Montenegro: 2019 Article IV Consultation—Press Release, Staff Report, and Statement by the Executive Director for Montenegro
Author:
International Monetary Fund. European Dept.
Search for other papers by International Monetary Fund. European Dept. in
Current site
Google Scholar Close
Publication Date:
10 Sep 2019
eISBN:
9781513513720
Language:
English
Keywords:
ISCR; CR; authority; debt; CBM balance sheet; development goal; MONSTAT; Montenegro; minimum wage; IMF staff calculation; feasibility study; wage freeze; labor force; Fiscal stance; Fiscal consolidation; Global; rate of return
Download PDF (3.5 MB)

2019 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Montenegro

Abstract

2019 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Montenegro

Context

1. Montenegro is a small, open tourism-dependent economy. Rigid labor markets and weak demographics constrain economic growth. The Bar-Boljare highway project has significantly increased public debt (Box 1), necessitating a fiscal adjustment which began in 2017. With unilateral euroization, there is no independent monetary policy. Foreign-owned banks make up nearly ¾ of the banking sector by assets.

2. Since independence in 2006, Montenegro has made progress in legislative reform and institution building. Yet, weaknesses in financial sector oversight the application of the AML/CFT framework, tax administration, procurement, and the regulatory framework could create vulnerabilities to corruption. Technical capacity in public investment also needs to strengthen. Montenegro is an EU candidate country, with accession envisaged in 2025 at the earliest. Parliamentary elections are due by late 2020.

uA01fig01

Selected Sub-Components of Pillar 1. Institutions, 2018

(Index: 1–7, 7=best performer; 9 lowest indicators out of 12 total)

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: World Economic Forum, Global Competitiveness Index; and IMF Staff calculations.

Recent Developments

3. Growth was strong in 2018. The economy expanded 4.9 percent, the fastest since 2008, following growth of 4.7 percent in 2017. Growth continues to be bolstered by public (highway) and private (energy and tourism) investment. Tourism experienced another record year. Private consumption remained strong, despite fiscal adjustment measures. Average inflation increased from 2.4 percent in 2017 to 2.6 percent in 2018, due to a VAT increase and oil prices. The unemployment rate declined from 17 percent in 2017 to 15 percent in 2018. Partially driven by a public sector wage freeze, average wage growth declined to 0.1 percent, down from 2.3 percent in 2017.

uA01fig02

Real GDP Growth Decomposition

(Percentage point contribution to growth)

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: Monstat; and IMF staff calculations.

Bar-Boljare Highway Project

The Bar-Boljare highway aims to connect Montenegro’s coast with Serbia. Only the first 41-kilometer phase—also the costliest due to difficult terrain—connecting Podgorica with the less-developed northern municipality Kolašin, at a cost of around €1 billion, is currently under construction. The remaining phases (totaling 136 kilometers) may cost somewhat more than the first phase. Phases 2 (21 kilometers from Mateševo to Andrijevica, with a possible cost around €300 million) and 3 (about 50 additional kilometers) would link the highway to the Serbian border. Phase 4 (about 65 kilometers) would extend the highway from Podgorica to the coast. An eventual corridor to Belgrade requires Serbia to extend a road currently under construction an additional 100 kilometers to the border.

China Road and Bridge Corporation started construction in 2015. Completion was initially expected in 2019 but has been delayed to 2020. Domestic contractors are allocated 30 percent of the work. China Ex-Im Bank is providing a USD-denominated loan for 85 percent of the total cost. The cost of phase 1 was initially set at €809 million (23 percent of 2014 GDP), but overruns may raise the cost by about 7 percent. Because of subsequent USD appreciation, and unhedged currency risk, the cost has increased a further 18 percent. The loan carries a 2 percent interest rate and a 20-year repayment period. Principal payments begin in 2021.

uA01fig03

General Government Debt with Guarantees

Percent of GDP

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: Ministry of Finance; and IMF staff estimates and projections.

Highway construction has weighed heavily on public finances. Had the first phase not been built, the tough fiscal adjustment strategy adopted in 2017 would not have been necessary to return debt to sustainable levels. Assuming no highway spending and a primary surplus of 1 percent of GDP (consistent with the non-highway primary balance before the 2017 fiscal strategy), government debt including guarantees would likely have declined to 59 percent of GDP by 2020 instead of rising to a projected 82 percent of GDP.

4. Fiscal adjustment continued in 2018, with some setbacks. The authorities continued the 2017 adjustment by increasing the VAT 2 p.p. and continuing a partial public sector wage freeze. However, the July 2018 supplemental budget slowed the pace of tobacco excise increases due to increased smuggling. The supplemental budget also had to accommodate new public sector hiring. The primary fiscal deficit declined from 4.5 percent of GDP in 2017 to 4.1 percent of GDP in 2018. Excluding highway spending, the primary balance improved by 3 p.p. of GDP since 2016, indicating continued progress in the underlying fiscal adjustment. General government debt (including guarantees) reached 79 percent of GDP, up from 74 percent of GDP in 2017.

uA01fig04

General Government Primary Fiscal Balance

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: Ministry of Finance; and IMF staff calculations.

5. The authorities intervened in two banks in 2018. Longstanding weaknesses in two related non-systemic domestic banks (Atlas and IBM) worsened in late 2018, forcing the Central Bank of Montenegro (CBM) to intervene by installing interim administrations and freezing deposit withdrawals.1 The CBM placed the smaller of the two banks (IBM, 1 percent of system assets) into bankruptcy within one month and placed Atlas (5 percent of system assets) into bankruptcy in April 2019 following unsuccessful offerings for new private capital. By early June, the Deposit Protection Fund (DPF) had paid out 84 and 73 percent, respectively, of eligible insured deposits.

uA01fig05

Bank Lending by Sector 1/

(Percent, year-on-year)

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

1/ 2019 data distorted by recent Atlas/IBM bankruptcies.Sources: CBM; and IMF staff calculations.

6. These interventions have not triggered spillovers into the broader banking sector. Despite the freeze on deposit withdrawals from the two intervened banks, system-wide deposits have been stable. Non-performing loans (NPLs) declined from 8 percent at end-2017 to 7.5 percent at end-2018. Private sector credit growth strengthened to 9.1 percent, led by household lending. Following the closure of the intervened banks, NPLs declined further to 5.3 percent in April 2019. The aggregate capital adequacy ratio of 15.3 percent remains above the minimum of 10 percent, while provisioning has improved. Liquid assets remain high at 22 percent of total assets.

7. External imbalances remain elevated. The current account deficit increased 1 p.p. in 2018 to 17 percent of GDP. While goods and services (especially travel services) exports expanded, imports also increased strongly, driven by oil and investment-related goods (including machinery). Net FDI declined to 7 percent of GDP from 11 percent of GDP in 2017. Driven mainly by the government’s issue of a Eurobond, external debt increased 8 p.p. to 167 percent of GDP in 2018.

Outlook and Risks

8. Growth is expected to moderate as highway investment peaks. The authorities have not yet defined the model or timing for construction of further phases of the highway. Therefore, baseline projections assume no further construction past phase 1. Growth is projected at 3.0 percent in 2019, driven again by domestic demand. With highway spending likely already having peaked in 2018, public investment will begin to act as an increasing drag on growth over 2019–21 as highway construction ends. Growth is projected to decline towards 2.5 percent in 2020 before increasing to around 3 percent over the medium term. Private investment, driven by tourism and energy sectors, is likely to remain strong over the medium term at around 21 percent of GDP. However, with public investment at a lower level, the contribution of investment to growth will moderate. Household consumption growth—alongside household credit and employment growth—is projected to moderate over the medium term to around 2 percent, compared to an average of 4.5 percent over 2016–18.

uA01fig06

Real GDP Growth Decomposition: 2018–2024

(Percentage point contribution to growth)

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Source: Monstat; and IMF staff projections.

9. The medium-term supply-side effects of highway completion are uncertain. With highway spending peaking and the underlying fiscal adjustment nearly complete, the medium-term growth outlook depends partially on how supply-side effects of the completed first highway section balance the contractionary effect of lower public investment Albeit uncertain, these effects are estimated to be moderate compared to a typical investment project due to the low economic rate of return.2

uA01fig07

Highway/Fiscal Adjustment: Contribution to GDP Growth

(Percentage point contribution to real GDP growth)

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: IMF staff estimates and projections.

10. External and domestic risks persist.

  • The external environment is the main risk: The need to refinance Eurobonds maturing in 2020/21 leaves Montenegro (B+/B1 rating) vulnerable to a tightening in global financial conditions. These risks could be largely mitigated with a successful Eurobond issue later this year. The current account deficit is projected to stay elevated, highlighting Montenegro’s dependence on FDI and external debt financing. A significant slowdown in growth in Europe could also pose risks for tourism. On the other hand, new investments in tourism facilities, could provide new tourism receipts.

  • Domestic risks relate mainly to sustaining fiscal consolidation. Parliamentary elections due in 2020 could pose a risk for fiscal discipline. Pressures to move ahead with further phases of the highway, or other large projects, without the necessary fiscal space may prove difficult to resist. Any further banking sector weakness could erode confidence and adversely affect financial stability and fiscal sustainability.

Figure 1.
Figure 1.

Montenegro: Real Sector Developments

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: CBM; Monstat; and IMF staff calculations.
Figure 2.
Figure 2.

Montenegro: Fiscal Developments

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: CBM; Ministry of Finance; and IMF staff calculations.
Figure 3.
Figure 3.

Montenegro: Tourism Developments

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: Monstat; Eurostat; CBM; Haver Analytics; and IMF staff calculations.

Policy Discussions

11. Policy discussions focused on three key issues: (i) consolidating the gains from fiscal adjustment, while weighing carefully the costs and benefits of further near-term construction of the Bar-Boljare highway; (ii) strengthening banking and AML/CFT supervision to safeguard financial stability; and (iii) improving labor market outcomes. Governance-related discussions focused on the structure of financial sector oversight, developing stronger AML/CFT supervision tools, and increasing the capabilities of tax administration.

A. Fiscal Policies

Rebuilding Fiscal Space: Preserving Fiscal Adjustment, and the Medium-term Reform Agenda

12. The bulk of the fiscal adjustment strategy has been implemented. The authorities have implemented 4½ percent of GDP in adjustment measures over 2017–19 (Table 1). The 2019 budget contained no further setbacks as did the 2018 supplemental budget. The primary balance is now projected to peak at 2.7 percent of GDP in 2021 (after the conclusion of highway spending), compared to a previous projection of 4½ percent of GDP based on the original 2018 budget.

