Mission Concluding Statement 

Podgorica, February 12, 2024:  

Economic Outlook

After strong performance in 2023, growth is expected to moderate in 2024. The economy grew strongly in 2023, at an estimated 6 percent, as tourism surpassed 2019 levels and the inflow of migrants continued to support private consumption. Positive labor market developments continued, with employment and labor force participation levels increasing. In 2024, tourism growth is expected to moderate. If there are no further net migrant inflows, consumption growth is also likely to slow. Overall economic growth is therefore expected to moderate to 3.7 percent. Inflation has come down from its 2022 peak of 17.2 percent to 4.3 in December 2023, thereby significantly reducing the differential with Euro Area inflation. Whether this trend will continue depends on the international environment for commodity prices, and on domestic wage pressures. The external current account deficit has narrowed sharply to an estimated 11 percent of GDP in 2023. FDI inflows going into the real estate sector remain the dominant identifiable source of financing of the current account deficit. As tourism growth moderates, the current account deficit is expected to return to its historical average of around 13 percent of GDP over the medium-term.

Maintaining Fiscal Sustainability

A general government fiscal surplus was recorded in 2023, driven mainly by one-off factors, and a return to deficits is expected from 2024 onwards. Continued strong tax revenue performance, temporary increases in nontax revenues, as well as lower than budgeted spending helped bring the public finances into surplus in 2023. A fiscal deficit of around 3.5 percent of GDP is expected in 2024. The removal of covid exemptions and preferential rates for VAT, the increases in excise taxes, as well as higher revenues from games of chance are expected to partially offset the planned spending increases in the 2024 budget.

We expect a gradual increase in public debt based on current policies. The fall of public debt from the 2020 peak of 107 percent of GDP to an estimated 62 percent in 2023 was aided by the post-pandemic economic recovery, high inflation, as well as the use of deposits that were accumulated through large debt issuance in 2020. As these tailwinds are abating, in the absence of additional measures to lower fiscal deficits, debt is expected to rise gradually in the coming years. Since 2022 there have been permanent revenue losses due to the abolition of health contributions and introduction of the PIT tax-free allowance, as well as increases in social expenditures. These fiscal losses were partially offset by higher pension contributions, VAT, and CIT revenues attributable to higher private consumption and economic growth, and the reforms of 2022.

A commitment to anchoring the debt will significantly strengthen the medium-term fiscal framework. Montenegro’s Law on Budget and Fiscal Responsibility already specifies a debt-to-GDP ceiling of 60 percent. Convergence to this ceiling by 2028 (the authorities’ target year for Montenegro’s accession to the EU) can be achieved by maintaining a non-negative primary balance from 2026 onwards. We recommend that a strong commitment to the debt anchor and the authorities’ strategy on how to adhere to it be prominently included in the upcoming Macroeconomic and Fiscal Policy Guidelines of the government and reiterated in budget documentation throughout the coming years. In our view, for the authorities to reach a primary balance by 2026, fiscal tightening of around 1.5 percent of GDP will be necessary. Further revenue losses and/or structural expenditure increases, would raise the required level of fiscal consolidation to reach this target. Given high financing needs coming over the next few years (estimated at 14 and 17 percent of GDP in 2025 and 2027 respectively), the adoption of a strong fiscal anchor would signal that Montenegro has a credible framework to manage its public finances responsibly. We stand ready to assist the Montenegrin authorities in their efforts to strengthen their fiscal framework.

Structural fiscal reforms would support healthy public finances. Social transfers need to be managed through better targeting of the eligibility of benefits to those who are most vulnerable. Growth in the public sector wage bill needs to be contained over the medium-term. The public investment planning process should fully include as active participants, those agencies in charge of implementing capital projects. This would increase the efficiency of capital budgeting and implementation so that the worthiest projects receive the needed funding. Strengthening the capacity of the newly split Tax Administration and Customs Agency will be essential to raising fiscal revenues in the smoothest possible way. The establishment of a fully functional fiscal council, and improved oversight of state-owned enterprises (SOEs) so that they cause less of an aggregate burden to the budget will usefully complement the fiscal efforts of the government. The IMF has and will continue to support the Montenegrin authorities through the provision of capacity development in these and other areas.

