VZCZCXRO8021
PP RUEHAG RUEHAST RUEHDA RUEHDF RUEHFL RUEHIK RUEHKW RUEHLA RUEHLN
RUEHLZ RUEHPOD RUEHROV RUEHSR RUEHVK RUEHYG
DE RUEHVB #0727/01 2910935
ZNR UUUUU ZZH
P 170935Z OCT 08
FM AMEMBASSY ZAGREB
TO RUEHC/SECSTATE WASHDC PRIORITY 8703
INFO RUEHZL/EUROPEAN POLITICAL COLLECTIVE PRIORITY

UNCLAS SECTION 01 OF 02 ZAGREB 000727 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN HR
SUBJECT: CROATIAN BANKS ARE STABLE, FOR THE MOMENT 
 
¶1.  Summary:  Croatia's economy and banking system remain 
reasonably stable, although not entirely immune to the 
effects of the world financial crisis.  The central bank has 
temporarily removed a restrictive reserve requirement on 
Croatian banks that draw credit from abroad.  The government 
also announced it will increase deposit insurance from 
100,000 kuna (14,000 euro) to 400,000 kuna (56,000 euro). 
The Croatian National Bank (HNB) claims this amount covers 90 
percent of deposits in Croatia.  The banking sector, although 
largely foreign-owned, has shown few signs of true crisis. 
Croatian banks have benefited from a restrictive monetary 
policy that has limited credit exposure abroad. 
Nevertheless, there is clear unease in the press, which 
tracks almost daily the woes of Croatian banks' European 
parent institutions.  Croatia also has a large foreign debt 
and current account deficit, which represent significant 
risks.  Flows of foreign direct investment, which had been 
adequate to cover the deficit, are forecast to decline. 
 
¶2. Summary continued: The main Zagreb stock market index, the 
Crobex, has also been volatile.  The index lost 30 percent of 
its value last week, only to rebound significantly early this 
week.  It then fell again 8 percent on October 15, due partly 
to a press report linking Raiffeisenbank (Austrian bank with 
a large presence in Croatia) to financial institutions in 
Iceland.  The true level of consumer confidence in the 
economy and the banking sector remains unclear, but sales of 
big ticket items, such as new cars, are already hurting in 
the uncertain climate.  Overall, officials and experts with 
whom we spoke agree Croatia is withstanding the crisis as 
well as can be expected, but that the economy remains 
vulnerable.  End summary. 
 
---------------------------------- 
Banks Foreign-Owned, but Insulated 
---------------------------------- 
 
¶3.  Approximately 90 percent of Croatia's banking sector is 
foreign-owned, mostly by other large European financial 
institutions.  All the parent banks of Croatia's major banks 
have experienced large drops in share prices this year. 
Italian UniCredit (owner of Zagrebacka Banka) and Intesa 
SanPaolo (owner of Privredna Banka) have experienced drops of 
48 percent and 69 percent, respectively.  These two banks 
comprise approximately 50 percent of the Croatian banking 
sector.  Austrian Raiffeisenbank (owner of a Croatian 
subsidiary of the same name) has seen a 53 percent drop in 
its share price so far this year.  There have been no major 
signs of mass withdrawals by Croatian depositors, although 
there were briefly long queues at Zagrebacka Banka two weeks 
ago after the press reported widely on UniCredit's 
difficulties. 
 
¶4.  Despite foreign ownership, Croatian banks enjoy 
significant structural and regulatory advantages.  First, 
local banks are distinct legal entities and are capitalized 
domestically, largely through deposits rather than lines of 
credit from other banks.  In 2006, the HNB imposed a 
restrictive 55 percent reserve requirement on capital raised 
from abroad.  This "tax" discouraged most banks from 
borrowing abroad and has correspondingly limited their 
exposure to risk. (NOTE: This reserve requirement has 
recently been removed temporarily in an effort to increase 
liquidity in the capital markets).  The HNB has also 
maintained a strict credit expansion ceiling introduced last 
year.  According to the EBRD Director for Croatia, the HNB's 
policies have been prescient in limiting risk to Croatia's 
banks, while encouraging them to build a strong domestic 
deposit base.  However, one of President Mesic's economic 
advisors told us he remains unconvinced that these advantages 
will prove sufficient should the situation continue to 
deteriorate for the European parent banks. 
 
--------------------------------------------- ------ 
Foreign Debt and Current Account Deficits Worrisome 
--------------------------------------------- ------ 
 
¶5.  Both Croatian officials and international financial 
institution representatives have told us that Croatia's 
foreign debt, currently 95 percent of GDP, is a large area of 
concern.  In the new environment of tight credit markets, the 
EBRD believes the government will be forced to shift its 
borrowing needs to the domestic market.  Domestic credit will 
be more expensive, but will reduce exposure to financial 
shocks from abroad.  However, private corporations and 
households account for a much greater share of the foreign 
debt, around 50 percent.  According to the World Bank, this 
could increase the speed and magnitude by which financial 
turbulence in Europe could transmit to Croatia. 
 
¶6.  Croatia's current account deficit also remains high, at 
8.6 percent of GDP.  This could be problematic, since the 
government has relied on significant foreign direct 
 
ZAGREB 00000727  002 OF 002 
 
 
investment (largely through big ticket privatizations) to 
cover the deficit.  These FDI inflows are likely to shrink 
since there are few major government assets left to sell. 
Shipyards are a large asset the government plans to privatize 
next year, but the success of the sale is both politically 
and financially uncertain.  Without FDI to cover the deficit, 
the government will have to rely on further borrowing in a 
very unfavorable credit market. 
 
¶7.  Another critical source of foreign currency inflow is the 
tourism industry, accounting for over 20 percent of GDP. 
  The president of the Croatian Association of Hotel 
Operators told the press that tourism will be among the 
industries hardest hit by the global financial crisis. 
Indeed, unofficial data indicate an effect already, recording 
a 9 percent drop in the number of tourists for September 2008 
as compared to 2007. 
 
¶8.  A lower availability of credit for companies and 
individuals will force adjustments in personal expenditures 
and limit new business enterprises.  Coupled with higher than 
expected inflation this year, the Croatian consumer could see 
some hard times ahead.  The EBRD has correspondingly adjusted 
its 2008 GDP growth forecast for Croatia from 6 percent to 
3,8 percent.  The World Bank forecasts 4.5 percent growth. 
 
¶9.  COMMENT:  The unknown factor is Croatians' true level of 
confidence in the banking sector.  Given the financial 
history of the country, Croatians have more reason than most 
to be skittish depositors and investors.  The collapse of 
Ljubljanska Banka after the breakup of Yugoslavia wiped out 
many Croatians' savings and legal proceedings to recover them 
continue to this day.  Croatians also remember the high 
current account deficits of the late nineties, which in 1998 
precipitated a severe banking crisis followed by a recession. 
 Consumer confidence is probably not aided by the press, 
which reports dire warnings of imminent European bank 
collapse one day, followed quickly by euphoric headlines when 
the stock market rebounds.  A story on October 15 describing 
supposed ties between Raiffeisenbank and financial 
institutions in Iceland appears to have led to a rapid 6 
percent decline in the Crobex.  For these reasons, the 
government's increase in deposit insurance is a logical, and 
probably effective, first step.  But it is clearly too early 
to say the Croatian economy is out of danger from turbulence 
in the European financial markets. 
Bradtke