Serbia's government and the central bank clashed over policy on Monday, with the cabinet wanting an easing of interest rates and the bank refusing changes which it fears would feed inflation and weaken the dinar.
The row takes place six weeks before the government is due to submit a new central bank law that would allow parliament to elect the governor and appoint a board of governors, seen as imposing cabinet control over monetary policy and financial sector supervision.
Deputy Prime Minister Bozidar Djelic told the Fonet news agency he would propose changes in macroeconomic, fiscal and monetary policy in the autumn to put an end to a soaring monetary policy bill and try to halt a surging foreign trade deficit.
"We will have to cut down public spending; monetary policy will have to change because it has resulted in massive central bank's losses...and the foreign trade deficit has grown by 40 percent in the first five months of the year," Djelic said.
"One will have to find a balance between the fiscal and monetary policies, make sure that inflation stays low and that economic growth is seven percent."
A high trade gap has weighed on the current account deficit, seen at 14 percent of gross domestic product (GDP) this year and fuelled by a 21 percent hike in retail lending activity at banks on top of a 40 percent wage hike in the past year.
After a nine-month easing cycle, the bank appears ready to raise interest rates in response to rising price pressures. It has kept the two-week repo rate on hold at 9.5 percent for two months. Central bank Governor Radovan Jelasic, a vocal critic of the government's loose spending, shot back that any policy change would reflect on both inflation and the dinar levels.
"Those who favour a monetary policy change, also favour a change in the dinar exchange rate, and an impact on inflation is unavoidable," Jelasic was quoted by Fonet as saying. "The central bank will not let it happen. Monetary policy will remain as expensive as necessary for the central bank to drain the surplus liquidity the government creates."
The central bank expects this year's core inflation to be closer to the lower end of its 4-8 percent band set for 2007. The government aims for a 6.5 percent headline inflation, but many officials say it will likely exceed its projection.
Djelic said the cost of monetary policy - which brought down 2006 inflation to a 15-year low of 6.5 percent from nearly 18 percent in 2005 - stood at 450 million euros, an amount the bank could not cover. The bank had used high interest rates to drain surplus liquidity from the market and intervened in the interbank forex market to offset appreciation pressures on the dinar. Jelasic has sharply criticised the government's spending, with the 2007 budget 27 percent larger than in 2006, including promises of a 13.6 percent real wage hike.
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