Republic of Serbia: 2021 Article IV Consultation and Request for a 30-Month Policy Coordination Instrument-Press Release; Staff Report; and Statement by the Executive Director for Republic of Serbia
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International Monetary Fund. European Dept.
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Publication Date:
21 Jun 2021
eISBN:
9781513583181
ISBN:
9781513583181
Language:
English
Keywords:
trading partner; government deposit; fiscal policy; Non-government sector; State aid; Fiscal risks; Europe
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1. Serbia has weathered the COVID-19 crisis well so far, but high uncertainty about the path of the pandemic persists. Serbia entered the crisis with sound macroeconomic fundamentals. In response to the pandemic, the authorities implemented a sizeable policy package, which helped mitigate the adverse impact on economic activity and supported the economic rebound. Serbia also embarked on one of the fastest COVID-19 vaccine rollouts in Europe (Text Figure 1). Nevertheless, high uncertainty about the course of the pandemic and its delayed effects on firms, banks, and households persist, and sustaining a solid economic recovery remains a policy priority.

Abstract

1. Serbia has weathered the COVID-19 crisis well so far, but high uncertainty about the path of the pandemic persists. Serbia entered the crisis with sound macroeconomic fundamentals. In response to the pandemic, the authorities implemented a sizeable policy package, which helped mitigate the adverse impact on economic activity and supported the economic rebound. Serbia also embarked on one of the fastest COVID-19 vaccine rollouts in Europe (Text Figure 1). Nevertheless, high uncertainty about the course of the pandemic and its delayed effects on firms, banks, and households persist, and sustaining a solid economic recovery remains a policy priority.

Context

1. Serbia has weathered the COVID-19 crisis well so far, but high uncertainty about the path of the pandemic persists. Serbia entered the crisis with sound macroeconomic fundamentals. In response to the pandemic, the authorities implemented a sizeable policy package, which helped mitigate the adverse impact on economic activity and supported the economic rebound. Serbia also embarked on one of the fastest COVID-19 vaccine rollouts in Europe (Text Figure 1). Nevertheless, high uncertainty about the course of the pandemic and its delayed effects on firms, banks, and households persist, and sustaining a solid economic recovery remains a policy priority.

Text Figure 1.
Text Figure 1.

COVID-19 Evolution in Serbia

Citation: IMF Staff Country Reports 2021, 132; 10.5089/9781513583181.002.A001

2. Further structural and institutional reforms are needed to put Serbia on a stronger, more resilient, and inclusive growth trajectory. The 2018 PCI supported the authorities in maintaining fiscal discipline and advancing structural reforms, albeit with delays in some areas, including in the wake of the pandemic. Good progress was made in modernizing tax administration, strengthening public investment management frameworks, and privatization, including of the largest state-owned bank (Annex II). However, further reforms will be important to rebuild buffers and anchor fiscal performance over the medium term. And an ambitious structural reform agenda will be needed to underpin high, inclusive and greener growth. These efforts would also help prepare the country to successfully join the EU.

uA001fig01

Nominal GDP per capita, 2019

(Percent of EU nominal GDP per capita; weighted averages)

Citation: IMF Staff Country Reports 2021, 132; 10.5089/9781513583181.002.A001

Sources: IMF, WEO database; and IMF Staff estimates.Note: CE5 includes CZE, HUN, POL, SVK, SVN; Baltics includes EST, LVA, LTU; SEE-EU includes BGR, HRV, ROU; SEE-XEU includes ALB, BIH, MKD, MNE, KOS.

3. Against this background, the authorities have requested a successor 30-month PCI. In the absence of balance of payments needs, the authorities view the PCI as an appropriate vehicle to demonstrate Serbia’s commitment to advance the reform agenda, enhance macroeconomic stability, and maintain close policy dialogue with the Fund.

4. Politics are dominated by the 2022 general elections. The current government, led by the SNS party, has maintained political and economic continuity, but the reform momentum could be affected by elections expected in April 2022. Discussions on normalizing relations with Kosovo have made limited progress.

Recent Economic Developments

5. Serbia’s economic recovery is on track, despite new waves of the pandemic. Serbia recorded one of the smallest output contractions in Europe in 2020 (Box 1). While private consumption decreased by 2.5 percent, government spending provided a critical stimulus. On the supply side, services continued to be a drag on growth from 2Q2020, while agriculture and manufacturing rebounded in 3Q2020 and continued to support growth in 4Q2020 amid a third wave of the pandemic. The 1Q2021 GDP estimate of 1.7 percent yoy growth exceeded the expectations of both staff and authorities, given the new waves of the pandemic and the related containment measures, and the weaker-than-expected economic performance in Serbia’s key EU trading partners. The fourth wave of infections, which started in February, is tapering while Serbia’s vaccination campaign remains one of the most successful in Europe. Given these developments, the growth forecast for 2021 has been revised up from 5 percent to 6 percent, although risks are pronounced.

uA001fig02

Contributions to growth

(Percent, yoy)

Citation: IMF Staff Country Reports 2021, 132; 10.5089/9781513583181.002.A001

Source: SORS, IMF staff calculations and projections.

6. Price pressures remain contained, thanks to a relatively stable exchange rate and well-anchored inflation expectations. Headline inflation returned to the tolerance range in March (at 1.8 percent), after three months below the lower bound, before picking up to 2.8 percent in April (Figure 4). Core inflation remains broadly stable at 1.8 percent. After four cuts in 2020, the NBS has kept the key policy rate unchanged at 1 percent since December.

Figure 1.
Figure 1.

Serbia: Real Sector Developments

Citation: IMF Staff Country Reports 2021, 132; 10.5089/9781513583181.002.A001

Figure 2.
Figure 2.

Serbia: Balance of Payments and NIR

Citation: IMF Staff Country Reports 2021, 132; 10.5089/9781513583181.002.A001

Figure 3.
Figure 3.

Serbia: Financial and Exchange Rate Developments

Citation: IMF Staff Country Reports 2021, 132; 10.5089/9781513583181.002.A001

Figure 4.
Figure 4.

Serbia: Inflation and Monetary Policy

Citation: IMF Staff Country Reports 2021, 132; 10.5089/9781513583181.002.A001

7. Fiscal policy continues to be expansionary, providing support to the economy as the recovery takes root. The fiscal deficit reached 8.1 percent of GDP in 2020, from near balance in 2019, as the original budget was amended to include a support package worth about 9 percent of GDP, covering higher pandemic-related subsidies, wage costs, and healthcare spending. Revenue collection was flat compared to the previous year, despite the deferral of labor taxes and social security contributions. Public debt increased in 2020, reaching 58.4 percent of GDP by year-end. 1 For 2021, a supplementary budget was adopted in April raising the projected deficit from 3 percent of GDP to 7 percent. The budget revision aims to cushion the impact of the new waves of the pandemic and the associated containment measures, as well as offset the weaker than-expected private consumer demand and the economic recovery in key trading partners, which could affect the Serbian recovery including via protracted or lagged effects.

8. The external position is assessed to be broadly in line with medium-term fundamentals and desirable policies (Annex V). The current account deficit in 2020 was 4.3 percent of GDP, 2.6 pp of GDP below the 2019 deficit. A decline in exports and remittances due to the economic slowdown in Europe was more than offset by lower imports from lower domestic consumption and by lower profits earned by foreign companies (Figure 2). Net FDI inflows were 18 percent below the 2019 level but still exceeded the current account deficit. Current account developments in early 2021 have been generally positive, with exports recovering faster than imports, a lower primary income deficit, and rising remittances inflows. Pressures on the dinar were broadly balanced and moderate during 1Q2021, after net sales of foreign exchange by the NBS during most of 2020. The Central Bank’s international reserve position remains adequate according to the usual metrics.

Serbia’s Output Performance During COVID-19

In 2020, Serbia’s economy contracted by about 1 percent, compared to the average contractions of about 2 percent and 7 percent in emerging and advanced Europe, respectively.

This is partly explained by a stronger carry-over effect going into the pandemic in Serbia. Growth in 2019 registered 4.2 percent, with growth in 4Q2019—which is particularly important for the carry over into 2020—the strongest in yoy terms since 3Q2008.

uA001fig03

European Economies: Real GDP Growth

(2020 vs. 2019, percent)

Citation: IMF Staff Country Reports 2021, 132; 10.5089/9781513583181.002.A001

Source: WEO
uA001fig04

Estimates of Carry-over Effect from 2019

(Percent)

Citation: IMF Staff Country Reports 2021, 132; 10.5089/9781513583181.002.A001

Sources: WEO, IMF staff calculations.

Serbia’s modest reliance on high-contact sectors helped absorb the negative impact of containment measures. Although relatively strict containment measures in the early phase of the pandemic (Text Figure 1) negatively affected mobility, particularly during the lockdown period1, their impact on Serbia’s economic activity was likely more subdued, given its modest reliance on high-contact sectors. Monthly data for 2020 confirms that high-contact sectors in Serbia were most affected by the pandemic. For example, catering turnover and overnight tourist stays declined more drastically in April and did not recover to pre-COVID levels later in 2020, whereas industrial production and retail trade (which have a larger share in GDP) recorded V-shape recoveries.

uA001fig05

Share of High-contact Sectors in Gross Value Added (GVA)

(Percent)

Citation: IMF Staff Country Reports 2021, 132; 10.5089/9781513583181.002.A001

Source: Haver Analytics; IMF staff calculationsNote: High-contact sectors include accommodation, food service, arts, entertainment and recreation.
uA001fig06

V-shaped recoveries

Citation: IMF Staff Country Reports 2021, 132; 10.5089/9781513583181.002.A001

Source: Statistical Office of Serbia, IMF staff calculations.Note: Seasonally-adjusted indices. 2019 = 300.
uA001fig07

Slower recoveries

Citation: IMF Staff Country Reports 2021, 132; 10.5089/9781513583181.002.A001

Source: Statistical Office of Serbia, IMF staff calculations.Note: Seasonally-adjusted indices. 2019 = 300.

The large and timely policy response played a key role in mitigating the economic costs of COVID-19. Serbia implemented a comprehensive support package in 2020 (Annex IV), including a fiscal impulse of about 6 percent of GDP, monetary policy relaxation (accommodating the increased domestic government financing needs) and financial sector support promoting high credit growth in 2020, see Table 6a).

Table 1.

Serbia: Selected Economic and Social Indicators, 2018–2023

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

Unemployment rate for working age population (15–64).

Includes employer contributions.

Includes amortization of called guarantees.

Primary fiscal balance adjusted for the automatic effects of the output gap both on revenue and spending as well as one-offs.

Excludes state guarantees on bank loans under the credit guarantee scheme introduced in response to the COVID-19 crisis, estimated at 0.85 percent of GDP as of end-April 2021.

At constant exchange rates.

After CR19/369, domestic securities held by non-residents are included in external debt. Historical data were updated since 2015.

The risk-weighted metric is IMF’s ARA metric for the fixed exchange rate. Serbia was reclassified as stabilized exchange rate regime in 2019.

Table 2.

Serbia: Medium-Term Framework, 2018–2026

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Sources: NBS, MoF, SORS and IMF staff estimates and projections.

Using constant dinar/euro and dinar/swiss franc exchange rates for converting FX and FX-indexed loans to dinars.

Includes employer contributions.

Includes amortization of called guarantees.

Calculated as one-off revenue items minus one-off expenditure items. Negative sign indicates net expenditure.

After CR19/369, domestic securities held by non-residents are included in external debt. Historical data were updated since 2015.

Table 3.

Serbia: Growth Composition, 2018–2026

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Sources: Serbian Statistical Office; and IMF staff estimates and projections.
Table 4a.

Serbia: Balance of Payments, 2018–2026 1/

(Billions of euros)

article image
Sources: NBS; and IMF staff estimates and projections.

SORS released revised 2016 BOP in October 2017.

Excluding net use of IMF resources.

Includes SDR allocations in 2009.

Includes trade credits (net).

Table 4b.

Serbia: Balance of Payments, 2018–2026 1/

(Percent of GDP)

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Sources: NBS; and IMF staff estimates and projections.

SORS released revised 2016 BOP in October 2017.

Excluding net use of IMF resources.

Includes SDR allocations in 2009.

Includes trade credits (net).

The risk-weighted metric is IMF’s ARA metric for the fixed exchange rate. Serbia was reclassified as stabilized exchange rate regime in 2019.

Table 5.

Serbia: External Financing Requirements, 2018–2026

(Billions of euros)

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Sources: NBS; and Fund staff estimates and projections.

Only includes equity securities and financial derivatives.

Excluding IMF.

Includes all other net financial flows and errors and omissions.

Table 6a.

Serbia: General Government Fiscal Operations, 2018–2026 1/

(Billions of RSD)

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Sources: Ministry of Finance; and IMF staff estimates and projections.

Includes the republican budget, local governments, social security funds, and the Road Company, but excludes indirect budget beneficiaries (IBBs) that are reporting only on an annual basis.

Includes employer contributions.

Including severence payments. Includes employer contributions.

Includes RSD10 billion military pension payment in 2015 following a Constitution Court ruling.

Excluding foreign currency deposit payments to households, reclassified below the line.

Excludes state guarantees on bank loans under the credit guarantee scheme introduced in response to the COVID-19 crisis, estimated at 0.85 percent of GDP as of end-April 2021.

Table 6b.

Serbia: General Government Fiscal Operations, 2018–2026 1/

(Percent of GDP)

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Sources: Ministry of Finance; and IMF staff estimates and projections.

Includes the republican budget, local governments, social security funds, and the Road Company, but excludes indirect budget beneficiaries (IBBs) that are reporting only on an annual basis.

Includes employer contributions.

Including severence payments. Includes employer contributions.

Includes RSD10 billion military pension payment in 2015 following a Constitution Court ruling.

Excluding foreign currency deposit payments to households, reclassified below the line.

Excludes state guarantees on bank loans under the credit guarantee scheme introduced in response to the COVID-19 crisis, estimated at 0.85 percent of GDP as of end-April 2021.

