September 2015 ECONOMIC DIGEST. Finance and Market Trends Guide

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1 September 2015 ECONOMIC DIGEST Finance and Market Trends Guide

2 Editorial Office> Analyst Marko Danon ) Secretary Jelena Radosavljević ) Translator Katarina Dimitrijevi' Publisher Hypo Alpe-Adria-Bank a.d. Beograd, Bulevar Mihajla Pupina 6, Beograd Info Center Hypo Alpe Adria bank> Design and prepress> ImageTeam d.o.o. Disclaimer Information and opinions contained in this report have been prepared by Hypo Alpe-Adria-Bank a.d. Beograd analysts. All opinions expressed in this report reflect the current assessment of the author and do not necessarily reflect the attitude of Hypo Alpe-Adria-Bank a.d. Beograd, Hypo Group, or any other of its subsidiaries and branches. This report was based on publicly available information, and all charts state the sources. This report does not represent advice for any type of investment or bid or call to buy or sell any securities. Information it includes present general information, and is not a replacement for independent financial advice, nor shall their publishing be binding upon Hypo Alpe-Adria-Bank a.d. Beograd, Hypo Group and its subsidiaries and branches. 2 Hypo Alpe-Adria-Bank a.d. Beograd, Hypo Group and its subsidiaries and branches shall not assume the obligation to publish changes of information or opinions that arose in the meantime, and shall not accept any responsibility for direct or indirect loss that occurred as an effect of using this report, information and prices from this material, nor shall it guarantee for their correctness and completeness. We also stress that further distribution or copying of this material or its parts without previous written approval of Hypo Alpe-Adria-Bank a.d. Beograd is strictly prohibited.

3 Overview Serbian economy stepped out of recession by mid 2015, mostly on the back of increased demand for local goods, in line with gradual recovery in Eurozone, the key trading parter of Serbia, as well as due to increased investments, courtesy of speedup of activities in several infrastructure projects. On the other hand, demand of households and government keeps exherting negative contribution to economic activity, seemingly in line with measures of fiscal austerity. Thus after 2% yoy contraction in Q1, activity rose by 1% in Q2. The Q3 was characterized by heavy drought, whcih will seemingly have relatively strong negative impact on agricultural output, i.e. mostly autumn crops such as maize. Also, some risk on Serbian growth can be exerted via ongoing slowdown of activity in Eurozone since mid Indeed, after ECB QE-related speedup in H1, mid year was characterized by decreasing market optimism, and growth slowdown in conditions of growing concerns over Greek debt crisis and plummeting indices at Chinese capital markets. Bearing in mind that these risks could affect Serbian net exports, in conditions of prolonged outlook of decrease of local demand, this year could see relatively modest GDP growth of app. 0.5%-1%. In line with somewhat increased external demand, H1 saw narrowing of current account deficit of as much as 30% yoy. This deficit reached merely EUR 0.7 bn, i.e. 4.5% of GDP. Also, this narrowed deficit was adequately covered by foreign capital inflows. Hence under pressure of relatively hefty net inflows of investments, and dramatically decreased net deleveraging of banks, stock of FX reserves rose by app EUR 80 m during H1. This external rebalancing apparently had a stabilizing effect on RSD value during most of In the same time, a similar trend of stablilization or strenghtening of other regional free floating currencies was evident, pointing to a possible effect of net inflows of foreign portfolio investments throughout the region, amidst significantly increased liquidity after the start of ECB QE. In order to mitigate these apprecation pressures, NBS purhcased a net of EUR 660 m ytd (by 18th September). However, bearing in mind that the Serbian current account deficit remains one of the largest in Europe, even despite its narrowing, it is plausible to expect a gradual nominal depreciation of dinar in the mid term. In line with the trend of low domestic demand, and decreasing global commodity prices, 2015 saw rather weak inflationary pressures. Hence the annaual inflation rose by merely 2.1%, by end of August. The effect of the summer drought on food prices, as well as the effect of low basis will seemingly represent the key inflationary pressures in forthcoming months, but these would largely be neutralized amidst weak local demand. Hence the annual inflation would return to NBS targeted band of 4+/-1.5% seemingly only along H In conditions of low inflation and RSD stability, NBS embarked on policy easing in order to spur economic activity. Hence the key rate has been lowered since March by a total of 3pp to 5%, where it was after the September s Executive board session. The Central bank has also introduced an additional measure of policy easing in terms of reduction of FX part mandatory reserve rate by one percentage points in next six months, meaning that by end February 2016, this rate would be reduced to 20% for sources of up to two years maturity and to 13% for longer term sources. Bearing in mind the prolong outlook of relatively low inflation, it is possible that there is room for a possible additional relaxation of monetary restrictiveness in forthcoming months. While monetary policy restrictiveness has been eased during 2015, fiscal policy restrictiveness obtained a relatively firm character, in line with measures of fiscal consolidation started in late Hence the condolidated budget deficit in 7M 2015 was decreased by as much as 65% yoy, by reaching RSD 39 bn (app. 2% of GDP). This is largely a result of increase of incomes by 5.4% yoy, and simultaneous decrease of expenditures of 2.4%, all in line with firm fiscal consolidation, i.e. decrease of pensions, wages in public sector and somewhat lower realisation of public investments. However, key contribution to increase of expenditures is exerted by the still soaring interest repayments, which topped as much as RSD 79 bn, i.e. 3.5% of GDP (vs 3% in 2014, 2.4% in 2013, 1.9% in 2012). This said, the consolidated deficit would reach app 4% of GDP (according to Fiscal council forecast), instead of initially planned 6%. In conditions of this relatively strong narrowing of budget deficit, the IMF mission, in visit to Belgrade in late August, approved the continuation of precautionary arrangement with Serbia. Financing needs of this narrowed deficit, as well as of earlier debt issuanecs, were being met along 2015 almost entirely through borrowing, especially in terms of T-bill and T-bond issuances at local market. That said, during 7M 2015, stock of these papers rose by a net EUR 670 m, amidst decreasing yields, in line with large global liquidity, restricted investment alternatives locally, RSD stability and decreased sovereign s need for financing. It is possible that the financing needs would be largely met via borrowing in the rest of the year, which would keep pushing up the public debt from the present level of 75% of GDP towards the level of 76-77%. 3

