## _cr1679 ## Source details **Canonical URL:** [_cr1679](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr1679.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr1679.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr1679.pdf.json) --- ### Montenegro’s Highway Project and Macroeconomic Outlook - Highway project (first segment) key facts: - Costed and budgeted first segment: EUR 809 million (23 percent of 2014 GDP). - Contract fixed cost implied of USD 1.1 billion; contract payments in U.S. dollars at the euro/US exchange rate at signing; foreign exchange risk borne by Montenegro. - Euro depreciation since agreement estimated to have increased costs in euros by about 5 percent of GDP. - Remaining 136 km not costed; expected to cost less per kilometer than first segment. - Financing for the first section: China’s ExIm Bank will finance 85 percent through a 20-year loan, denominated in dollars, with a fixed 2 percent interest rate and a six-year grace period. - Authorities indicate remaining 15 percent to be financed via cuts in non-highway capital spending and/or additional borrowing; toll revenues expected to help repayments. - Construction start date: May 11, 2015; Construction period: 48-months. - Domestic subcontracting: 30 percent of the investment. - Growth and prices: - Staff forecasts growth just over 4 percent in 2015, compared with 1¾ percent in 2014; staff projects growth of 4.1 percent in 2015, accelerating in 2016 as highway expenditure increases. - Inflation averaged 1½ percent in 2015 (after deflation in 2014). - External and financing outlook: - FDI flows robust at 19½ percent of GDP year to date. - Staff estimates external debt decreased modestly to 152 percent of GDP by end-2015, expected to rise above 160 percent over the medium term. - Current account deficit expected to average 18 percent of GDP over the period due to heavy import content and low private saving rates. - Funding needs average 12 percent of GDP from 2016 to 2020. - Highway spending (adjusted for pre-payments) projected: EUR 40, 240, 240, 224, and 65 million from 2015 to 2019. ### Fiscal outlook, risks, and staff baseline - Fiscal trajectory and debt: - Gross general government debt expected to increase from 66 percent of GDP currently to a peak of 80 percent in 2018 (baseline includes only first stage highway spending; debt falls thereafter). - Staff expects general government deficit to increase to 7½ percent of GDP in 2015 and to increase further in the medium term with highway spending. - Public gross financing needs (baseline, percent of GDP): 2013: 2.4; 2014: 9.5; 2015: 5.1; 2016: 17.8; 2017: 19.1; 2018: 13.5; 2019: 7.5; 2020: 9.3. - Risks to the baseline: - External risks: large public financing needs, reliance on foreign capital, exposure to changes in financial conditions, vulnerability to tourism demand from Russia, Serbia, euro area. - Domestic risks: implementation delays for major projects; potential crowding out of private investment; failure to clean bank balance sheets; fiscal slippage ahead of elections; calls on guarantees. - Debt dynamics and stress-test outcomes: - Baseline nominal gross public debt (percent of GDP): 2013: 38.2; 2014: 55.2; 2015: 59.9; 2016: 66.5; 2017: 70.5; 2018: 77.1; 2019: 80.4; 2020: 79.6. - Highway shock (construction cost 20 percent above baseline in 2018): debt increases to 84 percent of GDP. - Growth shock (one standard deviation): public debt ratio increases to 99 percent by 2018; half-standard deviation shock lifts debt to 89 percent. - Combined macro shock (recession, 200 bps interest, higher expenditure): debt ratio up to 95 percent in 2018. - Financial contingent liability shock (10 percent of banking sector plus GDP and interest shocks): debt peaks at 97 percent; gross financing needs over 27 percent of GDP in 2016. - Public debt drivers (cumulative 2013–2020, percent of GDP): Change in gross public sector debt: 16.7; Identified debt-creating flows: 16.7; Automatic debt dynamics: -3.4; Real interest rate contribution: 10.0; Real GDP growth contribution: -13.3. ### Fiscal consolidation recommendations and quantified options - Consolidation objective illustrated: - Staff recommends new measures from 2016 delivering an extra 1½ percentage point of GDP and a 1½ percentage point primary surplus sustained after highway completion to bring debt back to 60 percent of GDP by 2026. - Revenue-side quantified options (scope for additional fiscal consolidation, percent of staff baseline projection GDP each year 2016–2020 unless noted): - Taxes total: 0.9 each year 2016–2020. - Improved collection VAT: 0.3 each year 2016–2020. - Property tax increase: 0.1 each year 2016–2020. - Tourism tax increase: 0.2 each year 2016–2020. - Reinstating PIT crisis rate to 13%: 0.3 each year 2016–2020. - Restoring crisis tax rate from 11 percent to 13 percent would yield gains of about ⅓ of a percentage point. - Raising VAT to a uniform rate of 19 percent could notionally yield gains of 1½ percent of GDP. - Expenditure-side quantified measures (percent of GDP, medium term): - Wage freeze (2016): (0.5) in 2016–2019 and (0.4) in 2020. - Social security transfers: (0.9) in 2016–2018; (0.8) in 2019–2020. - Pension freeze (2016 & 2017): (0.2) each year 2016–2020. - Repealing social laws 1/: (0.7) in 2016–2018; (0.6) in 2019–2020. - Reducing other transfers 2/: (0.3) each year 2016–2020. - Budgeting for one-off payments 3/: 0.2 in 2016; 0.4 in 2017–2019; 0.4 in 2020. - Aggregate scope shown: (1.5) in 2016; (1.3) in 2017–2018; (1.1) in 2019–2020. - Primary balance implications: 2.4 in 2016; 2.2 in 2017–2018; 2.0 in 2019–2020. - Notes on measures: - 1/ New pension provisions and social allowances for mothers with three or more children. - 2/ Includes transfers to public corporations. - 3/ Arrears, guarantees. - Staff view: Immediate gains from freezes on public sector wages and pensions, together with cuts to transfers to public corporations, could deliver fiscal savings of about 1¼ percent of GDP over the medium term; repealing new social provisions in the 2016 budget would bring substantial savings. ### Pensions, social expenditures, and public wage bill - Pension system: - Pension funding gap around 4 percent of GDP and dominates structural fiscal deficit. - De facto average retirement age: 61 years for men and 59 years for women. - 2011 law phases in retirement age to 67 for both sexes (from 65 and 60), fully enforced by 2024 for men and 2041 for women. - Growth of old-age pensioners 2010–2014 more than three times expected based on demographics. - Recommendations: reintroduce a pension indexation freeze short run; accelerate increases in average retirement age or prevent early retirements; revoke new pension/social provisions that worsen structural deficit. - Public sector wage bill: - Government spending approaching 50 percent of GDP; public wages and pensions together account for more than half of total spending. - Staff recommends freezing public wages in short run; formalize a 3–1 attrition rule; reduce local government employees. ### Tax administration and revenue measures - Constraints: regional competition limits scope for raising corporate income taxes; low personal rates help participation and combat informality. - Recommended revenue measures: small increases in tourist taxes and VAT; revoke tax exemptions for “strategic” sectors; partially reverse decrease in crisis tax rate; broaden tax base through improved tax administration (registration, enforcement, debt management, appeals). ### Banking sector, NPLs, and financial stability - Banking sector summary: - Capital buffers adequate on average but heterogeneous; some domestic banks weakly capitalized. - Liquidity ample; many banks have loan-to-deposit ratios well below 100 percent. - Profitability weak due to high operating costs despite high net interest margins. - Reported NPLs at 14¾ percent of gross loans, or about 40 percent inclusive of loans transferred to asset management companies. - EUR 720 million of NPLs (21 percent of GDP) were transferred from bank balance sheets to AMCs belonging to parent banks. - FSAP findings and recommendations: - Conduct an Asset Quality Review (AQR) of all banks by independent internationally recognized auditors. - Develop time-bound supervisory action plans (including capital injection by shareholders) for “at risk” banks. - Continue work on resolution plans to maintain system stability and minimize cost to taxpayers. - Strengthen identification, measurement, and management of NPLs and liquidity risk; clarify prudential categorization of restructured loans; strengthen governance and consolidated supervision. - Refrain from introducing lending-rate caps; rigorously evaluate new bank licenses. - Euroization and ELA constraints: - Montenegro uses the euro unilaterally; central bank cannot independently create liquidity, constraining lender-of-last-resort funding. - Options to bolster ELA capabilities include a dedicated sub-account set up by the finance ministry for use by the central bank with objective criteria for public funding in crisis; bank fees or pooled liquidity have drawbacks. - Current liquidity buffers: excess reserves cover about [50] percent of short-term liabilities; CBCG capital ~5 percent; combined with required reserves, buffers nearly 75 percent (staff calculation). - Two-thirds of deposits held by subsidiaries of euro-area banking groups—possible parent support but not reliable if shock originates abroad. - Macroprudential framework: - Given limited monetary policy instruments (reserve requirements mainly), staff recommends broadening and operationalizing macroprudential toolkit (loan-to-value, debt-service-to-income, sectoral capital requirements, monitoring concentration limits). ### Consumer bankruptcy, enforcement, and debt-resolution framework - Personal insolvency law: - New law passed but implementation delayed due to lack of supporting institutional infrastructure; ambiguities risk undermining secured creditors’ rights and creating moral hazard. - Staff recommends correcting legal ambiguities and ensuring enabling regulations before implementation. - Enforcement reforms: - Introduction of Public Enforcement Officers (PEOs) reduced enforcement times and collected 15 percent of EUR 231 million total claims (6½ percent of 2014 GDP) in first nine months (20,381 cases closed out of 60,561 active cases). - Suggested further tightening of licensing, oversight, and education for PEOs. - Recommendations: strengthen voluntary debt restructuring framework; amend consumer bankruptcy law to clarify creditors’ rights and avoid deterring secured lending; bring nonbank credit institutions and AMCs under CBM oversight. ### External debt sustainability and stress tests - External debt baseline (percent of GDP): 2010: 141.6; 2011: 145.0; 2012: 155.9; 2013: 151.5; 2014: 154.8; 2015: 152.1; 2016: 154.8; 2017: 161.4; 2018: 164.1; 2019: 163.1; 2020: 158.7. - Stress-test outcomes: - Growth shock (one-half std dev): external debt ratio increases to 181 percent in 2020. - Interest rate shock (one-half std dev): external debt rises to 160 percent by 2020. - Non-interest current account shock (one-half std dev, +6¼ pp): external debt to 189 percent by 2020. - Combined macro shock (¼ std dev to real interest, growth, current account): external debt to 185 percent; gross financing needs increase by 28 percent of GDP cumulatively. - Real exchange rate shock (one-time 30 percent devaluation): external debt-to-GDP rises by 70 percent of GDP in 2016; gross financing needs higher by about 18 percent of GDP on average over 2016–20. - Implication: external debt is particularly sensitive to currency depreciation and current account shocks related to project cost overruns. ### Structural reforms, competitiveness, and labor market - Structural constraints: - TFP weak; Montenegro relied on labor intensity; declining population, low employment and participation constrain potential output. - Labor market rigidities: high long-term and youth unemployment; informal sector estimated 10–20 percent of GDP and employing one third of workers. - Labor costs high relative to Western Balkan and New Member State peers. - Export share to euro area declined; non-price factors (administrative costs, inefficient transport) impede trade. - Recommendations: - Increase wage flexibility to allow wages to adjust with productivity. - Maintain discipline over public sector wage bill. - Address disincentives to employment (onerous dismissal procedures). - Redirect subsidies for hiring graduates toward retraining the long-term unemployed. - Simplify regulatory frameworks, reduce administrative costs, improve permit and property registration processes, and increase judicial efficiency. ### Risk Assessment and Policy Sequencing - Key risks and policy responses (selected from Risk Assessment Matrix): - Structurally weak growth in advanced/emerging economies (Likelihood: High; Impact: High): let automatic stabilizers work; accelerate structural reforms. - Tighter global financial conditions (Likelihood: High; Impact: High): credible medium-term fiscal consolidation; let automatic stabilizers work. - Geopolitical risks (Russia/Ukraine) (Likelihood: Medium; Impact: Medium): accelerate structural reforms; facilitate resolution of problem loans. - Weakening fiscal discipline (Likelihood: Low; Impact: Medium): sustain fiscal consolidation; reinstate pension freezes; maintain public wage discipline; curtail subsidies and tax exemptions. - Policy sequencing: - Strengthen fiscal sustainability to avoid deterring private and foreign investment in tourism and infrastructure. - Complement investment-led strategy with structural reforms to improve business environment and anti-corruption measures (including AML/CFT improvements). *Source: IMF staff report excerpts and annexes (Montenegro — selected sections, _cr1679).