## Labor Market Selected Indicators 2006–2012Q3 (_cr13179)

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---

### Introduction — Stylized Facts and Regional Comparison
- Employment rates of working age population are below 50 percent; overall unemployment is above 30 percent; activity rates are among the lowest in Europe (period referenced: 2006–2012Q3).
- During 2006–2012Q3 (a period with an average real output growth above 3 percent) unemployment did not improve much.
- High proportion of long-term unemployed; skills degradation and disengagement from active job search are highlighted.
- Unemployment is concentrated among sub-groups: women, youth, older workers, ethnic minorities, and people in less developed regions.
- Labor force participation for working age population with low level of education (primary complete or less): 29 percent of women participate and more than 70 percent of men participate.

### Diagnostic Findings — Demand and Supply Side Indicators
- Wages and productivity
  - Macedonia is in the lower third of Central and Eastern European countries by average gross wages; productivity per worker per hour is also at the lower end.
  - Regression relationship (Figure 2): y = 0.4085x + 264.09 (Gross Wages (Euros) vs. Productivity (per worker per month), 2011).
  - Recent trend: increasing salaries accompanied by productivity decreases; public sector wage increases are a driving factor and may crowd out skills and induce a “queuing” effect for public sector jobs.
- Employment protection legislation (EPL)
  - Macro-level EPL in line with or more flexible than peers, but pockets of high regulation and low flexibility remain (example: mandatory prior registration of overtime work).
  - Discretionary application of regulation could create uncertainty and discourage demand; different population segments may be disproportionately affected.
- Reservation wages, social assistance, and unemployment benefits
  - Unemployment benefits not assessed as overly generous (Figure 5); social assistance spending (cash transfers) does not appear to provide large disincentives to work (Figure 4).
  - Remittances and household arrangements suggest additional unquantified drivers of reservation wages; further research recommended.
- Tax wedge and labor taxation
  - Tax wedge is below median and has been decreasing since 2009.
  - Reforms reduced social contribution rates paid by companies; implications include lower wage costs but fiscal pressure on social funds (notably the Health Fund).
  - Taxation is uneven: low wage earners and second-earners (mostly women) face higher effective tax burdens, creating disincentives for formal labor force participation.
- Business environment
  - Substantial improvements in the late 2000s; Macedonia ranked 23 out of 185 countries in the World Bank’s Ease of Doing Business for 2013.
  - Reductions in red tape and improved indicators supported operating conditions and attractiveness to foreign investors, supporting job creation.

### Labor Market Responsiveness and Structural Constraints
- Okun’s law and elasticity of unemployment to output
  - Balkan countries show wide dispersion in the GDP growth vs unemployment change relationship; NMS show a more concentrated pattern with a steeper regression slope.
  - Macedonia’s series over the past 15 years appear "de-linked" — employment/unemployment is relatively unresponsive to output changes.
  - Implication: structural factors, not cyclical responsiveness alone, likely explain the high measured unemployment.

### Unfinished Transition — Convergence Channels and Constraints
- Late integration and convergence in the Balkans relative to the EU.
- Income convergence channels: cross-border capital flows, labor flows (emigration), and fiscal transfers/developmental aid.
- Structural legacy issues: late transition, early outflow of a large pool of skilled workers, and incomplete effects of recent structural reforms.

*Prepared by Alexis Meyer Cirkel (EUR)*

---

### The first channel of convergence: longer term capital inflows and FDI

### A. Capital inflows, FDI, and structural transformation
- Macedonia accumulated a low stock of FDI per capita relative to many New Member States (Figure 10).
- Contributing factors: sidelining of the Balkans in regional FDI inflows and disruptive consequences of the breakup of former Yugoslavia.
- Structural transformation is underway but unfinished, in part because of the lack of FDI until very recently.
- Dependence on agricultural output remains large; a considerable portion is small scale or subsistence farming (Figure 11).
- A considerable FDI pipeline has emerged recently due to improvements in ease of doing business, low labor costs, and a relatively stable macroeconomic environment, but impact will be limited without improved technology absorption capacity (Figure 19).

### B. Labor market dynamics, informality, and human capital loss
- About a quarter of the total workforce is employed in the grey economy; among younger workers almost half of their employment is informal (Figure 12).
- Labor mobility produced considerable loss of important human capital: substantial skilled emigration during the 1990s (Figures 15 and 16).
- Brain drain estimates (2000/01 census based) indicate Macedonia was particularly hard hit among Balkan countries.
- Primary education enrollment is considerably below income peers and NMS; secondary and tertiary enrollment in line with income peers but below competitors for FDI (Figure 17).
- Education system effectiveness has gaps as measured by international assessments of pupils’ skills (Mojsoska‐Blazevski, 2013).

### C. Remittances and labor supply incentives
- Large émigré population generates sizeable remittance inflows. Private transfers stood above 15 percent in 2011 (noting potential BoP recording issues).
- Empirical evidence on remittances’ effect on labor force participation is mixed; some disincentives or more relaxed jobseeker engagement may be at play.

### D. FDI, technology absorption, clustering, and spillovers
- Empirical literature finds a consistently significant impact of FDI on economic growth across country groups and time spans.
- FDI provides foreign savings, technology, know-how, and marketing channels; medium-to-long-term horizon conducive to technology import.
- Spatial clustering and interlinkages (development zones) are crucial to promote global production networks and technology spillovers.
- World Bank firm-level technology absorption index: Macedonia performs poorly in capacity to absorb technology compared to NMS and income peers (Figure 19).
- Bivariate plot of FDI stock per capita versus unemployment rate (Figure 20) suggests FDI may be associated with lower unemployment; regression lines shown:
  - y = -0.1704x + 0.5053 (Okun's Law, Balkans: All Data)
  - y = -0.3146x + 1.0457 (Okun's Law, NMS: All Data)
  - y = -0.9677x + 21.772 and y = -5.855ln(x) + 25.202 (Unemployment rate vs. FDI, 2011)

### E. Export structure and implications for complexity
- 2010 exports remain heavily reliant on primary products: “browns and blacks” (mining and metals) and “yellows and oranges” (agriculture); few “blues” (machinery, electrical components, cars) (Figure 13).
- Slovenia’s 2010 export composition contrasts with more advanced export diversity and higher value-added products (Figure 14).

