CEFTA - RATIFICATION LIKELY AS GOVERNMENT PREPARES NEW

UNCLAS BELGRADE 000255

SIPDIS

STATE FOR EUR/SCE RIEHL
USEU BRUSSELS FOR MOZUR

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: ETRD ECON PREL HR SR
SUBJECT: CEFTA - RATIFICATION LIKELY AS GOVERNMENT PREPARES NEW
TOBACCO STRATEGY

REF: BELGRADE 1974

SUMMARY
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1. (SBU) Following the initialing of the Central European Free Trade
Agreement (CEFTA) in December, the Government of Serbia (GOS) is
still in negotiations with various parties to minimize the adverse
impact CEFTA will have on the domestic tobacco industry. Officials
told econoffs that Serbia will ratify CEFTA and that finding a
compromise with Croatia is unlikely due to Croatia's rigid position
on this issue. The GOS is now developing a new tobacco sector
strategy that aims at mitigating the negative impacts of CEFTA on
domestic tobacco companies through a variety of measures. The GOS
proposal appears to track closely with the approach that Philip
Morris has been pushing. END SUMMARY.

SERBIA WILL RATIFY CEFTA
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2. (SBU) On February 12, econoffs met with Deputy Minister Vlatko
Sekulovic, of the Ministry of International Economic Relations
(MIER),who is head of Serbia's CEFTA delegation. Sekulovic
indicated that CEFTA is too important for Serbia not to ratify in
its aspirations for EU accession. Negotiations with Croatia over
Serbia's excise tax structure have not been effective as Croatia has
taken a tough position against any discriminatory treatment of
cigarette imports to Serbia. Sekulovic said that of the options
available to Serbia at this time, developing a new tobacco strategy
is not only the easiest, but also the right thing to do in upholding
commitments made to investors like Philip Morris International (PMI)
and British American Tobacco during privatization.

NEW TOBACCO STRATEGY
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3. (SBU) In developing the strategy, Sekulovic emphasized four main
objectives of the government: 1) Ratification of CEFTA, 2)
increasing the quality of domestic tobacco production, 3) increasing
exports of cigarettes and 4) preserving budget revenues from duties
and taxes.


4. (SBU) As a result of CEFTA ratification, the excise tax system
must be equalized for domestic and foreign cigarette producers.
Serbia will unify the excise tax structure, requiring higher rates
for domestic manufacturers and providing lower rates to foreign
ones, Sekulovic said, but implementation likely will not take place
until January 1, 2008, thereby affording domestic manufacturers
additional time under the current excise structure. (Note: during
privatization of the tobacco industry, the GOS made commitments to
foreign investors of preferential excise treatment through January
1, 2010.)


5. (SBU) In order to redress domestic tobacco manufacturers' loss of
two years of preferential excise treatment, the GOS will propose
modifications to the Law on Excises, the Law on Customs Tax and the
Tobacco Law. Currently, domestic cigarette manufacturers must
procure 50 percent of tobacco from domestic farmers. State
Secretary Vesna Arsic at the Ministry of Finance told econoffs on

SIPDIS
February 9 that the Ministry of Agriculture conducted a recent study
to review the effects of this policy. Since 2003, the study showed
that the land used for tobacco production had decreased by 50
percent. Therefore, fewer farmers benefited, while cigarette
producers lacked the supply to meet demand and in many cases were
forced to procure poor quality product. Both Arsic and Sekulovic
confirmed that they expect the GOS to propose repealing the domestic
tobacco procurement obligation in the current Tobacco Law, replacing
it with a premium payment system that rewards quality. This move
will secure alignment with WTO and EU requirements in this area, as
well.


6. (SBU) In order to provide domestic manufacturers with a level of
protection similar to that enjoyed by manufacturers in other
countries, particularly in the EU, Serbia will revise the Law on
Customs Tax to increase the duty rate to 57.6 percent (EU level) on
cigarettes imported from all countries, except for those countries
where Serbia has concluded free trade agreements stipulating
otherwise (CEFTA countries and Russia). This move will also help
preserve budget revenues. Both Arsic and Sekulovic indicated that
the EU will not object to this change.


7. (SBU) As a concession to the domestic tobacco industry, Arsic
said that the GOS is considering waiving the requirement under which
tobacco companies must pay RSD 1.07 per pack of cigarettes sold into
the Serbian Health Fund.


8. (SBU) Arsic also said that the GOS also will adopt a long-term
schedule for excise taxes that will provide predictability to the
industry, but also reduce the ad valorem portion of the excise from

50 percent to 43 percent, to ease the impact on higher value
cigarettes, another key goal of Philip Morris.


9. (SBU) Tobacco industry representatives are pleased with the level
of cooperation demonstrated by the GOS. Eugenio Sidoli, Managing
Director of DIN "Fabrika Duvana," the Serbian subsidiary of Philip
Morris International (PMI),told econoffs that the GOS has actively
engaged the tobacco companies and is incorporating many of PMI's
suggestions into the new strategy. On another issue, the levy of
excise taxes by both Serbia and Montenegro on tobacco products
shipped to Montenegro, Serbia's Ministry of Finance reinterpreted
tax regulations to abolish the double taxation after PMI threatened
to shift production destined for Montenegro to a factory outside of
Serbia.

COMMENT
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9. Tobacco manufacturers understand the importance of CEFTA to
Serbia and support Serbia's decision to ratify. However, PMI has
led the industry in its advocacy efforts to ensure that the GOS
mitigates any adverse impacts from CEFTA accession. It appears that
the GOS has gotten the message regarding fair treatment of existing
investors and is following closely industry recommendations in its
proposed modifications to existing laws, although it remains to be
seen whether the new government will implement the policy that the
ministries are now developing.

POLT