Serbia and Montenegro – Look ahead!
•Despite continuing political uncertainty commitment to reasonable economic
policy appears strong.
•The dialogue with the European Union is set to
intensify, backed by strong public support.
•Increased political stability
would pave the way for rising direct investment inflows. Economic criteria speak
for a positive assessment of the investment location.
•Intensified trade
links between the Balkan countries imply an opportunity for stronger growth and
better living conditions. This bodes well for political stability and economic
reforms.
Economic forecast summary 2003 2004 2005
Real GDP
growth, % change 1.5 3.0 4.0
Consumer prices, year-end chg. 7.6 7.5 6.5
Current account bal., % of GDP -10.9 -9.5 -8.3
Budget bal., % of GDP
-4.5 -4.3 -3.9
CSD/USD, year-end 54.2 59.0 65.5
CSD/EUR, year-end 66.7
72.0 76.0
Politics determines the daily newsflow, but provides only a
narrow perspective of the country. Due to continuing political uncertainty,
assessment of the current situation remains widely critical, without indicating
a longer-term development path for the country. Although last year’s
presidential and parliamentary elections reinforced this view, economic
trends outline a more favourable outlook for Serbia and Montenegro.
In fact, cooperation with the International Monetary Fund and the
World Bank on the one hand and the dialogue with the European Union on the other
hand, will secure economic stability. The IMF agreement provides a reliable
medium-term macroeconomic policy framework, whilst convergence towards the
European Union implies a long-term process. In April 2003, the country accessed
the Council of Europe, and negotiations of the Stabilisation and Association
Agreement (SAA) have been started. This agreement is a precondition to becoming
an official EU candidate country. Therefore, the government faces strong
incentives to advance economic reforms.
Despite political
differences common economic policy decisions are likely, as public support for
EU convergence is strong. According to a survey, 74% of Serbs favour membership
of the European Union, whilst only 7% are opposed. Obviously, the EU perspective
provides an anchor of stability that should enhance the co-operative stance of
the political parties. From an economic perspective Serbia and Montenegro are
already on the right track. Most importantly, the country benefits from
well-diversified trade links. Reorientation of trade is indicated by the
share of exports destined for the EU, which increased to 40% in 2003. Italy is
Serbia and Montenegro’s major export market, but Germany is the most
important trading partner.
This underpins the interest of the German
government and the business community to improve political and economic
stability not only in Serbia but also in neighbouring countries. In this case,
investors could use Serbia and Montenegro as a location to supply the whole
region. Germany in particular has experience in using locations in former
Yugoslavia for manufacturing in the 70’s and 80’s. These traditional ties put
Serbia and Montenegro in a favourable position to advance investor demand
was given by last year’s privatisation of two tobacco companies and selling of
an 80% stake in Beopetrol’s retail outlet. Further investments have been made in
industry areas such as steel and beer. All in all, these privatisation steps
generated revenues of about USD 1.1 bn, which far exceeded the IMF target of USD
600 million.
The investor base was mixed, with foreign investments
from the EU and the US as well as Russia. Besides, these acquisitions should
be interpreted as a vote of confidence in the government’s commitment to
market-oriented economic policy. The government will have several
opportunities to underline its reformist stance. One important step would
be the completion of a unified market between Serbia and Montenegro.
Above all, this requires harmonised systems of terms of trade and tariffs. These
steps are also necessary to advance negotiations about a Stabilisation and
Association Agreement with the EU. Additionally, the government will have to
change legislation on energy, railways and taxation. With regard to the
tax system the government plans to introduce a value-added tax to reduce the
income tax burden that has led to a booming grey economy. Nevertheless,
budget performance is running widely in accordance with the IMF
agreement. Last year’s budget deficit remained below 4.5% of GDP and a gradual
decline to 3.9% is likely in 2005. Despite this benign fiscal outlook the tax
reform is important to reduce the government’s reliance on privatisation
revenues for financing the budget deficit.
In contrast, the current
account deficit still indicates significant vulnerability to external
shocks. However, we project a gradual decline of the deficit from last year’s
10.9% of GDP to 8.3% in 2005. A look at the major import and export
categories highlights future challenges with regard to industrial structural
change. So far, manufactured products such as clothing, rubber and iron products
account for nearly 30% of total exports, whereas food, beverages and tobacco
account for 21% of exports. Machinery and equipment account only for 10%, which
indicates the need for an investment-driven modernisation and diversification of
the economy.
In this regard, the role of the agricultural sector
is projected to decrease further. Since 1999 the agricultural sector’s GDP share
declined from 23% to 14.2% last year. At the same time the share of the
service sector increased from 35% to 58% of GDP. Both these trends,
gradual modernisation and structural change should improve international
economic competitiveness. Against this background the central bank’s
affirmation of the current exchange rate policy provides an important
signal. Despite several political calls for a weakening of the dinar, the new
governor of the central bank, Radovan Jelasic, dismissed a depreciation of the
currency to boost exports. The anti-inflationary stance of the central bank has
been the major factor behind last year’s significant decline in inflation. At
year-end 2002 retail price inflation stood at 14.2%. During the course of
2003 retail inflation followed a declining trend to 7.6% at year end. Average
inflation reached 11.6%, which was lower than the government target of 12%.
Assuming that the central bank adheres to its managed floating exchange rate
mechanism, the inflation rate should decline to 6.5% at year-end 2005. The
slowing of the disinflation process indicates the need for fiscal reforms and
productivity raising investments.
Besides these structural issues the
exchange rate development poses the biggest risk for inflation trends.
Particularly, short-term political factors weighing on the dinar could lead to a
significant rise in inflation. However, economic trends are basically
favourable, which implies a gradual decline in the external debt stock.
We project a fall below 50% of GDP by year-end 2005, which implies prudent
economic policy decisions. The debt-to-GDP ratio marked the top at 136% in 2000.
In the meantime, international reserves register steady growth. The
debt-cover ratio will probably reach 30% by year end. All in all, this clearly
improving economic environment means a big chance for the government to
strengthen its own position and to advance the integration between Serbia and
Montenegro as well as the EU.
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