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Danko Brčerević, Chief Economist Of The Fiscal Council Of The Republic Of Serbia

We’re Weakened As We Enter A Year Of Uncertainty

Despite being exhausted significantly by the health crisis, fiscal policy will have to play an important role, and perhaps a key role, in mitigating the impact of new economic disruptions. If the payment of aid to Serbia’s imperilled economy and population during covid-19 had been done using similar criteria to those deployed in other CEE countries, Serbia’s anti-crisis package would have cost as much as two billion euros less than it did. This large funding, which was so easily spent, would now be a very welcome addition to the budget for the uncertain year that is 2022

The war in Ukraine, alongside the pre-existing energy crisis and high inflation, will significantly worsen macroeconomic trends across the whole of Europe, Serbia included. Although Ukraine and Russia together account for only around two per cent of the world’s GDP, they have disproportionately larger global significance for the markets of energy, cereals and industrially important rare metals (palladium, nickel). That’s why the economic consequences of this conflict will be felt globally. The OECD’s preliminary forecasts indicate that the war in Ukraine could result in the growth of the world economy slowing by about one per cent, the European economy by about 1.5% (with the expectation of deep recessions for Ukraine and Russia). Of course, all forecasts remain extremely uncertain and will depend on the further development of the situation in Ukraine, which is currently impossible to predict with certainty. If the war (and sanctions) continues, there will be more lasting economic disruptions, leading to these initial OECD forecasts proving to be overly optimistic.

Serbia, ultimately like other European countries, is facing new instability with macroeconomic indicators that are somewhat weakened compared to the beginning of the health crisis back in 2020. Public finances have been largely exhausted over the past two years – because budget funds were utilised to finance increased healthcare costs and lavish measures to support businesses and the population. As a result of this extraordinary expenditure, public debt increased by as much as six billion euros between year’s end 2019 and year’s end 2021 (from 24.4 to 30.5 billion euros). Inflation has also accelerated strongly since mid-2021, in relative terms, reaching 8.8% annually in February 2022.

Despite being exhausted significantly by the health crisis, fiscal policy will have to play an important role, and perhaps a key role, in mitigating the impact of new economic disruptions – especially given that monetary policy is currently hampered by high inflation. We’ve already seen the adopting of some ad-hoc fiscal measures, such as reducing excise duties on petroleum products, while it has been decided that funds from the budget will cover Srbijagas losses incurred due to the difference between the high price at which the company procures gas and the lower price at which it sells that same gas. The budget cost of these measures is in the order of 500 million euros, and by all accounts this is just the beginning. There will likely be a need to help the parts of the economy that are hardest hit by the rising cost of energy and specific raw materials, to help companies that will sustain great losses due to the expected halting of exports to Russia and Ukraine, while it will also be important to additionally protect socially vulnerable segments of the population, because they are the worst affected by the high growth in food prices.

If the crisis in Ukraine becomes protracted, there will likely be a need to help the parts of the economy that are hardest hit by the rising cost of energy and specific raw materials, to help companies that will sustain great losses due to the expected halting of exports to Russia and Ukraine, while it will also be important to additionally protect socially vulnerable segments of the population, because they are the worst affected by the high growth in food prices.

In order to ensure new fiscal policy interventions are cost-effective, there must be an insistence that those interventions are well targeted this time around. There must be no repeating of budget funds being permitted to be wasted on citizens and companies that don’t sustain damage – as was the case during the health crisis – because, among other things, Serbia no longer has as much space to borrow. Another critical weakness of Serbia’s economic policy that must be eliminated is the very poor management of public companies operating in the energy sector, i.e., Srbijagas and EPS.

The Fiscal Council has spent recent months conducting extensive research on the budget measures that were implemented during the health crisis by Serbia and other European countries. This analysis showed that, in 2020 and 2021, Serbia held the record across the entire CEE region when it comes to the amount of funds paid to cover anticrisis measures: we provided as much as 55% more funding compared to the CEE average. Serbia allocated more funds than others for all three key components of the package: 1) for extraordinary health expenditures; 2) for supporting the economy; 3) for supporting the population.

It was unavoidable for Serbia to have higher extraordinary health expenditure compared to other CEE countries. Decades of insufficient investment led to Serbia awaiting the pandemic with health facilities lacking adequate capacities, a lack of necessary equipment, relatively low salaries and a shortage of health workers. This resulted in the emergence of extraordinary costs to construct and equip covid hospitals during the crisis (which other CEE countries didn’t do), as well as the extraordinary costs of additional hiring and increasing the earnings of existing health workers (which was also done by other countries, but to a smaller extent than Serbia). However, regardless of the causes of the stronger increase in healthcare expenditure in relation to comparable countries (which should certainly be analysed carefully by the competent institutions) – that was a priority cost during the pandemic, and these extraordinary funds were justifiably appropriated and spent by the state.

