Republic of Kosovo: Selected Issues
Author: International Monetary Fund. European Dept.
Publication Date:
05 Feb 2018
eISBN:
9781484340509
Language:
English
Keywords:
ISCR; CR; Kosovo; lending; amount; EU grant; management framework; EU country; EU average; Kosovo gap; Capital spending; Capital budget; Private investment; Europe
Download PDF (557.7 KB)

Selected Issues

Abstract

Selected Issues

Public Infrastructure: Challenges and Opportunities1

In Kosovo, the pace of public infrastructure investment has been high in international comparison, but will not be enough to bridge the gap with the EU and regional peers soon. Given the very low initial stocks, largely due to the sharp depletion of capital stock during the conflicts in the 1990s, higher investment rates are needed. The resources available from international development partners, including the European Union (EU), the European Investment Bank (EIB) and the European Bank for Reconstruction and Development (EBRD), are a unique opportunity to leverage and accelerate the implementation of priority projects. Strengthening Kosovo’s investment framework is key to achieving this objective.

A. Public Investment in the Western Balkans

1. Accelerating economic convergence with the EU is a key objective. The Stabilization and Association Agreement (SAA), which came into force in April 2016, is the first step of the EU accession process. This formal process needs to be supported by actual progress on the ground to accelerate income convergence with the European Union (EU). The lack of public capital is one of the key reasons behind the slow economic progress and recent stagnation in narrowing the income convergence. Upgrading and expanding public capital stock are essential in achieving higher and sustainable economic growth.

2. Low stock and the poor quality of public infrastructure, in both the Western Balkans and Kosovo, largely reflect the troubled regional history. In the former Yugoslavia, basic public infrastructure developed later than in Western Europe and proceeded at an uneven pace. The historical political fragmentation of the region, including the disintegration of the former Yugoslavia into a number of independent states, explains a large part of the lumpy capital accumulation, particularly in Kosovo. The regional conflicts and social unrest that followed the disintegration account for a large part of the public capital stock depletion until the end of the 1990s when the Kosovo’s conflict ended.

3. Several international initiatives, largely supported by the EU and International Financial Institutions (IFI), have helped to accelerate the rebuilding of public infrastructure with a special focus on regional projects (Box 1). International community efforts have been substantial in the last 15 years. At the same time, the limited progress on the ground in the whole region has not reflected the international community’s political will and strategy; largely due to the multiplicity and fragmentation of donors’ financial instruments, lack of coordination among them, and limited capacity/commitment/ownership of recipient countries and ongoing domestic political fragility.

Western Balkans—Various Regional Initiatives

The Stability Pact for South-Eastern Europe (“Stability Pact”) was launched in 1999 as the first comprehensive conflict prevention strategy of the international community. The Stability Pact’s overarching objectives are fostering peace, democracy, respect for human rights and economic prosperity. The objective of a unified approach for the whole region was aimed at drawing support, including financing, from a wide coalition of IFIs, donors, and other international organizations. While a substantial progress on the ground was achieved over the years, the internationally-led approach to implementing the Stability Pact became obsolete in light of the need to have stronger recipient governments’ ownership. Therefore, the international community decided to transfer the Stability Pact expertise to a more collaborative body to ensure a greater ownership by recipient countries.

A regional Cooperation Council was established in 2008 as a successor to the Stability Pact. This Council is a more focused, streamlined, regional body with an increased role for recipient countries. In parallel, the EU adopted the Instrument for the Pre-accession Assistance (IPA), which replaced multiple pre-accession assistance instruments, to support candidate and potential candidate countries.

The Western Balkans Investment Framework (WBIF), established in 2009, coordinates support from the EU Commission, IFIs and bilateral donors. The WBIF is aimed at accelerating the implementation of priority investments that are in line with regional and national strategies by leveraging loans and grants. It is a blending financial mechanism with a grant facility and lending facility. Eligible projects are identified by country beneficiaries, based on each of their own priority project pipeline (Single Project Pipeline).

The WBIF framework will continue to play an important role in catalyzing available resources provided by donors and IFIs for the implementation of large infrastructure plans. Financial institutions, participating in the WBIF framework, would be able to leverage up to a 1.5 percent of the regional GDP per year of financing in the next 5 years (including the EU EPA II), assuming disbursements in line with the past. Even though these available amounts might look large, the actual disbursements will depend on progress made by each country in improving the overall project cycle, including preparation, selection, monitoring, execution, auditing and ex-post assessment. However, even assuming a speedy progress on all these fronts, these resources will be just enough to fund up to 50 percent of the estimated financing needs to close the estimated infrastructure gaps.