### F. Conclusions and policy recommendations
- Necessary improvements in business environment, infrastructure buildup, and a strong FDI pipeline position Macedonia to experience faster structural change and income convergence vis-à-vis the EU.
- Main challenges (verbatim):
  - First, maintenance of macroeconomic stability, and further improvements of institutional capacity and legal certainty is crucial. The confidence of the business community must be fostered by avoiding discretionary policy and making sure that macroeconomic and fiscal policy are geared towards supporting growth.
  - Second, while attracting FDI is key, it is equally important to tie it to local production chains and to enable technology to spill over. For that purpose technology absorption capacity needs to be fostered trough increased linkages between industry, research institutes, capacity training centers, etc.
  - Third, educational gaps need to be closed. The considerable emigration of highly educated citizens still holds back output potential. Replenishing this pool of lost skills by ensuring attendance and high standards of local schools and universities is very important. Particularly a primary and secondary education of quality for all income groups has proven to be crucial in allowing technology absorption and fast economic development.
- Policy recommendations (implied):
  - Foster FDI linked to local production chains and encourage technology transfer and spillovers via clusters, research-industry linkages, and training centers.
  - Strengthen institutional capacity, legal certainty, and maintain macroeconomic stability to sustain business confidence and growth-supportive fiscal policy.
  - Improve education enrollment and quality—especially primary and secondary education—to rebuild human capital and enhance technology absorption.
  - Address informality by improving incentives and institutional capacity to move workers and firms from the grey economy into the formal sector.
  - Improve firm-level technology absorption capacity to maximize benefits from the FDI pipeline.

---

### Financial intermediation and banking sector (overview and diagnostics)

### Overview and structure
- Financial intermediation is traditionally bank-based in Macedonia; banks make up "some 89 percent of the financial system."
- Second pillar (funded) pension funds comprise "4 percent of the system."
- Insurance companies: "87 percent" of insurance assets related to property and casualty; life insurance assets make up "13 percent."
- Other financial sector parts (leasing, securities markets) have been residual in recent years.
- Objectives: benchmark trends against European transition countries; empirically disentangle credit supply and demand influences; formulate recommendations to enable banks to finance convergence.

### Banking system structure and concentration
- Total number of banks: "16."
- Large banks: "3" banks each with balance sheet of "€1 billion equivalent or more," together representing a "62 percent" asset market share.
- Medium-sized banks: "6" banks with balance sheets between "€182 and €440 million equivalent," representing "some 28 percent" asset market share.
- Small banks: "7" institutions, together representing "just under 10 percent" market share.
- Ownership: largely foreign-owned; low state ownership (only Macedonian Bank for Development Promotion (MBDP) is state-owned).
- Market concentration measured by top-3 banks’ asset share is "somewhat higher than in peers."
- Small banks often loss-making or barely profitable (negative ROE and ROA) and inefficient (relatively high cost-to-income ratios).

### Prudential indicators and performance
- Capital adequacy ratios: described as "high," below other Balkan countries but slightly above more developed Central European banking systems.
- Liquid assets: "29.4 percent" of assets at end-2012.
- Profitability:
  - Profitability deteriorating since the onset of the crisis.
  - Decline pace comparable to other Balkan countries, more gradual than Romania and Bulgaria.
  - Interest margins decreased more than in peers and remain significantly below comparable banking systems.
  - Increased NPL provisioning has significantly contributed to profitability deterioration.
- Nonperforming loans and provisioning:
  - NPLs almost doubled since 2007, to reach "11.7 percent of total loans in February 2013."
  - Loan loss provisions remain larger than the stock of NPLs due to high provision charges and modest provisions against performing loans.

### Credit developments and financial deepening
- Historical pattern:
  - Late 1990s/early 2000s: weak credit to private sector (“sleeping beauty”).
  - Mid-2000s: credit growth reached "44 percent y-o-y in May 2008."
  - Late 2008 onward: sharp downturn; credit growth remained very weak thereafter.
- Private sector credit to GDP: "45 percent in 2011" and "47.5 percent in 2012."
  - Peers: "55 percent" in other Balkan countries, Romania and Bulgaria; "67 percent" in Central Europe.
  - Increase of "some 10 percentage points between 2007 and 2011."
- Composition of credit: relatively low share to households; notably lower proportion of mortgage credits.
- Financing structure resilience:
  - Loan-to-deposit ratio has been "well below 1" since the onset of the crisis.
  - Strong deposit growth limited reliance on external wholesale parent financing.
- Euroisation: extent has been "kept in check" compared to peer countries with fixed exchange rate regimes.

### Causes: supply-side and demand-side factors
- Demand-side:
  - Mid-2000s boom: household and corporate financial reserves increased; since the crisis, reserves were used, reducing creditworthiness and unpledged collateral.
  - Conclusion: real economic developments likely had a positive causal effect on credit growth.
- Supply-side:
  - Banks curtailed credit supply due to increased risk aversion and preference for liquidity post-crisis.
  - Other supply-side factors: monetary policy stance, changes to banking sector financing model, varying degrees of risk aversion, structural impediments.
  - Conclusion: credit availability may have had a positive causal effect on economic growth.
- Empirical approach: cointegration model to assess link between credit availability and private consumption.

### Identified structural impediments and policy focus areas
- Structural constraints:
  - High market concentration among top banks.
  - Long tail of small, often loss-making banks with limited intermediation capacity.
  - Relatively late development of mortgage and household lending markets.
  - High provisioning practices affecting current profitability but strengthening buffers.
- Policy focus: disentangle supply and demand drivers; address supply-side obstacles and demand-side weaknesses; enable banking sector to better finance convergence.

