September 30, 2016
PRESS OFFICER: Wiktor Krzyzanowski
Phone: +1 202 623-7100Email: MEDIA@IMF.org
Macroeconomic developments have shown resilience to sustained uncertainties benefitting from accommodative policies, low oil prices, improving labor market conditions and robust external demand. However, the prolonged political crisis is starting to impact confidence and growth in the context of limited policy space. Policies should aim to pursue durable fiscal consolidation, maintain financial stability and address labor market and governance weaknesses.
The economy has endured a number of shocks, including a prolonged political crisis . Economic growth showed resilience through a series of crises in the last two years benefiting from accommodative policies, low commodity prices, sustained foreign investment and improving labor market conditions. However, the prolonged domestic political crisis is beginning to take a toll on confidence and the country’s EU accession prospects. An extended period of accommodative fiscal policy has helped support domestic demand, but has also depleted policy space to counter further shocks.
R ecovery from the global financial crisis has been solid, but growth has slowed down . Real GDP growth averaged around 2½ percent during 2010-15 compared to 4 percent during 2003-8 mostly reflecting a slowdown in potential growth as experienced by other countries in the region. Although contribution from capital has held up, lower contributions from labor and negative TFP growth is estimated to have nearly halved FYR Macedonia’s potential output growth in post-crisis years. High structural unemployment, low labor force participation and ageing population cast a lasting shadow on the longer-term economic outlook. As policy support and stimulus from infrastructure investment taper off, growth may lose steam unless reforms to improve productivity and labor’s contribution are put in place.
GDP growth is projected to soften in 2016 but pick up in the medium term. After strengthening in 2015, real GDP growth is projected to slow down to 2.2 percent in 2016 reflecting stalled investment and moderating credit growth due to political uncertainties. Assuming elections in December followed by stability, growth is projected to increase to 3.2 percent in 2017 with a gradual pick-up in the medium term benefiting from infrastructure investment, continued improvement in labor market and some strengthening of credit growth.
The positive outlook is highly contingent on the return of political stability and continued recovery in the Euro area . The recent agreement among main political parties to hold elections on December 11 is a welcome move but uncertainties remain. Restoring an effective political decision-making process is a prerequisite for decisively consolidating public finances and making the necessary reforms to raise the economy’s medium-term potential.
Against an unsettled political background and weaker growth, the mission saw three policy priorities.
Adopting high-quality revenue and expenditure measures to build fiscal policy space and enable public debt to remain below 50 percent of GDP
Maintaining monetary and financial sector stability
Improving the economy’s potential through labor market and governance reforms
Fiscal Policy
Fiscal policy space has significantly declined amidst rising risks. Public debt has more than doubled since 2008 and is projected to reach 48 percent of GDP this year. The fast rise in public debt is mostly due to rising primary deficits which, in turn, reflect a combination of low tax rates and low collection efficiency on the revenue side, and inefficiencies in social spending, transfers and subsidies on the spending side. For 2016, staff projects a widening in the overall fiscal deficit to 4 percent of GDP. In the medium term, without measures, overall fiscal deficit is projected to stay around 3½ percent with public debt reaching 55 percent of GDP. Meanwhile, high fiscal financing needs, rising borrowing costs and recent sovereign downgrading by Fitch have raised near-term fiscal risks.
P ublic finances also face long‑term challenges from population ageing. At 4½ percent of GDP, FYR Macedonia’s pension deficit is sizable. This reflects relatively generous benefits, low contribution rates and low labor force participation. Without reforms and with working age population set to decline, the pension deficit is projected to more than double by 2030. Population ageing is also likely to put pressures on health spending.
To create policy space and counter risks, f iscal consolidation should start without delay . For 2016, given the caretaker government and little time left in the year, a small consolidation of 0.4 percent of GDP is recommended relying on scaling back of goods and services spending and collection of VAT arrears. This would bring the overall deficit for 2016 to 3.6 percent of GDP. For 2017 and 2018, assuming parliamentary elections in December and resumption of stability thereafter, the mission recommends a reduction in the overall fiscal deficit to 2½ percent and 2 percent of GDP respectively to stabilize public debt below 50 percent of GDP. Any negative impact of recommended consolidation on private sector is expected to be offset by continued structural reforms to improve labor market conditions and attract FDI as well as monetary accommodation.
