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Speeches & Transcripts

After the Crisis: Towards a Smaller and More Efficient Government

November 1, 2011

Jan-Peter Olters, World Bank Country Manager for Kosovo, (World Bank Representative in Montenegro 2007-2011) Podgorica, Montenegro

As Prepared for Delivery

Slide 1
 
For today’s presentation, I have—quite on purpose—chosen the picture of a rescue cruiser.
 
These ships are small, agile, seaworthy, and powerful—and no hurricane can bring it to capsize, no wave will make it sink.
 
With the global economy’s storm clouds getting closer and darker by the day, this seemed a nice summary did not only seem appropriate but nicely summarize the vision for Montenegro’s economy, one that can be successful in an uncertain environment. 

But it is not only the vision of the World Bank’s team, it is one that is shared here as well.
 
Slide 2
 
Having adopted the euro as legal tender, policymakers are precluded from using inflation and currency depreciation as instruments to (i) reduce the real burden of local currency-denominated debt; (ii) offset wage increases in excess of productivity increases; and/or (iii) boost international competitiveness.
 
While it might prove more difficult short term, the economy will be helped over the medium- to long-term horizon when the Government addresses head-on the root causes of fiscal imbalances and macroeconomic misalignments.
 
Those countries of the eurozone that have done this (in time) are faring well, while others—not willing or able to take the difficult decisions—are struggling and are imposing immense socio-economic costs on their citizens.
 
Slide 3
 
There is no reason why Montenegro should not belong to the successful European economies.
 
It has enormous growth potentials, which—if fully unleashed—could generate dynamic rates of growth for decades to come.
 
Granted, at current growth rates of 2.5–3 percent, about 1 percent in excess of average growth rates in the EU, it would take more than 100 years to approach the same income level.
 
However, if growth rates could be increased to an average rate of about 5 percent, that is, to rates about 3–3.5 percentage points above those in the EU, Montenegrins (whose per capita income is currently about 35 percent of the EU average) would catch up with the EU in already about 30 years.
 
This can be done—provided that structural reforms are implemented with a view to fostering private-sector activities, particularly those of small and medium-sized enterprises.
 
Slide 4
 
Given how hard Montenegro has been hit in recent years, its economy has absorbed relatively well recent shockwaves, whether it was the domestic boom-bust cycle following independence or the global financial and economic crisis following immediately thereafter.
 
But we have not reached calm waters yet.
 
Risks are considerable, and they have increased in recent months.
 
Domestically, economic growth is being held back by very high—and still increasing—payment arrears in the private sector (a follow-up report will look into this issue much more in detail).
 
At the same time, economies worldwide are threatened by a potential crisis in the eurozone, fueled by severe debt and competitiveness challenges in some of the eurozone member countries as much as by speculation against the common currency, and/or by the fiscal problems in the US that, in the current political context, could easily spin out of control.
 
One can only hope for the best and prepare for the worst.
 
Slide 5
 
Related to the domestic risk factors, they largely represent legacy issues from the boom-bust cycle during 2006–08, and particularly from the speculative phase during mid-2007 to mid-2008.
 
This graph, in my view, is the single-most telling summary of recent experiences and challenges ahead.
 
By contrasting the stock of bank credits to the private sector (in orange) to bank deposits from the private sector (in white), you can nicely separate the five distinct episodes in Montenegro’s recent economic history, viz.,
 
(i)         the pre-independence stagnation until mid-2006;
(ii)         the immediate post-independence euphoria until mid-2007;
(iii)        the real-estate speculation and bursting bubble in mid-2008;
(iv)        the recession amplified by the global financial crisis; and
(v)         the fragile recovery seen as of mid-2010.
 
 
In addition, this graph shows that banks are still a long way away from re-establishing a balance between credits and deposits.
 
This means that, looking forward, it would be surprising to see a considerable change in banks’ lending behavior any time soon.
 
Slide 6
 
The situation is made worse by the fact that payment arrears have continued to accumulate, including non-performing loans in the banks’ portfolios.
 
Even if taking into consideration different statistical methodologies across countries in the region, they are exceptionally high—thereby reducing banks’ ability and willingness to increase lending.
 
The high degree of illiquidity is a little bit like poison increasingly affecting the balance sheets of otherwise healthy companies.
 
Slide 7
 
The government, as well, is unable to provide any additional liquidity to the economy either, largely because it has exhausted its fiscal buffers when responding to the last crisis.
 
In only 2½ years, the stock of public debt has doubled as a share of GDP.
 
It is not the level per se but the ease and speed with which public debt levels have increased that is concerning.
 
Slide 8
 
This has made Montenegro the country with the second highest stock of public debt in the Western Balkans, even when excluding the sovereign guarantees.
 
Slide 9
 
But not all is discouraging.
 
The increased political focus on macro-fiscal stability and the business climate has increased Montenegro’s credibility.
 
Most importantly—and allow me please to convey, at this point, my personal congratulations and best wishes—, Montenegro has received the recommendation from the European Commission to start EU membership negotiations.
 
This, in itself, is a very important step.
 
But at the same time, it is a promise that reforms aimed at strengthening public institutions, measures to improve the legal framework and the laws’ implementation remain on the political agenda for years.
 
This will help to strengthen the rule of law and, in so doing, the business and investment climate in Montenegro.
 
A variety of international surveys, including latest Doing Business survey, note the progress and identify—in a very consistent manner—reform priorities.
 
Already, the reform agenda has resulted in encouraging outcomes, including continued investor interest, not all yet realized, and the Government’s ability to access domestic and international capital markets at favorable rates.
 
Slide 10.
 
