REVISED BUDGET SEEN AS EXPANSIONARY

UNCLAS BELGRADE 000894

SIPDIS

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: ECON EFIN KPRV SR
SUBJECT: REVISED BUDGET SEEN AS EXPANSIONARY

SUMMARY
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1. (u) Serbia's new government on June 14 presented a 2007 budget
proposal that would continue expansionary fiscal policy with an
expenditure increase of 27.4 percent and a projected deficit of 0.6
percent of GDP. A chorus of criticism, from economists, the central
bank, and the IMF, greeted the Ministry of Finance proposal, which
will replace the provisional financing utilized by the lame duck
Kostunica government. Economists labeled the budget as expansive
and a threat to macroeconomic stability. Central Bank Governor
Jelasic pledged to maintain a tight monetary policy or even tighten
further if increased demand boosts inflation. Finance Minister
Cvetkovic answered critics by noting that "previously signed
obligations in wage policy had to be respected." END SUMMARY.


2. (u) The Kostunica government on June 14 sent Parliament a full
budget proposal for 2007 to replace the decree on temporary
financing that had provided funding to the lame duck government.
The budget, if approved by Parliament, would authorize total
expenditures of SRD 595.5 (USD 9.8 billion) or 25 percent of GDP, vs
revenues projected at SRD 581.8 billion (USD 9.6 billion) or 24.4
percent of GDP, for a deficit of SRD 13.7 billion (USD 220 million),
or 0.6 percent of GDP. However, National Bank Governor Radovan
Jelasic - who still awaits re-appointment - disputed this figure,
contending that the actual deficit is SRD 50 billion, or 2 percent
of GDP, based on exclusion of one-off revenue of SRD 25 billion from
sale of a mobile telephony license. The basic macroeconomic
assumptions for the budget include GDP of SRD 2,382 billion, real
GDP growth of 5.9 percent, and end-year inflation of 6.5 percent.


3. (u) Total revenue is projected to rise by 16.6 percent in nominal
terms, while tax revenue, which provides almost 88 percent of budget
income, would rise 18.4 percent, continuing the rapid increase in
collections recorded in the first half of the year. VAT revenue
would provide about half of tax income; VAT, excise, and customs all
are projected to increase by 20 percent over 2006, while income and
profit tax are projected to rise by 10 percent. The share of income
and profit tax is projected at 15 percent, and for excise taxes, 17
percent. Customs revenue should contribute 9 percent of total
revenues.


4. (u) The 20.8 percent jump in current budget expenditures (RSD
524.8 billion, net of capital outlays) is driven by a 22.2 percent
increase in salaries for public employees, to which the previous
Kostunica government agreed in the run-up to January elections;
payroll is 29 percent of current budget expenditure. Transfers to
the pension, health and unemployment funds, which make up another 28
percent of the current expenditures, will rise by 14.6 percent.
Transfers to other levels of governments, which represent 10.6
percent of expenditures, will rise 54.9 percent, while social
payments, including the transition fund, allowances for children,
the poor, veterans, etc., will increase 16.3 percent. Even
subsidies are up 15 percent.


5. (u) New Finance Minister Cvetkovic fulfilled his pledge to move
outlays for the National Investment Plan (NIP) on-budget; the new
spending plan increases NIP outlays by a factor of five, to SRD 44.3
billion (USD 731 million). Overall, capital expenditure would more
than double, to SRD 70.6 billion, or 11.8 percent of total
expenditure.


6. (u) The consolidated budget of the general government includes
not only the central government but also the budgets of Vojvodina's
provincial government, local government and the Pension, Health and
Unemployment Fund. This budget is projected to reach SRD 995.7
billion (USD 16.3 billion),or 41.8 percent of GDP. Overall
government revenues are projected to reach SRD 986.1 billion (USD
16.2 billion),or 41.4 percent of GDP, leaving a consolidated budget
deficit of SRD 9.3 billion (USD 100 million),or 0.4 percent of GDP.



