Former Yugoslav Republic of Macedonia
2013 Article IV Consultation and First Post-Program Monitoring Discussions

Conservative policies, together with external official assistance, provided Macedonia with buffers to confront spillovers from the global crisis and deal with domestic shocks. External and financial stability have been maintained despite a difficult external environment. The start of EU accession negotiations remains uncertain. Some key recommendations of earlier Article IV Consultations have been implemented; others remain outstanding. Macedonia is well positioned to return to growth, although the external outlook presents a key risk. Policies should remain focused on boosting medium-term growth.


Conservative policies, together with external official assistance, provided Macedonia with buffers to confront spillovers from the global crisis and deal with domestic shocks. External and financial stability have been maintained despite a difficult external environment. The start of EU accession negotiations remains uncertain. Some key recommendations of earlier Article IV Consultations have been implemented; others remain outstanding. Macedonia is well positioned to return to growth, although the external outlook presents a key risk. Policies should remain focused on boosting medium-term growth.


1. A track record of conservative policies, together with external official assistance, provided Macedonia with buffers to confront spillovers from the global crisis and deal with domestic shocks. As a result, with only a mild recession in 2009 and then again in 2012, Macedonia averted large real and financial dislocations.

  • Balance of payments pressures in the first half of 2009 were managed successfully through higher policy rates and tighter bank liquidity requirements.

  • In early 2011, in light of euro area risks, the authorities requested a high-access precautionary Fund arrangement (Precautionary and Liquidity Line). In March 2011, the authorities drew on the PLL, citing impaired access to external markets risks and reduced, market access largely due to the uncertain outcome of impending elections ( The drawing reinforced gross reserves.

  • A number of financing operations with the World Bank, notably in late 2011 and early 2013, relieved public sector financing constraints and allowed for a widening of the deficit to support weak domestic demand and start clearing budgetary arrears.

2. Looking forward, the authorities continue to face a difficult external environment but with reduced policy space, particularly in the context of the de facto peg1. Persistent uncertainty about financial and demand conditions in Europe will weigh on growth, while the margins for policy stimulus have narrowed.

3. The start of EU accession negotiations remains uncertain. The former Yugoslav Republic of Macedonia was granted candidate status in December 2005. However, the name dispute with Greece continues to block the initiation of EU accession negotiations and NATO membership. In its latest progress report from April 20132, the European Commission urged the authorities to implement the commitments made in March to end the political stalemate in Parliament, and noted that progress has been made in promoting good neighborly relations as well as on formal talks on the name issue.

4. Some key recommendations of earlier Article IV consultations have been implemented, others remain outstanding. The authorities have made important progress in lengthening domestic debt maturities as well as deepening domestic debt markets. They have closed all but one of the identified gaps in the crisis management framework. Progress with public financial management reforms is mixed. The public recognition of government payment arrears—which were reported at MKD 5.6 billion (1.2 percent of GDP) as of September 2012—and the commitment to clear them was a welcome policy decision. The authorities have recently initiated changes to the commitment, recording, and control systems. Continued transparency on the stock of arrears would boost confidence in the durability of the solution.

Recent Economic Developments

Following a shallow recession in 2012, a modest recovery is forecast for 2013, predicated on an acceleration in public investment and FDI projects coming on stream. The weak external environment and difficult liquidity conditions for the domestic private sector present important downside risks. Both fiscal and monetary policies—the latter constrained by the commitment to maintain exchange rate stability—are providing support. The impact of weaker trade on the current account in 2012 has been mitigated by high private transfers, and public sector net external borrowing has helped build up reserves despite modest FDI. The financial sector remains stable—liquid and well-capitalized—albeit with still rising NPLs.

A. Growth and Inflation

5. Weak domestic and external demand halted growth in 2012. Following a sharp decline in the first half of the year, growth picked up in the second half, mainly supported by construction and public consumption. Overall, activity declined 0.3 percent in 2012, with a negative contribution from net exports and private consumption, against the backdrop of a steady deceleration of private sector credit. In spite of a 0.6 percent increase in employment, gross wages remained flat throughout the year, implying declining real incomes. Trade weighted effective import demand for Macedonian products declined by 1.9 percent.


Quarterly Contributions to Real GDP Growth

(Y/y, percent)

Citation: IMF Staff Country Reports 2013, 178; 10.5089/9781484323717.002.A001

Sources: SSO; and IMF staff calculations.

6. In 2013, economic activity is expected to pick up to about 2 percent, with risks tilted to the downside. So far, notwithstanding an uptick of the industrial production index in February and March, low turnover in the retail trade sector and persistently weak credit do not point to a solid recovery in domestic demand. Nonetheless, baseline growth is predicated on an acceleration in the second half of the year, driven by public infrastructure works and foreign investment projects, as well as a slight rebound in private consumption. Despite stagnant effective external demand, projected export growth is driven by a rebound of metal exports from last year’s lows and FDI-generated specialized exports facing robust demand.

7. Inflation is expected to moderate to 2.5 percent in 2013. After peaking at 5.3 percent year-on-year in September 2012, driven by rising food prices and (regulated) price hikes in the electricity and heating sectors, headline inflation decelerated to reach an average of 3.3 percent for the year as a whole. For 2013, second-round effects of energy price hikes are assumed to wear off, while food prices are expected to decline. After accelerating to 2.9 percent year-on-year in December 2012, core inflation has been on a downward trend, falling to 2.4 percent in April, and is expected to settle at 2.2 percent on average this year. Cost side pressures are weak—unit labor costs are expected to remain broadly flat, and the output gap is not expected to close before end-2015.


