bojan markovic : desirable capital inflows in serbia speech by mr bojan markovic, vice - governor of the national bank of serbia, to dealers at the bloomberg conference, belgrade, 27 april 2010. * * * deliberating consequences and policies of capital inflows seems perhaps inappropriate against the backdrop of recession and depreciation pressure on dinar. yet, the situation may change rapidly, as the recent experience of the emerging europe attests. just a year ago poland, czech republic and romania were concerned about capital outflows and weakening exchange rate – as was serbia. now there are increasing signs that capital starts flowing again into the emerging europe and these countries are finding it difficult to cope with the consequences. a similar turnaround in capital flows can happen in serbia anytime soon too – we are not doing worse than these countries as regards the macroeconomic performance or financial system stability. one such trigger could be the planned issue of medium - term t - bonds that are likely to attract much attention of international investors. it is perhaps wise to use this occasion and review the thinking about capital flows from the perspective of the national bank of serbia. we feel it is important for traders and other players in the financial markets to understand the central bank ’ s attitudes so that they could anticipate our policies and feel comfortable in their activities. capital inflows are welcome! they have been a necessary backbone of our growth model, helping the serbian economy to realize its catch - up potential in the absence of domestic savings. before the crisis foreign savings financed most of our investments ( the investment share was 28 % of gdp and domestic savings around 8 % ). hand in hand went large productivity gains and terms of trade improvements, which were mostly associated with foreign direct investments ( share in gdp of 7 % was relatively high ). capital flows also contributed to improving financial sector infrastructure, increasing the resilience of the financial system to shocks, and allowing for a smoother and efficient allocation of resources. however, by drawing on foreign savings capital inflows also allowed our consumers and government keeping high consumption levels. practically the entire serbian income was consumed in the period before the crisis. such a model of growth was therefore socially attractive, but economically unsustainable. the prospects of repaying the ballooning external debts were dim against the backdrop of low competitiveness and exports of our economy. and although the investment ratios looked high, even higher were necessary, especially given that the investment structure did not support

. but who was the most important carry trader in serbia? a large number of households – not a shrewd financier from london. and who bore most of the currency and maturity risk? again domestic entrepreneurs and partly households – not the foreign investors. it is because of this unbalanced risk sharing that policy makers have to remain cautious about capital inflows. our macroeconomic and financial stability was put in danger during the crisis not because we had been borrowing abroad to finance growth, but because foreign investors did not carry adequate share of the risks involved in these activities. those businesses that were financed by foreign direct investment did not suffer so much from the lack of financing during the crisis, nor did those who borrowed in dinars, when the currency depreciated. in both these cases the foreign investors ventured into the future prospects of our economy – hoping to enjoy benefits but also sharing the risks. those foreign investors who bought into dinar denominated financial instruments took the fair burden on their shoulders, while those who had a stop - loss deposit with a local bank left the damage here. this discussion gives a background for our thinking about capital inflows in the future. we welcome all kinds of inflows, but as long as the financing risks involved rest fairly with the investor and not only with the local economy. that of course favors long - term flows to shortterm, because most investment projects require long - term financing. foreign direct investments or joint ventures are the most preferred examples here – also because they bring other positive externalities in terms of know - how and technology. such investors clearly demonstrate their long - term commitment to the prospects of serbian economy. but we also encourage pure financial flows – even short - term, if they match the financing needs. for many reasons explained earlier, they contribute to financial market development and help risk diversification. in particular, we are hoping the issue of dinar - denominated t - bonds will attract much attention of foreign investors, and the program will be success, eventually allowing the government to reduce the fx part of its debt. we are also hoping that higher volumes will help spur secondary trading and develop a dinar yield curve for benchmarking of other dinarbased instruments. for all these reasons we encourage foreign investors ’ involvement in local currency t - bonds – but we have clear preferences as regards specific forms of such an involvement. we prefer the forms in which the foreign investors take most of the credit and fx risks,