1. 1 Macroeconomic Developments January– September 2005 Radovan Jelasic, Governor Belgrade, November 3, 2005

2. Prices (inflation, interest rates, wages, productivity) The dinar exchange rate Contents External position (current account, capital inflow, foreign exchange reserves, indebtedness) Economic growth Моnetary policy and developmentsМоnetary policy and developments Fiscal policy ОtherОther

3. Measures to be undertaken by the NBS... Raising the reserve requirement ratio on enterprises’ foreign exchange deposits and external borrowing from 29% to 35% as of November 10, 2005; Lowering the reserve requirement ratio on dinar deposits from 20% to 18% as of November 10, 2005; Lowering the reserve requirement ratio on citizens’ foreign exchange savings from 41% to 40% as of December 10, 2005; Introduction of obligatory 20% deposit and a monthly installment of 30% of overall household income on all loans, apart from housing loans, for the period of 10 years instead of the present 5 years – otherwise, a higher provisioning level will be needed; As of February 1, 2006, physical persons will be required to obtain a report of the Credit Bureau when taking a loan or lease - otherwise, a higher provisioning level will be needed; The requirement for leasing companies to report to the Credit Bureau on all transactions with physical entities; The requirement to disclose the unique leasing fee as of February 1, 2006 Strengthening the role of repo operations.

4. ... and expected effects Curbed inflationary pressures as a consequence of reduced domestic demand; Decelerated external borrowing; Lower euroization level; Further strengthening of dinar and foreign exchange savings; Strengthening of NBS foreign exchange reserves, which will positively affect the dinar exchange rate!

5. During 2005 inflation will shoot past the projected level; it has been on the rise since 2003 Inflation is not just “one of the indicators” of the efficiency of economic policy, but one of the most significant indicators; From the viewpoint of the NBS, high economic growth does not justify the high inflation level! Out of 13.7% price growth in the first ten months, 6.2% was driven by: –Petroleum products2.5%- Utilities 2.2% –Еlectricity 0.5%- Effect of VAT introduction 2.0% Inflation in period 2002-2005 13.7 14.8 7.8 16-17 0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0 18.0 2002200320042005 у % Source: RSO

6. Rise in core inflation primarily points at aggregate demand growth In the first 10 months of 2005, core inflation accounted for almost 50% of overall inflation; In the second half of the year, money supply rose substantially mainly in respect of the conversion of foreign exchange into dinars due to foreign capital inflow, which negatively affected the inflation rate.

7. With a view to increasing sterilization and due to higher inflation rate, the NBS offers a higher interest rate The 14-day repo rate will be used as a reference rate by the NBS; Sterilization will be stronger albeit it implies higher costs for the NBS and possibly a higher level of interest rates in the short run!

8. Average wages in Serbia have reached CSD 18,345 (EUR 217), and the rise of real wages stands at 5.9% showing an upward trend

9. Wages in the public sector declined by 0.5% in real terms, reaching CSD 20,677 (EUR 245) with a stable tendency

10. Labor costs and productivity grow, but employment is on the decline Real gross wages growth in the industry (10.4% in the first nine months) is higher than productivity growth (5.6%), i.e. unit labor costs in the industry went up by 4.5%; However, at the level of the overall economy, unit labor costs have been reduced.

11. The NBS pursues an exchange rate policy that balances influences both on inflation and balance of payments A considerable depreciation or appreciation would exert a negative impact on either inflation or balance of payments. ** Real effective exchange rate calculated against the currency basket. Trends of retail prices and the dinar exchange rate** by quarters 2005 3.6 2.8 5.1 13.7 -2.3 -2.1 -2.7 -7.8 -1.5 -0.2 -2.2 0.3 -12.0 -8.0 -4.0 0.0 4.0 8.0 12.0 16.0 IIIIIIJanuary-October % Retail pricesEuro nominal exchange rateReal effective exchange rate** * Negative rate implies depreciation of the dinar, and positive rate implies appreciation of the dinar. Source: NBS and RSO

