IMF VIEWS END OF CROATIA PROGRAM

UNCLAS SECTION 01 OF 02 ZAGREB 000757

SIPDIS

SENSITIVE

SIPDIS

STATE FOR EB/IFD/OMA
EUR/SCE

E.O. 12958: N/A
TAGS: ECON EFIN HR
SUBJECT: IMF VIEWS END OF CROATIA PROGRAM

ZAGREB 00000757 001.2 OF 002


SENSITIVE BUT UNCLASSIFIED; NOT FOR INTERNET


1. (SBU) Summary: IMF Resident Rep Athanasios
Vamvakidis told Econ Off June 13 that the Fund is
likely to conclude its work in Croatia when its
current Stand-By Arrangement ends later this year.
Although frustrated by the slow pace of economic
reform in Croatia, particularly privatization, the
IMF is satisfied with the GOC's progress in fiscal
consolidation. Vamvakidis said the GOC is set to
revise its 2006 deficit projections down in a
supplemental budget later this summer, a first for
Croatia. However, it may be premature to pop the
champagne corks to toast the GOC's economic
epiphany. The IMF has generally been very
accommodating with Croatia's budgetary anomalies.
The World Bank and others are concerned that
mounting arrears in healthcare and a pending payment
to pensioners amounting to 1 percent of GDP, both of
which have been treated as "off budget" could come
back to bite. This is particularly the case of the
pension repayment, which the GOC had intended to
offset with privatization receipts, but may have to
borrow to cover. End Summary.


2. (SBU) Econ Off met with IMF Resident Rep
Athanasios Vamvakidis on June 13 for a readout on
the recently-concluded IMF mission to Croatia to
review progress on the Stand-By Arrangement.
Croatia's current Arrangement with the Fund, which
has always been considered precautionary and never
used, is set to end on November 15, 2006. Although
no decision has yet been made, Vamvakidis said that
he does not expect the GOC to request another
agreement. However, he did not exclude the
possibility that the European Commission would lobby
for another agreement with Croatia as a means of
ensuring greater fiscal probity as Croatia
negotiates its eventual EU accession.


3. (SBU) Vamvakidis said the IMF team came away
with mixed views on Croatia's progress. On the one
hand, the GOC's fiscal management has been fairly
solid and generally in line with its commitments to
the Fund. In fact, with faster than expected GDP
growth this year and growing VAT receipts, the IMF
expects the GOC to revise its projected 2006 deficit
down when it issues a supplemental budget later this
year. The expectation is that the new deficit
target will be 3 percent of GDP, as opposed to the
3.3 percent agreed with the IMF for this year. If
realized, this would mark a significant improvement
in the country's finances from the 4.2 percent
deficit registered in 2005 and the 6.3 percent
deficit of 2003. Indeed, this would be the first
time ever that any Croatian government lowered its
projected deficit mid-year and, in fact, the first
time it did not increase.


4. (SBU) However, while the Fund is happy with
fiscal progress, it noted a lack of momentum
elsewhere, particularly in health reform and
privatization. The Croatian parliament has yet to
pass even the watered-down health reform measures
that the government proposed earlier in the year,
none of which will go nearly far enough to staunch
the red ink. Likewise, despite a year of promises
of impending privatizations, there has been no
significant privatization in Croatia for the last
two years.


5. (SBU) The World Bank office in Zagreb is much
less sanguine about the progress of economic reform
than the IMF and is concerned that "off budget"
accounting of health care arrears and the pending
pension repayment mask a poorer fiscal situation
than either the IMF or GOC care to portray.
Proposed healthcare reforms show little prospect of
staunching the flow of red ink and deeper reforms
that the GOC has promised to undertake if needed
appear improbable, particularly with elections set
for 2007. The GOC intended to cover the pension
repayment by selling its remaining stakes in
telephone company Hrvatski Telekom and the state oil
company INA. However, both of these have been
delayed again, which means that the government will
have to borrow to pay the pensioners, effectively

ZAGREB 00000757 002.2 OF 002


moving this expenditure "on budget."


6. (SBU) When pressed on concerns raised by the
World Bank, Vamvakidis acknowledged that progress on
reform is less than the IMF hoped for, but that
nevertheless the GOC has improved its fiscal
position with a growing economy and modest
inflation. The IMF will make its last review of the
Stand By in September. According to, Vamvakidis its
message to the GOC was that it needs to present
credible timelines for privatization or risk
derailing the Stand By prematurely.


7. (SBU) Given that this is not the first time the
IFIs have vowed to stand firm and that the IMF is
likely winding down its presence in Croatia, it is
questionable how much weight this demand will carry.
More important to the GOC right now is the EU.
Since Croatia will not be able to negotiate the
competition and industrial policy chapters of the EU
Acquis without further steps on privatization, this
gives more hope that the promises will actually be
realized this time around. Finally, if the GOC
manages to bring its deficit down to 3 percent and
keep it there through election season in 2007
without international pressure, this will be a
strong message that, at least in fiscal management,
Croatia is demonstrating responsible leadership.


FRANK