Serbia : European integration, energy, war in Ukraine - The unknowns of the growth path

Serbia : European integration, energy, war in Ukrainethe unknowns of the growth path

Author Vincent Joguet

Serbia : European integration, energy, war in Ukraine - the unknowns of the growth path

Vincent Joguet – joguetv@afd.fr

Final date of writing: 20/07/23

Summary: The path of economic growth and development of Serbia, a country with a modern, diversified and outward-looking economy, depends at the same time on the fundamental reforms of its energy model, developments in the global economic environment, and a hypothetical rapid integration into the European Union (EU).

Since 2017, Serbia has benefited from strong economic performance, based on sound fundamentals achieved through ambitious reforms undertaken under the aegis of the International Monetary Fund (IMF) in the mid-2010s, and which are still ongoing today. The Government has thereby consolidated the public accounts, introduced tax and administrative measures to attract foreign investors, and adopted a monetary policy aimed at maintaining a stable exchange rate against the euro. The continued support of the IMF has paid off: the stronger economy and macroeconomic stability enabled Serbia to address the Covid-19 crisis under good conditions and get through 2020 with a decline in GDP of only 0.9%. At the same time, it managed to implement an ambitious recovery plan (9% of GDP) which contributed to the strong rebound in growth in 2021 (+7.4%). Between 2018 and 2022, economic growth reached an annual average of 3.5%, one of the best performances of all European countries. The debt reduction path, which was initiated in 2016 and interrupted by the health crisis, resumed in 2021.

There was a slowdown in economic growth in 2022 (2.3%) and this pace is expected to continue in 2023 (2%), due to the consequences of the war in Ukraine, the slowdown in activity among Serbia’s trade partners (mainly EU countries), and persistently high inflation despite the (late) increase in the key interest rate. However, IMF expects economic growth potential of 4% in the medium term, based on well-established growth drivers (foreign direct investment and exports). But this potential will not be sufficient for per capita income to rapidly catch up to the EU average. Considerable reforms will be necessary to transform the energy sector which holds back growth, improve labor productivity by retaining graduates, and succeed in the low-carbon transition.

Serbia’s integration into the EU, the official governing principle of the ruling party despite its ambiguous rhetoric, could be the catalyst for stronger growth. But the convergence towards EU standards poses major challenges for the Government, starting with the strengthening of electoral democracy, the judicial system and the freedom of the media, along with the normalization of relations with neighboring Kosovo.

Thematic area: Macroeconomics

Geographical area: Serbia

1. The strategy of “political illiberalism”: a risky choice

The dominant influence of the Serbian Progressive Party (Srpska Napredna Stranka, SNS) over the last ten years has been coupled with an authoritarian drift of the system of power and a deterioration in the rule of law, despite the recent timid steps forward in the independence of the judiciary. In terms of foreign policy, Serbia’s ambiguous position towards Russia and the repetitive flare-ups of tensions in northern Kosovo jeopardize the country’s integration into the EU in the medium term. However, with the improvement in social indicators and the living standards of the population, Serbia is in this sense the country in the Western Balkans the best placed, along with Montenegro, to join the EU.

The SNS party has dominated political life since the 2012 presidential election. With almost 800,000 members, or more than 11% of the population, it is by far the largest party in Europe in terms of size. At the same time conservative, populist and pro-European, it has managed, during its decade in power, to impose a political line close to the concept of “illiberal democracy” vaunted by Hungarian Prime Minister Viktor Orbán. This model is typified by intense nationalism, a centralization of power, a willingness to undertake economic reforms –without really calling into question the dominance of state-owned companies controlled by the party –, as well as a clear tendency towards paternalism and patronage and a form of non-alignment at the international level. President Aleksandar Vučić, re-elected in the first round of the last presidential elections of April 2022 with over 60% of votes and a founding member of the SNS, has a free hand to pursue this policy, despite the gains of a disparate and divided opposition during the last legislative election of April 2022.