* ### 1. Montenegro’s Highway Project __________________________________________________________________4 ### Montenegro’s Highway Project ### Context - Montenegro is a small, euroized economy with concentrated output (tourism, energy, hard commodities), heavy external financing dependence, a rigid labor market, unfavorable demographics, low labor participation, limited fiscal space, and an upcoming general election in 2016. - The Bar-Boljare highway will connect the main seaport of Bar to Serbia and is viewed as supporting regional integration, trade, and road safety. - Key facts about the first highway segment: - Costed and budgeted first segment: EUR 809 million (23 percent of 2014 GDP). - Contract payment terms: to be made in U.S. dollars at the euro/US exchange rate at the time the contract was signed; fixed cost implied of USD 1.1 billion, with foreign exchange risk borne by Montenegro. - Euro depreciation since the agreement is estimated to have increased costs in euros by about 5 percent of GDP. - Remaining 136 km not costed; expected to cost less per kilometer than first segment. - Financing for the first section: China’s ExIm Bank will finance 85 percent through a 20-year loan, denominated in dollars, with a fixed 2 percent interest rate and a six-year grace period. - Authorities indicate the remaining 15 percent will be financed via cuts in non-highway capital spending and/or additional borrowing; toll revenues expected to help repayments. - Construction start date: May 11, 2015. - Construction period: 48-months. - Domestic subcontracting: 30 percent of the investment. ### Recent developments - Output and prices: - Staff forecasts growth to be just over 4 percent in 2015, compared with 1¾ percent in 2014. - Inflation averaged 1½ percent in 2015 (after deflation in 2014). - Labor market: - Nominal wage growth flat since 2011. - Unemployment rate around 18 percent. - Labor participation around 55 percent. - Banking sector and credit: - Capital buffers adequate on average but heterogeneous across banks. - Liquidity ample; many banks have loan-to-deposit ratios well below 100 percent. - Profitability weak due to high operating costs despite high net interest margins. - Nonperforming loans (NPLs) at 14¾ percent of gross loans, or about 40 percent inclusive of loans transferred to asset management companies. - Lending to the private sector increased by 2¼ percent on average in 2015 (excluding receivables average total loan growth about 1 percent). - Credit growth remains weak relative to the growth rebound and high liquidity. - External sector: - Current account deficit decreased by about 3 percentage points of GDP in the first three quarters of 2015, driven by improved services (tourism) despite a deterioration in the merchandise trade deficit related to highway machinery imports and terms-of-trade. - FDI flows robust at 19½ percent of GDP year to date—almost double that of 2014. - Official recent external stocks unavailable; staff estimates external debt decreased modestly to 152 percent of GDP by end-2015. - Fiscal developments: - 2014 revenue overperformance matched by expenditure overruns of 3 percent of GDP. - 2015 budget implementation slipped: non-highway expenditure overruns estimated at 1½ percent of GDP, with modest revenue underperformance. - Unanticipated expenditures (activated guarantees and arrears from legal rulings) remain a persistent problem. - Highway construction delays imply under-spending of planned highway expenditures of around 1 percent of GDP in 2015; this will add to spending over in following years. ### Outlook and risks - Growth drivers: - Tourism and capital-intensive projects (notably the highway) will be main drivers; the highway assumed to have direct and indirect demand effects and when completed to raise the level of potential output. - Baseline projections and fiscal/external implications: - Staff projects growth of 4.1 percent in 2015, accelerating further in 2016 as highway expenditure increases. - Gross general government debt expected to increase from 66 percent of GDP currently to a peak of 80 percent in 2018 (baseline only includes spending on the first stage of the highway; debt falls thereafter). - Funding needs average 12 percent of GDP from 2016 to 2020. - Current account deficit expected to average 18 percent of GDP over the period due to heavy import content of infrastructure and low private saving rates. - External debt expected to increase from an estimated 152 percent of GDP to above 160 percent over the medium term. - Highway spending (adjusted for pre-payments) projected to be EUR 40, 240, 240, 224, and 65 million from 2015 to 2019. - Risks: - External risks: downside risks from large public financing needs and reliance on foreign capital, exposure to changes in financial conditions over next three years as debt escalates, vulnerability to fluctuations in external demand (tourism) from Russia, Serbia, and the euro area. - Domestic risks: sensitivity of growth to implementation delays of large investment projects; more projects could boost growth but add fiscal pressure; increased sovereign risk premia could crowd out private investment; failure to clean bank balance sheets could constrain credit recovery; recovery in lending could raise concentration risks; fiscal discipline could wane ahead of elections; calls on public guarantees could severely stress public finances. ### Policy discussions and recommendations - Policy focus: contain fiscal sustainability risks, sustainably revitalize credit conditions, safeguard financial sector stability, and boost competitiveness and economic flexibility. - Steps taken by authorities: - New fiscal rules aligned toward Maastricht criteria; Economic Reform Program acknowledges need to stem public debt acceleration. - Pension reforms adopted in 2011 increased average starting age for pensions and decreased disability pension volume. - Government has fully divested from the aluminum plant KAP. - Government guarantees largely directed to infrastructure and SMEs; pace of increase to 14 percent of GDP (up by two thirds) raises concerns about misdirection. - Intention to improve local government finances and reduce overstaffing. - 2016 budget considerations: - Revenues expected to increase more slowly than nominal GDP. - Nominal expenditures to increase substantially from 2016: new pension provisions and social allowances for mothers with three or more children will add approximately 1¼ percent of GDP in spending; a bill increases public wages by 5–15 percent in 2016; legislation to tackle the grey economy pending. - Expenditure levels assumed nearly constant from 2016 onward across most items; precise medium-term restraint measures on public wages and pensions not identified. - Staff projection of fiscal outcomes: - Staff expects the general government deficit to increase to 7½ percent of GDP in 2015 and to increase further in the medium term with highway spending. - Staff projects public debt to reach 80 percent of GDP within three years; staff projections show larger deficits and debt than authorities’ projections. - Euro depreciation at contract signing has sharply increased project cost; medium-term slight euro appreciation expected to partially offset increases. - Policy recommendation on consolidation: - Staff recommends additional consolidation to limit risks and maintain favorable funding conditions. - Illustrative consolidation required: new measures from 2016 delivering an extra 1½ percentage point of GDP (with respect to staff’s baseline path) and a 1½ percentage point primary surplus sustained after the completion of the highway would bring debt back to 60 percent of GDP by 2026. *Source: IMF staff report excerpt (Montenegro — selected sections).* ### 17. Achieving such a consolidation would require addressing weaknesses in social ### 17. Achieving such a consolidation would require addressing weaknesses in social ### Fiscal context and overall recommendations - Government spending approaching 50 percent of GDP; durable expenditure control is essential, particularly over public sector wages and pensions, which together account for more than half of total spending. - Revenue shares are already high, suggesting limits from increasing taxes, but options exist to boost revenues without creating a drag on growth. ### Pensions and social expenditures (including Box 2: Pension System Viability) - The pension system is unsustainable on current demographic and labor market trends. - The pension funding gap is large—around 4 percent of GDP—and dominates Montenegro’s structural fiscal deficit. - Current stresses: - High levels of early retirement and low labor participation rates and levels of formal employment. - Pressures will increase as population aging depresses an already low dependency ratio to around 1.4 by 2050. - De facto average retirement age: 61 years for men and 59 years for women. - Past reforms and challenges: - A 2011 law phases in a higher retirement age to 67 for both men and women (from 65 and 60, respectively), to be fully enforced by 2024 for men and 2041 for women. - Early retirement has often been allowed for selected groups, undermining reform efforts. - Growth of old-age pensioners from 2010 to 2014 was more than three times what would have been expected based on demographic trends alone. - Recommended policy responses: - Reintroducing a pension indexation freeze in the short run to contain fiscal pressures (to be lifted when a broader pension reform strategy is implemented). - Achieving sustainability will require some combination of accelerating increases in the average retirement age, reducing payments, or increasing contributions. - Raising the average retirement age is identified as the most efficient and growth-friendly option; could be facilitated by accelerating the phase-in of higher retirement ages or preventing early retirements. - New pension and social protection provisions that worsen the structural deficit should be revoked. ### Public sector wage bill - The public wage bill is high even compared with regional peers. - Staff recommends: - Freezing public wages in the short run. - Formalizing a 3–1 attrition rule that has intermittently been in place. - Reducing numbers of local government employees. ### Tax measures and revenue options - Constraints: - Regional competition to attract investment limits scope to raise corporate income taxes. - Keeping personal rates low assists efforts to raise participation from very low levels and combat informality. - Alternatives and recommendations: - Small increases in tourist taxes and VAT could bring immediate revenue gains. - Tax exemptions for “strategic” sectors should be revoked. - Recent decreases in the crisis tax rate could be partially reversed without significant damage to the labor market. - The tax base could be broadened by addressing deficiencies in tax administration: taxpayer registration, filing and payment enforcement, tax debt management, and taxpayer appeals. - Specific quantified options (scope for additional fiscal consolidation, percent of staff baseline projection GDP): - Taxes total: 0.9 each year 2016–2020. - Improved collection VAT: 0.3 each year 2016–2020. - Property tax increase: 0.1 each year 2016–2020. - Tourism tax increase: 0.2 each year 2016–2020. - Reinstating PIT crisis rate to 13%: 0.3 each year 2016–2020. - Restoring the crisis tax rate from 11 percent to its original level of 13 percent would yield gains of about ⅓ of a percentage point. - Raising VAT to a uniform rate of 19 percent could notionally yield gains of 1½ percent of GDP. ### Consolidation objectives and expenditure measures - Consolidation objectives could be immediately met with a combination of expenditure and revenue measures; feasible options can meet or exceed consolidation of 1½ percentage points of GDP. - Immediate savings will require some revenue measures, but targeting expenditures—particularly the public sector wage bill and social security expenditures—is crucial for durable consolidation. - Expenditure-side quantified measures (percent of GDP, medium term): - Wage freeze (2016): (0.5) in 2016–2019 and (0.4) in 2020. - Social security transfers: (0.9) in 2016–2018; (0.8) in 2019–2020. - Pension freeze (2016 & 2017): (0.2) each year 2016–2020. - Repealing social laws 1/: (0.7) in 2016–2018; (0.6) in 2019–2020. - Reducing other transfers 2/: (0.3) each year 2016–2020. - Budgeting for one-off payments 3/: 0.2 in 2016; 0.4 in 2017–2019; 0.4 in 2020. - Aggregate scope shown: (1.5) in 2016; (1.3) in 2017–2018; (1.1) in 2019–2020. - Primary balance implications: 2.4 in 2016; 2.2 in 2017–2018; 2.0 in 2019–2020. - Notes: - 1/ New pension provisions and social allowances for mothers with three or more children. - 2/ Includes transfers to public corporations. - 3/ Arrears, guarantees. - Immediate gains from freezes on public sector wages and pensions, together with cuts to transfers to public corporations, could deliver fiscal savings of about 1¼ percent of GDP over the medium term. - Repealing the new social provisions in the 2016 budget would bring substantial savings. ### Medium-term fiscal plans and institutions - New measures should be spelt out in detail in annual medium-term fiscal plans: - Plans should reflect most likely fiscal revenue and expenditure outcomes of policy measures; anticipate direct, indirect and hidden costs; and articulate contingency plans for unanticipated shocks. - Plans should specify how public debt is to be restored below 60 percent, in line with the fiscal rule. - To bolster fiscal credibility and maintain access to favorable funding terms, strengthen: - Establishment of an independent fiscal council. - Development of effective fiscal risk management. - Introduction of program/performance budgeting. - Moving to accrual accounting and associated reporting. ### Authorities’ views (fiscal) - Authorities acknowledged fiscal risks and judge them manageable. - Budget foresees expenditures remaining nearly constant in nominal terms after 2016; authorities expect current expenditure to be kept below current revenue, per the fiscal rules in the budget Law. - Authorities expect growth to average around 4 percent per annum over the medium-term, higher than staff projections, bringing higher revenues. - Authorities expect continued strong demand for Eurobond issuances, albeit with higher yields over the medium term, but would not rely exclusively on raising new debt; concessions and toll revenues could generate revenues for infrastructure projects and debt repayments. ### Credit policies and credit conditions - Collapse of the lending boom resulted in a long period of deleveraging; only now does the level of credit appear in line with Western Balkan peers. - Private sector indebtedness remains elevated, potentially inhibiting credit demand. - Banks have sought to restore profitability by raising spreads of lending rates over deposits; lending rates remained elevated even as deposit rates fell. More recently, interest rates have started to fall, but credit growth remains subdued. - Staff analysis: - Output and credit growth are highly correlated; effects of credit shocks on growth are higher than for other Western Balkan and emerging European peers. - Output growth is largely driven by fluctuations in tourism and FDI that “bypass” domestic credit conditions. - Current statistics and observations from figures and text (as presented): - Ratio of Private Credit to GDP: MNE compared to Western Balkans (excluding MNE) and historical series 2002–2012 shown in figures. - Effective Lending-Deposit Rate Spread and Effective Average Lending Rates shown for 2010–2015 in figures. - Nominal GDP, Tourism (Overnight Stays), and FDI developments shown as percent change series 2004–2014 in figures. ### Authorities’ views (credit) - Authorities regard easing credit conditions further as crucial for growth; concerned with persistently high levels of NPLs and average lending rates, viewing them as evidence of market failure. - Authorities believe voluntary restructuring law and other measures provide room for restructuring; pointed to a steady reduction in the level of NPLs. - Authorities consider interest rate caps to have a potentially useful role, citing increased lending and declining rates when caps were previously imposed in 2012. - Supervisor clarified bank license approvals depend on meeting licensing conditions; authorities recognize scope to give greater weight to financial stability considerations when considering new licenses. - Authorities agreed legal ambiguities in the new consumer bankruptcy legislation and lack of enabling regulations are problematic and should be corrected. - Authorities agreed structural factors could affect lending premia and cited progress such as procedures that cut down time to enforce court orders and secure collateral. ### Interest rate caps, competition, and consumer protection - Policy measures under consideration: - Voluntary debt resolution framework adopted. - Draft law capping interest rates on new loans at no more than 33 percent above the six-month weighted average lending rate. - Encouraging new banks to enter the market to boost competition. - Staff cautions and evidence: - Interest rate caps, when used to stimulate credit, have often reduced formal lending and driven riskier borrowers to unregulated lenders. - Concerns over excessive or usurious rates call for consumer protection measures rather than general lending rate restrictions. - Increased bank competition could reduce margins but might induce imprudent lending; supervisor should rigorously monitor banks’ business plans, capital levels, and lending concentration risks. - Voluntary restructuring law applies to a small subset of debtors; complementary measures—such as fast-track provisions—could boost effectiveness. - Example of public enforcement reform: introduction of Public Enforcement Officers (PEOs) reduced enforcement times and collected 15 percent of EUR 231 million total claims (6½ percent of 2014 GDP) in the first nine months of PEO operations (20381 cases closed out of 60561 active cases). ### Consumer bankruptcy legislation - A new law to increase protection for borrowers has been passed but is delayed due to lack of supporting institutional and regulatory infrastructure. - Staff concern: if implemented in current form, the law could undermine rights of secured creditors, including enforcement on a bankrupt debtor’s house, creating moral hazard and deterring new secured lending. - Authorities agree that legal ambiguities and lack of enabling regulations should be corrected. ### Reducing lending risk premia and enforcement - To sustainably reduce lending rates, reduce lending risks arising from difficulties in assessing credit-worthiness and recovering collateral. - Positive reform: introduction of Public Enforcement Officers (PEOs) focused on enforcing court decisions, associated with significant reduction in enforcement times and regarded as a significant step to reducing lending risk premia. - Lenders indicate reducing frequency of changes to laws affecting lending and more consistent and predictable enforcement would further reduce lending risk premia. ### AML/CFT framework - Montenegro is taking steps to enhance its AML/CFT framework but deficiencies exist. - The revised AML/CFT law strengthens customer due diligence obligations and practical steps have improved reporting of suspicious transactions. - Remaining deficiencies: - Reporting requirements narrowly focused on “transactions,” rather than “funds.” - Adequate and timely information on beneficial ownership of legal persons is lacking. - Due diligence measures should be enhanced to require reporting entities to establish sources of wealth of beneficial owners on a risk basis. - Lack of provisions prohibiting criminals or their associates from holding a significant or controlling interest in certain non-bank financial sector institutions and their functions is problematic. *Source: IMF staff report excerpt (chapter 17) provided in the supplied content.* ### 29. Financial sector vulnerabilities appear low overall, but with exceptions. The mission ### _cr1679 - 29. Financial sector vulnerabilities appear low overall, but with exceptions. The mission ### Financial sector vulnerabilities — summary findings - The FSAP assessed system-wide solvency and liquidity indicators as broadly sound, but vulnerabilities relate mainly to high levels of NPLs and/or low provisioning levels. - Some banks—mainly domestic—are weakly capitalized and vulnerable to shocks, such as an economic slowdown. - Increased bank competition is compressing profitability, raising the risk that some banks could lend imprudently to gain market share. - Emergency liquidity assistance (ELA) capacity is limited. ### Provisioning, asset quality, and supervisory weaknesses - Low IFRS-based provisions by some banks suggest overly-positive collateral valuations; some bank audits have been qualified. - Domestic supervisors lack a formal framework to challenge collateral valuations. - Recommended near-term actions: - Conduct an Asset Quality Review (AQR) of all banks by independent internationally recognized auditors to review loan classification and provisioning practices. - Develop time-bound supervisory action plans (including capital injection by shareholders) for “at risk” banks. - Continue work on resolution plans with objectives to maintain financial system stability, protect insured depositors, and minimize cost to taxpayers. - Priorities for strengthened supervision include improving identification, measurement, and management of nonperforming assets and liquidity risk; clarifying prudential categorization of restructured loans; reducing operational, funding, and credit risks; and strengthening governance frameworks for risk management. ### Euroization and lender-of-last-resort constraints - Montenegro has unilaterally adopted the euro as currency and unit of account and is outside of the euro system; the central bank cannot independently create liquidity. - This constrains the ability to provide lender-of-last-resort funding in emergencies. - Current assessment: banking system appears capable of handling modest liquidity pressures, but liquidity conditions can deteriorate quickly and parent-bank support cannot be relied upon in crisis. - Options to bolster ELA capabilities: - A dedicated sub-account set up by the finance ministry for use by the central bank, together with objective and quantifiable criteria for public funding in a crisis situation. - Note: Alternatives such as bank fees and pooled liquidity would likely add to costs and be passed on to lending rates; further analysis is needed to determine the appropriate size of the sub account. ### Macroprudential framework and EU accession - Given lack of independent monetary policy instruments (reserve requirements are the only actively-used instrument and are of limited effectiveness), convergence to EU and European Systemic Risk Board policies ahead of EU accession is advisable. - Staff recommends broadening and making the macro-prudential framework fully operational, with a potential toolkit to include: - Powers over loan-to-value, debt-service-to-income, and debt-to-income ratios; - Sectoral capital requirements and capital buffers; - Monitoring of lending concentration limits. ### Authorities’ views (financial sector) - Authorities broadly agreed with FSAP weaknesses and endorsed many recommendations. - Clarifications provided: - All banks are subject to annual on-site inspections; authorities intend to proceed with an independent AQR and take appropriate actions as needed. - Supervisors closely monitor banks’ loan classifications, emphasizing borrowers’ capacity to repay and limiting collateral assessments to improve classifications. - The central bank has drafted a law to extend supervisory remit to factoring, leasing, and credit and guarantee operations. - Authorities regard euroization as a vital anchor for price and economic stability and intend to align the central bank law with EU regulations by end 2016; because of EU state aid rules, this would preclude boosting ELA reserves through an MOF sub account and prevent direct liquidity assistance from the authorities to banks. - Authorities support clarifying and establishing new macroprudential tools in advance of EU accession. ### Structural reforms — constraints and priorities - Persistent concerns: productivity, flexibility, and competitiveness. - TFP growth has been weak; Montenegro has relied on labor intensity for growth; declining population and low employment/participation constrain potential output. - Rigid wage outcomes, high long-term and youth unemployment, and a substantial informal sector suggest labor market inefficiencies. - Authorities estimate the informal economy to account for 10–20 percent of GDP and employ one third of workers. - High public sector wage bill and subsidies to hiring schemes show skills mismatches; on average, only 25 percent of participants are offered permanent employment upon expiry of the nine-month internship program. - Labor costs are high relative to Western Balkan and New Member State peers. - An estimated current account imbalance of 7–8 percentage points of GDP could imply a real exchange rate imbalance of around 15–25 percent. - Progress and measures: - Labor law alignment with the EU is underway; consolidation of social benefits under a single “social card” could reduce fraud and informality. - Doing Business rankings comparable with regional peers, but shortcomings remain in tax compliance, starting businesses, registering property, and resolving insolvency. - Export share to the euro area has declined; non-price factors such as administrative costs and inefficient transportation infrastructure contribute. - Authorities are using sector-specific incentive schemes to promote competitiveness and diversification, though these can be hard to dismantle and may misallocate capital; recent labor legislation restricting non-resident hiring increases costs to the tourism sector. ### Structural reform recommendations - Continue reforms to improve underlying conditions for growth: - Increase flexibility in wage outcomes to allow real wages to adjust with productivity. - Maintain discipline over the public sector wage bill where private employers compete with the public sector. - Address disincentives for employment (e.g., onerous dismissal procedures). - Redirect subsidies for hiring university graduates toward retraining the long-term unemployed. - Prioritize simplifying regulatory frameworks, reducing administrative costs, improving permit and property registration processes, and increasing judicial efficiency. ### Staff appraisal — growth, fiscal risks, and policy advice - Growth outlook: - Strong growth this year looks set to continue into the medium term, driven by large capital-intensive projects and a major initiative to boost infrastructure. - Risks: - Emphasis on large infrastructure projects carries substantial risks, notably to public finances and potential misallocation of capital; investment-led growth can under-price risk and undermine financial and fiscal stability. - Public debt and fiscal policy: - Staff projects gross general government debt to increase substantially, peaking at around 80 percent of GDP over the next three to four years. - Given increasing public and external debt, vulnerability to shocks, limited policy space, and lack of independent monetary policy, staff recommends immediate and durable fiscal consolidation measures. - If further public infrastructure projects are debt financed, additional offsetting measures are required to limit fiscal risks and maintain market access. - Fiscal framework strengthening: - New fiscal measures should be complemented by medium-term fiscal plans, independent fiscal councils, public financial management reform, and tax administration reforms to broaden the tax base and increase revenues. - Financial conditions and credit growth: - Credit to the private sector has increased after a sustained shrinkage, but not as fast as expected given high liquidity and growth rebound, due to persistent NPLs, weak accounting/reporting, and slow collateral execution. - Some protective policies could unintentionally hold back credit growth (e.g., restrictions on lending rates, increased numbers of banks without regard to health, new consumer bankruptcy legislation that could deter secured lending). - Financial sector follow-up: - FSAP steps include an independent AQR, specific actions for weaker banks, and enhanced bank resolution planning; staff also recommends exploring options to bolster lender-of-last-resort capability. - Labor productivity and competitiveness: - Improved labor productivity and economic flexibility are crucial to complement the investment-led growth strategy. - Authorities should build on reform initiatives: improve labor market flexibility, reduce informality, continue improving the business climate (e.g., contract enforcement), and maintain discipline over public sector wages. *Source: _cr1679 - 29. Financial sector vulnerabilities appear low overall, but with exceptions. The mission* ### 46. It is expected that the next Article IV consultation with Montenegro will be held on ### It is expected that the next Article IV consultation with Montenegro will be held on the standard 12-month cycle. ### Real sector developments - Tourism has been buoyant, boosting construction. - Industrial production is recovering, notwithstanding falling electricity output. - The current account deficit is below its crisis peak and largely covered by FDI, but is nonetheless high. - Inflation has returned, but price pressures should remain subdued given restrained wage growth. - The trade deficit has improved, but remains large. - Employment gains have improved, but unemployment remains high. - Charts and indicators reference series spanning 2010–2015 (e.g., Tourism Overnight Stays, Construction, Industrial Production, Electricity Production, Current Account Deficit and FDI, Headline CPI, Core Inflation, Wages (3-month MA), Merchandise Trade, Employment Growth, Unemployment Rate). ### Financial sector developments - Deposits have recovered after the recession of 2011, but lending spreads remain near historic high despite falling deposit returns. - The stock of NPLs has been decreasing slowly due to weak economic conditions and inefficient debt