Total and Core Inflation

(Y/y, percent)

Citation: IMF Staff Country Reports 2013, 178; 10.5089/9781484323717.002.A001

Sources: SSO and IMF staff calculations.

B. External Sector

8. External stabilty was maintaned in 2012, despite weakness in trade and private capital flows. In 2012, the current account deficit widened to 3.9 percent of GDP, with a worsening of the trade balance to 23.7 percent of GDP partly offset by record private transfers (notably remittances), reaching 21 percent of GDP. Yet in spite of weak FDI inflows and some capital outflows in the form of intra-company cross-border loans and corporate deposits, the stability of the peg was supported by official external inflows, sizeable trade credits and inward bank deposits, resulting in a strengthening of official reserves.


Current Account Financing

(Mil. euros, cumulative over the past 12 months)

Citation: IMF Staff Country Reports 2013, 178; 10.5089/9781484323717.002.A001

Sources: NBRM; and IMF staff calculations.

9. The current account deficit is expected to deteriorate in 2013 on account of increased FDI-related imports. In 2013, import volume growth related to the implementation of FDI projects in the manufacturing sector is expected to accelerate while exports would come on-stream more gradually, resulting in a further deterioration of the trade balance to 25 percent of GDP. This would widen the current account deficit to about 4.9 percent of GDP, assuming no further acceleration of private transfers. The current account is expected to be financed by net FDI inflows of about 3 percent of GDP, as well as net public sector medium-term external borrowing—inflows already reflect a disbursement of a syndicated loan linked to a World Bank Policy-Based Guarantee which more than covered the eurobond maturity in January 2013.

10. On current projections, the level of gross international reserves provides a sufficient buffer against external shocks. Reserve levels are in line with standard ‘rule-of-thumb’ measures, covering about 120 percent of short-term debt, 4.7 months of prospective imports, and about 53 percent of broad money, as well as with combined metrics such as the Greenspan-Guidotti rule, covering 99.6 percent of the sum of the short-term debt and current account deficit, on average over the years 2012–2016. To better assess reserves against the type and size of pressures observed in past crisis episodes, a new Fund metric3 benchmarks the level of reserves against a weighted index comprising export earnings, short-term debt, other portfolio liabilities and broad money (M2), the parameterization of which also depends on the exchange rate regime. This metric places reserve levels in Macedonia almost exactly in the midpoint of the suggested adequacy range of 100 to 150 percent. Finally, reserves also provide appropriate cover against country-specific shocks (see text box).

Reserve Adequacy – Further Considerations

In view of the idiosyncratic characteristics of the Macedonian external sector, with a structural trade deficit covered almost 85 percent by private transfers (assumed to primarily reflect remittances), the standard metrics may usefully be adjusted to incorporate scenarios relating to a ‘sudden stop’ in these current account flows.

In this regard, the level of reserves covers about 90 percent of the needs corresponding to the new Fund metric augmented by a shortfall of expected private transfers by 50 percent, and about 75 percent of the similarly adjusted Greenspan-Guidotti metric, over the 2012–2016 period. A less severe scenario which assumes that the shortfall in private transfers is accompanied by some compression in imports, brings the reserve cover to about 80 percent of the identified financing needs under the Greenspan-Guidotti metric.

Moreover, a recent technical assistance mission, relying on country-specific calibrations of the Jeanne and Ranciere (2008) welfare-based model, where risk-averse policy makers are assumed to hold reserves as a self-insurance instrument against sudden stops in capital flows, also concluded that reserve holdings were adequate, including when incorporating the endogenous probability of a currency or banking crisis.

C. Fiscal Policy

11. The accommodation of weaker revenues and the start of the arrears clearance process widened the 2012 cash deficit to 3.8 percent of GDP. Total realized revenues—8 percent below the level forecast in the supplementary budget—were weaker across the board, reflecting weaker than expected economic activity. Substantially lower VAT revenues also reflected a policy choice to start clearing refund arrears—a total of MKD 1.8 billion (0.38 percent of GDP) VAT refund arrears were cleared in 2012. Keeping the cash deficit contained at 3.8 percent of GDP required expenditure compression beyond the ceilings established in the supplementary budget. With only about 20–25 percent of discretionary room in the budget, the adjustment fell mainly on capital expenditure.

Budget Execution

(Billion of denars)

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Notes: Total revenues and expenditures are net of transition costs for pension system and revenue from repayment of loans. Nominal GDP growth assumed for 2013 equal to 4.6 percent.

Deficit in 2013 excludes any deficit projections for the former Road Fund.

12. The deficit for the first quarter of 2013, at 2.4 percent of projected annual GDP, already represents two thirds of the annual target. Revenue developments were dominated by large VAT refunds through February, with all other revenues at about a quarter of the annual target, and an overperformance of profit taxes. On the expenditure side, subsidies and other transfers rose by 250 percent relative to Q1: 2012, mainly related to advance payments of agricultural subsidies. While this appears to be an intra-annual reallocation of expenditure, further expenditure compression will likely be needed to meet the deficit target of 3.5 percent of GDP. The authorities were not considering a supplementary budget at the time of the discussions, noting that on current revenue trends the required spending adjustment could be accommodated within normal capital spending buffers by postponing envisaged but not-yet started projects as has been the case in the past.

