Proposal from the Republic of Serbia for an Amendment to EU Economic Restrictive Measures

1

Contents

1.Introduction

2.The present situation in Serbia as a result of the EU restrictive measures

3.Future implications for the Republic of Serbia

4.Solution: Proposed amendments to the EU Regulation

Appendix 1: Current restrictive measures

Appendix 2: Overview of sanctioned entities in the EU candidate countries

Appendix 3: Clarification of the proposal for amending Council Regulation EU 833/2014…..……………………………………………………………………….

1. Introduction

1.1. The purpose of this paper is to inform EU stakeholders of the situation in the Republic of Serbia arising from the current EU sanctions measures (in particular, under EU Regulation 833/2014 (as amended)[1]), in an effort to gain support and understanding in relation to this situation. The resolution of these issues is of utmost importance for Serbia's economy, and consequently, to the successful accession of Serbia into the EU.

1.2. European integration is one of Serbia's most important foreign policy objectives, and in January 2014, Serbia's negotiations in respect of accession to the EU formally commenced. In September 2013, a Stabilisation and Association Agreement between the EU and Serbia entered into force, which sets out the framework of relations between the EU and Serbia pending full EU membership. Serbia firmly believes that its future lies in the EU and is working hard in its preparations to be able to meet the obligations of EU membership - i.e. the acquis expressed in the Treaties, secondary legislation and policies of the EU.

1.3. Serbia believes that the adverse effects of the EU financial restrictive measures regime on the Republic of Serbia, as outlined in this note, were not foreseen at the time of drafting of the sanctions rules, most likely because the EU candidate countries, such as Serbia, were not sufficiently consulted or considered during the discussions and drafting of the text of the EU Regulation. As further explained below, Serbia will face a looming dip in its economy if the issues arising from the present EU sanctions are not resolved.

1.4. This is why we would like to bring this critical issue to your attention, so the EU and Serbia can work together to reach a mutually acceptable solution.

2. The present situation in Serbia as a result of the EU restrictive measures

2.1. In 2014, in response to the situation in Ukraine, the EU introduced restrictive measures specifically targeting Russia. Targeted restrictions on access to the capital markets for certain financial institutions and legal persons were imposed with the clear aim of depriving Russia, and specifically Russian state-owned financial institutions and oil companies, of certain forms of financial support or investment.

2.2. In August 2014, the EU introduced the restrictions on Russia's access to capital markets (which were extended in September 2014 to include restrictions in respect of new loans or credit), by targeting certain listed major Russian companies (including Gazprom Neft, Sberbank and VTB), their non-EU affiliates and those acting on their behalf or at their direction. These financial sanctions form part of a package of targeted sectoral measures against the Russian economy. The primary focus of this note relates to these financial sanctions which have, since their imposition in August and September 2014, impacted Serbia and NIS jsc, one of the largest contributors to the Serbian economy and a joint company of Gazprom neft and the Serbian Government, and 2 Serbian banks: Sberbank Serbia and VTB Serbia. However, neither NIS nor the two banks have been individually notified of these sanctions, and it is highly questionable whether their sanctioning brings about any improvement in the situation in Ukraine, while it is absolutely certain that Serbia, a country under EU accession, is unduly penalised. The sole reason why NIS and the two banks are penalised is that they are headquartered outside the territory of the EU. Any other operator within the EU, which is in the same situation, i.e. owned by a listed entity, does not suffer the same grave consequences. In addition, such EU operators are not under the heavy burden of implementing a large web of obligations arising out of the acquis communautaire in a very short time .

2.3. Out of 5 EU candidate countries, only Serbia is hit by the restrictive measures to such an extent[2]. Serbia understands and believes it should not be the case that such measures restrict legitimate business activities outside of Russia that have no connection with those specific targets of the sanctions regime. As discussed in detail further below, the fact that Serbia's economy is, unintentionally, adversely and seriously affected by these sanctions necessitates a closer review of the situation so that such inadvertent but critical issues can be resolved.

2.4. Serbia is also in the midst of a highly sensitive economic climate, as it is currently placing great effort into implementing a stringent fiscal consolidation programme by curbing public expenditures and carrying out structural reforms to lay out a healthy foundation for future growth, with the aim of meeting the EU requirements for accession[3]. Therefore, the adverse effect for a country may arise from restriction to access to capital markets.

2.5. NIS currently finances its business operations from the credit agreements agreed and instruments issued prior to the above sanctions measures coming into force (i.e. before 12 September 2014, as those are exempted from the scope of the Article 5 prohibitions). This will however run out by the end of 2015. Hence by the beginning of 2016, the full ramifications of the financial restrictions (as described above) will adversely and seriously affect NIS' operations. Being deprived of the ability to finance its business via long-term credit, NIS would have no choice but to rely on short-term credit (up to 30 days maturity), which would significantly increase the costs of financing. This indirect effect of EU sanctions causes irreparable damage to NIS and places it at an unfairly disadvantageous position in comparison to any of its competitors in the EU, including those who are controlled by listed entities. Indeed, subsidiaries of listed entities within the EU are not subject to such restrictions.

