Former Yugoslav Republic of Macedonia: Second Review Under the Stand-By Arrangement and Ex Post Assessment of Performance Under Fund-Supported Programs
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International Monetary Fund
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Publication Date:
25 Aug 2004
eISBN:
9781451826029
Language:
English
Keywords:
ISCR; CR; FYR Macedonia authorities; policy; projection result; government; GDP estimate; current account; foreign currency; FYRM authorities; exchange rate; private sector; Credit
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The staff report for the Second Review Under the Stand-By Arrangement on the Former Yugoslav Republic (FYR) of Macedonia highlights economic developments and policies. FYR of Macedonia’s economic performance since independence has been marked by notable achievements in macroeconomic management, as well as some disappointments in the area of structural reforms. Inflation was brought down from hyperinflation levels to the low single digits by the de facto exchange rate peg, which was sustained in spite of sometimes challenging circumstances.

Abstract

The staff report for the Second Review Under the Stand-By Arrangement on the Former Yugoslav Republic (FYR) of Macedonia highlights economic developments and policies. FYR of Macedonia’s economic performance since independence has been marked by notable achievements in macroeconomic management, as well as some disappointments in the area of structural reforms. Inflation was brought down from hyperinflation levels to the low single digits by the de facto exchange rate peg, which was sustained in spite of sometimes challenging circumstances.

I. Introduction

1. Staff teams visited Skopje during October 29-November 19, 2003, February 4-19, 2004, and May 19-20, 2004 to discuss, respectively the 2004 budget, the second program review, and the ex post assessment.1 On April 30, 2003, the Executive Board approved a 14-month SBA for SDR 20 million, or 29 percent of quota (25 percent on an annual basis). The arrangement was extended to August 15, 2004, after the accidental death of President Trajkovski slowed program implementation and delayed the discussion of the ex post assessment. To date, three tranches of SDR 4 million each have been purchased; the two remaining tranches will become available upon completion of this review. The authorities have indicated an interest in a successor arrangement.

2. The key objective of the program—to regain a sustainable fiscal position after the 2001 security crisis—has been achieved and most end-March program targets were met, although two structural benchmarks and two indicative targets were breached (Table 1 and Appendix I).2 In the staff’s view, the breaches need not stand in the way of review completion (Box 1).

Table 1.

FYRM: Quantitative Performance Criteria and Indicative Targets for 2003 and Q1 2004 1/

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

Adjustments to quantitative targets under the program are described in the Technical Memorandum of Understanding (342 milion denars VAT Arrears and 802 milion denars RF Disbursements for End-March data).

The actual is adjusted to exclude the programmed transfer of unclaimed FFCBs that was scheduled for Q1 2003 but has been effected in Q3 2003.

Earlier reported data IMF Country Report/03/354 on Health Insurance Fund arrears and net credit to the general government was adjusted to accurately reflect credits by domestic banks to the Fund that were previously recorded as arrears.

Earlier reported data on central and general government deficits IMF Country Report/03/354 was corrected for lower privatization revenues, higher non-bank domestic amortization, adjustments to NBRM data on net domestic credit to the government, and adjustments to foreign financing.

Earlier reported actual stock IMF Country Report/03/354 is now adjusted to reflect more accurate data.

3. The accidental death of President Trajkovski in February was handled calmly, and the subsequent presidential election was conducted without major incident. The election resulted in a consolidation of the ruling coalition’s power: the Prime Minister, Branko Crvenkovski, won the presidency and a new government was formed by the Minister of the Interior, Hari Kostov. Most ministers from the previous government kept their portfolios. In an unrelated development, the term of the NBRM Governor ended on May 22; Petar Gošev, a former Minister of Finance, was appointed to the post.

Program Targets

Most end-March targets were met. The exceptions were breaches that did not undermine the objectives of the program, were small in size, or have now been corrected:

  • Health sector retrenchment (structural benchmark). While the benchmark was a cut of 1,240 positions by end-March 2004, (900 positions as a prior action for the first review and another 340 by March), only 1,160 positions have been eliminated.

  • General government deficit in the 2004 budget (structural benchmark). The 2004 budget presents a general government deficit equivalent to 1.4 percent of GDP, not 1¼ percent as agreed in the program. The staff supported this change, which allowed the Road Fund to bring a donor-financed project, delayed in 2003, back on schedule. The increase is more than offset by cuts in borrowing for other capital spending. (The benchmark was set on a definition of general government which includes the Road Fund but excludes some donor-financed projects that are difficult to monitor.)

  • Clearance of VAT refund arrears by end-March 2004 (indicative target). The stock of arrears, which was denar 933 million at end-June 2003, still stood at denar 133 million at end-March 2004. By end-May, the stock had been reduced to denar 40 million. The arrears still outstanding, which are very old, are being verified and cleared. Verification is taking time because the Public Revenue Office’s (PRO’s) database is weak. Nonetheless, the PRO expects to complete the process by end-September 2004.

  • Net Domestic Assets (NDA) of the banking sector (indicative target). The target was breached in March by 0.2 percent of GDP. The breach was smaller by two-thirds than in December 2003: this improvement was in part the result of a tightening of monetary policy in February.

4. Progress toward political stabilization continued in 2004 but the implementation of the Peace Framework Agreement (PFA) suffered further delays. Preparations for decentralization (a key component of the PFA), already well behind schedule, were delayed further by a parliamentary recess after the President’s death. The international community is pressing the authorities to enact the necessary—but highly controversial—legislation in the summer so that local governments can start work in 2005. Another key element of the PFA, hiring “nonmajority” individuals in order to redress ethnic imbalances, is being implemented sporadically but is broadly on track as regards overall numbers.

5. The authorities’ intention to join the EU and NATO—a key government priority—has begun to influence policy decisions. FYR Macedonia submitted a formal application for EU candidacy in March 2004. Admission to candidacy is likely to take some time and accession is years away, but the aquis communautaire, Maastricht criteria, and ERM II rules have already begun to influence the pace and direction of economic reforms. The government has also begun to restructure the army in order to meet standards for NATO accession.

II. Background and Near-Term Prospects

6. Growth has picked up in spite of a significant fiscal retrenchment in 2003, but the recovery was narrowly-based and constrained by the inhospitable business climate. Macroeconomic developments to date have been broadly in line with program targets (Text Table 1, Table 2):

  • The growth pickup in 2003 was fueled by strong household consumption and boosted by the reopening of a major steel exporter. Growth is projected to accelerate slightly in 2004 but remains dependent on the performance of a few key exports, notably steel and textiles. Recent floods in agricultural regions and a first quarter decline in industrial production have introduced downside risks to the projection. For the medium term, the outlook for broad-based and sustained growth is clouded by structural disincentives to investment: a weak judiciary, inflexible labor market institutions and weak governance.

  • Preliminary data for the first quarter of 2004 show a sharp decline in GDP (3.6 percent year-on-year). However, most indicators (such as tax collection and electricity consumption) suggest that the slowdown was much less pronounced than implied by the GDP data. The government has therefore set up a working group to reassess the data. The staff intends to issue a supplement prior to the Executive Board meeting, updating the assessment of macroeconomic developments.

  • Measured unemployment, which was already high owing to labor market rigidity and a wide tax wedge on labor, rose further in 2003.3 High labor force entry, a loss of jobs in agriculture and mining, and the concentration of growth in non labor-intensive sectors all contributed to the rise.

  • Inflation remains in the low single digits, anchored by the de facto peg of the denar to the euro. The inflation rate dipped to an exceptionally low 1 percent in 2003 and early 2004 owing to a decline in food prices and the strength of the euro (Figure 3). To date inflation in 2004 has been below the annual projection (2.8 percent). While food prices are expected to pick up owing to recent floods, inflation could turn out lower than projected.

