This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 03 BELGRADE 000768 
 
SIPDIS 
 
SENSITIVE 
 
OC FOR 4232/ITA/MAC/EUR/OEERIS/SSAVICH 
 
E.O. 12958: N/A 
TAGS: EFIN ECON EINV SR MW
SUBJECT: CENTRAL BANK TIGHTENS - AGAIN 
 
 
¶1.  SUMMARY:  THE NATIONAL BANK OF SERBIA REACTED TO  APRIL'S 
HIGHER INFLATION BY FURTHER TIGHTENING MONETARY POLICY.   THE 
CENTRAL  BANK  NOT  ONLY  RAISED THE RESERVE  REQUIREMENT  ON 
OVERSEAS  BORROWING  BY BANKS, BUT IT  ALSO  FORMALLY  IMPOSE 
LIMITS  ON BANKS' RETAIL LENDING, TIED TO THEIR BASIC  EQUITY 
CAPITAL.   BANKS COMPLAIN THAT THESE MEASURES WILL  DRIVE  UP 
INTEREST  RATES AND ENCOURAGE CORPORATE CLIENTS TO EVADE  THE 
RESTRICTIONS   ALTOGETHER   BY   BORROWING   OVERSEAS.    THE 
SUBSTANTIAL DETERIORATION IN THE CURRENT ACCOUNT DEFICIT  FOR 
THE  FIRST  QUARTER ALSO PLAYED A ROLE IN THE CENTRAL  BANK'S 
REACTION,  WITH  THE  BANK POINTING TO  A  CLOSE  CORRELATION 
BETWEEN  CONSUMER CREDIT AND IMPORTS. CENTRAL  BANK  GOVERNOR 
JELASIC  REPORTS "ZERO" INTEREST FROM THE IMF IN A  NEW  FUND 
PROGRAM. END SUMMARY. 
 
INFLATION RISING, WHILE CURRENT ACCOUNT DEFICIT WORSENS 
--------------------------------------------- ----------- 
¶2.  APRIL'S  HIGH INFLATION HAS FLATTENED HOPES  THAT  SERBIA 
COULD  ACHIEVE SINGLE-DIGIT INFLATION IN 2006. INFLATION  WAS 
UP  1.8  PERCENT IN APRIL, THUS REACHING 4.1 PERCENT COMPARED 
TO  DECEMBER 2005, AND 15.6 PERCENT IN THE YEAR ENDING  APRIL 
¶30.  QUARTERLY INFLATION WAS THE RESULT OF HIGHER OIL  PRICES 
(0.8   OF   THE   4.1  POINTS),  ELECTRICITY  (0.8   PERCENT) 
AGRICULTURAL PRODUCTS (0.5 PERCENT), WHILE CORE INFLATION WAS 
2.5  PERCENT.  AFTER CONSUMER PRICES ROSE BY 17.7 PERCENT  IN 
2005,   THE  FINANCE  MINISTER  HAD  PREDICTED  SINGLE  DIGIT 
INFLATION  FOR  2006,  BUT  CENTRAL  BANK  GOVERNOR   RADOVAN 
JELASIC,  IN A MAY 9 MEETING WITH ECON CHIEF, NOTED THAT  THE 
BANK HAD NEVER EMBRACED THAT PREDICTION. 
 
¶3.   AT THE SAME TIME, THE FOREIGN TRADE DEFICIT IN THE FIRST 
QUARTER  OF  2006  WAS UP BY 34.4 PERCENT  COMPARED  TO  SAME 
PERIOD  LAST  YEAR.   HOWEVER, THESE  NUMBERS  GENERALLY  ARE 
CONSIDERED  SUSPECT  BECAUSE THE INTRODUCTION  OF  THE  VALUE 
ADDED  TAX  LAST  YEAR  SHIFTED IMPORTS  INTO  DECEMBER  2004 
INSTEAD  OF  Q1  2005.  EXPORTS WERE UP  BY  A  HEALTHY  27.6 
PERCENT FOR THE FIRST QUARTER.  JELASIC NOTED THAT HE IS  NOT 
WORRIED BY THE CURRENT ACCOUNT RESULTS. 
 
