Former Yugoslav Republic of Macedonia
Selected Issues and Statistical Appendix

This Selected Issues paper and Statistical Appendix formulates a medium-term fiscal framework for the Former Yugoslav Republic of Macedonia (FYRM) and discusses the tensions that are likely to arise in formulating policy measures. The paper reviews recent fiscal developments and the 2002 budget. It discusses medium-term revenue and expenditure issues, the uncertainties and risks underlying the fiscal framework, and the sensitivity of the fiscal outlook to some of these uncertainties and risks. The paper also compares the size and structural aspects of FYRM’s public finances to those of other countries in the region.

Abstract

This Selected Issues paper and Statistical Appendix formulates a medium-term fiscal framework for the Former Yugoslav Republic of Macedonia (FYRM) and discusses the tensions that are likely to arise in formulating policy measures. The paper reviews recent fiscal developments and the 2002 budget. It discusses medium-term revenue and expenditure issues, the uncertainties and risks underlying the fiscal framework, and the sensitivity of the fiscal outlook to some of these uncertainties and risks. The paper also compares the size and structural aspects of FYRM’s public finances to those of other countries in the region.

I. Medium-Term Fiscal Challenges1

1. The security crisis of 2001 has redefined the medium-term fiscal challenges faced by the FYRM. Before the crisis, these challenges centered on removing structural weaknesses from the public finances. After the crisis, policymakers will also have to address new expenditure demands on the budget, including the costs of implementing the peace framework agreement. Thus, a strengthening of the fiscal position over the medium-term has become a major priority.

2. This note formulates a medium-term fiscal framework and discusses the tensions that are likely to arise in formulating policy measures. The note is organized as follows. Section A reviews recent fiscal developments and the 2002 budget. Section B discusses medium-term revenue and expenditure issues, the uncertainties and risks underlying the fiscal framework, and the sensitivity of the fiscal outlook to some of these uncertainties and risks. Section C compares the size and structural aspects of FYRM’s public finances to those of other countries in the region. It also looks at differences in the savings-investment balances and the external vulnerabilities for these countries. Concluding remarks follow in Section D.

A. Recent Fiscal Developments and the 2002 Budget

Recent Fiscal Developments

3. A tight fiscal policy stance has been a key element of FYRM’s economic strategy until 2001, but the fiscal position concealed a number of structural weaknesses. Labor income taxation was high, as reflected in the large share of personal income taxes and social contributions to taxes (about 50 percent) and the high tax wedge on net wages (slightly over 65 percent). Non-discretionary spending excluding interest payments (i.e. social transfers and wages) amounted to about 65 percent of general government expenditures, and interest payments amounted to an additional 5 percent. In addition, expenditure control was weak, with line ministries having recourse to self-generated revenues that were frequently used for wage increases and new hiring.

4. The government began to address these structural weaknesses from 2000. A value added tax (VAT) was introduced in April 2000 in place of the sales tax, as an important part of a strategy to modernize the tax system and provide stronger incentives for economic activity. The resulting boost in revenues, which increased from 35.4 percent of GDP in 1999 to 36.7 in 2000, created room for a reduction in income tax rates, introduced in February 2001.2 To control the drift in personnel expenses and reduce their share in total expenditure, gross employment in the civil service was reduced by 6½ percent in the first half of 2001.3 To strengthen expenditure control, the first phase of a Treasury system was put into operation and the expenses financed from self-generated revenues became subject to Parliamentary scrutiny with the 2001 budget.

5. The security crisis contributed to a substantial deterioration of the fiscal position during 2001 (Table I-1). The general government recorded a deficit of 6 percent of GDP, compared with 1.1 percent envisaged in the budget. This implies a fiscal swing during 2001 of 8½ percentage points of GDP relative to the fiscal outturn in 2000. Of this swing, 3 percentage points is accounted for by the income tax cuts introduced in early 2001 and by cyclical factors.

Table I-1.

General Government Operations

(in percent of GDP)

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Source: Data provided by the authorites.

