## 1mkdea2022005 ## Source details **Canonical URL:** [1mkdea2022005](https://www.imf.org/-/media/files/publications/cr/2022/english/1mkdea2022005.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2022/english/1mkdea2022005.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2022/english/1mkdea2022005.pdf.json) --- ### PLL arrangement approval, access, and intended use - Executive Board approved on November 21 a two-year PLL arrangement for North Macedonia for SDR 406.87 million (290 percent of North Macedonia’s quota, equivalent to about €530 million). - Authorities intend to draw amounts available in the first year: SDR 203.44 million (145 percent of quota, or about €265 million). - Amounts available in the second year (SDR 203.43 million, the remaining 145 percent of quota) are intended to be treated as precautionary. - Arrangement objectives: - support the authorities’ policies to address the fiscal and external impact of the pandemic and the commodity price shock following Russia’s invasion of Ukraine; - boost international reserves; - serve as a catalyst to obtain other external financing. ### Qualification for the PLL and rationale - North Macedonia qualifies based on: - sound economic fundamentals; - strong institutional policy frameworks; - a track record of good economic performance and policy implementation; - commitment to maintain such policies. - Staff assessment: performs strongly in four out of five PLL qualification areas and is not substantially underperforming in the fiscal policy area. ### Macroeconomic context and shocks - Two large global shocks: the Covid-19 pandemic and the commodity price shock following Russia’s invasion of Ukraine. - Key impacts and vulnerabilities: - GDP contracted by 6 percent in 2020 (report uses most recently available GDP dataset; a press release notes a 4.7 percent contraction in 2020 but full dataset not yet available). - High dependence on energy imports increased external financing need; energy trade deficit ballooned. - Global financial conditions tightened, increasing the cost of market financing. - Terms-of-trade shock and weak external demand created balance of payments pressures. - NBRNM intervened in early 2022 to support the de-facto exchange rate peg to the euro; reserves recovered during the summer, bringing reserve coverage to about 100 percent of the ARA metric at end-October. ### Recent policy responses and priorities under the arrangement - Fiscal policy: - Supplemental budget for 2022 targets an overall fiscal deficit of 5.3 percent of GDP (up from 4.3 percent in the initial 2021 budget). - Measures support low-income households, temporarily limit end-consumer price increases for electricity and heating in the regulated market, and build food reserves and protect domestic agricultural production. - Temporary tax cuts on food and fuel implemented after Russia’s invasion of Ukraine were not extended when they expired in May. - Government introduced block tariffs for electricity and hiked electricity tariffs. - Commitment to containing wage and pension benefit increases. - Monetary policy: - NBRNM tightening monetary policy to prevent high inflation and protect the de-facto exchange rate peg. - Response included unsterilized FX interventions, policy-rate tightening beginning in April, and six consecutive policy rate hikes totaling 225 basis points; reserve requirement rates adjusted in June and September to disincentivize shifts into euro deposits. - Actions moderated inflation expectations and abated exchange rate pressures. - Energy policy and social protection: - Plan to phase out untargeted energy subsidies, strengthen targeted support for the vulnerable, and improve energy efficiency. - Public investment and fiscal framework: - Policy agenda: continued deficit reduction over the medium term under newly introduced fiscal rules while scaling up public investment and managing associated fiscal risks. ### Outlook and risks (selected projections and indicators) - Real GDP: - Projected at 2.7 percent in 2022 and 2.9 percent in 2023 (a 2½ percentage points cumulative downward revision relative to the forecast prior to the war in Ukraine). - Modest recovery projected in late 2023 as global energy and food prices subside; medium-term growth to rise above potential for a few years as public investment is scaled up and reforms progress toward EU accession. - Inflation: - Headline inflation rose to 18.7 percent in September 2022. - Projected average inflation of 12.9 percent in 2022. - Projected average inflation of 7.1 percent in 2023. - Projected gradual decline to around 2 percent by 2025. - Risks: - Downside: slower external demand from a global recession, a sharper rise in international energy prices, further tightening of financial market conditions. - Domestic: persistent high inflation expectations, indexation, and high nominal wage growth could create domestic inflationary pressures in 2023. ### Current account, trade balance, and financing outlook - Trade and current account: - Trade deficit projected to exceed 24 percent of GDP in 2022, compared to 20 percent in 2021, mostly reflecting higher energy prices. - Current account deficit projected to rise to 7.5 percent of GDP in 2022 before narrowing to 4.2 percent of GDP in 2023. - Some mitigation from higher remittances. - Financial account and reserves: - Private sector expected to continue accumulating foreign assets, with faster growth of household deposits in euros than in local currency. - Balance of payments pressures partly offset by FDI inflows and government borrowing. - Gross international reserves expected to represent 105 percent of the ARA metric for fixed exchange rate regimes on average over 2020–22, and not fall below 93 percent in any of the years. - Without Fund disbursements under the PLL, reserve coverage would average 94 percent of the ARA metric during 2022–24 in the baseline and 86 percent in the adverse scenario. - Reserve coverage implications with program: 93 percent of the ARA metric in 2022, improving to 100 percent in 2023 and 106 percent when the PLL arrangement expires in 2024. ### Access, program size, and financing plan - Authorities requested a two-year PLL arrangement given uncertainty from the war in Ukraine and time needed to replenish buffers. - Authorities intend to draw on the PLL at approval and the first review. - Access and financing: - Proposed access: 145 percent of quota each year of the PLL arrangement. - Proposed PLL size: SDR 406.87 million (290 percent of quota). - Staff estimate external financing need of €110 million in 2022 and €235 million in 2023, to be covered by Fund disbursements of approximately €265 million and an EU budget support grant of €80 million. - Authorities committed to obtaining external market financing of €800 million in 2023 and €300 million in 2024, of which €450 million would amortize a Eurobond due mid-2023. - Additional potential financing: - EBRD approved a €100 million liquidity line to the state-owned energy company (pending parliamentary approval). - EU package to Western Balkans expected in first half of 2023; EU considering Macro-Financial Assistance. - Adverse scenario precautionary access: - In adverse scenario financing need would widen to about €345 million in 2023 and €155 million in 2024; authorities would likely draw in the second year (November 2023 and May 2024). ### Capacity to repay and safeguards - Capacity to repay assessed as adequate. - Current exposure and potential peak: - 100 percent of quota outstanding after drawing on Rapid Financing Instrument in April 2020. - If full PLL drawn, exposure would peak at 315 percent of quota, or SDR 442 million in 2024. - This would represent 13.9 percent of gross international reserves under the adverse scenario, or 3.6 percent of GDP. - Debt service and repayment profile: - Nominal debt service to the Fund would peak in 2027, equivalent to 4.8 percent of reserves and 2.0 percent of exports of goods and services. - Interest payments stay below 2 percent throughout the program period and gradually increase to 2.3 percent of GDP by 2027. - Safeguards assessment: - 2020 assessment found a relatively robust safeguards framework at the NBRNM. - Vacancies on the Council and Audit Committee have been filled; strengthening autonomy and governance provisions in the National Bank law remains underway. - An updated safeguards assessment will be completed by the time of the first review of the PLL arrangement. ### Fiscal consolidation, public investment, and governance - 2023 draft budget target: - Reduces the budget deficit to 4.6 percent of GDP. - Staff estimate this requires fiscal measures of about ¾ percent of GDP. - Fiscal measures and composition (Text Table 2 and 3): - Overall Fiscal Balance in 2022: -5.3 (percent of GDP). - Scaling-up of investment: -1.0 (percent of GDP). - Subsidies: 0.9 (percent of GDP) — Lower subsidies to state-owned electricity company 0.7; Withdrawal of stimulus measures 0.2. - Policy measures 1/: 0.7 (percent of GDP). - Other: 0.1 (percent of GDP). - Overall Fiscal Balance in 2023: -4.6 (percent of GDP). - Fiscal Consolidation Measures in 2023 (Millions of denars): - Corporate Income Tax streamlining: 1,156 - Personal Income Tax streamlining: 739 - Value-Added Tax streamlining: 2,713 - Reducing operating costs: 1,500 - Total: 6,108 (Total (percent of GDP) 0.7) - Medium-term consolidation: - Additional measures of about ½ percent of GDP in 2024 to bring deficit to 3.4 percent of GDP. - Staff recommend additional consolidation of about 1¾ percent of GDP after 2024, targeting a 1 percent of GDP deficit in normal times. - Strengthen fiscal governance via the organic budget law; improve revenue administration and compliance risk management. - Public Investment Management: - Authorities committed to implement IMF PIM Assessment action plan, including establishing a PIM unit in the Ministry of Finance. - Corridor 8/10d highway project: independent feasibility study as a structural benchmark (January 2023); project currently estimated to cost about 10 percent of 2022 GDP over 6 years and is incorporated in program baseline. ### Energy policy, block-tariff reform, and transition to improved energy efficiency - Market structure and subsidies: - Electricity prices for households and small firms are regulated; regulated market served by a “universal supplier”, EVN, procuring much from state-owned ESM at below-market prices. - Government provides direct balance sheet support to ESM to cover losses. - ESM cost profile: - ESM’s own production represents 75 percent of the