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ASer­bia’s econ­omy will slow down in 2014 in the af­ter­math of the spring 2013 floods as well as the gov­ern­ment aus­ter­ity mea­sures. Do­mes­tic de­mand is con­strained by the process of fis­cal con­sol­i­da­tion. Peren­ni­ally high lev­els of un­em­ploy­ment along with a cut­back in lend­ing to con­sumers un­der­mine de­mand. The pri­vate busi­ness sec­tor is starved of bank credit while an in­ef­fi­cient state-owned sec­tor is in ur­gent need of re­struc­tur­ing. The po­ten­tial rate of growth is about 3.0%. Ser­bia's econ­omy slipped into re­ces­sion in 2009 when ex­ports fell at a dou­ble-digit pace and in­dus­trial pro­duc­tion de­clined. In re­sponse, the gov­ern­ment in­tro­duced an emer­gency spend­ing pro­gramme val­ued at 3.0 bil­lion euro to stim­u­late pro­duc­tion and ex­ports. Mod­er­ate growth re­turned in 2010 and 2011 but Ser­bia re­turned to re­ces­sion in 2012 ow­ing to poor cli­matic con­di­tions, clo­sure of a ma­jor steel plant and weak­ness in the euro area. An­other re­bound was re­ported in 2013 when real GDP grew by 2.5%.

The tran­si­tion from a pat­tern of con­sump­tion-led growth to an ex­port-driven form of growth has proved to be ex­cep­tion­ally dif­fi­cult. Smaller firms are go­ing through a par­tic­u­larly trou­ble­some ad­just­ment, and em­ploy­ment in both for­mal and in­for­mal seg­ments of the pri­vate sec­tor has con­tracted. Many es­sen­tial re­forms have been de­layed un­til 2014. The level of eco­nomic ac­tiv­ity re­mains be­low the pre-cri­sis level ow­ing to struc­tural rigidi­ties.

Eco­nomic out­look

Ser­bia's real GDP is fore­cast to grow by 2.1% in 2014 – down from 2.5% in 2013. Re­cent flood­ing, as well as aus­ter­ity mea­sures, slow down the econ­omy. Do­mes­tic de­mand also re­mains sub­dued. The econ­omy grew by a dis­ap­point­ing 0.4% in the first quar­ter of 2014 com­pared with a year ear­lier.

Prices rose by 7.9% in 2013 and in­fla­tion of 3.2% is ex­pected in 2014. The cen­tral bank's tar­get range for in­fla­tion is 2.5-5.5%. The cen­tral bank low­ered bor­row­ing costs in May

2014 in a bid to help the slug­gish econ­omy.

Do­mes­tic de­mand is con­strained by the process of fis­cal con­sol­i­da­tion. Peren­ni­ally high lev­els of un­em­ploy­ment along with a cut­back in lend­ing to con­sumers also un­der­mine de­mand. The real value of pri­vate fi­nal con­sump­tion fell by 4.5% in 2013 and an in­crease of 1.9% is ex­pected in 2014.

The launch of the EU ac­ces­sion ne­go­ti­a­tions and in­creased mem­ber­ship prospects should pro­duce a rise in in­vest­ment ac­tiv­ity, al­beit from a very low level.

Un­em­ploy­ment was 22.1% in 2013 and that will not change in 2014. Ap­prox­i­mately half of all young adults are un­em­ployed. Ser­bia's rate of em­ploy­ment (the per­cent­age of peo­ple of work­ing age ac­tu­ally work­ing) is only about 45%. This is about 20% lower than the EU av­er­age. Amend­ments to the labour law make it eas­ier to fire work­ers.

Eval­u­a­tion of market po­ten­tial

The tran­si­tion from con­sump­tion-led growth to a greater re­liance on ex­ports is fi­nally be­gin­ning to pro­duce some results. The po­ten­tial rate of growth is about 3.0%.

In the medium term, rates of growth should ap­proach this bench­mark as in­vest­ment picks up. Im­prov­ing prospects for the EU ac­ces­sion and the hope of ad­di­tional re­forms should help to boost rates of growth over the next sev­eral years. In­flows of FDI are ex­pected to rise grad­u­ally in the medium term while macroe­co­nomic im­bal­ances will be re­duced.

Agribusi­nesses have con­sid­er­able po­ten­tial as re­cov­ery in the EU be­gins to take hold. The elim­i­na­tion of wait­ing times at bor­ders would make it pos­si­ble for pro­duc­ers to shift from low-profit frozen ex­ports to fresh ex­ports. In ad­di­tion, the grow­ing sea­son is unique and fits com­fort­ably with the EU's needs.

For­eign trade

The share of ex­ports in GDP has been ris­ing for sev­eral years and amounted to 34.4% of GDP in 2013, up from 23% in 2008. Ex­ports (in dol­lars) rose by 30.1% in 2013 and gains of 22.5% are ex­pected in 2014. Growth is driven by ex­pand­ing car and oil prod­uct ex­ports.

The EU is Ser­bia's main trad­ing part­ner. In 2013, it ac­counted for 61.7% of all ex­ports. The EU has agreed to a trade agree­ment as the re­ward for im­proved co­op­er­a­tion with Bel­grade. Ser­bia also has a free-trade agree­ment with Rus­sia, which al­lows Ser­bian­made prod­ucts easy ac­cess to a large market. Ser­bia's ex­ports of mil­i­tary arms have been ris­ing quickly since the in­dus­try was re­built. To­gether, ma­chin­ery and trans­port equip­ment and ba­sic man­u­fac­tures made up 45.7% of to­tal ex­ports in 2013.

Ser­bia's cur­rent ac­count deficit was 4.9% of GDP in 2013 and it will widen to 5.0% in 2014. Ser­bia is work­ing to lure in­dus­trial in­vestors to ex­port in­dus­tries to cut its re­liance on im­ports and nar­row the trade deficit. FDI in­flows fi­nance the ex­ter­nal gap.

Busi­ness en­vi­ron­ment

In late 2013, the gov­ern­ment adopted a set of aus­ter­ity mea­sures that in­cluded in­creas­ing the VAT on food­stuffs, cut­ting sub­si­dies, re­duc­ing the in­for­mal econ­omy, curb­ing new hir­ing in the pub­lic sec­tor un­til 2016 and im­pos­ing a so-called “sol­i­dar­ity” tax on civil ser­vants' earn­ings. In 2013, both the in­come tax and the VAT rate were raised. New leg­is­la­tion, which will be a by-prod­uct of Ser­bia's ac­ces­sion talks with the EU, should im­prove the reg­u­la­tory en­vi­ron­ment gov­ern­ing for­eign in­vest­ment. It is es­ti­mated Ser­bia is cur­rently los­ing more than $210 mil­lion per year due to tax eva­sion.

The role of the state is be­ing re­duced and the pri­vate sec­tor's share in to­tal em­ploy­ment has risen. State own­er­ship in banks is also be­ing phased out. How­ever, the re­main­ing state-owned firms con­tinue to ex­pe­ri­ence sig­nif­i­cant losses. The gov­ern­ment has stepped up its fight against cor­rup­tion and or­gan­ised crime as part of its ef­fort to achieve the EU mem­ber­ship.

Ac­cord­ing to the USAID, the in­for­mal sec­tor rep­re­sents about 30% of GDP. Gov­ern­ment of­fi­cials be­lieve the sec­tor em­ploys up to 600,000 un­reg­is­tered work­ers and costs the gov­ern­ment 1.5 bil­lion euro per year. High taxes on labour and, com­plex tax pro­ce­dures are some of the rea­sons for the large size of the in­for­mal sec­tor.

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