Former Yugoslav Republic of Macedonia
Staff Report for the 2011 Article IV Consultation.

This 2011 Article IV Consultation highlights that Macedonia is poised to achieve low but positive growth under the baseline scenario of a shallow recession in the euro area. Under a downside scenario, growth would be weaker, and external financing pressures could arise. In the near term, the government would need to reduce expenditure growth to meet the 2012 deficit target. A key longer-term challenge would be to reconcile the competing objectives of higher public investment and increases in pensions and public wages while preserving low public debt and low taxes.


This 2011 Article IV Consultation highlights that Macedonia is poised to achieve low but positive growth under the baseline scenario of a shallow recession in the euro area. Under a downside scenario, growth would be weaker, and external financing pressures could arise. In the near term, the government would need to reduce expenditure growth to meet the 2012 deficit target. A key longer-term challenge would be to reconcile the competing objectives of higher public investment and increases in pensions and public wages while preserving low public debt and low taxes.


1. Macedonia is a middle income country with a good record on macroeconomic stability but lower growth than its peers. The peg to the euro has anchored monetary policy and helped achieve a long record of low inflation, while low fiscal deficits have kept public debt ratios moderate1. Despite sound macroeconomic policies, growth has fallen short of other countries in the region, while high unemployment rates, which predate independence, persist.


Income levels and growth

Citation: IMF Staff Country Reports 2012, 133; 10.5089/9781475504149.002.A001

Source: IMF WEO. Data for Montenegro and Malta are for 2000.

2. The euro area crisis is affecting Macedonian exports and growth, and could also lead to pressures on external finances. About 50 percent of exports go to the euro area, and as in 2008–09, a sharp slowdown in exports would have a significant impact on growth. Banks have limited reliance on external financing, which provides a degree of insulation from external financial developments. Nevertheless, pressures on external finances could arise in a downside scenario.


Fiscal deficit and government debt, 2010

(in percent of GDP)

Citation: IMF Staff Country Reports 2012, 133; 10.5089/9781475504149.002.A001

Source: IMF WEO

3. Staff held discussions with the authorities during the December mission and into April 2012 on the second review of the two-year Precautionary and Liquidity Line (PLL) arrangement approved in January 2011. The discussions focused on public financial management issues, including government payment arrears, and the government’s fiscal financing plan for 2012. In April the government announced it had reached agreement on a foreign bank loan that would meet its fiscal financing needs for 2012 and into 2013, and it therefore would not need to draw upon PLL resources. The authorities informed staff that they would not pursue completion of the review and would allow the arrangement to expire in January 2013.


A. Growth and Inflation

4. The recovery slowed in 2011, due largely to worsening external conditions. The 2010–11 recovery was led by a surge in exports, with domestic demand picking up in 2011 on the back of lower interest rates, a moderate resumption of credit growth, and modest employment gains. In the second half of the year a slowdown was visible in softening exports, sales, production, and credit. Average growth for 2011 was 3 percent, but year-on-year growth in the fourth quarter was only 0.2 percent.


Quarterly GDP Growth Rates


Citation: IMF Staff Country Reports 2012, 133; 10.5089/9781475504149.002.A001

Source: SSO and IMF staff estimates

5. Staff expects 2012 growth to decline to 2 percent, with significant downside risks. This projection is based on a scenario with a shallow euro area recession in 2012.

  • Economic weakness and financial strains in the euro area are expected to feed through directly to lower demand for Macedonian exports and to some reduction in remittances and FDI, with indirect effects on domestic demand. Bank credit is expected to grow slowly due to external uncertainties and to deleveraging and reduced risk tolerance on the part of foreign parents. The relatively mild impact of the euro area crisis on growth under the baseline projection reflects Macedonia’s modest external financial linkages, the absence of significant financial sector or external imbalances, and a strong pipeline of FDI projects.

  • However, a deeper than expected downturn and intensified financial pressures in the euro area could have a sizable impact on exports, remittances and FDI, pushing the economy toward recession and putting pressures on international reserves. This could damage domestic confidence in the viability of exchange rate peg and prompt an outflow of bank deposits, adding to reserve pressures. In this scenario, the central bank would likely need to raise interest rates to protect reserves and the exchange rate peg, further dampening growth.


Economic activity in Macedonia

(Year-on-year percent change)

Citation: IMF Staff Country Reports 2012, 133; 10.5089/9781475504149.002.A001

Sources: Haver Analytics, NBRM, SSO

Macedonia and the Eurozone

(Year-on-year percent change)

Citation: IMF Staff Country Reports 2012, 133; 10.5089/9781475504149.002.A001

6. Inflation is expected to decline from 3.9 percent in 2011 to 2 percent in 2012. The jump in headline inflation in 2011 was due to increases in food and fuel prices, with core inflation a more contained 1.1 percent. In 2012 the impact of food and fuel price developments is expected to fade, and with growth remaining below potential, this will support a fall in inflation. Over the longer term, average inflation has broadly tracked the euro area, though with greater volatility due in large part to the greater weights of food and energy in the Macedonian basket.


