Republic of Montenegro
2007 Article IV Consultation: Staff Report; Staff Statement; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Republic of Montenegro
Author:
International Monetary Fund
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Publication Date:
04 Feb 2008
eISBN:
9781451826708
Language:
English
Keywords:
ISCR; CR; foreign direct investment; authority; Montenegrin authorities; outturn; policy; private sector; consumer demand; inflation rate; central bank of Montenegro; Credit; Global
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The economic expansion in Montenegro is proceeding at full strength. The economy is overheating. Rapid credit growth is overstretching banks, and has contributed to ballooning asset prices. Eroding competitiveness is a concern. Management of the boom falls on fiscal policy. Tax cuts have been procyclical and potentially destabilizing. Fiscal risks need to be contained. The main focus of credit policy should be to strengthen banking sector supervision. Completing the transition to a market economy should be kept at the top of the policy agenda.

Abstract

The economic expansion in Montenegro is proceeding at full strength. The economy is overheating. Rapid credit growth is overstretching banks, and has contributed to ballooning asset prices. Eroding competitiveness is a concern. Management of the boom falls on fiscal policy. Tax cuts have been procyclical and potentially destabilizing. Fiscal risks need to be contained. The main focus of credit policy should be to strengthen banking sector supervision. Completing the transition to a market economy should be kept at the top of the policy agenda.

I. Too Much of a Good Thing?

1. Independence and huge tourism potential has generated strong investor interest in Montenegro. The last five years have seen price stability restored through the adoption of the euro as sole legal tender; notable progress in fiscal consolidation; restructuring of the banking sector; progress in privatization; and a favorable resolution of the state liabilities of the former union that left Montenegro with low debt (Figure 1). The authorities' vision is to create a business friendly, open economy with low taxes and minimal state interference.

Montenegro: Main Indicators, 2007

article image
Sources: Authorities; and Fund staff estimates.
Figure 1.
Figure 1.

Montenegro: A Good Start to Independence, 2007

Citation: IMF Staff Country Reports 2008, 048; 10.5089/9781451826708.002.A001

Sources: WEO and Fund staff calculations.

2. But strong growth, and the exuberance it has generated, has brought its own problems. Foreign direct investment has snowballed, targeting mainly real estate and the tourism sector. Furthermore, aggressive competition for market share has led to an explosion of bank lending. In response, asset prices have been rising sharply, with the stock index shooting up, and real estate prices rapidly reaching those in wealthier neighboring countries. The resulting wealth effect has fueled pent-up consumer demand, widening external imbalances.

3. Euroization limits policy options to manage the boom. Strong import-related revenue growth has generated fiscal surpluses, but the authorities have been reluctant to let the fiscal stabilizers work. Income taxes have been cut sharply, and the 2008 budget is expansionary. With monetary policy discretion curtailed by use of the euro, the Central Bank has moved to tighten prudential regulations, but lacks effective enforcement powers. Structural bottlenecks have also been quick to emerge. Restrictive labor regulations, a decapitalized electricity sector, and a difficult business environment threaten to put a brake on growth if unaddressed. The unofficial economy is large at an estimated 30 percent of GDP.

II. Background

4. The economic expansion is proceeding at full strength. Real growth is expected to be 7½ percent in 2007, up from 6½ percent in 2006. The tourism sector is picking up, with large inflows of FDI generating strong construction activity. However, the manufacturing sector is stalling, partly due to disruption in electricity supply. Domestic credit has progressively replaced FDI as the main driver of demand.

5. Signs of overheating are becoming more pervasive…

  • The labor market has tightened. Unemployment has fallen sharply from 20 percent in 2005 to 12 percent in September 2007 and inflows of temporary workers doubled during the tourist season 2007 compared to the previous year.

  • Wages have grown rapidly. Gross wages increased at an annual rate of 22 percent in November, driven by tourism and construction. Public sector wage policy has been lax, with a 30 percent wage increase in the last quarter of 2007.

  • Inflationary pressures have increased despite euroization. Retail prices shot up during the summer, partly related to the region-wide drought and hikes in electricity and telecom tariffs, and the end-year inflation rate is expected to reach 5 percent, compared with under 3 percent in 2006.

  • Real estate and stock market prices have soared. Partial data suggest that land values have already reached levels comparable to those in richer neighboring countries. Meanwhile, notwithstanding a significant correction, stock prices have tripled since end-2005 and market capitalization was 172 percent of GDP at end-November 2007.

Credit expansion has overtaken FDI in size as demand stimulus

(In percent of GDP)

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Source: IMF staff calculations.

Gross Wage Increases in Selected Sectors

(Annual percentage change)

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Source: Statistical Office of Montenegro.

Annual average based on old official methodology.

A01ufig02

Stock market indices

(Dec. 2005 = 100)

Citation: IMF Staff Country Reports 2008, 048; 10.5089/9781451826708.002.A001

Source: Bloomberg.
A01ufig03

Real estate prices soared during 2004–06

(Annual average increase, in percent)

Citation: IMF Staff Country Reports 2008, 048; 10.5089/9781451826708.002.A001

Sources: ECB and Global Property Report.

6. …and vulnerabilities have been building up:

  • External imbalances have widened. The brunt of the strong demand pressures has been borne by the current account deficit, and Montenegro's competitive edge is eroding fast.

  • Credit growth has accelerated. Exceptionally rapid credit growth could mask nonperforming loan (NPL) problems, test the capacity of the young banking system to prudently assess and manage credit risks, and weaken private sector balance sheets.

  • Fiscal risks have increased. Large restitution claims amounting to well over 10 percent of GDP threaten to reverse the impact of the Paris Club debt write-offs at end-2006. Boom-related fiscal surpluses and large privatization receipts have raised the appetite for spending.

  • The asset price boom raises the specter of a correction. The FSAP raised concerns regarding low disclosure requirements, infrequent reporting, and financial safeguards. A correction of stock market and real estate prices, partly fueled by the rapid credit expansion and possibly amplified by the shallowness of the market, could generate strong balance sheet effects.

The widening current account deficit is increasingly debt financed.

7. The financing of the current account deficit is shifting. The current account is estimated to widen to 37 percent of GDP in 2007, from 31 percent in 2006 (Figure 2). Large current account deficits are not uncommon in small states experiencing booms, and the euro peg shelters the economy from currency crises. From a savings-investment perspective, the widening of the deficit initially reflected high investment (spurred by FDI) and very low savings (associated with FDI-driven wealth effects from real estate sales). However, tourism investments have not yet been fully reflected in earnings (Box 1), eroding competitiveness limits diversification of the export base, and increasingly imports are being fueled by pent-up consumer demand. Private external debt is estimated to rise from 19 percent of GDP at end-2006, to 30 percent at end-2007.

A01ufig04

External Balance and Its Financing

(In percent of GDP)

Citation: IMF Staff Country Reports 2008, 048; 10.5089/9781451826708.002.A001

Source: Authorities; and Fund staff estimates and projections.
Figure 2.
Figure 2.

Montenegro: Developments in the External Sector, 2007

Citation: IMF Staff Country Reports 2008, 048; 10.5089/9781451826708.002.A001

Sources: Montenegrin authorities, WEO, and Fund staff estimates.

Montenegro: A Tourism Enclave?1/

Tourism has fast become the main pillar of Montenegro's economy. The contribution of travel and tourism economy in overall GDP rose from 15 percent in 2004 to 21 percent in just three years. According to World Travel and Tourism Council (2007), Montenegro is a leading emerging tourist destination.

Despite rapid growth, the tourism sector is becoming an enclave in Montenegro. Hotels catering to international visitors rely on imported inputs, including a significant portion of labor. As a result, the tourism sector is characterized by high leakage. Meanwhile, developments in non-tourism related industries have been sluggish, and productivity has not shown any notable improvement, indicating weak linkage of tourism with the rest of the economy.

Available data on tourism suggest some inconsistencies between tourism goals and policies. Montenegro is targeting high-end customers. However, these tend to stay in resort hotels, resulting in high leakage-low retention of tourism earnings.

To achieve its target of tripling the travel and tourism sector by 2017, Montenegro must not only focus on increasing the number of beds and extending the season, but also improving infrastructure, especially roads, electricity and water supply.

A01ufig05

Impact of tourism on the rest of the economy appears limited.

Citation: IMF Staff Country Reports 2008, 048; 10.5089/9781451826708.002.A001

Sources: MTEP and WTTC, 2007.
article image

Based on estimates using CRS production function with capital and labor as inputs.

