Enhanced economic policies but external financing risks
Improved monetary policy has led to low inflation since 2014 and exchange rate sta-bility since 2016. After gradually weakening from 2008 to 2015, the RSD steadied in 2016 and even improved slightly in 2017-2018. Meanwhile, average annual consumer price inflation fell to 2% in 2018. As a result, the Central Bank has lowered its key monetary policy interest rate to 3.0% in April 2018. Going forward, we expect currency stability to continue in the near term, however, (occasional) downward pressure may reoccur in the medium term, especially in the event of any domestic or global bad news. We forecast inflationary pressures to pick up moderately in 2019-2020 as a result of robust domestic demand, rising wages and some fiscal loosening. However, headline inflation should remain in check, i.e. below or around 3%. Nevertheless, the Central Bank may start monetary tightening by end-2019.
Public finances have much advanced in recent years. Supported by IMF advice, fis-cal con¬solidation (e.g. less state involvement) has moved the annual fiscal account into surplus in 2017-2018, after large deficits until 2015, and reduced public debt from 76% of GDP in 2015 to less than 60% in 2018. Yet, as around 70% of the public debt is denominated in USD or EUR and since Serbia will remain sensitive to exchange rate fluctuations, the debt burden continues to be a source of external vulnerability. Going forward, we expect fiscal policy to be loosened somewhat as unpopular measures may be reversed after Serbia successfully completed its latest IMF funding program.
The current account posted sizeable annual deficits of more than -5% of GDP in 2017-2018, in part due to high energy imports, and is forecast to continue to do so in the next two years. Positively, the shortfalls have been entirely covered by net FDI inflows in 2015-2018, in contrast to earlier years.
Gross external debt has fallen from 81% of GDP in 2012 to 66% or so in 2018 but this is still large compared to peers and includes ongoing external arrears (5% of the gross external debt). The annual debt service on medium- and long-term debt is fore-cast at a relatively high 25% of export earnings in 2019.
Foreign exchange reserves have broadly moved sideward since 2010 and stood at just over EUR10bn at end-2018. Nonetheless, they are still comforta¬ble with regard to import cover (currently about 4.8 months, though down from over 6 months at end-2015) or, in other terms, coverage of all external debt payments due within 12 months.
Overall, external liquidity and debt risks have moderated in recent years but remain considerable.