For months, Serbias government grappled with a dilemma familiar to many emerging economies in crisis: how to make the budget cuts demanded by international creditors without grave political fallout.
Mass public demonstrations and the threat of widespread strikes finally forced the governments hand last month, and the Balkan nations authorities relented on adopting some unpopular measures in particular, a so-called solidarity tax intended to cope with the effects of the global financial crisis.
But in the end, it was a choice, as so often, of the lesser of two evils. When Serbias parliament pushed through a radically revised budget on April 29, the package of measures it proposed to cut spending and boost revenues met with varying degrees of public displeasure.
The cuts, a formal condition for signing a new E3 billion standby agreement with the IMF, were more radical though less extensive than the original proposals, and include a major overhaul of public-sector wages and a freeze on state pensions.
Public-sector wages and pensions had already been frozen to the end of 2010 and additional cuts amounting to 3% of GDP were made, including a 10% cut in state employees, including state-owned companies, which will result in some 20,000 job losses, although some of this reduction will comprise of natural wastage and voluntary redundancies.
Whats at stake
In an interview with Emerging Markets, Serbias deputy prime minister Bozidar Djelic admits the measures will cause public displeasure. But he stresses that the fundamental stability of the economy is at stake.
Although the mood in the country is not as buoyant as it was last year, there is a very wide understanding that stability in particular the dinar and normal operations of the state in the sense of regular payment of wages and pensions requires that we undertake significant measures, he says.
Djelic outlines the measures against the backdrop of Serbias sharp economic decline, which will see, on official estimates, a 2% contraction in the economy in contrast to the 3.5% predicted, and a 3% budget deficit which actually requires significant cuts in public expenditure, he says.
It is serious, and that is why we have taken very serious measures in order to manage the situation rather than be managed by it, adds Djelic.
He says the government has identified a E3.5 billion financial hole in the economy over the next two years, which the IMF deal will almost entirely fill. But he is quick to accentuate the positive notes amid the gloom, including the $1 billion in foreign direct investment so far this year, compared to $3 billion for the whole of 2008. The most important element of this is Gazproms E400 million purchase of Serbias national oil company, NIS. He also mentions forthcoming privatizations, including the pharmaceutical company Galenika, the Bor copper mine and Belgrade Fair.
Despite the cuts in current spending, Djelic notes that capital investment is continuing at roughly the level planned, with an emphasis on infrastructure and energy. The government has completed the financing of the E1.6 billion cost of Serbias section of Europes Corridor X, and has launched a tender for two 700MW thermal power stations, which will cost some $2 billion.
Grain of salt
Not everyone is taken by the positive spin, however, and even National Bank of Serbia (NBS) governor Radovan Jelasic raises a sceptical eyebrow at the governments projections. Regardless of the first quarters figures, he says, FDI is definitely going to be substantially less than last year.
From todays standpoint, minus 2% look rather optimistic, Jelasic says of the forecast economic contraction, which he believes is more likely to be 56%.
Bogdan Lissovolik, the IMFs resident representative in Serbia, acknowledges the risks. Downside risks to growth are materializing, he says. The downside scenario is more realistic now.
Lissovolik points to a weak first quarter on the revenue side, suggesting poor revenue compliance. Should GDP drop further than 2%, Lissovolik believes that the external financing gap will be broadly the same, but stricter control of spending commitments might be triggered, including cuts in public-sector wages and, as a last resort, an increase in the VAT rate.
But the IMF remains broadly satisfied that the authorities took courageous and quite significant measures, says Lissovolik. He also points out that the E3 billion loan and government fiscal control are only part of an agreed overall package of measures to maintain Serbias macroeconomic stability.
Other measures include additional funding from other international financial institutions, including $300 million committed by the World Bank for budgetary support.
But also crucial were commitments made by foreign banks in Serbia, under the so-called Vienna Initiative, not to leave their local subsidiaries in the lurch. The plan calls for foreign banks with local subsidiaries not to lower their group level exposure to Serbia below the level of December 31, 2008. This applies to local headquarters, subsidiaries and all other legal entities belonging to foreign banks operating in Serbia, which include Austrias Raiffeisen and Erste Bank, as well as Banca Intesa and Societe Generale.
