These days, the creators of Serbian fiscal policy received unexpected lessons from an unexpected place – from India. Although Olivier Blanchard, the former chief economist of the IMF, did not mention Serbia at all in his lecture to the students of Ashoka University, two lessons for developing countries can be applied to us as well. And both show that there is no magic number below which we are in a safe zone of indebtedness.
Serbian Minister of Finance Sinisa Mali certainly did not have the opportunity these days to flip through the notes of students of the Indian University Ashoka. And how would he, when this university is more than 5,000 kilometers by air from Belgrade. The lecture which was given to the students of this university a few weeks ago by the former chief economist of the International Monetary Fund (IMF), Olivier Blanchard, hides at least two lessons for the creators of Serbian economic policy.
The first is: a debt of 60 percent of gross domestic product (GDP) is an illusion. Blanchard said that to Indian students at a lecture that could be followed online, and is still available on the Internet, and is widely quoted and retold by the world press.
The second is: developing economies, and Serbia is one of them, should be much more cautious than developed countries. That is why Blanchard adds that the threshold of public debt for such economies must be lower.
After three packages of aid to the economy, which cost the budget a little more than eight billion euros, Serbia is approaching the limit of public debt of 60 percent. And Minister Sinisa Mali said on several occasions that the debt will not exceed that threshold. That threshold is also considered acceptable according to the Maastricht criteria of the European Union.
The state has been in legal violation for 10 years
But it is almost forgotten in the local professional public that the Serbian legislation envisages a lower level of public debt. According to the Law on Budget System, public debt cannot exceed 45% of GDP, but that level of debt, according to the then calculation of GDP, Serbia broke through in October 2011, during the government headed by the Prime Minister Mirko Cvetkovic. And only a few months after this fiscal rule was introduced into law. So, for almost 10 years, Serbia has been in legal violation, when it comes to public debt.
owever, Olivier Blanchard said that “the world is too complicated for us to reduce it to simple rules”. And that is why these arithmetic limits are illusions. Of these, it is much more important whether the debt is sustainable, the economic growth, as well as what is the deficit in the budget, and more importantly, how much is the deficit in the state treasury, less interest costs, which is what economists call the primary deficit.
Many economists, such as Nobel laureate Paul Krugman, today believe that debt poses no “national threat” because interest rates on new borrowing have never been lower. Despite global debt reaching 277,000 billion dollars, more than the world’s total annual debt. Many countries around the world borrow even at negative interest rates, which means that they do not have to repay even the entire principal. According to the latest market data, Germany is currently borrowing at a negative interest rate in Europe (0, 3 percent), Denmark (0.13 percent), Finland and France (0.06 percent), the Netherlands (0.24 percent), Switzerland (0.20 percent), Slovakia (0.02 percent), Austria (0, 07 percent) and Belgium (0.01 percent).
New world, new formulas
However, Blanchard warns that the world has changed and that the old economic rules no longer apply in it.
The limit of the public debt is not so important, nor the interest at which the state borrows, but a few more unknowns should be included in the equation. In good times, it is easy – smart borrowing is considered to be a debt whose interest rate is lower than the rate of economic growth.
But in a crisis this is not the case. No matter how low the interest rates were last year and no matter how much the countries borrowed at a negative interest rate, the decline in economic activity, due to the crisis caused by Covid, was greater. That was the case in Serbia as well. For example, Serbia entered the international financial market twice last year and issued Eurobonds. Once (May 15), it issued seven-year bonds with an interest rate of 3.37 percent, and the second time (December 1), it issued ten-year bonds with an interest rate of 2.35 percent.
For our conditions, that can be considered favorable loans, because during the past decade, interest rates for Eurobonds, of different maturities, ranged from 1.25 to 7.5 percent.
But judging by Blanchard’s formula, they are not. Because last year, Serbia had (although the smallest in the region) a drop in economic activity of about one percent. In order for this loan to be favorable, it is much more important than the share of debt in GDP whether the state has a primary surplus. That is, whether the budget is in the black, if interest expenses are not taken into account. However, it was not last year, because the primary deficit was six percent.
