Thisi is a slightly edited version of the article published in NIN magazine on July 30th, 2020.

Author: dr Kori Udovički

At a time when officially hundreds, and possibly many more, people are dying from covid in Serbia, it is important to be quite clear that this was not inevitable. It is not true that in this crisis one has to choose between the health of citizens and the economy. On the contrary– health management has become one of the most important economic policy tools – if the government does not keep the epidemic under control, its explosive spread takes control of everything, no matter how much the government resorts to repression. People in Serbia are dying today because of a cynical electoral calculation, but also because Aleksandar Vučić– despite holding a tight grip over his party and the (repressive) state apparatus– is not able to manage the fine web of measures and incentives needed to take the Serbian economy to safety.  Had he been able to, he could have won the election with greater political gain and benefit for the economy, without the unnecessary loss of life.

The first and second waves

Every day of this second wave of the pandemic is costing the Serbian economy over a million and a half euros in earnings—a rough and conservative estimate– compared with what could realistically have been expected after the state of emergency. It was to be expected that, at least for a year from now, businesses would operate under the twin effect of the restrictions’ direct limitations, as well as of the contraction in demand caused only partly by the restrictions themselves, but more so by the broader effects of the crisis in Serbia and internationally. The estimate of the additional cost includes the effect of the current deterioration in both these factors. Not included are the increased costs of health treatment (which will ultimately also be paid by businesses) and the chain effects of increased uncertainty and of failures of the most affected businesses.

In order to understand this wave, as well as how the epidemic can be better managed, it is useful to look at what can be learned from the state of emergency—although it is quite safe to assume this will not be exactly repeated.  It should not repeat because everybody – businesses, citizens, and the government—have in good measure become adapted to the inevitable new circumstances.

As with the first wave, this one is most strongly affecting micro, small, and medium sized limited liability companies and sole-proprietors (SMEs) – those that make the heart of the domestic economy.

The chain of causality during the state of emergency started with the closure of those activities that require direct contact or the gathering of large numbers of people (hotels, restaurants, personal care, open and enclosed market places). CEVES’ research shows that every fifth limited liability company (LLC) mainly micro, and every third sole-proprietor (with a total of some 230,000 formally employed) were not able to operate at all. In addition to businesses closed outright by the measures, also blocked were workers older than 65 and those that were not able to organize transport for their employees. However, for the majority of businesses, the first wave was centered around the need to adapt to safer working conditions. Establishing physical distance, working in staggered shifts, the use of PPE and disinfectants, shifting to digital/remote work in whatever capacity possible- all of that entailed costs that continue to burden businesses.

For the two thirds of SMEs that could not (partially or fully) shift to remote work, shortened work hours were highly limiting. Retail outlets were hit particularly hard, not only by the shortened work hours, but the many days of forced holiday.  Difficulties with, and the increased costs of, procurement and transportation of inputs should be added –problems which continue to be felt, especially in the import and export of goods.

Once operations were adjusted, the main cause of SMEs’ loss of income was the fall in demand. During the state of emergency, 40% of SMEs lost over 50% in profits; only every fourth LLC and every fifth entrepreneur had profits in line with pre-epidemic expectations. As soon as the state of emergency was ended, some businesses had even higher demand than usual (e.g. hair salons), while others dealt with continued shortfalls. Some sectors, especially those related with tourism, faced an especially drastic decline- in May, Serbia had 87.6% less tourists than at the same time last year. It was realistic to expect a continued shortfall in demand in other exposed sectors as well, considering that the public needed to be continually reminded of safety measures.  Some niches (eg. international congress tourism) would clearly not find solutions for the medium-term on their own. Instead, in June and July, the neglect of strict safety measures and a “we beat corona” attitude took hospitality and other similar businesses to a surprisingly high level.

Their decline is now that much more severe, more so due to the fall in demand and caution by citizens than restrictions. Coming out of the state of emergency, SMEs were optimistic. Covid caught them in the first rush of economic growth since the last crisis. According to CEVES’ research, they had in the meantime significantly increased exports and their contribution to the Serbian economy. They had even built up reserves– during the state of emergency, only 1% of SMEs let go of employees.

