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Weekly UpdatesHow has the global financial crisis impacted Serbia in comparison to its Balkan neighbors and to other European states? Was the impact more or less severe, and why?
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Balkan countries have experienced this crisis in a manner that is very similar to that of Western states--we have all faced significant deceases in foreign trade and industrial production. As a result, most countries in the region expect output reduction this year, but it is very difficult to give any confident projection. Of course, specific industry structure in these countries means that the crisis does not have exactly the same effect. For example, countries with coastal areas experienced a real estate boom in the previous year. However, after real estate prices started collapsing, the construction industry, as well as some banks, were in trouble. Also, the effect of the crisis depends on the country's level of trade integration with the rest of the world. Export-oriented countries were hit harder by this crisis. So, there are some similarities, but also some important differences.
Serbia had very strong GDP growth prior to the crisis, averaging at around 7 percent in the last five years. The crisis began in Serbia in exactly the same manner as anywhere else. The lack of financing meant slower development; lower demand in the world market meant shrinking exports; decreased output meant lower public revenues. The combined result of all these changes was a need to accommodate our budget to reality. Our exports dropped 25 percent and imports dropped 30 percent in the first quarter of this year. The same scenario occurred throughout Eastern Europe. At the onset of the crisis, foreign banks operating in our country started to repay loans from private companies, putting pressure on the exchange rate and creating an outflow of foreign currency. As a result, about 1 billion exited Serbia between November and January.
We also decided to pursue an agreement with the International Monetary Fund (IMF) because we needed to have some anchor for preserving external liquidity. Money was not our primary drive for reaching this agreement, as we have foreign currency reserves that are three times higher than the money supply. However, it was important because the IMF, for the first time, played an intermediate role in pursuing foreign banks to make sure that they keep their exposure to Serbia at the same level as in previous years. This means that if they repay some old loans, they will create a new loan, and we will at least emerge at the zero position. At the same moment, when we started the negotiations with the IMF, the exchange rate stabilized for psychological reasons as confidence took off again. Then, banks really stopped repaying the new loans, or at least they started to lend again. Thus, without the intervention of the central bank in the last three months, we have secured complete stability of foreign currency reserves and exchange rate. In addition, we agreed to receive 3 billion to fill up reserves, which will basically help us preserve external liquidity in the case that foreign banks don't keep the promises to maintain their exposure. This was the most important effect--the external liquidity issue. Meanwhile, banks have remained sound in Serbia, with capital adequacy at the moment being three times higher than the European Union average, which is due to our substantial banking reforms back in 2002.
Also, one of the effects of the crisis was that banks increased their spreads to a high extent; they doubled spreads, not only in Serbia, but also in other Eastern European countries. The spreads went up so that they could recover some of the losses they had previously incurred from bad loans in Western markets. Hence, the government responded to this problem of internal liquidity by subsidizing interest rates. Yes, this is a short-term answer to the crisis, this is a passive measure, but this was probably, at that moment, the only thing we could have done. The other thing that we are trying to do is jumpstart public works and build up infrastructure. We are going to ask the World Bank and other international financial institutions to issue us new loans for this purpose.
My personal belief is that the situation in Serbia is better than that in surrounding countries due to one specific thing--Serbia had elections several months before the crisis began. This means that the government was able to implement unpopular policy measures, such as expenditure cuts and an agreement with the IMF. In some other countries in the region, due to the pending elections, governments were much more hesitant to implement necessary adjustments, which may undermine their long run sustainability.
How do you think that Serbia's performance during the financial crisis might impact its bid for European Union (EU) membership?
I do not think that Serbia's performance during the crisis will undermine our bid for EU membership, but it certainly changes the political dynamics in the EU itself. The EU is, naturally, focused on domestic, political and economic issues, and it seems to us that further enlargement is not very high on the EU agenda right now. As I already said, I think that Serbia is performing much better now than most countries in the region. Basically, after three months of turbulence, we have managed to strike a new balance. Understandably, the balance exists at a lower level, but compared to the Baltic countries and Ukraine, where there is a collapse, Serbia is doing relatively well. There are even some new investments coming to Serbia from Western European companies, which are seeking to drive down their production costs and are relocating their facilities from other countries to Serbia. Some of their motives behind this strategy include very low corporate taxes and a highly competitive labor force.
EU accession is a top priority for the Serbian government. By the end of 2012, Serbia's regulatory framework will be brought in line with EU legislation, and, no later than next year, we expect to submit a formal application for EU membership. In terms of our economic figures, I have to point out the fact that, on certain macroeconomic indicators, we have recently performed even better than some EU member states. For example, our public debt is far below EU requirements, and the state budget deficit remains lower than the limit imposed for joining the Euro zone. Also, last year we managed to keep inflation in single digits, while achieving robust GDP growth of 7 percent. That said, I honestly do not see our economic performance as an obstacle on the path to the EU.
Our strategic goal is to become the platform for manufacturing and export to as many countries as possible without customs duties. As part of this strategy, the Serbian Government recently concluded Free Trade Agreements with the EU, Russia, Belarus, and Turkey, and we are currently negotiating an FTA with Iran. Our idea is to make Serbia, a country with only 8 million citizens, attractive for production and duty-free exports to this large market.
Another important issue is that in the middle of the crisis we started unilateral implementation of the Stabilization and Association Agreement with the EU, which entails liberalizing imports from the EU. We were, of course, fully aware that global crisis is not the best time for liberalizing imports, but we wanted to provide a clear signal that we are fully committed to being an EU member. I cannot think of a better way to prove our commitment to further European integration.
You have spoken about the importance of foreign direct investment to the economic vitality of the country. How do you plan to maintain Serbia as an attractive investment climate?
As I have already said, our vision is that Serbia will be the Souteast European hub for export-oriented production. To this end, we have provided foreign companies with duty-free access to a billion people market. Further, operating costs in Serbia are highly competitive: our corporate income tax is 10 percent, value added tax (VAT) stands at 18 percent, and labor expenses amount to merely 50 percent of the level in Eastern European countries such as the Czech Republic, Hungary, and Poland. The Serbian government offers state subsidies for investment projects in manufacturing, services, and research and development in the range between 2,000 and 10,000 for each new job created, while for large-scale projects in the automotive, electronics, and IT, we may cover up to 25 percent of the total investment value. At the moment, we are stepping up business reforms as well. They include company registration in only 5 days, elimination of all non-essential business regulations, and massive investments in transportation and telecommunication infrastructure.
One year from today, where do you envision the state of Serbia's economy in relation to both its current state and to that of its neighbors?
I believe that we will be, along with Croatia, the key economic agents of Southeastern Europe. Now, we are trying to attract companies from Massachusetts, mainly in the fields of information communications technology and biotechnology, to come to Serbia. We can offer an educated labor force, and this is why companies such as Microsoft, Intel, and Cisco Systems have already opened research and development centers in Belgrade.
Obviously, many action plans in our strategy will depend on when the global financial crisis ends. I believe that vigorous rehabilitation measures should be pursued to restore confidence in the banking sector. Recapitalization of banks will be crucial in this regard. Bank reform is politicall difficult, but it would be the shortest path to halting the recession. If banks do not start lending again, then people will not trust fiscal stimulus packages because they will see that they cannot use credit. To conclude, fiscal stimuli and recapitalization of banks will allow for a more rapid exit from the crisis.
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