3 Recent Economic Trends and Policies
Author: Ms. Davina F. Jacobs and Mr. Johannes Herderschee
Language:
English
Keywords:
BOOK; Kosovo's economy; UNMIK; Kosovo; economy from poverty; institution building; deutsche mark; UNMIK regulation; GDP estimate; pillar II; revenue performance; Budget planning and preparation; Public enterprises; Capital spending
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Abstract

The productive capacity of Kosovo had been severely degraded during the 1980s and 1990s. Like the rest of Serbia, the province had suffered from the breakup of the former Socialist Federal Republic of Yugoslavia and the associated conflicts, as well as the economic mismanagement of the Federal Republic of Yugoslavia during the 1980s and 1990s (Table 1). Especially after 1989, when the autonomy of Kosovo within the Republic of Serbia was suspended, the province experienced massive disinvestment. Operations and maintenance in industry and infrastructure were neglected. As a result, estimates based on official data suggest that industry collapsed and real output contracted in the early 1990s.

Production, Income, and Poverty

The productive capacity of Kosovo had been severely degraded during the 1980s and 1990s. Like the rest of Serbia, the province had suffered from the breakup of the former Socialist Federal Republic of Yugoslavia and the associated conflicts, as well as the economic mismanagement of the Federal Republic of Yugoslavia during the 1980s and 1990s (Table 1). Especially after 1989, when the autonomy of Kosovo within the Republic of Serbia was suspended, the province experienced massive disinvestment. Operations and maintenance in industry and infrastructure were neglected. As a result, estimates based on official data suggest that industry collapsed and real output contracted in the early 1990s.

TABLE I

Sectoral Investment Flows

(In percent 1971 = 100)

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Source: Riinvest estimates, based on official data.

The 1999 conflict caused additional destruction of economic infrastructure and severe loss of human capital. Two-thirds of the homes were severely damaged or destroyed; 40 percent of water sources were contaminated; bridges, roads, and other infrastructure suffered wartime damage; and large areas of the countryside were mined. Perhaps more importantly, the conflict and its aftermath caused a significant outflow of Kosovo’s human capital. Before the war, most managerial and professional positions had been held by Serbs. The subsequent expulsion of a large number of Serbs left the province with a severe shortage of educated and skilled workers and professionals.

The dearth of economic statistics precludes an accurate assessment of the current economic situation. There are no official statistics on any macroeco-nomic aggregates, including national accounts, inflation, trade, and other financial flows with the rest of the world. The Statistical Office of Kosovo is building up its operations with technical assistance by donors, but its output is thus far limited to vital statistics for the population, a business registry for large firms, and monitoring of farmgate food prices. A living standards survey in cooperation with the World Bank and the first business survey are also being finalized. In the meantime, other sources of data are scarce and coverage is fragmentary. The exception is public finances, where accurate statistics are available for the central government.

Preliminary staff estimates suggest that GDP amounted to DM 2.75-3.25 billion (US$700-800 per capita) in 2000. National accounts estimates by IMF staff (Table 2) are little more than guesses based on fragmentary information and supplemented by anecdotal evidence. The GDP estimate is almost identical to that made earlier by staff for the same year, 3 but incorporates lower figures for private consumption, based on a recent World Bank household consumption survey, and higher figures for private investment. Appendix II explains in detail these estimates and the source data.

TABLE 2

GDP and National Income

(In millions of deutsche mark, unless otherwise indicated)

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Sources: Central Fiscal Authority (CFA), Banking and Payments Authority of Kosovo (BPK), UNMIK departments; and IMF staff estimates.

All indicators show economic activity rebounding strongly in 2001, with real GDP growth well into the double digits. Reconstruction of buildings and infrastructure is evident everywhere; anecdotal evidence suggests that the 2001 harvest was perhaps 20-30 percent higher than in the previous year, as land was cultivated once again and agriculture recovered from a drought; the provision of public services is slowly improving; and there is a vibrant private service sector. Industrial production has yet to recover, but there are indications of light manufacturing activity—agricultural processing, machine parts, soft beverages—some of it associated with exports to the rest of the Federal Republic of Yugoslavia. Although domestic food prices remained fairly stable during the first part of 2001, reflecting increased supply, other prices have reportedly increased faster, and the GDP deflator is estimated by IMF staff to have risen by some 8 percent. 4 As a result, GDP in 2001 is estimated at DM 3.5-4 billion (US$850-950 per capita).

