Supporting Serbia’s Transition to Greener and More Resilient Growth Policy and Institutional Reforms OCTOBER | 2022 2 • Supporting Serbia’s Transition to Greener and More Resilient Growth Policy and Institutional Reforms OCTOBER | 2022 © 2022 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000; Internet: www.worldbank.org This work is a product of a collaborative effort of the staff of the World Bank Group. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of the World Bank, its Board of Executive Directors, or the governments they represent. 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Because the World Bank encourages dissemination of its knowledge, this work may be reproduced, in whole or in part, for noncommercial purposes as long as full attribution to this work is given. Please cite the work as follows: “The World Bank. 2022. Supporting Serbia’s Transition to Greener and More Resilient Growth. Policy and Institutional Reforms. © World Bank.” All queries on rights and licenses, including subsidiary rights, should be addressed to World Bank Publications, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2625; e-mail: pubrights@ worldbank.org. Contents Acknowledgments iv Abbreviations and Acronyms v Abstract vii Brief Summary viii Executive Summary 1 1. What are Serbia’s drivers for pursuing the transition to greener and more resilient growth? 5 1.1 Deteriorating environmental sustainability and economic growth 5 1.2 Challenges of transitioning to greener and more resilient growth for Serbia 10 1.3 Government strategies and priorities 14 2. What does Serbia need to do to turn greener and more resilient and how can this be achieved? 17 2.1 The role of pricing signals 17 2.1.1 Environmental fiscal reform 17 2.1.2 Carbon Border Adjustment Mechanism (CBAM) and Carbon Pricing 20 2.1.3 Distributional impacts of the proposed environmental fiscal reform (EFR) and carbon pricing on households and firms 27 2.2 Broad and deep sectoral reforms will ensure a fast transition 30 2.2.1 Energy efficiency 30 2.2.2 Air pollution 31 2.2.3 Waste management and Circular Economy 32 2.2.4 Water and wastewater 33 2.3 Strong institutions are needed to sustain the transition to greener and more resilient growth 34 3. Managing transition risks and charting a course to greener and more resilient growth 38 References 47 Annex 1: GRID Diagnostics Serbia – Indicators 49 Annex 2: Impact Assessment of Selected Opportunities for Environmental Tax Reform in Serbia 54 A2.1 Context 54 A2.2 Findings of the initial impact assessment 54 A2.2.1 Revision of excise energy taxes 54 A2.2.2 Abolishment of the fee for protection and improvement of the environment 56 A2.2.3 The fee for pollution of the environment: fee for the emission of SO2, NO2 ,particulate matter and produced or landfilled waste 56 A2.3 Institutional aspects 57 Annex 3. Carbon Border Adjustment Mechanism and Carbon Pricing 59 A3.1 Background on model and scenarios 59 A3.2 Drivers of macroeconomic impacts of CBAM and carbon pricing in Serbia 61 A3.3 Alternative revenue use: R&D investments and payroll tax reduction 62 Annex 4. SWOT Analyses of Key Reform Areas for Greener and More Resilient Growth 64 A4.1 Waste and Circular Economy 64 A4.2 Air Quality 66 A4.3 Climate Action 68 A4.4 Water 71 A4.5 Energy Efficiency 73 Annex 5. Performance Assessment of Public Environmental and Climate Institutions in Serbia: Focus on Addressing Air Pollution and GHG Emissions from the Energy Sector 76 Figures Figure 1. Overview of energy intensity in European countries, 2019 5 Figure 2. Overview of resource productivity in Europe, 2019 6 Figure 3. Growth rates in Serbia by sectors and external shocks 7 Figure 4. Change in net primary productivity (2000-2013) as a measure of land degradation 8 Figure 5. Carbon intensity of GDP in select countries 11 Figure 6. Going green – the preferred alternative growth path for Serbia 12 Level and composition of comprehensive wealth per capita in Serbia compared to other European Figure 7. 13 countries and fossil fuel exporters Figure 8. CBAM and carbon pricing scenarios for Serbia 21 CBAM and carbon pricing scenarios: sectors contribution to percentage change in country GDP Figure 9. 25 compared to BAU (in 2035) CBAM and carbon pricing scenarios – sectors’ contribution to percentage change in total employ- Figure 10. 26 ment compared to BAU (in 2035). Figure 11. Budget share of residential fuels and transport by expenditure deciles in Serbia 29 Figure 12. Value added multiplier and PM2.5 multiplier (supply side) 40 Figure 13. Organizing framework for transition to greener and more resilient growth in Serbia 42 Tables Table 1. Selected indicators from the World Bank’s GRID/RISE diagnostics for Serbia 9 Table A1.1 GRID indicators for Serbia 50 Table A2.1 Impact of alignment of excise duties in Serbia with the revised EU ETD proposal on GDP 55 Exogenous assumptions for Serbian GDP and exports annual growth rates in the Table A3.1 59 GEM-E3-SRB Baseline scenario Table A3.2 Overview of scenarios 60 Table A4.1 SWOT analysis for the Serbian waste sector and circular economy 65 Table A4.2 SWOT analysis for air quality management in Serbia 67 Table A4.3 SWOT analysis for climate action in Serbia 69 Table A4.4 SWOT analysis for the water sector in Serbia 71 Table A4.5 SWOT analysis for energy efficiency in Serbia 73 Boxes Box 1. Impact assessment of selected opportunities for environmental tax reform in Serbia 18 - 19 Box 2. The EU CBAM 21 Box 3. Carbon pricing revenue 23 Box 4. Institutional resources to implement measures in practice 36 Box 5. Supply side multiplier analysis 40 8 • Acknowledgments This report was prepared by a core team led by Sameer The consultant team that provided some of the Akbar (Senior Environmental Specialist, SCAEN) and background analysis included: Zoran Kapor (GFA South- Lazar Sestovic (Senior Country Economist, EECM2), East Europe), Zoi Vrontisi (E3-Modelling), Leonidas consisting of Grzegorz Peszko (Lead Economist, Paroussos (E3-Modelling), Konstantinos Fragkiadakis SENGL), Arno Behrens (Senior Environmental (E3-Modelling), and Dimitris Fragkiadakis (E3-Modelling). Economist, SCAEN), Anita Hafner (Junior Professional Officer, SCAEN), Marissa Santikarn (Climate Change The team is grateful to Thomas Farole (Lead Specialist, SCCMI), Ivana Novakovic (Environmental Economist, SCADR), Daniel Besley (Senior Climate Specialist, SCAEN), and Maja Murisic (Senior Change Specialist, SCCAO), and Stefan Ulrich Speck Environmental Specialist, SLCEN). (European Environment Agency) for their advice and collaboration, and to Richard Record (Lead The extended World Bank team that provided inputs Country Economist, EECDR), Helena Naber (Senior included Katharina Gassner (Senior Energy Economist, Environmental Specialist, SENGL) and Craig Meisner IECE1), Joern Huenteler (Senior Energy Specialist, (Senior Economist, SCCDR) for providing guidance as IECE1), Simon Ellis (Program Leader, IECDR), peer reviewers. Grace O. Aguilar (Program Assistant, Jennifer Uju Dim (Economist, SENGL), Raimund Mair SCAEN) provided logistical and administrative support. (Senior Water Resources Management Specialist, Timothy Justin Kortschak (Consultant, EEAF2) edited SCAWA), Stjepan Gabric (Senior Water Supply and the manuscript, and Nigara Abate (Consultant, SCAEN) Sanitation Specialist, SCAWA), Jason Daniel Russ and Elarefbellah Kaal (Consultant, SCAEN) prepared (Senior Economist, GGSCE), Shenghui Feng (Data the manuscript for publication. Analyst, GGSCE), Axel Baumler (Senior Infrastructure Economist, SCAUR), Silpa Kaza (Senior Urban The work was carried out under the overall guidance of Development Specialist, SCAUR), Zoran Skopljak Linda Van Gelder (Country Director, ECCWB), Nicola (Public Sector Specialist, EECG2), Verena Maria Pontara (Country Manager, ECCYU), Kseniya Lvovsky Fritz (Senior Public Sector Specialist, EECG2), Sasa (Practice Manager, SCAEN), and Jasmin Chakeri Eichberger (Senior Environmental Specialist, SCAEN), (Practice Manager, EECM2). ■ Abdoulaye Gadiere (Regional Environment and Social Standards Adviser, ECADE), Miriam Privarova (Junior Professional Associate, SCAEN), and Susanna Dedring (Junior Professional Associate, SCAEN). •  iv Abbreviations and Acronyms APACD Action Plan for Administrative Capacity Development KfW Kreditanstalt für Wiederaufbau AEL Achievable Emission Level kg kilogram AFD Agence Française de Développement LCDS Low Carbon Development Strategy BAT Best Available Technique LSG Local Self-Government BAU Business as Usual MCPs Medium Combustion Plants CBAM Carbon Border Adjustment Mechanism MCPD Medium Combustion Plant Directive CEM Country Economic Memorandum MoEP Ministry of Environmental Protection CGE Computable General Equilibrium MoME Ministry of Mining and Energy CO2 eq Carbon Dioxide Equivalent MRV Monitoring, Reporting and Verification DPO Development Policy Operations NAP National Adaption Program EC European Commission NAPP National Air Protection Plan Administration for Energy Efficiency EEA NCCC National Climate Change Council Financing and Promotion EE Energy Efficiency NDC Nationally Determined Contribution EFR Environmental Fiscal Reform NECP National Energy and Climate Plan EPR Extended Producer Responsibility NERP National Emission Reduction Plans EPS Elektroprivreda Srbije NOx Nitrogen Oxides ETD Energy Taxation Directive PM2.5 Particulate Matter ETS Emissions Trading System RES Renewable Energy Sources EU European Union R&D Research and Development EUR euro RISE Resilience, Inclusivity, Sustainability, Efficiency GDP Gross Domestic Product RSD Serbian dinar GHG Greenhouse Gas Emissions SCP Small Combustion Plants GNI Gross National Income SDG Sustainable Development Goal GRID Green, Resilient, Inclusive Development SEPA Serbian Environmental Protection Agency GTAP Global Trade Analysis Project SO2 Sulphur Oxide GVA Gross Value Added SOE State-owned Enterprises IMF International Monetary Fund UMI Upper Middle-income Countries IPPC Industrial Pollution Prevention and Control USD United States dollar WHO World Health Organization v  • Abstract Serbia needs to transition to a greener growth model implementation of carbon pricing will also enable Serbia for internal and external reasons. Internally, Serbia’s to proactively prepare for the upcoming EU CBAM. economy is still characterized by low energy and The proceeds of carbon pricing should be reinvested resource productivity, with significant impacts on health in innovation and education to further accelerate the and the environment. As a candidate country for EU green transition. Second, institutional frameworks membership, Serbia also needs to react to external need to be strengthened to support the government influences by aligning domestic policies with the EU’s in delivering on reforms. Third, sector-specific reforms energy, environment, and climate legislation, while will need to address important challenges like energy avoiding negative impacts of the EU’s planned Carbon efficiency, air pollution, waste management, water, Border Adjustment Mechanism (CBAM). This report and wastewater. Importantly, the transition needs draws from a rich analysis to provide recommendations to be based on a coherent and adaptive roadmap, on how the transition to greener and more resilient which mitigates the risks of 'brown' growth, protects growth in Serbia can begin. First, environmental those adversely impacted, and ensures an equitable fiscal reforms are needed to incentivize the adoption distribution of the benefits of increased growth. ■ of more environmentally friendly technologies. The •  vii 12 • Brief Summary Serbia’s economy is characterized by low energy and EU accession process, Serbia has made several bold resource productivity, with significant impacts on health commitments to enhance its capacities in the areas of and the environment. Serbia’s air quality ranks among environmental management and climate change. When the worst in Europe, while untreated waste and waste- Serbia imposes its own domestic carbon pricing system, water continue to pollute the environment. As Serbia or even to effectively deal with the terms of the EU’s looks to the future, it is essential for the government to CBAM, it will also need to have in place a robust mon- reduce the country’s dependence on the use of heavily itoring, reporting and verification (MRV) framework for polluting lignite, improve energy efficiency, and promote greenhouse gas (GHG) emissions. clean and green development across sectors. In addi- tion, as a candidate country for EU membership, Serbia Certain sectoral policies and regulatory reforms can be needs to align domestic policies with the EU’s energy, initiated quickly to catalyze the transition. While a broad environment, and climate legislation, while avoiding spectrum of reforms is needed to support the transition the negative impacts of the EU’s planned Carbon Bor- to greener and more resilient growth, some sectoral der Adjustment Mechanism (CBAM). Hence, the time reforms are already within reach. The report outlines is now for Serbia to act to achieve greener and more many such reforms in priority sectors like energy ef- resilient growth. This report draws from a rich analysis ficiency, air pollution, waste management, and water to provide broad recommendations on how the tran- and wastewater. Furthermore, reforms are needed to sition to greener and more resilient growth in Serbia finance sectoral interventions. As discussed in this re - can begin. port, through the example of fiscal reforms, additional financing needs can be met by shifting towards making Environmental fiscal reforms are needed to incentivize polluters pay in proportion to the environmental dam- a shift towards adopting more environmentally friendly age they cause. technologies. The implementation of carbon pricing will also enable Serbia to proactively prepare for the forth- A deliberate step-by-step approach is needed to man- coming EU CBAM. The results of the macroeconomic age the transition to greener and more resilient growth. modeling in this report show that CBAM could have a Given the potential impacts of the green transition on small negative impact on Serbia’s GDP (0.21 percent Serbia’s economy and society, the authorities should below baseline in 2035). Carbon pricing results suggest adopt a deliberate yet cautious approach with robust similarly modest impacts on the economy in the medi- preparatory work. The war in Ukraine and the associat- um term compared to facing CBAM (0.28 percent be- ed energy security concerns, together with internation- low baseline). However, adopting a carbon price would al price shocks, should not discourage or distract the exempt Serbia from CBAM costs, as well as generate authorities from pursuing the transition to greener and fiscal revenue that would lead to positive GDP impacts. more resilient growth. In fact, these events may serve Reinvesting the proceeds of carbon pricing in innova- as a trigger for even more ambitious and dedicated tion and education would help to further accelerate the efforts to facilitate the transition. Serbia needs to be transition to greener and more resilient growth. well-prepared with a coherent and adaptive roadmap, which mitigates the risks of 'brown' growth, protects Institutional frameworks need to be further strength- those adversely impacted, and ensures an equitable ened to support the government in delivering on re- distribution of the benefits of increased growth. ■ forms. It is not enough just to adopt new policies. The authorities will also need to ensure that they have the institutional frameworks to deliver. In the context of the •  viii 14 • Executive Summary Serbia faces several key challenges to achieving Second, Serbia needs to increase the resilience of greener and more resilient economic growth. While its growth by being prepared to address multiple 2021 saw a strong economic recovery from COVID-19 threats, including those related to climate change (Coronavirus), Serbia’s rate of economic growth has and environmental degradation. As Serbia looks to been modest in recent years. Further, growth has been the future, it is essential for the government to reduce accompanied by high environmental costs. On average, the country’s dependence on the use of heavily Serbian businesses create significantly more pollution polluting lignite, improve energy efficiency, and reduce and consume more energy and natural resources per environmental degradation risks by promoting clean value added than most European Union (EU) countries. and green development across sectors. To achieve this, Serbia also topped the 2019 list of death rates from it will be vital to strengthen institutions and governance. pollution among European countries and placed 9th In particular, gaps related to policy coordination and globally1. As a result, there is increasing public concern institutional capacities will need to be addressed regarding environmental degradation. In addition, as a and transparency and accountability will need to be candidate country for EU membership, Serbia needs further improved. These measures are key to enabling to align its domestic policies with the EU acquis—the Serbia’s private sector, particularly its domestic private rules and procedures that EU member states commit enterprises, to thrive and contribute to overall national themselves to. As Serbia’s main trading partner, the productivity gains. EU has already embarked on a deep, ‘green’ structural transformation of its economy and plans to impose a Third, Serbia needs commitment to transition to greener Carbon Border Adjustment Mechanism (CBAM) to and more resilient growth by adopting a roadmap that protect the EU internal market from ‘carbon leakage’ would help unleash its economic growth potential while stemming from the import of carbon-intensive products decoupling from environmental degradation. Adhering from jurisdictions with less stringent climate policies. to the roadmap will also make growth more resilient to Most significantly, Serbia’s continued dependence external shocks and more sustainable over the medium on locally extracted, heavily polluting lignite for to long term. The transition will provide benefits and electric power generation will ultimately decrease its create new opportunities; however, it will also have competitiveness and raise the costs of accessing EU costs and negative impacts on certain groups, which markets. Hence Serbia needs to act now. can be mitigated with the appropriate measures. For example, greener and more resilient growth may First, Serbia needs to grow faster and bring living facilitate shifts from low value-added sectors to those standards closer to the average for the EU. Economic with higher value-added and productivity. This will growth in the 10 years prior to COVID-19 averaged require additional investment in new technologies, just 1.8 percent. As a result, the gap between the increased education and training of employees, greater living standards of Serbians and of EU citizens has investment in research and development, better not been closing. Looking forward, building on its hard- environmental conditions, and the creation of more won macroeconomic stability, Serbia can now afford high-quality jobs. to switch gears and strive to become a faster-growing, more sophisticated modern economy. As the World Transitioning to greener and more resilient growth will Bank’s 2019 Country Economic Memorandum makes require reforms. Some of these reforms are horizontal clear, the achievement of Serbia’s new growth agenda in nature (i.e., affecting all sectors, such as tax reforms will require a range of actions to boost investment, to alter price signals), while others are sector specific, mobilize financing for growing firms, equip workers with such as changes in policies and regulations addressing the right skill mix, increase productivity levels, promote important challenges like energy efficiency, air pollution, competition, and foster a more conducive business waste management, and water and wastewater. While environment. the achievement of this transition involves multiple sectors and a wide range of issues, this report • 1 SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH BACK TO CONTENTS addresses only a subset of these, including potential as the higher reduction in exports (-1.54 percent) are costs and benefits of certain aspects of the transition, compensated by a reduction in imports (-1.61 percent). potential policy reforms in select sectors, and related In addition, adopting a carbon price would exempt Serbia institutional aspects. For example, the scope of the from CBAM costs, as well as generate fiscal revenue that report does not include several other important issues could be used to incentivize investments in new, more for the achievement of Serbia’s transition to greener productive economic sectors with lower carbon intensity, and more resilient growth, such as energy pricing, coal leading to positive GDP impacts. While results for both transition, the role of carbon sinks, and adaptation CBAM and carbon pricing show a sizeable potential priorities, some of which are being addressed through impact on emission-intensive sectors—affecting net parallel engagements by the World Bank or other real exports, output, and employment— carbon pricing development partners. would incentivize low carbon transition across many more sectors than CBAM. Environmental fiscal reforms would help initiate a shift towards greener production and consumption. This Reinvesting the proceeds of carbon pricing in innovation would mean adopting environmental reforms to existing and education would help to accelerate the transition energy and environmental taxes. These would include to greener and more resilient growth. If the revenues a focus on the near-term adjustment of excise policy generated through broader carbon pricing reforms to achieve greater alignment with the policies of the were reinvested in innovation and education, this EU and a medium- to long-term focus on preparations could facilitate both significant positive economic and for the introduction of carbon pricing. These reforms structural transformation and improved environmental could incentivize a shift away from polluting and conditions. The carbon-intensive sectors of Serbia’s climate-damaging technologies towards the adoption economy currently contribute to only 20 percent of of more environmentally friendly technologies. The GDP, 10 percent of exports, and only 3 percent of total implementation of carbon pricing would also enable employment. The imposition of domestic carbon pricing Serbia to proactively prepare for the forthcoming EU in these sectors could incentivize many businesses to CBAM. The results of the macroeconomic modeling in shift to new technologies and to develop the necessary this report show that CBAM could have a small negative skills to participate in cleaner, more knowledge-intensive impact on Serbia’s GDP over the medium to long term economic activities. Where cleaner sectors are able compared to the baseline of no CBAM, resulting in to absorb the labor and capital released from carbon- annual real GDP levels of 0.21 percent below baseline intensive industries and unlock new markets, this could GDP levels in 2035. This marginal shift is due to reduced have a positive impact on employment. Carbon pricing export volumes (-0.62 percent compared to the baseline could also help reduce annual greenhouse gas (GHG) of no CBAM in 2035) caused solely by the drop in emissions in Serbia by 40 percent in 2035 compared exports of CBAM sectors, counterbalanced by reduced to a business-as-usual scenario. import volumes (-0.59 percent) and a small decline in private consumption (-0.25 percent). Additional domestic Institutional frameworks need to be further strengthened policies are needed to incentivize a broader green to support the government to deliver on reforms. transition in Serbia. As such, the report also presents The lack of institutional capacities in the areas of results of modeling the macroeconomic impacts of environmental management and climate change is a reforming excise duties in line with the EU Environmental frequently cited issue in the European Commission’s Tax Directive and a carbon pricing system based on the annual EU accession progress reports for Serbia. EU Emissions Trading System. Carbon pricing results As part of Chapter 27 negotiations on issues related suggest similarly modest impacts on the economy in the to the environment, Serbia has made several bold medium term compared to facing CBAM, with annual commitments to enhance its capacities in these real GDP of 0.28 percent below baseline levels in 2035. areas. It is not enough just to adopt new policies. The Overall GDP impacts of carbon pricing remain small authorities will also need to ensure that they have the 2 • BACK TO CONTENTS SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH institutional frameworks to deliver. In addition, Serbia’s A deliberate step-by-step approach is needed to obligations under the Paris Agreement, the Energy manage the transition to greener and more resilient Community, and the EU-supported Green Agenda for growth. Given the potential impacts of the transition the Western Balkans also require the authorities to take on Serbia’s economy and society, the authorities action to strengthen the country’s institutions. When should adopt a deliberate yet cautious approach, with Serbia imposes its own domestic carbon pricing system, robust preparatory work. The war in Ukraine and the or even to effectively deal with the terms of the EU’s associated energy price shocks and energy security CBAM, it will need to have in place a robust monitoring, concerns, together with international commodity price reporting and verification (MRV) framework for GHG shocks, may serve as a trigger for even more ambitious emissions. and dedicated efforts to facilitate the transition. However, Serbia needs to be well-prepared with a coherent and Certain sectoral policies and regulatory reforms can be adaptive roadmap to mitigate the risks of ‘brown’ growth initiated quickly to catalyze the transition. While a broad and to make sure that the transition is effective and spectrum of reforms is needed to support the transition ‘just,’ to protect those who could be adversely impacted to greener and more resilient growth, some sectoral and to ensure that the benefits of increased growth are reforms are already within reach. For example, to scale equitably spread. up energy efficiency programs, there is a need to make the new Law on Energy Efficiency fully operational by This report sets out the key challenges that Serbia formulating and implementing regulations, introducing faces, along with broad recommendations on how the consumption-based billing in district heating systems, transition to greener and more resilient growth in Serbia and increasing energy tariffs while implementing can begin. Chapter 1 describes the factors driving measures to protect the most vulnerable. In the waste greener growth in Serbia, including the strong demand management sector, there is a need for a greater shift by the public for improved environmental conditions, towards recycling and the circularity of resources. The and examines the government’s strategies and plans Action Plan for National Waste Management Program for achieving this process. Chapter 2 consists of three 2022-31 needs to be adopted and implemented, as does sections, respectively describing the significance of the Circular Economy Development Program 2022- price signals for the achievement of greener and more 24. Furthermore, several new approaches, including resilient growth, selected sectoral interventions, and Extended Producer Responsibility programs, also need the need for strong institutional frameworks. Chapter 3 to be adopted. Similarly, a new Water Law is needed to draws conclusions from the preceding chapters, finding improve tariff setting and to achieve greater alignment that for Serbia to successfully achieve the transition, it with the EU acquis. Additionally, the legislative will be vital to get prices right, formulate and implement framework for air quality needs to be strengthened, the appropriate sectoral policies and regulations, and including through the adoption of a new Law on Air establish a strong institutional framework. ■ Protection, with measures to support the achievement of emissions reduction targets in the energy, industrial, and agricultural sectors. Furthermore, reforms are needed to finance green sectoral interventions. As discussed in this report, through the example of fiscal reforms, additional financing needs can be met by shifting towards making polluters pay in proportion to the environmental damage they cause. • 3 4 • 1. What are Serbia’s drivers for pursuing the transition to greener and more resilient growth? 