Serbia: Staying the Course as an Serbia: Staying the Course as an Investment DestinationInvestment Destination

Diana Dragutinović, PhD

• Serbia before the crisis• Crisis imported into Serbia

– Serbia has been hit at an unfortunate moment;• Some weak spots, some good achievements • Policy responses:

– Central bank measures addressing the liquidity situation;– Fiscal policy adjustments;– IMF program;– IFIs helping hand

Main Themes

• There is a joke that Serbia was the country of the future and always would be– I disagree (to me, the growth potential seems to be without

limits)

A joke…

•We had made a lot of progress since 2000 •Economic growth in Serbia was among the highest in Eastern Europe• The good economic performance was helped by a combination of

– Macro stability and structural reforms in the context of very strong external anchors:

• IMF programmes • EU accession perspective

– Very favourable external conditions:• Rapid global economic growth• Ample liquidity in financial markets enabling strong capital

inflows that fuelled mainly consumption, and less investment

A vulnerable growth model

•The future is not necessarily a simple extension of the past

• The crisis, although delayed, is now affecting the region

– Capital inflows slowing dramatically – parent banks– Deposit withdrawals, but without bank failures– Very substantial currency devaluation

• Prospects

– No radical “sudden stop” of foreign capital inflows, but reduced and more expensive financing of still large external imbalances

– Harsh adjustment in the real economy– Do we have a plan for the future (if you fail to plan, you plan to fail)

• Action plan depends on our weak spots, but achievements as well

Slowdown or faul, but not Armageddon

•...limit policy response to crisis – Dependence on the capital inflow– High level of euroization leaves fiscal policy as

the only/key short term policy instrument – External imbalances (high level of private

external debt) limit the scope for “Keynesian” fiscal stimulus policy response

Some Weak Spots

• Recent achievements of the Serbian economy, such as– Low sovereign debt level (regardless significant depreciation)– Comfortable level of FX reserves– Strong profit, capital and liquidity position of the banking system (no bank

failures):• Banks exceed not only the BIS regulatory minimum ratio, but also the

NBS’s more conservative 12% floor, for regulatory capital as a share of risk-weighted assets

• generally conservative and well-regulated• Domestic financial institutions without substantial exposure to the U.S.

sub-prime mortgage-linked toxic assets• Low direct exchange rate risk exposure in the banking sector

• …will help the economy to adjust in an orderly manner

• Shallow domestic capital markets protected the Serbian economy from the abrupt capital flight experienced by other emerging market economies

Some Good Achievements

• It is easy to be pessimist• Our first priority is to make the current crisis as short as possible

– There is a fairly wide consensus among economists that fiscal stimulus in the form of large spending bill is the way to go

– And there is a clear consensus that putting money into economy, to counter the recession and help people, is the right thing to do

Crisis – manageable, but needs to be managed

• The first package with a goal to preserve trust in financial sector, the Government adopted in November 2008

•In fact, the Government a) Increased deposit guarantees from EUR 3,000 to 50,000b) Suspended the tax on interest income and taxes in securities trade,

namely on capital gain and transfer of ownership

How Much is the Government Doing

• The second one, adopted in February is focused mainly on encouraging credit channel to work. In fact, through banks, the Governmnent

a) Subsidized interest rate – for companies

– on liquidity / investment loans

– for households– on consumer loans

b) Extended subsidies to households for cars and tractors, basedon the principle “old for new”c) Extended guarantees

» for investment loans with a 30% Development Fund component, for the 75% of the rest of the loan

» to the NBS for liquidity loans granted to banks

•The Government is active in mobilization IFIs funds to provide some stimulus to growth

– What is encouraging• The coordination of IFIs (IMF, WB, IBRD, EIB) in considering / providing

packages of equity and credit lines to support priority projects with focus on infrastructure, SMEs, energy efficiency, financial sector

– We agreed on support of • one billion euro for Koridor 10• 250 million fro NIP• 300 million for SMES• 300 million for the budget• 120 million for Komercijalna bank

•Serbian government asked for the support from IMF– The IMF approved the SBA in amount of 3 billion for 2 years,

that replaced a smaller package in January– What is encouraging

» In its long history, IMF was in favour of hard money / tight budget

– The new Fund beleives in Keynesian policy

» Monetary easing and fiscal stimulus (looks like joke)

– This programme is important for Serbia, not only because of money, but because its role in organizing other donors given, the absence of EU shield

– This will bring some confort for investors both, local and non-resident

– The IMF deal has helped the country negotiate loans from other international creditors

