Public Information Notice: IMF Concludes 2002 Article IV Consultation with the Federal Republic of Yugoslavia (Serbia/Montenegro)

May 23, 2002

Public Information Notices (PINs) are issued, (i) at the request of a member country, following the conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the public. This action is intended to strengthen IMF surveillance over the economic policies of member countries by increasing the transparency of the IMF's assessment of these policies; and (ii) following policy discussions in the Executive Board at the decision of the Board. The Staff Report for the 2002 Article IV Consultation with the Federal Republic of Yugoslavia (Serbia/Montenegro) is also available.

On May 13, 2002, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Federal Republic of Yugoslavia (Serbia/Montenegro).1


The government that came to power in late 2000-after ten years of regional conflict, international isolation, and economic mismanagement-inherited exceptionally difficult starting conditions. Output stood at less than half its 1989 level; inflation exceeded 100 percent; confidence in the financial system had been decimated; the country's infrastructure was in disrepair; the enterprise and banking sectors were both deeply insolvent and isolated from the outside world; and external debt, mostly in arrears, had risen to the equivalent of 140 percent of GDP.

With the strong support of the international community, the authorities have been able to take major steps toward stabilizing and reforming the economy. Twelve-month inflation has come down sharply from 113 percent at end-2000 to 23 percent in April 2002. Real GDP rose further by an estimated 5½ percent in 2001, but remained about one-half of its 1989 level. GDP growth is attributed to a rebound in agricultural output after the previous year's drought, and increasing activity in services. Industrial production has been stagnant, reflecting capacity constraints after years of disinvestment and the ongoing economic restructuring. The overall balance of payments improved, as a large increase in the current account deficit was comfortably financed by foreign assistance and private capital inflows. The official foreign exchange reserves reached US$1.6 billion at end-April 2002 (2½ months of imports), up from US$0.5 billion at end-2000.

The macroeconomic policies underlying these improvements have emphasized strict limits on bank credit and wage restraint in the public sector. The fiscal deficit was 1.3 percent of GDP in 2001, against a target of 6.1 percent, with borrowing from the banking system limited to 0.7 percent of GDP. The fiscal overperformance is explained by higher-than-budgeted revenue (1¾ percent of GDP) and a compression of spending (3 percent of GDP, primarily foregone public investment) in response to delays in foreign financing and privatization proceeds. Revenue collections benefited from a major simplification of the tax system and curtailment of tax evasion by fighting corruption and smuggling. Wage bills in the public sector were kept broadly unchanged in real terms. Growth in the Net Domestic Assets of the National Bank of Yugoslavia (NBY) during 2001 was limited to 2 percent of end-2000 reserve money. Large foreign exchange inflows accounted for an almost 90 percent increase in reserve money, in an environment of declining inflation and market interest rates, apparently reflecting a stronger demand for dinars. Against the background of a persisting balance-of-payments surplus, the NBY has kept the exchange rate of the dinar broadly unchanged against the euro since the adoption of a managed float at the beginning of 2001. The resulting real appreciation of the dinar has restored its real value close to the level reached in 1997-98 (a sanctions-free period when exports had reached a peak level).

Macroeconomic policies were complemented by equally impressive progress in structural reform, with technical assistance from the IMF and the World Bank. Soon after coming to power, the new authorities in Belgrade freed most prices with the exception of public utilities; unified a system of multiple exchange rates; abolished most import quotas and lowered average import tariffs to under 10 percent; simplified the tax system and improved the transparency of the budgetary accounts; and substantially liberalized employment contracts and wage determination. In addition, legal and institutional frameworks for bank restructuring and enterprise privatization were put in place, allowing important progress in this area.
In Montenegro-where reforms were initiated in 1999 with the support of bilateral donors-the authorities focused on fiscal reforms and privatization through a Mass Voucher Scheme.

The strengthened performance also reflected the international community's support of the FRY through foreign assistance and debt relief. Grant and loan disbursements amounted to US$8 million (8 percent of GDP) in 2001 compared with US$3 million in 2000. In November 2001, agreement was reached on restructuring Paris Club debt, involving a two-phase 66-percent write-off. The first phase (51 percent) is to enter into force with the approval of the Extended Arrangement (EA), while the second phase (the remaining 15 percent) will become effective upon successful completion of the EA. Debt restructuring negotiations with other official bilateral and London Club creditors are underway.

Executive Board Assessment

Directors commended the FRY authorities for the impressive achievements in stabilization and reform since late 2000, when the FRY succeeded to membership in the Fund. Directors noted, however, the daunting challenges that lie ahead, reflecting the exceptionally difficult starting conditions. They stressed the need for sustained policy implementation under the medium-term program supported by the Extended Arrangement, if the FRY is to remain on a path toward durable growth and external viability. The authorities' demonstrated commitment to reform augurs well for progress towards achieving these objectives. Directors also called on the authorities to continue to improve transparency and governance in all government institutions as a necessary precondition for improving the investment and business climate.