Ratios to GDP based on the budget approved by Parliament prior to the insurgency crisis and a nominal GDP calculated by applying the nominal GDP growth budgeted under the PRGF/EFF arrangements to the actual GDP for 2000.

Other revenue and expenditure factors that cannot be directly linked to security-related outlays.

Includes non-tax and capital revenue, and grants. Grants were projected to fall by 1.2 percent of GDP.

Room for the second round of policy measures originally scheduled for June 2001.

6. Tax receipts as a ratio to GDP, excluding the financial transaction tax, were roughly unchanged, but developments were more diverse at the level of each tax. Collections from direct taxes in 2001 were in line with budget projections, but revenues from indirect taxes were lower. Notwithstanding weak collections in the second and third quarter of 2001, reflecting the impact of the crisis on economic activity and a high level of refunds, VAT revenue as a ratio to GDP increased slightly for the year as a whole. Revenues from excise taxes were weak, in part owing to one-time losses following changes in payment rules.4 Import duties as a share of GDP fell, reflecting reduction in tax rates arising from the trade agreements signed in recent years, as well as a sharp contraction in imports that exceeded the decline in economic activity.5

7. On the expenditure side, developments were dominated by an increase in security-related expenditures. These outlays increased relative to the budget by 6¾ percent of GDP, and included such expenditures as the purchase of military hardware, the costs of mobilizing reservists, and new hiring and wage increases for security-related personnel.6

8. Non-security expenditures rose as a ratio to GDP from budgeted levels, reflecting in part the effect of a lower nominal GDP, but some outlays were also higher in nominal terms. The wage bill exceeded the budgeted amount in nominal terms, mainly on account of delays in implementing the program of downsizing the civil service. In addition, new outlays on investment projects financed from telecom privatization receipts totaled 0.6 percent of GDP. Capital outlays by the Road Fund were lower than budgeted in nominal terms by about ¾ percent of GDP.

9. Faced with a deteriorating fiscal position, the government took measures to shore up revenues and re-prioritize expenditures. In particular, it decided to forego the second round of revenue-reducing policy measures (1½ percent of GDP) that had been built into the budget and were originally scheduled for June 2001. Also, a new tax on financial transactions was introduced on July 1 for a six-month period. This tax yielded revenues equivalent to about 1¼ percent of GDP by year-end. Finally, cuts were introduced to several expenditure programs in November 2001; for example, savings for about ¼ percent of GDP were obtained by reducing the budget allocation for child allowances and capital transfers to the railway.

The 2002 Budget

10. The 2002 budget seeks to reverse the fiscal expansion of 2001. The 2002 central government budget envisages a deficit of 2¾ percent of GDP. Taking into account foreign-financed expenditures by the Road Fund, the general government deficit is projected to reach about 3½ percent of GDP, implying a decline of 2½ percentage points of GDP relative to 2001.

11. The authorities plan to request donors to cover the bulk of the costs related to the peace process.7 The budget includes a very small share of the costs arising from the implementation of the peace framework agreement. These costs have been estimated in 2002 at ¾ percent of GDP, but less than 0.1 percent of GDP is included in the budget. Resources to cover the expenses (i) on reconstruction of war damaged housing and infrastructure, and (ii) on refugees and internally displaced people are likely to be channeled by donors through non-governmental organizations. These off-budget expenses are projected at 1¼ percent of GDP during 2002.8

12. The authorities have adopted a number of temporary revenue and expenditure measures in support of their fiscal deficit objective in 2002. These measures include: (i) extending the tenure of the financial transactions tax by one year until end-2002; (ii) postponing the planned implementation of a new wage structure for civil servants; (iii) foregoing a general wage increase in the public sector; and (iv) postponing implementation of changes in the coverage and eligibility of the child allowance program. These measures are of a stopgap nature and, as such, will need to be replaced by more permanent measures in future years, as is later discussed.

