Serbia & state bankruptcy: choice of now or later

By M. Bozinovich | Serbia’s Deputy Prime Minister, Aleksandar Vucic, one of Washington’s darlings, noted last week that Serbia is near bankruptcy but he will not allow that to happen and has announced that some half million public sector employees will get their paychecks cut while the government asks around for a $1 billion loan in order to pay its bills.

Capitalism, Vucic pontificated, does not mean that government’s job is to find somebody a job but instead, government’s job is not to be in the way of those who can find one.

Presumably, the pay cuts is a method of getting out of the way of people finding jobs… and good luck finding one in Serbia.

To be realistic, Serbia has not been in business of generating jobs since at least the 1970s when the communists, in those days, thought that a more consumption oriented economy would serve the country better.

This strategy has enormously benefited “retailers” or people who can rent-seek licenses from the government to engage in import business of goods that Serbia cannot produce. Former Yugoslavia, as a result, has seen its corruption escalate enormously while perpetuating flight of its own capital to other countries and immiserizing what little productive capacity it had.


Regime of Milosevic did nothing to change this and in fact the cronies around Milosevic advised him to make sure Serbia is placed under international sanctions so that the business of imports can be concentrated in narrow hands of Milosevic’s insiders who made out with billions of profits.

Well, since the fall of Milosevic, the so-called reformers have done zero, nadda, nula… to change these entrenched ways.

That it is so, just eyeball the the chart below of Serbia’s current account since 2000 when the “reformers” took over.

The reason why the blue bars are upside down is because Serbia has imported way more than it has produced so each upside down bar represent the amount of money Serbs have sent over to another country.


The bars are very big for 2007-08, but they are also on the increase since the end of that “global financial crisis”… an indicator that Serbia is back to its good ‘ol ways – importing more and shipping off the people’s cash over to other countries.

The enormity of Serbia’s misplaced trade policy and the cost it is imposing on the people is better understood if we add up all the bars since 2000.

The cost is EUR 30,577,000,000!

In other words, Serbs have exported 30.5 billion euros since 2000, the money that could have gone to other uses, most notably domestic investments in production, debt pay offs or other projects that do not involve fattening up pockets of foreign producers.

Now, the policy makers have been keen on claiming that the outflow of cash can be offset by an increase in the financial inflows, a number seen as a capital and financial account on the balance of payments statement.

An implicit claim these policy makers made was that with privatization and pro-investment policies the red bars seen in the chart below will, eventually, become taller than the blue ones.

Twelve years into such policy claim, the bad news is that such thing never materialized.


Even in the hay-day of privatization (2006) the acquired privatization money only fueled an even larger orgy of imports. Just note how a large spike in the red bar is followed by an even larger blue bar as folks indulge in foreign spending.

By 2012, foreign direct investment has dried up to negligible 231.9 million euros – an amount some Wall Street guys spend on a casual daily trade.

So what is the cause of Serbia’s outflow of capital?

Multitude of things but if we are looking for one predominant variable that acts as an incentive for people to prefer buying foreign goods it is the value of Serbia’s currency.

If Serbia is to drop the value of its currency sufficiently low, the preference for foreign goods will be eliminated (because they will be too expensive) and the trade deficit will eventually be balanced.

Granted, Serbian currency has been dropping in value since 2007, both against the Euro and the dollar, but the drop in the value is insufficient to offset the trading deficit that keeps sucking off Serbia’s capital.

So why isn’t Serbia’s currency dropping in value faster?

Again… myriad of reasons.

Here are some financial ones:

1) A required drop in Serbian currency would decrease the value of GDP and increase the value of foreign debt. A corresponding rise in debt value would deteriorate all sorts of debt measures financial markets look at in order to price future loans. These are:

a) Debt/budget revenue (ability to make debt payment)
b) Debt repayment/GDP (debt sustainability)
c) Debt repayment/exports (ability to get foreign currency to pay debt)
d) Debt repayment/budget revenue (ability to afford the debt)

2) Too high a drop in currency value also fuels inflation measures and spurs capital flight to a more stable financial environment.