The Berlin Process is the latest regional cooperation initiative which follows the 5-year stalemate of the EU enlargement announced by the EU Commission. The Berlin Process was launched as a way to consolidate the Western Balkan countries’ integration policy dialogue. By bringing together all six Western Balkan countries and main EU member states supporting the region’s EU integration, the Berlin Process’s key objective is to strengthen each country’s accession prospects, despite the current temporary halt1. A natural focus of the integration remains regional infrastructure, in particular connectivity projects, which has been emphasized in the last four summits (Berlin, Vienna, Paris and Trieste). In the Trieste summit (July 2017), the EU committed an additional €190 million for connectivity projects and an action plan for establishing the regional economic area was adopted.

1/ President Juncker’s opening statement to the EU Parliament, October 22, 2014.

B. Kosovo’s Infrastructure Gap

4. Kosovo is characterized by insufficient transport infrastructure, very limited connectivity to the rest of the world, and inadequate and unreliable energy supply (Figure 1). Quantitative indicators—compared to the EU—indicate the inadequate coverage of motorways and railways. Airport capacity and power generation are also very low and insufficient to meet current and prospective demands. Insufficient public infrastructure has been one of the key factors impeding private sector development, economic growth and income convergence.

Figure 1.
Figure 1.

Kosovo: Public Infrastructure Gaps

Citation: IMF Staff Country Reports 2018, 031; 10.5089/9781484340509.002.A001

Sources: WDI database, International Road Federation, Eurostat, EIA, and IMF staffcalculations.1/ Gaps (indicated by a negative sign) are computed vis-a-vis EU average adjusted for population density.2/ Gaps (indicated by a negative sign) are computed vis-a-vis EU average.

5. Specifically, Kosovo’s public infrastructure situation is characterized by:

  • a) A weak railway and motorway density, which is well below that of peers. The railway network is limited and very obsolete compared to peers. Similarly, the motorway density is also inadequate, despite the sharp increase in new investments immediately after the independence and that are still ongoing2.

  • b) Power capacity is particularly poor in Kosovo. The existing power plants are insufficient to meet the current demand and provide reliable power supply (see Box 2). After more than a decade of negotiation, some progress has been made recently for the construction of a new plant; however, its actual operation is not expected to commence until 2023. The lack of reliable energy supply is one of the key obstacles to domestic and foreign investments. The 400 Kw interconnection between Albania and Kosovo—which would help to mitigate temporary supply fluctuations—was completed, but has not been activated yet.

  • c) Air transportation/utilization remains inadequate, but it is in line with regional peers. Cell phone connectivity and broadband appear to be broadly adequate, while phone land lines are well behind the EU average and other regions.

6. Infrastructure index gaps are significant in Kosovo as well as in the entire region. An infrastructure index3 has been generated for each country/year by putting together indicators discussed above. The index gaps are calculated as a distance from the EU average. The Kosovo gap is close to 60 percent, while it is slightly above the average 40 percent for the entire region. It is noteworthy to highlight that there is large variance among Western Balkan countries, ranging from Albania and Bosnia and Herzegovina at close to 60 percent lower than the EU while Serbia is only about 25 percent.

A01ufig1

Infrastructure Gap Index

Citation: IMF Staff Country Reports 2018, 031; 10.5089/9781484340509.002.A001

Sources: WDI, EIA, IRF, Eurostat, and IMF staff calculations.Note: Infrastructure Gap Index calculates the gap between a country’s infrastructure and that of an average EU member. In the following area’s railway density, motorway density, installed capacity for power generation, phone lines and cellular subscriptions, and air transport passengers. The index value ranges between 50 to −65 with a value of zero reflecting EU-28 average

Western Balkans’ Power Capacity—A Brief Snapshot

Solid fossil fuels dominate energy production. In Kosovo and Bosnia and Herzegovina, solid fuel production comprises more than 70 percent of the total energy production (about 90 percent in Kosovo). Domestic lignite amounts to more than 50 percent of the gross consumption of energy in Kosovo (69%), Bosnia and Herzegovina (64%), and Serbia (53%) and it is by far the most used and produced category of fuels. Despite this dominance of solid fossil fuels, there are positive developments in terms of introducing sources of renewable energy, largely hydro and biomass, even though from a low base.

In Kosovo and Albania, the current low power generation capacity is a binding constraint on the

economic growth and FDI attractiveness. In Albania and Kosovo, the lack of adequate energy supply is exceptionally pronounced, with generating capacity not exceeding 0.8 Kw per habitant, which is less than half of that in Slovenia and about one-fourth of that in Austria. While actual consumption is particularly low, the very high energy intensity (six times higher than in the EU)—calculated as consumption over the GDP—is a clear sign of poor energy efficiency.

