Press Release No. 15/80

Press Release: IMF Executive Board Concludes 2014 Article IV Consultation with the Republic of Serbia

February 26, 2015

On February 23, 2015, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation¹ with Serbia.

The Serbian economy is facing serious challenges. GDP contracted by an estimated 2 percent in 2014 on account of continued falling domestic demand aggravated by floods, and weak economic activity in trading partners. This, together with the low imported inflation, pushed Serbia’s inflation rate below the National Bank of Serbia’s inflation tolerance band, allowing some easing of monetary policy. The very high rate of unemployment remained one of the largest social concerns, as chronic structural rigidities continued to undermine the overall competitiveness of the economy.

Public debt continued to rise to an uncomfortably high level, prompting a new policy course towards stabilization and reform. Partial fiscal consolidation measures implemented in recent years were insufficient and the fiscal deficit rose to 7½ percent in 2014, due to higher state aid to loss-making state-owned enterprises and ballooning mandatory spending. Public debt reached about 70 percent of GDP in 2014. The new government appointed in April 2014 set a course towards fiscal consolidation and reform by passing difficult but necessary structural reforms and fiscal consolidation measures in the second half of 2014.

The financial sector has remained broadly resilient in the face of challenging economic conditions, but pockets of vulnerabilities persist. Overall capitalization appears strong and banks remain liquid. High levels of NPLs, particularly in the corporate sector, are one of the main challenges, requiring a comprehensive strategy for their resolution, although regulatory loan-loss reserves provide cushion against credit losses. Accumulating vulnerabilities in some state owned banks led to their failures, generating sizeable fiscal costs and exposing challenges in the application of the bank resolution framework.

To support their economic policies over 2015–17, the authorities have requested the IMF’s assistance. The program aims to restore public debt sustainability, strengthen competitiveness and growth, and boost financial sector resilience. It will be supported by an IMF Stand-by Arrangement (see Press Release No. 15/67), which is expected to be precautionary.

Executive Board Assessment²

Noting the serious challenges facing the Serbian economy, the directors welcomed the authorities’ renewed commitment to implement an ambitious reform package to restore macroeconomic stability, strengthen the financial sector, and boost growth prospects.

Directors agreed that significant budgetary adjustment is needed to address fiscal risks and put the public debt ratio on a downward path. They supported a consolidation strategy centered on reducing mandatory spending and aid for state-owned enterprises. Directors commended the authorities for underpinning the credibility of their fiscal plans with an early implementation of difficult, but necessary, measures in these areas. Additional fiscal reforms for the period ahead include strengthening tax administration, policy frameworks, and public financial management.

Directors agreed that the inflation targeting regime remains appropriate for Serbia, despite challenges in its implementation. Directors noted that, in light of the planned fiscal consolidation, a gradual monetary easing will be needed to support domestic demand, although the pace of adjustment should be mindful of external financing conditions and the evolution of inflation expectations. Directors welcomed the increased exchange rate flexibility and underscored that foreign exchange interventions should be used only for smoothing excessive volatility.

Directors agreed that the authorities’ policy package for the financial sector will strengthen its resilience and maintain stability. They took note of the recent legislative reform of the bank resolution framework and encouraged an early undertaking of diagnostic studies that would guide further regulatory and supervisory actions. Directors also called for prompt design and implementation of a comprehensive strategy for reducing distressed debt.

Directors concurred that deeper structural reforms are essential to restore competitiveness, stimulate private investment, and support growth over the medium term. They welcomed the recent amendments of the Labor Law, the additional steps in pension reform, and the simplification of construction permits. Directors emphasized that further reforms of state-owned enterprises, including restructuring and privatization, will be critical for improving their commercial viability and limiting fiscal risks. More broadly, they called for stepped-up efforts to improve the business environment and to stimulate private sector activity and job creation.