Nicholas Watson in Belgrade -

If you wanted a living embodiment of the "new" Serbia, then Dejan Soskic (pronounced Shoshkich), the governor of the National Bank of Serbia, is probably your man.

A graduate of the University of Belgrade's Faculty of Economics and a Fulbright scholar, he followed this with stints as a guest lecturer at a variety of US universities including Berkeley, before becoming a member of the Council of the National Bank of Serbia and then its chairman, finally assuming the governorship of the central bank in July 2010. Polished, highly articulate in English, tall, impeccably dressed and suitably pro-European, he would certainly would not look out of place at the highest economic tables in Europe.

Seated at the long wooden conference table where the Bank's council meetings are held, surrounded by busts and paintings of governors past and occasionally interrupted by the chimes of an antique grandfather clock, Soskic (without a media relations aide present) talks candidly about Serbia's economic shortcomings and the difficult issues the politicians on the stump need to raise with the electorate during this campaign.

He says the economic path that Serbia has to follow over the next decade is fairly well defined and apparent to all the major political players. "It's very important for the new government to be willing to commit itself to structural reforms, both to increase the income side of the budget, but also to decrease the spending as much as possible - and the structure of the spending to increase the portion that's not consumption but investments."

Serbia needs to export more, with particular emphasis on industrial and agricultural produce. "That may not be an easy path to take given the current economic conditions but we need to go on further down this lane because the alternatives are not really there," he says

Addressing this part of the economy that has been neglected for the past decade would go some way to sorting out the first major imbalance, the worryingly high current account deficit, which rose by a third in the period January through November 2011 to reach €2.5bn, amounting to around 8.5% of GDP. Improving this would hold down the cost of financing the other major worry, the rising levels of public debt, which look set to breach the constitutional limits of 45% of GDP, including state guarantees. "It's very important for all the political candidates in this period of time when they're very prominent in the media to be realistic about the options and to see that basically there is not much room for manoeuvre. There is this path that needs to be taken otherwise there will be a deterioration in the macroeconomic situation - something no one would like to see," Soskic says.

Indeed, Serbia is skating on thin ice as it is. For 2012, the government was targeting real GDP growth of around 1.5% for the full year, while the NBS recently revised its growth forecast for the year down to just 0.5%, following a disappointing 1.9% in 2011. First-quarter indications aren't good, and some worry that Serbia will actually be back in recession by the second quarter. And "without growth, the fiscal situation becomes more stressed."

Soskic points out that the previous Democratic Party government took some important steps in the right direction that weren't politically popular, such as holding down wage increases and freezing pensions, but stresses it's incumbent upon the new government, whatever its make-up, to enable a positive revision of the €1.1bn International Monetary Fund precautionary stand-by arrangement agreed in September 2011, but which has since come off the rails, with failure to agree deficit targets for 2012, and also the levels of state guarantees the government is seeking to extend/include in the budget for 2012.

To get back on track, the way forward is "relatively easy to comprehend," Soskic says: the government needs to take steps to grow the economy and put an immediate stop to further increases in public debt through spending cuts.

Are the Serbian people ready to hear such a frank message from their politicians? "I do believe the electoral body has matured over the past years. We have had three democratic elections over the past decade or so, and the times in which politicians got votes just by saying things that people wanted to hear are behind us," Soskic says. "The electorate want to know the truth - even if it's a sour message."

Dinar is served

A major worry for the electorate is the state of the dinar, which after losing more than 4% against the euro so far this year is trading at close to 112 to the euro, its lowest level in a decade. Soskic blames this partly on the country being in the political cycle, the inability of the government to resolve the issues with the IMF over the stand-by loan, and capital outflows related to US Steel's decision to quit its investment in the country.

The NBS has sold more than €500m in hard currency since the beginning of the year and made changes in banks' reserve requirements as part of short-term attempts to prop up the beleaguered currency. Raising interest rates would probably help choke off what meagre growth there is and so unsurprisingly on April 12 the council voted to keep rates unchanged at 9.5%. However, some argue that the traditional monetary policy tool of interest rates is a blunt instrument in an economy where more than 70% of all deposits and loans are done in euros - a remnant from the 1990s when the country suffered a nasty bout of hyperinflation and banking insolvency. This has fed through to a high level of forex mortgage loans, which has put some stress on, but not crippled the banking system, Soskic says.

To claw back some power for the NBS, therefore, Soskic has been pushing the "dinarisation" of the economy, signing in April a "Memorandum on Dinarisation Strategy", which aims to promote the use of the dinar. "The government, the financial industry, the corporate sector and the household sector - we all need to realise that using more local currency is going to decrease the [foreign exchange] risk pressure in the system," he says.

In current inflation terms, there's certainly some room for the NBS to cut interest rates further after slashing its main rate by 3 percentage points since last June. "Inflation is roughly around the target for this month in the year - we expect inflation to be around 4% for March," says Soskic.

However, given that interest rates influence aggregate demand with a certain time lag of around a year, then any effect from a cut would come through at the beginning of 2013 when Soskic sees inflationary pressures building from potential rises in regulated prices such as energy tariffs that have been kept steady due to the upcoming elections. "There are certain risks of accumulating inflationary pressures, especially with regulated prices, for the first couple of quarters in 2013 and this is making us relatively conservative at this point of time - I do not see at this point in time room for additional relaxation [of interest rates]," he says.

For all Serbia's economic difficulties, Soskic strikes a note of optimism about how the international investment community certainly views Serbia now in a different light to the dark days of the 1990s and early naughties. Proof of this was last year's debut $1bn Eurobond, which came with a 10-year maturity at a spread at a lower yield than some European peripheral countries. The Treasury expects to come to market again later in 2012 for Eurobond financing of around €1bn.

With April providing more evidence that the euro's problems are still far from over, Serbia's reputation as an improving long-term credit story is still very much alive.