resolution. - Profitability returned in 2013, but has retreated again; returns on assets are still very low. - Credit conditions have only recently showed signs of recovery. - Charts and indicators present series over 2010–2015 for deposits, deposit and lending rates, NPL shares and provisions, bank net profits (ROE), return on assets, and lending by sector. ### Fiscal developments - After successive increases, revenue gains have slowed, largely due to flat tax returns, despite new tax policies. - Wage restraint and pension freezes have helped consolidate current expenditure in recent years, but the fiscal balance has deteriorated this year with fiscal slippage and highway spending. - Public debt has increased sharply, leading to higher interest payments. - Charted series and components cover 2010–2015 and monthly tax revenue (EUR million). - Composition of government revenue and expenditure series (2010–2015) are shown. - Public debt series distinguish Domestic debt and Foreign debt (in percent of GDP). - Effective interest rate and Interest expenditure series are shown (in percent, in percent of GDP). ### Expenditure pressures - Public expenditures are large and mainly comprise social security and public wages. - Pension expenditures are persistently above contributions; pension expenditures are high by international comparison while the number of pensioners continues to rise. - The public sector wage bill is relatively high, although some consolidation has taken place. - Composition of Expenditure, 2014: 26% 6% 5% 33% 13% 17% (presented as components in the figure). - Pension Funding Gap and Pension expenditure charts span 2006–2014 and include international comparisons (EMG**, ADV*, SRB, etc.). - Number of Pension System Beneficiaries series cover 2009–2014 broken down by Disability pensions, Family pensions, Old age pensions. - Public wage expenditure series shown in percent of GDP and EUR millions for 2010–2015f. ### Credit conditions and competition - A high proportion of investment is funded externally, limiting lending opportunities for domestic banks. - Spreads are driven more by high overhead costs, reflecting low economies of scale, than profits. - Lending conditions in Montenegro are comparable to regional peers. - No single lender dominates the market, but four banks account for most lending. - Larger banks typically have higher-than-average lending margins but also lower lending rates. - Charts include Ratio of Foreign Direct Investment to Capital Formation (2006–2014 average), Interest Spread Decomposition (2007–2014), Interest Rates, Market Concentration by assets/deposits/loans, Interest-Deposit Rate Spreads by Bank, and Average Effective Lending Rates (2013–15). ### Banking sector - Bank capitalization has been stable, but the quality of assets and degree of loan provisioning is low. - Bank profitability is weak, related to high overhead and scale inefficiencies. - The largest and most profitable banks provide more lending than the rest of the system as a whole and consistently lend at lower rates. - Regulatory Capital (CAR) series and Regulatory Minimum are shown for 2007–2015 (as percent of risk-weighted assets). - Non-Performing Loans and Bank Provisioning series show NPLs to Gross Loans and Provisions to NPLs (2007–2015). - Bank sector profitability series include Return on Average Assets (ROAA) and Return on Average Equity (ROAE), Net Profits, Overhead Expenses to Gross Income, Non-Interest Expense to Gross Income. - Loan Portfolios by Bank Size (EUR million) and Lending rates by Bank Size series cover 2009Q1–2015Q1 and 2008Q1–2015Q1 respectively. ### Structural reform priorities - The business environment has improved steadily, although further improvements are needed in many areas. - The administrative process is long and setting up a business can be costly. - Tourism sector infrastructure lags peers in transportation; redundancy costs are now relatively low. - Tourism Competitiveness Scores (scale 1–7) and Labor Market Efficiency indicators (including cooperation in labor-employer relations and redundancy costs in weeks of salary) are presented with country and regional comparisons. ### External sector challenges - Goods exports have been declining and are weak compared to peers. - Montenegro has lost export share to the euro area, matched by an increasing share of low-value-added products. - High administrative costs for exports and high indirect costs also worsen price competitiveness. - Charts and comparisons reference Doing Business database (2016), DOT, and national authorities. ### Risk Assessment Matrix — key risks, impacts, and policy responses - Structurally weak growth in key advanced and emerging economies - Relative likelihood: High - Impact if realized: High — Protracted slowdown in the EU and neighboring countries could adversely impact appetite for external and public financing (especially FDI flows and tourism infrastructure developments); further “low-flation” could be imported from the euro area, harming 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. - Tighter and more volatile global financial conditions - Relative likelihood: High - Impact if realized: High — A surge in global financial market volatility and higher financing costs could inhibit market access; 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. - Heightened geopolitical risks associated with Russia/Ukraine tensions - Relative likelihood: Medium - Impact if realized: Medium — A prolonged and intensified downturn in Russia could undermine FDI inflows, weaken growth prospects, depress real estate prices, and limit Montenegro’s capacity to absorb shocks. - Policy response: - Let automatic fiscal stabilizers work, within limited fiscal space. - Speed up structural reforms to improve the business environment and competitiveness. - Accelerate structural reform and policies to facilitate the resolution of problem loans and encourage a revitalization of bank lending. - Weakening of fiscal discipline - Relative likelihood: Low - Impact if realized: Medium — Given high and increasing public debt, a loss of fiscal discipline could raise concern over the sustainability of the fiscal position; planned highway is a source of concern and pressure to raise public sector wages and pensions will remain. - Policy response: - Sustain fiscal consolidation; maintain public wage discipline, reinstate pension freezes, and further strengthen tax administration. - Curtail subsidies, reduce tax exemptions, and divest from loss-making public enterprises. *Source: IMF staff presentation and figures on Montenegro (selected figures and Risk Assessment Matrix from the provided content).* ### 5. Delays and ### 5. Delays and withdrawals from capital investment projects ### Risk summary - Risk level: Medium - Risk drivers: Ongoing geopolitical tensions, weak administrative procedures on land development, and concerns regarding public fiscal sustainability. - Potential impact: Could threaten capital investments in tourism and industry. - Context note: Construction and activity associated with large-scale investment projects (both tourism and infrastructure based) are key drivers of growth. ### Policy recommendation (from source) - 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, including through AML/CFT tools. ### Economic impact and channels - Delays or withdrawals from large-scale investment projects would directly reduce construction and investment activity, which are identified as key drivers of growth. - A negative shock to investment would feed through to: - Gross domestic investment (historical and projected levels include 21.8, 19.3, 20.6, 19.6, 19.8, 28.0, 28.6, 28.9, 26.6, 22.4, 21.7 percent of GDP for 2010–2020). - Gross national saving (historical and projected levels include -1.0, 1.8, 2.1, 5.1, 4.6, 14.6, 10.0, 9.8, 7.5, 6.8, 8.1 percent of GDP for 2010–2020). - The savings-investment balance/current account (current account balance: -22.7, -17.6, -18.5, -14.5, -15.2, -13.3, -18.6, -19.1, -19.1, -15.6, -13.5 percent of GDP for 2010–2020). ### Fiscal vulnerability (selected indicators from source) - Overall balance (percent of GDP): -4.9 (2010), -6.7 (2011), -5.8 (2012), -6.3 (2013), -2.6 (2014), -7.4 (2015), -9.2 (2016), -8.9 (2017), -6.0 (2018), -1.5 (2019), -0.6 (2020). - Primary balance (percent of GDP): -3.9 (2010), -5.3 (2011), -4.0 (2012), -4.2 (2013), -0.3 (2014), -4.9 (2015), -6.8 (2016), -6.5 (2017), -3.2 (2018), 1.5 (2019), 2.4 (2020). - General government gross debt (percent of GDP): 40.7 (2010), 45.6 (2011), 53.4 (2012), 55.2 (2013), 59.9 (2014), 66.5 (2015), 70.5 (2016), 77.1 (2017), 80.4 (2018), 79.6 (2019), 76.6 (2020). - General government debt, including loan guarantees (percent of GDP): 52.2 (2010), 57.2 (2011), 65.2 (2012), 65.4 (2013), 64.2 (2014), 69.0 (2015), 80.8 (2016), 84.1 (2017), 90.2 (2018), 93.0 (2019), 91.7 (2020). ### External sector sensitivity (selected indicators from source) - Current account balance (millions of euros): -710 (2010), -573 (2011), -588 (2012), -487 (2013), -526 (2014), -486 (2015), -715 (2016), -762 (2017), -792 (2018), -672 (2019), -617 (2020). - Trade balance (millions of euros): -1,267 (2010), -1,306 (2011), -1,389 (2012), -1,329 (2013), -1,376 (2014), -1,464 (2015), -1,662 (2016), -1,763 (2017), -1,852 (2018), -1,808 (2019), -1,843 (2020). - Foreign direct investment, net (percent of GDP): 17.7 (2010), 11.9 (2011), 14.5 (2012), 9.6 (2013), 10.2 (2014), 15.7 (2015), 12.0 (2016), 12.3 (2017), 12.5 (2018), 12.5 (2019), 12.5 (2020). - Gross external debt (percent of GDP): 141.6 (2010), 145.0 (2011), 155.9 (2012), 151.5 (2013), 154.8 (2014), 152.1 (2015), 154.8 (2016), 161.4 (2017), 164.1 (2018), 163.1 (2019), 158.7 (2020). ### Selected macro aggregates (levels and growth from source) - Nominal GDP (millions of €): 3,125 (2010), 3,265 (2011), 3,181 (2012), 3,362 (2013), 3,458 (2014), 3,641 (2015), 3,840 (2016), 3,989 (2017), 4,152 (2018), 4,314 (2019), 4,555 (2020). - Real GDP growth (percent): 2.5 (2010), 3.2 (2011), -2.7 (2012), 3.5 (2013), 1.8 (2014), 4.1 (2015), 4.6 (2016), 2.5 (2017), 2.5 (2018), 2.2 (2019), 3.8 (2020). - Gross investment (percent of GDP): 21.8 (2010), 19.3 (2011), 20.6 (2012), 19.6 (2013), 19.8 (2014), 28.0 (2015), 28.6 (2016), 28.9 (2017), 26.6 (2018), 22.4 (2019), 21.7 (2020). - Gross national saving (percent of GDP): -1.0 (2010), 1.8 (2011), 2.1 (2012), 5.1 (2013), 4.6 (2014), 14.6 (2015), 10.0 (2016), 9.8 (2017), 7.5 (2018), 6.8 (2019), 8.1 (2020). ### Implications for policy sequencing - Strengthening fiscal sustainability is central to reducing the risk that fiscal concerns will deter or interrupt private and foreign investment in tourism and infrastructure projects. - Structural reforms to improve the business environment and anti-corruption measures (including AML/CFT tools) are recommended to support continued investment inflows and project completion. *Source: IMF staff Risk Assessment and Montenegro macro-fiscal and external data as presented in the chapter "5. Delays and withdrawals from capital investment projects."* ### 4. Net acquisition of nonfinancial assets161131132124181287462474383211183 ### 4. Net acquisition of nonfinancial assets161131132124181287462474383211183 ### Net acquisition of nonfinancial assets (aggregate row) - 16 11 31 13 21 32 12 41 81 28 74 62 47 43 83 21 12 11 83 ### Capital revenue and capital expenditure (aggregate) - Capital reven u e: -5 -5 -5 -9 -7 -8 -8 -8 -9 -9 -10 - Capital expenditure: 166 136 138 132 189 295 470 482 391 220 192 ### Fiscal balance (Net lending (+) / borrowing (-) (= 3 - 4)) - -147 -216 -183 -207 -100 -268 -355 -360 -251 -67 -30 ### Net acquisition of financial assets (row 6) - Total: -39 -559 -45 -464 -685 1530 31 - Domestic: -39 -559 -45 -464 -685 1530 31 - Currency and deposits: -38 -511 3 -22 1874 -6114 233334 - Loans: 5434 -10 -1 -3 -3 -3 -3 -3 - Equity and investment fund shares: -6 -8 -6 -27 -12 -10 -5 -6 -600 ### Net incurrence of liabilities (row 7) - Total: 108 161 192 162 95 332 -491 111 117 -342 -543 - Domestic: -5 232 -624 -289 -412 -22 - Foreign: 160 129 198 139 98 324 -591 151 04 -340 -545 ### Discrepancy (= 5 - 6 + 7) (row 8) - 0 0 0 0 0 0 -336 -253 -149 -439 -604 ### Memorandum items (selected) - Primary balance: -116 -168 -123 -136 -21 -181 -265 -262 -136 61 108 - Nominal GDP: 3,125 3,265 3,181 3,362 3,458 3,641 3,840 3,989 4,152 4,314 4,555 *Source: Ministry of Finance; and Fund staff estimates and projections. 1/ Includes republican budget and local governments.* ### Annex I. Montenegro: Public Debt Sustainability Analysis ### Annex I. Montenegro: Public Debt Sustainability Analysis ### Baseline and realism of projections - Despite a sizeable fiscal adjustment in 2014, public sector debt has increased and is projected to rise further, to 80 percent of GDP by 2018, in the baseline. - Macroeconomic assumptions: - Growth momentum is projected to pick up to 4.1 percent in 2015 after a slowdown in 2014. - Growth is expected to converge average 3¼ percent. - Highway expenditures are assumed to add EUR 243 million to the nominal non-highway GDP path over the period 2015 to 2019 (being EUR 809 million less the assumed 70 percent import content), with an additional contemporaneous multiplier on aggregate demand of 30 percent during the construction phase. - Fiscal adjustment: - A sizeable fiscal adjustment was achieved in 2014 following a pension freeze and PIT and VAT rate hikes (including a one-off VAT receipts). - In the baseline projections, the primary balance worsens significantly in 2015–17 because of increased highway expenditures, unfreezing of pensions, and persistent arrears and guarantee payments. - Non-highway non-interest expenditures decrease modestly from their 2015 budget levels as a share of non-highway GDP in 2016–2020, implying cuts in mainly goods and services spending. - Heat map and debt profile vulnerabilities: - Risks from the debt level are deemed high as gross debt passes the 70 percent of GDP benchmark in 2016 in the baseline and increases substantially under several shock scenarios. - Gross financing needs go above the 15 percent benchmark. - Public debt held by non-residents also constitutes a vulnerability. - Growth shocks have a very large impact on the debt profile. - Realism of baseline assumptions: - The median forecast errors for real GDP growth and inflation (actual minus projection) in 2005–2014 suggest on average an upward bias in staff’s past projections. - The median forecast error for the primary balance suggests that staff projections have been too pessimistic on average. - With a large projected CAPB adjustment, the key risks are high dependence on external financing and vulnerability to macro shocks. ### Shocks and stress tests — overview - Stress tests indicate that: - Growth shocks would