Finally, teleworkability also played a helpful role. Before the pandemic, Serbia reported a larger share of employed persons working from home relative to CESEE peers. Data published by Serbia’s Statistical Office shows that this share has increased by about 25 percent over 2Q2020–4Q2020 compared to the same period in 2019.

uA001fig08

Employed persons working from home

(Percentage of total employed, 2019)

Citation: IMF Staff Country Reports 2021, 132; 10.5089/9781513583181.002.A001

Source: EurostatNote: Persons reported as usually working from home; 15–64 years.
1/ The authorities estimate that a 10-point increase in the stringency index led to a 13 percent decline in mobility in Serbia over a two-week period (National Bank of Serbia, February 2021 Inflation Report, Box 3, available here).

Outlook and Risks

9. A strong economic recovery is expected as the pandemic subsides and restrictions are lifted (Tables 1–8).

  • Real GDP growth is projected at 6 percent in 2021, gradually decreasing to its potential of around 4 percent over the medium term. This would leave a permanent effect of the crisis on the level of real GDP of 2 percent compared with pre-pandemic projections by end-2023. Over the medium-term, growth is expected to be supported by strong FDI, continued high public investment, and an assumed recovery in trading partner countries. Strong implementation of structural reforms, including under the PCI, represents an upside risk to medium-term growth.

  • Inflation is projected to remain in the lower half of the inflation target band, in line with domestic demand and the evolution of imported inflation, before reaching the midpoint over the medium term.

  • The current account deficit is projected at 5.1 percent of GDP in 2021 as both exports and imports recover from the 2020 downturn, while a normalization in remittances and tourism flows is expected to happen gradually. Over the medium term, the current account deficit is projected to remain at about 5 percent of GDP and be fully covered by FDI.

Table 7.

Serbia: Monetary Survey, 2018–2026

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Sources: National Bank of Serbia; and IMF staff estimates and projections.

Foreign exchange denominated items are converted at current exchange rates.

Excluding undivided assets and liabilities of the FSRY and liabilities to banks in liquidation.

Using constant program dinar/euro and dinar/swiss franc exchange rates for converting FX and FX-indexed loans to dinars agreed under 2015–17 SBA.

Calculated as nominal credit at current exchange rates deflated by the change in the 12-month CPI index.

Using current exchange rates.

Table 8.

Serbia: NBS Balance Sheet, 2018–2026

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Sources: National Bank of Serbia; and IMF staff estimates and projections.

Foreign exchange denominated items are converted at current exchange rates.

10. However, prospects for an ongoing swift recovery remain uncertain. The future course of the pandemic and related economic disruptions in Serbia and its trading partners are a key source of this uncertainty. A stronger resurgence of the pandemic (including through new variants), slower vaccine rollout, and delayed effects from the labor market present clear downside risks to the growth outlook and could lead to higher fiscal and external financing needs. On the other hand, building on the 1Q2021 growth momentum, a stronger-than-expected impact of the fast vaccine rollout in Serbia and globally could provide an upside risk. Furthermore, the permanent effects of the crisis could be smaller than now foreseen, in particular, if NPLs and firm closures do not rise significantly. The authorities broadly agreed with staffs assessment including the projected 6 percent growth rate in 2021. They assessed the risks to the baseline projection as symmetrical, with key downside risks stemming from the external environment (including potential slowdown in EU recovery) and upside risks from the domestic environment (stronger-than-expected domestic demand supported by the new fiscal package and the fast vaccine rollout).

11. Staff discussed with the authorities contingent policy options if new waves of the pandemic were to occur. A resulting deeper and more prolonged downturn could have a severe negative impact on corporates and households, whose buffers (credit lines and precautionary savings) could be quickly eroded. Additional support for the most affected sectors and the most vulnerable, including the informally employed, could become necessary. At the same time there would be limited fiscal space for additional measures. Against this background, contingent policies could cover:

  • Ensuring continued provision of adequate health care.

  • Targeted measures to support those most in need and companies or sectors that are most critical to the economy.

  • Identifying options for reallocations of spending within the 2021 budget.

  • Continued monetary accommodation, including operations to maintain market liquidity.

  • Intensified monitoring of emerging financial vulnerabilities, in particular of banks and troubled state-owned enterprises (SOEs).

Policy Discussions

Staff recommended to sustain the economic recovery through continued monetary accommodation and temporary and well-targeted fiscal support, while managing fiscal and financing risks, and reducing fiscal deficits over the medium term. Staff also advised advancing structural fiscal reforms to underpin the necessary restoration of fiscal buffers and to anchor fiscal performance. Advancing the structural reform agenda will foster stronger and more sustainable growth over the medium term. Program discussions built on this assessment.

A. Fiscal Policy

Background

12. Serbia entered into the COVID-19 crisis from a strong fiscal position. Under two consecutive IMF programs during 2015–20, Serbia revamped a stagnating economy burdened with collapsing tax receipts and overspending. Notwithstanding large public wage increases since 2017 and a stubbornly large pension bill, total current expenditures in percent of GDP remained stable through 2019, while rising public investment turned the fiscal balance from small surpluses to a small deficit in 2019—well within the program limit. Revenue collection gradually improved, on the back of improved tax administration and rising incomes. Public debt declined sharply during this period. Growing investors’ appetite for Serbia’s government bonds and relatively benign international financial market conditions helped to reduce borrowing costs, and create sizable liquidity buffers.

13. Following the 2020 support package, the authorities adopted a supplementary budget in April 2021, covering a new round of support measures. The original 2021 budget, approved as a prior action for the final PCI review, envisaged a deficit of 3 percent of GDP, and did not anticipate the third and fourth pandemic waves that hit both Serbia and its trading partners. This budget included higher public investments to support the recovery and boost potential growth, while phasing out the temporary crisis measures deployed in 2020. The 2021 supplementary budget will raise the deficit to 7 percent of GDP. It includes renewed temporary support measures for households and firms (estimated at 2.3 percent of GDP), healthcare expenditures (0.5 percent ofGDP) and subsidies, in particular to support SOEs (including railways and road maintenance) affected by the pandemic (0.5 percent of GDP). Capital investments were revised upward by 1.7 percent of GDP, primarily for investment in infrastructure—including environmental protection, a COVID-19 hospital, and transport infrastructure—and the purchase of military equipment. The higher spending is offset in part (about 1 percent of GDP) by higher revenues. The authorities also expanded the existing state-guaranteed bank loans to SMEs (1 percent of GDP) and announced a new lending guarantee scheme for vulnerable companies (1 percent of GDP).

Supplementary Budget 2021

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Source: Serbian authorities and I MF staff calculations

14. Financing the larger deficit will rely on continued favorable market conditions (Annex VI). The gross financing needs for 2021 are estimated at 12.4 percent of GDP, compared to 15 percent of GDP in 2020. At the onset of the crisis, non-residents scaled down their investments in government securities by 0.5 percent of GDP, prompting a larger drawdown of government deposits and liquidity provision by the NBS. However, as portfolio inflows resumed later in the 2020, Serbia successfully placed two Eurobonds, totaling EUR 3 billion. In February this year, Serbia issued a 12-year Eurobond for EUR 1 billion at a 1.9 percent yield, and JP Morgan announced the inclusion of three dinar-denominated government bonds into its EM indexes, which is expected to increase liquidity and broaden the investor base. Discussions with Euroclear for the settlement of Serbian securities are also advancing. Downside to the debt outlook would stem from the materialization of unforeseen liabilities, additional fiscal costs, a slowdown in growth, and pressures on the exchange rate.

Policy Discussions

15. The supplementary budget provides additional relief to households and businesses affected by the new waves of the pandemic. The authorities also pointed to the need to support growth, in particular given the still uncertain international environment. They considered that the policy support was sufficiently targeted, with the new credit guarantee scheme helping the most affected firms, direct support to employees and firms in the travel and hospitality sectors, as well as support for the unemployed. Staff concurred that the worsening of the pandemic and of the economic outlook warranted additional public sector support and agreed that the additional temporary loosening of the fiscal stance does not jeopardize fiscal sustainability. Since the mission, the economic outlook has improved but still, and notwithstanding the fiscal impulse, a significant output gap remains. Concerning the design of the measures, staff argued that some measures could have been better targeted—for example, granting wage subsidies to COVID-impacted businesses only, and targeting cash transfers to households in need. Staff welcomed the scaling up of public investment in green infrastructure (railways, sewage and waste treatment). The authorities noted that the increased spending in defense was one-off. They reiterated their commitment to closely monitor fiscal risks from the credit guarantee scheme, and to ensure transparency and accountability in COVID-related spending, including by ensuring that this spending is officially accounted for through regular budget execution reports and covered in the regular ex-post audit of expenditures by the State Audit Institution (expected by end-2021).

16. To help entrench the recovery, flexibility in the crisis response needs to continue in 2021 and 2022. The program seeks to avoid a premature withdrawal of support to the economy, and only in case of significant new adverse shocks, further support may be warranted. However, at this stage, the authorities did not see significant scarring effects from the pandemic on the economy except in tourism and hospitality, given the lifelines provided to households and firms, and the positive impact of the higher public investments in overcoming infrastructure gaps and transforming the economy. Staff reiterated that with fiscal room narrowing, any further support, if necessary, should be better targeted towards the most vulnerable households and the most affected firms and sectors, to limit the fiscal cost and increase the fiscal multiplier. Possible additional revenues stemming from better-than-expected economic performance in 2021 should be saved. With the expected rebound of private investment and consumption, a decline in the 2022 deficit to 3 percent of GDP—underpinned in full by the expiration of this year one-off support measures—would allow for maintaining sufficient support for the recovery through high public investment while setting the public debt ratio on a clear downward trajectory. A gradual further decline of the fiscal deficit in subsequent years would support the convergence of output toward potential by 2023.

17. Once the recovery is fully under way, public finances should be anchored by the adoption of a new fiscal rule. The crisis response confirmed the importance of having fiscal space, which should be restored as COVID-19-related support ends. Staff noted that a small fiscal deficit from 2023 onwards, anchored to the level of public debt, constitutes an appropriate framework to put public debt on a downward path and help secure investor confidence. The authorities agreed that a new fiscal rule framework should be designed in consultation with Fund staff—including key elements such as debt thresholds, escape clauses, correction mechanisms, and a strong accountability framework—and be formalized by mid-2022, in time for the 2023 budget (end-June 2022 RT). Staff also advised prioritizing capital investments and argued that a gradual reduction of the public sector wage bill as a percent of GDP is warranted, after sizable increases in the last few years, which the authorities agreed to (PS ¶10). Pensions should continue to be indexed in line with the Swiss formula. The authorities noted that there are no plans to revise the pension indexation formula.

18. Hard-won gains in fiscal management should be preserved while paving the way for policies that can deliver stronger and more inclusive growth, enhance transparency and accountability, and manage risks.

  • Tax administration. Despite some delays caused by the pandemic, Serbia’s Tax Administration (STA) has continued to make progress in auditing, compliance risks management, the large taxpayer unit, and new legislation on unexplained wealth. A new Transformation Program Action Plan (TPAP) for 2021–25 aims to guide further modernization. The reforms, with continued IMF and World Bank support, will focus on business process re-engineering, e-fiscalization, and procurement of a new IT system. Staff emphasized the importance of deliberate change management of the extensive reform process. Recruitment of additional staff remains a priority for the STA, and a new HR strategy is being developed.

  • Fiscal risks. With IMF and World Bank TA, the Fiscal Risks Department (FRD) continues to expand the range of risks it covers. Progress is ongoing to complete the methodologies to properly monitor and manage fiscal risks from litigation and local governments (end-September 2021 RT), in addition to those covering risks from natural disasters, SOEs and state guarantees which have already been completed. A set of bylaws detailing the responsibilities and roles in monitoring and managing fiscal risks, and the use of fiscal risks reports in the decision-making process will also be finalized (end-September 2021 RT). The authorities indicated that after recent personnel departures they were hiring new staff and rebuilding capacity. The mission encouraged these efforts and emphasized the importance of continued coordination with other ministries and departments.

  • Public investment management. A Public Investment Management Unit (PIMU) was established in 2019 with IMF and World Bank support. Following recent personnel departures, the authorities agreed to renew efforts to build human resource capacity and strengthen coordination across departments. Development of a Public Investment Management Information System (PIMIS) is ongoing, and the system is expected to be operational in 2022. This would facilitate monitoring and management of public investment projects, which should all continue to be included in a single project pipeline.

  • State aid. To advance transparency and oversight of state aid, an independent and well-resourced State Aid Commission has been appointed by Parliament. However, the effectiveness of the new system remains to be tested. The authorities will adopt the necessary secondary legislation to make the Law on State Aid Controls effective and aligned with the EU acquis and will publish an inventory of state aid schemes and the associated amounts (end-September 2021 RT).

  • Public procurement. A new public procurement system was introduced in July 2020, with support from the EU and the World Bank. By 2022, all transactions should use the new online portal that offers increased transparency and simplifies procedures. However, selected Government-to-Government projects and infrastructure projects of ‘special importance for the Republic of Serbia’ can be exempted from public procurement rules. The authorities noted that exception to the rules are justified to expedite the execution of critical public investments projects. The mission reiterated that, to mitigate risks of corruption, and enhance transparency and trust, it is important to ensure competitive bidding processes, full use of the new portal, to maintain audit trails and to publish information regarding entities awarded procurement contracts, their beneficial owners, and details of the contracts. Staff noted that the new procurement framework and its implementation should be assessed once it has been in full use.

  • Social protection. While the means-tested social assistance programs (especially financial social assistance and child allowances) are well-targeted, benefits and coverage are limited, leaving out many vulnerable people, including in times of crisis. Currently, only half of the population under the poverty line receives some support. Going forward, a more cost-efficient system would facilitate a more agile and effective response in times of crisis, while increasing its impact on poverty and inequality reduction. The ongoing effort of the government to upgrade the existing social cards should be a step in the right direction and should be used to expand the coverage of the most vulnerable.

  • Public wage and employment framework. The authorities confirmed their commitment to adopt the new public wage system, as well as amendments to the job catalogue for the public sector and the associated coefficients during 2021, for implementation in 2022. Staff emphasized that the pace at which wages converge to their new levels should depend upon available fiscal space. The general government employment framework continues to be controlled by a cap on the total number of new hires, and guided by the Employment Commission’s decisions on individual staff hires, although with enhanced flexibility since January 2021 for taking into account the institution’s budget limits and staffing needs. The authorities plan to phase out the existing system once a new system based on medium-term workforce planning is sufficiently effective and comprehensive. This should anchor their objective of gradually reducing the public sector wage bill as a share of GDP.