electricity it procures for the regulated market and is not making losses on that own production. - ESM is loss-making on the remaining 25 percent procured from less efficient facilities or imports. - Price charged by ESM to EVN is estimated to be 40 percent below cost recovery when including externally procured electricity. - To eliminate fiscal subsidies, price charged by ESM to EVN needs to be brought in line with total production costs. - Block-tariff reform introduced July 2022: - Four blocks with higher marginal tariff as consumption increases. - Design aims to ensure affordability of a basic quantity and motivate energy savings, with largest effect among high users. - Expected effect: 5 percent reduction in electricity consumption in the regulated market in 2023 and 2024, everything else remaining equal. - Reported marginal tariff changes by block (percentage points relative to the average increase): - First block (0-210 kW/h): -12.3 - Second block (210-630 kW/h): -7.5 - Third block (630-1050 kW/h): 0.5 - Fourth block (1050> kW/h): 120.9 - Consideration to bring top marginal tariff, and over time average tariff, in line with market price to incentivize movement back to liberalized market and recover ESM losses. - Authorities’ plan and benchmarks: - Phase out untargeted energy subsidies by 2025 and improve energy efficiency while strengthening targeted support for the vulnerable (structural benchmark, February 2023). - Prepare and publish action plan by end-February 2023. ### Inflation, monetary policy, and financial stability measures - Inflation and monetary response: - Inflation drivers: global factors, increased inflation expectations, high nominal wage growth. - NBRNM measures: unsterilized FX sales, higher policy rates (225 basis points by earlier description; elsewhere cumulative increases totaling 225 bps and seven hikes totaling 300 basis points noted), higher reserve requirement on FX deposits than denar deposits, interventions absorbing denar liquidity. - NBRNM increased the policy spread with the ECB and stands ready to undertake measures to maintain exchange rate and price stability. - Continued rate hikes may be needed if inflation differential with euro area persists due to indexation of minimum wage and pension benefits. - Financial sector soundness and macroprudential actions: - Banking system well capitalized; core Tier 1 capital ratio 15.9 percent at end-June 2022; NPLs 3.1 percent at end-June 2022. - Stress tests indicate system could withstand a severe macro-financial shock. - Financial Stability Law adopted in July 2022 to strengthen coordination; amendments to National Bank law to grant formal macroprudential mandate to NBRNM to be submitted in November 2022. - Counter-cyclical capital buffer: 0.5 percentage points, effective in August 2023. - New laws to strengthen deposit insurance and bank resolution frameworks expected to be submitted to Parliament by June 2023. - Operational independence of NBRNM emphasized; amendments to ensure autonomy over employment conditions planned. ### Competitiveness, labor market, and governance reforms - Labor market: - Higher energy prices produce a partly permanent terms-of-trade shock; allow labor market adjustment to preserve competitiveness. - Authorities will consider productivity when determining minimum wage increases; ad-hoc increases should be avoided. - Policies to support job-to-job transitions and improve education outcomes being implemented. - Governance: - Progress toward EU standards; judicial independence improved; institutional framework for prevention of corruption strengthened; new AML/CFT law in July 2022. - Commitment under PLL to enhance procurement transparency by connecting procurement system with register of ultimate beneficial ownership (structural benchmark). - Authorities committed to implement MONEYVAL recommendations. ### Debt sustainability and stress tests (Annex I highlights) - Bottomline: debt assessed as sustainable in the medium term with a high probability. - Baseline public gross debt (selected years, percent of GDP): 42.2 (2020), 59.6 (2021), 60.6 (2022), 58.3 (2023), 58.7 (2024), 58.9 (2025), 59.3 (2026), 58.3 (2027), 57.8 (projection years and historical as shown). - Public gross financing needs (selected years, percent of GDP): 13.2 (2020), 9.6 (2021), 16.9 (2022), 12.3 (2023), 15.0 (2024), 11.0 (2025), 13.6 (2026), 14.5 (2027), 10.7 (other indicated values). - Real GDP growth (selected entries): 2.6 (2020), -6.1 (2021), 4.0 (2022), 2.7 (2023), 2.9 (2024), 3.9 (2025), 3.8 (2026), 3.8 (2027). - Effective interest rate (selected entries): 3.0 (2020), 2.7 (2021), 2.5 (2022), 2.6 (2023), 3.0 (2024), 3.6 (2025), 3.9 (2026), 4.3 (2027). - Stress tests: - Macroeconomic and fiscal shocks can push public debt and gross financing needs above high-risk thresholds in some scenarios. - Scenarios of concern: one-standard-deviation real GDP growth shock in 2023–24; combined macro-fiscal shock; contingent liability shock. - Under some stress tests public sector debt would rise close to or above the 70 percent of GDP high-risk benchmark; gross financing needs could exceed 20 percent of GDP in 2023 in contingent liability shock. ### External Economic Stress Index (EESI) (Box 4) - EESI composed of five variables: euro area imports growth (weight 0.15), Germany GDP growth (weight 0.20), Financial Conditions Index (weight 0.18, sign reversed), food commodity price index (weight 0.10, sign reversed), energy commodity price index (weight 0.11, sign reversed). - Baseline and downside EESI averages in 2022 and 2023: - Baseline: -0.41 - Downside: -0.55 - Lowest observed value in projection period: -0.77 in Q1 2023. - Historical pandemic minimum: -1.53 in Q2 2020. - Negative EESI values indicate above-average stress. ### Corridor 8/10d Highway Project (Box summary) - Project overview: - Corridor 8 connects Bulgaria through North Macedonia with Albania; total planned highway length approximately 135 km, consisting of four sections. - Parliament adopted a special law as “lex specialis” in 2021; law exempts the project from public procurement. - Independent advisor to monitor project; regular monitoring reports and audits to be published. - Cost and timing: - Expected cost €1.3 billion (10 percent of 2022 GDP) over 6 years; incorporated in baseline macroeconomic framework. - Authorities requested comprehensive independent feasibility study from an internationally reputable company. - Growth and fiscal implications: - Using dynamic multipliers calibrated for the average Western Balkan country, staff estimate average growth would be 0.3 percentage points lower without the project. - Road spending offset by other fiscal measures; growth effect remains positive but modest; overall effects on fiscal balances, external balance, and inflation are modest. - Longer-term potential dividends: boost trade and tourism. - Notes: dynamic multipliers assume debt financing and low investment efficiency. ### Program monitoring, conditionality, and exit strategy - Written Communication (WCOM) focus areas: safeguarding public finances; improving energy efficiency and reducing energy subsidies while protecting the vulnerable; tackling high inflation; strengthening revenue collection and public investment management; ensuring investment projects fit within a sustainable medium-term fiscal framework; preserving financial stability. - Structural benchmarks and timelines: - Comprehensive and independent feasibility study of Corridor 8/10d shared with IMF staff: End-January 2023. - Adoption and publication of government action plan to gradually eliminate need for government subsidies for electricity services and improve energy efficiency: End-February 2023. - Indicative and performance targets (selected): - Indicative Targets — Floor on the central government cash balance (million denars): -17,560 (March 2023), -29,538 (September 2023), -10,881 (March 2024). - Indicative Targets — Floor on net international reserves (million euros): 2,919 (March 2023), 2,862 (September 2023), 2,759 (March 2024). - Multilateral program financing baseline: End-March 2023: 80 (in millions of euros). - Reporting and review schedule (assuming Executive Board approval on November 21, 2022): - First review no later than May 19, 2023. - Second review no later than November 22, 2023. - Third review no later than May 22, 2024. - Exit strategy: - Program expected to strengthen fiscal and reserve buffers, allowing a smooth exit when arrangement expires in November 2024. - Staff estimate fiscal deficit to narrow by end of arrangement and public debt to gradually decline; gross international reserves expected to be above 100 percent of the ARA metric at end-2024 and through the projection horizon. - Successful exit depends also on reduction of external risks beyond domestic policies. ### Staff appraisal and recommendations - Staff find that North Macedonia meets PLL qualification criteria; performs strongly in four out of five qualification areas; public finances identified as needing improvements. - Under the program, authorities will: - gradually reduce the deficit; - place public debt on a downward path; - manage fiscal risks and strengthen public financial management. - Staff recommend approval of the PLL arrangement and welcome authorities’ commitment to draw in the first year and to continue cooperation with the Fund. *Source: IMF staff report for the Republic of North Macedonia and associated chapters and appendices (excerpts provided in content unit 1mkdea2022005).