Elan and reserves

The first set of economic measures served to replenish part of the reserves that SMEs spent during the state of emergency. As such it was justified and its lateness (in contrast to my previously stated expectations) was less important. About two thirds of businesses resorted to deferring tax debts (the moratorium on loans was used by much fewer of them, because few SMEs borrow at all). Additionally, two thirds of businesses stated that they relied on their own reserves and the help of family and friends in order to aide their financial problems during the state of emergency, while 90% took (or were simply given) the minimum wage subsidy. Still, surveys showed only 5-10% of them reported that the government measures influenced their decision to (not) lay-off employees. About one fourth said they didn’t even have issues with making payments.

The greatest price of the new wave lies in the collapse of that optimism and the aimless depletion of those reserves. It takes the courage or ambition of many entrepreneurs to secure sustainable economic growth– and it requires that they believe it makes sense to risk their assets and savings. The crisis is not an opportunity as such, but crisis or not, the chances and ability of every entrepreneur to uncover solutions, to invest their reserves in the small opportunities they see – must be protected. This is possible only with consistent, predictable, and, if possible, agreed upon economic policies. In their absence, discouragement and costly directionless searching take over.  Although the delay of the first set of measures did not in itself create a problem, it is a reflection of a deep problem that is yet to take its toll.  First of all, let’s clear up the myth that the first set of measures had to be so broadly targeted and expensive due to the speed and limited administrative capacity of the Serbian state. All the countries that Serbia compares itself with adopted the first set of measures in the third or fourth week of March. Serbia announced a set on March 31st, and it adopted it only on April 10^th.  Additionally, all the countries in the region, and many others outside it, had much more targeted sets of measures.

One instead of all

The question is why was the set of measures late? I have no doubt that it waited on the “de facto” Minister of Finance to stop doing the job of the “de facto” Minister of Health. The public is very familiar with the effort Aleksandar Vučić personally put in to control the health aspects of the epidemic during the first month of the crisis: from selecting the professional advice to rely on, through the procurement of respirators while playing geostrategic policy, to the role of a spokesman for the Crisis Task Force. In the meantime, the economy and economic line ministries were preparing proposals that were waiting for a response. The first economic messages he sent into the ether were related to maintaining salaries in the public sector, supplementing pensions, and giving raises to health workers. Most likely, he was only able to pay attention to the economy when new health policies were following advice from the Chinese physicians (at the beginning of the last week of March). Meanwhile, only the National Bank appears to have acted autonomously.

The biggest problem in all of this is not the tardiness of important decisions (e.g. currently—forming the new Government). Even the disenfranchisement of ministry leaderships is not an insurmountable problem – Vučić can replace more than half the ministers (the policy of mass testing adopted near the end of March was in fact correct). The problem is that the occasional benefit from such engagement cannot even remotely compensate for the damage done by the unpredictability and caprice of such decision-making at the highest level. It disempowers and paralyzes entire ministry realms, from top to bottom. The problem is exacerbated by the fact that it is accompanied by a subtle, yet effective, message that nothing is to be expected from the initiative of the small individual, within the government and outside it. There is no hint even of a message that joint action, mutual help, but also a free (and fair) competition of many small and big players in society can create something valuable for the whole society.

When we look at how other countries adopt measures, it is obvious that they work in parallel tracks. Measures spring up in waves: first one minister, then another is announcing a step, there is a public dialogue – some of it nationwide, some between ministries and their constituencies. Businesses are investing in adapting to the new situation by connecting their interests and the health of citizens in ways that only they could have thought of – digitalization, better ventilation, new procedures that protect both employees and clients. The governments, with detailed sanitary analyses and instructions, support and follow the initiatives.

Do not get me wrong: business people in Serbia are fighting hard, and individuals and institutions everywhere, even within the government, are working as hard as they can to adjust their activities and make them as useful as possible in this moment. During the crisis, the Chamber of Commerce stood out with its engagement and agility. But that is not the same as mobilizing entire ministry realms into coordinated action top-down and bottom-up. The first set of measures should have been understood as buying time – to prepare the economy and the state for the “new normal”.

A chip off the old block

The set of measures did buy time, but — what for? The clarification did not follow. Immediately after coming out of the state of emergency, many businessmen probably had unrealistic expectations. Less than five percent thought they would need any debt forgiveness to survive! Only later in June did the realization begin to set in that serious problems await for the medium term. Like anywhere, the business sector needed political leadership: the “de facto” prime minister initiating and supporting a nation-, or at least government-, wide dialogue about what this “new normal” will look like- how much will it cost, what expectations could no longer be realistic? Hardly anyone reading the international press could have doubted that the hospitality sector, and especially hotels focused on international tourism, would remain under unbearable pressure. What is the country’s policy for them five months after the outbreak of the crisis?

