Statement by Menno Snel, Executive Director for Montenegro and Ana Martinis, Advisor to the Executive Director

This 2012 Article IV Consultation highlights that three years after the sudden end of Montenegro’s boom, there has been considerable progress toward recovery. Fiscal imbalances have proved difficult to rein in, reflecting a large fall in revenue after the collapse of the boom. Executive Directors have commended the authorities’ efforts to stabilize the economy, and welcomed the progress made since the financial crisis. Directors have also recognized the sizable public expenditure adjustment over the past few years, but underscored the need for further high-quality deficit reducing measures.


This 2012 Article IV Consultation highlights that three years after the sudden end of Montenegro’s boom, there has been considerable progress toward recovery. Fiscal imbalances have proved difficult to rein in, reflecting a large fall in revenue after the collapse of the boom. Executive Directors have commended the authorities’ efforts to stabilize the economy, and welcomed the progress made since the financial crisis. Directors have also recognized the sizable public expenditure adjustment over the past few years, but underscored the need for further high-quality deficit reducing measures.

The authorities of Montenegro would like to thank staff for the open and constructive dialogue during the mission. The authorities broadly agree with staff’s analysis and share staff’s views regarding the economic challenges ahead. The importance of the staff papers is hard to overestimate, especially for a small country like Montenegro, for which Fund publications represent the most complete source of information and reference for international financial markets. Bearing this in mind, and fully devoted to transparency, the authorities continue the practice of consenting to the publication of the staff report.

Macroeconomic developments

Montenegro’s economic activity recovered after a major contraction in 2009, boosted by continued foreign investment inflows and buoyant tourism revenues. Thus, real GDP grew by 2.5 percent annually in 2010 and 2011. Price stability has been maintained, despite moderate acceleration of inflation in 2011 driven by food and fuel prices and increases in excises on alcohol and tobacco. The current account deficit has adjusted considerably since the wake of the crisis (from above 50 percent in 2008 to 19.4 percent in 2011), but, nevertheless, external imbalances remain high.

As of late 2011 the external conditions deteriorated, leading to a slowdown in exports and consequently, weakening of growth. In addition, the first quarter of 2012 was particularly challenging due to several other exogenous shocks - the extremely difficult weather conditions, that paralyzed trade and transport for almost two weeks in February, and unplanned budget costs related to the repayment of a state-guaranteed loan for the aluminum company KAP. Hence, for this year the authorities expect growth to slow down to 0.5 percent, while inflation is expected to remain well contained (around 2 percent on average).

Fiscal policy

The authorities are fully aware that in a euroized system with no leeway for monetary policy, fiscal policy is the main effective instrument for policy adjustment. Against such backdrop, throughout the past three years the authorities have pursued strong fiscal consolidation. Fiscal expenditures have been cut by more than 8 percentage points of GDP in the period 2008-2012, achieving one of the largest expenditure adjustments among the peer countries. Last year alone the expenditures were down by 1.8 percent of GDP including a guarantee payment of 1 percent of GDP, bringing adjustment to 2.8 percent in only one year. While the cuts were mostly related to non-essential capital spending, the authorities also implemented new rules for strict control of public wages and initiated downsizing of the public sector work force, centralized monitoring of all current expenditures, reduced the number of spending units and adopted a new financing scheme for local governments. According to the authorities’ data, arrears were reduced in 2011 by 0.3 percent of GDP.

Also in line with previous Fund advice, the authorities recently signed an agreement with the public sector unions which introduces opt-out clauses from collective agreements and allows for public wage decrease if one of the two predefined criteria is satisfied: (i) real GDP growth below 2 percent or (ii) budget balance below zero. These triggers represent for the Government favorable economic criteria provisions for the wage adjustments and could easily result in public sector wage cuts already for this year.

Despite the sizeable headline fiscal adjustment, the country’s overall fiscal position has been hit hard by the materialization of contingent liabilities, in particular the state-guaranteed loans for the metal industry. In 2011 the government repaid a guarantee amounting to 1 percent of GDP for a steel company which declared bankruptcy, while in April 2012 a guarantee for the aluminum company KAP was called and fully repaid in the amount of 0.7 percent of GDP. Against this backdrop, and due to revenue shortfalls, the major consolidation efforts have not been reflected in the overall balances. However, the Government has recently (end-April) sold the bankrupt steel mill to a Turkish steel company, which will bring additional 0.3 percent of GDP of revenues in 2012 and thus help reduce the fiscal burden of the guarantee payments.

Public debt reached 45.3 percent of GDP as of end-February 2012 and, although it has not reached the 60-percent threshold, the authorities are mindful of the high debt sustainability risks due to their unique policy framework. Given the currently unfavorable financing conditions on international markets, this year the authorities plan to rely predominantly on bilateral and multilateral borrowing, including through World Bank assistance. After the approval of the Development Policy Loan (DPL) early this year, Montenegro is in the final stage of negotiations for a Policy-Based Guarantee (PBG), which, if successfully completed, would help the country in acquiring financing under substantially more favorable terms.

