Serbia Raises Rate Amid Dinar Weakness, Inflation Worry

Serbia’s central bank raised its benchmark interest rate for the first time in more than a year to keep a lid on inflation and boost the dinar.

The Belgrade-based Narodna Banka Srbije raised the two-week repurchase rate by a half point to 10 percent, the bank said today in a statement. The move ended a series of cuts that began in June 2011 and saw official borrowing costs fall 3 percentage points. Fourteen of 22 economists in a Bloomberg survey forecast an increase. Eight expected no change.

The central bank expects “inflation to increase from May as import prices advance, a new agricultural season starts and regulated prices gain from the second half of the year,” its said in the statement. The bank also changed some reserve requirements to “to stabilize the exchange rate.”

The Balkan nation’s currency has weakened about 10 percent against the euro this year, according to central bank figures. Vice Governor Bojan Markovic said on June 1 that the bank may increase rates to quell dinar volatility after inconclusive May 6 elections left the country without a government to speed up the consolidation of public finances as the economy struggles to avoid a second recession in three years.

The country’s five-month budget gap widened more than 80 percent from a year ago to 89.27 billion dinars as the shortfall in May increased 41 percent to 4.51 billion dinars.

Reserve Requirements

The reserve requirement rate on foreign currency-indexed dinar assets was raised to 50 percent, the central bank said. Banks will also now set aside 27 percent instead of 20 percent foreign-currency assets paid in dinars for maturities of less than two years, and 19 percent instead of 15 percent for maturities exceeding two years. The reserve requirement on foreign-exchange assets paid in euros remained unchanged.

“These measures are expected to lessen the difference between the cost of borrowing in dinars and in foreign exchange, contribute to the stabilization of movements in the foreign exchange market, and provide an additional impetus to long-term borrowing in the coming period,” the bank said.

Dinar Recovery

Today’s moves failed to arrest the slide of the local currency. It traded at 115.5161 versus the euro at 3:30 p.m., down 0.35 percent, according to data compiled by Bloomberg.

The level of restrictive monetary policy in the coming period will depend “on the speed, intensity and the implementation of fiscal consolidation program as well as a continuation of the International Monetary Fund assistance,” the bank said in the statement.

Central bank chief Dejan Soskic is scheduled to elaborate on the policy decision and macroeconomic outlook tomorrow at 2 p.m.. The next rate-setting meeting will take place on July 12.

Serbian parties may agree on the formation of the new Cabinet “in the coming days,” Boris Tadic, a former president and the leader of the Democratic Party, said after talks with President Tomislav Nikolic yesterday.

“The central bank will likely be eager to put pressure on politicians to quickly conclude an agreement to form the new government,” Timothy Ash, an emerging markets economist at Royal Bank of Scotland Plc said in an e-mail today before the announcement. “The dinar had come under heavy selling pressure, driven partly by broader Eurozone concerns, but also by uncertainty over the political and fiscal policy outlook in Serbia.”

Austerity Effect

With the euro region slipping toward a recession amid budget-cutting austerity measures and a flare-up of the debt crisis, governments across Europe have been putting off rate increases and considering easing to help their struggling economies.

The Polish and European Central Bank left interest rates on hold yesterday, while Czech policy makers last month left their main interest rate at 0.75 percent for a 16th meeting and Hungary held the European Union’s highest benchmark rate at 7 percent for a fifth month on May 29.

Serbia’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.

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 on June 5.

The inflation rate fell to 2.7 percent in April, a 30-year low. The bank targets an inflation rate of 4 percent, plus or minus 1.5 percentage points at the end of 2012. The economy contracted 1.3 percent in the first quarter after expanding an annual 0.4 percent in the previous three-month period.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE