NATIONAL BANK OF SERBIA Vice Governor Markovic`s Speech at

NATIONAL BANK OF SERBIA
Vice Governor Markovic’s Speech at the Presentation
of the May Inflation Report
Belgrade, 16 May 2012
Ladies and gentlemen, esteemed members of the press and fellow economists,
Declining steadily over the last year, inflation fell in April to 2.7% year-on-year, its lowest level
since comparable records are available from the beginning of 1980. Consistent with our projections
from the previous Inflation Reports, the inflation figure is slightly below the lower bound of the
target tolerance band for April. From May, however, we expect inflation to rise at a moderate pace
and to move temporarily around the upper bound of the target tolerance band in late 2012 and the
first half of 2013, only to return back towards the target thereafter.
Chart 1 Inflation projection
(y-o-y rates, in %)
Chart 2 GDP growth
(y-o-y rates, in %)
16
14
projection
7
6
5
12
4
10
3
8
2
6
1
0
4
3 6
2010
9
12
3 6
2011
9
12
3 6
2012
9
12
3 6
2013
9
12
3
2014
-1
2
-2
0
-3
I II
2010
III IV
I II
2011
III
IV
I II
2012
III IV
I II
2013
III IV
I
2014
Gross domestic product declined in the first quarter due to extremely cold weather, but also due to
the contraction in economic activity of our key foreign trade partners. Recessionary trends in the
euro area will continue to have a negative impact on the Serbian economy in the remainder of the
year, but modest economic growth of 0.5% is still expected in 2012 given the start of production in
the automotive industry.
The National Bank of Serbia last revised its key policy rate in January by cutting it down to 9.5%. In
April, the National Bank of Serbia amended the Decision on Required Reserves, lowering the FX
reserve requirement ratio and increasing the share of FX required reserves to be allocated in dinars.
* * *
The new Inflation Report comes out at a time of post-election uncertainties as to how fast the future
government will be formed. From the viewpoint of fostering macroeconomic stability and lowering
the country risk premium, it is desirable that the future government is formed promptly and that it
undertakes efficient fiscal consolidation measures to cut the budget deficit and contain public
debt. This also includes the continuation of the arrangement with the International Monetary Fund,
which will help improve the perception of country risk, and thus contribute to the stabilisation of
financial markets.
The euro area sovereign debt crisis showed some signs of abatement following successful
implementation of the debt swap agreement between Greece and private investors and
expansionary measures by the European Central Bank, but in the last few days uncertainty appeared
again over the formation of the new Greek government. Furthermore, as indicated by the
1
contraction of economic activity in the past two quarters, the situation in the euro area’s real sector
remains challenging. Growth forecasts for the euro area for the current year remain negative, while
countries in the region face muted growth prospects.
Nonetheless, Serbia’s country risk premium has declined, as a result of the easing of the euro area
sovereign debt crisis and expansionary measures taken by the European Central Bank, the EU’s
positive decision on Serbia’s candidate status, and affirmation of the country’s credit rating. In fact,
looking at the region, the sharpest fall in EMBI this year was registered for Serbia.
Chart 3 Risk premium
(daily, in basis points)
indicator − EMBI by country
Chart 4 Movements
(daily data, 31. 12. 2007 = 100)
120
116
112
108
104
100
96
92
88
84
80
76
72
68
64
1
5
9
1
5
2008
2009
1,450
1,350
1,250
1,150
1,050
950
850
750
650
550
450
350
250
150
50
1 4 7
2008
Hungary
9
EMBI Global
Composite
in exchange rates of national currencies
against the euro*
1 4 6 9 1 3 7 9 1 4
2009
2010
2005
Bulgaria
Poland
Turkey
7 10 1 4
2012
Croatia
Turkey
Poland
Serbia
9
1
2010
5
9
1
2011
Czech Republic
Hungary
5
9
1
2012
Romania
Serbia
* Growth represents appreciation.
The dinar nonetheless weakened against the euro. Depreciation pressures were driven by several
factors: increased energy imports due to cold weather, lower exports, departure of the private
owner from the Smederevo steel plant, postponed review of the arrangement with the International
Monetary Fund, increased government spending, and reduced capital inflow.
* * *
Together with a spell of extremely cold weather in February, recessionary trends in the euro area and
sluggish growth of the regional economies have led to a contraction in Serbia’s economic activity in
Chart 5 Economic activity indicators
(seasonally-adjusted data, 2008 = 100)
Chart 6 Contributions
(in p.p.)
101
9
100
7
99
5
98
3 2.3 1.5
1
97
3.6
1.4
-0.3
-0.7
-1
96
to quarterly GDP growth
-0.6
-0.7
-0.8-1.9
0.1
0.7 0.3
-0.5
1.4
1.2
-0.1
-0.2-0.6-0.1-0.5
-3
95
-5
94
-7
93
-9
I II III IV I II III IV I II III IV I II III IV I II III IV I
2007
2008
2009
2010
2011
2012*
GDP
* NBS estimate.
I II III IV I II III IV I II III IV I II III IV I II III IV I
2007
2008
2009
2010
2011
2012*
Non-agricultural value added
* NBS estimate.
Net exports
Government consumption and investment
Private sector investment
Household consumption
GDP (%)
2
early 2012. According to preliminary estimates for the first quarter, gross domestic product fell by
0.5% from the previous quarter and by 1.3% from the same period last year.
Unfavourable weather conditions in February strained and even restricted electricity supply to a
large number of enterprises. Together with the suspension of operations of the Smederevo steel
plant, this pushed manufacturing down by as much as 12%. However, as the production not only
normalised in March, but also compensated in part for what was missed in February, manufacturing
picked up by 19%.
Chart 7 Industrial production
(s-a data, 2011 = 100)
Chart 8 Retail trade
(seasonally-adjusted data, 2008 = 100)
106
103
104
100
102
97
100
94
98
91
96
88
94
85
92
82
90
79
88
76
86
73
70
84
I II III IV I II III IV I II III IV I II III IV I II III IV I
2007
2008
2009
2010
2011
2012
3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3
2010
2011
2012
Industrial production
Manufacturing
(75.6% of industrial production)
The same factors had a decisive impact on exports, which followed a pattern similar to that of
manufacturing in the first three months of 2012, while recording a mild fall at quarterly level. The
steepest drop in exports was registered for base metals, chemicals and chemical products, while
exports of agricultural products and electrical equipment increased.
Chart 9 Exports
(in EUR mln)
and imports
Chart 10 Imports by key components
(seasonally-adjusted data, 2008 = 100)
1,600
120
1,400
110
1,200
100
1,000
90
800
80
600
70
400
60
200
50
1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3
2007
2008
2009
2010
2011
2012
Original data
Seasonally-adjusted data
Trend-cycle
I II III IV I II III IV I II III IV I II III IV I II III IV I
2007
2008
2009
2010
2011
2012
Capital goods
Intermediate goods
Consumer goods
3
Cold weather prompted an increase in imports of energy, and thereby, intermediate goods, pushing
overall imports higher. On the other hand, imports of equipment and consumer goods recorded a
decline.
Economic activity contracted in the first quarter. The negative contribution came from net exports,
as well as lower private sector investment, signalled by a dip in imports of equipment and reduced
construction activity, and adverse weather conditions.
Conversely, an upturn in retail trade points to a positive, though modest, contribution of household
consumption to economic activity.
Economic activity is expected to increase in the upcoming quarters and reach roughly 0.5% for the
entire year 2012. Over the short run, increased government expenditure in the first half of the year
exerts some positive contribution to domestic demand. But, euro area recession and dented
economic growth of Serbia’s other foreign trade partners will reflect negatively on demand for
Serbian products and the inflow of FDI in the course of this year. Despite this, past and current
investments in export branches of industry, primarily in the automotive industry, will lead to
increased production and exports from the second half of the current year. Past weakening of the
dinar will also give impetus to exports growth. In view of high unemployment and modest economic
growth, final consumption is expected to contract this year as well. Coupled with a fall in investment
demand and past weakening of the dinar, this will probably result in lower imports in 2012.
