Republic of Serbia: Second Review Under the Policy Coordination Instrument and Request for Modification of Targets-Press Release; Staff Report; and Statement by the Executive Director for the Republic of Serbia
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1. While Serbia fared well during the COVID-19 pandemic compared with other countries, its continued recovery has been tested by new shocks during and since the last winter. The country experienced another pandemic wave in early 2022, but hospitalizations remained below previous peaks (Figure 1). The vaccine uptake has plateaued at close to 50 percent since 4Q2021. However, since the fall of 2021, the country has faced an energy crisis followed by the spillovers from the war in Ukraine.

Abstract

1. While Serbia fared well during the COVID-19 pandemic compared with other countries, its continued recovery has been tested by new shocks during and since the last winter. The country experienced another pandemic wave in early 2022, but hospitalizations remained below previous peaks (Figure 1). The vaccine uptake has plateaued at close to 50 percent since 4Q2021. However, since the fall of 2021, the country has faced an energy crisis followed by the spillovers from the war in Ukraine.

Recent Developments

1. While Serbia fared well during the COVID-19 pandemic compared with other countries, its continued recovery has been tested by new shocks during and since the last winter. The country experienced another pandemic wave in early 2022, but hospitalizations remained below previous peaks (Figure 1). The vaccine uptake has plateaued at close to 50 percent since 4Q2021. However, since the fall of 2021, the country has faced an energy crisis followed by the spillovers from the war in Ukraine.

2. Shortfalls in low-cost domestic electricity generation combined with rising international gas and oil prices significantly increased energy costs to the economy during the 2021–22 winter (Annex I). Although Serbia has typically been largely self-sufficient in electricity, starting in December 2021 Serbia’s coal-based power plant capacity was severely reduced by technical breakdowns. Elektroprivreda Srbije (EPS), the state-owned power company, had to import unusually large amounts of electricity throughout the winter. Simultaneously, natural gas imports surged due to higher demand from inclement weather and to back up electricity generation. While Serbia enjoys low-cost gas imports from Russia up to a daily limit, Srbijagas, the state-owned gas company had to import additional gas. Total energy costs during the winter exceeded past levels by about 2 percent of GDP.

3. The war in Ukraine is disrupting the economic recovery. Serbia’s large domestic electricity generation and food production partly cushions the terms of trade shock from the sharp rise in food and energy prices across Europe. And apart from gas imports, its direct dependence of trade with Russia and Ukraine is moderate. Hence, the war is expected to affect Serbia mostly through lower growth in partner countries and higher inflation (Annex II). However, for some companies it may be difficult to develop alternative markets, and a large refinery is majority-owned by Gazprom and could be affected by future EU sanctions against Russia.

4. Following strong growth through 2021, the impact of the more recent shocks is not yet visible in recent indicators of activity. Following a mild contraction by 0.9 percent in 2020, GDP strongly rebounded by 7.4 percent in 2021 on the strength of investment and private consumption, less than 2 percent below its pre-pandemic trend. The outcome exceeded projections at the first PCI review by nearly 1 percentage point, creating a positive carryover to 2022. Labor market indicators also remained favorable. In 4Q:2021 the headline unemployment rate declined to 9.8 percent from 10.5 percent, falling below 4Q:2019, resuming a trend decline (Figure 8). Seasonally adjusted, unemployment declined by 1.3 percentage points while activity and employment rates increased slightly. Industrial production and retail trades turnover in Q12022 showed a continued recovery but remain volatile, and the flash GDP estimate stood at 4.3 percent.

uA001fig01

Real GDP Growth Comparison

(In percent)

Citation: IMF Staff Country Reports 2022, 201; 10.5089/9798400214370.002.A001

Sources: IMF WEO database and IMF staff calculations.

