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Efforts towards economic recoveryand monetary stabilisation in FRYugoslaviaSvetlana Adamovic aa Assistant Professor, Faculty of Political Sciences , Universityof Belgrade , Belgrade, FR YugoslaviaPublished online: 13 Dec 2007.

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Communist Economies & Economic Transformation, Vol. 7, No. 4, 1995 527

Efforts towards Economic Recovery and MonetaryStabilisation in FR Yugoslavia

SVETLANA ADAMOVIC

Current monetary stabilisation and economic recovery policy in Serbia and Montene-gro represents the implementation of the 'Programme of Reconstruction of theMonetary System and the Strategy of Economic Recovery of Yugoslavia'. Thisprogramme was adopted in January 1994 by the federal government of the FederalRepublic of Yugoslavia (FRY), so that it applied to both Serbia and Montenegro—the two republics of which the present FRY consists. The governments of bothrepublics were free to introduce additional adaptations to monetary policy dependingon their own economy's needs.

It must be made clear that some eminent Yugoslav economists were and somestill are very critical of this programme, which does not fit into any knowntheoretical framework. However, the economic and social conditions in Yugoslaviaat the time the programme was adopted were extremely difficult, owing to threesimultaneous shocks that led to crises: secession, imposition of economic sanctions,and hyperinflation. Any economic policy choice was inevitably very risky in thesecircumstances.

A critical view expressed by one distinguished economic professor from Bel-grade University became an anecdote. In a public statement, he said that he wouldeat his own university diploma if the programme survived three months. Six monthslater (July 1994) the implementation of the programme was discussed at theConvention of the Yugoslav Economic Association and many of his colleagues askedhim humorously: 'What happened to your diploma?'

The Role of some Economic and Non-economic Factors in Forming theProgramme

The UN Economic Commission for Europe survey for 1993-1994 examined thedevelopment of the FRY, as one of the East European countries in transition, toinvestigate the degree of similarity of the economic problems currently facing thesecountries, as well as the economic measures designed to solve their problems.

The FRY—like other East European countries in transition from socialist tomarket economy—has been suffering many serious economic problems since 1990,when the process of transition officially started. Some of these problems wereinherited from the former economic system,1 but new ones appeared as a result of theprocess of transition.2 The dominant economic problems for all these countries are

Svetlana Adamovic, Assistant Professor, Faculty of Political Sciences, University of Belgrade,Belgrade, FR Yugoslavia

1351-4393/95/040527-15 © 1995 Centre for Research into Communist Economies

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528 Svetlana Adamovic

Table 1. European Transition Countries: Econ-omic Activity, 1990-1993 (% change over preced-

ing year)

Eastern EuropeFR Yugoslavia6

NMP or GDPa

1990

- 7 . 9- 8 . 4

1991

-12 .3-11 .2

1992

- 7 . 4-26 .1

1993

- 3 . 0-30 .3

aNet material product (produced) unless otherwise noted.bGross material product (value added of the material sphereincluding depreciation).

a sharp decline in economic activity, inflation, increasing unemployment and anexcessive employment rate. The bottom was reached in 1991 and modest improve-ment of economic activity in other socialist countries started in 1993. In contrast tothis general trend of economic activity in the other countries, the FRY economy in1993 was trapped in a crisis. These trends are presented in Table I.3

From these data it is clear that the decline of overall economic activity expressedthrough GDP in 1990 and 1991 both in the FRY and in Eastern Europe was seriousand at a somewhat similar rate (—11.2 % and — 12.3 % respectively in 1991).However, in 1992 and 1993, when the decline of economic activity in EasternEurope became much slower ( - 7 . 4 % in 1992 and - 3 % in 1993), the decline ofeconomic activity in the FRY jumped abruptly to alarming rates ( - 26.1% in 1992and - 30.3% in 1993). So the rate of decline in 1993 in FRY was ten times greaterthan it was in Eastern Europe.

After the acceptance of the Law on Enterprise in Yugoslavia in 1987, decisivelyoriented toward a market economy, the general expectation (at least for a certainperiod of time during 1989 and 1990) was that Yugoslavia would have fewereconomic difficulties during the transition towards a market economy than other EastEuropean countries, because Yugoslavia had opted for a market economy as itseconomic goal much earlier than other East European countries.4

Special Factors Destabilising the Economy of the FRY

Alongside the problems inherited from its former economic system and those arisingin the process of transformation from a socialist to a market economy, the FRY wasconfronted with several special destabilising factors. The most significant andinfluential are as follows.

(1) Secession of Four Out of Six Republics of Former Yugoslavia

For many Yugoslavs the secession of republics came unexpectedly. It provokedmany difficulties in the Yugoslav economy, destabilising it seriously. Since the sizeof the former state before the secessions was hardly large enough for moderneconomies of scale, its economic possibilities were considerably diminished as aresult of its reduced dimensions.

