US embassy cable - 05ZAGREB973

C O N F I D E N T I A L  ZAGREB 000973 
 
SIPDIS 
 
 
TREASURY FOR VIMAL ATUKORALA 
USAID FOR ANNE CONVERY 
 
E.O. 12958: DECL: 06/07/2015 
TAGS: EFIN, ECON, EAID, HR, Econ/Privatization 
SUBJECT: IMF GIVES WAY IN CROATIA - AGAIN 
 
 
Classified By: DCM Greg Delawie for Reasons 1.5 (b and d) 
 
Summary and Comment 
-------------------- 
 
1.  (SBU) The IMF mission that departed Croatia June 6 hopes 
to assemble a package that will pass IMF Board muster in 
August, despite Croatia's serial failure to come close to its 
budget targets.  The team is clinging to GOC commitments to 
structural reforms (not yet implemented) to justify the 
agreement.  In the absence of any real leverage on the 
GOC--including a galvanizing economic crisis -- the IMF 
believes that keeping the Standby Arrangement in place is the 
best way to encourage good behavior.  Despite our 
disappointment in the GOC's dismal economic management, we 
think the IMF is correct.  End Summary. 
 
Oops, We Did It Again 
--------------------- 
 
2.  (SBU) The GOC could have been expected to be on its best 
behavior for this visit.  After all, it was already on 
"probation," with the first review, scheduled for March, 
delayed because the GOC had missed its 2004 deficit target 
(5.0% vice 4.5%) and had not fulfilled its promise to reverse 
the introduction of higher pension indexation.  Nevertheless, 
when the IMF team arrived May 24, the GOC did not have data 
ready, spending was out of control (the IMF estimates that 
the GOC "used up" 80 percent of its target deficit in the 
first quarter), and the GOC failed to deliver what it had 
promised in March -- a plan to put the agreement back on 
track. 
 
Sanader Saves the Day with Promises -- Again 
-------------------------------------------- 
 
3.  (SBU) IMF Mission Chief Dimitri Demekas told the DCM in a 
meeting June 6 that the IMF's visit had seemed doomed to 
failure until PM Sanader returned from a trip in the last 
days of the visit.  Sanader pledged that Finance Minister 
Suker would bring a package of budget cuts to Washington by 
June 20.  Demekas acknowledged that the quality of such cuts 
would probably be dismal -- there was no time to carefully 
craft cuts that would aid the institutional reform of the 
government.  While the 2005 budget deficit target of 3.7% was 
unattainable, Demekas had refused to name an "acceptable 
figure."  (Nonetheless, a government leak to the press, 
citing 4.2% as acceptable, is apparently accurate.)  Demekas 
believes an IMF retreat is justified because of promises made 
on the structural front. 
 
The Half-Full Glass -- Structural Reforms 
----------------------------------------- 
 
4.  (SBU) Once again, the government is promising to return 
to the old pension indexation scheme.  The IMF 
(understandably) is skeptical.  It is more encouraged by the 
Ministry of Health plans (the details of which are not yet 
public) to introduce co-payments for medical services and the 
"privatization" of the heretofore ruinous "supplemental 
insurance."  The GOC has also allegedly agreed to a 
restructuring plan for the shipyards.  This plan would be 
different from previous restructuring plans because it would 
be done with the experience of experts from the World Bank 
and/or EU, with a view to ending the hemorrhaging of 
subsidies.  None of these measures can be done quickly, and 
certainly not before the parliament recesses mid-July.  The 
concrete prior actions for the August Board meeting are to be 
a revised budget, a new civil service law (also a World Bank 
requirement), a revision of the employment subsidy program, 
preparations for the next tranche of privatization of the 
state oil company, and reforms to the law on state aid. 
 
5. (C) Demekas expressed unease over a couple of developments 
-- the GOC is apparently dragging its feet over including all 
government spending in a single treasury account.  The 
government may be trying to maintain the ability to spend 
money off-budget.  The government is also backing away from 
commitments to privatize the large state-owned insurance 
company -- fueling suspicion that it still hopes to use the 
company for emergency funds or simply a place to park party 
faithful. 
 
No Crisis Here 
-------------- 
 
6.  (SBU) While the IMF (and the rest of the international 
community) is frustrated by the GOC's fiscal fecklessness, 
the relative health of the economy and the continued 
willingness of the markets to lend the government money leave 
 
the IMF little leverage.  While growth is slowing down (the 
IMF may revise its 2005 estimate from 3.8% to 3.5%), it 
hardly qualifies as a crisis.  Inflation is up slightly, but 
the Central Bank attributes this to one-time oil and food 
price increases.  Unemployment is up slightly according to 
local measures, but there are some small positive trends in 
employment as well.  Most significantly for the IMF 
agreement, foreign debt -- the key element of the agreement 
-- has stabilized and begun to edge down, if still at a 
dismal 77% of GDP. 
 
Last Chance to Make the Agreement Real 
-------------------------------------- 
 
7.  (SBU) Especially in the absence of a clear start date for 
EU accession negotiations, an IMF agreement is the best curb 
on government fiscal recklessness, thus we grudgingly support 
the IMF's attempt to keep the agreement alive.  However, the 
IMF Board should demand real performance BEFORE the August 
Board vote -- the agreement is due to end by the end of the 
year, and the credibility of the IMF and the international 
community can only suffer if the GOC is able to skate through 
yet another agreement without making real reforms. 
FRANK 
 
 
NNNN