Diana Dragutinovic: "Padlock on the Budget"

Minister of Finance Diana Dragutinović in the interview for the Ekonomist magazine says that after this year’s deficit estimated to exceed 700-800 million Euros, Serbia in the next year has a great chance to balance the budget, even to have it in the mild surplus.

For the Ekonomist magazine, Minister states that at no cost she is to allow for expansive fiscal policy to jeopardize macroeconomic stability. Diana Dragutinović says that she will insist on saving measures on all levels, and that implies that in the next year public sector wages will grow slower against gross domestic product (GDP).

The Minister of Finance has also announced that she will stand in favour of capital gain and real, i.e. absolute rights tax ablation, and that in the course of two years capital transactions will be completely liberalized.

Minister Diana Dragutinović, Interview for the Ekonomist magazine, July 24, 2008

After this year’s deficit estimated to exceed 700-800 million Euros, Serbia in the next year has a great chance to balance the budget, even to have it in the surplus, Minister of Finance Diana Dragutinović claims.

For the Ekonomist magazine, Minister states that at no cost she is to allow for expansive fiscal policy to jeopardize macroeconomic stability. Diana Dragutinović says that she will insist on saving measures on all levels, and that implies that in the next year public sector wages will grow slower against gross domestic product (GDP).

The Minister of Finance has also announced that she will stand in favour of capital gain and real, i.e. absolute rights tax ablation, and that in the course of two years capital transactions will be completely liberalized.

As NBS Vice-Governor you were among biggest critics of Government’s expansive fiscal politic. Why have you accepted Minister of Finance’s position when, at the moment, high public spending trends seem almost unavoidable?

That was the exact reason, because I believe that it can always get better. My critics haven’t been given as a consequence of the political differences between the NBS and Government, but the goal was to remind the Government that expansive fiscal policy, if it crosses some lines, will not bring general benefit. That critic, therefore, should be taken as a bona fide advice. If you look only whether macroeconomic stability if preserved or not, it seems to me that we have succeeded in that.

Your options are limited as you have inherited 2008 budget. On what will you insist on during this year’s budget rebalance, especially during 2009 budget drafting, will it be prudent, balanced or expansive?

Whenever there is a deficit, the budget is not prudent, but expansive. It is true that my options are limited in a way, but 2008 budget is not that bad because estimated 1.5-1.6 GDP deficit is within the limits implied by a responsible fiscal policy.

The problem is that behind the idea of rebalance is most likely budget deterioration concept, but I will try not to have higher deficit than 2-2.5 percent of GDP. There will be no government borrowing in lieu of current expenditure coverage. The concept of borrowing is not questionable, but only for capital expenditure financing purposes.

At the same time, tax burden structure will change because it does matter how budget funds are collected. It is always better to collect more funds from indirect than direct taxes. It also matter how those funds are used. There are standards on how high certain public spending levels should be.

And what is the plan for the next year?

For me the basic standing is the Memorandum on the Budget and Economic Policy, accepted by many ministers sitting in this government. That means they liked what it says, that for 2009 we should have balanced budget, i.e. low surplus. That is a huge step forward compared to 2008.

Is it realistic?

In all countries during election year, tax revenues are reduced and public spending is increased, because governments are buying their own reelection. I hope there will be no elections in 2009, and in that way only we can save 1.5 percent of GDP. That is why, jointly with responsible fiscal policy, we have a great chance for budget to be balanced.

There are those who believe that Serbia, at this level of development, doesn’t need a balanced state coffers, nor budget surplus, but exactly budget deficit?

The budget deficit definitely is not helpful when it comes to the maintaining of stability, and in order for economic growth to be faster, the government spending should be as low as possible. Additionally, general savings levels in Serbia are low and state should demonstrate that it is prudent as well, thus showing everybody else clear signals there as well.

Which expenditures will be first to be cut down?

There are no small savings, every one is big and important. The most savings can be done in those ministries and areas where spending levels are at highest. Public expenditures in health sector, compared against GDP share, are higher than in countries with similar level of development; when it comes to the education we are alike, and analysis are underway for defense sector. Additionally, the first to go will be budget expenditures related to the banks’ recapitalization.

Does that mean that faster privatization of remaining state owned banks can be expected?

I am in favor for state to sell its packages in the banks.

Where else can costs be cut down?

The time is for things to be called by their real name, because a lot of funds are going in lieu of various loans, even though there are really subventions which considerably raise public spending levels. Especially eye-catching is “purchase of goods and services”. With those current business expenditures the biggest breach is made compared to the original plans, and significant savings are possible exactly there.

The same goes for public sector wage bill, because according to their share in GDP, Serbia is regional leader. That is why wage bill should be restrained, not in nominal terms, but in the way to limit their faster growth than GDP. They can be differently redistributed, somewhere increased and somewhere reduced, which implies review in public sector employees’ numbers.

During previous period, precisely public sector wages grew much faster than productivity levels. Do you expect resistance, because every previous year budget adoption was accompanied by strikes?

