Yulia Ustyugova, IMF Resident Representative For Serbia

Solving geopolitical tensions, some of which are not within Serbia’s control, would support and strengthen foreign direct investment (FDI). Additionally, the ongoing trend of EU countries nearshoring could potentially lead to even higher levels of FDI in Serbia

Serbia has achieved remarkable economic progress over the last decade, with the government successfully preserving these gains in recent challenging years,” says Yulia Ustyugova, IMF Resident Representative for Serbia.

Living standards improved, inflation fell, public finances were strengthened and reserves were increased to an all-time high, helped by ample FDI inflows. The pandemic only temporarily interrupted this strong performance. Reflecting these positive developments, Serbia’s sovereign credit ratings were upgraded steadily over the past decade and now stand just one notch below investment grade, says our interlocutor.

“The past few years have, however, brought about crisis upon crisis,” says the IMF Resident Representative for Serbia.

Critical areas for reform encompass continuous improvements in energy and broader changes to state-owned enterprises (SOE), investing in human capital development, reducing regulatory expenses, enhancing infrastructure and refining governance

Spillovers from Russia’s invasion of Ukraine, the sharp increase in international energy prices, domestic electricity production problems and tighter global financial conditions have increased Serbia’s external and fiscal financing needs. In response, the authorities have focused on preserving macroeconomic stability through their policies under a new Fund-supported Stand-By Arrangement (SBA).

“We are pleased to report that we see good results: macroeconomic imbalances have already started declining and further improvements are expected over the medium term. The 2022 fiscal and current account deficits have turned out far lower than previously expected, and foreign exchange reserves are now well above projections. The labour market has remained resilient, public debt is on a downward trajectory, and there is a continued influx of FDI supporting investments and exports, and bolstering reserves,” says Ustyugova.

To what extent has high inflation negatively impacted citizens, businesses and the growth of the Serbian economy?

High inflation has been a serious concern to citizens, businesses and policymakers around the world, including in Serbia. For citizens, high inflation increases living costs. We can see this in Serbia’s statistical data suggesting weakness in private consumption in the second half of 2022 and the first half of this year. For businesses, high inflation tempers investment because of rising input costs and increased uncertainty amid restrained consumer spending. The data shows that gross fixed investments decreased in the second half of 2022 and firms chose to run down previously accumulated inventories. As a result, economic growth slowed down.

The authorities responded to high inflation by tightening macroeconomic policies. This has been an appropriate policy response. The National Bank of Serbia has been raising policy rates steadily. Fiscal consolidation has been supporting disinflation efforts. There is, of course, a cost to tightening in terms of softer growth in the near term, but not getting inflation under control now, and allowing it to become entrenched, would lead to much greater and longer-lasting pain later, including steeper rate hikes, weaker investment and weaker growth.

On a positive note, headline inflation has fallen from a peak of more than 16 per cent in March to 12.5 per cent in July, driven by favourable base effects and easing inflation momentum. And it is expected to fall further. Another positive observation is that, while employment growth has slowed in recent quarters, as businesses have been confronted by higher production costs, unemployment remains at a historic low. And the data suggest that economic growth accelerated in the second quarter of 2023. Having said this, it is important to continue to maintain tight macroeconomic policies in order to lower inflation further, as inflation remains a key challenge and there cannot be sustainable growth without price stability.

How likely is it that the fiscal policy will remain relatively tight in 2023, given the approved and expected additional spending measures?

The government did approve additional spending measures in mid-2023, but this has not changed fiscal targets for 2023 and beyond, envisaged under the Fund-supported SBA. This is because the new measures will be financed from revenue overperformance, savings in other public sector expenditure items, including lower subsidies to energy SOEs, and some targeted revenue measures. This means that an overall restrictive fiscal stance, planned for 2023, is being maintained and supports disinflation and debt reduction.

Deep structural problems persist in the energy sector and are a key focus of the SBA. How do you assess the government’s efforts in dealing with this problem?

The government recognises the importance of a robust energy sector in driving overall economic development and managing fiscal risks. Therefore, energy sector policies play a central role under the SBA. The planned reforms focus on a wide set of issues: securing financial viability and enhancing the corporate governance of energy SOEs, boosting Serbia’s energy security, and laying the foundations for green transition. A set of measures has already been implemented: EPS has undergone legal restructuring and a professional supervisory board has been appointed.

The most recent IMF report on Serbia noted that the authorities have successfully fulfilled all energy sector reform commitments outlined in the Stand-By Arrangement (SBA).

The process of selecting a new CEO is underway and a broader EPS restructuring plan is being prepared. Furthermore, ongoing tariff increases for electricity and gas are helping secure the financial viability of the energy SOEs. These tariff increases should also help finance crucial energy investments in the coming years which, according to the recently adopted energy investment plan, are needed to enhance energy security, stabilise electricity generation and conserve energy. As we wrote in the latest IMF report on Serbia, so far the authorities have delivered on all the energy sector reform commitments envisaged under the SBA.

As stated in the Staff Report and Statement by the IMF Executive Director for the Republic of Serbia during the first review of the SBA, long-standing geopolitical challenges persist, while FDI inflows, a core element of Serbia’s growth model, are sensitive to geopolitical developments. What do you foresee as the likely impact of these circumstances on the overall economic growth of the country?

Serbia is considered an attractive FDI destination that offers macroeconomic stability, a strategic geographical location next to the EU market, with strong transport links, competitive labour costs, a skilled workforce and supportive tax and investment policies.

This is clearly recognised by international companies, as FDI inflows to Serbia have been exceptionally strong over the past decade, exceeding its regional peers. These large inflows have helped drive investment, employment and economic growth. Resolving geopolitical tensions – some of which are beyond Serbia’s control – would help underpin this FDI, and ongoing nearshoring trends among EU countries could see it increase even further.

What do you consider as being the most important steps that Serbia should take to improve the business climate and attract more foreign capital, apart from what has been already said?

Preserving macroeconomic stability is a prerequisite for a good investment climate and attracting foreign capital. And the authorities have delivered well here. Going beyond this, targeted structural reforms will also help Serbia remain an attractive destination for foreign direct investment. Important reform areas include ongoing energy and broader SOE reforms, supporting human capital development, reducing regulatory costs, boosting infrastructure and improving governance. Regarding the latter, strengthening the rule of law, improving the efficiency of the judicial system and curbing corruption are critical. Importantly, the recently-adopted energy investment plan, which aligns with investor demands for reliable and green energy access, needs to be implemented. The priority reforms, however, should focus not only on improving the investment climate for FDI, but also on maximising spillovers to local firms and levelling the playing field between domestic and multinational firms.