The economic structure of former Yugoslavia contributed to this development.Industrial cooperation among the republics was highly developed and they were

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Recovery and Stabilisation in FR Yugoslavia 529

economically interdependent. Parts of many products were produced and assembledin different republics. The best example of this is the case of the car industry inSerbia: around 24% of all its supplies and 22% of its deliveries came from and wentto other republics. After the secessions, its production declined so much that the 1994level was equal to only 16% of that in 1991, and only 6.3% of its production levelin 1989.5

Also important was a well developed inter-republic trade: one-third of formerYugoslavia's GNP was sold in trade between the republics. Since the secessionsmeant a breakdown of all economic and trade relations with the FRY, this was animportant factor contributing to the enormous decline of its industrial production.

The level of Yugoslav industrial production was 11.7% lower than the precedingyear in 1990; 22.4% lower in 1992, and 41.1% lower in the period January-June1993.6 The Yugoslav economy today, because of its former interdependence withnow seceded economies, has inherited large overhead costs as well as costs ofadaptation to its diminished capacity for economic activities.

(2) Destabilising Effects of Military Confrontation

The military confrontations linked to the secession of Croatia and Bosnia andHerzegovina had a very serious destabilising impact on the economy of the FRY fortwo general reasons: one is of domestic and the other of international origin.

Among the domestically originating factors the most important are:

(1) Yugoslavia provided aid to Serbs in Croatia and Bosnia and Herzegovina inthe form of food, clothing, medical aid and medical supplies—even though itsown citizens and hospitals suffered a dangerous shortage of medical suppliesfor an extended period of time.

(2) Yugoslavia is burdened with having to support more than 460 0007 officiallyregistered refugees from Croatia and Bosnia and Herzegovina, plus someadditional 120 000 unregistered refugees living with their relatives in Serbiaand Montenegro. Around 230 000 of the refugees are children under the ageof 18. In fact, the refugees now represent about 4.2% of the population of theFRY. Yet the financial cost resulting from the number of refugees and theextended duration of their stay is only one part of the problem for the FRY;another lies in the problems inherent in refugees. The great majority of theserefugees left their homes in places where their families have lived forcenturies. Most of them were running for their lives, taking only what theyhad on them. Very soon they learned that their homes had been burned downor looted, members of their families killed, and that they had no home toreturn to when the war is over. Many of these refugees are children withoutone or both parents. Their needs are great, beginning with a need for regulareducation, but extending to other special needs, such as the services of socialworkers and psychologists.

There is no doubt that even a normally operating economy would have difficultyovercoming such additional, unexpected expenses that have to be met withoutdelay. It is clear, then, how destabilising an effect they have on the fragile economyof the FRY.

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530 Svetlana Adamovic

(3) United Nations Economic Sanctions against the FRY

The economic sanctions imposed in May 1992 by the United Nations against Serbiaand Montenegro are the most severe and the most omnipotent destabilising factorsfor the Yugoslav economy, threatening it with collapse. Even before that, inNovember 1991, the European Union suspended the Contract on Trade and Cooper-ation—a contract concluded with former Yugoslavia in 1983 and renewed in 1986,giving the country special treatment in trade, finance and scientific cooperation.

The imposition of these sanctions meant the breakdown of all foreign trade andfinancial relations with all foreign countries. The economic sanctions against theFRY also include the breaking of all research and technical cooperation with foreignsubjects, an end to transport and transit relations, and the complete blockade of FRYforeign exchange in foreign countries held not only by its government but also by itsfirms engaged in foreign transactions.8

The negative, destabilising effects of all these economic sanctions on theYugoslav economy have two dimensions—the effects on current economic activityand problems, and effects on the country's long-term development, with a high levelof interdependence between the two.

Although the effects of sanctions in principle depend primarily on the nature ofthe sanctions and their imposition, the condition of the subject against whom thesanctions are undertaken has substantial influence too. In this context it must bestressed that the economy of the FRY is extremely vulnerable from both sides.

The current vulnerability of the economy comes from its former general orien-tation towards openness—both to the world market and to the other republics offormer Yugoslavia. In 1989 about 8.4% of FRY supplies and 8.82% of its deliveriescame from and went to the foreign market, while 18.27% of all its supplies and13.37% of its deliveries came from other Yugoslav republics.9 Abruptly shutting offboth markets—the interrepublic market by secession (1991 and 1992) and the worldmarket by sanctions since May 1992—profoundly affected current economic activityin the FRY. Industrial production has declined to the extent that its 1994 level wasonly 36% of the 1989 level.10 While the decline in industries oriented to the domesticmarket was rather small (oil and natural gas — 1%, coal industry — 19%), thosewhere import of raw materials was vital for production (e.g. textiles) declined by70%. At the same time, economic sanctions blocked all FRY exports, making itimpossible for the country to earn the foreign exchange which was desperatelyneeded to pay for those imports necessary for industrial production. There is nodoubt that economic sanctions against the FRY are limiting the current economicactivity of the country. This problem is even more serious in the long-run.