Inflation in Macedonia and Eurozone


Citation: IMF Staff Country Reports 2012, 133; 10.5089/9781475504149.002.A001

Sources: Haver, SSO and IMF staff calculations.

7. The authorities’ views on the growth outlook were similar to those of staff. The NBRM recently reduced its 2012 projection from 2.4 to 2 percent, on the back of lower growth expectations of main trading partners. But overall the authorities believed that the lack of imbalances in the economy, in particular the moderate current account deficit and contained credit growth, would limit the impact of adverse external developments. This was in contrast to the run-up to the 2008–09 crisis, when a large current account deficit and rapid credit growth needed to be reined in quickly. The government’s official projection for 2012 growth was initially 4.5 percent, but it reduced this to 2.5 percent in April 2012 in the face of mounting evidence of slowing growth.

B. External sector

8. The current account deficit was 2.8 percent of GDP in 2011. The current account deficit widened modestly from 2010 to 2011, reflecting a pick-up in domestic demand and higher fuel prices. However, these were largely offset by the strong performance of private transfers as residents converted their euro-denominated assets into denars following the intensification of the euro area crisis in late 2011. Main sources of external financing included FDI of some €300 million (4.1 percent of GDP), the €221 million PLL purchase in March, and a €130 million commercial bank loan backed by a World Bank Policy-Based Guarantee (PBG) in December 2011.

9. International reserves increased significantly and are at broadly adequate levels. Gross international reserves rose by €355 million over the course of 2011 (€135 million excluding the PLL purchase), ending the year at 114 percent of short-term debt by residual maturity and over 4 months of prospective imports. End-2011 reserves were 119 percent of the new Fund measure of reserve adequacy based on risk-weighted liabilities, which is in the range considered adequate2.

10. The current account deficit is expected to widen and then level off at around 5 percent of GDP in the medium term and to be financed largely by FDI. Export growth is expected to be robust over the medium term, underpinned by FDI in the tradable sector (notably auto parts, see Box 1), low wage levels relative to neighboring countries, and improvements in the business climate. Meanwhile, restrained growth of private credit will help contain imports. The trade deficit is thus expected to widen only modestly in the next few years before narrowing in the medium-term. Private transfers are expected to normalize from their peak of 19½ percent of GDP in 2011, as euro area stress subsides. The behavior of private transfers is the main contributor to the projected increase in the current account deficit in 2012. The real exchange rate appears to be fairly valued, based on measures such as CGER estimates and relative wage levels.


Current Account Deficit, FDI and REER

Citation: IMF Staff Country Reports 2012, 133; 10.5089/9781475504149.002.A001

Sources: Authorities’ data; and IMF staff estimates.

Greenfield FDI in Macedonia

Macedonia has been successful recently in attracting greenfield FDI. Investments have branched out of the traditional export-oriented industries such as food and metal processing into new and higher value-added industries. In particular, with the entrance of two large car-parts manufacturers in 2007, automotive components have become one of Macedonia’s main exports. This rapid structural shift in greenfield FDI reflects Macedonia’s low labor costs and tax rates, its geographical proximity to assembly plants in Central and Western Europe and Turkey, duty-free access to the European market, and investment incentives such as tax holidays.

Pipeline Greenfield FDI Projects by Industry, 2012-15

(in million euros)

article image

Includes pharmacy and textile.

Source: Invest in Macedonia; IMF staff calculations.

A large pipeline of greenfield FDI projects is planned for the next two to three years, concentrating on the automotive components industry. This includes both expansion plans in incumbents and investments from new entrants. Other sectors attracting FDI include construction materials, residential construction, glass (e.g., for packaging of agricultural products and wine), and food processing.

Given the financial stress in Europe, some of the projects may be postponed or implemented more slowly. The pipeline consists mainly of confirmed projects for which contracts have been signed, and in some cases construction is underway. While adverse financial conditions and weaker demand in destination markets may delay some of these projects, they are expected to materialize in the medium term.

C. Fiscal Policy

11. The fiscal deficit was 2.6 percent of GDP in 2011 on a cash basis, as spending was reduced in line with revenue shortfalls to meet the government’s deficit target. Revenues rose 3.5 percent compared to 2010, below the 12.6 percent assumed in the budget. The shortfall was due largely to over-optimistic estimates of non-tax revenues. To meet its deficit target, the government under-executed budgeted spending, in particular on investment and goods and services. Nonetheless, capital spending rose 15.5 percent relative to 2010, consistent with the authorities’ goal of boosting infrastructure development. Wages and salaries were held down by a second year of government wage freezes. The PLL purchase and loan backed by the PBG provided the main sources of fiscal financing (¶25).

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Budget figures following the expenditure reallocation of Sep 2011

Including capital revenues and grants.

