VZCZCXRO6813
RR RUEHPOD
DE RUEHBW #1545/01 3190845
ZNR UUUUU ZZH
R 150845Z NOV 07
FM AMEMBASSY BELGRADE
TO RUEHC/SECSTATE WASHDC 1765
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/USDOC WASHDC 0020
RUEHVJ/AMEMBASSY SARAJEVO 0381
RUEHVB/AMEMBASSY ZAGREB 1452
RUEHSF/AMEMBASSY SOFIA 0870
RUEHBM/AMEMBASSY BUCHAREST 0268
RUEHUP/AMEMBASSY BUDAPEST 1130
RUEHSQ/AMEMBASSY SKOPJE 0890
RUEHTI/AMEMBASSY TIRANA 0385
RUEHPOD/AMEMBASSY PODGORICA 0136
RUEHPS/USOFFICE PRISTINA 3718

UNCLAS SECTION 01 OF 04 BELGRADE 001545 
 
SIPDIS 
 
SIPDIS 
DOC FOR 4232/ITA/MAC/EUR/OEERIS/SSAVICH 
 
E.O. 12958: N/A 
TAGS: EFIN ECON EINV SR
SUBJECT: SERBIA: ECONOMIC NUMBERS POINT TO RISKS AHEAD 
 
REF: Belgrade 1061 
 
Summary 
------- 
 
¶1.  According to third quarter data for 2007, 
industrial production in Serbia continues steady 
growth of 5% annually, GDP growth of 7% is expected, 
strong export expansion continues, while import growth 
slowed slightly.  The growing current account deficit 
as a result of the trade deficit and credit expansion 
is unsustainable in the long term and was described by 
Stojan Stamenkovic of the Economics Institute as, "a 
bomb that we are sitting on."  Inflation, as a result 
of booming public consumption and price pressure on 
basic food products, could reach 9.3% this year versus 
earlier projections of 6.5%.  The dinar appreciated 
against the euro due to restrictive monetary policy 
and strong inflow of foreign capital, reaching its 
highest level since October 2004.  End Summary. 
 
First Half 2007 GDP Growth 8% 
----------------------------- 
 
¶2.   GDP growth driven by the services sector in the 
first half of 2007 reached 8%, while it is expected to 
slow down and to be 7% cumulative for all of 2007. 
Overall industrial production grew by 4.7% in the 
first 9 months of 2007 compared to the same period in 
2006 and is expected to reach 5% growth for the whole 
¶2007.  The strongest areas of growth were: food 
processing, electricity production, machinery and 
appliance production, and basic metals production. 
 
Expansionary Fiscal Policy Threatens Macroeconomic 
Stability 
--------------------------------------------- --------- 
------ 
 
¶3.  The government generated revenues of $7.68 billion 
in the first nine months of 2007, which represented a 
10% increase in real terms over the same period in 
¶2006.  The increase came mostly from increased 
consumption (including imports) - improved collection 
of the VAT (17%), excise taxes (9.5%) and customs 
revenues (19%).  Budget expenditures reached $7 
billion in the first nine months, and were up 9% in 
real terms over the same period 2006.  The largest 
public expenditure item was the public wage bill of 
$1.95 billion, up 12% in real terms over the same 
period 2006.  Despite the current budget surplus of 
$672.7 million - from which under IMF methodology one 
must also exclude one-time revenue from the sale of a 
mobile telephone license of $455 million - the 
expansionary fiscal policy threatens macroeconomic 
stability by triggering higher than expected 
inflation, forcing the Central Bank to impose more 
restrictions in the monetary sector. 
 
