VZCZCXRO6099
RR RUEHAG RUEHAST RUEHDA RUEHDBU RUEHDF RUEHFL RUEHIK RUEHKW RUEHLA
RUEHLN RUEHLZ RUEHNP RUEHPOD RUEHROV RUEHSK RUEHSL RUEHSR RUEHVK
RUEHYG
DE RUEHBW #0912 2311117
ZNR UUUUU ZZH
R 191115Z AUG 09
FM AMEMBASSY BELGRADE
TO RUEHC/SECSTATE WASHDC
INFO EUROPEAN POLITICAL COLLECTIVE
RUCPDOC/USDOC WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUEHBW/AMEMBASSY BELGRADE

UNCLAS BELGRADE 000912 
 
SENSITIVE 
SIPDIS 
USDOC FOR 4232/ITA/MAC/EUR/OEERIS/SSAVICH 
 
E.O. 12958: N/A 
TAGS: ECON EINV ETRD EFIN SR
SUBJECT: SERBIAN ECONOMY: NEGATIVE GROWTH AND A DEBILITATING DEFICIT 
 
REF: BELGRADE 838; 08 BELGRADE 1262 
 
Summary 
------- 
 
¶1.  (SBU) Serbia's poor macroeconomic indicators for the first half of 2009 reflect the growing negative impact of the global crisis and the inherent structural weaknesses of Serbia's economy, specifically its overdependence on a large public sector.   GDP fell 3.5% year on year and estimates are that the drop could reach 5% by the end of 2009.  The government's budget deficit widened beyond 
the IMF-agreed 3.5% target due to poor economic performance and lower-than-expected tax revenues.  The government is borrowing heavily both domestically and internationally as it tries to close the budget gap without cutting public wages or introducing new taxes.  Just one week before the next IMF mission to Belgrade, the government still has no clear economic strategy other than to ask the IMF to widen the deficit target.  Top commercial bankers told us that although they believed the situation was stable in the short run, they had concerns about the mid-term sustainability of government policies based on unaffordable levels of public consumption.  End Summary. 
 
GDP Growth Rate of Minus 3.5% in Q1 
----------------------------------- 
 
¶2.  (SBU) First quarter GDP dropped 3.5% year on year (y/y), according to official statistics, a better result than the National Bank of Serbia's prediction of a 5% drop.  The fall in GDP came mostly from slumps in processing industries 
(excluding energy and mining), construction, and trade, while growth was recorded in transportation and financial services.  At a July 9 presentation, Stojan 
Stamenkovic of the independent Economic Institute disputed the government's calculation, claiming that the real drop for the first quarter was at least 4.5%, 
attributing the difference to government methodology. 
 
Production Down, Unemployment and Inflation Up 
--------------------------------------------- - 
 
¶3.  (SBU) Serbia's industrial production decreased by 17.4% (y/y) during the January-June time period.  Retail turnover in May 2009 decreased by 8.5% compared to May 2008.  Inflation measured by EU methodology (CPI) was stagnant in June 
2009, but accumulated inflation for the first half of 2009 reached 7%.  Serbia's average net monthly wage in June 2009 was $489, nominally higher by 9.3% y/y, but in real terms it was only 1.4% higher.  The official unemployment rate stood at 16.4% in April 2009, up from 14% in October 2008, according to estimates 
from the Statistical Office (ref A). 
 
Foreign Trade Shrinks by a Third 
-------------------------------- 
 
¶4.  (SBU) Serbia's foreign trade continued to shrink in the first half of 2009 
due predominantly to the drop in global demand as a result of the world crisis.  Serbia's exports in January-June 2009 shrank by 33% y/y to $3.75 billion, while imports shrank by 39% to $7.19 billion.  Consequently, the trade deficit fell by 45% to $3.44 billion. 
 
 
Budget Deficit - A Growing Problem 
---------------------------------- 
 
¶5.  (SBU) Serbia's budget deficit continues to grow as the economic crisis lingers.  The projected 2009 deficit, as agreed with the IMF last year, was to be only $1.1 billion (2.3% of the government budget); by the end of June 2009, however, it had already reached $800 million.  The deficit swelled due to a 15.8% drop in revenues in real terms y/y ($4.48 billion collected in the first half 2009), while expenditures fell by only 6.3% (overall expenditures reached $5.28 billion).  VAT, customs, and company profit tax collection were all down significantly due to poor performance of the domestic economy and the influence of the global crisis.  While the bulk of expenditure items recorded a drop, the second largest government expenditure - transfers for pensions and the health fund - recorded growth of 58.5% in real terms, as a result of the December 2008 political decision to raise pensions by 10% (ref B). 
 
