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.


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 thank staff for the comprehensive set of reports. The authorities are pleased that all quantitative and structural performance criteria under their Stand-By Arrangement have been met. Two indicative targets and two structural benchmarks were missed narrowly or have been corrected in the meantime, thus without implications for material compliance with the program. Successful program implementation offers the perspective of completing this second and final review of the Stand-By Arrangement. As always, the authorities agree to publication of the staff report and the Ex Post Assessment.

The end of the security crisis and consolidation of the fiscal stance contributed to the improved economic situation in 2003, supported by price stability and a stable exchange rate. After modest improvement in 2002 (GDP growth of 0.9 percent), the year 2003 registered a real increase in GDP of over 3 percent. For 2004, economic growth will show some slowdown, mainly due to the temporary closure of a major steel factory and restructuring of loss-making enterprises. For 2004, staff estimates imply a revised growth rate of 1½ -2½ percent GDP, compared with 3 percent projected at the time of the first review.1

Fiscal policy

On the fiscal front, the authorities realized an impressive consolidation in 2003 by implementing, among others, a politically difficult VAT increase, raising utility prices and cutting expenditure. In 2003, the central budget deficit was very significantly reduced to a level of 0.9 percent of GDP (from 5.3 percent of GDP in 2002), which contributed to the achievement of the key objective of the program - a sustainable fiscal position- as staff concludes. This trend is continuing. In the first quarter of 2004, an increase of more than 10 percent in budget revenues was registered compared to the same period last year, not in the least owing to the new management of the Public Revenue Office. Although expenditures showed a slight slowdown, the authorities note staff’s concern about a stop-go cycle. By strengthening their budget planning and expenditure management they are committed to avoid a repetition of this phenomenon. Furthermore, as staff mentions, the authorities are committed to keep the fiscal framework in place when preparing their supplementary 2004 budget later this year.

Conversely to the considerable reduction of the fiscal deficit, the current account deficit remained high in 2003, albeit at a substantially lower level compared to 2002. The current account is still projected to widen slightly by the end of this year. In this respect, the composition of the capital and the financial account indicates the need for relying more on foreign direct investment, as a high-quality and productive source of financing.

The indicators for the level of indebtedness in 2003 remained favorable and FYR of Macedonia belongs to the group of less indebted transition countries. As staff notes, the general government deficit will be comfortably below debt stabilizing level in 2004. Moreover, the introduction of short-term government securities in the domestic market expanded the sources for budget deficit financing, thereby inducing the further development of financial markets as well as diversifying the securities portfolio. In the first quarter of 2004, five treasury bill auctions were successfully conducted.

Monetary policy

In 2003, the National Bank of the Republic of Macedonia (NBRM) continued with the successful implementation of the strategy of targeting the exchange rate of the Denar against the Euro. The maintenance of exchange rate stability as a nominal anchor essentially contributed towards preserving low and stable inflation rates, as the ultimate goal of monetary policy. The year ended with an average inflation rate of 1.2 percent, below the projected inflation of 1.8 percent.

The tight fiscal stance in the first half of 2003 enabled the NBRM to reduce the interest rates on Central Bank bills. At the very end of the year, as staff rightly notes, there had been an increase in budget spending, which caused fluctuations in domestic liquidity and a dip in foreign exchange reserves. While monitoring these developments closely, the NBRM maintained the level for net international reserves above program targets without changing interest rates. Nevertheless, in light of a more expansionary fiscal policy in the second quarter of 2004 and the need for stabilizing the movements on the foreign exchange market, the NBRM, in line with Fund advice, raised the interest rate on CB bills early this year. Staff points out that the NBRM could have reacted more actively to the increased fiscal spending, but on the matter of timing the NBRM emphasized that, based on a thorough assessment of the situation and the expectations related to liquidity and reserves, they decided it was the right moment to increase interest rates early 2004. The effects of these changes were particularly evident in March, when a considerable amount of liquid funds was withdrawn through CB bills auctions. For the remainder of the year, the NBRM will, while learning from past experience, monitor these developments closely, remain vigilant on budgetary developments through an enhanced cooperation with the Ministry of Finance and be ready to react whenever there is a need for further measures.

Financial sector

Confidence in the banking system was evidenced by the continuous growth in deposits. In addition, banks actively supported economic activity through accelerated lending to the private sector. Deposit base extension (higher credit potential), expansion of credit supply (introduction of new types of credits and diversified terms and conditions for using the credits), as well as the further liberalization of foreign exchange operations (possibility for foreign exchange lending to all interested entities) resulted in a higher growth rate of lending to the private sector.

The process of harmonization of regulation with the European Union has continued. Amendments to the Law on the NBRM were made aimed at further enhancing NBRM independence and transparency. Furthermore, the introduction of on-site supervision procedures as well as amendments to the Banking Law should allow larger security, stability and efficiency in the operations of the banking system and are part of the ongoing process to strengthen overall financial supervision, also on smaller branches. The number of banks under enhanced supervision has successfully been reduced.

