Strong dinar, weak economy - Serbia is in trouble

From the BBJ today:

The runaway, vertigo-inducing hyperinflation was one of the symbols of Slobodan Milosevic’s era, so the first thing the new Serbian authorities did was to anchor the dinar and send a promising message of economic stability.

Now, as the nation looks Friday on the seventh year since Milosevic’s fall, the dinar is now stronger than ever, but the message it originally carried has been lost in the process. The Serbian currency is today swimming against the global trend and has been gaining on the euro, but with a desperate, one-handed battle against inflation instead of promised economic wellness as the backdrop. Following Milosevic’s fall, the dinar had been pegged to the German mark at 30 to one, or the equivalent of 60 for the euro, which arrived in 2002. After steadily weakening to reach 87.87 for the euro in May 2006, the dinar turned around and has since gained 11%, reaching the 78.18 mark last week. That however does not reflect the condition of the Serbian economy but a series of measures aimed at curbing the booming crediting activity. Actually, by being left to stand as the sole instrument against inflationary pressures, the overpriced dinar has been harmful in other segments of the economy, an expert warned.

“The exchange rate is now the only tool in combating inflation. ..and that is wrong,” said Vladimir Gligorov, a Balkans economics expert with the Vienna Institute for International Economic Studies. While it insists that it has rarely intervened to influence the exchange rate, the Serbian central bank has brutally tightened the monetary policy over the past few years to make the domestic currency scarce and expensive. That has dampened consumption and slowed prices, but monetary discipline alone cannot stem inflation in the long run, particularly when it stands against populist economic policies. And economic populism has ruled in Serbia since a series of elections became imminent in the H1 of 2006, starting with a constitution referendum in October.

The International Monetary Fund has been warning Serbia of overspending even before the middle of 2006, but the trend of loose finances has since then become even worse. In the 12 months until mid-2007, the average salary in Serbia rose by a “staggering” 30%, despite a modest productivity growth of 6-7%, the IMF resident representative in Serbia, Harald Hirschhofer recently said. While the central bank measures may help to depress the inflation to single digits, with the official annual target rate of 6.5% already revised upward to 8.5%, the burst dams to spending “cause concern,” Hirschhofer said. The swollen wages have started to unbearably pressure the prices, the majority of which are controlled by decree, not the market. “With retail prices growing by just 4.5% in the period, the average Serb could buy ... 26% more goods than a year before,” Hirschhofer explained. Turning imports artificially cheap is another damaging effect of an overrated currency, which fuelled the “very worrying” explosive growth of foreign-trade and current account deficits, Gligorov said.

The trade deficit reached $5.55 billion, within a 16.69 total trade volume, in the first eight months of 2007. The deficit was by 38.6% larger than in the corresponding period and is expected to reach an $9.9 billion by the end of 2007. While income from past privatizations, credits and hard currency inflow from the large Diaspora so far could finance the deficit, Serbia will run into trouble if it continues lagging with structural reforms, experts warn. However, nobody has been thinking about basic economic policy and everybody only talks about Kosovo,’ Gligorov said. He predicted that, with presidential and local elections looming, nothing would change in the near future despite the alarm bells, because “the situation currently suits the average consumer” - in other words, the voter. (m&c.com)