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Serb central bank raises key rate to 10.75 percent

By Aleksandar Vasovic

BELGRADE (Reuters) - Serbia's central bank raised its benchmark interest, already the region's highest, by 25 basis points to 10.75 percent on Tuesday, reflecting rising inflation and debt concerns.

Other central banks in Central and Eastern Europe have cut rates over the past two weeks, as growth slows across the region, although Poland bucked the trend last week by keeping rates flat due to concerns over inflation.

Serbia stands out as an exception because of a cocktail of rising inflation and debt and an economy sliding into recession amidst crisis in the euro-zone, its main trading partner.

"Considering that the increase of food prices and state-controlled prices is higher than expected and that inflationary expectations are on the rise, the Executive Board has decided to increase the benchmark rate to prevent the spillover... to other prices," the Serbian bank said in a statement.

Serbian inflation in August rose to 7.9 percent, up from 6.1 percent in July, due to a poor harvest and the government's bid to finance its 2012 budget gap amounting to 6.2 percent of GDP through a rise in value-added tax.

The central bank estimates that inflation should continue to rise until mid-2013 and then slide back to its target band of four percent, give or take 1.5 percentage points, the same as for 2012. However, some analysts voiced caution.

"That inflation is not driven by demand ... in that sense, the monetary policy is powerless," said Miladin Kovacevic, an analyst with the Belgarde-based Economics Institute.

Djordje Djukic, a lecturer of economics with Belgrade University, said Tuesday's rate hike was beneficial for portfolio investors, "who will make profits on short-term maturities, but bad for budget and debt".

"The effects (of the rate hike) on inflation are very uncertain as the Serbian economy is highly monopolized and plagued by high production costs, low productivity and competitiveness," Djukic said.

RISING DEBT

The deficit, inflation and rising social discontent have prompted the coalition government of nationalists and Socialists, which came to power in July, to borrow more. That included a September 27 issue of a $1 billion Eurobond and a $1 billion loan from Russia, planned for this year and next.

Serbia's total public debt this year is expected to reach 60 percent of GDP and the country wants a new stand-by loan deal with the International Monetary Fund to reassure investors.

The Fund froze a 1-billion euro ($1.30 billion) loan deal with Belgrade in February over inflated spending and debt and told Serbia last month to restore the autonomy of the central bank and rein in spending before any new loan talks.

In its October World Economic Outlook, the lender said Serbia's economy was expected to contract by 0.5 percent this year and grow 2 percent in 2013.

In the statement, the central bank said its future policy moves would depend on inflationary expectations, external influences and the effects of fiscal consolidation.

The dinar rallied versus the European common currency last month after domestic banks started issuing government-subsidized loans to aid exporters hit by the crisis in the euro zone, Serbia's main trade partner.

The dinar has been trading at an average of 115 dinars to one euro since, as opposed to an average 117.5 in the days before its recovery. By midday on Tuesday, following the rate announcement, it firmed against the euro and was trading at between 114.56 and 114.76 to one euro.

(Reporting by Aleksandar Vasovic; Editing by Zoran Radosavljevic and Ron Askew)

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