Montenegro: Staff Concluding Statement of the 2017 Article IV Mission
IMF News, February 28, 2017
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- Published: February 28, 2017
Recent Developments and Outlook
- Mission dates: visited Podgorica from February 15 to March 1 to conduct the 2017 Article IV consultations.
- 2016 economic performance:
- Real economic growth in 2016 is estimated at a lower-than-expected 2.4 percent, partly due to a delay in the highway project.
- Private sector credit expanded by 6.4 percent.
- End-year inflation was low at 1 percent.
- The external current account deficit increased to 19 percent.
- Fiscal outcomes and composition in 2016:
- The estimated fiscal deficit of 5¼ percent of GDP was substantially smaller than expected, but the underlying fiscal position deteriorated.
- Capital spending was 5 percent of GDP instead of a previously projected 12 percent because of the highway delay.
- Current spending grew by more than 3 percentage points of GDP due to lifetime benefits to mothers of three or more children, public sector wage increases, and one-off transfers.
- The mothers’ benefit had a fiscal cost of 2 percent of GDP.
- Tax-to-GDP ratio increased by 1½ percentage points.
- Nontax revenues increased due to a one-time communications fee of 1½ percent of GDP.
- General government debt increased to 71 percent of GDP, (79 percent of GDP including guarantees).
- 2017 projections:
- Economy projected to expand by 3¼ percent in 2017.
- Highway spending expected to more than double to 6 percent of GDP; overall budget deficit in 2017 projected to increase to 7½ percent of GDP.
- General government debt likely to end 2017 at 75 percent of GDP (82 percent of GDP including guarantees).
- Credit to the private sector expected to increase by 5 percent.
- Inflation projected to increase by slightly less than 2 percent on average.
- Medium-term outlook and highway impact:
- Highway estimated cost of €1.0 billion (higher than initially expected due to exchange rate effects).
- Highway projected to increase 2023 GDP by about €150 million.
- Economic growth expected to average 3 percent over the next five years.
- Non-highway capital spending over the next five years may amount to some €125‑150 million (around 3½ percent of GDP) per year.
- Estimated environmental investment needs to meet EU standards possibly almost €1½ billion.
- Banking system efforts to reduce NPLs should position banks to support increased private sector lending.
- Low inflation in the euro area expected to help restrain price pressures.
The Need for Fiscal Adjustment
- Concerns:
- Very high highway costs will limit ability to undertake other important investments and expose the economy to risks.
- General government debt projected to increase to 82 percent of GDP by 2019 (89 percent of GDP including guarantees).
- Diminished capacity to respond to temporary external or domestic shocks due to high debt.
- Large projected government refinancing needs for maturing debt will require recourse to external markets and exposure to volatile international financial markets.
- Actions already taken and 2017 budget implications:
- Mission views 2017 budget as containing more than 2 percent of GDP in fiscal measures.
- Revenue-side measures: extension of the 11 percent rate for the personal income tax, an increase in gasoline excises, improvements in tax administration, and collections from a tax debt restructuring program.
- Tax debt program contains elements of a tax amnesty because it forgives interest.
- Expenditure-side measures: limited financial impact of the mothers’ law, reduced wages for senior public officials, and restricted non-highway capital budget.
- Authorities’ identified measures amount to 1½ percent of GDP.
- Authorities’ medium-term consolidation plan:
- Targeted a primary fiscal surplus of 3 percent of GDP for 2020 (authorities’ plan).
- Mission recommends a primary surplus target of 4½ percent of GDP for 2020.
- Mission estimates fiscal adjustment measures of 2¾ percent of GDP would be needed to reach the target—this is in addition to the 1½ percent of GDP in measures already identified by the authorities.
- As part of the fiscal adjustment strategy the mission recommends creating room for increased capital spending of ½ percent of GDP and well-targeted social spending of ¼ percent of GDP.
- Starting in 2021, the primary surplus could be reduced gradually while keeping debt on a downward trend.
- Debt could be lowered to 66 percent of GDP by 2022 (72 percent of GDP including guarantees).
Possible Measures for Fiscal Adjustment
- General approach:
- Major adjustment effort should be on the expenditure side.
- Public sector wage bill and pension spending are high by international comparisons and should be reduced over the medium term.
- Specific expenditure measures:
- Continue public administration reform focusing on right-sizing government employment and shifting towards merit-based pay.
- Constrain public wage increases until a comprehensive public administration reform can be adopted.
