Former Yugoslav Republic of Macedonia: First Review Under the Stand-By Arrangement and Request for Waiver of Applicability of Performance Criteria

Macedonia's macroeconomic stabilization program continues to rest on the basis of fiscal and monetary policies, and has restored the fiscal balance to a sustainable level after two years of high deficits. Further structural measures are important to address impediments to growth and to reduce unemployment. Reforms are necessary to strengthen the investment climate by creating a predictable business environment, implementing judicial reforms, and addressing governance problems. The financial system stability assessment acknowledged the authorities' efforts to improve the soundness of the banking system and to address remaining vulnerabilities.

Abstract

Macedonia's macroeconomic stabilization program continues to rest on the basis of fiscal and monetary policies, and has restored the fiscal balance to a sustainable level after two years of high deficits. Further structural measures are important to address impediments to growth and to reduce unemployment. Reforms are necessary to strengthen the investment climate by creating a predictable business environment, implementing judicial reforms, and addressing governance problems. The financial system stability assessment acknowledged the authorities' efforts to improve the soundness of the banking system and to address remaining vulnerabilities.

I. Introduction

1. A staff team visited Skopje during July 23-August 8, 2003 to hold discussions for the first review under the Stand-By Arrangement (SBA).1 On April 30, 2003 the Executive Board approved the 14-month SBA for SDR 20 million or 29 percent of quota (25 percent of quota on an annual basis), to be made available in five equal tranches—a first purchase upon Board approval of the program and the remainder subject to performance and two program reviews, (IMF Country Report/03/131). The mission assessed performance under the program to date and reached understandings, ad referendum, on a Supplementary Memorandum on Economic and Financial Policies (SMEFP, Appendix IV). The authorities have expressed interest in a follow-up program.

2. All quantitative performance criteria and most indicative targets under the program to date have been met (SMEFP Tables 1 and 2). The fiscal and monetary targets for end-June were met by large margins, mainly due to low fiscal spending in the first half of the year—about 1¼ percent of GDP below the programmed level—and to a return of confidence in the denar. One indicative quantitative target, the non-accumulation of arrears by the Health Insurance Fund (HIF) was not met. In the structural area, the one performance criterion (a July 1 increase in the electricity price) was met, as were the benchmarks on expenditure control, including wages, labor market flexibility and the NBRM audit, but the audit of the HIF was initiated behind schedule.

3. Two years after the signing of the General Framework Agreement for Peace (Ohrid Agreement), ethnic and political tensions persist and significant challenges lie ahead. On the security front, a recent flurry of violent incidents—while largely criminal in nature—is undermining the business climate and testing the capacity of the authorities to maintain order. High—and rising—measured unemployment is also raising the political temperature at a time when overstaffing—in public agencies and enterprises—calls for labor shedding. On a more positive note, consultations between the political parties within the government have become more timely and regular, helping to defuse potentially explosive issues; there are also regular meetings between the Prime Minister and the leader of the main opposition party. A critical test of the political dialogue will be negotiations on municipal boundaries, which are needed in order to move ahead, in 2004, with a politically sensitive program of administrative and fiscal decentralization.

II. Background

4. Growth in 2003 to date was broadly in line with program projections (Text Table 1), but was mainly driven by positive developments in a few sectors. GDP is estimated to have grown by 2.7 percent (year-on-year) in the first half of the year, reflecting one off factors like the strong performance of a small number of exporting companies (for example, the reopening of a closed metals exporter), as well as some positive developments in the trade and transportation sector. A broad-based resumption of growth is still elusive, however, as evidenced by declines in 17 out of 23 sectors in the end-June industrial production index (Figures 1 and 2). The fragility of the economic turnaround was related in part to the abrupt withdrawal of fiscal stimulus in the first two quarters of the year, which offset the lagged effects of the strong fiscal impulse in late 2002. Job creation is also weak as shown by a nearly 5 percent increase in the official unemployment figure which reached almost 37 percent in 2003. The increase reflects job losses in the agricultural and mining sectors, and a large number of entrants into the labor force.

Text Table 1.

Real Sector Developments in 2003

(Percentage change; period average)

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Source: Macedonian authorities and IMF staff estimates.
Figure 1.
Figure 1.