---

### Cointegration analysis: credit to households and nominal private consumption (2003–12)

### Methodology and data
- Sample: quarterly data over 2003Q1–2012Q4 (40 observations).
- Variables:
  - CRHH: total loans to households.
  - NCON: nominal private consumption.
- Primary approach: Johansen (1995) VECM; robustness check: Engle-Granger (1987) two-step.
- Key steps: unit root tests, trace tests for cointegration rank, estimation of VECM and error-correction coefficients, Granger-causality tests to inform normalization.

### Statistical findings and key coefficients
- Stationarity and causality:
  - Both CRHH and NCON appear non-stationary; unit root not rejected for either series.
  - Granger-causality tests: null that one series does not Granger-cause the other rejected at the 1 percent level; CRHH shows causality at an even lower significance level.
  - Variance analysis: CRHH explains a large and increasing share of NCON variance following a shock.
- Cointegration evidence:
  - Trace statistics significant at the 1 percent level indicate existence of a cointegrating vector.
  - Engle-Granger residual ADF test: null of unit root in residuals rejected at the 5 percent level.
  - A restricted trend detected; interpret long-run equilibrium for de-trended series.
- Long-run slope:
  - Slope coefficient ~ 0.45 (0.5 in the Engle-Granger two-step).
- Speed-of-adjustment (error-correction) coefficients:
  - Normalizing on NCON:
    - Speed-of-adjustment in the NCON equation is strongly significant and negative.
    - Speed-of-adjustment in the CRHH equation is not significant.
    - Johansen (VECM) speed-of-adjustment for NCON: -2.64 (reported as -2.64 with significance).
    - Engle-Granger speed-of-adjustment for NCON: -2.39 (reported as -2.39 with significance).
  - Interpretation: corrections tend to “overshoot” the path of return to equilibrium; likely caused by quarterly aggregation while part of adjustment occurs at higher frequency.
- Selected statistics (as reported):
  - Johansen (VECM) trace test statistic: 38.154*** and 30.452***.
  - Engle-Granger entries include: -2.514**, 30.505***, -2.388***, -0.062.
  - Significance notation: *, **, *** at 10%, 5% and 1% thresholds, respectively.

### Interpretation and policy-relevant implications
- Main interpretation:
  - Long-term dynamic equilibrium links CRHH and NCON over 2003–2012, but slope ≈ 0.45–0.5 implies substantial role for other factors.
  - Adjustment is asymmetric: nominal private consumption adjusts to credit shocks, while credit does not adjust significantly in the short run.
- Implication for financial deepening:
  - Results point to prevalence of credit supply constraints, as opposed to insufficient aggregate demand, in curtailing financial deepening over 2003–2012.
- Caveats:
  - Small sample (40 quarterly observations) may produce small-sample distortions.
  - Quarterly aggregation may mask higher-frequency credit adjustments.

### Policy recommendations from analysis (summarized)
- Streamline bankruptcy procedures to reduce uncertainty and improve resolution timelines.
- Remove or amend interest rate cap legislation (capped at 8 and 10 percentage points above policy rate for household and corporate loans, respectively) to enable risk-based pricing; complement with better-targeted consumer protection.
- Improve corporate accounting practices in SMEs and collateral valuation (e.g., cadastre recording and publishing real estate sales transactions).
- Implement NBRM changes to provisioning and reserve requirements (effective in 2014) to free modest funds and give banks more leeway in provisioning new loans.
- Address excess risk aversion through maintaining macroeconomic stability and strengthening institutional capacity; low-cost steps could unlock marginal impediments to credit supply and contribute to growth by better financing consumption and investment.

Appendix 1 — selected banking-sector indicators (excerpted values)
- Domestic credit to private sector: Macedonia: 35.3 (2007), 44.9 (2011)
- Domestic credit to households: Macedonia: 13.9 (2007), 17.7 (2011)
- Mortgage lending (percent of household lending): Macedonia: 11.2 (2007), 21.7 (2011)
- Share of FX-loans to total loans: Macedonia: 54.7 (2007), 59.2 (2011)
- Deposit euroisation: share of FX-deposits to total deposits: Macedonia: 43.8 (2007), 48.7 (2011)
- Loan-to-deposit ratio (percent): Macedonia: 0.8 (2007), 0.9 (2011)
- CAR: Macedonia: 17.0 (2007), 16.8 (2011)
- ROA: Macedonia: 1.8 (2007), 0.4 (2011)
- ROE: Macedonia: 15.0 (2007), 3.4 (2011)
- Non-performing loans (percent of total loans): Macedonia: 7.5 (2007), 9.5 (2011)
- GDP (Billions of euros): Macedonia: 6.0 (2007), 7.6 (2011)
- Y/Y GDP growth rate, average over last 5 years: Macedonia: 4.6 (2007), 2.2 (2011)
- GDP per capita (euros, PPP): Macedonia: 7631.5 (2007), 8784.1 (2011)
- GDP per capita (euros): Macedonia: 2916.8 (2007), 3055.3 (2011)

*Source: IMF staff analysis in _cr13179_.*

### 1.   Labor Market Selected Indicators 2006–2012Q3 _______________________________________ 4

### Labor Market Selected Indicators 2006–2012Q3

### Introduction — Stylized Facts and Regional Comparison
- Employment rates of working age population are below 50 percent; overall unemployment is above 30 percent; activity rates are among the lowest in Europe (period referenced: 2006–2012Q3).
- During 2006–2012Q3 (a period with an average real output growth above 3 percent) unemployment did not improve much.
- High proportion of long-term unemployed; skills degradation and disengagement from active job search are highlighted.
- Unemployment is concentrated among sub-groups: women, youth, older workers, ethnic minorities, and people in less developed regions.
- Labor force participation for working age population with low level of education (primary complete or less): 29 percent of women participate and more than 70 percent of men participate.