M edium-term fiscal consolidation should rely on high-quality measures. In the last two years, the cyclically-adjusted fiscal balance has seen some improvement but mostly relying on under-execution of capital spending. To produce durable results and enhance confidence, particularly in light of the authorities’ intention to introduce a fiscal rule, it would be important to base consolidation on high-quality measures. On the revenue side, this entails raising collection by strengthening coverage, targeting compliance risks, improving the operation of large tax payer office, and establishing a Risk Management Unit. On the expenditure side, a reduction of subsidies and transfers together with greater efficiency in health and education spending would yield the required savings.
Reforms to rein in the sizable pension deficit are warranted . The authorities are encouraged to consider the following options as a means of to ensure long-sustainability of the pension system (i) raise statutory retirement age given the sizable gap with the EU average; (ii) consider revising indexation to CPI in line with many countries in the EU; (iii) implement reforms to increase labor force participation, particularly that of women (one of the lowest in Europe), and (iv) consider increasing contribution rates if sustainability is not secured through other measures.
Monetary and Financial Policies
Current monetary policy stance is appropriate. Low interest rates have helped sustain robust private sector credit growth without jeopardizing external stability. The current account deficit has narrowed significantly in recent years benefitting from low oil prices and strong exports. Price- and cost-based assessment of competitiveness also point to soundness. Given still-negative output gap, low core inflation and moderate real exchange rate undervaluation, historically low policy rate remains appropriate. However, in case of pressures on the exchange rate or the risk of deposit outflows, policy responses similar to those undertaken in April may be needed to ensure financial stability. Offical reserves remain adequate and are projected to improve in the medium term on the back of improving trade balances, continued FDI and other financial inflows.
Strong household credit growth has sustained financial deepening. Given that the pre-crisis credit boom was mostly financed by domestic deposits, post‑crisis resumption of credit growth has been more resilient compared to others in emerging Europe that faced deleveraging by parent institutions. However, credit to nonfinancial corporates remains weak reflecting prolonged uncertainties as well as structural impediments such as high collateral requirements.
Banking sector remains sound . Banks are well-capitalized, with the capital adequacy level twice as high as the regulatory requirement. The NPL ratio fell to 7 percent in July reflecting recent measure to write off NPLs that were fully provisioned and had been in the banks’ balance sheet for more than two years. Banks’ profitability continued to improve in light of strong growth in net interest income. Structural liquidity in the banking system remains ample and, according to NBRM’s latest stress tests, provides strong buffers to withstand severe deposit outflow shocks.
Structural policies
U nemployment rate has significantly declined in recent years. Benefitting from active labor market policies and broad-based growth, overall unemployment rate has declined by 10 percentage points since 2008. However, the unemployment rate at 24 percent remains very high reflecting skill shortage arising from emigration of skilled workers and low overall level of education. Labor force participation rate has however declined in recent years, particularly for young workers. With declining contribution of labor to growth and ageing population, low participation rates are a drag to long-term outlook.
Notable FDI inflows in the last decade have supported investment and exports although spillovers into domestic economy remains limited . Competitive wage and generous financial benefits have attracted sizable manufacturing FDI into FYR Macedonia since late 2000s. However, contributions to value added and employment, though increasing, is considered to be modest reflecting skills shortages and inability of local producers to meet technical and safety requirements. Examples of successful FDI- and export-led growth in Central European countries highlight the need to increase domestic value added over time to sustain interest of foreign investors and contain costs from financial incentives.
Futher efforts should aim at improving technical skills and increasing labor force participation. Policies to support on-the-job training and vocational education are bearing fruit and should continue although being mindful of fiscal costs. Increasing labor force participation, particularly that of young and female labor force, would help improve potential growth.
To enhance private sector’s role in the economy, it is critical to address judiciary and governance weaknesses . Frequent legal changes, uneven implementation of laws and difficult contract enforcement continue to burden domestic private sector despite improving business regulations. The European Commission’s most recent assessment highlights concerns about excessive political interference in public administration and judicial system. Addressing these weaknesses would increas trust in domestic institutions and policy making, and boost jobs growth via skills retention and higher investment.
The IMF team expresses its appreciation for the authorities’ cooperation and candid discussions.
