IMF Executive Board Concludes 2006 Article IV Consultation with Republic of Serbia

Failed corporate structures lie at the heart of Serbia’s economic difficulties. But the government emphasized instead the need for public investment and labor tax cuts. Capital inflows pose additional challenges. External concerns leave little room to fiscal maneuver. This puts the focus on public expenditure reform. Recent changes in monetary arrangements are appropriate. These steps would best be taken further—toward inflation targeting. However, the envisaged fiscal relaxation calls much of this into question. Serbia has made significant progress in recent years.


Failed corporate structures lie at the heart of Serbia’s economic difficulties. But the government emphasized instead the need for public investment and labor tax cuts. Capital inflows pose additional challenges. External concerns leave little room to fiscal maneuver. This puts the focus on public expenditure reform. Recent changes in monetary arrangements are appropriate. These steps would best be taken further—toward inflation targeting. However, the envisaged fiscal relaxation calls much of this into question. Serbia has made significant progress in recent years.

On October 18, 2006, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Republic of Serbia—the first Article IV consultation for Serbia alone following the dissolution of the former state union of “Serbia and Montenegro” in June.15


After two decades of stagnation and decline at the end of the last century, Serbia has made significant progress in recent years. Output is up 40 percent from 2000, and GDP growth reached 6.8 percent in 2005. This reflects progress in macroeconomic stabilization, banking sector restructuring, and privatization. Concomitantly, some 60 percent of non-budget non-agricultural employment is now in the private sector, almost double the share five years ago.

However, the legacies of earlier policies continue to weigh on economic performance. Employment has trended down—despite buoyant GDP growth—, headline inflation has only briefly dipped below the mid-teens, and fixed investment stagnated below 20 percent of GDP, falling well short of the level in comparable transition countries. Reflecting the low level of national savings, the current account deficit has remained in double digits, resulting in an increase in external debt to 65 percent of GDP by August 2006 despite Paris and London Club debt write-offs. Sizeable corporate losses of the non-financial sector—largely reflecting weak governance and soft budget constraints in socially owned and state-owned enterprises—are at the core of Serbia's external deficits, while also curbing investment and employment growth.

The strong—notably fiscal—policy response has been overwhelmed by surging capital inflows. Privatization-related FDI and direct corporate borrowing have been increasingly complemented by parent bank funding for subsidiaries to take advantage of high banking spreads. This, together with remonetization, has caused a credit boom, compounding external imbalances. As a result, the current account deficit has barely changed in four years despite fiscal consolidation of 5½ percentage points of GDP, macro-prudential measures, and foreign exchange intervention to contain appreciation.

Since 2002, the exchange rate regime has tried to balance internal and external objectives, ultimately securing neither. In early 2006, the National Bank of Serbia announced a transition to exchange rate flexibility and accommodated a considerably stronger dinar accordingly. At end-August, the NBS adopted a new monetary policy framework using the two-week repo rate as the main monetary policy instrument to achieve core inflation objectives (7-9 percent at end-2006, and 4–8 percent at end-2007). The new framework anticipates eventual transition to full-fledged inflation targeting. In the same vein, the NBS is scaling back foreign exchange intervention to a “leaning against the wind” role.

Reduced foreign exchange intervention in the face of continued strong capital inflows led to nominal dinar appreciation in the course of 2006. The strong dinar, combined with favorable international oil price developments and a slowdown in other administered price increases, helped reduce headline inflation to 11.6 percent and core inflation to 10 percent year-on-year in September.

Looking ahead, however, the envisaged fiscal expansion will exacerbate domestic demand pressures and complicate disinflation. The recently adopted supplementary budget provides for an increase in expenditures by 4 percent of GDP in 2006 relative to the original budget, funded by large privatization and license proceeds. This increase consists of additional current spending and expenditures under the National Investment Plan that provides for spending in the amount of € 1.7 billion (7½ percent of GDP) in 2006–07. Fully implemented, this would imply a general government deficit in 2006 of up to 1.4 percent of GDP (0.3 percent of GDP according to the authorities' more optimistic revenue projections and accounting standards—which treat license proceeds as revenue—implying a surplus of 0.6 percent of GDP for the Republican budget). This general government deficit on staff definitions, however, compares to a surplus of 2.7 percent of GDP envisaged under the former Extended Arrangement with the IMF. However, capacity constraints are likely to prevent full execution of these spending plans. The authorities have not yet finalized their budget plans for 2007.

