## _gpgd ## Source details **Canonical URL:** [_gpgd](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/kosovo/2005/_gpgd.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/kosovo/2005/_gpgd.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/kosovo/2005/_gpgd.pdf.json) --- ### Political-administrative context - Kosovo is a province of Serbia in Serbia and Montenegro with a population of some 1.9 million and an area of about 11 thousand square kilometers. - UN Security Council Resolution 1244 (June 10, 1999) placed Kosovo under temporary UN administration while re-affirming the sovereignty of the Federal Republic of Yugoslavia (FRY) over the territory. - New constitutional framework adopted May 15, 2001 established shared responsibility between UNMIK and Provisional Institutions of Self-Government (PISG); PISG took office in April 2002. - Final status unresolved at time of report; comprehensive review of standards expected in 2005. ### IMF engagement, scope, and methodology - IMF assisted institution building and formulation/implementation of economic policy at request of UNMIK and later PISG. - Technical assistance from FAD, MFS, and Statistics Department; European Department provided macroeconomic advice. - Report builds on previous IMF reports and is based principally on four staff visits spanning January 2003 to March 2004. ### Overview and principal policy conclusions - Postconflict transition after nearly 5 years: institution building and macro stabilization coexist with slow recovery and fragile achievements. - Key risks: - Pace of recovery too slow to meet public expectations. - Episodic ethnic flare-ups could reverse gains. - Dependence on foreign assistance and private inflows amid declining aid and unclear private inflows. - Principal policy aim: - Achieve growth that is sufficiently (i) strong to reduce unemployment and (ii) regionally and socially inclusive to foster national reconciliation. - Final-status resolution is an enabling factor to reduce political uncertainty and support investment. ### Economic structure, external inflows, and vulnerabilities - External inflows and donor sector: - Foreign assistance and external private inflows: 50 percent of GDP. - Donor-created artificial “export” market (hiring and local purchases by expatriates, peacekeepers, donor projects): about 20 percent of GDP. - Private inflows financing remainder of current account deficit: on the order of 30 percent of GDP. - Total foreign assistance over the period reached "84.1 billion, equivalent to over twice Kosovo’s 2003 GDP". - Private inflows added another "82.4 billion". - Domestic sector fundamentals weak; domestic savings largely negative: - Underlying domestic savings probably "on the order of −30 percent of GDP" (excluding donor sector). - If workers’ remittances are "13.7 percent of GDP", national savings would be "largely negative and on the order of −15 percent of GDP". - Labor market and human capital: - Headline unemployment figure of 55 percent overstates problem; staff estimates: employment rate about 33 percent and unemployment rate about 30 percent after factoring informal employment. - Job seekers swell by about 30,000 young people annually. - Historical GDP per capita: - Declined from about 81,800 in 1981 to below 8300 in late 1990s; stands at about 8930 in constant 2003 euros. ### Medium-term growth, investment, and financing scenario - Employment and growth targets: - Target employment growth rate: at least 3 percent per annum. - Sustained employment growth of 3 percent for 10 years would create about 145,000 net additional jobs and bring unemployment down to about 25 percent. - Achievable growth with combined factors: sustain growth at about 5–5 1⁄2percent with investments of 25–27 percent of GDP per annum over the next decade and gains in total factor productivity. - Financing and debt policy: - Prudent borrowing aim: limit buildup of external debt to no more than 30 percent of GDP over next 10 years from technical assumption of zero today (subject to inherited liabilities). - Scenario reveals a financing gap of about 8300 million annually over the medium term (on a declining trend). - Use of accumulated government assets: could provide an extra 870 million of external financing per year. - Technical baseline: gradual buildup of new debt to some 27 percent of GDP in 10 years, providing 870 million additional financing per year. - Caution: if inherited debt is not zero, safe borrowing limits must be recalibrated; studies suggest beyond 40–50 percent debt-to-GDP likelihood of debt correction rises. ### Sensitivity and baseline growth-accounting results - Baseline (percent unless otherwise indicated): - GDP growth: 5.4 - Total investment in percent of GDP: 24.3 - Net rate of return on capital: 9.1 - Capital-output ratio: 3.0 - Change in capital-labor ratio: 1.5 - Contribution to growth by TFP: 2.0 - Alternative scenarios (selected exact figures): - ∆K/L=2: GDP growth 5.7; Total investment 25.7; Change in capital-labor ratio 2.0. - K/Y=3.3: GDP growth 5.4; Total investment 26.2; Net rate of return on capital 7.8; Capital-output ratio 3.3. - TFP=1 percent: GDP growth 4.5; Total investment 25.2; Contribution to growth by TFP 1.0. - Policy implication: lower TFP or higher capital-output ratio requires materially higher investment-to-GDP ratios. ### Fiscal framework: achievements, risks, and short- to medium-term strategy - Revenue performance: - Tax-to-GDP ratio close to 30 percent; tax revenues reached 8,520 million in 2003. - Revenues (percent of GDP) by year: "19.8", "28.8", "32.8" (2001–2003). - Budget balances and government assets: - Budget balance (percent of GDP): "4.7", "5.6", "2.5" (2001–2003). - Government assets (percent of GDP): "9.6", "15.1", "17.1" and in millions: "156", "263", "307" (2001–2003). - By end-2003, government assets had accumulated to "over 8300 million, equivalent to about 17 percent of GDP". - Risks from current budget practice: - Liberal carry-forward of unused appropriations and split between reserved and transferred-power agencies risk wasteful, unsustainable fiscal policy. - Example: decrease in domestic absorption of 15 percent of GDP could translate into loss of expenditure-based tax revenues of about 3 percent of GDP. - Short- to medium-term fiscal strategy pillars: 1. Rein in expansion of current spending to preserve comfortable current budget surplus to finance public investment and ensure sustainability. 2. Step up medium-term strategies for education, health, and basic infrastructure; elaborate prioritized public investment program to enhance physical and human capital. - Framework specifics: - Anchor medium-term fiscal framework on rolling 3-year growth rates for current expenditures. - Capital expenditures and overall balance should be consistent with sustainable financing—using accumulated assets and prudent borrowing, and accounting for expected foreign grants. ### Tax system assessment and vulnerabilities - Reasons for revenue overperformance: - Higher-than-envisaged excise rates (petroleum products 45–80 percent higher; cigarettes five times higher). - Broader tax bases due to larger domestic absorption. - Improved enforcement and customs. - Structural caveats: - Donor sector contributes directly about 3 percentage points of GDP to tax revenues via taxes on donor-created implicit “exports”. - Close to 80 percent of taxes are collected at the border. - VAT rate is the lowest in the region; individual income tax rates among the lowest. - Shortcomings: - Wage tax exemptions for local UNMIK employees and local employees of specialized UN agencies estimated revenue loss in excess of 85 million annually. - Problems in VAT refund system and delays in lowering customs duty on capital and intermediate goods hurt competitiveness. - Recommendations: - Strengthen tax and customs administrations. - Avoid frequent tax changes; ensure cost-effective further tax system development. ### Expenditure policy, civil service, pensions, and POEs - Civil service and wage bill: - Close to 15,000 new civil servants hired over past 3 years. - Wages for two-thirds of civil service raised 20 percent in mid-2003; minimum civil service salary increased 33 percent in early 2004. - Wage bill absorbs about 9 1/2 percent of GDP and is almost 30 percent of government revenues. - General government wage bill (millions of euros): 2001 = 110; 2002 = 131; 2003 = 146; 2004 Budget = 176. - Number of government employees (avg.): 2001 = 59,367; 2002 = 63,139; 2003 = 67,452; 2004 = 74,095. - Proposed pay-scale reform cost estimate: 1 percent of GDP; would raise wage bill to 10 1/2 percent of GDP. - Proposed universal meal allowance would raise wage bill to close to 38 percent of government revenues. - Pensions and social assistance: - Three-pillar pension system in place (Pillar I basic, Pillar II mandatory funded with employee/employer each 5 percent, Pillar III voluntary). - Social safety net cost has reached 6 percent of GDP (assuming decided policies fully phased in). - Disability pension law promulgated December 2003; payments set to start mid-2004. - Subsidies to POEs and fiscal costs: - Faltering electricity company restructuring generates quasi-fiscal losses of about 7 percent of GDP annually. - Budget provides subsidies for KEK, TREPCA, UNMIK Railways, district heating, water, and waste POEs; subsidies to investment also provided for KEK, Trepca, and Airport. - Recommendations: incorporate POEs, endow with strong corporate governance, phase out subsidies, increase transparency and monitoring, tie budgetary support to restructuring. ### KEK (Kosovo Energy Corporation) — operational and fiscal facts - 2003 operational indicators: - Total supply: 3,910 (gigawatt-hours); Generation net: 3,263; Imports: 647; Total sales: 2,347; Losses: 1,563. - Losses as percent of net supply: 43.2 percent. - Billed electricity: 102.2 (millions of euros); Bill collections: 73.2 (millions of euros); Percent of billed electricity collected: 71.6 percent. - Paid electricity (percent of net supply): 40.7 percent. - Quasi-fiscal losses: - Total quasi-fiscal losses estimated at 8121.8 million (7 percent of GDP). - Decomposition (2003): - Excess system losses: about 872.2 million. - Collection failure: about 829 million (given 71.6 percent collection rate and avg end-user tariff 80.05 per kWh). - Tariffs set below recovery: about 820.6 million (based on recovery cost estimate 80.06 per kWh). - Causes: - Over 80 percent of losses due to commercial losses and low bill collection rather than low tariffs. - Ill-conceived social case ruling (September 2002) granted full debt write-off to social assistance beneficiaries, undermining collection incentives. - Recommended actions: - Joint UNMIK-PISG credible restructuring strategy via Working Group on Energy. - Enact law to curb theft and enforce collections; design targeted social assistance (lifeline block or direct subsidy). - Develop financing package combining budgetary resources, donor grants, and private participation; commit financing package up front. ### TREPCA and social welfare costs - TREPCA current social transfers: - Annual cost described as "88.5 million per year, mainly to cover social welfare payments." - Net present value (NPV) of stream of budgetary outlays over next 40 years estimated at 894 million (5 percent of GDP) assuming no policy change. - Inequities: severance equivalents vary widely; under existing law cap on severance pay is 5 months for 30 years of service or more. - Temporary early retirement scheme: - Introduced beginning of 2004 for over 3,000 TREPCA miners; intended 6 months, extended another 6 months. - Objectives for comprehensive solution: - Political feasibility, fiscal savings, restoration of equity, awareness of precedent, and incentives for redeployment and training. - Table V.1 (as of October 2003): Total workers 9,509; Total cost in thousands of euros 6,062; Cost per worker 93,709; Monthly payment in 2004 9,855 (source details in original). ### Monetary and financial framework — euroization and banking sector - Use of the euro: - External anchor via euro secured financial discipline and low inflation; promoted high level of monetization. - For long-term development, benefits of financial stability and trade facilitation likely outweigh cost of losing a stabilization instrument. - Banking and payments authority (BPK) and market liberalization: - BPK established as supervisor and regulator; fully liberalized setting (no interest rate/credit restrictions). - Financial sector assets grew from virtually zero in early 2000 to 39 percent of GDP at end-2003. - Banking system profitable and appears healthy; average capital adequacy ratio Dec 2003: 16.6 percent; NPLs to gross loans Dec 2003: 1.6 percent; return on assets end-2003: 1.3 percent; return on equity: 18.7 percent; liquid assets share: 58 percent. - Deposit and loan dynamics: - Deposits grew at average annual rate 67 percent in euro terms during 2001–03; estimated deposits about 32 percent of GDP (8,600 million) at end-July 2004. - Loans reached 8328 million by end-July 2004, equivalent to 17 percent of GDP; loan growth 90 percent year-on-year as of end-July 2004. - Loans-to-GDP ratio remains low: 16 percent vs emerging economies average ~63 percent. - Reasons for limited financial deepening and high intermediation costs: - Large share of deposits invested abroad: banking system’s foreign assets reached level equivalent to "40 percent of GDP" by end-2003. - Loan interest rates around 14 percent; deposit rates around 2 1/2–3 percent; estimated intermediation cost decomposed into loan loss provisions, overhead, and return on capital (total 13.5 percent). - Overhead expenditure high (7.0 percentage points for domestic banks) due to small market, information costs, lack of credit bureau, overstaffing. - Prudential guidance: loans not to exceed 65 percent of deposits. - Maturity structure: 40 percent loans <1 year, 40 percent 1–2 years, remainder >2 years; domestic banks more short-term than foreign banks. - Policy recommendations for financial sector: - Maintain banking sector soundness, strengthen legal system to protect creditors’ rights, develop credit culture, regulatory framework for auditing and accounting, enforce anti–money laundering law. - Consider targeted policy options to mitigate political-uncertainty externalities: credit guarantees, limited mortgage guarantees, auctioning medium-term loans tied to SME lending, contingency credit line exploration by BPK. ### Donor sector analytical framing and macro implications - Donor sector creates a virtual export market: - Total foreign assistance about "40 percent of GDP" while its contribution to GDP was "on the order of 13 percent". - Donor sector is creating a "8380 million (20 percent of GDP) 'export' market" for Kosovar goods and services. - Balance of payments and current account framing: - Consolidated current account deficit of economy as whole was "on the order of 77 percent of GDP in 2003", whereas underlying domestic sector only was "on the order of 50 percent of GDP". - Unidentified inflows reported as "363", "423", "341" (millions of euros for 2001–03). - Impact of decline in foreign assistance (2002): - Foreign assistance fell by "over 20 percent" in 2002. - Donor sector demand contracted by "about 8100 million", exerting contractionary impact on output of "some 4 percent". - In 2003, fiscal expansion increased spending contributing "7 percentage points to GDP growth", possibly boosting growth to "some 3 percent". - Fiscal revenue sensitivity: - Example illustrative calculation (2003): a decrease in domestic absorption of 15 percent of GDP could lower expenditure-based tax revenues by about 3 percent of GDP. ### Data limitations, estimation approaches, and remittances - Data gaps and uncertainties: - No reliable population census since 1981; population estimates within margin of 15 percent. - Private sector data scant; private consumption and investment estimates rely on SOK 2002/03 HBS and import proxies. - Commercial imports recording improved by 2003 (81,042 million recorded). - Estimating remittances: - HBS reported remittances for June 2002–May 2003 amounted to 8174 million (monthly avg per household 849; 16.6 percent of households receiving). - Staff conservative illustrative estimate: true remittances might be on the order of 8370 million (100,000 remitters × average annual remittance 83,700). - Official workers’ remittances listed in some tables as 217, 241, 241 (millions euros) for 2001–03. - Treatment of donor spending in national accounts: - Detailed decompositions for UNMIK, PIP, and KFOR spending and assumptions on import content used to adjust public consumption, investment, and imports. ### Illustrative fiscal scenario and medium-term public investment - Illustrative consolidated government budget scenario (selected exact figures): - Revenues (millions of euros): 2002: 500; 2003: 590; 2004 Budget: 619; 2004 Actual: 605; 2005 Illustrative: 616; 2006 Illustrative: 629. - Current expenditures (millions): 2002: 360; 2003: 449; 2004 Budget: 634; 2004 Actual: 534; 2005 Illustrative: 542; 2006 Illustrative: 546. - Capital expenditures (millions): 2002: 42; 2003: 62; 2004 Budget: 74; 2004 Actual: 115; 2005 Illustrative: 150; 