M. Bozinovich

Serbian central bank Governor Radovan Jelasic told the IMF and World Bank panel that he sees economic gloom for Serbia in 2009 that will extend over into 2010.

“What do I expect at the end of 2009?” asked the Governor rhetorically in his speech to the panel titled Global Crisis in Europe and Central Asia.

Then he answered:

I am afraid, nothing good.  Fiscal income will deteriorate even further while the shadow economy will gain in importance.  Governments will focus almost exclusively on financing current consumption (wages and pensions), even through accumulation of fresh debt, while capital investments will be substantially cut back.

The Governor said that banks will “face a deteriorating loan portfolio” and that their primary preoccupation will be refinancing bad loans, loan more to the government, cut its costs and hoard cash.

As there is no chapter 11 type of creditors’ protection scheme, the number of bankruptcies [the Governor probably meant liquidation] will increase as well.

The Governor also warned of a regional financial contagion and urged that Austria extends its promise not to disengage its banks from the entire region and not just Serbia.

Once we have finalized our deal, I hope in a matter of days, the deal makers should focus on all other countries as spill over effect is very large:  a rumor regarding any bank in Serbia or Croatian circulates in the region in matter of hours and could cause irreversible damages.

The Governor appealed to the politicians to stop spreading false expectations [see my previous blog].

The entire speech is available here.

Economics Economics

Last week, Serbia’s economist Stojan Stamenkovic warned that Serbia faces bankruptcy.

“Serbia needs to do everything so it can maintain its foreign currency liquidity because without that there is a threat like in 1980 when the country went bankrupt,” Stamenkovic told Serbia’s daily Politika.

Yesterday, Serbian Minister for Economy, Mladjan Dinkic, told Belgrade daily Vecernje Novosti that Serbia will not go bankrupt.

“Some countries have in this crisis, bankrupted, like Iceland, Letonia, Hungary is on the edge of collapse. We will for sure escape that,” said Dinkic.

Then again, Dinkic is the guy who, on several occasions in the past, said that, despite the global recession, Serbia will not see its economy shrink.

Serbia’s industrial production takes a dive

Today, the IMF told Serbia to expect its economy to shrink by 2% in 2009 and asked the government to freeze the wages and pensions for next 18 months if it wants IMF help to “reprogram”, euphemism for can no longer pay, about $7 billion of private debt obligations.

As of January 31, 2009 Serbia has $27.7 billion in total external debt of which some $19 billion is borrowed by private firms so the $7 billion it seeks to “reprogram” represents a rather astounding debt default rate of 37%.

Not surpassingly, from South America to Europe, politicians like Dinkic publicly claim that the government is on top of it.

“There is an intentional policy of setting positive expectations. I don’t think the government itself believes its numbers,” says Ilan Goldfajn, an economics professor at Rio’s Pontificia Universidade Católica, about the Brazilian government that, like Dinkic, belittled this financial crisis by calling it a “ripple”.

In fact, Dinkic reassured the public that the Serbian government is in the absolute agreement on how to handle the crisis, so if we are to properly understand what Goldfajn is saying, that means that Serbia will put a lipstick on the pig at every point it grows into a larger of a disaster.

“We are cutting the spending, we are pumping in liquidity in the economy, especially the private sector, because it employs 1.6 million people that feed the 550,000 that work for the government,” said Dinkic.

So why hasn’t the government spending been cut in the past when times were good? Why is the government allowing 1.6 million employed in the private enterprise to subsidize 550,000 government employees?

The politics in an economy whose population is shrinking like Serbia’s has a tendency to seek to inflate the living standard now at the expense of labor productivity which determines the wage in the long run. Hence we see, for example, that wages in Serbia increased in February by 6.4% from the previous month in real terms while the Statistical Office does not even tabulate country’s total labor productivity.

One way to inflate the living standard is by excessive borrowing, and like many other countries, Serbia hopes to get out of its deflating debt by borrowing to the maximum.

Economics Serbia

After publishing the warning Moody’s credit rating agency issued on Austria’s Raiffeisen bank, the owner of the Serbian media outfit Kurir became a target of personal attacks by the Deputy President of the Raiffeisen Bank Executive Board, Zoran Petrovic, who exposed private information about the owner that, to be nice, stretches the accepted decorum of a client-bank relationship.

“We tried to publish a dementi, but the newspaper didn’t want to do it and we are forced to bring charges against the newspaper and the journalist who wrote the article,” said Petrovic during the Round Table organized by Ekonomist Media Group in Belgrade, a gathering designed to declare that Serbia’s banking system is liquid and that Raiffeisen leads the way in the liquidity.