1.1 Deteriorating environmental sustainability and economic growth After strong growth in the early 2000s, Serbia’s Serbia is one of the most energy-intensive economic growth has decelerated in recent years, economies in Europe, with a high carbon footprint largely due to remaining structural constraints. and a high degree of vulnerability to energy price Following Serbia’s political reopening in the early 2000s, fluctuations. Serbia’s economy is four times more it experienced relatively strong growth, benefiting from energy intensive as compared to the EU27 average broad-based structural reforms and massive capital (see Figure 1). In other words, Serbia’s businesses use inflows from abroad. However, during the decade prior much more energy to produce a unit of output or add to the COVID-19 pandemic, in the period from 2009 much lower value to their energy use, than do their to 2019, its average annual economic growth rate European peers. In addition, the source of energy is had declined to a modest 1.9 percent, down from an heavily dominated by domestic, low-quality lignite. average annual rate of 6.2 percent in the preceding In turn, this directly increases the carbon footprint period. The decline in growth rates has been largely of Serbia’s economy. With narrowly concentrated due to structural economic issues, particularly low energy supplies, this high level of energy intensity also levels of productivity and investment but also due to increases Serbia’s vulnerability to energy crises, such the impact of natural disasters. as the one that occurred in the winter of 2021–2022, giving rise to energy security concerns. Figure 1. Overview of energy intensity in European countries, 2019 500  450  400  In kg of oil equivalent per 1,000 EUR 350  300  250  200  150  EU 27 average 100  50  0 Se vo N . ul bi a ed a g N o UK nm y I re a r k d Be iye C y ece N e Po r t u s e r al Fr in rm e Au any r ia m ly C r ni a Tü nia G r um S w nd s Sp n Hu t v ia hu y S l ani a m a F in t ia S l l and M ia E s alt a C z ni a Po h i a L a nd I c e IH K o nd ac r i D e r wa G e anc ur R o aki L i t n gar l an e xe Ita t h ug on a so B pr ed M ga la st la oa rk r ec a to e lgi bo e la ov ov B Lu Source: Eurostat • 5 SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH BACK TO CONTENTS Figure 2. Overview of resource productivity in European countries, 2019 8.0  In EUR of GDP per 1 kg of domestic 7.0  material consumption 6.0  5.0  4.0  3.0  EU 27 average 2.0  1.0  0.0 l an d Fr ly I re c e Sp d rm n Au ny M ia No a nm y I c e ar k S w and G r en Sl eece S l e ni a F in k ia Cy d Cz r u s Po h i a C r gal L ia hu i a Hu ani a Po r y N. E st d ac oni a Al ni a m a B u ani a S e ia ia B e u rg ds m UK um D e r wa t h l an R o ni alt l an l an l an G e ai It a rb L i t at v r t r a an a ed l ga st oa a u ec o ba ng p lgi bo l ov ov N e t ze r rt ed er xe i Sw M Lu Source: Eurostat In 2001–2019, the volume of materials used would enable Serbia to achieve higher value-added by Serbia’s economy, including extracted and production and create a greater number of better-paid imported natural resources, increased by 30 jobs. percent. Although its GDP grew by 80 percent over this period, the country still uses its material resources Serbia needs to implement a new growth agenda less efficiently than any other EU and Western Balkan to bring the country closer to the average living country, generating the lowest output value per standards in the EU while also ensuring that it kilogram (kg) of domestic material consumption (see pursues a greener trajectory. Looking forward Figure 2). Serbia’s low resource productivity can be to the post-COVID-19 phase, building on hard- explained by its relatively high degree of dependence won macroeconomic stability, Serbia can focus on on the extraction of material resources (e.g., mining and becoming a sophisticated modern economy like other quarrying) and by its ageing and inefficient industrial EU member states. As identified in the CEM, the new infrastructure, a legacy characteristic of economies in growth agenda for Serbia will require action to further transition. boost investment, mobilize financing for growing firms, equip workers with the right skill mix, raise productivity Not only is the level of productivity of Serbia’s levels, and promote competition and a better business production factors lower than average for the environment. However, the new growth will also need EU, but the gap has been widening too. As the to be greener for Serbia’s firms to stay competitive World Bank’s 2019 Country Economic Memorandum in the EU market. It will require Serbia to deliver on (CEM) showed, on average, a Serbian manufacturing its growth ambitions while reducing dependency on enterprise needs three times as many workers to polluting lignite, improve energy efficiency, and promote produce the same output as a business in the European green development across sectors. Experience and Union (EU) 2 . Furthermore, productivity growth has literature show that better environmental performance been slow, limiting income convergence and stifling is associated with higher productivity, innovation, and the creation of well-paid jobs. In particular, the poor higher export competitiveness. Strengthening policies performance of state-owned enterprises (SOEs) acts and institutions in support of greener and more resilient as a drag on the productivity of sectors that have real growth will be one of the key factors for the success of potential for growth. Increased firm-level productivity the new growth agenda. 6 • BACK TO CONTENTS SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH While addressing energy intensity and emissions Severe weather events associated with climate concerns, Serbia could improve productivity as change have also acted as a drag on Serbia’s well, thus improving the growth outlook. The recent economic growth. Figure 3 shows the volatility in CEM showed that aggregate productivity improves growth rates because of external shocks, with significant when firms adopt better technologies, enhance their adverse impacts in the years with climate-related management and organizational practices, and rely disasters. Areas of the country that have been particularly on workers with higher skills (the within-firm growth affected by droughts and weather variability have also strategy); or new firms enter and less successful firms experienced significant land degradation, increasing the exit (the dynamic growth strategy). The shift to a greener risk of other natural disasters, including landslides. As and more resilient growth agenda could enable Serbia Figure 4 shows, there is a high degree of variability in the to benefit from both strategies for higher productivity. In extent of land degradation across the country, with the particular, SOEs, including in the energy sector, would effects tending to be concentrated in areas with already benefit from measures that boost within-firm growth. high levels of poverty and vulnerability. The decline in Adoption of new technologies and innovation could also GDP associated with these impacts of climate change is lead to an increase in the creation of new businesses; expected to be associated with declines in employment young firms created 96 percent of new jobs (net) over and thus with increases in poverty unless timely and recent years.3 appropriate mitigation measures are put into effect. Figure 3. Growth rates in Serbia by sectors and external shocks  8.0  7.0  Severe droughts 6.0  Floods 5.0  Landslides In percentage points 4.0  3.0  2.0  1.0  0.0 -1.0 -2.0 -3.0 2006 2004 2009 2008 2005 2003 2002 2007 2020 2001 2010 2016 2018 2019 2015 2014 2012 2013 2017 2011 Agriculture Industry outside manufacturing* Other Total GVA growth Note: *Consisting of mining, supply of electric energy, gas, steam and acclimatization. Source: Statistics Office of Republic of Serbia. • 7 SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH BACK TO CONTENTS Figure 4. Change in net primary productivity (2000-2013) as a measure of land degradation4 Change in NPP (non-croplands), 2000 –2013 Avg precentage change % > 20% 10% – 20% 0% – 10% -20% – 0% -50% – -20% < - 50% Source: Perovic et al. (2021). With respect to indicators related to resilience, indicators compared to the EU mean (see Table 1), sustainability, and efficiency, Serbia’s performance with red colored cells showing areas where Serbia’s is considerably worse than the average for EU performance lags behind the EU mean, while green member states, particularly in terms of those colored cells indicate areas where it records stronger related to water and sanitation, waste management, than average performance, and grey cells show similar air pollution, and GHG emissions. The World Bank’s performance to the EU. While the government has Green, Resilient, and Inclusive Development (GRID) recognized the need to address at least some of the diagnostic, which is based on the Resilience, Inclusion, identified issues in the short term, much additional work Sustainability, and Efficiency (RISE) framework, shows is needed to reduce the gap between Serbia and the EU5. Serbia’s performance in terms of a number of key 8 • BACK TO CONTENTS SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH Table 1. Selected indicators from the World Bank’s GRID/RISE diagnostics for Serbia Indicator Name Serbia EU mean Resilience Indicators Natural disaster risk to assets (% of GDP) 1.4 0.3 Natural disaster risk to wellbeing (% of GDP) 1.7 0.4 Population exposure from disasters (% of total population exposed) 0.3 3.5 Population exposure from dry rainfall shocks (% of total population exposed) 20.1 13.0 Inclusion Indicators People Using Safely managed sanitation (% of total population) 18.4 87.4 People Using Safely managed drinking water (% of total population) 75.0 97.5 Belief that “Most people can be trusted” (% agreeing) 16.3 33.0 Human capital index (from 0 to 1) 0.68 0.70 Sustainability Indicators Total renewable water resources per capita (m³ per capita) 18,451 7,571 Biodiversity & habitat index (from 0 to 100) 42.8 47.2 PM2.5 % of population exposed above WHO (15µg/m³) 98.6 55.5 Mortality rate attributable to air pollution (per 100,000) 62.5 23.8 Solid waste generation (tons) per capita 0.33 0.47 Landfill disposal % share of total waste generation 95 33 Renewable energy consumption (% of total energy consumption) 19.9 21.3 Share of coal in electricity generation (% of electricity generated) 68.2 13.2 GHG emissions per capita (metric tons per capita) 9.2 8.5 Change in GHG emissions per capita (% change 2008-2017) -0.6 -15.6 Efficiency Indicators Productivity of water use ($ per m³ water withdrawals) 5.9 131.4 Efficiency of carbon use (GNI per kt of CO2 eq.) 730,106 4,267,773 Air pollution regulation economic efficiency (from 0 to 100 %) 21.6 40.4 Note: See Annex 1 for definitions of indicators. Source: World Bank, GRID/RISE. • 9 SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH BACK TO CONTENTS The public in Serbia has become increasingly This report is part of a broader set of analytical concerned and vocal regarding environmental work related to the Western Balkans’ achievement degradation, intensifying the pressure on the of greener growth, addressing a subset of focus government to act. A recent World Bank public areas particularly relevant to Serbia’s green opinion survey6 shows that Serbia’s citizens consider transition. In particular, the report focuses on issues a clean and livable environment as an essential factor including environmental taxation, the EU’s carbon in decisions related to where they want to live and border adjustment mechanism (CBAM), carbon pricing, bring up their children, with more than 75 percent of institutional analyses, and sectoral priorities covering survey respondents stating that they felt that pollution, energy efficiency, air pollution, waste management and particularly air pollution, is worsening7 and with almost circular economy, and water and wastewater. Its scope 85 percent stating that they felt that climate change was does not include a number of other issues that would affecting their immediate environment. A relatively higher be vital for facilitating Serbia’s green transition, such proportion of younger people (18–29 years) expressed as energy pricing, a transition away from coal, land similar sentiments, with a significant proportion even degradation, the role of carbon sinks, and adaptation stating that they had considered immigrating as a result of priorities. Some of these issues are currently being these factors8. This increased environmental awareness, addressed through parallel initiatives involving the particularly among the young, has resulted in increased World Bank and other development partners. The green social activism, with intensified pressure on the findings, interpretations, and conclusions expressed government to take action. in this report are based on data as of June 30, 2022. 1.2 Challenges of transitioning to greener and more resilient growth for Serbia The transition to a resilient, low-carbon and green Agenda for Sustainable Development and is thus economy is a global megatrend to which Serbia will formally committed to the achievement of the Sustainable need to adjust. Due to regulatory and other pressures, Development Goals (SDGs). It is also a signatory to the emission-intensive businesses, sectors, and countries UN Framework Convention on Climate Change and its are facing mounting constraints in accessing finance, associated Paris Agreement. At the regional level, it is a investments, and markets in advanced economies signatory to the Sofia Declaration on the Green Agenda (as per IMF classification). In particular, the European for the Western Balkans, which is based on the European Green Deal and the recent “Fit for 55” legislative initiative Green Deal. As a signatory to these agreements, Serbia create strong disincentives for emission-intensive has committed to working to achieve the 2050 target of activities, shaping the economic context in which Serbia transforming the EU into a carbon-neutral zone. However, will interact within the global economy for decades to currently, its internal economic incentives and policies come. Over the last 20 years, the EU has emerged as are not aligned with these commitments. For example, a prime mover of the global green transformation, and in 2021, the Energy Community Secretariat launched more recently, the EU is increasingly concerned about proceedings against Serbia related to its failure to meet unfair competition from countries hosting potential the National Emission Reduction Program’s targets ‘pollution heavens’ and strives to coordinate shared for sulfur dioxide (SO2), nitrogen oxide (NOx), and dust climate policy and sustainable product standards and emissions.9 In addition, a 2020 assessment of Serbia’s impose costs on countries that don't meet them. progress towards the achievement of defined SDGs published by the Statistical Office of Serbia indicated a While Serbia has ratified most major international number of adverse developments in key areas related to environmental agreements, their implementation food security, water use, clean fuel use, energy intensity, is lagging behind. Serbia is a signatory to the 2030 and waste management.10 10 • BACK TO CONTENTS SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH The most significant factors contributing to Serbia’s particularly domestic lignite.13 Serbia’s coal power poor environmental performance relate to the high plants are old and inefficient, with the average age of energy and carbon intensity of its economy and a thermal power plants in Elektroprivreda Srbije (EPS) strong dependence on domestic lignite to produce around 40 years and with the newest plant in operation energy. Despite significant improvements over the past being 30 years old. The collapse of a number of coal two decades, Serbia’s GHG level of emissions intensity power plants and resulting power outages in late 2021 is still more than 2.5 times higher than the EU average resulted in a new sense of political urgency related to (see Figure 5).11 The energy sector is by far the largest the need for the diversification of their energy systems contributor to Serbia’s GHG emissions, contributing to and associated investments. However, there has been 76.1 percent of the total in 2018.12 Within the sector, a lack of clarity and mixed signals from the government the largest shares of GHG emissions originate from regarding whether or not these coal-driven facilities the production of electricity and heat, with almost will be decommissioned and replaced with greener 70 percent of electricity being produced from coal, infrastructure, increasing the risk for potential investors. Figure 5. Carbon intensity of GDP in select countries  0.7  0.6  Carbon dioxide (CO2), kg of CO2/USD, 2000–2018 0.5  0.4  0.3  0.2  0.1 0  Source: OECD • 11 SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH BACK TO CONTENTS The recent surge in global fuel prices has resulted in If Serbia continues its current low-productivity, the authorities considering delaying the phasing out brown growth model path, it will face significant of coal-driven facilities from Serbia’s energy system, risks as the world in general and the EU in particular increasing the risk of locking the country into a transition to a greener, knowledge-based economic carbon-intensive growth model.14 With the current growth model. If Serbia continues its current trajectory, high prices of fossil fuels, Serbia’s use of domestic its future growth will become increasingly uncertain and lignite to produce power and heat may appear to serve unsustainable, particularly given that the EU, its largest as an effective hedge against the energy market shock. trading partner, is increasingly adopting a greener However, the global energy crisis of 2021/2022 is likely to growth model. If Serbia commits itself to transitioning be a time-limited event, resulting from global fuel demand towards a similar model, it could increase its resilience to rapidly rebounding during the post-COVID-19 recovery external climate policy shifts, such as the EU’s proposed and temporarily outstripping supply, with the price spikes CBAM. Serbia’s path to integration with the EU is exacerbated by a number of factors, including the prior highly dependent on the extent to which the country period of global underinvestment in extractive industries, implements a green transition (see Figure 6). This would supply chain hurdles, and the war in Ukraine. In the enable it to adopt a growth model that facilitates the long term, the reliance on coal-driven power generation achievement of higher productivity (and wages), better facilities is likely to be more a source of systemic risk than living conditions through improved environmental quality a hedge against it. If Serbia becomes a member state and higher levels of innovation, enabling it to participate of the EU, it will be directly subject to the EU’s carbon in new markets and value networks. pricing regime. However, if the country remains outside the EU, it will be affected indirectly through the carbon border adjustment mechanism (CBAM) that would limit its access to EU markets by imposing a tariff on carbon- intensive products. Figure 6. Going green – the preferred alternative growth path for Serbia15 STAY BROWN GO GREEN EU accession barriers Faster accession track Pre-accession funding Limited access to finance instruments available Tariff and non-tariff trade barriers None; price premiums Technological obsolescence, declining productivity Innovation, productivity Vulnerable to: Resilience against: • Environmental sustainability risks • Environmental sustainability risks • Green transition risk • Green transition risk 12 • BACK TO CONTENTS SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH However, for Serbia to adopt an EU-oriented, The green transition should be structurally easier greener growth strategy, it would need to undergo for Serbia than for fossil fuel exporting countries. a comprehensive process of modernization and While Serbia’s power sector is heavily dependent on coal, structural transformation of its economy, similar to its economy does not depend on revenues derived from that of other new EU member states. This process the extraction and export of fossil fuels. The structure of would require 'brown' enterprises that do not consider the the assets on which Serbia depends for future economic negative side effects of production on the environment to growth and revenues is more typical of diversified EU conform to the EU requirements and standards, which member states as compared to heavily hydrocarbon- increasingly are requiring polluters to pay for the damage dependent countries such as Azerbaijan and Saudi they inflict upon society. In the EU, these enterprises Arabia (see Figure 7). As in all advanced economies, could benefit from access to state aid and EU funds to human capital rather than fossil fuels dominates total modernize away from obsolete, dirty technologies and to wealth per capita in Serbia (55 percent), with the value of facilitate a ‘just transition’ for workers and communities subsoil assets (fossil fuels and minerals) accounting for dependent on brown industries, especially coal-mining a mere one percent of total wealth per capita, a similar communities and municipalities dependent on coal-fired level to that found in most European countries. Produced heating as well as those with large coal power, steel, and assets (buildings, infrastructure, machines, intellectual cement plants. At the same time, startups and disruptive property, and so forth), which account for 44 percent innovators could gain greater access to EU funding and of Serbia’s total wealth, are more energy and carbon- technology transfers, facilitating the creation of new intensive than is typical for the EU, as discussed earlier. green jobs and enabling them to leverage new sources Thus, Serbia’s integration with the EU economy could of comparative advantage. In the past, all Central lead to the premature retirement of some of these assets. and Eastern EU member states underwent similar However, it is expected that with such an integration, new, transformations, with significant assistance from the EU. more productive fixed assets will be introduced, while the risk of stranded assets is low. Figure 7. Level and composition of total national wealth per capita in Serbia compared to other European countries and fossil fuel exporters  400,000    Wealth Per Capita in 2018, constant 2018 USD 350,000  300,000 250,000  200,000  150,000 100,000  50,000 - Serbia Croatia Slovenia Italy Azerbaijan Saudi Arabia (50,000)  Produced capital Sub-soil assets Human capital Net foreign assets Renewable natural resources Source: World Bank. 2021. The Changing Wealth of Nations. https://openknowledge.worldbank.org/handle/10986/36400. • 13 SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH BACK TO CONTENTS While the Serbian authorities have recognized the International commitments also play an important changes to the external context and embarked on role in the country’s green transition. Serbia is a legislative changes to support its green transition, contracting party to the Energy Community, which progress has been slow. With the adoption of the aims to extend the rules and principles governing Law on Climate Change in March 2021 and the Law the EU energy market throughout Southeast Europe, on Use of Renewable Energy Sources (RES) in including through issues such as the preparation April 2021, Serbia has made a major step towards of decarbonization roadmaps for the energy sector aligning with the EU climate and environment acquis. and for Just Transition efforts for coal-producing The first of these new laws mandates the adoption regions. In November 2020, Serbia and a number of of the Low-Carbon Development Strategy (LCDS) other countries in the Western Balkan region formally and the National Adaptation Program (NAP) in 2022. adopted the Sofia Declaration on the Green Agenda, The Government is currently drafting a new energy which is intended to facilitate alignment with the EU’s sector strategy, the National Energy and Climate Plan climate laws, including those related to carbon pricing (NECP), which is intended to provide further definition mechanisms, among other climate objectives.17 The of the government’s aspirations for the energy sector, most important external commitment of green policy especially related to coal mining and power generation. making are the negotiations over Chapter 27 of the As an additional measure, Serbia’s authorities are also EU Acquis, which formally opened in December working to formulate a NAP. However, Serbia is one of 2021 and which influences policy making through the the very few countries that have not yet submitted their specific transposition of EU directives into national laws, second Nationally Determined Contribution (NDC), as having already shaped policy-making efforts during its mandated by the Paris Agreement. Also, while Serbia preparatory stage. formally promulgated its National Emission Reduction Plans (NERPs) in 2020, the implementation of these The government is aware that a deep commitment plans remains problematic.16 to green transition could enable it to gain increased access to significant financing opportunities from While work on key strategic documents is still external sources, including the private sector. ongoing, there are indications that the Serbian Under its economic and investment plan for the Western government is aiming to be ambitious on the Balkans, the EU has allocated 9 billion euros for the green agenda. The draft LCDS indicates a potentially development of the region, with a significant proportion ambitious target to reduce GHG emissions by 33.3 of these funds earmarked for the implementation of percent in 2030 compared to the 1990 level (or 13.2 the Green Agenda for the Western Balkans (GAWB).18 percent compared to the 2010 level). In the long term, This could play a positive role in crowding in additional GHG emissions will need to be aligned with the 2050 international donor initiatives and seeding important carbon-neutrality target of the EU, to which Serbia policy reforms. Furthermore, there are a number of is committed to through the Sofia Declaration. The new and innovative forms of financing available for draft National Air Protection Plan (NAPP) will require private investments in renewables, energy efficiency, significant emissions reductions if the proposed and adaptation. For example, the global green bond objective of reducing by half the health damage due to market has grown at an average annual rate of 49 poor air quality until 2030 (compared to 2015) is to be percent in the five-year period to 2021. In August 2021, met. The recently adopted Waste Management Program Serbia adopted a Green Bond Framework and issued 2022-2031 aims to reduce the share of municipal its first Green Bond in September 2021, which was waste disposed in unsanitary landfills from 81 percent oversubscribed by a factor of three and raised EUR in 2020 to 17.8 percent in 2031, while the Industrial 1 billion. Policy Strategy 2021-2030 calls for an increase in the circularity rate in industry to 10 percent by 2030. 14 • BACK TO CONTENTS SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH While Serbia’s political leadership recognizes the seen by delays in the adoption of a number of strategic risks associated with continuing with a business- documents, as mentioned previously, that would indicate as-usual growth model, more action is vitally a sense of urgency regarding the measures to shift to necessary. The current government has ambitions of greener growth. Furthermore, the energy crisis of winter achieving accession to the EU and has expressed its 2021–2022 and the energy price shock due to the war commitment to implementing a Green Growth agenda.19 in Ukraine have prompted a rethinking of commitment It is also aware of the need to respond to increasingly to coal phase-out. The topic of transitioning out of coal intense public pressure to address environmental has understandably ignited a debate on alternative degradation, with a number of large environmental growth sectors that would need to be the focus of future protests having taken place over the past couple of development. These important decisions will need to years. However, at the same time, it has sometimes be made based on robust analytics, considerations of appeared to be hesitant to move towards the full political economy, and potential distributional impacts.■ implementation of the required measures, as can be • 15 16 • 2. What does Serbia need to do to turn greener and more resilient and how can this be achieved? 2.1 The role of pricing signals To prepare for a transition away from a brown Environmental fiscal policies work through the economic model towards a more modern, greener incentive effect of taxes, fees, and subsidies, 21 and more resilient model, it is essential to structure with the incentive effect determined by the pricing signals to better reflect the costs of pollution choice of the tax base, rate, and subsidy amount. and the wasteful use of resources. Well-structured The environmental incentive is stronger if taxes and environmental tax reforms and carbon pricing policies subsidies target the products or activities that are act to shift price signals to incentivize the use of less most harmful/beneficial to the environment. The use polluting and low-carbon production models. These of government fiscal revenues collected via taxes, fees, instruments could encourage innovation and generate and the elimination of harmful subsidies, to subsidize additional revenue for the government, which it could activities with an environmental benefit can have a use to manage the challenges related to facilitating second incentive effect in countries. These countries economic transformation. They could also stimulate the could choose to earmark environmental tax revenue creation of greener jobs and contribute to other benefits, or recovered funds from discontinued environmentally such as improved air quality and energy security. This harmful subsidies. section examines the integrated environmental fiscal policy reform options, including changes to existing Serbia’s current taxation system provides only energy and environmental taxes and fees, the abolition limited incentives to encourage businesses to of some environmentally harmful subsidies, and carbon shift towards more environmentally friendly pricing. However, an examination of a number of other technologies and behavior. First, excise duties important price signals for greening growth is beyond on fossil fuels are established without reference to the scope of the current report. their relative carbon content. In addition, natural gas, coke, heavy fuel oil, and coal are not covered 2.1.1 Environmental fiscal reform by excises. These exemptions encourage the use of polluting fuels such as coal and fuelwood, both As discussed above, Serbia’s distorted price of which are major sources of air pollution in Serbia. signals and policies related to energy and other Second, while a number of Serbia’s parafiscal fees are environmentally harmful activities are the key formally constituted as environmental taxes, they do drivers of its excessive environmental footprint. not incentivize environmentally friendly behavior on Prices that do not factor in environmental costs to society the part of enterprises. For example, the fee for the encourage businesses and households to waste energy, protection and improvement of the environment applies water, and other resources and to decrease their own to economic entities regardless of the environmental financial costs by increasing environmental costs, which impact of their activities, with the fee set with reference are borne by all members of society. Fiscal reforms to the size of a company rather than to its environmental could transform these perverse price signals by shifting footprint. Finally, while the fees for emissions of SO2, the fundamental pricing incentives in the economy NO 2 , and particulate matter (PM) are well-targeted, away from wasteful and polluting technologies and their incentive effect is weak since rates are well below activities to more efficient and greener ones, in line with the costs of applying pollution reduction and mitigation the internationally acknowledged economic principle measures, with their impact further undermined by that polluters should pay for the damage they cause. 