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NATIONAL BANK OF SERBIA

Introductory speech at the presentation of the
Inflation Report - November 2023

Dr Jorgovanka Tabakovié, Governor

Belgrade, 15 November 2023

Ladies and gentlemen, esteemed members of the press, dear colleagues,

Welcome to the presentation of the November Inflation Report.

Before we elaborate in more detail on the current macroeconomic developments and
our new projections, I wish to highlight that, despite heightened uncertainty and
external challenges, developments in many areas are either in line with or better than
what we expected at the time of the previous Report. I here have in mind the

following:

e Inflation declined to 8.5% in October, moving somewhat below our August

expectations over the past months;

e Owing to a robust bank regulatory and macroprudential framework and
moderate monetary tightening, financial stability has been preserved and the

NPL share in total loans is close to a historical low;

e In Q3 GDP growth picked up to 3.5% y-o-y, exceeding our earlier
expectations. In light of favourable developments, our GDP growth projection

for the entire year is now around 2.5%;

e We have seen a major improvement of our external position - in the nine
months of this year, the current account deficit measured only 1.6% of GDP,
with FDI inflows exceeding it multiple times. As a result, FX reserves rose to a
new record high of EUR 24.4 bn at end-October;

e The fiscal deficit will be lower than initially planned and will measure around
2.8% of GDP in 2023, thanks to better than planned revenues and reduced
transfers to the energy sector, which will accelerate the downward trajectory
of public debt.

Also, at the very start, I wish to highlight several more things that I consider crucial

from the viewpoint of the NBS's competences and tasks:

e First of all, the measure of capping interest rates on variable-rate housing
loans is well-calibrated in all respects. The adoption of this measure and its
effect on the banking sector financial result are estimated not to jeopardise in
any way the operation of the banking sector, while contributing to the

preservation of financial stability by preventing a rise in NPLs. Household

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disposable income is thereby also increased, but it should be borne in mind
that it cannot jeopardise the downward trajectory of inflation as it makes up
merely around 0.3% of total household consumption in a single year. It can
only contribute to the recovery of consumption, which is indispensable for

achieving the desired economic growth.

e Second, already in Q1, or no later than early Q2 next year, the NBS real key
policy rate will return to positive territory, with y-o-y inflation and inflation
expectations going down. In other words, even by keeping the key policy rate
at the current level of 6.5%, the NBS will act increasingly restrictively, lending

a strong impetus to the disinflation process.

e That our monetary and overall economic policies are adequate is also attested
by IMF's positive second review under the arrangement, which, given the
created buffers, will become a precautionary arrangement most probably
already in December. This contributes to a favourable investment
environment, which is also confirmed by high investment inflows into the real
sector, elevated interest of foreign investors in government dinar securities at
recent auctions, and the country's credit rating one step away from

investment grade.

Later in the conference, we will present in more detail macroeconomic developments

in the international and domestic environments, and our new projections.

KK

Trends in the international environment continue to largely determine domestic
macroeconomic developments and are the key risk to our macroeconomic
projections. The majority of relevant international financial institutions agree that the
global economy has proven to be more resilient than initially expected despite the
consequences of the pandemic and the energy crisis, which caused disruptions in
the world food and energy market and pushed up global inflation, as well as despite

monetary tightening.

In H1, the euro area, our key trade partner, managed to avoid technical recession.
Still, according to the Eurostat estimate, Q3 saw a moderate decline. The leading
monthly indicators suggest that production contracted early this quarter. Subdued

euro area external demand is generating disinflationary pressures on our economy,

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but may also slow down export growth. Nonetheless, owing to rising export supply, in
the year to September our goods exports recorded relatively high growth rates, with
exports to Germany accounting for around 40%. More information is contained in one
of the text boxes in the current Inflation Report. Next year, with the expected recovery
of Germany and acceleration of economic growth in the rest of the euro area, our
production and manufacturing exports are likely to expand.

Chart 1 Revisions of euro area GDP growth projections for Chart 2 Revisions of Euro area inflation projections for 2023
2023 and 2024 and 2024
(in %) (in %)
16 ° N jection for 2022
. lew projection for
° New projection for 2023 . 8 = New projection for 2023 .
14 = New projection for 2024 @ Previous projection for 2022
@ Previous projection for 2023 7 @ Previous projection for 2023
1.2 @ Previous projection for 2024 v
6
1.0
° . e 5 ° .
08 4 85
69
06 3 ae
° .
46
04 07 07 2
02 0.5 4
0.0 °
. World Advanced E = i id
ECB Consensus Economics IMF economies uro area developing
Sources: ECB (June and September), Consensus Economics (July and October) and Sources: IMF WEO (October 2023) and IMF WEO Update (July 2023) °momies

IMF (July and October).

