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Interview of Bojan Markovic, vice governor of the National Bank of Serbia with “Perspective” magazine - March 2011

It is often said that Serbia does not have a developed secondary  securities market. How can this situation be improved?

- In the past, the major obstacle to the secondary market development was the absence of primary issue of government bonds.  But the situation changed in the last year or so, especially with the issue of longer maturity bonds (18 and 24 months).The window of opportunity for the liquid secondary market in Serbia now exists.  In my opinion, there are several key factors that should providefurther improvement.  First, continued extension of the maturity of primary bondissues, such as the launch of 36 months bond, announced for March 2011.  Second, an increase in the volume and the reduction in the frequency of the primary auctions would attract a larger pool of potential investors at the primary market.But it would also increase the potential for the development of the secondary market, since more bonds of the same issue would be available for trade.  Third, one should consider the possibility of introducing primary dealers in the market. This proved to be very important for both ensuring the stability of demand at the primary market, but also for increasing the liquidity of the secondary market, sincethe primary dealers have self-incentive to maintain the highly liquid secondary market and play a market-making role.  Fourth, there is a further potential for increasing the transparency and data availability regarding the secondary market trades.  The NBS is publishing the data on secondary T-bonds trades, as reported by the Central Registry and the Ministry of Finance, but these data does not distinguish between repos, buybacks, and outright sales, which can be important in assessing the liquidity of the secondary market.  Finally, a number of technical and legal improvements might help, such as clarifying the legal status of the collateral, introducing a standardized master agreement, and reviewing the counterparty risk imposed on local banks by their parent  institutions.

One is for sure: increasing the liquidity of the secondary securities market would bring major benefits to all economic stakeholders in Serbia: private corporates, financial institutions, government, foreign investors, and would also increase efficiency of the monetary policy.

Can long-term bonds be used as a reference point when determining  interest rates?

- Yes, of course. Using the yield curve, for pricing the interest rate on longer-term bank loans is a common practice internationally. In fact, probably one of the major obstacles for not having on offer longer-dated dinar bank loans to both corporates and households in Serbia, is the absence of the relevant benchmark for pricing such loans. The relevant benchmark would usually be the yield on longer-term government bonds traded at the liquid secondary market.

It has been announced that the EBRD is planning to issue dinar  bonds. Do you know when this will happen? Have they consulted the NBS  and how will this reflect on the market?

- When this will happen depends on how quickly the amendments to the Foreign Exchange Law pass the Parliament. Also it depends on EBRD’s ability to identify the relevant dinar investing opportunities by.  To clarify legally, there are no obstacles for the EBRD and other international financial institutions (IFIs) to issue dinar bonds immediately, but at the moment there is an obstacle to lenddinars collected by bond issue to their counterparties directly. The amendments to the Foreign Exchange Law due in the Parliament in March 2011 should remove the obstacle, and onewould expect to see the first EBRD dinar bond issue in the course of 2011.  The NBS is indeed in touch with EBRD and some other IFIs interested in dinar bond issues.  Such an issue will reflect positively on the market, since it would increase the number and the diversity of the dinar instruments available at the market.  Furthermore, a decision by an AAA-rated institution to issue long-term dinar bonds may reflect positively on the country risk premium, and also lead to a lengthening of the Serbian yield curve.

In mid-February, perpetual bonds worth 200 million euros were  issued. Less than half of the debut tranche has been sold. What is your  comment on this? Why didn’t the issue attract more buyers?

- These bonds denominated in euros were clearly targeting the domestic insurance and pension funds market, and their potential is currently limited.  Although diversifying an array of instruments can bring benefits in terms of the security of available financing sources for the Government, we should probably all focus on exploring the possibilities for extending and diversifying the dinar yield curve, possibly by considering the so-called long-term inflation-linked bonds.  Of course, the alternative of having the proper Eurobond is also an option to be exercised at some point.  But the proper Eurobond is defined as a bond issued at the international market (despite the name, thisbond does not necessarily have to be issued in euros), and not a domestically-issued bond denominated in euros.

What is the best debt model for Serbia if Serbia had to take  loans? (In dinars or in euros, on domestic market or abroad)

- Dinars first, targeting both the resident and international investors. Although the interest rate on dinar bonds is somewhat higher, the medium-term benefit these bonds will bring to the deepening the Serbian financial markets are certainly higher than costs.  Also, 90 percent of Government revenues are in dinars, and dinar bonds would remove the foreign exchange exposure of the budget. The second choice should be inflation-linked dinar bonds, since these bonds eliminate one of the major worries for long-term investors – inflation risk.  Finally, proper Eurobonds, i.e. foreign-currency bonds issued at the international market, may also bring benefit of diversifying the financing sources for the Republic of Serbia.  I believe that issuing for the domestic market bonds denominated in euros or euro-linked, should not be our preferred option.

In your opinion, are fiscal rules in Serbia well defined?

- They are current state-of-the art rules in theory and practice. They ensure a prudent fiscal policy, while allowing for flexibility over the business cycle. As I mentioned, it would be challenging to abide by them in the years to come, as would be the case in majority in countries worldwide that adopted fiscal rules.  But, if implemented, their adoption might well prove to be one of the most important measures undertaken in the recent history of economic policy in Serbia.

Great Challenges

Do you believe that it is possible to maintain the future tasks of  the Fiscal Council - public debt (without restitution) under 45  percent of GDP, budget deficit under one percent of GDP as of 2015, and  salaries and pensions growing at a slower pace than the economy?

- It is not impossible, although it will be challenging.  Serbia is still going through the aftermath of economic crisis, and as such is still in the zone of higher than prescribed mid-term fiscal deficit.  Furthermore, the austerity policy of lowering public salaries and pensions, although necessary, is socio-economically rather difficult to observe, not only in Serbia but throughout the world.  The challenges are indeed great.  But it was prudent to set the goal at the tighter level, and thus send a clear signal to various budgetary beneficiaries about the potential reach of ever present pressures for public spending increases.