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Title: Serbia: Seeking Loans From RussiaTeaser: Belgrade is playing political games to get financial help. (Both the title and the teaser suck, please help)

Summary: Serbia asked Russia for 1 billion euro ($1.4 billion) worth of financial assistance. The loan is intended to assuage Serbia's economic woes, but the request came only two weeks after an outreach visit by U.S. President Joe Biden. While it is highly unlikely that Serbia is going to fall within the Russian sphere of influence under its current leadership, it is clear that Belgrade believes that playing both sides has its benefits.Russian Ambassador to Serbia Aleksandar Konuzin said June 8 that the Russian government was considering Serbia's request for 1 billion euro ($1.4 billion) in financial assistance. Konuzin said Serbian President Boris Tadic officially made the request in a letter to Russian President Dmitri Medvedev. Konuzin's statement comes after Serbian First Deputy Prime Minister Ivica Dacic returned from Moscow, where he discussed Russian financing for a number of Serbian infrastructure projects, including expanding Belgrade's subway, highway system and reconstruction of the Djerdap hydroelectric power plant on the Danube.

Belgrade's request for financial assistance comes amidst worsening economic situation in the Balkans as a region and Serbia in particular. It also comes two weeks after a landmark visit to Belgrade by the U.S. Vice President Joe Biden during which the United States officially announced that it did not expect Serbia to accept or recognize Kosovo's independence and reaffirmed its support for Serbia's EU accession. Despite U.S. outreach efforts in the region, good relations between Serbia and the West are now almost entirely in the European Union's hands because the EU accession process is under Brussels' authority, not Washington's. But with the EU distracted with a deep recession and elections in Germany, room for maneuver in the Balkans opens for Moscow.

At the beginning of the current economic crisis, the Balkan countries were hoping that their low exposure to global high finance would spare them from the worst effects of the crisis. However, as the recession collapsed global trade demand and spooked investors of emerging markets, currencies in the Balkans began to depreciate. The Serbian dinar has lost a quarter of its value since the crisis spread to the Balkans in October. The slide in domestic currencies has since appreciated the value of foreign currency denominated loans, which are popular among both corporate and private customers of Western banks (particularly Austrian, Greek and Italian) operating in the region. [The falling currency made the value of the foreign-denominated loans increase?]

INSERT GRAPH: Dinar-Euro-Dollar (being created by TJ)

Added to potential banking problems is the collapse of global demand, which forced U.S. Steel (one of Serbia's main foreign investors) to slow down production at its Smederevo plant. This has contributed to the overall drop in the Serbian industrial output, with a 21 percent year-on-year fall in industrial output in April, the fourth consecutive monthly decline. Serbia's central bank tried to stimulate lending by cutting its interest rate from 14 percent to 13 percent on June 1, as well as by relaxing lending rules to consumers. But the central bank is in a difficult situation because the 3 billion euro ($4.19 billion) loan from the International Monetary Fund (IMF) is conditional upon keeping inflation in check. Serbia has already requested the IMF that its budget deficit target be expanded from the current IMF set target of 3 percent gross domestic product (GDP), a condition that if not fulfilled could stall the delivery of the second tranche to Serbia.

Serbia is now facing a ballooning budget deficit, slumping tax collection and 2009 GDP contraction of between 4 and 6 percent (first quarter contraction was 6.5 percent), much higher than the initial IMF forecast of 2 percent.

The economic malaise is further exacerbated by a tenuous political situation. Several political parties from all over the spectrum (nominally pro-Western parties ofboth the right and left working together with former allies of Serbian President Slobodan Milosevic) formed a coalition whose only foundation is political and economic patronage and EU membership. The lack of a coherent political foundation upon which to guide the country has resulted in a large government in order to accommodate the interests of all of the members in the coalition. With a 26-member executive branch, Serbia has one of the largest cabinets in the world. It also means that the country has deferred politically costly cost-cutting measures, particularly social welfare expenditures. Meanwhile, bureaucracy has been allowed to bloat in order to further extend party patronage to mid- and low-level party functionaries, and Belgrade continues to run a country of 8 million as if it were still a country of 23 million (the size of former Yugoslavia). As the revenue from various privatizations of nationalized industries has dried up, Serbia is left with an expensive executive, large social welfare provisions and no stream of revenue.

This is where the Russian loan comes into play. Russia is experiencing a difficult economic crisis of its own, but it remains very well capitalized with around $600 billion in currency reserves and various government coffers. This does not mean that Russia can act as the IMF for Central and Eastern Europe, but it can certainly choose where its lending will have great effect, particularly in places like Serbia where it does not have to lend a lot to make an impact (it similarly offered a substantial loan to Iceland in October). The Kremlin has offered similar loans to other countries it hopes to influence, namely Belarus, Kazakhstan and Ukraine; loans that will come with political strings attached.

Serbia is a smart investment for Russia because even though Serbian President Boris Tadic is pro-West and campaigns on an EU accession platform, he is willing to work with Russia. Serbia withdrew from the NATO exercises in Georgia in late April, for example, because it did not want to participate in a military exercise that threatened Russian national security. Furthermore, Tadic approved the sale of Serbian state-owned energy company NIS to Russian natural gas behemoth Gazprom for a deal in December 2008. This was the first sign that cash-strapped Belgrade was not picky about who bought its entire energy infrastructure as long as it got cash. This was a move that certainly unnerved the European Union, which was not pleased to see Russia make new inroads into the European energy infrastructure.

While it is highly unlikely that Serbia is going to fall within the Russian sphere of influence under its current leadership, it is clear that Tadic believes that playing both sides has its benefits. This strategy served Belgrade well during the Cold War, when Yugoslavia straddled important geopolitical fissures. However, a Serbia reduced to its current size, removed from sea access and surrounded by NATO and EU member states is not as geopolitically significant for the West (or Russia) as former Yugoslavia.

(click image to enlarge)Serbia is therefore only important if it is capable of wrecking havoc on its neighbors, a capacity that Serbia has lost completely despite nearly a decade of isolation and losing multiple wars. This point is not lost on the current U.S. administration, which is precisely why Biden went to Belgrade to reassure its leadership that Washington still wants to integrate Serbia into the European Union. The problem, however, is that it may not be in European Union's plans to do the same. With "enlargement fatigue" setting in with most EU member states and the recession further discouraging most enlargement advocates, prospects for the Balkans do not look good. This could allow the Kremlin to step up to the plate for Serbia and continue making inroads with the current government.