US embassy cable - 05ZAGREB1829

C O N F I D E N T I A L SECTION 01 OF 02 ZAGREB 001829 
 
SIPDIS 
 
SIPDIS 
 
E.O. 12958: DECL: 11/14/2015 
TAGS: EFIN, ECON, HR 
SUBJECT: IMF LIKELY TO EXTEND CROATIA STAND BY ARRANGEMENT 
 
Classified By: Economic Officer Nicholas Berliner for Reasons 1.4 b/d. 
 
 1.  (C) Summary and Comment:  The IMF expects to extend its 
current $142.8 million Stand-By Arrangement for Croatia to 
the end of 2006.  However, it considers the GOC's 2006 budget 
projections anticipating a deficit of 3.5 percent of GDP to 
be out of line with its commitments, and is also concerned 
about lackluster performance in key areas of reform, such as 
reducing industrial subsidies, privatization and reforming 
entitlement programs.  Thus far, the IMF has been very 
lenient with Croatia when it comes to adherence to its 
performance criteria, allowing the GOC to put off the 
politically tough choices necessary to foster greater growth. 
 The Fund believes that it can exert greater influence 
working with the GOC than it could if it were to force 
Croatia away from the Stand-By Arrangement.  With EU 
negotiations underway, the IMF hopes that it can bring more 
leverage to bear on the GOC, as its criteria are very much 
aligned with those of Brussels.  End Summary. 
 
2.  (U) Econ Officer met with IMF Zagreb representative 
Athanasios Vamvakidis on November 9 for a readout on the 
Fund's recent round of meetings with the GOC.  Vamvakidis 
offered a summary of the IMF's engagement with the GOC, 
centered on its $142.8 million Stand-By Arrangement, its 
position on Croatia's 2006 budget, as well as readout on a 
meeting with President Mesic. 
 
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GOC 2006 Deficit Projections Too High 
------------------------------------- 
 
3.  (C) In anticipation of the IMF's second review of 
Croatia's current Stand-By Arrangement and its possible 
6-month extension, Vamvakidis said that the GOC's projections 
of a 2006 deficit of 3.5 percent of GDP were far too high. 
The IMF has pushed for a 2006 deficit in a range from 3.0 to 
3.2 percent of GDP.  Vamvakidis said that such a high deficit 
for 2006 would be a non-starter for the IMF, although he 
acknowledged that the Fund has been fairly tolerant with the 
GOC missing its projections.  The IMF acquiesced to the GOC's 
raising its 2005 deficit in August from 3.7 to 4.2 percent of 
GDP. 
 
4.  (C) Econoff asked if the IMF was prepared to take a 
tougher line with Croatia, even to the point of walking away 
from the Standy-By Arrangement, if necessary.  (Note: 
Croatia's Stand-By Arrangement is viewed as "precautionary" 
and has not been used.)  Vamvakidis said that the IMF 
considered that it could be more useful if it remained 
engaged with the GOC.  He noted that the Stand-By Arrangement 
had strong EU support, since the Fund now carries water for 
Brussels on many issues, but hoped that this process would be 
complementary and that the further requirement of meeting EU 
standards would give the IMF more leverage with the GOC. 
 
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Pensioners' Debt Looms 
----------------------- 
5.  (U) Getting Croatia's structural deficit under control 
will be essential as the government faces the prospect of 
beginning repayment of the "pensioners' debt."  The 
"pensioners' debt" arose from a 1998 ruling by the 
Constitutional Court holding that the state was responsible 
for repayment of unpaid pension indexation entitlements from 
1993 to 1998.  All told, this is a liability now equivalent 
to between 6 and 7 percent of 2005 GDP, were all pensioners 
to claim the full amount of their "debt."  However, most 
analysts expect the vast majority of eligible retirees to 
choose a 2-year, 50 percent repayment plan, which will still 
amount to a burden of at least 1.5 percent of GDP annually 
for the government over the next two years.  Current plans 
call for privatization receipts to fund this liability. 
However, given the slow pace of privatization and the 
government's reliance year-to-year on these receipts to 
offset other spending and hold the deficit down, the 
implications of this outlay cannot be underestimated. 
 
6.  (U) Vamvakidis said the IMF is also concerned about the 
amount of liquidity repayment of the pensioners' debt would 
inject into the Croatian economy and its ability to absorb 
this amount without setting off inflation and increasing 
Croatia's already large current account deficit.  Early 
polling of eligible pensioners indicates that few of them 
would save what they receive, so the IMF is trying to 
encourage banks to offer savings incentives to draw off some 
of the money. 
 
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Reforms Lagging 
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ZAGREB 00001829  002 OF 002 
 
 
7.  (U) The IMF is also concerned about Croatia's lackluster 
progress in carrying out structural reforms.  Vamvakidis 
noted that Croatia's level of industrial subsidies amounts to 
3.8 percent of GDP annually, with the railroads and 
agriculture alone soaking up two-thirds of this amount and 
other industries such as shipyards and metals plants getting 
the rest.  He said that the IMF would push hard on this with 
the GOC, as well as in the reform of entitlement programs and 
the further reform of the healthcare system.  Many 
entitlement programs are rife with fraud, as no effective 
means tests exist to determine eligibility.  In healthcare, 
Croatia recently introduced a co-payment system, but with so 
many exemptions that it will likely have little effect in 
reducing chronic over-consumption of health services. 
Despite citizens' constant complaints about the poor quality 
of healthcare, Croatia spends over the EU average at about 
7.3 percent of GDP. 
 
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PM Sanader Go-To Person on Economy 
---------------------------------- 
8.  (C) Vamvakidis commented on the formulation and execution 
of economic policy in Croatia, noting that progress came only 
when PM Sanader engaged personally.  He said that the IMF now 
tailors all visits to Croatia to Sanader's schedule, as he 
appears to be the only one able to deliver action in the 
government.  He described Finance Minsiter Suker as a 
marginal player, unable to bring other ministries along on 
key fiscal and monetary issues.  He assessed that Deputy PM 
Polancec has the PM's ear and hoped that he would be able to 
deliver on the privatization and restructuring mandate 
entrusted to him. 
 
9.  (C) The IMF also met with Croatian President Mesic, an 
unusual move, given that the president has no formal role in 
the formulation or execution of economic policy. 
Constitutional limitations, however, have not stopped Mesic 
from expounding on economic issues, sometimes in ways more 
suggestive of his socialist past (Mesic was the last 
president of Yugoslavia) than current reality, such as 
comments about the importance of rebuilding heavy industry or 
suggestions that foreigners be restricted in their ability to 
buy property in Croatia.  Vamvakidis said that the IMF had 
hoped to bring Mesic around on some of these issues, but left 
the meeting generally doubtful that Mesic will refrain from 
statements that, while politically popular, often give succor 
to opponents of economic reform. 
DELAWIE