4 Macroeconomic Trends Economic Digest September 2015 Table 1 Macroeconomic overview Mar 15 Jun 15 Jul 15 Aug 15 Sep * 2016* Economic Activity GDP in EUR billion Real GDP growth in % yoy (cumulative) GDP per capita, EUR 4,401 4,783 4,626 4,581 4,664 Industrial production, growth in % yoy (cumulative) PRICES AND FX EXCHANGE Inflation CPI, in % yoy EUR\RSD (end of period) LABOR MARKET Unemployment rate, ILO definition, annual avg Average wage growth, yoy, EUR basis FOREIGN TRADE AND BALANCE OF PAYMENTS Goods and services exports, in EUR billion (cummulative) Goods and services imports, in EUR billion (cummulative) Trade deficit, in EUR billion (cummulative) Trade deficit, in % of GDP Current account deficit, in EUR billion (cummulative) Current account deficit, in % of GDP Net FDI in EUR million (cummulative) Net FDI in % of GDP (cummulative) FISCAL DATA Fiscal deficit of the consolidated state, in RSD billion (cummulative) Fiscal deficit of the consolidated state, in % of GDP Public debt in EUR billiion Public debt in % of GDP MONETARY DATA Domestic loans, EUR billion Domestic loans, yoy growth, EUR basis NBS key rate, end of period INTERNATIONAL DATA Real GDP growth in Eurozone, in % yoy EUR\CHF, end of period EUR\USD, end of period ECB key rate, end of period SNB key rate, end of period M Euribor, end of period Libor CHF 3M, end of period * forecasts Source> National Bank of Serbia, Serbian Statistics Office, Ministry of Finance, Bloomberg, Economic Research of Hypo Alpe-Adria-Bank (hereinafter> Hypo Research) 4