In this unprecedented crisis, no one has the crystal ball (or time) to work out ambitious policies and strategies. But it is possible and necessary to clearly weigh what portion of the country’s resources will be allocated to civic solidarity, and what to investments that we believe can pull everyone ahead? What principles do we stand for as a nation? One must, for example, choose between the following two: “unless something much worse than expected happens, we will not allow the country to be left without these, or such and such, hotels” or “we do not believe that even in a crisis like this, hotels should be helped. Some will fail, some who still have the resources will buy them.” With or without a national dialogue – which of the two is Vučić’s position? Instead of answering these questions, more than two months after the adoption of the first set of economic measures, the announcement of the second begins, and it is just a chip off the old set’s block.

Sorry, this entry is only available in SR.

By Kori Udovički, orig. 29/03/2020, rev. 01/04/2020

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The pandemic struck us just at the very moment when the payment discipline in Serbia begun significantly to improve. The measures to strengthen financial discipline in the private sector adopted in 2016 and the reduction in government arrears in the context of the fiscal consolidation, significantly reduced the chains of illiquidity in the system. Of course, no one could expect the pandemic, and it will inevitably cost us.  But if the payment discipline is now loosened, the pandemic will cost us much more. Clearly, those who cannot access liquidity will simply not be able to pay. It is the Government’s responsibility to make sure there are as few of those as possible.  In this, it must start from itself.

If the Government wants to mitigate the economic downturn during a pandemic and ensure its rapid recovery once the pandemic is over – a key task is to accompany intervention measures with safeguarding payment discipline. I start by assuming that it is clear to the reader how important this discipline is to economic growth. In short: non-payment creates a chain of illiquidity, which then creates problems for everybody. The first debtor affects his partners, suppliers, and employees, who in turn pull those, now many, into the third line of iterations, and so on. In this way, illiquidity snowballs through the system, further affecting everyone – even those whose business otherwise would not have been affected by pandemic at all. Its worse aspect is that it tends to spread distrust, discouraging new business ventures, and this carries over into the post-crisis period. Simply, economic activity is stifled over the longer term.

Payment discipline is actually one of the pillars of financial discipline. We understand financial discipline as “you incur only those costs that you can afford to pay”. We mostly interpret this as having to plan one’s budget carefully – which is, certainly, its first pillar. However, the discipline of realistic planning does not make sense unless it is accompanied by payment discipline. Once a cost has been incurred –it must be paid for. Even if it requires borrowing to pay. Not even the best plans can predict everything. Liquidity needs to be available/accessible if prompt payment is to always be possible. So, access to liquidity can be considered the third pillar of financial discipline. These three pillars reinforce one another. We will really take care to plan realistically only if we know with certainty that we will have to pay. Only if we plan realistically, will we be creditworthy when we need to access liquidity when unexpected problems do happen. And, finally, only if we have access to liquidity, will we be able to act upon that creditworthiness, that is–to borrow and to pay.

Financial discipline is a matter of political will and upgrading of the financial management system. In the distant past, we planned unrealistically and borrowed without much consideration. In the end, we paid for it through inflation. In the 1990s we had both hyperinflation and non-payment. Since the 2000s, we have started to plan somewhat more realistically, but not sufficiently. Therefore, we continued to fall back on non-payment, the so-called arrears. The unpaid expenditures from this year burden next year’s budget and hence leave less space for next year’s spending. However, this means that instead of the financial market, the difference is financed by businesses and citizens. The key at this point is to understand how harmful is the non-payment culture, and to tackle it. The Government needs to dare to look for liquidity in the market to cover the difference between expenditures and revenues, even unexpected ones. For financial discipline to be maintained despite more flexible borrowing in the market, Serbia needs to use more decisively and honestly its financial management instruments: primarily budget planning and oversight, which have been built over the past two decades.

