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The unsustainable path

Serbian state finances are on an unsustainable path. That means that, unless significant measures are taken, we will face a huge budget deficit this year, around 8%, i.e. approximately 2.5 billion euro. That’s three times more than a deficit that would be high, but bearable. This 2.5 billion euro deficit will cause a rising debt, i.e. we will have to borrow more. In addition to that, we will have to borrow more this year to pay for all accrued debts. That is an additional three billion euro of the old debt. So, we will have to borrow approximately 5.5 billion euro this year. During the next two or three years, we will have to borrow around 5 billion euro per year in order to pay for the old debt and pay for the deficit which will definitely last three or four more years, since it is very high now. As a consequence, the high debt, which is already 65% of the GDP, will continue to rise. The level of debt which Serbia can bear is 30-35% of the GDP. So, the debt is already twice as high than we can bear. Incidentally, it is 21 billion euro.

What are the consequences of this debt? The fact that it is high and rising causes those that lend money to the state and those who want to invest in Serbia to worry that this is unsustainable and that this path will sooner or later cause a crisis. In this respect, those that lend money to the state wonder whether it will be able to pay them back. Again, it is not a question of whether they will give the money or not, but how high will the interest rate be. The interest rate for our current loans is already about 7-7.5% for the euro. It is already unsustainable. The other side of that debt is that we are paying a huge interest. Already in 2014 the interest will be about a billion euro, which is dangerously near to the total amount allocated for education. This is also an unsustainable and irrational situation.

The next aspect of this debt and deficit is the way to pay and finance it. It is around 5 billion euro each year. The point is that we have to borrow more than half of that amount from foreign banks on the international market. The amount that we will get, if we get it, from Abu Dhabi, some from the World Bank, some from other international financial institutions – everything combined is less than half of the amount we need. At the end of this year, and especially during the coming years, we will have to enter the international market and, with the deficit this high and rising, they will ask for very high interest rates and we will have to pay for them too. Besides, at one point maybe this too will stop, and they will decide to hold back all funding.

The question is the extent to which this situation was caused by the crisis which broke out in the world, and especially in Europe, in 2008. Although we and other countries in the region – I am referring here to Romania, Bulgaria, Hungary, Croatia, Bosnia and Herzegovina, Montenegro, Macedonia, Albania – were also affected by the crisis, our debt has been increasing twice as fast compared to the average of these countries during the period 2008-2013.

At the time when the crisis broke out, our deficit was similar to those in the region, even somewhat average. However, those countries like Romania which had a huge deficit, rapidly started to lower it and that was a serious response to the crisis. Unlike them, Serbian deficit and, thus, the public debt, started growing. Deficit predicted for 2014 is huge, probably the highest in Europe, i.e. these 8% of GDP. Even if we do something, the deficit could be decreased only to 7% or 6.5% – because we only have six months left to do something. That would still be the highest deficit in Europe, and definitely the highest among the comparable countries.

The question is how we got here – and the shortest answer is that it was basically politics that destroyed the public finances. Pensions are almost the biggest expense in the budget. In 2008, pensions were increased by 30%. This was a terrible blow to the budget, and a permanent one at that. This was not a one-time thing, something that you had to pay for only in 2008, but something that has been increasing the expense ever since. Economists call this structural deficit. An interesting fact is that, out of those 30%, the 10% increase occurred after the outbreak of the crisis. This was in October 2008 when the new government was being formed. PUPS literally blackmailed the government to increase pensions by 10%. And we feel the results of this even now. The share of pensions in the GDP is around 13%, while the bearable level would be 10%. This is a structural, permanent inconsistency.

The second blow came in June 2011 when 400 million euro from the state budget was transferred to the local level. They called it fiscal decentralization. Although we were told that it was not a real deficit, that it was only a transfer of money, it was a new hole. 400 million euro of income was taken from the state and given to local governments. They spent this 400 million euro and the state didn’t have additional 400 million euro to finance its expenses. In order to neutralize this, the state had to decrease its expenses by this amount, but it did not. Back then, in June 2011 it was a political blackmail by URS. The problem is that these are all structural disorders – you gave that money once and now it is a permanent hole you have each year.

The third big influence of politics in public finances which causes permanent consequences are underperforming public companies. Why are they underperforming? Because politics dictates their management. Then we have political recruitment. As a result, we have losses which are eventually paid by the state. The most obvious, but not the biggest example is Galenika. It is a company that should perform great, invest, contribute to Serbian industrial growth, but the situation is exactly the opposite. The number of employees was doubled and, of course, they created losses. In the end, 100 million euro was left as a burden to the state. That is the total amount of the solidarity tax that will be collected this year. It is a typical model.

The most expensive is Srbijagas. During three or four years it made a loss of 1.2 billion euro. It is roughly the amount we could get if we sold Telekom now. So, Srbijagas managed to spend an entire Telekom in three years. There are also other public companies, state or public – Telekom is making a profit, but is losing its market share, growing worse. Dunav osiguranje (Dunav insurance company) is in a similar situation. There is no reason why Telekom shouldn’t be a private company and why it shouldn’t be successful. Now Dunav is also losing its market share, increasing the number of employees, and it could eventually become a burden for the state, like some banks.

There are other companies which would probably remain state owned, but which would have to be more efficient. EPS accounts for almost a half of the entire public sector and is performing marginally – has no funds to invest, so the state has to back it up, and eventually we could be in a situation that the state has to pay for it, like it is now doing for Srbijagas. There is no reason why this shouldn’t be an efficient company.