5. Inflation increased to 9.6 percent in April. The increase has been driven by rising food prices (contributing about half) and—to a smaller extent—energy prices. Core inflation rose to 5.5 percent, exceeding the 1.5–4.5 percent target band. The pass-through of higher global energy prices has so far been limited. In particular, electricity and gas prices for households are regulated and have been kept stable. Price increases for fuel have been moderated through reduced excise taxes (by 20 percent) and a price cap that is adjusted on a weekly basis in response to international price changes.1 Inflation expectations have remained reasonably anchored so far, in part reflecting the stable exchange rate to the euro. Both the financial and business sectors expect inflation near the top of the target band within one year and well within that range within two years, which is expected to mitigate second-round effects through wages. Average net wage growth picked up in late 2021 but has stabilized since then at around 13 percent yoy, implying falling real wage growth.2

6. Fiscal performance was strong in 2021 due to recovering tax revenues and lower-than-expected execution of expenditure. The general government recorded a deficit of 4.1 percent of GDP, 0.9 percentage points lower than projected, mostly explained by the strong GDP growth as well as lower non-wage and capital expenditure.3

7. The external position has remained robust, supported by strong FDI inflows, but affected adversely by energy import costs and confidence shocks triggered by the war in Ukraine. The external position in 2021 is assessed to be moderately stronger than the level implied by fundamentals and desirable policies (Annex IV). The current account deficit widened slightly to 4.4 percent of GDP in 2021, well below net FDI inflows which, at 6.8 percent of GDP, exceeded projections. During 2021, reserves increased by nearly EUR 3 billion to EUR 16.5 billion. Appreciation pressures prevailed until late 2021 when the central bank switched to foreign exchange sales, in large part to cover high energy import costs. During March 2022, reserves fell to EUR 14.3 billion reflecting high energy import costs (EUR 500 mn) and exceptional purchases of euros by households from banks after the start of the Ukraine war (by EUR 700 mn; see below). Reserves have broadly stabilized since then; and at EUR 14.1 bn at end-April—about 4.3 months of prospective imports, or 110 percent of the ARA metric—remained adequate. As expected, by early 2022 the authorities had used most of the SDR allocation for fiscal financing.

Text Figure 1.
Text Figure 1.

Inflation Developments

Citation: IMF Staff Country Reports 2022, 201; 10.5089/9798400214370.002.A001

8. The results of the presidential and parliamentary elections on April 3 appear supportive of policy continuity, including with respect to the PCI-supported program. President Vucic was reelected with close to 60 percent of the vote. In the parliamentary elections, with broader party participation than in the previous elections and no election boycott, the ruling Serbian Progressive Party (SNS) fell short of a majority but is expected to form a new coalition government with its allies, and remains supportive of the Fund-supported program’s main objectives and key policies. A caretaker government will be in place until the formation of a new government, no later than August. The caretaker government has a limited mandate and cannot adopt new legislation, but can ensure the program remains on track.4

Outlook and Risks

9. Spillovers from the war in Ukraine are projected to lower growth in 2022 followed by a return to trend beyond 2023 given the strength of the ongoing reform agenda.

  • Real GDP growth is projected at 3.5 percent in 2022, 1 percentage point below forecasts at the first PCI review. Stronger-than-expected activity in 4Q:2021 could have increased 2022 growth by about 0.5 percentage points, while the war in Ukraine is tentatively assumed to reduce growth by 1.5 percentage point in 2022 and 0.5 percentage point in 2023, reopening a negative output gap. Growth is expected to be supported by continued robust private demand, although weakened by inflation and a contractionary policy mix. Since the large fiscal expansion in 2020— which successfully limited the impact of the pandemic—fiscal policy has been on a gradual consolidation path, expected to continue through 2023, to help restore fiscal buffers. Monetary policy has been tightened since October 2021 in response to the rising inflation.

  • Inflation is projected to average 9.0 percent in 2022 amid elevated global inflation and impulses from energy pass through, commencing a gradual decline from 3Q2022 when food price inflation should decline after last year’s drought-induced price hike. Core inflation is expected to moderate as well during 2H2022 based on the GDP slowdown and contained wage growth. Inflation is projected to reach 8.0 percent yoy by December and to return to the middle of the target band over the medium term.

