Former Yugoslav Republic of Macedonia: IMF Executive Board Concludes the Fourth Post-Program Monitoring Discussion

Press Release No. 15/16 January 27, 2015

On January 15, 2015, the Executive Board of the International Monetary Fund concluded the fourth Post-Program Monitoring (PPM)¹ with the Former Yugoslav Republic of Macedonia and considered and endorsed the staff appraisal without a meeting.²

Macedonia’s economic growth is accelerating, driven by strong exports, public infrastructure projects and private consumption. At 3½ percent, growth is about 2 percentage points above the average for south-eastern Europe, and has allowed the unemployment rate to further recede to 27.9 percent. Monetary policy has been supportive, and private credit growth is returning to pre-crisis averages. The fiscal deficit target was adjusted from 3.5 to 3.8 percent of GDP as revenues came in lower than budgeted, which has resulted in a stronger-than-expected boost to the economy.

The short-term outlook appears broadly stable. The external position has been improved thanks to a €500 million Eurobond issuance in July that halted the decline in reserves and pre-financed the repayment of external debt maturing in 2015. The current account deficit, projected below 3 percent of GDP, would remain largely covered by foreign direct investment (FDI) inflows.

Public sector debt is expected to continue to rise to about 52 percent of GDP by 2019, driven by an increase in the debt of both the general government and non-financial state-owned enterprises (SOEs), projected respectively at 38.1 and 6 percent of GDP at end-2014.

Near-term risks primarily include a stalling recovery in the Euro area, which would weigh on external demand and potentially weaken—or postpone—FDI inflows. Energy supply disruptions resulting from the geopolitical conflicts would rapidly increase capacity constraints. Continued deflation—which has recently eased but averaged 0.3 percent year-on-year through December—could complicate fiscal adjustment. Regulatory spillovers from EU parent banks, particularly through differential treatment of home and host central bank and government securities for risk-weighted asset computation, may complicate the conduct of monetary policy.

Executive Board Assessment³

In concluding the fourth Post-Program Monitoring with the Former Yugoslav Republic of Macedonia, Executive Directors endorsed the staff’s appraisal as follows:

The improving economic outlook and employment situation are encouraging. The jobs and growth agenda should remain a top policy priority. Efforts should focus on alleviating key constraints for domestic firms, which generally operate under strong liquidity constraints, so as to ensure a handover to private sector-led growth. Key measures would include enforcing payment discipline in both public and private sector contracts, as well as upgrading the professional status of inspection bodies, clarifying their mandate, and streamlining their work.

The current public-sector led growth strategy will require careful expenditure prioritization if consolidation is to proceed as planned. In the absence of further tax policy changes to boost revenues, a comprehensive spending review that seeks to minimize the growth impact of current expenditure compression should be undertaken. Investment spending should target gaps in transport and energy infrastructure to maximize the payoff for medium-term growth. At the same time, with public debt rising steadily over the next years, the authorities should aim at frontloading fiscal consolidation. This will help secure compliance with the envisaged rules of a 3 percent of GDP deficit ceiling and a 60 percent of GDP debt threshold by 2017.

Renewed presence in international capital markets highlights the role of public debt management in supporting external sustainability. To further reduce risks, the debt management strategy should encompass the debt of SOEs as well as contingent liabilities, particularly in managing currency risk. Importantly, increased reliance on foreign currency borrowing has implications for external sustainability and the conduct of monetary policy through its impact on central bank reserve developments and domestic liquidity.

The monetary easing cycle has reached its end. The combination of relaxed financial conditions and tight prudential regulation has helped revive credit growth while preserving the health of the financial sector. The focus of monetary policy henceforth should be exclusively on maintaining the attractiveness of holding denar-denominated assets in support of the exchange rate peg. High banking sector liquidity and falling currency spreads argue against further easing.

IMF credit outstanding to Macedonia has fallen below the relevant threshold of 200 percent of quota at end-2014 and current risks to external sustainability or capacity to repay do not warrant an extension of the PPM, which will be discontinued.