Excess Employment

A drastic decline of industrial production, together with the decline of overalleconomic activity, would usually result in an associated increase in unemploymentand a decrease in the level of employment. This has not been the case in the currentFRY economy. Although GDP in 1992 declined by 26.1%," the rate of unemploy-ment in 1992 and 1993 was steady at 24.6%.12 At the same time the level ofemployment decline was very small, — 3.4% in 1992.13 Productivity dropped furtherand excess employment increased sharply from 8.1% in 1991 to 22.7% in 1992.14

Some Yugoslav experts15 estimate that the present level of activity in the FRYprobably requires no more than 600 000 employed (at 1979 productivity levels),

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Recovery and Stabilisation in FR Yugoslavia 531

Table 2. Transition Countries: Changes in Consumer Price Indices, 1991-1993(% change over preceding year)

AlbaniaBulgariaCroatiaCzech RepublicHungaryPolandRomaniaSlovakiaSloveniaThe FYR of MacedoniaYugoslavia (FR)

1991

104.0254.3223.056.735.070.3

165.561.2

117.7_

120.0

1992

266.079.4

765.511.123.043.0

210.910.2

201.3_

8 990.0

Jan-March

196.282.8

1 280.321.724.841.4

171.019.057.9

1 353.382 705.9

1993

Jan-June

159.279.5

1 479.921.723.339.7

194.720.543.8

602.9423 663.4

Jan-Sept

117.076.0

1 649.421.623.038.0

228.522.236.7

442.864 422 464.5

compared with some 2.3 million currently employed. Perhaps this estimate is toopessimistic, but nevertheless it illustrates the trend correctly. The rate of excessemployment grew further in 1993 and in 1994.

A great number of those who formed this excess employment during 1991, 1992and 1993 were on forced vacations. Most were employed in large-scale obsolete andunproductive enterprises still financed by the government, mostly from printingmoney. These enterprises await better economic and political conditions for theirvery urgently needed liquidation or privatisation. There is no doubt that thispostponement is leading to direct erosion of the economy and the governmentbudget, especially when the economy is operating under the triple shocks ofsecession, sanctions and hyperinflation.

The Record Price Increase

Ten East European countries in transition (among them Yugoslavia), experiencedhigh price increases in 1991, primarily as a consequence of their price liberalisationpolicy, abandoning the previous price control inherent in their former economicsystem. The Yugoslav rate of price increases in 1991, although high, tended towardsthe average in comparison with other countries in transition. This can be seen fromTable 2.

That year price increases varied between 254.3% (in Bulgaria) and 35% (inHungary), and in Yugoslavia were around 120%. The next year, 1992, in five ofthese countries, the increase in prices was smaller than in 1991; in the other four itrose, to a maximum of 765% (Croatia).16 The FRY 1992 price increases, however,marked the country's divergence from the trend in the others. In February 1992,when the monthly rate of price increase in the FRY was 50.6%, inflationary pressurereached the stage of hyperinflation.17 Later on, price increases in the FRY becamemore rapid: in 1992 the annual increase was 8990.0%.

The deteriorating price trend in the FRY in 1992 (and later on in 1993), whenprices in other East European countries in transition were decreasing, was the resultof specific developments already mentioned:

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(1) Deteriorating supply on the market caused by:(a) serious decline in production and general economic activity;(b) cuts in imports of consumer goods and raw materials (the foreign market

was an important source of supply before sanctions were introduced).(2) The loose monetary policy of the FRY government, to finance the fast

growing budget deficit, which in 1993 reached 30-40% of GDP. The budgetdeficit in other countries of this group was then 1-8% of GDP.18

(3) Inflationary expectations also greatly fuelled the price increases in the FRY.

All the factors influencing rocketing prices in the FRY during 1992 (includingspecial factors) persisted in 1993 as well. To them one must add the influence of thetime factor, causing further erosion of the supply side and, above all, the enormousincrease in foreign exchange demand and fall in the rate of exchange.19 Betweenmid-July and mid-August 1993 the black market price of foreign exchange went upten times.20 The combination of all these factors brought the hyperinflation in theFRY to the highest level in world history. The rate of price increase in December1993 was 180 000% (over the previous month).21 Hyperinflation also extended intoJanuary 1994, when the price increase in only one day was 97%. This, according tothe Director of the Federal Office of Statistics, would have brought the yearlyhyperinflation to 313 million to the power of 12, surpassing the worst world inflationin Germany in 1923 and in Hungary in 1946.22 The FRY hyperinflation is the leaderin duration—24 months, while the famous German hyperinflation lasted 'only' 16months, and the Hungarian 12 months.

Parallel Economy

The parallel economy ('grey market', 'black market', 'street trade', 'unofficialmarket') is not an unusual element of the regular economy, providing a substantialpart of GDP (e.g. 6-8 % in USA; 7-8% in Germany; 20-25% in Italy).23 Theformation and strengthening of the parallel economy in the FRY, however, is theresult of very complex trends and conditions which developed predominantly underthe influence of two shocks (secession and economic sanctions) during 1992, 1993and 1994. Perhaps the most important reasons for its development are the growingshortage of essentials, along with a number of other socioeconomic conditions,including a high level of unemployment, a growing number of workers on forcedvacations, low pay, a growing rate of excess employment with diminishing produc-tivity, general instability and uncertainty about the future, pauperisation of the greatmajority of the population and lack of adequate government policy.

