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DE RUEHBW #0352/01 1141325
ZNR UUUUU ZZH
R 241325Z APR 09 ZDK
FM AMEMBASSY BELGRADE
TO RUEHC/SECSTATE WASHDC 1204
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/USDOC WASHDC
RUEHZL/EUROPEAN POLITICAL COLLECTIVE

UNCLAS SECTION 01 OF 03 BELGRADE 000352 
 
SENSITIVE 
SIPDIS 
USDOC FOR 4232/ITA/MAC/EUR/OEERIS/SSAVICH 
 
E.O. 12958: N/A 
TAGS: ECON EINV ETRD EFIN SR
SUBJECT: SERBIA: GOVERNMENT STRUGGLES TO CLOSE THE BUDGET GAP 
 
Ref: A) Belgrade 272   B) Belgrade 210 
 
SUMMARY 
------- 
 
¶1. (SBU) The Serbian government revised downward the budget to 
reflect the stark economic contraction and the requirements of the 
IMF to move ahead with an expanded $4 billion program.  At its April 
16 session the government adopted a rebalanced 2009 budget which 
included deep expenditure cuts in an effort to keep the 2009 budget 
deficit at 3% of GDP.  The revised package has more public support 
than the government's bungled initial proposal to increase income 
taxes on all but the poorest Serbians by 6% and business leaders and 
economists told us the plan was a significant improvement.  The new 
plan's critics include mobile phone operators and mayors.  If passed 
through parliament and implemented the government's plan will 
maintain macroeconomic stability in the short-term, but questions 
remain about the economic situation later in the year.  End 
Summary. 
 
Let's Try This Again 
-------------------- 
. 
¶2. (U) On April 8, just two weeks after the Serbian government 
announced a package of budget measures as part of the agreement on a 
revised IMF Stand-By Arrangement (ref A), Prime Minister Cvetkovic 
presented a new package to meet the IMF requirement to close $1.5 
billion of the 2009 budget gap.  The revised budget deficit was 
projected at $1 billion or 40% higher than originally planned, but 
within the 3% of GDP limit the IMF imposed.  The government formally 
adopted the package at its April 16 session and sent it to 
parliament.  Parliament speaker Slavica Djukic-Dejanovic announced 
that Parliament will take up the package starting April 24. 
 
Solidarity Tax Proposal - Oops 
------------------------------ 
 
¶3. (SBU) The government's initial proposal to close the majority of 
the budget gap with a six percent "solidarity tax" on nearly all 
Serbs' income was rejected by the public with such fervor that 
within 24 hours the government backed away from the announcement. 
The government has publicly and privately tried to point the finger 
at the IMF for pushing the solidarity tax idea.  Deputy PM Dinkic 
told us on April 9 that the IMF team introduced the solidarity tax 
proposal.  President Tadic similarly pointed the finger at the IMF 
in a wide ranging interview in weekly magazine Vreme on April 16. 
 
Government Credibility Suffers 
------------------------------ 
 
¶4. (SBU) Business leaders and economists told us that the 
government's bungling of this announcement severely undercut the 
credibility of the economic team.  This reinforced public cynicism 
about Serbian leadership and squandered the opportunity to build 
momentum for long stalled reforms. 
 
¶5. (SBU) Despite having held several orchestrated public dialogue 
sessions with businesses and labor leaders the government appears to 
have failed at the basic business principle of listening to its 
customers.  Recent International Republican Institute polling 
indicated that more than half of Serbs gave the government a D or an 
F for handling the economic crisis.  The Serbian public did not 
blame the government for the crisis, but as the head of the Serbian 
Association of Managers pointed out, while in the U.S. banks were 
the focus of public outrage, in Serbia the public's ire was directed 
toward the inefficient and bloated government bureaucracy. 
 
Cut Spending by $1.3 Billion 
---------------------------- 
 
¶6. (U) The revised plan significantly shifts the burden of closing 
the gap from government revenues to government expenditures.  PM 
Cvetkovic said the package was the largest fiscal adjustment ever. 
 
