Press Releases 2017 - March

31.03.2017 - CBCG and NGO “Green Heart” signed the Cooperation agreement on recycling paper and electronic waste

29.03.2017 - The 7th CBCG Council Meeting Held

27.03.2017 - Financial Stability Council estimated financial system being stable

27.03.2017 - Celebration of the Global Money Week (GMW) started

24.03.2017 - ANNOUNCEMENT: CBCG celebrates Global Money Week for the fifth consecutive year

08.03.2017 - Ambassador of Romania in Montenegro visited the Central Bank of Montenegro

06.03.2017 - Sixth CBCG Council Session Held

01.03.2017 - Staff Concluding Statement of the 2017 Article IV Mission

CENTRAL BANK OF MONTENEGRO
Podgorica, 31 March 2017

CBCG and NGO “Green Heart” signed the Cooperation agreement on recycling paper and electronic waste

Central Bank of Montenegro and Non-Governmental Organisation “Green Heart” signed the Cooperation agreement on collecting office paper and electronic waste, as a contribution to development of personal and collective social responsibility.

The Agreement stipulates that CBCG employees separate office supplies from electronic waste which is then sent to NGO “Green Heart” for recycling, preserving raw resources and electric power in such way and at the same time helping the improvement of living environment.

By joining this activity, besides affirming cooperation with civil sector, CBCG confirmed its status as a socially responsible institution which, involving in these and projects alike, endeavours to provide full contribution to living environment preservation.

CENTRAL BANK OF MONTENEGRO
Podgorica, 29 March 2017

The 7th CBCG Council Meeting Held

The CBCG Council met today for the 7th meeting chaired by the Governor Radoje Žugić.

The Council adopted the Governor's Report for February 2017, the Central Bank of Montenegro Annual Report for 2016, Financial System Stability Report for 2016, Price Stability Report for 2016 and Quarterly Report on Banks and MFIs’ Operations for the fourth quarter of 2016.

The Governor’s Report stated that the activities of the Central Bank in this period were carried out in line with the obligations planned under the Central Bank of Montenegro Work Programme for 2017. The Report stated that lending and deposit interest rates continued to trend down, thus in February 2017, the effective interest rate on new loans amounted to 6.88%, while in February 2016 it amounted to 8.63%. In the first two months of 2017, the lending activity of banks increased by 10.76% y-o-y.

The CBCG Annual Report for 2016 stated that the year was marked by the intensification of economic activities. Preliminary Monstat data reveal that in the first three quarters, Montenegro's economy recorded a somewhat milder growth in relation to the corresponding period of 2015. The growth was primarily a result of the continued implementation of major investment projects in the sectors of energy, tourism and construction, with the same trend recorded in trade and transport sectors. Postponement of a part of planned activities on the construction of Bar-Boljare highway, along with the decline in the industrial output and foreign trade deficit, has had an adverse effect on the projected growth rates over the observed period. Continued implementation of fiscal system consolidation measures and capital expenditure below planned resulted in the narrowing of fiscal deficit in 2016, despite the significant pressures arising from social allowances increase and the cost of public sector wages. On the other hand, public debt remained on an uptrend. Financial and banking sectors operations were stable, resulting in continued interest for investing in Montenegro’s financial sector. In 2016, one new bank entered the market, while Montenegro Stock Exchange recorded its first successful issue of government bonds.

In the part of the Annual Report that refers to the implementation of the CBCG policy it was rated that this institution’s activities in 2016 were aimed at the preservation of the financial system stability by fostering and maintaining a sound banking system and safe and efficient payment system. Consequently, the key activities of the CBCG referred to preventive and supervisory activities, stabilisation and strengthening of the banking sector, maintaining the stability and improving the efficiency of the national payment system and promoting healthy competition.  In this segment, the practice has confirmed the expectations that the increase in the number of business entities in the banking sector, on condition that the high levels of stability, liquidity and solvency are preserved, will result in strengthening competitiveness, widening the spectrum and improving the quality of services, further interest rate decline and lending activity increase under favourable conditions. The Report further stated that CBCG’s regulatory activities were mainly determined by Montenegro’s negotiating position in the process of EU accession. The Council found that the CBCG’s operations were based on high transparency standards and social responsibility principles. In reference to financial results, the CBCG recorded net profit of 1.83 million euros in 2016.

The Financial System Stability Report for 2016 stated that the level of systemic risks, which affect the stability of the financial system, may be assessed as moderate, with the presence of financial risks at the individual level. Factors in the form of illiquidity and insufficient competitiveness of the real sector, high spending observed against relatively low accumulation and increased dependence on foreign capital inflow have induced the fiscal sphere pressures increase.

It was underlined that the banks represent the soundest segment of the economic-financial system. This statement was confirmed by the fact that the banking sector is characterised by the stability and continuous increase of deposits, as well as by the data provided in the Quarterly Report on Banks and MFIs’ Operations for the fourth quarter of 2016, which show that in 2016, the banking system recorded a positive financial result, i.e. profit of 7.4 million euros.  This report also provided data showing that in the final quarter of 2016, the banking sector was marked by a y-o-y increase in assets, gross loans and deposits, along with a y-o-y decline in the placements with banks and capital. Banking sector liquidity and solvency indicators were relatively high. It was stated that the banking sector still had systemic challenges in the form of non-performing loans (although they are on a continuous downtrend) and sluggish credit growth. It was assessed that the level of public debt and government guarantees poses a relatively strong systemic risk.

