On behalf of the Kosovo authorities, I thank Mr. Sosa and his team for the productive discussions and the well-structured comprehensive report, which confirms the authorities' strong program implementation and ownership both under the SBA and the RSF. Given the strong fiscal outcome, the authorities will continue to treat the SBA as precautionary.
Recent developments
Kosovo’s economy demonstrated resilience in a challenging external environment with real GDP growth of 3.3 percent in 2023. Although lower than the 4.3 percent growth in 2022, which can mostly be attributed to weaker external demand in goods, the exports of services increased by 18 percent, continuing the strong performance in previous years. At the same time, due to higher nominal growth, the balance of traded goods to GDP improved slightly. Robust private sector demand and significant improvements in the execution of public investments were the primary contributors to sustained economic momentum. Positive developments were also recorded in the labor market, with increases in both employment and real wages.
Fiscal performance remains strong, with the budget balance showing further improvement. Budget revenues increased by 14.4 percent, with tax revenues maintaining solid performance. Within tax revenues, property tax collection, which is the main source of income for the local-level government, experienced a 33 percent rise. Additionally, there has been a marked improvement in the shift from border to internal tax collection. In 2023, internally collected taxes increased by 18.4 percent, compared to a 9.4 percent rise in border collection. This trajectory of revenue collection over recent years is a result of legal, policy and operational reforms undertaken by the authorities, as detailed below.
Budget expenditures increased by 13 percent, reflecting various changes in spending patterns across categories. Notably, compared with 2022, capital expenditures rose by 32 percent, increasing their share in the total budget from 16.6 percent in 2022 to 19.4 percent in 2023. This is a result of the authorities' efforts to enhance capacities and streamline procedures for budget planning, execution and monitoring of capital projects, in line with PIMA and C-PIMA recommendations. On the current spending, the implementation of the new wage law and the necessity to maintain a growing inventory of public sector capital assets, drove expenditures on wages and goods and services higher by approximately 18 percent each. However, this rise was partially offset by lower spending on subsidies and transfers. Consequently, current spending overall went up by 9 percent.
The budget deficit was 0.26 percent of GDP, down from 0.52 percent of GDP in 2022, thus still well below both the legally binding ceiling of 2 percent of GDP and program targets. This favorable fiscal outcome was primarily supported by higher revenues, prudent planning and budget execution. Public debt also declined to just above 17 percent of GDP from 19.7 percent the previous year. So far in 2024, revenues and expenditures for January-April are higher than the same period of 2022, and in line with budget expectations.
The banking sector continues to grow. Banks are well-capitalized, liquid, and profitable and asset quality and soundness indicators continue to improve. Compared with 2022, as of December 2023, total assets of the sector increased by 11.5 percent, with the outstanding loans balance experiencing a 13 percent rise. New lending to firms and households increased by 7 percent and 14 percent respectively, whereas non-performing loans remained below two percent, indicating effective credit risk management strategies. The overall increase in asset size, loans and deposits is continuing in 2024. It is pertinent to acknowledge that the tightening of monetary policy within the euro area pushed interest rates slightly higher.
Outlook and risks
Over the next three years, economic performance is expected to improve, with average GDP growth projected to be around 4.2 percent. In terms of contribution, no significant changes from current and past trends are anticipated. Private sector demand is likely to remain strong, while exports and investments will continue to be important sources of economic growth. Although much will depend on the external environment, inflation is projected to stabilize at around 2 percent.
On the fiscal front, expanded economic activity combined with additional measures to enhance tax collection is expected to result in higher revenues. During the next 3 years, total revenues are projected to grow on average by around 6 percent. Direct taxes are expected to grow faster, thus increasing their share while the trend of the shift from border to internal collection will continue. On the expenditure side, the authorities are committed to adhering to strict, prudent expenditure management principles and the implementation of all budget rules, including the deficit rule, wage rule, and debt rule. Total spending is projected to increase at a higher rate than revenues, primarily due to a higher execution rate of capital investments. As a result, the budget deficit is projected to be higher, but still below 2 percent of GDP.
The banking sector is expected to maintain its strong performance. While its balance sheet is projected to expand, additional risk management measures will be enforced, as detailed under structural reforms, to ensure quality growth and maintain soundness indicators.
