A good move

IFR Emerging Europe and Turkey Special Report 2014
10 min read

After years of false starts, the pieces finally appear to be falling into place on Serbia’s political and economic chessboard – let the games begin.

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Alisa Maric embodies the intimate relationship that exists in the Balkans between economics, politics – and chess. An economist by training, the former Serbian sports minister and one of the country’s most popular celebrities is also a woman grandmaster – the world’s highest-ranking chess title restricted to her gender.

Any observer will tell you that in this part of the world outcomes in both economics and politics are determined like moves in a chess game – and when the pieces are positioned correctly, the result is assured.

For Serbia and its otherwise troubled economy – like a chess stratagem that was failing badly – those pieces may just have fallen into place.

A landslide victory for the ruling party in the March elections has provided an iron-clad mandate for sweeping economic reforms just as the country begins negotiations to join the EU that are likely to ensure that its government makes exactly the right moves.

“This really is an opportunity for Serbia to push ahead because until now, ruling coalitions have typically been more fragmented and have not had the same level of power that this government will have,” said Peter Sanfey, deputy director for country strategy and policy at the European Bank for Reconstruction and Development and a specialist on South-Eastern Europe.

“The EU accession process is going to take some years but the negotiations are likely to advance relatively quickly and will be very important for the overall reform mood in Serbia. They can really lock in some of the legislative changes and some of the administrative changes that are under way.”

Daunting challenge

On paper, Serbia’s economic challenges look daunting. It is running Europe’s highest budget deficit at 7.1% of GDP, public debt stands at 60% of GDP and rising, and the EBRD’s latest revision to its outlook suggests growth this year could undershoot the 1.3% it was forecasting in January. The consensus among observers is for growth of around 1% – a fall from last year when the accounts were artificially buoyed by Fiat’s investment of €1bn in a car plant at Kragujevac.

Reform has long been on the agenda, but the country’s economy has struggled to make the transition experienced elsewhere in emerging Europe.

“Serbia has been undergoing a long process to clean out the imbalances both in the public finances but also in the private finances, so growth has not been very strong. It’s on the recovery path and I think it will continue to recover, but it’s taking longer here than in some other parts of emerging Europe,” said Marcus Svedberg, chief economist at emerging markets specialist East Capital.

In March, the Progressive Party (SNS) of Deputy Prime Minister Aleksandar Vucic won 156 seats in the 250-member parliament in polls called by the ruling coalition to bolster its reform mandate.

Popular for his high-profile anti-corruption platform, Vucic was seen by voters as someone who delivers. The new government was sworn in on April 27 and has already unveiled a string of legislative initiatives. In a key sign of continuity, the strategist of Serbia’s reform process, Lazar Krstic, remains finance minister.

What makes this moment particularly important for Serbia is the way the pieces now sit on the chessboard: EU accession negotiations began in January and the Serbians have also been talking to the IMF.

Turning a corner

Svedberg said: “I don’t see it as a sharp turning point because they have been heading in this direction for quite some time, but it’s a take-off: they have much better possibilities now – Europe is out of recession, they are out of recession, they are starting to see foreign direct investment coming in, they have a reformist government, and they have finally started negotiations with the EU.”

A key theme in talks with the IMF is likely to be downsizing the public sector, although negotiations will be tough and cuts will further depress short-term growth prospects.

There is no doubt the challenges facing the economy are enormous, compounded by a fiscal deficit and a level of public debt so high that at the end of last year it looked like checkmate: in October the deputy prime minister warned that the country was “virtually on the verge of bankruptcy”. The government has promised fiscal consolidation of €1.6bn through to 2016.

While Serbia’s foreign dominated financial system survived the crisis without major bank failures, credit growth is weak, the share of non-performing loans is high, at about 20%, and deleveraging pressures persist.

In November, the sovereign negotiated a US$3bn loan package from the UAE and returned to the bond markets with an issuance of US$1bn of five-year notes. Nonetheless, some estimates put the country US$1.8bn short of the financing the government had planned for 2014, meaning it will need to approach the markets again. In January, Serbia indicated that it was planning the issue of €600m worth of euro bonds, although no timetable was given.

The mantra of reform

Reform has been a mantra since the messy break-up of Yugoslavia in the 1990s but, according to the EBRD, the economy still faces fundamental restructuring challenges.

About 600 major enterprises remain in public ownership and the state payroll remains huge at about 800,000 workers. Slashing this – a key source of political patronage – will be a mammoth task.

Dejan Tufegdzic, a Belgrade-based capital markets adviser, urges caution. “We have to remember that a lot of those people in the state sector are creators of demand in the Serbian market, so this has to be handled carefully,” he says.

”It cannot be cut overnight because that would be counter-productive and could have an impact on demand in every sector. Bear in mind that people have been living in hard circumstances for more than 20 years and Vucic knows that he needs to be very careful.”

Many of Serbia’s growth constraints reflect the limited size and evolution of the private sector and a challenging business environment.

Sanfey of the EBRD said: “A lot of them boil down to micro-economic constraints – bureaucracy, inefficient tax administration, problems of corruption, basically business environment problems that hold Serbia back. On the other hand, Serbia has a lot of potential – it is quite a well diversified economy, it has quite a good strategic location, a lot of the population are well educated, good at languages. Medium to long-term Serbia can be a dynamo for growth in that region but it has been held back by some of these micro-economic constraints.”

Francois d’Ornano, a partner in the the French international law firm Gide Loyrette Nouel, which works with foreign investors in Eastern Europe, believes a priority is to put in place a clear legal framework for PPP concessions to finance essential infrastructure projects.

D’Ornano said: “They do not have the legal capacity to do this and need to ask for external support in order to improve the legal and financial frameworks for big infrastructure projects, which are clearly key to attracting investors to Serbia.”

Benefits of reconciliation

D’Ornano believes that in the EU accession talks it will be essential for European negotiators to learn from past mistakes in Romania and Bulgaria, where problems were overlooked to speed integration. Serbia’s stock has undoubtedly risen since its decision last year to seek reconciliation with Kosovo.

Nonetheless, politicians have not fully spelt out the sacrifices Serbs must make to meet EU standards and the country lacks an influential champion in the 28-nation club.

The crisis in Ukraine has also complicated the geopolitical climate and, D’Ornano believes, puts further pressure on EU negotiators to make progress.

He said: “Serbia is clearly not Ukraine but it is an orthodox country very close to Russia and its market, and also historically and culturally, so you have to act quickly in order to push for change and support Serbia, because there is always the risk that it will look to the East. The EU has to give its full support and integrate well with a high level of expectation – but quickly.”

Tufegdzic, however, argues that signals made by Serbia in support of European efforts in Ukraine sent a strong message about the country’s direction of travel.

“This stated that we don’t want to hurt Russians but also we need to care about the EU – it is a major sign that the EU is our future,” he said.

There is no doubt that Serbia exerts a powerful attraction for Europe: it has huge potential as the largest and most diversified economy in the Balkans.

“The hope is that Serbia will portray itself as a dynamic, reforming economy advancing in the EU accession process. The negotiations for EU membership have the potential to advance quite quickly, because they can learn from the lessons of other countries like Croatia. So with a kind of virtuous circle of reform plus, we hope, an improving European and global economy, I think Serbia can attract quite a lot of investment,” said the EBRD’s Sanfey.