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Rising inflation isn’t a temporary phenomenon resulting from the hitherto unseen expansive monetary policy applied following the outbreak of the Covid-19 pandemic. Economic indicators suggest that, on the supply side, most of these factors will serve to maintain cost inflation at a high level, compared to historical standards, for many years to come. The U.S. is awaited by a recession, while Europe – which is closer to us – can expect high inflation followed by a significant slowdown in economic activity

We’re living in a time of inflation the likes of which hasn’t been seen for over 40 years, in a period of such conflict that hasn’t been seen in these lands since the end of World War II, and in conditions of the kind of disrupted value chains that we’ve never previously seen.

For many people, regardless of their level of education in economics, the question of what are brought by day and night, and what they will wake up with tomorrow, represents an unknown. CorD caught up with Dr Đorđe Đukić, professor at the University of Belgrade Faculty of Economics, a great connoisseur of the financial system and a witness to numerous inflation and hyperinflation episodes in the former Yugoslavia and Serbia, to discuss this new wave of inflation, which differs from all previous waves we’ve encountered on our territory. We also used this interview to discuss economic terms that we’ve rarely had opportunities to hear, if we exclude the period 2008 financial crisis: recession, stagnation and stagflation. What awaits the world, and what awaits us?

We’re again facing inflation after a long break, and this kind of inflation isn’t caused in large part by the printing of money at home, as was the case in the 1990s. How long do you expect this inflation to last?

The trend of rising consumer prices in industrialised countries, primarily the U.S. and the Eurozone, which preceded the outbreak of the conflict in Ukraine, showed unequivocally that rising inflation isn’t a temporary phenomenon resulting from the unprecedented expansionary monetary policy applied following the outbreak of the Covid-19 pandemic. The retaining of the rate of the U.S. Federal Reserve at just 0-0.25% until March 2022, as well as the European Central Bank’s multi-year policy of maintaining its key interest rate at zero, under the conditions of numerous disruptions on the supply side, such as broken supply chains, exploding prices or raw materials and energy on the world market, accompanied by halts in the production of certain metals (such as aluminium), have caused inflation to rise to a level not seen over the last 40 years.

The conflict in Ukraine only served to propel cost inflation even higher. In the U.S. in March 2022, the annual inflation rate, including of energy and food prices, stood at 8.5%, and at 6.5% without those two items, which represents the highest rate of inflation since December 1981. In the same month in Germany, the eurozone’s most powerful economy, the inflation rate reached its highest level since German reunification – 7.6% annually. The core inflation rate, i.e., with the exclusion of the food and energy sectors, stood at 3.4%, which is well above the ECB’s target rate of 2%. Serbia’s annual inflation rate in March totalled 9.1%, marking the highest level since July 2013, while core inflation was up 4.8%.

Central banks face major challenges in intelligently administering restrictive policy measures aimed at reducing demand and restraining inflationary expectations. If they overestimate, we will face recession

Economic indicators suggest that, on the supply side, most of these factors will serve to maintain cost inflation at a high level (according to historical standards), for many years to come. Considering the poor prospects of the conflict in Ukraine ending quickly, there are unlikely to be any significant reductions in the prices of food, energy and non-ferrous metals, which a large number of industries depend on. More enduring cost-push inflation will come as a result of labour market imbalances following the end of the Covid-19 pandemic, due – on the supply side – to shortages of workers with the qualifications needed by the industrial sector, thus compelling companies to offer higher wages.

Central banks face major challenges due to the risk of overestimating the dosage of restrictive policy measures aimed at reducing demand and restraining inflationary expectations, thereby causing a recession after a shorter or longer delay.

Our central bank and others have decided to raise the reference rate. However, this is happening at a juncture when it’s becoming clear that the conflict in Ukraine will have significant ramifications, not only on economic growth across a great part of the world, but also on continued disruptions in the work of major global value chains. Is it time for us to get used to stagflation, both globally and in our country?

The Bank of England announced the end of its policy of cheap money by increasing the key interest rate to 0.5% in February 2022, while the U.S. FED did the same in March – raising the rate from 0-0.25 to 0.25-0.5%. The intensity of the interest rate hikes deployed by the FED and the ECB in the fight against inflation during 2022 will determine the probability of recession or stagflation hitting the economies of the U.S. and the eurozone, on which the Serbian economy is the most dependent. Key market players expect the FED to try to keep price pressures under control by raising interest rates aggressively in May and June, by 50 base points each, and twice in the second half of 2022, by 25 base points, bringing them to 2-2.5% by the end of 2022. The FED is confronted by the risk of the U.S. economy entering a recession during 2023, but not the risk of stagflation. And this comes after many years in which the country grew accustomed to living with interest rates of close to zero and ample liquidity, accompanied by extremely high growth of the S&P 500 stock exchange index, by close to 90% over the last five years and by 36% since the beginning of 2020. And why is the stagflation scenario so unlikely?