* ### 2023. The authorities intend to draw on the PLL arrangement during the first year. ### 1mkdea2022005 - 2023. The authorities intend to draw on the PLL arrangement during the first year. ### PLL arrangement approval, access, and intended use - The Executive Board of the IMF approved on November 21 a two-year arrangement under the Precautionary and Liquidity Line (PLL) for North Macedonia for SDR 406.87 million (290 percent of North Macedonia’s quota, equivalent to about €530 million). - The authorities intend to draw the amounts available in the first year of the arrangement: SDR 203.44 million (145 percent of quota, or about €265 million). - The amounts available during the second year of the arrangement (SDR 203.43 million, the remaining 145 percent of quota) are intended to be treated as precautionary. - The arrangement is expected to: - support the authorities’ policies to address the fiscal and external impact of the pandemic and the commodity price shock following Russia’s invasion of Ukraine; - boost international reserves; and - serve as a catalyst to obtain other external financing. ### Qualification for the PLL and rationale - North Macedonia qualifies for the PLL based on: - sound economic fundamentals; - strong institutional policy frameworks; - a track record of good economic performance and policy implementation; and - commitment to maintain such policies in the future. - Staff assessment: North Macedonia performs strongly in four out of five PLL qualification areas and is not substantially underperforming in the fiscal policy area. ### Macroeconomic context and shocks - The economy has been hit by two large global shocks: the Covid-19 pandemic and the commodity price shock following Russia’s invasion of Ukraine. - Key impacts and vulnerabilities: - GDP contracted by 6 percent in 2020 (report uses most recently available GDP dataset; a press release notes a 4.7 percent contraction in 2020 but full dataset not yet available). - High dependence on energy imports has increased the external financing need; the energy trade deficit has ballooned. - Global financial conditions have tightened, increasing the cost of market financing. - Terms-of-trade shock and weak external demand have created balance of payments pressures. - The NBRNM intervened in the foreign exchange market during early 2022 to support the de-facto exchange rate peg to the euro; reserves recovered during the summer, bringing reserve coverage to about 100 percent of the ARA metric at end-October. ### Recent policy responses and priorities under the arrangement - Fiscal policy: - The supplemental budget for 2022 targets an overall fiscal deficit of 5.3 percent of GDP (up from 4.3 percent in the initial 2021 budget). - Measures support low-income households, temporarily limit end-consumer price increases for electricity and heating in the regulated market, and build food reserves and protect domestic agricultural production. - Temporary tax cuts on food and fuel implemented after Russia’s invasion of Ukraine were not extended when they expired in May. - The government has introduced block tariffs for electricity and hiked electricity tariffs to mitigate the fiscal and external impact of the shock. - The government is committed to containing wage and pension benefit increases given limited fiscal space and inflation risks. - Monetary policy: - The National Bank of the Republic of North Macedonia (NBRNM) is tightening monetary policy to prevent high inflation from becoming entrenched and to protect the de-facto exchange rate peg. - The NBRNM’s response included unsterilized FX interventions, a policy-rate tightening beginning in April, and six consecutive policy rate hikes totaling 225 basis points; reserve requirement rates were adjusted in June and September to disincentivize shifts into euro deposits. - These actions have moderated inflation expectations and abated pressures on the exchange rate. - Energy policy and social protection: - Authorities plan to phase out untargeted energy subsidies, strengthen targeted support for the vulnerable, and improve energy efficiency to reduce fiscal and external vulnerabilities to energy price shocks. - Public investment and fiscal framework: - The policy agenda focuses on continued deficit reduction over the medium term under newly introduced fiscal rules while scaling up public investment and carefully managing associated fiscal risks. ### Outlook and risks (selected projections and indicators) - Real GDP: - Projected at 2.7 percent in 2022 and 2.9 percent in 2023 (a 2½ percentage points cumulative downward revision relative to the forecast prior to the war in Ukraine). - A modest recovery is projected in late 2023 as global energy and food prices start to subside; over the medium term growth would rise above potential for a few years as public investment is scaled up and reforms progress toward EU accession. - Inflation: - Headline inflation rose to 18.7 percent in September 2022. - Projected average inflation of 12.9 percent in 2022. - Projected average inflation of 7.1 percent in 2023. - Projected gradual decline to around 2 percent by 2025, helped by the close link to euro area inflation under the de-facto peg. - Risks: - Risks are firmly to the downside, including slower external demand from a global recession, a sharper rise in international energy prices, and a further tightening of financial market conditions. - Persistent high inflation expectations, indexation, and high nominal wage growth could create domestic inflationary pressures in 2023. ### Institutional and procedural notes - The PLL was introduced in 2011 to meet more flexibly the liquidity needs of member countries with sound economic fundamentals and strong records of policy implementation but with some remaining vulnerabilities. - An informal Board meeting on a possible PLL arrangement was held on April 15, 2022. - A staff mission visited North Macedonia during April 27–May 4, 2022, July 12–15, 2022 and October 25–28, 2022, meeting high-level officials and stakeholders. *Source: IMF staff report for the Republic of North Macedonia, November 4, 2022; Executive Board approval statement, November 21, 2022.* ### 11. The current account deficit is set to ### 11. The current account deficit is set to ### Current account and trade balance outlook - The trade deficit is projected to exceed 24 percent of GDP this year, compared to 20 percent in 2021, mostly reflecting higher energy prices. - Some of the terms of trade shock is being mitigated by higher remittances. - As a result, the current account deficit will rise to 7.5 percent of GDP this year before narrowing to 4.2 percent of GDP in 2023. - In the financial account: - The private sector is expected to continue accumulating foreign assets, with a faster growth of household deposits in euros than in local currency. - Balance of payments pressures are expected to be partly offset by FDI inflows and government borrowing. ### Downside risks and upside factors - Risks are to the downside and unusually large: - Additional energy and food price shocks or a worsening security situation could further increase inflation and weaken the global growth outlook. - Global tightening in financial conditions could worsen the financing situation for emerging markets (as depicted in the adverse scenario). - A reemergence of domestic political instability could hamper implementation of the authorities’ policy program and weaken external market financing prospects. - Upside: A renewed push for reforms, reflecting the opening of EU accession talks, could boost capital inflows, confidence, and the reform momentum. ### Assessment of qualification for the PLL - Staff assess that North Macedonia meets the qualification criteria for a PLL arrangement. - Executive Board context and support: - The country’s policies were assessed as generally positive by the Executive Board in the Article IV consultation completed in February 2022. - Executive Directors were overall supportive during the April 2022 informal meeting when PLL qualification was discussed on a preliminary basis. ### Economic fundamentals and institutional policy frameworks (findings) - Following shocks from the pandemic and the war in Ukraine, growth slowed, inflation increased, and the external balance deteriorated, but economic fundamentals remain overall strong and authorities are taking appropriate measures. - Fiscal framework improvements: - New organic budget law adopted in September 2022 establishes fiscal rules and provides a basis to substantially improve the budget process. - Government implementing an action plan to address recommendations of the IMF’s 2020 Public Investment Management Assessment. - Central bank and transparency: - Central bank independence anchored in law. - A 2022 review under the IMF’s central bank transparency code found that the NRBNM is implementing advanced transparency practices; strong track record has cultivated high public trust. - Governance and rule of law: - Important progress toward EU standards; judicial independence improved (including the 2020 Law on the Public Prosecutor’s Office). - Institutional framework for prevention of corruption strengthened; national strategy adopted in April 2021; new AML/CFT law in July 2022. - Performance on governance indicators (government effectiveness, regulatory quality, rule of law) is favorable relative to peers; control of corruption improved between 2020 and 2021 but shows some deterioration after 2015 (not statistically significant). ### Qualification-area performance (summary by criterion) - External Position and Market Access: - Criterion 1. Sustainable external position: EBA-Lite (Feb 2022) estimates external position broadly in line with fundamentals. At end-2021, gross external debt stood at 82 percent of GDP, of which about a third is short-term debt at remaining maturity and 40 percentage points represent public sector debt. - Criterion 2. Capital account dominated by private flows: Private capital flows amounted to 73 percent, on average, in 2019–2021. Net cumulative FDI inflows in the last five years represented about half of financial account flows. Net international investment position stood at -62 percent of GDP at end-2021, with 85 percent representing FDI liabilities. Gross external debt of the banking sector was 7.6 percent of GDP at end-June 2022. - Criterion 3. Track record of sovereign market access: Three Eurobond issuances totaling €1.9 billion over the last five years. Most recent issuance in March 2021 at a 1.9 percent yield and a 7-year maturity. Sovereign spreads increased to about 530 basis points on average across issuances; September government issued a 3-year registered marketable bond worth €250 million at a 375 basis points spread over the 6-month Euribor rate. - Eurobond issuance table (selected rows preserved as in source): - Eurobond I 2005–2015: Amount €150 million; Yield-to-maturity 4.69 percent; Coupon 4.625 percent. - Eurobond II 2009–2013: Amount €175 million; Yield-to-maturity 10 percent; Coupon 9.875 percent. - Eurobond III 2014–2021: Amount €500 million; Spread with Bund 362.2 bps; Yield-to-maturity 4.25 percent; Coupon 3.975 percent; Over-subscription 2.4. - Eurobond IV 2015–2020: Amount €270 million; Spread with Bund 526.1 bps; Yield-to-maturity 5.125 percent; Coupon 4.875 percent; Over-subscription 2.2. - Eurobond V 2016–2023: Amount €450 million; Spread with Bund 628 bps; Yield-to-maturity 5.875 percent; Coupon 5.625 percent; Over-subscription 1.6. - Eurobond VI 2018–2025: Amount €500 million; Spread with Bund 280.3 bps; Yield-to-maturity 3 percent; Coupon 2.75 percent; Over-subscription 