Thank you for inviting the IMF to participate in this meeting. I shall concentrate my remarks on FRY’s relations with the Fund, the economic situation in FRY, and the authorities’ recently elaborated short-term stabilization program that is likely to be supported by a purchase under the Fund’s post-conflict emergency assistance policy.

Over the past several weeks, the FRY authorities have made good progress towards achieving IMF membership, an important component of their efforts to reintegrate FRY into the world economy. Two steps are still outstanding (but, as Deputy Prime Minister Labus told us morning, are likely to be taken by December 20): the clearance of about US$130 million of arrears to the Fund; and a finding—which depends on the judgment of the IMF Board—that FRY is able to fulfill its obligations under the Articles of Agreement. The clearance of arrears could be facilitated by a post-conflict emergency purchase from the Fund that would repay a bridging loan from Norway and Switzerland.¹ The short-term program that I will be describing has been agreed between the Fund staff and the authorities and is designed to provide the basis for the purchase.

The most immediate task in the path to FRY’s economic recovery will be to rein in inflation, while protecting the vulnerable groups of the population. The average monthly inflation rate jumped from 5½ percent in the third quarter of 2000 to 21 percent in October-November 2000 reflecting a large liquidity emission in the runup to the September elections and the relaxation of price controls in the last days of the outgoing government. This jump in prices has fueled inflation expectations and, given the lagged response of general government revenues, has resulted in a further real compression of wage and social spending. Addressing the immediate risks to financial stability, while alleviating social hardship will be a difficult task. From the international community, it will require substantial humanitarian assistance to meet immediate needs. From the authorities in Belgrade, it will require strong efforts to avoid the monetary financing of fiscal and quasi-fiscal deficits. Serbia’s economy is demonetized, and the room for monetary financing is virtually nil.

The authorities’ short-term program envisages tight fiscal and monetary policies to control inflation and stabilize the exchange rate, together with the introduction of a managed float and current account convertibility. Specifically, the program includes (a) strict credit limits (on borrowing of the general government from the banking system and on the Net Domestic Assets of the NBY) with a view to reducing monthly inflation to the low single-digits by early 2001; (b) a floor on the Net Foreign Assets of the NBY to ensure that they do not decline from the already low level prevailing at end-September 2000, and (c) the introduction of a managed float with current account convertibility by January 1, 2001, which would allow the exchange rate to find its equilibrium value. The program also envisages technical assistance from the Fund and other institutions in the areas of fiscal policy, monetary policy, banking supervision, and economic statistics.²

In the area of fiscal policy, the program provides for little or no general government recourse to bank financing through end-March 2001, in line with the policy objective for the entire year. Specifically, the federal government as well as the republican governments (including the social security funds under their jurisdiction) will eschew any bank borrowing through end-March 2001, with the exception of a small amount by the Serbian budget in 2001 Q1 (500 million dinars or 0.1 percent of annual GDP) to address seasonal financing needs. In Montenegro, bank financing (except on a very short-term basis) is effectively ruled out by the use of the DM as the sole legal tender.

The underlying fiscal position is clearly unsustainable. The consolidated general government deficit on a cash basis (after grants) has been kept very low (an estimated 0.2 percent of GDP in 2000) but this has been achieved only through: (a) a drastic compression of real government spending over the past two years, by a cumulative 40 percent; (b) the accumulation of nondebt arrears (equivalent to 8 percent of GDP at end-October 2000), (c) the non-servicing of a large government debt (over 100 percent of GDP); and (d) the toleration of very large quasi-fiscal deficits. Indeed, it is the monetary financing of the quasi-fiscal deficits of some of the large state-owned enterprises that has fueled inflation.

In these circumstances, the urgent extension of humanitarian and targeted financial support will be key to keeping the social costs of austerity at bearable levels, until the authorities are in a position to address the fundamental problems. Based on preliminary Fund staff estimates, external budgetary support in the amount of US$140 million or 3 percent of GDP would be needed to eliminate arrears incurred during 2000, principally with regard to wages and pensions, thereby limiting the real decline in those expenditure categories and alleviating social pressures.

