## 1. Electricity Block Tariffs for Households

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### A. Climate exposure and energy-sector context
- North Macedonia is exposed to climate change and natural hazards with substantial risks from flooding and forest fires.
- Historical events (1990–2023):
  - Riverine flood event count 9; Flash flood event count 2; Forest fire event count 3.
  - Total Damage, Adjusted ('000 USD): Riverine flood 476,105; Flash flood 168,391; Forest fire 23,050.
  - Forest fires affected over one million people.
- Short- to medium-term probabilities:
  - Potentially damaging and life-threatening floods likely at least once in the next 10 years.
  - Over a year, >50 percent probability of weather conditions supporting a significant wildfire.
  - At least one prolonged extreme heat period likely with probability >25 percent in the next five years.

### B. Current energy mix and emissions drivers
- Electricity production accounts for around 60 percent of total GHG emissions in North Macedonia.
- Coal-based electricity generation accounts for 50 percent of total domestic electricity production.
- Around 90 percent of electricity-sector emissions are from using coal as an energy source.
- Other contributing emission sources: transport sector (~10 percent), heating sector (~10 percent), agricultural sector (~10 percent).
- CO2 equivalent total GHG emissions: decreased from around 14 thousand kt in 1990 to around 11 thousand in 2020 (World Bank estimates).
- Domestic installed electricity generation capacity as of end of 2022: 2,266 MW.
- Newly installed and commissioned PV capacity (Jan 2022–Sep 2023): over 450 MW.

### C. National targets, planned measures, and investment needs
- Enhanced NDC (2021) commitments:
  - Reduce GHG emissions by 51 percent by 2030 compared to 1990.
  - Reduce net emissions by 82 percent by 2030 compared to 1990 (implies net emissions from 12,271 to 2,203 Gg CO2-eq).
- Energy-sector targeted emission reduction: expected to fall by as much as 66 percent of the 1990 level.
- FOLU sector removals expected to increase by approximately 18 times.
- NECP RES and efficiency targets by 2030:
  - RES share of gross final energy consumption: 38 percent by 2030.
  - RES share in final energy consumption in the electricity sector: 66 percent by 2030.
  - RES consumption targets: cooling/heating 45 percent; transport 10 percent.
  - Energy efficiency vs BAU: 20.8 percent savings of final energy consumption; 34.5 percent savings of primary energy consumption.
  - Transport planned savings: 19 percent relative to BAU.
- Energy security objective: limit import dependency at 59 percent (conditional on implementing RES and energy efficiency plans).
- Planned large RES projects: Chebren hydropower plant by 2029; Vardar valley in 2025–30; 120 MW PV power plants in Oslomej; further solar, wind and biogas capacities.
- Authorities’ cumulative capital investment needs through 2050 (public and private): between €18.5 billion and €34.1 billion.
  - Equivalent to 4.3–8.0 percent of 2023 GDP annually, and 130–241 percent of GDP cumulative.
- Short-term investment target (energy transition investment platform launched Dec 2023):
  - Deploy 1.7 GWs of renewable energy by 2030.
  - Estimated investments of €3 billion (20 percent of 2023 GDP) by 2030 to achieve platform objectives.

### D. Electricity market design, regulation, and subsidies
- Market design:
  - 2018 Energy Law de-regulated the market; transition allowed open market and regulated market to coexist.
  - Article 237 phased reduction of regulated market demand supplied by state-owned ESM: "from 100 percent in 2018 (100/2018), 80/2019, 75/2020, 70/2021, 60/2022, 50/2023, 40/2024, to 30 percent in 2025 (30/2025)."
  - ERC authorizes tariff increases for the universal supplier to ensure cost recovery; ESM is not regulated by the ERC.
- Subsidies and fiscal cost:
  - Ministry of Finance subsidized electricity prices at a cost of 1.3 percent of GDP in 2022.
  - Staff estimate electricity subsidies in 2023 around 0.8 percent of GDP; measures under the Precautionary and Liquidity Line (PLL) likely reduce subsidies in 2024 to 0.3 percent.
  - During the 2021–2022 energy crisis, ESM was mandated to cover 100 percent of regulated-market demand, increasing the subsidy burden.
- Market outcomes:
  - Almost all households and small companies shifted back into the regulated market after 2022 price surges.
  - Regulated-market prices remain, de facto, among the lowest in Europe for households.

### E. Electricity block-tariffs: design, consumption patterns, and recent tariff changes
- Implementation and structure:
  - Block-tariffs introduced 1st July 2022 to incentivize lower consumption among high-consuming households.
  - Four peak-hour blocks (7 am – 22 pm): 0–210 kWh/month; 210–630 kWh/month; 630–1050 kWh/month; above 1050 kWh/month.
  - Non-peak hours (22 pm – 7 am) subject to flat low non-peak tariff; from 1st December authorities plan to introduce additional non-peak hours 1 pm – 3 pm.
  - Small companies are not subject to block-tariffs and generally pay a higher tariff than households.
- Consumption patterns:
  - "As close to 90 percent of households are consuming in the 1st and 2nd block."
  - "Almost 50 percent of total electricity consumption among households happens during the very heavily subsidized off-peak tariff."
  - Households consume around 50 percent of electricity during non-peak hours and around 50 percent during peak hours.
  - During peak-hours: ~52 percent of consumption in block one; ~43 percent in block two; ~5 percent in blocks three and four.
- Tariff changes (1st July 2023):
  - First block tariff lowered by 9.8 percent to 69.3 €/MWh.
  - Second block lowered by 5.1 percent to 79.6 €/MWh.
  - Third block increased by 4.6 percent to 103 €/MWh.
  - Fourth block increased by 3.2 percent to 270.7 €/MWh.
  - Non-peak tariff remained broadly stable at 22.8 €/MWh.
  - Flat network fee: 42.7 €/MWh across all blocks.
  - Preferential VAT rate normalized from 10 percent to 18 percent; final price including VAT increased for top-three blocks and the non-peak tariff.

### F. Network losses, efficiency, and distributional implications
- Distribution losses: 13.5 percent in 2022.
  - North Macedonia ranks highest among European countries except Kosovo (28% in 2018) and likely Albania (24% in 2014).
  - Reported comparator average = 6.6 percent.
- Loss composition (anecdotal): ~2/3 technical losses; ~1/3 commercial losses.
- Climate implication: technical losses mean electricity produced without end-use, causing unnecessary emissions.
- Household policy implications: block tariffs affect consumption patterns, heating electrification incentives, energy efficiency uptake, and prosumer adoption.

### G. Recent government measures to reduce subsidies and strengthen price signals
- December decision increases:
  - Price charged by ESM to universal supplier from 53 €/MWh to 57 €/MWh.
  - Price charged by ESM for covering distribution losses from 100 €/MWh to 105 €/MWh.
- Mandate adjustments for ESM supply to regulated market:
  - From January 1st, 2024: ESM mandated to provide 95 percent of regulated-market demand (instead of 100 percent).
  - From 1st July 2024: mandate drops to 85 percent.
- Expected effect: lower electricity subsidies and modest market-pricing elements introduced into regulated market.