Source: MoF

12. The deficit was somewhat larger on an accrual basis due to arrears. The government failed to make payments totaling €7.6 million due to an external supplier of medical equipment in the second half of 2011 and eventually reached agreement to make the overdue payments (plus interest) in January 2012. It also reported €8 million in arrears on VAT refunds. These two items add up to 0.2 percent of GDP. There are also widespread reports by businesses of late payments by the government to its suppliers, suggesting the actual amount of arrears may be higher. Moreover, the government renegotiated some contracts to extend payments to future years for goods or services received in 2011.

13. The 2012 budget calls for a fiscal deficit of 2½ percent of GDP, but is based on highly optimistic revenue assumptions. The budget is based on a 4.5 percent real growth rate and assumes total revenue growth of 14.8 percent compared to the outcome for 2011. Similar to 2011, the budget prioritizes investment spending. It calls for a 52 percent increase in capital expenditure compared to the 2011 outcome, and a 9 percent increase in current expenditure. Staff project that revenues will grow 6 percent, significantly below the budget assumption, with the difference reflecting in part staff’s lower growth projections. Based on staff’s lower nominal GDP forecast, the authorities’ deficit target translates to 2.6 percent of GDP.

14. The government submitted a supplementary budget to parliament in April 2012 that would reduce annual expenditure by 4½ percent (1½ percent of GDP) relative to the budget while keeping the deficit target unchanged. The proposed cuts focus on capital expenditures (which would still grow 21 percent compared to the 2011 outcome). The revised budget assumes revenue growth of 9 percent, still above staff projections (by 1 percent of GDP).

D. Monetary and Financial Policies

15. The NBRM left interest rates unchanged from December 2010 to early April 2012, while modestly relaxing prudential requirements. The NBRM kept the benchmark rate at 4 percent, while issuing some 2½ percent of GDP in CB-bills (its sterilization instrument) over this period. Meanwhile it sought to ease credit conditions through a relaxation of prudential requirements by: (1) abolishing separate denar and foreign exchange liquidity requirements in favor of a unified requirement regardless of currency denomination; (2) reducing from 100 to 80 percent the share of term deposits counted as short-term liabilities; and (3) eliminating the reserve requirement on household term deposits with maturity over two years and repo transactions.


ECB and NBRM policy rates


Citation: IMF Staff Country Reports 2012, 133; 10.5089/9781475504149.002.A001

Sources: NBRM, Haver analytics.

16. In April 2012 the NBRM announced a new set of measures aimed at easing credit conditions and furthering money market development.

  • First, it announced it would gradually decrease the amount of outstanding central bank bills by limiting the volume offered at its auctions and reducing the frequency of auctions to once a month, which would be expected to lead to lower interest rates. The maximum interest rate would be 4 percent (the same as the previous benchmark rate) while quantities would be adjusted to ensure interest rate declines were gradual and consistent with exchange rate stability. As of early May, after four auctions under the new system, the average interest rate had declined only to 3.93 percent, despite a significant decrease in outstanding central bank bills. In early May the NBRM reduced the maximum interest rate to 3.75 percent.

  • Second, it introduced a 7-day and overnight deposit facility at an interest rate of 2 percent and 1 percent, respectively, which banks could use to place excess liquidity between the monthly bill auctions.

  • Third, it initiated a weekly repurchase operation to provide liquidity to banks against their holdings of treasury and central bank securities and reduced the rate on the overnight lending facility from 150 bps to 50 bps over the central bank bill rate.

E. Financial sector

17. Banking sector indicators suggest the system is in overall sound shape, and credit growth has been moderate. As of December 2011, the capital adequacy ratio was close to 17 percent (with tier 1 capital at 14 percent). Deposits provided the main source of funding (loans totaled 86 percent of deposits) and reliance on foreign funding was low. The NPL ratio was 9.5 percent, up somewhat from the previous quarter but down from its 2010 peak of over 10 percent, and provisions exceeded NPLs. Profitability was low but positive. Loan growth through December was 8.5 percent (year-over-year), compared to 9.2 percent deposit growth. Euroization of deposits, while high, had declined to pre-crisis levels (see Selected Issues Paper).


Private Sector loans and deposits growth

(3m ma annualized growth; percent)

Citation: IMF Staff Country Reports 2012, 133; 10.5089/9781475504149.002.A001

Sources: NBRM.

18. Banks have limited direct exposure to euro area financial turbulence. Two of the three large banks (who together account for some 40 percent of system assets) have parents from the euro area, namely Greece and Slovenia. With the exception of modest amounts of long-term subordinated debt instruments, they do not depend on their parents for funding, and nor do they hold significant claims against their parents (which are restricted by related-party limits). Nonetheless, in the event of an adverse scenario in Greece or the broader euro area, bank-specific or even system-wide deposit outflows could not be excluded.


Commercial Bank Foreign Liabilities, end 2011

(percent of total liabilities)

Citation: IMF Staff Country Reports 2012, 133; 10.5089/9781475504149.002.A001

Sources: Respective Central Banks and IFS.

Regional Loan to Deposit ratio, end 2011


Citation: IMF Staff Country Reports 2012, 133; 10.5089/9781475504149.002.A001

Sources: IFS, Haver and IMF staff estimates.