Table 1.

Montenegro: Staff Assessment of Fiscal Adjustment Factors 1/

Permanent fiscal impact (percent of GDP)

article image
Sources: Montenegrin authorities; and Fund staff estimates and projections.

In this table, a positive (+) sign indicates an improvement in the fiscal balance, while a negative (-) sign represents the opposite. A positive entry followed by “…” indicates a permanent impact in year 1, with no further impact in year 2 relative to a scenario without fiscal adjustment.

Fuels excise was increased as part of the 2017 budget.

The tax debt rescheduling raised a large amount of revenues in 2017, but these revenues are not permanent. Negative signs in later years indicate that the amount raised will be smaller than the previous year.

Social contributions made by government for mothers who received the social benefit and were previously employed. This is offset by equivalent spending by the government to make the contributions.

Dividend payments from state-owned electricity generator.

Includes the savings from partial wage freeze relative to alternative scenario with wage increases.

The authorities intend to reduce staffing levels at central and local government levels. Because the results are still uncertain, staff has not yet included savings in projections.

Includes support for Montenegro Airlines, the health sector, and other spending not envisioned in June 2017 spending projections.

Beginning in 2019, highway expenditures will begin to decline, and spending should stop in 2021, producing an automatic improvement in the fiscal balance.

uA01fig08

General Government Primary Fiscal Balance

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: Ministry of Finance; and IMF staff projections.

13. Successful debt management operations have reduced, but not eliminated, refinancing risks. In 2018, the authorities pre financed their 2019 financing needs by issuing a new €500 million Eurobond, which included the exchange of 1/3 of €1 billion in Eurobonds that were maturing in 2019–21. The authorities are exploring €500 million Eurobond issuance in 2019, which if successful would pre-finance the amortizations of the 2020 and 2021 Eurobonds. This would increase general government debt with guarantees to 89 percent of GDP.3

14. Staff underscored the need to maintain a primary fiscal surplus of at least 2 percent of GDP over the medium term. Under current policies (without further highway construction past phase 1), the primary surplus is projected around 2 percent of GDP over the medium term. Should planned bond issuance be completed successfully, there would be a significant decline in near-term refinancing risks, and currently projected primary surpluses are adequate to lower the trajectory of public debt and rebuild fiscal space to cope with future shocks. Under current policies, government debt including guarantees is projected to decline strongly beginning in 2020, reaching 61 percent of GDP in 2024. However, in the unlikely event of prolonged external market closure, the achievement of a peak primary surplus of 4½ percent of GDP by 2021, along with additional domestic funds, would be necessary to fully meet financing needs.

uA01fig09

General Government Debt with Guarantees

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: Ministry of Finance; and IMF staff projections.

15. Additional desirable reforms would create space for a more growth-friendly budget. The authorities plan to reduce government employment where inefficient and eliminate tax expenditures, especially related to the VAT, as part of EU directive harmonization. Pension reform is also important These initiatives are not included in the baseline.

  • Government employment (Annex VIII): The authorities aim to reduce employment at the central and local government levels, respectively, by 5 percent and 10 percent by 2020. The limited progress in 2018 underscores the difficulty of these reforms. The authorities should review active labor market policies to transition redundant employees to the private sector. Current plans to offer zero-interest loans to start businesses are not well targeted.

  • Tax expenditures: As recommended by FAD TA, the authorities should work to establish a transparent benchmark tax system based on economic grounds to estimate and phase out tax expenditures related to the VAT and other taxes. The authorities intend to move forward in 2019 to eliminate VAT tax exemptions, which they estimate totaled some 0.8 percent of GDP in 2018.

  • Pensions: Eligibility for early retirements should be tightened and early retirement actuarial penalties increased. Pensions should be valorized by wages and benefits indexed to inflation. Valorization by wages is necessary to maintain socially sustainable replacement rates. Eligible pension ages should be linked to life expectancies.4

16. Stronger fiscal institutions are needed to promote better medium-term adherence to fiscal targets.5 A comprehensive medium-term budget framework is needed, with more binding medium-term expenditure limits and the need to reconcile and justify deviations from these limits. The authorities could consider an overall expenditure limit based on the envelope of the medium-term budget. Any legislation with budgetary consequences should require an assessment by the Ministry of Finance.

17. The continuation of recent tax administration improvements would help generate additional revenues while combating the grey economy. Fiscal Affairs Department (FAD) TA has enabled the development of a multi-year agenda with the tax administration (MTA) to build on prior gains in tax administration. Tax arrears have been reduced, and a strategy with a clear reform direction to overhaul auditing and compliance has been adopted to focus on major tax risks. The government has also granted operational autonomy to the MTA. Yet, the operationalization of these significant reforms will encounter challenges. Legislative changes to the interest and penalty regime are also necessary to induce greater tax compliance.

18. The materialization of additional upside risks would increase scope to rebuild fiscal space. The authorities also hope to raise additional revenues through airport concessions, economic citizenship, and electronic fiscalization. Given the large uncertainties associated with these plans— both in terms of timing and magnitude—they have not been included in the baseline. Progress in these areas could significantly improve the outlook. Given the uncertainties, however, it is important to refrain from spending resources that have not yet materialized.

Authorities’ Views

19. The authorities broadly agreed with staff’s policy recommendations. The authorities agreed on the importance of maintaining primary surpluses to reduce debt. Compared with staff’s primary surplus projection of 2.7 percent of GDP in 2021, the authorities forecast a primary surplus of 4.6 percent of GDP, based on lower projections of spending on the government wage bill, transfers to public institutions, and capital expenditures, and gains to revenues from fiscalization. The authorities plan to complete medium-term refinancing needs with an additional Eurobond this year. They expected that a forthcoming offer of severance packages would help facilitate the planned reduction of public sector employees. They also agreed on the importance of further pension reform but did not plan to re-open the issue in 2019. The authorities plan to implement a medium-term budget beginning in 2021.

A More Careful and Considered Approach to the Bar-Boljare Highway Project

20. Staff advised the authorities to weigh the benefits of the Bar-Boljare highway project carefully against alternative uses for scarce public resources. With phase 1 of 4 to be completed in 2020, the authorities are weighing options for phase 2. Past feasibility studies completed several years ago estimated a low economic return on the overall highway, based on limited potential for toll revenues relative to the cost. Risks of delayed implementation of the Serbian section raise further questions. In this context, staff pointed to the need for better infrastructure and more public goods (such as waste water treatment) in areas which already experience significant bottlenecks, as well as for more and better targeted education and health spending (Figure 4). Staff urged the authorities to closely consider such opportunity costs before prioritizing one highway project with an uncertain rate of return.

Figure 4.
Figure 4.

Montenegro: Expenditure Efficiency

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: IMF FAD Expenditure Assessment Tool; World Bank Database; Making Public Investment More Efficient. IMF, 2015; and IMF staff calculations.

21. A rush to complete the highway is likely to jeopardize fiscal sustainability. Completion of the phases 2–4 of the highway could cost an additional 25 percent of GDP. Should the authorities move ahead to complete the highway over 2021–26 with new debt financing, general government debt (including guarantees) could remain over 80 percent of GDP for most of the 2020s, versus reaching 50 percent of GDP by 2030 in the baseline. Returning debt to the baseline level in 2030 would require a new round of fiscal adjustment around 3 p.p. of GDP over 2021 -23 and the maintenance of primary surpluses averaging nearly 4 percent of GDP over 2026–2030 (Figure 5). Completing and sustaining a new fiscal adjustment of this size would be difficult.

Figure 5.
Figure 5.

Montenegro: Fiscal Scenarios for Highway Completion

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: Ministry of Finance; and IMF staff projections.

22. Further highway planning should be paused until a new and credible feasibility study is completed. The authorities have commissioned a feasibility study to be completed in 2020. With results of the study, the authorities should weigh its rate of return against other priority infrastructure projects. Should they decide to proceed, the authorities are advised not to embark on further construction or its financing until at least 2023, when general government debt (by the authorities’ definition) is projected to decline below 60 percent of GDP. Phase 2 alone is likely to be less expensive (roughly EUR 300 million, or 5 percent of 2023 GDP) and to deliver a significant share of the envisaged benefits by further connecting the north and tourism areas. Assuming the feasibility of securing grant financing for 20 percent of phase 2 costs, a modest, temporary fiscal adjustment of 1 percent of GDP (returning the primary balance to the current baseline during construction) would be sufficient to nearly return debt to the baseline by 2030.

uA01fig10

General Government Debt with Guarantees

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: Ministry of Finance; and IMF staff projections.

23. Continuation of the highway through a PPP structure could also entail significant fiscal costs. The authorities are keen to explore a PPP structure to complete the highway to avoid taking new debt onto the government’s balance sheet. Should the feasibility study suggest that the remainder of the project is unlikely to meet a private partner’s required rate of return, a private partner would likely require guarantees from the state. The assumption of certain risks by the state -including construction, availability, and demand risks – would according to Eurostat rules require the project to be recognized on the government balance sheet, thus having an equivalent effect to the project being financed by government debt. The need to make minimum revenue guarantee payments from the budget could also impose significant expenditures over a lengthy concession contract.

24. More robust investment management and PPP frameworks are needed. For the Bar Boljare highway and other projects, it will be critical to establish a strong legislative and institutional framework to analyze projects, identify fiscal risks, and give the Finance Ministry a strong role in safeguarding public finances. The authorities have drafted a new Law on PPPs, strengthened through FAD input.6 Staff also advised the authorities to consider a Public Investment Management Assessment (PIMA) TA from FAD.

Authorities’ Views

25. The authorities emphasized that they would proceed cautiously on further highway construction. Pending the results of the new feasibility study in 2020, the authorities plan to analyze possible financing models for phase 2, including through a PPP or on-budget public procurement They stated that they viewed the completion of the first phase as the top priority and that they would not proceed with phase 2 unless questions about feasibility and financing are resolved such that fiscal sustainability is not jeopardized.

