SERVICIOS DE LARGA DISTANCIA Y REGIONALES POR LA RED DE ALTAS PRESTACIONES

3.1. Exchange Rate as a Nominal Anchor

Issue of exchange rate in Serbia is particularly sensitive. Although one can not deny the fact that the exchange rate in an open market economy plays a significant role (both at micro and macro level), there are still differences in the level of confidence, stability and variability of national currencies’ values among different countries. When speaking about Serbia, economic events in the past, above all the period of hyperinflation, have largely contributed to loss of trust in this country’s monetary authorities. For this reason, it should not be surprising that in October 2000 (which is a real beginning of transition process) Serbia decided to use the monetary exchange rate regime as a nominal anchor, as most transition and developing countries do, and to establish macroeconomic stability in this way. The last decade of the twentieth century was marked by a fixed exchange rate, however, without full convertibility, which led to appearance of the so-called „black“ market exchange. At that time, Serbia had two exchange markets – the official one, in which the fixed value of exchange rate was controlled by central monetary authority and the unofficial („black“) one, in which the value of exchange rate was determined on a market way. The monetary authority with its expansionary fiscal and monetary policy continuously increased dinar offer which resulted in devaluation of the national currency in the „black“ market (depreciation of dinar was performed). The difference between exchange rate values in the official and in the „black“ market led to an increasing avoidance of the official exchange market. In order to prevent further negative consequences of using the „black“ market, the monetary authority tried at the end of 2000 to equate the exchange rate at two different exchange markets by performing the devaluation of dinar, from 6 to 30 dinars for a single German mark. However, initial devaluation had to be even higher as at that point the exchange rate at the „black“ exchange market was already above that level. More significant devaluation could have stimulatively affected Serbian export and provided more time for adjusting to the export sector (Miljković, Vučković 2006, 249-250). The regime was „de jure“ managed floating, but „de facto“ the exchange rate served as a nominal anchor and was practically fixed. Given the weak financial system, high inflation rate, high inflationary expectations and a low level of trust in the national currency, it could have not been expected to be otherwise. Simply, the goal of using the exchange rate as a nominal anchor is to replace a bad credibility of the national monetary policy with „imported“ credibility of the central bank to which the national currency is related. Fixed exchange rate serves as a nominal „anchor“ for the domestic price level and thus contributes to determining the period of high inflation.

The exchange rate as a nominal anchor can be used in two cases: because of adequate macroeconomic indikators (external and structural) and as an transitory monetary regime with an aim of achieving macroeconomic stability. In the first case, it is preferable to target the exchange rate if: the country is small and open, there is a strong transmission of the exchange rate to prices, there is a significant informal financial dollarization (euroization), the economy is subject to monetary shocks, there is a high trade concentration and synchronised business cycle (subject to symmetric shocks) to the anchor country (countries) as trade partner (partners). In the second case, the achievement of macroeconomic stability is imposed as a primary goal which requires the application of fixed exchange rate regardless of the fulfillment of above mentioned parameters. The problem may arise when the costs of the applied policy become unsustainable in the long term, so that it appears necessary to timely conduct an adequate strategy towards more flexible regimes (of course, with adoption of new priorities in conducting the monetary policy) (Beker Pucar 2010, 70-71). The systemized factors, which make the exchange rate as a nominal anchor an acceptable regime in the long term, are given in the following table.

Table 2: „Pros“and „Cons“of Exchange Rate Regime as a Nominal Anchor

PRO CONTRA

Relatively small and open economies Relatively large and closed economies Strong transmission of exchange rate to

prices

Relatively weak transmission of exchange rate to prices

Significant unofficial financial dollarization/euroization

There is no unofficial financial dollarization/euroization Geographical concentration of foreign

trade activities with anchor country (countries)

