MONET

MONTENEGRO ECONOMIC TRENDS

September 2003

ABOUT ISSP ABOUT CEPS

The Institute for Strategic Studies and Prognoses (ISSP), established by Professor Vukotic in 1999, is the first independent economic institute in Montenegro. USAID assisted in this process and continues to support the work of the Institute. ISSP has a wide network of associates both in Montenegro (about 150) and abroad. ISSP is a member of the Balkan Network, the Global Development Network established by the World Bank and the European Integration Network. ISSP cooperates with ICER (Torino), WIIW (Vienna), CEPS (Brussels) and Chesapeake Associates (Washington).

The Institute’s mission is "to provide research that will contribute to Montenegro’s economic transformation and to change the current mindset, as well as to train today’s young people how to function successfully in the new environment."

Major projects: o Macroeconomic reform in Montenegro a) Privatization b) Monetary Reform c) Capital Markets Development d) Fiscal Reform e) Reform of the Pension System f) Introduction of the SNA system o Macroeconomic indicators in Montenegro o Economic education

President: Professor Veselin Vukotic, Ph.D. Executive Director: Petar Ivanovic, Ms. Sci. Advisory Board Chairman: Professor Miroljub Labus, Ph.D.

CONTACTS

ISSP Address: Naselje pod Ljubovic, Lamela C (1 i 2), 81000 Podgorica, Montenegro, Yugoslavia Tel/Fax: (381) 81 634 338; 634 329 Website: www.isspm.org / Email: ISSP@cg.yu

CEPS Address: Place du Congres 1, 1000 Brussels, Belgium Tel: (32) 2 229 39 11, Fax: (32) 2 229 39 71 Website: www.ceps.be / Email: info@ceps.be

CEPS was established in 1983. It performs independent analyses and critiques on European economic policy and politics, as well as on European institutions and security. It disseminates its findings through a regular flow of publications, public events and electronic commentaries. CEPS is an independent membership-driven organization with more than 100 corporate members and a large number of central banks, diplomatic missions and international business organizations in its constituency.

ABOUT MONET

MONET (www.isspm.org) is the result of the joint work of ISSP in Podgorica and CEPS in Belgium. It is financed by the grant from the European Agency for Reconstruction.

MONET team

-ISSP- ISSP team leaders: Professor Veselin Vukotic Petar Ivanovic

Researchers: Jadranka Kaludjerovic, Maja Bacovic, Milorad Katnic, Nina Labovic, Ana Krsmanovic, Tijana Stanković, Milica Vukotic

Lay out and web site: Boris Buskovic

-CEPS- Program Director: Daniel Gros Team Leader: Vladimir Najman (monet@ceps.be) Resident Economist: Przemyslaw Wozniak (monet@ceps.be, przemek@case.com.pl) Gérard Duchêne

Project Associates Zeljko Brkovic, Milan Dabovic, Miloica Dakic, Mirjana Djuranovic, Danijela Vukajlovic Grba, Jovanka Knezevic, Darinka Micanovic, Draginja Milatovic, Dejan Miljkovic, Dragica Pekovic, Milan Perovic, Natasa Radunovic, Vesna Samardzic, Zdravka Savic, Ljubinka Sekulic, Marina Vukanovic, Bosa Vukicevic, Tamara Saveljic, Zoran Djikanovic, Dragana Radevic, Darko Konjevic, Jelena Jokanovic, Maja Drakic

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Table of contents Events

3

Executive Summary

7

Part 1

Chapter 1. Output Chapter 2. Employment Chapter 3. Wages Chapter 4. Prices Chapter 5. Budget Chapter 6. Money Chapter 7. Capital Market Chapter 8. Trade Chapter 9. Regional Comparison

12 24 36 46 62 74 84 94

104

Part 2

Comment 1. International Conference “Economic Policies for a Viable Micro State”

Comment 2. Montenegro – Microstate Comment 3. Why Free Trade is Important for Montenegro? Comment 4. What does the EU have to gain

from trade liberalisation? Comment 5. Current trends on financial markets Comment 6. Tourist ambassador Project 2002 Comment 7. Energy sector in Montenegro Comment 8. What stage of pension reform are we in now?

111 115 133

151 154 161 166 169

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Events March 2003

03. Montenegroberza stock exchange introduces index MOSTE. Montenegroberza introduced index MOSTE that is composed of share prices of 35 most traded companies on the Montenegroberza stock exchange. On March 3rd the index was set to 100 and since then it has slowly increased.

04. NEX Montenegro stock exchange introduces two stock exchange indexes. NEX Montenegro stock exchange introduces two indexes: NEX PIF and NEX 20. NEX 20 monitors prices of shares of 20 important companies from Montenegro and NEX PIF monitors prices of investment units of all six Privatization Funds in Montenegro.

12. Montenegro receives World Bank credit in the amount of $ 15 mn. World Bank approved to Montenegro credit for structural adjustment in the amount of $ 15 mn.

19. Treasury bills issuance. Government in Montenegro decides to issue 28-day-treasury bills. Total amount of issuance is € 7 mn.

19. Wine producer “Plantaze” received gold prize for quality. Share company “Plantaze” from Podgorica on fair in Geneva received gold European prize for product quality and commercial prestige – “New millennium”.

25. International tourism and nutrition fair held in Budva. On the Adriatic coast in Budva the International Tourism and Nutrition Fair “Budva 2003” opened.

25. Compulsory reserve is reduced to 23%. Council of Central Bank of Montenegro decided to reduce compulsory reserve on deposits for commercial banks from 50% to 23%.

26. Accepted three offers for Hotels: “Belvi”, “Montenegro A” and “Rivijera”. Tender Commission of Privatization Council accepted three offers for sale of hotels of HTP “Budvanska rivijera” and HTP “Ulcinjska rivijera”. Interest has been shown for Hotel Belvi by “Imobilija CC - Budva”, for “Montenegro A” by Unis Tours from Banja Luka and for “Rivijera” by “Pemi Bau” from Berlin.

31. Ekos Bank loses work license. Central Bank of Montenegro Council decides to withdraw the license for Ekos Bank A.D. Podgorica. This was decided after few controls that show that Ekos bank didn’t work legally.

31. Tender for Aluminum Plant sale. Agency for Restructuring of Economy and Foreign Investment announced Tender for privatization of KAP’s plants: “Prerada”, “Kovacnica” and “FAK”.

April 2003

01. Price of electricity increased. Price of electricity in Montenegro increased by 23.24%. The average price for 1 kWh will now be 4.6 cents while that for households will be 4.4 cents for 1 kWh.

01. Start Value Added Tax (VAT) application. In Montenegro started VAT application. VAT will be calculated with a rate of 17%.

02. Aluminum Plant work better than planned. Aluminum Plant in Podgorica in March 2003 produced 10 million tons of aluminum and realized revenue in the amount of € 15.85 mn, of which € 14.3 mn is for export.

02. Treasury bills issuance. Government of Montenegro decides to issue 56-day-treasury bills. Total amount of issuance is € 3 mn.

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03. The first dealer license approved. Monte Adria Broker from Podgorica received license for

providing brokerage services as announced from Securities Commission.

09. “Telekom” of Montenegro accepted on “A” list of stock exchange listing. “Telekom Montenegro” shares are accepted on “A” list of stock exchange listing. Purchase of its shares on “A” list will start on April 14th 2003.

11. Started trade of shares with foreign currency saving bonds. On the Montenegroberza stock exchange trade with shares of foreign currency saving bonds are conducted for the first time for the price of € 0.75, or 75% of nominal value.

11. Government adopts Decree on tax relief for new employees. Montenegrin Government adopts Decree on tax relief for new employees. This decree provides that employers are free from paying employees taxes and contributions, for every new employee.

14. Ministers of Finance in Montenegro and Serbia sign Contract of representation in international finance organizations. Ministers of Finance in Montenegro and Serbia sign Contract of representation in international finance organization. According to the agreement, Serbia will be a fiscal agent in IMF for the Union of Serbia and Montenegro and Montenegro will be a fiscal agent in World Bank for the Union.

29. Accepted Nova Ljubljanska bank offer for buying Montenegro bank. Tender Commission of Privatization Council of Montenegro adopted offer “Nova Ljubljanska bank” from Slovenia for buying 91% of shares of Montenegro bank at the price of € 11.1 mn.

30. Adopt four decrees that regulate goods turnover between Serbia and Montenegro and its taxing. The Government of Serbia adopts four decrees that regulate goods turnover between Serbia and Montenegro and it’s taxing. According to the adopted decrees, the goods produced in Serbia and sold in Montenegro will not be taxed twice.

30. The Governments of Montenegro and Serbia agreed on customs tariffs for about 80% of products. The Governments of Montenegro and Serbia agreed on customs tariffs for 80% of the products subject to customs within the action plan on harmonization of economic relations between Serbia and Montenegro.

May 2003

06. Tariffs for steel harmonized. Negotiators between Serbia and Montenegro harmonized tariff rates for steel whose sole producer in Montengero is “Zeljezara” from Niksic. Tariff rates for respective steel products increase from 3%, 5% and 10% to 10%, 15% and 18%.

08. “Union Bridge” opened. President of Government of Montenegro opened “Union Bridge” in Podgorica. Construction of the bridge, in the amount of €1.4 mn, was financed by the European Union, The Government of Montenegro, and Municipality Podgorica.

09. Sign contract on sale “Montenegro bank”. Deputies of Montenegrobank and “Nova Ljubljanska” bank sign contract on the sale of Montenegro bank in the amount of € 11.1 mn.

09. The deputies of Governments of Montenegro and Serbia agreed on common tariffs between Serbia and Montenegro in several industrial sectors. The deputies of Governments of Montenegro and Serbia agreed on common tariffs between Serbia and Montenegro in the iron and steel industry, wood, chemical and graphical industry, the industry of construction materials, and leather, shoes and glass industries. The delegations also signed the Agreement on setting up a joint customs administration office of Serbia and Montenegro.

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10. Started hunger strike in “Jugooceanija”. 50 mariners of “Jugooceanija” with their wives

started a hunger strike. Mariners demand to be paid their salaries for the last two or three years.

11. Held Presidential Elections in Montenegro.

12. Filip Vujanovic – president of Montenegro. On elections for president of Montenegro, Filip Vujanovic won with 63.8% of votes and became the president of Montenegro.

13. First licenses obtained for six Montenegrin banks. The Council of Central Bank of Montenegro gave licenses for payments operations to six commercial banks: Euromarket bank, Crnogorska komercijalna bank, Hipotekarna bank, Atlas Mont bank, Podgoricka bank and Montenegrobanka bank. These are the operations that were previously carried out by ZOP and will now be done in the banks in view of elimination of ZOP.

14. Treasury bills issuance. Government in Montenegro decides to issue 28-day-treasury bills. Total amount of issuance is € 8 mn.

14. Serbia and Montenegro harmonize energy and agricultural tariffs. Serbian and Montenegrin Governments agreed on common tariffs in the energy and agricultural sectors. Tariff rate on oil derivate in Montenegro would be kept at 1%.

15. Achieved agreement between Serbia and Montenegro about tariff rates of agricultural goods. The Governments of Serbia and Montenegro agreed on the common tariffs for more than 950 agricultural goods. Both, Serbia and Montenegro will use the common tariff rates for more than 950 agricultural goods, of the total 1,087 goods that are subject to customs duties. According to that, tariff rates for agricultural products in Montenegro will be increased from an average of 3.5% to 12.2% while effective tariff rates with levies will increase from 11% to 19%.

21. Air company Montenegro Airlines received international prize for quality and efficiency. Montenegrin Air Company Montenegro Airlines received international prize for quality and efficiency that allow International Council “Global rating”.

28. The Government of Montenegro signs Protocol on Bilateral – Economy Cooperation with Germany in 2003. The Government of Montenegro signed a Protocol on Bilateral – Economic Cooperation with Germany in 2003 and the German financial support in 2003 will be € 6.7 mn.

29. The Anode Plant “Anotek - Vektra” received International Certificate for quality management. The Anode Plant “Anotek - Vektra” received International Certificate for managing quality JUS ISO 9001 – 2001.

29. Abolished visas for entrance in SCG. Ministry of SCG Council decided to abolish visas for entrance and stay of up to 90 days in Serbia and Montenegro for citizens of several countries.

June 2003

02. “Merkur” to buy Hotel “Mogren”. Company “Merkur” from Budva is to buy Hotel “Mogren” for € 5.1 mn.

03. Tariff rate on automobiles – 5%. According to Ministry of Finance in Montenegro announcement, Montenegro will retain tariff rate on automobile imports of 5% in the next two years, after that the rate will be doubled, as agreed in the Action Plan for Harmonization between Serbia and Montenegro.

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11. Treasury bills issuance. Government in Montenegro decides to issue 28 - day-treasury bills.

Total amount of issuance is € 7.5 mn.

13. Adopt Action Plan between Serbia and Montenegro. The Government of Montenegro adopts a draft version of Action Plan on Harmonization between Serbia and Montenegro. According to the announcement of Ministry of Finance, average nominal tariff rate in Montenegro will be 6.1% and average effective 5.7%.

16. Sold Hotels HTP “Budvanska rivijera” – “Mediteran” and “Montenegro”. According to the announcement of Privatization Council of Montenegro, “Maestral Tours” from Budva bought Hotel “Mediteran” for € 3,839,200, and “Hotel Apartment Brunsvik” from Budva bought Hotel “Montenegro” for € 2,930,000.

18. Deputies of the Parliament of the State Union Serbia and Montenegro adopt Law on Courts. State Court should protect human and minorities rights that regulate Constitutional Court and provide legality in work of institutions and union bodies.

20. Deputies of the Parliament of the State Union Serbia and Montenegro adopt Credit Law.

24. The tunnel “Sozina”. Workers from Niksic’s “Boksiti” and Slovenian “Slovenia ceste” have completed the last meters of tunnel “Sozina”. The Tunnel is 4,188 meters long and it should be opened for traffic next summer.

25. Treasury bills issuance. Government of Montenegro decides to issue 56 - day-treasury bills. Total amount of issuance is € 2.5 mn.

29. Euromarket Bank opened branch office in Niksic. July 2003

03. Adopt final version of Action Plan on harmonization between Serbia and Montenegro. The Government of Montenegro adopts the final version of Action Plan on Harmonization between Serbia and Montenegro. This document creates conditions for a Feasibility Study, which is a proposition for underwriting agreement on stabilization and association with EU.

08. The Parilament of Montenegro Adopted Law on the Protector of Human Rights and Freedom (Ombudsman), Labor Law and Law on Strike. This law defines ombudsman as a human rights and freedom protector, that will protect citizens from “bad and agressive administration”.

09. Treasury bills issuance. Government in Montenegro decides to issue 28 - day-treasury bills. Total amount of issuance is € 7 mn.

09. Adopt three laws on local self-government. Montenegrin Parliament adopted three laws on local autonomy: Law on Local Self-government, Law on Local Self-government Financing and Law on Election of the Local Self-Government President.

15. Parliament of Montenegro adopts Law on Action Plan of harmonization between Serbia and Montenegro.

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Executive Summary

First section The average level of industrial production in the first 4 months of 2003 was 14% higher than the average level in the analogous period of 2002. However, the annual dynamics of industrial production after registering positive rates in 2003Q1 fell to – 11% in April 2003. On an annual basis, in April 2003, processing industries fell by 16.6%, while the second industrial sector, electricity, gas and water grew by 13.2%. The third sector - mining and stone extraction registered an annual growth rate of 13.6% in April 2003. Cumulated over the first five months, the total number of tourists in 2003 decreased by 5.9% as compared to 2002. The share of foreign tourists increased to 28% in period January-May 2003 compared to 23% in the same period 2002. The level of transport services was lower in 2003 Q1 than in 2002 Q1, mainly due to slumps in road and sea transportation. With respect to retail trade, in 2003 Q1, the average value of retail sales was 21.5% higher than in 2002 Q1 and 4.1% higher than the average value of the index in 2002. Official data on the labor market are rather confusing. For quite some time, the fall in the number of the unemployed has been accompanied by the decrease in official employment figures. The average employment in the first five months of 2003 was 1.3% lower than in an analogous period of 2002, while at the same time the rate of unemployment fell by 7.3 percentage points between respective periods. Also, the Decree on Tax Relief for New Employees and the Decree on Employment of Nonresident Persons have been adopted by the GoM with the objective to channel gray labor into the regular economy and thus increase official employment. The first decree cuts the employers’ costs of employing new employees by about one-third, while the second encourages employment of a local labor force by imposing a tax on employing non-resident workers during the summer season. The new Law on Personal Income Tax is very likely to reduce the average taxation in Montenegro. When the new tax rates are applied to the 2002 wage distribution, the result is a weighted average tax rate of about 15% as opposed to the flat 19% rate under the old tax regime. Tax rates will be lower for the vast majority of Montenegrin employees with the exception of those making above €6,500 a year for which the new system will yield higher effective tax rates than 19%. CPI annual inflation continued to remain the falling trend through the end of 2002Q2 (6.6% in June) with the exception of April (rise to 7.7%) when VAT of 17% was introduced and electricity prices were raised by 24%. The average monthly rate of change was 0.9% for first six months of 2003. RPI annual inflation in June stood at 8.1% on an annual basis. Food continued to exert disinflationary pressures while most inflationary impulses originated in the sector of clothing and footwear, accommodations, as well as education and culture. In June, the Food consumer basket cost €264, or 4% more than in the same month of 2002. PPI annual inflation had been declining through August 2002, while September 2002 was marked by a slight increase; since December 2002, the dynamics were falling again to reach 0% in January 2003 and negative rates of – 1.5% and – 0.7% in February and March 2003, respectively. Increasing PPI dynamics, which reached 6.7% in June 2003,

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marked the second quarter of 2003. Consumer prices of goods grew much faster than producer prices since 2001. This points to the fact that inflation in Montenegro is mostly generated at the level of a narrow group of de facto monopolistic retailers and importers that face stable customs tariffs and € import prices but raise the retail prices in the Montenegrin market nevertheless. Forecasted inflation rate for end-2003 is 6.1% by optimistic and 8.3% by pessimistic scenario and 3.5% and 7.5% by optimistic and pessimistic scenario respectively in June 2004. Due to lower budget revenues in the first months of 2003 (a typical seasonal phenomenon), the GoM was forced to reduce some expenditure categories or postpone its obligations. However, at the end of the first quarter of 2003, the overall budget balance on a cash basis was negative and amounted to €-3.6 million, which was financed through borrowing. The increasing supply of T-bills and the difficult situation with the budget liquidity led to the rise of the interest rate from about 8%, which was January’s weighted average, to more than 10% in April. The annual growth rate of all monetary aggregates was negative in both March and April 2003. The source of this decline lies mostly in the fact that the new estimate of cash done by CB is 19% lower than the 2002 estimate. However, non-cash components of money aggregates also fell on an annual basis. On the other hand, savings of households continued to grow at a fast pace. However, the current high growth rates are, to a great extent, a consequence of a low base – i.e. the low level of savings in 2001 and 2002. Total loans given by banks continued to increase during the first months of 2003. On an annual level, total loans grew 76% in March and 75% in April. The upward trend in bank lending to non-financial and other clients, which was present during the last year, continued in the first four months of 2003. In 2003, the Montenegrin capital market is continuing to expand. In the first four months of 2003, total turnover presented almost half of turnover in the entire last year and the number of transactions exceeded the total number of transactions in the entire 2002. In April trade with shares with old foreign exchange saving bonds was initiated and the first companies were listed on list A. Additionally, on March 1st, stock exchange indices were introduced on both stock exchanges. Montenegrin foreign trade in 2003Q1 was concentrated in several sectors such as oil and oil derivatives, vehicles, telecommunication equipment, fruit and vegetables, meat and meat products, electrical machines and equipment, construction materials and industrial machines for general use on the imports side1, and aluminum, oil and oil derivatives (re-export), transportation equipment, and iron and steel on the export side. With respect to import, partners in the region, especially former Yugoslav republics (Slovenia, Croatia, Bosnia and Herzegovina) increased their share in foreign trade in 2003Q1, while on the export side, the main trade partner in the region is Kosovo. Furthermore, our own estimates of the Montenegrin Terms of trade (TOT) point to the fact that profitability of the Montenegrin foreign trade has worsened somewhat in 2003 vis-à-vis 2002. The current account deficit in Montenegro in 2003 Q1 amounted to €53.4 million, which is €10 million more than in the same period in 2002 when the deficit amounted to €43.5 million. Total revenues were equal to €127.2 million, or 3 % less than in 2002Q1, while expenditures amounted to €180.6 million and were 3.4% greater than the same period in

1 excludes trade with Serbia

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2002. The current account deficit in 2003 Q1 was partly balanced by the surplus in the capital and financial account in the amount of €1.887 million. During 2003, most Southeastern European countries are projected to achieve positive growth rates and the 2 slowest-growing countries in the region hope to see their GDP growth increase: Montenegro to 1.5% and Macedonia to 2%. Annual industrial output growth in the first half of 2003 varied significantly across the region. Industrial production fell on an annual basis in Serbia (by 3.4% in May) and Montenegro (by 11.3% in April), but increased in Macedonia and Croatia, BiH and Romania. Inflation in 2003 fell on an annual basis compared to end-2002 in all countries except for Bosnia and Herzegovina. Current account deficits were also higher in almost all SEE countries in 2002 and 2003 Q1.

Second Section International Conference, “Economic Policies for Viable Micro State” Institute for Strategic Studies and Prognoses, in cooperation with Chesapeake Associates and Institute for Global Economic Growth, with the support of USAID, has organized an international conference “Economic Policies for a Viable Micro State”. The conference was held on June 23-24th in Podgorica. The ISSP conference gathered approximately 170 people from 16 countries. The article gives a presentation of the subjects, discussions and conclusions from this event that attracted huge interest, not only regionally but to a wider public, as well. Montenegro – microstate This paper, written by President of the ISSP, Prof. Veselin Vukotic, was presented at the Conference “Economic Policies for Viable Microstates”. The paper answers the question, how should Montenegro deal with the challenges and necessities of its new institutional framework and increase the efficiency of Government and state administrations? The answer is Montenegro as a microstate, and some elements of this concept are presented in the work. The hypothesis is that products from Montenegro cannot be competitive in the global market with such high public consumption. Why Free Trade is Important for Montenegro? This paper was also presented at the Conference “Economic Policies for Viable Microstates”. The main argument for the proponents of the high custom rates is protection of the domestic economy. However, other questions are not answered, such as: do higher custom rates protect domestic employment, do higher custom rates protect domestic production and its contribution to the GDP, and do higher custom rates protect against the comparative advantage of those countries that threaten us with possible import of cheaper product? This paper answers these questions and explains why free trade is important for Montenegro. What does the EU have to gain from trade liberalization? And yet, another article with free trade as a subject. This paper explains why free trade is important for the European Union. The author of the article is David Smith, economics editor of The Sunday Times, London. The article is based on Mr. Smith’s speech given at a

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recent seminar on European barriers to free trade, organized by the Stockholm Network and the International Policy Network. Current trends on financial markets This paper gives an overall presentation of the current trend in the financial markets. It provides analysis and comments on issues, such as: impact of global economic developments on the international financial markets, causes of the drop on the international financial markets, foreign exchange rates and movements of foreign capital to developing countries, change of business politics of institutional investors, current trends in banking, and global appreciations. Tourist ambassador Project, 2002 In this article some clear problems of the tourist industry are identified, marked in the Tourist ambassador Project 2002, and presented in the publication of the Tourist ambassador report by the Center for Entrepreneurship and Economic Development. In addition to identifying and explaining the tourism problems in Montenegro, this article determines the best approach that should be taken in order to improve conditions for a successful tourist season. Energy sector in Montenegro The paper explains the situation in the energy sector in Montenegro, gives the background of reform in this area, and analyzes the current reform process in this sector. In addition, the author gives some recommendation for further steps that should be done in the future in order to achieve the defined goal of the reform of the energy sector. What stage of pension reform are we in now? The reform of the PAYGO system to the three-pillar system has begun with the first pillar reform. The New Law On Pension And Disability Insurance is regulating restrictive measures in order to achieve pension system sustainability and create a proper base for further reform. The main measures in the New Law are: Age requirement increase, Change of the pension formula, SWISS indexation, Exceeding base for contribution paying, Restrictive conditions for disability, survival and other benefits and Pension Fund administrative reform. The New Law analysis answers the question: How and why this Law was created?

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PART 1

Chapter 1. Output

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Table 1.1 Major Developments in the Real Sector

GDP *** Industrial Output Construction Tourism Retail trade

turnover Total

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%

*

1990 89.0 -11.0 100 1991 70.0 -21.3 86.8 102,256 2,963,675 1992 61.0 -12.9 69.8 -19.5 89,165 2,312,621 1993 39.0 -36.1 39.7 -43.2 38,104 1,694,769 1994 39.0 0.0 36.0 -9.2 10,574 1,997,483 1995 46.0 17.9 35.5 -1.4 26,071 1,504,302 1996 57.0 23.9 52.8 48.7 51,178 3,102,091 1997 61.0 7.0 53.6 1.5 80,600 2,276,868 1998 64.0 4.9 54.0 0.8 76,737 2,713,936 1999 58.0 -9.4 49.7 -8.0 80,936 2,711,929 100 100 2000 60.3 4.0 51.3 3.3 95,526 2,698,019 351 250.7 448,187 17.8 271 170.9 2001 62.7 4.0 50.3 -2.0 108,123 2,492,993 1,299 270.5 555,040 23.8 20.8 369 36.1 2002 63.2 0.8 50.7 0.7 116,482 2,194,516 998 -23.2 541,699 -2.4 24.7 352 -4.5 2000-Q1 52.3 952,727 137.3 38,745 16.0 145.0 2000-Q2 46.7 504,224 244.3 95,661 20.3 213.7 2000-Q3 49.9 403,666 454.0 277,003 16.3 357.0 2000-Q4 56.5 837,402 567.0 36,778 18.8 368.0 2001-Q1 53.2 1.8 26,060 952,441 862.7 528.2 35,067 -9.5 20.0 282.7 95.0 2001-Q2 48.5 3.8 26,610 524,536 1530.4 526.4 97,744 2.2 22.3 335.3 56.9 2001-Q3 44.7 -10.4 27,778 267,701 1605.1 253.5 387,023 39.7 20.1 471.9 32.2 2001-Q4 54.8 -3.0 27,675 748,315 1198.6 111.4 35,206 -4.3 20.6 385.5 4.8 2002-Q1 45.2 -15.1 26,619 507,743 674.9 -21.8 33,292 -5.1 20.9 305.8 8.2 2002-Q2 45.7 -5.8 29,513 265,271 850.3 -44.4 118,958 21.7 25.5 334.3 -0.3 2002-Q3 51.9 16.1 30,105 501,282 1183.2 -26.3 352,718 -8.9 26.9 398.6 -15.5 2002-Q4 59.9 9.4 30,245 920,220 1284.3 7.2 36,731 4.3 25.6 370.0 -4.0 2003-Q1 50.6 12.1 29,744 1,010,097 729.9 8.2 26913.0 -19.2 21.7 366.8 19.9 Jan-01 47.70 -7.3 8,877 311,502 971 943.5 11,520 -13.1 17.3 266.3 97.3 Feb-01 54.05 7.1 8,285 312,837 784 517.2 10,953 -18.6 18.3 276.9 96.4 Mar-01 57.78 8.0 8,898 328,102 834 334.2 12,594 4.7 24.4 304.9 91.8 Apr-01 46.17 -9.1 8,832 188,910 1,568 867.7 12,768 -3.9 28.1 318.9 66.1 May-01 52.03 17.9 9,184 199,982 1,605 710.6 26,328 1.7 19.9 329.4 58.4 Jun-01 47.30 -3.0 8,594 135,644 1,418 280.3 58,648 3.8 18.9 357.5 48.3 Jul-01 42.90 -14.6 9,177 94,796 1,904 401.0 161,832 42.9 17.9 455.6 52.4 Aug-01 45.04 -0.3 9,374 66,872 1,406 270.0 165,750 39.7 19.1 504.6 34.2 Sep-01 46.12 -2.2 9,227 106,033 1,506 150.1 59,441 31.7 23.3 455.6 15.0 Oct-01 50.83 -10.1 9,580 169,916 1,817 252.0 15,744 11.9 20.8 399.5 9.5 Nov-01 53.57 -9.7 8,793 275,357 771 43.4 9,820 -5.9 21.2 371.5 6.1 Dec-01 59.95 19.4 9,302 303,042 1,008 55.8 9,642 -21.4 19.9 385.5 -0.9 Jan-02 39.7 -16.0 7,949 186,203 571 -41.2 10,450 -9.3 18.4 307.0 15.3 Feb-02 45.2 -17.2 8,644 131,239 740 -5.6 11,648 6.3 22.1 285.6 3.1 Mar-02 50.6 -12.8 10,026 190,301 714 -14.4 11,194 -11.1 22.2 324.8 6.5 Apr-02 47.7 3.2 9,682 110,477 722 -53.9 15,584 22.1 24.7 321.2 0.7 May-02 40.9 -21.6 10,088 36,512 821 -48.9 34,190 29.9 24.3 335.5 1.9 Jun-02 48.4 2.2 9,743 118,282 1,008 -28.9 69,184 18.0 27.4 346.2 -3.1 Jul-02 53.5 24.5 10,187 171,070 972 -48.9 151,284 -6.5 21.1 417.6 -8.3 Aug-02 47.5 5.2 9,995 136,702 1,258 -10.6 137,230 -17.2 25.2 431.9 -14.4 Sep-02 54.6 18.2 9,923 193,510 1,320 -12.3 64,204 8.0 34.2 346.2 -24.0 Oct-02 59.8 17.4 10,216 289,604 1,061 -41.6 21,921 39.2 26.3 385.5 -3.5 Nov-02 59.0 10.0 9,840 284,397 1,418 83.8 6,826 -30.5 26.9 360.5 -3.0 Dec-02 60.9 1.6 10,189 346,219 1,373 36.3 7,984 -17.2 23.5 364.1 -5.6 Jan-03 46.5 17.2 10,217 337,645 498 -12.8 9,519 -8.9 22.3 351.9 14.7 Feb-03 52.7 27.9 9,238 371,125 498 -32.8 9,520 -18.3 18.7 368.1 28.9 Mar-03 52.6 14.3 10,289 301,327 1,194 67.4 7,874 -29.7 24.1 380.3 17.1 Apr-03 38.5 -11.3 9,903 125,751 13,792 -11.5 24.8 May-03 10,258 37,457 9.6 33.8

* - Annual changes refer to growth rates of the index vis-a-vis the analogous period of the preceeding year. For monthly data, these are growth rates of the index in a given month vis-a-vis the analogous month of the preceeding year. For quarterly data these are growth rates of the average value of the index in a given quarter over the analogous value for the same quarter of the preceeding year. For annual data, these are growth rates of the average value of the index in a given year vis-a-vis the average value of the index in the precedeeing year. ** end-year annual change of GDP *** GDP in constant prices, excluding informal economy sources: Monstat-Statistical Office of Montenegro, Aluminum Combine Podgorica, Power Plant of Montenegro (EPCG). GDP estimates : up to 1998 made by ISSP and based on Social Product, for other years: Central Bank of Montenegro, USAID/KPMG Barents Group and ISSP

Montenegro Economic Trends September 2003

ISSP - CEPS

13

1. REAL SECTOR

In the following chapter we will present the most recent developments in the real economy by commenting on the situation in the sectors of production (including industry), tourism, transport, and trade. Due to a lack of data, several sectors of the economy will not be included in the analysis. These sectors include health care, education, financial services, and services to firms (i.e. consulting). No official data are available for these sectors; therefore we cannot determine the prevailing trends. However, the sectors that are analyzed in this chapter comprise the most important sectors, which account for the majority of the national income. 1.1. PRODUCTION The production sector in Montenegro is composed of industrial production, forestry, and construction. 1.1.1. Industrial production Monthly and annual changes of industrial production in Montenegro, as well as its index based in December 1999, are presented in graph 1.1 below. Clearly, industrial production fluctuates heavily whether growth rates are expressed monthly or annually, and this fluctuation seriously complicates any inference about the longer-term trends and perspectives. The development of the index based in December 1999, reflects the fact that the level of industrial production, while rather unstable throughout the year, does not exhibit any strong longer-term trend.

Graph 1.1 Index of industrial production

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Annual changes of the index

source: Montenegrin Statistical Office note: Monthly changes refer to indices where previous month is equal to 100 and annual changes refer to indices where analogous month of the previous year is equal to 100.

Chapter 1. Output

ISSP - CEPS 14

Table 1.2. Industrial production: disaggregated indices of major industries share in the index 2001 2002 01-04/2003 02/2003 03/2003 04/2003

2000 2001 2002 2000=100

01-04/2002 = 100

02/2002 =100

03/2002 =100

04/2002 =100

INDUSTRY TOTAL 100 100 100 99.3 99.9 103.2 114.1 127.9 114.3 88.7

MINING AND STONE EXTRACTING 7.6 6.8 7.2 88.5 95.1 61.6 85.7 74.2 105.9 113.6

PROCESSING INDUSTRY 67.8 69.9 71.2 101.6 103.9 95.8 97.3 97.7 100.2 83.4

ELECTRICITY, GAS AND WATER PRODUCTION

24.6 23.3 21.6 93.9 87.7 134.0 187.9 289.3 164.1 113.2

MINING AND STONE EXTRACTING 7.6 6.8 7.2 88.5 95.1 61.6 85.7 74.2 105.9 113.6

RAW MATERIALS EXTRACTION 2.8 2.2 3.3 78.0 119.1 95.6 85.1 78.1 101.9 109.5

MINERAL COAL, LIGNITE MINING AND EXTRACTION

2.8 2.2 3.3 78.0 119.1 95.6 85.1 78.1 101.9 109.5

OTHER RAW MATERIALS EXTRACTION 4.8 4.6 3.9 94.6 81.1 41.8 86.9 70.2 112.5 115.2

Metal ores mining 3.4 3.4 3.3 96.3 96.6 44.5 86.2 75.5 133.3 103.3

Other ores and stone extraction 1.3 1.2 0.6 90.3 41.9 35.1 89.1 49.3 74.6 161.8

PROCESSING INDUSTRY 67.8 69.9 71.2 101.6 103.9 95.8 97.3 97.7 100.2 83.4

MANUFACTURE OF FOOD PRODUCTS, BEVERAGES AND TOBACCO

9 9.5 8.2 104.6 91.8 73.1 81.4 98.7 102.7 72.6

Manufacture of food products and beverages 7.1 7.2 6.4 100.1 90.0 73.3 82.5 106.3 89.9 78.2

Manufacture of tobacco products 1.9 2.3 1.8 121.9 99.1 72.1 77.4 76.3 155.9 54.9

MANUFACTURE OF TEXTILE AND TEXTILE PRODUCTS

2.4 1.7 2 72.1 81.5 66.4 74.4 67.7 86.6 54.0

Manufacture of yarn and fabrics 0.6 0.5 0.5 94.1 70.5 53.7 61.4 64.6 79.3 58.6

Manufacture of apparel and fur 1.8 1.2 1.5 64.9 85.0 70.6 78.5 68.6 89.3 52.7

MANUFACTURE OF LEATHER AND LEATHER PRODUCTS

0.4 0.3 0.2 73.6 57.3 40.0 66.5 66.4 51.8 119.0

WOOD PROCESSING AND WOOD PRODUCTS

3.6 2.8 2 78.2 54.8 12.7 25.8 22.6 26.6 17.9

MANUFACTURE OF PAPER; ISSUING AND PRINTING

1.8 1.9 1.8 107.2 98.4 62.0 66.7 58.7 58.5 49.8

Manufacture of cellulose, paper and paper processing

1 0.9 1 89.8 99.1 26.1 26.9 17.8 28.8 13.7

Publishing, printing and reproduction 0.8 1 0.8 129.7 97.7 108.1 122.6 149.3 111.9 115.8

MANUFACTURE OF COKE AND OIL DERIVATES

0.1 0.1 0.1 111.1 63.8 - - - - -

MANUFACTURE OF CHEMICAL PRODUCTS AND FIBERS

1.9 1.9 2 99.9 105.5 70.3 58.1 35.0 112.0 44.5

MANUFACTURE OF RUBBER AND PLASTIC PRODUCTS

0.5 0.4 0.5 72.9 91.9 68.7 67.5 63.2 72.3 79.5

MANUFACTURE OF PRODUCTS OF OTHER NONMETAL MINERALS

6.5 7.1 7.4 107.2 112.9 109.6 100.7 101.8 97.5 93.9

MANUFACTURE OF BASE METALS AND METAL PRODUCTS

39.3 43.4 45.2 109.7 115.2 116.1 108.6 108.1 108.2 93.7

Manufacture of basic metals 37.6 42.1 43.5 111.2 116.8 119.2 109.7 111.2 106.5 94.7

Manufacture of metal products, except machines 1.7 1.3 1.7 75.4 97.9 65.7 79.2 58.5 178.4 66.6

MANUFACTURE OF MACHINERY AND DEVICES, OTHER

1.8 0.2 0.9 12.5 52.3 28.8 77.1 797.7 38.5 40.8

MANUFACTURE OF TRANSPORT EQUIPMENT

0.4 0.6 0.8 144.0 174.0 145.6 74.9 78.1 83.9 45.7

PROCESSING INDUSTRY, OTHER 0.1 0.1 0.1 39.6 63.3 3.4 9.1 - 25.0 4.5

ELECTRICITY, GAS AND WATER PRODUCTION

24.6 23.3 21.6 93.9 87.7 134.0 187.9 289.3 164.1 113.2

Source: Monstat The annual dynamics of industrial production have been positive in the second half of 2002 and in the first quarter of 2003, albeit varying significantly from month to month. In January the dynamics was 17%, then rose to 28% in February, only to fall back to 14% in March, and be followed by a significant drop on a monthly basis (-27%) in April of 2003, which translated into negative annual dynamics of –11%. Nevertheless, as table 1.2 suggests, the average level of industrial production in the first 4 months of 2003 was 14% higher than the average level in the analogous period of 2002.

Montenegro Economic Trends September 2003

ISSP - CEPS

15

Three major industrial sectors The processing industry, which represents 71.2%1 of total industrial production, has registered a high annual growth rate in January 2003 and near-zero rates in February and March 2003. April brought a significant decline on a monthly basis and a fall on an annual basis of 16.6%. What were the sources of the substantial downfall in April? Most processing industries registered negative dynamics in April. Among the most important were foodstuffs and tobacco whose production in April 2003 was 27% lower than in April 2002 and the average level during January-April 2003 was 19% lower than the average level during the analogous period of 2002. The decline was even more pronounced in the textile industry, where the level of production in April 2003 and the average level during the period January-April 2003 were 45% and 25% lower respectively, than in the analogous periods in 2002. Production of wood products registered an annual decline of 80% in April 2003 and that of the paper and printing industry as well as the chemical products industry fell on an annual basis by 50%. The most important industry – basic metals and metal products (with a 45% share of total industrial production) registered annual growth rates of 11% in February, 7% in March and –5% in April, and thus had the most visible effect on the reversal of the annual dynamics of the total production index. The second industrial sector, electricity, gas and water, which accounts for 21.6% of total industrial production, registered relatively high annual growth rates in 2003: 289% in February, 64% in March and 13.2% in April. The average level of production in this sector in the first 4 months of 2003 was 88% higher than during the analogous period of 2002. This was mostly due to favorable weather conditions which enabled the water power plants to fully execute or even exceed their production plans (see below for more details). The mining and stone extracting industry, which represents about 7.2% of total industrial production, has registered an annual growth rate of 13.6% in April 2003. However, January and February 2003 saw a serious fall in annual dynamics, of –38% and –25% respectively and hence the average level of production in this sector during the first 4 months of 2003 was 14% lower than during the analogous period of 2002. Leading industrial producers The Power Company of Montenegro (Elektroprivreda Crne Gore), one of the most important industrial producers in Montenegro comprising three power plants, increased its production by 13.8% in April 2003 compared to the same month last year. However, in comparison to the average monthly production in 2002, production in April 2003 was lower by 31%, while March and February were 65% and 102% higher, respectively.

1 Data based on the share of sales in 2002, used in official statistics in 2003.

Chapter 1. Output

ISSP - CEPS 16

Graph 1.2. Total electricity production

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source: The Power Plant of Montenegro (EPCG) Graph 1.2 presents the aggregate actual and planned electricity production of the 3 power plants existing in Montenegro: Perucica Hydro Plant, Piva Hydro Plant, and Pljevlja Thermal Plant. For the period July 2002-February 2003, total electricity production was exceeding the planned level. However, since March 2003, actual production has fallen short of the planned levels. Output of the Perucica Hydro Plant was 17.8% below the planned level in April 2003 and that of the Piva Hydro Plant was 35% below the plan. Operation of the Pljevlja Thermal Plant was suspended for the plant’s renovation that is due to last until the end of May 2003.

Graph 1.3. Electricity production

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source: Montenegrin Statistical Office, EPCG Note: 12-month averages of annual changes are moving averages of annual changes during the past 12 months.

Montenegro Economic Trends September 2003

ISSP - CEPS

17

The production of the Aluminum Combine Podgorica (KAP) is expanding, albeit at a decreasing rate. Since March 2002 through the end of 2002, the annual growth rate amounted to approximately 10%, in January 2003 it went up to 30%, and then fell to 7% in February, and below 3% in March, April, and May. Aluminum production in May 2003 was 5.7% higher than the average monthly production in 2002 and the average production for the first 5 months of 2003 was 3% higher than the average monthly production for the entire year of 2002.

Graph 1.4 Aluminum production: dynamics and export prices

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source: KAP Graph 1.4 presents the annual and monthly dynamics as well as prices at which KAP exported its aluminum. Since January 2002, the export prices have been fluctuating in the range of 1325-1460 USD per ton. On average, the price in 2003 is 2.3% higher than the aluminum price on the London Stock Exchange. Table 1.3 Indices of developments in various sectors of the economy

index value 2000 2001 2002 1-3.2003 01/2002 02/2003 03/2003

base period 1999=100 1-3.2002

=100 01/2002=10

0 02/2002=10

0 03/2002=10

0

Forestry 121.5 214.0 160.3 12.3 11.3 18.1 6.1 13.4

Construction 350.7 1299.2 998.2 729.9 108.2 87.2 67.2 167.4

Services

Transport

road (goods) 83.4 99.2 96.9 74.9 75.9 85.5 63.1 79.6

road(persons) 102.6 73.3 66.0 39.8 66.1 76.9 56.3 68.9

sea (goods) 79.7 42.5 2.1 0.9 162.0 26.2 58.3 177.7

railway (goods) 94.3 93.4 120.6 93.1 81.2 67.1 96.9 151.2

railway (persons) 280.3 297.0 266.7 229.2 91.3 80.5 103.4 99.7

Retail trade 270.9 368.8 352.2 366.8 121.5 114.7 128.9 117.1

Catering 249.0 499.2 597.0 221.3 136.3 144.7 129.0 82.9

source: Monstat

Chapter 1. Output

ISSP - CEPS 18

1.1.2. Forestry and Construction As in the other sectors, the analysis of activity in forestry and construction is based on data from Monstat. However, the Statistical Office does not have data on the full activity of private firms that are active in forestry and construction, and hence they are not included in the index. Therefore, since coverage of these industries is not complete, these figures have to be treated with caution, as they describe just a fraction of the real activity in those sectors. Forestry Production in the forestry sector dropped radically in 2003. The monthly level of production in January, February and March amounted to only 18%, 6%, and 13%, respectively, of the analogous levels in 2002. On average, the level of production in the first quarter of 2003 was 89% lower than in quarter one of 2002. Construction Construction experienced a slump in January and February 2003, but increased in March by 67% as compared to March of 2002. Overall, quarter one of 2003 was characterized by a level of construction activity that was 8.2% higher than that of 2002 quarter one. 1.2. TOURISM The summer season of 2002 was relatively bad for tourism in Montenegro and the slump continues to prevail into early 2003. Consequently, cumulated over the first five months, the total number of tourists in 2003 decreased by 5.9% as compared to 2002. However, in line with the longer-term trend, the share of foreign tourists has been on the rise, 28% in the first five months 2003 compared to 23% in the same period in 2002. (see Graph 1.5).

Graph 1.5. Tourists in Montenegro (total monthly)

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source: Montenegrin Statistical Office

Montenegro Economic Trends September 2003

ISSP - CEPS

19

Graph 1.6 presents the number of tourists cumulated over the previous 12-month period. This data points to a slow-down in tourism; in fact, when cumulated annually, the number of tourists has been dropping consistently since October 2002, when tourists amounted to 546,000 while in March the cumulative total was 11,000 fewer. The positive sign for tourism is that the share of foreign tourists, observed on a cumulative basis, is going up: in May 2003 it was 25.9%, almost 6 percentage points higher than in May 2002.

Graph 1.6: Cumulated annual visits of tourists in Montenegro (during past 12 months)

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Source: Montenegrin Statistical Office Graph 1.7 presents the growth rates of tourism, cumulated since the beginning of the respective year. Likewise, the data presented in the graph confirms the downward trend in the industry. Data for period January-May 2003 points to the fact that the crisis has mostly affected domestic tourist visits: the total number of domestic tourists in this period was 12% lower than in period January-May 2002 while the number of foreign tourists in the first five months 2003 is 14.2% higher than the previous year. An important observation is that while for domestic tourists the growth rate has been negative since July 2002 (e.g. comparing Jan-July 2002 to Jan-July 2001), the negative growth rate for foreign tourists has only been observed since February until April 2003. In line with our observations on the number of tourists, the balance of payments statistics report lower revenues from tourism in 2003. These revenues dropped by 18% in 2003Q1 compared to the same quarter last year. A worrisome sign is that the aggregate drop of 18% was a result of the pronounced decline in revenues generated from visits by foreign tourists (-29%) and a slight increase in revenues from tourists from Serbia (+4%).

Chapter 1. Output

ISSP - CEPS 20

Graph 1.7. Annual growth rates of number of tourists (for the indicated period compared with analogous period of preceding year)

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g 02

jan

- se

p 02

jan

- oc

t 02

jan

- no

v 02

jan

- de

c 02

jan

- 03

jan-

feb

03

jan-

mar

03

jan-

apr

03

jan-

may

03

Domestic tourists Foreign tourists All tourists

t

Source: Montenegrin Statistical Office 1.3. OTHER SECTORS OF SERVICES Transport The majority of transport activities in Montenegro in 2003Q1 were at lower levels as compared to 2002Q1 (see table 1.3). Road transportation has been declining for the second year in a row. Annual growth rates for both goods and personal road transportation have been negative for a number of months now resulting in a consistent decline in both activities. The average level of indicators of goods and passenger transport in 2003Q1 were 24% and 44% lower than in 2002Q1, respectively. After collapsing fully in 2002 due to bankruptcy of the company Jugoocenija, sea transportation picked up somewhat in March 2003 resulting in positive annual dynamics at a level of 78%. The resulting growth in sea transportation was 62% in 2003Q1 vs. 2002Q1. Railway transportation of goods and persons is also going through a period of decline. Although positive annual dynamics have been registered in March (persons) and April 2003 (goods), the average level of respective indicators in the first quarter of 2003 was 19% (goods) and 9% (passengers) lower than in the first quarter of 2002. Despite the lower level of transportation activities in the country, export of transportation services as measured by revenues registered in the balance of payment was 4.2% higher in 2003 Q1 than in the same period of 2002. Retail trade Retail trade is developing rapidly (see table 1.3). In 2003Q1, the average value of retail sales was 21.5% higher than in 2002Q1 and 4.1% higher than the average value of the index in 2002. On an annual basis, retail sales have been growing since January 2003 and have registered relatively high growth rates of 15%, 29%, and 17% in January, February, and March, respectively.

Montenegro Economic Trends September 2003

ISSP - CEPS

21

CATERING Annual dynamics of turnover in catering has been positive since September 2002 and amounted to 45% in January and 29% in February 2003. March 2003 saw a significant drop in annual dynamics (–18%). Nevertheless, the average level of the index in catering in 2003Q1 was 36% higher than in the corresponding period of 2002. 1.4. Gross Domestic Product in Montenegro23 GDP accounting in Montenegro is a very complex issue. For 2001, the GDP figure is estimated based on accurate figures, while from 2002, all GDP forecasts are based on the accounting and behavioral model that was calculated in early 2002 and made use of the data from 2001 and earlier years. The GDP figures for subsequent years, 2002-2006, were produced by this model with input of assumed values for the model variables. Theoretically, the figures are forecasts since they are based on assumptions of several dozens of model variables made in early 2002, but practically, due to the lack of proper ex-post accounting based on actual data, they have also become the official estimates and basis for real-growth calculations. In the following section we will shed some light on the GDP figure for 2002 and forecasts for the future. 1.4.1. Model of GDP for Montenegro The macroeconomic model of GDP was calculated in early 2002 in the Central Bank of Montenegro under technical assistance from USAID/KPMG Barents Group/Economic Reform. The model’s coefficients were estimated in an eclectic manner: partly with historical Montenegrin data and partly they were calibrated or obtained by looking at similar equations/models in other countries in the region. The model covers the main components of GDP, the balance of payments, the aggregate revenues and expenditures of the government, international reserves and the money supply. It is basically demand-driven, though it does identify possible supply constraints. In many ways it is based on financial programming type models used elsewhere, which, in the case of Montenegro, need to be adapted and altered to fit its unique monetary arrangements involving the use of the Euro as the official local currency. GDP estimation was done using the expenditure approach and the methodology of the System of National Accounts 1993. Expenditure Method for GDP Estimation According to the SNA methodology, components of GDP from the expenditure side are:

MXGICGDP −+++= C – Personal Consumption

2 Gross Domestic Product – GDP is a basic aggregate of production, which can be calculated using the SNA (System of National Accounts) concept. The SNA methodology is internationally accepted statistical methodology for national accounts. The SNA system is based on a concept of broader material production, in which services are a productive activity and their value is included in the calculation of production aggregates. 3 Estimation presented in this paper does not include informal sector activities.