  • The external current account deficit, while still wide, narrowed significantly in 2003 thanks to the tightening of fiscal policy. FDI, which is low by regional standards, financed only about one-fourth of the deficit (Figures 1 and 5). Donor support and private debt-creating flows more than covered the rest, raising gross international reserves to a comfortable four months of imports by year-end. In 2004, the current account deficit is expected to widen, mostly because of government investments with a high import content. A slight decline in the import coverage of international reserves is projected for the year.

Text Table 1.

Macroeconomic Indicators (2002-04)

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Source: Authorities; and IMF staff estimates.
Table 2.

FYRM: Selected Economic Indicators, 1999–2004

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

As of end-December 2003

As of end-September 2003

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.

The projections for 2003 and 2004 are prepared based on current exchange rate data, while historic data is based on the stock-flow methodology.

Includes foreign currency deposits; strong growth of foreign currency component explains the high growth in Broad Money in 2003.

Adjusted for provisioning until 2002.

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.

Figure 1.
Figure 1.

Cross-Country Comparison of Selected Economic Indicators

Citation: IMF Staff Country Reports 2004, 276; 10.5089/9781451826029.002.A001

Sources: EBRD Transition Report 2003; and World Economic Outlook.1/ Average of EBRD index scores across various measures of transition including liberalization, privatization, enterprise reform, infrastructure, financial institutions, and legal environment.
Figure 2.
Figure 2.

FYRM: Selected Economic Indicators, 1996-2004 1/

Citation: IMF Staff Country Reports 2004, 276; 10.5089/9781451826029.002.A001

Sources: Macedonian authorities; and Fund staff estimates.1/ 2004: Fund staff projections.2/ 2003: Fund staff estimates.
Figure 3.
Figure 3.

FYRM: Real Sector Developments, 1998-2004

Citation: IMF Staff Country Reports 2004, 276; 10.5089/9781451826029.002.A001

Sources: Macedonian authorities; and Fund staff estimates.
Figure 4.
Figure 4.

FYRM: Monetary and Financial Indicators, 1998-2004

Citation: IMF Staff Country Reports 2004, 276; 10.5089/9781451826029.002.A001

Sources: Macedonian authorities; and Fund staff estimates.
Figure 5.
Figure 5.

FYRM: External Sector Developments and Competitiveness, 1996-2004

Citation: IMF Staff Country Reports 2004, 276; 10.5089/9781451826029.002.A001

Sources: Macedonian authorities; and Fund staff estimates.1/ A sharp increase in imports took place prior to the introduction of the VAT in March 2000.

7. In the fiscal area, program targets were met by large margins in 2003 but poor expenditure management and budget planning led to a see-sawing of demand. Spending was very low in the first three quarters, then ballooned in the final quarter when the rebalanced budget let ministries shift surplus funds to expenditure categories where funding was short. The sharp swings in expenditure, and an abrupt relaxation of the tax effort in the fourth quarter produced destabilizing swings in the deficit (Text Figure 1). This stop-go cycle threatens to recur in 2004, since low spending and a renewed tax effort have produced a first-quarter fiscal surplus and set the stage for a second-quarter surplus as well.

Text Figure 1.
Text Figure 1.

Interest Rate and Fiscal Balance 2002-04

Citation: IMF Staff Country Reports 2004, 276; 10.5089/9781451826029.002.A001

Source: Macedonian authorities.

8. The NBRM cut the interest rate drastically when the fiscal stance tightened in early 2003 but did not react in a timely way to the spending hike in the fourth-quarter (Text Figure 1). The budget’s injection of liquidity was thus not sterilized. The result was a large drain in foreign exchange reserves, which led to breaches of several program targets, eliminated a large NIR cushion, and sparked rumors of devaluation (Table 5). The NBRM’s slow reaction resulted in part from a preference for lower interest rates and in part from insufficient advance warning of the government borrowing.

Table 3.

FYRM: Central Government Operations, 2000–04

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

The budget is revised to incorporate external financing closing the financing gap: EU of about US$9 million budgeted in 2003 and received in 2004, EBRD financing of US$13.5 million, and succesion proceeds preliminary estimated at US$8 million.

The lower than programmed social spending in 2003 and 2004 is due to the faster than expected return of refugees and the tightening of criteria for social assistance, child allowances, and other social benefits.

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

Table 4.

FYRM: General Government Operations, 2000–04 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 budget is revised to incorporate external financing closing the financing gap: EU of about US$9 million budgeted in 2003 and received in 2004, EBRD financing of US$13.5 million, and sucession proceeds preliminary estimated at US$8 million.

Table 5.

FYRM: Central Bank Accounts, 2002-04

(Current exchange rate)

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

Excludes the unclaimed amount from the Frozen Foreign Currency Accounts (see definition in the Technical Memorandum of Understanding).

The External Account was closed in June 2003 (see Technical Memorandum of Understanding).

Reserve requirements on foreign exchange deposits were introduced in the second quarter of 2003.

9. The easier monetary stance in 2003, together with increased competition among lenders, contributed to strong private sector credit growth, which continues in 2004 (Table 6, Figure 4). Improvements in the quality of loan portfolios and the strong growth of the deposit base allowed banks to lend aggressively when GDP picked up in 2003. In this more competitive climate, banks promoted new loan products and allowed a greater-than-usual pass-through of the cut in the central bank interest rate. Another factor was an increase in mortgage lending in advance of the January 2004 hike in the VAT on real estate transactions.

Table 6.

FYRM: Monetary Survey, 2002-04

(Current exchange rate)

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

Differs from domestic credit shown in the fiscal tables until 2003 because part of the payments for frozen foreign currency bonds were not withdrawn from the government accounts by the bondholders.

Includes denar loans with foreign exchange indexing clause, amounting to 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.

Includes required reserves (RR) on FX deposits.

III. Policy Discussions

10. Discussions focused on policies for the program period and beyond. The November mission reached understandings on the budget and the macroeconomic framework for 2004. The February mission focused on the implementation of the budget, an interest rate hike needed to reach end-March program targets, and the implementation of structural policies.

A. Fiscal and Monetary Policy for 2004

11. A key policy decision in November 2003 was to maintain the overall macroeconomic framework and—with minor modifications—the 2004 fiscal targets that had been set during the first program review (Text Table 2 and Box 2). This was not a self-evident choice. In light of the tighter-than-planned fiscal outcome in 2003, the original fiscal targets for 2004 deliver a stronger positive impulse than had been envisaged. Was this appropriate in view of an incipient economic recovery and a still-wide external current account deficit (Table 7)? The mission and the authorities agreed that it was. Although growth was picking up, there was no evidence of overheating: unemployment was rising; the external current account deficit had narrowed compared to 2002; and inflation was in check. Bank credit was increasing rapidly, but from a very low base. Debt dynamics were also benign: the projected general government deficit for 2004 was comfortably below the debt-stabilizing level.

Text Table 2.

Fiscal Deficit, 2002-04

(In percent of GDP)

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Source: Ministry of Finance; and IMF staff estimates.
Table 7.

FYRM: Balance of Payments, 1999–2004

(In millions of U.S. dollars)

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

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.

Including IMF and short-term debt.

The 2004 Budget and Revised Budget

The 2004 budget reflects the government’s key priorities—restructuring the army to prepare for NATO accession, hiring minorities in line with the PFA, and increasing spending on roads (to make up for delays in 2003). With tax rates unchanged, budgetary savings to make room for these expenditures include a public sector salary freeze, a 4 percent across-the-board cut in public sector employment, limits on the escalation of pensions, and the elimination of the budgetary subsidy to the Health Insurance Fund (HIF).