20 partial exemptions for some major polluting activities. Environmental fiscal reforms (EFR) could include the repurposing of subsidies and the alignment of taxes To address these issues, the authorities should and parafiscal fees with environmental sustainability. prioritize reforms to gradually align excise duties They could also be leveraged to incentivize greener on energy products with the EU rules in this field. innovation and investments and to reduce other Computable General Equilibrium (CGE) modeling distortionary impacts of fiscal policy on the economy. suggests that the output and employment effects of Where fiscal revenues are increased as an outcome of aligning Serbia’s excise duties with the revised EU EFR, they can be ‘recycled’ within the economy. • 17 SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH BACK TO CONTENTS Energy Taxation Directive (ETD)22 would not negatively of the ill-targeted fee for the protection and improvement impact GDP, provided that revenue is ‘recycled’ in of the environment, which would reduce the tax burden terms of reducing the tax burden on labor or other on the economy without any harm to the environment GDP-improving policy priorities like investments in as it lacks an incentive effect. The authorities could also human capital or technology uptake. It is estimated that consider increasing the much better-targeted fees for these reforms would result in additional revenues of emissions of SO2, NO2, and PM, which would have the around 0.2–0.5 percent of GDP annually in 2025 (see potential to strengthen incentives to reduce air pollution Annex 2 for detail on modeling approach and revenue in terms of these indicators while replacing foregone estimation). revenues of other reform elements. Reforms of this sort have been proposed by business associations, such A restructuring and reform of fees imposed on as National Alliance for Local Economic Development entities that emit air pollutants could create strong (NALED), and are supported by the Serbian business incentives to reduce air polluting activities, while at community. Box 1 below summarizes the initial impact the same time correcting the distortionary tax burden assessment of these reforms, with full details of the on businesses. This reform could include the abolition analysis provided in Annex 2. Box 1. Impact assessment of selected opportunities for environmental tax reform in Serbia Option 1: Alignment of fossil fuel Option 2: Revise the fee for emissions Option 3: Abolish the fee for the taxation with revised EU ETD, including of SO2 , NO 2 , particulate matter (PM) protection and improvement of the phase out of direct coal subsidies from fuel combustion environment Name of the Law on Excise Duties Fee for the emission of SO 2 , NO 2 , Fee for the protection and improvement relevant fee particulate matter and produced or of the environment landfilled waste Current Fuels for vehicles and electricity. Operators emitting SO 2 , NO 2 or PM above All legal entities and entrepreneurs in coverage and Exemptions apply by user type. No annual thresholds (100kg, 30kg and 10kg Serbia are covered. Fee level is loosely applicability in coverage of coal, coke, heavy fuel oil and respectively) are covered (production based on type of activities conducted Serbia natural gas. of electricity, heat, agriculture, industry, (three impact categories) and size of among others). Fee level is calculated the economic subject (4 categories). based on measured emissions. Correction factors apply. Reform Alignment of fossil fuel taxation with Expand coverage and abolish distorting Reform proposal is to abolish this fee proposal and revised EU ETD, including phase-out of correction factors, introduce transparency given that. rationale direct coal subsidies, in order to: on planned increases in fee levels in order The fee is not directly related to the to: • reduce emissions by expanding fuel level of emissions (polluter pays coverage • improve coverage of emitters to principle is not respected), therefore reduce pollution does not provide incentives to reduce • reduce emissions by more realistic polluting behavior. costing of different fuels • reduce pollution by aligning fee levels with actual polluting behavior Abolition of this fee furthermore leads • align with EU standards. to a reduction of administrative costs • enable forward-looking decision- for local authorities and reduced tax making burden on covered subjects. 18 • BACK TO CONTENTS SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH Box 1. Impact assessment of selected opportunities for environmental tax reform in Serbia (continued) Option 1: Alignment of fossil fuel Option 2: Revise the fee for emissions Option 3: Abolish the fee for the taxation with revised EU ETD, including of SO2 , NO 2 , particulate matter (PM) protection and improvement of the phase out of direct coal subsidies from fuel combustion environment Name of the Law on Excise Duties Fee for the emission of SO 2 , NO 2 , Fee for the protection and improvement relevant fee particulate matter and produced or of the environment landfilled waste Expected Electricity prices for households could Environmental impact could remain No impacts on incentives for and environmental / increase by 16% (compared to 2020 small despite increase of the tax base behavior of businesses and other social impact average guaranteed supply price), 14% and fee levels, due to high abatement economic agents are expected from compared to current price cap for industry. cost for most activities. Nevertheless, this reform proposal; therefore, no Prices for natural gas could increase by the incentive effect will improve pollution environmental impacts from this reform up to 22%. Vulnerable consumers will efficiency and sector preparedness for option are expected. need income support, including to finance increased policy ambition in the long run. A small increase in pollution may energy efficiency improvements and fuel occur from increased output due to switch. improved profitability but is unlikely to GHG emissions could decrease by 1% be significant given the current scale compared to the baseline of no revision by of the fee. 2030, process emissions by 4%. Expected fiscal Estimated additional fiscal revenues Increase of revenues from this fee of Reduction of local-self-government impact 0.2–0.5% of GDP in 2030. between 31 and 47% over time (assuming revenues (19 million EUR in 2020, fee level increases 10% per year for three approx. 1.1% of local government years) tax revenues) and reduction of administrative cost for local authorities. Fiscal revenues in year 3 would then be Local self- governments currently equivalent to approx. 0.1% of GDP. receive 100% of revenues from this fee. Further Firewood, an essential heating source Consider introducing a feebate This reform proposal should be considerations for many Serbian households, could component to enable higher fee levels implemented jointly with Option 2 for also see price increase. Lower firewood without harming affected sectors’ or another tax reform with a partial implementation consumption would reduce exposure to competitiveness. allocation of tax revenues to local self- air pollution, but income support for poor governments in order to compensate Revising the distribution between national households would be required to finance for the loss in revenues. and local government will support reform alternative fuel use. However, firewood is option 3. largely traded outside the formal economy and requires other regulatory tools than taxation. Note: Reform options under assessment were selected based on their relevance with respect to current policy priorities in the country, as well as based on relevance in the context of recent EU policy developments and the opportunity for Serbia to align with updated EU guidance. • 19 SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH BACK TO CONTENTS For policy reforms to be effective, gain widespread The revision of Serbian excise duties to achieve stakeholder support, and be implemented smoothly, alignment with the EU ETD is likely to increase the it is vital to ensure policy coherence. All three reform cost of heating and transportation, which—unless options discussed above are complementary in that adequately mitigated—will have a disproportionate they could be applied in parallel in a mutually supportive impact on low-income households. The 2019 manner with existing policies intended to facilitate Serbian Household Budget Survey data indicates energy efficiency and renewable energy deployment. that households in the lowest income decile spend 8 Option 1, Alignment with the Revised EU Energy percent of their total household budget on electricity Taxation Directive (ETD), is also complementary to and heating, compared to only 2 percent in the case of policies for the provision of subsidies for the purchase of the richest decile. A similar tendency also holds true hybrid and electric vehicles. On the other hand, current in the case of expenditure on passenger transport. By policies that undermine the impact of the reform options contrast, the share of gas and other residential fuels to discussed above include the provision of subsidies for total expenditure is roughly similar across the various inputs for agricultural production (particularly fertilizer income groups. Middle-income households spend and diesel subsidies) and low emission standards for a higher proportion of their budget on motor fuels imported vehicles.23 These and other similar measures (petrol and diesel) than do the poorest and richest should be eliminated to increase the effectiveness of households. Other factors being equal, a five-percent the pro-environment reforms. increase in the cost of heating is associated with a four- percent increase in the heating expenditure share for In addition, environmental fiscal policy reform low-income households compared to a one-percent needs to consider impacts at the sectoral and sub- increase for the richest households. This suggests sectoral levels in order to gather strong stakeholder that the poorest households will bear a higher burden. support. For example, an increase in the prices of However, this negative impact can be mitigated through natural gas, coal and electricity that could result from the use of the generated tax revenues to fund poverty an alignment of excise duties with the revised ETD reduction programs. would increase production costs in related industries. This especially applies to industries that cannot pass 2.1.2 Carbon Border Adjustment the cost on to consumers (such as those exposed to Mechanism (CBAM) and Carbon Pricing25 stronger foreign competition) and those with a relatively high energy intensity of production.24 Unlike elsewhere The EU has proposed a CBAM on selected imported in Europe, in Serbia, state-owned enterprises (SOEs) goods to commence in 2026 (see Box 2). As the EU account for a very large share of pollution in relevant is Serbia’s main trading partner and given the emissions sectors. This needs to be accounted for through the intensity of Serbia’s production processes is 2.5 times environmental reform efforts. EPS, which is the biggest higher than the EU average, the CBAM could have major polluter in Serbia, is also both the biggest contributor implications for the country’s export competitiveness to pollution taxes and the recipient of the greatest and market access. Based on Serbia’s 2021 exports proportion of government subsidies. structure, 5 percent of its exports would be covered by CBAM, with this proportion possibly increasing if the CBAM is extended to indirect emissions and/or other sectors, both options currently being debated by the EU. 20 • BACK TO CONTENTS SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH Box 2. The EU CBAM To protect domestic industries against risks of unfair competition by businesses in jurisdictions with lower or no carbon pricing, the EU has proposed to levy a cost on selected imported goods through a CBAM. The mechanism is narrowly targeted at a relatively small number of products in certain emission-intensive sectors covered by the EU emissions trading system (ETS), most notably cement, iron and steel, fertilizers, aluminum, and electricity. Importers of these goods within the EU will need to present CBAM certificates to cover their embedded emissions multiplied by a price equivalent to the EU ETS auction price. Starting in 2026, the CBAM cost will be slowly phased in at an annual rate of 10 percent, in line with the gradual phase-out of free emission allowances to EU industries, reaching EU ETS price levels by 2035. CBAM will initially cover Scope 1 emissions (direct emissions from controlled sources). Scope 2 emissions (indirect emissions from electricity, heat and steam used in production) and other sectors may be covered in the future. Also, other countries could join the ‘climate club’ in the future and apply similar climate and trade measures. EU CBAM is not designed to harm the economies of trading partners but to send a signal that a high carbon pricing is an integral component of the economic system within the EU and that the bloc aims to prevent ‘carbon leakage’ and to incentivize other countries to join global efforts to mitigate climate change. More details are provided in Annex 3. Macroeconomic modeling26 suggests that CBAM non-EU countries. Imports of intermediate goods and, is likely to have a minimal negative impact on to a lesser extent, final goods could decline by 0.59 Serbia’s economy, while carbon pricing (reinvested percent annually by 2035, acting as a counterbalancing in innovation) has the potential to increase GDP driver that limits the deterioration to the balance of trade. above business as usual (BAU). By 2035, Serbia’s Total employment also remains nearly unchanged (a real GDP would decline by 0.21 percent annually with 0.1-percent drop annually) by 2035. These impacts CBAM in the version proposed by the EC (see Figure would increase if CBAM extends to Scope 2 emissions 8, light blue bars) compared to the baseline. This would (see Figure 8, blue bars) and to other EU ETS sectors be driven by a decrease in total exports to the EU by (navy bars). 0.62 percent, partly offset by an increase in exports to Figure 8. CBAM and carbon pricing scenarios for Serbia  0.20  Impact on GDP, % change from baseline 0.10  0.00 -0.10  -0.20  -0.30 -0.40 -0.50 -0.60 2025 2030 2035 2040 2045 2050 CBAM CBAM + scope 2 CBAM + scope 2, all EU ETS sectors Carbon Pricing + R&D investments Source: Original calculation for this publication. • 21 SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH BACK TO CONTENTS In the unlikely event that neither the Serbian While emissions in Serbia can be expected to government nor the country’s private sector makes decline slightly due to the imposition of the CBAM, domestic adjustments, the CBAM would affect the additional domestic policies are needed to drive net real exports, output, and employment in a few investments in technological innovation and targeted, highly emissions-intensive sectors. For efficiency improvements. As CBAM only imposes instance, if the EU CBAM is implemented as proposed a cost on the share of products exported to the EU, by the EC, Serbian electricity exports in 2035 would GHG emissions will decline slightly due to a decline decline by 27.01 percent annually, although with output in the output of those exported products (between declining only by 3.96 percent. The export of ferrous 2.81 and 5.29 percent annually by 2035 compared to metals would decline by 30.55 percent and output by BAU, depending on the scope of the CBAM). More 28.95 percent, as most of the production is exported to transformative domestic policies are needed to drive the EU. The export of chemical products would decline investments in disruptive technological innovation by 6.53 percent, while the output would drop by 5.63 and efficiency improvements, particularly if Serbia’s percent, with both the export and output of non-ferrous other trading partners also choose to apply the CBAM. metals falling by 3.47 and 3.44 percent, respectively. Policies involving the imposition of energy taxes aligned Negative sectoral employment impacts simulated by with the environmental cost of fuels and a domestic the model account for employees who move between carbon price could play a positive role in driving these sectors in response to policy change. The labor force transformative changes. In addition, the Serbian employed by CBAM-covered sectors would gradually government could reinvest the revenues it collects in move to other sectors, although active labor market research and development and measures to promote and social policies would be needed to facilitate the adoption of the new skills required to facilitate reskilling, retooling, and relocation of workers and to the emergence of a more productive and competitive support those who are unable to make the transition. economy (see Box 3). The greatest losses of employment would occur in the power generation (-3.97 percent), ferrous metals (-28.92 percent), non-ferrous metals (-3.53 percent), chemical products (-5.35 percent), and non-metallic minerals (-1.18 percent) sectors. However, these losses would not have a significant macroeconomic impact because cleaner sectors would record increased output due to the labor and capital shifts. The negative impact on carbon-intensive exports would be greater if the EU extended the scope of the CBAM and/or emissions coverage and if Serbia’s non-EU trading partners also applied the CBAM. On the other hand, the EU CBAM proposal allows plenty of time for Serbian businesses to adjust their use of technologies and fuel to mitigate the impact. 22 • BACK TO CONTENTS SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH Box 3. Carbon pricing revenue use Establishment of a carbon pricing system would generate domestic fiscal revenues for the government, which it could reinvest to amplify the benefits of the system for Serbia’s labor force and economy. Modeling suggests that the value of revenues from carbon pricing could amount to between 0.59 to 1.41 percent of baseline GDP annually over the 2025-2050 period.27 How the revenue is used will affect the macroeconomic and distributional impacts for Serbia, and so it is important to factor this in when assessing these impacts. Measures to recycle these revenues back into the economy are vital for the macroeconomic performance of climate policies, with potential double-dividend effects that may even have positive effects on domestic output and employment. A proportion of the revenue could also be directed to assist individuals, households, or businesses in dealing with any negative impacts of carbon pricing through direct transfers or other policies and programs. Depending on the economy and energy system structure of a particular country, revenues can be used in different ways to lower the cost of mitigation. Modeling conducted for this report assessed three options: i) reducing payroll taxes; ii) investments in low-carbon research and development; and iii) labor force training. Lowering payroll taxes could have a positive impact on employment and even on GDP in the short term. This is because the cost of labor goes down and Serbian production becomes more competitive. In turn, the increased demand for labor could result in increases in household income. Investments in research and development could increase the total factor productivity of Serbia’s production processes, counterbalancing the cost associated with the imposition of climate policies, but knowledge spillovers from and to international markets lower the near-term GDP effect of domestic R&D investment. Similarly, education and labor force training can improve overall labor productivity and thus Serbia’s overall competitiveness.28 This work did not aim to determine the best use of revenue for Serbia, and follow-up work will be required for that. The carbon pricing scenario presented in this report channels revenue toward a mix of R&D investments and training of the labor force, which can have positive macroeconomic effects, depending on the availability of human capital. Out of the three options described above, R&D and labor training had the highest positive macroeconomic impact. Other uses not assessed in this modeling exercise that could be considered in further analysis include redirecting carbon revenues to low-carbon investments that directly limit the pressure that additional investment requirements impose on the domestic capital markets. This is similar to how part of the revenue is used in the EU, where the ETS Directive requires that at least 50 percent of the auctioning revenue (or equivalent in financial value) is spent by Member States for climate- and energy-related purposes. Revenues could also be partly redirected as lump sum payments to households, which could help manage the potentially negative effects of the carbon price on low-income households. However, further analytical work would be required to assess the impact on different income groups and potential options for compensation measures. Overall, a combination of revenue recycling schemes could provide an optimal double dividend, both in terms of macroeconomic and distributional policy performance. Adopting an explicit domestic carbon price would show that while investments in innovation would result have only a minor negative impact on growth in a very minor, short-term cost to GDP (0.04 percent and could even trigger longer-term productivity loss annually by 2035), over time, they would result in improvements that would increase GDP above the increases to productivity boosts that would increase BAU scenario. The CGE modeling exercise assumed GDP above the ‘brown’ BAU baseline (see Figure 9, the introduction of an EU-compatible domestic carbon green bars). The imposition of a comprehensive carbon price (carbon price on EU ETS sectors and an excise price system would also result in a minor negative tax in line with the EU ETD) and the investment of the impact on overall employment (-0.10 percent annually revenue in innovation and education.29 Initial results by 2035) relative to CBAM exposure. • 23 SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH BACK TO CONTENTS A broad-based, ambitious energy and carbon pricing and development (green bars). Under this scenario, the reform initiative that involves the investment of the contraction of the ferrous metals sector would result in a resulting revenues in innovation and education decline in GDP of 0.69 percent in 2035 and to a decline would deliver significant climate benefits, reducing in employment of 0.12 percent relative to the BAU. The emissions by 40 percent annually by 2035 (compared contraction in the chemical sector would result in a to BAU). At the same time, it would facilitate increased decline in GDP of 0.71 percent and in employment of access for Serbian businesses to technologies, know- 0.07 percent, with the figures for power supply at 0.33 how, and markets and increased output and employment, percent and 0.11 percent, respectively and for coal at compensating for any loss of output from the carbon- 0.20 percent and 0.25 percent. However, this scenario intensive industries. The initial costs of investment in would increase output and employment through innovation initiatives could be partly funded through the use contributions from less emissions-intensive sectors such of EU assistance, such as the €3.2 billion first investment as market services, lifting national GDP by 0.79 percent package under the EU's Economic and Investment Plan for and employment by 0.46 percent, through increases to the Western Balkans, €9 billion Green Agenda Action Plan consumer goods (a 0.27 percent increase in GDP and for Western Balkans, and future structural and innovation 0.15 percent of total jobs), transport equipment (0.16 funds (if Serbia does become an EU Member State) or percent and 0.09 percent, respectively) and agriculture through international climate financing initiatives, which (0.10 percent and 0.25 percent, respectively). In 2015, would generate further improvements above and beyond these sectors contributed to 56 percent of total GDP the conservative results achieved with the CGE model. and 59 percent of overall employment. These structural shifts away from carbon-intensive sectors and towards While the impacts of the imposition of a domestic knowledge-intensive sectors help to explain why the net carbon pricing system on emission-intensive macroeconomic impact of carbon prices, energy taxes, sectors may be significant, these sectors account and innovation is small and indeed positive in the longer for only a small share of GDP and employment, with term. Furthermore, the growth and jobs resulting from this impact offset by the positive impact on larger this transformation are also of higher quality because knowledge-intensive sectors. The most affected they are driven by productivity improvement. sectors will include ferrous metals, chemicals, non- metallic minerals, power supply and coal mining, which Going forward, with Serbia’s emissions-intensive taken together accounted for 7 percent of Serbia’s total sectors facing increasingly severe policy and market production, 10 percent of exports, and only 3 percent risks, separate strategies will be needed to facilitate of total employment overall in 2015. This confirms the the structural adjustment and transformation of the point made earlier in this report that Serbia’s economy economy. Modeling suggests that emissions-intensive does not systemically depend on carbon-intensive sectors such as the coal and ferrous metals sectors are industries. Figure 9 and Figure 10 illustrate the structural the ones that are likely to record the most severe drop in shift that can be expected in Serbia’s economy under domestic production by 2035 as a result of the imposition alternative policy scenarios. The figures show the of carbon pricing, due to their highly carbon-intensive percentage change in a given sector’s output (Figure content or production process.30 While the chemical 9) and employment (Figure 10) against BAU weighted products industry is distributed across the country, coal by the share of this sector in GDP. The results should and ferrous metals industries are more tightly clustered be interpreted in terms of the contribution of changes in within specific regions, with this creating issues that will output/employment of individual sectors to percentage require additional attention by policy makers.31 changes in country GDP/total employment relative to the BAU (reported here just for 2035). The most disruptive structural transformation would occur under the scenario involving energy tax and carbon price reforms with the reinvestment of additional revenue in research 24 • BACK TO CONTENTS SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH Figure 9. CBAM and carbon pricing scenarios: sectors contribution to percentage change in country GDP compared to BAU (in 2035) Non-market service Market services Construction Water transport Land transport Air transport Consumer goods Industries Other equipment goods Transport equipment (excluding EV) Computer, electronic and optical products Non-metallic minerals Paper products, publishing Rubber and plastic products Basic pharmaceutical products Chemical products Fabricated metal products Non-ferrous metals Ferrous metals Power supply Gas Oil Crude oil Coal Agriculture -0.8% -0.6% -0.4% -0.2% -0.0%   0.2%   0.4%   0.6%   0.8%   1.0% CBAM CBAM + Scope 2 CBAM + Scope 2, all EU ETS sectors Carbon pricing + R&D investments Note. For example, a 0.8 percent increase in contribution of market services to Serbia’s GDP in the scenario with carbon pricing and R&D investments means that as a result of this policy, the increase of output of this sector would increase Serbia’s GDP by 0.8 percent above BAU in 2035. At the same time, the drop in output of chemical products would contribute to the reduction of Serbia’s GDP by 0.7 percent below BAU in the same year. Source: Original calculation for this publication based on GEM-E3 simulations. • 25 SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH BACK TO CONTENTS Figure 10. CBAM and carbon pricing scenarios – sectors’ contribution to percentage change in total employment compared to BAU (in 2035). Non-market services Market services Construction Water transport Land transport Air transport Consumer goods industries Other equipment goods Transport equipment (excluding EV) Computer, electronic and optical products Non-metallic minerals Paper products, publishing Rubber and plastic products Basic pharmaceutical products Chemical products Fabricated metal products Non-ferrous metals Ferrous metals Power supply Gas Oil Crude oil Coal Agriculture -0.3% -0.2% -0.1% -0.0%   0.01%   0.2%   0.3%   0.4%   0.5% CBAM CBAM + Scope 2 CBAM + Scope 2, all EU ETS sectors Carbon pricing + R&D investments Source: Original calculation for this publication based on GEM-E3 simulations. 