Source: MTEP and WTTC, 2007
1/ The role of tourism for Montenegro's development is examined in an accompanying Selected Issues Paper.

Credit growth has soared

8. Monetary developments have been dominated by large capital inflows and aggressive bank competition. Unlike in many other countries in the region, credit expansion was initially financed from domestic sources, especially the proceeds of asset sales (real estate) to nonresidents. Recently, however, foreign credit lines and banks' own funds have had an increasingly large contribution to credit expansion. Declining interest rates due to intensifying competition and expectations of improving economic prospects have also stimulated demand for credit. Aggressive competition among banks for market share has fueled credit supply, with two banks managing to multiply their loan portfolio by tenfold within a year, one partly financed by a shift in public sector deposits to the bank. At 190 percent (y-o-y in September 2007), credit has been expanded notably faster than suggested by historical convergence dynamics (Box 2). Higher effective reserve requirements and stricter prudential requirements have only dented credit expansion at best.

Counterparts of Credit Growth

(Change in percent of GDP)

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Sources: Authorities and Fund staff estimates

January-September, annualized.

A01ufig06

Spread of Average Interest Rates on Loans to Private Companies over 12-month EURIBOR

Citation: IMF Staff Country Reports 2008, 048; 10.5089/9781451826708.002.A001

Source: Central Bank of Montenegro.

Rapid Credit Growth1/

The credit-to-GDP ratio has risen rapidly during the past three years. At 79 percent, the ratio has already reached a level comparable to that in the Baltic countries but the pace of increase has been much faster.

A01ufig07

The financial sector has been rapidly deepening…

Citation: IMF Staff Country Reports 2008, 048; 10.5089/9781451826708.002.A001

Source: IMF, International Financial Statistics.1/ MNE 2003–07, and SRB 1998–2007.

.....and credit/GDP is now at the top among transition economies. Credit to Private Sector/GDP in Selected Credit Boom Episodes1/

article image
Sources: IFS and IMF staff calculations.

Adapted and updated from Hilbers et al. (2005)

Is credit growing too rapidly? Out-of-sample estimation, drawing on historical convergence dynamics, suggests that credit-to-GDP exceeds its equilibrium level for the current stage of development, and the banking sector's distance to default, measured by the Z-score, has declined slightly.

A01ufig08

Distance to default in CEE countries, 2001–07

Citation: IMF Staff Country Reports 2008, 048; 10.5089/9781451826708.002.A001

Sources: IFS, MCM database on FSIs; and IMF staff calculations.1/ The Z-score computes the number of standard deviations the return to capital m ust fall for equity to be depleted. It is measured by Z=(k + m)/s, where k is equity capital as percent of assets, m is average return as percent on assets, and s is the standard deviation of the return on assets. A lower score is associated with a higher probability of insolvency risk.

Private Sector Credit/GDP in Selected Transition Economies

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Source: IFS, WEO. Based on Schadler et al. (2005); IMF staff calculations.

Based on VECM of credit/GDP, log of GDP per capita at PPP and real interest rate

Actual average change in credit/GDP in 2003–06

Average predicted short-run change in 2003–06

2005-07 data, adjusted for the underground economy and the wealth effect from assets sales.

1/ Financial convergence in Montenegro is examined in an accompanying Selected Issues Paper.

Fiscal policies have recently slipped

9. The boom has contributed to fiscal surpluses (Figure 3), but the authorities have been reluctant to allow the fiscal stabilizers to work fully. The general government balance improved to 7 percent of GDP in the first three quarters of 2007, compared with 2½ percent of GDP in 2006. Revenues surged due to VAT on imports, and expenditures were kept under control. However, the cut in the PIT tax to 15 percent in the beginning of the year (with a further cut to 9 percent planned by 2010) added to demand pressures, and weakened the impact of the automatic stabilizers.

Consolidated General Government Fiscal Position, 2005–07:QI-III

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Source: Montenegrin authorities; and Fund staff estimates and projections.

In percent of annual GDP.

Figure 3.
Figure 3.

Montenegro: Consolidated Fiscal Developments, 2004–07

(Percent of GDP)

Citation: IMF Staff Country Reports 2008, 048; 10.5089/9781451826708.002.A001

Sources: Montenegrin authorities and Fund staff estimates.1/ Includes Paris Club debt reductions and assumption of restititution liabilities.

10. The revised 2007 budget, adopted in October, would reduce the surplus to 4½ percent of GDP. The rectification raises spending substantially on both goods and services and capital investment. In addition, a general public sector wage increase of 30 percent has been announced, which will be implemented in steps starting from October 1, 2007. However, staff estimate that capacity constraints are likely to contain expenditures and improve overall fiscal performance to 5½ percent of GDP (Table 3).

A01ufig09

Fiscal balance with revised 2007 budget

(In millions of €)

Citation: IMF Staff Country Reports 2008, 048; 10.5089/9781451826708.002.A001

Source: Montenegrin authorities and staff estimates.
Table 1.

Montenegro: Selected Economic Indicators, 2003–09

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Sources: Ministry of Finance, Central Bank of Montenegro, Statistical Office of Montenegro, Employment Agency of Montenegro; and Fund staff estimates and projections.

There is a break in the GDP series in 2005.

Includes extra-budgetary funds and, from 2006, local governments, but not public enterprises.

Gross debt minus deposits; projected path dependent on privatization receipts and restitution compensations. Gross debt includes also extra-budgetary funds; these are not included in official debt statistics.

As of September 2007.

As of August 2007.

As of June 2007.

Table 2.

Montenegro: Macroeconomic Framework, 2005–12

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Sources: Statistical Office of Montenegro, Ministry of Finance; and Fund staff estimates and projections.
Table 3.

Montenegro: Consolidated General Government Fiscal Operations, 2004–09 1/

(in percent of GDP)

article image
Source: Ministry of Finance; and Fund staff estimates and projections.

Includes republican budget and extra-budgetary funds; and, from 2006, local governments.

11. The level of public debt is set to increase. Public debt is projected to increase to 40 percent of GDP in 2007 mainly due to large restitution claims and additional compensation for foreign currency deposits seized during the Milosevic regime (Appendix I).

12. Performance could be further undermined by weak controls in the wider public sector, despite improvements in central budget implementation. The 2008 organic budget law will, for the first time, include the social funds, which will fall under the spending authorization of the central government. However, spending by municipal governments is unconstrained due to substantial privatization revenues; and the state-owned enterprise sector is loss making after taking into account the quasi-fiscal operations of the electricity company, amounting to an estimated 2 percent of GDP in 2006.

Structural barriers to growth are pervasive:

13. Electricity shortages pose a serious threat to growth. Electricity demand is growing fast while production is hampered by dilapidated production and distribution facilities, and chronic operating losses in the state-owned electricity company (EPCG) that have precluded investment in the sector. The situation is complicated by a distorted tariff structure that overcharges commercial consumers (to offset implicit subsidies worth 2 percent of GDP to the private aluminum complex (KAP), governed by a long-term contract). Household charges are not particularly low by regional standards, but are well below costs, contributing to EPCG losses. The increase of electricity tariffs in July 2007 has not been sufficient to bring EPCG to profit.

A01ufig10

Electricity tariffs are high in Montenegro, especially for commercial users

(Electricity tariffs in euro per MWh, in 2006)

Citation: IMF Staff Country Reports 2008, 048; 10.5089/9781451826708.002.A001

Source: USAID.

14. Restrictive labor legislation, too, is a drag on the local economy. Excessive employment protection, a fairly high tax wedge, and low wage flexibility are major deterrents to labor market participation, especially in the formal economy, and encourage the employment of temporary foreign workers, especially in tourism and construction.

15. The business climate remains weak. The reduction of corporate taxation, the speeding up of licensing and the adoption of a laissez fare attitude have bolstered the attractiveness of Montenegro as a business location. However, interference by municipalities remains pervasive, incomplete zoning regulations raise the effective cost of investment, and public administration is weak.

III. Policy Discussions

16. Against this background, the discussions focused on policies to manage the upswing and prevent a hard landing, complete the transition to a market economy, and reduce vulnerabilities.

  • The potential growth outlook is strong, but staff expressed concerns about the impact of overheating and eroding competitiveness on external sustainability. Staff and the authorities concurred that near-term prospects are positive, with strong tourism potential, but differed on the assessment of risks.

  • The CBM shared staff concerns regarding the extremely fast credit growth. There was agreement that the enforcement powers of the CBM need to be strengthened, and prudential supervision tightened further.