### Diagnostic Findings — Demand and Supply Side Indicators
- Wages and productivity
  - Gross wages and productivity position: Macedonia is in the lower third of Central and Eastern European countries by average gross wages; productivity per worker per hour is also at the lower end.
  - Regression relationship from Figure 2: y = 0.4085x + 264.09 (Gross Wages (Euros) vs. Productivity (per worker per month), 2011).
  - Recent trend noted: increasing salaries accompanied by productivity decreases; public sector wage increases are a driving factor and may crowd out skills and induce a “queuing” effect for public sector jobs.

- Employment protection legislation (EPL)
  - Macro-level EPL is in line with or more flexible than peers, but pockets of high regulation and low flexibility remain (example: mandatory prior registration of overtime work).
  - Discretionary application of regulation could create uncertainty and discourage demand; different population segments may be disproportionately affected.

- Reservation wages, social assistance, and unemployment benefits
  - Unemployment benefits are not assessed as overly generous (Figure 5); social assistance spending (cash transfers) does not appear to provide large disincentives to work (Figure 4).
  - The role of remittances and household arrangements suggests additional unquantified drivers of reservation wages; further research is recommended.

- Tax wedge and labor taxation
  - The tax wedge is below median and has been decreasing since 2009.
  - Reforms reduced social contribution rates paid by companies; implications include lower wage costs but fiscal pressure on social funds (notably the Health Fund).
  - Taxation is uneven: low wage earners and second-earners (mostly women) face higher effective tax burdens, creating disincentives for formal labor force participation.

- Business environment
  - Substantial improvements in the business environment in the late 2000s; Macedonia ranked 23 out of 185 countries in the World Bank’s Ease of Doing Business for 2013.
  - Reductions in red tape and improved indicators have improved operating conditions and attractiveness to foreign investors, supporting job creation.

### Labor Market Responsiveness and Structural Constraints
- Okun’s law and elasticity of unemployment to output
  - Comparative patterns: Balkan countries show a wide dispersion in the GDP growth vs unemployment change relationship; New Member States (NMS) show a more concentrated pattern with a steeper regression slope (greater elasticity).
  - Macedonia’s series over the past 15 years appear "de-linked" — employment/unemployment is relatively unresponsive to output changes.
  - Implication: structural factors, not cyclical responsiveness alone, likely explain the high measured unemployment.

### Unfinished Transition — Convergence Channels and Constraints
- Late integration and convergence in the Balkans relative to the EU.
- Income convergence channels highlighted: cross-border capital flows, labor flows (emigration), and fiscal transfers/developmental aid.
- Structural legacy issues contributing to labor market outcomes include late transition, early outflow of a large pool of skilled workers, and incomplete effects of recent structural reforms.

Prepared by Alexis Meyer Cirkel (EUR)

*Source: IMF staff report content (June 3, 2013) — Former Yugoslav Republic of Macedonia: "Will Structural Transformation Allow Labor Market Convergence?"*

### 11.      The first channel of convergence, longer term capital inflows, has been relatively

### 11.      The first channel of convergence, longer term capital inflows, has been relatively closed for Macedonia until recently.

### A. Capital inflows, FDI, and structural transformation
- Finding: Macedonia accumulated a low stock of FDI per capita relative to many New Member States (Figure 10), reflecting prolonged sidelining of the Balkans in regional FDI inflows.
- Finding: Contributing factors included slower allowance of structural transformation by many NMS and the disruptive consequences of the breakup of former Yugoslavia, which deterred foreign and local investors through uncertainty about institutions.
- Finding: Structural transformation in Macedonia is underway but unfinished, in part because of the lack of FDI until very recently.
- Finding: Macedonia still has a relatively large dependence on agricultural output; a considerable portion is achieved through very small scale or subsistence farming (Figure 11).
- Finding: A considerable FDI pipeline has emerged recently due to improvements in ease of doing business, low labor costs, and a relatively stable macroeconomic environment, but the impact will be limited without improved technology absorption capacity (Figure 19).

### B. Labor market dynamics, informality, and human capital loss
- Finding: About a quarter of the total workforce is employed in the grey economy, and among younger workers almost half of their employment is informal (Figure 12).
- Finding: Labor mobility has been relatively open and produced a considerable loss of important human capital: Macedonia experienced substantial skilled emigration during the 1990s (Figures 15 and 16).
- Finding: Brain drain estimates (2000/01 census based) indicate Macedonia was particularly hard hit among Balkan countries, reducing the domestic pool of qualified workers and slowing structural change in high productivity sectors.
- Finding: Primary education enrollment is considerably below income peers and NMS; secondary and tertiary enrollment is in line with income peers but below competitors for FDI (Figure 17).
- Finding: Education system effectiveness has gaps as measured by international assessments of pupils’ skills (Mojsoska‐Blazevski, 2013), affecting skill replenishment and technology absorption.

### C. Remittances and labor supply incentives
- Finding: Large émigré population generates sizeable remittance inflows. Private transfers stood above 15 percent in 2011 (noting potential BoP recording issues).
- Finding: Empirical evidence on remittances’ effect on labor force participation is mixed; some disincentives or more relaxed jobseeker engagement should be at play.

