Time to reinvigorate the economic reform process
Overview:
Serbia, like all economies in the region, is suffering from the harsh effects of the global financial crisis. Its currency has come under significant downward pressure and growth is decelerating sharply. Serbia's economic growth over the last few years has been strong but was too concentrated on particular sectors and also led to significant current account imbalances. The authorities now appear to have a reasonable strategy to counter these adverse economic trends: tighter fiscal policy; an Inflation Targeting regime and accelerated implementation of structural reforms. Their policies are supported by an IMF arrangement to help ensure macroeconomic stability. Strong implementation of this program will be unpopular politically but would, however, significantly improve Serbia’s long-run economic potential.
Recommendation:
Despite a significant devaluation the dinar is still vulnerable to a further downward correction if capital inflows continue to fall faster than the current account can adjust downwards. A larger, disbursing IMF program would clearly help stabilise the currency and the authorities are confident that they can secure one by April. Domestic interest rates are extremely high offering considerable compensation for currency risk if one believes that the 8% inflation targeting is credible. Deposit rates in euros are also attractive and the banking sector well capitalised, liquid and profitable. We are underweight on the dinar, neutral on local currency interest rates and overweight on Euro deposits and Serbian external debt.