Former Yugoslav Republic of Macedonia: Recent Economic Developments

The economy of the Former Yugoslav Republic of Macedonia suffered a setback owing to the Kosovo crisis. The impact of the crisis, however, was less severe. Inflation remained low, the balance-of-payments position and the fiscal situation improved, and indicators of external vulnerability remained satisfactory. The National Bank of Macedonia faced contrasting challenges in the conduct of monetary policy. The pace of structural reforms picked up and a value-added tax was introduced. However, structural weaknesses in the financial system have prevented a more vigorous economic recovery.


The economy of the Former Yugoslav Republic of Macedonia suffered a setback owing to the Kosovo crisis. The impact of the crisis, however, was less severe. Inflation remained low, the balance-of-payments position and the fiscal situation improved, and indicators of external vulnerability remained satisfactory. The National Bank of Macedonia faced contrasting challenges in the conduct of monetary policy. The pace of structural reforms picked up and a value-added tax was introduced. However, structural weaknesses in the financial system have prevented a more vigorous economic recovery.

VI. Fiscal Policy and Developments1

A. Overview

1. The general government sector in FYRM consists of the central government, four extrabudgetary funds, and local governments. The funds comprise the Pension and Disability Fund (‘Pension Fund’), the Employment Fund, the Health Fund, and the Road Fund. Expenditures by the funds accounted for 55 percent of general government expenditures in 1999, mainly reflecting extensive social transfers.

2. The central government makes transfers to all the funds: transfers to the Pension and Employment Funds to meet statutory obligations for paying entitlements, and capital transfers to the Road Fund for road building. Central government transfers to the funds totaled 4.4 percent of GDP in 1999. There are also significant transfers among the funds themselves. The Pension Fund makes transfers to the Health Fund for the health contributions of pensioners (1.3 percent of GDP in 1999), while the Employment Fund makes transfers to the Pension Fund for the contributions of recipients of unemployment benefits (0.4 percent of GDP) and to the Health Fund for their health insurance premiums (0.7 percent of GDP).

3. Fiscal policy in FYRM over the past few years has been supportive of restrained demand management. Fiscal deficits have been relatively small, and mainly reflected externally-financed (on concessional terms) capital expenditures- However, the overall fiscal position conceals a number of weaknesses. The taxation of labor income is very high, creating disincentives for job creation. With nondiscretionary spending—mainly wages, transfers, and social sector outlays—accounting for nearly four-fifths of total government expenditure, the scope for the budget to contribute to the restructuring of the economy is limited and fiscal management of contingencies is difficult. Many line ministries have recourse to self-generated special revenues that are not subject to the centralized budget allocation process, resulting in possible misallocation of scarce resources.

B. Fiscal Policy Developments in 1998

4. The fiscal situation deteriorated in 1998. The general government deficit widened to 1.8 percent of GDP, mainly reflecting a faster-than-expected implementation of a foreign financed road project and an increase in pension benefits. The central government deficit narrowed to 0.9 percent of GDP, but was higher than budgeted (Tables 29 and 30; and Figure 7). There were shortfalls in revenue, reflecting poor sales tax administration and lower excises from oil derivatives as a result of weak oil prices and the use of ad valorem taxes. There were also election-related slippages in spending: pensions were increased by 10 percent in June; vacation and food allowances were raised in September; and there was unbudgeted spending on textbooks. However, capital spending was squeezed to offset the slippage in current expenditures. The fiscal deficit was financed mainly through concessional external borrowing from the European Investment Bank (EIB) and privatization receipts.

Figure 7.
Figure 7.

FYRM: General Government Operations, 1996–2000

(Percent of GDP)

Citation: IMF Staff Country Reports 2000, 072; 10.5089/9781451825992.002.A006

Sources: Data provided by the FYRM authorities; and official projections.

