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