2006 Illustrative: 164. - Government’s bank balances (millions): 2002: 26; 2003: 307; 2004 Budget: 19; 2004 Actual: 263; 2005 Illustrative: 187; 2006 Illustrative: 106. - Selected ratios (percent of GDP): Capital expenditures 2005 Illustrative: 7.5; 2006 Illustrative: 8.0. Current balance 2005 Illustrative: 3.7 percent of GDP; 2006 Illustrative: 4.0 percent of GDP. - Policy measures in scenario: - Pay-scale reform and full 1-year impact of new disability pension raise wage bill and social program costs by 15 and 13 percent respectively (2005). - A 2 percent cut in goods and services spending and 20 percent cut in transfers to POEs contained nominal growth of current spending in 2005 to about 1 1/2 percent. - These measures maintain current budget surplus at about 3 1/2 percent of GDP in 2005 and could raise current surplus close to 4 percent in 2006 with further POE subsidy cuts. ### Structural reform recommendations and privatization - Privatization of SOEs: - Privatization strategy agreed mid-2002; KTA established June 2002; land-use regulation for 99-year transferable leases promulgated May 2003. - First two waves of tenders produced winning bids amounting to 829 million; third wave suspended Oct 2003 and resumed July 2004—suspension was harmful; further delays should be avoided. - Recommendation: privatization should proceed without further delay; permit liquidation via transferable leases where outright sale impeded. - POE restructuring: - Sector includes KEK, PTK, UNMIK Railways, Airport, and 55 POEs total. - Lack of progress in energy and mining (notably TREPCA and KEK) has great economic cost. - Recommendation: incorporate POEs, enforce hard budget constraints, tie any budgetary support or loan guarantees to credible restructuring, improve transparency and monitoring. ### Conclusions and ways forward — prioritized policy actions - Fiscal: - Rein in current spending growth, anchor medium-term fiscal framework on rolling 3-year current expenditure growth, prioritize public investment in human and physical capital. - Channel growing share of foreign assistance through the budget to boost growth, ownership, and transparency. - Monetary and financial: - Maintain euro anchor, preserve labor/goods market flexibility, strengthen BPK supervision, protect creditor rights, support credit information infrastructure, enforce anti–money laundering law. - Consider targeted guarantees and contingency facilities to mitigate political-uncertainty externalities. - Structural: - Accelerate privatization of SOEs, restructure POEs (notably KEK and TREPCA) with clear financing and institutional arrangements, develop export-friendly policies, strengthen rule of law and judicial capacity. - Social and labor: - Prioritize rebuilding human capital: education enrollment targets and quality improvements (selected indicators: preschool enrollment <20 percent vs European average 80 percent; tertiary enrollment about 16 percent vs European average 45 percent). - Manage pension and social assistance costs by enforcing eligibility criteria, keeping real benefits broadly stable, and complementing severance with redeployment and training. *IMF staff report prepared principally on the basis of staff visits from January 2003 to March 2004 (publication metadata in source).* ### 1. Kosovo (Serbia) — Economic policy. 2. Kosovo (Serbia) — Economic conditions — ### 1. Kosovo (Serbia) — Economic policy. 2. Kosovo (Serbia) — Economic conditions — ### Political-administrative context - Kosovo is a province of Serbia in Serbia and Montenegro with a population of some 1.9 million and an area of about 11 thousand square kilometers. - Following the end of the war of March–June 1999, the United Nations Security Council, in Resolution 1244 (June 10, 1999), placed Kosovo under temporary UN administration while re-affirming the sovereignty of the Federal Republic of Yugoslavia (FRY) over the territory. - A new constitutional framework adopted May 15, 2001, established shared responsibility for administering the territory between the UN Interim Administration Mission in Kosovo (UNMIK) and a Kosovar self-government, the Provisional Institutions of Self-Government (PISG), which took office in April 2002. - The final status of Kosovo was yet to be determined at the time of the report; the UN Security Council indicated support for a set of standards whose achievement could pave the way toward discussions on final status. A comprehensive review of progress toward these standards was expected in 2005. ### IMF engagement, analytical scope, and institutional coordination - At the request of UNMIK and later the PISG, the International Monetary Fund (IMF) assisted institution building and the formulation and implementation of economic policy in Kosovo. - IMF assistance was closely coordinated with the World Bank and other multilateral and bilateral donors. - Technical assistance was provided by the IMF’s Fiscal Affairs Department, Monetary and Financial Systems Department, and Statistics Department; the European Department provided ongoing macroeconomic policy advice. - This report builds on two previous IMF reports: Kosovo: Macroeconomic Issues and Fiscal Sustainability (2001–2002) and Kosovo: Institutions and Policies for Reconstruction and Growth. - The report is principally based on work performed during four staff visits spanning a 15-month period from January 2003 to March 2004. ### Purpose, intended audience, and expected contribution - The report aims to analyze economic conditions, policy options, and institutional requirements to support reconstruction and growth in Kosovo. - It provides analysis and recommendations intended to inform the debate about economic policies and broader issues shaping Kosovo’s future. - The authors express the hope that the analysis and recommendations will contribute to informing economic policy debate in Kosovo. ### Acknowledgments and authorship context (relevant to credibility and inputs) - Lead staff and contributors included Rakia Moalla-Fetini (team leader), Heikki Hatanpää, Anastassios Gagales, David Moore (EUR), Kentaro Ogata, Brian Olden (FAD), Zia Ebrahim-Zadeh, Natalia Koliadina (PDR), and assistance from Shehadah Hussein (head of the IMF liaison office in Pristina). - The work benefited from detailed comments by IMF and World Bank colleagues, including Vassili Prokopenko (noted help on banking system analysis), and editorial, research, and production support from IMF staff. - The views expressed are those of the authors and do not necessarily represent those of the IMF or IMF policy; responsibility for the views rests with the authors. *IMF staff report prepared principally on the basis of staff visits from January 2003 to March 2004 (publication metadata in source).* ### Preface ### Preface ### Overview and Policy Conclusions - Nearly 5 years into the postconflict transition, Kosovo faces a critical juncture: notable institution building and macroeconomic stabilization coexist with slow recovery and fragile achievements. - Key risks highlighted: - Pace of recovery too slow to meet people’s demands and expectations. - Episodic ethnic flare-ups that could reverse gains. - Dependence on foreign assistance and private inflows, with declining aid and unclear private inflows. - Principal policy aim: - Authorities should take stock of achievements, deepen understanding of challenges, and develop appropriate policy responses to achieve growth that is sufficiently (i) strong to reduce unemployment and (ii) regionally and socially inclusive to foster national reconciliation. - Final-status resolution is identified as an enabling factor that could reduce political uncertainty and support investment and economic activity. ### Economic Structure and Long-Term Prospects - Recovery driven by massive foreign assistance and private inflows, but this dependence renders gains fragile. - Quantified roles of external inflows: - Foreign assistance and external private inflows: 50 percent of GDP. - Donor-created artificial “export” market (hiring and local purchases by expatriates, peacekeepers, donor projects): about 20 percent of GDP. - Private inflows financing remainder of current account deficit: on the order of 30 percent of GDP; the official estimate of workers’ remittances is much smaller and the nature/stability of these inflows is unclear. - Domestic sector fundamentals weak, with large domestic dissavings reminiscent of the 1970s and early 1980s; sudden reversal of inflows or rapid withdrawal of assistance would cause painful retrenchment. - Labor market and human capital: - Headline unemployment figure of 55 percent overstates the problem, but employment is nonetheless likely to be very severe. - Staff estimates: employment rate about 33 percent and unemployment rate about 30 percent, after factoring informal employment. - Macroeconomic growth and investment targets: - Reasonable macroeconomic framework should target employment growth rate of at least 3 percent. - Achieving that would likely require investments of 25–27 percent of GDP per annum over the next decade. - Combined with employment increases and gains in total factor productivity, such investment could sustain growth at about 5–5 1⁄2percent. - Financing scenario and debt policy: - Prudent borrowing aim: limit buildup of external debt to no more than 30 percent of GDP over the next 10 years—from a technical working assumption of zero today (pending clarification of liabilities and assets from the former Federal Republic of Yugoslavia). - Scenario reveals a financing gap of about 8300 million annually over the medium term, albeit on a declining trend. - If inherited debt is not zero, financing needs would be affected accordingly. - Role of donors and budget channeling: - Sustained combined efforts from authorities and donors required. - Increasing the share of foreign assistance channeled through the budget is recommended to boost growth and reinforce ownership and transparency. ### The Fiscal Framework - Institutional progress: - Kosovo General Budget (KGB) maturing; tax revenues nearly fivefold increase since 2000. - Risks from current practices: - Liberal carry-forward of unused appropriations and unhealthy competition between reserved and transferred-power agencies impede clear fiscal strategy and risk wasteful, unsustainable fiscal policy. - Recommended short- to medium-term fiscal strategy pillars: - Rein in expansion of current spending to preserve a comfortable current budget surplus, help finance public investment, and ensure long-term sustainability. - Step up medium-term strategies for education, health, and basic infrastructure; elaborate a well-prioritized public investment program directed at enhancing physical and human capital. - Framework specifics: - Anchor medium-term fiscal framework on a rolling 3-year growth rate for current expenditures. - Level of capital expenditures and overall budget balance should be consistent with a sustainable financing strategy—making prudent use of accumulated government assets and eventual borrowing, and taking into account likely paths of foreign grants and donor-financed investment. - Tax system performance and caveats: - Tax-to-GDP ratio already close to 30 percent. - System relies on traditional broad-based taxes with low nominal rates and few exemptions. - Paradox: strong tax performance partly reflects structural weaknesses—donor sector contributes directly some 3 percentage points of GDP to tax revenues via taxes on the donor-created implicit “exports”; private inflows boost expenditure-based taxes. - Risks to revenues: political pressures to lower rates/grant exemptions; phasing out of peacekeeping forces’ mission. - Example sensitivity: a decrease in domestic absorption of 15 percent of GDP could translate into a loss of expenditure-based tax revenues equivalent to about another 3 percent of GDP, in addition to indirect negative impacts from lower activity. - Public wages, pensions, and transfers: - Limited scope for further expansion of civil service wage bill; proposed pay scale reform seen as prudent, but proposed meal allowance to all civil servants is described as significant and unwarranted. - Pension and social transfer system well designed; to ensure sustainability, expand coverage cautiously, keep real benefits broadly stable, and enforce eligibility criteria strictly. ### Monetary and Financial Frameworks - Use of the euro: - External anchor via the euro has secured financial discipline and a low-inflation environment and promoted a high level of monetization. - For long-term development, financial stability and trade facilitation with Europe from euro use likely outweigh costs of losing a stabilization instrument; enhancing labor and goods market flexibility is important to improve this trade-off. - Financial sector characteristics and prudent approach: - Perceived shortcomings—low credit volume, short maturities, high lending rates—largely reflect nascent institutional capacity and short lifespan of the sector. - Faster domestic credit expansion would have compromised loan portfolio quality given weak risk management, enterprise accounting and corporate governance shortcomings, and weak judicial processes; it would also have increased inflationary pressures and damaged competitiveness. - Aggressive maturity transformation would have been imprudent without tested deposit stability, lender-of-last-resort, or ties to world financial markets. - Policy priorities: - Maintain banking sector soundness; strengthen legal system to protect creditors’ rights and nurture credit culture; establish regulatory framework for external auditing and accounting standards. - Enforce anti–money laundering law to reinforce public trust in banks. - Policy interventions for political-uncertainty externalities: - Kosovo’s unresolved political status creates negative externalities (credit and liquidity risks, growth of deposit base, long-term investment decisions) that may justify policy options discussed in the paper; authorities should weigh pros and cons carefully. ### Structural Reforms - Privatization and enterprise sector: - Privatization of socially owned enterprises (SOEs) resumed recently after policy changes to increase transparency and ensure medium-term viability, but the long pause damaged investor prospects and politicized disagreements between PISG and UNMIK undermined investor confidence. - Recommendation: privatization should proceed without further delay; legislation defining land-use rights for liquidation cases should be promulgated promptly. - Publicly owned enterprises (POEs) and sector-specific issues: - Limited restructuring progress has imposed significant costs. - Main mining company de facto closure has virtually shut down an important sector; current social transfers to some workers are inefficient, onerous, inequitable, and a source of ethnic tensions. - Faltering electricity company restructuring deprives the economy of reliable electricity and generates quasi-fiscal losses of about 7 percent of GDP annually. - Recommendations: incorporate POEs, endow them with strong and stable corporate governance to stem losses, unleash economic potential, and attract private capital; increase transparency and monitoring of budgetary resources used by POEs. - Legal and implementation capacity: - Main building blocks of legal framework for private sector development in place; primary challenge is developing implementation capacity to enforce them. - Policies to support an export-friendly environment need to be pursued more actively. ### Recent Economic Trends, Short-Term Vulnerabilities, and Medium-Term Challenges - Recovery and vulnerabilities: - Kosovo staged a very strong recovery after the conflict driven by large foreign assistance and private inflows, but heavy reliance on these inflows makes gains fragile. - Economy operating far below potential: no more than one adult out of three holds a job; job seekers swell by an additional 30,000 young people annually. - Human capital severely eroded after years of exclusion from the job market and decline of the education system; majority of citizens lack necessary education and training for robust growth. - Major deficiencies in public utilities and infrastructure persist and remain a serious drag on competitiveness and investment profitability. - Large environmental liabilities noted as extremely costly to tackle. - Historical GDP per capita trajectory: - Federal transfers had previously provided about 40 percent of GDP annually. - GDP per capita declined from about 81,800 in 1981 to below 8300 in the late 1990s and stands at about 8930 in constant 2003 euros. *Preface — _gpgd - Preface* ### 84.1 billion, equivalent to ### _gpgd - 84.1 billion, equivalent to ### Recent economic trends and 2002–2003 developments - Total foreign assistance over the period reached "84.1 billion, equivalent to over twice Kosovo’s 2003 GDP". - Private inflows added another "82.4 billion". - A sharp decline in foreign assistance, the end of the postconflict construction boom, and the lagging impact of an unintended fiscal tightening in 2001 appear to have brought the economy to a grinding halt in 2002. - The fall of inflation had turned negative by end-2002. - In 2003, a large fiscal expansion—with an increase