30-day moths, without regard to the date of the first day or lastday of the Calculation Period unless, in the case of a Calculation Period ending on theMaturity Date, the Maturity Date is the last day of the month of February, in which case themonth of February shall not be considered to be lengthened to a 30-day month); and

(vi) if “Actual/Actual-ISMA” is specified in the Pricing Supplement,

(a) if the Calculation Period is equal to or shorter than the Determination Period during which itfalls, the number of days in the Calculation Period divided by the product of (x) the numberof days in such Determination Period and (y) the number of Determination Periods normallyending in any year; and

(b) if the Calculation Period is longer than one Determination Period, the sum of(x) the numberof days in such Calculation Period falling in the Determination Period in which it beginsdivided by the product of (1) the number of days in such Determination Period and (2) thenumber of Determination Periods normally ending in any year; and (y) the number of days insuch Calculation Period falling in the next Determination Period divided by the product of (1)the number of days in such Determination Period and (2) the number of DeterminationPeriods normally ending in any year,

where:

“Determination Period” means the period from, and including, an Interest Determination Datein any year to, but excluding, the next Interest Determination Date.

“sub-unit” means with respect to any currency other than euro, the lowest amount of suchcurrency that is available as legal tender in the country of such currency and, with respect toeuro, means one cent.

“Effective Date” means, with respect to any Rate of Interest to be determined on an InterestDetermination Date, unless otherwise specified in the Pricing Supplement, the first day of theInterest Accrual Period to which such Interest Determination Date relates.

“EURIBOR” means the euro-zone inter-bank offered rate.

“euro-zone” means the region comprised of member states of the European Union that adoptthe single currency in accordance with the Treaty establishing the European Community asamended by the Treaty on European Union (as amended) (the “Treaty”).

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“Interest Accrual Period” mans the period beginning on, and including, the InterestCommencement Date and ending on, but excluding, the first Interest Period Date and eachsuccessive period beginning on, and including, an Interest Period Date and ending on, butexcluding, the next succeeding Interest Period Date.

“Interest Amount” means the amount of interest payable, and in the case of Fixed RateNotes, means the Fixed Coupon Amount or Broken Amount, as the case may be.

“Interest Commencement Date” means the Issue Date or such other date as may bespecified in the Pricing Supplement.

“Interest Determination Date” means, with respect to a Rate of Interest and Interest AccrualPeriod, the date specified as such in the Pricing Supplement or, if none is so specified, (i)the first day of such Interest Accrual Period if the Specified Currency is Sterling or (ii) the dayfalling two Business Days in London for the Specified Currency prior to the first day of suchInterest Accrual Period if the Specified Currency is neither Sterling nor euro or (iii) the dayfalling two TARGET Business Days prior to the first day of such Interest Accrual Period if theSpecified Currency is euro.

“Interest Period” means the period beginning on, and including, the Interest CommencementDate and ending on, but excluding, the first Specified Interest Payment Date and eachsuccessive period beginning on, and including, a Specified Interest Payment Date andending on, but excluding, the next succeeding Specified Interest Payment Date.

“Interest Period Date” means each Specified Interest Payment Date, unless otherwisespecified in the Pricing Supplement.

“ISDA Definitions” means the 2000 ISDA Definitions published by the International Swapsand Derivatives Association, Inc., as amended and updated as at the Issue Date, unlessotherwise specified in the Pricing Supplement.

“LIBOR” means the London inter-bank offered rate.

“Rate of Interest” means the rate of interest payable from time to time in respect of this Noteand which is either specified or calculated in accordance with the provisions in the PricingSupplement.

“Reference Banks” means the institutions specified as such in the Pricing Supplement or, ifnone, four major banks selected by the Calculation Agent in the interbank market (or, ifappropriate, money, swap or over-the-counter index options market) which is most closelyconnected with the Reference Rate specified in the Pricing Supplement which, if theReference Rate is EURIBOR shall be the euro-zone.

“Relevant Financial Centre” means, with respect to any Rate of Interest to be determined inaccordance with a Screen Rate Determination on an Interest Determination Date, thefinancial centre specified as such in the Pricing Supplement or, if none is so specified, thefinancial centre with which the relevant Reference Rate is most closely connected (which, ifthe Specified Currency is euro, shall be the euro-zone) or, if such Reference Rate is notclosely connected with any financial centre, London.

“Relevant Time” means, with respect to any Interest Determination Date, unless otherwisespecified, 11.00 a.m. (London time) in the case of LIBOR and 11.00 a.m. (Brussels time) inthe case of EURIBOR.

(k) Calculation Agent and Reference Banks

The Issuer will procure that there shall at all times be four Reference Banks (or such other numberas may be required) with offices in the Relevant Financial Centre and one or more CalculationAgents if provision is made for them in the Pricing Supplement and for so long as any Note is

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outstanding. If any Reference Bank (acting through its relevant offices) is unable or unwilling tocontinue to act as a Reference Bank, then the Issuer will appoint another Reference Bank with anoffice in the Relevant Financial Centre to act as such in its place. Where more than one CalculationAgent is appointed in respect of the Notes, references in these Conditions to the Calculation Agentshall be construed as each Calculation Agent performing its respective duties under theConditions. If the Calculation Agent is unable or unwilling to act as such or if the Calculation Agentfails duly to establish the Rate of Interest for any Interest Period or to calculate any InterestAmount, Instalment Amount, Final Redemption Amount, Early Redemption Amount or OptionalRedemption Amount, as the case may be, or to comply with any other requirement, the Issuer willappoint a leading bank or investment banking firm engaged in the inter bank market (or, ifappropriate, money, swap or over-the-counter index options market) which is most closelyconnected with the calculation or determination to be made by the Calculation Agent (actingthrough its principal London office or any other office actively involved in such market) to act assuch in its place. The Calculation Agent may not resign its duties without a successor having beenappointed as aforesaid.

All certificates, communications, opinions, determinations, calculations, quotations and decisionsgiven, expressed, made or obtained for the purposes of the provisions of this Condition 5 shall (inthe absence of wilful default, bad faith or manifest error) be binding on the Issuer, the CalculationAgent, the Fiscal Agent, the Paying Agents, the Registrar and all Noteholders, Couponholders andReceiptholders and (in the absence as aforesaid) no liability to the Issuer, the Noteholders, theCouponholders or the Receiptholders shall attach to the Calculation Agent in connection with theexercise or non-exercise by it of its powers, duties and discretions pursuant to such provisions.

6. Redemption, Purchase and Options

(a) Redemption by Instalments and Final Redemption

(i) Unless previously redeemed, purchased and cancelled as provided in this Condition 6 or therelevant Instalment Date (being one of the dates so specified in the Pricing Supplement) isextended pursuant to any Issuer’s or Noteholders’ option in accordance with Condition 6(d)or Condition 6(e), each Note that provides for Instalment Dates and Instalment Amountsshall be partially redeemed on each Instalment Date at the related Instalment Amountspecified in the Pricing Supplement. The outstanding Aggregate Nominal Amount of eachsuch Note shall be reduced by the Instalment Amount (or, if such Instalment Amount iscalculated by reference to a proportion of the Aggregate Nominal Amount of such Note, suchproportion) for all purposes with effect from the related Instalment Date, unless payment ofthe Instalment Amount is improperly withheld or refused on presentation of the relatedReceipt, in which case, such amount shall remain outstanding until the Relevant Daterelating to such Instalment Amount.

(ii) Unless previously redeemed, purchased and cancelled as provided in this Condition 6 or itsmaturity is extended pursuant to any Issuer’s or Noteholders’ option in accordance withCondition 6(d) or Condition 6(e), each Note shall be finally redeemed on the Maturity Datespecified in the Pricing Supplement at its Final Redemption Amount (which, unlessotherwise provided in the Pricing Supplement, is its Aggregate Nominal Amount) or, in thecase of a Note falling within paragraph (i) of this Condition 6(a), its final Instalment Amount.

(b) Early Redemption of Zero Coupon Notes

(i) The Early Redemption Amount payable in respect of any Zero Coupon Note prior to theMaturity Date, the Early Redemption Amount in respect of which is not linked to an indexand/or a formula, upon redemption of such Note pursuant to Condition 6(c) or upon itbecoming due and payable as provided in Condition 10 shall be the Amortised Face Amount(calculated as provided below) of such Note unless otherwise specified in the PricingSupplement.

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(ii) Subject to the provisions of sub-paragraph (iii) of this Condition 6(b), the Amortised FaceAmount of any such Note shall be the scheduled Final Redemption Amount of such Note onthe Maturity Date discounted at a rate per annum (expressed as a percentage) equal to theAmortisation Yield (which, if none is set out in the Pricing Supplement, shall be such rate aswould produce an Amortised Face Amount equal to the issue price of the Notes if they werediscounted back to their issue price on the Issue Date) compounded annually. Where suchcalculation is to be made for a period of less than one year, it shall be made on the basis ofthe Day Count Fraction set out in the Pricing Supplement.

(iii) If the Early Redemption Amount payable in respect of any such Note upon its redemptionpursuant to Condition 6(c) or if the Optional Redemption Amount payable in respect of anysuch Note upon its redemption pursuant to Condition 6(d) or Condition 6(e) or upon the EarlyRedemption Amount becoming due and payable as provided in Condition 10 is not paidwhen due, the Early Redemption Amount due and payable in respect of such Note shall bethe Amortised Face Amount of such Note as defined in paragraph (ii) of this Condition 6(b),except that such paragraph shall have effect as though the reference therein to the date onwhich the Note becomes due and payable were replaced by a reference to the RelevantDate. The calculation of the Amortised Face Amount in accordance with this paragraph shallcontinue to be made (as well after as before judgment) until the Relevant Date, unless theRelevant Date falls on or after the Maturity Date, in which case the amount due and payableshall be the scheduled Final Redemption Amount of such Note on the Maturity Date togetherwith any interest that may accrue in accordance with Condition 5(c). Where such calculationis to be made for a period of less than one year, it shall be made on the basis of the DayCount Fraction set out in the Pricing Supplement.

(iv) Other Notes

The early Redemption Amount payable in respect of any Note (other than Notes described in sub-paragraph (i) above), upon redemption of such Note pursuant to Condition 6(c) or upon it becomingdue and payable as provided in Condition 10, shall be the Final Redemption Amount unlessotherwise specified in the Pricing Supplement.

(c) Redemption for Taxation Reasons

If, as a result of any amendment to or change in the laws or regulations of the Republic of Croatiaor of any political subdivision thereof or any authority therein or thereof having power to tax or anychange in the official or generally accepted interpretation or application of such laws or regulationswhich becomes effective on or after the date of issue of the first Tranche of the Series of which theNotes form part, the Issuer or the Guarantor, as the case may be, has or will become obliged topay any additional amounts as described in Condition 8 (and such amendment or change has beenevidenced by the delivery by the Issuer to the Fiscal Agent (who shall accept such certificate andopinion as sufficient evidence thereof) of (i) a certificate signed by two directors of the Issuer onbehalf of the Issuer stating that such amendment or change has occurred (irrespective of whethersuch amendment or change is then effective), describing the facts leading thereto and stating thatsuch requirement cannot be avoided by the Issuer or the Guarantor, as the case may be, takingreasonable measures available to it and (ii) an opinion of independent legal advisers of recognisedstanding to the effect that such amendment or change has occurred (irrespective of whether suchamendment or change is then effective)), the Issuer may (having given not less than 30 nor morethan 90 days’ notice to the holders in accordance with Condition 15 redeem all, but not some only,of the Notes (other than Notes in respect of which the Issuer shall have given a notice ofredemption pursuant to Condition 6(d) prior to any notice being given under this Condition 6(c) attheir Redemption Amount, together with accrued interest to the date fixed for such redemption,provided that no such notice of redemption shall be given earlier than 90 days prior to the earliestdate on which the Issuer or the Guarantor, as the case may be, would be required to pay suchadditional amounts were a payment in respect of the Note then due.

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(d) Redemption at the Option of the Issuer (Call Option) and Exercise of Issuer’s Options

If Call Option is specified in the Pricing Supplement, the Issuer may, on giving not less than 15 normore than 30 days’ irrevocable notice (or such other notice period as may be specified in thePricing Supplement) to the Noteholders in accordance with Condition 15 redeem, or exercise anyIssuer’s option in relation to all or, if so provided, some of the Notes on any Optional RedemptionDate prior to any notice being given under this Condition 6(d). Any such redemption of Notes shallbe at their Optional Redemption Amount together with interest accrued to the date fixed forredemption.

Any such redemption or exercise of the Issuer’s option relates to Notes of an Aggregate NominalAmount at least equal to the Minimum Redemption Amount specified in the Pricing Supplementand no greater than the Maximum Redemption Amount to be redeemed specified in the PricingSupplement.

All Notes in respect of which any such notice is given shall be redeemed, or the Issuer’s optionshall be exercised, on the date specified in such notice in accordance with this Condition 6(d).

In the case of a partial redemption or a partial exercise of an Issuer’s option, the notice toNoteholders shall also contain the certificate numbers of the Notes to be redeemed or in respectof which such option has been exercised, which shall have been drawn in such place as may befair and reasonable in the circumstances, with regard to prevailing market practices and in suchmanner as it deems appropriate, subject to compliance with any applicable laws and stockexchange requirements. So long as the Notes are listed on the Luxembourg Stock Exchange orany other stock exchange and the rules of the relevant stock exchange(s) so require, the Issuershall, once in each year in which there has been a partial redemption of the Notes, cause to bepublished in a leading newspaper of general circulation in Luxembourg (which is expected to bethe Luxemburger Wort) or as specified by such other stock exchange a notice specifying theAggregate Nominal Amount of Notes outstanding and a list of the Notes drawn for redemption butnot surrendered.

(e) Redemption at the Option of Noteholders (Put Option) and Exercise of Noteholders’ Options

If Put Option is specified in the Pricing Supplement, the Issuer shall, at the option of the holder ofany such Note, redeem such Note upon the holder of such Note giving not less than 15 nor morethan 30 days’ notice to the Issuer (or such other notice period as may be specified in the PricingSupplement) on the Optional Redemption Date(s) at its Optional Redemption Amount togetherwith interest accrued to the date fixed for redemption.

To exercise such option or any other Noteholders’ option that may be set out in the PricingSupplement the holder must deposit (in the case of Bearer Notes) such Note (together with allunmatured Coupons and Receipts and unexchanged Talons) with any Paying Agent or (in the caseof Registered Notes) the Certificate representing such Note(s) with the Registrar or any TransferAgent at its specified office, together with a duly completed option exercise notice (“ExerciseNotice”) in the form obtainable from any Paying Agent, the Registrar or any Transfer Agent (asapplicable) within the notice period. No Note or Certificate so deposited and option exercised maybe withdrawn (except as provided in the Agency Agreement) without the prior consent of theIssuer, except that such Note or Certificate will be returned to the relevant Noteholder by thePaying Agent, the Registrar or Transfer Agent with which it has been deposited if, prior to the duedate for its redemption or the exercise of the option, the Note becomes immediately due andpayable or if upon due presentation payment of the redemption moneys is not made or exercise ofthe option is denied.

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(f) Partly Paid Notes

Partly Paid Notes will be redeemed, whether at maturity, early redemption or otherwise, inaccordance with the provisions of this Condition and the provisions specified in the PricingSupplement.

(g) Purchases

The Issuer and the Guarantor may, to the extent permitted by applicable laws and regulations, atany time purchase Notes (provided that all unmatured Receipts and Coupons and unexchangedTalons relating thereto are attached thereto or surrendered therewith) in the open market orotherwise at any price.

Notes purchased by the Issuer or the Guarantor may be surrendered by the purchaser through theIssuer to the Fiscal Agent or any Paying Agent for cancellation or may, at the option of the Issueror the Guarantor, be held or resold.

(h) Cancellation

All Notes purchased by or on behalf of the Issuer or the Guarantor shall be surrendered forcancellation, in the case of Bearer Notes, by surrendering each such Note together with allunmatured Receipts and Coupons and all unexchanged Talons to the Fiscal Agent and, in the caseof Registered Notes, by surrendering the Registered Certificate representing such Notes to theRegistrar and, in each case if so surrendered, shall, together with all Notes redeemed by theIssuer, be cancelled forthwith (together with all unmatured Receipts and Coupons andunexchanged Talons attached thereto or surrendered therewith). Any Notes so surrendered forcancellation may not be reissued or resold and the obligations of the Issuer in respect of any suchNotes shall be discharged.

7. Payments

(a) Bearer Notes

Payments of principal and interest in respect of Bearer Notes shall, subject as mentioned below,be made against presentation and surrender of the relevant Receipts (in the case of payments ofInstalment Amounts other than on the due date for redemption and provided that the Receipt ispresented for payment together with the Note relating thereto), Notes (in the case of all otherpayments of principal and, in the case of interest, as specified in Condition 7(f)(vi)) or Coupons (inthe case of interest, save as specified in Condition 7(f)(ii)), as the case may be, at the specifiedoffice of any Paying Agent outside the United States by a cheque payable in the currency in whichsuch payment is due drawn on, or (at the option of the holder) by transfer to an accountdenominated in that currency with, a bank in the principal financial centre for that currency providedthat in the case of Notes denominated in euro, the transfer may be made to, or the cheque drawnon, a euro account with a bank in any city which has access to the TARGET System.

(b) Registered Notes

(i) Payments of principal (which for the purposes of this Condition 7(b) shall include finalInstalment Amounts but not other Instalment Amounts) in respect of Registered Notes shallbe made against presentation and surrender of the relevant Certificates at the specifiedoffice of any of the Transfer Agents or of the Registrar and in the manner provided inparagraph (ii) below.

(ii) Interest (which for the purpose of this Condition 7(b) shall include all Instalment Amountsother than final Instalment Amounts) in respect of Registered Notes shall be paid to theperson shown on the Register at the close of business on the fifteenth day before the duedate for payment thereof (the “Record Date”). Payments of interest in respect of each

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Registered Note shall be made in the currency in which such payments are due by chequedrawn on a bank in the principal financial centre of the country of the currency concernedand mailed to the holder (or the first named of joint holders) of such Note at its addressappearing in the Register. Upon application by the holder to the specified office of theRegistrar or any Transfer Agent before the Record Date and subject as provided in Condition7(a), such payment of interest may be made by transfer to an account in the relevantcurrency maintained by the payee with a bank in the principal financial centre of the countryof that currency; provided, however, that in the case of euro, the transfer may be made to, orthe cheque drawn on, a euro account with a bank in any city that has access to the TARGETsystem.

(c) Payments in the United States

Notwithstanding the foregoing, if any Bearer Notes are denominated in US dollars, payments inrespect thereof may be made at the specified office of any Paying Agent in New York City in thesame manner as aforesaid if (i) the Issuer shall have appointed Paying Agents with specifiedoffices outside the United States with the reasonable expectation that such Paying Agents wouldbe able to make payment of the amounts on the Notes in the manner provided above when due,(ii) payment in full of such amounts at all such offices is illegal or effectively precluded by exchangecontrols or other similar restrictions on payment or receipt of such amounts and (iii) such paymentis then permitted by United States law, without involving, in the opinion of the Issuer, any adversetax consequence to the Issuer.

(d) Payments subject to Fiscal Laws

All payments are subject in all cases to any applicable fiscal or other laws, regulations anddirectives, but without prejudice to the provisions of Condition 8. No commission or expenses shallbe charged to the Noteholders or Couponholders in respect of such payments.

(e) Appointment of Agents

The Fiscal Agent, the Paying Agents, the Registrar, the Transfer Agents and the Calculation Agentinitially appointed by the Issuer and their respective specified offices are listed below. The FiscalAgent, the Paying Agents, the Registrar, Transfer Agents and the Calculation Agent act solely asagents of the Issuer and do not assume any obligation or relationship of agency or trust for or withany Noteholder or Couponholder. The Issuer reserves the right at any time to vary or terminate theappointment of the Fiscal Agent, any other Paying Agent, the Registrar, any Transfer Agent or theCalculation Agent and to appoint additional or other Paying Agents or Transfer Agents, providedthat the Issuer shall at all times maintain (i) a Fiscal Agent, (ii) a Registrar in relation to theRegistered Notes, (iii) a Transfer Agent in relation to Registered Notes (including a Transfer Agenthaving its specified office in Luxembourg so long as any Registered Notes are listed on theLuxembourg Stock Exchange (iv) one or more Calculation Agent(s) where the Conditions sorequire, (v) Paying Agents having specified offices in at least two major European cities (includingLuxembourg so long as the Notes are listed on the Luxembourg Stock Exchange), (vi) such otheragents as may be required by the rules of any other stock exchange on which the Notes may belisted and (viii) to the extent not satisfied by (iii) and/or (v) above, a Transfer Agent and/or a PayingAgent with a specified office in a European Union member state that will not be obliged to withholdor deduct tax pursuant to European Council Directive 2003/48/EC or any other European UnionDirective implementing the conclusions of the ECOFIN Council meeting of 26th-27th November2000 on the taxation of savings income or any law implementing or complying with, or introducedin order to conform to, such Directive.

In addition, the Issuer shall forthwith appoint a Paying Agent in New York City in respect of anyBearer Notes denominated in US dollars in the circumstances described in Condition 7(c) above.

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Notice of any such change or any change of any specified office shall promptly be given to theNoteholders in accordance with Condition 15.

(f) Unmatured Coupons and Receipts and Unexchanged Talons

(i) Unless the Pricing Supplement provides otherwise, the relevant Coupons are to becomevoid upon the due date for redemption of those Notes, Bearer Notes should be surrenderedfor payment together with all unmatured Coupons (if any) appertaining thereto, failing whichan amount equal to the face value of each missing unmatured Coupon (or, in the case ofpayment not being made in full, that proportion of the amount of such missing unmaturedCoupon which the sum of principal so paid bears to the total principal due) will be deductedfrom the Final Redemption Amount, Early Redemption Amount or Optional RedemptionAmount, as the case may be, due for payment. Any amount so deducted will be paid in themanner mentioned above against surrender of such missing Coupon within a period of 10years from the Relevant Date for the payment of such principal (whether or not such Couponhas become void pursuant to Condition 9.

(ii) If the Pricing Supplement so provides, upon the due date for redemption of any Bearer Note,unmatured Coupons relating to such Note (whether or not attached) shall become void andno payment shall be made in respect of them.

(iii) Upon the due date for redemption of any Bearer Note, any unexchanged Talon relating tosuch Note (whether or not attached) shall become void and no Coupon shall be delivered inrespect of such Talon.

(iv) Upon the due date for redemption of any Bearer Note which is redeemable in instalments,all Receipts relating to such Note having an Instalment Date falling on or after such due date(whether or not attached) shall become void and no payment shall be made in respect ofthem.

(v) Where any Bearer Note which provides that the related unmatured Coupons are to becomevoid upon the due date for redemption of those Notes is presented for redemption without allunmatured Coupons and any unexchanged Talon relating to it, and where any Bearer Noteis presented for redemption without any unexchanged Talon relating to it, redemption shallbe made only against the provision of such indemnity as the Issuer may require.

(vi) If the due date for redemption of any Note is not a due date for payment of interest, interestaccrued from the preceding due date for payment of interest or the Interest CommencementDate, as the case may be, shall only be payable against presentation (and surrender ifappropriate) of the relevant Bearer Note or Certificate representing it, as the case may be.Interest accrued on a Note which only bears interest after its Maturity Date shall be payableon redemption of such Note against presentation of the relevant Note or Certificaterepresenting it, as the case may be.

(g) Non-Business Days

If any date for payment in respect of any Note, Receipt or Coupon is not a business day, the holdershall not be entitled to payment until the next following business day nor to any interest or othersum in respect of such postponed payment. In this paragraph, “business day” means:

(i) a day (other than a Saturday or a Sunday) on which banks and foreign exchange marketssettle payments and are open for business (including dealing in foreign exchange and foreigncurrency deposits) and are open for business in the relevant place of presentation; and

(ii) a day (other than a Saturday or a Sunday) on which banks and foreign exchange marketssettle payments (including dealing in foreign exchange and foreign currency deposits) andare open for business in such Financial Centres specified in the Pricing Supplement; andeither

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(iii) (in the case of a payment in a currency other than euro where payment is to be made bytransfer in the relevant currency) a day on which foreign exchange transactions may becarried on in the relevant currency in the principal financial centre of the country of suchcurrency; or

(iv) (in the case of a payment in euro) a day on which banks are open for business and carryingout transactions in euro in the jurisdiction in which the account specified by the payee islocated and a day on which the TARGET System is open.

(h) Talons

On or after the Interest Payment Date for the final Coupon forming part of a Coupon sheet issuedin respect of any Bearer Note, the Talon forming part of such Coupon sheet may be surrenderedat the specified office of the Fiscal in exchange for a further Coupon sheet (and if necessaryanother Talon for a further Coupon sheet) (but excluding any Coupons that may have become voidpursuant to Condition 9. Each Talon shall, for the purposes of these Conditions, be deemed tomature on the Interest Payment Date on which the final Coupon comprising the relevant Couponsheet shall mature.

8. Taxation

Subject as provided below, all payments of principal and interest in respect of the Notes, theReceipts and the Coupons or under the Guarantee shall be made free and clear of, and withoutwithholding or deduction for, or on account of, any taxes, duties, assessments or governmentalcharges of whatever nature imposed, levied, collected, withheld or assessed by or within theRepublic of Croatia or by any authority therein or thereof having power to tax, unless suchwithholding or deduction is required by law. In that event, the Issuer or, as the case may be, theGuarantor shall pay such additional amounts to the Noteholder or Couponholder as shall result inreceipt by that Noteholder or Couponholder of such amounts as would have been received by ithad no such withholding or deduction been required, except that no such additional amounts shallbe payable with respect to any Note, Receipt or Coupon or any payment under the Guarantee:

(a) presented for payment by or on behalf of a holder which is liable to such taxes, duties,assessments or governmental charges in respect of such Note, Receipt or Coupon byreason of his having some connection with the Republic of Croatia other than the mereholding of the Note, Receipt or Coupon;

(b) presented (or in respect of which the Certificate representing such Note, Receipt or Couponis presented) for payment more than 30 days after the Relevant Date, except to the extentthat the holder of it would have been entitled to such additional amounts on presenting it forpayment on the thirtieth such day.

As used in these Conditions, “Relevant Date” in respect of any Note, Receipt or Coupon means thedate on which payment in respect of it first becomes due or (if any amount of the money payableis improperly withheld or refused) the date on which payment in full of the amount outstanding ismade or (if earlier) the date seven days after that on which notice is duly given to the Noteholdersthat, upon further presentation of the Note (or the Certificate relating thereto), Receipt or Couponbeing made in accordance with the Conditions, such payment will be made, provided that paymentis in fact made upon such presentation. References in these Conditions to (i) “principal” shall bedeemed to include any premium payable in respect of the Notes, all Instalment Amounts, FinalRedemption Amounts, Early Redemption Amounts, Optional Redemption Amounts, AmortisedFace Amounts and all other amounts in the nature of principal payable pursuant to Condition 6 orany amendment or supplement to it, (ii) “interest” shall be deemed to include all Interest Amountsand all other amounts payable pursuant to Condition 5 or any amendment or supplement to it and(iii) “principal” and/or “interest” shall be deemed to include any additional amounts that may bepayable under this Condition.

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9. Prescription

Claims against the Issuer and/or the Guarantor for payment in respect of the Notes, Receipts andCoupons (which, for this purpose, shall not include Talons) shall be prescribed and become voidunless made within 10 years (in the case of principal) or five years (in the case of interest) fromthe appropriate Relevant Date in respect of them.

10. Events Of Default

If any of the following events (each an “!”) occurs, the holder of any Note may give written noticeto the Fiscal Agent at its specified office that such Note is immediately repayable, whereupon itshall become due and repayable at its Final Redemption Amount together with accrued interest tothe date of payment, unless such event of default shall have been remedied prior to the receipt ofsuch notice by the Fiscal Agent:

(a) Non-Payment

Default is made for more than 14 days in the payment on the due date of interest or principal inrespect of any of the Notes; or

(b) Breach of Other Obligations

The Issuer or the Guarantor does not perform or comply with any one or more of its otherobligations in respect of the Notes or the Guarantee which default is incapable of remedy or is notremedied within 45 days after notice of such default shall have been given to the Fiscal Agent atits specified office by any Noteholder; or

(c) Cross-Default by the Issuer

Any other obligation of the Issuer becomes prematurely due and payable because the Issuer hasbreached the terms and conditions of such obligation or its maintenance or such an obligation wasnot paid when due or following the expiry of any applicable grace period, or any guarantee grantedby the Issuer for the obligations of a third party on the due date is not complied with following theexpiry of any applicable grace period, provided that such obligation in this paragraph equals orexceeds e5,000,000 or its equivalent in any other currency; or

(d) Payments

The Issuer stops payments, and such payments have not been reinstated within 30 days from thefirst day on which such a payment should have been made by the Issuer, or announces its inabilityto pay; or

(e) Bankruptcy

Any bankruptcy or insolvency proceedings are initiated against the Issuer and are not permanentlyor temporarily stayed within 60 days from their commencement or the Issuer initiates suchproceedings or offers to make or makes an arrangement for the benefit of its creditors; or

(f) Liquidation

The Issuer is liquidated or dissolved (except pursuant to an amalgamation or reorganisation whereall the assets and liabilities of the Issuer are assumed by the new entity); or

(g) Ceasing to Carry on Business

The Issuer ceases or communicates its intention to cease to carry on all or a material part of itsbusiness; or

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(h) Illegality

The Issuer or the Guarantor is prevented from fully fulfilling their respective obligations under theNotes or the Guarantee, as the case may be, following the passing or pronouncement of an officialdecree in the Republic of Croatia and such circumstance is not remedied within three months; or

(i) Guarantee

The Guarantee is not (or is claimed by the Guarantor not to be) in full force and effect; or

(j) Membership of IMF

The Guarantor ceases to be a member of the International Monetary Fund (the “IMF”) or to beeligible to use the general resources of the IMF, and such situation continues unremedied for 90days after written notice thereof has been delivered by any Noteholder to the Fiscal Agent; or

(k) Analogous Events

Any event occurs that under the laws of any relevant jurisdiction has an analogous effect to any ofthe events referred to in paragraphs (e), (f) or (g).

11. Meetings of Noteholders, Modification and Waiver

(a) Meetings of Noteholders

The Agency Agreement contains provisions for convening meetings of Noteholders of a Series toconsider any matter affecting their interests, including the sanctioning by Extraordinary Resolution(as defined in the Agency Agreement) of a modification of any of these Conditions. Such a meetingmay be convened by Noteholders holding not less than 10 per cent in the Aggregate NominalAmount of the Notes for the time being outstanding. The quorum for any meeting of Noteholdersshall be two or more persons holding or representing in the aggregate a clear majority in AggregateNominal Amount of the Notes for the time being outstanding, or at any adjourned meeting two ormore persons being or representing Noteholders whatever the Aggregate Nominal Amount of theNotes held or represented, unless the business of such meeting includes consideration ofproposals, inter alia, (i) to amend the dates of maturity or redemption of the Notes, any InstalmentDate or any date for payment of interest or Interest Amounts on the Notes or the obligation of theIssuer to pay additional amounts pursuant to Condition 8 (Taxation), (ii) to reduce or cancel theAggregate Nominal Amount of, or any Instalment Amount of, or any premium payable onredemption of, the Notes, (iii) to reduce the rate or rates of interest in respect of the Notes or tovary the method or basis of calculating the rate or rates or amount of interest or the basis forcalculating any Interest Amount in respect of the Notes, (iv) if a Minimum and/or a Maximum Rateof Interest, Instalment Amount or Final Redemption Amount, Early Redemption Amount orOptional Redemption Amount is set out in the Pricing Supplement, to reduce any such Minimumand/or Maximum, (v) to vary any method of, or basis for, calculating the Final Redemption Amount,the Early Redemption Amount or the Optional Redemption Amount, including the method ofcalculating the Amortised Face Amount, (vi) to vary the currency or currencies of payment orSpecified Denomination of the Notes, (vii) to take any steps that as specified in the PricingSupplement may only be taken following approval by an Extraordinary Resolution to which thespecial quorum provisions apply, (viii) to modify the provisions concerning the quorum required atany meeting of Noteholders or the majority required to pass the Extraordinary Resolution, or (ix)to modify or cancel the Guarantee in which case the necessary quorum at any adjourned meetingshall be two or more persons holding or representing in the aggregate not less than one-third inAggregate Nominal Amount of the Notes for the time being outstanding. Any resolution dulypassed (including an Extraordinary Resolution) shall be binding on all Noteholders (whether or notthey were present at the meeting at which such resolution was passed) and on all Couponholders.The expression “Extraordinary Resolution” means a resolution passed at a meeting of Noteholdersduly convened by a majority consisting of not less than three-quarters of the votes cast. All other

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resolutions shall be passed at a meeting of Noteholders duly convened by a clear majority of thevotes cast.

(b) Modification of Agency Agreement

The Issuer shall only permit any modification of, or any waiver or authorisation of any breach orproposed breach of or any failure to comply with, the Agency Agreement, if to do so could notreasonably be expected to be prejudicial to the interests of the Noteholders.

12. Replacement of Notes, Certificates, Coupons, Receipts and Talons

If a Note, Certificate, Receipt, Coupon or Talon is lost, stolen, mutilated, defaced or destroyed, itmay be replaced, subject to applicable laws, regulations and stock exchange regulations, at thespecified office of the Fiscal Agent (in case of Bearer Notes, Receipts, Coupons or Talons) and ofthe Registrar (in the case of Registered Certificates) or such other Paying Agent or Transfer Agent,as the case may be, as may from time to time be designated by the Issuer for the purpose andnotice of whose designation is given to Noteholders, in each case on payment by the claimant ofthe fees and costs incurred in connection therewith and on such terms as to evidence, security andindemnity (which may provide, inter alia, that if the allegedly lost, stolen or destroyed Note,Certificate, Receipt, Coupon or Talon is subsequently presented for payment or, as the case maybe, for exchange for further Coupons, there shall be paid to the Issuer on demand the amountpayable by the Issuer in respect of such Notes, Certificates, Receipts, Coupons or furtherCoupons) and otherwise as the Issuer may require. Mutilated or defaced Notes, Certificates,Receipts, Coupons or Talons must be surrendered before replacements will be issued.

13. Further Issues

The Issuer may from time to time without the consent of the Noteholders or Couponholders createand issue further securities either having the same terms and conditions as the Notes in allrespects (or in all respects except for the first payment of interest on them) and so that such furtherissue shall be consolidated and form a single series with the outstanding securities of any series(including the Notes) or upon such terms as the Issuer may determine at the time of their issue.Notes or more than one Series may be consolidated into one Series denominated in euro, even ifone or more such Series was not originally denominated in euro, provided all such Series havebeen redenominated into euro and otherwise have, in respect of all periods subsequent to suchconsolidation, the same terms and conditions. References in these Conditions to the Notes include(unless the context requires otherwise) any other securities issued pursuant to this Condition andforming a single series with the Notes.

14. Currency Indemnity

Any amount received or recovered in a currency other than the currency in which payment underthe relevant Note, Coupon or Receipt is due (whether as a result of, or of the enforcement of, ajudgment or order of a court of any jurisdiction, in the winding-up or dissolution of the Issuer orotherwise) by any Noteholder or Couponholder in respect of any sum expressed to be due to itfrom the Issuer or the Guarantor shall only constitute a discharge to the Issuer or the Guarantor,as the case may be, to the extent of the amount in the currency of payment under the relevantNote, Coupon or Receipt that the recipient is able to purchase with the amount so received orrecovered in that other currency on the date of that receipt or recovery (or, if it is not practicable tomake that purchase on that date, on the first date on which it is practicable to do so). If the amountreceived or recovered is less than the amount expressed to be due to the recipient under any Note,Coupon or Receipt, the Issuer, failing whom the Guarantor, shall indemnify it against any losssustained by it as a result. In any event, the Issuer, failing whom the Guarantor, shall indemnify therecipient against the cost of making any such purchase. For the purposes of this Condition, it shallbe sufficient for the Noteholder or Couponholder, as the case may be, to demonstrate that it wouldhave suffered a loss had an actual purchase been made. These indemnities constitute a separate

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and independent obligation from the Issuer’s and the Guarantor’s other obligations, shall give riseto a separate and independent cause of action, shall apply irrespective of any indulgence grantedby any Noteholder, Receiptholder or Couponholder and shall continue in full force and effectdespite any other judgment, order, claim or proof for a liquidated amount in respect of any sum dueunder any Note, Coupon or Receipt or any other judgment or order.

15. Notices

Notices to the holders of Registered Notes shall be mailed to them (or, in the case of joint holders,to the first named) at their respective addresses in the Register and deemed to have been givenon the fourth weekday (being a day other than a Saturday or a Sunday) after the date of mailingand so long as the Notes are listed on the Luxembourg Stock Exchange in a daily newspaper withgeneral circulation in Luxembourg (which is expected to be the Luxemburger Wort). Notices to theholders of Bearer Notes shall be valid if published (i) in a daily newspaper of general circulation inLondon (which is expected to be the Financial Times) and (ii) so long as the Notes are listed onthe Luxembourg Stock Exchange and the rules of that exchange so requires, in a leading dailynewspaper with general circulation in Luxembourg (which is expected to be the Luxemburger Wort)or if any such publication is not practicable, notice shall be validly given if published in anotherleading daily English language daily newspaper or as otherwise required by that exchange. Anysuch notice shall be deemed to have been given on the date of such publication or, if publishedmore than once or on different dates, on the date of the first publication as provided above.

Couponholders shall be deemed for all purposes to have notice of the contents of any notice givento the holders of Bearer Notes in accordance with this Condition.

16. Contracts (Rights of Third Parties) Act 1999

No rights are conferred on any person under the Contracts (Rights of Third Parties) Act 1999 toenforce any term of the Notes, but this does not affect any right or remedy of any person whichexists or is available apart from that Act.

17. Governing Law, Jurisdiction, Service of Process and Waiver of Immunity

(a) Governing Law

The Notes, the Coupons, the Receipts, and the Talons are governed by, and shall be construed inaccordance with, English law, and the Guarantee is governed by, and shall be construed inaccordance with, Croatian law.

(b) Jurisdiction

The Courts of England are to have jurisdiction to settle any disputes that may arise out of or inconnection with any Notes, Coupons, Receipts or Talons or the Guarantee (“Disputes”) and,accordingly, any legal action or proceedings arising out of or in connection with any Notes,Coupons, Receipts or Talons or the Guarantee (“Proceedings”) may be brought in such courts.

The Issuer irrevocably submits to the jurisdiction of the courts of England and waives any objectionto Proceedings in such courts on the ground of venue or on the ground that the Proceedings havebeen brought in an inconvenient forum. This submission is made for the benefit of each of theholders of the Notes, Coupons, Receipts and Talons and shall not affect the right of any of them totake Proceedings in one or more jurisdictions or preclude the taking of Proceedings in any otherjurisdiction (whether concurrently or not).

(c) Service of Process

The Issuer irrevocably appoints Ince & Co. Solicitors, with its registered address at Knolly’s House,11 Byward Street, London EC3R 5EN, as its agent in England to receive, for it and on its behalf,

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service of process in any Proceedings in England. Such service shall be deemed completed ondelivery to such process agent (whether or not it is forwarded to and received by the Issuer). If forany reason such process agent ceases to be able to act as such or no longer has an address inLondon, the Issuer irrevocably agrees to appoint a substitute process agent and shall immediatelynotify the Noteholders of such appointment in accordance with Condition 15. Nothing shall affectthe right to serve process in any manner permitted by law.

(d) Waiver of Immunity

The Issuer hereby irrevocably and unconditionally waives and agrees not to raise with respect tothe Notes, the Receipts, the Coupons or the Talons any right to claim sovereign or other immunityfrom jurisdiction or execution and any similar defence, and has irrevocably and unconditionallyconsented to the giving of any relief or the issue of any process, including, without limitation, themaking, enforcement or execution against any property whatsoever (irrespective of its use orintended use) of any order or judgment made or given in connection with any Proceedings orDisputes.

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GLOBAL NOTES AND GLOBAL CERTIFICATES

1. Initial Issue of Notes

Bearer Notes

Temporary Global Notes

Unless otherwise specified in the Pricing Supplement, each Series or Tranche of Bearer Notes willinitially be represented by a Temporary Global Note if:

(a) Bearer Notes in definitive form are to be made available to Noteholders following the expiryof 40 days after completion of the distribution of an identifiable Tranche of such Notes; or

(b) such Notes are being issued in compliance with the D Rules (as defined in “Summary of theProgramme – Selling Restrictions” above).

Permanent Global Notes

In all other cases, each Series or Tranche of Bearer Notes will be represented by a PermanentGlobal Note.

The Temporary Global Note or Permanent Global Note (as the case may be) initially representingeach Series or Tranche of Bearer Notes will be deposited on the Issue Date thereof with a commondepositary for Euroclear and Clearstream, Luxembourg (the “Common Depositary”) (or, in the caseof a Series or Tranche to be cleared through a clearing system other than Euroclear orClearstream, Luxembourg (an “Alternative Clearing System”), as agreed between the Issuer, theFiscal Agent, the Arranger and the relevant Dealer).

Registered Notes

As set forth in the Pricing Supplement, each Series or Tranche of Notes in registered form will berepresented by either:

(a) Definitive Certificates one or more Certificates in definitive form which shall be delivered asagreed between the Issuer, the Fiscal Agent, the Arranger and the relevant Dealer(s); or

(b) Global Certificates one or more Global Certificates without Coupons, deposited on the IssueDate with, and registered in the name of a nominee for, the Common Depositary (or, in thecase of a Series or Tranche to be cleared through an Alternative Clearing System, as agreedbetween the Issuer, the Fiscal Agent, the Arranger and the relevant Dealer(s)).

2. Clearing Systems

Upon the initial deposit of a Global Note with the Common Depositary or registration of RegisteredNotes in the name of any nominee for Euroclear and Clearstream, Luxembourg and delivery of therelevant Global Certificate to the Common Depositary, Euroclear or Clearstream, Luxembourg willcredit each subscriber with a principal amount of Notes equal to the principal amount thereof forwhich it has subscribed and paid.

Notes that are initially deposited with the Common Depositary may (if indicated in the PricingSupplement) also be credited to the accounts of subscribers with (if indicated in the PricingSupplement) any Alternative Clearing System through direct or indirect accounts with Euroclearand Clearstream, Luxembourg held by such Alternative Clearing System. Conversely, Notes thatare initially deposited with any Alternative Clearing System may similarly be credited to theaccounts of subscribers with Euroclear, Clearstream, Luxembourg or other Alternative ClearingSystems.

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Each of the persons shown in the records of Euroclear, Clearstream, Luxembourg or anyAlternative Clearing System as the holder of a Note represented by a Global Note or a GlobalCertificate must look solely to Euroclear, Clearstream, Luxembourg or the Alternative ClearingSystem (as the case may be) for his share of each payment made by the Issuer to the bearer ofsuch Global Note or the holder of the underlying Registered Notes, as the case may be, and inrelation to all other rights arising under the Global Notes or Global Certificates, subject to and inaccordance with the respective rules and procedures of Euroclear, Clearstream, Luxembourg orsuch Alternative Clearing System (as the case may be). Such persons shall have no claim directlyagainst the Issuer in respect of payments due on the Notes for so long as the Notes arerepresented by such Global Note or Global Certificate and such obligations of the Issuer will bedischarged by payment to the bearer of such Global Note or the holder of the underlyingRegistered Notes, as the case may be, in respect of each amount so paid.

3. Exchange

Temporary Global Notes

Each Temporary Global Note in respect of a Tranche of Bearer Notes will be exchangeable, free ofcharge to the holder, on or after its Exchange Date:

(a) Definitive Bearer Notes. If the Pricing Supplement indicates that such Temporary GlobalNote is issued in compliance with the C Rules or in a transaction to which TEFRA is notapplicable (as to which, see “Summary of the Programme – Selling Restrictions”), in whole,but not in part, for Bearer Notes in definitive form as described below; and

(b) Permanent Global Note. Otherwise, in whole or in part, upon certification as to non-USbeneficial ownership in the form set out in the Agency Agreement, for interests in aPermanent Global Note or, if so provided in the Pricing Supplement, for Bearer Notes indefinitive form.

“Exchange Date” means, in relation to a Temporary Global Note, the day falling after the expiry of40 days after completion of the distribution of the Notes, as certified by the relevant Dealer.

