Author: M. Mirjačić
How would you assess your mission to Montenegro over the previous four years? What are the most important activities that you would highlight? What are the memories you are bringing with you from here?
The ultimate assessment of the success and failure of the World Bank program in Montenegro—including my personal contribution to it—will, of course, remain yours and that of the World Bank’s partners in Government and the public at large. The key question is: are there tangible results that have helped to improve the business climate, professional perspectives, and living standards? I came to Podgorica in early June 2007, five months after Montenegro became member of the World Bank Group, opening our Office here and helping to implement our first Country Partnership Strategy and prepare our second one. It has been an economic rollercoaster unlike anywhere else in this region—the stock-market boom, the real estate bubble, the hard landing in the summer of 2008 that was amplified by the worst global financial crisis in sixty years, with resultant troubles in, especially, the financial and industrial sectors.
On several occasions throughout my mandate here, I have used a quote by the Roman philosopher Seneca who had remarked more than 2,000 years ago that, if one does not know to which port one is sailing, no wind is favorable. For me, it was very encouraging to see that the harbor of destination is clear—possibly representing the only consensus across the political aisle—and strong efforts are being made to follow Croatia on its path towards EU membership. It was equally impressive to see that Montenegro, with its small public administration (in absolute terms), set out the voyage and managed to go from independence to EU candidate status in just 1,657 days. But every step from here on will become even more difficult and more challenging, making more important still the focus on the final destination.
I have been very pleased that we—the staff in the Country Office, management at headquarters, and visiting project missions—have been able to provide targeted support, advice, and financing in some selected areas of particular importance and comparative advantage. It is difficult to single out specific activities, as—I believe—our interventions in infrastructure (the integration of the electricity market with neighboring countries, energy efficiency pilots, or the regional water supply scheme), the strengthening of public institutions and services (in agriculture, education, health, pensions, land administration, or waste management) have provided important inputs to the reform agenda in Montenegro. But I cannot hide the fact that I am particularly pleased that the context of very comprehensive financial sector reforms, undertaken partly in the context of the €59-million budget support to be presented to our Board in early September, the financial sector has exited the financial crisis on a much stronger institutional foundation, including a fully independent central bank, with a mandate and policy instruments in line with international best practice and European standards. In this context, allow me please to single out the contribution of one close counterpart who—without having received the appreciation he would have deserved—advanced this reform agenda with particular courage and determination. Without the commitment, dedication, and, ultimately, sacrifice of former Governor Krgović, these reforms, at this high level of quality, would not have become reality and allowed his successor to address some of the fundamental post-crisis weaknesses in the banking sector.
What are the recommendations concerning Montenegro that you would give to your successor?
On this question, I would have to ask for your understanding that I will provide my assessments and recommendations first to Ms. Anabela Abreu directly before sharing them with you and your readers.How do you see potentials for the development of the Montenegrin economy and what should be done in order to accelerate the recovery after the crisis?
During the current post-crisis, pre-recovery period, I would characterize Montenegro’s economy as “high potential, high risk”. The more Montenegro comes to be seen by international investors as an open, transparent, predictable, and rules-based “regional hub” in an increasingly attractive—but still turbulent—region, the easier it will be to attract foreign direct investment at the scale and scope to increase productivity and foster innovation. A major ingredient in this challenge is the continued progress in the EU integration agenda. The link between the EU-inspired rule-of-law reforms and the business environment has been put very eloquently by European Commission President Barroso when he visited Podgorica in early April.
Areas of considerable growth potential seem evident and comprise tourism, energy, agriculture, and services. But it is important to ensure that the economic development strategies in these sectors are sustainable. It is well-understood from developments elsewhere that touristic overdevelopment will destroy the sector, which places careful urban planning and uniform penalties on infractions at the very center of a tourism development strategy. It was thus a foresighted policy to place sustainable development, environment, and tourism under the roof of one singly ministry. To develop the very significant energy potential, to entice foreign investors to provide the required funds and know-how, and to ensure long-term socio-economic net benefits to Montenegrins, I see an urgent need to deepen the debate within society, with a view to deriving, as closely as possible, at a national energy consensus. By fostering the processing of agricultural products and, in particular, by implementing the required food safety reforms to be able to exports food and vegetables to the gigantic market of 500 million people next door, it should be possible to improve the standard of living in the rural, mountainous areas, Montenegro’s poorest regions. And finally, economic policies aimed at encouraging further or higher-value activities in the services sector relate, to a large extent, to the progress made in higher education and research.