C. The 1999 Budget and Developments

5. The 1999 budget aimed for a central government deficit of 0.2 percent of GDP. The general government deficit was expected to reach 2.1 percent of GDP, mainly as a result of foreign-financed road construction. The budget called for a reversal of the slippages of 1998; and spending was to be directed somewhat more to capital expenditure items. The wage bill in nominal terms was to be held to its 1998 level, while growth in expenditure on goods and services was to be kept unchanged in real terms. Identified expenditure arrears to suppliers by a selected number of ministries and arrears on child allowances were to be eliminated.

6. Fiscal outturn in 1999 was better than expected, notwithstanding the impact of the Kosovo crisis during April-June. The central government accounts recorded a surplus of about 1 percent of GDP. With the exception of excises, all categories of tax revenue exceeded budget forecasts. Relative to GDP, tax revenues were 2.8 percentage points higher than in the budget. The revenue performance can be attributed to several factors: (i) tax administration efforts were strengthened and the arrears were collected; (ii) customs collections were buoyed by the higher tariffs on imports sourced from countries other than FRY; and (iii) excise tax rates on tobacco and alcoholic beverages, and sales taxes on personal care products, wholesale trade, and raw materials were increased in midyear. However, excises as a whole suffered because of lower collections from oil derivatives as domestic prices were not raised in line with international prices, with the effect that the excise tax rates tended to decline (see Annex II on Pricing of Oil Derivatives).

7. The expenditure outturn was 2.9 percentage points of GDP higher than budgeted. There were refugee-related expenditures of 1.3 percent of GDP, which were largely unanticipated but covered by donor support. Because of delays in the arrival of aid from relief agencies, the government had to provide for the shelter and basic needs of the first wave of refugees. After humanitarian organizations took charge of relief operations, the government continued to incur additional expenditures on utilities for camps, education, health care, special assistance to families hosting refugees, and operations to maintain social peace and border security. In addition, expenditures on the Social Assistance Program were about 10 percent higher than budgeted, which the authorities attribute to dislocations arising from the conflict, and expenditures for the Program for Employment were higher, reflecting an unexpected take-up in the program before its expiration.

8. There was a severe breach of wage discipline in 1999. The wage bill exceeded budgeted appropriations by 1.9 billion denar. This reflected an unbudgeted payment of onehalf month’s wages in December (930 million denar), unbudgeted wages for employees in the education and interior ministries (500 million denar), and vacation allowances (350 million denar).2 Several line ministries also made additional wage payments, totalling nearly 1½ percent of GDP from their off-budget self-generated revenues (see Section H, below).

9. The general government accounts were in balance in 1999. The difference between the balances of the central and general governments reflects externally financed projects of the Road Fund. Net foreign financing provided a source of funds of denar 4.4 billion and there was a corresponding increase in government deposits at the NBM.

D. The 2000 Budget

10. The budget for 2000 maintains support of restrained demand management and includes a broad agenda for reform. Key structural features in the budget are: (1) the oil pricing policy will be flexible so that domestic retail prices change directly with international prices, thereby allowing the excise taxes on oil derivatives to rise to their statutory levels; (2) a VAT is introduced on April 1, 2000; (3) excise tax rates will be maintained after introduction of the VAT; (4) the total wage bill is to be scaled back to its 1998 level; (5) the servicing of frozen foreign currency deposits will be regularized; and (6) funds totaling 1¼ percent of GDP have been allocated to meet the costs of enterprise sector and civil service reforms.

11. The central government budget for 2000 targets a small deficit of denar 213 million or 0.1 percent of GDP (Table 29). Revenues are forecast to decline as a ratio to GDP from 21.4 percent to 20.2 percent. The improved compliance achieved in 1999 is expected to be maintained, but revenue collections will be dampened because: (1) personal and corporate income taxes in 1999 included collection of tax arrears; (2) the transition from the sales tax to the VAT results in a one-time loss in tax collection owing to a longer filing time under the VAT; and (3) free trade agreements with Bulgaria and Turkey are estimated to lower customs duties by about denar 750 million or 0.35 percent of GDP. A part of these losses would be made up by higher excise tax collections. Excises on oil derivatives are forecast to increase by almost 40 percent as the statutory rates are applied from January 2000 under the flexible oil pricing policy. However, little increase is expected in excise collections on other goods (alcoholic beverages, tobacco products, cars, and coffee). Since these goods were not subject to the sales tax but are now subject to the VAT, their consumption is likely to be dampened.

