Christopher Sheldon, World Bank Country Manager For Bosnia And Herzegovina, And Montenegro

The World Bank stands ready to support the Government of Montenegro by providing technical, international best practice expertise in the designing and implementing of critical structural reforms, including through potential development financing operations that support ambitious reform programmes and provide financing under favourable terms

The latest European Commission Progress Report on Montenegro stresses the importance of maintaining macroeconomic stability. As shown in this interview with Christopher Sheldon, World Bank Country Manager for Bosnia and Herzegovina, and Montenegro, this is a comprehensive and complex task that will occupy the attention of the Montenegrin authorities in the years to come.

Due to its unilateral euroization, Montenegro relies on fiscal policy and structural reforms to maintain its macroeconomic stability. “However, a lack of commitment to fiscal targets in the past, together with the government financed highway construction, have amplified fiscal vulnerabilities and increased public debt from 40.7% in 2010 to an estimated 71 per cent in 2022,” says Sheldon, continuing: “despite declining over the past two years, public debt remains elevated, particularly given the currently unfavourable and highly uncertain global environment”.

As a small and euroized economy, Montenegro is hit particularly hard by shocks from the external environment, which was best evidenced during the pandemic, when the country suffered one of the sharpest recessions in the world. And while 2022 saw the country’s economy recover to the pre-pandemic level, it remains vulnerable in a turbulent environment, requiring Montenegro to fortify its internal stabilisation mechanisms. According to Sheldon, “the immediate priorities are to resolve the institutional and political crisis and to pursue prudent fiscal management. Prudent fiscal policy based on the continuous reduction of public debt and policies to support growth are critical to Montenegro’s macroeconomic stability”.

Given that Montenegro has changed several governments in its recent history, how successful have those governments proven in controlling the rising public debt and fiscal deficits?

– The pandemic wiped out the fiscal consolidation gains Montenegro achieved during 2017- 19, when the deficit swelled to 11 per cent of GDP and public debt peaked at 105 per cent of GDP. In 2021, the economic recovery, together with the consolidation of expenditure, helped bring down the deficit to 1.9% of GDP. The reduced fiscal deficit and large Eurobond issuance in December 2020 relieved financing pressures for 2021 and 2022, but Eurobond proceeds had been largely depleted by year’s end 2022. And while fiscal performance was better than planned in 2022, the planned medium- term fiscal deficits are of concern, given the unfavourable financial market conditions and the need to repay three large Eurobonds due between 2025 and 2029, starting with a €500 million Eurobond in 2025. The government needs to plan and reduce public debt as a share of GDP before the start of these large debt repayments, in order to place Montenegro in a better position to refinance that debt. The better Montenegro’s fiscal position is by 2025, the lower the cost of refinancing will be for all Montenegrins.

What does the future hold in this respect and what factors could contribute to ensuring fiscal soundness?

– As already mentioned, the broader global market setting has become less favourable for financing, given the rapid monetary tightening and high geopolitical uncertainty. Risk premia are rising for most borrowers and the appetite to absorb credit risk in emerging markets is shrinking. These conditions may lead to greater difficulty in mobilising large amounts of capital under favourable terms, particularly if fiscal targets are not solidified through fiscal prudence. It is therefore critical that the government demonstrates its commitment to the debt reduction path.

Tourism is expected to continue improving in 2023, though deteriorating growth prospects in the EU and the region could slow its recovery

To achieve this, continuous efforts need to be exerted to expand the tax base, improve tax compliance, and tax environmentally and health harmful products and activities that would generate stronger revenue. At the same time, better control is required over all government expenditure, but particularly the wage bill and social transfers, including in the health sector, where there is room to simultaneously optimise spending and increase the quality of services provided, which have not kept the pace with the spiralling costs in recent years.

Taking into consideration expected global developments in 2023, but also local constraints, what are your latest projections of GDP growth and overall economic activity?

– Montenegro’s economic outlook is positive, but there are significant downward risks. After a relatively strong performance in 2022, we expect economic growth to moderate to 3.4% in 2023, and further to 3.1% in 2024. Still high inflation will continue to erode real disposable incomes, which will translate to slower private consumption growth. The projections do not assume that the construction of the remaining sections of the highway will start by 2025, as fiscal space is very limited. The projections do assume, however, that overall investments will be recovering, driven by the energy and tourism sectors, but at a slower pace. Tourism is expected to continue improving in 2023, though that recovery could be slowed by deteriorating growth prospects in the EU and the region.

How will these developments impact employment and does the government have the capacity to cover social expenditure programmes?