What are the biggest problems of the Montenegrin economy that should be solved as a priority?
I see two challenges and one real problem that need to be addressed to exit the current phase of anemic growth. The first challenge relates, of course, to the adoption of the euro as legal tender, meaning that wages can only increase as quickly, or slowly, as the economy’s productivity increases (if one is not willing to accept rapidly rising rates of unemployment). The euro crisis engulfing Greece and other countries of the Eurozone’s Southern periphery is a combination of unsustainable public debt and a gradual deterioration in relative competitiveness with other countries in the common currency area. The two fastest and most long-lasting methods of improving productivity in an economy are (1) foreign direct investments by reputable companies that bring, next to financial resources, up-to-date know-how and (2) increased quality of education, requiring an increased degree of internationalization, cross-fertilization, and external quality control.
The second challenge I see relates to the ambiguous attitude towards privatization. There is no economic reason not to leave companies in state ownership if they either provide a public service for which citizens are willing to pay taxes (such as hospitals) or are profitable and not a burden to the state. However, if the decision is made to privatize an enterprise, it should not be attempted to “manage” a private company like a public one. The Government can pass labor laws to regulate lay-offs and settlements, but it should not specify or insist on the number of staff that a private company needs to keep on its payroll. This hesitation to let formerly public companies go has already caused substantial damage to the economy, the effects of which have dominated the headlines on your economy pages and cost the budget dearly. Similarly, if you seek to find highly regarded international investors that can bring in money and knowledge, it will not work if only minority shares are offered. That’s like a marriage in two separate beds. For investors, risk and profit expectations are flipsides of the same coin.
The single biggest problem and principal risk to economic growth over the medium-term horizon are continuously increasing payment arrears, including non-performing loans. The high level of payment arrears—but also the fact that they keep on increasing despite positive rates of economic growth—point to inherent dynamics by which the balance sheets of otherwise healthy companies are becoming increasingly infected. Unlike similar episodes elsewhere, the root cause lies in the private sector (or, more specifically, the credit crunch), but the problem appears to have reached a level that would require Government involvement, at least to moderate a process to record (with a given cut-off date) outstanding payment obligations, to net out mutually neutralizing claims, and devise—together with the banks and private enterprises—a comprehensive inter-enterprise arrears clearance process. For the upcoming Public Expenditure Review, to be published in early autumn, our economist has sought to provide initial estimates and derive policy recommendations.
The Government has recently reached an agreement with the World Bank about a credit facility of around €60 million. Was the State successful in meeting all conditions you have requested from it in order to obtain that facility? What was, in your opinion, the hardest condition for our Government?
This is a €60-million, one-tranche budget support that we will be able to present to our Board of Directors only because the Government and CBCG have been able to implement a comprehensive set of financial-sector policy reforms aimed at strengthening the banking sector, mitigating the impact from the global financial crisis, and increasing the financial sector’s resilience to possible future shocks. The various benchmarks that had been agreed on more than two years ago included the enactment of organic financial sector laws (which enshrined full central bank independence) and onsite examinations and stress tests for all systemically important banks with resultant bank-specific supervisory action plans. These have been really complex and very substantial reforms, for which the authorities deserve respect and praise.
One of the conditions was solving the problem that Prva banka had. Are you informed about events in Prva banka and do you think that said bank is now stable? What is the basis for your position?
The objective of our involvement has been simple, namely for Montenegro to have a banking system with eleven—rather than ten-plus-one—banks that operate on a level playing field. That said, Prva banka was subjected, like all the other systemically important banks, to an onsite examination with standard methodology. This provided the CBCG with the information on the capital shortfall to the legally proscribed capital-adequacy ratio (which Prva banka now fulfills) and the information necessary to agree on and sign with Prva banka a Supervisory Action Plan. There is a full tripartite agreement between the Ministry of Finance, the CBCG, and Prva banka on the gradual withdrawal of central government deposits from this bank, ensuring that there is no preferential treatment to any bank in the system.
What are the key weaknesses of the banking system, which was the main driver of the economic growth during the previous period, and what needs to happen in order for bank to reactivate their credit policy?
