IMF MISSION DIRECTOR OPTIMISTIC; GOC PLANNING

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"


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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?


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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


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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


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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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