## 1. Montenegro’s Highway Project

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### Project design, partners, and financing
- Purpose: connect Bar (Montenegro’s main seaport) to the border of Serbia; first stage links Podgorica to Kolašin.
- Main partners for first stage: China Road and Bridge Cooperation (CRBC) and China ExIm Bank.
- Construction timeline:
  - Agreement with CRBC: construction period of four years; 30 percent of the investment to be subcontracted to domestic companies.
  - Construction expected to begin in spring of 2015 (was to start in 2014).
- Financing terms:
  - ExIm Bank to provide 85 percent of financing: EUR 688 million as a 20 year loan, denominated in dollars, with a fixed 2 percent interest rate and a six-year grace period.
  - Government to provide remaining 15 percent of project financing from revenue over-performance, cuts in non-highway capital spending, and/or additional borrowing.
  - Government intends to rely on tolls once the highway is completed; authorities hope to raise toll revenues of EUR 17 million (0.4 percent of projected 2018 GDP) per year on completion of the highway in 2018, increasing to EUR 60 million in 2047.
- Cost:
  - First phase budgeted to cost EUR 809 million (24 percent of 2013 GDP).

### Macro outlook and project macroeconomic assumptions
- Growth projections:
  - Growth projected at 2 percent in 2014, converging to 3¼ percent by 2019.
  - Highway assumed to add about 2 percentage points to GDP growth in 2015, with work finishing in 2018 and corresponding base effects thereafter.
  - Staff projects growth to increase to 4½ next year as the highway project gets underway.
- Highway fiscal / GDP impacts (staff expenditure schedule):
  - Announced highway expenditures: EUR 206 million in 2015, EUR 253 million in 2016, EUR 303 million in 2017, and EUR 47 million in 2018.
  - Highway expenditures add to nominal GDP in 2015–2018, less import content (assumed to be 70 percent); additional contemporaneous multiplier on aggregate demand of 5 percent, resulting in additional growth of 1.9, 0.3, 0.3, -2.2, and -0.4 in the years 2015–19.
- Inflation and current account:
  - Inflation pressures likely remain negligible given low international commodity prices and subdued EU inflation.
  - Current account expected to widen as strong electricity export base effects dissipate.

### Fiscal developments, projections, and financing needs
- Fiscal adjustment and debt: 
  - Fiscal adjustment of nearly 3 percent of GDP in 2013 despite large repayments of guarantees to KAP.
  - Overall deficit reduced to 3.3 percent of GDP and primary deficit to 1.1 percent in 2013 (an overall balance of 0 and a primary surplus of 2.1 percent excluding repayment of loan guarantees).
  - Public debt increased to 58 percent in 2013 (double the level of five years earlier).
- Draft 2015 budget measures (central government, compared to 2014 budget):
  - Nominal non-highway capital spending reduced by 23 percent (around EUR 24 million), resulting in a 0.8 percentage point improvement in the overall balance.
  - Transfers for social protection fall as a share of GDP by 0.4 percentage points (0.3 percentage points from pensions and disability; 0.1 percentage points from redundancy payments), though they increase in nominal levels.
  - No new revenue measures; planned VAT changes are revenue neutral; an additional tax bracket is introduced.
  - Staff estimate: expenditure measures would result in a 0.9 percent improvement in the overall balance when excluding highway spending (assuming revenues constant as a share of non-highway GDP).
- Debt and financing projections:
  - Staff projects public debt to increase to around 69 percent of GDP in 2017, assuming 2015 budget policies maintained through 2019.
  - Gross financing needs exceed 15 percent of GDP with the additional highway burden.
  - Substantial repayments of Eurobonds and commercial bank loans to the state due over the next five years, peaking at 8–9 percent of GDP a year in 2015, 2016 and 2019.
  - A EUR 280 million Eurobond was issued in May 2014, at a coupon of 5½ percent, of which EUR 195 million was used for budget financing and EUR 85 million to retire Eurobonds from 2010 and 2011.
  - Domestic issuance of Treasury bills totals EUR 180 million so far this year; estimated financing needs of EUR 343 million in 2014 are covered. Staff estimates financing needs to be higher in 2015, even aside from the highway.

### Fiscal scenarios, sensitivities, and DSA stress-test results
- Baseline public debt and balances (selected):
  - Public debt (gross, percent of GDP): 2015: 60.7; 2016: 64.5; 2017: 69.0; 2018: 68.4; 2019: 65.6.
  - Public debt, including guarantees (percent of GDP): 2015: 70.1; 2016: 73.9; 2017: 78.4; 2018: 77.8; 2019: 75.0.
  - Memorandum: Overall balance (percent of GDP) 2015: -5.3; 2016: -7.4; 2017: -8.6; 2018: -2.7; 2019: -1.5.
- Key stress-test outcomes:
  - DSA shows debt would increase to 86 percent of GDP following a one standard deviation shock to growth (4.9 percentage points).
  - A 1ppt shock to growth would increase debt to 72 percent of GDP.
  - Highway shock (20 percent cost overrun in 2018): debt increases to 70 percent of GDP.
  - Growth shock (one standard deviation = 4.9 ppt in 2015–2016): public debt ratio increases to 86 percent by 2018; gross financing needs ratio in 2016 increases 9 percentage points relative to baseline. (Half a standard deviation shock pushes debt to 77 percent of GDP.)
  - Combined macro shock: pushes debt to 89 percent of GDP.
  - Financial contingent liability shock (noninterest expenditure shock = 10 percent of banking sector size, combined with GDP and interest rate shocks): debt ratio rises to 85 percent; gross financing needs rise to over 28 percent of GDP in 2015.
- Policy implication from scenarios:
  - Public debt is sensitive to timing of expenditures; more back-loaded spending lowers and delays peak debt.
  - Priority to ensure contingency planning for highway cost overruns and delays; first recourse should be to cut or delay spending on the highway if risks materialize.

### Key risks and risk matrix highlights
- Principal external risks:
  - Vulnerability to downturns in external demand (euro area, Russia, Serbia); exposure to imported “lowflation”.
  - Reliance on inward capital flows and substantial public financing needs expose Montenegro to shifts in risk aversion and global market disruptions.
  - Low oil prices: could lower inflation and improve external balances but may signal weaker external demand and lower electricity prices.
- Domestic risks:
  - Upside: earlier-than-expected start of large projects with stronger domestic spillovers.
  - Downside: delays to the highway and an undersea power connection with Italy could undermine growth.
  - Political economy: pressure to relax the freeze on pensions and increase public sector wages could undermine fiscal discipline.
- Quantified sensitivities:
  - DSA outcomes: under real exchange rate shock (13 percent real depreciation in 2015) debt increases to 70 percent due to the dollar-denominated ExIm loan.
  - External debt sensitivities (Appendix II): baseline external debt projected to 157½ percent of GDP; growth shock could raise external debt to 172 percent by 2019; non-interest current account shock could raise external debt to 189 percent by 2019; 30 percent real depreciation could raise external debt by 62½ percent of GDP in 2015 (charted outcome 229 percent under 30 percent depreciation).

### Banking sector: soundness, NPLs, and recommendations
- Key indicators and conditions:
  - NPLs: system-wide NPLs remain high at 17 percent of total loans.
  - Around EUR 600 million in NPLs were shifted to factoring companies during 2011–12.
  - Regulatory provisioning is 68 percent system-wide; provisioning ranges across banks from 33 percent to 85 percent.
  - Banks calculate regulatory capital based on Basel 1.
  - Interest rate spreads are around 7½ percentage points; deposit rates around 2 percent.
  - Overall credit contracted by 3 percent (yoy) through October; household lending modestly increased.
- Transparency and oversight weaknesses:
  - Banks report significantly lower provisioning under IFRS than under regulatory rules; regulatory provisions are not reported publicly (only IFRS provisions are published).
  - Quarterly Reports on banks are prepared but not published; no apparent published policy on collateral valuations.
  - Supervisor currently lacks oversight of factoring companies despite around EUR 600 million effectively transferred to factoring vehicles.
  - AML/CFT: practical problems identifying politically exposed persons and beneficial owners; fines limited by law to EUR 25,000.
- Recommendations to strengthen sector:
  - Publish regulatory provisioning and Quarterly Reports on banks; consider external asset quality reviews as independent assessments.
  - Simplify provisioning classifications from seven to five (A, B, C, D, and E) and increase automaticity of classifications to reduce evergreening.
  - Grant supervisory powers over factoring companies through draft law to create transparent standards for recording assets held by such vehicles.
  - Improve contract enforcement, recovery processes, and court timeliness; recent introduction of dedicated public enforcement officers noted, but further reforms needed.
  - Support voluntary restructuring via the “Podgorica Approach” for out-of-court workouts and complement with enforcement and collateral security reforms.

### Structural reform priorities and labor market
- Structural challenges:
  - Economy relatively undiversified; historically reliant on capital and labor deepening with muted productivity growth.
  - Population expected to decline; labor participation and employment need to increase from current levels of 53½ and 43½ percent.
  - Registered unemployment around 18½ percent (youth unemployment 32½ percent), of which 91 percent is long-term.
- Labor market measures and assessment:
  - 2011 reforms reduced lay-off costs and limited fixed-term contracts to 24 months.
  - Active labor market programs: targeted subsidies and a 9-month internship program for graduates (fiscal cost ~0.3 percent of GDP); anecdotal evidence suggests limited absorption (~10 percent hired).
  - Recommended policy measures:
    - Encourage flexibility in wage bargaining so wages evolve with productivity.
    - Reduce informal employment incentives and onerous dismissal procedures.
    - Favor outcome-oriented active labor market schemes with financial incentives linked to improved labor outcomes.
    - Implement “social card” system to consolidate benefits for transparency and fraud deterrence.
- Business environment and investment impediments:
  - Key constraints: lack of domestic economies of scale, infrastructure failings, delays in registering property, weaknesses in enforcing contracts, and administrative burdens.
  - Staff encourages rationalizing regulations, facilitating property registration, streamlining procedures, improving judicial efficiency (collateral enforcement), clamping down on informal businesses, and fighting corruption.

