Macroeconomic performance

Major floods have interrupted economic recovery. The Serbian economy bounced back in 2013, growing by 2.5 per cent after the previous year’s recession, when GDP declined by -1.5 per cent. Growth was supported by strong exports, boosted by the revival of the car industry and a good agricultural harvest. However, growth so far in 2014 has been negative. Serbia suffered extensive flood-related damage (officially estimated at €1.5 billion, or about 5 per cent of GDP) in late May 2014, which has severely affected vital sectors such as energy, mining and agriculture. As a result of this damage, most observers, including the government, expect GDP to fall again this year.

Inflation has dipped to an historic low in conjunction with cautious monetary easing by the central bank. Inflationary pressures subsided in 2013 and have stayed low. Inflation fell from its January 2013 peak of 12.8 per cent year-on-year to 2.2 per cent year-on-year in December. Low inflationary pressures have continued through 2014 as well, with the inflation rate below the lower bound of the central bank’s target range of 2.5-5.5 per cent. In response, the National Bank of Serbia has been loosening monetary policy and reducing the reference rate, bringing it down in a succession of cuts from 11.75 per cent in April 2013 to 8.5 per cent in June 2014. Despite the recent cuts, the policy rate remains high relative to peer countries.

The fiscal situation is increasingly serious. Public finances have reached a dire state in Serbia. The government deficit exceeded 5 per cent of GDP in 2013, and public debt is now more than 65 per cent of GDP. The government’s fiscal strategy, under the assumption that consolidation measures are implemented, envisages an augmented budget deficit (including additional “below the line” costs), of 7.1 per cent of GDP in 2014, followed by fiscal adjustment, which would reduce the deficit to 5.2 per cent of GDP in 2015, and 3.2 per cent of GDP in 2016. Under this scenario, the level of public debt will likely peak at around 70 per cent of GDP in 2015. Some fiscal adjustment was started in 2013 as the government announced new measures to reduce the deficit. However, these measures are insufficient to put public finances back on a sustainable path, and further cuts to public sector wages and pensions have been announced in October 2014. The government has expressed strong interest in negotiating a new programme with the International Monetary Fund (IMF).

Growth will be modest in the near future. After likely negative growth in 2014, a return to positive but modest growth may occur in 2015. Exports will continue to be the main growth driver. Meanwhile, consumption will remain subdued, largely due to continued tightness in domestic credit markets and the necessary fiscal retrenchment expected over the coming year. Nonetheless, medium-term prospects remain favourable if macroeconomic and external stability is sustained and economic reforms progress, which would help restore the confidence of domestic and foreign investor communities.

Major structural reform developments

EU accession talks have begun. On 21 January 2014 the first intergovernmental conference between Serbia and the European Union took place, representing the first formal steps in Serbia’s accession negotiations. As of the end of July 2014, the screening reports for most of the chapters of the acquis had been completed, and the first chapters are expected to be opened for negotiation by the end of 2014 or in the first half of 2015.

Serbia is close to WTO membership but further steps need to be taken. Most national trade rules are harmonised with World Trade Organization (WTO) regulations. However, there are still a few steps to be taken before the accession process is complete and Serbia can become a member of the WTO. In particular, Serbia needs to amend its laws on genetically modified organisms and on excise duties for alcohol products.

A new privatisation law has been passed. The new law, approved in July 2014, aims to privatise 502 state or socially-owned (wholly or partially) companies that have been costing the government an estimated €300 million each year. The new law envisages that sales will take place through public tenders and auctions. In parallel, parliament has also approved amendments to the bankruptcy law, which will enable a more efficient bankruptcy process. The sale of socially-owned companies is expected to be completed by the end of 2015.

Energy law implementation has advanced. In August 2013 a transmission network code providing for non-discriminatory third-party access was adopted by the country’s transmission system operator and approved by the regulator. The move represents the first major step in implementing the 2011 energy law. However, the sector remains in difficulty as the operations of state-owned power company, EPS, were damaged significantly by the floods in May 2014. Delays have also occurred in the planned unbundling of the major gas company, Srbijagas.

Credit to the private sector remains weak and NPLs are high. The banking sector posted a loss in 2013, and annual credit growth was negative for the year as a whole. Year-on-year credit growth remained negative in the first few months of 2014, but it picked up from May when the government introduced a subsidised lending scheme (for dinar-denominated loans). Furthermore, NPLs were at 23 per cent of total loans as of the end of the second quarter of 2014, more than 10 percentage points above their level at the end of 2008. In combination with cross-border deleveraging, the high level of NPLs poses further risks to credit recovery in the near term, although these NPLs are well provisioned.

Deposit insurance has been strengthened with support from international financial institutions. In March 2014 the World Bank approved a €144 million Deposit Insurance Strengthening Project. The new project is designed to improve the financial and institutional capacity of Serbia’s Deposit Insurance Agency (DIA) to enable it to meet its deposit insurance and bank resolution obligations, and serve as a core part of the financial sector safety net. This was followed by an EBRD loan of €200 million, designed as a credit line that would provide immediate funds to the DIA, if and when required. As such, the credit line will assist the DIA in the execution of its core mandate, namely providing a safety net to insured depositors, which will contribute to confidence in the banking sector.

A new labour law has been adopted. The new law was approved by parliament in July 2014, despite initial strong opposition from the unions. The law, which is broadly in line with EU legislation, contains a number of provisions designed to increase flexibility and strengthen incentives for firms to hire people. These include linking severance pay to the number of years of service with the current employer (rather than with all employers, current and previous) and allowing a longer duration of fixed-term contracts (of two years or in some cases three), beyond the previous one-year limit. At the same time, a new pension law will gradually raise the retirement age for women from 60 to 65 by 2032. Revised laws on employment and pensions are part of a broader set of reforms aimed at reviving the country’s economy and improving the business environment. Serbia ranks poorly on the World Bank Doing Business 2015 report for ease of doing business – 91st out of 189 countries – with particular problems in dealing with construction permits and paying taxes.