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Hard Won Results Should Be Carefully Defended

It is crucial that the structural reform agenda is fully and expeditiously carried out, to transform Serbia into a modern, private-sector led economy with higher and sustainable growth

We spoke with Mr Sebastian Sosa, IMF Resident Representative for Serbia, about the current economic situation in Serbia, the achievements of the arrangement between Serbia and the IMF, and the challenges that lie ahead for the Serbian government.

Mr Sosa warns than in many cases, after achieving the initial good results of reforms, countries’ authorities became complacent and started to relax fiscal discipline, quickly eroding hard-won achievements, and suggests what Serbia could do to avoid such mistakes.

The existing arrangement between Serbia and the IMF is considered as being one of, if not the, most successful arrangements in the history of the state. What made it so worthy of praise: previous failures or current successes?

– The current programme’s results have certainly exceeded all expectations in terms of reducing macroeconomic imbalances and reinvigorating economic growth. The achievements have been impressive, considering the dire economic situation Serbia was in back in early 2015.

Growth had been stagnant; the fiscal deficit had approached seven per cent of GDP, with public debt on an unsustainable path; and banking risks were significant. But in less than three years the macroeconomic situation has changed dramatically. Growth is projected at three per cent this year and the fiscal deficit is projected to narrow to about one per cent of GDP—the lowest level since 2005—while public debt is clearly declining.

Moreover, unemployment is falling rapidly, while inflation has remained low and banks’ non-performing loans are being reduced sharply. This is, no doubt, a huge turnaround in macroeconomic performance.

If the Serbian authorities request a follow-up IMF programme, the focus should be on the reforms needed to reach higher, more inclusive and sustainable long-term growth

Fiscal stabilisation seems to be the most successful part of the arrangement, but it was noted during the last IMF visit that a lot remains to be done. Which of those unfinished tasks were meant to be carried out under this arrangement but for some reason failed, and why?

– Under their programme, the authorities have also pursued a comprehensive and ambitious structural reform agenda, including public administration, public utilities and SOEs, the financial sector and the business climate. Although good progress has been made in some of these areas, in others there have been significant delays and the economy remains overburdened by a large and inefficient public sector, with too little reliance on the productive private sector.

Sebastian SosaAn area where delays have been substantial is in the reform of public utilities and SOEs. But even though we would have liked to have seen faster improvement, it is fair to say that few could have foreseen the progress made so far, given the long history of unsuccessful restructuring and resolution efforts.

Since the start of the programme, progress has been achieved in improving the efficiency and financial strength of large public utilities, disposing of failed state-owned enterprises and privatising viable ones. That said, the permanent resolution of some long-term troubled enterprises, mostly in energy and mining, such as RTB Bor, Galenika, Petrohemija, Azotara and MSK, is still pending. And further efforts are needed to restructure Srbijagas, EPS and the national railways.

It is crucial that the structural reform agenda is fully and expeditiously carried out, to transform Serbia into a modern, private-sector-led economy with higher and sustainable growth.

If Serbia decides to enter into a new arrangement, what should be in the focus of that new phase?

– If the Serbian authorities request a follow-up IMF programme, the focus should be on the reforms needed to reach higher, more inclusive and sustainable long-term growth. Of course, maintaining fiscal discipline and consolidating recent macroeconomic achievements would be necessary, but at this point, there is no need for additional fiscal adjustment. So, the main purpose of such an arrangement should be to boost employment, competitiveness and potential growth.

An area where delays have been substantial is the reform of public utilities and SOEs, but it is fair to say that few could have foreseen the progress made so far

In contrast, some Serbian economists believe that, without the IMF, Serbia might lose some of the trust of investors. Do you think that might be the case? Is there a measurable relationship between investor trust and the presence of the IMF in a country?

– To maintain strong investor and business confidence, with or without an IMF arrangement, Serbia needs to continue implementing policies consistent with macroeconomic and financial stability and the ambitious structural reform agenda envisaged in the current economic programme. A clear commitment to macro stability and reforms will help to ensure foreign and local investors remain confident about Serbia’s economic prospects.

