Serbia and Montenegro Business Forecast Report Q4 2008

New Government Leads To Improved Outlook

Serbia's political and economic outlook has been given a significant boost following the formation of a coalition government comprising the pro-Western 'For A European Serbia' (FESA) and the Socialist Party (SPS). The new government has announced its commitment to introducing reforms that we believe will improve the country's business environment and support economic growth over our forecast period. Indeed, while we expect growth will to slow in 2008, it will remain robust and is expected to come in at 6.5% this year due to the impact of political instability and weak external demand. Nevertheless, an improvement in both domestic and external conditions should lead to an outturn of 7.0% in 2010. The main risks to our five-year outlook are political, and we are concerned that FESA's plans to rein in the fiscal deficit to 0.4% of GDP in 2009 will run counter to the SPS's desire to increase social spending. This key difference in policy objective threatens to undermine the workability of the relationship. A further risk is the uncertainty created by Kosovo's declaration of independence, which will impact the investment climate in the region.

We anticipate that relations with the EU and Serbia will improve, with the arrest of Radovan Karadzic providing a strong indication of Serbia's commitment to EU membership and its desire to play a key role in promoting regional stability. Furthermore, the move demonstrates the SPS's commitment to co-operating with the International Criminal Tribunal for the former Yugoslavia (ICTY). The EU was initially concerned about the SPS's attitude towards the ICTY, as the SPS was previously led by the late Slobodan Milosevic who died in detention at the Hague war crimes prison during his trial. Indeed, it now appears that both key parties in the government - the pro-European Democratic Party (which has close links with President Boris Tadic) and the SPS - are singing from the same hymn sheet and that moves that boost the EU convergence process will be top of the agenda.

We expect Serbia to continue to post solid growth rates over the coming years - which will help to bring down the trade and current account deficit in tandem with slower import growth - but a potential crimp on higher sales abroad will be slower economic growth in Western Europe. Over the past five years, the EU-15 (i.e. the EU pre-May 1 2004) have taken an average of 38% of Serbia's exports, and growth in the region is set to slow significantly. Looking at the eurozone-15, we expect real GDP growth to sink from 2.6% in 2007 to 1.6% this year and 1.4% in 2008, which will naturally subdue demand for Serbian products. The good news is, though, that growth in emerging Europe - the destination for 57% of Serbian exports - is still going to remain strong. Real GDP expansion across CEE as a whole was 7.0% last year, and will still come in at a respectable 5.9% in 2008, which is forecast to be the bottom of the current economic cycle for CEE, which will average 6.0% over our five-year forecast period.

Serbia's Investment and Export Promotion Agency (SIEPA) announced on August 7 that it expects FDI in the country to total US$5.0bn in 2008. The agency stated that the relatively swift formation of a pro-EU government, following the May parliamentary election, combined with an increase in co-operation with the West in a number of areas - including the capture of alleged war criminals - should strengthen the investment climate. According to SIEPA's spokesman, Aleksnadar Miloradovic, companies from Europe, the US and Japan have already inquired about investment opportunities. Investors are keen to invest in heavy industry, machine building, the retail sector, biofuels and trade.