¶4.   JELASIC  SAID  THAT HE FOUND "ZERO" INTEREST  IN  A  NEW 
PROGRAM WHEN HE MET WITH THE IMF WHILE IN WASHINGTON IN  LATE 
APRIL FOR THE ANNUAL MEETINGS. HE SAID THE FUND REGARDED  THE 
LAST  PROGRAM AS LESS THAN SUCCESSFUL, GIVEN HIGH  INFLATION, 
AND  WAS  NOT  EAGER  TO TRY AGAIN.  AND THE  FUND  WOULD  BE 
LOOKING  FOR  AN AMBITIOUS PROGRAM WITH REGARD TO  STRUCTURAL 
REFORM,  EVEN IF SERBIA PUSHED FOR A PROGRAM.  THE FUND  ALSO 
COULD SEEK A REVISED 2006 BUDGET TO COPE WITH INFLATION. 
 
 
CENTRAL BANK AGAIN SEEKS TO CURB CREDIT GROWTH 
--------------------------------------------- -- 
 
¶5.  THE  NBS FACED A DIFFICULT TASK AS IT TRIED TO  STERILIZE 
RISING  INFLOWS OF FOREIGN CURRENCY OVER THE LAST 12  MONTHS. 
JELASIC  SAID  THAT  THE  BANK TOOK IN  ANOTHER  612  MILLION 
DOLLARS  IN  THE  FIRST  QUARTER,  WITH  THE  CENTRAL  BANK'S 
RESERVES NOW UP TO USD 6.4 BILLION, DESPITE A DECLINE IN  THE 
BANK'S INTERVENTION IN THE FOREIGN EXCHANGE MARKET. IN  2005, 
CAPITAL  INFLOWS AMOUNTED TO 3 BILLION EUROS (57  PERCENT  OF 
M3), AND THAT TENDENCY CONTINUED IN THE FIRST QUARTER OF 2006 
WITH AN INFLOW OF 804 MILLION EUROS. ONE NEGATIVE DEVELOPMENT 
IS  THE HIGH SHARE OF DEBT IN THE TOTAL CAPITAL INFLOW,  FROM 
61  PERCENT  OF  FLOWS  IN 2005 TO 78 PERCENT  IN  THE  FIRST 
QUARTER. THIS REFLECTS COMMERCIAL BANK BORROWING FROM  PARENT 
COMPANIES ABROAD. 
 
¶6.  THE  RISE  IN  INFLOWS WAS MATCHED BY AN ACCELERATION  IN 
CREDIT  GROWTH.   IN  THE  PERIOD  JANUARY-MARCH,  COMMERCIAL 
BANKS'  CREDITS  INCREASED  BY USD  646  MILLION,  I.E.  11.3 
PERCENT  (CONSUMER  LENDING BY 13.1  PERCENT,  AND  CORPORATE 
LENDING,  10.5 PERCENT). IN THE SAME PERIOD OF  2005,  CREDIT 
GROWTH  WAS  10.6  PERCENT  (CONSUMER  LENDING  8.4  PERCENT, 
CORPORATE LENDING 11.3 PERCENT). 
 
¶7.  ALTHOUGH  THE  CENTRAL  BANK  HAD  JUST  INTRODUCED  MORE 
RESTRICTIONS  ON  MARCH  30,  IT  REACTED  AGAIN  ON  MAY  8; 
JELASIC  TOLD  ECON CHIEF THAT HE WAS FORCED TO  ACT  BY  THE 
WORSENING  INFLATION NUMBERS.  THESE MEASURES WERE  TAKEN  IN 
ANTICIPATION  OF MORE INFLATIONARY PRESSURES IN MAY,  JELASIC 
SAID,  INCLUDING A FURTHER OIL PRICE INCREASE OF 4-5 PERCENT, 
A TELEPHONE PRICE INCREASE OF 10 PERCENT, AND A SEASONAL RISE 
OF  AGRICULTURAL PRICES.  JELASIC SAID THAT HE COULD NOT WAIT 
FOR  MORE  DATA, ESPECIALLY AFTER READING IN A  RECENT  FITCH 
RATING THAT SERBIA HAS THE SECOND HIGHEST INFLATION AMONG  98 
COUNTRIES IT RATES. 
 
