Republic of Montenegro
Monthly Macroeconomic Report
September 2002
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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 adjustment,
although data deficiencies should caution against strong conclusions in this regard. The
banking system appears to be 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. |
Introduction
The reform agenda in Montenegro has already established the euro as the currency, liberalized most prices (except for electricity), liberalized trade, and established the basic requirements of a market economy. A political impasse ahead of elections in October 2002 has halted the passage of new legislation but the Government has continued to implement already-approved reforms, including the introduction of a Treasury System at the Ministry of Finance, the preparation of share registers for companies, energy sector reform and bank restructuring and supervision. Many structural problems remain in the productive sector and data shortcomings, especially in the real sector and balance of payments, are endemic. Nevertheless this report will attempt to draw some conclusions on economy with two policy levers, fiscal and wage policies, as supported by a monetary policy that is chiefly aimed at improving soundness of the banking system.
Real Sector Developments
Despite the introduction of the deutsche mark (euro) as parallel currency in late 1999, prices continued to increase at a steady rate of about 25 percent per annum through mid-2002 (see Chart 1). This is largely explained by a progressive price liberalization of basic foodstuffs in 2001 and the lagged effect of large increases in charges for electricity (which doubled) and other services in late 2001 and early 2002.[1] The euro conversion of January-March 2002 may also have contributed to price increases but, in any event, inflation appears to have abated during the summer months of 2002, with expectations of a further deflation in September following on a net deflation in July and August.
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Large nominal wage increases in 2000 initially led to real wage increases of more than 20 percent, but these gains were more than eroded by a subsequent 15-month freeze in the minimum wage in the context of continuing inflation (see Chart 2).[2] A minimum wage increase in January 2002 saw real wages return to their early 2000 levels, and a further increase granted in August 2002 will only compensate for earlier price increases (see Chart 3). Therefore, real wages have essentially remained at the same level over a 2 ½ year period, and this is crucial to an open economy that does not have recourse to exchange rate policy to improve competitiveness. |
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Meanwhile, there have been some confusing signals about developments in the real economy. Industrial production, which had already decreased by some 40 percent during the 1990s, appears to have renewed its decline (see Chart 4). However, the apparent 30-percent decrease in the index in 2000-2002 is solely the result of a succession of electricity problems in 2001-2002 (see Box 1). The other sectors display an upward trend of about 5 percent per annum when electricity is removed from the index (see Chart 4).[3] The services sector has grown in importance over the same period, as indicated by an 85 percent increase in transportation activity in the early months of 2002 relative to 2001. Agricultural production also appears to be on an upward trend of about 5 percent per annum (see Monet 8, ISSP, March 2002). Overall, these data would appear to be consistent with growth rates of about 3-5 percent estimated for 2001 and anticipated for 2002.
Fiscal Developments
These growth rates, and continuing inflation, have combined to produce increasing fiscal
revenues in both 2001 and 2002. Central government taxes on domestic activity[4] have increased by 20 percent in both years (see Chart 5) and have contributed to an
overall improvement in the performance of the Central Government budget. This should ensure that targets
for 2002 are exceeded. The budget is expected to record a surplus of some Euro 17 million for the year,
against a budgeted deficit of Euro 5 million (see Table 1). This Euro 22 million improvement is largely
the result of delays in the conclusion of international debt agreements that left foreign debt servicing
some Euro 15 million below expected requirements. At the same time, foreign financing for the budget
will also be Euro 15 million below target, but the additional budget surplus should ensure that the
government exceeds (by Euro 7 million) the target set by the IMF of repaying Euro 17 million to the
domestic banking sector.[5] Privatisation revenues are expected to meet their targets, mainly as the result of the
successful sale of Jugo Petrol Kotor (JPK, see Box 2) in early October.
The first year of operation of the Treasury system has preserved the cash-based integrity of the budget (as outlined above) but there may have been some increase in accruals, especially reflected in a shortfall in cash expenditure on materials and services (see Table 1). On the other hand, a shortfall in expenditure on some transfers and subsidies will instead be met by some spending units that were slower to come into the budget than had been anticipated, and this factor is also reflected in the shortfall in the "own revenues" of these units recorded on the other side of the budget. Expenditures on salaries are expected to be above target, largely as the result of an unanticipated increase in public sector wages in August, and such overruns do not bode well for an already-bloated public sector. More generally, a comprehensive public sector wage policy will need to be formulated in order to place public sector finances on a surer footing.
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 is the same as the Central Government balance[6]. This is because the central government effectively makes transfers to the social funds as they are needed. The consolidated government accounts, which include the social funds, indicate significant adjustment in 2002 however, with expenditure falling to 20 percentage points of GDP in the first six months compared to 27 percentage points in the first six months of 2001 (see Chart 6).[7] 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 5 percentage points in the first six months of 2002 compared to the first six months of 2001 (see Chart 7). 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.
