## cr1830 - 2017. The staff team comprised Ms. Eble (head), Messrs. Cipollone

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### Context
- Kosovo is a small, unilaterally euroized economy with high unemployment, extensive informality, and a narrow production and export base, resulting in a large trade deficit largely financed by remittance flows.
- Since the 2015 Article IV and under a Stand-by Arrangement that expired in August 2017, steps were taken to foster fiscal sustainability, strengthen financial stability, and advance structural reforms, contributing to recovery and confidence.
- A new multi-party coalition government took office in September 2017 after early general elections in June 2017; its thin parliamentary majority may affect reform pace. Pending indictments by a special war crimes tribunal (expected to start in 2018) and ratification of the border demarcation agreement with Montenegro are political risks. Kosovo is recognized by almost two-thirds of UN member states.

### Recent developments, outlook and risks
- Growth and labor market
  - Real GDP growth has averaged about 4 percent per year since 2015.
  - Staff project growth at 4.1 percent in 2017, led by investment, export growth, and higher remittance inflows.
  - Unemployment remains the highest in Europe at just above 30 percent; youth unemployment is about 50 percent.
- Macro-financial projections (IMF staff estimates; KAS)
  - Real GDP Growth (in percent): 2016: 4.1; 2017: 4.1; 2018: 4.0; 2019: 4.0; 2020: 4.0; 2021: 4.0; 2022: 4.0.
  - Contributions to 2017 growth (in percent): Consumption 1.1; Investment 3.4; Exports 3.6; Imports -3.9.
  - CPI inflation (average, in percent): 2016: 0.3; 2017: 1.5; 2018: 1.0; 2019: 1.9; 2020: 2.1; 2021: 2.2; 2022: 2.2.
  - Fiscal balance excluding PAK and donor projects (in percent of GDP): 2016: -1.1; 2017: -1.1; 2018: -1.8; 2019: -1.9; 2020: -1.9; 2021: -1.9; 2022: -1.9.
  - Stock of government bank balances (in percent of GDP): 2016: 3.5; 2017: 4.9; 2018: 4.5; 2019: 5.0; 2020: 5.0; 2021: 5.0; 2022: 5.0.
  - Total public debt (in percent of GDP): 2016: 19.6; 2017: 21.0; 2018: 21.8; 2019: 24.9; 2020: 26.3; 2021: 27.8; 2022: 29.0.
  - Current account balance, incl. official transfers (in percent of GDP): 2016: -8.9; 2017: -8.7; 2018: -8.9; 2019: -8.6; 2020: -7.9; 2021: -8.0; 2022: -7.7.
- Inflation and prices
  - Headline inflation expected to pick up to 1.5 percent in 2017 (driven by food and energy); core inflation has turned negative.
- Medium-term outlook
  - Under gradual reforms, medium-term growth projected at 4 percent, driven by private consumption and investment; exports (mainly minerals) remain a relatively minor contribution.
  - Authorities’ objective: sustained growth above 5 percent to accelerate income convergence (GDP per capita in PPP terms was 20 percent of the EU average in 2016).
  - Even with scaled-up donor-financed public investment, debt-to-GDP projected to increase moderately but remain below the 30 percent threshold.
- Risks
  - Downside: Weaker reform momentum (including political risks), lower remittances or EU growth, shortfalls in tax compliance, social spending pressures, low IFI and privatization financing.
  - Upside: Moving ahead with a new power plant and accelerated reforms could attract more FDI and unlock large IFI financing for capital projects.

### External stability assessment
- Real effective exchange rate
  - Standard methodologies indicate REER remains stronger than implied by fundamentals and desirable policies in the range of 12-14 percent (compared to 15-18 percent at the last Article IV).
  - Improvement attributed to controlling public sector wages, budget consolidation, and some structural reforms.
- Trade balance and financing
  - Trade deficit remains substantial at 28-30 percent of GDP; exports have been increasing but from a low base.
  - Deficit largely financed by non-debt creating inflows: FDI (5 percent of GDP), remittances (15 percent), and other non-recorded capital inflows.
  - External debt expected to remain low at around 25 percent of GDP despite projected increase in IFI-financing.
- Reserves and reserve adequacy
  - Gross international reserves: 12 percent of GDP in 2016; expected to increase to 13.5 percent in 2017.
  - This covers more than 110 percent of a composite metric of reserve adequacy (ARA metric).
- Competitiveness indicators
  - Qualitative indicators show improvement since 2014 (starting a business, registering property, trading across borders), largely reflecting adoption of new legislation aligned with EU directives rather than de-facto productivity gains.

### Policy discussions — priorities and expected outcomes
- Focus areas:
  - (i) accelerating structural reforms to raise productivity and reduce unemployment;
  - (ii) improving budget composition within fiscal rule limits and spending efficiency;
  - (iii) safeguarding financial stability and deepening finance.
- Expected outcome: All three areas critical to improving competitiveness, achieving stronger and more equitable growth, and supporting income convergence with regional peers and the EU.

### A. Structural reforms: investment climate, governance and competitiveness
- Binding constraints and inequality drivers
  - Perceived weak rule of law, large informal sector, inefficient public enterprises, poor public health and education systems, and poorly targeted social benefits.
- Governance and anti-corruption
  - E-procurement use delayed and limited; need to expand capacity, enforce mandatory use, and increase list of goods/services under centralized procurement.
  - Strengthen investigative capacity of the anti-corruption agency and asset declaration regime (including assets owned domestically and abroad); subject large public investment projects to ex-post audit.
- Public enterprises and privatization
  - Reform priorities: strengthen independence of supervisory boards, timely publication of financial statements, external audits, reduce operating costs via rightsizing employment and lowering excessively high wages.
  - Develop a clear divestment strategy; strengthen Privatization Agency institutional and governance structure to accelerate privatization/liquidation (over 50 percent of identified assets—around 10 percent of GDP—remain to be liquidated).
- Education and labor market
  - 2015 PISA score (Kosovo’s first participation) ranks Kosovo low among participating countries.
  - Need higher-quality and better-targeted education, enhanced vocational curricula, and timely implementation of Action Plans for youth employment and active labor market policies (with EU support).
- Minimum wage policy
  - Any increases should follow current rules-based minimum wage mechanism linking adjustments to prices, private sector wages, and competitiveness.
  - Large discretionary increases risk disadvantaging low-skilled workers, increasing youth unemployment, migration, or informality, and creating fiscal pressures by raising social benefit expectations.
- Energy constraints
  - Addressing energy supply shortages is key for tradable sector investment. A commercial agreement to replace Kosovo A with a higher-capacity plant projected to be completed in 2023, assuming no further delays.

### B. Fiscal policy: macro-stability, revenue and expenditure policies
- Fiscal framework and performance
  - Fiscal rule: cap of 2 percent of GDP on fiscal deficit, excluding capital projects financed by privatization proceeds and donors; exemption for donor-financed investments can be invoked until 2025 provided debt remains below 30 percent of GDP.
  - 2017 fiscal deficit expected to be about 1 percent of GDP.
  - 2018 budget targets a deficit (fiscal rule definition) of 1.8 percent of GDP; wage bill kept constant as a share of GDP.
  - If execution includes IFI and privatization-financed investment exempted from the fiscal rule of about 1 percent of GDP, overall 2018 fiscal deficit would be about 3 percent of GDP (from 1 percent).
- Fiscal stance and medium-term outlook
  - Authorities aim to maintain budget deficits below the fiscal rule’s ceiling, and—when including IFI and privatization-financed capital spending—at around 3 percent of GDP, on average.
  - Public debt was 22 percent of GDP (2017).
  - Bank balances target: 4.5 percent of GDP.
  - Budget risks to reach the 2018 target:
    - Budget assumes about ¾ percent of GDP in gains from revenue administration reforms, which may not be realized.
    - Social spending could exceed the budget allocation by about ¾ percent of GDP without timely reclassification and verification of war veteran pension beneficiaries and tight administration of other social benefits.
    - Pressures exist to move ahead with several new unbudgeted social spending initiatives.
    - Spending on Route 6 of some 2½ percent of GDP is expected to be needed in 2018.

### Revenue mobilization and tax policy
- Revenue performance and gaps
  - Total revenue increased to 26 percent of GDP, but remains some 10 percentage points below the EM Europe average (or 6 percentage points if contributions to the second pillar pension system are included) and is collected from a narrow base.
  - Drivers of low tax revenue mobilization: low tax rates, high informality, weak collection efficiency.
  - Estimated tax gaps:
    - VAT gap: one-third of potential taxes collected.
    - PIT gap: two-third of potential taxes collected.
    - CIT gap: close to 20 percent.
  - Revenue composition: over three-quarters of Kosovo’s revenue comes from indirect tax (led by VAT and excise).
- Recommendations
  - Set publicly available quantitative and strategic performance targets for the tax administration.
  - Allocate resources to activities that generate the highest yields (e.g., risk-based audits).
  - Improve efficiency and productivity of audits; scale up tax debt collection.
  - Require filing a tax return by every registered taxpayer, even if no tax is due.
  - Minimize exemptions and broaden the tax base; no new VAT exemptions/reduced rate categories.
  - Continue to increase excises on products, such as tobacco, in line with the current schedule.

### Spending composition and efficiency
- Current spending and social benefits
  - Current spending increased from 17½ percent in 2011 to an estimated 20 percent in 2017, driven by social schemes and a higher wage bill (largely due to a wage hike in 2014).
  - Kosovo spends relatively more on untargeted and work dis-incentivizing social benefits and public wages, worsening competitiveness and inequality.
- Staff recommendations on wage bill and hiring
  - Restrain across-the-board wage increases.
  - Create space for priority hiring in the judiciary, health and education sectors within the limits of the rule.
  - Finance the health insurance scheme when introduced.
  - Reduce pressure from public sector wages on private sector wages.
- Social benefit reforms
  - Strengthen mechanisms to ensure no double dipping.
  - Better means-testing and removal of disincentives to remain employed.
  - Tightly administer and enforce eligibility of schemes.
  - Make the system more equitable (e.g., align disability threshold and payments for war veterans to civilian disability scheme).
  - Complete credible re-classification and verification of war veterans in line with the law in early 2018.
  - Staff urges not to introduce any non-contributory early retirement schemes for special groups.
- Notes on social spending
  - Spending on war veteran benefits in 2017 was 1 percent of GDP (compared to the 0.7 percent targeted), and may increase to 1.2 percent of GDP in 2018 in the absence of reform.
- Health and education
  - Healthcare and education spending levels and outcomes are poor; 2018 budget allocation increased but efficiency-improving reforms must move forward.
  - The contribution base must be broadened to secure sufficient revenue for health insurance.
  - Comprehensive education reforms should proceed to upgrade skills and address mismatches.
- Public investment and infrastructure
  - Capital spending is already high; scope exists to scale up by improving absorption of donor financing and strengthening efficiency.
  - Large resources allocated to motorways (Routes 6 and 7); implementation of other priority projects limited by capacity constraints and low IFI-financing absorption.
  - Scaling up public investment and improving quality could raise potential GDP growth with an estimated growth dividend of up to 0.8 percent yearly.
  - Recommended reforms: require cost-benefit analysis of major capital projects; strengthen project appraisal, selection, preparation, and execution; adopt multi-year budgeting for investment projects; ensure ex-post independent audit and assessment of large-scale projects.

