Closer ties to the EU are more urgent than ever to ensure Serbia avoids a currency and funding crisis, the country’s central bank governor has said in an interview.
His comments follow last week’s parliamentary elections that gave the pro-European bloc led by president Boris Tadic unexpectedly winning most seats in parliament.
“The people of Serbia have surprised politicians with this election result. We now need to transform this moral victory into a reformist government that can save the economy, because our monetary powers are limited,” National Bank of Serbia (NBS) governor Radovan Jelasic told Emerging Markets.
Serbian assets on both the currency and stock market received a boost following the elections, allowing the central bank to leave the two-week repo rate unchanged at 15.25% on Thursday.
The government collapsed in March in the wake of the declaration of independence of the Kosovo province and over disagreements about the pace of EU integration. Tadic’s Coalition for European Serbia is now eyeing a coalition with pro-EU allies, over the opposition of the ultra-nationalist Serbian Radical Party and outgoing Prime Minister Vojislav Kostunica’s Democratic Party.
But the repricing of country risk will be modest in the short term, Jelasic said. “There is so much political instability that is scaring off investors, and it will take time for the economy to normalize.”
The NBS has lifted the main base interest rate by a staggering 5.25% so far this year, to prop up the currency and stem inflation – that stood at 13.6% (year on year) in April on the back of rising food and fuel costs.
Jelasic explained that he is waiting for interest rate hikes to work through the economy before tightening the main rate further. Besieged by a weak export base and ferocious bank lending that has propelled imports, the current account deficit stood at 16.7% of GDP in 2007.
He is trying to encourage take-up of dinar-denominated assets, since 80% of household credit and 85% of corporate liabilities are in euros.
The NBS has imposed down payment charges on foreign currency loans, while removing them for dinar loans. Jelasic also criticized banks for “misleading individuals to think that lower interest loans in euros is cheaper than the dinar. People should be more educated and realize that exchange rates are volatile so they should stay in dinars.”
Nevertheless, he admitted that monetary policy tools to prop up the currency and reduce the country’s external imbalances were ultimately emasculated. This is because stable sources of financing in the form of foreign direct investment (FDI) and capital from foreign banks to fund the current account deficit rests on the wavering confidence of foreign investors.
“There is so much political noise that impacts on the exchange rate, and this is overpowering decisions on our monetary policies.”
Serbia relies upon large scale borrowing at 20% of GDP, according to Commerzbank. The unstable political environment, combined with tighter lending by foreign creditors, led Fitch to revise its BB- country outlook to negative from stable in March.
Jelasic called for progress towards EU accession, prudent fiscal policies and liberal structural reforms to drive FDI and stabilize the currency. “We need concrete action now. The challenges are well known and Serbia at now in the crossroads of history,” he said.