Serbia’s foreign exchange reserves are at a record level. They represent a type of defense system if there is any uncertainty in the international environment.
What influences their formation, why “special drawing rights” – although they are not currency in the classical sense – are nevertheless part of foreign exchange reserves, which savings grow at a faster pace, when inflation will slow down, as well as many other questions were answered for the Internet portal of RTS are Jorgovanka Tabaković, governor of the National Bank of Serbia, and her associates.
Gross foreign exchange reserves of the National Bank of Serbia at the end of February 2023 amounted to EUR 21,196.2 million, which is the highest level of gross foreign exchange reserves at the end of the month since the data has been monitored in this way, since 2000.
NBS Governor Jorgovanka Tabaković and her associates – Vice Governors Željko Jović, Ana Ivković, Dragana Stanić and Nikola Dragašević – gave RTS answers to questions about foreign exchange reserves, as a kind of security buffer, and why they are so important for the country’s credit standing.
Inflation at the end of this year should be at a level twice lower than the current level. You will find out why the dinar is the trademark of the central bank, as well as about the possible repercussions of the collapse of Silicon Valley Bank on Serbian finances. We solve the dilemma of saving in dinars or euros. We will also discover what fresh meat and tourist packages have in common.
Foreign exchange reserves of the NBS consist of: claims of the NBS in foreign currencies on its accounts abroad, securities, gold, effective foreign currency and special drawing rights and a reserve position with the IMF. Can you say which of these is the most important and clarify what “special right of tow” means?
Foreign exchange reserves should enable the achievement of a number of goals of the central bank and the state in general. Those goals refer to:
1) support for conducting monetary policy and exchange rate policy;
2) maintenance of the country’s liquidity in foreign currency;
3) maintaining the confidence of market participants that the state can respond to its external obligations and needs for the so-called hard currency (such as the euro and the US dollar);
4) provision of funds to mitigate the negative consequences of external shocks and in case of emergencies, natural disasters and war.
In order to achieve the aforementioned goals, foreign exchange reserves are managed in compliance with the principles of liquidity (which implies investing in easily marketable instruments that can be cashed out quickly in case of need), the principle of security (which implies investing in the highest quality securities, i.e. placing deposits with the most reliable international institutions), and with the realization of the highest possible yield that does not call into question liquidity and security and adequate risk management.
Therefore , foreign exchange reserves usually consist of those financial instruments, i.e. a class of assets that, in combination with each other, best enable the fulfillment of the mentioned goals, principles and requirements .
The combination of these asset classes (including their mutual correlations), with adequate participation of individual classes, enables sufficient liquidity and security, as well as achieving the required return with adequate management of various risks, so they should be viewed as a single entity.
In other words, no asset class can be singled out as the most important, but each one has its role and its place when creating the most adequate combination of asset classes in the foreign exchange reserves of each country.
“Special Drawing Rights” and currency baskets
Special drawing rights represent a special type of international asset created by the IMF . Their value is calculated on the basis of a basket of currencies, which currently consists of the US dollar, the euro, the Chinese yuan, the Japanese yen and the British pound. Although they are not a currency in the classical sense, SPVs can be converted into the currency of another member country (e.g. euro or dollar) at the request of an IMF member country, which allows the country to provide itself with additional liquidity.
That is why SPVs are part of foreign exchange reserves . By issuing new SPVs, and allocating them to its members, the IMF can support member countries, as it last did in August 2021, when it allocated new SPVs worth US$650 billion in the face of the global liquidity crisis caused by the virus covid- 19 and to support the economic resilience and stability of countries.
Also, member states can turn to the IMF for financial assistance, which the IMF grants them in the form of loans in the SPV, with the conclusion of a certain arrangement, i.e. program that the member state is obliged to implement.
What affects the formation of foreign exchange reserves?
There are numerous factors that influence the formation or increase of foreign exchange reserves, but also their reduction.
The increase and decrease of foreign exchange reserves are influenced by the activities of the state (borrowing and discharging on the basis of loans and securities in foreign currency, as well as the settlement of other foreign currency obligations of the state), interventions of the NBS on the domestic foreign exchange market in order to preserve the relative stability of the exchange rate of the dinar against the euro, collection of coupons and interest on the basis of management of foreign exchange reserves, activities of commercial banks in connection with mandatory foreign exchange reserves and various other inflows and outflows.
In the period from 2017 until now, based on the interventions of the National Bank of Serbia through the net purchase of foreign currency, foreign exchange reserves have been increased by more than 5.5 billion euros, which is the “healthiest” way to increase them because it does not imply any obligations in the future.
In this period, the supply of foreign currency on the domestic foreign exchange market increased as a result of the inflow of foreign currency based on foreign direct investments, a significant increase in exports, inflows from tourism and others.