  • There was less agreement on the use of fiscal policy to counter the boom. Staff emphasized the importance of a countercyclical fiscal stance, but the authorities pointed to high nation-building needs. Staff stressed the importance of a comprehensive medium-term expenditure framework to create space for public investments.1

  • Discussions on policies to promote growth were mixed. There was agreement on the need to strengthen labor and business legislation to increase the flexibility of the economy and reduce grey market activity, but less agreement on energy policies and privatization.

  • The authorities were more sanguine about the need for measures to offset vulnerabilities. Nevertheless, progress has been made on limiting restitution compensation, which is the main source of contingent fiscal liabilities, and strengthening financial markets

A. Medium-Term Framework

17. Growth potential is high, but with risks. The good prospects for tourism, as demonstrated by WTTC projections and phenomenally high FDI, provide a firm basis for strong growth over the medium term. However, current macroeconomic policies are adding to overheating pressures and increasing downside risks and, together with the slowing of reforms, are denting growth potential and impeding economic diversification by eroding competitiveness.

Medium-term Macroeconomic Framework, 2005–15

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Sources: Ministry of Finance; and Fund staff estimates and projections.

18. Short-term growth prospects remain positive, despite overheating. Staff projections are close to those of the authorities with growth of about 7 percent in 2008, as tourism picks up, and demand continues to be buoyed by strong FDI and credit growth (although less than in 2007). Both expected inflation to inch up in the face of wage pressures. The current account deficit is projected to narrow to 33 percent of GDP in 2008, due to a pick-up in tourism earnings, and less strong demand due to weakening wealth effects and policies to rein on credit growth.

19. The boom is expected to slow over the medium term (Figure 4). Medium-term growth prospects are where the authorities and staff differ. The staff see competitiveness erosion and the slow pace of structural reforms moderating potentially higher growth rates from strong tourism expansion (Box 3) to levels lower than expected for the current stage of transition. Both agree that the current account would narrow as the demand shock peters out, as credit markets are quickly saturated given the already high credit-to-GDP ratio (Box 2), and narrowing investment opportunities lead to the unwinding of FDI inflows. But staff stressed that labor costs have been rising very rapidly compared with the experience of other transition countries; and that wage moderation and reforms facilitating broader-based growth were indispensable for a soft landing.2 The current account would become increasingly debt financed, with private external indebtedness doubling from 30 percent of GDP at end 2007 to 59 percent by 2012 (Appendix II).

Figure 4.
Figure 4.

Montenegro: Macroeconomic Framework, 2005–15

(Percent of GDP)

Citation: IMF Staff Country Reports 2008, 048; 10.5089/9781451826708.002.A001

Sources: Montenegrin authorities; and Fund staff estimates and projections. The slow reform scenario is driven by lower FDI, weaker private investment, and smaller gains in labor force participation and unemployment reduction.

Montenegro's Competitiveness and External Sustainability

Montenegro's high current account deficit largely reflects transitory demand pressures, as confirmed by macroeconomic balance analysis, which implies a correction as the demand shocks unwind. Competitiveness indicators do not provide clear evidence of overvaluation but rapidly rising labor costs point to the need for productivity enhancing structural reforms to preserve competitiveness.

I. Price and cost competitiveness

Competitiveness indicators give mixed signals. The RPI-based REER shows little movement compared to other countries in the region, but the statistics are distorted by price repression. The average net wage is currently at middle range compared to other neighboring countries; however, it has been rising rapidly, and the wage-based REER suggests erosion of competitiveness. The internal terms of trade rose in 2004 but have stabilized since.

II. Tourism prospects: do costs matter?

Surveys have shown that tourism is not particularly sensitive to local costs, especially the type of enclave tourism resorts being established in Montenegro, which depend heavily on imported inputs and labor. Tourism receipts more than doubled from 2003 to 2006. According to the World Travel and Tourism Council, Montenegro ranks 3rd in speed of growth of tourism in 2007. This suggests that the importance of competitiveness is more to foster broad-based growth, and ensure that the local economy benefits from tourism-related activities.

Assessment of business climate

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Source: Transparency International, World Bank, World Economic Forum

Corruption Perception Index

Global Competitiveness Index

III. Macro-balance approach

The macroeconomic balance approach suggests that the large current account deficit will decline as FDI moderates, which is not unusual for transition economies. The underlying balance, which adjusts for transitory factors, is roughly equal to its equilibrium level but a gap is expected to emerge reflecting eroding cost competitiveness due to rapid wage increases and slow productivity growth. The equilibrium current account balance is based on economic fundamentals such as fiscal balance, old-age dependency ratio, population growth, relative income, and ratio of NFA to GDP.

IV. Institutional indicators

Various indicators of the business climate rank Montenegro consistently at the middle of the group. Montenegro ranked 84 out of 179 in the Transparency International's Corruption Perception Index, and 81 out of 177 in World Bank's Doing Business Index. The 2007 Freedom House report shows deterioration, in large part due to the lack of transparency in privatization.

A01ufig11

Price-based REER shows little movement…

REER (2001M1 = 100)

Citation: IMF Staff Country Reports 2008, 048; 10.5089/9781451826708.002.A001

A01ufig12

…but cost-based REER deteriorates…

(Wage and price-based REER, and ITT (2001M1 = 100)

Citation: IMF Staff Country Reports 2008, 048; 10.5089/9781451826708.002.A001

A01ufig13

…with wages growing faster than warranted by catch-up…

(In logs, 1992–2002 for all countries except for Montenegro (2000–2006))

Citation: IMF Staff Country Reports 2008, 048; 10.5089/9781451826708.002.A001

A01ufig14

…and macro balances suggeesting the need for real depreciation over medium term.

(In percent of GDP)

Citation: IMF Staff Country Reports 2008, 048; 10.5089/9781451826708.002.A001

1/ Ratio price of nontradeables to tradebles using RPI. Source: Central Bank of Montenegro, WEO and staff estimates and projections.

20. Staff cautioned that a harsher landing is clearly possible. Disillusion with current policies or diminished expectations could trigger a more abrupt private sector adjustment choking off private investment and discouraging FDI. Euroization rules out a currency crisis, but reliance on wage correction would be painful, especially if rigidities in labor markets are not addressed. The authorities acknowledged that overheating could result in a “hard landing,” but remained relatively sanguine about the risks of a disorderly adjustment and expected that after the adoption of the constitution the reform effort would regain momentum. Staff emphasized the downside risks including excessive restitution claims, potential volatility of the large FDI inflows, wage increases in excess of productivity growth, and an abrupt weakening of private sector balance sheets due to a shift in expectations. Public debt is not a source of vulnerability as confirmed by sustainability analysis (Appendix I).

FSAP Recommendations and Follow-up

The Central Bank of Montenegro is in the process of implementing an action plan to follow-up the FSAP, as described in the FSSA. The main findings of the FSAP were:

  • Rapid credit growth has strained banks' capacity to underwrite loans prudently, and eroded capital adequacy and profitability.

  • Banking supervision is robust, but the legal framework needs to be strengthened through adoption of the banking law, and enhanced enforcement powers.

  • The buoyant stock market is poorly supervised and may pose a reputational risk.

While the CBM has moved quickly to restructure supervisory practices and address specific vulnerabilities by tightening capital requirements, approval of the banking law has dragged.

Central Bank of Montenegro: Action Plan 1/

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As of October 31, 2007.

B. Safeguarding Financial Sector Stability

21. The central bank has moved to tighten credit, but lacks sufficient enforcement powers. The absence of a lender of last resort arrangement in Montenegro suggests the need for higher liquidity ratios. The authorities noted that they recently had raised effective reserve requirements to 14 percent (on average), which is high by international standards. They had also instructed some banks to strengthen their capital, and the average capital adequacy ratio at 18.7 percent appears to be at a comfortable level. CBM representatives noted that the turmoil in international financial markets had not been felt in Montenegro. The CBM has been following up on FSAP recommendations (Box 4), has been monitoring banks very closely, and has prepared regulations refining (effectively tightening) loan classification rules, but lacks effective enforcement powers. Staff agreed that the banking system is reasonably well supervised but noted that its resilience has not been tested in a downturn and the rapid credit growth has been taking its toll on banks' financial indicators, especially regarding liquidity (Table 5).

Table 4.

Montenegro: Summary of Accounts of the Financial System, 2003–September 2007

(In millions of euros)

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Sources: Central Bank of Montenegro; and Fund staff estimates.
Table 5.