This long stability at the head of the State has contributed to the economic growth of the country by giving visibility to investors. Consequently, social indicators have improved, driven by a gross national income (GNI) per capita multiplied by a factor of 5.5 between 2001 and 2021. The convergence of Serbia’s GNI per capita towards the level of the EU has accelerated significantly since 2018. At $8,460 [1] in 2021, it amounted to about 80% of the level of Bulgaria and 45%

of the EU level. The Human Development Index, reflecting the increase in GNI per capital, as well as in life expectancy and the level of education, steadily improved from the early 2000s until 2019. It today means that Serbia ranks among the very high countries, 63 rd worldwide in 2021, ahead of the other Western Balkans countries, with the exception of Montenegro. Income inequality has also fallen compared to 2012 (but has remained at a high level since 2018 [2] ), due to the dynamism of the labor market over the last ten years. The strengthening of entrepreneurial activity and gradual macroeconomic stabilization have contributed to a marked decline in the unemployment rate, from 25% of the labor force in 2012 to 9.4% in 2022.

2 The Government focuses on fiscal consolidation, macroeconomic stability and investment incentives. It does not prioritize the reduction of inequalities which are primarily regional.

Graph 1: Long-term improvement in social indicators

HDI (right scale) Povertyrate (<$6.85 PPP per day, %, left scale) Gini index (left scale)

Source: World Bank (WDI), UNDP

At the same time, the hegemony of the SNS has come with a deterioration in the rule of law. All the indicators of international political observatories have been falling since 2017, and more sharply since 2020. The checks and balances do not fulfil their role: the Parliament only exercises its control powers very tentatively and its agenda remains essentially dictated by the executive power. The most popular media, in particular the television, the preferred choice of Serbs, is mainly controlled by people close to the Government and serves as a mouthpiece for the executive power: 95% of the programs broadcast are pro-government and the President is invited on the TV news and political talk shows on almost a daily basis. The opposition is systematically ridiculed and has no say. The broadcasting regulators do not intervene to ensure there is a balance in the speaking time or sanction abuses and slander. The country ranks among the last in Europe in the 2023 World Press Freedom Index of Reporters Without Borders. Judicial power, for its part, is neither autonomous nor independent. Up until the recent justice reform in February 2023, the Parliament played a key role in the appointment of judges. Despite the reform, the Council of Europe continues to have doubts about the ability of the authorities to terminate their excessive proximity to the judiciary. The Corruption Perceptions Index has also been continuously deteriorating since 2015 and the country joined the rank of Albania last year (101 st out of 180 countries). [3] Consequently, Serbia is today no longer considered as a full-fledged democracy but as a hybrid regime. In addition to the reports of international organizations on the authoritarian drift of the Serbian Government, the European Commission and Parliament have criticized the lack of progress in the rule of law, fundamental rights, freedom of expression and the strengthening of media pluralism for several years. In its last report of October 2022, the European Commission concluded for the first time that Serbia had “fallen back” on the path towards EU membership, despite a certain amount of progress in several technical chapters of the Community acquis.

2 : Deteriorating perception of corruption

on the Corruption Perceptions Index

The positions of the European bodies also reflect an annoyance over Serbia’s foreign policy. Indeed, the non-alignment policy has an objective that will be difficult to achieve since the military aggression of Russia against Ukraine in late February 2022. It involves strengthening relations with partners in the West, by continuing to work for a rapprochement with the EU with a view to its integration, and in the East, by maintaining good business relations with China, a key economic actor in Serbia, with Russia, a traditional ally since the break-up of Yugoslavia and the Kosovo war, and with Gulf countries, including the United Arab Emirates, whose investments are increasing in Serbia. Consequently, while Serbia voted in favor of the two resolutions of the United Nations General Assembly in March 2022 and February 2023 condemning the aggression of Ukraine by Russia and demanding the withdrawal of Russian forces from the Ukrainian territory, it is also the only European country, along with Belarus, to refuse to apply the various packages of sanctions towards Russia. The main reasons for this position are i) economic, as Russia is one of the country’s main energy suppliers (natural gas); ii) historical, as public opinion has painful memories of the decade of international sanctions in the 1990s and the military bombing campaign by NATO of Serbian targets during the Kosovo war in 1999; iii) cultural, as Russians and Serbs are Slavic peoples, speaking languages of the same origin and with Orthodox Christianity in common; iv) diplomatic, as Russia, a permanent member of the United Nations Security Council, is Serbia’s main ally for the Kosovar case.

