Serbia’s Walking A Fine Line

07.27.15

Serbia’s Walking A Fine Line

07.27.15
Tomislav Nikolić/FacebookTomislav Nikolić/Facebook

By Lili Bayer for Global Risk Insights

Western governments and businesses are investing in Serbia as the country’s government moves to implement reforms and makes significant progress in resolving outstanding disputes with Kosovo. Nevertheless, internal economic problems, the impact of the Greek crisis, and the lack of serious prospects for European Union membership in the near to medium term could present a challenge to both the country’s economic recovery and its relationship with the US and EU.

Belgrade’s Balancing Act

The US and EU regard Serbia as a strategic linchpin in the Balkans. To many Western governments a stable, prosperous and Western-oriented Serbia is deemed necessary to preserve stability in the region and resolve regional quagmires: from the conflict between Serbia and Kosovo, to managing a growing migration crisis. At the same time, the crisis in Ukraine has heightened the desire of Western governments to undermine Russia’s influence in Serbia. Moreover, Serbia could play a role in the EU’s energy diversification strategy as a transit state for natural gas flowing to Central Europe.

Serbia’s leadership has taken significant political steps to move closer to the West. The European Union has facilitated high-level talks between the leaders of Serbia and Kosovo, with only a few outstanding issues regarding telecommunications, energy, the formation of the Association of Serbian Municipalities and movement within divided Mitrovica still up for negotiation. An agreement between Serbia and Kosovo is a pre-requisite for Serbia to pursue EU integration.

Serbia’s leadership has also worked to boost ties with the US. On October 16, 2014, thousands of Serbian soldiers marched in Belgrade with the guest of honour, Russian President Vladimir Putin, looking on. On the surface it appeared that Serbia’s government was reaffirming the country’s historic ties to Russia. In the background, however, the battle for influence in Serbia was underway. The night before, Serbian Prime Minister Vucic talked on the phone with US Vice President Joe Biden.

In a pattern to be repeated over the following months the Serbian side has come to couple major diplomatic contact with the Kremlin with parallel discussions with the White House: Prime Minister Vucic’s June visit to Washington, DC came nearly two weeks after Russian Foreign Minister Lavrov visited Belgrade. On July 14, US Assistant Secretary of State for European and Eurasian Affairs, Victoria Nuland, visited Belgrade and reaffirmed America’s public commitment to supporting Serbia’s aspirations towards EU membership.

Structural and Regional Hurdles

For Western businesses, Serbia has much to offer: the country boasts an educated workforce, proximity to major European markets, a low corporate tax rate, and incentives for foreign investors. Foreign investment over the past years has centered on banking and insurance, manufacturing, wholesale, retail and repair of motor vehicles, and real estate.

Nevertheless, Serbia’s economy is suffering from structural problems that have limited its competitiveness and growth potential. Floods and an unfavourable external environment in 2014 exacerbated existing structural weaknesses, with the country’s GDP contracting by 1.8%. Serbia’s leadership thus sought aid from the International Monetary Fund, which in February 2015 approved a three-year, EUR 1.2 billion Stand-By Arrangement. This aid was to be accompanied by a reform program which includes cuts to mandatory public spending, the privatization of over 500 state-owned enterprises, and efforts to address Serbia’s high non-performing loans (NPL) rate.

However, six months following the IMF’s approval of the Stand-By Arrangement Serbia has yet to fully implement promised reforms. The IMF indicated that credit growth remains sluggish and NPLs continue to pose a challenge in its June 2015 review of Serbia’s progress.

Another risk currently facing the Serbian economy is potential spillover from the Greek crisis. Greek-owned banks constitute 14.1% of total banking sector assets in Serbia. Serbia’s Greek-owned banks do have sufficient liquidity and capital buffers, but concerns over the situation in Greece could lead to large-scale deposit withdrawals.

Corruption is also undermining efforts to promote growth and investment. Corruption in public procurement contracts remains a significant challenge, while corrupt practices in state-owned enterprises are also common. Serbia’s judicial system reportedly has a backlog of over 2 million cases, while investigations into allegedly corrupt privatization deals have stalled.

Serbia’s Inclusion in EU on Hold

As the European Union works to address its own internal challenges, from the Greek crisis to divisions among member states over issues like migration, EU leaders do not intend to approve new membership in the near to medium term. Serbia is strategically important to the EU, and thus the organization does spend significant political and financial resources to boost its relationship with the country: Serbia receives financial assistance from the EU for projects in areas such as energy, infrastructure, agriculture, and competitiveness.

Nevertheless, with the future of EU enlargement plans becoming more and more uncertain, the EU’s leverage in Serbia may decline. While the IMF will continue pressing Serbia to comply with pledged reforms, a reduction in the EU’s influence in Serbia could lessen pressure on the Serbian leadership to implement a specific range of reforms, especially with regards to corruption. This will in turn undermine Serbia’s efforts to attract more foreign investment and boost the competitiveness of its economy.

On the political front, without the credible promise of EU membership and the economic benefits that membership brings, there is a risk that Serbia’s negotiations with Kosovo lose momentum, and that Belgrade refocuses its efforts away from impressing Brussels towards working more closely with the Kremlin.

Serbia’s government has adopted a wide variety of measures in order to improve the country’s competitiveness with an eye towards EU integration, but continued economic challenges, the impact of the Greek crisis, domestic corruption, and uncertainty over the future of EU expansion could ultimately undermine efforts both to transform Serbia’s economy and boost ties between Serbia and the West.

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