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UNCLAS SECTION 01 OF 03 ZAGREB 000802 
 
SIPDIS 
SENSITIVE 
 
TREASURY FOR OFFICE OF INTERNATIONAL AFFAIRS LARRY NORTON 
 
E.O. 12958: N/A 
TAGS: ECON EFIN PGOV HR
SUBJECT: QUESTIONS LOOM ON CROATIA'S DEBT AS PM ANNOUNCES A 
SALARY FREEZE 
 
¶1. (SBU)  Summary.  Prime Minister Sanader has announced his 
intention to balance the federal budget in 2009 and has 
called for a salary freeze and cutbacks in Christmas 
activities in both the government and state-owned industries 
to achieve this aim.  The PM feels he has little room for 
maneuver in fiscal policy as the possibility of securing 
credit abroad has evaporated, and the government faces major 
debt-servicing bills in the very near future.  Nevertheless, 
economic experts here agree that the government has enough 
financing options domestically, for the moment, to avoid a 
debt crisis or intervention by the IMF.  But they also 
question whether political horse-trading over salary 
increases can either balance the budget or help Croatia avoid 
whatever risks it faces from the world financial crisis. 
They say Croatia's challenge is not its federal deficit, or 
even its high household debt, rather the relative inability 
of the economy to produce sufficiently competitive goods and 
services to alleviate its severe external imbalances.  End 
summary. 
 
Government Continues to Keep IMF at Arm's Length 
------------------- 
 
¶2. (U) Croatia's gross foreign debt stands at roughly 36 
billion euros, or 95 percent of GDP.  In a climate of 
extremely tight credit, the government has been asked 
repeatedly in the press in recent weeks how it intends to 
come up with the estimated 700 million euros required to 
service its debt in the first quarter of 2009.  The 
government has proclaimed loudly and often that it has no 
need of IMF assistance and will be able to raise necessary 
capital on the domestic market. Experts with whom we have 
spoken are not as confident about the future, but agree that 
the government will try to avoid the IMF except as a last 
resort.  The GoC feels it cannot afford the damage to 
investor confidence that IMF intervention might conjure up, 
and fears the political battles that IMF conditionalities 
might provoke. 
 
¶3. (SBU) The director of the Croatian Banking Association 
(HUB) told us that the government will most likely be able to 
manage the situation without IMF assistance.  He said an IMF 
delegation routinely stops at his office in late fall as one 
of their country assessment meetings, but that he had not 
heard from them so far this year.  He also pointed to the 
fact that Croatian banks' assets, along with those of the 
central bank, are more than able to cover all deposits in the 
country, and the stock of deposits far exceeds the stock of 
household debt.  Nevertheless, anticipating increased 
government borrowing needs on the domestic market in the 
coming months, the central bank has reduced the marginal 
reserve requirement for Croatian banks. 
 
¶4. (SBU) The director of the Zagreb Institute of Economics 
(EIZ) expects little foreign demand for Croatian government 
bonds in the near future.  With foreign sources of cash 
drying up, the government will be forced to rely even more 
heavily on the domestic market to finance its activities. 
Fortunately, Croatia has four large pension funds that are 
legally obligated to purchase government securities, and the 
government has already tapped them to purchase bonds to help 
it repay 200 million euro in maturing debt by the end of the 
year.  A fifth fund, the Croatian Veterans' Fund, is flush 
with cash after selling its block of shares in the national 
oil company INA to Hungarian MOL and will be a likely 
customer for government debt as well.  The GoC will also turn 
to the domestic loan market which, according to the EIZ 
director, carries the serious risk of crowding out of private 
sector lending.  The HUB director believes this is one reason 
for the central bank's decision to reduce the reserve 
requirement, in order to free more credit for private sector 
lending in the face of increased domestic borrowing needs by 
the government. 
 
The Grinch who Stole the Christmas Bonuses 
-------------- 
 
¶5. (U) For fiscal policy there is very little room for 
maneuver in the environment of tight credit, and Prime 
Minister Sanader announced on November 12 that the government 
would attempt to balance the budget for 2009.  To achieve 
this aim, he proposed a one-year freeze on public-sector 
salaries, including those of employees of state-owned 
companies. Without the freeze, civil servants were set to 
receive a negotiated six percent raise.  Sanader also 
proposed foregoing Christmas gifts and cutting back on 
entertainment and representational spending, though these 
measures would mostly affect this year's budget, not next 
 
ZAGREB 00000802  002 OF 003 
 
 
year's. 
 
