THE GLOBAL ECONOMIC CRISIS HITS MONTENEGRO

UNCLAS SECTION 01 OF 04 PODGORICA 000078 SENSITIVE SIPDIS E.O. 12958: N/A TAGS: ECON EFIN PGOV PREL MW SUBJECT: THE GLOBAL ECONOMIC CRISIS HITS MONTENEGRO REF: A: 08 PODGORICA 279; B: 08 PODGORICA 267; C: PODGORICA 17 PODGORICA 00000078 001.2 OF 004 ¶1. (SBU) Summary: The global economic crisis is hitting Montenegro. IMF and other experts are predicting a sharp deceleration in growth in the near term, with GDP growth likely to decline to about two percent in 2009-2010. Credit growth is also likely to continue to decrease, given banks' reduced appetite for risk and inaccessibility of foreign financing in the current global environment. The probable reduction in capital inflows from abroad -- primarily foreign direct investments, depressed tourism revenues, and inter-bank loans -- will likely require significant additional budget cuts this year. The GoM has put some stopgap measures into place, but it is too early to tell whether they will be enough to contain the damage. The GoM also is talking to the IMF about the possibility of assistance in financing a possible budget shortfall. End summary. IMF Recommendations... -------------- ¶2. (U) The IMF released its annual assessment of Montenegro's economy earlier this month, which warned that the global financial turmoil and recession will likely have a substantial adverse impact on confidence, credit growth, tourism, and FDI inflows in the near term. The report -- and local experts agree -- predicted a rapid deceleration of GDP and credit growth and recommended Montenegro reconsider its current plan to cut taxes even further, given that the potential cost of helping the banking sector cope with the global financial crisis could create large budget gaps. They noted that a combination of tax cuts and spending increases could push the budget into deficit this year, following two consecutive years of budgetary surpluses. The report stressed that the priority should be on maintaining financial sector stability and fiscal sustainability. ...And GoM Plans to Mitigate the Crisis -------------- ¶3. (SBU) The GoM, in its proposed budget for 2009, has adopted a package of economic policy measures that aim to preserve macroeconomic stability, increase productivity, and maintain a favorable economic environment, primarily by: -- Strengthening investment in infrastructure: The budget proposal for 2009 allocates 217 million Euros for capital expenditures (compared to 85 million Euros in 2008). For the public sector (including municipalities),capital investment in 2009 is estimated to be 9.84 percent of GDP. -- Reducing spending: This is intended to free up money for increased investment in infrastructure by curbing the growth of current expenditures to below the level of GDP growth and the relative reduction of the current public spending from 41.5 percent of GDP in 2008 to 39.22 percent of GDP in 2009. It also involves the (temporary) freezing of ten percent of expenditures for materials and services in the first half of 2009. (The estimated savings for the first 6 months of 2009 on this basis is 6.5 million Euros.) -- Cutting government costs: The GoM has already begun to cut government spending because of a measurable decrease in receivables. DPM Igor Luksic announced recently that the GoM will freeze capital expenditures, e.g. for vehicles and IT equipment, as well as hiring expert consultants and reduce official travel. -- Ensuring additional liquidity for citizens and businesses: For example, income taxes were cut from 15 percent to 12 percent as of January 1, 2009, and the price of electricity for SMEs will be reduced by 10 percent. Also the GoM is aiming to preserve long-term credit lines from international financial PODGORICA 00000078 002.2 OF 004 institutions (EIB, KfW, etc) for small and medium-sized enterprises. -- Ensuring liquidity of the banking sector: The Government and the Central Bank have agreed on a model which will enable the commercial banks to use 20 percent of their mandatory reserves in order to additionally improve the liquidity of the financial system. -- Assisting companies in trouble: DPM Vujica Lazovic announced that the GoM is preparing assistance measures -- for example, allowing delayed payment of taxes and customs duties -- for companies that have been affected by the crisis. Lazovic emphasized that the government will have strict criteria to assess eligibility for this assistance, since many companies are using the crisis as a pretext to seek government aid. The DPM's office, however, told us that as yet no conditions