  • Labor taxation. The labor tax wedge remains relatively high, especially for low-income and part-time contract workers. The authorities indicated their willingness to reduce taxes weighing on labor income further by gradually increasing the threshold for non-taxable personal income. The mission suggested additional options for reforms, including the introduction of a family allowance, or tax breaks for social security contributions for low wage earners, that would make labor markets more inclusive and encourage formal employment.

  • Fiscal statistics. The submission of general government fiscal data to the IMF GFS Yearbook publication restarted in January 2021. With Fund TA, the reporting of monthly fiscal accounts in line with GFSM 2014 presentation, and in accordance with international dissemination best practices, is being finalized (end-September 2021 RT).

B. Monetary and Financial Sector Policies

Background

19. Within the stabilized exchange rate regime, monetary policy remains accommodative and the banking system liquid. With inflation pressures subsiding and the emergence of the pandemic, the NBS cut its policy rate from 2.25 percent in 2020 to 1 percent by December (with an interest rate corridor reduced to ±0.9pp), where it has remained since. Short term interest rates have remained near the bottom of the corridor. To offset depreciation pressures since the onset of the pandemic crisis, the NBS made foreign exchange sales of EUR 1.45 billion in 2020, falling to EUR 50 million in 1Q2021 (Figure 3). However, reserves remain high at around EUR 13.5 billion (or 5.4 months of prospective imports), supported by the Eurobond issuances.

20. Furthermore, the NBS has taken extraordinary measures to support economic activity during the pandemic (Annex IV. Table 2):

  • Providing additional liquidity through: (i) dinar repo purchases and FX swap auctions, (ii) outright purchase of dinar government securities at market rates (1.6 percent of GDP) to ensure stability of the government bond market, and (iii) making qualifying local-currency denominated corporate bonds issued before end-2020 eligible for open market operations and as collateral for banks to receive central bank short-term liquidity.

  • Arranging a repo line with the ECB (up to EUR 1 billion in exchange for adequate euro-denominated collateral) until March 2022 to address the possible euro liquidity needs of Serbian banks in case of market dysfunction.

  • Subsidizing loans in dinars, by increasing the remuneration (by 0.50 percentage points) on allocated required reserves in dinars for banks approving dinar loans under the state guarantee scheme at sufficiently low interest.

  • Introduced three rounds of debt moratoria to ease the burden of loan repayments. The first two moratoria lasted from April to June and from August to September 2020 and were directed at all borrowers unless they opted out. The third relief measure, from December 2020 through April 2021, targeted only retail and corporate customers affected by the pandemic. At end-February 2021 only around 43,000 had made use of this facility (with an amount of EUR 0.9 billion, around 4 percent of private sector credit outstanding).

  • Facilitating housing loans, including by reducing the mandatory down payment for first-time home buyers.

21. Credit activity remains robust. Supported by the NBS’ measures and the government guarantee scheme for bank lending to SMEs, credit growth reached 7.7 percent yoy in March 2021. These measures have also encouraged credit dinarization, which recorded an all-time high of 37.4 percent in February 2021. While NPLs remained low (at 3.9 percent at end-March 2021), total loan loss provisions were increased by 12 percent in 2020 and by an additional 1.9 percent in the first two months of 2021 (allowances for loans’ impairment covered 58 percent of gross NPLs at end-February 2021) in consideration of the possible increase in Stage 2 and Stage 3 status. Nonetheless, banks remained profitable (Table 9), and profitability declined less than elsewhere in the region.

Table 9.

Serbia: Banking Sector Financial Soundness Indicators, 2016–2021

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Source: National Bank of Serbia.

Policy Discussions

22. With inflation below target and inflation expectations well anchored, staff supported maintaining an accommodative monetary policy stance and other measures to secure the economic recovery. The authorities noted that they still had sufficient policy space to respond to further pressures if needed, including through the extension of the measures used so far. With inflation in Serbia expected to remain within the target band, a negative output gap, and interest rates in the eurozone low for the time being, monetary policy normalization is not anticipated until after 2021. The authorities were satisfied that their expansionary monetary and macroprudential measures had been effective in expanding bank lending to the real sector and had contributed to lowering the economic cost of the pandemic, and that the stability of the exchange rate had been key to preserving business and consumer confidence.

23. Staff stressed the need to closely monitor risks in the banking sector. While the NPL ratio is currently low, staff expected some increase once the crisis support measures expire. The authorities agreed that banks should continue to assess borrowers’ creditworthiness and reclassify exposures when repayment appears unlikely, and they noted that dividend distribution would remain suspended until the pandemic crisis had ended. New measures aimed at discouraging lending in foreign currency had been postponed in light of the pandemic, and were planned to become effective later this year. Staff urged the authorities to find a prompt solution to the increasing number of lawsuits challenging the charging of loan and mortgage insurance fees that are currently being litigated in court (more than 130,000 cases at end-December).

24. The authorities and staff discussed the case for more exchange rate flexibility over the medium term. The authorities continued to see exchange rate stability as essential to macroeconomic stability, given the adverse impact that a significant depreciation could have on confidence, inflation, FX denominated debt and the dinarization strategy. Staff argued that, although there was a case for maintaining exchange rate stability through the crisis to maintain confidence, a more flexible exchange rate could actually support dinarization by exposing borrowers to the risks they incur through unhedged FX loans. Development of hedging instruments would also minimize these risks. The authorities responded that investors valued exchange rate stability and noted that hedging markets had not developed in earlier periods of exchange rate volatility. They also stressed that the dominance of foreign-currency pricing in trade invoices limited the ability of a flexible exchange rate to act as a shock absorber.

25. The authorities plan to start reforms to strengthen capital markets and development finance. Capital markets in Serbia remain relatively underdeveloped. Over the longer term, developing capital markets could provide more financing options for firms, allowing them to borrow based on future cash flow rather than their ability to post collateral. It would also enable firms to obtain financing with longer maturity than most bank financing permits. Furthermore, this could facilitate the dinar to become a long-term store of value, supporting the dinarization strategy. The authorities have prepared a strategic outline to enhance capital markets (with EBRD support) and an action plan should be ready by end-September 2021 (RT). They are also preparing a plan for development finance, to facilitate access to finance, in particular, for SMEs. In this context, the authorities explained that they are continuing to implement the new strategy for the state-owned bank BPS, which was prepared with assistance from the World Bank. The strategy includes the bank’s commercial reorientation towards retail banking, entrepreneurs, micro-enterprises and small enterprises, as well as improvements in its corporate governance (PS ¶30). Staff reiterated the case against creating a development bank, given governance concerns and fiscal risks. The authorities indicated that such a bank would not be included in their planning (PS ¶31).

C. Structural Policies

Background

26. The impact of the pandemic on Serbia’s labor market appears contained, in the context of a declining unemployment trend and a still-large informal sector. Labor market conditions held fairly steady in 2020 (Figure 7): the unemployment rate fell to 9.5 percent (from 10.9 percent in 2019) and employment increased to 61.3 percent (from 60.7 percent in 2019). Informal employment dropped to 17 percent (from 18.2 percent in 2019), albeit with some recovery in 4Q2020 yoy. Both registered employment and unemployment showed some pick-up in early 2021, which could largely reflect a return to active job search of those who left the labor force due to the pandemic. Although policy measures were introduced to prevent layoffs (Annex IV), these did not cover informally-employed and temporary/seasonal workers. However, layoffs may still increase once job protections expire. While official statistics are not available, the authorities noted a significant return of Serbian citizens working abroad due to the pandemic.

Figure 5.
Figure 5.

Serbia: Selected Interest Rates

Citation: IMF Staff Country Reports 2021, 132; 10.5089/9781513583181.002.A001

Figure 6.
Figure 6.

Serbia: Fiscal Developments

Citation: IMF Staff Country Reports 2021, 132; 10.5089/9781513583181.002.A001

Figure 7.
Figure 7.

Serbia: Labor Market Developments

Citation: IMF Staff Country Reports 2021, 132; 10.5089/9781513583181.002.A001

uA001fig09

Registered Unemployed

Citation: IMF Staff Country Reports 2021, 132; 10.5089/9781513583181.002.A001

Sources: National employment service, IMF staff calculations.

27. In March, the authorities adopted a new ownership and governance strategy for SOEs, prepared with EBRD support. Serbia has a relatively large SOE sector, which has been a drag on growth and brought large fiscal costs in the past. 2 SOE governance frameworks could be improved for greater transparency, as well as for better accountability and performance. Reforms related to SOE governance were started under the previous PCI, but have not been completed (Annex II). The new state ownership policy complements ongoing efforts to better monitor and tackle fiscal risks and enhance efficiency (PS ¶40). It also identifies both the rationale and high-level objectives of the State’s ownership; develops criteria for classification of SOEs; designs the framework for setting objectives and targets for SOEs and for monitoring their achievement; and reviews the Legal and regulatory framework for corporate governance of SOEs.

Policy Discussions

28. Better formation and utilization of skills will be key to sustained growth. Serbia has been successful in attracting FDI, taking advantage of its relatively modest labor costs. However, as unemployment has reached historically low levels, and given unfavorable demographic trends and the pull of higher wages in EU countries, greater emphasis on productivity will be imperative. The authorities intend to continue to focus on digitalization as the underlying tool for the transition to a knowledge- and innovation-based economy, noting ongoing efforts to digitize the education system. Staff also noted that the large scale return during the pandemic of Serbs who have been working abroad presented an opportunity to reverse some of the pre-pandemic demographic headwinds and welcomed the authorities’ initiatives to encourage return migration.

uA001fig10

Formal and Informal Employment

(Percent, yoy change)

Citation: IMF Staff Country Reports 2021, 132; 10.5089/9781513583181.002.A001

Source; Statistical Office of Serbia (SORS), IMF staff calculations.

29. Staff underscored the importance of advancing SOE reforms. Staff urged the authorities to set ambitious time frames to anchor reforms outlined in the action plan which should be adopted by end-June 2021 (RT). The authorities agreed that the key actions should include developing a key performance indicators (KPI) framework, establishing a unified process for monitoring the implementation of the state-owned policy, and establishing composition, fit and proper criteria, and tenure guidelines for the supervisory boards. The development of a centralized and updated database with a registry of all SOEs and their assets and the adoption of a ministerial act by the Ministry of Economy presenting mechanisms and criteria for approving key SOE decisions (end-December 2021 RT) would demonstrate progress towards the preparation of a new ownership management law (December 2022 RT). In parallel, the government plans to restructure the large public utility companies and to resolve the remaining strategic companies in the privatization portfolio.

  • Petrohemija. The authorities noted recent progress towards privatizing the state-owned petrochemical company (a delayed reform under the previous PCI). They expressed an intention to launch a privatization tender during the Summer.

  • Elektroprivreda Srbije (EPS, state-owned power utility company). The government adopted a new law on renewable energy sources in April, replacing the feed-in tariffs for renewable energy sources with a competitive auction system. The electricity tariff was increased by 3.4 percent in February but remains significantly lower than the EU average. The mission reiterated the need for cost recovery, while underscoring the importance of incorporating the distributional impact of tariff increases. The authorities noted that recent amendments to the Law on Energy had expanded the identified group of vulnerable consumers who receive subsidies for electricity, heat, or gas, from about 70,000 to 200,000, to protect them from undue price increases. Staff welcomed the authorities’ plans to finalize the conversion of the company into a joint-stock company by end-November 2022 (RT).

  • Srbijagas. Staff supported the authorities’ intention to complete the operational unbundling of Srbijagas and encouraged them to convert the company into a joint-stock company.

  • Others. The authorities are in discussions with all stakeholders to implement an action plan for closing the unviable Resavica coal mines while cushioning the social impact in the vulnerable region. They also intend to continue exploring options for potential strategic investments for chemical company MSK and privatization of bus company Lasta in 2021.

30. Reducing the footprint of the informal economy remains critical to raising Serbia’s growth prospects. The size of Serbia’s grey economy remains high. The authorities reaffirmed their commitment to curb the grey economy with the adoption of a new action plan later this year, which prioritizes improvements in the inspection system, modernization of the tax administration, strengthening of incentives for voluntary compliance, and improving the business environment to encourage entrepreneurship and innovation. The authorities also noted that a large part of Serbia’s grey economy reflects unregistered labor, and staff therefore encouraged the planned expansion of the law on seasonal employment.

31. Serbia should advance reforms to transition towards a greener economy. Investments in green infrastructure and the transition to a lower-carbon future can support job creation while increasing economic and environmental resiliency (Box 2). Staff noted that green investments in energy infrastructure are critical not only to raise efficiency and reduce greenhouse emissions, but also to improve air quality. The authorities emphasized the adoption of the Law on Climate Change in March as a milestone towards reducing emissions and ensuring adaptation to climate change. They noted that a low carbon development strategy and an action plan should be adopted within two years.

32. Serbia’s anti-corruption framework needs further strengthening. Additional efforts are needed to strengthen the asset disclosure regime for high-level public officials, to enhance the capacity of anticorruption institutions, and to ensure credible prosecutions of false asset disclosures and of other corruption offenses. 3 The mission welcomed Serbia’s recent progress in addressing AML/CFT deficiencies, but underscored that work needs to continue to demonstrate sustained improvement in the effectiveness of the AML/CFT framework, including beneficial ownership information and risk-based supervision. Staff urged the authorities to step up the implementation of the recommendations made by the Council of Europe’s Group of States against corruption (GRECO). The authorities noted the ongoing constitutional reforms aimed at making the judiciary more independent, efficient and accountable, as well as intentions to upgrade the judicial IT system. The authorities expected that progress on GRECO recommendations will be acknowledged during the first PCI review.

Serbia’s Transition to a Greener Economy: Policies and Opportunities

Like other countries, Serbia has become increasingly vulnerable to climate and environmental risks.

The authorities estimate that costs associated with extreme climate and weather events have exceeded EUR 5 billion since 2000, with droughts and rising temperatures accounting for most of the losses.1 The Serbian population is also experiencing the negative repercussions from historical legacies, in particular those related to an energy sector centered on coal—which generates about 70 percent of total electricity in the country—and delays in waste disposal and water treatment. For example, when it comes to the health impact of air pollution, Serbia fairs particularly poorly relative to the EU and CESEE averages.

uA001fig11

Health Impact Due to Environmental Risks, 2019

(DALYs per thousand inhabitants)

Citation: IMF Staff Country Reports 2021, 132; 10.5089/9781513583181.002.A001

Source: OECD. IMF staff caculatioris.Note: The DALY (disability adjusted life year] indicator accounts for the years lost to premature death and reduced quality of life due climate and environmental risks-.