Montenegro: Financial Soundness Indicators of the Banking Sector, 2004–June 2007

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Source: Central Bank of Montenegro

Net interest income in percent of interest bearing assets

22. Staff noted that euroization still leaves some limited room for maneuver in controlling credit growth. Staff noted that expanding the base of calculation of reserve requirements to include all non-capital liabilities would discourage banks' recourse to foreign financing and reduce moral hazard. Moreover, relatively high concentration of risks, and the inexperience of some banks, argued for above average solvency rates. The CBM argued that the pending refinements in loan classification obviated at this stage the need for higher minimum solvency ratios. Direct credit controls were also discussed but rejected by the CBM on efficiency and enforceability grounds.

23. There was agreement on a number of structural measures to check credit growth and strengthen the financial system. These included acceleration of the approval of the laws on the central bank and banks to provide, among other things, CBM supervisors with effective enforcement powers and immunity in the discharge of their duties; and to facilitate strengthened supervision, a tightening of loan-to-income and loan-to-value ratios, and the development of early warning systems for systemic macro risks, particularly for bank exposure to the stock market and real estate sector. Improved access to the Credit Registry would also enhance risk management practices at banks.

A01ufig15

Loan concentration is high.

Citation: IMF Staff Country Reports 2008, 048; 10.5089/9781451826708.002.A001

A01ufig16

Bank capitalization remains at comfortable levels…

Citation: IMF Staff Country Reports 2008, 048; 10.5089/9781451826708.002.A001

A01ufig17

…and is high compared to other transition economies.

Citation: IMF Staff Country Reports 2008, 048; 10.5089/9781451826708.002.A001

A01ufig18

NPLs have been relatively low, mainly due to the fast credit growth.

Citation: IMF Staff Country Reports 2008, 048; 10.5089/9781451826708.002.A001

Sources: Central Bank of Montenegro, and Global Stability Report, IMF.

24. Exuberance on the stock market is a concern. The authorities have requested Fund technical assistance to help strengthen governance.

C. Fiscal Framework: Balancing Growth and Stability

Medium-term fiscal framework.

25. Staff and authorities agreed that implementation of two key elements of the medium-term fiscal framework would bolster policy credibility:

  • Fiscal policy should be anchored on a medium-term target. The target to reduce gross debt to below 30 percent of GDP by 2012 can be achieved with, on average, a small primary surplus over the medium-term (Appendix I).

  • Downsizing of the public sector. The authorities plan to reduce current spending to make room for further tax cuts, and higher public investments. They have yet, however, to formulate concrete public sector reforms that would lend credibility to these plans. Staff recommended the development of a medium-term fiscal framework to reconcile spending needs.

Fiscal policy in 2007–08: leaning against the wind

26. Staff argued for a countercyclical fiscal stance. Notwithstanding their medium-term objective of downsizing the public sector, the authorities' immediate plans were predicated by nation building expenditure and prior commitments to reduce tax rates. As a result, the revised budget for 2007 and preliminary 2008 budget would add additional fiscal stimuli to the domestic economy. Reductions of social contribution rates, large public wage increases, and increases in spending are estimated to add 3½ percent of GDP to demand in 2008. Staff recommended a re-assessment of the policy package to aim for an unchanged primary balance. But apart from scaling back a proposed abolition of municipal surtaxes and doubling the real estate turn-over tax, the authorities felt bound by political considerations and already announced policy changes.

Structural balance

(in percent of GDP)

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Sources: Montenegrin authorities; and Fund staff estimates and projections.

27. Staff suggested that strong fiscal performance should be used to implement difficult but essential public sector reforms. Staff noted that tax reductions and wage increases will be difficult to claw back when the economy slows, and fiscal space will be needed when large infrastructure projects are ready to be executed. Staff proposed the following:

  • Public administration reforms should accompany the announced wage increases. Montenegro is not alone in the region in facing the challenge of keeping qualified staff in the public sector as private sector wages increase. The answer is a reform of pay scales and streamlining of the public sector to allow pay to better match skills. The public expenditure review conducted by the World Bank provides useful recommendations for public sector reform.

  • Reassessing tax reforms. With tax rates already low by international standards, further reform should be undertaken with care and aim at strengthening the revenue base, and preventing distortions by eliminating exemptions and preferences.

  • Increased control of the broader public sector. Staff recommended that the government more actively exercise its ownership rights in public enterprises and strengthen control of local government spending decisions. In addition, staff proposed to transfer public sector deposits to the central bank to avoid fueling bank credit.

28. The authorities concurred with the importance of enhancing the monitoring and reduction of fiscal risks. The government is currently considering the possibility of financing large infrastructure projects through Private-Public Partnerships (PPP), in particular, regional highways. Staff pointed out that while PPPs could be an attractive means of financing they could also generate substantial fiscal risks; and stressed the need to introduce a sound legal and institutional framework, as suggested in earlier technical assistance. The government is contemplating prepayment of restitution claims, and while the discount could be sizeable, staff strongly advised against this due to the potentially sizeable negative impact on domestic demand and risk of unequal treatment of claimants.

D. Boosting Structural Reforms

29. The authorities stressed their commitment to structural reform but indicated that forging the necessary consensus is not easy. They noted that they had made considerable progress in privatization and establishing the legal basis for a business friendly environment.

30. Staff emphasized the importance of energy reforms to prevent shortages. Staff stressed that adjustment of electricity tariffs toward market levels was critical for reducing quasi-fiscal losses of about 2½ percent of GDP, and attracting much needed private investment into the sector. The authorities were less convinced of the importance of tariff reform and privatization. However, World Bank staff consulted were concerned that the electricity company had neither the resources nor the know-how to undertake the large investments needed. In addition, the tariff increase of July 2007 was barely sufficient to cover operating costs and regulators explained that it included no allowance for return on capital. More positively, the authorities have completed the financial unbundling of EPCG's operations into generation, transmission and distribution and were expecting to open up the market in early 2008.

31. The authorities were in the process of a comprehensive reform of labor legislation. They explained that the new draft law incorporated key provisions from international conventions. Staff stressed the need for flexibility in collective bargaining (especially allowing separate agreements for individual sectors and opt out clauses), facilitating job mobility, and reducing non-wage costs, which were among the highest in the region.

32. The authorities confirmed their commitment to improving the business environment. Staff acknowledged that significant progress had been achieved in improving the business environment but stressed the need for further progress, especially in improving predictability and limiting discretion, setting timely limits in processing applications, upgrading the judiciary, and completing zoning regulations at the municipal level. Staff emphasized the importance of strengthening corporate governance, especially regarding the timely release of financial statements for listed companies, and noted that failure to do so could risk the reputation of the young stock exchange.

33. The authorities were committed to combating money laundering and the financing of terrorism. They explained that the framework for AML/CFT was being upgraded and a new law would be submitted to parliament in early 2008.

34. Economic policy was hampered by deficiencies in macroeconomic statistics. The weakest area was the real sector, where the implementation of statistical standards has barely kept pace with the increasing data demand. The authorities noted that progress was being made in developing data sources, implementing international standards in statistics methodology, and developing expertise.

IV. Staff Appraisal

35. Much is going well. The economy is booming. Euro adoption has delivered low inflation and anchored expectation, and the discovery of Montenegro as an international tourist destination has drawn massive FDI inflows.

36. But strong growth is hiding growing vulnerabilities. The economy is overheating. Rapid credit growth is overstretching banks, and has contributed to ballooning asset prices.

37. Eroding competitiveness is a concern. Euro adoption precludes an exchange rate adjustment, but rapidly rising private debt raises the possibility of solvency problems related to asset markets, especially if competitiveness problems stunt Montenegro's tourism potential.

38. Policy levers are few, but need to be used. The authorities need to make more active use of those policy instruments available to address demand pressures, reduce vulnerabilities, and ensure a soft landing.

39. Management of the boom falls on fiscal policy. However, the preliminary 2008 budget would be expansionary unless revised. The 30 percent public sector wage increase and tax cuts would provide an unhelpful boost to an already overheated economy.

40. Tax cuts have been procyclical and potentially destabilizing. Corporate tax cuts, combined with absence of capital gains taxation, only provide investors with a windfall in a country with the enormous potential of Montenegro. Strong import-driven VAT growth should not be seen as providing scope for further tax cuts, as these revenues will eventually fall as import growth slows. The authorities should review ongoing tax reforms to strengthen the tax base and fiscal stabilizers.