FYRM: Selected Economic Indicators, 1996–2003 1/

Citation: IMF Staff Country Reports 2003, 354; 10.5089/9781451826074.002.A001

Sources: FYRM authorities; and Fund staff estimates.1/ 2003: Projections.
Figure 2.
Figure 2.

FYRM: Real Sector Developments, 1998–2003

Citation: IMF Staff Country Reports 2003, 354; 10.5089/9781451826074.002.A001

Sources: FYRM authorities, and Fund staff estimates.

5. Given that growth in the first half of the year was narrowly-based and dependent on one-time factors, the staff and the authorities agreed to trim the annual growth projection for 2003 from 3 percent in the original program to 2¾ percent. While the increased fiscal impulse in the second half of the year will provide some stimulus, it comes too late to boost 2003 growth significantly, and may spill over into 2004. Nevertheless, growth in the second half of 2003 is expected to be more broad-based than in the first half, spreading to food processing, construction and textiles. A solid performance in the second half of 2003, signaling a decisive turnaround, would be necessary to maintain the program growth projection for 2004 of 4 percent. However, the mission based revised projections for 2004 on a more conservative 3 percent growth assumption, to be reviewed in the context of the 2004 budget discussions (Table 1).

6. The external current account deficit was larger than programmed in the first half of 2003, reflecting a one-off import surge, but a turnaround is expected in the second half as export growth continues (Text Table 2, Table 6). The import surge in the first half of the year, comprised mainly two one-off items: equipment for a newly-opened mobile phone company and exceptional purchases of fuel by government agencies. For the year as a whole, however, the take-off of the steel sector, which is already underway, and a revival of textiles exports are expected to bring the trade deficit back to the programmed level.2 The current account deficit was covered largely by donor financing. Foreign direct investment (Figure 4) declined from already low levels, reflecting high political risk and an unfriendly business climate. Competitiveness indicators remain broadly unchanged ¶2).3

Text Table 2.

Current Account Developments in 2003

(In percent of annual GDP)

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Source: NBRM data and IMF staff estimates.

7. Inflation was close to zero (year-on-year) in early 2003, and the annual projection has therefore been revised down (Text Table 1). The main reasons for the lower than expected inflation in the first half of the year were the appreciation of the euro (to which the denar is pegged) and a dip in food prices due to a good harvest and increased food imports. Even though some developments that will push up prices are expected in the second half of the year, for example, an increase in electricity prices in June following the April VAT increase, the projection for 2003 has been reduced to 1¾ percent from 3 percent in the original program. Inflation is projected to rise to 2½ percent in 2004, or higher if administered prices are increased.

8. Delays in expenditures produced a much larger than planned fiscal contraction in the first half of 2003 (Text Table 3). Expenditures were delayed by the late (March) budget approval, a government review of capital projects, and teething problems with new, stricter, procurement procedures. Consequently, the general government deficit during January-June was below the program projection by the equivalent of 1.6 percent of GDP, with 1/3 of the shortfall in capital expenditure and 2/3 in recurrent expenditure (Tables 2 and 3), (¶13)).

Text Table 3.

Central Government Operations, Revised Fiscal Program, 2003

(In percent of annual GDP)

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

Figures are those presented in (EBS/03/51) except for an increase of Denar 320 million in both revenues and expenditures to present on a gross basis operations that had previously been presented on a net basis.

9. Overall tax collection was in line with projections, but the structure of collections raises concerns about the tax effort. In particular, VAT collection was broadly on target in spite of the import surge and the accumulation of VAT refund arrears, both of which should have raised VAT revenues above the target level. At the same time, VAT collection arrears increased in spite of a program commitment to strengthen the collection of arrears (¶13, 15). In other areas, higher-than-expected corporate profits taxes partly offset weak excise revenues, and pension contributions were well below projections.

