Serbia Seeks New IMF Embrace as Bond Unloved: East Europe Credit

Seven months after Serbia sidestepped International Monetary Fund support by selling foreign-currency bonds, the looming reduction in U.S. stimulus is driving sentiment lower and the nation back into IMF talks.

Investors demanded 433 basis points, or 4.33 percentage points, of extra yield to hold Serbia’s dollar bonds instead of Treasuries yesterday, compared with 345 for Nigeria, which has the same BB- junk rating from Standard & Poor’s, according to JPMorgan Chase & Co. indexes. The spread for Hungarian dollar notes, ranked one level higher at S&P, stood at 330 basis points, the data show.

Serbia is taking steps to curb its fiscal deficit, forecast by the IMF to reach 8.3 percent of gross domestic product this year, by as much as 1.6 billion euros ($2.2 billion) by 2016 to assuage investors and reach a stand-by loan agreement with the Washington-based lender. The Balkan nation’s budget and current-account shortfalls leave it vulnerable to foreign sentiment as the Federal Reserve weighs when to start paring stimulus.

“There is a credibility issue that needs to be addressed and an IMF program would help with that,” Agata Urbanska-Giner, a London-based economist at HSBC Holdings Plc, said by e-mail yesterday. “The noise seems positive now but the bottom line is that Serbia is not signing any IMF deal today.”

Talks Restart

The Fund refused to start talks on a possible aid deal with Belgrade in May after the nation missed fiscal commitments. The negotiations restarted this week “in a positive manner,” Serbia’s Finance Minister Lazar Krstic, a former McKinsey & Co. associate principal who assumed his post last month, said in an interview two days ago.

Serbia’s economy still bears the scars from wars, sanctions, hyperinflation and currency devaluations that occurred in the 1990s under former President Slobodan Milosevic, whose Socialist Party is now led by Prime Minister Ivica Dacic. The government will start accession talks with the European Union in January, while its former Yugoslav peers Slovenia and Croatia are already in.

The country, whose budget gap will be wider than any of the 28 EU countries in 2013 if no measures are taken, needs to borrow about 4 billion euros by June to refinance maturing debt and cover the deficit, Krstic said. Of that amount, 2.6 billion euros represent maturing debt securities, data compiled by Bloomberg show.

‘Strongly Dependent’

“Cooperation with the IMF would be desirable,” Juraj Kotian, co-chief east European economist at Erste Group Bank AG in Vienna, said in an e-mail Oct. 2. “Serbia is the only country from the region where the current account deficit has not narrowed sufficiently, so the country still remains strongly dependent on foreign capital inflows.”

The Balkan nation’s economy is reviving after two recessions in three years, buoyed by rising exports and farm output. The central bank forecasts gross domestic product will accelerate from 2 percent in 2013 to 2.5 percent next year.

Economic growth, combined with rising remittances from abroad, will help narrow the current-account deficit by three percentage points to about 7.5 percent of GDP, Erste estimates. The IMF in a July Article IV report forecast the shortfall at 8.7 percent of GDP, compared with a projected surplus in Hungary.

Fed Lifeline

The yield on Serbia’s 2021 dollar bond reached a 15-month high of 7.46 percent on Sept. 10, almost 300 basis points above its level when U.S. Federal Reserve Chairman Ben S. Bernanke said the central bank may gradually withdraw from bond purchases which have been used to stimulate the economy. It has since fallen 85 basis points after the Fed surprised investors by delaying tapering, underscoring Serbia’s vulnerability to shifts in global risk appetite.

“I believe the Fed gave Serbia a lifeline by delaying tapering,” said Abbas Ameli-Renani, a strategist at Royal Bank of Scotland Group Plc in London, who has an “overweight” recommendation for Serbian 2021 dollar bonds over Hungarian debt of the same maturity. “Serbia now has three-month window to issue dollar debt”

While the country could raise funds without an IMF accord, such sales would come at a “hefty” cost because above-market yields would be needed to lure investors, according to Ameli-Renani. Restarting talks with the IMF “will likely build a bridge toward final rapprochement” and government concessions such as a cut in public wages may lead to an agreement in the first quarter, he said.

Consolidation Ready

Serbia is ready for “fiscal consolidation” amounting to about 1.5 percentage points of GDP per year to stabilize its debt by 2016, Finance Minister Krstic said. The savings would be achieved via “structural reforms” in public administration, state-run companies, health, education and financing, and won’t necessarily translate into an equivalent drop in the budget deficit, he said.

In addition to selling a $1 billion Eurobond, the country’s refinancing options include domestic borrowing or a loan from the United Arab Emirates of as much as $3 billion to replace more expensive debt, according to Krstic. Selling a Eurobond, the fourth since September 2012, “won’t be cheap”, he said.

Serbian dollar bonds yielded 61 basis points more than Hungarian debt on Oct. 3, whereas as recently as June 6 the spread was negative, according to JPMorgan EMBI indexes. The surcharge over dollar debt issued by Poland, the biggest economy among the 11 eastern EU members, widened by 23 basis points over the same period to 274 basis points..

“Serbia falls into the vulnerable category,” HSBC’s Urbanska-Giner said. “The twin-deficits label still applies and for all countries with that label, tapering is a big story.”

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