Statement by Jeoren J. M. Kremers, Executive Director for Former Yugoslav Republic of Macedonia

Macedonia showed an economic recovery owing to its macroeconomic policies. Executive Directors appreciated the sound fiscal policies and efforts in bringing inflation under control and increasing international reserves. They stressed the need to reduce unemployment and keep the account deficit under control. Executive Directors stressed that the best way to meet these challenges would be by maintaining the country’s hard-won macroeconomic stability, accelerating structural reforms and prudent and well-coordinated monetary and fiscal policies, and liberalizing the labor market.


Macedonia showed an economic recovery owing to its macroeconomic policies. Executive Directors appreciated the sound fiscal policies and efforts in bringing inflation under control and increasing international reserves. They stressed the need to reduce unemployment and keep the account deficit under control. Executive Directors stressed that the best way to meet these challenges would be by maintaining the country’s hard-won macroeconomic stability, accelerating structural reforms and prudent and well-coordinated monetary and fiscal policies, and liberalizing the labor market.

On behalf of the Macedonian authorities I thank staff for the constructive policy dialogue during the mission and the comprehensive set of papers, including the very useful selected issues analysis, which will help the new government in their policy formation process.

The main political event since our previous Board discussion on Macedonia about two months ago was the July 5th Parliamentary election, which has been regarded both by the international and local observers as transparent and fair. As a result, the main opposition party VMRO-DPMNE (headed by the former Minister of Finance Nikola Gruevski) secured 45 out of 120 seats in the parliament and is currently conducting negotiations with potential partners for a coalition government. This marks Macedonia’s shift to sustained political and macroeconomic stability following the 2001 security crisis and confirms the progress in implementing the Ohrid Framework Agreement reflecting the county’s broad consensus on the need to strengthen democratic process towards full convergence to EU principles. In the same vein, Macedonia’s economic performance has remained strong, with exports being the main engine of economic growth for the second consecutive year, low inflation and a consistent increase in employment. Reflecting the policy stance and a considerable increase in transfers, Macedonia’s external position has improved substantially and is projected to remain sustainable over the medium term.

These achievements were accomplished thanks to continued support from the Fund and other development partners, prudent and well-coordinated monetary and fiscal policies, and labor market liberalization. The authorities share staff’s view that a continued stable macroeconomic policy is key to sustained growth, and remain committed to build on recent progress by addressing underlying long-term structural weaknesses, improving institutional capacity and enhancing financial market development. Their commitment enjoys broad support across society and is underpinned by the European Council’s decision to grant Macedonia EU candidate status.

Continued economic stability has also resulted in an increase in financial market confidence and improvement in the capital account, as evidenced by growing capital inflows including the large oversubscription on Macedonia’s first Eurobond issue at the end of last year. These developments were marked by a rating upgrade from Standard and Poor’s in 2005 followed by one from Fitch in June, 2006.

The authorities’ medium-term goals are consistent with the SBA, currently under implementation, and the main challenge is to accelerate real GDP growth to above 4.5 percent, while sustaining and building on recent macroeconomic performance.

Fiscal policy

Notably, the tight fiscal stance from 2003 onwards, supported by price stability, has contributed to the improved economic situation. A budget surplus was achieved for two consecutive years, the 2005 program target being exceeded by more than 1 percent of GDP. This is a significant improvement compared to a 5 percent of GDP deficit only three years earlier. The impressive fiscal consolidation reflects politically difficult measures undertaken by the authorities, who, among other measures, increased taxes, raised utility prices and cut expenditures. Given the improvement in the current account and lower public debt ratios, the modestly expansionary fiscal policy in 2006 is appropriate. This is also supported by Macedonia’s low capital expenditure as a share of GDP and the absence of major mediumterm fiscal sustainability risks. In this context, the deficit target of 0.6 percent of GDP for 2006 appears to be reachable.

The fiscal framework was recently assessed by the IMF through the fiscal transparency ROSC, which concluded that Macedonia meets the requirements of the fiscal transparency code in several key areas. In particular, the ROSC emphasized the appropriate allocation of responsibilities among different levels of government, the central bank’s operational independence, the availability of reliable information on public and publiclyguaranteed debt, the adequate legal framework for the management of public funds, and the transparency of the annual budget process. It also points out that the legislative basis for taxation is clear and comprehensive. At the same time, the assessment cites a number of areas were improvements are warranted including the provision in budget documents of public debt sustainability analysis and information on fiscal risks, strengthened reporting on state-owned enterprises, and the development of a system for tracking fiscal incentives and their expenditure implications, and further support to the recently-established internal audit units. Addressing these issues is a comprehensive part of the authorities’ broader fiscal reform agenda which is being implemented with support from the Fund and the Bank.

