annual report - nbs.rs · integrated supervision of the financial system. in 2004 the national bank...

NATIONAL BANK OF SERBIA

Annual Report2003

Ekonomski pregled


Annual Report2003

Governor�s Statement

The National Bank of Serbia has commenced the year of 2004, theyear of its 120th anniversary, with the high credibility of a trustful

institution persistently devoted to its legal commitments, as defined by thenew Law on the National Bank of Serbia, to preserve price stability andensure efficiency of the overall financial system.

By the measures of monetary policy undertaken in 2003, the NationalBank of Serbia supported the efforts towards accomplishing the keyobjectives of economic policy, above all the last year�s rate of inflation being7.8 per cent against the projected 9 per cent. The foreign exchange marketand the dinar exchange rate remained stable, net purchases in exchangeoperations reached nearly EUR 1.2 billion, considerable increase wasreported in foreign currency and dinar savings, bank privatization processwas initiated, and the development project was launched for the nationalDinaCard which should attract about a million cardholders by the end of theyear.

One of the most extensive financial projects was completed in earlyJanuary 2003, when payment operations were shifted from the Clearing andSettlement Bureau to commercial banks, and the RTGS and clearing systemof the National Bank of Serbia was launched. The number of orderschanneled through this system reached 104 million (or a daily average of343,289 orders) totaling CSD 7,114 billion (or CSD 23.6 billion per day),and the National Bank of Serbia was highly appraised by internationalinstitutions for the work done, particularly by the IMF.

Banking supervision systems were further developed in 2003. The focusof supervision was shifted from legal requirements in the operation of banksto the risks to which they are exposed and to risk management, as well as tothe timely taken corrective measures.

Government deposits, which were withdrawn from commercial banksand placed with the National Bank of Serbia in 2003, added to the centralbank�s more extensive control of monetary flows. This in turn contributed tothe macroeconomic stability, as a significant portion of money originatingfrom foreign capital inflows in 2003 could be sterilized.

The National Bank of Serbia will further support this year�s objectivesof development and economic policies by upgrading market mechanismstowards the implementation of monetary policy, and it has already startedorganizing auction sale of its own bills in the primary market at the variableinterest rate. In 2004 the National Bank of Serbia also intends to start

developing repurchase operations, thus contributing to the growth of bondand money market, and encouraging the demand for government securities.By stimulating direct interbank trading, the central bank plans to graduallyreduce the extent of its interventions in the foreign exchange market, and toallow most of the trading to be done between commercial banks.

After the capital requirement was set to be met by banks until the end of2003, in 2004 the National Bank of Serbia will particularly be committed tothe full application of the CAMEL bank ranking system, along with thecreation of early warning systems to respond to identified risks in thebanking sector. In 2004 the National Bank of Serbia will continue its efforts towards thetransparency of the banking sector and, guided by this objective, it haspublished its first report containing the information on ownership, balancesheet and income statement of banks for 2003. According to the newInsurance Law, this year the National Bank of Serbia will also take over thesupervision in the insurance activity, as the first step leading to theintegrated supervision of the financial system.

In 2004 the National Bank of Serbia plans to issue a new 500-dinarbanknote in addition to the current denominations. Furthermore, the Mintwill be involved in manufacturing excise stamps, and developing the newpassport and Personalization Center. A special collection ofcommemorative coins will be prepared for the 200th anniversary of the FirstSerbian Uprising and the 120th anniversary of the National Bank of Serbia.

In every country undergoing transition, central banks have a key role inbuilding up a sound background for the accelerated development ofeconomy. The National Bank of Serbia is fully aware of this role and it willnot only support, but also lead the reform processes to help Serbia bridgethe gap of several decades which have kept the country away from theEuropean Union.

Governor of the National Bank of Serbia

Radovan Jela{i}

5

Annual Report 2003

CONTENTS

ORGANIZATIONAL STRUCTURE OF THE NATIONAL BANK OF SERBIA 7

MACROECONOMIC DEVELOPMENTS 11

ACTIVITIES OF THE NATIONAL BANK 25

MONETARY POLICY 27

EXCHANGE RATE OF THE DINAR

AND FOREIGN CURRENCY RESERVES 47

ISSUE OF BANKNOTES AND COINS 59

BALANCE OF PAYMENTS 63

EXTERNAL RELATIONS 73

BANKING SECTOR AND BANK SUPERVISION 85

PAYMENT OPERATIONS 101

LEGAL AND REGULATORY ACTIVITIES 105

INTERNAL AUDIT 109

ORGANIZATIONAL AND PERSONNEL CHANGES 113

INFORMATION TECHNOLOGY 119

ANNUAL STATEMENT OF ACCOUNT 123

Annual Report 2003

7

ORGANIZATIONAL STRUCTURE OF THE

NATIONAL BANK OF SERBIA HEAD OFFICE (As of 31 December 2003)

Finance and Accounting Department

Treasury Department

Banking Supervision Department

Foreign Exchange and International

Relations Department

Vice Governor

Monetary System and Policy Department

Research Department

Information Technology Department

Legal Affairs Department

General Secretariat

Internal Audit Department

National Payment Card Center

Payment System Department

Department of Exchange

Transaction Supervision

General Administration Department

Vice Governor Vice Governor Vice Governor

Governor

Annual Report 2003

9

Monetary System and Policy Department

Banking Supervision Department

General Secretariat

Internal Audit Department

Research Department

Information Technology Department

National Payment Card Center

Legal Affairs Department

Payment System Department

Department of Exchange Transactions Supervision

Finance and Accounting Department

Treasury Department

General Administration Department

Registers and Forced Collection Department

Finance and Accounting Division

General Administration Division

Ekspoziture Palilula

Ekspoziture Vozdovac

Ekspoziture Novi Beograd

Ekspoziture Pancevo

Ekspoziture Sabac

Ekspoziture Pozarevac

Ekspoziture Smederevo

Monetary Department

Foreign Exchange Department

Division for On-Site Supervision of Exchange Transactions

Analyses Division


Vault Cash Operations Division


Ekspoziture Novi Sad

Ekspoziture Sombor

EkspozitureSremska Mitrovica

Ekspoziture Vrsac

Ekspoziture Zrenjanin

Ekspoziture Kikinda

Foreign Exchange Division

Solvency and Forced Collection Division





Ekspoziture Zajecar

Ekspoziture Vranje

Ekspoziture Prokuplje

Ekspoziture Pirot

Ekspoziture Leskovac

Ekspoziture Jagodina

Ekspoziture Krusevac

Ekspoziture Kraljevo

Ekspoziture Novi Pazar

Ekspoziture Leposavic

Ekspoziture Valjevo

Ekspoziture Prijepolje

Ekspoziture Loznica

Ekspoziture Cacak

Pre-Press Department

Banknote Printing Department

Mint

Securities Printing Department

Maintenance and Power Supply Department

Marketing Department

Development Center

Quality Center

Financial Department

Legal-Administrative Department

Foreign Exchange and International Relations Department

Ekspoziture Subotica

Ekspoziture Becej

Ekspoziture Senta

Ekspoziture Vrbas

Ekspoziture Stari grad

Specialized InstitutionM a i n O r g a n i z a t i o n a l U n i t s













ORGANIZATIONAL STRUCTURE OF THE NATIONAL BANK OF SERBIA(As of 31 December 2003)

11

Annual Report 2003

MACROECONOMIC DEVELOPMENTS

OVERVIEW OF MACROECONOMIC DEVELOPMENTS 12PRICE MOVEMENTS 13ECONOMIC ACTIVITY AND EMPLOYMENT 16

ECONOMIC ACTIVITY 16EMPLOYMENT 19

DOMESTIC DEMAND AND PUBLIC SECTOR 21EARNINGS 21INVESTMENT ACTIVITY 22TRADE TURNOVER 23

Annual Report 2003Macroeconomic Developments

Overview of Macroeconomic Developments

Serbia's economic growth did not reach the projected rate in 2003, althougha moderate improvement of the economic activity reported close to the end of theyear has been even more pronounced in the first quarter of 2004. Besides trade andservices, the economic growth in 2003 was basically generated by constructionindustry, as well as by telecommunications, and has additionally been supported byprocessing industry in the first quarter of 2004. The estimates are that the secondhalf of 2004 will see a substantial impetus given by agricultural production relyingon the positive effects of the planned increase in the agrarian budget for 2004.

Variations in the exchange rate of the dinar in 2003, within the limits ofmanaged floating, were marked by a highly stable real effective exchange rate anda moderately depreciated nominal effective exchange rate of the dinar. The stabilityof its real effective rate indicated that in 2003 the international pricecompetitiveness of local businesses maintained the same level in the areadetermined by the external value of national currency. As estimated, no changes inthe dinar exchange rate regime are expected in 2004 and the achieved stability willbe preserved.

Last year's interest rates reflected a moderately declining trend, although theyare still relatively high due to the high demand for loans. Interest rates offered inthe market vary to a great extent and are still determined by the investment andpolitical risk, inadequate legal framework capable of protecting creditors in theevent of any disputes, by lacking efficiency of the banking sector, as well as by theunresolved issue of the London Club creditors. High interest rates are among thefactors limiting a more expansive financing of production.

The area with the most limited progress in the past period, though extremelyimportant for a more rapid development, relates to the creation of adequateconditions for market competition. This segment of the economic policy still lacksa number of laws which have not been enacted yet, no new institutions have beenestablished to prevent the monopolistic market behavior of businesses, while theexisting institutions have not been restructured.

In order to achieve the growth of investment, as the driving force of thesustainable growth in the medium and long term, the increase in domestic savingsshould also be encouraged in addition to direct foreign investments. More intensivedirect foreign investments are extremely important for Serbia as, contrary to externalborrowing, they provide for new technology and for lacking capital which, combinedwith the business oriented management, generate direct effects in terms of increasedproductivity. Parallel to the strengthening of public trust in banks, it is important todevelop the non-banking sector, e.g. insurance companies and institutional investors.

12

Annual Report 2003 Macroeconomic Developments

13

To create a favorable investment climate, it is necessary to enact and enforcethe laws providing for legal safety of potential investors and simultaneouslyensuring the efficiency of courts and the compliance with the respective rights andcontracts, whereby the investment risk would be mitigated.

Taking into account the international economic environment, Serbia'sprospects appear to be brighter than in the same period of 2003. The factors bywhich Serbia's economy is encouraged or its balance of payments improved are theeconomic recovery in the EU countries, low interest rates, and the declining valueof the U.S. dollar. Last year's less favorable effects related to the rising oil prices(partly reflecting the depreciation of the U.S. dollar) which made oil import muchmore expensive, with the same trends continuing in 2004.

Price Movements

With respect to the measures taken in the area of monetary and fiscal policies,the year of 2003 saw a considerably reduced rate of inflation in the Republic ofSerbia, which was even below the projected level. According to the data reportedby the official statistics, the rate of inflation measured by retail prices was 7.8%(from December to December) relative to the projected 9%. The suppressedinflation was also supported by delayed adjustments of some of the administrativelyregulated prices, as well as the depreciated value of the dollar with positive effectson the prices of oil and gas which are Serbia's significant imports. The slowed-downinflation was further contributed to by the reduced customs and tax rates in tradewith Montenegro. In structural terms and in comparison to the previous year,inflation was undoubtedly decelerated by relatively slowed-down rise in industrialproducer prices (4.6% from December to December) and in agricultural producerprices in the first three quarters of 2003 (3.2%).

The increase in inflation reported in 2003 was influenced by the real rise inwages and labor unit costs, and to a smaller degree by variations in the exchangerate of the dinar, while the suppressing effects resulted from the high exports ofgoods and services, partly reduced taxes and customs duties, vigorous monetaryrestrictions, enhanced market competition and a number of other factors.

Broken down by groups of products and services, a relatively more rapid risein prices was reported with drinks (6.1%) and tobacco (9.1%), industrial non-foodstuffs and services (6.9%).

Core inflation was considerably below the overall inflation and was reportedat 5.4% as the prices of goods and services subject to market conditions rose moreslowly than those of products and services to which the price disparity adjustmentswere applied. Price disparity adjustments fall within the competence of governmentauthorities, either on the level of the Republic or of local government (for utilities,transport and other public services).

The current rate of core inflation approaches the level reported in 12 euro zonecountries and 25 EU countries. Even so, Serbia's inflation in 2003 was still much higherthan the average one reported in the euro zone countries (2.1%). Compared to each of thecountries which joined the European Union on 1 May 2004, last year's higher rate ofinflation was only recorded by Slovakia (9.3%). In Hungary, for example, it reached5.6%. In 2003 the prices of products and public services subject to disparity adjustmentsrose by 10.5%, which affected the overall inflation and its higher rate compared to coreinflation.


14

Core and Overall Inflation in the Republic of Serbia(December 2002 = 100)

99

101

103

105

107

109

XII2002

I II III IV V VI 2003

VII VIII IX X XI XII

Core inflation Overall inflation

Due to price disparity adjustments applied to utilities, municipal and otherpublic services, in 2003 the prices of services increased much more rapidly (11.1%)than those of goods (6.6%) measured in December relative to December 2002.Similar movements were reported both in 2001 and 2002, and resulted in the rise inprices of services by as much as 37.3% and prices of goods by 15,6% in the pastthree years, against the general retail price growth of 20.3%, all based on the yearlyaverage.

CCoorree aanndd OOvveerraallll IInnffllaattiioonn iinn tthhee RReeppuubblliicc ooff SSeerrbbiiaa (Retail price growth rates in %)

Dec 2001 Dec 2000

Dec 2002 Dec 2001

Dec 2003 Dec 2002

Overall retail price growth 40.7 14.8 7.8

Price growth in sectors with disparities

Energy

57.7 24.6 9.2

Of which: Electricity 150.1 52.4 16.5 Drugs 74.1 -6.4 -0.6 Bread and wheat flour 92.3 0.8 20.2 Utility services 155.0 70.6 16.1 Transport 57.3 39.8 8.2 PTT 143.6 13.0 1.4

One-off effect of the changes in the tax system 5.0* - -

Core inflation 18.4 6.0 5.4

Source: NBS-RD and RSO. *The effect of tax increase is estimated to be 5 percentage points of the overall retail price growth.

Consequently, the general price level accelerated to a certain extent relative tothe first three quarters. Measured by retail prices, inflation rose by 2% in the lastquarter against 1.7 - 1.9% reported in the first nine months. The rise in pricesreported in the last quarter was not caused by price disparity adjustments, but bygrowing prices of agricultural and food products, increased wages in real terms, andpartly by the so-called psychological inflation - inflation expectations relating to theproblems in forming the Government and the Parliament in late 2003.


15

The cost of living rose by 8.1% in 2003, while the prices of services and goodsincreased by 16.9% and 6.7%, respectively.

Similar to retail prices, the cost of living rose more rapidly in the last quarterthan producer prices, due to the growing prices of services and foodstuffs (causedby droughts and floods in 2003). As reported by the official statistics, the cost ofliving increased by 3.2% in the last three months, within which the increase in pricesof services was by 3.5%.

Prices and Cost of Living in the Republic of Serbia

0

20

40

60

80

100

120

140

160

1995 1996 1997 1998 1999 2000 2001 2002 2003

Retail prices Cost of living Industrial producer prices

Industrial producer prices recorded a very moderate (both current andaverage) growth of 4.6% in 2003, or even lower than core inflation. In the twoprevious years these prices rose by 6.1% (in 2002) and 29.1% (in 2001). In all thethree preceding years industrial producer prices increased at a lower rate than retailprices and consequently had a stabilizing effect on the general price level and costof living. Broken down by quarters, producer prices recorded a moderate growth inthe first two quarters, surged in the third by 2.2%, and increased by 1.4% in the lastquarter. When taken by purpose, the highest increase by 6.3% was reported withpersonal goods, the effective demand for which being most pronounced. On theother hand, investment goods and intermediate goods prices recorded a lowergrowth, by 2.4% and 2.9%, respectively. Prices in extractive industry rose by 3.3%in last December relative to December 2002, while a 3.4% increase was reported inprocessing industry. In the processing sector the above average increase wasrecorded by the prices of foodstuffs, drinks and tobacco (6.9%), basic metalproduction (5.5%), and the prices in the publishing sector (11%). A considerabledrop in prices was reported in oil derivatives production (6.6%), wood processingand wood products (2.7%) and in cellulose, paper and paper processing (1.2%).Prices in electric power, gas and water production sector rose by 15%, as the resultof price disparity adjustments and, broken down by industrial sectors, this was thehighest reported increase.

Agricultural producer prices rose by 11.0% in 2003 relative to 2002(measured from December to December), although the increase largely related to theperiod close to the end of the year. Such movements in agricultural producer prices


16

primarily resulted from adverse weather conditions and less extensively sown areas.Due to the reduced domestic supply, and after a 1% decrease in the first quarter, theprices rose in the second quarter. The upward trends in agricultural producer priceswere most pronounced in the fourth quarter, which saw an increase by more than9%. The average growth of these prices in 2003 exceeded the level reported in 2002by no more than 0.5%, which partly resulted from the lower statistical base in 2002,when agricultural producer prices fell by as much as 3% relative to 2001.

The highest current price growth (measured from December to December) wasreported with potatoes (127.7%), wheat (70.1%), corn (61.4%), and milk and dairyproducts (14.2%). A drop in prices was recorded by alcoholic drinks (24.7%), aswell as vegetables, cattle (beef cattle and swine), poultry and eggs.

As estimated by the NBS Research Center, the upward trend in agriculturalproducer prices will continue until the next harvest in mid-2004 and affect themovements in retail prices and the cost of living.

Economic Activity and Employment

Economic Activity

Industrial production, as opposed to the 1.7% growth in 2002, fell by 3% in2003. This resulted in adverse effects on the growth of the GDP, on exports andforeign trade deficit, as well as on the inflow of fiscal revenues from production. Therecorded fall in processing industry was 4.6%. The drop in production wasundoubtedly contributed to by the poor motivation in socially- and state-ownedcompanies relating to the expected privatization, which was accompanied by slowadjustment to the considerably increased competition in the domestic market(created by imported goods). Moreover, part of the production in the new privatesector was not fully covered by the official statistics, although this sector had notsufficiently accelerated its activity either, considering the initial adjusting steps andslow repositioning in the lost foreign markets.

Social Product and Industrial Output(Index 2001 = 100)

80

90

100

110

120

130

1995 1996 1997 1998 1999 2000 2001 2002 2003

80

90

100

110

120

130

Social product Industrial output


17

The growth in production was reported with four industrial branchesaccounting for 38% of industry: electric power, gas and water, coal production, andthe production and processing of chemicals. Other industries recorded a lower orhigher drop in production. The increase in stocks of finished products was alsoreported, due to the growing competition in the domestic market of industrialproducts resulting from extensive imports. In particular, considerable imports wererecorded with consumer goods and consequently resulted in growing stocks offinished products in this segment of domestic production.

GGrroowwtthh RRaatteess ooff RReeaall SSoocciiaall PPrroodduucctt aanndd IInndduussttrriiaall OOuuttppuutt

iinn tthhee RReeppuubblliicc ooff SSeerrbbiiaa ((11998899 −22000033))

Year Social Product (In %)

Industrial Output (In %)

1989 1.3 1.0 1990 -7.7 -12.0 1991 -11.7 -18.0 1992 -28.1 -23.0 1993 -30.4 -37.0 1994 2.6 2.0 1995 5.7 4.0 1996 4.7 6.0 1997 7.4 10.0 1998 2.4 3.9 1999 -22.8 -25.6 2000 5.7 11.4 2001 5.7 0.1 2002 3.3 1.7 2003 1.5* -3.0

Source: RSO *GDP growth for 2003 estimated by RSO.

In 2003, the restructuring of industrial companies continued, but there were stillmany large companies which had to be restructured. The process of privatizationwas considerably intensified and more than 1,000 socially- and state-ownedcompanies were privatized.

Taking into account the declining industrial activity in 2003, newmacroeconomic measures were to be set in action for encouraging the sustainablegrowth of industrial and the overall economic activity. In particular, it was importantto attract and stimulate new domestic and foreign investments. The investmentactivity would be strengthened by the effective use of the proceeds resulting fromthe privatization process, and particularly by foreign direct investments,concessions, etc., as well as by the development of SMEs in the new private sector.

The new investment and technology cycle was to be supported by projects inthe area of transport and economic infrastructure (as forms of public works). Inparticular, it was imperative to encourage housing construction and constructionactivity in general, with the aim of enhancing employment, and avoiding any socialturmoil and delays in economic reforms, including all positive dispersive effects. Inthis context, simpler procedures in obtaining building permits was one of thepriorities, as the way to encourage employment of all the domestic resources(building material, chemical, metal and electrical industry, creation of new jobs,etc.). Furthermore, it was important to adopt the strategies of industrial andeconomic development of the Republic of Serbia, particularly export and foreigntrade strategies.


Agricultural production was much lower in 2003 than in 2002. This wasundoubtedly the result of severe droughts, in addition to the lower sowing rates, theunresolved financing model for primary agricultural production, the purchase ofmarket surpluses, and other problems associated with agriculture. The preliminaryestimates were that the agricultural output reported in 2003 might be byapproximately 6% lower than in 2002. The drop in the output of some basic fieldcrops was 27% (wheat), 24% (corn), 30% (potatoes), 47% (tobacco), etc. Thedomestic supply of agricultural products decreased, both in terms of output andassortment, in the area of farming, fruit growing and cattle raising, with adverseeffects on the general price level, cost of living and the Republic's trade balance.

Nevertheless, the domestic market was adequately supplied with agriculturalindustrial products, due to purchased and stored products, transitory stocks ofprimary agricultural products, and to imports. Agricultural production is expectedto improve with the 2004 crops, with respect to the anticipated more favorableweather and other conditions of relevance to agriculture.

Construction activity recorded an upward trend in 2003. Measured byeffective work hours, it rose by 11% relative to 2002. The total value ofconstruction works carried out (according to the quarterly official statistical reports)reached CSD 36.6 billion and increased by 11% in nominal terms. The gradualrecovery of construction industry was also reflected in the growing volume ofcontracted works abroad where the value of completed projects exceeded by 14.3%the level reported in 2002.

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Construction - Effective work hours

(2001 = 100)

90

100

110

120

130

140

150

160

1995 1996 1997 1998 1999 2000 2001 2002 2003

In the same period, the number of workers employed in construction industrydecreased by 5.7%. The number of flats constructed in 2003 (based on quarterlyreports) reached 3,463. The number is estimated to be much higher in the area ofprivate construction.

The Planning and Construction Law enacted in May 2003 was aimed atcreating conditions for more extensive and efficient investments in construction(more simple procedures in obtaining building permits and approvals), the plannedlegalization and entry of buildings into the cadastral records, but this would requirethe Law to be improved.


19

In the course of 2003, the updating of cadastral records continued in theRepublic of Serbia, with approximately 50% of its territory included in the cadastralrecords until the end of the year. With the expected loan to be provided by the WorldBank, some 98% of Serbia's territory should be covered by the cadastral recordsuntil the end of 2008. This is an important prerequisite for the development ofeconomy, lending, privatization, and foreign investment.

The overall volume of transport services, according to the statistical data, fellby 0.9% in 2003 relative to 2002. Viewed by different transport branches, landtransport recorded a 10.4% decrease including an increase by 5.5% both in railwayand pipeline transport, and a drop by 29% in road transport. The physical volume ofriver transport fell by 30% and, and increased by 14.2% with air transport. The latterwas also the highest growth reported by a transport industry, followed by PTTservices and telecommunications (13.8%). The overall passenger transport fell by2.4%, as opposed to freight transport which rose by 6.5%.

In 2003 considerable allocations were made for the reconstruction anddevelopment of this branch of economy. Investment in the reconstruction of the1,000 km long road network was approximately EUR 300 million, Telecom Serbiainvested EUR 250 million in further telecommunications network development, andthe project "Belgrade Airport - Gate of Serbia", with the total cost of EUR 22million, was launched close to the end of the year.

With respect to the extensive investments planned in the area of transportinfrastructure, the coming period is expected to see a considerably intensifiedtransport activity and improved services, which would support the recovery of theentire economy.