Permanent Global Notes

Each Permanent Global Note in respect of a Tranche of Bearer Notes will be exchangeable, freeof charge to the holder, on or after its Exchange Date in whole but not (unless otherwise specifiedin the Pricing Supplement) in part for Bearer Notes in definitive form:

(a) unless principal in respect of any Bearer Notes is not paid when due, by the Issuer givingnotice to the Noteholders and the Fiscal Agent of its intention to effect such exchange;

(b) if the Pricing Supplement provides that such Permanent Global Note is exchangeable at therequest of the holder, by the holder giving notice to the Fiscal Agent of its election for suchexchange; or

(c) otherwise

(i) if the Permanent Global Note is held on behalf of Euroclear or Clearstream,Luxembourg or any Alternative Clearing System and any such clearing system isclosed for business for a continuous period of 14 days (other than by reason ofholidays, statutory or otherwise) or announces an intention permanently to ceasebusiness or in fact does so or

(ii) if principal in respect of any Notes is not paid when due, by the holder giving notice tothe Fiscal Agent of its election for such exchange.

“Exchange Date” means, in relation to a Permanent Global Note, a day falling not less than 60days after that on which notice requiring exchange is given.

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Global Certificates

Each Global Certificate will be exchangeable on or after its Exchange Date, in whole but not in part,for Certificates in definitive form:

(a) by the Issuer giving notice to the Noteholders, the Fiscal Agent and the Registrar of itsintention to effect such exchange;

(b) if the Pricing Supplement provides that such Global Certificate is exchangeable at therequest of the holder, by the holder giving notice to the Registrar of its election for suchexchange; or

(c) otherwise

(i) if the Global Certificate is held (directly or indirectly) on behalf of Euroclear orClearstream, Luxembourg or an Alternative Clearing System and any such clearingsystem is closed for business for a continuous period of 14 days (other than by reasonof holidays, statutory or otherwise) or announces an intention permanently to ceasebusiness or does in fact do so or

(ii) if principal in respect of any Certificates is not paid when due, by the holder givingnotice to the Fiscal Agent of its election for such exchange.

“Exchange Date” means, in relation to a Global Certificate, a day falling not less than 60 days, orin the case of failure to pay principal in respect of any Notes when due 30 days, after that on whichthe notice requiring exchange is given.

Business Days

Exchange of Global Notes or Global Certificates as referred to above shall only be effected if thedate on which such exchange is required to be made is a day on which banks are open forbusiness in the city in which the specified office of the Fiscal Agent or, as the case may be, theRegistrar is located and in the city in which the relevant clearing system is located.

Delivery

On or after any due date for exchange of any Global Note or Global Certificate, the holder of suchGlobal Note or Global Certificate may surrender the same or, in the case of a partial exchange,present it for endorsement to or to the order of the Fiscal Agent or Registrar, as the case may be.Upon surrender of any Global Note or Global Certificate, or the part thereof to be exchanged, theIssuer will:

(a) Permanent Global Note. In the case of a Temporary Global Note exchangeable for aPermanent Global Note, deliver, or procure the delivery of, a Permanent Global Note in anaggregate principal amount equal to that of the whole or that part of a Temporary GlobalNote that is being exchanged or, in the case of a subsequent exchange, endorse, or procurethe endorsement of, a Permanent Global Note to reflect such exchange; or

(b) Definitive Notes and Certificates. In the case of a Permanent Global Note or GlobalCertificate exchangeable for Notes or Certificates in definitive form, as the case may be,(unless such exchange is at the request of the Issuer) at the cost of the relevant Noteholderand against such indemnity as the Fiscal Agent, the Registrar or any Transfer Agent mayrequire in respect of any tax or other duty of whatever nature which may be levied or imposedin connection with such exchange, cause an equal aggregate principal amount of Notes orCertificates in definitive form to be executed and delivered to the Fiscal Agent, the Registraror any Transfer Agent, as the case may be, for completion, authentication and dispatch to therelevant Noteholders. Upon any such exchange the relevant Noteholders must provide theFiscal Agent, the Registrar or any Transfer Agent with a written order containing instructions

45

and such other information as the Issuer and the Fiscal Agent, the Registrar or any TransferAgent (as the case may be) may require to complete, execute and deliver such Notes orCertificates in definitive form.

Bearer Notes in definitive form will be security printed and Certificates in definitive form will beprinted in accordance with any applicable legal and Stock Exchange requirements in orsubstantially in the form set out in the Schedules to the Agency Agreement. Any Notes orCertificates in definitive form shall be available at the office of each Transfer Agent (including, forthe avoidance of doubt, the office of the Transfer Agent in Luxembourg).

On exchange in full of each Global Note or Global Certificate, the Issuer will, if the holder sorequests, procure that it is cancelled and returned to the holder together with the relevant Notesand/or Certificates in definitive form for which it was exchanged.

4. Legends

Each Bearer Note (including each Global Note), Talon and Coupon will bear the following legend:

“ANY UNITED STATES PERSON WHO HOLDS THIS OBLIGATION WILL BE SUBJECT TOLIMITATIONS UNDER THE UNITED STATES INCOME TAX LAWS, INCLUDING THELIMITATIONS PROVIDED IN SECTIONS 165(J) AND 1287(A) OF THE INTERNAL REVENUECODE.”

The sections of the US Internal Revenue Code referred to in the legend provide that a UnitedStates taxpayer, with certain exceptions, will not be permitted to deduct any loss, and will not beeligible for capital gains treatment with respect to any gain realised on any sale, exchange orredemption of Bearer Notes or any related Coupons.

5. Provisions Relating to Notes in Global Form

Each Global Note and each Global Certificate contains provisions that apply to the Notes that theyrepresent, some of which modify the effect of the Conditions of the Notes set out in this OfferingCircular. The following is a summary of those provisions:

(a) Payments. No payment falling due after the Exchange Date applicable to any TemporaryGlobal Note will be made on any Temporary Global Note unless exchange for an interest ina Permanent Global Note or for Bearer Notes in definitive form, as the case may be, isimproperly withheld or refused. Payments on any Temporary Global Note issued incompliance with the D Rules before the Exchange Date will only be made againstpresentation of certification as to non-US beneficial ownership in the form set out in theAgency Agreement. All payments in respect of Bearer Notes will be made againstpresentation for endorsement and, if no further payment falls to be made in respect of suchNotes, surrender of the relevant Global Note to, or to the order of, the Fiscal Agent, or suchother Paying Agent as shall have been notified to the Noteholders for such purpose. A recordof each payment so made will be endorsed on each such Global Note, which endorsementwill be prima facie evidence that such payment has been made in respect of the Notes.

No payments of principal (which for the purposes of this paragraph shall include finalInstalment Amounts but not interim payments of principal) falling due after the ExchangeDate applicable to any Global Certificate will be made unless exchange for Certificates indefinitive form is improperly withheld or refused. Any final payments of principal in respect ofRegistered Notes represented by a Global Certificate will be made against presentation andsurrender of that Global Certificate to or to the order of the Registrar.

(b) Prescription. Claims against the Issuer in respect of Notes issued by it that are representedby a Permanent Global Note will become void unless it is presented for payment within aperiod of 10 years (in the case of principal) and five years (in the case of interest) from theappropriate Relevant Date (as defined in “Terms and Conditions of the Notes – Taxation”).

46

Claims against the Issuer in respect of the principal of Notes issued by it that are representedby a Global Certificate will become void unless such Note it is presented for payment withina period of 10 years from the appropriate Relevant Date.

(c) Meetings. The holder of a Global Note or Global Certificate shall (unless such Global Noteor Global Certificate represents only one Note) be treated as being two persons for thepurposes of any quorum requirements at any meeting of Noteholders. The holder of aPermanent Global Note shall be treated as having one vote in respect of each minimumDenomination of Notes for which such Permanent Global Note may be exchanged. Theholders of Registered Notes will be entitled to one vote in respect of each Note comprisingsuch Noteholder’s holding, whether or not represented by a Global Certificate.

(d) Cancellation. Cancellation of any Bearer Note represented by a Permanent Global Note thatis required by the Conditions to be cancelled (other than upon its redemption) will be effectedby reduction in the principal amount of the relevant Permanent Global Note and evidencedby the appropriate notation in the relevant schedule to such Permanent Global Note.

(e) Purchases. Bearer Notes represented by a Permanent Global Note may only be purchasedby the Issuer or the Guarantor together with the rights to receive all future payments ofinterest and Instalment Amounts (if any) thereon.

(f) Issuer’s Options. Any option of the Issuer provided for in the Conditions of any Notes issuedby it while such Notes are represented by a Global Note or Global Certificate shall beexercised by the Issuer giving notice to the Noteholders within the time limits set out in, andcontaining the information required by, the Conditions, except that the notice shall not berequired to contain the serial numbers of Notes drawn in the case of a partial exercise of anoption and accordingly no drawing of Notes shall be required. In the event that any option ofthe Issuer is exercised in respect of some but not all of the Notes of any Tranche or Serieswhich are represented by a Global Note or Global Certificate, the rights of accountholderswith a clearing system in respect of the Notes will be governed by the standard proceduresof Euroclear, Clearstream, Luxembourg or any Alternative Clearing System (as the case maybe).

(g) Noteholders’ Options. Any option of the Noteholders provided for in the Conditions of anyNotes while such Notes are represented by a Global Note or Global Certificate may beexercised by the holder of the Global Note or Global Certificate delivering to the Fiscal Agent(in the case of Bearer Notes) or Registrar (in the case of Registered Notes), within the timelimits relating to the deposit of Notes or Certificates with a Paying Agent or Transfer Agentset out in the Conditions, a notice stating the principal amount of Notes in respect of whichthe option is exercised (but which shall not be required to state the serial numbers of suchNotes) and at the same time presenting the Global Note or Global Certificate to the FiscalAgent or Registrar (as the case may be), or to a Paying Agent or Transfer Agent acting onbehalf of the Fiscal Agent, for notation.

(h) Events of Default. Each Global Note and Global Certificate provides that the holder maycause such Global Note or Global Certificate to, or that such Global Note or GlobalCertificate or a portion of it will, become due and repayable in the circumstances describedin “Conditions of the Notes – Events of Default” by stating in the notice to the Fiscal Agentthe principal amount of such Global Note or Global Certificate that is becoming due andrepayable. If principal in respect of any Note is not paid when due, the holder of a GlobalNote or Global Certificate may elect for direct enforcement rights against the Issuer underthe terms of an Amended and Restated Deed of Covenant executed as a deed by the Issueron 23rd January 2004 to come into effect in relation to the whole or a part of such GlobalNote or Global Certificate in favour of the persons entitled to such part of such Global Noteor Global Certificate, as the case may be, as accountholders with a clearing system.Following any such election, the specified portion of the Global Note or, as the case may be,the Global Certificate and the corresponding entry in the register kept by the Registrar will

47

become void. However, no such election may be made in respect of Notes represented by aGlobal Certificate unless the transfer of the whole or a part of the holding of Notesrepresented by that Global Certificate shall have been improperly withheld or refused.

(i) Notices. So long as any Notes are represented by a Global Note or Global Certificate andsuch Global Note or Global Certificate is held on behalf of a clearing system, notices to theholders of such Notes may be given by delivery of the relevant notice to that clearing systemfor communication by it to entitled accountholders in substitution for publication as requiredby the Conditions or by delivery of the relevant notice to the holder of such Global Note orGlobal Certificate, except that so long as such Notes are listed on the Luxembourg StockExchange and the rules of such Exchange so require, notices shall also be published in aleading newspaper having general circulation in Luxembourg (which is expected to be theLuxemburger Wort).

6. Partly Paid Notes

The provisions relating to Partly Paid Notes are not set out in this Offering Circular, but will becontained in the Pricing Supplement and thereby in the Global Note(s) or Global Certificate(s)relating thereto. While any instalments of the subscription moneys due from the holder of PartlyPaid Notes are overdue, no interest in a Global Note representing such Notes may be exchangedfor an interest in a Permanent Global Note or for Definitive Bearer Notes (as the case may be) andno interest in a Global Certificate may be exchanged for definitive Certificates. If any Noteholderfails to pay any instalment due on any Partly Paid Notes within the time specified, the Issuer mayforfeit such Notes and shall have no further obligation to their holder in respect of them.

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FORM OF PRICING SUPPLEMENT

The form of Pricing Supplement that will be issued in respect of each Tranche is set out below:

This document constitutes the Pricing Supplement relating to the issue of Notes described herein.Terms used herein shall be deemed to be defined as such for the purposes of the Conditions setforth in the Offering Circular dated 23rd January 2004. This Pricing Supplement must be read inconjunction with such Offering Circular.

[Include whichever of the following apply or specify items as “Not Applicable” (N/A). Note that thenumbering should remain as set out below, even if “Not Applicable” is indicated for individualparagraphs or sub-paragraphs. Italics denote directions for completing the Pricing Supplement.]

1 Issuer: Hrvatska banka za obnovu i razvitak (TheCroatian Bank for Reconstruction andDevelopment)

Guarantor: The Republic of Croatia

2 (i) Series Number: [ ]

(ii) Tranche Number: [ ]

3 Specified Currency or Currencies: [ ]

4 Aggregate Nominal Amount: [ ]

(i) Series: [ ]

(ii) Tranche: [ ]

5 (i) Issue Price: [ ] per cent. of the Principal Amount [plusaccrued interest from [insert date] (in the caseof fungible issues only, if applicable)]

(ii) Net proceeds: [ ] (If different from Offering Circular.Required only for listed issues)

6 Specified Denominations: [ ]

7 (i) Issue Date: [ ]

(ii) Interest Commencement Date: [ ]

8 Maturity Date: [specify date or (for Floating Rate Notes)Interest Payment Date falling in or nearest tothe relevant month and year]

9 Interest Basis: [�% Fixed Rate][[specify reference rate] +/– �% Floating Rate][Zero Coupon][Index Linked][Other (specify)](Further particulars specified below)

(if fungible with an existing Series,details of that Series, the numberincluding the date on which the Notesbecome fungible)

49

10 Redemption/Payment Basis: [Redemption at Par][Index Linked Redemption][Dual Currency][Partly Paid][Instalment][Other (specify)]

[Specify details of any provision for convertibilityof Notes into another interest orredemption/payment basis]

12 Put/Call Options: [Investor Put][Issuer Call][(Further particulars specified below)]

13 Status of the Notes and the Guarantee: [Senior]

14 Listing: [Luxembourg/other (specify)/None]

15 Method of distribution: [Syndicated/Non-syndicated]

PROVISIONS RELATING TO INTEREST (IF ANY) PAYABLE

16 Fixed Rate Note Provisions [Applicable/Not Applicable] (If not applicable,delete the remaining sub-paragraphs of thisparagraph)

(i) Rate[(s)] of Interest: [ ] per cent. per annum [payable[annually/semi-annually/quarterly/monthly] inarrear]

(ii) Interest Payment Date(s): [ ] in each year [adjusted in accordancewith [specify Business Day Convention and anyapplicable Business Centre(s) for the definitionof “Business Day”]/not adjusted]

(iii) Fixed Coupon Amount[(s)]: [ ] per [ ] in Nominal Amount

(iv) Broken Amount(s): [Insert particulars of any initial or final brokeninterest amounts which do not correspond withthe Fixed Coupon Amount[(s)]]

[specify]

[ ] Insert regular interest payment dates,ignoring issue date or maturity date in the caseof a long or short first or last coupon]

[Not Applicable/give details][other (specify)]

17 Floating Rate Note Provisions [Applicable/Not Applicable] (If not applicable,delete the remaining sub-paragraphs of thisparagraph)

(i) Interest Period(s): [Specify either a period or periods or a specificdate or dates]

(vii) Other terms relating to the method of calculating interest forFixed Rate Notes:

(vi) Determination Date(s):(Condition [5(j)])

(v) Day Count Fraction:(Condition [5(j)])

11 Change of Interest or Redemption/Payment Basis:

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(ii) Specified Interest Payment Dates: [ ]

(iii) Business Day Convention: [Floating Rate Convention/Following BusinessDay Convention/Modified Following BusinessDay Convention/Preceding Business DayConvention/other (give details)

(iv) Business Centre(s): [ ]

[Screen Rate Determination/ISDADetermination/other (give details)]

[ ]

(vii) Screen Rate Determination:

– Reference Rate: [NB The Conditions are set up to deal withEURIBOR and LIBOR only. If the ReferenceRate is neither, consider what furtheramendments must be made to the Conditions]

– Interest Determination Date(s): [ ]

– Relevant Screen Page: [ ]

(viii) ISDA Determination:

– Floating Rate Option: [ ]

– Designated Maturity: [ ]

– Reset Date: [ ]

(ix) Margin(s): [+/–] [ ] per cent. per annum

(x) Minimum Rate of Interest: [ ] per cent. per annum

(xi) Maximum Rate of Interest: [ ] per cent. per annum

(xii) Day Count Fraction: [Actual/360][other (specify)]

[NB Consider specifying Reference Banks. If notnamed here, the Calculation Agent has adiscretion to select using certain criteriaspecified in the Conditions NB Consider specifying any Relevant FinancialCentre. If not named in the Pricing Supplement,it is the financial centre with which theReference Rate is most closely connected, or ifthe Reference Rate is not closely connectedwith any financial centre, London.NB Consider specifying the Effective Date. If notspecified here, it is the first day of the InterestAccrual Period to which an InterestDetermination Date relates]

18 Zero Coupon Note Provisions [Applicable/Not Applicable] (If not applicable,delete the remaining sub-paragraphs of thisparagraph)

(xiii) Fall back provisions, roundingprovisions, denominator and anyother terms relating to the methodof calculating interest on FloatingRate Notes, if different from thoseset out in the Conditions:

(vi) Party responsible for calculatingthe Rate(s) of Interest and InterestAmount(s) (if not the Fiscal Agent):

(v) Manner in which the Rate(s) ofInterest is/are to be determined:

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(i) [Amortisation/Accrual]: [+/-] per cent. per annum

(ii) Yield: [ ]

(iii) Reference Price: [ ]

[ ]

19 Index-Linked Interest Note Provisions [Applicable/Not Applicable] (If not applicable,delete the remaining sub-paragraphs of thisparagraph)

(i) Index/Formula: [give or annex details]

[ ]

[ ]

(iv) Interest Period(s): [ ]

(v) Specific Interest Payment Dates: [ ]

(vi) Business Day Convention: [Floating Rate Convention/Following BusinessDay Convention/Modified Following BusinessDay Convention/Preceding Business DayConvention/other (give details)]

(vii) Business Centre(s): [ ](Condition [5(j)])

(viii) Minimum Rate of Interest: [ ] per cent. per annum

(ix) Maximum Rate of Interest: [ ] per cent. per annum

(x) Day Count Fraction: [ ](Condition [5(j)])

20 Dual Currency Note Provisions [Applicable/Not Applicable] (If not applicable,delete the remaining sub-paragraphs of thisparagraph)

[give details]

[ ]

[ ]

[ ](vi) Person at whose option SpecifiedCurrency(ies) is/are payable:

(iii) Provisions applicable wherecalculation by reference to Rate ofExchange impossible orimpracticable:

(ii) Calculation Agent, if any,responsible for calculating theprincipal and/or interest due:

(i) Rate of Exchange/method ofcalculating Rate of Exchange:

(iii) Provisions for determining Couponwhere calculation by reference toIndex and/or Formula is impossibleor impracticable:

(ii) Calculation Agent responsible forcalculating the interest due:

(iv) Any other formula/basis ofdetermining amount payable:

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PROVISIONS RELATING TO REDEMPTION

21 Call Option [Applicable/Not Applicable] (If not applicable,delete the remaining sub-paragraphs of thisparagraph)

(i) Option Exercise Date(s): [ ] (NB If this is to cover a period, specifythis here)

(ii) Optional Redemption Date(s): [ ]

[ ] per Note of [ ] specified denomination

(iv) If redeemable in part:

[ ]

[ ]

(v) Notice Period: [ ]

22 Put Option [Applicable/Not Applicable] (If not applicable,delete the remaining sub-paragraphs of thisparagraph)

(i) Option Exercise Date(s): [ ]

(ii) Optional Redemption Date(s): [ ]

[ ] per Note of [ ] specified denomination

[ ]

[[ ] per Note of [ ] specified denomination/other/see Appendix]

24 Early Redemption Amount: [Insert amount or details including partyresponsible for calculation if not the FiscalAgent]

GENERAL PROVISIONS APPLICABLE TO THE NOTES

25 Form of Notes: Bearer Notes

[Temporary Global note exchangeable for aPermanent Global Note which is exchangeablefor Definitive Bearer/Registered Notes on [ ]

Early Redemption Amount(s) of eachNote payable on redemption for taxationreasons or on event of default and/or themethod of calculating the same (ifrequired or if different from that set out inthe Conditions)

23 Final Redemption Amount of eachNote:

(iv) Notice period (if other than as setout in the Conditions):

(iii) Optional Redemption Amount(s) ofeach Note and method, if any, ofcalculation of such amount(s):

(b) Maximum RedemptionAmount:

(a) Minimum RedemptionAmount:

(iii) Optional Redemption Amount(s) of each Note and method, if any, ofcalculation of such amount(s):

53

days’ notice/at any time/in the limitedcircumstances specified in the PermanentGlobal Note]

[Temporary Global Note exchangeable forDefinitive Notes on [ ] days’ notice]

[Permanent Global Note exchangeable forDefinitive Bearer/Registered Notes on [ ]days’ notice/at any time/in the limitedcircumstances specified in the PermanentGlobal Note]

[Registered Notes]

[Not Applicable/give details. Note that this itemrelates to the date and place of payment, andnot interest period end dates to which item16(ii), 17(iv) and 19(vii) relate]

[Yes/No. If yes, give details – including details ofhow interest is to accrue if not on the paid-upAggregate Nominal Amount of the Notes]

[Not Applicable/give details – give detailsincluding definitions of Instalment Amount(s),Instalment Date(s), Minimum and/or MaximumInstalment Amounts]

[Not Applicable/give details]

[Not Applicable/The provisions annexed to thisPricing Supplement apply]

31 Consolidation provisions: [Not Applicable/The provisions annexed to thisPricing Supplement apply]

32 Other terms or special conditions: [Not Applicable/give details]

DISTRIBUTION

33 (i) If syndicated, names of Managers: [Not Applicable/give names]

(ii) Stabilising Manager (if any): [Not Applicable/give names]

34 If non-syndicated, name of Dealer: [Not Applicable/give names]

35 Additional selling restrictions: [Not Applicable/give details]

OPERATIONAL INFORMATION

36 ISIN: [ ]

37 Common Code: [ ]

30 Redenomination, renominalisation andreconventioning provisions:

29 Details relating to Instalment Notes:amount of each instalment, date onwhich each payment is to be made:

28 Details relating to Partly Paid Notes:amount of each payment comprising theIssue Price and date on which eachpayment is to be made andconsequences (if any) of failure to pay,including any right of the Issuer to forfeitthe Notes and interest due on latepayment:

27 Talons for future Coupons or Receipts tobe attached to Definitive Notes (anddates on which such Talons mature):

26 Financial Centre(s) or other specialprovisions relating to Payment Dates:

54

[Not Applicable][Other]

39 Delivery: Delivery [against/free of] payment

40 Additional Paying Agent(s) (if any): [ ]

[Listing Application

This Pricing Supplement comprises the details required to list the issue of Notes described hereinpursuant to the e500,000,000 Euro Medium Term Note Programme of 23rd January 2004.]

Responsibility

The Issuer accepts responsibility for the information contained in this Pricing Supplement.

Signed on behalf of the Issuer:

By:____________________________________

Duly Authorised Signatory

38 Any clearing system(s) other thanEuroclear and Clearstream, Luxembourgand the relevant identification number(s):

55

USE OF PROCEEDS

The net proceeds from the issue of each Tranche of Notes will be used by the Issuer for its generalfinancing purposes.

56

HRVATSKA BANKA ZA OBNOVU I RAZVITAK

(The Croatian Bank for Reconstruction and Development)

Incorporation, Purpose and Authority, Seat

HBOR was established in 1992 pursuant to the Law on Hrvatska kreditna banka za obnovu (TheCroatian Credit Bank for Reconstruction) (now known as the Law on Hrvatska banka za obnovu irazvitak (The Croatian Bank for Reconstruction and Development)), published in the OfficialGazette of the Republic of Croatia (Narodne novine) No. 33/92, 76/93, 108/95 and 8/96 (the“HBOR Law”). All of HBOR’s founder’s capital (being the initial minimum capital contributed toHBOR on its establishment pursuant to the HBOR Law) is owned by the government (the“Government”) of the Republic of Croatia (“Croatia” or the “State“). The restrictions and controls oncommercial banks and companies generally imposed by Croatian law apply to HBOR to the extentthe HBOR Law does not specify otherwise. In accordance with the HBOR Law, HBOR is notrequired to keep obligatory reserves with the CNB or establish statutory provisions for specificbanking risks. In addition, HBOR is exempt from the payment of profit tax and all profits areallocated to reserves. HBOR can only be wound up by statute, has the capacity to contract withthird parties and is liable for its commitments to the value of its total assets.

When established, HBOR operated under the name Hrvatska kreditna banka za obnovu (TheCroatian Credit Bank for Reconstruction). Following the collapse of the former Yugoslavia, thewidespread destruction caused by the 1991 war in Croatia made it imperative to commence acomprehensive plan to reconstruct buildings, infrastructure, industry and agriculture in anorganised fashion. HBOR’s primary purpose was to grant loans for the reconstruction of thecountry. In December 1995, amendments to the HBOR Law were adopted, followed byamendments to the Statutes of HBOR (the “Statutes”) in 1996 which included a change of thename to its current name, giving it increased powers and enabling it to finance Croatian exportsand insure export contracts against political and commercial risks on behalf and for the account ofthe Republic of Croatia. In May 2003, new Statutes were adopted by HBOR’s Supervisory Board(see “Directors and Management”, below) which, inter alia, widen the scope of the Bank’s activitiesand further clarify the powers of the Supervisory Board and the Managing Board (see “Directorsand Management”, below). The new Statutes provide for more efficient corporate governance bygiving the Managing Board and the Credit Committee certain new powers in respect of lendingactivities and more precisely defining the Managing Board’s authority to make decisions regardingthe business policy and the internal organisation of HBOR, in accordance with the guidelines andframework set by the Supervisory Board.

At the time of HBOR’s establishment, the German development bank, Kreditanstalt fürWiederaufbau (“KfW“), provided technical and operational assistance to HBOR.

Pursuant to Article 16 of the Law on the Financing of the Reconstruction published in the OfficialGazette of the Republic of Croatia (Narodne novine) No. 33/92, HBOR took over the assets,liabilities and net equity of the Fund for the Construction and the Repair of Premises Destroyedand Damaged in the War (the “FRDR“) at the end of 1992. HBOR also took over the assets,liabilities, net equity and employees of the Croatian Development and Export Bank (Hrvatskarazvojna i izvozna banka d.d.) (“HRIB“) as of 1st November 1992 and of the Croatian Agency forReconstruction in September 1993.

Furthermore, pursuant to Article 11 of the Law on Privatisation published in the Official Gazette ofthe Republic of Croatia (Narodne novine) No. 21/96, funds available to HBOR after the sale ofcertain companies from the portfolio of the CPF were transferred to HBOR’s founder’s capitalbetween 1996 and July 1997. Out of these funds, HBOR granted loans to companies in regionsunder special State care for its own account and under mandate from the CPF. Repayments ofthese loans were paid into HBOR’s founder’s capital. After 9th July 1997 such funds were insteadallocated to the State Budget.

57

HBOR’s registered office is at Strossmayerov trg 9, 10000 Zagreb. These premises were grantedto HBOR in 1992 with the value of the premises incorporated into its founder’s capital. In January2003, HBOR purchased premises at Zelinska 3, 10000 Zagreb. On 9th December 2003, HBORopened an information centre for the Dalmatia region in Split. HBOR does not have any branchoffices or other premises.

Relationship with the Government and Supervision

Since its establishment, HBOR has been entirely owned by the State. Croatian legislation requiresthat HBOR remains owned by the State. The State is required by law to contribute to HBOR’scapital from the State Budget. According to the HBOR Law, HBOR’s initial capital was set atHRK3.7 billion (US$558 million based on 30th September 2003 exchange rates).

The capital is paid-in from the State Budget at a time determined by the Government and theCroatian Parliament upon ratification of the annual State Budget. As at 31st December 2002,HBOR’s capital was HRK3.65 billion, comprising paid-in founder’s capital of HRK2.71 billion,revaluation of the capital value adjustment in business years characterised by hyperinflation ofHRK426.6 million, retained earnings and reserves of HRK513.8 million and guarantee fund ofHRK1.4 million.

HBOR’s liabilities in respect of borrowings (including bonds issued by it) domestically andinternationally are automatically guaranteed by the State pursuant to Article 3 paragraph 2 of theHBOR Law. However, there are limits on the amount of such borrowings. In accordance with Article94 of the Budget Law, published in the Official Gazette (Narodne novine) of the Republic of CroatiaNo. 96/03, and pursuant to Article 35a of the 2003 State Budget Execution Law published in theOfficial Gazette No. 154/02 and 147/03, HBOR generally requires the Government’s approval toenter into credit transactions or issue guarantees in excess of HRK7.5 million. However, in respectof the refinancing of short-term, mid-term and long-term export loans granted by banks or otherfinancial organisations which are insured against non-commercial risks, bilateral and multilateralco-financing and pre-shipment export financing, HBOR is not required to obtain the Government’sapproval unless an individual lending or refinancing transaction exceeds HRK20 million or if aparticular guarantee transaction exceeds HRK50 million, in which case HBOR must obtain theapproval of the Ministry of Finance.

Until 31st December 1999, the State set limits under the State Budget Execution Law, passed eachyear for the following year’s State Budget, on the amount of HBOR’s debt obligations which wouldhave the benefit of the automatic State guarantee in any one year. The limit on the automaticguarantee effectively set a limit on HBOR’s borrowings each year. In 1999, such limit amounted toHRK750 million. HBOR has never exceeded any limit so set.

Since 1st January 2000, the borrowings of HBOR are no longer formally pre-determined under theState Budget Execution Law but are set by, and at the discretion of, the Ministry of Finance and,ultimately, the Government on a case by case basis.∆

Save as described above, there are no other limits on HBOR’s borrowing powers.

Since the 2001 State Budget, no general annual coverage limit for export insurance has been setin the State Budget Execution Law. HBOR’s reserves for this purpose are placed in the specialguarantee fund which is maintained by HBOR on behalf, and for account, of the State. If HBOR’sobligations arising from its insurance operations (which it carries out on behalf, and for the account,of the State) at any time exceed the amount placed in the special guarantee fund, the State isrequired to compensate HBOR for the shortfall prior to the maturity of such obligations.

HBOR does not borrow from the State but receives funds from the State Budget. On occasions,however, the State borrows from HBOR. In accordance with Article 6 of the HBOR Law, if theGovernment requires HBOR to lend money at below then prevailing interest rates, HBOR is entitledto compensation from the State Budget in order to maintain the real value of its capital.

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Principal Business Activities

The HBOR Law and the Statutes define and regulate HBOR’s powers and authority. The strategicgoals of HBOR are to: (i) support the reconstruction and development of the Croatian economy and(ii) manage the direction of funds to ensure the balanced development of all regions within Croatiawith special emphasis on the development of the islands and areas of special state concern.

Within the framework of its activities, HBOR performs foreign currency payment transactions,issues guarantees and letters of credit and undertakes mandated activities for and on behalf of theGovernment.

While a high percentage of HBOR’s loans are made to intermediary banks, HBOR also extendsloans directly to both private and public sector customers. Loans may be granted in Kuna or foreigncurrencies. HBOR may also carry out other banking operations if they correlate with theabovementioned functions. The Government may, from time to time, authorise HBOR to performother financial transactions if, in its opinion, such transactions are in the best interests of Croatia.

Currently, HBOR is one of the largest banks in Croatia (in terms of capital) and has substantialinfluence on the development of the country. It is not a commercial bank and its primary aim is notto maximise profit but to maintain the value of its capital. It aims to secure its return on loans madeby it and to preserve the value of funds lent by it, to set interest rates so as to cover its operatingexpenses, to create reserves by increasing capital and providing for risk exposure, and to pass onforeign exchange risk to counterparties through loan agreements.

Lending Activity

HBOR’s basic activities comprise: (i) the granting of loans to companies for the development of theeconomy and infrastructure; (ii) the granting of loans to small- and medium-sized enterprises(“SMEs”) and the tourist sector; and (iii) the financing of export businesses. HBOR’s activities havedeveloped over the years in response to the direction of the Government as follows:

� In 1996, in accordance with Government guidelines and the terms of foreign credit lines, aprogramme was developed for reviving the tourism industry that had suffered directly fromactual war damage and indirectly due to the unstable environment.

� In 1997, HBOR focused its activities on development programmes and preparations forexport finance and financing infrastructure projects. HBOR launched the “Loan Programmefor Incentives to Business Start-ups for Small Enterprises” as part of a systematic approachto developing the structure of SMEs, which are one of the main factors in Croatia’s economicdevelopment and job creation.

� In 1998, HBOR joined the Government’s programme aimed at stimulating housingconstruction and alleviating problems faced by young families seeking to purchase a housefor the first time. In the same year, programmes for pre- and post- shipment export financeand export credit insurance against political and commercial risks were implemented whichhelped Croatian exporters to enter foreign markets. This marked the beginning of HBOR’sdirect support for Croatian exports.

� In 1999, within the framework of financing the shipbuilding industry, HBOR joined the firstphase of the Government’s programme for the technological renewal of shipyards. In thesame year, HBOR launched the “Programme for the Development of Islands” aimed at theeconomic revival and improved demographic situation on the islands of Croatia.

� In 2000, new loan programmes were developed for financing exports of capital goods andfor financial restructuring of economic entities. The export financing programmes proved tobe popular with Croatian entrepreneurs because they enabled Croatian exporters to committhemselves to provide a direct “buyer’s credit” out of which payment for the goods could besettled. “Buyer’s credits” are effectively loans to foreign buyers enabling them to purchase

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Croatian goods. “Buyer’s credits” provide prompt payment of an export transaction to theCroatian exporter enabling it to be competitive on the international market. Since mid-2000,HBOR has financed exports of capital goods through “buyer credits” and since mid-2001through “supplier credits” (loans to suppliers).Through this process the entire cycle is closed,starting from pre-shipment financing to collecting payments abroad. The financialrestructuring programmes help with “asset-liability” matching for companies with long termassets but short term liabilities by replacing the short term liabilities with longer termliabilities thereby matching the asset duration.

� Since 2001, HBOR has initiated negotiations and entered into co-operation agreements withnumerous financial institutions (export banks and export credit agencies) aimed at facilitatingexports and enhancing economic co-operation with foreign countries for the benefit ofCroatian exporters.

� In 2002, new programmes were established for (i) the direct financing of SME start-ups andinvesting in the equity of Croatian companies focussed on supporting good quality projectswith high internal rates of return, (ii) encouraging investment and (ii) facilitating access to theinitial capital needed for new and promising projects. These programmes contribute to thepromotion of entrepreneurial activities and improved employment prospects at a time whencommercial bank finance is unavailable due to the risks involved. The co-operation betweenHBOR and the Croatian Guarantee Agency has enabled many entrepreneurs to successfullyimplement their projects.

� In 2003, new Short-Term Credit Insurance products were introduced – the Multibuyer Policy(insurance for a minimum of 5 foreign buyers or 70% of the whole export volume andretention of 15%) and the Wholeturnover Policy (insurance for the whole turnover andretention of 15%). For Short-Term Credit Insurance and Medium/Long-Term CreditInsurance products, new premium systems were adopted. Political risks insurance wasannounced for investments abroad and shareholder loans extended to foreign companies.Cover is provided for investments in newly established companies or existing companiesaimed at modernising, extending capacities or implementing take-overs and investments incash, goods and rights expressed in monetary units. The “Loan Programme for FinancingExports by Providing Lines of Credit to Foreign Buyers’ Banks” was also introduced.

Most loans for financial restructuring of economic entities and preparation of exports are grantedto companies through Croatian commercial banks (“loans via commercial banks“). These banksassume both the administration of, and credit risk associated with, the loans. Loans forinfrastructure are granted directly to state owned companies for individual projects and HBORbears any collection risk, subject to collateral being provided (“direct loans“). Loans to the tourismindustry and SMEs are granted either directly to customers or through banks. Loans for financialexport of capital goods are granted directly by HBOR subject to receipt of a counter-guaranteefrom an acceptable foreign bank or are granted through an acceptable foreign bank.

In this section, references to “total loan portfolio” include the amount of principal and interestreceivables under drawn loans and principal receivables under undrawn loans but exclude otherassets and contingent liabilities (such as guarantees and open letters of credit but excludingprincipal receivables under undrawn loans) and references to “total gross loans” mean the amountof principal receivables under drawn loans.

As at 31st December 2002, HBOR’s total loan portfolio was HRK9.2 billion, 54.8% of which wasguaranteed, directly or indirectly, by the State. Of the total loan portfolio, HRK6.3 billion (68.5%)was lent to customers through direct loans, 79.5% of which were guaranteed, directly or indirectly,by the State. The remaining share of direct loans not guaranteed by the State is secured bymortgage and fiduciary title. The remainder of HBOR’s total loan portfolio of HRK2.9 billion(31.5%), comprised loans via commercial banks.

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HBOR’s exposure through direct loans is secured either by guarantees or mortgages or both. Theguarantees are mainly given by the Ministry of Finance or local authorities and cover the total loan(including interest and fees). When a loan is secured by a mortgage, it is HBOR’s policy to obtainmortgage cover of at least 1.5 times the amount of the initial loan. HBOR also requires that thedebtor obtains a valuation from a court authorised surveyor, which is used as the basis for avaluation of the collateral. In respect of loans via commercial banks, HBOR requires directrecourse to the customers of the banks. All loans have bills of exchange and debentures asadditional collateral.

Lending transactions and the management of the loan approval process are regulated by the“General Conditions for Loan Operations of HBOR”, which were published in June 2003.

According to its internal policies, HBOR generally lends up to 80% of a particular investment. Allloans are fixed with interest rates ranging between 2% and 7%. Commercial banks retain between2%-3% of the interest rate.

As at 31st December 2002, HBOR’s ten largest borrowers by total gross loans had borrowingstotalling HRK3.8 billion or 46.5% of HBOR’s total gross loans of HRK8.1 billion. Two of these loansrelated to the shipping industry and the remaining loans related to the executive body of theRepublic, electricity and water-supply companies and the banking industry.

Between 1st January 2003 and 30th September 2003, the total volume of loans and guaranteesgranted by HBOR, in its name and for its account, amounted to HRK4.5 billion. HRK3.2 billion, or71.0%, related to loans granted. The remaining HRK1.3 billion, or 29.0%, related to approvedguarantees with counter-guarantees issued by the State in favour of HBOR.

Of the total volume of loans granted between 1st January 2003 and 30th September 2003, 13.1%comprised loans for the promotion of export, whereas 69.2% comprised loans for thereconstruction and development of the economy. Loans for the promotion of crafts and for SMEsmade up 4.2% of loans approved. Loans for the implementation of infrastructure and environmentalprojects made up 13.5% of the total loans approved.

In June 2003, the Supervisory Board resolved to reduce interest rates within a number of its loanprogrammes. A new range of lower interest rate loans within 11 of HBOR’s loan programmes wasintroduced: for exporters, small entrepreneurs, economic entities, start-up entrepreneurs andentrepreneurs with experience with investments in areas of special State concern and thedevelopment of the islands; and as support for the tourism industry, family-run tourism businessesand its financial restructuring. In accordance with Article 6 of the HBOR Law, HBOR is entitled tocompensation from the state budget where there is a difference between the prevailing marketinterest rates and the actual interest rates charged by HBOR.

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Direct loans

The following table sets out details of the amount (by book value) of gross direct loans to customersin the main industry sectors as at 31st December 2002 and 30th September 2003:

31st December 30th September2002 2003

(unaudited)Industry 1111111 1111111

HRK million HRK million

Shipbuilding industry * ............................................................ 1,734.3 1,925.2Tourism .................................................................................... 762.0 835.9Water, electricity-supply and other infrastructure .................... 1,183.3 1,560.0Reconstruction of apartments and residential ** .................... 199.4 127.6Agriculture and food industry .................................................. 382.1 510.5Other industry.......................................................................... 171.8 470.6Private households with employees ........................................ 162.8 161.2Construction industry .............................................................. 540.9 737.6Leather and textile industry .................................................... 46.8 51.0Health care .............................................................................. 44.2 43.8Transportation.......................................................................... 16.4 487.1Other........................................................................................ 217.1 378.5

1111111 1111111

Total gross loans...................................................................... 5,461.1 7.289,01111111 1111111

Specific Provisions .................................................................. (531.9) (661.9)1111111 1111111

Total net loans ........................................................................ 4,929.2 6.627,11111111 1111111aaaaaaa aaaaaaa

Notes:

* HBOR’s largest single direct borrower by reference to total gross loans as at 31st December 2002 was BrodosplitBrodogradilište d.o.o., which operates in the shipbuilding industry, accounting for approximately 8.6% of HBOR’s total grossloans. Pursuant to a decision by the Government in 2003, the Ministry of Finance assumed the obligation to repay the entiredebt of Brodosplit Brodogradilite d.o.o owed to HBOR amounting to HRK1,313.2 million as at 30th September 2003.

** Repayment of the total outstanding loans relating to the reconstruction of housing was assumed by the Ministry of Financepursuant to the Housing Loans Repayment Agreement from 1997.

HBOR’s largest single direct borrower by reference to total gross loans as at 30th September 2003was the Ministry of Finance, accounting for approximately 14.5% of all HBOR’s total gross loans.

Loans via commercial banks

The commercial banks through which loans are made are usually analysed each quarter byHBOR, and a decision as to whether to use a particular bank is made on the basis of objectivefactors as well as HBOR’s prior experience with such bank.

HBOR has prescribed limits for loans per bank. The monitoring of HBOR’s exposure to each bankis carried out by members of the Credit Committee and the Managing Board during weekly loanapproval meetings (see “Provisions – Loans via commercial banks”, below). All members areinformed by HBOR’s analysis department about the risks in respect of any particular bank.

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The following tables set out the details of the seven largest, in terms of total gross loans,commercial bank borrowers as at 31st December 2002 and 30th September 2003:

Balance SheetReceivables– Gross

31st December 2002 Collateral Held1111111112 1111111112

Bank (HRK millions)

Privredna Banka d.d., Zagreb.............................. 450.4 See Note 1Splitska Banka d.d., Split .................................... 293.4 See Note 1Jadranska Banka d.d., Sibenik ............................ 241.0 Sub-mortgage(2)

Nova Banka d.d., Zagreb .................................... 214.9 Sub-mortgage(2)

Hrvatska Poštanska Banka d.d., Zagreb ............ 165.1 Sub-mortgage(2)

Varaždinska Banka d.d., Varaždin........................ 160.2 Sub-mortgage(2)

Croatia Banka d.d., Zagreb.................................. 154.3 Sub-mortgage(2)

1111111112

Total...................................................................... 1,679.31111111112aaaaaaaaa2

Notes:

(1) As a bank is categorised into risk classification “A” (see “– Provisions – Loans via commercial banks” below) and with aguarantee capital in excess of HRK400.0 million, HBOR accepted instruments of security as determined by the commercialbank’s rules.

(2) Sub-mortgage with a loan to property value ratio of 1:2 (or 1:1.5 in circumstances of special State care) as well as bills ofexchange and debentures (see “– Provisions – Loans via commercial banks” below).

Balance SheetReceivables– Gross

30th September 2003(unaudited) Collateral Held

1111111112 1111111112

Bank (HRK millions)

Privredna Banka d.d., Zagreb.............................. 576.9 See Note 1Erste & Steiermärkische Bank d.d. ...................... 266.7 See Note 1Hrvatska Poštanska Banka d.d., Zagreb ............ 235.7 Sub-mortgage(2)

Splitska Banka d.d., Split .................................... 231.1 See Note 1Varaždinska Banka d.d., Varaždin........................ 206.2 See Note 1Jadranska Banka d.d., Sibenik ............................ 204.9 Sub-mortgage(2)

Nova Banka d.d., Zagreb .................................... 179.6 Sub-mortgage(2)

1111111112

Total...................................................................... 1,901.11111111112aaaaaaaaaw

Notes:

(1) As a bank is categorised into risk classification “A” (see “– Provisions – Loans via commercial banks” below) and with aguarantee capital in excess of HRK250.0 million (previously HRK400 million but amended by the Managing Board on 20thJune 2003) HBOR accepts instruments of security as determined by the commercial bank’s rules.