B. Financial Sector Policies

26. Initial steps taken by the CBM regarding Atlas/IBM could not prevent their eventual failure. The 2015 FSAP identified three weak domestic banks. In 2017 the CBM placed Atlas and IBM, along with a larger domestic bank (11 percent share) under supervisory action plans. Subsequent examinations of Atlas and IBM in 2018 revealed a high level of NPLs, inadequate provisioning, and significant lending to related parties. These problems were more acute for IBM, and it was placed into bankruptcy within one month of interim administration. Montenegrin prosecutors froze a sizeable portion of Atlas clients’ deposits due to concerns about money laundering, previously undetected by nearly annual full scope AML/CFT on-site inspections. The deposit freeze also severely lowered Atlas’ liquidity.

27. However, no immediate fiscal and real economy spillovers from these closures have materialized. With large related-lending activity, the closed banks did not play a significant role in credit creation, minimizing real economy spillovers. The deposit insurance fund promptly began to pay insured depositors without recourse to its EBRD credit line. Some local governments, however, have lost uninsured deposits.7 The central government will not compensate their losses.

28. These events do highlight the need for stronger banking supervision. The CBM’s supervisory structure needs enhancement, the process needs to be more risk based, and tools for credit risk supervision require further improvement. The CBM needs to focus on increasing the effectiveness of measures, not only their administrative enactment. The CBM is receiving TA from the Monetary and Capital Markets Department (MCM) to support these efforts.

  • Supervisory Committee: The CBM’s supervisory structure will now be strengthened by the establishment of a supervisory committee to better support decisions made by senior management. This staff-level committee with auditable activities aims to bring together all relevant supervisory expertise within the CBM, including on AML issues, and will vet all supervisory decisions, while avoiding the dilution of responsibilities.

  • Off-site supervision: Capacities for off-site supervision need to be strengthened, including by ensuring the availability of well-qualified and appropriately-compensated staff. Continuous off-site supervision and analysis is necessary to better inform and prepare on-site supervision, as well as to help identify systemic risks at an early stage.

29. A thorough asset quality review (AQR) is essential to provide a full diagnostic of banking sector health. This is a key recommendation pending since the 2015 FSAP. The AQR needs to be completed no later than end-2020 to help understand the true value of assets on bank balance sheets, the valuation of collateral (including real estate), and the adequacy of provisioning against potential losses. To ensure the integrity of the process, the AQR needs to be carried out by reputable international assessors.

30. Decisive action is needed to address any residual banking sector vulnerabilities. Informed by the AQR and ongoing supervision, any other weak banks in the system need intense scrutiny with effective action plans and timely enforcement. The CBM is also closely monitoring the rapid growth of uncollateralized consumer lending – often having long maturities and higher interest rates than collateralized loans – and should implement as needed effective macroprudential measures to pre-empt the buildup of systemic risks.

uA01fig11

New Loan Origination

(Index, 2012 = 100; >1 year maturity)

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: CBM; and IMF staff calculations.

31. The CBM is continuing its efforts to improve the regulatory framework for the financial system. The credit registry has been modernized and now covers a broader range of financial institutions with additional information. The rules for asset classification have also been gradually tightened, including with the implementation of IFRS-9 in January 2018. Effective July 2019, asset classification rules have been tightened by reducing the possibility that adequate collateral could prevent a reduction in asset classification. The CBM adopted in July a decision to remove the remaining reference to “prime” collateral for asset classification, effective in 2020.

32. The CBM has prepared a comprehensive package of legislation that would harmonize banking laws with EU directives. Legislative approval is expected later this year. The new legislation will increase the minimum capital requirement for new banks from EUR 5 to EUR 7.5 million. Banks will be required to develop clear recovery plans, and the CBM will establish a resolution fund to be financed by banks, with a special resolution unit within the CBM. The deposit protection fund will double the coverage of insured deposits to EUR 100,000, gradually shorten the mandate payout time, and be permitted to use its resources to finance the transfer of insured deposits from unresolvable banks to healthy ones (purchase and assumption).

Figure 6.
Figure 6.

Montenegro: Credit Developments

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: CBM; and IMF staff calculations.
Figure 7.
Figure 7.

Montenegro: Banking Sector Developments

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: CBM; IMF FSI database; and IMF staff calculations.

33. NPL ratios are expected to further improve, driven by continued credit growth and improved debt service. Loan restructuring and NPL sales should play a smaller role than in the years following the global financial crisis. The so-called “Podgorica Approach” to facilitate out-of-court restructuring has now expired. There is also room to improve debt recovery ratios, compared to peers.

uA01fig12

EU and West. Balkans: Resolving Insolvency, 2018

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Source: World Bank, Doing Business 2018.

34. Montenegro still has many banks relative to its size. With 13 banks in a small country, high fixed costs and increasing regulatory costs, following the implementation of the envisaged Basel III prudential framework, will trigger additional earnings challenges for small banks. After the completion of the purchase of Société Générale’s subsidiary by OTP, the number of banks will fall to 12. The CBM should forcefully apply prudential regulation and grant any new licenses carefully. Empirical evidence suggests that good governance practices – ranging from the rule of law, regulatory quality, government effectiveness, control of corruption, effectiveness of the insolvency framework, and contract enforcement -usually correlates with lower financial intermediation costs.8

uA01fig13

Net Interest Margins of Banks in Montenegro and EU

(Percent)

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Source: Thorsten Beck, Aslı Demirgüç-Kunt and Ross Levine, 2000, “A New Database on Financial Development and Structure,” World Bank Economic Review 14, 597–605. Database updated July 2018. Note: Net interest margin defined as the accounting value of banks net interest revenue as a share of its interest-bearing (total earning) assets.1/ Simple average of current EU members; missing 2015–2016 Finland observations.

35. The AML/CFT regime needs to be further strengthened to mitigate financial stability risks. The new AML/CFT law has improved the legal framework, and the CBM has issued detailed guidelines to provide guidance to banks on ML/TF risk analysis, but actions are needed to strengthen AML/CFT supervision by developing risk-based tools and procedures for offsite monitoring and onsite inspections. The fit and proper tests for banks’ owners and managers need to be formalized and applied consistently.9

36. The investor citizenship program launched this year creates potential financial integrity and reputational risks that should be addressed. The authorities should ensure implementation of comprehensive due diligence measures on applicants, including on their source of wealth and funds, as well as good transparency practices, including publication of the names of the new citizens.

Authorities’ Views

37. The CBM stressed that the overall banking system has remained stable, highly liquid, and well capitalized. Apart from Atlas/IBM, the overall sector was profitable. They also stressed that they are moving to contain remaining pockets of vulnerability, including through continued efforts to strengthen a third weak bank. The improved credit registry and the tightened asset classification will improve credit risk assessment and reduce information asymmetries. The CBM is studying the increase in uncollateralized cash loans and plans to shortly introduce macroprudential measures.

38. The CBM acknowledged the need to further improve bank supervision. In line with staff advice, the CBM has established a supervisory committee to better the support senior management. The offsite unit will be strengthened with additional staff. A separate AML Directorate has already been formed, and additional staff are being hired. The CBM is working to make the supervisory approach more risk-based to better allocate scarce resources. The legislative package transposing pertinent EU banking directives, which is expected to be adopted in late 2019, will bring the CBM’s banking supervision and crisis management tools in line with EU practices. The CBM also reiterated its commitment to completing an AQR of the banking system by end-2020 and has begun creating an action plan, defining a timetable, and drafting terms of reference for independent international assessors.

C. External Competitiveness and Labor Markets

39. The external position is assessed to be weaker than fundamentals and desirable policy settings warrant (Annex IV). Since 2010, the REER has appreciated 4 percent, in line with regional peers. The EBA-lite current account model suggests that the REER is overvalued by 12 percent, while the REER regression model estimates the REER to be in line with fundamentals. On balance, staff believes that the REER is overvalued by 10 percent due to persistently large current account deficits, high unit labor costs, stagnant productivity, and weak goods export performance. Gross international reserves appear adequate.

uA01fig14

Real Effective Exchange Rate

(Index; 2010=100)

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: IMF INS database; and IMF Staff calculations.
uA01fig15

Volumes of Goods and Services Exports

(Index, 2006=100)

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: Monstat; and IMF staff calculations.

40. Labor market outcomes remain weak. Despite an improvement in recent years, labor force participation remains low, and the unemployment rate is still high at 15 percent. The informal economy employs an estimated quarter of the labor force, and more than 30 percent of workers are employed on temporary contracts, the highest rate in Europe.

  • Reduction of labor tax wedge: The tax wedge, at nearly 40 percent, is the second highest in the Western Balkans.10 A large tax wedge reduces incentives for employment in the formal sector, particularly for low-wage earners. The authorities intend to implement in the second half of 2019 a 2 percentage point reduction in employers’ health insurance contributions, which would reduce the cost of employment. Such a reduction will reduce revenues by about 0.5 percent of GDP. The authorities expect that an increase in the minimum wage (see below) will partially offset the revenues losses. The authorities should ensure that lost revenues are fully offset through a reduction in tax expenditures. They could also consider extending the 11 percent upper tax rate on personal income past end-2019, when it is currently set to expire.

  • Labor Law: Employees on temporary contracts usually experience lower job security and development opportunities than those on open-ended positions. Montenegro’s draft new labor law (expected to be approved in 2019) appropriately aims to ease the most rigid employment protections, including large severance payments under regular contracts. By narrowing the gap between temporary and regular contracts, the draft law aims to make the use of open-ended contracts more attractive. The law will also extend the maximum length of fixed term contracts from 24 to 36 months, with some greater exemptions for seasonal activities. Before the law is finalized, the authorities should also ensure that requirements for organizational charts and classification of positions does not impose an unreasonable administration burden on micro enterprises.

uA01fig16

Productivity and Labor Costs

(Index, 2008 = 100)

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: Monstat; WEO; and IMF Staff calculations.

Remittances in Montenegro

Registered inflows of remittances appear low, given the very high expatriated share of the Montenegrin population. About 38 percent of the population living in Montenegro has resettled abroad, mainly in several neighboring countries, which suggests a high dependency on remittances. However, Montenegro’s recorded remittance inflows are smaller than regional peers and remain lower than FDI inflows.

uA01fig17

Montenegrin Expatriates: Country of Settlement

(Percent, 2017)

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Source: World Bank.
uA01fig18

Remittances and FDI Inflows, 2017

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: National Authorities; WIIW FDI Database; and IMF staff calculations.