  • The current account deficit is projected to widen to 6.1 percent of GDP in 2022 and 5.7 percent of GDP in 2023 due to higher energy imports, and temporary export revenue losses for goods previously destined for the Russian market. Furthermore, volume growth of imports and exports has been revised down with lower regional growth. Over the medium-term, fiscal consolidation is expected to contribute to a gradual current account improvement. Reserves are projected to recover modestly in the remainder of 2022 with a continued return of euro cash holdings to the banking system supported by the tightening of monetary policy, as well as continued strong FDI inflows (confirmed by recent indications from the authorities).

10. Risks to the outlook are elevated and mostly to the downside.

  • The main risks arise from a prolonged and escalating war in Ukraine, including through further pressures on energy and commodity prices, extended supply chain disruptions, tighter financial conditions, and lower external demand. Serbia’s continuing direct ties with Russia create a country-specific risk, as the country has thus far benefitted from favorable gas import prices, and as its refinery could be impacted by future sanctions against Russia.5

  • A new Covid wave could increase work absences given low vaccination uptake, and cause global supply disruptions.

  • The shortfall of domestic electricity generation may not be resolved by the next winter and the main energy companies could need further budget support.

  • Shocks to domestic financial stability in the wake of the war in Ukraine illustrated confidence risks that could, in turn, complicate domestic budget financing or create renewed pressures on international reserves.

uA001fig02

Serbia: Real GDP

(Index; 2019=100)

Citation: IMF Staff Country Reports 2022, 201; 10.5089/9798400214370.002.A001

Source IMF staff calculations

11. The authorities broadly concurred with the risk assessment while noting their mitigating actions. They acknowledged the adverse effects of the Ukraine war, but highlighted their quick response to manage the impact, and—in coordination with the Chamber of Commerce— to assist companies. They also continued monitoring the Covid pandemic, and expressed confidence in the preparedness of the health system. The adequate level of reserves of the NBS would offer an important buffer to financial disturbances.

Program and Policy Discussions

A. Energy Challenges

12. The authorities have sought to limit the impact of rising energy costs on inflation, including through direct controls.

  • Complementing the existing regulated household prices for electricity and gas, the increase in energy prices for corporates has been controlled as well since November. The authorities also introduced temporary caps on sales margins for fuel, price caps on a few basic food items, and export quotas for strategic food items.

  • Staff acknowledged that the absence of an effective targeted social safety net justified a delayed and phased approach to passing through international price increases to consumers, but also noted that sustained shocks ultimately would have to be absorbed. Staff encouraged the authorities to eschew introducing banning food exports and unwind export quotas as soon as possible. Staff also advised to increase energy prices to help ensure the financial viability of the energy companies, remove risks to the budget, and incentivize improvements in energy efficiency.

13. Addressing the energy sector’s challenges requires urgent financial, operational and governance reforms. While Serbia’s SOEs typically have not relied on government subsidies, in the past winter, Srbijagas needed liquidity support that was given through budget loans (0.5 percent of GDP in December 2021, and 0.4 percent of GDP in January 2022) and guaranteed loans from commercial banks (about 0.4 percent of GDP). The EPS received a government budget loan in March 2022 (0.1 percent of GDP).

  • Financial outlook. The authorities explained that during the summer months with low demand for electricity and natural gas, both main energy companies were expected to operate without subsidies. Furthermore, if exceptional subsidies were needed during the remainder of the year, these would be accommodated within the agreed fiscal deficit ceiling. The authorities also committed not to resort again to state guarantees for liquidity support to SOEs (PS 1119).

  • Electricity production. The technical problems in the thermal power plants, as well as the mining of sufficient quantities of coal of suitable quality need to be resolved urgently, if possible, ahead of the next winter, to avoid costly electricity imports. The electricity infrastructure also requires reinvestment. The authorities have enlisted World Bank support to assess the financial situation of EPS which would help guide the medium-term stabilization measures.

  • Energy tariffs. The authorities committed to initiating the tariff adjustment process to help restore cost recovery once the new government is formed and implement it no later than the second half of 2022 (PS U10).

  • Natural Gas. A high-level agreement with Russia has been reached on a new 3-year gas import contract on favorable terms. The authorities confirmed that gas prices for end users would need to be adjusted with new import prices.

