GOS DECLARES IMF VICTORY, LOOKS TO PARIS CLUB

UNCLAS SECTION 01 OF 02 BELGRADE 000188

SIPDIS

OC FOR 4232/ITA/MAC/EUR/OEERIS/SSAVICH

E.O. 12958: N/A
TAGS: EFIN ECON SR MW
SUBJECT: GOS DECLARES IMF VICTORY, LOOKS TO PARIS CLUB


1. (U) SUMMARY: The GOS economic team jointly declared
victory in completing the final review of its IMF program on
February 6 and invited Paris Club action on implementing the
final tranche of debt reduction before the next payment falls
due. Finance Minister Dinkic also announced an ambitious
plan to use the projected budget surplus of 2.6 percent of
GDP for 2006 to cut employers' payroll contributions from 73
cents on the dollar to 60. The borrowing capacity released
by the Paris Club debt reduction - and an expected reduction
from Kosovo negotiations - should be used to borrow USD 800
million for road construction, primarily in Southern Serbia,
Dinkic said. Serbia wants a follow-on IMF agreement, the
finance minister asserted, but it must await the outcome of
the Montenegro referendum. With Governor Jelasic seated to
his right, Dinkic also defended the central bank against the
recent scandal that has put the vice governor for the banking
sector behind bars, and he proposed a purge of judges to
fight corruption. end summary.


2. (U)Finance Minister Dinkic, National Bank of Serbia
Governor Jelasic and Minister of Economy Bubalo made a joint
presentation to the diplomatic corps on February 8 at which
they painted a bright picture of Serbia's economic outlook.
Dinkic noted that growth over the last two years, if the 2005
number comes in as expected, will have averaged 8 percent.
The consolidated budget surplus should hit 2.6 percent for
2006, he said, largely on the basis of a cut in 40,000 public
sector jobs (half in state-owned companies). And Serbia
should capitalize on its budget surplus to cut payroll
contributions for pensions, health and other items from 70
cents on the dollar to 63 cents, Dinkic argued, thereby
making Serbia more attractive to foreign investors.


3. (U)Foreign direct investment in 2005 was USD 1.481
billion, up 53 percent over 2004 and Serbia's best year yet.
Exports were the government's main task now, the finance
minister said, and the increase of 29 percent for 2005 was
largely driven by multinational companies, underlining the
importance of FDI, he noted. The strong export performance
also contributed to the sharp decline in the current account
deficit, from 13.7 percent of GDP to about 9 percent in 2005.


4. (U)Another reflection of Serbia's brightening outlook is
the rapid reduction in public debt, from 169 percent of GDP
in 2000 to 44.5 percent in 2006, including the expected write-
off of the last 15 percentage points of Paris Club debt.
Dinkic pointed out that a further write-off of USD 1.1
billion related to Kosovo - a development he expects as part
of upcoming status negotiations - will reduce public debt to
40 percent. Although that level still would mark Serbia as a
country of medium indebtedness, Dinkic said, public finances
would be strong enough to support an additional USD 800
million in borrowing to finance the completion of four-lane
highways in Corridor 10 of Southern Serbia. And Serbia's
improved financial status was recognized this week by the
World Bank's decision to make Serbia eligible for standard
Bank lending. (Note: Serbia no longer qualifies for
concessional lending from the World Bank.) Dinkic also called
on the OECD to reassess Serbia's credit rating.


5. (U)Inflation remains the dark cloud on Serbia's economic
horizon. Dinkic said that a tight incomes policy would help
to bring inflation down to single digits in 2006, from 17.7
percent in 2005, although many analysts believe this will be
difficult. The finance minister turned over the discussion
to Jelasic, who had been his deputy when Dinkic was central
bank governor.


6. (U)Jelasic immediately reminded the audience that the
IMF prescription for curbing inflation includes faster
restructuring of the economy, to improve its supply response,
as well as fiscal and monetary restraint. Bringing inflation
down to single digits would not be easy, he said. However,
the governor returned to the good news theme by announcing
that the National Bank's official reserves have reached USD 6
billion, enough to cover six months of imports. The exchange
rate has been stable. (Note: One questioner observed that
dinar actually appreciated against the Euro in 2005.)


7. (U)The NBS governor cited, with relish, the dramatic
increase in savings, from EURO 1.4 billion at end-2004 to
EURO 2.2 billion in 2005. This, in turn, had allowed a rapid
increase in lending based on domestic funding, as opposed to
external sources. Lending was up 65 percent in 2005, to EUR
5.3 billion. (Note: Almost all savings and lending are in
Euro, an issue highlighted by the IMF's sixth review report,
which pointed to the growing foreign exchange risk in bank
lending to companies and consumers that earn in dinar.)


8. (U)The discussion turned interesting as diplomats
questioned the Serbian economic team. Dinkic said that
Serbia wants a one-year precautionary IMF arrangement, in
part to drive further reform However, he said Montenegro
was against any new deal before the independence referendum,
so talks must wait. (Note: Jelasic did not address this
issue at the presentation, but he has been more forward-
leaning, urging Serbia to at least start talks with the IMF
now, in part because rating agencies expect a new agreement.)


9. (U)A Finnish official queried Dinkic on corruption, and
the finance minister used the opportunity to defend the
central bank in the recent scandal involving a sting
operation that put the vice governor for banking regulation
behind bars. He accused Israeli investors who bought a
borderline Serbian bank of using "big pressure" - the
corruption scandal - when the central bank withdrew the
bank's license. But the pressure would not work, Dinkic
said, because it was simply not possible for the National
Bank to reverse such a regulatory action. (Note: A lawyer
for the Israeli investors has claimed that Jelasic solicited
a Euro 2 million bribe to restore the bank's license, leading
to the sting that snared the vice governor.)


10. (U)The government campaign against Milosevic-era tycoon
Bogoljub Karic should be seen as an attempt to make all equal
before the law, Dinkic said. And corruption pervades the
courts, Dinkic said, which are independent of the government
but not independent of certain businessmen. (Dinkic did not
refer explicitly to the courts' repeated decisions in favor
of Karic's Astra Banka when the National Bank had revoked its
license.) The finance minister said he would propose to the
government that all judges be "re-elected," allowing the
removal of those found to be unacceptable.

Moore