Geographical dispersion of foreign trade activities

Diversified export supply Concentration of export supply Synchronization of the business cycle with

anchor country (countries) i.e. subject to symmetric shocks

Asynchronization of the business cycle with possible anchor country (countries) i.e. subject

to asymmetric shocks Relatively high level of foreign exchange

reserves in defense of their parity

High level of foreign exchange reserves is not necessary

Extreme vulnerability to monetary (nominal) shocks, (hyper)inflation periods

in the past and high inflationary expectations

Vulnerability to external shocks (monetary and real), as well as to domestic real shocks

Source: Beker Pucar, E., (2010), Managed Exchange Rate Floating within Inflation

Targeting Regime in Transition Economies with Regard to Serbia, PhD thesis, Faculty of Economics in Subotica, Subotica, p. 72

403 Based on the listed factors which are in favor of using the exchange rate as a nominal anchor, a conclusion may be drawn that economic authorities in Serbia have made the right choice in that particular moment. Practically, all factors given were characteristic for our country. Thus, the regime of conventional fixed parity which was de facto applied since October 2000 until January 2003 has given good results. The exchange rate has largely stabilized (ranged from 59,14 dinars for one euro to 61,56 dinars for one euro), the confidence in the local currency was improved to some extent, it came to reduction in the rate of inflation (from 115,6% in August 2001 to 14,8% in December 2002) and foreign exchange reserves of the central bank increased significantly (from 914,8 million euros in January 2001 to 4435,6 million euros in December 2002) (Beker Pucar 2010, 170-171).

However, fixing the nominal exchange rate had certain negative consequences as well. Despite the fixed exchange rate, thanks to the inflation inertia and omissions in the area of economic policy, prices and wages kept growing which gradually led to appreciation of the real exchange rate. The inflation rate was followed by the growth of nominal wages in dinars which caused a strong wages growth expressed in foreign currency (in euros). The growth of prices in the country, on the one hand, and the growth of wages in euros, on the other hand, have contributed to the fact that it was more profitable for the population to import products from abroad. With the lack of funds, credit expansion appeared. The problem is that those were the credits with currency clause, which led to appearance of the so-called financial euroization and currency differences, i.e. distinction is made between currency composition of credit and debt positions (Miljković, Vučković 2006, 253-254). Significant financial euroization opened the problem of exchange rate depreciation, because large decline in domestic currency value could cause problems to population, industry and governement to repay their credits, with the risk of financial crisis. On the other hand, growing current account deficit and decrease in price competitiveness of domestic economy have become a serious threat to sustainability of such monetary regime in the long term. Considering that the policy of using the exchange rate as a nominal anchor in terms of inflation consistently higher in the country than in the Eurozone has led to rapid growth and high level of unofficial euroization, it became obvious that the right moment for continuation of successful exchange rate policy has been missed in Serbia (Miljković, Vučković 2006, 253-254).

The above mentioned problems have contributed at the beginning of 2003 to the change of exchange rate regime in Serbia, and partly to the change of monetary strategy as well. At that moment, monetary authorities in Serbia decided for greater exchange rate flexibility (as it was the case in Poland, the Czech Republic, Slovakia and Hungary) than in the previous period (in opposite to the countries which turned to more rigid exchange rate regimes: Montenegro adopted euro, and Estonia, Lithuania, Bulgaria, Bosnia and Herzegovina adopted currency board arrangements).This involved one of intermediate exchange rate regimes – the so-called moving parity. The purpose of greater flexibility of dinar was to enable

the solution of the problem of rising external imbalance (in 2000 the current account deficit amounted to 158 million euros while in 2003 it amounted to 1,347 million euros).

Greater flexibility of dinar has been achieved, so that during the period of application of this strategy (from January 2003 until the end of August 2006) Serbian dinar depreciated by a total of 27,12% in nominal effective terms (on the 1st of January 2003 the official middle exchange rate was 61,5845 dinars for one euro while on the 30th of August 2006 it was 84,5000 dinars for one euro), in contrast to the previous period (2000-2003) when dinar depreciated by a total of 2,57% in nominal effective terms.

Chart 1: The Index of Nominal and Real Effective Exchange Rate of Serbian Dinar in