1. We thank staff for the accurate assessment and the candid and helpful policy dialogue with our Serbian authorities. The staff report well highlights the policy options for mitigating numerous domestic and regional risks, subject to the constraints of a subdued recovery. The Stand-By Arrangement (SBA) continues to be an effective anchor for economic and financial policies in a difficult external and internal environment and staff’s advice is highly appreciated. The Serbian government is committed to the implementation of this advice and of the program conditions as the program enters its last stages.

2. The SBA remains fully on track as all end-September quantitative performance criteria and indicative targets have been met. The two prior actions for this review (parliamentary approval of the 2011 budget, re-submission of the revised pension law to parliament) have also been fulfilled. However, the inflation rate has marginally exceeded the upper limit agreed under the inflation consultation clause, triggering further consultations with staff. As in the last three reviews, the authorities intend to draw only partially on the resources made available from this review, in the amount of 10 percent of quota.

3. The Serbian economy is recovering at a restrained but favorable pace relative to its regional peers. Exports are becoming the main engine of growth, reflecting improved competitiveness. The current account deficit is edging up nevertheless, but remains significantly lower than before the crisis. The key preoccupation of the authorities is the rapid rise in inflation that is driven by a sharp increase in food prices and delayed exchange rate pass-through. The exchange rate has proved effective in absorbing external shocks and has contributed to the rebalancing of the economy. The interventions of the National Bank of Serbia (NBS) in the foreign exchange market have aimed at smoothing volatility in the relatively shallow market. The managed floating exchange rate regime continues to serve the country well.

4. The fiscal policy parameters for 2010 are in conformity with the program. Revenues have performed according to projections, but with changes in composition (excises have compensated for lagging VAT collection). On the expenditure side, capital spending and interest payments were lower than planned. This underspending has allowed a rebalancing of the budget towards priority and social protection spending.

5. The budget for 2011 will be the first governed by the newly adopted fiscal balance rule. Fiscal policy will be tightened to reduce the deficit at the general government level to 4.1 percent of GDP. As revenues are declining—due to lower external grants, the elimination of the “crisis” tax on mobile phones, and lower custom revenues—, reaching this deficit target for 2011 implies significant expenditure cuts (of 2 percent of GDP relative to 2010). A set of measures will keep public spending within the agreed tight envelope. Wage and pension increases in January 2011 prescribed by the indexation rules will be capped at 2 percent, while transfers to local governments will be gradually restored to pre-crisis levels. Subsidies will be limited to their 2010 nominal level with two exceptions, while capital spending will cover only large infrastructure projects. The authorities plan to use privatization revenues for budget financing in order to reduce the interest burden.

6. The NBS has tightened its monetary policy stance in response to manifest inflation pressure. The policy rate has been raised significantly in the second half of the year, and the NBS has continued to signal further monetary tightening. The NBS stands ready to use its full set of monetary policy instruments, including reserve requirements, to bring inflation back into the tolerance band in 2011.

7. The authorities are progressing with their structural reform agenda. The privatization of Telekom Srbija has been initiated, while two other large public companies are to be restructured. The business environment will be improved with the implementation of a regulatory “guillotine” project and of the laws on competition. It is expected that the government will submit the company and securities laws to parliament before the end of the year. The pension law was submitted to parliament with two amendments that aim at enhancing the protection of the most vulnerable and of women. The key elements of the pension reform discussed during the fourth review of the SBA were preserved.

8. The authorities value the advice provided in the context of the program and will continue their close cooperation with the staff. They intend to consult with management on their future relationship with the Fund beyond this arrangement.