This level of activity, and the even higher level of disposable income and consumption, reflects the magnitude of foreign assistance. As Table 2 shows, the structure of GDP is very distorted. In 2001, gross national disposable income is estimated at about 172 percent of GDP, merchandise imports at about 75 percent of GDP, and consumption about 120 percent of GDP (or US$1,000-1,100 per capita). This was made possible by the extraordinary amount of foreign transfers from official sources, as well as from Kosovars abroad. Staff estimates show that official transfers amounted to DM 1.5 billion in 2000 and DM 1.6 billion in 2001, most of it for reconstruction (Table 3).

TABLE 3

Balance of Payments

(In millions of deutsche mark, unless otherwise indicated)

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Sources: Central Fiscal Authority (CFA), Banking and Payments Authority of Kosovo (BPK), UNMIK departments; and IMF staff estimates.

Excluding services provided by nonresidents living in Kosovo, which are paid by foreign donors.

including transfers effected earlier but deposited in the banking system during 2000 and 2001.

Transfers associated with the activities of KFOR are not included in these figures. Private transfers, on which there are no firm data, are estimated at an additional DM 750-850 million each year, and are used to finance private consumption or repairs of private homes. These transfers covered the large trade deficit. Finally, the sizable presence of expatriates in Kosovo also helped shore up demand for local goods and services and support private consumption. Although firm data are not available, there are currently about 10,000 UNMIK staff in Kosovo; an estimated 5,000-10,000 expatriates working for various other agencies and nongovernmental organizations; and perhaps 40,000 KFOR troops.

Poverty in Kosovo is widespread but relatively shallow. A World Bank assessment for 20005 suggests that about half the population of Kosovo had consumption levels below the poverty line. However, the size of the poverty gap indicates that the depth of poverty was small: the consumption levels of the poor needed to rise on average by less than 16 percent (or about DM 17 per month per person) for poverty to be eliminated. Moreover, the relatively flat distribution of income (an estimated Gini coefficient of 29 percent) makes the distinction between poor and nonpoor households in Kosovo very blurred. Extreme poverty was relatively limited: the share of people in this category was less than 12 percent. The assessment also found that donor assistance and, in particular, food aid in the postconflict period had been quite successful in mitigating poverty in Kosovo.

Public Finances

Although the CFA has established proper budgetary procedures, the management of the finances of the general government sector is fragmented, and reporting and accounting standards are uneven. The budgetary structure is presented in Box 2. The CFA has introduced a basic tax system, effective expenditure control mechanisms, and transparent accounting in the central government. However, reporting and accounting standards in the municipalities and public enterprises are much weaker. Also, the Kosovo consolidated budget so far covers mainly recurrent spending; the bulk of investment spending is financed by donors and managed separately by the Department of Reconstruction.

Given the low revenue base and UNMIK’s inability to borrow, fiscal policy has very limited room for maneuver and depends heavily on foreign grants. Total revenue amounted to some 24 percent of estimated GDP in 2001, of which some 60 percent was collected at the border because, despite recent improvements, domestic compliance is very weak. The main revenue sources of the Kosovo consolidated budget have thus far been an excise tax on oil products, a 10 percent import duty, and a VAT that replaced a tax on business turnover in July 2001 (Table 4). There are no direct taxes, although there are plans to introduce taxes on wages and profits in 2002 (for details on the current tax system and plans, see Appendix III). Expenditures, on the other hand, including for reconstruction, amounted to just under 60 percent of estimated GDP in 2001. 6 The gap was covered by donor grants (Table 5).

Budgetary Structure

General Budget: Recurrent costs of government; admistered by the CFA; financed by local revenue and foreign grants

Kosovo Consolidated Budget: General budget +municipalities + public enterprises; monitored by the CFA; financed by local revenue and foreign grants

Major Off-Budget Items:

  • Reconstruction: capital spending; administered by the Department of Reconstruction; financed by foreign grants

  • UNMIK: salaries of UNMIK staff; administered by the UN; financed by the UN and donors

  • KFOR: admistered and financed by the UN; financed by the UN and donors countries

TABLE 4

Consolidated Budget

(In millions of deutsche mark)

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Source: UNMIK;and IMF staff estimates. Budget as revised in November 2001.

Budtet as received in November 2001.

Due to a devolution of responsibility for education and health spending to municipalities, with a consequent increase in transfers from the consolidated budget.

Own revenues include only revenue raised directly and paid over to the Kosovo Central Bank.

Includes only current expenditure of public enterprises.

TABLE 5

Overall Fiscal Position

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Source: UNMIK;and IMF staff estimates.

Budtet as received in November 2001.

