The New Growth Model for Serbia: Monetary and Fiscal Policy Challenges Dejan Soskic – Governor, National Bank of Serbia Athens, 11 February 2011

Characteristics of the Previous Growth Model in Serbia (2000-2008) GDP growth was based primarily on domestic consumption and to a much smaller extent on investments. Rising domestic consumption was the main generator of the increase in trade deficit. Acceleration in economic activity was financed by large capital inflows (FDIs, corporate and bank borrowing). GDP growth resulted from the expansion in non-tradable sectors – most of the growth was realized in the services sector, and not in traditionally significant tradable sectors (agriculture and industry).

Unsustainability of the Previous Growth Model Growth in wages outpaced the growth in productivity, high level of domestic consumption and a very low level of investments. High trade deficit and also current account deficit. Maintaining the previous growth model, based on externally financed domestic consumption (through foreign borrowing and privatization revenues), would result in rising debt, decrease in economic growth and deterioration of macroeconomic stability.

First steps towards New Growth Model – since 2009 Introduction of public wages and pension freezing, and more then 25% depreciation of RSD at end 2008 and beginning of 2009 Consumption contributed negatively to GDP growth in 2009 and 2010. The fall in consumption induced a smaller trade deficit, causing net exports to contribute positively to the overall economic activity. Current account deficit was reduced to a third of its 2008 level.

No Bailouts Due to Restrictive Pre-Crisis Monetary and Prudential Measures of the NBS At end-September 2008, Serbian banks had a very high capital adequacy ratio of 23.3% Commercial banks had substantial NBS REPO holdings (EUR 3.2 bn or 13% of total banking sector assets at the time). High reserve requirements: 40% on new FX savings, 45% on foreign borrowing. Level of private indebtedness was low (EUR 627 per citizen, EUR 2,282 per employee). 74.8% of the banking sector was owned by EU resident banks. No need for bailouts of Serbian banks during or after the crisis. Stress tests conducted in collaboration with the IMF show that Serbian banks are resilient to potential negative shocks.

Central Bank’s Role in the New Growth Model National Bank of Serbia has a primary role in securing a stable environment – price and financial stability. Decreasing the level of Euroisation Increase in the share of domestic sources in investment financing. Key source of economic growth should be net exports (through export expansion and import substitution) and export-related investments. Fine tuning of monetary policy and micro and macro prudential tools in order to keep inflation in target, allow export growth and preserve systemic stability.

Monetary Policy Must Be Complemented with Effective Fiscal Policy Because monetary policy can not: decrease excessive public spending; curb the prices of individual products or groups of products; directly boost exports; directly increase employment. Stability and economic development can be fostered only through a combination of effective monetary and fiscal policies (low deficit and manageable public debt), supported by adequate budget-financed capital investment.

Risks Related to NBS’s Role Inflation High Eurisation increases the correlation of FX rate and NPLs Use of FX rate as an external shock absorber without negative implications for financial stability. From a standpoint of consistency between monetary and fiscal policy: Wage policy in public sector; Development of domestic financial market; Still high level of euroization in public financing; Higher than agreed growth in regulated prices.

Transition from 2000 to 2010 GDP growth driven by domestic demand, imports, services; FDI (brown field and green field predominantly in non-tradable GDP); External borrowing; Increased public spending on consumption including privatization revenues; From December 2000 until September 2010, FX rate has depreciated 78% against the EUR and 23,3% against the USD while RPI at the same time increased by 246,6%; Serbian industries predominantly import oriented and uncompetitive; In 2010 number of employees is less then in year 2000; Industrial output in 2010 is less then 50% of industrial output in 1989.

Post-crisis agenda Serbia needs to spend within its means (lower budget deficit and lower current account deficit) Serbia needs to invest much more (FDI, government capital investments, domestic private investments, portfolio investments) We need to produce more before we spend more We need to export more before we can import more As a rule: stable and strong currency is a consequence of a strong and competitive economy