### D. FDI, technology absorption, clustering, and spillovers
- Finding: Recent empirical literature finds a consistently significant impact of FDI on economic growth across country groups and time spans (Aizenman et al 2011).
- Finding: FDI provides foreign savings, technology, know-how, and marketing channels, and typically has a medium-to-long-term horizon conducive to technology import.
- Finding: Spatial clustering and interlinkages (e.g., development zones) are crucial to promote global production networks and technology spillovers (e.g., Qingdao example in Kim 2011).
- Finding: World Bank firm-level technology absorption index shows Macedonia performs poorly in capacity to absorb technology compared to NMS and income peers (Figure 19).
- Finding: A bivariate plot of FDI stock per capita versus unemployment rate (Figure 20) shows an empirical relationship suggesting FDI may be associated with lower unemployment, though causality is not established. Regression lines shown:
  - y = -0.1704x + 0.5053 (Okun's Law, Balkans: All Data)
  - y = -0.3146x + 1.0457 (Okun's Law, NMS: All Data)
  - y = -0.9677x + 21.772 and y = -5.855ln(x) + 25.202 (Unemployment rate vs. FDI, 2011)

### E. Export structure and implications for complexity
- Finding: Macedonian exports in 2010 remain heavily reliant on primary products: “browns and blacks” (mining and metals) and “yellows and oranges” (agriculture); few “blues” (machinery, electrical components, cars) (Figure 13).
- Finding: Slovenia’s 2010 export composition contrasts starkly, showing more advanced export diversity and higher value-added products with more “blues and pinks” (Figure 14).

### F. Conclusions and policy recommendations
- Finding: Necessary improvements in the business environment, infrastructure buildup, and a strong FDI pipeline position Macedonia to experience faster structural change and income convergence vis-à-vis the EU.
- Main challenges (threefold; verbatim):
  - First, maintenance of macroeconomic stability, and further improvements of institutional capacity and legal certainty is crucial. The confidence of the business community must be fostered by avoiding discretionary policy and making sure that macroeconomic and fiscal policy are geared towards supporting growth.
  - Second, while attracting FDI is key, it is equally important to tie it to local production chains and to enable technology to spill over. For that purpose technology absorption capacity needs to be fostered trough increased linkages between industry, research institutes, capacity training centers, etc.
  - Third, educational gaps need to be closed. The considerable emigration of highly educated citizens still holds back output potential. Replenishing this pool of lost skills by ensuring attendance and high standards of local schools and universities is very important. Particularly a primary and secondary education of quality for all income groups has proven to be crucial in allowing technology absorption and fast economic development.
- Policy recommendations (implied from text):
  - Foster FDI that is linked to local production chains and encourages technology transfer and spillovers via clusters, research-industry linkages, and training centers.
  - Strengthen institutional capacity, legal certainty, and maintain macroeconomic stability to sustain business confidence and growth-supportive fiscal policy.
  - Improve education enrollment and quality—especially primary and secondary education—to rebuild human capital and enhance technology absorption.
  - Address informality by improving incentives and institutional capacity to move workers and firms from the grey economy into the formal sector.
  - Improve technology absorption capacity at the firm level to maximize benefits from the FDI pipeline.

*International Monetary Fund — FORMER YUGOSLAV REPUBLIC OF MACEDONIA, extracted chapter content.*

### 1.      Financial intermediation is traditionally bank-based in Macedonia. Banks make up some

### Financial intermediation is traditionally bank-based in Macedonia

### Overview
- Banks constitute "some 89 percent of the financial system."
- Second pillar (funded) pension funds comprise "4 percent of the system."
- Insurance companies: "87 percent" of insurance assets related to property and casualty; life insurance assets make up "13 percent."
- Other financial sector parts (leasing, securities markets) have been residual in recent years.
- The paper's objectives:
  - Benchmark recent trends against other European transition countries.
  - Empirically disentangle the influence of credit supply and credit demand on weak credit performance using a simple cointegration model.
  - Attempt to formulate recommendations aimed at enabling the banking sector to play an enhanced role in financing convergence.

### Banking system structure and concentration
- Total number of banks: "16."
- Large banks: "3" banks each with balance sheet of "€1 billion equivalent or more," together representing a "62 percent" asset market share.
- Medium-sized banks: "6" banks with balance sheets between "€182 and €440 million equivalent," representing "some 28 percent" asset market share.
- Small banks: "7" institutions, together representing "just under 10 percent" market share.
- Ownership: largely foreign-owned; foreign-owned banks operate as standalone subsidiaries under domestic regulation and with their own balance sheets.
- Noted structural features:
  - Low state ownership (only Macedonian Bank for Development Promotion (MBDP) is state-owned).
  - High foreign penetration.
  - Relatively large number of banks given population and economy size, but high concentration among the largest institutions.
  - Market concentration measured by top-3 banks’ asset share is "somewhat higher than in peers."
  - Small banks often loss-making or barely profitable (negative ROE and ROA) and inefficient (relatively high cost-to-income ratios).

### Prudential indicators and performance
- Capital adequacy ratios: described as "high," below other Balkan countries but slightly above more developed Central European banking systems.
- Liquid assets: "29.4 percent" of assets at end-2012.
- Profitability:
  - Profitability has been deteriorating since the onset of the crisis.
  - Decline pace comparable to other Balkan countries, more gradual than Romania and Bulgaria.
  - Low interest margins contribute; interest margins "decreased more than in peers" and remain significantly below comparable banking systems.
  - Increased NPL provisioning has significantly contributed to profitability deterioration.
- Nonperforming loans and provisioning:
  - NPLs almost doubled since 2007, to reach "11.7 percent of total loans in February 2013."
  - Loan loss provisions remain larger than the stock of NPLs in Macedonia due to high provision charges and modest provisions against performing loans.
  - High provisioning depresses current profitability but increases buffers against shocks and may boost future profits if recoveries occur.