In Kosovo, the power sector is dominated by two lignite power plants; Kosova A (551 MW) and Kosova B (620 MW), sourced with domestic lignite reserves. The three operating units of Kosova A, which are operating at about 65 percent of installed capacity, were commissioned in the early 1970s and were expected to be decommissioned by end-20171 in line with the Energy Community Treaty obligations. After several attempts over the last decade to prepare a viable project, the government announced the selection of a preferred bidder in November 2015 to construct a 500 Mw power plant, and entered into negotiations with a private foreign company, with the International Finance Corporation (IFC) as the transaction advisor.

The completion and activation of the 400 Kw interconnection between Albania and Kosovo will help to mitigate supply fluctuations. With the completion of the interconnection of Albania and Kosovo, it will be possible to move ahead with the merging of grids of the two countries, which in turn will facilitate their participation in the regional energy market. The complementary seasonal supply of both countries provides additional energy resources to both markets, which will help to mitigate temporary demand spikes and minimize the impact of unplanned outages. Unfortunately, legal and political obstacles, which are preventing Kosovo KOSTT (a Kosovo transmission company) from becoming a member of ENTSO-E2 and thus having control over energy trade in Kosovo territory, are delaying the operationalization of the integrated grid.

1/ Now these power plants cannot be decommissioned before 2023, when the new power plant is expected to be fully operational.2/ European Network of Transmission System Operators for Electricity.

7. Public infrastructure gaps are aggravated by the poor quality of the existing infrastructure. The World Economic Forum survey-based indicators4 seem to suggest that the quality is poor and that its actual condition is much lower than what has been measured by quantitative indicators. Even though there are no available data for Kosovo, we can easily assume that quality is at least comparable to that of other Western Balkan countries, which still ranks low compared to other EU regional groups.

A01ufig2

Quality of Overall Infrastructure and Public Capital Stock, 2015

(European Union average = 1)

Citation: IMF Staff Country Reports 2018, 031; 10.5089/9781484340509.002.A001

Sources: WDI database; IMF, FAD database; and IMF staff calculations.1/ WEF measures the quality based on surveys. Kosovo is not covered by the survey.
A01ufig03

Quality of Infrastructure

Citation: IMF Staff Country Reports 2018, 031; 10.5089/9781484340509.002.A001

WEF survey results. Kosovo is not covered by the survey. WEF survey results. Kosovo is not covered by the survey.Sources: WEF database, FAD database, and IMF staff calculations Sources: WEF database, FAD database, and IMF staff

C. Kosovo’s Development in Investment and Capital Stock

8. Since independence in 2008, the Kosovo capital budget has been large, both as a share of GDP and total spending. Since 2008, the annual capital budget has accounted for 9 percent of GDP on average, which is high compared to neighboring countries. In addition, infrastructure capital spending has accounted for roughly 35 percent of total public spending, with a rate of implementation close to 90 percent.

Figure 2.
Figure 2.

Kosovo: Public Investment and Capital Stock

Citation: IMF Staff Country Reports 2018, 031; 10.5089/9781484340509.002.A001

Sources: IMF, FAD Database; and IMF staff calculations.Note: CEE = Central Eastern Europe; CIS = Commonwealth of Independent States; SEE-EU = Southeast Europe EU members; SEE-XEU = Southeast Europe non-EU members.

9. However, expenditures on motorways absorbed the largest share of the capital budget. For almost the entire period following Kosovo’s independence, public capital spending was largely dominated by the construction of Route 7, connecting Pristina with the Albanian border (at a cost of about 20 percent of GDP), and Route 6, which links Pristina to the Macedonian border. The completion of the Route 6 project will take up much of the available fiscal space until 2019 (with costs estimated to be in the range of 10-12 percent of GDP).

10. While Kosovo’s capital spending has been relatively high, the overall capital stock has remained below the EU average and neighboring countries. The public capital stock is currently 20 percent below the average of Western Balkans countries, and 60 percent below the EU average. This reflects in part a very low starting position, as Kosovo was the poorest and least developed province in the former Yugoslavia. In terms of composition, the new infrastructure projects have been dominated by Route 6 and 7 construction.

11. The National Development Strategy (NDS) 2016-2021 outlines key priority areas to address bottlenecks to development. Following the adoption of a revised investment clause5 of the fiscal rule, which allows capital spending financed by donors not to count towards the deficit limits, the authorities are striving to strengthen their planning framework to take advantage of the newly available resources. In March 2016, the authorities adopted for the first time a priority project list 6, which forms the basis for mobilizing donors’ and developing partners’ financing. The total estimated costs are in the range of €850 million-€1 billion (15-20 percent of GDP). Of course, priority projects can be revised over time subject to political changes and domestic and external financing availability.

article image

Preliminary estimation of total project costs.

