Supported by the Stand-By Arrangement (SBA), macroeconomic performance has improved markedly over the past two years. The regional energy crisis was skillfully managed and supply disruptions were averted, with a minimal impact on output. This year, growth is accelerating, driven by domestic consumption and investment, and inflation has returned to the National Bank of Serbia’s inflation tolerance band. On the fiscal front, the fiscal balance has steadily improved, and public debt has continued on a downward path, despite large budgetary outlays to support energy imports and generation in 2022. The principal objectives under the SBA related to the energy sector have been achieved: the financial solidity of the energy sector SOEs is being restored, supported by bold energy tariff adjustments, which are critical to minimize fiscal risks, create space for future investments, and support the green transition.
Over the past decade, Serbia has benefited from continuous engagement with the Fund, first through the 2015 precautionary SBA, followed by two consecutive Policy Coordination Instruments and the current SBA. Over nearly a decade, a wide range of difficult reforms have been implemented to stabilize the economy and spur growth, including restoring the health of the banking sector, resolving remaining loss-making socially-owned companies, and achieving a substantial fiscal adjustment that lowered the public debt-to-GDP ratio by more than 20 percentage points to slightly above 52 percent in 2023. A strong track record of reform implementation testifies to the authorities' resolve, ownership of reforms, and prudent approach to macroeconomic management. The authorities concur that the policies implemented under successive Fund-supported programs are yielding dividends in terms of stability, growth, and capacity to deal with shocks. The continuity of sound macroeconomic policies is underpinned by the decisive win of the incumbent SNS-led coalition in the recent parliamentary elections.
The Serbian economy weathered the energy shock well, supported by an early and decisive policy response, sizable buffers, and Fund support. At its inception in 2022, in the midst of the regional energy crisis, the SBA was instrumental in bridging energy-related transitory balance of payments (BOP) and budget financing needs. The sharp rise in energy prices, global inflationary pressures, regional and global uncertainty, and tightening global credit conditions, compounded by unexpected shortfalls in domestic electricity production, resulted in rising BOP and fiscal financing pressures. The policies implemented under the SBA-supported program helped stabilize and address structural deficiencies in Serbia’s energy sector, facilitated the resolution of external and internal imbalances and restored macroeconomic stability. The authorities continue to treat the SBA as precautionary.
Monetary and financial sector policies
Inflation is on a firm downward path. In May, inflation returned to the National Bank of Serbia’s (NBS) inflation tolerance band, earlier than indicated in the NBS’s February projections. The NBS expects a gradual decline of headline inflation in the second half of the year and a return to the 3 percent target in 2025. Disinflation has been driven by the tight monetary stance, declining inflation expectations, easing global cost-push factors, lower imported inflation, and subdued external demand in 2023.
On June 13, the NBS Executive Board reduced the policy rate by 25 basis points to 6.25 percent. The decision to ease monetary policy was driven by steady disinflation—headline inflation has been declining continuously since its peak in March 2023 to 4.5 percent year-on-year in May—, the return of inflation to the inflation tolerance band, and the easing of global inflationary pressures. In addition, the decision to lower the policy rate was motivated by a firmly declining trend of short-term inflation expectations to within the NBS inflation corridor. Furthermore, the restrictive monetary policy stance led to a sluggish credit growth, which improved only slightly in the first quarter, driven by higher household credit demand and the gradual easing of credit conditions. The authorities underscore that anchored expectations remain key to disinflation, reflecting the credibility of the NBS and its monetary policy.
International reserves are high at around 160 percent of the Fund’s ARA metric. As in 2023, the current account deficit in the first quarter of 2024 was more than covered by FDI inflows, leading to prevailing appreciation pressures on the dinar. Over the first four months of 2024, the NBS purchased EUR 530 million in the FX market, further strengthening FX reserves, which stood at EUR 25.2 billion at the end of May.
Serbia’s bank-dominated financial sector remains resilient and profitable, with healthy balance sheets, ample liquidity, and low non-performing loans. The capital adequacy ratio stood at 21.2 percent at the end of March. Non-performing loans remained close to the historical minimum of about 3 percent, supported by robust regulatory and macroprudential frameworks. Regular NBS stress tests of the banking sector indicate resilience to a variety of macroeconomic shocks. The NBS is well aware that global headwinds and potential adverse spillovers require heightened vigilance. It is closely monitoring the developments related to banks’ liquidity, deposits, and asset quality, while further strengthening the already robust prudential framework to bring it in line with international standards and EU requirements. More specifically, the NBS has completed a gap analysis of the domestic legal framework for banks with that of the EU and has introduced a modern legal framework for the management of liquidity risk in banks.
