## _cr12122

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---

### Context and recent developments
- Boom-bust legacy:
  - Three years after the sudden end of the boom, output has almost regained its pre-crisis level; bank deposits are recovering but deleveraging challenges remain and public debt has continued to build.
  - Without an exchange-rate and monetary-policy tool, fiscal policy bore the burden of preventing overheating during the pre-2008 inflow-driven boom; subsequent government dis-saving partly offset private deleveraging but at the cost of rapidly accumulating public debt and persistent external imbalances.
- Political and EU context:
  - Elections expected in late summer or early fall; European Commission expected to initiate membership negotiations later in the summer.
- Growth and near-term outlook:
  - Staff project growth of only 0.2 percent in 2012 after some 2½ percent in 2011.
  - Authorities' macroframework included 0.5 percent GDP growth in 2012 and they perceived significant upside if eurozone conditions improve.
- Short-term shocks in early 2012:
  - Tourism-led external demand boost from 2011 waning; early 2012 electricity shortfall due to severe cold spell required imports and added short-term drag.

### Fiscal developments — deficits, composition, and contingent liabilities
- Deficits and debt dynamics:
  - Deficits averaged 4.8 percent of GDP during 2008-11 and consistently overshot initial targets.
  - Public debt more than doubled in nominal terms; public debt (end of period) series: 31.9 (2008); 40.7 (2009); 42.4 (2010); 46.9 (2011 Prel.); 50.2 (2012 Proj.).
- Revenue and expenditure composition:
  - Revenue: 48.4 (2008); 42.6 (2009); 41.3 (2010); 37.9 (2011 Prel.); 38.0 (2012 Proj.).
  - Taxes: 30.0; 26.7; 24.4; 24.2; 24.8 (2008–2012 series).
  - Social security contributions: 9.5; 9.0; 11.2; 9.4; 9.6 (2008–2012).
  - Expenditure and net lending (accrual basis): 51.5 (2008); 47.9 (2009); 46.0 (2010); 44.2 (2011 Prel.); 43.2 (2012 Proj.).
  - Capital expenditures compressed: 10.1 (2008) → 3.6 (2012 Proj.).
  - Social security transfers rose: 11.4 (2008) → 14.3 (2012 Proj.).
- Arrears and guarantees:
  - Expenditure arrears averaged 1¾ percent of GDP between 2008 and 2011; estimated 1¼ percent of GDP accrued in 2011.
  - Loan guarantee to steel plant in 2010 was called in 2011, adding 1 percent of GDP to the deficit.
  - €132 million (4 percent of GDP) in loan guarantees to KAP are at risk of being called.
  - Stock of public guarantees shown as 5.0 (2007), 11.3 (2008), 11.7 (2009); series incomplete in table.

### Key fiscal indicators (selected, percent of GDP)
- Overall balance (accrual basis): -3.1 (2008); -5.3 (2009); -4.7 (2010); -6.3 (2011 Prel.); -5.2 (2012 Proj.).
- Social security financing gap: -1.8 (2008); -4.8 (2009); -2.4 (2010); -4.5 (2011); -4.8 (2012).

### Financial sector — deleveraging, asset quality, and liquidity
- Balance sheet and deposit developments:
  - Banks downsized since 2008; deposits remain more than one-fifth off their August 2008 peak.
  - Banks’ foreign liabilities fell to 27 percent of total funding at end-February 2012, lowest since end-2007.
- Credit and NPLs:
  - Banks’ assets declined by 20 percent from peak; credit to the non-financial private sector contracted by one-third.
  - Average loan-to-deposits ratio returned to end-2007 levels at 112 percent in February 2012.
  - Nonperforming loans fell from a high of 26 percent of gross loans in June 2011 to 16 percent at end-2011.
  - Provisioning remains insufficient; system as a whole continued to be loss making despite improved profitability in 2011.
- Prudential and supervisory actions:
  - CBCG plans to phase out temporary regulatory relaxations and adopt a permanent framework in line with international best practice.
  - Intensified supervisory presence, upgraded stress testing, and enforcement of capital requirements recommended; bank owners must meet capital shortfalls expeditiously or face sanctions.
  - Offloading of troubled assets to factoring companies and parent banks requires tight monitoring to guard against asset stripping.
  - Continued liquidity monitoring; staff recommended general reductions in reserve requirements once confidence and stability improve.
  - Progress on legal framework and creation of Financial Stability Council; further contingency planning and resolution framework work ongoing.

### Structural reforms, labor market, and enterprise sector
- Labor market indicators and reforms:
  - Unemployment rate remains at 18 percent (close to 20 percent in some tables); low labor force participation and growing long-term unemployment (over 60 percent of the unemployed are without a job for more than two years).
  - 2010 reform liberalized “fixed-term” contracts; 2011 amendments reduced availability of fixed-term contracts and may risk depressing new hiring.
  - Policy recommendations: reduce hiring and firing costs, provide greater scope to opt out from collective bargaining, reform social protection to remove disincentives to work, consider Earned Income Tax Credit.
- Enterprise sector and metals:
  - Steel and aluminum enterprises drained public finances via unpaid taxes, transfers, and guarantees.
  - Steel company declared insolvent in 2011; aluminum company (KAP) re-nationalized in early 2012.
  - KAP accounted for 41 percent of value of goods exported by Montenegro in 2011; staff estimate: without subsidies, KAP would have made a €21.9 million loss in 2011, or 0.7 percent of GDP.
  - KAP employment now accounts for 0.8 percent of total employment.
  - Estimated direct GDP impact of closing KAP: expenditure approach -1.3 percent; production approach -1.9 percent.
  - BOP impact of closing KAP: Export -5.7 (percent of GDP); Import -3.9; Trade deficit -1.8.
  - Staff recommended ending all fiscal and quasi-fiscal support to metals sector; a second-best option would be a dedicated new tax to cover plants’ losses rather than deficit financing.

### External competitiveness, tourism, and external balances
- Tourism:
  - Tourism competitiveness ranking improved substantially; growth of international tourist arrivals outpaced regional and world averages in past four years; tourism receipts accounted for close to one-fifth of GDP in 2012 (Annex II, Risk Matrix).
- External imbalances and FDI:
  - Current account balance: -39.5 (2007); -50.6 (2008); -29.6 (2009); -24.6 (2010); -19.4 (2011); -19.7 (2012).
  - Foreign direct investment (net, percent of GDP): 21.2 (2007); 18.9 (2008); 35.8 (2009); 17.8 (2010); 11.9 (2011); 11.4 (2012).
  - Staff view: sustainable medium-term growth requires attracting large-scale FDI; cautioned some recent FDI is backward looking (e.g., bank recapitalization).

### Debt sustainability — public and external debt projections (baseline)
- Public sector debt (percent of GDP), baseline:
  - 2007 27.5; 2008 31.9; 2009 40.7; 2010 42.4; 2011 46.9; 2012 50.2; 2013 52.1; 2014 53.2; 2015 54.8; 2016 56.7; 2017 58.6.
  - Debt-stabilizing primary balance: 1.0 (percent of GDP).
- External debt (percent of GDP), baseline:
  - 2007 74.1; 2008 90.8; 2009 93.5; 2010 96.4; 2011 99.9; 2012 107.3; 2013 114.5; 2014 120.7; 2015 126.5; 2016 133.3; 2017 140.4.
  - Debt-stabilizing non-interest current account (long-run constant): -15.4.
- Gross external financing need (percent of GDP): 48.6 (2007); 60.3 (2008); 44.6 (2009); 37.0 (2010); 29.7 (2011); 30.7 (2012); 31.0 (2013); 31.1 (2014); 34.6 (2015); 33.5 (2016); 37.6 (2017).
- Stress test highlights (external debt as percent of GDP):
  - Interest rate shock: baseline 140; shock up to 143.
  - Non-interest current account shock: baseline 140; shock up to 176.
  - Combined shock: baseline 140; shock up to 166.
  - Real depreciation (one-time 30 percent in 2010) combined result up to 206.

### Macroeconomic projections (selected series, current policies baseline)
- Real GDP (percent change): 2007 10.7; 2008 6.9; 2009 -5.7; 2010 2.5; 2011 2.5; 2012 0.2; 2013 1.5; 2014 2.0; 2015 2.0; 2016 2.0.
- Nominal GDP (millions of €): 2007 2,680; 2008 3,086; 2009 2,981; 2010 3,104; 2011 3,260; 2012 3,334; 2013 3,449; 2014 3,601; 2015 3,753; 2016 3,899.
- Gross national saving (percent of GDP): 2007 -5.1; 2008 -10.0; 2009 -3.1; 2010 -2.6; 2011 -1.2; 2012 -0.6; 2013 -0.4; 2014 0.0; 2015 1.1; 2016 1.8.
- Gross investment (percent of GDP): 2007 33.8; 2008 40.7; 2009 27.1; 2010 22.8; 2011 19.4; 2012 20.3; 2013 20.9; 2014 21.2; 2015 21.7; 2016 22.2.

### Risks and risk assessment
- Staff view: risks skewed to the downside; baseline uses current WEO forecast for modest euro area downturn.
- Risk matrix (Annex II) key entries:
  - Spillovers from an intensified eurozone crisis: Overall Level of Concern Medium; Likelihood High; Expected impact High.
  - Loss of confidence in banking system triggering deposit outflows: Overall Level of Concern Medium; Likelihood High; Expected impact High.
  - Additional contingent liabilities materialize (including KAP guarantees): Overall Level of Concern High; Likelihood High; Expected impact High.
  - Montenegro loses access to capital markets: Overall Level of Concern Medium; Likelihood High; Expected impact High (2016 Eurobond trading at a spread of roughly 800 basis points noted).
- Sensitivities: projections sensitive to tourism, foreign investment, parent-bank restructuring, commodity developments, depositor confidence shocks, and exhaustion of deposits.