### Policy recommendations and fiscal governance
- Fiscal policy guidance for a euroized economy:
  - Aim for larger fiscal buffers than typical emerging market peers.
  - Make fiscal policy more responsive to the business cycle and use boom years to create policy space.
  - Maintain spending restraint and prioritize measures that preserve debt sustainability given high external reliance and large financing needs.
- Long-term fiscal measures and expenditure reform:
  - Further pension reform (noting 2011 reform increases pensionable age to 67 only by 2025 for men and 2041 for women).
  - Further cuts in the public sector wage bill, including rationalizing employment.
  - Identify and budget for essential non-highway capital items (infrastructure for tourism and energy sector, addressing energy distribution losses).
- Revenue stance:
  - Staff does not favor substantial and permanent broad tax increases; potential to raise VAT revenues in near term by eliminating exemptions and unifying rates.
  - Current top CIT rate: 19 percent; exemptions bring the average effective rate to 12–13 percent.
- Fiscal framework weaknesses:
  - Fiscal rule approved in April embraces Maastricht 3 percent of GDP deficit and 60 percent of GDP debt limits, but enforcement weaknesses include no automatic spending caps and an exception for “strategically important projects.”
  - If the deficit or debt exceed the 3 and 60 percent limits, the government must submit corrective measures within 60 days, but no deadline to return below the limit.
- Contingency planning:
  - Additional measures should be pre-specified and laid out for application in the event of unanticipated shocks; first recourse should be to cut or delay spending on the highway.

### Data, statistics, and dissemination issues
- Data strengths and shortcomings:
  - Annual national accounts quality described as "good"; quarterly GDP methodology has room for improvement.
  - CPI broadly follows international standards; PPI improvements underway.
  - Labor market data affected by large informal sector and methodological revisions.
  - GFS: fiscal data compilation improved but re-classifications and incomplete SOE and local government arrears data remain issues.
  - Monetary and financial statistics compiled broadly following the Manual (2000) but not in IMF SRF format; Montenegro does not report Financial Soundness Indicators to the IMF.
  - BoP: major challenge is coverage of informal economy and large errors and omissions (~7½ percent of GDP noted elsewhere).
- Data dissemination:
  - Participant in GDDS since December 2011; latest metadata update in 2012.
  - Table of Common Indicators shows many series up to Oct-2014 / Sept-2014 with monthly or quarterly frequency.
- Press Release / Article IV (Press Release No. 15/31, February 4, 2015):
  - Key messages: slowdown in 2014; highway to boost 2015 growth but raises fiscal and financing vulnerabilities; need for clear long-term fiscal plans, NPL resolution, and structural reforms.

### Selected quantitative indicators (highlights)
- Real GDP (percent change): 2012: -2.5; 2013: 3.3; 2014: 2.0; 2015 Proj.: 4.6.
- Nominal GDP (millions of €): 2013: 3,327; 2014: 3,387; 2015: 3,588; 2019: 4,228.
- Public debt (gross, percent of GDP): 2013: 58.2; 2014: 58.5; 2015: 60.7; 2016: 64.5; 2017: 69.0.
- Public debt including guarantees (percent of GDP): 2013: 67.6; 2014: 67.9; 2015: 70.1; 2016: 73.9; 2017: 78.4.
- Current account balance (percent of GDP): 2013: -14.6; 2014: -15.1; 2015: -20.2; 2016: -23.6; 2017: -24.1.
- External debt (percent of GDP): 2013: 128.7; 2014: 132.9; 2015: 137.5; 2016: 144.8; 2017: 152.8; 2019: 157.6.
- Nonperforming loans (percent of gross loans): 17 percent (system-wide, recent).
- Regulatory provisioning (percent of NPL): 68 percent (system-wide); bank-level range 33–85 percent.
- Banking interest rate spreads: around 7½ percentage points; deposit rates around 2 percent.

*Source: IMF staff report — “1. Montenegro’s Highway Project” (PDF chapter)._cr1526*

### 1. Montenegro’s Highway Project _________________________________________________________________ 5

### 1. Montenegro’s Highway Project

### Context and recent developments
- Economy characteristics and vulnerabilities:
  - Highly dependent on tourism and FDI.
  - Relatively high public debt, unprofitable state companies, high levels of NPLs, and ongoing bank deleveraging.
  - Aging population and low employment.
  - Unilaterally euroized: lacks independent monetary policy; relatively rigid labor market.
- Recent macro performance:
  - Real GDP contracted by 2½ percent in 2012 and rebounded by 3¼ percent in 2013.
  - Preliminary data indicate a sharp growth slowdown beginning in the second quarter of 2014; construction activity decelerated.
  - CPI decreased steadily in 2014 through October.
  - Average net earnings broadly flat since 2011; bank credit retrenched through the first three quarters of 2014.
- External balances and financing:
  - Trade imbalance was 40 percent of GDP in 2013.
  - Current account deficit widened by 1.2 percent of GDP in the first nine months of 2014 (worsening income balance by about 1¼ percent and transfers falling by ½ percent).
  - Net FDI inflows decreased by 7 percent in the first nine months of 2014; historically net FDI covers about 70 percent of the current account deficit.

### Box 1 — Bar–Boljare Highway: project design and financing
- Project purpose:
  - Connect Bar (Montenegro’s main seaport) to the border of Serbia; first stage links Podgorica to Kolašin.
- Partners and construction:
  - Main partners for first stage: China Road and Bridge Cooperation (CRBC) and China ExIm Bank.
  - Agreement with CRBC: construction period of four years; 30 percent of the investment to be subcontracted to domestic companies.
  - Construction expected to begin in spring of 2015 (was to start in 2014).
- Financing terms:
  - ExIm Bank to provide 85 percent of financing: EUR 688 million as a 20 year loan, denominated in dollars, with a fixed 2 percent interest rate and a six-year grace period.
  - Government to provide remaining 15 percent of project financing from revenue over-performance, cuts in non-highway capital spending, and/or additional borrowing.
  - Government intends to rely on tolls once the highway is completed.
- Cost of first phase:
  - First phase budgeted to cost EUR 809 million (24 percent of 2013 GDP).

### Outlook and scenarios
- Growth outlook:
  - Growth projected at 2 percent in 2014, converging to 3¼ percent by 2019.
  - Highway assumed to add about 2 percentage points to GDP growth in 2015, with work finishing in 2018 and corresponding base effects thereafter.
  - As the first stage does not connect the coast to the Serbian border and density is low in construction area, no significant effect on potential growth is assumed.
- Current account and inflation:
  - Inflation pressures likely remain negligible given low international commodity prices and subdued EU inflation.
  - Current account expected to widen as strong electricity export base effects dissipate.

### Fiscal developments, measures, and projections
- Fiscal adjustment achieved in 2013:
  - Fiscal adjustment of nearly 3 percent of GDP in 2013 despite large repayments of guarantees to KAP.
  - Overall deficit reduced to 3.3 percent of GDP and primary deficit to 1.1 percent in 2013 (an overall balance of 0 and a primary surplus of 2.1 percent excluding repayment of loan guarantees).
  - Public debt increased to 58 percent in 2013 (double the level of five years earlier).
- Draft 2015 budget measures (central government, compared to 2014 budget):
  - Nominal non-highway capital spending reduced by 23 percent (around EUR 24 million), resulting in a 0.8 percentage point improvement in the overall balance.
  - Transfers for social protection fall as a share of GDP by 0.4 percentage points (0.3 percentage points from pensions and disability; 0.1 percentage points from redundancy payments), though they increase in nominal levels.
  - Increases in transfers to institutions, individuals, NGOs and the public sector (0.1 percentage points), and reserves (0.1 percentage points).
  - No new revenue measures; planned VAT changes are revenue neutral; an additional tax bracket is introduced.
  - Staff estimate: expenditure measures would result in a 0.9 percent improvement in the overall balance when excluding highway spending (assuming revenues constant as a share of non-highway GDP).
- Highway fiscal impact and debt projections:
  - Staff projects public debt to increase to around 69 percent of GDP in 2017, assuming 2015 budget policies maintained through 2019.
  - Staff projections based on announced highway expenditure schedule: EUR 206 million in 2015, EUR 253 million in 2016, EUR 303 million in 2017, and EUR 47 million in 2018.
  - Without the highway, a primary surplus of 2.7 percent would have been expected from 2015; with the highway, deficits of around 3 to 5 percent are incurred through 2015–2017.
  - Gross financing needs exceed 15 percent of GDP with the additional highway burden.
  - Public debt is sensitive to timing of expenditures: more back-loaded spending lowers and delays peak debt.
- Medium-term funding needs and debt service:
  - Substantial repayments of Eurobonds and commercial bank loans to the state due over the next five years, peaking at 8–9 percent of GDP a year in 2015, 2016 and 2019.
  - Montenegro remains highly dependent on external funding despite increased domestic demand for debt.

### Structural reforms and state assets
- Divestment progress and contingent liabilities:
  - Payments arising from KAP guarantees (0.8 and 3.2 percent of GDP in 2012 and 2013) finished; KAP sold though privatization payments not fully received.
  - Uniprom contracted to buy KAP for EUR 28 million; partial payments and guarantees were provided.
  - State still involved in a number of smaller companies; other guarantees amounting to almost 10 percent of GDP remain.

### Key risks and sensitivities
- External risks (mainly downside):
  - Vulnerability to downturns in external demand, especially from the euro area, Russia, and Serbia; exposure to imported “lowflation”.
  - Low oil prices: could lower inflation and improve external balances (energy accounts for 13 percent of the CPI basket; oil imports around 10 percent of total imports by value), but persistent declines could signal weaker external demand and lower electricity prices.
  - Reliance on inward capital flows and substantial public financing needs expose Montenegro to shifts in risk aversion and global market disruptions.
  - Public debt could escalate substantially in event of negative growth shocks or highway cost overruns.
  - External private debt is large and projected to increase further.
- Domestic risks:
  - Upside: earlier-than-expected start of large projects with stronger domestic spillovers.
  - Downside: delays to the highway and an undersea power connection with Italy could undermine growth.
  - Political economy: pressure to relax the freeze on pensions and increase public sector wages could undermine fiscal discipline.
- Quantified shock sensitivities:
  - The DSA shows debt would increase to 86 percent of GDP following a one standard deviation shock to growth (4.9 percentage points).
  - A 1ppt shock to growth would increase debt to 72 percent of GDP.
- Highway-specific risks:
  - Delays and cost overruns are common in highway projects.
  - Dollar denomination of the ExIm loan creates exchange rate risk that will be costly to hedge.

### Policy priorities and recommendations
- Major policy challenges:
  - Confront significant risks to fiscal sustainability.
  - Address ongoing problems in the banking sector (high NPLs, deleveraging).
  - Accelerate structural reforms to boost growth potential and economic resilience.
- Fiscal policy guidance for a euroized economy:
  - Aim for larger fiscal buffers than typical emerging market peers.
  - Make fiscal policy more responsive to the business cycle and use boom years to create policy space.
  - Maintain spending restraint and prioritize measures that preserve debt sustainability given high external reliance and large financing needs.

