August Inflation Report

The NBS has published today the Inflation Report – August 2020, which contains an analysis of current macroeconomic trends and the new inflation and economic activity projections.

Like the May Inflation Report, this Report was prepared amid pronounced uncertainty over the evolution of the coronavirus pandemic and its impact on economic activity globally. Although, after the initial phase of the pandemic, containment measures were gradually eased and economies began to recover across the world as of May, there is heightened uncertainty over the speed of global recovery, which affects movements in international commodity and financial markets.

As Serbia, like the rest of the world, has undertaken measures to mitigate the negative effects of the pandemic and speed up economic recovery, a significant part of the August Inflation Report focuses on the effects of the pandemic at home and abroad, and the responses of economic policy makers.

Main findings:

  • Timely and coordinated measures of the Government and the NBS prevented a major fall in economic activity in the initial phase of the pandemic.
  • The rest of the year is likely to see further recovery, supported by the adopted and announced, additional measures of the Government and the NBS. Favourable terms of financing businesses and households should stimulate growth and preserve the favourable medium-term outlook of the economy. A more than complete recovery is expected already next year, without jeopardising price and financial stability.
  • The strongest effects of the pandemic were felt in Q2, when the economy contracted by 6.5% y-o-y, which was, nonetheless, better than we expected in the May Report.
  • Economic recovery which began in May and continued into June exceeding our expectations, additional monetary and fiscal stimuli, and a better agricultural outlook are the upside risks suggesting that the economic slowdown this year could be softer than projected. Still, as the virus continues to spread globally, which may lead to slower recovery of the global economy and external demand, we kept the May projection according to which GDP will fall by 1.5% in real terms this year and rise by around 6% next year.
  • As in the previous seven years, inflation will remain under the NBS’s control. It will continue to move in the lower half of the target band, closer to the lower bound, at the level comparable with advanced economies. Inflation is expected to gradually approach the target midpoint in the medium run, reflecting the recovery of aggregate demand, supported by monetary and fiscal policy measures.

The NBS and the Government have responded with a set of economic measures to this challenge which is unprecedented in recent history. The measures are tailored for the character of the crisis. Without them, the economic slowdown would be much sharper this year and growth in 2021 more modest. In terms of their scope and depth, this robust set of economic measures has outstripped the measures taken to respond to the global economic crisis in 2008, which was enabled by the responsible conduct of economic policy in the past eight years. Serbia faced this crisis in a much better macroeconomic position, secured by the narrowed internal and external imbalances and the implemented structural reforms. In cooperation with the Government, in the past eight years we have stabilised the economy and contributed to the favourable outlook for its accelerated growth, by ensuring primarily low inflation and financial stability and bringing FX reserves to a record level. This created room for the adoption of the current, robust monetary and fiscal policy measures, and for potential new measures if necessary, without jeopardising the price and financial stability of our country and its fiscal position”, said Governor Jorgovanka Tabaković.

Text box “A comparison of Serbia’s macroeconomic position before the previous global economic crisis and the crisis caused by the coronavirus pandemic” contains an analysis and a comparative overview of Serbia’s main macroeconomic indicators before the outbreak of the global economic crisis in 2008 and the pandemic-induced crisis in 2020, which unambiguously confirm Serbia’s better macroeconomic position in the current crisis.

Effects of the coronavirus pandemic on Serbia

In accordance with our expectations from the previous Inflation Report, our economy felt the strongest adverse effects of the pandemic in April. Recovery ensued in the following months, as containment measures were gradually eased and the monetary and fiscal stimuli yielded results. Moreover, the economic contraction in Q2 was smaller than expected, owing to better results in almost all production and service sectors. According to the Statistical Office’s flash estimate, GDP fell by 6.5% y-o-y, versus 8%, anticipated in the May Report.

In Q2, industrial production was under the strongest sway of manufacturing, which declined in April, but experienced a recovery in May, which continued into June. The same dynamics of the physical volume of manufacturing was recorded in almost Central and Southеast European countries, though monthly changes were much more favourable in Serbia – the April decline was softer and the ensuing recovery more vigorous. The level of manufacturing production in Serbia was lower by around 3.5% in June compared to the Q1 average, while other countries of the region saw sharper falls.