(2) Sub-mortgage with a loan to property value ratio of 1:2 (or 1:1.5 in circumstances of special State care) as well as bills ofexchange and debentures (see “– Provisions – Loans via commercial banks” below).

Guarantees and Contingent liabilities

HBOR is authorised to extend guarantees and to issue letters of credit in both Kuna and foreigncurrencies. Together with committed undisbursed loans, issued guarantees are recognised ascontingent liabilities in HBOR’s audited financial statements. As at 31st December 2002, HBORhad net contingent liabilities of HRK2.4 billion, while as at 30th September 2003 HBOR had netcontingent liabilities of HRK3.8 billion.

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Contingent liabilities in respect of issued guarantees arise when HBOR acts as agent on behalf ofthe Government. As at 31st December 2002 and 30th September 2003, contingent liabilitiescomprised the following:


(unaudited)1111111 1111111

HRK million HRK million

Guarantees issued in foreign currency(1) ................................ 1,251.4 1,517.4Guarantees issued in Kuna(1) .................................................. 52.1 3.9Open Letters of credit in foreign currency(1) ............................ 301.5 331.7Guarantees in foreign currency(2) ............................................ 2.8 –Undrawn loans ........................................................................ 1,015.3 2,120.2

1111111 1111111

Total gross .............................................................................. 2,623.1 3,973.21111111 1111111

Provision .................................................................................. (189.3) (158.9)1111111 1111111

Total net .................................................................................. 2,433.8 3,814.31111111 1111111aaaaaaa aaaaaaa

Notes:

(1) In 2002, the total amount of HBOR’s exposure was covered by guarantees from the Ministry of Finance. Of the total amountof guarantees issued in foreign currency as at 30th September 2003, HRK16.7 million was not guaranteed by the Ministryof Finance but was covered by bills of exchange, debentures, mortgages on ships and insurance policies. Of the totalamount of guarantees issued in Kuna as at 30th September 2003, HRK2.7 million was covered by a grant by theGovernment of the Federal Republic of Germany (Deutsche Investitions und Entwicklungsgesellschaft).

(2) Granted to finance projects for the supply of electrical energy. This transaction is not covered by any guarantee from theMinistry of Finance.

As at 30th September 2003, 99.8% of all guarantees and open letters of credit issued by HBORwere in favour of the shipbuilding industry. The commitments were for advance paymentguarantees to buyers, payment guarantees to foreign suppliers, guarantees in respect of foreigncurrency loans and open letters of credit in foreign currency.

Contingent liabilities arising from performance guarantees are shown in the financial statements ofHBOR at the value of the advance that the shipyard has received plus the applicable interest rate.Other guarantees and other contingent liabilities are recorded at total approved value. The maturityof each performance guarantee is related to the completion of each ship.

As at 30th September 2003, HBOR had issued the equivalent of HRK694.6 million of foreigncurrency performance guarantees, HRK822.8 million of foreign currency payment guarantees andHRK3.9 million of payment guarantees in Kuna. As at 30th September 2003, total outstandingissued guarantees amounted to HRK1.85 billion (comprising issued Kuna guarantees, issuedforeign currency guarantees, foreign currency letters of credit and guarantees in foreign currencyas described in the above table). As described in the table above, all of HBOR’s outstandingguarantees are covered.

Committed Undisbursed Loans

As at 31st December 2002, 50.0% of HBOR’s committed undisbursed loans had the benefit of acorresponding direct or indirect State guarantee. As at 30th September 2003, 60.2 % of HBOR’scommitted undisbursed loans were covered by corresponding direct or indirect State guarantees.The obligations of the municipalities are also guaranteed by the State as are those of the CroatianWater Company.

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The following table sets out details of the counter guarantees provided to HBOR in respect of itscontingent liabilities at 31st December 2002 and 30th September 2003:


(unaudited)1111111 1111111

(HRK million) (HRK million)

Guarantees provided by the Ministry of Finance .................... 169.6 644.1Guarantees provided by Municipalities (under Municipal

Environmental Infrastructure Investment Programme(“MEIP“) and other programmes) ........................................ 295.8 533.3

Guarantees provided by Hrvatske Vode (CroatianWater Company).................................................................. 41.6 98.0

Amount not counter-guaranteed (loans throughcommercial banks, covered by a supra-mortgageand direct loans covered by the guarantee of theCroatian Agency for Small Businessmortgage, fiduciary title or bank guarantee) ...................... 508.3 844.8

1111111 1111111

Total gross Committed Undisbursed Loans ............................ 1,015.3 2,120.21111111 1111111aaaaaaa aaaaaaa

Asset and Liability Management (“ALM”) and other services

All units of HBOR are involved in ALM. ALM policies are determined in accordance with theBanking Law and regulations of the CNB.

In 2002, HBOR engaged external consultants to advise on the implementation of an integrated riskmanagement system. This led to changes to HBOR’s organisational structure as well asimprovements in the existing internal processes with a view to enhancing risk managementmeasurement.

HBOR manages assets and liabilities by balancing their maturity structure, thereby ensuringadequate liquidity but at the same time monitoring and controlling all possible risks that may arisefrom any mismatch.

HBOR also manages certain funds on behalf, and for the account, of the Ministry of Finance, theCPF and the Croatian Employment Institution in each case as an agent of the State. These assetsare kept separate from HBOR’s assets. Income and expenses related to transactions under thesefunds are not attributed to HBOR and HBOR does not have any other liabilities in respect of them.The balance sheet total of assets under such management amounted to HRK1.4 billion andHRK1.2 billion as at 30th September 2003 and 31st December 2002, respectively.

Risk Management

Pursuant to the Banking Act, HBOR performs measurement, assessment and management of allrisks to which it is exposed in its operations.

HBOR controls such risks through policies and prescribed procedures of work pursuant to whichthe internal control systems have been established with the purpose of preventing such risksarising (e.g. separation of responsibilities for loan granting from loan entry, limits for loan grantingetc.).

The Managing Board conducts a conservative credit risk management policy. The credit riskmanagement system forms the most important part of the HBOR business policy and is animportant factor in its operating strategy. Risk management is controlled by special regulationswhich apply to all phases of credit activity (from loan application to the final loan repayment).

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HBOR closely monitors its exposure to, and the credit standing of, each on-lending bank or directborrower. The Credit Committee, Managing Board and Supervisory Board are authorised to makeand implement decisions on granting loans and issuing guarantees up to the amount determinedby the Statutes of HBOR. For certain transactions over HRK7.5 million, the decision to grant aparticular loan or issue a guarantee is made by the Credit Committee, Managing Board andSupervisory Board, however implementation is contingent upon Ministry of Finance approval.

During the process of provisioning, borrowers are categorised into risk groups and the necessarylevel of provisions is determined according to (i) the borrower’s creditworthiness and financialstanding, (ii) the orderly fulfilment of obligations (according to days overdue) and (iii) the quality ofcollateral.

Pursuant to prescribed internal regulations, HBOR maintains the necessary level of liquidityreserves, continually monitors current liquidity, provides sufficient local and foreign exchange fundsnecessary to meet obligations upon their maturity and for disbursements on approved long-termloans. HBOR places any current surplus of available funds into government securities, short-termloans and deposits with domestic banks which are categorised by HBOR under risk group A, andforeign banks from the Organisation for Economic Co-operation and Development (“OECD”)member countries whose lowest rating is AA- by Standard & Poor’s Rating Service, a division ofthe McGraw-Hill Companies, Inc. and Fitch IBCA, Inc. and Aa3 by Moody’s Investors Service Inc.

Export Credit Insurance

HBOR started its export credit insurance business at the end of 1998 at the request of the State.Consequently, it carries on the business solely on behalf, and for the account, of the State. Theultimate risk of the insurance business lies with the State.

HBOR provides Croatian businesses with commercial and political short-term risk cover of up toone year and medium and long-term risk cover of up to 12 years. HBOR has developed a varietyof products to support Croatian exports. HBOR offers cover for single-buyer transactions, multi-buyer transactions and whole turnover export transactions.

The types of cover for export credit transactions with repayment terms of more than one year arelimited to buyer credit and supplier credit. Pre-credit insurance is available for export transactionswith repayment terms of more than one year.

In September 2003, HBOR introduced an investment insurance scheme offering coverage againstpolitical risks of up to 15 years.

Coverage can be given for an export transaction provided it meets the minimum requirement thatit comprises at least 60% Croatian goods and services. If this minimum content requirement is notmet, HBOR will only provide coverage in conjunction with export-credit agencies from the countriesof origin of the goods and services contained in the export product.

HBOR complies with international rules and standards in relation to state supported financing andexport credit insurance, including the Berne Union Understanding and the OECD Consensus.

Final decisions regarding the provision of export credit insurance are made by the InterministerialCommittee for Export Credit Insurance which comprises representatives of the Ministry of Finance,the Ministry of Economy, Labour and Entrepreneurship, the Ministry of Agriculture∆, Forestry andWater Management, the Ministry of Foreign Affairs, the CNB and the Croatian Chamber ofEconomy.

Up to 30th September 2003, HBOR issued 300 insurance policies in an aggregate amount ofUS$53 million. Short-term coverage comprised 287 policies for a total of US$30 million andmedium-and long-term coverage comprised 13 policies for a total of US$23 million. Since 1October 2003, “Letters of Indication” for a total amount of US$70 million have been issued fortransactions under negotiation.The total amount of premiums collected up to 30th September 2003

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amounted US$661,000. In the same period, 6 claims were paid totalling US$324,000. The totalexposure on outstanding policies as of 30th September 2003 was US$32 million. The loss ratio of paid claims/net premiums including recoveries for the period from 1998 (when the business began)to 30th September 2003 was 45.6%.

HBOR has, to date, concluded co-operation agreements with 21 export credit agencies,export/import banks and development banks including Slovene Export Corporation (Slovenia),Export Import Bank of India, Slovak Eximbanka, Macedonian Bank for Development Promotion(Macedonia), Banco de Inversion Y Comercio Exterior S.A. (Argentina), EXIM Bank of the UnitedStates, L’Istituto per Servizi Assicurativi del Commercio Estero (Italy), Export Credit GuaranteeCompany (Egypt), Export-Import Bank of Hungary, Hungarian Export Credit InsuranceLtd.(Hungary), Investment Guarantee Agency (Bosnia and Herzegovina), Export CreditsGuarantee Department (United Kingdom), Eximbank of Romania, Korporacja UezpicezenKredytow Ekspotowych (Poland), Export Credit Guarantee Corporation (India), Asuransi Ekspor(Indonesia), KfW, Export Development Bank of Iran, Export Guarantee Fund of Iran (Iran), CofaceGroup (France) and Algerian Credit Export Agency (Algeria).

Reserves, write off and provisions policies

Reserves

HBOR has reported a profit for each of the financial years since its establishment in 1992. Allprofits are allocated to reserves.

Write off policies

Potentially non-recoverable loans are generally rescheduled instead of written off. Where anycollateral has been enforced HBOR has successfully collected its receivables or obtainedreimbursement through the State guarantee. If, pursuant to a decision of a competent court, HBORis unable to collect its receivable under a particular loan, or otherwise obtain reimbursement asaforesaid, HBOR would write off the relevant loan.

In 2002, the volume of receivables written off amounted to HRK15.4 million, of which 89% weredebtors undergoing bankruptcy proceedings.

For the period 1st January 2003 to 30th September 2003, there were no receivables write-offs.HBOR has decided that accounts receivable from debtors, against which court proceedings havebeen initiated, or which are undergoing bankruptcy proceedings, will be partially transferred to off-balance sheet items as at 31st December 2003 after the annual list of assets and liabilities hasbeen compiled. HBOR has created full provisioning for such debtors.

Provisions policy

Since 1st January 2001, HBOR has calculated provisions by reference to International AccountingStandard (“IAS”) 39, Financial Instruments: Recognition and Measurement (Revised 1998) and therecommendations prescribed by the CNB. As a result, receivables are divided into 3 categories:collectible receivables, partially-collectible receivables and non-collectible receivables.

Direct Loans

For its direct loans, HBOR has adopted the maximum provisioning recommendations prescribedby the CNB. After dividing the receivables under direct loans into the 3 categories described above,they are further divided into risk classification groups A to E (as shown in the table below) basedon subjective criteria (such as the clients’ ability to pay) and objective criteria (such as thescheduled repayments, taking into consideration the number of days of delay and the collateralquality (the highest quality being guarantees issued by the Government)).

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Provision is made against the loan when it is first disbursed and again if the risk category of theloan declines over its term. The Risk Assessment and Monitoring Committee is responsible formonitoring the provisioning of loans in each risk category. Additional provisioning over and abovethat recommended by the CNB may be made depending on the type of the loan, the borrower andany other relevant circumstances surrounding the loan.

Following the implementation of the new provisioning policy, HBOR calculates provisions byreference to IAS 39, following the recommendations of the CNB. In 2002, HBOR adjusted itsprovisioning percentages for direct borrowers for risk classifications as follows:

Risk category Category of placement 2002 2001111111 1111111111 1111 1111

(%) (%)

A & B(1) Collectible Placements .................................... 1 – 3 1 – 2C & D Partially Collectible Placements ...................... 4 – 99 3 – 99E Uncollectible Placements ................................ 100 100

Notes:

(1) On placements allocated into risk classifications A and B from 2001, general banking reserve for unidentified risks hasbeen calculated.

Loans via commercial banks

For its loans via commercial banks, HBOR has developed provisions based on internal criteria byreference to the maximum provisioning recommendations prescribed by the CNB.The percentagesused for the calculations are, however, lower than those used in respect of direct loans sinceHBOR believes that banks are less of a risk than companies, and since mortgage collateral existsfor most of these loans. The criteria applied to determine the risk classification are the same as fordirect loans.

HBOR’s evaluation of the risk associated with commercial banks includes: (i) equity (liable capitalvalue, capital adequacy ratio), (ii) commercial bank exposure to loan risk (share provision as apercentage of total loans), (iii) HBOR’s exposure to loan risk (HBOR placements in relation to thecommercial banks’ guaranteed capital), (iv) liquidity (maturity risk analysis), and (v) profitability(gross profit in relation to equity). HBOR uses the quarterly reports prepared by the banks for theCNB and their annual audited financial statements for this evaluation.

In addition, HBOR monitors commercial banks through articles in the newspapers and via othersources. Banks are re-evaluated every three months as part of the loan monitoring and riskassessment process. Each commercial bank is itself responsible for monitoring the final borrowerof the loan.

Prior to June 2003, in respect of banks categorised into risk classification “A”, and with guaranteedcapital in excess of HRK400.0 million, HBOR accepted instruments of security as determined bythe commercial bank’s rules. In June 2003, the Managing Board changed this requirement forguaranteed capital to HRK250.0 million.

In respect of other banks, HBOR requires a sub-mortgage in favour of HBOR with a loan toproperty value ratio of 1:2 (or 1:1.5 in circumstances of special State care (being regions withparticular needs because of damage caused by war, under-development, demographics and othercriteria)) as well as bills of exchange and debentures.

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Following the implementation of the new provisioning policy, in 2002, HBOR adjusted itsprovisioning percentages for loans via commercial banks for risk classifications as follows:

Risk category Category of placement 2002 2001111111 1111111111 1111 1111

(%) (%)

A & B(1) Collectible Placements .................................... 1 – 3 1 – 2C & D Partially Collectible Placements ...................... 4 – 99 3 – 99E Uncollectible Placements ................................ 100 100

Notes:

(1) On placements allocated into risk classifications A and B from 2001, general banking reserve for unidentified risks hasbeen calculated.

The following table sets out provisions for identified placement losses and special off-balancesheet items and provisions for unidentified placement losses and general off-balance sheet itemsas at 31st December 2002 and 30th September 2003:


(unaudited)1111111 1111111

(HRK) (HRK)

Provisions for identified placement losses .............................. 1,143,371,130.08 1,330,113,765.50Provisions for identified special off-balance sheet items ........ 179,450,026.48 105,128,665,60

1111111 1111111

Total special reserves.............................................................. 1,322,821,156.56 1,435,242,431.101111111 1111111aaaaaaa aaaaaaa

Provisions for unidentified placement losses .......................... 45,916,215.05 92,303,501.01Provisions for unidentified general off-balance sheet items.... 9,810,287.70 53,759,256.31

1111111 1111111

Total general reserves ............................................................ 55,726,502.75 146,062,757.321111111 1111111aaaaaaa aaaaaaa

The Managing Board and the Supervisory Board believe that HBOR’s provisioning against risk atthe maximum level of CNB recommendations is prudent. Total provisioning increased fromHRK769,928,000 in 1999 to HRK956,246,801.54 in 2000, HRK1,165,149,637.71 in 2001,HRK1,378,547,659.31 in 2002 and HRK1,581,305,188.42 as at 30th September 2003 as a resultof increases in the overall volume of the loan portfolio and increased awareness of provisioningpractices.

Of the amount of total provisioning as at 31st December 2002, a total of HRK227.1 million, wascovered by the income for 2002. For the period 1st January 2003 to 30th September 2003 totalprovisioning amounted to HRK203.8 million and was covered by the income for such period.

The income recorded in the profit and loss account represents only income actually collected orthe collection of which is not doubted. The amount of interest income from borrowers which are notexpected to fulfil their obligations in full (risk classifications C, D and E) is recorded off-balancesheet and, if subsequently collected, will be recorded as income at that time.

Sources of Funds

Since its establishment in 1992, HBOR has been intensively working on its international reputation,resulting in it being among the few Croatian borrowers which have access to international markets.

In addition to its own capital and reserves, HBOR raises funds on the international capital andbanking markets and also through borrowings from “special financial institutions”.

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HBOR accessed the loan syndication market for the first time in 1996 with a DEM50,000,000(e25,564,594.06) 18 month facility. HBOR secured funding on the syndicated loan market formaturities of up to five years and signed other loan agreements in August 1998 in the amount ofDEM100,000,000 (e51,129,188), in March 2001 in the amount of US$45,000,000(e39,408,005.43), in November 2001 in the amount of e50,000,000 and in June 2002 in theamount of e82,500,000.

HBOR also has a good relationship with “special financial institutions” such as KfW, EuropeanBank for Reconstruction and Development (“EBRD”), International Bank for Reconstruction andDevelopment (“IBRD”), the Council of Europe Development Bank (“CEB”) and EuropeanInvestment Bank (“EIB”).

As at 30th September 2003, borrowings from IBRD amounted to e13,960,260.51, borrowings fromEBRD amounted to e28,207,322.74, borrowings from KfW amounted to e132,582,304.81,borrowings from Credit Agricole Indosuez and Banco Ambrosianio Veneto amounted toe4,548,620.23, borrowings from CEB amounted to e4,000,000.00, borrowings from Standard BankLondon Limited amounted to e89,408,005.43 (comprising loans of US$45,000,000 ande50,000,000), borrowings from Deutsche Bank AG amounted to e33,715,737.98 (US$38,500,000)and borrowings from ING Bank N.V./Raiffeisen Zentralbank Österreich Aktiengesellschaftamounted to e66,000,000.00.

At 30th September 2003, HBOR had total borrowings (including bonds) of e487,753,304.81, ofwhich the following had been advanced by HBOR to finance specific projects:

30th September2003

(unaudited)1111111

(f millions)HBOR’s Credit ProgrammesLoan Programme for SMEs in Croatia.................................................................. 54.47Loan Programme for the support of the tourist sector ........................................ 43.75Loan Programme for Communal Infrastructure in Croatia including MEIP .......... 63.01Financing of technological reconstruction of Croatian shipyards ........................ 37.4General financing.................................................................................................. 289.12

1111111

Total ...................................................................................................................... 487.751111111aaaaaaa

In 2001, HBOR issued its first series of notes under this Programme by way of an issue of US$38.5million bonds in a private placement. In 2002, HBOR issued its second series of Notes under thisProgramme by way of an issue of e100,000,000 5.75% Amortising Notes due 2008-2012. No otherNotes have been issued under this Programme.

As at 30th September 2003, HBOR had contractual commitments under loans (including bonds) inthe amount of e46,605,158.00.

70

The following table sets out the principal repayment schedule for HBOR’s outstanding borrowings,inclusive of contractual commitments, for the years 2004-2028 as at 30th September 2003:

Amount Total HRKYear (expressed in f) Equivalent11 11111111 11111111

2004 .................................................................... 170,999,659.21 1,294,01,689.752005 .................................................................... 48,880,817.76 370,094,757.162006 .................................................................... 51,552,386.36 390,322,191.512007 .................................................................... 51,892,781.81 392,899,451.412008 .................................................................... 49,001,511.26 371,008,572.312009 .................................................................... 43,561,738.04 329,822,036.542010 .................................................................... 40,020,071.46 303.006.768,452011 .................................................................... 33,353,404.82 252,530,968.652012 .................................................................... 27,862,551.32 210,957,685.192013 .................................................................... 5,784,168.77 43,794,081.902014 .................................................................... 511,291.88 3,871,180.002015 .................................................................... 511,291.88 3,871,180.002016 .................................................................... 511,291.88 3,871,180.002017 .................................................................... 511,291.88 3,871,180.002018 .................................................................... 511,291.88 3,871,180.002019 .................................................................... 511,291.88 3,871,180.002020 .................................................................... 511,291.88 3,871,180.002021 .................................................................... 511,291.88 3,871,180.002022 .................................................................... 383,468.91 2,903,385.002023 .................................................................... 255,645.94 1,935,590.002024 .................................................................... 255,645.94 1,935,590.002025 .................................................................... 255,645.94 1,935,590.002026 .................................................................... 255,645.94 1,935,590.002027 .................................................................... 255,645.94 1,935,590.002028 .................................................................... 127,822.97 967,795.00

11111111 11111111

Total...................................................................... 534,358,606.04 4,045,826,719.0111111111 11111111aaaaaaaa aaaaaaaa

Notes:

Exchange rate as at 30th September 2003: e1 = HRK7.57137

HBOR has never defaulted in the payment of principal of, or interest on, any of its obligations.

71

Under the HBOR Law, HBOR is not a depositary institution. Deposits from banks and companies,which are shown as liabilities in HBOR’s financial statements, are however held pursuant to otherregulations.

The following table sets out the amount of deposits from banks and companies held by HBOR asat 31st December 2002 and 30th September 2003:


(unaudited)1111111 1111111

(HRK million) (HRK million)

Bank deposits .......................................................................... 0.8 585.0Foreign currency accounts of companies .............................. 1.6 2.5Ministry of Finance of the Republic of Croatia limited deposits(1) 7.4 2.8Foreign currency accounts of companies – special purpose .. 69.4 111.1Foreign currency accounts – for payments abroad ................ – –Deposits by State institutions(2) ................................................ 249.8 340.1Other deposits ........................................................................ 0.1 3.4

1111111 1111111

329.1 1,044.91111111 1111111aaaaaaa aaaaaaa

Notes:

(1) Deposits are connected with the withdrawal of funds from an IBRD loan.

(2) Deposits are connected to HBOR in the name of, and on behalf of, the Ministry of Finance.

Liquidity

As at 31st December 2002, HBOR’s liquid assets consisted of cash in hand and cash due frombanks of 1.1% of total assets, deposits with banks of 10.7% of total assets and trading securitiesof 4.3% of total assets. Cash in hand and cash due from banks was HRK88.7 million and primarilycomprised cash due from foreign banks denominated in a foreign currency. HBOR holds depositsfor a maximum of one month with a number of international correspondent banks (although loansin practice mature within a one to two week period). These deposits are typically denominated ineuro and US dollars and carry a fixed rate of interest with maturities of up to one month.

The following table sets out deposits with commercial banks, net of provision for possible lossesas at 31st December in the years 2000 to 2002 and 30th September 2003:

As at 30thAs at 31st December September

(unaudited)1111121111111311 111122

2000 2001 2002 20031111 1111 1111 111122

With foreign banks .............................................. 480,790 672,846 810,618 167,788With domestic banks............................................ 30,398 81,921 105,140 95,800Subtotal ................................................................ 511,188 754,767 915,758 263,588Provision for possible losses................................ (8,230) (7,548) (9,164) (2,641)

1111 1111 1111 111122

Total...................................................................... 502,958 747,219 906,594 260,9471111 1111 1111 1111233aaaa aaaa aaaa ddaaaadd

72

The following table sets out trading securities consisting of Treasury bills issued by the CNB, bondsissued by the State and bills of exchange issued by the Ministry of Finance, held by HBOR as at31st December in the years 2000 to 2002 and 30th September 2003:


(unaudited)1111121111111311 111122

2000 2001 2002 20031111 1111 1111 111122

(in HRK 000’s)

Treasury bills of CNB .......................................... 129,176 – 159,680 –Bills of Exchange of Ministry of Finance.............. – – – –Bonds issued by the Republic of Croatia(1) .......... 256,368 224,535 200,634 248,341

1111 1111 1111 111122

Total...................................................................... 385,544 224,535 360,314 248,3411111 1111 1111 111122aaaa aaaa aaaa aaaaa

Note:

(1) Includes bonds issued by the Republic of Croatia in a total amount of e25,112,387.34, e26,958,620.11, e30,466,000 ande33,740,000 as of at 30th September 2003, 31st December 2002, 31st December 2001 and 2000, respectively, inexchange for receivables from Dubrovačka banka d. d., Dubrovnik. The principal thereof is repayable in six monthlyinstalments with the final instalment due on 15th November 2008. The bonds pay interest annually at the rate of 7 per centper annum.

During 2003, HBOR acquired bonds issued by the Republic of Croatia denominated in euro with bullet repayment on 23rdMay 2012 and a coupon of 6.875 % per annum. The interest is paid semi-annually. As at 30th September 2003, theaggregate principal amount of bonds held was e6,000,000.

HBOR also acquired bonds issued by the Republic of Croatia denominated in Kuna with bullet repayment on 28th May2008 and a coupon of 6.125 % per annum. The interest is paid semi-annually. As at 30th September 2003, the aggregateprincipal amount of bonds held was HRK7,440,000.

Bonds acquired during 2003 are held as liquidity reserve and are available for sale.

Liquidity Management

Pursuant to HBOR’s Liquidity Management Rules and Regulations, HBOR determines minimumliquidity reserves as a percentage of collectible contingent liabilities. The minimum reserve wasestablished in 2000 and can be changed only by a decision of the Managing Board. Prior to 2001,an amount of approximately US$30 million was held as the minimum liquidity reserve. HBOR setsits current minimum reserve at 7% of the balance of the planned contingent liability (includingfinance guarantees, open uncovered letters of credit, approved loans granted but not drawn), lessprovision for loan losses. As at 30th September 2003, the position was unchanged. Liquiditymanagement is performed on a daily basis. Inflow and outflow projections for the coming year areperformed on an annual basis. Implementation is monitored monthly and corrections are madeaccording to the circumstances prevailing at the time.

Exchange Rate and Interest Rate Risk

Assets and liabilities expressed in foreign currencies are converted into Kuna at the exchangerates quoted by the CNB at the date of the relevant balance sheet. Income and expenses arisingin foreign currencies are converted at the rate of exchange on the transaction date. Resultingforeign exchange gains and losses are recorded in the profit and loss account.

While HBOR obtains most of its funding and has to service its loans in foreign currencies, its loansto borrowers (and therefore its interest income) tend to be denominated in Kuna.

For the purpose of managing foreign exchange risk, HBOR monitors and matches total foreigncurrency liabilities and receivables. HBOR transfers exchange rate fluctuation risk on receivablesto borrowers. For the purpose of hedging against exposure to foreign exchange risk, the majorityof loans granted by HBOR incorporate a foreign currency clause. HBOR manages its exposure tocurrency risk through a variety of measures, including the use of foreign currency clauses.

This approach is applied to both direct loans and loans via commercial banks.

73

Total net exchange rate gains for the year ended 31st December 2002 amounted to HRK17.5million and for the period 1st January 2003 to 30th September 2003 amounted to HRK37.0 million.

Interest rate risk is controlled by the matching of funding and placements. Possible interest ratefluctuations are also monitored. Funds borrowed with variable interest rates are on-lent at variableinterest rates plus a margin and comply with HBOR’s general borrowing terms and conditions.

Directors and Management

HBOR is supervised by the Supervisory Board and is managed by the Managing Board. Themembers of the Managing Board are appointed and removed by the Supervisory Board. TheManaging Board comprises three members, one of whom is appointed as the President of theManaging Board. The Managing Board’s powers are set out in the HBOR Law and the Statutes.The constitution of the Supervisory Board is determined by the HBOR Law, and the SupervisoryBoard has power to amend HBOR’s Statutes by a majority vote of three quarters of the memberspresent which must be at least one half of all its members. The Supervisory Board consists of eightmembers, namely the Minister of Finance, the Minister of Economy, Labour and Entrepreneurship,the Minister of the Sea, Tourism, Transport and Development, the Minister of Agriculture, Forestryand Water Management, the Chairman of the Croatian Chamber of ∆Economy and three membersselected from the Members of Parliament by the Parliament. The Minister of Finance is thePresident of the Supervisory Board, and the Deputy President of the Supervisory Board is theMinister of Economy. The members of the Managing Board are appointed for a term of four yearsand may be reappointed.

The Credit Committee is a three-person body appointed by the Managing Board, consisting of thepresident and two other members of the Managing Board. The Credit Committee makes itsdecisions during its regular weekly sessions or, in absentia, in writing. The Credit Committee hasthe authority to approve credit applications of up to HRK700,000 for direct loans andHRK3,000,000 for loans via commercial banks. If the amount applied for exceeds the relevantthreshold, the Credit Committee may only take the application into consideration and, if it considersit acceptable, may forward it, together with a recommendation, to the Managing Board for approval.

Regardless of the amount, the Credit Committee may decide on any alteration of the availabilityperiod and the purpose of a loan, as well as on any increase in the number of drawings during theavailability period. It may also decide on any complaints by applicants for a housing loan subsidyunder the Housing Loan Subsidy Programme.

HBOR’s annual audited financial statements are submitted by the Managing Board to theSupervisory Board for approval, whereupon the Supervisory Board submits them for approval tothe Government and to the Croatian Parliament.

The business address of all the members of both Boards is the registered office of HBOR.

The names of the current members of each Board and their principal external activities are:

Supervisory Board

Name Title and Principal External Activities

Ivan Šuker .................... President of the Board and Minister of FinanceBranko Vukelić .............. Vice President of the Board and Minister of the Economy, Labour

and Entrepreneurship∆Petar Čobanković .......... Member of the Board and Minister of Agriculture, Forestry and

Water ManagementNadan Vidošević .......... Member of the Board and Chairman of the Croatian Chamber of

∆EconomyBožidar Kalmeta ............ Minister of the Sea, Tourism, Transport and Development

Three members of the Parliament are to be elected in one of the first sessions of the newGovernment to be scheduled.

74

Managing Board

Name Title and Principal External Activities

Anton Kovačev .............. President of the Managing Board (since 1st June 1993)Krešimir Leko ................ Member of the Managing Board (since 1st May 1996)Marija Kolarić ................ Member of the Managing Board (since 1st September 1997)

Recent Developments and Outlook of HBOR

Established primarily as an institution in charge of financing the reconstruction of war-devastatedareas and revival of the economy, HBOR has expanded its sphere of business constantly bysupporting the Government processes of creating a new economic structure, helping to create amore level regional development and adjusting to new increasingly larger development goals of theRepublic.

HBOR is the preferred institution in Croatia for financing and providing capital for reconstructionprojects in the areas of special State concern, infrastructure, environmental projects, SMEs,housing, tourism and the shipbuilding industry, as well for the support of the export-orientedbusinesses which form the backbone of the Croatian economy.

HBOR has always been oriented towards improving the standard of living throughout Croatia. It,therefore, intends to intensify its activities aimed at financing infrastructure projects – water supply,sewage, waste dump sites and social infrastructure – and expects that the financing ofinfrastructure projects with a significant environmental component will become particularlyimportant, requiring HBOR to develop specific technical expertise in this area. The SupervisoryBoard and the Managing Board believe that HBOR will continue to be one of the leading long termproject finance banks in Croatia.

As the existence of quality infrastructure is one of the most important contributors to successfuleconomic development, both at local and State level, HBOR intends in the future to continue toinvest local and foreign funds in Croatian infrastructure. HBOR has so far financed Stateinfrastructure projects and it has seen an increased need for investment in the development of localinfrastructure in co-operation with commercial banks. HBOR believes that, in order to create theright conditions for the development of the economy, special attention has to be given to thereconstruction of the local infrastructure in the war devastated and underdeveloped regions as wellas to solving ecological problems.

Investment in local infrastructure directly supports the development of SMEs by, for example,upgrading infrastructural and local services and improving the business areas, the so called “freezones”, “technological parks” and “special zones” for SMEs. Nevertheless, one of the secondaryobjectives of local infrastructure financing is the transition of local companies into market orientedinstitutions that conduct their business activities according to commercial principles and thatprovide good services at local level.

Special attention will be given to the development of SMEs, especially the establishment anddevelopment of farms, crafts and SMEs in the regions that require special State care. Thepromotion of economic activities by means of technological development and the establishment ofentrepreneurial centres and technological parks is expected to contribute significantly to the overallobjective of reducing unemployment. HBOR also supports foreign direct investments in theCroatian economy and finances joint venture investments by foreign and local companies inmanufacturing facilities in Croatia. HBOR can provide special support to projects to beimplemented by well known international manufacturers introducing not only their name but alsomodern and ecologically clean technology into Croatia. Croatian enterprises require partners withknow how, experience and position in the international market, who can offer their experience andtechnology to help such enterprises enter foreign markets which HBOR intends to facilitate.

75

HBOR believes tourism represents a promising part of the economy which requires support as wellas additional investment. HBOR, in co-operation with the Government and the relevantGovernment ministry, participates in activities designed to improve the current condition of touristcompanies which are still to the large extent Government-owned and are therefore in need ofprivatisation. Another goal for the tourist sector is to extend the duration of the season from thesummer months to the year round. The Government’s strategic approach to the furtherdevelopment of the Croatian tourist industry will define the future activities of HBOR in this sector,with a view to increasing the competitiveness of Croatia compared to similar European and world-wide destinations.

HBOR plays a key role in the support of the Croatian export industry by granting loans to buyersand suppliers of Croatian capital goods and services abroad, issuing insurance policies coveringpolitical and commercial risks in export business and issuing guarantees for the refund of advancepayments and due servicing of international loans. It has contributed to establishing competitiveconditions for businesses and to improving export position of the Croatian economy.

HBOR also intends to give special attention to further co-operation with local and foreigncommercial banks that have supported HBOR in developing a number of loan programmes andprojects, to implement an active risk management policy and to improve its operations byintroducing modern information technology as well as professional training for its employees.

In the future, HBOR intends to expand the business through new products, new technologicalsolutions and an increase in resources, which will accelerate development of the economy andfacilitate accomplishment of the objectives that will lead to the creation of new jobs – one of themost important priorities of the State and every Croatian developmental policy today.

76

CAPITALISATION OF HBOR

The following table sets out the unaudited capitalisation of the Issuer as at 30th September 2003:

As at 30th September 2003(unaudited)

1111111111111114

(HRK millions) (f millions(1))1111111 1111111

Short Term LiabilitiesLocal suppliers ........................................................................ 0.9 0.1Foreign suppliers .................................................................... 0 0Others(2).................................................................................... 1,911.2 252.4

1111111 1111111

Total Short Term Liabilities ...................................................... 1,912.1 252.51111111 1111111aaaaaaa aaaaaaa

Long Term Liabilities................................................................Foreign banks.......................................................................... 2,680.5 354.0HBOR Bonds .......................................................................... 1,012.4 133.7

1111111 1111111aaaaaaa aaaaaaa

Total Long Term Liabilities ...................................................... 3,692.9 487.7Founder’s capital .................................................................... 3,348.2 442.2Reserves formed out of profit .................................................. 583.3 77.1

1111111 1111111

Total Capital ............................................................................ 3,931.5 519.31111111 1111111aaaaaaa aaaaaaa

Guarantee fund........................................................................ 7.9 1.0Total Capital and Guarantee Fund .......................................... 3,939.4 520.3

1111111 1111111

Total Capitalisation .................................................................. 9,544.4 1,260.51111111 1111111aaaaaaa aaaaaaa

Notes:

(1) Amounts in euro have been calculated according to the middle exchange rate of the CNB valid on 30th September 2003of e1.00 = HRK7.571370.

(2) “Others“ includes deposits by banks and companies, liabilities in respect of calculated interest, special purpose depositcalculations, provisions for possible losses on commitments and contingent and other liabilities.

At 30th September 2003, the Issuer had gross commitments and contingent liabilities of HRK3.97billion (e524.8 million).

During October 2003, HBOR’s total borrowings increased by US$200 million following a newsyndicated loan granted by Bank Austria Creditanstalt AG, The Bank of Tokyo-Mitsubishi, Ltd., DZBank AG Deutsche Zentral-Genossenschaftsbank, Frankfurt am Main and San Paolo IMI S.p.A.

Save as disclosed above, there has been no material change in the capitalisation of HBOR since30th September 2003.

77

FINANCIAL STATEMENTS OF HBOR

Balance Sheet

As at31st December

1111111111

2001 200211112 11112

(HRK thousands)AssetsCash on hand and due from banks, net .................................................... 105,162 88,714Deposits with other banks, net .................................................................. 747,219 906,594Loans to banks, net .................................................................................. 2,146,318 2,038,844Loans to other customers, net .................................................................. 3,495,135 4,929,162Assets held to maturity .............................................................................. 224,535 360,314Interest receivables, net .............................................................................. 90,526 54,436Assets available for sale ............................................................................ 135 6,623Investments in subsidiaries and associates................................................ 5,000 12,211Tangible and intangible assets.................................................................... 26,288 25,556Assets for resale ........................................................................................ 2,341 14,307Other assets, net ...................................................................................... 2,250 1,794

11112 11112

Total assets .............................................................................................. 6,844,909 8,438,55511112 11112aaaas aaaas

LiabilitiesDeposits .................................................................................................... 282,163 329,143Borrowings .................................................................................................. 2,001,468 2,751,053Bonds payable ............................................................................................ 696,629 1,019,340Interest payable .......................................................................................... 61,075 66,140Other liabilities ............................................................................................ 391,904 621,679

11112 11112

Total liabilities .......................................................................................... 3,433,239 4,787,35511112 11112aaaas aaaas

CapitalFounder’s capital ........................................................................................ 2,972,020 3,136,055Retained earnings ...................................................................................... 388,842 438,520Net profit for the year .................................................................................. 49,678 75,237

11112 11112

Total capital .............................................................................................. 3,410,540 3,649,81211112 11112aaaas aaaas

Guarantee fund .......................................................................................... 1,130 1,388

Total capital and guarantee fund ............................................................ 3,411,670 3,651,200

Total liabilities, total capital and guarantee fund .......................................................................................... 6,844,909 8,438,555

31st December 2001 – e1.00 = HRK7.370030

31st December 2002 – e1.00 = HRK7.442292

78

Profit and Loss Account

As at31st December

1111111111

2001 200211112 11112

(HRK thousands)

Interest income ........................................................................................ 449,227 452,572Interest expense........................................................................................ (181,797) (160,765)

11112 11112

Net interest income .................................................................................. 267,430 291,80711112 11112

Fee income ................................................................................................ 37,689 29,828Fee expenses.............................................................................................. (383) (1,265)

11112 11112

Net fee income............................................................................................ 37,306 28,56311112 11112

Foreign exchange gains/(losses), net ........................................................ (14,144) 17,472Other income .............................................................................................. 22,317 18,364

11112 11112

312,909 356,206

Other expenses .......................................................................................... (48,826) (53,871)Provisions.................................................................................................... (214,405) (227,098)

11112 11112

Profit before income tax .......................................................................... 49,678 75,237

Income tax ................................................................................................ – –11112 11112

Profit after income tax .............................................................................. 49,678 75,23711112 11112aaaas aaaas

31st December 2001 – e1.00 = HRK7.370030

31st December 2002 – e1.00 = HRK7.442292

79

Statement of Cash Flows

As at31st December

1111111111

2001 200211112 11112

(HRK thousands)Operating activitiesProfit .......................................................................................................... 49,678 75,237Adjustments to reconcile to net cash from and used in operating activities:Depreciation................................................................................................ 3,473 3,408Net provisions ............................................................................................ 214,405 227,098

11112 11112

Operating profit before working capital changes ........................................ 267,556 305,74311112 11112

Changes in operating assets and liabilities:Net (increase) in deposits at banks, before provision for

possible losses........................................................................................ (243,579) (160,991)Net (increase)/decrease in loans to banks, before provision

for possible losses .................................................................................. (127,167) (47,171)Net (increase) in loans to customers, before provision for

possible losses........................................................................................ (1,135,780) (1,468,049)Net decrease/(increase) in accrued interest receivable and

other assets, before provision for possible losses .................................. (12,050) 38,326Net (increase) in assets held for resale ...................................................... (2,341) (11,966)Net increase in deposits from banks and companies ................................ 101,498 46,980Net increase in interest payables and other liabilities ................................ 186,342 196,322

11112 11112

Net cash used in operating activities .......................................................... (965,521) (1,100,806)11112 11112aaaas aaaas

Investment activitiesNet (increase)/decrease in assets available for sale .................................. 3,574 (6,488)Net (increase)/decrease in assets held to maturity .................................... 161,009 (135,779)Net (increase) of investments in subsidiaries and associates .................... – (7,211)Net (purchases) of tangible and intangible assets...................................... (1,310) (2,676)

11112 11112

Net cash used in/provided by investment activities .................................... 163,273 (152,154)11112 11112aaaas aaaas

Financial activitiesNet increase in founder’s capital ................................................................ 146,015 164,035Net increase in borrowings ........................................................................ 374,823 749,585Net increase in bonds payable.................................................................... 310,095 322,711Net increase/(decrease) in guarantee fund ................................................ (35) 258

11112 11112

Net cash provided by financial activities .................................................... 830,898 1,236,58911112 11112

Net (decrease)/increase in cash and cash equivalents .............................. 28,650 (16,371)Balance as of 1st January, net of provisions .............................................. 76,954 105,604Net cash (decrease)/increase .................................................................... 28,650 (16,371)

11112 11112

Balance net of provisions............................................................................ 105,604 89,23311112 11112aaaas aaaas

31st December 2001 – e1.00 = HRK7.370030

31st December 2002 – e1.00 = HRK7.442292

80

OVERVIEW OF THE REPUBLIC OF CROATIA

Territory and Population

Croatia occupies a total area of 89,738 square kilometres (of which sea accounts for approximately33,000 square kilometres). Croatia resembles an arc, with a long Adriatic coastline forming thewestern leg, and the land between the rivers Drava and Sava forming the northern leg. The capital,Zagreb, sits on the northern and western legs of the arc. Croatia’s Adriatic coastline has as manyas 1,185 islands, while the 1,500 metre high Dinaric Alps run the length of the country.The Danubeforms the eastern border with Yugoslavia (Serbia) while the other two large rivers, the Sava andDrava, form the southern and northern borders with Bosnia-Herzegovina and Hungaryrespectively.The area of land between the rivers is dissected by many other smaller tributaries.TheAdriatic coastline is the most prominent feature of Croatia, running the entire length of the westernborder, from the Istrian peninsula in the north to Dubrovnik in the south.

The capital city Zagreb is the largest in the country, with a current estimated population of around770,000, and is considered a leading industrial, cultural and scientific centre. Other cities ofsignificant size are Split (population 200,000), Rijeka (population 168,000), Osijek (population130,000) and Zadar (population 80,000). According to the last census carried out in 2001, the totalpopulation is 4,437,460. According to the 1991 census, carried out prior to the war which startedin May of that year and led to significant population displacement, the total population at that timewas 4,784,265.

Following the outbreak of war, between 1991 and 1995 almost one-quarter of Croatian territorywas occupied by rebel Croatian Serbs resulting in the displacement of approximately 245,000Croats and other non-Serbian nationalities.