It was clear early on that a supplementary budget would be needed to cover policies that were decided upon too late for the budget: civil service salary decompression and additional ethnic hiring. Two items were added later on: the cost of the delay in implementing the 4 percent scale-back in public sector employment and the cost of severance packages for a World Bank-supported railway reform. The latter will widen the deficit by 0.1 percent of GDP but all other expenditure increases will be offset by cuts in recurrent spending. The authorities intend to pass the supplementary budget in September.

12. With fiscal easing in prospect, the mission in February urged the NBRM to tighten interest rates in order to rebalance the policy mix and stem the persistent outflow of international reserves. The outflow signaled an overly loose monetary posture and put at risk the end-March program targets for NIR and NDA as well as the end-year target for international reserves. The NBRM shared the mission’s view and raised the interest rate on 28-day central bank bills by 125 basis points. The Ministry of Finance objected vigorously on the grounds that this hike might raise the cost of borrowing on the new treasury bill market and slow the economic recovery by driving up commercial banks’ lending rates.

13. In the event, the interest rate hike, combined with a tighter-than-anticipated fiscal stance in the first half of the year, had the desired effect. International reserves flowed in for the first time in five months and the end-March program targets for NIR and NDA were met. Commercial banks did not raise lending rates (Figure 4). The staff has emphasized to the authorities that when the fiscal position turns more expansionary later in the year the NBRM will need to consider further increases in the interest rate.

14. The mission also discussed the strong growth in M3 and private sector credit (Figure 4). This reintermediation reflects a return of confidence in banks. While denar deposits increased faster than GDP, much of the increase in M3 was in foreign currency deposits (Table 10). Households deposited “mattress money,” and enterprises deposited export proceeds, taking advantage of the more liberal foreign exchange law. As regards bank credit, the strong growth in lending has not caused, to date, a deterioration of loan portfolios, but makes it necessary for supervisors to monitor asset quality carefully and to increase their capacity to analyze new loan products.

Table 8.

FYRM: Balance of Payments, 1999–2004

(In millions of euros)

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

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.

Table 9.

FYRM: Medium-Term Balance of Payments, 1999–2007

(In millions of U.S. dollars)

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

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.

Including IMF and short-term external debt.

Table 10.

FYRM: Macroeconomic Framework, 1998–2004

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

External current account deficit, excluding official grants (+).

Equal to gross domestic investment minus foreign saving.

In 2001-02, includes security related expenditures and compensation to the depositors from failed pyramid schemes.

Includes domestic debt of central government and external debt of the public sector. Figures include bonds issued in 2001 for the frozen foreign currency deposits, as well as abilities assumed by the government as of end-March 2000 on account of bank and enterprise restructuring, but exclude obligations for retroactive payments to pensioners.

Gross debt net of general government deposits in the banking system.

B. Budget Implementation and Medium-Term Risks

15. Fiscal discussions in February focused on budget implementation and the future impact of reform initiatives underway.

16. On revenues, a sharp drop in VAT collection at end-2003 put tax administration in the spotlight in February, but collection has subsequently picked up and is now on track. The authorities attributed the decline in collection to an abrupt relaxation of the tax effort, which have been corrected by replacing the management of the Public Revenue Office’s (PRO). As of May, VAT was well ahead of program projections while other taxes were broadly on track, except for the corporate income tax, which is running slightly behind projections. Looking ahead, the PRO is taking steps to strengthen collection further.

17. On expenditures, budget implementation was set back in January when most ministries stonewalled a government-approved plan to prune public sector employment by 4 percent across the board. The episode reflects weak ownership as well as poor government discipline. The government introduced a revised plan, under which the retrenchment would be effected by a combination of layoffs—to be completed prior to the current program review—and natural attrition, through the year. The revised plan is a second best: it provides little scope to rationalize employment by selecting non-essential positions for elimination. However, the revision does not reduce the long-term fiscal impact of the retrenchment; for 2004 the fiscal impact of the modification is small and will be reflected in the supplementary budget. The agreed layoffs have now been completed, if at times in a non-transparent way.4

18. The successful launch of a Treasury bill market early in 2004 was an important first step to reducing the government’s dependence on external finance and privatization receipts. The volume of placements was initially smaller than hoped, owing to inadequate promotion and the absence of a secondary market, but more recent auctions have been oversubscribed. The introduction of a secondary market is underway, after a slow start. Once secondary trading picks up, the Ministry of Finance should move into longer maturities.

19. Turning to medium-term issues, the mission urged the authorities to limit the impact on the public sector wage bill of three multiyear reforms now underway (Box 3). The mission supports the reforms—civil service salary decompression, the hiring of ethnic minorities, and administrative decentralization—but noted that too little attention has been paid to phasing, to the interactions between the reforms, and to limiting their cost. Each of the reforms could lock in significant costs that would prove difficult to claw back in future. For the moment, the mission urged the authorities to refrain from further initiatives until overall public sector employment and wage policies had been assessed in a comprehensive multiyear framework.

Budget Risks Associated with Public Sector Reforms

Three major public sector reforms under way present risks for the budget:

  • In April 2004 the authorities began to implement a World Bank-supported program to decompress civil service salaries. Decompression will be achieved mainly by increasing the salaries of senior personnel, raising the average salary by about 20 percent. The fiscal impact in 2004 is small because the decompression will be phased in over three years and applies only to civil servants (12,000 of the 70,000 public sector employees). But Fund staff (and the authorities) are concerned that the wage increases could spill over to political appointees (numbering about 1,000) and to the wider public sector.

  • To date the PFA-mandated hiring of ethnic minorities has been episodic. The cost has been modest, but most of the hiring still lies ahead: the authorities intend to increase the share of ethnic Albanians in the public sector—now 13 percent—by about 10 percentage points. The authorities need to prepare a multiyear plan that uses natural attrition and further rationalization to achieve equitable representation while controlling the wage bill.

  • PFA-mandated government decentralization will start with the creation of new municipal governments in 2005. An effort will be needed to limit the duplication of positions and to exploit synergies with minority hiring. FAD has provided technical assistance on fiscal decentralization; while some FAD advice has been taken on board, key recommendations on municipal borrowing and on an equalization fund have not. At this stage, it is critical that public expenditure management capacity be created in the new municipalities before further spending responsibilities are devolved.

C. Financial Sector Issues

20. In view of the euroization of the banking system and the upsurge in foreign currency lending, tough supervision of exchange rate risks is a priority. A good start has been made. The NBRM has introduced on-site supervision procedures that incorporate borrowers’ exchange rate exposure in commercial banks’ credit risk assessment (structural PC) and has asked the Fund to help train supervisors in assessing exchange rate risks. In addition, the NBRM has put in place more detailed reporting requirements for banks in order to monitor the composition and time structure of foreign currency assets and liabilities.

21. In other areas progress has been mixed. The banking system is still anchored by large banks that appear stable, but little progress has been made in addressing the weaknesses of a few (small) banks under enhanced supervision.5 On governance, a bank partly owned by a political party (in violation of the law) has been sold, but the strategic investor is not a first-tier bank. On the positive side, the NBRM has started to supervise money transfer houses (structural benchmark) and amendments strengthening the Anti-Money Laundering (AML) law have been sent to parliament. However, the implementation of AML measures remains poor because of limited administrative resources.