Kosovo reconstruction budget and capital expenditure by public enterprises

Donor support for recurrent spending declined in 2001, but this was offset by improved domestic revenue performance. The 2001 budget envisaged about one-third of recurrent expenditure to be financed by donor grants (DM 162 million, primarily from the European Union), down from about one-half in 2000. In the event, revenue performance was much better than expected due to the rapid growth in activity and improvements in tax and customs administration. For the year as a whole, general budget revenue is estimated at DM 573 million, compared with an original budget target of DM 338 million. This enabled the CFA to revise its budget targets in November, allowing for an increase in current spending limits of DM 63 million and allocating the rest of the unanticipated revenue to building cash reserves.

The 2002 budget projects a further significant increase in revenue to DM 682 million on the basis of rapid growth in activity, further improvements in efficiency, and the introduction of taxes on wages and profits. On the financing side, the budget projects a fall in donor support for both recurrent and reconstruction spending: the former is expected to be limited to DM 50 million in 2002. This sets the envelope for expenditures. Within this envelope, the 2002 draft budget shifts priorities toward a number of one-off outlays associated with the new assembly and the expected decline in the number of UNMIK international staff, and includes an increased allocation for capital spending. Current spending is also projected to grow significantly, in part through higher transfers to municipalities, reflecting the devolution of responsibility to local governments for the provision of certain services. These services include primary health care, education, and the maintenance of restore roads. As a result, spending by the central government in these areas is projected to decline. UNMIK is planning a review of staffing and wages in its administration during 2002 to rationalize and increase the transparency of the system. Reconstruction spending projections show a marked decline in 2002, reflecting the expected decrease in donor transfers for investment projects. To facilitate better planning and coordination of the recurrent and reconstruction budgets, the CFA is currently working toward consolidating the two budgets, in line with earlier IMF and World Bank recommendations.

The performance and management of public enterprises is very uneven and raises questions about their governance. The main public enterprises are the electricity generation and distribution company; the posts and telecommunications company; Pristina airport; Kosovo railways; and a number of local water, waste, and heating companies.

  • The Kosovo Electricity Company (KEK) has major engineering and management problems-Its two thermal generators are old and prone to failure- About one-third of total electricity generated by the company is lost due to technical problems or theft, and less than half of the remaining output is paid by the consumers- With about 10,000 employees, the company is overstaffed. As a result, KEK has been a drain on the budget- Emergency repairs and stricter oversight by UNMIK have improved performance somewhat- However, KEK is still not able to generate enough electricity to meet domestic needs, and blackouts are frequent.

  • Posts and Telecommunications of Kosovo (PTK) is quite profitable as a result of its monopolistic position and a concession to a foreign company to operate a mobile telephone network- Indeed PTK appears to have been the single source of the sizable accumulation of deposits in the public enterprise sector during 2000-01 (TABLE 4) - However, the company suffers from serious internal accounting problems: its financial operations are not transparent, oversight by UNMIK is weak, and reporting to the fiscal authorities is deficient.

  • Although not a public utility, the Trepča mining complex is a drain on the budget. A vertically integrated conglomerate, including mining, smelting, processing, etc., Trepca has about 4,000 workers on its payroll, down from about 10,000 original employees, and currently operates at minimum capacity. UNMIK has estimated the immediate costs of revitalization at about DM 100 million, but it is unclear which parts of the company, if any, are viable in the long term. Also there is clearly a limit to the extent to which the budget can continue subsidizing the mining sector, and the fact that the company’s activities are largely in the Serb enclaves makes this a politically sensitive issue.

A new social security system is slated for introduction in 2002. Kosovo so far has not had an indigenous social security system, and "right"s accumulated under the old Yugoslav system cover only a small part of the population. UNMIK designed a three-tier system, and the regulation was signed into law in late December 2001. The new system is designed to provide a minimum social safety net for the elderly population through a universal basic citizens’ pension (first tier) and to create a mandatory, fully funded system for new contributors (second tier). The system also allows private pension funds to be created on a voluntary basis (third tier). The first tier will be funded through general budget revenues. Because of the phased introduction of the new system during 2002, the impact on the 2002 budget is expected to be DM 43 million.

The Financial Sector

The banking system is in a state of infancy. At the end of the conflict, financial intermediation in Kosovo was nonexistent and virtually all transactions were settled in cash. Although this is still largely the case, banking activity started in earnest in late 2001 and was spurred by the replacement of the deutsche mark by euros in 2002. There are currently 7 licensed banks and 15 microfinance institutions operating in Kosovo. Two of the banks and most of the microfinance institutions were created and financed by donors and, with one exception, are very small: the aggregate balance sheet of the commercial banks at end-December 2001 was DM 982 million. The exception is the Micro-Enterprise Bank, a foreign-owned bank partly capitalized by the European Bank for Reconstruction and Development and the International Finance Company, which accounts for more than half of the aggregate balance sheet of the banking system. Bank deposits amounted to DM 935 million (about one-quarter of estimated GDP), and bank loans to the private sector were just DM 48 million (Table 6), with the microfinance institutions providing an additional DM 29 million of loans, most of which were to finance trade and services. Most of the increase in deposits occurred in the last three months of the year as a result of preparations for conversion to the euro.