### Financing and investor base
- Market and debt management
  - Financing has been readily available and largely absorbed by banks operating in Kosovo and to a lesser extent by other institutional entities, despite 100 percent risk-weightings on government paper for banks with EU-based parents.
  - The CBK currently holds €190 million (35 percent of total government securities) on its balance sheet.
  - Authorities are gradually extending maturity of outstanding public debt (2-year average maturity), with recent 7-year issuances to reduce roll-over risks.
  - Risks: normalization of euro area monetary policy may make it more difficult to sell bonds in the domestic market.
  - Recommendation: diversify and expand the investor base to reduce costs and roll-over risks.

### Social outcomes and poverty (select)
- As of 2015, 18 percent of the population was below the national poverty line of €1.82 a day.
- High unemployment: 31 percent in 2017.
- Low participation: 57 percent inactive.
- Pension and social assistance share of current expenditure increased from 21½ percent in 2010 to 36½ percent in 2016.

### Financial sector: stability and deepening
- Banking sector characteristics and performance
  - Largely foreign-owned, well-capitalized and liquid.
  - System NPL ratio has halved in the past two years to below 3½ percent.
  - Credit growth averaged 9½ percent y/y since January 2016; credit depth at 38 percent of GDP.
  - Credit growth concentrated in unsecured consumer lending; lending to productive sectors remains low.
  - About two-thirds of system loans to corporate sector and one-third to household sector.
  - 79 percent of strong FDI inflows since 2015 have been directed toward real estate and construction sectors; construction loans comprise only about 5 percent of bank loans.
- Recommendations to support deepening and productive lending
  - Implement amended Law on Enforcement Procedures, reform PEA tariff structure, establish independent PEA inspection unit at the Ministry of Justice.
  - Adopt pending legislation to automatically send certain property rights cases through official arbitration.
  - Accelerate reduction of the large court case backlog; consider establishing a commercial court with specialized judges.
  - Establish a fully functioning cadaster system covering all of Kosovo; provide banks access to the recently-established agriculture registry.
- Supervisory vigilance
  - Monitor consumer and construction lending for pockets of vulnerability.
  - Develop a housing price index or centralized registry of property valuations.
- Insurance sector and AML/CFT
  - Insurance sector small (3 percent of system assets); returned to profitability after Solvency I rules and other reforms.
  - AML/CFT law adopted in June 2016 and supplementary regulations in November 2016; CBK issued guidance on beneficial ownership and is moving toward risk-based AML/CFT supervision.
  - An AML/CFT assessment under PECK will be carried out in 2018.

### Banking system soundness and authorities’ views
- Authorities and staff agree the banking system is sound and do not see any major pockets of vulnerabilities.
- CBK stress tests indicate resilience to most types of shocks, with some sensitivity to a further steep fall in lending rates.
- Authorities view strong growth in consumer and construction loans as reflective of pent-up demand and emphasize banks have strengthened risk management.
- Authorities consider expansion of the credit guarantee fund as key to support SME lending.
- Kosovo accepted Article VIII obligations on January 11, 2018; staff found Kosovo does not maintain multiple currency practices or exchange restrictions (with notified exceptions).

### Staff appraisal — macroeconomic and structural assessment
- Progress and macro policy
  - Kosovo has made significant progress; sound financial and fiscal policies strengthened the economy.
  - Medium-term growth outlook improved since 2015 Article IV consultations.
  - Current levels of international reserves and the government’s bank balance are adequate; public-sector debt is low.
- Remaining structural challenges
  - External competitiveness gap, high informality, weaknesses in governance, low labor force participation and high unemployment remain priorities.
- Policy recommendations (selected)
  - Structural: improve governance and business climate, implement procurement and bankruptcy laws, strengthen anti-corruption regime, subject large projects to ex-post audits, move ahead with new power plant, restructure public enterprises, upgrade education and skills.
  - Fiscal: maintain the fiscal rule, improve budget composition and spending efficiency, better target social benefits, finalize war veteran pension reform, limit wage increases within the wage bill rule, scale up public investment with better use of IFI financing.
  - Revenue: move ahead with revenue administration reforms, broaden tax base, avoid tax holidays or new exemptions, scope for excise and property tax revenue.
  - Financial sector: continue reforms to reduce lending bottlenecks, maintain vigilance for vulnerabilities, address limited access for agriculture and SMEs.

### Debt Sustainability Analysis (DSA) — key messages and scenarios
- General projection and drivers
  - General government debt projected to increase but remain within sustainable levels; driven by the primary deficit and IFI financing for large infrastructure projects.
  - Continued compliance with the fiscal rule is the key anchor.
  - General government debt expected to increase from 20 percent of GDP in 2016 to 29 percent of GDP by 2022 assuming rapid absorption of IFI-financing.
- Selected quantitative projections (percent of GDP unless noted)
  - Nominal gross public debt: 2015: 16.3; 2016: 18.9; 2017: 19.6; 2018: 21.0; 2019: 21.8; 2020: 25.0; 2021: 26.3; 2022: 27.8; (table shows 29.1 in a column heading).
  - Public gross financing needs (percent of GDP): 2015: 2.4; 2016: 6.5; 2017: 7.8; 2018: 7.4; 2019: 6.0; 2020: 7.0; 2021: 7.4; 2022: 8.7; 2022 (alternative cell) 8.9.
  - Primary deficit (percent of GDP): 2015: 2.7; 2016: 1.6; 2017: 1.5; 2018: 0.8; 2019: 3.0; 2020: 3.4; 2021: 2.5; 2022: 2.7.
  - Real GDP growth (in percent): 2015: 3.9; 2016: 4.1; 2017: 4.1; 2018–2022: 4.1, 4.0, 4.0, 4.0, 4.0.
- Alternative scenarios
  - Public Investment Shock: Real GDP growth increases in the short term (e.g., 2017: 4.1 to 4.8; 2018–2022: 4.7) but primary balances deteriorate and effective interest rates rise.
- Risks and recommended responses (selected)
  - External: weaker-than-expected advanced economy growth (Likelihood: High; Expected Impact: Medium) — policy: adopt structural reforms to improve competitiveness and reduce remittance dependence.
  - Domestic: political instability (Likelihood: Medium; Expected Impact: Medium/High) — policy: strengthen political credibility by advancing job-creating and transparency measures.
  - Domestic: pressure on budget through social benefit increases and lower revenue (Likelihood: Medium; Expected Impact: Medium) — policy: reform social benefit system; tighten war veteran pension schemes.

### Reserve adequacy assessment
- Adjusted RA metric result:
  - Adjusted metric puts Kosovo’s reserve adequacy at about 12 percent of GDP by end-2016 and 2017 (estimated).
  - Gross international reserves reached 12 percent of GDP in 2016 and are expected to increase to 13.5 percent of GDP in 2017.
  - GIR as ratio of Adjusted Norm: 2016 = 97; 2017 (projected) = 110.
  - Interpretation: Reserves would remain at comfortable levels, covering 97 percent of the norm in 2016 and 110 percent (estimated) in 2017.

### Data and statistical issues
- Data adequacy
  - Data provision is adequate for surveillance but the statistical system suffers from shortages of financial and human resources.
  - National Accounts compilation broadly in line with international standards; quarterly GDP data can be inconsistent with annual data.
  - CPI produced monthly; HICP available from January 2010 onward.
  - Government finance reported on a cash basis; budget classification not consistent with GFSM 2014.
  - Monetary data compiled broadly consistent with IMF Manuals; CBK reports FSIs monthly.
  - CBK provides quarterly balance of payments and IIP data following BPM6 starting 2013:Q1.
- Reporting and dissemination
  - Kosovo participates in the enhanced General Data Dissemination System (e-GDDS); National Summary Data Page available since May 11, 2017.
  - Kosovo has not had a Data ROSC.

### Authorities’ views (selected)
- Growth and inflation
  - Authorities' estimate: GDP growth reached 4.3 percent in 2017.
  - Authorities project growth of 4.6 percent in the current year and 4.9 percent and 5.3 percent in 2019 and 2020 respectively under current reform pace assumptions.
- Fiscal policy
  - Provisional fiscal deficit lowered to 0.7 percent of GDP in 2017; bank balances increased to 5.3 percent of GDP.
  - 2018 budget approved targets deficit of 1.8 percent of GDP (excluding PAK and IFI capital projects); keeps wage bill constant as share of GDP.
  - Authorities plan to better target and means-test social benefit schemes and complete reclassification of war veterans as essential for fiscal sustainability.
- Financial sector
  - Capital adequacy ratio increased to 18.2 percent by end-November; NPL ratio declined to 3.4 percent; credit growth accelerated to 11.2 percent.
  - Authorities report near-completion of most FSAP recommendations and commitment to further supervisory strengthening.
- Structural reforms and energy
  - Authorities highlight National Development Strategy 2016-2021 priorities: business environment, governance, education, labor market, energy supply.
  - Kosova e Re project (500-megawatt thermal power plant) seen by authorities as a major potential boost to growth.

*Prepared by The European Department (in consultation with other departments and the World Bank); January 19, 2018.*

*Source: cr1830 - 2017. The staff team comprised Ms. Eble (head), Messrs. Cipollone*

### 2017. The staff team comprised  Ms. Eble (head), Messrs. Cipollone

### cr1830 - 2017. The staff team comprised  Ms. Eble (head), Messrs. Cipollone

### CONTEXT
- Kosovo is a small, unilaterally euroized economy with high unemployment, extensive informality, and a narrow production and export base, resulting in a large trade deficit largely financed by remittance flows.
- Since the 2015 Article IV and under a Stand-by Arrangement that expired in August 2017, steps were taken to foster fiscal sustainability, strengthen financial stability, and advance structural reforms (Annex I), contributing to recovery and confidence.
- A new multi-party coalition government took office in September 2017 after early general elections in June 2017; its thin parliamentary majority may affect reform pace. Pending indictments by a special war crimes tribunal (expected to start in 2018) and ratification of the border demarcation agreement with Montenegro are political risks. Kosovo is recognized by almost two-thirds of UN member states.

