Serbia Wants In The European Union -- But Does It Have The Economy, And The Human Rights Record, To Make It?

LONDON -- Almost 20 years after the end of the conflicts that scarred the Balkans in the 1990s and destroyed Yugoslavia, Serbia is gearing up for what could be a major milestone in its recovery: entrance into the European Union. Long-awaited EU membership talks are expected to begin in January.

Traditionally the Balkans’, and former Yugoslavia's, manufacturing hub, Serbia suffered a significant economic downturn after a series of genocidal wars in the 1990s. For now, the best public relations the country has generated in more than a decade comes from tennis star and native son Novak Djokovic.

Yet Serbia has much to recommend it to the EU. PricewaterhouseCoopers ranked it the third-most attractive manufacturing and seventh-most attractive foreign direct-investment destination among emerging economies.

Tough economic reforms are beginning to take effect following significant setbacks in employment and development brought on by the global financial crisis. Before 2008 Serbia averaged 4 percent growth annually, but data released by its Ministry of Finance from a survey last April indicate that unemployment rose from 13.6 percent in 2008 to 24.1 percent in 2013.

For the EU talks to progress smoothly, Serbia must improve its image in the eyes of other European nations. Under its then-president, Slobodan Milosevic, who died in custody at the Hague seven years ago while on trial for crimes against humanity, Serbia (then the largest component of what was formerly Yugoslavia) became a much-reviled villain of Europe. The conflicts of the 90s, culminating with a 1999 war with NATO, encompassed complex and bitter conflicts among Serbs, Croats, Bosnians, Slovenes, Albanians and Macedonians that led to the deaths of 140,000 people. Milosevic was voted out of office in 2000.

The Yugoslav wars are often referred to as Europe's bloodiest conflict since World War II, and included mass murder and genocide -- neither of which is soon forgotten. A decision by Serbian authorities to ban a gay pride march in September, ostensibly on security grounds, further raised questions in the international community about the Serbian government's commitment to human rights.

Serbia must also reassure crucial foreign investors that it is serious about stamping out corruption, observers say. “The fight against corruption in all areas is at the heart of the EU's interests and is really a priority for Serbian society," said Belgrade-based World Bank economist Lazar Sestovic. Corruption, he added, "is a stumbling block for faster investment growth. When people see cases in which allegedly corruption was involved that have gone on for years moving forward, that will provide reassurance. It's the single most important factor that can change perceptions of Serbia."

According to Prime Minister Ivica Dacic, recent progress on relations between Serbia and Kosovo was an important step forward. Following decades of ethnic tensions, which culminated in a failed plan to give the majority Muslim and ethnic Albanian population in Kosovo more autonomy, the region unilaterally declared independence in 2008. The move was rejected by Belgrade, but there have been some signs of thawing relations in the past several years.

“Normalization of relations with Pristina [Kosovo's capital and largest city] was one difficult aspect of European integration, but a focus on honesty, integrity and realism in talks has helped us achieve real progress this year and conversations are ongoing,” Dacic said.

Vladimir Tomic, assistant director for foreign direct investment at the Serbia Investment and Export Promotion Agency (SIEPA), believes the country’s image abroad is improving. Serbia still suffers the repercussions of its past, but has made progress since the election of the new government and with continuing talks with Kosovo. "This will help Serbia create a better image as a secure place for investment,” he said at the Serbia Investment Day conference in London in October 29.

Serbia is keen to move on from the memory of the 1990s, with economic sanctions, civil war and the associated damage to infrastructure and industry during NATO airstrikes. But to join Europe, it has to get its public finances in order too.

A raft of economic reforms unveiled in October aim to rein in public debt and cut a bloated budget deficit to two percent of GDP by 2017, compared with an International Monetary Fund deficit forecast of about 7.5 percent for this year. Figures on the CIA website show Serbia's budget deficit stood at an estimated 7.7 percent of GDP in 2012, putting it at No. 190 on a list of 215 countries.