7. (u) Finance Minister Cvetkovic explained that the budget was
imposed on the Ministry by large salary increases for the public
sector agreed in late 2006 before the election campaign. Salaries
of budgetary users will increase by 22 percent on average through
2007, but salary growth will slow in the second half of the year, he
promised. However, Cvetkovic expects the 2007 budget deficit to be
much lower in execution than projected because NIP spending requires
detailed plans and time-consuming public procurement procedures.
Since just SRD 9 billion was spent for NIP in the first half of
2007, it is unlikely that the projected 35 million can be spent in
the second half.


8. (u) Serbia will continue to run a primary surplus, with interest
payments budgeted at SRD 17.4 billion, and overall debt service, at
SRD 58.6 billion. The finance minister contends that Serbia is not
a highly indebted country since public debt in 2006 was USD 12.4
billion, or 32 percent of GDP, of which domestic debt accounted for
USD 5 billion.

Analysts: Expansionary Budget a Threat to Prices
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9. (u) All observers agree that the budget is too expansionary, with
projected outlays increasing 27 percent over 2006 in nominal terms,
or 21 percent in real terms. NBS Governor Jelasic said that the
budget will not support price stability and could lead to more
restrictive monetary policy if inflation rises in response to
increased demand. He also observed that the draft 2007 budget will
not "open the IMF door for Serbia" since the Fund's April mission
recommended a healthy surplus to preserve macroeconomic stability,
vice the budget's 2 percent deficit.


10. (sbu) IMF Resident Representative Harald Hirschhofer publicly
warned that the draft budget could deepen macroeconomic risks by
causing even faster growth. Fiscal stimulus was limited to a degree
in the first half of 2007 by the spending limits imposed by the
temporary financing decree, but realization of the proposal 2007
budget would mean fiscal expansion in the second half of the year,
he points out. He recalled the IMF recommendation for a fiscal
surplus in 2007, increased efficiency in public spending, fast
privatization of public companies and revision of NIP. Privately,
Hirschhofer told a group of donor country officials that the deficit
could be as high as 3 percent of GDP and would increase the trade
and current account deficits even more.


11. (U) Independent analyst Vladimir Gligorov - who is close to the
opposition Liberal Democratic Party - called the budget populist and
warned that the central bank will have difficult task to keep
inflation in the target range of 4-8 percent. Stojan Stamenkovic,
of the Economics Institute, agreed that the budget is too high and
called for a cut of SRD 25 billion to harmonize fiscal and monetary
policy. If this budget is not reduced, he warned, the central bank
will be forced to tighten monetary policy by raising interest rates,
leading to appreciation of the dinar and an increase in imports of
some EUR 1.5 billion.

Opposition: A Status Quo Budget
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12. (U) Opposition deputies announced they will not support the
budget. Serbian Radical Party (SRS) deputies claimed that budget
was drafted without clear goals and "is not based on the current
Constitution." Socialist deputies will vote against it since the
budget has "an especially high deficit in the field of health
protection and a large number of people would remain without
appropriate treatment or certain drugs." The Liberal Democratic
Party (LDP) cannot support the budget due to the way it was proposed
in the Parliament as well as the character of the budget itself,
said LDP leader Jovanovic, calling it a "budget that sustains status
quo in Serbia".

Tax Breaks to Fulfill Pre-election Promises
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13. (U) On June 14, the Ministry of Finance also proposed amendment
of several tax laws, amendments that would fulfill pre-election
promises of the Democratic Party, which nominated Cvetkovic as
minister (although he says he is not a party member). The Ministry
proposed to decrease the tax rate on real estate transfers from 5 to
2.5 percent, with a full tax holiday for those purchasing their
first apartment; end the VAT on purchases of new apartments by
first-time buyers; decrease VAT for purchase of personal computers
from 18 to 8 percent, and decrease collections from several other
taxes.

POLT