 
¶8. THE CENTRAL BANK MEASURES INCLUDE: 
 
--   AN  INCREASE  OF  THE  RESERVE  REQUIREMENT  ON  FOREIGN 
BORROWING  AND FOREIGN EXCHANGE DEPOSITS OF UP TO TWO  YEARS, 
FROM  40  TO 60 PERCENT; THE CENTRAL BANK CITED THE  JUMP  IN 
BANKS'  SHORT TERM EXTERNAL BORROWING,   WHICH ALMOST TRIPLED 
OVER LAST 12 MONTHS TO EURO 2.4 BILLION (11 PERCENT OF GDP). 
-- HOUSEHOLD LENDING WILL BE LIMITED TO 200 PERCENT OF BANKS' 
EQUITY  CAPITAL, WITH A PHASE-IN BY SEPTEMBER 30. THE CENTRAL 
BANK  CITED THE HIGH GROWTH OF CREDITS TO HOUSEHOLDS, AS WELL 
AS  THE  HIGH  CORRELATION BETWEEN CONSUMER CREDITS  AND  THE 
CURRENT ACCOUNT DEFICIT. 
--  BANKS WILL BE OBLIGED TO PROVIDE ADDITIONAL CAPITAL OF 25 
PERCENT  FOR LOANS THAT EXCEED 10 MILLION DINARS  IN  FOREIGN 
CURRENCY,  OR  LINKED  TO  A  FOREIGN  CURRENCY,  UNLESS  THE 
BORROWER HAS ADDITIONAL SECURITY AGAINST EXCHANGE RATE  RISK, 
SUCH AS FOREIGN EXCHANGE REVENUES. 
--  ON  MAY 15, A SECOND ROUND OF NBS SAVINGS BILLS  WILL  BE 
ISSUED TO RETAIL CUSTOMERS IN THE AMOUNT OF USD 14.3 MILLION, 
WITH AN ANNUAL INTEREST RATE OF 24 PERCENT. 
 
¶9.   JELASIC DEFENDED THE MEASURES BY ARGUING THAT BANKS  ARE 
FREE TO CONTINUE CONSUMER LENDING AS LONG AS THEY ARE WILLING 
TO  INCREASE  THEIR EQUITY. HE NOTED THAT ONE TARGET  OF  THE 
MEASURES  WAS  THE PRACTICE OF CERTAIN BANKS  TO  FUND  THEIR 
LENDING VIA SHORT-TERM DEPOSITS FROM PARENT BANKS.  THE  BANK 
HOPES  TO PROMOTE A GREATER RELIANCE ON DOMESTIC DEPOSITS  TO 
FINANCE LENDING, SINCE THEY REMAIN SUBJECT TO A LOWER RESERVE 
REQUIREMENT  OF 40 PERCENT.  WHEN ECON CHIEF ASKED  WHEN  HOW 
THE  BANK  PROPOSED TO EXIT FROM SUCH QUANTITATIVE LIMITS  ON 
RETAIL  LENDING,  JELASIC  SAID  THAT  THE  LIMITS  COULD  BE 
ADJUSTED OVER TIME AS CONDITIONS WARRANT. 
 
