SERBIA: POLITICAL PRESSURES DRIVE PENSION HIKE

UNCLAS BELGRADE 000886 SIPDIS USDOC FOR 4232/ITA/MAC/EUR/OEERIS/SSAVICH E.O. 12958: N/A TAGS:, SR, MW SUBJECT: SERBIA: POLITICAL PRESSURES DRIVE PENSION HIKE REF: BELGRADE 708 Summary -------------- ¶1. On August 28 the Government of Serbia approved an extraordinary increase of pensions by 10% starting in October 2008. Together with the regularly scheduled 7% pension increase the total increase in October will be 17%, with an additional $144 million cost to this year's budget. The government supported this increase under pressure from the coalition partner Pensioners Party to address their demand to increase pensions up to 70% of the average salaries. Analysts said that this move could have dangerous consequences for macroeconomic stability and the budget. Economists, including USAID and World Bank advisors, recommended that the government develop a comprehensive pension reform plan, rather than making adjustments ad hoc to the pension system. End Summary. Government Votes to Increase Pensions -------------- ¶2. On August 28 the Serbian government approved an extraordinary increase if pensions of 10% starting in October 2008. Together with the regularly scheduled six-month adjustment for salaries and inflation of 7%, the total increase in pensions this October will be 17%. Deputy Prime Minister Jovan Krkobabic (Pensioners Party, PUPS) said that this increase would require an additional $144 million in expenditures for 2008. Krkobabic also said that this hike would push pensions up to the previous minimum of 60% of average salaries. Krkobabic said the government should propose changes to the current pension law that would stipulate an additional increase of pensions up to 65% by mid 2009 and up to 70% of the average salaries in Serbia by the end of 2009. Analysts Highlight the Risks -------------- ¶3. Jurij Bajec from the Economic Institute told us on August 29 that the Government would probably manage to cover the pension hike for this year but the real problem would be the new higher base for the next year. According to Bajec, the main problem was a political promise to increase pensions up to 70% of the average salaries given to the Pensioners Party as a prerequisite to form the current government. Bajec said that changes to the current pension law would open many questions that needed thorough analysis instead of ad hoc policy decisions. He concluded that the current pension hike would be probably covered through sale of bonds and an increase in public debt. ; ¶4. Bajec's colleague Ivan Nikolic told us that the government had underestimated the cost of the 17% increase. According to the Institute's estimates, just for the rest of 2008, the government would need $350 million to cover the increased pension costs. Nikolic said that additional government indebtedness was inevitable and he warned of slower growth and lower revenues if state investments suffered in the rebalanced budget. Finance Tries to Put the Best Face on the Increase -------------- -------------- ¶5. Janko Guzijan, State Secretary at the Ministy of Finance, said publicly following the government decision that the budget was "operating at its fiscal limits." According to Guzijan, the pension hike would be covered through savings and additional revenues in the rebalanced budget, avoiding additional increases in public spending and budget deficit. Guzijan said that the main problem was that the political promises made to form the coalition could be implemented in a four year mandate but not in a single year. Vuk Djokovic, director of the respected Center for Advanced Economic Studies (CEVES),said that pensions counted for 13% of the current GDP. With the promised increase up to 70% of the average salaries, that share would jump to 17% of the GDP with a budget deficit of 5-6% of the GDP. Comment -------------- ¶6. The government was expected to adjust pensions upwards because of the promises to build the coalition. However, it is not encouraging that this decision was taken without a clear strategy for pension reform and budget restraint. Ironically, just this week a senior World Bank advisor on pensions was in Belgrade meeting with the government urging development of a comprehensive pension strategy. USAID advisors have been working closely with Ministry of Finance officials to develop cost projections for comprehensive pension reform. The Ministry understands the challenge Serbia faces, but the new Finance Minister has a difficult task to reign in the political forces seeking to pay off on campaign promises. ¶7. Ultimately, the important question of how the government calculates pension adjustments for inflation and wages in the future will determine how costly this 10% boost will be in the coming years. Serbia had been moving to increase the weight of inflation over wages (which rise more quickly) in the calculation of regularly scheduled pension adjustments. If Krkobabic succeeds in indexing pensions solely to wages the Serbian economy will pay a heavy price. Serbian economic growth cannot continue at its recent strong pace with rising budget deficits and growing inflation. The government's decision will increase macroeconomic pressures on the Serbian economy and make it even more important that the government rapidly accelerate the pace of privatizations and regulatory reform. Without government action to support economic (private sector) growth, and not just government spending, the Serbian economy will stumble in the coming months. End comment. MUNTER