Response to the COVID-19 Crisis

The authorities’ response to the Covid-19 crisis was resolute, timely, and effective. Serbia entered the pandemic on the back of a strong growth momentum and utilized its large policy buffers built over time to successfully address the crisis and lay the ground for a strong recovery. Bolstered by sizable economic support measures in 2020, totaling to about 12.9 percent of GDP, Serbia managed to avoid a dramatic collapse of activity and recorded an output contraction of about 1 percent of GDP, among the lowest in Europe. In Q12021, output surpassed pre-crisis levels. The resolute policy intervention provided needed support to companies and households to withstand the impact of the crisis while upholding employment, disposable incomes, and domestic demand. The pre-crisis public debt level was moderate, at about 53 percent of GDP, and did not constrain the authorities’ high outlays to effectively contain the contraction. The available fiscal space also allowed the government to continue all public investment projects as planned.

Key fiscal measures included the deferral of labor taxes and social security contributions, the deferral of CIT payments, payment of minimum wages to companies aimed at preserving employment, direct loans to the SMEs and state guarantee scheme to banks for loans to SMEs, as well as one-off direct transfers to pensioners. At the same time, the National Bank of Serbia (NBS) implemented a range of measures to support liquidity and incomes, including a time-bound debt service suspension for households and corporates, the purchase of government securities to ensure domestic government bond market liquidity, additional FX swaps auctions, and other measures. Those actions helped cushion the immediate impact of the shock. Buoyed by successful containment measures, economic activity rebounded in the second half or 2020.

Driven by third and fourth waves of pandemic and the need to bolster the nascent recovery, the support to the economy continued in 2021 in a better targeted and scaled-down fashion. The support package for 2021 amounts to about 4.5 percent of GDP, underpinned by a supplementary budget approved in April. Key measures include direct subsidies to companies in the sectors most affected by pandemic and to vulnerable households, guaranteed lending, and increases in public investments.

Outlook and Risks

The growth outlook for Serbia has improved since the beginning of the year. Growth projections were revised upwards from 5 to 6 percent for 2021, driven by an increase in domestic demand, higher exports, and the expected recovery of key trading partners. Better than expected outturns in Q12021, as well as new anti-crisis measures, and higher public investments all point towards a robust recovery. The renewed activity is driving an increase in employment. In Q1, registered employment grew by 2.8 percent yoy, driven by private sector hiring. Registered unemployment declined in 2020, while the data for the first quarter of 2021 indicates a gradual return of the inactive population to the labor market, as both registered employment as well as unemployment are rising.

The positive growth outlook is backed by strong progress on vaccinations and declining Covid-19 incidence. Serbia is among the best performing countries in Europe regarding the vaccine rollout, which, paired with the phasing out of containment measures, has bolstered confidence and activity. Further on, the authorities expect potential economic scarring to be attenuated by massive public support to companies and households over the crisis, as well as by the relatively fast pace of the recovery, which helped safeguard productive capacity and employment. The improved risk outlook, Serbia’s increased resilience, and its benign debt risk profile were validated in March by the rating agency Moody’s, which increased Serbia credit rating by one notch from Ba3 to Ba2. As noted by the credit agency, key factors supporting such a decision pertained to increased resilience, a positive economic outlook, low and stable inflation, and reduced external imbalances. The agency also noted the diversified economy and reduced fiscal risks.

Fiscal Policy

The government’s medium-term fiscal strategy for the period 2022–2024, adopted in May, outlines a credible future path of fiscal policy, consistent with program objectives. Following an increase in the budget deficit and public debt over the Covid-19 crisis, the strategy envisages a gradual consolidation of public finances going forward. The general government deficit would decline from about 7 percent of GDP in 2021 to 3 percent in 2022, and to about 1 percent in 2024. The planned adjustment would revert the crisis-induced increase in public debt, from 60 percent this year to about 55 percent in 2024.

The fiscal adjustment will be achieved primarily by reducing the share of current expenditures in GDP, including by moderating the growth of public wages and pensions, and cutting subsidies and other current expenditures, while maintaining a relatively high level of public investments of about 6 percent of GDP. At the same time, the authorities do not plan to increase taxes. Moreover, if revenues overperform the targets, the authorities plan to reduce the tax burden on labor.

In 2020 the authorities adopted pension indexation in line with the Swiss formula, linking pension growth to inflation and average wage growth. This led to countercyclical pension increases in 2020 and 2021, as the formula tracks economic activity with certain delay. As a result of the pension indexation rule, the growth of public pensions is projected to be below the growth of nominal GDP going forward, thus allowing for a gradual decline of pension expenses towards the targeted share of GDP of about 10 percent. At the same time, the pension rule includes a cap for annual public pension expenses at 11 percent of GDP.

To ensure the stability and sustainability of public finances over the long run, the authorities plan to introduce a new set of fiscal rules. Back in 2010, Serbia adopted a legislation defining fiscal rules. However, those were inefficient in containing higher deficits and debt surges. In coordination with the Fund, the authorities will design and adopt a new deficit-based fiscal rule and implement it with the 2023 budget. At the same time, the new fiscal rule will improve accountability and retain the central role of the Fiscal Council.

With the support of the World Bank, the authorities are developing a public investment management information system (PIMIS) that will support the full operationalization of the PIM reforms initiated under the 2018 PCI. These reforms are pivotal for streamlining and further improving the efficiency of public investments.

Monetary Policy and Financial Sector

The monetary policy stance remains accommodative, consistent with the negative output gap, low inflationary pressures, and the need to support the recovery. Since the inception of the crisis, the NBS cut the reference rate from 2.25 to 1 percent. In 2020, inflation remained close to the lower bound of the inflation corridor and inched closer towards the target of 3 percent in April and May. Inflation expectations of the corporate and banking sector remain well-anchored below the inflation target. The financial sector remains well capitalized, liquid, and profitable. The NPLs remained at a historical low of 3.9 percent in March, although impairment provisioning has increased recently. Credit activity, buoyed by recent policy measures, remains strong, growing at about 7 percent in March. The recent survey of the banking sector points to an easing of credit standards, which will further support the healthy provision of credit to the economy. Advancing the dinarization agenda remains the authorities’ key policy objective over the medium-term. Credit dinarization reached 37.9 percent in March, fostered by macroprudential and monetary measures, including lower funding costs, higher reserve requirements on FX deposits, and higher mandatory down payment ratios for FX loans.

Structural Policies

In order to clarify the role of state ownership in the economy and set the basis for improving governance and transparency, Serbia adopted an ownership and governance strategy for SOE. The strategy clarifies issues related to state ownership, governance, international standards and best practices, and will guide the authorities’ further SOE reforms. Moreover, the strategy will support the ongoing efforts to better monitor and control fiscal risks. In November, Serbia signed a Declaration on the Green Agenda for the Western Balkans. The agenda primarily focuses on decarbonization and reducing pollution, but also on establishing a circular economy, sustainable agriculture, and preserving biodiversity, and thus sets an important milestone towards greening the economy.