IMF Finishes 2022 Consultation with Kosovo

Washington, DC: On January 25, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation[1]with Kosovo.

The increase in energy and food prices after Russia's war in Ukraine is weighing on private demand, activity, and inflation. Real GDP growth is estimated to have decelerated to 2.5–3 percent in 2022, after recovering by 10.7 percent in 2021. Average inflation reached more than 11 percent in 2022.

Fiscal consolidation that began in 2021 continued in 2022. The primary fiscal position is estimated to be balanced in 2022, compared with a deficit of about 1 percent of GDP in 2021. The tighter fiscal stance reflected solid fiscal revenue growth and low implementation of the public investment program (PIP) that offset the increase in transfers to lessen the impact of higher food and energy prices. In particular, the improvement in domestic tax collection reflected progress in strengthening tax administration and tackling informality. While credit to the private sector is estimated to have expanded by about 15 percent in nominal terms in 2022, real credit growth decelerated compared to 2021. Reflecting the tighter euro area financial conditions, domestic government bond yields and lending rates have begun to increase. With strong capital and liquidity buffers and low NPLs, the banking sector has remained resilient overall.

Economic activity is forecasted to grow at 3.5 percent in 2023, around Kosovo's potential of 3.5–4 percent. This forecast crucially depends on the assumption that international commodity prices will ease in 2023. Uncertainty around the outlook remains high; higher energy prices represent the main downside risk. Although sound fiscal and financial policies will help mitigate the impact of downside risks, structural reforms addressing infrastructure and governance gaps are essential to diversify Kosovo's growth engines and create the conditions for greener economic growth.

Executive Board Assessment^[2]

Executive Directors noted that following an economic rebound, spillovers from Russia's war in Ukraine, including high food and energy prices and tightening financial conditions, are weighing on growth, and the outlook remains uncertain with risks tilted to the downside. Directors commended the authorities' swift policy response, which helped cushion the impact of the terms of trade shock on households and firms. Looking ahead, they encouraged continued commitment to prudent policies combined with a revitalized structural reform agenda to unlock growth. Continued close Fund engagement can help Kosovo advance its reform efforts and rebuild policy buffers.

Directors welcomed the authorities' efforts to replenish fiscal buffers. They agreed that a return to the fiscal rule deficit ceiling in 2023 could support a soft landing without exacerbating inflationary pressures. Directors emphasized that measures to mitigate the impact of higher energy prices should be temporary, well targeted, and encourage efficient energy use. While welcoming an increase in public investment, Directors urged the authorities to improve its absorption and address public investment management shortcomings. Directors commended the progress toward reducing informality and encouraged exploring additional revenue measures.

Directors recommended that public spending be better balanced between social transfers and promoting economic transformation and resilience. They agreed that the phased implementation of the law regulating public wages would ensure talent retention while keeping the wage bill within its legal ceiling. Directors emphasized that early withdrawals from Kosovo's Pension Savings Trust should be avoided.

Directors welcomed the resilience of the banking system, which has remained liquid and well-capitalized. Noting the uncertain outlook, they urged continued close monitoring of bank asset quality and liquidity and emphasized the importance of enhancing surveillance of the housing market. Directors welcomed the authorities' commitment to implement the recommendations from the 2019 Financial Sector Stability Review and 2021 Safeguards Assessment. They underscored the key role of an independent and accountable central bank in maintaining financial stability.

Directors urged the authorities to address infrastructure and governance gaps, further enhance transparency, and reduce corruption, which remain essential to improve Kosovo's business environment and increase potential growth. They called for addressing weaknesses in the AML/CFT framework. Directors also underscored the importance of boosting green energy generation capacity to increase energy security and decrease emissions.

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