1

Macroeconomic DevelopmentsMacroeconomic Developments,, January January – – MarchMarch 2006 2006

Radovan Radovan JelašićJelašić – – Governor Governor

BelgradeBelgrade,, May May 8,8, 2006 2006

2

• 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

ContentsContents

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• 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 with increased 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.

SummarySummary

4

New measures of the NBS New measures of the NBS (1/2)(1/2)

I. 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%)

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New measures of the NBS New measures of the NBS (2/2)(2/2)

II. Credits to households have been limited to 200% of share capital;

Reasons:

• Growth of lending to households remains 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;

III. 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);

IV. 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%.

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Following a relatively high level of 2.2% in the first three months, and 1.8% in 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%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.

Annual Inflation Rates(in % )

17.7

7.8

14.813.7

15.6

2002 2003 2004 2005 Apr-06

Monthly and Year-on-year Inflation(in % )

1.1

1.7

1.2

2.2

0.4

1.4

0.3

1.8

0.8

0.5

1.10.9

0.50.4

0.8

0.4

0.80.8

1.1

2.0

1.2

0.9

1.3

0.6

2.1

0.0

0.5

1.0

1.5

2.0

2.5

Apr May Jun-05 July Aug Sept Oct Nov Dec Jan Feb Mar-06 Apr

13.0

14.0

15.0

16.0

17.0

18.0

19.0

Retail prices Core inflation Year-on-year retail price growth rates

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The level of May inflation will be determined primarily byThe level of May inflation will be determined primarily by

• 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

agricultural products due to

floods

• 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.

?%

May

inflation

8

World oil price movements have had substantial inflationary effects this year as World oil price movements have had substantial inflationary effects this year as

well, and not only in Serbiawell, 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.

1.8

2.0

2.2

2.4

2.6

2.8

3.0

3.2

3.4

3.6

2003 2004 2005 Април 06

*Average price in 2004 was USD 37 per barrel, compared to only USD 23 per barrel in 2001.

Inflation Rate in the USA and Eurozone

Eurozone

USA

Daily Ural Oil Prices (in USD)

54

56

58

60

62

64

66

68

4 11 18 25 1 8 15 22 2 9 16 23 30 6 13 21

January February March April

9

• The structure of capital inflow in the first three months of 2006 is 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).

First-quarter capital inflow of EURFirst-quarter capital inflow of EUR 984 984 millionmillion* * considerably exceeds current considerably exceeds current

payments deficitpayments deficit

* Including grants; without grants, capital inflow is EUR 946 million..

-1,360 -1,382-2,275

-1,679

908 9491,631 1,889508

1,221777

1,191

-2,500

-1,500

-500

500

1,500

2,500

3,500

2002 2003 2004 2005

in EUR million

Borrow ing

Current account

Foreign direct investments

Source:NBS.

Foreign exchange reserves

-330 -478

249625262

179

-600-400-200

0200400600800

Iquarter2005

Iquarter2006

in EUR mln

Borrowing

Foreign exchange reserves

Current account

Foreign direct investments

Capital Inflow 2002 – 2005 Capital inflow I quarter 2005 and I quarter 2006

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Continuing export growth of 25% is a bright spotContinuing export growth of 25% is a bright spot within thewithin the current accountcurrent 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%.

Export and Import Movements by Quarters

0

500

1,000

1,500

2,000

2,500

3,000

Export Import Export Import Export Import Export Import

2004 2005 2006

I quarter* II quarter III quarter IV quarter

in EUR mln

+25%+27%

-8%

+35%

+37%

+6%

+13%

+18%

+13%

-5%

Source: NBS.

* Both export and import in I quarter of 2005 represent a deviation, due to VAT introduction on January 1, 2005.

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Total foreign debt continues to grow, exclusively as the result of increase in Total foreign debt continues to grow, exclusively as the result of increase in

private debt to the Paris Clubprivate debt to the Paris Club

• 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).

Level and Structure of Republic of Serbia Foreign Debt*

0

2

4

6

8

10

12

14

2002 2003 2004 2005 31.03.2006

0

5

10

15

20

25

30

35

40

45

50

55

60

65

Share in GDP (right scale)

in EUR bln

65.7% 64.3% 59.7% 50.8%

25,8% 27,2% 32.3%

42,0%

in %

8.9 9.19.9

12.5

8.6% 8.5% 8.1% 7.1%

Private debt

Public debt

Kosovo and Metohija

13.3

44,6%

48,5

6,9%

Source: NBS.

Republic of Serbia Public Foreign Debt*

5.8 5.8 5.9

6.4 6.5

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

2002 2003 2004 2005 Mar-06

in EUR bln

Republic of Serbia Private Foreign Debt

2.3 2.53.2

5.35.9

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

2002 2003 2004 2005 Mar-06

in EUR bln

In USD bln 9,3 11,3 13,4 15,8 16,1

* The chart does not show the CSD 700 million write-off of debt to the Paris Club.