12. Expenditures are expected to decline by 1.2 percentage points of GDP to 22.1 percent in 2000. Current expenditures are projected to decline in absolute terms. This decline mainly reflects the termination of the Program for Employment on January 1, 2000 and the effective end to refugee-related expenditures.3 Also, child allowances are lower as arrears were paid off in 1999. The wage bill and allowances are capped at 1998 levels and are 10 percent below 1999 levels.

13. The restraint on current spending creates room for an allocation for civil service and enterprise reforms equivalent to 1¼ percent of GDP. Transfers to the Pension Fund are higher on account of a court-ordered increase in pensions of 8 percent that came into effect in September 1999. Capital expenditures, including transfers to the Road Fund, are budgeted to increase by 0.8 percentage points of GDP to 2.3 percent; spending on capital remains relatively low, however, following a number of years of restraint. The budget also includes a small contingency reserve of 0.3 percent of GDP.

14. Foreign financing is expected to provide a source of funds of denar 2.5 billion (reflecting privatization receipts from the sales of Stopanska Banka and the Okta refinery). These proceeds will be saved and the government deposits at the NBM will increase by 2.2 billion denar.

15. The general government accounts are projected to have a deficit of 1.3 percent of GDP in 2000 (Table 30). The general government deficit exceeds that of the central government by externally financed expenditures of the Road Fund from the EIB and World Bank; projects include road construction in Skopje and upgrades to roads to the Greek and Albanian borders. The Health and Employment Funds are expected to be in balance in 2000 and the Pension Fund is expected to incur a small deficit of denar 100 million which will be financed by the sale of shares.

E. The Structure of Public Expenditure and Revenues

16. General government revenues and expenditures in FYRM (equivalent to 36—37 percent of GDP) are high for a transition economy. This reflects FYRM’s extensive social safety net and a large civil service. Social security contributions equal 11½ percent of GDP and account for about one-third of total government revenues. Individual income taxes are another 5 percent of GDP. All told, social security contributions and individual income taxes equal 75—80 percent of after-tax pay.

17. Indirect taxes account for slightly more than 40 percent of government revenues, or about 15 percent of GDP. Excise taxes are levied on oil derivatives, tobacco products, alcoholic beverages, cars, and coffee, and account for about 15 percent of revenues. In spite of a number of preferential trade agreements in recent years, import duties remain an important source of revenues, accounting for 11 percent of revenues. The average effective tariff rate increased substantially in 1999 as imports that would normally have come from FRY and subject to only a 1 percent administrative fee were sourced from countries for which (higher) general tariffs applied. Sales taxes account for 14 percent of revenues; collections have suffered from administrative deficiencies, including the application of exemptions and preferential rates; the replacement of the sales tax by the VAT should increase the buoyancy of indirect tax collections.

18. Nondiscretionary expenditures, mainly in the form of wages and salaries, social transfers, spending on health, and interest payments account for 85 percent of government expenditures. The largest single component is wages and salaries, equivalent to 9.3 percent of GDP in 1999. In turn, this reflects the high levels of government employment (see below). Expenditures on health, a large component of which is wages and salaries, are equal to 6 percent of GDP. The various transfers—pensions, social assistance, unemployment benefits, employment subsidies, child allowances, and veterans’ allowances-are 13.6 percent of GDP. Interest payments are relatively small, at 1.6 percent of GDP. Discretionary spending on other goods and services (mainly operations and maintenance) and capital is relatively small. Capital expenditures, for example, are well below those of middle- and lower-income countries.

