bne -

The National Bank of Serbia will consider lowering interest rates if external risks recede and the government tightens spending, it announced on August 14. The change in tack comes on the back of deterioration in the outlook for 2014.

"Assuming a further drop in agricultural produce prices, the absence of external shocks and the implementation of fiscal consolidation according to a plan, the executive board will in the coming period consider a possibility of further monetary policy relaxation," the bank said in its quarterly inflation report, according to Bloomberg.

Inflation will return to its target band of 4% plus or minus 1.5 percentage points by October, the central bank predicted. Consumer price index rose 8.9% in July on an annual basis - an improvement over the 9.8% seen in June and lowest since it dropped to 7.9% in August 2012.

However, that improvement comes on the back of lower forecast growth. The economy is now expected to expand by just 2.5%, instead of 3%, in 2014. The estimate has been reduced "because of deteriorating growth outlook for our main trading partners," the report reads.

Growth remains more reliant on net exports than foreign direct investments, which totalled €294.3m in the first six months, while portfolio net outflows reached €346.7m after the government repaid early part of its debt to the London Club of creditors. The National Bank of Serbia (NBS) expects expanding exports and slower imports to lead the country's current-account deficit to below 7% of GDP this year from 10.5% in 2012.

Analysts suggest the NBS under Jorgovanka Tabakovic - a controversial appointment to head the central bank a year ago - is emerging as a beacon of stability in an otherwise fairly tricky scenario, particularly on the political front. In its first policymaking meeting after the ouster in late July of Mladjan Dinkic as finance minister, it kept its benchmark interest rate on hold at 11% on August 8 for the third meeting in a row.

The retreat in inflation offered space for a rate cut to support the economy's fragile recovery. However, political risk has risen recently with the jettison by the coalition - now featuring the Serbian Progressive Party and Socialist Party - of Dinkic's small, fiscally conservative, party URS. Investors are watching the pair's ability to agree a new cabinet and face Serbia's fiscal troubles head on, putting pressure on the dinar.

"Tabakovic is clearly trying to offer the government the carrot of rate cuts, should they continue to bite the bullet on the fiscal consolidation front," notes Tim Ash at Standard Bank. "Inflation is indeed heading lower ... but the NBS stalled the recent cycle of cutting policy rates, presumably concerned over the political context. [W]ith a reshuffle on-going [it is] mindful that selling of the RSD would put upside pressure on key debt ratios, which remain vulnerable due to the high share of external debt in public sector liabilities."

Adding to his postivie assessment of the central bank chief, Ash adds: "This week Tabakovic has again come out strongly in favour of a re-engagement with the IMF - now much needed."