When it comes to extraordinary budget allocations to the economic sector during the health crisis (subsidising minimum earnings, postponing the payment of taxes etc.), strong indications exist suggesting that this was done irrationally. Among CEE countries, an average of approximately 75% of state aid was directed exclusively to companies affected by the crisis (which saw their turnover fall in the range of 20-50%, or from particularly hard-hit sectors, such as tourism). In contrast to that, only six per cent of funds distributed in in Serbia targeted particularly hard-hit sectors (tourism, hospitality, bus transport etc.), while 94% of funds were distributed indiscriminately, without consideration for the vulnerability of a company.

As such, funds from the budget were also unjustifiably given to companies that weren’t affected in the least by the crisis (pharmacies, food delivery companies, IT sector players etc.). Also indicating the irrationality of the way state aid was distributed to companies during the health crisis is the almost absurd fact that the 2020 tax on profit was collected in record amounts, despite economic activity having fell by 0.9% in 2020. This leap can only be explained by the fact that state aid was also given to companies that didn’t have objective problems in doing business during the crisis.

The most economically irrational measures were nonetheless the indiscriminate payments to the population. From the initial allocating of 100 euros to all adult citizens, similar measures were repeated on multiple occasions – with a massive total of 1.9 billion euros set aside for these purposes. Other CEE countries primarily directed funds towards vulnerable sections of society (recipients of social assistance, low-income pensioners, to cover the costs of caring for a sick family member etc.). Given that Serbia’s measures also encompassed residents who aren’t socially endangered – such as employees who are paid regularly, retirees with aboveaverage pensions etc. – it spent four to five times more compared to similar countries. These obvious and huge differences represent just one in a series of arguments suggesting that it was economically unjustified to indebt all Serbian citizens (with interest) in order to distribute those funds to people who aren’t socially endangered according to any criteria. The Fiscal Council has repeatedly demonstrated that the impact of such indiscriminate measures on reducing inequality and poverty is very small and temporary; and that these measures are also economically inefficient, i.e., they have an almost negligible impact on accelerating GDP and increasing tax revenues.

If Serbia had applied criteria similar to other CEE countries for the payment of assistance to endangered segments of the economy and population, the country’s anticrisis package would have cost as much as two billion euros less. Given that all these measures were financed from government borrowing, the growth of public debt would have slowed by the same amount. This large funding, which was so easily spent, would now be a very welcome addition to the budget for the uncertain year that is 2022.

Serbia’s economy, despite its numerous weaknesses, certainly has indisputable qualities and the potential for rapid development… However, this doesn’t mean that the problems we’ve highlighted should be swept under the carpet

Another great weakness of Serbia’s public finances that must be resolved is the poor management of public enterprises, particularly Srbijagas and EPS. Srbijagas’s losses and debts, incurred from 2008 to 2014, have already cost taxpayers in excess of a billion euros. This company again incurred new losses at the end of 2021, and again received 300 million euros from the budget in December to cover them, and a similar cost can be expected during 2022. Srbijagas’s high expenditure in 2021 and 2022 could have largely been avoided if the company had been managed better. Specifically, it is a well-known fact that Serbia uses twice as much gas during winter as it does during summer, because gas is also used by heating plants during the heating season. That’s why Srbijagas should store gas in Banatski Dvor during the summer, then extract it during the winter. However, the Banatski Dvor storage facility doesn’t have a sufficient capacity to secure all the necessary quantities of gas during the winter (though its expansion has been planned since 2011), nor did it await this heating season fully supplied. As a result of these shortcomings, additional gas was bought at extremely high prices at the end of 2021 and the beginning of 2022, and the budget had to bear that cost.

EPS’s long-term problems and poor management had to eventually lead to breakdowns at its production facilities. It is bad luck that this just happened to occur at the end of 2021, when the stock market price of electricity (which must now be bought from imports) stood at a record high level. Until the end of 2021, the regular winter price of electricity stood at around €50/ MWh, while this winter’s energy crisis saw that price exceed €200/MWh. Our estimate is that, between November 2021 and March 2022, EPS spent a massive 500 to 600 million to purchase electricity (that it should have produced itself). This cost has not yet burdened the budget, because EPS took out a liquidity loan of 300 million euros to finance it at the end of 2021. However, it is questionable whether this company will be able to continue to function without state aid. It is almost impossible to even compile a list of all the problems that must be solved if EPS is to operate successfully, increase production and reduce the environmental pollution it generates, but also to successfully traverse the energy transition process that awaits it over the next decade. One positive signal for the future of EPS is that the Government’s latest reactions suggest that an alarm was set off following the last breakdowns, which will lead to a change in attitude towards what is perhaps the most important domestic company.

In conclusion, it should be noted that Serbia’s economy, despite its numerous weaknesses, certainly has indisputable qualities and the potential for rapid development. Even during the time of the global crisis and uncertainty, the domestic economy showed its vitality (GDP growth total 7.4% in 2021), FDI inflows remained high (almost 7% of GDP in 2021), the labour market hasn’t suffered major disruptions, and the financial system remained stable. However, this doesn’t mean that the problems we’ve highlighted should be swept under the carpet.

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