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Kosovo: Staff Concluding Statement of the 2022 Article IV Mission
November 4, 2022
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IMF Communications Department
MEDIA RELATIONS
PRESS OFFICER: Meera Louis
Phone: +1 202 623-7100Email: MEDIA@IMF.org
November 4, 2022
PRESS OFFICER: Meera Louis
Phone: +1 202 623-7100Email: MEDIA@IMF.org
Washington, DC – November 4, 2022: An International Monetary Fund (IMF) mission, led by Mr. Gabriel Di Bella, visited Pristina during October 25-November 4 in the context of the 2022 Article IV consultations. At the end of the visit, the mission issued the following statement:
Recent Developments and Outlook
The fallout from the war in Ukraine is increasingly affecting Europe’s economic activity and inflation levels, and Kosovo is no exception. Higher food and energy import prices have led to increased inflation, negatively impacting households’ real disposable income and private demand. Higher input prices have also led to a re-evaluation of investment project costs, which has been reflected in a slower than expected implementation of the public investment program. Accordingly, real GDP growth slowed to 4.5 percent in 2022:Q1 and further to 2.1 percent in 2022:Q2 (both y/y), down from the extraordinary growth of almost 11 percent last year. Inflation reached 14.4 percent in July 2022 (y/y), but has gradually declined thereafter. While food and energy prices have jointly contributed 80 percent of inflation so far in 2022, core inflation has started to creep up reflecting some moderate second round effects. In this regard, staff projects core inflation to reach 4.4 percent in 2022 (up from 2.2 percent in 2021).
Stronger fiscal revenues have allowed the government to cushion the impact of the terms of trade shock on households and firms, while also replenishing its liquidity buffers. The government reallocated 2.6 percent of GDP in April and an additional 1.7 percent of GDP in September for temporary measures to provide pension and social assistance top ups, wage bonuses, and energy subsidies for households and businesses. At the same time, stronger fiscal revenues, due to successful economic formalization efforts by the tax administration agency (TAK) and higher inflation, and a broadly prudent fiscal policy (reflected in a projected overall fiscal deficit of at most 1 percent of GDP for 2022) led to replenished government deposits, which increase the policy space to mitigate future shocks. Bank credit continued flowing, against the backdrop of adequate liquidity and capital buffers and low non-performing loans (NPLs). However, the tightening financial conditions in the Euro Area is resulting in some increases in deposit and lending rates, and the growth of credit in real terms decelerated compared to 2021.
Staff expect real GDP to grow by 3 – 4 percent in 2023, and inflation to gradually ease, but these forecasts crucially depend on international commodity prices, including of energy. The gradual projected decline of commodity prices would provide relief to households and firms, with a moderately expansionary fiscal policy also contributing to more dynamic activity. As the fiscal expansion will be largely predicated on an acceleration of public investment, which has a relatively large import component, staff expects that its impact on inflation will be minor. In this regard, staff’s baseline scenario projects average inflation to decline to 4 – 5 percent in 2023. These forecasts, however, are subject to significant risks. Higher energy prices could lead to higher inflation and input costs, as well as to electricity rationing, negatively impacting growth. Lower activity and tighter financial conditions can also weigh on credit growth and NPLs. On the upside, a faster implementation of the public investment program can lead to stronger activity. Moreover, foreign direct investment can be higher if Kosovo begins benefiting from the ongoing ‘near shoring’ efforts of many European firms, though their positive economic impact will likely be gradual.
Fiscal policy: Managing the energy price shock while increasing the absorption of capital spending
The draft budget for 2023 appropriately envisages a return to the fiscal rule deficit ceiling. The implied rise in the fiscal deficit will provide a moderate fiscal impulse of 1 – 2 percentage points of GDP, helping the economy soft land. Strong fiscal buffers suggest a still comfortable financial position. Staff assesses public debt to be sustainable with the public debt-to-GDP ratio projected to remain below the legal ceiling of 30 percent of GDP throughout the forecast horizon.
Work on the law regulating public wages should be finalized with a view to begin its implementation in 2023. The new law should increase compensation fairness, reduce arbitrariness and the number of allowances, and strive to result in talent retention in key areas like health, information technology, and public service regulation. While the implementation of the law will result in a warranted increase in nominal wages for most sectors (including health and education), the value of wage coefficients should be set so the wage bill does not breach its legal ceiling, and that private sector competitiveness is not negatively affected. Too high public sector wages may constrain labor supply for private firms, which are already experiencing labor shortages in some areas.
