Pavle Petrović, President of the Fiscal Council of the Republic of Serbia – Comprehensive social reforms, that are missing, are must to spur weak economic growth in Serbia

Due to the smaller decline in GDP, Serbia has a minimal drop of employment rate in this crisis and has managed to preserve macroeconomic stability, which is all really good. However, we missed the opportunity to make even better use of these circumstances.
Pavle Petrović, President of the Fiscal Council of the Republic of Serbia


In an interview for our first issue in 2021, Pavle Petrović, President of the Fiscal Council, talks about what Serbia needs to have rapid economic growth, the impact of pandemic on GDP and public finances, as well as what could have been done differently when planning the budget for next year.

In 2020, despite the pandemic, Serbia has recorded the smallest decline in the gross domestic product among European countries. What do you think of that?

 The final results for 2020 are not yet released, but we currently estimate that the decline in Serbia’s GDP could be around 1.5%. Since the average GDP decline in the countries of Central and Eastern Europe is expected to be around 5%, and in the entire EU around 7.5%, that means that Serbia will have one of the smallest, perhaps the smallest, GDP declines in Europe. The main reason for Serbia’s good result is its specific economic structure. The Serbian economy relies much more than others on activities that did not suffer during the crisis (agriculture, food industry), and less on tourism, the automotive industry, and the production of industrial equipment, which were most affected by the crisis. Relying so much on the production of existential products is bad in normal times because it indicates the low development of the domestic economy, but in this situation has proven to be a happy circumstance.

As a result of a lower economic decline, budget revenues in Serbia in 2020 were not as reduced as in other European countries.

What impact will this have on our economy and public finances?

 Due to the smaller decline in GDP, Serbia has a minimal decline in employment rate in this crisis and has managed to preserve macroeconomic stability, which is all really good. However, we missed the opportunity to make even better use of these circumstances. Also, as a result of a lower economic decline, budget revenues in Serbia in 2020 were not as reduced as in other European countries. We should have utilized that better and end 2020 with a smaller budget deficit. However, Serbia’s deficit will be among the largest in the CEE. The reason for that is the one-off payment of 100 euro to all adult citizens of Serbia, which was neither socially nor economically justified, and has increased the state deficit by over 600 million euros (1.3% of GDP). No one else in the CEE has implemented such a measure.

 Furthermore, in 2020, Serbia helped state-owned companies that encountered problems before the crisis like Air Serbia, and although several European countries, which are also in crisis, are helping their airlines, in Serbia that help is (relatively speaking) much higher. These are some of the reasons why the smaller economic downturn in Serbia in 2020 did not result in better fiscal indicators at all.

What do you think of the recently adopted state budget for 2021?

The proposed budget has both good and bad elements. The Fiscal Council’s main objection is that the Government was not careful enough in planning it. Projections of budget revenues and expenditures are based on the optimistic assumption that GDP growth in 2021 will be 6%, which will be difficult to achieve. In the case of lower economic growth, public revenues will not be collected according to plan, so the deficit could be significantly higher than 3% of GDP as originally planned. Besides, the government has not reserved funds in the budget for a new economic support package, and such a package may be needed because the epidemic is not over yet and some segments of the economy could experience liquidity problems. If the deficit is significantly higher than planned, and such a risk clearly exists, public debt would exceed 60% of GDP and would continue to grow relatively strongly in 2021 instead of slowing down. For a country like Serbia, such public debt is too high because the interest rates that Serbia pays on borrowing are twice as high as in developed European countries.

What should have been done differently?

First of all, the government should have not approved a relatively high increase in public sector wages of almost 5%. Civil servant salaries have already been increased by 10% in 2020, and the economic growth, which funds these salaries, will not be nearly as high in 2020 and 2021. Also, the government should not have implemented numerous projects that are not urgent in 2021. For example, the increased spending on the arms for the security sector and the construction of the airport in Trebinje are not projects that are important for the health of the population or effectively stimulate economic growth. Such projects should have been postponed for a better time. It is also a mistake that there are no sufficient budget allocations for the construction of communal infrastructure and environmental protection, which should be a priority because Serbia is one of the most environmentally polluted European countries.

However, the Fiscal Council had significant praise when assessing the 2021 state budget. We have noted its good sides such as a strong increase in investments in the construction of transport infrastructure. This contributes to a faster economic recovery of the country, and there is a need for that because the current condition of the basic infrastructure is very bad. During the 2008 crisis, one of the biggest mistakes made was that public investments were greatly reduced and that mistake has now been avoided.

