IMF LIKELY TO EXTEND CROATIA STAND BY ARRANGEMENT

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
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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
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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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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
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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