F. The Extrabudgetary Funds

19. The operations of the four extrabudgetary funds are summarized in Table 31.

The pension fund

20. Public pensions in FYRM are funded on a pay-as-you-go basis. The Pension Fund makes payments for old age, disability, and survivors pensions. There are currently 120,000 old age pensioners, 52,000 disability pensioners, and 62,000 survivors pensioners. Pensions are indexed to the average wage in the noneconomic sector, with a six-month lag. Average pensions were denar 6,300 per month in 1999, up from denar 5,750 per month reflecting the court-mandated increase of 8 percent on September 1, 1999. With this increase, the ratio of the average pension to the average wage rose from 59 percent in 1998 to 65 percent in 1999. The courts also ruled that the government could be liable to pay the 8 percent increase retroactively back to 1994 or 1995. This liability is estimated by the Pension Fund to be as high as DM 700 million or 10 percent of GDP.

21. Principal revenues of the Pension Fund are a payroll tax of 20 percent on gross wages (72 percent of revenues) and transfers from the state budget (20 percent). The Pension Fund also receives 9.2 percent of excises from oil derivatives.

22. Near-term financial pressures on public pensions are being addressed in a number of ways. Legislation was adopted in March 2000 that will lower the replacement rate from 80 percent to 72 percent; increase the retirement age for men gradually from 63 to 65 years and for women from 60 to 63 years, for those with a minimum of 15 years of pension service; and pensions will be indexed to 20 percent in terms of wages and 80 percent in terms of the CPI, after the freeze on civil service wages is lifted. These changes are scheduled to take effect from September 2000.

The health fund

23. FYRM inherited a highly decentralized and locally funded health system that were merged into a single, centralized Health Fund in 1991. Principal expenditures are for hospital treatment, outpatient care, and medicines. The main revenue source is an 8.6 percent payroll tax on gross wages, accounting for almost 60 percent of revenues. Transfers from the Pension and Employment Funds for social security contributions accounted for an additional 30 percent of revenues. There are no regular transfers from the state budget to the Health Fund, although in 1999 there was a small transfer vis-à-vis the Program for Employment.

24. There have been serious problems with respect to expenditure control in the Health Fund. It is estimated by the Health Fund that at end-1998 there was a cumulative deficit of denar 3.6 billion, of which about 0.7 billion was bank credits and 2.9 billion arrears to suppliers. The statutory basis for this bank borrowing is unclear. The true amount of arrears, however, is unknown and may well be overstated. Accounting practices in the Health Fund are poor in that they include a mix of cash and accrual accounting. Moreover, inadequate management practices and the lack of commitment recording encourages over-invoicing. The authorities are working with the World Bank to improve expenditure management and control in the Health Fund.

25. A new Law on Health Insurance has recently been passed, as per agreement with the World Bank. The new statute provides for a board of directors for the Health Fund; at present no board exists. Different types of co-payments are being considered. The costs of medicines are very high by international standards and the government intends to open up procurement to international tender.

The employment fund

26. The Employment Fund pays unemployment benefits, pension contributions for the recipients of benefits, and health insurance contributions for the registered unemployed. Unemployment benefits are relatively small, considering FYRM’s unemployment rate, because new entrants to the labor force, who constitute a large share of the unemployed, and the longterm unemployed are not eligible for benefits. To be eligible for benefits an individual has to have worked continuously for at least 9 months or for a 12 month consecutive period in the last 18 months. At present about 30,000 individuals receive unemployment benefits whereas there are about 260,000 unemployed according to the labor force survey.

27. Unemployment benefits account for only 40 percent of expenditures of the fund, with social security contributions accounting for the remainder. Revenues include contributions from a payroll tax of 1.5 percent on gross wages, accounting for 25 percent of revenues; transfers from the central government account for the rest. The Employment Fund was balanced in 1999; there is no statutory basis for the fund to borrow.

28. Recipients receive benefits equal to 50 percent of their average wage for the first 12 months of benefits and 40 percent for the remaining 6 months. The duration and size of benefits ranges from 3–18 months depending on the contribution period. In 1997, the maximum benefit period was reduced from 24 months and benefits reduced from 50 percent of average wages for the entire period of receiving benefits. Individuals with over 25 years of contributions are eligible for unemployment benefits until retirement.

