Former Yugoslav Republic of Macedonia
Second Review Under the Stand-By Arrangement and Request for Waiver of Performance Criteria and Rephasing of the Program: Staff Report; Staff Statement; Press Release on the Executive Board Discussion; and Statement by the Executive Director for the former Yugoslav Republic of Macedonia

This paper discusses the Former Yugoslav Republic of Macedonia’s Second Review Under the Stand-By Arrangement and Request for Waiver of Performance Criteria and Rephasing of the Program. The 2007 fiscal deficit target increased modestly to 1 percent of GDP. Taxes were cut and budget quality improved, but there remain fiscal risks, in particular in delivering the planned reduction in transfers and subsidies. Over the medium term, the government aims to keep the fiscal deficit below 1½ percent of GDP, cutting overall government spending by 2 percent of GDP while raising public investment.

Abstract

This paper discusses the Former Yugoslav Republic of Macedonia’s Second Review Under the Stand-By Arrangement and Request for Waiver of Performance Criteria and Rephasing of the Program. The 2007 fiscal deficit target increased modestly to 1 percent of GDP. Taxes were cut and budget quality improved, but there remain fiscal risks, in particular in delivering the planned reduction in transfers and subsidies. Over the medium term, the government aims to keep the fiscal deficit below 1½ percent of GDP, cutting overall government spending by 2 percent of GDP while raising public investment.

I. Introduction

1. Following completion of the First Review last April, a new center-right government took office in August 2006, with a manifesto commitment to economic reform. The new government’s program aims to raise investment and growth while maintaining macroeconomic stability, through incentives and accelerated structural reform.

2. Discussions focused on aligning these initiatives with the Fund-supported program. The resulting program for 2007 aims at preserving fiscal discipline, stimulating foreign direct investment, revising the banking law to enhance supervision and encourage foreign bank participation, putting the previous structural agenda back on track (or revising it consistent with the program’s goals), and integrating the new government’s plans for further structural reform.

II. Recent Developments

3. Economic activity continues to improve (Figure 1; Tables 2-3). Growth is around 4 percent, with higher world prices stimulating metal production and exports. Though statistics office estimates show growth slowed to 3 percent in 2006, activity indicators suggest the true growth rate was higher (Annex I).

Figure 1.
Figure 1.

FYR Macedonia: Real Sector Indicators, 2002-06

Citation: IMF Staff Country Reports 2007, 257; 10.5089/9781451826135.002.A001

Sources: State Statistical Office; NBRM; and IMF staff estimates.
Table 1.

Performance Criteria and Prior Actions in the Program

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See LOI for proposed quantitative performance criteria and indicative targets, and structural benchmarks.

Table 2.

FYR Macedonia: Selected Economic Indicators, 2003-07

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

Movements in 2005 and 2006 reflect the issuance of a Euro 150 million Eurobond and repayment of the London club debt. Net debt is defined as gross debt minus NBRM deposits of the central government.

Weighted averages for December of each year.

Debt service due including IMF as percent of exports of goods and services. Excludes rollover of trade credits.

Table 3.

FYR Macedonia: Macroeconomic Framework, 2003-2012

(Percentage change, unless otherwise indicated)

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Sources: NBRM, SSO, MOF, and IMF staff projections.

Current account deficit.

Growth and Domestic Demand, 2003-06

(percent change, year-on-year)

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Sources: NBRM; MOF; and SSO.

Preliminary SSO estimate. Staff estimate uses 4.0 percent, though demand side indicators in this table suggest true figure may have been higher.

4. The balance of payments is strengthening (Figures 2-3; Table 4). Since 2004, international reserves have doubled to €1.4 billion (4½ months of imports), allowing the authorities to reach agreement in January to prepay €78 million in Paris Club debt, and to make repurchases to the Fund (¶6).1 While competitiveness still appears adequate, the trade deficit widened to 20 percent of GDP in 2006, due to higher oil prices and domestic demand-led import growth (intermediate and investment goods). However, increasing foreign currency sales to exchange bureaus (recorded as private transfers) and delayed payment of the telecom dividend to foreign shareholders narrowed the current account deficit. Though the government could not sell its 40 percent stake in the fixed-line telephone monopoly, last March’s €225 million electricity distribution privatization exceeded expectations. Portfolio investment and loans to the private sector are recovering, but greenfield foreign direct investment (1.2 percent of GDP) is low.

