VZCZCXRO6748
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DE RUEHPS #0356/01 2320536
ZNR UUUUU ZZH
O 200536Z AUG 09
FM AMEMBASSY PRISTINA
TO RUEHC/SECSTATE WASHDC IMMEDIATE 9213
INFO RUEHZL/EUROPEAN POLITICAL COLLECTIVE PRIORITY
RUCNDT/USMISSION USUN NEW YORK PRIORITY 1709
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UNCLAS SECTION 01 OF 03 PRISTINA 000356 
 
SENSITIVE 
SIPDIS 
 
STATE FOR EUR/SCE, DRL, INL, S/WCI; NSC FOR HELGERSON, USUN FOR 
SGEE, USOSCE FOR AHYDE 
 
E.O. 12958: N/A 
TAGS: EAID ECIN ECON EFIN ETRD ETTC PREL KV
SUBJECT:  KOSOVO:  SIGNS OF FINANCIAL CRISIS SURFACING 
 
SENSITIVE BUT UNCLASSIFIED - PLEASE PROTECT ACCORDINGLY 
 
¶1. (SBU) SUMMARY:  Kosovo's limited international financial exposure 
has allowed the country to remain relatively untouched by the global 
financial crisis.  Heavily dependent on international donor 
assistance, rising public expenditures have managed to stave off any 
major decline in growth.  However, there are indications that 
Kosovo's financial sector is starting to show some initial effects 
from the crisis, most apparent in declining remittances and slightly 
higher non-performing loan rates.  Banks are planning to tighten 
access to capital as a precaution, anticipating tougher times ahead. 
 To date, the Government of Kosovo (GoK) and the Central Bank of 
Kosovo (CBK) have consistently maintained that the country will 
remain immune to the crisis.  Local financial institutions say this 
is not realistic and that the GoK should be more conservative with 
its spending.  The concerns of the financial sector were reinforced 
by the IMF this past June in a Mission Aide Memoire urging more 
prudent public spending, given the limited financial tools at the 
GoK's disposal.  With uncertain times ahead, and a heavy national 
dependence on sources of revenue outside the government's control, 
the GoK should approach discussions on the 2010 budget with caution 
and fiscal restraint, a point we have been stressing with our GoK 
interlocutors.  END SUMMARY. 
 
¶2. (SBU) Kosovo presents an unusual case when assessing the impact 
of the financial crisis.  Most indicators that would signal a 
country is entering financial distress -- falling exports, currency 
problems, declining foreign direct investment -- lack utility in 
Kosovo.  While Kosovo's exports have halved since the start of the 
year -- primarily due to falling metals prices -- overall exports 
and FDI are so small that a further drop in any other industry would 
have no noticeable impact.  Kosovo is not subject to wild exchange 
rate fluctuations because it uses the euro as the national currency. 
 While imports, private sector credit and FDI are slowing, these 
declines have been partially offset by rapid growth in public 
expenditures.  This combination of factors has allowed Kosovo to 
remain relatively untouched by the global financial crisis so far. 
Although the Ministry of Economy and Finance (MEF) revised the 
country's 2009 growth estimate from 5% to around 3.4% earlier this 
year, Kosovo is still one of the few countries in the region 
anticipating growth at all. 
 
BANKS PUT BREAKS ON LENDING AS FIRST SIGNS EMERGE 
--------------------------------------------- ---- 
 
¶3. (SBU) In July, CBK statistics revealed the first indications that 
the financial crisis might be surfacing in Kosovo.  CBK Vice 
Governor Gani Gerguri told us that demands for loans are increasing, 
but lending has slowed.  Commercial and private lending grew only 5% 
during the first two quarters of 2009, compared to 32% during the 
same period last year.  Two out of eight banks have effectively 
stopped lending due to liquidity concerns and significant first 
quarter losses.  Kosovo has a high loan-to-deposit ratio, nearly 
85%, and Gerguri said banks are concerned about a future liquidity 
crisis.  Banks are being much more cautious as a result, taking 
steps to decrease the sector's already limited international 
exposure, particularly in securities. 
 
¶4. (SBU) Iliri Aliu, Deputy Managing Director of ProCredit Bank, 
echoed Gerguri's assessment.  Aliu said that although the first two 
quarters of 2009 were positive for ProCredit, Kosovo's largest bank, 
overall growth has been much slower than in previous years, and the 
bank is taking precautions.  Loan applications are being scrutinized 
much more closely, particularly from industries that have been 
hardest hit by the crisis, such as base metals.  Aliu noted that all 
businesses, regardless of sector or size, have demonstrated 
difficulties repaying loans this year.  ProCredit's default rate has 
increased slightly to just under two percent, which Aliu believes is 
too high for the local market. 
 
¶5.  (SBU) Similar sentiments were expressed by Albert Lumezi, CEO of 
Kosovo's third largest bank Nova Ljubljanska Banka (NLB).  NLB also 
reported a slower pace of growth for the first half of the year, and 
Lumezi said the bank will tighten lending for the third and fourth 
quarters.  He explained that NLB's non-performing loan rate 
increased from 3.2% to 3.8% in July, and lack of contract 
enforcement in Kosovo makes banks more conservative in issuing loans 
 
PRISTINA 00000356  002 OF 003 
 
 
if they don't have a good feeling about a client.  The performance 
of other banks in the sector has also been cause for concern, said 
Lumezi.  The Turkish Economy Bank (TEB), which opened last year, has 
increased its share of the market by continuing to pay 7% interest 
on deposits despite first and second quarter losses this year.  Four 
out of eight banks in Kosovo are reporting losses in 2009, including 
second-largest bank Raiffesien, which was hard hit by bad loans and 
falling stock prices.  The other four banks are operating with very 
little growth or are just breaking even. 
 
