Fitch Outlines Economic Challenges for Serbia

The Serbian government’s recent plans to stabilise public finances show a commitment to fiscal consolidation and structural economic reform, says Fitch Ratings. However, the credit ratings agency (CRA) warns that weak economic growth and implementation risks pose significant challenges to meeting targets.

In advance of the 2014 budget recently-appointed finance minister, Lazar Krstic, announced savings and revenue measures, including cutting the salaries of up to 350,000 higher-earning civil servants and raising value added tax (VAT) on some goods to 10% from 8%. The government projects that the measures would yield €600m-€800m, or 1.4%-1.8% of projected gross domestic product (GDP), next year.

Achieving this, and meeting the target of reducing the fiscal deficit to 2%-3% of GDP in 2017, would lead to consolidation similar to that assumed by Fitch in its debt sustainability assessment for Serbia in July, which followed the government’s supplementary 2013 budget.

The fiscal deficit has narrowed slightly as the government has reined in spending growth in 2013. But revenue as a share of GDP is falling because consumption is stagnating, even as the economy recovers driven by a boost in exports. (Fitch expects real GDP growth of 1.5% in 2013.)

Government debt, already among the highest in emerging Europe at 58% of GDP, is rising steeply and could reach 64% of GDP by end-2013 as contingent liabilities migrate onto the sovereign balance sheet. A growing interest burden will make fiscal consolidation more difficult.

The 2013 overall fiscal deficit will exceed the revised consolidated general government target of 5.3% of GDP set out in July. Bank recapitalisation, arrears payments and the assumption of guaranteed debt would add at least 1.5% of GDP, bringing the overall deficit close to 7% of GDP.

The government’s target of increasing real annual growth to 3%-5% of GDP in 2016-2017 by improving economic competitiveness is ambitious – Fitch currently forecasts real annual growth of 1.5% in 2014 and 2% in 2015. Additionally, Serbia’s long-term growth potential still depends on the political resolve to implement unpopular structural reforms. This presents implementation risks, which may be heightened if unresolved political tensions result in early elections.

Previously announced plans to restructure 179 state-owned enterprises are already underway. The CRA does not expect this restructuring to have a major fiscal impact in the short-term, though it should increase economic efficiency in the medium term. The finance minister also pledged to reform labour laws to speed up growth and curb the shadow economy while the announcement of a future rise in the retirement age for women is a step towards containing the cost of pensions, which remains one of the biggest sources of pressure on the budget.

Fitch affirmed Serbia’s BB- rating with a negative outlook in July. The CRA now warns that failure to adopt a credible plan to reduce the deficit and stabilise debt could lead to a downgrade, while doing so in a manner that put public debt on a sustainable path would alleviate pressure on the rating.

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