7. - Eurobond VII 2020–2026: Amount €700 million; Spread with Bund 455.2 bps; Yield-to-maturity 3.95 percent; Coupon 3.675 percent; Over-subscription 4.4. - Eurobond VIII 2021–2028: Amount €700 million; Spread with Bund 236.9 bps; Yield-to-maturity 1.866 percent; Coupon 1.625 percent; Over-subscription 2. - Criterion 4. Reserve position: Gross international reserves expected to represent 105 percent of the ARA metric for fixed exchange rate regimes on average over 2020–22, and not fall below 93 percent in any of the years. Without Fund disbursements under the PLL, reserve coverage would be, on average during 2022–24, at 94 percent of the ARA metric in the baseline and 86 percent in the adverse scenario. Composition of private short-term debt (about 87 percent trade credits and intercompany loans) is mitigating. - Fiscal Policy: - Criterion 5. Sound public finance and sustainable public debt: Overall fiscal deficit averaged 2½ percent of GDP in five years prior to the pandemic; increased to above 8 percent in 2020; brought down to 5½ percent of GDP in 2021. Capital expenditure scaled up from 2½ percent of GDP in 2020 to 3¼ percent of GDP in 2021. - Recent measures in response to energy and food price shock would bring the deficit to about 5¼ of GDP in 2022. - Authorities preparing fiscal measures to reduce the deficit to 3.4 percent of GDP by 2024 and committed to further consolidation thereafter, consistent with the 3 percent of GDP deficit limit in the organic budget law. - Staff assess debt as sustainable in the medium term with a high probability. Public debt increased to close to 60 percent of GDP in 2020 and exceeded that threshold in 2021. Debt would remain below 60 percent of GDP during the projection period and gradually decline over the medium term, staying below the high-risk threshold in the baseline. - Gross financing needs are large in years with Eurobond amortizations, hovering around the 15 percent of GDP benchmark. Interest burden expected to increase from 1.2 percent of GDP in 2022 to 2.3 percent of GDP in 2027. - Monetary Policy: - Criterion 6. Low and stable inflation in a sound monetary and exchange rate framework. North Macedonia has maintained a de-facto stabilized arrangement since 1997. - Loan euroization declined from about 55 percent in 2009 to 42 percent in September 2022. - Deposit euroization reduced from about 65 percent in 2009 to 46 percent in September 2022 (noting an uptick since 2021 and mitigation via higher reserve requirements on banks’ FX liabilities). - Inflation averaged 1.6 percent over the past five years; recent rise driven by global commodity prices and domestic factors (regulated energy tariffs hikes, full passthrough of fuel prices, no VAT reductions on food and fuel, large weight of food in consumption basket). - NBRNM increased the policy spread with the ECB. - Financial Sector Soundness and Supervision: - Criterion 7. Sound financial system: Banking system well capitalized, core Tier 1 capital ratio of 15.9 percent at end-June 2022. NPLs declined to 3.1 percent at end-June 2022. Stress tests indicate system could withstand a severe macro-financial shock. - Criterion 8. Effective supervision: 2018 FSAP found strong legislative/regulatory basis; authorities complied with many FSAP recommendations; further steps needed to ensure NBRNM independence by excluding it from law of administrative staff and to give NBRNM a formal macroprudential mandate. Financial Stability Law adopted in July strengthened coordination. In November 2021, European Commission determined supervisory and regulatory framework could be regarded as equivalent to EU. - Data Adequacy: - Criterion 9. Data transparency and integrity: Special Data Dissemination Standard (SDDS) subscriber since 2011; adhered to SDDS Plus since January 2019. ### Circumstances for PLL approval - North Macedonia does not face any of the circumstances under which the Fund may not approve a PLL arrangement: - Demonstrated sustained ability to access international capital markets. - Needs moderate, but not large, fiscal and structural adjustments. - Public debt position that, with high probability, is sustainable in the medium term. - No widespread bank insolvencies. ### Duration, access level, and financing plan - Authorities requested a two-year PLL arrangement; considered appropriate given uncertainty about the duration and impact of the war in Ukraine and time needed to replenish buffers. - Authorities intend to draw on the PLL arrangement at approval and the first review, given the actual balance of payments need. - Program seeks to ensure that reserves exceed 100 percent of the ARA metric when the arrangement expires. - Authorities are committed to obtaining external market financing of €800 million in 2023 and €300 million in 2024, of which €450 million would be used to amortize a Eurobond coming due in mid-2023. - Staff estimate an external financing need of €110 million in 2022 and €235 million in 2023, to be covered by Fund disbursements of approximately €265 million and an EU budget support grant of €80 million. No additional financing need in 2024 in the baseline. - Reserve coverage implications: - Reserve coverage at 93 percent of the ARA metric in 2022, improving to 100 percent in 2023 and 106 percent when the PLL arrangement expires in 2024. - Additional (not baseline) potential financing: - EBRD approved a €100 million liquidity line to the state-owned energy company (pending parliamentary approval). - Additional financing could be provided by the EU as part of its package to Western Balkan countries expected in the first half of 2023. The EU is also considering the authorities’ request for Macro-Financial Assistance. - Adverse scenario precautionary access: - In an adverse scenario with slower global growth and tighter financial conditions, financing need would widen to about €345 million in 2023 and €155 million in 2024; authorities would likely draw also in the second year of the PLL arrangement (November 2023 and May 2024). - Proposed access: - Staff propose an access level of 145 percent of quota each year of the PLL arrangement. - Annual access at normal access limits; staff propose to phase available amounts on a semi-annual basis given expected purchases in the baseline. ### Capacity to repay the Fund and safeguards - Capacity to repay assessed as adequate. - Current exposure and potential peak: - North Macedonia has 100 percent of quota outstanding after drawing on the Rapid Financing Instrument in April 2020. - If the full amount under the PLL were drawn, exposure would peak at 315 percent of quota, or SDR 442 million in 2024. - This would represent 13.9 percent of gross international reserves under the adverse scenario, or 3.6 percent of GDP. - Debt service and repayment profile: - Nominal debt service to the Fund would peak in 2027, equivalent to 4.8 percent of reserves and 2.0 percent of exports of goods and services. - Authorities have an excellent track record in servicing obligations and regularly access international markets in normal times. - Interest burden projection note: - Baseline projections incorporate higher market rates on new debt in line with current tight global financial conditions; interest payments stay below 2 percent throughout the program period and gradually increase to 2.3 percent of GDP by 2027. *Source: IMF staff report (excerpts provided in the chapter "11. The current account deficit is set to")* ### 23. An update of the 2020 safeguards assessment has been initiated. The 2020 assessment ### 1mkdea2022005 - 23. An update of the 2020 safeguards assessment has been initiated. The 2020 assessment ### Safeguards assessment update - The 2020 assessment found a relatively robust safeguards framework at the NBRNM. - Staff recommended filling vacancies on the Council and Audit Committee to restore independent oversight; this has been completed. - Staff recommended strengthening autonomy and governance provisions in the National Bank law; this remains underway. - An updated safeguards assessment will be completed by the time of the first review of the PLL arrangement and will follow up on priority recommendations. ### A. Policy commitments under the PLL arrangement - The PLL arrangement would bolster the recovery and support efforts to strengthen macroeconomic and financial resilience. - Authorities’ Written Communication (WCOM) policy focus areas: - safeguarding public finances - improving energy efficiency and reducing energy subsidies while protecting the vulnerable - tackling high inflation - strengthening revenue collection and public investment management - ensuring investment projects fit within a sustainable medium-term fiscal framework - preserving financial stability ### B. Safeguarding public finances while scaling up investment - 2023 draft budget target: - reduces the budget deficit to 4.6 percent of GDP (WCOM ¶5). - Staff estimate this requires fiscal measures of about ¾ percent of GDP (Text Table 2). - Incorporates impact of higher interest rates on debt payments and scaling up public investment. - 2023 budget measures include: - streamlining preferential treatments and exemptions in corporate and personal income tax and VAT - reducing operating costs - reducing energy subsidies through tariff adjustments - phasing out the subsidy for social contributions on pay increases (introduced in 2019), creating savings of about ½ percent of GDP in 2023 - commitment to carefully manage public sector wage increases to avoid further pushing up inflation - Expected macro effect: consolidation should help prevent excessive demand pressures, aiding monetary policy in reducing inflation and narrowing the external current account deficit. - Text Table 2. North Macedonia: Overall Fiscal Balance, 2023, Decomposition (Percent of GDP) - Overall Fiscal Balance in 2022 -5.3 - Scaling-up of investment -1.0 - Subsidies 0.9 - Lower subsidies to state-owned electricity company 0.7 - Withdrawal of stimulus measures 0.2 - Policy measures 1/ 0.7 - Other 0.1 - Overall Fiscal Balance in 2023 -4.6 - Source: IMF staff estimates. - 1/ Cf. Text Table 3. - Text Table 3. North Macedonia: Fiscal Consolidation Measures in 2023 (Millions of denars, unless otherwise stated) - Revenue Measures — Streamlining preferential treatments in: - Corporate Income Tax (small and micro enterprises; donations to sports bodies; life insurance premiums) 1,156 - Personal Income Tax (capital gains; interest on term deposits; life, voluntary pension, and private health insurance premiums) 739 - Value-Added Tax (products for human