The pandemic also weighed heavily on the current account deficit. It declined by almost 47% y-o-y in Q2, in line with expectations, reflecting the narrowing in the deficit on trade in goods and the primary income deficit, and a slight improvement on the balance of services. As so far, the current account deficit was more than fully covered by FDI inflows, which declined in Q2 compared to the same period last year (which was a record year in this respect), but, nonetheless, continued even amid the pandemic. Capital inflows were also generated from the successful eurobond issue in May, worth EUR 2 bn. Balance of payments trends in Q2 were consistent with our expectations – the current account deficit will decline this year relative to last year and equal around 5% of GDP, remaining more than fully covered by FDI inflows.

The pandemic has so far not significantly affected formal employment in Serbia, owing primarily to the sizeable package of measures supporting the domestic economy, which helped preserve jobs in most sectors. However, the y-o-y dynamics of wage and employment growth and a decline in unemployment slowed in Q2 compared to the pre-crisis period.

A detailed overview of the impact of the pandemic on macroeconomic trends in Serbia so far is presented in Text box “Expected vs. actual macroeconomic developments in Q2”.

GDP projection

Although the evolution of the pandemic is hard to predict given the renewed spread of the virus globally and the uncertainty surrounding global recovery, including the recovery of our economy, the undertaken economic measures and the favourable medium-term macroeconomic prospects will help the incipient recovery to continue.

Owing to the recovery of economic activity in May and June, which was stronger than expected as a result of the adopted economic measures, and given that the share of tourism and catering sectors is small in the structure of the Serbian economy, we can expect a better GDP outcome this year than other European countries. This is also in line with the projections of international institutions”, underscored Governor Tabaković.

Taking into account the effects of the pandemic and the measures of the NBS and the Government, we still expect GDP to decline by around 1.5% in real terms in 2020 and to rise by around 6% in 2021. More favourable than expected trends in Q2 suggest that the economic slowdown this year could be softer than projected. Still, we did not change the projection bearing in mind the risks from the international environment, concerning primarily a new wave of the pandemic in Europe and the world, and the resulting, possibly weaker global recovery.

Domestic demand will decline at the year-level, while net exports will be a positive contributor as imports are expected to decline more than exports. Next year will see accelerated economic recovery of around 6%, led by domestic demand and exports, and supported by the timely and adequate response of our economic policy makers and the preserved favourable medium-term prospects of our country. This will ensure the return to a stable, medium-term growth trajectory of around 4% annually.

The risks to the GDP projection stemming from the international environment this year are judged to be tilted to the downside and relate in particular to the speed of recovery of the euro area, while those from the domestic environment are skewed to the upside as domestic demand may rally faster than anticipated.

Inflation projection

Consumer prices in Serbia were consistent with the global trend of declining inflation in the initial stage of the pandemic. After undershooting the lower bound of the target in April and May, y-o-y inflation returned within the target tolerance band and came at 2.0% in July. Inflation’s return to the target tolerance band was mostly due to the wearing off of last year’s base effect for food prices and the shrinking negative contributions of petroleum product prices on the back of a recovery in the global oil price from May. A positive and somewhat higher contribution than in the prior quarter came from fruit prices, while the contribution of other food categories, as well as non-food products, was stable, signalling that the market was fully supplied even in the difficult conditions of the pandemic.

Going forward, we expect inflation to stay low and stable. Under the central August projection, inflation will continue to move within the lower half of the target tolerance band, closer to the lower bound, until end-2021. Such inflation movements will be supported by relatively weak aggregate demand, subdued international inflation and global prices of primary agricultural commodities, while the effects of the lower global oil price will wane gradually. Thereafter, as the rise in economic activity and demand continues, inflation will edge up gradually towards the target midpoint of 3%, but remain below it even in 2022.