*Source: IMF staff report — “1. Montenegro’s Highway Project” (PDF chapter)._cr1526*

### 15.      The offsetting measures in the

### _cr1526 - 15.      The offsetting measures in the

### Fiscal measures, projections, and implications
- The draft 2015 budget’s offsetting measures are judged appropriate given still-fragile growth, but a long period of strong fiscal discipline will be needed.
- If measures are maintained through the highway construction period as assumed in Staff projections:
  - Primary surplus would be 2.7 percent of GDP in 2019 after highway construction is finished (if no downside risks eventuate).
- Staff advises maintaining current spending discipline and revenue measures after the highway spending ends, while restoring the non-highway capital budget to allow for other essential infrastructure projects.
  - This alternative would imply a surplus of 1.9 percent of GDP, to reduce debt below 60 percent within ten years.
- Financing and borrowing notes:
  - A EUR 280 million Eurobond was issued in May 2014, at a coupon of 5½ percent, of which EUR 195 million was used for budget financing and EUR 85 million to retire Eurobonds from 2010 and 2011.
  - Domestic issuance of Treasury bills totals EUR 180 million so far this year.
  - Hence, estimated financing needs of EUR 343 million in 2014 are covered.
  - Staff estimates financing needs to be higher in 2015, even aside from the highway.
  - Authorities hope to raise toll revenues of EUR 17 million (0.4 percent of projected 2018 GDP) per year on completion of the highway in 2018, increasing to EUR 60 million in 2047.

### Long-term fiscal plans and expenditure reform (recommended elements)
- A credible and reliable consolidation requires fundamental expenditure reform, especially:
  - Further pension reform, to show how pension costs can be contained over the near term.
    - Note: The 2011 pension reform increases the pensionable age to 67 only by 2025 for men and 2041 for women.
  - Further cuts in the public sector wage bill (including through rationalizing employment), which would also reduce the relative reservation wage and help improve competitiveness.
  - Identification of and budgeting for essential non-highway capital budget items.
    - Key needs include infrastructure to support the sustainable development of the tourism sector and investment in the energy sector, as losses in energy distribution are significant.

### Revenue policy stance and VAT potential
- Staff does not favor substantial and permanent increases in taxes broadly, but sees potential to raise VAT revenues in the near term:
  - Revenues are relatively high for the region.
  - A low PIT rate is viewed as appropriate to avoid further disincentives to formalization.
  - A much higher CIT rate risks deterring investment.
  - Potential VAT reforms include eliminating exemptions and unifying rates, which could increase compliance and yields.
    - Current top CIT rate: 19 percent; exemptions bring the average effective rate to 12–13 percent.

### Contingent consolidation measures if risks materialize
- Additional measures should be pre-specified and laid out for application in the event of unanticipated shocks to growth or refinancing and highway costs.
  - The first recourse should be to cut or delay spending on the highway.

### Fiscal framework and public sector governance
- A fiscal rule approved in April embraces the Maastricht 3 percent of GDP deficit and 60 percent of GDP debt limits.
  - Enforcement weaknesses noted: no automatic spending caps, no deadlines for implementing fiscal measures, and an exception for “strategically important projects” undermines credibility.
  - If the deficit or debt exceed the 3 and 60 percent, respectively, the government must submit a proposal of corrective measures to the parliament within 60 days, but there is no deadline by which the deficit/debt has to be below the limit again.
- Authorities should strengthen controls in the broader public sector and refrain from providing more support to enterprises, whether direct or indirect.

### Authorities’ fiscal views (summarized)
- Authorities acknowledge risks from the new highway and aim to manage them through revenue gains and expenditure restraint:
  - Point to conservative revenue estimates in budgets and further gains from on-going efforts to address informality (administrative measures, changes to criminal code regarding wage payments without tax contributions, and cash wage payments).
  - Highlight strong demand for the May 2014 Eurobond (heavily oversubscribed) and expect continued market access at favorable terms.
  - Expect large growth benefits from the highway to tourism, transport, trade and regional development, and consider the highway loan terms attractive despite exchange rate risk.
  - Hope to raise toll revenues of EUR 17 million (0.4 percent of projected 2018 GDP) per year on completion in 2018, increasing to EUR 60 million in 2047.

### Monetary and financial sector—key findings
- Financial conditions remain tight:
  - Lending rates remain high and have increased in real terms.
  - Interest rate spreads are around 7½ percentage points, near their historical peak, despite deposit rates falling to around 2 percent.
  - Overall credit contracted by 3 percent (yoy) through October, though household lending modestly increased.
- Banks’ health: mixed picture
  - Capitalization has improved but is relatively low compared to the rest of Eastern Europe.
    - Banks calculate regulatory capital based on Basel 1.
  - Deposits continue to grow; liquidity appears sufficient at 30 percent of short-term assets.
  - Loan-to-deposit ratio reduced to about 100 percent on average since the crisis, with wide heterogeneity across banks.
  - Asset quality remains a problem:
    - Around EUR 600 million in NPLs were shifted to factoring companies during 2011–12.
    - A classification change at end-2012 reduced reported NPLs, but system-wide NPLs remain high at 17 percent of total loans.
- Regulatory provisioning and transparency issues:
  - System-wide regulatory provisioning is 68 percent, but provisioning ranges across banks from 33 percent to 85 percent.
  - Banks report significantly lower provisioning under IFRS than under regulatory rules, which may reflect optimistic collateral valuations and could mean banks understate losses and avoid writing off bad loans.
  - Regulatory provisions are not reported publicly (only IFRS provisions are published). Quarterly Reports on banks are prepared but not published. No apparent published policy on collateral valuations.

### Recommendations to strengthen banking sector transparency and oversight
- Reporting:
  - Publish regulatory provisioning and Quarterly Reports on banks; consider external asset quality reviews as independent assessments.
- Regulatory classification:
  - Simplify provisioning classifications from seven to five (A, B, C, D, and E) to improve corroboration and reduce evergreening; increase automaticity of classifications.
  - Data on B1/B2 and C1/C2 subcategories are not available—simplification would help.
- Oversight of factoring companies:
  - Supervisor currently lacks oversight despite around EUR 600 million effectively transferred to factoring vehicles; staff urged progress on the draft law on factoring companies to grant supervisory powers and create transparent standards for recording assets held by such vehicles.
- Legal and market reforms to reduce credit risk and spreads:
  - Address structural drivers of spreads: contract enforcement delays, cost and procedures of enforcing contracts, recovery rates, and predictability of legal outcomes.
  - Recent introduction of dedicated public enforcement officers could help, but further progress requires timelier court decisions with penalties for delays and improved administration.
- Authorities’ proposed measures:
  - Draft law on voluntary restructuring—the “Podgorica Approach”—to encourage out-of-court workouts for impaired loans (useful for solvent firms with temporary cash flow or liquidity problems).
  - New bank licenses approved, bringing number of banks to 12, with indication of willingness to grant more; authorities discussed but did not pursue lending rate caps.

### NPLs, provisioning, and AML/CFT oversight
- Nonperforming loans remain at 17 percent of gross loans for the banking system.
- Regulatory provisioning is 68 percent system-wide; bank-level range 33–85 percent.
- AML/CFT:
  - Banks are responsible for identifying politically exposed persons and beneficial owners, but practical problems exist with data and tracing owners of foreign firms.
  - A new law in 2014 shifted responsibility for initiating violation procedures to the central bank.
  - Fines appear low, being limited by law to EUR 25,000.
  - Authorities are reconsidering laws governing the limit on bank penalties and see scope to increase penalties for AML/CFT breaches.

### Reserves and external liquidity
- Montenegro is euroized; traditional reserve metrics are less useful.
- Better metric: reserves as a ratio to deposits; on this basis Montenegro ranks fairly well against other dollarized or euroized economies and the ratio has been broadly stable.
- Gross international reserves and reserve coverage metrics are presented in staff calculations (figures in source).

### Structural reform priorities to boost resilience and growth
- Concerns on potential growth and competitiveness:
  - Montenegro historically relied on capital and labor deepening; productivity growth has been relatively muted.
  - Population expected to decline; labor participation and employment need to increase from current levels of 53½ and 43½ percent.
  - Recent low nominal wage growth lowered unit labor costs, but not relative to peers; wages have outpaced producer prices in recent years.
- Staff’s competitiveness assessment:
  - CPI-REER roughly stable relative to regional comparators.
  - Staff analysis using Macroeconomic Balance and External Sustainability approaches indicates the current account balance is around 9–11 percentage points below its norm, possibly pointing to weak cost competitiveness (data uncertainties noted, including errors and omissions amounting to about 7½ percent of GDP).
  - Preferred metric: relative unit labor costs slightly above the Western Balkans average, suggesting need for ongoing wage restraint and/or productivity boosts to restore competitiveness.
- Suggested structural reforms:
  - Increase labor participation and employment.
  - Boost productivity through reforms that improve the business environment, contract enforcement, and investor protection.
  - Prioritize infrastructure supporting tourism and energy sector investment to address energy distribution losses.

Italic source: IMF staff report content as provided in the supplied PDF content unit.

### Box 4. External Competitiveness (continued)

### Box 4. External Competitiveness (continued)

### External competitiveness and diversification
- Montenegro generally ranks well on business indicators compared with regional peers, but reforms to improve competitiveness remain important.
- Continued external stability hinges on sustained tourism development and attracting diversified FDI flows.
- Priorities to support competitiveness and diversification:
  - improving infrastructure;
  - enhancing the quality of services;
  - reducing administrative burdens that could undermine future diversified investment opportunities.
- Note on current account dynamics:
  - A significant share of the current account balance is related to imports funded by FDI, reflecting large investment needs, especially for large-scale infrastructure projects; conversely, in a small economy such as Montenegro, a surge in investment-related imports can result in large swings to the current account balance.

