Montenegro: Staff Concluding Statement of the 2019 Article IV Mission
IMF News, June 28, 2019
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- Published: June 28, 2019
Main points
- Economic growth has been strong, and fiscal adjustment has improved budget balances, but high public debt limits the government’s room to counteract possible future downturns.
- With global growth prospects increasingly uncertain, government debt needs to be further reduced.
- The costs and benefits of completing further phases of the Bar-Boljare highway in the near term need careful analysis; a credible new feasibility study is essential before decisions on financing mechanisms are made.
- Rush to complete the highway could entail large fiscal costs and leave the economy much more vulnerable to shocks, preventing allocation of fiscal resources to education, health, and critical public infrastructure.
- Additional efforts are needed to strengthen the financial system, including bank supervision and Anti-Money Laundering (AML/CFT) frameworks; implementation of the planned asset quality review (AQR) by end-2020 is critical.
- Continuation of strong growth requires careful prioritizing and sequencing of public spending.
Growth outlook and structural opportunities
- Findings:
- Economy projected to expand 3 percent in 2019, down from almost 5 percent in 2018.
- In the absence of further reforms, growth is expected to average just under 3 percent in the next five years.
- There is still untapped potential in tourism, but small-sized economies face a sustainability limit in tourism expansion.
- Authorities are focusing on renewable energy given natural endowments; rapid progress could raise growth above projections.
- Downside risks include worsening global trade, financial conditions, or geopolitical tensions.
- Policy priorities:
- Focus public spending on areas with highest social and economic returns: education, health, and infrastructure alleviating congestion in densely populated/visited areas.
- Sequence public investments so initial high-return projects generate dividends to fund more uncertain ambitious projects.
Fiscal policy, public debt, and consolidation
- Recent fiscal performance:
- Excluding highway spending, the primary fiscal balance swung from a deficit of 1 percent of GDP in 2016 to a surplus of 2 percent in 2018.
- General government debt including guarantees stood at 79 percent of GDP in 2018 (71 percent of GDP excluding guarantees).
- Projections and requirements:
- Maintenance of currently projected primary surpluses over the medium term of 2 percent of GDP is critical to reduce public debt.
- Under current policies, general government debt with guarantees is projected to decline to 61 percent of GDP by 2024 (53 percent of GDP without guarantees).
- Recommendations:
- Reduce public debt in the nearer term to retain room to counteract external shocks.
- Implement stronger budget procedures, including a medium-term budget framework beginning with the 2021 budget, binding medium-term expenditure limits, and requiring fiscal impact assessments for legislation with budgetary consequences.
- Pursue deeper fiscal reforms to create more fiscal space: pension reform aligned with increasing lifespans, overhaul of public employment to enhance public sector efficiency, and elimination of wasteful tax exemptions.
Bar-Boljare highway: assessment and trade-offs
- Findings:
- Construction of the first phase was expensive and required difficult fiscal adjustments.
- Remaining phases could be expensive to the public sector; economic benefits of the whole project are uncertain and earlier studies raised questions about viability.
- Authorities commissioned further studies; if doubts remain, investment plans would be revised and moved forward only once public finances are sufficiently strengthened.
- Recommendations:
- Proceed very carefully; require a credible new feasibility study before financing decisions.
- Weigh highway choices against alternative uses of fiscal resources that may offer higher returns.
Tax administration, investment management, and PPPs
- Tax administration:
- Montenegrin Tax Administration (MTA) has adopted a reform program with IMF technical assistance and has shown steady improvement and a significant reduction in tax arrears.
- Government granted autonomy to the MTA.
- Future audit activities should focus on major tax risks; legislative changes to the interest and penalty regime are necessary to induce greater compliance.
- Investment and PPPs:
- Establish strong legal and institutional frameworks to identify viable projects and avoid unaffordable fiscal burdens.
- Draft Law on PPPs contains welcome provisions, including a strong role for the Ministry of Finance to ensure economic viability and fiscal sustainability of PPPs.
- Enhance expertise to analyze fiscal risks and prudently establish ex-ante limits for PPP-related fiscal liabilities, including municipal governments.
Banking sector, supervision, and AML/CFT
- Recent developments and system health:
- No spillovers observed to the broader banking sector from interventions in two non-systemic banks; system-wide deposits stable.
- System-wide capital adequacy ratio is comfortably above the regulatory minimum, liquidity remains high, system profitable.
- Following closure of two banks, non-performing loans (NPLs) declined to 4.7 percent in April 2019.
- Private sector credit growth has strengthened.
- Supervision gaps and actions needed:
- Current structure, process, and tools for credit risk supervision need further improvement.
- Strengthen supervision within the Central Bank of Montenegro (CBM) by establishing a supervisory committee to support senior management decisions.
- Enhance off-site supervisory capacity with well-qualified and adequately compensated staff; focus on effectiveness, not just administrative enactment.
- Asset quality review and resolution framework:
- A thorough banking sector health review (AQR) must be completed by end-2020; AQR should be carried out by reputable international assessors.
- CBM should take decisive action on weak banks with intense scrutiny and enforceable action plans.
- Monitor rapid growth of uncollateralized consumer lending and implement macroprudential measures as needed.
- Forthcoming financial sector legislative changes will harmonize banking laws with EU directives; legislative approval expected later this year.
- Under draft legal framework: banks required to develop clear recovery plans; CBM to establish a resolution fund financed by banks; deposit insurance fund permitted to use resources to finance transfer of insured deposits to healthy banks.
- CBM has made progress modernizing the credit registry.
- AML/CFT and investor citizenship program:
- New AML/CFT law improved legal framework; CBM is improving staffing and capabilities.
- Need to strengthen AML/CFT supervision by developing risk-based tools and procedures for offsite monitoring and onsite inspections.
- Formalize and ensure consistent application of “fit and proper” tests for banks’ managers and owners.
- Investor citizenship program may create financial integrity and reputational risks; authorities should implement comprehensive due diligence on applicants, including source of wealth checks, and adopt good transparency practices, including publication of citizens-beneficiaries’ names.
Labor market and inclusive growth
- Labor market outcomes and challenges:
- Labor force participation is low.
- Unemployment rate is 15 percent.
- Informal economy employs an estimated quarter of the labor force.
- Key indicators and reforms:
- Tax wedge: At nearly 40 percent, the labor tax wedge is the second highest in the Western Balkans.
- Authorities intend to reduce employers’ social contributions by 2 percentage points; revenue loss must be offset (e.g., by reducing tax exemptions).
- Authorities could reconsider reverting to a flat tax of 9 percent on personal income.
- Labor law: More than 30 percent of workers are employed on temporary contracts.
- Draft labor law aims to narrow the gap between temporary and open-ended contracts and make open-ended contracts more attractive by easing excessive rigidities.
- Minimum wage policy:
- Minimum wage will rise 15 percent in July, the first increase since 2013.
- Ratio of the minimum to the average wage is estimated to increase from 38 to 42 percent, near the regional average.
- Future minimum wage decisions should assess impacts of prior increases and consider indicators including the poverty line and trends in average wage growth and productivity.
Source: Montenegro: Staff Concluding Statement of the 2019 Article IV Mission (June 28, 2019), International Monetary Fund.
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