### H. Policy recommendations on tariffs, market reform, and protection of vulnerable households
- Phase out subsidies while protecting vulnerable households:
  - "ESM pricing should be set to phase out subsidies in a resumption of the transition to market liberalization."
  - Return to 2019 market-liberalization intent by reducing ESM’s obligation to supply the regulated market with subsidized electricity.
- Address generation-sector structural issues prioritizing feasibility and timeliness; focus on renewable sources and prioritized projects to avoid rising import dependence and fiscal support needs.
- Implement incentive-based regulation of the distribution operator to improve efficiency and service quality.
- Reduce the universal supplier’s margin rate and exclude from margin base elements beyond the supplier’s control.
- Streamline and make regulated tariff-setting more transparent; reduce number of institutions involved; provide regular public accounts by ERC and detailed tariff component breakdowns on bills.
- Allow prices to reflect costs while delivering targeted transfers or bill discounts not linked to electricity consumption to vulnerable households; complement financial assistance with energy-efficiency policies (building retrofitting, efficient appliances).
- Revamp mitigation programs (e.g., PPVEC) to improve targeting and adequacy; consider a lifeline tariff during transition.
- Improve data quality for distributional assessments and calibration of compensatory measures (e.g., unified social registry integrated with universal provider customer database; revise HBS to collect better electricity consumption and social benefits data).

### I. Public investment management and climate integration (Climate PIMA Framework)
- Climate PIMA priority areas: Planning; Coordination; Appraisal and selection; Budget and portfolio management; Fiscal risk management.
- Key findings for North Macedonia:
  - Emerging good practices in budgeting and project appraisal; building codes aligned with EU energy efficiency rules.
  - Gaps: weak project appraisal lacking integrated climate considerations; no information on climate-related spending in the budget; no reliable register of assets.
- Priority reforms (selected actions):
  - Integrate ENDC infrastructure objectives into national/sectoral strategies.
  - Introduce climate perspective into spatial planning; review construction codes for mitigation/adaptation.
  - Develop reporting formats for budgetary units, local governments, public companies to report capital projects to MoF’s PIM Department.
  - Require public companies to produce annual sustainability reports.
  - Incorporate GHG and climate-resilience analysis into project appraisal and PPP frameworks.
  - Implement green budgeting reforms: establish working group to define climate-beneficial spending; require line ministries to apply definition; consider publishing table of identified expenditures in annual budget.
  - Screen critical infrastructure for climate resilience and develop a national database of critical infrastructure.
  - Disclose qualitative assessment of climate-related fiscal risks in fiscal risk statements or budget documents.
  - Increase PIM staffing, provide advanced training, and develop a short-term IT template to capture climate-related project information while IFMIS is completed.

### J. EU-CBAM, carbon pricing simulations, and fiscal implications
- EU CBAM overview:
  - From 2026 EU importers of non-EU goods must purchase certificates equivalent to the weekly EU carbon price if imports are not subject to equivalent carbon pricing as the EU ETS.
  - Initial CBAM sectors: Cement, Iron and Steel, Aluminum, Fertilizers, Hydrogen, and Electricity.
  - CBAM phased-in during 2026–2034; from 2035 CBAM will include all products covered under the EU ETS (scope may expand from 2030).
- Exposure:
  - Exports to the EU are just under 20 percent of North Macedonia’s GDP, but constitute most total exports.
  - Around 20 percent of goods exported to the EU are covered by CBAM.
- IMF–WB CPAT simulation design:
  - Policy: gradually introduce a 50 USD per ton CO2 tax starting in 2024 and linearly increasing until 2035.
  - Revenue recycling assumed: corporate taxes 15 percent; public investment 40 percent; current spending 30 percent; cash transfers 15 percent (distribution follows IMF Working Paper (2023)).
- Simulation results:
  - Welfare: welfare benefits average around 1.0 percent of GDP, per annum, in the medium run from lower GHG emissions and air-pollution co-benefits.
  - GDP: marginally lower GDP growth in the intermediate period; inflationary pressures expected to be relatively minor given long horizon.
  - Pollution: policy lowers GHG emissions by around 3 metric tons of CO2 equivalents (direct reduction reported in source).
  - NDC comparison: simulated policy achieves 15 percent vs. BAU in 2030, which is 38.1 percent of the emissions reductions vs. BAU required for the NDC (51% reduction vs. 1990).
  - Sensitivity to revenue recycling: without revenue recycling (upper bound on efficiency cost), growth falls by around 50–60 basis points over transition and does not return to BAU until full implementation.
  - Fiscal implication: not introducing an equivalent carbon tax leads to foregone fiscal revenues (potentially collected by EU via CBAM); adopting an equivalent CO2 tax retains revenue domestically and allows selective recycling to offset economic/distributional effects and support the green transition.

### K. CPAT model features and benefits
- CPAT: spreadsheet-based “model of models” covering >200 countries.
- Analysis modules: Energy and emissions; Macroeconomic impacts; Distributional impacts; Development co-benefits (mortality/morbidity, road safety, congestion).
- Modelling approach highlights:
  - Energy demand function includes prior year demand, growth effects, exogenous technology change (α), and price effects; elasticities ν_t, η_u, η_h are CPAT inputs.
  - GDP and prices projected endogenously to policy actions and revenue recycling; elasticity model allows GDP to respond negatively to higher carbon prices and positively to revenue recycling used to lower labor taxes.

### L. Overall transition financing and public investment management implications
- Authorities estimate cumulative capital investment needs through 2050 between €18.5 billion and €34.1 billion (public and private).
  - Equivalent to 4.3–8.0 percent of 2023 GDP annually; 130–241 percent of GDP cumulative.
- Meeting needs requires:
  - Strong Public Investment Management (PIM) framework incorporating climate considerations.
  - Catalyzing private capital and IFI financing.
  - Strengthened PIM action plan (adopted 2021) and Climate Module of the PIMA to identify climate-sensitive PIM reforms.

*Source: IMF staff report chapter “1. Electricity Block Tariffs for Households” (January 4, 2024).*

### 1. Electricity Block Tariffs for Households _______________________________________________ 11

### 1. Electricity Block Tariffs for Households

### A. Key contextual findings on climate exposure and energy sector
- North Macedonia is exposed to climate change and natural hazards posing substantial risks to public safety and public infrastructure, mainly from flooding and forest fires.
- Between 1990 and 2023, flooding events were the most numerous natural hazards and caused the largest damages; floods and fires are forecasted to become more frequent and extreme.
- Potentially damaging and life-threatening floods are likely to occur at least once in the next 10 years.
- Over a year, there is more than 50 percent probability of experiencing weather conditions which could support a significant wildfire resulting in property and life loss.
- At least one prolonged period of exposure to extreme heat is likely to occur with a probability of more than 25 percent in the next five years.
- Between 1990 and 2023: Riverine flood event count 9; Flash flood event count 2; Forest fire event count 3; Total Damage, Adjusted ('000 USD) from Riverine flood 476,105; from Flash flood 168,391; from Forest fire 23,050.
- Floods and fires affected large populations; forest fires affected over one million people.

### B. Current energy mix and emissions drivers
- Electricity production accounts for around 60 percent of total GHG emissions in North Macedonia.
- Coal-based electricity generation accounts for 50 percent of total domestic electricity production.
- Around 90 percent of electricity-sector emissions are from using coal as an energy source.
- Other contributing emission sources: transport sector (~10 percent), heating sector (~10 percent), agricultural sector (~10 percent).
- CO2 equivalent total GHG emission trend: decreased from around 14 thousand kt in 1990 to around 11 thousand in 2020 (World Bank estimates).
- Domestic installed electricity generation capacity as of end of 2022: 2,266 MW.
- Newly installed and commissioned PV capacity from January 2022 to September 2023: over 450 MW.