### Policy recommendations (staff and Executive Directors)
- Fiscal policy:
  - Urgent substantial reduction in the fiscal financing requirement; identify and implement high-quality structural deficit reducing measures to reverse debt dynamics quickly.
  - More sizable fiscal adjustment should come from expenditure cuts: reduce personnel spending (personnel spending about 12 percent of GDP) and entitlement growth; advance pension reform.
  - End fiscal and quasi-fiscal support to metals sector; avoid deficit financing of support; alternatively impose a dedicated tax to cover plants’ losses rather than general deficit financing.
  - Scope to raise tax rates (VAT and income tax) exists but only after strengthening tax administration and with flanking measures (for example an Earned Income Tax Credit) to protect employment and poverty outcomes; consider property taxation improvements.
- Financial sector:
  - Strengthen supervision and regulatory enforcement; require bank owners to meet capital shortfalls expeditiously or face sanctions.
  - Improve asset quality, provisioning, collateral execution frameworks, and contingency planning; maintain high prudential buffers given unilateral euro use.
  - Avoid administrative measures to force lending or selective reserve requirement relaxations.
- Structural and labor reforms:
  - Make regular contracts more attractive; reduce hiring and firing costs; allow greater opt-outs from collective bargaining; reform social transfers to reduce unemployment traps.
  - Improve business environment at municipal level (construction permits, registration); streamline investment procedures; maintain arm’s length relations with business to attract FDI.
  - Restructure metals sector through liquidations/work-outs and sell viable parts; use fiscal space to realize efficiency gains.
- Statistics and data:
  - Improve national accounts, balance of payments, and high-frequency indicators; progress on quarterly national accounts and external statistics; address export underreporting and data timeliness.

*Source: MONTENEGRO 2012 ARTICLE IV REPORT, INTERNATIONAL MONETARY FUND (selected excerpts provided in content unit _cr12122).*

### 1. Selected Economic Indicators, 2007–16 _______________________________________________________  25

### _cr12122 - 1. Selected Economic Indicators, 2007–16

### Context: The boom-bust cycle and remaining challenges
- Three years after the sudden end of Montenegro’s boom, output has almost regained its pre-crisis level and bank deposits are recovering, but deleveraging challenges remain and public debt has continued to build.
- Policy limits: Without an exchange-rate and monetary-policy tool, fiscal policy bore the burden of preventing overheating during the pre-2008 inflow-driven boom; subsequent government dis-saving partly offset private deleveraging but at the cost of rapidly accumulating public debt and persistent external imbalances.
- Political calendar: Elections expected in late summer or early fall; progress on EU accession noted with the European Commission expected to initiate membership negotiations later in the summer.

### Background and recent developments — Further adjustment still needed
- Recovery at risk:
  - Staff project growth of only 0.2 percent in 2012 after some 2½ percent in 2011.
  - The 2011 tourism-led external demand boost is waning; early 2012 electricity shortfall due to a severe cold spell required imports and added short-term drag.
  - Household demand and investment remain weak; bank credit continues to decline.
- Banking and credit flows:
  - Three larger foreign-owned banks curtailed new lending to repair balance sheets; the largest domestic bank has only recently resumed lending.
  - Policy buffers that supported growth over the last two years are depleting; government is drawing down deposits in banks, aggravating the liquidity squeeze.
- Public sector support and fiscal consequences:
  - Public sector actions offset private-sector repair and increased vulnerabilities: public debt increased some 15 percent of GDP, assets sold of 11 percent, issuing guarantees of 8 percent (some 1 percent of which have already been called).

### Fiscal developments — A fast rise in public debt
- Deficits and debt:
  - Deficits averaged 4.8 percent of GDP during 2008-11 and consistently overshot initial targets.
  - Public debt more than doubled in nominal terms.
- Revenue and expenditure composition:
  - Revenue collections dropped some 10 percent of GDP in two broad episodes; untimely cuts to personal income tax and social contributions compounded the drop.
  - Subsequent increases in excises and social contributions stabilized the revenue share, but 2011 again saw a sharp drop in social contributions and nontax revenues.
  - Most spending cuts came from capital expenditures; social security expenditures increased by more than 2½ percent of GDP.
- Arrears and contingent liabilities:
  - Expenditure arrears averaged 1¾ percent of GDP between 2008 and 2011; measures in 2010 slowed accumulation but still an estimated 1¼ percent of GDP were accrued in 2011.
  - A loan guarantee extended to the steel plant in 2010 was called in 2011, adding 1 percent of GDP to the deficit.
  - An additional €132 million (4 percent of GDP) in loan guarantees to the aluminum plant (KAP) are at risk of being called.
  - Sizeable below-the-line repayments to non-banks implied additional market debt accumulation of 1¾ percent of GDP per year on average.

- Key fiscal indicators (Percent of GDP, 2008–2012; Prel./Proj. for 2011/2012):
  - Revenue: 48.4 (2008); 42.6 (2009); 41.3 (2010); 37.9 (2011 Prel.); 38.0 (2012 Proj.)
  - taxes: 30.0; 26.7; 24.4; 24.2; 24.8
  - social security contributions: 9.5; 9.0; 11.2; 9.4; 9.6
  - other: 8.9; 6.9; 5.7; 4.3; 3.6
  - Expenditure and net lending 1/: 51.5; 47.9; 46.0; 44.2; 43.2
  - current expenditures: 22.1; 21.1; 21.3; 20.8; 22.2
  - social security transfers: 11.4; 13.9; 13.6; 14.0; 14.3
  - capital expenditures: 10.1; 8.4; 5.3; 4.1; 3.6
  - other: 8.0; 4.5; 5.7; 5.3; 3.1
  - Overall balance 1/: -3.1; -5.3; -4.7; -6.3; -5.2
  - Memorandum items:
    - Public debt (end of period): 31.9; 40.7; 42.4; 46.9; 50.2
    - foreign: 15.6; 23.5; 29.4; 32.6; 36.2
    - domestic: 16.3; 17.2; 13.0; 14.2; 14.0
    - Stock of public guarantees: -5.0; 11.3; 11.7; -
    - Social security financing gap: -1.8; -4.8; -2.4; -4.5; -4.8
  - 1/ On accrual basis

### Financial sector — Rapid deleveraging and gradual repair
- Deposit and asset dynamics:
  - Banks have downsized balance sheets since 2008 in response to sharp declines in domestic deposits; deposits remain more than one-fifth off their August 2008 peak.
  - Banks’ foreign liabilities fell to 27 percent of total funding at end-February 2012, their lowest level since the end of 2007.
- Credit, NPLs, and provisioning:
  - Banks’ assets declined by 20 percent from peak; credit to the non-financial private sector contracted by one-third.
  - Average loan-to-deposits ratio returned to end-2007 levels at 112 percent in February (2012).
  - Nonperforming loans fell from a high of 26 percent of gross loans in June 2011 to 16 percent at end-2011.
  - Provisioning remains insufficient; the banking system as a whole continued to be loss making despite improved profitability in 2011.
- Lending outlook: Debt overhang, asset quality concerns, and parent-bank stress have curtailed new lending.

### Structural reforms and labor market
- Reform momentum slowed compared with the immediate post-independence period.
- Enterprise sector strains:
  - Steel and aluminum enterprises, privatized before 2008, remained a drain on public finances through unpaid taxes, transfers, and guarantees.
  - In 2011 the steel company was declared insolvent; in early 2012 the aluminum company was re-nationalized, with recourse by previous private owners.
- Labor market indicators:
  - Unemployment rate remains at 18 percent, with low labor force participation and a growing share of long-term unemployed.
  - The 2010 reform liberalized “fixed-term” contracts and triggered duality; 2011 labor law amendments reduced availability of fixed-term contracts and may risk depressing new hiring.
- Product market weaknesses: High administrative barriers to business entry, regulated energy prices affecting electricity producer performance, and high airport fees that may deter low-cost carriers.

### Report on the discussions — Outlook, risks, and policy implications
- Growth and FDI:
  - Staff and authorities agreed sustainable medium-term growth requires attracting large-scale FDI; authorities noted FDI inflows still amount to more than 10 percent of GDP but staff cautioned some recent FDI is backward looking (e.g., bank recapitalization).
- Competitiveness:
  - Traditional competitiveness analysis is uncertain in Montenegro due to small size and weak statistics; staff consider competitiveness somewhat compromised given poor labor market and export performance.
- Risks:
  - Staff view risks as skewed to the downside. Baseline uses current WEO forecast for a modest euro area downturn; projections sensitive to tourism and foreign investment.
  - A pronounced eurozone deterioration, parent-bank restructuring, commodity developments, depositor confidence shocks, or exhaustion of deposits could sharply worsen the outlook.
  - Authorities' macroframework included 0.5 percent GDP growth in 2012 and they perceived significant upside if eurozone conditions improve.
- Staff policy recommendations (summarized):
  - Recalibrate policies: tighter fiscal policy, accelerated structural reform, and policies to facilitate orderly banking sector deleveraging to attract and catalyze stronger inflows.
  - Immediate priority: substantial reduction in the fiscal financing requirement while invigorating labor markets.

*Source: MONTENEGRO 2012 ARTICLE IV REPORT, INTERNATIONAL MONETARY FUND (selected excerpts).*

### 2011. On the other hand, its share of imports peaked in 2008

### _cr12122 - 2011. On the other hand, its share of imports peaked in 2008

### External competitiveness and tourism
- Tourism has contributed to increased external competitiveness.
- The tourism competitiveness ranking has improved substantially owing to a better regulatory framework and infrastructure.
- Growth of international tourist arrivals into Montenegro has on average outpaced the growth rates seen at the regional and world levels in the past four years.
- Given its importance in the Montenegrin economy, it is essential that the tourism sector continues to make gains.

### Fiscal policy: recent developments and stance
- Headline deficit deteriorated in 2011, but some tightening of the fiscal stance occurred.
- Authorities argued GFSM accounting overstated fiscal effort by recording guarantees when called; they preferred retroactive inclusion in the year guarantees were extended. Fund staff did not agree with departing from GFSM accounting.
- Staff view on called-up loan guarantees:
  - Staff agreed that the payment of called-up loan guarantees in 2011 did not constitute a demand boost that year, but rather in 2010 when the guarantees were extended and largely used to finance the metal firms’ redundancy payments and arrears clearance.
- No consensus on the extent to which the recently accelerating revenue shortfall reflected automatic stabilizers:
  - Arguments that shortfall may be structural:
    - Imbalances in the economy—especially still large absorption—inflated the tax base for indirect taxes beyond its structural and sustainable level, such that lower VAT collections may still be a structural rather than cyclical phenomenon.
    - Tax administration problems became apparent in the recently consolidated collection of income taxes and contributions, as the latter dropped far more than the former, despite being levied on largely the same tax base.
  - Arguments that shortfall may be cyclical:
    - The liquidity squeeze was arguably affecting taxpayers’ ability to pay, though there were no firm data on the evolution of tax arrears.

- Underlying fiscal risks and targets:
  - Staff noted the underlying deficit remained too high and that revenue and expenditure trends in the first part of 2012 resulted in considerable slippage from the budget plan.
  - The uncertain situation surrounding KAP posed substantial risks that new contingent claims would materialize.
  - Authorities aimed at significant fiscal consolidation, targeting a deficit of 1.2 percent of GDP in 2012 and achieving balance in 2013; staff considered these targets quite ambitious and likely to be missed.
  - Staff recommended urgent identification and implementation of high-quality structural deficit reducing measures to reverse debt dynamics quickly.