¶10. THE TIGHTENING PROVOKED VOCAL OPPOSITION AMONG COMMERCIAL 
BANKS.  JUST TWO DAYS AFTER THE NATIONAL BANK INTRODUCED  THE 
MEASURES, GERMAN-AUSTRIAN HVB BANK ANNOUNCED THAT IT WOULD BE 
FORCED  TO  INCREASE  RATES  ON ALL  RETAIL  CREDITS,  EXCEPT 
MORTGAGES.  ANNUAL INTEREST RATES FOR CONSUMER  CREDITS  WILL 
RISE TO 14.77 PERCENT. ALEXANDER PICKER, HVB GENERAL MANAGER, 
SAID  HIS  BANK  WOULD FEEL THE PINCH IMMEDIATELY,  SINCE  IT 
ALREADY  IS  AT THE 200 PERCENT LIMIT FOR RETAIL  LENDING  IN 
RELATION  TO  EQUITY.   OTHER BANKS, WHICH  ARE  MORE  HIGHLY 
LEVERAGED, WOULD BE HIT HARDER, HE SAID.  THE CENTRAL  BANK'S 
APPROACH IS NOT MARKET-BASED, HE COMPLAINED. 
 
¶11.  THE  HEAD  OF  THE MANAGEMENT BOARD OF RAIFFEISEN  BANK, 
BUDIMIR  KOSTIC,  AGREED THAT THE LATEST MEASURES  WILL  PUSH 
BANKS TO RAISE INTEREST RATES BY 2-2.5 PERCENTAGE POINTS.  HE 
ARGUED   THAT   THE  CENTRAL  BANK'S  POLICY  WILL   DECREASE 
COMPETITIVENESS BY INCREASING COSTS TO THE CORPORATE  SECTOR. 
KOSTIC,  WHO  ALSO IS THE HEAD OF THE SERBIAN ASSOCIATION  OF 
BANKS,  WARNED THAT THE CENTRAL BANK'S TOUGH MONETARY  POLICY 
HAD  FAILED  TO  CURB INFLATION OVER THE PAST TWO  YEARS.  HE 
ATTRIBUTES HIGHER INFLATION TO LOW PRODUCTIVITY, HIGH  PUBLIC 
SPENDING  AND  FUEL PRICE HIKES, RATHER THAN LENDING  TO  THE 
ECONOMY. 
 
¶12.  MOST  OF  THE COMMERCIAL BANKS, AT LEAST MARKET  LEADERS 
SUCH  AS  RAIFFESEN BANK AND HYPO ALPE ADRIA BANK, GRUDGINGLY 
ACKNOWLEDGE  THAT  THE  NBS HAS REASON  TO  FOCUS  ON  RETAIL 
LENDING,  BUT THEY ARGUE THE MEASURES SHOULD NOT  TARGET  THE 
CORPORATE SECTOR. THEY WORRY THAT MORE COMPANIES WILL  SIMPLY 
BORROW  OVERSEAS; SOME BANKERS WARNED THAT LOCAL  BANKS  WILL 
SIMPLY  SELL  THEIR LOANS TO THEIR OVERSEAS PARENTS.  AT  THE 
SAME  TIME,  BANKERS AGREE THAT CONSUMERS  WILL  CONTINUE  TO 
BORROW,  DESPITE  HIGHER  RATES, BECAUSE  OF  PENT-UP  CREDIT 
DEMAND. 
 
INFLATION DEBATE CONTINUES 
---------------------------- 
 
¶13. THE CENTRAL BANK AND ECONOMISTS AGREE THAT HIGH AGGREGATE 
DEMAND   IS  CAUSING  BOTH  INFLATION  AND  CURRENT   ACCOUNT 
PRESSURES.  THE DEBATE FOCUSES ON THE EXTENT TO WHICH  DEMAND 
PRESSURE  IS THE RESULT OF RISING PRIVATE CONSUMPTION  DRIVEN 
BY  SURGING COMMERCIAL BANK LENDING, AS OPPOSED TO  THE  HIGH 
LEVEL OF PUBLIC SPENDING AND AN UNRESTRUCTURED PUBLIC SECTOR. 
 
