OREANDA-NEWS. July 30, 2015. Executive Board of the International Monetary Fund (IMF) today approved a 22-month Stand-By Arrangement for the Republic of Kosovo, in an amount equivalent to SDR 147.5 million (about €184 million, 250 percent of Kosovo’s quota in the IMF).The program’s approval enables the immediate disbursement of SDR 28.1 million (about €35 million).

The program mainly aims at (i) preserving low public deficits and debt by containing current spending, while creating fiscal space for growth-enhancing capital spending; (ii) lifting Kosovo’s economic potential by removing key structural impediments to growth, including by creating a more conducive environment for private activity and investment, upgrading Kosovo’s infrastructure, and strengthening bank intermediation; and (iii) catalyzing support from other multilateral and bilateral creditors.

Following the Executive Board’s decision, Mr. Min Zhu, Deputy Managing Director and Acting Chair, issued the following statement:

“Despite relatively resilient growth and a stable financial sector, Kosovo faces the dual challenges of maintaining fiscal credibility and debt sustainability and increasing its growth prospects. The Fund-supported program will help the authorities meet these challenges by preserving financial stability and low debt, rebuilding the government’s bank balances, and creating conditions for a more dynamic economy and better-balanced growth. Achieving these objectives will require the authorities’ strong and continued commitment to the program and the timely implementation of all measures.

“Strengthening public finances is a key plank of the program, which includes measures to keep the deficit within the authorities’ fiscal rule while improving the composition of the budget by deflating unproductive current spending. At the same time, it creates space for much-needed infrastructure upgrade through donor-financed capital investments in key development areas, under appropriate safeguards to preserve fiscal credibility and ensure continued debt sustainability. As the fiscal consolidation takes hold, restoring government bank balances to adequate levels will be important for this euroized economy.

“Under the program, financial sector reforms, including the adoption of an emergency liquidity assistance framework in line with international best practice and the full rollout of risk-based supervision to all banks, will make Kosovo’s already-healthy banking sector sounder and safer. The program will also seek to further identify and, as appropriate, address potential structural impediments to bank lending, thus allowing the financial sector to more fully support economic growth.

“Structural reforms under the program will be critical to moving Kosovo away from its current remittance-driven growth model and toward one that is led by production and trade. To this end, the program includes measures to improve Kosovo’s competitiveness and business environment. In particular, the introduction of a public wage rule linked to a macroeconomic indicator will help contain high labor costs, while implementation of public procurement reform should increase transparency and oversight.”

Annex

Recent Economic Developments

In 2014, growth in Kosovo slowed to an estimated 2.7 percent of GDP, from 3.4 percent the previous year. Key reasons include the protracted political stalemate following the 2014 general elections, as well as the accident in the main energy plant that led to electricity cut-offs and higher imports. Low energy prices and the historically low inflation environment in the euro area have brought inflation into negative territory since end-2014. Given the narrow productive base and high dependence on imports, the external trade accounts have remained in large deficits (around 30 percent of GDP), but they have been mostly financed by stable, non-debt creating financial flows, such as remittances and official transfers. International reserves fell in 2014, but still remain at safe levels.

Sharp increases in public wages and social pensions ahead of last year’s elections, together with ill-targeted benefits to interest groups, have led to a significant increase in current spending. The budget deficit stayed within the fiscal rule last year, but only thanks to a 2 percentage point of GDP capital underspending. Public debt remains low, well below 20 percent of GDP.

Banks are in good shape, with liquid assets covering about 40 percent of short-term liabilities and capital adequacy ratios well above regulatory requirements. Asset quality is also improving, as witnessed by NPLs now below 8 percent of total loans. Credit growth is accelerating on the back of declining interest rate spreads. Despite this, credit penetration remains low at some 35 percent of GDP.

Despite steady growth since independence, GDP per capita of about €3000 remains well below standards in other Western Balkan countries. In addition, very low employment ratios (particularly among women and youth) remain a significant social concern.

Program Summary

The Stand-By Arrangement will support the authorities’ program to maintain macro-fiscal stability and foster growth and competitiveness. Consistent with this, the objectives of the authorities’ program are:

• Promoting fiscal consolidation and rebuilding government bank balances over the program period. Following a large pre-electoral relaxation, fiscal adjustment is required to arrest the rapid growth in unproductive current spending, create space for priority areas such as infrastructure projects, and safeguard low public debt. Because of this, the program envisages a continued freeze on wages and benefits (already initiated in the 2015 budget), as well as some tax measures.

• Further enhancing financial stability. The Central Bank of Kosovo is in the process of adopting a new framework for emergency liquidity assistance (key in a euroized economy) in line with best international practice. In addition, recently adopted risk-based supervision will be rolled out to all banks in the course of the program, allowing for a better identification of any risks building in the sector. Finally, development of a macroprudential toolkit and operationalization of the financial stability committee will be important elements of enhanced financial stability.

• Boosting competitiveness and productive capacity. The program includes a number of structural reforms aimed at boosting Kosovo’s growth potential and moving away from the remittance-based growth model. This will be achieved by (i) modifying the investment clause of the fiscal rule to create additional space for donor-financed infrastructure projects; (ii) putting in place a rules-based mechanism for the public sector wage bill, to help contain high labor costs; (iii) removing legal and judiciary obstacles that prevent banks from better supporting economic growth; and (iv) reforming the public procurement—in particular, moving towards centralized procurement of common goods and adopting e-procurement—so as to lead to a more even and transparent business environment.

Republic of Kosovo has been a member of the IMF since June 29, 2009 and has a quota of SDR 59.0 million.