### Credit developments and financial deepening
- Historical pattern:
  - Late 1990s and early 2000s: weak credit to the private sector; labelled a “sleeping beauty.”
  - Mid-2000s: credit growth picked up, reaching "44 percent y-o-y in May 2008."
  - Late 2008 onward: sharp downturn during crisis; credit growth remained very weak thereafter.
- Private sector credit to GDP:
  - "45 percent in 2011" and "47.5 percent in 2012."
  - Compared with peers: "55 percent" in other Balkan countries, Romania and Bulgaria; "67 percent" in Central Europe.
  - Increase of "some 10 percentage points between 2007 and 2011" noted.
- Composition of credit:
  - Relatively low share of credit to households, notably lower proportion of mortgage credits.
- Financing structure resilience:
  - Loan-to-deposit ratio has been "well below 1" since the onset of the crisis.
  - Strong deposit growth and conservative lending practices limited reliance on external wholesale parent financing; no deleveraging from parent-group stress occurred.
  - Slower mortgage market development associated with more moderate real estate price hikes and a more modest increase in NPLs during the crisis.
- Euroisation:
  - Extent of euroisation has been "kept in check" compared to peer countries with fixed exchange rate regimes.

### Causes: supply-side and demand-side factors
- Demand-side considerations:
  - During the mid-2000s boom, household and corporate financial reserves increased and collateral values rose, facilitating borrowing.
  - Since the crisis, economic agents used substantial parts of their financial reserves, reducing creditworthiness and unpledged collateral.
  - Accounting practices weakened or pre-existing weaknesses surfaced, reducing credit demand and quality.
  - Conclusion: real economic developments likely had a positive causal effect on credit growth (i.e., strong real activity increased credit demand; weak real activity reduced it).
- Supply-side considerations:
  - Banks may have curtailed credit supply due to strong risk aversion and a preference for liquidity post-crisis.
  - Other supply-side factors possibly affecting credit availability: monetary policy stance, changes to the banking sector financing model, varying degrees of risk aversion, and longer-standing structural impediments in the financial sector.
  - Conclusion: credit availability may have had a positive causal effect on economic growth (i.e., greater credit availability could have bolstered consumption and investment during the boom; contraction in credit availability may have dampened growth).
- Empirical approach:
  - The paper proposes to empirically assess the link between credit availability and private consumption, focusing on their dynamic adjustment following a shock, using a simple cointegration model.

### Identified structural impediments and policy focus areas
- Long-standing structural impediments exist on both the financial and real sides of the economy, constraining financial depth.
- Key structural constraints highlighted:
  - High market concentration among top banks.
  - Presence of a long tail of small, often loss-making banks with limited intermediation capacity.
  - Relatively late development of mortgage and household lending markets.
  - High provisioning practices affecting current profitability but strengthening buffers.
- The paper frames policy effort toward:
  - Disentangling supply and demand drivers of weak credit growth.
  - Addressing both supply-side obstacles in the financial sector and demand-side weaknesses in the real economy.
  - Formulating recommendations to enable the banking sector to play an enhanced role in financing convergence.

_This summary is based solely on the provided IMF text excerpt._

### 20.      Assessing whether credit has been driving economic growth or whether economic

### 20.      Assessing whether credit has been driving economic growth or whether economic

### Cointegration analysis and dynamic interactions
- Study period and variables:
  - Quarterly data over the years 2003–12.
  - Variables: nominal private consumption and total loans to households.
- Methodology:
  - Test for non-stationarity and for existence of a stable, long-term (cointegration) relationship.
  - Estimate an error-correction model to describe adjustment following deviations from the dynamic equilibrium.
- Key empirical findings:
  - Both the nominal private consumption and outstanding credit to households series are found to be non-stationary and linked by a cointegration relationship.
  - In case of short-run deviations from the long-run equilibrium, the relative signs and magnitudes of “speed-of-adjustment” coefficients suggest that adjustment primarily falls on nominal private consumption.
  - Interpretation: credit to households and private consumption co-move over the business cycle; following common shocks, private consumption adjusts to the new level of available credit, whereas credit does not adjust to consumption.

### Implication: unsatisfied demand for credit and limits of the analysis
- Findings support the hypothesis that there may be some unsatisfied demand for credit in the economy.
- The cointegration and error-correction results do not identify the causes behind insufficient credit supply.
- The subsequent analysis reviews candidate impediments that may contribute to the observed bottleneck in credit developments.

### Analysis of potential credit constraints
- Conceptual distinction:
  - Demand-side (real) constraints: consubstantial to economic growth; policy responses overlap with general growth-promoting policies.
  - Supply-side (financing) constraints: more exogenous to general economic developments; may be alleviated by specific policies.

#### Monetary policy and regulation
- Policy rate developments:
  - Policy rates decreased from a peak of 9 percent in 2009 to 3.5 percent currently.
  - Lending rates slowly and partially followed this movement.
- Liquidity and deposits:
  - Starting from outstanding deposits already exceeding loans in 2009, growth of deposits outpaced lending, resulting in excess liquidity.
  - Excess liquidity led to substantial increases in the outstanding volume of central bank securities.
  - Government tapped the domestic bond market for increasing amounts, with substantial bank participation primarily at the short end of the curve.
- Conclusion:
  - Excess liquidity suggests monetary policy has not been too tight and therefore cannot be deemed a factor constraining credit.

#### Prudential regulation
- Macroprudential stance:
  - Policies tightened at onset of the crisis in line with peer countries.
  - Reserve requirements were raised to curb credit growth and to incentivize saving in domestic currency.
  - Liquidity requirements set at full coverage of 30 and 180- day liquidity after a transition period.
  - Regulations remain in place but were loosened only modestly over the last few years.
- NBRM actions:
  - The NBRM has recently reviewed and is in the process of revising policies on reserve requirements, collateral in possession, and provisioning.
  - Gradual policy changes may free up modest funds and encourage banks to lend, probably only at the margin.
- Non-performing loans (NPLs):
  - NPLs represent close to 12 percent of total loans and are on average fully provisioned.
  - Full provisioning removes the drag from NPLs on credit growth observed in other countries.

#### Deleveraging and banks’ financing model
- Absence of deleveraging impact:
  - Because banks traditionally finance through deposits, the general retrenchment of wholesale financing did not affect the banking system much.
  - No substantial changes in lending practices were observed.

