Statement by Jeroen Kremers, Executive Director for Former Yugoslav Republic of Macedonia

This paper discusses key findings of the First Review Under the Stand-By Arrangement for Macedonia. Macroeconomic performance of Macedonia remains strong. Through end-December 2005, the authorities met all of the program’s quantitative performance criteria. Growth has remained steady at about 4 percent. Gross reserves have risen above €1 billion, allowing interest rates on National Bank of Macedonia bills to fall since November from 10 percent to 7 percent. To complete the First Review, the authorities have committed to strong policies, including measures to correct for delays in the program’s structural reforms.


This paper discusses key findings of the First Review Under the Stand-By Arrangement for Macedonia. Macroeconomic performance of Macedonia remains strong. Through end-December 2005, the authorities met all of the program’s quantitative performance criteria. Growth has remained steady at about 4 percent. Gross reserves have risen above €1 billion, allowing interest rates on National Bank of Macedonia bills to fall since November from 10 percent to 7 percent. To complete the First Review, the authorities have committed to strong policies, including measures to correct for delays in the program’s structural reforms.

April 17, 2006

Macedonia’s economic performance has remained strong, reflecting the authorities’ commitment to build on the progress made and to deepen the economic reform agenda. This commitment is underpinned by last December’s European Council decision to grant Macedonia EU-candidate status. Real GDP growth reached 4 percent for the second consecutive year. The robust growth in combination with labor market liberalization, helped to boost employment. Reflecting the policy stance and a considerable increase in transfers, Macedonia’s external position has improved substantially and is projected to remain sustainable in the medium term. At the same time, prudent and well-coordinated monetary and fiscal policies kept inflation at a low level. Moreover, financial market confidence and the capital account appear to be improving, as evidenced by the large oversubscription of Macedonia’s first Eurobond issue at the end of last year, followed by a rating upgrade from Standard and Poor’s. The outlook for 2006 remains favorable with real GDP growth projected to remain at 4 percent, while inflation is expected to rise somewhat as a result of the increase in cigarette taxes and the expected administrative increase of electricity prices.

The authorities attach great value to the close relationship with the Fund, and appreciate staff’s comprehensive report and the fruitful program review discussions. They are pleased that the program is on track, with the monetary and fiscal targets being met, some with wide margins. At the same time, two structural and one quantitative performance criteria were missed, as further explained below. Reiterating their strong commitment to the comprehensive reform agenda, which also aims at promoting convergence with EU standards, the authorities request the completion of the first review under the Stand-By Arrangement and a waiver of the missed performance criteria. I would like to emphasize that the authorities intend to treat the SBA as precautionary. To smooth the debt services profile, the authorities request an extension of repurchase expectations totaling SDR 13.39 million, that arise from September 30, 2006 through December 31, 2007.

Fiscal policy

A budget surplus has been achieved for the second consecutive year. The program target was exceeded by more than 1 percent of GDP, due to restraint in public employment, procurement delays, and underexecution of Special Revenue Account (SRA) spending.

The authorities are committed to a 2006 fiscal deficit target of 0.6 percent of GDP. They agree with staff that this target is appropriate given the improvement in the current account, lower public debt ratios, and the credible fiscal stance. This will be further underpinned by maintaining a tight wage policy and lower transfers, keeping current expenditures roughly constant in real terms.

An important element of the fiscal agenda is the implementation of the broad-based reform of tax administration with technical support from the Netherlands. Considerable progress has been made in this area, including Parliamentary approval of the new Law on Tax Administration Procedures, expanding taxpayer protection and broadening the Public Revenue Office’s (PRO) authority. The PRO’s organizational chart has been redesigned to comply with program requirements. Moreover, the authorities continue to make progress toward improving arrears collection, tax payer registration, performance measurement, and harmonization of personal income tax and social contribution collections. Preparations for establishing a Large Tax Payer Office (LTO) at the PRO and Large Contributor Office (LCO) at the Pension Fund are on track.

The authorities plan to harmonize the base for personal income tax (PIT) and social contributions as reflected in the program. However, given the complexity of this measure, they have decided to proceed with the implementation in two phases. The first phase will focus on harmonizing the base for social contribution, and will be completed by year-end, while the second phase aims at harmonizing the base for personal income tax and will become effective in 2008.

On the expenditure side, further measures aim at improving the quality and efficiency of fiscal spending and control mechanisms. To this end, a Public Expenditure review began in February with World Bank assistance and its preliminary findings will help guide the 2007 budget. Also, the authorities will start the regular monitoring and reporting exercises and pre-accession fiscal surveillance required for EU membership.