The actual magnitude of remittances may be much higher and could help explain the large share of the informal economy in Montenegro. Reported remittances are mainly based on bank reports and underestimate actual cash inflows. A steady flow of unreported cash transfers primarily supporting family incomes and new real estate construction could help entrench a high level of informality in the economy.

uA01fig19

High Protection of Regular Contracts Associated with Greater Temporary Employment

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: Eurostat and OECD.
uA01fig20

OECD Index of Regular Employment Protection

(Scale 0–6, 6=most restrictive)

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: OECD; and IMF Staff calculations.
uA01fig21

OECD Index of Temporary Employment Protection

(Scale 0–6, 6=most restrictive)

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: OECD; and IMF Staff calculations.

41. The authorities need to balance competing considerations for future decisions on the minimum wage. The government plans to increase the minimum wage 15 percent in the second half of 2019, the first increase since 2013. The net minimum wage will increase from EUR 193 to 222 per month, thus increasing modestly the ratio to the average wage from 38 to 42 percent This ratio and the absolute level of the minimum wage had been below regional peers but will now shift towards the regional average. The stagnant minimum wage had also not kept pace with increases in the poverty line. Yet, the hike exceeded both accumulated inflation and average wage gains of 6 percent since the last increase in 2013. In discussions with social partners, the government emphasized the importance of containing the fiscal impact of the minimum wage. For future discussions, the authorities are advised to assess the impact of prior minimum wage increases and consider a broad set of labor market indicators, including the poverty line, trends in average growth, productivity, and migration.

uA01fig22

Wages and Productivity Growth

(LHS: Index, 2012=100; RHS: Percent)

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: MONSTAT; Haver Analytics; ILO STAT Database; and IMF staff calculations.
uA01fig23

Net Minimum Wages, July 2019

(Euro / month)

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: Country authorities.1/ Republika Srpska.
uA01fig24

Net Minimum Wage and Absolute Poverty Line

(Euros per month)

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: Monstat.

Authorities’ Views

42. The authorities expect labor market reforms to have a positive impact on overall employment and informality. The authorities viewed the minimum wage increase and labor tax wedge as a package of measures negotiated with the social partners. They believe that employers would benefit from the reduction in the overall cost of employment while a minimum wage increase would help workers after a long period of stagnation. The authorities also believe that the minimum wage increase would force greater payment of salaries through formal means, thus raising tax revenues and partially offsetting the revenue loss from the tax wedge reduction. The authorities are of the view that the new labor law would significantly increase the flexibility of labor markets.

Staff Appraisal

43. Over the last two years, the Montenegrin economy has performed well, and public finances have improved. Growth is expected to moderate in 2019 as highway investment peaks. So long as external conditions remain stable, private investment and tourism should underpin continued growth of around 3 percent over the medium-term. The authorities have implemented most of the measures from their fiscal adjustment strategy begun in 2017. The underlying fiscal position (excluding highway investment) has improved by 3 p.p. of GDP since 2016.

44. High public debt still limits the room for countercyclical fiscal maneuver as well as the ability to invest for future growth. Notwithstanding recent progress, Montenegro lacks a strong track record of sustained fiscal discipline. To set the economy on a more durable path to stability and prosperity, a balance between debt reduction and more efficient public spending is needed. The primary surplus needs to be at least 2 percent of GDP over the medium-term for debt to reach safer levels. At the same time, resources need to be prioritized to where they deliver the highest economic and social returns. Improving technical capacity in public investment assessment and management is thus very important.

45. A more cautious and prudent approach to the Bar-Boljare highway is central to safeguarding fiscal sustainability. The authorities need to carefully evaluate this project against other uses of scarce resources. Financing the rest of the highway with debt would prevent the projected decline in debt over the medium term and likely jeopardize fiscal sustainability. The authorities should move cautiously with future phases of highway construction only after a new and credible feasibility study is completed. Outstanding questions about feasibility and financing must be resolved in a manner that does not jeopardize fiscal sustainability. Extra caution is needed with regard to possible PPP arrangements which could introduce significant contingent fiscal liabilities.

46. Fiscal reforms are needed to create space for a more growth-friendly budget. The authorities should formulate a disciplined medium-term budget framework that brings together short-term debt reduction and medium-term strategic fiscal priorities with more binding expenditure limits. Further expenditure reforms – including to government employment levels, tax expenditures, and pension reforms – would also increase fiscal space over the medium term for high-productivity capital spending and well-targeted social spending.

47. Recent measures to strengthen banking supervision are welcome. Robust action is needed to further improve supervision and address any remaining vulnerabilities. The structure of supervisory oversight is being strengthened. Its efficacy, however, depends on the development and employment of risk-based approaches to financial sector and AML/CFT supervision. An asset quality review should be completed no later than end-2020, with any identified weaknesses promptly addressed. The decisions to further refine the definition of non-performing loans to fully eliminate any role of collateral in asset classification and establish a supervisory committee are welcome. The transposal of EU banking directives into domestic law will also provide the authorities with new supervisory tools. The authorities should forcefully apply prudential regulation – including fit-and-proper requirements – and be judicious in granting any new bank licenses.

48. The proposed initiatives to improve labor market outcomes are well-motivated. Montenegro faces competitiveness challenges, and its external position is weaker than that consistent with medium-term fundamentals and desirable policy settings. Structural labor market impediments discourage greater labor force participation and the generation of formal sector employment. The authorities appropriately aim to reduce the cost of formal sector employment by reducing the labor tax wedge. It will important to offset the foregone revenues of this reform. The draft labor law also appropriately aims to reduce the gap in employment protection under temporary versus open-ended contracts. In setting the level of the minimum wage, the authorities should assess the impact of prior increases and consider a broad set of labor market indicators.

49. It is expected that the next Article IV consultation with Montenegro will be held on the standard 12-month cycle.

Figure 8.
Figure 8.

Montenegro: Labor Markets

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: Monstat; ILOSTAT; and IMF staff calculations.
Figure 9.
Figure 9.

Montenegro: Business Environment

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: World Bank, Doing Business.
Table 2.

Montenegro: Selected Economic Indicators, 2014–2024

article image
Sources: Ministry of Finance; Central Bank of Montenegro; Statistical Office of Montenegro; and IMF staff estimates and projections.

Includes extra-budgetary funds and local governments, but not public enterprises.

The authorities do not include the arrears of local governments in their definition of general government gross debt.

General government debt, including guarantees, net of central and local government deposits

General government debt, excluding guarantees, net of central and local government deposits

A negative sign indicates depreciation a REER depreciation.

CBM’s international reserves have been revised to exclude CBM’s holdings of Montenegrin government securities and reclassify SDRs for 2015–17.

Table 3.

Montenegro: Savings and Investment Balances, 2014–2024

(Percent of GDP, unless otherwise noted)

article image
Sources: Statistical Office of Montenegro; Ministry of Finance; and IMF staff estimates and projections.
Table 4.

Montenegro: Contribution to Real Gross Domestic Product, 2014–2024

(Contribution to real GDP growth)

article image
Sources: Statistical Office of Montenegro; Ministry of Finance; and IMF staff estimates and projections.
Table 5.

Montenegro: Consolidated General Government Fiscal Operations, 2014–2024 1/

(Millions of euro, GFSM 2014)

article image
Sources: Ministry of Finance; and Fund staff estimates and projections.

Includes central government budget and local governments.

Historical discrepancy refers to differences between reported financing and that derived from monetary and debt data.

Table 6.

Montenegro: Consolidated General Government Fiscal Operations, 2014–2024 1/

(Percent of GDP, GFSM 2014)

article image
Sources: Ministry of Finance; and Fund staff estimates and projections.

Includes central government budget and local governments.

Historical discrepancy refers to differences between reported financing and that derived from monetary and debt data.

Table 7.

Montenegro: Consolidated General Government Fiscal Operations, 2014–2024 1/

(Millions of euro)

article image
Sources: Ministry of Finance; and Fund staff estimates and projections.

Includes central government budget and local governments.

According to GFSM 1986, payments of loan guarantees or related to court rulings are recorded as government expenses.

To reflect pre-payments made for construction of Bar-Boljare highway that exceed the pace of actual capital expenditure.

Historical discrepancy is the difference between reported financing and that derived from monetary and debt data.

Table 8.

Montenegro: Consolidated General Government Fiscal Operations, 2014–2024 1/

(Percent of GDP)

article image
Sources: Ministry of Finance; and Fund staff estimates and projections.

Includes central government and local governments.

According to GFSM 1986, payments of loan guarantees or related to court rulings are recorded as government expenses.

To reflect pre-payments made for construction of Bar-Boljare highway that exceed the pace of actual capital expenditure.

Historical discrepancy is the difference between reported financing and that derived from monetary and debt data.

Table 9.

Montenegro: Summary of Accounts of the Financial System, 2014–2019

(Millions of euro, unless otherwise noted)

article image
Sources: Central Bank of Montenegro; and IMF staff estimates and projections.

CBM’s foreign assets have been revised to exclude CBM’s holdings of Montenegrin government securities and reclassify SDR holdings for 2015–17.

Table 10.

Montenegro: Balance of Payments, 2014–2024

(Millions of euro, unless otherwise noted; BPM6)

article image
Sources: Central Bank of Montenegro; and IMF staff estimates and projections.

The line reflects increase in GG liabilities, which captures pre-payments made for the construction of the Bar-Boljare highway that exceed the pace of actual capital expenditure.

CBM’s international reserves have been revised to exclude CBM’s holdings of Montenegrin government securities and reclassify SDRs for 2015–17.

Table 11.

Montenegro: Financial Soundness Indicators of the Banking Sector, 2012–2019

article image
Source: Central Bank of Montenegro.

Net interest income in percent of interest bearing assets.

Annex I. Risk Assessment Matrix1 (Scale – High, medium, or low)

article image
article image

Annex II. Public Debt Sustainability Analysis

Debt is sustainable under the baseline, if the authorities avoid a fiscal relaxation following the completion of the first phase of the highway and avoid fiscal costs related to further highway construction. However, debt sustainability and financing risks remain significant. General government debt (including guarantees) increased from 36 percent of GDP in 2006 to 79 percent of GDP in 2018. In the baseline, debt is projected to peak at 89 percent of GDP in 2020, though net debt (adjusted for government deposits) would peak in 2019, as the authorities pre-finance future Eurobond amortizations. Gross debt would decline to 62 percent of GDP in 2024, based on the completion of a fiscal adjustment began in 2017 and the maintenance of primary surpluses over the medium term. The projected debt trajectory is highly susceptible to shocks, especially a negative economic growth shock, but declines under all standard scenarios. Gross financing needs remain high, though the 2018 liability management operation reduced financing needs over 2019–21 by extending Eurobond maturities. Under the baseline scenario, debt begins a strong downward trend in 2021, but the authorities would still have to manage finances carefully to maintain market access.