#### Risk aversion
- Observations:
  - Risk aversion among banks increased during the crisis and remained high.
  - Many international banking groups operating in Macedonia experienced funding strain or recapitalization at the group level, leading to increased caution.
  - Evidence: banks giving up some growth and profits to stay more liquid.
- Policy implications:
  - Practical measures to mitigate increased risk aversion are not straightforward.
  - Policies aimed at maintaining macroeconomic stability are necessary to address risk aversion.

#### Characteristics of the banking system
- Small banks:
  - Substantial number of small banks may have affected credit on the margin due to low profitability.
  - Takeovers or mergers could enhance efficiency, but total market share of those banks amounts to under 10 percent; overall impact would be insignificant.
- Competition:
  - Despite relatively high number of banks, the sector is characterized by a high level of concentration.
  - Several medium-sized banks competing more aggressively have seen portfolios grow rapidly, which could indicate previously limited competition; increased competition could boost credit provision.

#### Structural factors inhibiting credit supply
- Transition-related impediments identified:
  - A cap on interest rates.
  - Inefficient bankruptcy procedures.
  - Weak accounting practices in small and medium-sized enterprises (SMEs).
  - Deficiencies in collateral valuation.
- Interest rate cap:
  - Interest rates are capped at 8 and 10 percentage points above the policy rate for household and corporate loans, respectively.
  - Potential effects:
    - Bunching of rates close to the cap, undermining rate differentiation based on creditworthiness.
    - Reduced access to finance for riskier borrowers and projects.
    - Cap is reset every 6 months; may affect monetary policy transmission during a tightening cycle and temporarily squeeze interest rate margins.
- Bankruptcy procedures:
  - Characterized by lengthy procedures often dragging for years.
  - Resolution process unpredictable due to inefficient court and bankruptcy administration system.
  - Increased uncertainty over future cash-flows from corporate loans likely translates into lower credit supply at any given rate.
- Corporate accounting practices in SMEs:
  - Large firms generally follow international accounting practices.
  - Many SMEs apply local accounting rules that fall short of standards.
  - Lack of reliable financial accounts reduces banks’ basis for lending decisions, increasing perceived risk and lowering supply of credit.
- Collateral valuation:
  - Banks mostly lend against collateral; valuation is therefore crucial.
  - No reliable time series data on prices exist even for liquid market segments, complicating proper collateral valuation.

### Policy recommendations and conclusions
- Streamline bankruptcy procedures:
  - Authorities are reviewing bankruptcy legislation to shorten procedures and introduce a framework for speedy restructuring of bankrupt enterprises.
  - Plans include scaling up training for bankruptcy administrators and addressing efficiencies in the court system.
  - Judiciary could benefit from training to increase understanding of economic issues.
- Remove or amend interest rate cap legislation:
  - Abolishing or amending the cap would allow proper credit risk differentiation among riskier borrowers.
  - Enables banks with good credit assessment mechanisms to better price risk and broaden access to finance.
  - To safeguard borrowers, complement changes with better targeted consumer protection, in line with regulation in European peers.
- Improve corporate accounting practices and collateral valuation:
  - Better accounting by SMEs would allow banks to consider lending against business plans rather than just collateral.
  - More realistic collateral valuations would lower credit risk.
  - Improvements require training for SMEs and their domestic auditors.
  - To improve valuation methods, data collection could be improved; a recommended start is for the cadastre to record and publish real estate sales transactions to build time series data for proper modeling.
- NBRM provisioning and reserve requirement changes:
  - Recent changes to provisioning rules for collateral-in-possession and reserve requirements, and comprehensive amendments to rules governing NPL provisioning, will become effective in 2014.
  - Objectives: force banks to progressively release collateral and give banks more leeway in provisioning new loans.
  - Expected effects on credit: marginal positive effects.
- Overarching conclusion:
  - Within a context of weak credit growth and low financial deepening, a few structural policy measures could enhance credit supply.
  - Low-cost steps may unlock marginal impediments to credit supply—stemming from excess risk aversion by banks or institutional/capacity constraints.
  - Increased credit could contribute to growth by better financing both consumption and investment needs.

### Appendix 1: Selected banking-sector indicators (excerpted values)
- Domestic credit to private sector:
  - Macedonia: 35.3 (2007), 44.9 (2011)
- Domestic credit to households:
  - Macedonia: 13.9 (2007), 17.7 (2011)
- Mortgage lending (percent of household lending):
  - Macedonia: 11.2 (2007), 21.7 (2011)
- Share of FX-loans to total loans:
  - Macedonia: 54.7 (2007), 59.2 (2011)
- Deposit euroisation: share of FX-deposits to total deposits:
  - Macedonia: 43.8 (2007), 48.7 (2011)
- Loan-to-deposit ratio (percent):
  - Macedonia: 0.8 (2007), 0.9 (2011)
- CAR:
  - Macedonia: 17.0 (2007), 16.8 (2011)
- ROA:
  - Macedonia: 1.8 (2007), 0.4 (2011)
- ROE:
  - Macedonia: 15.0 (2007), 3.4 (2011)
- Non-performing loans (percent of total loans):
  - Macedonia: 7.5 (2007), 9.5 (2011)
- GDP (Billions of euros):
  - Macedonia: 6.0 (2007), 7.6 (2011)
- Y/Y GDP growth rate, average over last 5 years:
  - Macedonia: 4.6 (2007), 2.2 (2011)
- GDP per capita (euros, PPP):
  - Macedonia: 7631.5 (2007), 8784.1 (2011)
- GDP per capita (euros):
  - Macedonia: 2916.8 (2007), 3055.3 (2011)

*Source: IMF staff analysis in _cr13179.*

### Appendix 2: Cointegration Analysis of Credit to Households

### Appendix 2: Cointegration Analysis of Credit to Households and Nominal Private Consumption Developments Over the Period 2003–12