Chapter 1. Output

ISSP - CEPS 22

I – Gross Investment (Net Investment + Depreciation) G – Government Consumption (excluding social transfers and subsidies) X – Export of goods and services M – Import of goods and services In the original estimation of the model the following data sources were used: o Personal Consumption: Data on consumption were extracted from the Household

Income and Expenditure Survey. Based on the income data, expenditures were estimated using the data on structure of household expenditures from the Statistical Office. According to the Statistical Office of Montenegro, 99% of disposable income was consumed, and only 1% saved. For income from wages the source of data were: Statistical Office of FRY and Statistical Office of Montenegro, for other types of income the source was the Household Income Survey (third edition) published by the Institute for Strategic Studies and Prognoses. Also, for income in kind, some figures from the Statistical Office of Montenegro were used. According to this source, 12% of total income of households is income in kind.

o Gross Investment: Statistical Office of Montenegro data for 2000. To get data for 2001, data on Net Investment and Depreciation for 2000 were multiplied by 1.23 (RPI grew by 23% in 2001) and net investment, additionally, by 1.03 to account for the assumed 3% real growth.

o Government Consumption: Reports prepared based on data from Ministry of Finance o Export and Import: Central Bank of Montenegro Based on the following data and assumptions, the components of the GDP in 2001 were estimated and are presented in Table 1.6. Table 1. 4. GDP in 2001 – expenditure side (thousand € )

Thousand €

Personal Consumption4 817.0

Government consumption (social transfers and subsidies excluded)5 200.6

Gross investment6 384.6

Exports minus Imports (trade balance)7 -353.2

Gross Domestic Product 1,049.0

Net factor income 84.2

Gross National Product 1,133.2

Source: Central bank of Montenegro, USAID/KPMG Barents Group and ISSP 1.4.2. GDP forecast for Montenegro for 2002-2006 The estimated model served as a basis for GDP forecasts for the period of 2002-2006. These forecasts were obtained by assuming specific values for several dozens of indicators that were part of the model. Table 1.7 presents these values for the most crucial variables in the model for the period 2001-2006 (most 2001 figures are based on actual data).

4 Source:Statistical Office of FRY and Statistical Office of Montenegro and “Household survey”, Institute for Strategic Studies and Prognoses (ISSP), Podgorica 5 Source: Ministry of Finance 6 Source: Statistical Office of Montenegro, data for 2000. Data on Net Investment and Depreciation for 2000 were multiplied by nominal growth rate of 23% (RPI) in 2001 and net investment by 3% of real growth. 7 Source: Central Bank of Montenegro

Montenegro Economic Trends September 2003

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23

Table 1.5. Selected exogenous variables in the model (in annual percent change except for average tax rate) – actual data for 2001; assumptions for 2002-2005

Variable / Year 2001 2002 2003 2004 2005 Domestic prices (domestically produced commodities) 22.1 9.6 4.8 2.7 2.2 Foreign Prices (in the eurozone) 2.6 2.0 1.8 2.0 2.0 Tax Rate (Tax revenues in the budget/GDP) 33.6 33.6 33.6 33.6 33.6 Government Expenditures 4.0 4.0 0.0 4.0 4.0 Real Investment 5.0 5.0 5.0 5.0 5.0 Net factor income and transfers 10.0 12.0 6.0 4.0 4.0 Other Net Capital Inflows 10.0 11.0 6.0 5.0 5.0 Real GDP Abroad 1.7 1.5 2.9 2.5 2.5

Source: Central bank of Montenegro, USAID/KPMG Barents Group and ISSP

The resulting indicators produced by the model are presented in table 1.8. The table includes real GDP growth and GDP deflator, Table 1.6. Selected endogenous variables in the model

Variable / Year 2002 2003 2004 2005 DQY – Real GDP growth 0.84 1.49 4.06 4.30 DPY – percentage change in GDP deflator 15.4 7.1 2.9 2.3 DQYP-Growth rate for Potential GDP 4.02 4.19 4.33 4.37

Source: Central Bank of Montenegro and USAID/KPMG Barents Group.

Based on the assumptions on the growth rates of numerous exogenous variables, the model produced real-growth rates and GDP in current prices which is presented in table 1.7 TABLE 1.7. GDP FORECASTS FOR 2002-2006

2002 2003 2004 2005 2006

GDP (billion €) 1.221 1.328 1.420 1.516 1.607

Source: Central Bank of Montenegro and USAID/KPMG Barents Group.

Box 1.1 Problems with GDP accounting in Montenegro

Undoubtedly, for any country the Gross Domestic Product (GDP) is one of the most important economic indicators and its accurate and timely calculation should be one of the top priorities for policymakers. Conventionally, GDP figures for a specific period are available with a lag of several months and are based on actual data from this period.

However, Montenegro does not possess such an accounting system and has to rely on the modelling approach, whereby GDP figures are the output of the macroeconomic model estimated in early 2002. Based on this model, in early 2002, the GDP for 2001 was estimated along with forecasts of GDP for the period 2002-2006 (more details in section 1.4).

As is the case with any forecast, forecasts of GDP are inevitably burdened with uncertainty. In the specific case of the GDP forecast for Montenegro this uncertainty is associated with assumptions concerning the exogenous variables in the model, such as domestic and foreign inflation, government expenditures, etc. (small sample of them are presented in table 1.7). When it comes to the GDP estimate for 2002, at mid-2003 this uncertainty could be greatly alleviated if these assumptions were substituted with the actual data for 2002. However, this has not been done and instead, the GDP forecast has been accepted as an official GDP figure for 2002 without verifying the underlying assumptions (i.e. confirming or falsifying them against actual data). Consequently, the official 2002 GDP figure remains a forecast and provides a much less accurate measure of GDP than it could.

As long as forecasts are accepted as official GDP figures, and even more importantly, a proper ex-post GDP accounting system is not in place, it will be impossible to estimate the actual Montenegrin GDP with satisfactory accuracy. Consequently, quoting, commenting or making inferences related to the GDP figure in 2002 should only be done with the highest caution and due awareness of these problems and limitations.

Chapter 2. Employment

ISSP - CEPS 24

Methodological note: • Population (mid-year) without migrations is an ISSP estimate based on vital statistics. The starting point is a census data for 1991 and population for each subsequent period is obtained by adding the difference between births and deaths in respective periods as reported by the

Monstat. • Official unemployment rate was calculated from official data on number of employed and unemployed with the use of the formula:

100⋅+

=zn

nUR

where UR-unemployment rate, n-number of unemployed and z-number of employed persons. • An ISSP estimate of the unemployment rate is obtained by combining data from Monstat, Federal Labor Force Survey and ISSP Household

Survey. These data are used to estimate the number of employed persons per household, number of households, average number of households, as well as the official number of employed and unemployed. In this way we obtain the number of employed and unemployed in the economy and

the rate is calculated using the standard abovementioned formula. • ISSP Survey unemployment rate has been obtained from the ISSP Household Income Expenditures Surveys and is,based on the answers to the

following questions: During the previous week, did you work, or were you involved in any gainful activity, for money or in-kind compensation (at least one hour)? Although you did not work in the previous week, do you have a job? Did you look for a job in the past 4 weeks? Then, using

the standard formula the rate is calculated.

TABLE 2.1. LABOR FORCE AND UNEMPLOYMENT

Population (mid-year)

without migration1

Total Employed

Persons (all sectors)

Number of Unemployed

Unemployment rate Unemployment

rate in% (estimate)

ISSP Survey unemployment

rate* %

Official data ISSP estimate based on

official employment data ISSP

1991 616,632 144,045 58,144 28.8 21.6 1992 621,763 134,205 64,632 32.5 23.6 1993 626,214 130,901 62,818 32.4 22.4 1994 630,441 128,835 58,210 31.1 21.8 1995 635,002 125,090 59,045 32.1 22.2 1996 639,114 124,264 60,225 32.6 21.9 1997 642,719 120,604 63,995 34.7 23.5 1998 646,618 117,745 68,373 36.7 25.7 1999 650,053 115,349 75,303 39.5 27.3 2000 653,825 113,818 83,583 42.4 27.8 2001 657,233 114,076 81,561 41.7 24.8 22.3 2002 660,051 113,743 80,865 41.5 23.7 18.0 2001-Q1 113,859 81,950 41.9 25.1 2001-Q2 113,914 82,620 42.0 24.6 2001-Q3 114,402 81,255 41.4 24.4 2001-Q4 114,130 80,723 41.4 23.9 2002-Q1 113,715 81,085 41.6 23.7 2002-Q2 113,785 81,541 41.7 23.4 2002-Q3 113,877 80,935 41.5 25.1 2002-Q4 113,593 79,898 41.3 23.4 2003-Q1 112,587 76,275 40.4 23.4 Jan-01 114,536 81,238 41.5 25.0 Feb-01 113,500 82,158 42.0 25.0 Mar-01 113,542 82,453 42.1 24.8 Apr-01 113,663 83,091 42.2 25.1 May-01 113,943 82,629 42.0 25.1 June-01 114,137 82,140 41.8 25.0 23.6 July-01 114,106 81,823 41.8 24.9 Aug-01 114,024 80,686 41.4 24.7 21.9 Sep-01 115,077 80,350 41.1 24.6 Oct-01 114,755 80,660 41.3 24.5 21.4 Nov-01 114,170 80,440 41.3 24.3 Dec-01 113,464 81,069 41.4 24.3 Jan-02 113,594 80,385 41.7 23.9 Feb-02 113,597 81,360 41.7 23.9 Mar-02 113,953 81,510 41.8 23.8 19.6 Apr-02 114,180 81,961 41.8 23.8 May-02 113,461 81,622 41.6 23.7 June-02 113,715 81,041 41.5 23.5 July-02 114,422 81,166 41.6 23.5 13.7 Aug-02 113,684 80,830 41.6 23.4 Sep-02 113,526 80,809 41.4 23.4 Oct-02 113,676 80,183 41.3 23.2 20.7 Nov-02 113,679 79,894 41.2 23.5 Dec-02 113,425 79,616 41.5 23.5 Jan-03 112,673 76,584 40,3 22.6 Feb-03 112,771 76,077 40,5 22.5 Mar-03 112,317 76,165 40,4 22.6 Apr-03 112,132 74,896 40,0 22.3 May-03 111,738 73,250 39.6 22.0

Source: Monstat (Statistical Office of Montenegro), Employment Office of Montenegro and ISSP

1 Population number is an ISSP estimate (except for 1991) based on the vital statistics data

Montenegro Economic Trends September 2003

ISSP - CEPS

25

CHAPTER 2. EMPLOYMENT In this issue of MONET we will discuss new trends in the Montenegrin labor market as well as some new measures that the Government of Montenegro has introduced in order to reduce the size of the shadow economy in the labor market and foster new employment. Also, in this issue we will present the structure of employment by economic activities and provide an international comparison of employment to population ratios. 2.1 EMPLOYMENT AND UNEMPLOYMENT There is a saying in Montenegro, that by the end of the morning you can see what the rest of the day will be like. If that is true, then we can expect a difficult year when it comes to the labor market in Montenegro. Namely, in the beginning of 2003 the official statistics registered a significant decrease in the number of employed persons. As evidenced in graph 2.1, to some extent it is a seasonal phenomenon. Employment is usually at a lower level in the first quarter2 and registers a peak in the summer months (as a consequence of the tourist and agricultural season). However, the fall in 2003 was deeper than usual: the average employment in the first five months of 2003 was 1.3% lower than in the analogous period of 2002. On an annual basis, monthly levels of employment have been falling since August 2002, and in April and May of 2003, the annual fall reached 1.7% and 1.5% respectively. On the other hand, the Ministry of Labor and Social Affairs credits a new Decree on tax relief for newly hired employees’, which is explained in more detail later in the text, with roughly 14,300 new employees being registered from early April through the end of June, which represents the first 3 months after introducing the Decree. During April and May, the same source reported that 8,000 new employees were registered, while official statistics (see Table 2.1) suggest that during this time period, the total number of employed persons decreased by 579. For both accounts to be true, at least 8,579 workers must have been laid off during this two-month period, which is highly improbable (Table 2.2 suggests that only 633 persons lost their jobs in April, and we have no data for May at this point)3. More likely, the Statistical Office and the Employment Office do not have adequate mechanisms in place to follow the flows in employment, particularly in the private sector. Consequently, reports on employment data coming from these institutions do not necessarily match those issued at the Ministry of Labor and Social Affairs, and consequently, the accuracy with which they reflect the true state of affairs in the labor market is questionable. While employment figures have been falling, the number of unemployed persons is also registering a consistent decline. In January 20034 the number of unemployed fell by over 3,000 persons, in March by an additional 500, in April – by 1,270, and in May by 1,450. In February, unlike the surrounding months, unemployment levels experienced a slight increase, by just 88 persons. In general, the average number of unemployed persons during the first 5 months of 2003 was 7.3% lower than in the analogous period of 2002, while the

2 2002 was an exception. 3 The Ministry reports point to 6,300 newly registered employees in June, which would mean that for the official employment figure to not go up, a commensurate number of lay-offs must have happened in June as well. We do not yet possess the data to verify this, but this figure looks very unlikely. 4 Official data about unemployment are based on data from the Employment Office (see table 2.2) from the previous period. Therefore, for example, the change in the number of the unemployed registered in December 2002 is visible in the official unemployment figure in January 2003.

Chapter 2. Employment

ISSP - CEPS 26

number of unemployed at the end of May 2003 was 9.9% lower than that at the end of May 2002. The most important flows related to unemployment and employment, from the Employment Office, are presented in table 2.2. Table 2.2: Flows in unemployment and employment in 2002 and 2003.

Registered new unemployed

Employed during the month5 Lost jobs

Entering the laborforce

Total

Deleted from the register

Employed Abroad

Change in the number of the unemployed

A B C D=B+

C E F G=D-E-F

Jan-02 405 812 1491 2303 1503 376 424

Feb-02 571 832 1720 2552 1064 505 983

Mar-02 580 578 1473 2051 1395 567 89

Apr-02 551 770 1254 2024 1150 472 402

May-02 563 602 1008 1610 1436 505 -331

Jun-02 833 460 1331 1791 1543 801 -553

Jul-02 825 619 1282 1901 1242 669 -10

Aug-02 580 531 1065 1596 1393 513 -310

Sep-02 486 526 1732 2258 1797 462 -1

Oct-02 832 618 1535 2153 2088 676 -611

Nov-02 833 523 1421 1944 1610 643 -309

Dec-02 705 639 1123 1762 4541 544 -3323

Jan-03 490 775 1540 2315 1747 357 211

Feb-03 447 669 1435 2104 1948 437 -281

Mar-03 573 652 1679 2331 1738 529 64

Apr-03 955 633 1620 2253 2328 1018 -1093

Total 2002 7764 7510 16435 23945 20762 6733 -3550 Total Jan-Apr 2003

2465 2729 6274 9003 7761 2341 -1099

Source: Monthly reports by Employment Office of Montenegro Note: Data on the change in the number of unemployed do not match respective data from table 2.1 because of different methodologies applied by Monstat (table 2.1) and the Employment Office (table 2.2) in calculating unemployment. The sources of this decline can be observed in table 2.2. The table makes clear that the declining number of unemployed persons in recent months is almost entirely due to the removal of people from the official register of the unemployed. As we already mentioned in previous issues of MONET, the new Employment law has introduced some more rigorous rules about registering regularly and attending trainings – hence more people are now being removed from the register on a regular basis. Persons deleted from the register6 have the right to re-apply for their unemployment status after 6 months. During last year, 16,425 persons entered the labor market and registered as unemployed. An additional 7,510 were also registered as unemployed due to the fact that they had lost their jobs (table 2.2). Among persons in this group, 37.5% saw their employment contract expire, 16.6% lost jobs due to company insolvency/bankruptcy, while 8.4% decided to quit their job (by issuing a written statement with the intention to end the labor contract) or lost

5 Number of employed during a given month includes new job openings as well as extensions of labor contracts that must also be announced through the Employment Office 6 Because, for example, they failed to show up at the Employment Office on a given day

Montenegro Economic Trends September 2003

ISSP - CEPS

27

their job for other reasons. In the first quarter of 2003, 2,096 persons lost their jobs, while 4,642 persons entered the labor market. Both figures are higher than ¼ of respective figures for the entire 2002 year, thus pointing to the increased dynamics in the flows in the labor market. On the other hand, 7,764 persons became employed during 2002 and in the first 4 months of 2003, 2,465 new employees were hired. Exactly 20,762 persons were deleted from the register of the unemployed during 2002, while in the first four months of 2003 this figure amounted to 7,761. Official unemployment has shrunk as a result of these flows, especially due to the significant number of persons that have been removed from the register. At the end of May 2003, unemployment stood at 39.6% compared to 41.5% in December 2002 and 41.6% in May 2002. The ISSP estimated rate of unemployment confirms this trend and has been falling consistently for a number of months now. Our estimate of the unemployment rate in May 2003 was 1.7 percentage points lower than in the same month last year and stood at 22.0%. Table 2.3. Official estimates of the labor force and supported persons (end of period)

2002 2001

1. Employed (official) 113,425 113,464 2. Unemployed (registered) 79,616 81,069 3. Students faculty 10,270 10,916 4. Students primary school 75,644 75,761 5. Students secondary school 32,284 31,157 6. Pensioners 88,301 86,270 7. Total Labor Force (1+2) 194,608 195,637

8. Supported persons (3+4+5 +6) 205,679 203,530

Source: Statistical Office of Montenegro and Ministry of Education

Graph 2.1: Number of unemployed persons (2000-2003)

66000

68000

70000

72000

74000

76000

78000

80000

82000

84000

86000

88000

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2000 2001 2002 2003

Source: Employment Office of Montenegro

Chapter 2. Employment

ISSP - CEPS 28

Graph 2.2: Number of employed persons (2000-2003)

110000

111000

112000

113000

114000

115000

116000

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2000 2001 2002 2003

Graph 2.3: Number of persons employed, unemployed and pensioners (official, 1994-2003)

50000

60000

70000

80000

90000

100000

110000

120000

130000

140000

1994

-Q1

1994

-Q2

1994

-Q3

1994

-Q4

1995

-Q1

1995

-Q2

1995

-Q3

1995

-Q4

1996

-Q1

1996

-Q2

1996

-Q3

1996

-Q4

1997

-Q1

1997

-Q2

1997

-Q3

1997

-Q4

1998

-Q1

1998

-Q2

1998

-Q3

1998

-Q4

1999

-Q1

1999

-Q2

1999

-Q3

1999

-Q4

2000

-Q1

2000

-Q2

2000

-Q3

2000

-Q4

2001

-Q1

2001

-Q2

2001

-Q3

2001

-Q4

2002

-Q1

2002

-Q2

2002

-Q3

2002

-Q4

2003

-Q1

Total Employed Persons (official) Number of unemployed persons Number of Pensioners (all categories)

Source: Statistical Office, Employment Office and Fund PIO note: data are quarterly averages

Montenegro Economic Trends September 2003

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29

2.2. EMPLOYMENT BY ECONOMIC ACTIVITY AND OWNERSHIP Since the beginning of the transition process in the early 90’s, the structure of the Montenegrin economy has undergone many significant changes, including changes in the ownership structure. In line with those changes, the structure of employment by activities has transformed accordingly. In this section we will take a closer look at the dynamics of the employment structure in the 1990s as well as during the recent years. In graphs 2.3 and 2.4 we present the sectoral structure of employment over the last 12 years. The real economy was divided into 4 broad groups made up of various sectors: production (industrial production, mining, construction, utilities), agriculture (agriculture, forestry and fishery), market services (transport, catering and tourism, financial intermediation, renting, trade and other services) and public services (public administration, education, health and social insurance as well as other public services). In 2001, the Statistical Office of Montenegro introduced a new classification of activities according to international standards, and consequently, most of the specific sectors (like industry) now have a slightly different composition and in some cases new sectors have been added (like real estate and rental services). For this reason both graphics are displayed and since the 4 groups now encompass a slightly different set of sectors, comparisons of employment between the pre-2001 and post-2001 series must be done with caution.

Graph 2.3: Structure of employment by activity (1990-2000)

0

5

10

15

20

25

30

35

40

45

50

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

%

Manufacturing, mining, construction, electrcitiy, gas and water supply.

Transport and communication, trade, catering and tourism, crafts and personal services, municipal, financial, technical andbusiness servicesEducation, science, culture, health and social protection, public administration

Agriculture, forestry, water and fisheries

Sources: Statistical Office of Montenegro and ISSP calculations

Chapter 2. Employment

ISSP - CEPS 30

Graph 2.4: Structure of employment by activity (2001-2003)

0%

5%

10%

15%

20%

25%

30%

35%

40%

Q1-01 Q2-01 Q3-01 Q4-01 Q1-02 Q2-02 Q3-02 Q4-02 Q1-03

Manufacturing, mining, construction, electricity, gas and water supply

Agriculture, forestry, water and fishery

Transport and communication , trade, hotels and catering, financial intermediation, real estate, rental and business services

Public administration and social insurance, education, health and social work, other municipal and social services

Sources: Statistical Office of Montenegro and ISSP calculations However, generally speaking, our division into 4 broad sectors holds and we will be cautiously monitoring employment developments over the entire period 1990-2003. Both graphs point to similar trends. During the period 1990-2000, the only sector in which employment grew was the sector of public services (graph 2.3). Graph 2.4 confirms that this increasing trend continued throughout the period 2001-2003. In the area of production during the decade of the 1990s employment fell by 10 percentage points (from 45% in 1990 down to 34% in 2000) and it continued to decline during the last couple of years, albeit at a much slower pace. Employment in the sector of market services, after a several-percentage-point decrease throughout the 1990’s has stabilized around 28% in 2001-2003. It is also true for the agricultural sector, where employment has been declining throughout the decade of the 1990s, that it has stabilized at 3-4% in recent years. Coupling this data with the survey data from ISSP Household Budget Surveys no. 4, 5 and 6, table 2.4 presents the employment structure (annual averages) in 2001 and 2002 based on the official data (depicted in Graph 2.4) as well as survey data for 2002. The economy is divided into 17 sectors, 2 of which (Humanitarian & NGOs and Other) are only accounted for in the survey data. Another difference between the two data sources is that army and police are part of the ‘Public Services’ sector in the survey data but are ignored in the official data. Official data suggests that production sectors continue to provide employment to the highest share of the employed in the economy (37% in 2002 and 36% in 2001), albeit public services rank a very close second (32% in 2001 and 33% in 2002). Market services employ slightly above 28% of the working population, while the sectors of agriculture, forestry, and fisheries employ a mere 3.3%. At a more disaggregated level, manufacturing seems to be the largest sector in terms of employment (around 23%), education ranks second (11%), and transport and communication services rank third (10%).

Montenegro Economic Trends September 2003

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Table 2.4. Structure of employment by economic activity (in % of total number)

2001 2002 2002 ACTIVITY

Official data ISSP survey data

1. Agriculture, forestry and water 3.2 3.1 3.2

2. Fishery 0.1 0.1 0.2

Agriculture, Forestry and Fishery (sum 1-2) 3.3 3.2 3.4

3. Mining 3.7 3.8 0.4

4. Manufacturing 23.3 22.5 13.5

5. Electricity, gas and water supply 5.1 5.1 4.1

6. Construction 4.5 4.5 1.6

Production (sum 3-6) 36.6 35.9 19.6

7. Wholesale and retail 8.9 9.1 15.9

8. Hotels and restaurants 5.7 5.4 5.5

9. Transport, traffic and communications 10.1 10.2 6.3

10. Financial intermediation 2.7 2.3 2.6

11. Mortgages, renting and business services 1.0 1.1 0.4

Market Services (sum 7-11) 28.4 28.1 30.7

12. Public administration and social insurance (army and police excluded in the official data)

7.7 8.0 15.2

13. Education 11.5 11.8 8.2

14. Health and social work 8.5 8.7 5.7

15. Other communal, social and service activities 4.0 4.2 3.5

Public Services (sum 12-15) 31.7 32.7 32.6

16. Humanitarian organizations, NGO etc. - - 0.8

17. Other - - 13.1

Other (sum 16-17) 13.9

Sources: Statistical Office of Montenegro, ISSP Household Income Expenditures Survey, issues 4,5&6 Survey data provides a somewhat different picture. Surveys indicate that the highest share of employees is employed in wholesale and retail trade (16%), while public administration and services (including army and police that are not accounted for in the official data) employs 15%, and that of manufacturing ranks third with a 13.5% share. In terms of the aggregate sectors, comparisons are somewhat distorted by the fact that the survey data reveals the presence of the 5th sector which is not accounted for in the official data, i.e. the sector of NGOs, humanitarian organizations and other related institutions. According to the survey, this sector employs a non-negligible 14% of the total. Regarding the shares of broad sectors in the survey data, a 31% share of the working population is employed in market services, 20% - in production, and 3% in agriculture, forestry and fishery. However, according to the survey data it is public services that comprise the largest sector, employing close to 33% of the working population (certainly due to the inclusion of employees in the police and army). Official data points to a similar share of public servants in total employment (32.6% survey vs. 32.7% official), however, we should remember that unlike the official data, survey data includes army and police as well as those employed in the shadow economy. Nevertheless, the number of persons employed in the public services sector is too great for the Montenegrin economy, which has been evidenced numerous times

Chapter 2. Employment

ISSP - CEPS 32

in the budgetary problems. The largest categories in the budget expenditures are salaries and other compensation to employees (for further detail see chapter 5, Budget in Monet 13, as well as the current issue). Earlier in the year it was announced that a total of 3,000 public servants would be reduced, but so far, no official decision has been made. According to some officials’ statements, the Government will first design a suitable social program, and then start to reduce the number of employees. In education, however, the government has already announced a program of “rationalization” of employment, which is set to start at the end of the 2002/2003 school years. In addition to the structure of employment by industry, the structure of employment by company ownership has changed as well. Mass voucher privatization and newly established private businesses have boosted the share of employees in the private sector. Over the 10-year period (1990 through 2000) the share of private sector employees has increased from 2.7% in 1990 to a 7.6% in 2000 (official data). In Table 2.5 we present results of the ISSP Household Survey for 2002 (for which no official data are available), and the survey suggests that the share of the private sector in total employment has increased to 34.8% (the data includes employment in both registered and non-registered enterprises). Table 2.5: Employment and company ownership (2002)

Type of company ownership (main job)

Private registered

Private non registered

State owned Mixed % of total employment

32.3 2.5 59.6 5.1

Cooperative

0.5

Source: ISSP Household Income Expenditures Survey, issues 4,5&6 However, the state remains the biggest employer, employing almost 60% of all working persons in public administration or public companies. It is certain that future privatizations of large state-owned companies like the Aluminum Plant (KAP), the Electricity Company (EPCG), the Steel Company, Telecom, and others like them will further increase employment in the private sector. 2.3. NEW REGULATIONS IN THE MONTENEGRIN LABOR MARKET In order to minimize the shadow economy practices in the labor market and to stimulate new employment, the Government of Montenegro in April 2003 has passed a Decree on Tax Relief for New Employees (Official Gazette of Montenegro 25/03). Also, since the summer season is considered to be the most critical with respect to shadow economy practices (among them, illegal employment from the neighboring countries), the Government of Montenegro (GoM) has passed a Decree on Employment of Nonresident Persons During the Season (Official Gazette of Montenegro 28/03)7. According to the Decree on Tax Relief for New Employees, the employers’ share of tax and social contribution on the employee’s wages are waived until May 1st 2004. Precisely, for the newly employed, employers will not have to pay their portion of the personal income tax and three contributions – to the Pension Fund (PIO), the Health Fund and the unemployment contribution8 as well as the compensation for use of public goods9. To prevent abuse there is

7 See details in Chapter 3. 8 Details on financial effects on employer could be found in the Chapter 3.

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a provision that tax relief implied by the Decree cannot be used by employers who pay wages lower than the minimum wage10 determined in the Collective agreement nor by those who decreased the number of employees compared to the period preceding the introduction of the Decree11. The Decree also orders labor inspection to take a tougher stance on illegal labor. If the inspection finds that a company has unregistered employees, it will be forced to pay a fine in the range of €1000 - €10,000. Additionally, the responsible person (e.g. director of the company) in the company might be ordered a fine in the range of €250 - €1000. So, parallel to offering a tax relief, this decree makes it more risky to keep illegal employees through the introduction of harsher punishments on the dishonest employers. The official goal of this decree is to increase the number of registered workers by 20,000 (out of currently working and unregistered), and additionally to create 5,000 new workplaces. Prior to the introduction of this decree, labor inspections have begun to control whether companies properly register their employees, and have temporarily closed several companies. Through the end of June, according to the Ministry of Labor and Social Affairs, roughly 14,300 new employees have been registered. Another law introduced recently by the GoM is related to nonresident employees working in Montenegro during the summer season. Although the unemployment rate in Montenegro (both official and via survey) is very high, it seems that Montenegrins are not really interested in finding a job during the season. This is a problem particularly pertinent to women (60.4% of unemployed) with families. If the Employment Office presents them with a seasonal job on the coast or in another more distant municipality, some women find it very difficult to organize it so that they can leave their family and household to move to the location where the job is offered. However, the consequence of a refusal is the removal from the register of the unemployed (and loss of related benefits) for 6 months. As a result, the majority of seasonal workers are hired from neighboring countries (such as Serbia and Bosnia). Contributing to this as well may be that employers find the labor force from these countries to be cheaper and more efficient and professional. The phenomenon is quite significant: the number of non-Montenegrin seasonal workers hired in 2002 was estimated at about 20,000 persons. Since the majority of these people are not registered and there is no legal framework to legalize their labor and pay due taxes on their salaries, this activity fully belongs to the gray economy (very much to the satisfaction of the employers). Thus, to alleviate this problem, provide incentive for local employers to hire local people, and at the same time to increase budget revenues, the Government of Montenegro passed a special decree. According to this decree, the employer is obliged to pay a tax of €2.5 per day when employing nonresident workers, which comes to €75 on a monthly basis (30 days of work). In addition to that, for all non-resident workers, the employer is obliged to pay personal income tax as well as a compensation for use of public goods according to Montenegrin regulations. The financial effects of these regulations are shown in more detail in Chapter 3 (Wages). In the near future we will be able to observe the effects of these regulations. The future months should make clear whether the new decrees did indeed provide an incentive for 9 This is a tax collected by municipalities varying in the range of 2-3% of gross salary depending on the municipality. 10 If the company has financial problems, it can actually pay its workers a salary that is lower than the minimum salary. This is called a “guaranteed” wage and amounts to 65% of the minimum wage. 11 To prevent re-employment of old employees under a new scheme.

Chapter 2. Employment

ISSP - CEPS 34

employers to fully register existing employees and hire new ones and whether or not these changes will have a negative impact on the performance of their companies. What we can already say, however, is that the tax relief decree distorts competition between companies by favoring those that have been active illegally in the shadow economy in comparison to those who have been paying all the due taxes and contributions on their employees’ wages. Furthermore, the seasonal workers decree is putting a brake on labor competition and will most likely result in increased prices for tourist services (which are already considered very high). These issues are discussed in Chapter 3 in more detail. 2.4. EMPLOYMENT / POPULATION RATIO: INTERNATIONAL COMPARISON The ratio of the total number of the employed to total population reflects how many people a single working person is required to support and thus points to the magnitude of the burden on the working population. The magnitude of the ratio is an indication of how many people one employed person must support, either directly (family, dependents) or indirectly (in the form of taxes and contributions) - the lower the ratio, the higher the burden. This can be the result of a difficult economic situation resulting in high unemployment. However, this can also be a reflection of the unfavorable demographic structure, high percentage of disabled and pensioners or large gray economy (as the ratio normally takes into account only those who are officially employed). In table 2.6 employment-to-population ratios for several developed and transition countries are sorted from highest to lowest. For Montenegro, 3 ratios were calculated using different employment figures: one from the Household Budget Survey and 2 more from Federal and Montenegrin Statistical Offices. Serbia and Montenegro rank as countries with the lowest ratio, i.e. the ones where the burden on the working population is the highest. Table 2.6: Employment/ population ratio

Country Employment/

population ratio Year

1. USA 62.712 2002

2. Sweden 60.3 2002

3. United Kingdom 59.5 2001

4. Germany 52.6 2001

5. France 51.9 2001

6. Italy 44.1 2002

7. Estonia 42.813 2002

8. Macedonia 36.914 2001

9. Albania 34.615 2001

10. Montenegro (ISSP Household Budget Survey) 32.5 2002

11. Croatia 31.116 2002

12. Montenegro (Federal Statistical Office) 26.9 2002

13. Serbia 20.6 2002

14. Montenegro (Statistical Office of Montenegro) 17.2 2002

sources: Respective statistical offices indicated in the footnotes

12 Data for France, Germany, UK, USA, Sweden and Italy are from Bureau for Labor Statistics -www.bls.gov 13 Statistical Office of Estonia -www.stat.ee 14 Statistical Office of Macedonia -www.stat.gov.mtk 15 Statistical Office of Albania -www.instat.gov.al 16 Statistical Office of Croatia -www.dzs.hr

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As we can see in the 5 developed market economies that rank highest in the table, the ratio exceeds 0.5, i.e. on average one employee supports less than one person (in addition to himself/herself). On the other hand, in the remaining countries the burden is higher: for each employee there is more than one person that does not work. For Montenegro we have calculated three different ratios using different estimates of employment. The first estimate puts Montenegro in 10th place in the table and is based on the ISSP Household Budget Survey (2002 issues) and amounts to 32.5%. The employment estimate used to calculate this ratio includes the gray economy and suggests that an average working Montenegrin supports two more persons in addition to himself/herself. According to the Federal Statistical Office Labor Force Survey (which partially includes the gray economy) the ratio is lower (27%) and suggests that there are almost 3 persons supported by each employee (i.e. only one working person in the average household17). The gloomiest picture emerges when using the official Monstat estimate that does not include workers in the unofficial economy. The ratio calculated with this data amounts to 17.2% and suggests that for every officially employed person, there are almost 5 persons that do not work and need to be supported. Regardless of the source of the data, these numbers point to a very serious problem and are the evidence of a difficult situation in the Montenegrin (and Serbian) labor market. The situation is only slightly better in other countries in the region (Croatia, Albania and Macedonia).

17 Average size of family in Montenegro, according to ISSP Household Budget Survey, is 3.89 persons.

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Table 3.1: Wages

Mini-mum wage

Average gross wage

Total social contributions and tax on gross wage

Average disposable

wage

Average pension (paid)

Ratio Min. Wage / Average

Disposable Wage (%)

Average disposable

wage*

Total labor cost

Official data ISSP estimates IN DINARS IN DINARS

1994 65 292.7 154.1 139 47 406 1995 128 637.8 330.8 307 280 42 873 1996 243 1349.0 689.7 659 600 37 1826 1997 332 1801.4 922.5 879 738 38 2445 1998 453 2503.8 1276.1 1228 1073 37 3391 1999 663 3159.3 1227.3 1932 1581 34 4356 1997-Q1 302 1537.3 788.7 749 40 2102 1997-Q2 323 1691.7 864.0 828 39 2306 1997-Q3 340 1896.0 962.3 934 36 2565 1997-Q4 363 2080.7 1075.0 1006 36 2807 1998-Q1 387 2027.3 1038.7 989 39 2763 1998-Q2 440 2417.7 1232.3 1185 37 3277 1998-Q3 463 2654.7 1349.7 1305 36 3581 1998-Q4 520 2915.3 1483.7 1432 36 3942 1999-Q1 563 2510.7 977.3 1533 37 3492 1999-Q2 575 2646.7 1026.0 1621 35 3666 1999-Q3 607 3144.7 1225.3 1919 32 4291 1999-Q4 908 4335.3 1680.3 2655 34 5976

IN EURO IN EURO 2000 37.0 150.9 55.5 96.4 83.5 38 218 2001 42.0 176.2 68.5 108 97 39 174 249 2000-Q1 32.4 126.3 42.5 83.7 67 39 186.9 2000-Q2 35.3 149.0 53.2 95.8 84 37 214.5 2000-Q3 39.4 155.1 59.1 100.2 88 39 228.1 2000-Q4 40.9 173.0 67.3 105.7 95 38 242.8 2001-Q1 40.9 170.9 66.6 104.3 96 39 240.3 2001-Q2 40.9 173.5 67.7 105.8 96 38 244.3 2001-Q3 40.9 177.9 68.7 109.2 101 37 250.4 2001-Q4 46.0 182.5 71.1 111.5 101 41 259.1 2002-Q1 46.0 178.5 69.7 108.9 103 42 254.2 2002-Q2 46.0 193.1 76.2 116.9 108 39 270.9 2002-Q3 50.0 112 2002-Q4 50.0 112 Jan-01 40.9 166.2 64.4 101.7 96 40 234.9 Feb-01 40.9 173.8 68.0 105.8 96 39 243.5 Mar-01 40.9 172.8 67.5 105.3 96 39 242.4 Apr-01 40.9 171.8 67.0 104.8 96 39 242.3 May-01 40.9 173.3 67.5 105.8 96 39 244.2 Jun-01 40.9 175.4 68.5 106.9 96 38 176.0 246.5 Jul-01 40.9 174.4 68.0 106.3 101 38 245.4 Aug-01 40.9 176.9 67.0 109.9 101 37 171.0 250.4 Sep-01 40.9 182.5 71.1 111.5 101 37 255.3 Oct-01 46.0 181.5 70.6 111.0 101 42 175.0 258.0 Nov-01 46.0 182.5 71.1 111.5 101 41 259.1 Dec-01 46.0 183.6 71.6 112.0 101 41 260.3 Jan-02 46.0 166.5 65.0 101.7 101 45 239.7 Feb-02 46.0 181.3 70.7 110.6 104 42 257.5 Mar-02 46.0 187.8 73.3 114.5 104 40 186.0 266.2 Apr-02 46.0 194.0 78.3 115.7 104 40 270.1 May-02 46.0 191.0 74.5 116.4 110 40 274.4 Jun-02 46.0 194.5 75.8 118.7 110 39 273.4 Jul-02 50.0 112 208.2 Aug-02 50.0 112 Sep-02 50.0 112 Oct-02 50.0 112 204.2 Nov-02 50.0 112 Dec-02 50.0 112 Jan 03 50.0 112 Feb-03 50.0 113 Mar-03 50.0 113 Apr-03 50.0 113

Minimum wage is the lowest wage that employers are obligated to pay. Average gross wage includes employee’s part of social contributions and payroll tax. Total labor cost includes average net wage and all benefits, as well as social contributions and payroll tax. Average disposable wage indicates the actual amount that employees receive. *Average wage is calculated from the ISSP Household Survey. The first survey was conducted in June 2001; to date, six surveys have been published.

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CHAPTER 3. WAGES In this issue of MONET we will discuss the details and consequences of 2 new decrees; one concerning newly employed persons and one being the decree on non-resident employees employed during the season. No data on the average wage in Montenegro has been published since June 2002, so we will only analyze the minimum wage. 3.1. WAGES Monstat - the Statistical Office of Montenegro continuously fails to disclose the data on the average wage. June of 2002 was the last month for which these data are available, thus we are unable to monitor wage developments over the last 12 months. The dynamics of nominal and real average disposable wages up to June 2002 is presented in graphs 3.1 and 3.2. Until June 2003, the minimum wage in Montenegro remained the same, although there were some announcements that it would increase. All announcements regarding the minimum wage were triggered by last year’s strike of employees in the education sector and a threat that it would repeat. However, despite the lack of an official increase in the general economy-wide minimum wage, as a result of the strike, the education employees managed to obtain the so-called “adjustment”, which is equal to an 8% increase in the minimum wage (equivalent to the minimum wage at the level of €54).

Graph 3.1: Average nominal and real disposable wage and the CPI (Jan-00 = 100).

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CPI Average nominal disposable wage Average real disposable wage

Source: Statistical Office of Montenegro and ISSP calculations

Chapter 3. Wages

ISSP - CEPS 38

Graph 3.2. Annual growth of nominal and real minimum wage and real average disposable wage.

-20%

-10%

0%

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40%Ja

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Annual growth of nominal minimum wage Annual growth of real minimum wage

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Source: Statistical Office of Montenegro and ISSP calculations The dynamics of the official minimum wage are presented in graph 3.2. Due to the fact that is has been kept stable at €50 since July of 2002, the annual dynamics of real minimum wage primarily reflect changes in annual inflation. Due to lower inflation, the annual dynamics of real minimum wage has been close to 0% since the end of 2002. However, if it is not adjusted upwards, the dynamics of real minimum wage will fall below 0 beginning in June 2003. 3.2. EFFECTS OF NEW REGULATIONS ON THE LABOR COST As mentioned in the Labor chapter, in April 2003, The Government of Montenegro passed a Decree on Tax Relief for New Employees. The main goal of this decree is to reduce labor costs in order to shift the workforce from the gray economy into the official economy as well as to provide an incentive for opening new jobs. This decree is planned to be in force through May 2004. In table 3.2 we give an example of the calculation of the employers’ cost incurred on wages paid to employees (excluding other payment to employees). In essence, with this decree for the newly employed1, employers do not have to pay contributions to social insurance (pension, health and unemployment) or the personal income tax until May 2004. It is common practice in Montenegro for an employer to withhold an amount equal to the employees’ share of contribution on wages and pay it along with the regular employers’ share of contributions. Therefore, employers are obligated to pay all contributions and employees receive a net salary, which is subject to negotiations with the employer. As a consequence, all contributions on wages constitute a cost to employers. Thus, the tax-relief

1 The decree only applies to newly employed employees. To prevent abuse (such as laying off and re-employment), the decree only applies in the case of employing an extra employee in excess of the previous number of employees.

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decree represents a considerable cut in labor costs for employers even though it was only the employees’ contributions that were waived. Table 3.2: Total Labor Cost: The changes introduced by the new Decree

% Existing employees

(in €) New employees

(in €)

1. Net salary 150 150

2. Gross salary 230.4 199.18

3. Employees share of contributions 80.35 49.18

Pension-invalid insurance 12.00% 29.51 29.51

Health care 7.50% 18.44 18.44

Unemployment 0.50% 1.23 1.23

Personal income tax 0-25% 31.3 0

4. Employers share of contributions 58.12 1.58

PIO 12.00% 29.51 0

Health care 7.50% 18.44 0

Unemployment 0.50% 1.23 0

Compensation for use of public goods 3.00% 7.36 0

Montenegrin Chamber of Commerce 0.32% 0.78 0.78

Yugoslav Chamber of Commerce 0.125% 0.31 0.31

Alliance of Independent Trade Unions 0.20% 0.49 0.49

5. Total taxes and contributions (3+4) 138.47 50.76

6. Total labor cost (1+3+4 or 2+4) 288.47 200.76

7. Total taxes and contributions as % of total labor cost 48.00% 25.28%

Source: ISSP Note: Contributions are paid on gross salary that is calculated as the difference between the total labor cost and employers’ contributions (or alternatively it can be obtained by multiplying the net salary by the coefficient of 1.63934) The example presented in the table is related to a €150 net salary. The first column presents data pertaining to an existing employee (and was applied to all employees prior to the introduction of the Decree) and the total amount of taxes and contributions paid by employers is equal to €138.47. In the case of employing a new employee with the Decree in force, the total amount of taxes and contributions falls to €50.76. Thus, the new law cuts the mandatory taxes and contributions by roughly 63% and lowers their share in total labor cost by almost 23 percentage points: from 48% down to 25.28%. From early April through the end of May, 8,000 new employees have been registered, but the source of these new hires remains an open issue. They may have resulted from the reduction of the labor cost implied by the new decree, but they may also be a consequence of stricter labor inspection controls. These controls have been intensified recently and inspectors threaten to temporarily close down companies if they find unregistered employees. These threats have been carried out in a number of instances and have forced many companies to officially employ their employees. Another issue that is unclear is how the social insurance, especially pensions, will be calculated for these newly employed persons; will it be based on the full amount due (waived by the decree) or based only on the amount that has actually been paid? Will these people later be entitled to the full amount of social transfers or to a lower amount that reflects their lower total contributions? If it is determined that they are fully entitled, who will pay the difference?

Chapter 3. Wages

ISSP - CEPS 40

A second important labor market regulation passed recently is related to non-resident workers employed during the summer season. As mentioned in Chapter 2, employers have to pay €2.5 per day as a tax for every employee who is not a resident of Montenegro. Additionally, employers will be obligated to pay the personal income tax and the compensation for use of public goods for non-resident employees. This decree also established a legal ground for employing non-residents and paying social contributions on wages paid to them. Previously, no legal framework was in place enabling employers to legalize such labor and consequently all non-residents working in Montenegro were inevitably part of the gray economy. The main goal of this regulation is to channel “black” labor during the season into the regular economy, and also to provide incentive for employers to hire people from the local labor force. In table 3.3 we present a calculation of the total labor cost to employers in the case of non-residents and residents working during the season, with the assumption that the new decree on tax relief will also be applied to seasonal workers. We did not take into account some additional incentives that employers can take advantage of while hiring the unemployed Montenegrins during the summer season2. Table 3.3: Total Labor Cost of Non-resident and Resident Employees during the summer season

Non-resident

employee Resident employee

Non-resident employee

Resident employee

In € per month Net salary 100 100 150 150 Non-resident taxes (2.5 euro per day3) 65 - 65 - Personal income tax 10.79 - 31.3 - Compensation for use of goods of common interest 4.9 - 7.36 - Employer share of contribution - 33.75 - 50.76 Total taxes and contributions 80.69 33.75 103.66 50.76 Total labor cost 180.69 133.75 253.66 200.76 Total taxes and contributions as % of total labor cost 44.66% 25.23% 40.87% 25.28%

Source: ISSP In the table above the two examples shown represent costs for a net salary of €100 and for a net salary of €150. The total labor cost of a non-resident employee is higher by the tax amount that an employer needs to pay for non-resident employees. Furthermore, the decree on tax relief can be applied to a resident seasonal worker, while it cannot be applied to a non-resident worker, which makes labor of non-residents even more expensive in comparison. As a consequence, the resident employees are “cheaper” by almost one-third than are non-resident employees. The impact of these measures on the behavior of the Montenegrin labor force remains to be seen during the summer season. According to the practice in previous years, Montenegrins were not very interested in finding a seasonal job. Furthermore, employers tended to think that non-resident employees (mostly from Serbia and Bosnia and Herzegovina) were more professional and efficient than local employees. During this year’s season we will be able to determine whether the financial incentives created by the new regulation are enough for employers to start favoring the local labor force and, to some extent, trade off labor quality for cost effectiveness. This will be a good test for the Montenegrin labor force in terms of professionalism and needed skills. If employers continue to hire non-resident employees,

2 Employment Office of Montenegro established a separate program for seasonal employment that enables employers to get help in financing social insurance etc. 3 We have assumed 26 working days per month.

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this would be a clear sign that the domestic labor force is not good enough or that Montenegrins would simply prefer to remain unemployed rather than work during the season. Both regulations are supposed to have a favorable effect on the labor market in the months to come. However, there are a few reservations; first of all, the regulations lower the labor costs only temporarily and selectively and because the tax relief decree will only be applied to new workers, it has the potential to be abused, as employers will find ways to somehow register existing employees as new employees; also, the law might create unfair competition favoring new businesses at the expense of established businesses, especially those that have been paying due taxes regularly. Ideally, the tax burden on wages should be lowered uniformly for all employers regardless of when they were hired. Another reservation concerns introducing measures to discourage the employment of non-residents, which may be interpreted as a means of restricting competition in the labor market. Also, it will inevitably increase the cost of labor during the season and ultimately lower the competitiveness of the Montenegrin tourist offering. Thus, we view these two measures as steps in a good direction (increasing employment in Montenegro) but at the same time they must be evaluated as questionable from many perspectives, particularly because of their temporary nature and competition restricting effect. 3.3. THE NEW METHOD OF WAGE TAX CALCULATION The Personal Income Tax (PIT) Law, implemented in July 2002, besides changing the tax rates, has imposed a new method of calculating salaries. The calculation has become somewhat more complicated due to a more complicated calculation of taxes. Although the PIT Law also anticipates taxation of all other payments to employees (meal compensation, transportation, summer allowances, etc.), the Government of Montenegro has decided to delay taxation of these benefits until January 1, 2004. The gross wage for the first month (January or any other month when employee starts to receive his or her wage) is calculated by multiplying a net wage by a coefficient of 1.63934 (net wage is calculated as minimum wage multiplied by a corresponding wage coefficient4), which is the same as in the previous system. For all subsequent months salaries are cumulated, and tax is paid only on the part that was earned in the respective month5. This ensures that taxes are calculated correctly and in the end of the year employees will have to pay the difference (if they underpaid) or can request a tax return (if taxes were overpaid). In table 3.4 we present the new system of tax calculation showing the amount of tax that needs to be paid on a monthly gross wage of €142.27, which allows for a €100 net wage. In the previous system tax was calculated as a flat 19% of gross salary.

4 See MONET 6 for details on wage calculation in the old system and wage coefficients. 5 The employer, as in the previous system, withholds and pays the taxes for employees.

