Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.
Republic of Kosovo—IMF Staff Visit, Concluding StatementPristina, September 16, 2009
Near-Term Outlook: Orderly Slowdown Likely to Be Followed by an Upturn Next Year
1. Amidst signs that the worldwide recession is easing, the slowdown in Kosovo’s economic growth has remained orderly. Growth of imports, remittances, and deposits has continued to decelerate in recent months, thus pointing to a slowdown in economic growth. These forces, however, are in part offset by a pronounced increase in this year’s fiscal expenditures, in particular for wages and capital outlays. Moreover, fuelled by imports, the decline in consumer prices continued, with the CPI having fallen nearly 4 percent year-on-year in July. Nevertheless, demand for domestically produced goods and services appears to have remained well supported. Against this background, the mission keeps its forecast for real GDP growth this and next year broadly unchanged (3.8 percent and 4.3 percent, respectively).
2009 Budget: Expenditure Pressures Raise Concerns About Sustainability
2. Expenditure pressures are leading to a pronounced deterioration in the underlying fiscal deficit this year. The mission estimates that public expenditures will grow by 26 percent this year, assuming that the execution of capital expenditures will fall short of budget allocations, as in previous years. Tax revenues are growing broadly in line with expectations. However, non-tax revenues will be boosted by a first and unexpectedly large dividend payment from PTK (5 percent of GDP), the publicly-owned telecom company. This one-off revenue should help to contain this year’s fiscal deficit to about 2 percent of GDP. However, the underlying deficit—excluding this dividend income—is forecast to reach 7 percent of GDP, highlighting the need for policy action to restore the medium-term sustainability of public finances.
2010 Budget Preparations: Further Measures Needed to Enhance Sustainability
3. Policy formulation underpinning the 2010 budget is still proceeding and therefore a comprehensive assessment of the government’s fiscal stance remains to be completed. Budget preparations still are at an early stage, and the mission broadly shares the authorities’ underlying growth and revenue assumptions. The current draft targets a small deficit (0.3 percent of GDP), in part reflecting a pronounced reduction in expenditure growth. However, policy formulation remains to be finalized and, therefore, a comprehensive assessment of the draft budget is not yet possible. Nonetheless, to strengthen fiscal sustainability and the credibility of the budget, the mission recommends that the authorities address the following issues before finalizing the third budget circular.
• Energy sector loan. The current budget draft is predicated on the optimistic assumption that the privatization of KEK, the publicly-owned electricity company, will be concluded next year. Based on this expectation, the authorities’ revenue projections include full repayment by KEK’s future owner of loans due to the budget over 5 percent of GDP (€197 million). However, interest among potential investors in the “New Kosova” project appears to be receding, and further privatization delays cannot be ruled out. As a matter of caution, loan repayments by KEK should be stricken from the 2010 revenue projections.
• Energy sector subsidy. Likely privatization delays also raise the budget’s contingent liabilities from the operations of KEK. Although the current draft includes subsidies (1 percent of GDP) to cover the company’s operational costs, these may prove insufficient. Given these uncertainties, the mission recommends that the budget set aside an energy sector contingency reserve of about 2 percent of GDP.
• Capital expenditures. The budget draft is predicated on an ambitious level of capital expenditures (10 percent of GDP). In view of past performance, expenditures are unlikely to reach this level. A clear separation of allocations for project planning and execution, combined with cost-benefit analysis of large projects, could result in material improvements in expenditure planning and efficiency. For 2010, the ceiling on capital expenditures should be lowered in line with execution rates observed during previous years (about 85 percent). Moreover, the mission welcomes the instructions from the Ministry of Finance and Economy (MoFE) to budget organizations to accommodate any carryover of capital spending to next year’s budget within the pre-determined 2010 ceilings to prevent a further increase in expenditure growth.
• Social and related laws. The fiscal impact of several social initiatives that are currently under preparation remains to be assessed and could be large. Any related costs either need to be included in the draft 2010 budget or these initiatives should be removed from the legislative agenda. The mission therefore calls on the authorities to accurately assess the fiscal costs from these initiatives and prioritize its expenditures accordingly.
