Press Release No. <a name="P16_75"></a>05/173

The following statement was issued today in Podgoriza by an International Monetary Fund (IMF) mission:

"The IMF mission visited Podgoriza from July 23-26 to review economic developments and the implementation of the government's economic program. The mission met with the President of the Republic, the Prime Minister, the Vice President of Parliament, several Cabinet members, representatives of the Central Bank, enterprises, and unions. Against the background of favorable economic developments, the implementation of the program seems broadly on track. The mission urged the authorities to take decisive steps to improve the competitiveness of the economy and to maintain a prudent fiscal policy to ensure macroeconomic stability.

"Economic developments have been broadly favorable. Various indicators suggest a continuing modest growth in the economy. In particular, the tourism industry is likely to have another good year. Inflation has remained at about 3.5-4 percent on a 12-months basis, and preliminary data for the first 5 months point to an improving current account deficit, albeit it remains at an unsustainably high level. The confidence in the banking sector is strengthening, as indicated by strong growth in deposits. However, competitiveness is of some concern.

"The mission commended the authorities for the good execution of agreed economic policies so far, in particular the budget, but challenges remain. Looking ahead, it is important that the government continues to maintain a conservative fiscal stance during the rest of the year and in 2006, and makes further progress towards lowering the size of the public sector. To lower current spending and create room for capital outlays, civil service reform and reductions in public employment should be stepped up and wage increases kept moderate. Furthermore, to ensure a well-prioritized use of the large privatization revenues, evaluation, prioritization, and medium-term planning of investments needs strengthening. To reinforce financial supervision, the Banking and Insurance Laws should be submitted to Parliament making good use of the existing institutional experience and capacity of the Central Bank.

"Specifically, the mission sees three main near term challenges for economic policies.

• To boost growth, competitiveness needs to be strengthened. As productivity remains modest, pressures to increase the minimum wage can be problematic, because many other wages, including the whole public sector wage structure, are linked to the minimum wage. Apart from potentially adverse consequences for competitiveness, this would put pressure on public finances. As the public sector wage bill is already too large as a share of the economy (close to 10 percent of GDP), real increases in the average wage would need to be financed by cuts in the level of public sector employment. Competitiveness can also be boosted by measures linked to increasing productivity. In this, workers training and retraining programs to equip people with the necessary skills in the work place, and improving the business climate to attract more private investment are important. Furthermore, broadening the agenda for privatizations should help in this.

• A wise use of the large privatization revenues remains a challenge. To further stabilize the current account, the government should continue to reduce the fiscal deficit. In this context, higher investment spending requires commensurate cuts in current spending. Furthermore, to ensure that money is well spent, it is important to prioritize investment projects according to economic return and to assess their medium-term impact in terms of future spending commitments. Technical capacities in this area need to be strengthened.

• A fiscally sustainable clearance of arrears is another difficult issue. The government has prepared an inventory of spending arrears, but a program commitment to agree on a strategy for their reduction has not yet been done. While it is commendable to use the privatization revenues to reduce debt, the government needs to be cautious about the demand impact of such steps and arrears reduction needs to be properly accounted for in the budget. Any pressures to increase the wage bill makes this task even more difficult."