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ISSP - CEPS 42

Table 3.4: Amount of taxes per income groups

Amount of taxable personal income (cumulated)

Amount of taxes Example

Monthly net wage € 100.00 = €142.27 gross wage

Period (Month)

In € In € In €

To 61 0,00

61-202 0 +17% on amount over 61 Cumulated income 142.27

202-354 24.06 + 21% on amount over 202 Cumulated tax 13.82 January

Over 354 55.9 + 25% on amount over 354 Tax paid in the month 13.82

To 121 0,00

121-404 0 +17% on amount over 121 Cumulated income284.54

404-708 48.12 + 21% on amount over 404 Cumulated tax 27.80 February

Over 708 111.8 + 25% on amount over 708 Tax paid in the month 13.98

To 182 0,00

182-606 0 +17% on amount over 182 Cumulated income 426.81

606-1061 72.17 + 21% on amount over 606 Cumulated tax 41.62 March

Over 1061 167.7 + 25% on amount over 1061 Tax paid in the month 13.82

To 243 0,00

243-809 0 +17% on amount over 243 Cumulated income 569.08

809-1415 96 + 21% on amount over 809 Cumulated tax 55.43 April

Over 1415 223.6 + 25% on amount over 1415 Tax paid in the month 13.82

To 303 0,00

303-1011 0 +17% on amount over 303 Cumulated income 711.35

1011-1769 120.3 + 21% on amount over 1011 Cumulated tax 69.42 May

Over 1769 279.49+ 25% on amount over 1769 Tax paid in the month 13.99

To 364 0,00

364-1213 0 +17% on amount over 364 Cumulated income 853.62

1213-2123 144.35 + 21% on amount over 1213 Cumulated tax 83.24 June

Over 2123 335.39 + 25% on amount over 2123 Tax paid in the month 13.82

To 425 0,00

425-1415 0 +17% on amount over 425 Cumulated income 995.89

1415-2476 168.4 + 21% on amount over 1415 Cumulated tax 97.05 July

Over 2476 391.29 + 25% on amount over 2476 Tax paid in the month 13.82

To 485 0,00

485-1617 0 +17% on amount over 485 Cumulated income 1138.16

1617-2830 192.46 + 21% on amount over 1617 Cumulated tax 111.02 August

Over 2830 447.19 + 25% on amount over 2830 Tax paid in the month 13.99

To 546 0,00

546-1819 0 +17% on amount over 546 Cumulated income 1280.43

1819-3184 216.52 + 21% on amount over 1819 Cumulated tax 124.85 September

Over 3184 503.09 + 25% on amount over 3184 Tax paid in the month 13.82

To 606 0,00

606-2022 0 +17% on amount over 606 Cumulated income 1422.70

2022-3538 240.58 + 21% on amount over 2022 Cumulated tax 138.84 October

Over 3538 558.99 + 25% on amount over 3538 Tax paid in the month 13.99

To 667 0,00

667-2224 0 +17% on amount over 667 Cumulated income 1564.97

2224-3892 264.64 + 21% on amount over 2224 Cumulated tax 152.65 November

Over 3892 614.9 + 25% on amount over 3892 Tax paid in the month 13.82

Do 728 0,00

728-2426 0 +17% on amount over 728 Cumulated income 1707.24

2426-4245 288.69 + 21% on amount over 2426 Cumulated tax 166.47 December

Over 4245 670.79 + 25% on amount over 4245 Tax paid in the month 13.82

Source: Guide for employers for withholding and payment of taxes and contributions from employment in 2003, Office for Public Revenues

Montenegro Economic Trends September 2003

ISSP - CEPS

43

Calculations of due taxes and tax rates for various amounts of annual income up to €15,000 are presented in Graph 3.3 and 3.4. Under the newly implemented progressive tax system, annual income of up to €6,504 (or €542 monthly) yields lower tax rates than the old linear tax system. This means that taxpayers making less than €542 a month are better off under the new system. This is particularly true for low-income taxpayers who gain the most from the change (see Graph 3.4). The gain is lower as income rises. For taxpayers making more than €6,504 a year, the new tax system means higher tax rates. For an annual income of €10,000, €13,000 and €15,000 the respective taxation rates are 21.1%, 22% and 22.4% vs. a flat 19% paid in the previous system.

Graph 3.3 Annual cumulated taxes under new and old system

0

50 0

100 0

150 0

200 0

250 0

300 0

350 0

0 1000 20 00 300 0 40 00 500 0 6 000 7000 80 00 9 000 100 00 110 00 1200 0 13 000 1400 0 1500 0

Gross annual income (in euro)

Tot

al a

nnua

l tax

(in

eur

o

New system Old system

Graph 3.4 Effective tax rate on annual income

0

5

10

15

20

25

0 1000 2000 3000 4000 5000 6000 7000 8000 9000 10000 11000 12000 13000 14000 15000

Gross annual income (in euro)

Eff

ecti

ve t

ax r

ate

(in

%)

New system Old system

Chapter 3. Wages

ISSP - CEPS 44

If we assume that the distribution of wages in 2003 will be identical to that revealed by the ISSP Household Survey in 2002, we could simulate the amount of taxes paid in the new vs. old system. Graph 3.5 presents the distribution of gross income based on the results of the Household Survey no. 6. Gross wages have been calculated by appropriate adjustment6 of net wages. Weighted average of gross annual wages in 20027 according to the survey was €4,130 (or €344 monthly) while the median amounted to €3,826 (or €319 monthly). If we apply the tax system to this wage distribution (Graph 3.5), we obtain due taxes and respective tax rates (i.e. taxes as percentage of gross wages). The distribution of these tax rates is presented in Graph 3.6. The new tax rates applied to the 2002 wages imply the average weighted tax rate of 15.1% (and a median tax rate of 15.2%) while the old system meant a flat rate of 19% for the entire wage distribution (simple and weighted average as well as median equal to 19%). Therefore, the new tax system means tax rates lower by about 4 percentage points compared to the flat 19% rate implied by the old system.

Euro

50,000

47,500

45,000

42,500

40,000

37,500

35,000

32,500

30,000

27,500

25,000

22,500

20,000

17,500

15,000

12,500

10,000

7,5005,000

2,5000

Chart 3.5: Distribution of annual gross wage

%

40

30

20

10

0

Source: ISSP Household Budget Survey, issue No.6

6 Gross wages were obtained by multiplying net wages by 1.6349 to account for all contributions due on net wages 7 Precisely, survey no. 6 reveals wages in October 2002 that were later annualized by multiplying by 12. This makes it an estimate of annual wages as wages vary from month to month.

Montenegro Economic Trends September 2003

ISSP - CEPS

45

%

24.022.0

20.018.0

16.014.0

12.010.0

8.06.0

4.02.0

0.0

Graph 3.6 Distribution of tax rates in the new system

%

12

10

8

6

4

2

0 %

Source: ISSP Household Budget Survey, issue No.6

Compared to linear tax systems, progressive tax systems have proven to require more administration and thus to be more costly, prone to corruption, and in the end, produce more gray economy. Therefore many transition economies8 have decided to change their progressive tax system into linear tax systems. Montenegro did the opposite, while it had a linear tax system (with 19% tax rate, moderate by European standards), it decided to introduce a progressive tax system under which most tax payers will pay tax rates lower than 19%. We can only hope that this system will function properly and more people will now pay their due taxes. However, the experiences of other countries and many stylized facts suggest the opposite, and this change has to be considered as an opposition to the Government’s efforts to reduce the gray economy and fight corruption.

8 Like Russia a few years ago and Ukraine recently; many other (Baltic states and Poland) are seriously considering replacing its progressive tax systems with linear tax system.

Chapter 4. Prices

ISSP - CEPS 46

Table 4.1. Prices

Consumer Price Index (Cost of Living Index1)

CPI total RPI total official

Producer Price Index

2000=10

0

monthly change in %

annual change in %

Foo

d, to

bacc

o an

d be

vera

ges

annu

al c

hang

e in

%

G

oods

less

foo

d,

toba

cco

and

beve

rage

s an

nual

ch

ange

in %

Serv

ices

an

nual

cha

nge

in

%

2000= 100

monthly change in %

annual change in %

2000= 100

annual change in %

DIN PRICES

1995 9.8 6.2 83.7 206 6.5 100.1

1996 18.2 3.4 89.7 379 3.3 89.1

1997 22.9 1.4 26.5 456 1.1 20.8

1998 29.8 3.1 29.8 582 2.9 27.5

1999 47.1 6.2 56.6 931 7.1 58.0 85.9

DM (until Dec 2001) and EURO (from Jan 2002)

2000 100.0 3.4 36.1 10.9 23.2 12.2 100.0 25.0 100.0 16.5

2001 120.2 1.8 21.8 18.9 22.8 42.0 123.0 23.0 114.5 14.5

2002 142.0 0.7 16.8 15.7 18.7 19.5 147.6 19.9 119.7 4.5

2001 Q1 112.0 1.6 19.9 18.2 22.4 25.9 113.7 1.5 110.3

2001 Q2 116.5 1.9 20.7 18.2 22.7 34.6 117.7 1.2 113.5

2001 Q3 122.7 1.5 23.1 19.4 22.8 53.9 126.6 1.8 116.2

2001 Q4 129.7 2.2 23.5 19.9 23.4 53.5 134.1 1.7 117.4 15.2

2002-Q1 136.6 1.1 19.6 18.5 18.9 31.2 142.1 0.8 122.2 10.8

2002-Q2 142.7 1.5 19.4 19.7 18.5 19.7 147.2 0.9 122.6 7.9

2002-Q3 143.5 0.1 16.3 15.3 20.0 13.9 149.5 0.3 120.5 3.7

2002-Q4 145.2 0.3 11.8 9.5 17.7 13.1 151.5 0.2 121.2 3.2

2003-Q1 146.7 0.1 7.3 4.5 7.5 4.8 153.8 0.5 121.6 -0.5

Jan-02 135.1 1.3 18.3 17.2 18.2 27.6 140.9 1.7 25.6 120.9 7.3

Feb-02 136.8 1.3 18.0 18.1 16.2 22.8 142.3 1.0 24.8 122.2 6.0

Mar-02 138.0 0.9 18.3 18.6 16.4 21.1 143.1 0.6 24.7 123.4 7.9

Apr-02 140.7 2.0 19.7 20.1 18.2 20.7 145.5 1.6 25.8 123.2 7.1

May-02 143.1 1.7 19.4 19.4 18.7 21.9 147.4 1.3 26.1 123.7 6.6

Jun-02 144.2 0.8 19.1 19.6 18.5 16.4 148.6 0.8 23.2 120.8 3.8

Jul-02 142.7 -1.1 17.6 17.4 19.2 14.4 148.7 0.1 20.4 120.4 2.4

Aug-02 143.3 0.4 15.8 14.6 19.8 14.4 149.3 0.4 17.7 119.7 0.9

Sep-02 144.6 0.9 15.5 13.9 20.9 13.0 150.5 0.8 16.3 121.4 3.8

Oct-02 144.9 0.2 15.1 13.0 21.5 13.0 151.1 0.4 16.1 121.2 4.2

Nov-02 145.0 0.1 11.1 7.6 20.0 13.6 151.6 0.3 13.3 121.2 3.9

Dec-02 145.7 0.5 9.2 8.0 11.5 12.6 151.7 0.1 9.5 121.0 0.7

Jan-03 146.5 0.5 8.4 7.5 11.1 6.8 152.9 0.8 8.5 120.9 0.0

Feb-03 146.6 0.1 7.2 5.9 10.7 6.9 153.8 0.6 8.1 120.9 -1.5

Mar-03 146.9 0.2 6.5 0.0 0.7 0.7 154.8 0.7 8.1 123.1 -0.7

Apr-03 151.6 3.2 7.7 2.3 5.5 0.6 159.8 3.2 9.8 127.8 3.8

May-03 151.8 0.2 6.1 3.0 13.2 7.6 160.1 0.2 8.6 127.7 2.9

June-03 153.7 1.3 6.6 4.0 12.6 7.0 160.7 0.3 8.1 128.9 6.7

Sources: Monstat Table presents end-of-period values for monthly data and average period values for quarterly and annual data. Currencies: DIN till 1999, DM from 2000 till 2002 and € from 2002.

1 Cost of Living Index (Indeks Troskova Zivota) is the official name of the CPI in Montenegro.

Montenegro Economic Trends September 2003

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47

COMMENT PRICES In this chapter we will present the main trends in consumer prices in March and April 2003. Also, we will try to provide answers to the following questions:

What was the influence of VAT and the electricity price increase on inflation?

Which groups of products and services were leading the inflationary process and which of them were slowing it down?

How did the price of the consumer basket change in March and April 2003?

Which inflation forecast scenario materialized?

4.1. CONSUMER PRICE INDEX 4.1.1 General inflation outlook Annual CPI dynamics continued the downward trend until March 2003 when it reached the level of 6.5%. This represents a significant slow-down of inflationary pressures as compared to 2001 and 2002. March 2002 saw annual inflation at a level of 18.3% (or almost 3 times as high as in March 2003), and in March 2001 this figure was at 20%. However, April 2003 brought a reversal of the downward trend that is clearly explained by price increases following the VAT introduction and a 23% electricity price increase. Both factors contributed to acceleration in annual price dynamics to 7.5% in April. May and June were marked by the return of a deflationary path. The annual dynamics of CPI reached 6.1% in May (the record-low in several years) and 6.6% in June. (see Graph 4.1.).

Graph 4.1. CPI inflation

-2

0

2

4

6

8

10

12

14

16

18

20

22

24

Mar

-00

Apr

-00

May

-00

Jun-

00

Jul-

00

Aug

-00

Sep-

00

Oct

-00

Nov

-00

Dec

-00

Jan-

01

Feb

-01

Mar

-01

Apr

-01

May

-01

Jun-

01

Jul-

01

Aug

-01

Sep-

01

Oct

-01

Nov

-01

Dec

-01

Jan-

02

Feb

-02

Mar

-02

Apr

-02

May

-02

Jun-

02

Jul-

02

Aug

-02

Sep-

02

Oct

-02

Nov

-02

Dec

-02

Jan-

03

Feb

-03

Mar

-03

Apr

-03

May

-03

Jun-

03

%

monthly annual

Source: Monstat

Chapter 4. Prices

ISSP - CEPS 48

The impact of April events on inflation is even more visible on a monthly basis. The CPI increased by a mere 0.2% in March and May, 1.3% in June and as much as 3.2% in April. Price growth in April, obviously triggered by the VAT introduction, clearly surpassed the level that would be justified by the change of the effective tax burden implied by the new tax. Instead, it reveals serious market weaknesses and imperfections of the Montenegrin consumer market goods. We will discuss this issue in more detail in section 4.4. These tendencies are confirmed by the alternative measure of prices i.e. the Retail Price Index (RPI)2. The annual dynamics of RPI has been falling consistently since early 2002, stabilized at the level of 8.1% in February and March 2003 to rise sharply in April 2003 to 9.9% and return to 8.6% in May and 8.1% in June (see Graph 4.2). Monthly RPI growth amounted to 0.7% in March, 3.2% in April, 0.2% in May, and 0.3% in June 2003.

Graph 4.2. RPI inflation

0

2

4

6

8

10

12

14

16

18

20

22

24

26

28

Jan-

01

Feb

-01

Mar

-01

Apr

-01

May

-01

Jun-

01

Jul-

01

Aug

-01

Sep-

01

Oct

-01

Nov

-01

Dec

-01

Jan-

02

Feb

-02

Mar

-02

Apr

-02

May

-02

Jun-

02

Jul-

02

Aug

-02

Sep-

02

Oct

-02

Nov

-02

Dec

-02

Jan-

03

Feb

-03

Mar

-03

Apr

-03

May

-03

Jun-

03

%

monthly annual

Source: Monstat

2The structure of weights in the RPI is based on the shares in the volume of sales while CPI is weighted by survey data on consumption expenditures.

Montenegro Economic Trends September 2003

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49

4.1.2. Disaggregated price changes Table 4.2 Annual inflation of disaggregated CPI components

Product or service group

Total index Food Tobacco and

beverages Clothing and

footwear Accommodation

Hygiene and personal

care

Education and culture

Traffic vehicles and transport

and communication

services Consumption Weight (until Dec 2002)

100 60.38 6.51 8.2 9.3 5.68 4 5.93

Consumption Weight (from Jan 2003)

100 58.61 7.71 8.01 10.51 5.24 4.2 5.72

2002

Jan 18.28 13.9 49.61 9.08 47.92 4.78 12.63 17.86

Feb 18 14.96 48.94 9.84 33.22 6.69 14.02 17.58

Mar 18.25 15.5 49.05 9.52 32.9 6.32 16.43 16.14

Apr 19.66 17.21 48.24 14.2 32.41 4.21 22.11 15.96

May 19.41 16.3 50.53 14.57 32.5 5.41 24.68 16.03

Jun 19.09 16.5 51.44 12.87 32.85 7.17 24.8 8.49

Jul 17.57 13.99 51.48 13.49 33.27 7.67 21.23 8.65

Aug 15.83 10.97 51.83 13.86 33.43 8.09 23.29 8.33

Sep 15.5 11.69 33.6 15.51 31.82 8.06 25.79 8.85

Oct 15.09 10.84 33.15 17.49 31.86 7.94 25.53 8.97

Nov 11.05 7.88 5.57 14.39 31.62 8.33 23.6 9.55

Dec 9.22 8.34 5.27 13.99 7.29 10.27 26.39 8.04

2003

Jan 8.4 7.8 4.88 13.8 4.09 9.99 31.6 2.2

Feb 7.17 6.4 4.62 13.83 3.5 9.08 30.07 2.86

Mar 6.46 4.71 4.54 14.39 3.38 8.59 26.9 6.08

Apr 7.69 5.02 3.23 10.59 15.66 9.07 27.62 7.18

May 6.12 3.16 1.41 9.58 15.74 8.6 25.18 5.14

Jun 6.56 4.39 0.32 10.41 15.18 5.68 24.54 4.52

Source: Monstat

Table 4.2 presents annual changes of price levels for 7 major CPI components whose weights sum to 100%, i.e. cover the entire consumption basket. The system of weights was updated3 beginning in January 2003 to account for the changes in the consumption structure. One feature of the consumption structure of Montenegrin households is a very high percentage of expenditures related to food purchases, namely: 59%. The remaining 41% of total expenditures are spent on accommodation (10.5%), clothing and footwear (8%), tobacco and beverages (7.71%), traffic vehicles, transport and telecommunication services (5.7%), hygiene and personal care (5.24%), and education and culture (4.2%). Due to the high weight of food in the consumption basket, price changes of food dominate the developments in Montenegrin inflation. The slowdown of inflation in 2003 is mostly due to declining dynamics of food prices, which continued to exhibit considerably lower annual growth rates than the total index. Annual inflation of food products stood at 5.02% in April and fell to 3.2% in May and 4.4% in June 2003. Prices of food continued to have a strong

3 This is an update based on weight changes following relative price changes and not based on new household expenditure survey.

Chapter 4. Prices

ISSP - CEPS 50

desinflatory effect on the total index, as their annual dynamics has been over 2 percentage points lower than the dynamics of the total index in 2003 Q2. The annual rate of change of prices of cereal products (mostly bread) has been falling since early 2002 and stood at 17% in March, 11% in April, and 10% in June 2003. Annual dynamics of fruits’ prices was falling likewise (13% in April and 1.3% in June) while that of vegetables picked up in June (6% in March and April, 1% in May and 8.4% in June). Meat and meat products, with their high 18.5% share in the consumption basket continue to pull inflation down: their annual price dynamics amounted to 3.7% in April and just 1.3% in June. Prices of dairy products, after several months of stability and decline (which resulted in slight deflation during the last couple of months), picked up in April by over 6.2% and further by 4.2% in June resulting in an annual rate of change exceeding 4% in April and May and exceeding 11% in June. Eggs, animal fats, and other foodstuffs continue to register annual rates of change well below the CPI inflation. Deflation on an annual basis has persisted in the market for sugar (-12.8% in June). Beverages and tobacco continue to slow down total inflation. Prices of alcohol have been stable during 2003 with the exception of a 1.6% fall in April (in view of the lower tax rate connected with the VAT introduction). This translated into a declining annual dynamics: it amounted to 10% in March, 4.3% in May and 0.8% in June. We also observe a similar situation in the market for tobacco products. With the exception of a 0.7% rise in April, prices of these products have been stable since May 2002. Hence, their annual dynamics fell from 2.1% in 2003 Q1 to 0.9% in April and 0% in May and June 2003. Combined, the dynamics of prices of beverages and tobacco fell to 4.5% in March and to 0.3% in June and have had a significant inflation-suppressing effect.

Graph 4.3 Annual inflation: CPI total and disagregated 2000-2003

-20

-15

-10

-5

0

5

10

15

20

25

30

35

40

45

50

55

Mar

-00

Apr

-00

May

-00

Jun-

00

Jul-

00

Aug

-00

Sep-

00

Oct

-00

Nov

-00

Dec

-00

Jan-

01

Feb

-01

Mar

-01

Apr

-01

May

-01

Jun-

01

Jul-

01

Aug

-01

Sep-

01

Oct

-01

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-01

Dec

-01

Jan-

02

Feb

-02

Mar

-02

Apr

-02

May

-02

Jun-

02

Jul-

02

Aug

-02

Sep-

02

Oct

-02

Nov

-02

Dec

-02

Jan-

03

Feb

-03

Mar

-03

Apr

-03

May

-03

Jun-

03

%

Total Food Tobacco and drinks Clothes and footwear

Source: Monstat Inflation of clothing and related services exceeded the aggregate CPI inflation by about 1-2 percentage points in 2003 Q2. Despite lower monthly price changes, footwear and services prices continue to create upward pressure on total inflation, registering annual growth rates well above CPI levels, e.g. 23% in March, 13.3% in April, and 14% in June 2003. Jointly, annual dynamics of clothing and footwear decreased from 14% in March and 11% in April 2003 to 10.4% in June 2003 and continues to constitute an important inflationary factor.

Montenegro Economic Trends September 2003

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51

Annual dynamics of accommodation prices accelerated in April to 15.7% due to a sharp 24%-increase of electricity in April (which accounts for over 50% of the total weight in the index). All other accommodation categories also registered relatively high annual price dynamics: apartment services (incl. utilities) stood at 10.3% in May and June and apartment equipment (incl. furnishings) stood at a surprisingly high 9% in April, 7.4% in May, and 5% in June 2003. Some of the household items from these categories registered a significant price growth in April, most probably due to the VAT effect (i.e. clothing cabinet 13%)

Graph 4.4 Annual inflation: CPI total and disagregated 2000-2003

0

5

10

15

20

25

30

35

40

45

50

55

Mar

-00

Apr

-00

May

-00

Jun-

00

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00

Aug

-00

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00

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-00

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-00

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-00

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01

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03

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-03

Mar

-03

Apr

-03

May

-03

Jun-

03

%

Total Accomodaton Hygienic and care Education, culture Trafic vehicles

Source: Monstat Hygiene and personal care prices are rather unstable on an annual basis. March and May were marked by high 8.6% inflation rates while April and June registered 6.4% and 5.7% respectively. The fastest growing price in this category is for medicines, which increased by over 2% in April. This pushed up the annual dynamics from about 16% in February and March to 18.4% in April 2003 and 9.4% in June. Surprisingly, cosmetic and washing needs continue to register 4-8% growth rates in 2003 Q1 in spite of their perfectly tradable character. The category of ‘education and culture’ continued to register high growth rates of around 26% on an annual basis in March 2003 and 2003 Q2. After a slowdown in the first quarter of 2003, prices in this category increased in April by 5.7%. Books continue to be the category with the highest annual inflation of 52%. At the monthly level, newspapers registered a surprisingly high price growth in April (16%), keeping the annual dynamics very high at 47%. Thus education and culture (with 4% weight in the basket) continues to exert high inflationary pressures.

Chapter 4. Prices

ISSP - CEPS 52

The annual growth rate of the last category, traffic vehicles, transport and telecommunication services, was slightly below the total index. Annual dynamics of fuel and lubricants fell sharply as a result of cuts of world oil prices and registered a near-0% dynamics in May and June. Prices of telecommunication services did not change significantly in 2003 Q2. Summing up, annual dynamics of prices of most products and services registered a decline in March compared to previous months, while April saw an increase in most of them triggered by the introduction of VAT and the electricity price increase. These measures did not influence food prices as much as other products and services and due to the high weight of food in the total CPI basket, food exerted desinflatory pressures overall. The acceleration in total annual inflation in April was primarily the result of high price growth of clothing and footwear, accommodation, as well as education and culture. Sources of lower CPI dynamics in May and June are likewise to be found in lower inflation of foodstuffs including alcohol and tobacco as well as falling prices of fuel. 4.1.3. COST OF THE FOOD BASKET4 Table 4.2 Cost of the food basket in Montengero (in € )

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2002 224.61 230.11 230.47 232.82 250.63 253.63 240.70 253.80 253.22 252.22 243.41 239.03

2003 240.06 242.10 241.72 246.01 257.92 263.57

source: Monstat The cost of the food basket, which consists of a group of basic food products in the quantities appropriate for a four-member family, was equal to €246 in April, €258 in May, and €264 in June 2003. This represents an annual increase of 5.7%, 2.9%, and 3.9% as compared to the corresponding months of the 2nd quarter of 2002. Not surprisingly, this increase was roughly in line with the annual food price inflation, which stood at 5% in April, 3.2% in May, and 4.4% in June. The annual price growth rates for specific products varied significantly. Averaged over the second quarter of 2003, annual inflation of lettuce reached 48%, frozen dough 45%, dried plums 30%, and pears 24%. Significant inflation was also registered in the case of carrots (20%), fruit jam (19%), food seasoning (15%), pickled cucumber and white cheese (14%), as well as mortadela sausage (13%). Several foodstuffs registered deflation on an annual basis in 2003 Q2; these included green peas (-43%), sugar (-11%), tea in bags (-10%), as well as cabbage and vinegar (-9%). Graph 4.5 shows the cost of the basket containing the same quantities of the same foodstuffs for Montenegro and Serbia. The difference in the basket has been within the range of €40-65. In May 2003, the cost of the basket in Serbia was €194 compared to €258 in Montenegro, making the basic food basket in Montenegro over 30% more expensive compared to Serbia.

4 The concept of the basket was developed following the guidelines of the EU to approximate the cost of basic food needs for a four-member family. Thus it allows for easy comparisons between countries.

Montenegro Economic Trends September 2003

ISSP - CEPS

53

Graph 4.5. Cost of consumer basket in Montenegro and Serbia

170

180

190

200

210

220

230

240

250

260

270

Jan-

02

Feb

-02

Mar

-02

Apr

-02

May

-02

Jun-

02

Jul-

02

Aug

-02

Sep-

02

Oct

-02

Nov

-02

Dec

-02

Jan-

03

Feb

-03

Mar

-03

Apr

-03

May

-03

Jun-

03

euro

Montenegro Serbia

Source: Monstat and Federal Statistical Office

Graph 4.6 presents a comparison of the annual growth rates of the Serbian and Montenegrin food baskets during the first 5 months of 2003. The annual dynamics of the food basket prices has been declining in 2003, albeit it still stands at relatively high levels. April 2003 is marked by a one-off jump in the annual dynamics reflecting the introduction of VAT. A significant increase in dynamics took place in June as well. For all 5 months, the Serbian food basket registered a slower price growth than did its Montenegrin counterpart (albeit the rates were almost identical in February and May). This means that not only is the price of the Montenegrin basket about 1/3 higher than the Serbian food basket, but it also continues to grow at a faster pace. This is yet another paradox and a piece of evidence that the Montenegrin market is far from being competitive. With a stable currency and customs tariffs, growth rates of Montenegrin food prices should quickly converge to those in the Euro-zone.5 That this is very far from happening is a worrying sign and points to a serious monopolization in the market for food imports.

Graph 4.6. Consumer basket (annual changes)

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8.00

Jan-03 Feb-03 Mar-03 Apr-03 May-03 Jun-03

%

Montenegro Serbia

5 The average annual food price inflation in the period January-April 2003 was 2.1% in the Eurozone and 5.9% in Montenegro. Analogous figures for the entire 2002-year are: 3.1% in the Eurozone and 13.2% in Montenegro.

Chapter 4. Prices

ISSP - CEPS 54

4.2. PRODUCER PRICES Beginning with this issue of MONET, the monitoring of producer prices will be part of chapter 4 ‘Prices’ (previously, data on PPI was partly analyzed in the first chapter on the real sector). The Producer Price Index (PPI) measures the level of prices in wholesale trade or trade between domestic enterprises. Unlike consumer price indexes (CPI and RPI), the PPI does not include services. Producer prices are aggregated into the PPI with the use of weights reflecting shares of specific sectors in total sales. The PPI provides information on price changes of intermediate and finished goods before they enter the retail sector. It constitutes a very important indicator that is helpful in monitoring the price setting mechanisms in any economy. Because the PPI measures prices directly at the enterprise and wholesale level, it reflects the costs of production of specific goods to a greater extent than the CPI. In essence, the difference between producer and consumer prices for specific products is a good measure of charges at the level of retailers, transportation costs, and the overall demand situation for respective products. Too great a difference points to big markups levied on consumers by transporters and/or retailers and might also be an indicator of monopolies or other market imperfections as competition among transporters and retailers would normally cut these mark-ups down. 4.2.1. PPI inflation

Graph 4.7 PPI inflation

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Annual dynamics of the PPI has shown a great deal of fluctuation during late 2002 and 2003. Until August 2002, the dynamics has been declining, while September 2002 was marked by a slight increase of the dynamics. Since December 2002, the dynamics was falling again to reach 0% in January 2003 and negative rates of –1.5% and –0.7% in February and March

Montenegro Economic Trends September 2003

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2003, respectively. Increasing PPI dynamics marked the second quarter of 2003, which reached 6.7% in June 2003. On a monthly basis, PPI has registered near-zero growth rates from October 2002 until February 2003. March, and particularly, April 2003 were marked with sharp monthly increases of 1.8% and 3.9% respectively (April growth was certainly triggered by the introduction of VAT). Monthly PPI growth declined again in May and June when it amounted to –0.1% and 1% respectively. 4.2.2 Disaggregated PPI annual changes Graphs 4.8 and 4.9 present annual inflation rates for PPI along with selected sectoral sub-indices. Graph 4.8 includes PPI and price indices in major sectors: processing industries, mining, electricity, gas and water supply, as well as construction materials. The following graph presents price inflation in 3 selected processing industries: food and beverages, chemical products, and textile and clothing.6 Annual dynamics of prices in processing industries has been fairly close to that of an aggregate PPI, which is a straightforward reflection of the fact that those industries contribute the most to the PPI index. Prices in mining have been going up at an approximate rate of 10% on an annual basis in 2002 to register deflation of about 1-2% since February. Annual price dynamics in the sector of electricity, gas, and water has been rather changeable, very much in line with consumer electricity prices (check 4.1). Until December 2002, their dynamics exceeded 20%, then registered 0% from December 2002 until March 2003, and rose to 24% in April 2003 and has held constant since then. Annual inflation of construction materials has been positive but falling consistently through June 2002, then registered 0% from June 2002 until February 2003, and a mere 1% since March 2003.

Graph 4.8. Annual inflation: PPI total and selected sectoral indices

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35

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PPI Mining and stone extraction Processing Industries

Electricity, gas and water Construction materials

6 Production of aluminum is not analyzed here since chapter 1 presents detailed information on price of aluminum.

Chapter 4. Prices

ISSP - CEPS 56

Graph 4.9. Annual inflation: PPI total and selected indices in manufacturing industries.

-20

-15

-10

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0

5

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15

20Ja

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PPI Food Products, beverages and tobacco Chemical Products Textile and clothing

;

Graph 4.9 presents annual inflation rates in the selected processing industries. The sector of food products (including tobacco and beverages) saw their prices rise at a relatively high pace, exceeding that of the aggregate PPI (with the exception of June 2002). Inflation rates for these products has declined, going from 15-20% in the first 5 months of 2002 to 5-12% in the second half of 2002 and further down to –1% in March 2003. The second quarter of 2003 saw a radical hike in dynamics, which registered 7% in May and 11.6% in June 2003. Prices of textiles and clothing were growing very much in line with the PPI in the first half of 2002, registered a stable 3.5% growth during the period June-November 2002, and fell down to 1% since then. Annual dynamics of chemical products has been negative throughout 2002 but gradually grew to register 0% in January 2003 and 2.6% in the rest of 2003.

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4.3 INFLATION MEASURED BY DIFFERENT INDICATORS: PPI, RPI AND CPI.

Graph 4.10 Annual inflation measured by PPI, RPI and CPI.

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PPI RPI CPI

Graph 4.11. Monthly inflation measures by PPI, RPI and CPI

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PPI RPI CPI

Chapter 4. Prices

ISSP - CEPS 58

Graph 4.12 Development in price levels : PPI, RPI, CPI and CPI-goods (Jan-2001=100)

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PPI RPI CPI CPI goods

Graphs 4.10 and 4.11 present inflation rates in Montenegro as measured by different price level indicators. Graph 4.10 points out that while differences in annual inflation rates between consumer price indicators RPI and CPI are not very large, the PPI has been generally registering considerably lower rates. In mid-2002, these deviations amounted to no less than 20 percentage points as CPI inflation was 26% and 23% compared to 6.6% and 3.8% PPI inflation in May and June 2002, respectively. The first quarter of 2003 saw deflation in PPI while both CPI and RPI registered a steady 7-8% annual growth. Recent months brought a closing of the gap as the annual dynamics of all 3 indicators grew closer to one another. June 2003 saw equalization of CPI and PPI dynamics at a level of approximately 6.5%. Monthly inflation rates (graph 4.11) also carry interesting information about inflation processes in Montenegro. We can observe that the slower price growth, or even deflation that CPI registers in the summer months, is not mirrored in the PPI. Instead, the PPI falls rather chaotically in different months throughout the year (for example, Mar-01, Sep-01 and June-02). After marked changes in monthly inflation rates measured by the 3 different indicators in 2001 and most of 2002, late 2002 and 2003 brought the monthly dynamics of them closer to one another. In 2003 Q2, monthly changes of all 3 price level indicators moved in parallel (especially CPI and PPI). VAT-related shock in April 2003 is equally well reflected in all 3 price indices (albeit PPI registered the highest 4% growth). Price growth related to the euro conversion in April 20027 is registered by both consumer price indexes (CPI and RPI), but is hardly visible in the PPI. Cumulated inflation in 2002 Q2 was 4.5% and 3.8% when measured by CPI and RPI respectively but –2.2% when measured by PPI. This confirms our previous notions that

7 In April 2002 retailers removed DM price tags and raised prices taking advantage of the initial confusion. See article in Monet13 (second part) for more details.

Montenegro Economic Trends September 2003

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sources of the euro-shock price growth are mainly to be found in the retail sector (see comment: Why is Montenegrin inflation so high? MONET 13). As a consequence of the different paces of growth of PPI, RPI and CPI, accumulated inflation measured by each one of them also varies. Graph 4.12 presents an index of respective price levels with the base in January 2001. Not surprisingly, on a cumulative basis, PPI registers much slower growth than its consumer-price counterparts. Compared June 2003 to January 2001, prices grew 43% if measured by the RPI, 39% if measured by the CPI, and only 21% if measured by the PPI. It might be argued, however, that the source of slower growth of PPI vis-à-vis the CPI lies in the fact that the latter includes services, which are more likely to register higher inflation.8 Thus, graph 4.12 also includes the index of CPI goods, which presents the price level of the CPI basket stripped of services. While the cumulative index of CPI-goods registers a lower growth (132 in June 2003) than the full CPI (139), it is still considerably higher than the PPI (121). Therefore, we can credibly assert that consumer prices of goods grew much more than producer prices since 2001. Consequently, this once again reinforces our notion that a great deal of inflation in Montenegro is generated at the level of retailers and importers. While they face steady import prices (near-zero inflation rate in the Euro zone and constant customs tariffs) and moderately growing domestic output prices (0.63% average monthly growth between 2001:1 and 2003:6), retailers and importers raise their prices incommensurately faster and apparently, the market imperfections allow them to get away with it. 4.4. INFLATION FORECASTS 4.4.1 Inflation forecasts in the previous issue April 2003 was marked by 2 important phenomena related to inflation: the introduction of VAT and an increase in electricity prices. The VAT with the flat rate of 17% replaced the turnover tax with rates of 0, 15 and 24%. The rate of the VAT was chosen so that, in essence, it would leave the effective tax rate at about the same level, i.e. the tax increase for some goods would be balanced out by the tax decrease for others. However, prices went up significantly in April, well beyond the rate that would be justified by a 2-percentage point increase in taxation that took place for most products (from 15% to 17%). On the other hand, among goods for which VAT introduced lower taxation, they did not register a commensurate price decline. For instance, turnover tax on furniture, coffee, and alcohol was originally 24% and became just 17% under the VAT, thus the tax change would imply a price decline of about 6%9, while in actuality, price changes for those products were: -0.5%, -4.5% and –1.6%. In general, retail prices of most products for which the VAT meant higher taxation moved upwards by more than would be justified by the tax increase, while those for which VAT implied lower taxation declined only marginally or did not decline at all. Importers and retailers seized this opportunity to exercise their monopolistic power once again, just about 1

8 Higher inflation in services that are non-tradables, is a common phenomenon especially in transition economies. 9 (1.17-1.24)/1.24≈0.94

Chapter 4. Prices

ISSP - CEPS 60

year after phasing out the DM from circulation, which was likewise accompanied by massive price hikes. So, the VAT introduction provides us with yet another example of imperfections of the market for consumer goods in Montenegro that allows importers, producers, and retailers to take any opportunity to raise prices. The second important price change that had a considerable effect on inflation was the electricity price increase of 23%. Considering that electricity has a 5.5% share in total consumption weights this impact was both direct and indirect through the cost factor in all other goods and services included in the consumption basket. Due to both effects, the CPI increase in April amounted to 3.8% on a monthly basis and translated into an annual growth rate of 7.7%. This was slightly lower than our optimistic scenario forecast in MONET13. Annual inflation in May fell to 6.15%, which was almost 1.8 percentage points lower than our optimistic scenario. Finally, annual inflation in June was 6.58% and exceeded the optimistic scenario forecast by about 0.5 percentage points. We were overly pessimistic in our forecasts in the previous issue of Monet mostly due to overestimating the VAT-related shock and spillover effects of electricity price increases. In addition, because of the Iraqi war, we assumed a relatively high 2% monthly growth rate of fuel prices in 2003, when in fact fuel prices fell by almost 8% in 2003 Q2. Also, the price increases predicted to take place as a result of an upward tariff adjustment following tariff harmonization with Serbia did not take place because no tariff changes have taken place as of yet. These assumptions have led us to overshoot the forecast for 2003 Q2 as well as for the entire 2003 year. The scenario that actually took place was more conducive to disinflation than our optimistic scenario. 4.4.2. Forecast for the next 12 months Beginning with this issue of Monet we will only consider two scenarios: optimistic and pessimistic, implicitly assuming that the moderate scenario would imply inflation at a half way in the optimistic and pessimistic scenarios. We will revise our previous forecasts of annual inflation rates downward due to the much lower than predicted monthly price growth experienced in 2003 Q2and also because other, more favorable factors are now shaping Montenegrin inflation. We will review them briefly below: o Customs tariffs harmonization of textiles and all other products will probably be

postponed due to many unresolved issues and somewhat weakened political support for the customs union on the part of both Union states. Thus, price hikes related to upward tariff adjustments probably will not take place in 2003 at all (optimistic scenario). Alternatively, new higher tariff rates will be introduced in late 2003 and will thus push prices of most consumer goods up (pessimistic scenario).

o Retail prices of fuel in Montenegro fall as a result of declining world prices of oil. Our optimistic scenario assumes that this fall will continue (on average the fall will be 0.2% monthly in 2003 and 0.1% in 2004). The pessimistic scenario assumes positive price change (on average, 0.2% monthly in 2003 and 0.1% in 2004).

o Electricity prices are assumed to rise by 18% in April 2004 (optimistic scenario) or by 1.2% from July 2003 until March 2004 and by further 21% in 2004 Q2.

o In general, the optimistic scenario assumes the absence of any significant adverse supply shocks that would drive prices up, while the pessimistic scenario allows for a limited scope of such effect.

Montenegro Economic Trends September 2003

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The resulting annual inflation rates for the next 12 months are visible in Graph 4.c. According to the optimistic scenario, after registering 7% in July, annual CPI dynamics would gradually go down to 6% in September and 6.1% in December 2003, 5.8% in March 2004 and 3.5% in June 2004. According to the pessimistic scenario the end-quarter inflation figures would be 7.2%, 8.3%, 8.8%, and 7.5% respectively for 2003 Q3, 2003 Q4, 2004 Q1, and 2004 Q2.

Graph 4.13 Annual CPI inflation: 12-month forecast (in %)

103

104

105

106

107

108

109

110

Dec

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03

Feb

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04

Optimistic scenario Pesimistic scenario

Forecast

Source: Monet

Chapter 5. Budget

ISSP - CEPS 62

5. BUDGET The implementation of new laws (Customs Law and Value Added Tax introduced on April 1st) had a direct effect on budget revenues in the initial months of 2003. Many taxpayers made their transactions prior to the introduction of the new Law to fulfill their tax obligations to the State; in some cases people wanted to avoid higher taxes, new procedures etc., while in other cases, ignorance and fear of a new law prompted their early handling. This brought significant increases in revenues in some budget categories in March as compared to the previous months and they fell in April and May. Lower revenues in the first months of the year forced the Government to reduce some expenditure categories or postpone its obligations. Additionally, the Government increased its net liabilities both through borrowing (which is evidenced in the budget) and through raising emissions of T-bills (see section 5.4). 5.1. FINAL ACCOUNT OF THE 2002 BUDGET In the last issue of MONET we presented a detailed analysis of budget executions in 2002, by economic classification, on the basis of the data obtained from the Ministry of Finance in the first quarter of 2003. The Parliament of Montenegro adopted the Final Account of the Budget on July 1, 2003. Data pertaining to specific budgetary categories in the Final Account differs somewhat from those previously obtained from the Ministry and analyzed in MONET 13. These differences follow from the fact that the final account presents final data free from errors and omissions taking into account delayed payments and revenues. In this issue of MONET, data for 2002 executions are taken from the final account (table 5.1) and may thus be slightly different when compared to the 2002 executions that we presented in the previous issue of our quarterly. The Budget Final Account states, “in 2002 unpaid expenses amounted to €36 million, and together with accumulated expenses from previous years to €64.6 million, while unpaid arrears on December 31, 2002 amounted to €100.6 million.” Classification of 2002 Expenses by Function of Government Additionally, the Final Account includes the classification of expenses by function of the Government. The table suggests that the largest category of expenditures (36%) in 2002 were general public services, which include ministries, law-making, fiscal, and financial state institutions. Second in the ranking come expenses for education with a 19% share. Together, these categories account for 55% of all budget expenditures. Other significant categories are public order and safety, which includes policy, army, prisons, fire brigades, and courts. Social protection (encompassing health care and social insurance) ranks 4th with a 10% share.

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Table 5.1. Classification of Expense by Function of Government (in euro)

Clas. Description Executed Structure in %

01 General public services 110,898,451.66 36.14

03 Public order and safety 52,540,719.38 17.12

04 Education 58,890,285.91 19.19

05 Health 2,210,479.84 0.72

06 Social protection 31,099,495.92 10.13

07 Housing and community amenities 1,754,030.27 0.57

08 Recreation, cultur, and religion 15,347,821.19 5.00

09 Fuel and energy 4,569,148.50 1.49

10 Agriculture, forestry, fishing and hunting 7,431,353.58 2.42

11 Mining, manufacturing, and construction 459,272.78 0.15

12 Transport 10,282,273.69 3.35

13 Other economic affairs 10,060,305.03 3.28

14 Other expenses 1,339,920.15 0.44

Total 306,883,557.90 100.00

Source: Ministry of Finance

Chapter 5. Budget

ISSP - CEPS 64

5.2 BUDGETARY EXECUTIONS IN 2003 Table 5.2 Central Budget Revenues and Expenditures, 2001-2003 (in million euro) YEAR 2001 2002 2003

MONTH Jan-Dec

Jan-Dec

Jan-May

Jan-Dec

Jan Feb Mar Apr May Jan-May

Jan-May*

TYPE OF ACCOUNT

Exe

cutio

n

Fin

al a

ccou

nt

Exe

cutio

n

Plan Execution Plan

Jan-May (Exec) / Jan-May (Plan)

Jan-Mar (Exec2003)/Jan-

Mar (Exec20

02)

A Total revenue and grants (1+2)

233.1 256.8 97.2 384.2 13.3 17.2 22.7 31.6 34.8 119.6

1 Total revenue (1.1+1.2) 221.2 229.8 85.2 361.0 13.3 17.2 22.7 29.1 31.7 114.0 123.7 92.2% 133.9%

1.1 Current revenue (1.1.1+1.1.2)

221.2 229.8 85.2 361.0 13.3 17.2 22.7 29.1 31.7 114.0 123.7 92.2% 133.9%

1.1.1 Tax revenue (1.1.1.1+1.1.1.2+1.1.1.3+1.1.1.4+1.1.1.5)

188.0 208.9 77.2 331.4 12.3 16.1 20.4 27.6 30.4 106.7 119.5 89.3% 138.2%

1.1.1.1 Personal income 56.7 57.9 21.0 76.2 3.2 4.1 5.7 6.8 5.0 24.8 27.4 90.7% 118.4%

1.1.1.2 Turnover (retail sales)/ VAT tax

58.5 56.5 24.9 98.3 2.3 3.2 3.4 8.9 16.7 34.5 33.3 103.8% 138.8%

1.1.1.3 Excises 35.7 50.8 13.3 86.3 3.7 3.3 4.3 5.9 4.5 21.7 37.2 58.4% 163.0%

1.1.1.4 Taxes on international trade and transactions

27.3 26.4 12.7 52.0 2.3 4.7 5.7 3.0 2.2 17.8 16.0 111.0% 139.8%

1.1.1.4.1 Custom tariffs 13.9 12.6 5.9 30.0 1.8 4.3 5.5 2.8 2.0 16.4 5.9 279.4% 278.5% 1.1.1.4.2 Custom transit fees 13.4 13.8 6.9 22.0 0.5 0.4 0.2 0.2 0.2 1.5 10.2 14.3% 21.2% 1.1.1.5 Other taxes 9.9 17.3 5.3 18.6 0.8 0.8 1.3 3.0 2.0 7.8 5.7 137.6% 148.1% 1.1.2 Nontax revenues 33.2 20.9 8.0 29.6 1.0 1.2 2.3 1.6 1.4 7.4 4.2 176.1% 92.0% 1.2 Capital revenue 0.0 2 Grants 11.9 27.0 12.0 23.2 0.0 0.0 0.0 2.5 3.0 5.5

year 2001 2002 2003

month Jan-Dec

Jan-Dec

Jan-May

Jan-Dec

Jan Feb Mar Apr May Jan-May

Jan-May*

type of account Execution

Final accou

nt

Execution

Plan Execution Plan

Jan-May (Exec) / Jan-May (Plan)

Jan-Mar (Exec2003)/Jan-

Mar (Exec20

02)

B Total expenditure and net lending (1+2)

259.3 255.0 49.9 431.2 10.1 19.1 27.7 56.8 107.8 52.7% 113.8%

1 Total expenditure (1.1+1.2) 252.6 247.5 46.9 422.8 9.7 18.8 26.8 55.3 105.7 52.3% 117.9%

1.1 Current expenditure (1.1.1+1.1.2)

233.3 236.7 44.3 400.8 9.5 18.4 26.2 54.1 100.2 54.0% 122.1%

1.1.1 Interest 0.6 12.9 0.1 25.5 0.2 0.3 2.9 3.4 6.4 53.0% 5709.4%

1.1.2 Non-interest (1.1.2.1+1.1.2.2+1.1.2.3+1.1.2.4+1.1.2.5+1.1.2.6)

232.7 223.8 44.2 375.3 9.3 18.1 23.4 50.7 93.8 54.1% 114.7%

1.1.2.1 wages and salaries 108.5 110.2 23.2 152.0 0.1 7.1 7.1 14.2 38.0 37.4% 61.1% 1.1.2.2 goods and services 55.4 41.8 10.4 43.8 1.0 2.1 3.1 6.2 11.0 56.2% 58.9%

1.1.2.3 Social Insurance and Social Security Transfers

45.3 35.8 4.4 149.5 6.6 6.9 10.1 23.6 37.4 63.2% 534.9%

1.1.2.4 Subsidies to enterprises 12.2 18.2 3.5 16.8 0.7 1.0 1.3 3.0 4.2 71.2% 85.4% 1.1.2.5 Reserve 6.5 14.8 2.1 9.5 0.8 0.8 1.5 3.2 2.4 133.6% 153.8%

1.1.2.6 Other non - interest expenditure

4.8 3.0 0.6 3.8 0.2 0.2 0.3 0.6 1.0 65.2% 100.7%

1.2 Capital expenditure 19.3 10.8 2.6 22.0 0.2 0.4 0.6 1.2 5.5 21.2% 45.2% 2 Net lending 6.7 7.5 3.0 8.4 0.4 0.3 0.8 1.5 2.1 73.1% 50.6% Lending 14.0 7.7 3.0 8.4 0.4 0.3 0.8 1.5 2.1 73.1% 50.6% Repayment 7.3 0.2 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Overall budget balance excluding grants (cash) (A-B-2)

-38.1 -25.2 -3.6 -70.2 3.2 -1.9 -5.0 -3.6

Overall budget balance (cash) (A-B)

-26.2 1.8 8.4 -47.0 3.2 -1.9 -5.0 -3.6

C Financing ( 1+2) 26.1 26.5 -6.9 47.0 -0.7 -0.5 5.9 4.7 -67.6%

1 Domestic and foreigh financing (net)

17.0 -11.2 -6.9 23.7 -0.7 -0.5 5.9 4.7 -67.6%

Borrowing 76.4 40.4 1.6 24.0 0.9 2.6 13.6 17.1 1042.6% Repayment 59.4 51.6 8.6 0.3 1.7 3.1 7.7 12.5 145.7% 2 Privatization receipts 9.1 37.7 0.0 23.3 0.0 0.0 0.0

A Total revenue and grants (1+2) as % of GDP

0.2 0.2 0.3

B Total expenditure and net lending (1+2) as % of GDP

0.2 0.2 0.3

Overall budget balance (cash) (A-B-C) as % of GDP

0.0 0.0 0.0

Memorandum items: Nominal GDP 1049.0 1327.6

* - Plan for Jan-May 2003 was obtained from the Budget Law for 2003 as the sum of the plan for the first quarter and 2/3 of the plan for the second quarter Source: The Ministry of Finance

Montenegro Economic Trends September 2003

ISSP - CEPS

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5.2.1 Budget revenues and grants

Graph 5.1 Monthly budgetary revenues

5

10

15

20

25

30

35

Jan

Feb

Mar

Apr

May Jun

Jul

Aug Sep

Oct

Nov

Dec

mn

euro

2002 2003

Source: Ministry of Finance Due to low economic activity, lower budget revenues characterize the first part of the year, particularly the first quarter. Budget revenues have a clear seasonal pattern that has been evidenced in 2000, 2001, and 2002. Likewise, relatively low revenues mark the first quarter of 2003. Budget revenues in 2003 exhibited a growing trend (see Graph 5.1), and higher revenues characterized each subsequent month. Revenues in January, February, March, April, and May 2003 amounted to €13.3million, €17.2mn, €22.7mn, €29.9mn, and €31.7mn, respectively. Cumulatively, budget revenues (excluding grants), at the end of May 2003 amounted to €114 million, which represented 92% of the plan1. Average monthly revenues, in the first five months, were €23.6 million, while according to the plan, they should have been €1 million higher. Although below the plan, budget revenues cumulated until the end of May 2003 represented 134% of last year’s revenues in the analogous period. This comparison has to be taken with caution because of structural changes in budget revenues in 2003. Namely, the new tax laws changed the system of tax collection. For the first time, revenues from the turnover tax, excises, and custom tariffs are centralized in the budget. Additionally, with the introduction of VAT, the system of collection of these revenues was changed, which is visible in revenues for April and May. Executions of revenues category At the end of May, revenues from custom transit fees and excises were significantly below the planned level while revenues from custom tariffs were significantly above the planned level and turnover tax/VAT revenues were approximately at the planned level.

