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Cablegate: Croatian Economy - the Difference a Year Makes

UNCLAS ZAGREB 00064

SIPDIS
R 300843Z JAN 08

FM AMEMBASSY ZAGREB
TO RUEHC/SECSTATE WASHDC 8524
INFO RUEHZL/EUROPEAN POLITICAL COLLECTIVE
RUEATRS/DEPT OF TREASURY WASH DC

UNCLAS ZAGREB 000064

SIPDIS

SENSITIVE

STATE FOR EUR/SCE

E.O. 12958: N/A
TAGS: ECON PGOV HR ECONOMIC CONDITIONS
SUBJECT: CROATIAN ECONOMY - THE DIFFERENCE A YEAR MAKES

REF: ZAGREB 0035

1. Summary: Croatia's economy grew strongly in 2007, with most
analysts predicting an annual growth rate of 5.9 percent. Fueled
largely by increased consumption, government revenues also grew at a
better-than-expected rate, rising nearly 15 percent. The
government's fiscal deficit is expected to be less than 3 percent of
GDP. However, with the global economic environment changing, 2008
promises to be much less benign for Croatia. Higher inflation and
flat consumption are likely to result in slower growth and pressure
for wage increases. Government revenue growth will also slow at a
time when a new government has come to power with promises of
spending increases to coalition partners that could prove difficult
to reconcile with its platform of fiscal consolidation. End
Summary.

Economy Solid in 2007
---------------------
2. By most accounts, 2007 was a good year for Croatia's economy.
Analysts' estimates predict an annual growth rate of 5.9 percent.
Inflation, although rising at the end of the year, was 2.9 percent
overall. Meanwhile, strong revenue growth of nearly 15 percent
enabled the government to continue with its program of fiscal
consolidation with projections that the fiscal deficit will drop to
2.8 percent. At the same time, central bank policies to limit
foreign currency credit growth appear to have taken hold, leading
banks to increase their share of kuna lending, effectively
stabilizing Croatia's substantial foreign debt at 86 percent of
GDP.

Consumption-led Growth
----------------------
3. Growth, which was above Croatia's six-year average of 4.78
percent, was driven largely by increased consumption, which accounts
for around 60 percent of Croatia's GDP. Bank lending, which has
been a strong driver of Croatia's economy, increased at a slower
pace than in previous years, but still grew by 16 percent from 2006.
At the same time, four large lump sum payments to nearly half a
million pensioners injected nearly 5.7 billion kunas (USD 1.1
billion) into the economy from mid-2006 until November 2007. These
payments were part of a settlement of a "debt" to pensioners that
has largely been cleared with the last payment in November. The
government financed these payments through sales of its shares in
the pharmaceutical company Pliva to Barr Pharmaceuticals of the U.S.
and through IPOs of shares in the national oil company INA and the
national telecom firm HT.

Economic Environment Not So Benign in 2008
------------------------------------------
4. Croatia has begun to feel some of the consequences of volatility
in international markets and rising energy prices. Inflation
reached 4.5 percent in December, prompting calls for government
action (reftel). Central Bank Governor Zeljko Rohatinski has said
on several occasions that inflation could be as high as 6 percent in
2008. Consumption, which accounts for 60 percent of Croatia's GDP,
is also expected to slow as consumers feel the pinch of higher
prices. The tightening of credit markets has already been felt in
Croatia as interest rates have begun to rise. Consequently,
analysts expect 2008 GDP growth to be a least a percent lower.

No Second Mandate Honeymoon for Sanader
---------------------------------------
5. The Croatian economy has strong seasonal variations due to the
heavy influence of summer tourism, which accounts for one fifth of
GDP. As a result, GDP growth rates are calculated against the same
quarter of the previous year. Last year saw an unusually high
growth rate of 7 percent in the first quarter, coupled with an
inflation rate of only 1.6 percent. Price hikes across the economy
since the first of the year, coupled with a slowdown in consumer
spending are likely to provide a very unfavorable comparison with
last year when first quarter results are tabulated this spring.

6. The coalition government of PM Ivo Sanader is likely to face many
more difficulties on the economic front in 2008 than during his
previous four year tenure. Adding to this are the demands of his
coalition partners for large spending increases in agricultural
subsidies, the abolishment of health insurance co-payments and other
commitments that could be difficult to reconcile with the
government's promise of continued fiscal consolidation. With a
slowing economy, rising prices and lower government receipts,
Sanader will have a more difficult time keeping economic policy on
track, his coalition partners on board and the opposition at bay.

BRADTKE

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