## Serbia and Montenegro--2006 Article IV Consultation and Post-Program Monitoring--Montenegro: Concluding Statement of the Mission

_IMF News, June 22, 2006_

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## Bibliographic details
- Published: June 22, 2006

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### Mission summary and context
- Mission type: Concluding Statement of IMF staff at end of the mission.
- Date: June 22, 2006.
- Core aim: Offer macroeconomic suggestions to capitalize on Montenegro's declaration of independence and to support sustained increases in economic growth, employment, and real incomes as a foundation for eventual EU accession.
- Positive developments noted:
  - Low inflation.
  - Public debt trending downwards.
  - VAT strongly underpins revenue.
  - FDI is up with more expected.
  - Banks privatized; credit is booming.
  - Preferential access to EU markets; prospects for SAA agreement, WTO, and PfP membership are good.

### A. Independence — legal and fiscal arrangements
- Immediate actions recommended:
  - Establish in Montenegro's own right agreements formerly held by Serbia and Montenegro on regional free trade, veterinary standards, double taxation, etc., to secure orderly economic conditions.
  - Clarify legal framework for economic relations with Serbia, including residency status, eligibility for social benefits, and work permits.
  - Consider a Free Trade Agreement (FTA) to secure continuation of prior trade arrangements.
  - Complete calculation of the former net fiscal transfer to the Union by subtracting costs the Montenegrin budget will now bear as Union functions shift to Montenegro; this will assist implementation of the 2006 budget and design of the 2007 budget.

### B. Medium-term policies — framework and reforms
- Monetary and external context:
  - Euro is sole legal tender; open capital accounts.
  - No independent monetary policy; domestic interest rates = euro area rates + "Montenegro risk premium".
  - Banking data suggest the Montenegro risk premium could be some 250-300 basis points currently.

- Flexibility: identified constraints and reform areas
  - Labor market:
    - High dismissal costs: 6 months of average salary.
    - High tax wedge: about 41 percent of total labor costs.
    - Inflexible employment contracts and wage determination mechanisms.
    - Recommendation: labor reforms including strengthened active labor market policies.
  - Corporate governance:
    - Privatization to strategic investors is key; envisaged sales should proceed swiftly.
    - Active use of exit mechanisms, notably bankruptcy, is recommended.
  - Financial sector:
    - Review arrangements for collateral assignation and collection.
    - Strengthen corporate accounting standards.
    - Continue efforts to bolster banking system, including additional foreign bank entry.
    - Forthcoming Financial Sector Assessment Program (FSAP) missions to assess further.
  - Automatic fiscal stabilizers:
    - Allow budget balances to weaken during downturns and strengthen during upswings to cushion cycles.

- Sustainability and the Montenegro risk premium
  - Market confidence in fiscal sustainability is key to a low risk premium.
  - Policies that raise the premium and borrowing costs can undo beneficial effects (including tax cuts).

- Fiscal anchor recommendation
  - Adopt a target for total budget sector debt covering:
    - Central government debts and arrears.
    - Municipalities.
    - Extra-budgetary funds.
    - Debts of public and municipal enterprises not run on a strictly commercial basis.
  - Target design:
    - Use a 5 year average relative to GDP (rather than a single-year target) to allow automatic stabilizers.
    - Set a separate target for public guarantees.
  - Proposed public debt target:
    - 35 percent of GDP on average between 2007-2011.
    - Assumptions underpinning target:
      - Strong structural reforms yielding average annual GDP growth of 5½ percent over 2007-2011.
      - Implementation of the second pension pillar.
      - Consistent with 3 percent per annum growth in real public spending.
      - Public debt below 30 percent of GDP in 2011.
      - Anticipates labor tax revenue reductions of over 2 percentage points of GDP due to rate cuts over that period.
    - Adjust the target mid-course if:
      - Privatization receipts from planned sales and second pillar costs differ markedly from projections.
      - Nominal GDP estimates are raised to reflect the grey economy.
      - Permanent unanticipated real external shocks occur.
      - Estimates of the initial debt stock alter.
    - Suggested action: adopt and announce this fiscal framework and target with the 2007 budget.

- Public debt stock and privatization receipts
  - Estimated public debt stock at end 2005: some €740 million (44.5 percent of GDP, including borrowing from banks and excluding debts of public enterprises).
  - Ongoing accounting may reveal more debt from restitution, military, and municipal liabilities.
  - Estimated prospective privatization receipts: well over 15 percent of 2006 GDP over the next five years.
  - International evidence cited: economic instability in developing countries with public debts above 30 percent of GDP underscores case for reducing debt.

- Pace of debt reduction considerations
  - If high-return public investment projects are ready now, debt trajectory should be back-loaded to allow implementation.
  - If implementation capacity is limited and privatization receipts are expected early, downward trajectory should be front-loaded.

- Financial sector assessment
  - Progress noted:
    - Sharp increases in private sector deposits.
    - Work underway on new banking law incorporating new standards.
    - Progress in strengthening risk-based supervision and compliance monitoring.
  - Concerns:
    - Accounting standards.
    - Possible deterioration in credit quality during recent credit boom.
  - Forthcoming FSAP mission will provide fuller assessment and policy recommendations.