41. Fiscal risks need to be contained. Paris Club debt reductions have lowered public debt, but the central government should resist assuming large restitution liabilities. Recent efforts to tighten criteria and ensure that property is returned to owners rather than compensated through government bonds are welcome. The authorities also need to guard against the assumption of guarantees and contingent liabilities, including PPPs, to solve their large infrastructure needs.

42. Better budgetary control is crucial. Control over local government should be strengthened, and state enterprise quasi-fiscal operations brought on budget.

43. Absent monetary policy, the main focus of credit policy should be to strengthen banking sector supervision. Passage of the banking law is the single most important measure to allow for enhanced supervisory practices to be enforced. Attention needs to be given to the monitoring of systemic risks, including real estate prices, and private external debt. Urgent attention is needed to limit risks associated with the highly capitalized stock market.

44. Completing the transition to market economy should be kept at the top of the policy agenda. Progress has been made, but energy and labor reforms, two areas critical for ensuring sustained growth, have been patchy at best. Privatization momentum, especially in the electricity sector, needs to be reinvigorated, and more weight given to market-based policies. Labor flexibility is crucial to ensure competitiveness given euroization. The authorities' plans to reform the labor legislation are welcome, but need to address restrictive practices and ensure sufficient weight is given to both private sector and social partners in the planned consultative process.

45. The authorities need to address the poor state of the statistics. Important deficiencies and gaps in the national accounts, fiscal, price, and balance of payments statistics undermine informed policy decisions. Reorganization of the statistical agency is essential if further technical assistance is to be effective.

46. It is recommended that the next Article IV consultation with Montenegro be held on the standard 12-month cycle.

Table 6.

Montenegro: Balance of Payments, 2004–12 1/

(In millions of euros)

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Sources: Central Bank of Montenegro; and Fund staff estimates and projections.

BOP compilation methods have been changed in 2006, including the recording system for trade data and treatment of income transfer of foreign workers. Therefore direct comparison with 2005 may not be feasible.

Table 7.

Montenegro: Indicators of External and Financial Vulnerability

(In percent of GDP; unless otherwise indicated)

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Sources: Central Bank of Montenegro, Ministry of Finance; and Fund staff estimates and projections.

End-September 2007.

End-July 2007.

Appendix I: Montenegro—General Government Debt Sustainability Analysis

1. The monitoring of general government debt has improved significantly, with the debt management department of the Ministry of Finance taking a leading role in clarifying and making public the debt situation.

2. This debt sustainability analysis includes gross public debt that is recognized by the authorities and covers the general government.1 Estimates of the liabilities from the restitution process are included. Parliament has limited the overall liabilities stemming from restitution to a maximum of 10 percent of GDP through amendments to the restitution law. For 2007, ca. €150 million is added to government liabilities. Debt of municipal governments has been revised upwards on account of recognition of domestic payment arrears (ca. €20 million). The discussions between Serbia and Montenegro on the division of external debt are not yet final, and under the current scenario, debt equivalent to €20 million is added in 2007 on account of assumed debt from the former State Union.2 The government has also decided to compensate confiscated foreign savings of Montenegrin citizens in banks outside Montenegro3 and, possibly, for losses incurred in the pyramid-schemes (additional €18 and €10 million are included in the current scenario). There is still uncertainty regarding debt of public enterprises from before the reconstitution of the Union between Serbia and Montenegro that ultimately could become a liability of the government. Montenegro has also decided to pre-pay World Bank debt. In September, a payment of €19 million was made, and the current scenario assumes that an additional early re-payment of €38 million will be effected before the end of 2007.

3. Under the baseline scenario, Montenegro's debt-to-GDP ratio would decline to below 30 percent of GDP in 2012 (Table 1). The primary balance is projected to improve with the current upswing in the economy. However, a weakening of the automatic stabilizers through tax rate reductions and expansion of the public sector will slow the pace of debt reduction. Nominal interest rates, while low due to the high share of relatively cheap domestic and foreign debt, are projected to reach 3½ percent on account of the government taking on a higher proportion of debt on non-IDA terms, and robust real economic growth will strengthen the automatic debt dynamics. Privatization revenues are expected to decrease following the windfall in 2005–08.

Table A1.

Montenegro: General Government Debt Sustainability Framework, 2003–2012

(Percent of GDP, unless otherwise indicated)

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Gross debt, including central government, social funds and local governments

Derived as [(r - π(1 +g) - g + αε(1 +r)]/(1 +g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; α = share of foreign-currency denominated debt; and ε = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

The real interest rate contribution is derived from the denominator in footnote 2/ as r - π (1 +g) and the real growth contribution as -g.

The exchange rate contribution is derived from the numerator in footnote 2/ as αε(1+r).

For projections, this line includes exchange rate changes.

Defined as public sector deficit, plus amortization of medium and long-term public sector debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; real interest rate; and primary balance in percent of GDP.

Derived as nominal interest expenditure divided by previous period debt stock.

Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.

4. The standard stress tests were performed using the methodology adopted in July 2005 (Information Note on Modifications to the Fund's Debt sustainability Assessment Framework for market access Countries-http://www-imf.org/external/np/pp/eng/205/070105.htm), but with modifications due to data constraints. Relevant economic information for Montenegro prior to 2002 does not exist, and estimates for 2002–06 are used for historical averages and standard deviations.

5. The standard stress tests result in a slower reduction of debt in the medium-term, but not a reversal (Figure 1), and the debt path is robust to most adverse scenarios. Montenegro, however, is facing large risks due to external concentration in trade and uncertainties in real debt levels; and euroization limits the economy's flexibility to respond to a shock. To test the limits of the debt dynamics the standard shocks applied to real interest rate, growth rate and primary balance was doubled, and 20 percent of GDP was added to the debt stock in 2008, reflecting possible hidden debt or addition of new liabilities (Figure 2). In this scenario, debt sustainability is particularly sensitive to growth and fiscal shocks, while less sensitive to interest and exchange rate shocks (due to the relatively low interest rates on existing debt stock and a small share of debt denominated in non-euro currencies). Thus, the relatively high sensitivity to changes in growth and fiscal policy reinforces the importance of continued structural reforms and a prudent fiscal stance.

Figure A1.
Figure A1.

Montenegro: General Government Debt Sustainability: Bound Tests 1/

(Public debt, percent of GDP)

Citation: IMF Staff Country Reports 2008, 048; 10.5089/9781451826708.002.A001

Sources: International Monetary Fund, country desk data, and staff estimates.1/ Shaded areas represent actual data. Individual shocks are permanent one half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.2/ Permanent ¼ standard deviation shocks applied to real interest rate, growth rate, and primary balance.3/ One-time real depreciation of 30 percent and 10 percent of GDP shock to contingent liabilities occur in 2008, with real depreciation defined as nominal depreciation (measured by percentage fall in dollar value of local currency) minus domestic inflation (based on GDP deflator).
Figure A2.
Figure A2.

Montenegro: General Government Debt Sustainability: Bound Tests 1/

(Public debt, percent of GDP)

Citation: IMF Staff Country Reports 2008, 048; 10.5089/9781451826708.002.A001

Sources: International Monetary Fund, country desk data, and staff estimates.1/ Shaded areas represent actual data. Individual shocks are permanent one standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.2/ Permanent ½ standard deviation shocks applied to real interest rate, growth rate, and primary balance.3/ One-time real depreciation of 30 percent and 20 percent of GDP shock to contingent liabilities occur in 2008, with real depreciation defined as nominal depreciation (measured by percentage fall in dollar value of local currency) minus domestic inflation (based on GDP deflator).

Appendix II. Montenegro—External Debt Sustainability

1. Montenegro's external public debt is low. Since the debt restructuring by Paris Club and bilateral donors in 2003, which almost halved external public debt to around 33 percent of GDP, the public external debt has continued to decline. Montenegro also benefited from another debt write-off by Paris Club creditors in 2006, which contributed to total external public debt falling to about 26 percent of GDP.

2. The data on private external debt is weak; however, staff and the authorities' estimates indicate that external private debt has been increasing rapidly since 2006 which warrants cautious monitoring. Based on available data so far, private external debt is expected to jump from 19 percent of GDP in 2006 to 30 percent in 2007. Commercial bank debt accounted for just under half of the increase, with financial institutions taking advantage of improved access to international capital markets and foreign bank branches in Montenegro borrowing from headquarters abroad. The remainder of the increase may partly reflect hidden FDI, with the debt later converted to equity. The mission has stressed the need to maintain record of private debt stock.

