Kosovo: Staff Concluding Statement of the 2017 Article IV Mission
IMF News, December 13, 2017
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- Published: December 13, 2017
Mission overview
- IMF mission led by Stephanie Eble visited Pristina during November 29-December 12 to conduct the 2017 Article IV consultation discussions.
- The mission thanks the authorities and counterparts for cooperation, frank discussions, and hospitality.
- Key policy focus: reforms to improve competitiveness, reduce income inequality, and achieve stronger and more inclusive growth while preserving fiscal discipline and financial stability.
Macro-economic developments and outlook
- Growth and inflation
- Growth is expected to reach 4.1 percent in 2017, among the highest in the region, led by high investment and exports.
- Headline inflation is expected to average 1.5 percent in 2017.
- The medium-term real GDP growth is expected to remain at 4 percent, driven by private consumption and investment, with exports making an increasing contribution.
- Inflation is projected to remain slightly above the euro area average of 1.8 percent, reflecting moderate productivity gains.
- Supporting factors and risks
- Continued growth supported by remittance inflows and bank lending.
- Higher growth is needed to accelerate job creation and lift incomes.
- Upside potential: medium-term growth could surpass 4 percent if the planned new power plant project and reforms attract more private sector investment and mobilize large IFI financing for key capital projects.
- Downside risks: political instability that could undermine confidence and halt reforms; social spending pressures that could crowd out productive spending; dependency on remittances leaving Kosovo vulnerable to external shocks.
Recent reform progress and remaining challenges
- Progress
- Fiscal discipline has been ensured under recent Stand-by Arrangements.
- Strengthened health of the financial sector and enhanced growth.
- Structural reforms initiated: more transparent public procurement (implementation lagging), adoption of a new bankruptcy law, strengthened contract enforcement.
- Remaining structural challenges
- Weak external competitiveness, informality, governance weaknesses, low labor force participation, and high unemployment—particularly among youth—constrain growth potential.
- Need to develop a productive, export-oriented private sector to accelerate income convergence with the European Union.
Structural reform priorities: improving investment climate, governance, and competitiveness
- Business environment
- Kosovo’s Doing Business ranking has improved, but legislative and regulatory changes need implementation in practice to reduce costs of doing business and level the playing field between debtors and creditors.
- Governance and judiciary
- Strengthen mandatory e-procurement platform usage.
- Enhance effectiveness of the anti-corruption agency and asset declaration.
- Subject large public investment projects to ex-post audits.
- Energy and infrastructure
- Move ahead with the much-delayed new power plant.
- Protect budget space for priority investments.
- Public enterprises and privatization
- Reduce inefficiencies: strengthen supervisory board independence, timely publication of financial statements, external audits, rightsizing employment, and reducing high wage bills.
- Strengthen Privatization Agency institutional and governance structure to accelerate privatization/liquidation.
- Labor market
- Support government action plan on vocational training, active labor market policies, and increased availability of affordable child-care; urge swift implementation.
- Any future increases in the minimum wage should be in line with the current rule-based minimum wage setting mechanism given high unemployment, large competitiveness gap, and weak enforcement framework.
- Caution: large discretionary minimum wage increases could disadvantage low skilled workers, increase youth unemployment, and crowd out priority budget spending.
Fiscal policy: macro-stability, and structural tax and expenditure policies
- Fiscal stance and fiscal rule
- The fiscal stance remains appropriate; the “fiscal rule” is an appropriate anchor for fiscal policy.
- 2017 budget deficit (fiscal rule definition) is expected to be about 1.5 percent of GDP, below the fiscal rule’s deficit ceiling of 2 percent of GDP.
- Draft 2018 budget targets a deficit of 1.8 percent of GDP, in line with the fiscal rule.
- Draft 2018 budget keeps the wage bill constant as a share of GDP, in line with the wage bill rule.
- Authorities expect to start utilizing donor and privatization-financed investment (exempted from the fiscal rule’s deficit ceiling); such project spending could reach 1 percent of GDP next year assuming past mobilization difficulties are addressed.
- Bank balances have been restored to a prudent level of 4.5 percent of GDP and are expected to stay at that level.
- Composition concerns and recommended structural measures
- Concern: pressures for higher social spending could crowd out investments in education, health, and infrastructure.
- Tax administration and revenue
- Broaden the tax base by strengthening tax and customs administration to reduce informality.
- Reinforce collections by setting quantitative and strategic performance targets, widening tax filing requirements, improving audits efficiency and productivity, and significantly scaling up debt collection.
- Authorities are preparing specific tax and customs administration reforms to meet the 2018 budget revenue target; these reforms should start in earnest.
- Avoid tax holidays or exemptions that could weaken the tax base.
- Social benefits reform
- Reform programs to better target inequality, poverty, and unemployment within existing spending envelope: ensure no double dipping, better means-testing, remove disincentives to remain employed, tightly administer and enforce eligibility, and make the system more equitable (e.g., align disability threshold and payments for war veterans to general disability benefits).
- Complete credible re-classification and verification of war veterans in early 2018 in line with the law.
- Urged not to introduce non-contributory early retirement schemes for special groups (such as for the police).
- Health and education
- Improve efficacy of health and education spending; welcome increased 2018 allocations.
- Accelerate efficiency-improving reforms in the health care system to keep spending in check once the new insurance system is rolled out.
- Broaden the contribution base to secure sufficient revenue.
- Move comprehensive education reforms ahead in earnest to upgrade skills and address mismatches.
- Wage bill management
- Make space for hiring in priority sectors within the limits of the rule by restraining across-the-board wage increases.
- Create space for hiring in the judiciary, health, and education; reduce pressure from public sector wages on private sector wages.
- Public investment framework
- Strengthen framework to increase capital spending efficiency and improve donor financing absorption: require cost-benefit analysis for major projects, strengthen appraisal/selection/preparation/execution, adopt multi-year budgeting, and ensure ex-post independent audit and assessment of large-scale projects.
- Financing and debt market development
- Diversify financing and reduce costs and roll-over risks.
- Welcome continued extension of maturities; urge improved absorption of available IFI/EU financing (especially for investment) to minimize crowding out once Euro area monetary policy normalizes.
- Encourage development of domestic debt market and promotion of a diversified participant base on both primary and secondary markets.
Financial sector: financial deepening and stability
- Soundness and supervision
- Kosovo’s banks are well capitalized, liquid and profitable.
- Mission welcomes low level of non-performing loans and adequate provisioning.
- Authorities should continue strengthening supervisory framework, including advancing an off-site bank examination manual and further strengthening macroprudential policy framework.
- Financial intermediation and credit composition
- Credit penetration is 38 percent of GDP, low relative to other CESEE and Western Balkan countries.
- Credit growth has been largest in mortgage and unsecured consumer lending; lending to productive sectors remains low.
- Reform priorities to support balanced lending:
- Full implementation of the amended Law on Enforcement Procedures.
- Address the still-large court backlog.
- Establish a fully-functioning property registry that covers all of Kosovo.
- Allow banks access to the agriculture registry.
- Continue supervisory vigilance amid strong and sustained consumer and construction lending.
Article VIII status
- Legal and financial experts found Kosovo is free from multiple currency practices and restrictions on the making of payments and transfers for current international transactions, except for sanctions measures maintained solely for reasons of international or national security.
- The authorities expect to move shortly to Article VIII status from Article XIV.
IMF Communications Department — Mission Concluding Statement, December 13, 2017