Baseline and Realism of Projections

  • Background. Public debt is reported on a gross basis and includes only general government debt and government-issued guarantees, which comprised 6.2 percent of GDP in 2018.1 A key driver of the increase in public debt since 2014 has been an external loan to fund construction of the first section of the Bar-Boljare highway. Denominated in U.S. dollars, this loan is projected to increase the foreign currency share of public debt to 21 percent by 2020 from 4 percent in 2014.

  • Macroeconomic assumptions. Growth is expected to slow to 3.0 percent in 2019, below growth observed in 2017–18, as the pace of highway construction has peaked, and government consumption slows in line with fiscal adjustment. Growth is projected to slow further in 2020–21 to an average of 2.7 percent as highway investment spending ends. Growth would then increase to average 3.1 percent over 2022–24 as the modest supply-side effects of the highway begin.

  • Fiscal scenario. The baseline projections assume implementation of fiscal measures in 2019 to complete the underlying non-highway fiscal adjustment strategy, improving the non-highway primary balance to 3.4 percent of GDP. After the completion of highway spending in 2020, a large (2.7 percent of GDP) primary surplus emerges in 2021. The maintenance of a primary surplus of 2 percent of GDP over the medium term critically depends on the avoidance of new budgetary spending on the next phase of highway construction.

  • Eurobond amortizations. The authorities completed in 2018 two financing operations to partially pre-finance coming Eurobond amortizations. Leveraging a World Bank Policy-Based Guarantee (PBG), they borrowed €250 million from a syndicate of international banks, with a 2.95 percent interest rate and 12-year maturity. They also issued a seven-year €500 million Eurobond, of which €362 million was used to buy back part of the €1.1 billion in Eurobonds set to mature in 2019–21. The Eurobond carries a coupon rate of 3.375 percent. These two operations increased government deposits at the central bank in 2018 by €200 million, which were used to amortize the remainder (€169 million) of the 2019 Eurobond. The baseline assumes that the authorities can fully meet medium-term financing needs largely based on two assumed operations in 2019–2020. First, the baseline includes the issuance of a new €500 million Eurobond in 2019 that would allow the authorities to pre-finance the amortization of the remainder of the 2020 Eurobond (€321 million) and the 2021 Eurobond (€228 million). Second, the baseline assumes a second World Bank PBG, raising €155 million in 2020.

  • Heatmap and debt profile vulnerabilities. Risks from the debt level are deemed high as debt exceeds the 70 percent of GDP benchmark in 2014. Debt only falls below this level in 2022 in the baseline and expands in some shock scenarios. Proactive debt management has reduced gross financing needs below the 15 percent of GDP threshold in the baseline scenario, but this level is still exceeded in some shocks. Public debt held by non-residents (Eurobonds and the China Ex-Im Bank loan) also constitutes a vulnerability. Shocks to economic growth have the largest impact on the debt profile.

  • Realism of baseline assumptions. The median forecast errors for real GDP growth (actual minus projection) in 2009–2017 suggests on average an optimistic bias in staff’s past projections, possibly due to the impact of the Great Recession. The median forecast error for the primary balance suggests that staff projections have been somewhat pessimistic on average over this period. While the three-year adjustment in the cyclically-adjusted primary balance is very large (in the 4th percentile of observations for advanced and emerging economies over 1990 to 2011), most of the adjustment comes from the reduction in highway spending, which will occur automatically after the completion of the first phase in 2020.

  • Domestic debt markets. Further development of the domestic government debt market could help mitigate future financing risks. The stock of government securities is small and consists primarily of T-bills, which are mostly held by domestic banks. The authorities have received MCM TA on developing the local debt market. A domestic debt issuance in early 2019 successfully placed new domestic debt securities with banks and non-bank creditors, including retail customers. A more regular offering of domestic bonds has been integrated into the baseline, increasing the share of domestic debt as a share of total debt from 16 percent in 2018 to 20 percent in 2024.

Alternative Scenarios

Alternative scenarios show worse outcomes, reflecting historically weak fiscal outcomes and the still-incomplete fiscal adjustment. Under the historical scenario, in which projections are based on the average level of the primary balance over the last ten years, a primary deficit of 3.6 percent of GDP over 2020–24 would lead debt to increase to 94 percent of GDP by 2024. If the primary balance were to stay at the projected 2019 level of -1.4 percent of GDP (before the completion of the fiscal adjustment), debt would remain nearly stable around 80 percent of GDP, instead of declining to 62 percent of GDP in the baseline scenario.

Shocks and Stress Tests

Debt and gross financing needs would still decline over time under all standard stress tests.

Stress tests indicate that growth shocks would have a substantial effect on the debt path. Fiscal shocks, including a decision to fund the remaining phases of the highway with debt, would also have a major impact on fiscal sustainability.

Montenegro-Specific Stress Tests

  • Highway Phases 2–4. In this scenario, the authorities decide to proceed with the debt-financed construction of the remainder of the Bar-Boljare highway, which staff assumes would cost €1.2 billion, equally spent over 2022–24. Assuming a low spending multiplier of 0.2 during the construction phase because at least 70 percent of the inputs are imported and modest supply effects upon completion, economic growth would increase ¾ percentage point on average over 2022–24 relative to the baseline. In this scenario, the primary balance declines in line with highway spending, and the public debt ratio increases to 81 percent of GDP by 2024 (compared to 62 percent of GDP in the baseline). Gross financing needs would peak at 16 percent of GDP in 2023, 9 percentage points higher than in the baseline. This scenario demonstrates that a decision to take on new debt to complete the remainder of the highway could jeopardize fiscal stability and sustainability.

Standard Stress Tests

  • Growth shock. Under this scenario, real output growth rates are lowered during 2020 and 2021 by one standard deviation (3.4 percentage points), also lowering inflation and raising interest rates. The public debt ratio remains at 87 percent of GDP in 2020 before falling to 73 percent of GDP in 2024, while the gross financing needs ratio in 2021 increases 5 percentage points of GDP relative to the baseline.

  • Interest rate shock. This scenario examines the implications of an increase in interest rates on new debt by 249 basis points (the difference between the maximum past effective interest rate and the average interest rate in the projection period) in 2020–24. Debt increases by 1 percentage point in 2024 in this scenario relative to the baseline, while financing needs increase by 1 percentage point of GDP in 2024.

  • Combined macro shock. This scenario comprises a recession in 2020 and 2021, a 249 basis-point increase in interest rates, a real exchange rate shock, and a sharp rise in expenditures in 2020–21. It pushes the debt-to-GDP ratio up to 90 percent of GDP in 2020 and substantially increases gross financing needs.

  • Financial contingent liability shock. Expenditures increase in 2020 equivalent to 10 percent of the size of the banking sector, combined with a shock to GDP and interest rates. The shock results in a sharp increase in the debt ratio to 93 percent of GDP in 2020. Meanwhile, gross financing needs would peak at 22 percent of GDP in 2020 and stay well above the baseline over the medium term.

  • Primary balance shock. This scenario assumes an expenditure shock and a rise in interest rates leading to a 1.5 p.p. deterioration in the primary balance over 2020–21. The combined shocks lead to deterioration in the debt ratio by about 2 percent of GDP by 2024, while the impact on gross financing needs peaks at 2 percentage points of GDP in 2020.

  • Real exchange rate shock. The scenario assumes a 13 percent depreciation of the real exchange rate in 2020. The debt ratio would fall marginally from the baseline, because the impact from a larger GDP deflator on total debt outweighs the increase in the relatively modest foreign currency debt. This depends critically on the assumption of an exchange rate pass-through to inflation of 25 percent.

Figure 1.
Figure 1.

Montenegro: Public Sector Debt Sustainability Analysis (DSA) – Baseline Scenario

(in percent of GDP unless otherwise indicated)

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Source: IMF staff.1/ Public sector is defined as general government and includes public guarantees, defined as Public enterprises.2/ Based on available data.3/ Long-term bond spread over German bonds.4/ Defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.5/ Derived as [(r – π(1+g) – g + ae(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).6/ The real interest rate contribution is derived from the numerator in footnote 5 as r – π (1+g) and the real growth contribution as -g.7/ The exchange rate contribution is derived from the numerator in footnote 5 as ae(1+r).8/ Includes changes in the stock of guarantees, asset changes, and interest revenues (if any). For projections, includes exchange rate changes during the projection period.9/ Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.
Figure 2.
Figure 2.

Montenegro: Public DSA – Composition of Public Debt and Alternative Scenarios

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Source: IMF staff.
Figure 3.
Figure 3.

Montenegro: Public DSA – Stress Tests

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Source: IMF staff.
Figure 4.
Figure 4.

Montenegro: Public DSA Risk Assessment

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Source: IMF staff.1/ The cell is highlighted in green if debt burden benchmark of 70% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.2/ The cell is highlighted in green if gross financing needs benchmark of 15% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.3/ The cell is highlighted in green if country value is less than the lower risk-assessment benchmark, red if country value exceeds the upper risk-assessment benchmark, yellow if country value is between the lower and upper risk-assessment benchmarks. If data are unavailable or indicator is not relevant, cell is white. Lower and upper risk-assessment benchmarks are: 200 and 600 basis points for bond spreads; 5 and 15 percent of GDP for external financing requirement; 0.5 and 1 percent for change in the share of short-term debt; 15 and 45 percent for the public debt held by non-residents; and 20 and 60 percent for the share of foreign-currency denominated debt.4/ Long-term bond spread over German bonds, an average over the last 3 months, 17-Apr-19 through 16-Jul-19.5/ External financing requirement is defined as the sum of current account deficit, amortization of medium and long-term total external debt, and short-term total external debt at the end of previous period.
Figure 5.
Figure 5.

Montenegro: Public DSA – Realism of Baseline Assumptions

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Source : IMF Staff.1/ Plotted distribution includes all countries, percentile rank refers to all countries.2/ Projections made in the spring WEO vintage of the preceding year.3/ Not applicable for Montenegro, Rep. of, as it meets neither the positive output gap criterion nor the private credit growth criterion.4/ Data cover annual observations from 1990 to 2011 for advanced and emerging economies with debt greater than 60 percent of GDP. Percent of sample on vertical axis.