3. The macroeconomic framework projects real growth to slow down gradually, while the current account situation improves with a fall in FDI related imports, and strong tourism earnings. Under the baseline scenario, the debt-to-GDP ratio increases from about 53 percent in 2007 to 59 percent in 2008 and continues to grow to reach 74 percent by 2012. During this period, the external public debt declines from 22 percent to 16 percent. Meanwhile, the private sector is expected to replace the role of FDI and pushing up the private external debt to 38 percent by 2008 and continue upwards to reach 58 percent by 2012. An alternative scenario with key variables at their historical average shows an improvement in external debt because of exceptionally high FDI. Scenarios with higher interest and a worsening current account indicate less favorable debt path, especially for the latter shock. A large real depreciation would boost exports, and lead to a significant improvement in the debt position.

Table A1.

Montenegro: External Debt Sustainability Framework, 2004–2012

(In percent of GDP, unless otherwise indicated)

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Derived as [r - g - ρ(1+g) + εα(1+r)]/(1 +g+ρ+gρ) times previous period debt stock, with r = nominal effective interest rate on external debt; ρ = change in domestic GDP deflator in US dollar terms, γ = ρεαλ ΓΔΠ γροωτη ρατε, ε = nominal appreciation (increase in dollar value of domestic currency), and α = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-ρ(1 +g) + εα(1 +r)]/(1 +g+ρ+gρ) times previous period debt stock, ρ increases with an appreciating domestic currency (ε > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Annex I. Montenegro: Fund Relations1

(As of October 31, 2007)

Article IV Consultation. The discussions were initiated during April 18–May 4, 2007, at which time the possibility of a precautionary Stand-by was discussed. The authorities determined that an arrangement was not needed at this time, and the Article IV consultation discussions were finalized during October 4–17, 2007. The team comprised of Messrs. Justice (head), Alvesson, Gagales (all EUR), Ms. Kim (PDR), Mr. Capuano (MCM), Mr. Norregaard (FAD), Ms. Mantcheva (STA), Mr. Lalonde (LEG), and Mr. Hirschhofer (resident representative). Mr. Christofides and Ms. Cerovic from the Executive Directors's office participated in the discussions. Mr. Driessen (MCM) joined the mission on April 19–20 to present the conclusions of the FSAP. The mission met with Prime Minister Sturanovic, Deputy Prime Minister Lasovic, Finance Minister Luksic, Economy Minister Gvozdenovic, Labor Minister Radanovic, Tourism and Environment Minister Nenezic, Governor Krgovic of the Central Bank of Montenegro, Minister of Transport Lompar, and other senior officials. A press conference was held at the mission's end.

Montenegro has accepted the obligations of Article VIII, Sections 2, 3, and 4, and the mission raised the need for a comprehensive examination of Montenegro's exchange system.

I. Membership Status: Joined: 01/18/07; Article VIII

II. General Resources Account:

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III. SDR Department:

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IV. Outstanding Purchases and Loans: None

V. Financial Arrangements: None

VI. Exchange Rate Arrangement: Exchange arrangement with no separate legal tender. The euro is the legal tender. Montenegro has accepted the obligations of Article VIII, Sections 2, 3, and 4, and awaits a comprehensive examination of the exchange system.

VII. Article IV Consultation: Montenegro is proposed to be put on a 12 month cycle. This is the first Article IV consultation.

VIII. FSAP Participation and ROSCs: A Financial Sector Assessment Program, initiated in July 2006 jointly with the World Bank, and was concluded during the current Article IV consultation.

IX. Technical Assistance:

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X. Resident Representative: Mr. Harald Hirschhofer, resident representative to Serbia, was designated resident representative in January 2007. A satellite office has been established in the Central Bank of Montenegro.

Annex II. Montenegro: Relations with the World Bank Group

Montenegro's Development Goals

1. Montenegro declared independence in mid-2006, joining the World Bank and IMF about half a year later in January 2007. Even under the umbrella of the State Union of Serbia and Montenegro, the Bank had effectively established a functional relationship with Montenegro.

2. World Bank support complements Montenegro's developments goals, especially its objectives spelt out in the Stabilization and Association process (SAp) with the European Union (EU).1 Montenegro is in the process of developing and/or updating its development and sectoral strategies and integrating those into the overarching national integration program. These are to update Montenegro's medium-term development strategy, as contained in the 2004 Development and Poverty Reduction Strategy (DPRS)2 and the Economic Reform Agenda.

3. Following independence, and against the background of accelerating growth rates, largely fueled by a very significant inflow of foreign-direct investments, Montenegro has made substantial progress in advancing its development goals. Euroization has contributed to anchoring macroeconomic stability as a central pillar of economic policymaking, complemented by programs to advance privatization, liberalization, and structural reforms—with the aim of ensuring fiscal consolidation and promoting stronger private sector-led growth. The prolonged debate on the Constitution, the lack of institutional capacity, and the reorientation of policy priorities has delayed the implementation structural reforms in several areas and led to some relaxation of fiscal policies during late 2007. Having completed the immediate state-building tasks and the SAp, the government should overcome quickly the delays in implementing the structural reform agenda.

World Bank Group Strategy

4. A Joint World Bank-IFC Country Partnership Strategy (CPS) for Montenegro, covering FY07–10 and endorsed by the Bank's Board on June 12, 2007, will support the government's key priorities, viz., to (i) enhance sustainable economic growth, through increasing economic freedoms and strengthening the role of the private sector; (ii) build institutions and the rule of law; and (iii) improve the standard of living of citizens, through efficient education, health and social protection systems.

5. Coordination with the IMF has been strong, with cooperation having focused on macroeconomic issues and sectoral ones with a potentially strong macroeconomic impact—more important still after the government's decision not to request a Fund-supported program and in light of the increased risks to macroeconomic stability. The Bank, through its ongoing and planned operations, as well its complementary economic and sector work, will continue to provide input on issues such as (i) labor market reforms; (ii) energy sector reforms; (iii) public expenditure, pension and health reforms, with a view to streamlining service delivery, and (iv) an appropriate framework to regulate concession arrangements and potential public/private partnerships, with a view to encouraging investment in a way that would ensure that the government does not accumulate significant contingent liabilities.

6. Total outstanding debt of Montenegro towards the various part of the Bank was about US$401.5 million on November 7, 2007 (US$56.9 million for IDA and US$344.6 for IBRD), at the current exchange rate about €290 million. In September 2007, the government prepaid €20 million, with further prepayments foreseen during the fourth quarter of 2007. With these payments, Montenegro has considerably reduced per-capita exposure ratios, which had previously been among the highest for any Bank borrower.

World Bank Activities

7. The 2007 CPS envisages a total lending envelope of US$70–90 million. Following the successful completion, in 2006, of the Second Structural Adjustment Credit (SAC 2), the government decided not to request a follow-up development policy credit, largely because of Montenegro's strengthened fiscal position. Investments aim at fostering private-sector activities and streamlining social services, while maintaining a quality environmental infrastructure that is required for sustainable growth in tourism (a key industry).

8. Streamlining social services is a particular challenge given the relatively large cost of social services as a proportion of GDP, even when compared to neighboring countries with similar income levels. The Montenegro Education Reform Project aims at strengthening the capacity of the education system to make continuous improvements, especially in the quality of teaching and learning in schools and in the efficient use of budgetary resources. There is a high degree of government ownership and no problems in project implementation.

Montenegro: World Bank Lending Envelope, FY07–FY10

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On IDA terms; IBRD terms otherwise.

In high-case lending scenario.

Source: World Bank, 2007, Country Partnership Strategy for the Republic of Montenegro, Report No. 39800-ME.

9. The Healthcare System Improvement Project seeks to put in place first steps toward a reformed healthcare system to increase the capacity for policy, planning, and regulation, stabilize healthcare financing, and improve primary healthcare service delivery. The implementation is proceeding well, and government ownership is strong. The Health Ministry has succeeded in securing CIDA grant funds to co-finance the project.

10. The Energy Community of South East Europe-APL3 Montenegro Project is awaiting effectiveness. Procurement activities for the projects have started. The General Procurement Notice is prepared and about to be published, while EPCG is finalizing the technical specifications for the projects and is planning to issue tender documents of some of these projects by end-December 2007. In addition, Bank teams have discussed an Energy Efficiency Project, planned for FY09, to support financing related projects in the public sector, especially in the education and health sectors. The Bank team has agreed with government representatives on next steps for further assessment of prospects and scope of energy efficiency investments in public sector buildings.

