Mission Concluding Statement 

Serbia: Concluding Statement of the Mission for the 2017 Article IV Consultation and the Seventh Review under the Stand-By Arrangement (SBA)

July 5, 2017

The IMF team and the authorities had constructive discussions on the 2017 Article IV Consultation and reached staff-level agreement on policies needed to complete the seventh review under the precautionary SBA. The program remains broadly on-track with all end-March 2017 performance criteria met, most with significant margins, and all end-June 2017 performance criteria expected to be met based on available data. Most structural benchmarks have been implemented, although some with delays. The agreement is subject to approval by IMF Management and Executive Board. Consideration by the Executive Board is tentatively scheduled for late August. The completion of the review will make an additional SDR 54.57 million (€66.64 million) available to Serbia under the SBA, bringing the total funds available to SDR 772.66 million (€943.52 million). The Serbian authorities have indicated that they do not intend to draw on the resources available under the arrangement.

Serbia’s economy has strengthened dramatically since the adoption of the economic program supported by the SBA. Serbia was in a difficult macroeconomic situation prior to the start of the program in early 2015, with stagnant growth, an unsustainable fiscal position, and rising non-performing loans in banks. Two years later, macroeconomic performance has made a major turnaround. Economic growth is expected to reach 3 percent this year and the fiscal deficit to narrow to 1.1 percent of GDP—the lowest level since 2005—and public debt is heading down faster than projected. Contrary to expectations, the larger than planned fiscal tightening has been associated with increased growth, reflecting the confidence engendered by decisively tackling the public debt sustainability concerns. Moreover, unemployment is falling sharply, along with the level of banks’ non-performing loans, while inflation has been maintained at low levels.

However, continued reform efforts are needed to address remaining vulnerabilities and structural weaknesses. Serbia has pursued a comprehensive reform agenda encompassing public enterprises and SOEs, public administration, the financial sector, and the business climate. Overall progress has been good. But there have been significant delays in some areas—notably in reforms of public administration, public services and SOEs. The economy is still overburdened by a large and inefficient public sector, with too little reliance on the productive private sector. The labor market is characterized by low participation rates, especially of women, and a high degree of informality. Future growth will thus depend on further improving the environment for private sector investment and employment growth. While Serbia’s ranking in business surveys has risen markedly, improvements are still needed in areas such as streamlining and modernizing tax administration, increasing transparency and predictability of public fees and charges, and ensuring a more efficient and independent judicial system.

Strengthening institutions will help consolidate macroeconomic achievements and create conditions for faster convergence with income levels in EU countries. Overhauling Serbia’s fiscal rules would help to establish a credible anchor for fiscal policy and enhance public debt sustainability over the medium term. Continued strengthening monetary and exchange rate policy frameworks, and advancing the dinarization strategy will enhance policy effectiveness and the resilience of the financial system. Concerted efforts across government are required to address the grey economy. And the quantity and quality of public infrastructure needs to be improved both through higher capital spending, and by better public investment management, with rigorous project selection and appraisal to ensure scarce resources and technical capacity are directed to projects with the highest returns. The new decree on project appraisal is an important step in this regard.

Cementing hard-won fiscal gains is a key policy priority. Notwithstanding recent declines, public debt is still elevated and fiscal risks stemming from SOEs are sizeable, so any fiscal overperformance in 2017 should be used to increase capital spending or to reduce debt faster. Pensions, public wages and subsidies are still putting pressure on public finances. Continuing to contain these expenditures in the medium term, while allowing for increases as the economy grows, would help provide fiscal space for addressing infrastructure gaps and targeted reductions in labor tax burdens, while ensuring adequate social protection for vulnerable groups.

The NBS has maintained a prudent policy stance and kept inflation under control. The sizeable fiscal consolidation under the program and improved policy coordination have supported a substantial easing of monetary policy, reflected in markedly lower lending rates and a recovery of bank credit. Looking forward, inflation is expected to remain within the recently lowered target band of 3±1.5 percent. Given Serbia’s improved fundamentals, increased exchange rate flexibility over the medium term will help to develop the foreign exchange market and foster dinarization.

Reforms under the program have helped ensure financial sector resilience. The NBS has successfully implemented a comprehensive agenda aimed at further strengthening the banking sector, reducing the high levels of non-performing loans, and harmonizing the regulatory framework with EU standards. Banks are now better positioned to fully support economic growth as credit demand continues to strengthen. However, reforms of state-owned financial institutions have faced delays and need to be accelerated. Consideration should be given to developing capital markets and improving access to finance for entrepreneurs and SMEs.

The mission team is grateful for the authorities’ hospitality and close cooperation.