Figure 2.
Figure 2.

FYR Macedonia: External Sector Indicators, 2000-06

Citation: IMF Staff Country Reports 2007, 257; 10.5089/9781451826135.002.A001

Sources: State Statistical Office; and NBRM.
Figure 3.
Figure 3.

FYR Macedonia: Exchange Rate Indicators, 2000-06

(2000q1 = 100) 1/

Citation: IMF Staff Country Reports 2007, 257; 10.5089/9781451826135.002.A001

Sources: Eurostat; IFS; and IMF staff calculations.1/ Trade weights based on 1999-2001 data for exports of goods. Partner countries comprise: Austria, Bulgaria, Croatia, France, Germany, Greece, Italy, Netherlands, Russia, Serbia, Slovenia, Switzerland, Turkey, United Kingdom, and United States.
Table 4.

FYR Macedonia: Medium-Term Balance of Payments, 2005-12

(Millions of Euro)

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

Amortization payments include prepayment of London club debt in 2006 and Paris Club debt in 2007.

Portfolio investment includes Eurobond issuance in 2005.

Private sector arrears.

Higher projected investment is expected to increase imports and lead to higher exports over the medium term.

Debt service due including IMF as percent of exports of goods and services. Excludes rollover of trade credits.

Including IMF.

Including trade credits.

uA01fig01
Sources: SSO; NBRM and IMF staff estimates.

5. Fiscal policy remains disciplined (Table 5). Last November’s supplementary budget increased spending on (overdue) tobacco subsidy payments, court settlements, and transfers to MEPSO (electricity transmission), and reduced VAT for agricultural inputs—financed by an anticipated telecom dividend of 0.8 percent of GDP. Though the dividend payment did not materialize, underexecution of capital expenditure (a fairly normal event) allowed the authorities to meet the deficit target.

Table 5.

FYR Macedonia: Central Government Operations, 2004–07

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

Excluding contributions and transfers related to the second pillar pension scheme that commenced in 2006.

Including Telecom dividend.

Central government and municipalities.

6. Money and credit growth are picking up (Tables 6-8; Figure 4-6). With global liquidity conditions favorable, fiscal discipline and increased reserves have reduced risk premia and interest rates, stimulating credit growth. Deposits grew by almost 25 percent in 2006. By taking new syndicated loans and drawing down assets held abroad, banks have financed credit growth of around 30 percent (though from a low base). Despite the credit expansion, inflation remains low (anchored by the exchange rate peg) and the financial sector stable. Although attempts to sell the largest private bank failed, foreign interest in the banking system is increasing.

Figure 4.
Figure 4.

FYR Macedonia: Financial Market Developments, 2004-06

Citation: IMF Staff Country Reports 2007, 257; 10.5089/9781451826135.002.A001

Sources: NBRM; and IMF staff estimates.
Figure 5.
Figure 5.

FYR Macedonia: Money and Credit Developments, 2001-06

Citation: IMF Staff Country Reports 2007, 257; 10.5089/9781451826135.002.A001

Sources: NBRM; and IMF staff estimates.1/ Includes foreign currency indexed lending (approximately one third of total denar credit).
Figure 6.
Figure 6.

FYR Macedonia: Banking Sector Developments, 2002-06

Citation: IMF Staff Country Reports 2007, 257; 10.5089/9781451826135.002.A001

Sources: NBRM; and Fund staff estimates.1/ Total assets include off-balance sheet items.2/ Adjusted for unallocated provisions for potential losses.
Table 6.

FYR Macedonia: Central Bank Accounts, 2004-07

(End-period; in billions of denars unless otherwise indicated)

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Sources: NBRM, and IMF staff projections.

Measured as a four quarter rolling sum.

Table 7.

FYR Macedonia: Monetary Survey, 2004-07

(End-period; billions of denars unless otherwise indicated)

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Sources: NBRM, and IMF staff projections.

Includes foreign currency indexed.

Includes municipal and public enterprise accounts.

Forex linked assets include banks’ NFA, forex loans (including forex indexed), and forex reserves at the NBRM. Forex linked liabilities include forex denominated and forex indexed deposits.

Measured as a four quarter rolling sum.