11. The Montenegro Sustainable Tourism Development Project is to help Montenegro to better design and implement an integrated coastal zone management approach. With this, coastal degradation is to be reduced and environmentally sound tourism development fostered by supporting activities aimed at (i) enhancing spatial development, the use of natural resources, regulatory policy, institutional capacity and governance of the coastal zone, and (ii) initiating priority investments to improve environmental conditions and foster development of high-quality tourism. These objectives will be achieved through (i) improvements in land-use planning and protection to guard against uncontrolled construction and development; and (ii) investments for the Continental and Southern part of the Regional Water Supply Scheme with the capacity to provide water from Lake Skadar/Shkodër to the municipalities of Bar and Ulcinj/Ulqin and the tourist areas of Valdanos and Velika Plaža. This phase of the MSTDP will only finance the investments from Lake Skadar/Shkodër to Bar.

12. The Montenegro Environmentally Sensitive Tourist Areas Project is to create ecological and commercially sustainable solid waste collection and disposal services in Montenegro coastal municipalities, needed to maintain a clean, environmentally attractive coastal area. This is to be achieved through the (i) development of the sector's institutional, policy and regulatory framework; (ii) rehabilitation of municipal disposal sites to function as properly designed regional sanitary landfills; (iii) closing existing disposal sites in an environmentally acceptable manner; (iv) provision of modern collection equipment; (v) initiating a pilot recycling campaign; and (vi) strengthening multi-municipal joint companies (MJC) that will be created to operate the two regional solid waste disposal systems.

13. Current Bank involvement is restricted to policy dialogue and an application to the Public-Private Infrastructure Advisory Facility trust fund, which is currently awaiting approval. The government wishes to improve competitiveness and has major development plans for two main road corridors (Bar to the Serbian Border, and Adriatic - Ionian Corridor). The government has commissioned a study to investigate the feasibility, and implementation schedule, of constructing motorways on both these axis, and political pressure is high and increasing. The estimated costs are significant, exceeding current GDP and, consequently, available resources. The government has therefore sought the support of PPIAF and the Bank to investigate this option.

14. Over the last year, the performance of projects in Montenegro has increased considerably. As of October 5, 2007, the portfolio consisted of six projects under implementation, with a total commitment of US$43 million, of which US$17 million have been disbursed during the FY 2007. The disbursement rate, for the same period, has been 33 percent. Performance rating is Satisfactory (S) for 2 projects (education and sustainable tourism development), Moderately Satisfactory (MS) for 2 (health and pension), and Unsatisfactory for one (MESTAP); one project has not been rated yet (energy). The average age of the portfolio is 2.2 years. Two new projects—in sustainable tourism and energy sector development over a total amount of US$19 million—have been approved during the third quarter of 2007. With respect to non-lending operations, a public expenditure and institutional review (PEIR) is planned for the FY08.

15. In support of the implementation of the project portfolio, the Bank is also administering 2 Trust Funds financed by single and/or multi donors. Two projects financed by Global Environmental Facility (GEF), the Tara and Lim River Basins Watershed Management Project and the Lake Skadar/Shkodër Integrated Ecosystem Management Project, both under preparation, should help boost tourism in the poorer northern part of the country and around Lake Skadar/Shkodër.

16. The Bank's assistance has been supported by a standard package of analytical and advisory activities. A CPAR and a CFAA were delivered in 2002, followed by a PEIR and a Poverty Assessment in 2003. A Montenegro Economic Memorandum was completed in 2005 and focused on macroeconomic issues (particularly public expenditure), labor market reform, the business climate and also synthesized findings of supporting studies of energy. A PEIR update and Debt Sustainability Analysis were recently completed, while a Poverty Assessment Update and an FSAP and ROSC are ongoing.

17. FIAS assisted the self-assessment of administrative procedures for doing business which identified several major areas of concern: complex procedures for registration of enterprises, along with the lack of funds as well as shortcomings in the legal framework for competition and management of public and private enterprises.

18. MIGA, with EAR support, is implementing a capacity building project in support of the new Montenegrin Investment Promotion Agency. MIGA's TA activities are feeding into a new, regional FDI outreach and marketing initiative for the Western Balkans launched in summer 2004 (the European Investor Outreach Program for the Western Balkans).

19. IFC has also provided $5.2 million through Opportunity Bank Montenegro to expand micro- and small-business enterprise loan portfolio. In addition, IFC has provided support through its Southeast European Enterprise Development (SEED) facility, later transformed into Private Enterprise Partnership of Southeast Europe (PEPSE) and assisted in introduction of Financial Leasing Law through its Leasing Project.

Prepared by World Bank staff. Questions may be addressed to Jan-Peter Olters.

Annex III. Montenegro: Statistical Issues

1. While data are broadly adequate for surveillance, weaknesses hamper economic analysis and policy making. Following the creation of the State Union between Serbia and Montenegro in 2003, statistical institutions were split and Montenegro, being the smaller partner and with a capital located far from Yugoslav institutions, lacked sufficient resources and qualified personnel, and lost institutional memory and know-how. The quality and timeliness of reporting vary across sectors. For monetary and balance of payments statistics, international reporting standards have been adopted, while the adaptation of national account data has been slower. Reporting of fiscal data has recently improved but coverage is limited. A page for Montenegro in International Financial Statistics (IFS) was introduced with the March 2007 issue.

2. The authorities have created a statistical council to coordinate efforts to improve data quality and requested technical assistance from foreign partners. In response, the Fund has provided a series of technical assistance missions to improve the quality of macroeconomic statistics and support policy formulation, often jointly with TA provided to Serbia. Over the period 2001–04, STA conducted six missions to the State Union, including a mission on monetary and financial statistics, separate balance of payments statistics missions to Serbia and to Montenegro, and a multi-topic mission covering national accounts statistics. The status of the statistical base, as reflected in these missions, can be summarized as follows: (i) there is a critical need to improve the quality of existing macroeconomic statistics by developing comprehensive data sources and improving statistical methodologies; (ii) informal activities are inadequately recorded in the national accounts, especially in the expanding service sector; and (iii) the principles for compiling monetary statistics are broadly consistent with MFSM 2000. A 2006 monetary statistics mission and a 2007 real sector statistics mission were undertaken to assist the authorities in improving the quality of the compiled data.

A. Real Sector

3. Real sector data are compiled by the Statistical Office of Montenegro (MONSTAT). MONSTAT has started to adopt the 1993 System of National Accounts as a framework for compiling national accounts estimates. However, the scope of the accounts is limited to compiling annual production account in current prices, and only aggregate GDP in previous year prices. The accuracy of the data sources needs to be improved. The business statistics are still following the material system product concepts, collecting data mainly on quantities produced. The national accounts estimates depend solely on bookkeeping data. There is no business register to be used for statistical surveying, although work has started with Statistics Sweden. On the expenditure side, there are no data on changes in inventories, and the quality of investment and merchandise trade data is unsatisfactory. The exhaustiveness of the national accounts data is seriously undermined by the lack of sound techniques to incorporate unobserved activities. Some work has been done on ad-hoc basis, but the estimates produced are not included in the regular compilation practice. The techniques for deriving volume measures of GDP are constrained by the lack of suitable price and volume indices.

4. MONSTAT compiles and disseminates retail price indices (RPI), and cost of living indices, and producer price indices. A proper consumer price index is planned to be introduced in 2008. In all price indices, the “carry-forward” technique for treatment of seasonal goods, new goods, and missing items are not following international standards. The quality of the labor and wage indicators is good.

B. Balance of Payments

5. Balance of payments statistics are compiled by MONSTAT (trade statistics) and the Central Bank of Montenegro (other current account elements, capital and financial accounts). Significant improvement is needed in data compilation, in particular in external trade, where MONSTAT uses the special trade system for imports but general trade system for exports. This inconsistency may have resulted in the overestimation of imports. In addition, the classification used by MONSTAT is the Harmonized System (HS), but data are disseminated according to the Nomenclature générale des Activités économiques dans les Communautés Européennes (NACE), on highly aggregated groups, and with a significant time lag. Some components are likely under-recorded, since a significant proportion of foreign exchange transactions occur through informal channels.

6. Data on private external debt are weak. While the Central Bank of Montenegro (CBM) has continuously maintained a record of flows of private external debt in recent years, there is no data on stock of external debt. The authorities' program includes strengthening the monitoring of private external debt by CBM and MONSTAT.