Graph

Indeed, Kosovo occupies a predominant place in Serbia’s foreign policy and stands as a further major barrier to the path towards European integration, despite recent changes in the European Commission’s positions on this issue – together with those of American diplomacy – in a more favorable light for Belgrade than Pristina. The recurring tensions came to a head in December 2022 and June 2023 with the Serbian army placed twice under high alert at the border, citing as the reason the threats to Serbian people in northern Kosovo. The imposition of sanctions towards Kosovo by the European Commission in mid-June 2023, the lifting of which is conditional on the implementation of de-escalatory measures by Pristina (withdrawal of special forces from Serb-majority municipalities, organization of new municipal elections in the area), confirms the analyses of certain observers in the region on the clear link between developments in the EU’s position and Europe’s priority of pulling Serbia out of the Russian orbit to secure the country’s anchoring to the West.

Today, President Vučić makes equivocal statements about the EU, presenting Serbia as an unfortunate candidate for the accession process, despite efforts to this endeavor. His comments,

relayed by media close to the Government, contribute to a growing sense of doubt towards the EU among the Serbian population (43% think that Serbia will never become a member of the EU) or even antagonism (44% of Serbian citizens would vote against membership).

In 2023, the political system has started to crack. Since the mass killings which took place within the space of two days in May 2023, the hateful and violent media discourse has been the focus of tens of thousands of demonstrators protesting every week, for the first time in 25 years, to demand, in vain, the revocation of the licenses of television channels broadcasting violent programs, the banning of pro-government newspapers fueling tensions, and the resignation of the Interior Minister and the Head of Intelligence. Initially in denial, the President has spoken about the organization of early general elections in response to the anger of the crowds, but without specifying a date. With no leader or stated political position, the coalition of demonstrators does not have the means to carry weight in the polls, especially as the opposition is diverse, fragile, and only has access to confidential media with very limited visibility.

2. Economic resilience impressive but eroding

The 2008-2009 financial crisis had a significant impact on Serbia’s economy, resulting in several years of recession. In 2014, the newly elected Government called on the IMF to reduce the public deficit and restore economic growth. These efforts paid off: the economy returned to significant growth until 2021, despite the shock of the health crisis. It is now modern, diversified and outward-looking, with a dominance of the service sector. However, there has recently been a slowdown in economic growth due to the weak international economic environment and high inflation rates.

During the 2000s, the transition towards a normalized political situation was slow and the country faced several crises. All the reforms were not in place when the international economic and financial crisis erupted in 2008-2009, which Serbia took several years to recover from. Between 2009 and 2014, the country experienced three recessions. Faced with the stagnation of the economy, the new administration which took office in 2014 decided to

Graph 3 : Dynamism of growth expected to resume in 2024

call on the IMF to overcome its public deficit, which spiraled with the crisis, and put the economy back on the path of growth. A large-scale consolidation program [4] and reforms of public institutions put the economy on a solid footing and restored the confidence of investors and banks. Between 2016 and 2019, the economy returned to significant growth rates (average annual growth rate of 3.6%). The strengthening of the economy and renewed macroeconomic stability enabled Serbia to get through 2020 and the Covid-19 crisis with a GDP which only declined by 0.9%, before rebounding strongly in 2021 (+7.5%). Between 2018 and 2022, economic growth reached an annual average of 3.5%, the best performance of all continental European countries (with the exception of Poland).

