Dejan Kozul and Nicholas Watson -

Serbia suffered its ninth fuel price hike so far this year on July 13. There are worrying signs now that energy and food price rises are spilling over into other sectors of the economy.

On July 13, the Ministry of Energy and Mining, which sets the price of fuel in Serbia, raised prices yet again, hiking the price of petrol by an average of 1.4%. The last hike took place on June 24 when prices rose 2.8% on average. In Serbia, fuel prices are not only the highest in the region, but also among the highest in the whole of Europe. The prices are approximately €1.4 per litre and, according to the Serbian Auto Motor Association, only Belgium, Denmark, Finland, France, Germany, UK, Netherlands, Italy, Norway and Sweden have higher fuel prices.

The Serbian state slaps on 40-60% in duty on the price of fuel, prompting calls for taxes to be cut, but the Finance Ministry has dismissed such a move. However, with core inflation, which excludes controlled prices, rising markedly in recent months, the government has a big problem in its hands as these price shocks are spreading into other sectors.

Consumer price inflation stood at 14.5% in May, with energy and food prices, which grew 30% on year in May, the main drivers. Serbia's central bank has taken steps to cool the rise, raising the two-week repo benchmark rate by 575 basis points to 15.75%. The authorities aim to bring core inflation back to down within a 3-6% range by the end of 2008, but they have a job on their hands. Not only have they to contend with surging energy and food prices, but they also need to get a grip on loose fiscal policy and calls for more money for public sector workers and pensioners. The deteriorating situation prompted National Bank of Serbia Governor Radovan Jelasic on July 9 to call on the new prime minister, Mirko Cvetkovic, to take "a great deal of unpopular measures" to reduce inflation to 4% in the space of the next four years.

Out with the old, in with the new

The new Serbian government, an odd coalition forged between pro-European President Boris Tadic's Democratic Party and the Serbian Socialist Party (SPS), which was created by the EU-hating late president Slobodan Milosevic, has already set out its stall.

On the fiscal side, Finance Minister Diana Dragutinovic told Reuters in an interview that the government aims to keep its fiscal deficit below 2% of GDP in 2008, as part of government efforts to back the central bank's fight against inflation. "I'll do my best to make the fiscal contraction happen," Dragutinovic told the newswire. "It would be best if we ran a surplus in order to cut inflation... you cannot criticise the central bank for high rates and still keep running a gap."

On June 9, the government said it's aiming to end 2008 with a budget deficit of 0.5% of GDP and to reduce this year's current account gap to 8%. It also said its priorities include boosting annual growth to 7%, cutting unemployment from 18.8% to 12%, and investing €5bn in the country's infrastructure, namely the development of Serbia's section of Corridor 10, a key highway linking northern and southern Europe.

However, the government's ability to meet such targets are questioned by analysts. "The economic policies unveiled by [Deputy Premier and Economy Minister Mladjan] Dinkic are very ambitious and concerns have already been raised that the projections are unrealistic given the present constraints of the Serbian economy," says Dragana Ignjatovic of Global Insight.

She points out the government is basing its infrastructure investment plans on an inflow of €5bn from EU pre-accession funds. However, given that the basis for Serbia's association with the bloc is still uncertain, "this is perhaps a little forward." The pre-membership Stabilisation and Association Agreement (SAA) signed with the EU in April has been frozen until Serbia hands over war crimes suspects to the International Criminal Tribunal.

Furthermore, Serbia needs between $4.5bn-$7.5bn in investment each year in order to finance its revised 2007 current account deficit of $5.29bn, equivalent to 13.1% of GDP. "The government will be hoping these funds can be provided in 2008 and 2009 by the privatisation of the remaining 40 major state-operated companies including metal producer Prva Petoletka Holding, the RTB Bor copper mining and smelting company, JAT Airways flag carrier and the FAP automotive producer," Ignjatovic says. Central bank chief Jelasic has already warned that the official privatisation target of €3.5bn-4.5bn for 2008 could be missed, thus leaving a major shortfall in the state budget.

There will also likely be strains on the "odd couple" coalition, especially given the demands of the Serbian Socialist Party for increased spending on welfare transfers – a coalition agreement envisages a 10% growth in pensions by September - which says Ignjatovic, is likely to "push the government's handle on macroeconomic stability to the test."

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