Mission Concluding Statement 

North Macedonia: Staff Concluding Statement of the 2025 Article IV Mission

February 26, 2025

Growth is gaining momentum amid rising risks

Growth is gaining momentum. After picking up in early 2024, growth is expected at 3.3 percent in 2025, driven by stronger domestic demand as public investment projects (including the Corridor 8/10d road project) intensify and consumption is supported by government transfers and real wage growth. The impact of weak external demand seen in 2024 is expected to persist in 2025, driven by structural shifts in the European automotive sector. In the long term, high emigration, especially among the young segment of the population, is projected to lower potential growth, which Staff now estimate at 3.0 percent.

Inflation is rising again. In January, inflation reached 4.9 percent year-on-year, up from a low of 2.2 percent in August 2024. Core inflation has become the main driver and remains persistent, fueled by strong wage growth. Food inflation remains high despite administrative price controls and other interventions.

Domestic risks are elevated and the external outlook more uncertain. Weak public investment, stalled productivity reforms, emigration, and slowing activity of key trade partners threaten growth in the medium-term. Meanwhile, high real wage growth without productivity gains and increased fiscal transfers could further fuel inflation and erode competitiveness. Trade policy shifts and shocks to FDI may suppress exports and tighten financial conditions.

Adhering to the fiscal rules requires credible fiscal consolidation

IMF staff agree with the authorities' goal of reducing the deficit this year, but are concerned revenue will underperform, rendering this goal out of reach. The 4 percent of GDP deficit envisaged in the 2025 budget will be exceeded if the authorities’ expected revenue gains (of 1½ percent of GDP) from reducing the shadow economy and increasing tax compliance fall short. We welcome the Public Revenue Office’s efforts to modernize tax collection and reduce informality, but these efforts will take time to deliver results. Staff recommends that in any planned supplementary budget, the authorities avoid increasing spending and focus on reducing tax expenditures and transfers (e.g., subsidies to agriculture). Ensuring the full and timely transfer of contributions to the second-pillar pension system is essential.

A credible fiscal strategy is needed to bring debt on a downward path. The budget deficit has exceeded the 3 percent of GDP ceiling in the fiscal rules, while public debt is on an upward trend and has surpassed 60 percent of GDP in 2024—14 percentage points above pre-pandemic levels. A credible fiscal strategy to restore compliance with fiscal rules is key, for preserving credibility to maintain access to international capital markets, for creating space for investment, and strengthening resilience against future shocks. The focus should be on:

• Controlling current spending:Staff recommend omitting further pension increases in September 2025 and returning to a rule-based pension system in 2026—indexing only to inflation—to support consolidation while protecting pensioners’ purchasing power. Staff advise limiting public wage growth to inflation in the near term. The Ministry of Finance should strengthen oversight to ensure public wage increases are consistent with achieving the fiscal rules. Over time, unifying the fragmented wage negotiating system will help prevent unexpected budget pressures.
• Mobilizing revenues. North Macedonia’s tax revenue potential is estimated at 22-24 percent of GDP. To realize these revenues, tax reforms should focus on reducing tax expenditures, limiting reduced rates and exemptions, improving tax compliance, and gradually increasing property tax. The government’s accelerated digitalization efforts will enhance revenue mobilization.

Beyond consolidation, structural fiscal reforms are needed to strengthen fiscal governance and improve spending efficiency, with some progress underway. Key ongoing measures include implementing the Public Investment Management decree and manual, adopting the PPP law, and conducting spending reviews to optimize budget allocation. Managing fiscal risks, especially from SOEs and major projects like the Corridor 8/10d road, is crucial. The inclusion of a fiscal risk assessment in the Medium Term Fiscal Strategy marks an achievement for the ministry. The state-owned electricity generator, ESM, requires investments in technology and efficiency improvements to lower production costs and expand production, while gradually reducing its role in the subsidized, regulated market. The operationalization of the Fiscal Council is a positive step and it is encouraged to strengthen its independent assessments.