Tourist activity measured by the total number of overnights fell by 7.2% in2003 relative to 2002. The number of overnights reported for foreign guestsincreased by 7.2% against an 8.9% drop with domestic guests. The total number ofarrivals decreased by 9.6%, where the number of arrivals rose by 8.7% with foreignguests, and fell by 12.6% with domestic guests.

Last year's number of incoming tourists was 1.2 million, with 6.7 millionreported overnights. In 2003, the privatization was completed for 52 companiesinvolved in tourist and catering industry. Last year's foreign exchange inflowresulting from tourism reached USD 150 million, or 115% over the level reported in2002. Tourist activity is expected to grow further in the coming period.

Employment

In 2003 the employment rate continued to show downward trends reported inthe previous years, as the economic activity was lower than projected, while the newprivate sector was unable to absorb the redundancies. As estimated by the StatisticsOffice of the Republic of Serbia, the number of the employed was 2,019.8 thousandin late 2003, or 0.9% less than a year ago. The number of the unemployed rose by4.5% in the same period and reached 944.9 thousand.

The estimates show that the gray economy absorbs nearly one third of theemployed, while the total number of unregistered workers is estimated at 600-800thousand. The labor inspectors discovered 48.9 thousand unregistered workers in2003 (relative to 18.6 thousand in 2002). Some three fourths of those discoveredwere duly employed after the inspection.


20

Employment and Unemployment(Annual average, in thousands)

0

500

1,000

1,500

2,000

2,500

1995 1996 1997 1998 1999 2000 2001 2002 2003

0

500

1,000

1,500

2,000

2,500

Number of employed Number of unemployed

On the other hand, the fictitious employment still poses a major problem. Asreported by the Statistics Office of the Republic of Serbia, over 12% of theemployed were not paid wages in December 2003, which speaks of serious problemsin the area of employment and the state of the economy. Although the number ofnewly employed by the private sector in 2003 exceeded by 40% the level reportedin the previous year, this is apparently far from being sufficient to make up for thedrop in employment resulting from the restructured state- and socially-ownedcompanies.

The new Law on Employment and Unemployment Insurance enacted in Julyprimarily focused on the reform of the employment office, with the emphasis on amore active involvement by the unemployed, subventions for self-employment andemployment of people over 50 years of age, increased fines for any employers withunregistered workers, etc. In addition to subventions, for the purpose of encouragingself-employment, which should be an important generator of employment in thecoming period, the opening of business centers in Serbia was initiated in 2003 toprovide education and professional help for the unemployed interested in launchingtheir own businesses.

However, simpler (and less expensive) procedures for establishing SMEs, aswell as for overcoming obstacles and creating adequate conditions (above all, interms of the legal framework) for foreign direct investments, are still the basicdirections to be focused on by the government in order to enhance employment.


21

Domestic Demand and Public Sector

In 2003 the consolidated public expenditures in the Republic of Serbia, aspreliminary reported by the government, accounted for 45.5% of the GDP, with thefiscal deficit equal to 3.5% of the GDP, which is somewhat above the fiscal deficitof the EU countries and other leading industrial western countries. The fiscal deficitreported in the OECD countries generally ranges from 2.5-3.5% of the GDP, i.e.1.5-2.0% in the European Union, approximately 5% in the U.S.A., andapproximately 6% in Japan. Serbia's objective is to have its fiscal deficit reducedbelow 3% of the GDP, as one of the requirements for the association to theEuropean Union in compliance with the Maastricht Criteria.

As reported by the Public Payments Agency, gross allocated revenuesincluding the social insurance revenues reached CSD 555.3 billion in 2003, i.e. innominal terms 9.5% above or in real terms 2% less than in 2002. Allocated taxesand other public revenues accounted for CSD 411.3 billion and increased by 8.7%in nominal terms. Social insurance revenues reached CSD 144.0 billion with thenominal growth of 11.9% relative to 2002.

Further improvements of the fiscal system and new statutory solutions arebeing prepared towards the harmonization with the fiscal systems of the EuropeanUnion. Most of all this refers to the Value Added Tax Law, the fiscalization in tradeand other businesses, and to other regulations to make the fiscal system moreefficient and help suppress illegal trade in goods and services.

Earnings

In spite of the increase reported in the past three years, wages in the republicof Serbia are still lower than in the majority of the European countries, excluding anumber of the East European transition countries. This is the reason why, ifmeasured by the level of wages, Serbia's economy is still much more competitivecompared to most of the countries in Europe. Therefore, labor unit costs arerelatively low and competitive, despite the growth reported in the period 2001-2003.

Wages considerably increased in 2003 both in nominal and real terms. InDecember 2003, the average net wage in the Republic of Serbia was CSD 14,528(EUR 123) and exceeded the level reported in December 2002 by 25.7%, or by16.2% in real terms. Compared to 2002, the average net wage increased by 24.9%and 13.7% in nominal and real terms, respectively. It should be noted, however, thatwages are not regularly paid to every eighth employed worker.

It is apparent that 2003 saw a continued trend of more rapidly growing wagescompared to productivity. However, the percentage of savings relative to the GDPis still low, whereas it should be taken into account that a further increase inhousehold savings and in the overall domestic savings is an important preconditionfor the economic growth in medium and long term. Although production may beencouraged by higher wages or by domestic demand in short term, experience hasshown that in Serbia this mainly results in increasing imports, i.e. in foreign tradedeficit.

The positive effect of the rise in wages is undeniably the enhanced standard ofthe employed, which measured by the minimum consumer basket improved by15.6% in 2003.


22

Wages paid in 2003 again varied to a higher or lower degree depending both onregions and on industries. Viewed by municipalities, the highest average net wagewas reported in Beocin, and the lowest in Dimitrovgrad. Broken down by industry,the highest wage of CSD 29,272 was earned in tobacco industry, and the lowest ofCSD 2,169 in textile and leather industry.

Average Real Wage Growth in the Republic of Serbia (Index, 2001 = 100)

70

80

90

100

110

120

130

140

1995 1996 1997 1998 1999 2000 2001 2002 2003

Investment Activity

The investment activity in 2003 was somewhat more favorable than in 2002 (inthe area of transport infrastructure, partly in construction industry, etc.), but theestimates are that it is still considerably below the requirements of accelerateddevelopment of Serbia's economy, with respect to the fact that the technical andtechnological lag equals 3-4 technological cycles.

Parallel to the insufficient investment activity, a significant real increase inpersonal and public consumption reported in 2003 was unfavorable in terms ofdevelopment and Serbia's future economic growth. In 2003 the growth of Serbia'seconomy was below the sustainable level and below the level causing employmentto increase and all the internal and external payments to be duly settled.

The estimates are that the total investments in fixed assets ranged around 16%of the GDP, while the sustainable development would require the investment rate toreach or even exceed 20% of the GDP in the shortest possible period. In the mediumand long term, the investment rate should go up by 25% of the GDP, or from timeto time even above that level. It would, therefore, be necessary to increase theinvestment from both domestic and foreign sources, to the extent that they couldreach an annual level of at least USD 3.5-4 billion. Such investment in fixed assetswould provide for the reconstruction and development of transport and economicinfrastructure, and for the recovery of housing and other construction, and ofSerbia's entire real sector. Particular efforts should be made to attract foreigninvestors on permanent basis (FDI, concessionary and BOT investment, jointventures, etc.), as well as to improve the credit and investment rating of the Republicof Serbia, and Serbia and Montenegro which is still at a low level.


23

Trade Turnover

The turnover in retail trade in 2003 increased by 12% in real terms relativeto 2002, and by no more than 3% in wholesale trade. Under the circumstances ofprice stability, the real increase in wages and purchasing power resulted in thegrowing turnover compared to the previous year.

Although the value added tax was not imposed in 2003, intensive activitieswere undertaken in the process of introducing electronic cash registers with fiscalmemory. The use of cash registers will have suppressing effects on the grayeconomy, with fiscal obligations and actual retail trade turnover properly recorded,in addition to the supported recovery of the domestic electronic industry and theencouraged cashless payment system, whereby trade will be brought in compliancewith the European standards.

Turnover in Trade and Transport (Index, 2001 = 100)

50

70

90

110

130

1995 1996 1997 1998 1999 2000 2001 2002 2003

Transport

60

80

100

120

140

160

Trade

Freight transport (in km) Physical volume of retail trade

Many socially-owned companies trading in goods and services were privatizedin 2003. This is one of the prerequisites for productive competition, which will inturn result in improved quality of services and in reduced retail prices of goods.

25

Annual Report 2003

ACTIVITIES OF THE NATIONAL BANK

MONETARY POLICY 27EXCHANGE RATE OF THE DINARAND FOREIGN CURRENCY RESERVES 47ISSUE OF BANKNOTES AND COINS 59BALANCE OF PAYMENTS 63EXTERNAL RELATIONS 73BANKING SECTOR AND BANK SUPERVISION 85PAYMENT TRANSACTIONS 101LEGAL AND REGULATORY ACTIVITIES 105INTERNAL AUDIT 109ORGANIZATIONAL AND PERSONNEL CHANGES 113INFORMATION TECHNOLOGY 119 ANNUAL STATEMENT OF ACCOUNT 123

Annual Report 2003

27

MONETARY POLICY

MONETARY POLICY OBJECTIVES AND TARGETS 28MOVEMENTS IN KEY MONETARY AGGREGATES 29

RESERVE MONEY 29MONEY SUPPLY M1 31MONEY SUPPLY M2 31MONEY SUPPLY M3 32MONEY CREATION 33

MONETARY POLICY INSTRUMENTS 35RESERVE REQUIREMENTS 35CREDIT FACILITIES 38DEPOSIT FACILITIES 38INTEREST RATES 39MINIMUM CREDIT RATING REQUIREMENTS 39

CREDITS TO THE GOVERNMENT 40ACTIVITIES IN THE PRIMARY SECURITIES MARKET 41PLANNED NBS ACTIVITIES IN THE MONEY MARKET IN 2004 43ACTIVITIES RELATING TO FROZEN FOREIGN CURRENCYSAVINGS 43

Annual Report 2003Monetary Policy

28

Monetary Policy Objectives and Targets

In 2003 the principal objectives of monetary policy were not significantlydifferent from those prevailing in the two previous years. The key objective againfocused on a further slow-down of inflation and a maintained macroeconomicstability. However, taking into account the assumption that the year of 2003 was tosee a considerably decelerated growth of money demand and that, under theexisting circumstances, the remonetization in economy had largely been completed,the rates of growth of the key monetary aggregates were set at much lower levelsand mainly adjusted to the nominal growth of the GDP. In this context, a strictmonetary policy was pursued in 2003.

With respect to the measures taken within the monetary policy, as well as toother macroeconomic efforts, the 2003 inflation in the Republic of Serbia wasfurther slowed down, with the preserved stability of the financial system. A strictmonetary policy of the NBS and its interventions in the open money and short-termsecurities market, as well as in the domestic foreign exchange market, reduced theinflation to the lowest level in the past nine years of 7.8% measured from Decemberto December. In the same period, core inflation was considerably below the overallinflation and was reported at 5.4% for products and services with prices setaccording to market conditions.

In 2004 the monetary policy will primarily focus on its key objective - pricestability. With respect to encouraging results in the area of disinflation, as well asto economic trends expected in the first quarter of 2004, the NBS reduced thediscount rate to the current 8.5%. The rate of inflation in 2004, as projected, shouldremain below 8.5% at annual level. The NBS will also be actively involved increating systemic and regulatory solutions so as to support increased competitionand improved efficiency of financial intermediation in the banking system.

The estimates are that no considerable changes should be expected in theconditions in which the monetary policy will be implemented in 2004, and that itshould remain firm in order to reach the targets set for this year. In this respect, theforecasts point to a relatively modest growth of key monetary aggregates, at therates which should be slightly above the rate of the nominal GDP growth. For thepurpose of achieving quantitative objectives of monetary policy, the NBS willfurther focus on strengthening and enhancing market instruments of monetaryregulation, which should contribute to the development of the financial market.Improvements should also be seen in open market operations in securities, primarilythrough repurchase transactions in the government securities, along with theintended upgrading of operations in the foreign exchange market aimed at making

Annual Report 2003 Monetary Policy

29

it more liberalized, less segmented and more integrated. This would result in arelatively smaller number of interventions by the NBS and in a greater involvementof banks in foreign exchange market transactions.

In addition to the enhanced monetary policy instruments and the developmentof money and capital market, it is necessary to create an institutional framework forthe insurance of deposits.

Movements in Key Monetary Aggregates

Reserve Money

The overall reserve money increased by approximately 14% in 2003. Theincrease predominantly related to bank foreign currency deposits with the NBS,while the dinar reserve money recorded a marginal increase. Within the latter, adrop was reported with currency in circulation against an increase in bank dinarreserves. Bank reserves reflected an increase in required dinar reserves, and adecrease in the excess reserves of banks. Growing foreign currency bank depositswith the NBS mostly resulted from increased allocations of banks based on foreigncurrency savings, and partly from those based on required foreign currencyreserves. Within the overall reserve money, a slight increase was also reported withdeposits by the local government and other financial organizations.

The reviewed trends in the reserve money creation point to the more significantincrease in the NBS net foreign position, mainly due to the growing foreignexchange reserves which had partly increased with respect to the credit facilitiesprovided by the IMF, though with a neutral effect on the net foreign assets (NFA).The increase in the NFA mostly resulted from the growth in the government andbank foreign currency deposits with the NBS. In 2003, the process of privatizationgenerated considerable foreign currency proceeds for the government whichdeposited the currency with the NBS. Consequently, this resulted in the increase inthe NBS foreign exchange reserves, i.e. the NFA. A portion of foreign currency wassold to the NBS by the government, and it used the dinars resulting from thesetransactions to settle its debts, which in turn caused the reserve money to grow. Theremaining portion of foreign currency still held by the government in its accountswith the NBS has not yet made any effects on the reserve money.

The NBS net domestic assets (NDA) recorded a rather significant decrease in2003, yet nearly half of it related to the rise in the government foreign currencydeposits with the NBS. This had no effects on reserve money, but on the increasein the NFA. The government dinar deposits with the NBS also rose to aconsiderable extent, which in turn resulted in the reduction of reserve money, as theincrease was largely created by transfers of deposits from banks to the NBS.Finally, a decrease in the NDA, as well as in reserve money, partly resulted fromthe reduced NBS credits to the government and other sectors, and lower borrowingsof banks from the NBS. The reduction in credits to the government and othersectors were mainly the result of adjustments applied to such credits after the bookswere finally reconciled for 2003.


30

Taking into account the marginal increase in the dinar reserve money in 2003,the conclusion is that the NBS pursued a very strict monetary policy under thecircumstances of the rising monetary multiplier, in order to accomplish the keyobjectives of monetary policy, primarily in the area of prices and the exchange rate.

BBaallaannccee SShheeeett ooff tthhee NNBBSS (In million dinars)

Dec 2002 Dec 2003 Changes in

2003

NNeett ffoorreeiiggnn aasssseettss 8855,,116600 112255,,334488 4400,,118888

Net foreign reserves 96,487 133,969 37,482

Gross foreign reserves 135,819 193,700 57,881

IMF credits and other short-term liabilities -39,332 -59,731 -20,399

Other net foreign assets -11,327 -8,621 2,706

NNeett ddoommeessttiicc aasssseettss 1166,,774488 -99,,110022 -2255,,885500

Net domestic NBS credits 14,676 -10,315 -24,991

Net claims on government1 9,552 -12,049 -21,601

Credits to government 20,720 19,051 -1,669

Government deposits -11,168 -31,100 -19,932

Dinar deposits -5,009 -12,992 -7,983

Foreign currency deposits -6,159 -18,108 -11,949

Net claims on banks 5,598 3,267 -2,331

Credits to banks 7,147 5,490 -1,657

NBS bills -1,549 -2,223 -674

Credits to other sectors 1,599 244 -1,355

Deposits by banks in liquidation -2,073 -1,777 296

Other net assets 2,072 1,213 -859

RReesseerrvvee mmoonneeyy 110011,,990088 111166,,224466 1144,,333388

Dinar reserve money 69,323 69,996 673

Currency in circulation 43,719 42,979 -740

Bank reserves 25,604 27,017 1,413

Required reserves 11,466 16,212 4,746

Excess reserves 14,466 10,805 -3,333

Other bank deposits 128 930 802

Local government deposits 92 1,313 1,221

Foreign currency bank deposits 32,365 43,362 10,997

Foreign currency required reserves 8,592 9,642 1,050

Other foreign currency bank deposits 23,773 33,720 9,947

Foreign currency deposits, other sectors - 645 645

1 Excluding local government


31

Money Supply M1

The increase in the money supply M1 continued in 2003, though it was muchless intensive than in the previous years with respect to the more moderate growthof money demand. M1 rose by CSD 11,216 million or 11.9% relative to the end of2002, and reached CSD 105,212 million by the end of December or EUR 1,540million at the rate of exchange applicable close to the end of 2003. Deflated by theretail price index, M1 in real terms rose by 3.8% relative to 2002 (40.5%).

The coverage of the money supply by the NBS foreign exchange reserves was184.4% at the end of 2003 and significantly increased in comparison to the end of2002, as the foreign exchange reserves rose more rapidly than M1.

Money Supply (M1)(Cumulative growth rates)

90

95

100

105

110

115

XII I II III IV V VI 2003


90

95

100

105

110

115

Retail prices Money supply (M1) Real money supply

Certain changes were recorded in terms of the money supply composition.Currency in circulation decreased against the increase in the deposit money, withconsequently reduced percentage of currency in circulation within the overallmoney supply, from 46.5% to 40.8% at the end of 2002 and 2003, respectively.

Broken down by sectors, the highest increase by CSD 9,195 million or 28.1%was reported in the real sector, as opposed to the much more moderate growth inother sectors and in households. In terms of available monetary assets, real sectorwas in a relatively better position in 2003.

Money Supply M2

The monetary aggregate M2, which in addition to M1 includes time and otherdinar deposits and securities, increased by CSD 13,663 million or 12.3% in 2003,and reached CSD 124,824 million at the end of the year.

A slightly higher growth rate reported in M2 relative to M1 was the result of amore rapid increase in savings and time dinar deposits with commercial banks.


Money Supply M3

The monetary aggregate M3 stood at CSD 244,811 million at the end of 2003,and increased by CSD 52,213 million or 27,1% compared to December 2002. Aconsiderably higher growth of M3 relative to M2 and M1 resulted from the surgingforeign currency deposits with commercial banks, primarily household foreigncurrency savings, although the increase was partly created by variations in theexchange rate of the dinar. Viewed by sectors, households recorded the highestnominal growth within M3. Monetary assets held by this sector rose by CSD 25,032or 24.8% relative to December 2002, mostly due to the growing new foreigncurrency savings, while the real sector recorded an increase by CSD 24,219 millionor 31.7%.

32

NBS Forex Reserves(Cumulative changes in million U.S. dollars)

-200

200

600

1,000

1,400

1,800

2,200

2,600

3,000

3,400

XII2002

I II III IV V VI2003


-200

200

600

1,000

1,400

1,800

2,200

2,600

3,000

3,400

Forex reserve inflow

Sales in the Interbank foreign exchange market

Forex reserves

Money Supply Coverage by Total Forex Reserves(In million dinars, end of period)

020,00040,00060,00080,000

100,000120,000140,000160,000180,000200,000220,000240,000260,000

XII2002

I II III IV V VI 2003


Money supply Total forex reserves


33

As for the M3 composition, at the end of the year M1 accounted for 43.0%,time dinar deposits for 8.0%, and foreign currency deposits for 49.0%. Thecoverage of M3 by the NBS foreign exchange reserves was reported at 79.2% at theend of 2003 (against 69.8% at the end of 2002).

Money Creation

The increase in the money supply M1 reported in 2003 was mostly influencedby bank corporate and retail lending, government spending of foreign currencydeposits resulting from the privatization process and as for M3, by a high growth ofdeposits with banks. However, based on the information reported in financialstatements it appears that the major portion of the money supply was created as theresult of the increased NFA of the banking sector, primarily the growth of the NBSforeign exchange reserves. On the other hand, if the movements in the moneysupply creation are analyzed in more detail, the conclusion is that the increase in theNBS foreign exchange reserves, with the effects based on the IMF credits excluded,resulted from the growing government foreign currency deposits with the NBS andforeign currency deposits with banks. Movements in the reserve money creationshow that part of the government foreign currency deposits spent by it in 2003, hadan increasing effect on foreign exchange reserves and the money supply, while theother part still held in accounts with the NBS had no effects on the money supply.

Moreover, a high increase in foreign currency deposits with banks resulted inthe growing foreign exchange reserves. If the effects based on changes in thegovernment foreign currency deposits and those held with banks are excluded fromthe NFA, it is apparent that withdrawals were reported as the result of direct foreigntransactions of the banking sector, which may be related to much higherinternational payments associated with relatively high imports compared to theforeign exchange inflow based on exports.

The NDA of the banking sector rose by CSD 14,582 million. The claims ongovernment fell by CSD 10,187 million, as opposed to the increase in bank lending,mostly to corporate and retail borrowers. The reduced net claims on the governmentpartly resulted from the decrease in loans provided to the government, and to alarger extent from growing government deposits with the banking sector. On theother hand, banks bought government bonds based on frozen foreign currencysavings and created money amounting to CSD 3,308 million.

Corporate and retail loans rose by CSD 16,124 million. However, their realgrowth and the resulting money creation were much more extensive, since the loansconsiderably decreased against the reported provisions. As provided by the newChart of Accounts for banks and with the applicable International AccountingStandards, at the end of 2003 banks were required to create provisions for theirloans and investments to the debit of previously allocated provisions underliabilities and, consequently, reported considerably reduced net receivables basedon disbursed loans. The net amount of dinar corporate loans reported by banksincreased by CSD 17,379 million and, with the provisions excluded, the increaseamounted to CSD 29,799 million. In addition to the growth of CSD 12,623 millionreported with retail lending, the real increase in the aggregate dinar corporate and


34

retail lending reached CSD 42,422 million or 48%. Net foreign currency loans fellby CSD 13,951 million, mainly due to considerably higher provisions.

Furthermore, the reported money creation based on other net assets of thebanking sector stood at CSD 5,337 million, but it largely resulted from the reducedprovisions under liabilities to which subsequently allocated loan provisions andmajor losses of banks were charged.

MMoonneettaarryy SSuurrvveeyy (In million dinars)

Dec 2002 Dec 2003 Changes in

2003

NNeett ffoorreeiiggnn aasssseettss 111144,,664422 115522,,227733 3377,,663311

NBS net foreign assets 85,160 125,348 40,188

Bank net foreign assets 29,482 26,925 -2,557

NNeett ddoommeessttiicc aasssseettss ooff bbaannkkiinngg sseeccttoorr 7777,,995566 9922,,553388 1144,,558822

Net domestic credits 151,415 160,660 9,245

Net claims on government -7,761 -17,948 -10,187

Credits to government 23,580 21,846 -1,734

Dinar 22,904 21,726 -1,178

Foreign currency 676 120 -556

Government deposits -31,341 -39,794 -8,453

Dinar -15,508 -17,830 -2,322

Foreign currency -15,833 -21,964 -6,131

Credits to other resident sectors 157,587 173,711 16,124

Credits to other financial organizations 632 392 -240

Credits to real sector 136,421 139,849 3,428

Dinar 71,532 88,911 17,379

Foreign currency 64,889 50,938 -13,951

Credits to households 16,020 28,643 12,623

Credits to local government 593 1,403 810

Credits to other sectors 3,921 3,424 -497

Purchased frozen foreign currency savings bonds 1,589 4,897 3,308

Other net assets -73,459 -68,122 5,337

MMoonneeyy ssuuppppllyy MM33 119922,,559988 224444,,881111 5522,,221133

Money supply M2 111,161 124,824 13,663

Money supply M1 93,996 105,212 11,216

Currency in circulation 43,719 42,979 -740

Transaction deposits 50,277 62,233 11,956

Dinars savings and time deposits 17,165 19,612 2,447

Foreign currency deposits 81,437 119,987 38,550


35

Monetary Policy Instruments

In 2003 the NBS continued the process of improving the mechanisms ofmonetary regulation commenced in 2001. The new Law on the National Bank ofSerbia enacted in July 2003 explicitly restricted the application of direct monetaryregulation methods. Furthermore, the Law does not allow the government andbanks to permanently borrow from the NBS, including the precisely definedrestrictions on short-term borrowing for the purpose of resolving liquidityproblems.