Although statistics on the parallel economy are unreliable because this economyis not legal and to some extent is illegal, it is estimated that if all the activities onthe parallel market were registered in official FRY statistics they would enlarge GDPby 31.1 % in 1991, by 41.7% in 1992 and by 54.4% in 1993.24 It is also estimatedthat about 1 million Yugoslavs are now engaged in the alternative economy.25

The effects of the parallel market on the economy and society could beconsidered to have positive and negative aspects. There is no doubt that at one time,when sanctions were very rigid and imports almost completely cut off (including themost critical medical supplies), or later, when the bureaucracy was extremely slowin allowing these specific medical supplies to enter the country, the help from thegrey economy was very real and very large. The grey economy was also helpful inproviding other needed items, such as critical parts for public transport vehicles.

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Table 3. Changes in per capita GDP, Real Wages, Unemployment and AverageWage/Consumer Basket

1989199019911992199319941995 (January)

GDP/per capita(US$)

27722530227416741163

Realwages (%)

-4.7-5 .8

-48.7-61.0

Unemploymentrate (%)

—_

24.624.6

Average wage/consumer basket (%)

126.1121.690.163.510.751.839.7

Sources: Ekonomska politika, 6 March 1995, p. 18; Economic Survey of Europe in 1993-1994,pp. 79, 86.

Another important function of the grey market was as a temporary job placementfor some 500 000 workers who practically had no real activity because of the cut inproduction in their enterprises, mostly due to economic sanctions.26 The paralleleconomy was also an important additional source of income for the pauperisedmajority strata of the FRY population.

However, there is also the other side of the coin: a growing part of thegrey economy was becoming literally a black market. While small non-legaltrade and production were functional in providing income for survival, theyoften developed into relatively big illegal trade and production organisedby individuals and private or state-owned firms or firms with mixed owner-ship, usually having a monopoly in some specific economic sectors and veryoften connected with the growing sector of organised crime. Their main goalswere to become very rich very fast, because it was uncertain how long these irregularconditions, so favourable for their activities, would persist. The primary sectorsin which these activities took place were oil trade, foreign exchange, medications,most important consumer goods which were in short supply and luxury goods.This small group of nouveaux riches was able to redistribute the already diminishedGDP to their own pockets, making the income of the great majority of citizenseven smaller.

A special category of black market on the edge of criminal activity wasthe trade in some essential consumer goods with very low prices set by thegovernment (sugar, flour, edible oil). From time to time the government releasedquantities of these goods from its reserve stocks in order to improve the supplyand maintain the low price of essentials. Not infrequently this added supplydisappeared from the shops and was later sold on the streets for much higherprices.

The activities of the grey economy were not only a factor polarising society, butalso an important factor fuelling the growing hyperinflation, in two main ways:distortion of market prices and tax evasion. It has been estimated that if all theactivities of the grey economy had been taxed at the same rate as the regular, legaleconomy, government budget revenue in 1992 would have been 41.7% greater.27 Thevolume of money printed to finance growing budget expenditure could then be muchsmaller.

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Pauperisation of the Population

The overall deterioration of economic and social life in the FRY from 1990 can beseen from Table 3.

Analysis of changes in GDP per capita indicates more concretely the deterio-ration of economic activity in the FRY under the influence of the special factorsprevailing in 1992 and 1993. Per capita GDP in 1993 was $1163, barely over halfof its value in 1991, when it was of $2274.

There is no doubt that this overall deterioration was felt even more seriouslyby some strata of the population. Among them were wage earners. Their realwage in 1992 was 48.7% smaller than the preceding year. In fact, the rate ofwage decrease in 1992 was ten times greater than it was in 1990. The level ofpauperisation was even greater in 1993, when the real wage was 61% smaller thanin 1992.

The rate of unemployment is also a very important indicator of the standard ofliving. The unemployment rate in the FRY in 1992 was very high—24.6%. The ratein 1993 did not change. Formally, it seems that there was no deterioration in thissector. But in fact there was a tremendous deterioration. Instead of an increase inunemployment rate, the diminishing economic activity in the FRY was met by adrastic increase in excess employment: from 8.1% in 1991 to 22.7% in 1992 (almostthree times).28 The overall employment rate increased further in 1993 and 1994,mostly in the form of workers on forced vacations29 with very little pay, but actuallynot working at all.

The degree of pauperisation and declining standard of living of the FRY areperhaps most completely indicated by changes in the ratio of the average wage andthe consumer basket that can be bought. In 1989 the average wage was able to buythe consumer basket and save 26%; in 1993 it could buy only 10.7% of the sameconsumer basket.

The most difficult situation was in the fourth quarter of 1993, when real incomewas only 18.8% of real income in the fourth quarter of 1992.30 Perhaps the best wayto understand the degree of pauperisation of Yugoslavs during this worst period (endof 1993, beginning of 1994) would be to say that one weekly wage paid in dinarswas equivalent to 4-5 German marks ($3-4), and pensions less than DM I.31 Toillustrate the standard of living at that time: for an average weekly wage one couldbuy four pens and for the highest pensions (only 300 people received such highpensions), one bar of soap or one-third of a tube of toothpaste.32 The picture growseven more bleak when it is considered that in Yugoslavia there were over a millionretired people.

