VZCZCXRO6923
RR RUEHSL
DE RUEHBW #0527/01 1690641
ZNR UUUUU ZZH
R 180641Z JUN 09
FM AMEMBASSY BELGRADE
TO RUEHC/SECSTATE WASHDC 1392
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/USDOC WASHDC
RUEHZL/EUROPEAN POLITICAL COLLECTIVE

UNCLAS SECTION 01 OF 02 BELGRADE 000527 
 
SENSITIVE 
SIPDIS 
 
USDOC FOR 4232/ITA/MAC/EUR/OEERIS/SSAVICH 
 
E.O. 12958: N/A 
TAGS: ECON EINV ETRD EFIN SR
SUBJECT: SERBIA ALREADY MISSING IMF TARGETS, REVISED ARRANGEMENT 
LIKELY NECESSARY 
 
REF: Belgrade 272 
 
BELGRADE 00000527  001.2 OF 002 
 
 
 
SUMMARY 
------- 
 
¶1.  (SBU) Just one month after approval of a $4 billion Stand By 
Arrangement with the IMF, it is already clear Serbia will be unable 
to meet the fiscal and GDP targets in the agreement and that a 
revised arrangement will be necessary by early fall.  The National 
Bank of Serbia remains confident that it can maintain a stable 
currency, but expressed deep concerns about inflation and government 
debt financing.  Private sector analysts believe the situation in 
Serbia may still get worse, as there appears to be little 
coordinated effort to promote economic growth.  Without deep 
structural reforms to stimulate export led growth, Serbia may 
continue to face recession long after the rest of Europe recovers. 
END SUMMARY. 
 
IMF Targets Not Being Reached 
----------------------------- 
 
¶2.  (SBU) One month after concluding the $4 billion Stand by 
Arrangement, Serbia is already not meeting its IMF targets.  Instead 
of a 3% fiscal deficit, Finance Minister Dragutinovic stated on May 
28 that a "fiscal gap of 4% would be more appropriate for Serbia" 
and that Serbia would ask the IMF to approve an expansion of its 
fiscal deficit to 4% of its output.  On June 11 Prime Minister Mirko 
Cvetkovic publicly stated that he expected the IMF would 
"understand" if Serbia requested to widen the fiscal deficit 
projection.  Serbia is also off target regarding its GDP, which was 
initially expected to contract by 2 percent.  Now, economic analysts 
are expecting a 5 percent contraction, which will put further 
constraints on government revenue projections. 
 
¶3. (SBU) IMF Resident Representative, Bogdan Lissovolik told us on 
June 8 that Serbia would need to take broader adjustments if it 
exceeded the 3% fiscal deficit.  Despite the government's April 
package of anti-crisis measures, which among other things included a 
26% cut in each ministry's discretionary spending, the efforts 
appeared insufficient and already there were signs that expenditures 
were rebounding.  Lissovolik said there was little evidence on the 
municipal level that spending was curtailed or that wages were 
frozen.  Serbia would need to further control spending, implement 
adjustments on the revenue side, such as raising the VAT, as well as 
implement long delayed structural adjustments, such as pension, 
health, and civil service reform, Lissovolik said. 
 
Central Bank: Monetary Side Stable, Fiscal Side Sloppy 
--------------------------------------------- --------- 
 
¶4.  (SBU) National Bank of Serbia (NBS) Governor Radovan Jelasic 
told us on June 10 that Serbia's monetary policy was stable and that 
the NBS did not require any additional technical assistance.  "We 
can sleep well, knowing that Serbia's taxpayers had not used one 
Dinar to support the financial sector," Jelasic said.  It was 
essential to focus on the fiscal side and to help the Ministry of 
Finance and Treasury, Jelasic said. 
 
¶5.  (SBU) The government was the country's largest foreign currency 
risk, Jelasic said, noting that over 90% of Serbia's public debt was 
based in foreign currency.   Finally the government was taping the 
domestic market for funds, but at a staggering pace.  In just three 
months the government had issued nearly $700 million in treasury 
bills.  Jelasic said he expected public debt to increase by 15% of 
GDP this year. In absolute terms this would be a $6.36 billion 
increase, jumping from $12.5 billion in April 2009 to an estimated 
$18.86 billion by the end of the year.  This new funding includes: 
the new IMF loan ($2.9 billion in 2009), loans from IFIs for 
infrastructure projects and budget support (around $1.38 billion), 
possible loans from Russia ($1.38 billion), and Treasury bills ($700 
million as of June 2009). 
 
