Serbia looks to stimulus to return economy to fast growth

By bne IntelliNews June 11, 2009

Ben Aris in London -

Extreme crises call for extreme action, and the upside of the current downturn is that some governments are using the huge dollops of international cash to launch some of the most radical reform plans the region has ever witnessed. Serbia is betting big on a massive fiscal stimulus package that it hopes will return the country to the fast pace of growth it has enjoyed in recent years.

After the trauma of the 1990s, the Balkan region has been growing faster than nearly any other part of emerging Europe. Most of the international attention has focused on the endgame to the break-up of the former Yugoslavia, and Kosovo's bid for autonomy in particular, but the real story is the blistering pace of economic growth.

Diana Dragutinovic, Serbia's finance minister, summed up the progress during the European Bank for Reconstruction and Development's (EBRD) annual general meeting in London in May: "We have enjoyed economic growth of an average 6.5% a year since 2000, which is almost the highest of any [Central and Eastern European] country. The crisis means there will be a slowdown and GDP will fall, but it is not Armageddon."

The Serbian economy has flourished since 2004. GDP grew by 8.8% in 2006, 7.5% in 2007 and 6.0% in 2008. The sectors that did best last year were transport, storage, finance, agriculture and trade. The amount of foreign direct investment in the first three quarters of 2008 was estimated at €1.6bn, with the greatest inflows in the banking and insurance sector, which was up 42%, followed by industrial production (18%), real estate (18%) and trade (11%).

Although there is no way the economy can match last year's performance, at the end of May Serbia looked like it could be one of the handful in the world that will avoid seeing its economy contract this year. The finance ministry is predicting 0% GDP growth for the whole of 2009, which is still less than the 4.5% it was forecasting only a few months ago.

Crisis was mild

Being a late starter has had its benefits and the crisis has hurt the smaller Balkan countries less than their larger CEE peers to the north and west. In November, there was a crisis of confidence in Serbia's banking sector that hurt. Then the gas row between Ukraine and Russia at the start of this year also led to energy shortages that temporarily halted industrial production. But local bankers say the central bank dealt effectively with the shocks to the economy. "In the first two months [of this year], about a quarter of all deposits in banks was withdrawn, or about $5.6bn," says Slavko Caric, CEO of Erste Bank's subsidiary in Belgrade. "But the situation didn't spin out of control and banks continued to pay out. Deposits have since started to return and while we haven't got back all the money that left, the situation is now stable."

Life for the Serbian government got a lot easier after it signed off on a €3bn International Monetary Fund (IMF) standby deal and received the first almost €800m tranche at the end of May, which will be used to support the local currency. The government has taken this money and launched a massive fiscal stimulus package, injecting more than €300m into the system in the first quarter and plans to inject another €300m in the second quarter have already been approved. "Fiscal stimulation is the way to go and putting money into the economy is the right thing to do," says Dragutinovic, who is a former academic from the Belgrade Faculty of Economics, where she still lectures. "I hope it will work, as there is no clear empirical evidence that fiscal stimulation necessarily leads to economic growth."

The government plans to spend a whopping €1bn this year on infrastructure projects and another €600m is going to support small business or will be distributed via budget spending. In all, the government is planning to spend a total of €3bn over the next four years - a new cross-country highway and a railway corridor are planned amongst other things - in the hope of using the crisis to dramatically transform the economy.

Other international financial institutions have also been on hand to help. The World Bank recently signed off on a large loan aimed at infrastructure investment, while the EBRD has increased its support for its highly successful loans programme for small and medium-sized enterprises (SMEs).

Banks bowed but not broken

The government is not just planning to throw money at the problems. Dragutinovic said policy is guided by two principles: to maintain the trust of the population and to make it possible for business to borrow again.

The legacy of the 1990s means the population has never had much confidence in the banking system and a bad situation at the end of last year was made worse after the local tabloid press hammed up the severity of the crisis with dire warnings that threatened to become a self-fulfilling prophecy, says Caric. Although the bank system was solid - not a single bank has gone bust and non-performing loans remain low - the volume of withdrawals almost became a run on bank deposits. At that time, the government gave the first sign of its radical approach to dealing with the looming bank crisis. "The government hiked the level of deposit guarantees from €3,000 to €50,000 overnight, which covered 96% of all the deposits in the country and managed to restore some confidence in the system," says Caric.

The action to achieve the second goal is even more radical. The government is heavily subsidising lending, especially to SMEs, in the hope of lifting economic growth up by the bootstraps. The average cost of borrowing for SMEs pre-crisis was 10-12%, but lending activity has recently come to a standstill. To get the ball rolling again, the government has been subsidising half the cost of the lending to SMEs since the end of February to the tune of hundreds of millions of euros. "This scheme has been a real boost to the economy. It was a really great idea that has been put into effect very quickly and adds significantly to the liquidity in the system," says Caric.

The government is also subsidising the interest on three-year loans as well as consumer loans: things like borrowing for tractors (which counts as a consumer loan in Serbia) will have an affective rate of 4.5% while other consumer goods have an effective rate of 6% over 5-7 years. "The subsidies paid on turning in an old car if you buy a new one that is made in Serbia have been extended to tractors and customers can get up to €2,000 discount. Agriculture is still one of the most dynamic parts of the economy and we need to support it," says Nebojsa Civic, minister of economic and regional development.

Agricultural remains a key sector and is on track for a good harvest this year, which will support both the economy and also give a boost to the trade balance. A recovery in steel prices have also provided a fillip. Global metallurgical company US Steel operates a big mill in the country, which has been shut for the first few months of this year, but as prices recovered was due to go back into production in June.

And as stability returns, the government has half an eye on the post-crash recovery. In June, it also launched a treasury bill market. The Serbian capital market regime is still pretty restrictive - for example, syndicated loan borrowing by banks is still outlawed - but the government is planning to issue its first three-month T-bills later this year as part of its efforts to create a domestic market for borrowers, says Dragutinovic. The idea is to continue spending to return to the strong growth the country has enjoyed in recent years.

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