5 Economic activity Local economy steps out of recession in mid 2015, driven mostly by recovering investments and increasing external demand, while demand of households and government keeps exerting negative contribution to growth. Industry-wise, speeding up of economic activity was largely driven by construction industry and certain export-oriented sectors, as well as, seemingly, the low basis effect in the energy sector. Thus, in Q2 2015, the GDP grew by of 0.9% y-o-y (according to a flash estimate of the Serbian Statistical Office), following the contraction of 1.8% in Q1, Chart 1. The Q3 activity featured primarily intense summer drought which might make a relatively significant negative effect to this year s agricultural production. Given that trends of low domestic demand and recovering external demand would likely persist in the rest of the year, we see GDP growth at around 0.5% at the level of * SORS flash estimate Table 2 Real growth of GDP, production principle Q Q Q Q Q Q Q Q Q Q Annual growth in % yoy Contribution to GDP growth in pp Gross domestic product (GDP) Final consumption expenditure of households Final consumption expenditure of the state Gross fixed capital formation Exports of goods and services Imports of goods and services Source> Serbian Statistics Office International environment The economic activity in the Eurozone countries accelerated moderately since Q1, evidently resulting from the launch of the ECB s quantitative easing program injecting monthly app. EUR 60 billion of liquidity in the system predominantly through buying of government securities at the secondary market. This growth acceleration in the key Eurozone countries gradually spilled over to the periphery EU members in the course of this year, Chart 2. On the other side, the Eurozone economic activity growth decelerated along mid-2015, which was most probably related to uncertainties about the solution of the Greek debt crisis, as well as market concern relating to the current Chinese growth deceleration, Chart 3. * PMI (Purchasing Managers Index) is a monthly index of the processing industry purchasing managers sentiment who report in surveys whether their operation is (i) improved, (ii) deteriorated, or (iii) unchanged m-o-m. The score x of the index for country i ranges 0 x i 100, where the values 0 x i 50 represent deterioration, x i =50 represents no change and 50 x i 100 represent improvement. Source> Bloomberg 5

6 Agriculture At mid-2015, the local agriculture was affected by unfavourable weather implying above-average warm and dry conditions. The drought was especially harmful to the growth and development of autumn crops, the most significant being the maize, soy, sunflower and sugar beet. Accordingly, at 2015 level, the agricultural production will most likely record a fall relative to 2014 and the multiannual average, Chart 4. Retail trade The retail trade growth accelerated and stepped into the positive zone, following a contraction occurring at 2014 end and 2015 beginning. This relatively moderate recovery was mostly contributed by, seemingly, the last year s low basis effect, Chart 5. Thus, the real growth in H1 reached 0.7% y-o-y, still being much lower compared to the 2% growth achieved in Construction In H1 2015, the construction industry accelerated gradually, especially in the segment of the construction of other structures (mostly infrastructure within current projects of road network construction), while the construction of buildings retained a downward trend. Thus, in H1, the value of performed works increased by nearly 19% y-o-y, out of which percent, the growth in the segment of the construction of other structures stood at 31% and the building construction activity made the fall of 5.5%, Chart 6. Industrial production In H1 2015, the industrial activity recovered moderately after a last year s contraction. This trend was primarily caused by the growth of demand in the Eurozone, as well as the low basis effect in segments which made a production slump in 2014, such as energy and mining, Chart 7. Thus, the industrial production grew by nearly 5% in H1 y-o-y, following the last year s contraction of 6.5%. Observed by industry, the production growth in recent months was the most intense in the energy and mining, as well as certain processing industry export-oriented segments, Chart 8. Thus, in H1 2015, the major positive contribution to the industrial activity growth was made by the segments of tobacco production (production growth of 75% y-o-y), base metals production (+25%), food processing (+5%) and pharmaceutical production (+13%). On the other side, the production volume in the motor vehicle production, dominated by the largest domestic exporter Fiat, decreased by app. 2.5% in H1 y-o-y, reflecting at the same time as the fall of Fiat s exports of app. 9% in H y-o-y. * The index is based on the sum of the production of wheat, maize, sunflower, soy and sugar beet in a calendar year. Meaning, the sum of the total production of the said crops for each individual year is divided by the average production in the period and multiplied by 100 for indexation purposes. The wheat production estimation was done by the Serbian Statistical Office (published on June 30, 2015) and the autumn crops production estimation was done by Hypo Research based on (i) Serbian Statistical Office s estimation of sown area (published on June 30, 2015) and (ii) average yield in t/ha for the period

7 Table 3 Industrial production growth, y-o-y Jan-Mar 2015 Jan-Jun 2015 The yoy growth rate of industrial production INDUSTRY TOTAL Manufacturing industry Food products Beverages Tobacco products Textiles Clothing Leather and related products Wood and wood products, except furniture Paper and paper products Printing and reproduction of recorded media Coke and refined petroleum products Chemicals and chemical products Basic pharmaceutical products Rubber and plastic products Other non-metallic mineral products Basic metals Fabricated metal products, except machinery Computer, electronic and optical products Electrical equipment Machinery and equipment n.e.c Motor vehicles, trailers and semi-trailers Other transport equipment Furniture Other manufacturing Repair and installation of machinery and equipment Mining and quarrying Electricity, gas, steam and airconditioning supply

