IMF Executive Board Concludes 2007 Article IV Consultation with the Republic of Serbia

Public Information Notice (PIN) No. 08/11
February 5, 2008

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2007 Article IV Consultation with the Republic of Serbia is also available.

On January 28, 2008, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Republic of Serbia.1


Serbia continues to grow strongly—a welcome result of the structural reforms of the past. Real GDP growth is projected to reach about 7 percent in 2007. Much has been done since 2000: inflation has come down significantly; the banking sector was restructured; and hundreds of companies were privatized. As a result, for the first time in years, the corporate sector posted aggregate profits.

However, sustaining the reform momentum has been a challenge and weaknesses in the corporate sector persist. Structural reforms stalled in 2006-07 and substantial progress—and growth—has been achieved only in a handful of sectors. State- and socially owned enterprises continue to drain domestic savings while fixed investment remains low. With slow job creation, employment continued declining and unemployment remained high at 21 percent in 2006.

Nevertheless, capital inflows surged, particularly in 2006, boosted by privatization-related receipts but also by foreign borrowing—mostly medium- and long-term. This led to rising, particularly private, external debt.

The large inflows allowed for significant official reserve accumulation (7½ months of imports as of November 2007), but also led to a surge in demand. This was compounded by rapid credit growth and expansionary domestic policies—large wage increases in the public sector, income tax cuts, and fiscal deficits in 2006-07. Given domestic supply rigidities—and a drop in remittances—the current account deficit continued to widen, reaching 16½ percent of GDP in the period January-November 2007.

Expansionary fiscal policies contributed to the widening of external imbalances. Driven by rising expenditure, the fiscal balance has deteriorated by over 2½ percent of GDP since 2005. In 2006, the deficit reached 1½ percent of GDP—some 4 percentage points adrift of the target envisaged in February 2006 under the Extended Arrangement with the Fund. In 2007, a deficit of 1¾ percent of GDP is expected.

Despite prudential tightening, credit growth remained largely unabated, as competition in the banking sector intensified. Coupled with high euroization of credit, this increased financial sector vulnerabilities, although banking sector soundness has so far been preserved as rigorous risk classification rules and high provisioning, reserve, and capital requirements have kept banks well capitalized.

The new monetary policy framework introduced in mid-2006 has so far been successful in achieving low inflation, as core inflation declined from 14½ percent at end-2005 to 5½ percent at end-2007—within the 4-8 percent target range for the year—despite headline inflation reaching 10 percent. The decline in inflation was aided by double-digit nominal and real appreciation. Monetary policy remained conservative in 2007 as the nominal appreciation persisted through most of the year.

A combination of weak structural, expansionary fiscal, and tight monetary policies in the past two years have resulted in a loss of competitiveness. Large pay raises granted ahead of the elections raised labor costs, and even in industry, wage growth outstripped productivity gains in 2006, although this was partly reversed in the first half of 2007. Nevertheless, export shares remained on an upward trend despite the sharp real effective exchange rate appreciation over the past year and a half.

Executive Board Assessment

Executive Directors welcomed the robust growth with moderate inflation in 2007, and recognized that this performance reflected, in large part, the impact of tight monetary policies and the authorities' progress on structural reforms and privatization during the past 7 years of transition. However, as a result of the rapid growth of domestic demand fueled by large wage increases, credit growth, and expansionary fiscal policies, imbalances have increased, the current account deficit has widened, private external debt has rapidly accumulated, and vulnerabilities have risen. Directors, therefore, recommended a significant rebalancing of policies, with enhanced structural reforms and tighter fiscal policy.

Directors noted that financial stability risks have been managed by building adequate buffers and rigorous prudential regulations. Large capital inflows, while allowing significant official reserve accumulation, have complicated macroeconomic management by boosting domestic demand. Directors considered that international financial market turbulence, increased volatility in domestic markets, and continuing political uncertainties have added to underlying vulnerabilities, and underscored the importance of stability-oriented macroeconomic policies.

Several Directors agreed that the present policy mix of loose fiscal, tight monetary, and until recently slow-moving structural policies are reflected in an overvalued real exchange rate, although the size of the overvaluation is uncertain. Others, however, pointed to more benign indicators of competitiveness. Directors cautioned that under such policies, external imbalances are likely to persist, with a continuing large current account deficit and rising external debt.