Government Headache: How to Close the Deficit 
--------------------------------------------- 
 
¶6.  (SBU) Prime Minister Mirko Cvetkovic stated on July 12 that the revised 2009 budget deficit would likely be $615 million higher than the previously projected $1.1 billion, totaling $1.7 billion for 2009, or around 4% of GDP.  Cvetkovic said Serbia would ask the IMF in late August to accept the higher deficit target.  Cvetkovic said Serbia would give "firm guarantees to the IMF that we can finance the higher deficit, that we would intensify reforms in administration, continue the restructuring of public companies and cut subsidies."  Cvetkovic 
said that the budget gap would be filled with loans from the EU, World Bank, Russia, commercial banks and selling Treasury bills on the domestic market.  However, Finance Minister Dijana Dragutinovic announced to the National Assembly on July 28 that the tax on wages above a certain level could be increased in order to fill the budget, but admitted that this had not been agreed within the government.  On August 13 Deputy Prime Minister and Economy Minister Mladjan Dinkic told the media that there would be no increase in taxes and no cut in public 
pensions or wages, despite Dragutinovic's statements. 
 
¶7.  (SBU) On August 13, Dragutinovic offered a more negative outlook that the final 2009 budget deficit would likely be around 5% of GDP (about $2 billion). 
Stamenkovic stated that if the trend continued without some additional adjustments in the fiscal side (new taxes or new spending cuts), the overall deficit (including municipalities and funds for social insurance) could reach as high as 
$2.5 billion or 6% of GDP, more than double what was initially agreed with the 
IMF. 
 
Treasury Bills for Sale 
----------------------- 
 
¶8.  (SBU) In an effort to cover the deficit, the government has aggressively issued Treasury Bills.  Between February and the beginning of August, Serbia had 
issued $1 billion in Treasury notes, Serbia's Treasurer Ivan Maricic told us on August 3.  Maricic said he was concerned that the government had no mid-term strategy for state borrowing.  He said he was concerned that the government's selling of short-term (3-6 month) T-bills, with an attractive 12-13% interest rate, was squeezing out commercial lending, but explained that without the Treasury sales Serbia would be unable to pay its pensions and wages. 
 
An Additional $500 Million in Drawing Rights 
-------------------------------------------- 
 
¶9. (SBU) On August 12, NBS Governor Jelasic told the media that the IMF would allow Serbia to withdraw an additional $500 million based on the new allocation 
of special drawing rights as part of the IMF efforts to boost global liquidity.  This funding would be in addition to Serbia's Stand By Arrangement of $4 billion.  Jelasic said the funds would be available at the end of August and could 
be used for budget support.  However, IMF Resident Representative in Serbia Bogdan Lisovolik stated the next day that it was too early to discuss the possibility of using these funds for Serbia's budget deficit, emphasizing that this could be the case only if it was impossible to finance the budget under reasonable and non-inflationary conditions.  Serbia's Foreign exchange reserves stood at 
$14 billion at the end of July, according to a National Bank of Serbia announcement on August 13. 
 
Commercial Banks Cautious 
------------------------- 
 
¶10.  (SBU) Despite the macroeconomic figures, top bankers in the country told us they were moderately optimistic.  Goran Pitic, President of the Board of Societe General Bank; Dejan Janjatovic, Member of the Board of ProCredit Bank; and 
Zoran Petrovic, Board Member of Raiffeisen Bank, all agreed that in the short run the government would muddle through, but that the mid-term view (second half of 2010 and 2011) was worrisome unless the government initiated significant structural reforms and found a more sustainable way to finance the budget and to 
cut public consumption. 
 
No More Cross Borders; Different Approach to Crisis 
--------------------------------------------- ------ 
 
¶11.  (SBU) Commercial banks have become more pragmatic and cautious as a result of the situation, but some are expanding their operations.  Draginja Djuric, President of the Board of Intesa Bank told us on August 13 that banks were no longer issuing cross border loans (loans issued by the headquarter office of a foreign bank operating in Serbia directly to a Serbian company in order to avoid 
stringent NBS regulations).  Such loans had been a significant source of financing for Serbian companies in the past.   Petrovic and Vladimir Cupic of Hypo Group Bank confirmed to us that Austrian banks, which were among the first to enter the Serbian market, were  under instructions from their head offices to be more conservative in their lending, focusing more on short term loans and government securities.  As a result, Italian and French banks are cautiously increasing their market share.  Djuric told us Intesa Bank had increased its lending exposure by 55% this year over 2008, wining over former clients from Austrian banks.  Pitic also told us on August 5 that Societe General  was increasing its commercial lending in Serbia, soaking up market share that Austrian banks had left behind. 
 
COMMENT 
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¶12. (SBU) Serbia is feeling the effects of the global economic crisis.  The government's heavy reliance on borrowing to fund the budget has increased the public debt burden that will be due in 2010.  The borrowing is increasingly shortsighted, without a clear governmental strategy to get the Serbian economy back on track and to decrease the size of the public sector or the growth in pension costs.  Commercial banks are adjusting to this economic situation, but are looking for durable solutions from the government to stabilize the mid-term macroeconomic picture.  The IMF visit at the end of August may provide some temporary motivation to undertake reforms, but deeper structural change will take greater 
political will that can only come from the top.  End Comment. 
BRUSH