  • Energy strategy and green energy: The authorities confirmed that the adoption of the National Climate and Energy Plan—already prepared in draft—will be an urgent priority for the next government (PS 1140), because it provides an essential framework for energy investments. The authorities indicated that green energy sources would become even more important due to their role in energy security6

  • Governance and restructuring (PS 1143): To prepare for the change in legal status of EPS to a joint stock company (end-November 2022 reform target (RT)), the valuation of EPS’ assets was completed at end-2021. The operational unbundling of Srbijagas is expected by 2024 in line with a Government Conclusion.

B. Fiscal Policy

14. The authorities’ commitment to accommodate recent support measures as well as possible further fiscal pressures within the agreed deficit of 3 percent in 2022 is welcome. Since the 2022 budget was passed, the authorities have announced additional support measures, totaling about 2 percent of GDP. Staff supported additional one-off payments to pensioners (given the long lag in indexation to inflation) and payments for medical workers, but argued that the provision of one-off EUR 100 grants to citizens aged 16–29 (about 0.2 percent of GDP) was not properly targeted. Staff reiterated that any additional support measures should target the most vulnerable individuals and firms. The authorities and staff concurred that strong revenue performance provided room for these past measures and that the 3 percent deficit limit remained appropriate, despite the risks to growth. Further spending needs may arise, in particular from risks in the energy sector, beyond the amounts already provided. The authorities indicated that such additional outlays would be accommodated through reallocations within the agreed deficit limit.

uA001fig03

Capital Expenditure, Fiscal Balance and Debt

(In percent of GDP)

Citation: IMF Staff Country Reports 2022, 201; 10.5089/9798400214370.002.A001

Sources: Ministry of Finance and IMF Staff calculations.

15. The authorities affirmed the planned deficit for 2023 of 1.5 percent of GDP and their commitment to further debt reduction over the medium term (PS H11, H14). Financing needs for 2022 are covered in part through the use of the SDR allocation, and in part were pre-financed in 2021. Financing needs for the remainder of the year are moderate and could be covered on the domestic market. For 2023, a return to the Eurobond market and development policy loans from development partners remain further options. In addition, project financing from multiple partners continues as planned and is projected to exceed the fiscal deficit in 2023. The updated debt sustainability analysis (Annex V) confirms that the profile of public debt remains benign. Nonetheless, following the pandemic-induced increase in the debt ratio by almost 5 percent of GDP, to 57 percent of GDP atend-2021, the authorities concurred on the importance of restoring the fiscal buffer through further consolidation.

16. Important fiscal structural reforms have continued.

  • Fiscal rule. The authorities affirmed their commitment to anchoring medium-term fiscal discipline by adopting a new set of fiscal rules (revised end-October 2022 RT, PS U15). In consultation with staff, the new rules will feature a more transparent and credible annual deficit ceiling anchored on public debt. Other key features should include strong accountability and a strong role for the Fiscal Council. The new rules will be incorporated into the budget system law before end-2022. The delay from the previous end-June 2022 RT is due to the legal inability of the caretaker government to adopt the rules. In parallel, the authorities are looking to strengthen medium-term budgeting with Fund technical assistance, which will enhance the credibility of the fiscal rules (PS 1119).

  • Tax administration. Significant progress in recent years involved a comprehensive registered taxpayer database, detection of unregistered taxpayers, taxpayer education, and e-filing. A new e-fiscalization model – that makes data from cash registers available to Serbia’s Tax Administration (STA) in real time -was introduced in May 2022, and an electronic invoice exchange system should be fully operational in early 2023. The preparation of the tender for a new commercial off-the-shelf (COTS) information system to support new business processes is on track (end-June 2022 RT). Staffing shortages in STA continue to be a key concern, yet recruitment procedures remain slow.

  • Fiscal risks. As an important milestone, expanded reporting on fiscal risks from SOEs, local governments and litigation is planned to be included in the November version of the 2023 Fiscal Strategy. It will draw on upgraded or new models and tools. Protocols on information sharing with relevant institutions will be signed once the new government is in place (PS 1121).

