VZCZCXYZ0002
RR RUEHWEB

DE RUEHBW #1974/01 3401415
ZNR UUUUU ZZH
R 061415Z DEC 06(CCY ADD ADDRESSEE AD05707E1 MSI3038-536)
FM AMEMBASSY BELGRADE
TO RUEHC/SECSTATE WASHDC 9853
RUEHBS/USEU BRUSSELS
INFO RUEHVB/AMEMBASSY ZAGREB 1382
RUEHVJ/AMEMBASSY SARAJEVO 0283

UNCLAS BELGRADE 001974 
 
SIPDIS 
 
C O R R E C T E D COPY--ADDRESSEE ADDED 
 
STATE FOR EUR/SCE RIEHL 
USEU BRUSSELS FOR MOZUR 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ETRD ECON PREL HR SR
SUBJECT: CEFTA - SERBIA SEEKS COMPROMISE ON CIGARETTES; 
U.S. BUSINESS INTERESTS INVOLVED 
 
REF: ZAGREB 1400 
 
SUMMARY 
------- 
¶1. (SBU) In order to break an impasse on the initialing of 
the Central European Free Trade Agreement (CEFTA), the 
Government of Serbia (GOS) has offered a concession to 
Croatia on cigarette duties.  In a November 30 letter, 
Serbia's chief negotiator offered to lower the overall 
level of protection for imports, a move that would be 
consistent with WTO standards, according to local experts. 
Serbian officials believe that Croatia's position is overly 
inflexible given market realities, but hope that a 
resolution can be reached that would allow initialing of 
the CEFTA agreement by December 19.  Philip Morris, which 
owns the largest cigarette factory in Serbia, is pressuring 
the Serbian Government to honor the commitments it made to 
support domestic manufacturers until the end of 2009. END 
SUMMARY. 
 
COMMITMENTS TO FOREIGN INVESTORS 
-------------------------------- 
¶2. (SBU) The Government of Serbia announced on November 9 
that it would not initial CEFTA, but, clearly feeling the 
pressure, it has continued to seek a way out of the 
stalemate.  Serbia's reluctance stems from Croatia's demand 
that Serbia reduce its excise tax on imported cigarettes to 
the level of excise on domestic cigarettes, without 
increasing cigarette import duties.  However, the GOS faces 
strong pressure from foreign cigarette producers because of 
prior commitments made to Philip Morris, British American 
Tobacco and Japan Tobacco International.  Philip Morris 
purchased the largest cigarette factory in Serbia for 
hundreds of millions of dollars in 2003. 
 
¶5. (U) The current protection for the cigarette industry 
was a commitment to foreign investors who took on heavy 
obligations regarding investment, employment, and use of 
local tobacco in their privatization agreements.  The 
excise tax favors domestic manufacturers over foreign in a 
1:10 ratio with a 30 percent ad valorem tax.  In January 
2007, the ratio goes to 2:10 with a 40 percent ad valorem 
tax, before reaching a 5:5 ratio with a 50 percent ad 
valorem tax in 2010.  However, Serbia came under heavy 
pressure from all quarters to abandon this system, which is 
clearly discriminatory. 
 
¶6. (SBU) On November 6, Serbia proposed an alternative that 
is consistent with World Trade Organization (WTO) and 
European Union standards.  It would equalize excise taxes 
while increasing Serbia's relatively low import duties on 
cigarettes, with no net increase in protection.  It also 
provided a phased structure that would put all CEFTA 
cigarette manufacturers on equal footing by 2010.  The EU, 
in a November 21 letter from Commissioners Rehn and 
Mandelson, affirmed the WTO-consistent status of the Serb 
offer, while Stability Pact trade expert Mary O'Mahony 
confirmed that the Serbian offer provides an equivalent 
level of protection. 
 