In the course of 2003, the NBS further pursued applying the bank requiredreserve model, whereby the required reserves are calculated against the dinar andforeign currency deposits, in addition to the average daily balance of allocatedreserve maintained in the accounting period. In line with movements in the liquidityof banks, several adjustments were applied to the required reserve ratio in thecourse of the year.

With respect to its commitment to rely on indirect instruments of monetaryregulation in implementing the objectives of monetary policy, at the beginning ofthe last quarter the NBS started trading its bills in independently organized andcompleted auctions using its auction platform - the RTGS technologicalinfrastructure. The new electronic trading system, as expected, made the purchaseof the NBS bills more attractive to banks.

With the decision on credit facilities issued in early 2003, the NBS created anadditional option made available to banks providing for sufficient liquidity in theirpayment transactions performed in compliance with the law. The use of depositfacilities created one more option for banks to employ their excess liquidity.

Credit rating requirements applicable to banks were tightened in 2003, as wellas the sanctions in case of non-compliance. The application of this policy resultedin the improved financial discipline of banks and most of them complied with theminimum credit rating requirements.

With the new Law on Payment Transactions enacted in early 2003, paymentoperations were shifted to commercial banks. The process was effectivelycompleted and the initial difficulties were resolved as they occurred. Banks hadconsiderable liquid assets available in the first months to facilitate paymenttransactions.

In early 2003, in line with the inflation trends, the NBS discount rate had beenreduced from 9.5% to 9% per annum, and remained unchanged until the end of theyear.

Reserve Requirements

In 2003 the NBS pursued an active policy relating to bank required reservesand the ratio was subject to relatively frequent changes, depending on the liquidityof banks. The required reserve model was further applied whereby the calculationis based on the dinar and foreign currency deposits, and the average daily balance


of allocated reserves maintained within the accounting period from the 11th day ofthe current month until the 10th day of the following month.

In the first months of the year, in January and February, the required reserveratio was 20%. However, with respect to the considerably improved liquidity ofbanks, the NBS increased the required reserve ratio from 20% to 23% on 10 March.The measure was aimed at neutralizing the effects of the excess liquidity of banksresulting from significantly increased government deposits. In the meantime, theNBS and the Republic of Serbia agreed on the planned withdrawal of governmentdeposits from banks and their transfer to deposits with the NBS, whichconsequently resulted in a further reduction of the required reserve ratio to 22% on10 April, and to 20% on 10 May.

As in early July the liquidity of banks fell below the average level reported inthe first six months of 2003, for the purpose of improving the banks' liquidity andlending potential, the NBS reduced the required reserve ratio from 20% to 18% andkept it unchanged until the end of the year.

36

With respect to allocated dinar required reserves, there were two distinctiveperiods: January-June when the average required reserves allocated by banks werebelow the calculated level, and July-December when the average allocationsexceeded the calculated required reserves.

In the first six months, due to the liquidity problems faced by some banks, thepercentage of allocated dinar required reserves ranged from 89.3% to 99.8%relative to the calculated level. With the improved liquidity of banks in the secondhalf of the year, the average dinar required reserves allocated by banks exceeded thecalculated level.

On the other hand, banks faced no problem with foreign exchange requiredreserves, and the average allocations on account of foreign exchange requiredreserves were above the calculated level throughout the year (as shown in RequiredReserves above).

RReeqquuiirreedd RReesseerrvveess 1100 JJaannuuaarryy 22000033 - 1100 JJaannuuaarryy 22000044 (In million dinars)

Dinar required reserves Foreign exchange required reserves Accounting

period Base Calculated Allocated average

Difference (3-2)

Base Calculated Allocated average

Difference (7-6)

Difference (8+4)

1 2 3 4 5 6 7 8 9 11/1 � 10/2

80,617.2 16,123.4 14,869.8 -1,253.6 36,883.5 7,376.7 8,528.0 1,151.3 -102.3 11/2 � 10/3

85,777.4 17,155.5 15,722.6 -1,432.9 37,366.2 7,473.2 7,757.7 284.5 -1,148.4 11/3 � 10/4

90,860.4 20,897.9 18,669.2 -2,228.7 38,384.9 8,828.5 8,877.6 49.1 -2,179.6 11/4 � 10/5

83,227.2 18,310.0 17,584.8 -725.2 39,278.7 8,641.3 8,693.3 52.0 -673.2 11/5 � 10/6

83,497.2 16,699.4 16,662.0 -37.4 39,955.3 7,991.1 8,123.7 132.6 95.2 11/6 � 10/7

83,199.2 16,639.8 16,725.9 86.1 40,980.7 8,196.1 8,322.9 126.8 212.9 11/7 - 10/8

81,885.8 14,739.4 14,886.3 146.9 42,694.2 7,685.0 7,809.0 124.0 270.9 11/8 - 10/9

81,183.6 14,613.1 14,733.2 120.1 42,338.5 7,620.9 7,699.2 78.3 198.4 11/9 - 10/10

84,529.7 15,215.3 15,492.8 277.5 43,730.6 7,871.5 7,939.5 68.0 345.5 11/10 - 10/11

86,601.6 15,588.3 15,597.6 9.3. 45,440.1 8,179.2 8,219.8 40.6 49.9 11/11 - 10/12

87,423.4 15,736.2 15,784.5 48.3 50,233.7 9,042.1 9,047.3 5.2 53.5 11/12/2003/- - 10/1/2004 87,011.1 15,662.0 16,389.2 727.2 52,791.3 9,502.4 9,561.8 59.4 786.6


37

In 2004 the NBS intends to modify the required reserve instrument to theeffect that:

• Giro accounts of banks and their required reserve accounts arecombined

Pursuant to the applicable Decision on Required Reserves Held with theNational Bank of Serbia, banks are obliged to have their required reserves allocatedto a special account. With respect to the applied method of average required reserveallocations, and the fact that the funds are available to banks to be freely used withinthe accounting period, depending on the level of their liquidity, it is believed thatthere is no need for dinar required reserves to be kept in special accounts. It is,therefore, planned to have these funds and those maintained on bank giro accountscombined, thus avoiding unnecessary orders for the purpose of transfers fromrequired reserve accounts to giro accounts and vice versa.

The previous obligation to have dinar required reserves allocated to specialaccounts had been provided by the Law on the National Bank of Yugoslavia, whileit was not specified by the new Law on the National Bank of Serbia.

• Foreign exchange required reserves are allocated in the euros and theU.S. dollars

As provided by the Decision, foreign exchange required reserves may beallocated by banks in different currencies. In 2003, the average composition ofallocated foreign exchange reserves was as follows: EUR 56.0%; JPY 25.9%; USD13.8%; and CHF 4.3%.

Calculated and Allocated Dinar and Foreign Exchange Required Reserves from 10 january 2003 do 10 january 2004

(In million dinars)

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

20,000

22,000

11/1 -

- 10/2

11/2 -

- 10/3

11/3 -

- 10/4

11/4 -

- 10/5

11/5 -

- 10/6

11/6 -

- 10/7

11/7 -

- 10/8

11/8 -

- 10/9

11/9 -

- 10/10

11/10 -

- 10/11

11/11 -

- 10/12

11/12 -

- 10/1

Calculated dinar RRs

Average allocated dinar RRs

Calculated foreign exchange RRs

Average allocated foreign exchange RRs

Monetary Policy

38

Annual Report 2002

As revealed by estimates and analyses conducted by the NBS, there is no needto have foreign exchange required reserves allocated in several different currencies.A new decision has consequently been issued for foreign exchange requiredreserves to be allocated only in the euros and the U.S. dollars, with respect to highyields generated by these currencies compared to the Swiss franc and the Japaneseyen.

Credit Facilities

After the new Law on Payment Transactions became effective on 1 January2003, payment operations were taken over by commercial banks. With adequatelymaintained current liquidity being the prerequisite for the normal functioning of thepayment system, by its decision on credit facilities issued at the beginning of theyear the NBS, as an active participant in the payment system, created an additionaloption available to banks for the purpose of providing sufficient liquidity for theirpayment transactions.

Credit facilities are provided through allowed bank account overdrafts, i.e. asort of intraday facilities available to banks within the time needed to complete theirpayment transactions.

Overdrafts are interest-free and any defaults in repayment of used funds aresecured by loans for the purpose of daily liquidity against the pledged NBS bills.

With respect to the relatively adequate liquidity in 2003, loans for the purposeof daily liquidity were used by no more than three banks. The maximum borrowingamounted to CSD 400 million.

The applicable credit facility model is subject to the collateral solely in theform of the NBS bills and it functions as a standard loan approved by the NBS.

The credit facility model is planned to be modified next year to provide for:

• Government bills to be included as collateral

With the government bills included as collateral, the NBS would contribute tothe development of securities market which is one of its priorities, on the one hand,and it would additionally encourage the purchase of the government bills, on theother.

• Less complex proceduresIn order to make the current procedures simpler and reduce the time needed for

all the formal and legal issues relating to collateralized loans, the idea is to use thesecurities trading electronic platform for accepting requests of banks and reduce thetime required to obtain liquid funds.

Deposit Facilities

With deposit facilities applicable throughout 2003, banks could place anyexcess liquidity in deposits with the NBS against the respective interest paid.

These facilities created an additional option for banks to employ any excess

39

liquidity and quite a few (39) banks chose to use the possibility of overnightdeposits with the NBS.

In the period from 1 January - 31 December 2003 the average stock of bankdeposits with the NBS was CSD 3,085.2 million. The lowest average stock ofdeposits was reported in June (CSD 1,614.4 million), and the highest in February(CSD 4,570.9 million).

The planned modifications of deposit facilities involve the transfers made tothe NBS account instead of to a bank's own account with the NBS, which used tobe the practice applied so far. In this manner, the funds deposited by banks wouldbe treated as actual deposits. The new model does not allow the deposited funds tobe freely available as, after the deposits have initially been made by banks, thefunds are reimbursed by the NBS on the following day. According to the previouslyapplicable model, transfers to and withdrawals from special accounts with the NBSwere arranged by banks.

Interest Rates

The monetary policy for 2003 provided for further decrease in interest rates inline with the reduced inflation and the achieved stability of exchange rate of thedinar.

The discount rate, as the NBS reference rate, was set at annual level. In Januaryit had been reduced from 9.5% to 9% p.a. and remained unchanged until the end ofthe year.

Other lending and deposit rates were established relative to the discount rate.

Minimum Credit Rating Requirements

For the purpose of maintaining the financial discipline of banks, in 2003 theNBS continued implementing the Decision on the Minimum Credit RatingRequirements for Banks.


0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

I II III IV V VI VII VIII IX X XI XII

Excess Liquidity Deposits(Average stock in million dinars)


40

The Decision effective as of 1 January 2003 was adjusted to the provisions ofthe Law on the Settlement of Public Debt of the FR of Yugoslavia Arising fromPersonal Foreign Currency Savings and the Law on Payment Transactions. As thepublic debt of the FR of Yugoslavia based on personal foreign currency savings hadbecome the debt of the Republic of Serbia and the Republic of Montenegro, bankswere no longer required to allocate1 15% of the debt resulting from personal foreigncurrency savings and, consequently, any outstanding liabilities of a bank under thepublic debt could not be treated as its non-compliance with the minimum creditrating requirements. Moreover, with payment transactions shifted to banks, bankswere made more responsible for their liquidity and it was no longer necessary toapply the provision whereby a criterion for non-compliance with the minimumcredit rating requirements related to a bank's failure to act upon orders received2 .

Furthermore, in early March one more credit rating requirement was tightened- the average daily balance of the allocated dinar and foreign exchange reserves inthe previous accounting period was set at 100% of the calculated required reserves(previously no less than 80%). However, as the non-allocation of required reserves(equal to the calculated required reserves) was provided by interest policies, theconclusion reached in the very next accounting period was that the strict creditrating requirement might be modified. Therefore, the obligation relating to themaintained average of allocated required reserves was reduced to 90% as of 11April.

According to the Decision on the Minimum Credit Rating Requirements, in theperiod of non-compliance with the minimum credit rating requirements, banks arenot allowed to use any loans from or make any investments with the NBS other thanthose for the purpose of daily liquidity, or to buy the NBS bills in the primary marketor foreign exchange from the NBS, or make any excess liquidity deposits with theNBS. Such rigid sanctions had a positive impact on the financial discipline of banksand most of them complied with the minimum credit rating requirements throughoutthe year.

Continual non-compliance with the credit rating requirements in 2003 mostlyrelated to the banks in the process of rehabilitation, and resulted from overdue debtsto the NBS and the average required reserve allocations below the level provided bythe Decision.

The NBS will continue implementing the Decision in the coming period,including the intended technical adjustments to facilitate its application in practice.

Credits to the Government

To bridge the gap between the revenues and expenditures within the budget ofthe Republic of Serbia, a short-term overdraft facility was made available by theNBS to the budget of the Republic in the period from January to November 2003.The average amount under the short-term credit used by the Republic in 2003 wasabout CSD 2 billion dinars and was duly repaid as agreed.

1These liabilities were replaced by the obligation to issue shares to be held by the member republics.2According to the Decision, the amount of any orders received and not acted upon in the previous daycould not exceed 5% of the aggregate amount of orders issued to the debit of a bank's giro account.


41

As for the payments due to the NBS from the government and other directborrowers, which were associated with servicing problems in the past, the NBScontinued to seek solutions for them to be settled. In this context, the consideredpossibilities of long-term settlement included the payments due from the Republicof Serbia, the FR of Yugoslavia, the Directorate for Commodity Reserves of theRepublic of Serbia, and the Public Enterprise Electric Power Supply of Serbia.

As the long-term settlement was not operationally feasible until the end of2003, the NBS started applying short-term debt postponement. Until 30 June 2004debt postponements included the payments due from the Republic of Serbia basedon short-term securities (CSD 17 billion) and from Electric Power Supply of Serbia(CSD 1.9 billion).

Taking into account the total amount of these debts, their scheduled maturities,the time in which they were created, the modified legal status of some of theborrowers, as well as the servicing problems, the NBS plans to cooperate with therelevant authorities of the Republic in 2004 in preparing the adequate systemicsolutions so that the debts may be settled.

Activities in the Primary Securities Market

Similar to previous years, for the purpose of reducing the excess liquidity ofbanks in 2003, the form in which the NBS basically intervened in the money marketinvolved the auction sale of its own short-term securities - the NBS bills.

In 2003, the NBS organized 231 auctions for its bills where the discountedamount of sold bills reached CSD 33,354.1 million out of the total issued billsamounting to CSD 88,200.0 million. The NBS also issued bills with maturity of 7,15, 30 and 60 days. In addition to regular auctions, a number of special auctionswere organized, particularly in the third and fourth quarters. The effort made byspecial auctions was aimed at reducing the purchase of foreign currency in theInterbank Foreign Exchange Market.

In the period from January to July, the sale of the NBS bills was continuallyfalling, from CSD 2,123.7 million in January to CSD 414.4 million in July. In theperiod from March to July, monthly volumes of the sold bills ranged between CSD414 and 502 million. The lowest amount in the portfolios of banks was reported on16 and 17 July, i.e. no more than CSD 392.9 million, or CSD 1,155.9 million lessthan on 31 December 2002.

Contrary to the first six months, an increase in the sold bills was reported in thesecond half of the year, particularly in the last quarter. The third quarter alreadypointed to the rising volume of sale, from CSD 1,717.9 million in July to CSD4,578.7 million in September. The highest monthly figures in 2003 were reportedin the last quarter. Banks became increasingly interested in bills in October, whenthe sold bills reached CSD 6,671.5 million and, particularly in November, with therecord amount of CSD 6,918.8 million, since the NBS started selling its bills inNovember 2000. With such favorable trends, bills reported in portfolio of banksstood at CSD 4,981.4 million on 7 November which was the highest amountreported in 2003. The sale declined to a certain extent in December (CSD 5,965.6million) relative to October and November, and the balance of bills in portfolios ofbanks was CSD 2,223.3 million on 31 December 2003.


The main factors which influenced the falling sale of bills in the first sixmonths of the year included considerably reduced liquidity in the banking system,as reflected in the statements of giro and excess liquidity accounts of banks, as wellas the fluctuating exchange rate, particularly in the period from March to June.

The increased sale of bills in the second half of the year was contributed to bya number of factors. In order to encourage banks to invest in bills, as they hadapparently become less interested in investing in bills with 30- and 60-day maturity,bills with maturity of 7 and 15 days were introduced in late May and early June.Combined with improved liquidity of banks reported in the same period, thisresulted in the increased monthly volumes of the sold bills.

On 10 October the NBS launched its independent operations in organizing andcompleting auctions for its bills using its own auction platform. Specific features ofthe new sale system were based on the RTGS technological infrastructure of theNBS. In this way, trading and settlement transactions between the NBS and theparticipating banks relating to the sale and purchase of bills were organized andcompleted in a simpler and more efficient manner than the auctions organized onthe Belgrade Stock Exchange (BSE). Furthermore, an important new aspect wasthat a commission to the BSE and brokers (formerly around 0.06% of eachtransaction) was no more payable by banks, which considerably reduced the tradingcosts and increased the yield earned on bills.

The new electronic trading system had a direct effect on increasing the interestof banks in the purchase of bills. Before it was introduced, the average number ofparticipating banks in auctions was four (per each issue of bills), and after 10October the number increased to approximately ten banks per auction. It should alsobe noted that some banks, which had not been involved in auction trading in the firsthalf of 2003, appeared at these auctions for the first time.

Bills were purchased by 25 banks in the course of 2003, while 8 banksaccounted for over 80% of the sold bills.

In 2003 the NBS issued bills with maturities of 7, 15, 30, and 60 days. The highestsale to banks was reported with bills of 7-day maturity (CSD 15,048.6 million or 45% ofthe total amount), and the lowest with bills of 60-day maturity (CSD 3,681.6 million or11% of the total realized amount). This was the reason why the weighted averagematurity of the sold bills fell from 40 days in January to 11 days in December.

42

Volume of Sold NBS Bills (Monthly, in million dinars)

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

I II III IV V VI VII VIII IX X XI XII


43

The weighted average interest rate on the bills sold in 2003 ranged from 9.35%to 14.95% p.a., while the weighted average interest rate3 on the government bills ofthe Republic of Serbia (the first issue in April 2003) ranged between 14.01% and20.83%. The weighted average interest rates on other short-term securities sold onthe BSE in 2003 ranged from 24.52% to 33.65% p.a.

Planned NBS Activities in the Money Market in 2004

Within its planned activities for 2004 involving further improvements in andthe development of open market operations, as from April the NBS has startedorganizing auctions for its bills to be sold in the primary market at the variableinterest rate. The main feature of this type of auction trading relates to the interestrate set in compliance with market criteria, i.e. based on particular offers made bybanks. The NBS also intends to start developing repurchase transactions in order toencourage further development of the repurchase and of the money market, and tostimulate the demand for government securities.

Activities Relating to Frozen Foreign CurrencySavings

The payments resulting from frozen foreign currency personal savingsdeposited with licensed banks and those based on personal foreign currencydeposits with Dafiment banka a.d. Beograd, in liquidation, and Banka privatneprivrede Crne Gore d.d. Podgorica (Jugoskandik) were settled in 2003 in themanner set by the Law on the Settlement of Public Debt of the FR of YugoslaviaArising from Personal Foreign Currency Savings and the Law on the Settlement ofPublic Debt of the FR of Yugoslavia under the Agreements on Personal ForeignCurrency Savings Deposits with Dafiment banka a.d. Beograd in Liquidation andBanka privatne privrede Crne Gore d.d. Podgorica, which became effective on 4July 2002. These laws provided for the schedule of settling payments, fundingsources, parties responsible for settlement, the obligation to have foreign currencysavings converted to bonds, purposes for which such bonds may be used upon andprior to maturity, etc.

Volume of Sold NBS Bills by Maturity in 2003

15 days19%

30 days25%

60 days11%

7 days45%

3The aggregate weighted average interest rate on the bills of the Republic of Serbia with maturities of91 and 182 days was calculated by applying the conform method for the purpose of comparability withthe weighted average interest rates on the NBS bills.


44

Operations relating to the implementation of the two laws were performed bythe NBS on behalf of the Republic of Serbia, as authorized by its Decision, forrecorded payments provided within the budget of the Republic of Serbia, fortransfers to banks for bond payments, and for professional, administrative andtechnical services connected with these payments.

Bond payments were funded by the Republic of Serbia through transfers tospecial accounts with the NBS. Bonds were paid in foreign currency or the dinarcounter-value, as requested by holders, by banks which maintain the accounts ofbond holders on their accounts. Upon requests received from banks, the NBSarranged advance transfers of foreign currency and dinars intended for bondpayments.

Daily reports delivered by banks to the NBS included the information onforeign currency savings converted to bonds of the Republic of Serbia, swappedFRY bonds for those of the Republic of Serbia for the purpose of following-up thedebt of the Republic based on these bonds, as well as the information on bondpayments upon or prior to maturity in order to monitor, supervise and reconcile thepayments made against the transferred funds.

The total accrued conversion of frozen foreign currency savings with banks tobonds of the Republic of Serbia (A 2002-A 2016) amounted to EUR 3,800.00million. Accrued conversion of foreign currency deposits with Dafiment banka andforeign currency funds with Jugoskandik equaled to the actual conversion and stoodat EUR 279.76 million on 31 December 2003.

In the course of 2003, the total amount of EUR 2,219.13 million was convertedto bonds of the Republic of Serbia (A 2002-A 2016).

The conversion to bonds of the Republic of Serbia (series A 2002 and A 2003)stood at the total of EUR 241.8 million on 31 December 2003, i.e.:

− to A 2002 bonds: EUR 78.78 million (frozen foreign currency savings -33.09 million; Dafiment banka - 28.43 million; and Jugoskandik - 17.26 million);

− to A 2003 bonds: EUR 162.4 million (frozen foreign currency savings -119.55 million; Dafiment banka - 27.37 million; and Jugoskandik - 15.48 million).

On 1 January 2003 the funds transferred for bond payments upon maturity andheld by banks, stood at EUR 4.66 million and CSD 9.0 million, while the NBSaccounts showed EUR 5.31 million and CSD 5.98 million. In addition, the amountsfunded from the budget in 2003 were EUR 205.30 million and CSD 9,682.00million. Pursuant to the Decision on Detailed Requirements for the Purchase ofForeign Currency for Payments of Bonds of the Republic of Serbia, the providedfunds were used for the purchase and sale of foreign currency.

In 2003 the total bond payments upon maturity for the series A 2002 and A2003 reached EUR 214.20 million, i.e. EUR 211.13 million in foreign currency andCSD 199.67 million, including:

− bonds of the Republic of Serbia, series A 2002, amounting to EUR 55.97million (frozen foreign currency savings - 16.81 million; Dafiment banka - 21.93million; and Jugoskandik - 17,23 million);

− bonds of the Republic of Serbia, series A 2003, amounting to EUR 158.23million (frozen foreign currency savings -120.99 million; Dafiment banka - 22.44million; and Jugoskandik - 14.80 million).


45

On 1 January 2003 the funds for bond payments prior to maturity intended forspecific expenses, subject to the Decision of the Government of the Republic ofSerbia, and held by banks, stood at CSD 32.14 million, while the NBS accountshowed CSD 50.67 million. The amounts provided from the budget for thesepurposes in 2003 were EUR 1.64 million and CSD 383.11 million. The paymentsfunded from these sources to bond holders amounted to EUR 0.78 million and CSD410.51 million (at discounted value of bonds), i.e. the nominal value of bonds paidfor these purposes was EUR 8.63 million.

For the purpose of implementing Art. 16 of the Law, the amount of CSD205.26 million paid from the budget of the Republic of Serbia to the special accountwith the NBS was transferred to banks in full on the due date (4 July 2003).