1 The planned value for revenues for the period Jan-May 2003 was obtained from the Budget Law for 2003 as the sum of the plan for the first quarter and 2/3 of the plan for the second quarter

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Graph 5.2. Monthly personal income tax revenues

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

Jan

Feb

Mar

Apr

May Jun

Jul

Aug Sep

Oct

Nov

Dec

mn

euro

2002 2003 2001

Source: Ministry of Finance

• As is evidenced in Graph 5.2, revenues from personal income tax follow a seasonal pattern. In the first 4 months of the year they exhibit an increasing trend. In 2003 they increased from €3.2mn in January up to €6.8mn in April. May saw a decline in PIT revenues, falling to €5mn. In 2003, higher PIT revenues in March and April were related to the deadline for submitting tax forms (and paying due tax) on April 30th2. Total revenues from PIT for the first five months of 2003 amounted to close to €24.8 million, which represented 91% of the planned level. Compared to the same period last year, revenues from personal income tax increased by more than 18%. This increase happened in spite of the fact that the average number of employees in the first 4 months of 2003 was 1% lower than in the corresponding period of 2002 (for details see Chapter 2: Employment). This might point to an increase in average wages, for which no official data has been made available since June 2002. However, the increase in minimum wage that took effect in July 2002 must have influenced the average wage as well3. Consequently, we see evidence of this in the increase of revenues from personal income tax.

Box 5.1 The Decree on Tax Relief for New Employees The new Decree on Tax Relief for New Employees came to force on April 14 (Official Gazette No 25). Tax relief means that until May 1, 2004, employers do not have to pay a personal income tax on wages and one part of contributions when they employ new workers. According to the Government, this should lead to legalizing unregistered workers and increasing the official employment. This Decree should boost contributions to the social fund as a consequence of the increased number of registered workers. Central budget and budgets of municipalities will lose revenues from personal income tax on new workers registered until May 2004. However, the projected increase in this revenue according to the Budget Plan for 2003 was mainly triggered by the rise of the average wage.

2 According to statement by officials of DPR, until April 30, 2,285 income statements were submitted compared to 25,000 expected. DPR has announced checks, controls, and measures against those who did not file their income tax forms. 3 For more details on the links between the minimum and the average wage see the article “ Minimum wage in Montenegro – a dangerous concept” in MONET 13

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• In comparison with previous years, the categories of turnover tax and excises underwent large structural changes. Namely, until the end of 2002 all revenues from turnover tax and excises were not centralized in the budget. Some part of these revenues was directly transferred to the Pension Fund and other institutions. From 2003 on, all these revenues are supposed to come to one central budget account. Additionally, on April 1st, the Value Added Tax (VAT) replaced the turnover tax. These changes had a positive effect on revenues resulting in total cumulated revenues from the turnover/VAT tax until May 2003 being 4% above the plan. On the other hand, revenues from excises were significantly below the plan. This category was executed at the level of €22 million, which represented only 58% of the plan. This was primarily a result of the lower execution of the category “excises on imported goods”, which reached only about €20 million compared with the planned level of about €29 million. Most likely, this difference follows from the failure to channel parts of illegal imports into the legal economy resulting in foregone excise on imported excises goods (see also Box 8.1 in the chapter on external sector).

• One revenue category, which was executed above the planned level, is custom tariffs. Cumulated until the end of May, revenues from custom tariffs reached €16.4 million, which represented about 280% of the plan (55% of the annual plan)4. In view of much higher expected revenues due to the centralization of custom tariffs, it is surprising that the Government projections for this category were at a static level to the last year for the first 6 months (see table 5.2). Additionally, increased tariff revenues in 2003 were due to the fact that many taxpayers wanted to make their transactions before April (when new laws, such as the Customs Law and the VAT were introduced) in order to avoid paying new (sometimes higher) taxes and conform to new procedures. As a result, revenues from custom tariffs in February, and especially in March, reached a higher level. April and May were marked by the decline in revenues from custom tariffs. On the other hand, revenues from custom transit fees in 2003 decreased on a monthly basis, and cumulated through the end of May they only amounted to about €1.5 million, which represented a mere 14% of the planned level (See graph 5.3). One of the major reasons for this decline is the lower transit of oil to Kosovo in the first months of 20035.

Graph 5.3. Monthly revenues from custom tariffs and custom transit fees

0.000

1.000

2.000

3.000

4.000

5.000

6.000

Jan-03 Feb-03 Mar-03 Apr-03 May-03

in m

n eu

ro

Custom tariffs Custom transit fees

Source: Ministry of Finance 4 In the previous year, almost half of the revenue from custom tariffs was transferred directly to the Pension Fund, so comparisons of this category in the central budget between years are misleading. 5 This is also seen in the lower exports of oil products in 2003Q1 as evidenced in table 8.1 in Chapter 8.

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• Other taxes (e.g. corporate income tax and real estate tax), cumulated until the end of

May were at a level of €7.8 million. Revenues from the corporate income tax reached €6 million, or 27% above the planned level. The highest amount was collected in April (€2.6 million), which was the last month for submitting the final CIT statement. Another part of this category, real estate tax, was executed 200% above the plan. Again, VAT seems to be the reason. People used the chance to register or re-register their property before the introduction of VAT, which led to significant revenue increase in March.

• Non-tax revenues (fees, fines, and other revenue), at the end of May, reached €7.4

million, which represented 176% of the planned level. Grants At the end of May, total foreign aid (grants) was €5.5 million (all of which was received in April and May). Total foreign aid for the entire year is planned at €23.2 million. 5.2.2 Budget expenditures and net lending

Graph 5.4 Monthly budgetary expenditures.

5

10

15

20

25

30

35

Jan

Feb

Mar

Apr

May Jun

Jul

Aug Sep

Oct

Nov

Dec

mn

euro

2002 2003

Source: Ministry of Finance At the time of this writing, analysis data on budget expenditures were only available for January, February, and March 2003. According to the plan, average monthly expenditures and net lending in 2003 should be at a level of roughly €36 million. This is calculated assuming linear projection, i.e. assuming that the expenditures in each month are 1/12 of the total planned expenditure for the entire year. Likewise, expenditures planned in 2003 Q1 represent one-quarter of total expenditures for the 2003 year. However, as Graph 5.4 suggests, this might not be the case. The stylized fact is that expenditures in Montenegro are very much dependent on current revenues and that availability of cash in the budget shapes the expenditure possibilities (compare Graph 5.1 and Graph 5.4). Therefore, using planned amounts based on linear

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projection might not be a very precise way of analyzing budgetary expenditures, however, it is the only acceptable approximation of the plan. Much in line with the above, the expenditures in January 2003 amounted to €10 million, much below the planned level, mainly because expenditures for the largest category, i.e. wages and salaries were negligible. In February, expenditures reached close to €19.1 million, and in March they reached €27.7 million. Thus, total expenditures in 2003Q1 amounted to €56.8 million, which represented roughly one-half (53%) of the planned level. Quite likely, this was the consequence of lower revenues, which amounted to €54 million (instead of €79 million planned) during 2003 Q1.

Executions of expenditures category Cumulated until the end of March all expenditures category except for ‘reserves’ were executed far below the planned level.

• As mentioned before, the largest expenditures category - wages and salaries was at a negligible level in January. Common practice in Montenegro is to pay December salaries at the end of December (instead of at the beginning of January), thus no salary expenditures are recorded in January. In February and March wages and salaries were paid as usual and thus related expenditures amounted to €7 million. Cumulated over the first quarter, expenditures for wages and salaries at the end of March reached €14.2 million. Even with the increase of the minimum wage in July 2002, expenditures for wages and salary in 2003 Q1 were about 40% less than in the corresponding period of 2002. The greatest portion of these expenditures (€11.7 million) was related to payment of net salaries which points to the fact that the Government paid only partially the amount due for taxes, contributions, and other liabilities on salaries paid to their employees. Failure to pay these taxes and contributions has been a problem throughout 2002 and it seems that the situation has not improved in 2003. Moreover, wages and salaries in 2003 Q1 were not paid timely (usually with a several-day lag), which once again reinforces our notion about the liquidity problem of the central budget that puts a constraint on expenditures.

• Cumulated expenditures for goods and services at the end of March amounted to €6.2

million, which represented about 56% of the plan. Expenditures in this category in 2003 Q1 were 40% below those in 2002 Q1.

• Expenditures for social insurance and social security transfer at the end of March

represented 63% of the plan and amounted to €23.6 million. This figure should not be compared with the respective figure for 2002 because of the new way of transferring budgetary money to the Pension Fund (these transfers are part of this category).6

• Subsidies to enterprises in 2003 Q1 amounted to €3 million, which represented 71%

of the planned level. In comparison to the same period last year, subsidies were lower by 15%.

6 Beginning with 2003, transfers to the Federal budget are also part of this category. However, until April no such transfers have been made.

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• Capital expenditure cumulated until the end of March reached €1.2 million or 71% of the plan. This represented 45% of capital expenditure in the same period last year.

• Other non–interest expenditure cumulated for the period January-March reached €0.6

million (65% of the planned level). This category includes rents of government buildings and other related expenditures.

• During the first three months of 2003, the Ministry of Finance paid €1.1 million

interest on the old foreign debt (debt accrued before 1990). Additionally the Ministry paid €1.7 million to cover interest for domestic debt. In total, the interest expenditures in 2003 Q1 reached a level of €3.4 million (twice the planned level and much more than in the corresponding period of 2002).

• The Reserve was the only expenditure category that was executed above the planned

level. In the first quarter of 2003, total expenditure in this category reached €3.2 million (33% above the planned level and 54% above last year’s level). One part of this amount was connected with financing elections.

Net lending In 2003 the Government does not expect any repayments of credits, which makes them closer to subsidies. New credits are planned at the level of €8.4 million for the entire year, of which €1.5 million (or 18%) were given during the first quarter of 2003. 5.2.3. Budget balance and financing Overall budget balance While revenues in January were low, expenditures were even lower which resulted in a positive cash budget balance in the amount of €3.2 million. In February and March, the overall cash budget balance was negative and amounted to €-1.9 million and €-5 million respectively. Cumulated over the first quarter of 2003, the overall budget balance on a cash basis was negative and amounted to €-3.6 million. Financing The negative cash budget balance (budget deficit) in the first three months of 2003 was financed through borrowing. Namely, the Government took new credits in the amount of about €16.3 million (exceeding the level of credits in 2002 Q1 by more than 10 times) and repaid €12.5 million, increasing its net liabilities by €3.8 million. 5.4 TREASURY BILLS MARKET IN 20037 In 2003 the Government continued to issue 28-day and 56-day T-bills. Moreover, it continued to gradually increase the offered value of issues, which boosted the interest rate.

7 Issuing and repayment of T-bills are the so-called “flying positions” which means that they are collected and repaid during the same fiscal year. Including these positions would increase both the budget revenues and expenditures side. That is why the Ministry of Finance does not include these positions in the budget.

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In the period January-May 2003, the Central Bank, on behalf of the Ministry of Finance, held 5 auctions of 28-day T-bills and 5 auctions of 56-day T-bills. The value of emissions of 28-day T-bills increased from €7 million at the first auction in 2003 (held on January 22), up to €8 million at the auction held on May 14. Similarly, the value of emissions of 56-day T-bills increased from €3 million on January 8 up to €4 million on April 4, while during the last auction €3 million was offered. The increased supply of T-bills and the difficult situation with the budget liquidity led to the increase of the interest rate. While the weighted average of the interest rate in January was about 8%, in April and May it went up to 10%. Furthermore, the maximum interest rate accepted during the auctions in April and May was 12.5%. However, even with this interest rate not all issued T-bills were sold. Thus, because the supply of T-bills exceeded the demand, commercial banks were allowed to invest their money in T-bills, which represent the most secure investment, with the interest rate exceeding 12%. This is an extremely high interest rate for Government T-bills issued in a secure currency such as the Euro. It is undoubtedly the result of the mixture of a high-risk premium, shallowness of the Montenegrin money market, and increased demand for credit on the part of the Government. This competition in the market for money brings about a classical ‘crowding out’ effect which produces high interest rates on commercial credits, which are a much less secure way of allocating funds from the perspective of the banks8.

Table 5.3 Overview of 28-day T-bill auctions

Interest rate % No. Date of auction

Date of maturity

Amount of issue in mil €

Total offered amount in mil €

Amount of sold T-bills

in mil € Lowest Highest Weighted average

1. 09/04/2001 10/03/2001 2.556 3.364 2.556 4.2 8 6.5

2. 10/02/2001 10/31/2001 3.579 2.669 2.669 6 8.95 6.89

3. 10/30/2001 11/28/2001 3.579 3.093 3.093 6 8.5 6.83

4. 11/27/2001 11/26/2001 3.579 4.714 3.579 6 8.95 7.31

5. 12/26/2001 01/24/2002 3.579 4.049 3.579 6 8.95 7.14

6. 01/23/2002 02/21/2002 2.5 2.794 2.5 6 8.95 7.05

7. 02/20/2002 03/21/2002 2.5 4.260 2.5 6 8.95 7.05

8. 03/20/2002 04/18/2002 2.5 3.070 2.5 6 8.5 7.02

9. 04/17/2002 05/16/2002 2.5 3.5 2.5 6 8 7.02

10. 05/15/2002 06/13/2002 2.5 2.864 2.5 6 8 6.99

11. 06/12/2002 07/11/2002 2.5 2.770 2.5 6 8 6.92

12. 07/10/2002 08/08/2002 3 2.870 2.870 6 8.5 7.13

13. 08/07/2002 09/05/2002 3.5 2.905 2.905 6 7.5 7.37

14. 09/04/2002 10/03/2002 3.5 3.492 3.492 6 8 7.53

15. 10/03/2002 10/31/2002 4 2.792 2.792 6 7.5 7.36

16. 10/30/2002 11/28/2002 6 4.467 4.467 6 8.25 7.41

17. 11/27/2002 12/26/2002 6 5.077 5.077 7.5 8.25 7.79

18. 12/25/2002 01/23/2003 6.6 5.774 5.774 7.5 9 8.14

19. 01/22/2003 02/20/2003 7 5.912 5.912 7.5 9 7.99

20. 02/19/2003 03/20/2003 6.5 5.762 5.762 7.5 9 8.49

21. 03/19/2003 04/17/2003 7 6.065 6.065 7.5 12 8.94

22. 04/16/2003 05/15/2003 7.5 7.028 7.028 8 12.5 10.17

23. 05/14/2003. 06/12/2003 8 6.949,5 6.949,5 7.5 12.5 10.45

Source: Central Bank of Montenegro. Note: Interest rates are expressed in annual terms. 8 And additionally cannot compete with T-bills whose possession is one of the ways of allocating mandatory reserves by the banks.

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Table 5.4 Overview of 56-day T-bill auctions

Interest rate % No. Date of auction

Date of maturity

Amount of issue in mil €

Total offered amount in mil €

Amount of sold T-bills

in mil € Lowest Highest Weighted average

1. 02/06/2002 04/04/2002 2 0 0 - - -

2. 03/06/2002 05/02/2002 3 1.085 1.085 6.5 8.5 7.5

3. 04/30/2002 06/27/2002 2 0.8 0.8 6.5 7.5 6.88

4. 05/29/2002 07/25/2002 2 1.5 1.5 6.5 8 7

5. 06/26/2002 08/22/2002 1 0.560 0.560 6.5 7.5 6.61

6. 07/24/2002 09/19/2002 2 3.120 2 7.5 8 7.72

7. 08/21/2002 10/17/2002 2.5 1.560 1.560 7.5 8 7.8

8. 09/18/2002 11/14/2002 3 1.387 1.387 7.5 8 7.82

9. 10/16/2002 12/12/2002 3 1.750 1.750 7.5 9.5 7.96

10. 11/13/2002 01/09/2003 3 1.670 1.670 7.5 9.0 8.04

11. 12/11/2002 02/06/2003 3.5 2.350 2.350 6 9.5 8.13

12. 01/08/2003 03/06/2003 3 1.670 1.670 7.5 9 8.13

13. 02/05/2003 04/02/2003 3 2.250 2.250 8 9.5 8.38

14. 03/05/2003 04/30/2003 4.5 1.320 1.320 7.5 9.5 9.13

15. 04/02/2003 05/29/2003 4 2.866 2.866 8 12.5 10.05

16. 04/29/2003 06/26/2003 3 2.100 2.100 8.5 12 10.06

Source: Central Bank of Montenegro Note: Interest rates are expressed in annual terms. 5.5. SOCIAL FUNDS Table 5.5: Social funds revenues and expenditures, 2002(in mil €)

Social funds Revenues Expenditures

Pension Fund 153.36 154.272

Health Fund 82.114 94.076

Employment Fund 15.624 11.77

Source: Ministry of Finance In the remainder of the chapter we will a present short analyses of data of social funds (Pension, Health, and Employment) for the first four months of 2003. 5.5.1. Pension Fund At the end of April, total revenues of the Pension Fund reached €49.4 million, while expenditures where €51.4 million. In the structure of revenues, the largest portion was related to contributions. It represented 53.4% of total revenues. Transfers from the budget represented 35.8% of total revenues, while revenues from special taxes9 and revenues from fees charged by the House for Settlements and Payments represented 3.4% and 2.4% respectively. 9 This is very surprising in view of the fact that from January 2003 all tax revenues are supposed to come to one budget account. Apparently some tax revenues are still going directly to the funds.

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Expenditures for pensions represented 77% of total expenditures. The second largest expenditure was related to contributions to the Health Fund for pensioners’ health insurance, it reached €7 million or 13.7% of total expenditures. 5.5.2. Health Fund At the end of April, total expenditures of the Health Fund were higher than revenues by about €2.5 million. Total expenditures reached €29 million while total revenues amounted to €26.6 million. Revenues from contributions of workers and employees10 represented 67% of total revenues. Revenues from the Pension Fund (as we see in expenditures for the Pension Fund) amounted to about €7 million, which represented 26.5% of total revenues. Revenues from the budget for unemployed persons represented 4.3%, while other revenues represented about 2.2% of total revenues. In the structure of expenditures, the highest share was had by expenditures for regular activity11, which represented 93.6%. Other expenditures were related to payments for social insurance during sick leave (1.7% of total expenditures), other costs during patients’ sickness (2.5% of total expenditures), and material expenditures (2.2% of total expenditures). 5.5.3. Employment Fund Total revenues of the Employment Fund at the end of April reached €2.5 million, while expenditures amounted to €3.4 million. The deficit, of about €0.9 million, was covered with funds transferred from the previous year. In the structure of revenues, contributions for workers and employees (paid by employers as part of the tax on wages) represented 44%, while the subsidy from the budget (for material support for unemployed and beginners) amounted to €0.7 million or about 30% of total revenues. Repayment of loans given for self-employment represented 21% of total revenues. On the expenditure side, the Fund spent almost 30% on support for the unemployed and the employed, 26% for preferential credits for self-employment, and the rest on administrative and material costs.

10 Contributions from economic activity, non-economic activity, self employed workers, and agricultural workers. 11 Ambulance and dispensary services, medicines, treatments in stationary health care facilities, dentists’ services and other forms of health care.

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6: MONEY 6.1. MONETARY TRENDS Table 6.1. Monetary aggregates

2002 2003

M

ar-0

2

Apr

-02

May

-02

Jun-

02

Jul-

02

Aug

-02

Sep-

02

Oct

-02

Nov

-02

Dec

-02

Jan-

03

Feb

-03

Mar

-03

Mar

-02

1 in mn euro

310 310 310 310 310 310 310 310 310 310 250 250 250 250

Cash -estimation in % of

GDP* 25.4 25.4 25.4 25.4 25.4 25.4 25.4 25.4 25.4 25.4 18.8 18.8 18.8 18.8

2 in mn euro

222 194 185 178 203 222 203 241 235 223 222 207 199 162

Demand deposits in Euros (3+4) in % of

GDP* 18.2 15.9 15.1 14.6 16.6 18.2 16.6 19.7 19.2 18.3 16.7 15.6 15.0 12.2

3 in mn euro

144 133 129 124 129 149 144 156 143 128 117.7 110.4 110 97

Demand deposits included in M1

in % of GDP*

11.8 10.9 10.6 10.2 10.6 12.2 11.8 12.8 11.7 10.5 8.9 8.3 8.3 7.3

3.1 Deposits at the banks

in mn euro

93 79 79 73 87 100 94 114 111 86 82 79 76 67

3.2 Deposits at ZOP

in mn euro

51 54 50 51 42 49 50 42 32 42 36 31 34 30

4 in mn euro

78 61 56 54 74 73 59 85 92 95 104.3 96.6 89 65

Demand deposits excluded from M1

in % of GDP*

6.4 5.0 4.6 4.4 6.1 6.0 4.8 7.0 7.5 7.8 7.9 7.3 6.7 4.9

4.1 Banks in mn euro

42 29 25 24 35 38 27 46 45 31 21.3 22.6 28 23

4.2

Government and government institutions

in mn euro

36 32 31 30 39 35 32 39 47 64 83 74 61 42

5 in mn euro

454 443 439 434 439 459 454 466 453 438 367.7 360.4 360 347

M1 (1+3)

in % of GDP*

37.2 36.3 35.9 35.5 35.9 37.6 37.2 38.2 37.1 35.9 27.7 27.1 27.1 26.1

6 in mn euro

40 51 51 49 54 59 58 58 61 54 52 54 64 64

Term deposits in Euros in % of

GDP* 3.3 4.2 4.2 4.0 4.4 4.8 4.7 4.7 5.0 4.4 3.9 4.1 4.8 4.8

6.1 Demand savings in Euros

in mn euro

3 4 4 4 5 4 3 5 4 5 4 5 4 5

6.2 Term savings in Euros

in mn euro

3 3 3 4 4 6 6 7 8 8 9 9 12 12

6.3 Other term deposits in Euros

in mn euro

34 44 44 41 45 49 49 46 49 41 39 40 48 47

7 in mn euro

44 32 30 36 33 34 34 42 38 37 32 28 31 31

Demand deposits in other currencies

in % of GDP*

3.6 2.6 2.5 2.9 2.7 2.8 2.8 3.4 3.1 3.0 2.4 2.1 2.3 2.3

8 in mn euro

3 4 5 5 5 4 6 3 4 3 3 3 4 3

Term deposits in other currencies

in % of GDP*

0.2 0.3 0.4 0.4 0.4 0.3 0.5 0.2 0.3 0.2 0.2 0.2 0.3 0.2

9 in mn euro

494 494 490 483 493 518 512 524 514 492 419.7 414.4 424 411

M2 narrow (5+6) in % of

GDP* 40.4 40.4 40.1 39.5 40.4 42.4 41.9 42.9 42.1 40.3 31.6 31.2 31.9 31.0

10 in mn euro

541 530 525 524 531 556 552 569 556 532 454.7 445.4 459 445

M2 broad (7+8+9) in % of

GDP* 44.3 43.4 43.0 42.9 43.5 45.5 45.2 46.6 45.5 43.6 34.2 33.5 34.6 33.5

Source: Central Bank of Montenegro Note: Deposits at banks does not include deposits of the government and government organizations and deposits of other banks Demand deposits excluded from M1 includes demand deposits of banks and government at banks and at ZOP

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The Central Bank of Montenegro (BCM) lowered its cash estimation in January 2003. Instead of €310mn, which was the official figure throughout 2002 (based on cash issued during the conversion from DM into €), in 2003 the official cash estimation is €250mn, or 19.35% lower than in 2002. The basis for this change was the deficit in the balance of payment in Montenegro in 2002 that roughly amounted to €60mn. The Central Bank assumed that the deficit was financed by cash (flowing out of the country) and hence lowered its estimation of the cash supply by this amount exactly. In Monet 13, in the chapter on the External sector, we looked in more detail at the related problems with the Balance of Payments statistics. We argued that even though cash outflow is the most natural consequence of a balance of payments deficit in a country that does not issue its own currency, this is highly unlikely in Montenegro where prices were growing at a very high pace throughout 2002. Persistently high inflation, which we have observed in Montenegro for a couple of years now, is very hard to reconcile with cash flowing out of the country. Therefore, we consider the CBM interpretation of the money supply developments highly doubtful and rather unlikely to have taken place.1 Nevertheless, since the new, lower quantity of cash is the only valid official figure, we accept it and will use it throughout this chapter.

6.1. Monetary agregates

0

100

200

300

400

500

600

Mar-02 Apr-02 May-02 Jun-02 Jul-02 Aug-02 Sep-02 Oct-02 Nov-02 Dec-02 Jan-03 Feb-03 Mar-03

in m

ilion

E

M1 narrow M2 broad M2

Source: Central Bank of Montenegro The CBM also introduced a broadened measure of M2 monetary aggregate. Broad M2 includes demand and term deposits not only in €, but also in other currencies, while narrow M2 includes only € deposits. However, cash still constitutes the major component of monetary aggregates, making up 72% of M1, 60.38% and 56.18% of narrow and broad M2 in April 2003. The annual growth rate of all monetary aggregates was negative in both March and April 20032. For M1 it was –20.70% and – 21.67%, for narrow M2 it was –14.17% and -16.8%, while for broad M2 it was -15.16% and -16.04% (in March and April, respectively).

1 The possible source of this inconsistency is unreliability of the BoP data. 2 Annual growth rate (or dynamics) in March 2003 is the percentage change between March 2003 and March 2002. Analogously the annual growth rate in April 2003 is the percentage change between April 2003 and April 2002

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The source of this decline lies mostly in the 19% fall of cash; however, non-cash components of money aggregates also fell on an annual basis. The annual growth rate of total demand deposits in Euros was negative in March and April amounting to -10.36% and –16.49% respectively. However, two components of total demand deposits in Euros exhibited different trends: while demand deposits that are included in M1 decreased by 27% in April on an annual basis (24% in March), those excluded from M1 registered a 7% increase on an annual basis in April (14% in March) as a result of the high growth of demand deposits of the Government and government institutions in banks and ZOP. On the other hand, demand deposits in other currencies that are part of the broad M2, continue to decline -- their annual dynamics amounted to -30% in March 2003 and - 3.13% in April 2003. Term deposits in Euros that are part of narrow M2 registered a positive annual growth rate (60% in March ‘03 and 25% in April ‘03). This increase was driven by the increase of the term savings in € by 380% (March ‘03, year-on-year) and 270% (April ‘03, year-on-year). One general message that emerges from table 6.1 is that of switching from demand to term deposits. This trend is a positive sign and represents the growing confidence of households and enterprises3 in the Montenegrin banking sector. Table 6.1 also presents monetization figures calculated as ratios of major monetary components and GDP in 2002 and 20034. Monetization figures are used as one measure of financial market development. Specifically, the difference between M1 and M2 monetization can be helpful in assessing the degree of financial market intermediation and trust in the financial system. At the end of April 2003, the share of cash in GDP was 18.8%, while M1, narrow M2 and broad M2 monetization was 26.1%, 31.0% and 33.5% respectively. The overall impression is that these figures are fairly low compared to other transition countries5. However, at the same time, the small difference between M1 and M2 monetization points to the fact that the Montenegrin financial market is rather underdeveloped and deposits still account for a very small share of GDP.

3 The broad Government increased its demand deposits significantly, most probably due to increased cash holdings related to Jugopetrol privatization. However, this should not be regarded as evidence against the notion of growing confidence of the public in the banking sector (as proven by switching from demand to term deposits). 4 GDP in 2003 is a forecast prepared by USAID/Barents and officially accepted by CBM. 5 For example in 2001, M2/GDP ratio in Czech Republic was 74.4, Hungary 46.8, Poland 46.3, Slovak Republic 70.5 and Slovenia 42.8.

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6.2. SAVINGS OF HOUSEHOLDS Table 6.2: Saving of households (in 000 Euros)

1. Demand savings 2. Term savings up to 1 year 3. Term savings over 1 year

total In euros other

currencies total In euros

other currencies

total In euros other

currencies

Total (1+2+3)

Dec-00 2035 932 1103 428 63 366 2 0 2 2465 Oct-01 1751 894 857 655 554 102 57 55 2 2463 Nov-01 2092 1179 913 809 668 141 466 465 1 3368 Dec-01 3517 2379 1138 1557 1332 225 550 549 1 5624 Jan-02 2844 1985 859 2090 1755 335 617 594 23 5551 Feb-02 2791 1714 1077 2336 1909 427 702 679 23 5829 Mar-02 4139 3358 781 3418 1853 1565 741 680 61 8298 Apr-02 4874 4135 739 4443 2525 1918 773 711 62 10090 May-02 4329 3813 516 4732 2815 1917 525 463 62 9586 Jun-02 4629 4212 417 5609 3013 2596 615 553 62 10853 Jul-02 5036 4579 457 6089 3394 2695 702 640 62 11827 Aug-02 4269 3802 467 7217 5184 2033 928 906 22 12414 Sep-02 3984 3183 801 7669 4798 2871 1663 1497 166 13316 Oct-02 5686 4730 956 8012 6140 1872 1038 1012 26 14736 Nov-02 5205 4310 895 9515 6772 2743 1099 1065 34 15819 Dec-02 6023 5154 869 9650 6823 2827 1127 1090 37 16800 Jan-03 5721 4426 1295 10326 7562 2764 1188 1170 18 17235 Feb-03 6301 4912 1389 10926 8138 2788 1194 1179 15 18421 Mar-03 6014 4303 1711 14446 10744 3702 1166 1142 24 21626 Apr-03 7605 5352 2253 13466 10421 3045 1179 1153 26 22250

Source: Central Bank of Montengro, reports of various banks

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Graph 6.2. Savings of households

0

2000

4000

6000

8000

10000

12000

14000

16000

Oct

-01

Nov

-01

Dec

-01

Jan-

02

Feb

-02

Mar

-02

Apr

-02

May

-02

Jun-

02

Jul-

02

Aug

-02

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02

Oct

-02

Nov

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-02

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03

Feb

-03

Mar

-03

Apr

-03

in 0

00 E

uro

Demand savings Term savings up to 1 year Term savings over 1 year

Source: Central Bank of Montenegro, reports of various banks The savings of households continued to grow at a fast pace. The annual dynamics of 3 major components of household savings for the period October 2002 – April 2003 are presented in Graph 6.3. The dynamics of all types of non-demand deposits reached extraordinarily high levels in the 4Q 2002 to fall below 400% in 2003. While we still witness growth rates above 50%, it will be interesting to observe the developments during the remainder of the year. The current high growth rates are, to a great extent, a consequence of a low base – i.e. the low level of savings in 2001 and 2002.

Graph 6.3. Annual growth of savings

0%

200%

400%

600%

800%

1000%

1200%

1400%

1600%

1800%

2000%

Oct-02 Nov-02 Dec-02 Jan-03 Feb-03 Mar-03 Apr-03

Demand savings Term savings up to 1 year Term savings over 1 year Total savings

Source: Central Bank of Montenegro, reports of various banks

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Total savings and all its components recorded higher growth rates in 2002 as compared to 2003. The annual growth rate of total savings in October 2002 was 498.32%, in November 369.70% and in December it was 198.74%. Term savings, especially those up to 1 year, recorded the most significant growth in 2002. Term savings up to 1-year recorded an annual growth of 1122.32% in October, 1075.60% in November and 519.62% in December 2002. Term savings over 1 year had the most significant growth rate in October (1728.97%), after which it increased at a lower rate recording an annual growth rate of 135.69% in November and 105.04% in December 2002. Demand savings had much more stabile growth, recording 224.79% on the annual level in October, 148.78% in November, and 71.27% in December 2002. Annual growth rate of savings in 2003 slowed down in comparison to 2002. During the first 4 months of 2003, growth rates of different components of household savings have continued to decline. The annual dynamics of total savings fell from 216% in January and 210% in February down to 161% in March and 121% in April. This decline is mostly due to the decline in annual dynamics of demand deposits (particularly those in €). Term savings up to 1 year also registered a declining annual dynamics (it fell from almost 400% in January down to 200% in April) mostly due to sharp declines in annual dynamics of non-euro savings. Annual growth of savings over 1 year registered a moderate decline while the non-euro component of these savings actually fell on an annual basis.

Graph 6.4. Structure of housholds savings

0%

20%

40%

60%

80%

100%

Oct-01 Dec-01 Feb-02 Apr-02 Jun-02 Aug-02 Oct-02 Dec-02 Feb-03 Apr-03

Demand savings Term savings up to 1 year Term savings over 1 year

Source: Central Bank of Montenegro, reports of various banks The structure of household savings has been fairly stable during the first few months of 2003. The majority of savings are term savings up to 1 year and they account for 60-70% of total deposits. Roughly one-quarter to one-third of total savings are demand savings, while longer-term savings (above 1 year) make up 5 to 7%.

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Minor fluctuations notwithstanding, a long-term view shows a consistent decline in demand savings while term savings increase, as shown in graph 6.5. However the dominant component of total household savings continues to be savings of up to one year. These developments reinforce our previous notions about the increasing confidence that citizens have in the banking sector.

Graph 6.5 Currency structure of savings

Demand savings

0%

20%

40%

60%

80%

100%

Dec

-00

Oct

-01

Nov

-01

Dec

-01

Jan-

02

Feb

-02

Mar

-02

Apr

-02

May

-02

Jun-

02

Jul-

02

Aug

-02

Sep-

02

Oct

-02

Nov

-02

Dec

-02

Jan-

03

Feb

-03

Mar

-03

Apr

-03

other currencies

euro

Savings up to 1 year

0%

20%

40%

60%

80%

100%

Dec

-00

Oct

-01

Nov

-01

Dec

-01

Jan-

02

Feb

-02

Mar

-02

Apr

-02

May

-02

Jun-

02

Jul-

02

Aug

-02

Sep-

02

Oct

-02

Nov

-02

Dec

-02

Jan-

03

Feb

-03

Mar

-03

Apr

-03

other currencies

euro

Savings over 1 year

0%

20%

40%

60%

80%

100%

Dec

-00

Oct

-01

Nov

-01

Dec

-01

Jan-

02

Feb

-02

Mar

-02

Apr

-02

May

-02

Jun-

02

Jul-

02

Aug

-02

Sep-

02

Oct

-02

Nov

-02

Dec

-02

Jan-

03

Feb

-03

Mar

-03

Apr

-03

other currencies

euro

Source: Central Bank of Montenegro, reports of various banks

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The currency structure of household savings shows that the majority of savings is denominated in euros. The share of up-to-1-year savings in foreign currencies is decreasing while demand savings in foreign currencies is increasing. In April 2003, approximately 70% of demand savings was denominated in euro, while this figure for term savings up to and over 1 year was 77% and 98% respectively. These shares have been fluctuating fairly significantly since October 2001, i.e. since the data has become available on a continuous basis. The ratio of demand deposits in other currencies within total demand deposits has been decreasing since November 2001 until mid-2002 when the trend reversed and the share began to rise -- it was less than 10% in July 2002 and is approximately 30% now. The reverse can be observed for term deposits, with both up to 1 year and over 1 year savings in foreign currencies as a share of all deposits rising until mid-2002 and then entering a falling trend (See graph 6.5.). 6.3. LOANS Table 6.3. Loans in 2002 (in 000 Euros)

2002 2003

III IV V VI VII VIII IX X XI XII I II III IV

Loans 82990 88479 90774 94078 95584 95282 99162 111269 115329 125453 135083 147333 145712 155249

1.Banks and Financial institutions

1533 2493 392 314 92 36 128 130 210 1188 1498 1272 935 925

2. Non Financial Institutions and other clients

74860 77811 82693 86707 88572 89597 88757 100256 106735 104212 114198 125151 127239 136519

2.1 Privetly owned local companies

59855 62298 66034 71360 69501 68262 67498 70800 74731 72129 78372 82178 84349 91327

2.2.Publicly owned organizations

8607 7698 8487 6687 9243 8551 5639 10181 10425 7603 10027 15155 13683 14189

2.3. Individuals 3027 4295 4591 5098 6404 9657 11990 14714 17284 21962 23197 25461 26986 29014

2.4. Other 3371 3520 3581 3562 3424 3127 3630 4561 4295 2518 2602 2357 2221 1989

3. Government, Municipalities and Agencies

6597 8175 7689 7057 6920 5649 10277 10883 8384 20053 19387 20910 17538 17805

Source: Central Bank of Montenegro, balance sheets of the banks Note: Data present the stock of loans at the end of the month Total loans given by banks continued to increase during the first months of 2003. On an annual level, total loans grew 76% in March and 75% in April.

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Graph 6.6. Structure of loans by clients

0

20000

40000

60000

80000

100000

120000

140000

160000

Mar-02 Apr-02 May-02 Jun-02 Jul-02 Aug-02 Sep-02 Oct-02 Nov-02 Dec-02 Jan-03 Feb-03 Mar-03 Apr-03

in 0

00 E

uro

Banks and financial institutions Non financial and other clients Government, municipalities and agencies

Source: Central Bank of Montenegro, balance sheets of the banks The upward trend in bank lending to non-financial and other clients, which was present during the last year, continued in the first four months of 2003. In April 2003 alone, these loans grew at a rate of 7.3%, well above the average monthly change last year (3.8%), while the annual growth of this category in March was 70% and in April 75%. The fastest growing component of loans to non-financial clients was loans provided to physical entities, which increased by 792% in the period March ‘02-March ‘03 and 576% during the last twelve months (April 2002- April 2003). Estimating these developments in 2003 and taking into account the possibility that interest rates, that are now high, would decrease in the future as a result of increasing stability in the overall economy and rising competition in the banking sector, we can conclude that Montenegrin enterprises and households will have more opportunities for money borrowing and consequently the volume of loans will go up. The second category that recorded significant increase is loans to government and government agencies, which increased 166% in the period March ‘02-March ‘03 and 117% in the period April ‘02-April ‘03. However, loans to banks and other financial institutions have a decreasing trend since February 2003. The monthly change of this category was –15% in February, -26% in March, and –1% in April. The annual change of this category in March 2003 was –39.% and it has decreased by 62% in the last twelve months of the observed period.

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Graph 6.7.

Structure of loans in December 2002

0.95%

83.07%

15.98%

Baks and financial institutions

Non financial and other cliens

Goverement, municipalities and agencies

Structure of loans in April 2003

0.60%

87.94%

11.47%

Banks and financial institutions

Non financial and other clients

Government, municipalities and agencies

Source: Central Bank of Montenegro, balance sheets of the banks A comparison of the loan structure at the end of 2002 and in April 2003 (see Graph 6.7.) shows that the structure is slightly changing during the observed period. The share of loans provided to non-financial institutions and other clients has an increasing trend (it increased by 5% from December ‘02 until April ‘03). On the other side, the other categories, loans to the banks and financial institutions and loans to the government, municipalities and agencies is decreasing (by 0.4% and 4.9% respectively, in the period December ‘02- April ‘03). The structure of loans in April 2003 suggests that the majority of loans were provided to non-financial and other clients, 87.9%. Loans provided to the Government and government agencies represent 11.5% of total loans provided, while loans to banks and other financial institutions represent 0.6%. The structure of the most significant category of loans provided, loans to non-financial and other clients, shows that the majority of these loans (67%) were provided to local private companies.

Chapter 7. Capital Market

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7. CAPITAL MARKET In the first four months of 2003, total turnover and the number of transactions on both of Montenegro’s stock exchanges1 continued to rise. In this period, trade with investment units of PIFs2 expanded and trading of shares with the old foreign exchange savings bonds was initiated. Additionally, the first companies were listed on list A of both stock exchanges, and finally, on March 1st stock exchange indices were introduced on both stock exchanges in Montenegro. 7.1. INDICES Stock exchange indices constitute the most convenient and transparent means of monitoring developments on stock exchanges. They provide a concise and coherent indication of price movements for the companies listed on the exchanges. In essence, indices of a specific group of companies are averages of real-time prices of their shares weighted by the capitalization of each company. Indices most widely used around the world are focused on a specific section of the financial market; for example, such indices include the NYSE US 100 at the New York Stock Exchange covering 100 biggest American firms and the FTSE Techmark covering innovative technology companies listed on the London Stock Exchange. On March 1, 2003 indices were introduced by both stock exchanges in Montenegro. NEX Montenegro introduced two indices, NEX 20 and NEX PIF. NEX 20 represents 20 important enterprises that have the greatest market capitalization, realized turnover, and number of transactions3. NEX PIF includes investment units of all 6 privatization funds. Montenegroberza introduced the index MOSTE that includes the 35 most liquid companies (including investment units). On their day of introduction, each of the three indices had an initial value of 1000 points.

1 Two stock exchanges operate in Montenegro: Montenegroberza and NEX Montenegro. 2 PIF-Privatization Investment Fund 3 The largest weights in NEX 20 are those of Telecom (26.51%) and Jugopetrol (16.05%).

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Box 7.1. STOCK EXCHANGE INDICES IN MONTENEGRO NEXPIF is calculated by the NEX Montenegro Stock Exchange and covers price developments for all 6 PIF (Privatization Investment Funds) investment units. The index excludes dividends, and individual funds are weighted according to their capitalization, number of investment units, and number of transactions on the NEX Montenegro stock exchange. NEXPIF is calculated according to the following formula:

Tn

iRii

n

iRiti

Cqp

qpPIFNEX ∗∗=

∑

∑

=

= 1000

1,0,

1,,

where:

n = 6 (6 investment funds) t = day of trading R = the day of index revision CT = a correction factor for the continuation of the index (changes its value only in case of the change of composition of the index in period T) qi,R = the number of investment funds units at day of revision. pi,t = the price of the investment unit on day t Regular revisions will take place twice a year, on June 15th and December 15th, but revisions will also occur at other times should significant changes in capitalization occur. The index took a value of 1000 on March 1, 2003 and has been calculated on a daily basis since that time. Another index calculated at NEX Montenegro is the NEX20 index monitoring developments in 20 Montenegrin companies with the highest capitalization. It is calculated in an analogous way as NEXPIF and weighting factors of each of the 20 companies are based on the capitalization of the company, the trade turnover and the number of transactions. The companies with the highest weight in the index include Telekom Crne Gore, Hipotekarna Banka, Jugopetrol, and TUP Juzni Jadran.

The index MOSTE, which is calculated at the stock exchange MontenegroBerza, monitors price developments of the 38 largest companies listed there using the analogous weighted-index methodology. This index includes several companies that are listed on both stock exchanges, such as Telekom Crne Gore, the winemaker Plantaze, and the oil company Jugopetrol, but it also includes other companies that are not listed on NEX: Inpek (the leading bakery) and the dairy factory Mlijekara, A.D. Podgorica. Index MOSTE also includes the 6 PIFs whose investment units are traded on both stock exchanges.

Chapter 7. Capital Market

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Graph 7.1. Stock Exchange Indices in Montenegro

900

950

1000

1050

1100

1150

1200

1250

1300

1350

3/1/2003 3/8/2003 3/15/2003 3/22/2003 3/29/2003 4/5/2003 4/12/2003 4/19/2003 4/26/2003 5/3/2003 5/10/2003 5/17/2003 5/24/2003 5/31/2003

MOSTE NEX 20 NEX PIF

Source: NEX Montenegro and Montenegroberza Graph 7.1 presents the development of all 3 indices during the first 3 months of their calculation: March, April, and May 2003. Each index has shown its own unique behavioral pattern during this period. After registering a maximum of 1015 points on March 4, the NEX 20 fell slightly in March and continued to fall throughout April to register a low of 918 on April 14. By the end of May, the index climbed back up to its initial value of approximately 1000 points. With the exception of April 2nd, when the PIF index dropped to 960 points, March and April were marked by values above 1000, mostly ranging from 1025-1050 points. The last two weeks of May showed a significant increase in the PIF index, going from 1060 on May 20th to 1320 on March 27th. This growth happened because price of investment units of Eurofund increase from € 0.006 to € 0.01, and HLT Fund from about € 0.005 to € 0.01; whilst prices of other PIFs were on the same level or experienced a negligible decrease. The MOSTE index from Montenegroberza has been the most stable of all indices quite justifiably because it is comprised of the highest number of companies. Through April 22, the MOSTE index fluctuated, ranging from 1000 to 1040 points. Afterwards, it increased slightly and stabilized between 1050-1060.

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Table 7.1. Stock exchange trade in Montenegro

MONTH MONTENEGROBERZA NEX MONTENEGRO TOTAL

TURNOVER (in €) TURNOVER (in €) TURNOVER (in€)

Primary Secondary Total Num

ber

of

tran

sact

ions

Primary Secondary Total Num

ber

of

tran

sact

ions

Primary Secondary Total Num

ber

of

tran

sact

ions

Jan-02 355,787 16,160 371,946 136 14,077 1,022 15,099 4 369,864 17,182 387,045 140

Feb-02 850,591 76,187 926,778 58 20,678 46,526 67,204 4 871,269 122,713 993,982 62

Mar-02 743,416 88,046 831,462 169 2,095,271 75,123 2,170,394 481 2,838,687 163,169 3,001,856 650

Apr-02 0 127,580 127,582 75 0 198,092 198,092 889 0 325,672 325,674 964

May-02 0 2,648,532 2,648,531 110 0 76,702 76,702 467 0 2,725,234 2,725,233 577

Jun-02 818,064 588,184 1,406,248 32 0 77,045 77,045 189 818,064 665,229 1,483,293 221

Jul-02 0 50,953 50,953 37 767,250 72,091 839,341 202 767,250 123,044 890,294 239

Aug-02 0 6,340 6,340 20 0 151,086 151,086 107 0 157,426 157,426 127

Sep-02 0 29,714 29,714 33 611,528 62,707 674,235 140 611,528 92,421 703,949 173

Oct-02 53,423 68,960 122,383 49 0 839,944 839,944 206 53,423 908,904 962,327 255

Nov-02 332,195 304,401 636,596 86 188,492 147,879 336,371 352 520,687 452,280 972,967 438

Dec-02 1,479,517 87,557 1,567,074 139 0 241,094 241,094 316 1,479,517 328,651 1,808,168 455

Total 02 4,632,993 4,092,614 8,725,607 944 3,697,296 1,989,311 5,686,607 3,349 8,330,289 6,081,925 14,412,214 4,301

Jan-03 130,123 73,770 203,893 105 0 588,673 588,673 374 130,123 662,443 792,566 479

Feb-03 1,459,751 511,390 1,971,141 351 0 175,566 175,566 782 1,459,751 686,956 2,146,707 1,133

Mar-03 2,170,818 174,930 2,345,748 414 0 298,291 298,291 1167 2,170,818 473,221 2,644,039 1,581

Apr-03 0 496,648 496,648 236 0 603,269 603,269 1268 0 1,099,917 1,099,917 1,504

Total 03 3,760,692 1,256,738 5,017,430 1,106 0 1,665,799 1,665,799 3,591 3,760,692 2,922,537 6,683,229 4,697

Source: Montenegroberza and NEX Montenegro

Chapter 7. Capital Market

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7.2. TURNOVER ON STOCK EXCHANGES Total turnover during the first four months of 2003 was € 6.7 million, which represents nearly half (46%) of total turnover in 2002. Moreover, a total of 4,697 transactions have occurred during the first four months of 2003, already exceeding the 2002 year-end total by 396. Through April, the average monthly turnover in 2003 was € 1.7 million, again, well above the average of € 1.2 million in 2002.

