Press Release No. 15/31

Press Release: IMF Executive Board Concludes 2014 Article IV Consultation with Montenegro

February 4, 2015

On January 23, 2015 the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Montenegro.¹

Economic momentum slowed in 2014, but growth is expected to accelerate in 2015, aided by expenditures on the highway project. Nonetheless, Montenegro is vulnerable to a downturn in external demand, and substantial financing needs expose the country to shifts in risk aversion and disruptions to global financial markets.

The authorities have undertaken bold fiscal adjustment over the past years, reflecting a combination of tax hikes, pension freezes, and efforts to increase tax compliance. Measures in the draft 2015 budget that partly offset the extra spending on the highway are welcome, but a sustained period of fiscal discipline will be needed nonetheless. Laying out clear and credible long-term plans for managing the public finances, including savings on pensions and the public sector wage bill, would boost credibility and reduce risks to market access. In addition, the authorities should define contingency measures to address unforeseen fiscal shocks, with the first recourse being a delay or cut in highway spending.

Addressing non performing loans and improving credit conditions are priorities. The “Podgorica Approach” has the potential to facilitate debt workouts; this effort should be complemented by reforms to address problems with contract enforcement and securing collateral. Although provisioning coverage for the banking system as a whole appears sizable on a regulatory basis, the wide variation across banks may warrant enhanced supervisory scrutiny. There is scope to improve transparency, including by publishing quarterly banking reports with information on the level of regulatory provisions and all stress test results.

Structural reforms are essential to raise potential growth and improve flexibility and competitiveness. Bolstering the economy’s ability to respond to macroeconomic shocks is especially important in a country lacking its own currency and with decreasing fiscal buffers. Measures to ensure that wages adjust in line with productivity developments and to reduce disincentives for employment would improve labor market outcomes. Sustaining recent policy momentum to strengthen the business environment and spur investment is also critical to broaden the economic base.

Executive Board Assessment²

The directors noted that moderate growth continues, but the outlook remains challenging, and risks weigh on the downside, including from external spillovers. Against this backdrop, Directors underscored the need for continued fiscal discipline, further efforts to strengthen the banking sector, and comprehensive structural reforms to address macroeconomic vulnerabilities and spur growth.

Directors commended the authorities’ efforts to address fiscal imbalances in recent years. While recognizing the potential impact on economic growth, they noted that the Bar-Boljare highway project places a large burden on public finances and exacerbates debt and financing risks. Directors underscored that the underlying fiscal restraint embedded in the 2015 budget needs to be sustained to contain fiscal risks and ensure debt sustainability. In this context, they encouraged the authorities to lay out a clear long-term consolidation strategy, including further measures to reform the pension system and reduce the public-sector wage bill. Directors stressed that contingent fiscal measures should be identified to address unanticipated shocks. They welcomed ongoing efforts to reduce support to state-owned entities, and called for the timely completion of the sale of the aluminum producer KAP.

Directors observed that banking system health indicators are mixed. Capitalization has improved and liquidity appears sufficient, but profitability has been weak and the large stock of non-performing loans burdens balance sheets and impedes lending. They agreed that improving credit conditions is a top priority, and welcomed the draft law on voluntary financial restructuring. Reforms to bolster contract and collateral enforcement are also needed. Directors agreed that the wide variation of provisioning coverage across banks warrants a strong supervisory scrutiny over banks’ classification and collateral valuation practices. They saw merit in taking steps to enhance regulatory transparency and reporting.

Directors underscored the importance of reforms to boost competitiveness and economic flexibility. They emphasized that improving labor market outcomes is necessary to boost growth potential and help contain long-term fiscal pressures. Lasting improvements require measures to ensure wages adjust in line with productivity and to reduce informal employment incentives. Directors also encouraged the authorities to sustain progress in improving the business and investment environments so as to promote economic diversification and boost long-term growth.