Credit rating of Serbia by cmcpresentation

CREDIT RATING OF SERBIA S P E CIA L S U P P L E ME N T

D I P L O M AC Y & CO M M E RC E 2017

C R E D I T R A T I NG O F S E R B IA

RECOGNISED PROGRESS Moody’s Investors Service has decided to upgrade the Government of Serbia’s issuer rating based on the positive results of fiscal consolidation, implementation of structural reforms, and better than expected economic growth outlook INTER VIEW

rice stability, as well as improved institutional framework and visible progress in the EU accession process influenced the positive decision too. Moody’s Investors Service in March has upgraded the Government of Serbia’s issuer rating from B1 to Ba3, with the stable outlook. Moody’s has also raised Serbia’s long-term foreign-currency and local-currency bond and deposit ceilings. The results of fiscal consolidation, implementation of structural reforms, better than expected economic growth outlook and ensured price stability, as well as improvements in the institutional framework and progress with the EU accession process were the key drivers behind the Moody’s decesion. We spoke with Evan Wohlmann, Vice President, Senior Analyst, at Moody’s about the Serbia’s economic performance, pace of reforms and steps need to be taken if Serbia wants to further enhance its rating. What were the major reasons for Moody’s to upgrade the Republic of Serbia long-term foreign and local currency Issuer Default Ratings from 'B1' to 'Ba3'? › There were two key drivers behind the upgrade in Serbia's issuer ratings to Ba3 from B1. The first driver was

E VA N WO H L M A N N Vice President, Senior Analyst, Moody’s

RESULT

FISCAL IMBALANCES Upward pressure on Serbia’s rating could arise from more favourable medium-term growth prospects, resulting from structural reforms and improvements in the investment environment, as well as faster than expected narrowing of fiscal imbalances.

Serbia's notable fiscal consolidation which has halted the increase in Serbia’s government debt burden and helps to reduce risks to Serbia’s fiscal position in the future. The second driver reflected Serbia’s recent structural reforms have increased the resilience of Serbia's economy to future shocks and in turn supports potential growth. How much fiscal trends as well as debt burden seem stable today when FED policy is changing? › The Serbian authorities have executed a highly successful fiscal consolidation which has led to a marked improvement in the country’s 2016 fiscal performance, with the first primary budget surplus since 2005 supporting a fall in the general government debt to GDP ratio to 74% of GDP at the end of 2016 after years of increases. Notably, Serbia's strong budget execution has been supported by improvements in revenue generation and a sharp reduction in permanent public sector employees has helped reduce expenditure on public wages to below 10% of GDP, in line with the EU average. As a result, Serbia has met the conditionality set out in the IMF SBA by a significant margin, with the general government deficit reaching an estimated 1.4% of GDP in 2016, far exceeding the 4% target in the original budget for 2016. We expect the deficit to decline moderately to 1.2% in 2017 and the debt burden is expected to reach just below 70% in 2018, although it will still remain above the median of

peers at the Ba-rating level (41.1% in 2015). Furthermore, fiscal reforms undertaken in conjunction with the IMF's 3-year Stand-by Arrangement (SBA) have improved the structure of the budget helping to limit fiscal risks in the future. Serbia’s high share of foreign-currency denominated government debt (79% of the total in 2016) remains vulnerable to a sharp depreciation of the local currency, although this share has been falling since the financial crisis. What do you see as major factors of GDP growth and are there possibilities of its further rise in the coming years? › The Serbian economy recovered strongly in 2016, growing by an estimated 2.8% of GDP, the highest rate of growth over the past 8 years. Notably, the economy is now less dependent on final consumption with a reorientation towards exports driven by strong foreign investment into the tradeable sector. We expect economic growth will rise to 3.0% this year and reach 3.3% in 2018, and we note that the diversity of growth drivers together with improvements to price stability will support potential growth in Serbia of between 3.5%-4%. The wide-ranging labour market reform undertaken in 2014 will help to sustain private consumption, reflecting an improvement in labour participation and recent strong employment growth driven by the private sector. Furthermore, consumer spending will be supported by the sharp drop in the La-