D. Structural Policies

22. While progress has been made in improving some aspects of the business climate, the most critical reform—that of the judiciary—is only now starting. The new government has made judicial reform a high priority, but plans for a comprehensive reform supported by the World Bank and drawing on expertise financed by USAID are at an early stage. In other areas, steps taken so far to improve the business climate include the establishment of an internal audit unit in the PRO (structural benchmark), the liberalization of the tobacco sector (structural benchmark), and the enactment of the company law.6 In addition, the World Bank and USAID are working with the government on measures to enforce the application of international accounting and audit standards.7

23. In the health sector, only limited progress has been made in cutting costs, increasing transparency, and improving governance. World Bank-supported reforms, particularly the introduction of open, competitive tender procedures, have been subject to delays. Implementation of Fund-supported measures has also been mixed:

  • The HIF has lived within the financial envelope agreed in the program: the budget transfer was cut to zero in 2004 (from 0.2 percent of GDP in 2002-03) and liabilities of the HIF (loans plus arrears) remain at the end-2002 level in line with the spirit of the program benchmark.8

  • In view of the inadequate reporting of the HIF, it is not possible at this stage to assess definitively whether the financial adjustment so far is sustainable. However, pending measures—notably the use of international tenders—should generate further savings.

  • On employment policy, the layoffs fell slightly short of the agreed number (structural benchmark).

  • To improve tracking of financial flows, the Ministry of Finance has taken steps to transfer the HIF’s account balances into the Treasury Single Account.9 HIF resistance could delay implementation beyond the September target date.

  • HIF audit. As agreed, the findings of the State Audit Office’s financial audit, which includes critical remarks on inefficiency and fraud, have been published.

The weakness of the reform effort in the health sector mainly reflects weak oversight and conflict of interest on the HIF’s board.

IV. Program Monitoring

24. Severe problems with data quality made it necessary to correct the reported outcomes of several performance criteria and indicative targets. The most important correction was to repair an omission: borrowing by the HIF had been reported neither by the HIF itself nor by the lending banks.10 Owing to wide overperformance margins, the PCs for June and September were still met after the corrections, which did not give rise to noncomplying purchases.

25. The authorities agreed on measures to improve the data submitted to the Fund. The coverage of HIF borrowing has been corrected in banks’ reports to the NBRM; the coverage of HIF arrears has been strengthened; responsibilities for data compilation have been consolidated at the NBRM; and the PRO is revamping its data management system. More broadly, a fiscal transparency ROSC is planned for early 2005, and the authorities requested technical assistance from the STA based on the findings of a recent statistics ROSC.

26. The elimination of VAT refund arrears, which was to have been a performance criterion, is treated in this report as an indicative target because it was inadvertently omitted from the relevant Board decision. The target was in fact missed, so a waiver would have been needed. Staff would have supported a waiver request because the authorities have now cleared nearly all arrears and provided an explanation of the delay (see Box 1).

27. All the core recommendations arising from FYR Macedonia’s safeguards assessment have been implemented.

V. Ex Post Assessment

28. In its ex post assessment (EPA), the staff found that FYR Macedonia’s IMF-supported macroeconomic stabilization had been successful while the implementation of structural reforms had been weak. In view of this experience, the EPA identified two possible circumstances in which further program engagement could be beneficial. First, a major push to implement ambitious medium-term structural reforms, showing a greater commitment to reform than before, could merit Fund support. Given the time needed, support for such reforms could best be provided through an extended arrangement. Second, in the absence of major structural reforms, an SBA could support a change in the exchange rate regime should that be viewed as necessary given increased capital mobility.

29. The authorities broadly agreed with the assessment but felt that Fund-supported programs had produced greater benefits than were recognized in the report. They stressed that the programs, and the associated conditionality, had buttressed political forces favoring reform. Thus, while progress on the structural side may have been slow it would have been slower still without the presence of a Fund-supported program. They also emphasized that some donor financing was still explicitly contingent on the existence of a Fund arrangement.11 Consequently, the authorities did not wish to restrict the circumstances in which a successor arrangement would be desirable.

30. The authorities shared staff’s view that a new program should give prominence to structural reform and possibly to the exchange rate regime. They emphasized that the new government had a mandate, and the intention, to move ahead with difficult and politically costly structural reforms. On the robustness of the peg, the NBRM’s view was that in the near term pressures arising from volatile, short-term capital flows would be modest and easily contained by existing administrative impediments or by domestic interest rate movements. In any event, the NBRM felt that further analysis was needed to determine the timing of any regime change and saw the need for further capacity building with Fund support. In considering the alternatives, the authorities did not wish to pursue the possibility of a currency board arrangement, which they felt would send an adverse and misleading signal.

VI. Staff Appraisal

31. The recent slowdown in FYR Macedonia’s growth and the wide external current account deficit are both cause for significant concern. FYR Macedonia’s lackluster productivity growth, its continued dependence on a short list of export products, and its rising imports—largely of consumption goods—underscore the risk of a future with slow growth and persistently large current account deficits. What is needed now is steady macroeconomic management and structural reforms bold enough to transform the business and investment climate.

32. By restoring fiscal sustainability, the authorities have achieved the core goal of the program; the challenge now is to ensure that upcoming fiscal reforms do not reverse this achievement. If well implemented, these reforms—fiscal decentralization, equitable representation of ethnic groups in public employment, and salary decompression—can contribute to political stability and more effective government. Otherwise, they could weaken administrative capacity and increase costs. Success will require more forward planning, and more attention to medium-term costs than has been evident to date.

33. The fiscal position in 2004 strikes an appropriate balance between growth and balance of payments objectives. The stimulus delivered by the 2004 budget is not inappropriate in view of the high unemployment and evidence of a growth slowdown. And public investment programs need to be put back on track. But a still more relaxed fiscal position would not be advisable, given the wide external current account deficit. The staff therefore welcomes the authorities’ commitment to keep the fiscal framework in place when preparing a supplementary 2004 budget.

34. The authorities should avoid repeating in 2004 the stop-go outcome that marred the 2003 budget execution. The end-year burst of spending in 2003 weakened the budget process and provoked speculative outflows of foreign exchange. In light of the underspending in the first half of 2004, there is a risk that the stop-go pattern will be repeated. To prevent this, the authorities should take immediate steps to strengthen budget planning and expenditure management. In any event they should refrain from another end-year spending spree, even if this restraint means lower-than-budgeted spending.

35. In managing monetary conditions, the NBRM should not again react too slowly when financial market conditions call for higher interest rates. In view of the robust growth in private sector credit and a likely increase in government borrowing in the months ahead, the central bank may need to increase the interest rate further in order to keep foreign exchange reserve cover at a comfortable level. Its readiness to do so will be a test of the NBRM’s independence.

36. The rapid growth of bank deposits and bank credit signals a return of confidence in banks, but also highlights the need to strengthen bank supervision. Since financial euroization is already deep and much of the new lending is in or indexed to foreign currency, recent steps to strengthen supervision of the exchange rate exposures of banks and their clients were welcome, but these initiatives need to be carried forward by providing further training for supervisors and developing the capacity to analyze the more detailed information on foreign currency exposures that banks now provide.

37. Although the de facto peg to the euro continues to serve FYR Macedonia well, the exchange rate regime needs to be kept under review. The peg has anchored both monetary and fiscal policy, and its robustness during several crises has lent it credibility. While exposure to volatile shifts in sentiment by foreign investors–which would weigh on the side of modifying the exchange rate regime–is not expected to become an issue in the near future, recent movements in foreign currency-denominated bank assets and liabilities underscore that shifts by domestic investors may be important. As proposed in the EPA, the staff encourages the authorities to make their decision on the exchange rate regime from a position of strength and stands ready to provide such technical support as the authorities may need.

38. With the successful implementation of this program, FYR Macedonia’s post-crisis financial stabilization is complete, but the inhospitable business climate is still stifling growth. Improving the business climate poses two major challenges. First, to press ahead and implement the PFA. This must be done quickly, to regain momentum after lengthy delays. It must also be done well or else the reform will be costly and counterproductive. Second, to move ahead with structural reforms. As indicated in the EPA, key reforms include strengthening the judiciary, reducing tax and institutional disincentives for employment, and improving governance and public sector management. The delays and non-transparency that have marred the ongoing public sector retrenchment suggest that the authorities are still hesitant to take politically difficult measures.