26 • BACK TO CONTENTS SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH Initial results of the modeling exercise indicate 2.1.3 Distributional impacts of the that there is a low risk of carbon leakage in Serbia, proposed environmental fiscal reform which is logical as the main trading partner (EU) (EFR) and carbon pricing on households introduces carbon pricing.32 The modeling results indicate a decline in fossil fuel imports due to the impact and firms of carbon pricing on energy consumption and due to a Energy tariffs are the main channel through which shift towards increased demand for cleaner fuels. It is households’ disposable incomes could be impacted also expected that there will be an increase in imports by the proposed environmental fiscal reforms. In of low-carbon technology. There is also a moderate general, polluting companies are likely to attempt to increase in the import of emissions-intensive goods, pass their increased costs due to environmental fees with imports of power increasing by 3.78 percent, of and carbon prices on to consumers by increasing non-metallic minerals by 2.73 percent, and of rubber and energy tariffs. In cases where the residential customer plastic products by 1.6 percent (all figures compared to tariffs cover the full utility costs, any increase to their BAU baseline for 2035, annually). However, overall, the costs due to the imposition of carbon prices or energy results suggest a low risk of carbon leakage for Serbia. taxes would have been passed through to consumers, Experiences with carbon pricing in other jurisdictions depending on the price elasticity and substitutability also provide little evidence to suggest leakage. To the of the goods and services. In Serbia, residential extent that such leakages occur, they could also be customers are largely protected from external market addressed through adjustments to the allocation and/ shocks due to the regulation of electricity, heat, and gas or use of revenues derived from carbon pricing. tariffs, especially as these tariffs apply to guaranteed supply to residential and other small customers. It is These initial modeling results may provide intended that the energy component of residential significant inputs to enable the authorities to electricity tariffs (as opposed to the fixed capital cost prepare Serbia for the implementation of carbon component) will reach the full economic cost estimated pricing in line with the EU model. While the EU carbon by EPS by 2025. However, planned tariff increases pricing model may serve as a template for the region, were put on hold in November 2021 due to the steep the authorities may need assistance to align Serbia’s price hikes during the 2021–2022 energy crisis and the policies with those of the EU, particularly for interim associated disruptions to the global energy market. At measures, perhaps involving a transitional period of the time of the writing of this report, the electricity and carbon and energy taxes. Furthermore, the Government gas tariff increase has remained on hold. However, in may also want to conduct more disaggregated analysis the mid-to-long term, protected residential consumers to gain a better understanding of how carbon pricing may be subject to an increase in the cost of guaranteed could affect different stakeholders or different regions supply, with the wholesale price for guaranteed supply and what additional policies may be needed to support gradually catching up with the generation costs and those geographic areas, households, and sectors. Also, wholesale market prices. If the environmental fiscal the authorities will need to intensify their efforts to reforms discussed in this report are implemented, develop a robust monitoring, reporting, and verification thermal power and heating plant operators would be (MRV) framework to manage emissions. required to start paying for the cost of the pollution they create, with this cost currently falling on Serbian society as a whole, and particularly on its poorest members, who are disproportionately impacted by environmental degradation and associated issues. This study did not attempt to quantify the tariff increases that would result from the imposition of the reform measures, as • 27 SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH BACK TO CONTENTS sufficient details related to planned changes to tariff markets and the additional uncertainty resulting from policy33 and the specific options of environmental fiscalthe war in Ukraine are resulting in increased pressure reforms were not available. on regulators in the regions to allow operators to make adjustments to tariffs to pass on at least a proportion The impact of the reforms on large commercial of the higher costs to residential consumers.34 If and customers of thermal power and heating plant when that happens, households in the Western Balkans operators would be different from that on protected will experience a significant impact as a result of the residential consumers. These larger commercial decreased energy affordability, given that they already customers already buy electricity from EPS under spend a relatively high proportion of their household market conditions, with the wholesale market price of budgets on energy (see Figure 11). While households in electricity pegged to the Hungarian spot market and the lowest income decile spend on average 8 percent of Austrian Power Future Year-ahead prices until 2027. their total household budget on electricity and heating, For EPS, while environmental fees, energy excises, the richest decile spends only about 2 percent. Poor and carbon taxes would increase generation costs and households also spend a higher share of their income reduce the company’s profit margin if the wholesale on passenger transport. The impact of the increases price (which has significantly increased in Hungary and to the emission fees for air pollutants (PM, SO2 and Austria since 2021) remains above production costs, NOx) is therefore potentially regressive for households, EPS would remain competitive, and the commercial while also having the potential to increase the thermal consumers would not experience any impact of EFR on energy costs of businesses. In contrast, the share of their offtake prices. Furthermore, the proposed design total expenditure on gas and other residential fuels of the EFR mitigates the risk of a significant impact on (including liquefied hydrocarbons, e.g., butane, propane; profit margins, even if energy prices were to increase liquid fuels, coal; and other solid fuels) is roughly similar (see discussion in the last paragraph of this section). across the various income groups. Middle-income households spend a higher proportion of their budgets If EFR or equivalent environmental policies were on motor fuels (petrol and diesel) than do the poorest not implemented, household incomes and welfare and richest households. Without any compensatory would be affected through different channels. At measures, the poor may suffer disproportionately, given present, the cost of environmental degradation is borne their limited room to immediately adjust consumption by the victims of the pollution, not by the polluting and fuel sources. For example, a previous simulation entities. This environmental degradation exerts upward analysis for Serbia suggests that an electricity tariff pressure on expenditure on health care and protection increase by 16.3 percent can lead to an increase in from pollution, with household incomes declining due the household budget share for electricity by 0.5 to the impact of pollution on human capital through percent and an increase in the overall poverty rate by diseases and premature deaths. The available evidence 1 percent.35 indicates that poor households generally experience lower environmental quality than rich households. The design of EFRs proposed in the report is Hence, these poorer households are more likely to intended to mitigate the negative impact both benefit to a relatively greater extent than rich ones as on households (especially the poorest and most a result of the improvements to environmental quality vulnerable) and on businesses. First, while the resulting from the EFR. proposed reforms recommend pollution fee increases, they also propose the abolition of the so-called fee The potential distributional impact of the EFR “for the protection of the environment,” since, despite depends on the relative differences between its name, it does not provide any incentives to reduce the expenditure of rich and poor households emissions. Second, if the NOx pollution is increased on different energy and transport services. The to a level close to the marginal abatement cost, the persistently high electricity prices on wholesale generated revenues could be returned to the same firms 28 • BACK TO CONTENTS SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH Figure 11. Budget share of residential fuels and transport by expenditure deciles in Serbia A. Budget share of B. Budget share of residential fuels in Serbia 2019 transport expenditure in Serbia 2019 08 03 % of total expenditure % of total expenditure 025 06 02 04 015 02 01 0 005 0 2 3 6 8 10 0 2 3 6 8 10 Expenditure deciles Expenditure deciles Electricity and heat Other residential fuels Motor fuels Passenger transport Gas Source: Serbian Household Budget Survey 2019. in proportion to their output (as is the case in Sweden) to the full social cost of energy. Maintaining energy for modernization expenditures. Third, a portion of net prices at artificially low levels constrains the government’s revenues generated as a result of the implementation already tight fiscal space, without providing protection of the EFR could be utilized to fund social programs to to those most in need of it, given that untargeted benefit the poorest households, compensating for any energy consumer subsidies disproportionately benefit decreases in disposable income resulting from energy richer households and encourage both households tariff increases. Revenues generated as a result of the and businesses to use energy wastefully and without EFR could also be used to reduce households’ payroll reference to environmental considerations. 36 The taxes or to invest in innovation and education to boost continuation of these subsidies would exacerbate firms’ productivity and competitiveness (human capital the vulnerability of Serbia's economy to future policy development). The manner in which these additional and price shocks related to the green transition and revenues are recycled should be determined on the disincentivize Serbian businesses from preparing to basis of comprehensive discussions with all stakeholder compete in the EU market under the emerging Green groups through the political process, although it will Deal policies. While a detailed distributional analysis almost inevitably require strengthening and expanding of environmental fiscal reform of the design of social targeted social protection for vulnerable consumers. transfer mechanisms was beyond the scope of this current study, it is suggested that follow-up studies While it is vitally important to provide effective should conduct such analysis to enable the authorities protection to poor and vulnerable customers, it is to better prepare for the distributional impacts of the also important that all users are gradually exposed reforms. • 29 SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH BACK TO CONTENTS 2.2 Broad and deep sectoral reforms will ensure a fast transition While the pricing reforms discussed in the coal are often burnt in old, inefficient boilers, leading to previous section are vital to Serbia’s green negative environmental and health impacts as a result of transition, their design will involve careful and air pollution, with the use of these fuels raising concerns lengthy consideration. On the other hand, a number related to the sustainability of wood harvesting. of sectoral reforms could be initiated in the shorter term to support the government’s priorities and ongoing The implementation of the EU acquis in the Serbian work. As noted earlier in Section 1.3, the government energy efficiency sector is well advanced, with has drafted a number of key policies and regulations the largest remaining gaps found in the building to address climate challenges and local environmental sector and in heating and cooling. Serbia has issues, thus facilitating the transition. This section achieved significant progress towards the EU’s Energy focuses on four sectoral interventions for which there Efficiency Directive by promulgating the new Law on is strong public demand, government momentum, and Energy Efficiency and Rational Use of Energy in April potential support from development partners. Annex 4 2021. Amongst other measures, this law established an provides a broad overview of the strengths, weaknesses, administrative entity — the Administration for Energy opportunities, and threats (SWOT) related to reforms Efficiency Financing and Promotion (EEA) — and in these sectors as well as climate action, which is a strengthened the energy management system and crosscutting agenda. framework for energy audits. The implementation of the EU acquis lags in the building sector and in heating and cooling. For example, in the area of district heating, 2.2.1 Energy efficiency Serbia has not yet assessed its potential for high- Serbian authorities have implemented a number of efficiency cogeneration and efficient district heating and initiatives to improve energy efficiency and thus cooling, as required by the Energy Efficiency Directive. reduce both the demand for energy and carbon emissions, yet these efforts need to be intensified. Many factors continue to constrain Serbia’s In the current context of energy insecurity resulting initiatives to increase energy efficiency, including from the war in Ukraine, measures to improve energy the inadequate implementation of legislation, low efficiency are perhaps the most viable intervention to energy prices, affordability concerns, and limited reduce both energy demand and emissions in the short access to financing. The slow roll-out of consumption- term. based billing in district heating (which could stimulate energy savings) is just one example of the inadequate The residential sector remains the largest consumer implementation and enforcement of the new legislation. of energy in Serbia, largely due to the poor energy Relatively low energy prices reduce incentives to invest efficiency of the country’s building stock. The in energy efficiency measures. Yet, even at current residential sector accounted for 31 percent of Serbia’s prices, energy poverty is a growing concern, with final energy consumption in 2019, followed by industry (24 households spending about 9 percent of their total percent), transport (25 percent), commercial and public budget on space and water heating on average. Low- services (9.5 percent), and agriculture and forestry (2 income households have fewer resources available percent).37 The average specific heat consumption (per to finance investments in energy efficiency measures m2) of residential buildings is 37 percent higher in Serbia and find it more difficult to access financing. Available than the average level for the EU27. About 75 percent funds from public sources (national and municipal of the final energy consumed by Serbian households is budgets) are very limited, with donor-funded programs used for space and water heating, largely through the insufficient to cover all investment needs and with a use of firewood and coal (36 percent and 12 percent, lack of sustainable (revolving) financial mechanisms. respectively, in 2018),38 with these sources of energy used almost exclusively in rural areas.39 Firewood and In the near term, implementing the proposed policy 30 • BACK TO CONTENTS SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH reforms will require secondary legislation to support particularly heating through burning wood.42With the the 2021 Law on Energy Efficiency and Rational significant negative impacts of air pollution in Serbia, Use of Energy, together with energy price reforms the country’s strategic policy framework remains and the establishment of sustainable financing incomplete, with a need to update key legislation to mechanisms. For effective implementation of the 2021 address these impacts. The most recent revisions to Law on Energy Efficiency and Rational Use of Energy, the Law on Air Protection were introduced in 2013, and many supporting regulations and by-laws will need to NAPP, which was supposed to be adopted within two be formulated and enforced, particularly to support the years following the adoption of the Law, still remains in establishment of a new energy audit system to assess the process of being adopted. While the need for a new the energy performance of buildings. In addition, four Law on Air Protection by 2023/24 has been recognized, remaining regulations related to labeling appliances the draft NAPP outlines interventions aimed at reducing need to be fully implemented.40 While energy prices are by half the health impact resulting from poor air quality close to or at the cost recovery level, energy taxation is by 2030. It is intended that the forthcoming NAPP will relatively low, leading to relatively low prices compared complement the National Plan for the Reduction of the to elsewhere in the region and to limited incentives to Main Pollutant Emissions from Old Large Combustion invest in energy efficiency measures and distributed Plants (NERP). While this plan was formally adopted in renewable generation. Therefore, the authorities may 2020, its implementation has been delayed. The NERP consider removing price caps and gradually increasing aims to reduce the total annual emissions of SO2, NOx, energy taxation (e.g., to account for externalities). At the and particulate matter from 12 old, large combustion same time, the government should consider gradually plants in order to reach limit values of emissions by the phasing out subsidies for electricity generation from beginning of 2028. Since the energy sector contributes coal and lignite, together with measures to protect to almost half of Serbia’s overall PM2.5 pollution, most of vulnerable households against energy price increases. which derives from coal combustion, it can be expected The government could also aim at transforming the EEA that the NERP will facilitate significant improvements to make it financially sustainable and autonomous in in air quality. matters related to governance, procurement, budget control, and staffing. In addition, the authorities should While Serbia has a good level of alignment with the prioritize the introduction of consumption-based billing EU acquis on air quality, it needs to accelerate the in all district heating systems to avoid deterioration of implementation of mandated measures. According financial sustainability and quality of district heating to the European Commission, Serbia needs to prioritize services. improving its air quality plans and air quality monitoring system. In particular, the Serbia 2021 Progress Report’s key recommendations include the adoption of the EU 2.2.2 Air pollution air quality index and ensuring adequate staffing of the In Serbia, air pollution is a major health concern, Serbian Environmental Protection Agency (SEPA). causing thousands of premature deaths and However, improved air quality management generally enormous costs to the economy. More than one- needs more effective support by the government, third of Serbia’s population lives in regions where the including through measures to update the Law on Air air contains at least one pollutant at levels deemed Protection, implement the NAPP, and strengthen the hazardous for human health. 41 The energy sector, institutional framework as presented in Section 2.3. residential combustion, and agriculture are the most Furthermore, as mentioned in Section 2.1.1, there is a significant contributors to PM2.5 concentrations, at 22.8 need to reform some of the existing fiscal instruments percent, 19.3 percent and 12.9 percent, respectively. since they do not penalize polluters. The emissions from the energy sector result mainly from lignite coal power plants, while in the residential sector, they come mainly from residential solid biofuel burning, • 31 SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH BACK TO CONTENTS Policy reforms in the near-term need to focus Serbia is committed to the development of Circular on strengthening the legislative framework for Economy strategies and to the construction and air quality issues and on providing support for maintenance of waste management infrastructure. the achievement of specific emissions reduction In January 2022, the government adopted a new targets in the energy, industrial, and agricultural National Waste Management Program 2022–2031, sectors. Among other measures, these reforms could which creates a strategic basis for the implementation be conducted through amendments to the Law on of investment measures over the next 10 years, with Industrial Pollution Prevention and Control (IPPC), the the program mandating the establishment of modern formal adoption of the new Law on Air Protection, and regional waste management centers across the country the implementation of the NAPP, including the specific and the introduction of various economic and other interventions outlined therein. Specific air quality instruments to incentivize a shift towards a circular targets aimed at containing SO2 and PM2.5 emissions economy. The latter will also be facilitated by the from the energy sector, achieving compliance with BAT- forthcoming Action Plan (2022-2024) and the Circular associated emissions levels in industrial processes Economy Development Program (2022-2024). In and product use, and reducing ammonia emissions addition, the authorities have established various waste from agriculture will require numerous policy reforms management and circularity targets, including targets to achieve greater alignment with EU legislation. In related to the reduction of municipal waste disposed addition to the actions outlined in the NAPP, an in unsanitary landfills from 81 percent in 2020 to 17.8 integrated climate change mitigation and air quality percent by 2031. management program needs to be implemented to manage potential synergies and trade-offs. Despite Serbia’s growing body of waste legislation and a high level of alignment with the EU acquis on waste, numerous barriers to improving 2.2.3 Waste management and Circular waste management remain. Serbia faces major Economy institutional challenges to its initiative to improve waste management, resulting not only from sluggish adoption Serbia’s economy is characterized by low levels of policy documents affecting the waste sector but also of resource productivity and ineffective waste in significant gaps in monitoring and enforcement of management. Serbia’s economy is only 1.4 percent existing legislation. A major weakness of the existing circular, meaning that almost 99 percent of all 43 legislative framework is that it provides few economic materials consumed each year are not recycled for use incentives for environmentally sound behavior and as secondary raw materials. The low levels of resource inadequate penalties for illegal practices. For example, productivity can be explained by its relatively high waste management fees are calculated per square degree of reliance on extracting material resources (e.g., meter of residential or commercial space and in some mining and quarrying), and by its ageing and inefficient municipalities, based on the number of household industrial legacy infrastructure. In 2020, 91 percent of members. 47 Given that many economic actors in the total waste generated across the economy was Serbia lack awareness regarding waste management landfilled.44 The separate collection of different forms and circular business models, institutional weaknesses of municipal waste is rarely conducted, confined mostly and the lack of incentives encourages the widespread to pilot projects by a few municipalities. Recycling rates practice of illegal landfilling. are low, with eight out of every 10 tons of municipal waste dumped in unsanitary landfills, including an 45 Serbia’s policy priorities for waste management estimated 2,305 illegal landfills (2019). 46 The large and for facilitating the emergence of a circular number of non-compliant landfills poses a serious economy are defined by the Waste Management threat to the health of the population, environmental Program and its Action Plan, the forthcoming safety and biodiversity conservation. 32 • BACK TO CONTENTS SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH Circular Economy Development Program, and by higher than the average level for the EU. There measures to achieve alignment with the EU acquis. have been no significant improvements in this area over There is a particular need to establish effective Extended the past decade, indicating a lack of investment in the Producer Responsibility (EPR) systems, tariff models maintenance and upgrading of aging infrastructure. With based on the amount of waste disposed, and a landfill increasing energy prices having a particularly severe tax. However, these measures need to be designed in impact on less efficient utilities and with the expected a way that avoids littering and illegal dumping, which impacts of climate change, high levels of water losses are likely in the absence of adequate monitoring and are becoming an increasing cause for concern. enforcement. There is a need to strengthen incentives for the private sector through the possible introduction Sector financing is inadequate and constitutes a of circular economy vouchers and circularity-related major constraint on network maintenance and on criteria to establish eligibility for state support. There the renewal and expansion of infrastructure, both is also an urgency to revise regulations related to of which will require huge investments to address by-products and the end-of-waste status to facilitate adequately. At present, tariffs barely cover operational greater reuse of certain types of waste. To achieve and maintenance costs, with average 49 residential better alignment with the EU acquis, the authorities tariffs being significantly lower than the regional should facilitate further implementation of the Waste average. The price of drinking water and wastewater Framework Directive through amendments to the Law treatment is relatively low at 0.61 EUR/m 3 (or 1.2 on Waste Management. percent of the average household budget) compared to the average for EU countries.50 As a result, subsidies 2.2.4 Water and wastewater from local budgets are sometimes required to cover the operational costs of water utilities and, to an even Serbia is affected by a large number of issues greater extent, investments in infrastructure. In most related to water and its management, with cases, water utilities largely rely on external sources wastewater management identified as a key local to finance capital expenditure. The cost of achieving environmental challenge. Other critical challenges compliance with EU standards is estimated to stand at include significant gaps in wastewater management around five billion euros (40 percent for drinking water and sanitation, freshwater pollution, poor drinking supply and 60 percent for sanitation), or an average of water quality, and excessive water losses, together with 32 euros per inhabitant per year for the next 20 years, water-related risks such as floods and droughts, whose around twice the current annual investment rate. frequency is increasing due to climate change, as stated earlier. A particularly pressing concern is the low While Serbia’s water sector legislation is percentage of wastewater that is treated (18 percent in comprehensive, the division of mandates is 2020; of which 1.3 percent was purified through primary unclear, resulting in a lack of a sense of ownership treatment, 11.8 percent through secondary treatment, by the responsible entities. Responsibilities for the and 4.9 percent through tertiary treatment). This water sector remain divided among many different results in significant environmental and public health ministries and agencies. There is also no regulatory hazards, including pollution of surface water bodies. agency charged with the overall responsibility for Inadequate connections to sewer systems and the lack establishing rules and regulating service provisions of wastewater treatment facilities have resulted in a low related to the water supply and sanitation sectors. rate of safely managed sanitation services. In fact, less The primary legislative instrument to establish a legal than 20 percent of Serbia’s population has access to basis for water management and water protection is safely managed sanitation services. the Water Law51, with an associated set of bylaws and regulations. The authorities have also formulated the Serbia’s water supply network experiences losses Water Management Strategy as a planning document of 41 percent of supplied water, significantly 48 to guide the long-term direction of the country’s water • 33 SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH BACK TO CONTENTS management until 2034.52 To implement the Water the transition to greener and more resilient growth, as Management Strategy, the authorities have developed further outlined in Annex 5 with examples for addressing an initial Action Plan for 2021-2023.53 air pollution and climate mitigation. To address Serbia’s water challenges in the near- While the government needs effective policies term, the authorities’ current policy priorities and regulations to address the challenges related include strengthening governance, adopting the to the transition to greener and more resilient new water law, setting effective tariffs, finalizing growth, their implementation is predicated on new planning instruments, and further alignment institutional capacity. As noted in the Action Plan for with the EU acquis. At the national level, clarification Administrative Capacity Development submitted to the and definition of the roles and duties are needed to EU as part of Chapter 27, there remains a significant improve the efficiency and effectiveness of water gap in Serbian institutions’ staffing needs. Furthermore, policy. To achieve this, the authorities need to adopt the there is a lack of effective local institutions to support newly drafted Water Law and formulate and implement the implementation of regulations.56 