KOSOVO: EFFECTS OF POSSIBLE SERBIA ECONOMIC

C O N F I D E N T I A L SECTION 01 OF 06 PRISTINA 000810

SIPDIS

SIPDIS

DEPT FOR EUR, EUR/SCE, DRL, INL, AND S/WCI, NSC FOR BRAUN,
USUN FOR DREW SCHUFLETOWSKI, USOSCE FOR STEVE STEGER, OPDAT
FOR ACKER

E.O. 12958: DECL: 12/04/2017
TAGS: PREL ETRD ECON EAID EAIR ETTC PTER KTFN UNMIK
KV, YI
SUBJECT: KOSOVO: EFFECTS OF POSSIBLE SERBIA ECONOMIC
BLOCKADE POST-INDEPENDENCE

REF: A. PRISTINA 542

B. PRISTINA 757

C. PRISTINA 786

Classified By: COM TINA KAIDANOW FOR REASONS 1.4 (B) AND (D)


1. (C) SUMMARY: Despite negative consequences for its own
economy, Serbia appears determined to implement an economic
blockade against Kosovo when independence is declared. While
the length and degree of a blockade is impossible to predict,
complete closure of every Serbia-Kosovo checkpoint to all
forms of transport could be viewed as the worst case
scenario, and the impact of these closures would be felt
almost immediately. We anticipate some local hoarding of
food, bottled water and cash until goods can be re-routed,
most likely through Macedonia. Severe shortages of food and
fuel are unlikely, however, even if life in Kosovo is certain
to become more expensive and consumer goods less available.
Kosovars have demonstrated considerable resilience in
response to retaliatory actions from Serbia in the past, and
they will likely find alternative resources to support
themselves in the event of a blockade. Our European
Commission colleagues share this assessment and do not plan
to stockpile commodities, though they will maintain an active
"watching brief" and say they can muster a rapid response to
any emergency within 24-72 hours.


2. (C) SUMMARY (cont,d): Serbia has several other measures
at hand to make life generally more difficult and frustrating
for Kosovo, magnifying the effects of a blockade. Cutting
off Kosovo from shared telecommunications cables, the power
grid, and water from the Gazivoda reservoir (though the
latter in particular is a deeply complex issue with impact on
Serbs and Albanians alike) are all within Serbia's capacity.
The closing of borders, in addition to economic hardship,
would contribute to physical isolation as well. Alternate
overland roads through Macedonia, Montenegro and Albania can
be arduous and are often blocked by rockslides, heavy
snowfall, and fog during the winter months. Scheduled
commercial air traffic into Kosovo might be cancelled for
several days immediately following an independence
declaration, but will likely resume as soon as the ground
environment is determined stable. Our take is that Kosovo in
the short-term would be able to weather these obstacles
without serious hardship. The long-term effects of a
sustained blockade, however, could be more damaging to
Kosovo's economy. A significant decrease in investment,
imports, and the subsequent lack of employment generation
could result in the loss of an entire year of growth.
Re-routing cargo to alternate border checkpoints, if well
managed, should diminish the severity of a blockade. END
SUMMARY.

SHORT-TERM EFFECTS OF A COMPLETE BLOCKADE


3. (C) In consultation with USAID advisors, Embassy Belgrade
and others, a prediction of the complete closure of every
checkpoint, blocking all movement of goods and people to and
from Kosovo at the Administrative Boundary Line (ABL) is the
agreed worst-case scenario. Statistics from the Office of
the Prime Minister indicate that just over one-third of
Kosovo,s total imports come from or through Serbia, with an
approximate value of 546 million euro. Imports originating
within Serbia amount to 200 million euro, or 12 percent of
all cargo coming through the ABL checkpoints, most of which
are consumer products. Almost no fuel comes through the ABL
crossings. These figures include the importation of wheat
and flour, which were subject to a general export ban by the
Serbian government in mid-2007 due to Serbian grain
shortages. This ban is still in effect, reducing the total
percentage of Serbian-produced imports to around 9 percent,
which is small in terms of overall consumption. Kosovo
exports about 30 million euro worth of goods (7 percent of
total exports) through the ABL checkpoints.


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4. (C) Assuming that end-restrictions (i.e. denial of passage
based on final destination of cargo) are not placed on goods
transiting through Serbia, non-Serbian imports coming through
the ABL checkpoints could be re-routed to alternate crossings
via Albania, Montenegro and Macedonia. Each of these
countries has one cargo checkpoint with Kosovo. Inclement
weather, rock slides and generally poor road conditions make
it possible that all three crossings could be closed for
significant periods during the winter months. The transit
point from Albania has improved significantly over the past
year, allowing for passage of small trucks and a wide array
of commodities, but still cannot accommodate large capacity
tractor-trailers. If Serbia enforces end-restrictions on
transiting goods, ground transportation would have to be
routed around Serbia, through Romania and Bulgaria, before
reaching the Kosovo-Macedonia border. Thus, in addition to
delays in delivery, significant transport costs could be
added to the import of goods to Kosovo.


