SEBASTIAN SOSA, IMF Resident Representative in Belgrade: Elections Haven’t Jeopardized Reforms

Progress in structural reform implementation has been mixed. The modernization of tax administration and the privatization of the largest state-owned bank proved to be a success. Yet progress has been slow in other areas and the new government will have to push further

An International Monetary Fund (IMF) mission, led by Jan Kees Martijn, which recently visited Belgrade (February 24–28, 2020) left the country with mostly satisfied with the results achieved in reforms in 2019, and discussed policy priorities for 2020. A full mission for the fourth review under the PCI is planned for the second half of May at the time when the new government will be probably already formed.

The Mission concluded that Serbia’s macroeconomic performance remained robust in 2019, with growth estimated at 4.2 percent, and unemployment at historically-low levels, with steady growth of wages, low inflation and resilient financial sector with non-performing loans falling to 4.1 percent in December 2019. The Mission noted that fiscal performance has remained strong and that prospects for 2020 are positive, with growth projected at 4 percent and inflation expected to stay within the lower half of the target band. However, the reports read that risks are elevated, especially on the external front, and an important structural reform agenda remains. In this context, the mission stressed  the need to fully implement the reforms committed under the   Policy Coordination Instrument (PCI) to cement macroeconomic gains and boost Serbia’s growth potential.

The job is far from completed and considerable efforts will be required by the next government if I wants to complete the reform agenda and ensure a faster income convergence and a reduction in living standard gaps vis-à-vis Western Europe, says Sebastian Sosa, IMF Resident Representative in Belgrade to whom we spoke after the latest IMF visit.  More will be known in the second half of May when a full mission for the fourth review under the PCI comes to Belgrade again.

How would you assess the pace  at which the government has been implementing the reforms lately?

Progress in structural reform implementation has been mixed. Good progress has been  made towards the modernization of tax administration, enhancing the public investment management framework, the privatization of the largest state-owned bank, and tackling shortcomings in anti-money laundering. But progress has been slow in other areas. The reforms of the public wage system and public employment framework have faced substantial delays. More decisive actions are also needed to resolve problematic SOEs such as Petrohemija and to strengthen professional management and corporate governance in public enterprises.

Given the overall achievements, how would you describe the results of the current government?

The results on the macroeconomic front have been very good. Economic activity expanded, with annual growth averaging 4.2 percent in the past two years, while unemployment declined to historically-low levels, with steady growth of wages. Investment levels have increased significantly, supported by strong foreign direct investment and higher public capital expenditures. A strong fiscal position has put public  debt on a declining path, with yields on government securities at record-low levels. Moreover, inflation have remained low and stable while the resilience of the financial sector has also improved, with the ratio of bank non-performing loans falling to about 4 percent. Overall, these are strong macroeconomic results. Results in terms of implementation of the structural reform agenda have been mixed, as mentioned before, with progress in some areas but delays in others.

Bearing in mind that elections will take place in Serbia soon, which is, by definition, a time when governments are not keen to make bold moves, when do you think the recommendations from your latest visit might be implemented?

The upcoming election has not prevented some bold moves. For instance, in February an agreement was reached with NLB for the sale of Komercijalna Banka. This privatization represents a key milestone of the state-owned financial institutions reform agenda. Other recommendations from the November program review mission have been implemented during the pre-election period. For example, the introduction of pension indexation based on the so-called Swiss formula and the electricity tariff increase recently adopted. Other measures are expected to be completed in the course of 2020, and preparatory work is ongoing—for example on the design of a new set of fiscal rules, an enhanced framework to monitor fiscal risks, a new ownership policy document for state-owned enterprises, and the reforms of the public sector wage system and employment frameworks. As you have publicly mentioned, the reforms were particularly slow in public companies.

Where are the biggest obstacles – at the administration or the company level?

These reforms are important to unlock Serbia’s growth potential but are also not easy to implement as they affect vested interests, especially in the case of the large public utility companies. Significant efforts are needed by both the public administration and the companies to adopt measures to strengthen corporate governance and professional management. Decisive actions by the government are also required to complete the privatization process. For instance, the privatization of Petrohemija, which has faced long delays, should be promptly undertaken, as fiscal risks stemming from the company are sizeable.

How this unfinished job relates to the overall goal of faster growth?

Promptly advancing these reforms is essential to transform these companies into modern, efficient entities that can positively contribute to economic growth in Serbia. A recent IMF study indicates that Serbia ranks poorly in terms of governance of state-owned enterprises, both against OECD best practices and compared to other countries in Central, Eastern, and Southeastern Europe. This is due to several factors, such as a weak ownership policy; lack of adequate financial oversight; and a weak role of boards of directors. Moreover, the size of the SOE sector is relatively large in Serbia compared to other countries in the region, so the payoffs of these reforms could be sizeable.

To what extent are civil servant salaries a challenge to sustainable fiscal discipline?

Regarding public sector wages, we understand the need to grant larger increases to some categories of workers that are relatively underpaid and could thus be moving to the private sector or leaving the country. Examples are nurses and doctors as well as IT experts. Hoverer, the overall wage bill has been growing faster than nominal GDP for two years in a row. While these wage increases do not jeopardize fiscal sustainability at this point, they may create expectations of large increases in the future, which will not be sustainable. The introduction of new fiscal rules, including a ceiling on the wage bill as a percent of GDP, would be important to ensure fiscal sustainability. Restraint in public wage increases will also help to ensure the fiscal space needed to increase pro-growth spending such as investment in infrastructure.

Aside from the challenges related to public sector, what would you outline as the most important tasks if Serbia wants to get an in vestment rating?

Improving credit ratings requires not only solid public finances but also high potential growth. To achieve this goal, it is critical to further improve the business climate and support private sector growth. This implies, in addition to tackling infrastructure gaps and improving the efficiency of public administration and the quality of public services, reducing the size of the informal sector as well as addressing skills shortages and mismatches in the labor market. A favorable business environment also requires stronger rule of law and improved contract enforceability, reduced corruption, and a more efficient and independent judicial system.

Which of these tasks would have to wait for the new government to be elected?

Progress has been made in some structural reform areas. But the job is far from completed and continued efforts will be required by the next government to complete the reform agenda, which is crucial to ensure a faster income convergence and a reduction in living standard gaps vis-à-vis Western Europe.

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