¶7.  (SBU) Croatia, however, rejected Serbia's proposal on 
the principle that CEFTA negotiations could be concluded 
only on the basis of a standstill in protection levels -- 
that is that tariff levels in the previous bilateral 
agreements, in effect, constitute a ceiling for the new 
CEFTA agreement.  Such a position poses a dilemma for 
Serbia:  if it abandons the discriminatory excise, while 
keeping its tariff level low, it would have no other means 
to provide the promised protection to domestic producers. 
 
¶8. (SBU) Philip Morris, in particular, has been outspoken 
in demanding that the GOS not retreat from the overall 
protection guaranteed in privatization agreements. (Philip 
Morris has invested about USD 560 million in its Nis 
cigarette operation and is the market leader in Serbia.) 
However, Eugenio Sidoli, general director of Philip Morris, 
told econoff that the industry, which is sensitive to 
Serbia's desire to initial the CEFTA pact, had agreed to 
the lower protection level in Serbia's November 30 offer to 
Croatia, which would reduce the current level of protection 
from EURO 8.9 per 1,000 cigarettes to 8.4 in April, 2007. 
 
¶9. (SBU) Croatia's insistence on a standstill has further 
complicated prospects for a deal, O'Mahony pointed out, 
because such a stance also undercut a tentative agreement 
between Bosnia and Croatia on agricultural tariffs. 
Croatia had agreed on October 20 to higher tariffs for 
 
agricultural imports in Bosnia and Herzegovina (BIH), but 
the Croats reportedly did an about-face on November 7 and 
have asserted the standstill principle in further 
discussions both with Serbia and Bosnia.  "They were 
willing to change it for Bosnia, till Serbia requested the 
same treatment," O'Mahony said. 
 
¶10. (SBU) O'Mahony said that Stability Pact officials are 
concerned that, even if the Serbs and Croats find some way 
to work around the cigarette impasse, Bosnia could still be 
left out in the cold over agricultural tariffs.  Rehn and 
Mandelson, in their November 21 letter to Croatian Prime 
Minister Sanader, zeroed in on this issue: "We were 
particularly disappointed to learn that, after having 
reached an agreement in principle with the Bosnian side at 
the last negotiating round; the Croatian negotiators were, 
in an apparent change of position, unable to confirm a 
possible deal on agricultural concessions." 
 
¶11. (SBU) Many in Serbia's tobacco industry perceive 
Croatia's position as unreasonable.  Eugenio Sidoli, 
general director of Philip Morris, told econoffs that 
Croatia's monopoly producer controls 6 percent of Serbia's 
market, which is three times larger than Croatia's. 
However, Serbian producers have zero market share in 
Croatia because of a discriminatory tobacco classification 
system that categorizes all imported cigarettes, regardless 
of brand, in the category with the highest excise tax.  He 
said that during accession negotiations, the EU had asked 
Croatia to change this system, but the transition period 
could last years. 
 
¶12.  (SBU) O'Mahony, who termed the latest Serb offer 
"quite attractive," is at a loss to explain the Croatian 
stance.  While the Sanader government certainly faces 
pressure from its government-owned tobacco producer, other 
Croatian producers should be in a position to exploit a 
more liberal trade regime, she explained.  (Croatia 
exported USD 9.3 million in cigarettes to Serbia in 2005, 
roughly 6 percent of the total market, while total exports 
were only USD 17.3 million, far less than 1 percent of 
Serbia's total imports.)  O'Mahony said that, given the 
underlying economics, Croatia's position simply doesn't 
make sense. 
 
¶13. (SBU) COMMENT.  Serbia will continue to seek ways out 
of this impasse; it clearly wants to sign the CEFTA deal in 
Bucharest on December 19.  But cigarette producers here 
have told the GOS bluntly that they want compensation if 
the protection levels are substantially reduced before the 
promised phaseout at the end of 2009.  There is a strong 
feeling in Belgrade that Zagreb is being unreasonable and 
that its position is, in essence, that what's ours is ours, 
while yours is negotiable. 
 
POLT