Serbia Has Potential to Cut Interest Rates, Central Bank Chief Soskic Says

Serbian central bank Governor Dejan Soskic said policy makers may be in a position to cut borrowing costs in the first half to help foster economic growth because inflation will continue to slow.

“We have a period in front of us where room for monetary policy relaxation will exist,” the head of the Belgrade-based Narodna Banka Srbije said in a Dec. 26 interview. There’s scope for more rate cuts at least in the “next six months.”

The central bank expects annual inflation to slow in the first quarter toward its target range for the end of 2012 of between 2.5 percent and 5.5 percent, from 8.1 percent in November. Serbia’s central bank lowered its benchmark two-week repurchase rate a quarter-point to 9.75 percent on Dec. 8 for the sixth time since June on concern Europe’s debt crisis will damp export demand and slow economic growth.

The rate cuts have resulted in a 5.24 percent decline in the dinar value against the euro since June, leaving it with a 3.3 percent cumulative year-to-date gains against Europe’s common currency, according to data compiled by Bloomberg.

The economy of Serbia, which is seeking to begin negotiations to join the European Union, is expected to grow 2 percent this year, less than an originally planned 2.5 percent, still exceeding the economies of its neighbors. Croatia, which will probably become an EU member in 2013, sees its economy growing 0.4 percent this year, while EU members Romania and Bulgaria expect growth of 1.5 percent and 1.9 percent respectively.

Budget Targets

Soskic said the targeted budget deficit of 140 billion dinars ($1.78 billion) in 2012, or 4.25 percent of gross domestic product, isn’t expansionary and won’t fuel inflation. The deficit target contained in the draft budget, agreed with the International Monetary Fund under a 1 billion-euro ($1.3 billion) precautionary loan program, is a quarter-point below the 4.5 percent limit imposed by fiscal rules.

An increase in risk premiums for borrowers like Serbia is a concern and Europe’s debt crisis could make it harder for Serbia to tap international markets for funds it needs to cover its deficit in 2012, Soskic said. An alternative to raising debt abroad would be to borrow both in dinars and euros on the local market, he added.

Serbia pays as much as 13 percent a year on 53-week borrowing in the local currency. Yields on its debut Eurobond, which the government sold in September with a 7.25 percent coupon, closed at 7.697 percent yesterday in Belgrade, according to data compiled by Bloomberg, more than the 6.39 percent yield on Georgia’s comparable 10-year bond and 6.20 percent on Latvia’s bond maturing in 2021.

Officials Warned

Soskic said he has warned the president and the prime minister of the risks to the economy as it heads toward general elections, adding that it’s important the country not sour investor sentiment even as it needs to borrow more than 5 billion euros next year for its deficit, pay old debt and build new infrastructure.

“Everyone should do their job” and prove “that Serbia is functioning as a relatively stable democracy where political cycles do not cause uncertainty in financial markets,” he said.

Opinion polls show the ruling Democratic Party led by President Boris Tadic trailing their main challenger, the opposition Serbian Progressive Party, by almost seven percentage points.

Prime Minister Mirko Cvetkovic and his cabinet started their term in July 2008, just months before the global crisis spilled over to Europe’s east and south, resulting in economic contraction, a decline in monthly incomes and a 6 percentage point increase in unemployment.

The ruling coalition of Democratic Party, Socialists and a dozen junior partners including the Pensioners Party, wants to call a vote for late April or early May, parliamentary Speaker Slavica Djukic-Dejanovic said yesterday.

“Serbia does not have much choice when it comes to future economic policy” regardless of whoever wins the election, Soskic said. Debt “must be brought under control but also the deficit.”

Monitoring Banks

The central bank is closely monitoring banks’ activities as their parent institutions prepare to raise core Tier 1 capital to 9 percent by mid-2012 to meet new capital requirements.

Soskic said the introduction of Basel II rules in Serbia as of end-2011, which requires some local banks to boost capital, will “counter-balance” the developments in the EU, which could lead to a drop in credit activity in countries like Serbia.

Banks have spent 300 million euros to boost capital since the start of 2011 and a further 90 million euros are planned, he said.

The central bank is “closely monitoring cash and capital flows” and has prepared measures to act if things go wrong, Soskic said, adding that Serbia still offers banks “room to further grow and develop, the potential that has been fairly exhausted in some of the neighboring markets,” because its financial intermediation measured by banks’ balance sheets stood at 78 percent of GDP and net credits at 50 percent of GDP.

To contact the reporter on this story: Gordana Filipovic in Belgrade at gfilipovic@bloomberg.net

To contact the editor responsible for this story: James M. Gomez at jagomez@bloomberg.net

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