However, Serbia’s economic growth has slowed since 2022: it reached 2.3% in 2022 and the Central Bank expects it to level off at between 2% and 2.5% in 2023 (2% according to the IMF). The weak international economic environment anticipated in 2023 and 2024 will affect the demand of EU partner countries, which will cost growth points to Serbia’s economy. In addition, Serbia is expected to have high inflation rates throughout 2023. The Government is very much counting on the new 2-year Stand-by Arrangement (SBA) ($2.4 billion), approved by the IMF in December 2022, to act as an additional buffer to these external risks. The situation is, however, far less dramatic than it was thought to be when the recourse to the IMF was decided in mid-2022. This SBA should also allow the country to finally overcome problems related to the energy sector. This type of program has proved to be effective in the past in times of crisis and allows the Government to push through unpopular reforms.

Public finances (excluding energy)

Fiscal balance (% GDP), left scale Primary balance (% GDP), left scale Expenditures (% GDP), right scale Revenues (% GDP), right scale

Source: IMF (WEO)

Indeed, the appropriate use of IMF programs and the Government’s strong will to ensure fiscal stability have allowed Serbia’s public accounts to absorb external shocks in recent years. Following the fiscal consolidation efforts in the years prior to the Covid-19 crisis, which made it possible to achieve four successive years of primary surpluses, the unprecedented budget deficit in 2020 (-7.2% of GDP) – generated by the massive fiscal stimulus plan to mitigate the economic and social shocks related to the health crisis – was reduced in the following year (-3.3% in 2021 and -0.1% in 2022). This rapid recovery confirms the resilience of public accounts and the quality of their management by the administration following years of reforms. This was backed up by the adoption of a new framework of fiscal rules in 2022, aligned with EU directives. In 2022, the country returned to a primary fiscal surplus excluding energy (+1.4% of GDP), which should be maintained in 2023 (+0.7% of GDP), despite the rather negative prospects for economic growth. The Government’s target is for the overall public deficit (including energy) to return to well below 3% of GDP in 2024 and around 1% of GDP in the medium term. The increase in the public financing requirement (primary balance plus public debt service), related to the rise in the primary deficit due to the health crisis, led to an increase in the public debt ratio in 2020, whereas it had been falling since the peak in 2015 (70% of GDP) as a result of fiscal

4 Control of current expenditure, in particular pensions and wages, reduction of transfers to state-owned companies, improvement in the efficiency of tax collection and broadening of the tax base.

Graph 4 : Fiscal consolidation, the cornerstone of economic growth

consolidation. This increase was only temporary, with the downward path of the debt ratio resuming in 2021, to 53.5% of GDP in 2022. Indeed, the public financing requirement is well below its level prior to the health crisis: the debt service (interest plus principal) has fallen considerably as a result of the decline in the level of debt since 2015 and favorable borrowing conditions until 2021. The public debt burden is falling sharply: it was halved between 2015 and 2022 and now only amounts to between 3% and 4% of budgetary revenue. However, in 2023, the public financing requirement is expected to increase slightly and temporarily due to a higher level of amortization.

holders), 30% by multilateral creditors, and 31% by bilateral creditors (including a third by China). In January 2023, as Serbia’s sovereign spreads had fallen to relatively attractive levels (229 basis points), the Treasury raised $1.75 billion via two USD-denominated eurobonds. The two issuances were heavily oversubscribed, with demand six times higher than supply.

Due to Serbia’s appetite for external debt, the composition of public debt could be a source of vulnerability, as 77% was foreign currency-denominated at the end of March 2023. However, 57% of this external debt is euro-denominated, with a sharp rise since 2018 (+41%). This limits the foreign exchange risk, in view of the stability of the Serbian dinar against the euro and a pegging deemed credible by the IMF. In addition, the sources of financing are diversified and the conditions for access to the international market are relatively favorable. The average maturity of public debt is high (about 7.5 years) and three-quarters of outstanding debt is fixed-rate. The weight of contingent liabilities related to guarantees on public undertakings reached 4.6% of GDP in 2022 and represents a moderate risk in the event of materialization. However, risks related to state-owned energy companies need to be monitored. In its last debt sustainability analysis in June 2022, the IMF classifies public debt as sustainable with a moderate risk of debt distress. In mid-February 2023, Fitch affirmed its sovereign rating of Serbia at BB+; Outlook Stable. The two other rating agencies, Moody’s and S&P, have positioned their sovereign rating of the country at Ba2; Outlook Stable and BB+; Outlook Stable since 2021 and 2022, respectively.