Serbia has committed to ambitious climate goals. In July 2017, Serbia ratified the Paris Agreement that aims to limit global warming by decreasing greenhouse gases (GHG) emissions. As an EU candidate, Serbia is also obliged to comply with EU legislation in a number of climate-related areas, as outlined in Chapter 27 of the EU acquis. More recently, Serbia has signed the Declaration on the Green Agenda for the Western Balkans that came as part of the Economic and Investment Plan for the Western Balkans adopted by the European Commission in 2020. The Declaration envisages action in five key areas: decarbonization, water and soil, circular economy, farming and food production, and biodiversity and air pollution.

To set the stage for meeting these goals, in March, Serbia adopted a Law on Climate Change providing the framework legislation to address climate change challenges. The law, developed with EU assistance, sets the scene for a low-carbon development strategy, which should be adopted in the next two years together with an action plan. The law also stipulates the reestablishment of the National Climate Change Committee, to provide expert opinion and oversight of climate action in the country. In March 2021, the government adopted four bills in the energy sector, aiming at enhancing energy efficiency and savings, enabling new investments in renewables, increasing transparency and competition in the energy market, and updating regulations in the mining sector.

Recent initiatives and legislation also aim to tackle environmental pollution. In January 2021, a new rulebook on liquid fossil fuels entered into force, which is expected to reduce SO2 emissions from heating and contribute to improving air quality, especially in urban areas. In February 2020 the National Plan for the Reduction of the Main Pollutant Emissions from Old Large Combustion Plants was adopted, which is expected to support implementation of emissions reductions and lead to reduction in pollutants from large combustion plants.

Prioritizing green investments—including through the Serbia 2025 infrastructure investment program—and carbon pricing mechanisms can support both job-rich growth and emissions reduction. As the recovery takes hold, a gradual increase in carbon prices could provide additional revenues and create a virtuous circle of cost-efficient investments and adjustments in behavior. Compensation mechanisms should be designed to support those households adversely affected by the transition (typically the poorer, for whom energy represents a larger share of consumption).

The implementation of an ambitious green agenda would require substantial public and private funding. To this end, EU institutions can play a pivotal role to channel sizable investments. Instruments under the next EU Multiannual Financial Framework (MFF, 2021–2027) are being negotiated. Existing Instruments for Pre-Accession Assistance (IPA) can support energy efficiency and renewable energy sources and a shift to low-carbon economies. The introduction of innovative financial instruments (e.g. green bonds) to lever on the private sector could also be used, with IFI support.

1 Intended Nationally Determined Contributions of the Republic of Serbia. Available here.

Program Modalities

33. The proposed new PCI aims at supporting the recovery from the crisis, maintaining macroeconomic stability, and anchoring the medium-term fiscal policy framework, while pushing ahead with structural reforms to deliver more inclusive and sustainable growth. Reform priorities under the program will reflect the authorities’ policy and reform agenda, and will be anchored around the following key pillars:

  • Anchoring the fiscal policy framework. After successful consolidation through 2019, fiscal discipline should be underpinned by new fiscal rules, effective implementation of the new employment framework, steps to contain public wage costs, ongoing strengthening of tax administration, effective implementation of PIM systems and fiscal risks monitoring, better controls of state aid, and updated accounting rules.

  • Strengthening SOE governance. Implementation of the new strategy should ensure better monitoring, increased efficiency, and reduced fiscal risks.

  • Developing capital markets and further increasing dinarization. Reforms should be guided by the forthcoming government strategies (see ¶25), which aim to develop domestic sovereign and corporate bond markets, and improve access to finance for SMEs, combined with already announced regulatory steps to limit risks from unhedged lending in foreign currency.

  • Improving the provision of social assistance. A new integrated social card registry should be put in place to identify social needs in real time. Building on this, the social assistance system should be made more flexible (to deal with crisis situations) and more targeted and comprehensive to cover those in need.

  • Transition to a green economy. Creating a legal framework for environmental and climate action, while implementing investments in green infrastructure and creating incentives for transition to a lower-carbon future.

34. The attached Program Statement (PS) details the authorities’ policy commitments under the 30-month PCI. Serbia does not need the Fund’s financial assistance under the baseline and is not seeking financial assistance from the Fund. Reviews are set out in PS Table 1, with quantitative targets (QTs) for the key set of macroeconomic variables to be monitored on a semiannual basis: general government fiscal deficit, current primary expenditure of the Republican budget, domestic payment arrears, and the inflation consultation band. In addition, there is a continuous target on the non-accumulation of external debt payment arrears. The proposed reform targets (RTs) under the program have been calibrated and phased in accordance with the authorities’ plans and implementation capacity, and in collaboration with other IFIs. Proposed RTs for the next 12 months are presented in PS Table 2. Over the course of the program, conditionality is expected to shift from fiscal reforms to other structural and financial-sector reforms, including those related to the green agenda and social protection, building on future TA and in collaboration with other IFIs on related strategies and actions over the course of the new PCI.

35. Risks to a new PCI are assessed to be moderate. Serbia built a good track record under the recently completed PCI. Going forward, Serbia will need to maintain a political consensus in favor of fiscal discipline and market-oriented reforms. There is no balance of payments gap for the next 12 months and there are good prospects that there will be adequate financing for the remaining program period. Nevertheless, program risks are elevated by pandemic-related uncertainties and the 2022 elections.

36. Serbia has small sovereign arrears outstanding. The authorities have been in contact with their Libyan counterparts to resolve its arrears to Libya, which arose in 1981 due to unsettled government obligations related to a loan for importing crude oil. Staff urged the authorities to continue their efforts to resolve these arrears as soon as possible.

Staff Appraisal

37. The fiscal, monetary and financial sector policy measures implemented in response to the pandemic provided vital support to the economy. Low reliance on tourism and other high-contact sectors, and strong growth momentum going into the crisis also helped to limit the pandemic’s negative effects on Serbia’s economy. Albeit exposed to many risks, the recovery now appears to be strengthening. Inflation is low and the banking system stable and liquid. Despite a large fiscal impulse, borrowing costs remain contained and public debt sustainable around 60 percent of GDP.

38. However, pandemic risks have not vanished yet, reflecting uncertainties on the pace and effectiveness of vaccinations across the region, and the timing and scale of reopening. In addition, the full impact of the pandemic on Serbia’s labor market and NPLs is likely to manifest later on during the year, as wage subsidies, and the related cap on dismissing workers, and the loan moratorium will have expired. Further policy initiatives may still be needed to cushion renewed crisis effects, while maintaining transparency and accountability, and taking into account the more limited fiscal space. Serbia’s external position remains broadly consistent with fundamentals and desirable policy settings.

39. The new program will assist the authorities navigating through the crisis, while advancing structural and institutional reforms to strengthen Serbia’s economic potential. The immediate priorities consist of supporting the economy through the crisis, overseeing implementation and phase out of the large policy support package, and monitoring risks. The longer-term goals of the program will include fostering inclusive growth and maintaining financial stability. As the recovery takes hold, a return to small fiscal deficits and declining debt levels needs to be entrenched into the program to restore policy buffers. Spending increases on public sector wages and pensions should be tightly controlled.

40. The opportunity to build a greener and more digital economy should not be missed. The renewed focus, both domestically and abroad, on climate-related risks should be taken as an opportunity to avoid carbon-intensive investments. Instead, spending should be redirected to well-designed climate-smart infrastructures and technologies, and environmental protection projects, which can support near-term growth and limit the potential scarring effects of the crisis.

41. Decisive actions should be taken to advance structural reforms and strengthen institutions. Moving forward with reforms of Serbia’s large and inefficient SOEs remains critical, to strengthen their governance and improve their management. Enhancing the business environment—including by strengthening the rule of law, improving the efficiency of the judicial system, and curbing corruption—would help attract foreign as well as domestic investments. Encouraging dinarization and developing domestic capital markets would enhance financial deepening and support medium-term growth.

42. The program faces domestic and external risks beyond those stemming from pandemic. Ongoing progress in the structural reform agenda hinges on continued political consensus. After several years of engagement with the Fund—first under a precautionary SBA, then under a PCI—it will be important to maintain the reform momentum, including during the forthcoming election period. Furthermore, Serbia remains exposed to external shocks, including possible tighter global financing conditions. Gradually allowing for greater exchange rate flexibility could be beneficial to financial stability.

43. The PCI provides an appropriate instrument to support the authorities’ program. Staff does not foresee a need for Fund financing during the program period. Program reviews will test the authorities’ commitment to reforms during the program period, as well as provide the opportunity to adjust policies in light of developments. Staff supports the authorities’ request for the PCI. It is recommended that the next Article IV consultation with Serbia be held on the 24-month cycle, in accordance with Decision No. 14747-(1096) on consultation cycles.

Table 10.

Serbia: Indicators for Monitoring Progress Towards SDGs

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Source: UN SDG Indicators Global Database; National Authorities

2016

2017

2018

2019

2020

Table 11.

Serbia: Schedule of Reviews Under the Policy Coordination Instrument, 2021–2023

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Annex I. Response to Past Policy Advice

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Annex II. Conditionality Under the 2018 Policy Coordination Instrument

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Annex III. Risk Assessment Matrix 1

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Annex IV. Chronology of COVID-19 Measures in Serbia

Annex IV. Table 1.

Serbia: Summary of Fiscal Response to COVID-19

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Source: Serbian authorities, IMF staff estimates.
Annex IV. Table 2.

Serbia: COVID-19 Measures for the Monetary and Financial Sectors

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Source: National Bank of Serbia

Annex V. External Sector Assessment

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Annex VI. Debt Sustainability Analysis

Public debt increased in 2020 due primarily to the large financing needs created by the economic support package in response to the COVID-19 pandemic. Going forward, under the baseline public debt is projected to increase marginally as a share of GDP in 2021 and gradually decline thereafter. Risk factors stem from the possible loss of fiscal discipline, negative growth shocks, and exchange rate volatility.

1. While starting from a higher base, the profile of public debt in percent of GDP remains benign. The unprecedented fiscal financing needs caused by the pandemic, combined with the growth shock, drove public debt 5.6 percentage points higher in 2020, to 58.4 percent of GDP, while contingent liabilities were broadly unchanged, at around 3 percent of GDP. 1 In 2021, under the baseline, public debt is projected to increase marginally to around 60 percent of GDP, and decline gradually thereafter. The DSA baseline is in line with staff’s macroeconomic projections. Real GDP is expected to rebound by 6 percent in 2021, while the fiscal deficit is projected at 6.9 percent of GDP, from 8.1 percent in 2020. Gross financing needs in 2021 are estimated at 12.2 percent of GDP, fully covered by issuance on domestic and international markets (8.7 percent of GDP), project loans and budget support from IFIs (2.4 percent of GDP), and deposits drawdown (1.2 percent of GDP). Over the medium term, the output gap is expected to gradually close, inflation to remain within the tolerance band of the NBS, and the fiscal deficit to narrow towards 1 percent of GDP.

2. Vulnerabilities remain concentrated in the large shares of foreign currency debt and debt held by non-residents, but mitigating factors apply. Compared to the last DSA, the main sources of risk remain broadly unchanged. Market perception risks have abated, reflecting lower risk premia across EMs compared to last year. Conversely, external financing needs continue to be elevated, just above the 15 percent threshold for EM economies. Debt held by-non-residents exceeds 60 percent, and the share of debt denominated in foreign currency stands at 69 percent (49 percent is in euro). Nonetheless, the large share of multilateral and institutional creditors to whom external debt is owned, the long average maturity of outstanding debt, and the fixed interest rate structure represent important mitigating factors. 2 The heat matrix points to risks from the change in short-term debt. However, this reflects the resumed issuance of short-term paper in 2020, which had not happened over a number of years. Risks from this practice are contained given that the amount remains small at 0.5 percent of GDP.

3. Macro-fiscal stress tests highlight risks from lack of fiscal discipline, low growth, and a weakening of the exchange rate. Over the medium-term, the positive outlook for both the debt profile and financing needs hinges on strong fiscal outcomes, and a return to sustained growth. Conversely, under the historical scenario debt remains on an increasing trajectory and financing needs are significantly higher than under the baseline. 3 The set of macroeconomic stress tests also underscores the importance of a return to fiscal discipline and sustained economic growth. The stress tests indicate that the currency depreciation shock would create quickly rising debt levels and financing needs, given the large share of foreign currency-denominated debt. In contrast, the interest rate shock would have only moderate effects, in light of the favorable interest rate structure. The calibrated contingent liabilities shock increases gross financing needs by about 4 percent of GDP in 2022. Only under the combined macroeconomic shock, public debt in percent of GDP reaches 70 percent.

4. Forecast errors are in line with other market access countries, and the projected fiscal stance is realistic. Large forecast errors for real GDP growth in some years are explained by sharp output contractions amid the global financial crisis in 2009, and by severe weather shocks with negative repercussions for agricultural output and energy production in 2012 and 2014. However, growth has typically been higher than projected since 2015, during the program years. Forecast errors in primary balance projections have been positive in recent years, reflecting better fiscal outcomes than budgeted, while those for inflation are in line with comparator countries. The DSA assumes a fiscal multiplier of 0.5, approximately in the middle of the range of values found in the literature, and appropriate for economies that are smaller and more open. The projected 3-year average level of the cyclically adjusted primary balance remains comfortably below the top quartile of the distribution. The planned fiscal adjustment over any three years during the projection horizon exceeds 3 percent of GDP, following the large pandemic-deficit in 2020 to help cushion the adverse effects of the COVID-19 crisis.

Annex VI. Figure 1.
Annex VI. Figure 1.

