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Republic of Serbia Fiscal Council

This analysis highlights the challenges and recommendations for budget revision and medium-term fiscal adjustment in the Republic of Serbia. It addresses the issues of public and state-owned enterprises, high deficit, and public debt, emphasizing the need for comprehensive fiscal consolidation.

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Republic of Serbia Fiscal Council

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  1. Republic of Serbia Fiscal Council ANALYSIS OF THE OPERATIONS OF STATE-OWNED ENTERPRISES KEY POINTS AND RECOMMENDATIONS FOR BUDGET REVISION AND MEDIUM-TERM FISCAL ADJUSTMENT: 2015-2017 31 July 2014

  2. Three pillars of fiscal consolidation • Reforms – adoption of laws that will lay the foundation for stable public finances in the medium term • Law on Pension and Disability Insurance, Law on Labour (economy, but also the basis for public enterprises and public administration), Law on Privatization (restructuring)… • Positive assessment, but the biggest challenge is yet to come (downsizing of employees), savings will not be made immediately • Bringing order in public and state-owned enterprises – the most difficult and uncertain • Huge problems: political (interest groups) and professional (redundant employees and their benefits, uncollected payment for services, inadequate prices, etc.) – there is still no adequate plan for addressing these issues • If this is not done, there will be an explosion of public expenditure and failure of consolidation • Establishing a sustainable level of budget expenditure • Suplementary budget: a step towards reducing the huge deficit and eliminating the biggest imbalances

  3. Public and state-ownedenterprises are the biggest problem • Already incurred a large fiscal cost (1 billion eurosannually) • And it keeps growing;unless reversed, it will make all savings useless • Srbijagas • It has already spent the state funds equal to the value of Telekom and continues to generate losses • Network of problems – the problem is not only Srbijagas, but also Azotara, Petrohemija, MSK, city heating plants…that do not pay for gas • EPS • Numerous problems, not only low prices but also redundant employees, poor payment collection, organisational fragmentation, losses in distribution (thefts)… beginning of liquidity problems, now the floods – newSrbijagas? • Other public enterprises have similar problems, but the operations of EPS are measured in hundreds of millions of euros, which is too muchfor public finances • Serbian Railways • There is no progress for decades - huge government subsidiesspent, the 19th century train speed, project funds not withdrawn • Huge system (20,000 employees) with problems, together with EPS nearly 60,000 employees out of the total of 250,000 in all public and state-owned enterprises

  4. High deficit in 2014 -over 2.6 billion euros (8.3% of GDP) • Projected deficit of 2.5 billion euroshas been exceeded for about 150 millioneuros • Combined result of drop in revenues of about 400 million euros and decrease in expenditures of about 250 million euros • Public revenue shortfall is primarily the result of changed macroeconomic environment (objectively) • Extremely low inflation (2% instead of expected 5% - lower public revenue), recession and largerdropin formal employment than projected • Missing and budgeted effects of combating grey economy (unrealistically planned) • Public expenditures were under control • Finally stopped salary increase above indexation (there are savings) – positive • Inefficient execution of public investment – negative

  5. Public debt at the end of the year over 70% of GDP • In countries like Serbia – even a significantly lower level of public debt leads to a crisis • It is difficult to reverse the growth of public debt – it will reach 80% of GDP (even with substantial cuts) • Creditors can easily lose confidence - a crisis of public debt • Large public debt is not the only risk • Annually over 5 billion euros (17% of GDP) needed to finance deficit and pay due debt • According to international standards – there is a risk of crisis with due payments of over 15% of GDP • Stopping the growth of public debt share in GDP- fiscal consolidation • Investors need to see a credible plan for medium-term adjustment and stopping of public debt growth in order to continue lending money