19. Credit growth is expected to be subdued in 2012. On the supply side, banks are likely to be conservative in light of financial turmoil in the euro area, weakening growth prospects, and low profitability. Foreign parents of the large banks are likely to reinforce a risk-averse stance as they seek to strengthen their capital ratios at the consolidated level. The deterioration of the economic outlook will also weigh on the demand side.

F. Medium-term outlook, risks, and data quality

20. The medium-term outlook is broadly favorable, as Macedonia builds on its advantages of low wages and taxes and implements structural reforms to boost potential growth and employment. The authorities’ pro-growth policies include preserving a low tax environment (including flat 10 percent corporate and personal income tax rates), investing in infrastructure and education, and promoting FDI. They are also pursuing structural reforms to improve the business climate, and adopted a new Energy Law to strengthen the long-term prospects of the energy sector. These policies have started to pay off, with several foreign investment projects underway. Reflecting these reforms, Macedonia’s global ranking in the World Bank’s Doing Business report improved from 34th in 2011 to 22nd in 2012. Other competitiveness indicators paint a more mixed but still generally favorable picture compared to neighboring countries (Box 3). Key areas to unlock faster growth and lower unemployment include improved property rights, judicial reform, and education, where Macedonia scores low on international indices.

21. The principal risks arise from developments in the euro area (Annex I).

  • A deeper recession in the euro area would affect Macedonia through lower exports and remittances and a slowdown in FDI, which would reduce growth and could lead to a loss of foreign reserves.

  • In the event of significant intensification of the euro area crisis, pressures on Macedonia’s exchange rate peg could emerge, potentially leading to outflows of bank deposits and pressures on foreign reserves.

  • An adverse scenario in Greece could damage confidence in Greek bank subsidiaries in Macedonia and also prompt deposit outflows.

22. Economic and financial statistics continue to be broadly adequate, and the authorities have subscribed to SDDS. The authorities improved the timeliness and periodicity of their data provision, leading to SDDS subscription in November 2011. Some remaining data shortcomings include quality of quarterly real GDP time series and incomplete fiscal data on public enterprises. The authorities are drawing on EU and IMF technical assistance to further improve national account statistics.

Macedonia’s Response to Past Policy Advice from the Fund

During the 2010 Article IV consultations (concluded in January 2011), Directors commended Macedonia for its sound macroeconomic and financial policies, while identifying sizeable downside risks from potential international spillovers.

On fiscal policy Directors agreed that the 2011 deficit target of 2.5 percent of GDP struck an appropriate balance between debt sustainability and the need to support growth. They advised that the authorities should consolidate the deficit once a robust recovery is underway. They also stressed the importance of developing the domestic public debt market. On monetary policy, Directors believed that interest rates were at appropriate levels and saw limited scope for further reductions. Directors praised the authorities’ commitment to improve data quality and subscribe to Special Data Dissemination Standards (SDDS).

The authorities’ policies over the past year have been broadly consistent with the advice of Directors. The government met its 2011 fiscal deficit target on a cash basis, after containing expenditures in response to revenue underperformance. The 2012 fiscal deficit target of 2.5 percent of GDP is appropriate in light of slowing growth. The government took initial steps towards deepening the domestic bond market with two issuances of 5-year treasury bonds. The NBRM kept interest rates unchanged through April 2012, when it initiated a limited easing, in the context of a contained current account deficit and increasing international reserves. The authorities have subscribed to SDDS.

Competitiveness and Growth in Macedonia

Macedonia’s growth over the past decade has fallen short of its peers and unemployment has remained high. Despite recent progress, further reforms will be needed to raise potential growth and employment.

Macedonia fares relatively well on standard measures of cost competitiveness.

  • The standard CGER analysis suggests no significant misalignment of Macedonia’s REER.

  • Wages in Macedonia are lower than in other countries in the region except Bulgaria. This contrasts to 2005, when wages in Macedonia were higher than those in Serbia and Romania.

  • Tax rates are low: both personal and corporate income tax rates are a flat 10 percent.


REER: Regional Comparison

(Jan 2004 = 100)

Citation: IMF Staff Country Reports 2012, 133; 10.5089/9781475504149.002.A001

Source: INS data and IMF staff calculation.

However, growth has been disappointing, averaging 3¼ percent over the past decade, and unemployment remains a chronic problem. Growth is significantly lower than what would be expected given Macedonia’s per capita GDP (poorer countries grow faster). Relatively low education levels explain part, though not all, of the underperformance. The remainder could be due to other factors such as inadequate infrastructure and institutional shortcomings. It could also reflect the legacy of economic and political shocks in the years after independence, including border closures with Greece, the Serbia trade embargo, and the ethnic conflict in Macedonia in 2001. High unemployment remains a chronic problem: while it has decreased from 37 to 32 percent over the past decade, it remains stubbornly high and is a drag on growth.


Average Monthly Nominal Wage in Manufacturing: Regional Comparison

(US dollars)

Citation: IMF Staff Country Reports 2012, 133; 10.5089/9781475504149.002.A001

Sources: ILO data; and IMF staff calculation.