Definitely is much easier to say then to do, but some things have to be done. I doubt that this government wants to have macroeconomic instability as a result. There is a discrepancy between high levels of public spending and low earning levels of government employees, and I believe that this fact is a consequence of soaring staff levels in the government structures.

Similar case happened couple of years in the National bank, and now the NBS has significantly higher earnings compared to the average ones, but much fewer staff. I believe that this is the recipe for public administration as well.

How do you plan to accomplish budget surplus in 2009, by expenditure cuts or by revenue increases, because it does matter at what level you set such balance?

By combination, but keeping in mind that my principal wish is to reduce public expenditure, and we will see whether there will be a room for revenue increase without increasing tax rates, but by improving collection which was somewhere weaker during the months of political crisis. Revenues can also be increased by improving collection, because there are a lot of companies with significant tax debts.

There will be sent, with due respect of the difficulties there are facing, a clear message that reprogramming of the debts is feasible option, but not a write-off, because is such case all other tax payers would find them selves in unequal position, cheated.

It is notable that VAT revenues in Q1 are increased by 10 percent, while retail trade grew twice as high. Is that a signal that tax evasion is increasing?

I also feel that regarding VAT collections there are still significant possibilities left for further increase in the collection segment. It turned out to be that the best VAT collection was during game of chance period, when citizens were encouraged to collect payment slips.

Do you consider increasing excises on some products?

Serbia’s top difference compared to the EU is precisely in the excises which are lower than regional ones, among which the lowest ones are on tobacco. But, that is set in the local tobacco factories’ privatization contracts, and they are due to expire by the end of 2009, and only in 2010 we can expect significant growth in revenues collected from tobacco excises, but keeping in mind that all that will not happen all at once, but they will be gradually align with the EU’.

What about oil excises, because many believe that now is the moment when they should be reduced so that raw oil price growth could be at least partially neutralized?

Oil excises are also lower in Serbia than in the region, but the key to the problem why our price of produced oil is higher is because of the inefficiency. According to one analysis, precisely such inefficiency is costing us additional 200 million Euros compared to the other countries. The possible reasons for that are poor, obsolete equipment and excessive staff numbers in NIS, and problem solving is a process that will last for at least two years. Additionally, oil exploitation reimbursement is low.

Can Serbia from its budget or from securities issuance finance building of infrastructure projects such is highway Horgoš – Požega?

No, there are “magical numbers” that I will never exceed and rules that I will stick to. Deficit shouldn’t be higher than 3 percent of GDP, current expenditures must be lower than current revenues, and for capital expenditures maximum 4-5 percent of GDP can be asset aside from the current revenues.

It is not the issue that we need more, because infrastructure is horrifying shabby, but the missing funds will have to be substituted with privatization proceedings which have to be used to increase state’s net property, such are roads. The third source is credits from EIB and EBRD, which are more favorable that market ones.

Do you believe that regardless of the promises made to the coalition partners, you can do something regarding the reduction of public spending levels?

The budget will definitely not reflect the sum of all pre-election promises. Moreover, you can not have liberal tax policy and socialistic public spending.

Will PIO Fund transfers with this year’s budget rebalance be increased for some ten billion Dinars, because without that, as of September, pensions will not be increased for 10 percent?

Even without that promise additional funds would have to be secured, because law in force foresees pensions’ adjustments as of September 1, but keeping in mind that they would be increased for some 7, and not 10 percent.

Is keeping macroeconomic stability compared to keeping the promises given to the coalition partners more important for you?

Yes, because I very well know the difference between stability and instability, and that fiscal policy can be much more effective on stability than on growth. Some athletes are relaxing before big competitions so that they could reach the peak of the form.

The role of the fiscal policy is also to relax the „competitors”, so that they could gather their straight before the start, and to perform maximum during the race. But, will someone win if it is relaxed all the time? Of course it will not, and for couple of years we have had a relaxed fiscal policy.

Are other members of the Government aware of that?

If they currently are not, I believe they will be, because political campaign is one thing and economic reality something completely different. Everyone wants a lot of things, and after facing reality, the majority is behaving very rationally.

Will you allow for average pension in 2009 to reach 70 percent of average salary, and were there some discussions on the issue during some Government’s sessions?

I can not support what is not the case anywhere else. The biggest share of disbursements for pensions as a part of GDP is 14, and we already have almost 15 percent. Biggest salary-pensions ratio is 60 percent. I am not saying that nothing can be done, things just need to be apportioned and mistakes that can cost us dearly need to be avoided.

I am more in favor of a selective approach: careful assessment of bottom and top pensions, which may include their diverse growth dynamics. I believe there is still room for negotiations.

Will Q2 see acceleration of public expenditure and which consequences that may have on macroeconomic stability?

Serbia is too poor to have 3 percent deficit, which is Maastricht criteria, but it has to be more prudent. That is why I am not expecting acceleration, but I will try for public expenditure levels to be lower than in the Q1.

What is current situation in the budget, keeping in mind that according to our and international methodology, budget is in plus, i.e. minus, respectfully?

