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Milosevic relies on grey market to keep afloat

Apart from the street demonstrations, the pressure of the international community, the growing divisions among his own supporters and the general embarrassment at being caught cheating at the ballot box, there is another reason why President Slobodan Milosevic needs to resolve the political crisis racking Serbia as quickly as possible: the country is running out of money.

The economy has lurched from disaster to disaster since the beginning of the Balkan wars in 1991, weathering hyper-inflation, international isolation and the establishment of a system which has concentrated wealth in the hands of the chosen few while leaving more than half the country on or below the poverty line.

For a long time the Serbian people seemed remarkably resilient to such hardships, but the new wave of anti-government feeling has made them far less tolerant. In the past few weeks, the government has dug deep into its pockets to catch up with pensions arrears, cut electricity prices and keep the riot police happy. These things require hard currency, and hard currency is one thing the Serbian leadership does not have - at least not officially.

The country's trade deficit for 1996 is estimated at $2.2bn (pounds 1.3bn), while official reserves deposited at the Yugoslav National Bank are no more than $300m. Nobody knows exactly how the country is making up the shortfall, but it is almost certainly via the semi-legal or illegal web of financial transactions, offshore banking ar- rangements and secret funding the government has built up over the past few years.

"It is impossible that the trade deficit is being financed by legal sources," says Mladjan Dinkic, an economics professor at Belgrade University and author of a critique of the Milosevic system, entitled The Eco- nomics of Destruction. One way the government manages to raise funds, he believes, is by squeezing it out of the people.

In the past few days, the Yugoslav dinar has yo-yoed dramatically in street trade, waver- ing from 3.8 to the German mark up to five and then down again to 4.2 - a sure sign, according to Professor Dinkic, of government manipulation.

In effect, the state-controlled commercial banks deny cash to their customers, forcing them to sell hard currency from their savings to street traders, who are also controlled by the state. The more they sell, the weaker the dinar becomes. Then, after a few days, the banks loosen their credit squeeze and the dinar strengthens. The dealers sell the hard currency they have bought and make a tidy profit, which they pass on to the government.

The process is illegal, Professor Dinkic says, because it is an issue of new money that entirely by-passes the central bank and requires an increase in the banks' debt exposure well beyond the established limit. But the government has used the tactic several times in the past two years, at the risk of reigniting the hyper inflation that raged through Serbia in 1992-93.

By now, such "grey issues" of new money are not enough to keep the ship afloat. Other covert sources of hard currency probably include profits from the black market in cigarettes, and company profits ploughed into Yugoslav-controlled offshore banks run by confidants of Mr Milosevic.

If Mr Milosevic stays in power and fails to change his policies radically, his resources are likely to dwindle fast. He can try to unfreeze Serbia and Montenegro's share of former Yugoslavia's assets held in Basle. But time is against him - exactly how much time, nobody knows.