Monetary Reform in Yugoslavia, 1989/1990

The SFR Yugoslavia, like other East European countries in transition from 1989,made a serious effort to transform the monetary system and to cut the growinginflation that reached the stage of hyperinflation in December 1989 (59.1%). On 18December 1989 the new Prime Minister, Ante Markovic, presented the Programmeof Economic Reform and Measures for its Realisation in 1990. An important part ofthis programme was monetary reform and an anti-inflationary programme with thefollowing main features:

• convertibility of the dinar, allowing citizens freely to purchase foreign exchangeat the banks;

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Recovery and Stabilisation in FR Yugoslavia 535

• the dinar pegged to the deutschemark at 7 dinars = DM 1;• the dinar backed by foreign exchange reserves which were accumulated during

1990 from around $2.5-6 billion;• the fixed exchange rate was not received with enthusiasm by some of the

constituent republics, because it threatened some privileges their exporterspreviously enjoyed.

In order to stop price increases the federal government introduced, among otherreform steps, a law on wages, limiting monthly wages at a ceiling of DM 435 ($225)for six months. This law provoked political unrest in some republics; the originallimit was broken, and towards the end of the year a new ceiling was established atDM 800—which of course led to inflation.

While the activities in some republics during 1989 and 1990 were oriented moretowards disintegration of the Yugoslav market, the federal government underMarkovic tried to find means to resist some disintegration forces. The existence ofthese disintegrational forces is linked to the introduction of the 1974 ConstitutionLaw. By giving priority to the development of the economies of the six republics andtwo autonomous provinces, this lead practically to the disintegration of the Yugoslavmarket. On the basis of this law, eight new National Banks were introduced, eachworking in the interest of its republic, almost independently of the Federal NationalBank (NBY), whose competence became very limited. Using, or misusing, opportu-nities given by the 1974 Constitution, some republics' governments introduced thepractice of holding foreign exchange earned by their exporters on their own national(republic) bank account, instead of the NBY account. The accumulation of foreignexchange by some republics strengthened their economic and political power overthe federal government. Trying to reverse these disintegration trends, Markovich, inhis reform effort in 1990/91, insisted on the obligation of republics to deposit foreignexchange earned from exports in the federal account, with the aim of strengtheningthe federal government's role and power.

During 1990 monetary policy was stable, as was the dinar. Retail price increasesslowed from 41.5% in January to 2.7% in December 1990. Short-term relativeimprovements associated with the Economic Reform during the period 1989/90 didnot gain the political support of regional leaders of the six constituent republics.

At the end of 1990, three republics—Croatia, Slovenia and Serbia—started a neweconomic policy, openly discriminating against each other and ready to harm the'enemy' they each perceived the others to be. This meant the growing issue of 'greymoney', breaking into neighbours' monetary systems, manipulating credits andexchange reserves, and some other 'dirty tricks' fuelling the inflation and leading toseparation.

Unfortunately, the narrow self-interest of some republics was more powerful thanthe federal government's effort to unify the Yugoslav market and the country. TheProgramme of Economic Reform for 1990 vanished completely in mid-1991 andsecession and military confrontation started.

The break-up of Yugoslavia, starting with the secession and international recog-nition of Slovenia and Croatia in mid-1991 and of Bosnia and Herzegovina in 1992,with the well known political and military consequences, seriously damaged thealready stagnant and inefficient economy of the new FRY (established on 27 April1992).

Social concern and efforts to minimise social instability in the FRY haveimposed a policy of super-soft budget constraint which inevitably led to inflationary

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pressure. This pressure was expressed in a cascade-type process of both devaluationsof the dinar and re-denominations of the currency. From April 1992 until theend of 1993 the dinar was devalued nine times, while between 1990 and the endof 1993 the currency was three times re-denominated. Toward the end of 1993the economic situation was deteriorating not only on a daily but on an hourlybasis, particularly during November and December. By December 1993 therewas a total breakdown of the monetary system, with all the disastrous consequencesfor the majority of the population as well as for public finances. In the meantimethree research groups of eminent economists were engaged in preparation ofprogrammes. The programme drawn up by the group headed by Professor DragoslavAvramovic (former Head of the Research Division of the World Bank) was selectedas the most acceptable for the existing conditions; implementation began on 24January 1994.

Programme of Reconstruction of the Monetary System and Strategy of Econ-omic Recovery

Popularly called the Avramovic Programme, this was supposed to deal with the veryserious problems analysed in this article. The programme addressed the crisis at theend of 1993, when the Yugoslav economy was not only suffering drastic decline ofproduction and standard of living but also complete distortion of the nationalcurrency (dinar), when there was galloping hyperinflation and when the survival ofthe economy was in question.