Global inflation has slowed owing mainly to falling world prices of energy and food,
and the effects of past monetary tightening, which is likely to drag down inflation at
home in the coming period. Given the established downward trajectory of inflation
and its expected movement going forward, it is estimated that central banks of
advanced economies are probably nearing the end of the monetary policy tightening
cycle. However, due to persistent risks, tight monetary conditions will be maintained
for some time yet, while, on the other hand, some inflation-targeting regional peers
have already started or announced the start of monetary policy easing. One of the
text boxes in the Report is dedicated to the outlook for global and domestic inflation,

and the dilemmas facing monetary policy makers in the current circumstances.

When it comes to risks to the projection, caution in the conduct of the NBS's
monetary policy is mandated by heightened global geopolitical tensions, which have
intensified with the latest developments in the Middle East. This fuels uncertainty in
commodity and financial markets, triggering volatility of the global oil price over the
past weeks and a moderate rise in the risk premium of emerging economies. Still,
according to the estimates of relevant international institutions, unless the conflict

spreads, we should not expect any major effects on primary commodity prices on this

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account, and on global inflation either. The macroeconomic effects of the
materialisation of the risks of escalating geopolitical tensions and their potentially
faster than expected resolution are examined in our text box on alternative projection

scenarios.

Y-o-y inflation in Serbia has been on a downward trajectory since April. In the past
three months, it measured even less than envisaged by our August medium-term
projection. The slowing of inflation to 8.5% in October and its return to a single-digit
level is the result of lower growth in food prices and prices within core inflation (CPI
excluding food, energy, alcohol and cigarettes), which softened to 7.3% y-o-y in
October. Such movements in core and, by extension, headline inflation reflect the
dissipation of global cost-push pressures, monetary policy tightening and the decline

in short-term inflation expectations of the financial and corporate sectors.

Chart 3 Change in contribution of main CPI components to Chart 4 Inflation projection
y-o-y inflation - compared to march (y-0-y rates, in%)
(in pp)
1 18
=
4 =
-2
; LJ
-4
5
6 I Processed food
7 tm Unprocessed food

mEnergy
8 Industrial products excluding food and energy

Services
me) -
9 12 3 6 9 123 6 9 12 3 6 9 123 6 9
Apr. May June July Aug. Sept. Oct. 2022 2023 2024 2025

Sources: SORS and NBS calculation. Source: NBS.

Under our new projection, after falling to around 8% late in the year, y-o-y inflation
will most probably retreat within the target band towards mid-next year and continue
to slow thereafter, approaching the target midpoint in late 2024. Such movements will
be aided primarily by the effects of past monetary policy tightening, subsiding global
cost-push pressures, slowing of imported inflation and subdued demand amid weaker
global growth. Though in our new projection we expect global oil prices to be higher
in late 2023 and 2024 amid mounting geopolitical tensions, the inflation projected for
2024 is almost unchanged relative to our August expectations as inflation has
receded in the past three months at a faster than expected pace and inflation

expectations have subsided.

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Since inflation is expected to move within the target band over the monetary policy
horizon and the full effects of past monetary tightening on inflation are yet to play out,
we have decided to keep the key policy rate unchanged at 6.5% in the period since
the previous Report. In September, we raised dinar and FX required reserves in
order to mop up surplus dinar liquidity in the market. The transmission of the effects
of past monetary tightening to interest rates in the money, lending and savings
market, and to the volume of lending to the private sector, signals the effectiveness of
the transmission mechanism through the interest rate and lending channel. The
decline in one year-ahead inflation expectations of the financial and corporate
sectors, and the movement of financial sectors two- and three year-ahead
expectations within the NBS's target band, indicate that we have helped contain
inflationary pressures through the expectations channel as well. When it comes to
corporate lending, it should be noted that companies' demand for liquidity loans has
diminished due to increased profitability, while investment loans continue to post solid

growth of around 4% y-o-y.

Chart 5 Movement in the key policy rate and average repo Chart 6 NPL level and share in total loans, gross principle
rate (in RSD bn) (in %)
(daily data, p.a., in %)

500 mmm Household sector 25

9 . "=== Corporate sector
--Key policy rate Other sectors

Lending facilities rate -- NPL share in total loans (RHS)
== Deposit facilities rate 400

-- Average repo rate
300 15
200 10

0. _ (SS i) T T T T T ¥ T T T ¥ 0
1/2020 7/2020 1/2021 7/2021 1/2022 7/2022 1/2023 7/2023 2011-2013 2015. 2017_- 2019 += 2021 September
2023

s= N © RB A DN &

Source: NBS. Source: NBS.