The reforms include raising taxes, cutting subsidies for struggling state companies, reducing public-sector workers’ pay and cracking down on the so-called gray economy of tax evasion that makes a large hole in state coffers. Those changes are expected to make life tougher for many, but Sestovic isn't worried. “There is a public support to these measures since the fiscal burden of not implementing them is unbearable for the Serbian budget,” he said. “The government envisages a similar level of deficit for 2014 as it was in 2013. The main reason is the fact that it needs to implement some costly structural reforms.”

“The past two decades have not been easy for Serbia, as the country has seen cruel wars, sanctions, bombardment, inflation and a devastated economy,” Prime Minister Dacic said in October, as the government prepared for Serbia Investment Day, when it highlighted its strategy of seeking more international investment. “We know there are many areas to address and improve before we can be a part of the EU, but we are working on this, and our European partners recognize our determination to make things better. Consolidation of the economic system is our first priority as we move even closer to the EU.”

SIEPA’s Tomic said he hopes the reforms will have a positive influence on foreign investment in Serbia. The country has attracted nearly €25 billion worth of foreign direct investment since 2000, but the rate has slowed in the past couple of years, partly because of economic problems in Europe as a whole. “Serbia’s public finances have to be put on a sustainable footing and we have set out a comprehensive plan to achieve this by stimulating investment, tackling the shadow economy, and making the public-sector wage bill affordable,” Dacic said. “We are ruthlessly guillotining unnecessary regulations, introducing e-government, and working every day to make Serbia a real player on the European stage."

Tomic added: “I think the reforms will give a very good message to investors that Serbia is doing business in a very serious way and lowering the risk of having some sort of budgetary crisis.”

The improvements to construction, privatization, labor and bankruptcy laws now under way will be crucial for keeping investors interested in the country, Tomic said.

The International Monetary Fund gave a cautious welcome to the economic reform plans, but said the Serbian economy was “still fragile.” In a statement released in October, the IMF noted, “Full implementation of these measures starting from 2014 would be an important signal of the authorities’ resolve to tackle the economic challenges.”

The World Bank’s Sestovic said the austerity measures were “definitely a step in the right direction. You can always argue that a bit more could be done.” “The main concern is that these [economic reform] measures might have some impact on growth,” he said.

The World Bank now forecasts lower GDP growth for 2014, of 1 percent, because of the slowdown of the bank's credit activity and the austerity measures, Sestovic said.

Jasna Atanasijevic, chief economist at Hypo Alpe Adria Bank in Belgrade, said she expects a negative impact on GDP of around one percentage point next year from the reforms.

Economists hope the reforms won’t put off foreign investors that have been a key part of getting the nation of 7.5 million people back on its feet and helped move its focus toward exports, which grew 24 percent in the first three quarters of 2013. Relatively low-cost and skilled labor, cheap electricity, good infrastructure, easy access to the rest of Europe, and free-trade agreements, including one with its traditional ally Russia, are selling points.

IT services -- which account for about 1.5 percent of GDP -- are another sector considered ripe for more foreign investment. Companies including Microsoft (NASDAQ:MSFT), which opened an innovation center in Belgrade in 2005 to recruit talent from Serbia and the region as a whole, are lured by good telecom infrastructure. And it is a buyer's market for skilled workers due to sky-high unemployment of around 25 percent.

“Before the crisis, growth was driven by domestic consumption. Post-crisis, the recovery is entirely export driven. This is encouraging,” said the World Bank’s Sestovic. The World Bank forecasts export growth of 8 to 10 percent in the medium term, while Hypo Alpe Adria’s Atanasijevic said she expected export growth to be close to 8 percent in 2014 and about 5 to 6 percent in 2015.

“At the moment [Serbia’s manufacturing industry] is operating at about half the level of the late 1980s. The potential is massive,” Sestovic added. Meanwhile, foreign capital has breathed new life into a sector that has had trouble attracting investors anywhere else in the world: air transport. Abu Dhabi-based airline Etihad took a 49 percent stake in the nation’s flag carrier JAT Airways earlier this year, after which it was rebranded Air Serbia. In place of the Boeing aircraft that dated from before the war, the carrier now flies newly delivered Airbus A319 jets made in the EU.