Further reforms will be needed to achieve significantly faster growth. Recent improvements in the business environment (as indicated by the World Bank’s Doing Business indicator), success in attracting FDI to non-traditional areas, and a more stable political climate in Macedonia and the region, should combine to raise potential growth to above 4 percent. However, additional efforts will be needed to boost potential growth further and speed convergence. Policies directed at the interrelated goals of improving education outcomes and reducing unemployment should be an important part of the strategy to strengthen long-term growth. Macedonia scores low on international measures of education quality, and unemployment is much higher among those who have not completed secondary schooling. Moreover, there is anecdotal evidence that employers have difficulty finding qualified workers, despite high unemployment.


Actual growth vs. growth implied by convergence

Citation: IMF Staff Country Reports 2012, 133; 10.5089/9781475504149.002.A001

Sources: IMF, World Economic Outlook database; and IMF staff calculations.1 Difference between each country’s actual growth rate and the growth rate that could be expected given initial income levels.

The authorities’ strategy to reduce unemployment focuses on two fronts. First, it seeks to promote increased growth through improving infrastructure and attracting investment. Second, it is pursuing initiatives to improve education and training to better match skills with employer needs. The unemployment agency has designed active labor market polices, including vocational training and internships. The government also recently passed legislation making school enrollment compulsory through the secondary level.


Regional Rankings for Competitiveness and Business Environment 2010–12

Citation: IMF Staff Country Reports 2012, 133; 10.5089/9781475504149.002.A001

Source: World Bank; World Economic Forum; and Transparency International.Note: in all charts, a lower figure indicates a better ranking


A. Fiscal Policy and Financing

23. Staff views the planned 2012 fiscal stance as broadly appropriate based on cyclical and debt sustainability grounds, but consolidation will be needed over the medium term to stabilize debt ratios at safe levels. In staff’s view, debt sustainability should provide the long-term anchor for fiscal policy, with cyclical considerations also playing a role, subject to availability of financing.

  • The government debt ratio was 28.6 percent of GDP at end-2011, which is moderate and consistent with debt sustainability. Staff recommended reducing the fiscal deficit to below 1.5 percent of GDP over the medium term, which will be required to stabilize public debt at 30 percent of GDP, consistent with previous staff advice. Low deficits would also provide space for counter-cyclical policies during future downturns. Consolidation must be undertaken in a medium-term budget framework and will require the government to prioritize among competing expenditure goals (¶28).

  • The 2012 deficit target of 2½ percent of GDP is roughly neutral on a cyclically adjusted basis. A more expansionary stance is not advisable in light of financing constraints, even if growth falls short of the staff baseline.

FYR Macedonia: Cyclically-adjusted Fiscal Balances

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Source: IMF staff estimates.Note: The fiscal impulse is the difference in the cyclically-adjusted balance between the previous and the current year (a negative fiscal impulse means a cyclically-adjusted contraction). Cyclical adjustment of fiscal balances is done with respect to both output and absorption gaps.

Percent of potential GDP

Percent of potential absorption

24. Given the optimistic revenue forecasts in the 2012 budget, expenditures will need to be reduced significantly below budgeted amounts to meet the deficit target. The amount of needed adjustment relative to the budget is estimated at 2½ percent of GDP. Reductions will need to be focused largely on investment spending, since there is limited discretionary spending elsewhere in the budget. In a scenario with the revenue shortfall projected by staff, and taking into account the limited room for reducing other expenditure, staff expects that investment spending will rise by just 3½ percent in 2012. The supplemental budget submitted to parliament in April, which reduces expenditure by 1½ percent of GDP (see paragraph 14), goes a considerable way towards addressing the expected revenue shortfall.

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Staff projections for 2012 NGDP

Including capital revenues and grants.

Source: MoF and IMF staff estimates

25. Foreign borrowing will provide the main source of budget financing in 2012. In December 2011 the government concluded an external bank loan of €130 million (backed by a World Bank guarantee). In April 2012 it announced that it had agreed on terms for a €250 million five-year loan from a foreign bank (which requires approval by parliament before it can be finalized). Finally, the authorities expect to borrow US$100 million from the World Bank through two DPLs in late 2012. These sources, together with €60 million in planned domestic Treasury debt issuance, will cover the 2012 fiscal deficit, pre-finance repayment of a €175 million Eurobond maturing in January 2013, and provide a significant buffer for 2013.

Central government financing 1/

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Projections of financing sources include MOF data and Fund staff estimates.

The EUR 130 million private loan backed by the World Bank Policy Based Guarantee of covered remaining 2011 needs and will finance roughly half of the 2012 deficit. The amount useable for financing, after fees, is EUR 126 mn.

The private external issuance of 2012 (EUR 250 mn) covers the remaining deficit financing of 2012 and pre-financing of the Eurobond falling due in January 2013.

The official financing projection includes two World Bank Development Policy Loans totalling EUR 76 mn (USD 100 mn), assumed to become available at end 2012.