Graph 7.2. Turnover and number of transactions on both stock exchanges in Montenegro

0

500,000

1,000,000

1,500,000

2,000,000

2,500,000

3,000,000

3,500,000

Jan-

02

Feb

-02

Mar

-02

Apr

-02

Maj

-02

Jun-

02

Jul-

02

Aug

-02

Sep-

02

Oct

-02

Nov

-02

Dec

-02

Jan-

03

Feb

-03

Mar

-03

Apr

-03

euro

0

200

400

600

800

1000

1200

1400

1600

turnover number of transactions

Source: Montenegroberza and NEX Montenegro As presented in the graphic above, the largest turnover in 2003 was registered in March (€2.6 million) while the lowest occurred in January (€ 0.8 million). The number of transactions roughly followed the trend of turnover, showing a rapid increase during the period January – March and decreasing slightly in April. 7.2.1. Trade on the primary market Total turnover in the primary market during the first four months of 2003 reached € 3,760,692 and represented almost 56% of total turnover on both stock exchanges. All new emissions took place on the Montenegroberza. The following companies entered the market: Hipotekarna Bank, Ekos Bank, Niksicka Bank and Lovcen Insurance. Turnover in the primary market during the first four months of 2003 was 8.5% lower than in the analogous period of 2002.

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Graph 7.3. Turnover in primary and secondary markets on both stock exchanges in Montenegro

0

500,000

1,000,000

1,500,000

2,000,000

2,500,000

3,000,000

Jan-

02

Feb

-02

Mar

-02

Apr

-02

Maj

-02

Jun-

02

Jul-

02

Aug

-02

Sep-

02

Oct

-02

Nov

-02

Dec

-02

Jan-

03

Feb

-03

Mar

-03

Apr

-03

euro

Primary Secondary

Source: Montenegroberza and NEX Montenegro The greatest turnover in the primary market was realized in March, when new shares were issued for Hipotekarna Bank in the amount of €1,242,945.99, Lovcen Insurance for €533,156, and Ekos Bank for €394,715.88. In April there was no trade in the primary market. 7.2.2. Trade on the secondary market Total turnover in the secondary capital market, on both stock exchanges, during the first four months of 2003, amounted to € 2,922,537, representing approximately 44% of total turnover. In January and February trade in the secondary market was stable at € 662,443 and € 686,956 respectively. In March, the value of trade decreased to €473,221, and in April it rose more than twofold, up to € 1,099,917. The significant rise in April was related to trade of shares with old foreign currency savings bonds that began in April and amounted to € 381,236. Compared to the same period in 2002, total turnover during the first four months of 2003 is 4.6 times higher. This is the effect of the Mass Voucher Privatization where shares traded from these companies, which began in March 2002, have continued to have the highest share of trade in the Montenegrin secondary market. Additionally, trade with investment units of PIFs, which began in December 2002, and with shares of old foreign currency savings, which began in April 2003, was significant as well and boosted trade in 2003.

Chapter 7. Capital Market

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Graph 7.4. Structure of turnover in the secondary market (Jan-Apr 2003)

Investment units of PIFs6%

Old foreign currency savings bonds

13%

Shares81%

Source: Montenegroberza and NEX Montenegro During the period January-April 2003, the greatest turnover in the secondary market was related to trade with shares (81%), while the remainder was related to trade with old foreign currency savings bonds (13%) and trade with investment units of PIFs (6%). Trade with shares Trade with shares was dominated by companies from the Mass Voucher Privatization, both in terms of turnover and the number of transactions. During the first 4 months of 2003 on the NEX Montenegro stock exchange shares of approximately 40 companies4 were traded, but just six companies accounted for more than 90% of turnover: Eko Meso, Proljece komerc, Eko Lina, Telekom, Servisimport and Jugopetrol. The following table presents the turnover and number of transactions realized with shares of these companies during the analyzed period. Table 7.2. Most traded shares on the NEX Montenegro

January-April 2003

Company Max. price Min. price Turnover Quantity

EKO - MESO A.D. BIJELO POLJE 6.72 3.00 511,374 80,857

PROLJECE KOMERC A.D. PLJEVLJA5 9.5 3.5 181,763 24,765

EKO - LINA D.D. BIJELO POLJE 0.37 0.37 157,664 432,000

TELEKOM CRNE GORE A.D. PODGORICA 0.65 0.6 124,675 203,227

SERVISIMPORT SI A.D. PODGORICA 0.36 0.36 112,921 313,670

JUGOPETROL A.D. KOTOR 3.06 2.00 69,479 24,360

Source: NEX Montenegro

4 Excluding shares that were offered by Development Fund, Pension Fund and Bureau for Employment. 5 Turnover in the amount of € 163,353 relates to trade with shares of Proljece komerc AD Pljevlja for old foreign currency savings bonds that began in April 2003

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A similar situation prevails in the Montenegroberza stock exchange where approximately 20 companies are traded and the majority of turnover (52%) is due to trade of the following few companies: Trebjesa, Inis Marko Radovic, Napredak, Proljece komerc, and Mljekara. Data related to these trades are presented in Table 7.3. Table 7.3. Most traded shares on the Montenegroberza

January-April 2003

Company Max. price Min. price Turnover Quantity

INIS MARKO RADOVIC 0.3182 0.31 211,779 665,700

NAPREDAK A.D. NIKSIC 0.4546 0.4546 200,024 440,000

PROLJECE KOMERC A.D. PLJEVLJA 9.65 3.5 74,353.15 10,136

MLJEKARA A.D. PODGORICA 2.00 1.70 68,221.32 34,390

JUGOPETROL A.D. KOTOR 3.05 3.00 54,519.13 18,135

Source: Montenegroberza Trade with investment units of Privatization Investment Fund6 As we wrote in the previous issue of MONET, the adoption of necessary regulations by the Montenegrin Security Commission made it possible to trade with investment units, and on December 23, 2002 trade was initiated. On the Montenegrin Stock exchanges, during the period January – April 2003, trade was carried out with investment units of all six Privatization Funds. In this period 2,819 transactions took place, of which 2,580 occurred on the NEX Montenegro stock exchange and 239 on the Montenegroberza stock exchange. Total turnover amounted to € 183,354 (€ 16,684 on Montenegroberza and € 166,670 on NEX Montenegro).

Graph 7.5. Monthly turnover with PIF investment units in 2003

0

200

400

600

800

1000

1200

Jan Feb Mar Apr

no o

f tr

ansa

ctio

ns

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

euro

Number of transactions Turnover

Source: Montenegroberza and NEX Montenegro

6 By transferring voucher points to privatization funds in the third phase of the MVP program, 237,316 citizens became fund shareholders (For more details see MONET 8, Comment 11).

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As shown in graph 7.5, both turnover and the number of transactions with PIF investment units were on the rise during the first four months of 2003. Turnover rose from €12,223 in January to €72,049 in April while the number of transactions rose from 403 to 1,050. Trade with shares of old foreign currency saving bonds As we noticed in MONET 11, in the beginning of May 2002, the Government of Montenegro adopted a Decree on the Purchase of Shares with the Old Foreign Currency Savings. This decree defines the companies’ shares as shares of companies that are being privatized, and whose owners are the Republic of Montenegro, the Development Fund, the Pension and Invalid Fund and the Employment Fund. The old foreign currency savings are defined as amounts of foreign currencies that citizens owned on December 31, 1997 in bank accounts located within the Republic of Montenegro and certain banks that are located outside of Montenegro, along with accrued interest through December 31, 2001.7 After the Securities Commission approved the Ministry of Finance to issue the bonds, citizens who own old foreign currency savings were able to exchange their savings for these bonds.8 Citizens can use these bonds to purchase shares of companies that are being privatized, and whose owners are the Republic of Montenegro, the Development Fund, the Pension and Invalid Fund and the Employment Fund9 or they can sell their bonds to interested investors. Trade of shares with old foreign currency savings bonds began in April 2003 on both Montenegrin stock exchanges; during this month, total turnover related to trade of shares with old foreign currency savings bonds amounted to € 381,236 on both stock exchanges, of which €156,190 was sold to investors and the rest was exchanged for shares. On Monetenegroberza 1 euro of old foreign currency savings was worth 0.75 euro, while on the NEX Montenegro 1 euro of old foreign currency savings was sold between 0.41 and 0.78 euro. 7.2.3. Listing on list ‘A’ Only shares that meet certain requirements regarding the financial status of business organization and reporting requirements (informing the stock exchange and the public) are allowed on the stock exchange lists (A and B) in Montenegro10. On both stock exchanges the first companies were listed on the “A” list. On April 14th, NEX Montenegro named Telekom as the first company to be accepted on the “A” list, and on May 14th, Montenegroberza named the insurance company Lovcen as the first to be listed on its “A” list. 7 Official Register number 23. 8 Ministry of Finance demanded approval from the Securities Commission for issue of bonds worth €121 million. 9 The Development Fund, Pension Fund and Bureau for Employment offered their shares that they own in 157 companies for 0-80% lower than their nominal value. 10 Both stock exchanges in Montenegro defined Listing Rules and set specific listing requirements. The requirements that issuer, whose securities are to be entered into the “A” list (list “A” is the most prestigious on both stock exchanges), must meet are similar on both stock exchanges. Some of the conditions are: to be registered as a legal entity for at least 3 years, to have a minimum share capital of €2.5 million (or €2 million on Montenegroberza), to have no losses in the last operating year, to have a minimum of 100 shareholders or owners of securities etc.

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Companies that are listed are in a better position to find additional funds through new issues of securities. Also, listing enables companies to get loans on more favorable conditions compared with similar companies that are not listed. Additionally, one advantage that listed public joint-stock companies have is better protection against possible manipulations in the market since trading of listed shares is overseen by the Exchange, the Securities Commission of Montenegro, as well as the Central Depositary Agency. To be listed on the exchange may also boost advantage over the competition and lend to a company’s reputation on the national and international markets. Furthermore, listing on the domestic stock exchange is a precondition for a company listing on foreign stock exchanges11. On the other hand, a listed company is more exposed to the public and it commits itself to publish information about itself thus leading to additional costs for collecting information, compulsory audits, etc.

11 www.nex.cg.yu

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Table 8.1 Imports and exports in 2002 and 2003Q1

Exports Imports 2002 2003Q1 2002 2003Q1

Sector total in euro as% of total

total in euro as % of

total total in euro

as % of total

total in euro as % of

total

1 Meat and meat products 206,579 0.08 17,218 0.03 26,823,190 4.51 5,474,019 4.96 2 Milk products and eggs 636,501 0.24 226,569 0.36 8,100,586 1.36 1,178,714 1.07 3 Fish and fish products 5,841 0.00 33,537 0.05 4,094,857 0.69 538,829 0.49 4 Cereals and cereal products 2,902,900 1.10 676,354 1.06 6,417,200 1.08 765,061 0.69 5 Vegetables and fruits 3,991,286 1.51 528,025 0.83 31,659,678 5.33 7,684,013 6.96 6 Sugar, sugar products and honey 561,577 0.21 169,765 0.27 13,165,195 2.22 1,298,202 1.18 7 Coffee, tea, cocoa and spices 794,144 0.30 360,583 0.57 8,074,081 1.36 1,956,635 1.77 8 Animal fodder (except cereals) 187,003 0.07 6,957 0.01 1,110,744 0.19 324,744 0.29 9 Various nutrition products 1,080,514 0.41 250,672 0.39 7,389,874 1.24 1,643,708 1.49 11 Beverages 3,727,037 1.41 1,012,643 1.59 5,880,244 0.99 616,404 0.56 12 Tobacco and tobacco products 18,698 0.01 0 0.00 2,446,683 0.41 554,626 0.50 21 Raw leather and pelt 3,967,900 1.50 597,786 0.94 35,798 0.01 0 0.00 22 Oil grain 7,410 0.00 0 0.00 62,296 0.01 14,379 0.01 23 Natural rubber 0 0.00 0 0.00 33,277 0.01 0 0.00 24 Cork and wood 3,904,883 1.48 563,015 0.88 873,846 0.15 182,280 0.17 25 Cellulose and paper pulp 74,355 0.03 17,195 0.03 1,625,766 0.27 458,019 0.41 26 Textile fibers and textile byproducts 7,375 0.00 0 0.00 767,243 0.13 78,592 0.07 27 Compost and minerals 709,793 0.27 212,267 0.33 820,396 0.14 149,863 0.14

28 Metal ores (nickel, aluminum and copper)

5,407,188 2.05 716,187 1.12 4,936,910 0.83 725,388 0.66

29 Animal and plant products 164,324 0.06 128,366 0.20 776,794 0.13 187,001 0.17 32 Mineral coal, coke and briquettes 37,347 0.01 3,740 0.01 74,575 0.01 0 0.00 33 Oil and oil derivates 41,435,667 15.71 6,659,330 10.44 105,980,782 17.84 16,139,456 14.62 34 Natural and industrial gas 0 0.00 0 0.00 303,799 0.05 54,862 0.05 35 Electricity 0 0.00 0 0.00 76,477,572 12.87 7,345,018 6.65 41 Animal oil and fats 0 0.00 0 0.00 399,532 0.07 27,173 0.02 42 Solid animal oils and fats 610,049 0.23 17,902 0.03 3,014,178 0.51 316,109 0.29 43 Animal and vegetable fats and oils 353,317 0.13 85,360 0.13 37,280 0.01 34 0.00 51 Organic chemical products 20,140 0.01 2,180 0.00 505,121 0.09 74,310 0.07 52 Inorganic chemical products 95,857 0.04 18,541 0.03 10,570,719 1.78 1,109,328 1.00 53 Products for painting 120,519 0.05 0 0.00 2,988,731 0.50 544,400 0.49 54 Medical and pharmaceutical products 108,681 0.04 16,555 0.03 7,946,090 1.34 1,633,631 1.48

55 Ether oils, perfumes and other products

1,209,266 0.46 525,163 0.82 14,211,464 2.39 3,239,019 2.93

56 Fertilizers (except unprocessed) 51,620 0.02 0 0.00 70,846 0.01 158,289 0.14 57 Unprocessed plastics 10,731 0.00 17,698 0.03 845,530 0.14 141,557 0.13 58 Molded plastics 188,986 0.07 13,203 0.02 3,844,323 0.65 675,691 0.61 59 Chemical substances and products 187,967 0.07 0 0.00 4,527,499 0.76 746,659 0.68 61 Leather and leather products, pelts 473,506 0.18 0 0.00 328,896 0.06 1,699 0.00 62 Rubber products 275,460 0.10 39,831 0.06 4,781,331 0.80 869,765 0.79 63 Cork and wood products 241,385 0.09 30,751 0.05 4,620,258 0.78 738,023 0.67

64 Paper, cardboard and cellulose products

704,810 0.27 154,266 0.24 10,692,956 1.80 2,852,488 2.58

65 Yarn, tissue and textile products 109,336 0.04 2,674 0.00 3,362,097 0.57 626,339 0.57

66 Construction materials (cement, glass, sand etc.)

377,620 0.14 34,993 0.05 29,292,322 4.93 3,705,410 3.36

67 Iron and steel 1,408,590 0.53 1,438,492 2.26 7,131,790 1.20 2,074,831 1.88 68 Ferrous metals 165,435,964 62.73 45,466,362 71.29 3,921,530 0.66 387,537 0.35 69 Metal products 965,520 0.37 701,480 1.10 12,396,513 2.09 2,551,629 2.31 71 Industrial machines and devices 30,142 0.01 13,165 0.02 5,921,885 1.00 481,251 0.44 72 Special purpose machinery 79,200 0.03 74,513 0.12 11,599,549 1.95 1,740,607 1.58 73 Machines for metal processing 1,278 0.00 0 0.00 2,337,263 0.39 147,563 0.13 74 Industrial machines for general use 1,365,047 0.52 41,044 0.06 21,984,832 3.70 3,456,322 3.13

75 Machines for offices and data processing

138,462 0.05 8,374 0.01 9,111,199 1.53 2,678,709 2.43

76 Telecommunication equipment 27,325 0.01 0 0.00 17,219,807 2.90 7,231,929 6.55 77 Electrical machines and equipment 372,961 0.14 188,940 0.30 28,058,720 4.72 4,336,261 3.93 78 Vehicles 201,908 0.08 66,725 0.10 27,352,970 4.60 11,294,743 10.23 79 Other transportation equipment 16,423,570 6.23 2,113,076 3.31 1,209,495 0.20 1,112,379 1.01 81 Prefabricated buildings 55,361 0.02 6,560 0.01 2,971,573 0.50 537,307 0.49 82 Furniture and parts 366,863 0.14 50,009 0.08 9,867,040 1.66 1,740,469 1.58 83 Traveling equipment 2,695 0.00 516 0.00 656,273 0.11 90,324 0.08 84 Clothing 373,094 0.14 111,602 0.17 4,669,792 0.79 1,096,240 0.99 85 Footwear 745,339 0.28 180,159 0.28 2,799,641 0.47 877,445 0.79 87 Scientific instruments 32,720 0.01 0 0.00 3,550,760 0.60 1,759,766 1.59 88 Cameras and clocks 5,820 0.00 25,682 0.04 1,755,014 0.30 316,167 0.29 89 Other finished products 748,068 0.28 152,431 0.24 9,645,030 1.62 1,667,601 1.51 TOTAL 263,747,501 100.00 63,778,460 100.00 594,131,230 100.00 110,408,819 100.00

Source: Central Bank of Montenegro

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8. EXTERNAL SECTOR 8.1. FOREIGN TRADE 8.1.1 Foreign Trade Structure by Goods Table 8.1 presents a divisional structure, by sector, of imports and exports for the first quarter 2003 as well as for the entire 2002. The data was obtained from the Central Bank of Montenegro and is based on customs declaration (implying customs duties) and banks’ statements. They cover foreign trade with all countries excluding Serbia, but including Kosovo. With respect to imports in the first quarter of 2003, oil and oil derivatives accounted for the highest share of total imports (14.6%) much in line with 2002 when they accounted for 17.8% of all imports (about 40% of these imports are re-exported). Vehicles ranked second with a share of 10.2%, more than twice the share in 2002 (when it was 3.7%). The growth of vehicle imports is undoubtedly the result of the introduction of VAT on April 1, which increased the effective tax rate on cars. Many Montenegrins, as well as Montenegrin companies, decided to purchase vehicles before April 1st, and hence the increase of imports that appears in the official statistics. Other key imports in 2003 Q1 were fruits and vegetables (7.0%), telecommunication equipment (6.6%), meat and meat products (5.0%), electrical machines and equipment (3.9%), construction materials - including cement and glass (3.35%), and industrial machines for general use (3.1%). Compared to 2002, the import of electricity became much less important as its share in total imports fell from 12.8% in 2002 to 6.7% in 2003 Q1. This was a result of higher domestic production of electricity in early 2003 (see chapter 1, section 1.1 for more details). Combined, the products listed above accounted for 60.5% of all imports in 2003 Q1. Problems surrounding the reliability of import data have been explained in more detail in the previous issue of MONET. Box 8.1 presents an update on imports of ‘sensitive’ products. With respect to exports, nearly 71.3% of the value of exports in 2003 Q1 was concentrated in the category ‘ferrous metals’ (compared with 63% in 2002), the vast majority of which were exports of aluminum. Oil and oil derivatives contributed 10.4% to total export in 2003 Q1, over 5 percentage points less than in 2002. As previously stated, a large portion of the oil and oil derivative exports were originally imported liquid petroleum gas and fuels. Another significant sector for exports was the sector of transportation equipment (excluding vehicles) with a 3.3% share of total exports. The fourth most important sector on the exports side was iron and steel with a share of 2.3% in total exports. In total, exports from these 4 sectors accounted for 87.3% of all exports in 2003 Q1.

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8.1.2 Foreign Trade Structure by Countries of Destination and Origin

Foreign trade structure by countries is presented in table 8.2 and graphs 8.1 and 8.2.

BOX 8.1 Imports of clothing, footwear, cigarettes and tobacco in 2002 and 2003 Q1 Since the 13th issue of MONET, we closely monitor the official imports in 4 sectors where the extent of illegal imports seems strikingly evident - textiles, footwear, alcohol and cigarettes. The table below presents the official imports of these goods as reported by the CBM coupled with respective data on expenditure from the household surveys. The difference between these figures (expressed both in € and as a percent of total expenditures) is the measure of non-imported consumption that can be explained by domestic production, imports from Serbia or illegal imports (smuggling).

Textiles and

footwear Cigarettes Alcohol

2002 10.87 1.59 4.60 Official per capita imports (source: CBM based on customs declarations; excludes

Serbia) 2003Q1 2.86 0.33 0.45

2002 192.30 57.40 33.60 Average annual expenditure per capita (source: ISSP household surveys in 2002 -

issues 5 and 6) 2003Q1* 48.08* 14.35* 8.40*

in €

182.10 55.90 29.30 2002

in % of expenditures 94.7% 97.4% 87.2% in € 45.21 14.02 7.95

The difference between imports and expenditures (per capita)

2003Q1 in % of expenditures 94.1% 97.7% 94.7%

*- average expenditure in 2003 Q1 was obtained by dividing the Survey figure for 2002 by 4. As we previously mentioned, domestic production might explain some of the expenditures for cigarettes and alcohol, as domestic manufacturers of these goods do exist in Montenegro. Imports from Serbia may be present, to some extent, in all three categories of goods (especially clothing); however their presence would not be very significant. Stylized facts and anecdotal evidence strongly point to smuggling activities as being the source of these differences. This is particularly striking in the case of textiles and clothes (smuggling from Italy and Turkey) as well as cigarettes (smuggling from Kosovo and Albania). In 2003 Q1, official imports on textiles and footwear amounted to €2.86, only 6% of total expenditures on textiles and footwear. The respective figures for cigarettes and alcohol are €0.33 (2.7%) and €0.45 (5.3%) and indicate that the share of legal imports in total expenditures has actually gone down compared with 2002 (by 0.3 and 7.5 percentage points in case of cigarettes and alcohol, respectively).

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Table 8.2. Foreign trade structure by countries

Imports Exports 2002 2002 2003 2002 2002 2003 Country

Q1-Q4 Q1 Q1 Q1-Q4 Q1 Q1 in % of total imports in % of total exports

Bosnia and Herzegovina 10.20 4.85 9.75 3.11 2.63 2.87 Croatia 9.48 14.14 11.23 0.46 0.14 0.60 Kosovo 0.29 0.25 0.20 20.48 15.21 14.77 Slovenia 9.57 9.41 11.20 0.35 0.20 0.26 Italy 10.99 11.93 12.59 5.62 2.80 6.98 Greece 6.98 4.23 14.71 0.34 0.02 0.58 Germany 5.85 5.91 7.77 0.33 0.10 0.56 Cyprus 4.37 4.76 5.27 2.53 3.43 1.36 Hungary 1.89 2.06 1.81 2.04 2.29 0.83 Virgin Islands 1.62 4.27 0.29 0.57 0.48 0.00 Albania 0.84 1.13 0.39 0.85 1.20 0.44 Austria 4.39 6.56 5.16 0.03 0.02 0.00 Gibraltar 2.67 4.81 0.14 0.19 0.00 0.00 Great Britain 8.06 1.36 0.95 0.24 0.07 0.14 Lichtenstein 0.99 0.06 0.03 Malta 0.05 0.06 0.11 1.01 1.22 0.32 Switzerland 1.85 1.52 2.32 59.39 66.95 68.45 USA 5.10 6.53 3.47 0.28 0.56 0.36 Other 14.81 16.17 12.61 2.18 2.67 1.48 total 100.00 100.00 100.00 100.00 100.00 100.00 Total in euros 594,236,575 100,324,744 110,436,739 263,752,161 64,621,433 63,799,480

Source: Central Bank of Montenegro

Graph 8.1 Import structure by countries of origin in 2003 Q1 and 2002 Q1

USA7%

Slovenia9%Croatia

14%

Gibraltar5%

Other17%

Austria7%

Virgin Islands4%

Great Britain1%

Greece 4%

Germany6%

Cyprus5%

Bosnia and Herzegovina

3%

Hungary2%

Italy12%

Liechtenstein4%

Kosovo0%

2002-Q1

Italy13%

USA3%

Croatia11%

Cyprus5%

Slovenia11%

Austria5%

Virgin Islands0%

Great Britain1%

Greece 15%

Germany8%

Hungary2%

Liechtenstein0%

Bosnia and Herzegovina

3%

Kosovo0%

Other23%

Gibraltar0%

2003-Q1

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Graph 8.2 Export structure by countries of destination 2003 Q1 and 2002 Q1

Bosnia and Herzegovina

1.0%

Germany0.1%

Italy2.8%

Greece 0.0%

Kosovo15.5%

Virgin Islands0.5%

Hungary2.3%

Albania1.2%

Cyprus3.5%

Malta1.2%

Switzerland68.0%

Other3.7%

2002-Q1

Malta0.3%

Cyprus1.4%

Albania0.4%

Hungary0.8%

Virgin Islands0.0%

Kosovo14.8%

Greece 0.6%

Italy7.0%

Germany0.6%

Bosnia and Herzegovina

1.6%

Switzerland68.5%

Other4.1%

2003-Q1

Export and import of goods in 2002 and 2003 Q1, according to their assignment or origin, are presented in table 8.2. These data come from the Balance of Payments statistics and do not include Serbia. The shares of imports from former Yugoslav republics (Slovenia, Croatia, Bosnia and Herzegovina) in 2003 Q1 increased by 4% as compared to 2002 Q1 and by 3% when compared with the entire 2002 year. This increase was mostly due to a twofold growth of share of imports from Bosnia and Herzegovina (9.7% in 2003 Q1 vs. 4.8% in 2002 Q1) and from Slovenia (9.4% in 2003 Q1 vs. 4.8% in 2002 Q1). Imports from Kosovo remained insignificant as share of total imports and imports from Croatia fell from 14% to 11% in respective first quarters. Considering imports from industrialized countries, Italy, Cyprus, Greece, Switzerland and Germany increased their shares in Montenegrin imports in 2003 Q1 compared to 2002 Q1 and as compared to the entire 2002 as well. The most striking increase occurred with Greece, which accounted for 14.7% of all imports in 2003 Q1 while its share was only 4.2% in 2002 Q1 and 7% in the entire 2002.

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Great Britain experienced the largest drop in market share of imports: in 2003 Q1 it amounted to less than 1% while in 2002 Q1 it was 1.4% and 8% for the entire 2002. Imports from United States decreased from 6.5% in 2002 Q1 and 5.1% in the entire 2002, to 3.5% in 2003 Q1. Other countries whose shares declined in comparison to both 2002 Q1 and entire 2002 were: Gibraltar, Liechtenstein and Virgin Islands. Imports from Austria in 2003 Q1 (5.2%) decreased when compared to 2002 Q1 (6.6%) but increased when compared to the entire 2002 (4.4%). Summing up, in the first quarter of 2003 major importers to Montenegro were Greece (14.7%), Italy (12.6%) and Croatia and Slovenia (both 11.2%). With respect to exports, the structure continues to be dominated by exports of aluminum to Switzerland. Share of this export in total exports amounted to 68.5% in 2003 Q1, an increase of 1.5% when compared to 2002 Q1 and 9% as compared to the entire 2002. Kosovo continues to be the second market for Montenegrin exports with its share in total exports at 14.8% in 2003 Q1, almost identical to that of 2002 Q1 (15.2%) and lower than the 2002 year (20.5%). The third most important export market for Montenegro, Italy, became more significant as its share in Montenegrin exports rose from 3% in 2002 Q1 (and 5.6% in the entire 2002) up to 7.0% in 2003 Q1. The remaining export markets are much less significant than the three presented above. Hungary, Cyprus, Virgin Islands, Albania, Austria and Malta have all seen their share of the Montenegrin market decline. Summing up, the importance of Switzerland (68.5%), Kosovo (14.8%) and Italy (7%) as markets for Montenegrin exports grew in 2003 Q1. Exports to those 3 countries accounted for over 90% of all Montenegrin exports in 2003 Q1, which is about 5 percentage points more than in 2002 Q1 and in the entire 2002. 8.1.3 TERMS OF TRADE Terms of trade play a very important role in foreign trade. They are conventionally defined as a ratio of the price of exports to the price of imports and measure the relative profitability of the foreign trade. A growing terms-of-trade series points to improvements in relative profitability of trade as the country receives more for its exports than it has to pay for its imports. A falling terms-of-trade suggests the opposite and indicates that price relations in foreign trade have turned unfavorable. Montenegrin Statistical Office does not calculate the terms of trade series, nor does it publish prices in exports or imports. Therefore, in order to estimate the TOT series, we must utilize other data. While it is impossible to calculate exact composite price level of all imports or exports, we can narrow our analysis to two of the most important foreign trade items. The highest share of imports consistently belongs to oil and oil derivatives1 (17.8% in 2002 and 14.6% in 2003 Q1), while on the export side, aluminum accounts for the lion’s share of all exports (62.7% in 2002 and 71.3% in 2003 Q1). While not representing an exact terms-of-trade, the ratio of prices of aluminum to prices of oil products does provide a good measure of profitability of Montenegro’s foreign trade and most likely reflects the actual terms of trade fairly well.

1 About 40% of oil and oil derivatives is later re-exported (see section 8.1) thus being reflected in the prices of exports. This lowers the net contribution of oil imports to the actual terms of trade.

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Graph 8.3. Prices of crude oil and aluminum

15

20

25

30

35

M1

2001

M2

2001

M3

2001

M4

2001

M5

2001

M6

2001

M7

2001

M8

2001

M9

2001

M10

200

1

M11

200

1

M12

200

1

M1

2002

M2

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M6

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M10

200

2

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200

2

M12

200

2

M1

2003

M2

2003

M3

2003

M4

2003

M5

2003

USD

per

bar

rel

1300

1400

1500

1600

1700

USD

per

ton

Crude oil (left axis) Aluminum (right axis)

Graph 8.4. Terms of Trade in Montenegro (Approximation

70

80

90

100

110

120

130

M1

2001

M2

2001

M3

2001

M4

2001

M5

2001

M6

2001

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M9

2001

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200

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200

1

M1

2002

M2

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M9

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200

2

M11

200

2

M12

200

2

M1

2003

M2

2003

M3

2003

M4

2003

M5

2003

Terms of Trade (approximation), 2000:1=100

Graph 8.3 presents the export prices of aluminum (in USD per ton) as provided by the aluminum plant KAP along with world prices of crude oil2 (USD per barrel) as listed in the IMF’s International Financial Statistics. Graph 8.4 presents the ratio of the two price levels thus yielding an approximation of the Montenegrin terms of trade. The series has been set equal to 100 in January 2001.

Graph 8.4 suggests that Montenegrin terms of trade have been improving throughout 2001 as both aluminum and oil prices fell (albeit the latter faster). However, 2002 and 2003 Q1 are marked by worsening profitability of foreign trade as oil prices go up and aluminum prices fall (April-October 2002) and later recover to early 2002 levels (November 2002- March 2003). During April and May 2003, aluminum export prices continued to fall and oil prices stabilized at an early 2001 level (slightly exceeding $25 per barrel), which led to a slight deterioration of the terms of trade in May. In comparison to early 2001, terms of trade were about 20% worse in 2003 Q1 and about 10% worse in April and May 2003. 2 The average crude price of SPOT oil.

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8.2. BALANCE OF PAYMENTS The Balance of Payments for Montenegro for the first quarters of 2002 and 2003 as well as for the entire 2001 and 2002 are presented in table 8.3. It includes current account, capital and financial accounts as well as errors and omissions expressed in thousands of euros. 8.2.1 Current account The current account balance consists of the following balances: trade balance (exports and imports of goods), balance of services, balance of income (compensation of employees and investment income) and balance of unilateral or current transfers (official and private). The current account deficit in Montenegro in 2003 Q1 amounted to €53.4 million, which is €10 million more than in the same period in 2002 when the deficit amounted to €43.5 million. Total revenues were equal to €127.2 million, or 3 % less than in 2002 Q1, while expenditures amounted to €180.6 million and were 3.4% greater than the same period in 2002. Goods Trade In 2003 Q1 total trade of goods (imports plus exports) was €231.9 million and increased by 3.3% compared to the same period in the previous year. Exports and imports rose by 3.4% and 3.3%, respectively. Overall, the ratio of exports to imports was 50% and was the same as in 2002 Q1. The resulting trade deficit was €77.6 million - nearly the same level as the previous year’s first quarter. The increase of imports and exports is primarily due to the increase of trade with Serbia and Kosovo; this is particularly true of imports. In 2003 Q1, Montenegrin imports from Serbia and Kosovo increased by 29% compared to the same quarter of the previous year. Import of electricity and oil and oil derivates was lower by 39.3% and 29.6% respectively in this quarter compared to the same period in 2002. Export growth was also primarily due to higher exports to Serbia and Kosovo. In 2003 Q1 these exports were 9% higher than in 2002 Q1. Exports of aluminum grew moderately; by 2.2% in 2003 Q1 (in comparison to 2002 Q1) and all other exports actually fell by 4.3%. Balance of services In 2003 Q1, the deficit on services was €2.8 million, while in the same period of 2002, Montenegro had a surplus of €0.45 million. All categories of services registered a lower balance compared with 2002 Q1. A lower surplus on tourism services was primarily due to the decrease of revenues from foreign tourists (by 30%). A deficit was registered in the area of financial services (in place of a surplus in 2002 Q1) and the surplus on transportation services was 2.3% lower in 2003 Q1 compared to 2002 Q1. Furthermore, a deficit of other services worsened considerably in 2003 Q1 compared to 2002 Q1. Income The net balance of income in 2003 Q1 rose by 30.7% as compared to the same period last year. This increase is due to a 24% increase of total compensation of Montenegrin workers abroad and a 13% increase of transfers from Serbia for Montenegrin persons.

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Transfers Current transfers to Montenegro decreased by 80% in 2003 Q1 versus 2002 Q1, as a result of lower foreign assistance and other transfers from abroad. The balance of transfers in 2002 remained positive, but the surplus decreased by 91.4% compared to 2002 Q1. 8.2.2 Capital and financial account Capital account Capital account comprises capital transfers and acquisitions and disposal of non-produced and non-financial assets (patents, for example). Capital account transactions have not been registered in Montenegro at all since 2001, since the Central Bank of Montenegro (CBM) is still in process of adopting their accounting procedures to properly register them. Financial account Financial account consists of: o -Direct investment (acquisition of 10% or more of a company); o -Portfolio investment (portfolio debt investment- bonds and portfolio equity investment,

e.g. shares with less than 10 % ownership); o -Other investments (loans, trade credits) In the financial account of Montenegro, ‘other investments’ constitute the most significant position. In 2003 Q1, this was due to the World Bank loan received in March 2003 and amounting to €7.6 million. The loan boosted the category ‘other investments, net’ (€7.5 million), especially in comparison with 2002 Q1 when it was at €-1.8 million. Net portfolio investments were not registered in this period, while foreign direct investment decreased by €1.2 million or 32.6% in 2003 Q1 versus 2002 Q1. Additionally, the Central Bank of Montenegro includes in the financial account 2 items that are conventionally positioned ‘below the line’ in the financing section of the Balance of Payments. These items are changes in: net foreign assets and the CBM reserves (CBM’s term deposits in foreign banks). In 2003 Q1 there was a switch in holdings of foreign assets by the CBM. Net foreign assets dropped by €34 million in 2003 Q1 (vs. a drop of €–2.1 million in 2002 Q1) while the CBM reserve increased by €22 million in 2003 Q1 (in 2002 Q1 they fell by €35 million). 8.2.3 Net errors and omissions The total balance of the current as well as capital and financial account as defined by the CBM amounted to -€55.3 million in the first quarter of 2003, which represents an improvement over the same period last year, when this balance amounted to -€78.7 million. The current practice of the CBM is to set the last item in the BoP statistics- ‘net errors and omissions’ explicitly equal to this balance. Therefore, official net errors and omissions were €-55.3 million in the first quarter of 2003. Problems regarding such an accounting system3 as well as other issues related to BoP accounting are explained in more detail in Chapter 8 of MONET 13.

3 As a result of undefined foreign reserves and a BoP financing item, all the gap in the balance of payments (current account balance + capital and financial account balance) is explicitly ascribed to net errors and omissions.

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Table 8.3 BALANCE OF PAYMENTS IN MONTENEGRO 2001-2003 (in thousand euro)

2001 Q1-Q4

2002 Q1-Q4

2002 Q1

2003 Q1

Difference: 2003Q1 - 2002Q1

in thousand euro

Ratio : 2003Q1/

2002Q1 in %

CURRENT ACCOUNT BALANCE -199,036 -166,157 -43,470 -53,427 -9,957 122.9Total current account revenues 631,628 704,354 131,186 127,182 -4,004 96.9Total current account expenditures 830,664 870,511 174,656 180,609 5,953 103.4

GOODS AND SERVICES BALANCE -393,658 -320,154 -74,755 -80,376 -5,621 107.5GOODS BALANCE -491,012 -42,195 -75,209 -77,607 -2,398 103.2Total exports of goods 235,311 320,823 74,641 77,190 2,549 103.4Export of goods excl. trade with Serbia and Kosovo and aluminum 52,148 54,023 9,290 8,893 -397 95.7Export of aluminum 157,644 165,365 44,469 45,464 995 102.2Export to Serbia and Kosovo 25,519 101,435 20,882 22,833 1,951 109.3Total imports of goods 726,323 742,773 149,850 154,797 4,947 103.3Import of goods excl. oil, electricity and trade with Serbia and 402,082 410,083 77,146 86,620 9,474 112.3Import of electricity 37,326 48,923 17,909 10,873 -7,036 60.7Import of oil and oil derivatives 172,065 105,961 22,921 16,139 -6,782 70.4Import from Serbia and Kosovo 11,485 177,806 31,874 41,165 9,291 129.1SERVICES BALANCE 97,354 101,796 453 -2,768 -3,221 -611.0Total revenues from services 150,737 176,094 13,015 12,529 -486 96.3Total expenditures for services 53,383 74,298 12,562 15,297 2,735 121.8Total Transportation Revenues 28,524 3,575 6,364 6,633 269 104.2Transport official data about revenues corrected by 12% (estimate) 26,537 32,455 5,612 6,178 566 110.1Transport revenues from Serbia 1,987 3,295 752 455 -297 60.5Total transportation Expenditures 20,055 24,487 4,621 4,913 292 106.3Transport official data about expenditures corrected by 12% 18,644 19,815 4,119 3,828 -291 92.9Transport expenditures to Serbia 1,411 4,672 502 1,085 583 216.1Balance of transportation services 8,469 11,263 1,743 1,720 -23 98.7Total Revenues from Tourism 106,299 124,916 3,501 2,881 -620 82.3Revenues from tourists abroad (estimate) 40,706 6,202 2,259 1,594 -665 70.6Tourists from Serbia 65,593 62,896 1,242 1,287 45 103.6Total Expenditures to Tourism 5,024 7,946 1,691 1,340 -351 79.2Expenditures for tourism abroad 4,856 6,341 1,282 1,194 -88 93.1Expenditures for tourism in Serbia 168 1,605 409 146 -263 35.7Balance of tourism 101,275 11,697 1,810 1,541 -269 85.1Revenues from Financial Services 4,095 2,751 965 786 -179 81.5Commision fee 4,045 2,335 896 440 -456 49.1Commision fee on Serbian import/export (estimate) 5 416 69 346 277 501.4Expenditures to financial services 3,194 335 752 1,151 399 153.1Commision fee 3,116 2,835 571 777 206 136.1Commision fee on Serbian import/export (estimate) 78 515 181 374 193 206.6Balance of financial services 901 -599 213 -365 -578 Revenues from other Services 11,819 12,677 2,185 2,229 44 102.0Expenditures for other services 2,511 38,515 5,498 7,893 2,395 143.6Balance of other services -13,291 -25,838 -3,313 -5,664 -2,351 INCOME BALANCE 46,525 67,126 19,864 25,969 6,105 130.7Income revenues 87,038 110,331 29,351 34,632 5,281 118.0Compensation of employees 40,949 55,375 12,228 15,165 2,937 124.0Revenues from Serbia for physical persons 44,466 53,834 16,899 19,090 2,191 113.0Received dividends 17 17 103 0 -103 0.0Interest income 1,453 952 121 377 256 311.6Income Expenditures 40,513 43,205 9,487 8,663 -824 91.3Compensation of employees 33,637 32,927 8,197 8,079 -118 98.6Expenditures for physical persons in Serbia 115 31 23 377 354 1639.1Interest expenses 2,465 1,601 467 207 -260 44.3Paid dividends 4,296 8,367 800 0 -800 0.0CURRENT TRANFERS BALANCE 148,097 86,871 11,422 979 -10,443 8.6Revenues 11,434 97,106 14,179 2,831 -11,348 20.0Transfers to Montenegro from abroad 68,508 5,584 2,843 417 -2,426 14.7Foreign assistance 786 41,707 11,336 2,414 -8,922 21.3Foreign assistance financial and material (NGO, humanitarian 10,445 49,815 Expenditures 10,445 10,235 2,757 1,852 -905 67.2Transfers from Montenegro abroad 10,235 2,757 1,852 -905 67.2

CAPITAL AND FINANCIAL ACCOUNT BALANCE 7,876 87,327 -35,191 -1,887 33,304 5.4CAPITAL ACCOUNT 0 0 0 0 FINANCIAL ACCOUNT 7,876 87,327 -35,191 -1,887 33,304 5.4Direct investment 10,636 76,306 3,876 2,614 -1,262 67.4Equity capital 4,696 11,021 3,876 2,614 -1,262 67.4Reinvested earnings and undistributed branch profits 594 -174 Portfolio investment-net -13 4,411 0 0 Other investments -6,052 23,679 -1,838 7,507 9,345 Loans 2,916 19,268 549 9,816 9,267 1788.0Repaid loans 8,968 10,007 2,387 2,309 -78 96.7Change in Net Foreign Assets 3,305 3,966 -2,145 -34,275 -32,130 Change in CBM foreign reserve assets (term deposits of CBM in foreign banks)

0 -35,084 22,267 57,351

BALANCE OF CURRENT ACCOUNT AND CAPITAL AND FINANCIAL ACCOUNT

-19,116 -60.620 -78,661 -55,314 23,347

NET ERRORS AND OMISSIONS -19,116 -60.620 -78,661 -55,314 23,347

GDP

Source: Central Bank of Montenegro

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9. REGIONAL COMPARISON This chapter presents a brief outlook on the most recent macroeconomic developments of Southeastern European (SEE). In the second part we discuss the issues concerning the membership of SEE countries in WTO and regional cooperation among those countries. 9.1 MACROECONOMIC INDICATORS The real GDP growth rates in Southeast European transition economies in 2002 slowed down and similar expectations prevail for 2003. Due to increasing openness, trade developments of the business cycle in the EU are becoming a significant source of real growth volatility for SEE in addition to domestic demand and private consumption in all SEE countries. Real GDP growth was positive in all southeastern countries in 2002 and ranged from 0% in Macedonia to 5.2% in Croatia and 6% in Albania. Romania, Serbia, and Bulgaria registered growth rates close to 4%, while Bosnia and Herzegovina 2.3% and Montenegro 0.8%. During 2003, most countries are projected to achieve similar growth rates, however, the 2 slowest-growing countries in the region hope to see their GDP growth increase: Montenegro to 1.5% and Macedonia to 2%. Graph 9.1 presents cumulative real GDP index starting with 1996 for most countries in the region.

Graph 9.1 Real GDP in SEE (1996=100)

80

100

120

140

160

180

200

1996 1997 1998 1999 2000 2001 2002

Albania Montenegro Bosnia and Herzegovina

Bulgaria Croatia Romania

Macedonia Serbia

Source: IMF, Vienna Institute and ISSP In 2002, industrial output grew in most countries in the region and the growth rates ranged from less than 1% in Montenegro to 8% in Croatia. Annual industrial output growth in 2003 varied significantly across the region; while Macedonia and Croatia registered a satisfactory 16% and 6% growth, BiH’s and Romania’s industrial production grew only by 2% in May year-on-year. Industrial production fell on an annual basis in Serbia (by 3.4% in May) and Montenegro (by 11.3% in April). Inflation in 2003 fell on an annual basis compared to year-end 2002 in all countries except for Bosnia and Herzegovina. The most pronounced decline took place in Romania (14% in

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June 2003 vs. 22.5% at end-year 2002), Montenegro (6.6% in June 2003 vs. 9.2% end-year 2002), Bulgaria (1.1% in June 2003 vs. 3.8% end-year 2002), and Croatia (0.9% in May 2003 vs. 2.3% end-year 2002). Inflation in the region falls due to the absence of demand inflationary pressures (weak domestic and external demand) as well as stable or appreciating currencies. Many countries in the region have tied their currencies to the € (Bulgaria, BiH, Macedonia) or decided to fully replace their currency with the euro (Montenegro). In these countries currencies are secured against depreciation which helps keep inflation down through stable import prices of tradables. The appreciation of the euro/USD exchange rate additionally strengthens the domestic currencies and makes an exchange rate an important channel contributing to disinflation. Remaining countries saw their currencies depreciate moderately (Albania) or quite substantively (Serbia and Romania), which is very clearly reflected in the higher inflation rates that these latter countries registered in 2002 and 2003. Table 9.1: Macroeconomic indicators of the Balkan countries

Albania

Bosnia and Herzegovina/

Republika Srpska

Bulgaria Croatia Macedonia Montenegro Serbia Romania

2001 6.0 4.0 4.0 3.8 -4.5 4.0 5.5 5.0

2002 4.7 2.3 4.3 5.2 0.7 0.8 4.0 3.8 Real annual GDP change

(in%) 2003* 6 -

4.0 (official 03Q1)

4.0 2 1.5 (official

forecast) 4.0 4.0

2001 - 12.2/-12.9 2.4 6.0 -23.2 -2.7 0.0 8.4

2002 2.0 9.2/-2.5 3.3 5.7 13.7 0.7 1.7 6.0 Annual change in industrial production

(in%) 2003 - 2.0/-1.6 (Mar) - 5.8

(Apr) 17.1 (Mar) -11.3 (Apr)

-3.38 (May)

1.9 (May)

2001 3.5 0.3/ 2.2 4.8 2.6 1.2 24.0 38.7 34.5

2002 2.1 -0.7/ 2.4 3.8 2.3 2.2 9.2 14.8 22.5 Annual

inflation rate (CPI, in %)

2003 1.9 (Mar) 0.5/ 0.4 (Mar) 1.1 (Jun) 0.9 (May) 1.9 (Mar) 6.6 (Jun) 14.0 (Jun)

14.0 (Jun)

Currency

name Lek

Convertible Mark; BAM

Leva Kuna Denar Euro Dinar Lei

2003 (per €)

136.0 (Jul)

1.956 (Jul) 1.942 (Jul)

7.498 (Jul)

60.478 (Jul)

1

66.00 (Jul)

36.536 (Jul)

National currency

annual change in %

2.7 0.0 0.0 1.0 0.0 - 8.5 11.7

2001 14.6 39.9/ 40.2 19.5 23.6 30.5 24.8 27.7 8.1

2002 15.8 42.7/ 38.2 16.3 23.0 31.9 23.5 28.5 8.8 Unemployment rate %

2003 - 43.1/36.6

(Mar) 14.9 (Apr)

21.0 (Apr) 30.0 (Mar) 22.0 (May) 31.8

(May) 7.4

(May)

2001 -22.6 -29.1 -11.6 -18.9 -15.3 -37.8 -26.1 -13.2 Trade balance (as % of GDP) 2002 -24.6 -38.0 -16.2 -23.5 -8.8 -26.2 -34.8 -8.6

2001 -6.1 -23.1 -6.5 -3.7 -6.9 -19.1 -5.5 -5.9 Current account balance (as % of GDP) 2002 -9.5 -22.0 -10.2 -7.1 -14.2 -13.6 -8.2

-4.5

Note: Data for 2001 and 2002 are end-of-period * Data for GDP in 2003 are Vienna Institute projections unless stated otherwise. Source notes:

Data for Montenegro are from ISSP database Data for other countries are from respective national banks Data about Croatian unemployment rate are from Croatian Employment's Office

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Considering unemployment in the region, it has to be mentioned, that due to the lack of reliable data, cross-country comparisons of unemployment rates should be done with the highest caution. Most SEE countries do not have experience in properly measuring unemployment rates and methodologies used across the region differ significantly. These problems notwithstanding, unemployment seems to be falling across the region when monitored in the time dimension for individual countries. Serbia and BiH are the only countries that registered higher unemployment in 2003 than at year-end 2002. All other countries have seen their unemployment rates drop by 1-2 percentage points1. Regardless of these changes, unemployment rates are still extremely high in the region. Bosnia and Herzegovina apparently has the highest rate, at approximately 40%, Macedonia and Serbia are at about 30%, Croatia and Montenegro are at about 20%, and Bulgaria and Albania about 15%. Romania remains the only country in the region with a single-digit unemployment rate, standing at approximately 7%. In this issue of Monet we comment on final BoP data for 2002. Trade balances in 2002 worsened in most countries across the region due to the weak export performance and stable or growing demand for imports. This is particularly visible for BiH, Bulgaria, Croatia, and Serbia. Macedonia, Montenegro, and Romania have managed to improve their trade balances (in terms of GDP) by several percentage points. However, Montenegro, along with BiH and Serbia still belong to countries with the highest trade deficit, exceeding 25% of GDP. Current account deficits were also higher in almost all SEE countries in 2002 than in 2001, albeit lower than trade deficits largely thanks to the positive balance of services (mostly due to tourism and transfers). Many countries, like Montenegro, Croatia, and Bulgaria are expanding their tourism sector and this is well visible in the current account statistics (for Montenegro, see also chapters 1 and 8 in MONET). This could be crucial for improving current account deficits, both in the short- and long-term. Romania and BiH improved their current account balance in 2002 vs. 2001, albeit BiH continues to maintain its status as the country with highest deficit in the region. Besides BiH where the deficit amounted to 22% of GDP, current account deficits in excess of 10% of GDP were registered in Bulgaria, Macedonia, and Montenegro. 9.2. REGIONAL FOCUS: WTO MEMBERSHIP AND REGIONAL COOPERATION BETWEEN SEE COUNTRIES In the process of integrating into the world economy, the countries of the SEE region should tighten regional cooperation and clearly define the institutions responsible for reforming their economies. This will undoubtedly enhance political stability in the region and foster successful catch-up with the EU countries. Currently many SEE countries are members of various regional and international organizations and have agreements that set preferential customs duties or otherwise facilitate conditions of foreign trade on a bilateral or multilateral basis. However, the major step and a priority for all of those countries should be to join the World Trade Organization (WTO) in the near future.