Then the Raiffeisen Deputy unleashed the client’s dirty laundry saying that Kurir’s motive for publishing Moody’s findings is “because the owner of Kurir was part of the ownership structure of a company that had a loan in Raiffeisen Bank and hadn’t paid its obligations for several months already.”

Even in the more primitive days, banks were courteous never to nail lists, like Luther during his Reformation campaign, of clients who did not pay their bills. Did we only think that banks are suppose to show some modicum of respect for private personal information?

Raiffeisen’s upside-down Swiss banking where client’s dirty laundry on privileged information is exposed by a bank should red-flag anyone with a loan at the Raiffeisen that, hey, perhaps you are next unless you help us in a bail out.

And Raiffeisen is everywhere in Eastern Europe: Russia, Ukraine, Poland, Albania, Serbia, Bulgaria, Romania… so much so that 80% of Raiffeisen banking empire profit came from the region last year.

In fact, nearly 57% of Raiffeisen’s total assets are in Eastern Europe and the ex-Soviet countries and as this region implodes so has its stock price.

Of course, like any bank, Raiffeisen wants to stop the downward reinforcing loop but the revelations of client’s dirty financial laundry, at least to a stock trader, says loudly and clearly: short the stock and make more money on Raiffeisen’s misery.

Why else would Austrian government decide to pump in money into Raiffeisen unless the bank is seen as a systemic risk? Austrian banks have over $378 billion is assets in Eastern Europe while the value of everything that Austria makes is, according to the CIA, less then that ($322 billion).

Says The Wall Street Journal:

“The bank has asked Austria’s Finance Ministry to buy preferred shares of Raiffeisen valued at €1.75 billion in a capital-raising measure. The coupons would pay 9.3% annual interest and must be repaid within five years, Austrian Finance Ministry spokesman Harold Waiglein says… Raiffeisen says the loan shouldn’t be seen as a rescue package but as capitalization that will allow it to continue operations in Eastern Europe.”

So, does Raiffeisen mean to say that, right now, they cannot do business in Eastern Europe and that without the €1.75 billion it would close shop immediately? And how long will Austrian €1.75 billion keep Raiffeisen resuscitated? What about €1.75 billion from other countries Raiffeisen has presence in, some of which face national bankruptcies.

If we are to believe Nouriel Roubini, who correctly predicted the ongoing financial calamity, Raiffeisen may be one or two sovereign defaults away from a collapse.

“The banking problem in Europe is becoming more severe,” Roubini told Bloomberg and then cited Hungary, Belarus and Ukraine, all countries where Raiffeisen banks, for possible national bankruptcies.

No wonder then that the Serbian central bank came out yesterday with a stern condemnation of the media scolding “that inadequate and unprofessional presentation of reports in foreign media about the financial sector can undermine the trust that this sector is based on. Moreover, media people should assume maximum responsibility for the damage that such unprofessional writing may cause.”

Well, yeah… Serbia’s central bank may be correct that Moody’s has misrepresented risk again but the question is whether Moody’s is now behind the curve like when it protected banks from the toxic assets that are devastating the globe now or has it made a computer error!

During the scolding, Serbia’s central bank made sure to touch upon Raiffeisen talking points: that, at 23% of capital to asset ratio, Raiffeisen in Serbia is liquid, that bank deposits are coming back after “withdrawal of the substantial amount of savings in October 2008″ and “there is no reason for clients of any bank operating in Serbia to ‘fret about their deposits and the safety of transactions’.”

So why is Serbia’s central bank up in arms defending an Austrian banking outfit?

Sure enough, Raiffeisen is a leader in Serbia sporting a huge loan portfolio that, we hope, is doing many people lots of good.

Yet one should be little more weary during Deputy sit-ins at the Round Tables as the banking Deputy tells the central bank Deputy that during the last crisis in October “Raiffeisen bank didn’t have to draw finances from the headquarters in Vienna” because for the next wave of the financial crises, some banks may have to draw finances from Serbia back to Vienna.

Economics Banks

On Friday, Serbian central bank governor Radovan Jelasic held another presentation on the effects of the global financial crisis on Serbian banking and he used the opportunity to admonish reporters for stirring up panic that is costing the economy.

“Inaccurate and incomplete reporting on global financial market developments,” says Jelasic has caused “belittling of facts on the Serbian banking sector” and in particular of capital adequacy, liquidity, foreign reserves that is costing “unfounded and artificial tensions” and costing 100 million Euros that has been pulled out of the system that could have been used to make loans to the public.

By requiring banks to hold in cash 40% of foreign currency deposits, Jelasic stressed that Serbia’s banking system has one of the most stringent requirements on foreign currency savings, and that makes those bank deposits very safe.

He also pointed that bank capitalization in Serbia is 28% of deposits.

Jelasic said that cheap loans are gone for good from Serbia but loans denominated in local currency are divorced from the global financial markets because they depend on inflation which he seeks to fight.

