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Republic of Serbia: 2013 Article IV Consultation

International Monetary Fund. European Dept.
Published Date:
July 2013
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External Sustainability Assessment1

Serbia faces serious external vulnerabilities that are currently mitigated by large reserve buffers and a relatively flexible exchange rate. Yet Serbia’s ability to service external debt could be endangered by adverse shocks, in particular to the exchange rate. Going forward, policy choices are crucial for medium-term external solvency. Under unchanged policies, significant exchange rate overvaluation could lead to persistently large current account deficits and a further deterioration of the net international investment position. In addition, projected external financing needs, roll-over risks, and drawdown of reserves would pose a challenge to external liquidity. Durable fiscal consolidation and structural reforms are therefore needed to reduce the current account deficit to a sustainable level, maintain adequate reserve buffers, stabilize the net international investment position, and help mitigate exchange rate misalignment.

A. Partial External Adjustment

1. Serbia’s large current account deficit partly improved since the onset of the global crisis. The current account deficit has consistently been higher than that of regional peers due to low domestic savings, and was on an increasing path during the pre-crisis period. The crisis led to a sharp reduction in domestic demand, external financing, and net imports, and consequently led to a significant current account deficit adjustment (Figure 1). Yet at end-2012, Serbia and Albania were the only two countries in the region with current account deficits of over 10 percent of GDP.

Current Account and Exports

(percent of GDP, 2012)

Source: National Bank of Serbia, IMF

Figure 1.Serbia: Balance of Payments, 2004–12

Sources: NBS and IMF staff calculations.

2. Trade deficits have narrowed after the crisis, but remain very large. This reflects a low export base and a recent plateauing of exports—despite a recent boost from Fiat exports—as Serbia’s exports faced several exogenous shocks including a closure of a steel-exporting plant, temporary effects of draught on agricultural exports, and lower demand from euro area trading partners.

Trade Deficits

(percent of GDP)

3. Current account deficits were financed by rapid accumulation of private external debt, and recently by public indebtedness. External indebtedness of the private sector peaked at 53 percent of GDP in 2010 from a low of 12 percent in 2004, implying a significant rise in foreign exchange risk. Additional vulnerability arises from nonfinancial firms’ high share of private external debt (70 percent), as their ability to hedge FX positions is limited. At the same time, public external debt more than doubled since 2008 to 41 percent of GDP in 2012.

Current Account and Net Foreign Disbursements

(percent of GDP)

Source: National Bank of Serbia and IMF.

B. External Vulnerabilities and Buffers

4. High external deficits and debt pose external vulnerabilities. At end-2012, Serbia’s external performance was weak relative to its peers, with one of the lowest export-to-GDP ratios and one of the highest current account deficits as percentage of GDP. Its undiversified and low export base makes it vulnerable to terms-of-trade shocks. Given Serbia’s external debt of 86 percent of GDP, higher global risk aversion could increase the cost of financing and heighten rollover risks of the private and public sectors.

External Debt, 2012

Source: National Bank of Serbia and IMF.

5. Serbia’s ample reserves mitigate somewhat the large external vulnerabilities. Gross international reserves at EUR 10.9 billion at end-2012 were above the standard rules-of-thumb for three months coverage of prospective imports of goods and services, 100 percent of short-term debt (at remaining maturity), and 20 percent of broad money. Reserve coverage is higher than suggested by the risk-weighted metric recently developed by Fund staff.2 Under such a metric, Serbia recorded the highest coverage in the region in 2012. All the above holds even if the assessment is based on reserves net of FX reserve requirements held at the central bank.

Gross International Reserves and Benchmarks

(in billion of Euros)

Source: National Bank of Serbia and IMF staff calculations.

International Reserves

(percent of risk-weighted metric)

Source: IMF staff calculations.

6. Yet despite the large reserve buffers, Serbia’s net indebtedness to the rest of the world is high. Serbia’s net foreign liabilities are large in cross-country comparison, and net FDI stock represents only about half of the total. Serbia’s large accumulation of net foreign liabilities stems from protracted external imbalances associated with long-delayed structural reforms, fiscal imbalances, and the over-indebtedness of the private sector before the crisis. Catao and Milesi Ferretti (2013) argue that external crisis risks increase significantly when net foreign liabilities exceed 50 percent of GDP. Hence Serbia’s large negative net international investment position is an indicator of external vulnerability.

International Investment Position

(percent of GDP, 2011)

Source: National Bank of Serbia, IMF

C. External Sustainability Illustrative Simulations

7. Assessment of external sustainability hinges on assumptions about future macroeconomic variables and policies. External sustainability requires the real exchange rate to be in line with its equilibrium value. The assessment under the two illustrative scenarios described below involves modeling the medium-term equilibrium value of the real effective exchange rate and comparing it to the country’s projected level of the current account deficit, to investigate the need for further adjustment. The most widely used approaches are the macroeconomic balance, external sustainability, and equilibrium real exchange rate methods. In Serbia’s case, absence of long time series precludes the use of the equilibrium real exchange rate method. Hence results from the other two methodologies are presented. The current account norm is obtained by modeling the current account balance as a function of saving and investment in medium-term equilibrium without explicitly taking the real effective exchange rate into account. The underlying current account deficit is instead based on the determinants of exports and imports in medium-them equilibrium and is a direct function of the real effective exchange rate. The degree of exchange rate misalignment relative to medium-run fundamentals is then inferred as the proportional change in the real effective exchange rate needed to reconcile the underlying current account balance with its norm.

8. Under the illustrative unchanged policies scenario, persistent external imbalances would be associated with an overvalued exchange rate. The projected underlying current account deficit at about 10 percent of GDP would remain above the current account norm estimated at 6 percent of GDP. Under this scenario, the dinar appears overvalued compared to medium-term fundamentals in the absence of fiscal consolidation and meaningful structural reforms. The macro balance (MB) and external sustainability (ES) approaches suggest overvaluation in the range of 15–20 percent. Serbia’s current adequate reserve coverage would be depleted as a result of external financing constraints and its negative international investment position would follow a decreasing path.

9. Sustained policy efforts would correct external imbalances. Durable fiscal consolidation and structural reforms targeted at improving the business environment, as in the illustrative adjustment scenario, would help ensure external sustainability, mitigate dinar overvaluation, preserve adequate reserve buffers, and reduce Serbia’s net indebtedness to the rest of the world.

Serbia: Exchange Rate Assessment 1/
ScenarioApproachREER misalignment (percent)
Unchanged policyMB20.3

Based on IMF CGER methodology extension in Vitek, 2013 (Vitek, Francis, “Exchange Rate Assessment Tools for Advanced, Emerging, and Developing Countries”, mimeo, 2013).

Based on IMF CGER methodology extension in Vitek, 2013 (Vitek, Francis, “Exchange Rate Assessment Tools for Advanced, Emerging, and Developing Countries”, mimeo, 2013).

Figure 2.External Sustainability Illustrative Simulations

Sources: Serbian Authorities; IFS; WEO; and IMF staff projections.


    Catão, Luis and Gian MariaMilesi-Ferretti,2013, “External Liabilities and Crises,”IMF WP No. 13/113.

    Vitek, Francis,2013, “Exchange Rate Assessment Tools for Advanced, Emerging, and Developing Economies,”mimeo, IMF.


Prepared by Cesar Serra (SPR).


The suggested appropriate range is 100–150 percent of the risk-weighted metric. The risk-weighted metric for countries with floating exchange rate is computed as 0.3*short-term debt (at remaining maturity) +0.1*(stock of portfolio and other investment liabilities)+0.05*(broad money) +0.05*(exports of goods and services).

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