have a substantial effect on the debt path. - Fiscal shocks, cost overruns, and delays related to the highway project would also have a major impact on fiscal sustainability. ### Montenegro-specific stress tests - Highway shock: - In this scenario, the construction of the highway is assumed to cost 20 percent more (in 2018). - Debt increases to 84 percent of GDP, while financing requirements far exceed those under the baseline in 2018. ### Standard stress tests and outcomes - Growth shock: - Real output growth rates fall during 2016 and 2017 by one standard deviation (4.9 ppt), also affecting inflation and interest rates. - The public debt ratio increases to 99 percent by 2018. - The gross financing needs ratio in 2017 increases 7½ percentage points relative to the baseline. - Even with a half-standard deviation shock, the debt ratio escalates to 89 percent of GDP. - Interest rate shock: - Increase in interest rates on new debt by 200 basis points (relative to the baseline) in 2016–20. - Debt increases by 2½ percentage points in 2020 by this scenario, while financing needs are affected only marginally. - Combined macro shock: - Comprises a recession in 2016 and 2017, a 200 basis point increase in interest rates, and a sharp rise in expenditures. - Pushes the debt to GDP ratio up to 95 percent of GDP in 2018, and also substantially affects gross financing needs. - Financial contingent liability shock: - Shock equivalent to 10 percent of the size of the banking sector combined with a shock to GDP and interest rates. - Results in a sharp increase in the debt ratio to peak at 97 percent of GDP. - Gross financing needs would rise to over 27 percent of GDP in 2016, and stay above the baseline over the medium term. - Primary balance shock: - Assumes a revenue shock and a rise in interest rates leading to a two percentage point deterioration in the primary balance in 2016 and 2017. - The combined shocks lead to deterioration in the debt ratio by about 5 percent of GDP. - The impact on gross financing needs is somewhat more than the interest rate shock scenario on average. - Real exchange rate shock: - Assumes a 13 percent devaluation in the real exchange rate in 2016. - The ExIm loan is issued piecemeal over the course of highway spending. - The impact is below 1 percent of GDP, though the impact depends critically on the extent of exchange rate pass-through to inflation. ### Key projection numbers and indicators (selected) - Baseline projections (selected years and indicators): - Nominal gross public debt: 2013: 38.2; 2014: 55.2; 2015: 59.9; 2016: 66.5; 2017: 70.5; 2018: 77.1; 2019: 80.4; 2020: 79.6 (in percent of GDP as shown in table). - Public gross financing needs: 2013: 2.4; 2014: 9.5; 2015: 5.1; 2016: 17.8; 2017: 19.1; 2018: 13.5; 2019: 7.5; 2020: 9.3 (in percent of GDP). - Real GDP growth: 2013: 3.6; 2014: 3.5; 2015: 1.8; 2016: 4.1; 2017: 4.6; 2018: 2.5; 2019: 2.5; 2020: 2.2 (in percent). - Inflation (GDP deflator): 2013: 5.1; 2014: 2.1; 2015: 1.0; 2016: 1.2; 2017: 0.8; 2018: 1.3; 2019: 1.5; 2020: 1.7 (in percent). - Nominal GDP growth: 2013: 9.0; 2014: 5.7; 2015: 2.8; 2016: 5.3; 2017: 5.5; 2018: 3.9; 2019: 4.1; 2020: 3.9; 2020 note: 5.6 (as shown in table) (in percent). - Effective interest rate: 2013: 3.5; 2014: 4.2; 2015: 4.2; 2016: 4.2; 2017: 3.7; 2018: 3.6; 2019: 3.8; 2020: 3.8 (in percent). - Change in gross public sector debt (cumulative 2013–2020): 16.7 (in percent of GDP). - Identified debt-creating flows (cumulative 2013–2020): 16.7 (in percent of GDP). - Primary (noninterest) revenue and growth (cumulative 2013–2020): 250.4 (in percent of GDP, cumulative as shown). - Primary (noninterest) expenditure (cumulative 2013–2020): 268.3 (in percent of GDP, cumulative as shown). - Automatic debt dynamics (cumulative 2013–2020): -3.4 (in percent of GDP). - Real interest rate contribution (cumulative 2013–2020): 10.0 (in percent of GDP). - Real GDP growth contribution (cumulative 2013–2020): -13.3 (in percent of GDP). - Contingent liabilities (2013–2020 cumulative): 0.0 (in percent of GDP). ### Debt profile vulnerabilities and risk assessment highlights - Gross financing needs exceed the 15 percent benchmark under the baseline and several shock scenarios. - Public debt held by non-residents and the share of foreign-currency denominated debt are flagged as vulnerabilities. - Predictive density evolution indicates a wide distribution of possible debt outcomes with higher percentiles reaching substantially above baseline projections. - Forecast track record and boom-bust analysis: - Median forecast error for real GDP growth (actual-projection) displays an upward bias in staff’s past projections. - Median forecast error for the primary balance indicates staff projections have been too pessimistic on average. - The 3-year CAPB adjustment and 3-year average CAPB level are presented relative to distributions—Montenegro’s percentile ranks are shown in the realism assessment (figures and percentiles reported in the source). *Source: IMF staff (Annex I. Montenegro: Public Debt Sustainability Analysis).* ### 1. Standardized stress tests indicate that external debt is particularly sensitive to ### 1. Standardized stress tests indicate that external debt is particularly sensitive to ### Stress-test scenarios and key outcomes - Growth shock: - Baseline real GDP growth profile permanently reduced by a one-half standard deviation calculated over the recent 10-year period (3.4 percent). - Corresponds to an average contraction during 2016–20 of -0.3 percent of GDP, compared with baseline average growth of 3.1 percent. - External debt ratio increases to 181 percent of GDP in 2020. - Interest rate shock: - Increase in nominal external interest rates on new debt (relative to the baseline) by a one-half standard deviation during 2016–20. - Implies an average increase in interest rates of 13 basis points in this scenario. - External debt profile rises to 160 percent of GDP by 2020. - Non-Interest Current Account shock: - Permanently increases the non-interest current account by one-half standard deviation in 2016–20. - Given historically-high current account deficits, amounts to an increase of 6¼ percentage points. - External debt increases to 189 percent of GDP by 2020 in the absence of offsetting debt-creating flows. - Combined macro shock: - Permanent ¼ standard deviation shock applied to the real interest rate, the growth rate, and the current account deficit during 2016–20. - External debt ratio pushed to 185 percent of GDP. - Gross financing needs increase by 28 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). - Shock increases the external debt-to-GDP ratio by 70 percent of GDP in 2016. - Gross financing needs higher by about 18 percent of GDP on average over 2016–20 relative to the baseline. ### Implications emphasized in the text - 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 affect external sustainability, with significant implications for gross financing needs. ### Selected metrics from the External Debt Sustainability Framework (2010–20) - Baseline: External debt (percent of GDP) - 2010: 141.6 - 2011: 145.0 - 2012: 155.9 - 2013: 151.5 - 2014: 154.8 - 2015: 152.1 - 2016: 154.8 - 2017: 161.4 - 2018: 164.1 - 2019: 163.1 - 2020: 158.7 - Change in external debt (line 2) - 2010: -0.7 - 2011: 3.4 - 2012: 10.9 - 2013: -4.5 - 2014: 3.3 - 2015: -2.7 - 2016: 2.7 - 2017: 6.6 - 2018: 2.7 - 2019: -1.0 - 2020: -4.4 - Current account deficit, excluding interest payments (line 4) - 2010: 19.4 - 2011: 13.8 - 2012: 14.9 - 2013: 11.1 - 2014: 12.0 - 2015: 10.3 - 2016: 15.6 - 2017: 16.1 - 2018: 16.1 - 2019: 12.6 - 2020: 10.5 - Exports (line 6) - 2010: 37.0 - 2011: 42.3 - 2012: 43.7 - 2013: 41.3 - 2014: 40.1 - 2015: 41.8 - 2016: 39.8 - 2017: 40.3 - 2018: 40.7 - 2019: 41.3 - 2020: 41.7 - Imports (line 7) - 2010: 62.7 - 2011: 64.3 - 2012: 68.1 - 2013: 61.4 - 2014: 60.0 - 2015: 59.7 - 2016: 63.0 - 2017: 63.9 - 2018: 64.4 - 2019: 61.5 - 2020: 59.8 - Net non-debt creating capital inflows (line 8; negative) - 2010: -17.7 - 2011: -11.9 - 2012: -14.5 - 2013: -9.6 - 2014: -10.2 - 2015: -15.7 - 2016: -12.0 - 2017: -12.3 - 2018: -12.5 - 2019: -12.5 - 2020: -12.5 - Automatic debt dynamics (line 9) - 2010: -3.3 - 2011: -2.3 - 2012: 7.4 - 2013: -5.0 - 2014: -1.0 - 2015: -3.0 - 2016: -3.7 - 2017: -0.7 - 2018: -0.9 - 2019: -0.5 - 2020: -2.8 - External debt-to-exports ratio (in percent) - 2010: 382.4 - 2011: 342.4 - 2012: 357.0 - 2013: 366.4 - 2014: 385.5 - 2015: 363.6 - 2016: 388.5 - 2017: 400.7 - 2018: 402.8 - 2019: 394.8 - 2020: 380.4 - Gross external financing need (in billions of Euro) - 2010: 1.1 - 2011: 0.9 - 2012: 0.9 - 2013: 0.9 - 2014: 1.0 - 2015: 1.2 - 2016: 1.6 - 2017: 1.5 - 2018: 1.5 - 2019: 1.7 - 2020: 1.9 - Gross external financing need (in percent of GDP) - 2010: 35.0 - 2011: 27.7 - 2012: 29.6 - 2013: 26.1 - 2014: 29.2 - (other year values presented in the table) ### Key macroeconomic assumptions underlying baseline (selected) - Real GDP growth (in percent) — historical averages and projection entries presented in the table (e.g., historical ten-year averages and year entries such as 2.5, 3.2, -2.7, 3.5, 1.8, 3.8, 6.8, 4.1, 4.6, 2.5, 2.5, 2.2, 3.8 as shown in the table). - GDP deflator in US dollars (change in percent) — entries include 2.3, 1.2, 0.2, 2.1, 1.0, 5.0, 6.7, 1.2, 0.8, 1.3, 1.5, 1.7, 1.8. - Nominal external interest rate (in percent) — entries include 2.4, 2.8, 2.4, 2.3, 2.2, 2.4, 0.3, 2.0, 2.1, 2.0, 1.9, 1.9, 1.9. - Growth of exports (Euro terms, in percent) — entries include 12.6, 19.4, 0.5, 0.1, -0.1, 13.9, 25.5, 9.7, 0.4, 5.0, 5.3, 5.4, 6.6. - Growth of imports (Euro terms, in percent) — entries include 0.6, 7.1, 3.2, -4.7, 0.4, 15.4, 34.4, 4.8, 11.3, 5.4, 4.8, -0.8, 2.8. - Current account balance, excluding interest payments — entries include -19.4, -13.8, -14.9, -11.1, -12.0, -20.4, 12.6, -10.3, -15.6, -16.1, -16.1, -12.6, -10.5. - Net non-debt creating capital inflows — entries include 17.7, 11.9, 14.5, 9.6, 10.2, 14.0, 10.5, 15.7, 12.0, 12.3, 12.5, 12.5, 12.5. ### Visualization notes (from Figure 1) - Shaded areas represent actual data. - Individual shocks are permanent one-half standard deviation shocks, except combined shock which applies permanent 1/4 standard deviation to real interest rate, growth rate, and current account balance; and a one-time real depreciation of 30 percent occurs in 2015. - Example scenario values shown in figure captions: - Interest rate shock: 160 (scenario) vs Baseline 159. - Growth shock: 181 (scenario) vs Baseline 159. - Non-interest current account shock: 189 (scenario) vs Baseline 159. - Combined shock: 185 (scenario) vs Baseline 159. - Real depreciation shock (30%): 229 (scenario) vs Baseline 159. --- ### Financial stability assessment and indicators - Overall assessment: - The financial sector appears stable and a risk of an imminent deterioration is limited. - Macro-financial indicators have not improved significantly since the financial crisis, but developments are not out of line with global trends. - Domestic asset prices do not signal imbalances; property prices have been declining, but gradually. - Overall financial sector vulnerability is assessed as modest. - Risks relate mainly to high NPLs and limited capacity by the central bank for lender-of-last-resort assistance. - Selected financial indicators (quarterly series and levels where provided): - Change in credit / GDP ratio (pp, annual) — series includes: -7.2, -5.2, -1.2, 2.9, 2.0, -0.1, -0.3, -4.4, -3.9, -2.6, -2.7, -2.7. - Growth of credit / GDP (%, annual) — series includes: -11.4, -8.5, -2.2, 5.2, 3.6, -0.2, -0.5, -7.6, -6.7, -4.8, -4.9, -4.9. - Deposit-to-loan ratio — series includes: 94.1, 105.8, 106.3, 80.0, 81.4, 85.2, 86.7, 87.2, 89.9, 92.5, 97.1, 97.1. - FX liabilities % (of total liabilities): 100.0 for each listed quarter. - FX loans % (of total loans): 0.0 for each listed quarter. - Leverage ratio (%): 10.5, 9.3, 10.3, 13.7, 13.9, 13.9, 13.4, 14.2, 14.2, 14.2, 14.2, 14.2. - ROA: -1.3, -2.3, -2.0, 1.4, 1.3, 1.3, 0.1, 1.3, 1.0, 0.9, 0.8, 0.8. - ROE: -11.9, -21.7, -18.3, 10.0, 9.2, 9.2, 0.5, 9.3, 6.8, 6.2, 5.4, 5.4. - NPL ratio: 17.1, 18.5, 17.6, 19.4, 18.8, 18.4, 18.4, 17.2, 17.9, 17.3, 16.8, 16.8. - NPL ratio change (%, annual): -32.4, -6.1, 13.3, 27.5, 9.9, -0.8, 4.4, -11.2, -4.8, -5.8, -8.7, -8.7. - Overall financial sector rating and sub-dimensions shown as vulnerability codes (text indicates categories such as High/Medium/Low vulnerability across credit cycle, balance sheet soundness, buffers, etc.). --- ### Appendix I. Spillovers from the Highway Project ### Demand spillovers during construction - Assumed demand multiplier during construction: 0.3 (staff projection). - Rationale and evidence: - Multipliers usually between 0 and 1 for advanced economies; can exceed 1 in abnormal circumstances. - Multipliers typically smaller for emerging and low-income countries, and even negative when public debt is high. - Batini, Eyraud, and Weber (2014) bucket approach assigns multiplier ranges based on structural characteristics; Montenegro exhibits two structural factors that increase multipliers (labor market rigidity and a quasi “fixed” exchange rate) but overall is placed in the low multiplier range. - Projections assume demand multiplier of 0.3 given these considerations and that Montenegro is not operating below capacity. ### Productive (supply) impact upon completion - IMF WEO evidence summarized: - Average effect of a 1 percent unanticipated shock to public infrastructure spending is a 0.4 percent increase in the level of output after the first year, increasing to 1.5 percent after 5 years. - The literature does not argue for an increase in the potential growth rate. - Staff assumption for the first stage of Bar-Boljare highway: - Productive boost upon completion of the first segment is assumed to be 20 percent of the level effects found in the WEO (i.e., a conservative supply effect). - Reasoning: effects likely weaker during periods of high growth or when economy near capacity; Montenegro exhibits those characteristics and public investment efficiency concerns; full benefits likely only when entire highway and cross-border links completed. ### Incorporation into projections - Highway contract stipulates 30 percent of the project be sourced locally, with the rest spent on imported goods and services. - Total value added of the highway during construction phase estimated at around 1½ percent of non-highway GDP on average during 2015–2019. - Demand spillovers apply to the net value added of total expenditure. - Supply effects apply to the entire value of the installed capital stock, regardless of local vs imported inputs. --- ### Appendix II. Analysis of Macrofinancial Linkages - Financial development in Montenegro: - Ranks relatively well within the Western Balkan region but lags more advanced emerging European economies. - Financial inclusion is in line with incomes but with room for improvement, especially across gender, education, and region. - Ongoing balance sheet repair; private sector remains highly indebted with corporates particularly leveraged. - This constrains prospects for a sustained strong credit-led recovery and increases vulnerability to shocks. - Empirical modeling: - A simple VAR model for Montenegro suggests that credit has a strong effect on output compared with some regional and European peers. *Source: IMF staff report content (country external debt sustainability analysis, financial stability indicators, and appendices on the highway project and macrofinancial linkages).