### RECENT DEVELOPMENTS, OUTLOOK AND RISKS
- Growth and labor market
  - Real GDP growth has averaged about 4 percent per year since 2015.
  - Staff project growth at 4.1 percent in 2017, led by investment, export growth, and higher remittance inflows.
  - Unemployment remains the highest in Europe at just above 30 percent; youth unemployment is about 50 percent.
- Macro-financial indicators and projections (IMF staff estimates; KAS)
  - Real GDP Growth (in percent): 2016: 4.1; 2017: 4.1; 2018: 4.0; 2019: 4.0; 2020: 4.0; 2021: 4.0; 2022: 4.0.
  - Contributions to 2017 growth (in percent): Consumption 1.1; Investment 3.4; Exports 3.6; Imports -3.9.
  - CPI inflation (average, in percent): 2016: 0.3; 2017: 1.5; 2018: 1.0; 2019: 1.9; 2020: 2.1; 2021: 2.2; 2022: 2.2.
  - Fiscal balance excluding PAK and donor projects (in percent of GDP): 2016: -1.1; 2017: -1.1; 2018: -1.8; 2019: -1.9; 2020: -1.9; 2021: -1.9; 2022: -1.9.
  - Stock of government bank balances (in percent of GDP): 2016: 3.5; 2017: 4.9; 2018: 4.5; 2019: 5.0; 2020: 5.0; 2021: 5.0; 2022: 5.0.
  - Total public debt (in percent of GDP): 2016: 19.6; 2017: 21.0; 2018: 21.8; 2019: 24.9; 2020: 26.3; 2021: 27.8; 2022: 29.0.
  - Current account balance, incl. official transfers (in percent of GDP): 2016: -8.9; 2017: -8.7; 2018: -8.9; 2019: -8.6; 2020: -7.9; 2021: -8.0; 2022: -7.7.
- Inflation and prices
  - Headline inflation expected to pick up to 1.5 percent in 2017 (driven by food and energy); core inflation has turned negative.
- Medium-term outlook and fiscal/debt outlook
  - Under gradual reforms, medium-term growth projected at 4 percent, driven by private consumption and investment; exports (mainly minerals) remain a relatively minor contribution.
  - Authorities’ objective: sustained growth above 5 percent to accelerate income convergence (GDP per capita in PPP terms was 20 percent of the EU average in 2016).
  - Even with scaled-up donor-financed public investment, debt-to-GDP projected to increase moderately but remain below the 30 percent threshold (Annex II).
- Risks (Annex III)
  - Downside: Weaker reform momentum (including political risks), lower remittances or EU growth, shortfalls in tax compliance, social spending pressures, low IFI and privatization financing—could lower growth and keep unemployment/migration high.
  - Upside: Moving ahead with a new power plant and accelerated reforms could attract more FDI and unlock large IFI financing for capital projects.

### EXTERNAL STABILITY ASSESSMENT
- Real effective exchange rate
  - Standard methodologies indicate REER remains stronger than implied by fundamentals and desirable policies in the range of 12-14 percent (compared to 15-18 percent at the last Article IV).
  - Improvement attributed to controlling public sector wages, budget consolidation, and some structural reforms (Annex IV).
- Trade balance and financing
  - Trade deficit remains substantial at 28-30 percent of GDP; exports have been increasing but from a low base.
  - Deficit largely financed by non-debt creating inflows: FDI (5 percent of GDP), remittances (15 percent), and other non-recorded capital inflows.
  - External debt expected to remain low at around 25 percent of GDP despite projected increase in IFI-financing.
- Reserves and reserve adequacy
  - Gross international reserves: 12 percent of GDP in 2016; expected to increase to 13.5 percent in 2017.
  - This covers more than 110 percent of a composite metric of reserve adequacy (ARA metric).
- Competitiveness indicators and reforms
  - Qualitative competitiveness indicators show improvement since 2014 (starting a business, registering property, trading across borders), largely reflecting adoption of new legislation aligned with EU directives rather than de-facto productivity gains.
- Authorities’ views
  - Authorities broadly concur on the external sector assessment but are more optimistic on reform implementation; Kosovo ranked among top 10 reformers in World Bank’s 2018 Doing Business Report but capacity constraints (notably human capital) hamper implementation.

### POLICY DISCUSSIONS
- Focus areas: (i) accelerating structural reforms to raise productivity and reduce unemployment; (ii) improving budget composition within fiscal rule limits and spending efficiency; (iii) safeguarding financial stability and deepening finance.
- Expected outcome: All three areas critical to improving competitiveness, achieving stronger and more equitable growth, and supporting income convergence with regional peers and the EU.

A. Structural Reforms: Improving Investment Climate, Governance and Competitiveness
- Binding constraints and inequality drivers
  - Perceived weak rule of law, large informal sector, inefficient public enterprises, poor public health and education systems, and poorly targeted social benefits contribute to inequality and low productivity.
- Governance and anti-corruption
  - E-procurement use delayed and limited; need to expand capacity, enforce mandatory use, and increase list of goods/services under centralized procurement.
  - Strengthen investigative capacity of the anti-corruption agency and asset declaration regime (including assets owned domestically and abroad); subject large public investment projects to ex-post audit.
- Public enterprises and privatization
  - Reform priorities: strengthen independence of supervisory boards, timely publication of financial statements, external audits, reduce operating costs via rightsizing employment and lowering excessively high wages.
  - Develop a clear divestment strategy; strengthen Privatization Agency institutional and governance structure to accelerate privatization/liquidation (over 50 percent of identified assets—around 10 percent of GDP—remain to be liquidated).
- Education and labor market
  - 2015 PISA score (Kosovo’s first participation) ranks Kosovo low among participating countries.
  - Need higher-quality and better-targeted education, enhanced vocational curricula, and timely implementation of Action Plans for youth employment and active labor market policies (with EU support).
- Minimum wage policy
  - Any increases should follow current rules-based minimum wage mechanism linking adjustments to prices, private sector wages, and competitiveness.
  - Large discretionary increases risk disadvantaging low-skilled workers, increasing youth unemployment, migration, or informality, and creating fiscal pressures by raising social benefit expectations.
- Energy constraints
  - Addressing energy supply shortages is key for tradable sector investment. A commercial agreement to replace Kosovo A with a higher-capacity plant projected to be completed in 2023, assuming no further delays.
- Authorities’ views and stakeholder input
  - Authorities agreed with reform priorities: rule of law, private sector development, skills, and energy gaps; they noted progress since independence is under-recognized in perception-based indicators.
  - Stakeholders (employers and trade unions) agreed on addressing inequality via education, health, fighting informality, enforcing labor standards, and better targeting social assistance.
  - Authorities not convinced that minimum wage increases beyond current rule would undermine competitiveness; internal discussions on raising the minimum wage and changing the mechanism are ongoing.

B. Fiscal Policy: Supporting Economic Growth Through Macro-stability, and Structural Revenue and Expenditure Policies
- Fiscal framework and performance
  - Existing fiscal rule: cap of 2 percent of GDP on fiscal deficit, excluding capital projects financed by privatization proceeds and donors; exemption for donor-financed investments can be invoked until 2025 provided debt remains below 30 percent of GDP.
  - 2017 fiscal deficit expected to be about 1 percent of GDP.
  - 2018 budget targets a deficit (fiscal rule definition) of 1.8 percent of GDP; wage bill kept constant as a share of GDP, in line with the wage bill rule.
  - If execution includes IFI and privatization-financed investment exempted from the fiscal rule of about 1 percent of GDP, overall 2018 fiscal deficit would be about 3 percent of GDP (from 1 percent).
- Fiscal policy implications
  - The fiscal rule provides an appropriate anchor for fiscal policy while allowing investment exemptions to address infrastructure gaps, subject to the debt threshold condition.

*Source: cr1830 - 2017. The staff team comprised  Ms. Eble (head), Messrs. Cipollone*

### 2017. While this would result in a pro-cyclical stance, the high import-content of investment and the

### cr1830 - 2017. While this would result in a pro-cyclical stance, the high import-content of investment and the

### Fiscal stance and medium-term outlook
- Authorities aim to maintain budget deficits below the fiscal rule’s ceiling, and—when including IFI and privatization-financed capital spending—at around 3 percent of GDP, on average.
- Public debt was 22 percent of GDP (2017).
- Bank balances target: 4.5 percent of GDP.
- Government debt is projected to increase in the medium term but the debt sustainability analysis shows it is expected to remain within sustainable levels (Annex II).
- Risks to the 2018 budget and need for efforts to reach the deficit target:
  - The budget assumes about ¾ percent of GDP in gains from revenue administration reforms, which may not be realized.
  - Social spending could exceed the budget allocation by about ¾ percent of GDP without timely reclassification and verification of war veteran pension beneficiaries and tight administration of other social benefits.
  - Pressures exist to move ahead with several new unbudgeted social spending initiatives.
  - Spending on Route 6 of some 2½ percent of GDP is expected to be needed in 2018.

### Revenue mobilization and reforms
- Total revenue increased to 26 percent of GDP, but remains some 10 percentage points below the EM Europe average (or 6 percentage points if contributions to the second pillar pension system are included) and is collected from a narrow base.
- Drivers of low tax revenue mobilization: low tax rates, high informality, weak collection efficiency.
- Estimated tax gaps:
  - VAT gap: one-third of potential taxes collected.
  - PIT gap: two-third of potential taxes collected.
  - CIT gap: close to 20 percent.
- Revenue composition: over three-quarters of Kosovo’s revenue comes from indirect tax (led by VAT and excise), making fiscal revenue highly vulnerable to consumption and imports.
- Recommendations to strengthen tax administration and reduce informality:
  - Set publicly available quantitative and strategic performance targets for the tax administration.
  - Allocate resources to activities that generate the highest yields (e.g., risk-based audits).
  - Improve efficiency and productivity of audits.
  - Significantly scale up tax debt collection.
  - Require filing a tax return by every registered taxpayer, even if no tax is due.
- Tax policy recommendations:
  - Minimize exemptions and increase yields by broadening the tax base.
  - New property tax legislation paves the way toward higher yields if exclusions of taxable objects or other tax relief are kept to a minimum.
  - No new VAT exemptions/reduced rate categories should be introduced.
  - Continue to increase excises on products, such as tobacco, in line with the current schedule; Kosovo has among the lowest tobacco excise rates in the region.
- Note on rates: The top PIT and CIT rates of 10 percent are roughly in-line with Western Balkan countries, except Albania and Serbia.

### Spending composition and efficiency
- Current spending increased from 17½ percent in 2011 to an estimated 20 percent in 2017, driven by social schemes and a higher wage bill (largely due to a wage hike in 2014).
- Kosovo spends relatively more on untargeted and work dis-incentivizing social benefits and public wages, worsening competitiveness and inequality.
- Staff recommendations on the wage bill and hiring:
  - Restrain across-the-board wage increases given already high public sector wage level.
  - Create space for priority hiring in the judiciary, health and education sectors within the limits of the rule.
  - Finance the health insurance scheme when introduced.
  - Reduce pressure from public sector wages on private sector wages to improve price competitiveness and job creation and reduce inequality between public-private employees.
- Social benefit reform priorities to improve effectiveness within existing spending envelope:
  - Strengthen mechanisms to ensure no double dipping.
  - Better means-testing and removal of disincentives to remain employed.
  - Tightly administer and enforce eligibility of schemes.
  - Make the system more equitable (e.g., align the disability threshold and payments for war veterans to those of the civilian disability scheme).
  - Complete credible re-classification and verification of war veterans in line with the law in early 2018 to keep current spending within the budget envelope.
  - Staff urges not to introduce any non-contributory early retirement schemes for special groups.
- Notes on social benefit spending:
  - Spending on war veteran benefits in 2017 was 1 percent of GDP (compared to the 0.7 percent targeted), and may increase to 1.2 percent of GDP in 2018 in the absence of reform.
- Health and education spending:
  - Healthcare and education spending levels and outcomes are poor.
  - The 2018 budget allocation has increased, but efficiency-improving reforms in the health care system must move forward to keep spending in check once the new insurance system is rolled out.
  - The contribution base must be broadened to secure sufficient revenue for health insurance.
  - Comprehensive education reforms should proceed to upgrade skills and address mismatches.
- Public investment and infrastructure:
  - Capital spending is already high; scope exists to scale up by improving absorption of donor financing and strengthening efficiency.
  - Large resources allocated to motorways (Routes 6 and 7); implementation of other priority projects has been limited by capacity constraints and low absorption of available IFI-financing.
  - Scaling up public investment and improving quality could raise potential GDP growth with an estimated growth dividend of up to 0.8 percent yearly.
  - Recommended reforms: require cost-benefit analysis of major capital projects; strengthen project appraisal, selection, preparation, and execution; adopt multi-year budgeting for investment projects; ensure ex-post independent audit and assessment of large-scale projects.

