Rating action

Scope Ratings GmbH (Scope) has today affirmed the Republic of Serbia’s long-term issuer and senior unsecured debt-category ratings at BB+, in both local- and in foreign-currency, and revised the Outlooks to Positive, from Stable. The short-term issuer ratings are affirmed at S-3 in local and in foreign currency, with the Outlook revised to Positive, from Stable.

The revision of the Outlook on Serbia’s long-term credit ratings to Positive reflects the country's improved medium-term growth and FDI prospects and strengthened external metrics. Effective macroeconomic management has ensured resilience, with strong growth projected for 2024-2027. This positive momentum has been reinforced with the agreement with the EU to develop a lithium mine, which should drive FDI over coming years and deepen Serbia’s integration into EU-based value chains. Continued private and public investments could further enhance productivity, supporting sustained economic expansion. Additionally, Scope expects improving fiscal fundamentals, including structural reform progress in the state-owned entities sector, to support a gradual reduction in Serbia’s moderate government debt-to-GDP ratio.

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Key rating drivers

Serbia's robust growth and favourable FDI prospects, supported by strengthened external metrics. Despite challenging global conditions, Serbia has maintained strong export levels and economic stability, achieving 2.5% real GDP growth in 2023. FDI inflow reached record levels of around EUR 4.4-4.5bn in 2022-2023. In Q1 2024, Serbia's year-over-year GDP growth accelerated to 4.6%, driven by the trade, industry, construction, and services sectors. Scope projects that Serbia’s economic growth will increase to 3.6% in 2024, driven by rising private consumption due to real wage increases and robust employment as well as higher investments as FDI inflows remain high and the government increases capital spending. Scope projects that Serbia’s real GDP growth will increase to 4.4% in 2025 and average around 4.2% over 2025 to 2029, supported by planned investments and more favourable financing conditions.

The recent Memorandum of Understanding between Serbia and the EU significantly enhances Serbia's role in the European green economy, particularly in electric vehicles and battery production. By aligning with EU strategic goals, this agreement boosts Serbia's FDI prospects in technology sectors. The reinstatement of the Jadar lithium mine license, potentially Europe's largest, positions Serbia as a key player in the EU battery material supply chain. This development indicates a potential continuation of significant capital inflows from mining and technology-driven sectors such as lithium extraction and battery production, likely providing a notable economic uplift to GDP. Scope expects this progression to enhance Serbia's role in the European automotive sector, increase exports such as lithium for electric vehicles, and draw additional investment. This aligns with EU objectives to diminish reliance on raw materials and strengthens Serbia's integration with and potential path towards EU membership.

Annual inflation fell to 4.5% in May 2024 in line with the upper bound of the National Bank of Serbia’s (NBS) target range. This improvement in macroeconomic stability is supported by effective macroeconomic management and tight monetary policies from the NBS and ECB, easing global price pressures, declining food and energy inflation, and favourable base effects. The NBS maintained its policy rate at 6.5% since July 2023, and recently reduced it to 6.25% in June and again to 6.0% in July. Average inflation is projected to be around the NBS target midpoint of 3.0% in 2025 and 2026.

In 2023, Serbia's current account deficit shrank to a historic low of 2.6% of GDP, bolstered by decreasing energy prices, robust exports, reduced imports, and strong remittances. Coupled with ongoing substantial FDI inflows, this resilience pushed foreign reserves to a record high of nearly USD 25bn (representing 447% of short-term debt) by year-end. Despite a projected modest widening of the deficit to around 4% by May 2024 due to increasing domestic demand, reserves remained stable, and coverage of short-term debt rose to 670% following a notable reduction in short-term obligations. This trend underscores Serbia's enhanced resilience to external shocks, facilitated by continued investment in tradable sectors and reserve accumulation.