Implementation of the broad-based reform of the tax administration with technical support from the Fund and the Netherlands remains an important element of the fiscal agenda. Considerable ground has already been covered in establishing a base for improved fiscal administration, including Parliamentary approval of the new Law on Tax Administration Procedures, expanding taxpayer protection and broadening the Public Revenue Office’s (PRO) authority. Also, the authorities made progress toward improving arrears collection, tax payer registration, public procurement and performance measurement. Harmonization of personal income tax and social contribution is underway, and its first phase is expected to be completed by year-end.

Looking forward, the authorities are aware of the medium-term fiscal challenges including those related to the fiscal costs of EU accession, further trade liberalization, SOEs privatization and the development of the second pillar pension system. To this end, they continue efforts to improve the quality and efficiency of fiscal spending and control mechanisms. Particular attention is paid to containing arrears in the health sector within SBA parameters. Furthermore, the preliminary findings of the Public Expenditure review conducted with Bank support will help guide the 2007 budget process. The authorities look forward to starting the regular monitoring and reporting exercises and pre-accession fiscal surveillance required for EU membership.

The staff report indicates that debt dynamics are generally subdued, with the government debt at around 35 percent of GDP and an average maturity of more than 10 years. The private short-term external debt is also low and constitutes only 8 percent of GDP. Although debt sustainability analysis suggests limited vulnerabilities, 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’s (NBRM) monetary policy, in combination with a tight fiscal stance, is consistent with maintaining the de facto currency peg backed by an adequate level of international reserves. The authorities believe that the exchange rate regime has served Macedonia well as a clearly defined monetary anchor and will continue to do so. Additionally, staff estimates of the equilibrium real exchange rate using the macroeconomic balance approach suggest that the exchange rate is broadly appropriate. At the same time, as the sterilization costs are increasing, the authorities are open to consider ways to improve its sterilization cost projections to asses the regime’s durability and to proceed with preparations for possible inflation targeting.

The improved external position and substantial privatization proceeds led to a greater than initially projected international reserves accumulation. Gross reserves are currently at around 1.2 billion EURO and represent about 4.5 months of import cover. This has allowed the NBRM to cut interest rates from 10 to 6 percent. The authorities are in agreement with staff that the scope for further rate cuts is limited given the uncertainty over the current account deficit, the lags in transmission to bank lending and the narrowing differential with the euro area rates.

With the increased confidence in the denar and growing capital inflows, the NBRM expects a fall in the level of euroization as the demand for local assets is increasing. To avoid inflationary pressures and ensure continued success of the exchange rate regime, the NBRM stands ready to sterilize capital inflows by issuing central bank and treasury bills.

Financial market development is key to sustained economic growth and the authorities remain committed to build on the progress made in encouraging financial intermediation. In this context, they will seek further support in improving the legal framework for insolvency and poor credit practices. 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 a number of important areas, including governance issues, clarification of the roles of the Audit Committee and Risk Management Committee, and increased capital and enhanced licensing requirements.

In anticipation of faster credit growth the NBRM has undertaken a number of steps to strengthen banking supervision. With World Bank assistance, a Supervisory Development Plan (SDP) has been developed to enable a more risk-based, anticipatory approach to banking supervision. To that effect, an MFD resident advisor has been in place since May. To give supervisors a more active role in AML/CFT implementation and enforcement, the central bank has established an emergency lending facility and revised supervisory circulars.

Structural reforms

The useful selected issues paper gives an excellent overview of the role of structural reform in improving productivity and attracting foreign investment that should ultimately result in achieving a GDP growth of 5-6 percent. The authorities are in broad agreement with staff that further structural reforms and improved institutional capacity are critical for a healthy business environment conducive to sustained economic growth.

Important components of an attractive business environment are enhanced governance and lower business costs. To this effect, the authorities have amended the constitution and passed new laws to introduce an ambitious and comprehensive judicial reform in line with the European Commission’s recommendations. In order to enhance business activity, government introduction of a one-stop shop for business registration, a new Bankruptcy Law and the Law on Audit were approved, among other measures. Also, the authorities see scope for faster completion of the cadastre project in order to improve property rights. With regard to further liberalization in telecommunication, the authorities will pursue with vigor the implementation of the February 2005 Law on Electronic Communications.

Reducing unemployment is one the most pressing and difficult policy challenges facing the authorities. With a recorded unemployment rate of 35 percent, much of which is structural, and low labor participation, as the staff report correctly emphasizes, bringing the unemployment rate to the regional level will require further labor market liberalization, improved unemployment measurement, reducing the labor tax wedge, and promoting parttime employment. Next to that, a broader context of economic stability and growth will be key to achieving this objective.