### C. National climate and energy targets, planned measures, and investment needs
- Enhanced Nationally Determined Contribution (2021) commitments:
  - Reduce GHG emissions by 51 percent by 2030 compared to 1990.
  - Reduce net emissions by 82 percent by 2030 compared to 1990.
  - Implies a reduction in net emissions from 12,271 to 2,203 Gg CO2-eq.
- Energy sector targeted emission reduction: expected to fall by as much as 66 percent of the 1990 level.
- FOLU sector removals expected to increase by approximately 18 times.
- RES targets by 2030 (NECP):
  - RES share of gross final energy consumption: 38 percent by 2030.
  - RES share in final energy consumption in the electricity sector: 66 percent by 2030.
  - RES consumption targets: cooling/heating 45 percent; transport 10 percent.
- NECP energy efficiency targets relative to BAU:
  - 20.8 percent savings of final energy consumption.
  - 34.5 percent savings of primary energy consumption.
  - Transport sector planned savings: 19 percent relative to BAU.
- Energy security objective: limit import dependency at 59 percent (conditional on implementing RES and energy efficiency plans).
- Planned large RES projects include: Chebren hydropower plant by 2029; Vardar valley in 2025–30; 120 MW PV power plants in Oslomej; further solar, wind and biogas capacities.

### D. Fiscal and investment implications
- Authorities estimate cumulative capital investment needs (public and private) through 2050 (30 years) between €18.5 billion and €34.1 billion depending on ambition level.
- This investment need is equivalent to 4.3–8.0 percent of 2023 GDP annually, and 130–241 percent of GDP cumulative.
- Meeting these needs would require: a strong Public Investment Management (PIM) framework incorporating climate considerations; catalyzing private capital; and IFI financing.

### E. EU-CBAM and carbon pricing considerations
- EU Carbon Border Adjustment Mechanism (CBAM) from 2026: EU importers of goods originating from outside the EU are required to purchase certificates equivalent to the weekly EU carbon price if imported goods are not subject to equivalent carbon pricing as the EU ETS.
- CBAM initial sectors: Cement, Iron and Steel, Aluminum, Fertilizers, Hydrogen, and Electricity.
- North Macedonia will be impacted by the EU CBAM and should consider a form of carbon tax in response and as a tool to incentivize the green transition; a gradual introduction of carbon taxation is suggested (also envisioned in existing legislation).

### F. Role of the electricity sector in the transition and household implications
- Electricity is consumed by large firms, households, and small consumers for general consumption and heating.
- The shift from inefficient coal-based power plants to newer plants and a larger share of RES is central to reducing GHG emissions and particle pollution.
- Household-level implications include the relevance of electricity block tariffs for consumption patterns, heating electrification, and incentives for energy efficiency and prosumer adoption (noted in plans to increase prosumers and electrification of heating/cooling).

*Source: IMF staff report chapter “1. Electricity Block Tariffs for Households” (January 4, 2024).*

### 16. Electricity prices are largely regulated for households and small companies. The

### 16. Electricity prices are largely regulated for households and small companies. The

### Market design and regulatory framework
- The electricity market was de-regulated with the 2018 Energy Law, whereby the consumer could freely choose their own supplier of electricity.  
- For a transition period two markets were allowed to exist:  
  - An open market, largely with market pricing.  
  - A regulated market, where households and small consumers would be supplied by a universal supplier and supplier of last resort.  
- According to the 2018 Energy Law, Article 237, the share of the regulated market demand to be covered by the state-owned generator ESM would gradually decrease: "from 100 percent in 2018 (100/2018), 80/2019, 75/2020, 70/2021, 60/2022, 50/2023, 40/2024, to 30 percent in 2025 (30/2025)."
- The Energy Regulatory Commission (ERC) authorizes tariff increases by the universal supplier to ensure cost recovery in the regulated market, based on reported cost of capital by the regulated entities. The state-owned generator, ESM, is not regulated by the ERC.

### Subsidies, fiscal costs, and ESM role
- As a state-owned enterprise, the government allows ESM to sell electricity at a loss to the universal supplier, thereby subsidizing households.  
- The Ministry of Finance subsidized electricity prices at a cost of 1.3 percent of GDP in 2022.  
- Staff estimate that electricity subsidies in 2023 will be around 0.8 percent of GDP, while measures under the Precautionary and Liquidity Line (PLL) likely will reduce subsidies in 2024 to 0.3 percent.  
- Following the 2021–2022 energy crisis and price surges, the ESM was mandated to cover 100 percent of the electricity demand in the regulated market (during crisis measures), increasing the subsidy burden.

### Household choices and market outcomes
- Almost all households and small companies have shifted back into the regulated market following the price surge in the open market in 2022.  
- Today, most households and small consumers remain in the regulated market; while tariffs have increased, the de facto subsidized price remains one of the lowest in Europe for households.

### Electricity block-tariffs (design, outcomes, and parameters)
- Implementation: Electricity block-tariffs for households were introduced on 1st July 2022 to incentivize lower consumption among high consuming households. The block-tariffs consist of four blocks with marginally increasing tariffs applicable during peak-hours (7 am – 22 pm). Non-peak hours (22 pm – 7 am) remain subject to a flat and low non-peak tariff. From 1st December authorities plan to introduce another two hours of non-peak consumption (1 pm – 3 pm). Small companies are not subject to the block-tariffs and generally pay a higher tariff than households.  
- Block definitions (peak-hours): 0–210 kWh/month, 210–630 kWh/month, 630–1050 kWh/month, and above 1050 kWh/month.  
- Consumption patterns:  
  - "As close to 90 percent of households are consuming in the 1st and 2nd block."  
  - "Almost 50 percent of total electricity consumption among households happens during the very heavily subsidized off-peak tariff."  
  - Households consume around 50 percent of their electricity during the non-peak hours and the same share during the peak-hours. On average, during the peak-hours, around 52 percent of electricity consumption lands in block one, around 43 percent lands in block two, and the remaining 5 percent land in block three and four.  
- Tariff changes (1st July 2023):  
  - First block tariff lowered by 9.8 percent to 69.3 €/MWh.  
  - Second block lowered by 5.1 percent to 79.6 €/MWh.  
  - Third block increased by 4.6 percent to 103 €/MWh.  
  - Fourth block increased by 3.2 percent to 270.7 €/MWh.  
  - The non-peak tariff remained broadly stable at 22.8 €/MWh.  
  - There is a flat network fee of 42.7 €/MWh across all blocks.  
  - The preferential VAT rate was normalized from 10 percent to 18 percent, and the final price of electricity, including VAT, in the regulated market therefore went up for the top-three blocks and the non-peak tariff.

### Network losses and system efficiency
- Distribution losses reached 13.5 percent in 2022. North Macedonia ranks highest among European countries except for Kosovo (28% in 2018) and likely Albania (24% in 2014). The reported average comparator "Average = 6.6 percent" is shown in the source figures.  
- Loss composition: anecdotal evidence suggests that 2/3 of distribution losses are technical losses in the distribution network and about 1/3 are commercial losses.  
- Technical losses can stem from voltage level complexities and underinvestment in the network; commercial losses are due to mismeasurement or illegal tapping. From a climate perspective, technical losses cause electricity produced without end-use, leading to unnecessary emissions.

### Recent government measures to reduce subsidies and strengthen price signals
- The government adopted a decision in December to:  
  - Increase the price charged by ESM to the universal supplier from 53 €/MWh to 57 €/MWh.  
  - Increase the price charged by ESM for covering distribution losses from 100 €/MWh to 105 €/MWh.  
- Mandate adjustments for ESM supply to the regulated market:  
  - From January 1st, 2024, ESM is only mandated to provide 95 percent of the demand of the regulated market (instead of 100 percent).  
  - From 1st July 2024, this mandate drops to 85 percent.  
- Expected effect: these measures are intended to help lower electricity subsidies and introduce a still modest element of market pricing into the regulated market.