bour Force Survey unemployment rate to 13.0%, one of the lowest rates in the Western Balkans. Furthermore, we expect investment activity will benefit from improvements in Serbia's business environment, an easing of financing conditions, and strategically important infrastructure projects, such as Corridor 11. Moreover, the recent broad-based recovery in exports, with almost all export sectors contributing to strong real growth in 2016, support the resilience of Serbia's relatively open economy to external shocks. Still Ba3 means that there are risk of changes in business environment and economic conditions. Where do you see drivers of such negative changes? › Serbia’s Ba3 rating has a stable outlook which reflects the balanced risks to Serbia's credit profile at this rating level. While the pace of reforms may slow following the significant gains achieved in 2016, we expect that Serbia's continued progress with the EU accession process and likely further engagement

with the IMF will help to limit the risk of a reversal of the reform progress achieved to date. That said, downward pressure on Serbia's Ba3 issuer rating could arise if a reduced commitment by policymakers to the reform agenda, particularly in relation to addressing budget risks from the SOE sector, leads to a markedly weaker growth outlook and a deterioration in fiscal metrics. Moreover, the emergence of structural imbalances in the form of a large and increasingly difficult-to-finance current account deficit could also trigger a rating downgrade. Ba3 is also connected to significant credit risk. Under which conditions do you see that as a realistic scenario for Serbia? › In our rating action we note that increased resistance to further reforms from vested interests, particularly those aimed at reducing fiscal risks from SOEs, could impact on the gradual reduction in Serbia's debt burden. Furthermore, Serbia's record of frequent elections, including snap parliamentary elections in

The Serbian economy recovered strongly in 2016, growing by an estimated 2.8% of GDP, the highest rate of growth over the past 8 years

2014 and 2016, increases implementation risks. Serbia's sizeable share of general government debt denominated in foreign currency also poses a credit risk, particularly in the event of a sharp deterioration in the Serbian dinar, as does the high degree of euroisation in the banking sector. However, we note that the authorities have been able to increase the role of local currency in the economy through its „dinarisation strategy“. What major achievements Serbia has to make to get investment grade? › Upward pressure on Serbia's rating could arise if progress on structural reforms led to a notable improvement in the country's economic and fiscal metrics, resulting in a faster than expected reduction in the public debt burden closer to the median of similarly rated peers. Furthermore, structural reforms, including those to stimulate private investment through improvements in the business environment which in turn help to further boost potential growth in the economy, would be credit positive. ‹

C R E D I T R A T I NG O F S E R B IA

RATINGS IMPORTANT FOR BOTH INTERNATIONAL INVESTORS AND SERBIAN AUTHORITIES The continuation of reforms and sustainability of macroeconomic results is subject to usual domestic and exogenous risks. The Presidential elections confirmed with huge majority the orientation to continue the scope and content of reforms initiated in late 2014

C O M ME N T

n March 17, 2017 Moody's finally upgraded Serbia’s rating from B1 to Ba3. A small but important step signaling an exit from the “highly speculative” territory to a promising “non-investment grade” zone. This is only two steps away from the investment grade (Baa3 for Moody’s and BBB- for S&P and Fitch), hopefully within reach in few years if: (a) the present pace of reforms is owned and sustained with already established track record of overachievement in policy reforms and economic growth results; and (b) these reforms and real performance are properly recognized by international investors and rating agencies. The significance of this change for international investors and Serbian authorities is at least twofold. It aligns key rating agencies at the same level with stable or positive outlook, and thus eliminates an evaluation bias (gap) and instability of ratings which both tend to be present in the initial stages of reform and greatly affect decisions of (institutional) investors. More importantly, this upgrade is earned. It is based on solid track record of fiscal consolidation, structural and institutional reforms which underpins Moody’s decision to wait a full year between indicating a “positive outlook” in March 2016 and confirming a rating upgrade now. Rating agencies should be consistently conservative and reserved in rendering their views, and firm in defending their decisions. This was not always the case in the early years of transition. Many countries (including Serbia) have received higher ratings based on the introduction of legal and institutional reforms. The intention was to boost the capital flows to transition economies and

