SHIPYARDS ALBATROSSES OF CROATIAN ECONOMY

UNCLAS ZAGREB 001265

SIPDIS

SIPDIS

STATE FOR EUR/SCE BALIAN AND RIEHL

E.O. 12958: N/A
TAGS: ECON KPRV EWWT EIND HR
SUBJECT: SHIPYARDS ALBATROSSES OF CROATIAN ECONOMY


1. Summary: Of Croatia's loss-making, unreformed industries, none is
more politically sensitive or costs the country's taxpayers more
than shipbuilding. With a total of six major shipyards on the
Adriatic coast, shipbuilding is a key employer in many communities
and an important component of Croatia's exports. However, the small
size of the yards, coupled with their chronic inefficiency, poor
management and relentless Asian competition results in annual losses
in the hundreds of millions of dollars being covered by the state.
The European Union has warned Croatia that these subsidies violate
the EU's competition regulations and the GOC will have to eliminate
them to close this chapter of its accession negotiations. The
government so far has shown no indication that it will swallow this
bitter pill. In fact, with elections set for 2007, it appears set
to ignore the advice of its own consultants and continue to dole out

guarantees to these industrial relics. End Summary.


Glorious Past; Grim Present
--------------

2. As much as Croatia's shipbuilding industry is a testament to
Dalmatia's rich maritime history, today it is but a rusty and costly
reminder of the more recent industrial past. Croatia has six major
Adriatic shipyards: Uljanik in Pula, 3 Maj and Viktor Lenac in
Rijeka, Kraljevica, Trogir and Split. Together, the shipyards
directly employ about 12,000 workers and, according to government
estimates, account for an equal amount of indirect employment.


3. Despite the fact that all of Croatia's shipyards have orders on
the books for the next several years, all lose money. With sales
last year worth approximately $700 million, the shipyards received
subsidies in various forms worth nearly $500 million. The reasons
for the chronic losses are many, but even excluding poor management
and inefficiency, the industry faces a difficult competitive
environment. During a recent visit, the CEO of Rijeka's 3 Maj told
econoff that, despite a doubling of productivity and reduction in
delivery times, Croatian yards, which can deliver 5 or 6 ships
annually face competition from yards in Asia that turn out upwards
of 60 vessels every year. 3 Maj sees salvation in moving up-market
into more sophisticated vessels than the relatively low value-added
tankers it currently produces, but competition is not static
either.


4. Compounding economic woes are steep rises in the price of steel
and the decline of the US dollar against other major currencies over
the last few years. A legacy of designed economic interdependence
in the former Yugoslavia, Croatia does not produce any of the steel
that is the main input for its ships, despite the fact that it has
two loss-making state-owned steel works. Steel is imported from
Macedonia. Such is the case with many other inputs. In fact, a
total of 80 percent of the value of every ship is imported and
priced in euros. Delivered ships, however, are priced in dollars in
contracts concluded years before delivery. This double blow from
exchange risk (which management failed to hedge) on the back of
higher steel prices has hit the industry especially hard.


Nostalgia and Local Politics Thwart Reform
--------------

5. The problems of Croatia's shipyards are well-known in the
country, yet any discussion of reform is inevitably prefaced with a
promise to keep all yards operational. Pre-emption of the option of
closing one or more of the shipyards means that the only course left
for the government has been to throw good money after bad in a
futile effort to bring the industry to profitability. GOC officials
never cease to point out the importance of ships in Croatia's dismal
balance of trade in which exports cover only 47 percent of imports.
Ships alone account for 15 percent of Croatia's exports, although
their large import content is rarely mentioned.


6. Jobs are the political boogeyman of reform. Few politicians in a
country with an unemployment rate over 12 percent want to give a
pink slip to several thousand people, to say little of the further
dislocations in local economies where the yards are based.
Ironically, however, the jobs issue is not so clear cut. When we
asked 3 Maj's CEO about the composition of the workforce (many of
whom live in on-site, company-provided housing),he conceded that a
large number of workers were not actually Croats. Many are from
other parts of the ex-Yugoslavia, but there are also sizeable
numbers from Slovakia and other countries. Croatia increasingly
lacks the skilled workers it needs in trades such as welding to keep
its shipyards running so, in addition to importing the ships' steel,
it is importing labor.


Running onto the Shoal of the EU Acquis
--------------

7. The Croatia government doles out hundreds of millions of dollars
in annual subsidies to the shipbuilding industry. It is a
value-destroying exercise that has gone on for years. However, now
that Croatia is in negotiations for EU membership, time is running
out. The Commission has told the government that further subsidies
can only be given within the context of a restructuring plan
designed to bring the industry to profitability. The GOC hired a
consultant whose recommendations have not yet been made public, but
already the government is denying that it will shut down any of the
yards. The most that seems likely to happen is that it will
privatize the Uljanik yard in Pula (the healthiest of the shipyards
that benefited from USAID assistance in restructuring). As the day
of reckoning for the others is again delayed, state funds will again
go to save what cannot be saved, crowding out other sorely needed
investments.

DELAWIE