STRUCTURAL FUNDS OFFER CENTRAL EUROPE MEANS FOR

UNCLAS SECTION 01 OF 04 BRUSSELS 000382

SENSITIVE
SIPDIS

STATE FOR EUR/ERA, EUR/CE, INL/PC, L/LEI
TREASURY FOR IA/EUR KOHLER

E.O. 12958: N/A
TAGS: PREL PGOV KDEM EUN EFIN BEXP EIND EAID XG
SUBJECT: STRUCTURAL FUNDS OFFER CENTRAL EUROPE MEANS FOR
WEATHERING ECONOMIC CRISIS

REF: A. BRUSSELS 331

B. BRUSSELS 280

C. BRUSSELS 134


1. (SBU) Summary and Introduction. Over the next four to
six years, the ten Central European Member States that joined
the EU since 2004 have the opportunity to avail themselves of
some $223 billion (176.6 billion Euros) of EU Structural and
Cohesion funds. These funds were established to advance
European economic and social cohesion by investing in
large-scale development programs for the EU's poorest
regions. Approximately 35 percent of the EU budget from
2007-2013 is dedicated to these funds, which benefit the new
member states. The new member states represent 20 percent of
the EU's population and only 7 percent of the EU's overall
GDP. Modeling experts in the European Commission maintain
that these investments will raise GDP levels in the new
member states on average by 3 to 5 percentage points above
baseline by 2016. Many EU economists believe that the global
economic slowdown is making these funds even more valuable to
Central Europe because they will serve as a de facto stimulus
plan in otherwise depressed markets. Still, the Central
European member states need to overcome a range of obstacles
in implementing these funds, including improving absorption
and administrative capacities, warding off potential
corruption, and contributing required matching funds.


2. (SBU) This cable is the fourth in a series (REFTELS)
looking at how the Central European states that joined the EU
since 2004 -- Bulgaria, Czech Republic, Estonia, Hungary,
Latvia, Lithuania, Poland, Romania, Slovakia, Slovenia --
commonly known as the CE-10, are faring within EU
institutions. This cable examines the significant economic
benefits available to the new member states in the current EU
budgetary period. End summary and Introduction.

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Structural and Cohesion Funds Defined
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3. (SBU) There are tremendous economic disparities across
the EU; a quarter of all EU regions have a GDP per capita of
less than 75 percent of the EU average. EU Structural and
Cohesion Funds were developed to minimize such disparities by
redistributing approximately one third of the EU's budget --
largely contributed proportionally according to GDP from all
member states -- to the poorest regions. These grants are
provided in seven-year increments, often with a two-year
grace period at the end, to member states to support projects
that advance priorities established by the European
Commission. The current 2007-2013 period prioritizes
innovation and entrepreneurship, expanding a knowledge-based
economy, and creating jobs.


4. (SBU) Structural Funds support three main objectives.
First is the "Convergence" objective, in which 82 percent of
the funds are concentrated on promoting growth-enhancing
conditions to lead to economic development. Second, the
"Regional Competitiveness and Employment" objective, with 16
percent of the funds, supports innovation, sustainable
development, and investment in human resources. Third, the
remaining 2 percent is dedicated to the "European Territorial
Cooperation" objective, which supports cross-border,
transnational, and interregional cooperation projects.


5. (SBU) Whereas Structural Funds comprise the broader range
of such grants, the Cohesion Fund supports projects
specifically in the transport and environmental sectors in
member states where gross national income per capita is less
than 90 percent of the EU average. States eligible for the
Cohesion Fund in the current period are Bulgaria, the Czech
Republic, Estonia, Greece, Cyprus, Latvia, Lithuania,
Hungary, Malta, Poland, Portugal, Romania, Slovenia, and
Slovakia. The European Commission has prioritized the
following types of Cohesion Fund projects for 2007-2013: air,
rail, river and sea transport, highway construction, water
distribution and treatment systems, and clean urban transport
networks. In a change from the 2000-2006 period, renewable
energy projects can now be financed using the Cohesion Fund.


