Serbia and Montenegro--2006 Article IV Consultation and Post-Program Monitoring--Montenegro: Concluding Statement of the Mission
IMF News, June 22, 2006
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- Published: June 22, 2006
Mission summary and context
- Mission type: Concluding Statement of IMF staff at end of the mission.
- Date: June 22, 2006.
- Core aim: Offer macroeconomic suggestions to capitalize on Montenegro's declaration of independence and to support sustained increases in economic growth, employment, and real incomes as a foundation for eventual EU accession.
- Positive developments noted:
- Low inflation.
- Public debt trending downwards.
- VAT strongly underpins revenue.
- FDI is up with more expected.
- Banks privatized; credit is booming.
- Preferential access to EU markets; prospects for SAA agreement, WTO, and PfP membership are good.
A. Independence — legal and fiscal arrangements
- Immediate actions recommended:
- Establish in Montenegro's own right agreements formerly held by Serbia and Montenegro on regional free trade, veterinary standards, double taxation, etc., to secure orderly economic conditions.
- Clarify legal framework for economic relations with Serbia, including residency status, eligibility for social benefits, and work permits.
- Consider a Free Trade Agreement (FTA) to secure continuation of prior trade arrangements.
- Complete calculation of the former net fiscal transfer to the Union by subtracting costs the Montenegrin budget will now bear as Union functions shift to Montenegro; this will assist implementation of the 2006 budget and design of the 2007 budget.
B. Medium-term policies — framework and reforms
- Monetary and external context:
- Euro is sole legal tender; open capital accounts.
- No independent monetary policy; domestic interest rates = euro area rates + "Montenegro risk premium".
- Banking data suggest the Montenegro risk premium could be some 250-300 basis points currently.
- Flexibility: identified constraints and reform areas
- Labor market:
- High dismissal costs: 6 months of average salary.
- High tax wedge: about 41 percent of total labor costs.
- Inflexible employment contracts and wage determination mechanisms.
- Recommendation: labor reforms including strengthened active labor market policies.
- Corporate governance:
- Privatization to strategic investors is key; envisaged sales should proceed swiftly.
- Active use of exit mechanisms, notably bankruptcy, is recommended.
- Financial sector:
- Review arrangements for collateral assignation and collection.
- Strengthen corporate accounting standards.
- Continue efforts to bolster banking system, including additional foreign bank entry.
- Forthcoming Financial Sector Assessment Program (FSAP) missions to assess further.
- Automatic fiscal stabilizers:
- Allow budget balances to weaken during downturns and strengthen during upswings to cushion cycles.
- Sustainability and the Montenegro risk premium
- Market confidence in fiscal sustainability is key to a low risk premium.
- Policies that raise the premium and borrowing costs can undo beneficial effects (including tax cuts).
- Fiscal anchor recommendation
- Adopt a target for total budget sector debt covering:
- Central government debts and arrears.
- Municipalities.
- Extra-budgetary funds.
- Debts of public and municipal enterprises not run on a strictly commercial basis.
- Target design:
- Use a 5 year average relative to GDP (rather than a single-year target) to allow automatic stabilizers.
- Set a separate target for public guarantees.
- Proposed public debt target:
- 35 percent of GDP on average between 2007-2011.
- Assumptions underpinning target:
- Strong structural reforms yielding average annual GDP growth of 5½ percent over 2007-2011.
- Implementation of the second pension pillar.
- Consistent with 3 percent per annum growth in real public spending.
- Public debt below 30 percent of GDP in 2011.
- Anticipates labor tax revenue reductions of over 2 percentage points of GDP due to rate cuts over that period.
- Adjust the target mid-course if:
- Privatization receipts from planned sales and second pillar costs differ markedly from projections.
- Nominal GDP estimates are raised to reflect the grey economy.
- Permanent unanticipated real external shocks occur.
- Estimates of the initial debt stock alter.
- Suggested action: adopt and announce this fiscal framework and target with the 2007 budget.
- Public debt stock and privatization receipts
- Estimated public debt stock at end 2005: some €740 million (44.5 percent of GDP, including borrowing from banks and excluding debts of public enterprises).
- Ongoing accounting may reveal more debt from restitution, military, and municipal liabilities.
- Estimated prospective privatization receipts: well over 15 percent of 2006 GDP over the next five years.
- International evidence cited: economic instability in developing countries with public debts above 30 percent of GDP underscores case for reducing debt.
- Pace of debt reduction considerations
- If high-return public investment projects are ready now, debt trajectory should be back-loaded to allow implementation.
- If implementation capacity is limited and privatization receipts are expected early, downward trajectory should be front-loaded.
- Financial sector assessment
- Progress noted:
- Sharp increases in private sector deposits.