In earlier presentation, Jelasic also noted that financial contagion from abroad is limited on Serbian banking sector because “banks in Serbia are daughter banks, i.e. separate legal entities with own capital, under NBS supervision”.

The governor also pointed out that Serbia’s central bank reserves are held in ultra safe instruments.

Of 9.72 billion Euros that make up the reserves, 6.69 billion are in securities, 2.33 billion in deposits of which 2/3 is in vaults of other central banks and the rest as AAA or AA quality foreign bank paper.

Jelasic noted that, according to the Article 3 of the mandate, central bank is in charge of a price stability, financial stability and support of the government’s economic policy.

Governor is in favor of a stand-by arrangement with the IMF. A stand-by loan is when the money to be borrowed is approved but not necessarily used. Such stand-by would alleviate pressure on Serbia and enhance its credit rating, claims the governor.

The negotiations of such loan will start on October 26 and it will be available next year. IMF will likely demand drastic cuts in government spending.

Analysts believe that the governor has won a short term victory for Serbian financial stability but the longer term trend of declining foreign investment inflow does not bode well for the financial stability.

Foreign direct investments have already declined this year so the remaining source of inflows is from privatization of state owned firms. IMF is critical of handling of the privatization.

Serbia owes $29 billion to international lenders which represents about 13% of the GDP. Private sector borrowing accounts for additional $20 billion of debt of which only $2 billion is short-term debt that is often seen as the trigger of currency crisis.

Economics Economy

In the past few days, Serb central bank has spent 50 million Euros buying up its own currency amid reports that there is a great deal of demand for foreign currency.

An economist Goran Nikolic tells Serbian daily Glas Javnosti that the 50 million spent is a dramatic action and says that there is a large demand for foreign currency. He did not specify who wants out of Dinar but said that bankers in Serbia are expecting the inflow of foreign capital to slow, so just like their banking kin in the West, the bankers in Serbia maybe the first to move and hoard foreign denominated cash.

Further, with private, non government debt at $20 billion and payments for it coming due, there is a likelihood that these private firms may soon themselves move to convert their Dinar holdings into foreign currency. As the financial contagion spreads across the world, these firms may realize that moving in first to convert has the advantage because being last means no money can be converted and that will force them to default on their debt. While the decision to move first may be rational, it is often a trigger for a run on the currency.

Serbian chief central banker, Radovan Jelasic, went public in number of venues to reassure soundness of the financial system and expressed his resolve to defend the Serbian currency. Jelasic told the public today that savings in Serbian banks are safe by citing that 45% of foreign currency deposits are with the central bank and that the banks are well capitalized up to one third.

Jelasic tells Belgrade daily Vecernje Novosti that savings accounts denominated in foreign currency are near 6 billion Euros of which 30% can be withdrawn at any time, while deposits of up to one year account for 27% of that.

According to these figures then, if there was a run on foreign denominated savings deposits central bank will immediately lose about 1.8 billion Euros or $2.43 billion (the 30%).

This translates into a depletion of official reserves down to $7.1 billion and that moves the debt-to-reserve ratio to the really alarming level of 52%.

An ordinary, conventional mortgage on a house in the US requires that this ratio must not exceed 37.5%.

These 3 sources as a possible trigger for a run on the currency whose effect is ballooning the debt-to-reserve ratio will cause a serious downgrade in creditworthiness of Serbia by the credit rating agencies such as the Moody’s. Such downgrade is followed by some serious consequences to the ability of the government to borrow.

Meanwhile, capital flight is collapsing the Belgrade stock exchange which has gone below 1000 from the height of 3000. The bourse is planning to introduce curbs on trading by limiting the bid-ask spreads to within 20%. Trading curbs are in effect in the US and the drastic collapse of the US Dow Jones during that time suggests that the curbs may do more damage then good.

One the bright spot in these negative news is the capitalization of the banks that operate in the Serbian market. According to Nikolic, the ratio of capital to exposure to risk is 3 times higher in Serbia then in rest of the Europe, and perhaps this conservatism in lending, may be the magic bullet that dissuades depositors from a run on their deposits.

Economics Economy

States and countries have became the latest victims of the financial hemorrhaging that is sweeping the globe.

Over the weekend the debt laden California is seeking emergency loans from Washington in order to avoid bankruptcy while Iceland is doing the same kind of begging from their neighbors to rescue them from reckless lending their banks did.

Bankers are suddenly alarmed that Pakistan may default on its debt as its debt-to-reserve ratio rose from 30% to 32%.

Turkey’s debt-to-reserve ratio of 31% is already alarming the IMF and may table that country at this week’s IMF/World Bank meeting in the US.

If what is happening to these countries is any suggestive what may await the debt strapped “developing” Serbia, the picture, at least for next several weeks, may look very alarming.

