VZCZCXRO9343
RR RUEHAG RUEHAST RUEHDA RUEHDF RUEHFL RUEHIK RUEHKW RUEHLA RUEHLN
RUEHLZ RUEHPOD RUEHROV RUEHSR RUEHVK RUEHYG
DE RUEHSQ #0265/01 1070859
ZNR UUUUU ZZH
R 160859Z APR 08
FM AMEMBASSY SKOPJE
TO RUEHC/SECSTATE WASHDC 7256
INFO RUEHZL/EUROPEAN POLITICAL COLLECTIVE 0278
RUEHNO/USMISSION USNATO 3761
RUEAIIA/CIA WASHINGTON DC
RUESEN/SKOPJE BETA

UNCLAS SECTION 01 OF 02 SKOPJE 000265 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
DEPT FOR EUR/SCE 
TREASURY FOR W. LINDQUIST 
 
E.O. 12958: N/A 
TAGS: ECON PGOV PREL MK
SUBJECT:  MACEDONIAN ECONOMY: PERIOD OF UNCERTAINTY 
 
REF: A. SKOPJE 262 
¶B.  SKOPJE 256 
 
Summary 
------- 
¶1.  (SBU)  Since 2001, the GOM has maintained conservative fiscal 
and monetary policies.  Those policies, agreed with the IMF, have 
sustained a foundation of economic stability that has supported the 
GOM's implementation of structural reforms.  Over the past few 
months, Macedonia's inflation rate has shot up, however, hitting 
10.2 percent in March, and the current account deficit has widened 
significantly.  During a recent visit, an IMF mission indicated that 
Macedonia faces macroeconomic risks over the next several months. 
Some analysts also fear that a perception of heightened political 
risk, following Macedonia's recent failure to receive a NATO 
invitation, could hit the economy hard.  We remain optimistic that 
Macedonia's economy will weather these trends without major 
downturns, although the GOM may have to struggle to reach its 
ambitious economic growth targets.  End Summary. 
 
Worrying Trends 
--------------- 
¶2. (SBU) Over the past few years, the GOM and Macedonia's National 
Bank have implemented economic policies that have maintained a 
stable macroeconomic environment.  The National Bank has maintained 
a fixed denar/euro exchange rate, providing the economy with a solid 
"anchor."  Relatively high interest rates have kept credit growth at 
a moderate pace.  The government has kept its budget roughly 
balanced and its external debt at a sustainable, and declining, 
level.  Although Macedonia has run a persistent trade deficit, 
financial inflows have covered most of the deficit and kept the 
current account deficit relatively low. 
 
¶3. (SBU) This positive macroeconomic picture continued in 2007 (ref 
B), but at the end of the year inflation was rising and the current 
account deficit was growing.  Year-on-year inflation, measured by 
the consumer price index, jumped to 6.1 percent in December 2007. 
The first three months of 2008 saw the inflation rate continue to 
accelerate, with an inflation rate of 8.7 percent in January, 9.6 
percent in February, and 10.2 percent in March.  The current account 
remained in surplus throughout most of 2007, before turning into a 
deficit equal to three percent of GDP by December. 
 
¶4. (SBU) Rapidly increasing food prices have been the greatest 
contributor to the higher inflation rate.  Food prices were 21 
percent higher in March 2008 than in March 2007.  Because incomes in 
Macedonia are substantially lower than in the EU, food represents a 
significantly higher percentage of consumer spending than it does in 
EU countries.  Therefore, the rise in global food prices has 
contributed to a greater increase in the overall consumer price 
index in Macedonia than in the EU (up only 3.5 percent in March), 
even though the denar exchange rate has remained fixed to the euro. 
In response to the higher inflation rate, the National Bank raised 
interest rates on the bills it offers. 
 