consumption currently taxed at 5 percent, accommodation services) 2,713 - Expenditure Measures — Reducing operating costs (electricity consumption, travel and representation expenses, recourse to external consultants, rental and equipment costs) 1,500 - Total 6,108 - Total (percent of GDP) 0.7 - Sources: Ministry of Finance; and IMF staff calculations. ### Medium-term consolidation and fiscal governance - Under the PLL arrangement: - Additional measures of about ½ percent of GDP will be implemented in 2024 to bring the deficit to 3.4 percent of GDP (WCOM ¶5). - In the baseline projection, the deficit would thereafter gradually fall below 3 percent of GDP, the recently introduced deficit ceiling in the organic budget law. - Staff recommendations: - Additional consolidation of about 1¾ percent of GDP after 2024, targeting a 1 percent of GDP deficit in normal times to provide a safety margin relative to the 3 percent of GDP ceiling. - Strengthen fiscal governance via the organic budget law to improve fiscal policymaking, budget preparation and execution, and fiscal reporting. - Improve revenue administration, particularly compliance risk management, to improve tax compliance and raise revenues (WCOM ¶9). ### Managing fiscal risks from public investment projects - Authorities committed to implement the action plan from the IMF’s Public Investment Management (PIM) Assessment, including establishing a PIM unit in the Ministry of Finance (WCOM ¶9). - Corridor 8/10d highway project: - Independent and comprehensive feasibility study underway as a structural benchmark (January 2023, WCOM ¶6). - Project currently estimated to cost about 10 percent of 2022 GDP over 6 years; incorporated in program baseline. - If feasibility study finds larger fiscal cost or high fiscal sustainability risk, timeline will be adjusted or parts implemented with IFI financing. - Publication of audits and project monitoring reports by an independent advisor to ensure transparency and accountability. ### C. Navigating the energy price shock and the green transition - Energy tariff and subsidy developments: - Consumer prices generally set to recover cost; regulated market consumers temporarily shielded through semi-annual adjustments. - Electricity and central heating tariffs have increased by about 30 percent for the average consumer over the past year. - Increasing-block tariffs introduced in the regulated market for households (WCOM ¶7). - Authorities’ plan: - Phase out untargeted energy subsidies and further adjust tariffs in January 2023 to reduce budget transfers to the state-owned electricity company (WCOM ¶7). - Develop an action plan to phase out untargeted energy subsidies by 2025 and improve energy efficiency while strengthening targeted support for the vulnerable (structural benchmark, February 2023, WCOM ¶7). - Authorities have expressed interest in the Resilience and Sustainability Trust; the plan could be a starting point for prospective policy actions. - Expected effects: phasing-out untargeted subsidies and block tariff system should incentivize energy savings and reduce the energy trade deficit. ### D. Addressing high inflation and guarding against financial stability risk - Monetary policy stance: - NBRNM tightening monetary policy via unsterilized FX sales, higher policy rates, and a higher reserve requirement on FX deposits than denar deposits to prevent high inflation becoming entrenched and to support the de-facto exchange rate peg (WCOM ¶10). - Continued rate hikes will be needed, including because of expected further rise in the ECB’s policy rate; if inflation differential with euro area persists due to indexation of minimum wage and pension benefits, NBRNM may need to tighten more than the ECB. - Macro- and microprudential measures and legislation: - Banking system: overall well capitalized, low NPLs and adequate provisions. - NBRNM intensified monitoring and will continue strengthening its stress testing framework (WCOM ¶11). - Financial Stability Law adopted in July to strengthen macroprudential oversight. - Amendments to the National Bank law to be submitted in November 2022 to grant NBRNM a formal macro-prudential mandate (WCOM ¶12). - Counter-cyclical capital buffer: 0.5 percentage points, effective in August 2023, in light of high mortgage lending and rising real estate prices. - New laws to strengthen deposit insurance and bank resolution frameworks expected to be submitted to Parliament by June 2023 (WCOM ¶12). - Operational independence: - Essential to preserve NBRNM operational independence to fight inflation and preserve financial stability. - Authorities intend amendments to the National Bank law, and laws on administrative staff and public employees to ensure autonomy to determine employment conditions (WCOM ¶10). ### E. Enhancing competitiveness through labor market and governance reforms - Labor market: - Higher energy prices produce a terms-of-trade shock likely to be partly permanent; important to allow labor market adjustment to preserve competitiveness. - Authorities will consider productivity when determining minimum wage increases (WCOM ¶14); ad-hoc increases should be avoided. - Policies to support job-to-job transitions and improve education outcomes are being implemented. - Governance reforms: - Authorities undertaken reforms enabling opening of EU accession negotiations; further actions needed over next years to strengthen rule of law and control of corruption to meet EU standards. - Under the PLL arrangement, authorities committed to enhance procurement transparency by connecting the procurement system with the register of ultimate beneficial ownership (WCOM ¶9). - New AML/CFT law adopted in July; focus now on implementation. Authorities committed to swiftly implement recommendations from the ongoing MONEYVAL assessment (WCOM ¶13). ### F. Exit strategy - Program effects and targets: - Proposed program would strengthen fiscal and reserve buffers, allowing for a smooth exit from the arrangement under the PLL. - Staff estimate fiscal deficit to narrow by end of arrangement, contributing to a gradual decline in public debt over the medium term. - Level of gross international reserves would be above 100 percent of the ARA metric at end-2024 and through the projection horizon. - Program would reduce dependence on energy imports and vulnerability to energy price swings; actions could be further supported under the Resilience and Sustainability Trust. - Caveat: Successful exit also depends on reduction of external risks beyond domestic policies. ### Staff appraisal and program size - Qualification and assessment: - North Macedonia meets the qualification criteria for the PLL; performs strongly in four out of five qualification areas; public finances identified as needing improvements. - Under the program, authorities will gradually reduce the deficit, place public debt on a downward path, manage fiscal risks, and strengthen public financial management. - Debt sustainability and Fund arrangement: - Staff project public debt to remain below 60 percent of GDP during the projection period and gradually decline over the medium term. - Proposed PLL arrangement size: SDR 406.87 million (290 percent of quota), representing 4 percent of 2022 GDP. - If fully drawn, capacity to repay the Fund would remain adequate assuming steady program implementation and continued market access. - Authorities have an excellent track record of servicing debt obligations. - Staff recommendation: - Staff recommend approval of the authorities’ request for a PLL arrangement for North Macedonia. - Authorities expected to draw on the arrangement during the first year due to two consecutive shocks (pandemic and Russia’s invasion of Ukraine); in the second year it would act as a backstop for fiscal and external financing needs. - Staff welcome close dialogue and authorities’ commitment to continue cooperating with the Fund. ### Box: The Corridor 8 and 10d Highway Project (summary) - Project highlights: - Corridor 8 connects Bulgaria, through North Macedonia, with Albania; total planned highway length approximately 135 km, consisting of four sections. - Parliament adopted a special law for the highway project as a “lex specialis” in 2021; the law exempts the project from public procurement. - To mitigate governance concerns, authorities are hiring an independent advisor to monitor the project and will publish regular monitoring reports and audits. - Macroeconomic significance and cost: - Corridor 8/10d expected to cost €1.3 billion (10 percent of 2022 GDP) and be completed over a 6-year period; incorporated in the baseline macroeconomic framework. - Authorities have requested a comprehensive and independent feasibility study, including appraisal documentation, from an internationally reputable company to firm up cost estimates. - Authorities selecting an independent financial transaction advisor, based on an international tender, to negotiate the contract and supervise implementation. - Growth and fiscal implications: - Staff used dynamic multipliers calibrated for the average Western Balkan country, assuming even distribution over time of the current cost estimate. - On this basis, the average growth rate would be 0.3 percentage points lower without the project. - Given that road spending will be offset by other fiscal measures (including cuts to other capital expenditure), the growth effect remains positive but more modest; overall effects on fiscal balances, the external balance, and inflation are modest. - Over the longer term, the road could have additional growth dividends by boosting trade and tourism. - Note on methodology: - The dynamic multipliers assume debt financing, and low investment efficiency. *Source: IMF staff report chapter provided in the content unit.