- Fiscal composition and reform priorities:
  - Consensus that revenue share remained at a comparatively high level, while expenditure stood at the top end of emerging Europe.
  - Personnel spending at some 12 percent of GDP is very large; authorities adopted a Personnel Policy paper, resulting in a 2 percent staff cut and recent agreement with public sector unions to contain wage increases in 2012 and beyond. Staff cautioned the complex triggers in the agreement carry risks and recommended further staff cuts as a more lasting solution.
  - Pension reform needed to bring down the large pension deficit; recent reform reduces longer-term aging costs but is not scheduled to be fully implemented until 2025 for men and 2040 for women.
  - Social protection reform needed to better target the neediest and remove impediments to labor market participation.
  - End fiscal and quasi-fiscal support to the metals sector; authorities intended to pursue a strict policy limiting loan guarantees. Staff recommended ending all fiscal and quasi-fiscal support; a second-best option would be raising new revenue through a dedicated new tax to cover plants’ losses—deficit financing of support should be eschewed.
  - Scope to raise tax rates:
    - VAT and income tax rates are below levels in the region; the tax wedge on labor is also below regional levels.
    - Limited rate increases could be considered; flanking increases with measures to reduce poverty traps (for example introducing an Earned Income Tax Credit) would support formal employment and tax collection.
    - Considerable scope to increase revenue from property taxation via higher rates, better valuation, and improved cadastre.
    - Care in raising indirect taxes to avoid heightening costs in the tourism sector.
  - Expenditure controls: some progress on expenditure commitment controls, but deep-seated problems remain.

- Comparative fiscal statistic (2010):
  - General Government Expenses (2010, % of GDP)
    - Montenegro 45.9
    - Emerging Europe, flexible exchange rate 39.8
    - Emerging Europe, fixed exchange rate 39.9
    - Advanced Europe, non-Euro 45.4
    - Advanced Europe, Euro 48.7

### Box 2 — Kombinat Aluminijuma Podgorica (KAP)
- KAP is the aluminum smelter in Montenegro; operated by Central European Aluminum Company (CEAC) until recently.
- CEAC acquired a majority share in KAP in 2005 when the plant was privatized. In 2010, the government retook half of CEAC’s stake in exchange for loan guarantees.
- KAP accounted for 41 percent of the value of goods exported by Montenegro in 2011.
- Operational and fiscal situation:
  - The plant suffers from significant operational inefficiencies and is neither competitive nor profitable without large investments in technology upgrades.
  - Operations sustained only with government-issued loan guarantees and energy subsidies that are an increasing drain on public finances.
  - Despite favorable aluminum prices in 2011, KAP ran large payment arrears on electricity bills; as the largest energy consumer, mounting receivables threaten the viability of the electricity producer.
  - Staff estimates: without subsidies, KAP would have made a €21.9 million loss in 2011, or 0.7 percent of GDP.
  - With €132 million of its €350 million debt covered by state guarantees, KAP is currently the biggest and most imminent fiscal risk.
- Macroeconomic impact and employment:
  - Net impact on the balance of payments is mitigated by imported inputs (electricity and alumina).
  - KAP has substantially reduced its workforce and now accounts for only 0.8 percent of total employment.
  - Direct impact on GDP from closing KAP due to decreased exports is estimated at 1.3 percent (expenditure approach); a similar estimate of 1.9 percent obtained using the production approach.
  - Short-term impact of closing would likely be substantially offset over the medium-term by efficiency gains realized from increased fiscal space, energy surplus, and reduced alumina import.

- Estimated Impact of Closing down KAP (BOP, Employment, GDP)
  - BOP (% GDP)
    - Export -5.7
    - Import -3.9
    - Trade deficit -1.8
  - Employment (% change) -0.8
  - Cost of dismissal (% GDP) 0.1
  - Nominal GDP (% change)
    - Expenditure approach -1.3
    - Production approach -1.9

### Financial sector: stability, supervision, and liquidity
- Context and challenges:
  - Uncertainty about a viable post-boom banking business model; calls for focus on macrofinancial stability and liquidity as deleveraging evolves.
  - Unilateral use of the euro in Montenegro essentially rules out significant central bank liquidity injections, necessitating additional buffers.
  - Weaker foreign owners and liquidity-stretched domestic owners add to challenges.
- Agreed policy elements:
  - Forcing more lending is unlikely to work and would probably require budget resources; shortage of profitable lending opportunities may explain lending drought.
  - Intense supervisory presence and aggressive enforcement of regulations across the system; risk profiles and capital needs of individual banks should be carefully examined, including via the upgraded stress testing framework. Bank owners must meet capital shortfalls expeditiously or face sanctions.
  - CBCG plans to phase out temporary regulatory relaxations of prudential regulation and adopt a permanent framework fully in line with international best practice.
  - Continued efforts to improve asset quality:
    - Offloading of troubled assets to factoring companies, other investors, and parent banks needs tight monitoring to guard against asset stripping.
    - CBCG adopted relevant regulations and is working on legislation; staff stressed government, CBCG, and other entities must improve frameworks and processes related to collateral execution.
  - Raising and monitoring liquidity:
    - CBCG has stepped up liquidity monitoring.
    - Government saw a case for raising the share of reserve requirements held in treasury bills; staff and Central Bank were unconvinced, noting additional risks and distortions for credit extension.
    - Staff recommended general reductions in reserve requirements once confidence and stability improve.
  - Improve crisis preparedness and banking resolution framework:
    - Progress includes passing financial sector legislation and creating the Financial Stability Council (FSC).
    - Further improvements should include concrete contingency plans; ongoing work on a national contingency plan following Fund staff technical assistance is welcome.

- Tax wedge and fiscal parameters table (selected values)
  - Country / Marginal Tax Wedge on Labor / Prescott Tax Wedge / Lowest PIT Rate / Employee's SSC / Employer's SSC / Standard VAT Rate
    - Montenegro 42.85 51.19 2 4 9.8 17
    - Albania 42.95 2.4 10 11.2 21.7 20
    - Bosnia & Herzegovina 51.55 8.5 10 3 11 0.5 17
    - Croatia 48.75 8.3 12 20 16.7 23
    - Macedonia, FYR 66 71.2 10 28 28 18
    - Serbia, Republic of 45.85 4.1 10 17 17.9 18
    - Slovenia 54.26 1.8 16 22.1 16.1 20
  - Note: Based on various sources of information. i) 2011 Staff Report; ii) Tax comparison table prepared by Ruud De Mooij.

### Structural reform priorities
- Ambitious structural reform can achieve rebalancing without sacrificing growth by unleashing potential in energy and tourism sectors.
- Labor market reform is a priority:
  - Make regular contracts more attractive for employers, including greater scope to opt out from collective bargaining arrangements.
  - Use public expenditure reforms (for example social transfer reform) to reduce unemployment traps.
- Business environment improvements:
  - Address deficiencies in time required to obtain construction permits and complete registration procedures, particularly at municipal level.
  - Authorities encouraged to demonstrate commitment to arm’s length and rules-based relations with business and continue streamlining investment procedures.
- Metals sector restructuring:
  - Liquidations and work-outs could be used to improve efficiency and productivity; parts of enterprises that remain viable can be sold.
  - Direct employment effect and contribution to value added and balance of payments are now small if properly measured.
- Improve economic statistics:
  - Although high-frequency indicators have improved, inconsistencies remain.
  - National accounts are published only annually and with significant lags.
  - External data are subject to frequent revisions; evidence of continued export underreporting.
  - Achieving data accuracy and timeliness is essential for sound policymaking.

### Staff appraisal: outlook, risks, and recommendations
- Recent performance and risks:
  - GDP growth estimated at some 2½ percent in 2011; real output nearly reached pre-crisis 2008 level.
  - Confidence in banking system recovering with deposits continuing to grow; foreign direct investment remained above one tenth of GDP.
  - Recovery at risk of stalling: activity indicators slowed sharply as tourism boost wore off, metals sector problems re-emerged, and international environment became more challenging.
  - Liquidity is tight and the debt overhang hampers credit growth. After rapid public debt buildup that offset private deleveraging, fiscal policy is now constrained.
  - GDP projected to only record modest growth in 2012.
- Policy risks and prescriptions:
  - Current policies risk sub-par economic performance; medium-term prospects imperiled by large fiscal and external imbalances.
  - Steep upward trajectory of public debt needs urgent reversal by bringing taxation and spending closer in line to redress large persistent fiscal deficits.
  - Specific deficit-cutting measures should be identified; budget targets should be ambitious yet achievable, with focus on high-quality structural deficit reducing measures.
  - The more sizeable fiscal adjustment needs to come from expenditure cuts: revenue share is comparatively elevated while expenditure is high. Personnel bill must be brought down and entitlement spending growth reversed—advance pension reform.
  - Fiscal drain from aluminum and steel plants must be arrested by ending all fiscal and quasi-fiscal support.
  - There is scope to raise tax rates and strengthen tax administration: VAT and income tax rates and the tax wedge on labor are below regional levels; limited rate increases would not significantly impede new employment but care is needed regarding tourism sector impact. Flanking increases with measures like an Earned Income Tax Credit would help formal employment and tax collection.
  - Banking system improvements still needed: high non-performing loans despite recent decline, lagging provisioning, and need for higher prudential buffers given unilateral euro use.

*Source: 2012 ARTICLE IV REPORT MONTENEGRO (excerpt provided in content unit _cr12122 - 2011. On the other hand, its share of imports peaked in 2008)*

### 34.      Continued vigilance is necessary to

### 34.      Continued vigilance is necessary to

### Financial sector stability and banking supervision
- Supervision and regulatory enforcement need further strengthening; bank owners must meet capital shortfalls expeditiously or face sanctions.
- Further efforts are essential to improve asset quality and the framework and processes related to the execution of collateral.
- Administrative efforts to boost credit growth or direct lending to certain sectors should be eschewed, as should selective relaxations of the reserve requirement.
- Indicators and recent developments:
  - Banks have downsized balance sheets since 2008, reducing dependence on foreign borrowing and realigning lending with deposit bases.
  - NPLs remain high and the profitability of the banking system remains low.
  - Banks' loans/deposits and NPL measures indicate continued stress in credit portfolios.