– EIB announced series of loans worth over 1.4 billion euros over the next two years

– WB agreed to provide the country 300 million USD for budgetary support

•The main pillars are– Fiscal adjustments– Vienna agreement providing assurance from the parent

banks to at least maintain their exposures to Serbia– Financial Sector Support Program

– The start of a new T-bill program

• First, we are targeting large fiscal adjustment – Running fiscal policy only within fiscal rules – Lower fiscal revenue require prompt fiscal rebalancing exercises– Lower revenues / expenditures ratio to GDP, but higher deficit - 3% of GDP,

among the lowest in the globe– Social and priority capital spending will be protected

• On the expenditure side, we will focus on tightening recurrent spending on wages, pensions, and discretionary spending at all levels In particular, we will:

– (i) freeze all general government and public enterprise wages and salaries in nominal terms in 2009 and 2010;

– (ii) extend the nominal freeze of pension benefits to end-2010; and – (iii) freeze hiring at all levels of government, including for temporary

contracts, with only duly motivated and limited exceptions– (iv) cut discretionary spending at all levels of Governments– (v) dicretionary actions are to be focused on financial crisis– (vi) safeguard medium-term fiscal sustainability

Fiscal Policy

• Monetary policy measures - addressing the FX market liquidity– Allowing banks to use FX reserves to address the liquidity problems– Reducing reserve requirements to facilitate borrowing from abroad

(note that RRs are high by international standard; accordingly, there is plenty of room for the CB to further foster liquidity on the back of RRR easing)

– Frequent interventions injecting FX liquidity and cushioning the speed of the FX adjustment

• however, the CB does not set any floor or ceiling for the currency; in other words, it may lean against the wind of currency moves and it can smooth the process, but it does not fight currency trends by defending any particular currency level and trend

– Interest rates remaining high

Monetary Policy

• What is encouraging– The coordination of IFIs in seeking agreements with

government and parent institutions of Serbian systemic banks to prevent reducing their balance sheets (to maintain their exposures to Serbia)

• A system of written promises could soon be extended to Hungary, Ukraine, Bulgaria and other vulnerable countries

• IMF is initiating a regionally coordinated stress testing exercises

Vienna Agreement

•Banks are obliged to assume some obligations like:

– pre-emptive recapitalization should the stress tests results indicate the need (In general, banks with CAR less than 12% could be given additional 4 -6 months to raise their CAR to 12 percent by the shareholders or new investors or the NBS could ask the Government to increase these banks’ capital)

– conversion of FX or FX-indexed loans to local currency, and – facilitate restructuring of loans to clients

•In exchange for some facilities such as:

– using the NBS dinar liquidity facilities at non-penalty interest rates, FX swaps facility and extension of zero mandatory reserve requirements on new external liabilities

– certain supervisory relaxations

Financial Sector Support Program

•...is a significant step in:

– developing money markets– improving monetary policy transmission – promoting the use of dinar instruments by the banking sector and public

•The program has so far focused on issuing 3M bills at modest volumes, but the plan is to start issuing

– 6M bills– 9M bills– 12M bills– T bond program

– T-bills are important source of collateral for inter – bank transactions– and also for the NBS new facilities under the IMF sponzored Financial

sector support program

The start of a new T-bill program

• One of the largest markets in the region with a lot of development potential and unique geographical location making it the natural center of the region• Many markets and market niches not occupied or saturated, giving advantages to early movers• Existing markets can be easily developed and sophisticated further at low costs and risks • Many business processes and networks are just being established, providing unique opportunities for business development and expansion• Low competition provides good profit opportunities to be reaped • Generally low labor costs (giving competitive advantage to traditional industries such as textiles)• Cheap qualified labor (in such areas like electrical engineering, IT, graphical design) • Young generation eager to learn, work hard and advance fast

Investments in Serbia bring many opportunities

• The future of Serbia in the European Union is known • Its economic, legal and political convergence to Europe will follow trajectories similar to other Eastern European countries the risks are therefore known from the experiences of other countries and relatively contained • The lessons learned by other countries can be used to avoid many unnecessary mistakes • In sum, there is probably not another country with such a large development and market potential whose economic and political future would be so well anchored in Europe such as Serbia today•I am very much aware, success depends on trust•Trust doesn t depend on being perfect •Trust depends on being honest, systematic and predictable

with very few risks

Thank you !

Ministry of Finance20, Kneza Milosa St., Belgrade

kabinet@mfin.gov.rs