39. A reform of the HIF will be an important test of the authorities’ commitment to fight corruption and improve basic social services. While there is some evidence of progress in fighting corruption in the public sector, governance at the HIF remains weak and has contributed to non-transparency, high costs and mismanagement.

40. Since all performance criteria have been met, and since the objectives of the program have been reached, the staff recommends that the second review under the SBA be completed.

Figure 6.
Figure 6.

FYRM: Recent Developments and Medium-Term Projections, 2000-2008 1/

Citation: IMF Staff Country Reports 2004, 276; 10.5089/9781451826029.002.A001

Sources: Macedonian authorities; and Fund staff estimates.1/ 2003 onward: Projections.
Table 11.

FYRM: Indicators of External and Financial Vulnerability, 1999-2003

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Sources: The FYRM authorities; and IMF staff estimates and projections.

The previously used time series, which was taken from the BOP, was replaced by data taken from commercial banks’ balance sheets.

APPENDIX I Structural Performance Criteria and Structural Benchmarks Under the Stand-By Arrangement

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APPENDIX II FYR Macedonia—Fund Relations

(as of May 31, 2004)

I. Membership Status: Joined 12/14/92; Article VIII

II. General Resources Account:

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III. SDR Department:

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IV. Outstanding Purchases and Loans:

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V. Latest Financial Arrangements:

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VI. Projected Payments to the Fund (Expectations Basis)1

(SDR million; based on existing use of resources and present holdings of SDRs):

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Projected Payments to the Fund (Obligations Basis)2

(SDR million; based on existing use of resources and present holdings of SDRs):

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VII. Safeguards Assessments:

Under the Fund’s safeguards assessment policy, the National Bank of the Republic of Macedonia (NBRM) is subject to a full safeguards assessment with respect to the Stand-By Arrangement, approved on April 30, 2003. The assessment was completed on April 24, 2003 and proposed specific measures to address a few weaknesses, as reported in IMF Country Report/03/151. These measures are being monitored by staff under the present Stand-By Arrangement.

VIII. Exchange Arrangement:

The currency of the FYRM is the denar. The FYRM maintains a managed floating exchange rate system with a de facto peg to the Euro. Households can transact only through commercial banks or through foreign exchange bureaus that act as agents of banks; enterprises can transact through the banking system. The reserve requirement on all foreign currency deposits is set at 7.5 percent.

At end-October 2003, the official exchange rate was denar 55.8 per U.S. dollar. The FYRM has accepted the obligations of Article VIII, Sections 2, 3, and 4 with effect from June 19, 1998. The FYRM maintains an exchange restriction subject to the Fund’s approval under Article VIII, Section 2(a) arising from restrictions imposed on the transferability of proceeds from current international transactions contained in former frozen foreign currency saving deposits.

IX. Article IV Consultations:

The first consultation with the FYRM was concluded in August 1993. The last consultation was concluded on April 30, 2003 IMF Country Report/03/131. The FYRM is on the standard consultation cycle.

X. Technical Assistance (since 1999)

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XI. Resident Representative

The Fund has had a resident representative in Skopje since 1995. Mr. Kevin Ross has held this position since May 2003.

APPENDIX III FYR Macedonia—Statistical Issues

The authorities, with technical assistance from the Fund, and other bilateral and multilateral agencies, have made significant progress in upgrading the country’s statistical system in recent years. Continued efforts are made to further improve the quality and data availability of the country’s statistical system. Data reporting to the Fund remains timely and an IFS page is available. The authorities began participating in the General Data Dissemination System (GDDS) from February 2004. A data ROSC mission was conducted in mid-February 2004. A fiscal ROSC mission and technical assistance for BOP have been proposed for 2004.

Real sector data have improved, but remaining deficiencies need to be addressed. Quarterly GDP volume estimates, based on a set of production indicators, are being produced on a regular basis. These estimates are revised to be consistent with the final annual GDP figures. Quarterly GDP data using the expenditure approach are not available but are expected to be developed within a year and a half under a Fund technical assistance program in national accounts agreed with the authorities in May 2004. Calculations of deflators should be reviewed, as historical deflators appear to be out of line with price developments elsewhere in the economy. Deficiencies in inventory valuation have been identified. Consumer, retail, and producer price statistics are compiled on a timely basis. However, methodological improvements are needed in the calculation of the producer price index. Employment statistics continue to be unreliable. The annual labor force survey has been conducted every April since 1996, except 2001 when it was postponed until October 2001 following the outbreak of the security crisis.

The compilation and coverage of balance of payments data, in particular on external debt, have improved in recent years. However, a large portion of private transfers and short-term capital flows is unrecorded, which manifests itself in significant and fluctuating errors and omissions. Kosovo-related non-resident purchases are recorded as a separate item under exports of goods and services in the national income accounts but are not fully captured in the exports of goods and services under the balance of payments statistics. The technical assistance mission from the Fund in June-August 2000 identified the following areas where improvement was needed: (i) recording of external assets and liabilities of the monetary authorities in accordance with the BPM5 methodology, and (ii) correcting the overstatement of private transfers due to transactions involving foreign currency accounts. Furthermore, the October 2002 STA technical assistance mission recommended further improvements to the estimation of short-term trade credits, reviewed the work that had been carried out to adjust for the “Euro-conversion effect” and to improve the valuation of transactions in goods. Further recommendations were made relating to the valuation of imports of goods and to the estimation of transportation services. A mission is planned for late 2004 to provide assistance with the implementation of new data sources—new surveys for short term trade credits and transactions of residents through their accounts abroad—and improvements to the data collection for direct investment and external debt.

No government finance statistics (GFS) have been reported to STA since the annual data for 1996 were provided by the Ministry of Finance and published in IFS. However, satisfactory sources exist for central government fiscal data from which GFS can be compiled. The financing data for the central government from the BOP and the monetary survey is now being reconciled on a monthly basis in line with the recommendations by the recent (June 2003) FAD technical assistance mission and discrepancy has been significantly reduced. The data for extra-budgetary funds are less reliable than the central government data; however, the authorities have started ad hoc monetary and fiscal data reconciliations for individual funds. Off-budget operations and special revenue and expenditures of line ministries have been compiled with a lag since February 2001 and are presented in the budget document. General government table, consolidating central government and funds’ operations, was presented to the Parliament for the first time with the 2004 budget. Data on central government domestic arrears has improved following introduction of commitment accounting in autumn 2003. Data on funds arrears, especially of the Health Insurance Fund, remain unreliable.

Money and banking data are reported to the Fund on a regular basis. However, there is a need for the National Bank of Macedonia (NBRM) to review the effectiveness of processes in place for reviewing and assessing the accuracy and reliability of source data for compiling monetary statistics. On several recent occasions, data inconsistency and misclassification have been identified. The institutional coverage of monetary statistics could be improved by including all other depository corporations, such as savings houses. Improvement of the analytical usefulness of interest rates could be made by compiling weighted average lending and deposit rates for different maturities. Other improvements need to be made in the data reported by the commercial banks to the NBRM for specific analytical and supervisory purposes, such as reporting of data on credit by economic activity, currency (including indexed lending) and maturity, and monthly data on full financial statements of the banks. The authorities have started reporting monetary data on both current and constant exchange rate basis although reconciling the data continues to be difficult due to weaknesses in institutional capacity. A monetary and financial statistics mission has been scheduled for early 2005 to follow up on the data ROSC mission in 2004.