### Labor market reform
- Labor market reform needs to target employment creation.
- The well-functioning market for non-resident employment should serve as the model to redress poor labor market performance characterized by:
  - high unemployment,
  - low labor force participation,
  - a growing share of the long-term unemployed.
- Policy recommendations:
  - The labor law must reduce hiring and firing costs and provide greater scope to opt out from collective bargaining arrangements.
  - Social protection schemes should be reformed to ensure that benefits target the neediest and no longer serve as impediments to labor market participation.
- Labor market indicators:
  - Unemployment still remains close to 20 percent.
  - Wage growth has slowed sharply.

### Business environment and investment climate
- The business environment needs nurturing and improvement despite steady progress in surveys.
- Remaining bottlenecks:
  - Time required to obtain construction permits and complete registration procedures, particularly at the municipal level, continues to hamper new investment.
- Policy guidance:
  - Arm’s length and rules-based relation with business will anchor Montenegro’s reputation as a safe haven for foreign investment.
  - Continued improvements in economic statistics are essential.

### Fiscal position and macroeconomic outlook
- The sharp fall in tax revenues since 2008 has resulted in large fiscal deficits and a rapid accumulation of public debt, leaving the government with little cushion for 2012.
- Fiscal and external projections and key indicators (selected series, 2007–16, under current policies):
  - Real GDP (percent change): 2007 10.7, 2008 6.9, 2009 -5.7, 2010 2.5, 2011 2.5, 2012 0.2, 2013 1.5, 2014 2.0, 2015 2.0, 2016 2.0.
  - Nominal GDP (millions of €): 2007 2,680, 2008 3,086, 2009 2,981, 2010 3,104, 2011 3,260, 2012 3,334, 2013 3,449, 2014 3,601, 2015 3,753, 2016 3,899.
  - Gross national saving (percent of GDP): 2007 -5.1, 2008 -10.0, 2009 -3.1, 2010 -2.6, 2011 -1.2, 2012 -0.6, 2013 -0.4, 2014 0.0, 2015 1.1, 2016 1.8.
  - Gross investment (percent of GDP): 2007 33.8, 2008 40.7, 2009 27.1, 2010 22.8, 2011 19.4, 2012 20.3, 2013 20.9, 2014 21.2, 2015 21.7, 2016 22.2.
  - Public debt (gross, percent of GDP): 2007 27.5, 2008 31.9, 2009 40.7, 2010 42.4, 2011 46.9, 2012 50.2, 2013 52.1, 2014 53.2, 2015 54.8, 2016 56.7.
  - Current account balance (percent of GDP): 2007 -39.5, 2008 -50.6, 2009 -29.6, 2010 -24.6, 2011 -19.4, 2012 -19.7, 2013 -20.0, 2014 -19.9, 2015 -19.3, 2016 -19.1.
  - Foreign direct investment (net, percent of GDP): 2007 21.2, 2008 18.9, 2009 35.8, 2010 17.8, 2011 11.9, 2012 11.4, 2013 12.4, 2014 13.3, 2015 14.2, 2016 15.1.
- Consolidated general government fiscal operations (selected ratios, percent of GDP):
  - Total revenues and grants: 2009 42.6, 2010 41.3, 2011 37.9, 2012 38.0, 2013 38.0, 2014 38.1, 2015 38.1, 2016 38.1.
  - Total expenditures and net lending: 2009 47.9, 2010 46.0, 2011 42.9, 2012 44.2, 2013 43.2, 2014 42.3, 2015 42.1, 2016 42.8.
  - Overall balance (percent of GDP): 2009 -5.3, 2010 -4.7, 2011 -5.0, 2012 -6.3, 2013 -5.2, 2014 -4.3, 2015 -4.1, 2016 -4.7.
  - Primary balance (percent of GDP): 2009 -4.4, 2010 -3.7, 2011 -3.4, 2012 -4.6, 2013 -3.3, 2014 -2.1, 2015 -1.6, 2016 -1.7.

### Policy recommendations and institutional priorities
- Strengthen supervision and regulatory enforcement; require rapid recapitalization or apply sanctions to bank owners who do not address capital shortfalls.
- Improve asset quality and strengthen collateral execution frameworks and processes.
- Avoid administrative measures to boost credit or mandate targeted lending; avoid selective reserve requirement relaxations.
- Implement labor law changes to lower hiring and firing costs and permit greater opt‑outs from collective bargaining.
- Reform social protection to better target the needy and remove disincentives to work.
- Streamline municipal-level permitting and registration procedures to facilitate new investment.
- Maintain arm’s length, rules-based relations with business and continue improving economic statistics.

*IMF staff assessment drawn from the 2012 Article IV report on Montenegro.*

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### 1. Re ve nue1262.41274.31235.61266.71311.41370.31429.51486.3

### Fiscal outcomes: revenue composition (millions of Euro)
- Total revenue (row 1): 1262.4, 1274.3, 1235.6, 1266.7, 1311.4, 1370.3, 1429.5, 1486.3
- Taxes: 795.7, 757.2, 789.4, 826.5, 856.0, 895.0, 934.0, 971.5
  - Personal income tax: 121.4, 115.1, 112.4, 121.4, 125.6, 131.1, 136.6, 141.9
  - Corporate income tax: 54.7, 20.3, 35.9, 34.2, 35.4, 37.0, 38.5, 40.0
  - Taxes on turnover of real estate right: 19.8, 16.5, 15.7, 12.9, 13.3, 13.9, 14.5, 15.0
  - Value added tax: 370.8, 364.2, 390.2, 402.6, 417.4, 437.0, 456.8, 475.7
  - Excises: 128.7, 134.3, 141.7, 161.8, 167.4, 174.8, 182.2, 189.2
  - Taxes on international trade: 49.1, 50.8, 45.1, 52.9, 54.7, 57.1, 59.5, 61.9
  - Local government taxes: 42.3, 44.6, 44.2, 37.6, 38.8, 40.6, 42.3, 43.9
  - Other taxes: 8.9, 11.6, 4.1, 3.3, 3.4, 3.5, 3.7, 3.8
- Social security contributions: 268.9, 347.6, 307.3, 318.7, 329.7, 344.2, 358.8, 372.7
- Nontax revenues: 186.2, 163.6, 131.1, 119.4, 123.5, 129.0, 134.4, 139.7
- Grants: 11.6, 5.9, 7.8, 2.0, 2.1, 2.2, 2.3, 2.3

### Fiscal outcomes: expenditure composition (millions of Euro)
- Total expense (row 2): 1214.1, 1262.5, 1304.1, 1322.0, 1337.3, 1385.1, 1461.0, 1526.7
- Gross salaries and other personal income: 358.8, 378.8, 382.7, 387.4, 387.6, 388.1, 404.5, 420.2
- Use of goods and services: 176.1, 194.9, 169.6, 203.8, 210.8, 220.1, 229.4, 238.3
- Interest payments: 25.4, 31.4, 52.7, 63.0, 77.9, 90.9, 107.1, 119.5
- Subsidies to enterprises: 51.0, 39.8, 46.4, 68.4, 30.0, 31.0, 38.3, 41.3
- Other current outflows: 18.1, 16.5, 26.2, 18.5, 18.7, 18.9, 19.7, 20.4
- Social security transfers: 413.1, 423.6, 455.5, 477.9, 508.5, 530.6, 553.0, 574.5
- Other transfers: 157.1, 161.6, 130.7, 69.6, 71.4, 73.1, 76.2, 79.1
- Capital transfers: 0.0, 0.0, 26.3, 22.0, 22.0, 22.0, 22.0, 22.0
- Reserves: 14.5, 15.8, 14.1, 11.5, 10.4, 10.5, 10.9, 11.3

### Balance indicators and fiscal position (millions of Euro)
- Gross operating balance (= 1 - 2): 48.3, 11.8, -68.6, -55.4, -25.9, -14.8, -31.5, -40.4
- Net acquisition of nonfinancial assets: 242.5, 157.0, 135.0, 119.8, 124.5, 133.5, 139.1, 144.5
  - Capital revenue: -8.7, -8.8, 0.0, 0.0, 0.0, 0.0, 0.0, 0.0
  - Capital expenditure: 251.2, 165.8, 135.0, 119.8, 124.5, 133.5, 139.1, 144.5
- Net lending (+) / borrowing (-) (= 3 - 4): -194.2, -145.1, -203.6, -175.2, -150.4, -148.2, -170.7, -184.9

### Financial transactions (millions of Euro)
- Net acquisition of financial assets: -101.0, -94.2, -107.5, -29.6, -27.6, -27.4, -30.8, -30.8
  - Domestic: same as above
  - Currency and deposits: 65.3, -66.9, -92.8, -10.6, -8.6, -8.6, -15.0, -15.0
  - Loans: -36.5, 0.1, 0.2, -1.0, -1.0, -0.8, -0.8, -0.8
  - Equity and investment fund shares: -129.8, -27.4, -14.9, -18.0, -18.0, -18.0, -15.0, -15.0
- Net incurrence of liabilities: 93.3, 50.9, 110.8, 42.3, 0.9, -31.9, -21.6, 2.5
  - Domestic: -30.0, -109.4, -16.1, 2.5, -33.0, -26.6, 25.0, 26.8
  - Foreign: 123.2, 160.3, 126.9, 39.7, 33.9, -5.3, -46.6, -24.3
- Discrepancy (= 5 - 6 + 7): 0.0, 0.0, 14.7, -103.4, -121.9, -152.8, -161.4, -151.6

### Memorandum items (levels)
- Primary balance: -168.8, -113.7, -150.9, -112.2, -72.5, -57.4, -63.6, -65.5
- Stock of net public debt: 965, 1151, 1444, 1601, 1732, 1862, 2016, 2186
- Stock of public guarantees: 150, 352, 381, ...............
- Nominal GDP: 29813, 1043260, 33343449360137533899

---

### Fiscal outcomes: percent of GDP presentation (2009–2016)
- Total revenue (percent of GDP): 42.3, 41.1, 37.9, 38.0, 38.0, 38.1, 38.1, 38.1
- Taxes (percent of GDP): 26.7, 24.4, 24.2, 24.8, 24.8, 24.9, 24.9, 24.9
  - Value added tax: 12.4, 11.7, 12.0, 12.1, 12.1, 12.1, 12.2, 12.2
  - Excises: 4.3, 4.3, 4.3, 4.9, 4.9, 4.9, 4.9, 4.9
- Social security contributions: 9.0, 11.2, 9.4, 9.6, 9.6, 9.6, 9.6, 9.6
- Grants: 0.4, 0.2, 0.2, 0.1, 0.1, 0.1, 0.1, 0.1
- Total expense (percent of GDP): 40.7, 40.7, 40.0, 39.6, 38.8, 38.5, 38.9, 39.2
  - Interest payments: 0.9, 1.0, 1.6, 1.9, 2.3, 2.5, 2.9, 3.1
  - Social security transfers: 13.9, 13.6, 14.0, 14.3, 14.7, 14.7, 14.7, 14.7
- Gross operating balance (= 1 - 2), percent of GDP: 1.6, 0.4, -2.1, -1.7, -0.8, -0.4, -0.8, -1.0
- Net lending (+) / borrowing (-), percent of GDP: -6.5, -4.7, -6.2, -5.3, -4.4, -4.1, -4.5, -4.7
- Primary balance (percent of GDP): -5.7, -3.7, -4.6, -3.4, -2.1, -1.6, -1.7, -1.7
- Stock of net public debt (percent of GDP): 32, 37, 44, 48, 50, 52, 54, 56
- Stock of public guarantees (percent of GDP): 5.0, 11.3, 11.7, ...............