### Financing and investor base
- Financing has been readily available and largely absorbed by banks operating in Kosovo and to a lesser extent by other institutional entities, despite 100 percent risk-weightings on government paper for banks with EU-based parents (in the absence of a sovereign credit rating).
- The CBK currently holds €190 million (35 percent of total government securities) on its balance sheet.
- Authorities are gradually extending maturity of outstanding public debt (2-year average maturity), with recent 7-year issuances to reduce roll-over risks.
- Risks: normalization of euro area monetary policy may make it more difficult to sell bonds in the domestic market.
- Recommendation: diversify and expand the investor base to reduce costs and roll-over risks.

### Social outcomes and poverty (Box 1 highlights)
- As of 2015, 18 percent of the population was below the national poverty line of €1.82 a day.
- High unemployment: 31 percent in 2017.
- Low participation: 57 percent inactive.
- Poverty and distributional gains constrained by high unemployment and low participation; worse among youth and women.
- Social assistance expansion has skewed toward categorical benefits; pension and social assistance share of current expenditure increased from 21½ percent in 2010 to 36½ percent in 2016.
- High social benefit spending has not translated into above-average distributional outcomes due to factors including limited coverage, low adequacy, and targeting issues.

### Financial sector: stability and deepening
- Banking sector characteristics:
  - Largely foreign-owned, well-capitalized and liquid.
  - System NPL ratio has halved in the past two years to below 3½ percent.
  - Credit growth averaged 9½ percent y/y since January 2016.
  - Credit depth at 38 percent of GDP remains low relative to peers.
  - Credit growth concentrated in unsecured consumer lending; lending to productive sectors remains low.
  - About two-thirds of system loans to corporate sector and one-third to household sector.
  - 79 percent of strong FDI inflows since 2015 have been directed toward real estate and construction sectors; construction loans comprise only about 5 percent of bank loans.
- Recommendations to support financial deepening and lending to productive sectors:
  - Maintain momentum in implementing the amended Law on Enforcement Procedures, including reform of the PEA tariff structure and establishment of an independent PEA inspection unit at the Ministry of Justice.
  - Adopt pending legislation to automatically send certain property rights cases through official arbitration.
  - Accelerate reduction of the large court case backlog and prioritize large commercial cases; consider establishing a commercial court with specialized judges.
  - Establish a fully functioning cadaster system covering all of Kosovo; provide banks access to the recently-established agriculture registry.
- Supervisory vigilance:
  - Monitor strong and sustained consumer and construction lending for pockets of vulnerability.
  - Develop a housing price index or centralized registry of property valuations populated by real estate appraisers.
- Insurance sector reforms:
  - Sector is small (3 percent of system assets); returned to profitability after adoption of Solvency I rules, regulation to limit distribution costs, establishment of arbitration to resolve claims out of court, and phasing-in of regulations on internal controls and risk management.
- AML/CFT framework:
  - AML/CFT law adopted in June 2016 and supplementary regulations in November 2016.
  - CBK issued guidance on beneficial ownership and is moving toward a risk-based approach to AML/CFT supervision.
  - An AML/CFT assessment under PECK will be carried out in 2018 to assess alignment with best practice.

*Source: https://www.imf.org/-/media/files/publications/cr/2018/cr1830.pdf*

### 44.      The authorities shared staff’s view of the soundness of the banking system and do not

### The authorities shared staff’s view of the soundness of the banking system and do not

### Banking system soundness and credit developments
- Authorities and staff agree the banking system is sound and do not see any major pockets of vulnerabilities.
- CBK stress tests indicate resilience to most types of shocks, with some sensitivity to a further steep fall in lending rates.
- Authorities view strong growth in consumer and construction loans as reflective of pent-up demand and emphasize that banks have strengthened their risk management.
- Given ample capital buffers, authorities are confident banks can absorb losses from a potential real estate shock, including indirect exposures through consumer credit.
- Authorities consider expansion of the credit guarantee fund as key to support an acceleration of credit for the productive sector with an emphasis for SMEs.
- While credit has been growing at a healthy clip, authorities agree significant scope for further credit deepening remains and see improving access to finance as a priority.
- On structural bottlenecks to credit provision, authorities see the contribution from demand and supply side constraints as balanced.

### Other issues
- Article VIII acceptance:
  - Kosovo accepted Article VIII obligations on January 11, 2018.
  - Kosovo notified the Fund at the time it became a member in 2009 that it intended to avail itself of transitional arrangements under Article XIV, Section 2.
  - Staff completed an assessment of the foreign exchange system and found that Kosovo does not maintain multiple currency practices or exchange restrictions, except for restrictions maintained solely for reasons of international or national security, which have been notified to the Fund pursuant to Decision No. 144.
  - Staff will circulate a staff report to the Board noting Kosovo’s acceptance of Article VIII obligations.
  - The acceptance of Article VIII obligations will send a positive signal to the investor community about the liberalized foreign exchange system and thus help facilitate a favorable business climate.
- Data adequacy:
  - Data remain adequate for surveillance purposes.
  - Fiscal and financial sector data are of good quality and are timely and available.
  - Authorities need to make further efforts to implement recommendations provided in the recent past to improve the quality and timeliness of real sector data.
  - Authorities should begin to publish donor inflow data for the national accounts.

### Staff appraisal — macroeconomic and structural assessment
- Progress and macro policy:
  - Kosovo has made significant progress in recent years and sound financial and fiscal policies have helped to further strengthen the economy.
  - Since the 2015 Article IV consultations, the medium-term growth outlook has improved.
  - Current levels of international reserves and the government’s bank balance are adequate, which should help mitigate external and liquidity shocks, and the public-sector debt is low.
  - Given Kosovo’s unilateral euroization, maintaining macroeconomic and financial stability is key.
- Remaining structural challenges:
  - Important structural challenges remain, including an external competitiveness gap, high informality, weaknesses in governance, low labor force participation and high unemployment rates.
  - Resolving these structural problems should be a priority to reduce inequality and achieve stronger and more inclusive growth to reduce the still large income gap with regional peers and the EU.

### Policy recommendations and priorities
- Structural reforms to raise productivity and support private sector and export-led growth:
  - Improve governance and business climate, including implementing the laws on procurement and bankruptcy procedures, strengthening the effectiveness of the anti-corruption regime and making large public investment projects subject to ex-post audits.
  - Move ahead with the new power plant and prioritize investment spending in the budget with multi-year commitments to address energy and infrastructure bottlenecks.
  - Restructure public enterprises and improve their governance to pave the way for private sector involvement.
  - Advance planned reforms focused on addressing skill-mismatches by upgrading education to improve labor productivity and address high unemployment.
  - Any increases in the minimum wage should be in line with the current rule-based minimum wage setting mechanism and large discretionary increases avoided, given the still high level of unemployment, competitiveness gap and weak enforcement.
- Fiscal policy and public spending:
  - Maintain the fiscal rule, which has established an anchor for fiscal policy and provides an appropriate balance between fiscal discipline and developmental needs.
  - Improve composition of the budget and efficiency of spending to make space for higher and more productive investment in education, health and infrastructure.
  - Better target social benefits and resist pressures to introduce new schemes that further increase spending.
  - Finalize the reform of the war veteran pension in line with the law and avoid introducing unfunded early retirement schemes.
  - Limit wage increases within the wage bill rule to make space for priority hiring and the introduction of the new health insurance scheme.
  - Scale up public investment, improve its quality, make better use of IFI financing and strengthen the public investment framework.
- Revenue and tax policy:
  - Move ahead with revenue administration reforms to mobilize domestic revenue by broadening the tax base and reducing informality, given the low revenue to GDP ratio.
  - Avoid introducing tax holidays or new exemptions.
  - There is scope for additional revenue from excises and property taxes.
- Financial sector and access to finance:
  - Maintain strong reform momentum to reduce structural bottlenecks to lending.
  - Maintain vigilance for pockets of vulnerability in the context of strong credit growth and continue to strengthen the supervisory framework.
  - Address limited access: credit penetration remains low, and agriculture and SMEs remain underserved while the bulk of credit goes toward less productive sectors.

*Source: cr1830 (PDF chapter/section).*

### 54.      It is recommended that the next Article IV consultation take place on the standard 12-

### cr1830 - 54.      It is recommended that the next Article IV consultation take place on the standard 12-

### Recent Economic Developments
- Growth is largely driven by domestic demand, despite a sharp drop in private consumption in Q2 2017.
- Current account balance is dragged down by the trade deficit, even with large remittances and official transfers.
- Financing of the external gap is primarily via non-debt creating flows, such as FDI.
- Unemployment has fallen somewhat in recent years but remains very high, especially among the youth.
- Inflation remains positive, led by external commodity prices, but core inflation has turned negative.
- Data sources: Kosovo Agency of Statistics; Central Bank of Kosovo; KPST; and IMF staff estimates.

### Fiscal Developments and Budgetary Indicators
- Since 2014, the overall deficit has remained well within the fiscal rule ceilings.
- Total revenues continued to perform well in 2017.
- Wages and salaries have remained broadly constant as ratio of GDP in the last three years, while current spending has continued to grow.
- Capital spending execution has remained at about 7 percent of GDP, despite the investment clause.
- Bank balances restored above the 4.5 percent of GDP floor.

Key fiscal figures (percent of GDP unless otherwise noted; 2014–22 columns where shown):
- Revenues: 23.9 (2014), 25.1 (2015), 26.3 (2016), 26.2 (2017), projections 26.9 (2018), 26.6 (2019), 26.4 (2020), 26.2 (2021), 26.1 (2022).
- Primary expenditures: 26.3 (2014), 26.7 (2015), 27.3 (2016), 27.1 (2017), projections 29.6 (2018), 30.0 (2019), 28.9 (2020), 29.0 (2021), 28.7 (2022).
- Wages and salaries: 8.7 (2014), 9.0 (2015), 9.0 (2016), 8.6 (2017), 8.7 (2018–2019–2021 ranges), 8.6 (2022).
- Subsidies and transfers: 6.6 (2014), 7.4 (2015), 8.0 (2016), 7.9 (2017), 7.8 (2018–2022 projections).
- Capital and net lending: 7.3 (2014), 6.8 (2015), 7.0 (2016), 7.1 (2017), projections 8.1 (2018), 7.7 (2019), 7.5 (2020–2021), 7.3 (2022).
- Overall balance Ex-PAK ex-IFI capital projects (Fiscal rule): -2.3 (2014), -1.7 (2015), -1.1 (2016), -1.1 (2017), projections -1.8 (2018), -1.9 (2019–2022).
- Overall balance excluding PAK current spending: -2.3 (2014), -1.7 (2015), -1.1 (2016), -1.1 (2017), projections -2.9 (2018), -3.7 (2019), -2.7 (2020), -3.0 (2021), -2.9 (2022).
- Stock of government bank balances (% of GDP): 1.8 (2014), 3.5 (2015), 3.5 (2016), 4.9 (2017), projections 4.5 (2018), 5.0 (2019–2022).
- Total public debt (percent of GDP): 16.7 (2014), 18.9 (2015), 19.6 (2016), 21.0 (2017), projections 21.8 (2018), 24.9 (2019), 26.3 (2020), 27.8 (2021), 29.0 (2022).
- Of which: Debt of the former Yugoslavia: 6.3 (2014), 5.8 (2015), 5.2 (2016), 4.6 (2017), projections 4.0 (2018), 3.4 (2019), 2.9 (2020), 2.4 (2021), 1.9 (2022).