* ### Box 2. Electricity Prices, Block-Tariff Reform, and Transition to Improved Energy Efficiency ### Box 2. Electricity Prices, Block-Tariff Reform, and Transition to Improved Energy Efficiency ### Market structure and subsidies - Electricity prices for households and small firms are regulated. - The electricity market was in principle fully liberalized in 2019, but distribution was segmented into a liberalized and a regulated market to ease the transition. - The regulated market has one “universal supplier”, EVN, which can in principle procure electricity from any source, but most is procured through the state-owned generator, ESM (Power Plants of North Macedonia), at a price below the market price. - Prior to the pandemic and current energy crisis, the “universal supplier” model was due to be phased out, with ESM’s obligation to provide a share of its output at subsidized prices to EVN steadily decreasing over time. This phasing-out has been suspended, and ESM is currently obligated to supply 100 percent of its output to EVN to satisfy the need of the regulated market. - Government subsidies occur at the generation stage. Tariff-setting is designed to ensure that the universal supplier can achieve both cost recovery and a specified margin for any given price for electricity supply charged by ESM. - Subsidized tariffs are provided to households through lower charges for electricity from ESM to EVN, with the government providing direct balance sheet support to ESM to cover losses. ### ESM cost and procurement profile - ESM’s own electricity production represents 75 percent of the electricity it procures for the regulated market and is currently not making losses on that own production. - ESM is loss-making on the remaining 25 percent, which is procured from less efficient production facilities or imported at a very high import price. - The price charged by ESM to EVN is estimated to be 40 percent below cost recovery, when also including all externally procured electricity. - To eliminate fiscal subsidies, as long as ESM needs to supply more than 100 percent of its own production to satisfy the need of the regulated market, the price charged by ESM to EVN needs to be brought in line with its total production costs, including through purchases of electricity. ### Block-tariff reform introduced July 2022 - The authorities introduced electricity block tariffs in July 2022 to incentivize energy savings. - The block tariffs consist of four blocks with a higher marginal tariff as consumption increases. - The design aims to: - Ensure that all households can afford a basic quantity of electricity through cross-subsidization. - Motivate electricity savings through lower consumption and greater efficiency, with the largest effect expected among high users who experience a step tariff increase. - The effect is expected to be largest among the high users of electricity, who experience a step tariff increase. ### Quantified effects and tariff signal - Higher electricity tariffs and the introduction of block-tariffs are expected to lead to a 5 percent reduction in electricity consumption in the regulated market in 2023 and 2024, everything else remaining equal. - An important element in the introduction of block tariffs is to reduce marginal consumption, as it is the marginal consumption (in particular through imports) which leads to a loss for ESM. - Consideration should be given to bring the top marginal tariff, and over time the average tariff, in line with the market price, to: - Provide an incentive for households and small consumers to move back to the liberalized market. - Recover the loss made by ESM in 2022. ### Reported marginal tariff changes by block (percentage points relative to the average increase) - First block (0-210 kW/h): -12.3 - Second block (210-630 kW/h): -7.5 - Third block (630-1050 kW/h): 0.5 - Fourth block (1050> kW/h): 120.9 *Source: IMF staff summary of Box 2, “Electricity Prices, Block-Tariff Reform, and Transition to Improved Energy Efficiency.”* ### Box 4. External Economic Stress Index ### Box 4. External Economic Stress Index ### Overview - The External Economic Stress Index (EESI) captures external risks for North Macedonia using five major variables: - real growth rate of euro area imports (proxy for net exports in the current account) - real growth rate of GDP in Germany (proxy for remittances, FDI, and other diaspora-related flows in the current and financial accounts) - Financial Conditions Index compiled by Banque de France (FCI, proxy for risk premia and financial conditions) - index of prices of food commodities (from IMF GAS, proxy for risks from further imported food prices) - index of energy commodities (from IMF GAS, proxy for risks from further imported fuel commodity price increases) - Calculation method: - EESI is a weighted sum of standardized deviations of the above variables from their means. - Signs are reversed for the FCI and the price indices. - Weights are estimated using the importance of each variable in GDP. ### Construction and Weights - External risk channels, external proxies, and weights: - External demand — Net exports — Euro area growth — weight 0.15 - Food imports — Food commodity price index (sign reversed) — weight 0.10 - Energy imports — Energy commodity price index (sign reversed) — weight 0.11 - Financial inflows — Remittances, FDI — Germany GDP growth — weight 0.20 - Financial inflows — Portfolio flows — Financial Conditions Index (sign reversed) — weight 0.18 - Weight interpretation: - Weight on euro area import growth corresponds to net exports in GDP. - Weight on German real GDP growth corresponds to the share of remittances plus FDI in GDP. - Weight on the FCI corresponds to the share of portfolio liabilities in the international investment position. - Weight on the food commodity price index corresponds to the share of food in imports. - Weight on the energy commodity price index corresponds to the share of energy in imports. ### Baseline and Adverse Scenarios; Key Findings - Baseline conditions: - Baseline EESI is already unfavorable due to effects of the Russian invasion of Ukraine, reflecting a sharp increase in commodity prices and higher yields. - Adverse (downside) scenario: - Reflects external risks such as a further rise in fuel prices, a deeper economic contraction in external demand, and higher risk premia. - EESI values: - Average EESI on average in 2022 and 2023: - Baseline: -0.41 - Downside: -0.55 - Lowest observed value in the projection period: - -0.77 in the first quarter of 2023 - Historical comparison: - Pandemic minimum: -1.53 in the second quarter of 2020 - Interpretation: - Negative EESI values indicate above-average stress. ### Chart and Data Notes - Time series span shown (chart axis labels): Mar-13, Sep-14, Mar-16, Sep-17, Mar-19, Sep-20, Mar-22, Sep-23. - Series plotted: EESI, Downside, Baseline. - Sources for data and calculations: Haver Analytics; WEO; BdF; and IMF staff calculations. - Note: Negative values indicate above-average stress. *Source: IMF staff calculations as reported in the Box 4. External Economic Stress Index content unit.* ### Annex I. Debt Sustainability Assessment (DSA) ### Annex I. Debt Sustainability Assessment (DSA) ### Bottomline - North Macedonia’s debt is assessed as sustainable in the medium term with a high probability. ### Baseline projections and dynamics - Public sector debt is expected to remain below 60 percent of GDP during the projection period and gradually decline over the medium term, therefore staying below the 70 percent of GDP high-risk threshold. - Gross financing needs will hover around the 15 percent of GDP high-risk threshold in years with Eurobond amortizations. - Public debt is set to slightly increase in 2023–25, with still high fiscal deficits offsetting a still favorable interest-growth rate differential, before gradually declining in the outer years. - The authorities are committed to consolidate over the medium term, which would place debt more firmly on a downward path. - The peak in gross financing needs in 2023 and 2025–26 reflects the higher deficit (2023) and repayment of Eurobonds (2023, 2025–26). Key baseline statistics (selected from DSA tables and figures) - Nominal gross public debt: 42.2 (2020), 59.6 (2021), 60.6 (2022), 58.3 (2023), 58.7 (2024), 58.9 (2025), 59.3 (2026), 58.3 (2027), 57.8 (projection years and historical as shown). - Public gross financing needs: 13.2 (2020), 9.6 (2021), 16.9 (2022), 12.3 (2023), 15.0 (2024), 11.0 (2025), 13.6 (2026), 14.5 (2027), 10.7 (other indicated values). - Real GDP growth: 2.6 (2020), -6.1 (2021), 4.0 (2022), 2.7 (2023), 2.9 (2024), 3.9 (2025), 3.8 (2026), 3.8 (2027). - Inflation (GDP deflator): 2.6 (2020), 0.9 (2021), 6.1 (2022), 10.6 (2022 projected elsewhere), 8.8 (2023), 3.8 (2024), 2.6 (2025), 2.5 (2026), 2.3 (2027). - Effective interest rate (defined as interest payments divided by debt stock at end of previous year): 3.0 (2020), 2.7 (2021), 2.5 (2022), 2.6 (2023), 3.0 (2024), 3.6 (2025), 3.9 (2026), 4.3 (2027), 4.5 (other indicated). - Change in gross public sector debt (cumulative series in table): 2.4 (2020), 11.5 (2021), 1.0 (2022), -2.3 (2023), 0.4 (2024), 0.2 (2025), 0.4 (2026), -1.0 (2027), -0.5 and -2.8 in later cumulative entries. ### Stress tests and risks - Macroeconomic and fiscal shocks can significantly increase public debt and gross financing needs relative to the baseline; these exceed the relevant high-risk thresholds in some scenarios. - Forecast error analysis suggests no systematic bias in historical projections. - Stress tests demonstrate risks associated with the government’s high public financing needs and the considerable share of FX-denominated debt. - Scenarios with largest vulnerabilities include: - Real GDP growth shock of one standard deviation in 2023–24. - A combined macro-fiscal shock. - A contingent liability shock. - Under these stress test scenarios: - Public sector debt would rise close to or above the 70 percent of GDP high-risk benchmark in the medium term. - Gross financing needs would exceed 20 percent of GDP in 2023 in the contingency liability shock. - Note: The first year of the pandemic (2020) is not treated as an outlier in the scenarios, which increases the size of the simulated shocks. Selected stress-test outcomes (as presented) - Adverse scenario nominal gross public debt: 42.2 (2020), 59.6 (2021), 60.6 (2022), 58.4 (2023), 58.4 (2024), 59.8 (2025), 60.0 (2026), 58.8 (2027), 58.4 (values mirrored from adverse table). - Adverse scenario public gross financing needs: 13.2 (2020), 9.6 (2021), 16.9 (2022), 12.3 (2023), 15.4 (2024), 11.9 (2025), 14.1 (2026), 15.1 (2027), 11.7 (other indicated). ### Assumptions underpinning the baseline - Real GDP growth: expected to slow to 2.7 percent in 2022 and 2.9 percent in 2023, then rebound and gradually converge to potential over the medium term. - Headline inflation: projected to exceed 10 percent in 2022, before gradually declining to around 2 percent by 2027. - Fiscal deficit: projected to remain broadly unchanged in 2022, due to measures taken by the authorities to mitigate the impact of higher energy and food prices. - Risks: Higher commodity prices, rising uncertainty, and tighter financing conditions would weigh on domestic demand; lower external demand and a prolongation of global supply disruptions would dampen exports. The balance of risks remains tilted to the downside. ### Coverage and contingent liabilities - Public debt includes guaranteed debt of nonfinancial state-owned enterprises. - Stress test scenarios include a standard scenario where contingent liabilities related to the banking system materialize. - Publicly guaranteed debt of nonfinancial state-owned enterprises has risen steadily over the past decade, reaching 7 percent of GDP in 2021, mainly due to public transport infrastructure projects by the public roads company. ### Additional DSA indicators and thresholds (summary points shown in figures) - High-risk benchmarks highlighted: - Public debt high-risk threshold: 70 percent of GDP. - Gross financing needs benchmark: 15 percent of GDP. - Contingent liabilities and exchange rate/interest shocks can push indicators into higher risk bands in the stress tests. - Market-perception and debt-profile vulnerabilities are displayed across a heat map of indicators including bond spreads, external financing requirement, change in short-term debt share, public debt in foreign currency, and public debt held by non-residents (as presented in the DSA figures). *Source: IMF staff (Annex I. Debt Sustainability Assessment).