5. (C) The Hani i Elezit/General Jankovic crossing with
Macedonia is by far Kosovo's most important overland link and
the most accesible alternative. This checkpoint is already
heavily utilized for cargo in and out of Kosovo, including
for KFOR supply operations, and is accordingly plagued by
general congestion. USAID advisors estimate that 40 percent
of all goods imported to Kosovo pass through Hani i Elezit.
If all goods passing through Serbia were re-routed to this
checkpoint, 70 percent of Kosovo,s imports would be fighting
to enter through one crossing. Delays could be considerable,
lasting weeks and possibly even longer. Currently, the Hani
i Elezit cargo clearing facility is operating at 70 percent
capacity. To accommodate the increase in traffic, trucks
could be moved to an inland facility to clear customs.
However, the assistance of Macedonian customs officials is
required to facilitate the increased cargo flow into Kosovo.
Kosovo's customs chief says he has contacted his Macedonian
counterparts about addressing this scenario, but admitted
that active cooperation between the two organizations has not
been forthcoming. (Note: USOP will pursue this issue with
counterparts at Embassy Skopje.)

Reaction of Kosovo Customs


6. (C) The Director General of the Kosovo Customs Service,
Naim Huruglica, told us recently that if Serbia completely
closes the ABL checkpoints, Customs is prepared to re-deploy
officers to the alternate border crossings within one week.
Huruglica added that the railway, with one international
connection to Skopje, and Pristina airport, which currently
handles about 8 percent of all goods entering Kosovo, will
also be crucial in maintaining the flow of goods. (Note:
UNMIK reports addressing possible consequences of an
independence declaration do not foresee airport operations
adversely affected. However, it is possible that commercial
flights to and from Kosovo could be halted for several days
while stability on the ground is assessed. Whether airlines
resume flights will depend largely on the governments of
their respective home countries, and possibly their
insurers.) The maximum capacity of Kosovo's railway system
is 8-10,000 tons per day, but the railway's managing director
maintains that capacity can be increased by borrowing railway
wagons and locomotives from Macedonia, a prospect that would
also need to be further explored. In addition, according to
our European Commission colleagues, European assistance
funding has recently been used to improve uploading capacity
for railway cargo in Macedonia and downloading capacity at
the railway terminus in Fushe Kosove (just outside Pristina),
potentially increasing the efficiency of transit via rail as
an alternate mode of transport. Substantial fuel reservoirs
exist at the Fushe Kosove terminus, as well, for further
redistribution to other parts of Kosovo.

Effects on the Consumer


7. (C) Consumer goods shortages and an increase in prices

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could well provoke some hoarding of food, water and cash in
the first few weeks after a blockade is declared. Rising
fuel costs and higher transportation expenses from re-routing
imports may not only increase the cost of consumer goods, but
could also harm the competitiveness of Kosovo exports.
Transport delays could lead to confidence issues if Kosovo
businesses cannot deliver on their contractual agreements.
Accurate statistics on inventories are not readily available,
but the wheat and flour ban-produced shortages indicated only
two months of stock available. Current inventories are
probably significantly lower, due to inadequate time for
businesses to re-build their stocks since the ban went into
effect.


8. (C) Kosovars could see substantially higher consumer
prices, particularly for foodstuffs. There will almost
certainly be short-run profit-taking from individuals seeking
to exploit immediate shortages. As long as the non-ABL
checkpoint routes remain reasonably free of blockages,
extreme shortages of food are not likely, but availability of
consumer goods could be reduced. Given that the bread crisis
resulting from the wheat and flour export ban was absorbed
quickly and with little difficulty, Kosovo appears capable of
absorbing even greater economic shocks that could result from
a blockade.

Currency Availability


9. (C) The physical availability of currency, notes and coins
could be an issue if supply routes are blocked. The cash
deposit ratio in Kosovo is 11 percent, with an estimated 65
million euro in cash-on-hand. Kosovo could face the
possibility of running out of cash if a run on banks is made
immediately after independence. The Kosovo Central Banking
Authority (CBAK) intends to increase cash holdings before the
end of the year, due to the uncertainty of any independence
timing and unforeseen initial demand. CBAK expects to see
some lines at ATMs, but otherwise extreme cash shortages are
not anticipated.