8 Prices In previous months, the local economy experienced intense deflationary pressures due to, most likely, (i) small domestic demand, (ii) low global prices of raw materials, and (iii) relative dinar stability in the major part of Thus, the annual inflation reached only 1% at July 2015 end (cf. +1.7% at 2014 end), being below the level of the NBS target corridor (4±1.5%) for over a year, Chart 8. This year s key inflationary pressures were made by increases of prices of fruit (+26% y-o-y), oil and fat (+13%) and coffee (+9%), while major disinflationary pressures were made by lowering of prices of meat (-5.5%), vegetables (-5%) and car fuel (-4.4%). In the remaining part of the year, major inflationary pressures would come from (i) increase of electric power price of 12% on August 1, (ii) potential pressures to the increase of prices of certain food categories due to the outlook of a relatively moderate agricultural season, and (iii) low basis effect, but these effects will be largely neutralised by the low domestic demand. Therefore, the inflation will most probably return within the target corridor in late 2015 or early Exchange rate Previous months featured relatively intense appreciation pressures causing dinar to nominally increase relative to euro by app. 0.8% from the year beginning (until August 18, 2015). Similar trends may be observed in the group of regional currencies with floating exchange rate regimes. Namely, in the same period, Polish zloty appreciated by 3.3%, Czech koruna appreciated by 2.5%, Hungarian forint appreciated by 1.8% and Romanian leu appreciated by 1.2%, Chart 11. These trends were apparently primarily caused by the increased appetite of foreign investors for debt securities of developing countries resulting from easing of external risks connected to Greece financial assistance pack- age from July beginning, as well as the continuation of the ECB s quantitative easing program. Additionally, dinar stability was also, most likely, contributed by the narrowing of the fiscal and current account deficit. In order to alleviate the intensified appreciation pressures, from the year beginning (until August 31, 2015,) the NBS bought the net of EUR 660 million in the interbank market, Chart 12. Still, the possibility of gradual dinar weakening on mid-term should not be ruled out, primarily due to the continued high external deficit and potential net capital outflows in case of the occurrence of global risk aversion episodes. Source> Bloomberg, National Bank of Serbia, Hypo Research Source> National Bank of Serbia, Hypo Research 8

9 Wages Average wages were decreasing since Q4 2014, most likely in line with fiscal consolidation, i.e. cutting of public sector wages in November Namely, for the first 7 months of 2015, average wages made the real fall of 0.2% y-o-y, denominated in dinars. Denominated in euros, the nominal fall reached 2.5%, Chart 13. Table 4 Average cumulative* wage in Serbia Dec 11 Dec 12 Dec 13 Dec 14 Mar 15 Jun 15 Jul 15 Average cumulative wage, in RSD 43,887 46,923 50,820 49,970 43,121 44,583 45,601 Average cumulative wage, in EUR * Cumulative wage is an average of monthly wages in all previous months of the year. Foreign trade and balance of payments In H1 2015, the exports growth accelerated, apparently resulting from the moderate increase of demand in the Eurozone, as well as the low basis effect following almost doubled production volume in the Smederevo steelworks from the year beginning. Namely, the exports result of nearly EUR 6 billion implied the growth of 8.1% y-o-y (cf. growth of 1.4% at 2014 level). Observed by industry, the acceleration was mostly contributed by the growth of the exports of base metals, tobacco and food products. The major negative contribution to the exports growth was made by the automotive industry, apparently in line with this year s decreasing of the Fiat production, Chart 15. On the other side, the imports growth also accelerated relative to 2014 and its result of EUR 8 billion in H1 implied an increase of 7.1% y-o-y (cf. growth of 0.4% at 2014 level). Despite the fact that this imports acceleration may only be partly ascribed to the acceleration of the industrial and construction activity, the Serbian Statistical Office s data indicate that the growth was mostly generated in the sectors of products not categorised by purpose, meaning that the cause of this year s imports growth, according to the official statistics, cannot be fully determined yet. Accordingly, in H1 2015, the deficit increased by 4.2% and reached EUR 2.1 billion or 12.8% of the GDP. Source> National Bank of Serbia, Hypo Research 9