Effective budget management, combined with high capital spending, supports moderate public debt trajectory. In 2023, the general government's budget deficit was reduced to 2.2% of GDP from 3.2% in 2022, despite additional spending last year. This reduction was supported by substantial VAT receipts and carefully managed expenditures on wages and subsidies. The execution of the large capital budget (around 7% of GDP) was nearly on target, demonstrating Serbia's budget flexibility and effective financial management. The 2024 budget foresees a deficit of 2.2% of GDP for this year, with a projected temporary rise in 2025 due to new investments. Scope expects that Serbia will meet this target, thanks to favourable budget trends as seen in the first quarter of this year, supported by strong growth. Moreover, improving financing conditions and disbursements from international financial institutions have facilitated early funding for the 2024 budget. Serbia's structural reforms are also progressing with those in the energy sector contributing positively to fiscal consolidation, with key state-owned enterprises showing improved finances and no longer requiring budgetary support in 2024.

Scope expects Serbia's public debt-to-GDP ratio to gradually decrease from moderate 52.3% in 2023 to 46.4% by 2029, supported by strong GDP growth and managed budget deficits. Under the EUR 2.4bn IMF Stand-By Arrangement, the country's fiscal strategy aligns with a forecasted budget balance of on average -2.2% and a primary balance of -0.4% from 2025 to 2029. The development plan through 2027 prioritises increased public investment, which is expected to sustain moderate fiscal deficits while maintaining a downward debt trajectory. Continuous structural reforms in public investment management are aimed at ensuring long-term fiscal stability.

Rating challenges: substantial external debt, institutional weaknesses and political complexities associated with Serbia's EU membership aspirations.

Serbia's BB+ credit rating is challenged by substantial external debt, predominantly in euros, affecting both public and private sectors, with external debt reaching 64.2% of GDP as of Q1 2024. The country's negative net international investment position (NIIP) stood at -72.0% of GDP in 2023, highlighting its dependence on foreign capital and the related imports, especially of equipment and goods. The prevalence of foreign-currency denominated debt in both public and private sectors poses financial stability risks. However, the foreign-owned banking sector presents minimal contingent liability risks to the sovereign. Additionally, the risks from the general government's large foreign-currency debt portion (77.7% in Q1 2024, mostly euros) are mitigated by fixed-rate obligations, long maturities, and substantial holdings by multilateral and institutional investors.

Serbia also faces institutional weaknesses as captured via the World Bank’s governance metrics, particularly in the areas of control of corruption and voice and accountability, which have both deteriorated over the past 10 years. Governance issues and weaknesses in the rule of law in Serbia are further evident through legislative inefficiencies, as highlighted by the fact that only two out of thirty-five EU accession negotiation chapters have been provisionally closed. The slow pace of reforms signals challenges in Serbia's institutional framework. Moreover, challenges surrounding the early parliamentary elections in December 2023 underscore the necessity for tangible improvements in governance.

Finally, while Serbia's EU membership ambitions underpin policy decisions, the process presents political challenges, including issues concerning relations with Kosovo and alignment with EU sanctions on Russia. The EU-backed draft agreement between Serbia and Kosovo, aimed at enhancing regional security and facilitating Serbia’s EU ambitions, faces uncertainties regarding formal signing and execution. Scope expects Serbia's EU accession progress to depend on the implementation of the EU-backed agreement with Kosovo.

Outlook and rating sensitivities

The Positive Outlook reflects Scope’s view that risks for the ratings are tilted to the upside over the forthcoming 12 to 18 months.

Upside scenarios for the long-term ratings are if (individually or collectively):

1. Public debt-to-GDP were set on a firm downward path over the medium term;
    
2. External position further strengthened, for instance due to robust exports or increased net FDI inflows; and/or
    
3. Governance and/or or political risks were redressed more durably, such as via tangible progress in the longer-run accession to the EU.