The interest rates on domestic T-bills, for which the government had to pay 4 percent in early 2009, have come down to about 2.3 percent only a few days ago.
 
Similarly, the price for 5-year Eurobonds in international markets has come down.
 
Slide 11
 
This, in a nutshell, is the background against which the current Public Expenditure and Institutional Review has been prepared.
 
With a view to fostering Montenegro’s growth potential, supported by a smaller, more agile, more efficient, and more modern government, it looks at the two available policy options.
 
Its pillars are:
 
first, fiscal sustainability, deriving policy recommendations to strengthen fiscal management and reverse adverse debt dynamics; and
 
second, competitiveness and productivity, with a view to increasing the efficiency and effectiveness in the provision of public services.
 
Slide 12
 
These two policy objectives are critical, given existing vulnerabilities in the state budget’s structure.
 
One-half the expenditures are reserved for pensions or salaries to civil servants and state employees.
 
Effectively, such a budget is much tighter than simple deficit figures would imply.
 
Slide 13
 
The more a Government spends on pensions and wages, the fewer are the resources left for public investments, often the budgetary expenses with the highest socio-economic benefits.
 
With most other spending items being largely pre-determined and not discretionary, it is not surprising that these two spending items, during 2006–10, were almost perfect mirror images.
 
Slide 14
 
Against this background, with a view to supporting the country’s twin objectives of maintaining macroeconomic stability and advancing socio-economic stability, we are recommending to strengthen and reinforce a rules-based approach to fiscal policies.
 
We believe that this would help to reinforce fiscal credibility and effectively recreate fiscal space as potential buffer and for discretionary priority expenditures.
 
The key recommendation is thus to put such a fiscal framework stands on three pillars, viz.,
 
(i)         the need to shadow the obligations of eventual eurozone membership and limit fiscal deficits to 3 percent of GDP and the stock of public debt to 60 percent;
 
(ii)         the obligation to borrow only to invest; and
 
(iii)        the gradual reduction (or, at least, the non-increase) in the ratio of recurrent expenditure to GDP.
 
Slide 15
 
Given the rapidly deteriorating external environment, Montenegro’s general vulnerability to external shocks, and the post-crisis fiscal weakening seen after mid-2008, it seems critical to regain fiscal strength, protect fiscal space, and have available a potential buffer to be able to respond to unforeseen events.
 
We thus propose to complement the more formal—ideally legally enshrined—fiscal framework described in the last slide with fiscal policy objectives aimed at limiting the public debt-to-GDP ratio to about 35 percent.
 
Slide 16
 
But risks to the budget also come from within, especially from pensions.
 
The Government—like others in the region—is faced with adverse demographic trends.
 
Fewer contributories to the pension system will have to pay for an increasing number of pensioners—a scenario that cannot be maintained with the current system, even after the first reform steps taken recently.
 
Slide 17
 
In fact, a lot has been done, both in terms of adjusting the retirement age and in increasing the weight of price increases over wage increases in the pension’s indexation.
 
These were courageous reforms, which will accumulate very positive compound effects in years to come.
 
In addition to the reforms already implemented, the study recommends the Government to have a particularly close look at reducing the scope for occupational early retirement.
 
In addition, like countries elsewhere, the increase in life expectancy and the adverse demographic trends will make more urgent the consideration of mechanisms to target “life expectancy at retirement.”
 
Slide 18
 
The second critical risk from within the budget is the public administration.
 
Partly reflecting the “fixed cost” of running a small country, Montenegro spends about 3 percentage points more on public-sector wages than its neighbors.
 
However, there are increased recruitment pressures on the public administration, partly for EU integration-related challenges.
 
All these factors make it critically important that the Government looks at the salary system that is not fully transparent and lacks a focus on job specifications, incentives, and individual performance within the public administration.
 
Slide 19
 
The report’s principal recommendation is therefore to increase the transparency of the payment structure by merging the “variable” and “supplementary” pay categories.
 
A reform agenda is proposed that is to culminate in the development of a new pay system with new job descriptions and methodologies for assessing individual performance, to be complemented by the implementation and automation of the Government’s payroll management.
 
Slide 20
 
Thus far, measured results in the education sector are unsatisfactory, irrespective whether viewed relative to the amount of public spending on this sector, …
 
Slide 21
 
…, or Montenegro’s per capital income.
 
Slide 22
 
Thus, to improve education quality and outcomes, while lowering costs, it is critical to increase monitoring and the accessibility of data—so as to allow for “rational” decision-making processes.
 
Key recommendations include the strengthening of external quality control, the increased importance given to quality-enhancing measures, and—where possible—the consolidation of classes and/or schools.
 
Slide 23
 
While the health sector as well spends an above-average amount on public health, it has achieved above average results as well.
 
Slide 24
 
On the basis of the study’s analysis, it is recommended that greater budgetary autonomy—but also increased fiscal accountability—be transferred to the Health Insurance Fund.
 
It should be possible for the Health Insurance Fund to retain savings in one given year to allow for the equalization of expenditures over longer periods of time.
 
In addition, it is recommended to support health promotion by introducing or increasing “sin” taxes on the consumption of alcohol, tobacco, and pre-packaged food with high sugar, high salt, and/or fat content.
 
Specialized health-care services should be outsourced to the private sector.
 
Slide 25
 
In terms of social assistance, the team found that programs respond to critical social needs of the most vulnerable members of society, with spending that is well targeted and, as a result, does not post a fiscal risk.
 
It is important to ensure and strengthen accurate targeting, broad coverage, and effective implementation, not least to accompany ongoing reforms of the contributory system.
 
The general policy focus thus would be to strengthen the family material support, a well-targeted program with low coverage, and to link cash social assistance to labor market activation.

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