In contrast to some earlier programmes that dealt only partially with certainproblems, this programme was conceived more as a complete shock therapy. If theeconomic situation in spring 1995 is compared with the period before the programmewas accepted (end of 1993) it could be said that the shock therapy was successful.Yet the problems postponed are tremendous. They could not be dealt with withoutthe positive results the programme has so far achieved; on the other hand, theproblems solved so far cannot stay permanently solved unless others are alsoovercome.

Programme of Monetary Reform

The first step in the current monetary reform was to make the National Bank ofYugoslavia come closer to fulfilment of its role as the Central Bank, solely incharge of:

• control of the money supply;• determining discount rates;• monetary policy.

The backbone of the programme is rigid monetary policy with strict discipline inpublic finance. Dealing with other economic problems was postponed until aftermonetary stabilisation was achieved.

The main features of the monetary reform were:

(1) creation of a new national currency—the new dinar (popularly named thesuper-dinar);

(2) the dinar is pegged to the German mark at a rate of 1:1;

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Recovery and Stabilisation in FR Yugoslavia 537

(3) the exchange rate is fixed;(4) the money supply is backed by foreign exchange reserves;(5) the dinar became convertible both for firms and individuals.

It should be kept in mind that this policy was market-oriented (prices, wages andinterest rates were freely determined on the market)33 and followed a liberal policyin foreign relations, to the extent of the limits imposed by UN sanctions.

Another important part of the programme was the one that dealt with publicfinance, because there is no monetary stability without adequate fiscal policy. Beforethe programme was implemented, during the crisis of 1993, the Tanzi-Oliveira effectwas at its fullest.34 The programme stopped this tendency, and in currency stabilisa-tion this effect was reversed, i.e. the real value of tax revenues stopped falling andstarted to increase.

The programme's promoters anticipated that economic sanctions would beterminated in the first months of implementation of the programme. This prognosiswas evidently wrong.

The programme was strictly implemented in both monetary and budget spheresduring 1994:

• From 24 January, when the programme began, till August, prices were mainlystable. The first price increases started in September and October (increasing0.65% weekly), the inflation rate was 9% from the start of the programme untilmid-November.35 Though the price increase of 10% is not considered a seriousproblem, the very fact that the increase started after a period of very stableprices is a signal for caution.

• Strict discipline in public finance also brought positive results, especiallyin the first phase, which ended on 24 July 1994. After many years, governmentrevenue and expenditure were balanced, and the practice of printing moneyto cover the deficit ceased. The budget deficit in the first quarter of 1994was 10.3 % of GDP and in the period January-October it decreased to 2.3% ofGDP.36

Analysts of the programme and its effect on the economy during 1994 vary in theiropinions. Even its most severe critics recognise that:

(1) The programme had a decisive positive role in creation of the new dinarand in reestablishing faith in the national currency. Also, the recordhyperinflation that seriously threatened to destroy the economy of the FRYwas halted.

(2) The programme succeeded in stopping the financing of the federal budgetdeficit with an unlimited supply of money, which of course was a huge sourceof inflation. However, not all public financing improved. The deficit wasgrowing in the pensions, veterans' and health insurance funds, and in somequasi-public expenditure—threatening very serious inflation and otherdifficulties. To face these problems requires long-run efforts to change theeconomic system, economic structure and behaviour of all partners.

(3) The programme helped an essential balance in the economy to be achieved;industrial production finally started an upward spiral. This has had a positiveeffect on the increase of real wages, from 25 dinars in January to 238 dinarsin October 1994 (a nine times increase). The monthly pension increased overthe same time from 23 to 178 dinars (seven times).

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538 Svetlana Adamovic

Table 4. Changes in Industrial Production

Year

1994/1993 by quartersIIIIIIIV1994/19891994/19911994/1993

Indices of industrial production

74.797.5

114.5124.33650

101

Source: Federal Office of Statistics, quoted in Mesecne analizei prognoze (Belgrade, Institute of Economic Sciences, 1994),p. 54.

The overall economic activity in the FRY in 1994 was relatively successful. RealGDP increased by 6.5% after four years of sharp decline. The increase was achievedwithout any foreign aid or foreign credit in very unfavourable conditions. Unfortu-nately, GDP was around 20 billion dinars, which amounted to only 43.2% of 1989GDP.37

Industrial production in 1994 is presented in Table 4.It must be stressed that while the increase in industrial production during 1994

continued through all four quarters, the yearly increase over the 1993 level was only1% and the level in 1994 reached only 36% of that in 1989. However, it is importantto underline that industrial production in 1994 turned from more thari four years ofcontinual decline to an upward trend. Still, more than 50% of existing industrialcapacity was not used in 1994.38

There were even more serious problems with the foreign exchange needed forimports of essential inputs and with the distortions of the grey economy. The foreignexchange reserves held by the government were largely depleted, while the possibil-ity for domestic exporters to earn foreign exchange was blocked by sanctions.

