High capital inflows and rising vulnerabilities underscore the importance of a comprehensive approach to ensuring stability. Standard balance sheet indicators mask a substantial build-up of exposures to exchange rate, maturity, and rollover risks. Household balance sheet risks originate from currency mismatches owing to credit euroization. The fiscal balance has a strong and significant impact on the current account in Serbia. The model is broadly able to reproduce recent economic and policy developments in Serbia. The analysis indicates that privatization can result in sizable fiscal savings.

Abstract

High capital inflows and rising vulnerabilities underscore the importance of a comprehensive approach to ensuring stability. Standard balance sheet indicators mask a substantial build-up of exposures to exchange rate, maturity, and rollover risks. Household balance sheet risks originate from currency mismatches owing to credit euroization. The fiscal balance has a strong and significant impact on the current account in Serbia. The model is broadly able to reproduce recent economic and policy developments in Serbia. The analysis indicates that privatization can result in sizable fiscal savings.

II. Financial Conditions in the Corporate Sector7

Objective: To assess the evolution of Serbia’s corporate sector vulnerabilities based on stock variables, drawn from companies’ balance sheets, as well as data on domestic and off-shore corporate borrowing.

Main findings: While standard balance sheet indicators appear to be broadly adequate relative to international standards, they mask a substantial build-up of exposures to exchange rate, maturity, and rollover risks stemming from the recent surge in foreign credit.

Policy implications: Productivity enhancing structural reforms and developing domestic currency capital markets would be instrumental to reduce risks stemming from the rising euroized liabilities.

A. Overview of the Main Balance Sheet Indicators

22. Standard balance sheet indicators8 point to a number of positive trends in the Serbian economy.9 The number of socially-owned companies more than halved since 2002, while the total number of companies in the economy rose. Alongside, assets under public and social ownership declined from over 40 percent in 2003 to 25 percent in 2006, while assets in private companies grew strongly (Figure 1). Moreover, GDP growth exceeded growth of assets over the same period, underscoring improvements in efficiency. The economy-wide return on assets—measured by the ratio of GDP to total corporate assets—has increased from 25 percent in 2002 to 33 percent in 2006. As a result, after years of persistent losses, the corporate sector posted an aggregate profit of over 6 percent of GDP in 2006.

Figure 1.
Figure 1.

Corporate assets by ownership.

(percent)

Citation: IMF Staff Country Reports 2008, 055; 10.5089/9781451834901.002.A002

Source: Solvency center of the NBS.

23. The corporate sector does not appear to be overly leveraged. Rapid growth of liabilities was matched by similar growth of assets. As a result, the leverage ratio—liabilities over assets—remained essentially flat since 2004.

24. Moreover, strict regulations appear to have helped to avoid maturity mismatches. High provisioning and reserve requirements have discouraged short-term borrowing domestically, and—combined with a ban on private short-term external borrowing—have contained growth of short-term liabilities. Overall, both maturity and leverage indicators seem broadly in line with international norms (Table 1).

Table 1.

Corporate Sector Leverage and Debt Maturity Indicators in Selected Economies, 2000 1/

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Source: Glen and Singh (2004) and NBS Solvency Center.

Leverage is measured as the ratio of total liabilities in total assets; maturity is measured as a ratio of short-term liabilities to total assets (in percent).

25. These indicators, however, need to be interpreted with caution for several reasons. First, the balance sheet in Table 1 is aggregated, but not consolidated—the liabilities include both inter- and intra-sectoral corporate obligations. This complicates interpretation by masking the net liability position of the sector.10 Second, in many cases, the maturity structure of liabilities is based on the definitions of “short-term” and “long-term” which were used during loan origination, rather than on the schedule of remaining repayments. Third, the data does not distinguish currency denomination of assets and liabilities, masking the rising exposures to exchange rate risk in recent years. These issues are addressed below by examining in greater detail the structure of the recent credit flows into the corporate sector.11

B. Vulnerabilities Stemming from the Recent Credit Growth

26. Growth and other improvements in the corporate sector were in part enabled by increased borrowing, which has accelerated markedly since 2004. With low own resources and non-existent capital markets, companies had to rely heavily on credit—both domestic and external—to finance their expansion. Thus, corporate debt rose from 13 percent of GDP in 2002 to over 37 percent in August 2007 (Figure 2). 12 The bulk of this expansion was due to a sharp growth in external borrowing. The latter was partly induced by high marginal reserve requirements on domestic banks’ foreign exchange liabilities, as well as by the arrival of international companies—in the course of privatization—with easier access to foreign credit. High reserve requirements prompted foreign-owned banks in Serbia to channel credit directly from parent offices abroad. However, a closer look at the structure of foreign loans reveals a significant worsening of the corporate sector’s financial position (see below).

