Macroeconomic Developments , January – March 2006 Radovan Jelašić – Governor

1. Macroeconomic Developments, January – March 2006 Radovan Jelašić – Governor Belgrade, May8, 2006

2. Contents • Inflation and new measures of the NBS • Capital inflow and external position • Capital inflow and monetary aggregates’ growth • Economic growth • Lending activity • Wages and productivity • Exchange rate policy • Monetary policy • Financial sector

3. Banks’ lending continued to grow strongly in the period January-March 2006: credit sum rose by CSD 46.5 billion or 11.3% (+CSD 30 billion for legal entities and +CSD 16.5 billion for households); • Economy shows clear signs of overheating; swelling aggregate demand retains economic activity on a high level, but cannot entirely reflect on the growth in supply, placing pressure on inflation; • The NBS has reacted both through a tighter monetary policy in the past six months (interest rate and reserve requirement hikes) and through stricter supervisory measures; • In the first quarter of 2006, the formation of the dinar exchange rate was determined chiefly by high supply of foreign exchange influenced strongly by growing external borrowing; • The measures taken yielded results in the form of inflation slowdown in the first quarter of 2006; • As the effects of exogenous factors (growing costs of imported inputs, expected weaker supply of agricultural products etc.), coupled withincreased borrowing in the first quarter, threaten to place at risk the initially firmer price stability, the NBS continues to pursue a still more restrictive monetary policy. Summary

4. New measures of the NBS (1/2) • Reserve requirement on foreign borrowing and foreign exchange deposits of up to 2 years will be raised from 40% to 60% as of May 10 this year. Reasons: • Banks’ short-term external borrowing currently amounts to EUR 946 million, and has close to tripled in the past 12 months; • Attractive repo interest rates ought to ensure: a) larger sterilization; b) wider range of dinar products, rather than inflow of speculative capital • Banks are channeled towards collecting domestic savings deposits, in the case of which reserve requirement remains unchanged (foreign exchange : 40%, dinar 18%)

5. New measures of the NBS (2/2) • Credits to households have been limited to 200% of share capital; Reasons: • Growth of lending to householdsremains high; • High level of correlation between consumer credits and import (current account deficit): Credits with state guarantees (e.g. agriculture, housing construction, etc.) will be exempted; • The obligation to provide additional capital of 25% for credits which exceed CSD 10 million approved in foreign exchange, or in dinars with a foreign currency clause, unless the borrower has additional security against exchange rate risk (forward purchase of foreign exchange, foreign exchange inflow); • May 15 – the second issue of NBS savings bills in the amount of CSD 1.0 billion, with maturity of 6 months, and p.a. interest rate of 24%.

6. Following a relatively high level of 2.2% in the first three months, and 1.8% in April, inflation has reached a total of 4.1% • Major contributors (in percentage points) to retail price growth in the first four months were: • Petroleum products 0.8% • Electricity 0.8% • Agricultural products 0.5% • Core inflation amounted to 2.5% in the first four months. Although in February it dropped to its lowest since May 2004, in March in doubled on the back of an energy price shock.

7. The level of May inflation will be determined primarily by • The strengthening of the dinar in March and April, and the March decline in money supply will have a stabilizing effect on prices; • New measures of the National Bank of Serbia. • Rise in prices of petroleum products in the range of 4.5 to 5%; • Rise in prices of telephone services (10%); • Somewhat higher-than-expected rise in prices of agriculturalproducts due to floods ?% May inflation

8. Daily Ural Oil Prices (in USD) 68 66 64 62 60 58 56 54 4 11 18 25 1 8 15 22 2 9 16 23 30 6 13 21 January February March April World oil price movements have had substantial inflationary effects this year as well, and not only in Serbia • The price of Ural oil (which we import) has soared by as much as 25% in the past month to the present USD 68 per barrel*; • Aside from having direct impact on inflation through rising prices of petroleum products, there is also a strong cost effect on other prices; • All central banks fight inflation by raising interest rates (FED has raised rates for 15 successive times, and is expected to do so for the 16th time this week); • In order to reduce inflation, additional restrictions in the form of cuts in public spending are always welcome– to observe the budget, and spending on wages, represents an absolute minimum. Inflation Rate in the USA and Eurozone USA Eurozone *Average price in 2004 wasUSD 37 per barrel, compared to only USD 23 per barrel in 2001.

9. First-quarter capital inflow of EUR 984 million* considerably exceeds current payments deficit Capital Inflow 2002 – 2005 Capital inflowI quarter 2005 andI quarter 2006 • The structure of capital inflow in the first three months of 2006is deteriorating – foreign direct investments are marginally lower than the year before, while borrowing is on the rise – we are living on credit! • A part of new borrowing in the period January-March 2006 will “transform” into FDI, but this will depend on further economic and political development of the country; • Capital inflow above current account deficit fuels demand to the extent it is monetized (in the first quarter of 2006 – additional sterilization through repo operations was CSD 15.8 billion, and through reserve requirement CSD 25.6 billion). * Including grants; without grants, capital inflow is EUR 946 million..

10. Continuing export growth of 25% is a bright spotwithin thecurrent account • First-quarter coverage of import by export of goods and services was 53.3%; • The coverage in the entire year 2005 was 52.8%. * Both export and import in I quarter of 2005 represent a deviation, due to VAT introduction on January 1, 2005.

