Mission Concluding Statement 

Serbia: Staff Concluding Statement of the First Review Under the Stand-By Arrangement and the 2023 Article IV Mission

April 5, 2023

• The Serbian economy has shown resilience in the face of strong headwinds from high food and energy prices, weak trading partner growth, and tight global financial conditions.
• Macroeconomic outturns under the program are strong. These include a narrower-than-expected fiscal deficit, a narrower current account deficit, and higher foreign exchange reserves amid strong and diversified foreign direct investment (FDI) inflows.
• But inflation and uncertainty remain high and macroeconomic policies should continue to focus on reining in inflation through a tight policy mix and on further strengthening buffers.
• Forcefully pursuing a structural reform agenda centered on energy sector reforms is critical for addressing Serbia’s vulnerabilities and supporting long-term growth.

Washington, DC: The mission benefited from constructive discussions and reached staff level agreement on the conclusion of the first review under the Stand-By Arrangement (SBA). The program remains on track with all end-December 2022 quantitative targets met, and all end-March 2023 indicative targets expected to be met based on available data. The structural reform agenda is advancing well. The staff-level agreement is subject to approval by the IMF’s Executive Board, which is scheduled to consider this review in in the second half of June. About EUR 203 million (SDR 163.7 million) would become available after the Board meeting, bringing total disbursements under the program to about EUR 1.2 billion.

A resilient performance

The Serbian economy has shown resilience in the face of strong headwinds. Over the past year or so, sharply higher food and energy prices, shortfalls in domestic electricity production, regional drought conditions, weak trading partner growth and tightening global financial conditions have posed major challenges to the Serbian economy. Real GDP growth was 2.3 percent in 2022 and, for this year, growth is projected to be around 2 percent as tight macroeconomic policies and weak trading partner growth weigh on activity. But the 2022 fiscal outcome was stronger than expected, as were the current account balance and reserve outcomes. And, reflecting ongoing reforms, growth is expected to recover to 3 percent in 2024, and to return to potential of about 4 percent over the medium term.

Inflation is likely near its peak. Headline inflation rose to 16 percent in February 2023, which was slightly higher than expected, led by higher food and energy prices. Core inflation also increased, to 11 percent, driven by broad-based pass-through of cost-push pressures. Inflation expectations are also elevated but have stabilized in recent months and remain within the National Bank of Serbia’s (NBS’s) inflation corridor at longer expectation horizons. Inflation is projected to start falling shortly, slowly at first, and then gathering pace as the impact of tighter policies take hold, and as energy- and food-related base effects kick in. By 2024, inflation is projected to fall to within the bounds of the NBS’s target tolerance band.

Despite a wide current account deficit, strong FDI and other financial inflows allowed the NBS to build their reserves materially since mid-2022 . The current account deficit increased to almost 7 percent of GDP in 2022 from less than 4½ percent in 2021 as energy imports surged. But the deterioration was partly mitigated by strong exports and remittance inflows. And, on the financing side, continued strong FDI inflows and recent external borrowing allowed the NBS to rebuild gross international reserves to more than EUR 21 billion by end-February 2023, a record high. In 2023, the current account deficit is projected to fall as a share of GDP, reflecting lower energy imports and continued strong exports. Over the medium term, the current account deficit is expected to decline to below 5 percent of GDP.

Fiscal performance remains a key strength. The 2022 fiscal deficit ended up much lower than anticipated at the time of SBA approval, at just over 3 percent of GDP despite fiscal support to the energy state-owned enterprises (SOEs) of about 2½ percent of GDP. This outcome reflected tight administrative controls across all areas of spending and better-than-expected revenue outturns. The 2023 budget was approved in December 2022 in line with the SBA targets. Public debt stood at 55 percent of GDP at end-2022 and, reflecting strong fiscal performance, is expected to fall sharply over the medium term, helped by Serbia’s new fiscal rule. Fiscal financing pressures have eased, aided by strong public debt management and Serbia made a successful return to international capital markets in January, in two heavily oversubscribed Eurobond issuances at interest rates on par with, or better than, peers.