10 Table 5 Growth rates of exports of certain categories by activity Dec 13 Dec 14 Mar 15 Jun 15 Dec 13 Dec 14 Mar 15 Jun 15 Dec 13 Dec 14 Mar 15 Jun 15 Export by segment Total exports, In EUR million Annual growth rate, in % Contribution to growth, in pp Agricultural and food products 1, , , Energy and ores Coke and oil derivatives Chemicals and chemical products Rubber and plastic products Basic metals Electrical equipment Motor vehicles and trailers 1, , , Other segments 3, , , Total exports 10, , , , Table 6 Serbian balance of payments* in EUR million Dec 12 Dec 13 Dec 14 Mar 15 Jun 15 Dec12 Dec 13 Dec 14 Mar 15 Jun 15 in EUR million, cumulative in % of GDP I CURRENT ACCOUNT -3, , , Goods -5, , , , , Exports 8, , , , , Imports 14, , , , , Services Exports 3, , , , Of which> transport Tourism Construction IT Imports 2, , , , Of which> transport Tourism Construction IT Primary income (net) -1, , , Of which> net income from direct investments Net income from portfolio investments Secondary income (net) 2, , , , Of which> net remittances 1, , , , II CAPITAL TRANSACTIONS (net) III FINANCIAL ACCOUNT 3, , , Direct investments (net) , , Portfolio investments (net) 1, , Other investments (net) , Trade credits (net) Credits (net)* , NBS Government Banks Other sectors Currency and deposits (net) Other IV ERRORS AND OMISSIONS (net) V NET FX RESERVES CHANGE -1, , Note> Since May 2014, the NBS presents the balance of payment statistics according to a new methodology and therefore, certain figures within the balance of payments have been changed in relation to previous releases Source> National Bank of Serbia, Hypo Research 10

11 Whereas the goods trade deficit slightly increased, the trade in services made an increasing surplus in previous years. Namely, in H1 2015, there were the positive net exports of EUR 250 million, being app. 80% higher y-o-y, Chart 16. Resulting from the growth of the net exports of services, as well as the intensified net inflow of remittances from abroad, the current account deficit reached EUR 730 million in H1 2015, being almost 30% lower y-o-y. In addition to the narrowed current account deficit, net capital inflow was relatively larger, seemingly causing the stabilisation of dinar for the major part of 2015 as well. The intensified net capital inflow was predominantly the result of much smaller deleveraging of the NBS, banking sector and private sector y-o-y, while there were somewhat smaller net FDI and portfolio investment inflows, Table 6. Thus, in H1 2015, FX reserves were increased by app. EUR 80 million, following the slump of almost EUR 1.8 billion in Source> National Bank of Serbia, Hypo Research Serbian external debt In Q1 2015, the total Serbian external debt increased by almost a billion EUR, reaching the level of app. EUR 26.8 billion. The government debt increase of app. EUR 880 million made the major part, while the corporate segment borrowed app. EUR 150 million and banks deleveraged by app. EUR 100 million, Table 7. Table 7 Serbian external debt, private and public Dec 11 Dec 12 Dec 13 Dec 14 Mar 15 in EUR million State 10,773 12,185 13,166 14,189 15,072 out of that> IMF 2,077 1,841 1, Private sector 13,352 13,460 12,579 11,637 11,728 Banks 4,364 4,150 3,400 2,566 2,470 Companies 8,988 9,310 9,179 9,071 9,258 Total Serbian foreign debt 24,125 25,645 25,745 25,826 26,800 in % GDP State Private sector Banks Companies Total Serbian foreign debt Source> National Bank of Serbia, Hypo Research 11

