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BELGRADE (Reuters) - Standard & Poor's cut Serbia's credit rating and three members of the EU candidate's central bank resigned on Tuesday in a growing crisis over the independence of monetary policy under a new Socialist-led government.
The rating agency knocked Serbia down one notch to BB-, citing in part a push by the coalition government to tighten its grip on the central bank in defiance of warnings from the European Union and International Monetary Fund.
It also put the country on negative outlook because of deteriorating fiscal and external deficits and the bank row. The dinar fell to a record low against the euro of 119.45, prompting the bank to intervene with the sale of 15 million euros.
The bank has sold over 1.3 billion euros this year in defence of the battered dinar. The currency crawled back to 118.75 by close of business.
The sense of crisis was compounded by more resignations at the central bank following those over the past week of governor Dejan Soskic and vice-governor Bojan Markovic.
Three out of five ordinary members of the bank's Council of Governors, including Council President Bosko Zivkovic, stood down, accusing the government of a "serious violation" of the principle of central bank independence.
Soskic, the governor, was replaced on Monday by Jorgovanka Tabakovic, an economist and lawmaker from the ruling coalition. There was no word on when replacements would be named for the officials who had resigned, with the bank facing a scheduled decision on its benchmark rate on Thursday.
Standard and Poor's cited a risk of interference in monetary policy, cut Serbia's credit rating and warned of worse to come.
"The negative outlook reflects our view that Serbia's twin fiscal and external deficits could create greater vulnerabilities, complicated by institutional interference and financial spillovers from the euro zone," the agency said.
The battle over the bank will only fuel doubts in the West over the new government's commitment to the largely reformist, pro-EU path taken by Serbia with the fall of late leader Slobodan Milosevic 12 years ago.
Shrugging off a warning from the EU that it risked taking a "step back" in its membership bid, the coalition has pushed through legislation creating a powerful, parliament-appointed supervisory body represented on the bank's executive board and giving parliament the job of appointing the entire top team.
The government is an alliance of socialists and nationalists who last held power together at the tail end of Milosevic's 13-year rule, when Serbia was mired in war and hyperinflation.
Socialist Prime Minister Ivica Dacic, Milosevic's wartime spokesman, has promised expansive fiscal policy to counter two quarters of economic contraction this year, and says the central bank should play along.
Finance Minister Mladjan Dinkic said the ratings cut was to be expected, and blamed the previous Democrat-led government.
The dispute echoes a recent clash between the EU and Serbian neighbour Hungary over the independence of its central bank.
"In terms of structure, the act (in Serbia) is far more aggressive than anything that even happened in Hungary," said Nomura economist Peter Attard Montalto.
"The key worry is that they've (the bank) lost a lot of talent," he said. "And that's a key worry that the rating agencies picked up on -- losing the ability for them to respond to vulnerabilities given what they (S&P) call institutional interference."
Former governor Soskic stuck to a restrictive monetary policy despite an increasingly bleak economic outlook, raising the bank's benchmark rate over the past two months to 10.25 percent, the highest in central and eastern Europe.
The budget deficit stands at over 7 percent of output but of more concern is public debt that is almost 55 percent of GDP, far higher than levels recommended by the IMF in the past for similar emerging economies.
That adds to the case for keeping rates relatively tight.
"I wouldn't see (the central bank) making any decision, but this will be more of a get-together," Martin Stelzeneder, Raiffeisen analyst in Vienna, said of Thursday's rates meeting.
"The dinar will be under pressure due to the political situation," he said.
Analysts say a revival of IMF funding will be crucial to stabilising the dinar, which has hit a series of record lows against the euro in the wake of an inconclusive May election.
But the IMF warned last week that the new central bank saga would have consequences for a frozen 1 billion euro (791.92 million pounds) standby deal.
Finance Ministry tax adviser Milica Bisic said Serbia was unlikely to get its debt down quickly enough to revive the current IMF deal. Instead, it would seek to negotiate a new arrangement toward the end of the year.
Bisic, in an interview with the Wednesday edition of Serbian weekly NIN, said that to bring down the "enormous deficit" the government was considering raising value added tax from 18 percent to 20 and capital gains tax from 10 percent to 15.
Additional reporting by Michael Winfrey in Vienna. Writing by Matt Robinson. Editing by Jeremy Gaunt, Ron Askew.