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Central & eastern EuropeSeptember 1 2015

Consolidation and stabilisation: Serbian finance minister's hopes for reforms

Serbia's economic struggles have been well documented over the past few years, with its fiscal deficit particularly worrying. The country's finance minister, Dušan Vujović, tells Stefanie Linhardt how its reforms are already advancing down a route he hopes will lead to full EU accession.
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Dusan Vujovic

Q: You took office as Serbia’s finance minister in July 2014, having previously worked at the World Bank for more than 25 years. What are the key points of your government’s reform programme?

A: The programme combines fiscal consolidation and macroeconomic stabilisation as the first pillar, with a range of structural reforms aimed at resolving the legacy of the past. This includes the resolution of more than 500 enterprises in distress, improved efficiency of public sector infrastructure companies, reform of the financial sector, and reform of the government itself and the entire public sector.

We tried to design a comprehensive programme that removes obstacles to growth by addressing inherited problems where they really are – in weak management and corporate structures of public enterprises, incomplete rule of law, inadequate protection of property and creditor rights, and inefficient public financial and resource management.

Obviously, this is more difficult than opting for simple programmes based on tight fiscal and monetary policy that many countries choose in the expectation that this will trigger structural reforms. In my experience, added realism and lower implementation risks are well worth the extra effort associated with comprehensive programmes.

To achieve these multiple objectives over three or more years, we will combine short-term fiscal consolidation with the resolution of failed enterprises and non-performing loans [NPLs]. Fiscal measures are based on International Monetary Fund [IMF]-style expenditure cuts and revenue enhancing policies, while structural reforms rely on financial and design support from a range of specific development policy loans from the World Bank and enterprise restructuring loans from the European Bank for Reconstruction and Development. When well designed and properly implemented, this combination has proved to be successful both in terms of sustaining macroeconomic stability and generating a basis for sustainable inclusive growth. 

Q: Where are you with the implementation of your programme?

A: A year ago, Serbia's fiscal deficit was estimated at 8.8% of gross domestic product [GDP], second to last in Europe, with bleak prospects of increasing further and getting out of control. By the end of 2014, before the official start of the programme, we reduced the deficit to 6.7% of GDP based on stronger tax collection efforts and the early introduction of a 10% public sector wage cut and a reduction of some pensions. Albeit politically and socially sensitive and costly, wage and pension cuts were the only hard fiscal measures at our disposal to initiate the consolidation process.

During the first half of this year we kept the fiscal deficit at RSD35.3bn [$324m] – or 1.8% of GDP. This is more than 3% better than the mid-year target agreed under the IMF-supported programme. Such a huge improvement, which now places Serbia among the leaders in Europe, was down to better tax and especially non-tax revenue performance and lower current and capital expenditures. Although some of these revenue and expenditure improvements clearly will not be sustained in the coming years, the €500m deficit reduction achieved thus far will have a positive impact on external financing needs and the level of external debt. 

Q: What are the next important steps?

A: The most important task at hand is to focus our efforts on completing the key structural reforms. We are faced with weak administrative capacity, many legal and institutional rigidities, which, in the hands of vested interest groups – both among managers and workers – tend to slow down or even stall the necessary restructuring and reforms of state-owned and public sector infrastructure companies. Reluctantly, we had to grant additional time for the privatisation and resolution of state-owned and distressed companies, but expect that most cases will be finalised before the new deadlines.

Likewise, we expect that restructuring programmes for the largest public infrastructure companies (electricity, gas, telecom, roads, railways, waterways, etc) will be finalised soon and implemented without delay. We stand firm on our commitment to stop state aid flows and strictly abide by EU rules.

Public sector reform, including 'rightsizing', will be the real test of our ownership of reforms. It will also be a clear demonstration of the government’s credibility in applying the same reform rules across the board. We critically lack the appropriate incentive systems, performance measurement and delegation of authority that will enable true reform of the public administration and the public sector as a whole. Presently, ministers and public sector managers perceive reforms and attempts to measure performance as a constraint on their behaviour. This must change before we can proceed with true public sector reforms. 

Q: What is your vision for Serbia in 10 years' time, and in the long term?

A: In 10 years' time, Serbia should be a modern society based on the rule of law, with true market and democratic institutions, a regional economic leader and, hopefully, a respected full EU member. This vision is consistent with public opinion polls, which consistently show that the vast majority of people in Serbia, especially the young and educated, would like to live in an organised, affluent society modelled on Western democracies. Their behaviour, economic choices and migration patterns strongly confirm that.

On the surface, this may be perceived to be at odds with the less pronounced public support for EU integration and [the strong approval] of Russia in the same polls, but these answers mostly pertain to the political/ideological realm of things, which cannot always be easily reconciled with real-life behaviours and choices.

At a more specific level, there is often a gap between desires and visions, trust in the institutions, and the necessary changes in individual and group behaviour. The financial sector is a good example of this. Serbia is technically more ready to embrace a higher level of financial system development than the country's economy and society are capable of accepting and sustaining. Our first attempts at developing a capital market went by the book, but had very little impact – the market is still very shallow, mainly because both entrepreneurs and investors do not sufficiently trust the capital market. We have to build missing institutions, reinforce the existing ones, and change the behaviour of both investors and managers. It will take a while to get to the point where the capital market can raise a significant portion of private investment funds in Serbia.

There are also exceptions to the rule. The successful financial deepening in government bonds on global financial markets is one example. The resolution of the NPL levels is another.

The domestic financial market has been predominantly constrained by the presence of NPLs and by the less than fully developed financial capacity of enterprises to directly raise financing using modern methods. Our reform programme supported by the IMF seeks to improve the depth and resilience of the financial sector through the resolution of NPLs that presently stand at about 22% of the banking sector assets. We recently finalised an NPL resolution strategy that proposes a hybrid resolution scheme. This implies a smaller haircut for the creditors than the expensive pure asset management approach and still offers sufficiently good results by working with the clients. If successful, this programme will free banks from NPLs, and allow them to lower interest rate spreads and fuel investment. 

Q: You mentioned EU accession as one target. What are the big challenges you are faced with in this process?

A: Obviously, the biggest challenge is to overcome the political issues – the quality of the Belgrade-Pristina dialogue, the rule of law and freedom of the media – and thus create space to open a range of pragmatic chapters related to economic issues where Serbia has successfully completed pre-screening.

Public financial management is seen as priority by both parties. It enables the EU to delegate the financial management and monitoring of the use of EU funds to candidate countries. But it also allows Serbia to develop its own public financial management systems in line with the EU and, thus, improve the quality of the public resource use. We are equally ready to open all other economic chapters, [such as] procurement, fiscal and monetary policy.

The broader EU accession process helps us to enhance reforms and should be treated as a benefit rather than a cost imposed on Serbia. For example, in public financial management and in public procurement, I am eager to move as fast as possible to meet EU standards. The only constraints are limited institutional capacity and human capital, but this can easily be addressed.

But there are other areas, such as the environment, where I’d love to be where Europe is today but we cannot afford it right now. We have to remember that Europe introduced tougher environmental standards over longer periods, in line with real income growth. In these areas my strategy is to say yes, we want to meet EU environmental standards, but we need reasonable time in which to do it. And the accession process allows that.

EU accession puts a lot of reform requirements on future member countries with limited total reform capacity – as we have seen in recent accessions. We are working with a team of consultants [including former UK prime minister Tony Blair] to enhance the delivery capacity of the government by focusing limited resources in achieving key development priorities.

Dušan Vujović is the finance minister of Serbia.

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Read more about:  Central & Eastern Europe , Serbia