12. The role of the market in determining the exchange rate is gradually becoming stronger Significant daily fluctuations reflect market relations; Banks should develop more efficient risk management; Banks should (if they wish to advise their clients in a professional manner) inform their clients of the existing risks. 0.6 JulyAugustSeptemberОctober 82.0 82.5 83.0 83.5 84.0 84.5 85.0 85.5 86.0 Daily changes*Level of exchange rate у % * Negative rate implies depreciation of the dinar, and positive rate implies appreciation of the dinar. Source: NBS in CSD

13. The NBS encourages the interbank foreign exchange market (IFEM) development, and its interventions are becoming increasingly less important Sale of foreign exchange by the NBS at the IFEM session and interbank trade outside the IFEM session 1,373 1,604 1,015 1,763 1,607 1,545 192 789 0 250 500 750 1,000 1,250 1,500 1,750 2,000 2002*20032004Јаn-Oct. 2005 Banks-NBS (IFEM)Bank-bank Source: NBS in EUR mill. * Total since the introduction of the fixing session on May 14 until Dec 12, 2002 462.6 358.0 386.8 577.7 452.7 370.4 0 100 200 300 400 500 600 700 IIIIII Banks-NBS (IFEM)Bank-bank Source: NBS. in EUR mill. 2005

14. Current account in 2005 is much more favorable mainly owing to export boost Coverage of import by export of goods and services in 2004 stood at 44.6%, whereas in the first nine months of 2005 it reached 54.6%.

15. Current trend of export growth is sustainable in the long run Export determinants –preferential status on EU markets; –better quality of export supply, especially supply of privatized companies; –effect of VAT introduction; –the key factors behind export growth are the following: ferrous metallurgy, non- ferrous metals, sugar, grain, clothes and footwear (almost 2/3 increment in the nine months of 2005). Import determinants –effect of VAT introduction; –growth of crude oil prices in the world market; –the key factors behind import growth are the following: energy, ferrous and non- ferrous metallurgy (increment higher by around 25%).

16. Current payments deficit and capital inflow Structure of capital inflow has improved – foreign direct investments have for the first time sufficed for financing the deficit in the first nine months of 2005; Determinants of capital inflow: lower risk, high interest spread and high demand for capital; The structure of the 2005 current account so far is sustainable in the long term!

17. Although external debt balance has been on the rise during 2005, the share of public debt is decreasing

18. The expected GDP growth in 2005 will be around 5% Sectors “responsible” for growth: Trade – 7.7% of GDP Financial services – 5.9% of GDP Transport – 7.7% of GDP

19. Role of fiscal policy remains crucial from the viewpoint of inflation In 2005, consolidated government revenues rose by around 19.5% compared to 2004 (the planned increase in 2006 is 15.4%); In 2005, consolidated government expenditures rose by almost 16.1% compared to 2004 (planned increase in 2006 is 13.7%); A surplus has been recorded, but both revenues and expenditures witnessed a high rise – the reduction of expenditures is still the main challenge facing the fiscal policy. Consolidated public revenues and expenditures 400 450 500 550 600 650 700 750 800 850 2003200420052006 CSD billion RevenuesExpenditures Source: Ministry of Finance Consolidated public revenues and expenditures 38 39 40 41 42 43 44 45 46 2003200420052006 % GDP RevenuesExpenditures Source: Ministry of Finance

20. Monetary policy challenges and key instruments Lowering of the inflation rate; Reduction of the euroization level; Growth of dinar savings; A more moderate rise in lending to households. ChallengesInstruments Strengthening the influence of interest rates; Open market operations; Banking sector liquidity; Required reserves; Deposit and credit facilities.

21. The largest change sustained by lending activity was that of its structure, with the share of household lending registering a steep rise Average monthly growth of household lending in 2005 amounted to CSD 4.6 billion, whereas in 2004 it stood at mere CSD 2.6 billion! 81.2 66.4 37.3 29.6 20.3 23.7 23.6 13.1 0.0 10.0 20.0 30.0 40.0 50.0 60.0 70.0 80.0 90.0 20042005200420052004200520042005 I quarter II quarter III quarter Total (I-III) Source: NBS CSD billion 28.1% 71.9% 77.8% 62.6% 37.4% 47.3% 52.7% 22.2% 59.8% 53.9% 46.1% 39.8% 60.2%46.8% 53.2% 40.1% legal entities households