Controlling the level of spending by limiting payments, in a time when the state needs to stimulate economic activity by increasing the deficit, is like stepping on the gas of a car while pulling the parking brake. It is this odd combination of actions that explains why in 2010-13 large fiscal deficits did not contribute more to growth. By the same token, a combination only in opposite directions explains how the recent sharp fiscal consolidation of 2015-2017 was not accompanied by such a larger contraction in economic growth: the tightening of the fiscal belt was accompanied by a reduction in public sector arrears giving the economy a substantial liquidity relief. It would be inexcusable if we fall into using the same wrong combination of instruments again. We need a true fiscal stimulus: a fiscal deficit, ie. overall public spending, paid for by adequate liquidity.

The price of the fiscal package, as well as its allocation, will be less important than the need that it be accompanied by a clear intention to maintain a sound financial discipline and the measures to do so. This should by no means be taken as a call to abandon reasonable budget planning. The state must weigh a very significant, but feasible package of support to the economy and citizens. In this greatly uncertain context, it is likely to err, but it should err on the side of looseness rather than tightness. We are witnessing “the mother” of unimaginable, unexpected events. Responsible planning, the first pillar of financial discipline will be observed if the plans are as realistic as possible, and then are revised as frequently as needed. The government, businesses, and citizens should certainly expect to produce much less this year, and therefore to be able to consume much less.

If paid in liquidity, excessive spending will be punished by inflation, which then needs to be quickly corrected.  However, in its early stages of acceleration inflation would get as much production rescued as possible. Some increase in inflation should be expected and allowed, (this is a supply contraction crisis).  However, if inflation starts accelerating, beyond 5-7%, then it could and should be arrested with corrective measures—tightening of spending, not by running arrears.   Loosening of financial discipline overall, would, of course, mean repeating the biggest mistake of the past. If accompanied by excessive liquidity, it would lead to hyper-inflation. If, as is more likely, accompanied by insufficient liquidity and non-payment it would drag us into a “swamp” of unfulfilled obligations, general illiquidity and insolvency as well as distrust, putting a break on the eventual recovery for the fourth time in three decades. This, clearly, would depress economic activity for a long time to come.

Focus on Payment Discipline

In order to support payment discipline throughout the system, the government must show commitment, set an example, and pay off all its outstanding obligations.  These are still substantial. Until recently, the state was the key ingredient in the lack of payment discipline in Serbia. On the one hand, as by far the largest single buyer in the market (procurement of goods and services by the public sector amounts to about 20% of GDP), its non-payments were, and may still be, the first and the biggest link in chains of non-payment. On the other hand, it is the Government that, through its example and actions, sets the culture of (non) payment. It sets the culture by taking on (un)realistic obligations and then (not)paying them, as well as systematically enforcing discipline in the private sector. This applies to both obligations that the Government assumes itself, and to those it obliges others to enter. Say, for example, that the Government requires the corporate sector not to lay off employees.  As we all know that many companies will not be able to pay them, if the Government would not provide the means for them to do it, then we would all know from the outset that the Government is counting with arrears. The culture of non-payment would start to spread.

Maintaining a steady flow of money into the economic system will require the state to cover the difference between planned and realized resources through borrowing on the financial markets (in these circumstances, ultimately, with the central bank “printing money”), and not as was the case so far, by running arrears. Only thus will it extinguish the fire of illiquidity instead of stoking it with non-payment. On the one hand, the deficit needs to be maintained at the desired level by strengthening budget discipline, i.e. through more realistic budget planning (and by revising plans when developments go in an unexpected direction). On the other hand, payments and / or injection of liquidity into the system must go smoothly. The “music has to keep going” while the government has to keep paying promptly for it.

Realistic budgeting requires a systematic, not just political, disciplining of the public sector. Politicians at the helm of the state, like all of their appointees as well as civil servants, should believe that they are to budget realistically and that their expenditures will be paid promptly. This requires the introduction of genuine professional ex-ante control of public budgets that will check the reality of planning. At first, politicians might think that they are at a loss because their discretionary influence on spending would be curtailed. However, they would soon discover that they can still steer spending through policies, while earning many points for successfully managing the crisis.

As far as the private sector is concerned, the discipline of payment suffices to enforce financial discipline. Until the culture is changed, payment discipline must be imposed, but it also has to be feasible. On the one hand, the prospect of enforced collection or bankruptcy, if credible, will force everyone to plan costs realistically and to pay for them. On the other hand, in situations just like the current one, the private sector needs to have access to enough liquidity to pay even when their plans will obviously have been missed.