have been established. Without any set regulation, there is a real risk that this measure could be used to allow GoM cronies easy access to GoM assistance. ¶4. (SBU) In addition to fiscal policy measures, the GoM is implementing socio-economic measures to maintain economic growth, preserve living standards, and encourage entrepreneurship. One project, entitled "Posao za Vas" ("A Job for You") -- initiated before the crisis, but whose budget for 2009 has been increased in the wake of the crisis -- aims to promote employment and viable entrepreneurial projects by providing concessionary credit to small businesses. For the implementation of the project, 18.15 million Euros (0.5 percent of GDP) has been allocated for 2009. ¶5. (SBU) The GoM's response to the economic downturn drew praise from IMF, which cited Montenegro's contingency planning for emergency liquidity situations. The GoM has initiated a dialogue with parent banks regarding liquidity support, detailed bank-by-bank contingency plans, increases in banknote inventory of the central bank, and opening of contingent credit lines. The IMF also welcomed the government's proposal to reduce spending further if the economic outlook continues to worsen. DPM Luksic also told us that the overall GoM stimulus package (including the tax cuts, "posao za vas" programs, etc) amounted to 10 percent of GDP. ¶6. (SBU) The GoM also has initiated talks with the IMF about the possibility of assistance in financing a possible budget shortfall of roughly three percent of GDP. The Finance Ministry tells us that for now this is just a backup plan as they have yet to determine whether another infusion of capital will be necessary, but that they want to be prepared if it is. Ministry officials tell us that they will be crunching numbers in the next week or so and plan to continue discussions with the IMF when they are in DC later this month for the annual IMF, WB meetings. ...But Banking Sector Still Weak... -------------- ¶7. (U) Montenegrins, historically distrustful of the banking system (reftel A),have been withdrawing deposits rapidly in the wake of the global crisis. In the last six months, roughly 300 million Euros -- a decrease of 6.5 percent since early 2008 -- in deposits have been withdrawn, putting aditional pressure on the liquidity of the domestic banking system. In addition to the Central Bank decision to decrease the level of mandatory reserves, the GoM also is providing guarantees for credit lines from international institutions in order to bolster the banking sector. On March 24, the Ministry of Finance announced a GoM-guaranteed 50 million Euros loan to the banking sector from German KfW bank and negotiations will begin this month with the European Investment Bank for another 100 million. The KfW loan was granted to Crnogorska Komercijalna Banka (CKB),NLB Montenegrobanka, and Opportunity Bank, and it will be earmarked specifically for loans to small and medium-sized entrepreneurship. PODGORICA 00000078 003.2 OF 004 ¶8. (SBU) Despite GoM measures to ensure the liquidity of the banking sector, insiders tell us all the banks are struggling. For some, chiefly Prva Banka, the global crisis has simply exacerbated existing problems caused largely by poor management. While the bank was able to repay a segment of the 44 million Euros loan they took from the GoM last fall (reftel A),they have requested an extension of three months to repay the remaining 33 million Euros, and many banking experts expect that the bank can only survive long term with a serious influx of foreign capital. For other banks, though ostensibly in better shape, the near constant delays of payment over the past few months -- for everything from public sector wages to GoM bills for foreign contracts -- lead us and others in the international community to speculate that liquidity issues are already more serious than anyone is willing to let on. ...And FDI Already Impacted... -------------- ¶9. (SBU) In the fourth quarter of 2008, FDI already had decreased significantly -- 21 percent from the same period in 2007 -- and the widespread expectation is that FDI will fall further in 2009. The world's financial woes also have decreased the number of investors able to bid on tenders for greenfield investments (many of which are large-scale projects in the tourism sector) or in state-owned companies which, according to the GoM privatization plan, should be launched in ¶2009. The deadlines for bids on the long-term lease of several tourist locations (Valdanos, Njivice) have been extended because none of the companies which submitted