## _cr15243

## Source details

**Canonical URL:** [_cr15243](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15243.pdf)

## Other formats

- [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15243.pdf.md)
- [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15243.pdf.json)

---

### Indicators of Export Performance—Some Definitions
- Context and objectives
  - For a small open economy such as FYR Macedonia, improving export competitiveness is critical to bolster economic growth and reduce unemployment.
  - Short- to medium-run objective: strengthen the trade balance and reduce dependence on remittances from migrant workers.
  - Long-run objective: technological and managerial spillovers from foreign exporting firms are expected to foster backward linkages to local producers and integrate the domestic tradable goods sector into global supply chains.
  - Attracting foreign direct investment (FDI) and building export capacities have been central to authorities’ economic policy over the last decade.
- Export shares and growth
  - Exports of goods and services have represented between 30 and 45 percent of nominal GDP.
  - Exports stemming from the Technological Industrial Development Zones (TIDZ) have been growing at double digits in recent years, representing about 40 percent of total exports in 2014.
- Contribution to GDP growth
  - Exports have contributed more to GDP growth in FYR Macedonia than in other Balkan countries.
  - Net exports have been a negative contributor to growth (notably due to high import content of new investments and low-end assembly production), but exports provided major contributions to real growth and helped pull the economy out of the short-lived recession in 2012.
- Revealed Comparative Advantage (RCA) and product mix
  - Main comparative advantages remain in intermediate and consumer goods.
  - RCA has diversified toward more capital-intensive goods; remained highly competitive in textiles, beverages, tobacco, and food products; and managed to dramatically push its advantage in chemical products.
- Export diversification and quality
  - Overall export product diversification (intensive margin/concentration) remained below that of other Western Balkan (WB) countries and New Member States (NMS) until 2010, despite some improvement since 2008.
  - Export partner diversification remained stable during 2000–2010 and may have decreased recently due to replacement of neighboring partners by a limited subset of ‘core’ euro area economies.
  - Overall improvement of export quality during 2000–2010 has been less pronounced and remains below average levels observed in NMS and WBs.
  - The gap between quality provided by Macedonian exports and that demanded by importing destinations has narrowed but remains significant.
  - At a disaggregated level, room for quality upgrade appears warranted even for successful export products such as automobile components.
  - When assessed by percentile rankings, the quality of exports in manufacturing and chemical sectors is just average.

### Constant Market Share Analysis (CMSA) — findings and numeric decompositions
- Methodology notes
  - Product disaggregation at SITC 1-digit and market groups (EU-28; Emerging Europe outside EU; rest of world).
  - Decomposition components: market growth effect; commodity composition effect; market distribution effect; competitiveness effect.
- Aggregate CMSA summary (2000–07 vs 2008–14) — textual findings
  - 2000–07: FYR Macedonia’s exports underperformed relative to the comparator group; market growth effect higher than 100 percent (if relative market share constant, exports should have been higher by 91 percent). Underperformance driven by lower demand commodity composition and a large competitiveness gap.
  - 2008–14: FYR Macedonia’s exports marginally overperformed comparator countries; market growth effect lower than 100 percent. Positive commodity composition and market distribution effects slightly outweighed a narrowing but still negative competitiveness effect.
  - Overall: export performance improved dramatically since 2007 relative to the comparator group, driven by faster demand commodity composition and a much lower competitiveness gap, which nonetheless remains sizeable and calls for further enhancement of export quality and efficiency.
- CMSA numeric table (as presented)
  - 2000-2007 / 2008-2014
  - Market Growth Effect19199
  - Commodity Composition Effect-2614
  - Market Distribution Effect11572
  - Competitiveness Effect -180-84

### Role of domestic policies and FDI in export success
- FDI trends and role
  - FDI picked up since the mid-2000s; inflows were negligible until 1998 and increased moderately until the global crisis.
  - Majority of FDI inflows took place in the tradable sector, supporting exports.
  - Privatizations and acquisitions (example cited: acquisition of national telecom operator by Magyar Telekom in 2001) contributed to earlier FDI flows.
  - Policy moves since the mid-2000s aimed to improve the business environment and provide incentives to attract FDI in tradable sectors.
- Tax and fiscal policy
  - FYR Macedonia offers a flat 10 percent tax on personal income and profits.
  - Implementation of these measures, combined with relatively low revenue efficiency by regional standards, has contributed to a continuous decline in government-revenues-to-GDP ratio (in contrast to other European emerging economies).
- Key implications and reform areas
  - Improve export product quality across sectors, including most successful export products, to narrow the remaining competitiveness gap.
  - Strengthen spillovers from foreign investment–led export sector into the domestic tradable sector to foster backward linkages.
  - To deepen integration with European supply chains and foster backward linkages, address:
    - infrastructure improvements;
    - further reforms to improve skills; and
    - enhancements to the operating environment for the domestic private sector.

*Prepared by Shan Chen, Marc Gerard and Patrick Gitton. Source: IMF staff analysis in the chapter "Indicators of Export Performance—Some Definitions."*

---

### FDI performance, composition, and spillovers (Against the backdrop of a low potential)
- FDI stock and comparative position
  - Stock of inward FDI is at around 50 percent of GDP.
  - FDI stock is above Albania and Bosnia, but below Serbia.
  - UNCTAD’s Inward FDI Potential Index (2011) ranks FYR Macedonia among the lowest in the region in terms of FDI potential, mostly due to lack of natural resources and market attractiveness constrained by small size.
  - UNCTAD country ranking for MKD (Inward FDI Potential Index, 2011): MKD 114 87 84 130 130 (Market attractiveness; Labour cost and skills; Infrastructure; Natural resources; Overall rank).
- Sectoral composition and recent trends
  - Recent FDI inflows have been greenfield and concentrated in the export-oriented manufacturing sector (as opposed to financial and transport sectors in the early 2000s).
  - Since 2009 a gradual shift from services to industrial products has been observed.
  - Industrial FDI expanded into technology-intensive industries, notably automotive components; major global players in automotive components have become FYR Macedonia’s main exporters.
  - Other sectors attracting FDI include construction materials, residential construction, glass, and food processing.
  - Drivers of the structural shift in greenfield FDI include low labor costs; various incentives; improved business environment; geographical proximity to assembly plants in Central and Western Europe and Turkey; duty-free access to the European market.
- Spillovers and constraints
  - Spillovers from FDI-led export sectors to the domestic economy have been limited so far.
  - Backward linkages between big foreign investors and domestic suppliers have been limited because many local producers cannot meet technical and safety requirements needed to export to the EU.
  - Small and medium-sized domestic firms mainly produce for exports to neighboring countries, with limited integration into European supply chains.
  - Despite significant export capacity build-up, the domestic tradable sector remains insufficiently developed.
- Constraints limiting backward and forward linkages (selected figures)
  - Firms face credit and liquidity constraints due to high collateral requirements and delays in collecting payments (on average requiring four months to collect claims).
  - Private sector debt has risen fast since mid-2000s; cross-country analysis shows FYR Macedonia’s private sector debt is high when compared to fundamentals.
  - Labor and skills shortages:
    - unemployment rate of nearly 28 percent;
    - automotive firms have difficulty filling management, technical, and lower-skill positions;
    - export-oriented apparel industry cites obsolete university curricula as a cause of skilled labor shortages.
  - Innovation and R&D capacity:
    - public R&D expenditures accounted for only 0.22 percent of GDP in 2012;
    - R&D expenditure is almost exclusively government-funded; brain drain in technical and engineering occupations remains a major concern.
- Policy lessons and recommendations
  - Fiscal room for incentives is largely exhausted given low revenue levels.
  - Further improvements to fundamentals (labor skills and infrastructure) and the operating environment for domestic private firms are needed to attract additional FDI and strengthen linkages.
  - Specific priorities:
    - Easing access to formal finance (address bad debts, shorten payment delays, tackle high collateral requirements).
    - Boosting higher education and skills (address emigration of highly educated citizens, improve school/university standards, develop technical and managerial skills, promote knowledge exchange programs with foreign investors).
    - Improving infrastructure to enhance connectivity, with projects assessed in a cost-benefit framework and consistent with sustainable public debt levels.