in spending contributing "7 percentage points to GDP growth"—may have offset further declines in foreign assistance and private investment, possibly boosting growth to "some 3 percent". - By end-2003, government assets had accumulated to "over 8300 million, equivalent to about 17 percent of GDP". ### Impact of the decline in foreign assistance (2002) - Foreign assistance fell by "over 20 percent" in 2002. - The demand for local goods and services originating from the donor sector is likely to have contracted by "about 8100 million", exerting a contractionary impact on output of "some 4 percent". - Additional contractionary pressures arose from: - A sharp decline in housing investment due to completion of most reconstruction. - Slowdown in expatriates’ demand for rental housing. - An unexpectedly strong performance of the newly established tax system, which outstripped rising budgetary spending and may have slowed the economy further. - Evidence supporting the assessment includes: - Sharp deceleration in growth of recorded commercial imports. - Fall of inflation to negative by end-2002. - Reports of anemic growth in most sectors from business surveys and banking community representatives. ### Banking system, private inflows, and external positions - The banking system accumulated sizable assets abroad funded by a sharp increase in deposits; by end-2003, the banking system’s foreign assets had reached a level equivalent to "40 percent of GDP". - A little less than half of these foreign assets reflected government assets deposited at the Banking and Payments Authority of Kosovo. - About "15 percent" of the buildup of net foreign assets likely reflected a fall in the public’s cash holdings of euros and a commensurate increase in bank deposits. - Present estimates suggest the economy attracted "81.2 billion" in other private inflows during the past 3 years (equivalent to "65 percent of GDP in 2003"). - Unidentified inflows are reported in the Balance of Payments table as "363 423 341" (millions of euros for 2001–03; see Table II.2). ### Exchange rate, inflation, and competitiveness - Trends in Kosovo’s real effective exchange rate suggest that, following a strong initial appreciation, competitiveness was gradually restored as inflation slowed (Figures II.4 and II.5). - Initially strong real appreciation reflected foreign-inflows-driven high domestic inflation and significant real depreciation of the Yugoslav dinar and the Turkish lira. - A gradual correction started in mid-2001 as price pressures subsided in response to declined aid flows and weakening domestic demand. - Nominal appreciation was smaller than the effective appreciation in the euro zone because main trading partners’ currencies were linked to the euro or did not depreciate as much as the U.S. dollar. ### Aid dependency and analytical framing of the donor sector - The donor sector runs a parallel structure of public spending financed by taxpayers in donor countries; part of this spending is in expatriates’ wages, foreign experts, international police and judges, and foreign peacekeeping soldiers. - The donor sector’s spending takes the form of a "virtual export market" for Kosovar goods and services through: - Hiring of local employees. - Purchases of domestic goods and services for consumption by expatriates and peacekeeping soldiers. - Donor-financed projects. - Total foreign assistance was about "40 percent of GDP", while its contribution to GDP was "on the order of 13 percent". - Using the framework in Box II.1, the consolidated current account deficit of the economy as a whole was "on the order of 77 percent of GDP in 2003", whereas the underlying current account deficit of the domestic sector only was "on the order of 50 percent of GDP". - The donor sector is creating a "8380 million (20 percent of GDP) 'export' market" for Kosovar goods and services. - Total private inflows are estimated at "on the order of 30 percent of GDP", helping close the remaining deficit. ### Structural vulnerabilities and savings - Excluding the net impact of the donor sector, underlying domestic savings rates are largely negative, probably "on the order of −30 percent of GDP". - If workers’ remittances are taken as "13.7 percent of GDP" (official statistic for 2003), the national savings rate would be "largely negative and on the order of −15 percent of GDP". - Official estimates and staff analysis leave uncertainty over the nature and stability of private inflows: possibilities include underrecorded workers’ remittances, investment by the Kosovar diaspora (notably in housing), or export receipts from illegal activities. - The authorities have adopted an anti–money laundering law; improved border controls and measures to curb cigarette smuggling are identified as helpful steps. ### Key fiscal and external numbers (selected tables and figures as presented) - General Budget (Table II.1, in percent of GDP and millions of euros): - Revenues: "19.8", "28.8", "32.8" (for 2001, 2002, 2003). - Percent increase in euros: "150.1", "55.5", "18.0". - Expenditure: "15.1", "23.2", "30.3". - Percent increase in euros: "20.6", "63.7", "35.5". - Budget balance: "4.7", "5.6", "2.5". - Government assets (percent of GDP): "9.6", "15.1", "17.1". - Government assets (in millions of euros): "156", "263", "307". - Balance of Payments (Table II.2, in millions of euros): - Current account (after foreign assistance): "−140", "−201", "−284" (2001–2003). - Current account (in percent of GDP): "−8.6", "−11.6", "−15.8". - Change in currency in circulation (increase) (adjusted): "−31", "13", "22", "4". - Change in banking system’s NFA (end-of-period stock): "−212", "−315", "−48". - NFA (end-of-period stock) (adjusted): "335", "649", "697". - Other identified capital transactions: "20", "−39", "−34". - Unidentified inflows: "363", "423", "341". ### Analytical framework (Box II.1) — decomposition summary - Foreign assistance FA decomposed as: FA = Wexp + Wle + GUNMIK + IPIP + GKFOR. - Direct contribution of foreign assistance to GDP (DCFA/GDP) equals the domestic component of UNMIK’s spending on goods and services, KFOR’s spending on goods and services, PIP spending on goods and services, and expatriates’ consumption net of their import content. - Current account CA formula: CA = NEXP + WR + Wle + FA. - Net exports of the domestic sector only (NEXPDS) relate to total net exports and the gap between FA and DCFA/GDP. *Sources: Kosovo authorities; and IMF staff estimates.* ### Appendix II—the national savings rate would be ### Appendix II—the national savings rate would be higher but still negative. ### Impact of a full phase-out of foreign assistance - The shock to output from a full phase-out of foreign assistance is measured by the balance of payments gap it would generate, estimated as a loss of export earnings equivalent to 20 percent of GDP. - The potential gap in the budget balance reflects both a decline in tax revenues and higher spending. - Foreign assistance contributes indirectly to higher tax revenues by sustaining a higher level of economic activity and contributes about 3 percentage points of GDP to tax revenues from taxes on the local spending of the donor sector. - A sudden reversal in private inflows or an overly rapid withdrawal of foreign assistance would lead to a painful retrenchment, amplified by the fixed exchange rate regime which prevents short-run real exchange rate adjustment. - Use of part of the foreign assets accumulated during the past 3 years could mitigate such an adversity. ### Key macroeconomic and sectoral statistics (2001–03; percent of GDP unless otherwise indicated) - Current account balance: −60.1; −53.7; −50.4 - Regular exports: 1.4; 1.6; 2.0 - Imports: 61.5; 55.3; 52.5 - Investment: 25.6; 24.1; 22.3 - Underlying domestic savings: −34.6; −29.6; −28.2 - Current account financing: 60.1; 53.7; 50.4 - Donors’ contribution to GNDI: 38.2; 28.2; 21.2 - Private inflows: 22.0; 25.5; 29.2 - Memorandum items: - Total foreign assistance: 72.3; 52.6; 41.0 - Total private inflows: 35.7; 38.3; 32.4 - Stock of net foreign asset position of the economy: 24.5; 38.3; 41.3 ### Medium-term growth and employment challenges - Main constraint: absence of sustained growth and job creation; employment objective anchored in a growth-accounting methodology. - Reasonable employment growth target: 3 percent per annum. - A sustained annual employment growth rate of 3 percent over the next 10 years would create about 145,000 net additional jobs and bring unemployment down to about 25 percent. - Labor market context: - Seasonally unadjusted headline unemployment figure of 55 percent likely overstates the problem; unemployment may be as high as 30 percent, with an employment rate of no more than 33 percent. - LFS 2001–02 (in thousands): Working-age population 1,144; 1,207. Employed 229; 263. Unemployed 305; 321. Not in labor force 610; 623. - LFS indicators: Labor force participation rate 46.7; 48.4 (percent). Unemployment rate 57.2; 55.0 (percent). - Staff estimates of informal employment: on the order of 150,000; factoring informality yields an unemployment rate in the range of 22–30 percent (with the higher end around 30 percent considered more plausible). - Baseline capital accumulation assumption: increase in the capital-labor ratio of 1.5 percent per year. - Growth and investment implications: - Achieving the employment objective could sustain growth at some 5–5 1/2percent but would require annual investments of 25–27 percent of GDP over the next decade. - If annual gains in total factor productivity (TFP) are 2 percent, growth could be sustained at 5 1/2percent with labor contributing 1.6 percentage points, capital 1.8 percentage points, and TFP 2 percentage points. - Increase in stock of remunerated capital would necessitate an investment rate of some 20 percent of GDP (assuming 5 percent depreciation). - Tentative estimate of necessary public investment to support TFP gains: in the range of 5–7 percent of GDP. ### Financing strategy and constraints - High negative domestic savings rate is the main financing constraint; relying on foreign borrowing would be imprudent. - Recent past financing relied on foreign assistance and private inflows equivalent to 50 percent of GDP. - Scenario parameters to maintain external solvency while supporting growth: - Private savings: increase in domestic savings from −28 percent of GDP in 2003 to about −10 percent by 2013, reflecting an expansion of regular exports to some 8600 million. - Private inflows: assumed broadly constant at some 8550 million over the next 10 years. - Use of accumulated assets: could provide an extra 870 million of external financing per year. - Foreign borrowing: technical assumption of zero inherited debt and a gradual buildup of new debt to some 27 percent of GDP in 10 years, providing 870 million additional financing per year. - Caution: if inherited debt is not zero, financing needs and safe borrowing limits must be recalibrated; studies suggest that beyond a debt-to-GDP ratio of 40–50 percent the likelihood of a debt correction rises and the impact on growth turns negative. ### Sensitivities and structural requirements - Faster increases in the capital-labor ratio (e.g., 2 percent instead of 1.5 percent) would raise growth by about 0.3 percentage points but require larger additional investment. - Structural prerequisites for the scenario: - Revive mining and power sectors and discover new export niches to reach proposed export targets. - Improve productivity, competitiveness, and access to foreign markets to expand production possibilities and savings. - Deepen structural reforms to attract regular foreign direct investment and stabilize private inflows. - Develop a bottom-up estimate of public infrastructure and human capital needs to underpin an appropriate fiscal strategy. *Italic: Source — Fund staff estimates and statistical appendices contained in Appendix II of the original chapter.* ### 1.4 percent of GDP. ### 1.4 percent of GDP. ### Sensitivity Analysis of GDP Growth and Investment Requirements - A higher initial capital-output ratio implies a lower underlying rate of return on capital and requires a larger volume of investment. - If the capital-output ratio in 2003 were 3.3, rather than 3 percent as in the baseline, implying a net rate of return on capital of 7.8 percent rather than 9.1 percent, additional investment of almost 2 percent of GDP would be required to achieve the same rate of economic growth as in the baseline. - Lower TFP gains weaken GDP growth and imply higher investment in relation to GDP. If TFP gains were limited to 1 percent per year, growth would be limited to 4.5 percent and the investment-to-GDP ratio would rise to 25.2 percent. - Sensitivity table (In percent, unless otherwise indicated) - Baseline - GDP growth: 5.4 - Total investment in percent of GDP: 24.3 - Net capital share in net output: 32.0 - Net rate of return on capital: 9.1 - Capital-output ratio: 3.0 - Change in capital-labor ratio: 1.5 - Contribution to growth by TFP: 2.0 - Scenario ∆K/L=2 - GDP growth: 5.7 - Total investment in percent of GDP: 25.7 - Net capital share in net output: 32.0 - Net rate of return on capital: 9.1 - Capital-output ratio: 3.0 - Change in capital-labor ratio: 2.0 - Contribution to growth by TFP: 2.0 - Scenario K/Y=3.3 - GDP growth: 5.4 - Total investment in percent of GDP: 26.2 - Net capital share in net output: 30.8 - Net rate of return on capital: 7.8 - Capital-output ratio: 3.3 - Change in capital-labor ratio: 1.5 - Contribution to growth by TFP: 2.0 - Scenario TFP=1 percent - GDP growth: 4.5 - Total investment in percent of GDP: 25.2 - Net capital share in net output: 32.0 - Net rate of return on capital: 9.1 - Capital-output ratio: 3.0 - Change in capital-labor ratio: 1.5 - Contribution to growth by TFP: 1.0 ### Financing, Foreign Assistance, and Debt Considerations - To ensure debt service obligations remain sustainable, new borrowing should be made at concessional terms. - Today's level of foreign assistance is about 8750 million, of which only 8380 million finances the current account deficit of the local economy. - As political normalization allows a gradual move toward more traditional forms of foreign assistance, the total level of foreign assistance could converge to the level of its current net impact on the domestic economy. - This would imply that the level of total foreign assistance could decline from about 8750 million today to some 8280 million by 2013. - In the baseline scenario, the debt stock of 27 percent of GDP by 2013 represents 135 percent of exports. - Information is not available with regard to the amount of debt Kosovo may inherit; clarification may need to await resolution of Kosovo’s final status. ### Policy Recommendations — Authorities - Implement strong policies aimed at: - An efficient and effective structure of public spending that promotes development and creates an enabling environment for productive private investment, while maintaining fiscal stability. - A speedy reform of the state enterprise sector. - An acceleration of the overall pace of market reform and of the establishment of the rule of law. - Policies targeted at raising labor productivity, ensuring a better skill match, lowering labor cost, and maintaining labor market flexibility to encourage labor-rich growth. - Reinforce reforms to achieve strong total factor productivity, a high rate of return on investment, and high growth to expand the economy’s production possibility frontier. ### Policy Recommendations — Donors - Continued donor involvement to support the authorities’ policies until the economy’s fundamentals strengthen and governance and market institutions reach maturity. - Reinvigorate the virtuous circle through which foreign assistance supports good policies and good policies provide a basis for continued donor support. - Channel a growing share of foreign assistance through the budget to increase its contribution to the domestic economy, boost growth, and reinforce ownership and transparency. - Provide clarity about policies and financing needs to maximize developmental impact. ### Fiscal Strategy, Tax, and Expenditure Systems — Main Issues - Kosovo has built capacity and institutions for autonomous fiscal management and achieved excellent tax performance, creating an opportunity for fiscal policy to address developmental challenges. - In the context of plentiful resources and weak capacity for expenditure management, the absence of a fiscal strategy risks wasteful and unsustainable fiscal policy. - Lack of proper assessment of main fiscal risks, in the presence of large government assets, raises the risk of creating unsustainable entitlements. - Fiscal risks are significant due to uncertainties about the main parameters of fiscal solvency and weak capacity and institutions for expenditure management increase the likelihood of significant inefficiencies. ### Budget Dynamics, Carryforwards, and Reform Steps - Under fast-rising tax revenues, the Kosovo General Budget (KGB) nearly tripled in 3 years and now covers most public services and all social transfers. - By 2003, the budget surplus had reached 2 1⁄2 percent of GDP, with an underlying current surplus equivalent to nearly 8 percent of GDP, and government