Evan Wohlmann, Senior Vice President, Moody’s: Recognised progress

Moody’s Investors Service has decided to upgrade the Government of Serbia’s issuer rating based on the positive results of fiscal consolidation, implementation of structural reforms, and better than expected economic growth outlook. Price stability, as well as improved institutional framework and visible progress in the EU accession process influenced the positive decision too.

Moody’s Investors Service in March has upgraded the Government of Serbia’s issuer rating from B1 to Ba3, with the stable outlook. Moody’s has also raised Serbia’s long-term foreign-currency and local-currency bond and deposit ceilings.

The results of fiscal consolidation, implementation of structural reforms, better than expected economic growth outlook and ensured price stability, as well as improvements in the institutional framework and progress with the EU accession process were the key drivers behind the Moody’s decesion. We spoke with Evan Wohlmann, Senior Vice President at Moody’s about the Serbia’s economic performance, pace of reforms and steps need to be taken if Serbia wants to further enhance its rating.

1. What were the major reasons for Moody’s to upgrade the Republic of Serbia long-term foreign and local currency Issuer Default Ratings from ‘B1’ to ‘Bа3’?

There were two key drivers behind the upgrade in Serbia’s issuer ratings to Ba3 from B1. The first driver was Serbia’s notable fiscal consolidation which has halted the increase in Serbia’s government debt burden and helps to reduce risks to Serbia’s fiscal position in the future. The second driver reflected Serbia’s recent structural reforms have increased the resilience of Serbia’s economy to future shocks and in turn supports potential growth.

2. How much fiscal trends as well as debt burden seem stable today when FED policy is changing?

The Serbian authorities have executed a highly successful fiscal consolidation which has led to a marked improvement in the country’s 2016 fiscal performance, with the first primary budget surplus since 2005 supporting a fall in the general government debt to GDP ratio to 74% of GDP at the end of 2016 after years of increases.

Notably, Serbia’s strong budget execution has been supported by improvements in revenue generation and a sharp reduction in permanent public sector employees has helped reduce expenditure on public wages to below 10% of GDP, in line with the EU average. As a result, Serbia has met the conditionality set out in the IMF SBA by a significant margin, with the general government deficit reaching an estimated 1.4% of GDP in 2016, far exceeding the 4% target in the original budget for 2016.

We expect the deficit to decline moderately to 1.2% in 2017 and the debt burden is expected to reach just below 70% in 2018, although it will still remain above the median of peers at the Ba-rating level (41.1% in 2015).

Furthermore, fiscal reforms undertaken in conjunction with the IMF’s 3-year Stand-by Arrangement (SBA) have improved the structure of the budget helping to limit fiscal risks in the future. Serbia’s high share of foreign-currency denominated government debt (79% of the total in 2016) remains vulnerable to a sharp depreciation of the local currency, although this share has been falling since the financial crisis.

3. What do you see as major factors of GDP growth and are there possibilities of its further rise in the coming years?

The Serbian economy recovered strongly in 2016, growing by an estimated 2.8% of GDP, the highest rate of growth over the past 8 years. Notably, the economy is now less dependent on final consumption with a reorientation towards exports driven by strong foreign investment into the tradeable sector. We expect economic growth will rise to 3.0% this year and reach 3.3% in 2018, and we note that the diversity of growth drivers together with improvements to price stability will support potential growth in Serbia of between 3.5%-4%.

The wide-ranging labour market reform undertaken in 2014 will help to sustain private consumption, reflecting an improvement in labour participation and recent strong employment growth driven by the private sector. Furthermore, consumer spending will be supported by the sharp drop in the Labour Force Survey unemployment rate to 13.0%, one of the lowest rates in the Western Balkans. Furthermore, we expect investment activity will benefit from improvements in Serbia’s business environment, an easing of financing conditions, and strategically important infrastructure projects, such as Corridor 11. Moreover, the recent broad-based recovery in exports, with almost all export sectors contributing to strong real growth in 2016, support the resilience of Serbia’s relatively open economy to external shocks.

4. Still Ba3 means that there are risk of changes in business environment and economic conditions. Where do you see drivers of such negative changes?

Serbia’s Ba3 rating has a stable outlook which reflects the balanced risks to Serbia’s credit profile at this rating level. While the pace of reforms may slow following the significant gains achieved in 2016, we expect that Serbia’s continued progress with the EU accession process and likely further engagement with the IMF will help to limit the risk of a reversal of the reform progress achieved to date.

That said, downward pressure on Serbia’s Ba3 issuer rating could arise if a reduced commitment by policymakers to the reform agenda, particularly in relation to addressing budget risks from the SOE sector, leads to a markedly weaker growth outlook and a deterioration in fiscal metrics. Moreover, the emergence of structural imbalances in the form of a large and increasingly difficult-to-finance current account deficit could also trigger a rating downgrade.

5. Ba3 is also connected to significant credit risk. Under which conditions do you see that as a realistic scenario for Serbia?

In our rating action we note that increased resistance to further reforms from vested interests, particularly those aimed at reducing fiscal risks from SOEs, could impact on the gradual reduction in Serbia’s debt burden. Furthermore, Serbia’s record of frequent elections, including snap parliamentary elections in 2014 and 2016, increases implementation risks, although we consider it unlikely that the forthcoming presidential elections will significantly delay the reform agenda.

Serbia’s sizeable share of general government debt denominated in foreign currency also poses a credit risk, particularly in the event of a sharp deterioration in the Serbian dinar, as does the high degree of euroisation in the banking sector. However, we note that the authorities have been able to increase the role of local currency in the economy through its „dinarisation strategy“.

6. What major achievements Serbia has to make to get investment grade?

Upward pressure on Serbia’s rating could arise if progress on structural reforms led to a notable improvement in the country’s economic and fiscal metrics, resulting in a faster than expected reduction in the public debt burden closer to the median of similarly rated peers. Furthermore, structural reforms, including those to stimulate private investment through improvements in the business environment which in turn help to further boost potential growth in the economy, would be credit positive.