Directors noted that macroeconomic policies have been prudent, with fiscal and wage restraint underpinning a monetary policy geared to lowering inflation. They welcomed the improvement in tax collection stemming from wide-ranging tax reforms and the prompt containment of government spending in response to delays in foreign financing and privatization receipts. They welcomed the improvement in the fiscal position in Montenegro, after some slippage in the first half of 2001.

Directors commended the expeditious implementation of key structural reforms, in particular the streamlining of the price, exchange, trade, and tax regimes; the liberalization of the labor market; and the establishment of new legal and institutional frameworks to guide the restructuring of the economy. These measures had paved the way for the successful privatization of several large companies and the cleaning up of the banking system through the closure of four large insolvent banks.

Directors considered that the authorities' medium-term fiscal policy framework is consistent with achieving lower inflation and fiscal sustainability, while providing for critical restructuring and investment needs. They noted that the risks related to macroeconomic uncertainties and the challenges of reform could be addressed through prudence and vigilance in policy implementation to safeguard the inflation and external objectives. A strict wage policy will be important in this regard. Directors were concerned that the budget relied heavily on financing from privatization receipts and cautioned the authorities against using the central bank as a source of deficit financing.

Directors stressed that it will be important, for fiscal sustainability, to improve tax administration and streamline expenditure, by containing current spending through improved efficiency in the delivery of services and better targeting of benefits. In this regard, they welcomed the pension reform adopted recently in Serbia and the plans to adopt similar reforms in Montenegro.

Against the background of a continuing real appreciation of the dinar, Directors endorsed the NBY's intention to monitor developments in the foreign exchange market closely, and to keep exchange rate policy under close review in light of export and wage developments. They welcomed the further liberalization of the exchange system, which will pave the way for the acceptance by the FRY of obligations under Article VIII, section 2, 3, and 4, and envisaged a positive impact on the transparency and efficiency of the foreign exchange market. Directors also encouraged the authorities to strengthen the independence of the central bank.

Directors called on the FRY to put in place adequate anti-money laundering legislation and all necessary measures to combat the financing of terrorism.

Directors stressed that enterprise and bank reform, as well as an improved business environment, will be critical to foster private sector-led growth. The task of restructuring the decapitalized and overstaffed enterprise sector will be challenging, especially in light of limited fiscal resources to mitigate the restructuring costs. With the bulk of insolvency removed from the financial sector, development of an efficient banking system will hinge on the strengthening of banking supervision and on privatizing the remaining state-owned banks.

Directors welcomed the recent agreement between the federal and republican authorities on a plan for a new constitutional framework, which should provide a basis for normalizing relations between Serbia and Montenegro, streamlining joint institutions, and strengthening the custom and tax systems.

Directors emphasized that, in light of initial conditions, the medium-term economic outlook remains challenging, leaving little room for maneuver. The authorities must therefore persevere with reforms while the international community should remain supportive throughout the intensive medium-term restructuring effort. In this respect, Directors noted possible risks to the achievement of debt sustainability over the medium term.

Federal Republic of Yugoslavia (Serbia/Montenegro): Selected Economic Indicators 1/







Real sector

(Changes in percent)

Real GDP






Retail prices (12 months average)






Unemployment rate (in percent) 2/






Gross national saving (in percent of GDP)






Gross domestic investment (percent of GDP






Public finance 3/

(In percent of GDP)

Cash balance






Commitment balance 4/






General government debt






Money and credit

(End-period, annual rate, in percent)

M1 (growth rate) 5/






M2 (growth rate) 5/ 6/






Discount rate






Lending rate (weighted average)






Deposit rate (weighted average) 7/






Balance of payments

(In percent of GDP)

Trade balance 8/






Current account balance 9/






Gross official reserves (US$ billion)






Reserve cover (months of imports of GNFS)






Exchange rate


Exchange rate regime

Fixed rate with parallel rate through November 2000, managed float thereafter

Present rate (dinar/euro, end-April 2002)


Nominal effective rate (annual average 1997=100)






Real effective rate (annual average,1997=100)






Sources: Federal Statistical Office; National Bank of Yugoslavia; Ministry of Finance of the Federal Republic; Ministry of Finance of the Republic of Serbia; and IMF staff estimates.

1/ With the exception of money supply and foreign debt, data for 1999-2001 exclude Kosovo. GDP excludes Kosovo throughout .

2/ Excludes workers on "forced holiday."

3/ Fiscal operations of all levels of government, except for Montenegro where it excludes local government.

4/ Excludes arrears of local governments.

5/ From 1999 onwards excludes Montenegro.

6/ Frozen foreign-currency deposits are excluded and other foreign-currency deposits are valued at parallel market rates until September 2000 and current exchange rate thereafter.

7/ Excluding demand deposits as well as time deposits with maturities of less than 15 days or over 3 years.

8/ From 1996, includes previously unrecorded exports of about US$0.2. billion.

9/ In 2000-01, includes previously unrecorded transfers of US$0.6 billion.

1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies.
On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. This PIN summarizes the views of the Executive Board as expressed during the May 13, 2002 Executive Board discussion based on the staff report.


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