Monetary Policy Tightening - Restriction on Credit 
Length 
--------------------------------------------- --------- 
--- 
 
¶4.  In an effort to slow down the inflation and 
inflationary pressures, the National Bank of Serbia 
(NBS) increased the reference interest rate at the end 
of August by 0.25% to 9.75% annually, but then 
reversed course and moved it back to 9.5% on October 
¶29.  The NBS also withdrew a total of $618 million 
through repossessing operations in the third quarter 
of 2007 thus increasing the stock of sold securities 
to $3.4 billion at the end of September 2007 - up by 
23% over December 31, 2006.  As a result of 
expansionary fiscal policy and increased salaries, 
strong credit expansion continues - the value of loans 
approved during the whole of 2006 has been exceeded in 
just the first seven months of 2007.  In order to slow 
down credit expansion, especially loans to 
individuals, the NBS adopted a number of measures at 
the end of August.  The least popular of these was the 
 
BELGRADE 00001545  002 OF 004 
 
 
limitation of the repayment period for cash loans to 
two years.  These measures yielded results and 
September credit growth was only $145 million, 
compared to average January-August 2007 monthly growth 
of $365 million. 
 
¶5.  Citizens' confidence in the banking sector has 
grown rapidly and hard currency savings reached $6.2 
billion at the end of September from nearly zero in 
¶2000.  However, confidence in the dinar is low after 
hyperinflation during the 90's and dinar savings 
reached only $174 million at the end September. 
 
2007 Inflation Projections Revised From 6.5 to 9.3% 
--------------------------------------------- ------ 
 
¶6.  NBS efforts to keep inflation down managed to keep 
core inflation near the bottom of the targeted range 
for 2007 of 4-8%. According to NBS projections it will 
be 4.5% by the end of 2007.  However, overall 
inflation, which includes administratively controlled 
prices, already in September had exceeded the 
projected level of 6.5% for the whole 2007.  Finance 
Minister Cvetkovic revised his projection at the end 
of September and stated that 2007 overall inflation 
will be 8.5%.  However, on October 9 the Economic 
Institute's Stamenkovic estimated that inflation would 
climb to 9.3% in 2007.  Stamenkovic added that the 
major cause for inflation was increased demand caused 
by increased wages.  The inflation situation was 
exacerbated by price increases for basic foods (milk, 
bread, cooking oil) which he attributed to increasing 
concentration of ownership of food processing and 
retail outlets, in addition to recent drought-related 
price increases. 
 
Real Average Wage Up By 11% 
--------------------------- 
 
¶7.  The average net monthly wage in September reached 
$521, up 11% in real terms over September 2006.  This 
growth is almost 50% greater than the GDP growth rate, 
and is not balanced by corresponding productivity 
increases.  Public sector wages again led the 
increase, with a monthly average of $560. 
 
January-August Exports Up By 41%, Imports 37%, Deficit 
34% 
--------------------------------------------- --------- 
---- 
 
¶8.  In the period from January-August 2007 the total 
value of exports reached $5.55 billion, an increase of 
41% compared to the same period in 2006, while total 
imports reached $11.14 billion or up 37% from 2006. 
The trade deficit reached $5.59 billion, 34% greater 
than the same period in 2006.  In euro terms the 
growth is somewhat less significant, as the fall in 
the dollar meant that in euro terms, exports grew by 
31%, imports grew by 27%, while the deficit grew by 
24%.  Imports grew due to: 
 
-- imports of oil and gas products which represent 17% 
of the total value of imports and grew by 8%; 
 
-- imports of copper and iron ore, reaching 9.8% of 
total imports and grew by 78%; and due to 
 
-- increased demand, as a result of an increase in 
public and personal consumption (e.g. vehicle imports 
grew by 52% and totaling 8% of imports). 
 
¶9.  Exports grew as a result of: 
 
-- continuing privatization and restructuring of 
companies; 
 
-- expanding trade with CEFTA countries (exports to 
these countries grew by 43% over 2006 and reached $1.8 
billion); 
 
 
BELGRADE 00001545  003 OF 004 
 
 
-- exports of agricultural products (fruit, vegetables 
and wheat) which reached 10% of total exports and grew 
by 53%; 
 
-- a surplus of $80 million in textile trade due to 
preferential treatment by the EU; 
 
-- beneficial terms of trade - Serbia mostly exports 
to euro zone, but much of its imports are priced in 
dollars; and 
 
-- high prices for Serbian raw materials exports. 
 