10. The restoration of confidence in monetary and exchange rate policies, combined with the liquidity effects of the fiscal tightening, eased pressures on international reserves and enabled the NBRM to lower the interest rate significantly. The clarification of policies following the adoption of the Fund-supported program restored confidence in the denar after a period when poor fiscal management had undermined confidence in monetary and exchange rate policies. At the same time, large liquidity injections in late 2002—resulting from the drawdown of government deposits at the central bank—came to an end in early 2003 when the fiscal position tightened. Consequently, a large and prolonged outflow of foreign exchange reserves slowed to a halt and the NBRM lowered the rates on central bank bills, in stages, from around 15 percent during December-February to 7 percent in April (Table 4). In spite of the lower interest rate, the reserve flow turned positive in July and August, when the central bank made significant net purchases on the foreign exchange market.

11. Commercial banks responded to the cut in the central bank rate by lowering deposit and loan rates (Figure 3) in the context of a significant re-intermediation, particularly in the euroized segment of the balance sheet. Commercial bank rates declined by less than the central bank rate, but nonetheless reached post-transition lows (¶4) and the low rates may have provided some monetary offset to the withdrawal of fiscal stimulus. In spite of the reduced interest rates, denar deposits rose strongly in the first half of the year partly because the elimination of the financial transactions tax reduced the incentive to hold cash. Foreign currency deposits increased by even more, reflecting increased confidence in banks, a narrowing of interest rate differentials which favor denar deposits as well as legislative changes that permitted exporters to retain earnings in foreign currency: overall, foreign currency liabilities rose to more than 40 percent of M3 in June. Foreign currency credit to the private sector rose significantly from a low base, mainly representing on-lending based on credit lines provided by IFI’s and bilateral donors to commercial banks.

Figure 3.
Figure 3.

FYRM: Monetary and Financial Indicators, 1998–2003

Citation: IMF Staff Country Reports 2003, 354; 10.5089/9781451826074.002.A001

Sources: FYRM authorities, and Fund staff estimates.

III. Policy Discussions

12. With growth broadly in line with expectations and inflation low, the main targets of the program—reducing the general government deficit to 2½ percent of GDP by 2004 and keeping gross international reserves at about 4 months of imports—remain appropriate and provided the framework for the program review. Macroeconomic policy discussions focused on whether to preserve the fiscal savings resulting from the underspending in the first half of 2003 or to accelerate spending in the second half in order to reach the annual spending and deficit levels in the original program. Other issues discussed included:

  • A calendar for bringing delayed health sector reforms back on track;

  • Measures to build or strengthen institutions in the areas of domestic debt management, public expenditure management, and fiscal decentralization.

  • Measures—to be incorporated in program conditionality—to increase the stability of the financial sector in light of the findings of the FSAP mission.

A. Financial Policies in 2003 and 2004

A01ct01

FYRM: General Government Balance, 2001–2003

(In percent of annual GDP)

Citation: IMF Staff Country Reports 2003, 354; 10.5089/9781451826074.002.A001

13. The discussions centered on whether to maintain the fiscal targets for 2003 or preserve the unprogrammed savings in the first half, resulting in a lower-than-programmed deficit for the year. While recognizing that the fiscal withdrawal in the first half had been larger than warranted, staff favored keeping budgetary spending in the second half of 2003, and therefore the second half deficit, close to the program targets in order to reduce the volatility of aggregate demand and interest rates and pressures on the current account deficit. In the staff’s view, the alternative—maintaining the 2003 deficit target and allowing expenditure in the second half to substantially exceed the programmed amount for that period—would cause an undesirable whipsawing of expenditure and the deficit (Text Chart). Moreover, the sharp increase in government borrowing would inject liquidity, which the NBRM would need to absorb in order to defend the external targets of the program.4 This could trigger possibly large interest rate hikes. Such volatility in the fiscal stance and in interest rates would introduce additional uncertainty into an already risky environment.

14. While acknowledging staff’s concerns, the authorities took the view that the revised 2003 budget should maintain spending ceilings at levels consistent with the original program.5 They felt that high spending was needed in order to reverse the larger-than-planned negative fiscal impulse during the first half of the year. Moreover, budgetary “saving” in the first half of the year had mainly reflected start-up problems with stringent new procedures for approval of spending programs, not delays or cancellations. Finally, in view of the increase in the VAT earlier in the year, reductions in annual spending allocations, particularly on investment programs, would be difficult at this stage. When staff expressed doubt about the feasibility or desirability of increasing the pace of investment in the remaining months of the year to more than four times that in the first half, the authorities responded that a comprehensive review of investment projects, completed earlier in the year, had already prepared the ground. Administrative constraints would be addressed by focusing on a small number of large, urgently needed, infrastructure projects.