2.6. The situation is also exacerbated in the banking sector by the fact that subsidiaries of EU banks established in Serbia apply the same EU restrictive measures in practice. Serbian banks’ capacity for financing, on the other hand, is pretty much limited and not enough to fulfil the needs of NIS, Serbia’s largest client.

2.7. Sberbank Serbia, a member of the European Banking group, is forbidden from withdrawing assets from its Austria-based mother-bank. As a result, it is forced to seek finance from the Sberbank Russia, which is more expensive. In addition, its contract with the European Investment Bank, worth 70 million EUR was cancelled. These measures will in long term force the bank to reduce its growth, which will have dire consequence for the Serbian banking sector.

2.8. The measures also hurting Serbia’s trading relationship with the EU. The negative effect of these measure in Serbia is felt by the EU banks incorporated in Serbia (e.g. Erste Bank, San Paolo Intesa Bank, Societe General, Unicredit bank, Raiffeisen bank etc.), as they are not able to serve its largest client, NIS, which needs loans of more than 1 billion EUR in 2016-2018 for its investments program. In addition, the value of goods and services that NIS purchased from the EU (NIS main subcontractors are EU-based companies, such as Siemens, BASF, Messer gas etc.) has decreased by 30% in 2015 relative to 2014, due to the uncertainty of the length and potential widening of the scope of restrictive measures.

2.9. Restrictive measures came during a period when EU-Serbia trade would be expected to increase. From 2011 till present NIS has invested more than 200 million EUR in Bulgaria, Romania, and Hungary[4], where currently it employs 111 people[5]. In 2016-2018 NIS plans to invest additional 91 million EUR to these three countries.

2.10. Moreover, the effect of the above financial measures contributed to establishing a negative reputation of Serbian companies amongst other companies, particularly Western companies from the EU and the US, such that they have been avoiding partnering with, or entering into contracts with sanctioned entities. Even if particular conduct is not prohibited by the Article 5 restrictions, companies are typically unwilling to take the time to understand and assess what they may still permissibly do with Serbian entities. As an example, the number of contracts NIS concluded with Western companies has so far dropped by 10% over the last year. Serbian entities continue to actively seek alternative suppliers and business partners in other markets, however, with little success thus far.

2.11. The impact of the EU sanctions is further intensified by US sectoral sanctions. These US measures restrict access to the US capital markets. The US measures have very broad extra-territorial effect and also apply to use of US dollars by non-US parties, thereby having a very significant dulling effect on the willingness and propensity of even non-US companies to trade with sanctioned Serbian entities.

2.12. In addition, with regard to Serbia’s corporations, the following factors should be taken into account:

They are not in any way connected with the cause of the sanctions. As stated above, the aim of the EU sanctions is to apply targeted restrictions on certain activities and services that contribute to the current situation in Ukraine. Serbia and its business have no connection to the Ukraine crisis, nor do they trade and invest in Crimea and Sevastopol. NIS takes no part in any offshore exploration and production, exploration or production in the Arctic or shale production in Russia, nor does it trade dual-use goods. On the contrary, sanctioning NIS by no means improves the situation in Ukraine. It only destroys a huge long-term effort by NIS and by Serbia as a whole to achieve EU accession criteria

No impact on Russia and Gazprom Neft. The financial sanctions result in unintended adverse consequences for the Republic of Serbia. On the other hand, these restrictions have no material impact on the Russian Federation or direct targets of the economic restrictive measures.

3. Future implications for the Republic of Serbia

3.1. Given the strong link between these entities and the Serbian economy as a whole, this adverse effect of sanctions would consequently affect Serbia and its financial stability. The prolonged inability to access European capital markets for unconditional long-term financing will therefore have long-term adverse effects not only on sanctioned entities, but also on Serbia and its ability to meet its accession requirements.

3.2. Destabilising the Serbian economy is contrary to the EU's commitment of cooperation to achieve reform under the Stabilisation and Association Agreement. Under the Stabilisation and Association Agreement between the EU and Serbia, the EU notes its commitment to the political, economic and institutional stabilisation in Serbia. In particular, the EU and Serbia have committed themselves to establishing a close cooperation aimed at contributing to the development and growth potential of Serbia, in order to strengthen existing economic links on the widest possible foundation[6]. In this context, the EU and Serbia have committed to facilitate the process of economic reform by cooperating to improve understanding of the fundamentals of their respective economies and the formulation and implementation of economic policy in market economies[7]. This must also be considered against the backdrop of the finding in the October 2014 Progress Report on Serbian accession that, although overall economic integration with the EU increased further and export performance improved, further progress is needed towards establishing a functioning market economy. Structural reforms were required to cope with the competitive pressures and market forces within the EU, and the application of Article 5 to Serbian companies would hinder, and may even reverse these processes of progress and reform. By not allowing the companies based in Serbia (as the EU-candidate country) to have the same treatment as the EU- based subsidiaries of the sanctioned entities in the application of the financial sanctions in Article 5, the EU unintentionally destabilises the Serbian economy and goes against this commitment of cooperation to achieve economic reform as enshrined in the Stabilisation and Association Agreement.