Calculus on a seesaw
If Blanchard’s formula is applied to this year, the situation is much better. A few days ago, Serbia borrowed at an interest rate of 1.92 percent, which is significantly less than the expected growth rate of six percent, as calculated by the Ministry of Finance. This practically means that the real rate at which our country borrowed is negative and amounts to minus 4.08 percent. If you look at the budget plan for this year, the primary deficit is slightly higher than one percent, which means that the debt according to Blanchard’s formula is sustainable. However, the situation is complicated by the fact that it is already clear that due to the aid package to the economy, the deficit will be higher than planned, and the primary deficit can reach around two to 2.5 percent. And when interest expenses are added to that, the total deficit reaches about four percent. So, the calculation for this year is sustainable, but it is close to a seesaw.
In addition, the Fiscal Council expects a growth rate of four percent for this year and considers the estimate of six percent on which the budget is tailored to be optimistic. So, if macroeconomic figures move in this more pessimistic direction during the year when it comes to public debt, the red lights will come on. And that is something that the Minister of Finance of Serbia must keep in mind. And not in the short term, but during the next 12 years of repayment of this loan.
When twelve-year Eurobonds with an interest rate of 1.92 percent were issued on the international financial market a few days ago, Finance Minister Sinisa Mali said that extraordinary success had been achieved and that the demand was worth 3.5 billion euros. As he pointed out, the money will be used to repay some old expensive debts, and stated that in September, 700 million dollars of debt will mature, whose interest rate is 7.25 percent.
Croatia borrowed cheaper
However, on the same day, neighboring Croatia offered the same financial product to the international financial market as Serbia – twelve-year Eurobonds in the amount of one billion euros. And she got a better price. It borrowed at an interest rate of 1,257, and the demand for these debt securities was higher than for our Eurobonds (6.4 billion euros).
Is Dusan Nikezic, president of the Department of Economy and Finance of the Party of Freedom and Justice, right when he says that the latest borrowing is expensive, citing the example of Slovenia, which borrows at a negative rate (0.096 percent), which, according to him, is a confirmation that we are one of the worst economies in the region.
It is true that Slovenia and Croatia, although they have a higher public debt than ours, borrow at more favorable interest rates than us, but Dusan Nikezic may be the last to object to Serbia’s latest borrowing being expensive. Because, at the time when he was the state secretary in the Ministry of Finance, during the mandate of Mirko Cvetkovic, and practically operationally headed the ministry, the state of Serbia entered the international financial market for the first time. Ten-year dollar bonds in the amount of 700 million dollars were issued at the end of September 2011, with an interest rate of 7.5 percent. That debt is due in September this year. These are by far the most expensive bonds out of a total of eight issues that Serbia has had on the international financial market in the past decade.
Old debts were more expensive
It is also true that market conditions were different then and that borrowing was more expensive for all countries. For example, at that time, Greece, which was on the verge of bankruptcy, was borrowing at an interest rate of as much as 22.08 percent. But even then, some countries in the region borrowed on better terms than us. Thus, neighboring Croatia, by selling ten-year bonds in dollars, then managed to get a slightly more favorable interest rate of 6.38 percent. Turkey did even better, whose debt securities, with the same repayment period, were sold with an interest of 5.63 percent. Indonesia was in the group of countries with a rating similar to ours at the time, but the government of this country paid 4.86 percent interest to investors annually for its debt securities. In the group of countries that then had a credit rating similar to ours, the Philippines seems to have borrowed the most, because the rate on bonds there was only 4 percent. And even at that time, when the world was still recovering from the economic crisis, there were countries for which loans were cheap, such as Japan (0.99 percent) or Switzerland (0.89 percent).
And why the debt level of 60 percent is an illusion is best shown by the example of Japan. Both then and now, the total public debt of this country was higher than 200 percent of GDP. Japan then (0.99 percent) and now (0.16 percent) borrowed at favorable interest rates. First of all, because the country borrows in its own currency, and it is also export-oriented.
Finance Minister Sinisa Mali described Dusan Nikezic’s latest statement as “lies of an economic ignorance”.