* ### 1. Montenegro’s experience of boom and bust draws attention to macrofinancial ### Montenegro’s experience of boom and bust draws attention to macrofinancial linkages ### A. Financial Development - Theoretical and empirical evidence indicates a trade-off between financial development and growth, with IMF analysis finding a significant bell-shaped relationship between financial development and growth. - Estimated financial development: - Western Balkan States (WBS) index: 0.27 - Montenegro proxied by ratio of corporate credit to GDP: 0.26 - New Member States (NMS) index: 0.38 - Other EU countries index: 0.72 - United States index: 0.87 - Finding: Montenegro’s level of financial development is well below the optimal level for growth and similar to the rest of the Western Balkans; consequently, more financial development would likely be associated with higher growth. ### B. Financial Inclusion - Access and trends: - Adults reporting an account at a formal financial institution increased by nearly 10 percent over the past three years to 60 percent. - Average in New Member States (NMS): about 80 percent of adults maintain a bank account. - Distributional patterns: - Among the bottom 40 percent of incomes, only half of the population had access to some kind of financial institution during 2006–08. - Among the top 60 percent of the population, about two thirds had access—comparable to the Western Balkan average. - Women have less access to finance than men, similar to patterns in the Western Balkans. - The rural–urban inclusion gap is one of the highest in the WBS region. - Adults with secondary or higher education are, on average, more than twice as likely to have an account as those with primary education or less. - Usage and informality: - The use of formal savings instruments is among the lowest in the region. - Borrowing from financial institutions is very high compared with the regional average. - Informality in saving and borrowing is extensive. - Policy implication: As nominal GDP increases, financial inclusion can be expected to increase overall, but heterogeneity across segments points to the importance of policies addressing informality and education to improve financial literacy. ### C. Private Sector Indebtedness and the Credit Environment - Post-crisis credit conditions: - Credit conditions have been persistently tight post crisis due to a surge in bad loans and balance sheet downsizing. - Corporate lending stands at 55 percent of its pre-crisis level. - Household lending stands at 85 percent of its pre-crisis level. - Nonperforming loans and asset management: - EUR 720 million worth of NPLs (21 percent of GDP) were transferred from bank balance sheets to asset management companies (AMCs) belonging to parent banks. - Reported NPL ratio remains at 14¾ percent. - When adjusted for impaired loans held by AMCs, NPLs are about 40 percent. - Corporate and household indebtedness dynamics: - Total indebtedness of the corporate sector has declined by about 1½ percent in nominal terms relative to the pre-crisis peak. - Household domestic liabilities have declined by about 15 percent relative to the pre-crisis peak—about one-third the percentage point adjustment observed in the corporate sector. - Anecdotal evidence: banks and AMCs reluctant to aggressively pursue collateral claims against individuals because of social sensitivities and perceptions of judicial bias in favor of borrowers. - Real private sector indebtedness: - Using a MONSTAT property price index for new dwellings as a deflator, real private sector indebtedness is estimated to have increased relative to pre-crisis peaks. - An internal Podgorica-specific property price index prepared by the CBM estimates a 50 percent post-crisis real estate price correction, implying an even larger degree of real indebtedness. - Conclusion: The high degree of private-sector leverage limits prospects for a strong and sustained credit-led recovery and underlines the need to clean up banks’ balance sheets (see measures recommended by FSAP, Appendix IV). ### D. The Effects of Credit on Output - Correlation evidence: - Credit growth in Montenegro is highly correlated with contemporaneous economic activity—the highest among Western Balkan states and larger than in CEE, Baltic, and developed European states. - Bank lending is especially important for construction, retail, and tourism sectors (notably high correlations with construction, wholesale & retail trade, hotels and restaurants, transport and storage). - VAR estimation (quarterly data 2005:Q2–2014:Q4, variables in percent change (yoy); single lag specification): - Montenegro VAR coefficients (Table 1): - GDP(-1): -0.317** (significant at 10 percent) - Credit(-1): 0.804* (significant at 5 percent) - Inflation(-1): -1.182 (not indicated as significant) - Constant: 7.360* (significant at 5 percent) - Adjusted R-squared: GDP equation: 0.48; Credit equation: 0.81; Inflation equation: 0.58 - Memorandum: GDP is nominal GDP; Credit is to the private sector; Inflation according to consumer prices. - Impulse response results: - Orthogonalized impulse responses indicate that a 1 percent shock to nominal private sector credit growth causes: - a 0.2 percent increase in GDP growth initially, - increasing to 0.3 percent before declining gradually, - and an accumulated impact over five years equal to a 3 percent boost to the level of nominal GDP. - Comparison with peers: - The immediate impact of a credit shock is larger in Montenegro than in Croatia, Serbia, and Poland based on a comparable VAR specification. - Interpretation: The analysis suggests that boosting credit would likely be associated with a boost in output, consistent with Montenegro’s relatively severe boom-bust cycle and its financial development level. ### Appendix III. Recent Legal Reforms to the Debt Restructuring Framework — Consumer Insolvency Law - Reform summary: - Authorities introduced changes to the enforcement regime and adopted a personal insolvency law in August 2015. - The changes to the enforcement regime have been generally well received; the effectiveness remains to be tested. - Consumer insolvency law: positive features - Provides for a mandatory forum of pre-insolvency debt mediation. - Provides for court-supervised debt discharge ("fresh start") for debtors after a set repayment period. - Consumer insolvency law: critical deficiencies and concerns - The law is ambiguously drafted, leading stakeholders to reach inconsistent and often contradictory interpretations. - The law may undermine secured creditors’ rights: - Broad readings suggest mortgage lenders could permanently lose the ability to foreclose on the debtor’s primary residence. - Even a restrictive reading could create circumstances where a mortgage creditor loses secured rights and becomes unsecured. - There is no consensus on whether the law applies to existing debt or only to debt contracted after its effective date: - The constitutional principle of non-retroactivity of laws in Montenegro could prevent applicability to debt contracted prior to the law’s entry into force. - If non-retroactivity applies, the law could never achieve its objective of providing debt relief to consumers distressed by the housing bubble burst. - Implementation challenges: - The law cannot be implemented in the near future because enabling regulations and supporting infrastructure (e.g., a mediation service, special insolvency fund) are required. - The law contains no deadlines for drafting necessary regulations. - Stakeholders including the Ministry of Justice are considering constitutional challenges that might result in full or partial repeal or significant changes. - Potential adverse effects if ambiguities and design issues are not resolved: - Adverse effects on general credit discipline. - Creation of moral hazard. - Potential increase in the cost of credit. *Source: IMF staff report: "Montenegro’s experience of boom and bust draws attention to macrofinancial linkages" (appendix and Appendix III).* ### 5. To provide proper incentives and a better balance between debtor/creditor rights, ### 5. To provide proper incentives and a better balance between debtor/creditor rights ### Personal insolvency and credit market infrastructure - The law would require significant changes in addition to supporting institutional infrastructure to provide proper incentives and a better balance between debtor/creditor rights. - As a first step, authorities could conduct a comprehensive assessment of credit market and institutional infrastructure necessary for building a well-functioning personal insolvency regime in Montenegro. - Ensuring the reliability financial information about debtors is of critical importance. ### The Enforcement Framework - Montenegro passed a number of changes to its debt restructuring and enforcement framework in 2014, most notably allowing an expedited procedure for debt collection through public enforcement officers. - Mixed stakeholder feedback on public enforcement officer reform: - Banks were broadly satisfied with the reform. - Other parties expressed concerns that public enforcement officers have been overzealous because their compensation is linked to the amount collected. - System weaknesses allow instances of unintentional multiple collections of the same debt, creating complications and appeals. - Suggested further measures: - Tightening licensing and educational requirements for public enforcement officers. - Strengthening oversight and supervision of public enforcement officers. - Institutional constraints: - Weak institutions and inconsistent application of laws are main obstacles to effective debt resolution and enforcement. - Lending institutions report delays due to courts' and public agencies' lack of competence, providing many opportunities for appeal and delay. - Institutional weaknesses plus low real estate demand continue to cause low recovery rates in debt restructuring and realization of collateral. ### FSAP main findings relevant to debt resolution and the financial sector - Context and overall assessment: - An FSAP mission took place during September 1–15. - Montenegro still suffers from the collapse of the lending boom in 2008. - Stress tests indicate domestically-owned banks are particularly vulnerable to shocks. - Action to deal with weak banks is needed to maintain financial stability. - Weak profitability and the large NPL overhang constrain prospects of a credit-led recovery. - Need to strengthen the financial safety net, especially with a streamlined emergency liquidity assistance framework and tested contingency planning. - Key supervisory and regulatory needs (selected): - Identify, measure, and manage nonperforming assets and liquidity risk. - Reduce concentration in credit, operational, and funding risks. - Strengthen banks’ governance framework for risk management. - Introduce effective consolidated supervision. - Capital and asset quality: - Some banks are deemed below the regulatory minimum capital adequacy ratio (CAR) after provisioning rates are adjusted to reflect credit risks. - Undercapitalized and weak banks should be put under intensive Central Bank of Montenegro (CBM) supervision. - CBM should develop and adopt time-bound supervisory action plans and bank-specific resolution plans. - An independent bank system asset quality review (AQR) is needed to accurately gauge bank health and adequacy of provisioning. - Profitability and competition: - Intensified bank competition and a slow economic recovery weigh on banking sector profitability. - Lending spreads are driven by costs (overheads and provisions) rather than lack of competition. - Authorities should refrain from introducing caps to lending rates in the current context. - Approval of new bank licenses could be harmful and requires rigorous evaluation. - Nonperforming loans (NPLs) and restructuring: - Reducing the large stock of NPLs is necessary to strengthen balance sheets but not sufficient to reinvigorate credit growth. - Shortcomings in NPL resolution framework include under-provisioning and regulatory forbearance. - Banks may need to raise additional capital to absorb NPL losses. - The recently enacted Law on Voluntary Restructuring of Debts could be broadened to include a wider set of loan categories. - The recent Law on Consumer Bankruptcy needs amendment as it could negatively affect collection of existing NPLs and issuance of new mortgage-secured loans. - Nonbank credit institutions and asset management vehicles need to be brought under CBM oversight to analyze, regulate, and monitor NPLs in their entirety. - Macroprudential and safety-net gaps: - Neither the CBM nor the Financial Stability Council (FSC) has been vested with authority to mitigate systemic imbalances. - Preparation for Basel III should prioritize sound liquidity risk management standards. - A macroprudential framework should be established and made fully operational with broader cooperation among agencies. - A comprehensive bank resolution framework is lacking. - ELA funding is constrained due to euroization; funding of resolution measures is not clear with respect to the Ministry of Finance and is prohibited for the Deposit Protection Fund. - Contingency plans exist but require continued attention to updating and testing by the FSC and financial agencies. ### FSAP key recommendations (selected, with timing) - Financial System Resilience - Prepare and implement time-bound supervisory action plans for vulnerable banks — I - Conduct Asset Quality Review for all banks to determine adequacy of provisions — I - Financial Safety Net and Resolution - Set strict and objective criteria for determining systemic importance of banks to determine eligibility for capital support — NT - Strengthen resolution funding options — NT - Organize a dedicated resolution unit within CBM and initiate bank-specific resolution planning — I - Macroprudential and Oversight - Introduce a macroprudential mandate consistent with EU/ESRB framework — MT - Tighten prudential norms for