The following table sets out a breakdown of population according to religion in 2001:

DistributionPopulation in %11112 11112

Total ............................................................................................................ 4,437,460 100.00Roman Catholics ........................................................................................ 3,993,854 87.98Orthodox Christians .................................................................................... 236,793 5.33Muslims ...................................................................................................... 56,777 1.28Other .......................................................................................................... 150,036 5.41

History

In October 1918, following the defeat of Austria Hungary in World War I, the Croatian NationalCouncil took power in Zagreb and called for union with the other South Slavic parts of AustriaHungary. Dalmatia, a separate Hapsburg Kingdom since 1815 also recognised the authority of theCroatian National Council. In December 1918, the Kingdom of the Serbs, Croats and Slovenes wasproclaimed in Belgrade and in 1929, the name of the country was changed to the Kingdom ofYugoslavia.

Following World War II, Communist led forces proclaimed a new Yugoslavia. A federal state of sixrepublics was set up, substantially restoring the old borders of Bosnia and Croatia, but splittingMacedonia off from Serbia and setting up two autonomous regions within Serbia. All power wasgiven to the non-ethnic communist party led by General Tito. In 1948, the former Yugoslavia brokeoff relations with the former Soviet Union (“USSR”) and initiated a certain amount of economicliberalisation.

The late 1980s brought dramatic changes in international politics. Reforms in eastern Europe,which culminated in the disintegration of the USSR and the Warsaw Pact, and the end of the coldwar, caused a transformation of the Eastern Bloc. This also had a profound effect on the former

81

Yugoslavia where reformers began to reject the existing federal concepts and embrace democraticideas.

The first free elections in Croatia since World War II took place in April and May 1990 and resultedin a clear victory for the Croatian Democratic Union Party (“HDZ”) which gained 205 of the 350seats in the Sabor, the Croatian Parliament. However the growing nationalism in Serbia at this timeinfluenced ethnic Serbs living in Croatia to fear for their safety.

The disintegrating Yugoslav federal government made it clear that changes would have to be madeto Yugoslavia’s constitution. Croatian leaders, along with the Slovenes, insisted on a very loosefederation or even confederation. In May 1991, 83.56% of the Croatian electorate turned out for areferendum on independence. Over 94% of the votes were in favour of independence, andCroatia’s declaration of independence on 25th June 1991 coincided with Slovenia’s decision to dothe same.

However, in May 1991, fighting between rebel Croatian Serb forces and Croatian police units brokeout in the area bordering Bosnia-Herzegovina (around Knin), in Baranja (north of Osijek) andSlavonia (the region west of the Danube River). The Yugoslav National Army (the “YNA”)intervened in support of the rebel Croatian Serbs. During the summer and early autumn of 1991,rebel Croatian Serb forces and the YNA took control of more than one quarter of Croatia’s territory.

Rebel Croatian Serbs proclaimed the independence of the occupied territories on 19th December1991, although they never gained international recognition. Despite this, Croatia declared itself anindependent sovereign state but was not immediately recognised by other countries. EUrecognition came on 15th January 1992, after the introduction of a law on Human Rights andMinorities by the Parliament, followed by the United States on 7th April 1992. On 22nd May 1992,Croatia was admitted to the UN.

In May 1995, Croatian forces re established control over the entire region of Western Slavonia. On4th August 1995, the Croatian army sought to re-establish control over the rebel Croatian Serb-held areas bordering Bosnia-Herzegovina and the majority of the Serb population left the area forthe Former Republic of Yugoslavia (“FRY”) and Bosnia-Herzegovina, although some have nowreturned.

In November 1995, an agreement was reached to return the area of Eastern Slavonia to Croatianrule by peaceful reintegration overseen by the international community, which was completed by1998.

International Relations

Croatia has established diplomatic relations with 135 countries and was admitted to the UN in May1992. On 15th January 1993, it became a member of the International Monetary Fund (the “IMF”).Croatia is also a member of the International Development Association, the International FinanceCorporation, the European Bank for Reconstruction and Development, the International LabourOrganisation, the Central European Initiative, Inter-American Development Bank and, since July2000, the World Trade Organisation (“WTO”).

In November 1996, Croatia became a member of the Council of Europe and in the same year,alongside Macedonia and Slovenia, was admitted to membership of the Bank for InternationalSettlements.

Following the political changes resulting from the Parliamentary and Presidential elections in early2000 and the aggressive reform programme of the previous Government, the relationship with theinternational community significantly improved and accelerated the integration process for Croatia.

The Croatian ∆Government is determined to maintain the country’s macroeconomic stability andattain rapid and sustainable economic growth. Since 2000, the Government has embarked onreforms to address several key economic challenges, including: (i) reducing macroeconomic

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imbalances to ensure stability while introducing complementary reforms to address underlyingstructural causes of fiscal imbalances; (ii) increasing the flexibility of the economy; and (iii) creatinga business-friendly environment that is conducive to attracting investment.

The IMF has taken the lead in assisting in Croatia in maintaining macroeconomic stability. Togetherwith the IMF, the IBRD also maintains a close collaborative relationship with Croatia in supportingthese reforms. The IBRD has taken the lead in policy dialogue on structural and institutionalreforms in a number of sectors. This reform agenda includes measures to: (i) reduce the level ofpublic expenditure and the size of the state (ii) restructure the pension and health sectors; (iii)enhance labour market flexibility; (iv) strengthen market institutions and the competitiveness of theeconomy; (v) mitigate the social cost of reforms and poverty through the restructuring of socialwelfare programs; and (vi) begin the process of judicial reform. Progress is being made in all ofthese areas.

Through its strategic role in ensuring the stability of the region and the West’s recognition andacknowledgement of its reform programme, Croatia was accepted as a member of the NorthAtlantic Trade Organisation (“NATO”) Partnership for Peace initiative on 25th May 2000. This wasan important first step for the integration and strengthening of co-operation with other NATOmembers and is considered to be of great benefit to Croatia’s preparations for entry into NATO.During the Euro-Atlantic Partnership Council (“EAPC”) meeting held on 1st and 2nd December2003 in Brussels, Croatia reaffirmed its position in the fight against terrorism and its pursuit of thereorganisation of its defence forces.

On 1st March 2003, Croatia joined the Central European Free Trade Area (“CEFTA”). This isviewed as an acknowledgement of the positive development of Croatia’s overall economicrelations, since all existing CEFTA members gave their support to Croatia.

Membership of the EU is a strategic goal of Croatia’s foreign policy. The Government showed itsdedication to the integration process by forming a Ministry for European Integration in February2000. The main responsibility of the Ministry for European Integration is to co-ordinate the activitiesof the other ministries in implementing the obligations arising from the Stabilisation andAssociation Agreement (the “SAA”), as well as the alignment of the Croatian legal system with theEU acquis communitaire. The Croatian Government believes it has dealt successfully withpolitically sensitive issues such as the co-operation with the ICTY, the return of refugees, freedomof the media and judicial reform. The newly elected government announced that it will continue thispath of reforms and reapprochement with the EU.

The SAA between Croatia and the European Community was initialled on 14th May 2001 andsigned on 29th October 2001. It was ratified by the Croatian Parliament on 5th December 2001.The European Parliament gave its assent to the SAA on 12th December 2001. To date, 13 out ofthe 15 actual EU Member States have ratified the SAA. In Italy, the SAA is in the final phase of theratification process. The Netherlands, although its Parliament has ratified the SAA, has not notifiedthe European Commission of its ratification, because of the “non sufficient co-operation of Croatiawith the International Criminal Tribunal for the Former Yugoslavia”. The United Kingdom has notratified the SAA for the same reason.The finalisation of the ratification process and the subsequententry into force of the SAA, by which Croatia becomes an associated member of the EU, isexpected in the first half of the 2004.

An Interim Agreement between Croatia and the European Communities, which covers theeconomic elements of the SAA (mainly trade and reduction of tariffs and trade barriers), enteredinto force on 1st March 2002, though it has been applied since 1st January 2002.

Although the SAA is not yet in force, Croatia has already fulfilled 80% of the obligations imposedunder the SAA, particularly in relation to the legal harmonisation with EU law. Accordingly, the CNBstrove to incorporate relevant EU regulations in the areas of its field of competence and sought theopinion of European Commission experts when preparing draft legislation. In line with the policy ofthe Republic, the CNB maintains contact with representatives of the European Central Bank.

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On 21st February 2003, the Republic of Croatia applied for EU membership and on 14th April2003, the Council of the European Union empowered the European Commission to prepare anopinion on the Croatian EU membership application. On 10th July 2003, Mr. Romano Prodi, thePresident of the European Commission, delivered the European Commission Questionnaire to thethen Croatian Prime Minister, Mr. Ivica Racan. The Government prepared answers to some 4,500questions contained in the Questionnaire which will serve as a basis for the opinion on the CroatianEU membership application. The Questionnaire was handed to Mr. Prodi on 9th October 2003 andthe Opinion of the European Commission is expected in spring 2004. The decision of the EUCouncil of Ministers on the status of candidature for the EU is expected in June 2004. Taking intoconsideration the economic development of Croatia, as well as its successful implementation of theSAA obligations, the Croatian Government is hopeful of a favourable opinion of the EuropeanCommission, and EU accession by 2007-2008.

On 13th November 2003, Günter Verheugen, Commissioner of the European Commissionresponsible for Enlargement of the European Union, participated in the Government session whenthe first topic on the agenda was the assessment of the progress in Croatia’s accession to theEuropean Union. Mr. Verheugen congratulated Croatia on everything it had accomplished in thepast few years and expressed his expectation that Croatia will take its place in Europeanstructures.

In addition, the Government has intensified and extended cooperation with international financialinstitutions, relying primarily on the IMF and the IBRD. In February 2000, a Letter of Intent wassigned with the IMF to establish a Precautionary Arrangement, which was approved by the IMF inMarch 2001. Such arrangement ensures that funds provided by the IMF under the stand-byagreement entered into in October 1994 are available to Croatia. This particular arrangement hasexpired and negotiations for a replacement precautionary stand-by facility were completed inDecember 2002 and approved by the IMF on 3rd February 2003. This replacement facility is dueto expire in April 2004. On 1st August 2003, the IMF’s Executive Directors completed the firstreview under the facility and commended the generally satisfactory observance of quantitativeperformance criteria in the first half of 2003. The Executive Directors expressed their confidence inthe stabilisation of the public debt ratio, which was the principal objective of the program.

For Croatia, this arrangement is primarily a precautionary measure and shows internationalconfirmation of the credibility of Croatia’s commitment to further fiscal consolidation and structuralreforms, especially with regard to public debt stabilisation, increased labour market flexibility andfurther privatisation. To show that the arrangement is merely precautionary, and in view of Croatia’scomfortable international reserve position, favourable balance of payments outlook and easyaccess to international capital markets, Croatia repurchased the entire amount of the IMF creditoutstanding at the end of 2002.

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Constitution and Government Structure

A new constitution was adopted on 22nd December 1990 and was substantially amended inNovember 2000 and March 2001 (the “Constitution”). It established a multi-party democracy, withan economy based on market principles and private ownership. Under the Constitution, thePresident is elected for five year terms. The President appoints a Prime Minister who, in turn,appoints Government Ministers. Ivica Racan was appointed Prime Minister following the electionsin January 2000, and Dr. Ivo Sander replaced him after the elections in November 2003. TheConstitution is based on the separation of powers between the legislature, executive and judiciary.The following diagram shows the constituent parts of each of those bodies:

Legislature

Croatia currently has a single chamber parliament, the Hrvatski Sabor (the “Parliament”). Until theend of March 2001 the Parliament consisted of 2 chambers, the House of Representatives and theHouse of Counties. The House of Counties was abolished on 28th March 2001 by a constitutionalamendment. The Parliament has the power to pass laws, amend the constitution, adopt the statebudget and decide on war and peace, as well as exercising certain supervisory powers over thework of the Government. Laws are passed by majority vote provided that a majority ofrepresentatives are present, except that laws which deal with certain constitutional rights can onlybe passed by (in certain cases) a two-thirds majority of all representatives or (in other cases) amajority of all representatives. The President of Croatia promulgates laws validly enacted by theParliament.

The Executive

The President is elected by majority vote of Croatian citizens for a term of five years, and may notserve more than two terms. The President has the power to appoint and dismiss the Prime Ministerand is the Commander-in-Chief of the armed forces. The President may, on a proposal of theGovernment countersigned by the Prime Minister and after consultation with the leaders of thecoalitions of political parties represented in the Parliament, dissolve the Parliament if theParliament adopts a vote of no confidence when such vote is requested by the Government, or ifit does not adopt the state budget within 120 days from the date when the state budget waspresented as a bill.

The Government consists of the Prime Minister, nominated by the President, and other membersof the Government proposed for appointment by the Prime Minister, subject to approval by amajority of all representatives in the Parliament.

Judicial Executive Legislature

Supreme Court

County Courts

Municipal Courts

President

Prime Minister

GovernmentMinisters

Ministries

Parliament

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The Judicial System

Croatia’s three tier judicial system is independent of the executive and legislature. On the first levelare the municipal courts, followed by county courts, and finally by the Supreme Court which is thehighest court in Croatia. Other specialised courts exist to deal with commercial and administrativelaw matters. Judges are appointed by the High Judiciary Council of the Republic (the “Council”),the members of which are selected from amongst judges, attorneys at law, and university lawprofessors, and are elected for an eight year term by the Parliament. Following an initial five yearterm for newly appointed judges, judges of these three courts are appointed for life and may notbe removed except by the Council under certain limited circumstances.

The Constitutional Court, which is independent of other courts in Croatia, consists of thirteenjudges who are elected for eight years by the Parliament, and it has the authority to annulunconstitutional laws or regulations, and to decide on jurisdictional questions between thelegislature, executive and judiciary, and on the impeachability of the President. It has jurisdiction toprotect the constitutional freedom and rights of citizens.

When promulgating laws, the Government seeks to follow EU guidelines on legislation. New lawshave been introduced and provisions have been made with respect to company, property,bankruptcy, competition, securities, labour, taxation and mutual funds law.

The Political Parties

The major political parties that participated in elections on 23rd November 2003 were the SocialDemocratic Party (“SDP”), HDZ, Croatian People’s Party (“HNS”) and Croatian Peasant Party(“HSS”). These elections have confirmed the re-election of HDZ (previously the opposition partybut in November 2003 won the largest number of seats (66) in the 152-seat parliament) which firstled Croatia to independence. The results demonstrated that the citizens of Croatia supported thechanges in the economic and political life in Croatia proposed by Dr. Ivo Sanader, the leader ofHDZ. Dr. Sanader became Croatia’s new Prime Minister in November 2003, replacing the outgoingPrime Minister and SDP leader, Mr Ivica Racan. The HDZ has adopted a strategy in favour of apro-European, mainstream conservative orientation that is committed to democracy, the rule oflaw, human rights and minority rights. Dr. Sanader has stated that HDZ would lead Croatia into theEuropean Union by 2007 and into NATO by 2006.

Presidential Elections

On 3rd February 2000, Stjepan Mesić of HNS became the new Croatian President after receiving56% of the vote in the second round of the presidential elections over Dražen Budisa of the HSLS,who collected 44% of the vote. Stjepan Mesić is considered by the public to be a pro-westernmoderate politician.

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Parliamentary Elections

The most recent elections of deputies for the House of Representatives were held on 23rdNovember 2003. The following table sets out the percentage breakdown of the vote in thoseelections and each party’s resulting number of seats in the House of Representatives:

Party Seats %11111 11111

Croatian Democratic Union (HDZ) .................................................... 66 43.42Social Democratic Party of Croatia (SDP) ........................................ 34 22.37Croatian People’s Party (HNS).......................................................... 10 6.58Croatian Peasant Party (HSS) .......................................................... 10 6.58Croatian Party of Rights (HSP) ........................................................ 8 5.26Istrian Democratic Council (IDS) ...................................................... 4 2.63LIBRA (LIBRA) .................................................................................. 3 1.97Croatian Pensioner’s Party (HSU) .................................................... 3 1.97Croatian Social Liberal Party (HSLS)................................................ 2 1.32Liberal Party (LS) .............................................................................. 2 1.32Democratic Centre (DC).................................................................... 1 0.66Croatian Democratic Peasant Party (HDSS) .................................... 1 0.66Primorsko Goranski Savez (PGS) .................................................... 1 0.66Autonomous Democratic Peasant Party (SDSS) .............................. 3 1.97Minority parties.................................................................................. 4 2.63

11111 11111

Total .................................................................................................. 152 100.0011111 11111aaaaa aaaaa

Source: Electoral Commission Report of the Republic of Croatia

In the November 2003 elections, HDZ secured additional support from 11 members of theParliament representing the HSLS-DC coalition (3), the HSU (3), minority representatives (4), andthe HDSS (1).

On 21st December 2003, Prime Minister, Dr. Ivo Sanader announced his final decision regardingthe members of the new Government which will consist of 5 Deputy Prime Ministers and 14Ministries: Ministry of the Family, Veterans’ Affairs and Intergenerational Solidarity; Ministry ofHealth and Social Welfare; Ministry of Foreign Affairs; Ministry of Finance; Ministry of Defence;Ministry of the Interior; Ministry of the Economy, Labour and Entrepreneurship; Ministry of the Sea,Tourism, Transport and Development; Ministry of Agriculture, Forestry and Water Management;Ministry of Environmental Protection, Physical Planning and Construction; Ministry of EuropeanIntegration; Ministry of Culture; Ministry of Justice and Ministry of Science, Education and Sports.

On 22nd December 2003, at the first session of the newly elected Parliament members, Mr.Vladimir Šeks was elected President of the Croatian Parliament.

Developments Relating to the ICTY

Croatia was one of the initiators of the suggestion that the United Nations establish theInternational Criminal Tribunal for the Former Yugoslavia (“ICTY”) and considers the co-operationwith the ICTY as its international and legal obligation as well as its moral obligation to punish allwar crime perpetrators, regardless of their nationality. Croatia has proved its support for the workof the ICTY particularly through continued co-operation in granting access to documents andevidence, hearing witnesses and suspects and providing assistance to investigating teams.

In September 2002, a sealed indictment was delivered against Janko Bobetko, a retired general ofthe Croatian army. The ICTY has now cancelled proceedings against Mr. Bobetko due to his death.

The only outstanding request by the ICTY of Croatia is the arrest and extradition of the retiredgeneral of the Croatian Armed Forces, Ante Gotovina. Besides other measures, Croatia has issued

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an international warrant for his arrest and has announced a financial reward for information on hiswhereabouts. In accordance with the ICTY rules, reports on activities aimed at locating andarresting Mr Gotovina were submitted to the ICTY on three occasions in 2003. Croatia is aware ofits obligations and is willing to continue with all existing measures aimed at locating and arrestingMr Gotovina whether in Croatia or abroad and surrendering him to the ICTY.

On the occasion of her visit to Zagreb at the beginning of October 2003, the Chief Prosecutor ofthe ICTY, Ms. Carla Del Ponte, confirmed that Croatia had fulfilled all of the requests made by theICTY so far and offered support from the Prosecutor’s Office in that respect.

The preconditions enabling the ICTY to transfer some of the indictments to the jurisdiction of theCroatian tribunals have been created by the improved co-operation between the State Attorney’sOffice of the Republic and the Prosecutor’s Office of the ICTY accompanied by the harmonisationof the national legislation achieved by the passing of new regulations – the “Witnesses ProtectionAct” (Official Gazette of the Republic of Croatia No. 163/03) and the “Act on the Implementation ofthe Statute of the International Criminal Tribunal and the prosecution of persons responsible forcriminal offences violating international laws of war and humanitarian law” (Official Gazette of theRepublic of Croatia No. 175/03).

According to the statements of the new Prime Minister, Dr. Ivo Sanader, Croatia will continue tofully co-operate with the ICTY in all aspects and will fulfil all requests of the ICTY.

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THE ECONOMY

Overview of Post Independence Developments

Croatia was expelled from the Yugoslav monetary system two days after the country’s declarationof independence in June 1991. The central bank of the former Yugoslavia kept all the country’sforeign exchange reserves, leaving Croatia with no hard currency reserves at independence.Simultaneously, the 1991 war meant that external sources of financing were no longer available.The 1991 war left approximately one third of the country’s territory outside Government control andsignificantly disrupted lines of communication, both within the country and with many of Croatia’strading partners. Hostilities also caused significant damage to the country (estimated at US$37.1billion) in such areas as infrastructure, housing and industrial plants. It also displaced hundreds ofthousands of people and substantially reduced tourism. Since 1992, Croatia has given refuge tosignificant numbers of refugees and displaced persons, something which has required significantexpenditure. Croatia’s industrial base was disrupted by the loss of markets in the former Yugoslaviaand the cutting of trade routes to the south and east. Between 1989 and 1993, Croatia’s realeconomic output decreased by approximately 40%, and disposable incomes fell sharply. The sharpdrop in economic activity, along with the expenditure linked to refugees and other pressures onpublic expenditure, increased the public deficit and caused very high levels of inflation.

Stabilisation of the Economy

Background to the 1993 Stabilisation Programme

At the time of the breakout of the war in 1991, Croatia was still using the currency of the formerYugoslavia. External borrowing was virtually impossible (the country was not recognisedinternationally at this stage and war risks meant that commercial lenders were unwilling to extendcredit). The deficit could only be financed by money creation, aggravating an already high inflationrate. Croatia introduced its own currency, the Croatian dinar (“HRD”), in December 1991 andinitially maintained a fixed exchange rate against the Deutsche Mark (HRD was later substitutedby the Kuna in 1994 after the first phase of the Stabilisation Programme (as described below) wassuccessfully implemented). At first, this helped to reduce inflation, but the lack of public confidencein the new currency led to further currency substitution, and soon reignited inflation. In addition, theCNB’s policy of increasing its foreign exchange reserves in the domestic market resulted inincreased issuance of the domestic currency which further aggravated inflationary pressures.

The 1993 Stabilisation Programme

In October 1993, the Government adopted a stabilisation programme (the “StabilisationProgramme”) with the short-term objective of eradicating hyperinflation and, in the longer term,transitioning toward an effective market economy with four general targets:

(1) the stabilisation and strengthening of the Croatian economy;

(2) the introduction of a competitive environment and appropriate ownership structure with areduced role for the state in the economy;

(3) the protection of low income population groups from the inflationary redistribution of income;and

(4) the establishment of preconditions for sustainable economic development and growth.

The successful implementation of the Stabilisation Programme, which broke the inflationary cycle,has provided the basis for economic policy in Croatia adhered to by each subsequent government.Thus, the goals and policies of the government are designed to fulfil∆ the conditions for long-termlow inflation by eliminating fiscal imbalances.

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In the longer term, the aim of these policies is to establish the full external convertibility of thenational currency, to achieve long-term price stability, reduce unemployment and to establishappropriate internal and external balance in terms of sustained growth.

The implementation of the Stabilisation Programme resulted in a fall in inflation from over 1,000%in 1992 and 1993 to 0.6% in 1996 (on a producer price basis). Once the initial monetarystabilisation had been achieved, the Government embarked on the second stage of the plan withthe rehabilitation of the banking system and acceleration of privatisations. Reflecting on thesuccess of the Stabilisation Programme, on 14th October 1994 the Government agreed to an 18month stand-by facility with the IMF. This agreement opened the door to additional financing fromthe IBRD and the EBRD.

The Privatisation Programme

Overview

Croatia commenced its privatisation programme in 1991. The aim of the privatisation programmewas to privatise approximately 3,000 “socially owned” enterprises. Privatisation is beingimplemented in two phases: the first under the 1991 Law on the Transformation of Socially OwnedEnterprises (the “Law on Transformation”) and the second under the Law on Privatisation (the “Lawon Privatisation”) which came into force on 22nd March 1996. Created at the request of the IMFand the IBRD by the merger of two former bodies (the Agency for Reconstruction and Developmentand the Croatian Development Fund), the CPF is the governmental agency responsible forprivatisation.

The Law on Transformation, effective from May 1991 and subsequently amended, provides theregulatory framework under which companies that were “socially owned” in the former Yugoslavia,can be incorporated and brought into the private sector. However, bank, insurance companies andutilities are not covered by this law.

Privatisation Process in the 1990s

By the end of 1999, more than 2,650 formerly socially owned enterprises had gone through theprivatisation process.

The methods of privatisation were, to a certain extent, dictated by the system of “social ownership”and socialist self management in the former Yugoslavia. “Socially owned” enterprises wererelatively independent from the state, and management was accustomed to making its owndecisions. Accordingly, it was decided that there would be a certain degree of autonomy in relationto the form of the privatisation of such enterprises: each enterprise could propose features of itsprivatisation, such as equity or debt structures, or debt/equity swaps, which could be eitheraccepted or rejected, but not modified, by the CPF. As a result, by the time the ∆Law on Privatisation∆was enacted in ∆1996, 1,100 small and medium sized enterprises were wholly privatised, withformer and current employees, pensioners and management acquiring ownership.

Under the Law ∆on Transformation, shares in the relevant enterprise, which are valued on the basisof the estimated net book value of the enterprise, had to be offered first to employees and formeremployees, then to state employees and employees of public enterprises, and finally to othercitizens of Croatia. All such subscribers were entitled to purchase shares at a basic discount 20%plus 1% for each year of employment in Croatia (up to a maximum discount of 60% on acquisitionwith a value up to and including DEM20,000).∆A 1993 amendment to the Law on Transformationintroduced a further limit in that no more than 50% of the value of any company could be purchasedby subscribers entitled to such discounts. Those acquiring shares were allowed to pay ininstalments over a five-year period (subsequently increased to 20 years). To the extent that sharesabove the DEM20,000 threshold were purchased, no discount was available but the instalmentpayment option was available; such shares as well as the discounted shares could be purchasedwith frozen foreign exchange deposits (“FFEDs”) (see “Debt — Internal Debt”). In January 1994,

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the Government changed its policy to allow a partially gratuitous distribution of shares incompanies to be privatised. Private subscribers were entitled to obtain outright that part of their fullentitlement of shares that represented their discount merely by paying either the first annualinstalment or 5% of the price of the non-discounted portion. Subscribers who obtained their“discounted shares” in this way were under no liability, in practice, to pay the remaining instalmentsunder the contract to purchase the remaining “non-discounted shares”.

Certain enterprises also have shares reserved for people whose land was confiscated after WorldWar II and, in such cases, decide on the level of compensation themselves. Until 1999, an averageof 5% of the equity of all privatised enterprises had been reserved for restitution in this way.

The remaining shares, namely those which were not acquired by employees, former employees,state employees and employees of public enterprises or other citizens of Croatia, were transferredto two funds: two thirds to the CPF and one third to state pension funds. The CPF was under anobligation to dispose of the shares in its portfolio by way of public auction, tenders or private sales.However, since cash generating methods did not prove effective, the remaining portfolio wasdivested by way of a mass voucher privatisation scheme, specially designed for the war-affectedpopulation.

The mass voucher privatisation involved a distribution of the shares not sold in the first phase ofprivatisation. The vouchers were given to individuals affected by the hostilities, such as injuredservicemen, war widows and their families, families of interned or missing soldiers or civilians,former political prisoners and displaced persons and refugees (around 5% of the total population).Under Croatian law vouchers are not securities and are not tradable. Individual voucher holderscould bid for single company shares or invest in a voucher fund. More than 90% of them chose toinvest in a voucher fund, so most of the bids were placed by these funds. The privatisationinvestment funds were listed on the Zagreb Stock Exchange in 1999 and have five years torestructure their portfolio and transform themselves into regular closed-end investment funds. Thestrategy of most funds is to sell their holdings in privatised companies and invest the proceeds inother listed securities. This should help increase liquidity of the stock market in the long term.

The cash proceeds from the privatisation of enterprises have accrued to the Government. Up toand including 1995, cash proceeds were transferred to the general budget; however, since 1996,all proceeds realised by the CPF have been transferred to the Croatian Bank for Reconstructionand Development. The Government initially saw the privatisation programme as a significantsource of revenue for the budget; however, receipts from privatisation have not been as large asexpected due partly to the option granted to investors to pay for their shares with FFED’s.

Approach to Privatisation

During the recession of 1999, many privatised companies entered periods of difficulties and theirowners returned their shares to the CPF. In addition, many small shareholders returned numerousshares to the CPF. At the beginning of 2000 the CPF’s share portfolio consisted of stakes in 1,850companies. In the first six months of 2000, holdings in almost 450 companies were divested by theCPF. The first phase of this consolidation has seen the losses and indebtedness of companies inthe portfolio fall providing a solid basis for the completion of the process.

The Government’s approach to privatisation has seen all government holdings in companies otherthan banks, insurance companies and utilities consolidated into the CPF portfolio. Each and everycompany in the combined portfolio has been analysed by the CPF. On the basis of this analysis,restructuring programmes have been developed for each company. In addition, these analyseshave formed the basis of negotiations with creditors and potential buyers. The principle of usingmarket value rather than book value as the basis for price negotiations has been adopted by theCPF as part of this new approach.

The aims of this approach were to increase foreign investor participation, to increase theparticipation of Croatian citizens in the privatisation process and to effect a fairer distribution of

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social capital, to increase budgetary revenues, to augment the liberalisation of the economy, toimprove the overall level of efficiency in the economy and to ensure transparency in theprivatisation process as a means of increasing domestic support for continued reforms necessaryto complete the process of transition into a market economy.

As of 1st October 2003, CPF’s portfolio comprised 1,133 companies, 854 of which are eligible forprivatisation. The main criteria for choosing an adequate model for privatisation is the share ofgovernment portfolio in the founder’s capital of each company. If the share of the governmentportfolio in founder’s capital is less than 50%, then CPF does not have a controlling interest andtherefore cannot have an impact on restructuring of the company.

Another important criteria when choosing an appropriate privatisation model is the company’ssignificance in terms of economic importance (employment, value of share, etc).

By way of example, the basic privatisation models for 2002 were as follows:

(i) shares sold by public tender – through this model for the privatisation of the government’sportfolio, a nominal value of HRK745,690,464 of the government portfolio in founder’s capitalis to be sold by a public tender.

(ii) shares sold by public collection of the offers – portfolios that are being privatised through thismodel comprise companies which are of strategic importance for Croatia and its economy.These are the companies that are burdened with inherited problems which are partially beingsold through programmes adopted by the Government. According to this model there are 88companies with a nominal value of HRK13,523,896,986.00, with the share of thegovernment portfolio in founder’s capital greater than 49.99%.

The new Board of the CPF is expected to be agreed upon in the first quarter of 2004. It is notexpected that the appointment of the new Board will have a negative impact on the ongoingprivatisation programme.

Privatisation of Utilities (including Oil and Gas)

Croatian Telecom has been partly privatised, with Deutsche Telekom purchasing 35% of the sharesin Croatian Telecom in 1999 for US$850 million and an additional 16% in 2001 for e500 million. TheGovernment has postponed the sale of a further 7% of Croatian Telecom to its employees until2004 due to resistance from unions.

Restructuring strategies for the privatisation of the oil and gas company INA were completed inJuly 2003 with the sale of an interest representing 25% plus 1 share to MOL, which investedUS$505 million.

Advisers have been appointed for the national utilities company, Hrvatska Elektroprivreda (“HEP”).Their task is to recommend restructuring strategies for HEP as the first step toward possibleprivatisation in 2004. During 2003, HEP Group was restructured and now comprises HrvatskaElektroprivreda d.d, HEP Generation, HEP Transmission d.o.o., HEP Distribution, HEP DistrictHeating d.o.o. and HEP Gas d.o.o..

The Government is pursuing an agreement with the Catholic church for the transfer of 25% of theshares in Croatia osiguranje (an insurance company) and is contemplating selling another 20% ofthe shares on the stock exchange.

The Government is also considering privatisation projects for 25% of the shares in Hrvatskapoštanska banka (Croatian Postal Bank) and Croatia banka.

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RECENT ECONOMIC TRENDS

Economic activity

The upward trend in economic growth that began in 2000 after recovering from the 1999 recessioncontinued in 2002. Since 2000, the GDP growth rate has increased each year to reach 5.2% in2002. The greatest source of growth in 2002 was an exceptionally strong domestic demand thatoffset the lack of foreign demand in economies of the EU member states which had slowed down.In 2002, the rate of change in the general level of prices measured by the growth of the GDPdeflator was 2.9%. A low rate of change in prices was recorded in most consumption categories,while a significant increase in nominal value as a result of a price growth was only observed ininvestments in gross fixed capital formation.

In 2002, GDP growth was mostly fueled by personal consumption. With its annual growth rate of6.6%, personal consumption contributed 4.0% to GDP growth. Following significant growth in thefirst half of 2002, consumption rose further in the third and fourth quarters, which resulted in a 7.6%increase in personal consumption in the second half of the year compared with the same periodof the previous year. A boost in consumption in 2002 was mainly financed by new household sectorborrowing from banks. Commercial bank credits to households rose at the average rate of 35.5%in nominal terms or by 43.0% at the December level.

Available indicators point to a modest acceleration of economic growth in 2003. Strong investmentactivity, including highway and residential construction, along with increased exports of goods andservices led the growth. Although the rate of growth of domestic consumption has slowed downsomewhat, with annual growth rates falling from over 6% at the end of 2002 to 4.9% in the firstquarter of 2003, strong investment demand has compensated, keeping domestic demand growing.Furthermore, exports of goods grew strongly in the first quarter of 2003 and exports of servicesgrew substantially in real terms in second quarter. This allowed foreign demand to make asignificant positive contribution to aggregate demand in the first half.

Changes in the Gross Domestic Product and the National Income

Gross Domestic Product

Croatia’s average growth figure of 3.38% over the last 6 years is one of the fastest in Europe andcompares favourably with other advanced transitional economies as well as with the EU. In 1998,however, GDP grew only by 2.5% after which a real fall in output of 0.9% followed in 1999. Therewere several reasons behind this drop in growth. First, the domestic banking crisis in 1998impacted heavily on the real sector as credit was curtailed. The effects of the Asian crisis, inparticular the difficulties experienced by Russia shortly thereafter adversely affected theperformance of a number of Croatian companies as previously promising markets shrank. All ofthese factors forced the Government to borrow domestically in an effort to maintain growth.Between the middle of 1998 and February 1999, economic indicators suggested a downward turn.1999 saw negative GDP growth for the first time since 1993, mainly as a result of NATO’sintervention in Kosovo, which adversely affected the tourism sector and confidence, just as theeconomy had begun showing signs of recovery. However, by the fourth quarter of 1999, a recoveryin the economy was evident with a rebound in industrial production and personal consumptionleading the way.

Since 1999, onwards growth has increased, with recorded GDP growth of 2.9% in 2000, 3.8% in2001, 5.2% in 2002 and 5.0% in the first half of 2003. This trend was a result of industrialproduction and retail trade positive trends and an increase in external demand as EU economiesresumed quicker growth. Having stagnated in the period between 1993 and 1995, industrialproduction recovered during 1996, growing at 3.1%, 6.8% in 1997 and 3.7% in 1998. In 2001,industrial production recovered from a fall of 1.4% in 1999 and a slight growth in 2000 (1.7%) toregister growth of 6.0% and 5.4% in 2001 and 2002 respectively. As a result of foreign retail chains

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entering the domestic market, competition in the trade sector intensified. That led to stronger retailtrade turnover, with real growth of 14.4% in 2000, 10.0% in 2001, and 12.5% in 2002. In July andAugust of 2003 the real retail trade turnover rose by as little as 0.1% compared with the sameperiod in 2002. The stagnant turnover was primarily the result of a decline in turnover (comparedwith the corresponding months in the previous year) of businesses engaged in the sale, repair andmaintenance of motor vehicles. Despite a considerable increase in the turnover of grocerybusinesses in the same period, it was not enough to halt decline in overall trade turnover at themonthly level which started in April. The construction sector, having previously suffered a severefall in output (over 50%), saw a contraction in 2000 as the post war reconstruction phase began totaper off and the Government, in pursuit of tighter fiscal policy, reduced capital expenditures. Thistrend was altered in the middle of 2001 so that construction works in 2001 increased by 3.6%. In2002, intensive road and dwellings construction led to a significant rise in construction works,which amounted to 12.8% in 2002 compared to the same period in the previous year. In 2003, thisactivity, which grows faster than any other economic activity, recorded annual growth rates of theconstruction project index reaching 23.9% and 19.7% in July and August respectively. The tourismsector, once Croatia’s largest earner of foreign currency (when the informal sector is taken intoaccount) contracted by almost two-thirds during the war. This sector however, has been recoveringmore rapidly than others. The growth rate of tourist overnights was 66.5% in 1996, 41.3% in 1997and 3.2% in 1998. The Kosovo War adversely affected tourism in 1999, which saw tourist arrivalsdown by 12.8% on 1998, and the number of nights stayed by tourists was down by 15% comparedto 1998. In 2000, as peace came to the region and Croatia became more accessible and attractiveas a tourist destination following political changes in the region, overnights increased by 44.6%followed by a 10.8% rise in 2001 and a 3.0% rise in 2002. In the first seven months of 2003, a 3%rise was recorded.

Savings deposits rose as confidence returned to the banking sector following the exit of five banksfrom the market in 1999 and the repayment of arrears by the Government to suppliers. This trendwas intensified by the conversion of euro currencies at the end of 2001 that was mainly channelledthrough deposits in the banking sector. As a result, banks started to extend loans to consumersand enterprises more actively, which gave impetus to an increase in domestic demand. Althoughthe slowdown of economic activity in European markets in 2002 negatively affected Croatianexport performance, stronger domestic demand contributed to higher growth than in previousyears. With the continuation of positive trends in industrial production and retail trade, and theadditional boost in construction works, real GDP growth in 2002 was 5.2%. In 2002, GDP stood atHRK176 billion in nominal terms, representing a HRK13.5 billion growth compared to the previousyear. Such an accelerated growth relative to the previous year was parallel to the overall globalgrowth deceleration – in the USA, the EU and Japan. Nevertheless, the Central Europeantransition countries managed to maintain the economic growth at a high level and even toaccelerate it to a certain extent (as was the case in Croatia), as a result of acceleration of structuralreforms and EU accession processes.

GDP growth was influenced by an increase in personal consumption, which rose by 6.6% in 2002,and gross capital formation. Its growth was stimulated by a wage bill increase as a result of theaverage wage growth, slightly increased employment and new household borrowing from deposittaking banks. Investment in inventories, together with investments in gross fixed capital formationwhich increased by 10.0% in 2002, also significantly contributed to growth. Investment growthoccurred not only in the private sector but also in public investment in infrastructure (roadconstruction) which has a long payback period.

The strong economic growth that started at the end of 2002 continued in early 2003. In the first andsecond quarters of 2003, the real growth of GDP was estimated at 4.9% and 5.0% respectively,compared with the corresponding periods in 2002. The main characteristic of the economicdevelopments in the first half of 2003 was the strong investment activity and an increase in theforeign goods and services trade. (See “Direction of Trade” below)

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Whilst the indicators of economic activity have greatly improved across all segments, there stillremains the problem that certain unofficial “grey market” economic activity is not included in officialstatistics. Therefore, the calculated growth rates set out below may be significantly understated.

The following table sets out a breakdown of estimated GDP for the years 1999 to 2003:

1999 2000 2001 2002 2003*11111 11111 11111 11111 11111

Nominal GDP (HRK millions)............ 143,500 157,511 162,909 176,429 ∆189,908∆Nominal GDP (US$ billions) ............ 19.91 18.43 19.54 22.44 ∆27.4∆Real Growth Rate (%) ...................... (0.9) 2.9 3.8 5.2 ∆5∆GDP per capita (US$) ...................... 4,371 4,206 4,403 5.057 ∆6.2∆Annual Average Exchange RateHRK/US$ .......................................... 7,112 8,277 8,339 7,864 ∆6.81∆Source: CBS, CNB, Ministry of Finance

*January-July 2003

Economic developments in 2003

Despite a weaker external environment, domestic economic activity has remained strong amideasing inflation. Underpinned by strong investment, year-on-year real GDP was 5% in the first halfof 2003. In the first eight months, industrial production and retail sales volume grew by 5.5% and5%, respectively, compared with the corresponding period in 2002. The twelve month retail priceinflation rate fell from 2.3% at the end of 2002 to 1.6% in September 2003, with core inflation at0.9%.

The external current account remains weak, although recent data suggests some improvement.Preliminary third quarter data indicates record tourism receipts and slowing merchandise imports,suggesting that the current account adjustment is underway.

The CNB has tightened monetary policy in response to the widening external current accountdeficit. In addition to administrative credit ceilings1 introduced in January 2003, the CNB raised thelocal currency component of reserve requirements on banks’ foreign currency liabilities to absorbHRK liquidity (see “Monetary policy” below). In response, money market interest rates rose fromsome 4.5% to 9% in mid-September, before easing to between 7% and 8%. The administrativecredit restraints have slowed credit growth to an estimated 12.75% during the first eight months ofthe 2003, compared with 20.5% in the corresponding period in 2002.

The twelve –month growth of corporate credit slowed considerably from 20.5% at the end of 2002to 5.25% in August 2003, while the growth of household credit moderated from 43% to 31.5% inthe same period.

Fiscal performance has improved and prospects for the general Government deficit target of 4.6%of GDP in 2003 being achieved are good. After a temporary reduction in revenue collections in thesecond quarter, preliminary data for central government revenue collections in the third quartershows a strong resurgence for practically all categories.The revenue shortfall in the second quarterwas largely attributable to three factors: (i) an overestimation of the effect of broadening the basefor social security contributions; (ii) a greater-than-expected loss of customs duties due toimplementation of trade agreements2; and (iii) a reduction in non-tax revenue. Total expenditureduring the first half of the year was in line with projections. The wage bill exceeded the projectedlevel mostly due to slower terminations and higher severance payouts in the defence sector3. This

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1 Banks with credit growth of over 4% per quarter are required to purchase CNB bills at penalty interest rates for twice theamount of the excess. At the same time, banks are required to raise their short-term foreign exchange liquidity requirementsto at least 35% of their foreign exchange liability by the end of March 2004.

2 Croatia has been implementing tariff reductions according to its trade agreements with the WTO, EU, CEFTA, and bilateralpartners. These agreements cover more than thirty countries.

3 By June 2003, employment in the military sector had been reduced by around 5,500 personnel, some 3,000 less thanplanned. By 31st December 2003, military sector employment is expected to be reduced by another 3,000 personnel. Asa result, employment will have been reduced by around 2,000 less than originally planned. However, an additional 3,000people are expected to be made reservists at 60% of their previous pay.

was offset by (i) lower spending on goods and non-wage services; (ii) savings on interest paymentsresulting from low interest rates and US dollar weakness; and (iii) fewer subsidies due to a drought-related decrease in agricultural production. Recent data suggests that spending remains in linewith projections, although highway construction costs are larger than expected.

Parliament adopted new bankruptcy, company, competition, and labour laws in July and 24 morelaws aimed at harmonising domestic legislation with EU standards in September- October 2003.

Principal Sectors of the Economy

Overview

Croatia has a relatively modern diversified economy with services accounting for around 60% ofvalue added. Agriculture accounts for only around 10% of output and industry accounts for theremainder. The country is not overly dependent on any one economic activity.

Tourism

One of the reasons Croatia’s service sector is larger as a percentage of GDP than in most othertransition economies is because it has a long tradition in tourism. From official GDP estimates andCNB data, tourism generated revenues of 17.1% of GDP in 2001, 17.0% in 2002 and 15.0% by30th September 2003. Although tourism revenues are growing, their share of GDP is reducing dueto the growth in GDP in recent years. This proportion is in effect much higher since a large part oftourism revenue is unrecorded. Many people employed in the tourism industry are not officiallyreported as such, which also indicates that tourism revenues as a percentage of GDP are higherthan recorded.

The Croatian tourism industry has a number of issues to deal with in the coming years. There hasbeen a shortage of investment in the industry, so that most tourism infrastructure is ageing oroutdated. There has been a dearth of privatisation in the industry since independence, not leastbecause the war years were not conducive to privatising hotels and similar assets. Recently,foreign investors have entered into partnerships or bought hotels in Istria and along the DalmatianCoast. With the part privatisation of Croatian Telecom and INA (see “Privatisation of Utilities(including Oil and Gas)” above) ushering in a new era in privatisation in Croatia, the Government’saim is to accelerate the privatisation of hotels.