12 Monetary sector The upward trend of the money supply M3 (representing cash in circulation and transactional, dinar and FX deposits) continued as a consequence of intense financing of the fiscal deficit through borrowing, with the growth rate gradually decelerating in 2015, most likely due to the alleviation of the low basis effect. Namely, the real growth of this money supply reached 5.8% by June end, y-o-y (cf. 7% at 2014 end), Chart 17. In line with relative dinar stability and small inflationary pressures, the NBS lowered the key interest rate by the total of 3 pp to 5% from March. Bearing in mind that the annual inflation will most probably stay below the lower level of the target corridor in the months to follow as well, the NBS could have space for further easing of the monetary restrictiveness. However, the potential relaxation will, seemingly, depend primarily on possible episodes of global risk aversion and measures of major central banks, i.e. on the potential increase of the FED s interest rates at the year end. In line with the small domestic demand, the loan growth decelerated in 2015, following an acceleration episode at 2014 end which was primarily caused by the loan subsidy program. Thus, the total loans increased by 0.6% for the first 7 months y-o-y (cf. +0.4% at 2014 level), and out of this figure, retail loans increased by 4.5% y-o-y (2014 figure: +3.6%), while the corporate loan stock decreased by 1.8% (2014 figure: -3.4%), Chart 18. The total retail savings continued increasing for the first 7 months of 2015 and made the growth of 1.4% y-o-y, with the result of EUR 8.7 billion (cf figure of +1.5%), Table 9. Source> National Bank of Serbia, Hypo Research * Adjusted by the effect of the change of the RSD exchange rate for indexed loans and the amount of unrecoverable placements of banks in bankruptcy Source> National Bank of Serbia, Hypo Research Table 8 Consolidated balance of commercial banks in EUR million Dec 11 Dec 12 Dec 13 Dec 14 Mar 15 Jun 15 Jul 15 TOTAL ASSETS 27,732 27,775 27,485 27,352 27,403 27,687 27,735 Liquid assets 8,228 7,799 8,365 8,328 8,253 8,596 8,628 Cash and deposits with NBS 4,635 4,431 4,340 3,724 3,979 4,030 4,199 of witch> mandatory reserve (allocated f\x reserve+calculated RSD reserve) 4,319 4,036 3,868 3,289 3,326 3,359 3,394 FX liquid assets 1,208 1,489 1,184 2,203 2,053 2,088 1,828 Placements to repo, NBS and RS t-bills 2,384 1,879 2,842 2,401 2,220 2,478 2,601 Placements (gross) 17,677 18,176 17,305 17,319 17,516 17,431 17,494 Companies 10,644 10,762 9,684 9,379 9,351 9,210 9,256 Households 5,751 5,739 5,876 5,991 6,108 6,183 6,212 Other 1,282 1,674 1,744 1,949 2,057 2,038 2,026 Fixed and other assets 1,827 1,800 1,815 1,706 1,634 1,660 1,613 TOTAL LIABILITIES 27,732 27,775 27,485 27,352 27,403 27,687 27,735 Deposits 13,301 13,623 14,099 14,618 14,588 14,760 14,788 Liabilities to Government Transaction deposits 1,637 1,632 2,129 2,249 2,090 2,253 2,383 Dinar term deposits 1,856 1,513 1,407 1,516 1,425 1,412 1,451 FX term deposits 9,607 10,166 10,119 10,169 10,385 10,419 10,286 Foreign liabilities (foreign borrowing + non.res.) 5,234 5,109 4,301 3,395 3,359 3,245 3,336 Reserves for potential losses 2,059 1,986 2,082 2,183 2,400 2,360 2,334 Equity and reserves 5,447 5,377 5,429 5,198 5,040 5,196 5,242 Other liabilities 1,692 1,680 1,573 1,960 2,016 2,125 2,034 Source> National Bank of Serbia, Hypo Research 12

13 Table 9 Total household savings in EUR million Dec 11 Dec 12 Dec 13 Dec 14 Mar 15 Jun 15 Jul 15 Total savings 7,597 8,156 8,439 8,568 8,664 8,708 8,675 Total RSD savings Short term A vista Up to one month Up to three months Up to six months Up to one year Long term Up to two years Up to five years Over five years Total FX savings 7,412 8,001 8,146 8,253 8,360 8,376 8,335 Short term 5,455 6,432 6,458 6,432 6,475 6,372 6,278 A vista 1,457 1,669 2,067 2,677 2,841 3,046 3,076 Up to one month Up to three months Up to six months Up to one year 2,824 3,659 3,744 3,095 3,015 2,776 2,663 Long term 1,957 1,569 1,687 1,821 1,885 2,004 2,056 Source> National Bank of Serbia, Hypo Research Fiscal flows The budget deficit of the consolidated government reached only RSD 39 billion for the first 7 months of 2015, being app. 65% smaller y-o-y. Further, there was the primary surplus of the general government budget (after excluding interest repayment) of app. RSD 40 billion, Chart 19. This considerable fiscal deficit narrowing primarily resulted from the revenues increase of 5.4%, mostly in the category of non-tax revenues which increased by as much as 50%, predominantly due to pay out of dividends of some public and state-owned companies in H The deficit shrinking was also contributed by the expenditure narrowing of 2.4% y-o-y, mostly resulting from decreased expenditures for wages (-11.9%), pensions (-3.3%) and CAPEX (-4%). Still, repayments of interest (16.3% growth y-o-y) and activated guarantees (+72%) continued to make the most intense pressure to the consolidated budget expenditure growth. Accordingly, the general government deficit at 2015 level could stand at app. 4% of the GDP (according to the Fiscal Council s projection), instead of initially planned 6% of the GDP. In case of the deficit reaching this lower level, government needs for financing the deficit and maturity of previously issued debt could reach app. EUR billion in the period August beginning year end. These needs will apparently be covered mostly by borrowing on the local market and possibly through bilateral agreements with foreign governments and institutions, and the option of the Eurobond issue in foreign markets cannot be ruled out yet, either. Source> Ministry of Finance, Hypo Research 13