Source: Authority’s priority project list.

12. The public investment management framework, however, needs to be strengthened substantially to improve the efficiency of public spending on infrastructure. Public investment can be an important catalyst for economic growth, but the benefit of additional investment depends crucially on its efficiency. The Public Investment Management Assessment (PIMA)7 reports point to significant institutional weaknesses in public investment management practices. These weaknesses are more pronounced in some areas: (i) project appraisal, selection and management; (ii) national planning and central-local coordination, (iii) multi-year budgets and their comprehensiveness; and (iv) ex-post independent auditing and assessment of large-scale projects. At the same time, the reports acknowledge some progress such as the publication of the National Development Strategy and the single project pipeline, which have become the cornerstones of the government’s strategy in prioritizing projects and facilitating discussions and negotiations with donors and IFIs.

D. National Investment Frameworks

13. Kosovo’s list of priority capital projects fully recognizes the critical importance of addressing large infrastructure bottlenecks. In line with the WBIF process (Box 1), Kosovo established a National Investment Committee (NIC), which adopts and updates the priority project list as well as monitors its implementation. In the WBIF context, all Western Balkan countries submitted their own project pipeline, where the scale and focus of the national pipelines vary significantly among them (see chart). The focus is largely on transport infrastructure (especially roads and railways) and energy generation capacity.

A01ufig4

Strength of Public Investment Management by Institution

Citation: IMF Staff Country Reports 2018, 031; 10.5089/9781484340509.002.A001

Sources: FAD; PIMA database; and IMF staff calculations.

14. Two new loan agreements were signed with the EBRD and EIB for the rehabilitation of railway 10, complemented by EU grants, connecting Kosovo with Serbia and Macedonia and one IDA loan for the water supply project. However, the actual work on the ground is moving very slowly. The total disbursement until end of June 2017 has been disappointing, despite the large fiscal room under the revised fiscal rule’s investment clause.

15. In Kosovo’s case, preliminary estimates suggest that the completion of the rail and road projects alone would close a quarter of the current infrastructure gap. The implementation of the priority projects implies an overall increase in capital spending by 12-15 percentage points of GDP over the next 6-7 years (Section F). This higher capital spending would be able to reduce Kosovo’s overall public infrastructure gap vis-à-vis EU countries from 60 to 40 percent.

A01ufig5

Impact of Priority Projects 1/

(Infrastructure Gap Index, EU=0)

Citation: IMF Staff Country Reports 2018, 031; 10.5089/9781484340509.002.A001

Sources: WDI; EIA; IRF; Eurostat; and IMF staff calculations1/ Assumes BIH average costs of building one kilometer of rail and road infrastructure for all countries.

E. Financing Options

16. Choosing the most appropriate financing instrument is essential to maintaining debt sustainability. Kosovo’s debt position is currently low, at around 20 percent of GDP8, characterized by no foreign commercial loans, due to the lack of any access to the international market. Foreign debt consists of loans provided by IFIs and bilateral donors. Of course, the magnitude of the debt-to-GDP ratio reaction to a capital spending surge depends on the economic activity and tax revenue responses to the investment “stimulus”. This, in turn, depends on the governments’ capacity to prioritize productive investments and strengthen capacity absorption as well as identify the most suitable financial terms. The impact of a capital spending surge on these factors will be simulated and analyzed below.

17. The scaling-up of infrastructure spending is constrained by limited domestic savings. The capital budget has been largely dominated by Routes 6 and 7 construction and some fiscal space will be available when Route 6 is completed. The revised fiscal rule provides sufficient budgetary room, particularly for donor/IFI-financed investment projects.9 However, given the small size of the economy, a single large project might easily exhaust the entire fiscal space for a number of years (as in the case of Routes 6 and 7). Therefore, limited domestic saving, coupled with a shallow financial system, is not able to secure sufficient financing for large-scale infrastructure projects, without crowding out private sector investment.

18. Revenue mobilization and expenditure rationalization could further help to finance higher capital spending, but only at the margin. Mobilizing tax revenues and containing current spending could play a key role in creating enough budgetary room for higher capital expenditures. However, since 2015 when the Stand-by Agreement-supported program was approved, tax revenues increased by more than 2 percentage points, and current expenditures were frozen at around 20 percent of GDP, despite the need to accommodate a number of political electoral promises adopted ahead of the 2014 election cycle (e.g. introducing a war veteran pension and a 25 percent increase in public wages and pensions). The potential to increase the fiscal space through higher tax revenues and/or lower current spending exists, but it is quite limited, at least in the near future.