FYR Macedonia—Core Statistical Indicators

(as of July 1, 2004)

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List of abbreviations:

  • NBM: National Bank of Macedonia

  • MOF: Ministry of Finance

  • UR: Unrestricted use

  • SB: For use by staff and the Executive Board

  • SOM: Statistics Office

Preliminary data received by Fund staff before it has been published by the authorities should be treated as confidential.

APPENDIX IV FYR Macedonia: IMF—World Bank Relations

Partnership in FYR Macedonia’s Development Strategy

The former Yugoslav Republic of Macedonia (FYR Macedonia) has been a member of the World Bank since 1993. Since FYR Macedonia joined the Bank, 29 loans have been approved with a total value of over $655 million. Of this, over $290 million has been extended under IBRD and over $365 million under IDA. Approximately $90 million remains undisbursed as at May 2004. FYR Macedonia graduated from IDA in 2003, and all new lending to FYR Macedonia is now on IBRD terms.

Table 1.

Summary of World Bank Operations

(As of May 2004)

(In US$ Millions)

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2. The World Bank’s Board endorsed a Country Assistance Strategy (CAS) for FYR Macedonia on September 9, 2003. The CAS presents an IBRD program of support which seeks to build on the improved macro-economic management and progress in structural reform that has occurred since the formation of the current Government following elections in September-2002. While considerable risks remain, the CAS reflects the window of opportunity for improved growth presented by the relatively calm internal and external environment, following regional conflict during much of the 1990s and the internal conflict in FYR Macedonia that was concluded with the Ohrid Peace Agreement of August-2001. The Stabilization and Association Agreement (SAA) signed between the Macedonian Government and the European Union in 2001 also provides a longer-term framework for the development agenda in FYR Macedonia, supported by FYR Macedonia’s application in early-2004 to join the EU.

Bank Group Strategy

3. Reflecting Government priorities, the CAS outlines three broad themes for World Bank assistance to FYR Macedonia: (i) promoting the efficient management of public resources and tackling corruption; (ii) promoting the creation of jobs through sustainable private sector led growth; and (iii) promoting social cohesion, building human capital and protecting the most vulnerable. Following ethnic tensions in 2001, the reform agenda was largely derailed and much of the program, under a TSS, focused on reconstruction and reconciliation, as well as a range of community focused programs intended to provide a peace dividend. Activities started in the late 1990s to support key road and energy infrastructure also continued. With a more conducive environment for reform, recent adjustment operations and associated investments have focused especially on strengthening public sector management. While maintaining a focus on key areas of public sector reform, the future program is anticipated to increasingly support Government efforts to improve the business environment and support broad-based growth and employment.

4. The CAS envisages a high-case program of up to $165 million over three years. In approving a Public Sector Management Adjustment loan and interlinked health and social protection investment operations in May-2004, the World Bank Board agreed that it was appropriate to move to a high case lending scenario subject to continuing policy performance. Disbursement of the bulk of the adjustment operation is, however, dependent on continuing reform of health sector management, which has proved a particularly problematic area in the past. Lending will be supported by a substantial body of diagnostic and fiduciary work and substantial TA. An indicative program is outlined in Table 2.

Table 2.

The Planned IBRD Assistance Program FY04-06

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5. Promoting the efficient management of public resources and tackling corruption. The Macedonian Government has been successful in stabilizing the economy. Macro-economic indicators have improved, and fiscal policy is relatively prudent. Nevertheless, public resource management has been, and remains, a major issue. Despite progress, much remains to be done, especially in strengthening fiduciary controls over public finances. A critical weakness which remains, and which has been a major source of corruption and misuse of public resources in the past, is the operation of four extra-budgetary funds, which have been outside the control of the central government budget and are subject to weak oversight. These together comprise approximately 40 percent of general government spending. The Bank is providing advice and assistance to support the Government to meet its commitments to the IMF to consolidate the extra-budgetary funds within the Treasury Single Account. The civil service and broader public sector employment structures require considerable reform, which is being supported by the Bank and the IMF. Significant function decentralization, as envisaged in the Law on Local-Self Government will also pose significant challenges.

6. Financial support and associated policy dialogue linked to the recently approved Public Sector Management Adjustment Loan (PSMAL 2) will assist as further measures to consolidate improvements in budgetary planning and execution such as the implementation of controls over commitments by budget entities, which was put in place in September-2003. A key element of this loan, and the associated Health Sector Management Improvement Project will be the reform of the Health Insurance Fund and the strengthening of pharmaceutical procurement through international competitive bidding. The ongoing wage decompression for the civil service will make a start at creating a structure that would help attract and retain qualified staff in the civil service and reduce some of the incentives for corruption. Reform of the existing instruments of social protection to improve targeting, eliminate adverse incentives affecting the labor market, and reduce the fiscal drain on government finances will also be supported. As progressively deeper reform of public administration is currently anticipated through the CAS period, the Bank will also look, as part of a high case lending program, to commence a three-year series of linked Programmatic Structural Adjustment Loans. The PSAL operations are planned to support both the improvement of public sector management and reforms to improve the investment climate.

7. Lending has been supported by a range of analytic work focused on improving public expenditure management. This includes a Public Expenditure and Institutional Review (PEIR) conducted in 2000, a Country Procurement Assessment Report (CPAR) in 2002, a Country Financial Accountability Assessment (CFAA) in 2003 and a Country Economic Memorandum in 2003. A PEIR update and a further CPAR are anticipated in FY06 to review progress.

8. Promoting the creation of jobs through sustainable private sector driven growth. A rebound in private sector activity and growth will be critical to reduce poverty in FYR Macedonia, especially given persistently high unemployment. Extensive work will be undertaken to define a multi-year program of reforms aimed to stimulate the private sector. This will include measures to improve the business environment, further strengthen the broader financial sector, improve the functioning of the judiciary and the application of commercial legislation, strengthen the land titling system and the scope for borrowers to use secure title to access credit, and complete the process of resolution of state owned enterprises.

9. Despite a relatively sound macro-economic environment, comparatively slow progress with structural reform has resulted in disappointing growth and employment creation. A key element of reform, the resolution of the largest loss making enterprises through privatization, financial restructuring, or closure, has been largely completed, with the Financial and Enterprise Sector Adjustment Loan (FESAL) supporting the sale or closure of approximately forty loss–making enterprises by December-2003. Nevertheless, the enterprise sector remains inefficient and uncompetitive. Weak enforcement of contracts and protection of property and creditor rights remain significant impediments to robust private sector growth. Given the importance of contract enforcement, creditor and property rights for private sector activity, the Bank intends to retain a degree of flexibility in designing future activities to support short-term actions that might be needed to implement recommendations of the judicial and legal diagnostic study (currently under preparation), and which could also contribute to the preparation of the groundwork for the planned free-standing project. Analytical work by the Bank and the IMF, including a ROSC (Report on Observance of Standards and Codes) on Accounting and Auditing, indicates that the observance of auditing and accounting standards in FYR Macedonia is poor, and contributes to the overall climate of poor fiduciary control. Changes currently being processed to the Audit Law should, however, help to ensure that a framework is in place to address these issues.

10. As with the public sector reform program, the Bank’s support to this objective will be anchored in programmatic lending, specifically through the linked PSAL operations. Adjustment lending will be supported by a series of complementary and linked investment operations. Reflecting the constraints to growth posed by a lack of secure land titles, a Land Registration project is planned for FY05 to support the completion of a real estate cadastre and the building of capacity to support land title transfer and land use monitoring. A Business Environment investment operation scheduled for late FY05 or early FY06 will focus on (i) improving business entry, operations, and exit; and (ii) enhancing the competitiveness of the enterprise sector. This will draw in part on the joint IMF and World Bank Financial Sector Assessment Program completed in September-2003 which identified priorities for strengthening of financial sector supervision and regulation. In addition, a Legal and Judicial Diagnostic study will expand on other studies which have identified significant weaknesses in the judicial system that adversely affect creditor and property rights, as well as generally undermining the rule of law. On the basis of this analysis, a Regulatory and Judicial Reform project is also planned for FY06, with a particular focus on improving the application and enforcement of commercial law. This will need to be coordinated closely with the European Commission, which has the lead among donors in the legal and judicial sector, as well as to ensure that proposed reform is consistent with the EU acquis communautaire.