Executive Board Assessment

Executive Directors commended the authorities for Serbia’s strong economic growth in recent years, the fruit of macroeconomic stabilization and structural reform. However, Directors underscored that large macroeconomic imbalances—including external deficits and debt, inflation, and unemployment—persist, with associated vulnerabilities, and that widespread financial euroization implies significant foreign currency exposures. In that light, they urged further policy effort, cautioning strongly that the proposed fiscal loosening carried risks of renewed macroeconomic instability.

Directors noted that sizeable surpluses for the consolidated general government remain appropriate. Though public debt is on a downward trajectory, fiscal surpluses are needed to contain external imbalances and vulnerabilities, support disinflation, and—in anticipation of reinvigorated structural reform efforts—create the basis for sustained medium-term growth. In this context, critical public investments should be funded by efficiencies in current spending, rather than fiscal relaxation. Directors also cautioned against relying on one-off privatization receipts to finance recurrent expenditure, such as wages. While recognizing the challenge of this approach in the current electoral context, Directors were of the view that the recently approved fiscal expansion, if fully implemented, would put at risk hard-won macroeconomic stabilization gains. They also noted that it would be inconsistent with key understandings under the post-program monitoring framework which were reached in February. In their view, re-anchoring fiscal policy from external to fiscal sustainability would be appropriate only once structural reforms—including corporate restructuring and credit deceleration—are reflected in a strengthened current account balance.

Directors considered that the remaining economic imbalances were symptomatic of weak corporate structures, which continue to drain domestic savings. In this light, an acceleration of corporate restructuring and completion of the privatization of sociallyowned and state-owned companies are the central response to the imbalances and associated vulnerabilities. Thus, the divestiture of the remaining portfolio of sociallyowned enterprises will require swift and consistent initiation of bankruptcy procedures should the tenders or auctions for these companies fail. To address employment concerns, Directors recommended increased flexibility of labor market institutions, including through a review of labor laws. They also recommended improvements in the business climate, including by strengthening the effectiveness of the judicial processes.

Directors noted that strong capital inflows pose additional challenges, including by spurring rapid credit growth and exacerbating current account strains. In this context, and given evidence of high non-performing loan ratios, they welcomed the new banking law, which has aligned the legal framework with Basel Core Principles. But further measures to strengthen banking supervision are necessary, including in regard to the exposure of unhedged borrowers to exchange rate risk. Moreover, additional measures to strengthen competition in the banking sector could, by securing efficient spreads, encourage greater attentiveness by banks to macroeconomic and indirect credit risks and, thereby, help contain credit growth. In this context, they encouraged the authorities to consider recommencing the issuance of licenses to greenfield banks.

Directors welcomed the new monetary policy framework as an important step towards eventual full-fledged inflation targeting. In this context, they supported the authorities' intention to scale back foreign currency interventions to a “leaning against the wind” role, in line with the goal of increased exchange rate flexibility. The new regime would support disinflation, which, in turn, would encourage economic growth. Directors underscored the importance of supportive fiscal policy for the credibility of the new regime and that, absent this, disinflation objectives could be compromised.

In view of Serbia’s substantial external imbalances and vulnerabilities, Directors approved the continuation of post-program monitoring for another year, despite early repurchases that have reduced outstanding Fund credit to below 100 percent of quota.

Public Information Notices (PINs) form part of the IMF’s efforts to promote transparency of the IMF’s views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

Serbia: Selected Economic and Financial Indicators, 2003–06 1/

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Sources: Serbian authorities; and IMF staff estimates and projections.

Excluding Kosovo (with the exception of external debt).

Excluding frozen foreign currency deposits.

Corrected for the surge in imports at end-2004 ahead of the introduction of the VAT in January 2005.


Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country’s authorities.