3.3. Restrictive measures are depriving the Serbian economy of much needed investment, and will thus have adverse effect on Serbia's GDP and revenues. NIS share of the overall investments in the country is 5% in 2015[8]. NIS accounted for 11% of total corporate investments in Serbia, and hence was listed as the largest corporate investor in Serbia in 2013. The next company on the list accounted for less than 5%[9]. It is also one of the leading Serbia’s exporters with 369,5 million EUR exported in 2014 in the region of South East Europe[10]. Investments and exports are the two key sources for Serbia's domestic growth. NIS' contribution the tax revenues of the Budget of the Republic of Serbia was around 16% in 2014[11].The fall in NIS investments in 2016 will lead to fall in overall investments for 1,5%, as a result of restrictive measures, which will have a long-term effect as well[12]. Moreover, the drop in NIS productivity will likely result in the decline of industrial production, investment spending and exports in the medium term, having an adverse effect on Serbia’s GDP: according to projections based on the Fiscal strategy of Serbia, decrease of NIS contribution to Serbia’s overall investments and exports for 1% would result in fall in Serbia’s GDP for 0,4% in 2016. It is important to note that there will be consequences beyond these figures shown in the table, as it does not take into account indirect impact of restrictive measures on 2400[13] small and medium entities which partner with NIS in one form or another. Should such factors be taken into account, the adverse effect of the EU sanctions measures on the Serbian economy could be much greater. Diminished investment from NIS could lead to a reduction in the Republic of Serbia’s budget revenues, since NIS will likely pay fewer taxes. NIS directly employs in all countries around 11,000 staff[14]. Sberbank has a 100 million EUR of turnover and with the same amount it supports the Republic of Serbia’s budget through the state bonds, and supports all bigger public utilities, local municipalities and companies in Serbia with 1.3 billion EUR. Before the sanctions were imposed, the strategy of Sberbank Serbia was to open 15 new branches and to employee additionally 105 employees to current 660. However, as the sanctions were enforced, Sberbank Serbia has opened only 8 branches and had to optimize the headcount, which does not contribute to the planned growth and employment rate in Serbia. Moreover, as a result of sanctions, Sberbank Serbia has suffered losses that led to decrease in profit, so the inflow in state budget will also decrease. In addition, the planned investments in information infrastructure were stopped so the turnover with domestic suppliers has not been reached. In a delicate economy of Serbia, when after a fall in economic activity the country finally witness first signs of recovery and positive developments of macroeconomic indicators, Sberbank Serbia is not able to support further growth by lending to the business and citizens of Serbia.

3.4. Serbia will not be able to meet the obligations arising from the Energy Community Treaty and the EU Accession Process. If Serbia's largest energy company is unable to meet its EU obligations in good time, which would require a total investment of around EUR 550 million, accession plans in the field of energy and environment might be derailed[15]. NIS stands ready to invest in order to meet even the most demanding obligations as per the EU legislation[16] specifically in the area of environmental protection and energy regulation alignment, but for this, financial security is absolutely necessary. In 2015-2017 NIS must invest at least EUR 250 million in its “Bottom of the Barrel” (DCU – Deep Conversion Unit) project to comply with the requirements of the EU acquis communautaire[17]. Moreover, NIS contributes strongly to the diversification of energy sources and provides security of supply in Serbia, by producing domestic gas, crude oil and electrical energy[18][19]. Therefore, Serbia's ability to contribute to resolving Europe's energy problems and attaining the goals of the Energy Union are dependent on NIS being able to access funding. This further leads to serious problems for Serbia, a country under EU accession, to achieve the acquis communautaire targets imposed by the EU itself. There is therefore a blatant contradiction: on the one hand, the EU requests Serbia and NIS to incorporate the acquis communautaire with extremely costly and fast-tracked actions and, on the other, the same EU causes irreparable damage to NIS thereby disallowing it to achieve such targets. It further damages the EU-Serbia trade without achieving any result whatsoever with regard to the desired objectives of the restricted measures. In addition, Serbia's economy is highly reliant on energy capabilities. Through a "stress-test" exercise launched by the Commission in summer 2014, it was found that of the countries that participated, Serbia would be among the ones most affected in case of supply disruption of gas in Europe[20]. The European Commission has also recognised that Serbia's economy is highly energy-intensive, and its heavy reliance on fossil fuels means it may become more vulnerable to fuel price shocks, thus undermining Serbia's prospects for growth and prosperity. Given the state of Serbia's energy markets, the negative impact of the restrictive measures will disrupt Serbia's energy supply and have serious consequences for the Serbian economy. Moreover, NIS significantly contributes to the “green economy” through its energy generation projects (wind farm, geothermal sources, energy efficiency projects) and to the achievement of Serbia’s environmental targets as per the National Renewable Energy Action Plan (27% of energy generated from renewable sources by 2020). The negative effects of the EU sanctions will have an adverse effect on these projects, and therefore on the Republic of Serbia’s abilities to meet the criteria for the accession to the EU.