Fitch Ratings has downgraded Serbia's long-term foreign and local currency Issuer Default Ratings (IDR) to B+ from BB- and the country's ceiling to B+ from BB-, citing deteriorating public finances and weak economic prospects, the ratings agency said in a statement on January 17. Fitch affirmed Serbia's short-term currency IDR at B. The outlook on the ratings is stable.

The rating agency expects Serbia's consolidated general government deficit to increase for the fourth year in a row to 7.1% of GDP in 2014 from 6.5% in 2013. Fitch noted that the government aims, however, to reduce the central government deficit by 1.6pp of GDP in 2014 and 1.9pp of GDP in 2015 but not all savings have been identified and the plan partly relies on improving tax compliance. 

Weak growth and fiscal slippage have resulted in further deterioration of Serbia's public debt which is expected to increase to about 70% of GDP in 2015 from 63% currently. The agency warned that exchange rate risks to government solvency are high, as about 80% of public debt is foreign currency-denominated.

In addition, Fitch expects Serbia's average GDP growth to remain sluggish, slightly below 2% in the next two years which will further undermine fiscal consolidation plans. The economy is projected to expand by a real 2.3% in 2013, thanks to higher automotive exports and a good agricultural season. 

According to Fitch, results from the government's plan to restructure state-owned enterprises remain uncertain. Policy credibility is affected by delays in fiscal consolidation and a weak track record of structural reforms, the agency said adding that new elections are expected to be held in the first half of the year and are likely to further delay structural reforms.  

On a more positive note, external financing pressures have eased as strong increase in exports led to a significant decline in the current account deficit in 2013 (5.2% of GDP). Negotiations between Serbia and the IMF to sign a precautionary lending agreement could begin in the first half of 2014. Such an agreement could provide a policy anchor and help to promote investor confidence, Fitch also said.

Fitch could further downgrade Serbia's rating  if the country fails to implement sufficient fiscal consolidation in order to curb its rising public debt. A downgrade is also possible if a recurrence of exchange rate pressures leads to a fall in reserves and a sharp rise in debt levels and the interest burden, the agency underscored.