In February 2015, Global Evolution visited Serbia for an extensive due diligence. Significant fiscal disappointments over the last year were recently reversed with prudent fiscal policy reforms in the context of a new IMF program.
However, the persistent recession and the unappealing business climate were key worries that Global Evolution addressed during the trip. It is now all about walking the talk - i.e. actually implementing the plan; with institutional capacity constraints being the main worry for the team!
Ahead of the trip, the investment management team conducted in-depth review of the Serbian economy through video- conference with the World Bank Mission Chief; and a pre-trip Debt Sustainability Analysis (DSA) was prepared to generate preliminary guidance to its investment process. During the trip the experts of the firm met with the National bank of Serbia, EBRD, Ministry of Finance, the Fiscal Council and the World Bank.
Fiscal anchor established with IMF precautionary program
Serbia is facing serious fiscal imbalances, and protracted structural challenges. The new government appointed in 2014 has a window of opportunity to address these issues, with support from a new IMF program. Strong fiscal consolidation over the program period - largely based on curbing mandatory spending and reducing state aid to state-owned enterprises (SOEs) - is needed to put public debt on a downward path.
In terms of program modalities, the IMF program supports the authorities’ medium-term policy goals to restore fiscal sustainability, bolster growth, and boost financial sector resilience by providing a precautionary 36-month Stand-By Arrangement with access of €1,122 million.
“We concur with the Serbian authorities and the IMF that the program will underpin Serbia’s resilience against adverse shocks that could give rise to a balance of payments need. The program structure is based on fiscal, monetary, financial sector, and structural reform pillars”, wrote Global Evolution in its reserch.
“The nominal reductions already legislated on - and budgeted with - with regard to wage levels and structures and pensions reforms combined with the real reduction coming from natural downsizing of the public sector labor force is likely to generate the required fiscal consolidation and we expect the government to strenuously follow this track of fiscal pain. It is now all about implementation which is challenged!”, continued the analisys.
The debt sustainability issue is also key for Serbia and the few- days-old IMF DSA reveals a flattening of the debt/GDP trajectory by 2016-2017 after which numbers start slowly improving. The debt/GDP ratio peaks in 2018 at 78.4% - a level that we see being rather optimistic.
“We believe that the number will exceed 80% and that the downward turn in the trajectory will last more than just to the end of 2016; rather we expect two more years of program implementation time for the consolidation process to be completed due to weak institutional capacity. But we categorize the degree of debt sustainability as Moderate since no dire threat to sustainability is present despite elevated levels”, point out Ole Hagen Jorgensen, research director at Global Evolution.
“The lack of institutional capacity is, in our view, a key obstacle to implementing the fiscal consolidation and structural reform program. With a reduction in the quantity of public sector human resources, an uplift in the quality should compensate. This is likely to be a very slow process, but the World Bank is supporting the Government with Development Policy Loans (DPLs) to enhance wide-spread public sector management practices”, said Jorgensen.
In addition, loans have been granted but not disbursed due to severe institutional shortcomings - leading to no implementation of projects and, thus, no disbursements of already approved loans with the World Bank. For example, approximately $1bn in infrastructure financing was signed off by the World Bank, but only 8 km of highway was built so very little was disbursed; the rest was missed out on.
This is a general tendency with public sector projects and a key worry for the team- a development we will follow closely as the IMF program unfolds; thus the title of this.
Structural reform key for economic and fiscal efficiency
Broad-based structural reforms, notably to improve the business environment and resolve loss-making SOEs, should foster Serbia’s medium-term growth potential and reduce fiscal risks. There are 502 SOEs to privatize/restructure with 118 filing for bankruptcy.
“As a consequence, our view on Serbia’s outlook is that the coming 2-3 years will entail a process for paving the way for growth by fiscal and structural reform that enables growth. This will provide a platform from which growth can take off over the medium term—though expectedly not over the short term”, conclude the research.
Global Evolution, an asset management firm specialized in emerging and frontier markets debt, is represented by Capital Stragtegies in the Americas Region.