We are delighted to be able to support the authorities’ aspirations through a new World Bank Country Partnership Strategy (CPF) for Serbia
About the Serbian economy, foreign direct investments, inflation and World Bank Group support for Serbia, we talked with Nicola Pontara, Country Manager for Serbia.
A World Bank report on Serbia was recently released, stating that Serbia has recovered from the pandemic. Can the current situation in Eastern Europe jeopardize the Serbian economy and negatively affect foreign direct investments?
The ongoing war in Ukraine, which resulted in a global economic shock, has affected the Serbian economy, but to a lesser extent than many other countries in Eastern Europe. Serbia’s combined exports to Ukraine and Russia account for 5 percent of the total, so trade will be impacted to a degree. Other primary channels include foreign direct investment, remittances and revenues from tourism. As a result, the World Bank has revised its economic growth projections for Serbia in 2022, from 4.4 to 3.2 percent of GDP in our latest Regular Economic Report ‘Steering through Crises’, published in May 2022. Concerning COVID-19, the robust and well-timed fiscal stimulus deployed by the authorities in 2020 helped to lessen the impact of the pandemic on the economy. Serbia experienced a minor recession in 2020 and rebounded to an impressive growth rate of 7.4 percent in 2021. Overall, the macroeconomic outlook for Serbia remains positive, despite important downside risks. Over the medium term, we expect Serbia to grow steadily at around 3 percent annually, similarly to levels before the pandemic, as the country’s main trading and investment partners further rebound from the global pandemic and, we hope, the Ukraine war.
Both global energy and food prices keep growing which, in turn, causes higher inflation. Food and energy prices also keep growing, further fueling inflation. When do you think will this situation normalize?
A combination of economic developments and geopolitical events has brought back inflation on the world stage, and Serbia does not constitute an exception in this respect. Global food, energy and metal prices are all expected to reach historically high levels in 2022, translating into higher inflation in Serbia too. The inflation rate in Serbia has been increasing for a while and we expect headline inflation to reach an average rate of 7.0 percent in 2022. The poorest ten percent of Serbian households, who spend 40 percent of their income on food, will be particularly affected by higher inflation. The National Bank of Serbia expects that inflation, including food inflation, will start to fall toward the end of this year and return to the targeted band during the next calendar year. As discussed in the 2022 World Bank Commodity Markets Outlook, global energy prices are expected to moderate to a certain extent in 2023 but will remain well above their five-year average at least until 2024. Wholesale electricity prices are expected to closely follow the price of natural gas (due to the coupling of the gas and electricity markets in Europe), and we also expect them to remain high at least until 2024.
You stated that the fiscal deficit could be higher than projected. Why is that so?
We project the fiscal deficit in 2022 at around 4.1 percent of GDP, higher than our earlier projection of 3 percent of GDP issued before the outbreak of the war in Ukraine. There are several reasons for that: first, after the 2022 budget was approved, the government enacted several transfers to businesses and households that were not originally planned, due to rising energy and food costs in the context of heightened uncertainty and the outbreak of war in the region.
“Our latest projection for growth in 2022 for Serbia is 3.2 percent”
Second, the Serbian economy is slowing down after a post-pandemic recovery, which might have an impact on the level of revenue collection. But it is also important to stress that these challenges are manageable, given that fiscal buffers continue to be adequate. That said, over the medium term, it will be important to resume a fiscal consolidation pathway and to identify new sources of revenue.
What is the 2022 growth projection for Serbia and the region?
Our latest projection for growth in 2022 for Serbia is 3.2 percent, but this number may change given the highly uncertain context on the geopolitical and economic fronts. For the Western Balkans region as a whole, we project a growth rate of 3.1 percent in 2022.
How much could structural reforms facilitate Serbia’s sustainable growth?
Serbia has considerable potential to grow faster than in the past. In the 2020 World Bank report titled ‘The New Growth Agenda for Serbia’, we highlighted several structural reforms that would allow Serbia to accelerate its convergence with the income levels of comparator countries already in the EU. The priorities that we presented at that time remain valid: they include better governance, a stronger human capital stock, and the deepening of the financial sector. Clearly, the importance of ensuring that growth will also become greener and more resilient cannot be overstated. The Serbian economy is very energy intensive and relies on fossil fuels that can result in adverse impacts on the environment. This is all the more important in the context of post-COVID: we have an opportunity to ensure that the economic recovery from the pandemic is gentler on the environment and also more inclusive of the poor and vulnerable.
What measures would stimulate and expedite economic growth in Serbia?
The first priority is to maintain hard-won macroeconomic stability – that is, containing inflation, the fiscal deficit and public debt while managing external imbalances. The second is to embark on an ambitious reform agenda to remove the remaining bottlenecks for faster private sector development and economic growth that are environmentally sustainable. In this respect, it would be important to (i) attract foreign direct investment into more complex, higher value added sectors such as electronics, pharmaceuticals, and machinery – taking advantage of Serbia’s proximity to Euro-centric value chains; (ii) modernize the energy sector to ensure energy supplies and gradually transition to a low-carbon economy ; (iii) improve transport infrastructure and trade facilitation measures to boost international integration; (iv) conduct education sector reforms (across all levels) to equip the Serbian population with the knowledge and skills demanded by the economy, and (v) strengthen service delivery at the local level to address spatial inequalities through greener and more resilient infrastructure.
What are the biggest challenges that Serbia will face next year, that are mentioned in the World Bank report?
The biggest challenge that Serbia will face in the next few months is to normalize the energy sector. During 2021/2022 winter, EPS and Srbijagas were forced to purchase expensive electricity and natural gas on wholesale markets. The government stepped in to provide financial support to these utilities. Until now, additional costs have been passed on to residential and industrial consumers only to a limited extent. But given the outlook on energy prices that we discussed above, continuing to subsidize public utilities may entail a high fiscal cost.
“Serbia has considerable potential to grow faster than in the past”
Any measure that shields consumers from energy price increases by keeping prices artificially lower than market prices or true costs (e.g., caps on energy prices or generalized tax breaks) should be time-bound, fully budgeted, and transparent. When they are not designed carefully, such measures can be regressive and cause distortions in the economy, also disincentivizing investments in energy efficiency and clean energy. To address this challenge, there are short-term measures that the authorities could adopt, including (i) promoting energy conservation and accelerating the implementation of energy efficiency measures; (ii) providing targeted social protection to vulnerable consumers; and (iii) designing liquidity programs in support to SMEs and critical industries – which may have to carry a higher share of international energy costs, as well as better-off private consumers.
How will the World Bank Group support Serbia in the next few years?
Serbia has an ambitious reform agenda. We are delighted to be able to support the authorities’ aspirations through a new World Bank Country Partnership Strategy (CPF) for Serbia which envisages around US$1 billion in financing over the next five years through investment lending, policy advice and analytical work. The CPF for 2022-2026 was discussed at our Board of Directors in Washington DC on May 26, 2022, and received strong support from all constituencies. We look forward to implementation in collaboration with the government and other development partners.