Public Information Notice No. 11/105

Public Information Notice: IMF Executive Board Concludes 2011 Article IV Consultation with the Republic of Kosovo

August 1, 2011

On July 6, 2011, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Kosovo.¹

Background

Kosovo enjoyed robust economic growth in the 2000s and weathered the global financial crisis well, owing to limited integration into global financial and goods markets. The economy is expected to grow by more than 5 percent in 2011, up from 4 percent in 2010, supported by continued large remittances inflows from the Kosovar diaspora, robust credit growth, especially to households, and higher public spending, including on infrastructure projects. Inflation follows closely price developments for imported food and gasoline, triggering deflation in 2009 and double-digit inflation in early 2011, but core inflation has remained well-behaved. While credit growth has moderated, banks’ portfolio quality has deteriorated only modestly and profits have remained high. Large capital buffers suggest banks—which are mostly foreign owned—have ample shock-absorbing capacity.

While Kosovo pursued a conservative fiscal policy during most of the 2000s, since 2008 the government has moved to an increasingly expansionary stance, financing the resulting deficits from accumulated savings, the sale of assets, and donor support. As a result, the general government balance shifted from a surplus of more than 7 percent of GDP in 2007 to a deficit of 2.6 percent in 2010. Capital spending has been the main driver of this expansion. Last year, construction started on a highway connecting Pristina with Albania’s border, with total costs estimated at more than 20 percent of annual GDP spread over a period of 4 years. In 2011, the government increased public sector wages and benefits for war invalids and their families by 30 to 50 percent.

An 18-month Stand-By Arrangement (SBA) was approved by the IMF Executive Board on July 21, 2010. The program supported by the SBA was built around (i) restraint on current spending, higher revenues and privatization receipts to contain the impact on the investment program on the overall deficit, and (ii) bolstering the government’s deposits with the Central Bank to build buffers for fiscal and financial contingencies. The 2011 budget adopted by the newly constituted Assembly deviated from the budget agreed in the context of the SBA, notably the large public sector wage increases. As a result, no review under the program could be completed.

Executive Board Assessment

Executive Directors welcomed the progress made by the Kosovar authorities in building key social and economic institutions. Nevertheless, further efforts are necessary to enhance competitiveness, ensure fiscal sustainability and safeguard financial stability.

Directors highlighted the need to reorient Kosovo’s growth model, especially to address the uncertain prospects of remittances and Foreign Direct Investment (FDI), which have so far supported growth. Going forward, policies should focus on enhancing competitiveness to foster the emergence of a tradable sector that can drive economic development and self-sustained growth, and help reduce unemployment. To this end, it will be critical to upgrade public infrastructure and education, improve the business climate, and maintain competitive wage levels.

Directors noted that while the unilateral adoption of the euro provides a strong monetary anchor, it also increases demands on macroeconomic management. A premium should be placed on disciplined fiscal policies and flexibility to adjust to external shocks.

Directors noted that Kosovo’s shift to an expansionary fiscal stance since 2008 was unsustainable. They stressed that improving fiscal management is essential to maintain fiscal sustainability. For the near term, Directors urged disciplined budget execution and public financial management. This should include prudent wage policies, and a careful design and sequencing of social and capital spending initiatives, with thorough assessments of the resulting fiscal costs and compensating savings measures as needed. Over the medium term, it will be critical to reorient fiscal priorities, including by raising more revenue from direct taxes.

Directors welcomed the progress on developing Kosovo’s financial system. They noted that a strong institutional framework, especially improved legal capacity and defined property rights, will be crucial to safeguard financial stability. Passage of the new banking law will be an important step in this direction. Building the capacity to provide emergency liquidity assistance to the banking system is also a priority and the authorities should undertake measures to make this operational.

Directors welcomed the agreement reached on the staff-monitored program (SMP). They underscored that steadfast implementation of policies under the SMP would allow Kosovo to take decisive steps towards ensuring fiscal sustainability and pave the way for a future Fund-supported program.