Serbia’s public debt obligations of $3.7 billion are a whopping 39% of its foreign reserves of $9.5 billion that the Central Bank has in the vault.

The larger the ratio the less money country has come bill payment time.

In addition, Serbia’s private debt is over $20 billion and to pay their payments, private firms will soon seek to convert their domestic Dinars from the Central Bank and deplete the savings even more.

The way to reduce this percent and have more money for paying bills, is for Serbia to export more, or attract more foreign investment or borrow on more favorable terms to pay its bills.

Serbia is paying only lip service to exports, globe trots for the diminishing pool of investment money and is running out of favorable borrowing terms.

IMFs recent report on its visit to Serbia assesses that “exports are not keeping up with surging imports” and has already warned of Serbia’s “unsustainable external current account deficit.”

The word “unsustainable” is often a code word to speculators that country’s currency may soon take a hit.

This outflow of reserves, says IMF, is offset by “abundant capital inflows [that] have, at least until now, largely defused macroeconomic tensions.”

But what about after now?

With borrowing terms now reduced to only 24 hours at a time, it will be a long time when banks will become willing to borrow long so that a country may pay off its short funding demands.

IMFs optimistic prognosis that Serbia’s “real GDP to continue to expand at a robust 6-7 percent during 2008-09″ is then predicated more on hopes then reality that foreign investors will have enough money in the future to pump into Serbia’s economy and keep its local currency propped up.

So, we have a 1-2-3 knock out set up on the currency - unsustainable trade deficit, prospect of diminishing foreign investment inflow and tight borrowing terms - all a culmination of an 8 year old borrow-and-spend policy.

Economics Economics

In a blow to the General Motors, French Renault is entering a strategic partnership with Russia’s AvtoVAZ by being awarded a right to buy 25% of Russia’s auto giant AvtoVAZ.

AvtoVAZ is owned by Rosoboronexport which is Russia’s weapons trading agency while the Chairman of AvtoVAZ is Sergei Chemezov who is Putin’s friend when both were KGB agents in 1980s.

These KGB connections suggest a political decision may have been behind the decision to anoint French Renault with access to the fastest growing car market in the world at the expense of the American GM.

Germany already has a presence in Russia because Moscow allowed Volkswagen to build a factory there. Japan is also present while US is the only major car-making nation deprived of a significant presence in Russia.

Coincidentally, Serbia is expected to privatize its state-owned Car maker Zastava Automobili since the separations from Zastava Weapons has been completed. GM recently signed a deal with Zastava to build an Opel model in Serbia, the only EU-track country with an open access to the Russian market without tariffs.

Although some speculate that GM may take a stake in Zastava, last week Russian tycoon Oleg Deripaska paid a visit to Serbia to talk privatization of Zastava.

Earlier this year, Deripaska was in talks with Daimler to buy the American Chrysler unit but Washington interfered to prevent the deal, labeled Deripaska a mafia man close to Putin, and summoned John Snow, Bush’s former Treasury Secretary, to convince Cerberus, private equity company on whose board Snow serves, to buy Chrysler.

Denied a US deal, Deripaska may attempt to snatch Zastava from GM as a small consolation prize but given that these privatization deals are politicized affairs, it will be more telling who ends up owning the Serbian car maker.

Economics

Back in April, we talked here about the forming bubble in the Serbian stock market: a rapid price rise in share prices that is not substantiated by a corresponding rise in profits. In most cases, bubble are apparent with a parabolic pattern of the stock market price index as noted in the point number 1 of the graph below and it is due to a massive entrance of speculative money mostly from inexperienced investors.

In March, when the bubble started forming its distinct contours, the good folks at the Serbian stock exchange (Belex) told me that “One of the reason(s) for that kind of result is that Serbian market is in early phase of transition, and there is a lot of speculation…”

More ominous was that the bosses of the exchange immediately alluded that even the non speculative money may be in for a fools game thus exacerbate the bubble because Serbian “practice of financial reporting is just based on annual publication of balances, so you have ratios with big tracking errors“!

In other words, Belex bosses themselves acknowledged that prices of shares not only do not fundamentally correspond to the underlying profits but even what we consider fundamental is itself erroneous.

So we have a typical bursting of the bubble with many textbook features: parabolic move, bullish flag at the end of it signaling entrance of dumb investors, double top signaling hope of the dumb money for recovery then a slow and painful slide to the long term linear line which, again as in a textbook meets the breached support price line.

Hereon after, it all looks downhill.

Economics

Economic times seem to travel backward in Serbia: it was in the past, in 1989, when Serbian per capita income exceeded today’s and Serbia is relentlessly raising its wages in order to catch up to the past.

