Montenegro macroeconomic report October 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 continued through mid-2002, despite the establishment of the euro as currency, but has recently shown signs of dwindling. At the same time, 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 significant adjustment in the balance of payments probably reflects the fiscal correction, although data deficiencies should caution against strong conclusions. The banking system appears on a sustained path to recovery and has begun to grow after many years of decline.

Montenegro has successfully met conditions for approval of a World Bank Structural Adjustment Credit and is in good standing with the IMF under a three-year Extended Fund Facility. It has also largely completed the renegotiation of old foreign debt and has begun to service the restructured liabilities. At the same time, negotiations on a future model of economic cooperation between Serbia and Montenegro should serve to clarify economic competencies and aims to harmonize and improve economic relations between the two Republics. These issues should be resolved ahead of the adoption of a new Constitutional Charter for Serbia and Montenegro toward the end of the year.

Recent events

The Central Bank of Montenegro reduced reserve requirements on deposits to 50% on 23 October.
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.
Deal for the privatization of Jugopetrol Kotor signed on 11 October.
On 18 October, a tender concerning eleven hotels owned by HTP Ulcinjska Rivijera, HTP Budvanska Rivijera and HTP Boka was launched.
Tender for the privatization of Montenegro Bank was launched on 8 November.
The US Congress began to consider in October a USD 40 million aid package for Montenegro for 2003.
An IMF mission visited FRY (23.10. - 7.11.) to hold discussions for the first formal review under the Extended Financial Facility (EFF) supporting the government's 3-year program.
In the context of the IMF Extended Financial Facility, the EC on the 30 July adopted a proposal for further macro-financial assistance of up to euro 130 million for FRY out of which euro 75 million would be a grant. After negotiations in the beginning of November, some 10% would be targeted to Montenegro.
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 first tranche of USD 7,5 million should be disbursed by the end of November.

Wage and Price Developments

Prices, as measured by the cost-of-living index, increased at a steady rate of about 25 percent per annum through mid-2002 but prices stabilised during the summer months of 2002, and annual inflation has already fallen (September 2001-September 2002) to 15.5 percent (see Chart 1). Prices for services, which have been the main contributor to overall inflation, have been virtually stable for about 6 months. Meanwhile, nominal wages continue to be led by changes in the official "minimum wage", which last increased by 8.7 percent in August (Chart 2). Real wages have essentially remained at the same level over a 2 ½ year period (Chart 3).

Economic Activity

Overall industrial production is stagnant, but has been weighed down by electricity production. When electricity is removed from the index, the other sectors display an upward trend of over 5 percent per annum (Chart 4). The services sector has grown in importance over the same period, as indicated by improvements in tourism (Box 1). Central Bank's BOP data (www.cb-cg.org) indicate a 60 percent increase in international transportation revenues in the first eight months of 2002 relative to 2001, although domestic road activity seems to have returned to more normal levels after the reopening of Southern supply routes into Kosovo (Chart 5). Construction activity has recovered after the cold winter months and in September registered an increase of 16 percent on a year-to-year basis (Chart 5). Retail sales, as an indication of demand, also display an upward trend of about 10 percent per annum (Chart 6). Overall, these data would appear to be consistent with growth rates of about 3-5 percent estimated for 2001 and anticipated for 2002.

Box 1 - Tourism

Despite a near 10 percent drop in overnight stays, tourism revenues have increased by 26% during the first eight months of 2002 compared to the same period in the previous year (USD 92.3 million vs 73.2 million). This is due to a changed structure of tourists: the overall number of domestic tourists fell by 11%, whereas the number of foreign tourists increased by nearly 25%), a change in the composition of foreign tourists toward Western Europeans. In 2003, annual revenues will likely exceed USD 100 million, taking account of the fact that the season extended into October for the first time in many years. According to a Master plan (www.mturizma.cg.yu) published in November 2001 (and prepared by the Ministry of Tourism and DEG from Germany), Montenegro expects annual tourism revenues of some euro 500 million by 2010. Five regions have been identified to be developed (with an emphasis on Ulcinjska Rivijera) and hotel capacity will be increase from 37.000 hotel beds to 50,000. A new Tourism Law, to tackle the grey-economy tourism was adopted in July 2002 and should have a telling effect in 2003..