Serbia: Public Sector Debt Sustainability Analysis (DSA) – Risk Assessment

Citation: IMF Staff Country Reports 2021, 132; 10.5089/9781513583181.002.A001

Source: IMF staff.1/ The cell is highlighted in green if debt burden benchmark of 70% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.2/ The cell is highlighted in green if gross financing needs benchmark of 15% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.3/ The cell is highlighted in green if country value is less than the lower risk-assessment benchmark, red if country value exceeds the upper risk-assessment benchmark, yellow if country value is between the lower and upper risk-assessment benchmarks. If data are unavailable or indicator is not relevant, cell is white. Lower and upper risk-assessment benchmarks are: 200 and 600 basis points for bond spreads; 5 and 15 percent of GDP for external financing requirement; 0.5 and 1 percent for change in the share of short-term debt; 15 and 45 percent for the public debt held by non-residents; and 20 and 60 percent for the share of foreign-currency denominated debt.4/ EMBIG, an average over the last 3 months, 03-Feb-21 through 04-May-21.5/ External financing requirement is defined as the sum of current account deficit, amortization of medium and long-term total external debt, and short-term total external debt at the end of previous period.
Annex VI. Figure 2.
Annex VI. Figure 2.

Serbia: Public DSA – Realism of Baseline Assumptions

Citation: IMF Staff Country Reports 2021, 132; 10.5089/9781513583181.002.A001

Source: IMF Staff.1/ Plotted distribution includes program countries, percentile rank refers to all countries.2/ Projections made in the spring WEO vintage of the preceding year,3/ Not applicable for Serbia, as it meets neither the positive output gap criterion nor the private credit growth criterion,4/ Data cover annual obervations from 1990 to 2011 for advanced and emerging economies with debt greater than 60 percent of GDP. Percent of sample on vertical axis.
Annex VI. Figure 3.
Annex VI. Figure 3.

Serbia: Public DSA – Baseline Scenario

(in percent of GDP, unless otherwise indicated)

Citation: IMF Staff Country Reports 2021, 132; 10.5089/9781513583181.002.A001

Source: IMF staff.1/ Public sector is defined as general government and includes public guarantees, defined as Government guarantees.2/ Based on available data.3/ EMBIG.4/ Defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.5/ Derived as [(r – π(1+g) – g + ae(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).6/ The real interest rate contribution is derived from the numerator in footnote 5 as r – π (1+g) and the real growth contribution as -g.7/ The exchange rate contribution is derived from the numerator in footnote 5 as ae(1+r).8/ Includes changes in the stock of guarantees, asset changes, and interest revenues (if any). For projections, includes exchange rate changes during the projection period.9/ Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.
Annex VI. Figure 4.
Annex VI. Figure 4.

Serbia: Public DSA – Composition of Public Debt and Alternative Scenarios

Citation: IMF Staff Country Reports 2021, 132; 10.5089/9781513583181.002.A001

Source: IMF staff.
Annex VI. Figure 5.
Annex VI. Figure 5.

Serbia: Public DSA – Stress Tests

Citation: IMF Staff Country Reports 2021, 132; 10.5089/9781513583181.002.A001

Source: IMF staff.

Annex VII. External Debt Sustainability Analysis

Serbia’s external debt is assessed to be sustainable over the medium term, although the COVID-19 pandemic temporarily influenced its path adversely relative to pre-pandemic projections. In addition, external debt dynamics are particularly sensitive to real exchange rate shocks, given that external debt is mainly denominated in foreign currencies. Thus, it is essential to continue with prudent fiscal policies and structural reforms.

1. Total external debt is expected to resume its gradual decline started in 2015, albeit moderated by the effects of the COVID-19 pandemic. With a sustained private sector deleveraging that took place over 2010–2015 coming to a halt, public sector deleveraging took over during the 2016–2018 period. The current landscape is influenced by COVID-19: after steadily declining since 2015, the external-debt-to-GDP ratio increased to 70.9 in 2020, is projected to remain broadly stable in 2021, and gradually decline in the following years, reaching 55.4 percent by 2026. In this context, gross financing needs are expected to be around 13 percent of GDP in 2021, and decline over the medium term, with external debt financing 81 percent of those needs in 2021 and gradually declining to finance 47 percent of the needs in 2026.

Annex VII. Table 1.

Serbia: External Debt Sustainability Framework, 2014–2026

(in percent of GDP, unless otherwise stated)

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Derived as [r – g – r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

2. Structure of total external debt. As of end-2020, about 82 percent of Serbia’s external debt was long term debt, with 45 percent issued by the public sector and 37 percent by the private sector, while about 18 percent is short term debt (on a remaining maturity basis), with 4 percent issued by the public sector and 14 percent by the private sector. In addition, about 40 percent of Serbia’s external debt is held by official creditors and 60 percent by private creditors, including Eurobonds issuances, accounting for 15 percent of total external debt, and banks and other financial institutions, accounting for the remaining 44 percent. Also, local currency debt held by nonresidents has remained below 5 percent of GDP.

3. The projected paths for economic growth, the current account, and net FDI inflows are the main factors driving the dynamics of Serbia’s external-debt-to-GDP ratio. Economic activity declined by -1.0 percent in 2020, putting upward pressure on the external-debt-to-GDP ratio, but growth is expected to recover and peak at 6 percent in 2021, before converging to its potential rate of 4 percent by 2023. The current account deficit narrowed significantly to -4.3 percent of GDP in 2020 (from -6.9 percent in 2019), largely due to a sharp decline in the primary income deficit, and lower imports from reduced domestic activity and a temporary drop in net FDI inflows. As the pandemic crisis recedes, the current account deficit is projected to increase in 2021 to -5.1 percent in 2021 and stabilize around -5 percent in later years. This, and the recovery in economic activity, will help keep external-debt-to-GDP on a declining path through 2026. Net FDI inflows, which were at historically high levels both in 2018 and 2019, declined to 6.2 percent of GDP in 2020, and are expected remain broadly around this level until 2026.

4. The external debt path is particularly sensitive to possible real exchange rate depreciation shocks. As shown among the shock scenarios, a 30 percent real depreciation of the dinar in 2020 would cause the external debt-to-GDP ratio to exceed 100 percent in 2022 and to stabilize at 83 percent by 2026. However, the large share of multilateral and institutional creditors to whom external debt is owned, the long average maturity of outstanding debt, and the prevalent fixed interest rate structure are important factors mitigating this vulnerability.

5. It is essential to continue with prudent fiscal policy and further enhance structural reforms. When the COVID-19 crisis is over, it will be crucial to go back to the strong fiscal performance Serbia experienced during 2019 and preceding years. This should include completing the fiscal-structural agenda which was being implemented in the context of successive Fund-supported programs. Regarding competitiveness, higher productivity and higher value-added investment would facilitate further convergence and resilience against shocks, including the potential exchange rate depreciation shock described above.

Annex VII. Figure 1.
Annex VII. Figure 1.

Serbia: External Debt Sustainability: Bound Tests 1/ 2/

(External debt in percent of GDP)

Citation: IMF Staff Country Reports 2021, 132; 10.5089/9781513583181.002.A001

Sources: International Monetary Fund, Country desk data, and staff estimates.1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.2/ For historical scenarios, the historical averages are calculated over the ten-year period, and the information is used to project debt dynamics five years ahead.3/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.4/ One-time real depreciation of 30 percent occurs in 2021.

Appendix I. Program Statement

Belgrade, June 3, 2021

Ms. Kristalina Georgieva

Managing Director

International Monetary Fund

Washington, D.C., 20431 U.S.A.

Dear Ms. Georgieva:

Serbia has weathered the COVID-19 crisis relatively well so far. Owing to prudent macroeconomic and financial policies prior to the pandemic, Serbia had sufficient policy space when the crisis hit to respond with a strong support package. This substantial policy response helped mitigate the economic and social impact of the shock. Following a severe output contraction in the second quarter of 2020, the economy rebounded quickly and the annual real GDP contraction in 2020 amounted to 1 percent—one of the smallest in Europe. With Serbia’s vaccine rollout among the fastest in Europe, we expect the economic recovery to continue in 2021. However, significant risks persist, especially due to the uncertainty about the future course of the pandemic, both in Serbia and in its key trading partners. After a sharp spike at end-2020, infections rose again in late-February and March, triggering new containment measures.

Our economic program supported by the Policy Coordination Instrument (PCI) that expired in January 2021 was instrumental in implementing policies that supported businesses and households through the crisis. The program also helped advance our structural reform agenda, albeit with delays in some areas mostly due to the pandemic.

The Government of the Republic of Serbia requests approval of a new macroeconomic and structural reform program supported by a PCI for the period June 2021-December 2023. To support this request, this Program Statement (PS) outlines the government’s objectives and sets out the economic policies that the Government and the National Bank of Serbia (NBS) intend to implement under the new program. The new PCI is intended to sustain the economic recovery, maintain macroeconomic and financial stability, and advance an ambitious structural reform agenda necessary to put Serbia on a faster and more sustainable income convergence path.

The implementation of our program will be monitored through quantitative, standard continuous, and reform targets, and an inflation consultation clause, as described in the PS and the attached Technical Memorandum of Understanding (TMU). There will be five reviews under the PCI by the IMF, scheduled to be completed on a semi-annual basis to assess program implementation progress and reach understandings on additional measures needed to achieve its objectives.

We believe that the policies set forth in this PS are adequate to achieve the objectives of the PCI-supported program, and we will promptly take any additional measures that may become appropriate for this purpose. We will consult with the IMF before adopting any such measures or in advance of revisions to the policies contained in this PS. Moreover, we will provide all information requested by the IMF to assess implementation of the program.

In line with our commitment to transparency, we wish to make this letter available to the public, along with the PS and TMU, as well as the IMF staff report on the request for a PCI. We therefore authorize their publication and posting on the IMF website, subject to Executive Board approval. These documents will also be posted on the official website of the Serbian government.

Sincerely,

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Attachment: Technical Memorandum of Understanding

Program Statement

1. This program statement sets out our economic program for the next 30 months. The program aims to (i) maintain macroeconomic stability, most notably by advancing a structural fiscal reform agenda to safeguard fiscal sustainability; (ii) enhance the resilience of the financial sector, including by further promoting dinarization and the development of capital markets; and (iii) implement a comprehensive structural and institutional reform agenda, to foster high, green, inclusive, and sustainable growth over the medium term.

2. Serbia has weathered the COVID-19 crisis relatively well. Our strong policy response has aimed at supporting households and businesses, preserving jobs, and enhancing public healthcare, and has helped mitigate the economic and social effects of the pandemic. Real output contracted by 1 percent in 2020, one of the smallest declines in Europe. The implementation of the crisis measures, together with the decline in fiscal revenues, has increased the fiscal deficit in 2020. Public debt has also increased but is expected to stabilize at around 60 percent of GDP in 2021 and revert to a downward trajectory over the medium term. Formal employment has remained broadly stable through the crisis, inflation has remained low and the exchange rate stable. The banking system remains liquid, well capitalized, with low non-performing loan (NPL) rates, and robust credit growth—supported by financial policy measures.

3. A PCI-supported program that expired in January 2021 helped advance our structural reform agenda, albeit with delays in some areas due to the pandemic. During the pandemic, we have prioritized key structural reforms, taking into account existing constraints. We have made progress in reforming tax administration, strengthening public financial management, enhancing SOEs corporate governance, and privatization—including of the largest state-owned bank.

4. However, further structural and institutional reforms are needed to ensure a stronger, greener, and more inclusive growth over the medium term. Sustaining the economic recovery remains a key policy priority, amid high uncertainty about the course of the pandemic and its delayed effects on firms, banks, and households. Over the medium term, structural fiscal reforms will be instrumental to rebuild buffers and anchor fiscal performance. A comprehensive structural and institutional reform agenda will be needed to foster high, green and inclusive growth. The goals of the program are compatible with our aspirations to join the EU, and strong program implementation will allow Serbia to accelerate convergence towards EU-income levels.

Recent Economic Developments and Outlook

5. Supported by a substantial policy response, Serbia’s economy suffered a relatively mild contraction in 2020. The economy rebounded following a sharp output drop in the second quarter of 2020, with real GDP growth in 2020 estimated at around -1 percent. High-frequency indicators point to a continued recovery in the first quarter of 2021.

6. Real GDP is projected to rebound in 2021, while inflation is expected to remain low and stable. On the back of one of the fastest COVID-19 vaccine rollouts in Europe, and supported by continued accommodative policies, the recovery is set to continue in 2021.

  • Real GDP growth is projected to reach 6 percent in 2021, before converging to around 4 percent over the medium term. Full implementation of our structural reform agenda will support the growth potential.

  • Inflation stood at 2.8 percent in April, after moving around the lower bound of the inflation target band in the first quarter. Within a one-year horizon, inflation is projected to hover around the central target point on the back of a temporary increase in commodity prices, before moving to around 2 percent later in 2022. Over the medium term, inflation is projected to gradually converge to 3 percent.

  • The current account deficit is projected at around 5 percent of GDP in 2021 and to decline to around 4 percent of GDP over the medium term. These deficits are expected to continue to be fully financed by net FDI. External financing will continue to consist mostly of FDI, and bilateral and infrastructure project loans.

Economic Policies

A. Fiscal Policies

7. To mitigate the impact of the COVID-19 crisis, we deployed a large fiscal package in 2020. The total cost of adopted fiscal measures amounted to about 9 percent of GDP in 2020. Measures included increased healthcare spending, deferment of corporate income taxes, labor taxes and social security contributions for private companies, wage subsidies, a one-off payment to pensioners, new loans to MSMEs from the Development Fund, and universal cash transfers. Moreover, a state guarantee scheme for bank loans to SMEs was introduced, for loans of up to EUR 2 billion, with a maximum cost to the budget of EUR 480 million. The fiscal deficit reached 8.1 percent of GDP in 2020, while public debt remained below 60 percent of GDP.

8. In early 2021, we announced a new round of measures to support business and households. The new measures, with an estimated total cost of about 2.5 percent of GDP, include:

  • i. Wage subsidies, including payment of ½ of minimum wages for all enterprenuers and employees in SMEs and large companies for three months (RSD 69.8 billion);

  • ii. Additional payments for employees in travel, hospitality and art (RSD 4.4 billion);

  • iii. Support for transportation sector (RSD 2.6 billion) and city hotels (RSD 1.3 billion);

  • iv. A universal cash transfers of EUR 60 to each citizen over 18 years old, paid in two installments of EUR 30 each—in May and November (RSD 31.2 billion);

  • v. A one-off payment of EUR 50 to all pensioners in September (RSD 10 billion);

  • vi. A cash transfer of EUR 60 to all pensioners in May and November (RSD 12 billion);

  • vii. A one-off financial assistance of EUR 60 to all the unemployed, paid in June (RSD 4.3 billion);

  • viii. A one-off payment of EUR 25 to all vaccinated citizens (RSD 9 billion).