14 Table 10 Realisation of the consolidated government budget Dec 11 Dec 12 Dec 13 Dec 14 Mar 15 Jun 15 Jul 15 Dec 11 Dec 12 Dec 13 Dec 14 Mar 15 Jun 15 Jul 15 in EUR million in % GDP I PUBLIC REVENUES (incl. Grants) 13, , , , , , , Current revenues 13, , , , , , , Tax revenues 11, , , , , , , Personal insome tax 1, , , , Wage tax 1, , , Other personal income tax Corporate income tax VAT 3, , , , , , Excises 1, , , , , Excises on petroleum Excises on tobacco Other Customs Other tax revenues Social contributions 3, , , , , , Non-tax revenues 1, , , , , Grants II PUBLIC EXPENDITURES 14, , , , , , , Current expenditures 13, , , , , , , Expenditures for employees 3, , , , , , Purchase of goods and services 2, , , , , Interest payment Subsidies Social grants and transfers 5, , , , , , , Pensions 4, , , , , , , Contributions for unemployed persons Sick leave Social assistance 1, , , , Other transfers to households Other current expenditures Capital expenditures 1, , Activated guarantees Net lending III CONSOLIDATED BALANCE (I - II) -1, , , , IV PRIMARY BALANCE (III - interest repayments) -1, , , , Source> Ministry of Finance, Hypo Research 14

15 Public debt In H1 2015, the public debt increased by app. EUR 1.3 billion and reached app. EUR 24 billion or app. 74.7% of the GDP. The growth resulted from continued relatively significant needs for financing the fiscal deficit and maturity of previously issued debt, as well as USD appreciation since it is the indexation currency for app. a third of the Serbian public debt. Having in mind that the said government needs for financing for the remainder of the year will be most probably predominantly fulfilled through new borrowing, there is space for the public debt to reach app % of the GDP by the year end. In the course of 2015, investor interest for the local debt market was intense, apparently in line with the initiation of the ECB s quantitative easing program and easing of external tensions related to the Greek debt crisis from July. Locally, the interest was additionally intensified by reaching the precautionary arrangement with the IMF, with dinar being stable and alternatives for investing in the local market being relatively limited, Chart 21. Stock of these papers rose along most of 2015, with the intensity somewhat lowering in recent months, seemingly due to the narrowing of fiscal deficit, i.e. decreased government financing needs. Thus, the t-bill and bond stock reached app. EUR 7.3 billion by July end, being app. EUR 670 million higher relative to 2014 end, Chart 22. Source> Ministry of Finance, Hypo Research Source> Ministry of Finance, Hypo Research * Calculated as a ratio of subscribed bids at auctions and realised amount Source> Ministry of Finance, Hypo Research 15

16 Money Market Local money market and NBS open market operations In line with the continued monetary easing by the NBS for the major part of 2015, market rates gradually lowered in previous months. On the other side, having in mind primarily increasing of the dinar liquidity in the system following the finalisation of the loan subsidy program implemented in 2014, the NBS restarted weekly repo auctions in the open market in April, after their discontinuation in Q Thus, these securities reached RSD 40 billion by mid-august (cf. RSD 15 billion at 2014 end). Source> Bloomberg Source> National Bank of Serbia T-bill and bond auction overview As a result of increased investor interest in the local debt market, monetary easing by the NBS, as well as the possibility for the Ministry of Finance to reject highest bids at t-bill and bond auctions, yields on these securities were retreating for the major part of In recent weeks, foreign markets recorded stagnation and certain decrease in yields on Serbian Eurobonds and other countries in the region, Chart 26. Nevertheless, in spite of recording a small fall, yields on Serbian Eurobonds still rank among the the highest in Central and East Europe, which is potentially indicative of the continued foreign portfolio investors perception of higher risk of the local economy. Source> Ministry of Finance, Hypo Research Source> Ministry of Finance, Hypo Research 16

