Political and economic developments

General elections were held June 5, 2011, in which the incumbent VMRO DRMNE party and its Albanian coalition partner retained their parliamentary majority. The new government was inaugurated on July 28 for a period of four years.

Macedonia has sound economic fundamentals. As elsewhere, the country was affected by the global economic crisis, but recovery from the 2009 recession is underway. Last year growth turned positive, and was led by a surge in exports. This year continued growth of exports and strong investment are expected to boost growth to 3.5 percent. This economic recovery is supported also by lower interest rates, and by recent moderate resumption of bank credit. Risks related to growth projections still exist however, especially in case export demand fails to continue recovering as expected. Vulnerabilities in euro zone countries could spill over to Macedonia through the current and capital accounts, and could hamper access to international capital markets. On the upside, progress towards EU accession would improve prospects for attracting foreign investment.

Inflation has risen recently due to food and commodity prices, but core inflation remained contained at around 1 percent and is expected to remain low.

The external position is solid, but stronger growth and more robust investment are expected to cause the current account deficit to rise to 5.5 percent of GDP this year, after 2.8 percent in 2010. On the positive side, the current account deficit will be financed largely by FDI, and international reserves are expected to rise from current levels over the rest of the year. Net international reserves were 1.44 billion euros at end-May, well above the indicative target under the PCL.

Fiscal policy and financing needs

In recent years the authorities have had a track record of sound fiscal policies, and fiscal policies this year have been consistent with the PCL program. Despite exceeding the fiscal deficit target by 0.01 percent of GDP, the authorities are fully committed to achieving the annual fiscal deficit target of 2.5 percent of GDP, and are ready to take the necessary steps to contain expenditures to achieve the target. At the same time, the Macedonian authorities will reduce the fiscal deficit to 2.2 percent of GDP in 2012. Over the medium term the authorities plan to reduce the fiscal deficit to 1.5 percent of GDP, which will stabilize public debt near 25 percent of GDP and help protect international reserves and the peg.

With the support of the PCL purchase, the authorities largely met their external and fiscal financing needs for 2011. To cover remaining fiscal needs for 2011 and finance part of the 2012 fiscal deficit, the authorities plan to issue debt in the fall of 2011 through a Eurobond or syndicated loan which may be supported by a World Bank Policy Based Guarantee. In the event of unfavorable external market conditions in the latter part of 2011, the Macedonian authorities will issue debt on the domestic markets. They also intend to increase the size of the domestic T-bills market in 2012. At the same time, the authorities intend to launch a new Eurobond in the second half of 2012 to pre-finance the January 2013 maturity of the 175 million euros Eurobond issued in 2009.

The authorities’ decision to purchase under the PCL reflected the lack of access to private debt markets, due in large part to electoral uncertainties, which have now been resolved. Looking forward, the authorities do not expect to make further purchases under the PCL, and are confident that they will be able to access external markets, even if they are required to pay a premium over current interest rates. The authorities are also committed to developing deeper external and domestic markets for Macedonian public debt, which will help to address remaining vulnerabilities, and they welcome IMF technical assistance in this area.

The authorities remain committed to looking for opportunities, when market conditions are favorable, to repay their PCL purchase early. However, they consider that early repayment is not advisable this year in light of the considerable uncertainties still prevalent in the world economy and the importance of first securing financing for 2012 fiscal financing needs.

Monetary policy and financial sector

The National Bank of the Republic of Macedonia (NBRM) continues to play a central role in ensuring the stability of the exchange rate peg, and in maintaining low inflation. The NBRM has kept the interest rate unchanged at 4 percent since last December, and the reserves are at broadly adequate levels and comfortably above the indicative target set under the PCL. In light of the favorable prospects for international reserves, the authorities agreed to an increase of 50 million euros in the end-November indicative target for NIR, which would provide an adequate buffer, and will send a positive signal to the markets on the authorities’ intention to safeguard the stronger reserve position resulting from the PCL purchase. The authorities will remain vigilant to keep monetary policy the main anchor in keeping a stable exchange rate regime backed by an adequate level of international reserves.

The financial sector and bank regulatory framework are both sound, and the banks are well capitalized. At end-March 2011 the capital adequacy ratio was around 17 percent, providing a significant buffer against shocks. NPLs started to decline from their peak of 10 percent last September and are expected to continue declining gradually.

Finally, we would like to express the authorities’ commitment to continuing to implement sound policies. However, external risks remain very high due to question marks over global growth prospects and financial turbulence in the euro area. The authorities consider the PCL a significant additional buffer that will improve market confidence and provide an extra buffer for the event of an extreme scenario that results in deterioration of access to market financing and significant balance of payments pressure.