Firstly, because the unemployment rate has fallen to 3.6%, which is slightly above pre-pandemic levels and expected to be the average for the whole of 2022. Secondly, with their downward adjustment of the forecast in March, FED officials confirmed their expectation that GDP will grow 2.8% in 2022 and 2.2% in 2023. Thirdly, any increase in individual workforce costs doesn’t pose a major threat due to labour productivity growth exceeding that of the 1970s; the productivity of all production factors was up four per cent in 2021, while the consumption of petroleum products per dollar of U.S. GDP has fallen by as much as 70% (according to FRB San Francisco) compared to the early ‘70s. As such, there is only minimal risk of the U.S. facing the stagflation scenario prompted by the oil shocks of the ‘70s – with inflation and unemployment rates rising in parallel.

The economy of the eurozone is closer to facing a stagflation scenario (with high inflation accompanied by a significant slowdown in economic activity). The unprecedented sanctions imposed on Russia will disrupt supply chains over a long period, hitting supplies of energy, metals and parts for the automotive industry, which is the driver of economic growth in Germany and European countries that have Germany as their main foreign trade partner. Serbia is also among those countries. Exports of vehicles fell by 10% in 2021, with foreign orders falling by 3.3% in February 2022 alone. Following the unexpected high inflation rate of 7.5% in the eurozone in March, the ECB will be under pressure to initiate a cycle of gradually increasing the key interest rate during the second half of 2022, which was postponed to avoid a further slowdown in economic activity. Confirming that Germany faces a significant risk of recession was government official’s March revision of its economic growth forecast for 2022 – from 4.6 to just 1.8%, alongside annual inflation of 6.1%.

Under current conditions, inflation is mostly punishing savers, particularly those who don’t keep their cash in banks. Those who opt for unproductive investments – real estate, gold etc. – will be punished by time, because the speculative real estate bubble will burst sooner or later

The central banks of the countries of Central and Eastern European that apply the concept of inflation targeting began raising key interest rates in the fourth quarter of 2021 for preventative reasons, in response to rising inflation and the weakening of their national currencies. In the January-April 2022 period, particularly after the outbreak of the conflict in Ukraine, they continued their aggressive increases (from 50 to 100 base points). The key interest rate stands at 4.4% in Hungary, 4.5% in Poland, 3% in Romania and 5% in Czechia. During that same period, Serbia’s central bank, the National Bank of Serbia (NBS), didn’t change its key interest rate, retaining it at an annual level of 1% until as late as 7th April 2022, satisfying itself with just the measure of extracting liquidity from the banking sector through so-called reverse repo operations. It increased it to 1.5% on that day.

It is clear that banking products will become more expensive, but how much will that actually benefit banks? What are your expectations when it comes to the results of banks’ operations during this year and next, assuming that current trends continue?

The extent to which the profits of banks in Serbia will grow in 2022 depends mostly on the dynamics of their lending activity, because the NBS has opted to maintain a fixed exchange rate after April through intervention in the foreign exchange market, as opposed to by further increasing the reference rate. Here I’m primarily referring to the predominant cash loans to retail clients (44% share), which recorded annual growth exceeding 10% in January 2022. Due to the slight increase in the price of dinar loans linked to the reference rate of the NBS or BELIBOR, which account for approximately 55% of total retail loans, growth in these loans will not reduce significantly.

The second most popular form of credit in terms of participation, housing loans (38.7% share), recorded the highest annual growth in January, totalling approximately 17%. The latest available data indicate that almost the same annual growth of cash loans and mortgages granted to households was also recorded in February 2022. Considering that it is only after the ECB raises the key interest rate that the six-month Euribor rate will be mostly negative or slightly above zero, the most likely scenario is that these loans will continue to experience growth for the majority of 2022, albeit at a much lower rate. This is due to citizens’ reluctance to borrow during times of crisis in light of the risk of them losing their jobs, but also the severe hike in real estate prices during the first quarter of 2022.

What will happen to savings? Everyone who has savings, in both dinars and foreign currency, is making a loss at the moment.

The taxing of savers due to low interest rates has lasted a long time. The interest rate on total foreign currency deposits, and deposits indexed in foreign currency, has stood at below 1% since 2017, while – under current conditions – inflation is mostly punishing savers who don’t keep their cash in banks, due to feelings of uncertainty. Unfortunately, that will remain the same over a longer period. The answer to this absurdity is the irrational allocation of savings, such as opting for unproductive investments – real estate, gold etc. History will repeat itself: the speculative real estate bubble will burst sooner or later.