In particular, three associated regulations. With low water tariffs in Serbia, main institutional issues need to be addressed: i) a gap the authorities should set the tariffs in accordance with in human resources (quality and quantity) available to the the cost recovery principle. Furthermore, the River Basin public sector; ii) a lack of cooperation and coordination Management Plan and the first Flood Risk Management across institutions and levels of government; and iii) Plan need to be finalized to guide the planning of inadequate accountability. investments in Serbia’s water sector. Finally, measures to further align Serbia’s water-related legislation with Given the cross-cutting nature of policies to achieve EU standards will be necessary, particularly regarding a green transition, multi-sectoral coordination the institutional framework for enforcement, monitoring, is particularly relevant to achieve progress. The and coordination.54 authorities have made efforts to improve multisectoral coordination through the establishment of the National Climate Change Council (NCCC) under the 2021 Law 2.3 Strong institutions are on Climate Change. This newly established entity needs a high level of government oversight (e.g., under needed to sustain the transition the Prime Minister’s Office). This would also enable the more explicit mainstreaming of the green agenda to greener and more resilient across sectoral strategies and plans, with leadership growth provided by core institutions. In addition, with the right incentives and support, local governments could Given that strong institutions form the foundation for also act as catalysts for greener growth solutions. For effective reforms, Serbia has the means to address example, the Law on Air Quality assigns the mandate many key institutional weaknesses that constrain the for the preparation of air quality plans and the operation effective implementation of needed interventions of the local network for air quality monitoring to local across sectors. Generally, the effectiveness of Serbia’s governments. However, a number of institutional government institutions has been assessed as only challenges constrain implementation, including limited slightly lower than that of Bulgaria and Romania at the capacities at the local level and a lack of communication point prior to their EU accession, suggesting that Serbia and coordination between local agencies and those at is capable of scaling up its capabilities to the necessary the national level. levels.55 As an upper middle-income country, Serbia has a high proportion of workers with tertiary education, Ensuring the effective and systematic enforcement providing a pool of talent upon which to draw. Hence of policies and regulations requires adequate institutional strengthening has the potential to support staffing and capacity within the responsible 34 • BACK TO CONTENTS SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH institutions. Inadequate enforcement is the result capacity in terms of quantity and quality or to develop of weak regulations and inadequate institutional some form of collaboration with technical institutes capacities (e.g., in the drafting and implementation of and academic institutions. To effectively implement the environmental regulations). For example, in the case of environmental fiscal reform options discussed in this local self-governments (LSGs), the penalties defined study, the authorities will need to introduce many major under the Law on Renewable Energy Sources (RES) changes to the institutional framework. The necessary are either not authorized by the regulation or are so changes include measures to increase the capacities low that they do not encourage the heat distribution of policy makers to design targeted measures and company to provide access to the grid for heat energy financial support mechanisms, manage the reporting from RES. Likewise, the capacities required to conduct and calculation of fee levels (e.g., through improved effective inspections are also insufficient. It is estimated IT systems and coordination with local registries), and that measures to improve staffing to adequate levels improve local enforcement of reporting requirements through approving new positions, agreeing on on emissions, among others. allocations, developing job descriptions, and recruiting, could take at least two years. To improve institutional efficiency, potential gains could be realized through ongoing digitalization, Work force planning and related budgetary which could ease the cost and burden associated allocations need to be strengthened to support with establishing effective systems for institutional needs and ensure that necessary environmental and emissions-related permits capacities are in place. Even though Serbia prepared and reporting. The authorities’ ongoing efforts to Action Plan for Administrative Capacity Development establish an IT system to monitor, report, and verify (APACD), which it submitted to the EU as part of (MRV) progress towards the fulfillment of international Chapter 27 negotiations, there is a significant gap in climate commitments is a step in that direction. It is the staffing needs. For instance, based on APACD, the expected that this initiative will be expanded to cover reinforcement of administrative capacity for air quality GHG emissions from specific installations, which will is necessary on all three levels of government (national, ease integration with the EU Emission Trading System. provincial and local). This is especially relevant in the With the possible introduction of CBAM and carbon case of SEPA and LSGs, which lack capacities in terms pricing, it could be challenging and resource-intensive of staff, budget for accreditation and maintenance of to track the emissions resulting from the production of monitoring systems, development and implementation complex products. To address this, further use of IT of air quality plans, etc. Moreover, the APACD does not solutions could be explored to facilitate implementation consider the institutional needs and capacities needed without compromising the security and integrity of the for the introduction of new policy reforms and measures, system. ■ as illustrated in the examples below. These additional capacities and related positions haven’t been included in the workforce planning, nor have they been budgeted yet. The introduction of policy reforms and measures will have an impact on the institutional frameworks needed for their implementation. While the draft NAPP and the draft Low Carbon Development Strategy (LCDS) and Action Plan provide several such measures, they require policy/regulatory and institutional support for their effective implementation (see Box 4). In particular, it will be necessary either to enhance SEPA’s • 35 SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH BACK TO CONTENTS Box 4. Institutional resources required for the effective implementation of measures associated with Serbia’s transition to greener and more resilient growth Draft National Air Protection Program and Action Plan Measure 1.1.2: Enforcement of the EU Directive 2015/2193 on the limitation of emissions of certain pollutants into the air from medium combustion plants This regulatory measure is aimed at supporting alignment with EU Directive 2015/20193 on Medium Combustion Plants (MCPDs). It includes four activities: i) finalizing a work program for full alignment of the national legislation with MCPs; ii) establishing a reporting system and database for medium combustion plants (MCPs); iii) implementing measures to improve and increase human resources in Serbian institutions to enable them to effectively manage MCPDs (and also other installations, such as small combustion plants (SCP) and domestic appliances); and iv) implementing measures to ensure compliance of MCPs with BAT Achievable Emission Levels (AELs). For the effective implementation of this regulatory measure, the Law on Air Quality must be amended and a regulation promulgated on emission limit values of pollutants in the air from MCPs. In terms of technical capacities, efforts to improve monitoring and reporting by SEPA are necessary. While an inventory of MCPs is available, an effective reporting system has not yet been established. Currently, SEPA is extending its IT system to cover the reporting of emissions from pollution sources to the local level. This system is intended to enable the monitoring and reporting of MCPs´ emissions through these local pollution registries. However, improvements to IT systems at both local and national levels will be required to ensure an effective and fully functioning system. Furthermore, improvements to institutional capacities are necessary to enable effective enforcement and compliance. In particular, measures to improve capacities within the MEP, the Autonomous Province of Vojvodina (Provincial Secretariat for Urban Planning and Environmental Protection) and SEPA are required, with these institutions needing dedicated staff with expertise in MCPD, SCP, and domestic appliances. Draft Low Carbon Development Strategy and Action Plan Measure 8: Energy efficiency, improvement of heating and cooling infrastructure and promotion of the use of renewable energy sources (RES) in households This measure involves a combination of regulatory and financial tools to replace inefficient equipment with Eco Design compliant boilers and heaters and to facilitate extending District Heating (DH) to more consumers and greater use of RES in buildings. The regulatory framework changes required under this measure have been partially completed, with the Ecodesign Framework Directive transposed in December 2021, although implementing regulations has yet to be enacted. Minimum requirements for the use of RES for heating in new and renovated buildings will need to be defined, although such measures have not yet been included in the legislation on energy efficiency in buildings. In terms of the overall institutional framework, the lead agency, the Ministry of Mining and Energy (MoME), is well positioned to take on the implementation of these measures, as it has benefited from the most recent workforce planning in October 2021. To facilitate the replacement of obsolete, inefficient solid fuel boilers with Eco Design boilers or heat pumps, this measure foresees the provision of financial incentives. Although mechanisms for the disbursement of incentives from MoME to local self-governments (LSGs) with households as final beneficiaries were tested in 2021, the disbursement of these financial support measures to a large share of households will require additional resources. At the national level, the Directorate on Energy Efficiency will play a key role, requiring the building and development of additional capacities. The same is true for the LSGs, which would also require dedicated staff, with a number of such staff depending on the size and number of households not connected to the district heating or gas supply. Similarly, in addition to the improvements in its capacity to manage funds, the Directorate needs to strengthen its capacities to conduct communication and awareness campaigns on the importance of replacing inefficient equipment. The LSGs will need to play a multiplier role to ensure the effective dissemination of awareness raising activities, with most LSGs currently not having adequate capacities for this purpose. 36 • • 37 3. Managing transition risks and charting a course to greener and more resilient growth With the EU moving towards an innovation and impacts on the environment and fiscal space. With the knowledge-based green growth model, Serbia will forthcoming introduction of CBAM, Serbia’s adoption need to proactively prepare for the transition and of carbon pricing and implementation of a few other adapt not only to increasing demands from its own environmental policy reforms, including alignment citizens for improved environmental management with the EU ETS, create a greener and more resilient but also to external drivers. This report makes the case pathway to EU integration. that by acting in anticipation of emerging megatrends, Serbia can successfully navigate the transition risks The proactive alignment of energy taxation with by capitalizing on the opportunities presented by the the evolving ETD and adoption of carbon pricing emergence of the new greener economy, especially could enable Serbia to mitigate risks associated on the pathway to EU accession. Serbia needs a set with the CBAM, creating stronger incentives for of well-formulated, transparent policies, particularly firms and households to innovate and change their fiscal policies, accompanied by the appropriate profile of investment and consumption choices. implementing regulations and strong institutions to While CBAM would not bring fiscal revenues to the facilitate a transition that will enable it to be more government (as the payment goes to the EU), energy resilient to external shocks and competitiveness and excises and carbon pricing could generate revenues achieve higher levels of sustainable, inclusive growth, that the government could reinvest in social protection and greater job creation. Businesses, investors, and of vulnerable energy consumers and in building the financial institutions expect more clarity on the long- country’s research and development capacities and term strategic direction of Serbia’s development as well fostering the new skills required for participation in a as policy consistency while maintaining flexibility and more productive and competitive economy. The base adaptability to change. for carbon pricing revenues could be broader than the exports targeted by CBAM, which is focused on a While inconsistent price signals are still one of the limited group of sectors. However, over time, the scope most significant constraints to Serbia’s transition to of the CBAM is likely to expand to other sectors, with its greener and more resilient growth, transformation gradual phasing in providing plenty of room for Serbian in this area is being driven by internal and external exporters to modernize and avoid the negative impacts drivers of change. As this report makes clear, the lack of CBAM. However, given its narrower sectoral focus, of adequate pricing of resources and environmental CBAM is expected to have a relatively small overall externalities, like air pollution, distorts investment impact on emissions (only 2–5 percent) as compared decisions and contributes to low productivity in energy, to 38 percent with the imposition of carbon pricing. The water, waste, and industrial sectors in particular. The impact of an energy tax increase and carbon price on environmental fiscal reforms suggested in this report different economic sectors could also be better targeted could incentivize the greening of Serbia’s enterprises, to facilitate structural transformation, with a shift away including through measures to link energy and from energy-intensive sectors and towards more resource prices to environmental taxes and to phase knowledge-intensive ones, especially if associated with out environmentally harmful subsidies to polluting revenue recycling to pro-employment and productivity- industries. For example, the reform of air pollution fees enhancing innovation. could create much needed incentives to encourage enterprises to adopt air pollution abatement and In its efforts to facilitate the transition to greener mitigation measures while correcting the distortionary and more resilient growth, Serbia is constrained tax burden on businesses and improving the tight fiscal by a number of major institutional deficiencies position of the government. The reforms could include that impact its ability to improve environmental the abolition of the ill-targeted fee for the protection and management, and these deficiencies must be improvement of the environment, which would reduce addressed as a matter of urgency. Serbia’s lack of the tax burden on the economy without detrimental institutional capacities in the areas of environmental 38 • BACK TO CONTENTS SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH and climate management is a frequently cited issue significant delays in the adoption of key strategic policy in the European Commission’s annual EU accession documents, which are essential to guide national and progress reports. To address these, the authorities sectoral action and investments to support greener and should focus on measures to improve inter-institutional more resilient growth. These include the Integrated cooperation, strategic investment planning to raise National Energy and Climate Plan, the Energy environmental investments, and overall management, Sector Strategy, the second Nationally Determined including measures to increase the transparency Contribution, the National Air Protection Program, of governmental procedures. As part of Chapter 27 the Flood Risk Management Plan, and the Circular negotiations on the environment, Serbia has made bold Economy Development Plan. All these documents commitments to enhance capacity, as described in the provide a potential menu of reform options that the Action Plan for Administrative Capacity Development government intends to pursue. However, even where submitted to the EU. This Action Plan recognizes the strategic documents are in place, implementation is need to strengthen capacities not only through the often at an early stage, with monitoring and enforcement deployment of additional personnel and the provision of measures remaining insufficient. For example, the new enhanced training but also through organizational and Waste Management Program 2022–2031 explicitly structural improvements, including the development of acknowledges that the previous program was not fully improved coordination mechanisms between relevant implemented. ministries and across levels of government; greater accountability from the central to the local government Serbia’s transition to greener and more resilient level; strengthened financial management and control growth will require a coordinated ‘whole of in administrative units, including better capacities to government’ effort to create the conditions manage funds; and more clearly defined career paths necessary for increased growth driven by to attract qualified professionals able to facilitate the environmentally friendly sectors that are shift towards a new knowledge-based, green economy. characterized by high returns on investment. Policy reforms should aim to establish an environment that The government has not yet adopted the strategic is conducive to increased investment in sectors that documents necessary to provide a roadmap for can promote more rapid growth and that have a less its transition to greener and more resilient growth, detrimental impact on the environment and climate. thus constraining its ability to attract investments Multiplier analysis could provide insights on expected and finance innovation to facilitate this transition. increases in emissions and value-added in response to As noted throughout this report, there have been additional investment and demand (see Box 5).57 • 39 SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH BACK TO CONTENTS Box 5. Supply-side multiplier analysis GTAP-based multiplier analysis shows that in Serbia, sectors with the highest investment-side value- added multipliers and the lowest PM2.5 and GHG multipliers are the services sectors (finance/insurance in particular) and renewable electricity, with the converse holding true for the conventional electricity sector, which is heavily dependent on coal and which provides small returns on investment and is a big polluter. Many other sectors have medium value-added multipliers and also show low PM 2.5 and GHG multipliers.58 A successful transition to greener and more resilient growth would require an increased reliance on sectors that have higher value-added multipliers and lower emissions (shown by the green arrow on the graph) while also supporting sectors with both low and high value-added and high levels of emissions to improve both their economic and environmental performance. Figure 12. Value added multiplier and PM2.5 multiplier (supply side) PM2.5 added from 1 milion USD investment, indexed Electricity, other 900 800 700 <0.5% of GVA Electricity, coal 600 0.5% to 3% of GVA 500 > 3% of GVA 400 300 Minerals/metals 200 Electricity, gas 100 >>Finance, insurance Electricity, transition Trade Construction Electricity, solar/wind (536,000; 223) 0 Education Communication Public Administration Healthcare 0 50,000 100,000 150,000 200,000 250,000 Value added per $1 million of investment Note: Data labels provided only for sectors >3% of GVA in 2020. Not all sources of PM 2.5 covered. Source: Original calculation for this publication based on Taheripour et al. 2021, GTAP, and SORS 2021. 40 • BACK TO CONTENTS SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH The implementation of green policies is negatively and European energy networks will be the most robust impacted by Serbia’s overall regulatory environment, strategy to energy security and resilience to external which is often characterized by a lack of secondary shocks. Further, reductions to the use of coal/lignite will regulations to ensure the effective implementation not be without challenges, given structural dependencies of legislation. This also has an impact on the and the socio-economic implications for certain regions institutional mechanisms required for implementation. and income groups. However, this transition can be For example, there is a need to adopt secondary manageable given Serbia’s geographical position, legislation to support the implementation of key endowments, regional integration and access to pre- policies and laws, including the Law on Climate accession and future EU funds. Change, Law on Renewable Energy Sources, Law on Energy Efficiency and Rational Use of Energy, to Serbia would benefit from developing a coherent name only a few. The long delays in the formulation and adaptive roadmap to support the transition to and adoption of secondary legislation not only delays greener and more resilient growth. This could lead implementation, but also sometimes results in the to numerous benefits for the Serbian economy and its need for the adoption of completely new laws, given citizens, including jobs and economic growth, macro- the sheer number of amendments that must be made. fiscal stability, and a cleaner environment. However, to get there, the government will need to address Economic shocks related to the COVID-19 pandemic, key policy drivers in terms of appropriate economic the war in Ukraine, and the ensuing energy crisis incentives, strengthen institutions, and put in place the may make the transition to greener and more right sectoral policies. The price increases related to the resilient growth appear more challenging, but green transition need to be well informed by the local they also have unveiled its urgency and systemic political economy and complemented with distributive importance. Recent energy price spikes have given welfare measures to ensure that they are inclusive and new life to old concepts of energy security, with some equitable. Financing for some of the measures could renewed calls for the achievement of energy autarky be through carbon pricing and energy taxation, and through reliance on domestic coal (especially non- the revenues could be further reinvested in innovation tradable, low-quality lignite) rather than the adoption and education to facilitate economic and structural of a more sustainable approach through diversification transformation. Carbon pricing has the additional of sources, fuels, technologies, and routes, which benefit of reducing the impacts of EU CBAM on Serbia’s underpins the EU energy security strategy. However, in economy. The roadmap could help mitigate the risks of the coming years, as global supply and demand for oil the current ‘brown’ growth model, as shown in Figure and gas rebalance again and the EU accelerates green 13, which also provides an organizing framework to energy transition diversification and greening of energy support the transition to greener and more resilient sources and supply routes, combined with energy growth in Serbia. ■ efficiency, system flexibility, and integration with regional • 41 SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH BACK TO CONTENTS Figure 13. Organizing framework for the transition to greener and more resilient growth in Serbia Fundamental Greener and more resilient growth outcomes jobs and growth, macro-fiscal stability, cleaner environment Coherent and adaptive roadmap Getting Prices Strong institutional Appropriate Sectoral Right: Framework: Policies and Regulations: Policy drivers of Carbon pricing, Capacity, coordination, waste, air pollution, green transition environmental fiscal governance, strategic water, energy efficiency, reforms, revenue vision climate change, others recycling to boost innovation and skills Domestic cross- Equity, inclusiveness, political economy cutting enablers Financing for environmental and climate actions Risks of current 'brown' growth Economic risks: Low energy and resource efficiency model Physical environmental risks: High levels of pollution and emissions, climate change EU context Transition risks: External (EU) policies, trade (CBAM), technology gap, investors' preferences Social risks: Increasing public discontent with lack of action on the 'green' agenda. Source: Original elaboration for this publication. 42 • • 43 1 Global Alliance on Health and Pollution (GAHP) and The Lancet Commission on Pollution and Health. 2019. Pollution and Health Metrics. Global, Regional, and Country Analysis. Geneva: GAHP. https://gahp.net/wp-content/uploads/2019/12/PollutionandHealthMetrics-final-12_18_2019.pdf. 2 World Bank. 2019. New Growth Agenda: Boosting Productivity for Faster Growth, World Bank. 3 Data refer to 2014-2017, based on the 2019 World Bank Country Economic Memorandum. 4 Perović, V., Kadović, R., Đurđević, V., Pavlović, D., Pavlović, M., Čakmak, D., Mitrović M. Pavlović, P. 2021. Major drivers of land degradation risk in Western Serbia: Current trends and future scenarios. Ecological Indicators, 123, 107377. 5 https://www.srbija.gov.rs/vest/en/164639/environmental-protection-one-of-the-priorities-for-government.php. 6 Public opinion surveys were completed in November 2021 and March 2022. 7 According to a recent World Bank report, PM 2.5 caused an estimated 12,578 premature deaths in Serbia in 2019 or some 144 deaths per 100,000 population. The annual costs of health damages from PM 2.5 amounted to the equivalent of 18.9 percent of Serbia’s GDP, the highest share worldwide. 8 On average each year, about 45 thousand people emigrate from Serbia to OECD countries. 9 https://www.energy-community.org/legal/cases/2021/case1021RS.html 10 Statistical O wffice of the Republic of Serbia. 2020. Progress Report on the Implementation of Sustainable Development Goals by 2030 in the Republic of Serbia. 11 https://www.iea.org/countries/serbia. 12 https://www.iea.org/countries/serbia. 13 https://www4.unfccc.int/sites/NDCStaging/Pages/All.aspx. 14 https://www.serbianmonitor.com/en/serbia-will-continue-to-use-coal-despite-environmental-threats/. 15 Source: Original elaboration for this publication. 16 https://energy-community.org/news/Energy-Community-News/2020/01/15.html. 17 https://www.rcc.int/docs/596/action-plan-for-the-implementation-of-the-sofia-declaration-on-the-green-agenda-for-the-western-balkans-2021-2030. 18 https://ec.europa.eu/commission/presscorner/detail/en/IP_20_1811. 19 Prime Minister’s meeting with Chancellor Angela Merkel in September 2021. 20 Application of the polluter-pays principle means that polluters, rather than victims, bear the cost of pollution, including the cost of public measures taken to prevent, control, and remedy pollution. When the principle is applied, polluters are incentivized to limit pollution to efficient levels, and sufficient revenues are generated to remedy all caused pollution. Full application of the principle requires availability of low-cost tax collection mechanisms. Limitations therefore apply where tax collection effort is high due to high informality or structure of the tax base. 21 Subsidies are understood here broadly in line with the EU state aid, WTO and OECD definitions as direct fiscal transfers as well as and subsidies implicit in tax exemptions and many other forms of government support that gives the recipient an advantage on a selective basis. 22 The EU's ETD entered into force in 2003 and lays down structural rules and minimum excise duty rates for the taxation of energy products used as motor fuel and heating fuel, and electricity. The revision as proposed in 2021 brings two main areas of reform: (1) a new structure of tax rates based on the energy content and environmental performance of the fuels and electricity and (2) a broader taxable base by including more products in the scope and by removing some of the current exemptions and reductions. 23 Note that regulatory measures for reducing pollution from vehicles are foreseen in the draft NAPP. 24 In the extreme case of the fertilizer industry, the price of natural gas determines 60–80 percent of total production cost. 25 This analysis was undertaken before the war in Ukraine and related price increases. 26 Simulations of multiple scenarios were conducted with GEM-E3 computable general equilibrium (CGE) model—the same that was used for Serbia’s Low Carbon Development Strategy. 27 See annex for assumptions on the baseline scenario. 28 However the effectiveness of labor force training and R&D investments is contingent on the availability of human capital. 29 This is the most likely scenario since it is aligned with the EU accession process and commitments like the Sofia Declaration on the Green Agenda for the Western Balkans. 30 Domestic carbon price at EU ETS Allowance levels and excise tax revision. 31 Once part of the EU, support to develop targeted industrial, labor and social policies for affected regions and industries in Serbia would be available through mechanisms like the Modernization and Just Transition Fund. Nevertheless, challenges from the broad, structural economic adjustments partly triggered by a carbon price will create new winners and losers and the issues in navigating these changes should not be underestimated. 