This, in the nutshell, is what the finding has been by the IMF whose visit to Serbia concluded yesterday.

That there is a race with the economic past attests productivity which, according to the IMF, trails real wages.

In order to spend one’s wages, one first has to produce. In Serbia, the spending of an unearned wage comes before production and this results in increasing indebtedness and more imports.

Instead of telling Serbia that it ought to consider making something others want to buy so that it can offset all the imports, IMF did exactly as any other financial institution that wants to increase creditworthiness of a potential borrower: Serbia was told that it’s government ought to spend less in 2008.

Then again, why spend less when all loans to IMF have been paid off?

Since the beginning of 2005, the size of the loan portfolio at the IMF has shrunk from $97 billion to $17 billion as nations found alternative funding sources willing to lend cheaper. Indeed, some even question IMFs relevancy in the world awash with cash, but as any prudent lender, IMF is anticipating the coming of a credit crunch that has already been triggered by the mortgage sub-prime losses in the USA. Skyrocketing property prices has been the global phenomena and as the phenomena is developing a vertigo financial institutions are finding less of a reason to lend to anyone, let alone to a nation with low productivity… and this is where IMF will come in handy once again, perhaps in 2008.

On a political side, though, IMF is still a European club so the growth endorsement Serbia got from it is an important stamp of approval, and we see that readily before our eyes: Serbia’s EU pre-membership deal came only after IMF concluded its examination.

Economics

Serbia’s 7th Economic Summit underway now is no different then any other gathering of egos where grandiloquent rhetoric cloaks jealous looks by participants evaluating who is invited, who not, and who is dressed which way.

Despite the usual hoopla, some economics did get done once a minister of this or that finished off his pro-European vitriol.

Serbia’s finance minister, Mladjan Dinkic, started the embellishing on the Serbian economic situation by claiming that the “Macroeconomic indicators are very strong”… a statement that is true only if a political objective is a short-term economic stabilization devoid of any organic and multisector economic growth. The fact is that nearly 20 years later, Serbia has not cought up to its 1989 income per capita yet.

Little talk then went into policies that could, say, reduce Serbia’s enormous unemployment that has never dipped below 25% since all these “reformists” came to power in 2000. By now, voters have developed an expectational immunity from political promises so much so that trivialities trump the issues of vital importance.

It is indeed very easy to conduct economic reform if the environment every politician faces is oblivious political impunity so that any talk of reform is not measured by deeds achieved but by the difference in semantics.

Even the American Ambassador to the US, Cameron Munter, went off on these semantic platitudes by congratulating on “apparent proofs” that Serbia is dedicated to reforms and that US stands ready to assist… blah, blah… then placed such low barriers to economic success - judicial reform, improvement in property rights and restitution of confiscated property - that one wonders whether…

Anyway, Greek Ambassador was rather critical that for all of the talk of Serb-Greek friendship only 120 Greek firms are in Serbia and nearly zero Serbian in Greece, then asked Belgrade to do something about corruption and graft.

It comes as no surprise that Slovenia puts it right with a more sober economic analysis just today, via its newspaper, and only a day after it came out offending Serbian sensibilities when its telecommunications company referred to the “state of Kosovo” as their new expansion frontier.

Slovenian Delo alluded to the idea of a “Serbian economic tiger” (pat-pat good doggy) but that would depend, and Delo puts this politely but correctly, on whether Serbia is capable to expand beyond driving around someone else’s goods (transport), manipulating someone else’s money (banking) and trading someone else’s goods and instead find a way to produce something that anyone is willing to buy.

Again and again, from Mexico to Malaysia, we see that government-managed production decisions lead to misallocation of investments and preclude an economy from having a balanced production portfolio that is not so susceptible to sudden swings in prices of what they produce. Instead, an open economy oriented towards exports - cheap labor, low barriers to doing business and trade - have won the day. Just ask China.

Well, despite ample evidence of government’s disruptive influence on production decisions, Serbia’s Minister, and without Portfolio at that, stepped up to the plate with a plan for a National Investment Plan, whose objective is as nobly vague “aim is to create a better life in Serbia,” as its lofty goals on building more roads, schools… The fact that it is modeled after an Irish plan which was successful seems to be the only bright spot.

By next year, we’ll see what if any of this comes through.

Economics

Some financial trouble may lie ahead for Serbia.

The outgoing IMF chief, Rodrigo Rato, says that the ongoing credit squeeze will force governments worldwide to make substantial changes to their budget plans. Rato says that countries with large current account deficits would be much more vulnerable to the tightening of availability of credit than those in a “more balanced situation”.

Rato warned of the coming financial panic in the credit markets back in February of this year.

Meanwhile, EBRDs chief economist, Erik Berglof, singles out five countries with high current account deficits that will “come under pressure at some point”. These countries are Latvia, Hungary, Bulgaria, Romania and Serbia.