- Modify mothers’ benefit so mothers who left jobs are compensated in ways that encourage rejoining the workforce.
- Return mothers previously unemployed or retired to the social protection system (subject to means-testing) or the pension system, possibly giving an additional year of service for pension calculation.
- Improve targeting of the social protection system to better protect vulnerable populations and reduce labor market disincentives.
- Pension reforms suggested:
- Include pensions in the taxable base for the personal income tax to affect high earners.
- Pensioners could pay a health insurance contribution assessed against the amount that their pensions exceed the average pension.
- Support World Bank recommendations: increase the early retirement decrement (penalty), abolish eligibility for retirement with 40 years of service, reduce the early retirement period to 2 years, and make accelerated pensions contributions actuarially fair.
- Revenue-side measures:
- Introduce an excise on coal to internalize local pollution and global warming costs; excise should be introduced gradually and eventually raised to full level of associated externalities; increased cost of coal should be fully reflected in electricity prices; transitional arrangements for affected industries should be considered.
- Mission estimates preliminarily that local pollution cost of using coal is a multiple of its current price and its global warming cost is about half of its current price.
- Increase excises for cigarettes, alcohol, fuel products, and sugary drinks, bringing them in line with EU standards where applicable while ensuring they do not significantly exceed similar excises in neighboring countries.
- Raise tariffs for water and waste disposal to full cost recovery levels, including future costs of capital improvements; current tariffs do not even cover current maintenance costs.
- Work with multi-lateral and bilateral donors to mobilize resources for local infrastructure and environmental needs.
- Increase collections for value-based real estate tax by improving legal and administrative framework, including better databases and valuation, and potentially by raising rates.
- Move the lower VAT rate to half of the regular rate, and move VAT for hotel services and marina services to the regular rate.
- Raise the higher rate on personal income tax to 13 percent and extend it through 2022.
- Fiscal financing:
- Accelerate privatization program, including privatization of Montenegro Airlines and other public enterprises without a public policy function.
- Improve the debt repayment profile and continue developing local T-bill and longer-term bond market.
Financial Sector
- Recent conditions:
- Financial conditions improved during 2016.
- Banks are highly liquid and average capital ratios exceed regulatory minimums, with some variation across institutions.
- Profitability for most banks has increased but remains weak despite declining NPLs and high interest margins.
- Credit to the private sector has increased after shrinking for a sustained period but not as fast as might be expected given high liquidity.
- Constraints on credit growth:
- Problems with collateral execution, weak enterprise accounting practices (particularly in SME sector), and relatively high lending standards after high NPLs.
- Authorities’ policies and recommendations:
- Voluntary debt resolution framework (Podgorica approach) expected to be extended until 2018 and enhanced to include more classes of NPLs and provide greater incentives.
- Banks should be allowed to respond to market conditions without administrative interference; mission supports intention to move away from interest rate caps.
- Authorities implementing FSAP recommendations: improve management of nonperforming assets and liquidity risk, reduce operational risks, and limit funding and credit concentration risks.
- Authorities monitoring weaker banks and preparing resolution plans; drafting a new banking law and intend to introduce IFSR 9 regulations in 2018 to result in more stringent provisioning practices; requested Fund TA to help.
- Plan to roll out asset quality reviews in 2018/19.
- Consideration could be given to increasing minimum required capital to help banks realize economies of scale and promote competition.
- Financial stability concerns:
- Authorities need to be especially vigilant monitoring threats to financial stability in the absence of monetary policy tools and limited fiscal space.
- Fiscal retrenchment may hurt banks’ profitability; central bank should closely monitor impact on individual banks and the system.
- Banks with no access to emergency funding should receive particular attention.
- Drafting a bank resolution law where public financial support would be considered only after shareholder equity, hybrid capital, and subordinated debt are written off.
- Drafting a new financial institutions law to eliminate supervisory gaps.
Structural Reforms
- Labor market and informality:
- Authorities plan to revise labor law to increase labor market participation and encourage formalization of informal economy.
- Focus should be on increasing labor market flexibility, reducing informality, and improving the business climate (e.g., contract enforcement).
- Accelerate approval process for permits and licenses.
- Consider more active labor market policies to reduce long-term unemployment.
- Improve practical skills of university graduates to facilitate faster integration into the labor market.
- Broader measures:
- Public outreach to explain benefits from government spending could boost revenue and reduce the grey economy.
Source: Montenegro: Staff Concluding Statement of the 2017 Article IV Mission (IMF), February 28, 2017.