The outstanding domestic public debt has remained at about €11.5 billion since 2020 (or 25% of GDP in 2020 and 19% of GDP in 2022), due to a narrow market, while the debt held by non-residents [5] increased by 60% in value between 2018 and 2022. Since 2018, the external public debt has amounted to 60% of total public debt on average, the Government having opted to revert to international financial markets as of 2019 following a 6-year break. The share of the debt stock in eurobonds in GDP doubled between 2019 and 2021 at the expense of the multilateral debt, which receded. At the end of 2022, 39% of the external public debt was held by private creditors (mainly eurobond

Since 2016, Serbia’s economic growth has been driven by investment, exports and household consumption, which is itself fueled by diaspora remittances (8% of GDP since 2015). The investment rate averaged a quarter of GDP between 2018 and 2022 (17% of GDP in 2015), including 7% of GDP of public investment at end of period (3% of GDP in 2015). These investment rates, both total and public, exceed most of those in the other European emerging countries and partly fill the serious infrastructure gaps after years of under-investment. The IMF expects that investment will continue to support the economy at this rate in the medium term. But exports continue to be the real driver of economic growth. Their share in GDP is constantly increasing and reached 59% in 2021, against 33% a decade earlier.

5 Debt mainly held in foreign currencies, as the share of debt in local currency held by non-residents is low (<2% of GDP).

Graph 5 : Public debt moderate but mainly external

Sources: IMF (WEO), World Bank (WDI)

Indeed, Serbia is one of the world’s most open economies, with trade accounting for 62% of its GDP (46% for all EU countries, 25% worldwide). It benefits from the free-trade status for almost all the products exported to the European customs area. The high current account deficit, which has ranged between 4% and 7% of GDP since 2017, reached 6.9% of GDP in 2022, while the much more disastrous prospects at the beginning of the year (-9% of GDP) had prompted the country to turn to the IMF. The current account deficit is expected to fall slightly in 2023 due to the decline in the value and volume of energy imports, and the strength of exports at the beginning of the year despite the slowdown in Europe. The IMF then expects it to fall to less than 5% of GDP in the medium term.

Serbia mainly trades intermediate goods with the EU, the country’s main client and supplier, with its Balkan neighbors, as well as with China (the main supplier alternately with Germany), Russia and Turkey. Despite the sharp rise in exports of goods, which quadrupled between 2010 and 2022, and an import-export coverage ratio which increased from 59% to 74% over the same period, its trade balance is structurally in deficit. The energy crisis in the country in early 2022 (see below) forced Serbia to import electricity and coal at very high prices to offset the problems in the production system. This partly accounts for the high trade deficit in 2022 (-14% of GDP), the highest level for ten years. However, export performance has been strong since the 4 th quarter of 2022 and remains dynamic in 2023. As with the services balance, the secondary income balance is positive and offsets the trade deficit. Indeed, as in most Balkans countries, diaspora remittances are high and stable at about 5.4% of GDP on average per year.

Graph 6 : Towards a reduction of the current account deficit

Graph 7 : FDI covers the current account deficit

Components of balance of payments

and still 49% in 2021, now only account for 34%, followed closely by Chinese FDI which rose sharply and reached a third of FDI in 2022.

International reserves fell sharply by 21% in the first quarter of 2022, due to the urgent recourse to electricity imports at high prices. Despite this situation and a substantial current account deficit, they were rapidly reconstituted as of the summer of 2022, due to massive FDI inflows, migrant remittances, strong export performance and recourse to external borrowing (early 2023). At the end of May 2023, international reserves excluding gold stood at almost €19.7 billion. Gross reserves had reached €21.6 billion at the end of April, a record level, or 5.7 months of imports of goods and services, a level higher than the threshold of 3 months recommended by the IMF.