### FDI incentives (Box 2 summary)
- Technological Industrial Development Zones (TIDZs) established; first operational company: Johnson Controls (automotive components) at end of 2007.
- Four operational zones: Skopje 1, Skopje 2, Stip, and Kicevo; ten others at various stages of development.
- Incentive features in free economic zones include:
  - 10-year corporate tax holiday;
  - no customs duties and VAT on imported raw materials, equipment & construction materials;
  - 0% personal income tax for 10 years;
  - 0% property tax;
  - 0% excise taxes;
  - free connection to utilities;
  - up to EUR 500,000 subsidies for construction costs;
  - ‘green’ customs channel at the border for expeditious export to EU countries;
  - long-term land lease for a period of up to 99 years;
  - grants for training and job creation.

---

### Appendix I — Constant Market Share Analysis (methodology and aggregates)
- CMSA methodology and decomposition
  - Market growth effect: increase in a country’s exports assuming exports grow at the same rate as a comparator group, in percent of its actual export increase. If below 100 percent, the country is overperforming relative to comparators. If higher than 100 percent, the country is underperforming.
  - Decomposition components:
    - (i) commodity composition effect;
    - (ii) market distribution effect;
    - (iii) competitiveness effect.
  - Decomposition formula for Δx provided in the source text (symbols and definitions preserved).
- Definitions and notes
  - r = percent change in the overall exports of competitor countries
  - r_i = percent change in competitors’ exports of SITC product i
  - r_ij = percent change in competitors’ exports of SITC product i to market j
  - x_i = FYR Macedonia’s exports of product i at the beginning of the period
  - x_ij = FYR Macedonia’s exports of product i to market j at the beginning of the period
  - J_1-3 = EU-28, Emerging and Developing Europe, World
  - Emerging Europe defined as: Albania, Bosnia and Herzegovina, Bulgaria, Croatia, Hungary, Kosovo, Lithuania, Montenegro, Poland, Romania, Serbia, and Turkey.
  - Product disaggregation at STIC 1-digit level (9 categories).
- FYR Macedonia: CMSA results (2000–2014, subperiods 2000–2007 and 2008–2014)
  - Table fragments and reported aggregates (Millions of US dollars) as presented (excerpted SITC lines and "Total" aggregates preserved in source format).
  - Reported effect ratios and metrics (Percent):
    - Market Growth Effect=[1]/[4]17419199
    - Commodity Composition Effect=([2]-[1])/4-11-2614
    - Market Distribution Effect=([3]-[2])/[4]10111572
    - Competitiveness Effect=([4]-[3])/[4]-164-180-84
  - Coverage: Periods shown: 2000-2014, 2000-2007, 2008-2014; Comparator: EM Europe (Emerging Europe).
  - Source: WITS Database; and IMF staff calculations.

---

### Fiscal Rules to Ensure Sustainability — key context, recommendations, and illustrative paths
- Fiscal context and trajectory
  - Public debt almost doubled since 2008 and is projected to reach 54 percent of GDP by 2020 in absence of adequate measures.
  - Historical path:
    - General government gross debt: 23 percent of GDP in 2008, 30 percent of GDP in 2011, and 44 percent in 2014.
    - Overall fiscal balance: deficit of 0.9 percent of GDP by end-2008, increased to 2.5 percent of GDP in 2011, and to 4.2 percent by 2014.
  - Fiscal risks highlighted:
    - Fiscal policy is the main macroeconomic policy tool.
    - A significant part of public debt carries FX risks.
    - Long-term spending pressures from pensions and health are considerable.
    - Financing needs are high.
- Assessment of proposed rule and recommended design
  - The paper argues the proposed debt ceiling at 60 percent of GDP is too high for FYR Macedonia and recommends a lower debt ceiling of 50 percent of GDP to ensure adequate fiscal space.
  - Required consolidation path for the 50 percent ceiling outcome: an upfront consolidation would be needed to reduce fiscal deficit to below 3 percent of GDP by 2017 in line with the authorities’ Medium-term Fiscal Strategy (MTFS) and pursuing a primary balance path that would stabilize public debt by 2018.
  - Alternative approach: combine a higher debt cap with debt brakes mechanism; any scaling up of public infrastructure investment should be accompanied by strengthened public investment management (clear and transparent procedures to assess, prioritize, and monitor public investment projects).
- Supporting institutional and PFM measures recommended
  - (i) further development of the MTFS so that it can more effectively guide the budget preparation process;
  - (ii) enforcement of strict expenditure controls and implementation of effective cash and debt management to ensure budget execution as planned;
  - (iii) increased robustness of macroeconomic projections to prevent revenue over-optimism;
  - (iv) strengthening both ex-ante and ex-post independent scrutiny including the eventual establishment of a fiscal council.

### Fiscal rules: objectives, types, and international patterns (selected points)
- Fiscal rule definition: an institutional setting imposing long-lasting numerical limits on budgetary aggregates to ensure sustainable fiscal variables in the medium to long run.
- Four main types:
  - Debt Rule (DR);
  - Budget Balance Rule (BBR);
  - Expenditure Rule (ER);
  - Revenue Rule (RR).
- Empirical patterns:
  - About 80 percent of all fiscal rules constrain the public debt or the budget balance.
  - About 80 percent of countries using fiscal rules use a combination of two or more rules.
  - About 59 percent of countries using combinations adopt a debt rule that caps overall public debt and a fiscal balance rule to guide achieving it.
- Emerging Europe practice:
  - Combination of debt and budget balance rules prevalent.
  - Debt rule upper limits observed range from 40 percent of GDP (Kosovo) to 60 percent of GDP (Poland).
  - Countries with debt limits at 60 percent typically start putting in debt brakes at 50 percent.