### Labor market: diagnosis and measures
- Key indicators and structural features:
  - Registered unemployment is around 18½ percent (youth unemployment 32½ percent), of which 91 percent is long-term.
  - Seasonal and low-paid employment is mostly provided by foreign workers.
  - A multi-tiered collective bargaining process applies a standard wage across sectors, including public and private employment.
  - Non-wage costs are relatively high.
  - Although the law provides specific criteria for dismissal, in practice the burden of proof is placed on employers, and outcomes are frequently over-turned by the courts, raising the risk premium for employment.
  - Private sector responses include placing new workers on short-term contracts and avoiding extending employment, which prevents human capital development and inhibits productivity.
- Recent and past reforms:
  - Substantial labor market reform in 2011:
    - Lay-off costs were reduced by restricting severance packages to “in-firm” as opposed to “lifetime” years of service.
    - Fixed-term contracts were limited to a maximum of 24 months, which effectively tightened employment protections.
  - Targeted subsidy programs and temporary government-funded hiring programs:
    - Financial incentives to hire “hard-to-employ” individuals and youths.
    - A temporary (9-month) government-sponsored internship program for recent university graduates.
    - Staff estimates the fiscal cost of the internship program at about 0.3 percent of GDP.
    - Anecdotal evidence suggests employers hire only around 10 percent of participating interns; youth unemployment has only decreased modestly since the internship program.
- Assessment and policy guidance:
  - Social benefits are not the primary driver of labor informality, though there is scope to lower opportunity costs of formal employment for beneficiaries (e.g., gradual withdrawal of benefits and/or earned income tax credits).
  - Authorities plan to implement a “social card” system by the end of 2014 to consolidate benefits in a single system; staff welcomed this initiative for transparency and fraud deterrence.
  - Efficiency-enhancing reforms recommended:
    - Encourage flexibility in wage bargaining so wages evolve with productivity.
    - Reduce informal employment incentives, such as onerous dismissal procedures.
    - Favor outcome-oriented active labor market schemes where financial incentives are linked to improved labor outcomes.
  - Subsidy schemes are characterized as “stop-gap” measures.

### Structural impediments to investment and business environment
- Key constraints:
  - Lack of domestic economies of scale and limited diversification make Montenegro vulnerable to external shocks.
  - Infrastructure failings, including dependence on seasonal energy and inefficiencies in utilities, hold back development.
  - Investment bottlenecks include delays in registering property and weaknesses in enforcing contracts.
  - The quality of the overall macroeconomic environment is cited as problematic, placing a premium on policy discipline and reforms to improve cost competitiveness and economic flexibility.
- Staff encourages further efforts to:
  - rationalize and ensure the consistent application of regulations;
  - facilitate property registration and streamline administrative procedures;
  - improve the efficiency of the judicial system, particularly regarding collateral enforcement;
  - clamp down on unregulated and informal businesses that hinder high-quality investments and fiscal revenue intake;
  - fight corruption.

### Authorities’ views and initiatives
- Labor market and informality:
  - Authorities are formulating a strategy to combat labor informality and increase transparency of the social benefit system.
  - They consider the multi-tier collective bargaining framework well-understood and sufficiently flexible.
  - Targeted employment programs, including the internship scheme, are seen as key to bridging skills mismatch.
  - A study of the underlying causes of the informal economy is underway (to be completed by July 2015) as a prerequisite to a broader policy strategy.
- Business environment:
  - Authorities view FDI as critical to long-term growth and diversification, especially in tourism and energy.
  - Recent measures include establishing a one-stop shop for construction permits, strict time limits for approvals, and a decrease in procedures required for obtaining a permit.
  - Nearly 60 percent of recommendations endorsed in a 2013 Action Plan to improve the regulatory environment have been implemented; full implementation is expected by end-2015.
  - Amendments to the Law on Enforcement and Security are being considered to improve enforcement of claims.

### Staff appraisal: macroeconomic outlook and policy priorities
- Current assessment:
  - Montenegro continues its economic transition but faces challenges from rising public debt and fallout from the lending boom.
  - The economy is relatively undiversified and relies heavily on external financing.
  - The rapid rise in public debt has increased vulnerabilities and the large stock of bad loans has likely constrained lending.
  - The highway project should provide a short-term boost to activity but exacerbates debt-related vulnerabilities.
- Growth and risks:
  - Growth is projected to increase to 4½ next year as the highway project gets underway.
  - Montenegro is vulnerable to a downturn in external demand, especially from the euro area and Russia, and to shifts in risk aversion and global financial market disruptions.
- Fiscal and financial priorities:
  - Sustained fiscal restraint over the medium-term is needed, with an emphasis on fundamental expenditure reform.
  - Authorities achieved fiscal adjustment of nearly 3 percent of GDP in 2013; measures include ceasing repayments of guarantees to KAP and addressing issues facilitating its sale.
  - Recommendations:
    - Lay out clear long-term plans for managing public finances to boost credibility and reduce market access risks.
    - Implement fundamental expenditure reform, especially of the pension system and the public sector wage bill.
    - Define contingency measures to address unforeseen fiscal shocks, with first recourse being a delay or cut in highway spending.
    - Continue reducing support to risky and/or loss-making state-owned enterprises.
  - Addressing NPLs and credit conditions:
    - Support the “Podgorica Approach” to facilitate debt workouts.
    - Complement workouts with reforms to contract enforcement and collateral security.
    - Enhanced supervisory scrutiny may be warranted given wide variation in provisioning coverage across banks.
    - Improve regulatory transparency by publishing quarterly banking reports with regulatory provisions and a summary of stress test results.
  - Structural reforms emphasized:
    - Ensure wages adjust with productivity.
    - Reduce disincentives for employment (e.g., onerous dismissal procedures).
    - Sustain momentum to strengthen the business environment: simplify regulations, eliminate burdensome procedures, improve judicial efficiency, combat economic informality, and effectively implement the AML/CFT regime.
- Consultation cycle:
  - It is expected the next Article IV consultation with Montenegro be held on the standard 12-month cycle.

### Risk Assessment Matrix — principal risks and policy responses
- 1. A protracted growth slowdown in advanced and emerging economies
  - Relative likelihood: High
  - Impact if realized: High
  - Rationale: A protracted slowdown in the EU and neighboring countries could reduce appetite for external and public financing (especially FDI flows and tourism infrastructure developments); imported “lowflation” could harm debt dynamics, consumption, and bank profitability.
  - Policy response:
    - Let automatic fiscal stabilizers work, within limited fiscal space.
    - Accelerate structural reforms to increase competitiveness and reduce structural bottlenecks that impede credit to the private sector.
- 2. Spillovers from a deterioration of global financial market conditions
  - Relative likelihood: High
  - Impact if realized: High
  - Rationale: Montenegro is highly reliant on external financing. Gross public financing needs range from 10-20 percent of GDP during the next five years.
  - Policy response:
    - Let automatic fiscal stabilizers work, within limited fiscal space.
    - Put in place a credible medium-term fiscal consolidation plan that puts debt on a sustainable trajectory.
- 3. Heightened geopolitical risks associated with Russia/Ukraine tensions and ongoing Middle East conflicts
  - Relative likelihood: Medium
  - Impact if realized: Medium
  - Rationale: A deterioration in Russia’s growth prospects could undermine FDI inflows and growth in Montenegro given tourism and real estate links.
  - Policy response:
    - Let automatic fiscal stabilizers work, within limited fiscal space.
    - Speed up structural reforms to improve the business environment and competitiveness.
- 4. Weakening of fiscal discipline
  - Relative likelihood: Low
  - Impact if realized: Medium
  - Rationale: Planned highway, pressure to raise public sector wages and pensions; given high and increasing public debt, loss of discipline could raise sustainability concerns.
  - Policy response:
    - Sustain fiscal consolidation; maintain public wage discipline and pension freezes, and further recent efforts to boost tax revenues.
    - Curtail subsidies to loss-making public enterprises.

*International Monetary Fund — Box 4. External Competitiveness (continued)*

### 5. Delays and

### _cr1526 - 5. Delays and withdrawals from capital investment projects

### Risks and policy recommendations
- Risk assessment: Medium — "Ongoing geopolitical tensions, weak administrative procedures on land development, and concerns regarding public fiscal sustainability could threaten capital investments in tourism and industry."
- Growth driver: Medium — "Construction and activity associated with large-scale investment projects (both tourism and infrastructure based) are key drivers of growth."
- Policy recommendation: "Put in place a credible strategy to safeguard fiscal sustainability and implement structural reforms to improve the business environment and strengthen mechanisms to fight corruption."

### Real economy: key indicators and projections
- Nominal GDP (millions of €): 2010: 3,104; 2011: 3,234; 2012: 3,149; 2013: 3,327; 2014: 3,387; 2015: 3,588; 2016: 3,759; 2017: 3,944; 2018: 4,045; 2019: 4,228.
- Real GDP (percent change): 2010: 2.5; 2011: 3.2; 2012: -2.5; 2013: 3.3; 2014: 2.0; 2015: 4.6; 2016: 3.3; 2017: 3.4; 2018: 1.0; 2019: 2.9.
- Gross national saving (percent of GDP): 2010: -2.6; 2011: -2.0; 2012: 0.9; 2013: 1.3; 2014: 3.0; 2015: 3.8; 2016: 2.3; 2017: 3.2; 2018: 2.6; 2019: 4.0.
- Gross investment (percent of GDP): 2010: 22.8; 2011: 19.5; 2012: 19.5; 2013: 15.9; 2014: 18.1; 2015: 24.0; 2016: 25.9; 2017: 27.3; 2018: 21.2; 2019: 20.3.
- Consumer prices (period average): 2010: 0.7; 2011: 3.1; 2012: 3.6; 2013: 2.2; 2014: -0.6; 2015: 1.2; 2016: 1.4; 2017: 1.5; 2018: 1.5; 2019: 1.6.
- Aluminum price (€ per tonne): 2010: 1,644; 2011: 1,822; 2012: 1,542; 2013: 1,348; 2014: 1,340; 2015: 1,417; 2016: 1,447; 2017: 1,467; 2018: 1,480; 2019: 1,494.