Supplementary budget for 2012

In order to address the revenue shortfall in the first quarter (amounting to 0.7 percent of GDP compared to last year) and to provide fiscal space for financing the guarantee payment, in April the Government introduced a supplementary budget with total fiscal adjustment of 1.2 percent of GDP. The new budget is expected to be adopted by the Parliament by end-May and includes specific deficit-cutting measures on both the revenue and the expenditure sides:

  • - Revenue-boosting measures (with expected effect of 0.7 percent of GDP) include: introduction of tax on mobile SIM cards, cable television and electricity meters, a fee for “smoking zones”, increase in excises on fuel oil for heating, tax on undistributed profits, measures against the unofficial economy, improvements in tax collection etc. However, the authorities aim at keeping the basic tax rates unchanged in order to maintain the country’s comparative advantage of low basic taxation.

  • - On the expenditure side, cuts amount to 0.5 percent of GDP and include savings on official automobiles, telephone services, travel allowances, office material costs, a 7-percent wage cut for high-ranking public officials and embassy employees and further cuts in capital spending.

Financial sector

The banking sector had been severely hit by the boom-bust episode, including through deposit withdrawals, credit crunch, deteriorating quality of credit portfolios and eroding profitability. Hence, given the limited scope for the use of conventional monetary policy instruments, the central bank focused its policy actions on improving the regulatory and supervisory framework.

Thanks to decisive actions by the authorities, during 2011 the situation in the banking sector improved significantly. Tightened regulation pressed foreign owners to recapitalize their banks and to ensure appropriate liquidity in the system. The capital adequacy ratio rose to 16.5 percent of risk-weighted assets as of end-2011. Non-performing loans fell by 10 percentage points from their peak reached in mid-2011 until the end of the same year, as major banks, pushed by the increased provisioning requirements, cleaned their balance sheets by selling their bad credit portfolio to parent banks or to factoring companies financed by parent banks. Confidence in the banking system has been restored and deposits started recovering. Nevertheless, credit activity still remains subdued, affected by the high financing costs and lack of credit demand from creditworthy clients.

Going forward, the authorities are fully aware of the potential spillover risks from the euro area crisis and the deleveraging processes in Europe and will thus continue improving the macroprudential framework. The central bank recently established a Council for bank liquidity, adopted regulation on large exposures and implemented stress testing in coordination with the ECB. Furthermore, contingency plans have been recently adopted by each and every regulatory institution at the internal level, and the National Contingency Plan, developed in cooperation with the Fund’s technical assistance, has been adopted by the Financial Stability Council. Finally, five new laws covering the financial sector will be adopted in 2012 (i.e. an insurance law and a compulsory insurance law, a law on capital markets, a law on payment services, and a law on financial collaterals).

Structural reforms

In addition to fiscal consolidation and improvements in public finances, significant progress has been made in tackling medium-term challenges through implementation of an ambitious and comprehensive structural reform agenda:

  1. A labor market reform, adopted in 2010 and additionally amended in 2011, liberalized the use of fixed term contracts, lowered the minimum obligatory level of severance payments and introduced restrictions in unemployment protection, including cuts in the unemployment benefits and maternity and sick leave benefits, with the aim to address low labor force participation rates.

  2. The pension system reform, implemented as of January 2011, increased the retirement age to 67 (from 65 for men and 60 for women), removed incentives for early retirement and reduced the frequency of pension benefit index calculation from biannually to once a year.

  3. This year the authorities have initiated social protection system reform, which will, inter alia, include cuts in the government compensation for maternity leave and sick leave and introduce private health insurance premium for obtaining full medical coverage.

  4. Having in mind the importance of foreign investment for this small open economy, the authorities are particularly dedicated to the business environment reform. Their efforts resulted in continued progress in various business climate and economic freedom indicators, according to which Montenegro stands out as the second best performer in the region (after Macedonia). Nevertheless, the authorities agree with staff that the business environment needs continued nourishing. In that respect, the Council for the Elimination of Business Barriers was established for monitoring business environment progress across the ministries, one-stop shops for business registration were opened and electronic registration will be introduced by end-June.

EU and WTO accession

International organizations and the European Union all note the significant and sustained progress on structural reforms, especially in the financial sector, trade, and social sectors. In particular, the forthcoming start of negotiations for EU membership, tentatively scheduled for June 2012, represents a confirmation of the authorities’ efforts in achieving the objective of adhering to the EU principles. Going forward, the EU accession process will undoubtedly bring additional stimulus for continued reforms in legislative, judicial and economic areas and provide incentives for foreign investments. Also, in May 2012 Montenegro became a member of WTO, reflecting the government’s commitment and tangible efforts toward open trade and regional trade collaboration within CEFTA.

Final remarks

The Montenegrin authorities are mindful of the key domestic and external risks presented in the staff paper, including sizeable external imbalances and fast-growing public debt, and will continue to use the available policy mix of fiscal and structural reforms to reduce vulnerabilities, as well as to improve competitiveness and enhance the long-term growth potential of Montenegro. Given the huge untapped potential in the tourism and energy sectors, the authorities firmly believe that Montenegro is set to return to a comparably higher growth trajectory.