11. In order to provide an enabling environment for private sector led growth, interventions in the transport and energy sectors are intended to increase private participation, improve services, and explore opportunities for greater sub-regional cooperation. Given FYR Macedonia’s land-locked position, improvements in the transport sector are essential for regional integration and to promote growth. A primary objective of a Railways Restructuring project planned for FY05 is to restructure Macedonian Railways to facilitate the opening of the transport sector to private sector investment and to reduce the burden on public finances from mounting losses. The Bank will also continue efforts to assist the harmonization of customs and improve trade links through the regional Trade and Transport in South East Europe (TTFSE) initiative. An Energy Sector Strategy will seek to analyze options for alternative fuel sources for FYR Macedonia giving dwindling lignite supplies as well as exploring possibilities to diversify electricity supply and integrate more closely into regional energy markets. This work will inform the design of an Electric Power Development project. Through this project the Bank will seek to catalyze partnerships with other institutions and the private sector, as well as reducing electricity losses in distribution. This operation will take advantage of the Bank’s position to overcome obstacles to private sector involvement in infrastructure provision.

12. Promoting social cohesion, building human capital and protecting the most vulnerable. The Kosovo crisis and the civil conflict of 2001 eroded social cohesion. There are substantial social and economic differences between FYR Macedonia’s ethnic communities, rural and urban populations and, more generally, between sub-regions of the country. While the implementation of some provisions of the Ohrid agreement has begun to promote reconciliation and reintegration of communities, there remains a substantial unfinished agenda.

13. The Government’s primary vehicle for improving social cohesion is the Ohrid Agreement. Given significant donor assistance pledged to support the implementation of the agreement, and especially to support technical capacity building at the municipal level, the Bank will not focus its resources in this area. The Bank will, however, be looking to support specific elements of the decentralization process and seeking to mitigate against critical risks, such as a breakdown in the delivery of key services. Support will focus especially on education. The Education Access Improvement project is focusing on improving the quality of primary and secondary education in FYR Macedonia while piloting new financing arrangements. The project will seek to improve the access of minority groups to education, including support especially for Roma children who remain particularly disadvantaged. Through the adjustment lending program and the Health Systems Improvement and Social Protection projects the Bank will also assist the government with a redesign of the existing social protection system to improve targeting of the safety net and provide better coverage of the poorest. The improvements in the transparency and accountability of health service delivery expected under the project will also be important to improving access to and quality of health care for the most vulnerable. The Bank will be working closely with the government to implement pension reform to improve the long term financial sustainability of the pension system, while mitigating the significant risks that exist. The Bank will also continue to support the broader reconciliation agenda through its existing portfolio, in particular through the Children and Youth Development and the Community Development projects under implementation.

14. Lending operations will be supported by a range of technical assistance and analytic activities. A Programmatic Poverty Assessment is intended to provide a comprehensive analysis of poverty data, as well as building the capacity of national institutions to collect and analyze data. Results of the November-2002 census will allow for the formulation of a new sampling frame and renewed analysis of poverty data from previous years. Although data deficiencies mean this is unlikely to be sufficient to deliver a robust poverty assessment, it will provide a much more accurate poverty profile than currently available and form the basis for more regular poverty monitoring reports. The proposed poverty assessment activities related to the evaluation and assessment of government programs will assist the authorities in better targeting of policies and improve public resource management.

Bank—Fund Collaboration in Specific Areas

15. World Bank assistance for structural reform in FYR Macedonia has supported the IMF’s lead role on support for macro-economic policies aimed at facilitating sustainable growth. Continuing collaboration is likely to become even more critical given that most of the outstanding areas for reform remain on the structural side. In areas of direct interest to the IMF, the Bank is engaging in policy dialogue and providing financial and technical assistance to support (i) improved public expenditure management; (ii) public sector reform; (iii) pension, health and social assistance reform; (iv) financial sector reform and development; (v) an improved policy environment for business, including legal and judicial reform, with a focus on the application of commercial law. This is set out in Table 3.

Table 3.

IMF—World Bank Collaboration in FYR Macedonia

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16. Public expenditure management. The Bank has complemented IMF policy conditionality and technical assistance to improve budget management with a multi-pronged assistance program including lending operations and fiduciary and diagnostic work. A range of weaknesses in public resource management identified in a Public Expenditure and Institutional Review (PIER) conducted in 2000 have since been addressed in a revised Law on Budget and Financial Management and other enabling legislation. The implementation of an effective treasury system, and a further systems upgrade being undertaken in September-2003, have been important steps forward in improving budget execution and strengthening expenditure control systems, although further improvements are needed especially in budget preparation and the establishment of a medium-term budgetary framework. The Law on Budget and Financial Management and the Law on State Audits have also provided a solid legislative basis for the operations of the State Audit Office and the establishment of internal audit functions, although this function will require further strengthening. The Country Procurement Assessment Report (CPAR) and the Country Financial Accountability Assessment (CFAA) undertaken in 2002 has helped to define further public expenditure management components and conditionality included in PSMAL II.

17. Public sector reform. The civil service and broader public sector employment structures require significant reform. Hiring has often proved to be politically motivated, although progress has been made to improve systems and to focus on merit, including the passage of and subsequent revision of a Law on Civil Servants and recent enforcement efforts. Recent wage decompression supported through PSMAL II should help to start improving the civil service salary structure, which is highly compressed and remains an obstacle to attracting and retaining skilled staff. The Bank and IMF will need to work closely to ensure that an appropriate framework is in place to allow the Government to move ahead with efforts to increase minority participation in the civil service in a manner that is fiscally responsible. Bank efforts to strengthen structural improvements in civil service salary scales, have been supported by IMF conditionality that has supported Government efforts to streamline overall civil service staffing. As progressively deeper reform of public administration is currently anticipated through the CAS period, the Bank will also look, as part of a high case lending program, to use the programmatic PSALs to continue to engage on civil service reform.

18. Pension, health and social assistance reform. The Bank and the IMF are cooperating closely to assist the Government to improve management of the Health Insurance Fund and the Pension Fund, which are the largest of the extra-budgetary funds, that the Government is consolidating within the Treasury Single Account. Continuing reform will be critical to reduce liabilities on the central government budget from these sources and to reduce opportunities for corruption and mismanagement, for which such funds have in the past proved a source.

19. Inefficiency and corruption in the state Health Insurance Fund (HIF) and state-owned healthcare institutions is a major source of poor performance in the health system. Efforts at reform have been tentative, though progress has occurred in some areas. For example, the HIF now contracts with private as well as public primary care providers. The Bank is also supporting the Government in its commitment to audit the Health Insurance Fund and to implement cost saving measures to ensure that further transfers to the HIF are not required from 2004. This will include new tenders for pharmaceuticals and other efficiency gains. Completing the audit of the HIF, implementing an action program to improve control and procurement systems, and undertaking international competitive bidding for pharmaceutical are key performance triggers for the disbursement of PSMAL II. Bank support for structural reform in the health sector has been supported by IMF conditionality to implement a redundancy program aimed at reversing the large number of appointments made immediately prior to the 2002 election.

