How not to spoil good measures?

The efforts of the Serbian government to support the Serbian economy during the COVID-19 pandemic are in their final phase, and the quick procurement of the money needed to implement planned economic measures is now becoming crucial.

It should be recalled that representatives of Serbia’s executive authority, with the active participation of economic professionals, came forward very quickly with conceptual solutions for an economic support package. Although there was no public debate on the proposals, the comments of the interested professional public were partly exchanged through the media. The government then, after two weeks, adopted regulations establishing the legal framework for implementing the measures they announced.

The adopted legal framework established a very simple and quick implementation mechanisms of planed economic measures, which is of utmost importance in order to avoid long-term negative economic effects through timely state intervention. It is now necessary for the state to obtain the required financial resources as soon as possible and to implement these measures and to meet its regular obligations at all levels, and especially those obligations of public companies.

Within a month of the crisis, the excess liquidity of nearly €1 billion contained in Serbia’s budget has almost fully been utilized. Bearing in mind the expected decline in public revenues in the coming period, it is important to secure additional resources as soon, and in as much volume, as possible.

The absolute priority must be to provide liquidity from external sources, through:

• financial support from international financial institutions (such as the International Monetary Fund – IMF and World Bank), amounting to approximately €6 billion;
• bilateral agreements with creditor countries (including the EU, China, and the United Arab Emirates), amounting to approximately €5 billion;
• and the issuance of bonds in foreign capital markets as soon as they stabilize, in an amount that would be determined based on the relative price/maturity of the borrowing relative to other external sources and the current need for additional liquidity.

Why borrow outside Serbia?

An agreement with international financial institutions would help to consolidate the credibility of the measures taken so far, and to increase the confidence of investors and the business community. The proposed measures, including the measure of distributing €100 to all adult citizens, would not be hard to “defend” during negotiations with foreign creditors, with adequate justifications. In any case, a request to the IMF should be submitted as soon as possible, since a number of countries have already submitted or announced similar appeals to the institution. Given the limited resources of the IMF, not only in financial but also human terms, the government’s delay could slow down the negotiation process and the subsequent acquisition of necessary funds. An agreement with the IMF is particularly important, as it would facilitate additional bilateral borrowing, providing international credibility to the planned measures.

Outstanding liabilities towards existing creditors should be serviced by the state with new borrowing, prior to resorting to a moratorium. This would avoid jeopardizing the achieved level of financial market confidence and the increasing credit ratings of Serbian government bonds.

In parallel with negotiations with international financial institutions, Serbia’s relatively-good political relations with significant global political and economic centres should be used to acquire funds through bilateral arrangements.

Furthermore, priority should be given, this year and the next, to issuing bonds and lending in foreign markets over the domestic capital market in order to finance current liquidity and potentially refinance more expensive loans with other, more favourable loans.

An easier, but more expensive solution…

If the necessary resources for recovery measures were provided from within the country, there would be a greater number of negative consequences. This could be done through:

• a delay in the payment of state, public enterprise and local self-government liabilities;
• massive borrowing in the domestic capital market;
• the inadequate transfer of appropriations.

If any of these possibilities become a reality, or if multiple do, it is very possible that the effect of implemented measures would be weak, and that, despite the state’s efforts, the economy would sink into a deep recession accompanied by chronic illiquidity and high unemployment.

During the 2008 financial crisis, the economy had a significant problem with chronic illiquidity, as public enterprises and local self-government units with their utilities suspended and/or significantly delayed payments. Injecting money into the private sector while generating illiquidity in the public sector is pointless, as that illiquidity will inevitably spill over again into the private sector and completely cancel out initial measures. Public and utility companies are now under pressure from reduced revenues due to the delay of current liabilities for parts of the population. It is therefore vital for the state to find a mechanism to bridge this revenue gap, to avoid its spread onto suppliers or the private sector. At the same time, cities and municipalities are also suffering a significant decline in their own revenues, which may also threaten their abilities to meet obligations.