Serbia is a hospitable place for foreign direct investment (FDI), as the Government has established highly advantageous tax policies and administrative facilities to receive it. In addition, the country’s geographical location, at the doors of the EU, is a comparative advantage. Between 2018 and 2022, net FDI inflows reached an average of 7.4% of GDP (compared to 1.8% for the EU). They have also remained substantial and diversified despite the succession of international crises since 2020. Since 2015, they have alone covered the current account deficit. In 2022, the easing of energy prices in the second half of the year and the very high level of FDI inflows from China (record amount) helped Serbia avoid drawing on its foreign exchange reserves. The Central Bank expects this situation to continue in 2023: FDI inflows during the first four months of the year have risen by 66% year-on-year. 80% of FDI is in the construction, real estate and industry sectors and, to a lesser extent, the transport sector. Historically, it originates primarily from the EU, but this market share is rapidly declining to the benefit of China. In 2022, the situation gained momentum: EU countries, which accounted for 82% of FDI in 2014

3. Persistent structural and cyclical constraints

Despite the strong economic performance since 2016 and the successful implementation of the various successive IMF programs, there are still structural weaknesses. They have long been identified and are exacerbated by the deterioration in the international economic environment. The IMF puts Serbia’s growth potential at 4% in the medium term. At this rate, it will take at least a generation for Serbia’s GDP per capita to converge with the EU average. It would also take a minimum of 5% of growth per year to accelerate the convergence. The EU integration, if it materializes, could be the driving force behind this.

Despite some advances in the reforms of the administration and the privatization of some state-owned companies, the latter remain over-represented and generate half of GDP. Many are inefficient and unprofitable, with weak governance, especially companies in the energy sector. This sector is both fragile and strategic and has been in the spotlight since the Ukrainian crisis, due to the strong dependence on hydrocarbon and gas imports, mainly from Russia, and the serious electricity crisis in early 2022 which revealed the mismanagement of the state-owned electricity company (Elektroprivreda Srbije, EPS). The overall reform of this sector, constantly postponed, is today central to the ongoing program with the IMF to ensure energy security and reduce the related risks. It is based on the adjustment of tariffs and the adoption of an investment plan to improve energy security, stabilize electricity production and green the infrastructure. The transformation of EPS into a public limited company should be completed this year. The unbundling of the activities of the gas company Srbijagas is planned for the end of 2024. To strengthen the governance of public institutions, a new law should be adopted soon to align practices with the OECD guidelines.

The private sector is underdeveloped and hindered by the weaknesses of the rule of law, corruption, and the inefficiency of the judicial system. SMEs face a number of challenges, including unfair conditions of competition compared to large companies and foreign investors. Local companies benefit little from the business environment, although its improvement in recent years to attract foreign direct investment is praised by observers. The development of a domestic financial market, repeatedly considered and delayed, would make it possible to diversify long-term sources of financing. It would also facilitate access to financing for SMEs and support medium-term growth.

The quality and relevance of education and training do not fully satisfy the needs of the labor market. Consequently, the low labor productivity and the brain drain constrain the country’s growth potential. Labor productivity is very low, as is the case in the other Balkans countries. It has shown little improvement over the last decade and no longer converges towards the labor productivity levels of EU countries, which are more than twice as high according to the World Bank. The rapid growth in employment in Serbia since 2014 reflects an increase in precarious, temporary and informal employment. In addition, the overwhelming presence of state-owned companies, in which patronage is prevalent, further affects productivity.

Graph 8 : Low labor productivity holds back growth

This problem of productivity is especially important as the population is decreasing and aging. This exacerbates the challenges in terms of financing the coverage of inactive people by active people. Indeed, with a loss of 12% of its population over the last 25 years, Serbia is one of the 10 countries in the world with the fastest shrinking population due to low birth rates and negative net migration.