Figure 2.
Figure 2.

Non-bank Corporate Debt by Lender

(percent of GDP)

Citation: IMF Staff Country Reports 2008, 055; 10.5089/9781451834901.002.A002

Source: NBS Solvency center.

27. Serbian companies have been borrowing externally on increasingly less favorable terms since 2004. A formal classification of ‘medium-term’—applied to loans maturing in over one year—has allowed companies to continue borrowing off-shore. In 2002–04, long-term loans with over 5 year maturity were the fastest growing component of foreign credit. Since then, however, their share has dropped markedly, while the share loans maturing in 1–3 years nearly doubled (Figure 3) over the same period. At the same time, almost all bank loans and over three quarters of loans from non-banks have adjustable interest rates, subjecting companies to interest rate risks (Table 2).

Figure 3.
Figure 3.

Maturity Structure of External Non-bank Corporate Debt

(percent of total)

Citation: IMF Staff Country Reports 2008, 055; 10.5089/9781451834901.002.A002

Source: NBS.
Table 2.

Average Terms on External Corporate Borrowing, August 2007

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Sources: NBS and Staff calculations.

28. This resulted in shorter effective maturity and heightened rollover risks. With repayments of the longer-term pre-2004 debt nearing, and the average maturity of new loans shortening, Serbian companies’ external short-term financial obligations have increased substantially. As of June 2007, over 50 percent of the outstanding external debt—11 percent of the 2007 GDP—was to be repaid or refinanced before 2010 (Figure 4).

Figure 4.
Figure 4.

Repayment Schedule of the External Non-bank Corporate Debt, as of June 2007

Citation: IMF Staff Country Reports 2008, 055; 10.5089/9781451834901.002.A002

Source: NBS.

29. The increased accumulation of arrears on external non-bank private debt is partly a reflection of the worsening terms of credit. Arrears on cross-border loans have been on the rise in 2003–06, nearly doubling to 7.7 percent, before declining somewhat to 6 percent in the first eight months of 2007 (Figure 5). This level of arrears most likely implies an even higher ratio of non- performing loans (NPL), underscoring substantial vulnerability to possible adjustments in risk premium. Moreover, since many of the cross-border loans are backed by guarantees from resident banks, the rising NPL ratios are also increasing domestic financial sector vulnerabilities.

Figure 5.
Figure 5.

Arrears In Percent of External Non-bank Corporate Debt

Citation: IMF Staff Country Reports 2008, 055; 10.5089/9781451834901.002.A002

Source: NBS.

30. The biggest risk to corporate sector balance sheets is posed by high liability euroization. With over 70 percent of domestic credit either indexed or denominated in euros, and with external credit reaching 54 percent of the corporate debt, the effective euroization rate of corporate sector financial liabilities exceeded 85 percent in August 2007. Even in the absence of large shocks to the exchange rate, this level of exposure raises concerns over the corporate sector’s ability to finance these liabilities, particularly given the small and vulnerable export sector (see Chapter I). By this measure, Serbia was one of the most vulnerable countries in the region as of mid-2007 (Figure 6).

Figure 6.
Figure 6.

Cross-border foreign bank credit to firms in Emerging Europe, 2007Q2

(percent of annual exports)

Citation: IMF Staff Country Reports 2008, 055; 10.5089/9781451834901.002.A002

Sources: Bank of International Settlements, the NBS and WEO.

31. High liability euroization raises the potential economic costs of shocks to the exchange rate. Agenor and Montiel (1999), among others, discuss the dangers of currency mismatches. When a firm’s assets are denominated in local currency, and its liabilities are in foreign currency, a depreciation could lead to a sizeable reduction in net worth. The latter, in turn, would increase the risk premium, making borrowing more difficult. Such a sudden change in borrowing costs (or ability) could not only lead to lower investment, but may also expose maturity mismatches and aggravate rollover risks, leading to costly defaults. These effects could outweigh the competitiveness gains from a depreciation. 13

