1. This statement updates the staff report with recent information on (a) program conditionality, (b) fiscal and external sector developments, and (c) the adoption of a new central bank law that set the basis for the election of a new Governor. This information does not alter the thrust of the staff appraisal.

Program conditionality

2. The latest information confirms that all end-June performance criteria (PCs) were observed with the exception of those on (a) NFA of the National Bank of Serbia (NBS) and (b) the electricity price increase. The authorities have requested waivers on the basis of revised policy understandings as described in EBS/03/101 (¶12 and 20). In particular, according to recent data, credit to the government at end-June was below the program ceiling by the equivalent of over 1 percent of annual GDP.

3. According to the latest information, four of the six structural benchmarks (SBs) for the period through end-June had been met by late July, compared with three SBs as of early July as reported in EBS/03/101. In particular, the SB on the adoption of restructuring plans for 7 large state enterprises in Serbia has been recently implemented. However, parliamentary adoption of a pension law in Montenegro has been delayed to September (after the summer recess), and the elimination of export quotas in Montenegro has been decided, but it can be implemented only when the harmonized tariff system comes into effect (in September). By the same token, several later benchmarks have been met. The end-December 2003 SB on the adoption of a NBS law providing for a Supervisory Council (in line with a Safeguards Assessment recommendation) has been adopted (see below). In addition, two proposed SBs for the period through end-September relating to Serbia (establishment of a joint NBS-Finance Ministry Committee to coordinate liquidity and cash management operations, and parliamentary adoption of a Secured Transactions Law) have been implemented.

Fiscal and external sector developments

4. Preliminary data through end-June show that the fiscal deficit (cash basis) amounted to about 1.5 percent of annual GDP compared with an original program target of 2.9 percent of GDP. Revenue remained buoyant. Owing to limited domestic financing (EBS/03/101, ¶8-9) and delays in foreign assistance, expenditure was contained below program levels mainly by keeping expenditure commitments below the budget but also by incurring new arrears (related to farmer pensions, child allowances, and the road directorate) of 0.6 percent of GDP. (As a result, the end-June indicative ceiling of zero new expenditure arrears was exceeded.) The authorities noted that they have begun to settle these arrears in July, following the receipt of delayed foreign budgetary assistance, and that the remainder will be settled in the coming months. The foreign exchange market has remained stable despite the public confrontation between the former NBS Governor and the Serbian government (see below), with net NBS purchases in the interbank market reaching about $50 million during July 1-23, increased from June. The exchange rate of the dinar vis-a-vis the euro depreciated by 1.3 percent from end-June 2003 (6.2 percent from end-2002).

New central bank law and election of a new Governor

5. On July 22, 2003, the Serbian parliament approved a new central bank law, confirming central bank independence and enhancing accountability of its top management, broadly in line with Fund staff recommendations. This set the stage for the election by parliament of a new Governor. The government decided not to support incumbent Mr. Dinkic’s reelection, citing his active involvement in politics and public criticism of government’s economic policies. The newly-elected Governor—Ms. Udovicki—pledged to maintain the NBS’s prudent monetary and exchange rate policies, thus helping calm markets, while re-focusing attention toward the critical issues facing the NBS, including banking supervision and bank restructuring. The parliament also elected five members of the newly-instituted NBS Supervisory Council.