Between 1997 and 1998, earnings from tourism grew from US$2.52 billion to US$2.73 billion. In1999, tourism earnings fell 8.8% compared to 1998. This was a result of the conflict in Kosovowhich caused tourist night and visitor entry to decline by 15% and 12% respectively. Touristovernights rose 44.5% in 2000 and 10.8% in 2001 with a growth of 3.0% in 2002. Revenues fromtourism exceeded US$3.3 billion in 2001, and in 2002 they amounted to US$3.8 billion whichrepresented an increase of 14.3%. In the first 3 quarters of 2003, revenues amounted to US$4.1billion.

2003 has seen exceptionally good performance in tourism, pointing to an improvement of thissector. Total tourist nights rose by 7.7% in the first 6 months of 2003, compared with the sameperiod in 2002, with a 7.9% growth in gross value added. Apart from the increased number oftourists, 2003 saw a growth in prices at tourist facilities. Thus, in the first six months the prices oftourist nights rose by 10.1% compared with the same period in 2002, resulting in an overall pricegrowth of 5.6% in catering for the same period. Despite the very low increase in the overall pricelevel, the rise in tourist services prices resulted from a greater investment in tourist facilities andthe focus on attracting high spending, sophisticated tourists. This led to an improvement in touristservices, and, accordingly, to improved financial results which, as confirmed by the preliminaryestimates of revenues from tourism in the balance of payments for the first half of 2003, are notonly as a consequence of the growth of physical indicators. The increase in prices also affected thesource of tourists. The increase in the total number of tourist nights in the first six months of 2003was mainly due to increased numbers of tourists from Germany (6.8%), Italy (19.8%), and Austria

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(8.1%). In addition to this, a sharp increase was recorded in the number of tourists from lessrepresented countries like Hungary, the Netherlands and France.

The following table illustrates that, while the services sector is generally the first to suffer in anydownturn, it is also generally the first to recover.

1999 2000 2001 2002 2003*11111 11111 11111 11111 11111

Total Tourist Nights (thousands) ...... 27,125 39,183 43,404 44,688 ∆46,033∆Domestic .......................................... 5,241 5,138 5,020 4,975 ∆4,977∆Foreign.............................................. 21,883 34,045 38,384 39,714 ∆41,026∆Tourism Earnings (US$ billions) ...... 2.49 2.76 3.34 3.82 ∆4.1∆Sources: CBS, CNB

*January-November

Industry

Industry generally accounts for approximately one-fifth of GDP and employs around one-quarter ofthe labour force. The largest sectors within industry in terms of production are electricalengineering, foodstuffs, chemicals, textiles, wood processing and shipbuilding. GDP figures for theindustry sector are combined with the mining sector which includes energy production (see“Energy” below). There is now more direct, as opposed to subcontracted, production of textiles andfinished goods, pharmaceuticals, machinery equipment, shipbuilding, communications equipment,food and beverages.

Croatia’s industrial sector produces both finished goods and intermediate goods (i.e. raw materialsand semi-finished products). This is a major difference from former Eastern Block economies thathave concentrated solely on the production and export of primary products. Croatia’s closeproximity to major western European markets made it an attractive sub-contracting country forwestern European manufacturers in the 1970s and 1980s, especially in Germany and Italy,although this has declined during the 1990s as wages have increased, in particular in comparisonwith other textile producing countries.

In 2002, industry (which includes mining, manufacturing and electricity, gas and water supply) wasthe largest production sector, with gross value added growing by 4.0% in real terms. The totalvolume of industrial production grew by 5.7% in 2002 compared with 2001. The highest annualgrowth rate of 8.3% was recorded in intermediate goods. Production of capital goods, as well asdurable and non-durable consumer goods, grew at the average rate of growth in the total industrialproduction, with modest growth recorded in energy supply.

In the first quarter of 2003, gross value added in industry rose by 4.8%, compared with the sameperiod in 2002, and continued to increase in the second quarter when the year-on-year growth ofgross value added reached 7.7%. Total volume of production in industry followed the developmentsin gross value added. On the whole, the second quarter saw the strongest growth in production in2003, with a 6.9% annual growth in the index of the total volume of industrial production. Thesummer months saw a further slowdown in industry, so the cumulative annual growth rate ofindustrial production was 5.7% as at the end of August 2003.

Industrial production developments were different for each industrial activity. According to the mainindustrial groupings, industrial production of non-durable consumer products grew strongly, whileproduction of capital goods stagnated. The growth in production in manufacturing and electricity,gas and water supply was equally strong. Mining and quarrying was the only industrial activity,showing a downward trend in 2003. High growth in production was recorded in electricity, gas andwater supply. In the first eight months of 2003 energy supply increased by 6.4% compared with thesame period in 2002. Manufacturing, which accounted for the largest share of total industrialproduction, also recorded a significant increase of 6.2% in the first eight months compared with thesame period in 2002. The food and beverages division accounted for the largest share of

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production in manufacturing, due to international market expansion, development of domestictrading activity and the growth of personal consumption.

The following table shows the yearly average growth in industrial production by main manufacturingsectors between 1999 and 2002. Figures are shown as an annual average index against 1995levels of production (1995 = 100.0):

1999 2000 2001 200211111 11111 11111 11111

11111

Total Industry .............................................. 112.6 114.5 121.3 128.0Capital Goods ............................................ 108.7 116.5 134.2 139.7Intermediate Goods, Except Energy .......... 108.6 112.6 117.3 127.0Energy ........................................................ 145.0 141.5 145.9 148.3Durable Consumer Goods.......................... 141.9 136.5 129.9 135.1Non-durable Consumer Goods .................. 102.9 104.1 112.0 118.0∆Source: CBS

Agriculture, Forestry and Fishing

Croatia is generally self-sufficient in agricultural products and the country’s most fertile land is inEastern Slavonia. Croatia had been a net exporter of food products prior to 1991.

Agriculture

Croatia is a country of rich natural resources – unpolluted, good quality fertile soil, mild climate andabundant water resources. More recently, the importance of agriculture has been recognised notonly due to its traditional significance relating to the necessity of providing sufficient food for thepopulation, but also due to its role within the framework of efforts aimed at maintaining the ruralenvironment, ecological balance, cultural and traditional values. The Croatian farming sector isrelatively sophisticated with a high degree of mechanisation, in contrast to many other parts ofCentral Europe. The Act on Ecological Production of Agricultural and Food Products, which isharmonised with the EU Directive on organic farming, has provided the standard for marketorganisation and the production of ecological products.

Agricultural activity accounted for 9.97% of GDP and had accounted for 11.8% of exports in 2002.Approximately 10% of the population of working age earn income from agriculture. The mostimportant products in agri-export in 2002 were cigarettes (US$90 million), fish and products(US$51 million), sugar (US$40 million), ‘Vegeta’ food seasoning (US$27 million), wheat (US$21million), and corn (US$17 million). In 2002, the highest exports were recorded since theindependence of Croatia. Agricultural activity recorded a fall in the first half of 2003 due to adverseweather conditions. In the first quarter of 2003, gross valued added in agriculture declined by 1.1%in real terms compared with the same period in 2002, while the second quarter saw an 8.0% falldue to the drought.

Forestry

Croatia has approximately 2.5 million hectares of forested land supporting a substantial forestproducts industry which includes pulp and paper, furniture and sawn timber. Forests in Croatiahave an economical, ecological and social function and therefore have a substantial impact on thequality of living. There are 60 different forest species that add to the richness of the diversifiedterritories comprised of Adriatic Sea, sub-mountain territory and Panonian valley. Croatian forestsare internationally recognized due to the fact that 95% of the forest land is naturally preserved andalso its diversified flora and fauna, which are the result of a forest tradition that is over 150 yearsold. Approximately 81% of Croatia’s forest and forest land is state-owned. The bulk of Croatia’swood production is hard wood, including beech and oak; of importance in this sector is Slavonianoak, traditionally one of the two main European sources for wine barrels.

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Fishing

Fishing and catching sea organisms together with breeding and processing represent rare sectorscharacterised by growing exports, favourable foreign currency balance of payments and a growingshare in the country’s total domestic product. The majority of fishing activities take place in theareas characterised by difficult economic conditions (including the islands) where the majority offishing, processing and breeding facilities are situated. It is suggested that the fishing industryrepresents one of the most significant factors in maintaining the population on the islands and insustaining life on the islands in general.

In accordance with strategic and programme guidelines, activities including construction andmodernisation of the fishing fleet, construction of harbours with adequate logistics andinfrastructure for fishing ships, implementation of ambitious aquaculture developments, and theestablishment of an organised system of collecting, trading and transporting fish and other fishindustry products are being undertaken. The immense but still unexploited fish and shell-fishbreeding potential, which is characterised by a significant increase in production, has beenrecognised. Simultaneously, preconditions for the improvement of the versatility and quality ofproducts have been completed as well as preconditions for further increases in productionsupported by high environmental protection standards.

Due to the widening of the national jurisdiction in the Adriatic, by means of which Croatia claimssovereign exploitation rights, protection and upgrading of the entire sea potential in the area underits jurisdiction, and the synergy of tourism and the Adriatic development orientation, it has becomeapparent that the fishing industry will become a significant element in the sustainable developmentof the coastal regions and the islands of Croatia and that it should play a decisive role in theprocess of forming Croatia’s Mediterranean identity and developing its recognisable image as afuture member state of the EU. The implementation of the identified objectives requires strongfinancial support from various sources, such as incentives for reconstruction and development,especially those for the development of the islands, upgrading of the food production industry,promoting tourism industry supply and self-employment. Support from various Europeandevelopment funds is also expected, which it is hoped will recognise the advantages of favourableclimate and ecological conditions in Croatia’s sea and coastal areas.

Construction

Despite reductions in capital expenditure by the Government that led to a contraction ofconstruction activity in 2000, growth of 3.6% during 2001 indicated positive signs for a recovery inthe industry. This was evident in 2002 when in addition to an increase in house building, the RoadConstruction Agency intensified works on toll highway construction, which led to a 12.8% increasein construction works in 2002 in comparison with the same period in 2001. The trends inconstruction were even more favourable in 2003. This was primarily the result of an increasedinvestment in road infrastructure, but also in the construction of buildings. Given the strong impactof seasonal factors on construction, an annual growth rate of 18.8% was recorded in the firstquarter of 2003. The second quarter showed an exceptionally high rise in the index of total volumeof construction projects of 28.7% compared with the same period in 2002. This trend wascontinued at the beginning of the third quarter of 2003.

On occasion, imported labour has been used to make up for the shortage of domestic workers inthe construction sector. Due to changes in the methodology for calculating the effective hoursworked and changes in the scope of data collected for this calculation, figures from 1998 onwardsare not comparable with those of previous years.

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The table below sets out the Total Volume Index of Construction projects undertaken in Croatiafrom 2001 to 2003:

2001 2002 2003*11111 11111 11111

Total Volume Index of Construction ........................................ 103.8 117.1 144.5*January-October 2003

Source: CBS

Transport and Communications

In the last few years, gross value added in transport, storage and communication grew steadily atthe rates exceeding the total average in all activities. Such trends continued into 2003, and evenstrengthened a little compared with 2002. Gross value added rose by 7.3% in the first quarter of2003 compared with the same quarter in 2002 and by 8.4% in the second quarter compared withthe second quarter in 2002. The strongest growth was recorded in telecommunications services,particularly the mobile network utilisation which is represented by two mobile phone networks,Cronet and VIPnet. (See “Telecommunications” below).

Railway and Urban Transportation

Mass transportation is the predominant mode of urban and inter-urban transportation in Croatiaand is regulated by the Government. Services are provided in Zagreb and other cities through tramsystems and bus networks. The Croatian State Railway operates trains between all major cities inCroatia and connects Croatia’s major ports with neighbouring Central European countries. Itcurrently has 2,726 kilometres of rail track, of which approximately 36% is electrified. Much ofCroatia’s track and rolling stock is in need of improvement. Zagreb is the hub for all train travel inCroatia.

In 2003, Croatian Railways made significant breakthroughs in its five year restructuring andmodernisation project, the value of which exceeds HRK15 billion. The company restructuringproject has reached its final phase and in the past five years the number of employees has beenreduced from 20,688 to 14,989. In the infrastructure sector, a major overhaul of 140 kilometres ofrailway-tracks has been finished. Almost 60% of works planned on the Zagreb – Split line havebeen completed and by the summer of 2004, after the delivery of eight ‘Tilting’ trains, expected by15th June 2004, Zagreb and Split will be connected by a train journey lasting less than five hours.

In 2003, 14 passenger cars were refurbished and by the summer of 2004, 36 additional passengercars will be refurbished to meet the requirements of high comfort standards including air-conditioning.

Croatian Railways became a member of the Community of European Railways (“CER”) on 30September 2003. Membership of the CER enabled easier access to European investment funds,providing money for projects in railway modernisation and reconstruction. Therefore, CroatianRailways expects future assistance from the CER in the realisation of its modernisation project.Croatian Railways’ membership of the CER also necessitates the modernisation of railway-tracksand rolling stock as well as adjustments needed to meet the strict technical requirements of theCER in order to enable other railway transporters to use its rolling stock on Croatian Railways’tracks. Membership of the CER is a significant achievement because admitting railway enterprisesfrom non-member countries and non-EU candidate countries is not standard practice.

Roads

Croatia has 28,009 kilometres of hard surfaced roads, including 413 kilometres of motorways. Thedevelopment of roads is a high priority for the Government in order to realise Croatia’s potential asa transportation hub. Within the framework of the implementation of the Public Road Constructionand Maintenance Programme 2001 – 2004, 460 kilometres of new motorway network sections and

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81 kilometres of new semi-motorway sections are planned for construction, of which 410kilometres of motorway sections are to be constructed by Hrvatske autoceste d.o.o., and 50kilometres of motorway and 81 kilometres of semi-motorway sections by concessionaires.Motorways linking Hungary, Zagreb and Rijeka, the biggest port in Croatia, as well as a motorwaylinking Zagreb, Karlovac, Split and Dubrovnik, are currently under construction. A 138.5 kilometremotorway and semi-motorway network was opened to traffic by 30th June 2003. Since 2000, 1,000kilometres of state roads have been renewed and 250 kilometres of the state roads have beenbuilt. The aim of the Government is to achieve the same standards of maintenance of state roadsas those in the countries of European Union. A motorway from Italy to Greece encompassingRijeka and Dubrovnik is being planned.

Since 1st January 2002, public roads are no longer financed by all tax payers from the statebudget. Instead, they are financed by their users from fees included in the price of fuel, tollscharged for the use of highways and other fees charged for the use of public roads, whichrepresent direct income of entities in charge of public road management.

The financial construction cost for each project is fully completed and payments effected at the duedate so none of the cost is financed out of the state budget.

Works involving road infrastructure enabled full employment of construction experts, designexperts and other experts as well as the employment of large numbers of workers.

All Government plans concerning road infrastructure are implemented exactly according toenvisaged dynamics, funds and deadlines. Progress in the quality of road infrastructure reducedthe number of accidents generally, particularly fatal ones.

Shipping and Ports

The Adriatic is Croatia’s most important natural resource and sea ports represent an importantelement in the process of reviving the transport of goods and the entire economy in Croatia.

The Maritime Act and the Maritime Ports Act of the Republic of Croatia and the new Maritime Codeand Seaport Act passed in 2003 aimed at separating the management and economic utilisation ofmaritime ports was successfully accomplished during 2003.

Port authorities have assumed the role assigned to them by the above mentioned laws and arenow the driving force within the framework of investment cycles in ports open for public traffic. Inaddition, more than HRK380 million was invested in the renewal and modernisation of port facilitiesover the past four-year period. This included the construction of 2 container bridges in the port ofRijeka, increasing the capacity for loading and unloading cargo at Rijeka, and the modernisationof the bulk cargo terminal in Bakar.

Almost all port authorities have been privatised and granted concessions. The process is not yetcomplete in the Port of Ploče and the Port of Split.

The systems of port management now in place are compatible with European and world systemsand have already produced favourable developments in port management in Croatia. Thesesystems are important to the Croatian and international traffic management systems.

Air Transportation

Croatia has seven airports for regular traffic, five of which handle international air traffic, and twosmaller airports. The national airline, Croatia Airlines, maintains regular connections with 14European countries. Since 1991, Croatia Airlines has modernised its fleet operating on bothinternational and domestic routes through the purchase of Western made airplanes and withtechnical assistance from Lufthansa. In September 1994, the EBRD granted Croatia US$22 millionto upgrade its air traffic facilities. In 2002, the BAe 146 (popularly called “Jumbolino”) wasintroduced to the Croatia Airlines fleet. This brought the total number of aircraft in the fleet, which

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is one of the youngest in Europe, to 11 (one Jumbolino, three A320 Airbuses, four A319 Airbusesand three ATR 42 propjets). In 2002, 1.32 million passengers were transported, representing anincrease of 6.4% compared to 2001.

On 27th June 2001, Croatia Airlines became a member of the Joint Aviation Authorities (the “JAA”).The JAA is an associated body of the European Civil Aviation Conference representing the civilaviation regulatory authorities of a number of European states which have agreed to co-operate indeveloping and implementing common safety regulatory standards for safety and a “level playingfield” for competition in Europe.

Telecommunications

The telecommunications network in Croatia is operated by Croatian Telecom. In October 1999,Deutsche Telekom won an international tender, marking the biggest single privatisation transactionin Croatia’s history, for the right to buy 35% of Croatian Telecom. The final amount paid byDeutsche Telekom for its 35% stake was US$850 million. In October 2001, Deutsche Telekomacquired a further 16% stake in Croatian Telecom for e500 million. By the end of 2003, the numberof telephone lines amounted to 1,513,217.

In addition, there are two mobile phone licences in Croatia one owned by Cronet and the other byVIPnet. The Government received around HRK100 million for the sale of each licence. Pursuant tothe respective licence agreements, both Cronet and VIPnet are required to pay the Government anadditional HRK5 million each year until 2011 when the licences expire.

Energy

Croatia produces and utilises the following primary energy sources: hydroelectric power, crude oil,natural gas and coal. Its main mineral resources are oil and gas but these are insufficient to coverdomestic demand, and thus the country is dependent on imported energy. Croatia currentlyimports approximately 70% of its oil requirements. Through the state-owned electricity company,Croatia is joint owner with Slovenia of a nuclear power station at Krsko. Besides energy supply, theCroatian energy sector also includes the following activities:

• exploitation, production, transport and storage of crude oil and production of oil products

• exploitation, production, transport, storage and distribution of natural gas

• production, transmission and distribution of electricity and heat.

The reform of the Croati∆an energy sector started in 2001 and is comprised of restructuring,privatisation and changes in the overall energy sector and has a significant effect on thepossibilities of introducing and increasing the share of renewable energy sources (“RES”).

The most important step in the reform of the Croatian energy sector has been the establishmentof the new legal framework, harmonised with EU directives in respect of gas and electricity, whichcomprises a package of five pieces of legislation (Official Gazette 86/01) – the Energy Act, the Acton the Electricity Market, the Act on the Gas Market, the Act on the Oil and Oil Products Market,the Act on the Regulation of Energy-related Activities.

Restructuring of the energy sector is ongoing. The privatisation of INA was completed in July 2003with the sale of an interest equal to 25% + 1 share to MOL which invested US$505 million. Duringthe first ten months of 2003, INA recorded net profits in the amount of HRK1.33 billion,representing an increase of HRK235 million against the same period in 2002, whereas operatingincome amounted to HRK834 million representing an increase of HRK154 million. The expectednet profits for the full year 2003 are 50% higher than in 2002 and will amount to approximatelyUS$150 million. In 2003, INA invested US$290 million in the gas industry and US$120 million inpetrol stations, through which it is intended that turnover will increase by 14%. Refineries, the

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modernisation of which will be completed in 2007, have processed 11% more raw materials thanplanned, and in 2004 oil reserves are expected to double.

The majority of marketing-related activities are conducted by INA. Transport of crude oil ismanaged by Jadranski naftovod d.d. (“JANAF”), which delivers crude oil to Croatian and foreign oilrefineries. JANAF is the operator of the oil pipeline system designed and constructed in the periodfrom 1974 to 1979 as a modern, efficient and economical system of crude oil transport intendedfor local and foreign offtakers in Eastern and Central Europe. The designed capacity of the pipelineis 34 million tonnes per year, and the installed capacity is 20 million tones. The JANAF systemconsists of:

• a crude-oil handling terminal in Omisalj on the island of Krk and the Omisalj port

• a 759 kilometre pipeline, of which 610 kilometres passes through the Croatian territory, withthe following sections:

• crude-oil handling terminals in Sisak, Virje and Slavonski Brod (under construction) withstorage areas in Sisak (100,000 m3) and Virje (40,000 m3) and appropriate pumping andmetering stations

• a submarine oil pipeline Omišalj-Urinj connecting the port and the terminal of Omišalja onthe island of Krk with INA – Oil Refinery Rijeka on the mainland. The total length of thepipeline is 7 kilometres, of which 6 kilometres is laid under the sea.

Transport of natural gas is managed by PLINACRO d.o.o.. Both JANAF and PLINACRO d.o.o. are100% State-owned. Approximately 40 companies, mostly owned by their local communities, areactive in the distribution of natural gas. The generation, transmission and distribution of electricityis managed by HEP, presently a 100% State-owned company, which is to be privatised. In Croatia,electricity is generated by hydro and thermal power plants. In addition, Croatia’s 50% stake inKrško Nuclear Power Plant, which is located in Slovenia, is owned by HEP.

The Croatian energy sector is characterised by its majority State ownership, with the exceptions ofnatural gas distribution and retail sales of oil products.

In 2003, HEP invested about HRK2 billion in projects including a new, large gas block in a Zagrebthermal power plant-heating plant in Žitnjak, as well as two large 400-kV transformer stations:Ernestinovo near Osijek and Žerjavinec near Zagreb with accompanying transmission lines. Thesenew stations should significantly improve the electric power supply provided to Croatianconsumers, and in spring they should enable the connection of the divided electric power systemof the south-eastern Europe and the rest of Europe via Croatia.

For the time being only the 15 largest consumers who consume more than 40 gigawatt hours peryear can choose which company they wish to buy electric power from, but the decrease of this limithas already been announced.

The former vice-president of the Government and the president of the Supervisory Board of HEP,Mr. Goran Granic, has announced that by 2007, all consumers in Croatia, including households,shall have the opportunity to choose which company they buy the electric power from.Through this,Croatia should be ready for accession to the European Union in this field.

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The following table shows the mineral and energy output of Croatia from 1997 to 2002:

1997 1998 1999 2000 2001 200211111 11111 11111 11111 11111 11111

Total electricity power (GWh)(1)...................... 9,684 10,897 12,241 10,701 12,174 12,285

Hydroelectric (GWh)...... 5,298 5,465 6,592 5,892 6,585 5,432Thermoelectric plants

(GWh)........................ 4,385 5,431 5,649 4,809 5,589 6,853Coal mining (in

thousand tons)(2) ........ 48,5 50,8 15,3 - - -Petroleum production

(in thousand tons) .... 1,496 1,389 1,292 1,213 1,121 1,108Natural gas production

(in million m3)............ 1,717 1,570 1,550 1,658 2,010 2,120

Note:

(1) GWh = Gigawatt hour = 1 million kilowatt hours.

(2) Coal mining ceased as of October 1998.

Sources: Ministry of the Economy and CBS

Organised and systematic care for renewable energy sources began on the basis of NationalEnergy Programs, initiated in 1997 by the Government. Special attention has been given to thefollowing programmes:

BIOEN – programme for the use of energy from biomass and waste,SUNEN – programme for the use of solar energy,ENWIND – programme for the use of wind energy,GEOEN – programme for the use of geothermal energy,MAHE – programme for construction of small hydropower plants.

When new energy legislation and by-laws come into force in early 2004, the RES projects inCroatia will be provided with a stable legal framework and support through incentive measureswhich will recognise the value of environmental and other benefits of renewables. Following trendsin other European countries, Croatia thereby expects to provide for an expected growth of the RESsector.

The Government believes that Croatia is well placed to take advantage of the expected growth inthe RES sector, due to the quality of its technological resources. In addition, foreign consultantshave assessed that Croatia has highly skilled human resources. This is important for theimplementation of projects and for the expected future growth and the wider social role of RES.

It is hoped that the introduction of economic measures aimed at increasing the RES share in theenergy system and in the environmental improvement system in Croatia will produce effects at themacroeconomic level too. The number and volume of investments will hopefully gradually increasewhich should not only help the growth of investments in RES and the protection of the environmentbut should help towards achieving sustainable development as well.

The Government expects that the application of legal and institutional mechanics and economicmeasures for the segmented RES market within the energy market as a whole, primarily the RESUse Rules and the associated Decision on the Minimum Share of Renewable Sources in theelectricity generation mix used by the energy supply entity, and the Environmental Protection andEnergy Efficiency Fund, as well as other incentive measures, will improve the quality of the overalldevelopment of Croatia, accelerate the creation of preconditions for sustainable economicdevelopment, and directly contribute to the use of RES as a condition of sustainable developmentand healthy living in a preserved environment. The success of the energy reform in Croatia in thearea of RES use will primarily depend on the harmonisation of energy policy instruments used forthe market structuring and direct government influence. The Government believes that renewable

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energy is an integral part of sustainable global development. One of the development challengesfor Croatia is to use the liberalisation process in the energy market and the creation of neweconomic, financial, legal, organisational and overall economic environment, to give RES theopportunity to compete with other sources of energy.

The objectives and implementation strategy for any renewable energy source depend on thespecific characteristics of a particular renewable source and/or on the use programme. TheGovernment hopes for a significant increase in the share of renewable energy sources by 2030,which is in line with the general trend in EU countries.

The following table shows the energy production and forecasts (in thousands of tons of oilequivalent) for the years 1990, 1995, 2000, 2005, 2010 and 2020:

Statistics ForecastsYear 1990 1995 2000 2005 2010 2020

11111 11111 11111 11111 11111 11111

Primary energy production.................. 5482.4 4364.4 3834.3 3483.3 3494.1 3244.5

Solid fuels...................... 100.6 46.8 0.0 0.0 0.0 0.0Crude oil ........................ 2718.7 1757.3 1448.9 961.7 638.4 500.0Natural gas.................... 1799.2 1784.7 1505.3 1593.7 1687.3 902.3Nuclear energy.............. 0.0 0.0 0.0 0.0 0.0 0.0Hydro power and

wind energy .............. 322.3 452.7 506.6 549.3 597.2 709.3Geothermal energy ...... 0.0 0.0 0.0 0.0 41.6 114.2Other renewable

sources...................... 541.7 322.9 373.5 378.5 529.7 1018.7

Source: Energy in Croatia, Ministry of Economy

Environment

Since 2000, when The Ministry for Environmental Protection and Physical Planning (the “MEPPP”)was established in line with the move towards EU membership, Croatia has satisfied significantpreconditions for the protection of its preserved nature, diversity of landscapes and cleaner waters.The aim is to co-ordinate sound economic growth with a clean environment and well managedspace, in a way which enables every present and future citizen of, and visitors to, Croatia will beable to live comfortably and in good health.

Preservation of a healthy environment and well-managed space is a priority for Croatia’s future.The National Environmental Protection Strategy adopted by the Croatian parliament in 2002outlined the course for the preservation of Croatia’s natural heritage and created a legal frameworkfor its protection. In 2002, Croatia developed the National Waste Management Strategy, the newLaw on Waste and the Rule Book on Packaging Waste. Preservation of landscapes and naturalattractions, as well as space in its entirety, will be regulated by the Law on Spatial Planning, theBuilding Law and the Law on Remediation of Illegal Construction (when these laws are passed),which shall provide owners of buildings who have not formalised the legal status of their buildingswith the possibility to do so. The Government believes that continuous public education, particularlyof younger generations, is of the utmost importance for the successful protection of theenvironment and space. The recently established Information Centre of the MEPPP provides theopportunity to obtain, with assistance from experts, all information on the MEPPP’s activities,especially in relation to protected natural areas, nature parks and national parks, the options forrenewable energy sources and the correct management of waste.

With the establishment of new Ministries in December 2003, the Ministry for EnvironmentalProtection and Physical Planning was succeeded by a newly formed Ministry of EnvironmentalProtection, Physical Planning and Construction.

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Trends in Prices

The following table shows the rate of inflation in Croatia from 1999 to July 2003:

1999 2000 2001 2002 2003*11111 11111 11111 11111 11111

Retail Price Index– annual average percentage change 4.2 6.2 4.9 2.2 ∆1.3∆Producer Price Index– annual average percentage change 2.6 9.7 3.6 (0.4) ∆2.5∆

Note:

*January-July

Source: CBS; Ministry of Finance

The Croatian retail price index (“RPI”), used by the Government to measure inflation, is based onthe price of a basket of 455 goods and services whose weights are dependent on the structure ofthe total retail trade volume. It differs from the consumer price index (“CPI”) and cost of living index(“COL”) which are quoted by the IMF, in its “International Financial Statistics” series, in the way inwhich the weights are formed, adjustments for the changes in the quality and the treatment ofseasonal products.

As at the end of December 2002, the year-on-year inflation rate has remained below 3.0% for thesecond successive year, standing at 2.3% in December 2002, a decrease of 0.3% compared withDecember 2001. These trends in the aggregate retail price level are evidence of the CNB’scontinued maintenance of a low inflation rate.

Having reached 4.9% in 2001, the average-year-on-year growth rate of retail prices declined to2.2% in 2002, while the average year-on-year core inflation rate declined from 3.6% in 2001 to1.1% in 2002. Croatia has maintained a relatively stable level of prices for the tenth consecutiveyear, which further enhanced the credibility of the CNB. The CNB’s interventions in the foreignexchange market contributed to the stability of the Kuna/euro exchange rate, which is a crucialdeterminant of inflationary expectations in the heavily “euroised” Croatian economy. In addition,other factors which contributed to the stability of retail prices in 2002 include: the moderate wagegrowth, a decrease in tariff rates brought about by trade liberalisation, increased competition inretail trade and relatively low rates of change in producer prices for industrial products in Croatiaand its most important trading partners.

In the first eight months of 2003, the year-on-year inflation rate measured by the RPI, being themain indicator of macroeconomic stability, stood at 0.7%. Over the first two quarters of 2003,inflation decreased by 1.2%, i.e. from 2.3% in December 2002 to 1.7% and 1.1% at the end ofMarch 2003 and the end of June 2003 respectively. According to the CBS data, in August 2003inflation again reached the level of 1.7%, the same as at the end of the first quarter. The increasein the aggregate level of retail prices over the first eight months in 2003 was as low as 1.0% andwas slower than in the same periods in the previous years.

Another indicator of price developments is core inflation, calculated by excluding the most volatilecomponents (such as agriculture product prices) and administratively set prices (such as energyprices which participate with a significant share) from the basket of goods and services used in thecalculation of the RPI. Since December 2001, the year-on-year core inflation has been lower than2.0%, while in the first eight months of 2003 it remained below 0.6%. Volatile developments in theyear-on-year inflation rate measured by the RPI during 2003 can be mainly attributed tofluctuations in crude oil prices on the global market, which affected the trends in the domesticrefined petroleum prices, products prices, and to dry weather conditions.

Labour Situation

Unemployment increased between 1998 and 2000 partly as a consequence of the demobilisationof military forces as well as the restructuring process. However, faster economic growth resulted in

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a decrease in unemployment in 2001, 2002 and 2003, and the Government believes that if suchgrowth continues in the next few years, together with the rebuilding of industry and infrastructureand the growth in tourism, employment figures should continue to increase and have a continuingbeneficial effect on the unemployment rate in the future. It recognises, however, the need for thelabour market to be flexible in order to react to opportunities presented by a changing economyand the importance of training personnel for employment under such conditions. The Act onChanges and Amendments to the Labour Act that envisage more flexible solutions came into effecton 19th July 2003.

The changes in the labour market in 2001, which resulted in a growth of total employment recordedby the CBS for the first time in the last decade, were a sign of an upturn in employment thatcontinued in 2002. For the second consecutive year, growth in the levels of employment wasrecorded, amounting to 0.6% in 2002. Early in 2002, registered unemployment also started todecline. This decline accelerated in the second half of 2002, particularly towards the end of 2002.Although employment growth was one of the reasons for registered unemployment, employmentintermediation reform was the key factor for its accelerated decline. Such developments wereencouraged by strong economic growth and a continuation of the restrictive wage policy in thepublic sector, which reduced the pressure on the wage in other sectors. As a result of the growthin employment in 2002, registered unemployment declined, unlike in the previous years.

In the second quarter of 2003, the strong impact of economic expansion continued. At the sametime, registered unemployment continued to fall at a faster pace than the growth of employment inthe second quarter and the first two months of the third quarter, due to employment intermediationreform.

A sharp fall in the number of persons registered with the Croatian Employment Institute was themain determinant of the registered unemployment rate. At the end of August 2003, registeredunemployment was around 2.0% less than in the same period in 2002.

The beginning of 2004 was marked by the introduction of more restrictive regulations of the LabourAct relating to the duration of the notice period and the amount of redundancy pay for laid-offemployees. Through amendments to the Labour Act passed this summer, the duration of noticeperiods was halved. Depending on the employment duration of a redundant employee, noticeperiods shall now range from two weeks to a maximum of three months. Shorter notice periods areaccompanied by lower redundancy pay. Instead of half net salary for every year of employment withone and the same employer, laid-off employees shall receive one third of gross salary for everyyear of employment with the same employer. Furthermore, the maximum amount of theredundancy pay shall not exceed the amount of six years’ gross annual salary, whereas matureage employees shall be protected by receiving one-off compensations from employmentinstitutions.

According to preliminary CBS data, administrative employment indicators point to a seasonalgrowth, which is customary for the summer months, and to continuation of the upward trend thatstarted in 2001.

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The table below shows the state of the labour market since 1998:

Rate ofTotal Unemployment

Employment Unemployment (%)111111 111111 111111

1998 .......................................................................... 1,366,125 302,371 17.51999 .......................................................................... 1,333,123 341,730 19.472000 .......................................................................... 1,321,476 378,544 21.382001 .......................................................................... 1,340,504 395,141 22.002002 .......................................................................... 1,351,364 366,162 22.282003* ........................................................................ 1,381,796 314,228 20.17

Note:

*January-July 2003

Source: Ministry of Finance; CBS

Subsequent to the removal of the restrictions on the wage bill for public administration,implemented from late 2000 to mid-2002, the average real gross wage paid in the public sectorrose in the third quarter of 2002, having decreased by approximately 7% in real terms over twoconsecutive years. The average real gross wage in public administration and defence andcompulsory social insurance rose by 3.1% in the last quarter of 2002. While wage policy in thepublic sector became less restrictive in the second half of 2002, wages in industry grew at anaccelerated rate of 7.6% in real terms in that period. Brought about by heightened economicactivity, this growth rate outstripped the rates from the previous years. However, the growth of grosswages in industry was somewhat lower than the growth of productivity in industry and is thereforeunlikely to result in significant inflationary pressures.

In the second quarter of 2003, wage growth slowed down again following the rapid growth over2002. The slower growth of real wages was mainly attributable to a slowdown in nominal wages.However, a slight increase in the cost of living contributed to a slower growth of wages in thesecond quarter. Beginning in 2003, personal tax deductions were increased, which has broughtaverage net wage increases without raising labour costs.

When analysing average monthly wages, it should be noted that some private enterprises mayunderreport wages by registering employees at the minimum wage. This may have a significantimpact on the official average wage level, as shown in the following table. Since wages in theprivate sector have not been limited by the Government’s income policy, their true values mayexceed the real average wage.

The following table shows average wages in Croatia for 1999 to 2003. Figures are net of incometaxes and social security contributions.

1999 2000 2001 2002 2003*11111 11111 11111 11111 11111

Average monthly gross wages and salaries in HRK ............................ 4,551 4,869 5,061 5,366 5,574

Average monthly net wages and salaries in HRK ............................ 3,055 3,326 3,541 3,720 3,910

Net wages and salaries in US$(av. exchange rate) .......................... 429 401 424 473 574

* January-∆July∆2003

Source: CBS

Social Security System

The Social Security System in Croatia consists of the Health Care Fund, the Pension and DisabilityFund and the Employment Fund.

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The funds collect their revenues through payroll contributions and from transfers from centralGovernment. Although the funds have responsibility for their own budgets, the Ministry of Financeis required to supervise their budget preparation and the performance of the funds and providereports to the Parliament. The pension system has undergone reforms (see “Pension Reform”below) aimed at improving its long-term viability, while the authorities are working together with theIBRD with the aim of improving the level of service provided and the cost effectiveness of the healthsystem.

In July 1998, Child Benefit contributions of 2.2% were abolished as part of certain changes to thetax regime. Child Benefits are now paid directly from the central budget. At the same time, thecontribution for the Water Management Fund of 1.8% was also abolished.

Pension Reform

Croatia’s pension system operated on a pay-as-you-go basis until the end of 2001. The funds heldby the pension fund were not sufficient to meet the future pension obligations of current employeesdue to the ageing of the population and an extraordinary increase in the number of beneficiariescaused by the 1991 war and declining economic activity between 1991 and 1993. The Governmenttherefore implemented a staged pension reform that follows a “three pillar approach”.

A new Pension Law, which is primarily focused on redesigning the first pay-as-you-go pillar, wasadopted by the Parliament in July 1998. As part of these changes, the retirement age was raisedto 65 years for males and 60 years for females and many of the provisions curtailed as a first stepto reforming the overall system.The first pillar is a modified pay-as-you-go system that will continueto pay full benefits to those above the relevant cut-off age (which is set at 40 years of age), but withsubstantially lower benefits paid to those below the relevant cut-off age. The second pillar is a fullyfunded system based on mandatory contributions from wages paid to individual accounts ofemployees below 40 years of age (people between the ages of 40 and 50 had the opportunity toelect whether they will be part of the first or second pillar). Contributions are collected at the samelevel as previously but on the basis that, for each 19.5% of wages paid as contributions, 5% iscontributed to the second pillar with the remainder to the first pillar. Pension funds managing thecontributions to the second pillar are permitted to invest such contributions in debt and equitysecurities. Although initially investments were primarily in debt securities (including governmentdebt), it is planned to increase the proportion of equity investments over time. The second pillar ofpension reforms, marked by the enactment of the Law on Mandatory and Voluntary Pension Funds,commenced on 1st January 2002. The third pillar is a voluntary private system, fully funded byvoluntary employee or employer contributions. Currently, there are 4 voluntary and 4 mandatorypension funds in Croatia.

The yield of obligatory pension funds amounts to 5% for 2003. Two years ago, calculations weremade on the basis of actual yield of 2.5 to 3%. Such funds have therefore outperformedGovernment expectations. Globally speaking, both obligatory and voluntary pension fundsoperated well and investment policy developed within the recommended and prescribed structure.In December 2003, with the 31st session of the Council of the Agency for Supervision of PensionFunds and Insurance – Hagena, the Croati∆an pension reform was completed. The approvals forthe establishment and management of three closed voluntary pension funds (RBA closedvoluntary pension fund, closed voluntary pension fund “Novinar” and AZ VIP closed voluntarypension fund) have also been given.

Assets of obligatory pension funds as at 30th November 2003 amounted to HRK4.43 billion,whereas the assets of voluntary pension funds amounted to HRK18.2 million. About 88.75% ofassets of obligatory pension funds were invested in Croatia, and 11.25% abroad. 63.29% of assetswere invested into government bonds. This percentage is expected to fall, meaning moreinvestments will be made into other securities. At the end of November, obligatory funds had 1.06million members, and in voluntary funds there were approximately 6,000 members.

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FOREIGN TRADE AND INTERNATIONAL BALANCE OF PAYMENTS

Outline of Foreign Trade and International Balance of Payments

Foreign Trade

Croatia conducted extensive trade in a wide variety of goods with Western countries before itsindependence. Croatia’s exports were able to compete internationally in a range of industrialsectors, including electrical engineering, pharmaceuticals and shipbuilding and had attractedsubcontracting business from Western European companies. Due to the need for reconstructionand restructuring, merchandise imports have grown faster than merchandise exports.

1999 2000 2001 2002 2003*(US$ millions)

111111111111111111111111

Merchandise exports, fob ................ 4,303 4,432 4,666 4,899 5,100Merchandise imports, cif .................. 7,799 7,887 9,147 10,713 11,500Trade balance .................................. (3,496) (3,455) (4,481) (5,815) (6,400)

*January – October 2003

Source: CBS

Trade Policy

The strategic goals of the Government with respect to trade agreements have been entry into theWTO, EU membership and membership of CEFTA. The application to join the WTO was filed inOctober 1993 and, in December 2000, Croatia became a full member of the WTO. Croatia’snegotiations with the EU on trade and co-operation agreements (the first step for entry into the EU)were temporarily suspended in August 1995, after Croatia’s military action to re-establish controlover the rebel Croatian Serb-held areas. However, the relationship with the European Union hasshown significant progress since 2000. The Croatian Government has promised to speed up thereturn of refugees, co-operate fully with the Hague International War Crimes Tribunal and to followthe Dayton Accords as agreed. The SAA, a framework offering many of the benefits of anAssociation Agreement, was signed in May 2001 and ratified by the European Union Parliament inNovember 2001 (see “International Relations” above). Croatia has also signed and applies freetrade agreements with EU countries (15), Slovenia, Macedonia, Bosnia-Herzegovina, Bulgaria,Romania, Hungary, Czech Republic, Slovakia, Poland, Albania, Slovenia, Turkey, Lithuania andEFTA countries. Free trade agreements have also been signed but are not yet fully ratified withSerbia and Montenegro. Agreement on CEFTA membership accession was signed in December2002 and Croatia became a full member on 1st March 2003.

In line with the requirements of the WTO, the Government has reduced the levels of tariffs whichpresently range from 0% to 25%, depending on the item imported. About 85% of imports are taxedin the range of 0% to 5% and a further approximately 10% are taxed between 5% and 10%. TheGovernment also equalised excise tax imposed on the foreign and domestic products.

Since 1994, the Government has been gradually reducing import quotas. In July 1996, all importquotas were abolished. However, export quotas are still imposed on crude oil, natural gas, crudetimber, raw leather, glass and newspaper waste (0.5% of the total number of tariff items). TheGovernment is planning to simplify the taxation system further in the sphere of custom duties.

Recent Trends in Foreign Trade

Details of Imports and Exports Classified by Goods and Regions

Composition of Trade. Imports of machinery and transport equipment, mainly in connection withthe ongoing programme of motorway construction, has remained relatively high in comparison toother import categories. In 2000 imports rose by 1.1%, mainly as a result of renewed economic

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growth. In 2001, imports grew by 16.0%, due to lower tariffs and therefore lower import prices,resulting from WTO accession, a significant increase in retail trade adding to the demand forimports, significantly increased imports of equipment and machinery and the abolition of customsduties exemptions for veterans on motor vehicles, which came into effect on 1st June 2001.

International transactions in 2002 were marked by deterioration of the merchandise trade balance.Goods exports, in terms of US dollars, amounted to US$4.9 billion, an increase of 5%, while goodsimports reached USD 10.7billion, an increase of 17.1%.

In the first ten months of 2003 commodity imports reached US$11.5 billion , while the export levelamounted to US$5.1 billion setting the foreign trade deficit to US$6.4 billion (125.5% of the 2002deficit). Import -export ratio for the first ten months of 2003 was 44.5%. In the same period exportof energy (39%) and capital goods (35.5%) increased significantly. Data for this period is notsuitable for comparison due to the fact that almost 60% of the total commodity exchange isconducted with EU countries expressing value of trade in euro. Since statistical data is usuallydenominated in US dollars, every depreciation of the US dollar will have a significant impact on thevalue of the total export. Commodity exchange with EU countries amounts to more than half thetotal, and therefore, given that these contracts are denominated in euro, depreciation of the USdollar increases the value of the exports and imports denominated in US dollars. Italy, Bosnia-Herzegovina and Germany remain Croatia’s main export partners. In the first ten months of 2003most goods were imported from Italy, Germany and Slovenia.

The table below shows the commodity export and import exchange with EU countries for the firstten months of 2003:

Jan Feb Mar Apr May Jun Jul Aug Sep Oct(in thousands of US$)

222222222111111111111111111111111

Export............................ 403 564 496 429 523 551 544 426 490 687Import ............................ 760 1039 1154 1198 1310 1144 1375 973 1233 1320Trade balance................ -357 -475 -658 -769 -787 -593 -831 -546 -743 -633% covered .................... 53 54 42 35 39 48 39 44 40 52

Increase of 28% for the same period for values denominated in US dollars, and 8.3% in Kuna.