One possible solution for this issue is to increase the amount available in the fund designated for liquidity by the amount that public and utility companies lack, with a state guarantee. This part of the fund should be specially allocated to these needs, as well as to enable the relatively-easy issuing of bonds to enterprises and local government units, which would be supported by the state.

Although, according to the final calculations of the country’s banks, there is approximately €5 billion in cash and deposits with the National Bank of Serbia, there is not enough money for all planned government needs and the maintenance of liquidity in the economy. It should also be kept in mind that significant direct borrowing by the government in the domestic capital market not only draws on its liquidity, but directly, almost “unfairly” competes with the private sector, as banks always prefer to choose the state as a client. During the crisis of the past decade, this practice proved detrimental, as it largely hampered the government’s efforts to improve the liquidity ofthe economy through other mechanisms, which directly delayed the stabilization of payments and created prolonged illiquidity and unemployment in Serbia even when the crisis had already passed in most European countries. This is why it is of utmost importance for the state to be cautious in borrowing on the domestic capital market, and for the National Bank of Serbia to continue to significantly loosen its monetary policy by reducing banks’ minimum reserves, by massive repo operations and by selling domestic bonds in the range of up to €2 billion.

The transfer of appropriations, although in certain cases justified and necessary, must not be carried out in such a way as to create illiquidity, or to prevent the financing of projects for which procurement procedures have been completed and in which contractors have already engaged their capacities and started work.

We must not forget the most vulnerable parts of the economy

Of particular importance are the announced, but still undeclared, sectoral measures to support those industries that will be impacted significantly from the crisis in the long term, such as the tourism industry, including the hotel industry, catering, travel agencies, air transport, as well as parts of the agriculture sector, such as small wineries and specialized agricultural producers who directly rely on these activities. In these sectors of the tourism industry, revenue has fallen to zero and there will not be a rapid recovery of demand: pressure to maintain employment levels without significant government involvement is therefore completely counterproductive and could hinder the normalization of business. Sectoral measures should include the transfer of social costs from business to the state, the negotiation of longer deadlines for a moratorium on overdue financial obligations, significant tax relief, and, in particular, measures to stimulate demand for domestic tourism after the end of the health crisis.

Why is “€100” a good measure after all?

The majority of the planned measures are focused on preserving the structure of the economy during the crisis, especially in terms of employment, so that after the end of this current crisis companies can quickly return to conducting regular business.

On the other hand, stimulating aggregate demand by distributing €100 to all adult citizens (so-called “helicopter money”) can have significant positive effects on triggering the economic cycle at the end of the health crisis and following the normalization of economic flows, as part of the funds spent will quickly return to the budget through consumption taxes, primarily through the value added tax (VAT).

This measure may be questionable from the standpoints of social justice or political opportunism, as it does not take into account the differences in material conditions of Serbia’s citizens and is implemented shortly before the elections. However, it is important to emphasize that this measure is not an instrument of social, but of economic, policy, and that other democratic states are also seriously considering similar measures following the end of the health crisis. Its primary objective is to use a simple market mechanism to stimulate aggregate demand and increase consumer confidence.

Considering the delay in the obligation to pay for utilities for three months, granted to a portion of the population, it is very likely that the money provided with this measure will primarily be used to settle bills for utilities delivered during that period. Also, given the amount of funds provided, as well as the relatively-low level of disposable household income in Serbia, it is unlikely that this money will be largely directed towards the purchasing of more expensive or luxurious (imported) goods.

In fact, it is far more likely that this measure will further encourage households to spend their own funds more freely on local craft services, market purchases, going to cafés and restaurants, and other similar activities, which will directly result in the further acceleration of the economic cycle, particularly in those segments of the economy that are principally of a local character.

The author, from the European Policy Centre, is the coordinator of the Working Group of the National Convention on the European Union for conducting Serbia’s EU accession negotiations for Chapters 4 (Free Movement of Capital) and 9 (Financial Services) of the acquis communautaire.