EU accession and Balkan pitfalls
IT HAS BEEN a tough 18 months for Serbia. At the beginning of last year, the country faced a mini-civil war involving criminal paramilitary gangs. The struggle for power led to the assassination of prime minister Zoran Djindic.
On the economic front, GDP growth slowed to 1.5%, according to RZB, in part because of a prolonged drought, which led to a 6% fall in agricultural output.
And in the middle of last year, the reformist movement was fractured by internal rivalries, notably between Bozidar Djelic, then minister of finance, and Mladjan Dinkic, then central bank governor. The two former friends had a destructive falling out. "The problem is they are both PR junkies, and are jealous of each other's media exposure," says a Serbian banker.
Democratic discord
A rift also developed between the main reformist parties, the Democratic Party and the Democratic Party of Serbia, prompting parliamentary elections in December. The nationalist Radical Party won the most votes, but not enough to form a majority. The Democratic Party of Serbia formed a coalition with Dinkic's G17 Plus party and the Socialist Party of former dictator Slobodan Milosevic. Serbia watchers were dismayed that the strife between the reformists had led to key figures being removed from government, such as former privatization minister Aleksander Vlahovic.
Vlahovic had overseen the rejuvenation of Serbia's privatization programme, which led to foreign direct investment rising to $1.3 billion last year. This year, by contrast, the World Bank has noted the delay of new privatizations and spoken out against it.
Serbia then faced the prospect of another nationalist leader – Tomislav Nikolic of the Radical Party – coming to power. At one point he led polls for the presidency by 11 percentage points.
However, in June Nikolic was defeated by Democratic Party leader Boris Tadic, to the great relief of investors. Oliver Roegel, deputy chairman of Raiffeisen AC Belgrade, says: "He's a very reputable choice. Nikolic would have been very bad for issues like EU accession, London Club debt restructuring or extradition of war criminals."
The new minority government looked far from secure, and investors feared that pro-market reforms would be slow to materialize. One banker says: "The talk this summer was that the new government wouldn't last very long."
However, to the pleasant surprise of the market, the new government then moved quickly to secure a London Club deal with creditors, some three years after negotiations began. Alex Garrard, emerging-market analyst at UBS, says: "The government confounded expectations, and made debt restructuring a priority."
Thanks to the deal, Serbia can finally return to the capital markets. As Mladjan Dinkic, now finance minister, says: "For years there has been an investment black hole in the centre of Europe. This deal finally clears that up."
To be fair, the goal scored by the new government was to a large extent set up by the previous one. Bozidar Djelic and his advisers injected a new sense of urgency into London Club negotiations in 2003, and many expected a deal before the elections. However, no doubt to the annoyance of Djelic, who is now reportedly pursuing investments in Russia, his rival appeared at the last minute to sign the final deal.
On July 1, the London Club creditors agreed to reduce the $2.8 billion in debt to about $1.075 billion. The new debt will be restructured into a 20-year bond, which will be issued on December 1, according to Dinkic.
JPMorgan, the country's agent, will act as arranger for the exchange. The new debt will pay a coupon of 3.75% for the first five years, then a 6.75% coupon for the next 15. There is a five-year grace period on principal repayments. In addition, Serbia agreed to make a $40 million goodwill payment to creditors.
A sovereign rating
Estimates of how much debt has actually been forgiven vary. Richard Segal, director of research at specialist broker Exotix, thinks it amounts to a 62% forgiveness of net present value, and a 58% face-value haircut. As part of the deal, Serbia will receive a credit rating from Standard & Poor's, its first ever. This is expected to be in the single B range.
The deal clears up one of the most intractable disputes in the capital markets. Serbia reached a similar deal in November 2001, to forgive 66% face value of its $4.5 billion in Paris Club debt.
But negotiations with London Club creditors proved much more difficult. For a start, the debt was more complex, consisting of two main types – new financing agreement debt and trade deposit facility agreement debt – as well as being in several different currencies.
Secondly, the London Club creditors were less flexible than those in the Paris Club, perhaps because they were less motivated by guilt than the Paris Club countries, after Nato air strikes had flattened Serbia's infrastructure in 1999.
A key sticking point was whether the London Club deal would be comparable with the Paris Club deal, in terms of debt forgiveness. Another issue was how much Serbia could afford to pay in debt servicing, given extensive obligations to multilaterals.
Dinkic says: "We got a realistic deal. Everyone realized there was no chance of getting a better deal from the London Club than from the Paris Club."
He says the deal has succeeded in gaining comparability to the Paris Club deal. "Comparability does not mean identical," he notes. "It means the same ball-park."
The deal has been structured with the country's obligations to multilaterals in mind. These are particularly acute over the next five years, hence the principal grace period and the low coupon until 2010.
Multilaterals have welcomed the deal. Dragica Pilipovic, director of the European Bank for Reconstruction and Development's office in Serbia, told the local media that the deal was very good news and would open the way for Serbian companies' return to the international loan markets. Carolyn Jungr, head of the World Bank's operations, also said the deal was a "significant relief" for Serbia and Montenegro. The IMF declined to comment.