13. Revenues and grants are projected to decline to 33.4 percent of GDP in 2002, a loss of 0.9 percent of GDP relative to 2001. Much of this loss reflects lower non-tax revenues and grants. Non-tax revenues are expected to decline on account of lower interest receipts and profit remittances from the central bank.9 Additional revenue losses are expected from import duties, owing to the elimination on January 1, 2002 of a one percent processing fee on all imports, and the impact of reduction in tariffs as a result of the trade agreements signed in recent years, including the EU Stabilization and Association Agreement.

14. On the expenditure side, the budget incorporates a number of special programs and one-time expenses. For example, even though a sharp decline is programmed in security-related spending, these outlays are still expected to remain above pre-crisis levels by about 2½ percent of GDP, in part because demobilization of security-related personnel will be completed only by mid-2002. Also, outlays on investment projects financed from privatization proceeds are expected to increase from 0.6 percent of GDP in 2001 to 1¼ percent in 2002. The budget also allocates about ½ percent of GDP to cover the net costs of structural reforms, and about 0.4 percent of GDP to pay for court-mandated pension obligations.

B. A Medium-Term Fiscal Framework

15. Several factors need to be taken into consideration in developing a medium-term fiscal framework. First, the framework needs to be based on prudent macroeconomic assumptions. In this regard, growth projections should be in line with country-specific and regional risk factors. Second, the framework should ensure that the private sector has room to develop, particularly in transition economies where substantial resources are needed to modernize the enterprise sector. Finally, external vulnerabilities need to be reviewed, assessing both the sustainability of the current account as well as the medium-term dynamics of public sector debt.

The Baseline Scenario

16. Sustaining high growth without recourse to exceptional foreign financing requires adopting a path of fiscal consolidation. Real GDP growth could reach 5 percent by 2005, as the political and security risks recede and the FYRM takes advantage of its access to European markets. However, this also requires an increase in private sector investment.10 Non-government savings should increase with progress in enterprise restructuring, but this increase is likely to be less than the increase in private investment (Table I-2). The scenario assumes that project lending from multilateral and bilateral sources will be forthcoming at current nominal levels, and that private borrowing and foreign direct investment will increase modestly. Given these capital account assumptions, the above scenario requires an improvement in the current account (excluding grants) of 2 percentage points of GDP; i.e. from 9¼ in 2002 to 7¼ percent of GDP by 2005 (Figure I-1). In turn, the fiscal path accompanying this scenario implies a gradual reduction in the general government deficit from 3½ percent in 2002 to ¼ percent of GDP by 2005. Under this scenario government net debt will be stable at 40 percent of GDP.

Table I-2.

A Medium Term Fiscal and Macroeconomic Framework, 1999-2005

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Sources: Data provided by the authorities; and IMF staff projections.

External current account deficit, including grants (+).

Equal to gross domestic investment minus foreign saving.

Equal to gross national saving minus net factor income and transfers from abroad, including private transfers.

Negative figure implies that revenue-enhancing or expenditure-reducing measures are required.

Public sector debt defined as domestic debt of central government and external debt of general government. Includes bonds issued in 2001 for the frozen foreign currency deposits, and liabilities assumed by the government as of end-March 2000 on account of bank and enterprise restructuring. Excludes court-mandated pension obligations.

Figure I-1.
Figure I-1.

FYRM: Savings-Investment Balance, 1997-2005

(In percent of GDP)

Citation: IMF Staff Country Reports 2002, 048; 10.5089/9781451826043.002.A001

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

Proposed Changes to VAT Policy and Administration

A technical assistance mission by FAD in December 2001 has suggested several measures to ensure that the VAT remains a reliable revenue source over the medium-term.

On administration, the mission stressed the need to conduct in-depth audits of VAT returns, instead of focusing mainly on auditing VAT refund applications. This requires introducing risk-based audit selection techniques, and creating a unit to investigate tax fraud.

On collection of arrears, the mission recommended strengthening enforcement, through more frequent seizure and disposal of assets, and through transferring some of these responsibilities to regional offices. In addition, an action plan to deal with the largest VAT debtors needs to be developed and implemented within a defined time schedule.

On legislation, the mission suggested changes to the law so as to empower the Public Revenue Office to reject voluntary registrations, unilaterally de-register small taxpayers, and levy penalties for regulatory offenses. In addition, the mission recommended that the need to file annual VAT returns and the option to file replacement VAT forms be eliminated from the law.