• Civil service reform. The authorities’ civil service reforms—drawn up with support from international partners—are an important step towards improving the functioning of the public sector. Nevertheless, a recent fiscal impact assessment shows that the costs could be substantial, and the mission urges the authorities to be mindful of these costs when finalizing the draft law and devising the new pay and grade structure. Any potential increases in the wage bill resulting from these reforms should be offset, including through rightsizing of staffing levels. Should these reforms indeed become effective next year, any related costs would also need to be included in the 2010 budget.
• Potential privatization receipts. The mission welcomes the government continued commitment to the privatization of several assets, including PTK. While revenues from the sale of PTK could be large, inclusion of these in the budget should only be considered upon a realistic timetable for a possible transaction and a prudent assessment of the company’s value.
4. The mission supports the government commitment to take decisive policy action to strengthen the 2010 budget draft. The issues raised above suggests two ways of improving policy formulation. Firstly, the authorities need to be mindful of the impact of short-term policy choices on fiscal sustainability. Secondly, the draft budget should be a realistic representation of the revenue and expenditure outcomes that are most likely to materialize.
Structural Policies—Vital to Underpin Fiscal Sustainability
5. Tax administration and other initiatives have a major role in underpinning fiscal sustainability. The mission wishes to highlight some important structural issues that could strengthen fiscal sustainability.
• Tax administration. Efforts to broaden the tax base need to be intensified. Improvements in domestic tax collections would provide funding for any well-targeted and sustainable expansion of social and other spending. The upcoming IMF technical assistance mission will provide the authorities with options to strengthen revenue collection.
• Public debt law. The mission welcomes ongoing progress with the draft Law on Public Debt. Latest revisions should help limit potential liabilities for the central government arising from possible non-payment by municipal borrowers, including by requiring an unqualified audit opinion as a prerequisite for municipal borrowing. The mission recommends that municipalities be required to establish a track record of sound financial management, as evidenced by three consecutive unqualified annual audits. Moreover, municipalities should be barred from pledging central government’s grants as collateral for their borrowing.
6. Comprehensive energy sector reform is vital to durable fiscal consolidation. The mission welcomes the agreement reached in the summer between the government, USAID and the World Bank on the reform strategy for the energy sector. The mission looks favorably to further steps by the government—and its partners—to carefully assess the fiscal implications of the adopted reforms. Moreover, the consequences of any potential delays in the implementation of these reforms should be carefully assessed, given seemingly waning interest from the private sector to enter Kosovo’s energy sector.
Financial Sector Stability—Close Policy Coordination Needed
7. Close policy coordination is needed to safeguard financial sector and macroeconomic stability. The impact of the international financial crisis on Kosovo’s banking sector has so far continued to be moderate. However, risks of flare-ups of the crisis have not fully subsided, especially given the presence of large foreign-owned subsidiary banks. Close policy coordination between the MoFE and the Central Bank of the Republic of Kosovo (CBK) is vital to ensure financial and macroeconomic stability.
• Budget financing and PTK dividends. The forthcoming PTK dividend payment is an important source of one-off income for the government. However, these resources are an equally—if not more—important source of funding for the commercial banking sector. The mission welcomes the MoFE’s decision to keep these funds with those commercial banks that are currently holding them as deposits. However, it is vital that banks be given an adequate period of time to replenish their funding base in order to offset the eventual withdrawal of these deposits by the government. The mission recommends that a firm timetable be worked out to safeguard banking sector liquidity.
• Government cash balances and lender of last resort function. Euroisation limits the scope for liquidity provision to the banking system largely to that of the counterpart of the government’s cash balances on the CBK’s balance sheet. Given the importance of its cash balances as the primary source of funds for a potential liquidity injection into the banking system, fiscal policy objectives need to be broadened and should recognize the responsibility of the fiscal authorities for financial stability.
• Central bank law and policy coordination. Under the current legal framework, the CBK does not have the authority to undertake lender of last resort operations. In contrast, the draft central bank law, drawn up with IMF assistance, provides limited discretionary authority to the CBK to exercise this function. The mission, therefore, encourages the speedy adoption of this draft.
8. The reputation of the CBK is closely linked with its continued success in supervision. Improvements of insurance sector supervision needs to keep pace with quality enhancements in banking sector supervision. The mission welcomes recent steps by the CBK to safeguard the protection of insurance policy holders—its key mandate as the insurance regulator - as well as the authorities’ agreement with the World Bank to appoint an advisor in insurance matters.
We would like to thank our interlocutors for their hospitality and informative discussions.