Trading in bonds on the BSE was regularly monitored throughout the year. Theoverall volume of trading in bonds of the Republic of Serbia reported from 1January to 31 December reached EUR 153.16 million or 6.9% of the conversion tobonds in the course of the year. These bonds were also traded off board, with thevolume exceeding 2.5 times the volume reported by the stock exchange trading.

47

Annual Report 2003

EXCHANGE RATE OF THE DINARAND FOREIGN CURRENCY RESERVES

EXCHANGE RATE 48FOREIGN EXCHANGE RESERVES MANAGEMENT 49

SOURCES OF FOREIGN RESERVES GROWTH 50STRUCTURE AND PROFITABILITY OF FOREIGN ASSETS AND RISK MANAGEMENT (SITUATION IN 2003 AND PLANS FOR 2004) 51PLANS FOR 2004 52

INTERBANK FOREIGN EXCHANGE MARKET 52TRANSACTIONS AT THE MEETINGS OF THE INTERBANKFOREIGN EXCHANGE MARKET 52

TRANSACTIONS OUTSIDE THE MEETINGS OF THE INTERBANKFOREIGN EXCHANGE MARKET 53EXCHANGE TRANSACTIONS 54EXCHANGE RATE POLICY IN 2004 55

CHANGES IN REGULATIONS GOVERNING FOREIGN EXCHANGE MARKET OPERATIONS IN 2003 56

CHANGES IN THE FOREIGN EXCHANGE REGIME ANDFOREIGN EXCHANGE CONTROL MEASURES 57THE MOST IMPORTANT MEASURES IN THE AREA OF FOREIGNEXCHANGE TRANSACTIONS 57SUPERVISION (RESTRICTIONS) IN THE AREA OF CURRENT ANDCAPITAL TRANSACTIONS 58

PLANS FOR 2004 58

Annual Report 2003Exchange Rate of the Dinar and Foreign Currency Reserves

Exchange Rate

Variations in the exchange rate of the dinar in 2003, within the limits ofmanaged floating, were marked by its highly stable real effective exchange rate anda moderately depreciated nominal effective exchange rate. Changes in the rate offoreign currencies to the dinar in the domestic foreign exchange market were theresult of movements in the supply and demand, as well as of fluctuating values ofthese currencies in international foreign exchange markets.

In December 2003 the real effective rate of the dinar exceeded by 1.9% itslevel in December 2002. However, in 2003 taken as a whole, although the realexchange rate fluctuated to a certain extent both up and down, it remainedunchanged compared to December 2002. Its stability indicates that in 2003 theinternational price competitiveness of local businesses maintained the same level inthe area determined by the external value of national currency.

The nominal effective exchange rate of the dinar was by 3.7% below the levelreported in December 2002. In 2003 the average monthly depreciation of thenominal effective exchange rate was 2.7% (index 97.3) compared to December2002. Its relatively low depreciation accompanied by the stable real effectiveexchange rate shows that the trends towards the convergence between domesticinflation and the inflation reported in industrial countries continued in 2003. Thus,for example, the relative difference between the real and nominal effectiveexchange rate of the dinar, concurrently an indicator of the relative differencebetween the domestic and foreign inflation, in December 2003 was reported at 5.8%(December 2002 = 100), against 11.6% recorded in December 2002 (December2001 = 100).

Parallel to the stable real effective exchange rate of the dinar and its lowernominal depreciation relative to domestic inflation, the reported trends continuallyrevealed the surplus in the country's overall balance of payments and the increasein foreign exchange reserves. It implies that this was one more period in which thepolicy of managed floating exchange rate provided for the country's strengthenedexternal liquidity and maintained price competitiveness of national companies onthe one hand, and for favorable effects on the process of price stabilization in thedomestic market, on the other.

The value of the dinar to the major world currencies varied in line with thechanges in their values in international foreign exchange markets, as well as withthe observed principle of orderly crossed exchange rate of the dinar. Consequently,

48

Annual Report 2002 Exchange Rate of the Dinar and Foreign Currency Reserves

49

when compared to the end of December 2002, the dinar depreciated against theeuro, the Swiss franc, the yen and the pound by 9.95%, 3.38%, 3.32% and 2.41%,respectively, while it appreciated against the U.S. dollar by 7.96%.

DDiinnaarr EExxcchhaannggee RRaatteess iinn 22000033 (End of period)

December 2002

March June September December

Nominal

CSD/EUR 61.52 64.38 64.27 65.96 68.31 CSD/USD 58.98 60.18 56.16 57.56 54.64

Indexes (Base)1

Nominal effective rate

100 96.4 99.0 96.5 96.3

Real effective rate 100 97.0 101.5 100.4 101.9 1Index below 100 implies a depreciation and above 100 an appreciation.

Nominal Dinar Exchange Rates* (December 2002 = 100)

80

85

90

95

100

105

110

XII 2002

I II III IV V VI VII VIII IX XII XII XII 2003

80

85

90

95

100

105

110

Nominal effective exchange rate Real exchange rate

CSD/EUR CSD/USD

*Index below 100 implies a depreciation and above 100 an appreciation of the dinar.

Divergent movements in the value of the dinar to the euro and the U.S. dollarin 2003, which were determined by the surging value of the euro against the U.S.dollar in international foreign exchange markets, were reflected in similarlydivergent movements in the real exchange rate of the dinar to the two currencies. InDecember 2003 the dinar in real terms depreciated to the euro by 4.7% andappreciated by 14.2% to the U.S. dollar compared to December 2002.

Foreign Exchange Reserves Management

Despite the relatively high deficit in the balance of goods and services, and thecurrent account deficit (24.0% and 10.2% of the country's estimated GDP), the rapidgrowth of national foreign exchange reserves reported over the previous two yearscontinued in 2003. Such increase in Serbia's foreign exchange reserves, twice the


one projected at the beginning of 2003, resulted from the high surplus in the overallbalance of payments, i.e. the extensive positive difference between the balance ofpayments based on the country's international credit and financial transactions andthe current account deficit.

Sources of Foreign Exchange Reserves Growth

Foreign exchange reserves of the Republic of Serbia managed by the NBSincreased from USD 2,280.1 million at the end of 2002 to USD 3,550.1 million atthe end of 2003, or by 55.7%.

50

NBS Disposable Forex Reserves

(In million U.S. dollars)

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000



The most significant sources which contributed to the increase included the netinflow from exchange operations (USD 1,370.7 million); proceeds fromprivatization (USD 641.5 million); the inflow from provisional foreign currencypayment transactions in the territory of Serbia and Montenegro (USD 442.5million), the IMF loans (USD 276.1 million), other IFI and EU loans (USD 172.6million), the net inflow from new personal foreign currency savings (USD 143.9million) based on required foreign currency deposits by commercial banks with theNBS equal to 50% of new foreign currency savings, grants (USD 82.9 million), withgrants to the government accounting for USD 44.3 million, and the remaining USD38.6 million relating to other beneficiaries, i.e. the obligation of commercial banksconcerning the sale of foreign exchange inflow from grants subject to the Law onGrants and Humanitarian Aid ("FRY Official Gazette" No. 53/2001).

Foreign exchange outflows mainly consisted of the net outflow resulting fromsold foreign exchange in the foreign exchange market (USD 1,958.2 million),outflows for the repayment of frozen foreign currency savings (USD 242.5 million),and from interest payments (USD 149.3 million).

The comparative analysis of inflows to the foreign exchange reserves based onexchange operations, provisional transactions in the territory of Serbia andMontenegro, and on the net purchase of foreign exchange from the governmentagencies, on the one hand, and the outflows of foreign exchange reserves based onforeign exchange sold by the NBS in the foreign exchange market, on the other,reveals that the buying and selling foreign exchange transactions had a positiveeffect of USD 247.13 million on the foreign exchange reserves which, inter alia,supported the stability of the exchange rate of the dinar in 2003.


51

Structure and Profitability of Foreign Assets and Risk Management(Situation in 2003 and Plans for 2004)

The underlying principles observed by the NBS in managing foreign exchangereserves are safety, liquidity and profitability.

Structure

Foreign exchange reserves in 2003 consisted of deposits in the NBS foreignaccounts, securities, foreign cash, gold, and special drawing rights. The trendsreported in the previous year continued towards the changes in the structure offoreign exchange reserves in favor of securities against foreign cash and deposits inforeign accounts. These changes in the structure of foreign exchange reserves wereaimed at their improved safety and liquidity, as well as the enhanced profitability.

The plans for the second half of 2004 are directed towards a more effectiveprocess of portfolio diversification by introducing new first-class securities(government bonds, IFI bonds, and other highest-rated bonds).

Profitability

In 2003 the NBS earned USD 51.5 million from payments made for couponson securities and interest payable on reserve deposits placed in foreign accounts.The amount exceeded by 37.7% the income reported in 2002.

The interest paid by the NBS on external borrowings amounted to USD 34.4million. Most of the interest payments related to the loans provided by the IMF.

To improve the profitability of foreign exchange reserves, in 2003 foreign cashwas continually deposited in the NBS foreign accounts. The deposit schedule wasadjusted to the schedule of payments, primarily those relating to frozen currencysavings.

Risk Management

Adopted annual and quarterly guidelines define the underlying directions andframework in managing foreign exchange reserves. This is how any possibility oftransacting business with unauthorized banks or unauthorized categories of assetswithin the foreign exchange reserves are excluded, as well as any conflicts ofinterest, exceeded limits, etc. In this context, benchmarks are set relative to theabove parameters (selection of banks, asset, currency and term structure, limits).The respective proposals of the Investment Committee become effective only afterthey have been approved by the Governor and the Monetary Board.

Withdrawals from mixed banks (EuroAxis Bank, Moscow) comply with theadopted withdrawal schedule and will be completed by the end of the year.

The currency structure of foreign exchange reserves correlates to that of theNBS liabilities and the country's foreign trade, as well as to the need for a


diversification of the currency risk. The largest share in the currency structure isabsorbed by the euro which is followed by the U.S. dollar and, to a smaller degree,by other currencies.

Foreign Exchange Reserve Management Department assisted by the RiskManager of the Swiss National Bank, Zurich (within the IMF Technical Mission) isinvolved in the activities relating to the portfolio monitoring and analysis againstthe approved benchmark. The following analyses are used in the regular riskmanagement activities: (a) comparison of portfolio characteristics against theapproved benchmarks, (b) reviewed portfolio life against the benchmark life, (c)risk decomposition (intercurrency relationships, variations in market value ofbonds), (d) VAR - Value at Risk, the potential loss determination method.

Plans for 2004

The plans for 2004 include:

− organizationally separated Middle Office (Risk Management) from FrontOffice (Dealing Room),

− continued moderately increased percentage of the euro within the currencystructure of foreign exchange reserves against the U.S. dollar, with unchanged shareof other currencies,

− continued investment of foreign exchange reserves in the highest qualitybonds of industrial countries.

Interbank Foreign Exchange Market

Transactions at the Meetings of the Interbank ForeignExchange Market

The total volume of transactions in the euro at the meetings of the InterbankForeign Exchange Market (IFEM) reached USD 1,999.8 million, i.e. USD 941.3million in the first six months, and USD 1,058.5 million in the second six months.The lowest level of transactions was reported in June (USD 101.8 million) and thehighest in October (USD 223.8 million). While the IFEM turnover volume wasmore or less balanced in the first and second half of the year, monthly volumes werehighly volatile in both periods. The level of trading reported in October reflected ahigh demand for the euro at the fixing session, as the result of seasonal factors andthe initiated parliamentary crisis in Serbia. The demand and the exchange rates ofthe dinar were stabilized by the interventions of the NBS (selling the euro at fixingsessions), which resulted in the falling turnover of USD 165.0 million in November.

There were practically no foreign exchange trading transactions betweencommercial banks at the IFEM meetings in the course of the year. Some trading wasreported only in the first half of 2003 amounting to USD 3.5 million.

52


53

As provided by the Decision on the Requirements and Procedures in the ForeignExchange Market Operations, one of the criteria to participate in fixing sessions effectiveas of 1 January 2003 relates to the restriction applicable to authorized banks which maybuy and sell foreign exchange, subject to the foreign exchange risk ratio, not exceeding30% of a bank's capital. The requirement was introduced in order to limit the effects ofthe risk resulting from the varying exchange rate on the operation of banks, on the onehand, and to reduce the demand pressure on the foreign exchange market, on the other.

Transactions Outside the Meetings of the InterbankForeign Exchange Market

The year of 2003 saw an exceptional increase in the volume of direct interbanktrading relative to 2002. The reported trading reached USD 900.6 million or 351.0%over the level recorded in 2002. Trading transactions in the first and second half ofthe year stood at USD 367.8 and USD 532.8 million, respectively. The lowest levelwas reported in February (USD 42.8 million) and the highest in December (USD136.6 million).

With respect to the extensive volume of direct interbank trading, its sharerelative to the IFEM turnover volume increased and reached 45%. The percentageof direct trading also rose relative to the volume reported at fixing sessions, andreached 39.1% and 50.3% in the first and second half of the year, respectively,which speaks for the increasing volume of direct interbank trading.

In the same period, high volumes were also reported with direct sale of foreignexchange and currency by banks to the NBS, which reached USD 69.2 million(USD 62.3 million in the first and USD 6.9 million in the second six months). Thisis one more fact supporting the concept of development of direct interbank trading.The highest volume of foreign exchange and currency sold by banks was reportedin June (USD 36.9 million), largely contributed to by the Postal Savings Bank (dueto the compliance with the required foreign exchange risk ratio). On the other hand,the amount directly bought by banks from the NBS reached USD 32.8 million. Theoverall volume of direct trading between banks, and between banks and the NBSoutside the fixing sessions was reported at USD 1,002.6 million.

Transactions in Euros at Fixing Meetings

(In million dollars)

0

50

100

150

200

250




54

Net Purchase of Foreign Cash Through NBS


020406080

100120140160180200



Exchange Transactions

Exchange transactions reported in the first months of 2003 decreased relativeto the end of 2002, mostly due to the shift of payment operations from ZOP tobanks, in addition to the new organization applied in exchange transactions, and thereduced number of the NBS branches. The net purchase figures recorded byexchange transactions in December 2002 were not reached before March.

At its counters and through authorized exchange offices, in 2003 the NBSbought and sold USD 1,694.2 million and USD 337.2 million, respectively, whichresulted in the net purchase of USD 1,357 million (against USD 1,156.1 million in2002). The net purchase stood at USD 560.5 million in the first and at USD 796.5million in the second half of the year.

January saw the lowest level of exchange transactions, i.e. the purchase ofUSD 51.1 million and the sale of USD 5.7 million (net purchase of USD 45.4million). The highest volume was reported in September, with USD 202.8 millionbought and USD 20.9 million sold (net purchase of USD 181.9 million).

Similar to 2002, a high level of purchased foreign currency had a significantstabilizing effect on the exchange rate of the dinar against the euro at the IFEMmeetings, to which the NBS redirected the surpluses of currency bought.

Direct Interbank Trading Outside Fixing Meetings


0

20

40

60

80

100

120

140

160




55

In 2003 a considerable increase was reported in exchange transactions ofbanks, with the following trends recorded in this segment of the foreign exchangemarket:

− in 2003, taken as a whole, banks reported the net sale of USD 147.5 million(USD 620.2 million bought and USD 767.7 million sold),

− in the first half of 2003, banks reported the net purchase of USD 76.1million (USD 284.9 million bought and USD 208.8 million sold),

− in the second half of 2003, banks reported the net sale of USD 223.6 million(USD 335.3 bought and USD 558.9 million sold).

The movements in the second half of the year were, above all, the result of theprivatization process, as well as of the stocks sold by individual holders and offoreign currency bought from banks. It should be noted that the net sale of foreigncurrency reported from September to December did not have any decreasing effecton the foreign exchange potential of banks. Namely, foreign currency bought bystockholders from authorized banks within the process of privatization (stocks werepaid in dinars, subject to the required scheme) was covered by foreign exchangeinflows based on privatization. The holders of stocks had and largely exercised theoption to exchange most of the stocks for foreign currency, although the interestrate on dinar investments was often relatively higher than the interest rate on foreigncurrency investments, when compared to the depreciation of the dinar.

Net Purchase of Foreign Cash Through Commercial Banks


-120

-100

-80

-60

-40

-20

0

20

40

60



Exchange Rate Policy in 2004

In 2004 the exchange rate of the dinar will be set within the limits of managedfloating. The key parameters in establishing the international value of the dinarshould include the supply of and demand for foreign exchange and nationalcurrency, the level of the country's foreign exchange reserves and the differencebetween domestic and foreign inflation.

Regarding the exchange rates to be set by authorized banks, they may be freelyestablished by banks as in 2003, in line with the foreign exchange and currencysupply and demand, with the observed principle of orderly crossed exchange ratesin international markets.


56

In 2004 the NBS will continue to direct the movements in exchange rates byselling the euro at the IFEM fixing sessions, and allow them to fluctuate in line withthe euro supply and demand. By its sale of the euro, however, as well as by itsoverall monetary policy, the NBS will prevent any excessive fluctuations inexchange rates and mitigate any strong supply or demand pressures in the foreignexchange market, which might occur due to the internal or external shocks sufferedby the national economy. It is expected that in 2004, with the high increase inforeign exchange reserves reported in 2003, the NBS will also be capable ofeffective interventions towards the balanced supply of and demand for foreignexchange at the current exchange rate, while eliminating any risks of unfavorableexchange rate fluctuations.

Changes in Regulations Governing Foreign ExchangeMarket Operations in 2003

In early 2003 the Decision on the Requirements and Manner of the NBSInterventions in the Interbank Foreign Exchange Market ceased to be applied. Itwas made ineffective with respect to the fact that the requirements applicable tobanks and their participation in the foreign exchange market, as provided by theDecision, were included in the new Decision on the Requirements and Proceduresin the Foreign Exchange Market Operations.

The new Decision on the Requirements and Procedures in the ForeignExchange Market Operations was passed in March 2003. It governs therequirements and procedures in the foreign exchange market operations, i.e.buy/sell transactions between the participants, the manner of setting exchange ratessubject to the Foreign Exchange Law, etc. The new Decision outlined the additionalrequirements to be complied with by authorized banks in order to take part both inthe IFEM meetings and in direct trading.

Two more decisions were passed in March, the Decision on Foreign Exchangeand Currencies Purchased and Sold by the NBS in the Foreign Exchange Market,and the Decision on Foreign Exchange and Currencies Purchased and Sold in theForeign Exchange Market. The Decisions govern the types of foreign exchange andcurrency traded by the NBS in the foreign exchange market. For the first time, theSlovenian tolar, the Bosnian convertible mark, the Hungarian forint, the Czechkoruna and the Polish zloty were included in the NBS exchange transactions, inaddition to the Slovakian koruna and the Croatian kuna introduced in exchangetransactions of authorized banks and/or banks.

The new Decision on Measures for Maintaining Foreign Exchange Liquidityof Banks to Provide for Payments of Foreign Currency Savings Deposits waspassed in July, in addition to the guidelines for its implementation. According to theDecision, in order to provide for payments of foreign currency savings deposits,banks are required to deposit 50% of such deposits with the NBS, while therequirement for banks in the process of rehabilitation is 100%. Compared to theformerly applied decision, this one contains a provision whereby banks are allowedto make changes in the currency structure of deposits on quarterly basis.


57

Changes in the Foreign Exchange Regime andForeign Exchange Control Measures

The Most Important Measures in the Area of ForeignExchange Transactions

1) In the course of 2003, initiatives were launched by the Ministry of Financeand the Ministry for Economic Relations of the Republic of Serbia for amendmentsto a number of regulations governing the foreign exchange and foreign tradeoperations. The participation of the NBS involved the comments and opinions onthe following amendments and supplements to the Foreign Exchange Law; ForeignTrade Law, Law on Public Debt, Money Laundering Act, and Law on HousingLoan Insurance Corporation.

2) Regular activities were associated with the assignments in supervising thecompliance of international payment orders with applicable regulations and refundorders relating to temporarily seized foreign currency, as well as the followingassignments:

− subject to the regulation governing the requirements for and any manner ofpersonally and physically exported or imported foreign currency, 39 decisions wereissued to authorized banks to export foreign currency for the purpose of fundingtheir foreign accounts,

− subject to the regulation governing the requirements for approvals to begranted to residents to hold foreign currency in foreign accounts, 179 decisionswere issued to residents allowing them to hold foreign currency in foreign accounts,

− subject to the regulation governing export incentives, 19,196 applicationssubmitted by companies and entrepreneurs were approved.

3) Draft by-laws to be enacted by the NBS were prepared subject to the Lawon Securities and Other Financial Instruments Market, i.e.

− Decision on the Requirements for and Manner of Issuing the NBSApprovals for the Issue of Securities Denominated in Foreign Currency;

− Decision on the Requirements for and Manner of Issuing the NBSApprovals for Distribution of Securities of Foreign Legal Entities within theTerritory of the Republic of Serbia;

− Decision on the Requirements for and Manner of Issuing the NBSApprovals for the Issue of Deposit Certificates.


58

Supervision (Restrictions) in the Area of Current andCapital Transactions

The provisions of the Foreign Exchange Law whereby current transactionswere fully and capital transactions partly liberalized, with restrictions in paymentsand transfers based on foreign investment and foreign loans given, as well as onshort-term capital movements, remained unchanged.

Plans for 2004

It is expected that the regulations to be enacted in 2004 will provide for furthergradual liberalization of the country's international capital transactions.

In this context, with respect to already applied liberalization in the area oflong-term capital transactions, the question of liberalization will also be consideredin the area of short-term capital transactions, in cooperation with the relevantinstitutions of the Republic, primarily the Ministry of Finance. Should thiscooperation reveal that further liberalization is necessary in the area of foreignexchange system to allow trading in short-term securities, adequate amendmentsand supplements to that effect will be made to the Foreign Exchange Law, andrespective by-laws enacted.

The cooperation with the Ministry of Finance will also include jointlyconsidered possibilities of amendments to the Foreign Exchange Law and by-laws,in the part referring to the registration procedures applied to credit transactions forinternational payments received against exported goods and services and to advancepayments for goods, in order to simplify these procedures.

Activities will also be initiated for bringing the regulations in the area offoreign exchange operations and international credit transactions in compliancewith the regulations of the World Trade Organization.

59

Annual Report 2003

ISSUE OF BANKNOTES AND COINS

CURRENCY IN CIRCULATION 60DENOMINATION OF CURRENCY IN CIRCULATION 60NEW BANKNOTE AND COIN SERIES IN CIRCULATION 61

COMMEMORATIVE COINS 62DINAR COUNTERFEITS 62NUMISMATIC CABINET 62

Annual Report 2003Issue of Banknotes and Coins

Currency in Circulation

Until the end of 2002, with the Settlement and Payments Bureau (ZOP) stilloperating, currency (banknotes and coins) was supplied from the Central Vault ofthe NBS to its branches, which supplied the ZOP and it on its part supplied theparties involved in payment transactions, banks, post offices, companies,individuals, etc.

Since the beginning of 2003, after the ZOP had been closed and paymentoperations shifted to banks, the supply procedures also changed. Currency is nowsupplied from the Central Vault of the NBS to its 36 branches and offices, whichare responsible for the further supply of currency to banks and other holders ofaccounts with the NBS, to exchange offices, as well as for withdrawing any wornor damaged banknotes. Banks supply with currency their corporate and retail clientsand others. Required currency is delivered to participants in payment transactions,after they have issued orders to banks to debit their accounts.

Denominations of Currency in Circulation

Within the total stock of currency in circulation on 31 December 2003banknotes and coins accounted for 98.6% and 1.4%, respectively, which wassimilar to the structure reported at the end of 2002.

Banknotes in the denomination of 5,000 dinars accounted for 10.0% ofbanknotes in circulation, i.e. less than at the end of 2002 (12.4%).

