Bojan Marković: Strategic management in overcoming the economic and
financial crisis
Speech by Mr Bojan Marković, Vice Governor of the National Bank of Serbia, at the 17th
International Scientific Conference on "Strategic management in overcoming the economic
and financial crisis", Palić, 20 April 2012.
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Ladies and gentlemen,
Before answering the question which strategy should Serbia follow in order to overcome the
economic and financial crisis, allow me to remind you of the message put forward repeatedly
by the National Bank of Serbia in recent years - it is better to have low but sustainable,
rather than high and unsustainable economic growth rates.
In the decade preceding the crisis we tried to compensate for a substantial decline in
economic activity of the 1990s. Between 2001 and 2008 average annual GDP growth rate
was 5.4%. But the structure of economic growth, was far from conducive to its stability and
sustainability because it implied excessive reliance on consumption and speedy expansion of
services, while the production of tradeables, in industry and agriculture in particular, lagged
substantially behind. Since most types of fiscal revenues came from sources linked to higher
consumption - such as VAT or import tax duties - an apparent and temporary fiscal balance
was attained. These sources of growth were also politically popular as rising consumption
created an impression of a lasting rise in the living standard. Nevertheless, faster growth in
consumption relative to production led to the rising foreign trade deficit, which in 2008
culminated with a record high current account deficit in excess of 20% of GDP. The fragile
balance was sustained by privatisation receipts and cross-border borrowing by the private
sector, but this was not destined to last long.
The outbreak of the global economic crisis lessened Serbia's capacity to attract foreign
capital and made it obvious sooner that the consumption-led growth, is unsustainable. It
became clear that Serbia had to adopt a different, sustainable model of growth which implied
a shift from imports and consumption towards exports and investment. Such a model should
help remove external imbalance, which is one of the two key factors focused by foreign
investors, economic analysts, and credit rating agencies when assessing macroeconomic
sustainability.
External balance
Since 2009, the current account deficit adjusted sharply. After the record high of 21.6% in
2008, it fell to 7.2% in 2009 and 7.6% of GDP in 2010. Slashing the current account deficit to
that extent, required increasing net exports and investment and cutting down real
consumption. The largest positive contribution to GDP growth in 2009 and 2010 was indeed
that of net exports (9.3 pp and 2.5 pp, respectively), while the contribution of investment in
2011 was 3.5 pp. According to the National Bank of Serbia's estimates, real consumption
subsided by 3.4% in 2009 and by 1.8% in 2010. Scaling down real consumption was painful
for our households, but at the same time necessary for achieving sustainable economic
growth. One of the key measures for reducing consumption was the freeze on pensions and
nominal public sector wages in 2009 and 2010. Allow me to remind you that some countries,
such as Romania and the Baltic states, had to base their adjustment not on the freeze, but
on a significant cut in nominal wages. In Serbia, the process of reducing consumption was
aided by the flexible exchange rate, which lowered real wages and other income through
nominal depreciation and higher import prices.
Is every current account deficit a bad signal? Not necessarily. If caused by a temporary
growth in imports of equipment and intermediate goods prompted by higher investment in
export-oriented industries, a temporary increase in the current account deficit might be
desirable. By contrast to a consumption-led deficit, this, let's call it, "good" deficit ensures
higher productivity, production and exports, better investment climate, and a stable inflow of
foreign direct investment over the medium run. In Serbia, for instance, the current account
deficit rose to 9.7% of GDP in 2011, but mostly as a result of increased investment in
export-oriented industries, indicated by the 48% growth in imports of equipment that year.
According to the National Bank of Serbia's estimates, completion of the investment cycle and
the expected growth in exports will lead to a reduction in the share of current account deficit
share in GDP as early as of 2012.
In practice, there are three basic mechanisms for eliminating the current account deficit:
1. Structural changes to encourage the tradeables, rather than the services sector.
2. Income- or expenditure-related fiscal policy measures to stimulate production and
savings, and discourage consumption.
