Thewesternbalkans
In its Report for the macroeconomic developments in the region of Western Balkans, The World bank has made following conclusion for Serbia:
• 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 NBS 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 CAD will be lower than expected in 2023, at about 2.5 percent of GDP, and the strong inflow of 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 SOEs, both in terms of the impact of SOEs on fiscal balances and on market competition.
The Report sad that Serbian economy grew slower than expected in H1 2022. The start of the year was particularly weak with growth in Q1 estimated at 0.9 percent only. In Q2, the situation improved somewhat as the construction sector started to recover, contributing to GDP growth that reached 1.7 percent, yoy. In the first half of the year, economic growth was supported heavily by net exports. While exports of goods saw an encouraging expansion (up by 9.4 percent in euro terms in H1), there was a noticeable decrease in imports (down 5 percent in H1), in particular imports of energy (down 24.5 percent) and raw materials (down 6.4 percent) which led to a significant positive contribution to growth in H1. Both consumption and investment had a negative contribution to growth in H1. Consumption is being hit by the effects of prolonged high inflation, while investment was impacted by a major decrease in inventories (while gross fixed capital formation had a positive contribution to growth). In the first half of the year, total investment decreased by 15.2 percent in real terms, primarily as a result of a major decrease in inventories. On the production side, some agriculture products were hit by unfavorable weather conditions (fruits and vegetables in particular), but the wheat and corn harvest was better than expected, thus helping the agriculture sector as whole to grow by 9.9 percent in H1 2023. The construction sector started to recover with strong growth of 17.9 percent, yoy, in Q2 2023, after four consecutive quarters of decline. Industrial production increased by 1.7 percent (yoy) in H1, driven by an improvement in the energy sector (up by 6.4 percent), while anufacturing declined by 1 percent in H1. Value added in services sectors increased by just 0.7 percent (in real terms, yoy) in the first half of the year.
Following the Report, the labor market was, by and large, resilient to the shock caused by the pandemic, and the unemployment rate has remained stable at around 10 percent. In Q2 2023, the unemployment rate decreased to 9.6 percent, compared to 10.1 percent in Q1 (or 9.4 percent on average in 2022). Labor market improvements also resulted in a higher employment rate, which reached 50.4 percent in Q2 2023. Nevertheless, the youth unemployment rate remained structurally high at around 25 percent. Wages continued to rise, increasing by 15.4 percent in nominal terms in H1 2023.
The consolidated budget shifted to a small surplus of 0.6 percent of annual GDP over the first six months of 2023. Revenues posted a strong performance (up 12.5 percent in nominal terms, in H1), thanks to major increases in corporate income tax (CIT), social contributions and domestic VAT. High inflation, among others, drove VAT revenues, while improved CIT collection reflects the recovered profitability of businesses in 2022. Social contributions increased on the back of both higher formal employment (up 2.7 percent in H1, yoy) and nominal wages (up 15.4 percent in H1, yoy). Meanwhile, expenditures have been kept under control (up by 7.7 percent over the same period). According to the supplementary budget (in preparation) this year’s fiscal deficit should be 2.8 percent of GDP, which could go even further down to 2.5 percent of GDP. Public debt remained broadly stable throughout 2023 and stood at around 56 percent of GDP.
As last year’s extraordinary imports of energy stopped, there is a significant improvement in the BOP in the first half of the year. The CAD decreased by 82 percent in H1 (from EUR 2.9 billion in H1 2022 to EUR 0.5 billion in H1 2023). The trade balance shrank by 40 percent as imports of energy (both gas and electricity) decreased by 24.5 percent (or EUR 926 million) over the first six months of 2023, compared to the same period of 2022.As a result of a major decrease of the CAD in H1, it is now projected to decrease to around 2.5 percent of GDP for 2023 as a whole. Financing flows remain comfortable as net foreign direct investment inflows increased by almost 35 percent compared to the same period of 2022, to reach EUR 2 billion in the first half of 2023. Most importantly, inflows related to equity and investment fund shares increased by over 50 percent. As a result, there was a significant increase in official foreign currency reserves which stood at EUR 22.6 billion at the end of June, covering 6 months of imports.
Inflation remains stubbornly high, and has only started to fall later than in peer CEE countries. The consumer price index (CPI) peaked at 16.2 percent (yoy) in March, the highest level of inflation since the CPI measurement begun (in January 2007). Inflation has started to fall since then, and reached 11.5 percent in August. Notwithstanding the fact that inflation started and reached its peak at different times across countries, inflation in Serbia is still among the highest in Europe. Food prices, notwithstanding the selective government price controls, drove this trend, increasing by 21.1 percent (yoy) in July 2023. It is expected that inflation will return to the NBS target band in mid-2024. Importantly, producer prices as measured by PPI went down significantly over recent months and in July were only 0.5 percent higher than a year earlier.
The NBS decided to keep the key interest rate unchanged in both August and September at 6.5 percent after 16 months of continuous, gradual increases. The nominal exchange rate remains stable but there has been a significant appreciation of the REER over the first seven months of 2023 (by 4.4 percent).
The performance of the banking sector has continued to be robust. Based on 2023 Q2 data, banks remained profitable and liquid. The liquidity ratio increased from 2.2 at the end of 2022 to 2.4 in June, while the capital adequacy ratio increased to 22.3 percent at the end of June (compared to 20.2 at the end of 2022). Nonperforming loans (NPLs) stood at 3.2 percent in June, a slight increase compared to 3 percent at the end of 2022. Credit growth has slowed down in 2023 due to tightening monetary conditions. The stock of loans in June was only 2 percent higher than a year earlier. The highest increase in credit growth relates to loans to government (up by 6.7 percent) while loans to private companies increased by a mere 0.3 percent (yoy) and to households by 2.6 percent (yoy, as of June).
Outlook and risks.
For the World Bank, the growth outlook remains positive with risks tilted to the downside. The Serbian economy started to slow down in the second half of 2022, a trend that continued in the first half of 2023. However, in mid- 2023 the construction sector started to recover, and some agriculture sectors (wheat and corn production in particular) scored better than expected results. Considering the impact of these factors, it is expected that growth will accelerate in the second half of 2023 thus leading to a growth rate of 2 percent for the year as whole. Going forward and over the medium term, it is expected that growth will be around 3–4 percent. These are rates that are below Serbia’s potential and any acceleration in growth will be dependent on structural reforms.
Growth constraints could be removed by a more ambitious domestic reform agenda and its implementation. The recent crisis in the domestic energy sector has once again emphasized the urgency of improving the management of SOEs. Therefore, the government should embark on an even more decisive, comprehensive and thorough reform of SOEs to make them financially and operationally viable. There are other reforms related to governance, education, transport, municipal-level utility services, financial sector etc. that should help Serbia to grow much faster.
The risks to the baseline macroeconomic outlook that could materialize in 2023 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.