Since the second quarter of 2021, despite the economic measures taken to mitigate price shocks on food products and energy, inflation has increased constantly, reaching 16.2% year-onyear (yoy) in March 2023 before starting to slow the following month for the first time since July 2021. Yet the other Western Balkans countries reached the peak in inflation well before Serbia. In addition, the inflation rate in Serbia is higher than the maximum level reached in Bosnia and Albania. Indeed, the National Bank of Serbia (Narodna Banka Srbije, NBS) waited a long time before raising its key interest rate to avoid adversely affecting economic growth. It only started to react in April 2022 when inflation had already reached almost 10%, by raising the key interest rates every month for a year. These rates had thereby risen from 1% to 6.25% in June 2023. Inflation was initially fueled by the electricity crisis in early 2022, which could only be resolved by massive imports of electricity and fuel at very high prices. There was also the general increase in energy prices on the European market as soon as Russia started to invade Ukraine, which spread to food prices. The Central Bank expects inflation to return to the target range of 3% (+/- 1.5%) in about mid-2024. The stabilized exchange rate regime, a key element of Serbia’s monetary policy, would not appear to be playing a convincing role in controlling inflation by limiting the effects of the increase in the prices of imported products on domestic prices, given the level of prices in mid-2023 (both prices related to energy and food and prices constituting underlying inflation).

Despite the increase in interest rates throughout 2022, the rate of non-performing loans reached a historically low level at 3% of total outstanding bank loans in December 2022. It stood at 17% in 2016 and has continuously decreased since then, even during the recent crisis years. However, the IMF remains cautious and expects negative impacts from the economic slowdown and inflationary pressures on SMEs and households. The financial sector nevertheless has good fundamentals: while banks finance the economy little, they are sound, liquid and profitable.

With the euro over-represented, a greater use of the dinar via the financial sector would enhance the country’s financial stability and the effectiveness of the monetary policy. A strategy to “dinarize” the financial system has thus been implemented for ten years now, but progress is very slow.

On the environmental front, as Serbia’s primary energy consumption and energy mix are dominated by the lignite coal the country produces, it has a high-carbon economy. 74% of greenhouse gas emissions are made up of CO2, mainly from the electricity sector. In view of the dominance of coal-fired power plants in Serbia’s energy mix (53% of the installed capacity and 70% of the electricity produced), the emission factor of the sector and heat production is very high: it stood at 1,085 tCO2 per GWh in 2020, against 400 tons around the world and 200 tons in Europe. In addition, per capita electricity consumption is high (4.8 MWh) due to the use of electricity for heating, a low level of energy efficiency, and the very low price per kWh for the consumer. Consequently, the air that Serbs breathe is one of the most polluted in Europe, due to the massive use of coal for individual and collective heating and industrial pollution. Virtually the whole population is exposed to fine particulate matter at an average level more than

Graph 9 : Serbia is still fighting inflation

Inflation (%, yoy) and key interest rate 0

(%) 5

10

15

20 jan. 22 mar. 22 may 22 july. 22 sept. 22 nov. 22 jan. 23 june 23 mar. 23 may 23

double the safety standard defined by the World Health Organization (WHO). Serbia ranks as the world’s 33 rd country with the most polluted air and as the 3 rd European country. Three Serbian cities are among the 15 most polluted European cities. Air pollution is responsible for 6,500 premature deaths a year – three times the EU level.

While the economy is highly carbon-intensive, its exposure and vulnerability to the transition risk are moderate. Indeed, the external accounts have limited exposure, as the production of industries that are “declining” in the context of the low-carbon transition is mainly for the domestic market. However, the fiscal balances and the labor market are more concerned due to the importance of declining industries, mainly mines, in terms of jobs, wages and tax revenues. Finally, the economy has strong potential for diversification towards greener and more complex products.

