Press Release No. 23/391

IMF Reaches Staff-Level Agreement on the First Review under the Precautionary and Liquidity Line and Conducts Discussions of the 2023 Article IV Consultation with North Macedonia

November 14, 2023

• IMF staff and the authorities have reached staff-level agreement on the First Review under the Fund’s Precautionary and Liquidity Line, subject to approval by the IMF Executive Board. Upon approval, North Macedonia will have access to around SDR161.35 million (around €200 million at current exchange rates.) The authorities intend to draw some three quarters of this and treat the rest as precautionary.
• The agreement supports the authorities’ intentions to continue reducing budget deficits, rebuild fiscal buffers, fight inflation, and safeguard financial stability. Beyond macro-financial stability, improving living standards will require boosting investment, raising productivity growth, and accelerating the green transition.

Skopje, North Macedonia: An International Monetary Fund (IMF) mission, led by Mr. Jacques Miniane, visited Skopje during October 31–November 13, 2023, to discuss economic and financial policies in the context of the first review of the Precautionary and Liquidity Line (PLL) and the 2023 Article IV consultation with North Macedonia. At the end of discussions, the mission issued the following statement:

“The economy of North Macedonia continues to recover from last year’s European energy crisis. After strong economic growth in the first half of 2023, IMF staff project the economy to expand by 2.3 percent this year and by 3 percent next year. In particular, domestic demand is projected to accelerate going into 2024, supported by the scale-up in public investments such as the Corridor 8/10d road project. The external trade balance has also improved significantly relative to last year, helped in part by the sharp decline in global energy prices. This, together with resilient foreign direct investment, is supporting international reserves, which remain at adequate levels. Risks to the outlook are obvious however, and include global geoeconomic fragmentation, the intensification of regional conflicts, and potential volatility in global commodity prices.”

“IMF staff supports the authorities’ intentions to reduce the budget deficit next year. This year, we expect the authorities to meet the nominal budget target (equivalent to 4.7 percent of GDP), supported by recent solidarity tax and tax policy reform. Looking ahead, we fully support the government’s intention to propose a budget consistent with a fiscal deficit of 3.4 percent of GDP in 2024. Fiscal consolidation is challenging, but there are three reasons why the government is right to pursue a lower deficit next year. First, it will facilitate the transition towards the 3 percent of GDP deficit ceiling required by the Organic Budget Law. Second, it is important to build fiscal buffers to help face increased global uncertainty and any crisis that could stem from it, or in case the large Corridor 8/10d road project ends up costing more than projected. Finally, fiscal consolidation will work hand in hand with monetary policy to further reduce inflation. To support fiscal consolidation, it will be key to:

· Keep current spending contained. In particular, the government and unions have a key role to play in advancing prudent policies and keeping spending at sustainable levels ahead of the elections. In this context, wage increases next year should not exceed what has already been agreed in the general collective agreement.

· Further reduce energy subsidies. While increases in electricity tariffs have impacted households’ budgets, electricity tariffs remain highly subsidized in North Macedonia, they are not targeted enough, and they take resources away from other priority spending, such as infrastructure, health, and education. Therefore, it is critical to continue tariff reforms in the electricity market, instead providing better targeted support to the vulnerable households that most need it.

· Continue with tax policy reforms. To enhance the mobilization of tax revenues, the government has adopted tax policy reforms aimed at extending the tax base for personal and corporate income taxation, reducing VAT exemption, and increasing excises. Nevertheless, to support fiscal consolidation efforts and ensure medium term fiscal sustainability, it is key to continue undertaking tax policy reform so as to further reduce exemptions and broaden tax bases.”

“Beyond reducing the deficit, several structural fiscal reforms are needed. Continued staffing of the Public Investment Management to its full capacity, together with the strengthening of methodologies for the identification and costing of projects, will lead to more efficient public investment. Separately, increasing tax compliance is crucial for improving the fiscal position and ensuring a competitive playing field in the economy. In this context, the reform efforts inside the Public Revenue Office are welcome, but they should be accelerated further. Finally, we welcome the appointment of the Fiscal Council and look forward to it becoming fully operational in 2024; this will improve fiscal governance.”

“In the months to come, close attention to risks to public finances stemming from the Corridor 8/10d project will be critical. This project will have a large impact on the economy and on public finances. Ongoing geo-technical studies will provide key information to validate the design of the road in critical sections, and to see whether initial estimates of the cost embedded in the contract hold up or not. The authorities’ plan to publish the independent transaction advisor’s monthly monitoring reports of the project to enhance transparency and accountability is also welcome.”

