Press Release No. 13/272

Press Release: IMF Executive Board Concludes 2013 Article IV Consultation with the Republic of Kosovo

July 23, 2013

On July 15, 2013, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Kosovo.¹

Kosovo’s economy has displayed resilience in the face of headwinds from the global financial crisis and euro area turbulence. Since the onset of the financial crisis in 2007, annual real GDP growth has never been less than two percent, and has averaged
4½ percent between 2007 and 2012, one of the highest growth rates in the region. The resilience owes primarily to the near-absence of financial or export linkages to crisis countries, and Kosovo’s exposure instead to Germany and Switzerland, countries in which two-thirds of the Diaspora reside. Remittances and FDI from the Diaspora have held up well, and have therefore continued to support domestic demand and finance a wide trade deficit. Unemployment remains very high at around 35 percent, although much of it reflects arguably informal employment.

Consumer price inflation has moved in line with import prices, notably for food, but core inflation has remained contained at around 2 percent, consistent with Kosovo’s unilateral adoption of the euro. The banking sector has remained liquid, profitable, and well capitalized, although financial strength differs across banks.

In the past two years, macroeconomic policies have been conducted in the context of a Staff-Monitored Program (in 2011) and a Stand-By Arrangement (from 2012). In this period, the authorities have restored a sustainable fiscal stance, improved the preparation and costing of spending initiatives, and strengthened the financial safety net. From 2014, fiscal policy would be anchored by a rules-based fiscal framework, expected to be enacted in July of this year. Further, the government is on-track to restore its cash buffers, provided the sale of the telecommunications company PTK proceeds as planned later this year. The authorities have also taken initiatives to strengthen competitiveness and enhance public infrastructure. The Stand-By Arrangement—that the authorities are treating as precautionary in 2013—expires toward the end of the year.

Executive Board Assessment

Executive Directors commended Kosovo's resilience to external turbulence, owing mainly to prudent policies and robust remittances and FDI inflows from the diaspora. Directors noted that looking ahead, it will be important to reduce dependence on these inflows and develop a robust tradable sector that can support self-sustained growth.

Directors welcomed the efforts to enhance competitiveness. They encouraged continued commitment to improving the business climate, strengthening investments in public infrastructure and education, and increasing regional integration. Maintaining wage restraint and flexible labor markets and initiatives to support small- and medium sized enterprises will reinforce these efforts.

Directors recognized the important steps taken by the authorities to restore fiscal sustainability. The challenge ahead is to preserve this strength while addressing pressing social and capital spending needs. In this context, Directors welcomed the development of a rules based fiscal framework that will anchor fiscal policy from 2014. They stressed that careful budgetary planning and costing of spending initiatives, while resisting ad hoc spending pressures, will remain critical.

Directors considered the heavy reliance on indirect taxes to be appropriate given the economy's transfer dependent structure. However, they emphasized that revenue policy would need to adjust as Kosovo integrates more closely with its neighbors and as the growth model shifts from dependence on transfers to domestic production. Directors agreed that the government's bank balance with the central bank needs to be guarded carefully as a critical prudential buffer to insure the economy against fiscal and financial shocks.

Directors noted that the banking system is liquid, profitable, and well capitalized. They also noted with satisfaction progress made with implementing key FSAP recommendations. To promote further financial sector development, Directors saw a need to strengthen the legal and institutional environment, in particular to expedite contract enforcement by the judicial system. To further reduce risks in the banking system, Directors recommended a gradual move to comprehensive risk based supervision, the development of a macro prudential policy framework, and the creation of a permanent funding mechanism for the special reserve fund for emergency liquidity assistance.