With production picking up in the mostly export-oriented automotive industry, a more palpable
growth of the Serbian economy of 3% could be expected in 2013. This, however, will largely hinge
on the speed of the global economic recovery. Growth may turn out slower than anticipated in
case stricter fiscal consolidation measures are applied. In our view, however, application of stricter
consolidation measures is desirable as it would contribute to macroeconomic stability, public debt
sustainability, lowering of the country risk and, consequently, of the cost of borrowing, all of which
would have a positive long-term impact on the economic activity in Serbia.
Chart 12 Contributions
(in p.p.)
Chart 11 GDP growth projection
(y-o-y rates, in %)
7
20
6
16
5
12
4
8
3
4
2
0
1
-4
0
-8
-1
-12
-2
-16
5.4
3.6
2005
III IV
I II
2011
III
IV
I II
2012
III IV
I II
2013
III IV
5.4
3.0
3.8
1.0
1.6 0.5
-3.5
2006
-3
I II
2010
to y-o-y GDP growth*
I
2014
* NBS estimate.
2007 2008 2009 2010 2011 2012* 2013*
Net exports
Government consumption and investment
Private sector investment
Household consumption
GDP (%)
4
We wish to underline again that sustainability of economic growth in Serbia is more important
than its pace, which assumes further shifting of the sources of growth from domestic final
consumption towards net exports and investments, primarily into export-oriented industries.
* * *
Inflation has been on a steady decline throughout the last year, mostly as a result of weakening costpush pressures on food prices, low aggregate demand and restrictive monetary policy measures
applied at times of strongest inflationary pressures.
The fall in year-on-year inflation was particularly pronounced in the first months of the year, as
substantial price hikes from early 2011 dropped out from the calculation. Inflation thus fell from
7.0% in December to 3.2% at the end of the first quarter and to 2.7% in April 2012, which is the
lowest year-on-year inflation rate since records are available beginning in 1980. This is also slightly
below the lower bound of the target tolerance band for that month. Such inflation movements are
consistent with our projections from the previous Inflation Reports.
Consumer prices increased by 2.0% in the first quarter, under the influence of several diverging
factors.
The rise in import prices on the back of a weaker dinar has so far produced only a minor inflationary
effect, as importers, faced with low demand, abstained as much as possible from raising domestic
prices. There were, however, some price increases in this respect, most notably in the case of foreign
currency indexed prices such as flat rentals and cars. This is also the key reason behind the rise in
market-determined prices of non-food products and services.
Chart 13 Price movements
(y-o-y growth, in %)
Chart 14 Contribution
( in p.p.)
16
16
14
14
12
12
10
10
8
8
6
6
4
5.6
14.7
14.1 13.4
12.7
12.6
12.1
11.2
10.5
10.3
9.6
9.3
8.9
8.7
8.1
7.7
7.0
6.6
5.6
5.1
4.9
4.8 4.7
3.9 4.33.74.2
3.2
2.7
2
4
2
to y-o-y inflation
2.7
0
-2
0
12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4
2008
2009
2010
2011
Consumer prices
CPI excluding energy, food, alcohol and cigarettes
Targeted inflation
Tolerance band
1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 8 9 101112 1 2 3 4
2010
2011
2012
Industrial products excluding food and energy
Unprocessed food
Processed food
Energy
Services
Consumer prices (%)
Excluding a substantial increase in prices of eggs, food prices continued to have a disinflationary
effect in the first quarter.
By contrast, a more notable push to consumer price growth came from an increase in prices of
petroleum products on the back of rising global oil prices early in the year, and prices of cigarettes
5
following the regular adjustment of excises to consumer price growth in the prior year. In the year to
date, there have been almost no increases in administered prices.
After reaching minimum level in April 2012, year-on-year inflation is expected to rise at a moderate
pace from May and return towards the target. It will hover close to the upper bound of the target
tolerance band in late 2012 and the first half of 2013 and thereafter fall back towards the target.