* ### Appendix I. Written Communication ### Appendix I. Written Communication ### Economic outlook and shocks - Pre-pandemic: public debt below 50 percent of GDP; moderate current account deficit; solid and broad-based growth. - Covid-19 impact: output fell by 4.7 percent in 2020; subsequent recovery supported by strong policy response. - Post-February 2022 shocks: Russia’s invasion of Ukraine led to sharply rising energy and food prices, weaker global confidence, and tighter global financial conditions, worsening growth outlook, widening the current account deficit, and increasing financing costs. - Government growth forecasts: - Supplemental budget (July 2022): real GDP growth 3.2 percent in 2022 and 4.5 percent in 2023. - Revised expectation: GDP growth 2.7 percent in 2022 and 2.9 percent in 2023; economic activity still exceeds pre-pandemic level in 2022. - Inflation forecasts: - National Bank forecast (April 2022): 8.8 percent on average for 2022. - Government expects to revise up in line with IMF staff: 12.9 percent for 2022 and around 7 percent for 2023 as global energy and food prices moderate. ### Request for IMF support and financing plan - Requested instrument: 24-month Precautionary and Liquidity Line (PLL). - PLL amount: SDR 406.87 million (290 percent of quota), approximately euro 530 million. - Immediate availability upon approval: SDR 84.18 million (60 percent of quota) would become available on IMF Executive Board approval. - Draw intentions: intend to draw amounts available at approval and at the first review; treat arrangement as precautionary thereafter. - Use of drawn amounts: channeled to government’s account at the NBRNM and used for budget financing. - Other financing/lines: - European Bank for Reconstruction and Development approved a loan for liquidity support of €100 million for ESM (Power Plants of North Macedonia) during 2022-2023 (pending parliamentary approval). - European Union will provide budget support of €80 million in early 2023 as a grant. - Plan to obtain additional external market financing of at least €800 million over the next 12 months. - €400 million repo line with the ECB, through mid-January 2023, to provide euro liquidity to the NBRNM. ### Fiscal policy stance, targets, and measures - 2022 supplemental budget target: fiscal deficit of 5.3 percent of GDP. - Policy objectives: safeguard public finances; strengthen revenue collection and public investment management; ensure investment projects fit sustainable medium-term fiscal framework; improve energy efficiency and reduce energy subsidies while protecting the vulnerable; tackle high inflation; buttress financial stability. - Deficit targets: - Reduce budget deficit to 4.6 percent of GDP in 2023 through revenue and expenditure measures of about ¾ percent of GDP. - Further reduce budget deficit to 3.4 percent of GDP in 2024. - Expenditure management: - Phase-out: subsidy on social contributions on pay increases phased out in October 2022. - No increase in stock of payment arrears to the private sector; unused allocations under the 2022 budget to be used primarily to clear arrears. - Curb operating costs: reduce electricity consumption, travel and representation expenses, use of external consultants, rental and equipment costs; monitor implementation quarterly. - No broad-based permanent public sector wage increases in 2023 beyond minimum wage adjustments. - Anti-crisis support: any support to households and companies will be strictly targeted and temporary; draft 2023 budget includes envelope to cover losses in the energy sector. - Consultation: will consult Fund staff ahead of any major reallocations between capital and current spending. ### Tax reform and revenue mobilization - Tax policy reform aims: improve quality of tax system and strengthen revenue mobilization. - IMF advisory support on tax reform package focused on consolidating tax base and increasing fairness, aligned with government’s strategy for tax system reform 2021-2025. - Process: inclusive stakeholder engagement; opened for public consultation prior to legislative amendments. - Expected fiscal yield: legislative proposal to streamline preferential treatments and exemptions in corporate and personal income tax and value-added tax that will yield savings of approximately ½ percent of GDP. ### Public investment and Corridor 8/10d project - Plan to gradually scale up investment while managing fiscal risks. - Structural benchmark: request independent and comprehensive feasibility study from a reputable international company and share with IMF staff (end-January 2023). - Project fiscal treatment: - Estimated fiscal cost of the project: €1.3 billion (incorporated in the medium-term fiscal framework). - If feasibility study finds higher fiscal cost or unmanageable risks, will adjust timeline and/or implement part of project with IFI involvement and financing consistent with program targets and fiscal rules. - Procurement/contracts: independent advisor to review contract pre-signing and monitor project monthly or more frequently; publication of project monitoring reports and audits to ensure transparency and accountability. ### Energy pricing reform and social protection - Tariff reform implemented July 1, 2022: - Implemented increasing-block tariffs; charged significantly higher tariff for consumption beyond basic needs. - Increased weighted average electricity tariff by about 18 percent. - Expected reduction in electricity companies’ loss by €60 million (0.5 percent of GDP) in 2022. - Plan to adjust tariffs further in January 2023 to reflect market prices and further reduce losses and related budget transfers consistent with budget deficit target. - Medium-term objective: continue increasing electricity tariffs to gradually eliminate untargeted government subsidies by the end of 2025 and improve energy efficiency. - Measures: incentivize small- and medium-sized enterprises (“small consumers”) to move to the liberalized electricity market; review block tariff experience; expand programs for energy vulnerable customers in coverage and adequacy. - Structural benchmark: prepare and publish an action plan covering these aspects, building on collaboration with the World Bank and the IMF, to be adopted by the government and published by February 2023. ### Fiscal framework and governance - Organic budget law adopted September 2022 (prepared in consultation with European Commission, World Bank, IMF): - Establishes a fiscal rule, effective 2023: ceiling for fiscal deficit of 3 percent of GDP and general government debt of 60 percent of GDP, with limited escape clauses. - Expands coverage of general government to include non-market state-owned enterprises by 2027. - Foresees annual reporting of tax expenditures as part of the annual budget. - Establishes a fiscal council to assess macroeconomic and budgetary projections and monitor adherence to rules. ### Revenue administration, PIM, and procurement reforms - Revenue administration: - Modernize revenue administration and tax compliance. - Public Revenue Office to strengthen centralized compliance risk management (CRM): establish CRM committee, staff CRM unit appropriately, create single reform governance structure within the organization by December 2022. - No tax amnesties. - Public investment management (PIM): - Adopted PIM action plan based on IMF’s 2020 PIM assessment. - Adopt legal acts for establishment of PIM Department in Ministry of Finance by December 2022. - Public procurement: - All procurements via electronic portal include contract as part of award notification. - Connect procurement system with newly created register of ultimate beneficial ownership by January 2023 to enhance transparency. ### Monetary policy and exchange rate policy - Inflation drivers: global factors, increased inflation expectations, high nominal wage growth. - Monetary normalization steps: - Interventions in foreign exchange market during October 2021-June 2022, absorbing denar liquidity. - Policy rate increased by 225 basis points cumulatively since April. - Increased differential between reserve requirement rates on banks’ euro and denar liabilities effective in June and September to encourage higher denar deposit rates. - Commitment to continue monetary tightening and act as needed to address large/persistent inflation differential with euro area or pressures on international reserves. - Preserve central bank independence; will amend legislation to ensure NBRNM autonomy over employment conditions of its staff (follow-up to 2020 Safeguards Assessment). ### Financial sector resilience and macroprudential policy - Banking system: well-capitalized, liquid, resilient to tightening global financial conditions. - Risks monitored: rising real estate prices, banks’ mortgage and FX lending, higher interest rates. - Macroprudential measures: - Introduced 0.5 percent counter-cyclical capital buffer for banks’ exposure to domestic economy, effective August 2023; will take further action if necessary. - Financial Stability Law adopted July 2022 to strengthen coordination on macroprudential policy and oversight. - Amendments to National Bank law to grant formal macroprudential mandate to NBRNM to be submitted to parliament by November 2022. - New laws for deposit insurance and bank resolution under preparation with World Bank technical assistance; legislative package to be