CROATIA'S 2008 BUDGET: IN LINE, IF NOT INNOVATIVE

UNCLAS SECTION 01 OF 02 ZAGREB 000290 SIPDIS SIPDIS SENSITIVE DEPT FOR EUR/SCE AND EB; OSD FOR WINTERNITZ; NSC FOR BRAUN E.O. 12958: N/A TAGS: ECON EFIN PGOV HR SUBJECT: CROATIA'S 2008 BUDGET: IN LINE, IF NOT INNOVATIVE ¶1. (U) SUMMARY: Croatia's 2008 budget represents a relatively conservative and fiscally responsible approach, with projected revenues set at 115.9 billion HRK ($24.7 billion) and expenditures at 118.4 billion HRK ($25.2 billion). The general government deficit is projected to be 2.3% of GDP. The GoC prepared the budget with a stated focus on improving the competitiveness of Croatia's economy, increasing expenditures for rural and regional development and stimulating entrepreneurship. The budget includes a 19.5% increase in defense expenditures for a total of 5.4 billion HRK ($1.1 billion),and is projected to be 1.8% of GDP for 2008 -- which is above the GoC's commitment to NATO in January 2008 of 1.77% of GDP (and using NATO formula would be 2.2% of GDP). END SUMMARY. ¶2. (U) The Croatian parliament passed the 2008 budget on March 5, with revenues planned at 115.9 billion HRK ($24.7 billion) and expenditures at 118.4 billion HRK ($25.2 billion). The government drafted the budget based on projections of 4.5% GDP growth and an inflation rate of 5.2% for 2008. With these assumptions, the Croatian Ministry of Finance estimates the government deficit, including the state budget, extra-budgetary funds and agencies, and local government, will be 2.3% of GDP, down from 2.6% in 2007. Expenditures are to increase by 6.4 billion HRK ($1.4 billion),with planned revenues up 7 billion HRK ($1.5 billion) from the 2007 budget. According to analysis by the Institute of Public Finance in Zagreb, the revenue plan is realistic, as it is in line with real GDP growth rates, though it may underestimate revenues from excise taxes and health care contributions. ¶3. (U) The budget maintains or increases funding for almost all beneficiaries. Similar to previous years, about 50% of the budget will go to social expenditures, 18% to wages, and 8% to material expenses. PM Sanader presented the budget to parliament in February as a "development-oriented" budget, saying it focused on improving the competitiveness of Croatia's economy. Relative to 2007, expenditures aimed at stimulating enterprise rise 26%, those for agriculture and rural development increase 32%, and those for regional development and capital investments rise 67% higher; although none of the absolute sums are very impressive: spending for �0A;all three categories combined is only around $1.5 million. ¶4. (U) The budget includes 5.4 billion HRK ($1.1 billion) in defense expenditures, a 19.5% increase over 2007. Defense expenditures constitute 4.3% of the budget and are expected to constitute 1.8% of GDP. (NOTE: Using NATO formula, i.e., deducting unallowed expenses for fire-fighting and coast guard, but adding allowed expenses for pension costs, the Croatian defense budget for 2008 is actually 2.2% of GDP. END NOTE.) About 70% of the increased funding in 2008 will go toward operations and maintenance and modernization projects. The other 30% will go toward salary increases. According to the Ministry of Defense Budget Department, the ministry will spend 472.2 million HRK ($100.5 million) on procurement and modernization programs in 2008. The state budget also provides the Ministry of Foreign Affairs 4.5 million HRK ($957,000) for NATO-related activities. ¶5. (U) The GoC will continue to provide substantial subsidies to public and private entities in 2008. Subsidies to farmers, craftsman, small and medium enterprises, and other companies, will rise by over 10% and total more than $1 billion. The budget also includes continued support for shipyards and other entities through government guarantees planned at 7.4 billion HRK ($1.6 billion). For comparison, the GoC planned for 4.9 billion HRK ($1.0 billion) in guarantees in the 2007 budget, but instead issued guarantees worth 13.6 billion HRK ($2.9 billion). (NOTE: Reducing subsidies to shipyards represents a major political challenge, but is a key issues the GoC must grapple with as it seeks to meet EU accession criteria. END NOTE.) ¶6. (SBU) COMMENT: Prior to Croatia's November 2007 elections, some politicians talked of 7% GDP growth for 2008. The projection of 4.5% growth used to prepare the budget is notably less optimistic, but also more realistic given current economic conditions. To its credit, the GoC has prepared a budget that anticipates the worsening economic situation but stays within the deficit band it promised and below the 3% of GDP limit required by the European Monetary Union. Although the budget plans for increases in both revenues and expenditures, it notably includes no significant changes in the tax or fee systems and no major new programs, despite the fact the government is at the start of a new mandate. The budget drew little criticism for its dearth of innovation, however, likely because it also includes few cuts to programs and because it keeps the country on course to ZAGREB 00000290 002 OF 002 achieving its primary goal: EU accession. Bradtke