Monday, 4 November 2013

Serbia’s Incomplete Transition and Country Risk: Mind the Gap

Serbia is one of those CEE States that is an enigma.  A Serb friend who was in both the Federal Yugoslav government and in the post-Yugo declining rump into the Serbia bit once Montenegro had gone its own way in 2006 reminds me regularly that Yugoslavia had negotiated 80% of the acquis for EU Membership during the 80s.

And as a kid growing up in Berkshire, I would often play football in the park against Yugoslav kids so travel was not an issue for a country seen as a half-way house breaching both sides of the iron curtain.  Indeed taking the train from Yugoslavia to Trieste for your jeans to flog off back home or to proudly wear was essentially the stamp of adulthood!

Fast forward three two decades.

Whilst the grand air of the capital of the Balkans remains (even the Slovenes come to party at weekends in Belgrade) in substance a lot has changed.  Aside from the Cyrillic alphabet and proximity of languages there are similarities – but also key differences – with another city coming to terms with loss of empire, Moscow.
For a start Belgrade lost a major trump card that Moscow retained by not retaining its high-calibre Federal civil service. Yes the EU annually rubber-stamps that the Serbian government has good administrative capacity, but drill down into actual mechanics and you’ll find a lot of bright well educated cadres but lack of a joined up government. Meaning decisions often lack clear strategic thinking or where – as for say for macro-stabilisation there seems to be some semblance of grey matter – alas it is often on the back of external conditionality (DC or Brussels).

And there tend to be  a lot of governments… where each new minister brings his mates along for key positions in the civil service. Meaning a continuous dilution of capacity and institutional memory in the ministries.  Again, not so in Moscow.

Russia remains a good risk but faces real challenges of how it reaches the nirvana of a broad-based economic landscape that often escapes resource rich economies. Serbia on the other seems often to be on the cusp of another macro shock, often due to failure to keep to terms on the previous stabilisation programme, and lacks any real resource endowment.

Whilst CEE watchers no doubt review the macro numbers and compare with other EM economies, what they often miss is the transition gap it still has to overcome, certainly relative to the CEE economies in the EU.

Although Serbia underwent a rapid transformation in the immediate period after the ousting of Milosovic in 2000 (cherry picking reforms that had worked elsewhere as someone from the World Bank once said) there has been not much reform since the early 2000s and Serbia rode the long cyclical wave of benign global and CEE growth when it was all about convergence plays.

Whilst the new EU Member States had to go through (some) hoops, Serbia had no such external anchor. And whereas the likes of Estonia or even Slovenia saw themselves very much in the western European family (if only to get away from the Ruuski bear), Serbia has until recently remained very agnostic if not plain disinterested (again the post-empire blues that also affected Britain’s initial two-fingers at the EU before its eventual entry in 1974 – although the fingers haven’t quite descended!).

Result: an economy with enormous structural issues, a bloated civil service, massive unemployment, fundamental issues for the business environment, an uncompetitive trade sector and economic growth that has relied on domestic absorption, often on the back of credit – where a lot of the bank credit is owned by a coterie of banks from the Euro-risk economies of Greece, Austria, Italy and to a lesser extent France – and where there is a high FX-debt profile through Euro-isation of loans.

Can Serbia manage the transition and macro-fiscal challenges? I helped put together the EU’s Emergency Budget Support for Serbia in 2009 and worked on budget reform prior to that and  whilst I have confidence in the Central Bank that sits on reasonable reserves I am less convinced about political will beyond short-term fixes on the fiscal side.

The country’s metrics on transition are often only beaten to bottom by Kosovo or Bosnia. I am also not entirely convinced about the magnetism of the EU despite promise of greater aid flows. Serbia is surrounded by the EU so has no choice but to integrate although it can affect the speed of convergence. But one wonders if the spectre of the EU of the 2020s that is moving toward a more German-led model of an integrated federation will be palatable to the Serbian politicians – although the same could be said for the Hungarians or Romanians.

But at least the latter are in the EU club. And with it have the implicit EU-put that entails through soft EU loans or via Structural Fund transfers.

What does this mean for Serbian investors and Serbian country risk?

1.       There is a fat tail risk on the downside, despite recent IMF-led efforts for fiscal consolidation announced last week and the likelihood of another Eurobond issue or putative loan from Manchester City…sorry UAE. 
2.       From past experience, the fiscal plan will be implemented in part but then fade away 
3.       With the real exchange rate still 1/5th overvalued and continuing current account pressure there is a risk  of further devaluation that the authorities will want to prevent from becoming excessive, even with the reserve buffer which in turn will feed into higher imported inflation
4.       The US taper-risk will lead to EM differentiation and which will affect Serbia dis-proportionately when it happens in 2014. 
5.       Getting back to the tube-metaphor, Serbia risk is under-priced. Mind the Gap.

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