15. On the monetary impact, the NBRM judged that it would be able to absorb the liquidity injected by the fiscal stimulus without raising interest rates paid on NBRM bills. The demand for NBRM bills has been strong over the last months. Furthermore, the recent increase in NIR has created a buffer that could be used to help sterilize liquidity later in the year in case demand for NBRM bills weakens. Recalling the experience of late 2002, the mission emphasized that, should market conditions become less favorable, it would be difficult to absorb a large injection of liquidity without raising interest rates. In response, the NBRM assured staff that it stands ready to increase interest rates, if necessary, to keep foreign exchange reserves above the program floors.

16. The concerns raised in the discussion were reflected in a compromise supplementary budget with a moderate expenditure reduction equivalent to 0.3 percent of GDP. Under this budget, all of the January-June under-spending on capital, but only half of the under-spending on recurrent items will be made up during July-December. In other respects—notably freezes on wages and employment (with exceptions related to the hiring of minorities)—the policies underlying the original budget will be preserved (¶13). The lower current spending will reduce the projected central government deficit from 1.6 percent of GDP under the original budget to 1.4 percent of GDP (Text Table 3) after allowing for the use of some VAT revenues to clear VAT refund arrears. The adoption of a supplementary budget in line with these understandings is a prior action for completion of the review.

17. In spite of the strong increase in fiscal stimulus in the second half of the year, aggregate demand and the external current account deficit in 2003 are expected to remain within program targets because of the backloading of the fiscal impulse. However, there will be some spillover of demand into the first quarter of 2004 and the NBRM needs to be ready to take compensating action, if necessary.

18. The financial program was extended to the first quarter of 2004 (the final quarter of the program) by working back from the agreed budget deficit for 2004 and a target stock of gross reserves equivalent to about four months of imports. In view of the seasonality of reserve money (which is weak in the first quarter), a large London Club payment, and a modest volume of external assistance, the program envisages only a moderate increase in NIR during the first quarter, roughly a sixth of the annual accumulation, The authorities would have preferred a less ambitious NIR target for the first quarter, but staff noted that the proposed target should be achievable as a seasonally low first quarter fiscal deficit would reduce the need to absorb liquidity after the end-2003 injections. In addition, a first issue of treasury securities, expected in the first quarter, will reduce the budget’s reliance on central bank financing.

19. While sufficient balance of payments financing is available up to March 2004, the end of the program period, the mission’s projections for the rest of the year identify an external financing gap on the order of 50-60 million US dollars (Table 6). The authorities are approaching the Fund, the Bank, and other bilateral donors to request balance of payments support in the context of a continued implementation of the Ohrid Agreement and a new or extended IMF program.

20. While it is hoped that external support to fill the gap will be forthcoming in 2004, it is essential that FYR Macedonia moves quickly to strengthen its capacity to borrow domestically and to implement a proactive debt management strategy. The need for domestic borrowing is made urgent by two developments: First, central bank financing will cease to be available once the government’s deposits of privatization receipts have been drawn down.6 Second, balance of payments support can be expected to decline rapidly from the exceptional levels provided in support of the Ohrid Agreement, In addition, large volumes of maturing foreign debt and foreign currency-indexed domestic debt will need to be rolled over during the next six to ten years.7 In this context it may be necessary to issue foreign currency government securities as well as domestic currency securities in order to balance the benefit of reducing the exposure to foreign currency risk with the risk of creating pressures on the balance of payments.8 The authorities plan to issue the first treasury securities in late 2003 or early 2004 (¶20).

B. Structural Reforms

21. Agreed structural measures focus on the stability of the banking system and on strengthening fiscal management, particularly by the health and pension funds.

22. While the FSAP found no immediate threats to the stability of the financial system, it flagged macro-financial risks arising from euroization and institutional weaknesses. Vulnerabilities include weak governance in smaller banks, the high level of non-performing loans, and problems in enforcement due to an ineffective judiciary. Euroization adds to the banking sector’s credit risk since borrowers in foreign currency are exposed to foreign exchange risk. In contrast, bank’s own foreign currency liabilities are covered against depreciation risks.

