November 18, 2019
PRESS OFFICER: Wafa Amr
Phone: +1 202 623-7100Email: MEDIA@IMF.org
With strong determination, the authorities have revived the reform momentum in recent years. Crucial institutional and governance reforms have demonstrated their commitment to tackle long-standing challenges. Moreover, the frameworks for pension and social spending have been strengthened, and taxation was made more equitable, improving the sustainability of public finances. Through these actions, the authorities have gained substantial policy credibility and the economy has rebounded.
It is essential to stay on the path of reform to further bolster the economy’s resilience to shocks and durably raise income levels. This will help retain policy credibility. IMF staff recommend using this period of solid growth to rebuild fiscal space, in order to strengthen the economy’s ability to cope with future shocks. In this context, plans to modify elements of the recent fiscal reforms could undermine some of the gains that have already been achieved. Going forward, speeding up income convergence and improving living standards will necessitate a more growth-enhancing fiscal policy mix and an unwavering commitment to the ambitious structural reform agenda.
Speeding Up Income Convergence and Improving Living Standards
After a protracted political crisis, the economy entered a period of solid growth and stability. After a temporary slowdown in 2017, growth recovered in 2018 and is expected to strengthen further this year, driven by strong domestic demand and robust export growth despite the global trade slowdown. Credit has picked up, including to firms, and inflation remains low. Unemployment, though still elevated, has seen a sustained decline, supported by strong job creation.
Growth is expected to accelerate to 3.4 percent in 2020, reflecting a temporary boost from the 2020 budget and higher wages. Lower taxes and higher pensions and wages―including public sector and minimum wages― are expected to provide a further, albeit one-off, stimulus to consumption. Export and investment growth would remain robust but slow somewhat, reflecting weak growth in trading partners. This moderation could become more pronounced if global trade tensions worsen or investment plans are delayed due to uncertainty during the election period.
Reforms to address key labor market and institutional weaknesses will help lift medium-term growth and speed up income convergence. Although growth has been solid in the past two decades, it has not been enough to substantially narrow North Macedonia’s large income gap with the EU. To accelerate convergence, it is essential to continue reforms to improve the public administration, rule of law, and control of corruption. This should be complemented by efforts to build physical capital given infrastructure gaps and to boost human capital to address skills shortages and mis-matches, including through vocational education and training and more use of skill-enhancing active labor market policies. Higher income levels, better employment opportunities, and stronger institutions would likely also help retain skilled workers in the country.
The minimum wage is set to increase rapidly compared to labor productivity. The net minimum wage will grow by 45 percent cumulatively since 2017. It will increase to above 50 percent of the average wage, which is high by regional standards. A higher minimum wage can help reduce poverty among employed persons. However, the incidence of poverty is much higher for those that are not employed. Increasing the minimum wage may therefore not be effective in reducing overall poverty, especially if it were to diminish formal employment. Staff recommend preserving competitiveness by aligning the minimum wage closely with productivity, while ensuring that it is fully enforced.
Ensuring A More Growth-Friendly Fiscal Policy Mix
Staff expect the fiscal stance to ease in 2020. On the spending side, the proposed 2020 budget envisages an additional increase in pension benefits linked to wage growth, by altering the CPI-only indexation adopted in 2018. The already adopted VAT reimbursement (MyVAT)—intended to enhance revenue collection—will add to spending. The proposed rollback of the progressive personal income tax rate and capital gains tax will slow down revenue growth. At the same time, higher social security contributions will generate additional revenues. On a preliminary basis, staff project the fiscal deficit to widen to 2.5 percent of GDP in 2020, from 1.8 percent in 2019.
Against a backdrop of solid growth, staff recommend re-building fiscal policy space. A cumulative consolidation of 1½ percent of GDP over 2020-22, compared to staff’s baseline projections, would achieve primary budget balance and ensure that there is policy space to act in an economic downturn. The consolidation should be achieved through steadfast implementation of already approved reforms to pensions and personal income tax, as well as enhanced revenue administration and rationalization of agricultural subsidies. These measures would also make space in the budget to increase capital expenditure as needed to narrow the investment gap.
Re-orienting public spending toward investment would strengthen medium-term growth prospects. The proposed increase in current spending is likely to reduce the scope for essential public investment. Considering the country’s large investment needs, staff recommend re-orienting public spending toward investment. This should be underpinned by measures to strengthen the public investment management framework, including better prioritization and addressing bottlenecks in execution of planned projects. To safeguard against fiscal risks from Public-Private Partnerships, staff recommend waiting to approve new projects until a strengthened framework is in place.
Reforms to tackle informality will help improve the business climate and protect workers, with potential large revenue gains. This is high on the government’s agenda. Informality is detrimental because formal businesses face unfair competition from the ones that do not pay taxes or comply with regulations, informal workers are deprived of many labor rights, and public resources are reduced. Strengthening revenue administration efficiency and compliance should be the priority, combined with measures that raise public trust in institutions and tax morale.
Bolstering Monetary and Financial Stability
The monetary policy stance remains appropriate. The National Bank of the Republic of North Macedonia (NBRNM) has appropriately used the favorable conditions to accumulate reserves within the de-facto exchange rate peg. While reserve coverage is broadly adequate, they should continue building buffers against possible shocks. Going forward, should the external environment worsen, the central bank should stand ready to tighten monetary policy.
The banking system is healthy, but efforts are needed to further mitigate credit risk. The banking system is well capitalized and liquid. Two ongoing bank mergers and acquisitions will help consolidate the system and improve efficiency. Steps to further increase deposit denarization, coupled with carefully calibrated measures to curb foreign currency lending to households, if needed, would help strengthen financial system resilience. Amid continued high credit growth to households, closer monitoring, including by collecting granular household data, is warranted.
Further strengthening the financial stability framework remains a priority . In line with the recommendations of the 2018 Financial Sector Assessment Program, the authorities have started to enhance the supervisory and regulatory framework, including by enhancing banks’ liquidity risk reporting and increasing the supervisory intensity for domestic systemically important banks. Legislation is being prepared to strengthen the macroprudential mandate of the NBRNM, to be accompanied by better systemic risk identification. Further progress is needed on the financial safety net, by introducing a comprehensive bank resolution framework and buttressing the deposit guarantee scheme.
The team is grateful to the authorities and other counterparts for their hospitality and the constructive dialogue.