accelerate the pace of economic growth, as well confirm the efficiency of market based democracy. Unfortunately, the necessary pace of reforms and economic performance could not always be sustained to justify the granted credit ratings. The resulting downgrades and changes in outlook (from “positive” to as low as “”negative watch”) eroded the credibility and stability of the suggested rating system. The example of Serbia is telling. In March 2012 Serbia received an improved rating from Standard and Poor (from BB- to BB) only two months before the crucial elections and in the absence of an IMF program. The rating was adjusted back to BB- with negative outlook by early August, even before the new government took charge and could affect the economic and reform performance. By contrast, significant results in fiscal consolidation, macroeconomic stability, and external balance achieved since the last quarter of 2014 have yet to be properly recognized in the ratings. Standard and Poor kept the BB- rating during the 30 months of reforms and only once changed the outlook from “negative” (April 2014) to “positive” (December 2016). This is really too little for the turnaround in economic growth from negative to positive during the austerity stage of the fiscal consolidation, and the significant reduction in twin deficits. Current account balance to 4 percent of GDP, and fiscal deficit of the general government to 1.4 percent of GDP (from -6.6 percent of GDP in 2014). Not to mention the turning point in debt to GDP ratio passed in late 2016. Fitch started from a lower rating (B+) -downgraded from BB- in early 2014, but did two adjustments: from B+ stable to positive in December 2015, followed by an upgrade from

P rof. D UŠA N V U J OV I Ć , Ph . D. Minister of Finance in the Government of Serbia

I expect that rating agencies will soon start another round of dialogue with us to fully understand and appreciate the content and commitment to reforms in Serbia

B+ positive to BB- stable in June 2016. I would expect that the next review will fully recognize the quality and sustainability of results achieved thus far and reflect this in the ratings. The markets have already done that to a large extent. On Eurobonds Serbia was faced with a 378-561 bps spread during the 20112013 period, which systematically declined to 200-300 bps in 2014-2017 period. Another illustrative market recognition of Serbia performance and investors perception during the reform period is the 3 percentage points reduction in the Government bonds issued in Euros between Q4 2014 and Q4 2016. Third illustration is the fall in the interest rates of the dinar denominated 7-year Government bonds. The interest rate went down from 12 percent annually to 5.83 percent (weighted average) in 2016, more than a 6 percentage points reduction. Domestic markets and banks are already recognizing these trends and currently refinance loans to public utility companies at below 3 percent annually, a 3-4 percentage points below rates original negotiated 5-6 years ago. Obviously, the continuation of reforms and sustainability of macroeconomic results is subject to usual domestic and exogenous risks. The Presidential elections confirmed with huge majority the orientation to continue the scope and content of reforms initiated in late 2014, with added emphasis on employment and shared prosperity through the creation of new jobs and greater public and private investment. I expect that rating agencies will soon start another round of dialogue with us to fully understand and appreciate the content and commitment to reforms in Serbia. ‹

C R E D I T R A T I NG O F S E R B IA

WE ARE CONTINUING WITH OBTAINING GOOD RATINGS The reform policy, implemented by the Serbian Government and the National Bank of Serbia, continues to receive excellent reviews. Consequent implementation of the set reform objectives is the best way for Serbia to gain a good investment rating in the future