23. The authorities have already taken steps to implement some of the FSAP recommendations and plan to take additional measures in the context of the program. Parliament has amended banking legislation to strengthen ‘fit and proper’ (¶8) and licensing requirements, extend the range of prompt corrective actions available to supervisors, and introduce new criteria for changes in bank ownership and for bank investments (¶24). Central bank accountability has been increased by obliging the governor to appear before Parliament, codifying the relationship with other supervisory agencies and increasing the exchange of information with the government. Measures to be taken under the program focus on banks’ management of risks related to their foreign currency lending (structural performance criterion) (Box 1, and ¶23). In addition, the legal framework for international money wire services and anti-money laundering will be modified to establish greater supervisory authority in licensing, monitoring and imposing sanctions. (¶25).

24. Measures have been agreed to bring the reform of the health sector back on track. The still pending retrenchment of 1240 employees, which was to have been completed by July 2003, is a key short-term measure in the cost cutting program aimed at eliminating the central budget subsidy to the HIF starting from 2004 (in line with the practice prior to 2002). The retrenchment will be completed in two steps. A first group, 900 employees, will be laid off as a prior action for Board consideration of the review while the remaining 340 layoffs will be finalized by end-March 2004. In mid-September, the authorities decided that personnel to be laid off in the first round would be selected mainly through a voluntary separation program and not, as originally planned, by the health care institutions identifying certain positions as redundant in the context of restructuring plans.9 The staff was concerned that the new approach might lead to the departure of personnel with essential skills, adversely affecting the quality of health care. To avoid such an outcome, the authorities have agreed to carry out a health sector restructuring—prepared with World Bank advice—that will allow for the reduction in employment and for a redeployment of the remaining staff with a view to maintaining the level of health care (¶19). In addition, though with some delay, the government has initiated, with World Bank support, a systems audit of the HIF. Finally, the authorities have committed to prepare, again with World Bank advice, a program of further cost saving measures (¶7, 19). All these measures are essential to bring the cost dynamics of the HIF-with a total budget equivalent to 5 percent of GDP-under control.

Main Recommendations of the Financial Sector Assessment Program

The FSAP focused on bank regulation and supervision and on financial market development. Recommendations sought to enhance market stability and resilience, especially to risks arising from euroization and financial market liberalization.

To strengthen banking and financial market supervision, the FSAP recommended:

  • Advancing to a more risk-based surveillance and monitoring system, and introducing accounting and disclosure standards for banks. In particular, the FSAP highlighted the importance of identifying and managing exchange rate risks arising from unhedged positions of borrowers. Banks are now required to submit to supervisors a report on their risk assessment methodology. In addition, the on-site supervision manual will be revised to require that supervisors check for borrowers’ exchange rate risk assessment in credit files (structural performance criterion).

  • Strengthening bank supervision in the areas of licensing, the quality of bank ownership, and governance. More specifically: strengthening the criteria for bank licensing, mergers and investments; imposing ‘fit and proper’ requirements on bank owners and board members (to replace requirements that were struck down by a Constitutional Court ruling); and empowering supervisors to investigate and seek criminal prosecution in cases where banking activity is undertaken without a license.

  • Broadening supervisors’ authority to enforce corrective actions, and expanding the powers of administrators overseeing weak banks.

  • Strengthening the legal framework for the Anti-Money Laundering/Combating of Financing of Terrorism (AML/CFT) policies and providing legal authority to monitor compliance with the AML/CFT laws and impose sanctions

To develop financial markets, the FSAP suggested introducing new instruments, improving infrastructure in payments and safety net systems, and increasing transparency and accountability. Recommendations included:

  • Developing a government securities market to expand the range of market instruments.

  • Improving liquidity management by introducing repos and increasing the range of instruments eligible as collateral for central bank lending.

  • Establishing a framework for central bank emergency lending.

  • Establishing a remote back-up facility for the Macedonian Interbank Payments Systems (MIPS).