To what extent did the Covid-19 pandemic affect the liquidity of state-owned enterprises and did it perhaps contribute to new problems emerging?

 The crisis has negatively affected the operations of these companies, but it is not the only or the main cause of their difficulties. The pandemic also exposed a number of structural problems that burdened their business before the current crisis. For example, in late 2019, we said that Electric Power Industry of Serbia (EPS) should increase its investments to around 600 million euro a year in order to meet future demand for electricity and meet at least the minimum environmental standards. Funds for the necessary investments could be provided with a fundamental reform of the company, which, however, is still not implemented. Since there was no progress in the reform plan, a 40-million-euro subsidy was given to EPS from the state budget at the end of 2020.

 The government has also decided to support Air Serbia with state funds both in 2020 and 2021. Although the specific plans and amounts are still not completely known, our analyses have shown that the company will need around 200 million euro by the end of 2021 and a less than half of these funds can be attributed to the impact of the pandemic.

What do you think are the biggest risks to the stability of public finances in the medium term?

 The biggest risks are unreformed public and state-owned companies and excessive salaries in the public sector. In terms of state-owned companies, their problems need to be solved the moment they appear, and not to be pushed under the carpet until that time when only the state’s assistance can save them. The state has now decided to cover part of the liabilities of Air Serbia and EPS, while in recent years, it had to pay the accumulated debts of Srbijagas and Petrohemija. Plus, every year state subsidies are given to the Resavica coal mine. Since there are still no indications that the failed state-owned companies will be restructured, it will be again their turn to receive state aid in the years to come.

Another risk is excessive wage growth in the public sector. Wage management in Serbia is not systematically regulated, which leaves room for the government to determine increases in civil servant salaries in a discretionary manner, which is not good. The increase in public sector wages is a politically popular measure, so the government has been increasing that expenditure significantly more than it has been economically justified over the years. The public sector wage bill has been growing significantly faster than rate of economic growth since 2018, and this was especially pronounced during the crisis in 2020 and 2021.

Without a systemic solution that would anchor wage growth in the public sector, there is no guarantee that this practice will not continue in the future. The problem with civil servant salaries is not only that they are too big of a burden for public finances, but also that they are already about 20% higher than in the private sector. This is a huge difference even when corrected in terms of the educational structure of public sector employees.

Pronounced corruption distorts level playing field and directs entrepreneurs’ scare resources towards unproductive activities, hence curbing economic growth.

Are there ways to reduce/control unsustainable expenditures when it comes to public sector wages?

 Back in 2018, we gave detailed guidelines for regulating the salary system in the country, following the example European countries. First, a single pay grade system should be created that should include all segments of the public sector, and then the wage indexation should be linked to the growth of productivity. A comprehensive wage system would be based on objective job characteristics rather than political priorities. This specifically means rewarding the most demanding and complex jobs in the country and reducing generous compensation for less demanding jobs. This would stop the outflow of the top quality and most needed staff from the public sector and at the same time, reduce the excessive number of unnecessary workers who would be more productive in the private sector.

 Pensions are a good example that the introduction of a good systemic solution is possible. The Swiss formula was again applied to the pension system of Serbia in 2019, which ensured that the annual increase in pensions was in line with clear parameters – the growth of average wages and inflation. Regulating the salary system in the public sector is a much more professional task than regulating the pension system, but if most other CEE countries could deal with this problem, there is no justification for Serbia not to do the same.

 What are the main problems of slow economic growth in Serbia, and can we expedite that growth?

 The Serbian economy is growing between 1.5 and 2 percentage points below its potential, i.e. on average about 3.5% instead of the potential 5 to 5.5%. The main reason for this lies in bad economic and social foundations: weak rule of law and high corruption, low investments and shortcomings in the education system. Pronounced corruption distorts equal market conditions and directs surplus funds created in the economy towards unproductive activities. Legal uncertainty discourages domestic private companies from investing while unsuccessful public enterprises do not have sufficient funds for investing.

Finally, the performance of our education system is below the CEE average, which hampers labour productivity growth and hinders knowledge transfer and the application of new technologies. Thus, the solution to the problem lies in comprehensive social reforms. Improving the rule of law, curbing corruption, restructuring public enterprises and reforming the education system are key levers for accelerating economic growth and catching up with comparable CEE countries, which have already advanced far in terms of faster economic growth in the previous decade.

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