We are also expanding the existing state guaranteed bank loans to SMEs by EUR 500 million (1 percent of GDP) and setting up a new EUR 500 million scheme for vulnerable companies.

9. The 2021 fiscal stance continues to support the economic recovery. The general government deficit reached 8.1 percent of GDP and public debt 58.2 percent of GDP in 2020. In 2021, following the adoption of the revised budget the general government deficit is projected at 6.9 percent of GDP (compared to 3 percent of GDP in the original 2021 budget). The upward revision of the projected deficit is largely explained by the cost of the new support measures (about 2.5 percent of GDP), higher planned public investment (about 1.8 percent of GDP), and additional current spending (mostly related to the health sector), which outweigh the upward revision of public revenues (about 1 percent of GDP). Public debt is projected to reach close to 60 percent of GDP by end-2021.

10. We will maintain strong fiscal discipline over the medium term. We are committed to narrow the fiscal deficit further in 2022 and aim at adopting a new fiscal rule to become effective in 2023, with a small overall deficit as a ceiling (see paragraph 13 below). This stance will imply a reduction of public debt to less than 45 percent percent of GDP over the medium term, thereby restoring the fiscal buffer. We will maintain high levels of capital spending, while containing current spending. Specifically, going forward we will ensure a gradual reduction of the public sector wage bill as a percent of GDP.

11. We will aim to contain fiscal risks and will prepare contingency measures as needed. We will closely monitor revenue and expenditure risks related to the pandemic and its economic impact—in particular, risks stemming from troubled SOEs, local governments, and state-guaranteed loans. We will maintain adequate liquidity buffers and will not accumulate public sector external debt payment arrears (continuous target). We will also refrain from accumulating domestic payment arrears (quantitative target). Our efforts to contain public spending will continue to be monitored through a ceiling on current primary spending of the Republican budget, excluding capital spending and interest payments (quantitative target).

12. We are committed to ensuring transparency and accountability for COVID19-related spending. Specifically, we will: (i) continue to ensure that the new procurement procedures are followed in line with the procurement regime that became effective in July 2020; (ii) ensure that execution of this spending is officially accounted for through regular budget execution reports; and (iii) subject all spending to regular ex-post control mechanisms and publish ex-post audits by the State Audit Institution. Any financial support to public enterprises will be delivered in a transparent manner and channeled through the government budget

B. Structural Fiscal Policies

13. Medium-term fiscal discipline will be anchored by the adoption of a new set of fiscal rules.

  • In consultation with Fund staff, we will adopt a new deficit-based fiscal rule anchored on public debt (end-June 2022 reform target). The new system will: (i) offer a more transparent and credible operational annual ceiling for the overall general government fiscal deficit (at a low level and depending on the level of public debt (including restitution bonds) compared with preset debt thresholds); (ii) improve accountability; and (iii) retain a strong role of the Fiscal Council. We will maintain a close collaboration with the IMF to define key elements of the new rules, such as the debt thresholds, escape clauses, possible cyclical adjustment, correction mechanisms, and the accountability framework. The new fiscal rule will become effective with the 2023 budget.

  • To ensure a rules-based pension system, we will continue to index pensions based on the formula that became effective in 2020 and will refrain from any ad-hoc pension increases. Pension indexation will automatically be suspended should the pension bill exceed 11 percent of GDP.

14. We remain committed to modernize tax administration, to strengthening revenue collection and improve the business environment. Our reform efforts are supported by IMF technical assistance (TA) and based on the Tax Administration Diagnostic Assessment Tool review. We have prepared a new Transformation Program Action Plan (TPAP) for the period 2021–25, which provides strategic guidance and an action plan to create a modern tax administration utilizing electronic business processes, improved taxpayer services, and a risk-based approach to compliance. We will explore options to further reduce the fiscal burden on labor and improve the progressivity and efficiency of the personal income tax system.

  • The next phase of reforms is supported by a World Bank Tax Administration Modernization Project, focusing on: (i) the improvement of the Serbian Tax Administration (STA) organization and operations, which include business process re-engineering; and (ii) the ICT system and record management modernization, including the implementation of an e-fiscalization system management.

  • A tender for procuring a new commercial-off-the shelf-system (COTS) system will be launched upon adoption of the new business model, which is expected to be completed by the end of 2021. This new system will facilitate an effective implementation of key reform activities, including the modernization of business processes.

  • We have hired an external consultant to review the STA’s existing business processes, which will guide the business process re-engineering.

  • To help ensure that the STA has adequate capacity to fulfill its tasks, we will aim at reducing staffing shortages, including by enhancing hiring processes.

  • The STA will continue to process the VAT refunds within the deadlines prescribed by the law (15/45 days for exporters and others, respectively), but it will strive to refund VAT earlier to low-risk taxpayers.

  • Following the recent adoption of the Law on Origin of Assets, we are setting up—with Fund TA support—a dedicated unit to analyze the level of noncompliance of high net worth individuals, including by applying indirect audit methods, and start implementing a response strategy.

15. We have introduced changes to the general government employment framework and will implement a reform of the wage system.

  • General government employment framework

    • The public employment framework in place until 2020 was governed by the budget system law, which regulated hiring decisions through the Employment Commission. This system, which included local public enterprises, helped to reduce public employment, but also resulted in reliance on fixed-term and contractual positions and staffing shortages in some areas.

    • Over the medium term, we plan to replace the existing framework with a new system based on personnel planning for all public sector entities. The new system should ensure medium-term workforce planning by all public sector institutions as well as alignment with budgetary constraints.

    • During the 2021–23 transition period, the Employment Commission will continue to allow the hiring of staff within the institutions’ budget limits, with some improvements introduced to the system. In December 2020, we amended the budget system law and adopted a decree to retain controls over total new hiring, while making hiring practices more flexible and better tailored to institutions’ staffing needs. Public sector entities can now replace up to 70 percent of the staff leaving the institution or retiring, without approval of the Commission. Any additional hiring beyond this 70 percent requires the Commission’s approval. At the same time, we have set a limit on overall hiring approvals, such that the total number of permanent staff in the public sector cannot exceed the end-December 2020 level by more than 1 percent. The amendments to the law also increase transparency of the process, by requiring the publication of decisions on hiring approvals on the institutions’ website.

    • Once the new, permanent system is sufficiently effective and comprehensive, we aim to phase out the existing framework of hiring approvals through the Employment Commission.

    • We have also developed a new electronic public employment registry for the Public Administration, and a pilot for the Ministry of Finance has already become effective. The system will be fully in place by 2023.

  • Public wage system reform

  • The 2016 Law on the Public Sector Employees Wage System sets the stage for a new system where employees are granted equal pay for equal work across the public sector, in a more transparent and systematic manner. Secondary legislation for employees in local governments, public agencies, and public services (health, education, culture, and social protection) was approved in December 2017.

  • A new Law on Salaries of Civil Servants and General Service Employees, as well as amendments to the job catalogue for public services and other organizations in the public sector, have been delayed and are expected to be adopted during 2021. This has also delayed the adoption of the decree specifying the coefficients under the new wage system. We remain committed to implement the new system and make it effective as of 2022. We will assess the adequacy of the wage coefficients under the new system, both before its introduction and while it is in force, to ensure that wages are consistent with market conditions for the various categories of employees.

16. We aim at further strengthening our public investment management (PIM) framework.

  • We will continue to include all project loans of the general government in the budget.

  • We have developed a single project pipeline to cover all ongoing and future projects.

  • We continue to develop working practices in the Ministry of Finance’s (MOF) PIM Unit, including processes, information flows and working relationships to operationalize the new system, and to ensure strong central oversight and compliance with all PIM requirements.

  • We will continue to build human resource capacity within the PIM Unit and strengthen coordination and information flows within the MOF departments.

  • We are developing, with World Bank support, a Public Investment Management System (PIMIS)—including an integrated database of public investment projects. The new system is being procured, aiming to have the first modules operational in 2021 and the full system in 2022.

17. We will continue to enhance public financial management (PFM).

  • In June, we will adopt a new PFM reform program for 2021–25 (and a related action plan for the same period), incorporating the findings of the World Bank’s Public Expenditure and Financial Accountability (PEFA) assessment, and inputs from SIGMA/OECD and the European Commission. Key measures include: improving capacities for budget planning and PIM; efficient collection and management of budget funds; enhancing budget discipline and more efficient management of EU funds; improving the implementation of the public sector internal control system; strengthening the regulation and the application of international accounting standards for the public sector and strengthening the external scrutiny of public funds.

  • We will continue to strengthen the role and capacity of the Fiscal Risks Monitoring Department (FRMD) at the MOF. We will finalize and adopt a methodology to properly monitor and manage fiscal risks, prepared with support of the World Bank, covering fiscal risks stemming from (i) SOEs; (ii) local governments; (iii) litigation; and (iv) natural disasters. In addition, we will adopt the by-laws required for an effective implementation of the new methodology and frameworks to monitor fiscal risks (end-September 2021 reform target). These bylaws will describe roles and responsibilities in the process of monitoring and management fiscal risks, main fiscal risk reports, and their use and consideration in decision making processes. We have also developed, with IMF TA support, a methodology for managing fiscal risks associated with the state-guarantee schemes designed in response to the COVID-19 crisis.

  • The new Law on Public Procurement became effective in July 2020. The law, prepared with support from the EU, helps to ensure alignment with the EU acquis and enhance competition and transparency. We will ensure that all procurement transactions in the public sector are conducted using the e-procurement portal. Supported by this system, we aim to increase the number of bids per procedure.

  • We will strengthen state aid controls and enhance transparency, building on the 2019 legislation prepared with support of the EU and the World Bank. We have also appointed an independent and well-resourced State Aid Commission. Further improvements include the publication of an inventory of state aid schemes, including the corresponding amounts, and the adoption of all the necessary secondary legislation to make the Law on State Aid Control effective and aligned with the relevant EU acquis (end-September 2021 reform target). Furthermore, we will adopt an action plan to align state aid with EU rules, including tax expenditures.

  • We will strengthen medium-term budgeting systems. We will continue to ensure a strict adherence to the budget calendar and transparency of the budget process. In this regard, we published the 2019 financial statement in December 2020. We will publish our fiscal strategy for 2022 in June 2021.

  • We will continue to strictly limit the issuance of state guarantees. We will not issue any new state guarantees for liquidity support to SOEs, or state guarantees for any company in the portfolio of the former Privatization Agency. The Government will refrain from issuing any implicit state guarantees.

  • To prevent arrears to public enterprises, we will continue the publication of monthly reporting of overdue receivables to Srbijagas and EPS of their top-20 debtors on the companies’ websites.

  • We will promptly resolve any new domestic arrears that may and address the underlying factors to prevent the emergence of new ones.

C. Monetary and Exchange Rate Policies

18. Inflation has remained low. During 2021Q1, headline inflation has hovered around the lower bound of the inflation target range, before moving to 2.8 percent in April on the back of vegetable and oil price increases, as well as last year’s low base. Core inflation has remained below 2 percent. Inflation expectations remain well-anchored, with one-year ahead inflation expectations of the financial and corporate sectors at around 2 percent.

19. We have maintained an expansionary monetary stance to support lending and economic activity during the COVID-19 pandemic.

  • We implemented four key policy rate cuts in 2020, reducing it from 2.25 percent to 1 percent. We also narrowed the interest rate corridor from ±1.25pp to ±0.9pp relative to the key policy rate.

  • We provided liquidity (both in dinars and euros) to banks through additional and regular EUR/RSD swap auctions as well as repo purchase auctions at lowered, preferential rates in local currencies, and conducted outright purchases of dinar government securities at market rates (amounting to RSD 97 billion), which helped ensure stability on the government bond (primary and secondary) market.

  • In May 2020, local-currency denominated corporate bonds became eligible for open market operations (OMOs) and as collateral for banks to receive daily liquidity loans and short-term liquidity from the NBS. Only corporate bonds issued before end-2020, with an original maturity of up to 10 years, and from companies with a solvency rating of at least “acceptable solvency” according to Serbia’s Business Registry Agency, are eligible. Total NBS’s purchases of corporate bonds are capped at RSD 55 billion, with limits to the purchase of individual bonds (up to 70 percent of a bond’s issuance) and companies (up to RSD 11 billion of bonds of a single issuer).

  • Since September 2020, we purchased RSD 27.6 billion of corporate bonds from domestic banks in secondary markets. These purchases helped to support the development of this segment of Serbia’s capital markets and provide an alternative source of financing to corporates, thus supporting firms through the economic recovery.

  • In July 2020, we introduced measures to make dinar loans more attractive under the state guarantee scheme introduced in response to the COVID-19 crisis. Specifically, we increased the remuneration (by 0.50 percentage points relative to the standard remuneration rate on allocated required reserves in dinars, which equals 0.10 percent) to eligible banks. This preferential remuneration rate has been available for banks approving dinar loans under the state guarantee schemes at an interest rate that is at least 0.50 percentage points lower than the ceiling interest rate envisaged by the first and second schemes (1M BELIBOR+2.5 percentage points and 1M/3M BELIBOR +2.75 percentage points, respectively).

  • We have extended by 9 months the repo line arrangement with the ECB to address possible euro liquidity needs of Serbian financial institutions in the presence of potential market disruption due to the COVID-19 shock. Under this repo line, the ECB provides euro liquidity (up to EUR 1 billion) to the NBS in exchange for adequate euro-denominated collateral. The maximum maturity of each drawing is three months, and the repo line will remain in place until end-March 2022.

20. The current inflation targeting framework remains appropriate for maintaining stable inflation and protecting the economy against external shocks. We remain committed to the objective of keeping inflation within the tolerance band (3 percent ±1½ percentage points). Inflation developments will continue to be monitored via a consultation clause with consultation bands set around the central projection (Table 1).

Table 1a.

Serbia: Quantitative Program Targets 1/

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As defined in the Program Statement and the Technical Memorandum of Understanding.

Cumulative since the beginning of a calendar year.

Refers to the fiscal balance on a cash basis, including the amortization of called guarantees.