Such developments led to the prevailing pressures towards the strengthening of the dinar in relation to the euro and the need for the NBS to intervene with a net purchase of foreign exchange in order to preserve the relative stability of the exchange rate.
In this way, favorable macroeconomic developments are “flowed” into the country’s foreign exchange reserves through the intervention of the National Bank through the excess of supply in relation to the demand for foreign exchange.
Can it be said, using military terminology, that foreign exchange reserves serve as a defense system in case of unfavorable circumstances in the environment?
Can. That is one of the roles of foreign exchange reserves. Unfavorable circumstances in the environment, i.e. “external shocks” or international financial crises can have negative effects on the state, the domestic financial system, the economy and citizens. The role of foreign exchange reserves is to enable mitigation of these negative effects.
Foreign exchange reserves represent a guarantee for the settlement of Serbia’s obligations to foreign countries, which affects the creditworthiness and reputation of the country.
Also, if certain disturbances occur on the domestic foreign exchange market due to external shocks, the NBS can use foreign exchange reserves in order to maintain the relative stability of the dinar exchange rate and eliminate disturbances in the operation of the domestic foreign exchange market.
What is the correlation between inflation and foreign exchange reserves?
There is no direct relationship between these two variables, in the sense that changing one has an effect on the other.
Nevertheless, when looking at the macroeconomic situation as a whole, it should be noted that a high level of foreign exchange reserves is a guarantee that in the event of certain disturbances on the international markets and eventual outflow of capital, there will be no direct spillover of those effects to the domestic market in the sense of weakening the currency (which can affect to the growth of inflation).
Additionally, a high level of foreign exchange reserves signals to investors that the country will be able to service all its international obligations in the event of a financial crisis. Knowing this, creditors are more ready to invest in the country, which also affects more favorable financing conditions and a lower risk premium, so capital outflow is less likely.
Year-on-year inflation in February was 16.1 percent, which is in line with the expectations of the central bank and the projections for the first quarter. What exactly does “year-on-year” inflation mean and when will it return to target?
The term “year-on-year” means the standard way of measuring price growth that is applied by all institutions dealing with measuring and analyzing inflation, and the same measure is used by central banks when determining the inflation target. This means that inflation is viewed as the ratio of prices in the current month compared to the same month of the previous year.
Thus, the general level of prices in February this year was 16.1% higher compared to February of the previous year. Such a way of observing prices allows us to avoid seasonality in measuring inflation, which would otherwise be very pronounced – for example, the prices of fruits and vegetables fall sharply during spring and summer, and rise during winter. Fresh meat prices, as well as tourist package arrangements, are also seasonal in movement.
On a year-on-year basis, according to our projection, inflation should be at a level twice as low as the current level at the end of this year, and inflation should return to the target by the middle of next year.
In the fight against inflation, the NBS increases the reference interest rate, now it is 5.75 percent, how long will this “series of increases” continue?
We cannot say that, not only because it is not our practice to comment on future monetary policy decisions, but because the volatility, i.e. fluctuation in the world markets is very high, so future decisions will significantly depend on developments in global frameworks.
This is not the case only with the NBS, but also with other central banks in the world. It should be borne in mind that the current episode of inflation is under the strong influence of international trends, as well as that the full effects of the change in the reference interest rate on inflation are transmitted over a period of one year.
Our decisions will therefore depend on the expected movement of key inflation factors both on the domestic market and in the international environment and their effect on inflation in the coming period.
The dinar is stable, which is, as you say, a trademark of the NBS. Is it nominally stronger against the euro?
Even in the very challenging year of 2022, the relative stability of the dinar exchange rate against the euro was maintained, i.e. the dinar nominally strengthened against the euro by 0.2%.
In 2022, the NBS was a net buyer of foreign exchange in the amount of one billion euros. At the same time, in the first four months, it intervened mainly by selling foreign currency in conditions of strong depreciation pressures caused, above all, by the effects of geopolitical tensions and the growth of energy prices on the world market.
From May to the end of 2022, pressures towards the strengthening of the dinar prevailed in conditions of an increased inflow of foreign exchange on various grounds (foreign direct investments, exports, tourism, etc.), and the NBS intervened mainly by buying foreign currency, mitigating the excessive strengthening of the dinar against the euro and maintaining a relative exchange rate stability.
In 2023, pressures towards the strengthening of the dinar also prevail, so that in the course of the year so far, the NBS has intervened by net buying foreign currency, and the nominal value of the dinar against the euro is almost unchanged.
