Serbian Real GDP Growth Projected to Reach About 7% in 2007

Serbian Real GDP Growth Projected to Reach About 7% in 2007

Serbian Economy continues to grow strongly, reserach by the International Monetary Fund indicates. Real GDP growth is projected to reach about 7% in 2007. The document states inflation has significantly come down since 2000, the banking sector was restructured and hundreds of companies were privatized.

As a result, for the first time in years, the corporate sector posted aggregate profits. However, sustaining the reform momentum has been a challenge and weaknesses in the corporate sector persist. Structural reforms stalled in 2006-07 and substantial progress—and growth—has been achieved only in a handful of sectors. State- and socially owned enterprises continue to drain domestic savings while fixed investment remains low. With slow job creation, employment continued declining and unemployment remained high at 21% in 2006.

Nevertheless, capital inflows surged, particularly in 2006, boosted by privatization-related receipts but also by foreign borrowing—mostly medium- and long-term. This led to rising, particularly private, external debt. The large inflows allowed for significant official reserve accumulation (7½ months of imports as of November 2007), but also led to a surge in demand. This was compounded by rapid credit growth and expansionary domestic policies—large wage increases in the public sector, income tax cuts, and fiscal deficits in 2006-07. Given domestic supply rigidities—and a drop in remittances—the current account deficit continued to widen, reaching 16½% of GDP in the period January-November 2007. Expansionary fiscal policies contributed to the widening of external imbalances.

Driven by rising expenditure, the fiscal balance has deteriorated by over 2½% of GDP since 2005. In 2006, the deficit reached 1½ percent of GDP—some 4% points adrift of the target envisaged in February 2006 under the Extended Arrangement with the Fund. In 2007, a deficit of 1¾ % of GDP is expected.

Despite prudential tightening, credit growth remained largely unabated, as competition in the banking sector intensified. Coupled with high euroization of credit, this increased financial sector vulnerabilities, although banking sector soundness has so far been preserved as rigorous risk classification rules and high provisioning, reserve, and capital requirements have kept banks well capitalized.

IMF research also says that the new monetary policy framework introduced in mid-2006 has so far been successful in achieving low inflation, as core inflation declined from 14½% at end-2005 to 5½% at end-2007—within the 4-8% target range for the year—despite headline inflation reaching 10%. The decline in inflation was aided by double-digit nominal and real appreciation. Monetary policy remained conservative in 2007 as the nominal appreciation persisted through most of the year.

A combination of weak structural, expansionary fiscal, and tight monetary policies in the past two years have resulted in a loss of competitiveness. Large pay raises granted ahead of the elections raised labor costs, and even in industry, wage growth outstripped productivity gains in 2006, although this was partly reversed in the first half of 2007. Nevertheless, export shares remained on an upward trend despite the sharp real effective exchange rate appreciation over the past year and a half.

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