The road fund

29. The Road Fund is responsible for the road construction and maintenance. Its activity varies considerably from year to year, owing mainly to the availability of external financing, but also to the size of transfers from the central government. Expenditures rose from 0.8 percent of GDP in 1997 to 1.9 percent of GDP by 1999. In recent years, about one-half of spending was for capital and one-third for maintenance

Local governments

30. The activities and responsibilities of local governments are minor, which is not surprising in a small unitary state like FYRM. Expenditures in 1999 were about denar 1 billion, equal to 1½ of general government expenditures or 1½ percent of GDP. Expenditures are mainly for garbage collection, the maintenance of parks, culture, and sports. Revenues are derived from a property tax and sales tax on real estate—where local governments have exclusive occupancy of the field—charges for public utilities, and a few fees. Transfers from the central government are negligible.

G. Structural Fiscal Issues

31. A key element in the 2000 budget is the introduction of a VAT on April 1, 2000. The introduction of the VAT is an important step in bringing Macedonia’s tax structure in line with international practice; its implementation is being assisted by a resident advisor from the Fund.

32. The VAT has the following features (see Annex IV, Tax System Summary, for more detail). It has standard exemptions for health, medical, dental, education, and financial services; there are also standard exemptions for renting and leasing residential accommodation. The first provision of residential accommodation and apartments—within five years of construction—are taxed, and subsequent supplies are exempt. Exports are zero-rated, as are services related to imports and exports and international air passenger transport. Full input tax credits are provided for the purchases of capital goods. The standard rate is 19 percent and there is a reduced rate of 5 percent, Goods that benefit from the lower rate include: food; fuel; public transportation; personal care; medicines; books, newspapers and periodicals; water; and the services of lawyers, accountants and auditors. Staff estimates indicate that goods taxed at the reduced rate account for one-half the tax base.

33. The threshold for which taxpayers are required to register for the VAT is annual turnover of denar 1 million (about US$ 17,000). The threshold for large taxpayers that are required to file monthly is denar 25 million; other taxpayers are required to file quarterly. The relatively high threshold for monthly filing is a positive feature of the tax. Payments bureau data indicate that will be 1,800 monthly filers, constituting less than 10 percent of the total number of filers but accounting for 90 percent of sales tax collections. All told, it is estimated that there will 22,500 filers under the VAT compared with more than 38,000 filers in the previous sales tax system.

34. Another important change in the 2000 budget is the cash servicing of frozen foreign currency deposits. Foreign currency deposits are liabilities to households that the government assumed from commercial banks at the time of independence from the FRY. Until now, withdrawals were permitted only on the basis of social need, for the purchase of government enterprises and apartments, or paying for education abroad. The deposits are for the most part denominated in deutsche marks. Interest accrues on the deposits at various rates depending on their currency of denomination and maturity; in 1999, interest rates averaged 2-2½ percent. The stock of outstanding deposits is large—DM 1,050 million at the end of 1999, or 17½ percent of GDP (Table 34). Of the total number of deposits, about 650,000 or threequarters are for accounts less than DM 200 (about 100 Euro).

35. In order to reduce the administrative burden of servicing small accounts and regularize the servicing of all deposits, the government is introducing legislation to make cash payments to depositors with balances up to Euro 50 and 3 percent for all other deposits, and to issue bonds. The bonds have a two-year grace period, an amortization period of 10 years, and will pay interest of 2 percent. The bonds will be transferable and can be swapped for land. They will be denominated in Euros, but payments will be made in denar.

36. Public expenditure management is another area where reforms are being accelerated, with the help of technical assistance from the Fund. In FYRM the lack of expenditure control has been a persistent problem. There is an absence of detailed information on the operations of budget institutions and almost all budget institutions have special revenue accounts. These accounts comprise earmarked receipts from various fees, charges, fines and other nontax revenues that the budget institutions can spend as they wish. Expenditure control has been further weakened by an excessive reliance on cash rationing as the principal means of controlling budget execution; this is disruptive to budget institutions’ operations and has inevitably resulted in arrears. There is also a lack of financial planning and no recording of expenditure commitments.