1 It has to be kept in mind, however, that this effect might be seasonal as employment and unemployment usually depend on the season.

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9.2.1. WTO Membership Because the World Trade Organization (WTO) is the only international organization with global reach dealing with rules of trade, becoming a member is a very significant step towards integrating into the world economy. WTO was established on January 2, 1995 and is located in Geneva, Switzerland. The main functions that the WTO performs are as follows: o Administering WTO trade agreements; o Providing a forum for trade negotiations; o Handling trade disputes; o Monitoring national trade policies; o Providing technical assistance and training for developing countries; o Cooperation with other international organizations. The main goal of WTO is to facilitate trade between countries and to help producers of goods and services, exporters, and importers to conduct their businesses. Currently, 146 countries are members of WTO. Major benefits they enjoy as members are better resolution of disputes, existence of clear trade rules, and defense against lobbying from narrow interest groups. Furthermore, on a macroeconomic level, better trade conditions brought about by the membership lead to higher productivity growth of their economies, reduction in costs of living, improved choice for domestic consumer, and hence higher incomes and faster economic growth. In the SEE region, only Serbia and Montenegro as well as Bosnia and Herzegovina are still not WTO members. Romania acceded to the GATT in 1971, being a signatory to almost all major Tokyo Round Agreements. Romania has also actively participated in all areas of negotiations in the Uruguay Round, expecting a more transparent, predictable and stable multilateral trading system to facilitate improved market access for Romanian products. This country continued to have full membership in WTO after its establishing in 1995. Bulgaria has been a member of WTO since December 1, 1996. Albania became the 138th member of the World Trade Organization on September 8, 2000. Croatia has been a member of WTO since November 30, 2000. Macedonia was set to join the WTO on April 4, 2003, following nearly ten years of negotiations. Bosnia Herzegovina applied for WTO membership on July 15, 1999 and is now in the process of negotiations. The country submitted a Memorandum on its Foreign Trade Regime in October 2002 and the first meeting about that may take place in late 2003. >Serbia and Montenegro submitted a request for Accession in January 2001. A Working Party was established at the General Council on February 8, 2001. The Memorandum on the Foreign Trade Regime was written in June 2002. The first meeting of the Working Group may take place in late 2003.

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The table below presents SEE countries’ membership in regional and international organizations. Table 9.2. SEE countries membership in regional and international organizations

Albania Bulgaria Bosnia and Herzegovina

Croatia Macedonia Serbia and Montenegro

Romania

WTO World Trade Organization

member member applied for membership

member member applied for membership

member

EU European

Union

In the accession process

- -

EU bilateral market

liberalization agreed on (see

separate document)

- In the

accession process

CEFTA Central

European Free Trade Agreement

- member -

member -

- member

EFTA European

Free Trade Agreement

- Free Trade Agreement with EFTA

- -

Free Trade Agreement with EFTA

- -

Source: TTFSE (www.ttfse.org) 9.2.2. Regional Cooperation Both the Southeastern Cooperative Initiative (SECI) and the Stability Pact for Southeastern Europe are devoted to creating a single regional trade and transport area. In the framework of the Trade and Transport Facilitation in South-Eastern Europe (TTFSE) Program a series of bilateral agreements were concluded along with common Southeastern-European Memorandum of Understanding. TTFSE is Trade and Transport Facilitation in the Southeastern European countries and has the aim to reduce or even eliminate customs duties and restrictions between member countries and to create a free trade area. TTFSE member countries are: Albania, Bulgaria, Bosnia and Herzegovina, Croatia, Macedonia, Moldova, Serbia and Montenegro, and Romania. The bilateral agreements of TTFSE countries with each other as well as with third countries facilitate the exchange of products and services traded between two signatory countries by reducing customs tariffs and other costs related to trade as well as eliminating all kinds of barriers that importers and exporters encounter in their business.

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Table 9.3. SEE countries bilateral agreements

Albania Bulgaria Bosnia and Herzegovina

Croatia Macedonia Serbia and Montenegro

Romania

Agreements with TTFSE countries:

Croatia FYR of Macedonia, Romania (Signed, application

by July, 2003)

Agreements with TTFSE countries:

Bosnia and Herzegovina (to be signed April, 2003)

Croatia (under CEFTA) FYR of

Macedonia Romania (under CEFTA) Other bilateral agreements: EU

accession agreement), Free Trade

Agreements with Estonia, Lithuania,

State of Israel, Turkey.

Agreements with TTFSE countries:

Bulgaria (to be signed April

2003); Croatia,

Macedonia, Serbia and

Montenegro.

Agreements with TTFSE countries: Albania,

Bosnia and Herzegovina,

Bulgaria (under

CEFTA), Macedonia, Romania (under

CEFTA), Serbia and

Montenegro.

Agreements with TTFSE countries: Albania,

Bosnia and Herzegovina,

Bulgaria, Croatia.

Agreements with TTFSE countries: Bosnia and

Herzegovina, Croatia,

Macedonia

Agreements with TTFSE countries: Albania, Bulgaria (under

CEFTA), Croatia (under

CEFTA), Moldova.

Other bilateral

agreements: EU accession

candidate.

Source: TTFSE (www.ttfse.org)

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PART 2

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COMMENT 1

INTERNATIONAL CONFERENCE “ECONOMIC POLICIES FOR A VIABLE MICRO STATE”

The Institute for Strategic Studies and Prognoses, in cooperation with Chesapeake Associates and Institute for Global Economic Growth, with the support of USAID, has organized an international conference “Economic Policies for a Viable Micro State”. The conference was held on June 23-24th in Podgorica.

This conference gathered over 200 people from 19 countries including: Albania, Belgium, Bosnia, Bulgaria, Estonia, France, Germany, Great Britain, Hungary, Italy, Kosovo, Lithuania, Macedonia, Montenegro, Romania, Serbia, Slovenia, Switzerland, and the United States. The Financial Times, the Economist, World Network News, Washington Times, and Serbian and Montenegrin local newspapers monitored the Conference. The international and local NGO’s, private sector, as well as representatives of the government, participated in the work of the conference. The official language of the conference was English. It would not be an exaggeration to say that this conference was a unique event in Montenegro, or for that matter in this part of Europe (Balkans), and that it gathered some very eminent economists and intellectuals, from our country and abroad. The conference was a great opportunity for all participants to hear new ideas and exchange views and opinions. Every session was followed with extensive discussions causing participants to “shake up” their minds and led them to think and exchange ideas. Prior to the official start of the conference, the Prime minister of Montenegro hosted the speakers for a dinner meeting. After welcoming remarks, the President of the ISSP, Veselin Vukotic, opened the conference by presenting a background paper on the subject of the Conference. In his opening remarks, he stressed the following: “Over the last five years, the ISSP has developed the idea of Montenegro as a microstate. The term microstate itself is more understood as a minimal role of state in the economy and limited political power of the state, as opposed to the mechanical application of criteria related to a microstate (territory, population…). When the criteria of a minimal state governance are applied to such a small state as Montenegro, the result is a microstate.” The first day of the conference was divided into three sessions: o Do Free Trade and Economic Freedom Contribute to Economic Development? Competition vs. Harmonization - moderated by Ms. Kate Thompson, Bearing Point, Chief of Party, and the speakers were: • Mr. Richard Rahn, Discovery Institute and Chairman of Novecon • Mr. Mark Miles, Director, Center for International Trade and Economics, the Heritage

Foundation • Petar Ivanovic, CEO ISSP o Optimum Size & Structure of Government to Maximize Economic Development – Tax Structure, Tax Competition and Best Fiscal Policy Mix - moderated by Ms. Jadranka Kaludjerovic, ISSP Program Director and the speakers were:

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• Daniel Mitchell, the McKenna Senior Fellow in Political Economy, The Heritage Foundation

• Ruta Vainiene, Latvian Free Market Institute • Slobodan Radovic, President of Montenegro Business Alliance o Can a Micro State be Economically Sustainable? Pro and Cons – Moderated by Ms. Dragana Ostojic, Central Bank of Montenegro Chief Economist, and the speakers were: • Robert Neff , Iur Director Liberals Institute Switzerland • Fletcher Hodges, Bearing Point, USA • Richard Eames, Economist Intelligence Unit, UK The second day was reserved for a session with the representatives of the Government of Montenegro on the subject – “What should Montenegro do to Intensify Economic Development?” To best provide a sample of what transpired at the conference, we have quoted the speakers. Richard Rahn: “This is a beautiful country. There are many things that it can hope for and expect. Why isn’t it rich? A couple of weeks ago, on my desk I had a new World Bank report that displayed a scale of countries and economies by people’s purchasing power. The sixth country, by World Bank estimate is Luxemburg, then the USA, Bermudas, Switzerland, and Liechtenstein. As you may notice, among these richest countries in the world, Liechtenstein and Bermudas have a smaller population then Montenegro. Of course the USA has a much larger population… This place should be rich and you see these small countries that have excellent life and make a lot of money…You have to have private property, and not just to have it but you must then protect it, and that means that you must have laws. That means that if someone owns something, something by which he can prove his ownership needs to exist. You have to abolish state ownership and privatize everything you can. And remember, privatization means putting something into private hands.” Mr. Mark Miles: “Whether free trade and economic freedoms contribute to economic development? I think that the right answer on this is: YES. Whether these are necessary conditions for development? Again, answer is: YES. Whether these conditions are enough for development? Here we have a problem. When we create an index of economic freedoms, we have 10 criterions by which we rank the countries. ... I will tell you on which things you need to focus, or pay special attention. First is trade policy – free trade is very important. Gains in trade do not come from our similarities, but from our differences. If we produce the same as everybody else and we want the same, then there is very little that we can offer to each other. But if we are different, there is a lot that we can offer to each other. … Also the customs rates are crucial.” Daniel Mitchell: “First question is what is contributing to a strong economy? Firstly, natural resources are certainly helpful, but the example of Hong Kong shows that resources are not necessary, and on the other hand there are a number of countries in the world that are rich in natural resources, but are not rich. Natural resources are important, but the economic structure influences whether your economy will be progressive, will it grow faster, will it create opportunities for your people? What development demands? It demands freedom – freedom for innovations, for production, freedom of choice. That means, that to maximize development, on which the development is depending, you have to have a small government, because a huge government uses large amounts that could find better use in the economy. When the government is large you have to pay high taxes.”

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Robert Neff: “The real danger for the freedom and identity of a small state comes from a rash development of parliamentarianism and the bureaucracy, the growth of public expenditure and continuous international unification of legal systems through the signing of state treaties and community agreements.” Fletcher Hodges: “Economies … are brought to life by the right kind of environment. You need an incubator, ingredients and electricity. Today, Montenegro has all these elements. Economic reform is the incubator; young people are the ingredients, and determination the electricity that can give Montenegro a sustainable economy. These elements, however, need to be mixed the right way. First, privatization and economic reform must be completed. Without clear laws, property rights and an effective judicial system you can’t create the trust and confidence you need to sustain economic activity. No citizen will deposit money in banks or businessman invest one Euro in Montenegro until economic reform is in place and working smoothly.” Petar Ivanovic: “The ISSP has been a proponent of and helped foster the idea of free trade in Montenegro. Ostensibly, many people in the Western Balkans support this idea. However once rhetoric is passed and action needs to be taken, it seems that some of these people who publicly support free trade are setting economic policies that create different kinds of protection, representing a burden for free trade. Free trade means eliminating burdens of all kinds for the exchange of goods, including very low customs rates (or eliminating customs rates), liberalizing import policies, simplifying procedures and legal protection.” Slobodan Radovic: “As more predictability and stability is brought into the system, foreign investors will begin to look seriously at bringing capital into the country.” During the lunch break, special guest of the conference, the Honorable Mart Laar, former Prime Minister of Estonia, spoke on the experiences of Estonia in transition. He also stressed that if Montenegro is heading for economic development, it must find its own way without listening to foreign advisors. As you can see there was a wide range of topics discussed and raised, all in all it was a very dynamic and interesting conference. General ideas that have been shared is that the role of government in the economy should be decreased, taxes should be reduced and flat rates introduced, trade policy should be liberalized, and that the only chance that a small economy has is to be open. Let’s look at the main conclusions of the conference: o Property rights need to be protected o In order to have development, trade must be liberalized and customs rates need to be as low as possible, preferably 0, because the only chance that a small economy has is to be open o The government does not make money, it just spends it o Taxes need to be lower or in some cases completely abolished (personal income tax, corporate profits tax) o Citizens and businessmen need to be aware of the actual level paid to the government for it services and what they are getting for that money, is the exchange equivalent o Small state can be economically sustainable, successful, flexible, and profitable o Minority rights need to be protected and the least minority is an individual o Economic freedoms are necessary o Small economy needs to specialize o Free capital flows

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And as a most important question of the conference, as we heard from some participants, is not whether the small state (in terms of geographic and population criteria and size of the government) can be economically viable, but can the small state (in territorial and population terms) can be viable if it does not have a small government. As a conclusion, we quote Professor Veselin Vukotic and his closing statement: “This conference has been a presentation of new ideas and young people. This conference has confirmed our approach toward economic reforms founded on economic liberty, market, and rule of law. We have discussed today our concept of Montenegro as a microstate. There are a lot of issues that we did not discuss, and we will do it in the future. This conference was a big test for our work in the last six years, since the Institute has been established. It took a lot of courage to realize this idea, however today’s result is very encouraging. Maybe, God was close to us… This big conference is a result of the hard work of many people (ISSP and the whole ERN network). They took responsibility for this conference. I’m sure that this network of young people has a bright future.”

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COMMENT 2

MONTENEGRO – MICROSTATE by Prof. Veselin Vukotić, President of ISSP

ABSTRACT Over the last 130 years, public consumption in today's developed countries has increased from 10% of GDP to approximately 45%. The decades of the sixties and seventies represent years when the idea of a great and powerful Government was extraordinarily strong – these were the golden years of Keynesians. Reaganism and Thatcherism were the first state policies aimed at reducing public consumption and redefining the role of the state. New industrialized countries in the world, which have achieved high economic growth rates, have had approximately half of the amount of public consumption as developed countries. Does this indicate that high public consumption impedes economic development? Where is Montenegro positioned in terms of the size of its state administration? All indicators show that Montenegro has high public consumption, at the same level as the most developed countries in the world, and twice as much as newly industrialized countries. How should Montenegro deal with the challenges and necessities of its new institutional framework and increase the efficiency of Government and state administrations? As the answer to these questions, this paper presents some elements of the concept Montenegro as a microstate. Our hypothesis is that products from Montenegro cannot be competitive in the global market with such high public consumption.

Key word: Microstate, Economic Freedom, Entrepreneurial Economy

*** PRELIMINARY REMARKS The ISSP has developed the idea of Montenegro as a microstate over the last five years. Microstate, in the sense we are using it here, is more focused on the state playing a minimal role in the economy and having limited political power, as opposed to the mechanistic application of criteria concerning microstates (size of territory, population, etc.). When you apply the criteria of minimal state governance to a small state, the result is a microstate. We wanted to discuss the idea of a microstate during an international meeting of reputable participants in Montenegro, such as this one. Up until this point, the concept of Montenegro as a microstate has been discussed in several meetings organized abroad, and the idea has attracted attention and interest. On the domestic scene, it was politically unacceptable and also attacked the famous sense of Montenegrin size and importance, which would have been negated by the term “microstate”. In order to understand this term in Montenegro, maybe it is time to start reading Negos’s “Luča mikrokozma”, instead of his “Mountain Wreath “!

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The purpose of this meeting is to discuss questions concerning the idea of Montenegro as a microstate. Above all, to discuss questions on economic policy making in: 1. a small state, like Montenegro1 2. the time of the creation of a new developing paradigm based on globalization and informatization, aka, the development paradigm of the twenty-first century Three key issues to be discussed today concern: (a) Tax rates and protectionism; (b) competitive policies and free trade; and (c) size of the state administration. A significant number of other issues will, hopefully, be discussed in another conference. Discussion of these issues should serve as an effective answer to at least three challenges Montenegro is facing: 1. Challenge of globalization 2. Challenge of harmonization within state union and EU 3. Challenge of new Constitution of Montenegro. The Constitution as a strategic vision of development, but not purely a legal act. The intended audience for this conference is above all, the young generation, those who know, on one hand, that they will live in a globalized world, and on the other, they have the necessity to retain their cultural and national identity. The objective of meetings such as this is not to make any final decision, but to send strong and effective messages -- messages based on arguments, and I hope that those who wish to present opposite opinions, as well, will also use this approach. 1. RELATION BETWEEN STATE AND ECONOMY Discussion of the role of state in economy is endless. Three elements are important in order to understand the role of state: 1. There has been an increase in the role of state, especially measured by participation of public consumption in GDP, evidenced during the past 130 years. According to Vito Tanzi, in or around the year 1870 (Berlin’s congress), public consumption as a percentage of GDP, was 10.8%, in 1913 it was 13.5%, in 1920 it was 19.6%, in 1960 it was 28%, in 1980 it was 41.9%, and in 1996 it was 45%. This 45% was not equally distributed among countries, for example, in France it was 55%, Germany 49.1%, Italy 52.7%, Sweden 64.2%, while in Switzerland 39.4%, Austria 35.9%, US 32.4%, Chile 19.9%, Argentina 22.5%, Malaysia 22.6%, and Mauritius 25.4%.2 How to limit the growth and influence of public consumption is a question that, during the 1980’s, was being asked across the world. 1 Montenegro is a small state, with populaton of 660,000 people. Gross Domestic Product (GDP) in 2002 was € 1,850 per capita. 2 Tanzi divides states into three categoris: small (Less than 40%), medium sized (40-50%) and big (more than 50% share of public consumption in GDP)

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2. The twentieth century is the century of socialism -- meaning a strong, paternalistic state in Eastern Europe. In Western Europe we had, and still have, the so-called snailing socialism, or the welfare state. The paternalistic state in Eastern Europe went to bankruptcy. But, regarding the welfare state, I am in a dilemma, and asking: What is the future of European capitalism?3 Is the welfare state simply a replacement for the paternalistic state? Does the path from a paternalistic state to a welfare state have to pass a phase based on cheating? 3. Is democracy, understood only as a majority role won in free parliamentary elections (which is the way most transition countries interpret democracy), sufficient protection for individualism, or the individual? Should we believe more in the honesty of political parties and politicians, or in a constitutionally arranged limitation of their power?4 Does the mental framework for understanding the relation between the state and the economy, based on three elements (high state consumption, welfare state and unlimited power of majority) provide enough scope to change the economic and political system in Montenegro? My question is: which is more important to change, ideas or interests? Here we are facing key philosophical differences between Adam Smith and John Maynard Keynes, with Adam as the founder of economic theory, and John as the founder of macroeconomics. It is interesting to note their significant ideological differences, given the fact that both were born on the same date (June 5). Actually, Smith insisted on personal interest, division of labor and free trade, and spontaneous market order, as Hayek said; while Keynes on the importance of planned, introduced planning, and constructivism in economy.5 The question is: Does higher public consumption (meaning lower level of economic freedom), lead to higher economic growth (as Keynes’s theory claims), or, does a higher level of economic freedom lead to faster growth?6 The 1960’s were golden years of Keynesians. Those were years of high optimism and the belief that the state is capable of solving all economic and social problems by increasing public consumption (increase of tax rates, customs, and public debt).7

3 Vivien A. Schmidt: “The Futures Of European Capitalism”, Oktoih, 2002 4 See Bjukanen: The Economics and The Ethics of Constitutional Order, The University of Michigan Press, Ann Arbor, 1991 5 “Each person”, Adam Smith said, “has its own egoistic and non-egositic part. Smith said that the nature of humans recommends to each individal to take care of himself, and it is more natural to take care of himself than of someone else. Even though we assume that individual may be selfish, it is obvious that some principles in human nature exist making him interested in bringing happiness to others and provide some joy” (Wealth of nation, Volume IV, page 43) 6 »Adam Smith was the first who proved that political interference in free market trade reduces economic wealth and individual freedom. But, Smith was naive, because he believed that government, when finally accepting the fact that protectionism-mercantilism makes only damages, rationally eliminate barriers. We know that government won’t do that. They will act according to their interests, to attract voters. This will initiate the game between interests to introduce protectionism« (Dž. Bjukanen: The Economics and The Ethics of Constitutional Order, The University of Michigan Press, Ann Arbor, 1991, page 247) 7 Generation of old economists criticize liberal approach and economic freedom, as resulted of their »ideological« basis and makes an argument that we should return to the sixties (or even thirties – Keynes and Galbrajt). But, the question is, if that model was successful, why did it fail? Maybe, as Madzar said, the model was self-destructive? Why didn’t that system, which was created after the Big Economic Crisis (1929-33) and the Second World War (1939-1945), survive the big oil crisis from the seventies? How that Reaganism and Thatcherism as philosophies of economic freedom increase were born in eighties?

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Empirical analysis of Vito Tanzi shows that the indicators do not support this idea. As Tanzi says, “our analysis does not show that small governments (less than 40% share of public consumption in GDP-V.V) produce less desirable socio-economic indicators than big states” (more than 50% share of public consumption in GDP-V.V).8 Additionally, in a significant number of papers and studies, the level of relationship between economic growth and economic freedom was analyzed. In a paper by Naau and Stern9, where this interrelation was analyzed for the period 1975-1992 in 80 countries, and based on the Index of Economic Freedom by the Heritage Foundation and Fraser Institute, the final conclusion is that economic freedoms accelerate economic growth, but also that the level of economic freedom does not directly influence the level of economic growth. Toretenjson showed that insecurity in terms of property rights protection leads to a slowdown in economic growth10. Analysis of public consumption done by Vito Tanzi in newly industrialized countries shows that in these countries, the current level of socio-economic development has been achieved with lower levels of public consumption (lower share of PC in GDP). Also, the level of public consumption in newly industrialized countries is still lower than industrialized economies, and amounts to 18.2% of GDP.11 These indicators from newly industrialized countries (Singapore, Korea, Hong-Kong, Chile, Mexico, etc.) should be analyzed in terms of understanding the role of state in those countries. Their approach is not based on the pro-consumption attitude that was characteristic of western countries during the 60’s and 70’s in the previous century. While many industrialized countries did experiments with Keynes and created welfare states, new industrialized countries encouraged economic growth and economic policies based on market and economic initiatives, while retaining public consumption at the same level.12 Also, in successful newly industrialized countries investment in human capital was high (education and health). Structure of public consumption in these countries is, approximately: one-third for government consumption, one-third for subsidies and transfers, and one-third for public investment. The cumulative total of these is less than one fifth of GDP. Even though public consumption in these states was low, average growth rates were three times higher than in developed countries. These countries still have good performance in terms of economic and political freedom and employment, as we can see from the table 8 Vito Tanzi, L.Schiknecht: Public Spending in the mid-20th Century, Cambridge, 2000, str.119. »In areas as economy, labor market, financial management, and environmental protection, small government makes better results than in countries with big government and public consumption« (page.119). See table II (Annex) 9 Jakob de Naau, Jau-Edgert Stum: On The Relationship between Economic Freedom and Economic Growth, University of Groningen, 1999 10 Tortenson J. (1994): Property Rights and Economic Growth, An Empirical Study, Kuklos, 47 11 Annex: table I 12 »In Singapore, Lee Kuan Yew, architect of the postcolonial success, believed that policy should focus on a few key principles of good governance promoted by many political philosophers, including Adam Smith or David Hume, such as: »maintaining the rule of law and the sanctity of property rights, fair commercial practices, a level playing field between all players whether they be well-connected insiders or unconnected outsiders, and transparency and accountability in decision making«. The application of these principles has made Singapore one of the freest economic areas in the world today. In Hong Kong, governments did not reject public intervention as a matter of principle but believed that: »The primary role of government is to provide public services and economic infrastructure which only the government can sensibly provide« (Haddon-Cave, 1984). In this, Haddon-Cave is essentialy restating Adam Smith`s views on the proper role of government. The provision of services was often transferred to the private sector, and consumers had to pay for the full costs of services.

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attached in the annex (table I).13 The experience in newly industrialized countries sends the message that those countries achieve the same level of economic and social indicators as developed countries but public consumption is significantly lower. Why? 2. RE-DEFINITION (NEW DEFINITION) OF ROLE OF STATE Analysis of Public Spending in developed countries worldwide shows the necessity of redefining the role of state, or level of public expenditures. The question is, what level of public expenditure is necessary to respond to the challenges of growth and globalization in the 21st century. The answer is: It is not necessary to have such high public consumption. This is shown by experience from newly industrialized countries, as well as from the experiences of some transition countries. The ongoing re-definition of the welfare state, starting with Reagan and Margaret Thatcher14, and the privatization of public services in western countries, also support this view. At the theoretical level, these issues are being discussed between monetarists and supply-side economists15 and new institutional economists16. More or less, the accepted conclusion is that it is necessary to reduce the size of the state in industrialized countries by decreasing public consumption. Many changes inside countries and within the international community influenced the need for important reforms. Reforms that were not possible in the past, but today are. The state has to use all advantages from the new environment (globalization, informatization, openness) and reform its fiscal regime, but also it must reduce its role in production of goods and services. Its new role has to be in establishing adequate game rules, for economic actors and for itself! More realism in what the state should do as well as pressure from globalization for small and efficient government will enforce the change of the state’s role in that direction. Privatization in many government services, including infrastructure, reform of education, pension system, and health system, in the direction of more involvement from private sector, is the basis for state reform in industrialized countries. This should lead to a reduction in the so called distributive role of state or, to avoid the situations where individuals or households are at the same time getting a service from government and paying taxes (“Fiscal Churning”). By avoiding “Fiscal Churning”, Vito Tanzi estimated that public consumption would be reduced from 50% of GDP to 32%.17 An indicative goal of public consumption reduction is to 30% of GDP in industrialized countries and around 20% in new industrialized countries18.

13 Annex: table III 14 Harvey Feigenbaumol and other: »Shrinking the State«, Cambridge, 1999 15 Lukas Robert, Jr. and Thomas J. Sargent: Rational Expectations and Econometric Practice, Volume 2, The University of Minnesota Press, Minneapolis, USA, 1981 16 Oliver Wi lliamson and Scott Masten: »The Economics of Transaction Costs«, An Elgar Writings Reader, UK i US 17 Table IV (Annex) 18 Vito Tanzi; ibid, “Our short survey indicates that the role of the state declined in several countries since the early 1980s. Our review of public expenditures in many countries has convinced us that 30 percent of GDP may be a reasonable target for public spending in industrial countries. This is, of course, only an indicative target that can be used as a general reference for industrial countries. One would expect that some countries would aim at higher and some at a lower figure. Newly industrialized countries may be well advised to maintain the public spending level at about 20 percent of GDP.

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3. WHERE IS MONTENEGRO IN THE CONTEXT OF THE MEGA TREND OF THE REDUCTION OF PUBLIC CONSUMPTION AND REDEFINITION OF THE ROLE OF STATE? The answer must begin with a few facts concerning Montenegro. Actually, there is no universal recipe for transition as a whole, as well as for the role of state in that context. The population of Montenegro is 660,000 with an area of 13,812 km2, or per capita 0.02 km2. GDP in Montenegro in 2002 was € 1.221 billion or € 1,850 per capita. The official number of employed in Montenegro is 114,000, while in state administration there are 37,336. The estimated number of employed persons is 202,000. Does Montenegro have “the big state “? In order to analyze this, we will take two indicators: 1. Share of public consumption in GDP 2. Index of Economic Freedom in Montenegro Public consumption. Analysis is based on official fiscal statistics, excluding expenditures related with new union of states of Serbia and Montenegro.

Table 1: Share of public consumption in GDP in Montenegro

Year Public consumption

Million €

Gross Domestic Product (GDP)

Million €

Share of Public Consumption in GDP

%

1994 255.7 524.8 48.7

1995 243.3 536.4 45.4

1996 290.0 718.2 40.4

1997 470.3 729.1 64.5

1998 349.8 751.0 46.6

1999 320.8 694.8 46.2

2000 374.0 781.3 47.9

2001 443.6 1,049.0 42.3

2002 507.5 1,221.0 41.6

2003 555.9 1,327.0 41.9

2003** 600.9 1,327.0 45.28

*Data in current prices. Nominal yearly changes ** Finance of Union of States of Serbia and Montenegro included

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Share of public consumption in GDP-%

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

If we include expenditures of Union of States of Serbia and Montenegro financed by Montenegro (approximately € 45 million), the share of public consumption in GDP would be 45.2%. In the chart below, the position of Montenegro compared with positions of industrialized and newly industrialized countries is presented .

Chart 1. Share of public consumption in GDP

0

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20

30

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Big states Medium states Small states Montenegro New-industrialized states

% o

f G

DP

- “Big state” – share of public consumption in GDP more than 50% - “Medium sized state” – share of public consumption in GDP between 40- 50% - “Small state” – share of public consumption in GDP less than 40%

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In table below, participation in finance of state per capita is presented. Table 2: Public Consumption per capita

Year Public Consumption

per capita EUR

GDP per capita EUR

1994 402.5 826.1

1995 381.0 839.9

1996 451.1 1,117.1

1997 727.2 1,127.3

1998 537.6 1,154.4

1999 490.1 1,061.5

2000 568.1 1,186.9

2001 669.9 1,584.1

2002 763.3 1,836.5

2003 832.8 1,988.0

Public services are main employers in Montenegro. In total, 37,336 people are employed in the public sector (Education, Ministry of interior, State Administration, Health, and other services). It accounts for 32.8% of official employment in Montenegro. Salary expenditures (wage bill) are 55% of public consumption, respectively, according to the estimation of World Bank, 12% GDP.

Table 3. Public Sector Employment in Montenegro

Public Services No. of Employees

Education 13,525

Ministry of Interior/Police 7,718

State Administration 5,985

Other 1,608

TOTAL PUBLIC SERVICES 28,836

Health Services 8,500

PUBLIC SERVICES &HEALTH 37,336

Total Employment 202,000

Officcial Employment 114,000

Public services & health as % of total employment 18.5%

Public services & health as % of offcial employment 32.8%

Graph 2. Participation of Wage Bill in Public consumption

100

55

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120

Total public consumption Wage bills

Graph 3. Participation of Employed in Public Services

100

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120

Total number of employees Number of employees in publicsector

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The weight of tax burden that is determined at work is quite high, even with low-level incomes. The marginal tax rate is high, even for a minimal salary of €50 the tax rate is 37%, while at a salary of €300, the rate is 45%. Additionally, the employee pays direct taxes and contributions and the employer also pays direct taxes. When direct taxes that are paid by employee and employer are added, then at a gross salary of €300, net salary is almost equal to the amount of direct taxes paid. Under these conditions, is it reasonable to expect employers to seek new employees and decrease the gray economy (non – taxed economy)? Not likely. Table 4. Tax Burden on salaries

Category € € € €

1. Gross salary of a employee 50.00 100.00 200.00 300.00

2. Employers expenditure 61.00 122.00 244.00 366.00

3. Net salary of a employee 40.00 71.50 133.17 191.83

4. Direct tax gap (=2-3) 21.00 50.50 110.83 174.17

5. Tax gap as % of net salary of a employee 52.5% 70.6% 83.2% 90.8%

Graph 4: Tax Burden on Salaries

300

366

191

0

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150

200

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Gross salary Employers expenditure Net salary

Characteristic of present tax rates is: 1) High public consumption 2) High tax burden With the tendency in the world to decrease public consumption to 30% of GDP in industrialized countries and to stay at about 20% in newly industrialized countries, those that are much more developed than Montenegro, we have a problem in Montenegro. How do we shift from 45% of public consumption in GDP to 20%? Is the Montenegrin product with participation of public expenditure at 45% competitive at world market?

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Graph 5: Participation of Public Consumption in GDP

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1 2

% o

f G

DP

????????

Another indicator of state size is economic freedoms. One of the measures of economic freedoms is Index of Economic Freedoms of the Heritage Foundation. Among 156 countries, Serbia and Montenegro are ranked at 149 together with Uzbekistan and Belarus. If economic freedom, as surveys are showing, is assumption of growth, should we expect economic growth under the existing institutional framework in Montenegro? Table 5. Components of index of economic freedom in several countries – comparative analysis

Component of index S&M Estonia Lithuania Cuba Albania Slovenia

1. Trade policy 4 1 2 3 5 4

2. Fiscal limitations 3.5 3.5 3.5 4.5 3.5 4

3. State interventions 4 2 2 4 3 2

4. Monetary policy 5 2 1 5 2 3

5. Foreign Investments 5 1 2 4 2 3

6. Banks and finance 4 1 2 5 3 3

7. Salaries and prices 3 1 2 5 2 2

8. Property rights 4 2 3 5 4 3

9. Regulations 5 2 3 4 4 2

10. Gray economy 5 2.5 3 5 5 2.5

Index of economic freedoms 4.25 1.80 2.35 4.45 3.35 2.85

Range in world 149 6 29 155 104 62

Index has four scales of freedom: 1. Free countries – countries with a score of 1.95 or less 2. Mainly free (score from 2 – 2.95) 3. Mainly non-free (score from 3 – 3.95) 4. Non - free (repressive) – (score 4.0 or more). Source: 1993 Index of Economic Freedom, Heritage Foundation If the level of economic freedoms is assumption of economic growth in Montenegro, and it is, then the question is: How do we increase economic freedom in Montenegro?

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Graph 6: Index of economic freedom

0

1

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4

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Repression

Freedom

Based on this data, I do not question, as many do -- including some international organizations, whether Montenegro, with such high public consumption, can survive. The question raised by researchers of ISSP is different: How should Montenegro develop? How should we provide a sustainable level of modernization and cultural renaissance? Our answer is that Montenegro in the longer term should follow a development concept named “Montenegro as a microstate”! 4. MONTENEGRO – MICROSTATE19 The goal of today’s event is to discuss some segments of this concept. Respectively, those are polices applicable at microstate. Other questions will be successively discussed. The concept of Montenegro as a microstate is a concept of comprehensive political, economic, and cultural turnover. It is about changing the concept of systems and institutions that would enable faster integration into the region, Europe, and world organizations. As a result, Montenegro should experience an increase in the quality of life of its citizens. Our starting point is that each country in transition has its specificities, cultural, historical, mental, and others that should be taken into consideration when choosing a reform model and method of implementation. There is no universal solution and mechanical transfer of others’ experiences. The type of reform undoubtedly depends on size of state, population, resources, geographic position, as well as other factors.

19 More details: Veselin Vukotić:«State and transition«, Milocher conference, 2001 i »Montenegro – microstate«; Veselin Vukotic: Macroeconomic trends and Economic Reforms in Montenegro, Suedosteuropa-Gesellschaft, Germany, 2003

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The key idea of a microstate is to build, instead of a paternal all-encompassing, but weak state presence as we have now, a minimal but strong state. It is a liberal approach to the development of relations between state and economy. It is an approach that refuses the concentration of power and stresses individuals and their freedom in creation. This approach specifically shows the importance of: 1. Moral 2. Law 3. Institutions to the behavior of people. A liberal economy is not a non-regulated economy, as well as relations in the majority of families are not without regulations. Liberalization is rule of law, rules, institutions, and not rule of citizens, leaders, groups, political parties, etc. According to this approach, our Institute and our Economic Reform Network do not understand economy as one organism, as an engine searching for an engine driver. Buccanen’s understanding of economy, as a group of rules and institutions that influence the behavior of an individual is acceptable for us. “Economy doesn’t have a purpose, or goal, or career”, says Buccanen. An important mental conclusion deriving from this is: economy is different from a company. Company has a purpose – it is the creation of profit in a market game. Economy, by itself, does not have a purpose – it is an institutional framework for the game. What is the subject of reforms? Concerning that question, our Institute and Economic reform network are different from a large number of local experts, NGOs and political parties: In our opinion, subject of reforms is institutional framework, rules of game, and not just a game! Our critics say that the subject of reforms is also a game, and that the state has to be included in work of enterprises, to help them, invest money in them (where does state get money?) Our concept is that the state is like the referee in sport. It is there to protect a change of rules made in a democratic procedure. It should perform its role very strictly, without exceptions, and transparently. Criticizers of the liberal approach, especially politicians, say that the state must “participate in the game”, thinking, how will enterprises know what they should “if I don’t show them that”? Imagine a referee in sport participating in the game? What does “rule of law” look like in that case? Our concept is not based on the engine- driver, on locomotives pulling forward, at tracks constructed in advance leading to an exactly determined goal. In our concept each individual is important, its energy and creation, each entrepreneur, investor, and manager is important. In our concept people are not just passive passengers in a locomotive driven by an “all-

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knowing engine- driver”. In the beginning it may be a set of attempts and mistakes, but then it is a ride on tracks toward a bright future! There is no constructivism in our concept nor do we believe in all-knowing individuals and a so-called all-knowing mind. The knowledge of each individual is limited. Life has much more spontaneity and unknowns than the followers of Newton’s understanding think. This is the time when Einstein’s “relativity principle” is accepted, or Haizenberg’s “principle of non-determinacy” or the “black holes of universe” of Steve Hoking. Devotion to a minimal role of state means: 1. Openness of micro state in all areas (“open state”) 2. Small but strong authority in legal protection a. Rights of individuals b. Protection of property rights c. Protection of contract freedom and execution of contract 3. Transparency Why can’t a microstate or a very small state rely on big paternalistic power? 1. Microstate has to avoid imitation of big states in respect to the structure of public

administration. It makes large expenditures, which increases taxes and decreases competitiveness.

2. Large administration in a small state creates the danger that the majority of the population works in state administration and Para-state institutions. It endangers democracy and sovereignty of individual (dependence from state). Who is going to make income for such large administration? Who is going to pay tax in order to support such large administration?

3. If a state is small, its internal market is small. This is the case of Montenegro. Companies cannot grow very large based solely on a market of such small power, but have to focus on export markets out of Montenegro, which requires openness of the economy.

4. The power of the economy has to be greater than the power of state, specifically politics. Our insisting on openness and market unavoidably raises the question: how can we increase the competitiveness of Montenegrin products at market? Increased competitiveness is the essence of the concept of a microstate!

5. MICROSTATE, OR HOW TO INCREASE COMPETITIVENESS OF MONTENEGRIN PRODUCTS TO A WIDER MARKET? Discussion about this question includes: 1. Selection of type of economy and macroeconomic policies 2. Reform of administration 3. Constitutional and political changes a) Selection of Type of Economy and Macroeconomic Policies The state has to stimulate a type of economy that is based on economic freedoms, on entrepreneurship, on individual creativity, and on efficient management. The role of the new state administration in macroeconomic policy in Montenegro should be considered in this context, and particularly how this influences the size and organization of state administration.

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Macroeconomic policies in our model are based on the following principles: Monetary policy. By the introduction of the Euro, the function of monetary authority no longer rests with Montenegro. Foreign trade policy. Openness of microstate requires a liberal trade policy, i.e. abolition of all barriers, quotas, contingents, tariffs. Fiscal policy. More and more international standards should be accepted, lower taxes, and a wider tax base, a transparent budget. Policy of regulation of utilities (especially after their privatization, in the areas of telecommunications, energy, media, and water supply). Regulation should be based on international standards. Development policy. Attracting investors and development of entrepreneurship as well as investments in human capital. In order that the state answers these macro economic policy requirements, a new organization of state administration should be established, with a professional instead of political basis. A new understanding of the role of state administration, its size, and organization in respect of macroeconomic policies, is influenced by: 1. Necessary increase of participation of private sector in public services. Public services shouldn’t be organized just by the state, but also by private investors and entrepreneurs. It is a mega trend in the world 2. Transparency and the importance of transparency in a microstate. It is much more important in a microstate than in a large state (disabling rent-seeking and corruption). 3. Role of independent institutions, associations and NGOs should increase. Governments are losing monopoly positions. Additionally, a larger number of people are included in the creation of market institutions and participate in public life. Based on this role of state and macroeconomic policies, what type of economy is suitable for a microstate? 1. Entrepreneurial economy, an economy where market is more important than state, big companies than political parties, economy than politics. 2. Importance of non-material factors of production in that type of economy is enormous: knowledge, information, and services. These factors are becoming more important than its resources. 3. Importance of small and medium enterprises and their flexibility. Does state redistribution increase income? Can we believe in the statement: higher state consumption has multiplicative effects on development? That is not the case in a small state. In short, if they want future generations to live better, the citizens of Montenegro will have to produce more goods and services that are not based solely on natural resources, but on knowledge, creation, and, above all, entrepreneurship!

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b) Organization of state administration In order to satisfy the requirements of an entrepreneurial type f economy, it is necessary to establish and build new principles of functioning of state administration at all levels – municipality, local, and republican. Key principles are: 1. Practicality, i.e. efficiency in production of services (importance of results) 2. Rationality: total costs of administration have to be bearable for citizens. 3. Directness: direct connection with citizens (decrease in transaction costs) 4. Internationalization of business and behavior: ability to communicate with environment 5. Transparency and publicity: holding back personal relations and discretionary power. 6. Anticorruption: reduce possibility of using public function in private purposes 7. Professionalism: creation of professional instead of political obedient administration at all levels Some practical steps: 1. Strategy of marketization (“narrowing state”): privatization of state companies and introduction of private sector in public services (strengthening role of private agencies) 2. Decrease administration at all levels (not mechanically but in accordance with the concept of microstate). For example, decrease the number of ministries to a maximum of seven. 3. Montenegro, in this concept, doesn’t need an army or military service. 4. Decrease the number of police and increase their professionalism. 5. Montenegro has to have several embassies and representative offices abroad. 6. Introduction of E-governance and government without paper. 7. De-monopolization of state education and University 8. Reform of education financing and preparation for introduction of vouchers in this area. 9. Introduction of English language as the official second language. 10. Development of philanthropic activities. 11. Larger investments into culture, art, sports. 12. Development of NGO and institutions of civil society. c) Political reforms in Montenegro All of these ideas have to be considered within the scope of changes of the Constitution and political reforms in Montenegro, policies of changes. One question is whether Montenegro has to introduce a presidential system or more efficient combination of presidential – parliament system. It is a question requiring serious discussions. We are, in this phase, supporting the introduction of a presidential system. 6. INSTEAD CONCLUSION There are three key messages of this paper: 1. The motto of our understanding of economy is “Even God encourages Entrepreneurs”.

Why shouldn’t state and state administration encourage them too? 2. If we want to live in the light of integration and internalization then we have to

understand that Smith’s free trade and division of work is a precondition. 3. If we want to live in peace, we have to understand Hayek’s message that “the market is a

mechanism that makes friends from enemies “.

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*** Literature: 1. Adair Turner: Just capital – the liberal economy, MacMillan, 2001 2. Anderson Lisa (editor): Transitions to Democracy, Columbia University Press, New York, 1999. 3. Ann Bernstein: Business and Democracy, Center for Development and Enterprise, South Africa and Bost University, ISEC, 1998. 4. Bastija Frederik: Ono što se vidi i ono što se ne vidi, Institut za strateške studije i prognoze (ISSP), Podgorica, 2001. 5. Bastija Frederik: Zakon, Global Book, Novi Sad, 1998. 6. Cristopher Pollit, Geert Bouckaert: Public Management Reform, Oxford, University Press, 2000 7. Fridrich Hajek: Kobna ideja, CID, 1999 8. Harvey Feigenbaum i dr.: Shrinking the State, University Press, Cambridge, 1999. 9. The Heritage Foundation: 2002, 2003 Index of Economic Freedom 10. John Saliven: Ne bojte se globalizacije, Economist, Beograd, 6/5/01 11. Joseph E. Stiglitz: Economics of the Public sector, third edition, New York – London, 2001. 12. Karl Poper: Otvoreno društvo i njegovi neprijatelji, BIGZ, 1990 13. Kenichi Ohmae: The End of the National State, FP, New York, 1996 14. Klaus Ofe: Modernost i država, “Filip Višnjić”, 1999. 15. Kornai Janosh: Reforming the State, Cambridge University Press, 2001. 16. Ljubomir Madžar: Politički uzroci siromaštva, Sremski Karlovci, 2000 17. Mijat Damjanović, Snežana Đorđević: Izazovi modernoj upravi i upravljanju, hrestomatija, Timit, Beograd, 1995 18. Miroslav Prokopijević: Konstitucionalna ekonomija, Beograd, 2000 19. Nikola Đonović: Zahtjevi Crne Gore, knjižara Hajduković, Bar, 1936 20. Norberto Bobbio: Liberalizam i demokratija, Novi lider, Zagreb, 1993 21. Peter Drucker: Post-kapitalističko društvo, Grmeč, 1995. 22. Ray Mac Sharry: The making of the Celtic Tiger, Mercer Press, 2000 23. Robert Dal: Poliarhija (participacija i opozicija), “Filip Višnjić”, Beograd, 1997. 24. Schmidt Vivien: The Futures of European Capitalism, Oxford University Press, 2002 25. Sofreco: Okvir za politiku plata i zapošljavanja u javnom sektoru u Crnoj Gori, Podgorica, 2002 (interni materijal) 26. Tanzi Vito, Schuknecht Ludger: Public Spending in the 20th Century – A Global Perspective, Cambridge University Press, 2000 27. The Economist: Economics – Making sense of the modern economy, London, 1999 28. The Economist: Economics – Mistery of Capital, London, 1999 29. Veselin Vukotić: Ekonomske reforme u Crnoj Gori, međunarodna konferencija “Budućnost Crne Gore”, Brisel, 2001. 30. Veselin Vukotić: Makroekonomski računi i modeli, CID, 2001. 31. World bank: The State After Communism, 1996 32. Yergin Daniel: The commanding Heights, The Battle between Government and the Market place, Atoncestone Book, 1996

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Annex

Table I: Size of Government and Public Expenditure Composition, about 1960 and 1990 (percent of GDP)

Industrialized countries

Big Governmentsa Medium-sized Governmentsb Small Governmentsc

Newly industrialized

countriesd 1960 1990 1960 1990 1960 1990 1990

Total expendituree 31.0 55.1 29.3 44.9 23.0 34.6 18.6

Consumption 13.2 18.9 12.2 17.4 12.2 15.5 9.1 Transfer and Subsidiesf 11.9 30.6 10.4 21.5 6.9 14.0 5.7

Interestf 1.5 6.4 1.3 4.2 1.3 2.9 1.5 Investmentf 3.1 2.4 3.2 2.0 2.2 2.2 2.7 Expenditure by function

Health 2.6 6.6 3.0 5.9 2.3 5.2 1.8 Education 4.5 6.4 2.9 5.6 3.4 5.0 3.3 Social Security 13.5 19.5 9.6 13.9 6.2 7.9 1.0 Research and Development

2.0 1.6 2.0

Environment 0.6 0.8 0.7

Source: Compiled by Tanzi and Schuknecht from previous tables a Belgium, Italy, the Netherlands, Norway, Sweden (public expenditures more than 50% of GDP in 1990) b Austria, Canada, France, Germany, Ireland, New Zeland, Spain (public expenditures between 40- 50% of GDP in 1990) c Australia, Japan, Switzerland, UK, USA (public expenditures less than 40% of GDP in 1990) d Chile, Hong Kong, Korea, Singapore, early 1990s e Please note that the components of total do not add to the totals because some expenditures are not netted out from the subcategories f Central Government, 1972 instead of 1960 for interest and dividends. Transfers and subsidies for 1960 is mostly general government. Table II Size of Government and Governance-Related Indicators, about 1990 (Percent of GDP)

Industrialized countries

Big Governments Medium-sized governments

Small governments

Newly industrialized countries

Economic and Political freedom indicatorsb

Political rights 10.0 10.0 10.0 7.5

Civil liberties 10.0 9.9 10.0 7.5

Economic freedom 6.6 7.2 7.6 7.5

Administrative efficiency indicatorsb

Efficiency of judiciary system 9.3 8.6 10.0 8.3

Red tape 8.1 7.8 9.0 8.9

Corruption 8.2 8.2 8.1 7.2

Regulatory Efficiency indicators

Size of shadow economy 17.7 12.0 9.4

Patents/10,000 population (intentiveness coefficient, 1990)

2.0 2.3 8.6

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Table III Government Performance Indicators, Selected “Small” Governments, and Newly Industrialized Countries, Early 1990s (% of GDP)

Industrialized countries Newly industrialized countries

United States Japan Switzerland Chile Korea Singapore

Economic Indicators

Economic Growth (percent, 1991-5)

2.3 1.3 1.6 7.4 9.5 8.8

PPP-based per capita GNP (US$, 1995)

26,980 22,110 25,860 9,520 11,450 22,770

Inflation (1991-5) 3.2 1.4 3.2 13.9 6.2 2.5

Gross Public Debt (1994-5) 64.3 81.3 48.2 17.4a 8.0 15.2

Labor market indicators

Unemployment (mid 1990s) 5.4 3.3 4.7 4.6 2.4 2.7

Social and distributional indicators

Life expectancy (1995) 77 80 78 76 72 77

Infant mortality (per 1000 live births)

9 4 6 12 10 4

Secondary School enrollment ratio

97 96 91 70 93 84

Educational attainment (mathematics scores, eight grade students, 1994)

500 605 545 607

Income share of lowest 40% of households (about 1990)

15.4 17.7 18.1 10.5 19.7 17.3

Economic and Political freedom indicatorsb

Political rights 10.0 10.0 10.0 7.0 9.0 7.0

Civil liberties 10.0 10.0 10.0 8.0 8.0 7.0

Economic freedom 8.0 7.3 7.9 6.2 6.7 8.2

Administrative efficiency indicatorsb

Efficiency of judiciary system 10.0 10.0 10.0 7.3 6.0 10.0

Red tape 9.3 8.5 10.0 9.3 6.5 10.0

Corruption 7.8 6.7 8.8 7.9 4.3 9.3

Sources: Tables 2.10-2.12a a External Debt only b Ranking between 0 = worst and 10 = best Table IV. Level of Fiscal Churning in Selected Industrial Countriesa (%)

Country/Year Churning as a percentage of income taxes and transfers

Government expenditure as a % of GDP

Public expenditures without Churning

United States (1995) 9.0 32.9 23.9

Japan (1994) 11.6 34.4 22.8

Germany (1994) 15.7 48.9 33.2

Italy (1993) 22.7 57.4 34.7

Canada (1994) 11.7 47.5 35.8

Australia (1993-4) 6.5 36.8 30.3

Belgium (1995) 23.7 53.8 30.1

Denmark (1994) 28.0 59.3 31.3

Finland (1995) 15.5 57.9 42.4

Netherlands (1994) 21.1 52.8 31.7

Sweden (1994) 34.2 68.3 34.1

Average 18.2 50.0 31.8

Source: Arranged from OECD Economic Outlook (june 1998), p.163 a Fiscal churning measures the extent to which the same households both receive government payments and pay taxes.