Business Community Anticipates Blockade


10. (C) The Kosovo business community appears already to be
planning for a blockade. It is actively seeking out
alternative suppliers in neighboring Macedonia, Montenegro
and Albania, and even casting its net wider to include
Turkey, Italy, Greece and the U.S. USOP has received three
inquiries about importing wheat and cooking oil from the
U.S., in an apparent pre-emptive move to alleviate possible
shortages and delays from a blockade. The president of the
Alliance of Kosovar Businesses, Agim Shahini, recently
declared Kosovo prepared for any trade embargo implemented by
Serbia. What local businesses cannot supply, Shahini
asserted, the grey market will provide.


11. (C) It is likely Kosovo Serbs will be able to continue
trading during a full blockade. Serb enclaves have been
exempt from the wheat and flour export ban, obtaining special
permits from Belgrade to receive shipments. This could place
the enclaves in an excellent position to re-sell consumer
products to Kosovo Albanians for a substantial profit,
fulfilling the prediction of the grey market stepping in to
meet consumer needs. In a slightly different scenario,
Serbia could choose not to cut off trade to northern Kosovo,
increasing the potential for smuggled goods to enter Kosovo
and move illicitly further south. Safet Gerxhaliu, head of
the Kosovo Chamber of Commerce, claims that grey market trade
is already in the neighborhood of 200 million euro per year.

POSSIBLE ANCILLARY EFFECTS


12. (C) Serbia could employ a number of additional measures
to make life generally more difficult and frustrating for
Kosovo. The multiplying effect of these measures will depend
on Belgrade's decision to implement a full or partial

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blockade and how strictly the blockade is enforced on the
ground.

Energy


13. (C) Kosovo is connected to Serbia's electrical grid, and
it imports additional power through these lines during peak
winter months. Serbia could cut Kosovo completely out of the
grid, though this would also cut electricity to the Serb
enclaves. Serbia has a contractual agreement to supply power
to Greece, Macedonia and Albania, routed through Kosovo.
Eliminating Kosovo from the grid also means cutting off
Serbia's own customers. Nevertheless, the likelihood of a
cutoff is significant, and could substantially raise the cost
of electricity imports, which would have to be purchased on
the regional spot market rather than through existing,
lower-cost arrangements via Serbia. Refs B and C provide
more information about the current energy situation in
Kosovo, including the broader implications of a Serbian power
cut.

Water


14. (C) Serbia could attempt to tamper with the extensive
water system that emanates from the Gazivoda reservoir,
located in the northern Serb-majority municipality of Zubin
Potok. Gazivoda supplies drinking and some irrigation water
to northern Kosovo (including both Serb-majority areas and
limited Albanian-majority areas like Vushtrri and Drenas),
and is the only water source with sufficient capacity for
operation of essential assets such as the Kosovo Electric
Company (KEK),though potable water for Pristina and other
areas of Kosovo is sourced primarily from the nearby Batllava
and Badovc reservoirs (Ref A). Gazivoda is an additional
back-up drinking water source for Pristina but has not yet
been used for this purpose, despite severe droughts this
summer.


15. (C) The water delivery system is complex; as an example,
potable water is actually pumped from Gazivoda and
transported via a canal system to a water treatment plant in
south Mitrovica before being returned to northern Kosovo as
drinking water. Multiple pumping stations, viaducts and
tunnels along the 50 km canal route that sends water further
south (notably, to cool the KEK plants as they operate) could
be potentially vulnerable, though sabotage could have an
impact on Serb communities in the north, at least in the
immediate term. Local experts also tell us that acts of
sabotage could, in the main, be quickly repaired unless there
were multiple system failures. KFOR and UNMIK are discussing
protection of the water delivery system, but protection of
all key nodes would be a tall order. The EU is also
conducting technical studies of the Gazivoda reservoir and
water delivery systems. Septel will report on these
water-related issues in more detail.

Movement of People


16. (C) Serbia currently refuses entry to vehicles with
Kosovo-issued license plates and is not expected to change
this policy post-independence. Kosovar vehicles would likely
continue to use third-country license plates to enter Serbia,
if the travel portion of the blockade is not in full effect.
According to UNMIK Police statistics, roughly 2,000 vehicles
enter and exit Kosovo through the ABL checkpoints daily,
along with 5,000 to 6,000 persons checked each way. Given
seasonal fluctuations and some statistical unreliability,
these data indicate a significant amount of traffic will be
halted under a full blockade.