60

CCuurrrreennccyy iinn CCiirrccuullaattiioonn aass aatt 3311 DDeecceemmbbeerr 22000033 (In million dinars)

Currency produced 133,349

Currency destroyed 10,066

Currency abroad 237

Currency in the NBS vaults 75,328

Currency in bank vaults1 4,739

Currency in circulation 42,979

1 Including cash with the Public Payments Agency of the Ministry of Finance and Economy of Serbia.

Annual Report 2003 Issue of Banknotes and Coins

61

The share of banknotes in the denomination of 1,000 dinars recorded asignificant increase. At the end of 2003 they accounted for 65.0% of banknotes incirculation against 50.7% reported at the end of 2002.

The percentage of banknotes in the denomination of 200 dinars fell from22.0% at the end of 2002 to 15.2% at the end of 2003. A decrease was also recordedby banknotes in denominations of 100 and 50 dinars.

The structure of coins in circulation at the end of 2003 revealed an increasedshare of denominations of 5 and 2 dinars, and a reduced share of denominations of1 dinar and 50 paras.

New Banknote and Coin Series in Circulation

In 2003 the NBS released new banknote and coin series for circulation in thefollowing denominations:

− on March 24 - banknotes in the denomination of 1,000 dinars (signed byGovernor Mladjan Dinkic);

− on July 2 - banknotes in denominations of 100 and 5,000 dinars (signed byGovernor Mladjan Dinkic), and coins in denominations of 1, 2, 5, 10, and 20 dinars;

− on September 15 - banknotes in the denomination of 1,000 dinars (signedby Governor Kori Udovicki).

DDeennoommiinnaattiioonn SSttrruuccttuurree ooff BBaannkknnootteess iinn CCiirrccuullaattiioonn

Denomination Stock on

31 Dec 2001* Stock on

31 Dec 2002 Stock on

31 Dec 2003

In million In % In million In % In million In %

5,000 dinar 0 0.0 5,370 12.4 4,238 10.0 1,000 dinar 11,549 46.1 21,884 50.7 27,545 65.0 200 dinar 7,041 28.1 9,522 22.0 6,441 15.2 100 dinar 3,832 15.3 3,933 9.1 2,670 6.3 50 dinar 2,095 8.3 1,991 4.6 890 2.1 20 dinar 294 1.2 277 0.7 339 0.8 10 dinar 191 0.7 219 0.5 254 0.6 5 dinar 68 0.3 0 0.0 0 0.0 TToottaall:: 2255,,007700 110000..00 4433,,119966 110000..00 4422,,337777 110000..00

*Aggregate data for old and new banknotes.

DDeennoommiinnaattiioonn SSttrruuccttuurree ooff CCooiinnss iinn CCiirrccuullaattiioonn

Denomination Stock on 31 Dec 2001

Stock on 31 Dec 2002

Stock on 31 Dec 2003

In million In % In million In % In million In %

5 dinar 53 21.0 53 21.0 248 41.2 2 dinar 15 5.9 15 5.9 71 11.8 1 dinar 135 53.0 135 53.0 217 36.1 50 para 51 20.1 51 20.1 66 10.9 TToottaall:: 225544 110000..00 225544 110000..00 660022 110000..00

Annual Report 2003Issue of Banknotes and Coins

Commemorative Coins

In the period from 1 January to 31 December 2003 the total proceeds fromthe sale of commemorative coins to individuals and legal entities in the countryreached CSD 4.3 million.

The income covered the costs of metal (gold and silver) amounting to CSD 2.4million, production and sales costs of CSD 1.2 million, and the differencebetween the selling price and the cost equal to CSD 0.7 million related to theamount payable to the budget of the Republic of Serbia.

The NBS presented a proposal to the Government of the Republic of Serbia todesignate the 200th anniversary of the First Serbian Uprising as the historicalevent to be marked by commemorative coins issued by the NBS in 2004.

Dinar Counterfeits

For the purpose of early detection and prevention of dinar counterfeits, theNBS regularly notified the parties involved in payment transactions, the Ministry ofInternal Affairs and the Interpol of newly discovered dinar counterfeits, includingdetailed descriptions of their main features and types. Furthermore, the NBSactivities included education intended for the parties involved in paymenttransactions, catalogues and posters displaying the main characteristics ofbanknotes and security features, as well as the distribution of these materials to itsbranches and offices and to commercial banks.

In the course of 2003, the relevant department processed 1,758 applications foror records of expertise relating to doubtful banknotes.

In the coming period, information on any new types of dinar counterfeitsdiscovered are planned to be made available on the NBS website.

Numismatic Cabinet

Numismatic valuables included in the NBS Numismatic Collection arecurrently processed by the NBS experts and planned to be permanently displayed inthe building at Kralja Petra Street 12. The work is based on reference catalogues,with each piece of money described by way of its distinctive characteristics whichmake it different from other similar pieces (methods complying with the worldstandards in presenting the numismatic material).

62

Respective decisions relating to the main features of banknotes and coins wereprepared and published, as well as those releasing them for circulation.

For the purpose of a more comprehensive denomination structure of banknotesin circulation, the 2004 Banknote Production Program was prepared providing for36,800,000 banknotes in the denomination of 500 dinars in the nominal amount ofCSD 18.4 billion to be produced and put into circulation.

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BALANCE OF PAYMENTS

TRADE BALANCE 65BALANCE ON SERVICES AND TRANSFERS 69CAPITAL AND FINANCIAL TRANSACTIONS ACCOUNT 69PROJECTIONS FOR 2004 70

Annual Report 2003

Annual Report 2003Balance of Payments

According to the preliminary data, the current account deficit reported in 2003was USD 1,928 million and exceeded by 34.4% the level recorded in 2002.

64

BBaallaannccee ooff PPaayymmeennttss ooff SSeerrbbiiaa (In million U.S. dollars)

2002 2003

Trade balance, net -3,539 -4,847 Exports 2,075 2,477 Imports -5,614 -7,324 Services, net 267 289

Receipts 839 1,007 Payments -572 -718

Exports of goods and services 2,914 3,484 Imports of goods and services -6,186 -8,042 Factor transfers, net (interest) -96 -150 Unilateral transfers, net 496 476 Current transfers, net 1,438 2,304 CURRENT TRANSACTIONS -1,434 -1,928 CAPITAL AND FINANCIAL TRANSACTIONS, NET 2,055 2,562 Foreign direct investments 475 1,360 Medium and long-term loans1) 755 1,162 Principal repayment -65 -204 Short-term loans and deposits2), net 158 66 Other capital inflows 876 280 Commercial banks (increase-) -144 -102 ERRORS AND OMISSIONS3) 490 636

OVERALL BALANCE 1,111 1,270 CHANGES IN FOREIGN RESERVES (increase-)1) -1,111 -1,270

Source: National Bank of Serbia (preliminary data) 1) Including IMF loans. 2) Including deferred payments of oil and gas. 3) Apart from standards errors, includes individual merchandise imports, net short-term trade credits (unpaid imports minus unpaid exports) and intercurrency changes.

Annual Report 2003 Balance of Payments

65

The surging current account deficit mostly resulted from the increase in tradedeficit1 and from net outflows for interest payments. To a certain extent, theincreased trade deficit was compensated by net receipts from current transfers andpartly by commercial services.

Main Components of Current Account Transactions in Serbia(In million U.S. dollars)

-1,600

-1,400

-1,200

-1,000

-800

-600

-400

-200

0

200

400

600

800

1,000

I II III IV I II III IV

Trade balance Balance on services

Net factor transfers (interest) Unilateral transfers (grants)

Current transfers Current account balance

2002 2003

Trade Balance

The deficit of USD 4,847 million in Serbia's foreign trade reported in 2003resulted from exports and imports amounting to USD 2,477 million and USD 7,324million, respectively. The increase in trade deficit reached USD 1,308 million or37.0% relative to 2002. In regional terms, the increase was reported in all theregions, mostly with industrial countries, in particular with those within theEuropean Union. The coverage of imports by exports fell from 37.0% to 33.8%.

Exports worth USD 2,477.4 million rose by 19.4% (0.1% translated to euros)relative to 2002, or less than projected, while the growth rate of 30.5% reportedwith imports exceeded the projections by several times.2

1As the imports reported in December partly resulted from the newly introduced Customs Declarationand the changed date for declarations submitted to the Statistics Office from the 6th to the 16th day ofthe month, for the purpose of comparability, a part of imports reported in January 2003 may betransferred to December 2002 whereby the current deficit in 2003 is reduced. 2In December 2002, exports and imports were projected to increase at the rate of 20% and 12%,respectively. It was apparent in the course of the year that these rates were not feasible and by the lastadjustment in October 2003 they were revised to 22.5% (exports) and 25.6% (imports).


The lower nominal growth of merchandise exports compared to projectionswas primarily influenced by the internal structural problems in the export sector, bynon-price related factors, e.g. inadequate quality of exports and marketing; weakstructural policies (favoritism towards industries lacking comparative advantages);unresolved issues in the harmonization of economic systems of Montenegro andSerbia relating to foreign trade policy, customs duties, nontariff protection,subventions, etc.; and the stagnant economic activity in the European Union, thecountry's major trade partner.

Exports from the region of central Serbia stood at USD 1,636.3 million androse by 21.8%, and Vojvodina reported USD 841.1 million or an increase by 14.9%relative to 2002. Export trends varied. In the first part of the year the finishingtreatment and export of sugar to the European Union under preferential terms had amore significant role in export movements (in the first quarter the highest increaseby 41.4% was reported since the suspension of sanctions in late 1995, and in theApril-June period exports rose by 22.6%). The trend recorded in the third and fourthquarter revealed a considerable slowdown in exports (increase by 10.9% and 9.6%relative to the same period of 2002).

The regional structure reflected the highest absolute and relative increase inexports to the transition countries, by USD 1,247 million or 22.8%.

Exports to the industrial western countries rose by one fifth (USD 1,159million), while those to the developing countries fell by 28% and reached no morethan USD 71 million.

66

FFoorreeiiggnn TTrraaddee ooff tthhee SSeerrbbiiaa 1),, JJaannuuaarryy - DDeecceemmbbeerr (In million U.S. dollars)

I-XII

2002 I-XII

2003 Index

EExxppoorrtt 22,,007755..22 22,,447777..44 111199..44

Industrial countries 961.6 1,159.3 120.6

EU 905.4 1,086.4 120.0

EFTA 20.7 20.6 99.5

Developing countries 98.1 70.7 72.1

Transition countries 1,015.5 1,247.4 122.8

IImmppoorrtt 55,,661133..99 77,,332244..00 113300..55

Industrial countries 2,880.4 3,831.3 133.0

EU 2,389.7 3,132.5 131.1

EFTA 121.4 167.2 137.7

Developing countries 352.9 392.3 111.2

Transition countries 2,380.6 3,100.4 130.2

BBaallaannccee -33,,553388..77 -44,,884466..66 113377..00

Industrial countries -1,918.8 -2,672.0 139.3

EU -1,484.0 -2,046.1 137.8

EFTA -100.7 -146.6 145.6

Developing countries -254.8 -321.6 126.2

Transition countries -1,365.1 -1,853.0 135.7

Source: RSO. 1)Excluding the data for Kosovo and Metohija.


67

Broken down by type of products, exported consumer goods rose by 22.4%(from USD 780 to 955 million), intermediate goods by 16.5% (from USD 1,130 to1,317 million), and equipment by 24.5% (from USD 165 to 205 million). Serbia'sincreased exports were mainly in sectors involving chemicals and foodstuffs(primarily fruit and vegetables, meat and meat products), as well as raw materials anddifferent products intended for further processing, partly because the EU marketopened to the sales of these products. However, the approved preferential termscould not be used, mostly due to non-compliance with international qualitystandards, and this caused some exports to be redirected to the transition countries.One of the additional reasons was certainly the lower import demand in the EUcountries, due to the slowed-down economic growth. On the other hand, a limitingfactor in terms of any higher expansion towards the developed markets lied in theexport offer, which mostly consisted of raw materials and products intended forfurther processing. Refining treatment accounted for approximately one fourth of theoverall exports, with a more intensive increase than with usual exports, relative to2002. In addition to the traditionally high percentage of clothing and footwear in thearea of refining treatment, sectors involving coffee, tea and spices, other means oftransportation and equipment and iron and steel, gained in importance in 2003.

Serbia's imports, including the aid in goods, reached USD 7,324 million andrecorded a 30.5% increase (or approximately 9% translated to euros). The lowestgrowth was reported in the third quarter (16%), while the increase in the last quarter(32%) resulted from the high December growth (49%). 3

The reported increase in imports reflected a stronger domestic demand thanexpected, mostly caused by the high foreign capital inflow. The growth in importsalso resulted from a more liberal trade regime and from intensified lending activitiesof banks.

Imports from all the three regions recorded an increase by 33% (USD 3,831million) with the industrial countries, by 30% (USD 3,100 million) with thetransition countries and by 11% (USD 392 million) with the developing countries.

Broken down by type of products, the largest portion of overall imports wasabsorbed by intermediate goods, although its share decreased by 3.6 percentagepoints relative to 2002 and fell to 57% of the total imports, due to the less intensiveschedules. On the other hand, the share recorded with imported equipment rose by1.9 percentage point and reached 22.1%. Consumer goods accounted for 20.9% andtheir share increased by 1.7 percentage point. Car imports dominated in the area ofconsumer durables, which were encouraged by loans and leasing arrangementsprovided by an increasing number of banks.

3It should be noted that the increase in merchandise imports partly resulted from more extensive datacaptured in December 2003, owing respect to the changed reporting date.


68

SSeerrbbiiaa��ss IImmppoorrttss bbyy EEccoonnoommiicc PPuurrppoossee ooff PPrroodduuccttss

In million U.S. dollars Percentage Index

2002 2003 2002 2003

TToottaall 55,,661144 77,,332244 110000..00 110000..00 113300..55

Intermediate goods 3,404 4,172 60.6 57.0 122.6

Investment goods 1,132 1,621 20.2 22.1 143.2

Consumer goods 1,078 1,531 19.2 20.9 142.0

Source: RSO.

The largest portion of imports was absorbed by oil and oil derivatives (US 700million), road vehicles (USD 553 million), textile products (450 million) andmachinery and appliances (approximately USD 700 million).

The increase in imports related to energy sources, transport facilities anddifferent finished products. The structure of energy sources was somewhat changedcompared to 2002, due to the reduced imports of oil derivatives and electric power.Within the imported oil and derivatives, which recorded an increased percentageshare in the overall imports of energy sources to 64.9% or by 2.0 percentage points,crude oil accounted for 58.1% (4.8 percentage points over the previous year), whilethe share of derivatives fell by 2.6 percentage points, down to 5.7% of the totalimports in the area of fuels and lubricants.

With respect to the more intensive rise in prices of derivatives than those ofcrude oil4, the declining imports of derivatives had a positive effect both onexpenditures and on the employment of domestic processing industry.

In 2003 Serbia's major foreign trade partners were Germany, Italy, the RussianFederation, Bosnia and Herzegovina, Macedonia and Slovenia which accounted forhalf of the overall trade. The surplus was recorded with Bosnia and Herzegovina,and Macedonia, while the highest deficit was reported with the Russian Federation,due to oil and gas imports.

The foreign trade results expressed in U.S. dollars should be seen in the contextof the rising value of the euro against the dollar. Had these intercurrency changesnot occurred, the increase in the foreign trade deficit expressed in dollars wouldhave been more moderate. The movements in the rate of the euro to the dollar, i.e.the weakening of the dollar had a net positive effect, due to the fact that it prevailedin outflows rather than in inflows based on international transactions(approximately 15% of foreign exchange merchandise-based inflows were indollars against some 27% on the side of outflows, mostly for payments for oil andgas).

For the purpose of more efficient integration into the world trade, thegovernment pursued a vigorous policy towards the liberalization of foreign trade.Nearly all quantitative restrictions were withdrawn (those still existing will bewithdrawn by the end of 2004) and the import tariffs were rationalized.

4The average Dubai, Brent and WTI price rose from USD 24.9 per barrel in 2002 to USD 28.8 in 2003,or by 15.7% (the euro price fell by 3%).


69

Balance on Services and Transfers

Net revenues from the services sector (USD 298 million) exceed by 8.2% thelevel reported in 2002. The revenues from services (USD 1,007 million) rose by onefifth, which was close to the projected rate. The revenues from transport (USD 306million) remained more or less unchanged relative to the previous year. Thereported revenues from tourism, however, were more than doubled (an increase byUSD 82 million). Capital works earned USD 78 million or 50% more than in 2002.Expenditures had a somewhat higher growth (25.5%) and reached USD 718million. The highest expenditures in the area of services were recorded withtransport (USD 188 million) or 51.6% more than in the previous year. The expensesfor tourist trips (USD 144 million) rose by 37.1% relative to 2002.

Factor transfers (interests) showed a negative balance of USD 150 million or50% over the figure reported in 2002, as the result of the revived debt servicing.

Current transfers (net) largely contributed to the increased foreign currencysupply, as they rose to USD 2,304 million (by 60%). The highest growth wasreported with the inflows from legal net purchases of foreign currency withinexchange operations and those based on incoming international transfers. Foreigncurrency purchased within exchange operations reached USD 1,261 million andincreased by 88%, while the inflow resulting from incoming international transfersand foreign currency held on personal accounts stood at USD 779 million and roseby 48.8%. Net foreign exchange inflow based on internal transactions withMontenegro, and Kosovo and Metohija5 amounted to USD 324 million, or 5.2%over the level reported in 2002. The inflow to non-resident foreign exchangeaccounts increased by 37.5% and stood at USD 348 million.

Unilateral transfers of USD 476 million fell by 4.0% relative to 2002. Nearlyone fourth of the official aid was in cash.

Capital and Financial Transactions Account

The surplus under credit and financial transactions reached USD 2,562 million,and rose by USD 507 million or 24.7%. In the first half of 2003 the surplus underfinancial and capital transactions had been lower than in the same period of theprevious year, while in the July-December period it considerably increased relativeto the second half of 2002, mainly as the result of the growing foreign directinvestments and disbursements under long-term external loans.

Net foreign direct investments were reported at USD 1,360 million (EUR1,190 million) and increased by USD 885 million, as the result of privatization(DIN and DIV, Beopetrol, Apatinska pivara, FGM Kanji`a, other tender and someauction sales, and companies sold through capital market). The inflows based on

5Subject to the Law on Payment Transactions within the FRY enacted in March 2001.


70

6The projected Balance of Payments for 2004 was adopted as the analytical framework for setting theobjectives and targets of monetary policy. The December projections were based on the assumptionthat the GDP growth would be approximately 4% in 2004, with the inflation reduced to 7%, while thenew assumption is - the economic growth of at least 4.5% and the rate of inflation around 8.5%.

foreign direct investments nearly tripled, in spite of slow developments in the areaof the country's constitutional system and the failure to agree on the external debtrescheduling towards commercial banks. Disbursements amounting to USD 1,162million under medium- and long-term loans rose by USD 407 million. With USD842 million, financial loans dominated in medium- and long-term facilities. Loansprovided for equipment nearly doubled and reached USD 268 mullion, with highlyvarying movements in the course of the year. Loans covering intermediate goods(USD 52 million) exceeded by over five times the level reported in 2002.

Net inflow resulting from short-term credit facilities and deposits stood at USD66 million, as the result of deferred payments for imported oil and gas. The largestportion of capital inflow consisted of the estimated amount of new foreign currencysavings resulting from the money hoarded up in the past years, and of part of theforeign currency from internal exchange operations. New foreign currency savingsand exchange operations recorded a lower increase relative to 2002, as theseinflows were overestimated in the previous year, due to the currencies exchangedto the euro. On the side of outflows, liabilities payable on the basis of frozenpersonal foreign currency savings stood at USD 250 million, or USD 126 millionover the level reported in 2002.

Principal repayments amounting to USD 204 million under medium- andlong-term loans increased by more than three times compared to the previous year.

Errors and omissions stood at USD 636 million and exceeded by USD 146million the level reported in 2002. They mostly related to intercurrency changes andunsettled payments for imports under commercial loans based on openeddocumentary credits payable in the coming period, and to part of households'merchandise deficit.

The overall balance of payments, in spite of the rising deficit in the balance ofgoods and services, was positive as the result of the high foreign capital inflow. Theincrease in the net inflow under the financial and capital accounts (foreign financialloans, foreign direct investments, new foreign currency savings and internalexchange operations) covered the current account deficit and contributed to the risein official foreign exchange reserves, two times more than projected. In this wayone of the NBS targets was accomplished, the increase in foreign exchange reservesup to the level providing for the average five-monthly merchandise imports, asprojected for the end of 2005.

Projections for 2004

In order to maintain the monetary stability and build up the competitivecapability of the Serbian economy in 2004, the key objectives in the ProjectedBalance of Payments for 20046 outlined in December 2003, included the growth ofexports by 18% and an 8% increase in imports of goods and services. The net


71

increase in foreign exchange reserves of the banking sectors was projected at USD150 million.

Taking into account the new developments in the macroeconomic environmentin early 2004, as agreed with the IMF during the consultations in April, themonetary policy for 2004 was revised and amended in late May.7

Based on the modified economic policy assumptions in terms ofmacroeconomic trends (primarily the GDP, prices and budget), monetaryprojections and the projected balance of payments were revised. The revisedprojections in the area of the balance of payments include a more rapid increase inexports of goods and services (28%), as well as in their imports (12%). With respectto the projected movements in current transactions, and credit and financialtransactions, a marginal decrease in foreign exchange reserves of the banking sectorwas projected (USD 38 million). The function of foreign exchange reservesmanaged by the NBS will be to support the stability of the exchange rate of thedinar and the liquidity in international payments. A minimum increase in foreignexchange reserves has been projected at USD 50 million.

7Decision on the Determination of the Monetary Policy Program of the National Bank of Serbia in2004, Official Gazette of the Republic of Serbia dated 21 May 2004.

73

Annual Report 2003

EXTERNAL RELATIONS

RELATIONS WITH INTERNATIONAL MONETARY INSTITUTIONSAND THE EUROPEAN UNION 74

INTERNATIONAL MONETARY FUND 74WORLD BANK GROUP 75

RELATIONS WITH THE EUROPEAN UNION 76EUROPEAN INVESTMENT BANK 76BANK FOR INTERNATIONAL SETTLEMENTS 77

RELATIONS WITH THE PARIS CLUB CREDITORS 77RELATIONS WITH THE LONDON CLUB CREDITORS 78BILATERAL COOPERATION 78SUCCESSION TO THE PROPERTY OF THE FORMER SFRY 80EXTERNAL DEBT OF SERBIA IN THE PERIOD FROM 2000 TO 2003 80

Annual Report 2003External Relations

Relations with International Financial Institutionsand the European Union

International Monetary Fund

Since the State Union of Serbia and Montenegro was constituted, the NationalBank of Serbia has been acting as fiscal agent and depositary for the State Uniontowards the International Monetary Fund (IMF), pursuant to the Decision of theCouncil of Ministers dated 15 April 2003 on the fiscal agent and the manner ofrepresenting Serbia and Montenegro in the IMF. By the same Decision, theGovernor of the National Bank of Serbia was appointed the Governor of Serbia andMontenegro in the IMF.

The NBS, as the fiscal agent for Serbia and Montenegro, performs all theoperations relating to financial transactions and to those provided by the IMFStatute while as the depositary it operates the IMF accounts used for transactionspertaining to all the obligations of the State Union towards the IMF.

In accordance with the three-year Extended Fund Facility made available bythe IMF to Serbia and Montenegro on 13 May 2002 for the total of SDR 650million, the disbursements under the facility are subject to satisfactory performancein implementing the agreed economic program and structural reforms.

The effects of the program are followed up on the basis of established three-month performance criteria and indicative restrictions, structural compliancecriteria and key structural measures in the area of privatization, in the fiscal andfinancial sectors. The program implementation and the performance are reviewedevery six months.

The first six-monthly review of the results in implementing the agreedeconomic program was completed in mid April 2003 and approved by the IMFExecutive Board. The positive assessment resulted in the disbursement of SDR 100million to Serbia and Montenegro under the third and fourth tranche. The resultsachieved in the area of macroeconomic stabilization and implemented reforms wereassessed as satisfactory by the IMF Executive Board. The progress was primarilyreflected in the considerably reduced rate of inflation, the strengthened foreignexchange reserves and a continued recovery of production and exports.