  • Clarifying the policy role for NBRM in the payment system and removing the obligation for NBRM to adjudicate and execute guarantees between third parties (without prior notice to the banks).

25. While plans for a second pillar pension system remain on hold pending further study, weaknesses in the existing pension system need to be addressed immediately. In particular, steps have been taken to strengthen collection of contributions. And, in order to strengthen the medium term viability of the pension fund, the indexation of pension payments to nominal wages will be replaced by a formula which indexes pension increases primarily to inflation (¶17).

26. Improvements in budget preparation and the continuation of the treasury reform are essential to reduce future whipsawing in fiscal policy and to improve the efficiency of spending. Drawing on FAD technical assistance, the government has begun to address weaknesses in the budget preparation process starting with the 2004 budget (¶16) and has taken further steps to improve treasury management and reporting, including the reconciliation of monetary and fiscal accounts (¶27) which is a prior action under the program (Box 2).

FYR Macedonia: Public Expenditure Management Reform

Substantial progress was achieved in treasury reform since 2000. The Treasury now includes virtually all central government revenues and expenditures in a Treasury Single Account (TSA), and produces timely reports on the execution of the central government budget. Further reforms are currently underway;

  • New financing instruments: introduce a treasury securities market; strengthen cash management and link it with debt management; strengthen communication with NBRM on monetary and fiscal policy; establish regular communication with major market players;

  • Reporting and control: develop analytical fiscal reporting in line with the GFS covering central government, local governments, extrabudgetary funds (EBF) and consolidated general government; reconcile fiscal and monetary data; introduce commitment recording and control;

  • Further consolidation of accounts: establish a system to include foreign financed projects in fiscal reports; transfer EBF’s accounts into the TSA as sub accounts with the idle balances to be used to fund any shortfalls in the budget.

While Treasury functions have been improved considerably, budget preparation techniques have lagged. It is necessary to restore balance, not least because the further development of the treasury system is likely to be constrained by the cumbersome budget that it is implementing. Progress is also needed in strengthening budget formulation techniques in order to be able to prioritize country expenditure policies. The following reforms are being initiated:

  • Ensure long term-sustainability: establish a medium-term budgetary framework with forward looking fiscal policy; develop a debt management strategy;

  • Enhance flexibility: increase room for discretionary expenditure and consolidate EBFs (about 40 percent of total expenditure is currently spend through EBFs);

  • Improve transparency: streamline overly detailed economic line-item classification, improve the present functional classification; provide more description of underlying policy, programs, and activities; give time comparison of the estimates; develop internal audit function in the ministry of finance and budget users.

27. While decentralization is a cornerstone of the Ohrid Agreement, an attempt to move ahead without adequate preparation would lead to a loss in fiscal control and a deterioration in the provision of services. The mission urged the authorities to adopt the approach proposed by FAD in 2002 in which resources are devolved gradually as the municipalities develop administrative capacity. To date, prerequisite steps have been delayed (e.g., defining the number and boundaries of the municipalities, strengthening the collection of revenues already administered by local governments). An FAD mission is currently assisting the authorities to draft a law on local government financing that sets out a framework for a phased decentralization and defines administrative preconditions for each phase (¶21).

C. Program Design and Monitoring

28. The original program design remains in place. The mission agreed on revised quantitative performance criteria for September and December 2003 and on targets for March 2004. The NIR target as well as the underlying assumptions for the balance of payment are unchanged (SMEFP Table 1), while the fiscal adjustment (over two years) will be slightly more front-loaded than in the original program. For 2004, the deficit target remains unchanged. As agreed in the original program, the review incorporates new measures recommended by the FSAP mission; other structural benchmarks focus on correcting slippages in the first half of 2003 (SMEFP Table 2). Beside the measures in the health sector, described above, these include structural benchmarks to address weaknesses in tax administration and a liberalization of the tobacco market, in which local monopolies have had access to non-transparent government-financed—and NBRM-financed—guarantee schemes (¶22). Finally, to address concerns raised by the safeguards assessment, the end-2002 submission of the NBRM to the IMF at current exchange rates has been reconciled with the audited financial accounts and a framework has been developed to monitor the program at constant exchange rates (¶29).

