Serbia to Announce Budget Cuts as Fiscal Risk Grows

Serbia’s government revealed a salvo of measures to bring the public finance deficit and debt back under control by 2017 after the head of the largest coalition party warned the country was on the brink of insolvency.

Prime Minister Ivica Dacic’s government said it would raise taxes, push back the retirement age for women, crack down on the shadow economy and cut subsidies to state-owned companies. The plan follows Finance Minister Lazar Krstic’s Oct. 2 pledge to save 1.6 billion euros ($2.2 billion) over three years.

“Without these measures, we could have survived over the next six, nine or 12 months, maybe two years,” Krstic told a news conference in Belgrade. “But we have decided to take measures while we still have liquidity, to bring things to order. Without those measures we would have gone bankrupt.”

The Balkan European Union aspirant wants to reassure investors that it can rein in a fiscal deficit the government estimates may reach 6.5 percent of annual output this year. It is also trying to secure financing from the International Monetary Fund, which balked at talks in May when it said Belgrade had fallen short of its budget commitments.

Krstic’s statements sent bond yields lower, unraveling a jump yesterday triggered after Deputy Prime Minister Aleksandar Vucic, who leads the poll-leading Progressive Party, said the country is “virtually on the verge of bankruptcy.”

‘Structural Reforms’

Yields on Serbian 10-year Eurobonds maturing in 2021 fell 20 basis points, or 0.2 percentage point, to 6.622 percent by 2:08 p.m. in Belgrade. The dinar slid 0.04 percent on the day to trade at 114.3128 to the euro, data compiled by Bloomberg show.

Krstic said Serbia will raise taxes on public servants making 60,000 dinars ($712) or more a month, affecting as many as 200,000 of almost 700,000 public workers, Krstic said. The government will raise the sales tax on food and other staples to 10 percent from 8 percent and increase the retirement age for women to 63 by 2020, from 60.

An overhaul of state-owned companies will save 300 million euros to 400 million euros by 2017, while the crackdown on the gray economy should save 150 million euros a year, Krstic said.

The plan is “good” and savings will total 1.5 percent of gross domestic product in lower spending in 2014, Milojko Arsic, a former central bank vice governor and an economic adviser to former Finance Minister Diana Dragutinovic, said by phone.

The government may still “need new measures in 2014 to save additional 1 percent of GDP,” he said.

Deficit Reduction

Along with an estimated 200 million euros a year from the value-added-tax increase, the measures should help cut the budget gap to 2 percent to 3 percent of GDP by 2016 or 2017, Krstic said. Public debt will stabilize at around 75 percent of GDP “in three to four years,” compared with a 45 percent of GDP cap set under fiscal rules.

“Our commitment is vital also for the sake of creditors,” Krstic said. “We are talking about fiscal consolidation of around 4.5 percent to 5 percent of GDP through 2017 which is more than 1.5 billion euros in savings over the next four years.”

Krstic stopped short of announcing budget gap targets, possibly signaling a plan to adjust deficit calculations to International Monetary Fund methodology, Arsic said.

Borrowing Options

The cabinet is considering borrowing options to keep financing costs under control including a $1 billion Eurobond, domestic borrowing or a loan from the United Arab Emirates, Krstic said last week.

“There will be no cheap and easy borrowing,” Krstic said. “Borrowing costs have gone up around two percentage points” and if Serbia was to borrow at current market prices, “it would expand our total interest payments by around 400 million euros,” he said.

With cash reserves of $1.3 billion as of Sept. 30, “Serbia will comfortably meet its forthcoming obligations,” Krstic said in a phone interview yesterday.

Arsic, who is also chief macroeconomist at the Foundation for Advancement of Economics, said that number also included cash belonging to local governments, schools, hospitals and other institutions financed by the state, on top of central government’s “own reserves” that he said were currently “roughly around 300 million euros.”

IMF Review

The IMF, which completed a week-long review of Serbia’s fiscal policies in Belgrade, cut its 2013 growth outlook to 1.5 percent, from 2 percent, and said the country’s economic situation “remains fragile.”

The Washington-based lender said the government’s general public finance deficit should reach about 7.5% of GDP in 2013 and the government’s fiscal plan was “appropriate.”

“Full implementation of these measures starting from 2014 would be an important step in the right direction and a signal of the authorities’ resolve to tackle the economic challenges,” the IMF said in an e-mailed statement.

Some of the measures may face political opposition among a government that has hesitated to cut public wages and change the country’s retirement system, according to Otilia Dhand, an economist at Teneo Intelligence, a London-based political risk evaluator.

“Widespread protests and systemic resistance present a risk to the implementation of the intended reform,” Dhand wrote in an e-mail yesterday.

Sentiment Hit

Speaking alongside Krstic, Prime Minister Dacic said the measures had “clear political backing” from the cabinet. The aim is to “push Serbia forward” toward economic and financial consolidation, he said.

The biggest Serbian trade union said today the package failed to include measures for economic recovery and that lower take-home wages would lead “to weaker economic activity among small and medium enterprises, which are supposed to be the engines of future growth.”

“This can work for a time but at the expense of a big hit to household and corporate sentiment which in turn feeds into worse growth numbers for some time and then ultimately the risk of protests and political difficulties,” Peter Attard Montalto, a London-based emerging-markets economist at Nomura International Plc, said in a note on Serbia today.

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