Medium-Term Revenue and Expenditure Issues

17. The baseline scenario discussed above is subject to significant policy tensions. Not only have new expenditure demands emerged, but also many additional demands are likely over the medium-term. In addition, some concerns have emerged on the revenue side, and additional revenue-enhancing measures will be required once the financial transaction tax is eliminated at end-2002.11

18. On the revenue front, revenues are expected to decline from 33.4 percent of GDP in the 2002 budget to 29.2 percent in 2005. Policies on direct taxes (i.e. rates and exemptions) are not programmed to change. However, as discussed in Box I-1, the authorities may need to consider strengthening VAT administration to ensure that these revenues do not weaken over the medium-term. Revenues from external trade are expected to decline, since as a result of the trade agreements signed in recent years the implicit tariff on duty paying imports is expected to decline from 8 percent in 2001 to less than 6 percent by 2005.

19. On the expenditure side, defense and security-related spending are projected to decline in 2003-05 by about 1 percentage point of GDP compared to 2002, but will still average 1½ percent of GDP above the pre-crisis level (Table I-3). While reservists will be fully released, the armed forces will be expanded and modernized in line with NATO standards. Specifically, the program of expansion in the military assumes the hiring of 2,700 professional soldiers in 2002. In addition, 1,000 ethnic-Albanians will be recruited in the police by end-2003 as agreed in the peace framework agreement.

Table I-3.

Security-Related Expenditures

(In percent of GDP)

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Sources: Data provided by the authorites; and IMF staff projections

20. As to the costs of structural reforms and the repayment of pension obligations, an average allocation of 0.8 percent of GDP per year is projected for 2003-05. Reform expenses are expected to cover (i) recurrent costs of the reduction in the civil service of 2001 (about 0.1 percent of GDP), and (ii) severance payments, unemployment benefits and other costs from lay-offs arising from enterprise restructuring (0.3 percent of GDP). The assumption is that the firms targeted under the World Bank’s FESAL operation will be resolved during 2002, and the remaining lossmaking firms will be resolved in 2003.12 The court-mandated payment of pension obligations will remain at 0.4 percent in 2003-04, but will be negligible in 2005 as the last payment of these pension obligations is scheduled to take place in January 2005.

21. Other non-interest current expenditures are assumed to increase in real terms by about 1 percent per year during 2003-05. But this assumption masks important differences in trends for various expenditure items. The wage bill, excluding that of new security-related personnel, is assumed to remain constant in nominal terms over the whole period of our baseline scenario. The cost of some social programs is expected to increase, as changes will be introduced to the coverage and eligibility of the child allowances program. These changes are projected to cost ¼ percent of GDP each year beginning in 2003.

22. The achievement of the fiscal consolidation path of the baseline scenario requires introducing permanent fiscal measures equivalent to about 2 percent of GDP in 2003. The FAD mission of December 2001 provided several revenue-enhancing options, such as reclassifying goods from the preferential to the standard VAT rate, increasing the preferential VAT rate, and modifying the coverage on some excise taxes.

Uncertainties and Risks

23. There are several restrictive assumptions in the baseline scenario. The most important relates to public sector wages, where two factors are at play. First, these wages have been largely frozen since the mid-1990s and have lost their premium over private sector wages (Figure I-2). In this context, pressures are mounting for the government to provide a general wage increase to public sector employees. Second, the authorities have been finding it difficult to retain and hire skilled staff in the civil service. Hence, the Law on Civil Servants aimed at decompressing the public sector’s wage structure beginning in 2002. The authorities have temporarily postponed consideration of both of these factors, but this is not likely to be tenable over the medium term.

Figure I-2.
Figure I-2.

