Serb Rate Moves Hang on Fiscal Policies, Central Bank Says

Serbia’s central bank may consider raising interest rates if the government fails to reverse the trend of a widening budget deficit, Vice Governor Bojan Markovic said.

Political leaders need to form a government quickly following May 6 general elections and look to consolidate finances, the Belgrade-based Narodna Banka Srbije said in its quarterly inflation report, released today.

The Balkan country, trying to avoid a second recession in three years, needs to renew its loan program with the International Monetary Fund and cut the budget deficit from 6 percent of gross domestic product in the first quarter to help calm investors and stabilize financial markets.

The central bank’s assessment of a recent widening of the budget deficit is that it “is temporary” and if the gap “remains persistently high” monetary-policy makers may be forced to raise the benchmark interest rate, Markovic told reporters in presenting the report.

The bank left its two-week repurchase rate unchanged at 9.5 percent on May 10, for a fourth consecutive month, amid a weakening of the dinar. The currency dropped to 112.9078 at 1:07 p.m. in Belgrade, its lowest level in a decade.

Presidential Runoff

Serbia will hold the second round of presidential elections on May 20, pitting Democratic Party leader and incumbent Boris Tadic against Tomislav Nikolic, the leader of the opposition Progressive Party. The outcome may determine whether Serbia keeps striving for European Union membership under Tadic or turns east for political and economic ties under Nikolic’s leadership.

Tadic won the first round, while his party finished second in a concurrent parliamentary race, giving it six seats less than the Progressive Party’s 73 in the 250-member assembly. His Democrats have already agreed with the third-placed Socialist Party of former Serbian strongman Slobodan Milosevic to form a new government. They need a third partner to garner a 126-strong majority in parliament and have said talks will start after the presidential run-off.

If the government is not formed soon, Markovic said, the central bank “can certainly not wait for three months or so with its policy response.”

Renewing Loan

Renewing a $1.3 billion precautionary loan which the IMF suspended in February on evidence slippage on fiscal targets would be sufficient and Serbia probably wouldn’t need a more binding program “if it takes appropriate fiscal consolidation measures,” Markovic said.

Public debt rose to almost 47 percent of gross domestic product, breaching self-imposed fiscal rules that limit the fiscal gap at 4.5 percent of GDP and public debt at 45 percent.

Serbia’s economy contracted 1.3 percent in the first three months of 2012. The central bank sees the economy growing 0.5 percent this year. Growth may be more modest if the government tightens spending, according to the report.

The dinar has weakened 6.5 percent against the euro this year amid a lack of capital inflows, high energy imports due to freezing cold weather in February and after two big foreign investors, United States Steel Corp. (X) and Hellenic Telecommunications Organization SA (HTO) left the market earlier this year, Markovic said.

‘Temporary’ Weakness

The dinar weakness and a widening current account deficit have resulted in a 2 billion-euro ($2.55 billion) decline in official foreign-currency reserves in four months through April.

The bank has spent almost 770 million euros to slow the dinar’s declines because of the belief that “pressures on the dinar are only temporary.”

Inflation remains the least of all central bank worries even as the central bank sees inflation gradually “rising and reaching its peak in the first half of 2013, occasionally exceeding the upper end of the tolerance band,” Markovic said.

The consumer price index fell to a “lowest level since 1980” of only 2.7 percent in April or 12 percentage points below its April 2011 level, he said. The end-2012 inflation target is 4 percent, plus or minus 1.5 percentage points.

The inflation forecast is based on the assumption that economic output in the euro area, Serbia’s main investor and trading partner, will contract 0.5 percent in 2012 and grow 0.9 percent in 2013, with the European Central Bank keeping its main interest rate at 1 percent through the end of 2013.

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

To contact the editor responsible for this story: Balazs Penz at bpenz@bloomberg.net

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