Serbian Trade Deficit 1997-2000. Source: Serbian Central Bank

“Bulgaria, Romania and Serbia have also enjoyed very rapid growth and credit expansion and have benefited from large inflows of foreign direct investment (FDI). The main effect of the crisis in the West will be the reduced appetite for risks in emerging markets, which means that countries representing a higher level of risk or which have large external financing needs will be the most affected,” says Berglof.

In other words, countries with large trade deficits, like Serbia, have a net outflow of money out of their country and their foreign purchases are paid for with foreign direct investment which will likely decrease as the cost of borrowing increases.

Economics

According to the latest World Bank data, Serbia ranks 86th in the world on the ease of doing business behind countries such as Papua New Guinea, Antigua and Barbuda, Maldives and other never-heards.

Of the 10 components that make up the ranking even Serbia’s best, Getting Credit, attributable to the wonderful banking reform under Mladjan Dinkic, is also showing signs of stale. Romania and Bulgaria have caught up to Serbia while the East Europe’s economic dynamo, Slovakia, outscores all the former communist states. In fact, Bulgaria, FYROM and Croatia are in the top 10 in the world ranking, all Serbia’s neighbors.

This study suggests that Belgrade has once again entered into a self-induced political hibernation where doing an actual economic reform gets in the way of talking about it.

Economics

US Ambassador to Serbia Cameron Munter says that big American firms are “holding off on investment in Serbia until after the issue of its Kosovo province has been resolved peacefully,” reports Reuters.

Munter says that this summer he “met the managers of ’some twenty big U.S. companies,’ and all of them were very interested in investing in Serbia.”

What Munter is not saying is whether he was the one to tell these big US forms to stay on the side… and why so?… is it because Kosovo resolution may not be peaceful?

Economics, Kosovo

Barclays is expected to launch an emerging markets bond fund that will consist of 26 countries including Serbia.

Barclays made a boon with the Exchange Traded Funds or ETFs, and this particular one will be US dollar denominated that will hold country debt instruments.

ETFs are traded like a stock via any brokerage. The symbol for this one has not been determined yet pending SEC approval.

John Sulski and Lee Sterne will be the portfolio managers of the ETF.

Economics

Belgrade Stock Exchange, BELEX, is sure on fire in the first three months of 2007 (Q1) scoring an impressive 70.09% gain since January 1.

Indeed, BELEX is just behind the stock market in Zimbabwe, up 606.56%, but once discounting those gains for Zimbabwe’s +1200% inflation, the country actually scored a net real loss of NEARLY -600%. Zimbabwe’s prospects are also bleak as the country’s president Mugabe is expected to print money and control prices.

By contrast, Serbia has finally got ITS grip on inflation taming it down to around 7% thus scoring an impressive +60% BELEX real gain. Many long term studies suggest a very high correlation between low inflation and high stock market returns. Moreover, a $4.6 billion influx in foreign direct investment and a sustainable +6% GDP growth is also a long term positive.

Since December 2006 BELEX has entered a parabolic rise similar to NASDAQ prior to the market crash in 2000

From a technical perspective, however, BELEX is entering a very dangerous territory with the index perhaps entering an unsustainable parabolic rise reminiscent of the 2000 pre-collapse in the NASDAQ. Similar stock market patterns can also be observed with the Chinese stock exchange as well as India’s.

Serbia’s average price per earnings ration is at 41 and new stock issues are offered almost daily.

Economics

According to the World Bank ranking of an ease of doing business, Serbia has improved by 27 places in 2006 from the previous year, thanks largely to liberalization in getting credit (+63) and cross boarder trade (+91). Coupled with stabilized inflation, it is no surprise then that the banking liberalization is expanding Serbian financial sector and attracting the likes of Citibank.

Despite these capital inflows and booming trade, showing up as a large trade deficit, there is an ongoing nag in the public debate as to the lack of job creation and low level of start-up investment, aka “greenfield” investment… and the World Bank data can also explain why that is so: Serbia made employing workers a much tougher prospect slipping by 30 in ranks and the complementary investment incentive - procedures for starting a business -  also slipped, by 17 places.

The trade deficit itself can partially be explained by Serbia’s procedural competitive advantage to import: it takes 11 days to export out of Serbia versus 10.5 in OECD while it takes 12 days to import, a figure below the OECD’s 12.2.

Enforcing contracts is still doubly cumbersome in Serbia then the OECD taking up 635 days versus 351 in OECD.

On the other hand, Serbia is very competitive on the tax side: It takes less hours then the OECD countries to pay the taxes, and the effective tax on corporate profit is 8.9% less then the OECD countries.

Of course, these data are lagging indicators, and in comparison to the region Serbia fares far better.