The gap between the supply and demand of foreign exchange had an immediateimpact on the exchange rate. Although the official exchange rate did not change (thedinar and German Mark stayed at 1:1), the real rate soon started to change. At thebeginning the change was 10%; in mid-year it increased to 30%; and in October1994 the black market exchange rate for the dinar was up to 70% lower.39 This is dueto illegal trading in foreign exchange, usually among enterprises and mostly out ofthe country. Still, it has influenced the black market exchange rate in the FRY. Blackmarket foreign exchange trade is usually done 'on the street', between individuals,and the premium is considerably smaller. Because of this distortion, as well asbecause of some other difficulties in the economy, by the end of October 1994 sharpmonetary measures were undertaken—reducing the free market premium for foreignexchange from 70% to 30%40 above the official rate. This downward movement wasnot considered as eliminating the problem, but the 30% premium is consideredtolerable. The official foreign exchange rate is still 1:1.

The discussion among experts now is what to do next in order to defend thestabilisation achieved and to keep it as the basis for further reform:

(1) Should the foreign exchange rate stay fixed?(2) Should the foreign exchange rate be devalued once and then stay fixed?

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Recovery and Stabilisation in FR Yugoslavia 539

(3) Would it be better to have a fluctuating exchange rate?

In fact, each of these solutions is the backbone for a new package of economicmeasures—or further steps that must be made if the FRY economy is to rejoin theclub of countries in transition toward a market economy.

(1) Promoters of the fixed exchange rate are mostly economists working with theNational Bank of Yugoslavia. In principle, but even more in practice, they favourvery pragmatic flexibility in monetary policy, 'as we go along'. For example, in thesecond half of 1994, when the programme was threatened by a great increase indemand for foreign currency, the National Bank temporarily changed its policy byfreezing the level of foreign exchange reserves, thereby stopping convertibilitywithin the country, especially for individuals. Exporting enterprises could still buyand sell foreign currency, but were required to keep their deficit of foreign exchangeat a very low level. Temporarily tolerating a 30% premium in the foreign exchangerate, the NBY in essence allowed a flexible exchange rate, but continued to keep theofficial rate fixed at 1:1. This fixed exchange rate here serves as the anchor for othermacroeconomic policy measures.

(2) Labus is one of a group of economists who think that the new dinar shouldundergo a small devaluation and then be kept at a fixed rate at that level. This theybelieve should remove the existing dual foreign exchange regime and allow thereform to continue.

(3) Popovic, Director of the Institute of Economic Sciences, is the promoter ofa package with a fluctuating exchange rate with more radical ambitions: fastereconomic growth, a bigger trade deficit, higher inflation, and faster redistribution ofincome with a smaller government share in total GDP and smaller role in theeconomy in general.

From the three programmes put forward for 1995, the government gave priorityto the first option. Many new economic policy measures are currently beingdiscussed. However, from the framework presented hitherto it is not yet clear to whatextent these measures, in the difficult conditions prevailing, will ensure the urgentlyneeded transition.

In spite of some very positive results of the Programme of Monetary Reformand Economic Recovery in 1994, the problems facing the FRY economy in 1995are numerous, extremely serious, and very often complex and interdependent.It is not easy to decide where to start with new economic steps. Yet itseems appropriate to give priority to the defence of the two greatest successes of1994:

• to keep the national currency stable and capable of serving its regular functions;• to provide incentives for economic activity in general and industrial productiv-

ity in particular.

The bare survival of the FRY economy has been achieved not only with no foreignaid or credit but also without the use of its own capital assets in other countries,which were frozen due to economic sanctions. The real rate of growth of GDP of6.5% and of industrial production of 1.3% in 1994 against all the odds is veryimpressive. However, the level is only 43.2% of that achieved in 1989. Accordingto some estimates, if the FRY economy could keep up this high rate of growth of6.5%, which will be very difficult, the GDP level of 1989 would be reached in theyear 2007.41

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540 Svetlana Adamovic

Notes

1. Among the inherited problems, a special burden comes from the structure of theeconomy—with several wrongly planned gigantic enterprises whose machinery andtechnology are now outmoded, with excess unproductive workers, and whose operationis still financed and subsidised by the government.

2. Most of the problems come from the discontinuation of economic ties with the CMEA,much slower access to the Western market than expected, lack of market, financial andbanking institutions, lack of experience and new, unstable economic policies.

3. UN Economic Commission for Europe, Economic Survey of Europe in 1993-1994 (NewYork and Geneva, United Nations, 1994), p. 52.

4. Jeffrey Sachs wrote in 1992:Yugoslavia, it is well known, chose a distinctive path of socialist develop-

ment...after 1948. Industry was socialized as in the rest of Eastern Europe andthe Soviet Union, but was not subject to central planning after 1965. Marketforces were given more scope. More important than the ownership and controlstructure itself was the fact that Yugoslav industrial enterprises were moremarket oriented than their counterparts in Eastern Europe...'. (Transition inEastern Europe, Vol. 1, Country Studies, p. 192).