13. Some capital expenditure has shifted off-budget starting in 2013. As of January 2013, most of the public sector road infrastructure projects will be taken up through the newly created Public Enterprise for State Roads (PESR). Previously part of the budgetary central government, this entity can borrow on its own behalf, although most of its debt carries an explicit sovereign guarantee. Given the envisaged increase in capital expenditure for developing road infrastructure in the near to medium term, it would be important to track the evolution of the public sector aggregate that includes the deficit and debt of this new state-owned enterprise, for assessing both debt sustainability and the aggregate demand impact of fiscal policy.4

14. Overall public sector debt has risen faster than central government debt, as the public sector has sought to accommodate the protracted economic downturn. Since the crisis, the authorities have sought to support domestic demand through both higher budget deficits as well as through financing support for SMEs through the Macedonian Bank for Development Promotion (MBDP). Debt of the MBDP has risen from 0.4 percent of GDP in 2009 to 2.2 percent in 2012, and largely reflects the use of credit lines provided by the European Investment Bank (some €250 mn in 2009–2012, and additional €100 mn announced in 2013). In 2013, the projected marked increase of SOE debt, from 2.7 to 4.5 percent of GDP, is mainly a result of the creation of the PESR, and the external credit lines supporting its expanding activity.


Evolution of Public Sector Debt

(Percent of GDP)

Citation: IMF Staff Country Reports 2013, 178; 10.5089/9781484323717.002.A001

Sources: FYR Macedonia Authorities; and IMF staff calculations.

15. Substantial net domestic issuance in 2012 as well as in the first quarter of 2013 has provided financing for the higher deficits. Net domestic issuance of €451 million and net external borrowing of about €79 million in 2012 financed the budget deficit as well as built up government deposits at the NBRM to €319 million (4¼ percent of GDP) at year end. Net domestic issuance through April 2013 stands at €120 million, higher than the €100 million envisaged in the budget, which the authorities intend to use as a financing buffer for 2014. In addition, in line with previous Fund advice, since Q3 2011 the Treasury has continuously sought to lengthen debt maturities. Some maturing 3-month T-bills have been rolled over into 6- and 12-month securities, and the authorities have increased the issuance of 3- and 5-year bonds. These longer dated securities currently make up 25 percent of the total debt stock, up from 5 percent at the end of 2011.

FYR Macedonia. Central Government Financing Table

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Source: MoF; and IMF staff estimates

The rollover requirements here are defined as the short term debt stock (smaller or equal to 12 month maturity) at the end of the previous year.

Includes the EUR 130 million syndicated loan backed by a World Bank Policy Based Guarantee.

Official financing includes a World Bank Competitiveness Development Policy Loan for EUR 35.5 M (USD 50 M), disbursed in November 2012.

Includes the amortization of the EUR 175 million Eurobond falling due in January 2013.

Includes syndicated loan (EUR 250 million) covered by a second World Bank Policy Based Guarantee, disbursed in January 2013.

Includes the second World Bank Competitiveness Development Policy Loan for EUR 35.5 M (USD 50 M) assumed to be disbursed in the second half of 2013.

This line includes the IMF PLL repayments of EUR 83 million in 2014, EUR 111 million in 2015 and EUR 28 million in 2016.

D. Monetary and Financial Developments and Policies

16. The absence of external pressures in a low growth environment allowed the NBRM to lower the policy rate by 25 basis points to 3.5 percent in January 2013, and to gradually reduce its stock of outstanding Central Bank bills. In addition, in order to stimulate private credit growth while also strengthening the balance of payments, the NBRM lowered reserve requirements by the amount of new loans to domestic net exporters and electricity producers, effective January 1, 2013, with limited take-up to date. Since April 2012, the amount of outstanding 1-month CB bills (its main sterilization instrument) has gradually been reduced by about MKD 10 billion to MKD 24 billion (Figure 3). Over the last few months, this has resulted in a higher subscription of 7-day NBRM deposits, which carry a 1¾ percent interest rate.

Figure 1.
Figure 1.

FYR Macedonia: Real Sector Developments, 2008–2013

Citation: IMF Staff Country Reports 2013, 178; 10.5089/9781484323717.002.A001

Sources: Haver; SSO; and IMF staff calculations.1/ Note: the percent balance is the difference in percentage shares between the ‘positive’ and ‘negative’ assessments on the current business situation.
Figure 2.
Figure 2.

FYR Macedonia: Credit Developments, 2008–2013

(Percent, unless otherwise indicated)

Citation: IMF Staff Country Reports 2013, 178; 10.5089/9781484323717.002.A001

Sources: NBRM; and IMF staff calculations.
Figure 3.
Figure 3.

FYR Macedonia: Monetary Policy Developments, 2004–2013

(Percent, unless otherwise indicated)

Citation: IMF Staff Country Reports 2013, 178; 10.5089/9781484323717.002.A001

Sources: NBRM; Haver Analytics; and IMF staff calculations.
Figure 4.
Figure 4.

FYR Macedonia: Banking Sector Developments, 2008–2013

(Percent, unless otherwise indicated)

Citation: IMF Staff Country Reports 2013, 178; 10.5089/9781484323717.002.A001

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

FYR Macedonia: External Sector Developments, 2008–2013

Citation: IMF Staff Country Reports 2013, 178; 10.5089/9781484323717.002.A001

Sources: NBRM; and IMF staff calculations.1/ Brazil, China, India, Russia and Turkey.
Figure 6.
Figure 6.

FYR Macedonia: External Debt Sustainability: Bound Tests 1/2/

(External debt in percent of GDP)

Citation: IMF Staff Country Reports 2013, 178; 10.5089/9781484323717.002.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/ For historical scenarios, the historical averages are calculated over the ten-year period, and the information is used to project debt dynamics five years ahead.3/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.
Figure 7.
Figure 7.