### Box 2 — Stability and Growth Framework: Maastricht-based benchmarks and FYR Macedonia assessment
- Maastricht benchmarks:
  - Fiscal deficit limit: 3 percent of GDP.
  - Debt limit: 60 percent of GDP for general government debt.
- Empirical evidence summary:
  - Fiscal rules are associated with stronger fiscal performance; tighter and more encompassing rules correlate with stronger cyclically-adjusted primary balances.
  - Countries in the top quartile of fiscal performance have at least two numerical rules and supporting institutional features.
- FYR Macedonia: proposed fiscal rule and illustrative path (percentages exact)
  - Authorities intend to introduce a fiscal rule by 2017: envisaged rule cap overall budget deficit at 3 percent of GDP and public debt at 60 percent of GDP as of 2017.
  - Assessment: 60 percent debt ceiling would be non-binding and create inadequate fiscal space.
  - Illustrative path for fiscal balance and debt under the current proposal:
    - 2014: Fiscal balance (% of GDP) -4.2; Primary balance (% of GDP) -3.2; Debt to GDP ratio 43.4
    - 2015: Fiscal balance (% of GDP) -3.8; Primary balance (% of GDP) -2.9; Debt to GDP ratio 43.9
    - 2016: Fiscal balance (% of GDP) -3.4; Primary balance (% of GDP) -2.5; Debt to GDP ratio 47.6
    - 2017: Fiscal balance (% of GDP) -3.0; Primary balance (% of GDP) -2.1; Debt to GDP ratio 49.8
    - 2018: Fiscal balance (% of GDP) -3.0; Primary balance (% of GDP) -2.1; Debt to GDP ratio 51.4
    - 2019: Fiscal balance (% of GDP) -3.0; Primary balance (% of GDP) -2.1; Debt to GDP ratio 51.9
    - 2020: Fiscal balance (% of GDP) -3.0; Primary balance (% of GDP) -2.1; Debt to GDP ratio 52.0
  - Shock assumptions referenced for public debt trajectory:
    - Real GDP growth shock: reduces growth by 1.5 percentage points throughout the projection period.
    - Real interest rate shock: assumes a 200 bps increase in real interest rates each year.
    - Real exchange rate shock: assumes REER depreciation of 10 percent.
  - Infrastructure and planned spending:
    - Planned road construction represents more than 2.2 percent of GDP from 2015 onwards.
    - PESR’s projected contribution to debt buildup from road construction: from 2.3 percent of GDP in 2014 to 6.6 percent by 2017.
  - Policy implication: a lower debt ceiling would be more suitable given fiscal vulnerabilities; alternatively, a somewhat higher debt limit should be accompanied by a debt brake triggered at 50 percent of GDP with pre-planned consolidation measures.
- Public investment management (PIM) and efficiency
  - Historical weak PIM can yield inadequate returns; scaling up investment in weak institutional settings risks undermining growth benefits and fiscal sustainability.
  - Priorities: improve project appraisal, selection, management, and evaluation to enhance returns and reduce fiscal risks.
- Legal, oversight, and PFM supporting measures
  - Legal basis, top-down budget process, Fiscal Responsibility Law, independent body (fiscal council), enforcement mechanisms, escape clause, and data availability are recommended supporting elements.
  - Address MTFS weaknesses: reconciliation with outturns, costed policy initiatives, realistic macro forecasts, and MoF capacity to evaluate costs of policy initiatives.

---

### MTFS performance, PFM weaknesses, and priority implementation actions
- Mixed performance and forecast bias
  - Analysis of 2008–10 to 2015–17 MTFS documents shows generally overoptimistic revenue and expenditure projections compared with actual outturns.
  - Optimism bias also evident in GDP forecasts, particularly in outer years.
- MTFS shortcomings
  - MTFS does not include detailed medium-term budgetary estimates for central government institutions.
  - MTFS is often issued late in the year (September) and cannot effectively guide the budget preparation process.
  - Unclear degree to which line ministries respect government-issued spending limits.
- Fiscal rules coverage and PFM legislative implications
  - Draft Constitutional amendment wording suggests deficit rules apply only to central government; debt rules apply to public debt defined as general government plus guaranteed debt of non-financial SOEs.
  - EU fiscal framework requires both rules to apply to the general government as defined in ESA2010.
  - Recommended: change draft amendment to reflect ESA2010 coverage or review regulatory arrangements for funds and local governments; reflect coverage decisions in PFM legislative revisions.
- Budget execution, arrears, cash and debt management
  - Ensure strict expenditure controls, effective cash and debt management, and timely comprehensive reporting.
  - Government’s recent arrears record raises questions about expenditure controls.
  - Recommended measures: address causes of arrears, strengthen multiyear commitment controls, establish proactive cash management.
- External scrutiny, fiscal council options, and forecasting capacity
  - Credibility of medium-term budgeting depends on effective external scrutiny.
  - Options: establish a fiscal council (would require new legislation before fiscal rules) or strengthen macroeconomic forecasting capacity via an autonomous professional institute.
- Priority PFM measures (timing relative to Year T = 2017 — actions and timing summarized)
  - Improve the credibility of the MTFS (Timing: T-1 July).
  - Strengthen the budget preparation process (Timing: T-1 & T; T).
  - Strengthen capacity to monitor fiscal risks (Timing: T-1 & T).
  - Strengthen capacity to prepare realistic macroeconomic forecasts and revenue projections (Timing: T-1 1st half; T-1 July; T-1 1st half).
  - Establish independent scrutiny of fiscal projections (Timing: T-2 Dec; T-1 July).
  - Strengthen expenditure controls, accounting and reporting, and cash management (Timing: T-2 Dec; T-1 Dec; T to T+3; T-1).
  - Amend the PFM legal framework to support fiscal rules (Timing: T-2 Dec).

*Source: IMF staff report excerpt (CR15243).*

### 1. Indicators of Export Performance—Some Definitions _________________________________________ 14

### 1. Indicators of Export Performance—Some Definitions

### Introduction
- For a small open economy such as FYR Macedonia, improving export competitiveness is critical to bolster economic growth and reduce unemployment.
- Short- to medium-run objective: strengthen the trade balance and reduce dependence on remittances from migrant workers.
- Long-run objective: technological and managerial spillovers from foreign exporting firms are expected to foster backward linkages to local producers and integrate the domestic tradable goods sector into global supply chains.
- Attracting foreign direct investment (FDI) and building export capacities have been central to authorities’ economic policy over the last decade.

