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Identifier
Created
Classification
Origin
07BELGRADE1061
2007-07-27 12:32:00
UNCLASSIFIED//FOR OFFICIAL USE ONLY
Embassy Belgrade
Cable title:  

SERBIAN GOVERNMENT SPENDING RAISES MEDIUM TERM RISK

Tags:   ECON  EFIN  KPRV  SR 
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VZCZCXYZ0029
RR RUEHWEB

DE RUEHBW #1061/01 2081232
ZNR UUUUU ZZH
R 271232Z JUL 07
FM AMEMBASSY BELGRADE
TO RUEHC/SECSTATE WASHDC 1241
INFO RUEATRS/DEPT OF TREASURY WASH DC
RUCPDOC/USDOC WASHDC
						UNCLAS BELGRADE 001061 

SIPDIS

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: ECON EFIN KPRV SR
SUBJECT: SERBIAN GOVERNMENT SPENDING RAISES MEDIUM TERM RISK


ref: Belgrade 799

SUMMARY
-------
UNCLAS BELGRADE 001061

SIPDIS

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: ECON EFIN KPRV SR
SUBJECT: SERBIAN GOVERNMENT SPENDING RAISES MEDIUM TERM RISK


ref: Belgrade 799

SUMMARY
--------------

1. (U) Adoption of the 2007 budget on June 23, along with issuance
of a memorandum of economic policies for 2008-2010, makes it clear
that fiscal tightening will take place, at best, only in the medium
term. The GOS outlook assumes a further increase in wages, which
will fuel the growing trade and current account deficits. NBS
Governor Jelasic responded with a pledge to tighten monetary policy
to keep core inflation in the target range of 4-8 percent for 2007.
However, the central bank chose not to raise the repo rate at its
July 27 session. Standard and Poor's issued a minor downgrade of
Serbia, and economists warn that the current account deficit could
reach 20 percent of GDP in 2007. End Summary

Finance Minister: Freezing Wages - Later
--------------

2. (U) Serbia's Parliament on June 23 approved substantially intact
the 2007 budget reported in reftel. The budget projects increased
expenditures of 18 percent in nominal terms, for a fiscal
consolidated public sector deficit of 0.5 percent of GDP (vice 0.6
percent deficit for central government reported reftel). However,
others project that the budget will produce a fiscal deficit
approaching 2.5-3 percent of GDP, adjusted for one-off revenues and
repayment of pension debt that was placed "below the line." Stojan
Stamenkovic, an influential macroeconomist, had called for cutting
at least 1 percent of GDP, to no avail.


3. (U) On July 5, new Finance Minister Cvetkovic presented a
Memorandum on the Budget and Economic and Fiscal Policies for
2008-2010 that laid out basic macroeconomic goals for the period:
decreasing the current account deficit from a projected 13.9 percent
in 2007 to 10.3 percent in 2010, reducing inflation from a projected
6.5 percent in 2007 to 4 percent in 2010, and decreasing the share
of public consumption in GDP by 1.7 percentage points in 2008 and
0.5 percentage points in 2009. This gradual retrenchment would be
achieved via a freeze in public salaries after November 2007,
curbing procurement of goods and services by 10 percent of the 2007
outlay, reducing subsidies by 5 percent, and cutting public

investment by 20 percent of the 2007 level. The deficit of the
consolidated public sector (including local governments) would
decline to 0.1 percent of GDP in 2008, vice 0.5 in 2007. Public
sector wages will be frozen only after implementation of all
increases approved by the previous government, resulting in a
projected increase of 15 percent in the wage bill for 2008.
Nonetheless, Cvetkovic maintained that the projected 2008 budget
would not disrupt macroeconomic stability.

