The Former Yugoslav Republic of Macedonia: Staff Concluding Statement of the 2017 Article IV Mission
IMF News, September 18, 2017
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- Published: September 18, 2017
Key economic developments and near-term outlook
- Prolonged political uncertainty has taken a toll on economic growth, with investment suffering because of weak sentiment.
- Real GDP growth slowed to 2.4 percent in 2016, the lowest since 2012.
- Data for the first half of 2017 point to economic contraction driven by a sharp drop in investment.
- Growth is projected to moderate to 1.9 percent in 2017.
- Inflation is expected to reach 1.2 percent in 2017, ending three years of deflation.
- Export growth has remained robust and private consumption has been resilient, helped by employment growth and rising wages and pensions.
Medium-term outlook and risks
- Real GDP growth is expected to rebound in 2018 and gradually rise to 3¾ percent over the medium term, contingent on continued political stability and robust external demand.
- Downside risks:
- A slim-majority governing coalition may be tested in the context of upcoming local elections; renewed political uncertainty could undermine fragile confidence.
- External risks from weaker growth in trading partners and global policy uncertainty, which could reduce exports and FDI inflows.
- Upside scenario:
- Strengthening political stability could lead to decisive structural reforms, enhance EU accession prospects, and lift growth potential.
Fiscal policy: support sustainability and create policy space
- Public debt was above 45 percent of GDP at end-2016, a near doubling since 2008.
- Despite slower growth, under-execution of capital and goods and services spending is likely to keep the fiscal deficit at around 3 percent of GDP in 2017.
- In the medium term, the deficit is projected to rise above 3½ percent of GDP, reflecting clearance of unpaid claims, wage subsidies, and additional social protection support.
- Public debt is expected to exceed 53 percent of GDP by 2022.
- Gross fiscal financing needs are estimated to reach around 15½ percent of GDP.
- The mission calls for gradual fiscal consolidation starting without delay to safeguard sustainability, rebuild buffers, and create space for social development and infrastructure.
Specific fiscal recommendations:
- Reduce the labor tax wedge at low-income levels:
- Decrease the minimum income base for the social security contribution.
- Accompany with strong audit processes to ensure compliance and some progressivity in income taxation to ensure revenue neutrality.
- Raise additional revenues through more efficient collection of VAT and higher property and fuel taxation:
- VAT collection has been deteriorating and remains significantly lower than in Western Balkan peers.
- Improve coverage and targeting of compliance risks, operation of the large tax payer office, and establish a fully-functioning risk management unit.
- Increase tax rates on gasoline (currently among the lowest in the region) and raise taxes on property.
- Reduce current spending by cutting subsidies and reforming the pension system:
- Untargeted subsidies should be reduced.
- Reforms to reins in large and widening pension deficits include raising the statutory retirement age to the EU average, tightening options for early retirement, indexing pensions to CPI inflation only, and refraining from ad-hoc increases.
- With only a quarter of non-pension social benefits going to the poorest quintile, improve targeting of social inclusion measures.
- Strengthen public financial management and fiscal transparency:
- Transform the government’s agenda into a properly prioritized plan focused on key weaknesses.
- Verify identified general government payment arrears and blocked VAT refunds, develop a transparent framework for clearance, and put in place systems to prevent new arrears by better controlling expenditure commitments.
Monetary and financial policies
- Monetary policy should remain accommodative in the near term given low inflation, external stability, and a still-negative output gap.
- Authorities should be prepared to tighten monetary policy if signs of inflation accelerating or pressures on foreign exchange reserves emerge.
- The banking system is healthy:
- Strong policy actions by the NBRM last year preserved banking system stability.
- Adoption of Basel III standards on capital adequacy earlier this year reinforces resilience.
- The banking system is well capitalized, liquid, and profitable, with limited exposure to parent bank financing.
- Risks to monitor:
- High degree of financial euroization.
- Moderate deleveraging risks from the large presence of EU parent banks.
- Use micro- and macroprudential tools as needed to manage risks.
Structural reforms to strengthen growth and EU accession prospects
- Decisive action is needed to tackle weaknesses in the judicial system and overall governance frameworks; limited progress in governance and competition policy has held back FDI inflows and deeper EU integration.
- The new government’s focus on reforming the judiciary and improving efficiency and transparency of public institutions is encouraging.
- Any direct support to enterprises in the form of subsidies or tax breaks should be carefully assessed to avoid jeopardizing fiscal sustainability.
- Labor market and skills priorities:
- With a projected decline in the working-age population, increase labor participation and upgrade skills.
- Address low female labor force participation (one of the lowest in Europe) by increasing availability of affordable childcare and allowing greater flexibility in family leave policies.
- Reduce the youth unemployment rate of 50 percent through vocational training and higher investment in skills, including active labor market policies.
- Refrain from recourse to minimum wage increases as planned, since these could exacerbate youth unemployment, drive more people to the informal sector, adversely affect competitiveness in the export-oriented sector, and put pressure on scarce budgetary resources.
Closing
- The IMF team expressed appreciation for the authorities’ cooperation, hospitality and candid discussions.
The Former Yugoslav Republic of Macedonia: Staff Concluding Statement of the 2017 Article IV Mission — September 18, 2017