Selected consolidated budget (millions of euro; 2014–22, projections):
- Revenue and grants (excluding donor designated grants): 1,333 (2014), 1,455 (2015), 1,595 (2016), 1,713 (2017), 1,683 (2018), 1,817 (2019), 1,896 (2020), 1,992 (2021), 2,102 (2022), 2,218 (projection column).
- Taxes: 1,162 (2014), 1,269 (2015), 1,424 (2016), 1,512 (2017), 1,498 (2018), 1,607 (2019), 1,686 (2020), 1,770 (2021), 1,866 (2022), 1,967 (projection).
- Primary expenditure (millions): 1,464 (2014), 1,552 (2015), 1,657 (2016), 1,989 (2017), 1,737 (2018), 2,081 (2019), 2,139 (2020), 2,180 (2021), 2,322 (2022), 2,443 (projection).
- Capital expenditure and net lending (millions): 404 (2014), 395 (2015), 426 (2016), 715 (2017), 457 (2018), 695 (2019), 613 (2020), 677 (2021), 634 (2022), 685 (projection).

Notes and assumptions cited in the budget tables:
- 1/ Does not yet reflect the GFSM 2001 methodology.
- 2/ For fiscal rule purposes, only projects post-July 2015 apply.
- 3/ Kosovo neither recognizes nor services nor tracks this debt.
- 4/ Assumes tax compliance gains of 0.7 percent of GDP, a timely and full implementation of the war veteran pension law, and tight administration for all other budgeted social schemes.
- 5/ Assumes a lower execution of IFI and PAK financed investments, taking into account implementation capacity.

### Banking Sector Overview and Financial Soundness
- Strong household and corporate credit growth continues, aided by historically low interest rates.
- Asset quality remains strong and banks remain well-capitalized and liquid, despite some shortening of deposit tenors.
- Profitability peaked in late 2015 but remains positive.

Selected banking indicators (levels and percent changes as reported):
- Non-performing loans (percent of total loans): 8.3 (2014), 6.2 (2015), 4.9 (2016), 3.4 (2017 as of November 2017).
- Bank credit to the private sector (percent change): 5.3 (2014), 7.3 (2015), 10.3 (2016), 10.5 (2017), projections 10.1 (2018), 10.4 (2019), 9.4 (2020), 9.1 (2021), 8.7 (2022).
- Deposits of the private sector (percent change): 4.0 (2014), 7.3 (2015), 8.7 (2016), 7.7 (2017), projections 7.3 (2018), 7.5 (2019), 7.8 (2020), 8.2 (2021), 8.4 (2022).
- Regulatory capital/risk weighted assets: 17.8 (2014), 19.0 (2015), 17.9 (2016), 18.7 (2017).
- Deposits of the private sector (Percent of GDP): 42.7 (2014), 43.9 (2015), 45.7 (2016), 46.6 (2017).
- Credit to the private sector (Percent of GDP): 33.8 (2014), 34.8 (2015), 36.7 (2016), 38.3 (2017).
- Financial soundness indicators (selected, percent):
  - Regulatory capital to risk weighted assets: 14.2 (2013), 16.7 (2014), 17.8 (2015), 19.0 (2016), 17.9 (2017).
  - NPL to total loans: 7.5 (2013), 8.7 (2014), 8.3 (2015), 6.2 (2016), 4.9 (2017).
  - Return on average assets: 0.8 (2013), 1.0 (2014), 1.9 (2015), 2.9 (2016), 2.2 (2017).
  - Liquid assets to total assets: 34.3 (2013), 37.8 (2014), 38.3 (2015), 37.8 (2016), 36.0 (2017).

### Key Macroeconomic Indicators and Projections (select)
- Real GDP growth: 1.2 (2014), 4.1 (2015), 4.1 (2016), 4.1 (2017), projections 4.0 (2018–2022).
- Contribution to growth — Consumption (percentage points of GDP): 7.2 (2014), 4.6 (2015), 4.7 (2016), 1.1 (2017), projections 4.3 (2018), 3.7 (2019–2021), 3.8 (2022).
- CPI, period average: 0.4 (2014), -0.5 (2015), 0.3 (2016), 1.5 (2017), projections 1.0 (2018), 1.9 (2019), 2.1 (2020), 2.2 (2021–2022).
- Official unemployment (percent of workforce): 35.3 (2014), 32.9 (2015), 28.7 (2016), 30.6 (as of Q2 2017).
- GDP (millions of euros): 5,567 (2014), 5,807 (2015), 6,070 (2016), 6,414 (2017), projections 6,749 (2018), 7,135 (2019), 7,556 (2020), 8,011 (2021), 8,508 (2022).
- GDP per capita (euros): 3,023 (2014), 3,160 (2015), 3,301 (2016), 3,436 (2017), projections 3,562 (2018), 3,710 (2019), 3,871 (2020), 4,044 (2021), 4,231 (2022).

### Balance of Payments Highlights (2014–22; millions of euros and percent of GDP)
- Goods and services balance (millions): -1,610 (2014), -1,665 (2015), -1,726 (2016), -1,730 (2017), projections -1,824 (2018), -1,908 (2019), -1,970 (2020), -2,105 (2021), -2,224 (2022).
- Exports (millions): 324 (2014), 322 (2015), 308 (2016), 390 (2017), projections 425 (2018), 454 (2019), 485 (2020), 524 (2021), 574 (2022).
- Imports (millions): -2,383 (2014), -2,432 (2015), -2,599 (2016), -2,854 (2017), projections -3,019 (2018), -3,216 (2019), -3,395 (2020), -3,662 (2021), -3,873 (2022).
- Transfers (millions): 1,109 (2014), 1,062 (2015), 1,096 (2016), 1,088 (2017), projections 1,133 (2018), 1,203 (2019), 1,282 (2020), 1,362 (2021), 1,447 (2022).
  - Official transfers: 292 (2014), 203 (2015), 207 (2016), 168 (2017), projections 177 (2018), 186 (2019), 192 (2020), 204 (2021), 216 (2022).
  - Remittances / other transfers (net): 817 (2014), 859 (2015), 889 (2016), 920 (2017), projections 956 (2018), 1,018 (2019), 1,090 (2020), 1,158 (2021), 1,232 (2022).
- Current account (millions): -392 (2014), -504 (2015), -543 (2016), -555 (2017), projections -603 (2018), -615 (2019), -595 (2020), -638 (2021), -657 (2022).
- Current account (percent of GDP): -7.0 (2014), -8.7 (2015), -8.9 (2016), -8.7 (2017), projections -8.9 (2018), -8.6 (2019), -7.9 (2020), -8.0 (2021), -7.7 (2022).
- Capital and financial account (percent of GDP): 3.2 (2014), 4.4 (2015), 2.1 (2016), 7.2 (2017), projections 6.7 (2018), 6.7 (2019), 5.9 (2020), 6.0 (2021), 6.1 (2022).
- Net foreign direct investment (percent of GDP): 2.2 (2014), 4.7 (2015), 3.0 (2016), 5.0 (2017), projections 5.0 (2018–2019), 5.2 (2020–2021), 5.0 (2022).
- Gross international reserves of the CBK (millions): 645 (2014), 734 (2015), 730 (2016), 872 (2017), projections 965 (2018), 1,082 (2019), 1,110 (2020), 1,141 (2021), 1,195 (2022).
- Gross international reserves in months of imports: 2.7 (2014), 3.0 (2015), 2.9 (2016), 3.1 (2017), projections 3.3 (2018), 3.5 (2019), 3.4 (2020), 3.2 (2021), 3.2 (2022).

### Additional Observations and Memoranda
- National savings and investment (percent of GDP): National savings 13.5 (2014), 15.2 (2015), 14.8 (2016), 17.6 (2017), projections 18.8 (2018), 21.3 (2019), 21.4 (2020), 22.0 (2021), 22.6 (2022). Investment 25.8 (2014), 27.6 (2015), 27.2 (2016), 28.9 (2017), projections 30.4 (2018), 32.5 (2019), 31.8 (2020), 32.5 (2021), 32.8 (2022).
- Current account excluding official transfers: -12.3 (2014), -12.4 (2015), -12.4 (2016), -11.3 (2017), projections -11.6 (2018), -11.2 (2019), -10.4 (2020), -10.5 (2021), -10.3 (2022).
- Debt service and external debt ratios (memorial items): External debt (percent of GDP) 23.4 (2014), 24.7 (2015), 24.5 (2016), 24.9 (2017), projections 24.9 (2018), 25.6 (2019), 24.5 (2020), 23.9 (2021), 23.7 (2022).
- Memorandum: Kosovo neither recognizes nor services nor tracks the debt of the former Yugoslavia.

*Sources: Kosovo authorities; and IMF staff estimates and projections.*

### Annex I. Implementation Status of the 2015 Article IV

### Annex I. Implementation Status of the 2015 Article IV Recommendations

### Structural reforms to improve growth and competitiveness
- Compliance status: Weak compliance
- Improve governance and business environment
  - The PAK Board was nominated, but with 3 out of the 5 board members whose mandate has expired not yet replaced, the board does not currently have a quorum.
  - The vacant seats of the Procurement Review Board (PRB) were also filled and the new legislation making e-procurement mandatory has been adopted, but only implemented in full yet.
  - Laws on contract enforcement and bankruptcy procedures were passed, but implementation remains pending.
  - Improvement in doing of business indicators. However, some of the improvements in the ranking on reflect changes to laws that have not been implemented yet.
  - A new AML/CFT law was adopted in 2016 and its implementation is ongoing.
- Reduce labor skill mismatching
  - No particular measures have been undertaken.
  - The 2016 PISA assessment (the first one conducted in Kosovo) shows very weak results.
- Replace and upgrade energy infrastructure
  - No substantial progress in this area yet.
  - Discussion is ongoing between authorities, the winning bidder and the World Bank.
  - The 400 Kv interconnection between Albania and Kosovo, which would help mitigate temporary supply fluctuations, was completed but not activated yet for political obstacles between Serbia and Kosovo.

### Fiscal policy
- Compliance status: Good compliance
- Fiscal consolidation by compressing current spending and VAT reform
  - The fiscal deficit has been reduced from 2.3 percent of GDP in 2014 to 1.1 percent in 2016 and it is expected to remain within the fiscal rule ceiling (below 2 percent) in 2017.
  - Despite GDP growth, current spending has increased by about 1 percent of GDP because of untargeted war veteran pension and other social benefits.
  - The standard VAT rate was increased from 16 to 18 percent, while a reduced rate of 8 percent for a limited category of goods was introduced.
- Limit public wage growth by linking it to macroeconomic indicators
  - The wage bill has remained fairly constant as a share of GDP during 2015-17.
  - A rule-based mechanism to limit any future increases to nominal GDP growth was adopted in 2015 and has become effective with the 2018 budget.