IV. Staff Appraisal

29. It is disappointing that, two years after the signing of the Ohrid Agreement, the economic recovery remains fragile. The macroeconomic stabilization underway should help strengthen the business climate, but it will need to be accompanied with measures to address political risks, accelerate structural reforms and create a business-friendly legal environment. Otherwise, it will be difficult to replace donor support in the medium-term with private capital flows, including foreign direct investment. The sharp decline in foreign direct investment in 2003 is particularly worrying and may reflect concerns arising from extensive litigation surrounding earlier privatizations.

30. The fiscal stabilization at the center of the program is on track and puts FYR Macedonia well on the way to restoring fiscal sustainability after the 2001 security crisis. At the same time, the NBRM’s continued steady management of the de facto peg of the denar—including during the crisis—has enhanced the credibility of the central bank and kept inflation low. The reduction in interest rates and the lifting of pressures on the foreign exchange market are testimony of renewed market confidence in the currency and in financial management.

31. Programming fiscal policy in the aftermath of the sharper-than-planned fiscal adjustment in the first half of 2003 has required a difficult choice between saving the over-adjustment and preserving full year spending plans. The compromise reached—preserving annual capital spending plans while reducing current spending plans and the programmed deficit—seems appropriate. It should prevent an undue change in spending plans for the year as a whole while containing the fiscal stimulus in the second half, which will need to be reversed in 2004. In this regard, the staff notes that, should the authorities be unable to achieve their very ambitious investment targets for the second half of 2003, a welcome consequence would be that the large fiscal stimulus, and the need for offsetting measures, will be reduced. The authorities’ plans to strengthen budget preparation and execution procedures should reduce unplanned volatility in the future and are welcome. In the same vein, the management of public sector investments in a multi-year framework should be strengthened.

32. With most of the fiscal deficit now concentrated in the second half of the year, the NBRM’s ability to neutralize a large liquidity injection will be tested. The NBRM’s view that the liquidity can be absorbed without raising the interest rate on central bank bills is plausible in light of the continued strengthening of the external reserves position. Nevertheless, risks remain: a weakening in the demand for central bank bills would lead to a larger than anticipated increase in the interest rate; and staff welcomes the NBRM’s assurance that it will stand ready to raise the interest rate, if needed, to defend the program’s external targets.

33. The delays in the reform of the health sector are worrying, particularly since the major scandals over the past years have made this sector a prominent example of mismanagement and corruption. The staff welcomes the commitment to eliminate the budgetary transfer to the Health Insurance Fund in 2004 and urges the authorities to work with World Bank staff on measures to achieve this objective while improving transparency and governance. As regards the retrenchment of redundant personnel, the reliance on voluntary departures creates some risk that the quality of health care could decline. To manage that risk, the authorities need to move quickly to restructure the sector—in line with World Bank advice—in order to ensure that the layoffs are permanent and that the quality of health care is maintained.

34. The authorities have started implementing the recommendations of the FSAP mission and have prepared further measures to strengthen financial sector stability. Strengthening prudential and supervisory procedures for the banking system is key to controlling the risks for the financial sector during the process of liberalizing capital movements in a highly euroized economy. The authorities have moved quickly to implement some recommendations; the additional measures agreed under the program lay a good basis for limiting the risks associated with financial euroization.

35. It is essential both for macro stability and the quality of public services that the fiscal decentralization be implemented in an orderly way. Staff is concerned that delays in the preparatory steps both on the central and local government levels and political pressures to accelerate the process could lead to a disorderly decentralization process that would deteriorate the provision of services and give room for corruption. Staff therefore urges the authorities to commit to a phased decentralization and to move quickly to put in place the required administrative reforms.

36. Since the performance criteria under the program have all been met and in view of the policies described in the attached SMEFP, the staff recommends that waivers of applicability be granted for the end-September performance criteria, and that the first review under the Stand-By Arrangement be completed.

Figure 4.
Figure 4.

FYRM: External Sector Developments and Competitiveness, 1996–2003

Citation: IMF Staff Country Reports 2003, 354; 10.5089/9781451826074.002.A001

Sources: FYRM authorities, and Fund staff estimates.1/ 2003 Q1-Q2: Preliminary.2/ A sharp increase in imports took place prior to the introduction of the VAT in March 2000.
Table 1.

