Serbia Seen Holding Rates on Fiscal Expansion, Dinar Drop

Serbia’s central bank will probably leave its benchmark interest rate on hold for a third month to avoid further declines in the dinar even as key economic indicators point to the need of additional monetary easing.

The Belgrade-based Narodna Banka Srbije will keep its two- week repurchase rate at 9.5 percent when it meets tomorrow, according to 15 of 23 economists in a Bloomberg survey. Three see a need for a rate increase while five expect rate-setters to lower the cost of borrowing.

Serbia is trying to avoid a second recession in three years, just weeks before the nation votes for new president, parliament and local governments on May 6. The central bank cut its main rate by a total of 3 percentage points since last June to contain the economic slowdown triggered by Europe’s debt crisis.

“The exchange rate of the dinar remains unstable and any further rate cuts would translate into additional dinar depreciation pressures,” said Ljiljana Grubic, an analyst at the Belgrade-based Raiffeisen bank AD in Belgrade.

The outgoing government of Prime Minister Mirko Cvetkovic, seeking re-election, has already slipped on fiscal targets in the first two months of the year, leaving it up to the new cabinet to tighten spending, raise taxes, cut public sector payroll and overhaul the unprofitable pay-as-you-go pension fund.

Gross domestic product expanded 0.4 percent in the last quarter of 2011 from a year earlier, compared with 3 percent growth in the first quarter of 2011.

Market Interventions

Instead of a rate cut, which has little impact in an economy where more than 70 percent of all deposits and credits are euro-denominated, the central bank is likely to shift to other policy instruments, including “market interventions and changes in the reserve requirements” to stop the dinar from sinking lower “amid catastrophic fundamentals and a lack of credit activity,” Grubic said in a phone interview.

The National Bank of Serbia sold more than 500 million euros ($656.45 million) since the beginning of the year to curb the declines in the dinar, which is trading at close to 112 to the euro, its lowest in a decade.

The dinar has lost 4.11 percent against the euro since the start of this year and it will soon begin to push up inflation, which the central bank targets at 4 percent plus or minus 1.5 percentage points at the end of 2012, Grubic said.

The bank may still take advantage of the worsening GDP and output data, combined with a fairly low inflation of 4.9 percent at the end of February, to do another rate cut, Dusko Vasiljevic of the CEVES economic research institute said. The pressure on the dinar may be contained once the government completes its second Eurobond sale in two years, he added.

Eurobond Sale

Government officials will meet U.S. investors later this month, as part of a roadshow to present them plans for a new 10- year, dollar-denominated bond worth around 1 billion euros.

Stojan Stamenkovic, the chief macro-economist at the Belgrade-based Economics Institute, said industrial output declines in February did not bode well for the full-year economic output and may even signal the economy is plunging into recession just like many of its Western European trading partners and investors.

With a 13 percent contraction, mainly caused by disruptions in electricity supply and transport, Serbia’s industrial production was the lowest since 2000, Stamenkovic said at a news conference in Belgrade today. While monetary policy could do little to aid growth, policy makers should be wary of underlying price pressures after producer prices rose by 0.8 percent in February, the highest in 10 months.

Fiscal worries topped economists’ concerns about Serbia, as the country’s high fiscal gap, wider than the one agreed with the International Monetary Fund for 2012, led to a freeze in a $1.3 billion precautionary loan program with the lender.

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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