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COMMENT 3

WHY FREE TRADE IS IMPORTANT FOR MONTENEGRO By Petar Ivanovic, Excutive Director of ISSP 1. INTRODUCTORY REMARKS The Institute for Strategic Studies and Prognoses (ISSP) has been a proponent of and helped to foster the idea of free trade in Montenegro. Ostensibly, many people in the West Balkans support this idea. However, once the rhetoric has passed and the time for action has come, some of those people who publicly support free trade are setting economic policies that in actuality represent burdens for free trade. Free trade should eliminate burdens of all kinds for the exchange of goods; this would include having very low custom rates (or eliminating custom rates), liberalizing import policies, simplifying procedures, and providing legal protection. Those who are opposed to free trade base crucial arguments on the subjective assumption that the economy, or some weak part of it, needs to be protected. Their thought is that by increasing the custom rates, the economy is protected. However, three questions remain unanswered: o Do higher custom rates protect domestic employment (protection of workers in non-developed sectors of the economy)? o Do higher custom rates protect domestic production and its contribution to the GDP? o Do higher custom rates protect against the comparative advantage of those countries that threaten us with possible import of cheaper products (lower wages, better resources)? If you ask politicians in Montenegro, “is it good to increase the custom rates and protect domestic production”, the answer is yes! If you ask the question, “is it good to introduce a tax on exported products”, the answer would be NO! Politicians in Montenegro are no different from those in the rest of the world. The signers of the American Constitution, in the first article, forbid tax on the export of products, but the first session of Congress began with questions of imposing custom rates. 2. CONCEPTUAL FOUNDATION This paper is based on three principles of free trade. First principle: tax on import is tax on export – Tax on import is equivalent to tax on export. Any import constraint has an effect, as it is an export burden, and vice versa. When the government takes an initiative to increase exports, an increase of imports will also occur, as export and import are two sides of the same coin. While exporting, you earn the money that is needed to pay for imported goods and services. Imports and exports are dependent on each other and any policy that aims to decrease one category will have a decreasing influence on the other category as well. In political discussions, import and export are viewed as two totally independent phenomena. With this view, government policies can decrease the level of imports without influencing the level of exports; however, that is simply not true. The intellectual basis for this analysis

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is presented within the Lerner Symmetry Theorem20, which is not just a hypothetical abstraction but has data to show its validity. If the Government implements measures to decrease imports, as a result we will have a decrease in the export of goods and services. Let’s look at some real life examples of India, Brazil, Korea and Chile, countries with totally different trade policies, to further support the Lerner Symmetry Theorem. India and Brazil were implementing classic policies of “import substitution” that were designed to promote industrialization through the restriction of imports (tariffs, quotas, even forbidding imports). In 1965, exports and imports in both of these countries were less than 10% of GDP. Trade policies were not dramatically changed over the next 25 years, so exports and imports in 1990 were still at the level of 10% of GDP. Ten years later (in 2000), exports and imports reached 19% of GDP in Brazil and 20% in India. On the other hand, South Korea and Chile were implementing totally different policies. Korea is well known for its policy of export promotion. In the year 1965, exports from Korea were 10% of GDP (the same as in India and Brazil). Nevertheless, by the year 1990, exports had risen to over 30% of GDP. At the same time, Korea was not known as a country with a liberated domestic market for imports, and even now, many people consider the Korean market difficult to access. Yet, imports have risen to over 30% of GDP – the rise of exports led to the rise of imports. By the year 2000, exports and imports reached 69% of GDP in Korea. Chile implemented high levels of deregulation and liberalization of trade in 1970. Rates, quotas and other restrictions were reduced on imports. As a result, imports in Chile increased from below 15% of GDP in 1965 to 35% in 1990. The same period was characterized by a rise in exports of the same percentage. In that way, the expansion of imports covered the expansion of exports. Ten years later (in 2000), trade in Chile reached 52% of GDP. Each of these examples illustrates the functional importance of the Lerner Symmetry Theorem. Second principle: the consumers are households and business - in his well-known attack on mercantilists, Adam Smith wrote: “Consumption is the sole end and purpose of production; and the interest of the producer ought to be attended to only so far as it may be necessary for promoting that of the consumer. But in the mercantile system the interest of the consumer is almost constantly sacrificed to that of the producer; and it seems to consider production, and not consumption, as the ultimate end and object of all industry and commerce.” Adam Smith believes that consumers should ask for the lowest price in the market by free trade. Since then, economists have always emphasized that consumer expenses rise with the introduction of any restriction. This argument however, has not succeeded in the political arena. At the same time, politicians have not answered the question, “are jobs in the protected sectors more important than those in sectors which are not given customs protection?” If we look at imports, not as consumer wealth, but as an input for further production, politicians should clearly recognize that the issue does not address the maintenance of employment, but a trade-off of jobs between sectors. And that fact reminds us of one very important economic lesson, and that is that there is no free lunch. In fact, each activity represents some kind of trade-off. That means that the alternative is not

20 Theorem is named by economist Abba Lerner who wrote an essey on this subject while he studied at London School of Economics in the mid of 30's of the last centery.

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between employment of a domestic worker or a foreigner, but between employment of one or another class of workers in the same country. Third principle: trade imbalances are influencing capital flows – The fact that some countries have relatively open and some have relatively closed markets isn't reflected in the balance of payments. Balance of payments is simply an accounting of the foreign payments of one country. The first lesson from accounting is that the sum of balanced accounts must be equal to zero. Balance of payments consists of balance-of-payment current account, which records transactions of comodities and services, and capital account balance, which records all goods transactions. As balance of payments must always be balanced, a country that has a deficit on itsbalance-of-payment current account must have a surplus on its capital account balance. Can one country buy more products and services than it sells? The answer is yes and there are two ways to do it: one is to borrow the money and the second is to sell capital goods. Both options result in decreasing net assets. The trade account of a country is connected with capital flows and not with unfair market practices, irrational competition, or whether the market is opened or closed. If a country wants to solve the problem of a trade deficit, it must change the direction of international capital so that it flows into the country. 3. WHY IS FREE TRADE IMPORTANT FOR MONTENEGRO? The process of globalization and regional integration leads to more intensive trade between countries. It changes the economic structure and the role of an individual, company, and state. Economic policy makers should ensure an institutional framework that will enable domestic companies to be competitive on the international market; in other words, general transactional costs should be minimized. Costs can be decreased through privatization, elimination of protectionism measures and monopolies, and through the promotion of free entry into the market. The degree of openness of a system is measured through custom and non-custom protection. Why is free trade important for Montenegro? (i) Montenegro cannot influence prices of imported goods. Therefore, high custom rates lead to decreased trade and/or to additional burdening of the final consumers. At first glance, higher customs appear to have a positive effect on budget revenues; this, however, should be questioned because someone must pay those high customs. If customs are high, the volume of trade decreases, resulting in further decreases in the customs base. Apart from that, achieved budget revenues only represent overlapped consumer income (resources are redirected from private to state pockets). This effect on the level of economy represents rent, but not loss. Loss emerges when we include transactional costs in the analysis. (ii) In Montenegro, there is a strong correlation between imports and exports and each increase of import taxes directly increases the prices of export products. This leads to a chronically non-competitive Montenegrin economy. Over 50% of Montenegrin imports go to raw materials and not finished production, and over 16% go to machinery and transport equipment. (iii) Liberalization of international business eliminates significant imperfections and disparity of prices. Low protection encourages competition in the domestic market and contributes to decreasing possibilities for rent seeking.

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(iv) Consumer goods represent about 35% of total imports. Outflow of resources, due to imports, represents a base line for frequent demands for increased customs. However, when Montenegro does not have industry protection, the effect of increased customs is to redirect trade to producers in Serbia. By doing so, the beneficiaries of custom constraints in Montenegro would be producers from Serbia, while consumers from Montenegro would be forced to use lower quality products at prices typical for closed markets, with little or no influence on decreasing the trade deficit. Apart from that, the next expected effect would be allocation of capital and its redirection toward industries that are under a high level of protection. In such conditions, it is easy to imagine a situation where capital moves out from tourism, an export oriented and competitively oriented branch in which Montenegro has certain competitive advantages, toward industries that are under a high level of protection. Analysis of the trade sector in Montenegro identifies that free trade represents one of the basic preconditions for economic development. All protectionist measures (customs, contingents, prohibition of imports) directly affect economic development by slowing it down! That is exactly why we at the ISSP have raised our voice against the increase of customs in Montenegro. It is our belief that increased customs will not benefit Montenegro and the issue, thus far, has been approached in the wrong way, from a political view (top down approach) rather than from an economic perspective (bottom up approach). Surveys conducted by ISSP have shown that price increases in Montenegro occurred exactly in the sectors where custom rates had been increased (in order to protect domestic production) and where certain stimuli and restrictions exist for producers (such as tax incentives and quotas). Foreign tourists that come to Montenegro do not want to pay for the high price of protection of domestic agricultural production. Therefore, leaving politics aside, the inevitable economic question is asked, “What is more important for the economic development of Montenegro: tourists (exports) or domestic agricultural production (redistribution of domestic income)? Clearly, only one of these options will provide an inflow of euros into the system, and that is tourism. All measures that are based on the protection of the domestic economy from factors of competition are simply acting as a generator for the renewal of past problems. Decision makers should not direct events to avoid competition, but rather they should create conditions allowing for equal participation in the market game. That is the reason why we insist on measures that would include Montenegro in the international integration processes, allow access to investments (not just loans), and decrease transactional costs and uncertainty of rules. 4. PARTICIPATION OF THE TRADE SECTOR IN THE ECONOMIC ACTIVITY OF MONTENEGRO Participation of the trade sector in the economic activity in Montenegro was influenced by a number of internal and external events. Oscillation in trade sector participation in economic activity was the result of a large number of factors, such as: o Inherited inefficient structure of the economy; o Broken links with surrounding countries during the 90’s and their re-establishment with the process of normalization of economic relationships; o Renewal of economic activities.

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Changes due to those factors resulted in a decrease in the trade share of GDP during the early 90’s, stagnation in the mid-90’s and intensive development during the last couple of years.

Graph 1. Trade share of GDP from 1989.21

0

5

10

15

20

25

30

35

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Year

%

An increase of 28.8% in exchange with foreign countries in 2000 was followed by an increase in the trade deficit. Foreign trade exchange in Montenegro for the last four years has realized a fairly stable import to export ratio. Higher coverage was marked during the year of 2002 when exports increased by 36% in comparison to 2001 while imports increased by 25%. Table 1. Trade sector share of GDP and trade balance

Year GDP

(in Mill USD)22 GDP per capita

(USD) Exchange

(in Mill. USD)23 Balance Trade share in GDP

1989 1,407.00 2,184.78 13.20%

1990 1,167.33 1,812.62 13.40%

1991 1,041.20 1,692.91 348.00 -32.00 1550%

1992 796.48 1,295.02 291.00 -79.00 10.30%

1993 505.52 821.94 305.00 -13.00 9.30%

1994 549.30 885.97 79.00 -5.80 11.90%

1995 560.30 882.36 123.00 -53.40 14.30%

1996 723.00 1,131.46 354.00 -164.00 11.40%

1997 795.00 1,236.39 441.00 -161.00 13.00%

1998 790.00 1,221.02 464.00 -206.00 25.00%

1999 670.00 917.81 481.00 -235.00 28.60%

2000 730.00 1,106.28 667.72 -341.00 12.00%

2001* 1,049.00 1,568.00 821.27 -401.68 19.30%

2002* 1,221.00 1,828.90 784.36 -345.58

Remarks: Data for 2001 and 2002 are in euros. Since November of 1999 Montenegro introduced DM as a parallel currency and from 01/01/2000 as the only currency. From 2002, Montenegro is using the euro. 21 Ministry of Trade of the Republic of Montengro 22 Data on GDP – Republic Statistical Bureau, adjusted to the SNA methodology without grey economy. Data for 2001 and 2002 are in euros. 23 Central Bank of Montenegroe – trade with Serbia and Kosovo is not included in calculation

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Parallel with the revitalization of economic activity that followed the transitional shock from the former Yugoslavia, was an intensifying of the trade sector, due to the following factors: o High return coefficient; o Less investment needed for starting; o Complementary relationship of trade with other economic activities; o Structural adjustment. Table 2. Participation of the trade sector in the economy according to the official data for 200124

Total Trade share (in DEM) Trade share (%)

Number of companies 6,730 3,634 54.00%

Number of employees 84,333 16,813 19.90%

Total income 4,720,814,930 1,640,997,504 34.76%

Total equity 11,991,806,778 1,343,858,254 11.20%

Assets 8,957,815,211 597,497,211 6.67%

Capital 8,556,171,690 623,340,062 7.28%

Relative to the economy as a whole, the trade sector is performing at a high level. With 19.9% of employees, 11.2% of equity value, and 6.67% of company assets, the trade sector is generating 34.76% of total revenue. 5. STRUCTURE OF THE TRADE SECTOR Higher efficiency of the private sector, as well as intensification of the privatization process, is leading to the growth of private sector influence. In total employment of the trade sector, private companies are participating with 68.9%, which represents growth of over 6% in comparison to last year. Apart from that, domination of private companies is visible in the sheer number of companies operating, with 95.3% of trade companies being private. Nine out of ten companies with the highest income are private, and out of the top 50 companies, 39 are private and 11 are of mixed ownership. The inefficiency of state-owned companies, together with privatization, has resulted in a decreased number of workers in the public sector. In the period of 2000-01 there was an evident rise in the share of small company employment. For example, 72.9% of small companies were participating in the trade sector in 2001 and in 2002, their participation increased to 77.9%. Liberalization of doing business enables more companies to extend their business possibilities, resulting in stronger competition. In the period of 2000-01, income of companies from the lower income groups was registered. The ten companies with the highest incomes generated 37.5% of total income in 2000 and 28.3% in 2001. This represents a decrease of approximately 10%. Also, it is very important to note that their fall did not influence the total income level.

24 Source: ZOP, balance sheets of all Montenegrin companies for 2001. “Gray economy ” is not included.

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6. FOREIGN-TRADE TRANSACTIONS The Montenegrin foreign-trade transactions are featured, as follows: o A high trade balance deficit; o A high dependence on one product of a low processing rate for exports (approximately

75% of total export was aluminum in the year 2001); o Negative balance of trade of consumer goods (consumer goods were 6.38% of total

export in 2001, while the same were 33.32% of total import in the same year). The situation was much the same in the year 2002. Table 3. Import and export transactions (in values) covering the period 1991-2002 (expressed in US $ millions)

Export Import

1991 158.0 190.0

1992 106.0 185.0

1993 146.0 159.0

1994 73.2 79.0

1995 69.6 123.0

1996 95.0 259.0

1997 140.0 301.0

1998 129.0 335.0

1999 123.0 358.0

2000 161.3 354.1

2001 188.0 544.9

2002 202.6 544.0

Export is grouped into a couple of product clusters (raw materials and semi-finished products; machines; transport equipment, and consumer goods). The 2001 increase in exports is a result of an increase in aluminum export. In Montenegro, we still lack modern technology in the economy resulting in our poor competitive power for developing export potentials. Raw materials and semi-finished production represent the major portion of the export structure. In 2002, 51.2% of exports were to the developed countries market, while 33.5% of imports came from developed countries. The industrial developed countries have held their position as important trade partners with Montenegro. When it comes to exports, the most important foreign-trade partner is Switzerland, due to its high aluminum importation. Other significant purchasers of Montenegrin exports include: Italy, Cyprus and Hungary. When it comes to imports, the major partners are: Italy, Slovenia, Croatia, Great Britain, Republic of Srpska, Greece, and Germany.

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In the first quarter of 2003, aluminum export to Switzerland was 68.5% (i.e. almost the same amount as in 2002). The other major export trade partners in the January - March 2003 period were: Kosovo (14.8% of total exports), Italy (7.8%) and Bosnia and Herzegovina (2.9%). The structure of the major trade partners is similar to that of 2002. In the year 2000, 61% of total imports were imported from major trade partners, while in the year 2001 the percentage was 59.9% and in 2002 it was 83.2%. Analyzing the structure of the major import foreign partners of Montenegro in the first quarter of 2003, the greatest portion has come from the neighboring countries: Greece (14.7%), Italy (12.6%), Croatia (11.2%), Slovenia (11.2%) and Bosnia & Herzegovina (9.7%). In terms of the developed countries, the largest import partners were Germany (7.8%) and Austria (5.2%). This structure differs from the same period in 2002 as well as the overall year 2002; namely , imports from the USA declined from 6.5% in the first quarter of 2002 and 5.6% in 2002 overall to 3.5% in the first quarter of 2003. The same is true of imports from Great Britain and Austria. Their imports declined from 1.4% and 8.1% respectively in the first quarter of 2002 to 0.9% in the first quarter of 2003. 7. TRADE TRANSACTIONS WITH SERBIA, KOSOVO AND WITH THE REGION The goods and services purchased or sold in Serbia are not referred to as import/export. Instead, the transactions of goods and services with Serbia are regarded as a domestic/internal trade. On the other hand, trade operations with Kosovo are treated as foreign trade, and therefore all foreign-trade regulations apply. If Montenegrin trade transactions with Serbia and Kosovo were considered as import/export, the structure of the Montenegrin foreign-trade partners would change. Namely, export to Serbia and Kosovo in 2001 was $25.5 million (USD), which would comprise approximately 10.8% of total 2001 exports. Import from Serbia and Kosovo in 2001 was $114.85 million (USD), or 15.8% of total Montenegrin imports for the period. In 2002, export to Serbia and Kosovo was $101.3 million (USD), a whopping 297.5% increase compared with the year 2001, which would represent 31.6% of total exports. Import from Serbia and Kosovo in 2002 was $177.8 million (USD), showing growth of 54.8% compared with the year before and representing 23.9% of total imports. Bosnia & Herzegovina, Croatia, Slovenia, and Macedonia are the major Montenegrin foreign-trade partners from the Balkans. The graphic below indicates the participation of these countries, together with Serbia and Kosovo, in the total import-export affairs of Montenegro.

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Graph 2. The import breakdown - countries of the region and others - 2001

Serbia and Kosovo Croatia Slovenia B and H (Republica Srpska) Macedonia Other

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Graph 3. The import breakdown – countries of the region and others – 2002.

Serbia and Kosovo Slovenia Croatia Republica Srpska

Bosnia and Hercegovina Developed countries Developing countries Other countries

While goods and services from other countries (developed countries, the countries in development, and other transitional countries) still contribute the majority of imports, the export analysis indicates that Serbia and Kosovo are the major partners in the region. Namely, 10.3% of total exports from Montenegro in 2001 and 31.6% in 2002 are gained in transactions with Serbia and Kosovo.

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Graph 4. The export breakdown – countries of the region and others - 2001.

Serbia and Kosovo Croatia Slovenia B and H (Republica Serpska) Macedonia Others

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Graph 5. The export breakdown – countries of the region and others – 2002.)

Serbia and Kosovo Hungary Republica Sepska Bosnia and Hercegovina

Albania Developed countries Developing countries Other countries

In the first quarter of 2003, total trade of goods (imports plus exports) was 231.9 million €, an increase of 3.3% over the same period last year. Exports increased by 3.4%, while imports rose by 3.3%. The ratio of exports to imports was at the same level as in the first quarter of 2002 and stood at 50%. Trade deficit in the first quarter of 2003 is 77.6 million €, slightly higher (by 3.2%) than in the same period of 2002. Montenegrin exports to Serbia and Kosovo increased by 9.3% in comparison to the same period last year and were about 29.6% of total exports. Imports in the first quarter of 2003 increased due to the growth of imports from Serbia and Kosovo by 29.1% in comparison to the first quarter of 2002.

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8. SYSTEM OF CUSTOMS Custom rates in Montenegro are relatively high before the process of harmonization has begun. They include 6 levels of customs that rank: 0, 1, 3, 5, 10 and 15 percent. The rate of 15% applies only to a very few products, such as luxury goods, alcohol, and some agricultural and basic nutritional products. Custom rates of 0-3 percent apply to approximately 60-70 percent of tariff positions, and these are mainly for products that are not produced in Montenegro or for those produced in insufficient quantity. Table 4. Share of each custom category in the total custom regime:

Custom rates: Share in %:

0.0% 12.1%

1.0% 40.8%

3.0% 19.5%

5.0% 19.4%

10.0% 7.6%

15.0% 0.6%

However, there are also special levies on imports of certain agricultural and food products. The aim of this type of levy is, of course, the aim of all kinds of customs – to protect domestic production. They apply to meat, milk, dairy products, fruits, vegetables, beer, wine, and water. They have to be paid in absolute amounts (Euro/ unit of product). Seasonal customs of 20% are charged only for certain types of fruits and vegetables and are valid only for a regulated period of time. Certain types of goods are on the regime of imports/exports contingents. The Government of Montenegro makes a decision on the scope of contingents for export and import of goods. The decision is made on the proposal of the Ministry for International Economic Relations and is based on the opinions of Ministry of Economy, Ministry of Agriculture, Forestry and Water Economy, Ministry of Transportation and Chamber of Commerce of Montenegro. According to the international trading regime in Montenegro, a good that is to be imported or exported has to be grouped with respect to its type of export or import: free export/import (LB); export/import based on contingents (Kk or Kv) and export/import based on permission (D). Table 5. Regime of exports and imports

No. Regime Exports in % Imports in %

1. Free (LB) 97.70 95.60

2. Contingents (KK, KV) 1.20 3.00

3. Permissions (D) 1.10 1.40

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9. HARMONIZATION OF CUSTOM RATES WITH SERBIA The average custom rate in Montenegro is about 3%25, while in Serbia it is 11%. After signing the Belgrade Agreement, EU requires harmonization of the custom rates. Actually, EU requires that Montenegro and Serbia prepare a plan in which they will precisely define the dynamic of harmonization of the custom rates. Why should custom rates be harmonized? In order to make a unique custom system in which the same custom rates will be valid. Although harmonization can be done in various ways, the dominant approach in the process of harmonization was that Montenegro had to increase custom rates to the level of current custom rates in Serbia.

Graph 6. Scenario of increasing the custom rates on which the experts from Serbia and EU insisted at the beginning

custom rate Serbia 10% 5% European Union Montenegro 0%

0 1 2 3 time The experiences of other countries with high custom rates have shown that sectors that were protected with high customs have not developed because they were not exposed to competition. Is our experience different? No! Let us ask ourselves: Did high custom rates on import of cars save Zastava from Kragujevac, textile producers from Serbia and Montenegro, Obod from Cetinje? No, on the contrary, significant progress has been achieved only in those sectors where customs were low, primarily due to exposure to competition. In Serbia, where domestic production is trying to be protected by high custom rates, imports are continuously increasing, especially the import of final products, the category most protected by high customs (15-30%). On the other hand, production, that is to say export of highly protected products, has not increased. Total imports increased in 2002 by 30% and exports by 20% -- imports have increased faster than exports. On the other hand, Montenegrin imports increased by 2%, while exports rose by 26% in the year 2002. Custom rates across the world have been decreasing since the end of World War II. The trend of decreasing custom rates exists in EU, too. WTO (World Trade Organization),

25 According to the calculations of the WTO-USAID Office in Belgrade, the average nominal custom rate in Montenegro is 2.81%, while the effective custom rate is 2.49%.

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GATT (the agreement on trade that preceded WTO), and NAFTA (regional trade zone that includes Canada, USA and Mexico) are just some examples of the decrease in custom rates. Table 6. Average custom rates in certain countries

Armenia 1.9 Israel 1.0

Belarus 4.8 Latvia 3.2

Cyprus 3.0 Lithuania 2.3

Czech Republic 1.2 Luxemburg 1.8

Denmark 1.8 Malta 3.5

Estonia 0.05 Moldova 4.5

Finland 1.8 Norway 1.1

Georgia 2.8 Sweden 1.8

Hungary 2.5 Switzerland 2.5

Iceland 3.6 UK 1.8

Table 7. Estimation of trading regime according to the Heritage Foundation and real GDP growth according to the IMF

Country Trade Real GDP growth (%)

Country Trade Real GDP growth (%)

1. Hong Kong 1 2.3 1. North Korea 5 1.0

2. Singapore 1 2.4 2. Iraq 5 3.026

3. Estonia 1 5.8 3. Libya 5 1.2

4. Cyprus 1 2.2 4. Cuba 5 -

5. Lithuania 1 5.9 5. Laos 5 5.5

6. Armenia 1 12.9 6. Iran 5 1.7

7. Mongolia 1 3.9 7. Turkmenistan 5 -

8. New Zealand 2 4.6 8. Uzbekistan 5 2.6

9. Ireland 2 6.0 9. Syria 5 1.8

10. Luxembourg 2 2.9 10. Burma 5 4.9

The European Union has significant experience in harmonization. The creation of the custom union took 13 years. However, the experience of the EU suggests that procedures are more important than rates. Free movement of goods, people and capital is much more important than the level of custom rates. Table 8. Average custom rates in Serbia, Montenegro and European Union before the harmonization

Statistics Custom level (in %)

Average 11.03

Minimum 0 Serbia

Maximum 30

Average 2.81

Minimum 0 Montenegro

Maximum 15

Average 4.38

Minimum 0 EU

Maximum 74.90

26 2001 data

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Politics, the behavior of state institutions, affects growth, efficiency in using resources, and development itself. How can state policy create an environment that contributes to faster growth and development? Economic theory suggests that private ownership, stable monetary policy, low taxes, and free trade contribute to economic prosperity. While free market can generate economic growth, provide higher living standards, and create a chain of possibility of choices, it cannot create values that increase the human spirit and lead towards social and moral decision-making. These values develop in societies that survive, they cherish them and transfer them to future generations. The dynamic of free trade enriches society in a way that laws emerge that ensure the blooming of an entrepreneurial economy and capture values that protect the human dimension in a market economy. That becomes the challenge for politicians and governments. However, instead of tackling the quoted challenges and building trust with citizens, most politicians, consciously or not, resort to the creation of falsehoods. Entrepreneurs uncover these falsehoods very fast, but to no avail since the percent of entrepreneurs is much lower than that of politicians. I will look at some of the actual falsehoods that were easily created by politicians. On these falsehoods overflow roles of politicians and entrepreneurs, levels of responsibilities and consequences. As a base, I will use the actual process of harmonization between Montenegro and Serbia. Falsehood I: Increase of customs will not increase prices in Montenegro. There is no country in the world where an increase of prices will not occur after the increase of customs. If this were true, all countries would increase their customs in order to decrease prices. If it were true, countries with the greatest level of economic freedom would not be those countries where the custom rate is zero, as is the case in reality. Falsehood II: With harmonization of the custom rates, Montenegro will achieve a larger market. If this were true, Montenegro would increase its exports to Serbia. However, with the current structure of Montenegrin exports, the Serbian market is not of great significance. Dominating the exports of Montenegro are: (1) aluminum, by far the largest export, (2) wine and brandy and (3) mushrooms and medicinal herbs. These are products that are, except for smaller quantities of wine and brandy, exported to the European countries. Montenegrin exports to Serbia have increased recently due to the lower custom rates in Montenegro. Firms registered in Montenegro, and among them some whose founders are persons and legal entities from Serbia, exported different goods from Montenegro to Serbia. If the custom rates increase, exports from Montenegro to Serbia will decrease. Therefore, the Serbian market will not be bigger, but smaller for Montenegro. Additionally, since the Montenegrin economy depends on imports, it will get a lot of products from Serbia that will, after the increase of customs in Montenegro, be much cheaper than those that are imported from other countries. In that way, the increase of custom rates will actually lead to a smaller market for Montenegro and a bigger market for Serbia. Therefore, the ultimate trade off is negative! The economies of Montenegro and Serbia depend on imports.

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Graph 7. Montenegro: Trade (includes only goods) in million USD

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Graph 8. Serbia Trade (includes only goods) in million USD

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Source: Vienna Institutes for International Economic Studies Note: trade with Montenegro and Kosovo is not included Falsehood III: Montenegro has to increase customs because they are currently lower than those in the EU, and it is not possible to enter the EU with lower customs. However, Estonia, for example, has a 0% custom rate, and Hungary, Poland and the Czech Republic also have lower average custom rates than Montenegro. The last enlargement of the EU included all of the above-mentioned countries proving that a lower custom rate does not have to be an obstacle for membership in the EU.

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Falsehood IV: Serbia will harmonize with Montenegro in all cases where custom rates and taxes in Montenegro are higher. This is not true, Serbia will always protect its economic interest. Starting on January 1, 2003, the tax rate on the profit of companies dropped from harmonized 20% to 14%. One need not be a top economist to conclude that such a decision would result in: (1) a higher inflow of foreign capital, meaning investments; (2) the closing of a number of firms in Montenegro and their transfer to Serbia, given that their owners are legal and physical entities from Serbia and better conditions for doing business exist in Serbia, and (3) a decrease of the grey economy. 10. SOCIO-ECONOMIC CONSEQUENCES OF INCREASING THE CUSTOM RATES IN MONTENEGRO To measure the impact of increasing custom tariffs on the budget of Montenegrin households, changes of custom tariffs in certain groups of products have been weighted by the share of these costs in total expenditures of Montenegrin households2. There are four scenarios to consider with the increase of Montenegrin tariffs: o To match the EU level (4.38%), o To match the EU level only if Montenegrin tariffs are lower o To reach a level between 7-8%, o To match the Serbian level (11%). One assumption is that the change of tariffs will have no impact on the following household expenditures: utilities, health, education, and housing (rent). The final impact on a households’ budget is calculated based on a weighted average of price increases for different categories of goods. Table 9. Absolute increase of household expenditures on an annual level

Change of the custom rates in Montenegro Source of data

EU level EU level

(Without decreasing) Level between Serbia

and the EU Serbia level

ISSP (Household survey)

132 151 498 865

Our calculation shows that, depending on the scenario, we can expect prices to increase from 1.3% (in the case of accepting EU custom rates) to 8.5% (in the case of accepting current custom rates in Serbia).

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Graph 9: Change of the poverty line and poverty rate

in Montenegro depending on custom tariffs change

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All of the examples shown in the graphics above confirm that when we have higher custom rates, it creates pressure on prices and household expenditures increase. Although you may think that the poverty rate in Montenegro is at a very low level, the last graph shows that there is a concentration around the poverty line. If the poverty line increases by 20%, the poverty rate would increase by 100%. This leads to the conclusion that the household budget is very sensitive to every price increase.

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CONCLUSION Freedom is most important at the margins of our knowledge, in other words, when no one can predict what lies ahead. The ultimate goal of freedom is to increase our capabilities so that we can do better than our ancestors. Each generation has to contribute its share of knowledge and improvement of moral and esthetic beliefs where no superior can force one set of rules and only future experience can decide what can be done. I see today’s conference in such a manner, as our effort to widen our knowledge. What do we have to do? At least three things: 1. Customs should be further reduced or eliminated;

2. Montenegro should become a free trade zone;

3. Increase economic freedom - with economic freedom we speed economic development:

4. Decrease regulation and eliminate customs. Political monopolies are creating

expenditures and limiting the power of development, efficiency, and entrepreneurial incentives, thus leading to technological chaos, increased unemployment, and decreased living standards.

***

Literature:

1. Ludvig von Mises i Friedrich Hayek, O Slobodnom trzistu, MATE Zagreb, 2000 2. Frederic Bastiat, What is Seen and What is Not Seen, Institute for Strategic Studies and Prognoses,

Podgorica, 2001 3. Index of Economic Freedom 2001, 2002, 2003, The Heritage Foundation, USA 4. Hernando de Soto, The Mystery of Capital, 2002 5. Sektorska analiza trgovine, Institut za strate{ke studije i prognoze, 2003 6. Petar Ivanovic, Socio-ekonomske posledice pove}anja carina u Crnoj Gori, Institut za strate{ke studije

i prognoze, 2003 7. Rose Wilder Lane, The Discovery of Freedom, Fox and Wilkes, 1993 8. Alan Deardorff, Measurement of Non-tariff Barriers, The University of Michigan Press, 1999 9. Henry Hazlit, The Critics of Keyenesian Economics, The Foundation of Economic Education 10. Lee Edwards, The Power of Ideas, Jameson Books Inc.

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COMMENT 4

WHAT DOES THE EU HAVE TO GAIN FROM TRADE LIBERALISATION?27 by David Smith, Economic Editor of the Sunday Times Sometimes, I think we all need to remind ourselves of the benefits of trade liberalisation. The other weekend I was watching the film A Beautiful Mind where, even through the Hollywood treatment, you could see that John Nash had given us the Nash equilibrium, the win-win situation. Trade is not a zero-sum game, with all the benefits accruing to the rich, even though that is what some people in the development lobby would have us believe. Long before Nash, Ricardo demonstrated how the gains from trade accrue to all those who take part in it. Often, however, it is not just the developing countries that need reminding of these benefits. In Europe too, the argument goes: we’ve already liberalised a huge amount. Why is worth going further for marginal gains that may involve significant political costs, most notably, upsetting the farm lobby. Why bother with external trade liberalisation when there is a huge amount still to be achieved from internal liberalisation within the EU. Why not simply focus on the challenging task of completing the single market and turning the EU into a genuine free trade bloc or on integrating the accession countries of eastern Europe into the EU? The single market indeed needs to be completed but that work should not come at the expense of external trade liberalisation. As Jagdish Bhagwati has warned, one of the greatest dangers to free trade is preferential trading agreements that exclude some countries. So what are some of the benefits of free trade to the EU? The first is that the benefits of free trade generally are incontrovertible. World trade increased 20-fold, in real terms, during the GATT-WTO liberalisation period that began in 1947. As average tariffs in the industrial countries have come down, from 40% to under 5%, so trade has gone up. This a proven economic relationship. Roughly speaking, world trade grows about as twice as fast as world output – during the 1990s world trade growth averaged 7% a year. The liberalisation of world trade gave us the unprecedented prosperity of the past half a century. Last year, world trade grew by 2.5%, following a 1% decline in 2001, while world output rose by 1.5%. Britain has played a strong role in trade liberalisation – and not just because UK governments have tended to push for free trade. One of the earliest GATT rounds was held in the British seaside town of Torquay, not usually thought of these days as a location for big international conferences, and much progress was made there. The EU has quite a high proportion of the world’s big exporters and it is currently suffering from the weakness of world trade. Last year EU exports rose by a mere 0.6% while imports fell by 0.5%. It has everything to gain from stronger world trade growth. Secondly, I am a strong believer in two related propositions. The first is that trade, through increased competition, puts pressure on countries to sharpen their economic act. The second

27 based on a speech given to a seminar European Barriers to Free Trade, organized by the Stockholm Network and the International Policy Network

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is that EU economies badly need that competitive spur to become more flexible and less regulated. GDP per capita in America is roughly 40% above the EU average, while US GDP growth exceeded that of the EU throughout the 1990s – the longest period it had done so in modern times. EU Research and Development spending is under 2% of GDP and steady, while in the US it is nearly 3% and rising. The EU employment rate is 65%, compared with nearly 80% in America. Long-term unemployment is nearly 4% of the active population, compared with under 1% in the US. Organisations like the World Economic Forum, scoring the Lisbon reform agenda, have consistently found that major EU economies such as France, Germany, Italy and Spain but not in general countries like the UK and Finland, have poor enterprise environments. The spur of internal competition, within the single market, will not be sufficient to bring the changes the EU needs. Greater external pressure is needed too. I think there is also a great prize to be had from the liberalisation of services. Trade in services accounts for only a fifth of all world trade. There appears to be a significant disconnect between the situation in most advanced economies, where two-thirds of GDP is accounted for by services, and the 20% share services has of world trade. Even allowing for the fact that some services cannot easily be traded internationally, services are lagging well behind. Growth in trade in services is picking up, but from a very low base, and needs new momentum, which it is to be hoped will be provided by the Doha trade round. Furthermore, whereas goods prices are subject to deflation, services are generally not. The EU could gain enormous potential from the liberalisation of services. EU economies have a significant share of global exports of services. The benefits of liberalisation in this area would not be purely for the advanced economy providers of services. The World Bank has estimated that trade liberalisation in services would also benefit developing poor countries to the tune of $900 billion. Clearly, the potential benefits to the EU from trade liberalisation are enormous– the general benefits of stronger world trade growth, the spur to economic reform and the potentially enormous gains from liberalisation of services. But there are many others not least the gains to EU consumers, and taxpayers, that would flow from genuine reform of the Common Agricultural Policy, which in its present form is a source of shame in Europe. If the CAP is responsible for derailing the Doha round, that would add hugely to the damage it has already done. Currently, the EU has more than ever to gain from pushing trade liberalisation. Even before the war in Iraq and its consequent impact on political relations between the United States and some European countries, the EU was dealing with a US government fully-prepared to abandon aspects of free trade, such as allowing large subsidies to its steel industry and to its farmers, often using EU protectionism as an excuse. The EU should make its mission not to provide any such excuse. Whether or not protectionism is increasing, the risk is that the momentum behind world trade is slowing. Foreign investment has been weaker, as has trade in recent years. Indeed, if we look at trend growth in world trade growth, a slowing from the heady days of the 1950s and 1960s is clear. What is crucial is that we do not go back to the grimness of the 1970s.

Are there any meaningful estimates of the benefits of trade liberalisation? Some readers may remember the great debate about the creation of a transatlantic free trade area, which was supported by the European Commission. Updated estimates from the UK Treasury – based on the liberalisation of transatlantic trade – show a boost equivalent to 1.3m EU jobs, an annual GDP boost of 1.1% but this probably only scratches the surface. Given Europe’s

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recent history of unemployment and its inflexible labour market, the economic and political benefits of such job creation speak for themselves In a host of areas, then, the European Union has an enormous amount gain from trade liberalisation, and everything to lose if the process starts to go backwards.

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COMMENT 5

CURRENT TRENDS ON FINANCIAL MARKETS by Danijela Grba – Vukajlovic, Cental Bank of Montenegro IMPACT OF GLOBAL ECONOMIC DEVELOPMENTS ON THE INTERNATIONAL FINANCIAL MARKETS Global economic developments are both a reflection of and a source of impact on global financial markets. Additionally, they are influenced by other events such as financial scandals and crisis of war. Generally speaking, financial markets are predominantly influenced by the performance of great, developed economies, firstly, the United States of America. Their free market enables great flexibility of the entire economy and successfully makes use of its' potential, while the high quality regulation facilitates attracting foreign capital and financing development. These basics are successfully “upgraded” with subtle, time-adjusted conducting of the macroeconomic policy, which reacts by lowering basic interest rates and stimulating fiscal policy at every major sign of economic decline. However, the US is a large importer of foreign capital but, because of the large amounts of domestic capital available, devaluation of the US dollar has some, even favorable, compensating effects on lowering the foreign trade deficit, which is rather high. Thanks to the very flexible labor market, the decrease of employment is being offset by the growth of productivity. This is the basic premise for the thesis on the ability of the US to quickly recover from an economic crisis. Because of the size of its economy, the US possesses the ability to positively influence the economic performances of the rest of the world. On the other side, Europe is restricted with massive regulation, high taxes, and inflexibility in its labor market, thus, their recovery from recessional phases is more difficult. Not only that, the inflexibility of the European market keeps it from making the most of its potential, and actually prevents the European market from moving upward with each stage of the global economic cyclus. The last such stage was marked by the development of information technologies, whose potential was maximally used by the US, and gradually, thanks to the foreign capital that didn’t find a more profitable engagement, in the developed European countries. For many years the countries of the European Union (EU) have been the net exporters of capital; and in 2001, despite the general drop of investments abroad of the EU member countries that was tempered by the general drop of investments into the EU from member countries and from abroad, the EU maintained its roll as net investor into the rest of the world (cca. 116 billion EUR were invested through 2001, or 1.3% of the EU-GDP). Japan, as a one-time economic force, is not currently considered to be a starter, neither in the region of Asia, nor in the rest of the world. The reason for Japan’s decline is a long-lasting recession that spans many years as a consequence of the structural disarrangements and lasting deflation, poor conditions of doing business especially in industry, negative trends in banking and bankruptcies of many companies, and a very high public debt (140% of GDP). The primary reason that these problems persist is the lack of power of the government of Japan to deal with them, for it would demand cutting certain monopolies. At the same time, in a deflation environment, monetary policy despite its’ expansiveness (the discount rate of the Central bank of Japan didn’t exceed 0.25%), as well as fiscal policy, are practically helpless to animate the growth of economy. Transmission of the negative effects from the international financial markets and the appreciation of the Yen against the US dollar (which prevails compared to temporary turnovers in their rates), have a negative

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impact on the level of consumption in Japan. Therefore, it is difficult to foresee the beginning of Japan’s return to their position of global economic leader. As it turns out, the developing countries were the greatest beneficiaries from the decrease on the developed financial markets, for they were the recipient countries for the capital, suddenly deliberated on those markets. Nevertheless, it is expected that developing countries will experience slower economic growth due to today’s close ties of all financial markets, developed and emerging. The growth of oil prices throughout 2002, as the result of the war expected in Iraq, positively influenced the income and the economic growth of developing countries. However, in developing countries in Asia it was more important to have a good concept of domestic macroeconomic policies, especially monetary and fiscal (low interest rates and tax lowering), which initiated the growth of private consumption and the increase of investments and inter-regional trade. In European transition countries, the basic start for economic growth was not oil prices but the high quality of the conducted macroeconomic policies, as well as the announcement of the soon-to-be association with the EU, which attracted foreign capital. CAUSES OF THE DROP ON THE INTERNATIONAL FINANCIAL MARKETS However, just as the US economy can have a positive impact, it can also make a negative impact on global economic trends; when the US economy completely adjusted to the new information technologies that pulled the last phase of the cyclic world growth, the downward stage of the global economy came up on the scene. Consequently, it caused a drop of share prices on the American and other international financial markets. The descent experienced was drastic, but it was not a result of any logical follow-up of cyclic movements of the global economy. However, through the upward phase of the cycles, investors on the stock exchanges were focused on companies in information technologies. Such a prolonged development on the international stock exchanges caused an overestimation of prices of those companies, even though at some point the indicators began to point to the discrepancies between high prices and non-corresponding business performances. The growth of prices among telecom and dot-com companies pulled upwards the whole market of equities. The idyllic stage on the world financial markets was roughly interrupted with the announcement of the financial scandals, stemming from the arranged auditors reports of those most popular telecom and dot-com companies. Such a sharp drop of the share prices was additionally influenced by the threats to the world peace, initiated with the terrorist attack on New York on September 11, and later complemented with the notification of the war in Iraq. In every case, the shock to international financial markets caused certain changes in investor behavior, stemming from their waning trust but also from their increased caution and pessimism, which were based on the continuous decline of the most important stock exchange indexes (in 2002, Dow Jones has recorded a decline for the third consecutive year, which hasn’t happened since the big bang in 1929). Such a development with share prices dictated the new adjustment of the financial markets and the real economy. It manifested itself through an increase of corporate defiance to bigger capital expenditures (especially in the US) and through the investors’ growth of risk aversion, thus resulting in lowered intentions of investors to support the recovery of the share markets. This development was most clearly observed in the US, where the decrease of share prices and the drop of foreign investments caused the devaluation of the US dollar, despite the relatively weak decrease of domestic consumption. At the same time, drop of share prices was followed by the increase of investments in securities with fixed returns. While the size of the American bond market is large, the huge demand for bonds caused a significant narrowing of the gap between the

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interest rates being paid for those bonds. Since those margins dropped below those in Europe, it diminished the attractiveness of the US bond market, additionally contributing to the devaluation of the US dollar, and it also changed the direction of free capital toward destinations outside the US. However, a lengthy persistence of the devaluated US dollar is not to be expected, not only as a consequence of certain US macroeconomic policies, but also because the recovery of the US dollar is going to be supported by those who mostly suffer from its’ weakness -- big exporters to the US and the owners of big US dollar holdings. FOREIGN EXCHANGE RATES AND MOVEMENTS OF FOREIGN CAPITAL TO DEVELOPING COUNTRIES Speaking of the effects that changes of the US dollar have on the global economy, we should note that the domination of the floating exchange rates in global terms represents a kind of buffer through the crisis in the foreign exchange markets. In support of this thesis speaks the experience of Argentina, which in 2002 finally dropped the system of currency board and pegging of domestic currency to the US dollar. At first, Argentina shifted to applying the fixed and later, the floating exchange-rate system. After that change, Argentina began to slowly come out of their economic crisis, which arose mostly due to the fixed relation between the US dollar and the Argentinean Peso. Namely, in 1991 Argentina adopted the currency board, which resulted with the lowering of the annual inflation rate from 5000% to below 10%, as well as with the annual growth of GDP of 6%, up to 1996. Nevertheless, the foreign exchange rate of the Argentinean Peso was pegged to the US dollar in the proportion 1:1, so that with every increase of the US dollar, the export position of Argentina worsened. Increase of the foreign trade deficit was followed with the expansive fiscal policy and with the growth of public debt and financial crisis, despite the restrictive monetary policy. Argentina responded too late to those developments, shifting only in 2002 from the currency board to the double exchange rate system – fixed for the foreign trade transactions, and floating for the other transactions, with the tendency of complete shifting to the floating exchange rate system. In the meantime, with the rising uncertainty on the Argentinean financial market, the financial crisis transferred to Brazil, which experienced the increase in interest rates and the devaluation of the national currency. Therefore, the whole region of Latin America came up to the “black list”. Namely, the crisis on the international markets brought a bred new quality; a differernt treatment of developing countries on the international capital markets depending on their credit rating. Therefore, countries with the lowest rating experienced huge difficulties in approaching the capital markets. Even when they did, it was very expensive for them (it is estimated that the inflow of foreign capital to the Latin American countries will not exceed USD 29 billion for 2002, whereas in 1997 it amounted to USD 106 billion, and in 2001 to USD 45 billion). On the contrary, Asian markets were supported with good macroeconomic fundament, regional liquidity and solid investors. Quite alike, Eastern Europe attracted investors based on the increase of its’ credibility and joining the EU. The attractiveness of Russia increased for its strong fiscal position and for the performances of growth, which were supported by the growth of oil prices. Important news regarding the last crisis on the international financial markets is that capital never stopped flowing to the developing countries, but only changed the shape of flow compared to the previous tendencies. Namely, up until the financial crisis in developing countries, which started in 1997 and 1998 in Eastern Asia, foreign capital that moved toward those countries was mostly in the shape of private loans. Therefore, the level of private

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loans that developing countries have received, reached its’ peek in 1996 (USD 330 billion), after which it fluctuated, showing its most significant increase in 2000. However, that upward trend was interrupted throughout 2001 and 2002, when the global economy began to experience the crisis. Although it is estimated that approximately 90% of total investments in developing countries are being financed from domestic sources, the necessity of foreign capital in those countries has not diminished, especially in some regions (Latin America). At the same time, developing countries are constantly recording high growth rates (in 2002 it was 3.1% in developing countries, vs. 1.4% in developed countries), which certainly attracts foreign capital (Table below).

Gross domestic product Retail prices

2000. 2001. 2002.* 2003.** 2000. 2001. 2002. 2003.