### Financial sector indicators (high-level highlights from Table 6)
- Regulatory capital as percent of risk-weighted assets: series includes 17.1, 15.0, 15.7, 14.3, 16.5, 14.6, 15.9, 15.4, 15.3, 15.1, 16.5
- Non-performing loans (NPL), percent of gross loans: 3.2, 7.2, 13.5, 14.9, 16.8, 17.6, 21.0, 23.2, 25.3, 19.7, 15.5
- Provisions, percent of NPL: 73.6, 55.6, 46.3, 45.7, 44.9, 44.9, 30.7, 23.8, 24.0, 30.4, 32.8
- ROAA (gross profits, percent of average assets): 0.8, -0.6, -0.6, -3.4, -3.2, -4.2, -2.7, -2.3, -0.7, -1.0, -0.1
- Deposits, percent of assets: 70.3, 60.1, 60.3, 60.6, 60.6, 61.3, 60.8, 61.4, 63.6, 65.0, 64.7
- Loans, percent of deposits: 107.4, 140.5, 131.4, 133.3, 129.1, 126.9, 122.9, 117.3, 111.3, 104.2, 107.6

### Labor market: key findings (Annex I)
- Quarterly unemployment rate since 2008 has ranged between 16 and 21 percent.
- Unemployment concentration by age:
  - Those between ages 25 and 49 comprise the largest segment of the unemployed.
  - Jobless rate highest among 15-24 age group.
- Foreign workers: recorded foreign workers accounted for 10.5 percent of the labor force in 2011.
- Unemployment duration:
  - Over 60 percent of the unemployed are without a job for more than two years.
  - Over 80 percent of the unemployed are below 50 years of age.
- Labor force and employment trends:
  - Over the past two years, average labor force and number of employed persons have fallen by 8 percent.
  - Inactive population has gone up by 3 percent.
- Employment contracts:
  - Majority of new jobs over the last 3 years were generated through fixed-term contracts.
  - Recent amendments: simplified dismissal and redundancy processes; restricted availability and duration of fixed-term employment contracts.
- Policy implications and recommendations cited:
  - Near-term imperative: job creation focused on the domestic labor market.
  - Reabsorb long-term unemployed and eliminate disincentives to work:
    - Reduce unemployment benefits (example cited).
    - Adopt Earned Income Tax Credit policy (example cited).
    - Offer training in areas with skill shortages.

### Risk Assessment Matrix: main threats and expected impacts (Annex II)
- 1. Spillovers from an intensified eurozone crisis
  - Overall Level of Concern: Medium
  - Likelihood of severe realization in next 1–3 years: High
  - Expected impact if realized: High
  - Key points: tourism receipts alone accounted for close to one-fifth of GDP in 2012.
- 2. Loss of confidence in the banking system triggering deposit outflows
  - Overall Level of Concern: Medium
  - Likelihood: High
  - Expected impact: High
  - Key points: banking system fragile; non-performing loans remain high; monetary response limited by unilateral euro use; limited fiscal or parent-bank support.
- 3. Additional contingent liabilities materialize
  - Overall Level of Concern: High
  - Likelihood: High
  - Expected impact: High
  - Key points: loan guarantees for KAP amounting to 3.2 percent (extended during 2009–10) are at risk of being called; further political pressure could increase support and contingent costs.
- 4. Montenegro loses access to capital markets
  - Overall Level of Concern: Medium
  - Likelihood: High
  - Expected impact: High
  - Key points: 2016 Eurobond trading at a spread of roughly 800 basis points; small domestic capital market increases reliance on international markets.

*Source: Ministry of Finance; Central Bank of Montenegro; Monstat's Labor Force Survey; Employment Agency of Montenegro; and Fund staff estimates and projections.*

### Annex III. Debt Sustainability Analysis

### Annex III. Debt Sustainability Analysis

### Projections: External Debt (Table 1)
- Baseline: External debt (in percent of GDP) by year:
  - 2007: 74.1
  - 2008: 90.8
  - 2009: 93.5
  - 2010: 96.4
  - 2011: 99.9
  - 2012: 107.3
  - 2013: 114.5
  - 2014: 120.7
  - 2015: 126.5
  - 2016: 133.3
  - 2017: 140.4
- Debt-stabilizing non-interest current account (long-run constant): -15.4

- Change in external debt (percentage points of GDP):
  - 2007: 26.6
  - 2008: 16.7
  - 2009: 2.7
  - 2010: 2.9
  - 2011: 3.5
  - 2012: 7.4
  - 2013: 7.2
  - 2014: 6.2
  - 2015: 5.8
  - 2016: 6.8
  - 2017: 7.1

- Identified external debt-creating flows (4+8+9) (percent of GDP):
  - 2007: 8.9
  - 2008: 22.0
  - 2009: -3.0
  - 2010: 3.1
  - 2011: 2.9
  - 2012: 8.1
  - 2013: 5.9
  - 2014: 4.4
  - 2015: 2.8
  - 2016: 1.5
  - 2017: 0.3

- Components (percent of GDP):
  - Current account deficit, excluding interest payments:
    - 2007: 37.3; 2008: 47.7; 2009: 26.7; 2010: 21.3; 2011: 15.7; 2012: 15.6; 2013: 15.6; 2014: 15.3; 2015: 14.4; 2016: 13.9; 2017: 13.5
  - Deficit in balance of goods and services:
    - 2007: 42.9; 2008: 54.4; 2009: 32.6; 2010: 27.6; 2011: 23.8; 2012: 23.4; 2013: 23.2; 2014: 22.8; 2015: 21.9; 2016: 21.3; 2017: 20.8
  - Exports (in percent of GDP):
    - 2007: 43.1; 2008: 38.9; 2009: 32.8; 2010: 35.6; 2011: 40.6; 2012: 40.4; 2013: 40.7; 2014: 41.1; 2015: 42.4; 2016: 43.4; 2017: 44.0
  - Imports (in percent of GDP):
    - 2007: 86.0; 2008: 93.4; 2009: 65.4; 2010: 63.2; 2011: 64.4; 2012: 63.8; 2013: 63.9; 2014: 63.9; 2015: 64.2; 2016: 64.6; 2017: 64.9
  - Net non-debt creating capital inflows (negative = inflow):
    - 2007: -21.2; 2008: -18.9; 2009: -35.8; 2010: -17.8; 2011: -11.9; 2012: -11.4; 2013: -12.4; 2014: -13.3; 2015: -14.2; 2016: -15.1; 2017: -15.8

- Automatic debt dynamics (percent of GDP):
  - 2007: -7.3; 2008: -6.9; 2009: 6.1; 2010: -0.4; 2011: -0.8; 2012: 4.0; 2013: 2.8; 2014: 2.4; 2015: 2.6; 2016: 2.7; 2017: 2.6
  - Contribution from nominal interest rate:
    - 2007: 2.1; 2008: 2.9; 2009: 2.9; 2010: 3.3; 2011: 3.8; 2012: 4.2; 2013: 4.4; 2014: 4.7; 2015: 4.9; 2016: 5.2; 2017: 5.4
  - Contribution from real GDP growth:
    - 2007: -4.1; 2008: -4.4; 2009: 5.4; 2010: -2.2; 2011: -2.2; 2012: -0.2; 2013: -1.6; 2014: -2.2; 2015: -2.3; 2016: -2.5; 2017: -2.9
  - Contribution from price and exchange rate changes (partial series shown):
    - 2007: -5.3; 2008: -5.3; 2009: -2.2; 2010: -1.5; 2011: -2.4; (table continues)

- Residual, incl. change in gross foreign assets (2-3) (percent of GDP):
  - 2007: 17.7; 2008: -5.3; 2009: 5.7; 2010: -0.3; 2011: 0.6; 2012: -0.7; 2013: 1.3; 2014: 1.9; 2015: 3.0; 2016: 5.3; 2017: 6.8

- External debt-to-exports ratio (in percent):
  - 2007: 171.8; 2008: 233.2; 2009: 285.3; 2010: 271.0; 2011: 246.0; 2012: 265.7; 2013: 281.2; 2014: 293.5; 2015: 298.4; 2016: 307.4; 2017: 318.8

- Gross external financing need (in billions of Euros):
  - 2007: 1.3; 2008: 1.9; 2009: 1.3; 2010: 1.1; 2011: 1.0; 2012: 1.0; 2013: 1.1; 2014: 1.1; 2015: 1.3; 2016: 1.3; 2017: 1.5
- Gross external financing need (in percent of GDP):
  - 2007: 48.6; 2008: 60.3; 2009: 44.6; 2010: 37.0; 2011: 29.7; 2012: 30.7; 2013: 31.0; 2014: 31.1; 2015: 34.6; 2016: 33.5; 2017: 37.6

- Scenario with key variables at their historical averages (external debt, percent of GDP):
  - 2012: 107.3; 2013: 110.6; 2014: 114.7; 2015: 119.4; 2016: 125.1; 2017: 131.4
  - Debt-stabilizing non-interest current account under this scenario: -22.1