assets had reached an amount equivalent to 17 percent of GDP. - Budgeting on a commitment basis and conservative initial revenue projections led to full appropriation of multiyear projects up front; better-than-expected revenue performance plus weak administrative capacity constrained actual spending and produced large unused appropriations carried forward across budget cycles. - After 4 years, carryforward commitments accumulated to the point where a nearly balanced budget adopted at the beginning of 2004, plus reappropriated carryforward commitments, resulted in total appropriations consistent with a deficit of 16 percent of GDP. - Consolidated general government data (2000–03) - Figure III.1 shows Revenues, Expenditures, and End-of-period bank balances (In millions of euros) for 2000–03 (source: Kosovo authorities). - General Budget: Cash and Commitments, 2003–04 (In percent of GDP) - 2003 initial budget - Revenues: 32.8 - Expenditures: 30.3 - Balance: 2.5 - 2004 cash budget, incl. carryforwards - Revenues: 32.7 - Expenditures: 34.4 - Balance: −0.7 - 2004 budget including reappropriated carryforwards - Revenues: 32.7 - Expenditures: 47.9 - Balance: −15.2 ### Institutional and Process Challenges - The split between “reserved-power” and “transferred-power” agencies hinders consensus building on priorities; reserved-power functions account for one-third of the total 2004 budget and close to one-half of the central government’s budget. - Delegation of POE supervision to a reserved-power agency has reduced incentives for PISG political backing of POE restructuring; unaddressed losses have led the SRSG to appropriate resources unilaterally to cover them. - Reforms underway: - Move to budgeting on a cash basis by lowering appropriations to expected annual cash expenditures. - Elimination of the carryover principle, effective January 2005. - Amendments to procurement law no longer mandate full up-front commitment of multiyear project costs. - MFE emphasis on building capacity for cash-flow forecasts and long-term planning. - Simplification of the 2005 budget circular to better align with capacity. - Improving the working relationship between MFE and reserved-power agencies is necessary so policy-formulating institutions can focus on strategic budget decisions. - PISG and UNMIK need a common understanding on economic priorities and how these should be reflected in budget allocations to avoid unilateral appropriations by the SRSG. ### Short- to Medium-Term Fiscal Strategy Pillars - The fiscal strategy in the short to medium term should be based on two pillars: 1. Reining in the expansion of current spending to prevent waste, preserve a comfortable current budget surplus to help finance public investment, and ensure long-term sustainability. - Given weak expenditure management capacity, a more guarded expansion is warranted to ensure value for money and inform the budgetary process with evolving policy analysis and strategic planning. - A prudent expansion is needed to ensure increases in public spending remain consistent with medium-term fiscal solvency, avoiding policy reversals. - Main parameters of fiscal solvency remain in doubt due to uncertainties about: the growth potential of the tax base; the cost of additional government functions to be transferred to the PISG and of needed public investment; the level of an eventual inherited debt; and the level of foreign assistance. *Source: _gpgd - 1.4 percent of GDP.* ### 2. Stepping up work on medium-term strategies for ### _gpgd - 2. Stepping up work on medium-term strategies for ### Medium-term fiscal framework and public investment - Anchor the medium-term fiscal framework on rolling 3-year growth rates for current expenditures. - Set the level of capital expenditures and overall budget balance consistent with a sustainable financing strategy that: - Makes prudent use of accumulated government assets and eventual borrowing; - Takes into account likely paths of foreign grants and donor-financed investment; and - Reflects overall macroeconomic conditions. - As implementation capacity for investment projects improves, encourage capital expenditures higher than the current surplus, so long as financing remains sustainable. ### Education: critical sectoral strategy and key indicators - Priority: give much higher priority to rebuilding the depleted stock of human capital; education achievements are very low in quantity and quality. - Enrollment and access: - Rate of enrollment in preschool is less than 20 percent, compared with a European average of 80 percent. - Rate of enrollment in primary and secondary schools may be less than 80 percent. - Rate of enrollment in tertiary education is about 16 percent, compared with a European average of 45 percent. - Operational constraints and quality: - Most schools operate two to three shifts a day, implying likely very poor quality of education. - Fiscal weight: - Share of education in total public spending (including donor sector spending) was only about 6 1/2 percent in 2003. - Data limitations: - Population statistics are very weak; no reliable population census since 1981 undermines gross enrollment rate precision. ### Illustrative medium-term fiscal scenario and 2005–06 measures (Table III.3) - Context: the scenario is illustrative and should be refined based on medium-term sector strategies and costing of investment needs. - 2005 policy measures and impacts: - Proposed pay-scale reform plus the full 1-year impact of the new disability pension raise the wage bill and cost of social programs by 15 and 13 percent respectively (2005), assuming a hiring freeze and leveling off of old-age pensioners. - A 2 percent cut in spending on goods and services and a 20 percent cut in transfers to POEs are proposed to contain nominal growth of current spending in 2005 at about 1 1/2 percent. - These measures should offset most revenue losses from the tariff reform and maintain the current budget surplus at about 3 1/2 percent of GDP in 2005. - In 2006, further cuts in subsidies to POEs could raise the current surplus to a level close to 4 percent of GDP. - Combined with some drawdown of government assets, these measures would allow significant volumes of investment to be financed from Kosovo’s own budgetary resources. - By end-2006, the government’s bank balances would have declined to slightly over 8100 million, close to the level that should be retained as a cushion for liquidity and risk management. - Consolidated Government Budget, Illustrative Scenario, 2002–06 (selected figures from Table III.3): - Revenues (In millions of euros): 2002: 500; 2003: 590; 2004 Budget: 619; 2004 Actual: 605; 2005 Illustrative: 616; 2006 Illustrative: 629. - Current expenditures (In millions of euros): 2002: 360; 2003: 449; 2004 Budget: 634; 2004 Actual: 534; 2005 Illustrative: 542; 2006 Illustrative: 546. - Current balance (In millions of euros): 2002: 139; 2003: 141; 2004 Budget: −15; 2004 Actual: 70; 2005 Illustrative: 75; 2006 Illustrative: 82. - Capital expenditures (In millions of euros): 2002: 42; 2003: 62; 2004 Budget: 74; 2004 Actual: 115; 2005 Illustrative: 150; 2006 Illustrative: 164. - Overall balance (In millions of euros): 2002: −9; 2003: 45; 2004 Budget: −28; 2004 Actual: −45; 2005 Illustrative: −75; 2006 Illustrative: −81. - Memorandum items (In millions of euros): Government’s bank balances: 2002: 26; 2003: 307; 2004 Budget: 19; 2004 Actual: 263; 2005 Illustrative: 187; 2006 Illustrative: 106. - GDP (In millions of euros): 2002: 1,735; 2003: 1,797; 2004 Budget: 1,895; 2004 Actual: 1,895; 2005 Illustrative: 1,999; 2006 Illustrative: 2,054. - Selected ratios (In percent of GDP): Revenues: 2002: 28.8; 2003: 32.8; 2004 Budget: 32.7; 2004 Actual: 31.9; 2005 Illustrative: 30.8; 2006 Illustrative: 30.6. - Current expenditures (In percent of GDP): 2002: 20.8; 2003: 25.0; 2004 Budget: 33.5; 2004 Actual: 28.2; 2005 Illustrative: 27.1; 2006 Illustrative: 26.6. - Current balance (In percent of GDP): 2002: 8.0; 2003: 7.8; 2004 Budget: −0.8; 2004 Actual: 3.7; 2005 Illustrative: 3.7; 2006 Illustrative: 4.0. - Capital expenditures (In percent of GDP): 2002: 2.4; 2003: 5.4; 2004 Budget: 4.1; 2004 Actual: 6.1; 2005 Illustrative: 7.5; 2006 Illustrative: 8.0. - Overall balance (In percent of GDP): 2002: −5.6; 2003: 2.5; 2004 Budget: −15.2; 2004 Actual: −2.4; 2005 Illustrative: −3.8; 2006 Illustrative: −4.0. ### Assessment of the performance of the tax system Findings - Kosovo rebuilt its tax system rapidly and exceeded initial revenue expectations. - Initial revenue projections (prepared in 2000) envisaged a gradual increase to about 14 percent of GDP by 2006; actual tax-to-GDP ratio reached 29 percent in 2003, with tax revenues of 8,520 million, more than doubling initial projections. - Reasons for overperformance: - Higher-than-envisaged excise rates (petroleum products 45–80 percent higher than envisaged; cigarettes five times higher). - Larger tax bases for VAT, excises, and customs duties due to larger domestic absorption as a share of GDP. - Corporate taxes yielded significant revenues despite expectations of depressed business profits. - Better tax enforcement and compliance—more border crossing points, antismuggling units, patrolling KFOR units, and larger, more experienced local tax administration staff. - Policy sequence and reforms: - August 1999: customs duties, sales tax, and excises on imports introduced. - 2000: excises extended to local production; hotel, food, and beverage tax; presumptive business tax introduced. - July 2001: sales tax on imported goods became a consumption-based VAT. - March 2002: wage withholding and profit taxes introduced. - June 7, 2004: 10 percent uniform import tariff lowered to zero for selected capital goods, raw materials, and intermediate goods. - September 2004: VAT law amended to zero-rate irrigation water and certain agricultural inputs. - Revenue dynamics: - Rapid growth in recorded imports (improved border controls) was the main driver of steep increases in tax revenues during 2001–02. - Phasing in domestic taxes increased the share of domestic tax revenues from 5 percent in 2000 to 18 percent by 2003. - Tax structure and comparators: - At 29 percent of GDP, Kosovo’s tax revenues (excluding social security contributions and payroll taxes) are comparable to EU-15 countries. - Kosovo relies more on expenditure-based taxes due to low yield of personal income taxes. - The share of corporate taxes in total revenues is in line with transition economies. - At 14 percent, the share of import duties is in line with other transition economies. - Close to 80 percent of taxes are collected at the border; only 17 percent of border taxes are genuine taxes on imported goods. - Kosovo’s VAT rate is the lowest in the region; individual income tax rates are among the lowest. - Employees’ and employers’ social security contributions are low. Shortcomings and vulnerabilities - Long delay in addressing high customs duty on capital and intermediate goods likely hurt export competitiveness and growth. - Wage tax exemptions for local UNMIK employees and local employees of specialized UN agencies: - Create distortions in the tax system and labor market. - Cause significant revenue losses (estimated to be in excess of 85 million annually). - May encourage tax evasion and divert labor to less productive uses. - Problems in the VAT refund system impose extra burdens on production and exports. - Structural vulnerabilities: - Economic activity is supported by foreign assistance (about 20 percent), which also contributes about 3 percentage points of GDP to tax revenues via taxes on implicit “exports” associated with the donor sector. - About 855 million, or more than 10 percent of total tax revenues, is attributed to local consumption of expatriates, KFOR soldiers, and donors’ local employees. - Large private inflows (supporting activity to the tune of 30 percent) raise domestic absorption; a decrease in domestic absorption of 15 percent of GDP would lower expenditure-based tax revenues by about 3 percent of GDP. - Risks: phasing out of peacekeeping forces, shrinking foreign assistance, or political pressure to lower rates or grant exemptions could materially reduce revenues. Recommendations for tax policy development - Ensure cost-effectiveness of further tax system development to avoid poor implementation that weakens compliance. - Strengthen capacities of tax and customs administrations to nurture a culture of tax compliance as donor-supported technical assistance diminishes. - Avoid overly frequent changes in the tax environment to limit administrative burden and compliance costs. ### Expenditure policy and civil service wage bill - Expenditure policy aim: ensure minimum coverage of basic public services; the budget remains formative. - Civil service wage bill: - Has increased rapidly over the past 3 years and is expected to reach 8175 million in 2004, 60 percent higher than in [text breaks here]. - Discussion areas: trends in budgetary expenditures on the civil service wage bill, social transfers, and subsidies and transfers; need for credible restructuring and closer monitoring of quasi-fiscal activities of POEs to sustain reductions in transfers. *Source: _gpgd - 2. Stepping up work on medium-term strategies for (IMF staff chapter).* ### 2001. This situation reflects both a rapid expansion in ### _gpgd - 2001. This situation reflects both a rapid expansion in ### Civil service employment and wage bill - Over the past 3 years, close to 15,000 new civil servants have been hired. - Wages for two-thirds of the civil service were raised by 20 percent in mid-2003, followed by a 33 percent increase in the minimum civil service salary in early 2004. - The wage bill currently absorbs about 9 1/2 percent of GDP. - As a share of government revenues, the wage bill is already almost 30 percent (the average in the EU countries is 23 percent). - The ratio of the wage bill to total general government spending is higher than in any of the comparator countries; this may indicate inefficiencies. - Civil service size indicators: - 3.6 civil servants for each 100 citizens (Kosovo, Table III.8). - Shares in total employment: about 17 percent. - Share in formal employment: more than 40 percent. - Table III.6 (selected figures): - General government wage bill (in millions of euros): 2001 = 110; 2002 = 131; 2003 = 146; 2004 Budget = 176. - Annual percentage change (wage bill): 2001 = 19; 2002 = 20; 2003 = 11; 2004 = 21. - Number of general government employees (avg.): 2001 = 59,367; 2002 = 63,139; 2003 = 67,452; 2004 = 74,095. - Annual percentage change (employees): 2001 = 6; 2002 = 7; 2003 = 10. - Average monthly gross wages (in euros): 2001 = 154; 2002 = 173; 2003 = 180; 2004 = 197. - Annual percentage change (avg. wages): 2001 = 13; 2002 = 4; 2003 = 10. - Relative comparisons (Table III.7, Wage Bill as a Share of GDP and other metrics): - Kosovo 2003: Wage Bill as a Share of GDP = 8.1; Wage Bill as a Share of Total Spending = 26.7; Wage Bill as a Share of Goods & Services = 83.9; Wage Bill as a Share of Revenue = 24.7. - Kosovo 2004 (budget assumption): Wage Bill as a Share of GDP = 9.5; Wage Bill as a Share of Total Spending = 28.0; Wage Bill as a Share of Goods & Services = 90.3; Wage Bill as a Share of Revenue = 29.3. - Euro area: Wage Bill as a Share of GDP = 10.6; Wage Bill as a Share of Total Spending = 21.8; Wage Bill as a Share of Goods & Services = 2.2; Wage Bill as a Share of Revenue = 23.0. - EU10: Wage Bill as a Share of GDP = 10.3; Wage Bill as a Share of Total Spending = 21.7; Wage Bill as a Share of Goods & Services = 25.1; Wage Bill as a Share of Revenue = 22.6. ### Fiscal sustainability and constraints - Indicators suggest the scope for further expansion of the civil service wage bill is being exhausted very rapidly. - The budget has yet to assume additional responsibilities as UNMIK’s activities are being phased out, and additional costs will be incurred through the soon-to-be-implemented pay-scale reform. - The growing size of the civil service relative to private sector employment leaves very little room for additional hiring to cover new areas of responsibility. - Recommendation: cover new areas by redeploying civil servants within and across sectors, supported by appropriate training. ### Proposed pay-scale reform and costs - The proposed new pay and grading system aims to: - Provide equal pay for equal work via consistent job grading and consistent rules for increasing individual pay. - Provide a clear basis for promotions and recognition of increased experience and performance at each job level. - Monetize most allowances, allowing rationalization and greater transparency. - Increase salaries in managerial categories to help attract and retain required skills. - Implementation guidance: - Preparatory work should be stepped up to allow uniform implementation as early as possible. - The new system should be phased in uniformly across all agencies once preparatory work is completed. - Wage increases should not be made retroactive. - Cost estimates and fiscal impact: - Estimated cost of the proposed pay-scale reform amounts to 1 percent of GDP. - This would raise the wage bill to 10 1/2 percent of GDP and to 32 percent of government revenues. - Wage dispersion (ratio of highest to lowest grades) would increase from 4.8 to 6.8. - The proposed meal allowance for all civil servants would raise the wage bill to close to 38 percent of government revenues and would undo most wage decompression. - Assessment: - Costs seem justified in light of reform benefits, but gains in wage dispersion are modest and competitiveness vis-à-vis private sector wages is unclear. - Uncertainty about future government revenues and resilience to withdrawal of donor assistance call for utmost prudence. ### Pensions and social assistance - The new three-pillar pension system balances long-term fiscal sustainability, minimum protection for today’s elderly, and higher pensions for tomorrow’s elderly without undue pressure on labor costs. - Recent introduction of a disability pension scheme complements social assistance to the poor; the social safety net now covers those needing income support. - Social safety net cost has reached 6 percent of GDP (assuming already decided policies are fully phased in). - Policy guidance: - Stabilize cost of social safety net by keeping benefits constant in real terms and enforcing eligibility criteria strictly. - Resist pressures to create unsustainable entitlements and general early retirement schemes; develop comprehensive solutions for labor redundancy in public sector enterprises. - Structure of the pension system (Box III.1): - Pillar I: basic old-age pension financed from general government revenues; flat pension for habitual residents aged 65 and older; level tied to price of a basic food basket; raised to 840 per month from 828 initially since mid-2002. - Pillar II: mandatory, fully funded, defined-contribution pension scheme; monthly payroll contributions by employees and employers each contribute 5 percent of total gross wages (each 5 percent mandatory contribution can be increased by voluntary contributions up to 15 percent of annual salary); managed by Kosovo Pension Savings Trust under BPK supervision; participation mandated for large employers in August 2002 and extended to all employers in August 2003; since August 2003 contributions also collected from self-employed. - Pillar III: voluntary supplemental system (defined-contribution or defined-benefit) financed by employees and employers; contributions transferred to private pension providers licensed and supervised by BPK; contributors eligible to start receiving benefits at age 65; currently six supplementary pension schemes, all except one are defined-benefit plans financed by the employer. - Main social assistance programs: - Social Assistance Program: benefits to families without resources where no one is capable of working (category 1), and to families with at least one child under age 5 where members capable of working are unemployed and meet additional criteria (category 2); introduced in 2000 and modified in August 2003. - War Invalid Benefits: introduced in December 2000 for war invalids and next of kin of those who died due to the armed conflict in Kosovo. - Disability Pension: provides benefits for total and permanent disability until recipient reaches old-age basic pension at age 65; level equal to old-age pension; law promulgated in December 2003, payment of benefits set to start in mid-2004. ### Subsidies to public enterprises (POEs) - Budget transfers to POEs are necessary at present but should be phased out as soon as feasible. - Lack of progress in restructuring POEs is reflected in large budget subsidies to loss-making POEs. - The 2004 budget provides subsidies for operating losses for electric monopoly KEK, mining conglomerate TREPCA, UNMIK Railways, and POEs in district heating, water, and waste sectors. - Subsidies to finance investment are provided to KEK, Trepca, and Airport. - Policy guidance: - Operational subsidies may be unavoidable in the near term but need to be phased out as part of POE restructuring. - Incorporating POEs and endowing them with stable and strong corporate governance is critical to improving financial performance and attracting private capital. - Use of budgetary resources by POEs must be made more transparent and monitored closely. - Loss-making enterprises must face hard budget constraints. - Greater transparency and accountability in subsidies would accelerate restructuring and reduce fiscal burden while improving budget process and relations between PISG and UNMIK. - Note: TREPCA is still identified as an SOE, subject to status determination by the Kosovo Trust Agency (KTA). ### Monetary developments and the financial sector - Postconflict challenges: choose a monetary framework, reestablish secure payment system, rebuild financial sector after confiscation/freezing of foreign exchange deposits in early 1990s and hyperinflation in 1993–94 (2 percent per hour at its peak). - UNMIK legitimized the use of the deutsche mark and other foreign currencies, leading to rapid euroization. - Three-pronged strategy adopted: - Use of the euro as a monetary framework anchor to maintain macroeconomic stability, rebuild trust, and support outward-oriented development. - Establish a Banking and Payments Authority (BPK) to foster efficient and safe payment system and develop a sound financial sector in a fully liberalized setting (no restrictions on interest rates, no compulsory or directed credit, no restrictions on movement of capital). BPK’s role expanded to include licensing, supervision, and regulation of all financial institutions. - Jump-start commercial banking through active policy intervention; first banks created by development agencies in January 2000 and November 2001; latter sold in early 2003 to a private foreign bank. Two banks dominate with assets equal to two-thirds of total banking assets. - Outcomes by end-2003: - Inflation decelerated sharply and is now below the euro area average after double-digit inflation in 2000. - Financial sector assets grew from virtually zero in early 2000 to 39 percent of GDP at end-2003. - Banking system represents over 80 percent of the sector, is profitable and appears to be healthy. - Banks are adequately capitalized, asset quality is good, earning indicators are strong, liquidity is ample, exposure to market risk is limited. - Box IV.1 highlights (financial sector soundness): - Total assets of financial institutions at end-2003: 7,694 million (approximately 39 percent of GDP), up from 7,108 million at end-2000. - Financial system includes seven commercial banks, eight insurance companies, six pension funds, and 17 microfinance institutions. - Average capital adequacy ratio in December 2003: 16.6 percent. - Minimum required amount of capital increased to 7.4 million at end-December 2003. - Nonperforming loans (NPLs) to total loans: 1.6 percent in December 2003 (down from 2.5 percent in December 2002). - Aggregate provisions against loan losses were almost twice reported NPLs. - Average return on assets at end-2003: 1.3 percent. - Average return on equity at end-2003: 18.7 percent. - Share of liquid assets in total banking assets as of December 2003: 58 percent. - Currency exposure: only 1 percent of total loans and less than 3 percent of total deposits denominated in foreign (other than euro) currencies. - Note: Fund has not performed formal prudential or supervisory assessments of Kosovar banking system; available data suggest system remains healthy and adequately capitalized. - Remaining concerns and weaknesses: - Financial intermediation perceived as lagging despite rapid deposit mobilization. - Less than half of deposits funded domestic credit; the rest invested abroad. - Domestic credit dominated by short-term trade loans; long-term lending to manufacturing negligible. - Loan interest rates around 14 percent; spreads about 12 percentage points. - Limited access to, and high cost of, bank financing cited as impediments to private sector development. - Trends in monetization and financial deepening: - Deposits grew at an average annual rate of 67 percent in euro terms during 2001–03. - Deposits reached an estimated level of about 32 percent of GDP (8,600 million) at end-July 2004. - Deposit growth still running at about 30 percent year-on-year as of end-July 2004. *Italic: Content derived from _gpgd - 2001. This situation reflects both a rapid expansion in* ### Appendix Table 26). ### _gpgd - Appendix Table 26) ### Broad liquidity, deposits, and cash changeover - Broad liquidity increased steadily at an average annual rate of 10 percent per annum during 2001–03. - The cash changeover to the euro (December 2001) and measures to encourage bank account use catalyzed a dramatic shift from cash to bank deposits: - Deposits more than doubled in the run-up to the cash changeover in December 2001. - Currency-to-deposit ratio may have been as high as 6 in 2000 and is estimated to have declined to about 1. - M2-to-GDP ratio: - Kosovo: 56 percent in 2003. - Transition countries average: 37 percent. - Emerging-market economies of Asia and Latin America average: 52 percent. - The cash changeover reinforced public trust in banks; about 97 percent of government employees receive salaries through bank accounts and government-sponsored basic pensions are paid into bank accounts. ### Financial intermediation and lending growth - Loans had reached 8328 million by end-July 2004, equivalent to 17 percent of GDP. - Loan growth rate was 90 percent year-on-year as of end-July 2004. - Despite rapid expansion from near zero at end-2000, loans-to-GDP ratio remained low: - Kosovo loans-to-GDP: 16 percent of GDP (noted as among the lowest in the world). - Average loans-to-GDP in emerging economies in Asia and Latin America: about 63 percent. - Developed countries: over 120 percent. - Microfinance: - About 50,000 bank loans and microfinance credits — equivalent to 25 loans for each 1,000 people. - Loans provided by 17 microfinance institutions add only 11 percent to the size of the market. - Banks initially accumulated foreign assets as deposits expanded; from 2003 some foreign asset holdings were repatriated to lend domestically. ### Reasons for relatively lagging financial deepening - Aggregate picture: - Monetary assets ~60 percent of GDP; only about half are bank deposits; only about half of these fund domestic loans. - Balance of payments and foreign asset accumulation: - Accumulation of banks’ foreign assets was a response to massive external inflows and a shift toward deposits; acted as sterilization of excessive inflows and built reserves. - Some deposit increases simply transferred cash from households to banking sector without changing consolidated net foreign asset position. - Savers’ behavior (preference for cash) explained by: - Size of the “gray” economy. - Less-than-full trust in the banking system and lingering sense of insecurity. - Low opportunity cost of holding cash due to fairly low returns on euro deposits. - Depositors value safety and security over return. - Banking system behavior and constraints: - Large banks accumulated net foreign assets instead of lending domestically early on. - Loan-to-deposit ratio variation (2001–03): - Average loan-to-deposit ratio: 44 percent. - Largest bank: 25 percent. - Other banks: about 60 percent. - BPK prudential guidance: loans not to exceed 65 percent of deposits. - Rationale: - Ensure credit expansion aligns with banks’ risk-management learning curve. - Allow gradual buildup of judicial capacity to enforce creditors’ rights. - Prudence because of absence of a lender of last resort, limited international market ties, absence of interbank market, and untested stability of short-term deposits. - A decline in currency-to-deposit ratio to 0.25 could generate additional loanable funds of 8234 million — equivalent to about 70 percent of outstanding domestic credit. ### Reasons for the high cost of financial intermediation - Loan interest rates and spreads: - Loan interest rates around 14 percent. - Deposit rates around 2 1/2–3 percent. - Decomposition of the 13 1/2 percent estimated cost of financial intermediation (Table IV.1): - Total cost (percent): Domestic Banks 13.5; Foreign Banks 13.5. - Due to: - Loan loss provisions: Domestic 4.5; Foreign 4.0. - Overhead expenditure: Domestic 7.0; Foreign 4.6. - Return on capital: Domestic 2.0; Foreign 4.9. - Drivers of these components: - Loan loss provisioning large (200 percent of NPLs on average), reflecting perceived macroeconomic and political risks. - High overhead costs (7 percentage points for domestic banks) due to high information costs in a small market, predominance of SMEs, absence of a collective credit information bureau, overstaffing, and overbranching in domestic banks. - Prudential capital and returns: - BPK requires minimum capital of 12 percent of risk-weighted assets. - Rates of return on equity demanded by banks range from 40 percent to 10 percent, with a system average of 20 percent. - Foreign banks' higher ex post returns on equity contribute about 5 percentage points to their overall cost of intermediation. - Market concentration: - Herfindahl index: 2.8 (an index higher than 1.8 is usually regarded as describing a highly concentrated market). ### Reasons for limited maturity transformation - Loan maturities (banking system as a whole): - 40 percent of loans have maturity shorter than 1 year. - 40 percent between 1 and 2 years. - Remainder over 2 years. - By bank type: - Domestic banks: 70 percent of loans up to 1 year; 3 percent over 2 years. - Foreign banks: 16 percent of loans up to 1 year; 50 percent over 2 years. - Liabilities: - Demand deposits represent about 55 percent of total. - Bulk of savings deposits have maturities of up to 1 year. - Factors limiting maturity transformation: - Short banking history (4 years) makes identification of “core deposits” difficult. - Political and economic uncertainty complicates ascertaining deposit stickiness. - Deposit concentration: 45 percent of deposits held by firms, with high concentration among a few large ones, increasing perceived volatility. - Absence of lender-of-last-resort facility and weak international links force prudence and constrain domestic banks’ ability to offer longer-maturity loans. * _gpgd - Appendix Table 26)._ ### Conclusions and Ways Forward ### Conclusions and Ways Forward ### Monetary framework and financial stability - The choice of a monetary framework anchored around the use of the euro has served Kosovo well. - Use of an external anchor imposed financial discipline—securing a low-inflation environment—and is likely to have played a major role in achieving a high level of monetization and a rapid expansion of financial assets. - The use of the euro deprives the economy of one stabilization policy. For long-term growth and development, the benefit from financial stability promoted by the use of a stable currency plus the benefit from trade facilitation with Europe are likely to outweigh the costs of having one less stabilization instrument. - To mitigate the loss from the absence of an independent monetary policy, Kosovo must preserve and further enhance the flexibility of the labor and goods markets. ### Banking sector performance and implications - High monetization and a healthy and stable banking system provide a solid foundation for further progress in financial intermediation. - Safeguarding soundness and stability will sustain robust growth in banking assets by strengthening incentives to move from cash to bank transactions. - Accumulation of foreign assets by the banking system in the past 4 years was largely a welcome response to large external inflows and the sharp drop in currency in circulation; through banks’ accumulation of foreign assets, the economy built up a valuable reserve to mitigate future negative shocks. - If the increase in bank deposits had been used to extend domestic credit, Kosovo’s current account deficit would have been larger, inflationary pressures stronger, and damages to Kosovo’s competitiveness greater. - Most perceived shortcomings in the financial sector reflect its short life span, limited institutional capacity, and limited business experience. - A faster expansion of domestic credit would have compromised loan portfolio quality given banks’ growing but still weak risk management capacity, accounting and corporate governance at enterprises, and judicial procedures for new laws. - A more aggressive push for maturity transformation would have been imprudent given untested stability of deposits, high overall uncertainty, absence of a lender of last resort, and lack of ties to international financial markets. ### Policy recommendations for the financial sector - Remain focused on maintaining a sound financial system and establishing a legal system conducive to a healthy credit culture. - The BPK’s perseverance in strengthening effective and proactive bank supervision will ensure the financial sector remains healthy and profitable. - Continue strengthening the legal environment to protect creditors’ rights and nurture a credit culture to support further growth in domestic lending and a decline in interest rates. - The recently launched credit information bureau should help reduce information costs and facilitate risk evaluation. - Strengthen the regulatory framework for external auditing and accounting standards. - If the largest bank