Once the political structure has stabilized following the elections in Serbia, the authorities will need to address the sources of the macroeconomic imbalances, and undertake an orderly transition to a well functioning market economy, in the context of a comprehensive reform program. To this end, we envisage that the Fund will start discussions with the FRY authorities, sometime early next year, on a comprehensive program that could be supported by a stand-by arrangement. The program should seek to establish the basis for sustainable growth, consistent with a viable external position and low inflation. It should also seek to buttress the emerging private sector and stimulate its further development, and commence a reform of public institutions to provide for transparency, predictability and accountability in government. In the context of such a program, progress will also need to be made toward normalization of FRY’s relations with official and other creditors, while taking into account FRY’s limited debt servicing capacity.

Wide-ranging fiscal reforms, aimed at strengthening fiscal sustainability, should be a key component of such a program. The fiscal reforms should include: improvements in tax administration; a widening of the tax base through elimination of tax exemptions and curtailment of the gray economy; prioritization of expenditures and strengthened control of expenditure commitments; and a major reform of the pension and health care systems, in both Serbia and Montenegro, in order to restore their long-term sustainability. Limiting the quasi-fiscal deficits will require appropriate pricing policies for public utilities, measures to enhance their operational efficiency, as well as a general tightening of financial discipline.

A key challenge will be to permanently relieve the economy from inflationary pressures through the transformation and restructuring of the enterprise and bank sector. Past efforts at stabilization have met with only short-lived success as both the banking and enterprise sectors continue to be affected by former Yugoslavia’s heritage of "social ownership," under which firms were owned collectively by their workers and governance was weak and highly politicized. Several privatization initiatives since 1992 have accomplished little as they did not challenge the authority of managements and employees in social enterprises over privatization decisions. Moreover, the ownership links between banks and enterprises as well as the legislative framework for their operation and bankruptcy all have tended to weaken financial discipline. We welcome therefore the authorities’ intention to propose amendments to the existing Serbian privatization law and to initiate privatization sales expeditiously. Pending progress in privatization, it is important to take measures to strengthen financial discipline in the state and social sectors.

The banking system is insolvent and unable to perform its intermediation functions, and in urgent need of comprehensive restructuring. The authorities, in cooperation with the Fund, the World Bank and bilateral donors, are now pursuing the formulation of a strategy to address major insolvency problems in the banking sector. This task will be facilitated to some extent by the fact that systemic laws (central bank and banking laws, including the Bank Rehabilitation and Deposit Insurance Laws) are relatively new and provide all the tools needed for monetary policy and bank supervision and resolution; however, they are yet to be fully implemented.

FRY’s external financing needs will be large over the medium term. FRY faces urgent humanitarian needs and—over the medium term—large reconstruction requirements, in the context of a crushing debt burden. Grants from the EU (in the amount of €200 million) and some bilateral donors are addressing some of the humanitarian needs in energy, food, and medicines, in addition to providing limited budgetary support. While the authorities and the donors are still in the process of assessing FRY’s reconstruction needs, these are expected to be very large, reflecting the under-investment and neglect of infrastructure over the past 10 years as well as the destruction associated with the Kosovo crisis. Especially in light of the humanitarian and reconstruction needs, FRY’s external debt which now stands at US$12.2 billion (140 percent of GDP) imposes an unsustainable burden on the economy. A full assessment of FRY’s external financing needs will be a key part of the discussions with the authorities on a comprehensive economic program.

The normalization of relations with foreign creditors and neighboring countries will be an important component of FRY’s reintegration into the world economy. In this regard, we welcome the authorities’ intention, as a policy priority, to pursue the normalization of relations with foreign creditors soon after Fund membership has been secured, and to seek a fair and expeditious agreement with other successor republics on the division of the assets of the former Yugoslavia.

The Fund welcomes the intention of the European Commission and the World Bank to convene, as soon as feasible in 2001, a Donors’ Pledging Conference, at which a comprehensive reform program would be presented and donor pledges for assistance would be sought. Meanwhile, early humanitarian assistance will be essential to ensuring financial and social stability.