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EM Country Briefing
Serbia: Fights for growth
Serbia is reclaiming its place in Europe; it expects to receive a candidate status this year and ties its economic links closer to Italy and Europe. Based on our recent visit, we see an improved outlook for the country. The government is observing Central Europe for central banking clues, Slovakia for an export-oriented transformation and tries hard to cooperate politically with the EU. The NBS runs a relatively free float to dinarise a heavily-indexed economy. Measuring by the results, the countrys policy choices are proving more effective than Croatias and the World Bank sees a fivequarter consecutive export growth reassuring on competitiveness. This should be reinforced by a prospective flow of foreign investments, including a 1bn project in the auto industry where the supply chain is substantial. Based on a best-case scenario and Slovakias experience, Serbias economic model that was conditioned by past high consumption standards could transform to an export-oriented one and its growth rate rise from 3% to 5%-7.5%. Fiscal populism typically surrounding political elections is a concern. External vulnerabilities are still large and funding gaps could still surface. The government has requested a new precautionary IMF SBA, which, in our view, would be necessary to secure the governments debut Eurobond scheduled for September/October. This, otherwise, could be a rare case of an improving credit.
12 August 2011
EM Country Briefing
As part of the dinarisation strategy of the NBS, the government introduced credit support programs via subsidised dinar loans, which have helped to shore up credit growth during the crisis. This program reduced slightly the share of foreign currency loans in total from 75% to c. 67%, although the support scheme is being phased out and the increased use of the dinar may fade out again. According to the OeNBs survey the practise of setting prices and wages in euro and denominating them in dinar only for legal purposes prevails, while payments for large consumer durable goods are made almost exclusively in foreign currency. As macroeconomic credibility is perceived to be low, the best hedge remains to be denominating contracts and prices in foreign currency. The favourable interest rate differential of foreign currency denominated financial services arouse from (previously) easy access to abundant foreign currency liquidity from abroad from parent banks and remittances (the latter c. 8% of GDP p.a.). A lack of a liquid government bond or bill market beyond the shortest maturities means the pricing benchmarks for local currency financial instruments and hedging products is missing. The authorities nevertheless continue to maintain a co-ordinated support for dinarisation, which involves the development of hedging markets, the NBS offering FX swaps and the Ministry of Finance issuing local debit instruments and lengthening T-bill maturities from three months to two years. The next hurdle is to encourage a secondary market in T-bills. Serbias monetary policy operation resembles that of Hungarys in its early inflation targeting period; it runs at high interest rate volatility, due to the overwhelming role of exchange rate transmission. When the exchange rate background is stable, the carry trade catches on; year-todate the NBS reports c. 0.7bn foreign portfolio investments in short debt instruments (361D+ Tbills, available to non-residents); one-half of the outstanding stock. With a shallow currency market this makes the RSD vulnerable (100m daily turnover, 300m-400m pre-crisis, catching up to Romania). According to local banks the (quasi-) free-float and non-resident participation in the local market helps the market to develop. The float, therefore, could prove a healthier strategy than Croatias quasi-fix (see more on this below), provided that the local market grows in liquidity and hedging instruments. The IFC is taking an active role in technical assistance, and a growing number of multinational corporate operations should also facilitate this. The NBS says that inflation volatility encourages euroisation more than exchange rate volatility. Therefore it is likely to continue to allow exchange rate volatility, as long as it can control inflation, but interest rates are likely to be held at a foreign currency risk premium to Europe. A turnaround into a currency board like fix, similar to Croatia, is not considered. (For comparison, annual average. EUR/RSD depreciation was 15% and 9.5% in 2009 and 2010, respectively, as against weighted average interest rate on Republic of Serbia Tbills of 14% and 11%). CHART 1: Foreign currency loans as % of GDP
90 80 70 60 50 40 30 20 10 0 Macedonia Moldova Hungary Serbia Albania Bulgaria Lithuania Belarus Romania Ukraine Russia Croatia Poland Turkey Latvia
12 August 2011
EM Country Briefing
TABLE 2: Banking sector ownership in the CEE and SEE, by assets (% share)
Bulgaria Greece Italy Hungary Austria Germany 28.7 15.8 12.5 9.9 6.0 Poland Italy Germany Netherlnd Spain Austria Portugal other domestic 10.8 16.3 other domestic 14.1 10.8 7.5 7.2 5.2 4.6 20.6 30 other 20.2 domestic 12.2 domestic 29 other 8 domestic 13 domestic 4.2 Romania Austria 31.8 France 14 Hungary Austria Italy Belgium Germany other 24 20 14 13 0 Serbia Italy 21.5 Greece 15.4 Austria 17.1 France Germany 7.9 2.6 Czech Belgium 20.8 Austria 25.3 France 16.4 Italy 6.4 Croatia Italy Austria France Hungary other 41 33.8 7.5 3.5 10
other 18.1
domestic 27.5
The banking system, nevertheless, has a strong regulatory hedge. The corporate sector suffered the largest damage from balance sheet exposure, but banks are able to absorb substantial credit risks; the capital adequacy ratio is among the highest in the region above 20%. According to stress tests under the IMFs oversight, banks are sufficiently well capitalised to absorb even a protracted corporate restructuring process. A new decision on reserving requirements that promotes the use of longer maturity RSD sources will further regulate funding vulnerabilities. According to local banks, Serbia is one of the safest banking markets in the world. This is due to the fact that lending is done nearly purely from capital; the system has a capital stock of c. 3.5bn for a loan portfolio of 14bn. As long as prudential regulations are kept tight, banks should remain stable in the face of unhedged private sector balance sheets.