If we want to join the EU, we have to use European methodology. We are already facing deficit estimated at approximately 2 percent GDP.

Your predecessor, current Prime Minister Mirko Cvetković, has announced that as early as of fall state must incur debt. Have you done something in that sense?

That is not bad thing to do, but only if state incur debt in lieu of capital expenditures, and initiation of more intensive work on infrastructure projects will ask for additional funds. That can be a flying-wheel for domestic financial market development, and by incurring debt in Dinars, monetary policy spread can be increased. Those are two good things.

Will that mean that you have already set up your mind, because of the dilemma whether state securities should be issued in Euro or Dinar currency?

My stand is that it should be in Dinars only.

Instead of announced reduction, during last couple of years public spending as a GPD share has increased from 40.4 to 44 percent. What have you set up as a goal to yourself until end of your mandate related to the public spending, and do you expect support of other ministers?

Present, relatively high public spending is partly consequence of election cycles, but also of correcting come injustices, i.e. paying back past debts. My goal is to reduce public spending share of GPD below 40, even if is to be 39.9 percent.

Will you support Vice President Dinkić’s proposal to reduce income tax from 12 to 10 percent, and would such tax have overall positive or negative effects?

Serbia is one of the rare if not the only state which has such type of citizens’ taxation, and I will insist on prompt synthetic income tax introduction. If tax reduction rates are to be part of law amendments introducing synthetic taxation on income, I will support it.

I will do the same if parallel to the tax rates reduction, savings related to the expenditures can be found, but not if it’s to directly affect budget deficit growth.

To what level is fiscal policy, which has in Q1 generated additional demand of 20-25 billion Dinars, responsible for growing inflation?

Inflation would be generated even if budget produced surplus because its dominant causes are on the other side. It is increased in the countries that conducted very responsible fiscal policy as well such are Bulgaria and Romania, where public spending is at 33 and 35 percent GDP, respectfully.

According to some calculations, aggregate demand growth, stimulated by fiscal policy, had as a consequence inflation rate growth of two percentage points. At the same time, NBS with its restrictive monetary policy has relaxed fiscal policy’s influence on inflation.

And for that was “praised” with criticisms for over expensive monetary policy?

Yes, but you can not have both ways. The ideal combination would be for fiscal and monetary policies to be restrictive. If not, and if stability is to be maintained within some frameworks, one of them must take more than fair share of job.

Part of the budget expenditures are currently being financed using privatization proceedings. What will happen when that source dries out?

It will not dry out.

It will in 3-4 years time, when public enterprises privatize as well.

When privatization proceedings dry out, large infrastructure projects financed by those funds will be in final stages of execution. Event today, those proceedings are not being used for current expenditures, apart of those regulating old debts settlement.

Will something change in your relation with the Governor Radovan Jelašić, now that you have crossed to the “other” side?

Nothing will change because we are on the same side and I don’t see that fiscal policy goal is much different than monetary. I understand every minister’s wishing to perform maximum in its line of work, but that doesn’t mean that that would be the optimum for the state as well. That is why I will try to canal their wishing so that it can be optimal for all.

The majority of the economists believe that this year’s inflation will be between 12 and 15 percents. Will you officially change projected rate of 8.5 percent, and how much damage for the Government’s credibility can bring the fact that every year’s real inflation rate is considerably different than projected one?

In all counties real inflation will be much higher than projected one, because no one could have estimated unprecedented oil price increase. I assume that with the budget rebalance we will admit increase to 8.5 percent, but no one should forget that in the Q1 monetary policy was restrictive, and that its effects on reduction of inflator pressures are felt three to six months afterwards.

Will it be more favorable for Serbia to sign a new arrangement with the IMF, because previous Government was not very much in favor of that option?

Not only that I am not against it, but for many reasons I would be happy to see it happen. Firstly, if our economic policy receives positive estimates from the IMF, it would definitely help Serbia reaching EU candidate status.

Secondly, regardless of the fact that I do not always agree with the IMF’s recommendations, it forces you to conduct responsible fiscal policy which can influence increasing country’s rating, meaning reducing financing costs. I am, therefore, in favor of some sort of program with the IMF, the sooner the better.

What do you plan to do to bring back to life benumbed capital market in Serbia?

We will amend laws on securities and take over, because they are literally a bridle for the faster development. Also, law on capital gains and absolute rights transactions must be changed.

In countries with underdeveloped financial markets usually there are no such types of taxation, while there are present in Serbia and they are high. I support the idea for their cancellation. Finally, the state will boost the market with securities issuance related to the capital projects’ financing.

Your predecessors in the Ministry of Finance have proposed reduction, but not cancellation of capital gain taxes?

That tax cancellation would definitely boost capital market development, and we need a big step forward during relatively short period, let’s say in the next six months.

When will we completely liberalize capital transactions as well?

We have four years as of the Stabilization and Association Agreement signing, and is possible that we will do that even sooner. As someone who has come from the NBS I am not in favor to do all things right away, especially when it comes to the short term transactions, but the biggest part will be liberalized in two years.

(Author: Milan Ćulibrk)