CROATIA SCENE SETTER FOR SENATOR VOINOVICH

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1. (SBU) SUMMARY: Croatia and the government of Prime
Minister Ivo Sanader have enjoyed several important
successes since your last visit in May 2005. With EU
accession negotiations opened on October 4 and Hague
indictee Ante Gotovina arrested in Spain on December 7,
Croatia has now cleared major political obstacles in its
path to Euro-Atlantic integration. What remains are the
more difficult agendas of defense and economic reform. The
GoC continues to demonstrate leadership in normalizing
relations with its neighbors and is actively promoting
regional stability. Zagreb advocates clear involvement of
Belgrade in determining the final status of Kosovo and is
anxious to play a helpful role following Montenegro's
upcoming referendum on independence. END SUMMARY.

INTEGRATION: POLITICAL BARRIERS TOPPLED, DEFENSE REFORM
UNDERWAY
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2. (U) PM Sanader has continued to push Croatia solidly
down the path to both the EU and NATO. Croatia cleared a
major hurdle with Gotovina's arrest and his transfer to the
International Criminal Tribunal for the former Yugoslavia
(ICTY) to stand trial on charges of war crimes committed in
the aftermath of Croatia's Operation Storm, which liberated
the rebel-Serb- occupied Krajina region in 1995. The
arrest, applauded by the U.S. and the international
community, was not popular domestically, as many Croats
consider Gotovina a hero of their war of independence. To
its credit, and at some potential political cost, Sanader's
Croatian Democratic Union (HDZ) worked to keep the few
protests which did occur after the arrest focused on
"support for Gotovina" rather than venting anger at the
international community or the ICTY.


3. (U) With Gotovina in The Hague, the GOC is focusing on
EU negotiations and public promotion of its goal of NATO
membership, which is currently supported by less than half
of the citizenry. There is a general consensus among the
political elite that Croatia belongs in NATO, but the GOC
acknowledges that it must do more to generate similar
levels of support among the general public.


4. (U) The Ministry of Defense and General Staff are
committed to increasing participation in NATO Peacekeeping
Operations, and are planning for and funding operations
through 2015. Over the summer, the parliament approved
tripling to 150 Croatia's troop (currently primarily
Military Police) contribution to NATO's ISAF mission in
Afghanistan. A Croatian MP platoon is currently in its
seventh rotation in Kabul and the first increase in ISAF
contributions will be a seven man Military Liaison and
Observation Team to deploy with the Lithuanian PRT in
Chagcharan. Currently, Croatia also has 31 persons
deployed on 10 UN peace support operations, including Major
General Dragutin Repinc, who assumed command on December 29
of the UNMOGIP operation in Kashmir.


5. (U) Croatia has an ambitious military reform program in
place to make the armed forces "NATO-ready" by 2007 -- a
difficult task under the best circumstances thanks to a
defense budget burdened by excess personnel and obligatory
pension payments to war veterans, leaving only minimal
resources for much-needed equipment procurement. We
support Croatia's NATO ambitions, but have been very clear
in our message that defense reform is an essential pre-
condition for Croatia to demonstrate that it will become a
net contributor to security through NATO operations.
Ambassador Victoria Nuland, the U.S. permanent
representative to NATO, echoed this message during a March
7 visit that may be mentioned during your visit.

THE REGION: LEADING THE STABILITY CHARGE
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6. (U) PM Sanader is very interesting in playing a leading
role in promoting regional stability. He continues to
promote high-level exchanges and hosted Serbian Prime
Minister Vojislav Kostunica in Zagreb in November 2005.
The GoC's approach remains one of moderation in the pursuit
of fully normalized relations. During that visit, Sanader
called for Belgrade's full involvement in determining the
final status of Kosovo.


7. (SBU) While fully supporting international efforts in
the region, Croatia urges caution and full consideration of
potential reactions to all proposals. In this context, the

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GoC is willing and anxious to play a helpful role in
maintaining stability. It is ready, for instance, to
assist however possible following the upcoming referendum
on independence in Montenegro.

WAR LEGACIES SLOWLY FADING
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8. (U) Since your last visit, we have witnessed important
events in addressing the legacy of the 1991-95 war. Two
major convictions of Croatian defendants in retrials for
war crimes against Serbs demonstrated that ethnic bias is
disappearing from the courts. International observers such
as the OSCE and UNHCR have praised the government's pace of
reconstruction of war-damaged housing and return of refugee
property, although ethnic discrimination and resistance to
change at the local level are persistent challenges.


9. (U) Of the estimated 350,000 people, mostly ethnic
Serbs, who were displaced during the war, about 134,000
have returned. A UNHCR re-registration project of March
2005 concluded that of the remaining 215,000, mostly now
living in Serbia and Montenegro and Bosnia and Herzegovina,
the majority have settled in place and do not plan to
return. An OSCE/USAID survey indicated that from five to
twenty percent of refugees would return if guaranteed
employment and housing.


10. (U) As suggested by the OSCE, UNHCR, and the European
Commission, the Government has created a "road map" with
the goal of closing the refugee file in 2006. Elements of
this include specific benchmarks such as the resolution of
refugee housing, equal access to information and government
services, and information on war crimes indictments.

ECONOMY: BETTER THAN NEIGHBORS, BUT ROOM FOR IMPROVEMENT
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11. (U) Croatia's economy is the most developed of the
former Yugoslavia, with the exception of Slovenia. Per
capita GDP is approximately $7,800, more than twice that of
neighboring Serbia and Montenegro and roughly equal to
Slovakia. Over the last six years, Croatia has enjoyed
general macroeconomic stability characterized by low
inflation and modest economic growth of approximately 4
percent annually. This growth, however, has been jobless,
with the official unemployment rate remaining stubbornly
high at approximately 18 percent.


12. (U) The state still plays an overly large role in
Croatia's economy. Although there has been progress in
shedding some of the state's large portfolio of assets,
notably banks, hotels and large agricultural combines, the
government continues to be saddled with loss-making
industrial companies whose subsidies drain approximately 3
percent of GDP annually. As a percentage of GDP, the
state's role in the economy is far above the EU average at
nearly 40 percent. With one pensioner for every 1.4
persons employed, above-average healthcare costs and out of
control entitlement programs, the government faces many
necessary, but politically unpopular decisions if it is to
reduce chronic deficits and liberalize the country's
economy.


13. (U) Croatia missed out on the initial rush of foreign
investment in Central and Eastern Europe following the fall
of the Berlin Wall, largely because of the war in the
former Yugoslavia, but also because of its slowness to make
the difficult but necessary decisions to reform its
economy. Foremost among the factors inhibiting greater
investment is an inefficient judicial system that can take
years to resolve even the most basic commercial disputes
and a stubbornly Byzantine bureaucracy. There has been
some improvement in this last area, with the government's
creation of a "one-stop shop" for business registration and
a trade and investment promotion agency to assist
prospective foreign investors, but much more remains to be
done.


14. (U) Croatia is also saddled by large budget and trade
deficits. Although the former has been reduced in recent
years partially as a result of an IMF program, the latter
has continued to balloon. Foreign debt, particularly in the
private sector, has soared as well, now totaling over 80
percent of GDP. The fact that most of this debt is "euro-
ized" limits Croatia's ability to let its currency
depreciate, a large factor in its uncompetitive exports.


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15. (U) Croatia's political elite is fully cognizant of the
need to further reform the economy and has made some recent
progress in that direction, but much remains to be done to
create the conditions to compete successfully in today's
global economy. The beginning of EU accession negotiations
has added new urgency to this fact.

FRANK