### Financial sector
- Compliance status: Strong compliance
- Improve bank supervision, strengthen Emergency Liquidity Assistance (ELA) framework
  - On-site supervision of all banks following the risk-based manual has been completed.
  - A new ELA regulation, in line with the best international practices, is in place.
  - A macroprudential framework has been also adopted and the authorities are in the process of operationalizing it.
- Remove bank lending impediments
  - An amended Law on Enforcement Procedures was passed, which should improve court operations, reduce existing bottlenecks to contract enforcement, and fully establish a unique account registry but still requires implementation.
  - A manual on PEA supervision has been adopted; the number of PEAs has been increased, although the number is still at 38 (compared to a target of 72).
  - Regulations have been updated to facilitate NPL write-offs.
  - Kosovo still lacks a fully functioning property registry.

---

### Annex II. Debt Sustainability Analysis (DSA)

### Key messages and assumptions
- General: The general government debt is projected to gradually increase, but remain well within sustainable levels, largely driven by the primary deficit and IFI financing for large infrastructure projects within the WBIF context.
- Continued compliance with the fiscal rule remains the key anchor to preserve fiscal sustainability.
- A gradual increase (up to three years) in the average maturity of outstanding domestic debt is assumed.
- IFI financing reflects the financial terms currently provided.
- The fiscal deficit, excluding IFI-financed projects and projects financed by non-debt creating financial flows (privatization proceeds), is expected to remain within the 2-percent of GDP fiscal deficit rule ceiling throughout the projection period.

### Public DSA — projections and drivers
- Coverage: The general government debt covers both contracted and guaranteed debt of the general government. Debt stock contracted by the state-owned enterprises are not included.
- Composition: The share of the domestic debt is close to two-third of the total (large bank loans). The external debt is largely owed to multilaterals, namely the IDA, EIB and EBRD.
- Projection: General government debt is expected to increase from 20 percent of GDP in 2016 to 29 percent of GDP by 2022, assuming a rapid increase in absorption of IFI-financing for new capital investments, particularly to implement regional connectivity projects within the WBIF context.
- Main contributors to debt accumulation:
  - The primary deficit, including IFI-financed projects, is the large contributor to the debt accumulation.
  - Higher real interest rates contribute to a lesser extent.
- Gross financing needs and maturity
  - Current annual gross financing needs are reported as 8 percent of GDP.
  - Continued efforts to increase the average maturity of domestic debt stock should continue to reduce annual gross financing needs and contain roll-over risks.
  - The CBK started purchasing Kosovo government securities in the secondary market in mid-2015. Now, it holds close to €190 million, about 35 percent of the outstanding stock and highly concentrated (up to 96.5 percent of a single T-bond).

### External DSA — projections and risks
- Total external debt (public and private) is expected to decline to 24 percent of GDP after having peaked at 25½ percent of GDP in 2019.
- Large gross financing needs reflect the assumption that all private debt is of a short-term nature, largely short-term credit from foreign parent banks.
- It is also assumed a gradual decline of neither recognized nor serviced of the portion of the former Yugoslavia debt.
- Shock scenarios:
  - A sharp contraction in remittances could have an adverse impact on the current account, but declines in remittances would be largely offset by a contextual decline in imports.
  - Sizable unrecorded remittances, now included in errors and omissions, would substantially reduce the actual current account deficit if assumed as remittances.

### Selected quantitative projections and indicators (from Figure 1 and tables; in percent of GDP unless otherwise indicated)
- Nominal gross public debt: 2015: 16.3; 2016: 18.9; 2017: 19.6; 2018: 21.0; 2019: 21.8; 2020: 25.0; 2021: 26.3; 2022: 27.8; (table shows 29.1 in a column heading as final projection).
- Public gross financing needs (percent of GDP): 2015: 2.4; 2016: 6.5; 2017: 7.8; 2018: 7.4; 2019: 6.0; 2020: 7.0; 2021: 7.4; 2022: 8.7; 2022 (alternative cell) 8.9.
- Real GDP growth (in percent): 2015: 3.9; 2016: 4.1; 2017: 4.1; 2018–2022: 4.1, 4.0, 4.0, 4.0, 4.0.
- Inflation (GDP deflator, in percent): 2015: 3.1; 2016: 0.2; 2017: 0.4; 2018: 1.5; 2019: 1.2; 2020: 1.7; 2021: 1.8; 2022: 1.9; 2022 (final column) 2.1.
- Nominal GDP growth (in percent): 2015: 7.1; 2016: 4.3; 2017: 4.5; 2018: 5.7; 2019: 5.2; 2020: 5.7; 2021: 5.9; 2022: 6.0; final 6.2.
- Effective interest rate (in percent): 2015: 1.4; 2016: 1.7; 2017: -1.7; 2018: 1.9; 2019: 2.8; 2020: 3.1; 2021: 3.1; 2022: 3.0; final 3.0.
- Change in gross public sector debt (cumulative): 2015: 0.9; 2016: 2.2; 2017: 0.7; 2018: 1.4; 2019: 0.8; 2020: 3.1; 2021: 1.4; 2022: 1.4; cumulative: 9.5.
- Identified debt-creating flows (cumulative): 1.6; 2.4; 1.4; 1.7; 1.5; 3.7; 2.1; 2.2; 2.2; cumulative: 13.4.
- Primary deficit (percent of GDP): 2015: 2.7; 2016: 1.6; 2017: 1.5; 2018: 0.8; 2019: 3.0; 2020: 3.4; 2021: 2.5; 2022: 2.7; cumulative: 15.1.
- Primary (noninterest) revenue and grants (percent of GDP): 2015: 24.7; 2016: 25.1; 2017: 26.3; 2018: 26.2; 2019: 26.7; 2020: 26.5; 2021: 26.3; 2022: 26.2; cumulative: 157.9.
- Primary (noninterest) expenditure (percent of GDP): 2015: 27.4; 2016: 26.6; 2017: 27.8; 2018: 27.1; 2019: 29.6; 2020: 29.9; 2021: 28.8; 2022: 28.9; cumulative: 173.0.
- Automatic debt dynamics (cumulative): -0.4; 0.4; -0.4; -0.7; -0.5; -0.5; -0.7; -0.7; -0.8; cumulative: -4.0.
- Residual, including asset changes (cumulative): -0.7; -0.2; -0.7; -0.3; -0.7; -0.5; -0.7; -0.8; -0.8; cumulative: -3.9.

### Alternative scenarios (selected)
- Historical and constant primary balance scenarios show a more favorable debt profile compared with baseline.
- Public Investment Shock scenarios:
  - Real GDP growth increases in the short term (e.g., 2017: 4.1 to 4.8; 2018–2022: 4.7).
  - Primary Balance under the shock: -0.8; -3.7; -4.1; -3.2; -3.4; -3.4 (2017–2022).
  - Effective interest rate under the shock rises: 1.9; 2.7; 3.5; 3.9; 4.1; 4.3.

### External debt sustainability indicators (selected from Table 1)
- Baseline external debt (percent of GDP): 2014: 23.4; 2015: 24.7; 2016: 24.5; 2017: 24.9; 2018: 24.9; 2019: 25.6; 2020: 24.5; 2021: 23.9; 2022: 23.7.
- Gross external financing need (in millions of EUR and percent of GDP): 2014: 903.1 (16.2 percent of GDP); 2015: 1060.2 (18.3); 2016: 1176.0 (19.4); 2017: 1181.2 (19.2); 2018: 1245.3 (19.3); 2019: 1321.6 (19.4); 2020: 1384.0 (19.1); 2021: 1465.6 (18.2); 2022: 1494.8 (18.5).
- External debt-to-exports ratio (in percent): 2014: 105.8; 2015: 113.8; 2016: 110.6; 2017: 97.7; 2018: 97.5; 2019: 98.6; 2020: 93.2; 2021: 89.4; 2022: 87.2.
- Debt-stabilizing non-interest current account (percent of GDP): -6.2 (shown in table footnote).

### Risks, likelihood, impact, and recommended policy responses (selected)
- External risks
  - Weaker-than-expected growth in key advanced economy; weaker growth in Germany or Switzerland could reduce consumption and investment and/or increase the current account deficit, given remittance/FDI dependence.
    - Likelihood: High
    - Expected Impact: Medium
    - Recommended policy response: The authorities should adopt structural reforms that improve competitiveness, and increase exports and domestic production to reduce the dependency from remittances.
  - Intensification of fragmentation/security dislocation in parts of Middle East, Africa, Asia, and Europe.
    - Likelihood: High
    - Expected Impact: Low
    - Recommended policy response: The authorities should closely monitor the situation and be ready to collaborate with the EU and neighbor countries to design and implement any response.
- Domestic risks
  - Political instability, including early elections: Slim majority of the new coalition government could hamper the reform process or lead to early elections.
    - Likelihood: Medium
    - Expected Impact: Medium/High
    - Recommended policy response: The authorities should strengthen political credibility by moving forward with key measures that would promote job creation, increase transparency and fight corruption.
  - Pressure on the budget through increases of social benefits and lower fiscal revenue.
    - Likelihood: Medium
    - Expected Impact: Medium
    - Recommended policy response: Reform social benefit system. Tighten the war veteran pension schemes, and resist to new categorical social schemes.

*Source: IMF staff.*

### introduction of unfunded pension

### introduction of unfunded pension

### Risk Assessment Matrix — Key Risks and Policy Responses
- Source of Risks: Unaddressed energy issues (aging power plants beyond economic lifespan; operate significantly below installed capacity; unable to provide reliable electricity without new generation capacity).
  - Relative Likelihood: Medium/High
  - Expected Impact: Medium/High
  - Expected impact description: Additional power cuts will further disrupt economic activity, while further undermining the weak business environment.
  - Recommended Policy Response: Following more than a decade of discussions, the authorities should accelerate protracted negotiations with its partners to replace Kosovo A to enable starting the groundwork as soon as possible.

- Upside Risks: Government implements an ambitious reform agenda, including a comprehensive reform of social benefits, decisively tackling corruption, improved capacity for higher IFI financing for capital projects, and starting the implementation of the new power plant.
  - Relative Likelihood: Low/Medium
  - Expected Impact: Low (Impact would be low in the next 12-24 months, but could be significant in the medium term.)
  - Recommended Policy Response: The authorities should build social and political consensus for reforms. Focus on the actual implementation of laws.

- Note on RAM methodology:
  - “Low” = probability below 10 percent; “medium” = probability between 10 and 30 percent; “high” = probability between 30 and 50 percent.
  - The RAM reflects staff views on sources of risks and overall level of concern as of the time of discussions. Non-mutually exclusive risks may interact and materialize jointly.

*The scenario most likely to materialize in the view of IMF staff is reflected in the baseline RAM.*

### Competitiveness and Real Exchange Rate Assessment — Findings and Implications
- Overall finding: Large current account deficits and real exchange rate overvaluation indicate a competitiveness gap, even though lower than that estimated in 2015. Some progress since 2015 achieved by controlling public sector wages, consolidating the budget, and moving ahead with structural reforms.
- Policy priority: Accelerate implementation of structural reforms, improve the composition of the budget, reduce the infrastructure gap, and deepen access to financing to raise productivity.
- Reserves: Reserves have remained at an adequate level.

