Proposed Fiscal Consolidation Measures Republic of Serbia Fiscal Council 30 May 2012

2 Public debt crisis threat Continuous public debt growth – by the end of 2012 it will exceed 55% of GDP –Fiscal deficit on the rise – over 6% of GDP in 2012 EUR 2.5 billion new borrowing required by the end of the year –For financing the fiscal deficit and repaying the principal from earlier borrowing  Public debt crisis possible already in this year –Dinar freefall, inflation, employment drop, significant living standard decrease 2

3 Immediate measures to be taken 1.Short-term - to interrupt public debt growth already in 2013 –Thus averting the crisis already in Medium-term - for sustained public finance recovery –The deficit is structural – it would be high (4 - 5% of GDP) even without the crisis... –...and even higher with the crisis (6.2% of GDP) 3.Reforms - to lay the foundations for high and sustainable medium-term economic growth 3

4 Reduce the deficit immediately The deficit is the main public debt growth driver –... Apart from the deficit, government guarantee issuance control is required Necessary cut – EUR 1 billion in 2012 and And additional EUR 1.1 – 1.2 billion from 2014 to 2016 –In 2016 a balanced budget (deficit of 0% of GDP) 4

5 Short-term measures ( ) 1) Pension and wage freeze (EUR million) –In October 2012 and during 2013 Tax reform (EUR 300 million) –Reduction of tax burden on labour – from 65 dinars per 100 dinars paid, to 54 dinars (from January 2013) а) VAT increase to 22% (July 2012) б) Or VAT to 20% and pension and wage cut by 5 – 6 percent 5

6 Additional expenditure cut (EUR 400 million) –Sustainable fiscal decentralisation model (EUR 200 million) restoring the previous system (but with full transfers to the local level, 1.7% of GDP) or devolving the functions to local self-government units –Subsidies – abundant, unselective (EUR 100 mil.) –Remaining savings (EUR 100 million) Government agencies and extrabudgetary funds (closure, merger, integration in the budget, etc) Savings in public procurement and improved tax collection Short-term measures ( ) 2) 6

7  Without wage and pension freeze and VAT increase the necessary short-term savings cannot be achieved Short-term adjustment significantly larger in expenditure than in revenue –Around EUR 700 million of savings –Revenue increase of EUR 300 million Short-term measures ( ) 3) 7

8 Alternative Possibilities Without tax reform (i.e., without reducing the tax burden on labour), but freezing wages and pensions. -Increasing VAT to 20% Only increasing taxes, without freezing wages and pensions. -Considerable increase of VAT, 25-27% -Undesirable and rather unsustainable

9 Fiscal consolidation and public debt Without the tax reform and pension and wage freeze –Unsustainable public debt growth → crisis With the proposed programme –The trend is reversed in 2013 and the crisis averted –By 2016 it comes down to around 48% of GDP and continues to fall… –...to below 45% of GDP by 2017 or

10 Goal - deficit reduction from 3% of GDP in 2013 to 0% of GDP in 2016 –Exclusively through expenditure cuts – without tax increase –Increase in investment share to 5% of GDP in 2016 (so far on average around 3.5% of GDP)  Current expenditure cut by 4% of GDP ( ) Required reforms: pensions, wages and employment, public and socially-owned enterprises, subsidy system… … Plus: tax reform, sustainable fiscal decentralisation model, reform of agencies and funds Savings only a year or two after the start of implementation… …Preparation immediately, implementation from 2013 Medium-term reforms ( ) 10

11 Fiscal consolidation and economic development Significant reduction of the fiscal deficit is the best policy for increased economic growth –Decreasing of the risk premia and interest rates for businesses and households, and avoiding crisis – falling production and employment –Empirical analyses: less public spending  higher growth –In the first half of the year there was fiscal stimulus… –…leads to the increase in current account deficit, dinar depreciates, uncertain influence/impact on the economy at large, GDP falls More public investment and infrastucture –Desirable stimulus in the short term –Incentive for private investments (higher FDI)

