Mission Concluding Statement 

Serbia: Concluding Statement of the Mission for the 2021 Article IV Consultation and a New Policy Coordination Instrument (PCI)

April 23, 2021

• While the COVID-19 crisis has dealt a severe blow to the people and the economy of Serbia, as it has in other countries, the economic contraction was relatively moderate in Serbia, partly due to a strong policy response. Policies should continue to support people’s lives and livelihoods until the economic recovery is fully entrenched.
• As the emergency phase of the crisis ends, policy support needs to be reoriented toward building a greener, more digital, and sustainable economy. Over the medium term, it will be important to restore the country’s financial defenses and anchor them through a new fiscal rule.
• Higher and more sustainable growth over the medium term will require improving the business environment, the rule of law, the efficiency of state-owned enterprises, and environmental policies.

Washington, DC:

The mission benefitted from constructive discussions on the 2021 Article IV Consultation and reached a staff-level agreement on policies and reforms that could be supported under a new PCI that would run through 2023. The agreement is subject to approval by IMF Management and Executive Board. Consideration by the Executive Board is tentatively scheduled in the second half of June.

Serbia’s recovery remains on track, supported by a substantial policy response, but the economic outlook remains highly uncertain.

Serbia has coped with the COVID-19 pandemic well and the economic recovery is expected to continue in 2021. The economic contraction in 2020 is estimated at around 1 percent—one of the smallest in Europe. Job losses have mostly been contained to the informal sector, which could not be covered by direct policy measures. The banking system remains stable, liquid, and well capitalized. However, during the first part of 2021 new waves of infections in Serbia and across Europe have hampered the economic rebound. At the same time, the vaccination rollout in Serbia has been among the fastest in Europe and we expect the pandemic to fade in the second half of this year. Supported by ongoing measures to boost the economy, we project real GDP growth to reach 5 percent in 2021. In the following years, growth is projected to gradually converge to its potential of 4 percent.

Decisive policy responses have helped limit the pandemic’s effects on Serbia’s economy. The fiscal package in 2020—of about 8.5 percent of GDP—supported households and businesses, and enhanced public healthcare, mitigating the economic and social effects of the pandemic. Moreover, a well-designed guarantee scheme for bank loans to small and medium-sized enterprises (SMEs) was introduced. Economic activity was also supported by accommodative monetary and financial sector policies.

However, high uncertainty surrounds the growth outlook. The future course of the pandemic in Serbia and its trading partners remains highly uncertain. New waves of infections (including new variants of the virus) present a clear downside risk to the growth outlook and could lead to higher fiscal and external financing needs. On the other hand, a stronger-than-expected impact of the fast vaccine rollout in the country and globally could provide an upside risk. Tighter global financing conditions could push up the cost of borrowing and prolong the downturn.

Macroeconomic policies should remain supportive until the recovery is fully entrenched.

Against this background, a supportive policy stance continues to be appropriate. The supplementary budget will provide further support to the economy in 2021. While our growth forecast remains unchanged since October 2020, we are now expecting a higher contribution from the public sector offsetting weaker private sector activity. The overall fiscal deficit is expected to reach 7 percent of GDP in 2021 rather than 3 percent, and public debt will rise to 60 percent of GDP. This expansion provides room for additional wage subsidies, support to sectors hit hard by the crisis, and continued financial assistance for households, including the unemployed (in total, amounting to 2.3 percent of GDP). It also includes additional healthcare spending and increased public investment (2 percent of GDP), mostly in infrastructure, environmental protection, and defense.

The latest round of fiscal support—and the extension of the loan guarantee scheme—will help underpin the recovery as well as prevent bankruptcies and protect employment. Amid low inflation and well-anchored inflation expectations, monetary policy should remain accommodative and financial sector policies supportive. Continued close monitoring of risks in the banking sector is crucial.

As fiscal room is narrowing, we recommend that any further support be targeted more directly at the most vulnerable households and firms and sectors most affected by the pandemic. This would limit the fiscal cost and maximize its impact. Indeed, some of the income support measures envisaged in the supplementary budget could have been better targeted. Well-designed investments in infrastructure and environmental protection can support near-term growth and limit the potential scarring effects of the crisis.

Once the recovery is fully under way, it will be important to rebuild the policy buffers and to anchor them by a new fiscal rule. The policy response to the pandemic underscored the importance of having room for fiscal policy maneuver to face adverse shocks. Therefore, fiscal buffers should gradually be restored over the medium term, through low fiscal deficits that will put public debt on a downward path and help secure investor confidence. Within this envelope, productive capital spending should be prioritized, while containing current spending. A gradual reduction of the public sector wage bill as a percent of GDP is warranted, after the sharp increase in 2020, while pensions should continue to be indexed in line with the Swiss formula. Further advancing the reforms of the tax administration, enhancing public investment management, and closely monitoring and managing fiscal risks, including from SOEs, would strengthen the fiscal framework.

Accelerated structural and institutional reforms are needed to ensure faster, inclusive, and sustainable growth over the medium term.

Advancing reforms of Serbia’s large and inefficient state-owned enterprises (SOEs) remains critical. The recently adopted strategy for SOEs should set the ground for reforms to strengthen corporate governance and for improving the management of these institutions. Priorities include an enhanced framework for setting targets and monitoring, and increasing the accountability of CEOs. Promptly resolving the excessive reliance on acting directors in SOEs also remains crucial. The conversion of EPS into a joint-stock company and the unbundling of Srbijagas should be completed without further delay. We also look forward to the swift privatization of Petrohemija, to revitalize the company and reduce fiscal risks.

Improving the business environment would help attract foreign as well as domestic investment. Reforms to strengthen the rule of law, improve the efficiency of the judicial system, and curb corruption are critical to improve the investment climate. Efforts to tackle informality should continue, including by strengthening e-fiscalization and extending the regime for seasonal employment in agriculture to other sectors. Finding a prompt solution for the increasing number of court cases faced by banks contesting the legality of loan processing and mortgage insurance fees would strengthen the financial sector and improve business climate. Finally, developing domestic capital markets and further encouraging dinarization would enhance financial stability and support medium-term growth.

Promoting green growth and enhancing the social safety net would support the recovery and ensure a more sustainable development. Investments in green infrastructure and the transition to a lower-carbon future can support job creation while increasing economic and environmental resiliency. Strengthening the existing social protection programs would help to protect vulnerable groups, reduce inequality, and fight poverty.

The mission team is grateful for the authorities’ candid conversations and close cooperation.