### Public finances: revenues, expenditures, balances, and debt
- Total revenues and grants (millions of €): 2010: 1281.4; 2011: 1246.0; 2012: 1258.8; 2013: 1381.8; 2014: 1454.0; 2015: 1511.9; 2016: 1578.8; 2017: 1651.2; 2018: 1729.3; 2019: 1814.2.
- Total expenditures and net lending (millions of €): 2010: 1424.3; 2011: 1415.0; 2012: 1444.3; 2013: 1490.0; 2014: 1484.5; 2015: 1702.6; 2016: 1856.9; 2017: 1991.9; 2018: 1840.2; 2019: 1878.9.
- Overall balance (millions of €): 2010: -142.9; 2011: -169.0; 2012: -185.5; 2013: -108.2; 2014: -30.5; 2015: -190.8; 2016: -278.1; 2017: -340.6; 2018: -110.9; 2019: -64.7.
- Primary balance (millions of €): 2010: -111.5; 2011: -121.4; 2012: -125.8; 2013: -37.4; 2014: 47.4; 2015: -110.3; 2016: -153.0; 2017: -199.1; 2018: 62.9; 2019: 114.2.
- Public debt (gross, percent of GDP): 2010: 40.9; 2011: 46.0; 2012: 54.0; 2013: 58.2; 2014: 58.5; 2015: 60.7; 2016: 64.5; 2017: 69.0; 2018: 68.4; 2019: 65.6.
- Public debt, including guarantees (percent of GDP): 2010: 52.4; 2011: 57.8; 2012: 65.0; 2013: 67.6; 2014: 67.9; 2015: 70.1; 2016: 73.9; 2017: 78.4; 2018: 77.8; 2019: 75.0.
- Interest payments (millions of €): 2010: 31.4; 2011: 47.6; 2012: 59.7; 2013: 70.8; 2014: 77.9; 2015: 80.5; 2016: 125.1; 2017: 141.5; 2018: 173.8; 2019: 178.9.
- Capital expenditures (millions of €): 2010: 165.8; 2011: 135.6; 2012: 124.4; 2013: 108.9; 2014: 179.8; 2015: 365.3; 2016: 419.2; 2017: 477.3; 2018: 229.0; 2019: 191.1.
- Memorandum: Overall balance (percent of GDP): 2010: -4.6; 2011: -5.2; 2012: -5.9; 2013: -3.3; 2014: -0.9; 2015: -5.3; 2016: -7.4; 2017: -8.6; 2018: -2.7; 2019: -1.5.

### External sector: current account, FDI, and external debt
- Current account balance (millions of €): 2010: -710; 2011: -573; 2012: -588; 2013: -487; 2014: -513; 2015: -726; 2016: -888; 2017: -951; 2018: -756; 2019: -687.
- Current account balance (percent of GDP): 2010: -22.9; 2011: -17.7; 2012: -18.7; 2013: -14.6; 2014: -15.1; 2015: -20.2; 2016: -23.6; 2017: -24.1; 2018: -18.7; 2019: -16.2.
- Trade balance (millions of €): 2010: -1,267; 2011: -1,306; 2012: -1,389; 2013: -1,329; 2014: -1,342; 2015: -1,574; 2016: -1,718; 2017: -1,822; 2018: -1,667; 2019: -1,665.
- Services account receipts (millions of €): 2010: 801; 2011: 906; 2012: 998; 2013: 994; 2014: 1,012; 2015: 1,067; 2016: 1,129; 2017: 1,197; 2018: 1,260; 2019: 1,336.
- Foreign direct investment, net (millions of €): 2010: 552; 2011: 389; 2012: 462; 2013: 324; 2014: 330; 2015: 382; 2016: 429; 2017: 462; 2018: 481; 2019: 503.
- External debt (percent of GDP): 2010: 115.5; 2011: 117.6; 2012: 126.6; 2013: 128.7; 2014: 132.9; 2015: 137.5; 2016: 144.8; 2017: 152.8; 2018: 157.4; 2019: 157.6.
- Investment income, net (millions of €): 2010: -172; 2011: -142; 2012: -120; 2013: -120; 2014: -133; 2015: -139; 2016: -194; 2017: -216; 2018: -252; 2019: -263.

### Financial system and banking sector indicators
- Consolidated system: Credit to private sector / GDP: 2010: 66.9; 2011: 55.9; 2012: 55.3; 2013: 53.4; 2014: 53.4; 2015: 50.6.
- Banks' capital / credit to private sector: 2010: 15.0; 2011: 16.9; 2012: 16.6; 2013: 21.9; 2014: 25.3.
- CBCG reserves / bank deposits: 2010: 30.9; 2011: 22.2; 2012: 23.8; 2013: 28.6; 2014: 34.0.
- Reserves ratio (percent): 2010: 20.5; 2011: 15.1; 2012: 16.2; 2013: 21.5; 2014: 18.0.
- Effective required reserves ratio: 2010: 9.9; 2011: 9.5; 2012: 8.8; 2013: 10.1; 2014: 10.1.
- Net foreign assets of consolidated system (millions of €): 2010: -146; 2011: -751; 2012: 6; 2013: 12; 2014: 333.

### Selected fiscal and external vulnerabilities highlighted
- Large share of GDP in gross domestic investment: 2015: 24.0 percent; 2016: 25.9 percent; 2017: 27.3 percent — indicating high reliance on investment projects.
- Sharp increases in capital expenditures and public debt coincide with large negative overall balances: capital expenditures 2015: 365.3 (millions of €); public debt including guarantees 2016: 73.9 percent of GDP; overall balance 2016: -278.1 (millions of €).
- Current account deficits remain large: 2016: -23.6 percent of GDP; 2017: -24.1 percent of GDP.

*Source: IMF staff estimates and projections as presented in the supplied chapter content.*

### 1. Revenue41.038.439.641.442.742.041.841.742.642.7

### _cr1526 - 1. Revenue41.038.439.641.442.742.041.841.742.642.7

### Fiscal aggregates (selected series from tables)
- 1. Revenue: 41.0 38.4 39.6 41.4 42.7 42.0 41.8 41.7 42.6 42.7
  - Taxes: 24.4 24.6 25.0 26.0 26.9 26.5 26.4 26.3 26.8 26.9
    - Personal income tax: 3.7 3.5 3.5 3.7 4.0 3.9 3.9 3.9 4.0 4.0
    - Corporate income tax: 0.7 1.1 2.0 1.2 1.4 1.4 1.4 1.4 1.4 1.4
    - Property taxes: 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5
    - Value added tax: 11.7 12.1 11.3 12.9 13.6 13.3 13.3 13.2 13.5 13.6
    - Excises: 4.3 4.4 4.8 4.9 4.7 4.6 4.6 4.6 4.7 4.7
    - Taxes on international trade: 1.6 1.4 0.9 0.7 0.6 0.6 0.6 0.6 0.6 0.6
    - Local government taxes: 1.4 1.4 1.8 1.9 1.9 1.8 1.8 1.8 1.9 1.9
    - Other taxes: 0.4 0.1 0.1 0.2 0.2 0.2 0.2 0.2 0.2 0.2
  - Social security contributions: 11.1 9.6 10.1 10.7 11.2 11.0 11.0 10.9 11.2 11.2
  - Nontax revenues: 5.3 3.9 4.2 4.4 4.3 4.3 4.2 4.2 4.3 4.3
  - Grants: 0.3 0.3 0.3 0.3 0.3 0.2 0.2 0.2 0.2 0.2

- 2. Expense: 40.5 39.6 42.0 41.6 38.6 37.3 38.3 38.4 39.8 39.9
  - Gross salaries and other personal income: 12.1 11.8 12.0 11.3 11.5 10.7 10.6 10.6 10.8 10.9
  - Use of goods and services: 6.3 4.9 7.2 4.3 3.9 3.2 3.2 3.2 3.2 3.3
  - Interest payments: 1.0 1.5 1.9 2.1 2.3 2.2 3.3 3.6 4.3 4.2
  - Subsidies to enterprises: 1.3 1.4 0.8 0.5 0.6 0.6 0.6 0.6 0.6 0.6
  - Other current outflows: 0.5 0.5 0.9 0.9 0.8 1.5 1.5 1.5 1.5 1.5
  - Social security transfers: 13.6 14.1 15.3 14.5 14.7 14.1 14.0 14.0 14.3 14.3
  - Other transfers: 5.2 3.9 2.4 4.3 4.1 4.4 4.4 4.4 4.5 4.5
  - Repayment of guarantees: 0.0 1.1 0.8 3.2 0.3 0.0 0.0 0.0 0.0 0.0
  - Reserves: 0.5 0.4 0.7 0.5 0.4 0.5 0.5 0.5 0.5 0.5

- 3. Gross operating balance (= 1 - 2): 0.5 -1.2 -2.4 -0.3 4.1 4.7 3.6 3.3 2.7 2.8

- 4. Net acquisition of nonfinancial assets: 5.1 4.0 3.5 3.1 5.1 10.0 11.0 11.9 5.5 4.3
  - Capital revenue: -0.2 -0.2 -0.4 -0.2 -0.2 -0.2 -0.2 -0.2 -0.2 -0.2
  - Capital expenditure: 5.3 4.2 3.9 3.3 5.3 10.2 11.2 12.1 5.7 4.5

- 5. Net lending (+) / borrowing (-) (= 3 - 4): -4.6 -5.2 -6.0 -3.4 -1.0 -5.3 -7.4 -8.7 -2.8 -1.5

- 6. Net acquisition of financial assets: -3.0 -2.9 -1.0 -2.3 1.9 -1.0 0.2 0.2 0.3 0.3
  - Domestic: -3.0 -2.9 -1.0 -2.3 1.9 -1.0 0.2 0.2 0.3 0.3
    - Currency and deposits: -2.2 -2.5 -0.5 -1.4 2.5 -1.0 0.2 0.3 0.3 0.3
    - Loans: 0.0 0.0 -0.1 -0.1 -0.1 0.0 0.0 0.0 0.0 0.0
    - Equity and investment fund shares: -0.8 -0.5 -0.4 -0.8 -0.6 0.0 0.0 0.0 0.0 0.0

- 7. Net incurrence of liabilities: 1.6 2.3 5.0 1.0 2.9 5.3 -3.3 2.6 -1.9 -10.8
  - Domestic: -3.5 -1.7 -1.3 -3.8 0.3 -3.7 -2.0 -1.9 -1.6 -1.5
  - Foreign: 5.2 4.0 6.3 4.8 2.5 9.0 -1.3 4.5 -0.2 -9.2

- 8. Discrepancy (= 5 - 6 + 7): 0.0 0.0 0.0 0.0 0.0 1.0 -10.9 -6.3 -4.9 -12.6

- Memorandum item:
  - Primary balance: -3.6 -3.8 -4.1 -1.2 1.3 -3.1 -4.1 -5.1 1.5 2.7

(Source lines: Ministry of Finance; and Fund staff estimates and projections. Includes republican budget and local governments.)