19. External commercial borrowing could play an important role in financing large projects when the availability of domestic resources is tight. External commercial borrowing, assuming Kosovo manages to get a reasonable credit rating, can provide the necessary funding for large projects, and free up domestic resources for private investments. However, new external debt also comes with refinancing, interest, and exchange rate risks. Therefore, the use of external financing should be balanced with the risk of building up unsustainable debt.

20. IFI financing remains the most suitable financing source. Given the lack of domestic savings and the risk to crowding out private investment, the burden of the infrastructure stimulus should be carried out by external official sources (IFI borrowing and bilateral donors). With favorable interest costs, longer maturity and grace periods, official financing is the most suitable financial instrument to fund capital projects, without crowding out private investment. In this context, IFIs could and should play an important role, by providing technical assistance in facilitating prudent project selection and preparation, streamlining internal processes, and catalyzing the involvement of private capital.

21. Diaspora bonds could be useful for tapping into the wealth of the diaspora community to finance infrastructure. Given the sizable and stable remittance inflows, diaspora bonds could contribute in mobilizing the wealth of relatively richer migrants, who have moved to richer EU countries. If the proceeds were to directly finance some key basic infrastructure projects, or benefit the diaspora community and/or their family, the chances of success in issuing diaspora bonds could be even higher. Diaspora communities could also facilitate FDI inflows from sending countries, given their insights on Kosovar investment opportunities and ways to ensure compliance with domestic regulation and legislation. Designing and managing a diaspora bond program could be challenging. There are sizable fixed costs largely for the assessment of risks, liquidity preferences and expected return of the diaspora community. Several countries have tried, but a large number have failed to issue diaspora bonds.

22. Private financing of public infrastructure could also be an attractive option, as long as a sound PPP framework is in place that limits fiscal risks. When fiscal space is limited and public sector capabilities are low, Public and Private Partnership (PPP) initiatives can be a viable option for mobilizing private savings, increasing efficiency and providing value for money. At the same time, a PPP approach could be quite complex and involve fiscal risks at all stages of the project cycle, including budget preparation, procurement, financing, and managing performed-based contracts. PPP initiatives usually generate large explicit and implicit contingent liabilities (e.g. guarantees), and encourage off-balance operations while reducing transparency. So far, public private partnership experiences have been marginal in the region and almost absent in Kosovo. Key factors behind this poor performance are various, including inadequate legal and institutional frameworks, perceived political risk, and governments’ limited capacity to make credible long-term commitments. The opportunity for scaling up PPP investments is a call for strengthening the PPP investment management framework.

F. The Macroeconomic Impact of Scaling-up Public Capital Spending

23. Higher public investments can generate benefits in both the medium- and long-term. In the short/medium term, output is affected by the increase in the aggregate demand stemming from higher public spending. In the long term, expanded and upgraded infrastructure raises the productivity capacity of the economy by increasing the coverage and quality of the existing capital stock. Of course, the overall macroeconomic effects depend on various factors, including the stage of the economic cycle, the efficiency of public investments and the range of available financing options.

24. The model-based approach can simulate the dynamic interactions of public investment, growth and fiscal stance. The role of the public capital is the model’s “engine”. In the long run, greater public capital stock supports higher output and raises the return on private capital and labor. Public finances are subject to budget constraints to ensure debt sustainability of the model. This constraint triggers the fiscal adjustment needed for any given investment buildup. In the short/medium run, however, the model allows for any fiscal gap between taxes and capital spending to be financed with borrowing.

25. Higher public infrastructure spending, together with a strengthening of the public investment management framework and concessional financing, will significantly increase potential output. The priority project list provides a useful framework for assessing the dynamics of key variables under different scenarios (Figure 3). The key assumption, which is the same under any scenario, is an exogenous increase in public investment by about 12.5 percentage points of GDP, over seven years.

Figure 3.
Figure 3.

Kosovo: Model-based Simulations Assuming a Public Investment Shock

Citation: IMF Staff Country Reports 2018, 031; 10.5089/9781484340509.002.A001

Source: IMF staff calculations.

  1. The domestic scenario assumes that the capital surge is entirely financed by domestic borrowing (domestic debt issuance largely absorbed by banks). Under this scenario10, the growth dividend is marginal, with less than a 0.1 percentage points increase in the annual growth rate compared to the baseline. The impact of higher investment spending on the aggregate demand is largely offset by lower private investment (crowding out) and compressed consumption, due to increased tax burden (e.g. VAT) needed for debt service. The debt burden increases more rapidly (above and beyond the 30-percent ceiling), with higher debt vulnerabilities throughout the foreseeable future.

