Nicholas Watson in Prague -

The new Serbian government appears to be adhering to that cultural trait of inat - a Balkan attitude of proud defiance and stubbornness, often to the detriment of everyone, including oneself. In little over a month in office, it has proudly thumbed its nose at the EU and the other global institutions, forced out the central bank governor and crimped the bank's independence, for which it has suffered international condemnation and the ire of the rating agencies.

To be sure, the signs were there when the price that the Serbian Progressive Party, which narrowly won the May elections, had to pay to form a government was to team up with the Socialist Party of Serbia and make Ivica Dacic prime minister. Dacic has the dubious distinction of having been the spokesman for the late dictator Slobodan Milosevic during the Balkan wars in the 1990s, and though obervers say he has mellowed somewhat since those firebrand days, his outlook remains defiantly populist.

Inevitably, therefore, his views on how to revive Serbia's ailing economy - GDP fell 1.3% and 0.6% in the first and second quarters of the year, with a 1% drop forecast overall for 2012 - were never likely to correspond with those of the former central bank governor, Dejan Soskic, a western-educated deficit and inflation hawk.

Soskic told bne in April before the elections that to get the country's finances back on track, the way forward was "relatively easy to comprehend:" the government, he said, needs to take steps to grow the economy and put an immediate stop to further increases in public debt through spending cuts.

Alas, Dacic sees spending and borrowing as way out of the growing crisis, so it was no surprise that as soon as the coalition took office, it set about undermining the central bank in general with changes to the law governing its independence, and Soskic in particular, forcing his resignation on August 2. His replacement, Jorgovanka Tabakovic, is a senior member of the Progressive Party and will no doubt toe the coalition line.

The moves provoked howls of protest from the EU and international organisations, such as the International Monetary Fund (IMF), which prize central bank independence and liked Soskic's restrictive monetary policy that was aimed at holding down inflation.

IMF European Department Director Reza Moghadam warned that the changes to the central bank law that were rushed through parliament would create insecurity, tarnish credibility and raise doubts about the capacity of the government to run its macroeconomic policy properly. Coming from the IMF, this pointed criticism is particularly noteworthy given the new government desperately needs to unfreeze a $1.3bn IMF stand-by loan, which was put on hold as the previous government allowed the budget deficit to rise above the 4.5% of GDP target for 2011, and "the 2012 budget deviated from the agreed fiscal programme, in particular with regard to higher planned issuance of public debt (including government guarantees) and domestically-financed projects," the IMF said.

Finance Minister Mladjan Dinkic, leader of a small technocratic party within the three-party coalition, has pledged to start talks with the IMF over a new deal and to cut the budget deficit from some 7% of GDP to below 4% next year by limiting growth in pensions and public sector pay - implying difficult budget talks ahead for the coalition - as well as introducing austerity measures such as raising VAT to no more than 20%, with the rate for food remaining at 8%.

However, that hasn't been enough for the ratings agencies who, alarmed by the coalition's moves so far, took action in August.

Death by several cuts

On August 7, Standard & Poor's announced it has lowered its long-term rating on Serbia to 'BB-' with a negative outlook, implying further cuts ahead. The downgrade, the agency said, reflected its view that Serbia's new government has failed to quickly adopt policies "that would promote confidence in its monetary regime and restore post-election fiscal stability," and expressed doubts that any new deal with the IMF will be possible.

This was followed by Fitch Rating's announcement on August 16 that it had revised the outlook on its 'BB-' rating to negative from stable, also citing the deterioration in the country's financing position and weak economic growth outlook. "Rather than focusing on correcting a rising fiscal deficit and public debt ratio, the new government has amended the central bank law in a manner which has dented investor confidence and might complicate the agreement of a new IMF deal," Fitch said.

Still, there has been some welcome signs by the coalition. It quickly signalled its intention to tackle corruption and solve some of the numerous financial scandals of the recent years, with police arresting eight people on August 8 on suspicion of approving fraudulent loans of more than €200m from the failed Agrobanka, including the former general manager, Dusan Antonic, who had tried to flee the country. "According to the Serbian Progressive Party, further arrests are expected between now and September, as the new administration strives to fulfil campaign promises," says IHS Global Insight. "Minister for Defence Aleksandar Vucic, with responsibility for combating crime, stated that no one was beyond the reach of investigators, regardless of party political affiliation."

In the other big issue for Serbs, Kosovo, Dacic announced August 16 that Belgrade was ready to discuss the normalisation of relations with Pristina - though hued to the line that it will never recognize the independence of its erstwhile province that unilaterally declared independence in 2008. Still, it's progress of sorts, even if it's still unclear when and in what format the talks are going to resume. "The agenda and format of talks haven't yet been outlined," Dacic told journalists, adding that those issues would be the subject of discussion at his meeting with senior EU officials in Brussels on September 4.

It remains to be seen whether Dacic will being displaying much inat at those talks.