US embassy cable - 04ZAGREB737

C O N F I D E N T I A L  ZAGREB 000737 
 
SIPDIS 
 
 
TREASURY FOR VIMAL ATUKORAVALA 
 
E.O. 12958: DECL: 04/23/2014 
TAGS: EFIN, ECON, SOCI, HR, Trade 
SUBJECT: IMF MISSION DIRECTOR OPTIMISTIC; GOC PLANNING 
SNEAK RETREAT ON PENSIONS? 
 
REF: ZAGREB 627 
 
Classified By: Economic Officer Isabella Detwiler, reasons 1.5 (b & d) 
 
Summary 
------- 
 
1.  (C) The recent visit of IMF Mission Director to Zagreb 
showed that there is political will (for the moment) to 
conclude a Standby Agreement, but considerable political 
blood will have to be spilled along the way.  While the 
government is figuring out how to backtrack on promises to 
the pensioners, other ministers are announcing plans for 
increased spending.  End summary. 
 
PM: "Make it So" 
---------------- 
 
2.  (U) IMF Croatia Mission Director Dimitri Demekas and 
Resident Representative John Norregaard called on the DCM 
April 19.  The purpose of Demekas' visit to Zagreb was to 
participate in the normal IMF annual review and to lay the 
groundwork for "real" negotiations on a new Standby 
Arrangement, which will begin in May. 
 
3.  (SBU) Demekas was heartened by the strong political will 
displayed by the Prime Minister, with whom he had met twice. 
The PM made it clear he was intent on making an SBA happen, 
even though it would mean some pain. 
 
4.  (SBU) Demekas seemed confident that the slowing economy 
would pave the way for an improvement in the current account 
deficit and foreign debt.  He told the government that the 
IMF would want to see some fiscal trimming later this year, 
especially if revenue collection continues to be weak, as it 
has been in the first quarter. 
 
5.  (C) Demekas took a much less firm line on the pension 
issue than have resident representatives of the IMF and the 
World Bank over the last few months.  While it would be very 
unfortunate if the pension giveaways stood, he said, it would 
not be the end of the world, especially if the GOC cut 
spending in other areas.  Also, Demekas felt that the 
government was moving to address the issue.  He had been told 
that the second tranche of pension increases, which the 
government had promised to submit to parliament in June, were 
on indefinite hold.  Also, the package of pension increases 
passed in March might not be as bad as thought. 
 
What Pension Bill? 
------------------ 
 
6.  (C) When Demekas raised the 23 billion kuna (over 10 
years) bill for pensions as a problem in a discussion with 
the Prime Minister, Minister of Finance Suker and State 
Secretary Dalic, he got an astonishing response: "What are 
 
SIPDIS 
you talking about?  It's not going to cost that much."  After 
Demekas showed them the official government estimate, they 
claimed they had not been aware of it.  (Note: This frankly 
beggars belief.  The cost estimate was prepared by the 
Ministry of Economy and tracks with independent estimates 
prepared by the Pension Fund and the World Bank.  It was 
posted on the internet and was in the package approved by the 
Cabinet.  Furthermore, the World Bank and IMF have been 
raising alarms for some time.  End Note.) 
 
7.  (C) Suker said the pension changes would only cost 4 
billion kuna.  His explanation is that while the law says 
that now pensions will be indexed to wages (full stop), what 
the law REALLY meant was they would be indexed to REAL wages 
(wage growth adjusted downward to take out inflation).  The 
GOC will try to confirm this interpretation via an 
"explanatory note" from by the Parliament. 
 
8.  (SBU) Demekas was also blase about the VAT reduction, 
which he concluded, based on government comments, was a sure 
thing.  Sure, it would have been nice to have started tax 
 
 
reductions in other areas, such as payroll taxes, but as long 
as the government paid for it with spending cuts or other tax 
increases (such as introducing VAT on items currently at 
zero, like bread), it did not really matter. 
 
9.  (SBU) Demekas was pleased with the Prime Minister's 
commitment to SBA -- and hoped it would remain steadfast even 
after a positive EC avis, or future (June perhaps) invitation 
to begin negotiations on EU accession.  He doubted that the 
World Bank's Programmatic Adjustment Loan by itself would 
provide enough leverage on the GOC to maintain fiscal 
discipline.  As the recent road show to sell government bonds 
demonstrated, the GOC can raise lots of cheap money on its 
own. 
 
IMF Previews Negotiations 
------------------------- 
 
10.  (C) In a close-out meeting latter in the week, Demekas 
told the Prime Minister that the IMF would ask the GOC to 
trim the current year's budget by a modest 800 million kuna 
(the total budget is 89.4 billion kuna), and agree to 
decrease next year's fiscal deficit to under 3.5 percent of 
GDP.  This would be serious belt-tightening -- a full 
percentage point below this year's 4.5 percent deficit.  The 
Prime Minister was apparently receptive.  In the meantime, 
the hyper-active Minister of Transportation is announcing new 
subsidies for construction of fishing boats, and rumors 
abound that cuts in spending for the railroads -- a victory 
for budget hawks -- are about to be reversed. 
 
Comments 
-------- 
 
11.  (C) Demekas appears to have concluded his visit to 
Croatia convinced that the government is committed to signing 
a new Standby Arrangement.  This reflects Sanader's 
understanding that an agreement is what the EU wants -- and 
accession to the EU remains front and center for the 
government.  However, if the Arrangement has any teeth at 
all, a heavy political price will have to be paid in order to 
reach it. 
 
12.  (C) Particularly difficult will be walking back from the 
pension promises.  We are skeptical of the way the government 
has apparently chosen to do so -- reinterpreting an already 
passed law in a way that lawyers contacted by the World Bank 
say is contrary to any plain or legal reading of the 
legislation.  Also, changing pension indexation from the 
previous half-price inflation/half-nominal wage increase, to 
an index made up solely of real wage increases, could result 
in no increased benefit or even a decreased benefit to 
pensioners over the old system.  This would understandably be 
considered mendacious and a betrayal by the almost 
twenty-five percent of the Croatian public that receives a 
pension, and their families and friends.  While a frank 
admission that Croatia cannot afford the March pension 
legislation would be painful, it would be more honest. 
FRANK 
 
 
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