### Policy recommendations and IMF technical assistance (Box 2)
- Key recommendations to phase out subsidies while protecting vulnerable households:  
  - "ESM pricing should be set to phase out subsidies in a resumption of the transition to market liberalization." Return to the intent of the 2019 market liberalization reforms gradually reducing ESM’s obligation to supply the regulated market with subsidized electricity.  
  - Address structural issues in the generation sector with a coherent approach prioritizing feasibility and timeliness alongside capacity gains; focus on renewable sources and prioritized projects to avoid rising import dependence and fiscal support needs.  
  - Implement incentive-based regulation of the distribution operator to improve efficiency and service quality; distribution losses have stabilized at an abnormally high level in the past four years.  
  - As sole supplier of the regulated end-user market with a contractual margin, the universal supplier is in a dominant position; reduce the margin rate of the universal supplier and exclude from the margin base elements that cannot be controlled by the universal supplier.  
  - Streamline and make the regulated tariff-setting process more transparent; reduce the number of institutions involved and provide regular public accounts by ERC and detailed breakdowns of tariff components on consumers’ bills.  
  - Allow prices to reflect costs while delivering targeted transfers or bill discounts not linked to electricity consumption to vulnerable households; complement financial assistance with policies to increase energy efficiency (e.g., building retrofitting, efficient appliances).  
  - Revamp programs to mitigate the financial impact of price increases on the vulnerable (e.g., PPVEC), improve targeting and adequacy of compensation, consider a lifeline tariff during transition.  
  - Improve data quality for assessing distributional consequences and calibrating compensatory measures (e.g., unified social registry integrated with universal provider customer database; revise HBS to collect better data on electricity consumption and social benefits).

### Public investments, climate sensitivity, and energy transition financing
- Estimated cumulative capital investment needs (public and private) for North Macedonia are between €18.5 billion and €34.1 billion through 2050 (30 years), depending on ambition in reducing GHG emissions and strengthening climate resilience. This is equivalent to 4.3–8.0 percent of 2023 GDP annually, and 130–241 percent of GDP cumulative.  
- North Macedonia launched an energy transition investment platform in December 2023, supported by the EBRD, to bring together the government, IFIs, and private sector on investment and policy development. The platform targets:  
  - Completely phasing out coal-fired power plants.  
  - Deploying 1.7 GWs of renewable energy by 2030, as well as grid storage and investments for energy security.  
  - Estimated investments of €3 billion (20 percent of 2023 GDP) by 2030 to achieve these objectives.  
- Public Investment Management (PIM) is in its early stages; a PIM action plan adopted in 2021 should guide reforms to enhance planning, appraisal, budgeting, and monitoring. A Climate Module of the PIMA has been undertaken to identify climate-sensitive PIM reforms.

*Source: IMF staff report text from the provided content unit.*

### Box 3. The Climate PIMA Framework

### Box 3. The Climate PIMA Framework

### Framework overview
- The Climate module of the Public Investment Management Assessment (PIMA) aims to identify the main institutions—processes and practices—that are critical for developing climate-smart infrastructure.
- The assessment focuses on five priority areas—institutions—for the integration of climate considerations in the public investment management cycle:
  - Planning: national and sectoral plans, and associated investment portfolios should be aligned with climate objectives for transforming public sector infrastructure in the direction of climate-resilience and sustainability.
  - Coordination: ensure that all stake holders within the different levels of government and on joint-ventures with private sector are coordinated in their areas of involvement.
  - Appraisal and selection: include climate-related analysis of mitigation and adaptation impacts of investments in the decision-making process on major infrastructure projects.
  - Budget and portfolio management: appropriate budgeting and reporting practices of green investments and maintenance are followed, and asset management includes climate-related impacts.
  - Fiscal risk management: governments should have the capacity to understand the impacts of climate change on public infrastructure and mechanisms to address its impact.

### Key findings for North Macedonia (summary of assessment)
- Good emerging practices and priority areas for reform were identified, particularly in budgeting and project appraisal and selection.
- Existing regulation is already taking steps to improve mitigation, such as building codes requiring energy efficiency aligned with EU regulations.
- Coordination with PCs on climate-related investments—particularly in the energy sector—is conducted during the annual dialogue on NDC commitments.
- The Organic Budget Law provides for budget reserves against the impacts of natural disasters, including on infrastructure.
- Gaps and weaknesses:
  - Project appraisal in general is weak; climate impact considerations are not integrated during design or project selection.
  - No information on climate-related spending in the budget.
  - No reliable register of assets, undermining the government’s capacity to manage climate-related risks on public infrastructure.

### Priority areas for reform (Box 4 — reform measures emphasized)
- Integrate ENDC infrastructure-related objectives, targets, and expected outcomes into national and sectoral development strategies for infrastructure. Actions include:
  - Introduce a climate change perspective to the spatial planning process.
  - Review construction codes from climate mitigation and adaptation perspectives.
  - Develop guidance and provide training to public bodies on integrating climate change considerations in public investment planning.
- Use existing coordination and reporting channels to improve public investment decision-making across the public sector, including climate change considerations. Actions include:
  - Develop a reporting format for all budgetary units, local governments, and public companies to report to MoF’s PIM Department on capital projects.
  - Require public companies to produce annual sustainability reports as part of the monitoring framework.
- Incorporate analysis of climate change impacts in planned methodologies for project appraisal and project selection. Minimum inclusions:
  - Analysis of the likely impacts of the project on GHG emissions and other climate change mitigation measures.
  - Analysis of the likely exposure of the project to climate-related harm from extreme weather and natural disasters and the construction, operation and maintenance cost implications arising.
  - Review and update standard criteria for project prioritization and include climate change issues as criteria; ensure criteria directly inform project selection.
- Incorporate climate-change impact analysis in the planned PPP framework. Recommended procedures:
  - Pre-assess climate change-related risks to the project.
  - Determine strategies for adaptation and asset resilience.
  - Assess and determine the appropriate allocation of risk between the government and private partner.
- Leverage existing budget tools informing annual investment allocation decisions to strengthen the PIM function, including from a climate change perspective. Recommended action:
  - Incorporate within the Budget Circular a requirement for all proposals that request increased capital allocations, above a threshold, to describe the expected impacts of this investment on GHG emissions and climate resilience and reflect this requirement in the Budget Circular guidelines.
- Gradually implement green budgeting reforms supporting PIM. Recommended steps:
  - Establish a working group to consider, formalize and publish a definition of spending that may be beneficial to climate outcomes.
  - Require line ministries to apply this definition to areas of expenditure within their remit.
  - For full overview, consider publishing a table of all expenditures identified under the above as part of the final annual budget publication.
- Screen critical infrastructure for climate resilience. Recommended actions:
  - Develop a national database of critical infrastructure.
  - Expand the screening exercise to determine potential vulnerability of this infrastructure to identified climate risks.
- Include analysis of climate change related fiscal risks and their impact on public infrastructure within efforts to strengthen overall fiscal risk management. Recommended actions:
  - Disclose a qualitative assessment of climate change related risks on public infrastructure either in a fiscal risk statement or as part of information accompanying budget documents.
  - Consider developing climate assessment models that allow estimating the impact of climate change scenarios on fiscal sustainability.
- Increase PIM staffing and expertise across government. Recommended actions:
  - Prioritize hiring to fill vacancies in the PIM Dept. as a matter of urgency.
  - Consider designing and implementing a talent retention scheme for the PIM Dept.
  - Provide PIM Dept. staff with advanced training on project appraisal and selection methodologies incorporating climate considerations, and provide training more broadly to public sector PIM staff.
- Develop a basic short-term IT solution to bridge critical information gaps undermining public investment management, including climate-related impacts. Recommended action:
  - Develop and populate a template that captures key information, including climate-related, on public investment projects from planning through implementation while the new IFMIS system is completed.