In the second quarter of 2012, with the coming of the new agricultural season, inflation growth will
be driven primarily by rising prices of fruit and vegetables. Our expectations are based on the fact
that these prices are currently low because of a drop in the prior season and that there will be some
scope for their increase even if the new agricultural season turns out to be average.
Moreover, we expect that the absence of administered price growth in the year to date will be
compensated after the formation of the future government, which will impact on growth in headline
inflation in that period. Over the medium term, however, it is likely that growth in administered
prices will slow down from earlier years as they come close to their economically sustainable level.
After reaching their historical high in euros early in the year, global oil prices have been vigorously
declining since the beginning of April, and are likely to generate a disinflationary effect over the
coming months.
In addition, given the high unemployment rate and a modest outlook for economic growth in both
Serbia and its major foreign trade partners, we estimate that low aggregate demand will weigh down
on price growth in the coming period. The expected fiscal consolidation measures of the future
government will work in the same direction.
Another reason for deceleration in price growth are lower inflation expectations which over the last
eight months have fallen by around 2 percentage points.
Growth in import prices driven by past weakening of the dinar may generate inflationary pressures. It
is, however, probable that importers will react rather by cutting their margins in an environment of
low demand than by raising prices. Furthermore, if the expected fiscal consolidation measures of the
future government turn out to be intensive enough, they may strengthen the dinar and push down
import prices in autumn.
However, overall, the coming of the new agricultural season, the past rise in import prices and
sharper administered price growth after the formation of the future government will (despite low
aggregate demand) lead inflation closer (at a moderate pace) to the upper bound of the target
tolerance band by the end of the current and in the first half of the next year. Thereafter, inflation is
expected to gradually return towards the target.
6
Chart 17 Short-term inflation projection
(y-o-y rates, in %)
Chart 18 Inflation projection
(y-o-y rates, in %)
16
14
14
12
12
10
10
Projection
8
8
6
6
4
4
2
0
2
6
2011
7
8
9
10
11
12
1
2
3
4
5
6
2012
3 6
2010
9
12
3 6
2011
9
12
3 6
2012
9
12
3 6
2013
9
12
3
2014
The key risks to this projection are associated with the future government’s fiscal policy,
developments in the international environment and movements in food and administered prices.
At a time when financial markets are highly sensitive to indicators of public debt sustainability, the
absence of fast and vigorous fiscal consolidation measures of the future government may produce
inflationary consequences through rising risk premium and elevated depreciation pressures.
If on the other hand, fiscal consolidation measures involve VAT hikes, this will bring about a one-off
temporary rise in prices, but in the medium-run inflationary pressures would weaken owing to the
strengthening of the dinar and falling risk premium.
Movements in the risk premium and the exchange rate, including the speed of Serbia’s economic
growth, will also be affected by developments in the euro area, which still faces numerous challenges
as financial markets react vehemently to every unfavourable piece of news.
Risks acting in both directions, associated with coming of the new agricultural season, are present in
this period of the year as well. Weather conditions and movements in world prices of agricultural
products will have a significant impact on trends in these prices in the domestic market and
therefore on cost-push pressures on food prices.
Uncertainties also prevail in terms of administered price movements, i.e. the speed at which the
future government and local government authorities will remove the disparities in the pricing of
services under their remit.
***
Since January 2012, the Executive Board of the National Bank has not revised the key policy rate
which currently stands at 9.5%. However, given the inflation projection, a decision was made in April
to reduce the reserve requirement ratio from 30% to 29% on liabilities with the maturity of up to two
years, and from 25% to 22% for the maturity over two years. At the same time, the dinar portion
allocated against foreign exchange reserve requirements was raised by 5 percentage points for all
7
maturities. The aim of this measure was to contribute to moderate stabilisation of inflation
movements and developments in the foreign exchange market, to slightly reduce the costs of bank
funding and stimulate banks to use long-term sources of funding. All of the above is likely to have a
positive impact on financial stability.
The future path of the key policy rate will depend primarily on the pace and intensity of fiscal
consolidation to be undertaken by the future government. Price and financial stability can be
delivered at a lower degree of monetary restrictiveness provided fiscal consolidation and structural
reforms are more intensive and effective.
8