- Russia's war in Ukraine has had significant repercussions for the Montenegrin economy. Inflation has reached record highs, while Russians and Ukrainians who have taken up temporary residence in Montenegro have supported consumption and growth. Growth is expected to slow next year, while inflation is projected to decline gradually.
- Strong revenue growth is masking underlying fiscal weaknesses. It is imperative to preserve the sustainability of public finances by containing the fiscal deficit and reducing public debt, over the medium-term.
- The financial sector has been broadly resilient to the turbulence caused by the pandemic, with strong system-wide capital and liquidity buffers. Continued supervisory vigilance is needed in a rising interest rate environment.
Washington, DC: An International Monetary Fund (IMF) team led by Mr. Srikant Seshadri conducted a staff visit to Montenegro from December 5-12, 2022. At the end of the visit, Mr. Seshadri issued the following statement:
"Russia's war in Ukraine is having significant consequences on the Montenegrin economy. Higher global food and energy prices contributed to record-high inflation, close to 17 percent as of October. At the same time, Ukrainian and Russian nationals taking up temporary residence have helped boost domestic demand and foreign currency inflows. Borrowing costs have risen steeply, and access to international capital markets may be curtailed for a prolonged period. The current account deficit is expected to increase this year due to high import prices, and is also likely to remain elevated.
"Growth is expected to wane in 2023 . Private consumption, a further recovery in tourism and strong credit growth contributed to a 10 percent year-on-year increase in real GDP in the first half of 2022. But momentum is expected to slow next year, as these effects fade and the impact of higher prices constrains household spending. Weak global growth could also negatively affect tourism next year. Inflation is likely to decline in 2023, depending on the degree to which import prices stabilize or fall, but keeping wage pressures in check will be crucial. We currently forecast that inflation will remain high at around 9-10 percent.
"Labor markets have strengthened. An apparent increase in labor force participation has helped to push the unemployment rate back down to pre-pandemic levels. The large minimum wage increase at the beginning of this year does not seem to have had a notable impact on measured formal employment, although data limitations make a full assessment difficult. We advise against further large increases in the minimum wage in current economic conditions. Slowing growth momentum will make it harder for businesses--particularly for small and medium-sized enterprises which account for a significant share of private sector employment--to sustain higher costs without fueling further rises in inflation.
"Strong revenue growth this year is masking underlying fiscal weaknesses . Strong consumption growth exceeding 20 percent year-on-year in the first half of this year (driven in part by Russian and Ukrainian temporary residents) and high inflation supported VAT revenues this year. VAT performance has more than compensated for the decline in personal income tax and other labor contributions associated with the tax and wage reforms introduced in the 2022 budget. Notably, the health sector is struggling with arrears. We currently project that the fiscal deficit in 2022 will be 3-4 percent of GDP, subject to uncertainty around execution of the capital budget.
"Containing the fiscal deficit is imperative over the coming years . Financing sizable fiscal deficits on top of rising debt repayments over the coming years will prove challenging, particularly in a high interest rate environment. We therefore advise that immediate consideration be given to a credible fiscal adjustment with attention to both expenditure and revenue measures, targeting at least a zero primary balance by 2025 and at least a 1 percent primary surplus by 2026. The required pace of fiscal adjustment may need to be quicker, depending on prevailing global financial conditions. Such an adjustment will help reduce public debt and financing risks in coming years, especially ahead of the 2025 Eurobond amortization. To preserve the sustainability of public finances, further unfunded spending or tax cuts will need to be avoided.
"Continued banking supervisory vigilance is essential in a rising interest rate environment. System-wide bank capital adequacy and liquidity ratios remain high and NPLs are low despite pandemic-related measures expiring. However, recent strong credit growth amid rising global interest rates call for careful monitoring by the Central Bank. The introduction of a risk-based framework for Anti Money Laundering and Combating of the Financing of Terrorism (AML/CFT) is welcome, and requires continuing emphasis on effective implementation.
"Central bank independence is critical for the credibility and stability of the financial system. The existing procedure of appointment of the Governor by the Parliament, upon a proposal to be put forward by the President of Montenegro is in line with international best practice. Separating the nomination and the appointment of this important official between two separate and directly elected powers (the so-called "double veto" procedure), provides strong and transparent institutional checks and balances in the selection process, while also preserving the Central Bank's independence.
"The mission held fruitful discussions with Prime Minister Abazović, Minister of Finance Damjanović, Governor Zugić of the Central Bank of Montenegro, government and central bank officials, Members of Parliament, and representatives from the private sector. The mission thanks the authorities and all interlocutors for the frank and constructive dialogue. The IMF maintains its strong commitment to providing Montenegro with constructive advice and technical assistance across a broad range of areas. We look forward to the 2023 Article IV Consultation."