For example, starting a business in Serbia takes half the time then the average in the region. Dealing with licenses is less cumbersome then the region as is non wage labor cost, commission jobs that require personality skills and risk taking.

Meanwhile, Serbian stock market, BELEX, has caught a fever as its capitalization at the end of February was up 6% from the month previous. BELEX was also rather immune to a recent turmoil in capital markets that started in India, shook China then took down the New York Stock exchange and others. The latest craze is investment in insurance companies and as the money flows into new insurance issues their share prices are ballooning.

Life insurance is hot in Serbia because, conventional reasoning goes, 2006 issuance of life policies rose by 50% and despite the growth it is still only 2.1% of Serbia’s GDP and a gross premium on insurance is EU 64, a number expected to rise by up to 15%. Serbia has 17 insurance companies.

Then there are stories of fortunes to be made on the stock market, legends that fuel bull markets more then any that equity fundamentals can. Serbian PE ratios are over 40 and chat rooms dedicated to stock market investing in Serbia are on the rise, many of them filled with extraordinary money making anecdotes of ordinary folks that raised capital, risked it and made a bundle.

Just last week Vital’s initial public offering that went up almost 280% in a day is the investment legend story of money making that fuels a stock market bubble as much as it creates incentives for reluctant businesses to go public and, if anything, get their stock holders wealthy via legal means, curbing corruption.

Capitalism is indeed in Serbia.

Economics

In June, NBS central bank chief Jelasic was accused by banks in Serbia that he is killing them with his overly restrictive monetary policy. Now, the exporters took a turn to complain.

At an NBS sponsored event at the Serbian Chamber of Commerce where these exporters were invited for a pep talk and a vent, an owner of copper smelter East Pointe, for example, told Jelasic that the central bank is not thinking about them so he may be forced to lower wages because the central bank’s tight money has strengthened Serbian currency and that is making his refined copper less attractive to foreign buyers.

Copper prices have risen nearly 100% so far this year while dinar has appreciated about 6% against the Euro in July. Many also believe that demand for copper will outstrip supplies in the coming year.

In a clear signal that the central bank’s business is stable prices and not wages, Jelasic urged the disgruntled exporters to make use of currency futures contracts in order to hedge against uncertainties in the value of dinar… and the HVB bank executive, who happened to be on hand, agreed that they are ready to make such contracts.

NBS has used repo-action, buying and selling of short-term maturity papers, to bring down the inflation in recent months. Last year, repo-action was negligible and the current fight against inflation has grown it into a viable monetary policy instrument. By urging expansion of the futures market, NBS has managed to leverage policy gains from the repo instrument beyond the realm of inflation fighting and into real market incentives for exporters to develop Serbia’s futures contracts. Futures should be immediately introduced in the agriculture plagued by chronic supply imbalances because of uncertainty in government’s willingness to pay for the produce.

Jelasic has been under some criticism from IMF who recently questioned the quality of cadere at the central bank in executing more sophisticated monetary policy initiatives. In a wonderful stroke of an economic policy coup, however, Jelasic managed to channel the disgruntled energies of exporters into incentives for greater market participation.

Economics

Used to an ever collapsing national currency, Serbs were shocked that this week, their dinar, once synonymous with hyperinflation and financial malaise, is rising against Euro, the anchor currency that most large ticket items such as cars, real estate or investments are denominated in Serbia.

Over the past week, Serbian Dinar rose 4% in value as a result of Central Bank’s sharp increase in reserve requirements that moved the inflation down to nearly zero in June and a surprising announcement that the government is running a budget surplus of some $86 million.

However, judging by Belgrade’s numerous currency exchange parlors, the Serbian speculative money is betting that the halt to the Serbian inflation is temporary, not just because of Serbia’s hyperinflationary tradition, but also out of a belief that the current trade deficit is unsustainable.

Imports are rising at a 23.4% clip while exports are growing at 17% and the 6.4% gap between these two cannot be covered by any government savings. The trade deficit is expected to be $6.5 billion so what the government saved in 6 months, the measily $86 million, is a trivilality constituting only 1.3% of needed funds to pay for the consumption desires Serbs have.

In fact, many people believe that Serbian government is incapable of saving and the recent announcement by the Finance Minister Dinkic fuels this beief.

Dinkic said that government will spend even more because it plans to provide export subsidies, increase in wages to government employees, subsidies to greenfield investments while lurking elections may be the cherry on top of an unrestrained government spending.

In other words, Serbian dinar may tank for the similar reasons that most world markets expect the US dollar to tank: large trade deficit and too much government spending.

Moreover, recent data suggests that the European central bank may not be comfortable with its level of inflation which may prompt a rise in interest rates that will strengthen the Euro and as a result reduce the value of Serbian Dinar.