ecause of the uncontested and internationally recognized results, Serbia is today much more appealing to foreign investors which is beneficial to both the country’s economy and the citizens. Higher credit rating is just one indicator that we are on a good path – says Jorgovanka Tabaković, the Governor of the National Bank of Serbia (NBS). What implications does a higher credit rating have on Serbia and its reform policies? › Higher credit rating is yet another validation that Serbia has made a significant economic recovery, and that the accomplished macroeconomic stabilty and more balanced external and internal situation are being recognized and appreciated by the relevant credit rating institutions which opinion is revered among investors worldwide. The reform policy, implemented by the government and the National Bank of Serbia, continues to receive excellent reviews. I would also like to remind you that other relevant institutions have given Serbia the same rating as Moody's on the account of the country's results in stabilizing macroeconomy in the last few years. To what extent does a higher credit rating affect the cost of borrowing in Serbia and credit cost on the domicile market? › Credit rating upgrade should positively reflect on better borrowing conditions. At the same time, we should bear in mind that the cost of borrowing on the international financial market depends on several other factors so the effect that the higher credit rating has on financing conditions on the domicile market is generally very difficult to measure up. Of course, the overall effect is what we consider important, and

INTER VIEW

J O RG OVA N KA TA BA KOV I Ć Governor of the National Bank of Serbia

C O NF I D E N CE

ECONOMIC PROSPERITY We are confident that maintaining the effects of the accomplished results like the low inflation, the stable financial system and growing dinarization is the best way for the NBS to continue contributing to the country’s economic prosperity.

this effect is positive. Relative to 2012, a decline in average interest rate at which the state, banks and companies borrowed abroad was much bigger compared to the decline of Euribor (3 to 6 month maturity) in the same period. I would like to reiterate that, thanks to the pronounced relaxation of our monetary policy, low interest rates on the international market, and stronger competition among banks, the interest rates on the loans indexed in dinars and foreign currency have been quite reduced on the domicile market. We are talking about huge savings in the cost of financing both for our businesses and citizens. Considering that our country still has a high risk rating and bearing in mind its foreign debt, how does the Federal Reserve's decisions affect borrowing risks and currency stability? › People in our country are well aware that the NBS is very careful about assessing the developments on the international financial market and the decisions made by leading central banks. At the moment, markets expect that the divergence of monetary policies exercised by the Federal Reserve and ECB will increase by the year end. This could add to the insecurity regarding capital flow towards emerging countries, and thus towards Serbia. Like central banks in other emerging countries, the NBS cannot influence the decisions made by other central banks and the developments on the international financial market. What we can and have to do is to increase the resilience of our economy to external shocks, which is what we have been actively and successfully doing. The accomplished results give us enough confidence to say that we have

been successful at that. The fiscal and balance of payment deficits were significantly reduced in the last few years. The trajectory of the growing share of public debt in the national GDP has been reversed. Thanks to the improved macroeconomic indicators and our economy’s outlook, Serbia today is much more resilient to external shocks, and this is one of the important factors in having a stable currency. Despite possible short-term adverse effects coming from the international environment that nobody is immune to, the achieved reduction in imbalances is the best and the most sustainable way to maintain stability on the foreign currency market in the long run. What measures from the scope of the NBS can Serbia implement to finally obtain an investment rating? › It was actually Moody’s that already replied to this question in March when it said that it expected for the accomplished results regarding price and financial stability which have significantly contributed to the growing dinarization and reduction in long-term interest rate to continue. Moody’s and other similar institutions also agree that NBS’ decision to reduce the projected inflation to 3±1,5% is a reflection of the improved macroeconomic foundation, lower expected inflation, and higher credibility of our monetary policy. We are confident that maintaining the effects of the accomplished results like the low inflation, the stable financial system and growing dinarization is the best way for the NBS to continue contributing to the country’s economic prosperity, and to remain an important partner to the government on the road of obtaining an investment rating. ‹