Source: MoF and IMF staff estimates

26. Debt financing remains a significant medium-term challenge. Although the authorities have met their financing needs for the next year, they remain dependent on access to external markets to finance their deficits and repay some €750 million (10 percent of GDP) in private external debt and IMF loans maturing in 2014-17. Such reliance on external financing poses significant risks in light of uncertainties and volatility in external capital markets. This vulnerability was evident in 2010 and 2011, when the authorities drew on official sources (the SDR allocation in 2010 and the PLL in 2011) in response to unfavorable conditions on private external markets.

27. Public debt management reform to deepen domestic markets and improve access to external sources should be a key policy priority. The domestic debt market is small, with outstanding debt equal to only 5 percent of GDP (excluding 2 percent of GDP in structural bonds issued in compensation for transition-related expenses). Deeper domestic debt markets will diversify funding sources and help insulate public finances from disruptions in access to external markets. Compared to other countries in the region and elsewhere, the domestic public debt market is small and dominated by short-term securities, suggesting there is significant room for growth (see Selected Issues Paper). Moreover, the ample liquidity of the domestic banking system, including significant holdings of central bank debt instruments, points to room for increased domestic public debt without crowding out lending to the private sector (¶35). A deeper domestic debt market, with longer maturities (which will require higher interest rates than those on short-term T-bills), will also help to build a domestic yield curve and support development of private debt markets. In this context, the auction of a five-year treasury bond in September 2011 was a welcome development, although a similar auction in December 2011 raised a smaller amount because the government failed to offer higher interest rates in response to changed market conditions. The authorities should also continue to access private external debt markets at an early stage to pre-finance their borrowing needs, as they are doing in 2012, to guard against the risk that market conditions turn unfavorable.

Debt Market Development in Macedonia

The public debt market in Macedonia is very small and is dominated by short-term Treasury bills. This has required the authorities to rely on external markets for public financing, exposing the country to volatility of market access. Development of domestic debt markets and a more strategic approach to external debt issuance will help strengthen the stability of public finances. Issuance of longer-term debt will entail somewhat higher interest rates, but will reduce rollover risk and help establish a reference yield curve for private debt markets. The experience of other countries in the region suggests there is considerable scope for deepening domestic debt markets, although this will take time.


Central government domestic debt,

(percent of GDP, end 2010)

Citation: IMF Staff Country Reports 2012, 133; 10.5089/9781475504149.002.A001

Source: Haver Analytics and country authorities

An IMF technical assistance mission in October 2011 and an Article IV Selected Issues Paper identified a number of key recommendations, including:

  • Lengthen domestic maturities, and be prepared to pay higher interest rates;

  • Enhance liquidity through fungibility of debt instruments and attention to secondary market development;

  • Measure risks explicitly and benchmark them against a chosen debt profile;

  • Reduce refinancing risk through pre-financing and avoiding bunching of maturities;

  • Develop institutions and market practices to help achieve the above objectives.

28. Staff recommended public financial management reforms in the areas of revenue forecasting, commitment control systems, and medium-term budgeting, in order to improve budgeting practices and avoid arrears.

  • The revenue assumptions in the 2012 budget are optimistic (even after the revisions in the supplementary budget), implying the need for further expenditure reductions. The authorities have a strong track of reducing expenditure to meet their fiscal targets. However, more realistic revenue forecasts would allow earlier and better planning and prioritization to match expenditures with available resources. Moreover, larger contingency buffers in the budget would help to accommodate revenue shortfalls.

  • Commitment control systems should be strengthened and budget laws and procedures should be strictly enforced to prevent budget users from making commitments that are not matched by budget appropriations. The government should also ensure that annual budgets provide funding for multiyear contracts signed in previous years. Progress in these areas will help to prevent government payment arrears such as those that arose in 2011. The government should make public the amount of any arrears and commit to reduce them over time. The practice of seeking to reschedule amounts due to private suppliers should be discontinued because suppliers may feel they have little choice if they want continued access to government contracts, and on grounds of transparency.

  • A greater focus on medium-term budgeting would allow the government to set its priorities based on a realistic assessment of available fiscal space and required trade-offs. In this context, the government’s intentions over the medium term to increase investment spending, raise pensions and public sector wages, and reduce the labor tax wedge—without raising taxes—will be difficult to achieve without increased deficits or cuts in other spending. To accommodate higher investment spending the authorities should avoid discretionary pension increases and continue current policies of public wage restraint. It should also move forward with plans for public administration reform to improve efficiency and contain the wage bill over the medium term, which would help to create fiscal space.

29. The authorities confirmed their commitment to reduce spending in the event of revenue shortfalls, so as to meet their fiscal deficit target. They explained that the 2012 budget assumptions on growth and revenue performance had been set in the third quarter of 2011, before the deterioration in euro areas growth prospects had become apparent to them. The authorities recognized that revenue growth was likely to fall well short of budget assumptions, which motivated the spending cuts in the proposed supplementary budget. They were committed to further expenditure restraint if needed to meet their deficit target.

