Republic of Serbia Fiscal Council 31 July 2014 ANALYSIS OF THE OPERATIONS OF STATE-OWNED ENTERPRISES KEY POINTS AND RECOMMENDATIONS FOR BUDGET REVISION.

Republic of SerbiaFiscal Council

31 July 2014

ANALYSIS OF THE OPERATIONS OF STATE-OWNED ENTERPRISES

KEY POINTS AND RECOMMENDATIONS FOR BUDGET REVISION AND MEDIUM-TERM FISCAL ADJUSTMENT:

2015-2017 

Three pillars of fiscal consolidation1. Reforms – adoption of laws that will lay the foundation for stable

public finances in the medium term− Law on Pension and Disability Insurance, Law on Labour (economy, but also the

basis for public enterprises and public administration), Law on Privatization (restructuring)…

− Positive assessment, but the biggest challenge is yet to come (downsizing of employees), savings will not be made immediately

2. Bringing order in public and state-owned enterprises – the most difficult and uncertain

− Huge problems: political (interest groups) and professional (redundant employees and their benefits, uncollected payment for services, inadequate prices, etc.) – there is still no adequate plan for addressing these issues

− If this is not done, there will be an explosion of public expenditure and failure of consolidation

3. Establishing a sustainable level of budget expenditure− Suplementary budget: a step towards reducing the huge deficit and eliminating the

biggest imbalances2

Public and state-owned enterprises are the biggest problem

• Already incurred a large fiscal cost (1 billion euros annually)– And it keeps growing; unless reversed, it will make all savings useless

• Srbijagas – It has already spent the state funds equal to the value of Telekom and continues to

generate losses

– Network of problems – the problem is not only Srbijagas, but also Azotara, Petrohemija, MSK, city heating plants…that do not pay for gas

• EPS– Numerous problems, not only low prices but also redundant employees, poor

payment collection, organisational fragmentation, losses in distribution (thefts)… beginning of liquidity problems, now the floods – new Srbijagas?

– Other public enterprises have similar problems, but the operations of EPS are measured in hundreds of millions of euros, which is too much for public finances

• Serbian Railways– There is no progress for decades - huge government subsidies spent, the 19th century

train speed, project funds not withdrawn

– Huge system (20,000 employees) with problems, together with EPS nearly 60,000 employees out of the total of 250,000 in all public and state-owned enterprises 3

High deficit in 2014 -over 2.6 billion euros (8.3% of GDP)

• Projected deficit of 2.5 billion euros has been exceeded for about 150 million euros– Combined result of drop in revenues of about 400 million euros and

decrease in expenditures of about 250 million euros

• Public revenue shortfall is primarily the result of changed macroeconomic environment (objectively)– Extremely low inflation (2% instead of expected 5% - lower public

revenue), recession and larger drop in formal employment than projected

– Missing and budgeted effects of combating grey economy (unrealistically planned)

• Public expenditures were under control– Finally stopped salary increase above indexation (there are savings) –

positive

– Inefficient execution of public investment – negative 4

Public debt at the end of the year over 70% of GDP

• In countries like Serbia – even a significantly lower level of public debt leads to a crisis– It is difficult to reverse the growth of public debt – it will reach 80% of

GDP (even with substantial cuts)

– Creditors can easily lose confidence - a crisis of public debt

• Large public debt is not the only risk – Annually over 5 billion euros (17% of GDP) needed to finance deficit and

pay due debt

– According to international standards – there is a risk of crisis with due payments of over 15% of GDP

• Stopping the growth of public debt share in GDP - fiscal consolidation– Investors need to see a credible plan for medium-term adjustment and

stopping of public debt growth in order to continue lending money5

Fiscal consolidation –2 billion euros of savings

• In order to stabilise the public debt by 2017, the deficit must be reduced to below 1 billion euros (from the current amount exceeding 2.6 billion euros)

– However, some expenditures will be growing: payment of interests (as long as there is a growth of public debt) and public investment (currently insufficient)

– Required savings of nearly 2 billion euros

– Reforms and improvement of public finances are required, but "painful" cuts cannot be avoided (there are no easy solutions)

• Serbia’s credibility is low and adjustment of 2 billion euros is possible only in the medium term

– New arrangements with the IMF required

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  Possible savings(million EUR)

Time of full effect Current situation Risks

Public and state-owned enterprises 

400 – 500 Next 3 to 4 years Unfavourable – problems are rapidly increasing instead of

decreasing

High – professional (plan and downsizing of employees,

appropriate prices, collection of receivables, technical

improvements and investment, etc.) and political (interest groups)

Cutting salaries and pensions by 15% 

800 2015 Pending political decision Low – possible exemption from salary cuts for individual public

sector categories

Combating grey economy 

300 – 350 Next 2 to 3 years Initiated personnel changes in the Tax Administration, some positive effects are already

noticeable: increased collection of contributions and excise tax on oil products, decreased revenue from

cigarette excise taxes

 Moderate – presently on the right track, but major challenges still lie

ahead

Reforms (of earnings and employment, pension reforms, etc.) 