It is also important to emphasise that we have been tightening our monetary policy
continuously, but gradually, taking care to minimise the effects on financial stability
and economic growth. At the same time, we chose not to wait for the risk of rising
interest rates in the euro area to materialise and affect the capacity for repayment of
housing loans in the domestic market; instead, in September we decided to cap the
interest rate at 4.08% for first-time beneficiaries of variable-rate housing loans whose
contracted amount does not exceed EUR 200,000. At around 3% in September, the

share of NPLs in total loans clearly confirms that financial stability has been

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preserved as a result of a robust regulatory and macroprudential framework and

measured tightening of monetary conditions.

Economic growth picked up speed in Q3. According to the SORS flash estimate, y-o-
y GDP growth measured 3.5%, which, in our view, was underpinned primarily by
construction due to accelerated implementation of infrastructure projects. Though
external demand slackened, manufacturing posted better than expected outturns,
propped up by past investment and rising domestic demand. Further, data on the
yields of key crops indicate that this year's agricultural season was better than
average, exceeding our expectations from August. A positive contribution also came
from most service sectors. On the expenditure side, third-quarter growth was led by
rising investment, mostly private. Net exports also gave a positive contribution,
though lower than in H1 2023, as real growth in the exports of goods and services
continued up, and imports declined further.

Chart 7 Contributions to y-o-y GDP growth rate,

expenditure side
(in pp)

Chart 8 Contributions to real GDP growth, expenditure side
(in pp)

o

Net exports I
18 lm Change in inventories
15 === Gross fixed capital formation

mms Government spending
12 Household consumption
-GDP (in %)

Change in inventories
"=m Net exports
===" Government consumption

Gross fixed capital formation
mmm Household consumption
--GDP (in %)

2017-2018 = 2019S 2020S 2021 2022 = 2023* 2011 2013. «2015 «2017, 2019S 2021» 2023* += 2025*

Sources: SORS and NBS calculation. Sources: SORS and NBS.
Note: NBS estimate for Q3 2023.

ob kK &w oy B® @

* NBS estimate.

Owing to favourable movements in Q3, we now estimate the GDP growth rate in
2023 to measure around 2.5%, whereas in August we expected it to settle closer to
the lower bound of the projected 2-3% range. A key contribution to this year's GDP
growth will come from net exports, even as the imports of goods and services are
expected to accelerate and exports decelerate in Q4. On the other hand, we expect
overall domestic demand to stagnate. Fixed investment will go up thanks to
increased corporate profitability, high FDI inflows, and government investment in
transport infrastructure. A positive impulse is also anticipated from private

consumption which is expected to rebound in Q4 on the back of an increase in

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employment and wages in the private and a part of the public sector, and in

pensions. We expect the depletion of inventories to work in the opposite direction.

As global inflationary pressures wane, the euro area, our key trade partner, recovers
and the implementation of investment projects in the area of transport, energy and
utility infrastructure gains speed as planned, we expect Serbia's GDP growth to step
up to 3.0-4.0% as of 2024 and then return to the pre-pandemic growth trajectory of
around 4% per annum. Growth will be led by domestic demand, notably private
consumption and private investment as a result of receding inflationary pressures,
preserved labour market and investment confidence. The achievement of the
projected GDP growth rate in 2024 will also be facilitated by a stronger carry-over
effect than in 2023, resulting from accelerated economic growth in H2 this year and

estimated at around 1.5 pp.

Our external position continued to improve in Q3, hence in the nine months of the
year the current account deficit was just shy of EUR 800 mn, which is as much as
EUR 2.5 bn lower than in the corresponding period in 2022 and at the same time the
lowest deficit to date. The current deficit declined mostly under the impact of the EUR
2.8 bn contraction in the goods deficit as a result of the combined impact of exports
growing by around 6% and imports declining by the same percentage against the
backdrop of, among other things, lower energy balance deficit (by around EUR 1.8
bn). Another factor driving the deficit down is the continued vibrant growth in
manufacturing exports, thanks to investments in tradable sectors, as well as growth
in the services trade surplus. Also, 17 of the 23 manufacturing branches posted
growth, especially the ones associated with the car industry and the production of
machinery, equipment and electronic products. Our projection still maintains that the
current account deficit this year will be around or even below 2.5% of GDP, which is
more than twice lower than last year's deficit. The IMF came out with a similar
projection during the second review of the arrangement. According to our projection,
the anticipated pick-up in the investment cycle and the associated import of
equipment and intermediate goods, which will nonetheless be greatly offset by the
growth in export capacities and the recovery of demand from the euro area, will lead
to the current account deficit trending at around 4% of GDP next year and in the

medium term, which is a level that ensures external sustainability.

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Chart 9 Structure of the current account

(im EUR bn) Chart 10 Current account and FDI projection

(in % of GDP)
10 == Goods
Services 25 . .
mmm Primary income, net - Secondary income - Primary income
° Sore iat 20 Current account -=FDI
-- Current account deficit

6

2019 2020 2021 2022 = 2023* 2024* 2025" 2026*
Sources: SORS and NBS.
* NBS projection.