### Simulations of carbon pricing and CBAM (sections 26–30 and simulation results)
- EU Carbon Border Adjustment Mechanism (CBAM) design and timeline:
  - From 2026 EU importers of goods originating from outside the EU are required to purchase certificates equivalent to the weekly EU carbon price if the imported goods are not subject to equivalent carbon pricing as the EU ETS.
  - The CBAM initially applies to imports in selected emission-intensive sectors: Cement, Iron and Steel, Aluminum, Fertilizers, Hydrogen, and Electricity.
  - The CBAM will be phased-in during 2026–2034 as the free allowances under the EU ETS are phased-out.
  - From 2035, the CBAM will include all products covered under the EU ETS, with the possibility of product scope being reviewed such that other products may be included from 2030 already.
- Exposure of North Macedonia to CBAM:
  - Exports to the EU are just under 20 percent of North Macedonia’s GDP, but most of total exports.
  - Around 20 percent of goods exported to the EU are covered by the CBAM and will be subject to the EU CBAM taxation.
- Simulation design (IMF-WB CPAT model):
  - Policy simulated: gradually introduce a 50 USD per ton CO2 tax starting in 2024 and linearly increasing until 2035.
  - Baseline results assume that revenue from the carbon tax is recycled as corporate taxes (15 percent), public investment (40 percent), current spending (30 percent) and cash transfers (15 percent), where the distribution follows IMF Working Paper (2023).
- Simulation results and impacts:
  - Welfare: The simulated policy increases welfare gradually as the policy is enacted. Welfare benefits stem from lower GHG emissions and air pollution co-benefits, such as lower mortality and morbidity. The welfare benefits average around 1.0 percent of GDP, per annum, in the medium run.
  - GDP: The simulated policy lowers GDP growth marginally in the intermediate period as firms and households respond to higher carbon prices. The carbon tax may also fuel inflationary pressures by increasing energy prices, but this is expected to be relatively minor given the long horizon.
  - Pollution: The simulated policy directly lowers GHG emissions by around 3 metric tons of CO2 equivalents. This results in climate benefits to the population and co-benefits from improved air quality.
  - NDC comparison: Latest NDC target for North Macedonia is a 51% reduction in absolute emissions by 2030 vs. 1990. The simulated policy achieves 15% vs. BAU in 2030, which is 38.1% of the emissions reductions vs. BAU for NDC.
  - Sensitivity to revenue recycling: When revenue collected from the carbon tax is not recycled (upper bound on efficiency cost), the simulation shows growth falls by around 50-60 basis points over a transition period as the carbon tax is introduced and does not return to the business-as-usual baseline until after full implementation. Policy design should ensure revenues are used productively to offset costs.
  - Fiscal implication: Not introducing an equivalent carbon tax will result in foregone fiscal revenues in North Macedonia, which may instead be collected by the EU via the CBAM. Adopting an equivalent CO2 tax would retain revenue in the state budget and allow selective recycling to mitigate economic and distributional effects and support the green transition.

### Climate Policy Assessment Tool (CPAT) — model features
- CPAT is a spreadsheet-based “model of models” developed by the IMF and World Bank covering over 200 countries.
- Analysis modules include:
  - Energy and emissions: effects on prices, consumption, global pollutants (GHGs), local pollutants (PM2.5, NOx, etc.).
  - Macroeconomic impacts: effect on GDP, government revenues, trade balance.
  - Distributional impacts: effects on households (across income distribution and urban versus rural) and firms.
  - Development co-benefits: reductions in mortality and morbidity from improved air quality, road safety, and reduced congestion.
- Benefits of CPAT:
  - Allows integration of revenue recycling benefits into the analysis, capturing indirect benefits such as freeing fiscal space to lower labor or corporate taxes.
  - Baseline is the BAU scenario assuming growth follows IMF WEO projections and pollution and policy follow current paths.
- Modelling approach:
  - Energy demand is modeled as a function of prior year energy demand, growth effects, exogenous technology change (α), and price effects; estimated elasticities ν_t, η_u, and η_h are inputs into CPAT.
  - GDP and prices are projected endogenously to policy actions and revenue recycling using an elasticity model allowing GDP to respond negatively to higher carbon prices and positively to revenue recycling used to lower labor taxes.

*Source: Box 3, Box 4, sections 25–30, and Box 5 of the provided IMF document.*

### 31. A scale-up of private and public investments, along with decommission of old and

### A scale-up of private and public investments, along with decommission of old and polluting coal-based power plants,  is needed to adapt to climate change and meet emissions targets as part of the green transition.

### Climate exposure, commitments, and energy structure
- North Macedonia is exposed to climate change and natural hazards that pose substantial risks to public safety and public infrastructure, mainly from flooding and forest fires.
- North Macedonia has committed to reducing GHG emissions by more than 50 percent by 2030 compared to 1990.
- A large potential exists for better energy efficiency; a large share of electricity is produced from fossil-fuel based energy generating infrastructure.
- North Macedonia recently targeted completely phasing-out coal-fired power plants by 2030.

### EU-Carbon Border Adjustment Mechanism (EU-CBAM) and fiscal implications
- North Macedonia will be impacted by the EU-Carbon Border Adjustment Mechanism (EU-CBAM) from 2026.
- The introduction of the EU CBAM will:
  - impact North Macedonia’s exports to the EU negatively; and
  - cause revenue collected as part of the EU CBAM to be foregone revenue for North Macedonia.
- The authorities should consider a gradual introduction of carbon taxation to prepare for the EU-CBAM, as also envisioned in existing legislation.
- A form of carbon taxation would allow the state to collect revenue and recycle part of it to mitigate the impact of the carbon tax and further support the green transition.

### Key policy recommendations
- Scale-up public and private investments to support adaptation to climate change and the phase-out coal-powered electricity production, replacing it with renewable energy sources.
- Strengthen the public investment management framework, supported by Fund-provided TA, and introduce climate considerations in the framework.
- Continue to phase-out electricity subsidies and develop the electricity tariff structure to incentivize greater energy efficiency among households and companies.
- Consider a form of carbon tax to mitigate the effect of the EU CBAM and to support the green transition.

---

### Interest rate pass-through in North Macedonia — summary of findings
- The monetary framework has been effective in achieving price and exchange rate stability and to keep inflation expectations well anchored.
- Interest rate pass-through of the monetary policy rate to domestic market interest rates in North Macedonia is modest compared to other regional peers.
- Structural features contributing to modest pass-through include:
  - structurally high liquidity in the banking system; and
  - shallow interbank markets.
- Improving the monetary policy operations framework would help strengthen pass-through.

### Institutional and empirical context
- National Bank of North Macedonia (NBRNM) follows a pegged exchange rate strategy targeting the nominal exchange rate of the Denar against the Euro; the "de facto" peg has served as an anchor for almost three decades.
- Inflation expectations (two-year ahead) remain close to the medium-term inflation (2 percent); the inflation expectation gap is at less than ½ percentage point.
- The monetary framework has allowed the country to maintain adequate levels of international reserves; reserves have been on an upward trend as a share of GDP.

### Empirical assessment of pass-through
- Methodology used:
  - Implicit pass-through during the current monetary policy tightening cycle.
  - Contemporaneous transmission within a month using simple regressions (Jan-2007 – Sep-2023).
  - Long-term pass-through using framework by Mishra, Montiel, and Spilimbergo (2012) to account for delays.
- Key empirical findings:
  - During the current tightening cycle, implicit elasticities of domestic interest rates to the NBRNM’s policy rate have been lower than regional or advanced comparators.
  - There is low pass-through to interbank rates and banks’ retail (loans and deposits) rates in North Macedonia; strong pass-through to T-bills.
  - Regressions of monthly changes in domestic interest rates on changes in the NBRNM’s policy rate for Jan-2007 – Sep-2023 point to a moderate historical pass-through.
  - Pass-through from ECB rates to FX-loan rates is strong; FX-loans are priced relative to Euribor while domestic loans are priced based on banks’ funding cost.
  - Banks review interest rates every 6 months due to legal caps; sizable lags observed in retail rate adjustments.