DELAYED IMPACT OF REMITTANCES 
----------------------------- 
 
¶6.  (SBU) Remittances constitute a significant portion of Kosovo's 
economy.  Financial institutions estimate that remittances through 
official channels, such as money transfer agencies and commercial 
bank transfers from abroad, comprise somewhere between 15-17% of 
GDP, with a larger amount coming in unrecorded.  Both ProCredit and 
NLB expressed skepticism that Kosovo's large diaspora will be able 
to continue providing as much financing as they have in previous 
years According to Pro-Credit's Aliu, the impact of cuts in 
remittances to Kosovo remains to be fully felt.  He elaborated that 
though the disapora's expenses have increased, and some have lost 
their jobs, social benefits have compensated for the loss of wages, 
continuing the flow of funds back to Kosovo.  Aliu predicts that 
when these social benefits run out, Kosovo's citizens will begin to 
feel the effects of the financial crisis more concretely, probably 
toward the end of 2009. 
 
¶7.  (SBU) There is some indication that the effects are already 
beginning to be felt.  Early estimates from the CBK indicate 
remittances are down 5-9% this year.  In addition, the diaspora, 
which usually descends on Kosovo each summer flush with cash to 
spend on retail purchases and services, seems to be spending less 
this year than in the past.  Aliu said that many businesses are 
already reporting lower sales this summer season, ostensibly because 
the diaspora is bringing back less money. 
 
BUDGET EFFECTS 
-------------- 
 
¶7.  (SBU) While Kosovo's financial sector remains stable, the GoK is 
heavily reliant on income sources that are out of the government's 
control, such as remittances, donor contributions and FDI.  About 
70% of Kosovo's budget is financed by VAT and other customs fees 
collected at the border, holding critical public expenditures 
hostage to high volumes of imports.  Foreign assistance is another 
significant funding source and actual assistance could decrease as 
donor countries face liquidity issues of their own, resulting in 
reduced imports, decreased tax revenues, lower GDP growth, and 
possibly job losses.  The GoK has few tools at its disposable to 
even address financial difficulties.  While the euro provides 
welcome stability, Kosovo is reliant on the ECB to make sound 
decisions on monetary policy and the CBK pegs interest rates to ECB 
rates.  The lack of a national monetary policy leaves Kosovo with 
only fiscal policy as a major macroeconomic mechanism.  At this 
time, the GoK is not able to loan money to cover eventual liquidity 
issues that may arise, leaving prudent management of public funds 
the primary instrument at the government's disposal.  This makes a 
stable financial sector and adequate bank reserves all the more 
important, in order to give the GoK some flexibility when faced with 
a financial crisis. 
 
¶8. (SBU) The GoK dipped into national reserves during this year's 
mid-year budget review, electing to increase expenditures to over 
1.5% of GDP without serious consideration of how external factors 
could impact future financing.  If the government executes the 
budget in its entirety, Kosovo's fiscal deficit is likely to reach 
almost 11% of GDP in 2009.  This, coupled with the country's 
enormous and growing trade deficit hovering around 45% of GDP, does 
not leave the GoK with many options to respond to a financial 
crisis.  The decision to engage in deficit spending during uncertain 
times and without prudent fiscal policies earned the GoK harsh 
criticism from the IMF this past June in a Mission Aide Memoire that 
urged a reassessment of spending priorities to restore fiscal 
sustainability.  Although Kosovo exports very little, poor fiscal 
management will harm nascent exporters and negatively impact 
 
PRISTINA 00000356  003 OF 003 
 
 
employment growth in export industries.  Kosovo already faces a 
high, but steady, unemployment rate of around 43%.  Further job 
losses and reduced spending will lead to lower imports, directly 
impacting customs revenues and stagnating Kosovo's already modest 
economic growth, leading to even more pressure on the GoK to create 
jobs and increase assistance to various social groups. 
 
COMMENT 
------- 
 
¶9. (SBU) Although the effects of the financial crisis have been slow 
to surface in Kosovo, and it is unclear what the ultimate extent of 
the impact will be, the country is not invulnerable.  Although it 
has avoided the more extreme effects the crisis has wreaked on other 
economies, Kosovo could suffer longer-term effects that lead to a 
shrinking economy.  Avoiding this fate will require Kosovo to 
attract more foreign investment and execute prudent public spending, 
in order to escape the whims of unpredictable revenue streams.  The 
GoK has all but ignored IMF advice to cut back on spending and 
develop sound fiscal policies to inform budget decisions, insisting 
that Kosovo will remain immune to the financial crisis.  Mr. Lumezi 
of NLB pointedly told us it would help if the GoK admitted there are 
difficulties, instead of claiming Kosovo is immune.  Not only would 
this give foreign investors more confidence that Kosovo has prepared 
to address potential financial issues, it would also set the stage 
for a more realistic discussion on future budget spending.  Ignoring 
possible difficulties will do the opposite.  In advance of 
government's discussions on the 2010 budget, we and others in the 
international community are urging the GoK to develop and implement 
sound fiscal policies that exercise restraint.  END COMMENT. 
 
 
MURPHY