7. A June/July 2004 mission to the CBM assisted with adoption of compilation methodologies consistent with the fifth edition of the Balance of Payments Manual (BPM5) and provided recommendations to improve international trade and external debt statistics, as well as Montenegro's international transactions reporting system (ITRS). The authorities have implemented many of the recommendations of the 2004 mission. Following the authorities' request for further assistance, a mission visited Montenegro in September - October 2007. Although it noted substantial progress, inadequate data sources continue to constrain progress in improving balance of payments data.

C. Government Finance

8. Fiscal data are compiled by the Ministry of Finance (MOF) based on a new GFS institutional classification, and since early 2006, include data for the social security funds and local governments. The chart of accounts introduced in 2001 has been implemented at the local level from mid-2005. Fiscal data reporting suffers from frequent re-classifications, especially, at the level of local governments and social funds. The MOF has recently created a unit responsible for data collection for state-owned enterprises (SOE), but a satisfactory compilation of the public sector fiscal balance requires significant further efforts. Data on stock of local government arrears need to be strengthened.

D. Monetary Accounts

9. Monetary and financial statistics are compiled by the CBM, broadly following the institutional coverage, classification, and valuation methodology set forth in the Monetary and Financial Statistics Manual, 2000. Dissemination practices meet GDDS recommendations with respect to the periodicity and timeliness for financial sector data. Beginning in early 2006, the CBM publishes detailed monetary statistics in its monthly Statistical Bulletin, which includes tables on monetary statistics, balance sheets and surveys for the CBM and the commercial banks.

10. Significant progress notwithstanding, there is need for further improvement. The 2006 monetary and financial statistics mission made recommendations to the CBM on methodological issues concerning: (i) the exclusion of two banks in bankruptcy from financial reporting (the mission proposed that if these institutions are excluded from the coverage of the monetary survey, a separate table on their monetary accounts could be included in the CBM's Statistical Bulletin); and (ii) treatment of interest accrued but not yet due (which is maintained in aggregate on separate accounts rather than incorporated in the outstanding amount of the financial asset or liability).

11. The CBM does not yet report monetary data in the format of Standardized Report Forms (SRFs). To avoid duplication of effort, the CBM will need to decide whether to adopt the European Central Bank's framework for collecting, compiling and reporting monetary data or the STA-developed SRFs, either of which will provide monetary data that accord with international standard.

Montenegro: Table of Common Indicators Required for Surveillance

As of November 15, 2007

article image

Includes reserve assets pledged or otherwise encumbered as well as net derivative positions.

Both market-based and officially-determined, including discount rates, money market rates, rates on treasury bills, notes and bonds.

Foreign, domestic bank, and domestic non-bank financing.

The general government consists of the central government (budgetary funds, extra budgetary funds, and social security funds) and state and local governments. General government reporting is incomplete; local government expenditure data are available only after a six-month lag.

Including currency and maturity composition.

Daily (D), Weekly (W), Monthly (M), Quarterly (Q), Semi-annually (SA), Annually (A), Irregular (I); or Not Available (NA).
1

The fiscal framework is discussed in an accompanying Selected Issues Paper.

2

The macroeconomic adjustment to the large FDI inflows is discussed in more detail in the accompanying Selected Issues Paper.

1

The central government, social funds (pension, health and employment) and local governments. Debt of state-owned enterprises is included only as so far it is explicitly recognized as a liability of the government. Official debt figures do not include extra-budgetary funds.

2

Debt expected to be assumed by the Republic of Montenegro is toward Kuwait, Libya, Czech Republic, and Slovakia.

3

This goes beyond the previous compensation that applied only to foreign savings confiscated by banks in Montenegro, and, in principle, the Montenegro government will have a claim on the countries in which these banks reside.

1

Updated information relating to members' positions in the Fund can be found on the IMF web site (http://www.imf.org/external/np/fin/tad/exfin1.aspx).

1

The Stabilization and Association Agreement (SAA) with the EU was signed on October 15, 2007, joining Albania, Croatia, and Macedonia as the fourth Southeastern European country to have successfully concluded the SAp.

2

The Document was presented to the Board as self-standing part of the joint Serbia and Montenegro Poverty Reduction Strategy.

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Cover IMF Staff Country Reports
Republic of Montenegro: 2007 Article IV Consultation: Staff Report; Staff Statement; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Republic of Montenegro
Author:
International Monetary Fund
Volume/Issue:
Volume 2008: Issue 048
Publisher:
International Monetary Fund
ISBN:
9781451826708
ISSN:
1934-7685
Pages:
62
DOI:
https://doi.org/10.5089/9781451826708.002
  • Figure 1.
    View in gallery
    Figure 1.

    Montenegro: A Good Start to Independence, 2007

  • View in gallery

    Stock market indices

    (Dec. 2005 = 100)

  • View in gallery

    Real estate prices soared during 2004–06

    (Annual average increase, in percent)

  • View in gallery

    External Balance and Its Financing

    (In percent of GDP)

  • Figure 2.
    View in gallery
    Figure 2.

    Montenegro: Developments in the External Sector, 2007

  • View in gallery

    Impact of tourism on the rest of the economy appears limited.

  • View in gallery

    Spread of Average Interest Rates on Loans to Private Companies over 12-month EURIBOR

  • View in gallery

    The financial sector has been rapidly deepening…

  • View in gallery

    Distance to default in CEE countries, 2001–07

  • Figure 3.
    View in gallery
    Figure 3.

    Montenegro: Consolidated Fiscal Developments, 2004–07

    (Percent of GDP)

  • View in gallery

    Fiscal balance with revised 2007 budget

    (In millions of €)

  • View in gallery

    Electricity tariffs are high in Montenegro, especially for commercial users

    (Electricity tariffs in euro per MWh, in 2006)

  • Figure 4.
    View in gallery
    Figure 4.

    Montenegro: Macroeconomic Framework, 2005–15

    (Percent of GDP)

  • View in gallery

    Price-based REER shows little movement…

    REER (2001M1 = 100)

  • View in gallery

    …but cost-based REER deteriorates…

    (Wage and price-based REER, and ITT (2001M1 = 100)

  • View in gallery

    …with wages growing faster than warranted by catch-up…

    (In logs, 1992–2002 for all countries except for Montenegro (2000–2006))

  • View in gallery

    …and macro balances suggeesting the need for real depreciation over medium term.

    (In percent of GDP)

  • View in gallery

    Loan concentration is high.

  • View in gallery

    Bank capitalization remains at comfortable levels…

  • View in gallery

    …and is high compared to other transition economies.

  • View in gallery

    NPLs have been relatively low, mainly due to the fast credit growth.

  • Figure A1.
    View in gallery
    Figure A1.

    Montenegro: General Government Debt Sustainability: Bound Tests 1/

    (Public debt, percent of GDP)

  • Figure A2.
    View in gallery
    Figure A2.

    Montenegro: General Government Debt Sustainability: Bound Tests 1/

    (Public debt, percent of GDP)

Figure 1.

Montenegro: A Good Start to Independence, 2007

Stock market indices

(Dec. 2005 = 100)

Real estate prices soared during 2004–06

(Annual average increase, in percent)

External Balance and Its Financing

(In percent of GDP)
Figure 2.

Montenegro: Developments in the External Sector, 2007

Impact of tourism on the rest of the economy appears limited.

Spread of Average Interest Rates on Loans to Private Companies over 12-month EURIBOR

The financial sector has been rapidly deepening…

Distance to default in CEE countries, 2001–07
Figure 3.

Montenegro: Consolidated Fiscal Developments, 2004–07

(Percent of GDP)

Fiscal balance with revised 2007 budget

(In millions of €)

Electricity tariffs are high in Montenegro, especially for commercial users

(Electricity tariffs in euro per MWh, in 2006)
Figure 4.

Montenegro: Macroeconomic Framework, 2005–15

(Percent of GDP)

Price-based REER shows little movement…

REER (2001M1 = 100)

…but cost-based REER deteriorates…

(Wage and price-based REER, and ITT (2001M1 = 100)

…with wages growing faster than warranted by catch-up…

(In logs, 1992–2002 for all countries except for Montenegro (2000–2006))

…and macro balances suggeesting the need for real depreciation over medium term.

(In percent of GDP)

Loan concentration is high.

Bank capitalization remains at comfortable levels…

…and is high compared to other transition economies.

NPLs have been relatively low, mainly due to the fast credit growth.
Figure A1.

Montenegro: General Government Debt Sustainability: Bound Tests 1/

(Public debt, percent of GDP)
Figure A2.

Montenegro: General Government Debt Sustainability: Bound Tests 1/

(Public debt, percent of GDP)