  • Public investment management. The Public Investment Management unit in the Ministry of Finance monitors all approved public investment projects. The Public Investment Management System (PIMIS), which includes an integrated database of public investment projects, is in the commissioning phase, and expected to be fully operational for projects in the implementation phase by end-2022 (PS 1120). Staff noted the importance of effective scrutiny of cost-effectiveness and financial risks beyond verifying procedural requirements.

  • Procurement. The use and functionality of the e-procurement portal continues to be strengthened, and the 2021 Annual Report of the Public Procurement Office indicates that the value of contracts increased to about 9 percent of GDP. However, exempted contracts at about 6 percent of GDP remained large, and the average number of bids is only 2.5.

  • Public wage and employment registry (ISKRA). The first phase of the new ISKRA information system – covering direct budget users and government units in three sectors – became operational with a delay through May for a small number of budget users (end-April 2022 RT). The next phase will include the education sector (except higher education institutions; new end-February-2023 RT).

  • Fiscal statistics. Work is ongoing with Fund technical assistance to automate the preparation of monthly GFSM 2014 compliant fiscal data, expand the coverage of extrabudgetary units, and develop data for the compilation of financial accounts (PS 1146). Completion will facilitate timely monitoring and adherence to the new fiscal rules.

17. The authorities have re-committed to transparency and accountability in the use of public funds. Pandemic and other emergency spending7 will be accounted in regular budget execution reports and subject to the annual ex-post audit by the State Audit Institution (PS 1113). Any financial support to public enterprises is to be delivered transparently (PS H13). While a guarantee was issued to Srbijagas in early 2022 to ensure uninterrupted gas imports, the authorities committed to strictly limit the issuances of guarantees and especially not to issue any new guarantees for liquidity support to SOEs (PS 1119).

C. Monetary and Financial Sector Policies

18. Within Serbia’s stabilized de-facto exchange rate regime, the National Bank of Serbia (NBS) raised the policy rate to 2 percent in May. The process of monetary tightening began in October 2021 with the gradual increase of the repo rate in reverse repo auctions, to curb inflation expectations and contain second-round effects on prices in the wake of rising food and global energy prices. As inflationary pressures turned out to be stronger and more persistent than previously expected, including because of the war in Ukraine, the NBS raised the key policy rate twice, in April and May—by 50 bp each time—to 2 percent. It also raised rates on deposit and credit facilities to 1 and 3 percent, respectively.

uA001fig04

Weekly Interest Rate Corridor and Excess Liquidity

(LHS: Percent; RHS: Billions of RSD)

Citation: IMF Staff Country Reports 2022, 201; 10.5089/9798400214370.002.A001

Sources; NBS; and IMF Staff calculations.

19. Staff supported the monetary tightening and encouraged the NBS to take further actions as needed to keep inflation expectations anchored and help projected inflation return within the target band within the projection horizon. Staff acknowledged that a more measured pace of monetary tightening in Serbia compared with emerging market peers, in particular in the EU, could be justified in light of relative importance of higher food prices because of a drought (with core inflation remaining lower than regional peers), the ongoing fiscal tightening, moderate inflation expectations, and the stabilization of the exchange rate to the euro during the pandemic. Nevertheless, staff advised the authorities to continue closely monitoring inflation developments, including relative to the euro area, and stand ready to tighten further as needed. In particular, in case of stronger-than-expected second round effects, more decisive policy tightening would be warranted. Monetary policy should also take into account tightening by the ECB and the interest differential with the euro area.

20. At the start of the war in Ukraine, the authorities acted swiftly to mitigate shocks to financial stability.

  • The NBS orchestrated the quick sale of Sberbank Srbija to AIK Banka a.d. Beograd, which halted deposit outflows from the bank. Staff appreciated this successful first use of bank resolution procedures, which achieved a market-based take-over without financial involvement of the public sector.

  • The spillovers from the war also triggered temporary cash withdrawals in euros from the banking system, peaking in the first two weeks of March. The authorities emphasized in a public campaign that the exchange rate would be kept stable through the crisis, and that any withdrawal requests would be honored.

