Sustainability of fiscal framework and economic growth in Serbia

Abstract

In the last three years, Serbia led a very expansionary fiscal policy, with a fiscal deficit higher than the average of the countries of Central and Eastern Europe (CEE) 1 and the Western Balkans 2 . This led to a significant rise in public debt in absolute terms, while public debt-to-GDP ratio increased only slightly, due to the currency structure of debt, the unchanged exchange rate of the dinar against the Euro, and high inflation. At the end of 2022, Serbia was the European median in terms of public debt, although the debt was above the average of comparable CEE countries. Despite the moderate level of debt, public interest expenditures and the effective interest rate on Serbia's public debt are relatively high in European terms, which is a consequence of the fact that financial markets in less developed countries see the limit of sustainability of public finances at a lower level of indebtedness than in developed countries. Tightening of monetary policy in the world will trigger the further increase of government spending on interest, which may crowd-out more productive public expenditures or narrow the room for tax cuts, which is why it is especially important to keep the public debt at a lower level in the coming period. At the end of 2022, Serbia implemented a fundamental reform of fiscal rules. The advantage of the new fiscal rules is reflected in a lower deficit target and a more detailed elaboration of the government's response mechanisms to violations of the rules. Raising the public debt ceiling to the upper limit of the prohibitive zone, the elimination of countercyclical elements in the deficit rule and the absence of clear escape clauses for periods of crisis may pose a limitation. The new fiscal rules could contribute to the sustainability of Serbia's fiscal policy, provided that their consistent and continuous application is ensured.