Annex III. External Debt Sustainability Analysis

External debt has increased by about 38 percentage points of GDP since 2007 to an estimated 168 percent of GDP in 2018. This increase was driven partly by the sharp increase in the general government external debt ratio, which tripled over this period and comprises 37 percent of Montenegro’s external debt. The current account deficit also continues to weigh adversely on external debt dynamics. Under the baseline, external debt is projected to increase to 180 percent of GDP in 2019 before slowly declining to 166 percent of GDP in 2024. The debt trajectory is highly sensitive to a range of shocks, particularly to a growth or a non-interest current account shock (i.e. tourism receipts). A depreciation of the euro would also raise external debt. Montenegro’s heavy dependence on external financing reinforces the importance of fiscal and structural reforms to safeguard market access.

1. At 168 percent of GDP at end-2018, external debt is high and projected to further increase to 180 percent of GDP in 2019 and slowly decline thereafter. More than one third of external debt is general government debt, which has increased by 31 percentage points of GDP since 2010. About half of external debt comes from the non-bank private sector, which is nearly evenly distributed between long-term intercompany debt and long-term loans contracted by private and public non-financial corporations. The share of private sector short-term debt (including non-resident bank deposits) is relatively small at 12 percent of external debt. Construction of the Bar-Boljare highway has played a key role in the increase in government external debt.

uA01fig25

Private External Debt

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: CBM and IMF staff estimates.Notes: Majority of private external debt outstanding at year-end is financial loans.

Shocks and Stress Tests

2. Standardized stress tests indicate that external debt is particularly sensitive to a variety of shocks. Current account shocks—possibly due to a decline in revenue from tourism, higher interest rates, and some overruns on highway construction costs—and a combined deterioration in the macroeconomic environment would also impact external sustainability, with significant implications for gross financing needs. In addition, external debt would be sensitive to a depreciation of the euro.

Standard stress tests

  • Growth shock. Under this scenario, baseline real GDP growth is permanently reduced by a one-half standard deviation calculated over the recent 10-year period ending in 2018. This corresponds to an average growth rate during 2020–24 of 1.2 percent, compared with baseline average growth of 2.9 percent. Under this scenario, the external debt ratio increases by 10 percentage points (compared to the baseline) to 176 percent of GDP in 2024.

  • Interest rate shock. This scenario examines the implications of an increase in nominal external interest rates on new debt (relative to the baseline) by a one-half standard deviation during 2020–24. Stable average external interest rates historically imply only a modest average increase in interest rates of 20 basis points in this scenario and, consequently, only a small increase in external debt by 1 percentage point to 167 percent of GDP by 2024.

  • Non-interest current account shock. This scenario permanently increases the non-interest current account by one-half standard deviation in 2020–24. Given historically-variable current account deficits, this amounts to an increase of 2.5 percentage points. In the absence of offsetting non-debt-creating flows, external debt increases by about 10 percentage points to 177 percent of GDP by 2024.

  • Combined macro shock. This scenario comprises a permanent ¼ standard deviation shock applied to the real interest rate, the growth rate, and the current account deficit during 2020–24. The combined shock pushes the external debt ratio up by about 10 percentage points to 176 percent of GDP by 2024.

  • Real exchange rate shock. The scenario assumes a one-time 30 percent devaluation in the real exchange rate in 2020 applied to the estimated stock of external debt in foreign currency (not in euros). For the public sector, this is mainly related to the construction of the highway, which represents 20 percent of public external debt. For the private sector, in the absence of data on currency breakdown, we have assumed that 100 percent is non-euro external debt, which results in an upper-bound estimate of the impact. Given the large stock of external debt, the shock increases the external debt-to-GDP ratio by 19 percentage points of GDP by 2024. Gross financing needs are correspondingly higher, by 10 percentage points of GDP, on average, over 2020–24 relative to the baseline.

Table 1.

Montenegro: External Debt Sustainability Framework, 2014–2024

(In percent of GDP, unless otherwise indicated)

article image

Derived as [r – g – r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Figure 1.
Figure 1.

Montenegro: External Debt Sustainability: Bound Tests 1/,2/

(External debt in percent of GDP)

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: International Monetary Fund, Country desk data, and staff estimates.1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.2/ For historical scenarios, the historical averages are calculated over the ten-year period, and the information is used to project debt dynamics five years ahead.3/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.4/ One-time real depreciation of 30 percent occurs in 2020.

Annex IV. External Sector Assessment

Staff assesses that Montenegro’s external position in 2018 was weaker than implied by fundamentals and desirable policies. A real exchange rate depreciation driven by wage restraint and productivity improvements based on structural reforms to strengthen competitiveness would help reduce imbalances over the medium term.

1. The current account has been in persistent deficit since Montenegro’s independence. After peaking at nearly 50 percent of GDP in 2008, the current account deficit has persisted at a level between 10 to 20 percent of GDP since 2010. In 2018, the current account deficit reached 17 percent of GDP, above its five-year average of 15 percent of GDP, boosted by imports for large-scale infrastructure projects and robust domestic demand. Trade in goods remained at a high deficit in 2018 at 44 percent of GDP. This deficit was partly offset by a continued, growing surplus in services trade (20 percent of GDP in 2018), primarily driven by the tourism sector. Primary and secondary incomes provided a surplus of 7 percent of GDP in 2018, reflecting in part growing remittances from expatriated workers (see Box 3 on remittances).

uA01fig26

Current Account Balance

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: CBM; and IMF staff estimates.

2. Montenegro’s goods export performance has been weak, and its goods trade with the EU remains lower than regional peers. Montenegro’s goods exports volume is estimated to have declined by 27 percent since 2007, principally due to a reduction in aluminum exports after the closure of KAP (aluminum smelter). Montenegro’s share in world goods exports has fallen since 2007, while its regional peers have seen expanding market shares. Compared to regional peers, Montenegro’s goods exports are more concentrated in non-EU Southeastern Europe rather than the EU. Services exports have increased steadily, more than doubling since 2007, driven by strong increases in tourism (see Figure 3 on tourism).

uA01fig27

Volumes of Goods and Services Exports

(Index, 2006=100)

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: Monstat; and IMF staff calculations.
uA01fig28

Trading partners by region, 2017

(Percent of total trade)

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Source: UN Comtrade database; and IMF Staff calculations.

Current Account

3. The current account model of the EBA-lite framework suggests that the current account deficit is larger than that suggested by medium-term fundamentals and desirable policies. The model estimated an unadjusted current account gap of -7.4 percent of GDP for 2018, with a current account norm of -10.3 percent of GDP, implying a current account gap of 7.4 percent of GDP and a REER overvaluation of nearly 20 percent1 If the highway project (which mostly explains the increase in the current account deficit since 2016) is treated as a one-off factor, the cyclically-adjusted current account deficit is estimated at 14.1 percent of GDP, implying an adjusted current account gap of 4.4 percent of GDP and a REER overvaluation of nearly 12 percent.

EBA-Lite Current Account Approach Results, 2018

(Percent of GDP)

article image
Source: IMF staff estimates

Exchange Rate Indicators

4. The real effective exchange rate (REER) has appreciated modestly since 2010, and the EBA-lite REER model estimates the REER to be in line with fundamentals. Since 2010, the REER has appreciated 4 percent. This is similar to the appreciation experienced by the other Western Balkans countries, but in contrast to the new EU member states (excluding Baltics), which saw a depreciation of the REER. In 2018, the REER registered an appreciation of 2.5 percent, driven by a positive inflation differential. From a medium-term perspective (2009–18), unit labor costs have been relatively stable since 2009, while labor productivity growth has also stagnated. While the EBA-lite REER regression model estimates the REER to be in line with fundamentals in 2018, data limitations make an accurate estimation of the REER norm difficult for Montenegro.2

uA01fig29

Real Effective Exchange Rate

(Index; 2010=100; increase signals appreciation)

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: IMF INS database; and IMF staff calculations.
uA01fig30

Productivity and Labor Costs

(Index, 2008 = 100; CPI based)

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: Monstat; WEO; and IMF Staff calculations.

5. Considering current account and exchange rate indicators, staff assesses the external position of Montenegro to be weaker than fundamentals and desirable policy settings. While the current account approach (adjusted) estimates a current account gap of -4.4 percent of GDP, the REER model estimates the REER to be in line with fundamentals. Both approaches suffer from shortcomings, including a short data series and missing data. On balance, staff assesses the external position to be weaker (rather than substantially weaker) than fundamentals and desirable policy settings due to these uncertainties and the results of the REER approach. The REER has also only appreciated modestly since 2010. A real depreciation through wage restraint and productivity improvements from structural reforms to strengthen competitiveness would help reduce economic imbalances over the medium term. The large current account deficit also reflects large fiscal deficits. The current account deficit is projected to decline over the medium term once highway construction concludes and the fiscal deficit improves. Nevertheless, the continued construction of large energy and tourism projects could continue to put pressure on the current account deficit in coming years.

Foreign Asset and Liability Position

6. The authorities are in the early stages of publishing information in the international investment position (IIP). The authorities are implementing the recommendations of a 2017 technical assistance mission by the Statistics Department to construct annual and quarterly IIP data and have released data for 2016 and 2017. The data show a net IIP of -189 percent of GDP in 2017, driven by the high level of foreign FDI in Montenegro. At end-2018, gross external debt reached an estimated 168 percent of GDP and is expected to peak around 180 percent of GDP in 2019. About a third of external debt is government debt, which has increased by 32 percentage points of GDP since 2010 due to Eurobond issuances and borrowing from China Ex-Im Bank to finance highway construction.

uA01fig31

Total External Debt

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: CBM; and IMF staff estimates.

Capital and Financial Account Flows

7. FDI inflows finance most of the current account deficit. Annual net FDI has averaged 12 percent of GDP since 2010, compared to an average current account deficit of 15 percent of GDP during this period. Gross FDI inflows of nearly 9 percent of GDP in Montenegro in 2018 were high compared to regional peers. Large government Eurobond issuances have increased net portfolio investment liabilities as government financing needs have grown, and other investment flows also increased in 2015–18 as the government received large external loans from China Ex-Im Bank for highway construction and secured several syndicated bank loans from international banks. After significant deleveraging of banks’ external liabilities over 2009–12, banks’ external liabilities have declined more slowly since 2013.

uA01fig32

FDI Inflow, 20181

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: WIIW, FDI database; and IMF Staff calculations.1/ Based on BPM6, directional principle.