20. Further reform of the pension system is also urgent. In 2002, the Pension and Disability Insurance Fund (PDIF) required considerable transfers from general revenue to meet expenditures. The structural deficit in the PDIF is expected to grow into the future. Reform will need to include parametric changes, along with efforts to improve administration through strengthened accounting and improved internal controls. The Bank has been active in supporting pension reform efforts in the past through a series of operations and technical assistance. The recently approved Social Protection Project, will focus especially on strengthening the financial sustainability of the current defined benefit “first pillar” pension scheme, as well as ensuring that essential pre-conditions for the move to a “second pillar” (including sufficient depth and breadth of financial instruments to allow a sensible investment strategy) are put in place.

21. Financial sector reform and development. The health of the banking system has been improved through the strengthening of regulatory and supervisory framework and the resolution of a number of problem banks, but the sector remains under-developed and significant weaknesses persist. More effective banking and financial market supervision will especially be important to improve financial stability and integrity and to ensure that capital is allocated efficiently to promote private sector led growth. The Government has already taken steps to implement the recommendations of the joint IMF and World Bank FSAP completed in September-2003, including moves to improve central bank accountability and strengthen banking and financial market supervision. A planned Business Environment project will assist further improvements in the regulatory and supervisory framework for the financial sector, including the insurance and pension systems, strengthening the legal framework for Anti-Money Laundering. Counter-Terrorist Financing (AML/CTF) polices and provide legal authority to monitor compliance. The operation will also support efforts to promote financial market development, including increasing market breadth, by the introduction of new instruments and increase transparency and accountability.

22. Improving the business environment. Improving the business environment will be crucial to overcome very high levels of unemployment and to attract investment flows, which, to date, have been disappointing. Complementing IMF dialogue with the Government o maintain a stable macro-economic environment conducive to increased private investment, the Bank will be engaging in policy dialogue through proposed adjustment operations, as well as providing technical and financial support to assist the Macedonian Government engage in structural reform. Extensive work will be completed through FY04 and FY05 to define a multi-year program of reforms aimed to stimulate the private sector. A proposed business environment investment operation could potentially help to: (i) reduce the heavy regulatory burden on business, including through streamlined licensing systems and increased accountability of Government processes; (ii) strengthen the institutional and regulatory framework to enhance competitiveness and encourage healthy competition, including through strengthening the anti-trust regime and improved standardization, testing and quality systems; and (iii) improve access to finance and commercial information, including upgrading credit information systems. This reform agenda will be coordinated closely with European Commission institutions, especially in those elements of the reform agenda, such as competition policy, that are linked with the acquis communautaire.

23. Legal and judicial reform will also be a crucial element in strengthening the business environment in FYR Macedonia. A legal an judicial diagnostic study is currently underway in order to provide a basis for policy dialogue through the linked PSAL adjustment operations and for a proposed investment project. Systemic problems in the Macedonian judicial sector include weak enforcement of creditor and property rights, high levels of politicization at all levels in the courts, lack of accountability of judges and the absence of a systematic program of assessment, review and training of judges. This will focus on the impediments in the legal framework and key institutions necessary for the effective enforcement of creditor, contractual and property rights, in particular the linkages to the judicial system.

APPENDIX V FYR Macedonia: Selected Social and Demographic Indicators

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Sources: World Development Indicators, 2002, World Bank; FYR of Macedonia: Statistics Office; Bulgaria: Poverty Assessment Update, 2001, World Bank; World Development Report 2002, World Bank; and Albania: National Strategy for Socio-Economic Development, Medium-term Program of the Albanian Government “Growth and Poverty Reduction Strategy”, November 2001.

Percentage of population below the national poverty line. For FYR of Macedonia, the poverty rate or the incidence of poverty is the proportion of individuals with an income (consumption) below 70 percent of median monthly 2000 consumption. Data for Romania refer to 1994. For Bulgaria, data refers to 2001 and the poverty rate is the proportion of indifiduals with consumption below two-thirds of median consumption in 1997. Data for urban Albania refers to 1998.

Data for Macedonia is for 1997.

Data for Albania is for 1995, and for Romania is for 1996.

Data for Macedonia is for 1999.

APPENDIX VI FYR Macedonia: Millennium Development Goals

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Sources: World Development Indicators database, April 2004.
1

The staff teams comprised Mr. Rozwadowski (head), Ms. Dieterich, Ms. Ribakova, and Ms. Tuladhar (all EUR), and Mr. Loko (PDR) (for the February mission). Mr. Lane (PDR) and Mr. Rozwadowski discussed the ex post assessment. The missions were assisted by the Resident Representative, Mr. Ross, and met the Prime Minister, key economic ministers, and the Governor of the NBRM. The mission also met labor leaders, the leaders of some political parties and representatives of the international community.

2

Several end-December 2003 targets, including performance criteria, were also breached but waivers are not needed because end-March 2004 data now govern this review.

3

Measured unemployment is inflated by workers in the “grey economy” who register as unemployed to receive health care benefits.

4

For example, one Ministry (acting without informing the Ministry of Finance) signed an agreement to purchase services from laid off workers and allow them to use government premises and equipment without remuneration. When staff questioned this practice, the Ministry clarified that it did not intend to carry out the agreement which, indeed, was not consistent with the Law on Public Procurement.

5

One small bank was closed, in an orderly manner, but after significant delay and at a high cost to the NBRM which had pledged assets to guarantee certain liabilities of that bank.

6

The law strengthens minority shareholders’ rights, tightens the regulation of conflict of interest, and facilitates company registration by introducing a “one-window” system.

7

The World Bank also intends to address administrative and regulatory barriers to business and to assess the need for labor market reforms.

8

The benchmark was set on arrears, but staff focused on total liabilities after learning that the HIF had borrowed from banks in violation of its statute.

9

The transfer is also part World Bank PSMAL conditionality.

10

Other, smaller, corrections affected privatization revenues, non-bank domestic amortization, domestic credit to the government, and foreign financing.

11

The staff noted that assessment letters could be an alternative signaling device.

1

This schedule presents all currently scheduled payments to the IMF, including repayment expectations and repayment obligations. The IMF Executive Board can extend repayment expectations (within predetermined limits) upon request by the debtor country if its external payments position is not strong enough to meet the expectations without undue hardship or risk, repayment schedules and IMF lending for details).

2

This schedule is not the currently applicable schedule of payments to the IMF. Rather, the schedule presents all payments to the IMF under the illustrative assumption that repayment expectations-except for SRF repayment expectations-would be extended to their respective obligation dates by the IMF Executive Board upon request of the debtor country (see repayment schedules and IMF lending for details). SRF repayments are shon on their current expectation dates, unless already converted to an obligation date by the IMF Executive Board.

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Cover IMF Staff Country Reports
Former Yugoslav Republic of Macedonia: Second Review Under the Stand-By Arrangement and Ex Post Assessment of Performance Under Fund-Supported Programs
Author:
International Monetary Fund
Volume/Issue:
Volume 2004: Issue 276
Publisher:
International Monetary Fund
ISBN:
9781451826029
ISSN:
1934-7685
Pages:
98
DOI:
https://doi.org/10.5089/9781451826029.002
Figure 1.

Cross-Country Comparison of Selected Economic Indicators
Figure 2.

FYRM: Selected Economic Indicators, 1996-2004 1/
Figure 3.

FYRM: Real Sector Developments, 1998-2004
Figure 4.

FYRM: Monetary and Financial Indicators, 1998-2004
Figure 5.

FYRM: External Sector Developments and Competitiveness, 1996-2004
Text Figure 1.

Interest Rate and Fiscal Balance 2002-04
Figure 6.

FYRM: Recent Developments and Medium-Term Projections, 2000-2008 1/