With hindsight, there is no surprise. Understanding why that is so may shed some light on the way policy is made in Serbia and on the enduring characteristics of the preferred policy mix.
Starting from the most visible signs, the governor has been under constant and rather elevated attack since the most recent depreciation of the currency. Both the government and the representatives of the corporative sector were angry that the central bank has not kept the dinar stable with more forceful interventions on the foreign exchange market. Even relatively moderate depreciation of about 6 or 7% has proved damaging to the liquidity of the bigger companies in the corporate sector. That, in turn, reveals the main problem in the economy: weak balance sheets of the corporations. They have liquidity and possibly also solvency problems.
Looking deeper, monetary policy was clearly creating problems to the preferred relationship between the businessmen and the government. The expressed preference for fixed exchange rates with strong central bank interventions indicates that both the government and the leading businessmen believe that the exchange rate risk should be nationalized, that is should be borne by the tax payer. In two ways: through the speed up of inflation and through increase in public debt. Inflation is needed because current tax revenues are insufficient, they are, in fact, disappointingly low at the beginning of this year. In addition, government is expected to borrow and then subsidize the corporate sector in one way or the other. In current deflationary circumstances, depreciation does not push prices higher all that much, but it makes debt more expensive. So, there is less scope for tax payer support of the failing corporate sector. Thus, the cosy relationship between the business and politics is in trouble.
At the deepest level, however, the uneasy relationship between the government and the central bank is the consequence of the policy mix that is believed to be natural in Serbia: fiscal policy, which should be understood as politics pure and simple, is dominant over monetary policy. The governor has to think about politics only when he has to be reappointed, while the parties in the governing coalition need to think about their political standing all the time. They need money to buy votes and support generally. Independent monetary institution, however, constrains the political rationing of money, subsidies or prices, because that is reflected in the exchange rate if the central bank does not want to spend its foreign currency reserves.
Thus, in retrospect, the governor had to go because he started showing signs of independence. This should not be simplified. The governor had little choice than to try to take a stand because otherwise he risked complete loss of credibility. The reason for that is important because it highlights the state of Serbian economy. The depreciation of the currency is the consequence of decreasing supply of foreign currency: money is leaving Serbia. Thus, the governor could have spent the foreign currency reserves and lead the country into a much deeper crisis. This would not have looked good on his CV. So he chose to bow out.
Of course, all the problems and the policy setup will be there when the new governor takes over. Chances are, he or she will initially be supportive of government’s policies. Then, there are, on the strength of historical evidence, two options: to govern over the complete loss of the central bank’s credibility or to resign more or less voluntarily. Current governor has chosen the second option like a number of others before him.
CorD Magazine, April 2010.