### Quantitative indicators and comparative elasticities (selected exact values reported in source tables and figures)
- Contemporaneous/event-study implicit elasticities (current tightening cycle):
  - Accumulated Δpolicy rate (percentage points) examples: 5.05, 2.50, 5.50, 12.40, 6.65, 5.75, 6.75, 4.50, 5.15, 4.00, 2.50, 6.20, 4.25
  - Months of tightening up to Sep-2023 examples: 18, 19, 18, 28, 23, 24, 29, 15, 22, 21, 7, 16, 24, 17
  - Implicit elasticity examples (Interbank interest rate (local currency)): 0.58 for North Macedonia; regional peers and selected advanced medians presented in tables and figures.
  - Implicit elasticity examples (T-bills (local currency)): 0.70 for North Macedonia; other values shown in source tables.
  - Implicit elasticity examples (New local currency-loans): 0.32 for North Macedonia.
  - Implicit elasticity examples (New local currency-deposit): 0.32 for North Macedonia.
  - Consumer loans and mortgage elasticities reported (e.g., New local currency consumer loans 0.23; New local currency mortgages 0.26 for North Macedonia).
- Long-term pass-through estimations indicate a moderate long-term elasticity to denar-loan and deposit rates relative to regional peers; long-term elasticity of denar-mortgages is almost in line with Emerging Europe.
- Bank-level panel cointegration analysis (2005M1–2022M12) by NBRNM suggests higher pass-through in the long term, with coefficients indicating full pass-through from policy rates to market rates in that study.

### Drivers of moderate pass-through (identified factors)
- Significant excess liquidity in commercial banks reduces need to borrow from NBRNM and lessens policy rate relevance.
- The asymmetric monetary policy rate corridor allows substantial flexibility for interbank rates; with excess liquidity the deposit rate becomes more relevant.
- Effective policy rate (weighted average of liquidity mopped up by CB-bills, 7-day deposits, and overnight deposits) increased by less than the headline policy rate in some periods.
- Other contributing factors noted: high euroization, shallow securities markets, legal caps on interest rates updated every 6 months, and banks’ funding structures.

### Policy implications for strengthening pass-through
- Improve the monetary policy operations framework to strengthen interest rate transmission.
- Address structural liquidity features that dampen pass-through (for example, evaluate instruments and corridor design that better align effective rates with the policy rate).
- Monitor legal and regulatory factors (such as interest-rate caps and their update frequency) that produce sizable delays in the adjustment of retail rates.

*Source: IMF staff analysis and country authorities, as presented in the provided chapter content.*

### 15. The limited pass-through is also associated with structural issues:

### 15. The limited pass-through is also associated with structural issues:

### Structural drivers of limited pass-through
- High concentration in the banking system reduces competition and weakens interest rate pass-through. The Herfindahl-Hirschman index (HHI) based on total assets suggests that regional peers with less concentrated banking systems have higher interest rate pass-through.
- Legislation sets caps on retail interest rates for loans via a penalty interest rate. The penalty interest rate is a de facto cap on interest rates in the country. The penalty interest rate is determined for each half-year as 8 or 10 percentage points above the level of the NBRNM’s policy at the beginning of the 6-month period (reference interest rate). Therefore, banks significantly revise their interest rates every six months after this cap rate is observed. Operationally, it would be important to update more frequently to ensure flexibility of interest rates.

### Empirical evidence on pass-through and competition
- Figure referenced: "Pass-Through and Competition" (source: Country authorities; and IMF staff estimates).
- Penalty rate mechanics and timing:
  - The penalty interest rate is determined for each half-year, 8 or 10 percentage points (for natural persons or legal entities respectively) above the level of the NBRNM’s reference interest rate for denars or the one-month Euribor rate for euros, that were effective on the last day of the previous half-year.
- Observed relationships in regressions (Simple Contemporaneous Regressions; sample 2007M1-2023M9):
  - Table 2. North Macedonia: Elasticity of Selected Interest Rates to Policy Rates (Δinterest rate = α + βΔmonetary policy rate)
    - Interbank rate (LC): N. Macedonia 0.48*** (Obs 1941, R² 0.29); Selected Regional Peers 0.94*** (Obs 1200, R² 0.15); Selected Advanced Europe 0.94*** (Obs 1200, R² 0.07)
    - T-bill yield (LC): N. Macedonia 0.46*** (Obs 1908, R² 0.10); Selected Regional Peers 0.74*** (Obs 1208, R² 0.26); Selected Advanced Europe 0.46** (Obs 3800, R² 0.17)
    - New LC-loans rate: N. Macedonia 0.20*** (Obs 2001, R² 0.04); Selected Regional Peers 0.56*** (Obs 1567, R² 0.07); Selected Advanced Europe 0.53*** (Obs 770, R² 0.18)
    - New LC-consumer loans: N. Macedonia 0.08 (Obs 2001, R² 0.00); Selected Regional Peers 0.22** (Obs 1049, R² 0.01); Selected Advanced Europe 0.37** (Obs 675, R² 0.04)
    - New LC-mortgages: N. Macedonia 0.25* (Obs 2001, R² 0.03); Selected Regional Peers 0.49** (Obs 1049, R² 0.03); Selected Advanced Europe 0.46*** (Obs 770, R² 0.50)
    - New LC-deposit rate: N. Macedonia 0.10 (Obs 2001, R² 0.01); Selected Regional Peers 0.65*** (Obs 1567, R² 0.30); Selected Advanced Europe 0.52** (Obs 772, R² 0.42)
    - New FX-loans rate: N. Macedonia 0.57** (Obs 2009, R² 0.04); Selected Regional Peers 0.44*** (Obs 6..., R² 0.02)
    - New FX-deposit rate: N. Macedonia 0.13 (Obs 2009, R² 0.01); Selected Regional Peers 0.24* (Obs 6..., R² 0.04)
  - Note: LC = Local currency. *** 97.5 / ** 95 / * 90* percent confidence p-value.

### Regression methodology and longer-run pass-through estimates
- Regression specification (based on Mishra, Montiel, and Spilimbergo (2012)):
  - Δy_{t,i} = β0 Δx_{t,i} + β1 Δx_{t-1,i} + β2 Δx_{t-2,i} + γ1 Δy_{t-1,i} + γ2 Δy_{t-2,i} + ε_{t,i}
  - y = New local curr. loans interest rate; New local curr. consumer loans interest rate; New local curr. mortgages interest rate; New local curr. deposit rate
  - x = policy rate
  - Short term pass-through = β0
  - Long term pass-through = (β0 + β1 + β2) / (1 - γ1 - γ2)
- Table 3. North Macedonia: Long Term Elasticity of Selected Interest Rates to Policy Rates—Two-Month Lags (Sample 2007M1-2023M9)
  - Retail lending rate (LC): N. Macedonia 0.32*** (Obs 1981, R² 0.16); Selected Regional Peers 0.84*** (Obs 1447, R² 0.18); Selected Advanced Europe 0.79*** (Obs 762, R² 0.27)
  - Consumer loans: N. Macedonia 0.15 (Obs 1981, R² 0.00); Selected Regional Peers 0.48*** (Obs 1376, R² 0.00); Selected Advanced Europe 0.56*** (Obs 667, R² 0.00)
  - Mortgages: N. Macedonia 0.56*** (Obs 1981, R² 0.00); Selected Regional Peers 0.68*** (Obs 1377, R² 0.00); Selected Advanced Europe 0.66*** (Obs 762, R² 0.00)
  - Retail deposit rate (LC): N. Macedonia 0.20** (Obs 1981, R² 0.09); Selected Regional Peers 1.02*** (Obs 1447, R² 0.47); Selected Advanced Europe 0.75*** (Obs 764, R² 0.56)
  - Note: Statistical significance of long term passthrough estimated via boostraping. LC = Local currency. *** 97.5 / ** 95 / * 90* percent confidence p-value.