17 International money market In 2015, global market interest rates reached historically low values, most likely in line with effects of monetary easing by major central banks and very low inflationary pressures against the conditions of modest economic growth and low prices of commodities, Chart 27. In the Eurozone, market interest rates were falling for the major part of the year, entering the negative zone in Q1, in line with the initiation of the ECB s quantitative easing program, i.e. injection of liquidity into the system through buying securities in the secondary market. Thus, 3M EURIBOR reached the historically low value of -0.31% at August end (cf % at 2014 end). CHF interest rates (CHF LIBOR) were in the negative zone since December 2014, following the SNB s introduction of negative interest rates for savings. At the same time, USD interest rates (USD LIBOR) gradually increased for the first 7 months of 2015, most probably caused by the FED abandoning the quantitative easing policy in 2014 (implemented since 2012 end). Source> Bloomberg Major world currencies overview After relative stability of euro to major global currencies at mid-2015, August end featured an appreciation episode, in line with market uncertainties and growing risk aversion occurring after devaluation of Chinese yuan and share plunge at Chinese stock exchanges, Chart 28. In line with the ECB s quantitative easing program, the remainder of 2015 and 2016 beginning is expected to feature relatively increased depreciation pressures to euro and retaining of the zero level by market interest rates. Moderate economic growth in Switzerland may provide the SNB with the possibility to retain the existing level or even additionally ease monetary restrictiveness, so that CHF LIBOR, according to market expectations, would remain within the negative zone. Recent market uncertainties related to the Greek crisis and the devaluation of Chinese yuan apparently continue to defer the expected FED s decision to increase interest rates by 2015 end. Still, the potential increase of the FED s key interest rate could make pressure on USD appreciation as well as the attractiveness of the US capital market for international portfolio investors. Table 11 Forecast of central bank interest rates, in % Table 12 Forecast of market interest rates, in % Q2 15 Q3 15 Q4 15 Q1 16 Q2 16 3M Euribor M USD Libor M CHF Libor Table 13 Forecast of exchange rates Q2 15 Q3 15 Q4 15 Q1 16 Q2 16 ECB FED SNB Source> Bloomberg contributor composite Source> Bloomberg contributor composite Q2 15 Q3 15 Q4 15 Q1 16 Q2 16 EUR \ USD EUR \ CHF Source> Bloomberg contributor composite * Values below 100 indicative of EUR depreciation and values above 100 indicative of appreciation, in pp, relative to 2013 end. Source> Bloomberg, Hypo Research 17

18 FX Market Volume of trading in the interbank FX market The turnover in the interbank market had a downward trend since January end, in line with the stabilisation of RSD to EUR at , Chart 29. Source> National Bank of Serbia, Hypo Research Capital Market Considerably increased liquidity in international markets, in line with the initiation of the ECB s quantitative easing measures, apparently made a contribution to the growth of indices in European stock exchanges in H However, the optimism in European stock exchanges, including the local one, was somewhat smaller in summer, due to uncertainties related to the solution for the Greek debt crisis in July and share plunge in Chinese stock exchanges in August, Chart 30. For the first 7 months of 2015, the turnover in the Belgrade SE reached EUR million, making the fall of app. 11% y-o-y, Chart 31. Out of the said amount, international investors participated with a half, which represents the same level y-o-y. For the first 7 months of 2015, most traded shares were those of AIK banka, NIS and Komercijalna banka, Table 14. Expectations of market players about developments in the Belgrade SE (shown through BelexSentiment) were mostly negative in previous months. Source> Belgrade SE, Hypo Research Source> Belgrade SE Table 14 Most traded shares in first 7 months of 2015 Symbol Issuer Closing price (RSD) Turnover (EUR) Share in total turnover YTD (%) AIKB AIK banka a.d. Beograd 1,740 36,306, NIIS NIS a.d. Novi Sad 660 6,349, AIKBPB AIK banka a.d. Beograd 954 4,015, KMBN Komercijalna banka a.d. Beograd 1,900 3,970, ENHL Energoprojekt holding a.d. Beograd 1,166 3,879, AERO Aerodrom Nikola Tesla a.d. Beograd 1,306 3,849, IMLK Imlek a.d. Beograd 4,014 1,949, JMBN Jubmes banka a.d. Beograd 5,200 1,578, TGAS Messer Tehnogas a.d. Beograd 6,983 1,474, ALFA Alfa plam a.d. Vranje 26,001 1,463, Source> Belgrade SE

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