21. The authorities emphasized that exchange rate stability was essential to macroeconomic stability. They noted the adverse impact that a significant depreciation could have on confidence, inflation, FX denominated debt and the dinarization strategy. While acknowledging that the sharp reserve losses of early March 2022 were due to exceptional circumstances and that the NBS had already started to repurchase euros withdrawn by households, staff emphasized the risks to reserves. The recent tightening of monetary policy was an appropriate complement within the policy mix in this context. Staff agreed that there was a case for maintaining exchange rate stability through crises to maintain confidence, and recognized that the external sector assessment (Annex IV) indicates a fairly valued exchange rate. Nevertheless, staff reiterated that a gradual return to a more flexible exchange rate would be more aligned with a regime of inflation targeting and could help limit risks from unhedged FX loans.

22. Domestic credit growth picked up since mid-2021 and dinarization increased. In March, creditgrowth reached 12.4 percent yoy, largely reflecting the fading of high base effects from 2020 due to moratoria and rising credit growth to corporates. NPLs have remained stable, registering below 3.5 percent at end-February Credit and deposit in dinars increased to 38 percent and 40 percent, respectively, at end-December. Dinar savings have been supported by rising interest rates. Starting from July 2022, the authorities plan to apply higher capital requirements on banks’ FX lending above a threshold in order to increase dinar lending further.

23. While the banking system remains liquid and well capitalized, and financial stability has been preserved, close monitoring of risks in the banking sector remains critical.

  • As the crisis evolves, staff re-emphasized that banks should continue to assess borrowers’ creditworthiness and reclassify exposures when repayment appears unlikely.

  • Staff and the authorities agreed that risks to financial stability from litigation of loan fees charged by banks are receding thanks to a ruling of the Supreme Court of Cassation affirming the legality of such fees.

  • Staff reiterated the need to monitor the expansion plans of Banka Postanska Stedionica (BPS) the largest remaining state-owned bank, while noting that performance was in line with the approved business plan.

  • In view of the ongoing growth in lending, staff suggested phasing out the remaining temporary incentives for housing and other loans. The authorities noted that the economy and citizens still needed support and that the housing measure had been extended through 2022.

24. The authorities have continued enhancing the financial safety nets. The Deposit Insurance Agency (DIA) plans to introduce risk-based premiums in 2022. The authorities were launching the final tendering process of the DIAs residual bad assets (with a nominal value of EUR 492 million), with a goal to complete it by end-2022.

25. The authorities confirmed their plans for strengthening capital markets. Following the adoption of the Capital Market Development Strategy (end-September 2021 RT), the authorities passed a new Law on Capital Markets that aligns the Serbian regulatory framework with the EU acquis in December 2021. The authorities aim to introduce a primary dealer system in support of the first auction of dinar-denominated securities using Euroclear (expected in early 2023). Accordingly, the primary dealer system will be applied at least for one benchmark issuance no later than 1Q2023 (new end-March 2023 RT).

D. Structural Policies

26. Against the backdrop of robust labor market conditions, the authorities emphasized the continued importance of combatting the grey economy and targeting of social assistance programs. Reform initiatives for fighting the informal economy include the new e-fiscalization model, and draft legislation (to be presented by the new government) on extending the law on seasonal workers beyond agriculture to the construction and tourism sectors. The authorities noted that the minimum wage remains a key tool to support the vulnerable. The Social Card Registry, which consolidates all relevant data on people’s socio-economic status, was launched in March. In combination with a new “Social Care” IT system, the design and implementation of social protection programs can now become more targeted. Staff considered that spending on social assistance was low, and suggested that with a better system, there was a case for expanding its coverage and the level of benefits. The authorities also highlighted the successful “My First Salary” program, which aims to boost youth employment.

27. SOE reforms are progressing.

  • In December 2021 a centralized and updated database with a registry of all SOEs and their assets was published, and the Ministry of Economy adopted an internal act on the baseline for setting mechanisms and criteria for reviewing and approving key decisions of SOEs (end-December 2021 RT). The authorities have created a working group for preparing a new law on ownership management for SOEs (end-December 2022 RT).

  • In December 2021 an agreement on the privatization of Petrohemija through a strategic partnership with NIS, a Serbian subsidiary of Gazprom, was reached, and closing was expected in July 2022.