increases lending activity, its greater efficiency could help bring down the cost of financing intermediation; authorities should be ready to encourage mergers among local banks that may be priced out of the market. - Enforce the anti–money laundering law to reinforce public trust in banks. ### Policy options to address political uncertainty and market failures - Kosovo’s unresolved political status creates negative externalities (credit and liquidity risks, constrained deposit base growth, complicated long-term investment decisions). Because banks cannot obtain institutional ratings and cannot borrow from outside, policy intervention could be justified. - Possible options to address this market failure: - Providing credit guarantees to local banks to access international capital markets or to mobilize additional domestic long-term funds to help lengthen maturities and promote development of long-term domestic savings instruments. - Providing a limited guarantee to banks’ mortgage loans to help jump-start mortgage lending and promote labor-intensive investment in housing. - Auctioning off to domestic banks medium-term loans from the government or from some donors, possibly tied to lending to small and medium-sized enterprises. - The BPK could explore obtaining a contingency credit line to provide short-term liquidity to banks if required and to help banks establish linkages with international capital markets, yielding efficiency gains through better liquidity management, exposure to foreign expertise, and market discipline through greater transparency. ### Structural reforms: overall assessment - Achievements in fiscal and financial management have been remarkable; progress in structural reforms has been more limited. - Specific observations: - Good progress in building legal framework for private sector development (mortgage, bankruptcy, immovable property rights registry laws) but capacity to enforce new legislation remains very weak; complex and nontransparent municipal regulations impose heavy costs on businesses. - Recent progress in tackling trade issues that had hindered exports: exports to the European Union (zero tariff) have been hurt by difficulties obtaining travel documents, car license plates, trademarks, and by high transit costs; exports to neighboring countries have been hurt by high tariff and nontariff barriers, including from partners with whom Kosovo had free trade agreements. Export competitiveness was further damaged by delay in finding a solution to the high import tariff and by a malfunctioning VAT rebate system. Policies to promote an export-friendly environment need to be pursued more actively. - Progress has stalled in the main areas of SOE privatization and POE restructuring. ### Privatization of SOEs: issues, timeline, and recommendations - A process of “commercialization” of SOEs started in late 2000 as an interim measure; over 70 SOEs were advertised, and 16 were leased. - A privatization strategy adapted to Kosovo’s circumstances was agreed in mid-2002, addressing employees’ rights, creditors’ rights, and use of SOE land: - A 20 percent fee levied on the sales price would be distributed to current workers who had worked for the enterprise for at least 3 years. - All privatization proceeds were to be held in trust until resolution of Kosovo’s final status. - Sale of transferable 99-year leases for use of SOE land was adopted where outright sale was legally impeded. - Implementation steps and dates: - Kosovo Trust Agency (KTA) established in June 2002 with mandate to supervise SOEs and POEs and to enhance value, viability, and governance. - KTA operating policies approved in February 2003. - Land use regulation allowing sale of transferable unencumbered 99-year leases promulgated in May 2003. - Privatization progress and setbacks: - First wave of tenders (seven SOEs) announced in mid-May 2003; second wave (another 20 SOEs) launched shortly thereafter. - Investors’ interest was encouraging in both rounds—with total winning bids amounting to 829 million—and the experience was generally regarded as a success. - Concerns about process integrity and bidder backgrounds led to cancellation of the third wave and suspension of privatization in October 2003 pending clarification of legal issues. - Privatization was resumed in July 2004 following changes to the KTA’s operating policies, but the nearly 1-year suspension was harmful; further delays should be avoided. - Recommendations: - Privatization on the basis of the already agreed upon strategy should proceed without further delays. - Because the bulk of SOEs are unlikely to attract buyers as ongoing concerns, liquidation should be made possible by extending the applicability of the land use regulation to liquidation cases. ### Restructuring of POEs: issues, developments, and fiscal risks - POEs are sole providers of public utilities and responsible for managing Kosovo’s main natural resources. The POE sector consists of the electricity monopoly, KEK; the main telecommunications company, PTK; UNMIK Railways; the airport; and a number of service providers in the water, waste, irrigation, and district heating sectors. In total, there are 55 POEs. - Years of neglect, disinvestment, and mismanagement have undermined POEs’ financial position, depriving the economy of reliable public utilities and draining public finances. - The agreed restructuring strategy called for turning POEs into commercially viable entities by improving operational efficiency and reducing financial losses, incorporating POEs, and establishing strong corporate governance to attract private capital via capital participation in subsidiaries. - Progress has been limited; specific sectoral outcomes: - Progress in restructuring airport facilities, enhancing profitability of the telecommunications company, and reorganizing the water sector. - Lack of improvements in energy and mining POEs (notably TREPCA and KEK) has entailed great economic costs and shut down sectors with strong comparative advantage and economic multipliers. - TREPCA’s unresolved social and environmental legacies have effectively shut down that main mining sector enterprise. - Faltering progress in restructuring KEK has deprived the economy of a reliable electricity supply—a major impediment to private sector development. - Employment and political constraints: - Main difficulty in restructuring POEs is reforming governance and dealing with quasi-fiscal activities rather than reducing excess employment. - Number of surplus employees in the POE sector (excluding TREPCA) is estimated at about 6,500, or about one-fourth of total employment. - Political setup and ethnic conflict have made POE restructuring unusually difficult; lack of PISG support and ethnic dimensions of social and labor policies have complicated consensus-building. - Fiscal implications and donor fatigue: - Lack of POE restructuring progress increases strain on budgetary resources as donors show signs of fatigue; donors have shouldered most costs of shoring up loss-making POEs since the conflict. - In the absence of external financing, increased demands on budgetary resources have arisen in the form of operational and capital subsidies. - Recommendations for budgetary support: - Any budgetary support or loan guarantees should be tied to steady implementation of sound and credible restructuring strategies. - As long as an enterprise is 100 percent publicly owned, loans to that enterprise are effectively direct borrowing by the budget; such risk should be undertaken only with adequate safeguards to ensure efficient use of borrowed resources. - Use of budgetary or donor resources requires greater transparency and closer monitoring to build and maintain stakeholders’ trust in the restructuring process. ### Focused problems: TREPCA (summary start) - TREPCA, a vertically integrated company engaged in mining and processing of lead and zinc, was once a large employer and important source of foreign exchange earnings. - In the early 1980s TREPCA’s financial health deteriorated due to inadequate investment, maintenance, and repairs; dismissal of most Albanian workers in 1990 led to further deterioration. - After the conflict, KFOR ordered closure of the smelter because pollution levels were deemed unacceptable; all production stopped. Since then, TREPCA has been administering a line in the KGB of some... *Conclusions and Ways Forward — content unit* ### 88.5 million per year, mainly to cover social welfare ### _gpgd - 88.5 million per year, mainly to cover social welfare ### Social welfare payments to TREPCA workers - Annual cost described as "88.5 million per year, mainly to cover social welfare payments." - Current social transfers characterized as: inefficient, onerous, inequitable, and a source of enduring social and ethnic tensions. - Inefficiency: some workers continue to receive salaries while they could be more productively employed. - Onerous fiscal burden: assuming no change in policy, the staff team estimates that the net present value (NPV) of the stream of budgetary outlays over the next 40 years would equal 894 million (5 percent of GDP). - Inequity across workers: - Existing policy effectively offers severance equivalents of 15 years’ salary to some workers, 3.2 years’ salary to others, and no payments to the remaining 5,000 former workers. - Under existing labor law, the cap on severance pay is equal to 5 months for 30 years of service or more. - Temporary early retirement scheme: - Introduced at beginning of 2004 for over 3,000 TREPCA miners. - Intended to last 6 months, extended for another 6 months due to delays in developing a comprehensive solution. - Objectives for a comprehensive solution: - Political feasibility. - Achievement of some fiscal savings given high uncertainty about the fiscal outlook and competing budgetary claims. - Restoration of equity among TREPCA workers to address social and ethnic tensions in the Mitrovica area. - Awareness of precedent for other POE labor redundancy programs. - Creation of incentives for redundant workers to seek jobs elsewhere; severance package should be complemented with redeployment assistance, including new training. - Table V.1 (summary data as of October 2003): - Total workers: 9,509; Total cost in thousands of euros: 6,062; Cost per worker: 93,709; Monthly payment in 2004: 9,855; Ratio to average annual wage: (not explicitly restated here). - Working: 2,448 workers; Total cost in thousands of euros: 1815; Cost per worker: 32079? (table columns preserved in original; full table in source). - Receiving stipend: 2,061 workers; Total cost in thousands of euros: 3074?; Cost per worker: 214,367? (table values as presented in original). - Not receiving any benefit: 5,000 workers; Total cost: 0; Cost per worker: 0; Ratio to average annual wage: 0.0. - (Note: data as of October 2003; sources: Kosovo authorities; and Fund staff estimates.) ### Problems at KEK (Kosovo Energy Corporation) - Historical role: a vertically integrated POE mining lignite to generate and distribute electricity within Kosovo. - Physical and operational deterioration due to inadequate maintenance, war damage during the 1990s, and three recent calamities (lightning damage, a power plant fire, a mine slide), eroding production capacity. - Despite 8500 million in grants for maintenance and repairs (equivalent to about 28 percent of Kosovo’s 2003 GDP), KEK unable to provide reliable electricity. - Businesses estimate power shortages and use of backup generators add 10 percent to their overall costs. - Commercial losses and uncollected bills undermine KEK’s finances: - In 2003, KEK lost about 43 percent of its generated electricity to technical and commercial losses (outright theft via illegal connections and indirect theft via meter tampering). - Of the remaining 57 percent of electricity that was billed, KEK collected only 72 percent. - Combined effect: 60 percent of total electricity distributed in 2003 was consumed for free (Table V.2). - Quasi-fiscal losses or implicit subsidies estimated at about 7 percent of GDP annually (Box V.1). - Causes differ from many transition countries: more than 80 percent of the losses are due to commercial losses and low bill collection rather than low tariffs. - An ill-conceived "social policy" (the "social case ruling" by UNMIK, September 2002) granted full debt write-off to social assistance beneficiaries and other disadvantaged people; many eligible customers did not pay bills even after expiration of special treatment period, believing it would be renewed. - Recommended actions and institutional responses: - Build UNMIK-PISG joint ownership of a sound and credible strategy to restructure KEK via the Working Group on Energy (with PISG and KTA representatives). - Enact a satisfactory law to curb theft and create specific enforcement mechanisms. - Design and implement a targeted social assistance system to provide lifeline support for the most vulnerable, either via direct budget subsidy or a very low tariff rate for a limited first tariff block. - Review taxation of petroleum products to encourage fuel switching and ensure affordable energy; excise rate for gas oil (LPG) could be lowered to zero with no direct revenue losses (virtually no imports), and excise on low-quality heating oil could be lowered to zero when chemical marker technology becomes available. - Develop a financing strategy combining budgetary resources, donor grants, and private capital participation to cover KEK’s large investment needs; commit financing package up front to ensure orderly investment spending. ### KEK operational and financial indicators (2003, Table V.2) - Total supply: 3,910 (gigawatt-hours). - Generation net: 3,263 (gigawatt-hours). - Imports: 647 (gigawatt-hours). - Total sales: 2,347 (gigawatt-hours). - Domestic sales: 2,058 (gigawatt-hours). - Exports: 289 (gigawatt-hours). - Losses: 1,563 (gigawatt-hours). - Losses as percent of net supply: 43.2 percent. - Billed electricity (in millions of euros): 102.2. - Bill collections (in millions of euros): 73.2. - Percent of billed electricity collected: 71.6 percent. - Paid electricity (in percent of net supply): 40.7 percent. - Source: KEK. ### Estimating quasi-fiscal losses at KEK (Box V.1) - Total quasi-fiscal losses estimated at 8121.8 million (7 percent of GDP). - Decomposition (2003 estimates): - Losses due to excess system losses: implicit subsidies due to commercial losses estimated at about 872.2 million. - Losses due to collection failure: given a collection rate of 71.6 percent in 2003, collection losses estimated at 829 million, based on an average end-user tariff of 80.05 per kilowatt-hour. - Losses due to tariffs set below recovery levels: based on a World Bank estimate of recovery cost tariffs of 80.06 per kilowatt-hour, losses related to this factor estimated about 820.6 million. - Methodology: follows World Bank approach to analyze quasi-fiscal losses in public power companies. ### Data and measurement issues - Appendix purpose: explain main gaps in data and difficulty assessing macroeconomic developments since the end of the conflict; explain data sources used to compile national accounts and balance of payments estimates for 2003. - Margin of error for 2003 estimates narrower due to improved data quality and range, notably commercial imports. - Available data sources and limitations: - Fairly accurate and consistent fiscal sector data from the Ministry of Finance and Economy (MFE) for past 3 years. - Less accurate but broadly comparable data on donor assistance assembled recently, covering: UNMIK budget (wages of expatriates and local employees, purchases of goods and services); public investment program (PIP) and donor-designated grants (DDGs) (wages of expatriates and local employees, purchases of goods and services); budget support grants; humanitarian assistance to households. - Margin of error in estimating foreign aid manageable, but larger uncertainty in estimating its impact on GDP and GNDI due to weak data on share of spending that falls into domestic goods and hiring of local labor. - Consistent monetary statistics compiled by the Banking and Payments Authority of Kosovo (BPK) since end-1999, providing reliable estimates on changes in net foreign asset position of the banking system. - Kosovo uses the euro; changeover to the euro in early 2002 provided a unique opportunity to establish a point estimate of euros in circulation (details continued in source). *Italicized source attribution: IMF staff report content as provided in the source PDF.