Cumulative change since the start of the year.

Staff level consultation is required upon breach of the band limits.

Defined as the change over 12 months of the end-of-period consumer price index, as measured and published by the Serbian Statistics Office.

Indicative targets are not monitored as part of program conditionality.

Table 1b.

Serbia: Standard Continuous Targets

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21. We aim to maintain relative stability of the exchange rate, especially during the crisis period. Foreign exchange interventions will continue to be used to smooth excessive short-term exchange rate volatility, while considering the implications for financial sector and price stability. In the context of heightened uncertainty due to the pandemic, we intervened in the FX market with a net sale of EUR 1.45 billion during 2020, with additional net sales of EUR 50 million in January-April 2021. We assess the current level of gross international reserves as adequate and comfortable for precautionary purposes.

22. Promoting dinarization remains an important medium-term objective. The dinarization strategy adopted in 2012—and updated in 2018—is based on three pillars: (i) maintaining overall macroeconomic stability; (ii) creating favorable conditions for developing the dinar bond market; and (iii) promoting hedging instruments.

  • Several measures to foster dinarization remain in place, such as higher reserve requirements on FX deposits, mandatory down-payment ratios for FX loans, and systemic risk buffers. We will continue to communicate to the public the risks of unhedged FX borrowing, the need for prudent management of FX risks, the availability of hedging instruments, and the benefits of dinar savings.

  • Based on results from a survey of banks’ exposures to foreign currency borrowers, in December 2019 we adopted a set of prudential measures related to banks’ capital adequacy and risk management, aimed at supporting dinar lending. In 2020, due to the COVID-19 crisis, we postponed the introduction of these measures.

  • In March 2021, deposit and credit dinarization reached 38.3 percent and 37.9 percent, respectively. Over the past few years, we have also increased the share of public debt in local currency, which reached 30.5 percent at the central government level (30.2 percent at the general government level), in March.

23. Our dinarization strategy aims to further strengthen liquidity management and develop local currency debt and hedging markets.

  • Once the uncertainty associated to the COVID-19 pandemic dissipates, we will consider additional measures to (i) further develop local and foreign currency derivative markets, and (ii) encourage prudent pricing of credit risks of unhedged foreign currency borrowing.

  • We will continue to strengthen public debt management. We aim to make possible the settlement of Serbian government securities through Euroclear effective in 2022, to expand the investor base, reduce transaction costs, and improve liquidity. The due diligence has been finalized, and we have hired external consultants to align IT systems and legal practices with Euroclear standards. We also plan to establish a primary dealer system and develop an adequate supervisory framework. However, implementation of these plans, as well as a Market Maker Agreement, have been delayed by the COVID-19 crisis. The necessary changes to the Public Debt Law and the Law on Capital Market will be approved. To this end, a working group comprising representatives of the PDA, MOF, prospective primary dealers, and other relevant institutions has been established and a pilot will be effective in 2022.

24. During the period of the PCI we will not, without IMF approval, impose or intensify restrictions on the making of payments and transfers for current international transactions, nor introduce or modify any multiple currency practices or conclude any bilateral payment agreements that are inconsistent with Article VIII of the IMF’s Articles of Agreement. Moreover, we will not impose or intensify import restrictions for balance of payments reasons.

D. Financial Sector Policies

25. We implemented several financial sector measures in response to the pandemic.

  • We initially introduced a 3-months moratorium (April-June 2020) relieving debtors of repayment of their obligations under loan and lease agreements. This was followed by the introduction of a new 2-month moratorium, relieving debtors of repaying their liabilities during August and September, as well as those obligations that were due in July but were not settled. In December 2020, we adopted new measures to support debtors (corporates and households) affected by the pandemic. These measures envisage rescheduling and refinancing of bank loans and a six-month grace period with extension of repayment terms. The period for borrowers to request rescheduling expired in end-April 2021.

  • In June 2020, we relaxed the loan-to-value (LTV) cap for first-time home buyers’ mortgage loans in foreign currency, increasing the limit from 80 percent to 90 percent.

  • We have kept the countercyclical buffer rate (CCyB) at 0 percent, given persisting global uncertainty caused by the pandemic and considering that the estimated credit-to-GDP level, while increasing, is still below its long-term trend. Meanwhile, the systemic risk buffer has been kept at 3 percent of total FX and FX-indexed loans to corporates and households, to limit the risks stemming from the still high level of financial euroization.

26. We will continue to strengthen financial sector regulatory and supervisory frameworks, to fully align them with international standards. We continue to enhance the prudential framework for banks and insurance companies to ensure full compliance with international standards and EU requirements. We will further harmonize our financial legal framework with EU Acquis taking into account the specificities of the Serbian financial market.

27. We will further enhance financial safety nets. Significant progress has been achieved in strengthening the bank resolution, deposit insurance, and crisis management frameworks.

  • We have further aligned the deposit insurance scheme with EU directives. In October 2019, we amended the Law on Deposit Insurance to address the findings and recommendations of the IADI core principles assessment. These amendments allowed for the introduction of risk-based premia, established backstop funding, and modified the basis for the computation of deposit insurance premiums and targets from eligible to insured deposits, while extending the deadline to reach the target fund level to 2030. In collaboration with the NBS, the DIA adopted a methodology for implementation of a risk-based premium assessment model in October 2020. We aim to introduce risk-based premiums in 2022.

  • In response to the pandemic, the DIA limit to invest in foreign currency government securities (of up to 25 percent of its portfolio) was temporarily lifted. In this context, the DIA has increased its holding of government securities from 25 percent to about 47 percent of its foreign currency investment portfolio by end-September 2020. The DIA reverted to the previous exposure limit in May 2021, 12 months after the expiration of the state of emergency.

28. NPL ratios have remained at very low levels but will be monitored closely. As of end February, the NPL ratio was at 3.8 percent While the COVID-19 crisis may negatively impact NPLs, such impact should be mitigated by the comprehensive measures to support firms and households deployed by the NBS and the government We will continue to closely monitor NPLs trends, including after the expiration of the moratorium of bank loan repayments and the fiscal measures to support companies.

29. We will continue our efforts to contain NPLs. Our NPL resolution strategy focuses on measures to prevent accumulation of new NPLs, further improve bankruptcy frameworks, while broadening the scope to include the export credit agency (AOFI), the Development Fund (DF), and the bad assets managed by the Deposit Insurance Agency (DIA) on behalf of the State and the bankruptcy estates of banks in liquidation. We have been resolving the DIA portfolio of bad assets through a tendering process implemented in two phases. In June 2019, the first phase of the sale was completed. The sale of the second, larger portfolio (of EUR 1.8 billion) was completed in April 2021. By end-July, we will develop—with support of external consultants—a time-bound plan to resolve the residual assets of the DIA portfolio.

30. We will continue to implement state-owned financial institutions reforms. We will further strengthen our oversight of state-owned financial institutions.

  • The privatization of Komercijalna Bank was completed in December 2020.

  • We will continue to implement the new strategy for Banka Poštanska Štedionica (BPS). The strategy focuses on (i) the bank’s commercial reorientation towards retail banking, entrepreneurs, micro-enterprises and small enterprises, (ii) improvements of the bank’s internal organization, corporate governance and risk management, and (iii) enhancement of its IT infrastructure.

    • In April 2020, we amended the government conclusion on BPS to (i) allow the bank to lend to medium-size companies through the state guarantee scheme introduced in response to the COVID-19 crisis, (ii) eliminate the loan-size limit for private enterprises, (iii) introduce the possibility of lending to municipalities and local governments (while requiring MOF consent for any loan over RSD 20 million), and (iv) and abolish the cap on exposure to SOEs.

    • We will continue to closely monitor risks related to new lending to medium-size companies, SOEs and local governments, including in the context of the state guarantee scheme.

    • We are implementing the new Business Plan for 2020–22, adopted in June 2020 to reflect: (a) the significant organic growth of total assets in 2019; (b) changed operational circumstances due to the COVID-19 pandemic; and (c) the recent amendments of the government conclusion on BPS.

    • Preparations for the procurement of a new core banking system are ongoing. The procurement will be undertaken after the merger between BPS and MTS bank, expected to be completed by end-June 2021.

  • We will prepare a plan for the future of Srpska Banka by end-September 2021.

  • The Development Fund and AOFI have continued to implement (i) the supervisory boards’ decisions recognizing losses on their credit portfolios and (ii) the government conclusion to restrict the institutions’ exposures to SOEs, enhance risk management frameworks, prevent further deterioration in asset quality, and resolve impaired assets.

31. We are developing strategies for capital market deepening and development finance. Serbia’s capital markets remain underdeveloped with limited stock-market activity, nascent domestic bond market volumes, and a very small corporate bond market. Alternative sources of financing such as private equity or venture capital, are negligible.

  • A diagnostic assessment, prepared with the World Bank support, focused on developing capital markets and diversifying sources of long-term financing. A working group, chaired by the Minister of Finance, has prepared a strategic outline of the main objectives, priority areas and measures, which has served as a guide for the development of a strategy and an action plan to enhance Serbia’s capital markets. This outline consists of 35 action items organized under four “pillars”: (i) needed regulatory reforms; (ii) institution building; (iii) providing focused stimuli; and (iv) outreach and education for issuers and investors.

  • With support of external consultants hired under an EBRD project, we have prioritized those action items with a view to finalize and adopt the new strategy and a related time-bound action plan to implement it (end-September 2021 reform target).

  • A working group for Development Finance has been formed, led by the Ministry of Economy and with support from the World Bank. Preparation of a strategic document for development finance and an action plan to implement it has been delayed due to the COVID-19 crisis and is expected to be completed by September-2021. This strategy will not include the creation of a development bank.

32. We will continue strengthening the AML/CFT framework. While Serbia is either largely or fully compliant with FATF standards, we will further enhance AML/CFT frameworks:

  • We continue our regular reporting under the EU agenda, both as part of negotiating chapters (e.g. Chapters 24 and 4) and sub-committees of monitoring the implementation of the Stabilization and Association Agreement. We continue reporting to MONEYVAL under the enhanced follow-up reporting process. The most recent report was submitted by end-March 2021, requesting an upgrade to our ratings on the outstanding four FATF Recommendations, rated as partially compliant.

  • We are implementing the action plan related to the 2020–24 National Strategy Against Money Laundering and the Financing of Terrorism. To monitor the timely implementation and to report to the AML/CFT Coordination Body, we appointed coordinators for each of the four strategic specific objectives in March 2021.

  • A new national risk-assessment update will be completed in 2021. With this aim, in March 2021 a Working Group was established.

  • We have continued to align regulations with the amended AML/CFT Law. The Securities Commission aligned its regulations in June 2020. The MOF passed an amended Rulebook on the Methodology for Complying with the AML/CFT Law and a Rulebook on the licensing examination for compliance officers.

  • In December 2020, we adopted a new Law on Digital Assets and amendments to the AML/CFT law, updating the legal framework concerning digital assets in full compliance with FATF updated Recommendation 15.

  • Good progress has been made in terms of prosecution, with several persons convicted for money laundering in 2020.

E. Structural Policies

33. We will enhance the existing social protection programs to protect vulnerable groups, reduce inequality, and fight poverty. We are developing a Social Cards Registry, envisaging a single, centralized, and electronic record with up-to-date data on the socio-economic status of individuals and persons related to them. The new system will improve the consistency and efficiency of social protection programs. Furthermore, we will prepare plans to enhance the coverage of the social protection system to protect households against poverty, using the new database.

34. We will develop a comprehensive agenda for green growth, to support the economic recovery and ensure a more sustainable and environmental-friendly development. The recent adoption of the Law on Climate Change sets the scene for the development of a low-carbon development strategy and prescribes the need for consistency across national strategies, general and sectoral, and plans and policies that affect green-house gas emissions. The Law on Amendments and Supplements to the Law on Energy envisages the adoption of a National Energy and Climate Plan (NECP), which is currently under preparation. In the context of this evolving agenda, we are prioritizing green investments, including in renewable energy, and we will consider carbon pricing mechanisms once the overarching goals and principles have been designed. This agenda will complement our priority to strengthen and prioritize regulations, legislation, and public investments to tackle environmental pollution. We are also planning the issuance by the government of the first green bonds in Serbia, to finance green projects and support the green-growth agenda.

35. We will continue to implement structural reforms to improve the business environment and support higher private sector-led growth. Our focus is on policies to improve the investment climate, strengthen rule of law, fight corruption, reduce informality, and enhance corporate governance of public and state-owned enterprises.

36. We are implementing measures to fight the grey economy. We continue to implement the Action Plan on the National Program for Countering the Grey Economy. Our priorities have included improvements in the inspection system, modernization of the tax administration, strengthening of incentives for voluntary compliance, and improving the business environment to encourage entrepreneurship and innovation. We are enhancing coordination across inspections through an e-inspection system, which provides a horizontal e-platform facilitating full implementation of a risk-based approach to inspection oversight. We will expand the scope of fiscalization, building on the new law, including through adoption of appropriate bylaws, training of employees in STA, as well as processing and analysis of data collected from fiscal cash registers. We will also expand the Law on Simplified Seasonal Employment in Specific Industries—which currently defines rights and obligations in the context of seasonal work and allows simplified registration of seasonal workers in agriculture—to additional sectors and activities with occasional, temporary or seasonal character, including domestic work, construction, and tourism and catering.

37. We will continue restructuring large public utilities companies to enhance efficiency and contain fiscal costs and risks. We remain fully committed to implement the corporate and financial restructuring in these companies over the medium term. We will closely monitor and tackle fiscal risks from these companies.

  • Elektroprivreda Srbije (EPS). We will change the legal status of EPS to a joint stock company (end-November 2022 reform target), in line with the ongoing corporate restructuring process and financial consolidation, aiming to improve the viability of the company and ensure its professional management. With this aim, we plan to complete the valuation of the company’s properties and assets by end-2021.

  • Srbijagas. The operational unbundling of the company will be completed in line with the Government Conclusion. We have phased out Srbijagas’ reliance on government support for servicing debt incurred in the period 2008–2012 and are committed not to provide further support going forward.

38. We will make further efforts to resolve the remaining strategic companies in the portfolio of the former Privatization Agency:

  • Negotiations with potential investors regarding Petrohemija have continued. A privatization advisor has been hired, and we intend to launch a privatization tender by end-June, with a view to complete the privatization by end-2021.