IMF Moderately Concerned 
------------------------ 
¶5. (SBU) An IMF mission that visited Skopje April 1-8 to review 
Macedonia's progress conveyed to us several concerns about these 
trends.  The head of the mission, Mark Griffiths, appraised the 
higher inflation rate in Macedonia as primarily the result of 
international increases in food and energy prices.  Assuming 
international food and energy prices do not continue their rapid 
rise, the inflation rate in Macedonia should begin to moderate, 
according to Griffiths.  He noted, however, there was a risk of 
"secondary" inflationary effects if domestic spending accelerates 
and workers demand higher wages in anticipation of continuing high 
inflation. 
 
¶6.  (SBU)  Griffiths welcomed the National Bank's recent interest 
rate increase (to six percent) on the bills it sells to banks and 
argued that the GOM should avoid an expansionary fiscal policy.  In 
his public statement, Griffiths warned the GOM against engaging in 
additional spending, above that currently budgeted, despite higher 
than anticipated tax revenue during the first three months of 2008. 
Griffiths told us that he expects Macedonia's inflation rate will 
decline during the rest of the year and end the year at about five 
percent. 
 
¶7. (SBU)  Griffiths was more concerned about the potential problems 
stemming from the growing current account deficit.  The IMF mission 
estimated that the current account deficit for 2008 will be about 
ten percent of GDP, three times higher than in 2007.  A growing 
current account deficit could put pressure on the National Bank's 
currency reserves and raise concerns about the Bank's ability to 
maintain the denar's fixed exchange rate to the euro. 
 
SKOPJE 00000265  002 OF 002 
 
 
 
Political Risk and the Doomsday Scenario 
---------------------------------------- 
¶8. (SBU)  Some local analysts have speculated that the international 
price shock could combine with worries about political stability 
here and lead to an economic crisis in Macedonia.  In March, the 
local weekly business magazine Kapital featured on its cover a 
picture of a sinking and burning ship flying the Macedonian flag 
under the title "political risks for Macedonian business."  The 
magazine article sketched a scenario that some local economic 
analysts have also raised with us. 
 
¶9. (SBU)  Under this extreme scenario, Macedonia's failure to gain a 
NATO invitation or a date for EU negotiations, and the GOM's call 
for early elections (ref A), would deter potential foreign and 
domestic investors and stall economic reforms.  The GOM (according 
to this scenario) would spend freely and make expensive promises in 
the run-up to the election.  This government stimulus would increase 
inflationary pressures.  Concerned Macedonians would convert their 
denars to euros.  As a result of the high domestic demand for euros 
and the low level of foreign capital coming into the country, the 
National Bank's reserves would become depleted, forcing the National 
Bank to devalue the denar and dramatically raise interest rates.  In 
the end, Macedonia would be stuck in a vicious cycle of high 
inflation, a devalued currency, and low investment. 
 
Comment: Not Business Heaven Or Hell 
------------------------------------ 
¶10. (SBU) We do not believe this economic crisis scenario is likely. 
 The initial economic reaction to NATO's failure to invite Macedonia 
has been moderate.  The Macedonian stock market index dropped over 
eight percent on the day of the NATO decision, but it has since 
fluctuated in a narrow range.  In the past week, potential foreign 
investors have continued to visit Macedonia and some new projects 
have been announced.  A few days before the NATO decision, the head 
of Macedonia's second largest bank told us that he had seen a slight 
increase in customers' demand for euros but no dramatic shift away 
from denars.  On April 14, Standard and Poor's announced that 
political events had not changed its credit rating for Macedonia. 
 
¶11. (SBU)  It is likely, however, that economic growth will not hit 
the GOM's six percent growth target for 2008.  Inflation concerns 
and political uncertainty may reduce private consumption and 
investment somewhat in the short-term.  Early elections, and 
subsequent coalition building, will stall government capital 
spending and put on hold important government tenders for a few 
months.  Ironically, this fiscal restraint is exactly what the IMF 
prescribed and should dampen inflationary pressures.  However, 
economic growth, at least for the next few months, will suffer. 
Important structural reforms will also slow until a new government 
is in place. 
 
Milovanovic