bne -

The sense of crisis in Serbia deepened on August 7 as Standard & Poor's cut the country's credit rating a notch and three more board members of the National Bank of Serbia resigned, accusing the government of a "serious violation" of the principle of central bank independence.

S&P cut Serbia's credit rating by a notch from 'BB' to 'BB-' with a negative outlook, because of a lack of urgent government steps to improve faith in the monetary system and restore fiscal stability. "The negative outlook reflects our view that Serbia's twin fiscal and external deficits could create greater vulnerabilities, complicated by institutional interference and financial spillovers from the eurozone," S&P said.

The new nationalist-led government's decision to tighten state control over the NBS with amendments to the central bank law, as well as its efforts to force previous governor, Dejan Soskic from office (he resigned last week in protest over the new legislation), is part of efforts to increase spending to get the economy moving again, after GDP contracted in the previous two quarters. Soskic was a deficit and inflation hawk, putting him at odds with the new administration led by the Progressive Party of President Tomislav Nikolic and the Socialist Party of Serbia led by Prime Minister Ivica Dacic, who both want increased spending.

Soskic's resignation was followed by that of three other members of the bank's Council of Governors on August 7, saying the bank's independence has been compromised. On August 6, parliament elected senior governing party official Jorgovanka Tabakovic as the new NBS chief.

S&P joined the warnings that the introduction a parliamentary monitoring body within the NBS could reduce the central bank's independence. The agency also expects the changes to the legislation to have a negative effect on the value of the dinar and the country's foreign exchange reserves, as well as inflation and the central bank's ability to maintain price stability.

Indeed, the dinar fell to a record low against the euro of 119.45 on August 7, prompting the central bank to intervene to the tune of €15m, inching the currency back to 118.75 by the close of business. The NBS has now sold over €1.3bn this year in defence of the battered dinar, according to Reuters.

S&P also warned that the fiscal and foreign deficit have worsened in the first half of the year. The budget deficit stands at over 7% of GDP it points out, while saying that it has even more concern over public debt that is now almost 55% of GDP. That latter figure is far higher than levels recommended by the IMF in the past for similar emerging economies, and is heading in "a Greek direction," Soskic warned in an interview with bne two months before he resigned.

S&P expects that another consequence of the new government's policy choices will be a likely delay in negotiations with the IMF, which it views as a key provider of policy guidance and liquidity support to Serbia. In February, the IMF suspended its stand-by agreement (SBA) with Serbia in response to the previous government's relaxation of its fiscal stance.

"The pre-election fiscal slippage was pronounced on the expenditure side; wage and pension hikes were up 15% year-on-year, subsidies were up nearly 90%, and interest payments increased 36% year-on-year," S&P worries. "We had previously expected that talks would resume once a new government was formed and that, regardless of composition, it would prioritize fiscal consolidation and key structural reforms that had been committed to under the suspended 2011 SBA with the IMF. Last week's adoption of amendments to the law on the central bank, which establishes a parliament-appointed supervisory body, could also jeopardize EU relations if perceived to be curbing the independence of the central bank."