- External accounts and financing:
  - Trade deficit: remained in the range of 28-29 percent of GDP in the last 3 years.
  - Imports: remained close to 50 percent of GDP, growing at the same pace as GDP.
  - Remittances: both recorded and unrecorded (included in errors and omissions) have been at around 14-17 percent of GDP in the last 3 years.
  - FDIs: expected to reach 5 percent of GDP in 2017, up from 3 percent recorded in 2016.
  - Disbursements from new IFI-financed projects: zero in 2017; expected to accelerate in coming years.

- Real Exchange Rate (REER) assessment approach:
  - Two methodologies used: current account (EBA-lite) and external sustainability approaches.
  - Adjustments: underlying current account adjusted to include one-third of errors and omissions to account for large unrecorded remittances.
  - REER approach could not be conducted given limited time series availability.

- Results summary:
  - Improvement relative to 2015 achieved due to timely fiscal adjustment and structural reform under the SBA-supported program 2015-17.
  - EBA-lite (CA approach) results:
    - CA Norm: -4.4 percent of GDP
    - Adjusted Underlying CA: -7.5 percent of GDP
    - CA Gap: -3.1 percent of GDP
    - RER Gap: 15.2
  - External Sustainability results (benchmark to stabilize NIIP at around -60 percent of GDP in 2035):
    - CA Norm: -5 percent of GDP
    - Adjusted Underlying CA: -7.5 percent of GDP
    - CA Gap: -2.5 percent of GDP
    - RER Gap: 12.4
  - RER Elasticity: 0.2 (for entries in the table)

- Medium-term outlook: External imbalances expected to decline due to projected expansion of the export base and slower import growth as domestic production expands.
- Rationale for NIIP benchmark: Kosovo likely to continue to receive FDI inflows and borrow from IFIs to implement priority infrastructure projects; NIIP target of around -60 percent of GDP in 2035 is in line with current level of Albania but below the average regional level. Stabilizing NIIP at -60 percent of GDP implies a CA norm of -5 percent of GDP and a real exchange rate overvaluation of 12.4 percent.

### Reserve Adequacy Assessment — Metrics and Indicators
- Role of reserves: Mitigate external risks and reduce likelihood of balance of payments crises; liquidity buffers needed for fully euroized economies to support domestic financial institutions and government financing.
- Adjusted RA metric used for Kosovo:
  - RA = 10% (X+R) + 30%STD + 15%OPL + 15%LPD
- Assessment results:
  - Adjusted metric puts Kosovo’s reserve adequacy at about 12 percent of GDP by end-2016 and 2017 (estimated).
  - Gross international reserves reached 12 percent of GDP in 2016 and are expected to increase to 13.5 percent of GDP in 2017.
  - Reserves relative to norm:
    - 2016: GIR = 12; Adjusted Norm = 12.4; GIR as a ratio of the Adjusted Norm = 97
    - 2017 (projected): GIR = 13.5; Adjusted Norm = 12.3; GIR as a ratio of the Adjusted Norm = 110
  - Interpretation: Reserves would remain at comfortable levels, covering 97 percent of the norm in 2016 and 110 percent (estimated) in 2017.
- Notes on metric definition and components:
  - Alternative RA metric suggested for fixed exchange rate economies: RA = 10%X + 30%STD + 15%OPL + 10%M2 (IMF, 2011, Assessing Reserve Adequacy, IMF Policy Paper).
  - Gross international reserves include: (i) reserve assets, (ii) SDR allocation, and (iii) IMF net disbursement, minus deposits of the privatization agency and pension funds, which are not under the control of government and CBK.
  - Reserves in the range of 100-150 percent of the composite metric are considered broadly adequate for precautionary purposes.

### Financial Sector Assessment (FSAP) Recommendations — Implementation Status
- Short Term (within 12 months of FSAP):
  - Ensure legal defense costs for CBK employees sued while carrying out official responsibilities are carried out ex ante.
    - Status: Completed. CBK developed instructions for legal representation when staff is sued for carrying out official duties in good faith.
  - Subject ELA granted to potentially insolvent systematically important institutions to very strict conditions.
    - Status: Completed. CBK operationalized this understanding, including modifying the tripartite MOU on financial stability cooperation to clarify CBK and MOF responsibilities in ELA.
  - DIL should raise the DIFK target level to 8-9 percent of insured deposits and clarify use of government and KfW contributions; banks’ premiums should not be reduced.
    - Status: Completed. In January 2013, DIFK set a working range of the DIF to 8-9 percent to be reached within 14 years. Legislation clarified that contributions by the government and KfW can be used to repay insured deposits.
  - Amend the Banking Law to address shortcomings in bank resolution framework and obstacles to competition and MFI sector development.
    - Status: In progress. New Banking and Microfinance Law passed in 2012 to enhance CBK’s supervisory and resolution powers. Obstacles to competition for microfinance sector remain; CBK working on draft legislation.

  - Reinstate Solvency I for all insurers; establish investment regulation; mandatory annual actuarial audit; retain two in-house actuaries.
    - Status: Completed. Solvency I adopted. One actuary appointed in the CBK.

- Medium Term (within one to three years of FSAP):
  - Institute a bank premium to fund ELA needs.
    - Status: Incomplete. Authorities consider bank premium unnecessary given ELA’s sufficient coverage and comfort letters from foreign parent banks.
  - Put in place extraordinary funding arrangements for the DIFK.
    - Status: In progress. DIFK concluded a series of agreements with the EBRD for credit lines.
  - Adopt legal framework for crisis management, contingency plans, and perform crisis simulations.
    - Status: In progress. Kosovo created a National Financial Stability and Crisis Management Committee (FSC) with an MOU; conducted a crisis simulation with World Bank assistance. CBK drafting a crisis management framework to be finalized by end-June 2018.
  - Conduct comprehensive review of financial system legal and regulatory framework to remove inconsistencies.
    - Status: Completed. Several legislative and regulatory initiatives adopted in recent years.
  - Revise AML legislation to address technical weaknesses.
    - Status: Completed. New AML/CFT law passed in May 2016; subsequent regulation adopted by CBK in November 2016. An AML/CFT assessment will be carried out in 2018 under the PECK II project.
  - Introduce risk-based supervision focused on systemic banks and parent-bank relations; enhance CBK supervisory capacity.
    - Status: Completed. CBK’s Bank Supervision Department received extensive TA over 2014-16 to roll out risk-based supervision to all banks, align regulations with international standards, and enhance staff capacity.
  - Enact out-of-court insurance dispute resolution mechanism.
    - Status: Completed. New regulation introduced in March 2017; implementation in progress.
  - Enhance stress testing framework to include macro scenario analysis and macro-financial linkages.
    - Status: In progress. CBK utilizes such stress testing in its semiannual financial stability report and is working with IMF TA to strengthen the framework and incorporate stress testing into macroprudential policy.
  - Develop and implement macroprudential policy using quantifiable indicators and policy instruments.
    - Status: Completed. CBK adopted a macroprudential policy framework with IMF TA, including quantifiable indicators and policy instruments.

### Fund Relations and Key Financial Data (as of December 31, 2017)
- Membership Status:
  - Joined: June 29, 2009; Article VIII (as of January 11, 2018).
- Quota and holdings (SDR Million; Percent Quota):
  - Quota: 82.60 (100.00)
  - Fund holdings of currency: 197.94 (239.64)
  - Reserve Tranche Position: 20.07 (24.29)
- SDR Department:
  - Net cumulative allocation: 55.37 (100.00)
  - Holdings: 55.84 (100.86)
- Outstanding Purchases and Loans:
  - Stand-By Arrangements: 135.4 (163.92)
- Latest Financial Arrangements (selected entries from table):
  - Stand-By: Date of Arrangement July 29, 2015 — Amount Approved (SDR Million) 147.50 — Amount Drawn (SDR Million) 78.22
  - Stand-By: Date of Arrangement July 21, 2010 — Amount Approved (SDR Million) 92.66 — Amount Drawn (SDR Million) 18.76
- Projected Payments to Fund (SDR Million; based on existing use of resources and present holdings of SDRs):
  - Forthcoming Principal and Charges/Interest totals by year:
    - 2018: Principal 3.51; Charges/Interest 2.37; Total 5.88
    - 2019: Principal 24.59; Charges/Interest 2.16; Total 26.75
    - 2020: Principal 54.29; Charges/Interest 1.60; Total 55.88
    - 2021: Principal 43.11; Charges/Interest 0.70; Total 43.82
    - 2022: Principal 9.90; Charges/Interest 0.09; Total 9.99

*Prepared by The European Department (in consultation with other departments and the World Bank); January 19, 2018.*

*Source: cr1830 - introduction of unfunded pension (cr1830.pdf).*

### 2. Bank  work

### 2. Bank  work

### Statistical issues — Assessment of data adequacy for surveillance
- General
  - Data provision is adequate for surveillance.
  - The statistical system suffers from considerable shortages of financial and human resources.
- National Accounts
  - Compilation methods used for annual national accounts (ANA) are broadly in line with the international standards.
  - Annual nominal and real GDP data quality and timeliness improved.
  - GDP by economic activity and by expenditure are published simultaneously in an excel format on the web-site of the Kosovo Statistical Agency with a delay of 10 months.
  - Quarterly national accounts series provide a first estimate of the annual GDP by April every year; further reduction in the time lag in dissemination of ANA is advisable.
  - Quarterly GDP data can be inconsistent with annual data (upon publication), requiring significant revisions; improvements in methodology are required.
  - Need to improve existing and develop additional high-frequency (monthly) indicators, with priority to wholesale and retail trade data and services.
- Labor Markets
  - Reliable labor force data is challenging given the large share of the informal economy.
  - Quarterly labor data began to be published in 2016.
- Consumer Price Index (CPI)
  - A monthly CPI has been produced since 2002 and is published on a monthly basis (with a lag of 13 days).
  - Uses a COICOP-compatible item classification with 352 elementary aggregates.
  - A new index was introduced in December 2014, with new weights largely based on National Accounts data aimed at bringing the CPI in line with the HICP.
  - Targets all products and services purchased by all households (resident and non-resident) in Kosovo.
  - HICP is available from January 2010 onward.
  - The HICP was rebased from 2002 to 2015 in January 2016.
- Government Finance Statistics
  - Monthly reports on budget execution of the general government (central government and municipalities) on a cash basis are provided five weeks after the end of each month.
  - Budget classification is not consistent with GFSM 2014 because:
    - (i) data is on cash basis, not accrual;
    - (ii) lending for policy purposes (similar to subsidies) is included after calculating the primary balance;
    - (iii) capital transfers should be included in current expenditure instead of capital expenditure;
    - (iv) memorandum of understanding (MOU) should be properly classified depending on their final purpose;
    - (v) annual budget documents should specify both current and capital spending related to individual projects.
  - While data is generally adequate, strengthening monitoring and disclosure of arrears will be important.
- Financial Sector Data
  - Monetary data are compiled broadly consistent with the IMF’s Monetary and Financial Statistics Manual.
  - The CBK reports monetary data monthly, using Standardized Report Forms for the central bank, other depository corporations, and other financial corporations, which are published in the International Financial Statistics.
  - Due to difficulties with obtaining adequate source data needed for estimation of Euro currency in circulation, the CBK ceased compiling currency in circulation in 2006, underreporting broad money.
  - The CBK reports Financial Soundness Indicators (FSIs) monthly according to the Compilation Guide on Financial Soundness Indicators.
  - FSIs including all 12 core indicators and 7 encouraged indicators for deposit takers are available through IMF’s FSI webpage.
- External Sector Statistics
  - CBK provides to STA quarterly balance of payments and international investment position data following BPM6 starting with 2013: Q1 reference data.
  - Authorities participate in:
    - Coordinated Direct Investment Survey with inward and outward data starting with 2010;
    - Coordinated Portfolio Investment Survey with annual data starting from December 2010 and semiannual data starting from June 2013, including encouraged items;
    - Quarterly External Debt Statistics.
  - Direction of trade data are available on a monthly basis.
  - Accuracy, periodicity, and timeliness of external sector statistics have improved with technical assistance from STA.
  - Authorities are working towards reporting the international reserves and foreign currency liquidity template.

