Identifier
Created
Classification
Origin
03ZAGREB2666
2003-12-22 12:00:00
CONFIDENTIAL
Embassy Zagreb
Cable title:  

IMF CONCERNED THAT DEFICITS WILL RISE UNDER NEW

Tags:  ECON EFIN PGOV HR 
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C O N F I D E N T I A L ZAGREB 002666 

SIPDIS


E.O. 12958: DECL: 12/22/2013
TAGS: ECON EFIN PGOV HR
SUBJECT: IMF CONCERNED THAT DEFICITS WILL RISE UNDER NEW
GOVERNMENT

REF: ZAGREB 2446

Classified By: ECONOMIC OFFICER ISABELLA DETWILER: REASON 1.5 (B AND D)

Summary
-------

C O N F I D E N T I A L ZAGREB 002666

SIPDIS


E.O. 12958: DECL: 12/22/2013
TAGS: ECON EFIN PGOV HR
SUBJECT: IMF CONCERNED THAT DEFICITS WILL RISE UNDER NEW
GOVERNMENT

REF: ZAGREB 2446

Classified By: ECONOMIC OFFICER ISABELLA DETWILER: REASON 1.5 (B AND D)

Summary
--------------


1. (C) The incoming government is playing its economic game
close to its chest. A visiting IMF team that met informally
with the HDZ's economic players came away without much new
information. The HDZ's campaign promises, much like the
campaign promises of the other parties, were expensive.
Perhaps more worrying, because they were in writing, were the
concessions the HDZ made to the Pensioners Party (HSU) in
order to secure its three votes in the next Parliament. If
implemented in anything like their current form, concessions
would severely boost the budget deficit and upset the
delicate balance the last government reached on pensions.


2. (C) In what was not a big surprise given the timing of
the team's visit -- right after parliamentary elections --
the IMF was not able to complete the third review of the
Stand-by Arrangement. It was in no position to judge
Croatia's economic plans for the next 12 months -- primarily
because the plans do not really exist yet. The IMF, the
outgoing government, and Central Bank were able to complete
an informal, backward-looking review, which found the
situation generally satisfactory, but with some lingering
areas of concern. End Summary.

Expensive Promises
--------------


3. (C) The two areas of the HDZ's economic policies that
have attracted the most attention appear to have come from
two different camps within the HDZ. A cut of two percent in
the VAT tax was urged by young academic (and former Central
Bank employee) Ante Babic. Babic, who is rumored to be
interested only in an advisory role in the new government, is
said to believe that this tax cut would stimulate business,
rather than translate into lower prices. However, a recent
roundtable of business people reportedly scoffed at the idea,
and worried about the fiscal effects. The VAT cut, estimated
to cost about 1.2 percent of GDP, would be partially financed
by increased compliance and enforcement of tax collections,
optimistically estimated to provide additional revenue of 0.4

percent of GDP.

Pensioners Strike Back?
--------------


4. (C) In an unpublished but well-reported memorandum
signed by representatives of the HDZ and the HSU, it was
agreed to increase the base level of pensions and adopt a
more favorable methodology for indexation. Other goodies are
rumored, but not confirmed. World Bank economists have
estimated that if the additional costs were fully covered by
additional payroll taxes (not likely),the contribution rate
would rise from 20 percent to 35 percent. Even if the
worst-case scenario does not materialize, any significant
increase in payroll taxes would create additional
disincentives to employment. The World Bank and others also
worry that these changes will destroy what have been the
significant accomplishments of the Racan government's
three-pillar pension reform. One possible result is that the
private sector second and third pillars would be "crowded
out" by the bulking up of the first, pay-as-you-go, pillar.


5. (C) The IFIs have tried, in the absence of hard plans or
data from the incoming government, to calculate the effect of
these proposals on the fiscal deficit. The deficit, which
was expected to be 4.5 percent of GDP in 2003 and drop to 3.8
percent next year, could increase to between 5.8 and 8
percent, depending on assumptions. The calculation that
arrives at the lower (but still large) figure increases the
deficit for the VAT reduction, promised wage increases,
pension and maternity benefit increases, investments in the
railroads (also promised by the SDP, to have been paid for by
social transfer cuts),and decreases the deficit through the
hoped-for better collection of taxes and a fairly generous
credit for capital expenditure cuts to the tune of 0.7
percent of GDP. While many do not believe that the HDZ will
be able to implement this full package, if a significant
fraction of it is, the budget deficit could balloon.

IFIs in Limbo
--------------


6. (C) The IMF team visiting Zagreb in December left after
signing what was called a letter of intent. It looked more
like a memorandum looking back over developments over the
last few months. Several players in the process told us that


it was not quite clear why the IMF was here. The GOC's
principle interlocutor with the IMF reportedly opposed the
team's coming, while the Central Bank said that, if the team
came, it had to complete the review. As it is, the letter
signed by the three parties concludes "...we believe that our
program implementation during 2003 has been broadly
satisfactory, and it is our sincere hope that the third
review can be completed early next year." The IMF has
tentative plans to come back in late February (the program
lapses in early April),at which time the next government
would have to be ready to present detailed plans and a budget.


7. (C) When the new IMF Mission Director for Croatia,
Dimitri Demekas, met with us, he said he had told the HDZ
leadership -- including Prime Minister-designate Sanader and
top economic advisor (and incoming Finance Minister) Ivan
Suker -- to take their time in deciding what form of
cooperation they would like to have with the IMF. Demekas
emphasized to us that he was not pushing another Standby
Arrangement on the incoming government (a good thing, since
the HDZ has publicly expressed its skepticism about such a
program). The IMF would like to keep engaged, however,
perhaps through intensive monitoring, and would like to keep
an office in Zagreb. According to Demekas, the HDZ officials
were polite and non-committal.


8. (C) The World Bank's Country Director also told the
Ambassador that the World Bank would like to see a strong IMF
presence in Croatia. He quipped that while they were
flattered by HDZ statements that they wanted to "graduate"
from IMF programs and that they would prefer to work more
closely with the World Bank, the IMF and World Bank came
together. We have received mixed information on whether an
IMF program would be necessary for the next big World Bank
program, and Programmatic Adjustment Loan.

Racan Government takes a Bow
--------------


9. (C) As reported reftel, the Racan government leaves
office with higher than expected growth -- projected at 5
percent this year -- and lower than expected inflation. The
accumulated government debt has stabilized at 51 percent of
GDP, the fiscal deficit will come in better than programmed,
at 4.5 percent of GDP, and even the current account deficit
is better than feared, at 5.4 percent of GDP. The dark
cloud, especially given the Standby Arrangement's focus on
stabilizing overall debt, is the burgeoning foreign debt --
public and private -- which increased from 68.5 percent of
GDP to an expected 74 percent in the past 12 months, spurred
on also by booming consumer borrowing. The IMF remains
unhappy with the Central Bank's monetary instruments, and the
government and Central Bank point fingers at each other
assigning blame.

Comment
--------------


10. (C) The new HDZ-led coalition will have its hands full
on the economic front, and the fact that it will effectively
be a minority government will make matters all the more
tenuous. Because HDZ made a lot of generous promises during
the election campaign to cut taxes -- and now must give away
much to get small coalition partners on board -- it will be
difficult for the new economic team to start preaching fiscal
rectitude. But sooner or later it likely must, and at that
time it may appreciate having the IMF, in some form, around
to serve as the bogey man requiring it to do a course
correction.
FRANK


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