11. Total foreign debt continues to grow, exclusively as the result of increase in private debt to the Paris Club In USD bln 9,3 11,3 13,4 15,8 16,1 • USD/EUR relation has strong impact on total debt (debt in USD terms rose more than debt in EUR terms in the period December 31, 2005-March31, 2006 due to changes in the EUR/USD relation from 1.1839 to 1.2077). * The chart does not show the CSD 700 million write-off of debt to the Paris Club.

12. GDP growth in 2005 was 6.3% • In theI quarter of 2006, relative to the same period in 2005, industrial production recorded a 5.7% growth, whereas the processing sector recorded a relatively high growth of 8.0%; • Key contributors behind this growth are the production of basic metals, tobacco, food products and motor vehicles;

13. Via the banking sector, capital inflow enabled a rise in banks’ lending activity I quarter II quarter III quarter IV quarter I quarter 2005 2006 • In the first three months of 2006, credits to the corporate sector and households increased by CSD 46.5 billion (11.3%); the bulk of this increase refers to corporate credits (+CSD 30 billion); • In contrast to the slowdown in the annual growth rate of monetary aggregates – reserve money (18.9%), money supply in the narrower (26.1%), and money supply in the broader sense (44.4%) – annual growth rate of lending to nonmonetary sectors gained speed, amounting to 58.2% in March, • For the most part, lending activity grew on account of further external borrowing by banks.

14. First-quarter growth of average wages in Serbia was accelerated – real wages grew by 11.0% relative to I quarter of 2005 (6.8% last year) Year-on-year growth in real wages has outstripped productivity growth, leading to higher unit labour costs and pressure on prices.

15. Public sector wages also witnessed stepped-up growth – rising by 6.0% in real terms (2.2% last year) In contrast to the year before, wages in the local government sector have been on a decline in real terms, whereas in other sectors there has been accelerated growth.

16. Labour costs and productivity go up, but employment goes down • The increase in industry real gross wages (13.1% in the first two months) exceeds productivity growth (10.5%), which means that industry unit labour costs gained 2.3%

17. The NBS pursues an exchange rate policy that offsets both effects on inflation and balance of payments • Foreign exchange reserves of the National Bank of Serbia on April 30, 2006 stand at EUR 5.7 billion (USD 7.2 billion); • Through intensified purchases the NBS relieved the pressureof high foreign exchange liquidity on the appreciation of the dinar (in December, March), whereas through intensified sales it relieved pressure on the depreciation of the dinar (in January).

18. The role of the market in determining the exchange rate is slowly but steadily increasing • Substantial daily oscillations reflect market relations; • Banks should develop more efficient risk management and offer such services to clients as well. • Dinar savings are the safest form of savings!

19. 3,667 3,115 2,555 1,292 The NBS encourages the development of the interbank foreign exchange market, and the import of its interventions is smaller and smaller 450.0 Sale of Foreign Exchange by the NBS in the IFEM Session and Interbank Trade Outside the IFEM Session 406.1 400.0 345.2 350.0 18% 300.0 54% 279.6 262.3 Banks-NBS 8% 250.0 40% 200.0 150.0 82% 92% 100.0 46% 60% 50.0 Banks 0.0 January 2006 February 2006 March 2006 April 2006 • The National Bank of Serbia has accomplished its set objective: in the period January-April 2006 • the NBS sold only 37% of foreign exchange in the market, and in April only 8%.

20. Monetary policy • Kein Geld, keinе Inflation – Ottmar Issing, chief economist and founder of the ECB, stated after 16 years as member of the ECB Executive Board; • Due to increased liquidity, the NBS will continue to react by changing the interest rate policy and reserve requirement; • Repo rates should continue to offer banks an alternative, in the form of a lucrative investment in dinars; • Highest increase of the repo rate occurred in November and December by 2% and 3.5% respectively, which led to real yield in the interval of 2.5% to 5%; • NBS again issues savings bills – issue value is CSD 1 billion, maturity 6 months with p.a. interest rate of 24%.

21. On May 8, the National Bank of Serbia will effect a new issue of savings bills • Maturity 6 months; • Issue on May 15, 2006; • Interest rate – 24% p.a.; • Par value of the issue is CSD 1 billion; • Sale will continue at Komercijalna banka counters; • CSD 745.1 million from the previous issue has been sold. All additional information can be obtained by dialing the NBS Call Center free of charge 0800-111-110

22. Financial sector • Banks: • MB banka from Nis had its license revoked; • Supreme Court issued a decision on the illegality of deferring liquidation proceedings in respect of Astra banka; • The request of the NBS for the protection of legality in the matter of Kreditno-eksportna banka was adopted; • Ownership consolidation: Jubankaand АLPHA, Nacionalna stedionica and EFG, Zepter banka and OTR; • Insurance companies: • SIM osiguranje had its license revoked; • Order for the transfer of the portfolio of Prizma osiguranje issued; • Triglav’s interest in Kopaonik osiguranje; • UNIQA’s interest in Zepter osiguranje. • Voluntary pension funds: • Secondary legislation drafted, Securities Commission is expected to issue licenses for portfolio managers – application for examinations until May 20, 2006; • The process of issuing licenses to companies has begun.

23. Thank you! NBS Call Center Call free of charge 0800-111-110