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GDP growth in 2005 was 6.3%GDP growth in 2005 was 6.3%

Real GDP Growth by Quarters in 2004 and 2005

7.5

5.5

9.5

14.2

9.3

5.6

7.36.4 5.9 6.3

0

2

4

6

8

10

12

14

16

I II III IV Total

in %

2004 2005Source: RSO.

•In the I 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;

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Via the banking sector, capital inflow enabled a rise in banks’ lending activityVia the banking sector, capital inflow enabled a rise in banks’ lending activity

Lending Activity Growth (in CSD billion)

27.2 25.5

40.3

57.2

46.5

Source: NBS.

19.9%

80.1%

49.8%

50.2%

38.8%

61.2%

49.9%

50.1%

35.3%

64.7%Legal entities

Households

• 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.

I quarter II quarter III quarter IV quarter I quarter

2005 2006

14

First-quarter growth of average wages in Serbia was accelerated – real wages 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)grew by 11.0% relative to I quarter of 2005 (6.8% last year)

Average Real Net Wages

0

2

4

6

8

10

12

14

16

18

20

12 2003.

3 6 9 2004.

12 3 6 9 2005.

12 3

Year-on-year growth

Тренд

Source: RSO.

у %

Year-on-year growth in real wages has outstripped productivity growth,

leading to higher unit labour costs and pressure on prices.

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Public sector wages also witnessed stepped-up growth – rising by 6.0% in real Public sector wages also witnessed stepped-up growth – rising by 6.0% in real

terms (2.2% last year)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.

Average Real Net Wages in the Public Sector

-10

-5

0

5

10

15

20

25

30

35

40

12 2003.

3 6 2004.

9 12 3 6 2005.

9 12 3 2006

Year-on-year growth

Тренд

Source: RSO.

in %

16

Labour costs and productivity go up, but employment goes downLabour 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%

Productivity and Real Wages in Industry

60

70

80

90

100

110

120

130

1 3 5 7 2003

9 11 1 3 5 7 2004

9 11 1 3 5 7 2005

9 11 1 2006

Productivity Real gross wagesSource: RSO.

17

The NBS pursues an exchange rate policy that offsets both effects on inflation The NBS pursues an exchange rate policy that offsets both effects on inflation

and balance of paymentsand 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 pressure

of 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).

Retail Prices and Dinar Exchange Rate* by Quarters in 2005 and 2006

-1.6

5.25.1

2.8

3.6

2.2

-0.9

-2.7-2.1 -2.3

0.3

-2.2

-0.2

3.8

0.3

-4.0

-2.0

0.0

2.0

4.0

6.0

I II III IV I

2005 2006

in %

Retail prices Nominal euro exchange rate Real effective exchange rate***Negative rate means depreciation, and positive apreciation of the dinar.** Real effective exchange rate calculated based on currency basket.Source: NBS and RSO.

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The role of the market in determining the exchange rate is slowly but steadily The role of the market in determining the exchange rate is slowly but steadily increasingincreasing

• 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!

Nominal Exchange Rate of the Euro Against the Dinar

-1

-0.8

-0.6

-0.4

-0.2

0

0.2

0.4

0.6

0.8

1

July August September October November December January February March

2005 2006

83.0

83.5

84.0

84.5

85.0

85.5

86.0

86.5

87.0

87.5

88.0

Daily changes* Exchange rate

in %

* Negative rate means appreciation, and positive depreciation of the dinar. Source: NBS.

in USD

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The NBS encourages the development of the interbank foreign exchange market, The NBS encourages the development of the interbank foreign exchange market,

and the import of its interventions is smaller and smallerand the import of its interventions is smaller and smaller

Sale of Foreign Exchange by the NBS in the IFEM Session and Interbank Trade Outside the IFEM Session

63%

56%

31%

48%

37%

44%

69%

52%

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

2003 2004 2005 Јануар-април 06

у млн ЕУР

Извор: НБС

2,555

3,667

1,292

3,115

Banks-NBS

Banks

• The National Bank of Serbia has accomplished its set objective: in the period January-April 2006the NBS sold only 37% of foreign exchange in the market, and in April only 8%.

92%82%

60%46%

8%

18%

40%

54%

0.0

50.0

100.0

150.0

200.0

250.0

300.0

350.0

400.0

450.0

January 2006 February 2006 March 2006 April 2006

406.1

279.6

345.2

262.3

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• 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%.

Monetary policy Monetary policy

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On May 8, the National Bank of Serbia will effect a new issue of savings billsOn 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

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Financial sectorFinancial 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: Jubanka and 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.

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Thank you!

NBS Call Center

Call free of charge

0800-111-110