6. (SBU) Central European member states presented their
lists of national priorities for these grants in documents
called the "National Strategic Reference Framework," which
outlines the projects needed in the poorest regions. The
European Commission then negotiated and approved the specific
programs, and determined the share of national and EU funds
to be used to implement such initiatives. Stefaan Pauwels,
an Economist with the European Commission responsible for

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Central Europe, informed Poloff on 9 March that the
co-financing percentages for the new member states were
recently reduced from about 20 to 15 percent in an effort to
make it easier for the new members to use these grants.
Pauwels opined that this would also undercut arguments he
often hears from the new member states that the co-financing
requirement forces recipients to increase their budget
deficits in the short term. Describing a strange logic in
the Commission and the complex process of administering these
funds, Pauwels pointed out that in some cases, the member
state share of co-financing can actually come from other EU
funds, such as those offered by other Commission initiatives.

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Funds Coming at Ideal Time, Given Economic Slowdown
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7. (SBU) Polish MEP Janusz Lewandowski, Vice Chair of the
Committee on Budgets, told Poloff recently that the
structural funds destined to the CE-10 are coming at a
propitious time, because they constitute a natural
anti-financial crisis package for these countries facing the
global financial crisis. (By statue, the EU budget must
balance, and therefore cannot have a stimulatory effect for
the entire EU). In noting the ideal timing, Lewandowski
asserted that the EU bureaucracy urgently needs to simplify
the prepayment process -- the steps by which funds are
transferred from the EU to the national banks of the member
states. He argues that this area is especially important
because it fills a liquidity gap for the recipient states.
The vast majority of Structural Funds to Central Europe will
be going to transportation infrastructure such as highways
and rail construction and modernization, development of human
capital through education improvements and training programs,
communication investments, and investments in business and
innovation; all these can spur job creation and investments
during the financial crisis. Naturally, as Lewandowski
noted, priorities vary from state to state. Poland, for
example, needs to focus on highway construction, as it lags
behind other EU member states in transportation
infrastructure. Lewandowski noted that Poland will be
receiving the largest share of the EU's Structural Funds for
Central Europe, about $86 billion (67 billion Euros),and
possibly more through direct contributions to agriculture.
He noted that Central European states are only now beginning
to receive project funding for the 2007-2013 period, and this
is because the new member states were late in submitting
their National Strategic Reference Frameworks.


8. (SBU) In line with the priorities laid out by the
European Commission, the Central European member states -- to
varying degrees -- have selected transportation
infrastructure, human capital, business and entrepreneurship,
and balanced territorial development as among their top
programs to receive Structural Funds in the current budgetary
period. Jose Luis Robledo Fraga, the Head of the Unit
overseeing the Baltic States in the European Commission's
Directorate for Economic and Financial Affairs, told Poloff
on 9 March that these types of initiatives are exactly the
types of projects needed to reduce the economic and social
disparities between Western and Central Europe. Robledo
Fraga, agreeing with the ideal timing of these funds, told
Poloff that the Central European states with non-Euro
currencies that have experienced considerable depreciation,
such as Hungary and Poland, will benefit in that the value of
the Euro funded projects will now go further. Furthermore,
whereas the European Commission had previously worried about
structural funds causing Central European economies to
overheat -- in which these massive cash influxes would cause
demand and prices to rapidly rise with little effect on
production -- Robledo Fraga viewed that as a less relevant
concern in the current depressed market.

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Commission Predicts Transformational
Effects in Central Europe . . .
--------------


9. (SBU) On 9 March, Poloff met with Jan in 't Veld, an
Economist with European Commission's Directorate General for
Economic and Financial Affairs, who is responsible for
modeling the expected impact of EU Structural and Cohesion
Funds. In 't Veld maintained that the EU Structural and
Cohesion Funds will yield a transformational effect on the
Central European member states. Describing his model, which
is widely praised by EU officials, In 't Veld projects that
EU Structural and Cohesion Funds will cause GDP levels in the
new member states to rise, on average, between 3 to 5

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percentage points over baseline projections by 2016.
Discussing possible negative aspects of these funds, In 't
Veld told Poloff he was concerned about their propensity to
crowd out private capital in the new member states. Filip
Keereman, Head of Unit for the Czech Republic, Poland,
Romania, and Slovakia in the European Commission's
Directorate for Economic and Financial Affairs, described an
ongoing economic debate among Commission economists,
regarding where to prioritize resource allocation. One group
favors focusing on growth-leading sectors, with the
expectation that development would emanate from those focal
points. Another group favors spreading these investments
throughout the countries in a bid to encourage more even
development. Keereman himself favored the first approach,
warning against a premature focus on wealth redistribution.

