The Serbian economy will shrink by 0.5% this year and stagnate in 2015 as a result of the devastating mid-May floods and the need for tighter than previously expected fiscal consolidation, the head of the central bank's unit for economic research and statistics, Branko Hinic, said on Aug 13.

The domestic production, above all in the areas of energy, mining and agriculture, was severely hit by the floods and its recovery will need a longer period of time - which is one of the reasons why the central bank (NBS) cut its GDP forecast for this and next year, Hinic said in a presentation of the NBS latest inflation report for August.

This is the second downgrade of the central bank's GDP forecast. In June it said it believed that the flood damage to the agriculture and energy sectors would leave the economic growth stagnating this year instead of growing by 1% as previously thought.

The statistics office said at the end of July the GDP dropped by a real 1.1% y/y in the second quarter of 2014 (after growing only 0.1% y/y in Jan-March), verifying the worries that the national output will shrink this year. Hinic confirmed the second-quarter GDP fell 1.1% y/y due to the damage caused by the floods.

He explained that on the expenditure side, the contribution of net exports in the three-month period was negative because of the rise in energy imports and the drop of exports of manufacturing goods.

Expected 0.5% drop in 2014 GDP

The projected GDP contraction for full 2014 will come as a result of lower agricultural output and the smaller activity of the mining and energy sectors. The contribution of the construction sector, on the other hand, should be positive given the renovation works on damaged roads, buildings and infrastructure. The central bank expects that the approval of subsidised loans to the economy will also have a positive contribution.

The contribution of net exports to the full-year GDP will be positive but smaller than previously estimated due to the expected increase in the imports of energy, construction material and equipment, and the smaller exports of the manufacturing sector. At the same time, the works on the flood damage recovery should result in higher inflow of investments.

Fiscal consolidation to dent growth in 2014, 2015

The contribution of household spending to the GDP is seen negative in both 2014 and 2015 because of the expected fiscal consolidation measures. Moreover, with the announcement of additional austerity, the negative impact of the fiscal consolidation on next year's growth is now seen bigger that previously projected and most certainly neutralising the expected positive contribution of net exports and investment. Otherwise, the growth of next exports in 2015 should be supported by a stronger recovery of the EU economies, while the growth of investments should be boosted by the flood recovery works and Serbia's further progress towards EU integrations.

The Serbian government has said it will revise this year's budget in September, adjusting it to the new reality in the economy, which suffered floods-related losses and damages estimated to equal 5% of GDP. Finance minister Dusan Vujovic said in July that public sector wages and pensions will be cut by up to 10% as part of the pending revision as budget deficit this year is seen rising close to 9% of GDP - the highest in Europe.