Montenegro macroeconomic report November 2002

Summary: The economy still exhibits signs of moderate growth, although much of this growth probably pertains to the grey economy and is difficult to assess. Inflation has recently demonstrated that it is abating and nominal wage increases have lagged price increases and maintained real wages at about the same level for two and a half years. The fiscal sector has undergone substantial adjustment, largely as the result of lagged increases in nominal wages and benefits in the context of high inflation (and, therefore, revenues), but needs further adjustment to achieve a sustainable footing. A substantial further adjustment is envisaged in the budget for 2003, although increased debt service costs and transfers to the new Union budget have mitigated the overall effect of controlled expenditures. A comprehensive wage policy will be required in order to implement the budget for 2003.

Montenegro has successfully met conditions for approval of a World Bank Structural Adjustment Credit and has reached ad referendum agreement with IMF staff on financial targets and structural measures to be undertaken in 2003-2005. These agreements, combined with undertakings to the EU and USAID in the context of budget assistance, have set the reform agenda for the coming years. At the same time, negotiations on a Constitutional Charter for Serbia and Montenegro have been completed and should serve to clarify economic competencies and harmonise and improve economic relations between the two Republics. The new Constitutional Charter for Serbia and Montenegro should be adopted toward the end of this year or early next year.

Recent events

Amendments to the Law on Off-Shore Banks, approved by Parliament in early-November, will remove the special status afforded to these banks, making them subject to Central Bank supervision and regulatory requirements.
Parliament approved the final execution of the budget for 2001.
On 13 December, a draft Budget for 2003 was forwarded to parliament (see approved budget for 2003).
The tender for the privatization of Montenegro Banka moved into its final stages, following the expiration of the deadline for preliminary bids on December 6.
On 15 November, the education strike was called off.
On 13 November, the Chamber of Citizens of the Federal Assembly ratified a World Bank Structural Adjustment Credit (SAC) of USD 15 million for Montenegro (that was approved by the board of World Bank in August). The credit of USD 7,5 million still needs to be ratified by the Chamber of Republics. In the meantime, the Parliament of Montenegro has approved the necessary counter guarantee.

Wage and Price Developments

Prices, as measured by the cost-of-living index, have now been virtually stable since June, and the annual rate of inflation fell to 15.1 percent in October from about 25 percent per annum in mid-2002 (Chart 1). The rate of inflation from December 2001 to October 2002 was 8.6 percent. Prices for services, which were the main contributor to overall inflation in 2001 and early 2002, have been virtually stable for nine months.

Meanwhile, nominal wages are expected to have been steady for the past few months, reflecting the fact that there has been no change in the official "minimum wage" since August (Chart 2), but current average wage data is not available due to a delayed change in methodology. The real minimum wage is still at the same level as in early 2000 (Chart 3).

Economic Activity

Industrial production increased by almost 30 percent in September and October, but this increase was largely due to a return to full production in the electricity sector. When electricity is removed from the index, the other sectors have continued to display an upward trend of over 5 percent per annum (Chart 4). Construction activity in August and September was about 15 percent above levels recorded in the same months of last year, while effective hours worked were recorded at about the same level as last year, and road transportation is recovering slowly after the reopening of southern routes to Kosovo (Chart 5). Retail sales suffered a seasonal decline in September but the annual trend growth is still measured at about 10 percent (Chart 6).

Fiscal Developments

Fiscal performance has progressively improved during 2001 and 2002, and Central Government taxes on domestic activity (see footnote) have increased by 20 percent in both years (Charts 7, 8 and 9). This should ensure that IMF targets for 2002 are comfortably met.

The draft Budget for 2003 (Table 1), as negotiated with the IMF, envisages that:

Taxes will grow slightly in percent of GDP, due to improved efficiency in tax collection and the introduction of VAT after the first quarter of 2003, but that taxes previously ear marked for the social funds will accrue directly to the government (before transfer to the social funds)
Overall current domestic expenditures will decline in percent of GDP, with a constant relative level of net salaries and benefits
The budget deficit (before privatization and grants) will be contained at about 5 percentage points of GDP
Transfers for Union expenditures and debt service will increase by about 3 ½ percentage points of GDP, such that
the underlying structural domestic balance (measuring the impact on the local economy) will need to tighten by 3 ½ percentage points of GDP and will be in surplus by almost 4 percentage points of GDP in 2003.

The tight budget aims to address a number of underlying structural problems that have been identified in some recent studies. A World Bank Public Investment and Expenditure Review pointed to public sector wages and expenditures on services such as education as being higher than regional averages. It suggested that a comprehensive public sector wage and employment policy would need to be formulated in order to place public sector finances on a surer footing. In response, and in order to help implement the budget agreed with the IMF, a review of public sector wages and the labour market was undertaken by a European Union project on Government Expenditure Management in November. This clearly identified some areas that need to be quickly addressed (Box 1).

Developments in Trade and Banking

Exports of goods have grown by 36% in the first eight months of 2002 compared to the same period in the previous year; largely reflecting increased exports to Serbia. After eight months of 2002, exports had already reached the same amount as for the whole of 2001 (Chart 10). Imports have fallen slightly compared to the same period in 2001. This is largely due to a significant decrease in imports of petroleum and oil derivatives while imports of other products increased. The Balance of services has improved (Chart 11) due to increased transport and tourism revenues and the current account deficit fell from 17 percentage points of GDP in the first eight months of 2001 to approximately 8 percentage points in the same period in 2002.

Sight deposits at banks appear to have levelled off (Chart 12), pending some further restructuring in the banking system. On 6 December, the deadline for initial bids in the sale of Montenegrobanka to a foreign strategic investor saw the tender procedure enter the final phase, which should be completed by the end of January 2003. The destiny of Beranska Banka is close to resolution.

Developments in Relations with International Financial Institutions and Donors

The first formal review by the IMF Board of a three-year IMF Extended Fund Facility (EFF) should take place in January following negotiations in October and November which found that fiscal and reform targets were basically on track. Further economic conditions and a budget for 2003 were agreed. This agreement, in conjunction with understandings reached with USAID, the EU and the World Bank, has established the overall structural reform agenda for 2003-2005, as presented (with time-tables for implementation, see Conditionality.xls) in the following chart. On November 5, the Council of the European Union adopted a proposal for further macro-financial assistance for FRY of up to euro 130 million in 2003, comprising a loan facility of up to euro 55 million and a grant facility of up to euro 75 million. After negotiations at the beginning of November, some 10 percent would be targeted to Montenegro. The World Bank Structural Adjustment Credit of US$ 15 million for Montenegro still awaits ratification by the Chamber of Republics of the Federal Parliament, despite being approved by the Board of the World Bank in August.