Directors observed that fiscal policy is the main short-term macroeconomic tool available for reducing Serbia's external imbalances. They noted that targeting a tighter fiscal stance than that set out in the budget document for 2008 will help contain excess demand pressures and increase the likelihood of a turnaround in the current account. Fiscal restraint will continue to be needed until the effects of structural reforms take hold to support monetary policy and create space to finance growth-enhancing infrastructure needs. Fiscal consolidation should focus on expenditure savings, in particular by curbing discretionary spending and subsidies, controlling public sector wages and pension benefits, and prioritizing capital spending.

Directors welcomed the tight monetary policy, which has been successful in containing inflationary pressures despite food and oil price shocks. They encouraged the authorities to aim at keeping inflation at the middle of the 3-6 percent core inflation target in 2008, and to entrench low inflation, including through the adoption of formal inflation targeting, once necessary conditions are in place. Competitiveness concerns should be addressed through corporate restructuring and wage moderation rather than exchange rate intervention, which should continue to focus on smoothing shocks.

Directors viewed corporate sector reforms and further measures to improve the business climate as key to enhancing growth and employment, while noting that these will take time to bear fruit. They welcomed the renewed efforts to accelerate privatization and to implement bankruptcy procedures of socially owned enterprises and urged completion of the process as soon as possible. Directors supported opening stakeholding in state-owned utilities to private sector participation.

Directors supported further strengthening of the regulatory and supervisory framework to manage increasing financial sector risks. The prudential framework should remain restrictive, particularly while macroeconomic and financial vulnerabilities persist. This requires continued monitoring of banks' non-performing loans, resilience to shocks, and cross-border supervisory coordination. Developing domestic capital markets should also contribute to growth and financial stability in the medium term.

Serbia: Selected Economic and Financial Indicators, 2004-08 1/

  2004 2005 2006 2007 2008
        Est. Proj.

  (Change in percent)

Real economy


Real GDP

8.4 6.2 5.7 7.0 6.0

Retail prices (end of period)

13.7 17.7 6.6 10.1 7.2

Core retail prices (end of period)

11.0 14.5 5.9 5.4 4.5
  (In percent of GDP)

General government finances


Revenue (excl. grants)

41.4 41.3 40.7 41.3 41.2


41.4 40.6 42.3 43.1 43.3

Overall balance (cash basis, excl. grants)

0.0 0.7 -1.5 -1.8 -2.1

Gross debt

63.1 54.1 39.6 37.6 34.5

of which: Forex-denominated (in percent of total)

85.7 90.8 89.5 87.6 85.8
  (12-month change, in percent)

Monetary sector (end of period)


Credit to non-government

52.1 57.0 27.5 40.0 ...
  (In percent)

Interest rate


NBS bills / Repo rate

16.3 19.2 14.0 10.0 ...
  (In percent of GDP, unless otherwise indicated)

Balance of payments


Current account balance, before grants

-13.6 -9.7 -12.2 -16.1 -16.5

Current account balance, adjusted 2/

-12.4 -10.9 -12.2 -16.1 -16.5

Exports of goods (f.o.b.)

16.6 18.9 20.4 21.4 21.3

Imports of goods (f.o.b.)

43.0 39.1 40.0 42.1 42.9

Current account balance, after grants

-11.7 -8.5 -11.5 -15.5 -15.9

External debt (end of period; billions of $)

14.1 15.5 19.6 25.3 29.1

Gross official reserves (in billions of $)

4.2 5.8 11.9 14.6 14.6

(In months of prospective imports of GNFS)

4.3 4.7 7.1 7.5 6.8

Exchange rate (dinar/euro, period average)

72.6 82.9 84.2 80.0 ...

Real Effective Exchange Rate (annual average change, in percent; + indicates appreciation)

-3.6 -3.1 6.6 8.8 ...

Sources: Serbian authorities; and IMF staff estimates and projections.

1/ Excluding Kosovo (with the exception of external debt).

2/ Corrected for the surge in imports and remittances ahead of the VAT introduction in 2005.

1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.


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