Fiscal policy
Fiscal outcomes in 2023 were strong, surpassing the program targets. Driven by notable revenue overperformance and lower-than-expected expenditure, the 2023 fiscal deficit outturn of 2.2 percent of GDP was notably better than the planned 2.8 percent. Good fiscal results continue in the first quarter of 2024, as the general government recorded a deficit of 0.9 percent, while the primary balance recorded a surplus of 2.2 percent. Compared to the first quarter of 2023, tax revenue show double-digit growth, driven by higher VAT and social contributions on the back of growth in wages and private consumption.
The authorities consider that at the current juncture, an additional infrastructure investment push would be critical to further modernize the country, address the infrastructure gap, buttress potential output, and lay the foundation for stronger income convergence. The new development plan “Leap into the Future—Expo 2027” is critical in this regard, and while it would require a slightly higher fiscal deficit path from 2025 onwards, it would not jeopardize fiscal consolidation and sustainability. It is worth noting that the bold fiscal consolidation implemented since 2015 has been crucial in creating the fiscal space for the current higher public investments. Since 2018, Serbia has increased public investment spending to about 7 percent of GDP, with a tangible impact on the quantity and quality of infrastructure. The authorities have been well aware that the shortage of core public infrastructure was a headwind to higher economic growth and faster convergence, exacerbated by the poor quality of existing infrastructure. Since 2018, the authorities have stepped up public investment spending and related policies to modernize transport networks, improve road and rail connectivity to foreign markets, and increase the economy’s attractiveness as an investment destination, all while keeping public debt on a downward path.
A renewed public investment effort is key to close the infrastructure gap. As noted by the Serbian Fiscal Council, Serbia needs to increase density of its highway network (1.1 km per 100 km2), to reach the Central, Eastern and Southeastern European (CESEE) average (1.25 km per 100 km2). Furthermore, Serbia’s total road network of 52 km per 100 km2 is considerably below the CESEE average (130 km per 100 km2). This calls for ramping up infrastructure spending, commensurate with available fiscal space and consistent with the declining path of public debt. At the same time, public investment management reforms are ongoing, with an objective of operationalizing the Decree on Capital Projects, adopted in late 2023, and establishing a single project pipeline. These efforts are supported by the introduction of a Public Investment Management Information System at the national level in 2024 and at the local level in 2025. Additionally, the authorities remain committed to enhance the transparency of public investment projects. To accommodate the need to accelerate spending on infrastructure, the deficit agreed under the program will be slightly higher than originally planned, at 2^ in 2025 and 2% in 2026.
Based on modest deficits, low public debt, a prudent borrowing strategy, and strengthened fiscal buffers, the government’s gross financing needs remain manageable. Against the backdrop of increased volatility and bouts of risk aversion in global capital markets, the authorities stepped up efforts to strengthen fiscal buffers and substantially increased government deposits. Gross financing needs declined from about 10 percent of GDP in 2023 to below 9 percent in 2024. The 2024 budget is fully financed and the remaining debt issuances in 2024 will be aimed at pre-funding the 2025 budget while maintaining market presence. At the same time, debt management is geared towards extending maturities while reducing exposure to exchange rate risks by gradually increasing the share of dinar-denominated debt.
Energy sector policies
Addressing long-standing shortcomings in the Serbian energy sector and limiting related fiscal risks remain key pillars of the Fund-supported program. A critical, gradual increase in energy tariffs, paired with a decline in energy prices and restored electricity generation, stabilized energy markets and led to the end of budgetary support to energy SOEs. Both the EPS—the electricity generation SOE—and Srbijagas—a gas import and distribution SOE— recorded profits in 2023. While the current energy tariffs allow EPS to cover all its operational costs, the authorities agree on the pressing need to establish a viable energy tariff mechanism for the unregulated market segment.
The authorities underscore that the restructuring of EPS is critical to ensure a stable electricity supply, minimize energy security risks, and foster the green transition. To improve governance, the legal status of EPS was changed to a joint-stock company, new members were appointed to the EPS Executive Board, including international and domestic experts, and a new CEO was selected. EPS has adopted a comprehensive restructuring plan, which is critical for modernizing the company’s governance and organizational structure, as well as strengthening its operations and investment project development. These efforts to modernize EPS will ensure national energy security while fostering the green energy transition.