  • The authorities are continuing to explore strategic investments or partnerships for bus company Lasta.

28. The AML/ CFT framework continues to be strengthened and progress is being made on anti-corruption initiatives. In the MONEYVAL report following the December 2021 Plenary, Serbia was assessed as “compliant” or “largely compliant” for 39 of the 40 FATF recommendations. The national risk assessment (NRA) in the digital assets sector adopted in September 2021 was not yet reflected in the report. The Action Plan for implementing the National 2020–2024 Strategy Against Money Laundering and the Financing of the Terrorism (AML/CFT Strategy) was updated in March 2022 following the 2021 NRA exercise. The updated Rulebook on the methodology for complying with the AML/CFT Law was published in February 2022. The March 2022 Second Interim Compliance Report, which deals with corruption prevention in respect of members of parliament, judges and prosecutors, of the Group of States against Corruption (GRECO) notes that Serbia implemented 8 of 13 recommendations satisfactorily and the remaining were partially implemented. Staff encouraged the authorities to continue advancing the effective implementation of these initiatives.

Program Modalities

29. Program implementation has been broadly on track.

  • All but one end-December 2021 quantitative targets (QTs) and continuous targets (CTs) were observed (PS Table 1a and 1b). The energy crisis triggered temporary additional fiscal spending to ensure adequate supply of natural gas. As a result, the end 2021 ceiling on current primary expenditure was missed by 0.2 percent of GDP.

  • As the war in Ukraine has raised international energy and food prices further, the upper inflation band under the Inflation Consultation Clause was breached in March 2022 (PS H24 and PS Table 1a). The authorities have consulted with staff on the drivers behind inflation, and staff considered that the continued tightening of monetary conditions, including the increases in the key policy rate in April and May, was appropriate.

  • In light of the rise in inflation and the spending adjustments, staff is proposing to modify the December 2022 QTs for the fiscal deficit and primary expenditure of the Republican budget, and the inflation consultation band (PS Table 1a).

  • The actions under the end-December 2021 and end-April 2022 reform targets (RTs) were completed. In December 2021, a centralized SOEs database was created, and an internal act on mechanisms and criteria for reviewing and approving key decisions of SOEs was adopted. The end-April RT on expanding the central electronic public wage and employment registry was missed due to a delay for a small number of budget users (entities) and completed in May.

  • Staff is proposing to modify the target date for the RT to adopt a new fiscal rule from end-June 2022 to end-October 2022. Revising the timeline is necessary since a formal government decision on a fiscal rule will not be possible while a caretaker government is in place. The authorities reaffirmed their commitment to a new fiscal rule and intended to present it with the 2023 budget.

  • Staff is proposing two additional RTs (PS Table 2). First, by end-February 2023 the second phase of a new payroll information system covering the education sector (except higher education) should be operational (PS 1118), which will be critical for preparing the delayed public sector wage grid reform (PS U17). Second, the authorities will introduce a primary dealer system in support of at least one benchmark issuance of dinar-denominated government securities by end-March 2023 (PS H27).

30. Financing assurances. The program remains fully financed with firm commitments in place for the next 12 months and there are good prospects for the remainder of the program period (HI 5).

31. Serbia has small sovereign arrears outstanding. The authorities have been in contact with their Libyan counterparts to resolve Serbia’s 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 persist with efforts to resolve these arrears as soon as possible.

Staff Appraisal

32. Following the COVID-19 pandemic, the energy crisis and the war in Ukraine have posed new challenges for the Serbian economy. Serbia demonstrated its resilience during the pandemic, and production as well as employment recovered more rapidly than in many other countries. However, the recent energy crisis exposed the lingering risks to fiscal sustainability and growth from weak governance and investment planning in key public enterprises. The adverse spillovers from the war in Ukraine are projected to result in a marked reduction in economic growth, and possibly some economic scarring. The further increase in international energy and commodity prices has pushed up inflation further.

33. Immediate policy priorities are to preserve macro-fiscal and financial stability and mitigate the impact of the ongoing external shocks. Should economic disruptions warrant further support to the affected groups or activities, including the state-owned enterprises in the energy sector, the additional expenditures should be accommodated by reprioritizing spending within the agreed 3 percent of GDP fiscal deficit ceiling—which remains an appropriate anchor. Any additional emergency assistance should be temporary and targeted to vulnerable households and viable firms.