Regarding the relationship between investor confidence and IMF arrangements, it is very difficult to measure that empirically. This is because even though an IMF-supported programme may help stabilise the economy and boost confidence in countries with large macroeconomic imbalances, countries seeking an IMF arrangement are usually countries facing substantial economic and financial difficulties, and typically weak investor confidence in the first place. Therefore, it is very difficult to observe a clear, simple correlation.

How can the new government reassure investors, both domestic and foreign, that it intends to proceed with reforms, with or without the IMF?

– It is first very important to consolidate recent macroeconomic achievements by maintaining sound policies—especially fiscal discipline. 

Sebastian Sosa

This does not mean, as I said earlier, that additional fiscal adjustment is needed. But it is critical to maintain tight control over current expenditures, to ensure that public debt—which is still high— remains on a firm downward trajectory.

Strengthening institutions would help to cement recent macroeconomic gains. For instance, enhancing Serbia’s fiscal rules would help to establish a credible anchor for fiscal policy and ensure public debt sustainability over the medium term, with or without an IMF arrangement. Advancing the dinarisation strategy would enhance the effectiveness of monetary policy and the resilience of the financial system.

At the same time, it is crucial to continue with the reform efforts in order to address the remaining vulnerabilities and structural weaknesses of the Serbian economy. Although some of the reforms are complex and cannot be implemented overnight, it is crucial to show strong commitment and determination by making steady progress.

What does the IMF’s experience say about why countries that were good pupils sometimes fail after concluding an arrangement?

– One common problem is complacency. After implementing difficult adjustments and stabilising the economy, in some cases the authorities became complacent and started to relax fiscal discipline, quickly eroding hard-won achievements.

There are also countries—including Serbia in the past—that succeeded in restoring macro and financial stability in the short term but failed to decisively address the underlying weaknesses and structural rigidities of the economy. These structural weaknesses eventually undermined the short-term improvement, causing growth to falter and fiscal and other macro problems to re-emerge.

Despite specific sectoral problems, underlying economic growth trends in Serbia remain relatively robust, and we are maintaining our baseline growth projection for 2017 at three per cent

Does the observed slowdown in GDP growth, as well as Serbia’s widening trade deficit, concern you?

– We believe the slowdown in GDP growth in the first half of the year, as well as the deterioration of the trade balance, is mainly driven by temporary factors. The slowdown was concentrated in the energy sector in the first quarter—largely due to the disruptions of EPS’ electricity production—and in agriculture in the second quarter—partly due to a severe drought.

Despite these specific sectoral problems, underlying economic growth trends remain relatively robust, and we are maintaining our baseline growth projection for 2017 at three per cent. However, downside risks for annual growth this year have clearly increased, because of weaker-than-expected growth figures in the first two quarters.

Several prominent Serbian economists believe that in the next phase, higher pensions and wages would be beneficial for GDP growth, albeit not at the percentage mentioned by Serbian officials. Why have you decided to remove that topic from the table for a while?

– Serbia has an annual budget, so the discussion about public wages and pension increases should take place in the context of the preparation of the 2018 budget. Therefore, this issue will probably be on the table in our next missions later this year.

Do you believe that, with the first optimistic results about the EU economies, we will soon experience a sea change in terms of interest rates? Is Serbia today in a better position than previously when it comes to sustaining such a change in ECB policy?

– After a period of protracted weak growth, several economies in the euro area have shown upside momentum in the first half of 2017, and their economic outlook has also improved. However, stubbornly weak price and wage inflation suggest that economic slack is still quite sizeable. Core inflation has remained at very low levels of about 1.1 per cent since March, and headline inflation is expected to converge to the ECB target slowly in the next few years.

In this context, monetary policy should remain accommodative in the near term, while any policy normalisation and rate increases should be very gradual. Even if we don’t expect a sharp increase in interest rates in the euro area soon, Serbia is in a much better position to face the gradual increase in interest rates expected over the medium term in the euro area. Its fiscal position has strengthened markedly, reflected in much lower sovereign yields, while inflation has been kept at moderate levels, providing more space to the NBS.

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