While uncertainties persist, including those related to the external economic environment and regional and global geopolitical developments, short-term risks remain balanced. On domestic risks, as part of the overall approach to prudent fiscal management, the authorities, with the support of the SBA and leveraging the IMF's technical assistance report on using the Fiscal Risk Assessment Tool (FRAT), have started to produce fiscal risks analyses in the context of the annual budget, focusing on publicly owned enterprises, guarantees to sub-national governments, and other potential domestic risks as well as identify potential sources of risks from the external environment. A dedicated fiscal risk unit has been set up and is in charge of these tasks.
Structural reforms
As part of the government work program, reform efforts continued across sectors, including with the support of the SBA and RSF. To improve tax compliance, various measures have been taken. For example, with the entry into force of a new law on tax procedures as well as with the implementation of the previously adopted tax compliance action plan, requirements for taxpayers' registration have been simplified, the time required to claim tax refunds has been shortened, and penalties for not complying with the tax legislation have increased. For the coming period, the authorities aim to reduce the stock of outstanding tax debt, whereas on tax policy and legislation, with support from the World Bank, they are reviewing tax expenditures and proposing amendments to the Laws on Personal Income, Corporate Income, and Value Added Taxes, to strengthen the equity of the tax system and improve revenue mobilization. Further, in the context of the ongoing work to prepare a National Strategy on Preventing and Fighting the Informal Economy, Anti-Money Laundering and the Financing of Terrorism and Financial Crimes, a concept document that identifies key areas of needed changes to the law on AML has been prepared and the actual amendments to the law fill follow.
Guided by the PIMA and C-PIMA recommendations, the authorities aim to further strengthen procedures and systems to enhance public investment management, including by addressing procurement-related aspects through the revision of the procurement law. These actions are intended to improve the execution rate of capital projects, ensuring more effective and efficient allocation of public resources.
On the financial sector, the Central Bank of Kosovo (CBK) finalized a new Law on Banks that, among other, intends to improve licensing criteria, standardize operations, organization, and management, and strengthen, recovery, resolution, and liquidation in line with FSSR recommendations. Also, in line with the new organizational structure of the CBK structure, two deputy governors were appointed earlier this year. To further strengthen the financial sector's legal and governance framework, the CBK, with the support of the IFC, aims to finalize a new law on Microfinance Institutions by end-2024. Also, with the support of the World Bank, a new draft law on Payment Services is expected to be approved during 2024. Furthermore, leveraging the recommendations from the recent Fund Safeguards Assessment report, the CBK will continue with its efforts to further strengthen internal control systems, such as enhancing audit-related skills, and improve risk management practices.
RSF-linked reforms have already yielded strong results. Actions and reforms are focusing on strengthening the regulatory framework, mobilizing private capital, expanding green electricity generation, improving the efficiency of energy markets, and reducing air pollution and emissions.
With the support of USAID, the authorities successfully concluded the first competitive auction for constructing and operating a 100 MW solar photovoltaic plant. This auction saw participation of investors from many countries, with a consortium led by a Swiss construction company winning the bid. The project, valued at approximately €70 million, will be operational under a 30-year concession contract and a 15-year power-purchase agreement, setting a precedent for competitive mechanisms in Kosovo. The additional solar energy generation capacity is expected to be in place by 2026. Building on this success, the government plans to launch a competitive auction for 150 MW of wind generation. With continued assistance from USAID and support from the International Finance Corporation (IFC) as the transaction advisor, this initiative aims to attract significant private capital into wind-based generation through a PPP. Furthermore, procurement for an additional 100 MW of solar electricity generation capacity on the current public sector energy company (KEK) property is scheduled to begin in June. This project, with total financing of approximately €105 million, is supported by loans from KfW and the European Investment Bank (EIB), as well as a grant from the EU's Western Balkans Investment Framework (WBIF).
A new law promoting the use of renewable energy sources, fully transposing EU directives, was approved by Parliament on April 8. This law aims to modernize the energy sector, reduce carbon intensity, and increase energy efficiency. It establishes a general framework to attract private capital into renewable energy through competitive auctions, regulates the use of PPPs to expand green energy capacity, and sets market prices as the reference for regulatory purposes. The law also introduces feed-in premiums and tariffs, providing benefits to various renewable energy sources, including wind, solar, biomass, biogas, and geothermal energy.
In the financial sector, steps are being taken to monitor and report climate risks more effectively. In December, the CBK issued instructions to banks to standardize practices for monitoring and reporting climate-related data for their business clients, helping identify energy transition costs for exporting firms. The CBK has also joined the Sustainable Banking and Finance Network (SBFN) and is seeking membership in the Network of Central Banks and Supervisors for Greening the Financial System (NGFS) to advance its sustainable finance practices.