FYR Macedonia: Public Debt Sustainability: Bound Tests 1/2/

(Public debt in percent of GDP)

Citation: IMF Staff Country Reports 2013, 178; 10.5089/9781484323717.002.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/ For historical scenarios, the historical averages are calculated over the ten-year period, and the information is used to project debt dynamics five years ahead.3/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and primary balance.4/ One-time real depreciation of 30 percent and 10 percent of GDP shock to contingent 11 abilities occur in 2010, with real depreciation defined as nominal depreciation (measured by percentage fall in dollar value of local currency) minus domestic inflation (based on GDP deflator).

ECB and NBRM Policy Rates


Citation: IMF Staff Country Reports 2013, 178; 10.5089/9781484323717.002.A001

Sources: NBRM; and IMF staff calculations.

17. Banking sector indicators suggest that the system is in overall sound shape, but non-performing loans are increasing. As of December 2012, the capital adequacy ratio stood at 17.1 percent (with tier 1 capital at 14.5 percent), and over 29 percent of total assets were highly liquid. Deposits provide the main funding source. The NPL ratio rose to 11.7 percent in February 2013, but provisions exceed NPLs. Profitability remains low but positive. Euroization of deposits, while high, continues to decrease gradually to below pre-crisis levels.

18. After steadily decelerating in 2012, credit growth is expected to remain subdued in 2013. Loan growth declined from 5.2 percent (year-on-year) in December 2012 to 4.4 percent in February 2013, even as deposit growth accelerated from 4.9 percent to 5.6 percent. On the supply side, banks are likely to remain conservative in light of modest growth prospects and low profitability. In addition, group-wide policies prescribed by foreign parents seeking to strengthen their capital ratios at the consolidated level are likely to limit asset growth in the largest banks in the system. Meanwhile, credit demand continues to be affected by the economic outlook.

19. The NBRM made several changes to banks’ provisioning rules. In mid-2012, it introduced minimum provisions for unsold collateral-in-possession on banks’ balance sheets. In March 2013, it announced further changes, effective December 1, 2013, providing the banks with somewhat more leeway in taking into account collateral value when provisioning loans. The NBRM expects the latter amendments to result in a modest release of provisions, which the banks will be obliged to allocate to reserves.

20. Adoption of amendments to the banking law early this year closed all but one of the long-standing gaps in the crisis management framework. The amendments ensure that the NBRM has the ability to impose fit and proper requirements on bank management and owners, and pave the way for the central bank to widen the class of collateral that banks may use to access liquidity support. The last outstanding issue in this area requires clarification of the NBRM’s power to intervene an insolvent bank without being subject to court challenge.

Policy Discussions

Despite a long track record of macroeconomic stability, income convergence has been slow. The discussions focused on policies that would reduce risks to the outlook in the near to medium term, preserve the sustainability of fiscal and external positions, and address structural constraints that have held back sustained strong growth.

A. Outlook and Risks

21. Macedonia’s near-term growth outlook remains difficult, but the economy is well-positioned to restart the convergence process. In the short run, the main risk to growth is a slower than anticipated pick up in private consumption in a context of weak export growth—a repeat of the factors that stalled growth in 2012. Over the medium term, staff’s baseline scenario envisages growth to settle around 4 percent by 2016, implying a modest acceleration relative to average growth in the pre-crisis decade but also only a moderate speed of convergence toward living standards in EU countries. Over this horizon, the main risks relate to weaker-than-expected investment and a continued drag of net exports on growth, should there be setbacks in the implementation of FDI plans or difficulties in developing backward linkages to the domestic economy.

22. Despite strong real and financial linkages to the euro area (text chart and Box 1), a number of factors mitigate risks in the near term:

  • New tradable sector FDI has reduced reliance on traditional exports and reoriented exports geographically.

  • Local subsidiaries of euro area banks (Greece and Slovenia) are well-capitalized and liquid and have limited exposure to parents—with no short-term wholesale funding dependency—as well as limited credit exposure to those economies.

  • With banks funded mainly by resident deposits, and with public sector external financing requirements for 2013 already met, the channels for transmission of any renewed stress in Europe appear limited to relatively low probability but high impact confidence shocks. The short-lived spike in deposit withdrawals from the Macedonian subsidiary of Slovenia’s NLB in late March bears testimony to such risks.


Macedonia: Trade and and FDI linkages


Citation: IMF Staff Country Reports 2013, 178; 10.5089/9781484323717.002.A001

Note:Risk map based on WEO growth projections for 2013 <red < 0%, yellow >0%)FDI stock data, end 2011. Exports shares data, end 2012.

23. A sudden loss of confidence could be transmitted through remittances, which are sensitive to domestic conditions. While generally a stable source of current account financing, a sudden stop of remittances—a large share of the 20 percent of GDP in private transfers—has the potential to quickly create large balance of payments pressures, as was the case in 2009. Renewed political uncertainty could affect the volume of these flows.

24. The toolkit for crisis management has been strengthened further. Creating the scope for widening ELA collateral eligibility provides a substantial enhancement of the crisis management toolkit. The standing Financial Stability Committee (FSC) can serve as a useful platform for a regular discussion of risks, and some thought could be given to expanding the membership to include other financial sector regulators such as the Insurance Supervision Agency. In light of the heightened risk of confidence shocks in the current environment, staff suggested that the authorities may want to review the scope of the deposit insurance system, which currently applies only to natural persons.