### Banking sector financial soundness (selected indicators)
- Capital adequacy
  - Regulatory capital as percent of risk-weighted assets: 15.7 15.9 16.5 14.7 14.4 15.5 15.0 14.4 15.1 15.8 16.2
  - Capital as percent of assets: 11.0 10.6 10.9 10.3 13.7 13.9 13.9 13.4 14.2 14.3 14.2

- Asset composition and quality
  - Distribution of bank credit by borrower (selected): Central government, local government, government agencies: 1.3 2.1 4.9 4.8 4.5 5.2 6.9 6.7 6.4 6.1 5.5
  - Citizens: 36.6 37.1 40.5 41.3 33.3 34.3 34.3 34.3 35.6 35.9 36.5
  - Private companies, entrepreneurs: 56.4 54.8 47.7 47.7 36.8 36.7 34.4 34.4 35.7 35.7 36.3

- Asset quality metrics
  - Non-performing loans (NPL), in percent of gross loans: 13.5 21.0 15.5 17.6 19.4 18.8 18.4 18.4 17.2 17.9 17.3
  - Provisions, in percent of NPL: 46.3 30.7 32.8 40.2 42.1 40.7 39.7 44.7 44.6 44.5 43.8
  - Provisions, in percent of total loans: 6.3 6.4 5.1 7.1 8.2 7.7 7.3 8.2 8.0 8.0 7.6
  - NPL net of provisions, in percent of capital: 52.5 102.8 66.9 68.0 71.7 68.6 68.6 62.9 53.5 56.0 54.5

- Profitability and liquidity (selected)
  - Net profits, in percent of average assets (ROAA): -0.7 -2.8 -0.1 -2.0 1.4 1.3 1.3 0.1 1.3 1.0 0.9
  - Net interest margin: 4.9 4.9 4.8 5.0 1.0 2.1 3.2 4.2 1.1 2.2 3.4
  - Liquid assets, in percent of total assets: 15.3 19.1 19.9 24.0 13.2 14.5 21.2 20.0 18.0 18.8 23.2
  - Deposits, in percent of assets: 60.3 60.8 64.7 70.5 69.9 69.7 71.5 71.6 71.6 72.1 73.5
  - Loans, in percent of deposits: 131.4 122.9 107.6 94.0 114.8 113.4 108.8 105.8 105.5 102.4 99.9

(Source: Central Bank of Montenegro. Net interest income in percent of interest bearing assets.)

### Public debt sustainability — baseline and key projections
- Despite sizeable fiscal adjustment, public sector debt increased and is projected to rise further to 69 percent of GDP in the baseline.
- Projected debt trajectory is highly susceptible to shocks, especially a negative real GDP growth shock.
- Gross financing needs are high and Montenegro is highly dependent on external financing.

- Baseline macro-fiscal assumptions and implications (selected)
  - Highway project fiscal impact assumptions:
    - Expenditures on the highway add EUR 206 million, EUR 253 million, EUR 303 million, and EUR 47 million to nominal GDP in 2015–2018, less import content (assumed to be 70 percent).
    - Additional contemporaneous multiplier on aggregate demand of 5 percent, resulting in additional growth of 1.9, 0.3, 0.3, -2.2, and -0.4 in the years 2015–19.
  - Growth momentum: projected to slow in 2014; in absence of highway project, growth would reach 3.3 percent.
  - Inflation pressures expected to remain negligible.
  - Fiscal adjustment: primary balance worsens significantly in 2015–17 on account of highway expenditures; non-highway non-interest expenditures are assumed to remain at 2015 budget levels as a share of non-highway GDP in 2016–2019.

- Key baseline indicators (table excerpt "As of August 30, 2013")
  - Nominal gross public debt: 37.6 (2012), 54.0 (2013), 58.2 (2014), 58.5 (2015), 60.7 (2016), 64.5 (2017), 69.0 (2018), 68.4 (2019), 65.6 (projection end)
  - Public gross financing needs: 11.5 11.5 12.6 10.5 20.2 21.8 18.1 8.1 9.7 15.1
  - Real GDP growth (in percent): 4.1 -2.5 3.3 2.0 4.6 3.3 3.4 1.0 2.9
  - Inflation (GDP deflator, in percent): 5.9 -0.1 2.2 -0.1 1.3 1.4 1.5 1.6 1.6
  - Effective interest rate (in percent): 3.2 4.0 4.2 4.2 4.5 4.4 4.2 4.2 4.5
  - Change in gross public sector debt (cumulative): -3.3 8.0 4.2 0.3 2.2 3.8 4.5 -0.6 -2.8 7.4
  - Identified debt-creating flows (cumulative): -2.5 7.3 0.0 0.0 0.2 2.3 3.9 4.6 -0.4 -2.7 7.7

- Automatic debt dynamics components (selected):
  - Interest rate/growth differential (automatic debt dynamics): -2.8 3.2 -1.2 1.3 -0.8 -0.2 -0.5 1.1 0.0 1.0
  - Real interest rate contribution: -1.2 1.9 0.9 2.5 1.7 1.7 1.6 1.8 1.9 11.2
  - Real GDP growth contribution: -1.4 1.2 -1.7 -1.1 -2.5 -1.9 -2.1 -0.7 -1.9 -10.2

### Stress tests and scenario outcomes (key results)
- Highway shock (20 percent cost overrun in 2018): debt increases to 70 percent of GDP; financing requirements far exceed baseline in 2018.
- Growth shock (real output growth lowered in 2015–2016 by one standard deviation = 4.9 ppt): public debt ratio increases to 86 percent by 2018; gross financing needs ratio in 2016 increases 9 percentage points relative to baseline. (Half a standard deviation shock pushes debt to 77 percent of GDP.)
- Interest rate shock (increase on new debt by 200 basis points in 2015–19): deterioration in debt and gross financing needs is back-loaded; by 2019 impact on financing needs is significant.
- Combined macro shock (recession in 2015–2016, 200 basis point interest rate increase, sharp rise in expenditures): pushes debt to 89 percent of GDP and greatly increases gross financing needs.
- Financial contingent liability shock (noninterest expenditure shock = 10 percent of banking sector size, combined with GDP and interest rate shocks): debt ratio rises to 85 percent of GDP; gross financing needs rise to over 28 percent of GDP in 2015 and remain elevated.
- Primary balance shock (revenue shock + rise in interest rates causing 2 ppt of GDP deterioration in primary balance in 2015–2016): leads to deterioration in debt ratio and gross financing needs, but impact is more muted relative to other scenarios.
- Real exchange rate shock (13 percent real depreciation in 2015): debt increases to 70 percent due to dollar-denominated ExIm loan; impact depends on pass-through to inflation.

- DSA stress-test table (selected underlying assumptions)
  - Baseline real GDP growth: 2.0 (2014), 4.6 (2015), 3.3 (2016), 3.4 (2017), 1.0 (2018), 2.9 (2019)
  - Primary balance under baseline: 1.3 (2014), -3.1 (2015), -4.1 (2016), -5.1 (2017), 1.5 (2018), 2.7 (2019)
  - Under Real GDP Growth Shock: real GDP growth series becomes 2.0 -0.3 -1.5 3.4 1.0 2.9; primary balance becomes 1.3 -5.9 -10.0 -5.1 1.5 2.7
  - Under Combined Shock: real GDP growth 2.0 -0.3 -1.5 3.4 1.0 2.9; inflation  -0.1 0.1 0.2 1.5 1.6 1.6; primary balance 1.3 -5.9 -10.0 -5.1 1.5 2.7; effective interest rate 4.2 4.6 5.0 5.3 5.6 6.0

### Risk assessment and policy implications (synthesis of findings)
- Fiscal and debt vulnerabilities
  - Debt approaches the 70 percent of GDP benchmark under the baseline and exceeds it under several shock scenarios; risks from debt level are high.
  - Gross financing needs exceed the 15 percent benchmark even under the baseline.
  - Public debt held by non-residents and high external financing dependence constitute vulnerabilities.
  - Growth shocks have a very large impact on the debt profile; baseline projections show susceptibility to negative growth shocks.

- Realism of baseline assumptions
  - Median forecast errors for 2005–2013 indicate staff projections have on average an upward bias for real GDP growth and inflation; median forecast error for the primary balance suggests staff projections have been too pessimistic on average.
  - Key risks include high dependence on external financing and vulnerability to macro shocks despite a small projected CAPB adjustment.

- Policy considerations implied by stress-test results
  - Prioritize measures to reduce external financing reliance and shorten gross financing needs exposure.
  - Ensure contingency planning for highway project cost overruns and delays; cost-control and close project monitoring are critical given large potential debt impacts.
  - Strengthen fiscal buffers and consider options to improve primary balance resilience to adverse macro developments.
  - Monitor banking-sector contingent liabilities given NPL levels and provisioning ratios; mitigate fiscal risks from potential banking-sector shocks.

*Source: Ministry of Finance; Central Bank of Montenegro; IMF staff estimates and projections (content from the provided IMF chapter).*

### Appendix II. Montenegro: External Debt Sustainability Analysis

### Appendix II. Montenegro: External Debt Sustainability Analysis

### Summary of external debt trends
- External debt increased by nearly 60 percentage points of GDP since 2007 to an estimated 133 percent of GDP in 2014.
- Increase driven in part by a sharp increase in public debt, which more than doubled over this period and comprises about 45 percent of total external debt.
- Under the baseline, external debt is projected to increase to 157½ percent of GDP.
- Montenegro’s heavy dependence on external financing reinforces the importance of fiscal and structural reforms to safeguard market access.

### Shocks and stress tests — key findings
- Standardized stress tests indicate external debt is particularly sensitive to currency depreciation.
- Current account shocks—possibly related to highway project cost overruns—and a combined deterioration in the macroeconomic environment would also materially affect external sustainability and gross financing needs.

### Standard stress-test scenarios and outcomes
- Growth shock
  - Baseline real GDP growth profile is permanently reduced by a one-half standard deviation calculated over the recent 10-year period (2.5 percent) effective in 2015.
  - This corresponds to an average growth rate of 0.6 percent of GDP over 2015–19, compared with baseline average growth of 3 percent.
  - Under this scenario, the external debt ratio increases to 172 percent of GDP in 2019.
- Interest rate shock
  - Increase in nominal external interest rates on new debt by a one-half standard deviation in 2015–2019.
  - Stable average external interest rates historically imply an average increase in interest rates of 27 basis points in this scenario.
  - External debt increases to 160 percent of GDP by 2019.
- Non-Interest Current Account shock
  - Permanently increases the non-interest current account by one-half standard deviation in 2015–2019.
  - Given historically-high current account deficits, this amounts to an increase of 6¼ percentage points.
  - In the absence of offsetting debt-creating flows, external debt increases to 189 percent of GDP by 2019.
- Combined macro shock
  - Permanent ¼ standard deviation shock applied to the real interest rate, the growth rate, and the current account deficit effective 2015–19.
  - The combined shock pushes the external debt ratio to 182 percent of GDP.
  - Increases gross financing needs by 26½ percent of GDP cumulatively over the shock period.
- Real exchange rate shock
  - One-time 30 percent devaluation in the real exchange rate in 2015 applied to the stock of external debt (second-round impacts not taken into account).
  - Given the large stock of external debt, the shock increases the external debt-to-GDP ratio by 62½ percent of GDP in 2015.
  - Gross financing needs are higher by about 17½ percent of GDP on average over 2015–19 relative to the baseline.
  - Charted outcome shows external debt rising to 229 (percent of GDP) under the 30 percent depreciation scenario.