Monetary and financial sector policies to maintain stability and mitigate risks

Policy rates should remain on hold and liquidity tools warrant further tightening until inflation steadily declines. Robust reserves accumulation in 2024 has fostered stability in the foreign exchange market. Given the renewed acceleration in both headline and core inflation, the National Bank (NBRNM) should remain on hold until there is clear evidence of sustained disinflation. Staff support the changes in reserve requirements implemented by the NBRNM and advise further tightening to absorb excess liquidity. The NBRNM should remain vigilant to inflationary risks from domestic factors, including wage and pension increases, as well as heightened external risks from trade uncertainties. If these risks materialize, the NBRNM should be prepared to tighten further to prevent inflation from becoming entrenched. The NBRNM has effectively managed recent challenges, including the energy cost shock. Its resilience stems from operational and financial autonomy, which underpin its independence and credibility—both essential for maintaining price and exchange rate stability and must be safeguarded.

The financial system remains resilient, but macro prudential settings may need to be tightened in response to brisk credit growth. Overall, the banking sector is well-capitalized, highly liquid, and profitable, with low system-wide non-performing loans. NBRNM’s active macroprudential and microprudential measures have strengthened resilience. Strong balance sheets and increased deposits have fueled an acceleration in lending activity towards the end of 2024. The implemented loan-to-value and debt service-to-income ratios will continue to help safeguard financial stability by reducing pressures in the real estate market and preventing higher levels of indebtedness. Staff support the NBRNM’s gradual tightening of the countercyclical capital buffer and additional capital requirements to ensure banks maintain adequate loss-absorbing and recapitalization capacity, in line with EU regulations. Should lending and real estate prices continue growing briskly, further tightening of macroprudential instruments may be warranted.

Structural reforms to boost productivity and offset costs of emigration

IMF staff support the authorities’ objectives of boosting productivity, raising living standards, and reducing informality. Over the past decade, growth in North Macedonia has lagged regional peers and convergence with the EU has stalled. High emigration has led to a declining population that threatens to be a drag on potential growth. Accelerating structural reforms is key to achieving the authorities’ objectives, offsetting the costs of emigration, and supporting the country on its path to EU accession. The priorities are well known:

• Improving the business environment. Reducing informality through streamlined business registrations and expanded digital public services is a priority. The predictability of the legal and regulatory environment can be improved by limiting the use of expedited procedures in Parliament, increasing stakeholder consultation, and applying the regulatory requirements more consistently. Simplifying and digitalizing work permits would help businesses address skill and labor shortages more efficiently. Avoiding ad-hoc adjustments to the minimum wage will help contain inflation, preserve competitiveness and provide a more predictable policy environment for business.
• Strengthening the labor market. Improving labor market outcomes can stimulate private investment, increase labor participation, and reduce emigration. Raising educational quality and job matching between firms and workers through vocational training will help address labor shortages. Expanding affordable childcare in municipalities, and gradually raising the retirement age of women to match men can help to offset workforce losses from high emigration.
• Increasing public infrastructure investment. The quality of public infrastructure in North Macedonia lags peers. The major infrastructure projects Corridor 8/10d and the Kicevo-Ohrid highways are over budget and behind schedule. Staff urge the authorities to complete the started projects and realize their investments. Capital expenditures should be safeguarded in the budget and public investment management should be strengthened to prioritize high-impact projects.
• Strengthening the rule of law and anti-corruption efforts. Improving judicial independence and impartiality would strengthen contract enforcement and help reduce informality. The fight against corruption remains weak, particularly in prosecuting high-profile cases. Aligning the Criminal Code with international standards and enhancing resources for key anti-corruption institutions are crucial. The upcoming new national anti-corruption strategy is an opportunity to accelerate reforms through stronger accountability and coordination.
• Enhancing governance.Improving public resource efficiency, accountability, and transparency requires expanding digital public services, reassessing state aid schemes, strengthening procurement systems, and improving SOE management.

The IMF team thanks the authorities of North Macedonia and other counterparts for their productive collaboration and constructive policy dialogue.