Increase of 31.9% for the same period for values denominated in US dollars, and 11.5% in Kuna.

Value of the US dollar against the euro had depreciated in the same period by 16.7%.

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There have been no major fluctuations in the composition of imports over the past five years,although the volume of imports, particularly of intermediate and capital goods, has increasedsubstantially. The following table sets out the composition of imports for the period 1999 to 2003:

1999 2000 2001 2002 2003*(% of total imports)

22222222211111111111111111112

Food and live animals ...................... 7.2 7.1 7.6 7.4 7.1Beverage and tobacco...................... 0.8 0.9 0.8 0.8 0.9Raw materials exc. fuel .................... 2.2 2.4 2.3 2.4 2.4Fuels and lubricants ........................ 11.0 14.5 12.9 12.2 ∆10.88Animal and vegetable oils and fats .. 0.3 0.2 0.2 0.3 0.02Chemical products ............................ 12.1 12.7 11.4 11.3 11.3Construction materials...................... 16.1 17.6 19.5 19.4 18.9Machines and transport equipment .. 35.0 32.6 33.9 34.4 36.5Miscellaneous manufactures ............ 11.8 12.0 11.4 11.7 11.8Other goods...................................... 3.5 0 0 0.1 ∆0.2

22222222211111111111111111112

Total .................................................. 100.0 100.0 100.0 100.0 100.02222222221111111111111111111222222222211111111111111111112

* January –October 2003

Note: Columns may not add due to rounding

Source: CBS

The following table sets out the composition of exports for the period 1999 to 2003:

1999 2000 2001 2002 2003*(% of total ∆exports)

22222222211111111111111111112

Food and live animals ...................... 6.8 6.2 6.9 8.0 8.5Beverage and tobacco...................... 2.4 2.5 2.6 2.7 2.6Raw materials exc. fuel .................... 5.6 5.7 5.2 5.6 5.5Fuels and lubricants ........................ 7.9 11.0 10.2 9.4 9.8Animal and vegetable oils and fats .. 0.2 0.1 0.2 0.3 0.2Chemical products ............................ 12.0 12.5 10.6 10.3 9.2Construction materials...................... 13.3 15.1 14.2 14.7 14.1Machines and transport equipment .. 29.3 27.0 29.3 28.5 30.5Miscellaneous manufactures ............ 22.5 20.0 20.7 20.6 19.4Other goods...................................... 0.1 0 0 0 ∆0.2

22222222211111111111111111112

Total .................................................. 100.0 100.0 100.0 100.0 100.02222222221111111111111111111222222222211111111111111111112


Note: Columns may not add due to rounding

Source: CBS

Direction of Trade. Prior to 1991, there were wide trade links between enterprises in the variousYugoslav Republics. Trade was diversified to a certain extent, with links with EU countries, inparticular Germany and Italy. These countries, together with Austria and Bosnia – Herzegovinaremain Croatia’s main trading partners. A boost for exporters came at the end of 2000 when theEuropean Union lifted tariffs and quotas on all goods except for fish, meat and wine.

In 2002, goods were mainly exported to the Western Europe (58.1%), and the majority of goodsimported were imported from Western Europe (64, 5%). Croatia’s imports exceeded exports withinthe commodity exchange with any of EU countries, with an exception of Monaco.

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Italy and Germany are Croatia’s most important foreign trade partners. Exports to Germanydecreased by 12% in the period 2001 – 2002. This indicates a decrease in Croatia’s internationalcompetitiveness. Exports of the Republic of Croatia to the developed countries reached 61.7% oftotal exports in 2001 while in the 2002 it only reached 58%. The reopening of the traditionally highconsuming markets of Croatian goods such as the former Yugoslavia and former USSR countries,as well as Middle East and North African countries is showing promising signs of growth in exportsin the forthcoming years.

The following tables list Croatia’s trading partners in respect of both imports and exports for theperiod 1999 to 2003:

Trading Partners — Imports (f.o.b.)1999 2000 2001 2002 2003*

(% of total imports)22222222211111111111111111112

EU 15................................................ 56.6 55.4 57.1 55.8 56.5Other European developed economies 2.6 2.4 2.1 2.0 1.8Other developed economies ............ 7.5 7.0 6.7 6.8 7.0Total developed economies .............. 66.7 64.7 65.9 64.5 65.3CEFTA .............................................. 13.8 14.8 14.8 16.0 16.7Other European developing economies 12.2 11.3 10.2 9.7 8Other developing economies ............ 7.3 9.1 9.0 9.8 8.7Total developing economies ............ 33.3 35.3 34.0 35.5 34.7

22222222211111111111111333331111

Total .................................................. 100.0 100.0 100.0 100.0 100.02222222221111111111111133333111122222222211111111111111333331111


Source: CBS

Trading Partners — Imports (f.o.b.)1999 2000 2001 2002 2003*

(%)22222222211111111111111111112

EU 15................................................ 49.0 54.5 54.1 52.7 55.05Other European developed economies 3.5 1.0 1.0 0.8 0.7Other developed economies ............ 4.4 4.6 6.5 4.6 6.15Total developed economies .............. 56.9 60.1 61.7 58.1 61.9CEFTA .............................................. 13.5 13.8 12.1 12.4 11.6Other European developing economies 19.4 17.9 20.5 21.7 22.5Other developing economies ............ 10.3 8.2 5.7 7.8 4Total developing economies ............ 43.1 39.9 38.3 41.9 38.1

22222222211111111111111333331111

Total .................................................. 100.0 100.0 100.0 100.0 100.02222222221111111111111133333111122222222211111111111111333331111


Source: CBS

Details of the International Balance of Payments

The balance of payments is compiled in accordance with the recommendations of the IMF. Datasources include: reports of the CBS, the Croatian Institute for Health Insurance, the Institute forPayment Transactions, banks, enterprises and the CNB, as well as research by the Institute forTourism. In 1998 and 1999 the CNB completely revised its Balance of Payment (“BOP”) statisticalmethodology. The first stage of the revision was finished in January 1998 and applies to Croatia’sBOP from 1993 to 1998. The second stage of the revision was completed at the beginning of 1999.These changes to BOP statistical methodology involve better coverage of tourism andtransportation services and new coverage of the short-term borrowing up to 90 days. Accordingly,data for tourism and transportation services from 1999 may not be fully comparable to that in theprevious years.

113

114

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CN

B

Balance of payments of the Republic of Croatia data are recorded in US dollars and domesticcurrency.

In 1998 and 1999, the current account deficit decreased sharply, with the merchandise trade deficitfalling substantially. In 2000, current account deficit was the lowest since 1994 and came in atUS$438.8 million (2.4% of GDP). Improved tourist revenues and increased transfers, along with afairly stable merchandise trade deficit, account for the improvement. In 2001, the current accountdeficit increased to US$741.2 million (3.8% of GDP) mainly due to an increase in imports. As aresult of deterioration of the merchandise trade balance and due to pronounced cross-currencychanges of the US dollar against the euro and kuna, the current account deficit in 2002 increasedto 7.2% of GDP. Deficit growth was caused by foreign trade liberalisation together with consumptionincrease triggered by credit expansion. In 2003, strong tourism revenues contributed to moderatingthe external account deficit. Based on preliminary data, the 2003 current account deficit isexpected to decline to 5.9% of GDP.

Foreign Direct Investment (“FDI”)

FDI is a key channel through which Croatia hopes to be able to intensify its economic integrationprocess. The dynamic effects of trade are expected to be largely achieved through FDI that bringscapital, technology, knowledge and opportunities for skills enhancement as well as regionalmarketing and distribution networks. It is expected that, from a macroeconomic point of view, FDIflows will become an important source of aggregate investment and external financing. Accordingto the IBRD, FDI flows are the most stable of all types of capital flows.

Foreign investments in Croatia are regulated by the Company Act. Foreign investors have the samerights, obligations and legal status within an enterprise as domestic investors. The Constitutionstates that rights acquired through capital investments cannot be withdrawn by law or any otherlegal act. It also ensures that there may be unrestricted repatriation of profits and free repatriationof capital on dis-investment after all legal obligations in Croatia have been met.

Since 1994, most investments have been in existing companies that were previously successfu∆l,i.e., investments were not directed towards new production facilities. Most FDI to date has beenconcentrated in a few large privatisations such as “Croatian Telecom”, “Pliva” (pharmaceuticalcompany), and three large banks (Rijecka banka, Splitska banka and Privredna banka Zagreb).The privatisation process resulted in a high share of foreign ownership in many sectors includingbanking (28% of total FDI between 1993 and 2001), transport, storage and communication(21.1%), manufacture of chemicals and chemical products (14.9%) and the manufacture of othermineral products (7.3%).

In 1998 net FDI inflows (sourced from Croatian balance of payment figures) amounted toUS$932.42 million, and reached US$1.47 billion in 1999, US$1.09 billion in 2000, US$1.56 billionin 2001 and US$980.51 million in 2002. In first six months of 2003 inflows to Croatia amounted toUS$990.65 million. On 30th November 2003, FDI had increased by another US$505 million whichcan be attributed to the sale of 25% plus 1 share of INA to MOL.

In the coming years Croatia expects to become more integrated into the European Union and itexpects to take further measures to increase FDI. The CNB conducts regular surveys of FDI. FDIincreased in 1998 and, up to 2003, became the leading item on the financial and capital account.Total amount of foreign investments in the period from 1993 to the end of June 2003 amounted tomore than US$8.42 billion.

In 1999, FDI inflows in Croatia grew substantially because of the sale of 35% of Croatian Telecomto Deutsche Telekom. FDI was again strong in 2000, with three state-owned banks privatised andsold to foreign strategic partners. In 2001, the sale of an additional 16% stake of Croatian Telecomto Deutsche Telekom was completed in November of that year with the payment of e500 million byDeutsche Telekom. The privatisation of two more banks and a number of other smallerprivatisations also had a positive impact on FDI in 2001.

115

In 2002, FDI decreased to the level of US$980.51 million. However, e500 million of the 2001 figurewas attributable to the privatisation of Croatian Telecom alone.

By the second quarter of 2003, the FDI structure had changed significantly; reinvested profit, whichwas largely contributed to by earnings from the transfer of the market value of the patents of PLIVAd.d., accounting for US$301 million, which foreign investors used in the development of theCroatian companies in their majority ownership.

Historically, the biggest investor in Croatia from 1993 to June 2003 was Austria with US$2.07billion. Germany follows with US$1.84 billion. The United States is the third largest investor withUS$1.41 billion. Countries or organisations with a smaller share in FDI are Luxembourg(US$487.21 million), Italy (US$469.01 million), Netherlands (US$444.30 million), Slovenia(US$326.32 million), United Kingdom (US$245.99 million), EBRD (US$178.03 million) andSwitzerland (US$134.19 million).

Attracting FDI inflows is the cornerstone of Croatia’s recent economic reform program. The newGovernment believes that FDI can contribute to the improvement of competitiveness and jobcreation and is determined to accelerate FDI inflows through the introduction of investmentincentive legislation, the reduction of payroll and corporate tax, the revision of the privatisationframework, and further liberalisation of the telecommunications and energy sectors. Croatia hasadopted tax legislation which the Government believes is competitive with respect to the Centraland Eastern European Countries – a 20% corporate rate and a 15% dividend tax that encouragesreinvestment of dividends. Croatia has also adopted a fairly comprehensive scheme that theGovernment believes benefits investors (not just FDI) in new companies through tax and custom’sbenefits. A new draft of the Investment Incentive Act proposes to enlarge the list of companieseligible to include existing companies; it also lowers the minimum investment threshold thusavoiding preferential treatment for new large investments. The overall fiscal impact of this schemeis yet to be assessed and must also be borne in mind if this policy is to be sustained. TheGovernment is also working on the further elimination of certain administrative barriers describedin the Foreign Investment Advisory Service study carried out in 2001, “Croatia – AdministrativeBarriers to Foreign Investment”. The study identified several areas where administrative barriers toinvestment were present and provided practical recommendations on entry procedures –elimination of multiple procedures for the issue of business and employment visas for foreigners,company registration and business establishment procedures, expedited procedures inCommercial Courts, expedited procedures for land acquisition, registration and site developmentand the improvement of co-ordination between land acquisition and construction permitprocedures.

Changes in Foreign Exchange Reserves and trends in Foreign Exchange Rates

Foreign Exchange Reserves

After the successful introduction of the Stabilisation Programme in October 1993, Croatiaexperienced a process of reverse currency substitution. Strong capital inflows, mainly consisting offoreign direct investments, privatisation revenues and foreign borrowing, followed. This resulted ina large rise in the CNB’s foreign exchange reserves, as the CNB bought foreign currencies fromthe Government and commercial banks. Introduction of euro banknotes led to a strong inflow of in-currency cash previously held by households into the banking system at the end of 2001, fuellingthe strong growth of domestic credits in 2002.

In April 2001, the five successor states to the former Yugoslavia initiated an agreement to dividethe assets of the former Yugoslavia, held in the Bank of International Settlements (“BIS”), accordingto the IMF formula by which Croatia assumed 28.49% of all assets. As a result, Croatia receivedUS$11 million in shares, US$3 million in dividends, gold to the value of US$115 million and foreignexchange to the value of US$8.3 million. These assets were deposited with the CNB in the secondquarter of 2001.

116

The table below sets out the foreign exchange reserves for the years 1999 to 2003:

Foreign Exchange Reserves

1999 2000 2001 2002 2003*(US$ millions)

22222222211111111111111111112

Croatian National Bank foreign exchange reserves .......................... 3,025.0 3,524.8 4,704.2 5,885.8 7,235.7Banking system foreign exchange reserves ............................................ 1,562.9 2,389.2 3,915.0 2,868.7 3,810.8

*January to October 2003

Source: CNB

The official reserves reflect the currency composition of a trade basket and the currencies in whichCroatia’s foreign debt is denominated. The share of euros in the CNB’s international reserves atthe end of 2002 amounted to 72% while most of the remaining international reserves were in USdollars (approximately 28%). As at 5th December 2003, international reserves amounted toUS$7.92 billion. Depreciation of the US dollar was a major factor spurring growth of theinternational reserves.

The Kuna is officially a managed-floating currency with the CNB intervening in the foreignexchange market to limit fluctuations of the currency and to prevent its rapidappreciation/depreciation.

Foreign Exchange Rates

Croatia used the Yugoslavian dinar (“YUD”) before and immediately after independence. Croatiaintroduced its own currency, called the Croatian dinar (“HRD”), on 23rd December 1991. Initially,the HRD was introduced at parity to the YUD but the exchange rates rapidly diverged. Theexchange rate was pegged at DEM1 = HRD55 from 23rd December 1991 until 6th March 1992when it was devalued to DEM1 = HRD67. On 17th April 1992, the currency was again devalued toDEM1 = HRD94 and was subjected to a controlled downward float until the introduction of the Lawon Foreign Exchange on 19th October 1993. Since 20th October 1993, the CNB has maintained amanaged float of the currency and the currency has been internally convertible. The Croatian dinarwas replaced by the Kuna on 30th May 1994 at the rate of HRD1,000 = HRK1. The Kuna is dividedinto 100 lipa.

The Kuna/euro exchange rate is frequently used as a reference rate in Croatia instead of theKuna/US dollar rate both because of the importance of euro-denominated foreign trade andbecause it is the favoured currency for hard currency savings by residents. During periods of highinflation, many companies have kept their accounts in euro.

117

The following table shows the end-of-month Kuna/euro exchange rate from January 1999 toDecember 2003:

1999 2000 2001 2002 2003(HRK/f)

222222222111111111111111111112

January ............................................ 7.3871 7.7200 7.6757 7.5685 7.5558February .......................................... 7.5674 7.7305 7.7031 7.4378 7.6204March................................................ 7.5967 7.7273 7.6807 7.4025 7.6923April .................................................. 7.5911 7.7102 7.5269 7.3958 7.5673May .................................................. 7.5919 7.6838 7.2785 7.3778 7.5464June .................................................. 7.5966 7.6391 7.3207 7.3207 7.5088July .................................................. 7.5913 7.6008 7.1859 7.3949 7.5415August .............................................. 7.5895 7.5596 7.6106 7.3766 7.4578September ........................................ 7.6326 7.5113 7.5420 7.3413 7.5713October ............................................ 7.6408 7.5354 7.4440 7.4984 7.5939November ........................................ 7.6582 7.5677 7.4320 7.4312 7.6103December ........................................ 7.6790 7.5983 7.3700 7.4423 7.6469

Source: CNB

Banks are free to set foreign exchange rates, but are required to report their transactions to theCNB.

On 13th June 1995, the IMF announced that Croatia had accepted the obligations of Article VIII,Sections 2, 3 and 4 of the IMF Articles of Agreement effective 29th May 1995. By accepting theobligations of Article VIII, Croatia undertook to refrain from imposing restrictions on the making ofpayments and transfers for current international transactions and from participating inindiscriminate currency arrangements or multiple currency practices without IMF approval.

Outline of the Foreign Exchange Control System

Exchange Controls

An amendment to the Foreign Exchange Law, passed on 10th April 2001, relaxed the restrictionson capital account transactions by allowing banks to grant loans in foreign currencies to legalentities, permitting them to effect payments abroad, and by allowing legal entities to dispose offoreign currencies to settle payment of their liabilities arising out of transactions with foreignpersons. The further gradual liberalisation of capital account transactions as well as the lifting ofremaining exchange controls is envisaged in the process of preparation for joining the EU. In thatrespect, the new Foreign Exchange Law enacted in June 2003 regulates the terms under whichnon-residents invest in domestic securities. Provisions whereby non-residents will be prohibitedfrom selling domestic bonds/shares to a resident within a period of one year from the date ofpurchase are not applicable to residents of countries with whom Croatia has concluded 50 bilateralagreements for the promotion and reciprocal protection of investments. The countries are asfollows:

Date of ratification Date of entry into Date of signature in Croatia force2222222221111111111111111111222222

1. Republic of Albania ................................ 10-05-1993 03-02-1994 16-04-19942. People’s Republic of China .................... 07-06-1993 03-02-19943. Romania ................................................ 08-06-1994 11-05-1995 30-04-19984. Republic of Macedonia .......................... 06-07-1994 31-08-19955. Republic of Chile .................................... 28-11-1994 05-04-1996 15-06-19966. Argentine Republic ................................ 02-12-1994 07-03-1996 01-06-19967. Malaysia.................................................. 16-12-1994 06-06-19968. Republic of Poland ................................ 21-02-1995 31-08-1995 04-10-19959. Portuguese Republic .............................. 10-05-1995 24-07-1997 24-10-1997

118

10. Slovak Republic .................................. 12-02-1996 15-01-1997 06-02-199711. Republic of Turkey ................................ 12-02-1996 18-09-1997 21-04-199812. Bosnia and Herzegovina ...................... 26-02-1996 12-05-1997 04-08-1997

Changes and Amendments .................. 23-07-2002 24-10-200213. Chech Republic .................................... 05-03-1996 27-03-199714. Republic of Hungary ............................ 15-05-1996 22-01-1997 01-03-200215. Russian federation .............................. 20-05-1996 21-11-199616. French Republic.................................... 03-06-1996 15-01-1997 05-03-199817. Republic of Bulgaria ............................ 25-06-1996 05-12-1996 20-02-199818. USA ...................................................... 13-07-1996 10-04-1997 20-06-200119. Hellenic Republic.................................. 18-10-1996 10-04-1997 21-10-199820. Swiss confederation ............................ 30-10-1996 10-04-199721. Italian Republic .................................... 05-11-1996 06-03-1997 12-06-199822. Canada ................................................ 03-02-1997 11-07-1997 30-01-200123. Republic of Austria .............................. 19-02-1997 30-11-1997 01-11-199924. State of Kuwait .................................... 08-03-1997 26-06-1997 02-07-199825. United Kingdom of Great

Britain and Northern Ireland ................ 11-03-1997 07-08-1997 16-04-199826. Federal Republic of Germany ............ 21-03-1997 10-09-1998 28-09-200027. Kingdom of Spain ................................ 21-07-1997 24-07-1998 17-09-199828. Arab Republic of Egypt ........................ 27-10-1997 14-05-1998 02-05-199929. Republic of Slovenia ............................ 12-12-199730. Ukraine ................................................ 15-12-1997 30-03-200131. Kingdom of the Netherlands ................ 28-04-1998 09-07-1998 01-06-199932. Federal Republic of Yugoslavia ............ 18-08-1998 21-01-2002 31-01-200233. Republic of Finland .............................. 01-06-1999 01-08-2002 06-09-200234. Hashemite Kingdom of Jordan ............ 10-10-1999 17-02-2000 27-04-200035. Kingdom of Thailand ............................ 18-02-2000 11-05-200036. Republic of Zimbabwe.......................... 18-02-2000 11-05-200037. Islamic Republic of Iran ........................ 17-05-2000 27-12-200038. Kingdom of Denmark............................ 05-07-2000 24-11-2000 12-01-200239. State of Israel ...................................... 01-08-2000 24-11-200040. Kingdom of Sweden ............................ 23-11-2000 18-07-200141. Republic of Cuba.................................. 16-02-200142. Republic of India .................................. 04-05-2001 07-12-200143. Kingdom of Cambodia.......................... 18-05-2001 27-07-200144. Republic of Belarus .............................. 26-06-200145. Republic of Malta.................................. 11-07-200146. Belgian-Luxemburg Economic Union .. 31-10-2001 28-12-200347. State of Qatar ...................................... 12-11-200148. Republic of Moldova ............................ 07-12-200149. Republic of Indonesia .......................... 20-09-200250. Socialist People’s Libyan

Arab Jamahiriya .................................... 20-12-2002

119

Monetary and Financial Systems

The Croatian National Bank

The CNB became the central bank of Croatia on 23rd December 1991 when the Croatian dinarwas introduced. Its role as a central bank was defined by the Act on the Croatian National Bankwhich was passed on 4th November 1992 (the “CNB Act”).

Article 53 of the Croatian Constitution and the CNB Act establish the CNB’s independence and setout its relationship with Parliament. The Governor of the CNB and the members of its Board ofGovernors are appointed by Parliament for a six-year term and can only be removed by Parliamentin extraordinary circumstances defined by the CNB Act.

A new law regulating the policies and powers of the CNB was enacted on 5th April 2001 (the “2001CNB Law”). The 2001 CNB Law, which is modelled on the rules governing the European CentralBank, grants the CNB further independence and allows it new powers of self-governance. Forexample, the 2001 CNB Law prohibits the Government from borrowing directly from the CNB andallows the CNB to trade only in the secondary market for Government paper. Also, the 2001 CNBLaw specifies that the CNB’s main goal is price stability while retaining the CNB’s responsibility forbanking supervision and monitoring of the payments system.

Set out below are the Balance Sheets for the CNB for each of the years ended 31 December 2000to 31st December 2002 and the period ended 30th September 2003:

120

121

End

of

perio

d1111111111111111111111111111111122211111111111111111111111111113222222222222222222

(HR

K m

illio

ns)

11111111111111111111111111111111111111111111111111111111111111122211111111111111111111111111113222222222222222222

1999

2000

2001

2002

2003

21111111111111111113222222222222222222322222222222223

Dec

.D

ec.

Dec

.D

ec.

Mar

.Ju

n.Ju

l.A

ug.

Sep

.11111111111111111111111111111111111111111111111111111111111111122211111111111111111111111111113222222222222222222

AS

SE

TS

1.F

orei

gn a

sset

s23

,135

.728

,747

.439

,308

.942

,058

.844

,479

.044

,520

.543

,919

.445

,277

.046

,801

.61.

1.G

old

--

--

--

--

-1.

2.H

oldi

ngs

of S

DR

s1,

449.

21,

204.

290

5.8

17.4

10.2

8.3

8.3

6.9

6.9

1.3.

Res

erve

pos

ition

in t

he I

MF

1.6

1.8

1.8

1.6

1.7

1.6

1.6

1.6

1.6

1.4.

Cur

renc

y an

d de

man

d de

posi

ts w

ith fo

reig

n ba

nks

1,10

9.6

7.4

6.1

6.4

5.9

1,37

0.7

22.8

6.1

10.0

1.5.

Tim

e de

posi

ts w

ith fo

reig

n ba

nks

17,7

02.4

20,9

86.9

25,5

65.9

28,1

83.2

25,2

43.7

18,4

23.8

18,6

94.4

20,4

06.8

21,3

89.5

1.6.

Sec

uriti

es in

f/c

2,87

1.6

6,54

5.7

12,8

29.3

13,8

50.0

19,2

17.5

24,7

16.2

25,1

92.3

24,8

55.5

25,3

93.6

1.7.

Non

conv

ertib

le fo

reig

n ex

chan

ge1.

31.

30.

00.

00.

00.

00.

00.

00.

02.

Cla

ims

on c

entr

al g

over

nmen

t an

d fu

nds

24.1

0.0

-0.

52.

01.

50.

52.

63.

02.

1.C

laim

s in

kun

a24

.10.

0-

0.5

2.0

1.5

0.5

2.6

3.0

2.2.

Cla

ims

in f

/c-

--

--

--

--

3.C

laim

s on

oth

er d

omes

tic s

ecto

rs27

6.8

289.

522

9.2

110.

611

0.5

102.

410

2.4

100.

894

.54.

Cla

ims

on D

MB

s1,

138.

732

9.9

18.5

17.9

14.1

13.7

13.8

13.8

343.

44.

1.C

redi

ts t

o D

MB

s1,

125.

331

3.6

--

--

--

329.

4Lo

mba

rd c

redi

ts17

6.7

--

--

--

-32

9.4

Sho

rt-t

erm

liqu

idity

cre

dits

929.

0-

--

--

--

-O

ther

cre

dits

19.7

14.0

--

--

--

-C

NB

bill

s un

der

repu

rcha

se a

gree

men

t-

299.

6-

--

--

--

4.2.

CN

B d

epos

its w

ith D

MB

s13

.415

.216

.617

.613

.813

.713

.813

.814

.04.

3.O

verd

ue c

laim

s0.

01.

11.

90.

30.

3-

--

-5.

Cla

ims

on o

ther

ban

king

inst

itutio

ns-

--

--

--

--

11111111111111111111111111111111111111111111111111111111111111122211111111111111111111111111113222222222222222222

Tota

l (1+

2+3+

4+5)

24,5

75.3

29,3

66.8

39,5

56.6

42,1

87.7

44,6

05.6

44,6

38.0

44,0

36.1

45,3

94.1

47,2

42.4

11111111111111111111111111111111111111111111111111111111111111122211111111111111111111111111113222222222222222222

Sou

rce:

CN

B

122

End

of

perio

d1111111111111111111111111111111122211111111111111111111111111113222222222222222222

(HR

K m

illio

ns)

11111111111111111111111111111111111111111111111111111111111111122211111111111111111111111111113222222222222222222

1999

2000

2001

2002

2003

21111111111111111113222222222222222222322222222222223

Dec

.D

ec.

Dec

.D

ec.

Mar

.Ju

n.Ju

l.A

ug.

Sep

.11111111111111111111111111111111111111111111111111111111111111122211111111111111111111111111113222222222222222222

LIA

BIL

ITIE

S1.

Res

erve

mon

ey10

.310

.011

,717

.317

,803

.223

,027

.921

,883

.524

,264

.725

,064

.825

,854

.227

,289

.11.

1.C

urre

ncy

outs

ide

bank

s5,

958.

96,

636.

78,

507.

49,

680.

99,

526.

110

,637

.211

,294

.211

,320

.610

,506

.01.

2.D

MB

s’ca

sh in

vau

lts38

2.1

532.

353

8.8

1,21

4.8

1,62

4.7

1,54

8.5

1,55

3.5

1,51

6.1

1,38

5.7

1.3.

DM

Bs’

depo

sits

3,96

0.4

4,54

0.7

8,74

1.5

12,1

09.4

10,7

19.2

12,0

75.5

12,2

12.9

12,9

93.0

15,3

85.2

Set

tlem

ent

acco

unts

247.

945

9.5

2,45

0.1

3,92

3.4

2,13

2.0

3,09

7.3

3,03

1.7

3,15

7.2

4,34

0.7

Sta

tuto

ry r

eser

ves

3,71

2.5

4,08

1.2

6,29

1.4

8,18

6.0

8,58

7.2

8,95

1.5

9,09

5.5

9,75

0.0

10,9

58.8

CN

B b

ills

on o

blig

ator

/ ba

sis

--

--

-26

.785

.885

.885

.81.

4.D

epos

its o

f ot

her

bank

ing

inst

itutio

ns8.

57.

515

.519

.14.

21.

51.

61.

21.

21.

5.D

epos

its o

f ot

her

dom

estic

sec

tors

-0.

00.

13.

59.

21.

82.

623

.311

.02.

Res

tric

ted

and

bloc

ked

depo

sits

5,01

6.8

5,80

5.5

6,03

0.5

7,09

1.2

7,58

9.1

7,99

8.5

7,89

6.8

8,32

7.7

6,85

8.4

2.1.

Sta

tuto

ry r

eser

ve in

f/c

4,63

6.2

5,49

0.5

5,70

5.1

7,04

2.3

7,56

2.5

7,98

3.0

7,88

0.7

8,31

0.4

6,83

9.7

2.2.

Res

tric

ted

depo

sits

380.

631

5.0

325.

449

.026

.615

.516

.117

.318

.72.

3.E

scro

w d

epos

its-

--

--

--

--

3.F

orei

gn li

abili

ties

1,67

1.2

1,63

0.8

1,59

7.5

195.

71,

134.

286

8.0

1,42

3.7

1,14

2.9

2,61

0.6

3.1.

Use

of

IMF

cre

dit

1,50

1.7

1,29

0.3

1,02

5.5

2.8

--

--

-3.

2.Li

abili

ties

to in

tern

atio

nal o

rgan

izat

ions

6.8

9.5

12.2

12.6

13.2

16.3

16.3

16.6

16.3

3.3.

Liab

ilitie

s to

fore

ign

bank

s316

2.7

331.

055

9.8

180.

21,

121.

085

1.7

1,40

7.4

1,12

6.3

2,59

4.3

4.C

entr

al g

over

nmen

t an

d fu

nds

depo

sits

397.

21,

157.

41,

752.

176

8.1

2,85

8.9

2,55

5.9

1,05

1.2

1,33

0.9

1,21

4.8

4.1.

Dem

and

depo

sits

394.

21,

008.

51.

752.

160

8.3

649.

975

0.1

536.

181

6.8

762.

2C

entr

al g

over

nmen

t de

man

d de

posi

ts38

8.0

980.

81,

564.

856

9.5

648.

174

2.1

535.

981

3.5

762.

1C

entr

al g

over

nmen

t fu

nds

dem

and

depo

sits

6.2

27.7

187.

338

.71.

87.

90.

33.

30.

14.

2.C

entr

al g

over

nmen

t f/c

dep

osits

0.0

--

-2,

094.

31,

741.

051

5.1

514.

145

2.6

4.3.

CN

B b

ills

2.9

148.

8-

159.

911

4.8

64.9

--

-5.

CN

B b

ills

2,88

7.2

4,20

7.3

6,37

2.3

6,21

2.4

5,27

9.0

4,22

9.4

3,83

4.4

3,95

6.6

4,23

0.2

5.1.

CN

B b

ills

in k

una

1,25

2.5

2,39

4.6

3,45

8.9

4,98

6.2

3,87

1.4

2,65

9.9

2,17

4.2

1,13

4.8

104.

95.

2.C

NB

bill

s in

f/c

1,63

4.7

1,81

2.7

2,91

3.4

1,22

6.3

1,40

7.6

1,56

9.5

1,66

0.2

2,82

1.8

4,12

5.3

6.C

apita

l acc

ount

s4,

535.

55,

216.

66,

425.

25,

353.

56,

328.

85,

194.

05,

236.

25,

251.

15,

482.

87.

Oth

er it

ems

(net

|-2

42.4

-368

.112

4.2

161.

1-4

67.9

172.

4-4

71.1

-469

.3-4

43.5

11111111111111111111111111111111111111111111111111222111111111111111111111111111111111111111113222222222222222222

Tota

l (1+

2+3+

4+5+

6+7)

24,5

75.3

29,3

66.8

39,5

56.6

42,1

87.7

44,6

05.6

44,6

38.0

44,0

36.1

45,3

94.1

47,2

42.4

11111111111111111111111111111111111111111111111111111111111111122211111111111111111111111111113222222222222222222

11111111111111111111111111111111111111111111111111111111111111122211111111111111111111111111113222222222222222222

aS

ince

Oct

ober

200

1, L

iabi

litie

s to

fore

ign

bank

s in

clud

e al

so li

abili

ties

base

d on

CN

B b

ills

subs

crib

ed b

y no

nres

iden

ts.

b In D

ecem

ber

2002

, C

DA

acc

ount

s w

ith t

he C

NB

for

the

gros

s an

d ne

t se

ttlem

ent

of p

urch

ased

sec

uriti

es h

ave

been

rec

lass

ified

fro

m t

he s

ecto

r ce

ntra

l gov

ernm

ent

to t

he s

ecto

r ot

her

finan

cial

org

anis

atio

ns.

Sou

rce:

CN

B

Monetary Policy

Since the implementation of the Stabilisation Programme of 1993, the main goal of the CNB hasbeen to maintain price stability. It seeks to achieve this by intervening to prevent sharp exchangerate adjustments and by regulating the money supply.

The CNB has been engaged in developing financial markets and new financial instruments. It hasintroduced CNB bills, and currently bills with maturities of 35 days are sold at auctions tocommercial banks every Wednesday. The main purpose for issuing the CNB bills is to offset themonetary effects of the CNB’s interventions in the foreign exchange market. The CNB bills alsoserve as collateral for obtaining “Lombard” credits from the CNB.The CNB bills market has becomemuch more liquid with the development of the banking system since 1996, paving the way for theCNB to develop the market and substantially reduce the interest rate. In 1998, the CNB beganissuing CNB bills denominated in foreign currency. The CNB has been effective in managing theexchange rate with the Kuna being stable against the euro and the CNB’s international reservescontinually rising.

In 2003, economic policy makers had to work hard to reduce the current account deficit financedby foreign borrowing. To slow down the negative trends and credit expansion, the CNB tightenedits monetary policy by increasing the Kuna component of the foreign exchange reserverequirements and decreasing the foreign exchange component.

Measures to further reduce surplus Kuna liquidity continued throughout the year through netforeign exchange sales by the CNB. Higher interest rates have been the result of lower liquidity.

Although somewhat rigid as an instrument of monetary policy, in a small open economy such asCroatia, reserve requirements are a principal and the most effective instrument for liquiditysterilisation.The reduction in the reserve requirements rate from 30% to 19% in the period between2000 and 2001, contributed to the system’s high liquidity. In the summer of 2003, the CNB beganincreasing the reserve requirement from 19% to 25%. This was followed by another increase inSeptember 2003, from 25% to 35%. A further rise followed in November 2003 increasing the rateto 42%. This move helped sterilise parts of the privatisation related inflows and also marked atransition period during which monetary authorities intend to develop open market operationsfacilities using the interest rate channel more extensively. Prudent monetary and fiscal policy aswell as an improving current account balance is expected to provide comfort for the exchange ratestability in the coming years. At the beginning of Croatian independence in 1991, foreign exchangereserves were at zero but, as at 5th December 2003, they stood at US$7.92 billion.

In December 2003, the CNB announced its monetary policy and financial plan for 2004. The issueof money based on the purchase of foreign currency will be significantly lower: according to presentestimates, net purchase of foreign currencies for international reserves held on the accounts withthe CNB are expected to reach approximately US$100 million. For the second half of 2004, it isexpected that open market operations will be initiated. The unit rate for computing the obligatoryreserves (19%) was not changed by the new decision on obligatory reserves, but the rate relatingto the reserves deposited in separate accounts with the CNB was increased. Foreign currencyreserve requirements relating to foreign currency sources abroad and to other foreign currencydeposits of persons that have a special relationship with the CNB will be computed on the basis ofa 100% rate, whereas, for the remaining foreign currency and total obligatory reserves in Kuna, therate for allocations to special accounts with the CNB will, at the very least, be increased from 40%to a minimum of 60% of the computed foreign currency reserve amount. CNB has publishedinformation suggesting that the money supply is expected to grow by approximately 10% in thenext year and that bank loans are expected to rise by 14%, which corresponds with the economicgrowth rate of 4% and inflation rate of 2.5% as concluded by the Council of CNB.

The objective of the above changes is to discourage banks from further borrowing for the purposeof increasing their placements in Croatia based on foreign sources of funding, from offering the

123

foreign currency portion of obligatory reserves as security for their borrowings and to reduce dailyfluctuations in the balance of the reserves on the banks’ accounts with the CNB.

The definite fiscal policy of the Government is expected to become clear in February 2004.Monetary projections have been prepared on the basis of an assumption that the deficit of theconsolidated State will be reduced to 2.9%.

Further improvements in the co-ordination between monetary and fiscal policy are expected tofollow. The new monetary instruments and credible fiscal policy are expected to align economicpolicy more closely with those in existence in EU member states bringing Croatia closer to itsmedium term goal, namely entering the EU by the end of 2007.

Croatian Banking System

Croatia has a two-tier banking system in which the CNB acts as a central bank but does notengage in commercial banking. As of October 2003, there were 45 banks operating in Croatia.Foreign banks may operate in Croatia and, to date, seven foreign banks have commencedoperations but only six continue to operate. Four foreign banks (of which three still operate),entered the market through the privatisation of the domestic banks. Currently, there are 23 majorityforeign owned banks in Croatia. As at 31st December 2002, approximately 90.2% of total bankingassets were held by foreign investors. The end of the first half of 2003 saw a further increase in theshare of bank assets in majority foreign ownership to 90.5%, representing a steady growth since1998 (6.7% at end-1998, 39.9% at end -1999, 84.1% at end-2001).

The following table sets out an overview of the Croatian banking system for the years 2001 toSeptember 2003:

30th31st December September

2001* 2002* 2003**(HRK billions)

222222221111111 1111

∆Total assets 148.4 174.1 192.1

∆Total placements 151.6 183.0 199.9

∆131.9 157.5 173.8

∆7.9 7.3 6.7

∆Core capital 12.8 14.6 15.5

∆Total regulatory capital 14.0 16.8 18.0

* audited data

** preliminary unaudited data

Source: CNB

At the end of June 2003, there were five savings banks operating in Croatia — one more than atthe end of 2002 – comprising four house savings banks and one savings bank.

During 1998 and 1999, some of Croatia’s small and medium sized banks encountered severedifficulties. Between January 1999 and February 2001 10 banks were declared bankrupt, two hadtheir licences revoked, two were rehabilitated through a process of Government receivership andfive were liquidated. In addition, in 2000 and early 2001, there were several mergers. Theseprocesses reduced the number of banks from 60, as at December 1997, to the current 45, andimproved the soundness of the Croatian banking system.

All banks in Croatia are registered as joint stock companies.

Placement valueimpairment (loss)

Classified on-balancesheet assets

124

Bank Regulation and Prudential Standards

Since 1992, the CNB has set prudential guidelines for all Croatian banks. The current system ofprudential standards includes a minimum 10% risk-weighted capital adequacy ratio calculatedsubstantially in accordance with BIS recommendations and international authority standards, dailymonitoring of liquidity levels, classification of the quality of bank assets, provision of reserves withrespect to problem loans and limits on foreign exchange positions. Individual loans or the total ofall loans to a single borrower cannot exceed 25% of guaranteed capital (defined as tier-one capitaland a portion of tier-two capital).

Banks must provide security for their operations and, therefore, are required to set aside reserves.In addition to general reserves for covering unidentified potential loan losses, banks must set asidespecific reserves against identified potential losses from doubtful credits, investments and aportion of their off-balance-sheet items. Annual reports of banks must be checked and evaluatedby an authorised external auditor. Large banks usually have their annual reports audited byinternationally recognised auditing firms.

Banks carry on their business activities independently of the Government and the CNB andoperate as joint stock companies with management being responsible to their shareholders. Banksmay be established by one or more legal or natural persons, resident or non-resident. Theminimum equity capital requirement is HRK40 million. Both new banks and savings banks mustobtain a licence from the CNB. Licence applications must include, among other documents, proofof the minimum capital required, names of qualified managers and business plans for two years.Under certain conditions, the licence can be revoked if the bank does not comply with CNBregulations. To date, the CNB has withdrawn a licence on four separate occasions, from PrivatnaAustrijsko – Hrvatska banka Zagreb and Histria banka Pula in 1995-96 and from Razvojna bankaDalmacija and Alpe Jadran in 2000.

In December 1998, a new act on banks (the “1998 Banking Act”) was passed to strengthen thesupervisory authority of the CNB. The prime purpose of the 1998 Banking Act, effective as ofDecember 1998, was that of delegating more power to the CNB to prevent and/or resolve problemsin banks more rapidly.

In addition, the 1998 Banking Act granted the CNB three types of authority to intervene in theactivities of banks: the first was to impose severe measures on banks undertaking imprudent orillegal activities; the second was to appoint a monitor; and the third was to appoint a temporaryadministrator where a bank was being restructured. The temporary administrator can be appointedfor a period of six months and such period may be extended for another six months only. Theadministrator is obliged to submit, within a certain period, a report concerning the conditions of thebank, together with proposals for the appropriate courses of action for dealing with the problemsconfronting the bank. Provision of financial support, merger with a suitable bank or thecommencement of bankruptcy procedures may be the courses of action contained in suchproposals.

Further major legal change occurred in 2002 when the Parliament approved the 2002 Banking Act.The 2002 Banking Act introduced the legal framework for the operation of banks during Croatia’spreparations for, and upon accession to the EU. It has further strengthened the CNB supervisorypowers, and has introduced consolidated supervision. Under the 2002 Banking Act, all bylaws andregulations were enacted by February 2003, while the Act itself came into effect immediately, savefor certain provisions that can only be applied once Croatia joins the EU.

The Act on the State Agency for Savings Deposit Insurance and Bank Rehabilitation (which cameinto force on 11th June 1994) provides for a scheme of bank-funded deposit insurance for all banksthrough the creation of a special account with full coverage for savings deposits in Kuna or foreigncurrencies of individuals up to a level determined by the Minister of Finance, which is currentlyHRK100,000. The deposit insurance scheme began in mid-1997 so that depositors who held theirmoney in banks that failed during the 1998-1999 hardship period received payment from the StateAgency up to the HRK100,000 limit by the end of 2000.

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The Bank Rehabilitation Programme

In an attempt to recapitalise banks suffering from high levels of bad debt and to aid indebtedenterprises, in 1991 and 1992 the Government issued bonds under the so-called “Big BondsScheme”. Under the Big Bonds Scheme, bonds denominated in Kuna were issued by theGovernment in exchange for equity to non-financial companies that were experiencing financialdifficulties and which had defaulted on their bank debt. The companies transferred the bonds tobanks in order to close their debt positions. As a result, banks’ solvency improved but they heldlarge amounts of non-tradable Government debt in their portfolios, which caused liquidity problemsfor some banks many years later. The proportion of claims on the Government is declining. At theend of 1993, 39.4% of the total assets of deposit money held by banks were claims on theGovernment; this percentage had fallen to 9.75% by the end of September 2002.

Rehabilitation Programme and Privatisation of Banks

The legislative structure for the rehabilitation programme is set out in the Act on BankRehabilitation and Restructuring which came into force on 11th June 1994 but was revoked in2000, after the Government privatised most of the restructured banks. In late 1995, theGovernment began implementing a new rehabilitation programme for the banking system. Theobjectives of the programme included changing bank ownership structures, ensuring additionalcapitalisation of banks that were suitably qualified to operate successfully and excluding bankdebtors from the management of the banks. Rehabilitation was being implemented on a case bycase basis. The CNB was responsible for appraisal of the economic feasibility of the rehabilitationin particular cases. A new state agency, the State Agency for Savings Deposit Insurance and BankRehabilitation (the “Agency for Rehabilitation”), was established to implement certain aspects ofbank rehabilitation.

The bank rehabilitation process had three phases:

(1) a financial restructuring designed to recapitalise the bank, restore its liquidity and transfer itsnon-performing assets to the Agency for Rehabilitation;

(2) an institutional reform process, designed to install new governance, controls and policies,and to focus the business strategy and operations of the bank on new and growing markets;

(3) as the rehabilitation process was completed, the Agency for Rehabilitation would return thebank to the private sector by selling its shares to qualified investors (i.e. investors who werenot also major debtors of the bank).