300 – 400 Next 2 to 3 years, longer for pension

reform

Adopted the reform Law on Pension and Disability Insurance; the central registry data are being prepared; beginning of the salary grade scale reform announced for autumn; there is no information about downsizing plans at the

local level, in the sectors of health care, education, state administration, etc.

Low – for pension reformModerate – for salary grade scale

High – for redundancies

Total 

≈ 1,900 By 2017 Unfavourable – trends of deficit, enhanced problems of public

enterprises 

Favourable – still low interest rates, political environment

 The highest risk – bringing order in

the business operations of public enterprises

Fiscal consolidation must be comprehensive

• It is futile to cut salaries and pensions without solving the issue of public and state-owned enterprises (∙∙∙∙∙).

• It is insufficient to solve the issue of public enterprises without cutting salaries and pensions (----); it is necessary to do both ( ─ ).

• In order to stabilise the public debt, it is necessary to reduce salaries and pensions by 15%

smaller reduction of salaries and pensions would require additional adjustment measures, most probably further tax increase – an inferior measure

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Fiscal consolidation and growth• The major deficit adjustment (3% of GDP) in the first year of

consolidation (2015) – Front-loading– Each successful fiscal consolidation has the biggest deficit reduction in the

first year

– Important for entire programme credibility - a smaller deficit makes the continued fiscal consolidation less risky - will be rewarded with confidence

– Political economy – it’s now or never

• Strong deficit reduction leads to reduced economic activity, which can be mitigated– Fiscal consolidation of 3% of GDP would lead to a temporary drop of GDP by

roughly 1%

– If not mitigated = deflation and recession failure of programme

– It can be avoided with a broader package of fiscal and monetary policy measures to boost economic activity

– Positive effect on economic growth from increased public investment (recovery after the flood), business environment (Law on Construction, etc.), attracting investors, perhaps considering fiscal and credit incentives 9

Public revenue in 2014

• Revenue shortfall of about 50 billion dinars• 30 to 35 billion objectively, due to changed economic

circumstances– Inflation below the lower bound: 2-2.5% against the projected 5.5% – Greater drop in employment: 1.5% against the expected 0.7%– Economic recession, floods

• 20 billion dinars due to optimistic budgeting– Revenue from grey economy included in advance; however, measures have not

been implemented in the first half of the year

• The 2013 trend of weakening tax discipline has been stopped

– Efficiency of VAT collection unchanged compared to 2013– Collection of payments for contribution partially improved – Pace of excise tax collection is extremely divergent

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Excise tax revenue

• A large growth of excise tax collection recorded for oil products

• A large drop recorded for tobacco products11

Oil products Tobacco

Combating grey economy

• One of conditions for fiscal consolidation and sustainable economic growth

• It is possible to increase revenue by 350 million euros by 2017

• It requires a systemic approach and political support− Ad hoc measures implemented in 2013, attracting media attention,

are not the right solution

• Some progress has already been made , but substantial efforts are still needed− Personnel improvements, more efficient control system

− Coordination of tax authorities, inspections, judiciary12

State-owned enterprises• Revenues are not sufficient even for salaries• Illiquidity

− Explosion of short-term debt and spillover to the state• Failure to collect payment for supplied goods and covering

debts of loss-generating enterprises• Low sales prices of goods and services

− Imposed social function• High number of employees and mass of earnings

− Number of employees, salaries, 13th salary, bonuses, loans• Public procurement

− Possible savings• Low investment

− Lagging behind for decades• Poor management, party management

− Inappropriate selection of management, sponsorship, public procurement, incorrect accounting reports 13

Problem solving guidelines

• Professionally and politically challenging process:– Concurrent elimination of several problem sources (Srbijagas, EPS,

etc.)

– Problem diagnosis and awareness exist, we need consistent implementation

– Reform of public enterprises affects interests and it is politically and socially challenging

• This has to be done:– Privatization; stop the practice of selling without collecting payment;

price liberalisation; downsizing of employees and reducing salaries; greater investment and improvement of performance indicators; hard budget constraints; transparency; resolving the future status of enterprises in restructuring; corporate governance; centralised monitoring of the operations of enterprises

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