The banking sector is in the final stages of recuperation from unsustainably high private-sector credit growth rates in 2006 and 2007, which had increased by about 140 and 180 percent, respectively. At that point, the owners and parent banks of the previously privatized financial institutions had engaged in an aggressive race for market share that came to a complete halt and reversal the day Lehman Brothers collapsed in New York in late September 2008 and dragged the world economy into its deepest recession in 60 years. At that point in time, deposits by the private sector in domestic banks represented only about 60 percent of the credits outstanding, and the deposit base, over the next seven months, contracted by about one-third, leaving deposits at only about 40 percent of credits outstanding. Ever since, the banking sector, also with the help of parent banks, took steps to consolidate their investments in Montenegro, narrow the deposit/credit gaps, improve the quality of their portfolios, and recapitalize the banks to stay within legally proscribed limits. The recuperation is continues in a gradual—but consistent—manner, with more than two-thirds of private-sector credits now being covered by deposits. In particular those banks that had been more conservative during the boom years (that is, generally the smaller banks) have recovered more quickly and managed to re-engage in credit activities earlier than the larger banks.
Recently the State Treasury became thinner by €26 million due to the loan took-over for the Steelworks. Do you believe that some similar case can happen again, which would “ease the State Treasury”? Should the policy of issuing the state guarantees be changed?
Clearly, whenever a state guarantee is issued, there is the risk that it will be called, as now happened with the steelworks. The situation there was as unfortunate as it was unique. In general, it is very difficult to legislate what sort of state support, if any, should be provided to the restructuring efforts of struggling enterprises. In a situation as we had it two years ago, there is no clear-cut advice to government, as some cost would always be borne by Government, whether in terms of unemployment and social assistance or some type of “emergency” support the company’s restructuring efforts. However, what can form the basis for an ultimately political decision is an economic assessment of the underlying business plan with realistic assumptions, required decisions on retrenchment, staffing, social programs and the simulation of corresponding revenues and costs.
Only for over a six-month period, we have borrowed €524 million on the Eurobond market, and all that was spent for servicing debts and public consumption? Will the State have problems in repaying the entire amount resulting from the issued Eurobonds in five years?
To my knowledge, the Government of Montenegro borrowed €200 million at 7.875 percent in September 2010 and another €180 million at 7.25 percent in early April 2011. Montenegro’s ability to access the international capital market at this very difficult period of time at rates significantly below what commercial banks in Europe or elsewhere would have charged has sent a positive signal of the capital market’s confidence in Montenegro’s conduct of fiscal policies, reinforced by the fact that that the rates have come down by 62.5 basis points. Given this exposure, the capital market as well as international credit rating agencies will monitor closely the implementation of economic policies in Montenegro, which should help to enshrine fiscal discipline over the medium to long term. Experiences made by Greece and other countries at the eurozone’s Southern periphery have sent too clear a message of the economic, fiscal, and social costs of ignoring these constraints. Montenegro borrowed these amounts with an explicit communication to the market of its medium-term Economic and Fiscal Program, making this an even more binding policy document.
Do the state guarantees and public debt represent a threat to the State?
In the end, there is no fundamental difference to a household and it holds universally true: the higher the debt the higher the risk. In general, Montenegro has sought to pursue prudent fiscal policies, with the recent increase in public debt reflecting measures of crisis response. And there are a number of specific considerations that need to be taken into account when preparing the budget for next year and over the medium term. First, given Montenegro’s particular exchange-rate regime and its objective to formalize the use of the euro as legal tender, it is critical that it seeks to shadow the fiscal obligations of eurozone membership, meaning a deficit of 3 percent of GDP or less and public debt of all levels of government of 60 percent or less. Recent years have shown how quickly the debt-to-GDP ratio can increase, and there is not much space. Second, the Government’s political decision to keep tax rates low and not consider changes in tax policy except in emergency situations places a particular responsibility on the budget and its largest expenditure items, including the wage bill and pensions. Third, Montenegro is considering large—and very costly—public investments. While needed and potentially very beneficial, it will prove difficult to absorb the fiscal implications. Fourth, expenditures and the tax regime (particularly given the relative importance of the value-added tax) are highly pro-cyclical, requiring the Government to create fiscal buffers during years of high growth. Government has taken steps to tighten control over expenditure and this will remain—for the foreseeable future—a dominant feature in budget preparations. Thus, with a view to sustainable fiscal policies over a longer-term horizon, our advice to the Finance Ministry has been to orient fiscal policies around three benchmarks, namely (i) to stay within the fiscal Maastricht criteria; (ii) to ensure that fiscal deficits are less than public investments; and (iii) recurrent expenditure does not further increase (and ideally gradually decline) as a share of GDP.