Serbia Holds Rates as Cabinet Shuffle Clouds Fiscal Outlook

Serbia’s central bank kept borrowing costs unchanged for a second month as a cabinet shuffle that shook the governing coalition clouds the outlook for the cabinet’s fiscal overhaul plan.

The Narodna Banka Srbije in Belgrade left its one-week repurchase rate at 11 percent, it said on its website today. Fourteen of 24 economists in a Bloomberg survey predicted no change, while eight forecast a quarter-point reduction, one saw a half-point cut and one a 0.75 percentage point drop.

Signals that the U.S. Federal Reserve may soon pare its asset purchases are compounding uncertainty for the Balkan nation after its political leaders averted early elections on July 31 with an agreement that led to the ouster of the finance minister and his party.

“Having in mind that investors have reacted to the Fed’s indications of a possible reduction in volumes of quantitative easing with reduced readiness to accept risk, which has led to an increase in risk premium and resulted in depreciation pressures in all countries of the region and Serbia,” the benchmark rate will remain unchanged, policy makers said.

The threat of a snap ballot sent yields on state bonds to the highest in a month. The Serbian Progressive Party of Deputy Premier Aleksandar Vucic and Prime Minister Ivica Dacic’s Socialists plan to sign a new coalition agreement and appoint new ministers by September.

Dinar, Bonds

The dinar traded 0.1 percent stronger at 113.9419 against the euro at 12:05 p.m. in Belgrade, according to data compiled by Bloomberg. The yield on the government’s 10-year Eurobonds maturing in 2021 dropped two basis points, or 0.02 percentage point, to 7.15 percent, after rising 0.75 percentage point since July 30, when the finance minister was ousted.

Inflation has been decelerating and will fall within the central bank’s target band by October while the economy remains on track this year for 2 percent expansion driven by exports, according to the regulator.

“The decline in annual inflation continues, mostly driven by monetary policy measures and food market stabilization,” the central bank said. “Weaker inflationary pressures indicate that the trend will accelerate in the coming period.”

The central bank is seeking to bring inflation to 4 percent, plus or minus 1.5 percentage points. Price growth slowed to 9.8 percent in June. It peaked at 12.9 percent in October, fueled by regulated price increases and rising dinar liquidity, which forced policy makers to raise borrowing costs eight times in nine meetings through February even as the economy shrank.

Uncertain, Unfavorable

“The political backdrop remains uncertain and external risk appetite remains unfavorable” even as “activity indicators call for looser monetary conditions,” Carlos Ortiz, economist at UniCredit SpA in London, said in note to clients before the rate announcement.

The International Monetary Fund has warned the fiscal gap may soar to 8.3 percent of gross domestic product this year without additional cost cuts, compared with a revised deficit target of 4.7 percent.

With the Progressive Party taking over the finance and economy portfolios, investors will wait to see if planned policy changes are implemented, UniCredit’s Ortiz said.

“The political environment remains uncertain,” he said. “In particular, it’s unclear which direction, if any, fiscal policy takes from here” while the government “needs to return to external markets before year end given a financing requirement” of as much as 2 billion euros ($2.7 billion), Ortiz said.

Serbian rate setters surprised most economists for two consecutive months by lowering the benchmark rate by a quarter point in June and holding borrowing costs in July after the IMF said relaxing policy would be premature.

The Washington-based lender last month urged restraint in further easing while fiscal consolidation is implemented to avoid risks to inflation, the dinar and economic stability.

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