* ### Appendix I. National Income Accounts ### Appendix I. National Income Accounts and Balance of Payments Estimates ### Main gaps in the data and difficulty in assessing macroeconomic developments - Currency changeover effects: - Large buildup of bank deposits prior to the changeover (late 2001) and official data on net exports of cash by the banking system during 2002 suggest a sharp decline in currency in circulation and a structural shift toward bank deposits. - Much of the decline in currency in circulation took place in the last few weeks of 2001; a modest increase occurred when euro notes and coins were put into circulation in early 2002. - Balance of payments estimates smooth abrupt swings and show the bulk of the reduction in currency in circulation taking place during 2002. - Given persistent net exports of cash through the banking system and offsetting informal inflows, cash export/import data via banks cannot alone yield a reasonable estimate of currency in circulation. - Balance of payments estimates assume growth of broad money equal to the growth rate of GNDI; currency in circulation is derived as a residual. Robust growth in bank deposits during 2003 implied a moderate decline in euro cash in circulation. - Private sector data limitations: - Data regarding private sector activities are scant; no data sources have tracked main aggregates through time. - Estimates of private consumption in 2002 and 2003 are based on the Household Budget Survey (HBS) 2002/03 (June 2002–May 2003), the first HBS run by the Statistical Office of Kosovo (SOK). - The World Bank Living Standards Measurement Survey (2000) is not comparable to the HBS (design, timing, survey tools, sampling, aggregation); making them comparable would require extensive reaggregation and adjustments, which have not been performed. - Estimates for 2001 are tentative and based on the weak assumption that private sector consumption in real terms remained flat in 2002 compared with 2001. - Population uncertainty: - Last reliable population census dates to 1981; large migration before, during, and after the conflict. - Current population size and its evolution over the past 3 years are known within a margin of 15 percent, with some researchers quoting up to 25 percent. - National accounts are based on a consensus estimate of the population of 1.9 million in 2003, with an average household size estimated at 61⁄2 people. - Civil register data: Economic Policy Department of the Ministry of Finance and Economy (MFE) estimated population above age 16 is 1,234,500. Using averages of proportions yields a population estimate of 1,948,000. - Private investment and remittances: - No systematic surveys of private investment; current estimates are extremely preliminary and subject to sizable revisions. - Prior to 2002 there were no reliable data on workers’ remittances; 2002 and 2003 estimates were derived from the 2002/03 HBS. Appendix II discusses margins of error. - Private sector imports and customs recording: - Private sector imports are the main source of errors in compiling national accounts and balance of payments. - In initial post-conflict years a large share of imports went unrecorded as customs administration developed; recorded imports in 2003 (81,042 million) suggest most imports are now captured. - Given commercial imports are equivalent to about 54 percent of GDP, uncertainty in import levels in prior years heavily impacts GDP growth estimates: if imports in 2001 were 10 percentage points higher or lower than currently estimated, GDP growth in 2001 would be lowered or increased by 71⁄2 percentage points, with a similar impact in 2002. ### Estimates of GDP and the Balance of Payments in 2003 Private Sector Consumption and Investment - Private consumption: - Based on SOK’s 2002/03 HBS with three adjustments: 1. Imputed rent adjusted downward by 25 percent; imputed rent share of total consumption declined from 24 percent to 18 percent. 2. Added estimated monthly expenditure of 820 per household to reflect durable goods spending not reported in HBS. 3. Adjusted households’ spending for unpaid electricity consumption using KEK data, assuming households’ debt amounted to 70 percent of the unpaid balance. - To derive separate estimates for 2002 and 2003 from the 2002/03 HBS, assumed real per capita consumption constant between 2002 and 2003. - Nominal aggregate household consumption for 2002 and 2003 reflects average CPI inflation rate in 2003, SOK’s estimated population growth rate of 1.7, and constant average household size equal to 61⁄2 people. - Private investment: - Extremely tentative; no surveys properly quantify the aggregate. - 2003 estimate based on imports of construction materials and other investment goods adjusted for labor costs and taxes. - Assumed share of local materials in private investment below 15 percent (anecdotal evidence). - Private investment in 2003 amounted to 17 percent of GDP. Table AI.1 — Private Sector Consumption (selected figures; in euros, unless otherwise indicated) - 2002/03 HBS Monthly Consumption Per Household - Total Unadjusted: 490 - Total Adjusted: 488 - Monthly Total Consumption (in millions of euros): 1,682 (2002), 1,728 (2003) - Selected components (per household monthly, and totals where shown): - Food purchased: 176; totals 607 (2002), 623 (2003) - Tobacco: 18; totals 61, 63 - Nonfood: 72; totals 248, 255 - Health: 7; totals 24, 25 - Communications: 31; totals 110, 108 - Recreation and culture: 44; totals 151, 6 - Education services: 33; totals 101, 11 - Restaurants and hotels: 33; totals 99 - Miscellaneous goods and services: 1,814; adjusted total 495, 1 - Consumer durables: 2,070; total 72 - Food produced at home or fetched: 535; totals 318, 418, 9 - Imputed rent: 115; totals 872, 983, 07 - Memorandum items: - Population (in thousands): 1,900 - Average size of household: 6.5 - Notes: - Miscellaneous goods and services adjusted for unpaid electricity consumption using KEK data and assuming 70 percent debt of unpaid balance. - Consumer durables were missing from HBS household spending estimates and were added. - Imputed housing rent from HBS adjusted down because hypothetical rents of house owners exceed those paid by renters by about one-third. The Government Sector - Government consumption: - Estimated at 8,322 million on a cash basis (budget outturn 2003). - For simplicity and lack of detailed data, government consumption on an accrual basis was not adjusted for. - Government investment: - Estimated government investment spending amounted to 896 million in 2003. - Figures include part of public enterprise investment expenditure financed directly from the budget. The Donor Sector - UNMIK spending (2003): - Total estimated UNMIK spending: 8,356 million. - 8,258 million was wages of about 6,220 man-year equivalent expatriates; local spending by expatriates estimated at 840 million (that is, 8542 per month). - 850 million was wages paid to about 4,357 full-time-equivalent local employees. - 849 million was spending on goods and services, of which 814 million estimated to be imported goods. - PIP (Donor Coordination Sector reported spending in 2003): - Total reported spending: 8,275 million. - 8,106 million for reconstruction and rehabilitation - 82 million for the supply of equipment - 1,113 million for training and technical assistance - 820 million for other expenditures - 85 million for participation in commercial banks’ capital - DDGs amounted to 829 million. - Assumptions: equipment plus 75 percent of reconstruction/rehabilitation and other expenditures (total 896 million) counted as spending on goods and services, of which 828 million was on imported goods. - Assumed import content of DDG spending equal to 94 percent of total. - Wages of expatriates (897 million) assumed to account for two-thirds of the PIP wage bill of 1,145 million; balance 848 million wages paid to local employees. - Expatriates assumed to spend one-quarter of their salaries locally (824 million), of which two-thirds was spent on domestically produced goods and services (818 million). - Aggregation and treatment in accounts: - Added to public consumption: total wage bill of 8,478 million (8,355 million for expatriates) and 8,123 million of UNMIK’s and KFOR’s spending on goods and services. - PIP component of spending on goods and services (including DDGs) — 8,126 million — treated as investment spending and added to total investment. - Wages of expatriates (8,355 million) and imports of goods and services by donors — total 899 million (855 million for PIP including DDGs, 814 million for UNMIK, 830 million for KFOR) — were added to imports as an offsetting item. KFOR Spending (estimates and assumptions) - No official KFOR spending data; staff relied on scanty press release information. - Press release (2003) indicated KFOR procured 875 million in goods and services locally and paid 825 million in wages to local employees (6,000 employees at an hourly wage of 82). - Staff estimated KFOR’s 19,000 soldiers stationed in Kosovo spend about 842 million in local consumption outside barracks (86 per day per soldier), of which 824 million goes for locally produced goods (83.5 per day per soldier). - No information on import content of locally procured goods and services by KFOR; assumed share of imports declined from 80 percent in 2001 to 40 percent in 2003 due to recovery and improved domestic sourcing. - Estimated value of imported goods and services used by KFOR: 830 million in 2003. - Assumed KFOR imports fully reflected in commercial imports, along with soldiers’ consumption of imported goods. - Using estimates of UNMIK, PIP, and KFOR budgets: - Public consumption additions and import offsets detailed above (wage bills, spending on goods and services, PIP investment treatment, donor imports). Net Exports - Merchandise exports: - Based on customs data: 836 million in 2003 (up from 827 million in 2002 and 823 million in 2001). - Sales to the expatriate nonresident community estimated at 8150 million. - Tourism receipts (mainly expatriate-related) assumed equal to one-quarter of the local consumption of the expatriate community. - Assumed no unrecorded exports from 2003 onward due to improved customs data. - Private imports and other import components: - Private imports based on BRICO data in 2003. - c.i.f. value of imports in 2003 estimated at 8,968 million. - Assumed no smuggling from 2003 onward as customs data capture vast bulk of imports. - Total imports include pharmaceuticals (820 million) and electricity (823 million). - Donor-related imports (added to imports as offsetting items): total 899 million (855 million PIP including DDGs, 814 million UNMIK, 830 million KFOR). - Staff working assumption: difference between donors’ imports (899 million) and BRICO-reported donor imports (825 million) — 874 million — treated as imports through commercial channels and reflected in commercial imports. Remittances and pensions - Estimated using HBS data and domestic pension payments in 2003: - Total remittances and pensions receipts from abroad: 8,241 million in 2003. - Remittances reported in HBS: 8,174 million - Pensions from Serbia: 835 million - Other pensions from abroad: 832 million - Remittances estimate based on HBS monthly transfer of 849 per household; reflects remittances of 8295 per month to 16.6 percent of households and no remittances for remaining households. - Merchandise exports (customs): 836 million (2003) - Commercial imports (BRICO, c.i.f.): 8,968 million (2003) - Pharmaceuticals imports: 820 million - Electricity imports: 823 million - Remittances and pensions receipts from abroad: 8,241 million (2003) *Source: Appendix I. National Income Accounts and Balance of Payments Estimates (from the supplied content).* ### Appendix II. Estimating Workers’ Remittances ### Appendix II. Estimating Workers’ Remittances ### HBS estimate and likely underestimation - HBS (2002/03 Household Budget Survey, Statistical Office of Kosovo) reported remittances from abroad during the 12-month period June 2002–May 2003 amounted to 8174 million. - Reported monthly average per household: 849. - Reported monthly remittances to 16 1⁄2percent of the households: 8295. - Interpretation in text: about 50,000 households received on average slightly over 83,500 during the year; the rest of households received no remittances. - Survey-based underestimation issues highlighted: - Infrequent/irregular income sources (typical of remittances) are prone to underreporting. - Visits by relatives bringing cash may not be fully captured. - Households may underreport to avoid attention to finances or conceal transfers from relatives abroad without documentation. - Nonreporting (not declaring receipt at all) is identified as likely the primary downward bias rather than mere underreporting of amounts. - Table AII.1 (SOK HBS summary, as reported): - Share of households (in percent): Not Receiving Remittances 83.4; Receiving Remittances 16.6; Total/Average 100 - Total income (in euros per month per household): Not Receiving 300; Receiving 433; Total/Average 322 - Of which: Remittances from abroad (in euros per month per household): Not Receiving 0; Receiving 295; Total/Average 174 - Number of households: Not Receiving 247,929; Receiving 49,348; Total/Average 297,277 - Total yearly remittances (in millions of euros): Not Receiving 0; Receiving 174; Total/Average 174 ### Migration history and estimates of Kosovars abroad - Historical context: - Peak about 1973: an estimated 1.1 million Yugoslavs working abroad (12 percent of the labor force). - 1981 data: total Yugoslav workers abroad about 770 thousand (8 percent of labor force); Kosovo migrant workers increased from 22,000 in 1973 to 26,600 in 1981. - Late 1980s: total Yugoslav migrant workers estimated at 650,000 in 1988; Kosovo diverged with more than 50,000 people emigrating from Kosovo between 1981 and 1987. - 1990s breakup: latest available data for 11 Western European countries indicate 3.3 million foreign population from former SFRY; about 60 percent from Serbia, Montenegro, and Kosovo. Foreign data do not identify Kosovo separately. - Staff population-based estimates (reported): - Using 1981 census 15 percent share would yield an estimate of 291,000 Kosovars abroad; however, a larger share is likely. - Starting from 1981 population census and assuming natural growth rates (2 percent for Albanians, 1.2 percent for the rest) and using SOK resident population estimates for 2002 yields an estimate of total Kosovars living abroad of about 470,000, of which about 220,000 are Kosovar Albanians (Table AII.2). - Table AII.2 (Estimates of Kosovar Living Abroad, In thousands, as reported): - 1981 / 2003 (staff projection) / 2003 (staff estimate) - Total population: 1,611 / 2,400 - Albanians: 1,241 / 1,918 - Residents (Albanians): 1,220 / 1,700 / 1,700 - Living abroad (Albanians): 20 / 217 - Others: 371 / 482 - Residents (Others): 364 / 232 / 232 - Living abroad (Others): 6 / 250 - SOK 2003 survey reported: - 170 thousand Kosovars reported by families in Kosovo as being usually absent from Kosovo. - Close to 80,000 of these “absentees” were working-age males and 35,000 were working-age females. ### Estimating number of remitters and average remittance amounts - Conjectured number of emigrants sending remittances: on the order of 100,000 (roughly the working-age males reported plus 50 percent of working-age females). - Text notes uncertainties: some working-age males may be unemployed or students and unable/unwilling to remit; some of assumed 50 percent of females abroad may not remit; others abroad not reported by families may remit occasionally. - Plausibility of average remittance size: - HBS-reported average amounts: about 83,500 (annual per recipient, as used in text). - This represents about 13 percent of a worker’s annual salary in Germany (contextual comparison; average annual earnings of all employees in Germany in 2003 cited as 826,700). - Comparative evidence: Latino workers in the United States send about 15 percent of their income on average. - Western Union reported its typical clients transfer an annual amount of about 85,000 on average; clients likely to be among richer remitters, so not fully representative. - Conservative adjustment for underreporting: - In absence of precise quantification of underreporting, a conservative estimate of 5 percent underreporting is suggested for illustration. - Staff conservative illustrative estimate of true remittances (conclusion/conjecture): - Real figure might be on the order of 8370 million, corresponding to about 100,000 workers abroad remitting an average annual amount of 83,700. ### Analysis and implications (from text) - HBS remittance totals are likely significantly underestimated because of survey nonresponse/nonreporting and the special characteristics of remittance flows. - Combining demographic evidence, SOK surveys, and remittance service provider data supports a materially higher estimate of remittance inflows than HBS totals alone. - Given uncertainty and lack of precise quantification, the staff presents a conservative scenario (100,000 remitters × average annual remittance 83,700 = 8370 million) as a plausible magnitude for workers’ remittances to Kosovo. *Source: Appendix II. Estimating Workers’ Remittances (from the provided IMF content unit).