¶14. ALTHOUGH SERBIA RECORD A BUDGET SURPLUS OF 2.2 PERCENT OF 
GDP  IN  2005 AND PROJECTS A 1.3 PERCENT SURPLUS  THIS  YEAR, 
MANY  BELIEVE  THAT THE HIGH LEVEL OF SPENDING  (CONSOLIDATED 
BUDGET  REVENUES IN 2005 WERE 43.5 PERCENT OF GDP) IS FUELING 
INFLATION.   THE  GOS EXPECTS A PRIVATIZATION  WINDFALL  THIS 
YEAR,  WITH ADDITIONAL REVENUES OF MORE THAN 1 BILLION  EUROS 
EXPECTED  FROM SELLING THE SECOND CELLULAR PROVIDER  AND  TWO 
BANKS.  ALTHOUGH THE GOS PROMISED THE INTERNATIONAL  MONETARY 
FUND  (IMF)  THAT  IT  WOULD  SAVE ALL  ADDITIONAL  REVENUES, 
FINANCE MINISTER DINKIC HAS ARGUED PUBLICLY THAT INFLATION IS 
NOT  A SERIOUS THREAT, WHILE THE NEED TO GENERATE GROWTH  AND 
EMPLOYMENT  THROUGH  PUBLIC WORKS IS MORE  PRESSING.  JELASIC 
WARNED  THAT 1 BILLION EUROS IS 17 PERCENT OF SERBIAN BUDGET; 
SUCH  EXPENDITURES,  EVEN OVER SEVERAL  YEARS,  SURELY  WOULD 
EXACERBATE INFLATION. 
 
¶15.  AT  A  RECENT  ROUNDTABLE IN THE NATIONAL  BANK,  STOJAN 
STAMENKOVIC,  A  PROMINENT  LOCAL MACROECONOMIST,  MAINTAINED 
THAT  HIGH INFLOWS OF FOREIGN CAPITAL ARE THE MAIN  CAUSE  OF 
INFLATION, TOGETHER WITH THE LOW DEGREE OF COMPETITION IN THE 
RETAIL  SECTOR.  ON  THE  OTHER HAND, VLADIMIR  GLIGOROV,  AN 
ANALYST  WITH THE VIENNA INSTITUTE FOR INTERNATIONAL ECONOMIC 
STUDIES,  ARGUES THAT ALL OTHER COUNTRIES IN THE REGION  HAVE 
FACED  SIMILIAR INFLOWS, ALONG WITH SIMILAR PROBLEMS SUCH  AS 
THE  GROWTH  OF SALARIES ABOVE PRODUCTIVITY AND  EUROIZATION, 
BUT ALMOST NONE OF THEM HAVE SUFFERED SUCH INFLATION. HE LAYS 
THE BLAME ON HIGH PUBLIC EXPENDITURES. 
 
¶16.  ON  THE OTHER HAND, SOME ECONOMISTS CLAIM THAT  NATIONAL 
BANK  SHOULD  FURTHER TIGHTEN THE MONETARY  POLICY,  TO  CURB 
DEMAND  AND  INFLATION.   STAMENKOVIC  EVEN  SUGGESTED   THAT 
ADMINISTRATIVE  MEASURES  FOR LIMITING  THE  FOREIGN  CREDITS 
SHOULD  BE  CONSIDERED. HE PROPOSED LIMITS  ON  FOREIGN  DEBT 
CONNECTED  TO A BANK'S EQUITY CAPITAL, ALONG WITH A  DECREASE 
OF THE REQUIRED RESERVE ON DOMESTIC DEPOSITS FROM THE PRESENT 
40 PERCENT. 
 