Telecommunications


17. (C) According to UNMIK reports, 40 percent of
international incoming telephone traffic passes through fiber
optic lines between Serbia and Kosovo, using Serbia's

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international dialing code. Belgrade could conceivably cut
off telephone landlines and interfere with the international
dialing code, in an attempt to isolate Kosovo. Some
international outbound traffic is also being routed through
Serbia. Traffic both ways could be re-routed through other
channels to maintain international connectivity, although it
should be noted that Serbia makes a profit from termination
charges for all calls ending in Kosovo on its fixed lines.
The mobile network already operates independently of Serbia.
Some cell towers in northern Kosovo are located on private
property, which, if confiscated, would disrupt mobile service
in northern Kosovo only.

LONG-TERM EFFECTS


18. (C) USAID advisors foresee significant long-term effects
from a blockade, particularly if in full force for several
months or more. The 2008 Kosovo budget includes large public
sector capital expenditures, partially based on the current
government surplus. If funds for these projects are
redistributed to meet emergency needs, such as subsidizing
consumer goods and electricity, real GDP growth could
decrease from a projected 8.1 percent to 3.4 percent. If
investment imports continued to be blocked and alternative
sources of capital expenditures did not materialize,
investment projects and employment creation would not occur.
GDP could drop as low as 0.9 percent, which is effectively
the loss of an entire year of growth.


19. (C) Customs revenues are the primary contributor to
Kosovo's budget. According to statistics from the Office of
the Prime Minister, the revenue collected at the ABL
checkpoints is estimated at 89 million euro per year. This
comprises about 17 percent of revenues collected at all
border checkpoints throughout Kosovo. UNMIK estimates that
the initial drop in revenues from the ABL closures will be
temporary until alternate transportation routes are
established. However, any drop in budget revenue would mean
less cash flexibility overall. This could be of particular
concern regarding electricity needs, in addition to the
possible decline in economic growth. If KEK is unable to
supply enough power during the peak winter months, Kosovo
could find itself without adequate cash reserves to purchase
additional energy on the spot markets and would have to delve
into the budget surplus to meet this need. Kosovo Customs
Director Huruglica noted that total revenue collection for
2007 is expected to exceed targets by as much as 20 percent
(approximately 70 million euro above projections). Huruglica
offered the opinion that this surplus could offset any
potential revenue drop from the ABL checkpoint closures,
though again this would hinder use of the surplus for other
economic objectives.

European Commission Prepared, But Not Alarmed


20. (C) Our European Commission colleagues share our overall
assessment that Serbian measures are likely to cause
difficulties, but not to derail the Kosovo economy. Acting
EC head of office Renzo Daviddi told USOP that he had just
been to Brussels the week of December 3 to review crisis
contingencies, but was satisfied that there was no need to
move either people or commodities to the region in advance of
a Kosovo declaration of independence. The EC, he noted, has
crisis management and rapid response mechanisms that can
respond within 24-72 hours in the event of an emergency,
though Daviddi said he was convinced that Kosovo would not
experience large scale economic problems as the result of a
blockade. He cited three potential areas for concern,
including water supply (which he termed a security issue),
electricity (which he asserted was best dealt with via
political understandings with Macedonia and Montenegro on
assured transmission of electricity via their grids, though
he acknowledged the cost of imports could be considerably
higher than under current arrangements),and the free
movement of people. He foresaw, as in our analysis, possible

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price increases and shortages of some commodities, though not
massive ones, and believed that smuggling and rerouting of
goods would go a long way towards ameliorating the shortages.
Daviddi also previewed the strong possibility that the EC
would make available 50 million euro (previously set aside
for Kosovo budget support in the event of a budget deficit)
for use by Kosovo as an emergency fund, though the decision
had not yet been taken in Brussels.


21. (C) COMMENT: How extensively Serbia will choose to
implement, or strictly enforce, a blockade will vary the
level of stress to Kosovo's economy. We anticipate Serbia
will feel the need to make a strong statement, one that is
physically felt by Kosovars, in response to any declaration
of independence. An economic and travel blockade, even if
implemented to the maximum extent possible, will certainly
hurt the Kosovo economy but not cripple it. USAID advisors
predict that after the initial shocks are absorbed, Kosovo,s
economy will slowly normalize. Kosovars have learned to be
extremely resourceful during past crises, continuing to trade
with Serbia on the ground even during conflict. The
possibility that economic and business interests will prevail
over political maneuvering in this instance is also fairly
likely, though the exigencies of the gray market will
increase costs to the Kosovo consumer. The potential for
long-term damage of a full boycott to Kosovo,s growth
opportunities could, however, be more significant. Kosovo
authorities are beginning slowly to grapple with these
issues, and we are encouraging them to think through the
implications of Serbian measures. Stockpiling commodities
does not seem like a necessary measure at this point, though
we and our EU counterparts are continuing to evaluate the
situation and will advise further. END COMMENT.
KAIDANOW