Thewesternbalkans
24-th of February 2022, Russia invaded Ukraine in its efforts to “equalize” and “strengthen” its eastern position. The West responded in its way. With support for Ukraine’s territorial integrity and condemnation of violations of international law, Russia was “attacked” with economic sanctions, trade bans, asset freezes, exclusion from SWIFT UN resolutions, and exclusion from international institutions.
Historically, Serbia has always been on the border between East and West. In this context even after the war erupted, the President Vucic and the Serbian Government tried to balance relations with the West and Russia. Serbia supported all political decisions of the UN condemning the aggression. In the same time Serbia signed a Free Trade Agreement with Russia’s led Euro Asian Economic Union, and did not follow the Western sanctions against Moscow.
Serbia emerged from the COVID-19 crisis in 2021 with a 7.5% GDP growth and a stable forecast for further expansion of 4.5% GDP in 2022. The inflation rate was predicted to remain at an annual level of 7-8% for several months and stabilize at the target range of 3-4.5% by mid-year.
When the war in Ukraine happened, inflation in Europe surged into double digits, food, energy and commodities prices soared, and adjustments to interest rates in Western European countries and America still didn’t yield sufficient results. The first signs of recession were already evident, with high prices for food and energy expected to persist for some time.
Things were not much better in Serbia, where food and energy prices were rising. The European Bank for Reconstruction and Development (EBRD) has adjusted its projected GDP growth rate to 3.3% with uncertain further adjustments throughout the year. The benchmark interest rate was recently raised from 1% to 1.5%, explained by the need to counter inflation. While this adjustment is a good measure given the visible inflation, it comes with more expensive loans, reduced credit activity, and, consequently, slower economic growth.
Impact on the Serbian Economy.
It was calculated in the beginning of the war in Ukraine that the escalation of the war will affect the Serbian economy on at least three fronts.
The first is the price of energy and food. Although Serbia has historically been self-sufficient in food production, energy prices inevitably affect all costs, including food. In Europe, 40% of gas and 27% of oil come from Russia, but that percentage is much higher in Serbia. Serbia is 100% dependent on Russian gas, and the leading oil distributor is NIS, which is 51% owned by Russia and its energy giant Gazprom owns crucial energy infrastructure in this country.
The second front is raw materials for heavy industry. Ukraine and Russia are significant importers of aluminium and nickel used in the Serbian processing industry. Additionally, rare metals used in auto components (the most important number of foreign investments in Serbia in recent years) make the problem even more evident. The expected decline in European economies, especially Germany and Italy, and traditional markets for Serbian exporters, coupled with an anticipated drop in demand, could bring additional challenges for Serbian exporters.
The third front is the disrupted transportation, both from conflict or sanctions-affected areas and from EU and China due to completely distorted transportation prices and difficulty in finding available transportation capacity.
For the moment, the two years Russia-Ukraine war has a modest direct impact on the Serbian economy as Russia accounts for around 4% of country’s goods trade exports and 5.3% of its imports. Nevertheless, the indirect effect of the war, which has materialised in globally higher energy prices in the European market, has spread to food and other goods prices owing to increased production and transportation costs. This pushed the yearly inflation rate in Serbia up to an average of around 12% in 2022, i.e., the highest inflation rate since 2008-2009 when the financial crisis hit Serbia. Price tensions are eroding households’ purchasing power and their consumption are further decelerated over the 2022-2023 winter and spring months. Consumer prices increased further throughout 2023, albeit at a slower pace than in 2022.
Serbian Government’s measures.
Serbia has responded to these challenges by adjusting the benchmark interest rate to tame inflation. Temporary measures banning the export of wheat, corn, and oil have been in place for some time, and prices of certain products, primarily necessities and fuel, have been limited. Even more so, Serbia refused to follow the Western sanction and this permitted to the country to slow down the negative impact of energy dependence from Russia.
To stabilise inflation expectations, the National Bank of Serbia (NBS) raised its policy rate on eight occasions by a cumulative 350 basis points to 4.5% by late 2022. Further interest rate hikes were introduced in 2023. Rising interest rates have already weigh on private investment as borrowing costs have increased. Modest support came from government spending in the form of aid for households and companies to cope with higher energy prices. Additionally, the minimum wage increased in 2023 as the labour market remains relatively robust. Net exports’ contribution to GDP growth remain positive but moderate as imports increase at a faster pace than exports.