### Comparative Evaluation of Export Performance
- Export shares and growth
  - Exports of goods and services have represented between 30 and 45 percent of nominal GDP.
  - Exports stemming from the Technological Industrial Development Zones (TIDZ) have been growing at double digits in recent years, representing about 40 percent of total exports in 2014.
- Contribution to GDP growth
  - Exports have contributed more to GDP growth in FYR Macedonia than in other Balkan countries.
  - Net exports have been a negative contributor to growth (notably due to high import content of new investments and low-end assembly production), but exports provided major contributions to real growth and helped pull the economy out of the short-lived recession in 2012.
- Revealed Comparative Advantage (RCA) and product mix
  - Main comparative advantages remain in intermediate and consumer goods.
  - RCA has diversified toward more capital-intensive goods; remained highly competitive in textiles, beverages, tobacco, and food products; and managed to dramatically push its advantage in chemical products.
- Export diversification
  - Overall export product diversification (intensive margin/concentration) remained below that of other Western Balkan (WB) countries and New Member States (NMS) until 2010, despite some improvement since 2008.
  - Export partner diversification remained stable during 2000–2010 and may have decreased recently due to replacement of neighboring partners by a limited subset of ‘core’ euro area economies.
- Export quality and room for improvement
  - Overall improvement of export quality during 2000–2010 has been less pronounced and remains below average levels observed in NMS and WBs.
  - The gap between quality provided by Macedonian exports and that demanded by importing destinations has narrowed but remains significant.
  - At a disaggregated level, room for quality upgrade appears warranted even for successful export products such as automobile components.
  - When assessed by percentile rankings, the quality of exports in manufacturing and chemical sectors is just average.
- Constant Market Share Analysis (CMSA) findings
  - Methodology: product disaggregation at SITC 1-digit and market groups (EU-28; Emerging Europe outside EU; rest of world).
  - 2000–07: FYR Macedonia’s exports underperformed relative to the comparator group; market growth effect higher than 100 percent (if relative market share constant, exports should have been higher by 91 percent). Underperformance driven by lower demand commodity composition and a large competitiveness gap.
  - 2008–14: FYR Macedonia’s exports marginally overperformed comparator countries; market growth effect lower than 100 percent. Positive commodity composition and market distribution effects slightly outweighed a narrowing but still negative competitiveness effect.
  - Overall: export performance improved dramatically since 2007 relative to the comparator group, driven by faster demand commodity composition and a much lower competitiveness gap, which nonetheless remains sizeable and calls for further enhancement of export quality and efficiency.
  - CMSA numeric table (as presented): 
    - 2000-2007 / 2008-2014
    - Market Growth Effect19199
    - Commodity Composition Effect-2614
    - Market Distribution Effect11572
    - Competitiveness Effect -180-84

### The Role of Domestic Policies and FDI for Export Success
- FDI trends and role
  - FDI picked up since the mid-2000s; inflows were negligible until 1998 and increased moderately until the global crisis.
  - Majority of FDI inflows took place in the tradable sector, supporting exports.
  - Privatizations and acquisitions (example cited: acquisition of national telecom operator by Magyar Telekom in 2001) contributed to earlier FDI flows.
  - Against the EU accession objective, major policy moves since the mid-2000s aimed to improve the business environment and provide incentives to attract FDI in tradable sectors.
- Tax and fiscal policy as an FDI pillar
  - FYR Macedonia offers a flat 10 percent tax on personal income and profits.
  - Implementation of these measures, combined with relatively low revenue efficiency by regional standards, has contributed to a continuous decline in government-revenues-to-GDP ratio (in contrast to other European emerging economies).

### Key implications and areas for further reform (based on analysis)
- Improve export product quality across sectors, including most successful export products, to narrow the remaining competitiveness gap.
- Strengthen spillovers from foreign investment–led export sector into the domestic tradable sector to foster backward linkages.
- To deepen integration with European supply chains and foster backward linkages, address:
  - infrastructure improvements;
  - further reforms to improve skills; and
  - enhancements to the operating environment for the domestic private sector.

*Prepared by Shan Chen, Marc Gerard and Patrick Gitton. Source: IMF staff analysis in the chapter "Indicators of Export Performance—Some Definitions."*

### 12. Against the backdrop of a low potential, FYR Macedonia has fared reasonably well in

### 12. Against the backdrop of a low potential, FYR Macedonia has fared reasonably well in attracting FDI compared with regional peers

### FDI performance and comparative potential
- Stock of inward FDI is at around 50 percent of GDP.
- FDI stock is above Albania and Bosnia, but below Serbia.
- UNCTAD’s Inward FDI Potential Index (2011) ranks FYR Macedonia among the lowest in the region in terms of FDI potential, mostly due to:
  - lack of natural resources;
  - market attractiveness constrained by small size.
- UNCTAD country ranking for MKD (Inward FDI Potential Index, 2011): MKD 114 87 84 130 130 (Market attractiveness; Labour cost and skills; Infrastructure; Natural resources; Overall rank).

### Sectoral composition and recent trends in FDI
- Most recent FDI inflows have been greenfield and concentrated in the export-oriented manufacturing sector (as opposed to financial and transport sectors in the early 2000s).
- Since 2009 a gradual shift from services to industrial products has been observed.
- Industrial FDI has branched out from traditional sectors (food and metal processing) into technology-intensive industries, notably automotive components.
- Major global players in automotive components have become FYR Macedonia’s main exporters.
- Other sectors attracting FDI include construction materials, residential construction, glass (e.g., for packaging of agricultural products and wine), and food processing.
- Drivers of the structural shift in greenfield FDI:
  - low labor costs;
  - various incentives (see Box 2);
  - improved business environment;
  - geographical proximity to assembly plants in Central and Western Europe and Turkey;
  - duty-free access to the European market.

### Spillovers into the domestic economy
- Spillovers from FDI-led export sectors to the domestic economy have been limited so far.
- Backward linkages between big foreign investors and domestic suppliers have been limited because many local producers cannot meet technical and safety requirements needed to export to the EU.
- Small and medium-sized domestic firms mainly produce for exports to neighboring countries, with limited integration into European supply chains.
- Despite significant export capacity build-up, the domestic tradable sector remains insufficiently developed.

### Constraints limiting backward and forward linkages
- Prevalence of informality and impediments to access finance are major constraints for domestic firms (by regional comparison).
- Firms face credit and liquidity constraints due to:
  - high collateral requirements;
  - delays in collecting payments (on average requiring four months to collect claims);
  - weak private sector balance sheets.
- Private sector debt has risen fast since mid-2000s, fueled by both credit growth and external borrowing; cross-country analysis shows FYR Macedonia’s private sector debt is high when compared to fundamentals such as interest costs and growth potential.
- Shortages of skilled labor constrain spillovers:
  - unemployment rate of nearly 28 percent;
  - skills shortages across sectors despite improvements in primary learning outcomes and compulsory secondary enrollment;
  - automotive firms have difficulty filling management, technical, and lower-skill positions;
  - export-oriented apparel industry cites obsolete university curricula as a cause of skilled labor shortages.
- Innovation and R&D capacity are weak:
  - public R&D expenditures accounted for only 0.22 percent of GDP in 2012;
  - R&D expenditure is almost exclusively government-funded;
  - government-sponsored R&D facilities rarely invest in applied research or have mechanisms to transfer knowledge and technologies to the private sector;
  - brain drain, particularly in technical and engineering occupations, remains a major concern.

