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Much Better Institutions Needed

It is my sincere hope that Serbia’s new government will make radical strides when it comes to the further implementing of structural reforms and improving the business climate for domestic investors

The latest World Economic Outlook offers a picture that’s more optimistic in relative terms when it comes to the recovery of the world economy, but we shouldn’t be deceived by this, warns Aleksandar Vlahović, president of the Serbian Association of Economists. As he explains, we live in an age of complex crises to which there are no easy solutions and which could easily deepen.

When all of this is collated, which of these positive news stories and risks should interest us in particular when thinking about the context in which the Serbian economy functions?

— Regardless of the slightly more optimistic projections from the beginning of this year, the world (and Europe in particular) finds itself in an extremely complex geopolitical and geo-economic situation. Today’s situation can be described as a polycrisis; a situation characterised by multiple simultaneous crises with different causes and possible solutions. The “firestorm crisis” forming the current global polycrisis was initiated by the Covid-19 pandemic, followed by the war in Ukraine and the subsequent energy crisis. This led to food supply problems at the global level and rising living costs. Since last October, the war in the Middle East has only served to intensify geopolitical tensions and thereby deepen the polycrisis. Dimensions of the polycrisis that are less visible but equally troubling include acute environmental concerns, the negative impact of climate change, geo-economic fragmentation and the effects of the growing use of artificial intelligence. I’m afraid that the current year won’t alleviate geopolitical tensions, given that this is an election year in almost all of the largest countries (with the exception of China), which is why it is difficult to expect sudden and radical solutions in areas hit by crisis. Serbia is tied to Europe in an economic sense and will share the fate of its expected weak growth to a certain extent. Under the conditions of geo-economic fragmentation, i.e., the relocating of the capital of major European companies from Asia, Serbia has a chance to additional accelerate its growth, but only if it speeds up the reforms that will improve the quality of the business environment significantly.

How much should we add good news or risk to this picture when it comes to some of the internal characteristics of our economic environment?

— The good news is that Serbia entered 2024 with satisfactory macroeconomic aggregates. The previous year saw the achieving of growth of 2.5%; the budget deficit stood at 2.8% (less than planned); the economy’s external position is more favourable thanks to the faster growth of exports than imports; the current payment deficit is half that of 2022; FDI amounted to around 4.4 billion euros; capital investments were maintained at a high level of approximately 6.5% of GDP; public debt has a downward trajectory when measured in relation to GDP and amounted to 52.7% of GDP (€35 billion) at the end of last year. It is also good news that inflation has a downward trend, which is particularly important when considering that our average inflation was the fourth highest in Europe last year (after Turkey, Hungary and Moldova).

The Government must clearly and unequivocally reaffirm our strategic goal of gaining full membership in the EU, especially now that Europe has set a clear timeline for enlargement

There are also problems, of course. They can be classified into two groups: institutional constraints and fiscal policy. Institutional restrictions primarily threaten the economic activity of domestic private investors. When it comes to observing fiscal policy, frequent non-selective fiscal interventions, which the budget mostly doesn’t plan for, threaten efforts to curb inflation and inflationary expectations. It should be noted that these kinds of payments to certain categories of the population, mostly presented under the banner of social benefits, are politically motivated and are far from being able to repucts practicalresent an appropriate way of conducting social policy. We should add to this the lack of adequate efficiency in managing public investments. Specifically, we are witnessing the non-transparent implementation of almost all major infrastructure projects through the circumventing of the Law on Public Procurement. This is not good, because when it comes to overall economic activity the ultimate effects of investing are questionable, to say the least. Capital investments are not preceded by a rigorous project selection process, no studies of socioeconomic justification are conducted and competition is lacking, and the total investment amount thus has no market checks.

Despite global instability, the government of Serbia has enjoyed a relatively comfortable position in the last few years. Will the new government that’s expected to be formed soon also have a more or less well-trodden path of action, or do you expect some qualitative shift?

— I honestly hope that the new Government will take radical strides when it comes to the further implementation of structural reforms. Here I’m primarily referring to the restructuring of large public companies. Certain progress in the operations of this group of companies was achieved over the previous year. However, that is still not the result of extensive business consolidation measures, but rather is primarily a consequence of an altered pricing policy. Specifically, with the signing of the arrangement with the IMF, the Government obliged itself to raise the price of energy products (electricity and natural gas) for the population and businesses several times. And that has been done in the meantime and is why companies EPS and Srbijagas are today operating profitably. The government is no longer subsidising these companies and thus the burden on the budget has been eased greatly, in contrast to previous years. And yet, we still haven’t seen a clear plan for the restructuring of these companies, starting with the professionalisation of their management and extending all the way to the partial privatisation of core and non-core activities. This obviously relates to a very sensitive endeavour that could cause social tensions, especially in the case of EPS, as a result of resistance from well-organised workers’ unions. Of course, there is also resistance coming from political structures, which reveals the unwillingness of politics to withdraw from the managing of a significant part of the economy.