¶10.  More than half of Serbia's total trade was with 
EU countries.  Serbia had a trade surplus with former 
Yugoslav republics.  The largest trade deficit was 
with Russia, mostly due to imports of oil and gas. 
Key exports from January-August 2007 were: 
 
-- iron and steel ($780 mil.), 
 
-- non-ferrous metals ($458 mil.), 
 
-- fruits and vegetables ($289 mil.), 
 
-- clothes ($272 mil.), and 
 
-- metal products ($260 mil.). 
 
The largest imports were: 
 
-- oil and derivatives ($1.1 billion), 
 
-- road vehicles ($903 mil.), 
 
-- iron and steel ($626 mil.), 
 
-- industrial machines ($570 mil.), and 
 
-- gas ($495 mil.). 
 
Stamenkovic: Current Account Deficit is Unsustainable 
--------------------------------------------- -------- 
 
¶11.  The current account deficit in the period 
January-August 2007 reached $3.76 billion or 78% up 
over the same period last year, mostly due to the 
increased trade deficit.  Out of the $1.64 billion 
difference between 2006 and 2007, $1.28 billion 
represents an increase in the trade deficit.  The 
surplus in the capital balance in January-August 2007 
reached $4.67 billion, but it was 30% lower than in 
the same period 2006.  The major contributors to the 
surplus were new loans of $2.42 billion.  Foreign 
direct investment (FDI) in the period was just $1 
billion compared to $3 billion in the same period 
¶2006.  Jasna Matic, State Secretary in the Ministry of 
Economy, stated on October 27 that 2007 FDI will be 
$2.5 billion less than in 2006 due to the lull in the 
privatization process earlier in the year following 
parliamentary elections in January and the slow 
formation of a new government. [Note: Serbia's net FDI 
figures include a $700 million deduction due to 
Serbian investment in Telekom Republika Srpska]. 
Asked how long the high current account deficit can 
last, Stamenkovic replied "as long as there is enough 
inflow in capital balance to finance this, i.e. as 
long as there is enough FDI."  Thus, according to 
Stamenkovic the situation is not sustainable in the 
long run, and is like "a bomb we are sitting on" and 
could explode unexpectedly if political turbulence 
(such as Kosovo) slows the inflow of FDI. 
 
Dinar Appreciation - The Highest Value since October 
2004 
--------------------------------------------- --------- 
--- 
 
¶12.  On October 26, 2007 the dinar reached its highest 
value (76.86 dinars to the euro) since October 2004. 
Dinar appreciation is "collateral damage" of the 
 
BELGRADE 00001545  004 OF 004 
 
 
current monetary policy and the lack of coordination 
between monetary and fiscal policies.  To keep low 
inflation, the NBS has had to maintain high interest 
rates due to expansionary fiscal policy and credit 
expansion.  Higher interest rates paid by the NBS 
stimulate banks to borrow cheap money abroad and to 
use the money locally to either buy NBS securities or 
lend money in Serbia at higher rates.  The additional 
inflow of hard currency: 
 
-- increases the value of the dinar; 
 
-- increases hard currency reserves (generating net 
losses for the NBS since reserves are kept in low- 
yield foreign securities, while the NBS pays high 
interest rates on domestic securities); and 
 
-- increases NBS losses due to increased repossessing 
operations which reached $545 million in 2006. 
 
Comment 
------- 
 
¶13.  Robust economic growth and FDI have staved off 
threats to Serbia's economic balance over the past 
several years.  With increased demand generated by 
wage increases in the run up to last January's 
elections, there is increasing pressure from import 
growth and inflation.  The current account deficit and 
inflation highlight the fragility of Serbia's economic 
engine.  Serbia is dependent on FDI and foreign 
borrowing and as a result the economy is particularly 
vulnerable to political instability that slows capital 
inflows from abroad.  While the political leadership 
in Belgrade is focused on their immediate political 
goals of maintaining Kosovo, the collateral damage to 
Serbia's economy could be significant if achieving 
these political goals comes at the cost of 
international investor confidence.  A significant dip 
in international investor perception of Serbia's 
attractiveness would threaten economic growth. End 
Comment. 
 
MUNTER