Know Your Cluster-Macedonia1

A network analysis of global interconnectedness suggests that Macedonia and its neighboring countries form a tight cluster of economies that are mutually interdependent—more connected to one another than those outside the cluster2—with Greece and Serbia acting as likely gateways, connecting the cluster to others. Membership in the cluster reflects the strength of trade, banking, and migrant and remittance links.

Data limitations are unavoidable in any large cross country comparison: in this context, issues of nationality in classifying origin and destination of migrants and remittances, as well as accounting for transshipping of exports through neighbors to Germany may obscure stronger direct linkages to the core.

Nonetheless, this framework is useful in highlighting the following: 1) with two gateways in the cluster, there is greater potential for negative feedback effects within and between clusters; 2) a shock to one member of the cluster may be transmitted more widely to other members through the variety of links that define the cluster. Finally, this broad and systematic approach does not uncover any new sources of spillovers that may have remained hidden by a more narrow focus on bilateral linkages in specific areas.


Trade and Financial Ties since 2010

(Percent of total; unless otherwise indicated)

Citation: IMF Staff Country Reports 2013, 178; 10.5089/9781484323717.002.A001

Sources: Central bank; BIS.1/ 2011–12 figure is for end-June 2012. Defined in per hundred basis points.2/ Pre-crisis average 2000–10 for exports, 2007–10 for inward FDI, 2005–07 for cross-border claims.

Looking forward, recent changes in export destinations and FDI and bank flows may have moved Macedonia closer in within the global network, as bilateral links to Germany and Turkey have strengthened.

1 Franziska Ohnsorge (SPRAM).2 The network of bilateral ties as of 2010 in Figure 1 is based on trade, bank exposures, portfolio assets, FDI stocks, migrants, and remittances. A link between a country pair is defined as its share in the average of the two countries’ total. To produce the network graph, the links that are “sufficiently large” are aggregated by either taking an unweighted average or choosing the maximum (if the difference between the maximum and minimum link is sufficiently large). See I. Derényi, G. Palla, T. Vicsek, “Clique percolation in random networks” Phys. Rev. Lett. 94, 160–202 (2005). Details of the approach can be found in the IMF Board Paper FO/DIS/12/38.

25. The authorities noted that they are prepared for tail risk events, and the past stress in Europe has not translated into a loss of confidence in the banking sector. The authorities monitor deposits on a daily basis, and have tested bank IT systems’ ability to generate reliable insured deposit data on short notice. In case of deposit outflows, they expect to be able to supply the system with ample liquidity on a short notice, which should serve to stabilize the situation quickly. Overall, the NBRM believes that its bank resolution framework is adequate. Deposit insurance coverage and scope are seen as appropriate.

B. Fiscal Policy—Restoring a Medium-Term Perspective

26. As the crisis subsides, fiscal policy should regain its medium-term perspective. The authorities are appropriately looking to increase growth potential with some upfront fiscal costs. However, as debt levels have shifted up from low to moderate, the authorities have revised up their near term deficit targets while at the same time shifting some capital expenditure off-budget Until there are palpable payoffs from the authorities’ growth enhancing strategy, the debt-carrying capacity of the economy will remain low, which calls for a careful reconciliation of competing fiscal policy objectives.

27. In order to preserve debt sustainability, there is a critical need to anchor fiscal policy in a medium-term fiscal strategy which would reconcile competing priorities. The authorities’ commitment to a business friendly, low tax environment is paired with increasing pressures on current and capital expenditures:

  • Ad-hoc pension increases in excess of the standing indexation formula add about MKD 2 billion (0.4 percent of GDP) to 2013 primary expenditure; agricultural subsidies continue to increase, and public sector wages—which were temporarily frozen as a crisis-adjustment measure—are expected to rise by 5 percent in 2014.

  • Scaling up public investment projects, namely road and railway infrastructure, is a key stated medium-term objective. The authorities also appropriately envisage higher spending on labor market activation policies, training, skills and education to maximize the benefits of FDI inflows.

  • In addition, in the medium term, rising interest cost—due to a higher debt stock and a projected rise in global interest rates—will compete for space with productive expenditure in the overall spending envelope. This is currently mitigated by the still large share of long-dated official external public sector debt at concessional rates (around 40 percent of total public sector debt in 2012), which will reprice rather slowly.

28. A greater focus on multi-annual budgeting would provide a better framework for assessing available fiscal space and help avoid arrears. Optimistic revenue assumptions and weaknesses in the commitment recording and control framework—particularly as it pertains to multiyear projects—were key factors behind the emergence of public sector payment and VAT refund arrears. Strengthening the forecasting framework, as well as the system of commitment controls will improve fiscal management. The authorities have been taking corrective measures, but weaknesses in the Treasury system (text box) will complicate monitoring and control functions in the near term. Meanwhile, it remains crucial that commitments are entered promptly into the existing system.

Treasury Operations: Status of Corrective Measures

Reporting. The Manual of Treasury operations has been amended to define the procedures for reporting multi-annual liabilities of budget users to the Treasury, improving the procedures for reporting liabilities in line with signed contracts, and defining the procedures for validation of liabilities by internal auditors.

IT upgrade. In line with findings of shortcomings in the Treasury System by successive annual audits by the State Audit Office, a working group has been set up to define the technical specifications and needed documentation for upgrading the Treasury software, so as to give it the required capacity for proper detailed electronic filing of payment orders as well as sending out electronic reports to budget users. However, this new Treasury module would not be rolled out before 2014.