FYRM: Private and Public Sector Wage Developments

(January 1997 - September 2001)

Citation: IMF Staff Country Reports 2002, 048; 10.5089/9781451826043.002.A001

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

24. A fully-funded second pillar to the pension system is to be introduced in 2004 and could cost the budget 1-2 percent of GDP annually for a transitional period, as resources from social contributions are diverted from the pay-as-you-go system to private funds. The immediate revenue loss associated with the reclassification of public to private pensions does not imply an underlying weakening in the fiscal stance from the perspective of national saving. But fiscal adjustment will need to cover the costs of establishing a second pillar and the higher borrowing costs faced by the government. For example, if participation in private funds is such that social contributions to the pension fund decline by 25 percent, the central government is likely to face cumulative new borrowing costs of 0.2 percent of GDP per year.13 In addition, to the extent that private pension funds invest resources abroad and the authorities wish to maintain a certain level of reserve coverage, some adjustment in financial policies may be required.

25. An additional uncertainty arises from the decentralization process required under the peace framework agreement. According to the Law on Local Self-Governments, decentralization should be completed by end-2003. This process is likely to change the structure of public finances, as local governments would assume responsibilities in education, health and social care. These reforms need to be carefully reviewed to ensure that the fiscal position is not weakened.

26. Finally, the costs that have been estimated for implementing the peace framework agreement are preliminary and incomplete (see Box 1 in the Staff Report for the Article IV consultations). If donor support were not to become available to fully cover these costs, then additional fiscal measures would be required.

Sensitivity Analysis

27. The baseline scenario will need to be modified if the wage bill of the public sector increases. This increase could be as a result of general wage increases, allocation of resources to decompress the wage structure, or a combination of these two factors. In turn, an increase in the wage bill would imply an increase in pensions obligations for the State, as these are tied to the average wage of the economy. If the wage bill increases by 10 percent in 2003, and the policy objective is to maintain net debt to GDP ratio at the baseline scenario level, then additional fiscal measures with an annual yield of 0.7 percent of GDP would be required for 2003-05 (Table I-4).

Table I-4.

Sensitivity Scenarios

(In percent of GDP)

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Sources: Data provided by the authorites; and IMF staff estimates.

28. Changes also should take place if the GDP growth assumption is lower than that assumed in the baseline scenario. If this were the case, then revenues would weaken in nominal terms. More importantly, outlays would remain constant in nominal terms, slightly increasing their share in GDP. As a result, the fiscal deficit would deteriorate. However, if the policy objective were to keep constant the ratios of net debt to GDP, then this would require introducing revenue-enhancing or expenditure-reducing measures to compensate for the decline in growth (Table I-4). If real GDP growth was lower by 1 percentage point, then there would be a need to introduce fiscal measures that are, on average, about 1 percent of GDP higher than in the baseline scenario.

C. Cross-Country Comparisons

Comparison of Structural Aspects of Public Finances

29. In terms of fiscal balances and size of revenues and expenditures as a ratio to GDP, the FYRM fares well when compared to other countries in the Balkan region. The FYRM has maintained a strong fiscal position—on average, over the period 1998-2000, a balanced overall fiscal position and a 2 percent of GDP primary surplus. In contrast, Albania, Croatia, and Romania have experienced large overall fiscal deficits during the same period, ranging from -4 to -10 percent of GDP (Figure I-3, first panel). As to the size of revenue and expenditure as a ratio to GDP, the second and third panels of Figure I-3 show that FYRM’s ratios are on the high side vis-à-vis other countries with similar incomes per capita. More precisely, FYRM lies above the regression line that fits the observations of size of revenues and expenditures with incomes per capita.14 The performance of the other countries for which data is presented is mixed; for example, Bulgaria and Croatia lie well above the regression line, while Romania and Albania are closer to the line than FYRM itself.

Figure I-3.
Figure I-3.

FYRM: Cross-Country Comparison of Public Finances

(In percent of GDP)

Citation: IMF Staff Country Reports 2002, 048; 10.5089/9781451826043.002.A001

Sources: Country desk data, IMF.