Labor market policy and business environment

Unemployment remains the crucial weakness of the Macedonian economy. In 2003, the registered rate of unemployment amounted to 37 percent, which is an annual increase of 5 percentage points. High structural unemployment still reflects the lingering effects of the transition process. Overcoming this problem is the key priority of government policy, which will be focused on establishing mechanisms for restoration of the distorted labor market functions. To that end, in accordance with the government employment strategy, a National Employment Action Plan for 2004-2005 is being prepared.

Special emphasis will be put on entrepreneurship, by considerably reducing the overhead costs and administrative barriers for business. The recently launched Agency for Support of Entrepreneurship will contribute to this government policy. Furthermore, in collaboration with the World Bank, a Business Environment Investment Operation is scheduled for late FY05 or early FY06, which will draw in part on the FSAP completed in September 2003. A Regulatory and Judicial Reform project is also planned for FY 2006.

Public sector reform

As staff highlights, another major challenge for the authorities will be to implement the provision of the Framework Agreement, in a democratic and well-sequenced manner. Adopting the decentralization agreement and implementing it in a fiscally sound manner will be a milestone. The ongoing wage decompression for the civil service (with the help of the World Bank) will make a start at creating a structure that would help attract and retain qualified staff and help fight corruption. In this light, the government will by the end of this year complete the reduction of public sector employment by 4 percent, a highly sensitive but necessary measure. Progress has also been achieved in some areas of the health sector, particularly in reducing inefficient employment. Nevertheless, more significant savings need to be realized, especially regarding the Health Insurance Fund.

The authorities, with technical assistance from the Fund and other bilateral and multilateral agencies, have made significant progress in upgrading their statistical system in recent years. They began participating in the General Data Dissemination System in February 2004 and a data ROSC mission was conducted in mid-February 2004. Further methodological improvements are needed. In the area of debt management, the authorities have requested a follow up FAD mission to provide assistance with the implementation of new data sources.

Ex Post Assessment

The authorities appreciate the Ex Post Assessment (EPA), which contains a balanced evaluation of successes and failures on the side of both the authorities and staff. As mentioned in the staff report, the authorities consider the Fund dialogue and programs as highly valuable. Although some reforms proceeded slower than envisaged, they always felt a strong sense of ownership of the programs and were well aware of the importance of reaching the program targets.

Regarding the appropriateness of the exchange rate regime, as highlighted in the EPA, the authorities would like to emphasize that the current peg has helped Macedonia achieve and maintain macroeconomic stability, even throughout the 2001 security crisis and subsequent elections, and has continued to deliver low inflation. For the future, they agree that the adequacy of the regime has to be kept under close review. Given the proven capability of the current regime to contain inflation and preserve macro stability, the authorities would not see a currency board as credible progress. Going forward, the Fund will have to treat the exchange rate mechanism as part of Macedonia’s overall policy-mix and economic environment. In doing so, the Fund is right to open discussion of the exchange rate regime and should also be prepared to close it. The authorities welcome an open assessment of underlying factors that influence the choice of exchange rate regime, with the objective of maintaining a well-founded policy in this area. Clear Fund advice will be important as part of exploring a follow-up arrangement.

Going forward

As the EPA mentions, the authorities agree that important structural challenges need to be addressed and they are firm in their determination to cope with them in an expeditious and constructive manner. Some of these reforms have been burdening the authorities for years, such as reducing unemployment through reducing the tax wedge on labor, and strengthening fiscal management and the financial sector. Other challenges are new, such as the proposed fiscal decentralization, reforms of the public administration and the road towards EU accession.

To tackle these challenges, Macedonia counts on continued support from the international community. Over the past few years, Macedonia has received important support from bilateral donors and the multilateral organizations. After the current arrangement expires, the authorities would like to continue their cooperation with the IMF through the most appropriate medium-term arrangement that will strengthen the reform component of existing economic and financial policies, while tackling the projected financing gap and external vulnerabilities. In this way, the authorities are confident that the international community will continue to support the country in the final stages of transition to a modern market economy.

In closing, I would, on behalf on the authorities, like to once again thank staff, the IMF Resident Representative and management for their dedicated work and sound policy advice to Macedonia.


The preliminary official data for the first quarter of 2004 showed a 3.6 percent decline in GDP, compared to the 3.1 percent increase projected at the beginning of the year. As this sharp reversal in official GDP and manufacturing data was not consistent with the behavior of other economic indicators, it appeared the discrepancy reflected shortcomings in the method used to calculate GDP and the industrial production index. The government has established a working group, to analyze the applied methodology and production trends of companies having a significant weight in the calculations of GDP.