30. The authorities’ medium-term fiscal plans call for continued moderate deficits to provide room to build infrastructure, while keeping public debt at sustainable levels. The authorities believed that infrastructure investment—including roads, railroads, and natural gas networks—is a critical priority for growth, and that this justified maintaining moderate deficits on the order of 2–2½ percent of GDP over the medium term. They indicated that their target ceiling for government debt was 30 to 35 percent of GDP (a de facto increase from the previous ceiling of 30 percent), which provided the medium-term anchor for fiscal policy. The authorities indicated that pension increases and social contribution reductions would be undertaken only if they could be accommodated without increasing the deficit beyond the targeted range.

31. The authorities agreed on the need to improve public financial management systems. In particular, they indicated that they would upgrade Treasury IT systems in line with recommendations by a recent Fund TA mission so that all budget users would be required to enter detailed information on annual and multiyear spending commitments into the Treasury information system. They believed that in addition to providing for better control over spending commitments, this would support the medium-term budget process by improving baseline spending estimates. The government acknowledged only nominal amounts of arrears outside the delayed payments to external medical suppliers and VAT refund delays. However, the government believed that the spending reductions in the supplemental budget and the action to secure full financing for the 2012 budget early in the year would help to prevent payment delays from arising in the future.

32. The authorities agreed on the importance of public debt management and development of domestic debt markets. They welcomed many of the recommendations of the recent Fund technical assistance mission in this area. However, the authorities were less certain than staff about the room for expanding the domestic debt market without crowding out private investment, and they were concerned that offering higher interest rates in order to place more debt would lead to higher bank loan rates.

B. Monetary Policy and International Reserves

33. The exchange rate peg against the euro has served Macedonia well, delivering low inflation, a stable real exchange rate, and moderate volatility of output. CGER estimates do not indicate significant misalignment, and the medium-term balance of payments appears sustainable. Staff continues to view the peg as appropriate for Macedonia, provided supportive macroeconomic policies remain in place.

Macedonia: Estimated REER Misalignment

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Source: IMF staff estimates.

A negative value indicates undervaluation.

34. The authorities believed the recent changes to the monetary policy framework were consistent with the exchange rate peg and affirmed their readiness to raise interest rates if necessary to respond to potential exchange rate pressures. They explained that the changes had been introduced against the background of a significant increase in foreign exchange reserves, favorable BoP developments and prospects, low core inflation, a negative output gap, and subdued credit growth. In this context they believed the new policies would improve credit conditions in the economy, boost money market development and would bring a side benefit of improving the central bank balance sheet position by reducing interest expenses on central bank bills. The NBRM expected that the new framework could lead to some increase in banks’ holdings of foreign assets in lieu of central bank bills and a corresponding lower accumulation of NBRM reserves. However, they believed that bank foreign assets provided a useful buffer to support the exchange rate peg.

35. Staff broadly shared the authorities’ assessment on monetary policy. Staff agreed that economic developments provided a supportive context for the recent modest relaxation of prudential requirements and changes to the monetary policy framework. They emphasized that reductions in the benchmark interest rate should be pursued cautiously and that the NBRM should remain ready to respond to any BoP pressures that might arise. Staff did not expect the modest easing would have a significant impact on bank lending, in light of the already ample levels of bank liquidity. Slow credit growth primarily reflected low demand by borrowers and a more cautious approach to risk by banks. Staff also underscored that the overriding objective of monetary policy should be to protect the exchange rate peg and that credit growth and central bank balance sheet considerations should be subordinate. While the interest rate spread between the central bank benchmark rate and the ECB policy rate remained above levels of 2006–08—suggesting potential room for easing—the latitude for maneuver appears limited, given that the policy rate spread over Euro area rates has historically tracked measures of risk premium (see Selected Issues Paper).

36. The authorities had also considered the tail risk event that euro area stress could intensify. In such an event they believed the best course would be to continue to peg. They believed that the pegged regime had provided a valuable framework for disciplined macroeconomic policies and had helped to preserve competitiveness.


Policy rate and currency spreads


Citation: IMF Staff Country Reports 2012, 133; 10.5089/9781475504149.002.A001

Sources: NBRM, ECB.

Policy rate spread and Euroization


Citation: IMF Staff Country Reports 2012, 133; 10.5089/9781475504149.002.A001

C. Financial Sector

37. Staff encouraged the authorities to be prepared for adverse scenarios. Specifically:

  • The authorities should make progress on closing remaining gaps in the NBRM’s regulatory toolkit by expanding its ability to provide emergency liquidity assistance (ELA) and passing legislation to ensure adequate powers to impose fit and proper requirements on bank owners and managers and to intervene insolvent banks without being subject to court challenge. These gaps had been identified in the most recent (2008) FSAA and in the 2011 PLL arrangement and should be given greater priority in light of external risks.

  • Staff advised the NBRM to undertake daily monitoring of deposits to ensure early warning of any negative trends, to engage in contingency planning, and to review its bank resolution powers.