30. The indicators on structure of revenues and expenditures of the FYRM are less encouraging. FYRM’s share of labor income taxation (i.e. social contributions and personal income tax) in total tax revenues was higher (i.e. 50 percent of tax revenues) than in the other four countries in the region for which data is presented. The lowest reliance on labor income taxation was observed in Albania—about 30 percent of total tax revenues (Figure I-3, third panel).15 As to the structure of expenditures in the FYRM, non-discretionary outlays excluding interest payments (i.e. wages and social transfers) are slightly over 60 percent of total expenditures. The other countries in the region were lower, with the lowest ratio corresponding to Albania (i.e. 39 percent of total tax revenues, see last panel in Figure I-3). It is also worth noting that FYRM does worse on both counts than neighboring Bulgaria, a country with similar incomes per capita on a PPP basis (i.e. Bulgaria’s share of labor income taxation in total tax revenues is 44 percent, and its non-discretionary outlays amount to 40 percent of total expenses).

Comparison of Savings-Investment Balances and External Performance

31. In contrast to FYRM’s balanced fiscal positions, the savings-investment balances of the private sector have been highly negative. Similarly, FYRM’s current account deficits have been high (Table I-5). This compares in some respects unfavorably with the experiences of other countries in the region. For example, Albania has experienced high and positive private sector savings-investment balances since 1996. In turn, given Albania’s external performance, this private sector behavior has allowed for a much weaker fiscal path; the overall fiscal deficit was 12 percent of GDP for 1996-1998, and 10 percent of GDP for 1999-2001. Also worth noting is that non-government savings of the FYRM, excluding developments in 2001, have increased from about 11½ percent of GDP in 1996 to 16 percent in 2000, only to decline sharply in 2001 as a result of the security crisis. Private investment levels have been high, averaging about 19 percent of GDP since 1996, but declined sharply in 2001 (Figure I-4, first panel, and Table I-5). By contrast, the investment levels of other countries in our sample have been lower. For example, Albania’s private investment has been about 11½ percent of GDP since 1996 (Table I-5).

Table I-5.

Savings-Investment Balances and External Performance

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Source: Based on data provided by IMF country desks.
Figure I-4.
Figure I-4.

FYRM: Savings-Investment Balances and External Performance

Citation: IMF Staff Country Reports 2002, 048; 10.5089/9781451826043.002.A001

Sources: Country desk data, IMF.1/ Debt data adjusted for domestic debt denominated in foreign currency.

32. From the perspective of non-debt creating external financing sources, other countries in our sample also appear to face a more comfortable situation than the FYRM (Figure I-4, second panel). Albania and Romania have received official transfers that are larger than those of the FYRM; 2½ to 3 percent of GDP compared to 1½ percent of GDP in the FYRM. The levels of official transfers to the FYRM are not negligible, though an increase was observed during the Kosovo crisis, but this is not likely to be available on a recurrent basis. Also, FYRM’s FDI levels as a share of GDP are the lowest in the region when adjusted to exclude privatization receipts.16

33. Finally, debt levels also suggest limited room for the FYRM to pursue a debt-financed growth strategy.17 Total gross public sector debt is equal to 59 percent of GDP, double the level of Romania though slightly lower than the levels in Albania and other countries in our sample. The external debt figures present a more concerning picture. At first, these appear to be modest in the FYRM (i.e. 39 percent of GDP). However, the FYRM has a large level of domestic debt denominated in foreign currency. Adjusting external debt figures to take into account foreign-currency denominated debt results in external debt ratios to GDP of 55 percent, higher than in most countries in the region (Figure I-4, third panel).

D. Concluding Remarks

34. The security crisis has drastically changed the medium-term fiscal challenges faced by the FYRM. Not only have new expenditure demands emerged, but also more are likely to arise over the medium-term. The baseline scenario discussed in this note assumes an increase in private sector investment in 2002-05, and assumes an improvement in the current account of 2 percentage points of GDP over the same period. To achieve this improvement, fiscal measures of at least 2 percent of GDP will need to be introduced once the financial transaction tax is eliminated. The fiscal stance chosen is also consistent with sustainable debt dynamics for the public sector; specifically, by 2005, net debts are projected to stabilize at 40 percent of GDP.

