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
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
Download PDF (413 KB)

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.