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Cablegate: Croatia's 2010 Budget; Fails to Address Needed

VZCZCXRO6569
PP RUEHIK
DE RUEHVB #0710/01 3371453
ZNR UUUUU ZZH
P 031453Z DEC 09
FM AMEMBASSY ZAGREB
TO RUEHC/SECSTATE WASHDC PRIORITY 9701
INFO RUCNMUC/EU CANDIDATE STATES COLLECTIVE PRIORITY
RUEHZL/EUROPEAN POLITICAL COLLECTIVE PRIORITY
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
RUEAIIA/CIA WASHDC PRIORITY

UNCLAS SECTION 01 OF 02 ZAGREB 000710

SIPDIS
SENSITIVE

EUR/SCE FOR CATHERINE WESTLEY, TREASURY FOR INTERNATIONAL
AFFAIRS LARRY NORTON

E.O. 12958: N/A
TAGS: ECON EFIN PGOV HR
SUBJECT: CROATIA'S 2010 BUDGET; FAILS TO ADDRESS NEEDED

REFORMS

REF: ZAGREB 665

ZAGREB 00000710 001.2 OF 002


1. (U) SUMMARY: The Croatian parliament passed PM Kosor's
proposed $25.3 billion 2010 budget draft December 2, with all
coalition parties voting in favor. Increased spending for
social payments and the public sector comprise the majority
of the budget with cuts in Defense, Foreign Affairs and other
line ministries. The budget assumes low but positive GDP
growth and rising VAT revenues next year, which, if accurate,
will result in a budget deficit of 2.5 percent of GDP.
Political opposition parties and most of Croatia's
presidential candidates wasted no time in leveling criticism
against PM Kosor for increased spending without substantive
fiscal reform. Despite this criticism, the ruling HDZ party
and its coalition partners defended the budget draft. The
response from prominent economists has been skepticism of the
government's optimistic GDP growth and revenue assumptions
and exasperation over the lack of serious reform efforts. END
SUMMARY

THE NUMBERS

2. (SBU) The GoC submitted its 2010 budget proposal to the
Sabor November 21, with $25.3 billion in expenditures and
anticipated revenues of $23.5 billion, resulting in a deficit
of 2.5 percent of GDP. Social payments, pensions, and public
sector salaries account for approximately 87 percent of the
total budget. (Note: Both expenditures for salaries and
pension payments increased 1.7 percent compared to 2009, and
the overall 2010 budget is 1.5 percent higher than the 2009
budget). The GoC will spend 23 percent less on Defense
expenditures in 2010 than in 2009, with minor cuts for
Ministries of Foreign Affairs and Culture. The Croatian Sabor
passed the budget draft December 2, with coalition parties in
favor and the opposition against.

3. (SBU) The 2010 budget assumes GDP growth in 2010 of 0.5
percent. Finance Minister Suker explained that although
revenues from business profit taxes and income taxes are
lower overall, there has recently been an 11 percent increase
in revenue from the value-added tax. The new budget relies
heavily on the increased VAT for its revenue projections. The
GoC raised the VAT to 23%, one of the highest in Europe, in
July 2009, imposing an additional "crisis" income tax
supplement at the same time. Additional funds to finance the
deficit have been raised through a successful bond sale to
European and U.S. investors this fall. The government has
announced that the increased VAT and "crisis" income tax
levied this summer will remain in place for the foreseeable
future.

4. (SBU) The GoC also forwarded to the Sabor budget
projections for the next two years and a draft law on the
execution of the budget, which would authorize the GoC to
borrow $6 billion in 2010 in order to finance due liabilities
and the deficit.

POLITICAL OPPONENTS SCORE POINTS

5. (SBU) PM Kosor's critics in the opposition wasted no time
criticizing the proposed budget. Opposition deputies raised
strong concerns about Croatia's growing indebtedness, rising
interest rates and also criticized Kosor for unfulfilled
pledges of fiscal reform. Social Democratic Party (SDP)
parliamentarians were the loudest critics, arguing for deeper
fiscal reforms, including attrition of as much as one-third
of government employees. The ruling Croatian Democratic
Union (HDZ) and its coalition partners, however, closed ranks
and defended the budget. In the midst of an on going
presidential election, several of Croatia's presidential
candidates also took the opportunity to score media points
and criticized PM Kosor's leadership. Despite the loud and
well-publicized criticism, none of the opposition parties,
nor their presidential candidates, offered any specific
alternative policy recommendations.

6. (SBU) Many prominent economists and financial analysts
with private banks have expressed frustration with the 2010
budget. Unicredit bank's chief economist in Zagreb, Goran
Saravanja, told us that the budget is no surprise and that
there is no appetite to announce radical budget cuts in a
presidential election season. Other prominent economists
quoted in the media tend to agree. The general consensus is
that Suker's optimistic revenue predictions for 2010 are
unrealistic because of growing unemployment and weaker

ZAGREB 00000710 002.2 OF 002


consumer spending. Several economists and opposition figures
noted that, assuming revenue and spending forecasts are
optimistic, a budget revision was likely to be needed as
early as the first half of 2010.

COMMENT

7. (SBU) The 2010 budget reflects the political reality in
Croatia, even at the expense of the fiscal one. The
government and the ruling HDZ party simply do not have the
political will at this time to make needed reforms and cuts
in Croatia's public and social sector. Although political
opponents have called the GoC out on this, there are no
concrete proposals from the SDP or any other political
parties for a realistic solution. Katarina Ott, the Director
of the think tank Institute for Public Finance, put the
necessary budget reforms in succinct terms at a conference
last week: privileged pensions (such as those for war
veterans) should end, the retirement-eligibility age should
be raised from the current 49, younger pensioners should
return to the labor market, and administration costs must be
cut severely. Kosor and her new economic team understand that
endless deficits and increased indebtedness cannot be
sustained in the long run but there are no indicators to
suggest that the GoC is going to adopt meaningful fiscal
reform any time soon. Any chance that this anti-reform
calculus could change will only come after the looming
presidential elections on December 27 and January 10 are
complete.
FOLEY

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