  2. Under the “improved” policy scenario, the surge in public investment is associated with an improved efficiency in public spending (the rate at which investment is converted into productivity-enhancing capital) and a greater focus on regional connectivity projects (higher economic returns). Under this scenario, the growth dividend is somewhat higher but debt-related vulnerabilities11 remain high, despite the fact that the debt ratio is expected to decline.

  3. The concessional financing scenario assumes that the increased public investment is totally financed by an equal mix of donor grants and IFI financing. This is the most favorable scenario due to the better financial conditions of IFI financing (low interest rates and longer maturity), which will substantially reduce the need for higher tax rates to service the new debt. This could generate a long-term improvement in the level of real GDP per capita in the range of 3-3.5 percentage points above the current baseline.

G. Conclusions and Policy Implications

26. Kosovo faces significant public infrastructure gaps, which constrain private sector development. Scaling up public investment will raise GDP growth potential and accelerate income convergence toward the EU average level. The priority project list has helped the authorities to prioritize plans and facilitate the discussions and negotiations with donors and IFIs. However, implementation so far has been modest, despite the new investment clause of the fiscal rule exempting IFI-financed projects from the deficit ceiling.

27. The recently regained fiscal sustainability should be preserved. Scaling up infrastructure will be better funded through donor and IFI financing, which provides better financial terms and longer maturity. This option would reduce risks of private sector crowding out, while ensuring a better selection and vetting of projects. However, a weak public investment management framework will make more challenging any efforts to mobilize higher donor and IFI financing. Therefore, the following multi-pronged approach would help mobilize external financing, increase absorption capacity, accelerate project implementation, and improve the efficiency of investment:

  • Introducing a requirement for cost-benefit analysis, strengthening selection, planning, execution of priority projects, and ex-post auditing. The development of a priority project list is a step in the right direction, but the challenge is to prevent the addition of “politically” motivated projects with unclear economic impact.

  • Maximizing regional coordination, particularly in the WBIF context, will help increase expected returns on investment, improve the region’s investment attractiveness and European integration, while securing concessional financing and grants from the EU and IFIs.

  • Preparing multi-year budgets for investment spending to cover construction and maintenance costs, based on conservative assumptions. The medium-term expenditure framework should better reflect fiscal pressures from large scale capital projects.

  • Last but not least, modernizing the public procurement process. The adoption of e-procurement is an important step forward to ensure a more transparent and levelled playing field among all suppliers, which is essential to ensure adequate returns from spending and to tackle corruption.

Appendix I. An Index for Infrastructure Gaps1

1. Measuring infrastructure gaps is complex. Two key challenges are measuring the quality of infrastructure and aggregating different kinds of infrastructure. Aggregation is complex as different kinds of infrastructure can complement or substitute each other—for instance, railways can substitute highways or air transport. Country sizes and geographical features might imply various optimal infrastructure, which might differ across countries. The literature has not yet been able to reach a consensus on how to measure infrastructure gaps, with only some approximations to assess and compare some key features.

2. Infrastructure gaps are approximated by considering six key indicators reflecting the quantity of infrastructure. The infrastructure gap analysis focuses on a few infrastructure sectors with higher impact on growth. It includes transport infrastructure measured by the highway density, railway density, and air passengers per capita. Energy generation is measured by the installed capacity to generate electricity per capita. The telecommunication sector is estimated according to telephone and cell phone lines per capita, and broadband connections per capita. Each indicator is benchmarked relative to the EU average. A positive gap means the infrastructure of a country is above the EU average (and vice versa). Data limitation and lack of quality dimension are two shortcomings of the above approach.

Infrastructure gaps will be measured by the following:

Infrastucture gapi,j,t=[Indicator ji,taverage (Indicator j)EU,t−1]*100

Where: j = telephone/cell phone lines per capita, broadband subscriptions per capita, installed capacity to generate electricity per capita, air passengers carried per capita, highways per km2 after controlling for population density, railroad per km2 after controlling for population density

i = country name

For example, for installed capacity to generate electricity in Albania, the gap is the following:

Infrastucture gapElect., ALB,t=[Installed capacity to gen.⁢ electricityALB,tInstalled capacity to gen.⁢ electricityEU,t−1]*100

For highways and railroads, the gaps are calculated relative to the EU average, but adjusted for population density. The adjustment addresses the issue that countries with higher population densities have, on average, higher transportation infrastructure (motorway and railway) density. For example, the infrastructure gap for Albania is generated by comparing Albania motorway and railway density with the density of a theoretical Albania country in the EU. This country has the same population density as Albania, but is equipped with the average motorway and railway density characterizing the EU. The following is the infrastructure gap for highways in Albania:

Infrastucture gaphighways, ALB,t=[Highways per km2ALB,tHighways per km2(ALB)EU,t−1]*100

Highways per square kilometer (ALB) EU, t results from a simple regression of highways per square kilometer on population density over the EU average. Then the highways per square kilometer for Albania is projected using the estimated coefficients and Albania population density.

