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Country Report Serbia

Country Report


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Serbia’s newly-elected government promised to embark on a comprehensive structural reform programme as the country’s fiscal situation has deteriorated markedly, but the prospect of faltering economic growth could confront it with considerable social challenges. 

Strengths (+) and weaknesses (-)

(+) Favourable geographic location and competitive wage levels

Due to its location on the Danube river at the heart of the Balkan region, Serbia’s manufacturing sector benefits from relatively short transportation routes to major industrial production centres in Central Europe and Germany, while large wage differentials boost price competitiveness.

(-) Large persistent twin deficits and sizeable external financing needs

Owing to the combination of recurrent sizeable deficits on the current and fiscal account, Serbia’s economy is highly susceptible to a deterioration of external financing conditions, while gross external financing needs this year are gauged at about USD 10.5bn.

(-) Wide-spread euroization

Serbia’s economy is heavily euroized, which limits the effectiveness of domestic monetary policy and makes the country vulnerable to a depreciation of the local currency.

(-) Poor business climate

Reflecting years of structural reform backlog, Serbia’s business climate suffers from a bloated bureaucracy, outdated regulations, wide-spread state-ownership and corruption issues.

Key developments

1. Surprisingly strong growth last year is unlikely to last

Serbia’s economy exited recession last year, as economic growth strengthened to 2.5% solely on the back of strongly rising exports driven by a bumper harvest and the start of car production at Fiat’s new vehicle plant in Kragujevac. Domestic demand, however, continued to contract. While private consumption was weighed down by ongoing deleveraging, and very high unemployment, public consumption and investments contracted as the government was forced to cut spending in order to control the spiralling budget deficit. Reflecting the weakness of domestic demand, Serbia’s poor business climate, and sluggish demand in the country’s major export markets, foreign direct investments remained weak. Owing to the one-off nature of last year’s growth drivers, economic growth this year is expected to weaken once more to about 1% before strengthening slightly to about 2% in 2015. While export growth is expected to moderate, the outlook for domestic demand remains bleak, as further fiscal consolidation measures and the announced start of the restructuring of 179 state-owned enterprises will likely lead to sizeable job losses and a further decline in household purchasing power. Given Serbia’s heavy dependency on external financing, the risks to the growth outlook are tilted to the downside, as external financing conditions may worsen amid ongoing US Federal Reserve tapering, even as the expected renewal of an IMF standby agreement should boost investor confidence.

2. EU membership talks started

Serbia started EU membership talks in January, following the granting of EU candidate status last year. As had been the case for neighbouring Croatia, which joined the EU last year, accession negotiations will first focus on the improvement of Serbia’s judiciary and rule of law, while issues such as financial control and the recognition of Kosovo also rank high on the agenda. Even though Serbia’s government expects EU accession in 2020, EU entry around 2025 seems more likely given the early stage of Serbia’s transition to a market economy and possible EU enlargement fatigue. 

Figure 1: Economic growth expected to weaken
Figure 1: Economic growth expected to weakenSource: European Commision
Figure 2: Twin deficits remain sizeable
Figure 2: Twin deficits remain sizeableSource, EIU, European Commission

3. Serbia’s newly-elected government promises an ambitious reform program amid a gloomy fiscal outlook

Former Deputy Prime Minister Aleksandar Vučić’s Serbian Progressive Party (SNS) won a landslide victory at the March snap elections after having promised tough economic reforms on the campaign trail. Even though the SNS succeeded in gaining a large absolute parliamentary majority, Mr Vučić decided to form a coalition with former Prime Minister Ivica Dačić’s Serbian Socialist Party (SPS) and the Alliance of Vojvodina Hungarians (SVM), which should help in garnering support for his reforms among Serbia’s vested interests. Mr Vučić has set three policy priorities, part of which should be addressed as early as the end of June 2014: halting the deterioration of public finances, reforming the business environment and downsizing Serbia’s bloated public sector. As worrying public debt dynamics are expected to push Serbia’s public debt ratio to 70% of GDP by the end of this year, a supplementary budget that limits this year’s budget deficit to a still very high 7% of GDP should be passed in June. The passage of a pension and labour market reform, a new law on planning and construction, as well as new bankruptcy and privatization regulations are planned for mid-July. The latter should facilitate the restructuring of 179 state-owned enterprises, which so far constitute a major burden for public finances and slow down economic development. Mr Vučić’s renewed push for reforms comes at a critical moment. Serbia’s considerable structural reform backlog renders the re-anchoring of fiscal policies increasingly difficult, lingering uncertainties regarding flood-related fiscal costs cast a shadow over this year’s budget deficit, and the conclusion of another IMF standby agreement remains essential to ensure financial market access. Still, it remains to be seen whether Mr Vučić will succeed in implementing these reforms, as public support will likely cool due to expected pension cuts and mass lay-offs at currently state-owned enterprises amid weak economic growth in both 2014 and 2015.

4. Halving of current account deficit reduces external vulnerability

Serbia’s current account deficit narrowed from 10.8% of GDP in 2012 to 5.3% of GDP last year, as goods and services exports rose strongly and improving economic conditions in the euro area boosted the structural transfers balance surplus. Yet, given foreign ownership of the Fiat car factory, as well as rising interest rate costs, the improvement of the current account deficit was limited by a rising income deficit. Owing to weakening export growth, this year’s current account deficit is expected to come in at a still elevated 4.6% of GDP, half of which has already been financed with a concessional loan from the UAE, while a pending IMF agreement could finance the remaining gap.

Factsheet of Serbia
Factsheet of SerbiaSource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

Background information

Located at the heart of the Balkan region, Serbia is a small open economy with a nominal GDP of USD 43bn (2013) and a population of about 7m inhabitants. Agriculture, which generates about 10% of GDP and employs about one-third of the workforce, as well as manufacturing constitute the mainstays of the economy. Owing to the postponement of various structural reforms, the former Yugoslav republic is still in a relatively early stage of transition to a market economy. State-ownership remains prevalent in various sectors, which burdens public finances with considerable subsidies for numerous loss-making enterprises. A bloated bureaucracy, outdated regulation and widespread corruption undermine the country’s business climate. Serbia’s structural problems, in particular its weak export performance and the still dominant role of the public sector, bring with it sizeable twin deficits on the current and fiscal account that expose the country to a deterioration of access to external funding. Recurrent failure to consistently rein in both deficits contributed a considerable build-up of largely foreign currency-denominated external private and public debt. Given these weaknesses, access to concessional financing from the IMF, Russia or the United Arab Emirates has been instrumental in avoiding refinancing problems of the Serbian sovereign in recent years. Even though Serbia’s unemployment rate has hovered around 20% in recent years, the country’s domestic political and social situation is relatively stable so far. However, social tensions may rise, once Serbia’s newly-elected government embarks on recently announced large-scale privatizations and subsidy cuts for ailing state-owned enterprises, which will likely result in mass lay-offs. Meanwhile, Serbia’s once tense external relations have improved recently, which helped the country earn EU candidate status in 2013.

Economic indicators of Serbia
Economic indicators of SerbiaSource: European Commission Spring Forecast*, EIU
Fabian Briegel
RaboResearch Global Economics & Markets Rabobank KEO
+31 88 726 7864

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