Dejan Šoškić: This crisis could seriously hamper economic growth in Europe

We spoke with Dr. Dejan Šoškić, a professor at the Faculty of Economics (EFB) at the University of Belgrade about economical trends and crisis that seems to harm Europe.

Dr. Dejan Šoškić, Professor at Faculty of Economics (EFB), University of Belgrade

The war in Ukraine caused extreme uncertainty for next winter. In how many ways could this crisis overflow? What could ordinary people with tiny wallets and enlarged bills that should be paid expect?

War in Ukraine in itself would have had primarily a negative impact on Ukraine and Russian Economies and on Ukraine’s exports due to the direct negative effect of the war on the economy of this country. However, sanctions imposed by the West have threatened to cut off the Russian economy and its global exports from international markets. And Russian economy measured with GDP corrected with purchasing power parity (PPP) is the sixth economy in the world and the second economy in Europe. It is, according to World Bank data, lagging behind Germany’s only around 5%, and with a significant presence in global energy, food, fertiliser, metals, and other commodities markets. Such a large economy and such a significant supplier of global inputs is a poorly chosen candidate for sanctions since expelling it from international markets means creating a huge supply shock and breaking numerous supply chains on both sides. Inflation comes as a natural consequence of such measures, mainly driven by supply shocks, and the disentanglement of supply chains creates downward and recessionary pressures, not only for the Russian economy but also for western and many other economies of the world. This crisis could seriously hamper economic growth in Europe, decrease the living standards of ordinary people and bring about stagflation (stagnation with inflation) as an almost forgotten, but very unpleasant state of macroeconomic circumstances from the 70-ies.

Competence in governance and a low level of corruption are needed if the country seeks a sound and robust position in an international environment.

Ordinary people are already experiencing the higher cost of fuel, higher heating costs, and higher cost of food, but also an increase in prices of many other products and services that are less in the everyday spotlight but can still further erode the living standard of ordinary people. If we combine this with the deceleration of economic activity then the picture for the following several quarters, for Europe specifically, looks pretty gloomy.

Can we believe that our government and administration could cope with soon coming challenges, especially if we could see how many stronger economies have suffered already?

Serbia has wasted a lot of time and has not still completed some of the necessary economic reforms. Some internal problems, especially related to public sector enterprises, have nothing to do with the Ukrainian crisis, but rather with poor management and weakened institutions in the country. And these can prove to be a significant fiscal challenge in the near future. Countries that are most resilient to crises are, as a rule, with strong institutions, and with merit-based decision-making. Competence in governance and a low level of corruption are needed if the country seeks a sound and robust position in an international environment. Serbia, in my opinion, is, unfortunately, very far from such a position.

Is this war the only culprit, or some other reason(s) could be blamed?

Covid is partly responsible for some supply problems and, therefore, some inflationary pressures. But war and especially the response to the war in terms of Western sanctions, closely followed by financial speculations based on expectations that the prices will rise as a consequence of sanctions. This has led to prompted purchases of sanctioned goods, both spot, and futures, driving the prices immediately upward without real significant change in total supply and total demand for these goods. This speculative effect was fuelled by the engagement of financial institutions with excess to cheap money being created for years back, and in the US since 2008. Therefore, in my opinion, excessive monetary expansion going on for years back, and the creation of this extraordinary, but in its essence, artificial supply shock (sanctions) lay in the basis of this significant increase of inflation that we are experiencing.

What the ratio of the euro to the dollar could say? Is this a sign of the stumbling of the European economy? How can this reflect on the Serbian economy and GDP?

Dollar has appreciated against the Euro since the FED started to increase interest rates ahead of ECB, and since the dollar is traditionally perceived as a safe haven in times of imminent crisis. A stronger dollar will additionally fuel inflation both in Eurozone, but also in Serbia due to our fixed exchange rate with Euro. A weaker Euro and Dinar against the Dollar could actually help exports on Dollar markets.

Do you expect a further rise in interest rates in Serbia? Could this punch the real estate market?

Yes, and partially yes. Interest rates in Serbia are still too low for the current level of inflation and it should not be a surprise if they continue to rise in the near future. As for the real estate market, part of the current demand stems from the fact that interest rates are still negative in real terms (lower than the rate of inflation) and that therefore, free capital that seeks secure investments, i.e. that can protect it from inflation, sees that real estate investments, for the time being, still fit the bill. Therefore, rising interest rates will gradually decrease demand for real estate, but not immediately. That is, rather, going to be the case in the medium and long run.

Inflation in Serbia – is it normal under these global circumstances, can it cause more troubles, and what do you expect about its trend?

Inflation in Serbia is partly spilled over from the international markets and partly has been internally generated. In July it has hit almost 12% in spite of government control over certain prices (food, energy) in the past several quarters. Supply-generated inflation was mainly imported from international markets. But there was and is also a portion of demand-driven inflation in Serbia, mainly generated by government measures with linear support to all households, young people, pensioners, etc. In addition, the National bank was also conducting some exotic and wrong monetary policy measures during Covid (purchases of specific corporate bonds without a developed secondary market) and has been late in monetary tightening when it became clear that inflation is not just a transitory one.

Interest rates in Serbia are still too low for the current level of inflation and it should not be a surprise if they continue to rise in the near future

Now, inflationary expectations are on the rise, and additional pressures are coming due to the weak Euro, so my expectations are that inflation is most probably here to stay longer than it is officially expected. Having said that, my belief is that this inflation both globally and in Serbia also, cannot be treated only with monetary policy measures. Supply-side has to be dealt with simultaneously with monetary tightening. That includes policy measures to increase the supply of goods whose prices are raising the most, but also to seek political solutions and decrease politically generated tensions in global trade. Some promising moves have started occurring (grain exports from Ukraine, EU relaxation of sanctions for food and fertilisers), but more are very welcome and needed.

As a university professor, could you, for a moment, imagine that our government does an exam? What mark would you give to the student and why?

The government of Serbia has produced certain results in the past ten years. Some infrastructure has been built, some laws have been enacted and some previous ones improved, and some results have been created in digitalisation. Moreover, most measures in the first government reaction to Covid were mainly adequate. However, in international comparisons, Serbia has had one of the lowest rates of growth in Europe in the period of 2012 to 2016, according to international observers it has deteriorated its position concerning corruption perception, has a rather poor record concerning money laundering, and has been continuously reminded by EU institutions for its underperformance in the areas of rule of law, freedom of media, and overall institutional development. Overall, in the past ten years Serbia has done too little, often too late, and in some areas (institutional development) has been going even backward. Many comparable countries in Europe have done much more and moved on. Obvious lack of understanding that investing in human capital i.e. investing and reforms in education, research and development and quality health care in today’s world are essential elements in building a competitive economy and that institutional development (rule of law foremost) is a fundamental base for a market economy to thrive, are crippling realities in the evaluation of any governments performance.

Could you find anything soothing in this situation? Any advice for people?

We should not forget that the problems we are facing now, have been made by people, and can be solved by people. At least in a democratic world, there is hope that citizens could exert pressure towards their political elites to seek constructive solutions to the problems we face today. War in Ukraine should be stopped immediately, rebuilding and recovery of that nation should be internationally supported, and global trade should be normalized. Imperial ambitions and games for global dominance should be put aside. However unlikely, this is possible if there is adequate political will. The world has some real global problems to solve (climate change, environment preservation, food production, and distribution) and the political energy of leading nations of the world should be shifted away from global dominance issues, and focused on collaboration in solving these existential issues for our species. Large democratic nations of the world, especially the ones with the ambition to lead, in my opinion, have a specific responsibility in this respect for humanity as a whole.

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