¶6. (U) Sanader's plan has sparked a firestorm of criticism, 
both from unions opposing the idea outright and from economic 
experts who say the salary freeze will not be nearly enough 
and that the state must put major infrastructure projects on 
hold.  He has also received a fair amount of ridicule; there 
have been caricatures of Sanader in the press as the Grinch. 
 
¶7. (SBU) Sanader's response to the criticism has been uneven 
and tentative.  On November 17, press reported that Sanader 
had appointed a "brain trust" of economic experts to advise 
him on the financial crisis, among them our contact at EIZ. 
However, she told us that seeing her name in the newspaper 
was the first she had heard of the appointment.  The PM 
recently also argued semantics, claiming that his proposal 
was not a salary "freeze", but rather only a "postponement" 
of wage increases.  Finally, the press on November 18 
announced that the PM had backtracked and was now pushing for 
only a six month freeze, followed by reduced raises of 3 
percent. 
 
¶8.  (SBU) Also named as a member of the prime ministerial 
brain trust was the chief economic strategist of the 
opposition SDP, Ljubo Jurcic.  He told us he was happy to 
offer his advice even though Sanader last year told the press 
that Jurcic should win a Nobel Prize for idiocy.  He said he 
planned to tell the prime minister that the truly troubling 
imbalance in the Croatian economy was not the government 
deficit, but the trade deficit.  He recommended putting 
big-ticket infrastructure projects on hold (such as the 
Peljesac bridge and the arenas for the 2009 World Handball 
Championship) in favor of beginning to invest in actual 
productive industries that would make Croatia more 
competitive in the world.  He did not believe a public sector 
salary freeze will have much impact except to hurt individual 
civil servants. 
 
Economic and Political Realities Hurt Prospects for Balanced 
Budget 
---------------------- 
 
¶9. (U) The government has not yet released the full budget 
publicly, but is holding meetings with unions and employers 
to negotiate on Sanader's proposals.  The Croatian Employers 
Association largely supports Sanader's proposals.  The 
unions, however, oppose the salary freeze and have suggested 
alternative cost-saving measures, such as reducing 
higher-level state officials' salaries.  They have called on 
the GoC to do more to reduce costs for households and 
maintain production levels. 
 
¶10. (U) After a meeting with the unions and employers on 
November 17, Sanader told the press budget expenditures in 
2009 would increase by 1.5 billion HRK ($270 million) in the 
areas of pensions, welfare benefits, and health care. He said 
an additional 1.4 billion HRK ($250 million) increase would 
be needed for raises if the salary freeze is not approved. 
Sanader said the government is willing to negotiate on 
infrastructure projects, officials' pensions and other 
benefits, as well as managers' salaries and benefits, but 
stressed that infrastructure work should continue, as it will 
be a key component of keeping GDP growth from falling below 
two percent.  Analysts have also noted the government will 
not want to pull back on announced investments in the energy 
sector and other smaller projects for fear of implications in 
the local elections scheduled for May 2009. 
 
¶11. (U) In addition to the political challenge of reaching 
agreement on cost-saving measures, the GoC faces significant 
fiscal and economic challenges to balancing the budget for 
¶2009.  The cost of preparing government administration for EU 
accession remains high and, according to analysis by the EIZ, 
businesses are increasingly demanding various forms of state 
aid.  The EIZ analysis indicates that subsidies and other 
expenditures--not salaries--have contributed most to 
expenditure increases in 2008, and stopping that trend in 
2009 will be difficult.  On the revenue side, the GoC relies 
heavily on the value-added tax for revenue and the slow down 
in economic activity will result in poorer collection in 
¶2009. 
 
¶12. (SBU) Comment.  Sanader's "cancellation of Christmas" 
will probably do little to alleviate whatever risk Croatia 
may face from the world financial crisis.  As the EIZ 
director reminded us, it is not the government deficit, or 
even high household debt, that matter in Croatia; it is the 
economy's continuing inability to produce sufficient goods 
 
ZAGREB 00000802  003 OF 003 
 
 
and services of value to the world market outside of the 
tourist industry. 
Walker