International Reserve Adequacy

8. Montenegro’s gross international reserves are estimated to be adequate. Montenegro has adopted the euro as its currency, which provides a strong monetary anchor but does not entail access to the Eurosystem. The central bank’s reserves are primarily a function of banks’ required and excess reserves and central government deposits at the CBM. Reserves stood at 23 percent of GDP at end-2018, above standard rules of thumb (months of import cover, short-term external debt, and bank deposits). Montenegro’s reserves are estimated at 159 percent of the standard IMF metric for reserve adequacy and projected to further exceed the ARA metric in 2019 as the government further increases its CBM deposits following the anticipated issue of an additional Eurobond.3

uA01fig33

CBM Liabilities and Capital

(percent of GDP)

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Source: Central Bank of Montenegro
uA01fig34

Montenegro: Decomposition of the ARA Metric for International Reserves

(In percent of GDP)

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: Montengrin authorities; and IMF staff calculations.

Annex V. Implementation of Past IMF Recommendations

In the 2018 Article IV consultation, Directors stressed the importance of continued fiscal adjustment to reduce debt and meet financing needs, sustained efforts to strengthen the financial sector, and fiscal and structural reforms to support higher and more inclusive growth.

article image
article image

Annex VI. Implementation of 2015 FSAP Recommendations

article image
article image
article image
article image

“I-Immediate” is within one year; “NT-near-term” is 1–3 years; “MT-medium-term” is 3–5 years.

Annex VII. Public-Private Partnerships Framework Assessment

1. Public and private investment have been key drivers of Montenegro’s economic growth. Private investment increased to 19 percent of GDP in 2018, while public investment similarly reached nearly 11 percent of GDP in 2018. Growth in the private capital stock has been driven primarily by investments in tourism facilities, and energy production/transmission. On the public side, the construction of the first phase of the Bar-Bojlare highway has greatly increased public investment Still, the total capital stock in Montenegro remains below the average of neighbors.

uA01fig35

Montenegro: Public and Private Investment

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: Monstat; Ministry of Finance; and IMF staff calculations.
uA01fig36

Total and PPP Capital Stock, 2015 1/

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: Public Infrastructure in the Western Balkans IMF Departmental Paper, using IMF Fiscal Affairs Department database; and IMF staff calculations.1/ 2015 is last observation in FAD database.

2. Investment through public-private partnerships (PPPs) is limited. At less than 4 percent of GDP in 2015, the PPP capital stock remained in line with the average for emerging Europe but below the average of emerging market economies worldwide (6 percent of GDP). The experience with PPP projects in the Western Balkans has been limited in part due to the small size of national markets, inadequate legal and institutional frameworks, and perceived regional political risks.

3. Montenegro seeks to increase the use of PPPs in future investments. With general government debt (including guarantees) reaching nearly 80 percent of GDP in 2018, financing the remainder of the highway with debt could jeopardize fiscal sustainability. The authorities are considering the feasibility of constructing further phases through a PPP structure. The authorities also plan to auction airport concessions.

4. PPPs can deliver benefits but also bring fiscal risks. If properly managed, PPPs can raise private capital and channel expertise to raise the efficiency of investments. However, PPPs also pose risks for fiscal management, especially if used primarily to bypass traditional budgetary constraints. While the use of a private partner reduces the upfront use of public funds to start a project, the net cost to the government is the same in theory, with the cost paid over time either as foregone user fees or payments to the private partner. Governments often bear residual risks in such contracts, including by providing revenue guarantees.

5. It is critical to build a proper legal framework and institutions to promote good projects and manage fiscal risks from PPPs. The authorities expect to adopt a new Law on PPPs in 2019. The main strengths and weaknesses of the draft law and PPP-related institutions (compared with best practices identified by the Fiscal Affairs Department) are:

  • The draft PPP law clearly defines PPPs and broadly applies to nearly all PPPs. It is important to avoid fragmentation of the regulatory framework. Montenegro’s draft law has broad coverage, with the exception of natural resources concessions, which will be covered by a separate law.

  • However, PPPs are not integrated with the budget and overall investment strategy The PPP process will be held outside the budget cycle, resulting in two project pipelines. This process risks creating a bias towards PPPs, accepting lower value for money, and failing to internalize their fiscal risks.

  • Positively the Minister of Finance will be able to veto PPP projects due to their potential fiscal impact. PPPs should pass through a gateway process that empowers the Minister of Finance to stop any projects that are fiscally unaffordable. According to the draft PPP law, a proposed PPP (including one implemented by a municipality) would have to obtain the positive opinion of the Ministry of Finance.

  • The process to review PPPs and estimate value for money should be improved. The Montenegrin Investment Agency will check compliance with financial objectives, but as the promoter and evaluator of PPPs, the agency may have a conflict of interest, even if separate parts of the agency will handle these functions. The Ministry of Finance currently lacks the technical capacity to analyze the value of PPP projects.

  • Mechanisms for PPP bidding and unsolicited proposals are generally well developed. The draft Law on Public Procurement, written with the EU legal framework in mind, should ensure competitive bidding processes for PPPs. The draft law requires that unsolicited proposals be awarded under equal conditions to other PPPs. The authorities should also require outside verification of the feasibility analysis for unsolicited proposals.

  • The framework to analyze and manage fiscal risks needs to be improved. The authorities do not plan to implement a ceiling on the stock of PPPs or PPP-related payments. Such ceilings can help contain fiscal costs and provide incentives for project prioritization (including at the municipal level). Similarly, the Ministry of Finance does not currently possess the resources to properly analyze fiscal risks coming from PPPs.

  • The authorities should implement procedures to provide transparent accounting and reporting of PPPs. Accounting for PPPs in line with international standards contributes to fiscal transparency and provides the government with vital information to help understand the potential fiscal costs of PPPs. Transparent accounting also helps reduce the incentive to use PPPs to “hide” public investment by pushing them off balance sheet to escape fiscal constraints.

Annex VIII. Montenegro’s Government Wage Bill

1. Montenegro’s government wage bill remains high. The general government wage bill peaked at 11.5 percent of GDP in 2012 and declined to 9.8 percent in 2018, driven more by strong nominal GDP growth than spending restraint. In the Western Balkans, Montenegro has the highest wage bill as a percent of GDP – excepting Bosnia and Herzegovina, which has a complex government structure.

uA01fig37
Sources: Ministry of Finance; IMF FAD Expenditure Assessment Tool; and IMF staff calculations.

2. Government employment appears high, even considering Montenegro’s small size. In 2017, government employment accounted for 10 percent of the working age population in Montenegro, above the Western Balkan average of 8 percent. Montenegro’s small population (approximately 622,000) is an obstacle to achieving economies of scale. Still, among a sample of other small European countries, Montenegro’s ratio stands out, only exceeded by Iceland and Latvia.

uA01fig38
Sources: World Bank Database; IMF FAD Expenditure Assessment Tool; and IMF staff calculations.

3. Government wage growth has exceeded that in the private sector in recent years. In 2016, government employees were granted a wage increase averaging 8 percent. In 2016 and 2017, the carryover impact of the wage increase was largely responsible for increases in the nominal wage bill.

uA01fig39
Sources: Monstat; Ministry of Finance; and IMF staff calculations.

4. Government wages have been partially frozen since 2016. Across-the-board wage increases were not granted in 2017–19. The authorities also reduced the salaries of senior officials by 8 percent in the 2017 budget, followed by a further reduction of 6 percent later in the year. Average government wage growth declined to approximately zero in 2018.

5. The authorities adopted an ambitious public administration optimization plan in 2018. Besides reducing the level of employment, the authorities aim to improve HR management, enhance efficiency, and deepen coordination with municipal governments. Relative to 2017 levels, the authorities aim to reduce by 2020 central government employment by 5 percent and local government employment by 10 percent. These targets would be achieved through a combination of strict limits to new hiring, termination of existing fixed-term contracts, and consensual termination of employment.

Table 1.

Montenegro: Progress on Public Sector Optimization, 2018

article image
Source: Ministry of Public Administration

6. Initial progress on employment reductions in 2018 was disappointing. The authorities aimed to decrease general government employment by 3.5 percent in 2018, but employment increased a further 1.2 percent. Although local governments reduced employment by 3.9 percent in 2018, the central government grew by 2.8 percent, led by new hiring in health and education.

Figure 1.
Figure 1.

Employment Growth Comparisons

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: Ministry of Finance; MONSTAT; and IMF staff calculations.

7. If implemented, employment reductions would reduce the government wage bill to 8.9 percent of GDP in 2020, versus staff’s current projection of 9.5 percent of GDP. The current projection (baseline) more conservatively assumes that government employment will not change over the projection period and that the partial wage freeze will continue through 2019, after which nominal wage growth will resume.

uA01fig40

General Government Wage Bill

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 293; 10.5089/9781513513720.002.A001

Sources: Ministry of Finance; and IMF staff calculations.

8. A successful employment optimization would be supported by better monitoring tools, improved transparency, and effective implementation at the local level. So far, optimization efforts have been focused on downsizing, while other key elements outlined in the plan (HR planning, increasing efficiency and productivity) are lagging. Cross-country experience suggests that wage bill reductions achieved during periods of fiscal adjustment are rarely maintained over the long term. Therefore, the authorities are advised to focus on:

  • Functional analysis: Functional reviews are instrumental to successful wage bill optimization and should be treated with high priority, but the process has not been completed, hindering the identification of redundancies.

  • Severance packages: To ensure that the severance packages do not suffer from adverse selection, there should be limits on the number of available packages and alternatives for employees who were not admitted into the optimization program.

  • HR management: To mitigate the risk of a migration to SOEs, the Ministry of Public Administration is creating a registry of former public employees who received severance packages.

  • Transition of employees to private sector: The authorities should carefully take stock of active labor market policies to facilitate transitions to the private sector. Promotion of early retirements should be avoided. The plan to offer zero interest credit from the Investment and Development Fund (IDF) is not well targeted.

  • Data integration: Comprehensive access to employee-level data necessitates the merger of salary and personnel databases and the expansion of coverage to more employees. Combining personnel and payroll database with stricter audits would help identify ghost workers. Data-driven monitoring will be especially important given the reductions and shifts of responsibilities related to EU pre-accession requirements.

  • Cooperation across governance levels: The collection of employee data at the local level has been challenging. Implementation of the optimization needs to be sustained at the local level, which will require enhanced cooperation with municipal governments.