The bulk (85%) of the fiscal adjustment would come through 
aggressive cuts in expenditures ($1.3 billion), while only 15% would 
be met through increases in revenues ($230 million).  The plan would 
cut each ministry's budget by 26% ($571 million); cut expenses of 
all institutions which collect their own revenues, i.e. 
universities, ($171 million); cut transfers to municipalities by one 
third ($214 million); and cut in costs at public companies and the 
Health Fund ($129 million). 
 
¶7. (U) The revised package would also freeze public sector salaries 
and pensions ($186 million).  The government also plans to cut 
salaries for high wage public sector workers by 10% or 15% depending 
on their wages ($29 million).  The workers affected by these cuts 
would be limited as those in education, health, culture, the army 
and the judiciary would all be exempt from the cuts (but not the 
 
BELGRADE 00000352  002 OF 003 
 
 
freeze).  However, public support for this measure is high because 
it is perceived at attacking a fundamental reform issue, namely that 
public sector wages outstrip private sector wages. 
 
¶8. (U) Cvetkovic also announced that the government would begin cuts 
in overall number of public sector employees with a goal of reducing 
the public sector wage roles by 8,000 people (10%) in the next 9 
months.  Cuts would also be necessary in local government, with 
severe cuts in transfers to municipalities.  These cuts, if they are 
carried out, would only lead to savings in future years as a result 
of severance costs.  More importantly, current employment laws must 
change to allow for reductions in government jobs, as the current 
laws and procedures make it nearly impossible to layoff or fire 
public sector employees. 
 
Increase Revenues by $230 Million 
--------------------------------- 
 
¶9. (U) The revised budget cuts revenue projections by 7.1% to $9.28 
billion.  The new budget projected revenue decreases are based on a 
drop in VAT collection of 11% below the original budget, a corporate 
profit tax revenue drop of 21%, and a 16% fall in customs revenues. 
The government package includes revenue increases through hikes in 
excise taxes on fuel ($72 million); introduction of a 10% surcharge 
on cell phone bills ($43 million); increases in property taxes for 
large houses and luxury vehicles ($43 million); and a surcharge on 
capital gains income ($72 million). 
 
Anyone Willing to Give us a Loan? 
--------------------------------- 
 
¶10. (SBU) Spending cuts and limited revenue increases leave the 
Serbian government with a $1.3 billion deficit.  The government 
plans to cover this gap with a combination of measures.  Deputy PM 
Dinkic told us on April 9 that the government planned to seek $650 
million in loans from commercial banks, mostly in foreign currency. 
In addition, Deputy PM Djelic has lobbied Brussels to allow Serbia 
to use $160 million of the EU's IPA program assistance in 2009 on 
budget support.  The Treasury also plans to issue additional 
short-term treasury bills.  Dinkic told us, and Finance Minister 
Dragutinovic told daily Politika on April 18, that Serbia will also 
pursue a loan from Russia.  The government is also seeking tied aid 
projects, focusing on a proposed Chinese deal to construct a $200 
million bridge as part of the Belgrade ring road. 
 
Some Stimulus Measures 
---------------------- 
 
¶11. (U) While spending cuts and taxes were the headlines in the 
budget package, the proposal did add to some existing measures to 
support infrastructure investment and support business liquidity. 
The package increased capital to subsidize the interest rates on 
banks loans to businesses from $1.74 billion to $2.31 billion, 
provided $29 million for business start-up loans and added $214 
million for loans to SMEs.  Dinkic also reaffirmed the government's 
commitment to conclude $1.3 billion in loans from IFIs and bilateral 
credits for road construction along Corridor 10. 
 
Possible Additional Measures 
---------------------------- 
 
¶12. (SBU) Dinkic also proposed several measures to deal with public 
and private sector debt.  The heads of Societe Generale and Hypo 
Bank complained to us that the government is behind in making 
payments to private companies for purchases, and VAT refunds, adding 
to liquidity problems in private firms.  The government hoped to use 
a new commercial credit line from Societe Generale to address catch 
up on these payments.  At the same time, many firms have outstanding 
debts to public utilities (gas and electric power).  Dinkic has 
suggested publicly and privately to us that recently privatized 
firms could trade equity to the government as payment for these 
debts.  Dinkic has also promoted measures to increase cooperation 
among banks and companies to examine debt linkages where a liquidity 
crunch at one firm leads to cash flow and payment problems in a 
series of other firms.  These efforts on linked debt and debt-equity 
swaps are still just proposals and have not attracted additional 
champions in the government. 
 
