Serbian Assets to be Supported by Strong Fundamentals


Serbia’s central bank meets tomorrow and is expected to keep rates steady at 3.5%.  With inflation falling to cycle lows, we see risks of a dovish surprise.  The growth outlook remains favorable for equities, while the inflation outlook is favorable for bonds.


The ruling Serbian Progressive Party (SNS) won the Belgrade elections this past weekend.  The SNS won 45% of the vote, which translates into an estimated 63 seats in the 110-seat city assembly.  President Aleksandar Vucic said his party’s nominee for mayor would be named within 15 days.

National elections need not be held until April 2020.  Polls show a likely landslide win for SNS and its coalition partners that would eliminate the opposition’s presence in parliament for the first time since 1991.  As such, Vucic may decide to call early elections, though it would be the fourth in six years following elections in May 2012, March 2014, and April 2016.  Only three governments have served a full 4-year term since the current system was adopted in 1989.

Serbia is currently in negotiations to join the EU.  Croatia joined in 2013 and Slovenia in 2004.  Slovenia went on to join the eurozone in 2007 whilst Croatia is committed to eventual euro adoption.  The European Commission recently predicted that both Serbia and Montenegro could join the EU by 2025.  The remaining Balkan nations (Albania, Macedonia, Bosnia-Herzegovina, and Kosovo) have not started EU membership talks.

Serbia successfully completed a three-year IMF program last month.  The program began in March 2015 and helped restore growth and confidence, which led to significant fiscal consolidation.  According to the head of the IMF’s Serbia team, “the program has done much better than expected, over-performing many of its macroeconomic goals.”  He added that Serbia and the IMF will discuss “macroeconomic goals and policy priorities for the next several years.”  Serbian officials have said that another program was desirable in order to sustain the momentum.

Serbia scores well in the World Bank’s Ease of Doing Business rankings (43 out of 190).  The best components are dealing with construction permits and trading across borders, while the worst are paying taxes and getting electricity.  Serbia does slightly worse in Transparency International’s Corruption Perceptions Index (77 out of 180 and tied with China, Suriname, and Trinidad & Tobago).



The economy is finally picking up.  Growth has been lackluster since the financial crisis.  GDP is forecast by the IMF to grow 3.5% in 2018, up from an estimated 2% in 2017.  GDP rose 2.5% y/y in Q4, accelerating for the third straight quarter to the fastest rate since Q4 2016.  Looser monetary policy should add to the tailwinds.

Price pressures continue to fall, with CPI inflation decelerating to 1.5% y/y in February.  This is the lowest since November 2016 and close to the bottom of the 1-3% target range.  PPI inflation has moved into negative territory (-1.1% y/y in February) and has provided two straight months of deflationary readings.  This argues for looser monetary policy.

The central bank delayed its policy meeting from March 8 to March 14.  The bank cut rates aggressively from 11.75% in April 2013 to 4% in July 2016.  Then, it kept rates steady for over a year before cutting rates cautiously by 25 bp in both September and October 2017 to the current 3.5%.  While markets expect no change, we see risk of another 25 bp cut at tomorrow’s meeting.

The fiscal outlook improved greatly under the IMF program.  The budget deficit was one of the largest in Europe at -10% of GDP in 2014, but moved to a surplus of 3% in 2017.  The balance is will be allowed to move back into modest deficit in 2018 under the budget law, but the overall trajectory remains in good shape and another surplus may be seen.

The external accounts bear watching.  The current account was an estimated -4% of GDP in both 2016 and 2017, the smallest annual deficit since 2002.  The IMF expects the deficit to remain near -4% of GDP in 2018.  Strong growth in the EU should help exports, but this will be offset by stronger imports as growth picks up.

Foreign reserves have edged lower from record highs.  Gross reserves were EUR11.1 bln ($13.3 bln) in December.  They cover nearly 7 months of imports and are about 2 ½ times the stock of short-term external debt.  As such, external vulnerabilities are relatively low.



The dinar has started to outperform.  In 2017, RSD rose 4.5% vs. EUR and was ahead of HUF (flat) and HRK (+2%) while lagging CZK (+6% vs. EUR) and PLN (+5.5%).  So far in 2018, RSD is flat against EUR and is slightly ahead of regional peers HRK (-0.1%), HUF (-0.3%), PLN (-0.7%).

Serbian equities are starting to outperform after a poor 2017.  In 2017, MSCI Serbia was up 5% vs.  29% for MSCI Frontier and 34% for MSCI EM.  So far this year, MSCI Serbia is up 6% YTD and compares to 5% YTD for MSCI Frontier and 6% YTD for MSCI EM.  This outperformance should continue in light of strong economic growth coupled with a dovish central bank.

Serbian bonds have outperformed.  The yield on 10-year local currency government bonds is up 2 bp YTD.  This is behind only the best EM performers Egypt (-109 bp), Brazil (-76 bp), Russia (-51 bp), South Africa (-48 bp), Peru (-35 bp), Mexico (-11 bp), China (-4 bp), and Chile (flat).  With inflation likely to remain low and the central bank in dovish mode, we think Serbian bonds will continue to outperform.

Our own sovereign ratings model showed Serbia’s implied rating steady at BB+/Ba1/BB+.  This still suggests some upgrade potential for actual ratings of BB-/Ba3/BB-.