Moreover, I expect the new government to sincerely commit to resolving the problem of the stagnation of domestic private investment, the share of which in the portfolio of total investment is actually decreasing. Such a trend testifies to the existence of serious institutional limitations that lead to domestic investors recognising high investment risks. I am thus referring to the need to improve the business climate and the quality of institutions, both those that regulate the market and those that guarantee legal certainty. Domestic investors expect clear, predictable, stable and equal rules for all market participants. All reports of reputed international organisations that evaluate the state of the public sector point to the existence of significant obstacles to the development of the domestic private sector. It is worth reminding that it isn’t possible to build a competitive and sustainable economic structure without domestic investments.

To what extent is the Serbian economy, institutionally and practicalresent ly, anchored in European business processes?

— Great effort has undoubtedly been exerted to develop road infrastructure over the previous seven or eight years. Likewise, the renovation of the railway infrastructure network is being worked on intensively. It should be noted that the EU has contributed significantly to this, primarily financially, but also with the launching of initiatives that relate to the whole of the Western Balkans (Berlin Initiative), in order to improve the quality of the transport network significantly. Just like every other country in the region, we are also signatories of the European Green Deal, and an entire raft of projects are also being implemented there, again with the assistance of the EU, the EBRD and the EIB. So, we are achieving progress in all of the mentioned areas.

The non-transparent implementation of major infrastructure projects, through the circumventing of the Law on Public Procurement, raises a question about the ultimate effects of such investments on economic growth

However, the situation differs markedly when it comes to the rule of law, the quality and independence of institutions, media freedom etc. It should thus come as no surprise to us that the European Commission’s assessments in its regular reporting mostly note “a lack of visible progress”. This is also precisely why we are “treading water” on our journey to the EU. I also believe that our progress will be slowed further by the European Parliament resolution regarding the recent elections in Serbia. As such, I think that the Government must, with its actions, clearly and unequivocally reaffirm our strategic goal of gaining full membership in the EU, especially now that Europe has set a clear timeline for enlargement after a long time. Historically, despite all its shortcomings and functional problems, the EU is the community that has had the greatest influence on raising the living standards of the population of its member countries, improving democracy and the free movement of people, goods and capital. In terms of values and technology, we belong to Europe. In an economic sense, we are inextricably linked.

We realise two-thirds of our foreign trade turnover with EU countries, while a similar percentage of foreign investments in Serbia come from these countries. As such, any disregarding of the actual situation, obstruction and, or even worse, possible change in the strategic course of political and economic development could lead to immeasurable negative ramifications for our country and the population’s standard of living.

How much progress have Serbian companies really made in terms of connecting with global production chains and can we talk about a bigger collective of Serbian companies that are today internationally competitive?

— One indicator of the improved competitiveness of the Serbian economy, and thus its level of connection with global production chains, is the relative ratio between exports and imports of goods, i.e., the extent to which imports are covered by exports. That coverage ratio stood at a record 80% last year. In other words, the structure of the Serbian economy has been changed for the better by the intensive inflow of FDI over the past five years. However, the investors who’ve so far chosen our country as an investment destination do not – with rare exceptions –belong to the group of so-called “blue chip” investors, i.e., those with a reputation for being the most renowned.

That’s why it’s often the case that some of them pull out suddenly, without fulfilling the obligations they accepted and that led to them receiving significant subsidies. Whether we’ll succeed in attracting “big names” depends mostly on us, or more precisely on the willingness of the government to work to improve the quality of the business environment. This also implies clearly defined industry policies, specifically the rational directing of subsidies towards encouraging the development of the tradable section of the economy. That section of the economy drives technological progress and high productivity. These are branches of the economy that have high added value, are directed towards the international market and are capable of competing on the market.

Serbia’s IT sector is one positive example of dynamic development, albeit in the service sector. Despite the problems afflicting global companies in this field, the IT industry is still experiencing exponential growth in our country. And this trend is expected to be maintained in the future. IT sector exports over the past year exceeded a value of four billion euros. Best testifying to the robust growth of this sector is the fact that exports realised in the first quarter of last year exceeded the total exports of the IT sector in 2017.