  • We will explore options for potential strategic investments or partnerships for MSK.

  • We remain committed to the privatization of Lasta. The process has been delayed due to the pandemic, and a new timeline will be set by end-June 2021.

  • We will implement a time-bound action plan for Resavica mines, developed with the assistance of the World Bank, that foresees the closure of four unviable mines, while developing a voluntary social program and labor optimization plan. We will ensure sufficient resources in the budget to transparently support Resavica through subsidies and to prevent further accumulation of arrears to EPS.

39. We continue to resolve enterprises in the portfolio of the former Privatization Agency through either privatization or bankruptcy, in accordance with the revised Privatization Law. By March 2021, more than 310 companies entered bankruptcy, and 68 were privatized since end-2014. About 36,000 employees from 357 companies have received severance payments. 76 companies with nearly 28,000 employees remain.

40. We have developed a new ownership and governance strategy for SOEs. On April 1, 2021 we adopted a state-ownership policy for SOEs (SOP) consistent with the core principles embodied in the OECD Guidelines on Corporate Governance of State-Owned Enterprises, prepared with the EBRD support. This SOP identifies ownership rationales and high-level objectives of the State’s ownership; develops criteria for classification of SOEs; designs the framework for setting objectives and targets for SOEs and for monitoring their achievement; and reviews the Legal and regulatory framework for corporate governance of SOEs. The SOP complements ongoing efforts to better monitor and tackle fiscal risks and enhance efficiency.

41. The next step will be to adopt a time-bound action plan to implement this SOE strategy (end-June 2021 reform target). Key actions under the action plan will include: (i) developing the KPI framework for SOEs, including general, sectoral and tailored KPIs; (ii) establishing a process for monitoring the implementation of SOEs’ strategy and business programs by the Ministry of Economy; and (iii) establishing composition and tenure guidelines for SOEs’ supervisory boards/board of directors. We will (i) develop a centralized and updated database with a registry of all SOEs and their assets and (ii) establish mechanisms and criteria for reviewing and approving key decisions of SOEs by the Ministry of Economy, which will serve as a good basis for future amendments to the legislative framework (end-December 2021 reform target). Advancing reforms in this area requires the adoption of a new law on ownership management for state-owned enterprises (end-December 2022 reform target). We will also adopt a dividend policy that fits with our long-run views of the key PEs and SOEs. We will make efforts to promptly resolve the excessive reliance on acting directors in state-owned companies.

42. We will continue to improve the quality and transparency of national statistics:

  • In December 2020, the Ministry of Finance started to submit monthly fiscal accounts to the European Department of the IMF using the templates in line with the GFSM 2014 framework, developed with the assistance of IMF TA

  • In January 2021, the Serbian Statistical Agency (SORS) submitted cash budgetary general government data per GFSM 2014 to the IMF GFS Yearbook publication, for the period 2013–2019. This provides revenue and expenditure data for the central and local government budgetary units and social security funds. SORS developed sophisticated automation procedures to compile these data on a unit-by-unit-basis or by groups of units, as relevant, which will make ongoing (high frequency) data compilation and submission sustainable.

  • We remain committed to comprehensive, timely, and automatic data sharing across relevant compiling agencies (including MOF, SORS and NBS) for statistical purposes. With regard to this, NBS and SORS will coordinate to compile and disseminate annual cash financing data consistent with the GFSM 2014 compliant revenue and expenditure data now published. Meanwhile, coordinated and phased work will continue to migrate all annual fiscal statistics to an accrual (or modified cash) basis.

  • In accordance with international dissemination best practices, MOF will compile and SORS will publish on the national summary data page (NSDP) monthly GFSM 2014 compliant fiscal accounts covering the central and local government, social security funds, and the consolidated general government, and quarterly debt data covering central and general government debt, and government guaranteed debt by creditor (end-September 2021 reform target). SORS will continue reporting data per GFSM 2014 to the IMF GFS Yearbook publication.

Program Monitoring

43. Progress in the implementation of the policies under this program will be monitored through quantitative targets (QTs)—including an inflation consultation clause, continuous targets (CTs) and reform targets (RTs). These are detailed in Tables 1 and 2, with definitions provided in the attached Technical Memorandum of Understanding. The first review is scheduled to be completed by October 1, 2021, the second review by April 1, 2022, the third review by October 1, 2022, the fourth review by April 1, 2023, and the fifth review by October 1, 2023.

Table 2.

Serbia: Reform Targets

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Attachment I. Technical Memorandum of Understanding

1. This Technical Memorandum of Understanding (TMU) sets out the understandings regarding the definition of indicators used to monitor developments under the program. To that effect, the authorities will provide the necessary data to the European Department of the IMF as soon as they are available. As a general principle, all indicators will be monitored on the basis of the methodologies and classifications of monetary, financial, and fiscal data in place on May 7, 2021, except as noted below. Reviews will assess quantitative targets as of specified test dates. Specifically, the first review will assess end-June 2021 test date, the second review will assess end-December 2021 test date and the third review will assess end-June 2022 test date.

A. Fiscal Conditionality

2. The general government fiscal deficit is defined as the difference between total general government expenditure (irrespective of the source of financing) including expenditure financed from foreign project loans, payments of called guarantees, cost of bank resolution and recapitalization, cost of debt takeover if debt was not previously guaranteed, repayments of debt takeover if debt was previously guaranteed, and payment of arrears (irrespective of the way they are recorded in the budget law) and total general government revenue (including grants). For program purposes, the consolidated general government comprises the Serbian Republican government (without indirect budget beneficiaries), local governments, the Pension Fund, the Health Fund, the Military Health Fund, the National Agency for Employment, the Roads of Serbia Company (JP Putevi Srbije) and any of its subsidiaries, and the company Corridors of Serbia. Any new extra budgetary fund or subsidiary established over the duration of the program would be consolidated into the general government. Privatization receipts are classified as a financial transaction and are recorded “below the line” in the General Government fiscal accounts. Privatization receipts are defined in this context as financial transactions.

3. Current primary expenditure of the Republican budget (without indirect budget beneficiaries) includes wages, subsidies, goods and services, transfers to local governments and social security funds, social benefits from the budget, other current expenditure, net lending, payments of called guarantees, cost of bank resolution and recapitalization, cost of debt takeover if debt was not previously guaranteed, repayments of debt takeovers if debt was previously guaranteed, and payment of arrears (irrespective of the way they are recorded in the budget law). It does not include capital spending and interest payments.

Adjusters

  • The quarterly ceilings on the general government fiscal deficit will be adjusted downward (upward) to the extent that cumulative non-tax revenues of the General Government from dividends, debt recovery receipts, debt issuance premiums, and concession and Public Private Partnership (PPP) receipts recorded above-the-line exceed (fall short of) programmed levels. The IMF Statistics Department will determine the proper statistical treatment of any concession or PPP transaction signed during the IMF program.

  • The quarterly ceilings on the primary current expenditure of the Republican budget will be adjusted upward (downward) to the extent that (i) cumulative earmarked grant receipts exceed (fall short of) the programmed levels and (ii) cumulative proceeds from small-scale disposal of assets (the sale of buildings, land, and equipment) recorded as non-tax revenues exceed the programmed levels up to a cumulative annual amount of 2 billion dinars in each year. For the purposes of the adjustor, grants are defined as noncompulsory current or capital transfers received by the Government of Serbia, without any expectation of repayment, from either another government or an international organization, including the EU.

Cumulative Programmed Revenues of the General Government from Dividends, Debt Recovery Receipts, and Debt Issuance at a Premium1

(In billions of dinars)

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Cumulative numbers are calculated from the start of each calendar year.

Cumulative Receipts from Earmarked Grants and Small-scale Asset Disposal1

(In billions of dinars)

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Cumulative numbers are calculated from the start of each calendar year.

4. Domestic arrears. For program purposes, domestic arrears are defined as the belated settlement of a debtor’s liability which is due under the obligation (contract) for more than 60days, or the creditor’s refusal to receive a settlement duly offered by the debtor. The program will include a quantitative target on the change in total domestic arrears of (i) all consolidated general government entities as defined in ¶2 above, except local governments; (ii)the Development Fund, and (iii) AOFI. Arrears to be covered include outstanding payments on wages and pensions; social security contributions; obligations to banks and other private companies and suppliers; as well as arrears to other government bodies. This quantitative target will be measured as the change in the stock of domestic arrears relative to the stock at December 31, 2020, which stood at RSD 2.6 billion.

5. Debt issued at a premium. For program purposes, debt issued at a premium refers to proceeds accruing to the government that are recorded as revenue when the government issues debt at a premium. It most commonly occurs when a bond with an above-market coupon is reopened ahead of a coupon payment.

B. Ceiling on External Debt Service Arrears

6. Definition. External debt-service arrears are defined as overdue debt service arising in respect of obligations incurred directly or guaranteed by the consolidated general government, the Export Credit and Insurance Agency (AOFI), and the Development Fund, except on debt subject to rescheduling or restructuring. The program requires that no new external arrears be accumulated at any time under the arrangement on public sector or public sector guaranteed debts. The authorities are committed to continuing negotiations with creditors to settle all remaining official external debt-service arrears.

7. Reporting. The accounting of external arrears by creditor (if any), with detailed explanations, will be transmitted on a monthly basis, within four weeks after the end of each month.

C. Inflation Consultation Mechanism

8. Inflation is defined as the change over 12 months of the end-of-period consumer price index (CPI), base index (2006=100), as measured and published by the Serbian Statistics Office (SORS). Where the official press release differs from the index calculation, the index calculation will be used.

9. Breaching the inflation consultation band limits (specified in Program Statement, Table 1) at the end of a quarter would trigger discussions with IMF staff on the reasons for the deviation and the proposed policy response.

D. Reporting

10. General government revenue data and the Treasury cash position table will be submitted weekly; and the stock of spending arrears as defined in ¶6 45 days after the end of each quarter. General government comprehensive fiscal data (including social security funds) will be submitted within 35 days of the end of each month.

11. The stock of spending arrears (> 60 days past due) as reported in the MOF e-invoice system will be submitted within 14 calendar days after the end of each month.

12. Gross issuance of new guarantees by the Republican budget for project and corporate restructuring loans will be submitted within 35 days of the end of each month.

13. Cumulative below-the-line lending by the Republican budget will be submitted within 35 days of the end of each month.

14. Borrowing by the Development Fund and AOFI will be submitted within four weeks of the end of each month.

15. New short-term external debt (maturities less than one year) contracted or guaranteed by the general government, the Development Fund, and AOFI will be submitted within four weeks of the end of each month.

16. Receivables of the top 20 debtors to Srbijagas and EPS will be submitted in the agreed-upon templates within 30 calendar days after the end of each month as well as published on the company websites.

Data Reporting for Quantitative Targets

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1

Public debt excludes state guarantees on bank loans issued under the government guarantee scheme, with a potential maximum fiscal cost estimated at EUR 435 million (0.85 percent of GDP) as of end-April 2021.

2

See Annex II in 2019 Article IV Staff Report (CR 19/238).

3

See also the 2019 Article IV Staff Report (CR 19/238).

1

The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path. The relative likelihood is the staff’ s subjective assessment of the risks surrounding the baseline (“ low” is meant to indicate a probability below 10 percent, “ medium” a probability between 10 and 30 percent, and “ high” a probability between 30 and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly. The conjunctural shocks and scenario highlight risks that may materialize over a shorter horizon (between 12 to 18 months) given the current baseline. Structural risks are those that are likely to remain salient over a longer horizon.

1

The external sector assessment is based on staff’s estimates.

1

Public debt includes general government debt, and public guarantees covering SOEs, local governments, and other entities. Public guarantees on banks loans to SMEs are not included and estimated at 0.85 percent of GDP as of end-April.

2

The residual maturity is above 2 years for more than 70 percent of dinar-denominated debt, and 60 percent of euro-denominated debt. The share of debt with fixed interest rate is about 86 percent.

3

The historical scenario sets real GDP growth, the primary balance, and the real interest rate at their historical averages.

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Cover IMF Staff Country Reports
Republic of Serbia: 2021 Article IV Consultation and Request for a 30-Month Policy Coordination Instrument-Press Release; Staff Report; and Statement by the Executive Director for Republic of Serbia
Author:
International Monetary Fund. European Dept.
Volume/Issue:
Volume 2021: Issue 132
Publisher:
International Monetary Fund
ISBN:
9781513583181
ISSN:
1934-7685
Pages:
107
DOI:
https://doi.org/10.5089/9781513583181.002
Text Figure 1.

COVID-19 Evolution in Serbia

Nominal GDP per capita, 2019

(Percent of EU nominal GDP per capita; weighted averages)

Contributions to growth

(Percent, yoy)
Figure 1.

Serbia: Real Sector Developments
Figure 2.

Serbia: Balance of Payments and NIR
Figure 3.

Serbia: Financial and Exchange Rate Developments
Figure 4.

Serbia: Inflation and Monetary Policy

European Economies: Real GDP Growth

(2020 vs. 2019, percent)

Estimates of Carry-over Effect from 2019

(Percent)

Share of High-contact Sectors in Gross Value Added (GVA)

(Percent)

V-shaped recoveries

Slower recoveries

Employed persons working from home

(Percentage of total employed, 2019)
Figure 5.

Serbia: Selected Interest Rates
Figure 6.

Serbia: Fiscal Developments
Figure 7.

Serbia: Labor Market Developments

Registered Unemployed

Formal and Informal Employment

(Percent, yoy change)

Health Impact Due to Environmental Risks, 2019

(DALYs per thousand inhabitants)
Annex VI. Figure 1.

Serbia: Public Sector Debt Sustainability Analysis (DSA) – Risk Assessment
Annex VI. Figure 2.

Serbia: Public DSA – Realism of Baseline Assumptions
Annex VI. Figure 3.

Serbia: Public DSA – Baseline Scenario

(in percent of GDP, unless otherwise indicated)
Annex VI. Figure 4.

Serbia: Public DSA – Composition of Public Debt and Alternative Scenarios
Annex VI. Figure 5.

Serbia: Public DSA – Stress Tests
Annex VII. Figure 1.

Serbia: External Debt Sustainability: Bound Tests 1/ 2/

(External debt in percent of GDP)