2014 Article IV Consultation and Third Post-Program Monitoring Discussions with the Former Yugoslav Republic of Macedonia—Concluding Statement of IMF Mission
May 19, 2014
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.
1. Growth is expected to gather pace and to further broaden towards domestic demand. Growth of about 3½ percent in 2014 appears achievable. Employment growth and increased public wages and pensions will support consumption, while investment will be bolstered by large public sector infrastructure projects. Dynamic exports reflect both stronger external demand as well as higher capacity in the free trade zones. In that light, the lower-than-expected inflation rate does not signal a softening of domestic demand, but largely the transmission of food and import price shocks.
2. External risks are squarely on the downside. Surges in global financial market volatility related to the normalization of monetary policy in the U.S. have limited channels of transmission to the Macedonian economy. Similarly, tensions surrounding Russia and Ukraine have limited direct spillovers. However, commodity price shocks, particularly to oil, could widen the current account deficit, further weakening the foreign exchange reserve position. Finally, slower growth in advanced economies in Europe is a key risk, both to the near term outlook as well as over the medium term.
3. In the short run, fiscal policy should be geared toward meeting the 3.5 percent of GDP deficit target. Private demand is firm, reinforcing the case for gradually withdrawing fiscal stimulus. Containing the central government fiscal deficit will be important to keep debt on a sustainable path. Revenue outturn through the first quarter suggests some downside risks to the annual objective, which to some extent reflect one-off factors. Absent an acceleration in revenues, meeting the deficit target may require expenditure compression. The effect on growth of lower spending will be partially mitigated by the positive impact on employment and investment from large infrastructure works implemented outside the central government budget, by the public enterprise for state roads (PESR).
4. Over the medium term, the planned course for fiscal policy remains appropriate; laying out the measures underpinning the adjustment will reduce implementation risks. The planned reduction of the deficit to 2.6 percent of GDP in 2016 remains appropriate. The adjustment relies on revenue growth outpacing expenditure growth. Therefore, an articulation of the measures to contain expenditure—in the context of the next medium-term fiscal strategy—will help the authorities reduce the deficit while achieving their desired growth-friendly expenditure mix. Continuing to base annual budgets on prudent macroeconomic assumptions, particularly in the context of the low inflation environment, will also support those goals. Finally, strengthening public investment policy remains a priority: clear procedures to assess, prioritize, and monitor public investment projects should enable higher realization of budgeted capital spending and long term economic return.
5. Fiscal strategy should be grounded in a medium-term debt management strategy. The medium-term fiscal strategy should be accompanied by a debt management strategy that strikes a balance between external and domestic financing and overall macroeconomic stability. In particular, it should integrate the two policy priorities of ensuring adequate financing for the domestic private sector and accumulating foreign exchange reserves. The latter is all the more important that the balance of payments baseline is relatively weak. Finally, taking into account the operations of the broader public sector in both strategies would help emphasize the consistency of fiscal policy with internal and external stability.
Monetary and Financial Sector Policies
6. Monetary policy is appropriately focused on ensuring a level of reserves consistent with the sustainability of the peg. Further relaxation of the monetary policy stance is not warranted, particularly as credit growth is picking up. Reserves coverage and the capacity to service outstanding external debt obligations remain adequate. However, reserves have steadily declined and, should pressures develop, the NBRM should stand ready to raise its policy rate.
7. The financial system remains stable, well capitalized, and highly liquid, but insufficiently geared towards lending to the private corporate sector. Prudent supervisory policies have resulted in a system-wide capital adequacy ratio of about 17 percent, comfortably above regulatory minimum, and an aggregate Tier 1 capital close to 14½ percent. Gross NPLs represent 11 percent of total loans and are fully provisioned. However, in the context of strong deposit growth, increasing investment in government securities at the expense of corporate credit has resulted in a high liquidity and low profitability of the financial sector which entails an opportunity cost for the economy.
8. The central bank’s intention to preserve a conservative approach to bank supervision in a changing European framework is appropriate. The authorities should remain closely involved in the design of an institutional arrangement that would establish effective coordination between the SSM and non-EU members. In light of the systemic importance of euro area subsidiaries to the domestic banking system, preserving the established level of cooperation and coordination between home and host country authorities will be important as the ECB assumes its new supervisory role in late 2014.
Boosting competitiveness and potential growth
9. Investment in human and physical capital will be needed to unlock faster growth. In the medium-term, growth could reach 4 percent, supported by strengthening exports as well as some import substitution, suggesting a slow income convergence with EU countries. Low productivity growth is likely to curb more rapid economic growth.
10. Cost competitiveness in manufacturing is high, but the large trade deficit suggests that exports and import-competing sectors remain underdeveloped. Cost conditions in the manufacturing sector have supported the authorities’ successful policy of attracting FDI in export-oriented, labor-intensive industries. However, the large structural trade deficit, low labor force participation and high unemployment rates indicate some obstacles to overall competitiveness.
11. Remittance flows could play a role in supporting potential growth. Large-scale migration of labor through the past decades has resulted in sustained large private transfer flows. These flows carry important economic benefits, including for poverty reduction and cyclical stabilization, but may have also weakened the development of a dynamic tradable sector and raised reservation wages. It would be important to harness these flows to productive investment, possibly by creating dedicated savings and investment instruments for the diaspora, but more critically, through improving public infrastructure and the business climate. In that respect, continuing to tackle key constraints faced by SMEs by improving their access to finance, enforcing payment discipline in both public and private sector contracts, upgrading the professional status of inspection bodies and clarifying their mandate and rights are all steps that would help.
12. To lock in the ongoing reduction of unemployment, efforts to alleviate key employment constraints should continue. Labor market institutional factors (social assistance and labor taxation) appear in line with those of EU new member states and are therefore not likely to be the main explanatory factor of the poor labor market outcomes in FYR Macedonia. Skill mismatches remain an issue that current policies try to alleviate. In addition, strengthening supply chain linkages between newly-established foreign enterprises and domestic firms would create more job opportunities. This would require proactive information sharing and the reduction of costs associated with doing business in and out of the free trade zones.
The IMF team is grateful to the authorities and private sector representatives for their hospitality and open and constructive discussions during the mission.