MACEDONIA: MIXED SIGNALS AS BUDGET REALITIES MEET ELECTION

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TAGS: EFIN ECON PREL EAID MK
SUBJECT: MACEDONIA: MIXED SIGNALS AS BUDGET REALITIES MEET ELECTION
POLITICS

SENSITIVE BUT UNCLASSIFIED - PLEASE PROTECT ACCORDINGLY

Summary
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1. (SBU) The Macedonian Government seems to be underestimating the
likely effects of the global economic crisis on the Macedonian
economy, especially on the domestic currency. Not only has revenue
collection in the first two months of 2009 fallen short of the
projections on which the state budget was based, but revenues are
down from the same period in 2008. Demonstrating a lack of
coordination on monetary policy measures, the GoM has begun
borrowing from the domestic market, offering surprisingly high
interest rates. At the same time, foreign currency reserves
continue to be depleted, adding to concerns for the stability of the
domestic currency. End summary.

Economic Crisis Damaging the Real Sector
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2. (SBU) Macedonia's real sector economy has begun to feel the
effects of the global downturn. Industrial output in
January-February 2009 fell 14 percent compared to the same period of
last year. Additionally, the trade deficit grew, with exports
dropping by 44 percent. Several large exporters in the metal
industry closed plants and placed workers on forced leave to help
deal with the drop in demand. The GoM, however, has so far ignored
the damage to Macedonia's most important export sectors.
Significantly, the GoM in advance of the second round elections
April 5 held firm to its original projection of 5.5 percent GDP
growth, upon which the 2009 state budget was created.

Revenue Projections Not Met, but Not Changing
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3. (U) As a result of the country's reduced economic activity,
revenues to the state budget have been insufficient to finance the
GoM's populist spending projects. In fact, the GoM missed its
revenue collection targets for January and February by 17 percent,
and Finance Minister Slaveski announced that actual collection was
down three percent from the same period last year. Still, the state
budget has not been adjusted to account for the reality of the
country's revenues. Instead, the GoM announced plans to spend more
than USD 10 billion on infrastructure and energy projects in the
period 2009-2017, as Prime Minister Gruevski focused on campaigning
for the local and presidential elections. Unheeded, officials from
international financial institutions such as IMF have warned the GoM
of the widening budget deficit and recommended a prompt budget
rebalancing with more realistic targets. These calls, however,
appear to have been lost in the cacophony of the election campaign.

GoM Reaches to Unsustainable Financing
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4. (U) In order to finance the budget deficit, the GoM borrowed an
additional USD 90 million from the domestic market in March by
selling 28-day treasury bills at rates significantly higher than the
interest rate on the Central Bank bills. On March 25, IMF Resident
Representative Bert Van Selm told us that this short term borrowing
did not provide sustainable financing, although it draws denar
liquidity out of the banking sector. Furthermore, Van Selm told us
that Slaveski had told him that the GoM could use the resources of
the National Bank of the Republic of Macedonia (NBRM),or Central
Bank, to finance the budget as needed. Van Selm expressed serious
concerns about Slaveski's cavalier claim that the GoM wished to use
the NBRM for these purposes, which is both illegal and contrary to
EU regulations with which the GoM has declared it seeks to
harmonize.

Central Bank Increases its Bills Rate
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5. (U) Facing a serious drop in the level of Central Bank bills, the
NBRM on March 27 increased the interest rate on Central Bank bills
from seven to nine percent, sending a signal that banks should
further tighten lending. Most banks announced they will follow the
Central Bank's signal and would increase their interest rates,
leading to more expensive loans to businesses and households.

Devaluation Expectations Pressure the Exchange Rate
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6. (U) Even as pressures for devaluation of the exchange rate are
increasing, the GoM has been preoccupied with elections and remained
on the economic sidelines. In particular, the GoM sent confusing
budget messages by offering high interest rates on government paper.
That action was not coordinated with the monetary authorities and
heated up devaluation expectations, which officials at the NBRM
complained had made their job even harder. In the first three weeks
of March, the NBRM had to sell an additional USD 110 million of
reserves to defend the peg of the denar against the euro.

Comment
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7. (SBU) Devaluation of the denar would be costly and have long term
negative effects to the economy. The NBRM knows this and is
desperately trying to avoid it. However, many IFIs and economic
experts in the country think that the GoM does not fully understand
the possible consequences. Rumors circulate that Gruevski has a
political game in mind and is setting up scenario for replacing NBRM
Governor Goshev after the presidential elections. With Gjorge
Ivanov's election victory, this becomes a real possibility: NBRM's
Governor is nominated by the President, with Parliament's
concurrence. Gruevski and his government have long been at odds
with the Goshev's conservative approach. The PM also has emphasized
publicly that the NBRM is responsible for maintaining the denar's
exchange rate. Current economic difficulties may well provide the
pretext needed to replace the Governor and to justify an eventual
devaluation. End comment.

REEKER