Remarks by Serbia Country Manager at the Leaders of Reform Conference

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Dear Deputy Prime Minister Mihajlovic, Ministers Brnabic and Nedimovic,

NALED Board and Members, Ladies and Gentlemen,

Serbia has made major progress in addressing the fundamental causes of the dismal economic performance the country showed in the 2008-2014 period. Three recessions in six years combined with rapidly rising unemployment and growing public debt combined to undo a significant part of the gains made between 2000 and 2008. The turnaround achieved since 2014 is all the more remarkable given the depth of the fiscal consolidation effort Serbia had to make to turn around a spiraling public debt level.

However, unfortunately, there is no room for complacency.

Fiscal risks emanating from remaining commercial state-owned enterprises (SOEs) and public enterprises (PEs) remain and there is a notable perception that SOE resolution has firmly stalled, even though the ‘big fish’ remain unresolved. The rationalization of expenditures in the social sectors has yet to start. In the end, all these elements of the reform agenda serve to support the transformation of the economy towards a private sector driven model, and it is here that the main challenge lies: SME growth in particular remains anemic, which in turn means that foreign companies investing in Serbia are insufficiently anchored in the local economy.

Addressing this remains the most fundamental economic problem of Serbia: encouraging Serbians to take economic initiative while giving them the confidence that government will reward rather than hinder entrepreneurship.

Summing up 2016

Serbia’s economy expanded by an estimated 2.8 percent in 2016, the highest growth rate since 2008.

Growth continued to stimulate job creation and to enhance labor market outcomes. Improved economic performance was reflected in the labor market as employment rates at last exceeded the rates from before the international financial crisis. However, almost a third of the new jobs were in the informal sector as the good agricultural and construction season pushed up informal jobs by 8.2 percent.

Fiscal adjustment resulted in a record low 2016 fiscal deficit of 1.4 percent of GDP. The combination of better budget performance and strong economic growth helped to reduce public debt as a share of GDP from 75.9 percent in 2015, to 74.0 percent at the end of 2016.

Serbia’s external position improved in 2016 as the current account deficit (CAD) narrowed to 4 percent of GDP, supported by improvements in the trade balance.

Start of 2017

These good results from 2016 made us all a bit more optimistic. Growth for this year is projected to 3 percent, with further drop in unemployment envisaged.

However, yet again, some external factors pose a risk to a faster recovery of Serbian economy: developments in the EU (BREXIT; elections in largest member states; future of euro etc); Agrokor crisis (Croatian based, but the largest private sector employer in Serbia); changes in interest rates and prices of commodities on global markets; and finally, a very cold winter. The last one probably deserves most of attention since we see its impact already.

Still, we hope that growth will continue to be strong – to average 3-4 percent, per year, over the next couple of years.  However, as noted before, sustaining and enhancing growth levels will critically depend on continued progress in addressing risks posed by SOEs and PEs, while at the same time ensuring that state institutions change their approach and attitude towards entrepreneurs, in particular by facilitating rather than suffocating SMEs.

Remaining on the agenda: SOE and PE reform

Unresolved commercial SOEs and unreformed public utilities have been at the core of Serbia’s fiscal and growth challenges for two decades. Several attempts were made to reduce this problem, and there was important progress, but the pressure from these companies remained.

Five years ago there were still almost 600 commercial SOEs with about 100,000 workers, controlling significant assets, but adding very little to the economy (only about 1 percent of the GDP), while requiring massive public resources to stay afloat.

Just this group of companies was using almost EUR 100mn annually in subsidies, and additional over EUR 200mn in indirect support through accumulation of arrears for unpaid taxes, contributions and utility bills. Their privileged position (protection from creditors) and presence in many sectors of the economy distorted the level playing field and discouraged private investment. Complex links they had with public utilities and large unpaid utility bills made reforms of public utilities almost impossible.

Over the last three years, the Government has made important steps to resolve this portfolio, which has been significantly reduced, to around 170 companies, with about 45,000 workers. Importantly, almost all the companies in the restructuring, the most problematic part of the portfolio, have been resolved.

However, the “strategic” companies that remain include the largest and most challenging cases.  If not resolved quickly, they will become a new fiscal drain: already in 2016 several ‘strategic’ SOEs ran up large arrears to EPS, Srbijagas and Railway, hindering the transformation process in the public utilities.

In this area, the momentum that was built needs to be maintained and reforms continued to avoid this risk from growing. Some of the important steps to which the Government has committed are being delayed, and this should be addressed quickly. This includes appointing the professional management at RTB Bor, privatizing or resolving through bankruptcy companies in the petrochemical complex, restructuring and rightsizing companies like Resavica and privatizing or resolving several other large commercial SOEs, like Galenika.

In parallel, the efforts to reform large public utilities have also picked up. Financial consolidation programs are now under implementation for all main companies, significantly reducing fiscal risk. EPS and Rail Cargo are significant potential assets in building a competitive economy if put on a sustainable footing, but for this implementation efforts need to accelerate. Some of the critical issues which remain are: completing the right-sizing efforts in several of the largest utilities; bringing tariffs closer to market rates; revisiting over-ambitious investment plans; and implementing measures to limit financial risks from remaining “strategic” commercial SOEs.