In late July the IMF Executive Board completed the second review of theresults in implementing the economic program under the three-year financialarrangement, and approved the fifth and sixth tranche to be withdrawn by Serbiaand Montenegro, equal to SDR 100 million. The review revealed that the economic

74

Annual Report 2003 External Relations

75

situation in Serbia and Montenegro was further improving, with positive objectivesof the economic policy set for the second half of the year and aimed ataccomplishing a low rate of inflation, strengthening the country's foreign position,and enhancing its economic competitiveness. For these objectives to be achieved, itwill be necessary to consistently implement the macroeconomic policy and speedup the pace of structural reforms.

Since the arrangement became effective six tranches have been withdrawn,equal to the total of SDR 300 million. The remaining amount (SDR 350 million)can be disbursed to Serbia and Montenegro until 13 May 2005.

Further disbursements under the approved financial arrangement are subject tothe agreed performance criteria and the completion of the three-year review of theresults in implementing the economic program based on the positive assessment bythe IFM Executive Board.

Regarding the third review to be conducted by the IMF in respect of theimplementation of the economic program, discussions were held between the IMFmission and the delegation of Serbia and Montenegro in late October 2003 with theparticular focus on the budgets of the two republics. The discussions with the IMFmission are expected to continue after the Government of the Republic of Serbia hasbeen formed to agree on the objectives and measures of economic policy in 2004,and the completion of the third review of performance under the three-yearfinancial arrangement.

World Bank Group

In accordance with the Decision of the Council of Ministers in respect of thefiscal agent and representation of the State Union of Serbia and Montenegro in theWorld Bank, the National Bank of Serbia acts as the depositary for the World Bankfunds, withdraws the funds made available to Serbia and Montenegro, and acts asthe paying agent of the State Union in servicing the debts towards the World Bank.

In 2003 the funds disbursed by the World Bank were subject to IDA terms (10-year grace period, 20-year maturity, 0.75% annual fee) under the facility forfinancial support to the structural and sector adjustment amounting to USD 540million in the period from 2002 to 2004.

The Social Sector Adjustment Credit (SOSAC) equal to SDR 60.4 million(approximately USD 89 million) and the second Private and Financial StructuralAdjustment Credit (PFSAC II) equal to SDR 58.7 million (approximately USD 87million) were approved in mid-2003. The credits were scheduled for disbursementin two equal tranches. The first tranche was disbursed after the credit was agreedon, and the second disbursement is expected in the second half of 2004.

Furthermore, the following credits were approved by the World Bank in 2003:for the Privatization and Restructuring of Banks Technical Assistance Project equalto SDR 8.4 million (approximately USD 12.2 million), for the EmploymentPromotion Project equal to approximately SDR 2 million (approximately USD 3million) and for the Health Care Development Project equal to SDR 14.7 million(approximately USD 21.3 million).

Both Serbia and Montenegro finalized their activities on the Poverty ReductionStrategy Paper (PRSP) in late 2003. The strategy involves the implementation of


adequate economic programs, while encouraging the compliance with the EUstandards in foreign trade and other areas and the membership in the WTO.

The outlined Poverty Reduction Strategy in Serbia and Montenegro provides aframework for further measures to be taken and implemented to reduce poverty, andthe paper was expected to be discussed by the World Bank Executive Board in early2004.

As the IDA status of Serbia and Montenegro will expire in 2004, the WorldBank's new Country Assistance Strategy (CAS) is expected to be prepared as anunderlying document for the further financial support to be provided to Serbia andMontenegro in the next three years.

Relations with the European Union

Further disbursements to Serbia and Montenegro were provided in the courseof 2003 under the EU new macrofinancial aid of EUR 130 million, as approved bythe EU Council on 5 November 2002. The aid includes a credit facility amountingto EUR 55 million and a financial grant of EUR 75 million.

With respect to the results achieved in implementing the economic programagreed upon with the IMF, and the fact that the progress had been positivelyassessed by the European Commission, the disbursements to Serbia andMontenegro totaled EUR 105 million (the credit facility of 40 million and the grantof 65 million).

The remaining funds to be approved by the European Union amount to EUR25 million (the credit facility of 15 million and the grant of 10 million). Thesedisbursements within the macroeconomic aid are subject to the quarterlycompliance with quantitative performance criteria and satisfactory performance inrestructuring the areas of finance, banking sector and privatization.

Following the increase by EUR 70 million in the macrofinancial aid to Serbiaand Montenegro approved by the European Union in November 2003, the overallmacrofinancial aid reached EUR 200 million. The aid funds will be used to supportthe balance of payments, subject to the results in implementing the agreed economicprogram, and they should be disbursed up to November 2004.

In 2001 the European Agency for Reconstruction approved a grant of EUR 15million available to the Government of Serbia intended for the SME financing. Lastyear the funds were fully disbursed, while the disbursements from the revolvingfund started in mid 2003.

European Investment Bank

Disbursements to Serbia and Montenegro under the credit facilities approvedby the EIB in 2002 continued in 2003, i.e. for the railway reconstruction; for theCorridor 10 construction; and under the Apex Global Loan for the SME andmunicipal infrastructure projects.

Three new credit facilities to the State Union were approved by the EIB in2003, for support to the development of telecommunications network (EUR 22million), for improvements in the health care infrastructure (EUR 50 million), and

76


77

for reconstruction projects in the City of Belgrade (EUR 90 million). The creditfacility of EUR 70 million to support the power supply system reconstructionagreed upon in August 2002 was ratified in June 2003. There were nodisbursements under these facilities in 2003.

The second credit facility (Apex Global Loan II) of EUR 45 million for thefinancing of SMEs and municipal infrastructure projects is expected to be agreedupon in 2004. In addition, loan agreements are expected to be signed for therehabilitation of the flight control system (EUR 47 million), for the water supplysystem reconstruction (EUR 25 million), and for the Belgrade-Novi Sad highwayconstruction (EUR 120 million).

Bank for International Settlements

After the Constitutional Charter of the State Union had been adopted and,consequently, the State Union of Serbia and Montenegro constituted, with twocentral banks existing in its territory, according to the decision made by the Bankfor International Settlements (BIS) in June 2003, the representation, voting anddisposal rights in respect of the funds of the National Bank of the Federal Republicof Yugoslavia, were temporarily suspended. Full membership and disposal rightswill only be possible after the final agreement has been reached on the distributionof property of the former FR of Yugoslavia.

Relations with the Paris Club Creditors

In 2003 activities for the implementation of signed bilateral agreements with141 member countries of the Paris Club creditors continued, as well as those on thereconciliation of data relating to the debts towards Italy, Japan and Finland for thepurpose of signing the respective bilateral agreements based on the Agreed Minuteon the debt consolidation of the FRY (now Serbia and Montenegro) in respect ofthe Paris Club creditors dated 28 December 2001. The year of 2004 is expected tosee continued negotiations on bilateral agreements to be signed with thesecountries, as well as with Kuwait and other creditor countries not belonging to theParis Club.

The NBS was actively involved in negotiations with representatives of thecreditor countries and was designated as the government agent for external debtservicing towards the Paris Club creditors.

As provided by the Agreed Minute, the first phase for the 51% write-off ofexternal debt was completed with the respective countries under the signed debtrescheduling bilateral agreements. Within the period until March 2005, when the nextphase of the agreed 15% write-off will be implemented after the adequate performanceunder the IMF Extended Arrangement has been positively reviewed, a number ofrequirements should be complied with. One of the requirements, i.e. the servicing ofdebts due under the signed bilateral agreements, is currently fully complied with.

1Bilateral agreements on rescheduling the debt of Serbia and Montenegro were signed withDenmark, Spain, the Netherlands, Austria, Germany, Canada, Norway, Belgium, France, GreatBritain, Switzerland, the U.S.A., Russia and Sweden (initialed).


Relations with the London Club Creditors

In 2003 negotiations continued with the London Club creditors for the purposeof rescheduling the debt of Serbia and Montenegro under the New FinancingAgreement (NFA) and the Trade and Deposit Facility Agreement (TDFA). The debtrelating to this category of creditors is approximately USD 2.6 billion.

The efforts of the delegation of Serbia and Montenegro in negotiations with therepresentatives of the London Club creditors were aimed at the most favorable debtrescheduling terms possible, in respect of the amount to be written off andrepayment terms. The proposals of the London Club creditors were not acceptable,as the State Union would not be capable of servicing the debt under such terms.Furthermore, the acceptance of these proposals would result in the breach of theagreement made with the Paris Club creditors, which includes the undertaking bythe government to request other creditors to agree to the similar debt reschedulingterms.

Although further progress was undoubtedly made in terms of reconciling thedebt records and bringing closer the positions over the debt accountingmethodology, no agreement has been reached yet. Negotiations with the LondonClub creditors are expected to continue in 2004 and hopefully lead to the final debtrescheduling agreement with this significant group of creditors.

Bilateral Cooperation

In 2003 within the cooperation between the NBS and central banks of othercountries, the Governor of the NBY/NBS visited the central banks of Germany,Great Britain and France. The visits were aimed at enhancing the financialcooperation with these countries. The discussions covered Serbia's economic andfinancial position, the restructuring in the banking sector and the privatization ofdomestic banks.

In 2003 significant progress was made in the cooperation between the NBS andthe Chinese banks relating to the implementation of intergovernmental aidagreements, and solutions to outstanding issues within the NBS financialcooperation with these banks.

In June 2003 Belgrade was visited by the delegation of Export-Import Bank ofChina, and this was an opportunity to continue the talks on the settlement of debtunder the financial loan of USD 100 million commenced in 2002. The agreementwas reached, whereby the liabilities under the Loan Agreement signed by theNational Bank of Yugoslavia would be taken over by the NBS.

At the fifth session of the Intergovernmental Commission for Trade andEconomic Cooperation between Serbia and Montenegro and the People's Republicof China, the discussions held at the Export-Import Bank of China includedoutstanding issues relating to the debt towards this bank, particularly the NBSproposals for debt rescheduling the financial loan of USD 100 million underfavorable terms, however no agreement was reached.

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79

Further activities with Exim Bank of China should be pursued in 2004 toproduce a mutually acceptable debt-rescheduling model and sign the respectiveagreement under new favorable terms.

The National Bank of Yugoslavia and the Bank of China had signed theagreement whereby the validity of the short-term interbank investment amountingto USD 100 million was extended until the end of 2003. The NBS asked that theshort-term investment be extended for one more year. The agreement on depositextension until 20 December 2004 with the Bank of China is expected to be signedin 2004.

In 2003 two banking arrangements were signed by the NBS with the Bank ofTokyo - Mitsubishi for the purpose of grants disbursed by the Government of Japan,as follows:

− In April 2003, the grant of JPY 1,392 million (approximately USD 11.6million) for the project supporting the improvements in medical equipment of themajor clinic in the Republic of Serbia;

− In May 2003, relating to the grant of JPY 645 million (approximately USD5.5 million) for the project of rehabilitation of the reversible Hydro Electric PowerPlant Bajina ba{ta (second phase).

The banking arrangement based on the grant of JPY 49 million (approximatelyUSD 0.5 million) to the Faculty of Dramatic Arts for the purchase of audio-visualequipment is expected to be signed with the Bank of Tokyo - Mitsubishi in 2004.The grant will be disbursed in accordance with the Agreement between theGovernment of Japan and the Council of Ministers of Serbia and Montenegro dated3 September 2003.

Following the constructive negotiations involving the NBS representatives, theMemorandum Related to Settlements of Accounts Under the Commodity Exchangebetween the Former USSR and the Former SFRY was signed on 17 September 2003between the Governments of the Russian Federation and the Governments ofBosnia and Herzegovina, Macedonia, Serbia and Montenegro, Slovenia, andCroatia. The Memorandum defined the final balance of settlement between theformer USSR and the former SFRY amounting to 1,291,951,838.77 clearing dollarsin favor of the successor states of the former SFRY. The amount of 490,941,698.73clearing dollars or 38% was allocated to the State Union of Serbia and Montenegro.

The multilateral interbank arrangement for the purpose of implementing theprovisions of the Memorandum is expected to be signed in 2004 between the NBSand the Central Bank of Montenegro (the bank authorized by the Council ofMinisters of Serbia and Montenegro) and Vnjesekonombanka, Moscow.

Negotiations are also expected to continue between the delegations of Serbiaand Montenegro and the Russian Federation including the NBS representatives,which commenced in 2003 and resulted in the framework agreement on the termsto be applied in the settlement of obligations of the former USSR due to Serbia andMontenegro (approximately USD 306 million).


Succession to the Property of the Former SFRY

a) Unblocking of assets of the National Bank of SFRY in the foreign accounts

Foreign assets of the National Bank of the former SFRY frozen in the accountsin the U.S. banks were unblocked by the decision of the U.S. administration in April2003. The amount allocated to Serbia and Montenegro was approximately USD 90million or, according to the Agreement on Succession Issues, 38% of the totalblocked assets.

The Agreement on Succession Issues, signed in Vienna, on 29 June 2001, isexpected to come into force in the first half of 2004 after it has been ratified and theinstruments of ratification deposited by the Republic of Croatia with the depositary- the UN Secretary General. Once the Agreement has become effective, it will bepossible to have frozen foreign assets of the (SFRY) National Bank in the accountswith commercial banks worldwide unblocked (excluding the U.S.A. where theyhave already been unblocked).

b) Activities towards agreements to be reached on outstanding issues inimplementing Annex C of the Agreement on Succession Issues, which commencedin 2003, will continue in 2004 at the meetings of the Committee for the Distributionof Financial Assets and Liabilities of the Former SFRY, including the NBSrepresentatives, for the purpose of determining the balance and distributing thedebit balance in the clearing account SFRY/CSFR; determining the balance, anddistributing the credit and debit balance in the clearing and special accounts of theNational Bank of the SFRY (excluding CSFR), etc.

External Debt of Serbia in the Period from 2000 to 2003

Serbia's external debt at the end of 2000 stood at USD 10,830 million. In theperiod of international economic sanctions and isolation it was not possible toservice any external debts. With the normal and default interest accrued, however,the debt reached 125% of the GDP.

In late 2000 negotiations were initiated relating to the settlement ofoutstanding debt servicing obligations. Obligations were settled towards the IFIsand the governments of the countries belonging to the Paris Club. In December2000, the Emergency Post-Conflict Grant of approximately USD 152 million wasextended to settle overdue payments to the IMF.

The loan of USD 221 million provided by the EC in September 2001 was usedto settle the obligations due to the EIB. As agreed with the EIB, former loans notyet due for repayment were also rescheduled.

The debt towards the IBRD was settled in late 2001. The problem ofoutstanding debt was resolved by refinancing.

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81

According to the Agreed Minute on debt consolidation in respect of the ParisClub member governments signed in December 2001, 51% of the debt was writtenoff in March 2002, and the remaining portion was rescheduled for the period of over22 years.

Subject to the compliance with the requirements under the ExtendedArrangement agreed upon with the IMF, additional 15% of the debt will be writtenoff in March 2005.

In April 2002 the debt to CEB (former EUROFUND) was rescheduled.

Currency Structure of Serbia's External Debt on 31 December 2003

SDR9%

Othercurrencies

1%

USD34%

JPY4%

EUR48%

GBP1%

CHF3%

Out of the total external debt of USD 13,574.5 million on 31 December 2003,approximately USD 5,466 million or close to 40.27% was settled. The outstandingexternal debt stood at USD 5,651 million or 41.63%, while the loans entered intoand disbursed after 20 December 2000 accounted for 18.10%.

The outstanding debt consists of the debt towards the London Club creditors,other governments (China, Libya and Kuwait), the IFC, part of the short-term debtand the clearing debt.

The remaining portion of the outstanding debt relates to the debt notguaranteed by the government, with 520 million due to China and Russia, and owedby public companies under the short-term debt for oil and gas. Negotiations withthese creditors are under way.

Foreign Creditors Share in Serbia's External Debt on 31 December 2003

Governments(Paris Club)

21%

Other governments5%

Commercial banks (London Club)

20%

Other creditors12%

International financial

organizations33%

Clearing1%

Short-term debt8%

Annual Report 2003

The total debt of Serbia on 31 December 2003 stood at USD 13,574.5million, as follows:

I. Long- and medium-term debt of USD 12,336.7 million or 90.88% of thetotal debt, including:

• Debt to IFIs of USD 4,533.5 million or 33.40% of the total debt,

• Debt to government members of the Paris Club creditors of USD 2,808.9million or 20.69% and debt to other governments of USD 620.5 million or 4.57%of the total debt,

• Debt to the London Club creditors of USD 2,737.9 million or 20.17% of thetotal debt, and

• Debt to other creditors of USD 1,636.0 million or 12.05% of the total debt.

II. Short-term debt of USD 1,055.7 million or 7.78% of the total debt.

III. Clearing debt of USD 182.5 million or 1.34% of the total debt.

In Serbia's total external debt amounting to USD 13,574.5 million on 31December 2003, government-guaranteed debt accounted for USD 10,327.9 millionor 76.08%, and non-guaranteed debt for USD 3,154.2 million or 23.24%.

In 2003 the total credit disbursements reached USD 1,162.47 million againstthe repayments of USD 423.23 million, with principal repayments accounting forUSD 203.97 million and interest payments for USD 219.26 million.

The total amount of debt due under the repayment schedule of the Republic ofSerbia for 2004 is USD 885.48 million, i.e. USD 523.21 million for principalrepayments, and USD 362.27 million for interest payments.

Serbia's external debt in the period 2000 - 2003 is given in the table below.

82

External Relations


83

EExxtteerrnnaall DDeebbtt ooff SSeerrbbiiaa BByy CCrreeddiittoorr 1) (In million U.S. dollars) 2)

Creditors 22000000 22000011 22000022 22000033

LLoonngg- aanndd mmeeddiiuumm -tteerrmm ddeebbtt 99,,446688 99,,991166 1100,,002277 1122,,333377

International financial organizations 2,206 2,415 3,356 4,533 IMF 152 272 565 913 IBRD 1,538 1,602 1,893 2,270 IDA 168 273 EUROFIMA 120 122 148 156 IFC3) 106 135 170 239 EIB 256 49 107 195 EU - EC 197 233 325 MIB4) 10 11 EBRD 2 44 131 EUROFUND � CEB 24 24 27 30 Governments and government agencies 4,357 4,344 3,100 3,429 Paris Club 3,887 3,792 2,516 2,809 � Consolidated debt5) 3,872 3,776 2,432 2,659 � Loans entered into after Dec. 20, 2000 14 16 84 150 Other governments 3) 471 552 584 620 China 160 224 241 258 Libya 33 34 36 38 Kuwait 278 294 307 318 Other 7 London Club6) 2,267 2,300 2,442 2,738

Other creditors 637 857 1,129 1,636

SShhoorrtt -tteerrmm ddeebbtt 11,,115533 11,,002266 11,,002200 11,,005566 Oil and gas 490 502 513 520 Other 663 524 508 535

CClleeaarriinngg 3) 220099 118833 118822 118822

TTOOTTAALL DDEEBBTT 1100,,883300 1111,,112255 1111,,223300 1133,,557755

Memorandum items: Kosovo and Metohija 1,215 1,150 1,105 1,322

Source NBS 1) The stock of debt includes the debts of Kosovo and Metohija under the loans entered into prior to the arrival of the KFOR mission. 2) At the exchange rate applicable on December 31 of each respective year. 3) Most of the debt towards these creditors has not been settled and is partly in default. 4) The creditor under this loan is no longer the International Investment Bank, Moscow, but PFHC Establishment, Liechtenstein, and as of 2002, the debt towards this creditor is included under 'Other creditors'. 5) The debt to the Paris Club creditors was consolidated in November 2001 under the agreement to have the write-off and other rescheduling terms applied as of March 22, 2002. 6) Excluding debt repurchased by the NBY and other Yugoslav entities.

85

Annual Report 2003

BANKING SECTOR AND BANKSUPERVISION

BANKING SECTOR 86STRUCTURE OF THE BANKING SYSTEM 86ASSETS AND LIABILITIES OF THE BANKING SECTOR 89

QUALITY OF ASSETS 93RISK RATIOS 94PROFITABILITY 94BANK SUPERVISION 95

BANK SUPERVISION ACTIVITIES 95PRUDENTIAL CONTROL OF BANKS 97DIRECT BANK SUPERVISION 97MEASURES AGAINST BANKS 97CENTRAL CREDIT REGISTRY 98

PLANS FOR 2004 99

Annual Report 2003Banking Sector and Bank Supervision

Banking Sector

Structure of the Banking System

After the banking sector had extensively been restructured in 2001 and 20021,at the end of 2002 there were 50 banks operating in Serbia (including 2 in northernKosovo) of which:

• 12 banks mostly owned by foreign shareholders,

• 15 banks with predominantly private capital,

• 8 banks with predominant holdings by socially-owned companies,

• 11 banks mostly owned by the Republic of Serbia, 3 of them in the

process of rehabilitation,

• 4 banks with considerable state-owned holdings.

In 2003 the reforms in the banking sector were further pursued in severaldirections. One of them involved the continued policy aimed at restrictinggreenfield investment in banking until the privatization procedures relating to state-owned banks have been fully completed. Consequently, no new banking licenseswere issued in this period. In mid-2003 the operating license of Kapital banka a.d.Beograd was revoked, the resolution on winding-up was passed by Dijamant bankaa.d. Zrenjanin, and Poljoprivredna investiciona banka a.d. Novi Sad merged withDelta banka a.d. Beograd.

In the course of 2003 foreign banks and foreign legal entities and individualsbecame majority owners of 4 banks.

At the end of 2003 Serbia's banking sector included 47 banks, i.e.:

• 16 banks mostly owned by foreign shareholders2,

86

1In this period quite a few banks were closed, including some of the country's largest financialinstitutions and a number of new banks were founded, mostly owned by foreign banks, in addition tothe launched ownership restructuring of the banking sector through the conversion of debts resultingfrom loans provided by the Paris Club and London Club creditors, as well as from those based onfrozen foreign currency savings. 2Banks mostly owned by foreign shareholders are: (1) Alpha Bank A.E. Belgrade Affiliate, Beograd;(2) Atlas banka a.d. Beograd; (3) Delta banka a.d. Beograd; (4) EFG Eurobank a.d. Beograd; (5)Eksimbanka a.d. Beograd; (6) HVB banka Jugoslavija a.d. Beograd; (7) Hypo Alpe-Adria-Bank a.d.Beograd; (8) LHB banka a.d. Beograd; (9) Meridian banka a.d. Novi Sad; (10) National Bank ofGreece S.A. - Belgrade Branch; (11) ProCredit banka a.d. Beograd; (12) Raiffesenbank Jugoslavijaa.d. Beograd; (13) Raj banka a.d. Beograd; (14) Société Générale Yugoslav Bank a.d. Beograd; (15)Volksbank a.d. Beograd; (16) Zepter banka a.d. Beograd.

Annual Report 2002 Banking Sector and Bank Supervision

87

• 16 banks with predominantly private capital,

• 15 banks mostly owned by the Republic of Serbia.

In addition, the following financial organizations operated:

• 1 savings organization,

• 8 savings credit organizations,

• 5 savings credit cooperatives.

In 2003 there was an increasing number of banks owned by foreignshareholders.

OOwwnneerrsshhiipp SSttrruuccttuurree ooff tthhee BBaannkkiinngg SSeeccttoorr (Amounts in million dinars, share in %)

Balance sheet amount

Share Capital Share

Domestic banks 226,351 61.6 63,612 73.7 - state-owned 125,477 34.1 32,330 37.5 - private 100,874 27.5 31,282 36.2 Foreign banks 141,135 38.4 22,691 26.3 TToottaall:: 336677,,448866 110000..00 8866,,330033 110000..00

Domestic and Foreign Banks' Share in the Overall Capital of the

Banking Sector

Domestic Banks74%

Foreign Banks26%

Ownership Structure of Domestic Banks

State51%

Private49%


According to the aggregate data from reclassified balance sheets for the yearup to 31 December 2003, the aggregate balance sheet reported by all the banksstood at CSD 367,486. Consequently, the aggregate balance sheet of the bankingsector increased by nearly CSD 51 billion, or 16.1%.

