The Serbian government announced a modest raise in public sector wages and pensions on November 11, the day after an International Monetary Fund (IMF) mission approved the request, citing Serbia’s improved economic performance.

The government reduced public wages and salaries approximately by 10% in November 2014 as one of its first public finance consolidation measures. A year later, the IMF allowed the government to make a small increase, though this is conditional on an increase in fuel excises. This should make Prime Minister Aleksandar Vucic’s future agenda - which includes privatisations and the closure of unprofitable state-owned enterprises - more palatable to voters.

The International Monetary Fund (IMF) completed a 12-day visit to Serbia on November 10 to conduct the third review of its precautionary €1.2-billion three-year stand-by arrangement (SBA) with Belgrade. In his November 10 statement, the head of the IMF mission, James Roaf, said the programme has delivered very good results in its first year.

The following day, the government announced on its website, a 1.25% linear increase in pensions as of January 1, 2016. In the education sector, school teachers will get a 4% pay rise, while for university professors a 2% salary increase is planned. Health and social protection workers have have 3% higher salaries from the beginning of 2016, and the military and police will get a 2% raise.

According to Vucic, since some 141,000 people are employed in the education sector, an increase of their salaries will cost the budget around RSD4bn (€33.33mn) while for the health sector and social system workers, the government will need almost RSD210mn and for the police and military an additional RSD8bn.

Teachers in elementary and high schools will also get a one-off payment of RSD7,000 by the end of the year.

“The fiscal improvement so far plus a planned increase in fuel excises, allows space for a modest pension increase in 2016, as well as some targeted wage increases aimed at narrowing the wage gaps in the general government. Overall spending on wages and pensions should continue to fall as a share of GDP towards the medium-term targets of 7% and 11% of GDP respectively,” the Fund explains.

The IMF’s support is crucial for the further economic development of Serbia at both domestic and international levels, as the Fund is helping Belgrade to consolidate public finances as well as improving of its image on international markets, which that helps it to attract foreign investors.

The IMF mission revised the real GDP growth projection for 2015 to 0.75% after, during its second review of the SBA on end of August, it was lifted to 0.5% from -0.5% annual growth envisaged in the SBA.

“This improvement reflects earlier-than-expected recovery of the mining and energy sector and a pick-up in investment and job creation. However, despite a milder-than-expected decline, consumption remains subdued,” the IMF said.

“Inflation remains well anchored but below target, on account of still subdued aggregate demand and import prices, and a fall in prices of fruits and vegetables. The external current account deficit is declining, amid significant fiscal rebalancing and robust exports. Continuing sound macroeconomic policies and progress in structural reforms are crucial to maintain and expand the current growth momentum.”

On November 10, the IMF stated that Serbia’s strong fiscal performance continued in the third quarter of the year.

According to the latest flash estimate of the country’s statistical office published on October 30, Serbia’s economy continued to grow in the third quarter, increasing by a real 2.0% y/y, after rising by 1% y/y in Q2.

Tim Ash, chief strategist at London based Normura, said in a note that real GDP growth has surprised on the upside – helped by low base period effects – and despite fiscal consolidation, has helped to cushion the impact of that fiscal consolidation, certainly helping on the revenue side and moderating the size of the budget deficit, capping the rise in public sector indebtedness.

The Serbian Ministry of Finance announced on October 27 that the country's consolidated (general government) deficit in January-September 2015 stood at RSD51.1bn (€425.83mn). This was well below the RSD152.91bn in the same period of 2014.

The general government deficit in 2015 is projected at 4.1% of GDP, well below the budgeted deficit of 5.9% of GDP, representing a structural deficit improvement of around 2.5% of GDP compared to 2014. At the same time, there have been some delays in fiscal and structural reforms, notably general government rightsizing and wage system reform, the Fund said.

The mission supports the authorities’ plan to use part of the fiscal over-performance in 2015 to cover one-off expenses related to arrears in military pensions and payments by gas company Srbijagas. Going forward, it is essential to put public sector reform firmly on track and ensure that state-owned enterprises cease to create repeated fiscal costs, the Fund said.

Since one of main topics of the talks that occurred in Belgrade from October 29 until November 10, was budget for 2016, the IMF stated in its press release that the mission agreed with the authorities on the key parameters of the 2016 budget.

“This involves a further structural deficit improvement of 0.75% of GDP, mainly reflecting government rightsizing, containment of wages and pensions, and reductions in subsidies for agriculture and broadcasting. Taking into account severance pay and other one-off expenses, the overall headline deficit will remain close to 4 percent of GDP,” according to the Fund.

Serbia has been carrying out the process of privatisation and restructuring of public enterprises which are seen as crucial for the state’s economic recovery and development. It has been trying to restructure some 500 public companies and has promised to stop financially supporting them. But, the process has been facing numerous obstacles as requires significant reduction of jobs and thus increase of risk of losing citizens support for the government. However, for the IMF this is a necessary step.

Even though the the mission welcomes the authorities’ renewed commitment to press ahead with a broad-based structural reform agenda, it states that more decisive reforms of state-owned enterprises are needed to deliver tangible benefits, including improved financial viability, corporate governance, and private sector-led growth. In this regard, the mission urges the sustainable resolution of 17 strategic companies in coming months, through privatisation, restructuring, or bankruptcy, as well as steadfast implementation of energy and transportation sector reforms.

Under the law on privatisation adopted in August 2014, the process should have been concluded by the end of 2015 but in May the Serbian parliament approved amendments extending by up to one year court protection from creditors for 17 companies of strategic state interest employing a total of 25,000 people. Among them are bus and truck manufacturer FAP, pharma company Galenika and petrochemicals company HIP-Petrohemija.

The IMF said that the financial sector reform agenda is progressing as planned. Legislative changes to facilitate the removal of impediments to resolving nonperforming loans (NPLs), following the recent adoption of the NPL resolution strategy, are advancing, albeit with some delays.

During the first review of the stand-by arrangement in June, the IMF asked Belgrade to implement a comprehensive strategy to resolve the high number of non-performing loans (NPLs), assist economic recovery and reduce financial vulnerabilities.

Earlier in August, the National Bank of Serbia introduced a strategy for reducing NPLs, which the IMF welcomed during its second review.

The completion of the review will make SDR70.2mn of €89.6mn available to Serbia under the SBA, bringing the total funds available to SDR491mn (€627 million) but the Serbian authorities have indicated that they do not intend to draw on the resources available under the arrangement.

The €1.2-billion three-year stand-by deal Serbia signed with the IMF in February is intended to support Serbia's 2015-2017 economic targets, restore public debt sustainability, strengthen competitiveness and growth, and boost the resilience of the financial sector.

Ash believes that a positive IMF health check – and similar positive comments from the EC on November 5 in its Serbia progress report, could see nearer term positive ratings momentum. He adds that Serbia remains an improving credit story, and this is not yet reflected in its ratings – with Moodys (B1) and Fitch’s B+ ratings appearing tight, relative to S&P’s more generous BB-.