3. Depreciation of the dinar.
Implementing structural changes to improve the business environment for export-oriented
and import-substituting sectors is the best possible way forward that will strengthen
medium-term productivity and competitiveness of the Serbian economy and gradually
remove the current account deficit. Fiscal policy, may contribute on the side of revenue
through tax recomposition, which stimulates production and discourages consumption - for
instance, by raising the VAT rate, while at the same time lowering wage taxes. On the side of
expenditure, fiscal policy may contribute to the medium-term narrowing of the current
account deficit by shifting the budget from transfers and consumption towards investments
that target export-oriented and import-substituting sectors.
The more effective the use of these two mechanisms, the lesser the need for adjustment
through depreciation of the dinar. In fact, I am convinced that efficient structural measures
aided by fiscal policy would be more than sufficient to fully eliminate our current account
deficit, with no medium-term adjustment of the exchange rate whatsoever.
Fiscal balance
While the composition of fiscal revenues and expenditures represents a potent tool for the
reduction of external imbalances in Serbia, the balance between fiscal revenues and
expenditures represents another key factor for the assessment of credit rating and the
country risk premium. Recent fiscal problems experienced by some eurozone members,
which contributed to the second wave of the crisis, have further heightened the significance
of fiscal balance and public debt levels in the assessment of macroeconomic sustainability of
many economies.
Though the share of public debt in GDP in Serbia is lower than in many other European
countries, it has reached the prudent limit of 45% as laid down by the fiscal rule (as defined
by the Law on the Budget System) and this created the need for valid fiscal consolidation.
Fiscal consolidation may induce a decline in demand in the short run, but has advantages in
terms of improving economic activity and growth over the medium run. High fiscal deficit and
growing public debt boost the country risk, which increases the cost of borrowing for the
Serbian state, corporates, banks and households alike, and discourages the inflow of foreign
capital. Together, this results in lower economic growth and lower living standard in the
medium and long run.
Fiscal or monetary stimuli
Fiscal consolidation and implementation of a responsible fiscal policy would create more
scope for the counter-cyclical impact of monetary policy, i.e. its capacity to support the
economic recovery and contribute to faster recovery at a lower level of real interest rates.
In the initial wave of the crisis many countries, including Serbia, implemented expansionary
fiscal policy to stimulate economic activity. But in this phase of the crisis relying on fiscal
expansion would be rather risky due to the limited room for its financing and the fact that
foreign investors, credit rating agencies and international financial institutions, such as the
IMF, are particularly sensitive to high deficits and growing public debts. One should bear in
mind that the scope for using fiscal stimuli is rather limited in countries with high levels of
foreign debt since increasing public consumption leads to a further increase in foreign debt
and higher cost of borrowing. Serbia's foreign debt is already relatively high - almost 80% of
GDP and any further increase in fiscal deficit would only lead to its further rise.
It is probably more opportune in such circumstances to consolidate fiscal policy and thereby
open up the room for a more efficient implementation of the monetary policy on the way to
recovery.
Allow me to reiterate - fiscal and external imbalances are often connected and, represent the
key factors for the assessment of macroeconomic sustainability and the risk premium of any
country. Therefore, any valid strategy of recovery, i.e. exit from the economic and fiscal
crisis, must take into account the effect of such growth on the external and fiscal balance of
the country. Only growth which leads to the achievement and maintenance of external and
fiscal balance in the medium and long run is sustainable growth. Only this growth can lead to
a sustained decrease in Serbia's risk premium and hence cheaper credits for the Serbian
state, corporates, banks and households. And that is precisely why it is better to have low but
sustainable rather than high and unsustainable growth rates.
The argument that Serbia should persevere on the path of investment and export-led
economic growth and that the key role in its achievement should be played by structural
reforms and fiscal consolidation was also suggested by Standard&Poor's in its official
statement in March 2011 when Serbia's credit rating was improved from BB- to BB:
"The increase of Serbia's credit rating reflects the agency's belief that the
implementation of economic policy in Serbia has improved and that the country
has gained a new momentum when it comes to fiscal consolidation, structural
reforms and economic rebalance."
The National Bank of Serbia, on its part, shall continue to strive towards stabilising inflation at
a low level and preserving a healthy financial system, which, I am utterly convinced,
represents the best way to help the economy in current circumstances and contribute to the
creation of an environment conducive to business and investment. The more effective fiscal
consolidation and structural changes are, the more easily will the National Bank of Serbia
achieve its objectives with less monetary policy restrictiveness.