### Policy recommendations to improve pass-through and transmission
- Recalibrate monetary policy operations to improve transmission to market rates with a holistic approach, careful sequencing, and clear communications to avoid disruptions.
- Specific operational measures recommended:
  - Reducing the CB-bills maturity.
  - Increasing the deposit rate facility to narrow the interest rate corridor.
  - Streamlining deposit facilities. (Currently NBRNM has two deposit facilities: an overnight deposit facility and a 7-day deposit facility; in the future, consideration should be given to consolidate them.)
  - Improving the auction systems.
- Ongoing plans to streamline reserve requirements will help to manage excess liquidity.

### Related observations in the chapter context
- Despite structural challenges that take time to address, the NBRNM has room to improve pass-through through operational and market-based reforms.
- Empirical results show weaker short- and long-term pass-through for many retail rates in North Macedonia relative to selected regional peers and selected advanced European economies, particularly for retail deposit rates and some retail lending categories.

*Source: Excerpt from IMF staff analysis in the referenced chapter.*

### 11. Allocative efficiency across firms in North Macedonia hinders aggregate productivity.

### 11. Allocative efficiency across firms in North Macedonia hinders aggregate productivity.

### Key findings on factor allocation and productivity
- Employment elasticity with respect to firm-level productivity (log(Employment) on log(TFP)) in North Macedonia: 0.286 (standard error (0.00120)).  
- Capital elasticity with respect to firm-level productivity (log(Capital) on log(TFP)) in North Macedonia: 0.208 (standard error (0.00352)).  
- Comparable elasticities in France: employment elasticity 0.867 (standard error (0.00066)); capital elasticity 0.466 (standard error (0.00103)).  
- Interpretation: while more productive firms in North Macedonia tend to employ more workers, the employment and capital responses are substantially smaller than in advanced economies (employment elasticity about three times smaller than in France), indicating suboptimal allocation of resources across firms.

### Firm dynamics and lifecycle evidence
- Typical firm dynamics (annual averages):
  - Productivity increases by around 5 percent per year.  
  - Employment and capital inputs increase by around 3 percent per year, indicating that firms accumulate labor and capital more slowly than productivity growth.  
- Average TFP growth rate of firms in the sample: around 3.4 percent.  
- Cross-sectional and age patterns (Table 3: lifecycle coefficients):
  - log(TFP): age coefficient 0.0491 (standard error (0.001127)); age^2 coefficient -0.00067 (standard error (0.000035)).  
  - log(Employment): age coefficient 0.0278 (standard error (0.000969)); age^2 coefficient 0.00004 (standard error (0.000033)).  
  - log(Capital): age coefficient 0.0335 (standard error (0.00161)); age^2 coefficient 0.00051 (standard error (0.000053)).  
- Growth TFP regressors (Table 4):
  - age coefficient -1.47 (standard error (0.0624)).  
  - log TFP coefficient 11.11 (standard error (0.0011)).  
  - age^2 coefficient 0.03 (standard error (0.0017)).  
  - (log TFP)^2 coefficient -2.65 (standard error (0.0640)).  
- Interpretation: younger firms exhibit faster TFP growth; a one-year increase in firm age corresponds to TFP growth falling by around half the average growth rate, and higher initial TFP is associated with faster subsequent TFP growth (but with diminishing returns).

### Structural model, wedges, and measurement
- Model features:
  - Endogenizes aggregate productivity conditional on allocative efficiency of capital and labor.  
  - Firms use labor ℓ, capital k, and technology z. Households supply labor subject to labor income wedges τ^L_t and face capital accumulation wedges; firms face entry wedges τ^E_t, operational wedges τ^f_t, and idiosyncratic production barriers parameterized by elasticity ρ of distortions to firm-level productivity z.  
  - Higher ρ implies more productive firms face higher barriers, consistent with the data.  
- Measurement:
  - Firm-level productivity and production barriers (wedges) calculated as in Hsieh and Klenow (2009).  
  - Dispersion in wedges captures deviation between observed allocations and model-implied optimal allocations; greater dispersion implies more severe misallocation.  
- Sectoral dispersion:
  - Standard deviation of log firm-level TFP across sectors ranges from around 1.2 (professional services) to around 1.6 (trade).  
  - Standard deviation of firm-level wedges ranges from around 0.8 to 1.0, with a close relationship between productivity dispersion and wedge dispersion.  
  - Conclusion: sectoral differences in misallocation are comparatively minor; focus is on economy-wide reallocation.

### Policy experiments (model calibration and quantitative impacts)
- Model calibrated to match North Macedonian firm-level productivity and aggregate conditions; five policy experiments examined, each with fiscal impact broadly consistent across experiments (around one percent of GDP).
- Experiments and interpretations:
  - Entry barriers (reduce τ^E): lowers cost of firm entry (e.g., reduce bureaucracy/time to register businesses).  
  - Size-dependent production barriers (reduce elasticity ρ): removes size-dependent distortions (e.g., size-dependent taxation, credit constraints, hiring/firing costs). Reduction parameter: lower ρ by around one third of the measured gap between North Macedonia and France (this increases employment and capital elasticities with firm TFP by about one-third of that gap).  
  - Operational barriers (lower τ^f): reduce operational costs and exit incentives (e.g., reduce uncertainty, improve infrastructure).  
  - Capital barriers (lower τ^K): support capital accumulation (e.g., remove credit constraints, encourage public investment and FDI).  
  - Labor participation (lower τ^L): increase net wages / reduce barriers to labor supply (e.g., lower income taxes, childcare support, skills training).
- Quantitative outcomes (Table 6: outcomes relative to benchmark economy):
  - Entry Barriers: Output-per-Capita 16.4% chg; TFP 10.2% chg; Participation Rate 1.00 pp chg; Capital-Output Ratio 0.05% chg; Number of Firms 9.4% chg; Exit Rate 31.5 pp chg.  
  - Size-Dependent Barriers: Output-per-Capita 14.5% chg; TFP 10.2% chg; Participation Rate 0.00 pp chg; Capital-Output Ratio 0.01% chg; Number of Firms 8.7% chg; Exit Rate -1.0 pp chg.  
  - Operational Barriers: Output-per-Capita 9.1% chg; TFP 6.4% chg; Participation Rate 0.00 pp chg; Capital-Output Ratio 0.03% chg; Number of Firms 9.0% chg; Exit Rate -2.3 pp chg.  
  - Capital Barriers: Output-per-Capita 0.6% chg; TFP 0.1% chg; Participation Rate 0.00 pp chg; Capital-Output Ratio 1.2% chg; Number of Firms 0.6% chg; Exit Rate -0.2 pp chg.  
  - Labor Barriers: Output-per-Capita 0.1% chg; TFP 0.0% chg; Participation Rate 0.10 pp chg; Capital-Output Ratio 0.00% chg; Number of Firms 0.2% chg; Exit Rate 0.0 pp chg.
- Relative effectiveness (ranking from model results):
  - Most effective: reducing entry barriers and reducing size-dependent production barriers (both raise aggregate TFP by around 10.2% and output-per-capita by 16.4% and 14.5%, respectively).  
  - Operational barriers: meaningful gains (TFP +6.4%, output-per-capita +9.1%).  
  - Capital and labor participation reforms: modest aggregate gains in this model calibration (capital: output-per-capita +0.6%; labor: output-per-capita +0.1%).