34. The ongoing tightening of monetary policy, including the policy rate increases in April and May, is important for bringing inflation back into the target band in 2023, but more may be needed. The authorities should stand ready to respond as needed to contain second-round effects of higher imported prices on inflation. Maintaining exchange rate stability throughout the extended crisis period has helped maintain and restore confidence and anchor inflation expectations. That said, gradually allowing more exchange rate flexibility once the crisis is over could be beneficial.

35. The banking system remains well-capitalized and liquid, but continued vigilance is essential. The swift response by the NBS to war-related spillovers on the banking system was instrumental for preserving financial stability. The NBS timely initiated a resolution procedure in respect of Sberbank Srbija, and quickly finalized its acquisition by a domestic banking group. At the same time, recent events illustrated the remaining risks to confidence in the currency and the financial system, calling for continued close monitoring of depositand foreign exchange movements.

36. The recent disruptions in domestic electricity production demonstrated the urgency of rigorous reform of governance in the energy companies as well as of a new strategy for investments in the sector. While the caps on energy prices have helped maintain social and economic stability, forthcoming price adjustments are needed to help ensure cost recovery and financial sustainability of the energy companies without putting pressure on the government budget. When adjusting energy prices, it will be important to soften the impact on vulnerable households.

37. The reform momentum should be maintained. A critical reform under the program will be anchoring medium-term fiscal discipline with a new set of fiscal rules. Further actions should include continued implementation of the SOE ownership and governance strategy, and the expansion of the central public wage registry to improve control. Implementing the new capital market development strategy would underpin private investment. Furthermore, strengthening the rule of law, curbing corruption, and pursuing the transition to greener growth should be vital overarching priorities.

38. Staff supports the completion of the second review under the Policy Coordination Instrument. Staff also supports the authorities’ request for the completion of the second review under the PCI, the modification of end-December 2022 targets (fiscal deficit, current primary expenditure, and the inflation consultation band), the new proposed RTs and the modification of the completion date for the RT on adopting a new fiscal rule (to end-October 2022).

Figure 1.
Figure 1.

COVID-19 Evolution in Serbia

Citation: IMF Staff Country Reports 2022, 201; 10.5089/9798400214370.002.A001

Figure 2.
Figure 2.

Serbia: Real Sector Developments

Citation: IMF Staff Country Reports 2022, 201; 10.5089/9798400214370.002.A001

Figure 3.
Figure 3.

Serbia: Balance of Payments and NIR

Citation: IMF Staff Country Reports 2022, 201; 10.5089/9798400214370.002.A001

Figure 4.
Figure 4.

Serbia: Financial and Exchange Rate Developments

Citation: IMF Staff Country Reports 2022, 201; 10.5089/9798400214370.002.A001

Figure 5.
Figure 5.

Serbia: Inflation and Monetary Policy

Citation: IMF Staff Country Reports 2022, 201; 10.5089/9798400214370.002.A001

Figure 6.
Figure 6.

Serbia: Selected Interest Rates and Credit Development

Citation: IMF Staff Country Reports 2022, 201; 10.5089/9798400214370.002.A001

Figure 7.
Figure 7.

Serbia: Fiscal Developments

Citation: IMF Staff Country Reports 2022, 201; 10.5089/9798400214370.002.A001

Figure 8.
Figure 8.

Serbia: Labor Market Developments

Citation: IMF Staff Country Reports 2022, 201; 10.5089/9798400214370.002.A001

Table 1.

Serbia: Selected Economic and Social Indicators, 2018–24

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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. The calculation of the structural balance has been revised to include temporary one-off measures enacted to respond to the pandemic.

Excludes state guarantees on bank loans under the credit guarantee scheme introduced in response to the COVID-19 crisis, estimated at 1.1 percent of GDP as of August 15th 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, 2018–27

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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, 2018–27

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

Serbia: Balance of Payments, 2018–27 1/

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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 2021.

Includes trade credits (net).