88

Domestic and Foreign Banks' Share in the Balance Sheet Amount of

the Banking Sector

Domestic Banks62%

Foreign Banks38%

BBaallaannccee SShheeeett AAmmoouunnttss iinn 22000022 aanndd 22000033 (In million dinars)

31 Dec 20021) 31 Dec 20032)

Total balance sheet amount 331166,,557788 336677,,448866

1)Excluding the data for Jugobanka a.d. Kosovska Mitrovica. 2) Excluding the data for two banks whose operating licenses were revoked in 2003, and the data for Borska banka a.d. Bor for which the decision on initiating bankruptcy proceedings was issued in early 2004.

In terms of balance sheet, the structure of the banking sector shows that themajority of banks belonged to the medium size group with the balance sheet rangingfrom CSD 1,000 to 5,000 million, along with continued declining trends in thenumber of the smallest banks which were halved in 2003, both in terms of thenumber and of the balance sheet.

BBaannkkss bbyy tthhee BBaallaannccee SShheeeett AAmmoouunntt iinn 22000022 aanndd 22000033 (In million dinars)

31 Dec 2002 31 Dec 2003

Balance sheet amount Number of banks

Balance sheet amount

Number of banks Balance sheet

amount

Above 10,000 7 168,929 8 212,427

From 5,000 to 10,000 10 79,089 14 102,835

From 1,000 to 5,000 26 65,032 22 50,569

Below 1,000 6 3,528 3 1,655

TToottaall 4499 331166,,557788 4477 336677,,448866


89

0

5

10

15

20

25

30

Below 1,000 1,000-5,000 5,000-10,000 Above 10,000

Number of Banks by Balance Sheet Amount in 2002 and 2003

2002 2003

Assets and Liabilities of the Banking Sector

International Accounting Standards (IAS) and the related Rules on the Chart ofAccounts and Content of Accounts within the Chart for Banks and Other FinancialOrganizations, as well as the Rules on the Format and Content of Positions in theForms of Financial Statements for Banks and Other Financial Organizations,required that the statutory reports provided by banks to the Bank SupervisionDepartment be adequately revised and applied as of the annual account for 2003.

Liabilities

On 31 December 2003 liabilities aggregately reported by banks were as shownin the table below:

BBaannkk LLiiaabbiilliittiieess (In million dinars, share in %)

31 Dec 2003

Amount %

Liabilities to banks 39,556 10.8 Liabilities to clients 22,299 60.8 Interest and fees payable 415 0.1 Liabilities for securities 512 0.1 Liabilities from profits 85 0.0 Other operating liabilities 7,416 2.0 Deferred negative goodwill 0 0.0 Loan loss reserves 6,209 1.7 Other liabilities and accruals 3,688 1.0 Deferred tax liabilities 3 0.0 TToottaall lliiaabbiilliittiieess 228811,,118833 7766..55 Capital 86,303 23.5

TToottaall lliiaabbiilliittiieess aanndd ccaappiittaall 336677,,448866 110000..00


Within the aggregate liabilities of CSD 367,486 million the largest portion wasabsorbed by liabilities to clients (60.8%), which were followed by capital (23.5%),and by liabilities to banks (10.8%). These were the only significant positions inliabilities of the banking sector aggregately accounting for 95.1%.

The aggregate deposits reported by banks amounted to CSD 222,948 millionor 60.7% of the total liabilities. The increase in deposit base by CSD 49,453 millionor 28.5% primarily resulted from the growing demand deposits (by CSD 27.6billion) including a 48% increase in short-term deposits, while the long-termdeposits were doubled.

90

0

10

20

30

40

50

60

70

%

Liabilitiesto clients

Capital Liabilitiesto banks

Otheroperatingliabilities

Loan lossreserves

Otherliabilities

andaccruals

Other

Structure of Commercial Banks' Liabilities in 2003

BBaannkk CCaappiittaall SSttrruuccttuurree (In million dinars)

CAPITAL 31 December 2002 31 December 2003

Equity capital 79,447 89,055 Issue premium 126 127 Revaluation reserves 16,917 893 Reserves set aside from profit 4,913 5,351 Profit 931 7,257

Own shares 162 7 LLoossss 38,583 16,373

TToottaall 6633,,558877 8866,,330033

The capital of the banking sector on 31 December 2003 stood at CSD 86,303

million and accounted for 23.5% of liabilities. The reported increase was CSD22,716 million or 35.7%. relative to 31 December 2002.

At the end of 2003 the second round of debt conversion was ordered under theliabilities toward the Paris Club creditors (interest - normal, moratorium anddefault, as well as the transfer of liabilities from off-balance items to balance sheet)amounting to CSD 15.1 billion. Banks were required to pass the resolution within30 days whereby these liabilities would be transferred to their capital. The effectsof the second round of conversion on the changed ownership of the banking sector,particularly the government holdings, were reflected in the increased aggregateshare capital of the banking sector.


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Assets

Assets reported by banks aggregately as at 31 December 2003 included thefollowing:

BBaannkk AAsssseettss SSttrruuccttuurree (In million dinars, share in %)

31 December 2003

Amount Share

Cash and cash equivalents 40,555 11.1 Deposits and securities refinanceable with central bank 31,134 8.5 Interest and fees receivable 1,836 0.5 Loans to and investments in banks 48,191 13.1 Loans to and investments in clients 194,295 52.9 Securities and other trading investments 1,180 0.3 Securities held to maturity 7,759 2.1 Equity shares and other securities available for sale 5,558 1.5 Intangible investments 1,121 0.3 Fixed assets 25,738 7.0 Other assets and prepayments 10,048 2.7 Deferred tax assets 71 0.0

Total assets 367,486 100.0

0

10

20

30

40

50

60

Currency in

circulation

Deposits with

the NBS

Loans to and

investments

in banks

Loans to and

investments

in clients

Fixed assets Other assets

and

prepayments

Other

Structure of Commercial Banks' Assets in 2003%

Within the aggregate assets reported by the reviewed banks, the largest portionwas absorbed by loans to clients (52.9%), followed by loans to and investments inbanks3 (13.1%), and cash and cash equivalents (11.1%).

Loans to banks and clients included CSD 133,277 million of short-term loansand other financial investments, CSD 76,335 million of long-term loans and otherinvestments and CSD 32,874 million of foreign currency savings deposited with theNBS. In accordance with the IAS, and amended Chart of Account and balance sheet

3According to the new Chart of Account for banks and new balance sheet formats, loans to andinvestments in banks include CSD 32,874 million of foreign currency savings deposited by banks withthe NBS for the purpose of maintaining foreign exchange liquidity to provide for withdrawals offoreign currency savings deposits.


formats, the amounts of short-term loans and other financial investments, as well asof long-term loans and other investments, reported in this manner, included bothspecific and general provisions for identified loan losses, which stood at CSD31,944 million on 31 December 2003 (the total covering loans to banks and clients).

Off-Balance Sheet Positions

According to the aggregate data from reclassified balance sheets on 31December 2003, the aggregate off-balance sheet positions reported by all the banksstood at CSD 378,665 million, and increased by CSD 175,336 million or 86.2%relative to 31 December 2002.

92

AAggggrreeggaattee OOffff -BBaallaannccee SShheeeett PPoossiittiioonnss iinn 22000022 �� 22000033 (In million dinars)

31 Dec 2002 31 Dec 2003

TToottaall ooffff -bbaallaannccee sshheeeett ppoossiittiioonnss 220033,,332299 337788,,666655

The structure of off-balance sheet positions reported by the banking sectorshows that the majority of banks (more than half) belonged to the group with off-balance sheet positions ranging from CSD 1,000 to 10,000 million, but also that onebank accounted for one third of the aggregate off-balance sheet positions of thebanking sector.

BBaannkkss bbyy OOffff -BBaallaannccee SShheeeett PPoossiittiioonnss (In million dinars) 31 Dec 2003

Number of banks Off-balance sheet positions

Above 100,000 1 114,827 From 50,000 to 100,000 1 56,546 From 10,000 to 50,000 4 94,983 From 1,000 to 10,000 24 103,005 Below 1,000 17 9,304 TToottaall 4477 337788,,666655

In 2003 it happened for the first time that balance sheet positions wereexceeded by off-balance sheet items, mainly as the result of CSD 228,281 million(60.3%) relating to frozen foreign currency savings bonds reported under off-balance sheet positions.

Foreign Exchange Position

The aggregate foreign exchange and dinar positions based on reclassifiedbalance sheets reported by banks show that foreign exchange liabilities exceededforeign exchange assets by 5.1% on 31 December 2003.


93

Quality of Assets

The IAS conversion applicable to annual accounts for 2003 required banks torecognize in a different manner their specific provisions against potential lossesunder assets and off-balance sheet positions of a certain degree of recoverability.Provisions created for identified losses (for receivables classified in categories B,C, D, and E) are charged to expenses and recognized as indirectly written-off loansand investments under balance sheet assets (general provisions) and loss provisionsunder off-balance sheet positions. Provisions for unidentified losses (receivablesclassified in category A) under balance sheet and off-balance sheet positions arecreated from retained earnings and recognized within reserves from profit.

The structure of risk-weighted assets of the banking sector in terms ofclassification by degree of collectibility, as reported on 31 December 2003, is givenin the table below:

Bad assets (assets classified in categories C, D, and E) stood at CSD 54,783million and increased by CSD 5,622 million or 11.4% in absolute terms relative to31 December 2002. The percentage of bad assets in the total balance sheet assetsand off-balance sheet positions fell from 9.5% in 2002 to 7.3% at the end of 2003.The ratio of potential losses to capital decreased from 51.4% to 42.2%.

In 2003 potential losses of the banking sector rose by CSD 2,593 million or8.1% relative to 2002.

BBaannkkss�� FFoorreeiiggnn EExxcchhaannggee BBaallaannccee SShheeeett

(Amounts in million dinars, share in %) 31 December 2002 31 December 2003

LLIIAABBIILLIITTIIEESS Forex balance sheet 132,477 174,504

Share in liabilities 41.8 47.5

AASSSSEETTSS

Forex balance sheet 159,891 166,054

Share in assets 50.5 45.2

CCllaassssiiffiiccaattiioonn ooff BBaannkk AAsssseettss (In million dinars)

31 December 2002 31 December 2003

Classified assets Classified assets CCaatteeggoorryy Allocation

In % Amount Share

Specific provisions

Amount Share Specific

provisions

A 2% 127,886 63.2% 2,558 159,322 63.3% 3,186 B 5% 25,336 12.5% 1,267 37,536 14.9% 1,877 C 25% 10,218 5.1% 2,555 20,935 8.3% 5,234 D 50% 26,739 13.2% 13,370 19,197 7.7% 9,599 E 100% 12,204 6.0% 12,204 14,651 5.8% 14,651

TToottaall 202,383 100% 31,952 251,641 100% 34,547


Risk Ratios

On 31 December 2003 majority of banks complied with the required ratiosrelating to capital adequacy, large and largest permissible credits and investmentsin capital assets.

94

RReellaattiivvee OOppeerraattiinngg IInnddiiccaattoorrss 11)) (In %)

31 December 2003 Number of non-complying banks

Capital adequacy ratio (min. 8%) 31.3% 1 Ratio of large and the largest permissible credits (max. 400%) 132.9% 1 Ratio of investment into fixed assets (max. 60%) 33.6% 4 Liquidity ratio 2.45 1 Foreign exchange risk ratio 14.4% 3 1)Excluding the data for Borska banka a.d. Bor.

BBaannkk FFiinnaanncciiaall RReessuullttss iinn 22000022 aanndd 22000033 (In million dinars)


Amount

Number of banks

Amount Number of

banks

1. Profit 910 26 6,105 34 2. Loss 28,318 23 7,105 13

FFiinnaanncciiaall rreessuulltt ((11 -22)) -2277,,440088 4499 -11,,009900 4477

The above ratio requirements were fully complied with by 37 banks. Thefailure to comply with the required performance ratios was reported by 6 banks (inrespect of 1 ratio), 2 banks (in respect of 2 ratios), and 1 bank in rehabilitation (inrespect of 4 ratios).

The obligation to provide for the required minimum amount of monetaryportion of share capital equal to the dinar equivalent of EUR 10 million until 31December 2003 was not complied with by 4 banks, 1 of them being in the processof rehabilitation.

Profitability

In the period from 1 January to 31 December 2003 banks reported a negativeaggregate financial result of CSD 1,090 million expressed as a net amount (totalprofit minus total losses).


95

The loss reported with 2 banks accounted for approximately 62% of theaggregate loss in the banking sector, and the profit of 2 banks which reported thehighest profit in 2003 absorbed approximately 48% of the aggregate profit recordedby the banking sector.

Nearly half of the total income and expenses in the banking sector related togain and loss through the rate of exchange, interest income accounted for one fifthof the total income and one fourth of the total expenses related to other operatingexpenses (mostly operating costs).

Bank Supervision

Bank Supervision Activities

The NBS supervision function provides for the country's financially sound andstable banking system, capable of protecting the interests of depositors, meeting theneeds of retail and corporate clients, and encouraging a further development of theeconomy. The bank supervision system continued to develop in 2003. Activitieswere pursued towards a further compliance with the Core Principles for EffectiveBanking Supervision, as defined by the Basle Committee on Banking Supervision.Consequently, the focus of supervision shifted from legal requirements in operationof banks to the risks banks are exposed to and to risk management, as well as to thetimely corrective measures taken towards building up adequate risk managementsystems in banks, maintaining the stability of the financial system and strengtheningthe public trust in such system.

With the IAS published and applied to the annual accounts for 2003, inaddition to the newly issued Chart of Accounts for Banks and Other FinancialOrganizations and the effective Rules on the Format and Content of Positions in theForms of Financial Statements for Banks and Other Financial Organizations, it wasalso necessary to modify other related regulations in the area of supervision, i.e.:

23 26

13

34

0

5

10

15

20

25

30

35

2002 2003

Number of Banks with Profit/Loss in 2002 and 2003

Banks with loss Banks with profit


− Decision on Detailed Requirements in Implementing Articles 26 and 27 ofthe Law on Banks and Other Financial Organizations,

− Decision on Criteria for Classification of Balance Sheet Assets and Off-balance Sheet Items According to the Level of Collectibility and SpecificProvisions of Banks and Other Financial Organizations,

− Decision on the Manner of Implementing Articles 8, 9, 10a, 12, 15, 19b,19e, 28, 29, and 59 of the Law on Banks and Other Financial Organizations and

− Reporting Guidelines for Banks and Other Financial Organizations.

The new regulations are aimed not only at improvements towards theharmonization with the recommendations of the Basle Committee, the EUdirectives and the IAS, but they also provide for:

− taking a preventive approach in banking supervision rather thansubsequently mitigating the consequences,

− creating the background for safer operation of banks and for a minimizedcredit risk,

− identifying actual ownership, with clearly defined management structuresin banks,

− minimizing any possibilities of fictitious increase in capital throughfacilities extended to shareholders and

− more effective supervision of borrowing by related parties.

The system of early warning in respect of any changes in risks associated withbank operations was improved and further developed by adjusting and reorganizingthe database relating to each bank and the entire banking system to function onquarterly, monthly and, for a number of ratios, on daily basis. The electronic bankreporting project has also reached its final stage, which will allow all requiredreports and statements, regularly or as needed, to be generated from the newlycreated database.

The intensified banking supervision in 2003 included activities in creating thebank rating system by applying CAMEL and CAEL criteria (based on the type andextent of assumed risks associated with capital adequacy, asset quality, earningsand liquidity).

One more project was designed and implemented relating to the specified dailyinformation used in following up dinar and foreign exchange liquidity ratios ofbanks based on their daily reports provided to the Monetary Department, and theForeign Exchange and International Relations Department.

In 2003 the Bank Supervision Department was involved in preparing thematerials for the discussions with the IMF mission (on the activities implementedin the area of supervision, credit activities of the banking sector, performance andcapital adequacy ratios, effects of debt conversion under the liabilities to the ParisClub and London Club creditors, insolvent banks subject to the administration ofthe Agency for Deposit Insurance, Bank Rehabilitation, Bankruptcy andLiquidation), as well as with the World Bank mission (Development Plan of theSupervision Function of the National Bank of Serbia).

96


97

Prudential Control of Banks

Off-site supervision of banks in 2003 was directed towards following up andreviewing the compliance with the performance ratio requirements and otherstatutory obligations of banks, and also towards the initiated development ofmethods for the assessment of risks assumed by banks.

The reviews were based on analyzed information provided by banks to theNBS, primarily on:

− detailed quarterly reports (reclassified balance sheet, reclassified incomestatement, asset classification, performance ratios, statements of major shareholdersand depositors, credits broken down by industry and sector, etc.),

− monthly reports on cash flows, liquidity risk, and foreign exchange risk,

− documentation supporting the requests for approval to acquire bank votingshares equal to or exceeding 15% of a bank's share capital and/or the approvals toacquire a bank's own shares,

− auditors' reports in respect of annual financial statements of banks.

Activities close to the end of 2003 included the work on regulations and newreporting forms to be used by banks.

Important activities in the area of prudential control of banks related to theassessment of adequate conditions to approve the acquisition of a substantialpackage of banks' shares (voting shares equal to or exceeding 15% of a bank's sharecapital), particularly in cases where the requests involved the majority shareholdingpackage to be sold to a new shareholder.

Direct Bank Supervision

On-site supervision included 19 banks and 5 other financial organizations in2003, i.e.:

− in 9 banks and 5 other financial organizations, comprehensive review ofsolvency and legal compliance,

− in 8 banks, compliance review in respect of the Law on PaymentTransactions,

− in 2 banks, compliance review in respect of the NBS orders.

In 2003 an adequate background was also created in the area of direct banksupervision towards further focusing on risks to which banks are exposed in theiroperations. This primarily involved operating risks which asked for regular contactsto be established with the management of banks.

Measures against Banks

Orders issued and measures taken by the NBS in 2003 included 9 banks. Theseorders related to the compliance with different provisions of the Law on Banks andOther Financial Organizations, as well as with other regulations, and in some caseswith enactments of banks. Most of the orders referred to:


− classification of assets as required by the respective regulations (4 cases),

− compliance of operations with Articles 26 and 27 of the Law on Banks andOther Financial Organizations (6 cases),

− compliance with other provisions of the Law on Banks and Other FinancialOrganizations (2 cases) and

− implementation of other regulations or enactments of banks (4 cases).

To a larger extent than in the past, the measures taken in 2003 focused oneliminating the causes of non-complying operation of banks, taking into account thenecessity to interfere with their normal operations to the least possible extent and toencourage personal responsibility for any identified failures.

By the NBS decisions the operating license was revoked from and liquidationproceedings instituted against one bank, as the supervision of its operationsrevealed its failure to comply with a number of statutory regulations.

The General Meeting of one bank passed a winding-up resolution.

Following the requests submitted by banks, the NBS issued the followingapprovals in 2003:

− 36 decisions approving the amendments and supplements to thememorandum of association and/or articles of association of banks and otherfinancial organizations,

− 12 decisions approving the changes in the name and the place of businessof banks,

− 9 decisions approving the acquisition of voting shares in banks exceeding15%, and

− 6 decisions approving the trading operations to be performed by banks infinancial markets.

The adoption of the new Law on the National Bank of Serbia and the LawAmending and Supplementing to the Law on Banks and Other FinancialOrganizations, was followed by the new Decision on Detailed Requirements andManner of Conducting the Supervising Function of the National Bank of Serbia.

Central Credit Registry

The data reported by banks and other financial organizations to the CreditRegistry Department include their accounts receivable (balance sheet, off-balancesheet, short- and long-term, etc.) due from borrowers and/or a group of associatedborrowers aggregately amounting to at least CSD 5,000,000, excluding those basedon equity shares and participating interests in corporate entities.

In addition, daily reports provided by the BSE include the information onsecurities broken down by corporate issuers, amounts of issued and sold securities,and/or their obligations resulting from issued and sold securities.

98


99

Plans for 2004

Activities in 2004 will be aimed at:

− intensified on-site supervision of banks, particularly those with the mostapparent risks,

− comprehensive measures taken in the so-called sector of other financialorganizations (savings organizations, savings and credit organizations, and savingsand credit cooperatives), for the purpose of their consolidation4,

− improved transparency of ownership in the banking sector, for the purposeof clearly identified actual ownership of banks,

− adequately implemented new regulations in the area of supervision, as wellas the application of the IAS and new Chart of Accounts for banks and otherfinancial organizations,

− fully implemented CAMEL bank rating system, in addition to the designedsystem of early warning to ensure timely response to identified risks in the bankingsector,

− upgraded human and technical resources, primarily by newly recruitedstaff, their education and training, and

− improvements in the NBS website in the area dealing with the supervisingfunction, especially in terms of accessible information on the banking sector and onparticular banks.

4In early 2004, these activities resulted in revoked operating licenses of three savings and creditcooperatives.

101

Annual Report 2003

PAYMENT OPERATIONS

PAYMENT SYSTEM OPERATION IN 2003 102

Annual Report 2003Payment Operations

Payment System Operation in 2003

In early January 2003 one of the country's most extensive financial projectswas completed - the shift of payment transactions from the Clearing and SettlementBureau (ZOP) to commercial banks, and the launched operation of the RTGS andclearing system of the National Bank of Serbia. The implementation of similarprojects in the world usually takes more than two years, while the preparations inSerbia lasted no more than five months without any major problems in the area offinancial activity. The NBS was highly appraised for the work done, primarily bythe IMF. The IMF report in May 2003 included, inter alia, the following: "The shiftof payment operations from the ZOP to commercial banks in January marked animportant milestone in the financial development of Serbia"� "The infrastructurefor the NBS services is now comparable to the best of other central banks inEurope"� "The single day conversion to a modern payment system was remarkablein that it was achieved in just a few months"� "The shift of payment operationsfrom the ZOP to commercial banks in January was completed with minimaldisruption of the financial activity"� "The expiration of the ZOP has removed themain obstacles to the development of a market-based monetary policy frameworkand new capital markets".

The accomplishments of the NBS Payment System Department in 2003confirmed that the country had been provided with the cost-effective, reliable andefficient interbank payment system fully in compliance with ten underlyingprinciples defined in the BIS Core Principles for Systematically Important PaymentSystems. Moreover, the RTGS and clearing system is quite ready for the connectionto the TARGET system used for major payments in the euro zone, as soon as all theother necessary conditions have been created.

The RTGS and clearing system availability reached 99.71% in the first year ofoperation, which is above the availability of these systems in the EU countries.

The new internal payment system brought numerous benefits to banks, most ofall a considerable expansion of their branch networks (branches, offices, counters),the increased income resulting from internal payment system services, the improvedquality of liquidity management and the opportunity to have a direct access to thetransactions of their clients, experience and knowledge gained through theimplementation of an extensive and complex project, new products offered to themarket (e-banking, etc.).

At the beginning of 2003 the system had included 50 participating banks, andthe number was reduced to 47 by 31 December. In addition to banks, the parties

102

Annual Report 2003 Payment Operations

103

participating in the system were the Public Payments Agency of the Ministry ofFinance and Economy of the Republic of Serbia, and the NBS departments. Nobanks were disconnected from the RTGS and clearing system in the course of theyear for non-compliance with the respective rules.

In 2003 the number of orders channeled through the RTGS and clearing systemreached 103.67 million totaling CSD 7,114.4 billion. Thereof, the RTGS paymentsaccounted for 5.2 million orders or 5.02%, and the clearing payments for 98.5million orders or 94.98%. The amount of clearing payments made 8.64% of theoverall RTGS and clearing transactions on the average. The average RTGS orderwas CSD 1,247,677.10, and the average clearing order reported in 2003 amountedto CSD 6,241.66.

In order to overcome some serious problems which occurred in January 2003in the system for settling claims based on personal current account checks, theNBS's own solution, check clearing, was agreed upon with banks. From 8 February,after the NBS Payment System Department started its check clearing operations, thereported average daily number of cleared checks was 115,638 worth CSD 195.5million.

From 9 April, following the launched dinar settlement operations based onYUBA card transactions, until 31 December, the settlements reported by thePayment System Department reached CSD 658.66 million and the total of 644,559payment transactions.