C R E D I T R A T I NG O F S E R B IA

A LOT STILL NEEDS TO BE FIXED Despite the recent upgrade, Serbia's rating is still considered speculative and has only returned to the level from the year 2012. Also, our rating is among the worst in the region. Still, it is important for the world to recognize good results that Serbia has accomplished in fiscal consolidation and economic recovery INTER VIEW

oody's decision to upgrade Serbia's credit rating is undoubtedtly good, but we should not be tricked into thinking that we can relax now – says Professor Vladimir Vučković, PhD, a member of the Serbian Fiscal Council. How important is Serbia's upgraded rating relative to the general macroeconomic developments? Is this an important signal that our fiscal position has improved and that our external indebtedness is sustainable? › Credit rating upgrade is good news for Serbia, but it shouldn't be given too much gravity, especially if we are talking about the recent upgrade by Moody's. This credit agency has only done what other two leading rating agencies had also done before, namely upgraded the credit rating. Despite the upgrade, Serbia's rating is still considered speculative and has only returned to the level from 2012. Also, our rating is among the lowest in the region. Still, it is important for the for the world to recognize good results that Serbia has accomplished in fiscal consolidation and economic recovery. Higher rating is an acknowledgement of good macroeconomic results achieved in the last two years, and can effect the interest rates at which we borrow, as well as the investor sentiment towards Serbia. What practical influence did the previous upgrades have on cost of borrowing on external market? › It is very difficult to precisely asssess that because of the two major trends in the last few years. The first one is abundance of capital and declining interest rates on the global market, and the second is a better

economic situation in Serbia. If we compare the interest rates at which the countries like Serbia are borrowing against, we can see that interest rates in our country have been dropping faster than those in the neighbouring countries. In order words, if we did not bring order into public finances, the interest rates would go up now and in the future. The question remains whether we would have been able to borrow on the international market if our debt and budget deficit had been too high. The current credit rating still entails high risk in terms of debt servicing. How much can the Federal Reserve's policy affect our ability to regularly service our debt? › I believe that it won't have a bigger effect this and the next year. Despite higher interest rates in the US, they might not happen in Europe so we still don't see a possibilty of higher interest rates happening worldwide too. This is the reason why I think that both the interest rates and the foreign currency exchange rate are going to be stable. Naturally, a lot hinges on the unpredictable political circumstances in Europe and the European Union. Stronger shocks here would echo throughout the world and lead to higher aversion towards lesser developed markets, including Serbia. In order to easier absorb future shocks on the international market, it is important for us to lessen our dependency on borrowing and the only way we can do this is by reducing our public debt and budget deficit. Considering that Serbia has failed to meet a number of requirements stipulated in the agreement with the

Professor

VLADIMIR V U Č KOV I Ć PhD, member of the Serbian Fiscal Council

In order to easier absorb future shocks on the international market, it is important for us to lessen our dependency on borrowing and the only way we can do this is by reducing our public debt and budget deficit

IMF, do you think that the time has come to loosen the reins of our fiscal policy? › Not at all. Our public debt, which currently stands at 70% of the GDP, is exceptionally high and unsustainable in the long run. The budget deficit should be lower in order for the public debt to drop to an acceptable level. Bearing in mind the unreformed and unprivatized stateowned companies, low level of public investments, huge problems that local authorities have with their finances, and challenges in the pension, healthcare and education system, it is clear that now is not the time to relax and increase the current budget expenditure. If this happens, we might not be able to reduce the high deficit and public debt, and would become very susceptible to a new crisis in public finances. Considering how many requirements Serbia still has to fulfill, how far or close are we to getting an investment rating? › We are quite far from obtaining an investment rating. Romania, Hungary and Bulgaria are the only countries in this region which have one. We can cover these few steps towards an investment rating only if we invest several years worth of effort into our economy and society. To be more precise, it is vital to continue reducing budget deficit and public debt, and have a more dynamic economic growth. In order to accomplish this, it is exceptionally important for the state to reduce its influence on businesses, and for the private sector to grow, to become more efficient and to be the driving force behind economic growth. ‹

C R E D I T R A T I NG O F S E R B IA

MOODY'S UPGRADES SERBIA'S ISSUER RATING TO BA3; STABLE OUTLOOK Moody's Investors Service, has upgraded the Government of Serbia's longterm issuer and senior unsecured ratings to Ba3 from B1. The outlook has been moved to stable (from positive). The key drivers of the upgrade in Serbia's senior unsecured and long-term issuer ratings are:

Serbia's notable fiscal consolidation which has halted the increase in its debt burden and reduces risks to the fiscal position; and

Recent structural reforms which have increased the resilience of Serbia's economy, supporting potential growth.