### Data standards and quality
- Kosovo participates in the enhanced General Data Dissemination System (e-GDDS); metadata posted on the Fund’s Dissemination Standards Bulletin Board in 2001.
- A National Summary Data Page has been available since May 11, 2017.
- Kosovo has not had a Data ROSC.

### Kosovo — Table of Common Indicators Required for Surveillance (As of January 5, 2018)
- Frequency and latest observations (selected entries preserved exactly):
  - Exchange Rates: N/A; Frequency D; Frequency of Reporting D; Frequency of Publication D
  - International Reserve Assets and Reserve Liabilities of the Monetary Authorities1: N/A; Frequency M; Frequency of Reporting M; Frequency of Publication M
  - Broad Money: 09/30/2017 (Date of Latest Observation); 10/27/2017 (Date Received); Frequency M; Frequency of Reporting M; Frequency of Publication M
  - Central Bank Balance Sheet: Nov/2017 (Date of Latest Observation); 01/02/2018 (Date Received); Frequency M; Frequency of Reporting M; Frequency of Publication M
  - Consolidated Balance Sheet of the Banking System: 09/30/2017; 10/27/2017; M; M; M
  - Interest Rates2: Nov/2017; 01/02/2018; M; M; M
  - Consumer Price Index: Nov/2017; 12/14/2017; M; M; M
  - Revenue, Expenditure, Balance and Composition of Financing3—General Government4: Nov/2017; 12/20/2017; M; M; M
  - Stocks of Central Government and Central Government-Guaranteed Debt5: 10/30/2017; 29/11/2017; Q; Q; Q
  - External Current Account Balance: Oct/2017; 12/29/2017; Q; Q; Q
  - Exports and Imports of Goods8: 07/31/2017; 09/14/2017; M; M; M
  - GDP/GNP9: 06/30/2017; 09/28/2017; Q; Q; Q
  - Gross External Debt: 09/30/2017; 11/29/2017; Q; Q; Q
  - International Investment Position6: 09/30/2017; 11/29/2017; Q; Q; Q
- Footnotes (preserved language)
  - 1 Includes reserve assets pledged or otherwise encumbered as well as net derivative positions. While data are not reported for lack of capacity, authorities are working to start reporting these data in the near future.
  - 2 Both market-based and officially-determined, including discount rates, money market rates, rates on treasury bills, notes and bonds.
  - 3 Foreign, domestic bank, and domestic nonbank financing.
  - 4 The general government consists of the central government (budgetary funds, extra budgetary funds, and social security funds) and state and local governments.
  - 5 Including currency and maturity composition.
  - 6 Includes external gross financial asset and liability positions vis-à-vis nonresidents.
  - 7 Daily (D), weekly (W), monthly (M), quarterly (Q), annually (A), irregular (I), and not available (NA).
  - 8 Services data available on annual basis.
  - 9 GNDI data not available.

### Statement by Michaela Erbenova, Executive Director for the Republic of Kosovo and Mentor Mehmedi, Advisor to the Executive Director (February 2, 2018)
- Authorities’ overall view
  - Thank mission team for constructive engagement during the Article IV mission in Pristina.
  - Authorities broadly agree with staff’s assessment and look forward to continued close dialogue and cooperation with the Fund.
- Progress and challenges
  - Significant progress in preserving fiscal discipline and maintaining low debt levels, strengthening the health and resilience of the financial sector, and advancing the structural reform agenda.
  - Persistent challenges: low labor participation rate, high unemployment rate (especially among women and youth), and structural impediments to growth and investment.
- Government priorities
  - Accelerate implementation of structural reforms to expedite income and institutional convergence with the EU and shift growth model from remittances and consumption to investment and tradable sector.
  - Key objectives: safeguard fiscal and financial stability; strengthen rule of law; fight corruption; enhance business and investment environments; create conditions conducive to private sector-led growth.

### Recent economic developments and outlook (authorities’ summary)
- Growth and inflation
  - Initial estimates indicate GDP growth reached 4.3 percent in 2017.
  - Growth drivers: investment, consumption, remittances, and a steady recovery in exports.
  - Average inflation increased to 1.5 percent in 2017 driven by fuel, tobacco, food products, and household items.
  - Core inflation projected to remain subdued.
- Authorities' optimistic forecast (assuming current pace of reforms)
  - Growth expected to reach 4.6 percent of GDP this year.
  - Growth expected to increase to 4.9 percent and 5.3 percent of GDP in 2019 and 2020 respectively.
- Current account and financing
  - Current account deficit (CAD) remains elevated at 8.8 percent of GDP.
  - CAD financed by non-debt creating capital inflows, including remittances and net foreign direct investment.
  - CAD expected to hover around 9 percent of GDP in the medium-term.
- Upside risk example
  - A contract to build a 500-megawatt thermal power plant “Kosova e Re” (an investment valued at approximately 20 percent of GDP) could boost Kosovo’s growth by up to 2 percent of GDP in the medium-term.

### Fiscal policy (authorities’ summary)
- Fiscal stance and outcomes
  - Authorities committed to safeguarding macro-financial stability while preserving credibility of the fiscal rule and keeping public debt low.
  - Gradual, growth-friendly fiscal consolidation over the last three years kept current spending in check and created room for priority spending and capital investments.
  - Positive fiscal performance continued through end-2017.
  - Provisional fiscal deficit lowered to 0.7 percent of GDP in 2017.
  - Bank balances increased to 5.3 percent of GDP, above prudent level of 4.5 percent of GDP.
- 2018 budget
  - Approved in December; fully in line with the fiscal rule and staff’s suggestions.
  - Targets a deficit of 1.8 percent of GDP (excluding the Privatization Agency of Kosovo and IFI capital projects).
  - Keeps the public wage bill constant as a share of GDP, in line with the wage rule.
- Social spending and pensions
  - Authorities plan to better target and means-test social benefit schemes to enhance spending efficiency and distributional effects.
  - Committed to strengthening mechanisms to eliminate double dipping, improve means-testing, remove disincentives to employment, and tightly administer eligibility criteria.
  - Reclassification of war veterans per amended Law of War Veterans is essential for fiscal sustainability.
  - Authorities will refrain from introducing non-contributory early retirement schemes for special groups.
- Revenue mobilization and public debt
  - Total revenues increased to over 26.6 percent of GDP in 2017.
  - Scope to further mobilize domestic revenues by broadening the tax base, addressing VAT and personal income tax gaps, and fighting informality.
  - Tax and customs administration reforms underway (organization and performance management, compliance risk management, filing enforcement, debt collection, tax audit).
  - Public debt remains low at 16.6 percent of GDP.
  - Public debt management strategy 2018-2022 aims to diversify investor base, extend maturities, and minimize roll-over risk.
  - Measures to enhance public investment management and strengthen National Investment Committee are underway.

### Financial sector (authorities’ summary)
- Banking sector soundness
  - Largely foreign-owned banking sector is well-capitalized, profitable, and liquid.
  - Capital adequacy ratio increased to 18.2 percent by end-November, above regulatory minimum of 12 percent.
  - Non-performing loan ratio declined to a historical low of 3.4 percent of total loans with high provisioning coverage.
  - Returns on equity and assets at 22.1 percent and 2.7 percent in November, respectively.
  - Credit growth accelerated to 11.2 percent last year, aided by higher demand from corporate and household sectors.
- Regulatory and supervisory reforms
  - CBK adopted emergency liquidity assistance framework, rolled out risk-based supervision, developed macroprudential policy framework, and addressed weaknesses in the insurance sector.
  - Almost all 2012 Financial Sector Assessment Program recommendations implemented.
  - Authorities committed to further strengthening supervision (off-site bank examination manual, refining macroprudential policy framework).
  - CBK moving towards risk-based AML/CFT supervision based on recently adopted law.
- Financial deepening and credit access
  - Credit-to-GDP ratio at 38 percent, lower than predicted by fundamentals.
  - Need better access to credit and financial deepening to sustain growth and income convergence.
  - Efforts to strengthen insolvency regime, enhance credit registry, improve contract enforcement, and reduce interest rate spreads.
  - Addressing non-banking structural obstacles: slow court procedures, large court case backlog, weak cadaster system, nascent private contract enforcement mechanism.

### Structural reforms (authorities’ summary)
- Reform priorities (National Development Strategy 2016-2021)
  - Foster a business-friendly environment.
  - Improve governance and fight corruption.
  - Reform the education sector.
  - Enhance functioning of the labor market and align wages to productivity.
  - Guarantee sustainable energy supply.
- Achievements and ongoing work
  - Moved up over 70 positions in World Bank’s Doing Business Index in last five years; now ranked 40th overall and one of the top 10 reformers globally.
  - Adoption of comprehensive insolvency law and establishment of clear priority rules in bankruptcy for secured creditors.
  - Need to bolster anti-corruption framework and strengthen Anti-Corruption Agency’s capacities.
  - Full roll-out and enforcement of mandatory e-procurement is needed.
  - Publicly owned enterprises remain inefficient; policy measures required to improve corporate governance, fiscal discipline, and attract private participation.
  - Upgrading pre-university curricula and vocational school system in cooperation with development partners, focusing on IT and agriculture.
  - Plans to remove barriers to employment and reduce inactivity among women (greater and more affordable childcare, adequate maternity leave in new labor law).
  - Increases to minimum wage should follow the rule-based minimum wage-setting mechanism.

### Energy sector and investment projects (authorities’ summary)
- Kosova e Re project
  - Construction of a supercritical thermal power plant “Kosova e Re” intended to address environmental and social externalities and improve energy supply reliability.
  - The project, plus energy efficiency and renewable energy projects, aim to remove a major constraint to growth and investment.

### Acceptance of obligations under Article VIII
- Authorities moved from Article XIV to Article VIII and accepted Article VIII obligations on January 11, 2018.
- Authorities welcome staff’s findings that Kosovo is free from multiple currency practices and restrictions on payments and transfers for current international transactions, except for sanction measures maintained solely for reasons of international or national security.
- Authorities expect Article VIII acceptance to send a positive signal to investors about the liberalized foreign exchange system.

*IMF — Chapter: 2. Bank  work (cr1830 — Kosovo).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2018/cr1830.pdf_