¶13. (U) The debt problem is exacerbated by the primitive state of 
bankruptcy procedures here in Serbia which leads debt holders to 
race to put holds on accounts of firms with overdue debts, locking 
up liquidity to help solve the problem.  Of the over 380,000 
registered companies in Serbia (many of which are just shell 
companies) more than 60,000 have accounts blocked.  As a result, 
many businesses are forced to operate on a cash basis, further 
contracting government tax revenues. 
 
Experts: Measures Good if Implemented 
------------------------------------- 
 
BELGRADE 00000352  003 OF 003 
 
 
 
¶14. (SBU) The Prime Minister established a council of economic 
advisors to provide advice and support during the crisis, but the 
group has met only once since January.  Unfortunately, Cvetkovic 
only consulted with the group of prominent economists about the 
budget package after he finalized the details.  Economists and 
business leaders that we spoke with said that the amended government 
package was much better than the initial solidarity tax proposal. 
However, many said that the government was still playing catch up 
with the deteriorating economy.  Economists, including Vladimir 
Gligorov from the Vienna Institute and Mihailo Crnobrnja, former 
Yugoslav Ambassador to the EU and professor at the private Faculty 
of Economics, Finance and Administration, commented that the 
government based its budget projection on a now optimistic 
projection of a 2% drop in GDP.  Gligorov told us that a 5-6% GDP 
fall was more realistic and that he had concerns about the 
government's ability to follow through on expenditure cuts. 
 
Resistance: Mayors 
------------------ 
 
¶15. (U) The mayors association held a press conference on April 7 to 
protest the package's cut in transfers to municipalities.  Leading 
mayors, including Mayor Jesic from the business friendly 
municipality of Indjija, said that the cuts would lead to collapse 
in municipalities some could face bankruptcy.  So far local leaders' 
concerns have not slowed the progress of the package through 
government. 
 
Businesses Say They Want to Help 
-------------------------------- 
 
¶16. (SBU) Business leaders, including the heads of two major banks 
and the head of the Serbian Association of Managers told Dinkic and 
the Prime Minister's Chief of Staff at an event hosted by the 
Ambassador April 9 that companies wanted to work with the government 
to build support for crisis measures.  The leaders said they wanted 
to support the government publicly, but pleaded for more 
consultation and the opportunity to provide suggestions on new 
measures.  One business person suggested that the government needed 
a "situation room" to coordinate actions and messages, and to show 
the public the actions it is taking to address the crisis. 
 
¶17. (SBU) While President Tadic and PM Cvetkovic have held several 
formal and informal meetings with businesses and labor groups, the 
government leadership is still not comfortable building allies and 
support with business.   The government's concern for building 
relationships with businesses has been tempered by a fear of 
becoming politically linked with unpopular Serbian "tycoons," who 
are thought to wield significant political influence behind closed 
doors. 
 
COMMENT 
------- 
 
¶18. (SBU) The government's already limited credibility took a big 
hit with the aborted solidarity tax proposal.  The new package 
focuses the pain on the easily vilified government bureaucracy and 
has thus received little criticism.  Even labor unions, which are 
concerned about the planned cuts in public sector jobs, have been 
unable to organize demonstrations or a campaign against the package. 
 The political opposition has not advanced any economic alternative. 
 
 
¶19. (SBU) The government's new budget package will be painful, if 
fully implemented.  It is difficult to believe that the deep cuts in 
expenses across the public sector will result in as much saving as 
the budget projects.  The Finance Ministry will need a strong hand 
to stand up to the political demand from ministers for resources. 
With the additional IMF resources, and the commitment from 
international banks in Serbia to keep capital in the market, Serbia 
can limp through to the fall.  The real crunch time will be the when 
Belgraders return from summer vacation to a still bleak economic 
outlook.  Regardless, the government has recovered some momentum and 
will need to press ahead with the difficult spending cuts needed to 
stabilize the macroeconomic situation, while advancing the reforms 
that can support new business activity once the global economy 
begins to recover. 
End Comment. 
 
PEDERSON