29. A return to medium-term fiscal strategy documents would help revitalize fiscal transparency. The last such document, covering 2011–2013, was published in December 2010. Resuming the preparation and publication of such strategy documents would foster a better-informed public debate, strengthen government accountability and credibility, as well as improve risk awareness. The published fiscal reports should cover a wider scope of public institutions than the budgetary central government, capture a broad range of direct and contingent liabilities, be published in a timely manner, and take a rigorous approach to risk analysis. As such, these documents would prove to be valuable tools to the public, investors, and policymakers alike.

30. In that light, while an economic case can be made for creating the PESR, fiscal risks should be carefully monitored. A proliferation of entities set up as public non-financial corporations can be associated with the dilution of accountability and control and problems in reporting and consolidating fiscal data, complicating overall fiscal management. First and foremost, the central authorities should be able to exercise tight control of the entity’s budget preparation and execution. In addition, they should ensure that financial reporting is timely, transparent and subject to oversight, and allows for the consolidation of PESR activities with central government fiscal tables for the purposes of macro-fiscal analysis.


Fiscal Balances in FYR Macedonia. 2009–2013

(Percent of potential output)

Citation: IMF Staff Country Reports 2013, 178; 10.5089/9781484323717.002.A001

Source: IMF Staff estimates.Note: HP stands for Hedrick-Prescott Filter, and CFF for Christiano-Fitzgerald Filter. The fiscal impulse (primary balance here) is the difference in the cyclically-adjusted balance between the pervious and the current year (a negative fiscal impulse means a cyclically-adjusted contraction). Cyclical adjustment of fiscal balances is done with respect to output gap. The fiscal deficit is adjusted for a structural break to include central government and the off-budget PESR deficit in 2013.

31. To ensure debt sustainability, the central government primary deficit should be gradually reduced to first stabilize debt and then rebuild fiscal buffers.

  • In the near term, fiscal policy should remain supportive. On current fiscal targets, fiscal policy is expected to provide a very small positive impulse in 2013, appropriately aiming to sustain the still fragile recovery in output as private sector activity starts to strengthen.

  • Once the recovery sets in, central government deficits should decline. Country-specific factors such as a low and volatile revenue ratio, low average growth, rigidity of expenditure, and the constraints imposed by the exchange rate regime suggest that safe debt levels for Macedonia would be generally on the lower end of standard intervals5. While rebuilding fiscal buffers used during the crisis will be important in the longer term, the more immediate policy goal is to stabilize debt. Under benign assumptions about the growth-interest rate spread, this would require a reduction of central government primary fiscal deficit by about 1.6 percent of GDP relative to forecast for 2013 outturns (text table and chart). Given largely downside risks to growth, the start of the consolidation process could be effectively managed by identifying consolidation measures that the authorities could commit to in 2014, but which would have a full year effect in 2015.

  • The recommended fiscal path for central government deficits appropriately balances risks to debt from plausible shocks against the growth benefits of higher public infrastructure spending. Recent research, addressing the criticism that the lack of an explicit link between public investment and the resulting acceleration of growth creates a bias toward conservative borrowing limits,6 suggests that even if scaling up public investment can be favorable in the long run, the transition period is challenging and exposes the country to increased risk of carrying a permanently higher debt level. Offsetting some of the planned scaling up of public investment in Macedonia by some adjustment to current expenditures would stem a rapid build-up in debt, particularly under an uncertain outlook for growth (see Annex I on debt sustainability).


Debt path under consolidation scenario and growth shocks

(Percent of GDP)

Citation: IMF Staff Country Reports 2013, 178; 10.5089/9781484323717.002.A001


Debt path under current policies scenario and growth shocks

(Percent of GDP)

Citation: IMF Staff Country Reports 2013, 178; 10.5089/9781484323717.002.A001

FYR Macedonia: Underlying Assumptions for Debt Paths

(Percent of GDP, unless otherwise indicated)

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Sources: IMF staff estimates.

Authorities’ views

32. The authorities noted that boosting growth is indeed the centerpiece of economic policies. In the near term, addressing arrears has played a crucial role in supporting demand. Increasing capital expenditure is a key pillar of their growth strategy, as well as attracting and accommodating FDI in a manner that ensures positive spillovers and linkages to the domestic economy.

33. The authorities concurred with the need to reduce the deficit as the cycle turns, but noted that the pace of consolidation would depend on a number of factors. They saw the need for a cautious pace of deficit reduction. The authorities noted that capital expenditure plans include big projects that would require budgetary space—Corridor X highway construction, railways, a gas pipeline. They argued that a solid social safety net is an important stabilizer, and saw higher subsidies in agriculture and increases in pensions and social assistance as a needed cushion that counterbalances less popular structural reforms.

34. The authorities noted that a medium-term fiscal and debt management strategy is currently under preparation. They saw the suspension of medium-term fiscal strategy documents as a reflection of the extreme uncertainty under which policymakers have been operating through the global downturn. They noted that a medium term fiscal and debt management strategy would be provided to Parliament before the 2014 budget. They concurred that the strategy should indeed provide detailed information and analysis on expenditure and debt of various levels of government.

35. The authorities were mindful of the need to maintain sight of and control over broader public debt. They noted that fiscal risks from the broader perimeter of government are contained by strict controls at the central government level, and reiterated that the Ministry has full control over the indebtedness process of public enterprises, including the newly created Public Enterprise for State Roads.

36. The authorities emphasized their commitment to a durable solution for public sector arrears. They have publicly announced that all arrears have been cleared and noted that they have taken measures to prevent reoccurrence, including by strengthening reporting requirements for multi-annual contracts, and are confident in their ability to properly monitor the emergence of payment delays. Execution of the budget through March has been in line with the authorities’ expectations, providing assurances that there is enough budget space and liquidity to remain current on all due obligations.