3. Aggregating different indicator gaps is also challenging. Aggregate infrastructure gaps are calculated using weights inversely related to the volatility of the indicator across time. The intuition is that infrastructure indicators are a combination of actual information and noise (Moore and Moore 1985; Moore 1983, 1990). Then, series with higher volatility are likely to have a higher noise component. Consequently, the aggregate gap is constructed using weights that are inversely related to the volatility of the indicator gap.

Aggregate infrastructure gapi,t=ΣjWj*infrastructure gapij,tWj=1Σistdi(infrastructure gapi,t)# of countries

where wi approximates the inverse of the standard deviation of each gap. When the indicator gap has high volatility, a low weight is given. When the indicator gap has a low volatility, a higher weight is given.

A robustness check of gaps using equal weights show similar results:

Aggregate infrastructure gapi,t=ΣjInfrastructure gapij,t6

The data sources for the infrastructure indicators are:

article image
Source: IMF staff estimates.

Appendix II. General Equilibrium Model1

1. A general equilibrium model—developed by Berg et al (2012)—was used to simulate a public investment surge. The model allows analysis of the interactions between GDP growth, public investment, and public debt. The key feature is the public investment-growth nexus. The model was originally designed for low income countries (LICs) and applied by IMF staff to emerging market countries as well. Western Balkan countries share several features of LICs such as significant remittances, limited financial development, and large IFI financing.

2. The model is a small open economy with two sectors. In this economy, the private sector produces tradable and a non-tradable goods. Both goods are made using private capital, public infrastructure, and labor as inputs. The model includes public and private capital, then depending on the productivity of public capital, public investment can increase output by stimulating private investment, but can also crowding it out. Agents can also import goods either to consume or produce capital. Private and public capital are produced using imported inputs and nontraded goods. There are two types of consumer: saver and hand-to-mouth consumer. There is a government that collects taxes on consumption and fees on public capital. Government funds are allocated to transfers or to build public capital.

3. The government has several alternatives to finance public investment, such as by increasing tax revenues, collecting fees on the use of public capital, borrowing domestically, externally, and externally at concessional rates (e.g. a mix of EU grants and IFI financing). The model ensures debt sustainability by allowing the tax rates to respond to public debt increases.

4. The model allows the assessment of the role of public investment frameworks and the productivity of the public capital. Public investment expenditures do not always increase the stock of public capital as part of the expenditures can be wasted, meaning that the government pays “X” amount but only a fraction of it helps to expand the public capital stock. The model allows analysis of this feature by taking into account different levels of public capital productivity and consequently different impacts on growth.

5. Simulations are calibrated to reflect the structural features of an average Western Balkan country. Main parameters include a real GDP per capita of 3 percent, based on the growth observed in 2006-16, a public debt to GDP ratio of 51 percent (average public debt for the region in 2016), an average tax rate of 18 percent, and a public investment to GDP ratio at 5.2 percent to match the average observed in the region in 2016. The real average domestic and external interest rates are assumed to be 7 and 5 percent, respectively. The efficiency of the public investment framework is calibrated based on Dabla-Norris et al (2011) and the productivity of capital is assumed to be 20 percent. This value is in the medium range of estimates by Dalgaard and Hansen (2005) and Foster and Briceno-Garmedia (2010).

References

  • R. Arezki, P. Bolton, S. Peters, F. Samama, and J. Stiglitz, 2016, From Global Savings Glut to Financing Infrastructure: The advent of investment platforms. IMF Working Paper.

    • Search Google Scholar
    • Export Citation

  • M. Babic and E. Primorac, 1986, Causes of the Growth of the Yugoslav External Debt, Soviet Studies.

  • Berg A. and others, 2012, “Public Investment, Growth, and Debt Sustainability: Putting Economic Consulting Associates 2015, South East Europe Gas Power Consortium, Interim Report –

    • Search Google Scholar
    • Export Citation

  • European Commission, 2014-2015, Instrument For Pre-Accession Assistance (IPA II) for Albania, Bosnia and Herzogovina, Kosovo, Macedonia, Montenegro and Serbia.

    • Search Google Scholar
    • Export Citation

  • Energy Community Secretariat – Annual Implementation Report for 2015 and 2016.

  • Epec, 2014, Overview of the PPP Legal and Institutional Framework in the Western Balkans, European PPP Expertise Centre, EIB, Luxembourg.

    • Search Google Scholar
    • Export Citation

  • European Court of Auditors, are EU cohesion funds well spent on roads? Special report N.5, 2013

  • European Investment Bank, 2016, The EIB Group Operational Plan 2017-19.