Downside scenarios for the rating and/or Outlooks are if (individually or collectively):

1. Sustained rise in the public debt-to-GDP ratio over the medium term;
    
2. Serbia’s external vulnerabilities intensified, causing pressure on reserve adequacy; and/or
    
3. Governance and/or political risks increased, affecting the quality and predictability of policymaking.

Sovereign Quantitative Model (SQM) and Qualitative Scorecard (QS)

Scope’s Sovereign Quantitative Model (SQM) provides a first indicative credit rating of ‘bbb’ for Serbia. This ‘bbb’ first indicative rating receives no uplift from the SQM’s reserve-currency adjustment and a one-notch negative adjustment from the political-risk adjustment. This sees a final SQM indicative credit rating of ‘bbb-’ for Serbia. On this basis, the final SQM quantitative rating of ‘bbb-’ is reviewed by the Qualitative Scorecard (QS) and can be changed by up to three notches depending on the size of Serbia’s qualitative credit strengths or weaknesses compared against a peer group of sovereign states identified by the SQM.

Scope identified the following QS relative credit weaknesses for Serbia: i) Resilience to short-term shocks; ii) financial imbalances; and iii) governance factors. Relative credit strengths were identified: i) growth potential and outlook. On aggregate, the QS generates a further one-notch negative adjustment affecting Serbia’s credit rating, resulting in the final BB+ long-term ratings. A rating committee has discussed and confirmed these results.

Environment, social and governance (ESG) factors

Scope explicitly factors in ESG issues within its ratings process via the sovereign-rating methodology’s stand-alone ESG sovereign-risk pillar, which holds a significant 25% weighting under the quantitative model (SQM) and 20% weight under the methodology’s qualitative overlay (QS).

Serbia faces a substantial challenge in reducing emissions due to its high energy intensity, nearly four times that of the EU. While coal, primarily lignite coal, still accounts for about two-thirds of electricity production, wind power has shown growth. However, the recent Memorandum of Understanding signed between Serbia and the EU enhances Serbia's role in the European green economy and sustainable raw materials.

Socially related credit factors are captured under Scope’s SQM and reflect increasing labour force participation rates that are counterbalanced by significantly increasing old-age dependency ratios. Serbia's labour market faces long-term challenges due to demographic trends, including an aging population and emigration, which constrain the labour supply. The old-age dependency ratio is projected to increase to over 35% by 2030, up from 31.6% in 2022. Nevertheless, positive developments in migration flows, such as the influx of skilled workers and foreign students, have been observed.

Finally, governance factors are explicitly captured in Scope’s assessment of ‘institutional and political risk’ under its methodology, for which Serbia scores unfavourably on a composite index of World Bank Worldwide Governance Indicators. Serbia’s ratings include a negative adjustment of one notch to the indicative rating due to elevated political risk. The EU-backed agreement with Kosovo faces uncertainties in execution due to ongoing tensions, with Serbia's EU accession progress hinging on its implementation.

Rating committee
The main points discussed by the rating committee were: i) public finances including budget performance and outlook; ii) growth prospects; iii) external environment, financial stability and macroeconomic sustainability; iv) institutional developments and political risks; and v) peer comparison.

Methodology
The methodology used for these Credit Ratings and/or Outlooks, (Sovereign Rating Methodology, 29 January 2024), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The model used for these Credit Ratings and/or Outlooks is (Sovereign Quantitative Model Version 3.0), available in Scope Ratings’ list of models, published under https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. Also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Credit Ratings were not requested by the Rated Entity or its Related Third Parties. The Credit Rating process was conducted:
With Rated Entity or Related Third Party participation   NO
With access to internal documents                                NO
With access to management                                         NO
The following substantially material sources of information were used to prepare the Credit Ratings: public domain.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting these Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and/or Outlooks and the principal grounds on which the Credit Ratings and/or Outlooks are based. Following that review, the Credit Ratings and/or Outlooks were not amended before being issued.

Regulatory disclosures
These Credit Ratings and/or Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlooks are UK-endorsed.
Lead analyst: Jakob Suwalski, Senior Director
Person responsible for approval of the rating: Alvise Lennkh-Yunus, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 3 June 2022. The Ratings/Outlooks were last updated on 27 October 2023.

Potential conflicts
See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings, as well as a list of Ancillary Services and certain non-Credit Rating Agency services provided to Rated Entities and/or Related Third Parties.

Conditions of use / exclusion of liability
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