### Policy lessons and recommendations
- Strategic policy choices (tax breaks and other incentives) have attracted FDI in the tradable sector, re-oriented exports toward technology-intensive products, contributed to market share gains, and generated employment; however, they have also:
  - contributed to a decline in revenues as a share of GDP;
  - contributed to rising public sector indebtedness.
- Two main imperatives going forward:
  - fiscal room for incentives is largely exhausted given low revenue levels;
  - further improvements to fundamentals (labor skills and infrastructure) and the operating environment for domestic private firms are needed to attract additional FDI and strengthen linkages.
- Specific policy priorities:
  - Easing access to formal finance for the domestic corporate sector:
    - address crisis legacies of bad debts;
    - shorten payment delays in the economy to ease liquidity constraints;
    - tackle high collateral requirements so banks lend more on business models and cash flow projections rather than only physical assets.
  - Boosting higher education and skills:
    - address significant emigration of highly educated citizens;
    - ensure attendance at, and high standards of, local schools and universities;
    - develop technical and managerial skills such as business planning to integrate into global supply chains;
    - promote systematic negotiation of knowledge exchange and learning programs with incoming foreign investors.
  - Improving infrastructure to enhance connectivity with trading partners:
    - scale up public infrastructure, notably transport, provided projects are assessed in a cost-benefit framework and remain consistent with sustainable public debt levels.

### FDI incentives (summary from Box 2)
- Technological Industrial Development Zones (TIDZs) established; first operational company: Johnson Controls (automotive components) at end of 2007.
- Four operational zones: Skopje 1, Skopje 2, Stip, and Kicevo; ten others at various stages of development.
- Incentive features in free economic zones include:
  - 10-year corporate tax holiday;
  - no customs duties and VAT on imported raw materials, equipment & construction materials;
  - 0% personal income tax for 10 years;
  - 0% property tax;
  - 0% excise taxes;
  - free connection to utilities;
  - up to EUR 500,000 subsidies for construction costs;
  - ‘green’ customs channel at the border for expeditious export to EU countries;
  - long-term land lease for a period of up to 99 years;
  - grants for training and job creation.

*Source: IMF staff report excerpt (CR15243).*

### Appendix I. Constant Market Share Analysis

### Appendix I. Constant Market Share Analysis

### CMSA methodology and decomposition
- The market growth effect shows the increase in a country’s exports assuming its exports were to grow by the same rate as a comparator group, in percent of its actual export increase. If this is below 100 percent, the country is overperforming relative to comparators. If this is higher than 100 percent, the country is underperforming.
- Over- or underperformance is decomposed into three components:
  - (i) a commodity composition effect: exports are concentrated in faster growing products;
  - (ii) a market distribution effect: exports are concentrated in faster growing markets; and
  - (iii) a competitiveness effect: exports growth is due to other factors (differentials in prices, taxation, productivity growth, quality, efficiency,...).
- Decomposition formula for the actual increase in Macedonian exports between 2000 and 2014 (Δx):
  - Δx = Σ r x_i  (market growth effect)
    + Σ r_i x_i - Σ r x_i  (commodity composition effect)
    + ΣΣ r_ij x_ij - Σ r_i x_i  (market distribution effect)
    + Δx - ΣΣ r_ij x_ij  (competitiveness effect)
- Definitions:
  - r = percent change in the overall exports of competitor countries
  - r_i = percent change in competitors’ exports of SITC product i
  - r_ij = percent change in competitors’ exports of SITC product i to market j
  - x_i = FYR Macedonia’s exports of product i at the beginning of the period
  - x_ij = FYR Macedonia’s exports of product i to market j at the beginning of the period
  - J_1-3 = EU-28, Emerging and Developing Europe, World
- Notes:
  - Emerging Europe: Albania, Bosnia and Herzegovina, Bulgaria, Croatia, Hungary, Kosovo, Lithuania, Montenegro, Poland, Romania, Serbia, and Turkey.
  - Product disaggregation at STIC 1-digit level (9 categories).

### FYR Macedonia: CMSA results (2000–2014, with subperiods 2000–2007 and 2008–2014)
- Table fragments and reported aggregates (Millions of US dollars) as presented:
  - Σ r xiΣ ri xiΣ Σ rij xijΔxΣ r xiΣ ri xiΣ Σ rij xijΔxΣ r xiΣ ri xiΣ Σ rij xijΔxΣ r xiΣ ri xiΣ Σ rij xijΔx
  - [1][2][3][4][1][2][3][4][1][2][3][4]
  - SITC 03 13416690322193176320182115246382140
  - SITC 16 16852140394379282487789628851616
  - SITC 22 332184352181441172581207910219398
  - SITC 33 0037238624185231239102777985-78
  - SITC 41 13240107912015710
  - SITC 52 813825459771731802656758107163911
  - SITC 62 344206334124741443140024521045716538858-571
  - SITC 73 9644281495924430557967705384892
  - SITC 81 7811086175053310976101037375349362616158
  - SITC 92 23971-1133843-31042
  - Total 629759039545361038773349569120331562178029081577
- Reported effect ratios and metrics (Percent):
  - Market Growth Effect=[1]/[4]17419199
  - Commodity Composition Effect=([2]-[1])/4-11-2614
  - Market Distribution Effect=([3]-[2])/[4]10111572
  - Competitiveness Effect=([4]-[3])/[4]-164-180-84
- Coverage:
  - Periods shown: 2000-2014, 2000-2007, 2008-2014
  - Comparator: EM Europe (Emerging Europe)
- Source: WITS Database; and IMF staff calculations.

### Interpretation (from text framing)
- CMSA isolates the part of export growth explained by overall market growth, commodity composition, market distribution, and residual competitiveness dynamics, enabling assessment whether FYR Macedonia over- or underperforms relative to comparator exporters.

*Source: _cr15243 - Appendix I. Constant Market Share Analysis (PDF), WITS Database; and IMF staff calculations.*

---

### Fiscal Rules to Ensure Sustainability

### Key fiscal context and trajectory (FYR Macedonia)
- The public debt of FYR Macedonia has almost doubled since 2008 and is projected to reach 54 percent of GDP by 2020.
- Historical fiscal path (selected figures cited):
  - General government gross debt rose from 23 percent of GDP in 2008, to 30 percent of GDP in 2011, and to 44 percent in 2014.
  - The overall fiscal balance was a deficit of 0.9 percent of GDP by end-2008, increased to 2.5 percent of GDP in 2011, and to 4.2 percent by 2014.
- Projection in absence of adequate measures: public debt would continue trending upward and reach 54 percent of GDP by 2020.
- Fiscal risks highlighted:
  - Fiscal policy is the main macroeconomic policy tool.
  - A significant part of public debt carries FX risks.
  - Long-term spending pressures from pensions and health are considerable.
  - Financing needs are high.