RISING CURRENT ACCOUNT DEFICIT AND EXCHANGE RATE 
--------------------------------------------- ---- 
 
¶17.  THE  CENTRAL BANK ALSO IS CLOSELY WATCHING  THE  CURRENT 
ACCOUNT.  THE FOREIGN TRADE DEFICIT IN THE FIRST  QUARTER  OF 
2006 WAS 34.4 PERCENT HIGHER THAN IN THE SAME PERIOD OF 2005, 
BUT ABOUT 10 PERCENTAGE POINTS LOWER THAN THE SAME PERIOD  OF 
¶2004.  HOWEVER, JELASIC, POINTING TO THE DISTORTION OF  EARLY 
2005  RESULTS  BY  IMPOSITION OF  A  VAT,  SAID  HE  WAS  NOT 
ESPECIALLY WORRIED BY THE FOREIGN TRADE NUMBERS. 
 
¶18.  THE  POSITIVE DEVELOPMENT OF EXPORTS, UP BY 27.6 PERCENT 
IN  THE  FIRST QUARTER, CONTINUED DESPITE DINAR APPRECIATION. 
(THE  DINAR  APPRECIATED IN REAL TERMS 3.5 PERCENTAGE  POINTS 
RELATIVE TO THE EURO.)  THIS INDICATES THAT THE LOW RATIO  OF 
EXPORTS TO GDP (ABOUT 20 PERCENT IN 2005) IS MORE THE  RESULT 
OF  STRUCTURAL  WEAKNESSES IN THE ECONOMY.  JELENA  PETKOVIC, 
THE  GENERAL  MANAGER  OF TIGAR CORPORATION,  SERBIA'S  THIRD 
LARGEST  EXPORTER, SAID THAT TIGAR WOULD NOT EXPORT  MORE  IF 
THE  EXCHANGE  RATE  HAD  BEEN DIFFERENT,  ALTHOUGH  SHE  DID 
EXPRESS CONCERN OVER INFLATION. 
 
¶19. THE CURRENT ACCOUNT DEFICIT FOR THE FIRST QUARTER REACHED 
EURO 478 MILLION, WELL BELOW THE FOREIGN CAPITAL INFLOW (EURO 
804  MILLION).  HOWEVER,  THE FINANCING  WAS  THROUGH  RISING 
INDEBTEDNESS. 
 
¶20.  ECONOMISTS  AND  BANKERS AGREE THAT  THE  EXCHANGE  RATE 
SHOULD  BE  SET BY THE MARKET, THAT DINAR SHOULD  BE  LET  TO 
APPRECIATE.   HOWEVER, JELASIC SAID THAT THE BANK IS STEADILY 
DECREASING ITS INTERVENTION IN THE FOREIGN EXCHANGE MARKET BY 
LOWERING ITS PURCHASES FROM EXCHANGE BUREAUS. DATA BEARS  OUT 
HIS  ASSERTION;  THE NBS SHARE OF FOREIGN EXCHANGE  PURCHASES 
FROM  RETAIL  EXCHANGE DEALERS DECREASED FROM 55  PERCENT  IN 
2005  TO 44 PERCENT IN THE FIRST QUARTER.  JELASIC SAID  THAT 
THE  BANK MORE AND MORE WAS FINDING DEMAND FOR EURO  WEAK  IN 
ITS  FIXING SESSIONS, WITH COMMERCIAL BANKS UNDERCUTTING  THE 
CENTRAL BANK'S RATE. 
 
¶21.  ECONOMIC ANALYSTS AGREE THAT CAPITAL OUTFLOWS SHOULD  BE 
LIBERALIZED  TO PERMIT THE MARKET TO DETERMINE  THE  EXCHANGE 
RATE  AND TO RELIEVE THE PRESSURE FROM HARD CURRENCY INFLOWS. 
ACCORDING TO JELASIC, THE NATIONAL BANK WILL NOT INTERVENE TO 
STOP  DINAR APPRECIATION, BUT STILL WILL NOT FULLY LIBERALIZE 
CAPITAL OUTFLOWS BY ENDING RESTRICTIONS FOR INDIVIDUALS. 
 
POLT