Serbia Seen Holding Interest Rates on Fiscal Uncertainty, Dinar

Serbia’s central bank will probably leave its benchmark interest rate on hold for a second month as fiscal expansion, the slower inflow of funds and a weakening dinar limit room for a cut to aid economic growth.

The Belgrade-based Narodna Banka Srbije will keep its two- week repurchase rate at 9.5 percent when it meets tomorrow, according to 11 of 23 economists in a Bloomberg survey. Six predicted a quarter-point and two saw a half-point decrease. Four respondents expected an increase by 50 basis points.

Policy makers are weighing the domestic fiscal situation and Europe’s sovereign-debt crisis for future direction. The weakening dinar and declining capital inflows, along with fiscal expansion are taking away room for a rate cut made by slowing inflation, Bosko Zivkovic, the central bank’s advisory board chairman, said yesterday.

“We see the central bank leaving the two-week repo rate unchanged at 9.5 percent against heavy risk-off pressures,” Andrej Knez, an analyst at Hypo Alpe Adria bank in Zagreb, said in a report dated March 6 referring to investors turning away from Serbian assets and toward lower-risk securities.

Serbia is trying to avoid a second recession in three years, just months before the nation holds parliamentary elections. Gross domestic product expanded 0.8 percent in the last quarter of 2011 from a year earlier, compared with 3.7 percent at the beginning of last year.

Capital Inflows

The central bank, which cut its main rate by a total of 3 percentage points since last June to contain an economic slowdown triggered by Europe’s debt crisis, needs to pay special attention to slowing capital inflows. European Union banks, which control two-thirds of Serbia’s market, will probably reduce their funding in the Balkan country and its neighbors to meet end-June core Tier 1 capital requirements, Zivkovic said.

“Meeting those capital requirements will, at least temporarily, lead to a halt in funding inflows,” Zivkovic said, adding that no central bank in the region has the capacity to deal with a “sudden-stop” in capital inflows. “These circumstances leave no scope for monetary expansion,” he said.

The central bank and the International Monetary Fund see the economy expanding 0.5 percent this year as the crisis in Europe weakens demand for Serbian exports and its government debt, putting pressure on the dinar.

Dinar Losses

The currency has lost 4.3 percent against the euro in the past month to trade at 111.2285 at 10:48 a.m. in Belgrade, according to data compiled by Bloomberg, after hitting a record low 112 to the euro on Feb. 27. Analysts in the survey see the dinar stabilizing at 110 through April.

“Any further cuts would trigger additional depreciation of the dinar and that’s the bottom line,” Ljiljana Grubic, chief analyst with Raiffeisenbank AD in Belgrade, said in a phone interview today. “A lower benchmark interest rate won’t encourage dinar lending in an economy which is 80 percent euroized.”

The central bank has sold more than 200 million euros ($262.9 million) since the beginning of the year, to curb the declines triggered by investors’ concern that Serbia will continue to slip on fiscal targets ahead of the elections. Its wider fiscal deficit and spending in 2011 and 2012 led to a freeze in Serbia’s $1.3 billion precautionary loan program with the IMF.

Currency Sales

The bank will probably need to continue selling euros in the market only to smooth excessive daily volatility, which won’t stop the dinar trend, said Eldar Vakhitov, emerging market economist at the London-based Barclays Capital. An interest rate increase to halt the depreciation is still not an option as indicators point to low inflation and weak growth, he said.

The central bank targets inflation in a 2.5 percent to 5.5 percent band at the end of the year. Consumer-price growth slowed to 5.6 percent in January from 7 percent in December and weak domestic demand may push it below the lower end of the band by April, according to the bank’s quarterly inflation report.

Inflation may slow to 5.5 percent at the end of March and climb to 5.8 percent one year from now, according to the Bloomberg survey.

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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