Modest Recovery Ahead

BMI View: The Serbian economy posted a real GDP growth of 2.1% y-o-y in Q113, confirming our expectation that the economy is poised for a modest recovery this year. We continue to forecast full-year growth of 1.2%, which will increase to 3.4% in 2014, driven mainly by a pickup in fixed investment and private consumption, which will offset the negative contribution to growth from government consumption.

The Serbian economy suffered severe setbacks in 2012, as a result of drought, which halved agricultural production and hit exports, while leading to a double digit inflation and eroded consumers' purchasing power. As these effects are already receding in Q113, we believe that the economy is poised for a modest rebound. Serbia's structural deficit means net exports will continue making a negative contribution to GDP, similar to public consumption, which will remain limited by the government's fiscal consolidation drive. On the other hand, we see a positive contribution from fixed investment on the back of an expanding manufacturing base, in addition to support from private consumption on the back of improving purchasing power. As a result, we forecast full-year growth of 1.3% in 2013 and 3.4% in 2014 in real terms.

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Poised For A Rebound
Serbia - GDP, Constant 2005 prices RSDmn, % chg, y-o-y

BMI View: The Serbian economy posted a real GDP growth of 2.1% y-o-y in Q113, confirming our expectation that the economy is poised for a modest recovery this year. We continue to forecast full-year growth of 1.2%, which will increase to 3.4% in 2014, driven mainly by a pickup in fixed investment and private consumption, which will offset the negative contribution to growth from government consumption.

The Serbian economy suffered severe setbacks in 2012, as a result of drought, which halved agricultural production and hit exports, while leading to a double digit inflation and eroded consumers' purchasing power. As these effects are already receding in Q113, we believe that the economy is poised for a modest rebound. Serbia's structural deficit means net exports will continue making a negative contribution to GDP, similar to public consumption, which will remain limited by the government's fiscal consolidation drive. On the other hand, we see a positive contribution from fixed investment on the back of an expanding manufacturing base, in addition to support from private consumption on the back of improving purchasing power. As a result, we forecast full-year growth of 1.3% in 2013 and 3.4% in 2014 in real terms.

Poised For A Rebound
Serbia - GDP, Constant 2005 prices RSDmn, % chg, y-o-y

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Household spending fell by 1.1% in Q113, as record high unemployment and double-digit inflation in 2012 continued to weaken consumer confidence into the beginning of 2013. Unemployment, at 24.1% in April, will remain an impediment to household spending, as will be declining real net wages, at 1.2% in April. Despite this, we see a number of positive factors that signal a modest turnaround for this component of GDP, underscoring our forecast of full-year growth of 1.2% in 2013. Enter Text

Signs Pointing To A Reversal
Serbia - Retail Trade Constant Prices, Real Net Wages, % chg y-o-y

With the Consumer Price Index posting 9.9% year on year growth in May from 11.4 y-o-y in April and an average of 12.1% for Q113, we expect inflation to abate even further this year and fall to 5.0% by year-end. This will provide an important boost to consumer purchasing power. Secondly, even though real net wages declined by 1.2% y-o-y in April, this was a marked improvement from the 8.4% y-o-y decline in March, and given that inflation is poised to subside, we expect to see a rebound in households' real incomes this year. Finally, although retail sales contracted by 3.8% y-o-y in May, this marked a substantial improvement from the 17.5% decline in March. Overall, we expect private consumption to rebound mildly this year and grow by 1.2% by year-end, contributing 0.9 percentage points (pps) to growth in 2013, and to grow by 2.5% in 2014, contributing 1.9pps to growth.

Government Consumption

Serbia's growing foreign debt burden, coupled with its aspirations to abide by EU rules for membership eligibility, will continue to motivate the government's fiscal consolidation efforts, and we do not expect the administration to boost expenditure for the foreseeable future. At the same time, however, it is unlikely to see more drastic expenditure cuts either, in light of recent disagreement voiced by Finance Minister Dinkic over the IMF's recommendations to cut public sector wages and pensions above a certain level by 10%. Instead, the government is trying to avoid harsher conditionality attached to deals with the IMF, by approaching the World Bank for help with structural reform.

Even though the government is not willing to cut public sector wages and pensions, it is nevertheless ready to take significant steps towards fiscal consolidation by reducing subsidies and guarantees to loss-making state owned enterprises, as evident from the recently revised budget aiming to rein in expenditure. Taking into consideration these factors, we forecast a conservative public spending contraction of 1.5% in real terms this year, subtracting 0.3pps from GDP in 2013.

Gross Fixed Capital Formation

Q113 saw fixed investment shrink by 3.9% as subdued domestic and external demand have continued to limit the incentive for businesses to invest. Industrial production declined by 0.5% y-o-y in May, due to falling production of manufactured food, machinery and equipment, non-metalic mineral products, and electronic and optical products. Nevertheless we see other segments of industrial production, as well as the energy and transport sectors to broadly offset the downward pressure on investment stemming from weak demand, underlying our forecast for fixed capital formation to grow by 5.0% in 2013 and by 6.0% in 2014 in real terms.

Manufacturing To Reverse
Serbia - Industrial Production Index, Manufacturing %chg, y-o-y

Already, production of motor vehicles grew by 302% y-o-y in May on the back of expanding operations of the Italian automaker Fiat's subsidiary, set up in mid-2012, which is likely to offset falling production in the other industrial segments and lead the overall production index into positive territory by year-end. In addition, the motivation to close Serbia's sizeable infrastructure deficit has led the government to foster ties with several Chinese companies, which already started operating in the area across various sectors including energy and transport ( see, 'China and Europe Drive Roads And Energy Growth', March 15), a trend our Infrastructure team sees continuing.

Another factor behind our relatively optimistic outlook on fixed investment is the likely improvement in the business environment this year in light of the EU's recent announcement to begin accession talks with Serbia which is likely to bolster investor confidence in the country going forward. Looking further ahead, the country's labour cost competitiveness and relatively educated labour force will be an important pull-in factor for attracting foreign investment.

Net Exports

We expect export growth of 10.0% in 2013, led by a rebound in agricultural exports and continued expansion of the automobile manufacturing sector. The impressive y-o-y expansion of 13.5% that exports posted in Q113 lends further support to our forecast. At the same time, imports grew by the modest 1.2% in Q113 due to subdued domestic demand. However, we believe that imports will pick up driven mainly by imports in the machinery and transport equipment segments. The reason for this is the exported manufacturing goods' dependence on imported capital goods and intermediary inputs. Overall, we expect imports to grow by 7.5% in 2013 and by 8.5% in 2014, subtracting 4.3pps in 2013 and 5.1pps in 2014. Because imports exceed exports in volume terms, net exports will remain a drag on growth, subtracting 0.4pps in 2013.

Risks To Outlook

The main risks to our forecast pertain to fixed investment. It is possible that the growth in the energy and infrastructure industries we expect to see this year takes longer to materialise. In addition, foreign investor interest might remain subdued despite positive developments in the domestic business environment. In this case, we would revise down our forecast for fixed investment growth.

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Sector: Country Risk
Geography: Serbia, Serbia
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