At the start of August, the National Bank of Serbia (NBS) announced changes in its monetary policy, which include the start of inflation targeting.

The target of the central bank will be core inflation (covering some 55% of all prices) with its first objectives being 7- 9% y/y inflation at the end of 2006 and 4-8% y/y at the end of 2007. In line with the new policy, NBS also decided to change the instruments for achieving its monetary objectives. Its main policy instrument in the future will be the 2-week repo interest rate, which will be determined by the Monetary Council at its regular sittings (we recall that so far the central bank used mostly the mandatory reserve requirement ratio to conduct its monetary policy). The key policy rate is currently set at 18% and is used for determination of the other basic interest rates used by the central bank. As of Jan 1, 2007, the central bank will start issuing 6-month T-bills, which will replace the current 2-month instruments. It will also continue withdrawing from the forex market so that the local currency is determined by market supply and demand.

The strong credit growth in Serbia has started eroding financial stability, IMF said in March in a report that assessed the financial system of the country. The Fund underlined the high level of euroization and the fact that almost all credits extended are in EUR, which exposes borrowers (and thus indirectly the lenders) to considerable foreign exchange risks.