January-September 2022 January-September 2023
Source: NBS.

The backbone of external sustainability is also composed of FDI inflows which
overshot EUR 3.7 bn in the ten months of the year, outperforming the corresponding
period of the record-setting 2022 and exceeding the current account deficit many
times over. This has kept appreciation pressures strong and facilitated an increase in
the country's FX reserves.

Chart 11 Dinar exchange rate and NBS transactions in the Chart 12 Value and structure of NBS FX reserves
FX market (in EUR mn)
(EURIRSD)** (in EUR m)

140 750 30,000 Securities

135 600 - foreign cash and deposits abroad

mmm SDRs
130 450 25,000 mm Gold 24,389
125 300 -* Nominal FX reserves
1 '] 160 20,000
110 1 ls °
105 "150
~ 15,000

100 300

95 -450

90 600 10,000

85 I gummi NBS transactions in the FX market, monthly (RHG)* ~780

80 I --EURIRSD, monthly average (LHS)** -800 5,000

75 -1,050

70 -1,200

2011-2013. 20152017, «2019 2021~- 2023 0

Source: NBS. 2009 2011 «2013-2015 2017, 2019 2021-2023"
* + net purchase; -net sale. .

EUR 1 in RSD. Source:

NBS.
* Data at 31/10/2023.

Once again I would like to emphasise that we have secured record high FX reserves
and the relative stability of the dinar against the euro, which we have preserved
through all of the previous episodes of elevated international risks. They have been
and remain an important pillar propping our macroeconomic stability during this
global crisis. I would like to draw your attention to the fact that one text box in this
Report is dedicated to trends in the FX market and indicates that an improvement in

the balance of payment flows contributes to an increase in the number of local

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companies selling foreign exchange, which is conducive to the more favourable

structure and deepening of the domestic FX market.

In the year to date, we have recorded a fiscal surplus of 0.3% of GDP - a much more
favourable result than the one initially projected. This was facilitated by revenues
outperforming the planned figures, notably on account of increased corporate
profitability in the past year, and reduced transfers to the energy sector. Thus, we
created room for fiscal policy to support domestic demand without jeopardising the
declining trajectory of public debt. We estimate that the adopted fiscal measures on
the expenditure side (wage growth in one part of the public sector and in payments to
pensioners) will not have a major effect on inflation, as you can read in the text box
on the fiscal impulse that we have prepared for this Report. The medium-term fiscal
framework, whose important anchor are the adopted fiscal rules, projects the
continuation of responsible fiscal policy conduct with a reduction in the share of the
deficit in GDP - from 2.8% this year to 1.5% in 2025. Going forward, a sizeable
portion of budget funds is planned to be earmarked for boosting investments in road
infrastructure and the energy sector, thus helping to increase our economy's
production potential.

Chart 13 Consolidated government balance - revenues, Chart 14 Public debt (general government)
expenditures and result (% share in GDP)
(% share in GDP)
Primary balance, rhs 80 mmm RSD mms EUR
55 I umm Fiscal balance, rhs 4 12 gay == USD mms CHF
~~ Revenues, Ihs 70 SDR mmm Other
-- Expenditures, Ihs 3
50 2
60
1
45 0 50
1
40 2 40
3
36 4 30
6 20
6
30 7 10
8
25 -8.0 9 0 -
2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Qi- 2015 2016 «2017 2018 §=2019 I 2020 2021 2022 Sept.
Q3 2023
Source: Ministry of Finance. 2023

Source: Ministry of Finance.

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Ladies and gentlemen, dear colleagues,

I believe that all of the above-said clearly shows that the Serbian economy has
demonstrated a strong resilience to the many challenges from the international
environment that we have faced over the past several years. Understandably,
nothing is resolved on its own. To achieve resilience and maintain macroeconomic
stability, we needed to pursue consistent and responsible economic policy,
implemented in a synchronised manner and working pro-actively by identifying
potential issues on time and preparing appropriate solutions, including the

implementation of the necessary structural reforms, some of which were quite painful.

Nevertheless, despite the undoubtedly good results, our job is not yet done, and
there will always be new opportunities and challenges looming on the horizon to be
used or overcome. One sentence is particularly relevant for these times, and I often
say it - there are no final victories. Aware of that, the NBS will continue to keep a
close eye on and analyse movements in the international environment in order to
better estimate their impact on our economy and react in an appropriate and timely
manner. Our priority is the return of inflation within the target tolerance band while
safeguarding financial stability and, as much as we possibly can, preserving room for

growth of our economy, employment and our citizens' living standard.

We are at your disposal for any questions you may have in the remainder of the

conference.

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