International Loans:  From Russia, With Love? 
--------------------------------------------- 
 
¶6.  (SBU) In addition to issuing Treasury bills, Serbia is 
considering using additional international credits to plug the 
budget holes and to begin much delayed infrastructure projects. 
Press reports about potential loans from Russia state that these 
loans, in addition to filling the budget gap, would be for the 
construction of the long discussed but prohibitively expensive metro 
project in Belgrade and other undetermined infrastructure projects. 
Jelasic told us he hoped the government would not use credits solely 
for additional consumption.  He stressed however that any Russian 
credits would not come cheaply, noting that Armenia had recently 
received Russian loans at a significant cost (Libor +3 percent, 15 
 
BELGRADE 00000527  002.2 OF 002 
 
 
year repayment with a five year grace, according to what the 
Armenian Central Bank Governor told Jelasic.) 
 
¶7.  (SBU) Jelasic was cautious about Serbia's future economic 
forecast.  From the monetary side, it all depended upon inflation, 
which could "hit hard," he said.  Even though public wages and 
pensions were currently frozen until the end of 2010, "inflation 
keeps eating away," said Jelasic. Inflation for 2009 is estimated to 
be between 8-9%, driven mostly by administratively controlled 
prices, such as utilities and gas. 
 
Pensions are "Killing Serbia" 
----------------------------- 
 
¶8.  (SBU) Serbia's overburdening pension system is suffocating the 
country and would further make it difficult for Serbia to meet IMF 
targets, Jelasic said, echoing Lissovolik's call for greater 
structural changes.  Jelasic said this pension burden would increase 
in this current environment of rising unemployment, frozen wages, 
and a growing unofficial economy that was not paying into the social 
security system.  Nearly 45% of pensions payments were provided 
directly by the budget, Jelasic said, adding that there were 1.2 
million pensioners for Serbia's 7.5 million citizens and only 2 
million paying taxes. 
 
Private Sector Pessimistic 
-------------------------- 
 
¶9.  (SBU) The current economic environment in Serbia had done little 
to encourage greater investment or commercial lending by banks, 
Raiffeisen Bank's Deputy Chairman of the Board, Zoran Petrovic told 
us on June 10.  Petrovic said the Vienna Agreement, in which ten 
banks agreed in April under IMF auspices to maintain their exposure 
in Serbia (reftel) had successfully stabilized the financial 
situation, but had done little to change Serbia's underlying 
economic fundamentals.  The restricted supervisory measures imposed 
by the NBS and banks themselves, while useful for assuring a strong 
Dinar, also limited the funds available for domestic borrowers. 
(Serbia has the highest capital adequacy ration in the region, 
nearly 21%, compared to the international standard of just 8%, 
according to Petrovic.)  Petrovic said he also expected a 5% 
contraction in Serbia's GDP for 2009.  Noting the steady increase of 
non-performing loans on the balance sheets of commercial banks, 
Petrovic expected the situation would become tougher in the next 
three to six months.  Lending in Serbia was at a "standstill," said 
Petrovic. 
 
Next Steps with IMF 
------------------- 
 
¶10.  (SBU) The IMF will send a technical team in late June to look 
at the stress testing of the banks who agreed to the Vienna 
Agreement.  Afterwards, an IMF review team will visit in late 
August, which will then present its findings to the IMF Board by the 
end of September, Lissovolik said.  In addition, IMF Deputy Managing 
Director Murilo Portugal will visit Belgrade on July 2 to 
commemorate 125 years of the National Bank of Serbia.  Jelasic said 
he hoped Portugal would use that visit to deliver some "tough 
messages" so the government can take action before the IMF review 
team's August arrival.  If all goes well in September, the IMF would 
revise the arrangement so that additional IMF funds could be 
released this year, Lissovolik said.  The IMF delivered the first 
tranche of $1.06 billion on May 20.  Two additional tranches could 
be delivered by end of year, making the total amount withdrawn in 
2009 $2.9 billion. 
 
COMMENT 
------- 
 
¶11.  (SBU) By signing the IMF agreement in March, Serbia may have 
stopped any potential balance of payments problem, but its work is 
far from over.  To date, Serbia's weak commitment to meeting the 
fiscal targets agreed to with the IMF and the further contraction of 
GDP makes a revision of the standby agreement not only likely, but 
essential.  Serbia must seriously address the underlying flaws in 
its public sector spending, such as pensions, and get on track to 
stimulate export led growth if it is to weather the ongoing economic 
storm.  End Comment 
 
BRUSH