38. The authorities agreed with the need for heightened contingency planning and a full set of central bank powers to respond to adverse developments. They noted that the recently established Financial Stability Committee was now meeting quarterly and was focused on closing the gaps in the regulatory toolkit that had been identified in the FSAA. Although the NBRM still lacked powers to provide ELA against private loans, it had made progress in expanding the class of acceptable collateral. The NBRM had also put in place procedures to monitor deposits on a daily basis and believed that its bank resolution framework was adequate.

39. The authorities and staff agreed it was important to strike the right balance between stability-oriented policies and supporting credit growth to the economy. The NBRM acknowledged the need to preserve adequate liquidity buffers and had reviewed its liquidity requirement framework and determined that it was consistent with the Basel III framework. The NBRM also conducted liquidity stress tests on a regular basis, and believed that banks had adequate liquidity to withstand a severe scenario. The authorities shared staff’s concern that deleveraging by parent banks could result in tighter credit conditions.

D. Risks

40. The authorities broadly shared staff’s views on risks. They pointed to the domestically-financed banking system, low public debt, a contained current account deficit and adequate foreign reserves as important buffers against risks. Nonetheless, they agreed that growth would suffer in the event of adverse conditions in the euro area, and that in a case of extreme financial turbulence the exchange rate peg could come under pressure. With respect to spillovers from the euro area through the banking system, they did not believe Macedonian banks were directly exposed to their parents but were mindful of possible confidence effects and were monitoring deposit trends closely.


41. Macedonia is well-positioned to avoid an economic downturn in the baseline scenario of a shallow recession in the euro area. Growth should be supported by a solid pipeline of FDI, a banking sector that is predominantly funded by domestic deposits, underlying improvements in the export base, and a contained current account deficit. However, a more adverse scenario in the euro area could put growth at risk and lead to external financing pressures.

42. The policy mix appears to be appropriate. The fiscal policy stance is close to neutral and consistent with debt sustainability, while monetary policy reflects an appropriate balance between stability and growth. In the event of an adverse external scenario and slower growth, policies would likely need to become more pro-cyclical. Monetary tightening could be needed to protect the exchange rate peg, while financing constraints would constrain the use of automatic stabilizers in fiscal policy. Over the medium term, the fiscal deficit should be contained to below 1.5 percent of GDP to stabilize debt ratios at below 30 percent of GDP.

43. Reliance on external borrowing from private markets to meet fiscal financing needs is a vulnerability, which calls for greater focus on public debt management and deepening of domestic debt markets. The authorities’ decision to access external debt markets early in 2012 to pre-finance the January 2013 Eurobond repayment was welcome in light of the potential volatility of external market conditions. Nonetheless, looking forward Macedonia remains exposed to disruptions in access to external debt markets, which are its main source of fiscal financing. Development of deeper domestic debt markets is needed to diversify funding sources and reduce risks. The authorities must be prepared to offer higher interest rates, especially on longer-term instruments, to expand the domestic market.

44. The authorities should focus on improving public financial management, including revenue forecasting, commitment control, and medium-term budgeting. This will help to reduce the risk of arrears and allow a more considered evaluation of medium-term spending priorities within the available budget envelope. In the event that arrears arise, transparency about their amount and a firm commitment to repay them over time would be desirable.

45. Macedonia faces good medium-term growth prospects. To achieve higher growth potential it will be important for Macedonia to continue to focus on improving the business environment, infrastructure, and education, and to preserve its track record of sound macroeconomic management.

46. It is expected that the next Article IV consultation will be held on the standard 12-month cycle.

Figure 1.
Figure 1.

FYR Macedonia: Recent Economic Developments

Citation: IMF Staff Country Reports 2012, 133; 10.5089/9781475504149.002.A001

Sources: Haver, SSO, NBRM and IMF Staff estimates.1/ Excluding food, tobacco, fuels and heating.
Figure 2.
Figure 2.

FYR Macedonia: External Sector Developments

Citation: IMF Staff Country Reports 2012, 133; 10.5089/9781475504149.002.A001

Sources: Bloomberg; Authorities’ data; and IMF staff estimates.1/ 12-month moving average of imports.
Figure 3.
Figure 3.

FYR Macedonia: Banking Sector Developments

Citation: IMF Staff Country Reports 2012, 133; 10.5089/9781475504149.002.A001

Sources: NBRM and IMF staff estimates.
Table 1.

FYR Macedonia: Macroeconomic Framework, 2007–17

(Year-on-year percentage change, unless otherwise indicated)

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Sources: NBRM; SSO; MOF; IMF staff estimates and projections.
Table 2.

FYR Macedonia: Central Government Operations, 2006–12

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Sources: IMF Staff and MoF estimates.Note: Central government refers to the core government, plus consolidated extra-budgetary funds.
Table 2.

FYR Macedonia: Central Government Operations, 2006-12

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Sources: IMF Staff and MoF estimates.Note: Central government refers to the core government, plus consolidated extra-budgetary funds.
Table 3.

FYR Macedonia: Balance of Payments, 2008-17

(Millions of euros, unless otherwise indicated)

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Source: NBRM, IMF Staff Estimates.