### Key Macroeconomic Assumptions Underlying Baseline (Table 1)
- Real GDP growth (in percent):
  - 2007: 10.7; 2008: 6.9; 2009: -5.7; 2010: 2.5; 2011: 2.4; 2012: 0.2; 2013: 1.5; 2014: 2.0; 2015: 2.0; 2016: 2.0; 2017: 2.2
- GDP deflator in Euros (change in percent):
  - 2007: 12.7; 2008: 7.7; 2009: 2.4; 2010: 1.6; 2011: 2.5; 2012: 2.1; 2013: 1.9; 2014: 2.3; 2015: 2.2; 2016: 1.8; 2017: 1.7
- Nominal external interest rate (in percent):
  - 2007: 5.6; 2008: 4.5; 2009: 3.1; 2010: 3.7; 2011: 4.1; 2012: 4.3; 2013: 4.2; 2014: 4.3; 2015: 4.3; 2016: 4.3; 2017: 4.3
- Growth of exports (Euro terms, in percent):
  - 2007: 31.4; 2008: 3.9; 2009: -18.7; 2010: 13.0; 2011: 19.9; 2012: 1.7; 2013: 4.3; 2014: 5.5; 2015: 7.4; 2016: 6.3; 2017: 5.6
- Growth of imports (Euro terms, in percent):
  - 2007: 37.2; 2008: 24.9; 2009: -32.3; 2010: 0.6; 2011: 7.1; 2012: 1.3; 2013: 3.7; 2014: 4.4; 2015: 4.7; 2016: 4.5; 2017: 4.3
- Current account balance, excluding interest payments (percent of GDP):
  - 2007: -37.3; 2008: -47.7; 2009: -26.7; 2010: -21.3; 2011: -15.7; 2012: -15.6; 2013: -15.6; 2014: -15.3; 2015: -14.4; 2016: -13.9; 2017: -13.5
- Net non-debt creating capital inflows (percent of GDP):
  - 2007: 21.2; 2008: 18.9; 2009: 35.8; 2010: 17.8; 2011: 11.9; 2012: 11.4; 2013: 12.4; 2014: 13.3; 2015: 14.2; 2016: 15.1; 2017: 15.8

### External Debt Dynamics: Bound Tests and Shocks (Figures 1)
- Summary of stress test outcomes (external debt in percent of GDP):
  - Interest rate shock, historical/permanent one-half standard deviation: baseline 140; shock result up to 143
  - Historical scenario: baseline 140; historical line includes actual data (e.g., 131 at one point)
  - Non-interest current account shock: baseline 140; shock result up to 176
  - Combined shock (permanent 1/4 standard deviation shocks to real interest rate, growth rate, and current account balance): baseline 140; combined shock result 166
  - Real depreciation shock: one-time real depreciation of 30 percent occurs in 2010; combined result shown as 206 (external debt in percent of GDP) for that scenario
- Gross financing need under baseline shown on right scale for various scenarios.

### Projections: Public Sector Debt (Table 2)
- Baseline: Public sector debt (percent of GDP):
  - 2007: 27.5
  - 2008: 31.9
  - 2009: 40.7
  - 2010: 42.4
  - 2011: 46.9
  - 2012: 50.2
  - 2013: 52.1
  - 2014: 53.2
  - 2015: 54.8
  - 2016: 56.7
  - 2017: 58.6
- Debt-stabilizing primary balance: 1.0 (percent of GDP)

- Share foreign-currency denominated (percent of GDP):
  - 2007: 14.3; 2008: 12.4; 2009: 12.3; 2010: 11.8; 2011: 10.8; 2012: 10.1; 2013: 9.2; 2014: 8.2; 2015: 7.3; 2016: 6.5; 2017: 5.6

- Change in public sector debt (percent of GDP):
  - 2007: -5.1; 2008: 4.4; 2009: 8.8; 2010: 1.7; 2011: 4.5; 2012: 3.3; 2013: 1.9; 2014: 1.2; 2015: 1.6; 2016: 1.9; 2017: 1.9

- Identified debt-creating flows (4+7+12) (percent of GDP):
  - 2007: -13.2; 2008: -0.5; 2009: 6.4; 2010: 3.1; 2011: 4.2; 2012: 4.2; 2013: 2.7; 2014: 1.9; 2015: 2.4; 2016: 2.7; 2017: 2.6

- Primary deficit (percent of GDP):
  - 2007: -7.8; 2008: 2.4; 2009: 4.4; 2010: 3.7; 2011: 4.6; 2012: 3.3; 2013: 2.1; 2014: 1.6; 2015: 1.7; 2016: 1.7; 2017: 1.6

- Revenue and grants (percent of GDP):
  - 2007: 47.7; 2008: 48.4; 2009: 42.6; 2010: 41.3; 2011: 37.9; 2012: 38.0; 2013: 38.0; 2014: 38.1; 2015: 38.1; 2016: 38.1; 2017: 38.1

- Primary (noninterest) expenditure (percent of GDP):
  - 2007: 39.9; 2008: 50.8; 2009: 47.1; 2010: 45.0; 2011: 42.5; 2012: 41.3; 2013: 40.1; 2014: 39.6; 2015: 39.8; 2016: 39.8; 2017: 39.8

- Automatic debt dynamics (percent of GDP):
  - 2007: -5.4; 2008: -2.8; 2009: 2.0; 2010: -0.6; 2011: -0.4; 2012: 0.8; 2013: 0.6; 2014: 0.3; 2015: 0.7; 2016: 1.0; 2017: 1.0
  - Contribution from interest rate/growth differential mirrors automatic debt dynamics.

- Of which contribution from real interest rate (percent of GDP):
  - 2007: -2.6; 2008: -1.2; 2009: 0.1; 2010: 0.4; 2011: 0.6; 2012: 0.9; 2013: 1.3; 2014: 1.3; 2015: 1.7; 2016: 2.1; 2017: 2.2

- Of which contribution from real GDP growth (percent of GDP):
  - 2007: -2.8; 2008: -1.6; 2009: 1.9; 2010: -1.0; 2011: -1.0; 2012: -0.1; 2013: -0.7; 2014: -1.0; 2015: -1.0; 2016: -1.1; 2017: -1.2

- Contribution from exchange rate depreciation shown as 0.0 for 2007–2012 (series continues).

- Residual, including asset changes (2-3) (percent of GDP):
  - 2007: 8.1; 2008: 4.9; 2009: 2.4; 2010: -1.4; 2011: 0.2; 2012: -0.9; 2013: -0.8; 2014: -0.7; 2015: -0.8; 2016: -0.8; 2017: -0.7

- Public sector debt-to-revenue ratio (percent):
  - 2007: 57.7; 2008: 65.8; 2009: 95.4; 2010: 102.6; 2011: 123.6; 2012: 132.1; 2013: 137.0; 2014: 139.9; 2015: 143.9; 2016: 148.8; 2017: 153.6

- Gross financing need (percent of GDP):
  - 2007: -6.7; 2008: 3.1; 2009: 8.7; 2010: 8.1; 2011: 9.3; 2012: 8.2; 2013: 7.2; 2014: 7.2; 2015: 11.9; 2016: 11.2; 2017: 15.7
- Gross financing need (in billions of Euros):
  - 2007: -0.2; 2008: 0.1; 2009: 0.3; 2010: 0.3; 2011: 0.3; 2012: 0.3; 2013: 0.2; 2014: 0.3; 2015: 0.4; 2016: 0.4; 2017: 0.6

- Scenario with key variables at their historical averages (public debt, percent of GDP):
  - 2012: 50.2; 2013: 47.0; 2014: 44.0; 2015: 41.2; 2016: 38.6; 2017: 36.2
  - Debt-stabilizing primary balance under this scenario: -2.3

- Scenario with no policy change (constant primary balance) in 2012–2017 (public debt, percent of GDP):
  - 2012: 50.2; 2013: 53.3; 2014: 56.3; 2015: 59.5; 2016: 63.2; 2017: 66.9
  - Debt-stabilizing primary balance under no-policy-change scenario: 1.2

### Key Macroeconomic and Fiscal Assumptions Underlying Baseline (Table 2)
- Real GDP growth (in percent):
  - 2007: 10.7; 2008: 6.9; 2009: -5.7; 2010: 2.5; 2011: 2.4; 2012: 0.2; 2013: 1.5; 2014: 2.0; 2015: 2.0; 2016: 2.0; 2017: 2.2
- Average nominal interest rate on public debt (in percent):
  - 2007: 4.0; 2008: 3.2; 2009: 2.6; 2010: 2.6; 2011: 4.0; 2012: 4.1; 2013: 4.7; 2014: 5.1; 2015: 5.6; 2016: 5.8; 2017: 5.8
- Average real interest rate (nominal rate minus change in GDP deflator, in percent):
  - 2007: -8.7; 2008: -4.5; 2009: 0.1; 2010: 1.0; 2011: 1.5; 2012: 2.0; 2013: 2.8; 2014: 2.7; 2015: 3.4; 2016: 4.0; 2017: 4.1
- Inflation rate (GDP deflator, in percent):
  - 2007: 12.7; 2008: 7.7; 2009: 2.4; 2010: 1.6; 2011: 2.5; 2012: 2.1; 2013: 1.9; 2014: 2.3; 2015: 2.2; 2016: 1.8; 2017: 1.7
- Growth of real primary spending (deflated by GDP deflator, in percent):
  - 2007: 12.2; 2008: 36.1; 2009: -12.6; 2010: -2.0; 2011: -3.2; 2012: -2.7; 2013: -1.5; 2014: 0.8; 2015: 2.4; 2016: 2.1; 2017: 2.3
- Primary deficit (percent of GDP) repeated:
  - 2007: -7.8; 2008: 2.4; 2009: 4.4; 2010: 3.7; 2011: 4.6; 2012: 3.3; 2013: 2.1; 2014: 1.6; 2015: 1.7; 2016: 1.7; 2017: 1.6

### Public Debt Bound Tests and Shocks (Figure 2)
- Stress test outcomes (public debt in percent of GDP):
  - Growth shock (permanent one-half standard deviation): baseline 59; shock result up to 79
  - Primary balance (PB) shock: baseline 59; shock result up to 69
  - Interest rate shock: baseline 59; shock result up to 64
  - Combined shock (permanent 1/4 standard deviation shocks to real interest rate, growth rate, and primary balance): baseline 59; combined shock result up to 70
  - Real depreciation and contingent liabilities shocks (one-time real depreciation of 30 percent and 10 percent of GDP shock to contingent liabilities occur in 2010): baseline 59; shock results up to 64–69 depending on combination
- No policy change scenario (constant primary balance) summary:
  - Baseline primary balance: -1.7; Scenario: -3.7; Historical: -0.8
  - Baseline growth: 2.0; Scenario: -0.3; Historical: 3.8
  - Baseline gross financing need behavior and scenario values shown in figures.