The successful preservation of the relative stability of the exchange rate of the dinar against the euro for more than a decade clearly shows that this is the hallmark of the NBS. We will remain committed to this in the future, bearing in mind the importance of the relative stability of the exchange rate for the economy and citizens and the entire financial and macroeconomic system.
The concept of savings is the basis for credit activity, but it does not belong to foreign exchange reserves. Which savings grow faster – dinar or foreign currency?
The total savings of the population has recorded continuous growth for several years now, which represents the result of the achieved and preserved stability of the domestic financial system and an indicator of preserved trust in the maintenance of this stability by the competent institutions of our country.
This was primarily contributed by the activities of the NBS in the previous period, thanks to which the banking system rests on sound foundations, as well as the timely and decisive reactions of the central bank aimed at preserving the stability and security of the operations of all banks in Serbia, maintaining the relative stability of the exchange rate, as well as the normal functioning of the foreign exchange market and other segments of the domestic financial market.
The fact that dinar and foreign currency deposits of clients in banks, in accordance with the provisions of the Deposit Insurance Act, are insured up to the amount or equivalent of 50,000 euros is also of exceptional importance.
In the previous period, dinar savings recorded a significantly more dynamic growth than foreign currency savings, so that in the past ten years (since the end of 2012), dinar savings increased almost six times, while foreign currency savings increased by about two thirds.
The dynamic growth of dinar savings is greatly contributed by its higher profitability compared to foreign currency savings.
According to analyzes that the NBS regularly conducts and publishes thanks to the relative stability of the dinar exchange rate against the euro, higher interest rates on dinar savings compared to foreign currency savings, as well as more favorable tax treatment of interest on dinar savings (given that interest on dinar savings is not taxed), savings in domestic currency were more profitable than savings in euros regardless of the term period, i.e. both in the short and long term, and the longer the term period, the greater the difference in favor of the domestic currency.
The increase in interest rates has contributed to the growth of dinar savings recently, which is partly the result of the tightening of the monetary policy of the NBS through the increase of the reference interest rate.
The NBS points out that the banking sector of Serbia is stable and that citizens can be confident in the safety of bank operations and all savings deposits. Will the collapse of Silicon Valley Bank have an echo in Serbia?
Taking into account the fact that banks in Serbia do not have business relations with Bank Siliciumska dolina , so there is no possibility of manifesting either direct or indirect effects of the closure of this bank on the banking sector of the Republic of Serbia.
Thanks to the numerous and comprehensive activities of the NBS, the domestic economy and financial system are significantly more resilient compared to some previous crises and uncertainties on the international market, as evidenced by the performance indicators of the domestic banking sector. All relevant indicators of banks’ operations are many times higher than regulatory requirements.
The capital adequacy indicator of the banking sector at the end of December 2022 was more than 20%, and the value of all relevant indicators of bank liquidity confirms the high liquidity of the domestic banking sector.
Also, the share of gross non-performing loans in total gross loans at the end of December 2022 was 3.01%, which is the lowest value since this indicator has been monitored and is a confirmation of the preserved and strengthened stability and quality of banking sector assets.
The NBS will continue to carefully monitor and analyze the situation in the financial sector, as well as the situation on the entire domestic and international market. As before, we remain determined to take all the necessary measures in order to preserve monetary and financial stability, and thus macroeconomic stability as a whole, even in conditions of increased uncertainty on the international market.
“Fitch” agency has confirmed Serbia’s credit rating at the BB+ level, explain what that means and what needs to be done to improve the rating.
The BB+ level is one level below the investment grade credit rating. It is one of the factors that international investors look at when making a decision to invest in the securities of a country or in the real sector of that country.
An increase in the rating means lower interest rates for the bonds we issue, which increases the space in the budget for productive investments in areas such as infrastructure, education or energy efficiency.
Such investments in the long term increase economic growth, and therefore the living standard of the population. A country’s credit rating is affected by its overall ability to service its obligations, which depends on the country’s overall macroeconomic and financial situation.
Specifically, in the case of Serbia, rating agencies almost always cite macroeconomic stability in conditions of shocks in the international environment, a credible monetary policy framework, responsible fiscal policy, progress in management and a high level of GDP per capita (compared to countries with a similar rating) as favorable. ).
As factors that could contribute to the increase in the credit rating, the agencies cite the continuation of the implementation of structural reforms and more favorable prospects for economic growth in the medium term on this basis, the conduct of a responsible fiscal policy that will ensure the continued reduction of the share of public debt in GDP, as well as the further strengthening of external positions.
Bearing in mind that Serbia achieves significant results in all these fields, it is realistic to expect that, if global tensions ease in the coming period, Serbia will also receive the investment rating that it has long deserved based on domestic indicators, the governor of the NBS and his associates clarified for the Internet portal.
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