Serbia set to swallow bitter pill after snap election

SMEDEREVO, Serbia (Reuters) - The steel mill in this Danube river town has fed three generations of Milos's family. But the 17-year veteran believes he will be the last.

"The plant will close down," he said. "There's no business and we won't get salaries for much longer."

Milos, who declined to give his surname, is one of 5,000 workers at the Smederevo Steel Mill who face a growing threat of redundancy following an election this weekend in Serbia.

The former Yugoslav republic's likely next rulers promise a dramatic overhaul of the economic order, a costly and chaotic hybrid of Socialist-era central planning and fledgling capitalism that experts agree is no longer sustainable.

Facing the chop are dozens of factories and firms on state life support, Smederevo among them. The public sector employs nearly 800,000 people, or around half the Serbian workforce, and is a huge drain on the meagre eight-billion-euro (6.6 billion pounds) budget.

Successive governments since Serbia's emergence from isolation with the fall of strongman president Slobodan Milosevic in 2000 have shied away from reforming the public sector for fear of being punished by voters.

But if opinion polls are to be trusted, the centre-right Progressive Party (SNS) of Aleksandar Vucic will win big on Sunday, and enter power on an unprecedented mandate to stabilise Serbian finances.

The stakes are high, as the biggest market to emerge from old federal Yugoslavia embarks on talks on joining the European Union within the next decade.

"I didn't come to Smederevo to tell you that you will live easy, that milk and honey will flow, that flowers will bloom if you vote for us," Vucic said last month during campaigning in the town. "Reforms will be difficult and painful. Those who say cancer can be cured with aspirin are not being honest."

For decades, public sector jobs were coveted for security, higher-than-average salaries and generous holidays. They were a rich source of political patronage, doled out to the party faithful with each change of government.

Now, pensions and public sector wages amount to the equivalent of nearly a quarter of Serbian national output. Sixty percent of state budget revenues are paid out in pensions and wages. By comparison, affluent EU member state Austria last year devoted some 32 percent of budget revenues to pensions, social security and health sectors.

Serbia's consolidated budget deficit, which includes municipal finances and support for public companies such as Smederevo, has soared to 7.5 percent of gross domestic product, and by some estimates will reach 8.5 percent this year.

Public debt has climbed by 30 percentage points since 2008, hitting 69 percent of GDP last year, higher than the International Monetary Fund recommends for similar emerging economies.

"STARK CHOICES"

It is testimony to the rapid rise in Vucic's personal popularity - mainly on the back of a much-publicised fight against crime and corruption - that his mantra of reform has not hurt the party's chances in the March 16 election.

The outgoing government, in which he is deputy prime minister, debated an overhaul of the labour market and public sector, but backed down in the face of coalition tensions.

Forcing a snap election, the SNS said it needed a stronger mandate to push through tough structural reforms. If it does so now, it faces a public backlash, but to put off such measures risks even greater economic consequences, economists warn.

"Serbia's political and economic leaders face some stark choices," Tony Verhayden, the World Bank's top official in Serbia, told a business forum last week in the Serbian ski resort of Kopaonik.

Without reform of the public sector, "one does not have to look too far south to see the potential consequences which, for a country still outside the EU, are extremely dire," he said, alluding to debt-laden Greece.

According to the Belgrade-based Economic Institute think-tank, Serbia needs to attract 1.6 billion euros of foreign investment per year to secure a growth rate of 4 percent by 2020 and catch up with regional peers and EU members Croatia and Slovenia, two other ex-Yugoslav republics.

Last year, 700 million euros of foreign direct investment (FDI) entered the country. Smederevo was once a shining example, sold to U.S. Steel for $23 million (13 million pounds) in 2003 in the biggest post-Milosevic era privatisation. But U.S. Steel sold it back for a token $1 in 2012 as the state stepped in to prevent the mill's closure after years of losses.

Other investors have been put off by suffocating red tape, widespread corruption and political turbulence.

The lack of an IMF safety net since early 2012 has also unnerved investors. That may change quickly after the creation of a new government, with SNS-chosen Finance Minister Lazar Krstic now in talks with a visiting mission from the Fund.

The IMF will seek spending cuts through structural reforms. The outgoing government has already raised value-added tax and cut into public sector salaries, which triggered a protest by doctors on Monday. Further measures may meet resistance in the streets, testing Vucic's mettle.

"Even if the government would be ready to start painful reforms, it would be difficult," said Zoran Cirjakovic, a media and communications analyst at Singidunum University in Belgrade. "People working in the public sector are not ready for reforms. They don't think they should be the ones to sacrifice."

Or, as Milos in Smederevo put it: "As soon as we stop getting paid, we'll take to the streets and block the roads."

(Additional reporting Georgina Prodhan in Vienna; Editing by Matt Robinson/Mark Heinrich)

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