The war in Ukraine has a significant impact on the Montenegrin economy

Russia’s war in Ukraine has significant consequences for the Montenegrin economy, and higher food and energy prices at the global level contributed to record high inflation of nearly 17% in October, announced the head of the International Monetary Fund (IMF) mission for Montenegro, Srikant Seshadri.

– At the same time, citizens of Ukraine and Russia who applied for temporary residence helped the growth of domestic demand and the inflow of foreign currency. Borrowing costs have risen sharply, and access to international capital markets may be limited for a long time. It is expected that the current account deficit will increase this year due to high import prices, and it will probably remain at a high level – said Seshadri in a statement published after the visit of the IMF team to Montenegro.

As he stated, during 2023, growth is expected to weaken.

– Private consumption, further recovery of tourism and strong credit growth contributed to real GDP growth of 10% on an annual basis during the first half of 2022. However, it is expected that this impulse will slow down in the coming years, as these effects weaken, and higher prices will affect the consumption of the population – said Seshadri.

Weak global growth could also negatively impact tourism next year.

– Inflation is likely to decrease during 2023, depending on the degree of stabilization or decline in import prices, but keeping wage pressure under control will be crucial. We are currently forecasting that inflation will remain high, at around 9-10% – the announcement reads.

He goes on to say that the labor market has strengthened, and an apparent increase in labor force participation has helped the unemployment rate return to pre-pandemic levels.

– The large increase in the minimum wage at the beginning of this year does not appear to have had a noticeable impact on formal employment being recorded, although a full assessment is difficult due to data limitations. Our advice is against any further increase in the minimum wage in the current economic conditions. Slowing down the momentum of growth will make it difficult for companies, especially small and medium-sized ones, which make up a significant share of employment in the private sector, to bear higher costs, without this leading to further stimulation of inflation – according to the IMF.

Seshadri says strong revenue growth this year masks underlying fiscal weaknesses.

– This year’s VAT revenues rely on a strong consumption growth exceeding 20% ​​on an annual basis in the first half of this year (stimulated in part by temporary residents from Russia and Ukraine) and high inflation. The effect of VAT more than compensated for the decrease in personal income tax and other contributions to work, which is connected with the tax reforms and wage reforms adopted in the budget for 2022 – he stated.

As he said, the health sector is particularly struggling with arrears.

– We currently forecast that the fiscal deficit in 2022 will be 3-4% of GDP, which will depend on the uncertainty regarding the execution of the capital budget – he adds.

He further states that curbing the fiscal deficit is of utmost importance in the coming years.

– Financing a large fiscal deficit on top of rising debt repayments over the coming years will prove challenging, especially in a high interest rate environment. Therefore, we advise that a credible fiscal adjustment should be considered immediately, paying attention to both expenditure-related measures and income-related measures, aiming for the primary balance to be at least zero by 2025 and the primary surplus at least one percent by 2026 – he believes.

The IMF believes that it may be necessary to accelerate the necessary pace of fiscal adjustment depending on the prevailing global financial conditions.

– This adjustment will contribute to the reduction of public debt and financing risks in the coming years, especially ahead of the amortization of Eurobonds in 2025. In order to preserve the sustainability of public finances, it will be necessary to avoid further spending or reducing taxes for which there is no source of financing – Seshadri says.

The announcement states that the continued vigilance of bank supervision in an environment of rising interest rates is of key importance.

– Banks’ capital adequacy and system-wide liquidity ratios remain high with low non-performing loans (NPLs) despite pandemic-related measures winding down. However, recent strong credit growth amid rising interest rates globally warrants close monitoring by the Central Bank. We welcome the introduction of the risk-based framework for the prevention of money laundering and financing of terrorism (AML/CFT), which requires continued emphasis on its effective implementation – they point out.

He believes that the independence of the Central Bank is crucial for the credibility and stability of the financial system.

– The existing procedure for electing the governor by the Assembly, after the proposal to be submitted by the President of Montenegro, is in accordance with international best practice. The separation of the appointment and election of this important official into two separate branches of government directly elected in the elections (the so-called double veto procedure), enables a strong and transparent institutional division of power in the election process, while preserving the independence of the Central Bank – the announcement states.

– The IMF remains strongly committed to providing constructive advice and technical assistance to Montenegro in a wide range of areas. We are looking forward to consultations regarding Article Four in 2023 – said Seshadri, local media writes.