5. Official statistics cited in Ekonomska politika, 6 February 1995, p. 18.6. Economic Survey of Europe in 1993-1994, p. 52.7. Ekonomska politika, 13 March 1995, p. 20.8. The first economic sanctions against Serbia and Montenegro were implemented by the

European Economic Community in November 1991 (in the beginning they applied toCroatia as well, but were lifted due to the intervention of some other West Europeancountries). On 30 May 1992 Resolution No. 757 of the Security Council of the UNordered all members of this organisation to forbid their citizens to have any businessactivities in FRY, to ban all trade relations, to freeze financial funds of FRY in theircountries, to forbid the use of FRY ships and planes and also to forbid FRY planes tofly over and land on their territory, to stop all scientific, technological and culturalrelations and to forbid FRY athletes to participate in international competitions orgames. The formal reason for the sanctions was the war in Bosnia which started in April1992. On 16 November 1992 the UN Security Council adopted Resolution No. 787,which forbade international transit of important raw materials and goods across theterritory of the FRY. On 17 April 1993 Resolution No. 820 tightened the squeeze so thatnot only was inland transit of raw materials and goods forbidden, but also the Danuberiver and the only FRY port (Bar) could not be used to import goods. Also, all financialtransactions, financial and non-financial services with foreign countries were forbiddenfor firms and citizens of FRY.

9. Federal Office of Statistics, cited in Ekonomska politika, 6 February 1995, p. 18.10. Ibid.11. Economic Survey of Europe in 1993-1994, p. 85.12. Ibid., p. 86.13. Ibid.14. Ibid., p. 85. The indicator of excess employment is the difference between the rate of

change of GDP and of employment.15. Centre for Economic Studies, Economic Development in FR Yugoslavia (Belgrade,

September 1993), p. 9.16. Economic Survey of Europe in 1993-1994, p. 75.17. According to the UN methodology, hyperinflation is reached when retail prices increase

by 50% a month. Economic Survey of Europe in 1993-1994, p. 74.18. Economic Survey of Europe in 1993-1994, p. 56.19. In 1993 foreign currencies, particularly German marks, US dollars and Swiss francs,

were in great demand in the FRY, surpassing the supply many times. The problem wasnot only caused by decreased supply of foreign exchange (the embargo froze all FRY

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Recovery and Stabilisation in FR Yugoslavia 541

assets in foreign countries and imposed export cuts where foreign exchange could beearned), but also by unusual increased demand for foreign currency. The loss ofconfidence in the domestic currency caused some of its functions to be transferred toforeign currency. In summer 1993, especially in July and August, instead of the dinar,'foreign exchange has become a favourite store of value, unit of account, means ofcapital flight, even preferred form in which increasing circles of consumers keep theircash in the short run, in the period between the payment of salaries'. DragoslavAvramovic, Crisis of the Dinar in July-August 1993: What Now? (Belgrade, EuropeanCentre for Peace and Development, 1994), p. 9.

20. Ibid., p. 8.21. Economic Survey of Europe in 1993-1994, p. 78.22. According to Odraz B, London, Daily information Service, 24 January 1995, p. 12.23. Weekly Business Review, Ekonomska politika, 6 February 1995, p. 13.24. NIN, 27 January 1995, p. 26.25. Ekonomska politika, 6 February 1995, p. 26.26. Ekonomska politika, 6 March 1995, p. 18.27. NIN, 27 January 1995, p. 26.28. Economic Survey of Europe in 1993-1994, p. 85.29. This status exerted less pressure on the government than did unemployment; for workers

it gave them preservation of some social benefits and also priority rights to work—whentheir enterprise starts working fully again.

30. Federal Office of Statistics, cited in Bilten Ekonomskog Instituta, Belgrade, IV quarter1994, p. 58.

31. Odraz B, London, 24 January 1995, according to an interview given by the Director ofthe Federal Office of Statistics of FR Yugoslavia.

32. M. Dinkic, Ekonomija destrukcije (Belgrade, VIN, 1995), p. 243.33. Prices of some essential consumer goods (milk, bread, edible oil) had a ceiling at a very

low level, although the supply kept increasing due to the fact that it was coming fromgovernment reserves. Prices were extremely low for public utilities; not even enough forthe repair of existing capacities.

34. The Tanzi-Oliveira effect explains how inflation can be one of the main reasons for thefall in tax revenues: there is a big time lag between income earning, income declarationand the collection of taxes, such that tax revenues are almost negligible in real terms.

35. Nebojsa Savic, 'Dalji putevi ekonomske stabilizacije—osnove ekonomske politike u1995', in Jugoslovenski ekonomisti O Aktuelnoj Ekonomskoj Politici (26th AnnualConference of Yugoslav Economists) (Belgrade, 1994), p. 13.

36. Ibid., p. 15.37. Ekonomska politika, 6 March 1995, p. 34.38. J. Bajec, 'Ekonomska stabilnost kao uslov rasta u 1995 godini', in Jugoslovenski

ekonomisti o Aktuelnoj Ekonomskoj Politici, p. 69.39. M. Labus, 'Devaluation—Yes or No?', in Yugoslav Economists: Current Economic

Policy (Belgrade, 1994), p. 92.40. Ibid.41. Ekonomska politika, 6 March 1995, p. 34.

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