Balance of Payments Developments
This significant fiscal adjustment, combined with relatively stable real wages, has produced a substantial improvement in the current account of the balance of payments in 2002 (see Table 2). The current account deficit fell from 10 percentage points of GDP in the first seven months of 2001 to 6 percentage points of GDP in the first seven months of 2002 and the current account deficit for the year should fall to about 4 percentage points. This likely improvement of 4 percentage points compared to 2001 was badly needed, as the levels recorded in 2001 could likely not have been sustained. At the same time, the large net errors and omissions that "finance" the current account deficit probably include many unrecorded current account transactions, most notably unrecorded transfers.
Exports have grown by 35 percent in the first seven months of 2002 compared to the same period in the previous year and much of this is due to increased exports to Serbia. At the same time, imports have fallen slightly (while imports from Serbia have increased). Tourism revenues have increased, despite a near 10 percent drop in overnight stays over the summer months. Increased tourist prices served to reduce the number of domestic tourists while overseas tourist nights increased by 25 percent. The current account improvement in 2002 was recorded in spite of a slowdown in foreign aid transfers.
Developments in Money and Banking
The growing number of deposits is indicative of some renewed confidence in a
banking system that is in the final stages of rehabilitation. There are now 10 licensed
banks in Montenegro and 3 branches of Serbian banks. Two domestic banks and 2 branches of Serbian banks
were placed in bankruptcy during 2002 and the government took over the largest domestic bank, Montenegro
banka, with a view to rapid privatisation (see Box 3). A second bank with overseas investment was opened
in September 2002.
Meanwhile, the Central Bank reduced reserve requirements on banks from 80 percent (of the average amount of deposits held over the previous two weeks) to 70 percent in March 2002 and to 60 percent in June.[8] As a result, statutory reserves declined from Euro 65 million in January to Euro 43 million in June. Further cautious reductions in reserve requirements could be expected, but only as the supervisory capacity of the Central Bank further improves and the inflation rate abates.
Developments in Relations with International Financial Institutions and Donors
The third review under an IMF Stand-By Arrangement was successfully completed in May 2002 and a new three-year Extended Fund Facility (EFF) with the Federal Republic of Yugoslavia was approved soon afterwards. The new programme envisages the implementation of substantial structural reforms in both Serbia and Montenegro, in association with other donors, and would place fiscal and monetary policies on a sustainable path. A mid-year informal review by the IMF noted that the program was broadly on track and a forthcoming formal review at end-October is expected to reach the same conclusion on Montenegrin fiscal and reform targets. For its part, the Government of Montenegro endorsed the EFF in April, with the proviso that there may be a need to adjust the programme at the time of the first review (in October/November 2002) in line with the new constitutional agreement on the future of Serbia and Montenegro. The EFF document recognizes that it may be necessary to undertake "changes to policies and programme conditionality, to reflect the evolving constitutional framework…"
In tandem with the successful implementation of the IMF agreement, the debt consolidation process for the old debt of FRY has proceeded. World Bank debt has been divided between the two Republics and Montenegro has agreed a separate Debt Consolidation Loan with the World Bank that fully paid off its liabilities of US$ 242 million. The new loan will be repaid over an extended period, at preferential rates, and debt service has been fully provided for in the 2002 budget and is envisaged for succeeding years' budgets. Montenegro's share of Paris Club debt, which was substantially reduced and settled in broad terms with official creditors at the end of 2001, will amount to a maximum of about US $150 million. At present, bilateral agreements with official creditors are being finalized and this process will determine the ultimate amount. As regards the London Club of commercial creditors, a final agreement will probably not be reached until the end of 2002 but, in any event, Montenegro's share in this debt is not likely to be substantial. This contrasts with the large share (of about 10-15 percent) of World Bank and Paris Club debt that was apportioned to Montenegro. Debts associated with specific enterprises or institutions were allocated to the territory on which that enterprise or institution resides and debt that could not be allocated on this basis (so-called "non-allocated debt") was apportioned by percentage.
A World Bank Structural Adjustment Credit (SAC) for US$ 15 million was negotiated and agreed at the end of May 2002 and was approved by the Executive Board of the World Bank in August. This followed on 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. The credit is still pending final approval by the Federal Parliament before the tranche can be released. A second tranche is set for approval in late-2002.
Negotiations on other World Bank projects have also been completed; including an Export Finance Facilitation loan that could make some US$ 20-30 million available to FRY (possibly augmented with donor co-financing) that would be administered by a new Export Credit Agency. A Trade and Transport Facilitation project aims to update customs and border posts, including infrastructure, with a view to easing cross-border trade. An Energy Sector Loan of US$ 5 million has been successfully negotiated and a coastal water treatment credit of US$ 2 million is being implemented.
An Interim Poverty Reduction Strategy Paper (IPRSP) was submitted to, and approved by, the Executive Boards of the World Bank and IMF during the summer of 2002 and preparations for the development of a full PRSP are well under way. The Government hopes to complete the full PRSP in early 2003. This extensive exercise will elucidate the government's strategy for poverty reduction, in consultation with civil society.
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