II. Developments in the Banking System, 2000-0118

A. Introduction

1. A major element of FYRM’s reform efforts has been the creation of a sound banking system. The focus has been on upgrading banking legislation in line with international standards and the Basel core principles, strengthening supervision, improving lending practices, and reforming the payment system. Progress on these fronts through end-1999 was discussed in Drummond (2000).19 The primary purpose of this note is to review developments in the banking sector during 2000-01, focusing particularly on banks’ lending behavior and the dynamics of classified debt. The note also examines the impact on banks’ balance sheet as a result of the contrasting economic environment of the past two years. While the economic outcome was favorable in 2000, there was a marked downturn in 2001 owing to a six-month security crisis.

2. The rest of the paper is organized as follows. Section B describes the market structure of the banking system. Section C describes the developments in the assets and liabilities of the banking system. Section D examines the dynamics in the quality of the credit portfolio and soundness of the banking system. Section E concludes.

B. Market Structure

3. The banking sector in FYRM is concentrated. Of the 20 commercial banks, the top two banks account for more than one-half of the banking system assets and about two-thirds of the deposits, as of end-September 2001 (Table II-1). The third largest bank accounts for only about 8 percent of the assets and about 5 percent of the deposit base. With the sale in early 2000 of the state’s share in Stopanska Banka (the largest commercial bank) to foreign strategic partners, privatization of the banking sector was completed. The number of banks with majority foreign shareholders increased to 6 banks from 4 banks at end-1999; two of the largest three banks have a majority foreign stake.

Table II-1.

FYRM: Summary Balance Sheet of Banks, 1998-2001

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Sources: National Bank of Macedonia (NBM), Banking Supervision Department; and IMF staff estimates.

Includes unallocated specific provisions as determined by NBM.

C. Banking system assets and liabilities

4. The banking system is characterized by a low level of intermediation. This is reflected in the low asset to GDP ratio; as of end-September 2001, this was about 31 percent compared to a minimum of about 65 percent in central European economies in 2000.20 Loans comprised about half of the assets at 53 percent, while liquid assets accounted for another 44 percent. The bulk of the latter represents foreign currency assets placed abroad. The rising trend in banking system assets from end-1999 through end-2000 was reversed in the first quarter of 2001 (Table II-2). This reflected mainly the decline in cash assets related to the withdrawal of deposits triggered by the outbreak of the security crisis. However, with the security situation stabilizing, total assets increased in the third quarter of 2001.

Table II-2.

FYRM: Banking System Assets, 1998-2001

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Sources: National Bank of Macedonia (NBM), Banking Supervision Department, and IMF staff estimates.

Includes other receivables, fees, and claims classified in temporary accounts.

Since March 2000, reflects shortfall in provision identified by the NBM. Prior to that includes uncovered losses and capital investments as per the Banking Act.

5. The deposit base of FYRM’s banking system is equivalent to 12 percent of GDP at end-September 2001. Deposits accounted for only about one half of total liabilities, while equity capital contributed about one fourth (Table II-3). An important characteristic of the deposit base is the high share of foreign currency deposits; about 40 percent at end-September 2001. This reflects depositors’ preference for asset substitution, and has persisted despite the 6-7 percentage points higher interest rates paid on denar deposits. Deposits increased in 2000. But with the onset of the crisis in late-February 2001, they declined in the first and second quarters of 2001. With improvement in the security situation, facilitated by the signing of the Framework Agreement, the deposit base recovered in the third quarter, but was still below the pre-crisis level. The recovery in deposits was led by a higher foreign currency deposits.

Table II-3.

FYRM: Banking System Liabilities, 1998-2001

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Sources: National Bank of Macedonia (NBM), Banking Supervision Department; and IMF staff calculations.

Credit expansion and risks

6. Credit to the private sector expanded in 2000 and through first half of 2001. Several factors help to explain this: the growth in the deposit base in 2000, a favorable economic environment in 2000, and a reduction in interest rates. Credit expansion slowed in Q3, 2001, as banks turned cautious in mid-year as the crisis wore on.