Late in 2022, the government agreed to a 24-month stand-by arrangement (SBA) with the IMF, giving Serbia access to financing support of EUR 2.4 billion. The arrangement will ease Serbia’s funding pressures and counter potential investor concerns over external and fiscal financing risks amid weaker economic activity. In return for financing support, Serbia has agreed to reforms monitored by the IMF. The public deficit is consequently likely to narrow in 2023 as the government curbs spending, but no tax increases are planned. Public debt should therefore continue to decrease gradually.
The current account deficit declined a little in 2023, but remains at a high level compared to that of the previous 7 years. The significant trade-in-goods deficit should narrow only marginally due to the country’s import dependence. The small primary income deficit is likely to be totally offset by modest surpluses in services and secondary income (especially remittances) accounts. The current account deficit is likely to be financed by foreign direct investment inflows and a two-year stand-by arrangement with the IMF.
As a result of war, Russia’s sources of influence have been moderately strained, among other causes as a result of Serbia’s first steps to diversify energy sources and Western pressure to diminish their political and security links with the Russian Federation. For the time being, this has not yet affected Moscow’s ability to act as a spoiler to the Euro-Atlantic integration of Serbia.
Although after the Russian invasion in Ukraine Western concerns about Moscow’s influence in the Western Balkans have grown, the region is not a foreign policy priority for Russia.
What is the current situation:
In its Report for the macroeconomic developments in Serbia, the World Bank has made following conclusions:
- Even though some acceleration of the economic activity is expected in H2, results from the first half of the year suggest that annual GDP growth in 2023 will be around 2 percent.
- Inflation has started to decline, but it is still among the highest in Europe. It is expected that it will return to the target band in mid-2024.
- Fiscal performance has been better than expected, with a lower-than-anticipated deficit, thanks to a strong performance of revenues, while public debt has plateaued at around 56 percent of GDP.
- The current account deficit (CAD) is lower than expected in 2023, at about 2.5 percent of GDP, and the strong inflow of Foreign direct investment (FDI) continues. As a result, foreign currency reserves have increased to a record high.
- While growth projections over the medium term (2024-2026) remain unchanged, those are still below potential growth rates. This underlines the importance of structural reforms to accelerate growth in potential output.
- A possible new source of growth could be FDI in high value-added sectors, but there are risks too, in particular those related to small enterprises (SOEs), both in terms of the impact of SOEs on fiscal balances and on market competition.
The risks to the baseline macroeconomic outlook that could materialize in 2024 and beyond are numerous. First, high inflation could persist for an unexpectedly long period and a more coordinated effort between fiscal and monetary policy would be needed to help to bring it down to the targeted level. High inflation hurts growth and diminishes gains in improved living standards, especially for the poor. Second, it is critical, given Serbia’s levels of public debt, that scarce public investment resources are prioritized towards projects with high economic and social returns, and are balanced against fiscal risks over the medium to long run.
Comments: Russia’s hopes of using the Balkan region as a route to supply its oil and gas to Europe were already dashed back in 2014, when the South Stream project was abandoned. The 2022 Ukraine invasion only confirmed this, with reduced Russian gas supply, lower European demand, and EU sanctions on Russian oil imports cementing the shift.
Russia is, however, still working to maintain its energy-based economic influence in the region. In the energy sector, Russia maintains influence by supplying almost all gas imports to Serbia where it also owns energy infrastructure.
The Serbian economy is an open economy and is inextricably linked with that of the EU member states. On the other hand, attempts to balance the geopolitical relations of the Serbian leadership, as well as the desire to derive maximum benefit from any foreign policy action, led to complete energy dependence on Russia and to the signing of a free trade agreement with the Euro-Asian Economic Union (as well as with China). This provided opportunities and an alternative and helped Serbia’s economy as it seen in the World Bank report for Serbia.
However, these treaties are yet to be discussed within the process of negotiations for Serbia’s accession to the EU and will certainly be assessed as a serious obstacle, and if the country ever enters the EU, they will have to be denounced.