### Methodology
- Sample: quarterly data over the period 2003Q1 to 2012Q4.
- Variables:
  - CRHH: total loans to households (constructed from monthly NBRM loan categories).
  - NCON: nominal private consumption (quarterlies from State Statistical Office).
- Primary approach: Johansen (1995) VECM procedure; robustness check using two-step Engle-Granger (1987) methodology.
- Estimation steps:
  - Step 1: Unit root tests on each series to assess integration order; lag lengths selected by information criteria.
  - Step 2: Estimate specifications of the VECM functional form:
    - X is the bivariate vector [CRHH, NCON]'.
    - D includes possible deterministic elements (time trend or constant restricted to cointegrating vector).
    - Number of lags determined by step-down procedure using likelihood ratio tests and information criteria, with cointegrated least squares to ensure residuals are Gaussian white noise.
    - Trace tests used to determine rank of coefficient matrix and existence of cointegrating relationship.
  - Step 3: Re-estimate specifications with a detected long-run relationship after normalization of the cointegrating vector using the variable found to be less ‘weakly exogenous’; select final model by log-likelihood maximization.
- Engle-Granger two-step: test stationarity of residuals from the long-term relationship, then estimate a difference equation plugging estimated long-run equilibrium lagged one period on the RHS.
- Granger-causality tests used to inform provisional normalization and weak exogeneity (tests not reported in full).

### Principles of interpretation
- Slope coefficient β:
  - Measures magnitude of long-term co-movement between CRHH and NCON.
  - Higher β indicates stronger relationship over the sample, accounting for deterministic trends or cointegrating vector.
- Speed-of-adjustment vector α:
  - Captures how each series corrects short-term deviations from the cointegrating relationship following a common shock.
  - Absence of adjustment by a variable interpreted as that variable being most ‘weakly exogenous’ (leading); the other variable bears adjustment.
  - For an error-correction mechanism: the coefficient entering the equation for the normalized variable needs to be significant and negative, and/or the coefficient entering the equation for the other variable needs to be significant and positive.

### Results — statistical findings and key coefficients
- Stationarity and causality:
  - Both CRHH and NCON appear to be non-stationary over 2003Q1–2012Q4; the null hypothesis of a unit root cannot be rejected for either series.
  - Granger-causality tests indicate the null that one series does not Granger-cause the other can be rejected for both at the 1 percent significance level; CRHH shows causality at an even lower significance level, supporting use of NCON as provisional dependent variable and for normalization.
  - Variance analysis suggests CRHH explains a large and increasing share of NCON variance following a shock.
- Cointegration evidence:
  - Trace statistics for the coefficient matrix significant at the 1 percent level indicate existence of a cointegrating vector linking CRHH and NCON.
  - Engle-Granger residual ADF test: null of a unit root in residuals of the long-term relationship is rejected at the 5 percent level.
  - A restricted trend is detected, implying the long-run equilibrium relationship should be interpreted for ‘de-trended’ series once common stochastic trend is removed.
- Long-run slope:
  - Slope coefficient measuring long-term interplay is found to be about 0.45 (0.5 in the two-step Engle-Granger methodology).
- Speed-of-adjustment (error-correction) coefficients:
  - When normalizing on NCON:
    - Speed-of-adjustment coefficient in the NCON equation is strongly significant and negative.
    - Speed-of-adjustment coefficient in the CRHH equation is not significant.
    - This indicates nominal private consumption (NCON) absorbs the bulk of adjustment after departures from long-run equilibrium, while credit to households (CRHH) does not adjust significantly.
  - Estimated magnitude:
    - Johansen (VECM) speed-of-adjustment for NCON: -2.64 (reported as -2.64 with significance indicated).
    - Engle-Granger speed-of-adjustment for NCON: -2.39 (reported as -2.39 with significance indicated).
  - Interpretation: these rather high negative values imply corrections tend to “overshoot” the path of return to equilibrium, signaling an imperfect error-correction process.
  - Likely cause of overshooting: use of quarterly data while a significant part of adjustment occurs at higher frequency given micro-economic nature of credit transactions.
- Selected statistics reported in Table 2 (as presented):
  - Johansen (VECM) trace test statistic: 38.154*** and 30.452*** (as reported in table layout).
  - Restricted linear trend reported alongside speed-of-adjustment: -2.637*** and -0.025 (as presented).
  - Engle-Granger (two-step procedure) entries include: -2.514**, 30.505***, -2.388***, -0.062 (as presented).
  - Reading: *, **, *** indicate significance at the 10%, 5% and 1% thresholds, respectively.
  - In the trace test, null hypothesis is no cointegrating vector against alternative that there is one. In the ADF tests, null hypothesis is that residuals of the long-term relationship have a unit root.

### Interpretation and policy-relevant implications
- Main economic interpretation:
  - The evidence points to a long-term dynamic equilibrium linking credit to households (CRHH) and nominal private consumption (NCON) over 2003–2012, but the strength of the long-run link (slope ≈ 0.45–0.5) indicates substantial role for other factors in driving dynamics.
  - Adjustment dynamics are asymmetric: nominal private consumption adjusts to restore equilibrium following shocks to credit, while credit does not show significant short-run adjustment toward equilibrium.
- Implication for constraints on financial deepening:
  - Overall conclusion: results point to the prevalence of credit supply constraints, as opposed to insufficient aggregate demand, in curtailing financial deepening in Macedonia over the period 2003–2012.
- Data and inference caveats:
  - Small-sample considerations: use of a 40-point time series (quarterly observations from 2003Q1 to 2012Q4) implies small-sample distortions may affect estimates.
  - Frequency mismatch: quarterly aggregation likely causes part of the apparent overshooting in error-correction; true adjustment may occur at higher frequency.

*Source: Appendix 2, "Cointegration Analysis of Credit to Households and Nominal Private Consumption Developments Over the Period 2003–12" (IMF staff analysis, as presented in the supplied content).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13179.pdf_