3) Too high a rise in debt value (and drop in GDP) would make the already growing debt repayment obligation against GDP (chart below) even more unsustainable.

Unlike the US central bank, a non-dollar denominated central banks, like the Serbian one, has to worry not just about basic inflation-growth stuff but also about additional issues such as:

does the bank…

(1) have enough dollars and euros to cover the debt payment check the government writes to the creditor

(2) have enough foreign currency to cover international money transfers people make on daily basis

(3) have sufficient back up funds for unusual bank system draw downs

(4) have enough foreign money to sustain a financial shock


There are, of course, political/contractual problems most notably of which is Serbia’s agreement with the London and Paris creditors from 2001/04 on debt restructuring and forgiveness.

According to that “political” deal, 62% of the debt was forgiven in exchange for “a repayment period of 20 years and a grace period of 5 years. The Memorandum was ratified on July 24, 2004.”

Based on this contract, known as “Memorandum of Understanding on the Debt Restructuring Under the NFA and TDFA Between the Republic of Serbia and the International Coordinating Committee”, Serbia’s current financial/economic policy (of overvalued domestic currency) seems locked-in until at least 2024… if not 2029.

This means, that Serbia will, in all likelihood, keep racking up balance of payments deficits for another 11 years which, if applying the current trend, amounts to another 30 billion Euros in indirect payments to foreigners for a total of 60 billion Euros, at least, on top of the debt it has to pay off and debt it has to get in order to make it through bad years like this one.

Yet, the opportunity cost is enormous.

At some 30% unemployment there are some 2 million unemployed in Serbia with prospects of getting a meaningful career very low. Suppose each unemployed earned just 100 Euros. That is 200 million Euros per year which translates into 2.2 billion euros over the next 11 year period during which time Serbia has signed a contract to repay its debt.

There are, of course, other, upcoming issues that could wreck Serbia financially even more and the most notable is the EU membership.

As Serbia gets “closer” to the EU, more pressure would be applied on Belgrade to control the drop of its currency. Many arguments aginst the drop will be made under “financial stability” argument, a euphemism for a stronger currency that is pegged to the value of the Euro.

Such artificially high Serbian currency would stimulate imports, something Germans will like, but Serbia would eventually find itself into another debt-budget unsustainability because the currency level is not matched by productivity growth.

However, as Serbia gets more “integrated” into the EU, a more worrisome problem is the artificial drop in interest rates, something that is plaguing Spain and Italy right now and has gotten Greece into so much trouble.

For example, worker productivity as proportion of country’s GDP is used to establish domestic wages and the availability of credit but since Germany’s productivity and the GDP are so much higher than everybody’s Eurozone interest rates have been basically tracing Germany. This means that any Eurozone integration for Serbia means, like in Greece, cheap loans that more people will take out.

Even if Serbia is to stay out of the Eurozone the incentive to over borrow is already felt in Serbia via its overpriced currency. For example, since Serbia’s wages are already artificially high because of the myriad of reasons noted above than a foreign bank assumes the ability or repayment is also higher than what it actually is. As a result, rates are lower than otherwise would have been – which stimulates over borrowing.

As we go forward, this rate effect will be amplified because Germany’s input into productivity basket will be proportionally higher than anyone else in the Eurozone.

Countries like UK are already re-evaluating any benefits of their association with the EU. Among the smaller EU members, the Czech President is the only vocal one against the EU althoughbecause of his own intuitive/legal reasons.

There are, however, huge amounts of financial reasons that small economies with weak productivity should not aggrandize themselves by joining a financial union in which they will come out as losers.

Even France is viewed a partner suspect in this German-led union although Poland and Ukraine are looked at as Germany’s more “natural” partners to whom it can sell stuff rather than go to war agaisnt as it did in WWII.

Serbia indeed needs to definitively reevaluate its economic and financial policy because it is totally incompatible with membership in the EU and the financial forces emanating from the Eurozone: the country can no longer afford to remain dominated by forces of consumption fueled by borrowing because, eventually, it will not be able to sustain its lifestyle. A shift towards production, something Slovakia is doing, is the way forward if it wants to find its EU membership bearable.