The authorities attach great importance to containing arrears in the health sector within program parameters and regret the worsening of the overall health finances despite improvements at the end of 2005. To address this shortfall, further corrective measures have been taken. In particular, starting as of January 1, 2006, public health institutions (HCIs) are operating within hard budget ceilings. In line with World Bank guidance the Health Insurance Fund (HIF) has introduced competitive international tendering for drugs on the positive list, resulting in 0.2 percent of GDP savings. Also, additional measures envisaged in the program will help to improve monitoring of the debt level and budget execution of Public Health Institutions.

The debt sustainability analysis shows that debt dynamics are generally subdued and the authorities have used the favorable environment to substantially upgrade debt management at the Ministry of Finance.

Monetary policy and exchange rate regime

The National Bank of the Republic of Macedonia (NBRM) continues to support the economic program by maintaining the de facto pegged exchange rate regime backed by an adequate level of international reserves. The exchange rate has served Macedonia well as a nominal anchor. There are also indications that competitiveness pressures have been easing. The NBRM’s monetary program for 2006 is consistent with average broad money growth of about 20 percent. Given the expected considerable increase in capital inflows, the authorities project gross official reserves to reach 1.3 billion euro by the end of the year, covering over 4 months of projected imports.

The authorities expect a slight fall in the level of euroization as the demand for denar assets remains strong. To avoid inflationary pressures and ensure the continued success of the exchange rate regime, they stand ready to sterilize capital inflows by issuing central bank and treasury bills, if needed. At the same time, to ensure a prudent monetary stance and to prevent the increase in reserves from resulting in excessive monetary expansion, the NBRM will lock in two-thirds of the 2005 Net Foreign Assets overperformance. Given the importance of the government securities market for monetary policy implementation, the NBRM has established regulatory and infrastructure framework for secondary trading of treasury bills, by creating the over the counter market (OTC) and introducing repo. This enables settlement in real time and increases the efficiency of liquidity management.

Safeguarding the NBRM’s independence and strengthening its financial soundness remain key. In this vein, and in line with Fund recommendations, by end-June the NBRM Law will be amended to allow the retention of 70 percent of its profits in case general reserves are below the statutory limit and to protect its decisions in the areas of banking licensing, receivership and bankruptcy from court reversal. Furthermore, the authorities intend to revise the National Bank Law next year to make it consistent with EU standards.

In order to improve the soundness of the banking system, the authorities are preparing a comprehensive revision of the legal framework. They have produced a new draft of the Banking Law aimed at addressing a number of important areas, including governance issues, clarification of the roles of the Audit and the Risk Management Committees, and increased capital and enhanced licensing requirements. The submission of the new Banking Law to Parliament was postponed to December 2006, as the authorities believe that the law will benefit considerably from additional provisions that bring it more in line with EU standards and international best practices. Further IMF assistance has been requested in this field. In addition, the authorities will review the Law on Deposit Insurance to make it consistent with the new Banking Law.

The NBRM has undertaken a number of steps to strengthen banking supervision. With the help of the World Bank, a Supervisory Development Plan (SDP) has been developed to enable a more risk-based, anticipatory approach to banking supervision, and to facilitate implementation. To that effect, an MFD resident advisor will be in place by May. At the same time, a number of measures aimed at improving the quality of banking supervision have been introduced, including enforcement of existing requirements for accurate and timely electronic data submission, tightening guidelines for foreign exchange loans, and completing the work on bank peer-group comparison.

Structural reforms

While Macedonia has made substantial progress, the authorities recognize that much remains to be done in the areas of regulatory reform, liberalization of telecommunications and business environment.

One of the centerpieces of the reform program, which will have a major impact on the business environment, continues to be the ambitious and comprehensive judicial reform program. With the passage of the key constitutional amendment in 2005, the authorities are moving to the next phase of the reform. By mid-2006 the Parliament will adopt a new Law on Courts and the Law on Judicial Council aimed at strengthening the independence of the Judiciary. The Law on Enforcement will become operational by June 1, 2006, which will reduce the workload for courts. While reaffirming their commitment to staff the Judicial Budget Council (JBC) and to undertake an analysis of the fiscal cost of judicial reform, the authorities believe that sufficient resources are available in the current court budget and from donors to cover the start-up costs in 2006.

Following the successful privatization of the state-owned electricity distribution company, the authorities plan to sell the generation component in 2007. At the same time, the authorities reiterate their commitment to ensure the independence of the energy regulatory commission, e.g. in case of requests from the new operators for electricity price increases. Furthermore, the authorities remain determined to implement the February 2005 Law on Electronic Communications and to meet their program commitment regarding the sale of its remaining telephone company shares.

The positive outcomes of the labor market and judicial reforms have been complemented by a number of measures to enhance business activity. Such measures include, among others, introduction of a one-stop shop for business registration, approval of the new Bankruptcy Law, and the Law on Audit. Furthermore, the number and complexity of licensing requirements will be reduced. To this end, by end-September 2006, the government will publish a list of all licenses administrated by line ministries and government agencies. In order to enhance transparency in the management of the state-owned assets, an annual report will be produced by the end of the year.