VZCZCXYZ0020
RR RUEHWEB

DE RUEHVB #1265/01 2911313
ZNR UUUUU ZZH
R 181313Z OCT 06
FM AMEMBASSY ZAGREB
TO RUEHC/SECSTATE WASHDC 6810
INFO RUEHZL/EUROPEAN POLITICAL COLLECTIVE
RUCPDOC/DEPT OF COMMERCE WASHDC

UNCLAS ZAGREB 001265 
 
SIPDIS 
 
SIPDIS 
 
STATE FOR EUR/SCE BALIAN AND RIEHL 
 
E.O. 12958: N/A 
TAGS: ECON KPRV EWWT EIND HR
SUBJECT: SHIPYARDS ALBATROSSES OF CROATIAN ECONOMY 
 
¶1. Summary: Of Croatia's loss-making, unreformed industries, none is 
more politically sensitive or costs the country's taxpayers more 
than shipbuilding.  With a total of six major shipyards on the 
Adriatic coast, shipbuilding is a key employer in many communities 
and an important component of Croatia's exports.  However, the small 
size of the yards, coupled with their chronic inefficiency, poor 
management and relentless Asian competition results in annual losses 
in the hundreds of millions of dollars being covered by the state. 
The European Union has warned Croatia that these subsidies violate 
the EU's competition regulations and the GOC will have to eliminate 
them to close this chapter of its accession negotiations.  The 
government so far has shown no indication that it will swallow this 
bitter pill.  In fact, with elections set for 2007, it appears set 
to ignore the advice of its own consultants and continue to dole out 
 
guarantees to these industrial relics.  End Summary. 
 
 
Glorious Past; Grim Present 
--------------------------- 
¶2. As much as Croatia's shipbuilding industry is a testament to 
Dalmatia's rich maritime history, today it is but a rusty and costly 
reminder of the more recent industrial past.  Croatia has six major 
Adriatic shipyards: Uljanik in Pula, 3 Maj and Viktor Lenac in 
Rijeka, Kraljevica, Trogir and Split.  Together, the shipyards 
directly employ about 12,000 workers and, according to government 
estimates, account for an equal amount of indirect employment. 
 
¶3. Despite the fact that all of Croatia's shipyards have orders on 
the books for the next several years, all lose money.  With sales 
last year worth approximately $700 million, the shipyards received 
subsidies in various forms worth nearly $500 million.  The reasons 
for the chronic losses are many, but even excluding poor management 
and inefficiency, the industry faces a difficult competitive 
environment.  During a recent visit, the CEO of Rijeka's 3 Maj told 
econoff that, despite a doubling of productivity and reduction in 
delivery times, Croatian yards, which can deliver 5 or 6 ships 
annually face competition from yards in Asia that turn out upwards 
of 60 vessels every year.  3 Maj sees salvation in moving up-market 
into more sophisticated vessels than the relatively low value-added 
tankers it currently produces, but competition is not static 
either. 
 
¶4. Compounding economic woes are steep rises in the price of steel 
and the decline of the US dollar against other major currencies over 
the last few years.  A legacy of designed economic interdependence 
in the former Yugoslavia, Croatia does not produce any of the steel 
that is the main input for its ships, despite the fact that it has 
two loss-making state-owned steel works.  Steel is imported from 
Macedonia.  Such is the case with many other inputs.  In fact, a 
total of 80 percent of the value of every ship is imported and 
priced in euros.  Delivered ships, however, are priced in dollars in 
contracts concluded years before delivery.  This double blow from 
exchange risk (which management failed to hedge) on the back of 
higher steel prices has hit the industry especially hard. 
 
 
Nostalgia and Local Politics Thwart Reform 
------------------------------------------ 
¶5. The problems of Croatia's shipyards are well-known in the 
country, yet any discussion of reform is inevitably prefaced with a 
promise to keep all yards operational.  Pre-emption of the option of 
closing one or more of the shipyards means that the only course left 
for the government has been to throw good money after bad in a 
futile effort to bring the industry to profitability.  GOC officials 
never cease to point out the importance of ships in Croatia's dismal 
balance of trade in which exports cover only 47 percent of imports. 
Ships alone account for 15 percent of Croatia's exports, although 
their large import content is rarely mentioned. 
 
¶6. Jobs are the political boogeyman of reform.  Few politicians in a 
country with an unemployment rate over 12 percent want to give a 
pink slip to several thousand people, to say little of the further 
dislocations in local economies where the yards are based. 
Ironically, however, the jobs issue is not so clear cut.  When we 
asked 3 Maj's CEO about the composition of the workforce (many of 
whom live in on-site, company-provided housing), he conceded that a 
large number of workers were not actually Croats.  Many are from 
other parts of the ex-Yugoslavia, but there are also sizeable 
numbers from Slovakia and other countries.  Croatia increasingly 
lacks the skilled workers it needs in trades such as welding to keep 
its shipyards running so, in addition to importing the ships' steel, 
it is importing labor. 
 
 
Running onto the Shoal of the EU Acquis 
--------------------------------------- 
¶7. The Croatia government doles out hundreds of millions of dollars 
in annual subsidies to the shipbuilding industry.  It is a 
value-destroying exercise that has gone on for years.  However, now 
that Croatia is in negotiations for EU membership, time is running 
out.  The Commission has told the government that further subsidies 
can only be given within the context of a restructuring plan 
designed to bring the industry to profitability.  The GOC hired a 
consultant whose recommendations have not yet been made public, but 
already the government is denying that it will shut down any of the 
yards.  The most that seems likely to happen is that it will 
privatize the Uljanik yard in Pula (the healthiest of the shipyards 
that benefited from USAID assistance in restructuring).  As the day 
of reckoning for the others is again delayed, state funds will again 
go to save what cannot be saved, crowding out other sorely needed 
investments. 
 
DELAWIE