letters of interest last year subsequently purchased the tender documentation. The situation is little better even for the largest properties (Velika Plaza, Ada Bojana, Jaz, Buljarica. The GoM just released tenders to two of the largest -- Velika Plaza and Ada Bojana -- but experts are skeptical that they will be able to find a qualified bidder in this market. The success of at least one of these projects, however, is seen as essential for the economy to weather the current storm; DPM Lazovic told us that the GoM was really hoping for a short-term infusion from one of the large projects to finance the budget shortfall. He suggested that EPCG was the best shot, since it would involve a rapid infusion of capital, but should that fail one of the larger tourism valorization projects, like Velika Plaza, could be the ticket. ¶10. Existing investments -- primarily Russian -- also are facing challenges. As noted reftels, Russian-owned KAP is nearing collapse amidst low worldwide aluminum prices. We have been told that investments by Russian tycoons Deripaska and Polonski are suffering as well (septel). In recent months, significant interest in Montenegro (especially the tourism and real estate sectors) has been originating from Egypt, the UAE, and Qatar. ...Concern Over Tourism Season Rising... -------------- ¶11. (SBU) The tourism sector is likely to suffer from the global downturn, as tourists from Western Europe and Russia cut back on recreational expenditures to cope with their own domestic economic problems. Ministry of Tourism data shows that the current number of tourists in Montenegro compared to last year is already down by seven percent. DPM Luksic told us a GoM analysis predicts a nine percent decrease in tourist numbers on average this year. (Comment: We assess the drop will be greater. Even Tourism Minister Nenezic told us on March 28 that this figure seemed very optimistic. He predicted significantly fewer tourists from Russia and Western Europe. End Comment.) PODGORICA 00000078 004.2 OF 004 ...And Politization of the Crisis Already Begun -------------- -- ¶12. (SBU) The effect of the crisis in Montenegro was felt in the conduct of election campaigning for the March 29 parliamentary election. Opposition candidates warned that the GoM was misleading the public by downplaying the seriousness of the economic situation. Even DPS-SDP officials -- who by all accounts had plenty of cash in their campaign coffers -- told us that they watched their spending lest the opposition or their constituents resent their splurging while others were starting to feel the pinch of the financial crisis. ¶13. (SBU) PM Djukanovic has claimed publicly that Montenegro's current economic problems are not of its own making but due to the global financial crisis. The PM has denied allegations -- primarily from opposition parties -- that the crisis simply exposed the weaknesses in the domestic economy. Opponents of the government charge that Montenegro's problems are rooted in a combination of poor decisions made during the recent period of rapid, almost euphoric, economic growth. Comment: In the End, Some Crisis Unavoidable -------------- ¶14. (SBU) After several years of strong economic growth, Montenegro's small economy is now caught in a growing storm of negative global trends, particularly in Russia and the countries of Western Europe, upon which the Montenegrin economy is heavily reliant for trade, FDI, and tourism revenue. Many of our interlocutors are optimistic that Montenegro can continue some economic growth, despite a tough year (or two, as DPM Luksic estimates) ahead. For example, the recapitalization of the Electricity Company of Montenegro (EPCG) could bolster the entire economy. DPM Lazovic (perhaps optimistically) predicts the GoM would gain 300 to 500 million Euros from the deal, a huge sum for this small country. The EPCG tender is increasingly touted in the press as a magic bullet for the country's impending economic woes, but little else concrete is on the horizon if the deal fails to materialize. ¶15. (SBU) There is no denying that the banking sector is weak. Moreover, the tourism sector, roughly 20 percent of GDP in 2007 and 2008 is vulnerable. Finally, the rising corporate bankruptcy rate and growing number of unemployed will further reduce government revenues just as greater demands are placed on the social welfare system. PM Djukanovic's faith in the "vitality and flexibility of the Montenegrin economy" may be overstated, but his government's prudent fiscal planning may help Montenegro muddle its way through the crisis. MOORE