Republic of Kosovo -- IMF Staff Visit, Concluding Statement

IMF News, June 24, 2009

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• Published: June 24, 2009

Near-Term Outlook—Risks Remain High Despite Benign Growth Performance

• Economy: recession in Europe has so far had little impact on real growth due to small export base and rapidly rising public expenditures.
• Domestic demand: steady slowdown in remittances, imports, private sector credit, and FDI, suggesting moderating domestic demand growth.
• Public expenditures: rapid growth expected to widen fiscal deficit this year.
• Exports: sharp contraction, but muted impact on GDP because of very narrow export base; small export sector will also limit benefits from projected global recovery.
• Growth projections:
  • Real growth projected at 3½ percent in 2009.
  • Real growth projected to rise by about 4 percent in 2010, considering plans for public expenditure restraint.
• Downside risks:
  • Banking sector stability is not guaranteed; many European parent banks may yet recognize losses, which could affect subsidiaries including in Kosovo.

Fiscal Sustainability—Undermined by Ad Hoc Expenditure and Financing Policies

• Assessment:
  • Fiscal policies lack clarity and expenditure management is loose.
  • This year’s budget assumed budget neutrality of a loan from the budget to KEK equal to 3¾ percent of GDP.
  • Privatization delays of KEK likely to result in pronounced increase in capital expenditures.
  • Additional unfunded mandates inflate this year’s budget expenditures by at least 1½ percent of GDP.
  • Mission projects government expenditures to grow 39 percent this year.
• Mid-year budget review (MYBR):
  • Spending ministries requested additional allocations contrary to MoFE instructions.
  • Government is considering a further increase in expenditures over 1½ percent of GDP this year.
  • Recommendation: no increases should be granted.
• Fiscal risks identified:
  • KEK’s dilapidated state may necessitate costly energy imports.
  • Highway project to Albania risks committing government to substantial future outlays; costs and financing not properly assessed.
  • Fiber-optics projects for schools (2 percent of GDP) under consideration by PTK should, if undertaken, be accounted as public investment.
  • Calls for renewed wage hikes ahead of November local elections should be resisted.
• Legal initiatives and mandates:
  • New laws and policy documents (Law on the Rights and Responsibilities of Deputies, Law on Civil Service, Law on Salaries of Civil Servants, White Paper on Social Policies) could add at least about 1 percent of GDP to future expenditures.
• Deficit scenarios and financing risks:
  • If all expenditures executed in full the fiscal deficit is likely to reach nearly 11 percent of GDP this year.
  • Assuming about 80 percent execution rates for investment projects and some current expenditures, the budget deficit would still reach approximately 8 percent of GDP.
  • Three main deficit-financing options (and associated risks):
  • Drawing down government’s bank balance at the CBK: reduces scope to intervene in financial sector if needed; risks liquidity shortage.
  • Spending prospective dividend from PTK: PTK deposits are 17 percent of total deposits at end-May 2009; using dividend as budget financing could weaken bank funding patterns.
  • Borrowing from financial institutions upon passage of the Law on Public Debt: risk of crowding out private sector investment as private sector credit growth follows deposit growth.

Policy Recommendations—Expenditure Prioritization, Credible Fiscal Policy Anchor, and Improvements in Tax Administration

• Expenditure prioritization:
  • Reassess expenditure priorities and implement substantial expenditure cuts to restore fiscal sustainability.
  • Reprioritize capital expenditure allocations based on year-to-date execution to identify scope for further reduction.
  • Safeguard adequate level of government’s bank balance held at the CBK and put deficit financing on a solid footing.
• Fiscal anchor:
  • Establish a credible anchor derived from a consistent medium-term macro framework ensuring fiscal and external sustainability while addressing development needs.
  • Consider embedding policy targets from such a framework into a simple and transparent fiscal rule.
  • Political backing from the highest level is necessary for any fiscal rule to be effective.
  • IMF mission offers to help develop a simple fiscal rule consistent with a long-term macro framework.
• Tax administration:
  • Step up efforts to broaden the tax base to reduce need for expenditure adjustment.
  • Planned introduction of taxpayer identification numbers for new businesses and rollout to existing businesses by year-end is encouraged.
  • Introduction of electronic cash registers is useful; government should set standards and leave provision to private sector.
  • Appointment of a new director of tax administration with qualifications commensurate with challenges is anticipated.

Structural Policies—Vital For Fiscal Sustainability

• Law on Public Debt:
  • Draft requires further modification to support fiscal sustainability.
  • Municipal borrowing terms should be tightened; require mechanism certifying municipalities’ financial management capacity and a more prudent ceiling on municipal debt stock.
  • Clarify CBK’s role as sole fiscal agent of the government.
  • Assess draft’s consistency with other laws; IMF staff ready to assist MoFE and CBK.
• Energy sector:
  • Urgent reform required; annual costs to the budget of the energy sector are at least 3½ percent of GDP and rising.
  • Adopt one of the two competing energy sector strategies proposed by the World Bank and USAID rather than inaction, but carefully assess fiscal implications and feasibility, including market-test feedback.
  • Interim actions: improve collection and billing of KEK to curtail quasi-fiscal risks; consider audits of financial operations, including energy imports, to strengthen KEK finances.

Financial Sector Stability—Closer Policy Coordination and Tighter Regulation Needed

• Coordination:
  • Close coordination between financial sector and fiscal policies is vital to underpin macroeconomic stability.
  • Improved collaboration and close policy coordination needed between CBK and MoFE to mitigate risks from foreign parent bank difficulties and potential liquidity shortages.
• Central bank law and lender-of-last-resort:
  • Current legislation does not authorize CBK to provide liquidity to the banking sector; draft law (drawn up with IMF assistance) provides limited discretionary authority.
  • Mission urges speedy adoption of the draft law; in the interim, CBK and MoFE should enhance coordination.
  • Euroization limits macro instruments to fiscal policy; fiscal policy objectives should recognize fiscal authorities’ responsibility for financial sector stability and maintain adequate government bank balance.
  • Avoid decisions that may weaken banking sector stability, including reliance on PTK dividend payments as budget financing.
• Regulatory measures:
  • CBK should consider limits on subsidiaries’ gross exposure to their parent banks in addition to existing net exposure limits to safeguard subsidiaries’ liquidity.
  • CBK should continue to ensure proper NPL classification; regulator should maintain intensified on- and off-site supervisory activities.
  • Proactive risk management needed in insurance and banking sectors given possibility of pronounced increases in NPLs.

Mission conducted in Pristina, June 24, 2009. We would like to thank our interlocutors for their hospitality and insightful discussions.

Republic of Kosovo -- IMF Staff Visit, Concluding Statement

References

• Republic of Kosovo and the IMF
• Mission Concluding Statements
• PRESS CENTER
• Article IV
• https://www.imf.org/en/home