Global economy 4.8 2.0 2.6 3.7 4.5 4.0 3.1 3.6

of which:

Industrial countries 3.4 0.7 1.4 2.6 2.2 2.0 1.2 1.6

Eastern Asia 6.6 1.7 4.1 4.9 2.1 4.4 3.8 3.6

China 8.0 7.3 7.8 7.7 0.3 0.5 -0.5 0.5

Latin America 4.3 0.5 -1.3 2.6 7.3 6.0 10.0 10.3

Russian Federation 8.3 5.0 3.5 4.0 20.8 21.7 16.0 15.0

Transition economies from the Central Europe

3.8 3.0 2.6 3.4 14.1 10.3 6.5 5.4

Source: MMF and national statistics * and **, estimations However, the mode of foreign capital that flows into developing countries has switched in the last two years from private lending to foreign direct investments, while the remittances of emigrants has become more significant too. Namely, the financial crisis in developed financial markets resulted in the lowering of interest rates, which is in narrowing of credit margins on the emerging and mature bond markets, impacting the shift from the debt to equity financing of developing countries. While during the period 1995 –1996 net flow of private loans to developing countries was positive, amounting to approximately USD 135 billion, in 2002 it turned negative, observed from the position of developing countries, for they have repaid USD 9 billion more foreign private loans than what they have received. At the same time, the net foreign direct investments in developing countries during 2002 amounted to USD 143 billion, and the portfolio investments USD 9 billion, or in total USD 152 billion. Remittances of emigrants in 2002 amounted to USD 80 billion (in 1998, USD 60 billion). Transferring the focus from private lending to foreign direct investments and emigrant remittances can be observed as desirable from the developing countries point of view, for those are the less volatile sources of financing. Also, they create a more stable business climate in those countries (foreign direct investors are more oriented toward long-term projects). However, bearing in mind the encouraging outlook for the future performance of developed countries, it could be supposed that the debt financing of developing countries will have a relatively fast recovery (it is estimated that in 2003, net foreign private loans will increase to USD 24 billion, thanks to the already registered growth of returns on bonds from the emerging markets for the whole 31% since October 2002 through May 2003). It is estimated that in total, in 2003 net private capital flows will reach USD 139 billion. Despite the growth achieved in comparison to the previous year, this figure is still approximately USD 50 billion lower than the average level of flows registered in the last 10 years.

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CHANGE OF BUSINESS POLITICS OF INSTITUTIONAL INVESTORS In every case, it is important that the international flows of capital have not stopped because of the crisis in the international financial markets. The Bank for International Settlements recorded another positive trend that arose from the financial markets crisis -- that was the growth of consumer credits and credits for real estate. That trend is desirable from the point of growth of consumption and its impact on the global economy going out of crisis. In that development, the registered trend of raising credits for real estate had some positive impacts on the performances of certain types of institutional investors. Namely, they have experienced some lowering of their portfolios too, which were the consequence of a drop in prices of shares and bonds. However, thanks to the decrease of interest rates and growth of the real estate credits, certain types of institutional investors have rearranged the structure of their portfolios. The pension funds (mostly in US) have particularly magnified the portion of their investments that are in real estate in their portfolios from 25% to 50% (while Dow Jones recorded a 17% drop during 2002, the third consecutive year of decline, investments in commercial real-estate promised a return of 7% to 8%). The registered trend of an increase of investments in real estate was supported, especially by the banks, which have increased the volume of real estate loans. Those loans were well accepted on the market thanks to the low interest rates. Such developments have forced pension funds to start thinking about leveraging their portfolios too for the purpose of buying real estate, which is not usual for those institutional investors, and in some cases, is even forbidden. Those considerations were particularly intense in the pension funds of corporations, because during the period of decrease of their business performances, corporations have lowered funding of their own pension funds. Although investing in real estate became interesting for the pension and investment funds, it is now interesting only for those insurance companies which are in mutual ownership. Those insurance companies, being organized as public companies have restrained from real estate investments because their shareholders were not satisfied with the average return on investments ranging from 7% - 8% annually. Opened and closed investment funds, besides the increase of investments in real estate, particularly commercial ones, also magnified their investments in the small-cup shares and in bonds – especially short-term and international. Moreover, they increased the proportion of cash and cash-equivalents in their portfolios. That shift happened, of course, due to the lowering of large–cup stocks in their portfolios, whose prices have significantly decreased. By sentimentally keeping those stocks in their portfolios, they would very soon would have brought the deterioration of performances of both, opened and closed investment funds. CURRENT TRENDS IN BANKING The above mentioned trend of growth of consumers and real estate credits of banks, which started as the reflex to a general drop in interest rate levels, could present one of the possible straws of salvation for current incomes of many banks. Namely, it is true that the big banks doing business internationally remained well capitalized and liquid. It happened despite having huge write-offs and lowering of their earnings, because they have avoided the exposure to the systemic risk. However, in global terms, banking did experience certain problems. Some of them are simply the result of the cyclic decrease - lowering of interest rates, greater penetration of products, slower growth of nominal GDP, and a drop on the capital markets – all of which are used as excuses for bad loans being given in excessive amounts to the telecom and dot-com companies. The other source of problems in global banking is the domination of the universal banking concept, which erodes the profits of banks in terms of the growth of competition. Namely, in 80’s, incomes of banks were

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growing on average by 8% annually, which turned to 4% in the 90’s due to high expenditures and the losses that stemmed from, among other sources, lower credit standards that were applied before the 1990’s. The growth of their incomes reached a peak during 2000 and it seems that its’ growth will be far slower in the next few years. However, in 1990 it seemed very attractive for a bank to be the one that obtains the full service, but when good years passed, that concept left banks with enormously huge expenditures and enabled the increase of competition in banking. The last trend was contributed with non-banking financial institutions entering into traditional banking services, but also with the development of new financial instruments that relocated the classic banks assets into the balances of non-banking financial institutions. The way out of this phase of development of world banking is returning banks back to basic competition, focusing on what they do the best and differentiating themselves from the competition. At the same time, the domestic consolidation of banks is something to count on in many countries, after they wake up from illusions on international mergers and acquisitions (M&A) or for the reason of regulating of that area with the anti-trust legislative. Until recently, M&A were viewed as the salvation for many banks, but studies have shown that from 50% - 70% of all acquisitions destroy more than create the fortune of banks. Nevertheless, what really motivates M&A in an international sense is the achievement of the economy of volume and increased profits. However, this concept is frequently facing informal restrictions on further domestic consolidations that result from concerns on lowering competition. We may see an increase in the trend of shifting from a universal to a more focused banking, where the focus is to be transferred to one of four possible areas: development of products, distribution, infrastructure, and wholesale banking. In corporate and investment banking that process will likely result in the elimination of second and third range competitors. Banks that are based on the concept of universal banking will have to give up on investment banking or to merge with other banks in order to obtain one specific service. One example of this is the specialization regarding check-clearing (“mono-lines”), currently organized by a couple of banks, such as, The Intelligent Processing Solutions Ltd, established in the UK by Barclays Bank, Lloyds TSB, and by Unisys - the company for technology services, for which is estimated that today processes the clearing of checks for approximately 70% - 80% of the total market. That concept is broadly viewed as the direction of the future.

GLOBAL APPRECIATIONS Generally, it is considered that the global economy and financial system have shown great elasticity to successive shocks over the last two years. Namely, payment and clearing systems were capable of dealing, and allowed the attack on New York on September 11th to only influence the transactions of shares, bonds, and the repo-market for 7 days, while the global system was functioning efficiently all the time. After the collapse of Enron, the utility shares market functioned normally, which was a surprise since the 1998 crisis (collapse of The Long Term Capital Management and crisis of the Russian Rubble) led to the run away to liquidity. Quite opposite to that, after the crisis in 2001 and 2002, credits continued to flow freely, although conditions were more expensive for the less credible loan solicitors. There are a couple of factors that helped to offset the shocks. As the first and the most important, there was a rapid and strong reaction of certain politics, monetary and fiscal, particularly in the US, but in other developed countries too, as well as the improvement of financial stability in global terms. It is a reflection of today’s flexibility of the financial markets, which itself is the consequence of the deregulation process lasting for many years. Besides that, general orientation toward floating exchange rates helped many countries,

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which use that system to isolate themselves from the exchange rate crisis occurring in other countries. However, the information-based technologies infrastructure that supports the global financial system was improved too. Moreover, markets became more capable in differentiating credit risks of various loan applicants, which alone became more risk-adverse. It is especially true when banks are in question, for during the 1990’s they were more cautious in operating their business than in 1980’s. In the world financial circles it is appreciated that the descending phase of the global economic cycle has reached its bottom and the majority of economic indicators show slow, but in every case –the global economy is rising out of crisis. It will definitely contribute to the stabilization of the financial markets and to the growth of the financial instruments prices. That scenario may be improved by the continuing advancement of macroeconomic policies (not only in the industrial, but even more so in other countries), as well as by the creation of conditions for flexible reactions on the repeated signs of economic decreases. Moreover, it is necessary to continue the process of improving corporate governance, accounting, supervision, as well as the other sound banking practices that are aimed to reassure investors that they will again have access to complete and true information. Besides that, it is necessary to consistently implement sustainable policies in order to facilitate the approach to capital under acceptable expenses. In developing countries it is necessary to encourage the development of local financial markets so they can obtain alternative sources of finances and help to offset the changes of the global financial conditions.

***

Literature: 1. Paolo Passerini, Fall in FDI in 2001: EU-15 as main actor, Statistics in focus, Theme 2 – 12/2003, Eurostat 2. Alan Budd, The Queen’s College, Oxford Recent developments in international financial markets, China Development Bank, Chonqing 7th August 2002 3. World Economic and Financial Survey Global Financial Stability Report, Market Developments and Issues, March 2003 4. World Bank Report, Global Development Finance 2003 5. Capital Flows to Emerging Market Economies, May 15, 2003, Institute of International Finance 6. Mike Fickes, Pension Funds Plan to Plow $14B into Real Estate in 2003, National Real Estate Investor, Feb 1, 2003 7. Tom Mandel, Mutual Funds Trends/Research Newsletter, Feb. 5, 2003, http://funds-newsletter.com 8. Search for strategy, Cover feature, The Banker, December 2002 9. Vera Zelenović, Globalization of financial institutions, Svet finansija, Jan – March 2003, Vojvodjanska bank

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COMMENT 6

TOURIST AMBASSADOR PROJECT 2002 By Srdjan Vukcevic, CEED After the completion of the 2002 Tourist ambassador Project, the publication of the Tourist ambassador report by the Center for Entrepreneurship and Economic Development pointed to some clear problems concerning the tourist industry. Primarily, these problems pertain to the infrastructure, prices of goods and services, quality of services for the prices given, cleanliness, etc. It is now our objective to tour through each of these obstacles within the tourist industry and determine the best approach we might take in order to improve conditions for a successful tourist season. In conducting this project and in speaking with the tourists and business people directly, we observed some very direct negative influences on the tourist season through their comments. In the field, TA’s primarily observed problems with respect to parking, cleanliness, and traffic throughout the monitoring process. The objective of the monitoring activity was to observe the view from the tourists’ perspective and to pay attention to any regularities and irregularities. According to the intensity of problems noticed by the Tourist Ambassadors, problems were grouped into two major areas: traffic and cleanliness. The accommodations survey showed that more than one half of tourists polled (58%) stay in private accommodations, while 28% chose hotels.

28%

58%

14%

0%

10%

20%

30%

40%

50%

60%

hotels private other

This is most likely due to the fact that private accommodations provide a better offering as compared to hotels or it may be due to the absence of communication mechanisms between tourists and hotels, that is to say, underdeveloped information systems and uncoordinated relations between hotels and their potential clients. The survey related to “Tourist Agencies” was aimed to gather data regarding the tourists’ duration of stay in Montenegro, other spots or locations they may visit apart from those in which they spend their holiday and how often, the additional services they use, and their

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satisfaction with the quality of the products and services and with their prices. We acknowledged that tourist agencies do not offer much when it comes to excursions and places visited. Although every Montenegrin municipality could be a target of excursions, nearly one-quarter (23%) of the respondents have not visited any place, while half (52%) have visited between 1 to 3 different places in Montenegro. Our observations within each town separately found a similar situation with the exception of Ulcinj where 50% of the respondents have not visited any other location and only 35% of the tourists have visited between 1 to 3 places. Eight of ten respondents (79%) are satisfied with the quality of products and with the quality of the service provided (83%); however, the majority (58%) are dissatisfied with the relationship between price and value.

very dissatisfied5% dissatisfied

16%very satisfied

28%

satisfied51%

Source CEED Tourist ambassador program Half of respondents (51%) say that they are “satisfied” with the quality of products, more than one-quarter (28%) are “very satisfied” and just 5% are “very dissatisfied” with the quality of products. Cleanliness is one of the things tourists’ first face when they arrive in Montenegro. Therefore, cleanliness on the Montenegrin coast was clearly an issue to be discussed. With this survey we have succeeded to better identify and make concrete the problems regarding: warehousing, lack of garbage receptacles, and overall cleanliness of squares and streets. According to the results of this survey, questions of responsibility and efficiency should be addressed as soon as possible. Nine of ten respondents (89%) think that streets and squares could be much cleaner. Another significant finding of this data is that seven of ten respondents (70%) feel that, among both tourists and citizens alike, there is no culture or internal value in the warehousing of garbage. Everyone who visits any of our seaside towns during the summer season notices the traffic crowd that is caused by a lack of parking space, and due to the nature of supply and

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demand, parking places are extremely overpriced. The aim of this survey is to identify this as a problem so that improvements can be proposed. The survey shows that seven of ten respondents (71%) think that there is a problem associated with adequate parking in the location they were visiting, while eight of ten (80%) think that prices they pay for parking are too high. Therefore, the lack of parking space is a problem for tourists as well as for citizens of the seaside towns. The aim of the survey on restaurants was to provide information on what tourists think and whether they are satisfied with the services of restaurants on the Montenegrin coast. Encouraging data is that more than three-quarters of respondents (78%) say that their experiences with restaurants are “good”. As special satisfaction they quote the quality of food and ambient, but, a rather humiliating statistic, is that only 48% are satisfied with services and cleanliness in restaurants. Furthermore, the level of prices is higher than expected, and this appears here as a general problem. The question is whether expectations are unrealistic or whether the prices in restaurants on the Montenegrin coast are indeed too high. To sum up, this is one segment within the tourist offer to which more attention should be paid, since it directly influences the health of people that visit Montenegro. Beaches are a main attraction for tourists, and thus a place in which they spend a great deal of time, and therefore they have to be adequately arranged with all additional elements. The basic advantage of Montenegro as a tourist destination is its natural beauties. Therefore, beaches present by themselves great wealth but if they are not adequately maintained and protected from various negative influences, it can in the long-term cause an erosion of tourism. With this in mind, this survey has been undertaken in order to locate problems and to give concrete suggestions for their solutions. This survey has found that just half of tourists (48%) think that the beaches are adequately arranged. As basic shortages, tourists quoted: cleanliness (34%), lack of showers (24%), and insufficient number of garbage receptacles (16.6%). Just 7% think that there is nothing wrong with beaches, while 3.4% think that everything is wrong with them.

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

cleanliness showers bins

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The aim of the survey on entertainment was to show whether, and how much, tourists are satisfied with the entertainment contents on our coast. Interestingly, just over half of tourists (52.9%) visit other towns in addition to their primary vacation spot, but for the most part they stay nearby, with 43.3% only visiting places that are near by the town in which they are accommodated. This supports the data from the tourist agency survey that shows that 52% visit only 1-3 places and that these are places in the neighborhood. So, the flow of tourists through Montenegro is concentrated on specific points rather than on Montenegro in general. According to the survey, seven of ten respondents (70.3%) are satisfied with the “night life”, ranking the cafe bars in first place. Businesses, viewed as direct participants in the market game, are here analyzed from the aspect of their problems in order to identify them. We have gathered data about types of businesses, results of their activities, and their expectations and estimates regarding future performance. When asked about the biggest challenges they face while doing business, respondents referred to: money (18.4%), competition (16.4%), satisfaction of customers (10.1%), quality of products or services (8%), and better relation with inspections (6.1%). Encouraging data is that nearly seven of ten respondents (69%) are willing to cooperate in order to improve development of the local business. The aim of the survey “citizens about tourism” was to include a very important part of the tourist economy, that being the citizens of the tourist location where the survey has been conducted, in the process of analyzing the tourist supply. The survey shows that citizens of these towns are aware of the influence that the tourist economy has on their lives. According to this, two-thirds of respondents (66%) think that some portion of their income depends on tourism. However, seven of ten polled citizens (71%) say that the benefits of tourism are not equally distributed in the society. Probably the most interesting questions in this survey are those that refer to the relationship between the social community and the tourist economy. Namely, nine of ten citizens (94%) think that the community should do more to improve the tourist economy, but also, nine of ten (93%) think that the tourist economy should contribute more to the community. Based on the research findings, recommendations include:

Development of a web site that will include the entire Montenegrin supply and would allow

o tourists to buy our products, o the local community to contribute by way of standardization of the supply at a

local level and creation of image, o for organization of trainings for hotelkeepers, o for continued education of the staff, o and for offering development strategies and new marketing concepts.

Forming associations of tourist agencies in Montenegro to bring together the agencies,

the local communities, and the transport companies. o local communities contributing by enriching the supply with cultural and

entertaining events o local communities providing adequate promotion of events and a greater

number of one-day-long excursions

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o improved cooperation between agencies and transport companies.

The organization and implementation of a “Clean-Up Campaign” o obtain the help of the local communities in organizing programs to increase

the level of consciousness among citizens, and therefore among tourists, regarding cleanliness,

o public campaign on protection of living space, o control of work of public (communal) services, and o introduction of penalties for inappropriate behavior, and o registration and control of activities that jeopardize the environment.

Building up new parking spaces (above-ground and underground).

o obtain the help of local communities in solving this problem by giving location to potential investors and placing traffic signals.

Creation of the integral rating list on quality and supply of our restaurants which can be

viewed by clients’ eyes o help restaurants within the local community by preparing suggestions for

improvement to the restaurants’ offer (creating menu in at least two languages, training staff in the English language, cooperation when creating joint booklets and flyers, etc.)

Local communities to more favorably grant permission to private businesses for renting

public beaches o the survey shows that private beaches are more efficiently arranged and are

valued as much cleaner, o decreasing the number of easy chairs with help of local community, o better organization regarding the amenities/activities offered on the beaches,

and o establishing safety standards by the local community.

Increased participation of the local community in increasing the entertainment offering

o building bars and discotheques out of the localities where the concentration of accommodation capacities is the greatest,

o organization of various entertaining contests by local communities, television stations, tourists and citizens (“no limit games”, karaoke, sport tournaments…), and

o help of local community in building up sport fields (tennis, beach soccer, beach volley…).

Providing consulting services (organization, staff, marketing, finances…),

o initiative of the local community to establish cooperation with local businesses in order to help their development,

o homogenization of the businesses’ activities in a sense of joining existing business associations (MBA- Montenegro Business Alliance), and

o the joint solution of problems that concern all businesses.

Improvement of relations between the local community and the tourist economy o institutionalize citizens’ activities in the sense of establishing organizations

that will work within the local community and will deal with the problems that concern citizens.

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COMMENT 7

ENERGY SECTOR IN MONTENEGRO by Aleksander Golas, Stone & Webster Consultants The electricity sector in Montenegro, the vertically integrated monopoly of EPCG, has three large power plants and several very small hydroelectric plants. The installed capacity is equal to 868 MW. The large plants are two hydro stations: Piva and Perucica (about ¾ of total installed capacity) and one thermal plant, Pljevlja (less than ¼ of total installed capacity). The other smaller plants have only 9 MW in total. Electricity sales in 2002 totalled 140.6 million euro. Estimates for 2003 forecast consumption at approximately 4.4 TWh, with 1.5 TWh to be imported. The transmission system is comprised of: o kV lines - 249 km o 220 kV lines - 318 km o 110 kV lines - 656 km The distribution system is comprised of: o 35 KV - 764 km o 11 kV – 4210 km o 0.4 kV – 13 658 km BACKGROUND FOR REFORMS Until the beginning of the eighties, and in some countries until the nineties, the electricity sector was seen as a natural monopoly and as such it needed to be owned and therefore regulated, by the state. This was reinforced by the importance of the sector, seen as the motivator for any economic activity and thus for national independence and security. However, the energy crises of the seventies, the inefficiencies of state controls over complex developments within the sector (resulting in, amongst other things, an additional overburden of ‘stranded assets’), the ever-increasing investment needs of the sector, and the experiments in South America and the UK all led to the shattering of this belief. Thus, a desire for private sector participation (PSP) emerged in order to help the energy sector improve its infrastructure and efficiency and access the broader capital markets. This enabled the sector’s increasing investment needs to be met without putting any additional strain on the taxpayers’ pockets through additional taxation. The need for PSP is especially important with respect to Montenegro, which is chronically short of generating capacity and where the level of deferred investment is estimated by various sources to be several hundred million euros. The maintenance plans, together with the plans to commence additional capacities, and the estimated high costs of realization thereof, combined with the artificially low electricity prices, made these plans impractical. Worldwide experience with successful privatizations of generating assets, distribution networks, and even of transmission (e.g. in the UK - founding of the National Grid Corporation) indicated however, that PSP may prove to be the correct answer to the sector’s problems. However, attraction of PSP requires an efficient regulatory framework, including

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an independent regulatory agency (founded by the particular states). PSP is associated with the restructuring of the sector. The development of strong regulatory systems serves (1) to ensure that tariff levels, appropriate enough, cover costs and reasonable returns, (2) to prevent the anticompetitive behaviour by the electricity market participants, and (3) to restructure the sector to be performed in an efficient and organized way. APPROACH TO THE REFORMS Various international donor organizations (including World Bank, European Agency of Reconstruction (EAR), US Agency for International Development (USAID), and British Department for International Development (DFID)) commenced several programs to help in the reform and restructuring of the sector in order for it to be compliant with the European directives on Electricity. In 2002, the World Bank approved a US$5 million credit aimed at reducing the illegal use of electricity and increasing collection through the installation of electronic meters, remote reading, disconnection facilities, and the prevention of meter tampering. EAR is providing policy advice to the Ministry for Economy, support for energy efficiency measures, advice on the future of the Pljevlja Thermal power plant and associated lignite mine, as well as assistance with the disbursement of an European Investment Bank loan. USAID assisted in drafting The Energy Law (the Law) and continues to assist with the initial establishment of the Energy Regulatory Agency (Agency) and supports EPCG primarily in unbundling accounts and providing policy advice to the Ministry for Economy on energy issues. One of the prerequisites for the successful reform and restructuring of the sector, and perhaps its ultimate privatization, is unbundling (i.e. functional and legal separation of different activities) of the incumbent vertically integrated monopoly into discrete generation, transmission, distribution, and supply entities. Unbundling is performed in order to separate the activities that potentially may compete on the market (such as generation and supply), from these that will further require regulation (transmission and distribution network services). The electricity sector of Montenegro (EPCG) still requires unbundling. An appreciable amount of work has been done already within EPCG (such as the extensive functional unbundling, in respect to accounts separation and introduction of international standards of accounting and reporting). This was done with much help from the USAID accounting consultants. However the scope of tasks that still need to be implemented before the success of unbundling can be heralded, is still significant. This includes: (1) separation of the ‘supply’ business from distribution, (2) establishment of the proper financial (profit, loss) structure, and (3) debenture accounts for the various businesses. Further steps would include (4) the separation of the management functions for particular activities, (5) the true separation of information flows between these entities, and (6) their commercialisation. During the management/organizational stage of unbundling efforts, consideration should be given to (7) devising (through sale, privatization, management/staff buy-outs) the non-core or related non-critical activities (such as minor renovation, transport, and leisure services, kindergartens etc.).

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The UK DFID has agreed with the Government of Montenegro to support the establishment of the new Agency in Montenegro throughout 2003. This support is to be delivered through Stone & Webster Consultants under contract to DFID. The Parliament’s approval of the new Energy Law on May 25th laid the legal grounds for establishing the Agency. In the initial six-month period, after the Agency is established, there would be a range of relevant activities to be undertaken: o Issuing the electricity licenses; o Issuing the licenses for the petroleum sector (mainly with the view to put some order

within the sector, to identify all the participants, etc); o Addressing electricity market organization; o Approval of technical codes. In respect to electricity, The Energy Law requires all such undertakings to be licensed by the Agency. There are five classes of license under the law: generation, transmission (including TSO), distribution, market operator, and supply. All electricity undertakings are required to apply for an interim license within six months of the Law coming into effect. After assessing the: (1) analyses of social impact of any tariff increases or rebalancing required under the Law, (2) choices available in terms of tariff setting methodologies, (3) administrative processes, and (4) transition periods, etc., the Agency may further concentrate its efforts on tariff setting for particular activities. The Law also provides the Agency with the responsibility for regulating electricity tariffs. This responsibility continues until such time as a competitive market is established in generation and/or supply, when the Agency may choose to no longer regulate tariffs in these sub-sectors. GOALS OF THE REFORM The goal of the reform should provide the Montenegrin citizens with a stable and reliable supply of electricity, available at market prices with a financially viable electricity industry. This is the chief objective, as reasonable prices for electricity are one of the fundamentals for the whole Montenegrin economy in order for it to grow, reduce poverty, and to be internationally competitive in the long-term perspective. The establishment of an efficient regulatory framework and the successful unbundling of EPCG (i.e. creating of few, independent electricity companies, dealing with particular components of the electricity-related services) will begin this process, and PSP could further favour it. Whether in due course the Government of Montenegro decides to privatize some of these companies (and which of them) depends on its policies and strategies.

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COMMENT 8

WHAT STAGE OF PENSION REFORM ARE WE IN NOW? by Tijana Stankovic, ISSP One year ago we were analyzing the “necessity” of pension reform in Montenegro, and since then things have changed in the sense of regulations, decisions, and environment. The final draft of the new pension insurance law has been completed and adopted by the Parliament, the Economic Agenda implies the second pillar to be introduced in the next two years, and administrative reform of the Fund PIO has begun. The following sections will provide detailed analysis of the current situation in the pension system regarding measures implemented in the new pension law and its implications for the future. 1. WHAT ARE THE MAIN PROBLEMS OF THE CURRENT SYSTEM? The pension system of generation solidarity has been applied in Montenegro for almost half a century. This type of system is built on the proper number of employed, who are paying contributions, and a proper number of retired, who are receiving benefits. The system needs to be designed with serious consideration of the long-term due to the inherent promise that current contribution payers will have their pensions financed by some future generations of the labor force. Thus, this system does not have direct relationship between individual’s most important resources (valued more than his/her real estate) and sum of benefits paid in retirement. The PAYGO system did not pass the exam in reality; as it turns out, the younger generations, mostly poorer, are maintaining the older generations, who are relatively richer, through their current contributions, but at the same time the young generation is taking a huge political and demographical risk by relying on the fulfillment of the government’s promise. Political risk is in the changing rules of the pension system dependent on government’s preferences and demographic risk comes from the ability or disability of future generations to pay contributions. It has been stated many times that the pension system in Montenegro is in deep financial crisis. There are two main reasons for such a situation: 1. The pension system is financially unsustainable. During its history, the PAYGO system in Montenegro has been too generous, with its low age border, non-medical criteria for assigning disability pensions, broad beneficial pension regulations, and more than 20 non-pension benefits paid by the pension system. These over-extensions of the pension system have been a financial burden throughout the years, accumulating pension expenditures to 9.3% of GDP in 2002 with the difference between contribution revenues and pension expenditures amounting to 1.7% of GDP. Thus, pension coverage with contributions is less than 1, i.e. one pension is financed from 0.8 contributions and only 60% of total Fund PIO28 expenses are covered by contributions. With the primary assumption of pension system sustainability being that total expenditures are covered by 28 Fund PIO is Pension and Disability Insurance Fund

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contributions, this leads to a questionable future under this system. The share of contributions in total revenue of the pension Fund was 59%, leaving more than 40% that came from other non-contribution sources. Total expenditures of the Fund PIO increased from 10% of GDP in 2000 to 13% of GDP in 2002. Only two-thirds of the total Pension Fund expenditures are pension costs, and only 40% of total pensioners are old age pensioners (see Graph 1). This fact leads us to the conclusion that every 24th citizen of Montenegro is a disabled person.

Graph 1. Pensioners structure in 2003

40%

30%

30%

Old age Disabled Survivors

Problems could be solved in the short-term through foreign help, credits, or budget transfers. However, any of these solutions lead to more questions: When will foreign help arrive to Montenegro? Who is going to repay the credits and interests? What is the opportunity cost of financing the pension deficit? The pension system in Montenegro has matured and must be replaced with a new, reformed system more compatible to current and upcoming conditions. 2. Aging of the Montenegrin population. Negative demographic trends characterize not only Montenegro, but most of the other countries as well. In developed countries, an aging population is reason enough for pension reform in order to keep the system sustainable. UN research and projections show that every 50 years the world’s population of the elderly (60 and more) is tripled, and in the year 2050, the number of elderly will exceed the number of young (those less than 15 years) for the first time in human history. A similar trend is occurring in Montenegro. The following indicators refer to 2002: o Population over 60/population less 19 = 49.529 (aging index), represents the aging of the Montenegrin population. An index number above 40 refers to an elderly nation. o Population over 60/population 18-59 = 28%30, meaning that for every older person there are 4 persons in the labor force (see table 1) o Employees/pensioners = 1.28 (dependency ratio), indicates that the contributions of 1.3 workers finance the pension of one retired person (see Graph 1)

29 Source: Working group for Pension Reform 30 Source: Working group for Pension Reform

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Table 1. Population over 60 / Population 18-59

2002 28% 1:4 2020 35% 1:3 2030 42% 1:2 2050 58% 1:2

Source: Working group for pension reform Thus, the demographic changes, entering demographic transition, are negatively related to the pension system in Montenegro. In the last 50 years, the birth rate fell from 34 to 1231 while life expectancy at birth increased from 62.5 to 73.132. The population is living longer, which translates into a longer period of using pension benefits. According to projections, the life expectancy of the Montenegrin population will increase more than 5 years at birth and 4 years at 60 until 2060 (see Table 2.) Table 2. Life expectancy at birth and at 60 projection structured by gender in Montenegro

2003 2010 2020 2030 2040 2050 2060

Male 70.1 71.0 72.0 73.0 74.0 75.0 75.4 Life expectancy at birth

Female 76.1 77.0 78.0 79.0 80.0 81.0 81.4

Male 16.4 17.0 17.6 18.3 19.0 19.7 20.0 Life expectancy at 60

Female 20.1 20.7 21.4 22.2 23.0 23.8 24.,1

Source: Working group for pension system modeling This data refers to the negative pension system trends that imply fewer and fewer young people that will be able to work and pay contributions and an every increasing number of elderly people who will need income but will not be able to work (See Graph 2).

Graph 2. Pensioners-employees scissors in Montenegro

50,000

60,000

70,000

80,000

90,000

100,000

110,000

120,000

130,000

140,000

150,000

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

Employees Pensioners

Graph 2 indicates that over the past ten years, the gap between the number of employees and the number of pensioners has narrowed. In 1991, the dependency ratio was 2.04 and it has decreased to 1.28 in 2002. The closer the lines in the above graphic become, the more

31 Source: Statistical Yearbook 2002, ISSP 32 Demographic report, Federal Statistical Office

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necessary our need for pension reform. Excluding all other factors, the demographic changes supported by negative trends in the economy (a great share of gray economy) are reason enough for pension reform. 2. IMPROVED FIRST PILLAR IS CONTRIBUTING TO PENSION SYSTEM SUSTAINABILITY The final draft of the new Pension and Disability Insurance Law has been completed, adopted by Government, and waiting adoption by Parliament. The main changes in the law that will be analyzed in the following section are: o Age border increase o Change of the pension formula o The working period entered into the pension calculation o New indexation o Expanding base for making contributions o Restrictive conditions for disability, survival and other benefits o Pension fund administrative reform 2.1. Age border increase The age border will gradually be increased from 55 for women and 60 for men to 60 and 65 respectively. Each year, the age requirement will be increased by 6 months so that in 2004 the age requirement for women will be 55.5 and for men 60.5, and will continue in this manner until it reaches the newly determined limits. Life expectancy at birth has increased. When the generation solidarity system was created, life expectancy was much less than it is now (for men 71 and for women 76). Additionally, life expectancy at 65 years has also increased by 15 years. The proposed change to the pension age border will not be an obstacle to the employment of young people, as it has been feared. While it might have been in the past that young workers would need to wait for the older workers to retire in order to get their jobs, this is not possible in the market economies and free labor markets, especially in transition countries. The total economic environment is more in correlation with employment than demographic trends. A comparative analysis shows that countries with a high employment rate also have a high age requirement for their pension system. Montenegro remains the country with the lowest age requirement in the region. The PAYGO system in Montenegro was constituted half a century ago. The age border has not changed despite the longer life expectancies that lead to pensioners receiving benefits for a longer period of time. An increase in the age requirement will contribute to the pension system by earning more in contributions and paying less in benefits, thus alleviating the pension deficit and increasing sustainability in the long run. 2.2. Change of the pension formula The new formula is using a personal coefficient as an overall representative of a person’s working period. This system, used in Germany and Croatia too, takes into account every working year by applying a certain coefficient and is a much easier way to calculate ones pension.

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Old age pension calculation Old age pension = PP x Pension for 1 PP

Pension for 1 PP= % of average wage, exp. = 1.42 % of average gross wage

PP = Average PC x pension period

Pension insurance period – at least 15 and not more than 45

Average PC = (PCy1+PCy2+…+PCyt) / t t = g1+g2+…+gt = 1+1+...+1 Every year is counted as 1, every month as 0.833 and every day as0.00274. PCy = Wageg / Average wage in Montenegro g

Wageg – Wage in year y Average wage in year y – calculated by Statistical Office of Montenegro

Acronym explanations: PP – personal points PC – personal coefficient PCy, - personal coefficient in year y y – specific year of pension period insurance used for calculating pension t – period of calculation, number of years (months, days) enter the pension insurance

The aim of the formula is to create a stronger relationship between the working period, paid contributions, and the resulting pension. A longer period of employment and higher wages earned will add up to a higher pension.

2.3. The working period that is entered into the pension calculation In the previous Law, calculation of the pension was based on the 10 highest paid, consecutive years in the carrier. For most workers, wages will vary throughout their working period, typically increasing. This measure was used as an incentive for “fixing” wages for a 10-year period in order to receive a higher pension, and other workers who were unable to “fix” the wage, received the same level of wages until going to pension. This system does not achieve one of the main goals of the pension system: objective redistribution of revenues. If the system does not consider a worker’s contribution to the system, the system is in danger of being unsustainable. According to the new Law, a worker should work a minimum of 15 years in order to get a pension. The new Law will gradually take into account all years included in the working period, thus each year an additional two years will be added into the pension formula; for instance, in 2004, the formula will consider 12 years, 14 years in 2006, etc. until it reaches 45 years. This measure creates a stronger connection between pensions and contributions, incentives for paying contributions, and higher incomes.

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2.4. New indexation The New pension law provides a new indexation. The percentage of pension growth is the sum of 50% of the inflation rate and 50% of the wage growth rate.

% Pension growth = % consumer prices rate of change (inflation)/2 + % average nominal income rate of change/2

Note: Percentages are referred to half-annual rate of change Or:

NIG = I + RIG SWISS = 50%I + 50%NIG SWISS = 50%I + 50% (I+RIG) SWISS = 50%I + 50%I + 50%RIG SWISS = I + 50%RIG

Note: NIG – nominal income rate of change, SWISS – swiss indexation formula, I – inflation; RIG –real income rate of change This indexation means that pensioners will partly participate in standard of living and partly their pensions will be narrowed at the real level. This measure provides right position between generations. Currently, if the average wage growth rate is higher than the inflation rate, pensions become very high putting a burden on the young working generations, while if the inflation rate is higher than the wage growth rate, pensioners’ purchasing power is decreased. 2.5. Expanding the base for making contributions The old Law determines the working contract as a base for calculating pension. According to the new Law, the pension base is expanded to include all income from work. It means that one will pay contributions (24% of gross wage) from ones regular job wage as well as from all other paid honorary jobs. In this way contribution revenues of the pension system will increase, creating lower bias between total revenues and expenditures. This approach to contributions increases the possibility of paying pensions from contribution revenues in the future. In 2002, the total sum of pensions was € 21 million higher than paid contributions. Equalizing contribution revenues and total Fund PIO expenditures is a necessity in the long run. 2.6. Restrictive conditions for disability, survival and other benefits Restrictions are made in the field of other benefits. All benefits that have been obtained prior to the new Law’s implementation will be paid in the future but new ones will not be awarded. Survival pensions will be restricted to children and widows/widowers only. Some interesting facts about other benefits received in 2002, not due to old age include:

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o the number of disabled pensioners represents 31% of total pensioners o the costs for disability pensions represent 28% of total pension expenditures o 41 disabled persons receive benefits per 1000 people, or every 24th Montenegrin is disabled33 A high proportion of disability pensions, awarded by non-medical criteria without any periodical control, represent a huge burden to the pension system. Therefore, the new Law is proclaiming restrictive disability pensions based on the statement of a licensed doctor. This leads to the consideration of founding a new diagnostic licensed center that would be responsible for organizing and monitoring those citizens who are receiving a disability pension, with the thought that they would be re-evaluated every third year of disability. 2.7. Pension Fund administrative reform The Fund PIO was in charge of pension policy, administration, and many other non-pension businesses. Reform of the first pension pillar assumes narrowing the Fund PIO responsibilities to the administrative function of the pension system. Fund PIO is a shareholder of many state companies. Considering the absence of portfolio managing revenues of the Fund on one side, and the significant investment costs (pension accommodation, investment in hotels at the coast and in the north, etc), this role should be awarded to the private sector and leave the administrative job to the state institution, as the Fund is. It is hard to believe that state managers could contribute to the economy’s development better than private ones. On the other hand, administrative reform refers to minimization of administrative cost and increased efficiency. The new Law assumes a strong relationship between the Fund and DPR34. DPR should collect contributions and all necessary information about pension insurances. Pension Fund reform is work, with those employed in the Fund improving their knowledge and skills. A new pension system that will involve radical changes cannot be introduced if all participants are not informed on time and in the right way, beginning with the main administrative institution employees. Thus, efficient administration of the pension system relies on communication and a skilled IT staff that is well informed of new procedures. 3. PENSION SYSTEM PROJECTION IN THE LONG- AND MID-TERM35 (or: How main reform measures were created?) The basic reform solutions are predicated on a computer model of the next 70 years and experiences of other countries that applied a similar reform for similar reasons. Standardized actuarial techniques were applied in order to calculate old age, disability, and survivor expenditures dynamics36.

33 Population in Montenegro in 2002 is ISSP estimation (Statistical Yearbook 2002, ISSP) 34 Direction for Public Revenues of Montenegro 35 Projection is the result of modeling of Working Group for Pension Reform 36 The model was using: 1. Population data from Monstat, 2. Fund PIO planned balance for 2003, 3. Assumption of 3.5%GDP real growth, 4. Assumption of 2.5% real income growth, 5. Calculation of revenues from contributions and expenditures for tree types of pensions, 6. Other revenues and contributions are based on past dynamics and presented as percentages of GDP

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The model has created an optimistic scenario for employment growth and total economic development and growth. It is very hard to make projections based on the low macroeconomic current capacities in Montenegro and a census done in 1991. Thus, it is very important to observe these projections more as an intention to provide future trends in the pension system with or without reform, not to give exact figures. 3.1. Pension system projection without reform The pension system in Montenegro is paying three types of pensions, contributions for health insurance, supplements, and administrative needs (wages, material costs and costs for paying pensions). Without reform, the pension system would be under an enormous burden (see Table 3) Table 3. Long-Run Forecast of PIO’s Budget Operations (% GDP)

2004 2005 2010 2020 2030 2040 2050

Pension Expenditures 9.5% 9.5% 9.4% 10.5% 12.5% 15.0% 17.7%

Health Transfer 1.9% 1.9% 1.9% 1.9% 1.9% 1.9% 1.9%

Other Expenditures 1.5% 1.5% 1.5% 1.5% 1.5% 1.5% 1.6%

Total Expenditures 12.9% 12.8% 12.7% 13.8% 15.9% 18.4% 21.2%

Contributions – Expenditures -3.9% -3.8% -3.7% -4.8% -6.9% -9.4% -12.2%

Budget Transfer for Official Obligations 1.9% 1.9% 1.9% 1.9% 1.9% 1.9% 1.9%

Contributions + Transfer – Expenditures -1.9% -1.9% -1.8% -2.9% -5.0% -7.5% -10.2%

Without reform, the difference between revenues and expenditures will increase from 3.9% to 12% of GDP in the long-term. The pension system deficit will increase from 1.9% to 10% of GDP. The difference between those two definitions is state budget transfers, which cover warier pensions, policemen pensions, and minimal pensions. 3.2. Reformed pension system long-run projection and comparison to the old system When we refer to the long run, we consider the next 50 years. Over that time, pension fund balance scenarios are analyzed with and without reform. Reformed system analyses takes into account the impact of three basic changes (individually and cumulative) on the pension balance: increasing the age requirement by 5 years, SWISS indexation, and applying a new formula for pension calculation. Legal budget transfers of 1.9% GDP are constant. Analysis of the pension system is done in long-term, considering life and work period of past and future generations to provide financial stability for pension payments now and in decades to come. The main assumptions used in this analysis is that pension reform is long-term reform and that it takes into account a persons' life and work periods of both past and future generations. It is created in order to provide financial stability of the pension system - regular pensions, today, tomorrow and for future decades. The assumptions used in this projection are:

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Table 4: Some pension system cost dynamics in projected balance of pension system

Type of cost Gradually

decreasing in the following…:

In 2004 Decrease to

the level of… Average annual rate of decrease

1 Supplement for aid and care of work disabled and blind persons

…25 years 0.22% GDP 0% GDP 0.08

2 Supplements for remainder working ability …10 years 0.15% GDP 0% GDP 0.2

3 Costs of vacation, recreation and rehabilitation of pensioners

…0 years 0.15% GDP 0% GDP 0

4 Cost of paying pensions …5 years 0.23% GDP 0.13% GDP 0.4

Other types of costs are projected to stay at a fixed level (as % of GDP): Table 5. Fixed pension system costs (as % of GDP)

Type of costs Level of cost

1 Health contributions 1.9% DBP

2 Body injury supplement 0.15% DBP

3 Funeral costs supplements 1.3% of total pension annual costs

4 Labor costs in Fund PIO 0.23% DBP

5 Operational costs 0.21% DBP

Table 6. Fund PIO Balance= Contributions +1.9%GDP-Total pension expenditures in the long run

Deficit as % of GDP 2004 2005 2010 2020 2030 2040 2050

Old Law -1.9 -1.9 -1.8 -2.9 -5 -7.5 -10.2

Age requirement increase -1.9 -1.4 -0.5 -0.5 -2.2 -4.5 -7

1+SWISS indexation -1.9 -1.2 0.2 0.6 -0.7 -2.5 -4.5

2+ change of formula -1.9 -1.1 0.3 1.3 0.7 -0.5 -2.1

Table 6 presents Pension Fund revenues as a sum of contributions and state budget transfers of 1.9% GDP. Thus, we came to the conclusions:

The old law increased the pension deficit to more than 10% of GDP in the long run (until 2050).

Gradual increase of the age requirement reduces future pension costs, so Fund PIO deficit would be 7% of GDP in the long run.

Further, the pension deficit would be lowered to 4.5% of GDP with the age requirement increased by 5 years (for both genders) and SWISS indexation.

In the end, the age requirement increase, SWISS indexation, and the new pension formula could reduce the budget deficit of the Fund PIO to 2% of GDP by the year 2050; this is 8 percentage points less than if the old law were to stay in effect. It is important to note that only the combination of all reform measures will put the system in balance and demographic dynamics can disturb that balance creating a deficit of 2% GDP in the long run.

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Presented by graph:

Graph 3. Fund PIO balance in the long run(contributions+budget transfers 1,9%GDP-total expenditures)

-12

-10

-8

-6

-4

-2

0

2

2004 2010 2020 2030 2040 2050

%B

DP

Old Law

Age border increase

Age border increase and SWISS indexation

Age border increase, SWISS indexation and change of formula

3.3. Reformed pension system mid-term projection and comparison to the old system The following analysis provides Fund PIO balance in the mid-term, until 2010, when the pension system is projected to reach a zero deficit. As in the long-term projection, we take into account a comparative analysis of the new and old law. Table 7. Balance of the Fund PIO = Contributions +1.9%GDP-otal expenditures in the mid-term

2004 2005 2006 2007 2008 2009 2010

Old Law -1.9 -1.9 -1.9 -1.8 -1.8 -1.8 -1.7

Age requirement increase -1.9 -1.6 -1.4 -1.1 -1.0 -0.9 -0.7

1+SWISS indexation -1.9 -1.5 -1.2 -0.8 -0.6 -0.4 -0.1

2+ change of formula -1.9 -1.5 -1.1 -0.8 -0.5 -0.3 0.0

In the short run (until 2010), implementation of all reform measures could equalize revenues (contributions + 1.9% GDP state budget transfers) and expenditures (see Graph 4).

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Graph 4. Fund PIO balance (contributions+budget transfers 1,9%GDP-total expenditures)

-2

-1.8

-1.6

-1.4

-1.2

-1

-0.8

-0.6

-0.4

-0.2

0

2004 2005 2006 2007 2008 2009 2010

% o

d B

DP

Old Law

Age border increase

Age border increase and SWISS indexation

Age border increase, SWISS indexation and change of formula

4. PRIVATE PENSION FUNDS – KEY TO SUSTAINABLE PENSION SYSTEM AND DIGNIFIED RETIREMENT According to negative trends in the pension system, the concept of pension reform in Montenegro is created and based on a three-pillar pension system. The pillars of the pension system present an independent source of pensions. Like the first pillar, the second pillar is also mandatory, but in this kind of system contributions are defined but not benefits. It means, that contribution and pension are directly related. For workers paying contributions to individual pension accounts, their pensions will be dependent on the amount of contributions they have made and their investment earnings, not on the welfare of future generations of workers. Chile was the initiator and the first to implement the second pillar, and since then, it has been popular in many developed and transition countries (Argentina, Bolivia, Kazakhstan, Hungary, and Croatia). Private pension funds have many advantages related to individual and state perspective. First, private pension funds are more focused on maximizing investment turnover and reducing risk for shareholders, owners of the fund. Second, private pension funds are actuating financial market development by creating demand for financial products and institutions. The third pillar is voluntary and the government does not regulate contributions. At first, the third pillar was part of the occupation plan of the company or part of the private pension savings. Although the third pillar is voluntary, governments are creating many legal regulations in order to protect workers' interests from the market incertitude, such as the requirement of licenses of managing company or managers. The pension reform framework and timetable are completed. According to the first draft of the second pillar law, the second pillar is a defined contribution, privately managed pension

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system, with private individual capitalized accounts. The functioning of the second pillar is based on three main institutions: 1. Pension Fund – workers saving resources is virtual body 2. Investment manager – licensed bank, insurance company or investment consultant is investing pension resources in international and domestic capital market 3. Custodian – licensed bank is keeping pension resources, supervising investment manager and maintaining database on all resources. Contributions and interest need long run to accumulate and be paid as pensions. The second and third pillars provide a certainty to working and future generations for revenues when they will not be able to work. Without the backing of private pension funds and radical measures in the state system, the pension system in Montenegro would soon collapse. The collapse of the pension system would spiral on many of the negative trends in the economy: higher contributions followed with gray economy on one side, and lower current consumption, savings and investments on the other side. Therefore, pension reform in Montenegro is a concern of organized pension associations, but much more of a concern for young working generations and those who have just begun their working period.

Montenegro Economic Trends September 2003

ISSP - CEPS

181

Montenegro Economic Trends is the publication sponsored by the European Agency for Reconstruction. The European Agency for Reconstruction is responsible for the management of the main EU assistance programmes in the Federal Republic of Yugoslavia (the Republic of Serbia, Kosovo, and the Republic of Montenegro) and the former Yugoslav Republic of Macedonia. It was established in February 2000 and has its headquarters in Thessaloniki, and operational centres in Pristina, Belgrade, Podgorica and Skopje. The total sum of EU funds newly delegated to the Agency for management in 2001 amounted to some €525 million. The Agency now oversees a total portfolio of over €1.6 billion across its four operational centres.

Headquarters Thessaloniki - Egnatia 4, Thessaloniki 54626, Greece Tel. +30 31 505 100, Fax +30 31 505 172 John Phillips, Head of Information and Communication Unit John.Phillips@ear.eu.int Operational centres Pristina - The Museum, Miladin Popovic, Pristina, Kosovo Tel. +381 38 513 100, +381 38 500 300 200, Fax +381 38 549 963 Sarah Fradgley, pokesperson Sarah.Fradgley@ear.eu.int Belgrade - Vasina 2-4, Belgrade 11000, Serbia Tel. +381 11 30 234 00, Fax +381 11 30 234 55

John White, Spokesperson John.White@ear.eu.int Podgorica - Urb. Parcel 137, Gorica C, Podgorica 81000, Montenegro Tel. +381 81 231 740, Fax +381 81 231 741 Dragan Mugosa, Information Officer Dragan.Mugosa@ear.eu.int

Comments

ISSP - CEPS 182

Montenegro Economic Trends is the publication sponsored by the European Agency for Reconstruction. The European Agency for Reconstruction is responsible for the management of the main EU assistance programmes in the Federal Republic of Yugoslavia (the Republic of Serbia, Kosovo, and the Republic of Montenegro) and the former Yugoslav Republic of Macedonia. It was established in February 2000 and has its headquarters in Thessaloniki, and operational centres in Pristina, Belgrade, Podgorica and Skopje. The total sum of EU funds newly delegated to the Agency for management in 2001 amounted to some €525 million. The Agency now oversees a total portfolio of over €1.6 billion across its four operational centres.