FYRM: Selected Economic Indicators, 1998–2004

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

As of end-May 2003.

As of end-april 2003.

In the forthcoming SMEFP, 2004 GDP is projected in a range of 3 to 4 percent. For program purposes, a conservative estimte of 3 percent is used.

The decrease in revenue and expenditures is due to lack of reliable data on municipalities. The series are taken out and therefore both revenues and expenditure are lower by 0.4 percent of GDP compared to the last staff report (EBS/03/51, 4/16/03).

Total debt of the general government; includes liabilities assumed by the government upon the sale or closure of loss-making enterprises and associated with the cleaning up of Stopanska Banka's balance sheet prior to its sale.

Includes foregin currency deposits; strong growth of foreign currency deposits in H1 2003 explains the revision of the end-2003 figure.

Includes receipts from privatization of telecommunications company of US$323 million in January 2001.

Debt service due, including IMF as a percentage of exports of goods and services.

An increase means appreciation of the denar. Partner countries include among others Serbia and Montenegro, and Bulgaria.

Table 2.

FYRM: Central Government Operations, 2000–2004 1/

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

Excludes most of the costs of implementing the Peace Framework Agreement. These costs are financed off-budget during 2002–04.

The Ministry of Finance records wages and allowances of reservists during 2001–03 under goods and non-labor services.

Excludes foreign-financed capital expenditure projects. These projects are included in the general government operations (Table 3).

For Q1 2004, the deficit targed of Denar 433 million was set Detailed quarterly revenue and expenditure projections are subject to further discussion during the follow-up 2004 budget negotiations mission.

Deficit for Q1 2004 is fully financed, financing is needed for Q2-Q3 of 2004.

Expenditures by the Ministry of Defense and by the Ministry of Internal Affairs.

Table 3.

FYRM: General Government Operations, 2000–2004 1/

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

Includes all donor funded investment projects carried out by government institutions except a large share of the costs of implementing the Peace Framework Agreement (PFA). Most of the PFA costs are financed off-budget during 2002–04.

The Ministry of Finance records wages and allowances of reservists during 2001–03 under goods and non-labor services.

For Q1 2004, the deficit targed of Denar 433 million was set. Detailed quarterly revenue and expenditure projections are subject to further discussions during the follow-up 2004 budget negotiations mission.

Deficit for Q1 2004 is fully financed, financing needed for Q2-Q3 of 2004.

Expenditures by the Ministry of Defense and by the Ministry of Internal Affairs.

Table 4.

FYRM: National Bank Accounts, 2001–2004

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

Compared to the credit to the government reported in the fiscal file, this number has been corrected for the unclaimed portion of payments foreign currency accounts in line with the definition in the Technical Memorandum of understanding.

This account has been closed in June 2003 in line with the Technical Memorandum of Understanding.

Includes reserve requirements on foreign exchange deposits; scheduled to be introduced in the second quarter of 2003.

Table 5.

FYRM: Monetary Survey, 2002–2004

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Sources: The National Bank of Macedonia; and staff projections.

A loss of foreign reserves equivalent to about Denar 2.1 billion is assumed following the repayment of frozen foreign currency bonds in 2003. corresponding increase in the NFA of the NBRM.

Includes denar loans with foreign exchange indexing clause; i.e. about 25 percent of total private sector denar lending at end-2002.

Includes deposits of extra-budgetary funds and public entities outside the central government.

Adjusted for the removal of fully provisioned loans from banks’ books.

FX assets of DMBs include NFA, RR on FX deposits, loans in foreign currency and, from 2001, denar loans with foreign exchange indexing clause.

Table 6.

FYRM: Balance of Payments, 2001–2004

(In millions of U.S. dollars)

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

Projected trade credits are included in the projected “Errors and omissions, and short-term capital”

Private sector arrears. Clearance of technical arrears to Paris Club is included in debt service due.

Refers to deferral of debt service to Paris Club creditors from April 1999 through March 2000.

Debt service due including IMF as percent of exports of goods and services.

Medium-term and long-term debt including IMF.

Includes the potentiual need for additional Fund financing.