Monetary aggregates such as money supply numbers tend to lag the actual inflation and judging by those numbers, Serbian inflation, despite the June abberation, is on the upswing.

Serbian M3 and the Foreign Currency Deposits (FCD) seem to be the most correlated as M3 standard deviation is 1.89 while FCD is 1.80 thus suggesting that these two indices may be the best predictors of inflation. Similarity in the standard deviation suggest that whatever the effect of the one, the effect of the other is similar. As supply of money is the inflation indicator, then, in case of Serbia, so could the foreign currency deposits.

Chart above shows that both have hit the low in March 2006 so that June’s inflation number of zero may be the result of Central Bank’s work as of, circa March 2006.

… but, note the spike since March, a spike that breaks the trend line.

So, if Serbian monetary policy works on a 4 month lag, October 2006 may be the month when dinar collapses, and not just because of the technical monetary aspect depicted above, but also because the West may punish Serbia by recognizing Kosovo independent and thus introduce more uncertainty in the region: If Kosovo goes independent why not some other minority region inside Serbia? Why not break up Serbia all together and have it nonexistent as some Muslims that battled Serbs, including al-Qaeda in Kosovo would love to see?

Financial markets would love to see an orderly transition in Kosovo, yet the paid news media such a Reuters, for the last year, has been pumping the idea that Kosovo’s independence is inevitable although no major western investor was willing to get financially screwed on Reuters’s independence promise.

Serbia is working on an economic plan for an economic revival of Kosovo and will such plan be more effective in the Albaninan-dominated Kosovo then Serbia itself?

Probably… because Serbia can then focus on building cities inside Kosovo to make it multiethnic, as required by EU, while Kosovo Albanians can focus on providing industry to Albanians whose nationalists cleansed it from Kosovo Serbs.

The end of 2006 is less then 6 months away so… shall we see?

Economics

For well over a year now, Serbian Bond market has had an inverted yield curve, a financial phenomena associated in the West with economic recessions.

A yield curve is a single graph that shows what the current interest rate is on various length debt securities. First plot the years horizontally, stack the interest rate vertically then play connect-the-dots.

A “normal” yield curve is one where the interest rate on the short term debt is lower from the longer one, and theory is that investors want to be compensated more now for taking risks on events far down into the future because those events are less predictable to them.

An inverted yield curve, as an economic indicator and not a cause, has been empirically observed in Germany, Canada and the UK.

Taking an established financial rule of thumb that predominates in the developed markets of the West and applying it on an underdeveloped one such as the thinly traded Serbian BELEX is risky business.

However, what the Serbian bond yields suggest to the trained Western financial eye is that, in Serbia, the immediate economic future is less certain then the one 16 years (c.2012) down the road. The risk taken now in Serbia is higher then risk taken in the future, so it costs less to postpone one’s investments… and this is extrapolated on government debt which, almost by definition, cannot go bankrupt because there is always some asset in the country that can be used to pay the obligations.

The policy solution for Belgrade should be rather clear: institute certainty to the markets fast, starting by writing a constitution, reform the central bank by giving it a clear mandate, improve savings situation in the country and make it predictable…

Economics

Over 33% of Serbian government owned firms complain that “too low” of a price for their product(s) is the stumbling block towards their profitability. On the other hand, over 36% of private firms do not complain about prices but about low demand and high cost of borrowing to finance expansion.

These snippets of data are important because they vividly encapsulate the productive focus and its stark contrast between the government and private sector in Serbia.

Government’s complain about “too low” price indicates that they are completely incompetent, or to be more polite, not focused, on increasing productivity in order to make money at the market price that predominates on the Serbian market. Government firms would rather price fix, something dear to communists, then think how to compete in the market place.

On the other side is the regenerative thrust of the private enterprise that does not complain about prices because their productivity is sufficiently high to compete at the predominant market price. What they complain about is lack of demand, a result of low real wages, and high cost of capital, a result of low savings.

The longer the government keeps ownership of these firms, the larger the tax bill for subsidizing their inefficiency. Recent capacity utilization numbers are indicators of this increasing marginal social cost of inefficiency for keeping government owned enterprises in Serbia.

For example, both the government and private firms increased their capacity utilization - a good thing - by 3.74% in the government and by 6% in the private sector. Yet, to achieve this half-the-size increase, government had to increase the size of labor while the labor tilted slightly to the negative in the private. This implies that Serbian private firms can out-produce the government firms by a factor of 2 and still make more money then them.

We are going onto 7 years of “transitional reforms” in Serbia yet only half of the government owned enterprises have been sold. Seven years from now we could complain about the unprivatized 25%… so at this rate, Serbia may be the only one to modernize Zeno’s fourth paradox: why privatize when it’s impossible to achieve.

Economics