### Selected quantitative indicators (from the External Debt Sustainability Framework table)
- Baseline external debt-to-GDP, 2009–2019 (in percent of GDP):
  - 2009: 93.5
  - 2010: 115.5
  - 2011: 117.6
  - 2012: 126.6
  - 2013: 128.7
  - 2014: 132.9
  - 2015: 137.5
  - 2016: 144.8
  - 2017: 152.8
  - 2018: 157.4
  - 2019: 157.6
- Debt-stabilizing non-interest current account (long-run): -13.0
- Change in external debt (line 2), 2009–2019 (in percent of GDP): 2.7, 2.0, 2.1, 9.0, 2.1, 4.2, 4.6, 7.4, 8.0, 4.6, 0.3
- Identified external debt-creating flows (line 3), 2009–2019 (in percent of GDP): -4.7, 1.4, 1.0, 7.2, -1.9, 2.9, 3.9, 7.8, 7.7, 5.3, 0.0
- Current account deficit, excluding interest payments (line 4), 2009–2019 (in percent of GDP): 25.0, 19.6, 13.9, 15.0, 11.2, 11.5, 16.8, 18.9, 19.2, 12.9, 10.5
- Net non-debt creating capital inflows (line 8), 2009–2019 (in percent of GDP): -35.8, -17.8, -12.0, -14.7, -9.7, -9.7, -10.6, -11.4, -11.7, -11.9, -11.9
- Automatic debt dynamics (line 9), 2009–2019 (in percent of GDP): 6.1, -0.4, -0.8, 6.8, -3.4, 1.1, -2.3, 0.3, 0.3, 4.3, 1.4
- Contribution from nominal interest rate (line 10), 2009–2019 (in percent of GDP): 2.9, 3.3, 3.8, 3.6, 3.4, 3.6, 3.5, 4.7, 5.0, 5.7, 5.7
- Contribution from real GDP growth (line 11), 2009–2019 (in percent of GDP): 5.4, -2.2, -3.6, 3.1, -4.0, -2.5, -5.7, -4.4, -4.7, -1.5, -4.3
- Residual, incl. change in gross foreign assets (line 13), 2009–2019 (in percent of GDP): 7.5, 20.6, 1.1, 1.8, 3.9, 1.3, 0.8, -0.5, 0.2, -0.8, 0.3
- External debt-to-exports ratio (in percent), 2009–2019: 271.2, 309.7, 275.1, 286.9, 307.9, 327.9, 340.6, 356.7, 374.4, 377.8, 375.0
- Gross external financing need (in billions of Euro), 2009–2019: 1.3, 1.1, 0.9, 0.9, 0.9, 1.1, 1.4, 1.6, 1.6, 1.3, 1.6

### Baseline and historical scenario reference points (chart annotations)
- Baseline external debt shown around 158 percent (chart baseline label: 158).
- Historical scenario baseline comparison shows historical external debt point 157.
- Chart scenario outcomes (labels):
  - Growth shock: 172 (baseline 158)
  - Interest rate shock: 160 (baseline 158)
  - Non-interest current account shock: 189 (baseline 158)
  - Combined shock: 182 (baseline 158)
  - Real depreciation (30 percent): 229 (baseline 158)

*International Monetary Fund staff estimates and country desk data as presented in Appendix II. Montenegro: External Debt Sustainability Analysis.*

### 3. Joint work program None None

### _cr1526 - 3. Joint work program None None

### Statistical issues — assessment and main shortcomings
- General: "Data provision has some shortcomings, but is broadly adequate for surveillance. The most affected areas are labor market indicators, and government finance statistics."
- National Accounts:
  - MONSTAT compiles annual production and expenditure accounts in current and previous year’s prices; production and expenditure GDP estimates are reconciled through the supply and use framework.
  - Quality of annual GDP is described as "good."
  - Quarterly GDP by production disseminated since 2012 using an indirect method; methodology "has room for improvement" and estimates are compiled at an aggregated level (mostly NACE section level).
  - Short-term statistics accuracy needs improvement "mostly for agriculture, and construction."
  - Latest national accounts TA mission in September 2014 worked on quarterly GDP estimates by expenditure approach; "Experimental estimates have been compiled; the official dissemination will be in March 2015."
- Price Statistics:
  - MONSTAT compiles monthly CPI "that broadly follows international standards."
  - MONSTAT implementing improvements to PPI: developing a total output PPI; expanding coverage to services and construction; updating index calculation methods.
  - MONSTAT began compiling and disseminating the EU harmonized consumer price indices beginning in 2011.
  - Export price index published since 2009; industrial import price index since 2011.
  - "There is need to improve the industrial production index."
- Labor market statistics:
  - MONSTAT reports labor and wage statistics from the LFS and administrative sources.
  - Unemployment rate from LFS computed according to the ILO definition.
  - Quality of wage indicators "is relatively good," but information on foreign employment is limited.
  - Large informal sector impedes accurate assessment of unemployment rate; frequent methodological revisions impair time series analyses.
- Government Finance Statistics (GFS):
  - Fiscal data compiled by Ministry of Finance (MOF) based on a new GFS institutional classification; since early 2006 includes local governments and social security funds (latter merged with treasury account in 2010).
  - Charter of accounts introduced in 2001 implemented at local level from mid-2005.
  - Fiscal data reporting suffers from frequent re-classifications.
  - Unit for SOE data collection established, but "a satisfactory compilation of the public sector fiscal balance requires significant further effort."
  - Data on enterprises owned by municipalities "are rarely available."
  - Data on the stock of local government arrears "need to be significantly strengthened and disseminated."
  - Data on stocks of financial assets and liabilities are incomplete.
  - Latest GFS TA mission (March 2013) recommended: update table on institutional structure of public sector; establish migration plan to phase in GFSM 2001; start publishing quarterly budgetary central government data in the IFS.
- Monetary and Financial Statistics:
  - Compiled by Central Bank of Montenegro (CBM) broadly following the Monetary and Financial Statistics Manual (2000), but not reported in IMF Standardized Report Form format.
  - Dissemination practices meet GDDS recommendations on periodicity and timeliness for financial sector data.
  - Since early 2006 CBM publishes detailed monetary statistics in monthly Statistical Bulletin.
  - At beginning of 2013 CBM adopted new financial reporting requirements for banks in line with IAS 39; "monetary data for 2013 are not comparable with data from previous years."
  - Montenegro does not report Financial Soundness Indicators to the IMF.
- External sector statistics / Balance of Payments (BoP):
  - BoP compiled by CBM and follow international reporting standards.
  - MONSTAT improvements have aided coverage, valuation, classification of merchandise trade statistics.
  - Trade data compiled under special trade system; CBM adjusts MONSTAT import/export data from CIF to FOB.
  - Biggest BoP challenge is coverage of transactions through the informal economy.
  - As a euroized economy, estimating currency and deposits is difficult; "large errors and omissions continue to be an issue."
  - Errors and omissions are still large with a persistent positive sign, largely due to underestimation of export of tourism services.
  - CBM improved ITRS transaction coding and bank interaction, but ITRS remains inadequate for reinvested earnings, trade credits, and records on a cash basis rather than accruals.
  - CBM needs to undertake direct enterprise surveys and prepare comprehensive documentation on compilation methods and data sources.
  - CBM interested in reporting BoP statistics under BPM6 presentation.
  - CBM received TA on IIP statistics but does not yet disseminate these data; CBM conveyed continuous difficulties compiling and disseminating IIP.
  - Latest BoP TA mission (January 2013) action items: (i) compilation and regular dissemination of IIP and external debt statistics; (ii) revise compilation of flows in currency and deposits assets by other sectors; (iii) improve estimation procedure for Compensation of Employees (credit).

### Data standards and dissemination status
- Participant in the Fund’s General Data Dissemination System (GDDS) since December 2011.
- Latest update of metadata and GDDS plans for improvement were in 2012.
- "No data ROSC available."

### Table of Common Indicators Required for Surveillance (selected metadata as of end-Dec 2014)
- International Reserve Assets and Reserve Liabilities of the Monetary Authorities: Date of latest observation Oct-2014; Date Received 21-Nov-2014; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M.
- Reserve/Base Money: Oct-2014; 21-Nov-2014; M; M; M.
- Central Bank Balance Sheet: Oct-2014; 21-Nov-2014; M; M; M.
- Consolidated Balance Sheet of the Banking System: Oct-2014; 21-Nov-2014; M; M; M.
- Interest Rates: Oct-2014; 21-Nov-2014; M; M; M.
- Consumer Price Index: Oct-2014; 21-Nov-2014; M; M; M.
- Revenue, Expenditure, Balance and Composition of Financing – General Government: Sept-2014; 21-Oct-2014; Q; Q; Q.
- Revenue, Expenditure, Balance and Composition of Financing – Central Government: Sept-2014; 21-Oct-2014; M; M; M.
- Stocks of Central Government and Central Government-Guaranteed Debt: Sept-2014; 24-Oct-2014; Q; Q; Q.
- External Current Account Balance: Q3-2014; 21-Nov-2014; Q; Q; Q.
- Exports and Imports of Goods and Services: Q3-2014; 21-Nov-2014; Q; Q; Q.
- GDP/GNP: Q2-2013; 24-Sept-2014; Q; Q; Q.
- Gross External Debt: --; --; NA; NA; NA.
- International Investment Position: --; --; NA; NA; NA.