Six banks entered the rehabilitation process. Slavonska banka, which suffered primarily fromliquidity problems, received a total of HRK150 million in cash assistance in late 1995 and early1996. The Agency for Rehabilitation purchased all of Slavonska banka’s Big Bonds and alsopurchased a 35% equity stake in the bank. In accordance with the CNB’s requirements, with effectfrom 31st December 1995, Rijecka banka and Splitska banka wrote off their non-performing loansand other non-performing assets, with the result that their existing capital was eliminated. TheAgency for Rehabilitation subsequently injected a total of HRK552 million (HRK170 million in cashand HRK382 million in bonds) in new capital to recapitalise Rijecka banka. A total of HRK765million (HRK100 million in cash and HRK665 million in bonds) was simultaneously injected intoSplitska banka by the Agency for Rehabilitation. As a result, the Agency for Rehabilitation becamethe sole shareholder of both banks and replaced or restructured their former management teams.

In December 1996, Privredna banka Zagreb d.d. (“PBZ”) entered into the rehabilitation process. InJune 1998, the Agency for Rehabilitation purchased HRK620 million of Government bonds fromDubrovacka banka as it also entered the rehabilitation process. The 1997 and 1998 budgetsprovided HRK800 million and HRK1,569 million, respectively, for bank rehabilitation, whilst the1999 budget provided HRK1,130 million.

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Four of the banks which were included in the rehabilitation process were successfully privatised in1999 and 2000. Slavonska banka was sold to EBRD, Erste und Steiermärkische Bank and Bankfür Kärnten und Steiermark in 1999. On 17th December 1999, the Agency for Rehabilitationannounced that it had signed an agreement to sell 66.3% of the shares in PBZ for e300 million toBanca Commerciale Italiana SpA (“BCI”). The Agency for Rehabilitation sold the remaining stakeof 25% plus two shares in December 2002. The transaction closed on 28th January 2000 when theAgency for Rehabilitation received the proceeds. In the first quarter of 2000, Rijecka banka wassold to strategic partner Bayerische Landesbank for US$41 million.This was subsequently followedby a strategic sale of Splitska Banka to Unicredito ltaliano for e48 million.

In 2001, Unicredito Italiano sought approval from the CNB for the acquisition of a majorityshareholding in Zagrebacka banka, Croatia’s largest bank. CNB approved the acquisition subjectto Unicredito Italiano selling its interest in Splitska Banka to Bayerische Hypo-und Vereinsbank AG(“HVB”). Both transactions were completed in April 2002.

In March 2002, Riječka banka announced heavy losses in foreign exchange trading activitiesresulting from internal fraud. Due to a successful agreement between its two major shareholders,Bayerische Landesbank and the Government, the crisis was quickly brought under control.Bayerische Landesbank withdrew from the bank by returning its shares to the Government and inApril 2002, the Government sold an 85% interest in the bank to Erste und Steiermärkische Bankfor e55 million with an obligation to inject a further e100 million into the bank as capital. As at 1August 2003, following the merger of Riječka banka d.d. and Erste & Steiermärkische Bank d.d.Zagreb, Erste & Steiermärkische Banka d.d. Rijeka was created with ∆a balance of e2.23 ∆billionholding third position in the market at the time with a market share∆of 10%.

In March 2002, Dubrovacka banka was acquired by Dalmatinska banka for e24 million. TheGovernment is also considering privatisation projects for 25% of the shares in Hrvatska poštanskabanka (Croatian Postal Bank) and Croatia banka.

The process of integrating HVB Croatia and Splitska banka, which started in September 2002, wassuccessfully completed on the 30th June 2003, as planned. From 1st July 2003, the joint bankoperates under the name of Splitska banka, member of HVB Group.

The Securities Market

In general, the Croatian equity market is dominated by small investors who have becomeshareholders through the process of privatisation. There are an estimated 600,000 privateshareholders and a few institutional shareholders. The pension and health funds, which alsoreceived parcels of shares as part of the privatisation process, have not yet sought to manage theirportfolios. The leading players in the market are the commercial banks and private brokeragehouses which are members of the relevant exchange. The CPF is active in the market, though onlyas a seller as it seeks to dispose of its holdings. A new Securities Act came into force on 1stJanuary 1996 which instituted primary and secondary market procedures and regulations alongstandard Western lines and set up a Croatian Securities and Exchange Commission (“CROSEC”)with supervisory powers over the primary and secondary markets.

The liquidity in Croatia’s capital markets is improving. Currently, the market has 38 members.CROSEC supports Croatia’s capital markets by establishing and monitoring the laws andregulations to protect the rights of market participants, as well as developing its technicalinfrastructure.

The Zagreb Stock Exchange (“ZSE”) was founded in 1918 but was disbanded in 1946 by thecommunist authorities. In June 1991, the ZSE was incorporated as a joint stock company andreopened by 25 commercial banks and insurance companies.Today, the ZSE has 43 shareholders.In July 2002, the over-the-counter market in Varazdin became the Varazdin Stock Exchange.

Trading at the ZSE takes place either on the official market (the ZSE’s principal market), in thequotation of public limited companies (“JDD Quotation”) (mandatory listings) or through the ZSE’s

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second-tier market. There are two fully listed companies, 112 in JDD Quotation and 43 in thesecond tier market (TN quotation).

Trading is now executed through “MOST”, a new fully electronic distribution trading system,developed in-house by the ZSE. All trading in equity and fixed income instruments must beexecuted through ZSE members. There are no restrictions on foreign direct investors and the samerules apply as for the domestic investors.

Market capitalisation of companies with equity listed on the ZSE rose considerably in 2003 incomparison with the end of 2002 and the end of the first quarter of 2003. This was partly due tothe growth of share prices but was mainly due to the rise in the number of companies havingshares listed on ZSE. More specifically, pursuant to the Securities Market Act, by the end of July2003, public limited companies were obliged to list their shares in JDD Quotation on the stockexchange or other regulated public market. The first public limited company was listed on the ZSEin March 2003 and 102 companies were listed by the end of August 2003. Market capitalisation ofshares owned by companies listed on the ZSE was HRK36.2 billion at 12th December 2003, aconsiderable rise in comparison with the HRK26.1 billion at the end of 2002.

The shares of Pliva d.d., whose price in the domestic capital markets mainly depends on the priceachieved on the London Stock Exchange, has dominated domestic equities market trading,although there was a large volume of shares listed in JDD Quotation, in the second half of 2003.

The Varazdin Stock Exchange trading segments totalled six after the introduction of the JDDQuotation, comprising five segments for share trading and one segment, the Rights Quotation,involving rights trading (specifically the rights of the Ministry of Finance and the Ministry of PublicWorks, Reconstruction and Construction). Most trading (70% on average) is carried out in the FeeMarket segment.

The Croatian Central Depository Agency (“SDA”), which began operations in April 1999,implemented a new clearing and settlement process (“NKS”) on 5th February 2001. The NKSreplaced the manual trade-for-trade environment between counterparty brokers.

Trading Overview

1999 2000 2001 2002(US$ millions)

1111111111111111111111111

Turnover:Shares ........................................................ 68.9 187.5 115.9 164.0Bonds ........................................................ 2.8 56.5 85.0 653.5Total ............................................................ 71.7 244.0 201.6 822.9Volume:Shares ........................................................ 2,709,176 6,229,431 3,675,775 5,910,000Bonds ........................................................ 16,211 60,820,932 92,232,311 597,087,864Rights ........................................................ – 1,058,043 14,591,176 24,301,041Total ............................................................ 2,725,387 68,108,406 110,499,262 658,098,905CROBEX (1) ................................................ 715.3 890.0 1,034.7 1,172.6Total number of trades................................ 7,538 18,175 25,943 33,241Number of securities traded ...................... 43 44 60 66Market Capitalisation of shares.................. 2,513.8 2,719.5 3,089.5 3,963.8Number of listed shares: ............................ 64 64 73 73Quotation I.................................................. 6 4 4 3Quotation TN .............................................. 58 60 69 70Number of listed bonds .............................. 1 2 5 9Average daily:Turnover...................................................... 0.3 1.0 0.8 3.3Volume........................................................ 11,647 275,741 441,997 2,653,625Number of trades........................................ 32 74 104 134

Note:

(1) Zagreb Stock Exchange Share Index

Source: ZSE

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Debt securities market

Two new Kuna denominated bond issues, a Government and a corporate issue, were listed on theZSE in the second and third quarters of 2003. These were the first Kuna bonds issued in thedomestic market, and are expected to play an important role in the further development of theCroatian financial market. In May 2003, the Ministry of Finance issued the first Kuna denominatedGovernment bond, in an aggregate principal amount of HRK1 billion, with a coupon of 6.125% anda maturity date in 2008. Standard & Poor’s assigned a BBB+ rating to the bond and a BBB- ratingto the foreign currency Government debt. The bond extended the Kuna yield curve to a 5-yearmaturity and set a benchmark for the evaluation of future corporate bond issues.

The Kuna corporate bond was listed on the ZSE in June 2003 and had an aggregate principalamount of HRK150 million, a coupon of 6.5% and a 5-year maturity.

Intense bond trading in the ZSE began in mid-2002 and continued into the second and thirdquarters of 2003. The bond turnover increased by 60% in the first eight months of 2003 comparedwith the total turnover in 2002. Market capitalisation of Government bonds was 5.8% (e1.4 billion)of GDP in 2002. Market capitalisation of corporate bonds stood at e49.6 million.

The Zagreb Stock Exchange Bond Index (“CROBIS”) is comprised of six bonds: the CroatianInstitute for Health Insurance (“CIHI”) bond, the DAB State Agency for Banks (“DAB”) bondmaturing in 2005 and all four bonds issued by the Republic.

Recent trends in money supply and official discount rate

Money Supply

September 2003 was marked by a slowdown in bank placements to the non-banking sector. Asusual for that month, monetary aggregates M1 and M4 (each as defined in the table below)declined, despite an increase in foreign exchange deposits following the tourist season. September2003 also saw a decline in money (M1) that is usual for the post-summer season. Bothcomponents of this monetary aggregate declined. As at 30th September 2003, M1 and M4 stoodat HRK10.5 billion, which represents an annual growth of 8.5%, but a decline compared with July(9.8%) and August (10.0%). After growing throughout the summer, demand deposits declinedslightly in December (2.8%), compared with the end of August. At the end of the third quarter of2003, demand deposits stood at HRK22.1 billion and the annual growth rate during that period was14.8%, which is a decline compared with the annual growth rates recorded in July (23.7%) andAugust (18.3%).

September 2003 also saw a mild fall in Kuna non-monetary deposits (1.0%), compared withAugust, which was mainly caused by a fall in deposits of other financial institutions (HRK0.7 billion).Deposits of the household and corporate sectors increased by HRK0.1 billion and HRK0.2 billionrespectively. At the end of September 2003, Kuna non-monetary deposits stood at HRK18.9 billion,which is an increase of HRK2.8 billion compared with the end of the second quarter of 2003.Generally speaking, 2003 was marked by a growth in total Kuna deposits, which can be attributedto price stability and the stability of domestic currency, higher interest rates on term and savingsdeposits and term deposits used as loan collateral. The end of third quarter of 2003 was alsomarked by an increase in foreign exchange deposits from July and August, reflecting a good touristseason. As at 30th September 2003, foreign exchange deposits reached HRK75.4 billion,representing an annual growth rate of 4.4%. Exchange rate effects excluded, the annual growthrate of foreign exchange deposits during 2003 to 30th September was 4.0%. More specifically,exchange rate effects excluded, the annual growth rate of household foreign exchange depositswas 5.2% while that of corporate foreign exchange deposits was 0.2%. As a result of suchdevelopments, total liquid assets (M4) declined mildly (HRK0.1 billion), compared with August. Asat 30th September 2003, M4 stood at HRK127.1 billion, an increase of 11.8% on an annual level,though smaller compared with 13.7% and 12.1% in July and August respectively.

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The following table sets forth information concerning Croatia’s money supply for the period 2000to September 2003:


2000 2001 2002 2003(HRK millions)

11111111111111111111

Reserve money .................................................... 11,717.3 17,803.2 23,027.9 27,289.1Money (M1)(1) ........................................................ 18,030.3 23,703.5 30,869.8 32,589.4Broad money (M4)(2) ............................................ 73,061.1 106,071.4 116,141.8 126,910.9Net domestic assets ............................................ 44,043.9 57,410.0 83,324.4 92,696.3Domestic credit .................................................... 60,883.8 74,964.5 97,463.7 107,180.1

Note:

(1) Money (M1) comprises cash outside banks, deposits made by banking institutions and other domestic entities with the CNBand deposit money banks’ demand deposits.

(2) Broad money (M4) comprises money (M1), savings and time deposits and foreign currency deposits, as well as bonds andmoney market instruments.

(3) Net domestic assets are defined as a difference between total liquid assets and foreign assets (net).

(4) Domestic credit comprises deposit money banks’ claims on other domestic sectors, other banking institutions and otherfinancial institutions.

Source: CNB

Interest Rates

All interest rates in Croatia are set by the market except the CNB’s “Lombard” and discount rateswhich were set by the CNB.The following table sets forth the interest rates set by the CNB between1999 and 2003:

1999 2000 2001 2002 2003*(% per annum)

222222222111111111111111111112

Lending ratesDiscount rate .................................... 7.9 5.9 5.9 4.5 4.5Lombard rate .................................... 13.0 12.0 10.0 9.5 9.5intra day refinance facility ................ – – – – –Intervention credits .......................... 19.0 18.0 – – –Daily credits ...................................... – – – – –Special credits for illiquidity problems 14.0 13.0 11.0 10.5 10.5Inaccurately calculated statutory

reserves ........................................ 19.0 18.0 15.0 15.0 15.0On arrears ........................................ 18.0 18.0 18.0 15.0 15.0Deposit ratesStatutory reserves: to HRK .............. 5.9 4.50 2.0 1.75 1.5In foreign currency(1)

Bill issued by the CNB(2)

In HRK35 days ..................................91 days .................................. 10.5 6.7 3.4 2.08 2.55182 days ................................ 11.6 7.0 4.1 – –

In foreign currency (e and US$)35 days .................................. – – – 2.28 1.6963 days .................................. 4.8 5.5 2.6 2.67 1.1991 days .................................. 3.6 4.8 3.1 – –182 days ................................ – – – – –

Note:

(1) Interest rate achieved on international markets for funds held by CNB

(2) The interest rates on CNB bills are average auction rates. Source: CNB

* January-September 2003

Source: CNB

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PUBLIC FINANCE

Outline of the Public Finance System and Tax System

After independence, the budget of Croatia was separated from the finances of the formerYugoslavia and quickly went into deficit as war costs escalated. The authorities recognised that thebudget deficit was the main cause of inflation and expenditures were cut in real terms in 1993 inorder to tighten fiscal policy.

Central Government Budget

The fiscal year of the Government is the calendar year. The Organic Budget Law which becameeffective on 1st July 2003 (the “2003 Law”) (replacing the Organic Budget Law from 1994),established the procedure according to which the State Budget for each fiscal year is prepared,approved and implemented. The 2003 Law is applicable for the budgets of local governmentauthorities such as municipalities, cities and counties. Certain provisions of the 2003 Law areapplicable to companies and funds over which government has control and/or influence. By the endof April in each year, the Ministry of Finance must prepare and deliver a report on economic andfiscal policy to the Government for the next fiscal period (a three-year period that includes thecurrent fiscal year). All spending units are required to prepare estimates of expenditure withinparameters established by the Ministry of Finance by the end of June in the same year. By 15thOctober in each year, the Ministry of Finance is required to present a draft budget to theGovernment, and, by 15th November, the Government must present the proposed budget to theParliament. If the Parliament does not approve the budget before the beginning of the fiscal yearto which such budget relates, provisional funding, on the basis of amounts approved in the budgetfor the previous fiscal year, is provided, but for no longer than the first three months of that nextfiscal year. It is a requirement of the 2003 Law that any budget deficit can be financed by domesticand external borrowing within limits established by the budget. Thus any proposed foreignborrowing must be explicitly approved in the budget or through specific legislation passed by theParliament. Budget figures are presented on a cash basis.

The following table sets out the unconsolidated Central Government Budget summary for 1999 to2002 and the expected figures for 2003:

1999 2000 2001 2002 2003*1111 1111 1111 1111 1111

(HRK millions)

Total revenue .................................... 46,335.46 44,635.67 53,503.62 70,217.92 77,783.96Total expenditure .............................. 47,379.59 50,743.53 57,812.76 74,434.16 79,702.13Current surplus ................................ 1,568.52 (2,702.44) (3,912.90) 604.99 1,909.75Current surplus (% of GDP) ............ 1.10 (1.72) (2.40) 0.34 1.01Primary Budget Balance .................. (424.17) (3,655.62) (1,330.50) (792.87) 2,117.64Primary Balance (% of GDP) .......... (0.30) (2.25) (0.82) 0.45 1.12Overall Budget Balance.................... (2,523.30) (6,107.86) (4,309.14) (4,216.23) (1,918.17)Overall Balance (% of GDP) ............ (1.76) (3.89) (2.65) (2.39) (1.01)

Source: Ministry of Finance

* 2003-expected

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The following table sets out the consolidated** Central Government Budget for ∆2000 to 2002 andthe ∆expected figures for 2003:∆

∆Budget

∆ 2000 2001 2002 2003*∆ 1111 1111 1111 1111

(HRK millions)

Total revenue and grants......................................∆ 66,735.00 70,∆845.64 ∆74,726.01 81,∆441.57Budgetary central government ............................∆ 44,635.67 52,∆747.43 ∆66,905.54 ∆74,584.86Extrabudgetary funds ..........................................∆ 22,099.33 18,09∆8.21 ∆7,820.48 ∆6,856.711.∆ Pension fund ..............................................∆ 11,254.16 5,80∆6.77 ∆128.79 830.002. Health insurance fund ................................∆ 8,967.45 10,∆314.52 ∆451.55 864.813. Employment fund........................................∆ 822.40 91∆0.95 ∆25.39 20.004. Child benefit fund ......................................∆ 7.13 5.06 0.00 0.005. Public water management fund..................∆ 1,048.20 1,0∆60.92 ∆1,093.97 1,033.006. Development and employment

fund ............................................................∆ ∆1,797.777. Regional development fund........................ 500.858. Croatian motorways.................................... 1,696.17 1,714.259. Croatian roads............................................ 1,216.12 1,356.0010. State agency for banks .............................. 617.91 885.5011. Croatian privatisation Fund ........................ 291.97 153.15Total expenditure and net lending ........................∆ 74,432.28 74,∆889.14 ∆80,670.59 ∆86,303.80Budgetary central government ............................∆ 36,730.8∆3 44,∆844.52 ∆67,882.20 ∆74,486.08Extrabudgetary funds ..........................................∆ 37,701.44 30,0∆44.63 ∆12,788.39 ∆11,817.731. Pension fund ..............................................∆ 20,180.82 12,12∆5.32 ∆1,557.83 1,775.352. Health insurance fund ................................∆ 13,918.08 13,1∆92.74 ∆1,281.55 1,123.803. Employment fund........................................∆ 995.51 983.4∆4 ∆236.69 136.954. Child benefit fund ......................................∆ 1,250.59 2,46∆6.99 0.00 0.005. Public water management fund..................∆ 1,356.44 1,∆276.15 1,∆416.61 1,384.886. Development and employment

fund ............................................................∆ ∆2,288.037. Regional development fund........................∆ ∆276.568. Croatian motorways.................................... 3,727.94 5,313.619. Croatian roads............................................ 1,153.97 1,500.9610. State agency for banks .............................. 605.85 525.9711. Croatian privatisation Fund ........................ 243.37 56.24Overall (deficit)/surplus ........................................∆ (7,697.28) (∆4,043.51) (∆5,944.58) (∆4,862.23)Total financing ......................................................∆ 7,697.28 ∆4,043.51 ∆4,010.50 ∆4,862.23Abroad..................................................................∆ 6,859.89 ∆2,220.05 ∆2,253.20 ∆7,058.64Domestic ..............................................................∆ 837.39∆ 1,823.46 ∆1,757.30 ∆(2,196.41)From other general government .......................... 0.00 0.00 0.00 0.00From monetary authorities .................................. (12.49) (389.12) 241.72 0.00From deposit money banks.................................. 1,270.16 2,362.02 1,615.89 2,392.77Other domestic financing .................................... (420.28) (149.44) (100.31) 196.37

Notes:

* Preliminary Source: Ministry of Finance

** Figures include extrabudgetary funds but exclude interdepartmental transactions

Central Government Budget for 2002

The main features of the Central Government Budget for 2002 were: (i) the integration of all fiveextrabudgetary funds into the Central Budget and treasury system, (ii) the integration of ownrevenues of budget beneficiaries into the Budget, and (iii) the further reduction of publicexpenditures and the budget deficit. Integration of extrabudgetary funds into the Central Budget

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aims to achieve enhanced transparency of the overall system, improved control and more efficientuse of public revenue collections.

Two new funds were established with an aim to provide incentives for increased employment anddevelopment, as well as for balanced regional development.

Further, the Budget for 2002 was created according to the Government Financial Statistics (“GFS”)manual and consequently was not completely comparable with previous years’ budgets. Forcomparison purposes, Central Government Budget revenues and expenditures are reclassifiedaccording to the old GFS manual.

The 2002 Budget included further efforts to reduce government spending. This was shown by thedecreased wage bill of budget beneficiaries and a further decrease of material costs. In addition,significant efforts were undertaken to reduce social expenditures, namely child benefits, maternityleave, war veterans’ benefits and certain pension system benefits. Significant savings were alsoundertaken in the health care system.

Central Government Budget Outcome for 2002

Total revenues and grants in 2002 amounted to HRK∆74.73 billion. In 2002, total expendituresamounted to HRK∆67.88 billion, resulting in a budget deficit of HRK∆5.9 billion, which was ∆3.3% ofGDP for 2002.

Revenues from value added tax totalled HRK25.95 billion, and were ∆10.4% higher than in 2001.The increase in revenues collected from value-added tax is the result of higher consumptionexpenditures in 2002. Tax on individual income revenues amounted to HRK3.36 billion, in line withtheir 2001 outcome as a result of increased tax-free thresholds. Tax on corporate income revenuesamounted to HRK2.66 billion, ∆25.6% higher than in 2001 and confirming the improved operationalresults of businesses. Excise tax revenues totalled HRK7.47 billion, ∆2.8% lower than in 2001,mostly as a result of the newly-introduced revenue sharing of the excise tax on petroleum productsin favour of Croatian Roads and Croatian Motorways companies. Petroleum excises generatedHRK3.33 billion in revenue, while tobacco excises amounted to HRK2,19 billion.

On the expenditure side, wages and contributions accounted for HRK19.∆89 billion, while purchasesof other goods and services totalled HRK11.6∆6 billion. Interest payments rose to HRK3.2∆6 billion.Transfers amounted to HRK31.∆91 billion, and subsidies to HRK2.19 billion. Capital expendituresfell to HRK3.∆06 billion.

Central Government Budget for 2003

The main features of the Central Government Budget for 2003 were (i) the further reduction of thebudget deficit, and (ii) in accordance with an arrangement with the IMF regarding the applicationof the 2000 GFS manual, the integration of four agencies namely, Croatian motorways, Croatianroads, the State agency for banks and the CPF, into the Central Budget and (iii) the full integrationof the two remaining extra – budgetary funds (Development and Employment Fund and RegionalDevelopment Fund) into the Central Budget and treasury system.

The integration of these agencies into the Central Budget aimed to achieve enhancedtransparency of the overall system, improved control and more efficient use of public revenuecollections.

On a non-consolidated basis the total revenues were planned in the amount of HRK77.78 billionand the total expenditures at HRK79.70 billion, resulting in a deficit of HRK1.92 billion (being1.01% of projected GDP for 2003).

On a consolidated basis, including the four agencies mentioned above, the total revenues wereplanned at HRK81.44 billion and the total expenditures were planned at HRK86.30 billion, resultingin a deficit of HRK4.86 billion (being 2.56% of projected GDP for 2003).

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Croatian Government Programme of Public Finance

The fundamental guideline of fiscal policy was the reduction of the overall tax burden by decreasingthe amount of public spending and balancing of the central budget.

Through fiscal policy, the Government’s aim was to encourage the development of a marketeconomy and economic growth and attempt to foster social justice. It also intended to encourageexports, develop financial markets and alter the ratio between income earning citizens and thosebeing supported by them.

Structural reforms in the pension and health sectors have been undertaken to address the growingdeficits of those sectors recorded in the late 1990s. In respect of pension reforms, see “RecentEconomic Trends – Pension Reform”, above. In respect of health reforms, work is continuing withthe assistance of the IBRD, to create a more cost effective and efficient health sector. During 2002,health insurance has been provided for approximately 500,000 people and a further 500,000people are expected to benefit from the introduction of private health insurance in 2003.

The Government was seeking to reduce transfer payments and subsidies to state-ownedcompanies and to end the practice of utilising budgetary funds to financially rehabilitate privatecompanies.The intention was to limit state guarantees to provide support for export production andcapital development in the public sector.

A state treasury system has been introduced to support fiscal responsibility, which includes the duesettlement of all liabilities to suppliers as a regular operational practice. The treasury beganoperations on 1st January 2002.

This reduction of central budgetary outlays will in turn create the possibility for the reduction of thetax burden in order to encourage economic growth. The Government reduced profit and incometaxes and made the tax system more equitable by increasing tax free thresholds.

In order to secure additional funds for the implementation of the overall programme of adaptationand the establishment of permanent growth, together with the maintenance of macroeconomic andfinancial stability, the Government intensified and expanded co-operation with internationalfinancial institutions, primarily the IMF and the IBRD, as well as the European Union. The StandbyAgreement with the IMF, announced in December 2000, and the Structural Adjustment Loan (the“SAL”), announced in January 2001 were the results of this policy. The SAL is a loan aimed atassisting the Government in meeting the costs of structural adjustments.

Extra Budgetary Funds and Agencies

In addition to the Central Government Budget, there have been five extra budgetary funds coveringseveral social services and water management. With effect from July 1998, the Child Benefit Fundhas been reintegrated into the Central Government Budget. Child benefits are now directly paid tothe beneficiaries without deducting the contributions from gross wages. The expenditure of thesocial security funds is funded from payroll tax contributions, as well as the allocation of sharesfrom the privatisation process and transfers from other levels of the Government.

In July 2001, the Government integrated pension insurance contributions and pension paymentsinto the Central Government Budget. Since January 2002, all social security funds transactionsoperate through a single treasury account.

Local Government

There are three levels of local government in Croatia: municipalities, cities and counties. Thesehave their own local taxes while at the same time they receive a proportion of income taxescollected by central Government. Surtaxes levied on income tax may be levied at the discretion ofthe local authorities.

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Local governments can incur indebtedness annual repayment of which may not exceed 20% oftheir revenues in the preceding year. Central Government can influence the revenue structure oflocal government by transfers or by its tax sharing policy. Total transfers from the centralGovernment to the local authorities in 1998 were approximately 0.32% of GDP, in 1999 wereapproximately 0.19% of GDP, in 2000 were 0.12% of GDP and in 2001 were 0.11% of GDP.

Local government budgets do not have to be approved by the Parliament. The responsibility for theexecution of the budget lies with the local authorities.

Taxation System

The Constitution stipulates that everyone in Croatia participates in the defrayment of publicexpenses in accordance with their economic capabilities and that the tax system is based onprinciples of equality and equity as well as on economic efficiency. Croatia’s tax year is thecalendar year. The country’s tax structure includes both direct taxation through income taxes andprofit taxes, and indirect taxation through value added tax. In addition, there are excise taxes, taxeson property and custom duties. Income taxes are assessed on individuals. The profit tax isessentially a corporate tax. More than 2.2 million individuals and businesses pay income and profittax in Croatia.

The Croatian tax authorities have been undertaking a very wide-ranging reform programme inorder to harmonise the country’s tax legislation and practice within EU standards and a major partof this process began in 1998.

Income Tax

Income tax is payable under the Income Tax Act which came into effect on 1st January 2001.Amendments to the Income Tax Law were adopted in December 2002 (applying as of 1st January2003) and in October 2003 (applying from the beginning of November 2003) are related towardfurther tax relief for the investments into research and development.There are four levels of incometax, 15%, 25%, 35% and 45%. Any amounts earned equal to up to twice an individual’s non-taxableamount or personal allowance (which was increased in January 2003 to HRK1,500) are taxed at15%, amounts earned between two and four and a half times an individual’s non taxable amountare taxed at 25%, amounts earned between four and a half and fourteen times an individual’s non-taxable amount are taxed at 35% and all amounts in excess of this level are taxed at 45%. Tax ispaid only on income earned through employment, self employment, capital, insurance and fromproperty or proprietary rights. Income tax is withheld at source from an employee’s monthly salary.Several types of income are excluded from taxation including war reconstruction benefits andseverance pay up to a certain amount. The following income is regarded as income from capital:receipts from dividends, income distributed to shareholders based on their share of the company’sshare capital and receipts from the interest realised in the tax period. Dividends are taxable at 15%and are withheld at source. Interest is taxable at 35% and is withheld at source. Capital gains andinterest payable on deposits at the accounts with banks and savings banks, as well as interestpayable on securities issued in accordance with a special law, are not taxable.

Income tax is also payable by the foreign taxpayers (natural persons without permanent or habitualresidence in the Republic of Croatia) on their income earned in Croatia.The payment of the interestto foreign natural persons, effected in the Republic of Croatia or effected by legal or natural personswith residence in the Republic of Croatia is subject to Income Tax, except for the interest payableon securities issued in accordance with the special law.The Income Tax Law provides for no furtherelaboration of the term “special law”. However, pursuant to the opinion of the Ministry of Financeof the Republic of Croatia, Tax Authority, Class: 410-01/00-01/932, Reg. No. 513-07/01 -13, dated2 April 2001, the interest on the securities issued in accordance with the Law on SecuritiesMarkets, which regulates the issuance of securities on foreign and domestic markets (this Law hasreplaced the Law on Issuance and Sale of Securities, Official Gazette No. 107/95, 42/98 I 87/00)is not subject to Income Tax.

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Profit Tax

Profit tax is payable under the Profit Tax Act which was amended on 1st January 2001.Amendments to the Profit Tax Law were adopted in October 2003 and are applied from thebeginning November 2003. Such amendments relate to further tax relief’s for investments inresearch and development.

Profit tax is now payable at 20% of the taxable base by “entrepreneurs”, defined as legal entitiesor natural persons independently and permanently engaged in a business activity for the purposeof gaining profit and who maintain business books and submit financial reports, while the protectiverate of interest has been abolished. Other tax amendments include the introduction of deductionsfor first year salaries of newly-employed persons, if by their employment the number of employeesof that entrepreneur is increased, and for donations (up to 2% of revenues) to certain legalpersons, while the value of equipment bought can be depreciated in the same year. In addition, awithholding tax of 15% was introduced on certain payments by entrepreneurs of certain services,dividends and interest to foreign legal entities other than interest on loans extended by foreignbanks.

However, the position of the Ministry of Finance, as currently expressed in the Profit Tax By-Law,is that withholding tax is payable on interest paid by the Republic of Croatia to foreign legal entities,other than interest on loans extended by foreign banks.The rate of 15% may be reduced (in certaincases up to zero) pursuant to a treaty on avoidance of double taxation between the Republic ofCroatia and the country of residence of the foreign holders of the Notes.

Profit taxes account for approximately 3.9% of total tax revenues.

Excise Taxes and Custom Duties

Excise taxes are levied on seven categories of product: tobacco, petroleum, alcohol, coffee, softdrinks, beer and motor vehicles. Excise taxes and custom duties are an important source ofrevenue for the Government: excise duties raise nearly 19% of total tax revenues while customsduties account for a further 9.8% of total tax revenues. Excise tax increases in 2000 will mean thatthe importance of this revenue category will increase while trade liberalisation stemming from WTOmembership and free trade agreements will ensure customs tax revenues will decline over time.

Value Added Tax

VAT came into effect on 1st January 1998, replacing the retail sales tax. The VAT rate is a uniform22% rate. Both goods and services are assessed at this rate. Exemptions apply only to medical,cultural, educational and financial services and began with the exemption for books, bread, milkand medical products and drugs on the Health Fund list as at 1st November 1999. Since 1stJanuary 2001, holiday packages booked outside Croatia have been exempt from VAT. The Ministryof Finance has estimated that the imposition of VAT in 1998 enabled the authorities to tax a partof previously unreported activities since it is far harder to evade VAT than other taxes. In 2000, VATaccounted for 54.7% of total tax revenues and in 2001 it accounted for 48.1% of total revenues. In2002, VAT accounted for 38.2% of total tax revenues.

Outline of Principal Governmental Institutions

Public enterprises or enterprises in full government ownership still constitute a significant part ofthe Croatian economy. Public enterprises appear in the following sectors: oil production anddistribution (INA), railway transportation (Croatian railways), electricity production and distribution(HEP), forests (Croatian forests), Narodne Novine (Official Gazette), postal services (CroatianPost) and also in the shipbuilding sector.

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Revenue and Expenditure of General Accounts for the Past Five Fiscal Years

Non-consolidated Central Government Budget Revenue and Expenditure on a Cash Basis

1999 2000 2001 2002 2003*1111 1111 1111 1111 1111

(HRK millions)I Total revenues and grants .................. 46,357 44,636 53,504 69,869 77,784II Total revenues .................................. 46,357 44,636 53,504 69,869 77,784III Current revenues................................ 40,046 41,535 48,906 69,651 75,077IV Tax revenues ...................................... 38,318 39,939 47,274 67,965 72,727

1. Taxes on individualincome.................................... 4,571 4,094 3,404 3,363 3,252

2. Taxes on corporateincome.................................... 2,366 1,674 1,987 2,659 2,843

3. Social securitycontributions .......................... 0 0 6,781 25,190 27,667

4. Taxes on real estatetransactions ............................ 247 259 282 295 319

5. Retail sales taxes .................. 388 153 156 513 7036. Value added tax...................... 19,830 21,825 22,267 25,953 27,3257. Excise taxes .......................... 6,161 7,673 7,699 7,474 8,052

on petroleum products............ 3,433 4,633 4,194 3,330 3,546on alcohol .............................. 168 256 276 238 269on beer .................................. 277 417 464 712 758on beverages.......................... 85 87 88 106 119on tobacco products .............. 1,970 2,074 2,099 2,192 2,471on coffee ................................ 78 93 116 124 131on luxury goods...................... 1 13 15 17 18

8. Taxes on internationaltrade ...................................... 4,288 3,795 3,215 2,051 2,067

9. Other taxes ............................ 467 465 483 469 499V Non-tax revenues .............................. 1,728 1,596 1,632 1,686 2,350VI Capital revenues ................................ 6,311 3,101 4,597 218 2,707VII Grants ................................................ 0 0 0 0 0

Non-consolidated Central Government Budget Revenue and Expenditure on a Cash Basis (cont.)

1999 2000 2001 2002 2003*1111 1111 1111 1111 1111

(HRK millions)

I Total expenditures and netlending................................................ 48,879 50,744 57,813 73,370 79,702

II. Total expenditures .............................. 47,380 49,567 56,723 71,992 77,919III. Current expenditures .......................... 38,476 44,237 52,819 68,923 73,167

1. Wages and employercontributions .......................... 14,695 15,574 14,878 19,897 20,310

2. Other purchases of goods and services ................ 7,396 8,751 7,343 11,662 11,434

3. Interest payments .................. 2,099 2,599 3,015 3,260 4,0363.1. Domestic ................................ 933 945 1,043 1,374 1,9183.2. Foreign .................................. 1,166 1,654 1,972 1,887 2,1184. Subsidies and other

current transfers .................... 14,286 17,314 27,583 34,104 37,3874.1. Subsidies ................................ 3,419 3,803 3,656 2,191 4,5244.2. Transfers ................................ 10,867 13,511 23,927 31,913 32,8634.2.1. Transfers to other levels

of Government........................ 8,458 11,679 11,318 3,776 3,3804.2.2. Transfers to non-profit

institutions .............................. 422 433 663 819 7994.2.3. Transfers to households ........ 1,341 949 11,833 27,223 28,6024.2.4. Transfers abroad .................... 646 451 112 93 81

IV. Capital expenditures .......................... 8,903 5,330 3,904 3,068 4,752V. Lending minus repayments ................ 1,499 1,176 1,089 1,377 1,783(Overall deficit)/surplus .................................. (2,522) (6,108) (4,309) (3,500) (1,918)(Current deficit)/surplus .................................. 1,570 (2,702) (3,913) 728 1,910

Notes:

* Preliminary

** Figure not available


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Consolidated Central Government Revenue and Expenditure on an Accrual Basis

Revised1999 2000 2001 Budget Budget

Actual Actual Actual 2002 20031111 1111 1111 1111 1111

(HRK millions)

Revenue and grants ........................ 61,122 62,801 48,906 70,018 75,007Current revenue................................ 61,122 62,801 48,906 70,018 75,007Tax revenue ...................................... 58,044 59,739 47,274 68,083 72,727Personal Income tax ........................ 4,571 4,095 3,404 3,406 3,252Social Security contributions ............ 19,727 20,549 6,781 25,181 27,667Profits tax.......................................... 2,366 1,674 1,987 2,634 2,843Real Estate Transactions tax ............ 247 259 282 296 319Taxes on goods and services .......... 26,379 28,902 30,107 31,560 33,286Value-added taxes ............................ 19,830 21,425 22,731 24,007 25,290Excises ............................................ 6,161 7,323 7,533 7,666 7,973- on oil products ................................ 3,433 4,633 4,194 3,401 3,537- on alcohol ...................................... 168 256 260 263 274- on beer .......................................... 277 417 463 725 754- on beverages.................................. 85 86 87 112 116- on tobacco products ...................... 1,970 2,074 2,095 2,376 2,471- on coffee ........................................ 78 93 9 117 122- on luxury goods.............................. 1 13 15 17 18- on imported motor vehicles ............ 149 101 410 655 681Other ................................................ 388 153 483 512 499Customs duties ................................ 4,288 3,795 3,820 3,839 4,179Other ................................................ 467 465 525 512 499Non-tax revenue .............................. 3,078 3,063 3,034 1,935 2,350Capital revenue ................................ 0 0 1 200 2,707Grants .............................................. 0 0 0 0 0Expenditure and net lending ............ 71,614 71,735 73,503 74,432 79,702Expenditure ...................................... 70,115 70,559 72,673 72,855 77,919Current expenditure .......................... 62,102 65,291 67,404 69,412 73,167Expenditure on goods and services 31,528 33,091 30,568 31,618 31,745Wages excl. employer’s contributions 16,686 18,143 16,709 2,901 17,234Wages and salaries .......................... 16,686 18,143 16,709 2,901 17,234Other purchases of goods and

services ........................................ 14,842 14,948 13,859 11,635 11,434Interest payments ............................ 2,334 2,879 3,645 3,423 4,036Subsidies and other current

transfers ........................................ 28,240 29,321 33,192 34,372 37,386Capital expenditure .......................... 8,013 5,268 5,269 3,442 4,751Lending minus repayments .............. 1,499 1,176 830 1,580 1,783Consolidated central government

balance ........................................ (10,491) (8,934) (8,873) (4,414) (4,695)(as % of GDP) .................................. (7.4) (5.7) (5.2) (2.5) (2.5)Consolidated central government

current balance ............................ (979.9) (2,489.8) (2,774.7) 606 1,840(as % of GDP) .................................. (0.7) (1.6) (1.6) 0.3 1.0Consolidated central government

primary balance ............................ (8,157.2) (6,055.8) (5,228.1) (991) (659)(as % of GDP) .................................. (5.7) (3.8) (3.1) (0.6) (0.4)


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PUBLIC DEBT

Outline Of Recent Debt Issues

Croatia has comparatively moderate levels of internal public and external public and private debtand had a public debt to GDP ratio of 41% for the year 2002. The conservative stance and fiscalrestraint of the Government since independence has meant that the country has not accumulatedsignificant debt and therefore is now able to use debt financing for the reconstruction of capitalprojects. A significant proportion of Croatia’s public debt was inherited from the former Yugoslavia.

Internal Debt

Croatia’s internal debt is made up of FFEDs (as described below), which are denominated in euroand payable in Kuna, bonds for restructuring (the so called “Big Bonds”) which are denominated inKuna, bonds for bank rehabilitation (“BRA bonds”), Treasury Bills and bonds issued throughsyndicates of domestic banks (“G-Bonds”). The largest component of internal debt, FFEDs,originate from the right of the former Yugoslavian citizens to hold foreign currency accounts indomestic banks. These banks were obliged to redeposit this foreign currency in the National Bankof Yugoslavia (“NBJ”) in return for domestic currency. At the time of the break up of formerYugoslavia, Croatian banks held more than HRK17.75 billion in the NBJ. The NBJ subsequentlyretained all of these funds. The Government decided to accept these commercial bank assets aspublic debt because they represented the lifetime savings of a sizeable proportion of thepopulation. However, it announced a three year freeze on the paying out of these deposits. At theend of the three years, the FFEDs were restructured with a maturity of ten years and an annuity of10% p.a. including interest of 5% FFEDs are eligible for tendering in privatisation and have beenwidely used by Croatian citizens to buy state property and equity. Due to such purchases andrepayments of principal, the outstanding stock of FFEDs had fallen from HRK17.5 billion in 1991to HRK1.62 billion at 31st December 2003.

The next component of internal debt, “Big Bonds”, are restructuring bonds that were issued tocertain state-owned companies in 1991 and 1992 in order to exchange enterprise debt to bankswith government debt. Approximately HRK5.86 billion of Big Bonds were issued. The Big Bondswere not issued in the form of tradable interest bearing securities; and therefore, banks are not ableto trade the debt actively.

The BRA Bonds are issued to the Bank Rehabilitation Agency as a capital injection to Rijecka,Splitska, Privredna and Dubrovacka banks, as part of their process of rehabilitation. A total ofHRK5.52 billion of BRA Bonds have been issued (HRK2.78 billion in 1996, HRK0.14 billion in1997, HRK1 billion in 1998 and HRK1.6 billion in 1999).

In 2001, the Government issued two series of G-Bonds totalling e400 million which are payable inKuna at the CNB’s Kuna/euro exchange rate on the maturity date. A further two tranches of a thirdseries of G-Bonds totalling e300 million were issued in 2002. Total servicing payments due oninternal debt were approximately HRK2.16 billion in 1997, representing approximately 2.5% of1997 GDP approximately HRK2.22 billion in 1998, representing approximately 1.6% of 1998 GDP,approximately HRK2.97 billion in 1999, representing approximately 2.1% of 1999 GDP,approximately HRK2.92 billion in 2000, representing approximately 1.8% of 2000 GDP andapproximately HRK2.77 billion in 2001 representing approximately 1.6% of 2001 GDP, andapproximately HRK2.99 billion in 2002 representing approximately 1.7% of 2002 GDP. All internaldebt is payable in Kuna with around 80% of the country’s internal debt linked to the euro exchangerate.