*Source: Annex III. Debt Sustainability Analysis, Montenegro: 2012 Article IV Report (tables and figures as provided).*

### 1. Fund work

### 1. Fund work

### Fund and Bank work programs
- Fund work program:
  - Article IV staff report
  - Technical assistance on Contingency Planning and Crises Preparedness for the Central Bank of Montenegro — February 2012
  - Fall 2012; April 2012; December 2012
- Bank work program:
  - Policy Based Guarantee
  - Technical assistance on the NPL resolution
  - Country Economic Program — May 2012; Spring-Summer 2012; January-July 2012; June 2012; July 2012; Fall 2012
- Joint work program: None

### Statistical Issues — A. Assessment of Data Adequacy for Surveillance (As of end-March 2012)
- General:
  - Data provision has some shortcomings that significantly affect surveillance.
  - Main problems are in national accounts and balance of payments.
  - Montenegro began participation in the GDDS in December 2011.
- National Accounts:
  - MONSTAT compiles real sector data and has started to adopt the 1993 System of National Accounts.
  - Scope limited to the annual production and expenditure account in current and previous year’s prices.
  - Accuracy of data sources needs improvement; breaks in time series need elimination by revising historical data.
  - Business statistics follow the material system product concept; data mainly on quantities produced.
  - Quality of investment and merchandise trade data is unsatisfactory.
  - MONSTAT switched from general to specific trade statistics to better capture imports; indications that exports remain under-recorded, resulting in an underestimation of GDP.
  - Lack of sound techniques to account for unreported activities; some work on informal activity in construction, retail trade, hotels and restaurants, but a more comprehensive approach is needed.
  - Statistical techniques for deriving volume measures of GDP are constrained by lack of suitable price and volume indices.
  - Progress on quarterly national accounts (QNA) after STA missions (December 2010, August 2011), but critical needs remain:
    - (i) improve data quality, volume measures price indices by economic activity, as well as data exhaustiveness for annual GDP;
    - (ii) compile quarterly GDP components at current and previous year’s prices.
  - QNA statistics for the first quarter of 2012 are scheduled to be published in July 2012.
- Price statistics:
  - MONSTAT compiles monthly consumer and producer price indices, broadly following international standards.
  - Use of “carry-forward” technique for seasonal goods, new goods, and missing items results in a downward bias.
  - Inconsistencies between monthly and annual price indices.
  - EU harmonized consumer price indices, and export and import price indices were compiled and released starting in 2011.
  - Export price index published since 2009, industrial import price index since 2011.
- Labor market statistics:
  - MONSTAT reports labor and wage statistics from LFS and administrative sources.
  - Unemployment rate from LFS computed per ILO definition.
  - Quality of labor and wage indicators relatively good; information on foreign employment limited.
  - Frequent methodological revisions impair time series analyses.
- Government finance statistics:
  - Fiscal data compiled by Ministry of Finance (MOF) based on new GFS institutional classification; since early 2006 include local governments and social security funds (latter merged with treasury account in 2010).
  - Chart of accounts introduced in 2001 implemented at local level from mid-2005.
  - Fiscal data reporting suffers from frequent re-classifications.
  - MOF established unit for data collection for state-owned enterprises (SOE), but satisfactory compilation of public sector fiscal balance requires significant further effort.
  - Data on enterprises owned by municipalities are rarely available.
  - Data on stock of local government arrears need to be significantly strengthened and disseminated.
- Monetary statistics:
  - Compiled by Central Bank of Montenegro (CBM), broadly following Monetary and Financial Statistics Manual (2000).
  - Dissemination meets GDDS recommendations for periodicity and timeliness for financial sector data.
  - Since early 2006 CBM publishes detailed monetary statistics in monthly Statistical Bulletin, including tables on monetary statistics, balance sheets and surveys for CBM and commercial banks.
- Balance of payments:
  - Compiled by CBM following international reporting standards.
  - Improvements from MONSTAT on coverage, valuation, classification of merchandise trade statistics.
  - Imports and exports in BOP compiled according to special trade system; CBM adjusts MONSTAT data from CIF to FOB basis.
  - Indications that exports continue to be underestimated; MONSTAT investigating.
  - Weaknesses due to paucity of source data and shortage of staff.
  - As a euroized economy, difficulty in estimating currency and deposits and large errors and omissions continue to be issues.
  - CBM improved recording via ITRS by refining coding system and increasing interaction with commercial banks, but ITRS remains inadequate for:
    - recording reinvested earnings and trade credits;
    - recording on accruals basis (ITRS records on cash basis).
  - CBM needs to undertake direct surveys of enterprises to supplement ITRS and prepare comprehensive documentation on compilation methods and data sources.
  - CBM has received TA on International Investment Position (IIP) statistics, but does not yet disseminate these data.

### Statistical Issues — B. Data Standards and Quality
- Montenegro began participating in the GDDS in December 2011.
- No data ROSC is available.

### Statistical Issues — C. Reporting to STA
- A page for Montenegro in International Financial Statistics (IFS) was introduced in the March 2007 issue.
- Montenegro does not report government finance statistics for publication in the Government Finance Statistics Yearbook or IFS.
- Montenegro does not report data for the IMF’s Coordinated Portfolio Investment Survey and the Coordinated Direct Investment Survey.
- The CBM does not yet report monetary data in the format of Standardized Report Forms (SRFs).
  - CBM will need to decide whether to adopt the European Central Bank’s framework or the STA-developed SRFs.

### Table of Common Indicators Required for Surveillance (As of end-March 2012) — selected publication/timeliness entries
- International reserve assets and reserve liabilities of the monetary authorities — Latest Observation: Jan. 2012; Date Received: Feb. 2012; Frequency of Data: M; Frequency of Reporting: M; Frequency of Publication: M
- Reserve/base money — Latest Observation: Jan. 2012; Date Received: Feb. 2012; Frequency: M M M
- Central bank balance sheet — Latest Observation: Jan. 2012; Date Received: Feb. 2012; Frequency: M M M
- Consolidated balance sheet of the banking system — Latest Observation: Jan. 2012; Date Received: Feb. 2012; Frequency: M M M
- Interest rates — Latest Observation: Jan. 2012; Date Received: Feb. 2012; Frequency: M M M
- Consumer price index — Latest Observation: Dec. 2011; Date Received: Jan. 2012; Frequency: M M M
- Revenue, expenditure, balance and composition of financing — general government — Latest Observation: Dec. 2011; Date Received: Feb. 2012; Frequency: Q Q Q
- Revenue, expenditure, balance and composition of financing — central government — Latest Observation: Dec. 2011; Date Received: Feb. 2012; Frequency: M M M
- Stocks of central government and central government-guaranteed debt — Latest Observation: Dec. 2011; Date Received: Feb. 2012; Frequency: Q Q Q
- External current account balance — Latest Observation: Dec. 2011; Date Received: Feb. 2012; Frequency: Q Q Q
- Exports and imports of goods — Latest Observation: Dec. 2011; Date Received: Feb. 2012; Frequency: Q Q Q
- GDP/GNP — Latest Observation: 2010; Date Received: Nov. 2011; Frequency: A I A
- Gross external debt — Latest Observation: Dec. 2011; Date Received: Feb. 2012; Frequency: Q Q Q
- International Investment Position — Latest Observation: ......; Date Received: NA; Frequency: NA NA NA

### Statement by the IMF Staff Representative on Montenegro (May 11, 2012) — key updates
- The information does not alter the thrust of the staff appraisal.
- 1. First quarter fiscal outturn weaker than expected: revenue decline of 12 percent year-on-year; wages and entitlement spending came in lower than budgeted; first quarter Central Government deficit 1.6 percent of GDP, in excess to the original full-year general government deficit target of 1.2 percent.
- 2. Cabinet adopted a revised 2012 budget that:
  - increases excise duties on heating oil and gas;
  - introduces a new tax on SIM cards, cable TV, electricity meters and smoking zones;
  - reduces allowances and salaries for public officials and capital spending.
  - Authorities estimate combined 2012 fiscal savings from these measures at 0.7 percent of GDP and are seeking parliamentary approval.
- 3. Government finalized a commercial bank loan: five-year loan for €150mn provides €100mn in new financing, with €50mn refinancing a previous loan due in 2015, lowering near-term fiscal financing risks.
- 4. Privatization/resolution developments:
  - A potential buyer for the insolvent steel mill has emerged; a successful bid was placed at the third steel plant auction in May.
  - Discussions on the future of the aluminium plant (KAP) ongoing; parliamentary decision in March to cancel the privatization contract.
  - Negotiations with the owner over resolution of their stake in KAP continue.
  - Parallel negotiations with lenders over possible rescheduling of two guaranteed loans to KAP (totaling €110 million) that are at risk of being called.

### Public Information Notice (PIN) No. 12/51 — Executive Board Concludes 2012 Article IV Consultation (May 16, 2012)
- Background:
  - Real GDP growth: 2½ percent in 2011; tourism supported recovery.
  - Recovery at risk from projected downturn in euro area weighing on growth in 2012.
  - Public debt rose from 28 to 47 percent of GDP at the end of 2011.
- Fiscal developments:
  - Headline deficit rose to 6.3 percent of GDP in 2011; adjusting for payments of called loan guarantees, the fiscal stance tightened by 0.7 percent of GDP.
  - Authorities aim for further consolidation in 2012 and over the medium term.
- Banking sector:
  - After rapid deleveraging, conditions stabilizing; deposits returning in 2011; banks off-loading problem loans and re-aligning lending with domestic deposit base.
  - System remains burdened by high non-performing loans and is lagging in provisioning; new bank lending limited.
- Executive Directors’ assessment and recommendations:
  - Commended authorities’ stabilization efforts and progress since crisis.
  - Called for intensified efforts to address large fiscal and external imbalances, enhance financial sector stability, and improve competitiveness.
  - Fiscal policy:
    - Need for further high-quality deficit reducing measures to put public debt on a declining trajectory.
    - More sizable adjustment should come from further spending cuts.
    - Saw 2012 supplementary budget as a step in the right direction.
    - Recommended further reducing personnel and entitlement spending; end fiscal and quasi-fiscal support to metals sector and assess its viability.
    - Revenue measures should focus on improving tax administration; some scope to raise tax rates that are below regional levels, noting caution that tax rate increases be considered only after tax administration is strengthened.
  - Financial sector:
    - Commended efforts to stabilize the financial sector and improve crisis preparedness and banking resolution framework.
    - Need to further strengthen supervision and regulation, including macroprudential framework.
    - Enforce capital requirements, improve asset quality, monitor liquidity closely, and maintain high prudential buffers.
  - Structural reforms:
    - Accelerate efforts to enhance competitiveness and attract foreign investment.
    - Improve business environment and increase labor market flexibility.
    - Reform social protection schemes to target the neediest and avoid impeding labor market participation.
  - Statistics:
    - Continue efforts to address shortcomings in economic statistics which hamper policy design and evaluation.