Preserving Financial Stability

Systemwide financial stability indicators appear healthy amid ample liquidity. Systemwide bank capital adequacy, liquidity, and profitability indicators are high and NPLs have continued to decline despite the withdrawal of COVID support measures and gradual application of stricter asset classification standards. The strong post-COVID recovery of the economy and large nonresident deposit inflows resulted in record-high deposit growth. At the same time, private sector credit growth has slowed, and the loan-to-deposit ratio has fallen. Despite expanding real estate sector activity, banks’ exposure to the sector has remained contained. The widening spread between lending and deposit rates has driven strong profits in the banking sector. High levels of liquidity, high market concentration in the banking sector, limited opportunities for profitable lending, as well as challenges for local depositors to tap higher yields abroad or “home bias” are the likely drivers of low deposit rates. In this respect, developing a retail government bond market would help provide diversification for savers.

Continued close supervision of the financial sector by a strong and independent central bank should help navigate the changing landscape of risks. The reduction of the share of variable rate loans in total loans, as prompted by CBCG guidance to banks to offer the conversion option to borrowers, has helped contain the riskiness of the loan portfolio. In addition, in line with IMF’s endorsed recommendation, CBCG removed its forbearance measure allowing banks to exclude from their calculation of regulatory capital unrealized losses from holdings of government securities. This serves the purpose of supervisory data appropriately reflecting market realities for enhanced discipline and resilience of the banking system. Further, it will be important to closely monitor domestic leverage through regular reporting and analysis of trends in key macroprudential indicators. This is essential for macroprudential policies to be well-designed. Lingering pockets of vulnerability in the banking system warrant continued close monitoring by the CBCG, and contingency planning should remain a key area of focus. To continue to achieve all the goals within its mandate, maintaining the Central Bank’s independence and credibility is of paramount importance.

Strong progress in aligning Montenegrin regulation and supervision practices with international standards should continue. Digitalization and the development of crypto assets and fintech initiatives need to be accompanied by a legal framework that aligns with emerging guidelines from standard setters such as the Basel Committee on Banking Supervision, FSB, ECB, and the FATF. Adequate supervision capacities are needed to understand complex global risks associated with such innovations. Potential risks associated with large inflows in the real estate sector, while not posing immediate leverage-related risks to the banking system, warrant close monitoring from an AML perspective. Implementation of a practical and fully operational risk-based AML/CFT framework is essential.

Supporting Economic Diversification and Female Labor Force Participation

Economic diversification is important for decreasing Montenegro’s vulnerability to economic shocks. Improving infrastructure connectivity, boosting tourism in the North, and expanding further into niche tourism markets, can diversify the tourism sector, while making fuller use of Montenegro’s comparative advantages. Outside the tourism sector, Montenegro should leverage its natural endowments in hydro, solar and wind power, increasing energy production and exports, while also helping to achieve the country’s climate goals. In this respect, improved practices of public investment management will be key in ensuring that high return public investments in physical and digital infrastructure are prioritized. Finally, effective policies to reduce informality will help create a conducive environment for the SME sector, enabling it to benefit from the presence of skilled migrant labor in the country.

Female labor force participation is an untapped engine of growth. At 14 percentage points, the gap in labor force participation between men and women is high and, if reduced, can lead to significant macroeconomic gains. Raising female labor force participation to the third quartile of neighboring countries could increase GDP by 6 percentage points. Women are under-represented in employment and are paid less across most sectors of the economy. Recent tax reforms to increase progressivity are likely to have contributed to reducing gender gaps in employment. Unpaid care work presents a significant barrier to women’s participation in the labor force and could be tackled through improving access to affordable and accessible high-quality childcare services. Attention should also be paid to address the relatively low enrollment and graduation of women in STEM fields, despite the overperformance of women in educational attainment in general. Finally, recent efforts to introduce gender budgeting are welcome -- deepening it can further improve resource allocation and policy design to reduce gender inequalities.

The mission would like to thank the Montenegrin authorities and other counterparts for their warm hospitality, engaging discussions, and productive collaboration.