In their written reports in 2003, the parties participating in the NBS RTGS andclearing system estimated the cooperation with the NBS Payment SystemDepartment as very effective.

105

Annual Report 2003

LEGAL AND REGULATORYACTIVITIES

LEGAL AND REGULATORY ACTIVITIES 106

Annual Report 2003Legal and Regulatory Activities

In 2003 the NBS Legal Department took part in preparing, namely, renderedits opinion in respect of the following draft laws of the Republic: Draft Law on theBudget of the Republic of Serbia for 2003, Draft Law on the Right of Pledge inrespect of Registered Movable Property, Draft Law on Financial Leasing, DraftLaw on the Housing Loan Insurance Corporation, Draft Law Amending andSupplementing the Corporate Profit Tax Law, Draft Law Amending andSupplementing the Financial Transaction Tax Law, Draft Law on the National Bankof Serbia, Draft Law on Borrowing and Guarantees Provided by the State UnionSerbia and Montenegro, Draft Law on Public Debt, Draft Law Amending andSupplementing the Foreign Exchange Law, Draft Law on Bank Rehabilitation andBankruptcy, Draft Law on Banking Agency, Draft Law Amending andSupplementing the Law on Securities and Other Financial Instruments Market,Draft Law on Foreign Trade and Draft Memorandum on the Budget and Economicand Fiscal Policies for 2004, with Projections for 2005 and 2006.

For the purpose of implementing and putting into effect the operations of theNBS, in 2003 the Governor issued 88 general enactments, including 79 decisions,seven guidelines, one document containing rules and one announcement, whichwere published in the "FRY Official Gazette" or the "Official Gazette of theRepublic of Serbia". The regulations covered the following operations of the NBS:

− Monetary system and policy (the NBS monetary policy program for 2004,discount rate, interest rates, reserve requirement, requirements for and the mannerof issuing short-term securities by the NBS, open-market operations, short-termcredit policy in the fourth quarter of 2003, terms and the manner of depositingexcess liquidity of banks with the NBS, minimum credit rating requirements ofbanks, measures for maintaining foreign exchange liquidity of banks to provide forwithdrawals of foreign currency savings deposits, etc.);

− Foreign exchange and international operations (terms and the manner ofoperating the foreign exchange market, foreign exchange and currencies purchasedand sold by the NBS in the foreign exchange market, purchase of currencies of theEMU member countries, operation of the Securities Central Registry, Depositoryand Clearing, requirements and the manner of performing exchange operations andthe related supervision procedures, requirements for authorizations issued to banksto perform international operations and for such authorizations to be revoked,requirements for banks authorized for international operations to be entered into theregister and the manner of maintaining such register, the scope of and proceduresto be applied in 2004 to disbursements under financial credits for the purposesreferred to in Article 2, paragraph 2 of the Foreign Credit Transactions Law, etc.);

106

Annual Report 2003 Legal and Regulatory Activities

107

− Supervision (detailed requirements and procedures in implementing the NBSsupervisory function, etc.);

− Vault operations (issuing, main features of, and putting into circulation the1,000-dinar banknote, issuing, main features of, and putting into circulation the 1,2, 5, 10, and 20-dinar coins, issuing, main features of, and putting into circulationthe 5,000-dinar banknote, cash flow management procedures in supplying bankswith banknotes and coins, withdrawal of the 1, 5, and 10-para coins fromcirculation, etc.).

− Accounting and finance (Chart of Accounts and the related contents ofaccounts for banks and other financial organizations, detailed accounts within theChart of Accounts for banks and other financial organizations, etc.);

− Payment operations (the manner of performing payment transactionsthrough the monetary account of the Securities Central Registry, Depository andClearing, form and contents of and the manner of using uniform instruments inpayment operations, terms and the manner of cash payments made in dinars by legalentities and individuals involved in business activities, types of information to bereported by banks to the NBS and the reporting dates, interbank settlement forpersonal current account checks, settlement for card transactions, cash flowmanagement procedures in supplying banks with banknotes and coins, proceduresfor bills of exchange issued before 31 December 2002, the manner of andrequirements in monitoring liquidity and solvency of legal entities, etc.).

In 2003 five proceedings were initiated before the Constitutional Court of theRepublic of Serbia for the assessment of the adherence to constitution and thelegality of general enactments of the National Bank of Yugoslavia (Serbia). Currentproceedings before the Commercial Court in Belgrade include 13 litigation cases,one liquidation case, one bankruptcy case, two enforcement cases and three casesrelating to criminal offences. Current proceedings before other Commercial Courtsinclude 11 litigation cases and one liquidation case. There are 12 administrativedisputes being currently resolved before the Supreme Court of Serbia, while theproceedings before municipal courts include 26 litigation cases and 8 criminalcases.

In the course of 2004 the Legal Department will take part in the preparation ofregulations and bylaws governing the bank deposit insurance, as well as of theconstitutional provisions relating to the position of the National Bank of Serbia,together with efforts aimed at strengthening its independence and autonomy. Forthese purposes, the Legal Department will participate in preparing the provisions tobe proposed for amendments and supplements to the Law on the National Bank ofSerbia, the Law on Banks and Other Financial Organizations, the Law onRehabilitation, Bankruptcy and Liquidation of Banks and the Law on the Agencyfor Deposit Insurance, Bank Rehabilitation, Bankruptcy and Liquidation.

109

Annual Report 2003

INTERNAL AUDIT

MAIN ACTIVITIES IN 2003 110

Annual Report 2003Internal Audit

Main Activities in 2003

The objectives of internal audit are accomplished by identifying and assessingrisks, evaluating the established internal control system and recommending itsimprovements, as well as by way of advising activities to support the effortstowards the NBS strategic objectives, with the focus on the risk and internal controlmanagement.

The NBS internal audit operations are conducted by the independent InternalAudit Department, and its activities are governed by the rules defining the mainprinciples of organization and procedures, objectives and tasks, as well as therespective responsibilities and authorizations.

The priorities of the Internal Audit Department in 2003 included the auditsconducted as required by the Annual Audit Plan, and those ordered by the Governorrelating to the compliance with statutory and internal regulations, to the adequacyof established internal control systems, as well as to financial and other audits.

Following each audit conducted, fair and independent reports prepared byInternal Audit Department covered the assignments of those involved in suchactivities, the adequacy and functioning of internal control systems, in addition torecommendations for identified failings to be eliminated, potential risks mitigatedand operating processes improved.

After the period given to the respective departments to act upon the distributedfinal reports, the follow up process included the compilation and processing of dataregarding the implementation of recommendations. In this manner, the InternalAudit Department monitored the activities of other units of the NBS inimplementing recommendations contained in its reports.

Furthermore, the Internal Audit Department was responsible for thecooperation with the NBS external auditors, and hence for the communicationbetween the external auditors, on the one part, and the NBS departments andmanagement, on the other.

To enhance the quality of processes in the NBS through a standardizedapproach to operating practices and adequately perceived responsibility, whileunderstanding the entirety of integrated processes and the possibilities to improvetheir efficiency, to provide for more effective supervision and control, to assist intraining the newly recruited staff and the like, in 2003 the Internal ControlDepartment launched the initiative for documenting all the processes in the NBS.

110

Annual Report 2003 Internal Audit

111

Parallel to their regular assignments, the Internal Audit staff were continuallyinvolved in their professional development, required, inter alia, by the IASconversion process. In particular, the Department staff were trained in the area ofinternal audit and international accounting standards through site visits to centralbanks, through workshops and other forms of training.

With respect to the relatively short existence of internal audit as anindependent function within the NBS, in addition to the adequate performanceunder the annual audit plan, the focus of its actions in 2004 will primarily be todefine and develop operating methodologies relying on the risk based auditorsapproach to operations of the NBS departments, as well as to promote the internalaudit function. With this course taken, in its further development the Internal AuditDepartment will contribute to the efforts to attain the standards and practicesapplied in the industrial countries, and will help its core function to be betterunderstood, accepted and practiced at all the levels of organization.

113

Annual Report 2003

ORGANIZATIONAL AND PERSONNELCHANGES

NUMBER OF EMPLOYEES (RELATIVE CHANGES AGAINST 2002) 114

QUALIFICATION STRUCTURE OF EMPLOYEES 115

AGE STRUCTURE OF EMPLOYEES 116

PROFESSIONAL DEVELOPMENT AND TRAINING 116

RECRUITMENT OF TRAINEES AND PLANS FOR 2004 117

Organizational and Personnel Changes Annual Report 2003

Number of Employees (Relative Changesagainst 2002)

On 31 December 2003 the number of employees in the National Bank ofSerbia was 5,349 against 9,162 on 31 December 2002, i.e. it decreased by 3,813 or41.62%.

114

TToottaall NNuummbbeerr ooff NNBBSS SSttaaffff


Organizational part Permanent

Non-assigned

and available

Temporary Total

(2+3+4) Permanent

Non-assigned

and available

Temporary Total

(6+7+8)

Percent increase

or reductions (9-5):5

1 2 3 4 5 6 7 8 9 10

NBS - Head Office 1,251 147 146 1,544 1,263 51 125 1,439 -6.8

GRF - Belgrade 72 179 - 251 755 338 10 1,193 475 Novi Sad Branch 118 - - 118 699 77 38 814 690 Pristina Branch 7 24 - 31 5 22 - 27 -12.9

Ni{ Branch - - - - 351 44 43 438 - Kragujevac Branch - - - - 307 40 25 372 - U`ice Branch - - - - 244 26 14 284 -

ZIN 789 14 - 803 744 8 - 782 �2.62 ZOP 5,024 187 1,204 6,415 - - - - - TToottaall:: 77,,226611 555511 11,,335500 99,,116622 4,398 606 345 5,349 ��4411..6622

The reduced number of staff was primarily caused by reasons of organizationalnature, i.e. the closing of the NBY specialized section the Clearing and SettlementBureau (ZOP), and the shift of some operations to commercial banks to the Ministryof Finance of the Republic of Serbia. As a number of operations remained with theNBS (solvency, enforced collection, securities and a part of treasury operations),some employees were taken over by the Main Branch and other branches, andconsequently the overall number of staff in those branches increased.

Organizational and personnel changes

Qualification Structure

The qualification structure compared to 2002 reveals that the most apparentdifference was in respect of the number of employees with the PhD degree, i.e. anincrease from 5 to 28, and a considerably reduced number of those with collegeeducation, while no significant changes occurred with other qualifications.

Annual Report 2003

115

QQuuaalliiffiiccaattiioonn SSttrruuccttuurree ooff EEmmppllooyyeeeess

31 December 2003 Organizational part

PhD MA BA Two-year college

High school

Highly skilled Skilled

Low-skilled Unskilled Total

NBY - Head Office 6 25 535 96 571 26 60 115 5 1,439 GRF - Belgrade - - 182 158 651 10 47 18 127 1,193

Novi Sad Branch 2 3 100 89 467 5 42 106 - 814

Pristina Branch 1 - 12 2 7 - 1 - 4 27 Ni{ Branch - - 59 44 260 - 22 53 - 438 Kragujevac Branch - - 58 35 227 - - 52 - 372 U`ice Branch - - 32 27 173 4 7 41 - 284

ZIN - 5 80 64 216 242 56 35 84 782

TToottaall:: 99 3333 11,,005588 551155 22,,557722 228877 223355 442200 222200 55,,334499

%% 00..1177 00..6622 1199..7788 99..6633 4488..0088 55..3377 44..3399 77..8855 44..1111 110000..0000

QQuuaalliiffiiccaattiioonn SSttrruuccttuurree ooff EEmmppllooyyeeeess iinn 22000022 aanndd 22000033

Qualification

PhD MA BA

Two-year college

High school

Highly skilled

Skilled Low-skilled

Unskilled Total

31 Dec 2002 5 35 1,470 1,277 3,715 290 245 661 114 7,812 % 0.01 0.45 18.82 16.35 47.56 3.71 3.14 8.46 1.46 100.00

31 Dec 2003 28 14 1,058 515 2,572 287 235 420 220 5,349

% 0.52 0.26 19.78 9.63 48.08 5.37 4.39 7.85 4.11 100.00

Annual Report 2002Organizational and Personnel Changes

Age Structure

116

AAggee SSttrruuccttuurree ooff EEmmppllooyyeeeess ((eexxcclluu ddiinngg ZZOOPP))

31 December 2003 Organizational

part Under 20 20 to 30 30 to 40 40 to 50 50 to 60 Over 60 Total

Average

NBY - Head Office - 209 385 495 337 13 11,,443399 4422..3366

GRF - Belgrade - 64 297 535 290 7 11,,119933 4477..22

Novi Sad Branch - 48 130 349 275 12 881144 4466..3399

Pristina Branch - 1 12 11 3 - 2277 5500..0044

Ni{ Branch - 25 69 176 155 13 443388 4466..6633

Kragujevac Branch - 8 45 165 145 9 337722 4433..9911

U`ice Branch - 17 41 127 93 6 228844 4477..8811

ZIN - 32 235 343 166 6 778822 4466..5511

TToottaall NNBBSS - 440044 11,,221144 22,,220011 11,,446644 6666 55,,334499 4455..4444

%% - 77..5555 2222..7700 4411..1155 2277..3377 11..2233 110000..00

The age structure shows that the dominant group is between 40 and 50 years

of age, accounting for 41.15%. The NBS Head Office employs the youngest staff.

Professional Development and Training

EEmmppllooyyeeeess IInnvvoollvveedd iinn PPrrooffeessssiioonnaall DDeevveellooppmmeenntt iinn 22000022 �� 22000033

Number of employees

TTyyppee ooff eedduuccaattiioonn oorr ttrraaiinniinngg 2002 2003

M.A. degree, bar examination, and specialization 19 15 Educational upgrading 15 8

Professional training for brokerage certificate 3 -

Foreign language courses (from beginner to advanced, and specialized business-banking courses)

346 378

Professional examinations for trainees 10 4

Local and international training courses, seminars and conferences

53 140

Computer training courses were not organized in 2003.

The number of employees who attended foreign language courses in 2003increased by 9.24% relative to 2002.

The number of participants in local and international courses, seminars andconferences exceeded by 164.15% the one reported in the previous year.

Annual Report 2003 Organizational and Personnel Changes

117

Recruitment of Trainees and Plans for 2004

The plan for 2004 includes 10 newly-employed trainees and 8 volunteers in theNBS Head Office with a university degree (economics, law, organizational sciencesand electrical engineering), as well as a number of highly experienced experts, asneeded.

Moreover, the two-month summer practice is again planned for the best(senior) university students from relevant faculties, allowing them to gain some on-job experience in a central bank's functions and operations.

Long-term plans also include the NBS staff training to improve and ensure amore efficient performance in tasks and duties within the scope of the central bank'sfunctions.

119

Annual Report 2003

INFORMATION TECHNOLOGY

IT SUPPORT TO COMMERCIAL BANKS AND THE NBS 120

Annual Report 2003Information Technology

IT Support to Commercial Banks and the NBS

The process of electronic data transfer by banks and other financialorganizations to the NBS was fully undertaken in 2003. Following significanttechnical improvements in the data reception and control software, the efficiency ofthe process applied in receiving and processing messages was greatly upgraded, inaddition to the fully automated system of control and communication to relevantNBS departments. Monitoring system for messages received from banks was alsoimplemented.

In 2003 approximately 220,000 reports were received containing some27,000,000 transactions.

Amendments to statutory regulations made in the course of the year requiredadequate changes in the message structure and data control criteria, which wereimplemented within the set dates in cooperation with the NBS departments.

In 2003 considerable improvements were made in the support provided tocommercial banks in the area of operation and maintenance of the single Registryof Payment System Account Holders. At the end of the year the Registry (database)contained approximately 440,000 accounts held by corporate clients andentrepreneurs. Some 3,500 written notes were issued, in addition to 400 e-mailmessages, some 100 CDs, and several thousand pieces of verbally providedinformation on details about and the status of particular account holders.

Newly introduced application solutions provided for improvements in thefollowing fields:

− International operations

• automated operations in the area of registration, recording, review and reporting in respect of borrowings under credit facilities from international financial organizations

− Monetary operations

• Securities Electronic Trading System (SET) - auction platform for trading in the NBS bills

• statement of the RTGS accounts of banks and other financial organizations

• frozen foreign currency savings deposits

− NBS operations

• personnel records

• records of fixed assets

• postings and transfers to the Accounting Department

• new version of Intranet services (WebHouse)

120

Annual Report 2003 Information Technology

121

− Vault operations

• dinar cash at the Head Office and branches and/or Vault Offices

• dinar cash in Control Department (Mint)

• foreign currency at the Head Office and branches and/or Vault Offices

• exchange operations

− Enforced collection procedures

− Supervision operations

• analytical reporting project relating to operations of banks, as required by the Basle Committee recommendations, for the purposes of portfolio manager in the Bank Supervision Department (10 complex monthly and quarterly reports which are automatically web-server generated within the NBS Intranet).

The NBS technical infrastructure was advanced through the followingactivities:

• created network infrastructure for the National Card Center operation,

• improvements in the NBS network through optical ring connection by applying new communications equipment and protection mechanisms,

• participation in projects for developing the Slavija communicationscluster and the IP telephony implementation,

• completion of the Network Layout and Standardization of the IP Address Scheme projects,

• implementation and administration of new operating systems (Linux I MS Windows 2003).

The IT management process was upgraded by applying international standards,and the management process was adopted and implemented in all the projectsdeveloped by the IT Department.

Information protection program was initiated in the NBS, and the workcontinued in the area of quality control of application solutions to comply with theproject management process.

In 2004 the IT Department plans to set up and establish a Call Center whichwould be responsible for:

• communicating uniform and consistent information on the NBS corporate policies,

• creating the central question & answer database,

• ensuring that all the answers comply with the uniform NBS standards, as the result of common efforts of all the NBS departments,

• providing for all the answers to be communicated within 24 hours by different channels (phone, e-mail, electronic messages, etc.).

The IT Department will be actively involved in the further project developmentin the area of open market operations, foreign exchange operations, accounting, expertsystems for monetary and bank supervision operations and insurance. With the projectaimed at Help Desk improvements, the support to final users will be centralized,adequate and prompt. The work on the information protection program will continue.

ANNUAL STATEMENT OF ACCOUNT

AUDITOR�S REPORT 125STATEMENT OF INCOME 127BALANCE SHEET 128

Annual Report 2003 Makroekonomska kretaxa

123

Annual Report 2003 Auditor�s Report

125

INDEPENDENT AUDITORS’ REPORT To the Governor and the Council of the National Bank of Serbia

We have audited the accompanying balance sheet of the National Bank of Serbia (hereinafter: “the NBS”) as of 31 December 2003 and the relating statements of income, changes in equity and cash flows for the year then ended. These financial statements are the responsibility of the NBS management. Our responsibility is to express an opinion on these financial statements based on our audit. The NBS financial statements as of, and for the year ended, 31 December 2002, before restatements by the NBS management, as disclosed in Note 22 to the accompanying financial statements, were audited by other auditors whose report dated 11 June 2003 expressed a qualified opinion with respect to their inability to determine the effects on the financial statements of borrowings in default. We conducted our audit in accordance with International Standards on Auditing. Those Standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the accompanying financial statements present fairly, in all material respects, the financial position of the NBS as of 31 December 2003, and the results of its operations, changes in equity and cash flows for the year then ended in accordance with International Financial Reporting Standards. Without qualifying our opinion, we draw your attention to the following matters: (a) As disclosed in Note 17 to the accompanying financial statements, as of 31 December 2003,

matured and unpaid liabilities with respect to certain foreign bank loans amounted to Dinar 2,459 million. Given that NBS did not repay the matured portion of the loan and relating interest when due, the creditor may call for early re-payment of the non-matured portion of the loan in the amount of Dinar 3,005 million. Management has informed us that terms and conditions of these loans are currently being negotiated with the foreign creditor regarding its rescheduling and potential write-offs and the creditor has not made any repayment demands as of the date of these financial statements.

(b) As disclosed in Note 23 to the accompanying financial statements, the NBS maintains

memorandum accounts on the assets and liabilities of the former National Bank of Yugoslavia, originating from the period prior to the dissolution of the former Socialist Federal Republic of Yugoslavia (“SFRY”). Upon the release of the former SFRY balances from the previously frozen accounts held with US banks, in the year ended 31 December 2003, the NBS recognised exceptional income in the amount of Dinar 2,130 million. In addition, the NBS has similar balances on frozen accounts maintained with European banks. The effects of the release of such accounts, if and when it happens, will be included in the NBS financial statements of the future periods.

Annual Report 2003Auditor�s Report

126

INDEPENDENT AUDITORS’ REPORT To the Governor and the Council of the National Bank of Serbia (continued) As disclosed in Note 25 to the accompanying financial statements, the succession-related

negotiations that are ongoing between the Republic of Serbia and the Republic of Montenegro, commenced upon the adoption of the Constitutional Charter of the State Union of Serbia and Montenegro, have not yet been finalised as of the date of these financial statements. The results of the negotiations may have effects on the NBS financial statements. As further disclosed in Note 2 to the financial statements, the accompanying financial statements include the operations of the NBS organisational units with the exception of its Main Branch in Podgorica, Republic of Montenegro. This branch has been excluded from these financial statements as the central bank functions in the Republic of Montenegro are maintained by the Central Bank of the Republic of Montenegro and the NBS does not have control over the assets of the branch.

(c) As disclosed in Note 26 to the accompanying financial statements, as of 31 December 2003,

certain legal proceedings are initiated against the NBS. Based on the independent legal advisors and the NBS management, it is not expected that those legal proceedings will have significant adverse effects on the NBS financial statements.

Deloitte & Touche revizija d.o.o. Belgrade 28 May 2004


127


STATEMENT OF INCOME Year Ended 31 December 2003 (Millions of Dinars) Audited by

Other Auditors

Notes 2003 2002 Interest income 3.1, 4 5,376 5,224 Interest expense 3.1, 5 (3,423) (3,706) Net interest income 1,953 1,518 Fee and commission income 3.1, 6 4,575 10,918 Fee and commission expense 3.1 (975) (1,314) Net fee and commission income 3,600 9,604 Net trading income 7 3,387 240 Dividend income 3.1 54 2 Other income 3.1 952 1,534 Total operating income 9,946 12,898 Net impairment losses and provisions 3.8, 8 (3,022) (3,008)Other operating expenses 9 (5,254) (8,433) Profit before exceptional item 1,670 1,457 Exceptional item 23 2,130 - Profit 3,800 1,457

Annual Report 2003Auditor�s Report

128


BALANCE SHEET As of 31 December 2003 (Millions of Dinars)

Audited by Other

Auditors, Restated

Notes 2003 2002

ASSETS Cash and current accounts 3.4, 10 16,581 20,672 Deposits with foreign banks 3.5 92,176 66,663 Gold and other precious metals 11, 3.6 7,837 6,717 Trading securities 3.7 84,175 45,915 Securities held-to-maturity 3.8, 12 17,000 18,188 Loans 3.8, 13 1,586 2,688 IMF membership quota and SDR holdings 14 37,848 37,425 Property, plant, equipment and intangible assets 3.12, 15 7,947 7,187 Other assets 16 3,483 3,778 Total Assets 268,633 209,233 LIABILITIES AND EQUITY Liabilities Liabilities to other banks and financial institutions 17 87,302 70,537 Liabilities to the Government and other depositors 18 33,796 13,762 Liabilities to the International Monetary Fund 19 92,308 75,210 Securities issued 2,223 1,551 Currency in circulation 42,979 43,431 Other liabilities 20 3,259 2,839 Total Liabilities 261,867 207,330 Equity 21 Capital 3,319 3,319 Revaluation reserves 5,067 4,004 Accumulated loss (1,620) (5,420) Total Equity 6,766 1,903 Total Liabilities and Equity 268,633 209,233


129

Edited and printed byThe National Bank of Serbia

Belgrade, 12 Kralja Petra StreetTelephone: (381 11) 30-27-100

www.nbs.yuNumber of copies: 400

ISSN 1451-4737

2004

annual report - nbs.rs · integrated supervision of the financial system. in 2004 the national bank...

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