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The following table sets out historical levels of internal debt from 1999 to 2003:

Stock of internal debt, end of the year

1999 2000 2001 2002 200311111 11111 11111 11111 11111

FFED ................................................ 755.20 638.35 516.27 340.98 211.25Big Bonds I ...................................... 182.05 209.56 228.06 226.97 225.31Big Bonds II (RB,SB) ........................ 98.40 92.97 87.15 79.66 73.06Big Bonds III (PBZ) .......................... 96.28 91.50 83.97 78.38 72.39Big Bonds IV (PBZdm) .................... 20.93 0.00 0.00 0.00 0.00Reconstruction Bond ........................ 3.01 3.10 3.10 0.28 0.00BRA Bonds I (RB, SB)...................... 132.88 119.50 105.38 90.19 74.22BRA Bonds II (PBZdm) .................... 39.00 36.76 34.18 31.64 28.96BRA Bonds III (PBZk) ...................... 99.76 94.81 87.07 81.28 75.06BRA Bonds IV (PBZk5) .................... 54.48 51.34 46.79 43.30 39.64BRA Bonds V – A (DUB) .................. 50.66 3.50 2.91 2.50 2.06BRA Bonds V – B (DUB) .................. 201.47 184.74 166.81 147.61 127.04G-Bond 01 due 04 ............................ 0.00 0.00 200.00 200.00 200.00G-Bond 02 due 08 ............................ 0.00 0.00 200.00 200.00 200.00G-Bond 03 due 12 ............................ 0.00 0.00 0.00 300.00 500.00G-Bond 04 due 08 ............................ 0.00 0.00 0.00 0.00 130.77

TOTAL : ........................................ 1,734.12 1,526.13 1,761.69 1,822.79 1,959.76

Short term ........................................ 93.63 391.49 663.81 795.82 1,033.81Treasury Bills ................................ 93.63 337.53 663.81 756.85 856.30Other ST Loans ............................ 0.00 53.96 0.00 38.97 177.51TOTAL ST, MT and LT: ................ 1,827.75 1,917.62 2,425.50 2,618.61 2,993.56

Domestic bonds guaranteed by MOF 0.00 552.00 552.00 552.00 447.00Insured Deposits series I .............. 0.00 105.00 105.00 105.00 0.00Insured Deposits series II ............ 0.00 225.00 225.00 225.00 225.00Health Fund Bonds ...................... 0.00 222.00 222.00 222.00 222.00

GRAND TOTAL:............................ 1,827.75 2,469.62 2,977.50 3,170.61 3,440.56


Internal Debt Instruments

FFEDs – Represent the bonds issued to Croatian banks in exchange for their claims against theNBJ regarding their obligatory foreign currency deposits with the NBJ. Issued in 1991 and totalingHRK17.87 billion with a 5% coupon, the bonds are structured for the repayment of principal over20 semi-annual insta∆lments, the first one scheduled on 30th June 1995. These bonds are eligibleto be exchanged for privatisation assets and have been widely used by citizens to buy stateproperty and equity, thereby amortising nearly HRK7.1 billion worth by the time the first repaymentinstallment fell due. Installments and interest are payable in Kuna according to the CNB exchangerate for euro on the due date.

Big Bonds – Represent the bonds for the restructuring of the economy issued during 1991 and1992 to Croatian banks replacing their bad loans to the state owned companies. HRK5.86 billionof Big Bonds were issued. Big Bonds have a 5% or 7.2% coupon and bullet maturity in 2011 andtheir nominal value fluctuates according to the Croatian industry price index.

Reconstruction Bonds – Sold during 1992 and 1993 mainly to Croatian Diaspora. Issues weredenominated in DEM, US dollars, Canadian dollars (“CAD”) and Australian dollars (“AUD”), Bondswere structured for the repayment of the principal over 10 semi-annual installments following a twoyear grace period, with a coupon set according to that of government bond issues in related

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countries, plus a 1% margin. The total amount issued was DEM50 million, US$30 million, CAD10million and AUD17.2 million. Most of these bonds were immediately exchanged for privatisationassets.

Treasury Bills – In July 1996, the MOF established a Treasury Bills issuance programme throughpublicly announced auctions. The issues had maturities of 91,182 and 364 days.

BRA Bonds – Represent the bonds issued to the Bank Rehabilitation Agency as a capital injectionto Rijecka, Splitska, Privredna banka and Dubrovacka banka, as part of their process ofrehabilitation. These bonds were issued during 1996 in the amount of HRK2,822 million withmaturities of 10 and 15 years and carry coupons of 5%, 6% and 7.2%.

BRA Insured Deposit Bonds – Two domestic bullet bond issues, one with a three-year maturity(coupon 8.000%) and the other with a five-year maturity (coupon 8.375%) were issued in late 2000to pay out all the remaining insured deposits in bankrupt banks.

Health Fund Bonds – In 2000, the Health Fund issued a four-year maturity bullet bond with acoupon of 8.500%.

G-Bonds – In 2001, the Government issued two series of bonds through syndicates of domesticbanks. The first series was issued in September 2001 in the amount of e200 million with a maturityof three years and coupon of 6.500%. The second series was issued in December 2001 in theamount of e200 million with a maturity of seven years and coupon of 6.875%. In 2002, two tranchesof a third series were issued in the total amount of e300 million with a bullet maturity in 2012 anda coupon of 6.875%. The G-Bonds are denominated in euro and payable in Kuna according to theCNB exchange rate on the maturity date.

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The following table sets out domestic debt as at 31st December 2003:

Central Domestic Debt Stock

Stock: Maturity: Interest(HRK rate:

Debt Item: thousands)11111 11111 11111

Frozen foreign exchange deposits .......................................... 1,615,380 2005 5%Big Bonds - Series I ................................................................ 1,722,935 2011 5%Big Bonds - Series II .............................................................. 558,682 2011 7.20%Big Bonds - Series III .............................................................. 553,544 2012 7.20%G Bonds - Series 01 D-04 ...................................................... 1,529,382 2004 6.50%G Bonds - Series 02 D-08 ...................................................... 1,529,382 2008 6.875%G Bonds - Series 03 D-12 ...................................................... 3,823,455 2012 6.875%G Bonds - Series 04 D-08 ...................................................... 1,000,000 2008 6.125%Reconstruction Bond .............................................................. 0 2003 7 - 10%BRA Bonds I ............................................................................ 567,560 2007 6.00%BRA Bonds II .......................................................................... 221,461 2012 5%BRA Bonds III .......................................................................... 573,981 2012 7.20%BRA Bonds IV ........................................................................ 303,146 2012 5%BRA Bonds V-A ...................................................................... 15,725 2007 6%BRA Bonds V-B ...................................................................... 971,440 2008 7%Medium and long term debt ................................................ 14,986,073Trasury Bills ............................................................................ 6,548,061Other short term debt .............................................................. 1,357,385Short term debt...................................................................... 7,905,446BRA Insured Deposit Scheme Bonds I .................................. 0 2003 8%BRA Insured Deposit Scheme Bonds II .................................. 1,720,555 2005 8.375%Health Fund Bonds.................................................................. 1,697,614 2004 8.50%Bonds Issued with a Government Guarantee .................... 3,418,169Pension Fund Borrowings........................................................ 0Total Debt .............................................................................. 26,309,688


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The following table sets out the projected debt service of internal debt from 2003 to 2010:

Internal Debt Service Projection

2003 2004 2005 2006 2007 2008 2009 20101111 1111 1111 1111 1111 1111 1111 1111

(e millions)

Amortisation .................... 304.63 625.79 361.97 75.54 80.55 263.91 37.21 39.66FFX deposits .................. 137.41 137.41 66.16 0.00 0.00 0.00 0.00 0.00Big Bonds I...................... 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00Big Bonds II (RB, SB) .... 6.69 7.17 7.68 8.22 8.79 9.39 10.02 10.68Big Bonds III (PBZ) ........ 5.99 6.43 6.90 7.41 7.95 8.54 9.16 9.83BRA Bonds I (RB, SB) .... 15.98 16.95 17.98 19.06 20.19 0.00 0.00 0.00BRA Bonds II (PBZdm .... 2.68 2.81 2.95 3.10 3.26 3.42 3.60 3.78BRA Bonds III (PBZk) .... 6.21 6.67 7.16 7.68 8.25 8.85 9.50 10.20BRA Bonds IV (PBZk5 .... 3.66 3.85 4.04 4.25 4.46 4.69 4.93 5.17BRA Bonds V – A (DUB) 0.44 0.47 0.50 0.53 0.56 0.00 0.00 0.00BRA Bonds V – B (DUB) 20.57 22.03 23.60 25.29 27.09 29.02 0.00 0.00G-Bond 01 – due 2004.... 0.00 200.00 0.00 0.00 0.00 0.00 0.00 0.00G-Bond 02 – due 2008.... 0.00 0.00 0.00 0.00 0.00 200.00 0.00 0.00G-Bond 03 – due 2012.... 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00HZZO bonds.................... 0.00 222.00 0.00 0.00 0.00 0.00 0.00 0.00BRA Bond Ins Dep I........ 105.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00BRA Bond Ins Dep II ...... 0.00 0.00 225.00 0.00 0.00 0.00 0.00 0.00

Interest payments............ 171.15 151.74 108.62 82.44 77.42 72.30 54.71 52.24FFX deposits .................. 16.19 9.40 2.61 0.00 0.00 0.00 0.00 0.00Big Bonds I...................... 11.80 11.80 11.80 11.80 11.80 11.80 11.80 11.80Big Bonds II (RB,SB) ...... 5.60 5.12 4.60 4.05 3.47 2.86 2.22 1.55Big Bonds III (PBZ) ........ 5.54 5.10 4.63 4.12 3.58 2.99 2.37 1.70BRA Bonds I (RB, SB) .... 5.25 4.20 3.17 2.09 0.96 0.00 0.00 0.00BRA Bonds II (PBZdm) .. 1.55 1.41 1.27 1.12 0.96 0.80 0.63 0.44BRA Bonds III (PBZk) .... 5.74 5.29 4.80 4.27 3.71 3.10 2.45 1.76BRA Bonds IV (PBZk5) .. 2.12 1.93 1.74 1.54 1.32 1.09 0.86 0.61BRA Bonds V – A (DUB) 0.14 0.12 0.09 0.06 0.03 0.00 0.00 0.00BRA Bonds V – B (DUB) 9.98 8.53 6.94 5.26 3.46 1.53 0.00 0.00G-Bond 01 – due 2004.... 13.00 13.00 0.00 0.00 0.00 0.00 0.00 0.00G-Bond 02 – due 2008.... 13.75 13.75 13.75 13.75 13.75 13.75 0.00 0.00G-Bond 03 – due 2012.... 34.38 34.38 34.38 34.38 34.38 34.38 34.38 34.38HZZO bonds.................... 18.87 18.87 0.00 0.00 0.00 0.00 0.00 0.00BRA Bond Ins Dep I........ 8.40 0.00 0.00 0.00 0.00 0.00 0.00 0.00BRA Bond Ins Dep II ...... 18.84 18.84 18.84 0.00 0.00 0.00 0.00 0.00

Total: ................................ 475.78 777.53 470.59 157.98 157.97 336.21 91.92 91.90


External Debt

Croatia had an estimated external debt to GDP ratio of 70.3% as at 30th September 2003.Approximately one third of Croatia’s foreign debt has been inherited from the former Yugoslavia.The allocation of the former Yugoslavia’s debt and assets among the successor states has provento be a complex matter, especially given the fact that the FRY seized all of the former Yugoslavia’sassets and claimed them as successor to the country.

At the end of August 2003, external debt of the Republic of Croatia reached US$18.7 billion, whichcorresponds to an increase of US$3.3 billion or 21.7% compared to the balance recorded at theend of 2002. As regards debt sectors, in the first eight months of 2003 the largest contributions tothe increase in total external debt arising from net transactions (excluding cross-currency changes)were made by banks. In the stated period, banks’ external debt arising from net transactions roseby US$1.0 billion, of which US$ 0.7 billion relates to a debt increase based on net transactions

143

arising from loans, while the remaining amount relates to a debt increase for currency anddeposits. The government sector follows, in which external debt arising from net transactions grewby US$0.6 billion in the stated period, mainly due to movements in net transactions arising fromforeign bonds (portfolio investments).

Debt increase on the basis of the Republic of Croatia’s bonds issued in the international capitalmarkets over the first eight months of 2003 amounted to US$0.8 billion (eurobonds equivalent toUS$542 million were issued in the first quarter of 2003 and bonds denominated in JPY equivalentto US$212 million were issued in the second quarter of 2003), while principal payments arisingfrom the foreign issues of government bonds stood at US$0.2 billion (two semi-annual annuitiesdue and payable to the London Club).

An increase in external debt of other sectors on the basis of net transactions amounted to US$0.8billion, of which the largest part can be accounted for by an increase in net long term loans (US$0.5billion). Net portfolio investment increase mainly relates to the foreign issue of US$202 million Bina-Istra corporate bonds in the first quarter of 2003. Growth in external debt of the Republic of Croatiaon the basis of cross-currency changes amounted to US$0.5 billion in the January-August 2003period. Cross-currency changes reflect the fact that the largest part of the external debt of theRepublic of Croatia is reported in euro (the share of euro in total external debt excluding non-residents deposits, was 70.8%), which was effected by depreciation of the US dollar exchange rateagainst the euro of 4.8%, recorded at end-August 2003 in comparison with the US dollar/euroexchange rate at end-December 2002.

The share of external debt in the projected GDP for 2003 amounted to 67% as at 31st August2003, which is a 1.5% decrease compared to the indicators for end-2002 (68.5%).

The following table sets forth external debt ratios for 1999 to 2003:

External Debt Ratios

1999 2000 2001 2002 200311111 11111 11111 11111 11111

(%)

Outstanding External Debt / GDP .... 52.6 57.0 57.5 68.5 70.3Total Debt Service/Exports of

Goods and Services .................... 29.3 29.0 27.8 26.0 24.5*January-September

Source: CNB

The basic formula for the allocation of former federal liabilities (which the successor states expectto be used for allocating assets too) was devised by the IMF in order to distribute the formerYugoslavia’s quota in the organisation. The division was based on a GDP per capita formula underwhich Croatia inherited 28.49% of the former Yugoslavia’s assets and liabilities. Of the otherrepublics, Slovenia’s share is 16.39%, Bosnia-Herzegovina’s share is 13.20%, Macedonia’s shareis 5.40% and the FRY’s is the remaining 36.52%.

Paris Club

On 21st March 1995, Croatia concluded a debt restructuring agreement with 15 member countriesof the Paris Club relating to debt originating from the payment obligations of the former Yugoslavia.Under the terms of the agreement, Croatia agreed to pay debts of the former Yugoslavia owed orguaranteed by entities located on Croatian territory (“allocated debt”) and 28.49% of debts owedor guaranteed by the former Yugoslavia and not attributable to any successor republic (“non-allocated debt”). The debt was restructured over 14 years with a two year grace period. The firstpayment was made on 31st January 1998, and the final payment will be made on 31st July 2009.

The representatives of the governments of each of the participating creditor countries and theGovernment of Croatia agreed to recommend to their respective governments or appropriate

144

institutions that they initiate bilateral negotiations at the earliest opportunity and conduct them onthe basis of the principles set forth in the Paris Club agreement. By September 1999, bilateralagreements had been finalised and/or signed with 14 out of the 15 bilateral creditors (Germany,France, the United Kingdom, Kuwait, Switzerland, Spain, the United States, Belgium, Netherlands,Austria, Norway, Japan, Denmark and Sweden).Texts of the agreements have not been exchangedwith the remaining creditor country, Italy.

Arrears and current payments have been paid in accordance with the Paris Club agreement tocreditor countries.

London Club

Croatia reached an agreement on 26th April 1996 with the International Coordinating Committee(“ICC”) of the Bank Creditors of the former Yugoslavia. Under such agreement, Croatia assumed29.5% of Refinancing Loans under the New Financing Agreements (“NFA”), dated 20th September1988, and 19.7% of the Trade and Deposit Facility Agreement (“TDFA”), dated 20th September1988. On 31st July 1996, this debt (amounting to US$1.46 billion) was exchanged for CroatianSeries A and B Bonds.

As at 31st December 2002, Series A Bonds amounted to US$623.85 million which was equal tothe outstanding amount of 29.5% of the unmatured instal∆ments of principal of the RefinancingLoans held by Participating Creditors. Series B Bonds amounted to the outstanding amount ofUS$332.88 million and included: (i) 29.5% of the principal installments which matured on or priorto the Exchange Date on the Refinancing Loans held by such Participating Creditors, (ii) 29.5% ofthe interest accrued but not paid as of the exchange date on the Refinancing Loans held byParticipating Creditors, (iii) interest on interest and (iv) 19.7% of the TDFA amount held byParticipating Creditors. Both Bonds are listed on the Luxembourg Stock Exchange. Series A Bondshave a 3.5 year grace period and amortise over 22 semi-annual installments. Series B Bondsamortise over 20 semi-annual increasing installments.

After signing an agreement with the London Club in July 1996, Croatia resumed normal relationswith all its foreign creditors.

Debt Issues

By reaching the agreement with the member countries of the Paris Club and bank members of theLondon Club, the grounds for Croatia’s emergence on the international capital markets wereestablished.

In July 1997, Croatia issued its first eurobond denominated in DEM in the amount of DEM300million, with an interest rate of 6.125% and a maturity of 2004. The bonds were issued with aspread of 0.95% above the corresponding German government bonds.

In March 1999, Croatia issued eurobonds in the amount of e300 million, with a maturity of 2006and an interest rate of 7.375%. The bonds were issued with a spread of 3.75% above thecorresponding seven year German government bonds.

On 10th June 1999, a syndicated loan agreement in the amount of US$75 million was signed forthe financing of the construction of the motorway between Bregana Zagreb Dubrovnik. The loanmatured in 2003.

On 14th December 1999, Croatia completed a JPY 25 billion Samurai issue in Japan with a 4.0%coupon and a maturity date of 14th December 2004. Interest is paid semi-annually on 14th Juneand 14th December of each year. These bonds were issued with a spread of 2.84% above thecorresponding five year yen Libor.

145

In March 2000, Croatia issued its second eurobond in the amount of e500 million, with a maturityof 2005 and an interest rate of 7.00%. The bonds were issued with a spread of 2.10% above thecorresponding five year German government bonds.

In July 2000, Croatia issued a JPY 40 billion Samurai with a 3.0% coupon and maturity date of 11thJuly 2007. These bonds were issued with a spread of 1.35% above the corresponding seven yearyen Libor.

On 6th February 2001, Croatia launched a JPY 25 billion Samurai issue with a 2.5% coupon anda maturity date of 23rd February 2006. These bonds were launched with a spread of 1.52% abovethe corresponding five year yen Libor.

On 14th March 2001, Croatia issued its third eurobond in the amount of e500 million, maturing in2011 and with an interest rate of 6.75%. The bonds were issued at a spread of 2.15% above thecorresponding 10 year German Government bond. On 16th July 2001, the Republic of Croatiaincreased the issue to the amount of e750 million at a spread of 1.83% above the correspondingGerman Government Bond.

On 28th January 2002, the Republic of Croatia issued its fourth eurobond in the amount of e500million, with maturity in 2009 and an interest rate of 6.25%. The bonds were issued at a spread of1.58% above the corresponding seven year German Government Bond.

On 26th June 2002, Croatia launched a JPY 25 billion Samurai issue with a 2.15% coupon and amaturity date of 26th June 2008. These bonds were launched with a spread of 1.44% above thecorresponding six year yen Libor.

On 20th February 2003, Croatia issued its fifth eurobond in the amount of e500 million, withmaturity in 2010 and an interest rate of 4.625%. The bonds were launched at a spread of 0.95%above the corresponding seven year euro mid swap rate.

In July 2003, Croatia issued the fifth series of Samurai bonds worth JPY 25bn (US$212.3m),maturing in 2009. The placement was made with a coupon interest rate of 1.23% and a spread of0.99% above the six-year Japanese Yen LIBOR.

146

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147

Total External Debt

The following table sets out a breakdown of the total external debt as at 31st December for theyears 1999, 2000, 2001 and 2002, and as at 30th September 2003:

Million US dollars1111111111111111111111111111111111111111111111111111111123

1999 2000 2001 2002 2003311111111111111111111111111

Dec. Dec. Dec. Dec. Mar. Jun. Jul. Aug. Sep.11111 11111 11111 11111 11111 11111 11111 11111 11111

1. Direct investment 348.6 626.6 635.0 1,056.9 1,282.3 1,469.0 1,560.1 1,509.8 1,600.92. Government........ 3,975.3 4,828.4 5,132.6 6,360.9 6,894.5 7,371.2 7,367.1 7,184.0 7,508.02.1 Portfolio

investment .......... 2,522.9 3,141.2 3,677.1 4,357.1 4,882.3 5,286.2 5,211.2 5,089,0 5,289.1Bonds .................... 2,522.9 3,141.2 3,677.1 4,357.1 4,882.3 5,286.2 5,211.2 5,089.0 5,289.1Money market

instruments ........ 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.02.2 Other investment 1,452.4 1,687.2 1,455.5 2,003.9 2,012.2 2,085.1 2,155.9 2,095.0 2,218.92.2.1 Trade credits.. 3.3 0.1 1.1 1.3 1.0 1.0 0.8 0.8 0.8Long-term .............. 0.6 0.1 1.1 1.3 1.0 1.0 0.8 0.8 0.8Short-term .............. 2.7 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.02.2.2 Credits .......... 1,449.1 1,687.1 1,454.4 2,002.6 2,011.2 2,084.1 2,155.1 2,094.2 2,218.1Long-term .............. 1,373.8 1,327.1 1,454.4 2,002.6 2,011.2 2,084.1 2,155.1 2,094.2 2,218.1Short-term .............. 75.3 360.0 0.0 0.0 0.0 0.0 0.0 0.0 0.03. Croatian National

Bank .................. 196.6 158.7 122 1 0.0 0.0 0.0 0.0 0.0 0.0o/w: IMF.................. 196.6 158.7 122.1 0,0 0.0 0.0 0.0 0.0 0.04. Banks ................ 2,134.8 2,086.5 2,299.4 4,019.8 4,473.4 5,002.5 5,409.9 5,185.2 5,684.14.1. Portfolio

investment .......... 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Bonds .................... 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Money market

instruments ........ 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.04.2 Other investment 2,184.8 2,086.5 2,299.4 4,019.8 4,473.4 5,002.5 5,409.9 5,185.2 5,684.14.2.1 Currency and

deposits .............. 537.7 432.8 633.5 1,975.7 2,130.0 2,737.1 2,709.2 2,376.3 2,707.94.2.2 Credits .......... 1,647.1 1,653.7 1,665.9 2,044.2 2,343.4 2,265.4 2,700.8 2,808.9 2,976.2Long-term .............. 1,627.0 1,640.0 1,657.7 2,037.0 2,334.0 2,257.0 2,646.6 2,756.1 2,912.9Short-term .............. 20.1 13.7 8.2 7.2 9.4 8.4 54.2 52.9 63.35. Other sectors...... 3,272.6 3,354.6 3,127.5 3,945.6 4,345.3 4,717.1 4,870.6 4,831.7 5,179.85.1 Portfolio investment 48.5 38.4 54.8 167.7 374.7 408.9 410.7 391.6 428.8Bonds .................... 31.1 28.9 27.3 167.7 374.7 398.6 399.3 380.8 398.5Money market

instruments ........ 17.4 9.5 27.4 0.0 0.0 11.3 11.3 10.8 30.35.2 Other investment 3,224.1 3,316.3 3,072.8 3,778.0 3,970.7 4,307.1 4,460.0 4,440.2 4,751.05.2.1 Trade credits.. 383.9 334.0 293.7 324.8 321.6 328.5 326.2 313.5 326.5Long-term .............. 298.5 269.5 239.9 275.3 270.0 272.3 271.6 258.1 261.5Short-term .............. 85.4 64.4 53.8 49.5 51.6 56.3 54.7 55.5 65.05.2 2 Credits .......... 2,840.2 2,982.3 2,779.1 3,453.2 3,649.0 3,978.6 4,133.7 4,126.6 4,424.4Long-term .............. 2,611.6 2,838.0 2,691.6 3,358.6 3,469.2 3,809.7 3,951.3 3,926.6 4,226.2Short-term .............. 228.6 144.3 87.5 94.6 179.9 168.9 182.5 200.0 198.3Total (1+2 + 3+4+5) 9,977.9 11,054.8 11,316.6 15,383.3 16,995.5 18,559.7 19,207.8 18,710.7 19,972.7

Source: CNB

148

The following table sets out a currency composition of the total external debt as at 31st Decemberfor the period 1999 to 2002:

Currency Composition of External Debt

1999 2000 2001 20021111 1111 1111 1111

(%)Eurozonee.................................................................. 54.5 55.7 61.6 66.7thereof originally denominated in:

ATS (Austrian Schillings) ........................ 10.4 21.5 35.8 66.7BEF (Belgium Francs) ............................ 4.8 4.1 4.1 –DEM........................................................ 0.1 0.1 0.1 –ESP (Spanish Pesetas) .......................... 36.0 27.3 19.9 –FIM (Finnish Markkaa) .......................... 1.0 0.8 0.0 –FRF (French Francs) .............................. 0.1 0.0 0.0 –ITL (Italian Lira) ...................................... 0.8 0.6 0.5 –NLG (Netherland Guilders) .................... 0.7 0.6 0.5 –

US$ ............................................................ 36.8 33.3 27.4 21.7Other .......................................................... 8.7 11.0 11.0 11.6CHF (Swiss Francs) .................................. 2.9 3.1 2.5 2.4GBP (British Sterling) ................................ 0.5 0.4 0.2 0.3JPY (Japanese Yen) .................................. 3.0 5.8 6.9 7.9NOK (Norwegian Kroner) .......................... 0.2 0.2 0.1 0.1XDR (Special Drawing Rights (IMF)) .......... 2.1 1.5 1.2 0.8Other .......................................................... 0.0 0.1 0.1 0.1

1111 1111 1111 1111

Total .......................................................... 100.0 100.0 100.0 100.0Source: CNB

Payment Schedule of Total External Debt

Project Servicing of Medium and Long Term External Debt

Estimates of Croatia’s foreign debt servicing over the next few years will be subject to adjustmentuntil completion of all bilateral agreements with Paris Club countries. All the agreements have beenreached except for the agreement with Italy. The current projected servicing of medium and longterm outstanding external debt is provided in the following table:

149

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150

The estimates of future principal and interest payments on the previous page indicate thatpayments of US$2.3 billion and US$0.7 billion will fall due during 2004. In 2004, governmentforeign liabilities will be significantly larger than in 2003 due to the repayment of the foreign bondissues described below. According to the balance of external debt as at 31st August 2003, theestimated value of principal maturing in 2004 is US$0.9 billion, which is a US$0.5 billion or 128.1%increase compared to the amortised and estimated principal payments in 2003. More specifically,two foreign bond issues will fall due in the second half of 2004: euro-DEM bonds issued in 1997(DEM 300 million or e153 million) and an issue denominated in JPY from 1999 (JPY 25 billion or,according to the midpoint Kuna/JPY and Kuna/euro bilateral exchange rate from the CNBexchange rate list No. 180, e192 million). The estimated government interest payment will alsoincrease by US$70 million or 23% in 2004 in comparison with the previous year.

Payment History of External Debt

Croatia has honoured in full all of the external debt it has contracted or guaranteed since itsindependence on 25th June 1991.

Of the Government debt of US$2.29 billion outstanding as at 31st December 1996, US$1.79 billionwas previously rescheduled debt assumed by the Government (Paris Club non-allocated debt ofUS$0.3 billion, assumed in March 1995 and London Club allocated debt of US$1.46 billion,assumed in July 1996). This debt has been rescheduled and serviced as agreed upon. Byassuming the London Club debt, Croatia was released from the joint and several liability for theindebtedness to banks of the former Yugoslavia.

The Government also assumed the allocated debt owed to international financial institutions by theformer Yugoslavia, amounting to US$82.2 million, which has been paid.

The primary obligations plus guaranteed obligations assumed to Paris Club creditors amounted toUS$0.6 billion as at September 2003. This debt has been rescheduled and serviced according tothe respective agreements. Croatia has honoured all of its assumed obligations under itsrescheduling agreements.

151

The following table sets out a breakdown of the total external debt as at 31st December for theyears 1999 to 2002 and from March to September 2003:

Million US dollars1111111111111111111111111111111111111111111111111111111123

1999 2000 2001 2002 2003311111111111111111111111111

Dec. Dec. Dec. Dec. Mar. Jun. Jul. Aug. Sep.11111 11111 11111 11111 11111 11111 11111 11111 11111

1. Portfolio investment .......... 2,571.4 3,179.6 3,731.8 4,524.8 5,257.0 5,696.1 5,621.8 5,480.6 5,717.9

Bonds .................... 2,554.0 3,170.1 3,704.4 4,524.8 5,257.0 5,684.8 5,610.5 5,469.8 5,687.6o/w: London Club .. 1,380.9 1,255.4 1,106.0 956.7 876.1 876.1 795.5 795.5 795.5Money market

instruments ........ 17.4 9.5 27.4 0.0 0.0 11.3 11.3 10.8 30.32. Other investment 7,406.5 7,875.2 7,584.8 10,858.5 11,738.5 12,863.6 13,585.9 13,230.1 14,254.82.1. Currency and

deposits .............. 537.7 432.8 633.5 1,975.7 2,130.0 2,737.1 2,709.2 2,376.3 2,707.92.2. Long-term ........ 6,442.8 6,781.7 6,769.0 8,675.2 9,189.2 9,714.1 10,360.5 10,342.3 11,010.02.2.1. Public creditors 2,157.6 2,269.1 2,230.4 2,569.1 2,648.9 2,750.0 2,773.3 2,704.5 2,806.8a) International

financial organizations ...... 1,032.8 1,128.6 1,166.1 1,376.9 1,416.9 1,428.5 1,472.6 1,454.6 1,506.6

-IMF ........................ 196.6 158.7 122.1 0.0 0.0 0.0 0.0 0.0 0.0-IBRD...................... 396.3 417.7 468.8 611.0 618.5 629.4 638.4 622.6 634.7-IFC ........................ 28.6 71.9 85.6 132.3 131.2 105.3 105.4 101.6 101.6- EBRD .................. 219.1 296.8 318.7 374.9 405.3 408.5 426.9 409.8 431.5-EUROFIMA .......... 78.5 85.6 82.7 109.4 111.6 115.1 115.2 110.4 115.4-EIB ........................ 98.2 74.0 52.2 84.8 84.1 97.4 102.1 124.7 132.1-CEB ...................... 15.4 24.0 36.0 64.5 66.2 72.7 84.6 85.5 91.4b) Governments

and government agencies ............ 1,124.9 1,140.5 1,064.3 1,192.2 1,232.0 1,321.5 1,300.7 1,249.9 1,300.2

- Paris Club ............ 771.9 687.5 622.4 631.2 613.9 630.7 607.8 588.9 605.8-Other .................... 353.0 453.0 441.9 561.1 618.2 690.8 692.8 660.9 694.52 2.2. Private

creditors.............. 4,285.1 4,512.6 4,538.6 6,106.1 6,540.3 6,964.1 7,587.2 7,637.8 8,203.2a) Banks ................ 3,366.8 3,397.6 3,477.9 4,707.6 5,153.6 5,425.7 6,003.8 6,089.3 6,554.6o/w: guaranteed by

government agencies ............ 441.2 634.6 733.9 686.2 615.3 582.2 581.8 557.5 563.2

b) Other sectors .... 918.3 1,115.0 1,060.6 1,398.5 1,386.8 1,538.4 1,583.4 1,548.5 1,648.6o/w: guaranteed by


2.3. Short-term ...... 426.1 660.8 182.3 207.7 419.3 412.5 516.3 511.5 536.92.3.1. Public

creditors.............. 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.02.3 2. Private

creditors.............. 426.1 660.8 182.3 207.7 419.3 412.5 516.3 511.5 536.9a) Banks ................ 246.5 486.5 62.5 49.7 123.6 105.8 163.5 181.3 196.9o/w: guaranteed by


u) Other sectors .... 179.6 174.3 119.9 158.0 295.8 306.7 352.8 330.2 340.0o/w: guaranteed by


Total (1+2) .............. 9,977.9 11,054.8 11,316.6 15,383.3 16,995.5 18,559.7 19,207.8 18,710.7 19,972.7

Source: CNB

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TAXATION

The following is a general description of certain tax considerations relating to the Notes. Itdoes not purport to be a complete analysis of all tax considerations relating to the Notes,whether in the countries referred to below or elsewhere. Prospective purchasers of Notesshould consult their own tax advisers as to which countries’ tax laws could be relevant intheir particular circumstances to acquiring, holding (including, without limitation, thepayment, receipt or accrual of interest, principal and/or amounts under the Notes), anddisposing of Notes, the consequences of such actions under the tax laws of the relevantcountries and their obligations under the tax laws of the relevant countries. This summaryis based upon the law and tax authority practice of the countries referred to below as ineffect on the date of this Offering Circular and is subject to any change in law or practicethat may take effect after such date.

The Republic of Croatia

Under existing Croatian laws and regulations, payments of principal and interest on the Notes orunder the Guarantee to any individual or legal entity which is not resident or incorporated in Croatiawill not be subject to taxation in the Republic of Croatia, and no withholding of any Croatian tax willbe required on any such payments.

No Croatian tax will be payable in respect of any gain, whether realised or unrealised, made by aholder (which is not resident or incorporated in the Republic of Croatia) in respect of any Notes.No stamp, registration or similar duties or taxes will be payable in the Republic of Croatia byNoteholders in connection with the issue or transfer of the Notes. However, subject to anyapplicable double taxation treaty, any natural or legal person who inherits or receives gifts(including Notes) in the Republic of Croatia is under an obligation to pay Croatian tax in respect ofsuch inheritance or gift.

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SUBSCRIPTION AND SALE

Subject to the terms and on the conditions contained in a Programme Agreement dated 6thOctober 2000, as amended and restated on 23rd January 2004 (the “Programme Agreement”)between the Issuer, the Arranger and the Permanent Dealers, the Notes will be offered on acontinuous basis by the Issuer to the Permanent Dealers. However, the Issuer has reserved theright to sell Notes directly on its own behalf to Dealers that are not Permanent Dealers or to otherDealers procured by it. The Notes may be resold at prevailing market prices, or at prices relatedthereto, at the time of such resale, as determined by the Relevant Dealer. The Notes may also besold by the Issuer through the Dealers, acting as agents of the Issuer. The Programme Agreementalso provides for Notes to be issued on a syndicated basis that are jointly and severallyunderwritten by two or more Dealers.

The commissions payable to each Relevant Dealer in respect of Syndicated Issues will be statedin the Pricing Supplement. The Issuer has agreed to reimburse the Arranger for certain of itsexpenses incurred in connection with the establishment of the Programme and the Dealers forcertain of their activities in connection with the Programme.

The Issuer has agreed to indemnify the Dealers against certain liabilities in connection with theoffer and sale of the Notes. The Agreement entitles the Dealers to terminate any agreement thatthey make to subscribe Notes in certain circumstances prior to payment for such Notes beingmade to the Issuer.

United States

The Notes have not been and will not be registered under the Securities Act. Notes in bearer formhaving a maturity of more than one year are subject to US tax law requirements. Subject to certainexceptions, Notes may not be offered, sold or delivered within the United States or its possessionsor to US persons. Each of the Dealers has agreed that it will not offer, sell or deliver a Note inbearer form within the United States or to US persons, except as permitted by the ProgrammeAgreement.

In addition, until 40 days after the commencement of the offering, an offer or sale of Notes withinthe United States by any dealer (whether or not participating in the offering) may violate theregistration requirements of the Securities Act.

Each issuance of index-, commodity- or currency-linked Notes may be subject to such additionalUS selling restrictions as the relevant Dealer may agree with the Issuer as a term of the issuanceand purchase or, as the case may be, subscription of such Notes. Each Dealer has agreed that itshall offer, sell and deliver such Notes only in compliance with such additional US sellingrestrictions.

United Kingdom

Each Dealer has represented and agreed that:

(a) in relation to Notes which have a maturity of one year or more, it has not offered or sold and,prior to the expiry of the period of six months from the Issue Date of such Notes, will not offeror sell any such Notes to persons in the United Kingdom except to persons whose ordinaryactivities involve them in acquiring, holding, managing or disposing of investments (asprincipal or agent) for the purposes of their businesses or otherwise in circumstances whichhave not resulted and will not result in an offer to the public in the United Kingdom within themeaning of the Public Offers of Securities Regulations 1995 (as amended);

(b) in relation to any Notes which must be redeemed before the first anniversary of the date oftheir issue, (i) it is a person whose ordinary activities involve it in acquiring, holding,managing or disposing of investments (as principal or agent) for the purposes of its business

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and (ii) it has not offered or sold and will not offer or sell any Notes other than to personswhose ordinary activities involve them in acquiring, holding, managing or disposing ofinvestments (as principal or as agent) for the purposes of their businesses or who it isreasonable to expect will acquire, hold, manage or dispose of investments (as principal oragent) for the purpose of their businesses where the issue of the Notes would otherwiseconstitute a contravention of section 19 of the FSMA by the Issuer;

(c) it has only communicated or caused to be communicated and will only communicate orcause to be communicated any invitation or inducement to engage in investment activity(within the meaning of Section 21 of the FSMA) received by it in connection with the issueor sale of any Notes in circumstances in which Section 21 (1) of the FSMA does not applyto the Issuer; and

(d) it has complied and will comply with all applicable provisions of the FSMA with respect toanything done by it in relation to the Notes in, from or otherwise involving the UnitedKingdom.

Republic of Croatia

Each Dealer has represented and agreed in respect of the Notes issued under the Programme thatit will comply with any laws, regulations or guidelines of the Republic of Croatia from time to time,including, but not limited to, any regulations made by the Croatian National Bank, in relation to theoffer, sale, delivery or transfer of such Notes or the distribution of any offering material in respectof the Notes to Croatian persons.

Federal Republic of Germany

Each Dealer has agreed not to offer or sell Notes in the Federal Republic of Germany other thanin compliance with the Securities Selling Prospectus Act (Wertpapier-Verkaufsprospektgesetz) of13 December 1990 (as amended), or any other laws applicable in the Federal Republic ofGermany governing the issue, offering and sale of securities.

Japan

The Notes have not been and will not be registered under the Securities and Exchange Law ofJapan (the “Securities and Exchange Law”). Accordingly, each of the Dealers has represented andagreed that it has not, directly or indirectly, offered or sold and will not directly or indirectly, offer orsell any Notes in Japan or to a resident of Japan except pursuant to an exemption from theregistration requirements of, and otherwise in compliance with the Securities and Exchange Lawand other relevant laws and regulations of Japan. As used in this paragraph, “resident of Japan”means any person resident in Japan, including any corporation or other entity organized under thelaws of Japan.

General

These selling restrictions may be modified by the agreement of the Issuer and the Dealersfollowing a change in a relevant law, regulation or directive. Any such modification will be set out inthe Pricing Supplement issued in respect of the issue for Notes to which it relates or in asupplement to this Offering Circular.

No action has been taken in any jurisdiction that would permit a public offering of any of the Notes,or possession or distribution of the Offering Circular or any other offering material or any PricingSupplement, in any country or jurisdiction where action for that purpose is required.

Each Dealer has agreed that it will, to the best of its knowledge, comply with all relevant laws,regulations and directives in each jurisdiction in which it purchases, offers, sells or delivers Notes

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or has in its possession or distributes the Offering Circular, any other offering material or anyPricing Supplement and none of the Issuer nor any other Dealer shall have responsibility therefor.

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GENERAL INFORMATION

1. Listing

In connection with the application to list the Notes issued under the Programme on theLuxembourg Stock Exchange and any application which may be made to list Notes issued underthe Programme on the Zagreb Stock Exchange, copies of the HBOR Law and the Statutes of theIssuer will be deposited with the Register of Commerce and Companies in Luxembourg (Registrede Commerce et des Sociétés à Luxembourg), the Zagreb Stock Exchange and the Zagreb ListingAgent where such documents may be examined and copies obtained. A copy of this OfferingCircular will also be deposited with the Zagreb Listing Agent where it may be examined and fromwhom copies may be obtained.∆The Luxembourg Stock Exchange has allocated the number 12419to the Programme for listing purposes. However, Notes listed on the Zagreb Stock Exchange andunlisted Notes may also be issued pursuant to the Programme.

2. Authorisations and Consents

Each of the Issuer and the Guarantor has obtained all necessary consents, approvals andauthorisations in the Republic of Croatia in connection with the issue and performance of the Notesand the giving of the Guarantee. The establishment of the Programme and the issue of Notesthereunder was authorised by a resolution of the Managing Board of the Issuer on 13th July 1999and the Guarantee was given pursuant to the HBOR Law and a Decision of the Government of theRepublic of Croatia dated 26th July 2000.

3. No Significant or Material Change

There has been no significant change in the financial or trading position of the Issuer since 31stDecember 2002 and no material adverse change in the financial position or prospects of the Issuersince 31st December 2002.

4. No Litigation

Neither the Issuer nor the Guarantor is involved in any litigation or arbitration proceedings relatingto claims or amounts that are material in the context of the issue of the Notes nor so far as theIssuer or the Guarantor is aware is any such litigation or arbitration pending or threatened.

5. Clearing Systems

The Notes have been accepted for clearance through Euroclear and Clearstream, Luxembourg.The Common Code and the International Securities Identification Number (ISIN) (and any otherrelevant identification number for any alternative clearing system) for each Series of Notes will beset out in the Pricing Supplement.

6. Accepting Deposits in the United Kingdom

With respect to any Tranche of Notes (including Notes denominated in sterling) which have amaturity of less than one year and in respect of which the issue proceeds are to be accepted bythe Issuer in the United Kingdom or whose issue would otherwise constitute a contravention ofsection 19 of the FSMA, the Issuer will issue such Notes only if (a) the Dealers covenant in theterms set out in paragraph (iii) of the United Kingdom selling restrictions set out in the “Subscriptionand Sale” section of this Offering Circular and (b) the redemption value of each such Note is notless than £100,000 (or an amount of equivalent value denominated wholly or partly in a currencyother than sterling), and (c) no part of any Note may be transferred unless the redemption value ofthat part is not less than £100,000 (or such an equivalent amount).

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7. Report and Accounts

Copies of the latest audited non-consolidated annual report and accounts of the Issuer may beobtained, and copies of the Agency Agreement, the Deed of Covenant and the Guarantee will beavailable for inspection free of charge at the specified offices of each of the Paying Agents(including the Paying Agent in Luxembourg) during normal business hours, so long as any of theNotes is outstanding. The Issuer does not publish consolidated accounts nor interim accounts,whether consolidated or non-consolidated. Each Pricing Supplement relating to the Notes issuedunder the Programme may be obtained free of charge from the Paying Agent in Luxembourg.

8. Auditors

Ernst & Young d.o.o., independent public accountants, have audited, and rendered unqualifiedaudit reports on, the accounts of the Issuer for the year ended 31st December 2002 and Deloitte& Touche will be rendering audit reports for the year ended 31st December 2003.

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ISSUER GUARANTOR

Hrvatska banka za obnovu i razvitak Government of the Republic of CroatiaStrossmayerov trg 9 Katančićeva 5

10000 Zagreb 10000 Zagreb

ARRANGER

Deutsche Bank AG LondonWinchester House

1 Great Winchester StreetLondon EC2N 2DB

DEALERS

ABN AMRO Bank N.V. Alpha Bank250 Bishopsgate ∆40 Stadiou Street

London EC2M 4AA 10252 Athens

Bank Austria Creditanstalt AG Citigroup Global Markets Limited

∆Julius Tandler – Platz 3 Citigroup CentreA-1090 Vienna Canada Square

Canary WharfLondon E14 5LB

Deutsche Bank AG London Dresdner Bank A∆ktiengesellschaftWinchester House ∆Jürgen-Ponto – Platz 1

1 Great Winchester Street 60301 Frankfurt am MainLondon EC2N 2DB

J.P. Morgan Securities Ltd. Privredna banka Zagreb d.d.125 London Wall Račkoga 6

London EC2Y 5AJ HR-10000 Zagreb

UBS Limited UniCredit Banca Mobiliare S.p.A.100 Liverpool Street ∆Via Tommaso Grossi, 10London EC2M 2RH Milano 20121∆

FISCAL AGENT, TRANSFER AGENT AND CALCULATION AGENT

Deutsche Bank AG LondonWinchester House

1 Great Winchester StreetLondon EC2N 2DB

REGISTRAR, PAYING AGENT AND PAYING AGENT AND TRANSFER AGENT TRANSFER AGENT

Deutsche Bank Luxembourg S. A. Credit Suisse First Boston2 Boulevard Konrad Uetlibergstrasse 231

Adenauer CH-8070 ZurichL-1115 Luxembourg

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LISTING AGENTS

Luxembourg Listing Agent Zagreb Listing Agent

Deutsche Bank Luxembourg S.A. InterCapital Securities Ltd2 Boulevard Konrad Adenauer Bogoviceva 1b

L-1115 Luxembourg HR-10000 Zagreb

LEGAL ADVISERS

Internal counsel to the Issuer To the Issuer as to Croatian law

HBOR (Legal Department) Law Office of Mislav LaktićStrossmayerov trg 9 Savska cesta 129/IIIHR-10000 Zagreb HR-10000 Zagreb

To the Dealers as to Croatian law To the Dealers as to English law

Bogdanović & Dolički Linklaters A. von Humboldta 4b One Silk Street

HR-10000 Zagreb London EC2Y 8HQ

AUDITORS

To the Issuer

Deloitte & ToucheKačićeva 3/b

HR-10000 Zagreb

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