Serbia Will Probably Raise Interest Rates to Support Dinar

Serbia’s central bank will probably increase its benchmark interest rate this week as it seeks to halt the decline of the dinar even as the economy slows.

The Belgrade-based Narodna Banka Srbije will raise its two-week repurchase rate on June 7 from the current 9.5 percent, according to 14 of 22 economists in a Bloomberg News survey. Eight expect the bank to keep borrowing costs unchanged.

The dinar has weakened 11 percent against the euro this year, according to central bank figures. The bank has spent nearly 1.2 billion euros ($1.5 billion) since February to slow the currency’s decline. Vice Governor Bojan Markovic said June 1 the central bank may increase interest rates to quell volatility in the dinar, while bank officials, who requested anonymity, said reserve requirements may be raised.

A “mix of a rate hike and the reserve requirement increase could be effective,” as the dinar’s decline is “to some degree psychologically driven.” said Jasna Atanasijevic, chief economist at the Belgrade-based Hypo Alpe Adria Banka AD.

Serbia cut borrowing costs by a total of 3 percentage points from June to December last year to contain an economic slowdown triggered by Europe’s debt crisis. The Balkan nation is seeking to avoid a second recession in three years after its economy contracted 1.3 percent from a year earlier in the first quarter and the size of a rate move needs to balance a need to tame the dinar’s decline with economic activity.

Debt Crisis

The nation’s Fiscal Council, a three-member body monitoring budget performance, said on May 30 that Serbia faces the threat of a debt crisis after the budget deficit rose to between 7 percent and 8 percent of gross domestic product and public debt approached 50 percent of GDP.

Adding to the equation on whether to change borrowing costs is mounting political turmoil. Inconclusive elections on May 6 and the May 20 presidential runoff win by Tomislav Nikolic over incumbent Boris Tadic, who had led the country into European Union entry talks, worried investors who feared the formation of a government would be delayed.

Serbia, which is struggling to head off a return to recession, has been without a government able to cut spending and create new jobs in an economy with unemployment at about 24 percent.

New Government

“With plans to raise the reserve requirements, even a quarter-point rate increase could be a strong signal,” said Predrag Stojanovic, head of treasury at Belgrade-based Piraeus Banka AD, said June 1 by phone. “Of course, it will also not only take a new government to be formed quickly, but they need to come out quickly with a valid program for this situation.”

Over the past five months, Serbia has widened its deficit to 6 percent of GDP as revenue lagged forecasts. The goal was to keep the gap within 4.25 percent of GDP, in line with a $1.3 billion precautionary loan program with the International Monetary Fund, frozen in February when it became clear that Serbia would slip on its fiscal target.

The dinar traded at 116.2600 per euro at 4:37 p.m. in Belgrade after touching a record low 119.1761 earlier in the day.

The dinar may plunge to 125 per euro by the end of the year and inflation may accelerate to 10 percent if a new Cabinet is not in place soon to implement fiscal consolidation, the Belgrade-based Economics Institute said in a monthly report today.

‘Responsible’ Government

The failure to have a “responsible” government may lead to “spontaneous fiscal consolidation through inflation,” a stagnant economy and a drop in foreign-currency reserves by 3 billion euros, the think-tank said, urging a return to the IMF program as “an important signal” to investors.

Central bank officials have warned a further weakening of the dinar could fueling price growth in a country which had bouts of hyper-inflation and currency denominations in the early 1990s, when the country was subject to international sanctions over its role in Balkan wars.

Inflation remains tame by Serbian standards, falling to a 30-year low of 2.7 percent in April. The bank targets an inflation rate of 4 percent, plus or minus 1.5 percentage points, at the end of 2012.

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