Anemic economic growth, slowing inflation
The assessment from the end of December by the Statistical Office of the Republic of Serbia (RZS) indicates an economic growth of only 2.5%, which is a very weak result and the second consecutive year of low growth. However, it is important to look at the sources of growth – it’s one thing if it is widely spread across multiple sectors, and a completely different picture emerges if it results from developments in a small number of industries. Last year’s economic growth is primarily a consequence of three factors: the recovery of EPS’s (Electric Power Industry of Serbia) operations, followed by a better agricultural season and increased volume of construction work.
Agriculture recorded a physical production growth of 9%, compared to the previous year, which was marked by drought. In other words, this is not a significant growth but rather a return to the average annual values of agricultural production due to higher rainfall.
The value of construction works in the construction industry grew by 8.9%, supported by high government spending on infrastructure projects. According to the Ministry of Finance data for the first 11 months (for which data has been released), capital expenditures of the general government level have nominally increased by over 13% during 2023 compared to the previous year 2022. This certainly pushed the value of construction works upward.
Finally, we come to the industry, which recorded a growth of 2.4%. However, almost the entire growth is due to the recovery of EPS’s operations. Mining, which was the driver of growth in the previous period, is now stagnating, as is the manufacturing industry, which is much more concerning.
When we look at these three industries and their contribution to GDP creation, positive developments in them account for about 1.4% of growth or over half of the recorded economic growth of 2.5%. Growth was also noted in transportation (in the field of passenger transport) and in the hospitality sector, while other sectors are practically in stagnation.
In economic theory, economic growth is a function of the quantity of available labor, capital, and technological progress in an economy. In our economic practice, economic growth seems to be a function of the rain dance performed by the Minister of Agriculture and the Minister of Energy.
In the case of agriculture, the matter is evident – no rain, no good crops. Improved rainfall during 2023 resulted in the recovery of crop production and higher yields. The level of agricultural production has rebounded and returned to more or less the level of a multi-year average.
For the Electric Power Industry of Serbia (EPS), the situation is a bit more complex but essentially the same. According to data from the Business Report for the first half of the year, EPS increased electricity production in hydropower plants by a staggering 40% compared to the previous year 2022! This allowed them to reduce the import of electricity and coal for its production in thermal power plants, increase exports, and even profit from the difference in price by buying and importing electricity when it was cheap on the market (mostly at night) and producing and exporting it when the price was high. This wouldn’t have been possible without rains enabling such operation of hydropower plants.
Slowing inflation, but also a decline in consumption
Inflation during the past year finally began to decelerate, reaching around 7.6% compared to a high of 15% in 2022. However, a slowdown in inflation does not mean a return to previous price levels; it simply indicates that prices are growing at a somewhat slower pace. Inflation in Serbia was higher than in the Eurozone, and its deceleration started considerably later. This suggests that part of the inflationary pressures originated from domestic economic policies, rather than being solely imported from abroad due to the ECB’s monetary policy or the conflict in Ukraine. The delay in tightening monetary policy (waiting for the 2022 elections to pass) and high non-targeted government spending are the main reasons for this.
Despite inflation slowing down, consumption is decreasing. Retail turnover at constant prices (i.e., taking inflation into account) decreased by 2 percentage points compared to the previous year. This indicates a clear decline in the standard of living and household consumption, despite nominal increases in wages and pensions. Even when wages grow slightly more than inflation, there is still a decrease in standards due to the Cantillon effect. Simply put, not all prices are rising at the same rate; some prices are increasing more slowly while others are rising faster. Essential goods (primarily food), which contribute significantly more to consumption than others, experienced a higher price increase, making the impact on household budgets significantly stronger than the nominal inflation rate.
What (haven’t) we learned this year?
The first lesson is that the current economic policy based on attracting high foreign investments has its limits. Foreign investments are good and should not be hindered, but they are not sufficient for rapid economic development. In this equation, domestic private investments, which are extremely low, are missing. According to the World Bank research, difficult access to financing is a bottleneck that hinders the development of the domestic economy, primarily small businesses, which consequently struggle to grow.
Therefore, special attention should be given to the small domestic economy – and no, it doesn’t mean providing subsidies (not for locals nor foreigners). Instead, what needs to be eliminated are the obstacles to the development of domestic entrepreneurship that fall within the jurisdiction of the state. These obstacles include bureaucratic procedures, legal uncertainty, and high corruption.
The second lesson is that monetary and fiscal policies should not be in opposition. High inflation is a serious problem, and if the central bank is fighting it by reducing liquidity (read: raising interest rates), then fiscal policy should not hinder it, as was the case with very generous and broad grants financed through borrowing and deficits.
The third lesson is how important professional management of state-owned enterprises is. A good example is EPS, whose deterioration was halted by appointing new leadership after the previous director, the owner of a barbecue joint. The new director managed to turn many things around and save the situation, with the help of favorable hydrological conditions, of course. Unfortunately, this director seemed to be too independent of politics, so despite good results, he was replaced. It remains to be seen what results the Norwegians or the “Norwegians” will achieve.
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