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O 031018Z FEB 09
FM AMEMBASSY ZAGREB
TO RUEHC/SECSTATE WASHDC IMMEDIATE 8971
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UNCLAS SECTION 01 OF 02 ZAGREB 000061 
 
SENSITIVE 
SIPDIS 
 
DEPARTMENT FOR EUR/ERA, EUR/SCE, AND EEB/IFD; TREASURY FOR 
INTERNATIONAL AFFAIRS LARRY NORTON 
 
E.O. 12958: N/A 
TAGS: ECON EFIN HR
SUBJECT: CROATIAN ECONOMY BACKED INTO A CORNER 
 
¶1. (SBU)  SUMMARY.  The Economics Institute of Zagreb (EIZ), 
a key independent government think tank, has released a 
negative 1.4 percent growth forecast for 2009, the first 
domestic institution to forecast negative growth for the 
country.  Press were quick to publish headlines of recession, 
leading to greater anticipation of a package of 
anti-recession measures the Prime Minister ordered from his 
economic council (of which the director of EIZ is a key 
member).  At lunch with econoffs on January 29, the EIZ 
director privately told us there are few recommendations the 
council can usefully make that the government could 
undertake.  There are no budgetary resources available to 
stimulate the economy, new credit will be very hard to come 
by, and the central bank cannot afford to let the exchange 
rate fall.  We asked her whether the government could 
continue to avoid the prospect of IMF financing, at least 
until after the local elections in May.  While she didn't say 
IMF intervention was inevitable, she replied that government 
finances and debt obligations could easily reach a crisis 
point well before the elections.  In a meeting with foreign 
ambassadors last week, the Vice Governor of the central bank 
was more confident the government's financial obligations 
were manageable, at least for the first half of the year. 
END SUMMARY. 
 
GOVERNMENT LOOKING TO ECONOMIC COUNCIL TO SAVE THE DAY 
---------------- 
 
¶2. (SBU) The government has called on its recently-convened 
economic experts' council (of which the EIZ director is a 
leading member) to provide anti-recession recommendations 
this week.  Privately, EIZ told us there is no traditional 
anti-recession measure, either fiscal or monetary, that the 
government will be able to undertake.  New stimulative 
spending is not an option with the budget in its current 
form, but meaningful revision of the budget will be extremely 
difficult in the current political environment.  New credit 
will be very hard to come by given the high stock of foreign 
debt.  The kuna has to remain relatively stable to avoid 
severe pain from the high number of euro-denominated loans 
outstanding.  She expressed frustration with the task given 
to the council and the fact that the government and press are 
now looking to them to provide a magic bullet.  Instead, she 
said the Institute plans to offer suggestions aimed at simply 
shoring up economic stability. 
 
BUDGET MUST BE REVISED 
---------------------- 
 
¶3.  The budget agreement hashed out between the government 
and unions in December has already proven to be unrealistic. 
Revenues in January are already sharply down, and a Finance 
Ministry State Secretary publicly admitted earlier this week 
that growth figures lower than the budget's 2 percent 
forecast were likely, and would soon require a new budget. 
The opposition SDP presented their own anti-recession package 
late last week including a new bill calling for a civil 
servant wage freeze.  A similar proposal by the HDZ 
government in December to abandon a 6 percent wage increase 
called for in the collective bargaining agreement went down 
to defeat after strong union opposition.  The government's 
latest deficit financing plan calls for a large 750 million 
euro syndicated loan to be secured in the middle of the year. 
 According to the EIZ director, tight foreign credit and a 
rising risk premium could make the rate on such a loan 
difficult to swallow, if such financing would be available at 
all. 
 
CONTINUING DEBT SERVICE CONCERNS 
-------------------------------- 
 
¶4.  The Vice Governor of the Croatian National Bank (HNB) 
recently told a group of foreign ambassadors that Croatia's 
debt obligations are manageable, at least for the next six 
months.  The HNB recently lowered its reserve requirement in 
order to free up 800 million euro for the government to 
borrow from domestic banks to cover a large portion of its 
foreign debt service obligations (total obligations for 2009 
in the government sector are estimated at 1.23 billion euro). 
 Private sector foreign debt continues to rise faster than 
the government sector and could pose an even greater 
challenge to the economy.  The stock of private sector debt 
rose last year 15 percent to over 27 billion euro.  Debt 
servicing obligations for the private sector in 2009 are 
estimated at over 8 billion euro.  Many banks and companies 
have told the EIZ privately that they have individual 
strategies they are confident will help them weather the 
crisis, but none have been willing to reveal exactly what 
 
ZAGREB 00000061  002 OF 002 
 
 
those strategies may be.  According to EIZ, exchange rate 
pressure alone has been responsible for a 10 percent 
deterioration in the debt/GDP ratio, which now stands at 
nearly 100 percent. 
 
THE CENTRAL BANK HAS LITTLE FLEXIBILITY WITH THE KUNA 
--------------------------------------- 
 
¶5.  A managed currency depreciation to spur the export sector 
and improve Croatia's trade balance is not an option for the 
HNB, according to the EIZ director.  With a large proportion 
of private sector loans denominated in euros, and currency 
clauses in most loans that pass exchange rate losses on to 
the consumer, a depreciation of the kuna would be too painful 
for the economcy to bear.  A depreciation might also be of 
little utility in rebalancing trade, since many of Croatia's 
highest value manufactured exports, such as shipbuilding, are 
composed mainly of inputs imported from abroad.  The kuna is 
sliding against the euro, but the HNB is determined to do 
what it can, recently expending 328 million euro of its 
foreign currency reserves to halt the slide (this in 
comparison to 1 billion in reserves it spent for this purpose 
during all of last year). 
 
A FEW BRIGHT SPOTS 
----------------- 
 
¶6.  The EBRD, which holds the largest development lending 
portfolio in Croatia, recently praised Croatia's overall 
reform path, and said the economy was still well positioned 
for long term growth (despite the EBRD's own zero percent 
growth forecast).  The EBRD also announced it will make as 
much as 300 million euro in new credit available, targeting 
small and medium enterprises.  HNB's stock of foreign 
reserves remains significant, around 9 billion euro (although 
further pressure on the kuna this spring could certainly 
deteriorate their position).  The banking sector remains 
stable by all accounts.  The banks are well capitalized, 
deposits are strong, and domestic credit is still available 
(although rates are rising). 
 
¶7.  COMMENT:  The qualified optimism of the central bank and 
the EBRD on debt servicing and long-term growth prospects 
suggest Croatia is better positioned than many to avoid 
long-term damage from the crisis.  But in the short term, 
there are few good options for the economy, and little or no 
margin for error.  We can expect some attempt at a budget 
revision soon.  We still believe the government will do all 
it can to avoid the IMF, at least until after May's local 
elections, but it was sobering to hear the view of one of 
Croatia's more influential economists at the EIZ that things 
could spin out of control well before then.  She also told 
us, though, that negative 1.4 percent growth could easily 
turn out to be much better than the recessions faced by other 
countries in the region.  That's what passes for good news 
these days in Croatia.  END COMMENT. 
BRADTKE