  6. Fiscal consolidation –2 billion euros of savings • In order to stabilisethe public debt by 2017,the deficitmust be reduced to below 1 billion euros (from the current amount exceeding 2.6 billion euros) • However, some expenditures will be growing: payment of interests(as long as there is a growth of public debt) and public investment (currently insufficient) • Required savings of nearly 2 billion euros • Reforms and improvement of public finances are required, but "painful" cuts cannot be avoided (there are no easy solutions) • Serbia’s credibility is low and adjustment of 2 billion euros is possibleonly in the medium term • New arrangementswith the IMF required

  7. Fiscal consolidation must be comprehensive • It is futile to cut salaries and pensions without solving the issue of public and state-owned enterprises (∙∙∙∙∙). • It is insufficient to solve the issue of public enterprises without cutting salaries and pensions (----); it is necessary to do both ( ─). • In order to stabilise the public debt, it is necessary to reduce salaries and pensions by 15% smaller reduction of salaries and pensions would require additional adjustment measures, most probably further tax increase – an inferior measure

  8. Fiscal consolidation and growth • The major deficit adjustment (3% of GDP) in the first year of consolidation (2015) – Front-loading • Eachsuccessful fiscal consolidation hasthe biggest deficit reduction in the first year • Important for entire programmecredibility - a smaller deficit makes the continued fiscal consolidation less risky - will be rewarded with confidence • Political economy – it’s now or never • Strong deficit reduction leads to reduced economic activity, which can be mitigated • Fiscal consolidation of 3% of GDP wouldlead to a temporary drop of GDP byroughly1% • Ifnotmitigated = deflation and recessionfailure of programme • It can be avoided with a broader package of fiscal and monetary policy measures to boost economicactivity • Positive effect on economic growth fromincreased public investment (recovery after the flood), business environment (Law on Construction, etc.), attracting investors,perhaps consideringfiscal and credit incentives

  9. Public revenue in 2014 • Revenue shortfall of about 50 billion dinars • 30 to35 billion objectively, due to changed economic circumstances • Inflation below the lower bound: 2-2.5% against the projected 5.5% • Greater drop in employment: 1.5% against the expected 0.7% • Economic recession, floods • 20 billion dinarsdue to optimistic budgeting • Revenuefrom greyeconomy included in advance; however, measures havenot been implemented in the first half of the year • The 2013 trend of weakening tax discipline has been stopped • Efficiency of VAT collection unchanged compared to 2013 • Collection of payments for contribution partiallyimproved • Pace of excise tax collection is extremely divergent

  10. Excise tax revenue • A large growth of excise tax collection recorded for oil products • A large drop recorded for tobacco products Oil products Tobacco

  11. Combating grey economy • One of conditions forfiscal consolidation and sustainable economic growth • It is possible to increase revenueby350million eurosby 2017 • It requires a systemic approach and political support • Ad hocmeasures implemented in 2013, attracting media attention,are not the right solution • Some progress hasalready been made​​, but substantial efforts are still needed • Personnel improvements, more efficient control system • Coordination of tax authorities, inspections, judiciary

  12. State-owned enterprises • Revenues are not sufficient even for salaries • Illiquidity • Explosion of short-term debtand spillover to the state • Failure to collect payment for supplied goodsand covering debts of loss-generating enterprises • Low sales prices of goods and services • Imposedsocial function • Highnumber of employees and mass of earnings • Number of employees, salaries, 13th salary, bonuses, loans • Public procurement • Possible savings • Low investment • Lagging behind for decades • Poor management, party management • Inappropriate selection of management, sponsorship, public procurement, incorrect accounting reports

  13. Problem solving guidelines • Professionally and politically challenging process: • Concurrent elimination of several problem sources (Srbijagas, EPS, etc.) • Problem diagnosis and awarenessexist, we need consistent implementation • Reform of public enterprises affects interests and it is politically and socially challenging • This has to be done: • Privatization;stop the practice of selling without collecting payment;price liberalisation;downsizing of employees and reducing salaries;greaterinvestment and improvement of performance indicators;hardbudget constraints; transparency;resolvingthe future statusof enterprisesin restructuring;corporate governance;centralisedmonitoring of the operations of enterprises

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