C. Monetary Policy and International Reserves

37. The exchange rate peg to the euro continues to serve Macedonia well, delivering low average inflation and a stable real exchange rate. Staff continues to view the peg as appropriate for Macedonia, provided supportive macroeconomic policies remain in place. CGER estimates do not indicate significant misalignments of the real exchange rate, and the current account deficit remains lower that the estimated norm. Yet the persistence of a large trade deficit, mainly attributable to structural constraints, needs to be addressed by policies aimed at boosting non-price competitiveness, securing foreign direct investment and unlocking potential growth by establishing backward linkages from newly established firms to domestic suppliers (Box 2).

FYR Macedonia: Estimated REER Misalignment

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Source: IMF staff estimates.

A negative value indicates undervaluation.

38. The primacy of the exchange rate peg limits the latitude for further easing. The policy rate spread over euro rates has narrowed. Reserves remain adequate, balance of payments pressures are limited, core inflation is coming back down, and the ratio of euro-denominated to denar deposits continues to decline, but credit growth is weak—conditions that, at the margin, may allow for some further limited stimulus. Nonetheless, this needs to be carefully weighed against external risks, particularly as further rate declines may be less effective in light of banks’ demonstrated risk aversion and already high liquidity. With regards to the efficiency of monetary transmission, staff sees the recent (since January 2013) persistent shift of volume from Central Bank bills to 7-day deposits as a risk to the effectiveness of CB bills as the main instrument of monetary policy. This risk is emphasized by recent issuances of 6-month government paper below the policy rate.

Authorities’ views

39. The authorities see monetary policy as appropriately accommodative, and reaffirmed their readiness to raise interest rates to respond to potential exchange rate pressures. They noted that while conditions late last year were conducive to some further relaxation, they had been concerned about the uptick in core inflation. Nonetheless, last year’s inflationary peak is seen as a transitory consequence of fuel and food price developments, and a gradual decline in headline and core inflation is expected to continue, with monthly core inflation in February and March at zero percent. This may provide some further room, if necessary, to support activity. The authorities explained that the decision to keep the central bank bill level stable in the face of excess demand was intended to give banks an incentive and opportunity to extend credit to the private sector. They noted that even 7-day deposits enjoy a comfortable interest rate differential in favor of holding denars. Finally, they saw the recent increase in the take up of 7-day deposits as temporary, and see no obvious factors—higher capital flows or higher economic activity—that would lead to continued increases in these balances. Nevertheless, they reiterated that it was not their long-term policy intention to use this instrument as their main instrument for liquidity management. The authorities continue to see the monetary policy framework as consistent with the exchange rate peg, and reaffirmed their readiness to raise interest rates if necessary to respond to any potential exchange rate pressures.

External Sector Assessment

Macedonia’s external position appears sustainable. In particular, while net external liabilities are on a declining path, various frameworks for computing the real effective equilibrium exchange rate do not point to overvaluation. Nonetheless, the persistence of a high trade deficit is an important vulnerability, and suggests that there are important non-price factors that weigh on competitiveness. To a large extent, the authorities’ policies center on addressing these structural bottlenecks to growth.

Economic policies in Macedonia are geared toward attracting foreign direct investment by maintaining cost competitiveness and improving the business environment. These policies have been largely successful. Since the mid-2000s, brownfield and greenfield foreign direct investments have gathered speed in the tradable sector, particularly in the automotive component, but also in the food processing and tobacco sectors, leading to increased export diversification and trade integration with the EU. Key features of the Macedonian economy that have been behind the recent inflows are the proximity to core EU markets, a stable macroeconomic environment, contained unit labor costs attributable to a policy of wage moderation, and a large pool of available labor, and a low-tax environment.

External debt is projected to have peaked at 68 ½ percent of GDP in 2012. Staff’s baseline forecast is for a decline in the external debt to GDP ratio of about 8 percentage points over the forecast horizon. The baseline forecast is predicated on about 4 percent of GDP in non-debt creating inflows annually, i.e., slightly below the average inflows recorded over the pre-crisis years 2003–2008, fully financing the non-interest current account deficit. The assumed recovery of FDI to pre-crisis levels seems plausible, given supportive policies put in place in recent years and in view of increasing export market shares.

Continued effort to address non-price competitiveness constraints is needed to boost growth and reduce the large trade deficit over the medium term. Labor participation rates remain notably low and the grey economy widespread. Infrastructure gaps—particularly in roads and railways, but also in energy—are being addressed through public expenditure programs, mostly financed by concessional long term loans. The mechanisms for providing feedback from the needs of new industries to the education and training on offer should help absorb the large pool of unemployed labor. Skill upgrades, together with continued improvements in the business environment should help strengthen linkages of FDI to the domestic economy.


Macedonia: Competitiveness Indicators

Citation: IMF Staff Country Reports 2013, 178; 10.5089/9781484323717.002.A001

Source: Haver; WEO; INS; Country Authorities; and IMF staff calculations.1/ MKD statistics with break due to change from net to gross wage accounting.
1 The latter factor is expected to largely limit the scope of second-round effects that may arise from the recently announced indexation of the minimum wage in the private sector.