The stable outlook reflects the balanced risks to Serbia's credit profile at the Ba3 rating level. We asked the leading banks in Serbian market to comment:

To what extent have improved credit ratings of the country, compared to other factors, affected the current credit policy, i.e. interest rates in the domestic market...

DR AGINJA ĐUR IĆ President of Banca Intesa Executive Board

SIGNIFICANT IMPACT ON THE NATION’S COST OF BORROWING

Used as a key tool for investors to assess a country’s credit worthiness, sovereign country ratings have a significant impact on the nation’s cost of borrowing, which constitutes the most important component of the banks’ funding base. Therefore, an improvement in the country rating that sustainably drives the cost of bank funds lower can pave the way for credit institutions to reduce interest rates on lending. Interest rates in Serbia, which have been brought down to all-time lows amid favorable conditions in the domestic and international markets, supported by rating upgrades and rating outlook improvements by all three main rating agencies, confirm this. Moody’s recent upgrade of Serbia’s sovereign rating, which follows upward rating outlook assessments by Standard & Poor’s and Fitch last

year, acknowledges the success of the government’s fiscal consolidation program and the continuation of key structural reforms that have boosted the resilience of the domestic economy. Still, a further reduction in the country’s borrowing cost is vital for banks to continue to lower interest rates. This largely depends on the further implementation of Serbia’s stand-by arrangement with the IMF, a strong focus on corporate restructuring of public enterprises, as well as the continuation of the stabilizing and growth-oriented monetary policy with a floating dinar exchange regime. On the external front, a stable geopolitical situation in the EU would further accelerate growth and reform momentum in Serbia and most probably materialize in another cycle of positive rating and outlook actions.

ZOR AN PETROVIĆ Chairman of the Executive Board of Raiffeisen Bank

THE STRENGTHENING OF INVESTORS’ CONFIDENCE

Upgraded fiscal position and improved macro-economic stability supported all three rating agencies to upgrade the country’s perspective, whereas Moody’s upgraded the country rating by one notch to Ba3. Usually, credit rating upgrade supports enhancement in the credit risk perception, reducing the risk premiums and indirectly affecting interest rates when banks are borrowing funding on international markets. Nonetheless, the business financing models of local banks changed in the last few years, shifting from wholesale funding to local deposits, so in that way, the rating upgrade did not quite affect the pricing models directly, but rather indirectly. Hitherto, the rating upgrades are undoubtedly sending positive signals to foreign investors and have supported the strengthening of investors’ confidence with the authorities, which resulted in steady growth of FDIs. At any rate, interest rates touched the bottom last year and reverted the trend upwards due to the growth in inflation but also supported by the expected shift in the monetary policy framework in 2018.

D R V L A D I MI R K R U L J Chairman of the Executive Board of Komercijalna Banka

INTERNATIONAL RECOGNITION OF SUCCESS IN IMPLEMENTING REFORMS

The decision made by the renowned rating agency Moody's to upgrade Serbia's long-term credit rating for borrowing in domestic and foreign currency from B1 to Ba3 is based on realistic economic assessment of the accomplished results in the reforms conducted by the Serbian Government, primarily in the segment of fiscal consolidation, dynamic economic growth which was better than projected, successful implementation of reform measures agreed with the IMF within the framework of the current standby arrangement, and progress made in the EU accession process. It is certain that the upgraded credit rating will have a positive impact on interest rates in the domicile market, especially when it

MAR INOS VATHIS President of the Executive Board, Vojvodjanska banka ad Novi Sad

comes dinar interest rates. A better credit rating will enable Serbia to borrow under favourable conditions in the international capital market. It is very important that Moody's has moved the outlook for further upgrade of the credit rating to stable, that the projected annual economic growth this and next year will be 3% and 4% respectively, and that the fiscal deficit and public debt will continue to decline. This decision by Moody's is yet another international recgonition to the Serbian economic authorities of their success in implementing reforms, and will definitely contribute to a better image of Serbia's economy in the eyes of international investors and international financial institutions.