32 The risk that firms may lose business, profits, or market share to competitors operating in jurisdictions with a lower or no carbon price. 33 https://www.prosperoevents.com/serbia-to-join-europe-in-instituting-electricity-price-increase/. 34 World Bank. 2022. Steering Through Crises. Western Balkans Regular Economic Report; 21. Washington, D.C.: World Bank. 35 World Bank. 2016. Serbia First Public Expenditure and Public Utilities Development Policy Loan. 36 World Bank. 2022. Steering Through Crises. Western Balkans Regular Economic Report; 21. Washington, DC: World Bank. https://openknowledge.worldbank.org/handle/10986/37368 License: CC BY 3.0 IGO. 44 • 37 https://www.iea.org/countries/serbia. 38 Eurostat. https://appsso.eurostat.ec.europa.eu/nui/submitViewTableAction.do. 39 Statistical Office of the Republic of Serbia, 2011 Census. 40 To implement the energy efficiency law and fully implement the Framework Labelling Regulation (EU) 2017/1369. 41 World Health Organization. 2009. Environment and Health Performance Review Serbia, https://www.euro.who.int/__data/assets/pdf_file/0008/95345/E93534.pdf 42 McDuffie, E.E., Martin, R.V., Spadaro, J.V. et al. 2021. Source sector and fuel contributions to ambient PM 2.5 and attributable mortality across multi- spatial scales. Nat Comm 12, 3594. https://doi.org/10.1038/s41467-021-23853-y ple 43 Statistical Office of the Republic of Serbia, Eco-Bulletin 2020. 44 Statistical Office of the Republic of Serbia, Eco-Bulletin 2020; although the GRID diagnostic estimate is 95 percent. 45 Waste Management Program 2022-2031. 46 Circular Economy Development Program in the Republic of Serbia for the Period 2022-2024 47 EEA. 2021. Municipal waste management in Western Balkan countries – country profiles, European Environment Agency: Copenhagen.. 48 Serbian Association for Water Technology and Sanitary Engineering (UTVSI). Serbia water utility benchmarking report for 2020. 49 World Bank. 2015. State of the Sector Report – 2018 Update. https://sos.danubis.org/files/File/country_notes_pdf/SoS_Serbia.pdf. 50 The European Federation of National Association of Water Services. 2021. Europe’s water in figures – an overview of the European drinking water and wastewater sectors. https://www.eureau.org/resources/publications/eureau-publications/5824-europe-s-water-in-figures-2021/file 51 Water Law. Official Gazette of the Republic of Serbia. No. 30/2010, 93/2012, 101/2016, 95/2018 and 95/2018. 52 Water Management Strategy of the Territory of the Republic of Serbia until 2034. Official Gazette of Republic of Serbia, No. 03/2017. 53 Action Plan for the Implementation of the Water Management Strategy of the Republic of Serbia for the period from 2021 to 2023. Official Gazette of Republic of Serbia, No. 79/2021. 54 More details on the strengths, weaknesses, opportunities, and threats (SWOT) related to water and wastewater management are provided in Annex 4. 55 World Governance Indicators. http://info.worldbank.org/governance/wgi/. 56 For instance, in case of City of Valjevo, the legal obligation of having a local air quality plan is fulfilled as part of the third 5-year action plan currently under preparation. However, the previous two local air quality action plans were not implemented partly due to the lack of institutional capacities. 57 Multiplier analysis presented in this report is a result of the Taheripour et al. 2021 I-O model based on the Global Trade Analysis Project (GTAP) database. The model captures increases in economy-wide indicators in response to hypothetical increases in sectoral investments as well as sectoral demand, respectively. The model represents the structure of the economy at a fixed point in time and thus does not take into account resource constraints as well as the possibility of factor substitution. However, this approach provides useful insight regarding optimal resource allocation within the current economic structure.Taheripour et al. show in their research, covering over 140 economies, that investments in service sectors such as health, education, and communication, and in a few non-service sectors such as forestry and construction are associated with relatively high job multipliers and lower GHG emissions. In some countries, agriculture also falls into this category, with crops and non-ruminant livestock, being associated with lower emissions and high employment multipliers. Conversely there are more severe trade-offs in other sectors where relatively high job/VA growth is associated with large emission multipliers. The direct employment multipliers of some sectors could be small, but with large spillovers of jobs to the rest of the economy. For more detail, see World Bank Policy Research Working Paper, “Putting the Green Back in Greenbacks: Opportunities for a Truly Green Stimulus,” Taheripour et al, 2021. 58 The analysis finds a high correlation between industries that generate GHG emissions, which cause long-term climate impacts, and those that generate air pollution, which have immediate harmful impacts on human health, suggesting that in many cases policies could be designed to address both simultaneously, based on Taheripour et al. 2021. The model also provides for the analysis of the relation of value-added multipliers and CO 2 emissions, as well as jobs multipliers and different emissions 59 Calculated with the exchange rate from 31.12.2018 1 EUR = 118.1946 RSD.. 60 The Law on Fees for the Use of Public Goods imposes the Environment protection fee also on individuals, but the implementing government Decree did not set the fee schedule for individuals thus making this provision unimplementable. 61 This does not mean that LSGs spend less for environmental protection. On the contrary, the representative of the Standing Conference of Towns and Municipalities stated that municipalities spend more money on environmental protection than revenues collected through the fee for protection and improvement of the environment. 62 https://e3modelling.com/modelling-tools/gem-e3/. 63 https://ec.europa.eu/commission/presscorner/detail/en/IP_21_3541. 64 EUR 35 (2025), EUR 48 (2030), EUR 222 (2040) and EUR 395 (2050). 65 World Bank own estimations. This narrow focus of the analysis is due to the importance of both areas for Serbia’s effort to transition to greener growth. Poor air quality is a decade long problem in Serbia and recently the Government of Serbia (GoS) recognized this as one of its priorities, following an increasing demand for action from the public. At the same time climate mitigation, especially in the energy sector, is crucial for Serbia’s transition to greener growth and for fulfilling commitments in the context of the Paris Agreement and the European Union (EU) accession process. Moreover, with the current energy crisis and rise of fossil fuel prices, the need for reducing energy consumption and deployment of renewable energies is more pressing than ever. • 45 46 • References Acemoglu, D., and J. Robinson. 2012. Why Nations Fail: The Origins of Power, Prosperity, and Poverty. New York: Crown Business. EEA. 2021. Municipal waste management in Western Balkan countries – country profiles, European Environment Agency: Copenhagen. McDuffie, E.E., Martin, R.V., Spadaro, J.V. et al. 2021. Source sector and fuel contributions to ambient PM2.5 and attributable mortality across multiple spatial scales. Nat Comm 12, 3594. Perović, V., Kadović, R., Đurđević, V., Pavlović, D., Pavlović, M., Čakmak, D., Mitrović M. and Pavlović, P. 2021. Major drivers of land degradation risk in Western Serbia: Current trends and future scenarios. Ecological Indicators, 123, 107377. Serbian Association for Water Technology and Sanitary Engineering (UTVSI): Serbia water utility benchmarking report for 2020. Statistical Office of the Republic of Serbia. 2020. Progress report on the implementation of Sustainable Development Goals by 2030 in the Republic of Serbia. Statistical Office of the Republic of Serbia. 2011. Census. Statistical Office of the Republic of Serbia. Eco-Bulletin 2020. Taheripour et al. 2021. World Bank Policy Research Working Paper – Putting the Green Back in Greenbacks: Opportunities for a Truly Green Stimulus. World Bank: Washington D.C. The European Federation of National Association of Water Services. 2021. Europe’s water in figures – an overview of the European drinking water and waste water sectors 2021. WHO. 2009. Environment and Health Performance Review Serbia. World Bank. 2016. Serbia First Public Expenditure and Public Utilities Development Policy Loan. World Bank. 2018. State of the Sector Report – 2018 update. World Bank. 2019. Serbia's New Growth Agenda: Forging a New Future. World Bank. 2019. New Growth Agenda: Boosting Productivity for Faster Growth. World Bank. 2022. Western Balkans Regional Economic Report, No. 21, Spring 2022, Steering Through Crises. • 47 48 • Annex 1: GRID Diagnostics Serbia – Indicators The GRID diagnostics analysis indicators for green and Regarding sustainability, Serbia’s performance varies inclusive development consider not only produced but widely. Air pollution is a serious concern affecting large also natural and human capital. The diagnostics consists amounts of the population. Although Serbia performs of four pillars: Resilience, Inclusion, Sustainability relatively well when it comes to mortality rate from air and Efficiency (RISE). The diagnostics can identify pollution using the WHO figure, other sources show key problems along those pillars. Here, only selected a much more severe impact with a mortality rate of indicators covered by the report are included. The 62.5 per 100,000 – almost three times higher than results for Serbia compared to the upper middle-income the EU mean. Serbia faces the threat of water quality countries (UMI) and EU mean are shown in Table A1.1. degradation and water pollution, which is primarily caused by inadequate treatment of wastewater and Regarding resilience to natural disasters, although industrialization. Solid waste production per capita population exposure to disasters is low, Serbia is prone is lower than the EU mean, but is almost exclusively to a wide variety of natural hazards, including floods, deposited in landfills. Energy consumption in Serbia landslides, droughts, and earthquakes due to extreme highly relies on fossil fuels, with nearly 70 percent of weather and climate change. In comparison to the EU27, electricity being generated using domestic lignite coal. Serbia ranks in all indicators below the EU mean, except Although total GHG emissions and CO2 emissions from for population exposure from disasters. This indicates agriculture and land use change are far below UMI high risks to assets and wellbeing from natural disasters. average, CO2 emissions per capita from production is Additionally, exposure to dry precipitation shocks is above UMI average. Serbia falls behind all the income above UMI average. For Resilience, Serbia is only groups as well as Western Balkan countries in the ranked ahead of Western Balkan countries and LICs. rankings regarding the sustainability indicators. In the field of inclusion, access to electricity and Regarding the efficiency of resource use, Serbia education are nearly universal. However, access to performs inadequately. Although energy intensity has health services and safely managed drinking water are declined by 14 percent from 2005 to 2015, the energy still inadequate. Safe sanitation access is extremely low intensity level of Serbia is still above the UMI average (18.4 percent of the population). For Inclusion, Serbia as of 2017. The efficiency of carbon use is very low performs better than UMI average and is similar to ECA compared to the EU mean, and economic efficiency average level, but it is ranked behind Western Balkan in air pollution abatement is inadequate. Compared to countries and the EU mean. other countries’ efficiency indicators, Serbia is the best performer next to high-income countries but performs below the Western Balkan average. In summary, Serbia performs throughout the different GRID indicators much worse than the EU countries. ■ • 49 SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH BACK TO CONTENTS Table A1.1: GRID indicators for Serbia UMI EU Indicator Name Indicator Description Serbia mean mean Resilience Indicators Natural disaster The average value of the damages disasters cause to assets risk to assets 1.4 0.6 0.3 (expressed in repair or replacement value). (% of GDP) Natural disaster The decrease in GDP that would have the same impact on risk to well-being people’s well-being as the disasters that occur in the country 1.7 0.9 0.4 (% of GDP) (i.e. people’s willingness to pay to prevent all disasters. Population exposure The average share of the population affected by geophysical, from disasters meteorological, hydrological, or climatological natural 0.3 1.8 3.5 (% of total pop exposed) disasters over a 20-year period (2000–2019). Population The average share of the population exposure to a dry rainfall exposure from dry shock (rainfall <1 st. dev. below average) over a five-year 20.1 16.8 13.0 rainfall shocks period (2009–2013). (% of total pop exposed) Inclusion Indicators The percentage of people using improved sanitation facilities People Using that are not shared with other households and where excreta Safely managed are safely disposed of in situ or transported and treated offsite. 18.4 46.0 87.4 sanitation Improved sanitation facilities include flush/pour flush to piped (% of total pop) sewer systems, septic tanks or pit latrines: ventilated improved pit latrines, compositing toilets or pit latrines with slabs. The percentage of people using drinking water from an People Using improved source that is accessible on premises, available Safely managed when needed and free from fecal and priority chemical 75.0 76.6 97.5 drinking water contamination. Improved water sources include piped water, (% of total pop) boreholes or tubewells, protected dug wells, protected springs, and packaged or delivered water. Survey question from the World Value Survey, which conducts nationally representative surveys in 77 countries and societies. Belief that Respondents are asked if most people can be trusted, and "Most people can be 16.3 17.1 33 the indicator is the share of those that respond “Most people trusted" (% agreeing) can be trusted,” with the other option being “Need to be very careful.” The index measures the amount of human capital that a child born today can expect to attain by age 18, given the risks of poor health and poor education that prevail in the country where she lives. It is designed to highlight how improvements Human capital index in current health and education outcomes shape the 0.68 0.60 0.70 productivity of the next generation of workers, assuming that children born today experience over the next 18 years the educational opportunities and health risks that children in this age range currently face. 50 • BACK TO CONTENTS SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH Table A1.1: GRID indicators for Serbia UMI EU Indicator Name Indicator Description Serbia mean mean Sustainability Indicators Total renewable freshwater resources per capita (cubic meters): Renewable resources (internal and external river Total renewable water flows and groundwater from rainfall) in the country. Total 18,451 10,246 7,571 resources per capita renewable freshwater resources per capita are calculated using the World Bank's population estimates. The index is calculated from remote sensing data and other Biodiversity & habitat studies of ecological diversity. A score of 100 indicates that a 42.8 56.3 47.2 index country has experienced no habitat loss or degradation, and a score of 0 indicates complete habitat loss. Percent of the population exposed to ambient concentrations of PM 2.5 that exceed the World Health Organization (WHO) PM2.5 %pop exposed Interim Target 3 (IT-3) is defined as the portion of a country’s 98.6 91.4 55.5 above WHO (15ug/m) population living in places where mean annual concentrations of PM 2.5 are greater than 15 micrograms per cubic meter. Number of deaths attributable to the joint effects of household and ambient air pollution in a year per 100,000 population. The rates are age standardized. Following diseases are Mortality rate taken into account: acute respiratory infections (estimated attributable to air for all ages); cerebrovascular diseases in adults (estimated 62.5 67.9 23.8 pollution (per 100,000) above 25 years); ischemic heart diseases in adults (estimated above 25 years); chronic obstructive pulmonary disease in adults (estimated above 25 years); and lung cancer in adults (estimated above 25 years). A water quality index which covers the pollutants tracked by SDG 6.3.2, namely nutrients, salts, and chemical pollutants. It is an index of 3 water quality parameters, nitrates, electrical conductivity, and biological oxygen demand. The dataset Water quality, was generated for the report Quality Unknown: The Invisible nutrients, salts, -4.6 -2.8 Water Crisis, using a machine learning model using data from chemicals (SDG 6.3.2) 2000-2013. The resolution is the 0.5 x 0.5 degree gridcell. The country value here is calculated by taking a population weighted average of all gridcells where the centroid falls within the country. Solid waste Annual municipal solid waste generation in tonnes/ generation (tonnes) 0.33 0.31 0.47 population size per capita Landfill disposal % share of total waste 95 33 generation • 51 SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH BACK TO CONTENTS Table A1.1: GRID indicators for Serbia UMI Indicator Name Indicator Description Serbia EU mean mean Sustainability Indicators Renewable energy consumption Renewable energy consumption is the share of 19.9 20.5 21.3 (% of total energy renewable energy in total final energy consumption. consumption) Share of coal in electricity generation 68.2 23.2 13.2 (% of electricity generated) GHG emissions 9.2 7.5 8.5 per capita Change in GHG Percentage change of GHG emissions per capita from emissions per capita -0.6 2.1 -15.6 2008 to 2017. (% change 2008-2017) Efficiency Indicators The value added in US dollars per volume of water Productivity of withdrawn in cubic meters by a given economic activity water use ($ per m3 5.9 19.2 131.4 over time. It considers water use by all economic activities, water withdrawals) with a focus on agriculture, industry and the service sector. The ratio of GNI (constant 2010 US$) to total greenhouse gas emission (kt of CO2 equivalent). Total greenhouse Efficiency of gas emissions in kt of CO2 equivalent are composed of CO2 totals excluding short-cycle biomass burning (such carbon use as agricultural waste burning and Savannah burning) 730,106 1,277,034 4,267,773 (GNI per kt of CO2 but including other biomass burning (such as forest eq.) fires, post-burn decay, peat fires and decay of drained peatlands), all anthropogenic CH4 sources, N2O sources and F-gases (HFCs, PFCs and SF6). *Energy intensity (mj per constant 609 494 387 2011 purchasing power parity GDP) Measures the share of the budget spent on reducing air pollution that is spent efficiently, i.e. the share of the Air pollution actual budget that could have been spent to achieve the same air pollution related morbidity. A value of regulation 100% means it would not be possible to spend less 21.6 23.1 40.4 economic and achieve the same level of efficiency. 90% means efficiency a country could have spent 10% less to mitigate air pollution and achieved the same morbidity outcomes if it had spent those funds more efficiently. 52 • • 53 Annex 2: Impact Assessment of Selected Opportunities for Environmental Tax Reform in Serbia This annex provides more information on the Method methodology behind the impact assessment of The environmental impact assessment is conducted selected opportunities for environmental tax based on a review of the policy documents, reform in Serbia. The first and second sections stakeholder and institutional landscape, national provide context and background information. The third and municipality level tax budget statements, section details the methodologies applied. The final as well as exemplary firm balance sheets and section provides additional detail on findings on each cost structures of production and abatement of the assessed reform options. technologies. A sample of local self-governments has been screened to determine the relevance of the A2.1 Context environmental fees for the income, level of execution and compare the level of income with spending. An initial impact assessment was conducted of three Similarly, selected installations have been assessed for opportunities for environmental fiscal reform in their cost structure and estimated tax payments under Serbia. For the three reform options under assessment, current policy design and assessed reform options. environmental and fiscal impacts were analyzed, and a rapid overview of relevant institutional aspects in the The impact assessment was furthermore informed context of environmental taxes and charges in Serbia by economic modeling to identify whole-of- is provided. The assessment furthermore covered legal economy effects of energy tax reform, including basis, collected amounts, subjects and recipients of coal subsidy phase-out. A dynamic CGE (GEM-E3- existing environmental taxes and charges, including SRB) was employed to estimate impacts to sectoral excise duties in Serbia and policy interactions. Reform GDP and employment as well as production cost of the options under assessment were selected based on their proposed reform of excise duties in line with the revised relevance with respect to current policy priorities in the EU ETD. Similar assessment was not conducted for the country, as well as based on relevance in the context other two reforms under assessment, as no whole-of- of recent EU policy developments and the opportunity economy effects are expected from these reforms due for Serbia to align with updated EU guidance. to their small fiscal impacts. For details on the model as well as baseline assumptions, see the technical annex Background on environmental taxation in on CBAM and Carbon Pricing. All analysis on CBAM, Serbia carbon pricing, and EU ETD alignment was conducted in the same model with identical baseline calibration. Despite the share of environmental taxes in Serbian GDP being high, incentives for avoiding environmental damage remain low. The overall amount of environmental taxes collected in Serbia A2.2 Findings of the initial impact in 2019 was slightly over 223 billion RSD (ca. 1.9 bill. assessment EUR59). The share of environmental taxes in Serbian GDP increased in the last 10 years from 3.3 percent A2.2.1 Revision of excise energy taxes to 4.2 percent, while the share of environmental tax The policy reform proposal is to align excise duties revenues in total tax revenues over the last eleven in Serbia with minimum levels of taxation applicable years (2009-2019) was between 8.3 and 11.4 percent. under the revised ETD. With the Law on Excise Duties Environmental taxes in Serbia are dominated by energy in place, Serbia’s minimum thresholds for taxation of taxes (more than 85 percent), followed by transport transport fuels largely comply with the existing 2003 taxes and pollution fees and, finally, fees for the use Energy Taxation Directive (ETD, 2003/96/EC). The of natural resources. Within all mentioned categories, greatest deviation is in terms of coverage since the a majority of applicable taxes are not at all or not Serbian Law does not cover coal, coke, heavy fuel oil directly linked to polluting behavior, therefore providing and natural gas. Existing thresholds are not promoting imperfect or non-existent incentive effects. 54 • BACK TO CONTENTS SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH energy efficiency and use of renewable energy due to fiscal impacts of alignment would be significant. energy or CO2 content not being considered. The EU The revenues collected could increase by 470 million has proposed a revision of the ETD in the context of euros from coal and natural gas alone. This amount is the Fit-for-55 package, with the aim to reflect relative more than the combined revenues from the pollution, GHG intensities of fuels in minimum tax levels, which is natural resources and transport fees and would increase not the case under the existing 2003 Energy Taxation the energy taxes by almost 29 percent. The impact Directive, and to reduce distorting exemptions. on the electricity price is still estimated as negligible and will depend on tariff regulation, while the impact Given current tax rates, significant increases in fee on natural gas price is estimated to be 7.7 RSD/m 3 levels are required for natural gas, non-sustainable equaling an increase of nearly 22 percent. Assuming biogas, non-renewable fuels of non-biological revenues are redirected towards the reduction of origin and others for Serbia under this proposal. payroll taxes, this reform can have positive employment Alignment with the EU ETD will furthermore require a impacts leading to small increases in GDP in the mid- more detailed differentiation between different types of term, with the impact fading in the long-term.Final biofuels and a phase-out of direct fossil fuel subsidies. impact of the policy reform on household groups will The rationale for this proposal is to compensate for also depend on revenue use. Next to increasing taxes the eroding tax base due to the decarbonization effort, on natural gas and coal, the revised ETD introduces increase environmental effectiveness and increase taxation for different categories of biofuels, depending alignment with the EU Acquis. on sustainability, including firewood. A great share of households in Serbia is heating with firewood (46.8 Focusing the analysis on the most relevant percent). For an average household consuming 8.1 discrepancy between the revised ETD and the stacked m3 of firewood per year, the increase in costs is Serbian Law on Excise Duties (introduction of around 65 euros per year. Including the additional costs excise tax for coal and natural gas and firewood), for taxes for coal and natural gas, the additional costs Table A2.1: Impact of alignment of excise duties in Serbia with the revised EU ETD proposal on GDP, over time (left) and decomposition of impact (right) GDP impact of excise duty revision GDP impact of excise duty revision % deviation from baseline annually (EU alignment), 2025-2050 (EU ETD alignment), 2035, by driver 0.20% % deviation from baseline 0.03% 0.02% 0.10% 0.01% 0.00% 0.00% -0.10% -0.01% -0.20% 2025 2030 2035 2040 2045 2050 Imports Public consumption Private consumption Exports Investment GDP Source: GEM-E3-SRB. • 55 SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH BACK TO CONTENTS are estimated to amount to more than 110 euros per EUR) in 2020, which is 100 percent received by local year per household (note that a considerable portion of self-governments. used firewood is traded outside of the formal economy, which would make tax compliance less effective). The policy reform proposal is to abolish the fee for The increase in costs for the households should be protection and improvement of the environment mitigated by channeling the collected revenues for due to the lack of incentive effect. Subjects are bound grants and incentives for energy efficiency measures to full payment of the fee even if they do not create any or deployment of RES, to not only prevent an increase pollution or create less pollution than their peers. Thus, in energy poverty but also to promote the development the fee does not incentivize the reduction of pollution of clean technology and market uptake. as the level of payment is set by the assumed impact to the environment of payers’ economic activity and its An increase in the prices of natural gas and coal size, regardless of the amounts of pollutants emitted. that could result from the alignment with the revised ETD would lead to increased costs and The direct impact of this policy reform proposal is reduced profits for businesses, but the overall the reduction of local-self-government revenues impact on GDP and employment is expected to and reduction of costs on economic subjects. While remain insignificant due to counteracting effects the fiscal impact will be small at about 19 million euros from revenue use. Industries that are the largest annually (0.16 percent of government tax revenues in consumers of coal are in the production of electricity 2020), the fee is more significant from the perspective and steel, cement and chemical industries. In this of local self-governments who are recipients of the context, an interesting example is the fertilizer industry, fee (1.05 percent of local government tax revenues on where the price of natural gas can account for 60-80 average). It is recommended that the abolishment of the percent of the cost structure, but strong market power fee is introduced jointly with other policy reform options suggests price-pass-through to consumers is likely. filling the gap in revenues for local self-governments. Coal subsidy removal is also required under the No impacts on incentives for and behavior of revised ETD and could be implemented jointly with businesses and other economic agents are the revision of excise taxes in Serbia. Coal subsidies expected from this reform proposal in the short provided through fiscal support, public finance support and long term; therefore, environmental impacts and SOE investment support are estimated at more from this reform option are found to be nonexistent. than 40 million EUR per year (2019). A small increase in pollution may occur from increased output due to improved profitability, but this is unlikely given the current scale of the fee: For an exemplary A2.2.2 Abolishment of the fee for medium-sized company producing fertilizers and protection and improvement of the nitrogen compounds, the annual fee is 500,000 RSD environment (about 4,200 euros), presenting less than 0.05 percent of annual revenues. The fee for the protection and improvement of the environment (known as eco-tax in Serbia) applies to legal entities and entrepreneurs in Serbia