  • Holzner, M., R. Stehrer, and H. Vidovic, 2015. “Infrastructure Investments in the Western Balkans,”

  • International Monetary Fund (IMF), 2012, Together the Pieces,” IMF Working Paper 12/144 (Washington).

  • International Monetary Fund (IMF), 2014. “Is It Time for an Infrastructure Push? The World Economic Outlook (Washington).

  • International Monetary Fund (IMF), 2015, Making Public Investment More Efficient, Policy Paper (Washington).

  • International Monetary Fund (IMF), 2014, Legacies, Clouds, Uncertanties. The World Economic Outlook,

  • International Monetary Fund (IMF), (2008) Macroeconomic Consequences of Remittances (Occasional Paper 259)

  • O. Levitin, J. Milatovic and P. Sanfey, 2016, China and South-Eastern Europe: Infrastructure, trade and investment links, EBRD working paper.

    • Search Google Scholar
    • Export Citation

  • P. Sanfey, J. Milatovic and A. Krevis, 2016, How the Western Balkans can catch up, EBRD working paper N.185.

  • K. E. Smith, 2005, The European Neighbourhood Policy, Royal Institute of International Affairs (Chatam House).

  • Western Balkans Investment Framework, Annual report, various years.

  • European Commission, 2015, Evaluation of Western Balkans Investment Framework.

  • World Bank, 2017, Western Balkans Economic Report.

  • E. Zizmond, 1992, The collapse of the Yugoslav Economy, Soviet Studies.

  • International Monetary Fund, Yugoslavia Recent Economic Developments, 1980-19

1

Prepared by Giuseppe Cipollone based on the International Monetary Fund European Department Paper “Public Infrastructure in the Western Balkans: Opportunities and Challenges” forthcoming.

2

Route 7, which connects Pristina with the Albanian border, was the largest public infrastructure project completed after Kosovo’s independence, with the total cost of the motorway close to 20 percent of GDP. Route 6—connecting Pristina with the Macedonian border—is expected to be completed by early 2019 with an estimated total cost in the range of 10-12 percent of GDP.

5

New donor/IFI-financed capital projects will not count against the 2-percent fiscal rule deficit limit if (a) the government bank balance is at least 4.5 percent of GDP and (b) the underlying fiscal deficit is within the fiscal rule. This exemption is subject to a 10-year sunset clause and a debt limit (30 percent of GDP).

6

A slightly revised list was adopted in 2017.

7

Public Investment Management and Medium-Term Expenditure Framework, IMF April 2016 and June 2017.

8

This includes the bilateral official debt of the former Yugoslavia, which the authorities neither recognize nor track.

9

See footnote 5.

10

Model-based simulations are calibrated to reflect the Kosovo’s economic and structural features. A real GDP growth of 4 percent is assumed under the 2015 SBA arrangement, and it is not far from recent developments. The public debt to GDP ratio of 20 percent is in line with the current level, which includes the former Yugoslavia debt. The VAT is 18 percent, and the public investment to GDP ratio is set at 9 percent to match the average observed in the period 2008- 2016. The real average domestic and external interest rates are assumed to be at 7 and 5 percent, respectively. The efficiency of public investment framework is related to the PIMA assessment conducted by the Fund. Finally, the productivity of capital is assumed to be at around 20 percent. This value is in the medium range of estimates by Dalgaard and Hansen (2005) and Foster and Briceno-Garmedia (2010).

11

This is due to the assumed domestic bank financing, which is characterized by higher financing costs and shorter maturity.

1

See International Monetary Fund European Department Paper “Public Infrastructure in the Western Balkans: Opportunities and Challenges” forthcoming.

1

See International Monetary Fund European Department Paper “Public Infrastructure in the Western Balkans: Opportunities and Challenges” forthcoming.

Same Series

Other IMF Content

Other Publishers

Cover IMF Staff Country Reports
Republic of Kosovo: Selected Issues
Author: International Monetary Fund. European Dept.
Volume/Issue:
Volume 2018: Issue 031
Publisher:
International Monetary Fund
ISBN:
9781484340509
ISSN:
1934-7685
Pages:
59
DOI:
https://doi.org/10.5089/9781484340509.002

Kosovo: Public Infrastructure Gaps

Infrastructure Gap Index

Quality of Overall Infrastructure and Public Capital Stock, 2015

(European Union average = 1)

Quality of Infrastructure

Kosovo: Public Investment and Capital Stock

Strength of Public Investment Management by Institution

Impact of Priority Projects 1/

(Infrastructure Gap Index, EU=0)

Kosovo: Model-based Simulations Assuming a Public Investment Shock