### Barriers to TFP growth: empirical indicators
- Corruption:
  - 16.8 percent of firms in the sample reported that they were expected to give gifts to secure a government contract (highest among Western Balkans and higher than France, Germany, Spain).  
  - Percent of firms experiencing at least one bribe payment request is lower relative to some Western Balkans countries but still higher than France, Germany, Spain.  
  - Implication: corruption can act as a barrier to entry and distort resources toward older or politically connected firms, reducing allocative efficiency.  
- Informality:
  - Informality estimated to constitute from 20 to 40 percent of economic activity in North Macedonia (EBRD 2019).  
  - 54.5 percent of firms report competing against unregistered or informal firms (second highest among Western Balkans and much higher than EU4).  
  - Significant share of firms identify practices of informal competitors as a major constraint.  
  - Implication: informality can keep firms small, compress markets, and distort resource allocation away from productive firms; reducing informality complements policies that improve labor participation and capital allocation.

### Policy implications and priorities
- Prioritize reforms that reduce barriers most linked to allocative inefficiency and entry costs:
  - Streamline business registration and reduce bureaucracy to lower entry barriers.  
  - Reform size-dependent regulations or taxes, address credit constraints and hiring/firing costs, and reduce policies that incentivize informality to allow productive firms to scale (reduce elasticity ρ).  
  - Address operational constraints (reduce uncertainty, improve infrastructure, skills) to lower exit rates and raise firm lifetimes.  
- Complement reallocative reforms with anticorruption measures and policies to reduce informality, since both can materially affect entry, exit, and the allocation of resources across firms.  
- Targeted policies to increase labor participation (childcare, skills, lower effective labor taxation) and to ease capital accumulation (credit access, FDI facilitation, public investment quality) can add gains but, in the calibrated experiments, generate smaller aggregate effects than entry and size-dependent reforms.

*Source: IMF staff analysis in "11. Allocative efficiency across firms in North Macedonia hinders aggregate productivity."*

### 22. Some areas of bureaucracy are a challenge to productivity growth. Results from the

### 22. Some areas of bureaucracy are a challenge to productivity growth. Results from the

### Bureaucracy, informality, and firm-level frictions: empirical findings
- World Bank Enterprise Surveys show mixed results for North Macedonia:
  - Senior management time spent dealing with requirements of government regulation is relatively low compared to other Western Balkans countries and EU4 (lower panels of Figure 8).
  - Number of days to obtain operating license is relatively low compared to other Western Balkans countries and EU4 (lower panels of Figure 8).
  - Number of days to obtain construction-related permit is high relative to other countries in the Western Balkans, though still lower than EU4 (Figure 8).
  - Number of days to clear imports from customs is high relative to other countries in the Western Balkans, though still lower than EU4 (Figure 8).
- Overall implication:
  - Bureaucracy in certain areas remains high in North Macedonia relative to peers, which could heighten entry and operational costs for firms and negatively impact productivity growth.
  - There is room to reduce entry and operational barriers by decreasing bureaucracy; policy experiments in the model indicate such reductions can yield nonnegligible improvements in aggregate productivity.

### Credit constraints and allocative efficiency
- Empirical evidence:
  - North Macedonia has the largest shares of firms reporting being fully credit constrained and a comparatively high share of partially credit constrained firms compared with others in the region and the EU4 (Figure 9).
- Economic implications:
  - Prevalence of credit constraints can lead to lower-than-optimal use of capital and smaller-than-optimal firm size, producing allocative inefficiencies and hindering productivity growth.
  - Gains from capital accumulation alone are comparatively small, but credit constraints also impact allocative efficiency of capital across firms and can hinder firm operation decisions, implying larger potential costs than capital accumulation effects alone.

### Model-based conclusions and policy implications
- Labor participation and capital accumulation:
  - Increasing labor participation and capital accumulation can raise output but are unlikely to drive long-run growth materially according to the quantitative model.
  - The model shows limited effect on output from direct policy intervention to increase labor participation; however, the model neglects non-pecuniary barriers (e.g., skill mismatches) that policies could address with potentially larger impacts.
  - Policies to push capital accumulation could be expensive; unclear that substantial long-run growth gains exist through this channel alone. Certain forms of capital (e.g., public infrastructure) may have larger benefits than implied by the policy experiments because the model considers only aggregate stock of capital.
- Allocative efficiency and business environment:
  - Increasing allocative efficiency across firms and improving the business environment can substantially increase aggregate output and productivity.
  - Policy-relevant areas to improve allocative efficiency include: financial development, bureaucracy, and informality.
  - High entry and operation costs are actionable policy targets; these barriers may relate to indirect factors such as bureaucracy and corruption.
  - Examples of policy synergies:
    - Improving access to credit for small firms is likely to increase allocative efficiency, lower operational barriers (as firms can better leverage productivity), and promote aggregate capital accumulation.
    - Improving skill matching of labor is likely to increase allocative efficiency by allowing productive firms to find appropriate employees, lower entry barriers by improving access to skills, and promote labor participation.
- Model delivers a multi-faceted policy message: design policies that address multiple barriers (finance, bureaucracy, informality, skill matching) together to improve aggregate productivity.

### Model structure, key parameters, and calibration moments relevant to policy experiments
- Model highlights (selected):
  - Firms face idiosyncratic production technology z and firm-level wedges τ that act as distortions; wedges follow log(1−τi,t) = ρ log zi,t + νi,t with νi,t ∼ N(0, σν2). The elasticity of wedges ρ captures size dependence of production barriers.
  - Firm entry cost is (1 + τE) ψ and operational cost is (1 + τf) f; entry and operational barriers capture delays, excessive regulation, and other frictions.
  - Total factor productivity à depends on the joint distribution of (z, τ) and the degree of misallocation across firms as shown in the model’s aggregate TFP expression.
- Empirical estimation inputs used for calibration:
  - Productivity process estimation: lnTFP i,t = θ lnTFP i,t−1 + Γt + εi,t with estimated autocorrelation θ = 0.72 and residual variation implying a value of σ ε = 0.90 (text). Annex calibration table reports SD of TFP = 0.87 (see calibrated parameter list).
  - Estimated distortions: implied elasticity of the firm-level productivity to the production barrier is ρ∗(1−γ) = 0.535.
  - Residual variation in estimated ν̂ i,t implies standard deviation of production barrier σν = 0.20 (text).
- Calibrated model parameter values (as reported in Annex Table 1):
  - Population 1.0
  - Discount Rate 0.9
  - Elasticity of Substitution 3.0
  - Capital Share 0.4
  - Span of Control 0.8
  - Capital Depreciation 0.1
  - Labor Preference 1.0
  - Labor Supply Curvature 1.0
  - Exit Rate 0.007
  - Entry Cost 1.0
  - Operation Costs 1.3
  - Autocorrelation of TFP 0.72
  - SD of TFP 0.87
  - Elasticity of Wedges 0.118
  - SD of Wedges 0.37

### Annex results on population adjustment and growth accounting (selected numeric outcomes)
- Population and employment adjustments:
  - Adjusted series assume recorded values are correct in 2002 and 2021 and interpolate between them with parameter ξ set to 2.
- Growth accounting with adjusted population and employment (Annex Table 1):
  - Benchmark / Adjusted (two columns reported)
    - Output-per-Capita: 3.67 100 / 4.07 100
    - Capital / Output: 0.66 9.7 / 0.66 8.7
    - Labor Participation: 1.69 46.1 / 1.67 41.1
    - Total Factor Productivity: 1.05 44.2 / 1.32 50.2
- Interpretation:
  - Output-per-capita growth is around 0.4 percentage points higher in the adjusted series than in the baseline because the denominator (population) shrinks over the period; this additional growth is absorbed by the residual component, total factor productivity, when labor participation is held fixed.
  - Main qualitative conclusions of the growth accounting exercise remain broadly unchanged after adjustment.

*Source: 1mkdea2024002 - 22. Some areas of bureaucracy are a challenge to productivity growth. Results from the (chapter/section text and annexes provided).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2024/english/1mkdea2024002.pdf_