Compared to the May projection, the new inflation projection is somewhat higher in the short term, primarily in Q3 this year, due to higher than assumed fruit and vegetable prices and global oil price in the preceding months. In the medium term, the inflation projection is lower, since we estimate that the more disinflationary effect of aggregate demand and import inflation will outstrip the inflationary impact of the global oil price.

Uncertainties surrounding the inflation projection in the short run are mostly associated with movements in fruit and vegetable prices, as well as global prices of oil and primary agricultural commodities. In the medium run, the key risks to the projection are still associated with the international environment, and relate primarily to the speed of recovery of the euro area and capital flows to emerging economies. In part, the risks to the projection also relate to the speed of recovery of domestic demand and movement in administered prices at home. On the whole, the risks to the inflation projection are judged to be symmetric.

In the past year, inflation was largely aligned with the projection made and published in the August 2019 Inflation Report (slightly below the projection midpoint), which helps strengthen confidence in the NBS and anchor inflation expectations.

Text box “Impact of the pandemic on inflation” considers in more detail the effects of the pandemic on inflation and the reasons why inflation is expected to stay low in most countries, including Serbia.

Measures taken by the NBS in the period since the May Inflation Report

  • Estimating that the negative effects of the virus on global growth are stronger than initially expected and that low inflationary pressures allow this, the key policy rate was cut further in June by 25 basis points to 1.25%, its new record low in the inflation targeting regime. It was thereby trimmed by an entire percentage point compared to its pre-pandemic level, in order to minimise the negative effects of the coronavirus on economic activity and employment and enable the fastest possible recovery of our economy. Continued monetary policy easing led to a further fall in interest rates in the interbank money market and on dinar loans, encouraging further growth in lending.
  • Stimulating measures were introduced under the Guarantee Scheme, contributing to still better terms of dinar lending to corporates, and by extension, to higher dinarisation and further strengthening of financial stability. Namely, banks approving dinar loans under the Guarantee Scheme at an interest rate that is at least 50 bp lower than the ceiling interest rate (1M BELIBOR + 2.5 pp) are paid a 50 bp higher remuneration rate on allocated required reserves in dinars, on the amount of loans approved at more favourable conditions.
  • The NBS allowed a new moratorium on the repayment of loan and financial leasing liabilities, for all borrowers who wish to use this option, in the duration of further 60 days, after the initial 90 days, which will help relieve the burden of the crisis for our households and businesses.
  • A precautionary repo facility with the ECB was arranged, whereby additional euro liquidity could be provided to the domestic financial system, in case of need. It is important to emphasize that neither dinar nor foreign exchange liquidity of the domestic banking sector are jeopardised, and that the country’s high foreign exchange reserves are more than sufficient to respond to any potential foreign exchange liquidity shocks. The precautionary repo line with the ECB instils security and represents another example of the NBS’s proactive approach in the conditions of high global uncertainty induced by the pandemic.

All of this has greatly softened the blow of the first wave of the crisis for banks and, by extension, for businesses and households, supporting continued smooth functioning of the lending channel and contributing to the incipient recovery of our economy. It is also important to emphasise that loans worth over EUR 630 mn were approved until end-June under the Guarantee Scheme, more than half of which was in dinars, pushing up the degree of dinarisation of receivables to a record high of 34.6%. According to preliminary data, almost a half of the total amount planned under the Guarantee Scheme was approved by end-July.

Text box “Micro, small and medium-sized enterprises – disbursement of Guarantee Scheme loans and terms of financing” provides a detailed overview of stimulating measures and their effects so far on the hardest-hit part of the economy, which at the same time represents an important generator of economic growth and employment.

By taking timely and well-calibrated measures, we have supported economic recovery, preserved employment and helped minimise the effects of the pandemic on businesses and households. In terms of the speed of responding to the effects of the pandemic, we were one of the leading institutions in the country and among the first central banks in the world”, said Governor Tabaković. “Our goal is to save people’s lives, but at the same time to preserve employment and help corporates that were affected the most. I believe we have demonstrated that we can recognise the challenges of the present times and lead our economy along the path of sustainable and accelerated growth, while ensuring further improvement of our citizens’ standard of living”, underscored Governor Tabaković.

Governor’s Office