and is A2.2.3 Revision of the fee for pollution loosely based on the level of impact and size of the of the environment: fee for the emission economic subject.60 The fee applies to legal entities of SO2, NO2, particulate matter and and entrepreneurs depending on the level of impact produced or landfilled waste of activities conducted (three categories) and the size of the economic subject (4 categories). The revenues The fee for the emission of SO2 , NO2 , particulate from this fee amounted to 2.3 billion RSD (19 million matter and produced or landfilled waste is one 56 • BACK TO CONTENTS SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH of the two highest revenue environmental fees increase in cost from the removal of correction factors. (excluding energy taxes). The subjects of this fee In the long run, the fee’s share of revenue is expected to are integrated pollution prevention and control (IPPC) decrease significantly due to investments in abatement operators, producers or operators of hazardous action driven by the regulatory instruments, such as waste obliged to have IPPC permits, and public utility NERP and measures foreseen under the draft National companies, as well as legal entities and entrepreneurs Air Protection Program. managing municipal waste emitting SO2, NO2 or PM above selected annual thresholds. The fee is calculated Opposition to the reform is expected to be low given based on actual quantities of emissions and disposed the low impact on net revenues and a low increase waste. The fee is subject to three correction factors in average burden per taxpayer; however single which reduce the applicable fee level, depending on actors could feel disproportionally disadvantaged. the amounts emitted, the existence of continuous Given that EPS contribute more than 25 percent of measurements and breach of limit values of emissions the total revenue from environmental taxes, a special and source of emissions. Historically, revenues from stakeholder plan needs to accompany any reform, even the fee on NO2, SO2 and particulate matter amounted where expected changes are small. for up to 0.2 percent of GDP. In 2020, revenues were proportionally smaller and only amounted to 0.06 percent of GDP. A2.3 Institutional aspects The policy reform proposal is to revise the It is important to assess the impact on the budget coverage by expanding to all polluters in the of local self-governments, where applicable, and registry of sources of pollution, removing the consider rebalancing measures. It is clear that in thresholds, abolishing the correction factors local self-government units, the revenues collected and increasing the level of the fee by 10 percent from the fees are not earmarked but are partly used annually over three years. The rationale for extending for covering operational expenses.61 Where a fee is the coverage is to cover a larger share of emissions by abolished that served as a source of revenues for LSGs, the instrument, which is especially relevant for NO2 and it is recommended to accompany the reform with a PMs. The rationale for abolishing the correction factors revision of the local/national distribution of another fee. is to provide a fully proportional abatement incentive independent of the emitted amounts. Increasing the It is furthermore necessary to strengthen fee level following a pre-announced path increases the capacities and position of the Ministry of the incentive to abate and informs forward-looking Environmental Protection (MoEP) in the context of investment decisions. proposed reforms. Taxation policy is the responsibility of the Ministry of Finance, with little or no influence from For fiscal impacts of the proposed reforms of the Ministry of Environmental Protection. The polluters´ the air pollution fee, the estimated upper bound registry is under the responsibility of SEPA and based for increase in expected tax revenues from the on interviews with stakeholders, SEPA needs more proposed reform is 50 percent, while impacts capacities in maintenance of the registry and for taking on businesses will vary significantly by industry over a greater role in monitoring and verification of and also size of the entity. Effective collections will collected fees and taxes. When considering expanding depend on the pace of changes in polluting behaviors in the base of potential fee payers as proposed in this response to increased fee levels. Emissions-intensive analysis, consideration should be given to improving industries will see a higher increase in cost proportional the capacity to adequately manage compliance risk, to revenues. Entities that were covered by one or both with a special focus on organizing audit processes and of the applicable correction factors see the highest assisting in voluntary compliance. ■ • 57 58 • Annex 3. Carbon Border Adjustment Mechanism and Carbon Pricing This annex provides more information on the projections of the economy and energy systems until modeling results undertaken for CBAM and carbon 2050 in five-year time steps. It serves to assess the pricing scenarios in Serbia. The first section provides direct, indirect and induced effects of EU and Serbian details on the model used, as well as assumptions climate policies. The model accounts for changes in behind and design of the baseline, CBAM and carbon the competitiveness of the Serbian industries and how pricing scenarios. The second section breaks down the changes in production and exports of industries the key drivers of GDP impacts under the scenarios affect employment, household income and domestic modeled. The final section explores alternative revenue consumption. Represented regions are Serbia, other uses from domestic carbon pricing policies and how Energy Community countries, the EU, and the rest of that could alter the impact on Serbia. the world. Results are dependent on scenario design as well A3.1 Background on model and as baseline assumptions. Baseline assumptions include strong export-led growth in the medium to scenarios long term, shaped by growth in exports of services, This analysis builds on the dynamic general while the existing trend of a declining population equilibrium model GEM-E3-SRB, also used by continues (Table A3.1). With respect to climate policies, the Serbian government to inform its long-term continuation of currently legislated climate and energy development strategy. GEM-E3-SRB is a tailored policies is assumed for Serbia under the baseline (2015 version of the GEM-E3 62 model co-developed and NDC is met and surpassed). For the EU, the baseline frequently operated by the European Commission’s scenario assumes implementation of the Fit for 55 63 Joint Research Council. The model represents policy package, leading to carbon neutrality by 2050. the structure of the economy and energy system, The model is furthermore sensitive to the EU carbon including the carbon intensity (Scope 1, 2 and 3) of price, which is calibrated assuming that the Fit-for-55 production processes of goods and services, including targets are achieved with a mix of carbon pricing process emissions which are highly relevant for most and supporting regulation.64 The model furthermore CBAM sectors. The model is dynamic and produces assumes high labor and capital mobility across sectors. Table A3.1: Exogenous assumptions for Serbian GDP and exports annual growth rates in the GEM-E3- SRB Baseline scenario Real annual 15-20 20-25 25-30 30-35 35-40 40-45 45-50 50-55 55-60 60-65 65-70 growth rates, % GDP growth 2.64 4.82 4.00 4.10 4.25 4.35 4.50 4.50 4.50 4.50 4.50 Exports (goods 9.14 7.20 7.50 7.50 7.50 7.25 7.00 7.00 6.50 6.50 6.00 and services) Population, % -0.53 -0.54 -0.61 -0.68 -0.75 -0.79 -0.82 -0.53 -0.54 -0.61 -0.68 Source: World Bank own estimations. • 59 SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH BACK TO CONTENTS The CBAM scenarios assume the mechanism as the EU. It also assumes a gradual phase-out of is gradually phased in consistent with the most direct coal subsidies and revision of fuel excise taxes recent ETS proposal. As the EU CBAM is designed aligned with the revised EU Energy Taxation Directive. to gradually replace free allowance allocation, in 2026 All results should be understood as an upper the mechanism is only applied to the power sector (as it boundary of expected outcomes, as CGE models is the only sector under full auctioning in the EU ETS to tend to overestimate mitigation costs and date). From 2026, CBAM coverage gradually increases underestimate the adaptive capacity of the market. by 10 percentage points each year until 2035, in line Models tend to overestimate the cost of mitigation as with the phaseout of free allowance allocation in the respective sectors. they underestimate the impact of low-carbon innovation, which reduces costs. Supporting regulation, as well The carbon pricing scenario assumes Serbia as early announcements of policy changes, may introduces an ETS with similar scope, coverage, furthermore allow adaptive adjustments within sectors permit allocation method and carbon price levels before assessed policies take place. Table A3.2: Overview of scenarios Carbon CBAM + Scope 2, Pricing + R&D Carbon Pricing + Baseline CBAM CBAM + Scope 2 all EU ETS sectors investments reduced payroll tax Cement, iron and steel, CBAM n/a aluminum, fertilizers, All EU ETS sectors Scope electricity CBAM Emissions n/a Scope 1 Scope 1 and 2 Scope Domestic yes carbon no no no no (EU allowance price level on EU ETS pricing sectors) Carbon Investment Reduce pricing n/a n/a n/a n/a in R&D and payroll revenue training taxes use CBAM exemption n/a no no no yes for Serbia Excise Excise tax on fossil fuels aligned with BAU BAU BAU BAU Taxes revised ETD Fossil fuel Gradual phase-out of direct coal BAU BAU BAU BAU subsidies subsidies 60 • BACK TO CONTENTS SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH A3.2 Drivers of macroeconomic of the overall emissions intensity for those sectors. Expanding CBAM to all EU ETS sectors almost doubles impacts of CBAM and carbon costs for Serbia, with a loss of 0.52 percent of GDP in pricing in Serbia 2035 (all costs expressed as the difference in GDP in a given year under baseline and selected policy scenario The introduction of CBAM is projected to have respectively. limited macroeconomic implications for Serbia, though costs increase with broader CBAM The key driver of GDP losses from CBAM is a coverage. Under the current EU proposal, GDP costs reduction in total exports, with a loss of 0.62 percent range from -0.06 percent in 2025 to -0.24 percent by of total exports by 2035. However, a drop in imports 2050 in the main CBAM scenario (current EU proposal). for intermediate goods and to a less extent, final goods Costs increase marginally if scope 2 emissions (i.e., drop by -0.59 percent and act as a counterbalancing electricity consumption) are covered by CBAM, as the driver to the deterioration of the balance of trade (see emission intensity of such consumption is only a share Figure A3.1). Figure A3.1: Decomposition of GDP impacts in 2035 2.5% Absolute deviation from baseline GDP (%) 2.0% 1.5% 1.0% 0.5% 0.0% -0.5% -1.0% -1.5% -2.0% -2.5% CBAM CBAM + Scope 2 CBAM + Scope 2, Carbon pricing + R&D all EU ETS sectors investments Investment Public consumption Private consumption Exports Imports GDP • 61 SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH BACK TO CONTENTS If Serbia imposes a carbon price in line with the pricing and excise duties range between 0.6 and 1.4 EU model, this will have limited macroeconomic percent of Baseline GDP in the 2025-2050 period. impacts on economic growth while driving Redirecting revenues to investment in R&D and significant emissions reductions. Compared to training can increase the total factor productivity of CBAM (3-5 percent emissions reduction), a domestic the Serbian production processes, depending on the carbon price would result in 40 percent emissions availability of human capital, leading to a small but reductions by 2035 as it sends a more ambitious signal positive impact on GDP (up to 0.12 percent by 2045). across the economy to increase efficiency and shift These investments increase demand for services that from carbon-intensive production. Carbon pricing is are almost exclusively delivered by the domestic market found to have a limited impact on the economic growth while enhancing knowledge growth. of Serbia, reducing annual growth rates by less than 0.1 percentage points in the entire 2025-2050 period and Using revenue to reduce distorting payroll taxes even bringing positive effects in the short or long-term was also modeled, leading to slightly adverse depending on the revenue recycling approach (see next impacts on GDP in the long run. Reducing payroll section). By 2035, GDP impacts from a carbon price taxes can have positive employment and GDP are a result of declines in exports, investments, and implications (+0.28 percent compared to baseline by private consumption from the higher cost of carbon- 2030) in the short term. This reduces the cost of labor intensive products and production processes. and Serbian products become more competitive while the increasing demand for labor increases household A3.3 Alternative revenue use: income. In 2035 and beyond, GDP impacts of carbon pricing could become slightly negative under this R&D investments and payroll tax revenue use option (-0.28 percent), driven by the loss in competitiveness as the model assumes Serbia is reduction the only country in the region increasing its climate The macroeconomic cost of domestic carbon policy ambition. However, given the need for countries pricing will depend on the use of revenues; to increase the ambition of their NDCs every five years – impacts could be more adverse than presented and the pressure of CBAM and external green transition above in the absence of productivity boosting drivers – this will likely not be the case. ■ revenue investment. Fiscal revenues from carbon 62 • • 63 Annex 4. SWOT Analyses of Key Reform Areas for Greener and More Resilient Growth This annex provides an overview of the strengths, IFIs active in Serbia. They do not provide an in-depth weaknesses, opportunities, and threats (SWOT) analysis but are meant to give an overview of the key related to the transition to greener and more challenges and opportunities in the respective sectors. resilient growth in key reform areas of the Serbian economy. The reform areas that have been analyzed A4.1 Waste and Circular Economy include waste and circular economy, air pollution, The Serbian government has identified municipal water, and energy efficiency. Climate action is also solid waste as one of the critical local environmental included as a cross-cutting reform area that influences challenges in Serbia. The lack of waste treatment and the other four areas. All areas are considered priority disposal infrastructure generates serious environmental areas for the Serbian government and are likely to have problems in terms of pollution of air, soil and rivers, reform actions ready in the next year or so. Detailed with impacts throughout the region. The transition to narratives have been developed for each area from a green economy in Serbia will thus require significant which the SWOT analyses have been extracted for improvements in waste management as well as this report. These SWOT analyses are intended to intensified efforts towards the circular use of products give a broad overview of each reform area and to and materials. Serbia is committed to this path through give background information regarding the basis for the Sofia Declaration, which, among others, calls for the policy conclusions included in the main part of the the development of circular economy strategies and document. The SWOT analyses are based on a review further progress in the construction and maintenance of policy and analytical documents, complemented by of waste management infrastructure. inputs from experts from relevant World Bank Global Practices and from external sources, including other 64 • BACK TO CONTENTS SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH Table A4.1: SWOT analysis for the Serbian waste sector and circular economy Strengths Weaknesses Solid waste is identified as one of the Implementation of existing laws remains poor three critical challenges to environmental Insufficient monitoring and enforcement sustainability Economic instruments not yet implemented Primary legislation is largely in place and policy is under development Low levels of penalties Good level of alignment with the EU Low tariffs for waste collection and lack of interest from local decision acquis makers to increase them jeopardizing the financial viability of sanitary landfills New Waste Management Program 2022–2031 adopted No earmarking or transparency on the use of waste collection fees Waste Management Law in place Previous Waste Management Strategy 2010–2019 not fully implemented First CE Roadmap in the region Low institutional/administrative capacity both at the central and local level New CE Development Program Limited capacities of the waste management department at MoEP 2022–2024 forthcoming Limited capacity of Serbian Environmental Protection Agency and Recognition of environmental protection environmental inspectorates and circular economy in Serbia’s Industrial Lack of capacities for planning, tendering and implementation Policy Strategy as a source of new of complex investments industrial growth Low investment in waste reduction, separation and recycling PPP framework operational Insufficient cooperation between national and local level Difficulties in cooperation between local self-governments Low level of implementation of regional landfill agreements and inter-municipal cooperation Data reporting and management Opportunities Threats EU accession perspective Weak overall agenda for environmental reform Opening of Chapter 27 negotiations in Delays in the adoption of regulations and policy documents December 2021 Slow and inconsistent procedures CE is a key pillar of the EGD and the Illegal practices, e.g., landfilling Green Agenda for the Western Balkans Lack of MSW treatment and disposal infrastructure Action Plan for Administrative Capacity Development submitted to EU Limited alternative sources of funding and underdeveloped financial markets EU funding Lack of awareness, particularly regarding waste management and Funding support from donors opportunities to use waste as a raw material in industrial processes High economy-wide investment activity Industrial production is predominantly based on outdated technologies, and FDI inflow characterized by a high generation of waste per unit of output Competitiveness of Serbian industry through the application of new business models Downward trend in the total amount of waste and a slightly upward trend in recycling in urban settlements Construction of regional landfills pursuant to the Waste Management Strategy Signed financing agreements for loans from CEB and China • 65 SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH BACK TO CONTENTS A key strength of the Serbian waste sector is the Green Agenda for the Western Balkans provides rich and expanding body of (primary) legislation. opportunities for EU and donor finance. Improved In January 2022, the Serbian government adopted a waste management and the circular economy are new Waste Management Program 2022-2031, which key elements of the Green Agenda for the Western creates a strategic basis for the implementation of Balkans and are also at the center of EU finance in the investment measures over the next 10 years – such as programming period 2021-2027. This is an opportunity the setting up of modern regional waste management in terms of funding from the EU, donors and – inter centers across the country – as well as the introduction alia through leverage effects – from the private sector. of various economic and other instruments that will Another opportunity is the opening of Chapter 27 on the incentivize the separation of different waste streams, environment and climate change under the EU accession recycling and a general shift towards the circular negotiations. This will provide for further alignment of economy. The legal basis of the new program is Serbian waste legislation with the EU acquis. the Law on Waste Management, passed in 2009. In addition, Serbia was the first country in the Western However, there are many threats to the improvement Balkans to have developed a Roadmap for Circular of waste management in Serbia, including Economy in 2020. This more general strategy is being awareness and political momentum. Many economic complemented by a forthcoming Circular Economy actors in Serbia, including from industry, still lack Development Program 2022-2024 together with awareness and basic knowledge about the benefits of an associated Action Plan, which will set concrete waste management and circular business models. On objectives and identifies measures for the three years the larger scale, this translates into the environment covered by the program. agenda playing a subordinate role on the political level. The sluggish adoption of policy documents affecting the Despite the political will expressed in various waste sector are just one manifestation of this. Perhaps strategies, a major weakness is the poor related to the lack of awareness is the widespread implementation and enforcement of existing practice of illegal landfilling and the general absence strategies and laws. For example, the new waste in monitoring and enforcement. Without addressing management program recognizes that the previous illegal practices in the waste sector, it is unlikely that strategy (2010-2019) did not fully achieve goals new waste management strategies will be successful. related waste collection, separation and recycling, the construction of infrastructure and the termination of waste disposal to unsanitary landfills, as well as the A4.2 Air Quality application of economic instruments and more generally Air quality is a major health concern in Serbia, the establishment of a sustainable waste management causing thousands of premature deaths and system. Part of the reason is that Serbia faces major enormous costs to the economy. It is a multi-sectoral institutional challenges to improve waste management. challenge, with the energy sector as the main contributor. The lack of capacities for planning, tendering and The emissions from the energy sector result mainly from implementation of complex investment projects is also lignite coal power plants and in the residential sector, an obstacle for much needed investments in the waste mainly from residential solid biofuel burning (e.g., heating sector. An additional weakness of the existing legislative with wood). Notable, also fuel oil plays a role in the framework is the low level of economic incentives for heating sector and can be locally an important source, environmentally friendly behavior and inadequate as in Belgrade where it contributes to 38 percent to PM2.5 penalties for illegal practices. This is recognized by concentration. Other key sources of air pollution include the new Waste Management Program 2022-2031 but vehicle exhaust (especially nitrous oxide emissions), requires urgent action to induce change. industrial emissions, resuspended dust, and agricultural clearing fires. Although air pollution is one of the leading The EU accession perspective and the clear environmental problems in Serbia, more work needs to commitment of the Serbian government to the be done to lay the groundwork for further policy steps. 66 • BACK TO CONTENTS SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH Table A4.2: SWOT Analysis for Air Quality Management in Serbia Strengths Weaknesses Air quality is acknowledged by the government No up-to-date air quality laws exist as one of the critical challenges to environmental Lack of sufficient staffing of Serbia Environmental sustainability. Agency Huge public support for addressing air pollution Legislation and bylaws do not recognize emissions Primary legislation is largely in place from individual household heating as a major source Good level of alignment with the EU acquis Non-existent or insufficient capacity of LSGs to treat First air quality plans on city level (Belgrade, Nis) air quality issues National Plan for the Reduction of the Main Pollutant Emission inventories and air quality monitoring Emissions from Old Large Combustion Plants Technical robustness of air quality plans backed by (NERP) adopted in 2020 implementation mechanism and financing Emissions of air pollutants from operators operating under national jurisdiction Insufficient allocation of budget for cleaner air. Opportunities Threats National Air Protection Program (NAPP) to be Weak overall agenda for environmental reform adopted in 2022 Commercial and foreign investment interests are Alignment between draft NAPP and the draft low given priority over the environmental agenda carbon development strategy Lack of regional cooperation to address Plans to adopt a new law on air quality in 2023/24 transboundary air pollution National goal of EU accession Lack of government support, including financing, for EU grant financing implementing the NAPP Air quality is a key pillar of the EGD and the Green Agenda for the Western Balkans Engagement with IFIs keen to support air quality management • 67 SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH BACK TO CONTENTS A strength of legislation on air pollution in Serbia NAPP shall be followed by the planned new law on air is that the primary legislation is largely in place quality to be adopted in 2023/24. These measures can and mostly aligned with the EU acquis. One of the be supported by EU grant financing and the engagement major sources of air pollution – electricity production of IFIs since air quality is a key pillar of the EGD and in old large power plants – is targeted by the National the Green Agenda of the Western Balkans. Plan for the Reduction of the Main Pollutant Emissions from Old Large Combustion Plants (NERP). Also, on However, there are multiple threats to these the city level, first air quality plans exist, like in Belgrade opportunities, especially the inadequate political and Nis. Another strength is the huge public support for momentum to address air pollution. This is addressing air pollution. It is also acknowledged as one expressed by the lack of funding for the implementation of the critical challenges to environmental sustainability of the NAPP and the priority of commercial and foreign by the government. investment interests over the environmental agenda. Additionally, there is a lack of regional cooperation to Although Serbia’s legislation is mostly in line address transboundary air pollution, which is also not with the EU acquis, there is a great weakness in mentioned in the NAPP. updating the laws to current EU guidelines, with the Law on Air Protection dating back to 2013 and no corresponding air protection strategy. This is A4.3 Climate Action accompanied by a lack of funding in the sector resulting Serbia is one of the countries most affected by in a lack of staffing of the Serbia Environmental climate change worldwide, which has massive Agency as well as insufficient emission inventories and effects on people, the environment and the monitoring. This is also true on the local level — the economy. Currently, Serbia faces wide-ranging and technical robustness of the existing air quality plans on grave climate change impacts, inter alia, on water the city level is backed by implementation mechanisms availability and quality, biodiversity, human health and and financing, as well as a lack of capacity of the local health of ecosystems (including forestry). These will governments to treat air quality issues. continue to pose a significant risk to practically all sectors of the economy, yet, with higher frequency and The National Air Protection Program to be adopted severity of extreme weather events, some sectors will be in 2022 presents an opportunity to get air quality more exposed and vulnerable to the effects of climate regulations up to date. While the NERP includes only change than others. According to the first Intended old, large power plants, the NAPP targets small power Nationally Determined Contribution of Serbia submitted plants, industry, transport and agriculture. The strategy to the UNFCCC in 2017, the most vulnerable sectors of is aligned with the (draft) low-carbon development the country are agriculture, hydrology, forestry, as well strategy proving a holistic and cross-cutting approach as human health and biodiversity. to air quality management and climate mitigation. The 68 • BACK TO CONTENTS SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH Table A4.3: Analysis for Climate Action in Serbia Strengths Weaknesses Commitment of the government to a green agenda and Carbon-intense economy and the country´s heavy reliance climate action on coal National Council on Climate Change (NCCC) Lack of clear leadership: in case of mitigation, more Member of Energy Community influence on the side of the Ministry of Mining and Energy than the Ministry of Environmental Protection; in case of Some progress in alignment with EU acquis adaptation, strong influence on the side of the Ministry of Adoption of Law on Climate Change in March 2021 Agriculture, Forestry and Water Management Adoption of Law on Use of Renewable Energy Sources in Insufficient coordination and cooperation between April 2021 ministries and between national and local level Low Carbon Development Strategy prepared in 2020, Delays in the adoption of regulations and policy documents setting an ambitious target to reduce GHG emissions by Secondary legislation lacking to enable full implementation 33.3 percent in 2030 compared to 1990 level Poor enforcement due to lack of capacities Several other important laws and programs have been approved in recent years: Slow development of key policy documents, including NECP, NDC and Adaptation Strategy • Adoption of the National Emission Reduction Plan (NERP) in 2020, in view of complying with the EU Limited progress on EU Chapter 27 as indicated in the Large Combustion Plants Directive 2021 EU Progress Report • Sustainable Urban Development Strategy (June 