### Montenegro: Selected Economic Indicators, 2008-12 (selected rows)
- Nominal GDP (millions of €): 2008: 3,086; 2009: 2,981; 2010: 3,104; 2011: 3,260; 2012 Est. Proj.: 3,334
- Gross national saving (percent of GDP): 2008: -10.0; 2009: -3.1; 2010: -2.6; 2011: -1.2; 2012: -0.6
- Gross investment (percent of GDP): 2008: 40.7; 2009: 27.1; 2010: 22.8; 2011: 19.4; 2012: 20.3
- Real GDP (percent change): 2008: 6.9; 2009: -5.7; 2010: 2.5; 2011: 2.5; 2012: 0.2
- Industrial production: 2008: -2.0; 2009: -32.2; 2010: 17.5; 2011: -10.3
- Tourist arrivals: 2008: 4.8; 2009: 1.6; 2010: 4.6; 2011: 8.7
- Consumer prices (average): 2008: 9.0; 2009: 3.6; 2010: 0.7; 2011: 3.1; 2012: 2.0
- Consumer prices (end of period): 2008: 7.2; 2009: 1.7; 2010: 0.7; 2011: 2.8; 2012: 1.7
- Bank credit to private sector (end of period, percent change): 2008: 25.0; 2009: -15.1; 2010: -8.9; 2011: -13.0
- Enterprises (bank credit): 2008: 21.3; 2009: -18.0; 2010: -11.2; 2011: -17.6
- Households (bank credit): 2008: 31.2; 2009: -10.7; 2010: -5.7; 2011: -2.6
- Private sector deposits (percent change): 2008: -14.2; 2009: -4.1; 2010: 5.9; 2011: 1.2
- General government finances (accrual; percent of GDP):
  - Revenue and grants: 2008: 48.4; 2009: 42.6; 2010: 41.3; 2011: 37.9; 2012: 38.0
  - Expenditure: 2008: 51.5; 2009: 47.9; 2010: 46.0; 2011: 44.2; 2012: 43.2
  - Overall balance: 2008: -3.1; 2009: -5.3; 2010: -4.7; 2011: -6.3; 2012: -5.2
  - Primary balance: 2008: 0.5; 2009: -4.4; 2010: -3.7; 2011: -4.6; 2012: -3.3
  - Privatization receipts: 2008: 1.2; 2009: 4.4; 2010: 0.9; 2011: 0.5; 2012: 0.5
  - General government gross debt (end of period): 2008: 31.9; 2009: 40.7; 2010: 42.4; 2011: 46.9; 2012: 50.2
- Balance of payments (percent of GDP):
  - Current account balance: 2008: -50.6; 2009: -29.6; 2010: -24.6; 2011: -19.4; 2012: -19.7
  - Foreign direct investment: 2008: 18.9; 2009: 35.8; 2010: 17.8; 2011: 11.9; 2012: 11.4
- External debt (end of period, stock): 2008: 90.8; 2009: 93.5; 2010: 96.4; 2011: 99.9; 2012: 107.3
- REER (CPI-based; average percent change, + indicates appreciation): 2008: 1.6; 2009: 6.4; 2010: 0.0; 2011: -3.2

### Statement by Menno Snel, Executive Director for Montenegro and Ana Martinis (May 11, 2012)
- Authorities thanked staff for open dialogue and broadly agree with staff’s analysis.
- Emphasized the importance of staff papers for a small country and consented to publication of the staff report.
- Noted that Montenegro’s economic activity recovered after a major contraction in 2009, boosted by foreign investment inflows and buoyant tourism revenues; real GDP grew by (table above).

*Source: _cr12122 - 1. Fund work (Montenegro 2012 Article IV Report — Informational Annex), IMF.*

### 2.5 percent annually in 2010 and 2011. Price stability has been maintained, despite moderate

### _cr12122 - 2.5 percent annually in 2010 and 2011. Price stability has been maintained, despite moderate

### Economic outlook and performance
- Real GDP growth: "2.5 percent annually in 2010 and 2011."
- Inflation: "Price stability has been maintained, despite moderate acceleration of inflation in 2011 driven by food and fuel prices and increases in excises on alcohol and tobacco."
- Current account adjustment: "from above 50 percent in 2008 to 19.4 percent in 2011."
- 2012 outlook and shocks:
  - External conditions deteriorated in late 2011, leading to a slowdown in exports and weakening of growth.
  - Q1 2012 shocks: extremely difficult weather conditions that paralyzed trade and transport for almost two weeks in February; unplanned budget costs related to repayment of a state-guaranteed loan for aluminum company KAP.
  - Authorities' 2012 expectations: "growth to slow down to 0.5 percent, while inflation is expected to remain well contained (around 2 percent on average)."

### Fiscal policy: consolidation and contingent liabilities
- Policy context: In a euroized system with no leeway for monetary policy, "fiscal policy is the main effective instrument for policy adjustment."
- Consolidation outcomes (2008–2012):
  - "Fiscal expenditures have been cut by more than 8 percentage points of GDP in the period 2008-2012."
  - Last year alone: expenditures down by "1.8 percent of GDP including a guarantee payment of 1 percent of GDP, bringing adjustment to 2.8 percent in only one year."
  - Arrears: "reduced in 2011 by 0.3 percent of GDP" (authorities’ data).
- Measures implemented:
  - Cuts mostly in non-essential capital spending.
  - New rules for strict control of public wages; downsizing of public sector workforce; centralized monitoring of current expenditures; reduced number of spending units; new financing scheme for local governments.
  - Agreement with public sector unions introducing opt-out clauses and allowing public wage decrease if either: "(i) real GDP growth below 2 percent or (ii) budget balance below zero."
- Contingent liabilities and fiscal impact:
  - 2011 repayment of guarantee: "1 percent of GDP for a steel company which declared bankruptcy."
  - April 2012: guarantee for aluminum company KAP called and fully repaid "in the amount of 0.7 percent of GDP."
  - Revenue shortfalls have prevented consolidation from fully reflecting in overall balances.
  - End-April sale of the bankrupt steel mill expected to bring "additional 0.3 percent of GDP of revenues in 2012."

- Public debt and financing:
  - "Public debt reached 45.3 percent of GDP as of end-February 2012."
  - Authorities mindful of debt sustainability risks given unique policy framework.
  - Financing plan for 2012: predominantly "bilateral and multilateral borrowing, including through World Bank assistance."
  - Montenegro has an approved Development Policy Loan (DPL) and is in final stage of negotiations for a Policy-Based Guarantee (PBG) which, if completed, "would help the country in acquiring financing under substantially more favorable terms."

### Supplementary budget for 2012
- Rationale: Q1 revenue shortfall "amounting to 0.7 percent of GDP compared to last year" and financing the guarantee payment.
- Total fiscal adjustment: "1.2 percent of GDP" introduced in April; expected parliamentary adoption by end-May.
- Revenue measures (expected effect "0.7 percent of GDP"):
  - Introduction of tax on mobile SIM cards, cable television and electricity meters.
  - A fee for "smoking zones".
  - Increase in excises on fuel oil for heating.
  - Tax on undistributed profits.
  - Measures against the unofficial economy; improvements in tax collection.
  - Authorities aim to keep basic tax rates unchanged.
- Expenditure measures (cuts amount to "0.5 percent of GDP"):
  - Savings on official automobiles, telephone services, travel allowances, office material costs.
  - A "7-percent wage cut for high-ranking public officials and embassy employees."
  - Further cuts in capital spending.

### Financial sector developments and safeguards
- Banking sector impact from boom-bust episode: deposit withdrawals, credit crunch, deteriorating credit portfolios, eroding profitability.
- Regulatory and supervisory response: central bank focused on improving regulatory and supervisory framework due to limited monetary instruments.
- 2011 outcomes:
  - "Capital adequacy ratio rose to 16.5 percent of risk-weighted assets as of end-2011."
  - Non-performing loans fell "by 10 percentage points from their peak reached in mid-2011 until the end of the same year."
  - Major banks cleaned balance sheets by selling bad credit portfolios to parent banks or to factoring companies financed by parent banks.
  - Deposits started recovering; credit activity remains subdued due to high financing costs and lack of credit demand from creditworthy clients.
- Macroprudential and contingency measures:
  - Continued improvements to macroprudential framework given potential spillovers from the euro area crisis and deleveraging in Europe.
  - Central bank actions: establishment of a Council for bank liquidity; adopted regulation on large exposures; implemented stress testing in coordination with the ECB.
  - Contingency planning: internal contingency plans at each regulatory institution; National Contingency Plan developed with Fund technical assistance and adopted by the Financial Stability Council.
  - Legal framework: "five new laws covering the financial sector will be adopted in 2012 (i.e. an insurance law and a compulsory insurance law, a law on capital markets, a law on payment services, and a law on financial collaterals)."

### Structural reforms
- Labor market reform (adopted 2010, amended 2011):
  - Liberalized use of fixed term contracts.
  - Lowered minimum obligatory level of severance payments.
  - Introduced restrictions in unemployment protection, including cuts in unemployment benefits and maternity and sick leave benefits.
  - Objective: address low labor force participation rates.
- Pension system reform (implemented January 2011):
  - Increased retirement age to "67 (from 65 for men and 60 for women)."
  - Removed incentives for early retirement.
  - Reduced frequency of pension benefit index calculation from biannually to once a year.
- Social protection reform (initiated this year):
  - Will include cuts in government compensation for maternity leave and sick leave.
  - Will introduce private health insurance premium for obtaining full medical coverage.
- Business environment reforms:
  - Continued progress in business climate and economic freedom indicators; Montenegro "stands out as the second best performer in the region (after Macedonia)."
  - Established the Council for the Elimination of Business Barriers to monitor progress across ministries.
  - Opened one-stop shops for business registration; electronic registration to be introduced "by end-June."

### EU and WTO accession
- EU accession process:
  - "The forthcoming start of negotiations for EU membership, tentatively scheduled for June 2012," noted as confirmation of authorities' reform efforts.
  - EU accession expected to stimulate further reforms in legislative, judicial and economic areas and incentivize foreign investments.
- WTO membership:
  - "In May 2012 Montenegro became a member of WTO," reflecting commitment to open trade and regional collaboration within CEFTA.

### Final remarks and policy direction
- Authorities recognize key risks identified in the staff paper: "sizeable external imbalances and fast-growing public debt."
- Policy stance: continue using fiscal and structural reforms to reduce vulnerabilities, improve competitiveness, and enhance long-term growth potential.
- Growth prospects: authorities believe Montenegro can return to a higher growth trajectory given "huge untapped potential in the tourism and energy sectors."

*IMF staff report content as provided in the source document.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12122.pdf_