### Press Release / Article IV consultation — key findings and policy messages (Press Release No. 15/31, February 4, 2015)
- Economic momentum slowed in 2014; growth expected to accelerate in 2015, aided by expenditures on the highway project.
- Vulnerabilities: downturn in external demand; substantial financing needs expose country to shifts in risk aversion and disruptions to global financial markets.
- Fiscal policy:
  - Authorities undertook bold fiscal adjustment over past years via tax hikes, pension freezes, and measures to increase tax compliance.
  - Measures in draft 2015 budget partly offset extra highway spending but "a sustained period of fiscal discipline will be needed nonetheless."
  - Recommendation: lay out clear and credible long-term plans for managing public finances, including savings on pensions and the public sector wage bill; define contingency measures to address unforeseen fiscal shocks, with first recourse being delay or cut in highway spending.
- Banking sector / NPLs:
  - Addressing non performing loans and improving credit conditions are priorities.
  - "Podgorica Approach" can facilitate debt workouts; should be complemented by reforms to contract enforcement and securing collateral.
  - Provisioning coverage appears sizable on a regulatory basis but wide variation across banks may warrant enhanced supervisory scrutiny.
  - Recommendation: improve transparency by publishing quarterly banking reports with information on level of regulatory provisions and all stress test results.
- Structural reforms:
  - Essential to raise potential growth and improve flexibility and competitiveness.
  - Measures to ensure wages adjust in line with productivity and to reduce disincentives for employment.
  - Sustain policy momentum to strengthen business environment and spur investment.

### Executive Board Assessment — summary of directors’ views
- Directors noted "moderate growth continues, but the outlook remains challenging, and risks weigh on the downside, including from external spillovers."
- Emphasized need for:
  - Continued fiscal discipline.
  - Further efforts to strengthen the banking sector.
  - Comprehensive structural reforms to address macroeconomic vulnerabilities and spur growth.
- Fiscal remarks:
  - Commended authorities’ efforts to address fiscal imbalances.
  - Noted Bar-Boljare highway project places large burden on public finances and exacerbates debt and financing risks.
  - Underscored need for sustained underlying fiscal restraint embedded in 2015 budget; encouraged a clear long-term consolidation strategy, including pension and public-sector wage reforms.
  - Stressed contingent fiscal measures should be identified to address unanticipated shocks.
  - Welcomed reductions in support to state-owned entities and called for timely completion of sale of aluminum producer KAP.
- Banking sector:
  - Health indicators mixed: capitalization improved and liquidity appears sufficient; profitability weak; large stock of NPLs burdens balance sheets and impedes lending.
  - Agreed improving credit conditions is top priority; welcomed draft law on voluntary financial restructuring.
  - Recommended reforms to bolster contract and collateral enforcement and stronger supervisory scrutiny over provisioning, classification, and collateral valuation practices.
  - Saw merit in enhancing regulatory transparency and reporting.
- Structural reforms:
  - Emphasized labor market reforms to boost growth potential and contain long-term fiscal pressures.
  - Encourage authorities to sustain progress in improving business and investment environments.

### Selected economic indicators (table: Montenegro: Selected Economic Indicators)
- Output, prices and labor market
  - Real GDP (percent change): 2010 2.5; 2011 3.2; 2012 -2.5; 2013 3.3; 2014 2.0; 2015 Proj. 4.6.
  - Nominal GDP (in millions of euro): 2010 3,104; 2011 3,234; 2012 3,149; 2013 3,327; 2014 3,387; 2015 Proj. 3,588.
  - Industrial production: 2010 17.5; 2011 -10.3; 2012 -7.1; 2013 10.6; 2014 --; 2015 --.
  - Tourism (Overnight stays): 2010 5.5; 2011 10.2; 2012 4.3; 2013 2.8; 2014 --; 2015 --.
  - Unemployment rate (in percent) 1/: 2010 19.7; 2011 19.7; 2012 19.7; 2013 19.5; 2014 --; 2015 --.
  - Consumer prices (average): 2010 0.7; 2011 3.1; 2012 3.6; 2013 2.2; 2014 -0.6; 2015 Proj. 1.2.
  - Consumer prices (end of period): 2010 0.7; 2011 2.8; 2012 5.1; 2013 0.3; 2014 0.6; 2015 Proj. 0.9.
- General government finances (percent of GDP) 2/:
  - Revenue and grants: 2010 41.3; 2011 38.5; 2012 40.0; 2013 41.5; 2014 42.9; 2015 Proj. 42.1.
  - Expenditure: 2010 45.9; 2011 43.8; 2012 45.9; 2013 44.8; 2014 43.8; 2015 Proj. 47.5.
  - Fiscal balance: 2010 -4.6; 2011 -5.2; 2012 -5.9; 2013 -3.3; 2014 -0.9; 2015 Proj. -5.3.
  - Primary fiscal balance: 2010 -3.6; 2011 -3.8; 2012 -4.0; 2013 -1.1; 2014 1.4; 2015 Proj. -3.1.
  - General government gross debt: 2010 40.9; 2011 46.0; 2012 54.0; 2013 58.2; 2014 58.5; 2015 Proj. 60.7.
- Monetary sector (end-period, percent change):
  - Bank credit to private sector: 2010 -8.9; 2011 -13.0; 2012 -3.1; 2013 2.1; 2014 -3.6; 2015 Proj. 3.2.
    - Enterprises: 2010 -11.2; 2011 -20.3; 2012 -4.9; 2013 0.1; 2014 --; 2015 --.
    - Households: 2010 -5.7; 2011 -3.2; 2012 -1.1; 2013 3.7; 2014 --; 2015 --.
  - Private sector deposits: 2010 5.9; 2011 1.2; 2012 7.2; 2013 5.4; 2014 --; 2015 --.
- Balance of payments (percent of GDP, unless otherwise noted):
  - Current account balance: 2010 -22.9; 2011 -17.7; 2012 -18.7; 2013 -14.6; 2014 -15.1; 2015 Proj. -20.2.
  - Exports of goods and services: 2010 37.3; 2011 42.7; 2012 44.1; 2013 41.8; 2014 40.5; 2015 Proj. 40.4.
  - Imports of goods and services: 2010 -63.2; 2011 -64.9; 2012 -68.8; 2013 -62.1; 2014 -61.0; 2015 Proj. -66.0.
  - Foreign direct investment: 2010 17.8; 2011 12.0; 2012 14.7; 2013 9.7; 2014 9.7; 2015 Proj. 10.6.
  - External debt 3/: 2010 115.5; 2011 117.6; 2012 126.6; 2013 128.7; 2014 132.9; 2015 Proj. 137.5.
  - REER (CPI-based; average change, in percent; + indicates appreciation): 2010 2.8; 2011 -3.2; 2012 3.3; 2013 -1.1; 2014 --; 2015 --.
- Notes in table:
  - 1/ Labor Force Survey (LFS) data.
  - 2/ Includes extra-budgetary funds and local governments, but not public enterprises.
  - 3/ Staff estimates, as private debt statistics are not officially published.

### Authorities’ statement — key points (Statement by Menno Snel and Andrijana Cudina, January 23, 2015)
- Economic developments and outlook:
  - Real GDP "rebounded by 3¼ percent in 2013, but has weakened in 2014 and looks likely to be close to 2½ percent for the year."
  - Slowdown attributable to weakened external demand and floods in the region.
  - Positive developments in tourism, construction, forestry and retail trade.
  - Employment rising but unemployment rate "persistently high"; inflation "has fallen sharply but remains in positive territory"; credit growth has not recovered.
  - Medium-term growth expected to converge to "about 3 percent" backed by large-scale investment projects including first stage of Bar-Boljare highway "costing a quarter of the national product," energy sector projects and tourism.
  - Authorities note clear risks due to high dependence on foreign capital inflows and substantial refinancing needs.
- Fiscal policy:
  - Fiscal consolidation narrowed overall deficit from -5.9 in 2012 to -0.9 percent of GDP in 2014 via higher taxes, pension freeze, and measures against grey economy.
  - Public debt rising to 58 percent of GDP in 2014.
  - Authorities agree strong fiscal discipline needed given highway cost; 2015 budget envisages measures expected to improve budget balance (excluding highway spending).
  - Focus on rationalization of current expenditures; capital expenditures limited to essential infrastructure; wage and pension bill and social transfers to be contained.
  - Pension adjustment likely on the downside since cost of living and average wages are declining.
  - Fiscal rule: authorities see room for further strengthening; progress in divesting from SOEs noted (KAP sale to new owner, full payment pending).
- Public debt sustainability:
  - Authorities contend staff’s DSA may not fully capture spillover effects from infrastructural projects on growth and inflation.
  - Argue highway loan terms with Chinese partners are "rather favorable"; annual installments about EUR 50-60 million (net fiscal burden about EUR 25 million annually when accounting for tolling revenues).
  - If construction finished by 2019, budget would have two years of receiving tolls before first installment due.
  - Authorities prepared to consider a swap arrangement for exchange rate risks.
  - In event of shocks or highway cost overruns, authorities prepared to lay out a contingent consolidation plan; preference to avoid cutting/delaying highway mid-construction and instead focus on tackling current budget expenditures and boosting revenues (e.g., stronger taxation of alcohol, tobacco and oil derivatives).
- Monetary policy and financial system:
  - Banking sector "sound and liquid" by liquidity and solvency ratios, but tight lending policy, weak credit activity, low profitability.
  - Level of NPLs "still high at around 17 percent."
  - Authorities implementing measures including the "Podgorica Approach" voluntary financial restructuring to reduce NPLs; plan closer monitoring of factoring companies.
  - High lending interest rates hamper NPL resolution and new lending; efforts to reduce market inefficiencies, increase competition, and address structural credit risks.
  - Priority: strengthen institutions, legal framework and rule of law, especially contract enforcement.
- Competitiveness and structural reforms:
  - Priority areas: labor market, pension system and business environment.
  - Labor market reforms include reducing dismissal costs, simplifying hiring, temporary government-funded program for graduates, aligning education with labor market needs.
  - Introduction of "social cards" to streamline social benefits and reduce work disincentives.
  - Pension reforms aim to reduce Pension Fund deficit via better collection of contributions and stricter retirement rules.
  - Business environment: improved from 42nd to 36th in World Bank Doing Business 2015, mainly due to improvements in obtaining construction permits; other procedures (starting a business, enforcing contracts, registering property, tax collection) remain challenging.
  - Authorities focusing on attracting FDI and considering new incentives for foreign investors.

*Prepared by World Bank staff; questions may be addressed to Sanja Madzarevic-Sujster (smadzarevic@worldbank.org) and Gallina A. Vincelette (gvincelette@worldbank.org).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr1526.pdf_