### Main recommendations and rule design advice
- Assessment of proposed rule:
  - The paper argues that the proposed debt ceiling at 60 percent of GDP is too high for FYR Macedonia and recommends a lower debt ceiling of 50 percent of GDP to ensure adequate fiscal space.
- Required consolidation path:
  - For the 50 percent ceiling outcome, an upfront consolidation would be needed to reduce fiscal deficit to below 3 percent of GDP by 2017 in line with the authorities’ Medium-term Fiscal Strategy (MTFS) and pursuing a primary balance path that would stabilize public debt by 2018.
- Alternative approach for infrastructure needs:
  - Given high infrastructure needs, an alternative is combining a higher debt cap with debt brakes mechanism. While a higher debt limit would be justified by needed investment in infrastructure, any scaling up of public infrastructure investment should be accompanied by measures to strengthen public investment management: notably clear and transparent procedures to assess, prioritize, and monitor public investment projects.
- Supporting institutional and PFM measures recommended:
  - (i) further development of the MTFS so that it can more effectively guide the budget preparation process;
  - (ii) enforcement of strict expenditure controls as well as implementation of effective cash and debt management to ensure that the budget is executed as planned;
  - (iii) increased robustness of macroeconomic projections to prevent revenue over-optimism; and
  - (iv) strengthening both ex-ante and ex-post independent scrutiny including the eventual establishment of a fiscal council.

### Fiscal rules: objectives, types, and international patterns
- Definition:
  - A fiscal rule is a type of institutional setting under which fiscal variables are allowed to develop sustainably in the medium to long run. It imposes a long-lasting constraint on fiscal policy through numerical limits on budgetary aggregates.
- Rationale:
  - Providing a credible medium-term anchor has been the pervasive motive for adopting fiscal rules or strengthening fiscal policy after the experience of the global financial crisis.
- Four main types of fiscal rules (Box 1):
  - Debt Rule (DR): sets an explicit limit or target for the public debt in percent of GDP. Pros/cons noted: effective for debt convergence and easy to communicate; slow to impact and can induce pro-cyclicality when binding.
  - Budget Balance Rule (BBR): constrains budgetary balances (overall, structural, cyclically adjusted, or balance over the cycle). Pros/cons: can account for economic shocks (except overall balance), but estimating adjustments (output gap) is challenging.
  - Expenditure Rule (ER): sets limits on total, primary, or current spending (absolute terms or growth rates, sometimes percent of GDP). Pros/cons: operational tool to trigger consolidation, easy to communicate, does not directly constrain revenues.
  - Revenue Rule (RR): sets ceilings or floors on revenues to boost collection or prevent excessive tax burden. Pros/cons: not directly linked to debt, can be pro-cyclical if used alone.
- Empirical patterns:
  - About 80 percent of all fiscal rules in the world constrain the public debt or the budget balance.
  - Expenditure rules are prevalent mostly in advanced economies.
  - Revenue rules are much less common.
  - About 80 percent of the countries using fiscal rules use a combination of two or more rules.
  - About 59 percent of countries using combinations adopt a debt rule that caps overall public debt and a fiscal balance rule to guide achieving it.

### Fiscal rules practice in emerging Europe (selected points)
- Combination use:
  - Almost two-thirds of fiscal rules in emerging Europe are a combination of debt and budget balance rules.
- Numerical targets observed (examples):
  - Debt rule upper limits in emerging Europe range from 40 percent of GDP in Kosovo to 60 percent of GDP in Poland.
  - Debt rules commonly cover general government debt (central government, local government, and entities where central government is the source of 50 percent of revenues).
  - Countries with debt limits at 60 percent of GDP typically start putting in debt brakes at 50 percent.
  - Numerical targets for budget balance rules range from 1 percent of GDP in Serbia to 3 percent of GDP in emerging European countries.
- Table excerpts and country examples:
  - Kosovo: Balance rule 2, Debt rule 40
  - Serbia: Balance rule 1, Debt rule 45
  - Hungary: Balance rule 3, Debt rule 50
  - Poland, the Slovak Republic, Romania: Balance rule 1, Debt rule 60
  - Bulgaria: 0.5 percent of GDP for structural deficit, Debt rule 60
  - Outside Europe examples: Namibia 25-30 (debt rule); Panama Balance rule 2, Debt rule 40; Pakistan Balance or surplus of basic balance, Debt rule 60; Costa Rica Golden rule 70
- Debt brakes examples in emerging Europe (excerpted rules):
  - The Slovak Republic: triggers at 50, 53, 55, 57 percent of GDP with specific ministerial and cabinet actions and automatic expenditure cuts.
  - Poland: corrective actions triggered at thresholds 50, 55, 60 percent of GDP; automatic measures (e.g., increasing VAT) triggered above 55 percent.
  - Hungary: Parliament may not adopt a State Budget Act which allows state debt to exceed 50 percent of GDP; budget acts must contain state debt reduction while debt exceeds 50 percent.

*Source: _cr15243 - Appendix I. Constant Market Share Analysis (PDF), IMF staff calculations, WITS Database.*

### Box 2. Stability and Growth Framework

### Box 2. Stability and Growth Framework

### Budget and Debt Rules (Maastricht-based framework)
- Budget balance rule:
  - Maastricht fiscal deficit limit: 3 percent of GDP. If the deficit exceeds that limit, an excessive deficit procedure (EDP) is normally opened. (corrective arm)
  - Medium term budgetary objectives (MTO) set for the structural budget balance (Preventive arm). MTOs are defined as a budgetary position “close to balance or in surplus.”
- Debt rule:
  - Maastricht debt limit: 60 percent of GDP for general government debt.
  - November 2011 governance reform: required annual pace of debt reduction based on a benchmark of 1/20th of the distance between the actual debt ratio and the 60 percent threshold on average over three years, starting three years after a country has left the current EDP procedure.
  - If progress is insufficient during the transition period, an excessive deficit procedure can be opened, with sanctions and fines for euro area members.

### Empirical evidence on fiscal rules
- Summary of econometric findings (selection of studies cited):
  - Fiscal rules are associated with stronger fiscal performance (Debrun et al, 2008; European Commission, 2006; Deroose, Moulin, and Wierts, 2006; Debrun and Kumar 2007; Kopits, 2004; Corbacho and Schwartz, 2007).
  - Main empirical findings:
    - (i) Tighter and more encompassing fiscal rules are correlated with stronger cyclically-adjusted primary balances in EU countries.
    - (ii) Budget balance and debt rules have contributed to better budgetary outcomes than expenditure and revenue rules.
    - (iii) Rules covering a wider level of government have been associated with more fiscal discipline.
  - Schaechter et al (2013): countries in the top quartile of fiscal performance have at least two numerical rules and supporting institutional features (e.g., independent monitoring, broad coverage of general government).

### Underlying institutions for successful fiscal rules
- Institutional settings that support implementation:
  - Legal basis: rules enshrined in higher-level legislation are more durable.
  - Top-down process: aggregate expenditure limit decided before distribution; medium-term budget frameworks (MTBFs).
  - Fiscal Responsibility Law (FRL): sets procedural and transparency responsibilities toward parliament.
  - Independent Body: independent fiscal councils to provide independent assessments.
  - Enforcement: enforcement and automatic correction mechanisms to prevent systematic debt buildup.
  - Escape clause: clearly specified and limited circumstances for temporary suspension, with guidelines on interpretation and time path back to the rule.
  - Data availability: reliable data and technical forecasting capacity; timely release of fiscal data for monitoring and accountability.
- Trends:
  - Over the last decade, fiscal rules became more comprehensive and convergent across advanced and emerging economies; independent monitoring and formal enforcement procedures became more common.