Jelasic says that without the Vienna Initiative we would have an additional problem of E4 billion, because technically speaking banks would be able to take out all the money that is maturing this year and next year. Then the financial needs would not be E3 billion but E7 billion.
Under the Vienna Initiative, the NBS will provide banks with additional liquidity facilities in dinars as well as additional swap facilities in dinars and euros. Jelasic also calls on other countries in the region to adopt a similar scheme to aid regional stability.
Serbias banking sector comprising 34 banks that are mostly foreign-owned entered the crisis in a healthy state, and Jelasic happily points out that not a single dinar of taxpayers money has been injected into the system. The sectors overall capital adequacy ratio remains at 22%, largely thanks to the tough policies imposed by the NBS in recent years.
Raiffeisen Bank Serbias CEO Oliver Roegl credits the central banks restrictive policies with having been ideal preparation for the worst-case scenario. As a result, he adds, the banking sector in Serbia is in a much better position than most banking sectors of central and eastern Europe but also compared to western countries.
High liquidity levels helped cushion the banking sector from 20% deposit withdrawals last October and November, says Roegl: banks remained strongly overliquid rather than excessively overliquid. Deposits have remained stable since November.
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The sectors combined profits rose 44.5% to $450 million last year, despite strong exposure to the global financial crisis. Roegl believes that the sector will remain profitable this year. After record 2008 profits, albeit with a fourth quarter downturn, Raiffeisen should still make decent profits in 2009, but the bank will be more conservative this year, cutting costs, and freezing staff and branch numbers. Roegl, who is putting in place a more cautious lending policy, says the banks lending portfolio will not increase in 2009, in light of decreased demand.
In stark contrast, Hypo Alpe-Adria-Bank CEO Vladimir Cupic says that his bank is increasing its loans and also points out that government-subsidized loans are having an effect: The economy ministrys programme to subsidize lending to corporates is very attractive, especially liquidity loans, he says. So far total volume of requests is E530 million, E230 million has been approved and E140 million has been paid out in the first quarter, of which most was done in the last month. This is hitting the target and is what corporates need improving liquidity.
But Cupic adds: The investment facilities which are also envisaged by this programme simply dont work only one investment has been approved. We believe there are restrictions inside, such as keeping the employment level until a certain date, that we think are unnecessary.
A social issue
Serbian Chamber of Commerce vice-president Mihailo Vesovic also bemoans what he sees as unrealistic employment targets. Companies are asking for loans while employing more people than they need; production is decreasing, and the best way to increase productivity, and for firms to make themselves more competitive, is actually to cut the workforce.
Vesovic says that the crisis, particularly its effect on Serbias export markets, has resulted in a 20% drop in industrial output and a 35% drop in imports and exports in the first quarter of this year. The least affected sector is agriculture and the worst affected the metal industry, in particular steel.
But the worst effect of the crisis has been on company liquidity, even though it is becoming easier to get bank loans. Turnover is declining but loan repayments remain the same, so companies are delaying payments to suppliers, and we are afraid that SMEs will be affected the most because they are at the end of the line.
An increasing number of companies have had their bank accounts blocked, a fact which often results in workers not getting paid. Its already a social issue, but its not dramatic, says Vesovic. It is estimated that 10,000 people a month are losing their jobs, but companies are going into liquidation and opening new companies, so a lot of these people are rehired.
According to Vesovic, Serbian companies need to take advantage of the downturn to restructure in order to be more competitive once export markets pick up again. Ninety percent of exports go to 10 to 15 countries; we need to open up new markets to overcome this lack of diversity, he says.
The government should do as much as they can to make the business climate better, says Vesovic, transforming the European directives into legislation, taking administrative barriers down, trying to make the customs service more efficient, and trying to attract more investment so we have better value-added products for the export market: its the worst thing to be exporting steel sheets.
The central banks Jelasic says the government needs to recognize that times have changed: We definitely need to rethink the entire macroeconomic policy in the medium and long term. We need to face the crucial reality about the way we lived during the first eight years of transition I have my doubts that such times will come back fast.
Ultimately, however, Serbia cannot recover alone, says Bozidar Djelic. [Recovery] depends to a large degree on the degree of success of the recovery packages adopted by the European Union, the United States, China, he says.
Djeclic notes that Serbias strategy is to take whatever steps necessary to maintain stability. He adds: We are to a large degree policy-takers not makers.