Similar to peers, Serbia’s economic outlook is subject to much uncertainty. This uncertainty stems from geopolitical and energy sector developments, uncertainties over trading-partner growth, a still-challenging inflation environment, and adverse global financial market developments. On the upside, Serbia could benefit from the relocation of skilled migrants and businesses, and continued nearshoring.

Tight policies needed to rein in inflation and build buffers

A tight macroeconomic policy mix is needed to rein in inflation, a key policy priority. The NBS’s ongoing monetary policy tightening is appropriate. Following a data-driven approach, further increases in relevant policy rates are most likely needed to achieve positive real interest rates.

Fiscal consolidation should continue to play an important complementary role in containing inflation, as well as in building buffers. For 2023, a fiscal deficit of no more than 3 percent of GDP would be consistent with the needed tight policy stance. At the same time, given strong revenue performance, strong control over current spending, and possible lower-than-planned support to energy SOEs, there may be fiscal room for additional public investment relative to the level envisaged in the budget. Where possible, such additional capital expenditure should be targeted on projects that help alleviate structural bottlenecks in the energy sector. Untargeted transfers should be avoided.

The financial sector has shown resilience, although vigilance is required as interest rates rise and global financial system turbulence may continue. Banking sector capital and liquidity ratios remain well above minimum regulatory levels, and non-performing loans are at record low. Nevertheless, rising interest rates could put pressure on asset quality. Contagion from the recent global financial sector turmoil has been limited although the riskier global environment calls for continued close scrutiny of the sector, including ongoing careful monitoring of deposits and liquidity.

An energy-focused structural reform agenda

Energy sector reform is at the core of the SBA. Deep-rooted weaknesses exposed in Serbia’s energy sector require comprehensive reforms to ensure energy security and reduce associated fiscal risks. Meeting these goals requires further adjustment in energy tariffs. Such adjustments should be complemented by efforts to extend the rollout of the energy-vulnerable consumer protection program and to raise the share of households benefitting from lower energy bills.

After years of underinvestment, energy investment needs are large. It will be important to finalize and adopt by end-May, as agreed under the program, a prioritized and fully costed investment plan for the energy sector with projects that will enhance energy security, stabilize electricity generation, and conserve energy. Investments in green infrastructure to accelerate green transition would support the resilience of Serbia’s growth model that heavily relies on foreign direct investment.

Other structural reforms of the energy sector are also critical. We welcome the authorities’ commitment to convert the state-owned power utility Elektroprivreda Srbije (EPS) to a joint stock company shortly. We also welcome the commitment to prepare by end-2023 a strategic restructuring plan for the EPS and complete the unbundling of the state-owned Srbijagas by end-2024.

Strengthening governance in the energy SOEs is key. The new SOE law is the lynchpin of these reforms. The law should be aligned with the OECD Guidelines on Corporate Governance of SOEs and should delegate the management of SOEs to professionals while limiting the government involvement in day-to-day operations of the SOEs. In line with SBA commitments, the law should be adopted soon to underpin the transformation of the SOE sector overall and energy enterprises in particular.

Fiscal reforms should continue apace. The recently approved fiscal rule is instrumental in anchoring fiscal consolidation and maintaining fiscal buffers beyond the program period. We welcome the authorities’ commitment to improve medium-term budgeting, strengthen fiscal risk and public investment management, and modernize tax administration.

Further improving the business environment would help support higher private sector-led growth. Reforms to strengthen the rule of law, improve the efficiency of the judicial system, and curb corruption are critical to improve the investment climate. Efforts to tackle informality should continue. Finally, further developing domestic capital markets over time would help diversify sources of long-term financing, ease access to financing for small and medium enterprises, and support medium-term growth.

The IMF team is grateful to the authorities and private sector counterparts for their close collaboration and helpful and constructive discussions .