- Statistical issues
  - Significant scope for improvement.
  - National accounts not available beyond 2003; external data unstable.
  - Strengthening national accounts data is urgent to reduce investor uncertainty and risk premium.

- Supply-side reforms
  - Key constraints to remove: state ownership, former-Yugoslav labor institutions, implicit energy subsidies, weak enterprise exit procedures.
  - Support for:
    - Ambitious program of privatization.
    - Modernization of labor legislation.
    - Improving public sector productivity.
    - Lowering tax burden, especially on labor.
    - Significant increases in public investment, coupled with increased capacity to design and implement capital projects.
  - Caution: privatization procedures should be efficient, fair, and perceived as such to avoid undermining investor participation.
  - Social considerations: provide social safety net for those adversely affected in the short term.

- Strategic choice regarding privatization receipts
  - Warning: using privatization receipts to postpone broader real and budgetary reforms will yield temporary public debt reductions and eventual fiscal sustainability problems when receipts stop; growth and employment performance likely to remain disappointing (Text Table 1).
  - Recommendation: accompany privatization with ambitious structural reforms and reductions in non-productive budget spending to secure permanent growth, robust real public spending growth, and reductions in the tax burden (Text Table 2).

### C. Economic outlook and policies for 2006-07
- GDP growth projections:
  - 2006: 5½ percent.
  - 2007: 6 percent.
  - Drivers: past structural reforms, exports, strong bank credit growth.
- Fiscal performance and 2006 indicators:
  - First quarter 2006 data show a surplus €15 million, largely due to strong VAT collections.
  - Suggested fiscal outcome for 2006: deficit outturn of 0.2 percent of GDP and an end-2006 public debt stock of 37 percent of GDP.
- 2007 budget guidance:
  - Budget should demonstrate commitment to a strong medium-term framework.
  - Accelerate preparations for key public investment in 2007.
  - Proceed with ambitious reform to personal income tax (PIT), but:
    - Estimated budgeted revenue loss from PIT reform: 1.8 percent of GDP.
    - Recommendation: match the 1.8 percent of GDP revenue loss with corresponding reductions in current expenditure.
    - Make appropriate arrangements for effects on municipalities of the PIT reform.
  - With public investment assumed at 3.8 percent of GDP in 2007, the budget should target a deficit of consolidated general government of 0.3 percent of GDP, consistent with the medium-term public debt target.
  - Structural reforms should commence vigorously alongside the budget.

- Policy objective:
  - Establish a high growth, high employment, low tax, low debt, and flexible economy led by the private sector.

### Key statistics and selected table figures
- Estimated public debt stock end-2005: €740 million (44.5 percent of GDP).
- Montenegro risk premium estimate: 250-300 basis points.
- Proposed medium-term public debt target: 35 percent of GDP (average 2007-2011).
- Privatization receipts estimate: well over 15 percent of 2006 GDP over the next five years.
- GDP growth projections: 2006: 5½ percent; 2007: 6 percent.
- First quarter 2006: surplus €15 million.
- Suggested 2006 fiscal outturn: deficit 0.2 percent of GDP; end-2006 public debt stock 37 percent of GDP.
- PIT reform estimated revenue loss: 1.8 percent of GDP.
- Assumed public investment in 2007: 3.8 percent of GDP.
- Target deficit for consolidated general government in 2007: 0.3 percent of GDP.

- Selected figures from Text Table 1 (No reforms scenario, percent of GDP unless noted):
  - Fixed investments (2005): 23.7
  - Revenues (2005): 40.1
  - Fiscal balance (cash, before grants) (2005): -1.9
  - Privatization revenues (2005): 9.9
  - Public debt (end of period, stock) (2005): 44.5
  - Average public debt 2006-11 (percent of GDP): 38.0 (memo)

- Selected figures from Text Table 2 (Reforms scenario highlights):
  - Average public debt (percent of GDP): 33.2
  - Real public expenditures growth (average 2007-11): 2.8

- Selected figures from Text Table 3 (Public Finance Budget Indicators, percent of GDP):
  - Revenue and grants (2003): 40.7
  - Of which: PIT (2003): 6.1
  - Expenditure (2003): 45.5
  - Of which: Wages (2003): 11.8
  - Cash balance (after grants) (2003): -5.4
  - Privatization receipts (2003): 2.4
  - Nominal GDP (2003): 1,392

*Source: Montenegro: Concluding Statement of the Mission (Article IV Consultation and Post-Program Monitoring), IMF, June 22, 2006.*

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## References

- [Montenegro and the IMF](http://www.imf.org/external/country/MNE/index.htm)
- [Serbia and Montenegro and the IMF](http://www.imf.org/external/country/SCG/index.htm)
- [Republic of Serbia and the IMF](http://www.imf.org/external/country/SRB/index.htm)
- [Mission Concluding Statements](https://www.imf.org/en/news/searchnews)
- [PRESS CENTER](http://presscenter.imf.org/)
- [Article IV](https://www.imf.org/external/pubs/ft/aa/aa04.htm)
- [Serbia](https://www.imf.org/external/np/ms/2006/062706.htm)
- [https://www.imf.org/en/home](https://www.imf.org/en/home)

_Source: https://www.imf.org/en/news/articles/2015/09/28/04/52/mcs062206_