Finance Deputy: Consumption Unsustainable
--------------
4.(SBU) However, others in the government are less optimistic. New
Finance Ministry State Secretary Janko Guzian (protect), a former
IMF employee, recently told econ chief that freezing salaries in
November is not sufficient to curb the deficit. He explained that
current policy would produce a 2008 budget deficit of 2.5-3 percent
of GDP; closing the gap would require further expenditure cuts
(mostly from the National Investment Plan) as well as increasing the
value-added tax from 18 percent to 20 percent in 2008. He estimates
that the budget needs EUR 600-700 million annually in privatization
revenues to hold the fiscal deficit to 3 percent of GDP;
consequently, the Finance Ministry will push for privatization.
Another difficult issue is a provision in the Constitution requiring
that the province of Vojvodina get 7 percent of budget revenues, an
obligation implemented in 2007 through creative accounting.

Central Bank Weighs Tighter Monetary Policy
--------------

5. (U) National Bank of Serbia Governor Jelasic stated publicly that
current fiscal policy will not contribute to macroeconomic stability
and that, as a result, the central bank will have to tighten
monetary policy in order to achieve its main goal: to keep core
inflation within the target range of 4-8 percent. June inflation
statistics showed an uptick, with inflation for the year ending June
30 at 5.1 percent, from 4.4 percent in May, while core inflation was
up 0.5 percent just in June, after virtually no increase in the
first quarter.


6. (U) Under the National Bank's inflation targeting policy, the
most likely policy change would be an increase in the rate on
two-week dinar repurchase agreements. The rate has declined
steadily, to 9.5 percent, from above 15 percent in December. The
monetary policy council will meet again on July 27. Analysts point
out that a monetary tightening is likely, but they also note that a
higher repo rate typically attracts more capital inflows, driving up
the dinar and stimulating imports.

Analysts: Current Account Deficit to 20 Percent
-------------- ---
7.(U) Stamenkovic, of the Economic Institute, explained that
current economic trends, if they continue, will result in import
growth of 40 percent in 2007 over 2006, a trade deficit of 29
percent of GDP (vice the projected 19 percent), and a current
account deficit of 20 percent of GDP (vs projected 13.9 percent in
Memorandum of Economic Policies). Monetary policy likely will be
tightened, he believes. He even sees a modest risk on external
financing of the current account deficit if non-tax revenues, e.g.,
privatization revenues, are not forthcoming.


8. (U) However, despite medium-term risks, current economic trends
appear encouraging. Industrial production has recorded unusually
steady growth since the beginning of the year, up 4.5-5 percent over
the previous year; this upturn likely is a result of privatization
and restructuring. For the first time in a long period, Serbian
companies reported, overall, a net profit for 2006. GDP growth in
the first quarter of 2007 was 8.7 percent. Exports were up 44.9
percent, although the 39.8 percent growth in imports resulted in a
35 percent increase in the trade deficit.

STANDARD AND POOR'S TAKES NOTE
--------------


9. (U) Rating agency Standard and Poor's took note of the 2007
budget with a July 10 downgrade of the outlook for Serbia from
positive to stable, although the actual ratings of sovereign credit,
unsecured debt and foreign currency debt were unchanged. (In rating
agency practice, this means that S&P no longer is leaning toward an
upgrade of Serbia.) The rating cited "a loosening fiscal policy
that exacerbates the Republic's rising external imbalances." It
identified the key issues in the outlook as whether a) the GOS could
contain domestic spending and rising external imbalances, and b)
resolution of Kosovo's final status could jeopardize Serbia's
political and economic stability.


10. (SBU) Comment. If economic trends continue to be favorable, and
reforms continue at a moderate pace, Serbia's new government
probably can deal comfortably with the increased risks it has raised
through expansive fiscal policy. Nevertheless, the external risks
are, to some extent, vulnerable to shifts in the political outlook.
Serbia needs generous inflows of foreign direct investment to
finance its current account deficit and sustain growth. The central
bank's sterilization has reached about USD 2.5 billion, a stock that
must be rolled over every two weeks. The willingness of banks - and
the foreign investors who invest through the banks - to keep their
money in the repo is subject to change. And the dinar itself has a
history that Serbian savers have not forgotten.

POLT