Outlook on Serbia ratings remains negative

Standard & Poor's Ratings Services today said that Serbia's arrest of wanted war criminal suspect Radovan Karadzic and his expected transfer to the UN War Crimes Tribunal in The Hague are two key steps toward cementing the country's path to EU accession. The action signifies a notable reduction in political risk, particularly if it were followed up with the successful arrest of Ratko Mladic, the remaining high profile war criminal suspect still at large.

The outlook on the sovereign rating of the Republic of Serbia (BB-/Negative/B) remains on negative, however, due to the pro-cyclical fiscal policies of the new coalition government, which are likely to reinforce economic overheating. The new government has yet to formulate any measures to combat rapidly rising inflation, which by driving the appreciation of the real effective exchange rate is contributing to upward pressure on demand, in turn generating high import growth and a widening of the already double-digit current account deficit. Even so, there is no concrete evidence at present of a loss in competitiveness of Serbia's export sector. Unlike nearly all of its Eastern European peers, there is, moreover, enormous slack in Serbia's labor market, with unemployment estimated at over 20%–an indication that potential growth is higher in Serbia versus nearly all of its regional peers.

The outlook on the rating on the Republic of Serbia would improve if the coalition government were to move ahead with privatizations and structural reforms, in tandem with expenditure cuts to help restore balance to the economy. On the other hand, should imbalances increase further in the absence of a contra-cyclical policy response, the rating could come under downward pressure.