12 Fiscal consolidation and economic development (2) Structural changes in public revenue –Higher tax on consumption, less on production –Increase of price competitiveness (fiscal devaluation), increased incentives for exports, and investments. Medium-term reforms –Economic environment, incentives for organizations et al. in the private sector development, predictability of the working environment, more efficient public enterprises…

13 Social policy priorities Temporary decline in living standards –Increase in taxes, utility prices, and freezing of wages and pensions –Inevitable, if not now then in crisis time (higher increase of prices and taxes) Mid-term (in 2014 or 2015) recuperation of losses –By 2016 ought to be past all negative effects Social security measures –Social help will be allocated to those most in need (thus, those receiving the smallest pensions will be exempted from the freeze) –Funds for immediate/one-off relief for the disadvantaged –Balanced distribution of fiscal burdens –Indiscriminate struggle against corruption

14 Tax Reform Graphic As earnings decrease, VAT increases. VAT Burden on wages

Tax reform –Increase in excise duties on tobacco and alcohol –VAT 22%, lower rate 10%, transfer of 1/5 of non- subsistence goods to the standard rate –More progressive wage tax, employers' contributions from 17.9 to 10% of gross wage –Burden on wages from 64% to 54% for average employee, and 45% for the minimum wage 1% of GDP of additional budget revenue 2% of GDP transfer from wage to consumption, economy rebalancing without impact on the budget 15

Pension System 16 Italy Serbia Austria France Portugal Greece Poland Hungary EU-10 Czech Lithuan. Romania Bulgar. Slovak. Latvia Ireland

Pension System Introducing actuarial neutrality factors –It's possible to receive a 200-eur pension over 20 year period or a 400-eur pension over a 10 year period, but the possibility to receive a 400-eur pension over a 20 year period needs to be eliminated. Increase in age req. for women to be eligible for retirement –Unsustainable disparity in retirement eligibility age-wise between men (65 y.o.) and women (60) 17

Wages and Employment 18 Wages, %GDP Serbia Slovenia Estonia Lithuania Hungary Latvia Poland EU-10 Romania Bulgaria Czech R. Slovakia

Wages and Employment 19 Serbia Latvia Hungary Lithuania Slovenia Bulgaria EU’10 Poland Estonia Slovakia Romania Czech R. Public wage premium over the remaining economy

Wages and employment Balancing wages in the public and the private sector Balancing wages within the public sector Headcount reduction in the public sector –Possible reduction by around 5% of 440,000 employees in medium term –Requires serious structural reforms in education, health, local and central government administration 20

State-and socially-owned enterprises Status and problems: –After ten years of transition, in Serbia there are still around 1,300 companies under state control –They receive direct and indirect subsidies (guarantees, no payment of liabilities, bridging gaps in pensionable years of service) – total government expenditure around 2.5% of GDP Меasures: –In a two-year period privatisation or bankruptcy –Solid budget framework and subsidy elimination –Management improvement –Price liberalisation and correction Еffects: –Savings of around 1% of GDP in

Fiscal decentralisation Status and problems: –Imbalance in the division of revenue and expenditure between the Republic and local communities –Low level of efficiency and minor competences of the local government level Меasures: –Short-term measures: prevention of wage and employment growth at the local level, local self-governments should reduce arrears and increase investment, increase in the Republic share in the wage tax to 60%/devolution of functions to the local level –Medium and long term: reduction of local headcount and subsidies to utility companies; promoting competition among local self- governments, improvement of transfers and political decentralisation; increase in competences of local communities Еffects: –Savings of around 1.5% of GDP in

Budget beneficiaries and extrabudgetary funds Status and problems: –Around 160 government institutions generate own revenues (by selling goods, providing services and collecting dues, fees for issuing licenses, permits, approvals…) –Own revenues remain at the disposal of budget beneficiaries for spending Меasures: –Comprehensive registry of all budget and extrabudgetary beneficiaries, revenue and expenditure to be presented in the consolidated government account –Significant portion of fiscal and quasi-fiscal revenue to be integrated in the budget, expenditure financed by the institutions with their own revenue to be reduced, institution merger/abolishment Еffects: –Savings of around 1.5% of GDP in