12 August 2011
EM Country Briefing
CHART 4: Loan/deposit %
160
20
140 120
15
100 80
10
60 40
5
20 Romania Hungary Czech Poland Croatia Serbia Bulgaria 0
Source: Commerzbank Corporates & Markets, National banks and bank regulators, Fitch Ratings
Source: Commerzbank Corporates & Markets, National banks and bank regulators, Fitch Ratings
12 August 2011
EM Country Briefing
also Italian investments in renewable energy generation and additional infrastructure projects financed by China. According to World Bank estimates, given the small size of the economy the Fiat investment alone would generate an extra GDP growth of 1.7% GDP, and if the 2014 production plan of 200,000 units is met, an extra 1% over the long term. More importantly, the supply chain of the auto industry is sizeable. Using IMF base case projection and best-case scenario for prospective investments, Serbias growth rate could rise from 3% pre-crisis to 5%-7.5%. The countrys attraction as a manufacturing base lies in its harmonisation with the EU and simultaneous free trade zone with the CIS, cheap availability of high voltage electricity, which could kick-start an investment cycle. There is, however, a lot to be done on the investment environment and macroeconomic stabilisation. Slovakia is a model economy that showed unstable growth prior to the Dzurinda reforms and was of similar size. It received two large greenfield investments in the auto industry of 2%-3% of GDP, which (together with market reforms) attracted annual FDI flows of 5%-6% of GDP over a period of 4-5 years and lifted Slovakias growth rate from c. 3% to 5%-7% over the medium term. CHART 5: Hourly labour cost ()
30 25
80%
20 15 10 5 0 Hungary Czech R. Germany Bulgaria Lithuania Slovenia Greece Serbia Latvia Poland Croatia Romania Slovakia Portugal UK
70% 60% 50% 40% 30% 20% 10% 0% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
2.0
130
1.2
-3.0
120
-1 -4.1 -3.5
-8.0
110
-13.0
100
-18.0
90
-23.0
80 Serbia Croatia Romania Bulgaria Hungary
-28.0
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EM Country Briefing
The governments macroeconomic framework is based on the assumption of a new economic model; 10% annual gross fixed capital investment growth in 2011-13 which produces a recovery in growth to 3% and 4.5%. The share of exports in GDP, and domestic savings would increase over the medium term. Serbias export results already stand out in comparison with Croatia. Most regional peers show a sustained export recovery in 2010-11 (and over the 2007 base), while Croatia is notably lagging behind (chart 7). Croatias exchange rate peg and lack of internal devaluation over the recent period has been highlighted as a structural drag, and by the results, Serbias policy choices appear to have been better. While the countrys current account gap is still among the largest in the region, an estimated 7%7.5% of GDP (including c. 10% of GDP worth of remittances from abroad), capital flows are improving and FDI could reach between 5% and 6%. A funding gap may still be present this year if the government fails to issue the planned Eurobond, which is to replace the postponed privatisation of Telekom Sbrja (1.4bn). On the back of the prospective investments the sustainability of Serbias external position should gradually improve (one-third of its current account deficit alone could be covered by Fiat operations). Serbias growth opportunities have improved and it could become a new growth market in Central Europe.
Portfolio cap.
Commercial loans
FDI
CAD
2,000 -2,000 Dec-08 Apr-09 Aug-09 Dec-09 Apr-10 Aug-10 Dec-10 Apr-11
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EM Country Briefing
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12 August 2011