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Inflation in Serbia: from highs to lows, are one digit numbers possible soon?

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As the interest rates of most of the loans approved in Serbia are linked to the movement of the Euribor, we should be very careful when borrowing, says Dr. Dejan Šoškić, professor of the Faculty of Economics and former governor of the National Bank of Serbia (NBS), in an interview for „Nova“. The reason for this is possible changes in Euribor and the exchange rate, which can reduce the debtor’s ability to regularly pay off his credit obligations.

In an interview, Dr. Šoškić explains that Serbia’s public debt has grown by more than nine billion euros since the beginning of the pandemic, which should also be the source of various types of expansive fiscal policy implemented in recent years. It also reveals why basic products are becoming more expensive than official inflation, as well as what will happen to prices when inflation starts to fall.

The governor of the NBS announces single-digit inflation until the end of the year. In your opinion, how realistic is that and what do you expect?

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Unfortunately, lately we often hear estimates from the NBS about future inflation that are not realized in reality. For example, in February 2022 they used to forecast inflation of 3.5 to 4 percent for the end of 2022. In May 2022, they forecast declining inflation from the end of June to the end of the year and further declining inflation in 2023. For August 2023, they forecast that inflation would peak in the third quarter of last year and that, after that, it will decrease sharply until the end of 2022 and in 2023. In November, they predicted that inflation had reached its maximum and that it would gradually decrease in the following period. What was happening in reality was the constant growth of inflation (acceleration of price growth) which is now, despite the freezing of some prices in the last year or more, at a level of more than 16 percent. At the same time, it is already declining in Europe and has fallen to 6.9 percent. Therefore, each of those NBS forecasts turned out to be incorrect.

This is not good for the credibility of that institution. Given that we have agreed to correct electricity and gas prices upwards this year, inflation will not go down so easily and quickly. The correction of the price of electricity and gas should have been done several years ago when inflation was already below the inflation target. From a whole series of examples in recent years, it seems that decisions in the domain of economic policy are made untimely, spontaneously and without sufficient understanding of the causes and consequences for the economy and citizens. I still expect inflation to stop growing further in the next two quarters, but I do not believe it will return to the target level of 3 percent anytime soon.
Will prices fall with falling inflation?

In most cases, no. Only downward price corrections are possible in some cases where prices have gone too high and far from their equilibrium level under new conditions.

How is it possible for the state to claim that inflation is 15-16 percent, and that the prices of meat, milk, and oil (the list is long) have risen by up to 60 percent in stores?

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High inflation in the food sector directly affects the poorest citizens the most. However, it reveals serious weaknesses in the domain of economic policy in agriculture, where it is obvious that there is no effective coordination of the key components of agricultural policy (subsidies, levies, purchase prices, exports, lending, commodity reserves, intervention imports, customs duties). It is also possible that there are speculative and monopolistic structures in the market that, in conditions of inflation, make extra profits and further encourage inflation. In my opinion, if we had strong and independent institutions, many of these problems would not have arisen.

One of the inflation control measures used by the NBS is raising the reference interest rate, which has been in effect since April 2022. Why does this measure seem to be ineffective?

Because most of the loans are in foreign currency. The NBS reference interest rate has an impact only on dinar lending and savings. This is precisely why the NBS, when I worked for a short time in that institution more than ten years ago, advocated for the dinarization of the domestic financial system. Since 2012, no work has been done on dinarization, and it is crucial for strengthening financial stability in the country as well as for strengthening the effectiveness of the tools used by the NBS, especially the reference Interest rates of the NBS.

What would produce results?

A lot of opportunities were missed. The reference rate of the NBS should have been raised already in the summer of 2021, and not just nine months later. The first shock of the rise in world prices should have been absorbed by the rise in the value of the dinar (and we used that tool unnecessarily in 2017, when the only effect was that wages in euros were higher, and debt in relation to GDP was lower). The growth of the reference interest rate of the NBS would have had a much greater effect on reducing inflation if dinarization had been carried out since 2012. In the existing conditions, with the growth of the reference interest rate of the NBS, the conditions for foreign currency lending in the country should have been tightened using other tools of the NBS, which also was not done.

Many economists believe that the state prints excessive amounts of money without any basis and that there is no control. How can we know that the government is printing money?

The relationship between monetary aggregates and GDP should be analyzed. These data do not support the claims that we are in a period of uncontrolled monetary expansion, but it should be borne in mind that in conditions of uncertainty, money can accelerate its circulation through the economic and financial system, which creates a similar effect as if there is more money.

What are the consequences?

The consequences of money creation may or may not be inflationary. As a rule, the first effect of money creation is a fall in interest rates, but after that, due to rising inflation and inflationary expectations, there is a rise in nominal interest rates.

A real exchange rate of the euro should ensure balance in trade (exports and imports) and payments of the country with foreign countries. Serbia has both a trade deficit and a current account deficit. All the countries of Central and Eastern Europe managed to eliminate the deficit in the current part of the balance of payments with foreign countries through reforms and the growth of the competitiveness of their economies. Serbia failed to do so and since 2017 (when the dinar exchange rate strengthened from 124 to 117.5 dinars to the euro), the gap between imports and exports (trade balance deficit) has, unfortunately, grown again. In order for the existing exchange rate to be sustainable in the long term and become realistic, it is necessary to significantly increase the productivity and competitiveness of our economy.

In your opinion, how much did the crisis really affect the standard of living in Serbia?

The standard of living is measured by the average purchasing power of citizens’ incomes. Not their size in dinars or euros, but their value in terms of how much goods and services can cover. I believe that most of the nominal wage growth has been “spent” by inflation, which is now more than five times the inflation target.

Do you think that the increase in salaries and pensions contributed to the increase in standards, as claimed by Serbian President Aleksandar Vučić?

I think that these increases in wages and pensions primarily contributed to such high inflation that we have in the country.

What worries you the most at this moment?

Complicating political, economic and financial circumstances in the international environment combined with a lack of understanding of them and unclear goals of the decision makers in the country.

What are the biggest economic challenges?

Mainly what we regularly read in the reports of the European Commission: high corruption, seriously damaged rule of law and weakness of state institutions. Of particular concern is the systematic neglect of the development of quality staff in education, science and healthcare.


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