Fiscal policy

The authorities continue to be committed to prudent fiscal policy, with the aim of preserving hard-won stability. Fiscal prudence and keeping the public debt to GDP ratio below the 60 percent ceiling remain a cornerstone of their policy. The authorities are well aware of the risks and costs related to high public debt, given the recent experience of large but necessary fiscal adjustment, which brought public debt from about 76 percent of GDP in 2015 to about 53 percent in 2019. At the same time, given the current headwinds and prevailing uncertainty, they see a need for flexible policy implementation and smoothing the impact of the current shock, commensurate with the available fiscal space and program objectives. The authorities agree that against the backdrop of high inflation, global growth slowdown, and tighter external financing conditions, fiscal policy shouldbe nimble and increasingly targeted in supporting viable companies and vulnerable populations. The government’s medium-term fiscal strategy for the period 2023–2025, adopted in May, outlines a credible future fiscal policy path, consistent with the program, and a gradual decline in public debt, with general government fiscal deficits set to 3 percent and 1.5 percent in 2022 and 2023, respectively.

The authorities see scope for further strengthening the fiscal frameworks and advancing structural fiscal reforms. They started drafting the amendments to the existing fiscal rule already in 2019, however, the onset of pandemic delayed their adoption. In 2020, the authorities re-introduced indexation of public pensions usingthe “Swiss formula”, which links pensions to inflation and wage increases. In the second half of this year, the authorities plan to adopt a new deficit-based fiscal rule, which will also incorporate a debt anchor. The new fiscal rule will define escape clauses, correction mechanisms and expenditure caps for public pensions and wages. The new fiscal rule will strengthen fiscal responsibility and debt sustain ability while retaining the key role of the Fiscal Council to provide fiscal oversight, including through monitoring the fiscal rules and assessing the credibility of budgets and quality of public policies.

The authorities are continuing to strengthen debt management. On the back of liability management operations, extended maturity of new bond placements, and improved currency composition, they managed to reduce the gross financing needs from about 11 percent in 2019 to about 8 percent at present. Projections indicate that the gross financing needs will continue to decline, consistent with the decline in public debt. The authorities also took advantage of the benign global financing conditions in 2021, and partially pre-financedthe financing needs for 2022. Further refinements in debt management include the first Euroclear—an international central securities depository (ICDS)—settlement of dinar-denominated securities and the introduction of a primary dealer system. Since late 2021, Clearstream—an ICDS—has enabled direct settlement of dinar-denominated government securities for foreign investors.

Monetary policy and financial sector

To contain persistent inflationary pressures, exacerbated by the conflict in Ukraine and the sanctions imposed on Russia, the National Bank of Serbia (NBS) continues with the tightening cycle. Using the flexibility built into its monetary regime, the NBS started policy tightening in Q4 2021, by increasing the average repo rate by about 84 basis points followed by three consecutive increases of the reference rate in 2022. On June 9, the monetary council of the NBS increased the dinar reference rate by 50 basis points, to 2.5 percent. The rate hike came on the back of sustained inflationary pressures stemming from the global energy crisis, disrupted supply chains, and higher food and commodity prices, aiming at limiting second round effects while dampening inflation expectations. While the CPI reached 10.4 percent in May, the core inflation remains at 6.2 percent. The authorities note that the relative exchange rate stability over the past 8 years has been instrumental in maintaining price stability and underscore its centrality in the current context of prevailing uncertainty, imported inflation, and heightened volatility of capital flows. The high depreciation pressures on the dinar recorded in March stabilized in April, while in May the dinar was exposed to mild appreciation pressures fueled by an increased supply of foreign cash. International reserves remain adequate by the Fund’s ARA metrics, covering about 5 months of imports.

The Serbian banking system remains stable, liquid, profitable, and well capitalized. The capital adequacy ratio stoodat20.8 percent in February, against the statutory threshold of 8 percent. To avoid uncertainty and preserve confidence in the domestic banking system, the NBS intermediated effectively in the acquisition of Sberbank Serbia (3.8 percent of banking assets) by a domestic banking group, following the EU decision regarding the operations of Sberbank Europe AG, parent bank of Sberbank Serbia. NPLs remain low, atabout3.5 percent. The authorities remain vigilant and continue to rigorously monitor NPLs following the expiration of the moratorium of bank loan repayments. The provision of credit to the economy remains adequate. The credit is growing by about 12.4 percent annually, while the share of loans in dinars is increasing, supported by the dinar-denominated loans guarantee scheme—a critical measure enacted to support SMEs during the Covid-19 pandemic. Deposits in dinars are at record-high, bolstered by favorable interest rate differentials, tax exemptions, and a stable exchange rate. To further foster lending in domestic currency and support dinarization, the authorities will introduce higher capital requirements for FX lending to corporates.

Energy sector

A broad range of reforms have been implemented over the past decade to restructure SOEs, to address their organizational, financial, and governance shortcomings, to minimize fiscal risks, and to reduce state aid. However, in late 2021 and early 2022 the SOEs operating in the energy sector—EPS and Srbijagas—faced a series of challenges related to exceptionally high energy demand, high global energy prices as well as a series of operational breakdowns. In order to ensure stability of the energy supply, those companies resorted to expensive energy imports, which resulted in draining liquidity and eventually requesting direct budgetary support and government guarantees. Furthermore, the government decided to temporarily dampen the impact of soaring global energy prices on the population by limiting electricity and gas price increases on the domestic market, exacerbating the liquidity crunch of the energy sector SOEs. The substantially lower energy demand during the summer months will allow the companies to address their operational shortcomings. The authorities are also aware of the need to strengthen the governance of those companies, and the appointment of a new management team in EPS points in that direction. Furthermore, Srbijagas is increasing its storage capacity, which will allow building larger buffers for peak demand over the winter. The electricity tariffs will be adjusted upwards once the new government is in office, with a view to implementing the medium-term tariff strategy that will ensure full cost recovery and financial sustainability of EPS while creating space for critical investments.

Regarding the greening of the economy, in 2021 Serbia adopted the Law on Use of Renewable Energy Sources, a milestone on the path towards the decarbonization of its energy mix and incorporating renewable energy sources, while fostering broader participation of the private sector. Serbia signed the EU-backed Declaration on the Green Agenda for the Western Balkans, which primarily focuses on decarbonization and reducing pollution, and count on the support of the EU and IFIs for its implementation.