Availability of Liquidity

Securing enough liquidity, the third pillar of financial discipline, in general is the responsibility of the central bank. In these circumstances, it will also require that NBS’s measures be strongly supported by the Government.

The NBS has already taken adequate earliest measures to ease the immediate pressure of debt servicing on the economy and citizens. As a first measure, a moratorium on debt payments was introduced. This has put pressure on banks’ liquidity that the NBS has eased using favorable monetary and foreign exchange operations. Subsequent measures should contribute to the activation of the financial sector in support of the economy, especially the most affected ones.  The problems are twofold in a crisis situation like the current. First, banks will need stronger incentives, as well as guarantees, to dare to issue new loans to most of their clients. It should be expected that tomorrow’s package of measures lends support to short-term lending, with low, zero or even negative interest rates. Negative interest is a subsidy to a bank and / or even a business entity. In this case, it is not only about providing liquidity but also about financial assistance to the borrower. The package is likely to also include significant government guarantees for loans issued by banks during the crisis, especially to the hardest hit sectors.

However, the second problem is that the above classic package of measures, aimed at enhancing liquidity through the financial system will not be enough for Serbia because its financial sector does not reach far or deep enough. The financial markets are so-called “shallow”-reflected in the low ratio of total domestic credit to GDP. While in countries with developed financial markets it is common for it to be 90-140% of GDP, in Serbia it is around 50%. In the more advanced transition countries. it is generally above 70-75%. This means, on the one hand, that our businesses rely heavily on own-resources and would not be hit as quickly by the bank credit crunch as those in more financialized countries. However, for the same reasons, our economy’s ability to recover from the crisis will depend on these funds not being exhausted. A particular issue is that most businesses are farmers and SMEs. SMEs generate about 27% and farmers about 6% of GDP. About half of SMEs do not borrow from banks, and the majority of those who borrow do so rarely. Under these conditions, banks will not know them well enough to take the risk or lending now. To make the problem worse, banks require guarantees in personal property from small businesses. How many will be willing to risk their property? And how fair is it to require it under these circumstances?

Matters are made worse by the fact that Serbia does not have an extensive network of special institutions dedicated to supporting and financing SMEs, like other countries do. For example, Germany’s package of measures envisages that significant amounts of liquidity assistance (€ 750 billion) are pumped through separate networks—the regular financial system and the network of support institutions for SMEs.

The state should help the NBS with its own actions as well. It would be a good idea to expedite the payment of all the Government’s liabilities dragging through the courts, or waiting in line to be paid by the Treasury. We know less about the Government’s first actions, but I hope that at least it will continue to spend regularly and pay its obligations promptly so that its powerful demand and liquidity help mitigate the contraction of the economy – until targeted measures in the announced package become operational. Also, in the very short term, I expect the state to assist the system’s liquidity through segmented deferral of tax liabilities – at different rates for differently affected sectors and even for different sizes of businesses. A low interest rate would encourage those who still do not need the liquidity to pay them anyway. The Government’s support measures for businesses and citizens will also supply liquidity. Subsidies were already provided to pensioners, and the payment of subsidies per employee for SMEs, should also be considered, especially for those in the most affected sectors. This would reach a significant number of households.

Many countries in the world (and Slovenia among them) have announced the purchase of corporate bonds that are likely to target vulnerable sectors. There are no corporate bonds in Serbia, but the possibility to help corporations issue them and hence start the development of the market should be considered. In particular, the economic viability and operational feasibility of securitizing claims on certain segments of the corporate sector, especially SMEs, should be considered. For example, the administrative securitization of 30% of the economy’s claims on SMEs with certain characteristics (size, sector, previous business performance) should also be considered. These securities could be packaged and the banks could buy them using facilitated credit terms and guarantees from the state. After the crisis, banks could unpack the packages, collect claims, and trade those securities. Most likely, business would emerge to interested in dealing with the assessment of the value of these securities and willing to trade and collect on them. Unlike many other scenarios, the risk of such a liquidity injection would be split between banks and the state and its cost could be calculated in advance.

The Serbian economy will not emerge stronger from this crisis, as will not the economies of the rest of the world. However, if there is political will, and with the proverbial ability of Serbia’s society to rally action and improvise in response to adversity, Serbia can come out of this crisis with a significantly strengthened system of macroeconomic management. This would allow it to be among the faster, instead of the slowest recovering countries.