identification, classification, and re-classification of nonperforming assets — NT - Improve regulatory and supervisory framework for liquidity and credit risks — I - Introduce effective consolidated supervision — NT - Resolution of NPLs and Creditor Rights - Strengthen the voluntary debt restructuring framework — I - Amend personal bankruptcy regime to clarify creditors' rights regarding existing and future loans secured by mortgages — I (I = Immediate within one year; NT = Near-term 1–3 years; MT = Medium-term 3–5 years.) ### Reserve Adequacy and Emergency Liquidity Assistance (ELA) - Constraints and context: - Montenegro has adopted a foreign currency as legal tender, constraining ELA options for the central bank (CBCG). - CBCG’s current ELA options include: borrowing from liquid banks in the system; borrowing from abroad; allowing illiquid banks to draw down required reserves (RR) for a short period; and drawing down designated ELA reserves (i.e., CBCG capital). - Only the latter two options are directly within CBCG control and they do not constitute traditional ELA tools; CBCG capital drawn down would need replenishment with public resources after a crisis. - Current liquidity buffers (staff calculations and CBCG data): - Excess reserves cover about [50] percent of short-term liabilities for the banking system as a whole. - CBCG capital provides a small additional buffer of around 5 percent of short-term bank liabilities. - Including required reserves, the combined liquidity buffer (own assets, CBCG capital, and RR) increases to nearly 75 percent. - Access to parent bank liquidity: - Two-thirds of bank system deposits are held by subsidiaries of banking groups located in the euro area, providing a potential additional liquidity buffer via parent banks' access to ECB facilities. - CBCG capital is estimated to account for about 31 percent of short term deposits of domestic banks and coverage, which increases to 93 percent when banks’ own liquidity buffers are included (108 percent including required reserves). - Risks and recommendations: - Foreign liquidity support from parent banks cannot be relied upon if the shock originates abroad. - CBCG’s capital endowment is fixed; ELA coverage will decline as bank liabilities grow. - Authorities should use the relative period of calm to establish mechanisms to bolster ELA capacity. Options include: - A bank fee or premium (capital surcharges based on systemic importance), though larger banks already bear significant costs and increased fees could be passed on in lending rates. - A pooled liquidity arrangement for ELA, funded by banks, was found problematic due to high share of foreign-owned banks. - Establishing contingent credit lines with foreign banks, which does not impose fiscal costs but carries coordination costs. - Obtaining letters of comfort from parents of foreign-owned banks committing to provide liquidity in times of stress. - A dedicated ELA sub-account at the central bank established by the Ministry of Finance and under the central bank’s control. - Preferred option: establishing a dedicated account, recognizing that size and funding require further analysis and accommodation within broader fiscal policy objectives. - Preparatory steps for a dedicated account: - Define rules for use of public funding in crisis situations, including adoption of explicit policies with strict, objective, quantifiable, and measurable criteria for systemic importance. - Explicitly recognize public funds as a last resort and clarify that shareholders and hybrid capital and subordinated debt holders fully absorb losses; shareholders should be fully written off prior to any government capital support. ### External Competitiveness - Current account and competitiveness concerns: - Montenegro’s external balances are characterized by persistent current account deficits funded mainly by FDI inflows. - Staff analysis suggests current account deficits are about 6 percentage points larger than would be implied by the norm. - Data uncertainties (errors and omissions averaging about 7½ percent of GDP), short time series, and volatility make point estimates imprecise. - Cost competitiveness indicators: - CPI-based REER has depreciated against other Western Balkan currencies due to nominal euro depreciation; nominal wage growth pressures have been subdued. - An estimated current account imbalance of 7–8 percentage points of GDP could imply a RER imbalance of 15–25 percent. - Unit labor costs are slightly above the average for the Western Balkans and far higher than the level of New Member States, suggesting a need for productivity improvements. - Tourism and services: - Service exports have been robust, driven almost entirely by tourism. - Montenegro’s tourism competitiveness ranks well in travel environment and infrastructure compared with regional peers. - Staff analysis indicates services demand has high income elasticity, but price competitiveness remains important. - Maintaining a tourism advantage will depend on maintaining costs and providing higher value-added services, as conventional tourism tends to have low productivity growth. *Source: IMF staff report content as provided in the supplied PDF excerpt.* ### 4. Reducing non-price costs will also ### _cr1679 - 4. Reducing non-price costs will also ### Trade performance and non-price costs - Montenegro’s share in world goods trade fell further in 2014 to its lowest since independence. - Staff analysis attributes part of the decline to reduction in aluminum exports with the partial shutdown of the KAP smelter. - Staff analysis also suggests that non-price factors are important obstacles to improved trade performance (see Selected Issues Paper). Key statistics and chart references - Time series referenced: 2008–2014 (chart title: Montenegro: Importance in World Trade (Percent of total world trade)). - Chart data axes annotated with values including 0.000, 0.005, 0.010, 0.015, 0.020, 0.025 and secondary axis values 0.0000 through 0.0040. ### Fund relations and financial position - Membership Status: Joined January 18, 2007; Article VIII. - Quota: 27.50 100.00 - Fund Holdings of Currency: 20.90 76.00 - Reserve Position: 6.60 24.00 - SDR Department: - Net cumulative allocation: 25.82 100.00 - Holdings: 26.35 102.03 - Outstanding Purchases and Loans: None. - Latest Financial Arrangements: None. - Projected Obligations to Fund (In millions of SDR): Forthcoming 2015 / 2016 / 2017 / 2018 / 2019 - Principal: 0.00 0.00 0.00 0.00 0.00 - Charges/Interest: 0.00 0.00 0.00 0.00 0.00 - Total: 0.00 0.00 0.00 0.00 0.00 - Exchange Arrangement: Montenegro does not issue its own currency and has been using the euro as legal tender since 2002; accepted obligations under Article VIII; maintains an exchange system free of restrictions on current international transactions except pre-1992 blocked foreign currency savings accounts and restrictions for security purposes not notified to the Fund. - Latest Article IV Consultation: Concluded on January 23, 2015 (IMF Country Report No. 15/26). - FSAP Participation: Financial Sector Assessment Program initiated in August 2015, concluded during the 2015 Article IV consultation; Executive Board discussed the Financial System Stability Assessment in January 2016. Technical assistance (past 12 months) - FAD Oct-15 Tax Diagnostic Tool Assessment - STA Oct-15 National Accounts Statistics - FAD Oct-15 Public Financial Management - STA Aug-15 Balance of Payments Statistics - FAD Mar-15 Tax Administration - STA Feb-15 National Accounts Statistics - Additional technical assistance available through resident advisors covering tax administration and public financial management. - Resident Representative: None. ### World Bank Group relations and engagement - Montenegro joined the World Bank Group as an independent country in January 2007. - IBRD delivered program amount: US$262 million. - IFC committed two long-term finance projects totaling US$26.5 million in the infrastructure sector. - Montenegro: World Bank Project Portfolio, December 2015 (selected project entries) - Higher Education and Research for Innovation and Competitiveness: Date, Board App 01/24/2012; Net Comm Amt ($m) 15.98; Total Percent Disb. 46.1; Percent Disb. 10.7 - Energy Efficiency: 12/09/2008; Net Comm Amt ($m) 16.20; Total Percent Disb. 69.6; Percent Disb. 33.1 - Montenegro Institutional Development and Agriculture Strengthening: 04/21/2009; Net Comm Amt ($m) 15.70; Total Percent Disb. 83.0; Percent Disb. 50.9 - Montenegro Institutional Development and Agriculture Strengthening (GEF): 04/21/2009; Net Comm Amt ($m) 4.00; Total Percent Disb. 83.9; Percent Disb. 33.9 - Land Administration and Management: 12/09/2008; Net Comm Amt ($m) 16.20; Total Percent Disb. 81.4; Percent Disb. 28.2 - Industrial Waste Management and Cleanup: 09/19/2014; Net Comm Amt ($m) 68.90; Total Percent Disb. 3.5; Percent Disb. 0.2 - Portfolio subtotal: 136.98 36.8 6.1 - Committed portfolio increased to US$137 million in 2015; about 63 percent of these commitments remain to be disbursed. Priority objectives from the Systematic Country Diagnostic (September 2015) to guide the CPF FY16–20 - (i) Strengthening resilience to shocks and volatility; - (ii) Reducing unemployment and inactivity, in particular amongst the young; - (iii) Facilitating private sector development. Pipeline and planned Bank projects (CPF FY16–20, under preparation) - Revenue Administration Reform Project: build on tax administration assessment to increase effectiveness and efficiency of tax administration and reduce cost of compliance for the taxpayer. - Second Health Improvement project: support financing reforms and governance for quality in the health sector. - Additional financing for the ongoing Institutional Development and Agriculture Strengthening project. ### Bank–Fund cooperation and joint activities - Cooperation described as good, particularly on macroeconomic and financial sector policies. - Joint work examples: Financial Sector DPL and Policy-Based Guarantee (2011–2012); TA on NPL resolution; FSAP update (2015). - Areas of continued input and coordination: - (i) public expenditure, including pension and health reforms; - (ii) business climate and competitiveness, including labor market reform and the resolution of nonperforming loans; - (iii) public sector institutions and fiduciary reviews; - (iv) agricultural assessments; - (v) statistical capacity building and poverty monitoring. Montenegro: Joint Management Action Plan - Bank and Fund Planned Activities in Macro-critical Structural Reform Areas, January—December 2015 (selected entries) - Fund work program: Article IV staff report — Fall 2015; Expected delivery January 2016. - Bank work program: Systematic Country Diagnostics — February 2015; Pension System TA — March 2016; Revenue Administration Project — January 2016; (Expected delivery dates include June 2016; Feb 2016). *Source: MONTENEGRO STAFF REPORT FOR THE 2015 ARTICLE IV CONSULTATION—INFORMATIONAL ANNEX (February 8, 2016).* ### 3. Joint work program None None ### 3. Joint work program None None ### Statistical issues — Assessment of data adequacy for surveillance - General: Data provision has some shortcomings, but is broadly adequate for surveillance. The most affected areas are labor market indicators, and government finance statistics. - Real sector statistics: - MONSTAT suffers from resource constraints and limited capacity. - National Accounts: - MONSTAT compiles annual production and expenditure accounts in current and previous year’s prices. - Production GDP estimates are reconciled with expenditure GDP estimates through the supply and use framework. - The quality of the annual GDP is good. - Montenegro started disseminating quarterly GDP by production using an indirect method in 2012; methodology has room for improvement. - Quarterly estimates are compiled at an aggregated level (mostly NACE section level); short-term statistics need improvement, mostly for agriculture and construction. - Recent national accounts TA missions focused on developing robust quarterly GDP estimates by expenditure approach. - Quarterly GDP estimates have been compiled for 2010-2014; official dissemination took place in March 2015. - Price statistics: - MONSTAT compiles and disseminates a monthly consumer price index that broadly follows international standards. - Little progress on the producer price index (PPI). Improvements needed: develop a total output PPI; expand coverage to services and construction; update index calculation methods. - Need to improve the industrial production index. - Labor market statistics: - MONSTAT reports labor and wage statistics from the labor force survey (LFS) and administrative sources. - Unemployment rate from the LFS is computed according to the ILO definition. - Quality of wage indicators is relatively good; 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 the Ministry of Finance (MOF) based on a new GFS institutional classification; since 2006 includes local governments and social security funds; social security funds merged with the treasury account in 2010. - Chart of accounts introduced in 2001 implemented at local level from mid-2005. - Fiscal data reporting suffers from frequent re-classifications. - MOF has a unit for data collection for state-owned enterprises, but satisfactory compilation of 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. - Montenegro does not report GFSM 2001 based data to the IMF. - March 2013 GFS TA mission recommended: - Update the table on institutional structure of the public sector to facilitate consistency among producers of official statistics. - Establish a migration plan to phase in the GFSM 2001 framework. - Start publishing quarterly budgetary central government data in the IFS. - Monetary and financial statistics: - Central Bank of Montenegro (CBM) reports monthly monetary statistics covering the CBM balance sheet and the balance sheet of commercial banks only. - Monetary data are not reported in accordance with STA’s Standardized Report Forms; follow an older format. - Montenegro does not report Financial Soundness Indicators to the IMF. - External sector statistics: - Balance of payments (BoP) statistics compiled by the CBM follow international reporting standards. - Improvements by MONSTAT on coverage, valuation, and classification of merchandise trade statistics aided external sector statistics. - Imports and exports in the BOP compiled according to the special trade system; CBM adjusts MONSTAT CIF data to FOB basis. - Biggest challenge: coverage of transactions through the informal economy. - Errors and omissions in the current account are still large and persistently positive, largely due to underestimation of export of tourism services. - CBM improved ITRS coding and interaction with