2019, No set coal phase-out date Action Plan adopted in April 2021), Pending alignment of legislation on monitoring, reporting • Nature Protection Program 2021-23 (May 2021). and verification of GHG emissions in line with the EU emissions trading system and effort-sharing regulation Nature-based solutions (NbS) are not explicitly mentioned in the current draft of the NDC Opportunities Threats Funding support from donors The pace of policy changes in the EU is higher than the EU accession perspective, EU funding transposition process Further alignment with EU acquis will enhance climate Lack of administrative, institutional and technical capacity mitigation and adaptation efforts at central and local levels Action Plan for Administrative Capacity Development Lack of awareness and the level of overall understanding submitted to EU of links between climate change, its impacts, development of sectors and solutions to tackle it among wide population Suspension of activities to build a new thermal power plant (Kolubara B) in May 2021 Insufficient information and capacity of different stakeholders Implementation of NbS for climate change can gain further support from international funds Insufficient involvement of local governments Work is delayed but ongoing with respect to: Plans for additional thermal power plans • Update of the Nationally Determined Contribution Companies, especially MSMEs face a lack of funding, (NDC) to the Paris Agreement, skills and information on green technologies, as well as complex legal requirements • National Energy and Climate Plan (NECP), Companies receive insufficient support from commercial • National Adaptation Plan (NAP), banks • National Air Protection Plan (NAPP). Insufficiently developed capital markets Increasing demand for green finance Migration of skilled labor force Increase in costs of electricity and energy can lead to energy poverty • 69 SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH BACK TO CONTENTS A key strength of Serbia in addressing climate risks an opportunity in terms of funding from the EU, donors is its repeated commitment to the green agenda and – among others, through leverage effects – from and climate action through numerous international the private sector. Another opportunity is the opening and European agreements. On the international level, of Chapter 27 on the environment and climate change Serbia is committed to implementing Agenda 2030, under the EU accession negotiations. This will provide including the Sustainable Development Goals (SDGs), for further alignment of Serbian climate and energy and also ratified the Paris Agreement on Climate legislation with the EU acquis. Change. On the EU level, Serbia is committed to the EU’s ambition to become carbon neutral by mid-century Capacity constraints of public institutions are a through the Green Agenda for the Western Balkans. key threat to the improvement of environmental With the adoption of the Law on Climate Change and management in Serbia. The problem of persisting the Law on Use of Renewable Energy Sources, the environmental and climate risks is strongly linked to country has progressed alignment with the EU acquis. weak institutions. The institutional problem stems from This shows that the government is aware of the risks three major issues – a gap in human resources (quality associated with climate change and the highly energy and quantity), a lack of cooperation and coordination and carbon-intensive Serbian economy. However, the across institutions and levels of government, and poor success of these policies depends on the speed and accountability. The lack of capacities for planning, quality of their implementation through the necessary tendering and implementation of complex investment by-laws. projects is also an obstacle for much needed climate investments. On a positive note, Serbia has made bold Despite some advancement on the strategic level, commitments to enhance capacity in the Action Plan for key weaknesses are Serbia’s slow alignment with Administrative Capacity Development submitted to the the EU acquis and repeated delays in the adoption EU as part of Chapter 27 negotiations. This Action Plan and implementation of key policy documents. recognizes the need to strengthen capacity not only Despite the political will expressed in various strategies through more personnel and training but also through and public statements, significant delays in the adoption organizational and structural improvements. of key regulations and policy documents are a major weakness for tackling climate change and for guiding There are also other threats to effective climate private investment towards the green transition. In the action in Serbia, including a lack of public awareness absence of an ambitious NECP, for example, Serbia’s and inadequate green finance. According to the 2021 climate policy remains unaligned with the EU’s climate Balkan Public Barometer, 81 percent of the Serbian neutrality aspirations. However, the slow development population considers climate change to be a very serious and adoption of crucial strategic documents is also or somewhat serious problem. Yet, there remains a evident in other areas, including Serbia’s LCDS, its persistent lack of awareness among economic actors updated NDC and the National Adaptation Plan. Without and the wider population regarding the links between these key strategic documents and related objectives climate change, its impacts, economic development and and targets, Serbia’s decarbonization and adaptation the solutions aimed at mitigating GHG emissions and path is uncertain, and the country remains a carbon- adapting to climate impacts. This hinders the integration of intensive economy heavily reliant on coal. effective climate action in public, economic and private life. Another obstacle is the limited access to green finance, The EU accession perspective and the clear particularly among SMEs. One reason for this is the lack commitment of the Serbian government to the of support from commercial banks, for example, by asking Green Agenda for the Western Balkans provides for significant collateral on unfavorable terms. Similarly, opportunities for EU and donor finance. Climate regarding the regulatory environment, the lack of a and energy are key elements of the Green Agenda for functioning fiscal/financial framework does not incentivize the Western Balkans and are also at the center of EU the private sector to reduce its environmental footprint. finance in the programming period 2021-2027. This is 70 • BACK TO CONTENTS SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH A4.4 Water Water-related challenges in Serbia are manifold, well as water-related risks like floods and droughts but wastewater management is a government in the context of climate change. The fact that the priority. Critical challenges include significant gaps government has identified wastewater management in wastewater management and sanitation, related as one of three critical local environmental challenges freshwater pollution, remaining issues regarding in Serbia promises intensified action and improvements drinking water quality and excessive water losses, as in the future. Table A4.4: SWOT Analysis for the Water Sector in Serbia Strengths Weaknesses Water Management Strategy until 2034 Access to safely managed sanitation services is below regional standards Action Plan for the Implementation of the Only around 18 percent of the wastewater is treated in wastewater treatment Water Management facilities Strategy for the period 2021 – 2023 Degraded quality of water bodies and limited water conservation mechanisms Overall sufficient availability of water resources Inadequate quality of drinking water in some areas Relatively high access rate to water supply Underdevelopment of the state of utility services According to the Water Exploitation Index, Inadequate investment & rather insufficient maintenance of water infrastructure with Serbia is in a safe zone in terms of water a high level of water losses of around 41 percent stress Low water use efficiency in the economy, low water recycling and reuse levels Possibilities for funding from the EU for Low institutional capacity and complex administrative procedures modernizations of water networks and water treatment facilities Fragmentation of institutions and their responsibilities and underfunding Wastewater treatment is an environmental Lack of effective planning instruments for river basin and flood risk management policy priority of the Serbian government Opportunities Threats A new Water Law is under preparation and is planned to be adopted by the Climate change impacts end of 2022 Weak overall agenda for environmental reform Further by-laws to be developed and adopted afterwards Water pollution is primarily due to outdated technology, Clear responsibilities of water-sector related institutions have the potential lacking storage and disposal of by-products, lack of to improve the effectiveness of sector regulation and policy pollution abatement installations, untreated wastewater, Water and wastewater services sector can be a driver of the promotion of drainage water from agriculture, leachate from landfills, greener circular economy - tapping into the potential of treated wastewater and pollution linked to river navigation (e.g. improving the management of sludge) Discharge of the untreated wastewaters into the water The implementation of EU environmental standards, through Chapter 27, bodies will provide an opportunity to develop a water and wastewater management The small amount of surface water formed on the framework national territory that decreases over time New legislation can be a driver for investments in water quality and ease of Reduced amount of water as a result of climate change access, particularly for commercial and industrial sectors and higher competition for water resources EU funding to support the building of the wastewater treatment plants The impacts of climate change on water quality and Funding from other multilateral development banks and development availability can affect many sectors partners High spatial and temporal unevenness of the water Potential to reduce organic pollution of the national surface water bodies by regime putting in place at least biological treatment technology Highly flood-prone areas First River Basin and Flood Risk Management Plans according to EU Transboundary water cooperation is often a politically standards are under preparation, bringing along the opportunity for an sensitive issue integrated approach to water management • 71 SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH BACK TO CONTENTS Key strengths of the Serbian water sector are Importantly, Serbia has fragmented responsibility the richness of water resources and generally for the water sector and institutional capacities comprehensive legislation. Serbia is relatively rich in need to be strengthened. Serbia lacks coordination water resources and not considered as water stressed, between institutions and single ministry responsibility although with a high dependency on water resources for the water sector. Five main ministries constitute originating from outside its territory. The legal basis for the national institutional framework of the water sector, water management and water protection is the Water sometimes with overlapping mandates. Unlike most of Law and its bylaws. It determines the legal status of the countries in the region, Serbia has no independent water, water facilities and water land management, water regulatory agency. In addition, improving local as well as the way and sources of financing water governance and strengthening capacities, in particular activities. In addition, the Water Management Strategy for operating and maintaining water and wastewater until 2034 is a planning document indicating the long- facilities, remains a priority. Increased transparency term direction of water management in Serbia. To put on planning, selecting and managing environmental the Water Management Strategy into practice, Serbia investments will ensure better adherence to EU laws developed its first Action Plan for the Implementation and standards in this sector and better value for money. of the Water Management Strategy for the period 2021 – 2023. The new Water Law, currently under preparation, should provide a more effective framework for However, the water sector remains characterized water management, water regulation, protection by poor sustainability of service provision, lack and control of waters in Serbia, and further of investments, lack of capacities, fragmented alignment with EU water legislation. In order to sector organization, and the regulation of services. deal with the above outlined issues, the Government Sector financing is inadequate mainly because water is in the process of the preparation of a new Water and wastewater tariffs barely cover operation and Law. A draft for the new law has been prepared and maintenance costs. Reaching adequate water fees and is planned for adoption after the internal negotiation tariffs is still an unaccomplished objective. As a result, and consultation process by the end of 2022. Further subsidies from the national/local budget are sometimes by-laws are planned to be adopted in the following still necessary to supplement tariffs to cover operation years. In addition, the first River Basin and Flood Risk costs of utilities, as well as most of investments, which Management Plans, according to EU standards, are are mainly funded by international grants and loans. under preparation, bringing along the opportunity for Non-compliance with drinking water quality standards an integrated approach to water management. remains a big concern in some areas, such as those where arsenic is present. Untreated sewage and Climate change is a major threat to the water sector. wastewaters are still the main sources of water pollution Even though Serbia is currently not experiencing water and a serious issue even for the country's capital. stress, a high spatial and temporal unevenness of the Serbia should address river pollution more rigorously by water regime might affect water availability in the future. focusing on the development of wastewater treatment Coupled with climate change effects, rising demand for facilities and reduction of nutrient runoffs from agriculture. water by many segments of the economy and higher Work on the river basin management plan for the period competition for water resources might exacerbate the 2021-2027 is progressing, although slowly, with gaps above-mentioned trend. Due to the high dependency of which will need to be closed stepwise in upcoming Serbia on water resources originating from outside its iterations and updates. Similarly, limited progress has territory, transboundary cooperation is gaining further been achieved as regards the development of flood importance in the context of climate change. risk management plans which will need to be further strengthened in future updates, and an ambitious but realistic program of measures to be implemented to increase the country’s resilience. 72 • BACK TO CONTENTS SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH A4.5 Energy Efficiency Energy efficiency is one of the key instruments for total final energy consumption has been declining over fueling Serbia’s economic growth while meeting the last few years, and the residential sector remains GHG reduction objectives. The International Energy the main consumer. The investments required to Agency (IEA) considers energy efficiency to be the ‘first improve the energy efficiency of Serbian buildings are fuel’ as it represents the cleanest and, in most cases, significant, but they are estimated to result in sizeable the cheapest way to meet a country’s energy needs. It benefits. Potentials are largest in the residential sector, is thus a key element of the green transition. Serbia’s particularly in single-family houses. Table A4.5: SWOT Analysis for Energy Efficiency in Serbia Strengths Weaknesses Implementation of EU legislation in the energy Insufficient human capacity in the line ministry and local authorities; the efficiency sector is well advanced new EEA is not fully staffed yet New Law on Energy Efficiency approved, and its No concrete targets, as NECP and updated Energy Sector Strategy are not ‘operationalization’ through secondary legislation is adopted yet ongoing Lack of effective monitoring and evaluation system Energy Efficiency Administration was established in Serbian enterprises and households lack awareness of possible energy the Ministry of Mining and Energy (MoME) with the savings and available measures to reduce their consumption mandate to support the clean energy transition People perceive higher-quality energy-efficient installations as being A new support mechanism for energy efficiency in expensive. the residential sector has been piloted (public calls implemented by MoME and Local self-governments). Delays in the adoption of regulations, including: • regulations for the calculation of energy performance in buildings and certification • ecodesign regulations/minimum energy efficiency requirements for key energy consuming products in the residential sector • technical documentation for buildings Underdeveloped ESCO market Industrial production is predominantly based on outdated energy-intensive technologies Opportunities Threats Significant energy savings potential in most sectors, Implementation and enforcement of existing laws remain poor, e.g., roll-out especially in buildings of consumption-based billing in district heating is incomplete Prospects of improving the competitiveness of Serbian Low energy prices discourage investment in energy efficiency and mean industry through energy and resource efficiency higher payback periods Mitigation of energy price increases in the residential Affordability issue: low financial capacity of a significant part of the Serbian sector thanks to energy efficiency investments population EU accession perspective Absence of a sustainable and effective financing system (donor funding is not sufficient to cover all investment needs) Opening of Chapter 15 negotiations on Energy in December 2021. Difficult access to commercial financing for lower-income households and homeowners’ associations (HOAs) Funding support from the EU and other donors for both investment and technical assistance Difficult decision-making in HOAs for the renovation of multi-apartment buildings High economy-wide investment activity and FDI inflow Grey economy, which is common for investment in home renovations, Energy Efficiency is integrated into the climate pillar reduces tax revenues for the government and results in poorer quality of the EGD and the Green Agenda for the Western interventions. Balkans Source: World Bank, based on policy documents and literature review. • 73 SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH BACK TO CONTENTS The key strength of the Serbian energy efficiency competitiveness of Serbian industry and would sector is related to the recent improvements in the enable mitigation of future energy price increases legal, regulatory and institutional framework. The in the residential sector thanks to reduced energy new Law on Energy Efficiency improves the legal basis consumption. for energy efficiency improvements in all sectors and establishes a new Energy Efficiency Administration to Yet, these opportunities are hindered by several implement national energy efficiency (EE) programs. factors, including poor implementation of A new support mechanism for Energy efficiency in the legislation, low energy prices, affordability residential sector, which was piloted in 2021, is being concerns, and limited access to financing. The enhanced and scaled up. slow roll-out of consumption-based billing in district heating (that can stimulate energy savings) is just one Several barriers deter further progress in increasing example of poor implementation and enforcement of energy efficiency in Serbia. These include weak the adopted legislation. Relatively low energy prices institutional capacity (especially at the local level), a reduce incentives for investing in Energy efficiency. lack of specific EE targets and an effective monitoring At the same time, even at current prices, energy and evaluation system, missing rules and regulations poverty is a growing concern: even before the war in for some sub-sectors, low awareness of energy Ukraine, households spend about 9 percent of their efficiency opportunities, and underdeveloped energy total budget on space and water heating, which makes services market. them vulnerable to changes in the price of the energy products used for heating. Low-income households Serbia’s EU accession perspective provides an have fewer resources available to finance Energy opportunity in terms of potential funding support efficiency investments and find it more difficult to from the EU and other donors. Supported by donor- access financing due to their lower creditworthiness funded investments and technical assistance, Serbia and missing collaterals. Available funds from public is well-equipped to grasp the large energy efficiency sources (national and municipal budgets) are very potential in all sectors of the economy. Apart from limited, donor-funded programs are not sufficient to the environmental and climate change benefits, cover all investment needs, and sustainable (revolving) enhanced Energy efficiency would result in improved financial mechanisms are missing. ■ 74 • • 75 Annex 5. Performance Assessment of Public Environmental and Climate Institutions in Serbia: Focus on Addressing Air Pollution and GHG Emissions from the Energy Sector A strong institutional framework and related development, environmental and climate objectives capacities are essential complements to credible will require not only coherent policy incentives and and effective policies to support the green and just measures, but also strong institutional and governance transition. As noted in the Action Plan for Administrative frameworks to enable their implementation. Further Capacity Development (APACD) submitted to the EU as recommendations for strengthening institutional part of Chapter 27, a significant gap remains in terms of framework in Serbia which can actively support public the staffing needs that the government plans to fill. In order policies, regulations and future market mechanisms to help prepare institutions for the challenges related to and investments that will be critical for fostering the green transition, the analysis of the performance sustainability and green growth going forward are as of institutions at both national and subnational levels follows. – limited to selected exemplary municipalities – in the areas of air pollution and climate change mitigation was Serbia has the means to focus more on addressing conducted.65 A summary of the analysis (which includes some of the key institutional weaknesses for the overview of the regulatory framework and its gaps, undertaking effective green action across sectors. as well as the institutional framework itself and related As an upper middle-income country with numerous close capacities that are limiting the investments in the areas links to highly developed countries in its neighborhood, of air quality and climate change mitigation) is included tertiary education levels are relatively high, giving policy in the box below. makers a potential pool of talent to draw on. As such, human capital is one of the major assets in Serbia The analysis shows that even though Serbia has that needs to be further utilized. Hence strengthening made significant progress in recent years, it still the institutional framework presents an opportunity to needs to strengthen the institutional framework create new job positions for dedicated professionals to flexibly pursue the policy reform agenda interested to work in the public sector. that support a green transition. Meeting multiple Regulatory Framework: There are significant gaps in strategic orientation with key pieces of draft public policy not enacted yet. Primary legislation development is well advanced with a high level of alignment with the EU acquis. However, development of the secondary legislation is still ongoing and presents a barrier for implementation. In general, the implementation and enforcement of regulations are lagging due to insufficient capacities and weak enforcement mechanisms. Institutional Framework: The division of responsibilities in the institutional framework is clear. However, the involvement of several ministries leads to fragmentation of scarce capacities and requires additional coordination efforts. In the case of the energy and agriculture sectors, the need for integration of climate change in sector policies was recognized and structures dealing with the topic of climate change were included in their institutional set-up. In terms of capacities, there are significant gaps at MoEP, operating with barely 50% occupied positions compared to the work force plan. The efficiency of the system is further limited by the centralized decision making and the lack of managerial accountability on lower administration levels. Likewise, even though the roles and responsibilities of the LSGs are critical in case of air quality, as well as in the implementation of climate change mitigation measures in the energy sector, their effectiveness is hampered by insufficient capacities, estimated at less than one third of what is recommended in APACD. Investments: The regulatory framework is aimed at enabling, but not driving investments. Overall positive trend in increasing investments is driven mainly by the financial support in the form of grants. National financing is insufficient and there is significant dependency on international donors and financing institutions. The level of investments is also limited by insufficient institutional capacities in the public sector institutions. Furthermore, there are no sustainable financing mechanisms for air pollution or GHG emission reduction. The mechanism of PPP for attracting private sector financing is equally underused. 76 • BACK TO CONTENTS SUPPORTING SERBIA’S TRANSITION TO GREENER AND MORE RESILIENT GROWTH The mechanisms for monitoring and enforcement be catalysts for green growth solutions. Based on the also need to be reinforced as a prerequisite Law on Air Quality, local governments have several for effective and systematic implementation of responsibilities, including preparation of the Air Quality policies and regulations. Poor enforcement is often Plan, establishment and operation of the local network the result of weak regulations (that set the system for air quality monitoring, regular reporting on collected of penalties and controls), but also of an inadequate data to SEPA, and enactment of short-term action plans, institutional capacity. In most cases, the penalty levels amongst others. However, even with a decentralized are quite low, while the capacities for the inspection and prescriptive regulatory framework, there are several are equally insufficient both at the national and local institutional challenges that hinder its implementation, levels. Based on APACD, the inspection capacities including the weak or insufficient capacities at the local need to be increased by 28 positions in MoEP, 17 level and the lack of communication and coordination positions in the Ministry of Agriculture, Forestry and with the national level. Water Management (MoAFWM), 12 positions in the Ministry of Health, more than 60 positions in the Serbia also needs to consider the introduction Ministry of Interior, and 24 positions at the Provincial of new policy reforms and measures, which will level. The capacities of inspection on the local level have an impact on the institutional frameworks are also insufficient. Based on the annual report of needed for their implementation. For example, the environmental protection inspection for 2017, in 11 out introduction of the CBAM will require an increase in of 145 local self-governments, there are no inspectors. SEPA’s capacity, both in terms of quantity and quality, or some other collaborative arrangements will have Given the nature of climate change and air to be pursued with technical institutions. Likewise, quality, there is room to strengthen multi- should Serbia pursue environmental fiscal reforms, sectoral coordination, which is necessary for the the institutional framework would have to be adapted, implementation of sector policies and programs. such as in the area of administering financial support An effort in this direction has been made through the schemes, calculation of fee levels to be paid (including establishment of the National Climate Change Council through improved IT systems), and ensuring polluters’ (NCCC) under the 2021 Law on Climate Change. NCCC reporting on their emissions, amongst others. needs to have a clear policy coordination mandate and be placed under adequately high level of government Serbian institutions need to be made more effective oversight (e.g. the Prime Minister’s Office). This would in facilitating investments in measures that are also allow to embed the green agenda across sectoral already identified in government strategies and strategies and plans, help scale-up policy making plans. While many measures requiring investments and implementation, and provide opportunities for in pollution reduction technology are not yet in place engagement with businesses and citizens. yet, the draft NAPP and the draft LCDS and Action Plan foresee several such measures that need to be The implementation of air pollution and climate put in place and will need institutional support. Going change mitigation policies and regulations forward, it will be important to ensure that policies which requires coordination not only on the national enable investments and strengthen market incentives for level but also between the ministries and the local green investments are complemented with appropriate level. Although the regulatory setting is not putting the institutional and capacity strengthening efforts. ■ local level as the key agents of change, with the right incentives and support, local governments too can • 77 78 •