TABLE 6

Commercial Bank Balance Sheet

(In thousands of deutsche mark)

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Bank supervision is strong. UNMIK regulations promulgated in November 1999 with IMF technical assistance established a framework for licensing, regulating, and supervising banks. The BPK has since built a small but strong supervisory team, staffed largely by international staff.

Although the BPK is operationally independent, it depends on the budget for financial support and suffers from internal accounting problems. Its dependence on budgetary transfers to finance its operations reflects the absence of seigniorage from the issuing of currency; a low level of capitalization; and high operating costs: the BPK maintains 29 branches partly due to the lack of commercial bank branches in many locations- Moreover, the BPK has been plagued by internal accounting weaknesses.

In the insurance sector, an inadequate legal framework, the absence of supervision, and UNMIK’s slow response to a festering problem led to a crisis. In November 1999, UNMIK promulgated a legal framework for third-party motor vehicle liability insurance that did not set adequate prudential requirements and did not provide for supervision-Following this, five insurance companies quickly emerged. Their operations gradually raised concerns about their solvency and allegations of extortion and criminal activity. Only in October 2001, however, did UNMIK pass a new regulation and hand over the responsibilities for licensing and supervising the insurance industry to the BPK (Box 3), which is in line with international best practice.

Chronology of Developments in the Insurance Sector

November 1999. NMIK decides to make thirdparty motor vehicle liability insurance mandatory and issues an administrative order setting the requirements for licensing insurance companies: DM 5 million of capital (could also be a commercial letter of credit), reinsurance arrangements, and adequate staff. No prudential standards are specified, and no supervisory agency is set up (UNMIK’s Pillar II is responsible for licensing insurance companies, but without specialized staff). Five insurance companies are quickly set up.

April 2000. In the face of complaints about business practices, UNMIK issues a second administrative order specifying minimum premiums, commissions, and maximum discounts allowed for car insurance contracts. In response to this administrative price setting, illegal practices multiply, allegedly including extortion and criminal activity.

July 2000. The co-owner of an insurance company applies for a banking license, and the BPK discovers that he is not fit and proper for a financial institution.UNMIK begins to realize the extent of the problems in the insurance sector.

October/November 2000. UNMIK requests financial information from the insurance company, which the company refuses to provide. UNMIK’s legal adviser confirms that, under the existing legal framework, the company is under no obligation to report financial information. UNMIK and the BPK decide to draft a new insurance regulation and ask for donor assistance. In the meantime, insurance companies continue to issue policies under the existing framework.

May 2001. With the new regulation still in the drafting stage, UNMIK renews the licenses of the existing insurance companies for three months, under the condition that they undergo an audit of their financial activity. By the end of July 2001, about 189,000 policies have been issued, yielding premium income of DM 67 million (about 1 1/2 percent of estimated GDP).

September 2001. With the draft of the new regulation still under review, UNMIK again extends the licenses of the insurance companies, under the condition that they deposit 40 percent of unearned premiums with the BPK. At the same time, the BPK starts the process of evaluating the audits in order to assess the state of the existing insurance companies and to determine any necessary remedial measures.

October 2001. The new regulation is promulgated, and insurance supervision passes to the BPK.

3

R. Corker, D. Rehm, and K. Kostiel, Kosovo: Macroeconomic Issues and Fiscal Sustainability (Washington: International Monetary Fund, 2001).

4

This may indeed be an underestimate. A preliminary exercise by the CFA shows that consumer prices rose by 6.2 percent during the first half of 2001, and the 12-month inflation rate in June 2001 was 14.4 percent. These estimates would suggest that the increase in the GDP deflator could be in the range of 10-15 percent in 2001.

5

The World Bank, Poverty Assessment, Kosovo, Federal Republic of Yugoslavia (Washington: World Bank, 2001).

6

This excluded the cost of maintaining UNMIK; the direct contributions to the administration of Kosovo made by the European Union, the UN, and other donors; and KFOR’s contribution to security.

Within Same Series

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Cover Kosovo
Kosovo
Institutions and Policies for Reconstruction and Growth
Author: Ms. Davina F. Jacobs and Mr. Johannes Herderschee
ISBN:
9781589060982
Publication Date:
11 Apr 2002
Publisher:
International Monetary Fund
DOI:
https://doi.org/10.5089/9781589060982.071
Pages:
32