### FYR Macedonia: proposed fiscal rule and assessment
- Authorities intend to introduce a fiscal rule by 2017:
  - Envisaged rule: cap overall budget deficit at 3 percent of GDP and public debt at 60 percent of GDP as of 2017.
  - Authorities appear to have used Maastricht criteria as benchmark; exploring options to secure compliance, including debt brakes.
- Assessment that the 60 percent debt ceiling would be non-binding and create inadequate fiscal space:
  - Even with fiscal deficits at 3 percent of GDP, public debt would be below the 60 percent threshold for some time, limiting operational guidance.
  - Empirical points:
    - Long-run debt levels for emerging markets tend to be lower than advanced economies (IMF, 2011). Cross-country median estimates for 1985–2002: AEs range 50 to 75 percent of GDP, EMs 25 percent of GDP.
    - Re-estimation for EMs for 1993–2009 gives range 49–58 percent for long-run debt level.
  - Specific risks and indicators for FYR Macedonia:
    - Public sector borrowing has pushed up gross external debt already to around 70 percent of GDP.
    - Gross fiscal financing needs: currently at 15 percent of GDP, projected to rise to 18 percent by 2020.
    - Foreign currency-denominated debt accounted for 84 percent of public debt at end-2014.
    - Debt Sustainability Analysis: adverse shocks to growth, real interest and real exchange rate could significantly push up the debt level.
    - Fiscal policy effectiveness concerns: literature finds fiscal policy becomes ineffective at high debt ratios; estimates suggest negative responses to fiscal stimulus when public debt surpasses 50 to 60 percent of GDP.
    - Pension pressures: pension deficit is 2.9 percent of GDP; pension spending 9.1 percent of GDP or 28.7 percent of total spending in 2014. UN projections: share of people aged 65+ rises from 12 percent in 2010 to 26 percent in 2050.
    - Public health spending: 4.2 percent of GDP in 2014.
- Illustrative path for fiscal balance and debt under the current proposal (table as presented; percentages are exact):
  - 2014: Fiscal balance (% of GDP) -4.2; Primary balance (% of GDP) -3.2; Debt to GDP ratio 43.4
  - 2015: Fiscal balance (% of GDP) -3.8; Primary balance (% of GDP) -2.9; Debt to GDP ratio 43.9
  - 2016: Fiscal balance (% of GDP) -3.4; Primary balance (% of GDP) -2.5; Debt to GDP ratio 47.6
  - 2017: Fiscal balance (% of GDP) -3.0; Primary balance (% of GDP) -2.1; Debt to GDP ratio 49.8
  - 2018: Fiscal balance (% of GDP) -3.0; Primary balance (% of GDP) -2.1; Debt to GDP ratio 51.4
  - 2019: Fiscal balance (% of GDP) -3.0; Primary balance (% of GDP) -2.1; Debt to GDP ratio 51.9
  - 2020: Fiscal balance (% of GDP) -3.0; Primary balance (% of GDP) -2.1; Debt to GDP ratio 52.0
  - Note: illustrative path assumes fiscal deficit decreases steadily to 3 percent of GDP by 2017 per the fiscal rule objectives, and stays at this level thereafter.
- Shock assumptions referenced for public debt trajectory:
  - Real GDP growth shock: reduces growth by 1.5 percentage points throughout the projection period.
  - Real interest rate shock: assumes a 200 bps increase in real interest rates each year.
  - Real exchange rate shock: assumes REER depreciation of 10 percent.
- Infrastructure and planned spending:
  - Planned road construction represents more than 2.2 percent of GDP from 2015 onwards.
  - PESR’s projected contribution to debt buildup from road construction: from 2.3 percent of GDP in 2014 to 6.6 percent by 2017.
- Debt profile and policy implications:
  - A lower debt ceiling would be more suitable for FYR Macedonia given fiscal vulnerabilities.
  - Recommended fiscal posture:
    - Reduce the overall fiscal deficit to well below 3 percent of GDP by 2017.
    - Further consolidation needed to reverse debt build-up and keep debt comfortably below 50 percent of GDP in the medium term to preserve fiscal space for counter-cyclical policies and ageing-related spending pressures.
  - Alternative: somewhat higher debt limit may be justified given high infrastructure needs but should be accompanied by a debt brake mechanism:
    - Debt brake could be triggered starting at 50 percent of GDP with pre-planned fiscal consolidation measures to arrest rapid rise.

### Public investment management (PIM) and efficiency considerations
- Growth potential from scaled-up infrastructure investment depends on addressing PIM weaknesses:
  - Historical weak PIM can yield inadequate returns due to poor project selection and implementation, limited information, waste, leakage, and weak technical expertise.
  - Scaling up investment in weak institutional settings risks undermining growth benefits and fiscal sustainability.
- IMF findings on PIM efficiency:
  - PIM overall is weakest in LIDCs and strongest in AEs across planning, allocation, and implementation cycles.
  - Most efficient public investors get twice the growth bang for their public investment buck than the least efficient ones.
  - Strengthening PIM can reduce the public investment efficiency gap by around two-thirds, largest payoffs in EMs and LIDCs.
  - FYR Macedonia ranks in the middle among 31 middle-income countries in public investment efficiency; project appraisal stage lags most relative to peers.
- Priorities for FYR Macedonia:
  - Improve project appraisal, selection, management, and evaluation to enhance returns from infrastructure spending and reduce fiscal risks.

### Legal, oversight, and supporting public finance management measures
- Legal framework design recommendations:
  - Include independent monitoring and oversight, and enforcement mechanisms such as corrective measures to restore deviations over a specified period.
  - Consider independent bodies to oversee implementation (examples: Romania, Poland, Slovak Republic, Kosovo, Lithuania).
  - Fiscal rules cannot substitute for strong commitment to fiscal discipline; rules can be circumvented or abandoned without institutional backing.
- Supporting public finance management (PFM) reforms needed for effective fiscal rules:
  - Strengthen medium-term fiscal and budgetary framework quality and mechanisms to ensure budgetary discipline during execution.
  - Enhance transparency and accountability to publicly review fiscal proposals and evaluate performance.
  - Address weaknesses in the existing medium-term Fiscal Strategy (MTFS):
    - MTFS provides projections but lacks reconciliation with previous projections and actual outturns, undermining credibility.
    - MTFS includes fiscal policy changes that are not costed; fiscal implications of policy initiatives are not systematically provided by the Ministry of Finance (MoF) prior to adoption.
    - Review MoF capacity to evaluate costs of policy initiatives as preparatory action for implementing fiscal rules.
  - Base MTFS on realistic macroeconomic forecasts:
    - Forecast quality depends on availability, quality, and timeliness of underlying data, models used, and availability of alternative scenarios.
    - Implementation of fiscal rules requires review of institutional arrangements for collecting and forecasting macroeconomic data, including arrangements for independently reviewing forecasts.