submitted to parliament by June 2023. ### AML/CFT and labor market measures - AML/CFT: - New AML/CFT law adopted July 2022. - MONEYVAL assessment underway with final report scheduled for 2023; authorities will follow up on recommendations. - Labor market and minimum wage: - Aim to reduce skills shortages and reverse decline in labor force participation by strengthening education outcomes and supporting job-to-job transitions. - Future minimum wage increases will consider productivity levels and trends to preserve jobs and competitiveness. ### Program monitoring, transparency, and conditionality - Data and information: will provide IMF staff requested data for program monitoring. - PLL-related standards: will observe standard criteria on trade and exchange restrictions, bilateral payment agreements, multiple currency practices, and non-accumulation of payment arrears on external debt. - Commitment: policies considered adequate for macroeconomic and financial objectives; will consult IMF staff on additional measures or revisions; consent to IMF publication of this Communication, the Technical Memorandum of Understanding, and accompanying Executive Board documents. - Program exit: aim to be well positioned to exit PLL when it expires in November 2024. ### Structural benchmarks and reporting calendars - Structural benchmarks: - Adoption and publication of government action plan to gradually eliminate need for government subsidies for electricity services and further improve energy efficiency (¶7): End-February 2023. - Comprehensive and independent feasibility study of Corridor 8/10d road project, shared with IMF staff (¶6): End-January 2023. - Indicative and performance targets (Table 2 excerpts; end of period, million denars, unless otherwise indicated): - Indicative Targets — Floor on the central government cash balance: -17,560-29,538-10,881 (March 2023, September 2023, March 2024). - Indicative Targets — Non-accumulation of domestic payment arrears: 000. - Indicative Targets — Floor on net international reserves (million euros): 2,9192,8622,759 (March 2023, September 2023, March 2024). - Continuous Performance Criteria — Non-accumulation of new external debt payment arrears: 000. - Multilateral program financing baseline (Table 3): - End-March 2023: 80 (in millions of euros). - TMU definitions and reporting: - Central government cash balance measured from “above the line”; floor measured cumulatively from start of year; end-March 2023 floor adjusted for shortfall/surplus of multilateral program financing cumulative from end-December 2022. - Domestic arrears defined per May 16, 2018 rulebook; change measured relative to stock at end-December 2022; monthly reporting no later than one week after month end. - Net International Reserves (NIR) definition includes reserve assets minus reserve-related liabilities; exchange rate for monitoring during first year: Macedonian denar (MKD) 61.4950 per euro (rate prevailing on October 1, 2022). Foreign currency accounts in currencies other than the euro and monetary gold valued in euros at rates and gold prices prevailing on October 1, 2022. - NIR floor adjusted for shortfall/surplus of multilateral program financing cumulative from end-December 2022. - NBRNM to report international reserves to the IMF on a daily basis. - Ministry of Finance to report profits and losses of ESM monthly no later than four weeks after end of month. - Review schedule (assuming IMF Executive Board approval on November 21, 2022): - First review no later than May 19, 2023. - Second review no later than November 22, 2023. - Third review no later than May 22, 2024. *Source: Appendix I. Written Communication (Skopje, November 4, 2022) — Republic of North Macedonia.* ### 2024. The PLL will help the country weather current shocks and allow it to sustain its policy ### 2024. The PLL will help the country weather current shocks and allow it to sustain its policy ### Program purpose, duration, and expected catalytic financing - The program duration is two years, with the authorities expecting the program and committed reforms to put the North Macedonian economy in a stronger position by end-2024. - Two-year duration noted as in line with the duration of the previous PLL in 2011-2013. - The authorities expect a catalytical effect on private and public financing and report the following financing outcomes and targets: - In 2022, the authorities obtained EUR 300 million in external financing. - The authorities are committed to obtaining at least EUR 800 million in external financing in 2023, of which EUR 450 million will be used to amortize a Eurobond. - The European Union has announced it will provide EUR 80 million in budget support to North Macedonia in early 2023. - The European Bank for Reconstruction and Development (EBRD) has approved EUR 100 million in support for North Macedonia’s electricity-producing company, subject to parliamentary approval. - Discussions are ongoing with the World Bank for Development Policy Operation support and about possible Macro-Financial Assistance from the EU. ### Fiscal policy actions and targets - Prudent fiscal policy: a supplemental budget for 2022 was adopted in July 2022 to address multiple shocks; the revised budget includes measures to support low-income households and help build food reserves. - The additional spending in 2022 was partly offset by higher revenue and lower capital spending, limiting the increase in the deficit to below earlier projections by staff. - Deficit reduction path and fiscal commitments: - Budget deficit targeted to be reduced to 4.6% of GDP in 2023. - Budget deficit targeted to be reduced to 3.4% of GDP in 2024. - Revenue-side measures: - Commitment to a tax reform to strengthen revenue mobilization. - The tax code will be simplified by streamlining preferential treatments and exemptions to generate additional revenue. - Expenditure-side measures: - Subsidies will continue to become more targeted. - Authorities will publish an action plan to gradually eliminate electricity subsidies by end-February 2023 (structural benchmark). - Commitment to eliminating untargeted energy subsidies by 2025. - Avoidance of any broad-based permanent public sector wage increases in 2023 beyond the minimum wage adjustments. - Institutional fiscal safeguards: - Adoption of an Organic Budget Law in September 2022, providing a strong medium-term fiscal framework with limits to deficit and debt levels similar to those in EU Treaties. - The Law introduces improvements to budget preparation, execution, and fiscal reporting. - A fiscal council is tasked with assessing macroeconomic and budgetary projections and monitoring adherence to the Organic Budget Law. ### Monetary policy and central bank independence - The NBRNM tightened monetary policy starting in the last quarter of 2021 by prudently managing banking system liquidity through foreign exchange interventions and other instruments. - In 2022, the NBRNM adjusted the required reserve instrument on three occasions to differentiate forex and domestic currency reserve requirements. - Since April 2022, the NBRNM increased the main policy rate seven times by 300 basis points in total, resulting in a widening of spread compared with the ECB. - The latest policy rate increase took place in the week of November 14. - The NBRNM will continue to monitor incoming macroeconomic data and stands ready to undertake measures to maintain exchange rate and price stability. - Commitment to preserving central bank independence: - Steps will be taken to ensure the NBRNM has autonomy to determine employment conditions of its staff through amendments to relevant legislation. - Authorities welcome the safeguards assessment performed as part of the requested PLL arrangement and stand ready to act upon recommendations. ### Financial sector and macroprudential measures - Strengthening of financial sector legislation and oversight: - Introduction of a counter-cyclical capital buffer by August 2023. - Adoption of a formal macroprudential mandate for the NBRNM. - Legal work ongoing to strengthen deposit insurance and bank resolution frameworks, inspired by EU legislation. - Supervisory equivalence and AML/CFT: - In November 2021, the European Commission determined that North Macedonia’s supervisory and regulatory framework could be regarded as equivalent to that applied in the EU. - AML/CFT framework improved through legal changes in June 2022. - A MONEYVAL assessment of the AML/CFT framework is scheduled to be finalized in 2023; authorities will act swiftly on any recommendations. ### Public investment, project feasibility, and structural reforms - Public investments will be scaled up in a well-targeted manner and coordinated with the IMF to ensure adherence to fiscal objectives. - Corridor 8/10d road project: - Part of the investments will go to the Corridor 8/10d road project to increase interconnectedness with neighboring countries. - Authorities commissioned a comprehensive feasibility study of the road project (structural benchmark). - The feasibility study will be available by end-January 2023 at the latest and will be shared and discussed with IMF staff. - Structural reform priorities: - Strengthen education and active labor market policies. - Minimum wage increases will take into account productivity levels and trends. - Additional economic reforms will be carried out in view of EU accession negotiations. ### Risks, contingency planning, and longer-term arrangements - Authorities are cognizant of downside risks and have prepared contingency measures, including possible expenditure or revenue measures, if serious downside risks materialize. - Interest in IMF Resilience and Sustainability Facility (RSF): - Authorities have shown an interest in an RSF arrangement to assist North Macedonia in actions against climate change. - Ongoing work on better targeting energy subsidies and improving energy efficiency will be useful in RSF exchanges with IMF staff. ### Conclusion and next steps - Negotiations toward the PLL staff-level agreement involved in-depth, transparent, and candid discussions that deepened engagement and supported recent policy actions. - The PLL, together with IMF surveillance and technical assistance, provides support for the authorities’ reforms and EU accession objectives following the start of EU accession negotiations in July 2022. *Source: 1mkdea2022005 - 2024. The PLL will help the country weather current shocks and allow it to sustain its policy* --- _Source: https://www.imf.org/-/media/files/publications/cr/2022/english/1mkdea2022005.pdf_