Mission Concluding Statement 

Former Yugoslav Republic of Macedonia: Concluding Statement of the 2015 Article IV Mission

July 8, 2015

July 8, 2015

An International Monetary Fund (IMF) mission visited Skopje during June 29-July 7 for the 2015 Article IV consultation discussions, part of the IMF’s regular surveillance of all member countries. At the end of the visit, IMF mission chief Jesmin Rahman issued the following statement:

GDP growth is expected to moderate to 3.2 percent this year but remain broad-based. Public infrastructure investment, robust credit growth, improving labor market conditions and strong exports continue to support growth; however, domestic political uncertainties and the crisis in Greece are likely to slow momentum as confidence weakens and some investors hold off investment decisions. A possible derailment of the recent political agreement and further deepening of the crisis in Greece pose significant downside risks to the outlook.

Rebuilding policy space and buffers to preserve macroeconomic and financial stability remains a priority. In particular: 

• Fiscal deficit is projected to reach 4.0 percent of GDP in 2015. This compares to 3.4 percent targeted in the budget. Under-performance of Value-Added Tax (VAT) and non-tax revenues, as well as wage increases for the police force and additional capital expenditures entailed by the worsened security situation, are likely to result in a higher deficit despite stronger-than-budgeted performance in profit tax revenues. The supplementary budget currently in consideration should identify compensating measures, including spending cuts in goods and services and subsidies, and collecting tax arrears, while any revenue over-performance should be saved to ensure a fiscal outcome broadly in line with the original budget.

• Fiscal consolidation should continue in line with the authorities’ medium-term objectives. FYR Macedonia entered the global financial crisis with one of the lowest public debt to GDP ratios in emerging Europe. However, since 2008, public debt has nearly doubled reflecting appropriate support for the economy, but also policy choices consisting of adopting a low tax environment and maintaining large social transfers. With recovery continuing, fiscal consolidation should target achieving a deficit below 3 percent of GDP by 2017 as planned. In the absence of any changes in the tax rates, the consolidation would require increasing VAT efficiency, which is low by regional standards, and reducing social expenditures and transfers based on a thorough public expenditure assessment.

• The plan to enshrine fiscal sustainability in a rule is a step in the right direction. The 60 percent of GDP debt ceiling should be complemented by a lower operational threshold or a debt brake so that fiscal policy can create adequate space to effectively counter shocks to the economy and absorb future spending pressures of an ageing population. Successful implementation of fiscal rules would also require strengthening institutional arrangements to support a robust medium-term budgeting framework, efficient control over public investment projects, and effective and transparent budget execution prior to adoption of the rule.

• The financial sector remains healthy. Banks, including the two Greek subsidiaries, are well-capitalized, highly liquid and increasingly funded by domestic deposits. Profitability has been on the rise along with broad-based credit expansion. Nonperforming loan ratios have stabilized at relatively low levels by regional standards and remain fully provisioned.

• Spillover risks from Greece to the financial sector are being closely monitored. Since 2010, the authorities have strengthened their supervisory framework and crisis management tools to contain possible spillovers stemming from Greece. Banks have been subjected to stringent provisioning requirements for holding low rated assets and to ex post notification for any significant transactions with Greece. In addition, the prudential regulation limits intra-group exposure to 10 percent of capital. Communication and exchange of information within the European Single Supervisory Mechanism (SSM) has intensified. Enhanced monitoring and prudential measures as well as effective communication currently in place are warranted to counter possible contagion effects from the Greek crisis.

• Monetary policy should remain vigilant against risks from excess liquidity in the banking system. Over the past two years, the central bank has used reserve requirements and low policy rate to appropriately support the resumption of credit growth and the de-euroization in the economy. In the current context, where credit growth is picking up and structural liquidity is sizable, the authorities should stand ready to start tightening monetary conditions, including using macro-prudential instruments, in case of a build-up of financial risks. This would also help preserve the ongoing process of de-euroization and ensure exchange rate stability.

A key challenge for FYR Macedonia going forward is to sustain recent gains in exports and FDI to raise potential growth. Financial incentives, competitive wages and improvements in business environment, have successfully attracted FDI and contributed to export diversification and employment. Going forward, structural reforms are needed not only to sustain these gains, but also to produce greater spillovers to the domestic economy. This would entail continued efforts to ensure easier access to credit for firms, shortening delays in collecting payments, including from the public sector, a more predictable legal and regulatory framework, boosting labor skills and reducing mismatches in the labor market, and further streamlining the role of the numerous inspection bodies.

We thank the authorities and other interlocutors for warm hospitality, and constructive discussions during the mission.