What are the key economic priorities for the new Government?

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The questions that press all of us every day are related to the economy. If the exposé is anything to go by, the new government will place these issues high on its priority agenda. But what exactly are the key economic priorities for the new government and how should they be approached?

Extinguishing an energy fire

The first task of the new government should definitely be to solve the problems in the energy sector. The heating season is upon us, so the question is often raised whether our thermal power plants will be able to produce the required amount of electricity for domestic needs by spring. The main problem lies in the functioning of EPS, primarily in the insufficient amount of coal obtained from the mines and its poor quality.

Some steps to solve this problem have already been taken (such as coal intervention intervention or electricity consumption reduction plans) but we do not know if it will be enough to significantly improve the situation. In previous years, Serbia had to import electricity during every winter because the domestic production was not enough to satisfy consumption, but in comparison to last year’s failure of thermal power plants, the amounts were small and the prices were affordable. Now the price of electricity is higher, bearing in mind the energy crisis in Europe due to the sanctions and counter-sanctions of Russia and the European Union, which practically stopped the import of Russian energy into Europe.

Bearing in mind that gas storages in the EU are now full, and that the demand for gas in China is decreasing due to the country’s zero-tolerance policy towards the spread of covid, as well as unusually good weather, electricity prices are now lower than a few weeks ago – in Western Europe they start around 120 euros/MWh, and in Centralna around 170 euros/MWh – and during the previous winter we imported electricity at prices often over 200 euros/MWh.

This intervention import saved the energy system, but about 1 billion euros were spent, which is the price of irresponsible EPS management. Returning the energy system to normal will take some time, maybe even a few years, so just surviving this winter is not enough, but energy must remain at the top of the priorities of this and the next Government for the next few years.

Maintenance of macroeconomic stability

Inflation and the decline in purchasing power caused by it are hardly among the main topics for the majority of people in Serbia. Although inflation in Serbia is not an isolated incident that is the result of domestic monetary policy only, but is caused by the monetary policy of the ECB (which is monitored by our National Bank due to the exchange rate policy) and disruptions in production due to covid and the war in Ukraine, this does not mean that Serbia should behaves in such a way that it promotes this inflation.

We should stop indiscriminately giving aid to categories of the population that do not need it – the most recently announced program of this kind concerns young people – and instead, funds should be directed only to where it is necessary, only to the socially vulnerable. Pensions and salaries in the public sector should also be increased in accordance with reasonable economic parameters, so that their share does not ultimately increase in relation to GDP. Therefore, the Swiss formula can be temporarily abandoned due to high inflation that rapidly devalues ​​fixed incomes, such as pensions, provided that this first condition is met. This will prevent the increase in government current spending from being an additional inflationary impulse that will accelerate price growth.

The other side of the coin is the sustainability of the public debt. Although Serbia is not in a public debt crisis, this does not mean that the situation is rosy – the public debt is still above 50% of GDP, which is quite high for a country at our level of development and history of bankruptcies. This means that only a few years of high deficits and low growth rates are enough to reach the situation of 2014, when fiscal consolidation was forced by the near bankruptcy of the state.

Public consumption must therefore be moderated so that in the coming years the deficits are significantly reduced, and are in the range of around 1% of GDP. This will also have an impact on inflation, as it will reduce inflationary pressures through current government spending. Let’s not forget that inflation also led to an increase in interest rates – the era of cheap money seems to be over, bearing in mind that during the monetary impulse of the world’s central banks, which released a huge amount of money into the system, Serbia could easily borrow, even for only 1% in the case of green bonds, while now a loan from the UAE with an interest rate of 3% is justifiably presented as a gift from creditors, while the interest rate would normally be around 6%.

This means a large increase in interest expenses, because we not only have to borrow to finance the deficit, but also to return the principal of previously taken debts that have come due, which is close to 4 billion euros per year. In such a situation, any increase in the interest rate at which the state borrows money means a new increase in budget expenditures.

The first step should definitely be the conclusion of a precautionary arrangement with the IMF, because this is a clear signal that the state will lead a responsible fiscal policy (and thus be a safe debtor who will not run into problems repaying its obligations), which will enable us to borrow cheaper in the short term. In such a situation, the first instinct of every politician should be resisted – the reduction of investment expenditures in order to finance current consumption through salaries, pensions and public procurement. We should think about the analysis of public infrastructure projects, bearing in mind that many of them are late in implementation, or that the costs are much higher compared to similar projects in the environment, as well as that too much priority is given to traffic compared to communal infrastructure.

Preservation of macroeconomic stability, primarily in the case of state finances, is a necessary prerequisite for investments. And investments today mean economic growth tomorrow – which can be seen in increased production, productivity, employment and earnings. When public finances are not in the best order, it brings a dose of insecurity to entrepreneurs because they rationally expect that the state will increase their taxes in the future, which can make their entrepreneurial ventures less profitable, which makes some of them abandon investments or postpone them while the situation does not change.

This is exactly what happened in Serbia – only after the fiscal consolidation began to produce results, did private investments grow, which triggered economic growth in the following years.

Acceleration of economic growth

Economic topics are those that are created and overthrown by governments in Serbia – topics such as unemployment, low wages or living standards have traditionally been at the top of public interest in public opinion surveys for years. But this is a topic where the projections say that Serbia will fare quite badly after several years of decent growth from 2018. Already for this year, the expected growth rate has been reduced from 4-4.5% to 3-3.5%, and for the next one from the initial 4.5% to only 2.7%. The third most important task of the Government is therefore to do what it can to accelerate this low growth rate.

In our situation, the conventional instruments of monetary and fiscal policy cannot play a standard role because their influence is stifled. Monetary policy is a rather ineffective instrument due to the high dinarization rate of loans and deposits; as a result, the National Bank decided to follow the monetary policy of the European Central Bank, practically fixing the exchange rate towards the euro.

Fiscal policy is again not influential because Serbia is a small open economy and the fiscal multipliers are low – in other words, stimulating the economy through an increase in wages and pensions would mean a small increase in economic activities because a large part of this consumption would be transferred to imports, and the planned economic growth would go away Germany instead of being realized here. The Serbian government therefore acts as if both hands are tied in conducting economic policy.

But there is still serious room to stimulate economic growth through the improvement of the economic environment. This implies establishing the rule of law and legal certainty, reducing the bureaucratic burden, changing the regulatory framework that would facilitate business, a higher degree of digitization of public services, and the like. Such measures would reduce the costs of doing business in Serbia, which would lead some businessmen to continue investing because now they can do business more easily and earn more.

Cleaning the state’s Augie stables is a necessary condition primarily for the sector of micro and small domestic companies that do not have the resources that large foreign companies have to jump over the numerous obstacles that the poor business environment in Serbia presents to them. Such reforms would be a direct measure that would accelerate economic growth rates, when fiscal and monetary policies cannot do so, Talas writes.

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