MACEDONIA: CAN THE DENAR AVOID DEVALUATION?

C O N F I D E N T I A L SKOPJE 000117


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E.O. 12958: DECL: 03/10/2018
TAGS: ECON EFIN EAID PGOV PREL MK
SUBJECT: MACEDONIA: CAN THE DENAR AVOID DEVALUATION?

REF: SKOPJE 0052


Classified By: DCM Tom Navratil for reasons 1.4 (b) and (d)


1. (SBU) Summary. Macedonia's current account deficit
widened dramatically in 2008. The central bank's currency
reserves have dropped at an alarming rate in 2009, raising
concern about the country's ability to maintain the pegged
value of the denar at roughly 61 to the euro, a fundamental
element of the country's economic policy. Some
businesspeople are concerned that a devaluation of the denar
may occur in the late summer or fall as a result. The
official response, however, is split: While the National
Bank of the Republic of Macedonia (NBRM) is taking steps to
tighten monetary policy in defense of the peg, the GoM has
advocated a looser fiscal policy, including deficit spending.
It is unclear if the center can hold. End summary.


2. (SBU) Macedonia's small economy is heavily reliant on
imports. The country's trade deficit grew from about 23
percent of GDP in 2007 to 33 percent of GDP in 2008.
Statistics from the first two months of 2009 indicate that
the trade deficit will grow further as imports continue to
increase and demand for Macedonia's exports declines as a
result of the global economic slowdown. The dramatic
increase in imports in 2008 was a result of the rise of the
cost of imported fuel (44.8 percent increase in 2008 compared
to 2007) and the increasing ease with which households were
able to obtain credit for purchases such as automobiles. In
fact, NBRM Governor Petar Goshev told the Ambassador, the
value of imports to the country now doubled that of exports.
Macedonia's largest export sector, metals, has been hit
particularly hard by lack of demand. While overall
industrial production dropped in January 2009 by 16.7 percent
from January 2008, metals production in January 2009 plunged
by 76.6 percent compared to the previous year. As a result
of this and other pressures, the current account deficit rose
to an estimated 14 percent of GDP in 2008.


3. (SBU) Until the fourth quarter of 2008, foreign direct
investments brought significant funds into Macedonia, easing
the current account deficit and spurring growth. However,
much of these inputs were themselves used to import equipment
and raw materials, dampening the effect on the overall
current account deficit. By October 2008, however, foreign
investors began to postpone or cancel planned investments.
The latest postponement came from the Turkish firm TAV
Airports Holding, the chosen concessionaire for the upgrade
and operation of two existing airports in Skopje and Ohrid,
and for building a new cargo airport in Stip. TAV's
estimated USD 260 million investment has been postponed to a
later, undetermined date. Finally, estimates for net private
transfers to Macedonia dropped from 18 percent of GDP to 15
percent of GDP in 2008, according to IMF statistics.


4. (SBU) At the same time, the GoM has set itself on a
course for increased spending. The government has ignored
IMF's advice to save money for more difficult times, and
spent wildly in December 2008. The GoM's budget for 2009
aims for a budget deficit of 2.8 percent of GDP, while
optimistically projecting GDP growth of 5.5 percent. See
reftel. However, on March 5, Minister of Finance Trajko
Slaveski announced that budget revenues in the first two
months of 2009 were 3 percent lower than in the same period
of last year, and were below GoM projections. (Note: Many
of our interlocutors expect the GoM to revise the budget
after the April 5 second round of presidential and municipal
elections to account for reduced revenues. However, there is
no indication that the GoM would restrain its own spending,
as budget projections for 2010 and leading party campaign
slogans call for increased deficit spending. End Note.)


5. (C) To pay for the growing current account deficit, the
NBRM has been spending currency reserves at an alarming rate.
Valued at USD 2.4 billion in September 2008, the country's
reserves were worth about USD 1.8 billion in early March, and
are being spent at an average rate of about USD 65 million a
month. On February 26, the NBRM issued a press release
claiming that additional denar purchases were not needed to
support the peg. However, on March 5 NBRM Governor Petar
Goshev told the Ambassador that foreign currency inflows were
desperately needed as reserves were quickly being spent. In
fact, Goshev said that during the first four days of March,
the NBRM had spent more than USD 25 million to maintain the
peg. Goshev said that he suggested to Prime Minister
Gruevski a prompt budget rebalancing to direct more funds to
promote exports, and taking an IMF loan of about USD 390-650
million for direct balance of payments support. Neither of
the two suggestions, the Governor said, were acceptable to
the PM, because the proposals would "hurt the government's
reputation." Instead, PM Gruevski has pressured Goshev to
state publicly that under no circumstances will there be a
currency devaluation. Goshev so far has resisted doing so,
concerned that he would be blamed if the peg becomes
unsustainable. Goshev assured the Ambassador that the NBRM
would continue to intervene to maintain confidence in the
currency as needed, defending it "to the last breath."
Separately, IMF representatives told us they believed that a
ten percent drop in the currency's value would be likely if
it were allowed to float against the euro. IMF also said
their message to the PM is that sustaining the peg requires
fiscal discipline as well as proper monetary policy.


6. (SBU) In the business community, however, confidence
appears to be vulnerable. In recent weeks we have heard
repeated concern for the denar's stability, even before the
story was picked up by the press late February. Skopje's
licensed Coca Cola bottler and brewer of the popular
"Skopsko" beer, for instance, estimated that some 60 percent
of the company's inputs were imports purchased with euros.
Against that, 100 percent of the company's income was
denominated in denars. Similar concerns have been voiced by
AmCham members from across several industries at recent
events, and many Macedonians are concerned that car and other
personal property loans denominated in euro could become
unmanageable if the current exchange rate were not
maintained. Bank customers have increasingly sought to
convert their denar deposits into foreign currency, mainly
euro, reversing a trend toward holding deposits in denars.
Companies were concerned that customers were paying in
denars, while commercial loans and raw materials were
denominated in euro. That said, the GoM and many importers
are actively pressuring the Governor of the NBRM to change
its policy and lower the interest rate, to stimulate spending
and make credit less expensive for customers.


7. (C) Comment. We believe Goshev when he says he will
defend the denar as long as he can. However, GoM policy and
the country's dependence on imports are working against him.
The GoM takes issue with Goshev's recommendation to slow
credit growth to reduce imports and his recommendation to
take an IMF loan, preferring instead to argue for more
stimulus spending. The GoM has several policy options open
to it. Most likely is a recalculation of the budget
adjusting spending downward, a tactic that has been used by
the GoM several times in recent years. Less likely but not
out of the question would be a GoM adoption of a loan from
the IMF. In any case, the GoM is unlikely to take any
serious action on balance of payments issues before the April
second round elections.


REEKER