EXCELLENT SIGN FOR THE INVESTORS

Recent improvement of the credit rating of Serbia is an excellent sign for the investors, confirming the sound macroeconomic stability of the country. It should contribute mainly to the stronger FDI inflow in Serbia. I don’t think it will contribute to the change of the level of interest rates, as I don’t think interest rates will go any lower. In the last three years, the Central bank cut key rate several times reaching the current level of 4.00% as a result of fiscal consolidation, exchange rate stability, low inflationary pressures, relaxation of monetary policy, low interest rates in the euro zone and strong competition among banks. So we have today in the banking sector interest rates on loans at the lowest levels, following the trend on low interest rates on deposits, as the main source of financing the lending activity in Serbia.”

BR ANKO GR EGANOVIĆ Chairman of Executive Board of NLB Banka Beograd

S L A V K O CA R I Ć Chairman of the Executive Board of Erste Bank

THE UPGRADE IS IMPORTANT FOR FUTURE ISSUES

Empirical research and experiences of various countries, especially after the last financial crisis, show that markets perceive both positive and negative changes in the countries’ economies before rating agencies decide to formally change their ratings and outlooks. We can observe the Serbian debt market in that context too, where, in the last year and a half, there has been a significant decline in yield both from primary issue and in trading. The reasons for this were of technical nature like the introduction of benchmark bonds, and stronger development of the secondary market, as well as fundamental where investors recognized that fiscal and economic indicators were better than projected. The latest rating upgrade came after a significant compression, and doesn’t have a decisive influence on yields at this moment. But the upgrade is important for future issues where higher rating may affect the required yield due to lower risk premiums.

BETTER LOAN TERMS BOTH FOR CITIZENS AND BUSINESSES

Lower interest rates, both active and passive, which in certain countries have dropped to below zero, are a result of latest developments on financial markets, and a trend which has been going on for some time now. There are several factors that have caused this. In Serbia, lower interest rates are definitely also a result of the upgraded credit rating which has caused the drop, especially when financing sources come from abroad. The costs associated with the country's risk are an integral part of the final costs of loans that clients pay back to their banks so, due to the improved credit rating, the loan interest rates have been reduced in proportion to the share that the said costs have which, all together, resulted in interest rates hitting their lowest level in the last twenty years.

Further upgrade of the country's credit rating will translate into better loan terms both for citizens and businesses. Still, I believe that an even more important thing for us is to fully understand a great importance of credit ratings, and the fact that the higher credit rate is also a result of a shift in perception of Serbia in the eyes of international financial institutions which see Serbia as a stable market, as well as a result of the implementation of reforms. First and foremost, the improved credit rating sends a positive signal to domicile and foreign investors who consider stability and the predictability of economic environment as the most important prerequisite for investing on a certain market that is even more important than interest rates.

