The Former Yugoslav Republic of Macedonia: Staff Concluding Statement of the 2016 Article IV Mission
IMF News, September 30, 2016
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- Published: September 30, 2016
Macroeconomic developments and outlook
- Macroeconomic developments have shown resilience to sustained uncertainties benefiting from accommodative policies, low oil prices, improving labor market conditions and robust external demand.
- The economy has endured a number of shocks, including a prolonged political crisis; economic growth showed resilience through a series of crises in the last two years benefiting from accommodative policies, low commodity prices, sustained foreign investment and improving labor market conditions.
- An extended period of accommodative fiscal policy has helped support domestic demand, but has also depleted policy space to counter further shocks.
- Recovery from the global financial crisis has been solid, but growth has slowed down:
- Real GDP growth averaged around 2½ percent during 2010-15 compared to 4 percent during 2003-8.
- Contribution from capital has held up; lower contributions from labor and negative TFP growth are estimated to have nearly halved FYR Macedonia’s potential output growth in post-crisis years.
- High structural unemployment, low labor force participation and ageing population weigh on the longer-term outlook.
- GDP growth projections:
- Real GDP growth is projected to slow down to 2.2 percent in 2016 reflecting stalled investment and moderating credit growth due to political uncertainties.
- Assuming elections in December followed by stability, growth is projected to increase to 3.2 percent in 2017 with a gradual pick-up in the medium term.
- The positive outlook is highly contingent on the return of political stability and continued recovery in the Euro area.
- Political context:
- The recent agreement among main political parties to hold elections on December 11 is a welcome move but uncertainties remain.
- Restoring an effective political decision-making process is a prerequisite for decisively consolidating public finances and making necessary reforms to raise medium-term potential.
Key policy priorities (mission’s three priorities)
- Adopting high-quality revenue and expenditure measures to build fiscal policy space and enable public debt to remain below 50 percent of GDP.
- Maintaining monetary and financial sector stability.
- Improving the economy’s potential through labor market and governance reforms.
Fiscal policy — current situation, risks, and recommendations
- Fiscal deterioration and risks:
- Public debt has more than doubled since 2008 and is projected to reach 48 percent of GDP this year.
- The fast rise in public debt is mostly due to rising primary deficits reflecting low tax rates, low collection efficiency, and inefficiencies in social spending, transfers and subsidies.
- For 2016, staff projects a widening in the overall fiscal deficit to 4 percent of GDP.
- In the medium term, without measures, overall fiscal deficit is projected to stay around 3½ percent with public debt reaching 55 percent of GDP.
- High fiscal financing needs, rising borrowing costs and recent sovereign downgrading by Fitch have raised near-term fiscal risks.
- Long-term fiscal pressures from ageing:
- At 4½ percent of GDP, FYR Macedonia’s pension deficit is sizable.
- The pension gap reflects relatively generous benefits, low contribution rates and low labor force participation.
- Without reforms and with working age population set to decline, the pension deficit is projected to more than double by 2030.
- Population ageing is also likely to put pressures on health spending.
- Near-term consolidation recommendation:
- For 2016, given the caretaker government and little time left in the year, a small consolidation of 0.4 percent of GDP is recommended relying on scaling back of goods and services spending and collection of VAT arrears.
- This would bring the overall deficit for 2016 to 3.6 percent of GDP.
- Medium-term targets and approach:
- For 2017 and 2018, assuming parliamentary elections in December and resumption of stability thereafter, the mission recommends a reduction in the overall fiscal deficit to 2½ percent and 2 percent of GDP respectively to stabilize public debt below 50 percent of GDP.
- Any negative impact of recommended consolidation on the private sector is expected to be offset by continued structural reforms to improve labor market conditions and attract FDI as well as monetary accommodation.
- Quality of consolidation:
- Medium-term fiscal consolidation should rely on high-quality measures.
- On the revenue side: raise collection by strengthening coverage, targeting compliance risks, improving the operation of large taxpayer office, and establishing a Risk Management Unit.
- On the expenditure side: reduce subsidies and transfers and increase efficiency in health and education spending.
- Pension reforms suggested:
- Consider raising statutory retirement age given the sizable gap with the EU average.
- Consider revising indexation to CPI in line with many countries in the EU.
- Implement reforms to increase labor force participation, particularly that of women.
- Consider increasing contribution rates if sustainability is not secured through other measures.
Monetary and financial policies
- Monetary stance:
- Current monetary policy stance is appropriate.
- Given still-negative output gap, low core inflation and moderate real exchange rate undervaluation, historically low policy rate remains appropriate.
- In case of pressures on the exchange rate or the risk of deposit outflows, policy responses similar to those undertaken in April may be needed to ensure financial stability.
- External and reserve position:
- The current account deficit has narrowed significantly in recent years benefitting from low oil prices and strong exports.
- Official reserves remain adequate and are projected to improve in the medium term on the back of improving trade balances, continued FDI and other financial inflows.
- Credit and banking system:
- Strong household credit growth has sustained financial deepening; post‑crisis credit recovery has been more resilient compared to others in emerging Europe.
- Credit to nonfinancial corporates remains weak reflecting prolonged uncertainties and structural impediments such as high collateral requirements.
- Banking sector remains sound: banks are well-capitalized, with the capital adequacy level twice as high as the regulatory requirement.
- The NPL ratio fell to 7 percent in July reflecting recent measures to write off NPLs that were fully provisioned and had been in banks’ balance sheets for more than two years.
- Banks’ profitability continued to improve in light of strong growth in net interest income.
- Structural liquidity in the banking system remains ample; NBRM’s latest stress tests provide strong buffers to withstand severe deposit outflow shocks.
Structural policies and labor market
- Labor market developments:
- Unemployment rate has significantly declined in recent years; overall unemployment rate has declined by 10 percentage points since 2008.
- The unemployment rate at 24 percent remains very high reflecting skill shortage arising from emigration of skilled workers and low overall level of education.
- Labor force participation rate has declined in recent years, particularly for young workers.
- With declining contribution of labor to growth and ageing population, low participation rates are a drag to long-term outlook.
- FDI and domestic spillovers:
- Notable FDI inflows in the last decade have supported investment and exports although spillovers into the domestic economy remain limited.
- Competitive wages and generous financial benefits have attracted sizable manufacturing FDI since the late 2000s, but contributions to value added and employment are considered modest due to skills shortages and inability of local producers to meet technical and safety requirements.
- Successful examples in Central Europe highlight the need to increase domestic value added over time to sustain investor interest and contain costs from financial incentives.
- Policy recommendations to improve potential:
- Further efforts should aim at improving technical skills and increasing labor force participation.
- Policies to support on-the-job training and vocational education should continue, being mindful of fiscal costs.
- Increasing labor force participation, particularly among young and female workers, would help improve potential growth.
- To enhance the private sector’s role, it is critical to address judiciary and governance weaknesses: frequent legal changes, uneven implementation of laws and difficult contract enforcement burden the domestic private sector.
- The European Commission’s most recent assessment highlights concerns about excessive political interference in public administration and the judicial system; addressing these weaknesses would increase trust in domestic institutions and policymaking, and boost jobs growth via skills retention and higher investment.
IMF staff concluding statement, September 30, 2016.