24 March 2020
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The COVID-19 pandemic & response of central banks

Increased uncertainty about the economic outlook

The global spread of the COVID-19 virus is a human tragedy on a massive scale and it strongly hit Europe, which is currently the epicenter of the global outbreak. As the virus rapidly spreads, it has become obvious that the global financial system will face its biggest challenge since 2008. Quantifying the economic impact of the current crisis is extremely complex and gives rise to significant uncertainty about the economic outlook and the associated negative consequences. Such an abrupt rise in uncertainty can put both the economic growth and financial stability at risk.  Investors are especially worried about the threat of slower growth and reduction of corporate profits.

Closed factories, quarantines, limited travel and cancellations of major events are deemed to be the root of the crisis. The stock markets in major economies, such as the US, the EU, and Japan, all suffered major drops and there are increased fears of future instability.

The investors are frightened as they are trying to observe the emerging risks caused by the COVID-19 pandemic. As a result of this sharp increase of uncertainty, they are trying to reallocate funds from relatively risky to safer ventures. Meanwhile, companies are facing higher funding costs in the market.  Consequently, most investors are postponing investment decisions while individuals are delaying consumption as they feel financially insecure.  One thing is for sure: additional economic policies and fiscal measures –and  especially right and timely monetary and financial stability measures – will be vital to help strengthen national economies as well the global economy.


Monetary policy measures

Expectations of low inflation (more on the Serbian situation on this link, based on inflation movements in February) and the features of the current shock, mean that monetary policy measures will have a key role to play. Central banks should act quickly to prevent the tightening of financial conditions by injecting liquidity and cutting interest rates, thus preventing a possible credit crisis.  Synchronized actions across countries will increase the power of monetary policy.  Therefore, “global cooperation to synchronize monetary policy must be high on the agenda” should be the main policy, as propagated by the IMF.  Ample liquidity within countries and across borders is a prerequisite for successful reversal of the rapid tightening in financial conditions. In these extraordinary circumstances, if liquidity pressures threaten the market function, central banks need to step in and provide emergency liquidity.  Accordingly, leading central banks around the world (e.g. the US Federal Reserve, Bank of England, Bank of Canada and Bank of Australia) decided to cut their policy rates in the past few days, announcing their readiness to take all available measures to prevent a negative impact of the COVID-19 pandemic on the global economic growth.  Similar measures were taken by the central bank of Serbia – the National bank of Serbia (“NBS”) – as the public institution in charge of safeguarding the value and purchasing power of money.


NBS cuts key policy rate

At its extraordinary meeting held on 11 March 2020, the NBS Executive Board voted to cut the key policy rate by 50 bp to 1.75%.  By making this decision, the NBS is taking a timely and adequate response to heightened uncertainty in the international financial environment which was triggered by the pandemic. This decision is also in line with favorable movements in the domestic environment.  By trimming the key policy rate in the conditions of low inflationary pressures, the NBS is providing additional support to credit and economic growth. At the same time, the NBS decided to narrow the corridor of its main interest rates from ±1.25 pp to ±1 pp relative to the key policy rate. As a result, the deposit facility rate was cut by 25 basis points to 0.75%, while the lending facility rate was cut by 75 basis points to 2.75%.

The NBS points out that the domestic economic and financial system is stable and strong enough to face potential negative consequences of the pandemic. Furthermore, the domestic factors which contributed to domestic economic growth in the past few years will continue to have a strong stimulating effect on the economic activity in Serbia. These factors are proven by the size of foreign exchange (“FX”) reserves and reduced external debt. At end-February, gross NBS FX reserves reached EUR 13,458.6 million and net FX reserves (total reserves less banks’ FX balances on account of required reserves and other requirements) came at EUR 11,371 million (see here).


Financial stability policies

The sharp decline in interest rates, combined with growing anxiety about the economic outlook, also raised investor concerns about the stability of banks. Share prices of banks have fallen sharply, and banking bonds also came under some pressure. The good news is that banks are generally more resilient than before the 2008 financial crisis, because they have greater capital and liquidity bases. This means that the risks to financial stability arising from the banking sector are much lower, in spite of the falling share prices. Nevertheless, supervisory authorities should very closely monitor all developments in the banking sector. Given the, – hopefully temporary – nature of the pandemic, banks could consider a temporary restructuring of debt payment terms for their most-affected clients (see more about in article National Bank of Serbia Introduces 90-Day Moratorium on Loan Repayments). The supervisors should work closely with banks to ensure that such actions are both transparent and temporary. The goal must be to preserve banks’ financial strength and overall transparency across the financial sector.  In line with these priorities, the following measures were taken by the NBS:


  1. NBS keeps countercyclical buffer rate unchanged

At its meeting held 12 March 2020, the NBS Executive Board decided to keep the countercyclical capital buffer (“CCyB“) rate for the Republic of Serbia at 0%, in order to support bank credit activity. The NBS runs a quarterly calculation which determines the reference guide based on which the CCyB rate for the Republic of Serbia is set. The reference guide is calculated based on the deviation of the credit-to-GDP ratio from its long-term trend. Additional information about the CCyB and the explanation for the above decision are available in the capital buffers section of the NBS website.


  1. Additional FX swap auction

On Monday, 23 March, the NBS announced that it will hold an additional FX swap auction where it is buying foreign exchange (euros) for dinars, to supply dinar liquidity to the banking sector for a period of three months at a favorable interest rate of 0.85%. Although, the NBS stresses that neither the dinar nor FX liquidity of the domestic banking sector are under threat and that there are ample liquidity buffers (excess liquidity) to sustain normal functioning of the financial system, the decision to hold an additional EUR/RSD swap was adopted in order to provide additional support to the domestic financial system and overall economic flows. FX swap auctions are a regular instrument which the NBS uses to regulate the dinar and FX liquidity of the banking sector. Additional EUR/RSD swap auctions already organized by the NBS proved exceptionally effective as they contributed to maintaining stability in the money market amid a temporary reduction in excess dinar liquidity.


  1. Repo purchase of dinar government securities

On Tuesday, 24 March, the NBS will hold two repo auctions to buy dinar-denominated government securities, with transaction maturity of seven days and three months, at a favorable interest rate of 0.75% (equal to the deposit facility rate).

By holding these two types of auctions, the NBS aims to facilitate liquidity management for banks. This way, banks will be able to obtain the necessary dinar liquidity through dinar government securities (repo auctions) as well as foreign exchange (FX swap auctions), which would serve as collateral in the said transactions with the NBS.



Policymakers must act decisively and cooperate at the global level to preserve monetary & financial stability during this time of extraordinary challenges. It is important that monetary and fiscal policy measures continue to be fully coordinated, which will facilitate preservation of the macroeconomic stability and reduction of the negative effects of the current situation.

It is also important that the NBS continues to closely monitor global developments and assesses their implications for the domestic economy and inflation. The NBS also needs to be quick to respond to any changes in order to preserve the current price and financial stability and be able to contribute to sustainable economic growth of the country.  Using the mantra of “hoping for the best, preparing for the worst” as a guide for policies has long been a success.  No individual country in this situation can, nor should be left alone.  Accordingly, member states could look for the help of the IMF to face this difficult, but hopefully temporary crisis.


For more information about similar issues contact us via covid19@geciclaw.com