Fiscal Developments

Economic growth rates, and continuing inflation, have combined to produce increasing fiscal revenues in both 2001 and 2002. Central government taxes on domestic activity [1] have increased by 20 percent in both years (Chart 7). This should ensure that IMF targets for 2002 are comfortably met. However, expenditures on salaries are expected to be above target, largely as the result of an unanticipated increase in public sector wages in August. A comprehensive public sector wage and employment policy will need to be formulated in order to place public sector finances on a surer footing.

[1] This definition excludes taxes on international trade.

The social funds generally record a balance or a small deficit on a cash basis, so that the overall cash balance for the consolidated government (which includes the social funds [2]) is the same as the Central Government balance. The consolidated government accounts indicate significant adjustment in 2002 with expenditures falling to 24 percentage points of GDP in the first three quarters compared to 29 percentage points in 2001 (Chart 8). This has resulted in an improvement in the "structural balance" of the consolidated government, which is defined to exclude revenues from grant aid and privatisation and expenditure on foreign debt service, of 4 percentage points in the first three quarters of 2002 compared to 2001 (Chart 9). This should ensure that the government meets its target of reducing the structural deficit to below 4 percentage points of GDP in 2002 from close to 7 percentage points in 2001. The same structural balance measured about 10.5 percentage points of GDP in 2000. Following the completion of the Mass-Voucher Privatisation (MVP), privatisation activity has recently increased (Box 2).

[2] The Health Fund has probably increased accruals and requires significant reform.

Box 2 - Privatizations

On 11 October, the government concluded negotiations with Hellenic Petroleum for the sale of 54 percent of Jugopetrol Kotor and the largest Montenegrin privatisation to date was secured. Hellenic Petroleum won the preceding international tender with an overall offer of Euro 105 million (65 million in cash and 40 million in future investments). The cash has been disbursed but the government will only release one third of the proceeds for immediate budgetary use, retaining two thirds for investment in future restructuring needs and other costs associated with economic development and reforms.

In March 2002, the Government of Montenegro secured a 91 percent share in Montenegro Bank. After the restructuring of some claims and liabilities, the balance sheet of the bank was reduced to some Euro 45 million. The bank's operational balance has turned positive, and the bank has been operating since June under the Central Bank's license. The Government launched an international tender on 8 November 2002 in order to attract a reputable strategic foreign investor. The Government's full shareholding is for sale. The deal is scheduled to be completed by the end of January.

On 18 October, a tender concerning eleven medium-sized and large hotels (with room numbers ranging from 50 to 400) owned by HTP Ulcinjska Rivijera, HTP Budvanska Rivijera and HTP Boka was launched. Total beds in these hotels is almost 5,000, such that they represent almost 15 percent of total hotel-bed capacity in Montenegro.

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 about USD 40 million.

The Balance of services has improved (Chart 11) due to increased transport and tourism revenues, and tourism revenues have increased, despite a lower number of overnights stays during the season. Higher prices and a change in the composition of tourists can be presented as explanations (see box 1). Overall the current account deficit has fallen from 17 percentage points of GDP in the first eight months of 2001 to approximately 8 percentage points in 2002 in spite of a reduction of foreign assistance of almost 2 percentage points of GDP.

In October the Central Bank once again reduced reserve requirements on banks, from 60 percent to 50. The decreased reserve requirements and a growing number of deposits (Chart 12) are indicative of some renewed confidence in a banking system that is in the final stages of rehabilitation. A tender for Montenegro Bank was launched on 8 November (Box 2).

Developments in Relations with International Financial Institutions and Donors

The first formal review of a three-year an IMF Extended Fund Facility (EFF) took place at end-October and Montenegrin fiscal and reform targets were basically on track. Further economic conditions and a budget for 2003 are likely to be agreed in mid-November.

The EC on the 30 July adopted a proposal for further macro-financial assistance for FRY of up to euro 130 million in 2003, out of which euro 75 million could be in grants. After negotiations at the beginning of November, some 10% would be targeted to Montenegro. Final conditionality is expected to be agreed in mid-November.

On the 13 November, the Federal Parliament finally ratified a World Bank Structural Adjustment Credit (SAC) of US$ 15 million for Montenegro and the first tranche should be released by the end of November. This followed the satisfaction of first tranche conditionality in the areas of public expenditure management, pension fund sustainability, labour market reform, improving the business environment and energy sector reform that had always been completed in August.

Overall, the structural reform agenda for 2003 will emerge from the combination of these agreements and should become clear by end-November.

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