The Government has actively engaged in improving the country’s environmental and climate performance. However, most observers note that these declarations are accompanied by limited results far from the stated objectives. Serbia submitted its first Nationally Determined Contribution (NDC) in 2015 for COP21 and updated it in August 2022. In this new version, the country sets an objective of reducing greenhouse gas emissions by 33.3% by 2030 compared to 1990, against 9.8% in its first NDC. In March 2021, Serbia also adopted a law on climate change, which provides for the adoption of regulations, and policy documents accompanying a low-carbon trajectory. New legislative packages on renewable energies and energy efficiency have been adopted in 2022 and 2023, as well as several environmental policy documents and action plans, in particular for waste management. Serbia has also made regional commitments as part of its EU adhesion process. Indeed, in 2020, it signed the Sofia Declaration on the Green Agenda for the Western Balkans which highlights the importance of pollution abatement, the circular economy, biodiversity and sustainable food systems. However, certain policy documents and action plans have yet to materialize, most often with a lack of financial and human resources allocated to the objectives. In summary, and without being the only one facing this challenge, the country is experiencing difficulties in coordinating its environmental planning.

The country’s aspirations towards a low-carbon transition are obviously motivated by the timetable for EU accession, but before this by the European Carbon Border Adjustment Mechanism (CBAM) which will enter into force gradually as of 1 October 2023. This mechanism will impose a tax on the carbon content of certain goods imported in the EU from countries that do not have a comparable ambition in terms of climate policy. The carbon intensity of Serbia’s economy makes it highly vulnerable to its implementation, with the risk of the country seeing the competitiveness of its exports plummet. The projections made by Agence Française de Développement (AFD) highlight the fact that 1.4 to 4.1% of the country’s GDP is exposed to the effects of the CBAM, with significant risks for jobs and wages. With no carbon pricing mechanism, Serbia will also not be able to retain part of the carbon revenues generated by the CBAM, which could result in a tax loss of $150 million a year. According to AFD’s study, these two factors mean that Serbia is one of the five countries in the world the most exposed to the CBAM.

Graph 10 : Serbia’s economy is one of the most carbon-intensive in Europe

Bibliography

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List of figures

Graph 1: Long-term improvement in social indicators

Graph 2: Deteriorating perception of corruption

Graph 3: Dynamism of growth expected to resume in 2024

Graph 4: Fiscal consolidation, the cornerstone of economic growth

Graph 5: Public debt moderate but mainly external

List of acronyms and abbreviations

BN: Billion

CBAM: European Carbon Border Adjustment Mechanism

EPS: Elektroprivreda Srbije (Serbian public electricity company)

EU: European Union

FDI: Foreign direct investment

GNI: Gross national income

IMF: International Monetary Fund

M: Million

International Monetary Fund (July 2023), “Article IV Consultation, First Review Under the StandBy Arrangement”.

IQAir (March 2022), “World Air Quality Report”.

IRENA and European Commission (October 2020), “Renewable Energy Prospects for Central and South-Eastern Europe Energy Connectivity”.

Statistical Office of the Republic of Serbia (May 2022), “Labour Force Survey in the Republic of Serbia”.

Statistical Office of the Republic of Serbia (2023), “Statistical Pocketbook of the Republic of Serbia”. UNDP and UNFPA (July 2022), “National Human Development Report – Serbia 2022, Human Development in Response to Demographic Change”. World Bank (June 2021), “Serbia - Public Expenditure and Financial Accountability (PEFA) Performance Assessment Report”.

World Bank and UNICEF (April 2022), “Building Human Capital for long Term Prosperity –Serbia Human Capital Review”.

Graph 6: Towards a reduction of the current account deficit

Graph 7: FDI covers the current account deficit

Graph 8: Low labor productivity holds back growth

Graph 9: Serbia is still fighting inflation

Graph 10: Serbia’s economy is one of the most carbon-intensive in Europe

NBS: Narodna Banka Srbije (National Bank of Serbia)

NDC: Nationally Determined Contribution

OECD: Organisation for Economic Co-operation and Development

SBA: Stand-by Arrangement (IMF)

SNS: Srpska Napredna Stranka (Serbian Progressive Party)

UMIC: Upper Middle Income Countries

WHO: World Health Organization

yoy: Year-on-year

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Final date of writing: 20/07/2023

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Dépôt légal 3e quarter 2023

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