* ### 1. Pharmaceutical products2. Medical and surgical instruments and apparatus3. Milk4. Cooking oil and fats5. Vegetables6. ### _gpgd - 1. Pharmaceutical products2. Medical and surgical instruments and apparatus3. Milk4. Cooking oil and fats5. Vegetables6. ### Tax structure, exemptions, and specific rates - Goods exempted (for humanitarian purposes and not to be offered for sale in Kosovo): 1. Pharmaceutical products 2. Medical and surgical instruments and apparatus 3. Milk 4. Cooking oil and fats 5. Vegetables 6. Fruits 7. Wheat flour. - Goods funded from the proceeds of grants made to UNMIK in support of humanitarian and reconstruction programs/projects: exemption determined by Director-General of the UNMIK Customs Service. - Exempted entities: - Foreign diplomatic and consular missions. - UNMIK, UN agencies, KFOR, etc., on goods used for official purposes. - UN contractors: same as VAT. - Registered NGO: same as VAT. - No credit for input tax. - Sales tax/collection rules: - 15% of c.i.f. value + duty/excise payable. [For goods produced in Kosovo, collection of sales tax is suspended] - 10% of gross receipts of hotel, food, and beverage providers. - 10,000 DM/month (15,000 DM/month before 23 May 2000). ### Profit tax and presumptive tax (UNMIK regulations) - Regulation No.: UNMIK/2002/3 (Profit Tax), UNMIK/2000/29 (Presumptive Tax). - Effective date: 20 February 2002 (applicable to taxable profit from 1 April 2002) for Profit Tax; 20 May 2000 (applicable from 1 July 2000) for Presumptive Tax. - Taxpayers: - “Business organizations” covers companies (joint stock and limited liability), public and socially owned enterprises. - Business organization required to prepare financial statements in accordance with REG/2001/30. - Business organization that opts to prepare financial statements in accordance with REG/2001/30. - PE of a nonresident person. - Registered NGOs. - Key rules and rates: - Taxpayers of profit tax are not liable for presumptive tax. - Profit Tax rate: 20% of taxable profit (9/12 of annual taxable profit for 2002). Insurance company: 7% of gross premiums. - Tax period: Calendar year. Due by 1 April of the year following the tax period. - Quarterly installments: based on estimated taxable profit or on the taxable profit for the preceding year (same due dates as presumptive tax). - Exempt incomes include: - Incomes exclusively used for the public benefit purposes by a registered NGO with public benefit status. - Dividends received by a resident taxpayer from a resident company that paid Kosovo profit tax. - Income from a contractor, other than a local contractor, generated from contracts for the supply of goods and services to UNMIK, UN agencies, and IAEA. - Income of the Banking and Payments Authority of Kosovo. - Depreciation: - Category 1 (Buildings and other construction structures): Segregated asset account, 5% declining-balance depreciation. - Category 2 (Automobiles, computers, office furniture/equipment, etc.): Pooled account, 20% declining-balance depreciation. - Category 3 (Plant and machinery, heavy transport vehicles, etc.): Pooled account, 15% declining-balance depreciation. - *Expenditure less than 1,000 euro on asset in category 2 or 3 = current expense. - Amortization of leasehold improvements: straight-line depreciation over the length of the lease. - Amortization of intangible assets: straight-line depreciation for the useful life. - Carry forward up to 5 years. - Transfer pricing: ALP = CUP or resale price/cost-plus method. - Foreign tax credit: up to the amount of tax that would be paid under Kosovo profit tax. - Withholding: 15% withholding tax on dividends, interest, or royalties to nonresidents (subject to pre-1999 Yugoslavia Double Tax Agreements). ### Presumptive tax and flat tax categories - Presumptive Tax rules: - The tax is 3 percent of gross sales over 87,500 per quarter, plus a standard amount for the first 87,500 per quarter. - Profit tax (corporate income tax) planned to replace presumptive tax in comprehensive reform; presumptive tax would be eliminated as a stand-alone tax. - Flat tax (small taxpayers and location-based standard amounts): - Small taxpayers: gross receipts in all previous calendar quarters < 7,500 euro -> flat tax. - Large taxpayers: flat tax + 3% × (quarterly gross receipts − 7,500 euro). - Flat tax (euro/quarter) by location: - A (Pristina): Businesses/Professionals 200; Entertainment 200; Transport 125; Artisans 37.5. - B (Prizren, Gjilan, Peje, Gjakova, and Ferizaj): Businesses/Professionals 150; Entertainment 150; Transport 100; Artisans 37.5. - C (Elsewhere): Businesses/Professionals 100; Entertainment 100; Transport 75; Artisans 37.5. - Insurance company presumptive: 10% of gross premiums. Calendar quarter; payments 15 days after the end of each calendar quarter. ### Wage-withholding tax / Personal income tax (Regulations) - Regulations: REG/2003/3 (Effective 1 January 2003) and REG/2002/4 (Effective 1 March 2002, applicable from 1 April 2002). - 2003 and after (Tax period = Calendar year) brackets and rates: - Taxable income < 960 euro: 0%. - 960 euro < taxable income < 3,000 euro: 5%. - 3,000 euro < taxable income < 5,400 euro: 10%. - > 5,400 euro: 20%. - 2002 (9 months: April–December) brackets: - < 600 euro ×9/12: 0%. - 600 euro ×9/12 < <3,000 euro ×9/12: 5%. - > 3,000 euro ×9/12 < 10%. - Deduction: Mandatory contributions by employees to funded pension schemes approved by the competent government authority. - Excluded income (wage exemptions): detailed list including foreign diplomatic and consular representatives; foreign representatives, officials, and employees of international governmental organizations and international NGOs with public benefit status; foreign representatives, officials, and employees of donor agencies or their contractors or grantees carrying out humanitarian aid, reconstruction work, civil administration, or technical assistance within Kosovo; foreign and locally recruited officials of UNMIK, UN agencies, IAEA; foreign personnel of KFOR. - Withholding: Each employer responsible for withholding tax from gross wage income (after pension contribution deduction) each payroll period. - Declaration: Taxpayers requiring adjustment must submit tax declaration by 1 April of the year following the tax period. - Wage tax historical phasing: - Initial March 2002 regulation: 0 percent for monthly wages below 850, marginal 10 percent for wages between 850 and 8250, marginal 20 percent for wages above 8250; rates halved during first 9 months (until end-2002). - Early 2003 adjustment agreed with visiting IMF mission: 0 percent for monthly wages below 880; 5 percent for wages between 880 and 8250; 10 percent for wages between 8250 and 8450; 20 percent for wages above 8450. - Policy rationale included preserving horizontal equity, sending signal of contribution as incomes rise, increasing progressivity to improve compliance, and manageable revenue loss. ### VAT, thresholds, and VAT treatment - 6 months’ deferment for payment of VAT on imported capital goods. - Taxable persons with turnover greater than 850,000 are subject to VAT and can get an input tax credit for the VAT paid on imports or domestic purchases. - Taxable persons below the threshold can elect to be VAT filers. - Taxable persons with turnover greater than 850,000 (threshold preserved as stated). ### Main macroeconomic indicators, 2001–05 (selected) - Real growth rates (in percent): GDP 2001 1.2; 2002 3.1; 2003 3.2; 2004 1.7 (Proj.); 2005 (Proj.) — note table lists years with values: GDP . . .1.2 3.1 3.2 1.7. - Contribution of foreign assistance to GDP growth: −3.9, −3.3, −1.7, −1.2. - GNDI: −0.2, 1.1, 1.8, 0.8. - Price changes (in percent): CPI 11.7, 3.6, 1.0, 1.5, 2.0 (2001–05). - GDP deflator changes: 1.6, 5.5, 0.5, 2.2, 3.7. - General government budget (in percent of GDP): Revenues 19.8, 28.8, 32.8, 31.9, 30.8; Expenditures 15.1, 23.2, 30.3, 34.3, 34.6; Capital 1.3, 2.4, 5.4, 6.1, 7.5. - Domestic savings (in percent of GDP) full-economy: −63.1, −51.5, −47.5, −40.7, −32.2. - Investment (in percent of GDP): 40.7, 34.5, 29.3, 27.8, 28.8. - Current account balance (before foreign assistance & remittances): −103.7, −86.0, −76.8, −68.5, −61.0 (in percent of GDP). - Workers’ remittances and donor local employees’ wages: 24.8, 22.5, 20.2, 18.5, 17.1 (in percent of GDP). - Foreign assistance (in percent of GDP): 70.4, 52.0, 40.7, 32.9, 25.9. - Current account balance (after foreign assistance): −8.6, −11.6, −15.8, −17.1, −18.0 (in percent of GDP). - Main aggregates (in millions of euros): GDP 2001 1,625; 2002 1,735; 2003 1,797; 2004 proj 1,895; 2005 proj 1,999. GDP per capita (in euros): 870, 913, 930, 964, 1,000. - GNDI per capita (in euros): 1,086, 1,119, 1,118, 1,143, 1,171. - Workers’ remittances (millions euros): 217, 241, 241, 244, 244. - Foreign assistance (millions euros): 1,144, 902, 732, 624, 518. - Population (in thousands): 1,868, 1,900, 1,932, 1,965, 1,999. ### GDP composition, growth contributions and projections (selected) - GDP (real) growth and components 2002–05 (in percent): GDP 2002 1.2; 2003 3.1; 2004 3.2; 2005 1.7 (proj). - Contributions to GDP growth (selected): - Private consumption contributions: −1.3, 1.6, 0.9, 1.6. - Government consumption contributions: 3.8, 3.6, 1.5, −1.0. - Private investment contributions: −1.9, −4.2, 0.1, 0.2. - Foreign assistance contribution: −3.9, −3.3, −1.7, −1.2. - GDP at current prices (in millions of euros) 2001–05: Consumption 2,651; 2,630; 2,651; 2,666; 2,643. GDP 1,625; 1,735; 1,797; 1,895; 1,999. - Net exports of GNFS (in millions): −1,686; −1,493; −1,379; −1,299; −1,220. - Exports (millions): 269; 217; 186; 190; 185. - Imports (millions): 1,955; 1,710; 1,565; 1,488; 1,405. ### Savings/investment balances and current account (selected) - Savings/investment balances of domestic sector (in percent of GDP): Domestic savings −34.6, −29.6, −28.2, −24.5, −20.7; Investment 25.6, 24.1, 22.3, 22.8, 24.5. - Current account balance (before foreign assistance & remittances) (in percent of GDP): −60.1, −53.7, −50.4, −47.3, −45.2 (analytical presentation). - Donors’ contribution to GDP (in percent of GDP): 23.1, 18.1, 14.1, 11.7, 10.1. ### Balance of payments and foreign assistance details - Balance of Payments 2001–05 (in millions of euros): - Goods and services balance: −1,686; −1,493; −1,379; −1,299; −1,220. - Current account balance (before foreign assistance): −1,284; −1,103; −1,015; −948; −878 (in millions). - Foreign assistance: 1,144; 902; 732; 624; 518 (in millions). - Current account (after foreign assistance): −140; −201; −284; −324; −360 (in millions) and −8.6, −11.6, −15.8, −17.1, −18.0 (in percent of GDP). - Foreign assistance composition (2000–05, in millions of euros): - Total foreign assistance: 1,271; 1,175; 912; 737; 628; 523 (2000–05). - Foreign assistance excluding capital participation: 1,229; 1,144; 902; 732; 624; 518. - UNMIK, PIP, and KFOR components and wages detail provided (e.g., Wages 601; expatriates 416; local employees 185 for 2000). - Number of expatriates (selected years): 58,155; 54,745; 41,319; 26,773; 22,069; 17,577 (2000–05). - Number of local employees in donor sector (selected years): 19,946; 20,136; 17,022; 14,540; 12,998; 12,197 (2000–05). - Budgetary support 121; 41; 18; 0; 0; 0 (2000–05). - Humanitarian assistance to households: 36; 18; 9; 5; 0; 0 (2000–05). ### Fiscal accounts and government budget (selected) - Consolidated Government Budget (Excluding donor designated grants; in percent of GDP) 2000–04: - Total revenues: 12.1; 19.8; 28.8; 32.8; 32.7; 32.7; 31.9 (table includes indicative staff proj). - Taxes: 11.4; 17.5; 25.6; 29.0; 28.1; 28.1; 27.6. - Border taxes: 10.8; 15.0; 21.0; 23.6; 22.9; 22.9; 22.0. - Nontax revenues: 0.7; 2.2; 3.2; 3.8; 4.5; 4.5; 4.3. - Total expenditure: 19.2; 15.1; 23.2; 30.3; 33.4; 47.9; 34.3. - Current expenditure: 17.6; 13.8; 20.8; 25.0; 26.5; 33.5; 28.2. - Capital expenditure: 1.6; 1.3; 2.4; 5.4; 6.9; 14.5; 6.1. - Current balance: −5.5; 5.9; 8.0; 7.8; 6.2; −0.8; 3.7. - Overall balance: −7.1; 4.7; 5.6; 2.5; −0.7; −15.2; −2.4. - Budgetary support grants: 11.3; 2.5; 0.6; 0.0; 0.0; 0.0; 0.0. - Overall balance after budgetary support: 4.3; 7.2; 6.2; 2.5; −0.7; −15.2; −2.4. - Consolidated Government Budget in levels (millions of euros) 2000–04 included with comparable figures (Total revenues 128.5; 321.3; 499.6; 589.6; 619.3; 619.3; 604.6 etc.). ### Growth projections and financing strategy (medium-term) - Baseline medium-term growth scenario, 2003–13 (selected): - GDP at market prices (constant 2003 prices, in millions of euros): 2003 1,797; 2004 1,899; 2005 2,004; 2006 2,114; 2007 2,229; 2008 2,350; 2009 2,474; 2010 2,606; 2011 2,742; 2012 2,885; 2013 3,033. - Number of employees (in thousands): 415; 428; 441; 454; 467; 481; 496; 511; 526; 542; 558. - Growth of employment, in percent: 3.0 for each year 2003–13 listed. - Average wage per month, in euros: 155 for each year 2003–13 listed. - Capital stock (in millions): 4,004; 4,184; 4,372; 4,569; 4,775; 4,989; 5,214; 5,449; 5,694; 5,950; 6,218. - Gross return on capital (in millions): 563; 589; 615; 643; 672; 702; 734; 767; 801; 837; 875. - Investment in percent of GDP (mem.): 20.0; 19.8; 19.6; 19.5; 19.3; 19.2; 19.0; 18.9; 18.8; 18.8; 18.6. - Financing strategy for baseline growth (2003–13, in percent of GDP): - Current account balance −50.4; −48.6; −46.9; −45.1; −43.3; −41.5; −39.7; −37.9; −36.1; −34.3; −32.5. - Regular exports: 2.0; 3.8; 5.6; 7.4; 9.2; 11.0; 12.8; 14.6; 16.4; 18.2; 20.0. - Imports: 52.5 for each year shown. - Investment: 22.3; 25.0; 24.8; 24.6; 24.5; 24.3; 24.2; 24.0; 23.9; 23.8; 23.6. - Donor net: 20.9; 15.0; 14.4; 13.7; 13.1; 12.5; 11.8; 11.2; 10.5; 9.9; 9.2. - Private inflows: 29.5; 28.4; 27.2; 26.1; 24.9; 23.8; 22.6; 21.5; 20.3; 19.2; 18.0. - Drawdown on net foreign assets: 2.5 each year. - Borrowing: 2.8 each year. - Memorandum (millions, constant 2003): Current account balance (excl. aid and private transfers) −907; −924; −939; −953; −964; −974; −981; −986; −989; −988; −985. ### Employment, labor, and social indicators - Illustrative estimation of total employment (three scenarios): - Total labor remuneration (in millions of euros): 894 in each scenario. - Number of full-time employee equivalents: Scenario 1 464,758; Scenario 2 436,325; Scenario 3 415,309. - Average wage (in euros/month) overall: Scenario 1 160; Scenario 2 171; Scenario 3 179. - Subsistence agriculture full-time equivalent employees: 125,078; avg wage 124 euro/month. - Informal sector full-time employee equivalents: 189,554; 161,121; 140,105 (scenarios). - Informal sector, percent of total employment: 56; 52; 48 (scenarios). - Medium-term employment projections, 2003–13 (selected): - Total population 16–64 (in thousands): 1,227; 1,247; 1,268; 1,290; 1,312; 1,334; 1,357; 1,380; 1,403; 1,427; 1,451. - Employed (in thousands): 415; 428; 441; 454; 467; 481; 496; 511; 526; 542; 558. - Unemployed: 179 for most years; slight change to 180/181 in some years. - Participation rate increases by 0.5 each year; unemployment rate declines from 30.1 to 24.4 over 2003–13 in projections. ### Financial sector and monetary statistics - Financial system structure (Dec. 2003): Total financial system assets (EUR m) 2,440.0; total percent 100; commercial banks assets 2,254? (table indicates breakdowns with percent totals). - Financial soundness indicators for banking sector (Dec. 2000–Dec. 2003, in percent): - Regulatory capital to risk-weighted assets: 23.0; 32.1; 22.0; 16.6. - Capital (net worth) to assets: 6.0; 6.3; 5.9; 6.2. - Nonperforming Loans (NPLs) to gross loans: 0.0; 0.6; 2.5; 1.6. - Provisions to NPLs: 0.0; 49.3; 118.2; 199.1. - Return on assets: 1.7; 1.4; 0.6; 1.3. - Return on equity: 28.7; 22.3; 9.7; 18.7. - Liquid assets to total assets: 94.0; 91.1; 75.0; 57.6. - Loans (non-interbank) to total deposits: 3.5; 10.0; 22.4; 44.4. - Monetary survey (2000–2004, in millions of euros): - Net foreign assets: 122.6; 583.3; 649.5; 697.0; 687.1 (Dec. 2000–Dec. 2003, Jul. 2004). - Bank deposits (staff estimate): 106.2; 486.8; 413.6; 501.2; 599.5. - Loans to the private sector: 3.1; 25.9; 86.5; 232.8; 327.9. - Staff estimate of cash in circulation: 637.2; 668.0; 536.3; 512.1; 512.1. - Staff estimate of broad money (M2): 743.4; 906.3; 949.9; 1,013.3; 1,111.6. ### Revenue effects of foreign assistance and illustrative fiscal impacts - Estimated contribution of foreign assistance to tax revenues (illustrative, 2003): - Total taxes related to foreign assistance: 54.9 (millions of euros). - Wage taxes paid by local employees: 1.4. - Expenditure-based taxes on personal consumption: 46.0 (local employees of donors 22.0; local consumption by expatriates 15.0; local consumption by KFOR soldiers 9.1; other donor-related tax revenues 7.4). - Donor spending on goods and services: 4.9. - Donor-financed investment: 2.5. - Memorandum: Total tax revenues 521; share of tax revenues related to foreign assistance (in percent) 10.5. - Illustrative calculation of declining domestic absorption and tax revenue (based on 2003): - Domestic absorption estimate 2003 2,450; illustration decline to 2,156. - Domestic absorption = tax base (percent of GDP) 136; 120. - Effective expenditure-based tax rate on domestic absorption (percent) 16; 16. - Total tax revenues 521; less taxes derived from foreign assistance 55; less direct taxes 62; equals expenditure-based taxes from domestic absorption 404; illustration 355 => total revenue impact −103 (millions), apportioned: foreign assistance −55; lower domestic absorption −48. - Total revenue impact (percent of GDP) −6; foreign assistance −3; lower domestic absorption −3. - Memorandum: Taxes without foreign assistance and assuming domestic absorption of 120 percent of GDP (percent of GDP) 23. *Source: IMF staff estimates and UNMIK regulations and administrative directions as presented in the source PDF.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/kosovo/2005/_gpgd.pdf_