*International Monetary Fund — Box 2. Stability and Growth Framework (excerpt).*

### 22. Analysis of recent macroeconomic and fiscal data shows mixed performance. The analysis

### _cr15243 - 22. Analysis of recent macroeconomic and fiscal data shows mixed performance. The analysis

### Mixed performance and forecast bias
- Analysis based on the 2008–10 to 2015–17 MTFS documents shows generally overoptimistic revenue and expenditure projections when compared with actual outturns.
- Significant differences observed between deficit projections and actuals over the same period.
- Optimism bias also evident in GDP forecasts, particularly in the outer years.
- Figure referenced: "Recent Trends in Revenue and Expenditure Forecasts" (FYR Macedonia: General Government Revenues and Expenditures; Actual and Projections in the Medium Term Fiscal Strategy, Billions of denars).

### MTFS shortcomings and recommended enhancements
- Key shortcomings:
  - MTFS does not include detailed medium-term budgetary estimates for central government institutions.
  - MTFS is often issued late in the year (September) and therefore cannot effectively guide the budget preparation process.
  - Unclear degree to which line ministries respect government-issued spending limits accompanying the annual budget circular.
- Recommended improvements (to qualify MTFS as an effective medium-term budgetary framework and meet EU convergence program requirements):
  - Reconciliation between MTFS projections and budget figures.
  - More detailed analysis of sectoral/ministerial budgets, separated between on-going policy and new initiatives.
  - Identification of fiscal risks.
  - Adoption of the MTFS by the government by midyear and submission to the parliament at least for information.

### Fiscal rules coverage and PFM legislative implications
- Current draft Constitutional amendment wording suggests:
  - Deficit rules will apply only to the central government.
  - Debt rules will apply to public debt defined as general government plus guaranteed debt of non-financial SOEs.
- EU fiscal framework requires both rules to apply to the general government as defined in ESA2010.
- Recommended options:
  - Change the draft Constitutional amendment to reflect ESA2010 coverage; or
  - Review regulatory arrangements for funds and local governments to ensure adherence to fiscal rules.
- These coverage decisions must be reflected in revisions to public financial management (PFM) legislation once the Constitution is amended.

### Budget execution, arrears, cash and debt management
- Ensuring budgets are executed as planned requires:
  - Strict expenditure controls.
  - Effective cash and debt management.
  - Timely and comprehensive reporting.
- Government’s recent record on arrears raises questions about expenditure controls.
- Measures prior to adoption of fiscal rules:
  - Address underlying causes of arrears and institutional behavior regarding arrears.
  - Recent improvements in multiyear commitment controls appear to have addressed central government arrears issues.
  - Establish proactive cash management to ensure budget institutions can spend according to approved plans.
- Complementary measure: change institutional behavior and strengthen cash flow planning.

### External scrutiny, fiscal council options, and forecasting capacity
- Credibility of medium-term budgeting based on fiscal rules depends on effective external scrutiny.
- Current supreme audit institution focuses on compliance issues, not evaluation of fiscal policies.
- Institutional requirement: new arrangements equipped with macroeconomic capacities (not merely accounting).
- Options for FYR Macedonia:
  - Establish a fiscal council to perform fiscal policy evaluation ex-ante and ex-post (would require new legislation enacted prior to implementation of fiscal rules).
  - Alternatively, if authorities are unconvinced of immediate benefit from a fiscal council, consider strengthening macroeconomic forecasting capacity by establishing an autonomous professional institute to produce macroeconomic forecasts (example cited: Slovenia).

### Priority PFM measures for implementing fiscal rules (Table 4 — summary by measure and timing relative to Year T, currently 2017)
- 1. Improve the credibility of the MTFS
  - Actions: reconciliation table; evaluate cost of all new policy measures (including investments); expand detail to main budget institutions; adopt MTFS with binding ministerial ceilings prior to budget preparation.
  - Timing: T-1 July
- 2. Strengthen the budget preparation process
  - Actions: strengthen capacities of line ministries for costed strategic plans and public investment projects; strengthen analytical capacity in Ministry of Finance; develop methodology to separate on-going policies from new initiatives.
  - Timing: T-1 & T; T-1 & T; T
- 3. Strengthen the capacity to monitor fiscal risks
  - Actions: identify key fiscal risks including from SOEs; establish/strengthen institutional arrangements to routinely monitor and analyze fiscal risks; include fiscal risk reporting in the MTFS.
  - Timing: T-1 & T
- 4. Strengthen capacity to prepare realistic macro-economic forecasts and revenue projections
  - Actions: review and broaden institutional participation in macro-economic forecasts; include alternative scenarios; strengthen capacity for realistic revenue forecasts.
  - Timing: T-1 1st half; T-1 July; T-1 1st half
- 5. Establish an independent scrutiny of fiscal projections
  - Actions: agree on design choices and institutional anchor for a fiscal council; implement independent scrutiny of government macro-economic and fiscal projections.
  - Timing: T-2 Dec; T-1 July
- 6. Strengthen expenditure controls, accounting and reporting, and cash management
  - Actions: review and strengthen expenditure control arrangements and sanctions; strengthen requirements and coverage for fiscal reporting to meet ESA2010 standards; improve monitoring of assets and liabilities through gradual adoption of IPSAS standards; improve in-year cash flow planning and coordination with debt management; design and implement PFM IT system enhancements.
  - Timing: T-2 Dec; T-1 Dec; T to T+3; T-1; T-1
- 7. Amend the PFM legal framework to support fiscal rules
  - Actions: prepare revisions to existing provisions to strengthen MTFS, budget preparation, expenditure controls; prepare new provisions (or separate law with qualified majority) to operationalize fiscal rules and establish independent oversight (e.g., fiscal council).
  - Timing: T-2 Dec

### Regional experiences relevant to FYR Macedonia (Box 3)
- Slovak Republic
  - Prior to 2012 debt brake rule introduction, debt was rising toward EU 60 percent limit.
  - PFM reform measures included: identifying savings through improved costing and monitoring; setting fiscal objectives more transparently; improving macro forecasts through independent scrutiny (Council for Budget Responsibility); rigorous assessment of new policy measures; strengthening fiscal risk identification and management.
  - Fiscal rules and accompanying measures had high consensus facilitating enforcement of early warning measures under the debt brake in 2013 and 2014.
- Serbia
  - Adoption in 2009 of fiscal responsibility provisions in the Law on Budgets accompanied by: two-stage budget process; addition of fiscal risks and medium-term forecasts to annual Fiscal Strategy Document; launch of program budgeting; strengthening expenditure controls to address arrears.
  - Some measures took time to implement (program budgeting completed in 2015).
  - Serbia’s EU ambitions gave renewed impetus to these reforms.

*International Monetary Fund — Excerpt from the FYR Macedonia staff report chapter on fiscal framework and PFM reforms (content unit: _cr15243 - 22).*

---


_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15243.pdf_