But Nikezic is not the only one who used public debt data for daily political confrontations. At one time, Sinisa Mali did the same, but while he was the mayor of Belgrade. When he took over the position of mayor from Dragan Djilas, the current leader of the Party of Freedom and Justice, Sinisa Mali claimed that Belgrade’s debt amounted to more than a billion euros. According to the internationally recognized methodology, at the end of 2013, Belgrade’s debt was exactly 412 million euros. This was confirmed by the Fiscal Council and the then Minister of Finance Dusan Vujovic, who did not dispute that Sinisa Mali significantly reduced the path of the capital’s debt in 2016 and reduced it to 356 million euros.
At the time when he was the mayor of Belgrade, Sinisa Mali pointed out that he was not interested in methodologies, because with the interest and obligations of public companies and other arrears, the debt of the capital is much higher. And according to his methodology, it amounts to more than a billion euros.
However, he did not use the same methodology when he became Minister of Finance at the end of May 2018. Because if it had, the republic debt would have jumped from the then 24 billion euros in one day to about 40 billion euros. At the time of taking over the mandate of the Minister of Finance, that would be the amount of public debt if the calculation included interest expenses, which at that time were around five billion, liabilities of public companies of 5.7 billion, and added to all that the debt of state companies of three billion, but also late at the local. According to that methodology, around which Mali, as mayor, led an expert controversy with the Fiscal Council and former mayor Dragan Djilas, the share of public debt in gross domestic product (GDP) in the summer of 2018 would not be 59 but 105 percent of GDP. It is good that Mali did not apply this methodology as Minister of Finance. Because, of course, public debt is not calculated that way, and of course it is not an internationally recognized calculation.
Public debt is not comparable if only the absolute amount is considered. Thus, the representatives of the opposition very often pointed out that during the rule of Aleksandar Vucic, the public debt increased significantly, because at the end of 2012 it amounted to 17.7 billion euros, and at the end of 2016 it reached 24.8 billion euros. In terms of money, that is true, just as it is true that over the next two years, the public debt dropped to a little more than 23 billion euros, and last year’s “corona” reached 26.66 billion euros.
But that doesn’t mean much. Because, in the internationally recognized methodology, public debt is viewed as a share of GDP. Viewed in this way, public debt grew until 2015. From 52.9 percent at the end of 2012, it reached 70 percent of GDP in 2015, so that the trend would be reversed next year, in 2016.
It is also true that the growth trend of public debt does not reverse overnight. For example, the Fiscal Council warned about that in 2011 and 2012. That is how Nikola Altiparmakov said at that time that turning the path of public debt is the same as turning a big ship. When the Titanic sees an iceberg, it is already late, so it is with the public debt – the measures must be applied earlier in order for the path of the public debt to start turning in a safe direction.
So, a good part of the growth of the public debt was inherited by the progressives after coming to power, because the trend in public debt is inherited, precisely because it is impossible to bring it down overnight. But it is also a fact that the fiscal consolidation measures were not adopted immediately after the change of government, but the fiscal consolidation took two years. The new authorities lost so much time, so the public debt grew because the recommended measures were not implemented immediately.
And they were difficult, and at that time they meant “freezing” salaries and pensions. Two years later, the freezing was no longer enough to bring down the level of public debt. Severe measures to reduce salaries and pensions were adopted in November 2014, when the National Assembly and adopted the Budget Law for 2015, proposed by the then Minister Dusan Vujovic, which is proof that the trend of public debt is not falling overnight, despite the fact that severe measures have been implemented, that salaries and pensions have been reduced, public debt continued to grow that year (from 66.2 to 70 percent of GDP).
So, as Olivier Blanchard would say, a level of 60 percent is not a magic number. Nor is any other figure magical.
One data on public debt without a deeper analysis is really just an illusion. Such an isolated figure, although accurate, is an ideal victim for daily political confrontations and various types of spinning. An isolated figure on public debt can prove any thesis – and the government’s thesis that the situation in public finances is spectacular, but also the opposition’s thesis that the situation is catastrophic.
And the truth about public debt is as complicated as today’s world is complicated. Or, in Blanchard’s words, managing public debt would not be so difficult if it were just simple fiscal arithmetic. Who doesn’t believe, let him ask the students of Ashoka University, RTS reports.