7. There has been an improvement in the lending behavior of banks since end-1999. In contrast to 1999, when about 80 percent of the credit flow was directed to the largest 16 high-risk borrowers, in 2000 and 2001, about 95 percent of all new loans and rolled-over credits were extended to enterprises rated as A or B (text table on next page).21 This reflects in part the stricter credit-worthy oversight by the central bank and the enforcement of the prudential guidelines on provisioning. An additional factor was the privatization of Stopanska Banka, which in the past accounted for about one half of the high-risk loans. Under new management, Stopanska Banka has curtailed its lending activity, as it undergoes restructuring. Its share in total bank credit has dropped from 36 percent at end-1999 to 25 percent as of end-September 2001.

New and Rolled-Over Credit

(In millions of denars)

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Source: National Bank of Macedonia.

8. Lending in foreign currency and indexing denar loans to a foreign currency is a common practice of banks in FYRM.22 As of end-September 2001, the combined share of these types of lending was about 40 percent in total lending (Table II-4). The attraction to the borrower is the lower interest rate that these loans typically carry compared to regular denar credit. Interest rates are about 3 to 7 percent lower for foreign currency loans and about 3 to 4 percent lower for indexed loans. The share of foreign currency loans has tended to rise during tighter monetary conditions. Thus, foreign currency lending declined from end-1999 through to end-March 2001, when denar liquidity was high (Figure II-1). Accordingly, the share of foreign currency lending to total lending declined from 21 percent at end-1999 to 12 percent at end-March 2001. However, with the tightening of monetary conditions in mid-2001, there was a slight pick-up in lending in foreign currency. On the other hand, indexed lending declined slightly, broadly in line with the slow down in denar lending (data on indexed lending is only available starting April 2001).

Table II-4.

FYRM: Credit to the Private Sector, 1999-2001

(In millions of denars; unless otherwise specified)

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Source: National Bank of Macedonia.

As reported in the monetary survey excluding valuation effects.

Figure II-1.
Figure II-1.

FYRM: Commercial Banks’ Liquidity and Effective Interest Rate Spread

Citation: IMF Staff Country Reports 2002, 048; 10.5089/9781451826043.002.A001

Sources: National Bank of Macedonia; and IMF staff calculations.1/ Effective interest rate spread is calculated as the ratio of interest income to credit to nonbanks less ratio of interest expense to deposits of nonbanks.

9. Although banks have covered their net foreign exchange position, foreign currency/indexed loan borrowers are not hedged against foreign currency risk. As of end-September 2001, 16 of the 20 banks had long aggregate net foreign exchange open position. The 4 banks with short aggregate net open foreign exchange positions were within the prudential guidelines. The users of foreign currency/indexed credit are diverse and are involved in production of agricultural products, tobacco, manufacturing, textiles, construction, retail trade, and tourism. Partial data indicate that over 60 percent of the borrowers are domestically oriented enterprises and do not have access to foreign exchange revenues.

10. The banking system is exposed to off-balance sheet risks. Outstanding off-balance sheet claims (primarily guarantees and letters of credit) are around 20 percent of total assets, and more than half of these claims are uncovered (Table II-2). Since its privatization in 2000 Stopanska Banka, has lowered its off-balance sheet exposure. But, off-balance sheet exposure (both covered and uncovered) of other banks has risen (text table below). The default rate of uncovered off-balance-sheet claims have fallen since 1999: it averaged 20 percent in 2000 and 18 percent through the first nine months of 2001 (Table II-5), compared to an average of 25 percent during the last 6 months of 1999.

Table II-5.

FYRM: Credit and Off-Balance Sheet Activity, 2000-2001 1/

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Sources: National Bank of Macedonia; and staff estimates.

Based on monthly off-balance sheet reports submitted by banks to the NBM.

Credit measured from the monetary survey (excluding exchange rate valuation effects).

Cumulative beginning January of each year.

In percent of current due.

Uncovered letters of credit (L/Cs) and uncovered guarantees.

FYRM: Selected Off-Balance Sheet Items

(In millions of denars; unless otherwise specified)

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Source: National Bank of Macedonia.