“Inflation is coming down thanks to monetary policy tightening and the normalization of global energy and food prices; the recent government measures have also provided some relief. However, upside risks to inflation remain, and the central bank need to stand ready to tighten further if these risks materialize. Over the last 18 months, the National Bank (NBRNM) has appropriately tightened monetary policy. These efforts have translated into a slowdown in credit growth and a deceleration in both headline and core inflation, which have fallen by more than half relative to their peaks. They have also helped stabilize the foreign exchange market. However, high nominal wage growth of around 15 percent, if sustained, creates risks that inflation will reaccelerate. Given these latent risks, monetary policy needs to remain tight for the time being, and the NBRNM should stand ready to tighten further if these risks were to materialize. The government and unions have a key role to play in this regard, by pursuing prudent wage and pension policies. The recent administrative price-control measures provide only temporary relief against inflation, and they should not be counted as a lasting solution to inflationary issues.”

“IMF staff welcomes the National Bank’s plans to improve the transmission from its policy rate into market rates. The NBRNM has a robust monetary framework, with a clear mandate and instruments to deliver it. In the last eighteen months, inflation expectations have remained anchored, and the foreign exchange market has been stable in the face of shocks. However, several issues, including structural features of the economy—such as excess bank liquidity—pose challenges for the transmission of the headline policy rate into market rates. This is one aspect and one channel of monetary policy, but an important one. In this context, the central bank’s plans to improve this transmission are welcome, though the exact nature of the measures, and their sequencing, will need careful calibration.”

“The banking system has proven resilient despite sizable global shocks. This was thanks to strong balance sheets entering the pandemic and measures taken since then by the central bank to bolster them. At present, banks are liquid, well capitalized and profitable. At the same time, deposits and credit continue to grow, and NPLs are at record lows. Staff welcomes the phase-in of macroprudential tools to mitigate risks and build up financial buffers. The new loan-to-value ratios and debt service-to-income ratios are helping to safeguard financial stability by reducing pressures in the real estate market. Also, in this context of high bank profitability, staff supports the NBRNM’s objective to tighten capital requirements further. Recent upgrades to the regulations on credit risk management and on banks’ disclosure, as well as the new bank-resolution law, are also good steps forward. Looking ahead, upgrading the bank deposit insurance law should remain a priority.”

“It is important to expeditiously approve amendments to the central bank law. These amendments would establish a formal macroprudential and resolution mandate, improve the NBRNM’s governance framework, and ensure autonomy to set employment conditions–which matters for central bank independence.”

“North Macedonia has achieved macroeconomic stability, but it now needs to unlock higher growth. North Macedonia’s income per capita was 27 percent of the EU level in 2000, 38 percent in 2010, and still slightly below 40 percent now. Accelerating structural reforms to lift living standards is therefore a priority. Reigniting convergence will require a multi-pronged approach towards reducing the flow of emigration, boosting investment and productivity, and accelerating the green transition. This can be achieved by:

· Improving the business environment and rule of law. In particular, it will be important to reduce informality, not least through a more effective Public Revenue Office and lower bureaucratic delays, and to combat corruption. On the latter, IMF staff fully shares the concerns expressed by the European Commission on the recent changes to the criminal code.

· Preserving room in the budget to support public infrastructure and education. A key reason for the slowdown in potential growth in North Macedonia lies in relatively weak investment levels. Therefore, recent increases in the size of the budget for capital expenditures are welcome and should be preserved going forward. Improving public investment management will also help better prioritize public investment projects.

· Accelerating the green transition and adapting to climate change. Scaling-up green investments is needed because, ultimately, the decommissioning of old and polluting power plants before the end of the decade cannot be avoided if North Macedonia is to meet its emission targets. Setting the right incentives for the transition towards energy efficiency and preparing for the phasing in of the EU’s Carbon Border Adjustment Mechanism are also important objectives. Adding emission and resilience objectives in public investment will help with climate mitigation and adaptation. Ongoing progress in greening the financial sector will facilitate the climate transition.”

“These reforms will be crucial in laying the foundations for strong, sustained growth, and will support the country on its path to EU accession.”

“The mission would like to thank the authorities and other counterparts for their warm hospitality as well as open and productive discussions. ”