32. Balance sheet stress tests were employed in order to gauge the extent of corporate sector exposures to exchange rate risk (Table 3). Under assumptions of fixed assets denominated in dinar and a euroization rate of liabilities and liquid assets of 80 percent, a nominal depreciation of 10 percent would raise the corporate sector’s financial liabilities by roughly 8 percent, squeezing net worth by 4 percent. In the worst scenario considered—when firms are caught with half of liquid assets in euros and a large depreciation of 50 percent—the liabilities rise by 40 percent while the net worth would shrink by over a quarter. These effects capture only the first stage in the process outlined above. In the second stage, the lenders could raise interest rates—possibly on both new and old loans—in order to reflect the increased risk. This could lead to further hikes in liabilities, potentially pushing firms into default and/or forcing a drop in output.

Table 3.

Aggregate Corporate Sector Balance Sheet: Stress Tests 1/

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Source: NBS Solvency Center and IMF Staff Calculations.

Assumptions: liability euroization of 80%; dinar denomination of all fixed assets, and tax-related assets and liabilities; euroization rate for liquid assets refer to share of short-term receivables and cash in Table 1 denominated in euro.

C. Concluding Remarks

33. The considerations above suggest that the high growth of credit in recent years has made Serbian companies more vulnerable. While the still low leverage may insulate the sector in the short run, the present trends could dissolve this advantage. This calls for continuous monitoring and analysis of “early warnings” based on the underlying trends. In addition to productivity-enhancing structural reforms, developing local capital markets would be important going forward in order to help companies hedge against exchange rate risks, as well as to stimulate dinar borrowing domestically, thereby relieving the rising euroization-related vulnerabilities.

Table 4.

Aggregate Corporate Sector Balance Sheet

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Source: NBS Solvency center.

References

  • Agénor Pierre-Richard, and Peter J. Montiel, 1999, Development Macroeconomics (Princeton, NJ: Princeton University Press, 2nd edition).

  • Allen, Mark, Christoph Rosenberg, Christian Keller, Brad Setser, and Nouriel Roubini, 2002, “A Balance Sheet Approach to Financial Crisis,” IMF Working Paper No.02/210 (Washington: International Monetary Fund).

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  • Cook, David, 2004, “Monetary Policy in Emerging Markets: Can Liability Dollarization Explain Contractionary Devaluations?Journal of Monetary Economics, Vol. 51, pp. 115581.

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  • Glen, Jack, and Ajit Singh, 2004, “Comparing Capital Structures and Rates of Return in Developed and Emerging Markets,” Emerging Markets Review No. 5, pp.16192.

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  • Sorsa, Piritta, Bas B. Bakker, Christoph Duenwald, Andrea M. Maechler, and Andrew Tiffin, 2007, “Vulnerabilities in Emerging Southeastern Europe—How Much Cause for Concern?IMF Working Paper No. 07/236 (Washington: International Monetary Fund).

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7

Prepared by Tokhir Mirzoev (EUR).

8

Allen et. al. (2002) discuss the use of the balance sheet approach to studying vulnerabilities.

9

Data on Serbian companies’ balance sheets is collected by the NBS Solvency Center. Access to the Solvency Center database is available through the website of the National Bank of Serbia: http://www.nbs.yu/internet/english/15/index.html.

10

The low leverage ratio may also reflect London Club debt restructuring and other write-offs, while new loans mostly represent borrowing after December 2000, which may also partly explain favorable debt maturity.

11

Sorsa et al. (2007) discuss the increased vulnerability to financial risks in Southeastern Europe.

12

Data on private non-bank corporate external debt includes loans contracted after December 20, 2000.

13

In 1995, external debt to foreign banks in East Asian emerging markets ranged between 11 and 55 percent of GDP. The consequences of these exposures became apparent in 1997, when large depreciations led to sharp recessions (See Cook (2004).)

Republic of Serbia: Selected Issues
Author: International Monetary Fund
  • View in gallery

    Corporate assets by ownership.

    (percent)

  • View in gallery

    Non-bank Corporate Debt by Lender

    (percent of GDP)

  • View in gallery

    Maturity Structure of External Non-bank Corporate Debt

    (percent of total)

  • View in gallery

    Repayment Schedule of the External Non-bank Corporate Debt, as of June 2007

  • View in gallery

    Arrears In Percent of External Non-bank Corporate Debt

  • View in gallery

    Cross-border foreign bank credit to firms in Emerging Europe, 2007Q2

    (percent of annual exports)