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. . . Provided Recipients Overcome Absorption
and Administrative Challenges
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10. (SBU) Dalia Grigonyte, a Desk Officer for Central Europe
in the Directorate General for Regional Policy in the
European Commission, recently told Poloff that the largest
obstacle to maximizing the utility of these funds will be low
absorption rates. While the new member states, on average,
used 94 percent of the Structural Funds available to them
from 2004-2006, they only made use of 52 percent of the
Cohesion Fund in the same period. Mission contacts point out
that the Commission enforces considerably more oversight over
the Cohesion Fund than Structural Funds, a likely explanation
for the lower absorption rate of the former. Grigonyte
judged that while generally the smaller Central European
member states have done a better job at absorbing available
funds, Bulgaria, Hungary, Poland, and Romania need to
increase their rate of spending to achieve full absorption.
She noted that it is natural for member states to accelerate
their spending as they approach the end of the budgetary
period.


11. (SBU) Poloff met on 3 February with Dr. Sabina Kajnc, a
Research Fellow specializing on Structural Funds at the
Center for European Policy Studies. While her conclusions
note that Slovenia performed the best in terms of applying
for and absorbing EU structural funds, its experience was not
problem free. The amount of funds available to Slovenia
tripled once it became an EU member in 2004, and Kajnc
posited that Slovene officials were not prepared for this,
and had not put much thought into the long-term projects
Ljubljana would propose. Further complicating matters was
the issue of absorption capacity, and this touches on three
areas: 1) macroeconomic capacity, 2) the question of whether
the government could come up with its required matching
funds, and 3) administrative capacity, whether Slovenia had
the local expertise needed to initiate, plan and execute such
EU projects.


12. (SBU) Lewandowski conceded that no member state can make
use of all available structural funds, but noted that
concerted efforts need to be taken to avoid the appearance of
failure in this regard. Echoing this point, Marek Evison,
Foreign Policy Advisor to Joseph Daul, Chair of the European
People's Party (Christian Democrats) and European Democrats,
informed Poloff on 6 March that the main reason Central
European countries failed to spend all the money allocated to
them was poor administrative capacities. He argues that as a
result, Central European member states could be hard-pressed
to justify future requests for funding. Evison asserted that
in the Polish example, the local level was of key importance;
some mayors did a much better job than others at securing EU
financing for their municipalities. He viewed central
governments in the region as doing a generally poor job at
coordinating the planning and disbursements of these funds.


13. (SBU) The European Commission is particularly wary of
corruption in the administration of EU funds, especially
instances of misuse in Bulgaria and Romania, according to
economist Stefaan Pauwels. He noted Commission concern about
the prospect of Structural and Cohesion Funds falling into
the hands of organized crime in Bulgaria, or being lost to
corruption. Although news of Bulgaria losing access to some
$285 million (220 million euros) of EU funding in the
agriculture sector dominates European media coverage, Pauwels
pointed out that Romania also has some of its EU financial
assistance frozen due to corruption concerns. The EU has
established monitoring and auditing mechanisms to counter the
potential misuse of EU funds, although the effectiveness of
these safeguards is unknown. There is a widespread

BRUSSELS 00000382 004 OF 004


perception among EU experts and some within the Commission
that the current safeguards for Structural Funds, which have
been relaxed in the current period to make it easier for
member states to use the funds, could be insufficient to
prevent corruption. Also, as the issue of where to spend
these funds is a political one, there have been allegations
of misuse and cronyism in Central Europe. Some EU policy
experts warn that extremist political parties can be
"purchased" into a governing coalition by giving them control
of ministries responsible for overseeing EU Structural and
Cohesion Funds.

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Opportunities Exist for European and U.S. Businesses
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14. (SBU) Comment: Despite absorption, administrative and
corruption concerns, the EU Structural and Cohesion Funds
represent a significant transformational possibility for the
Central European member states. These funds are likely to
prove effective at stimulating jobs and long-term growth in
the region, depite the global economic slowdown. Moreover,
these funds represent a unique opportunity for European and
U.S. businesses. U.S.-based firms are eligible to
participate as partners in projects that receive EU
Structural or Cohesion Funds, and supplies of U.S. origin are
permitted. The only requirement is that the fund beneficiary
establish a bank account in an EU member state. U.S. firms
are advised to find a suitable European partner to interact
with local regional authorities. U.S. subsidiaries located
in the EU that are legally registered in a member state are
considered "European firms," and are thereby fully eligible.
Over time, as income levels in Central Europe rise, the
region will become an even more attractive market for
higher-end global goods and services. End comment.

MURRAY
.