C R E D I T R A T I NG O F S E R B IA

DR AGAN LAZAR EVIĆ Chairman of Executive Board of Direktna Banka ad Kragujevac

GOOD NEWS AND EXCELLENT SIGNAL FOR INVESTORS

In its widest sense, a country’s political risk and continuation of stability are probably the most important elements of investment climate, immediately followed by credit rating, i.e. fiscal stability. When these two aspects are positive for a considerable amount of time, interest rates on the market can be lowered. The successful implementation of the fiscal consolidation programme has lead to a drop in the public debt share in GDP, as did the implementation of the required structural reforms, which resulted in the country’s being given an upgraded credit rating. The improved credit rating is good

SANDR A VOJINOVIĆ Positive results of fiscal consolidation

news and sends an excellent signal to investors that Serbian economy is heading in the right direction, and that the country is now more attractive and appealing for future investments. Some signs of the impact that better credit rating has on the credit policy are already apparent, while further decline in interest rates will also depend on global developments. In the following period, interest rates are expected to rise globally hence the country’s improved credit rating will, first and foremost, contribute to mitigation of the effects that the possible increase in borrowing costs on the global market might have.

MEMBER OF THE MANAGEMENT BOARD, CFO

The fact that Moody's upgraded Serbia's credit rating for longterm borrowing in local and foreign currency is certainly a step forward. It represents a consequence of positive results of fiscal consolidation and improvement of institutional framework that can significantly support the further growth of the economy. In market conditions in which country rating improvement is not is not so usual, this kind of decision is a good signal to foreign investors that consider credit rating as one of the factors when making investment decisions. This decision should contribute to reducing the cost of borrowing for Serbia, especially in cases when investors are first-class financial institutions. However, it is necessary to consider that, due to the fact that interest rates in the country have already experienced a significant decline in recent years, space for their further reduction is not large and therefore drastic drop in interest rates cannot be expected.

K E NA N B O Z K U R T Chairman of the Executive Board of Halkbank ad Beograd

MORE SHARE FOR THE COUNTRY’S POTENTIALS

Every passing day, the world is getting smaller thanks to technological development. Due to this fact, we cannot see whole picture without understanding the trend in the world. We witnessed huge inflow to the emerging markets in the past decades and those markets took the benefits from it. After a long and devastating economic crisis, now Serbia is again back on the right track. In 2015 GDP started to increase after long period of decrease. Real sector activities are on the trend of increasing and FDI too. Capital, as usual and expected, is looking for stability and trust first. Serbia is promising these to the investors. There are plenty of possibilities in almost all sectors for foreign investors. That’s why FDI is on the trend of increasing. This safe environment is getting response from related rating agencies and/ or foundings. Serbia is now 5th rank on OECD risk classification list, previously it was on 7th place. When a country becomes safe for investors, naturally risk premium of the country starts to drop. Also, it increases competition to get more share for the country’s potentials, decreasing trend of interest rates is the result of those facts and we think that the country will enjoy this for a long time.

MARKUS FER STL President of Executive Board, VTB Banka Beograd

LESS RISK FOR ANY INVESTOR

The betterment in the country rating has been an important driver in this sharp decline. Since 2013 Serbia is not anymore classified as “junk rating”, in contrary due to its positive economic development Serbia has enjoyed continuous upgrading from the leading Rating agencies, e.g. Moody’s was recently upgrading Serbia’s longterm sovereign credit rating by one notch from B1 to Ba3 which is now just two notches from “investment grade”. The improvements in the country rating were mainly driven by fiscal consolidation, the start of structural reforms, price stability, increase in FDIs and exports which lead to impressive growth rate in 2016. And the outlook for further growth of the GDP is bright, most likely we will see growth rates of the economy of more than 3% in the coming years. Better country rating means less risk for any investor and triggers a drop in interest rates.

The decrease of interest rates was also triggered by the zero-interest rate policy of the European Central Bank, and also the Central Bank in Serbia has started to charge negative interest rates for overnight deposits. Due to very high NPL rates in the past, bank are very cautious in credit decisions, and also Corporate and Retail clients are more careful in taking loans. This has led to a decrease of the loan portfolio, and the banks have now more liquidity than needed which motivates them to lend even with cheaper rates to the clients just not to sit on too much cash which generates negative interest rates. Nevertheless, Serbian Retail and Corporate clients will still enjoy for a longer time period the current low rates, and especially for citizens it is a good opportunity to refinance old, expensive cash loans with more favorable terms.