– There were solid improvements in the labour market in 2022. In the first three quarters of 2022, employment increased by an average of 20 per cent compared to the same period of the previous year, while labour market activity also increased.

This is a significant improvement that resulted from continued economic recovery and the implementation of the recent tax reform that reduced labour taxes from a flat 39 per cent of total labour costs to an average of 22 per cent by removing healthcare contributions and introducing progressive income taxation. The administrative data show that employment growth was also strong in the last quarter, but the data also points to the moderation of employment growth.

On the other hand, Montenegro’s social expenditure programmes have been expanded over the past two years, and with over 30 programmes covering different groups of people in need, the system covers more than half of the Montenegrin population. Through the introduction of numerous new social assistance programmes, the coverage of social assistance is now expanding rapidly. However, not all new schemes have a precise focus on those most in need. Social spending already accounts for over a quarter of total government spending, and redesigning social programmes, rather than expanding them, would lead to higher efficiency. This would mean better use of Montenegro’s limited fiscal resources by directing social protection to those most in need and the most vulnerable, rather than spreading assistance in a universal manner.

From today’s perspective, how have the large-scale public infrastructure investments of the past influenced the economy as a whole? What lessons can be learnt from that experience?

– Infrastructure development lies at the nexus of economic growth, productive investment, job creation and poverty reduction. However, infrastructure development requires careful consideration and prioritisation, as the infrastructure needs of any country exceed its sources of available funding. Montenegro is no exception there. However, Montenegro largely based its past growth on the rapid accumulation of capital, with low or negative contributions from productivity and human capital growth. While the country experienced several episodes of growth spurts―for example, between 2006 and 2009 growth was driven by large foreign real estate investments or, from 2015-19, by large public infrastructure investments and tourism―average growth has been limited by more severe economic downturns than in peer countries.

Montenegro has a comparative advantage in clean energy from hydro, solar and wind, which is also a major growing European market that can help Montenegro diversify its goods exports

At the same time, these investments tended to boost GDP growth mostly during the construction period and created jobs mostly in low value-added sectors. These investments also tended to have limited productivity spillovers to the rest of the economy. They also increased fiscal vulnerabilities, because they necessitated large deficits and external imbalances due to their high import dependence. However, public investment is critical to growth and in order to reap its full benefits and maximise its positive impact on economic growth, Montenegro needs to strengthen its public investment management framework.

Green transition is perceived as one of the important winning strategies for Montenegro. Would it be possible to proceed with such projects given the overall crisis?

– The external environment is going through a major structural change, and fundamental environmental pressures are changing the foundations of economic activity, consumer choices and investor behaviour everywhere. The energy crisis is accelerating decisions on green transition polices across European Union countries and strengthening interest in clean energy sources and energy efficiency, as a means of diversifying the supply mix and enhancing energy security. Montenegro has a comparative advantage precisely in clean energy from hydro, solar and wind, which is also a major growing European market that can help Montenegro diversify its merchandise exports. Furthermore, Montenegro’s major comparative advantage – tourism – requires that the state accelerate its green transition, better manage waste, and invest in green infrastructure, as the quality of its tourism offering – and its sustainability over time – will depend in good part on maintaining a pristine environment. The analysis of, and recommendations for, more resilient and sustainable growth is further discussed in the forthcoming publication of the World Bank growth study for Montenegro.

How does the World Bank Group Country Partnership Framework support Montenegrin efforts to build a sustainable economy over the medium term?

– The World Bank is working continuously with the authorities in support of policies that can improve the living standards of Montenegrins, especially the poor and vulnerable. This includes ensuring macroeconomic stability and fiscal sustainability, and specific policies in many different sectors, including agriculture, environment protection, tax administration etc. At the same time, the Bank is also providing technical expertise and assistance to improve the public administration, public procurement, environmental protection and tax systems.

As argued in the recently completed and forthcoming publication of the World Bank Country Economic Memorandum for Montenegro, higher standards of living can be achieved through a new, more sustainable economic growth strategy: one based on productivity and human capital gains, while preserving natural resources to enable the country to sustain higher growth rates over longer periods. This would require the removal of barriers that hinder markets in rewarding more productive firms by enforcing competition and consistent policy implementation, the better leveraging of trade for sustainable development and the improving of human capital by reducing inequality of opportunity. But reaping the full benefits of reforms for higher, more sustainable growth requires the empowering of public institutions. If these reforms are implemented, that would result in a more vibrant private sector, more job creation and, consequently, higher wages and higher benefits for all citizens of Montenegro.