The next problem are state and private banks, those that were built on some kind of politics-business blending. The expense of the number of banks which have been closed so far, even for the private banks like Univerzal, is transferred to the state, because it has to pay for the ensured deposits. The expense of the banks so far is 800 million euro, which is a huge amount. Thus, the primary issue is the management of state banks, but the problem is also the commercial banks built on politics-business blending which provided loans under obviously unsustainable criteria, because they eventually went bankrupt. If this system doesn’t change, it will again create a huge deficit in the budget and there is no way to cover it with any savings.

Here’s what 2014 was like. Some measures were taken in October, like the increase of VAT from 8% to 10% and the solidarity tax. This saved about 250 million euro, but instead of causing a decrease of the deficit, all this and more was eaten by Srbijagas, Privredna banka Beograd and Univerzal banka: about 330 million euro. If you don’t straighten up the banks, public companies with all the losses, Srbijagas and the others, this means that you will have to raise taxes and VAT and decrease salaries again next year in order to pay for the losses of public companies, but still have the same huge deficit in the budget. So, if you don’t straighten up the banks and public companies, probably nothing else would be sustainable, i.e. no savings could make up for their losses. Then we shouldn’t even try, we should just go with the flow and when we hit hard, we will think about what to do.

We need to implement the reforms, i.e. to pass the laws. The first on the agenda is the reform of the pension system – and the problem of early retirement. Almost 70% of men retire before the age of 65, and 50% of women before the age of 60. It is a huge expense for the pension system, because those people receive pensions for many years. It is not fair, because basically the pension system is set so that everyone could receive pension for approximately the same number of years. The European practice is to somehow level those who retire early with the others. As they will receive pensions longer than those who retire later, their pensions are lower. These are the so called penalties for early retirement, and this is the practice in Germany, Hungary, Croatia and Montenegro. The other part of the reform is the age for retirement. We have the biggest difference between women and men, 60 and 65 years of age. Most often the age limit is the same – 65 and 65, but there are also countries like Bulgaria and Romania, with the age limit of 63 and 65. Of course, this should be introduced step by step, increased every six months. It is not impossible that some additional calculations would show that both age limits should be increased. But, it is clear what needs to be done.

We also have an unsustainable share of pensions in the GDP, around 13%, while Bulgaria has a significantly lower share, around 10%, as well as a significantly lower rate of unemployment. And besides that, their average pension is 150 euro and ours is about 200 euro. We have literally fallen into an unsustainable system. Of course, it is clear that the pensions and salaries are low, but with the existing deficits we can’t even think about an increase.

In addition to the reform of the pension system, we also have the issue of reform of the wages and employment in the public sector. The system of wages in the administration has been completely destroyed, again due to politics – whoever was the strongest, had more influence and could fight for coefficients, bonuses, so that it has become a completely irrational and unfair system. This also pertains to the number of employees in the public sector. I am talking about state administration, police, military, but also the educational and health systems. In the next two or three years we should analyze the real surplus of employees. There are some indications that the surplus exists primarily in local governments, partially in the health sector with the non-medical staff and in the educational system, where the number of teachers is rising and the number of children decreasing.

We need time to analyze this and to make plans on how to correct it. In the past, the solution was always “the problem is huge, cut it down”, and then you cut it down by 10%. The result of these short-term actions has always been more negative than positive. You lose the best people, those who can find jobs elsewhere, and those worth less stay, and eventually you realize you can’t work with them. And then come new elections and a new wave of party recruitment.

In addition to this, some laws need to be changed. First of all, the labor law which is, of course, important for industry, but also for public and state employees, as well as other laws that regulate public sector employment. It must be possible to employ and fire people more flexibly. Because, when the new elections bring a new wave of recruitment and you can’t fire old employees, what will you do.

These are the two basic things – public companies and reform of the pension system and labor law. The content of the reform of the pension system and appropriate laws which must be passed is clear, it is only a question of whether they will be passed during the next 4 or 5 months or not. No additional analyses are necessary, it is only a matter of political will to do that, and that would show whether the foundations for something sustainable in the mid-term are being laid down. The same is true for the labor law and other systemic laws.

The first attempt at consolidation was made in October 2012. Wages and pensions were frozen, VAT was increased from 18% to 20%, income tax was raised, but the other part was not done – the reform of the pension system and everything that comes with it. This means that we have already suffered through the pain, raised taxes, controlled wages and pensions, but inflation obliterated part of it and since we didn’t deal with the basics, we are back where we were. A similar thing happened in October 2013, at a lower level. It was declared “here are the painful measures, solidarity tax, increase of VAT”. But, as I said, all these measures together brought in 250 million euro, while Srbijagas, Privredna banka Beograd and Univerzal banka cost 330 million euro. They just erased this. And what has been done? Several times the citizens were forced to save money, but it was all blown in the opposite direction. The biggest expenses are short-term – wages and pensions. But these two examples show that it is better not to do anything, i.e. not to lower wages and pensions and raise taxes – if you are not willing to reform the public sector, because we will definitely hit a wall and the entire action of saving, which is neither fair, nor sustainable, nor rational, will simply lose its purpose. But, if we really want to change our ways, this is basically what the IMF and the World Bank expect us to do, this would allow us to get out of this completely unsustainable situation in a somewhat orderly manner. If we stretch this problem to three or four years, it will still be painful, but it would lead us towards healing. The alternative is to keep hitting the wall and to adjust chaotically.

Even if we stop paying our debts, we still have a 2.5 billion euro deficit. And this is for salaries, pensions, all state activities. It is nearly 18% of budget expenses that must be decreased. Instead of decreasing it gradually, you will have to decrease it all at once. Then it will tumble over to the economy, because the consumption will decrease. The economy will freeze. Even in countries like Greece, Portugal, Spain, where the IMF, the ECB and the European Commission partially controlled the crisis, it still caused a great decrease of production and increase of unemployment.

From the radio show, April 4th, 2014

Translated by Marijana Simic

Peščanik.net, 10.04.2014.