Contingency allocations as a form of risk management need to be accompanied by a description of their intended use. Large blanket allocations are usually opaque and increase policy discretion. While heightened uncertainty justifies building contingency buffers, the budget documents should broadly describe their intended use. This would result in a budget document that more clearly spell out the government’s vision about the risks shaping the outlook, increasing transparency and the overall usefulness of the budgetary process.
Programs to mitigate the impact of surging energy costs need to be temporary and targeted. These measures should be intended to smooth the pass-through of higher energy prices, and thus, need to be temporary and well targeted at vulnerable households and viable firms. Given inelastic domestic electricity supply, this calls for energy savings through more frequent pass-through rates to tariffs (from one to at least two per year), with higher tariffs for peak-hour consumption for non-vulnerable clients. This would allow to flatten the intra-day electricity demand and reduce the overall financial imbalance of the sector during the winter. Power outages as a form of temporary shock management should be the last resort given its high social and economic costs. Careful scenario analysis and planning, as well as strengthened dialogue between the main sector stakeholders are essential at the current juncture, given that international energy prices are expected to remain above their pre-war levels for the foreseeable future.
The increase in the public investment envelope is welcome, but the challenge continues to be to increase absorption. Staff urged authorities to keep increasing allocations to health and education, as social infrastructure is a key bottleneck to growth. A recent initiative to compensate contractors for higher project costs through mid-2023 (on an invoice-by-invoice basis) can help speed up implementation rates. Consistent progress in the implementation of the 2018 IMF’s Public Investment Management Assessment’s recommendations can help address remaining shortcomings in this area.
Financial policies: Preserving the flow of credit and containing potential risks
As growth decelerates and financial conditions tighten, the Central Bank (CBK) should further strengthen the monitoring of banks’ credit and liquidity. Surging energy costs and a weaker outlook will impact asset quality and firms’ earnings. The CBK should take note of the shifting macroeconomic environment when supervising banks’ working assumptions for credit, liquidity, and interest risks, and stand ready to take supervisory action when warranted. To address possible liquidity shocks, systemic banks have contingent credit lines with foreign financial institutions, and the CBK has renewed its repo line with the ECB through early 2023, and intends to negotiate its extension at that time. In particular, the monitoring of the housing sector needs strengthening. Housing sector statistics are poor, constraining the authorities’ ability to monitor this sector’s developments.
The good pace of implementation of the 2019 Financial Sector Stability Review (FSSR) needs to be maintained. Priorities going forward include the approval of the draft banking law and further work to clearly delineate the responsibilities of the executive and Central Bank boards. While staff commends the temporary filling of one deputy governor position through June 2023, the remaining deputy governor vacancy needs to be filled as soon as possible.
Structural policies: Continue addressing infrastructure and governance gaps
Infrastructure gaps constrain investment and growth. Gaps in physical and social infrastructure vis-a-vis the EU15 are significant, limiting the attractiveness of Kosovo as a foreign direct investment destination. In particular, high non-technical and commercial losses make the electricity sector financially vulnerable, and some unreliability in domestic supply leave the sector exposed to fluctuations in external electricity prices. More reliable and greener electricity supply will both reduce fiscal and business costs, while preparing Kosovo for the carbon content demands linked with further European integration. Staff urged the authorities to redouble their efforts to expand green capacity, explore further regional market integration, increase effective penalties for electricity theft, and strengthen the coordination between the sector’s stakeholders both at the regulatory and management levels.
Staff commended improvements in the area of economic governance. The full roll-over of e-procurement and the new commercial courts are decisive steps forward in this regard. The adoption of beneficial ownership reporting, which would tackle conflicts of interest in public procurement, is a natural next step in this area. Hiring additional commercial court judges will strengthen economic security and lead to lower informality rates. Staff urged against additional withdrawals from the pension fund (KPST), as this would harm the viability of the pension system and domestic capital market development. Finally, staff encouraged the authorities to keep efforts at implementing the EU-Kosovo Stability and Association Agreement.
The mission wishes to thank the authorities and other stakeholders for their warm hospitality and open dialogue.