37. The ZPP is designated as an agent for treasury operations, but the ZPP account structure is too big to be used for management purposes. The authorities now operate a treasury single account that consolidates all bank balances, but financial limits are set at too aggregate a level for real financial control. In addition, the absence of financial planning coupled with poor revenue forecasting has led to a poor match between ministries cash needs and financial limits; this has resulted simultaneously in large unused cash balances in some ministries and expenditure arrears in others.

38. A Fund treasury advisor has been a resident in Skopje since January 2000. The advisor is helping to: develop analytical fiscal reports from the ZPP database; coordinate the work of the Ministry of Finance and ZPP in designing a treasury system based on expenditure commitments; improve budget classifications, particularly for the special revenues accounts; and integrate the special revenue accounts and associated expenditures into the budget and budget planning. The work on special revenue accounts will be used to determine which activities will be privatized, leased, or remain in government.

39. In addition, the authorities plan to begin in 2000 a program of civil service reductions through cutbacks and early retirement. Government sector employment in FYRM is about 95,000, or about 17 percent of total employment. Employment levels are particularly excessive in the education and health sectors. Employment in these two sectors accounts for close to 60 percent of general government employment. Employment in education as a proportion of the labor force exceeds that of industrialized OECD countries by about 20 percent, as student-teacher ratios are relatively low, the number of support staff is high, and the provision of education is almost exclusively in the public sector. In the health sector, employment per population is in line with more advanced market economies, reflecting both excessive numbers of doctors and support staff; in addition, hospital capacity is underutilized and the costs of medicines are high compared with international levels. In both sectors, these large levels of employment have been maintained in spite of budget constraints, resulting in a squeeze on capital expenditure and maintenance as well as on operating costs.

40. The authorities have developed a register of civil service employment. This will assist in the determination of the ministry-by-ministry reductions in employment and provide the structure of employment by grade and pay in order to be able to cost out policies to decompress the government’s pay scales.

H. Special Revenue Accounts

41. In FRYM, many government ministries and agencies raise revenues that are not included in the budget, but in so-called special revenue accounts. The associated expenditures are not included in the budget either, and are spent at the discretion of the receiving organization. The revenues are large, more than denar 9 billion or equivalent to about 4.7 percent of GDP in 1999 (Table 32).

42. Expenditures from the special revenue accounts on wages and benefits increased sevenfold in 1999, from denar 400 million in 1998 to almost denar 2.9 billion (another indicator of the breach in wage discipline) (Tables 32 and 33). In addition, expenditures on supplies and services grew markedly to denar 4.8 billion in 1999. Expenditures from the special revenue accounts on wages are equivalent to 16 percent of spending on wages in the central government budget while spending from the accounts on goods and services is equivalent to more than 90 percent. Clearly, a large component of government activity is outside the scope of the budget. There is a basic lack of transparency by these accounts, as spending is determined by the access to revenues rather than priorities in the budget and the expenditures out of these accounts put pressure on the spending of budget institutions, notably for higher wages and allowances.

I. Total Government Debt

43. From 1996 to 1999, the government debt-to-GDP ratio rose from 41.5 percent to 53.2 percent (Table 34). The rise in the debt ratio is accounted for by foreign debt; the domestic debt to GDP ratio was unchanged. Domestic debt in nominal terms was little changed until 1998 but rose in 1999 on account of the bond issue to finance the clean-up of Stopanska Banka’s balance sheet. The recording of government debt and guarantees is weak. Different ministries have extended guarantees without seeking approval from nor reporting to the Ministry of Finance.


Prepared by Hugh Young.


The Minister of Finance agreed to treat the unbudgeted wage payment in December 1999 as an advance against payments due for January 2000.


Under the Program for Employment, the government paid social security contributions on personal income tax for new hires who were long-term unemployed, whose firms were bankrupt, or who were laid off.