UPDATE 2-Serb central bank raises key rate to 10.75 pct

* Rate rise of 25 basis points tied to inflation, retailprices hike

* Future policy moves hinge on inflation, fiscalconsolidation

(Updates with IMF report, background)

By Aleksandar Vasovic

BELGRADE, Oct 9 (Reuters) - Serbia's central bank raised itsbenchmark interest, already the region's highest, by 25 basispoints to 10.75 percent on Tuesday, reflecting rising inflationand debt concerns.

Other central banks in Central and Eastern Europe have cutrates over the past two weeks, as growth slows across theregion, although Poland bucked the trend last week by keepingrates flat due to concerns over inflation.

Serbia stands out as an exception because of a cocktail ofrising inflation and debt and an economy sliding into recessionamidst crisis in the euro-zone, its main trading partner.

"Considering that the increase of food prices andstate-controlled prices is higher than expected and thatinflationary expectations are on the rise, the Executive Boardhas decided to increase the benchmark rate toprevent the spillover... to other prices," the Serbian bank saidin a statement.

Serbian inflation in August rose to 7.9 percent, up from 6.1percent in July, due to a poor harvest and the government's bidto finance its 2012 budget gap amounting to 6.2 percent of GDPthrough a rise in value-added tax.

The central bank estimates that inflation should continue torise until mid-2013 and then slide back to its target band offour percent, give or take 1.5 percentage points, the same asfor 2012. However, some analysts voiced caution.

"That inflation is not driven by demand ... in that sense,the monetary policy is powerless," said Miladin Kovacevic, ananalyst with the Belgarde-based Economics Institute.

Djordje Djukic, a lecturer of economics with BelgradeUniversity, said Tuesday's rate hike was beneficial forportfolio investors, "who will make profits on short-termmaturities, but bad for budget and debt".

"The effects (of the rate hike) on inflation are veryuncertain as the Serbian economy is highly monopolised andplagued by high production costs, low productivity andcompetitiveness," Djukic said.


The deficit, inflation and rising social discontent haveprompted the coalition government of nationalists andSocialists, which came to power in July, to borrow more. Thatincluded a Sept. 27 issue of a $1 billion Eurobond and a $1billion loan from Russia, planned for this year and next.

Serbia's total public debt this year is expected to reach 60percent of GDP and the country wants a new stand-by loan dealwith the International Monetary Fund to reassure investors.

The Fund froze a 1-billion euro ($1.30 billion) loan dealwith Belgrade in February over inflated spending and debt andtold Serbia last month to restore the autonomy of the centralbank and rein in spending before any new loan talks.

In its October World Economic Outlook, the lender saidSerbia's economy was expected to contract by 0.5 percent thisyear and grow 2 percent in 2013.

In the statement, the central bank said its future policymoves would depend on inflationary expectations, externalinfluences and the effects of fiscal consolidation.

The dinar rallied versus the European commoncurrency last month after domestic banks started issuinggovernment-subsidised loans to aid exporters hit by the crisisin the euro zone, Serbia's main trade partner.

The dinar has been trading at an average of 115 dinars to oneeuro since, as opposed to an average 117.5 in the days beforeits recovery. By midday on Tuesday, following the rateannouncement, it firmed against the euro and was trading atbetween 114.56 and 114.76 to one euro.

($1 = 0.7711 euros)

(Reporting by Aleksandar Vasovic; Editing by ZoranRadosavljevic and Ron Askew)