Annex IX. Recommendations to Strengthen AML/CFT Supervision

1. Montenegro faces money-laundering-related risks to financial stability, particularly from the banking sector. The CBM’s work as the AML/CFT supervisor for the banking sector is informed by the 2015 ML/TF National Risk Assessment (NRA) analysis and conclusions, including that the banking sector is the riskiest segment of the financial sector. The authorities have initiated an update to the NRA in 2018, which is expected to be finalized by September 2019.

  • Conduct a sectoral risk assessment of the banking sector, and other sectors under CBM supervision, to improve understanding of ML/TF risks and to keep the sectoral risk assessments up-to-date.

2. The CBM routinely gathers information from banks for the purposes of AML/CFT on-site inspections but an offsite monitoring function should be established. The information gathered by the CBM includes data on the bank’s customer base, suspicious transactions, nonresident customers, politically exposed persons (PEPs), and internal controls. These data are requested two weeks before an on-site inspection and are used solely for the on-site work.

  • Expand the information questionnaire by building on the results of the sectoral risk assessments and include relevant data on non-resident clients and cross-border activity, to be collected periodically (e.g. annually, semi-annually) from all reporting entities.

3. CBM should have a formalized process for evaluating a bank’s ML/TF risk profile. The data already gathered by the CBM for on-site inspection may provide some understanding of the relative level of ML/TF risks faced by banks, but formalized risk profiles of individual financial institutions have not been developed.

  • Develop an institutional risk assessment model, using the data from the expanded information questionnaire as input, for evaluating the ML/FT risk profiles of all financial institutions under CBM supervision.

4. The on-site inspection schedule and the inspections’ focus should be guided by a risk-based approach. The CBM conducts on-site inspections in 70–100 percent of all banks every year, and each inspection is full scope, covering the same AML/CFT topics. The inspection usually involves all the CBM’s AML/CFT staff (4–5 persons) and lasts around three weeks, followed by two weeks of writing the inspection report. Implementation of risk-based rather than compliance-based supervision will allow adjusting both the frequency and scope of the inspections, leading to more efficient allocation of limited resources.

  • Adjust the inspection schedule, using the results of the institutional risk assessment model, to ensure supervisory resources are allocated based on the ML/FT risk profile of financial institutions.

  • Introduce thematic inspections targeted at implementation of specific AML/CFT requirements to ensure coverage of higher-risk areas.

5. AML/CFT supervisory procedures, including fit and proper tests for banks’ managers and owners, need to be adequately formalized. The CBM is responsible for application of the licensing controls for banks but lacks formalized procedures for gathering or verifying relevant information. The CBM may request information from other agencies (e.g. criminal records from the Ministry of Justice) whenever it suspects that the information submitted by the potential managers or owners is inaccurate or insufficient. The CBM also lacks an AML/CFT-specific manual for offsite monitoring and on-site inspections, such as procedures for sampling customer files and transaction records. The CBM has imposed sanctions on banks, including warnings and two misdemeanor applications in the past two years, but lacks formalized procedures for determining the type and the amount of sanctions based on the severity of identified breaches of the AML/CFT requirements.

  • List the minimum level of procedures and fit and proper tests that need to be followed in every application for a banking license or for a change of ownership or management functions regardless of the supervisor’s suspicion.

  • Develop an AML/CFT-specific supervisory manual, including procedures for offsite monitoring and on-site inspections (full scope and thematic).

  • Develop procedures for determining sanctions and remedial actions to ensure that effective, proportionate and dissuasive actions are applied.
1

See Box 1 of the CBM’s Financial Stability Report 2018 for additional background information on the Atlas/IBM intervention.

2

See the 2017 Selected Issues Paper, Chapter 1 “Accounting for the Highway in the Macroeconomic Framework” for a discussion of the impact of the highway on growth.

3

With the Eurobond issue, the central government will accumulate sizeable deposits as pre-financing for 2020/21 Eurobond amortizations. Net of deposits, general government debt with guarantees will increase from 72 percent of GDP in 2018 to 76 percent of GDP in 2019.

4

See 2017 Selected Issues Paper, “Pension Reform Priorities.”

5

According to Montenegro’s Law on Budget and Fiscal Responsibility, the general government fiscal deficit should not exceed 3 percent of GDP, while general government debt should not exceed 60 percent of GDP. If the debt ratio exceeds 60 percent of GDP due to investment projects, the government must propose a reduction program for a period not exceeding five years (which the government proposed in 2017).

6

See Annex VII for an assessment of the strengths and weaknesses of the current PPP management framework.

7

The coastal municipality of Tivat lost approximately EUR 2 million in deposits. The Finance Ministry reported that the municipality had secured short-term loans to manage resulting short-term liquidity issues and that the situation was manageable.

8

See Can Good Governance Lower Financial Intermediation Costs? By Mariusz Jarmuzek and Tonny Lybek, IMF Working Paper WP 18/279.

9

See Annex IX for a list of recommended actions to strengthen AML/CFT supervision.

10

See 2018 Article IV Selected Issues Paper, “Labor Market Outcomes in Montenegro: Challenges and Policy Options”

1

The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability of 30 percent or more). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly.

1

Existing government guarantees are mostly directed to infrastructure and SMEs, often in conjunction with the EBRD. Since peaking at 11.6 percent of GDP in 2012, guarantees fell to 6.2 percent of GDP in 2018, as the authorities have been more cautious in issuing guarantees. The authorities plan to issue 1.5 percent of GDP in guarantees in 2019. Data on public enterprises are not available.

1

Staff has revised the data on the percentage of overseas population as a share of the national population, filling in missing data on Montenegrins living in Turkey. As a result, the share of the overseas population increases from 22 to 42 percent, resulting in an increase in the fitted current account deficit from 7.5 to 10.3 percent of GDP in 2018. Data on the capital control index were also not available for Montenegro, so Serbia was used as a proxy.

2

As in the current account approach, staff has revised the data on the percentage of overseas population as a share of the national population. The REER regression model also did not estimate a country fixed effect for Montenegro, so staff has taken the averages of the fixed effects of Serbia, Albania, and Croatia as a proxy. The level of the country fixed effect can make a significant difference to the calculation of the REER norm and is significantly different from the level used last year, using the former EBA lite methodology.

3

See 2018 Selected Issues Paper “Reserve Adequacy” for details on the application of the reserve adequacy methodology to Montenegro.

Same Series

Other IMF Content

Other Publishers

  • Collapse
  • Expand
Cover IMF Staff Country Reports
Montenegro: 2019 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Montenegro
Author:
International Monetary Fund. European Dept.
Volume/Issue:
Volume 2019: Issue 293
Publisher:
International Monetary Fund
ISBN:
9781513513720
ISSN:
1934-7685
Pages:
88
DOI:
https://doi.org/10.5089/9781513513720.002

Selected Sub-Components of Pillar 1. Institutions, 2018

(Index: 1–7, 7=best performer; 9 lowest indicators out of 12 total)

Real GDP Growth Decomposition

(Percentage point contribution to growth)

General Government Debt with Guarantees

Percent of GDP

General Government Primary Fiscal Balance

(Percent of GDP)

Bank Lending by Sector 1/

(Percent, year-on-year)

Real GDP Growth Decomposition: 2018–2024

(Percentage point contribution to growth)

Highway/Fiscal Adjustment: Contribution to GDP Growth

(Percentage point contribution to real GDP growth)
Figure 1.

Montenegro: Real Sector Developments
Figure 2.

Montenegro: Fiscal Developments
Figure 3.

Montenegro: Tourism Developments

General Government Primary Fiscal Balance

(Percent of GDP)

General Government Debt with Guarantees

(Percent of GDP)
Figure 4.

Montenegro: Expenditure Efficiency
Figure 5.

Montenegro: Fiscal Scenarios for Highway Completion

General Government Debt with Guarantees

(Percent of GDP)

New Loan Origination

(Index, 2012 = 100; >1 year maturity)
Figure 6.

Montenegro: Credit Developments
Figure 7.

Montenegro: Banking Sector Developments

EU and West. Balkans: Resolving Insolvency, 2018

Net Interest Margins of Banks in Montenegro and EU

(Percent)

Real Effective Exchange Rate

(Index; 2010=100)

Volumes of Goods and Services Exports

(Index, 2006=100)

Productivity and Labor Costs

(Index, 2008 = 100)

Montenegrin Expatriates: Country of Settlement

(Percent, 2017)

Remittances and FDI Inflows, 2017

(Percent of GDP)

High Protection of Regular Contracts Associated with Greater Temporary Employment

OECD Index of Regular Employment Protection

(Scale 0–6, 6=most restrictive)

OECD Index of Temporary Employment Protection

(Scale 0–6, 6=most restrictive)

Wages and Productivity Growth

(LHS: Index, 2012=100; RHS: Percent)

Net Minimum Wages, July 2019

(Euro / month)

Net Minimum Wage and Absolute Poverty Line

(Euros per month)
Figure 8.

Montenegro: Labor Markets
Figure 9.

Montenegro: Business Environment
Figure 1.

Montenegro: Public Sector Debt Sustainability Analysis (DSA) – Baseline Scenario

(in percent of GDP unless otherwise indicated)
Figure 2.

Montenegro: Public DSA – Composition of Public Debt and Alternative Scenarios
Figure 3.

Montenegro: Public DSA – Stress Tests
Figure 4.

Montenegro: Public DSA Risk Assessment
Figure 5.

Montenegro: Public DSA – Realism of Baseline Assumptions

Private External Debt

(Percent of GDP)
Figure 1.

Montenegro: External Debt Sustainability: Bound Tests 1/,2/

(External debt in percent of GDP)

Current Account Balance

(Percent of GDP)

Volumes of Goods and Services Exports

(Index, 2006=100)

Trading partners by region, 2017

(Percent of total trade)

Real Effective Exchange Rate

(Index; 2010=100; increase signals appreciation)

Productivity and Labor Costs

(Index, 2008 = 100; CPI based)

Total External Debt

(Percent of GDP)

FDI Inflow, 20181

(Percent of GDP)

CBM Liabilities and Capital

(percent of GDP)

Montenegro: Decomposition of the ARA Metric for International Reserves

(In percent of GDP)

Montenegro: Public and Private Investment

(Percent of GDP)

Total and PPP Capital Stock, 2015 1/

(Percent of GDP)
Figure 1.

Employment Growth Comparisons

General Government Wage Bill

(Percent of GDP)