D. Structural Reform—Boosting Growth

Unemployment and Jobs

40. The high unemployment rate in Macedonia cannot be easily explained by standard labor market frictions. While measured unemployment –at 30½ percent—is disquietingly high, there are no obvious large policy-induced distortions on the demand or supply sides of the labor market that could explain such an outcome. A comprehensive analysis of traditional labor market constraints suggests that employment protection legislation is slightly more flexible, on average, than in peers, the size and duration of social assistance does not provide notable disincentives to seek work, nor are labor tax wedges particularly high (see Chapter 1 of the Selected Issues Papers). This, combined with the observed degree of unresponsiveness of employment to output changes, suggests that more structural factors are at play.

41. Large emigration flows, considerable loss of skilled labor, and small FDI inflows slowed the necessary structural transformation to boost employment. While civil conflicts were much less disruptive in Macedonia than in some other former Yugoslav republics, brain drain estimates place Macedonia among the most affected countries (Beine et al. 2006). Late structural transformations, and a weak flow of foreign investments, partly due to armed conflicts in the region in the 1990s, also hindered the natural development of new sectors with large productivity increases. The composition of output in Macedonia still shows a relatively large dependence on low-productivity sectors such as small scale farming and heavy industry.


FDI stack per capita, 2011

(Thousands of US dollars)

Citation: IMF Staff Country Reports 2013, 178; 10.5089/9781484323717.002.A001

Source: HP Database; and IMF staff calculations.

42. The effort to attract FDI is bearing fruit, and should have a positive impact on the speed of structural transformation and, critically, on activity rates and employment. The authorities have developed a strategy that goes beyond a low tax environment—focusing on building needed infrastructure and allowing feedback from the needs of new industries to the education and training on offer. This, together with a greater focus on primary education, should help absorb the large pool of unemployed labor. However, with labor costs being an important input into location decisions of labor-intensive industries, the authorities should carefully monitor the impact on labor costs of the decision to link the minimum wage to the average wage. Durably boosting growth would also depend on FDI projects developing closer linkages with the domestic economy—this will be a gradual process, but continued improvements in the business environment would help.

Authorities’ views

43. The authorities broadly concurred with this overall assessment. They highlighted the magnitude of the structural challenge, particularly in light of the limited public expenditure space. In that respect, the authorities noted that further work could usefully investigate which of the constraints to job creation are most binding. In addition, as job creation accelerates, it would be useful to understand the potential role of other constraints, such as the real scope for mobility of the labor force to accommodate higher labor demand created by new FDI.

Financing Convergence

44. Boosting sustainable credit growth would help finance economic convergence to European income levels. While cyclical considerations and conservative policies at the parent group level currently play a role in limiting credit extension, Macedonia has historically stood out for its low level financial deepening, as proxied by the credit-to-GDP ratio compared to peer countries. Empirical analysis (see Chapter 2 of the Selected Issues Papers) provides some evidence of unsatisfied demand for credit in the economy, likely due to constraints on credit supply.

45. A number of possible structural impediments to credit supply could be alleviated. The authorities have already initiated the process of reviewing the bankruptcy legislation, with a view to streamline inefficient and lengthy procedures. Further improvements to corporate accounting practices at SMEs would allow banks to lend against business plans rather than only against collateral. More realistic valuations of collateral would lower perceived risks by banks; these would require improved data collection and dissemination, particularly on real estate sales transactions. Finally, the interest rate cap, set at 8 and 10 percent above the policy rate for household and corporate loans, respectively, has led to a bunching of rates close to the ceiling and has likely negatively affected access to credit for riskier projects. In addition, the cap, which is reset every 6 months, could inhibit monetary policy transmission in an environment of rising rates.

Authorities’ views

46. The authorities largely concurred with staff’s analysis. They noted that in addition to the effects mentioned above, the interest rate cap may have raised lending rates across the board, as banks cannot properly differentiate risk by adjusting the price of credit. Recording and publishing real estate transaction data could technically be done by the cadastre, but would likely require a formal change to its mandate. The authorities noted, and staff agree, that while all of these measures could boost credit growth at the margin, the overall effects may not be large.

E. Capacity to Pay

47. Macedonia’s capacity to repay the Fund is adequate. Fund repayments (some €230 million in total) are concentrated in 2014–15 (Table 7); a €150 million Eurobond matures in 2015, and further bulky repayments are due on syndicated lending operations in 2016. The authorities noted that current domestic issuance plans will cover financing requirements for this year and part of next year. They saw external capital markets as open, with potential for bond issuance in the second half of 2014. Staff projects a modest accumulation of reserves in 2014 even in the absence of a sovereign bond issue, contingent on the realization of current public sector external borrowing plans and benign market conditions that would allow the rollover of short term external debt.

Table 1.

FYR Macedonia: Macroeconomic Framework, 2009–2018

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

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

The Road Fund was converted into the Public Enterprise for State Roads (PESR) in January 2013.

Total Public Sector (including MBDP, municipalities, public sector non-financial enterprises; w/o NBRM).

Table 2.

FYR Macedonia: Central Government Operations, 2010–2013

(Billions of denars)

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Sources: IMF Staff and MoF estimates.

Adjusted for transitional costs for the pension system and revenue from the repayment of loans, amounting to MKD 4,200 million and MKD 600 million respectively in 2013.

Note: Central government refers to the core government, plus consolidated extra-budgetary funds.
Table 2.

FYR Macedonia: Central Government Operations, 2010–2013 (concluded)

(Percent of GDP)

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Sources: IMF Staff and MoF estimates.

Adjusted for transitional costs for the pension system and revenue from the repayment of loans.

Note: Central government refers to the core government, plus consolidated extra-budgetary funds.
Table 3.

FYR Macedonia: Balance of Payments, 2009–2018

(Millions of euros, unless otherwise indicated)

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Sources: NBRM; and IMF staff estimates.