Serbia will keep rates high to hit inflation targets

BELGRADE (Reuters) – Serbia’s central bank said yesterday its policy will be as tight as needed to make sure end-year inflation falls within its 3-6 percent target band. «High interest rates can beat inflation and we did it (in 2006),» central bank Governor Radovan Jelasic told a news conference. «This will temporarily boost the cost of borrowing… but there is nothing more expensive than inflation.» In 2006, the bank used an 18-percent repo rate to slash inflation of nearly 18 percent to a 15-year low of 6.5 percent. «In order to reach the targeted inflation of 3-6 percent in the last quarter this year, the national bank has to tighten policy and raise interest rates now,» Jelasic said. He spoke a day after the bank hiked its two-week repo rate by 75 basis points, for the second time this month, to 11.5 percent, trying to offset the impact of surging price pressures, the falling dinar and ongoing fiscal expansion. February monthly core inflation was 0.6 percent, or 6.6 percent year-on-year. Headline inflation rose to 11.3 percent. Headline inflation was 10.1 percent and core inflation 5.4 percent in 2007. Growth was above 7.1 percent, but the budget gap doubled to 1.0 percent of GDP and the current account deficit rose to 16.1 percent of GDP. «All key macroeconomic fundamentals are negative,» Jelasic said. «The negative output gap is the only indicator not fueling inflation, because the economy is not growing so strongly. «Inflationary expectations are growing, the dinar has depreciated 5.1 percent so far this year, and our interest rates have become negative in real terms,» he added. The dinar traded at 83.60/euro at 1325 GMT on the interbank market, just off 83.80 where it started the day, after the central bank sold euros again amid lean trading volumes. «It seems that 84.00 is a psychological barrier,» a trader said. Crude oil prices were now above $100, food prices continued to rise and the government has just approved a 7.6 percent electricity price increase, he said. The electricity price hike alone will add 0.6 percentage points to March inflation, FREN/CEVES think tank said. Politics also weighs heavily on the economy in the aftermath of Kosovo’s secession, triggering outrage and sometimes violent protests against Kosovo’s unilaterally declared independence. «The higher risk has already translated into higher cost of borrowing for Serbian companies. It has gone up to 300 basis points above what developed economies pay,» he said. Jelasic said it was vital to rein in inflation before it was too late. «Higher inflation will boost pressures on the government to increase wages and higher wages will result in higher consumption, all leading to spiraling inflation.» Hyperinflation of up to 60 percent an hour was one of the hallmarks of the rule of late autocrat Slobodan Milosevic in the 1990s, and the bank takes pride in having given consumers and investors a greater sense of economic stability in recent years. Jelasic urged the government to refrain from any fiscal expansion. «Any additional fiscal expansion in a situation like this would be utterly destabilizing.» The government plans to revise the 2008 budget to include payments to Serb communities in Kosovo, to keep the area linked to Belgrade. Options discussed include tax hikes and relocation of other ministries’ funds for Kosovo. Fiscal expansion was extreme in November and December. «Spending soared in the last quarter so dramatically that the consolidated fiscal deficit reached 7 percent of the quarterly GDP,» Dusko Vasiljevic at FREN/CEVES said.

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