- Work underway on new banking law incorporating new standards.
- Progress in strengthening risk-based supervision and compliance monitoring.
- Concerns:
- Accounting standards.
- Possible deterioration in credit quality during recent credit boom.
- Forthcoming FSAP mission will provide fuller assessment and policy recommendations.
- Statistical issues
- Significant scope for improvement.
- National accounts not available beyond 2003; external data unstable.
- Strengthening national accounts data is urgent to reduce investor uncertainty and risk premium.
- Supply-side reforms
- Key constraints to remove: state ownership, former-Yugoslav labor institutions, implicit energy subsidies, weak enterprise exit procedures.
- Support for:
- Ambitious program of privatization.
- Modernization of labor legislation.
- Improving public sector productivity.
- Lowering tax burden, especially on labor.
- Significant increases in public investment, coupled with increased capacity to design and implement capital projects.
- Caution: privatization procedures should be efficient, fair, and perceived as such to avoid undermining investor participation.
- Social considerations: provide social safety net for those adversely affected in the short term.
- Strategic choice regarding privatization receipts
- Warning: using privatization receipts to postpone broader real and budgetary reforms will yield temporary public debt reductions and eventual fiscal sustainability problems when receipts stop; growth and employment performance likely to remain disappointing (Text Table 1).
- Recommendation: accompany privatization with ambitious structural reforms and reductions in non-productive budget spending to secure permanent growth, robust real public spending growth, and reductions in the tax burden (Text Table 2).
C. Economic outlook and policies for 2006-07
- GDP growth projections:
- 2006: 5½ percent.
- 2007: 6 percent.
- Drivers: past structural reforms, exports, strong bank credit growth.
- Fiscal performance and 2006 indicators:
- First quarter 2006 data show a surplus €15 million, largely due to strong VAT collections.
- Suggested fiscal outcome for 2006: deficit outturn of 0.2 percent of GDP and an end-2006 public debt stock of 37 percent of GDP.
- 2007 budget guidance:
- Budget should demonstrate commitment to a strong medium-term framework.
- Accelerate preparations for key public investment in 2007.
- Proceed with ambitious reform to personal income tax (PIT), but:
- Estimated budgeted revenue loss from PIT reform: 1.8 percent of GDP.
- Recommendation: match the 1.8 percent of GDP revenue loss with corresponding reductions in current expenditure.
- Make appropriate arrangements for effects on municipalities of the PIT reform.
- With public investment assumed at 3.8 percent of GDP in 2007, the budget should target a deficit of consolidated general government of 0.3 percent of GDP, consistent with the medium-term public debt target.
- Structural reforms should commence vigorously alongside the budget.
- Policy objective:
- Establish a high growth, high employment, low tax, low debt, and flexible economy led by the private sector.
Key statistics and selected table figures
- Estimated public debt stock end-2005: €740 million (44.5 percent of GDP).
- Montenegro risk premium estimate: 250-300 basis points.
- Proposed medium-term public debt target: 35 percent of GDP (average 2007-2011).
- Privatization receipts estimate: well over 15 percent of 2006 GDP over the next five years.
- GDP growth projections: 2006: 5½ percent; 2007: 6 percent.
- First quarter 2006: surplus €15 million.
- Suggested 2006 fiscal outturn: deficit 0.2 percent of GDP; end-2006 public debt stock 37 percent of GDP.
- PIT reform estimated revenue loss: 1.8 percent of GDP.
- Assumed public investment in 2007: 3.8 percent of GDP.
- Target deficit for consolidated general government in 2007: 0.3 percent of GDP.
- Selected figures from Text Table 1 (No reforms scenario, percent of GDP unless noted):
- Fixed investments (2005): 23.7
- Revenues (2005): 40.1
- Fiscal balance (cash, before grants) (2005): -1.9
- Privatization revenues (2005): 9.9
- Public debt (end of period, stock) (2005): 44.5
- Average public debt 2006-11 (percent of GDP): 38.0 (memo)
- Selected figures from Text Table 2 (Reforms scenario highlights):
- Average public debt (percent of GDP): 33.2
- Real public expenditures growth (average 2007-11): 2.8
- Selected figures from Text Table 3 (Public Finance Budget Indicators, percent of GDP):
- Revenue and grants (2003): 40.7
- Of which: PIT (2003): 6.1
- Expenditure (2003): 45.5
- Of which: Wages (2003): 11.8
- Cash balance (after grants) (2003): -5.4
- Privatization receipts (2003): 2.4
- Nominal GDP (2003): 1,392
Source: Montenegro: Concluding Statement of the Mission (Article IV Consultation and Post-Program Monitoring), IMF, June 22, 2006.