banks, but ITRS remains inadequate for recording a broad range of BoP transactions (e.g., reinvested earnings, trade credits). - ITRS records transactions on a cash basis; BoP transactions should be on an accruals basis. - CBM needs to undertake direct enterprise surveys to supplement ITRS and prepare comprehensive documentation on compilation methods and data sources. - CBM reports BoP statistics under BPM6 presentation. - CBM received TA on International Investment Position (IIP) statistics but does not yet disseminate these data. - January 2013 TA mission action items: - Compilation and regular dissemination of the IIP and external debt statistics. - Revision of compilation of flows in currency and deposits assets by other sectors. - Improvement of estimation procedure for Compensation of Employees (credit). ### Data standards and quality - Participant in the Fund’s General Data Dissemination System (GDDS) since December 2011. - Latest update of metadata and GDDS plans for improvement were in 2015. - No data ROSC available. ### Table of Common Indicators Required for Surveillance (as of December 16, 2015) - Date of latest observation / Date received / Frequency of data / Frequency of reporting / Frequency of publication (selected entries preserved exactly as reported): - International Reserve Assets and Reserve Liabilities of the Monetary Authorities: Nov-2015 / Dec-2015 / M / M / M - Reserve/Base Money: Nov-2015 / Dec-2015 / M / M / M - Central Bank Balance Sheet: Nov-2015 / Dec-2015 / M / M / M - Consolidated Balance Sheet of the Banking System: Nov-2015 / Dec-2015 / M / M / M - Interest Rates: Nov-2015 / Dec-2015 / M / M / M - Consumer Price Index: Oct-2015 / Nov-2015 / M / M / M - Revenue, Expenditure, Balance and Composition of Financing – General Government: Sept-2015 / Dec-2015 / Q / Q / Q - Revenue, Expenditure, Balance and Composition of Financing – Central Government: Oct-2015 / Nov-2015 / M / M / M - Stocks of Central Government and Central Government-Guaranteed Debt: Sept-2015 / Dec-2015 / Q / Q / Q - External Current Account Balance: Q3-2015 / Nov-2015 / Q / Q / Q - Exports and Imports of Goods and Services: Q3-2015 / 21-Nov-2015 / Q / Q / Q - GDP/GNP: Q2-2015 / Sept-2015 / Q / Q / Q - Gross External Debt: -- / -- / NA / NA / NA - International Investment Position: -- / -- / NA / NA / NA ### Statement by Menno Snel and Zorica Kalezic (February 19, 2016) — Authorities’ views, outlook, and policies - Concurrence with staff appraisal and recommendations in the Article IV report and FSSA; authorities thank mission teams. - Authorities pursue an investment-led growth strategy; recognize benefits and challenges. - Economic outlook and risks: - GDP growth reached 4.1 percent in 2015, driven by strong fixed capital investment and service export. - Authorities expect growth to average at 3.7 percent for 2016-2018. - Authorities expect stronger fiscal impulse from 2015-postponed highway construction work in 2017 and 2018, which will push growth somewhat above staff’s forecast of 2.5 percent in both years. - Growth primarily driven by large investment projects in infrastructure, connectivity, and tourism. - Tourism accounts for 20 percent of GDP. - Recent tourism data for 2015 give confidence that robust tourism inflows will remain; excellent 2015 tourist season narrowed current account deficit, but it is expected to widen again because of upcoming construction-related imports. - Inflation expected to remain stable amid suppressed oil prices and moderate private consumption recovery. - Wages were flat for 2011-2015 in nominal terms; expected to grow moderately in 2016. - Authorities attentive to risks from weakening EU demand and regional geopolitical tensions, especially impacts on tourism and cost of financing. - Authorities working on market diversification in tourism; Montenegro was assessed in the WTTC Report as the third fastest growing destination in the world. - Authorities pressing ahead with a five-year consolidation plan to rebuild fiscal space and put debt on more comfortable footing. - Authorities will refrain from new large capital spending based on full project financing or sovereign guarantee issuance. - Eurobond issuance in 2015 was oversubscribed, maintaining an upward sloping yield to maturity curve. - Sovereign rating agencies have absorbed information about substantial financing needs during highway construction. - Fiscal policy: - Authorities recognize need for urgent and sustained consolidation to absorb substantial financing needs. - Consolidation measures narrowed overall deficit from -5.9 in 2012 to -3.1 percent of GDP in 2014. - Authorities agree with staff that a close to balanced budget can be expected by 2020, despite a short-term sharp rise in fiscal deficit. - Given public debt exceeded the “Maastricht” limit in 2015, authorities will propose to Parliament a medium term fiscal consolidation plan with contingency scenarios to reduce public debt over a five-year horizon and contribute to convergence to the “Maastricht” ceiling by 2025. - Authorities requested IMF TA to build capacity to enforce the Law on Budget and Fiscal Responsibility and fiscal rules provisions. - Revenue-side measures for 2016 include: - Increase of the health insurance contribution rate. - Introduction of tax on gains from gambling and coffee. - Increase in excise duties on cigarettes and mineral oils. - Additional recent measures (authorities’ note): - Regulation allowing tax collection on illiquid but solvent tax debtors, expected to increase fiscal revenues by at least 0.5 p.p./p.a. of GDP over the medium term (on top of staff’s projections). - Amendments to the Law on Tax on Immovable Property to enable municipalities to generate more tax revenues. - Expenditure-side actions: - Addressing social expenditures, public sector wages, and pension system sustainability. - Recently introduced social protection laws (especially the Law on Social and Child Protection) are under review due to adverse fiscal effects and low labor participation; authorities will ask for its revocation. - Nominal public wages (and related pension bill) remained virtually flat in 2011-2015; authorities open to reinstating a productivity-based anchor for the public wage bill. - Number of public sector employees will be reviewed. - Interim measure: pensions will be adjusted to the average wage and current inflation. - Given limited fiscal space, authorities will streamline and prioritize recurrent capital spending, focusing on projects filling infrastructure gaps with high value for money and catalytic roles in growth and job creation. - PFM capacity and transparency: - Authorities adopted the ESA 2010 Implementing Strategy and the Strategy for Transition of Public Sector to Accrual Accounting in 2015. - Given capacity constraints, authorities will rely on TA for efficient implementation. - Public debt sustainability: - Authorities share staff’s DSA assumptions but with a somewhat lower baseline peak. - Authorities forecast public debt to peak to 77.9 percent of GDP in 2018, while expecting somewhat lower financial needs compared to staff. - Authorities foresee stronger growth assumptions for 2017-2018 because of highway construction and higher fiscal discipline, especially through improved tax collection. - Authorities mindful of risks that could deteriorate the debt profile: adverse growth scenarios, further balance deterioration, interest rates on newly issued debt, and highway-related cost overruns. - Authorities working on a medium term fiscal consolidation plan with contingency scenarios to protect primary balance from medium-term slippages. - Authorities consider leveraging new debt financing on international markets and alternative sources such as policy based financing to ease impact of potential interest rate hikes. - Authorities consider risk of delay or cost overruns on the Bar-Boljare highway possible, but note the constructor’s pristine track record in almost eighty countries and ample penalty triggers as reassuring. - Structural policies and business environment: - Primary goal: improve labor market flexibility and overcome rigidities. - New WBG CPF envisages projects addressing lack of labor market flexibility and high labor market costs, mismatches between education/skills and labor market needs, and weak labor participation. - New drafted Labor Law aims to significantly lower employer’s cost of firing while streamlining dismissal and redundancy procedures. - CPF builds upon “Montenegro Development Directions 2015-2018” for smart, inclusive, sustainable growth. - Progress in business environment: 2016 Doing Business indicators show particular progress in construction permits (advanced by 51 positions over two years) and paying taxes. - Authorities will amend and improve monitoring of the Action plan - “Regulatory guillotine” to accelerate reforms in lagging areas such as access to energy, starting a business, protection of minority investors, and resolving insolvency. - Authorities agree non-tariff barriers hamper trade flows; work in progress and correlates to EU Acquis alignment. - In 2015 COFACE started issuing an SME excellence certificate in Montenegro to promote integration of Montenegrin SMEs in regional and EU markets by enhancing market transparency. - Financial sector policies and stability risks: - Authorities broadly share staff’s assessment of financial system resilience and vulnerabilities. - Banking system has ample liquidity and comfortable capitalization levels but is stressed by weakened asset quality from the crisis, constraining credit growth and profitability. - Authorities noted staff recommendations and are preparing an action plan based on the FSSA conclusions, building on strategy to align domestic regulatory framework with EU financial sector Acquis. - High levels of NPLs reduced; lending contraction moderated. - NPLs reduced to 12.47 percent in December 2015, almost half compared to the post real-estate boom level of 25.3 percent. *Source: _cr1679 - 3. Joint work program None None (as of December 16, 2015; Statement dated February 19, 2016).* ### 2011. The authorities attribute the strong NPL reduction in 2015 to four reasons: 1. the ### _cr1679 - 2011. The authorities attribute the strong NPL reduction in 2015 to four reasons: 1. the ### Nonperforming loans (NPLs): causes of reduction and supervisory measures - Authorities attribute the strong NPL reduction in 2015 to four reasons: - 1. the recently introduced structural regulatory measures - 2. the uplifted growth prospects - 3. continued deleveraging of the banks - 4. the increased banking competition - Authorities committed to treat NPLs in a holistic manner while considering the FSAP team’s recommendations. - CBM actions: - Created a draft Law on Financial Factoring, Lease, and Credit and Guarantee operations to put remaining non-banking stocks of NPLs under strict supervision of the CBM. - Will analyze modalities for independent asset quality reviews. ### Banking competition, market structure, and supervisory stance - Authorities’ view: - Increased bank competition believed to have a positive impact on interest rate spreads, market depth, consumer inertia, and access to finance. - With 14 banks Montenegro is below the average of its smaller European/regional MIC peers. - Bank licensing and market access legislation is fully aligned with the EU practice (Directive 2006/48/EC). - If a strong institutional framework is in place, financial stability and banking competition can coexist. - Supervisory emphasis: - To compensate for still-strengthening supervision, the CBM vigilantly monitors banks that might be under cost funding distress or practice ominous risk taking behavior in light of increased competition and curbing interest spreads. - Staff view vs. authorities: - Staff noted that increased competition could lead to vulnerabilities; authorities acknowledge and monitor these risks. ### Interest rate policy, consumer protection, and insolvency framework - Authorities are not considering reintroduction of interest rate caps at this moment. - They view interest rate caps as an instrument to restrain further protraction of NPLs, restricting market access to clients with enormous risk premiums and high probability of default—not as a credit growth policy measure. - Personal Bankruptcy Law: - Recently adopted Personal Bankruptcy Law is currently under review. - Financial safety net: - Authorities welcome guidance on establishing a Resolution Unit within the CBM. ### Macroprudential framework, systemic liquidity, and crisis management - Authorities support staff suggestion to enhance the macroprudential framework and systemic liquidity. - Will analyze which suggested macroprudential measures are effectively calibrated to country-specific characteristics of the Montenegrin financial system. - Constraints and adjustment: - Systemic liquidity management is bounded by euroization. - Existing liquidity crisis management framework has only recently come to fore. - Current large liquidity buffers offer a period for adjustment to new liquidity risk management standards, in line with Basel III requirements. ### Regulatory alignment: banking and insurance oversight - Authorities welcome staff’s assessment that banking and insurance oversight frameworks have significantly progressed in alignment with the Basel core principles and the EU Acquis, and agree that further improvements are warranted. - Authorities developed a time-bound strategy committed to full alignment of the regulatory framework with the EU Acquis and the Basel principles, including: - Provisions referring to recommended enhanced credit risk assessment. - Development of prudential limits on large exposures. - Insurance supervision: - Authorities will consider recommendations on transitional strategy referring to gradual introduction of Solvency II regulation in the insurance oversight framework. ### AML/CFT progress and remaining gaps - Staff notes Montenegro is taking active steps to enhance its AML/CFT, but significant room for improvement remains. - Authorities’ view: - Acknowledge remaining gaps and highlight that according to the MONEYVAL cycle assessments, Montenegro has been making constant progress, especially in the area of money laundering offences. - Banks, insurance companies, MFIs and their supervisory authorities are fully provisioned to prevent criminals or their associates from holding or being the beneficial owners of a significant or controlling interest. - The remaining legislation gap refers solely to recently introduced Voluntary Pension Funds (constituting tail end part of Montenegrin financial market). *Source: IMF staff report content provided in the supplied PDF excerpt.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr1679.pdf_