Finally, along with the continued implementation of structural reforms, business climate enhancement needs to further continue. Also here, some of the most egregious ills of the past have been addressed, in particular on construction permitting, property registration and e-taxation.

However, the continued perception of predatory behavior of inspection services and parts of the tax administration constitute critical reasons why Serbian citizens are reluctant to take economic initiative. Programs like the Tax Administration transformation program and Inspection reform should therefore place special emphasis on changing the approaches and mindsets that would help create risk-based system rather than the heavy-handed intrusions that many SMEs report.

Yet to be implemented: public administration reform and improving public services

The next frontier for Serbia’s long term economic development is strengthening the performance of public services. This has two main aspects: strengthening the legal and organizational basis for public service delivery and addressing expenditure anomalies within sectors.

On the first aspect, important progress has been made on ‘making order’ in what had become an anarchic system. Today, wage bill expenditures and staffing levels are under control due to broadly enforced savings measures. However, Serbian government is yet to embark on deeper structural reforms which will result in affordable and efficient public sector. The most critical areas which will remain in focus in the mid-term period is the following:

  • Design and delivery of better services to public, which will be done through further improvements and capacity building of inspection services, tax services and full implementation of the law on administrative procedures;
  • Implement organizational rationalization based on the series of functional reviews conducted over the last 15 months;
  • Implementation of the Law of Salary System of Employees in Public Sector, which supports “equal pay for the same work “principle. The next step in implementing the new wage system is the adoption of three ‘sector wage laws’ for local government, public service and security services staff. This is a critical but controversial element of reforms that must be completed by Summer 2017 so that it can be applied to wage setting under the 2018 budget.

A second aspect of this agenda is improving effectiveness and efficiency of sector spending. Serbia invests significant resources in education and health, with disappointing outcomes. It invests less in social protection, where mandatory and relatively generous programs like pensions and maternity leave crowd out targeted social assistance, thus weakening basic safety nets. 

As Serbia’s best asset is a qualified and healthy work force, the continued decline in education and health outcomes is of particular concern. Functional reviews in the education, health and social protection sectors have highlighted where Serbia overspends and where it needs to invest.

In education, Serbia lags behind its EU counterparts in access to early childhood education (one of the most critical parts of education), where only 50% of all Serbian children and less than 10% of children from poor households have access. This compares to the 94 percent target for EU member states. At the same time, Serbia spends significantly more than comparator countries on an over-expanded school network and an outdated TVET system that generally prepares graduates for unemployment, given that most streams provide skills for jobs that no longer exist or are no longer relevant.

Major overhauls of the TVET sector should be combined with a rationalization of the school network to free up resources for ECD, for targeted dual education programs, improved general secondary education (including providing skills in entrepreneurship and IT) and for consolidated schools that provide an appropriate learning environment.

Similarly, in the health sector a shift of resources into preventive care (strengthening primary health facilities) should combine with efforts to rationalize and improve tertiary care provision. The application of applying DRG based financing, planned by the Ministry of Health, will create a push for reducing a now overly heavy health sector administration. Finally, further transparency measures in pharmaceutical procurement should free up funds that would help create access to innovative and state of the art drugs.    

These efforts will help enhance long term competitiveness by creating a competitive and health labor force that will allow Serbia to continue to attract external investments and generate inward employment.    

Enhancing the role of local governments

Local governments (LGs) are key to delivery of public services, both to citizens and businesses. Still, often the local governments’ needs and problems are overlooked, and this is not the problem specific to Serbia.

Local budgets increased by 11 percent in 2016 thus allowing for better quality of services. At the same time, there were some important savings – most importantly on the wage bill, which went down by 5 billion dinars, compared to the peak level in 2013. And savings were not linear, which is good.  Most importantly, LGs increased investment in infrastructure – capital expenditures increased by 19 percent in 2016 (compared to 2015).

This is crucial not only to allow equal access to public services to all citizens (by investing in water systems; sewerage; streets etc) but also to increase attractiveness of each individual municipality to potential investors. Proactive approach in organizing a business-friendly administration; investment in infrastructure and cooperation with central government institutions (like RAS; Ministry of Economy etc) can help to attract investors.

Local governments are also fast becoming front runners on public service innovation and PPPs. The first PPPs to modernize critical service delivery in municipal waste and waste water management are likely to become operational in the near future in Belgrade and several other cities are exploring opportunities.

Even smaller cities are not left behind, I was recently impressed by what I saw in Vranje which managed, on the back of the modernized E-75 highway infrastructure, to develop a new economic zone where several foreign investors operate already, thus employing thousands of people and providing a lot of additional revenues to the local budget.

There are several other good examples, but not yet enough to push the overall growth of economy. Therefore, I would like to urge you all, to work even harder on improving local infrastructure and creating business friendly administrations. 

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