The Price Stability Report for 2016 stated that, following a positive inflation in 2015, in 2016, in Montenegro, the prices were affected by the global market oil price trends, and the price trends of specific food products. Taking into consideration the annual rates, the prices were negative for the most part of the year. However, at end-December, the annual inflation rate was positive (1%) and virtually identical to the one recorded in the euro area (1.1%). In reference to the region, positive inflation rates were observed in Albania (2.2%), Serbia (1.6%), Croatia (0.7%) and Slovenia (0.6%), while negative inflation rates were recorded in Macedonia and Bosnia and Herzegovina (-0.2% each). The CBCG’s survey revealed that majority of banks and economic subjects expect the 2017 inflation to range between 0.5% and 1.5%. CBCG’s expert assessment indicated inflation between 1% and 3% for the end of 2017.

On today’s meeting the Council also considered other current issues from its competency.

FINANCIAL STABILITY COUNCIL
Podgorica, 27 March 2017

Financial Stability Council estimated financial system being stable

34th Financial Stability Council session was held today, presided by Radoje Žugić, Central Bank Governor and the Council President. All other members of the Council attended the session, those being Mr Darko Radunovic - Minister of Finance, Mr Branko Vujovic - Insurance Supervision Agency President, Mr Zoran Djikanovic - Securities and Exchange Commission President. Mr Predrag Marković – Deposit Protection Fund Director attends the sessions, at call.

Both the Financial Stability Council 2016 Annual Report and current issues from Deposit Protection Fund activities were discussed at the session today.

2016 Annual Report includes review of activities for the previous year as well as current policy topics concerning financial stability. Also, financial stability risk indicators in Montenegro for 2016 were sorted out and the expert evaluation on the level of those was done. Based on these estimations, financial stability systemic risk was evaluated as moderately stable, with certain risks having a negative impact on specific system vulnerabilities.

The Report, inter alia, stated that the financial system was stable during the previous year and the systemic risk level moderate, with illiquidity and insolvency risk of the real sector being present, which all had impact on increasing the pressure in fiscal sphere. Credit risk in banking sector, although still present, recorded downtrend.

The banking system as a predominant part of financial system in Montenegro is relatively stable. Financial risks are decreasing but are still present at the individual level. Financial result of banks on an aggregate level is positive, while liquidity and solvency improved and their levels are still significantly above the minimum level prescribed by the law. When compared to a previous year, almost all positions from the banks’ balance recorded the uptrend, those being: total assets, deposits, loans and capital. The banks, even during 2016, had prudent real sector lending policy, relying mainly on their own liquid funds. Significant part of the new lending was focused on restructuring and refinancing of the existing loans, which had a positive impact on corporate recovery. Bank deposits exceeded the approved loans, confirmed by the data that 85% of deposits is used for corporate lending. Total loans and receivables during 2016 recorded a positive trend with a slight increase of 1.27% when compared to a previous year. Asset quality parameters during 2016 recorded an improvement, which had a positive influence on system stability. The share of non-performing loans in total loans was reduced but still noticeable (10.3% at end-December 2016) and this very fact makes banks to be cautious when it comes to new lending. Lending interest rates, although having a slight downtrend, are still high and represent a barrier for more dynamic corporate recovery.

When the 2016 international environment is the issue, a modest GDP growth was recorded in the countries which are the main Montenegrin trade partners, excluding Russia, which recorded a modest drop in two previous years. For Montenegro, as a small and open economy, a significant impact in international climate is achieved through capital flows, i.e. foreign direct investments varying in volume, but still being significant, making 10% of the GDP. In 2016, in spite of the high previous year base, uptrend in tourism is also recorded, which had a positive impact on the achieved corporate growth rate. 

Investment consumption was positive and is a result of a significant capital investment volume. Continuation of such trend is expected directly through positive influence that investment have on employment and GDP, decrease of a real sector risk in mid-term.

Price stability in Montenegro has not been jeopardized although a deflationary trend in certain prices was recorded. Aluminium prices recorded a continuous decrease during previous years, while fuel prices fell by December 2016, when they recorded 3.3% growth. An increase in fuel prices is expected in the upcoming period due to excise duties, as well as for the expected growth in crude oil prices in the world market. Inflation in Eurozone amounted to 1.1% and does not represent the additional risk.

In the fiscal sector sphere, current budget deficit and government debt exceeds the law prescribed limits, and for that reason the Government of Montenegro reacted by defining and implementing fiscal consolidation measures, reducing the level of these categories in 2016 compared to 2015. Higher budget revenues were achieved in the previous year while, on the other hand, budget expenditures were reduced through public consumption restrictions. Even though the measures taken gave good results, further fiscal adjustments were needed in order to diminish the existing risks in this sphere and reach a desirable fiscal stability level. According to Ministry of Finance estimations, the government debt level and current account deficit will record a decrease as of 2019.

Stability is slightly strengthened in insurance sector with indicators pointing out to positive growth rates with obvious domination in mandatory forms of insurance. There is a large space for further development in this sector, which would have positive effects on system stability in the upcoming period.

During 2016, capital market indicators in Montenegro were under a great influence of the transaction related to treasury bills issuance amounting to EUR 80.4 million. More dynamic trade with financial and non-financial sector shares was not noted while market capitalization recorded negative growth rates when compared to a previous year.

The Council also discussed information on current issues from the Deposit Protection Fund competence and supported solutions to improving business efficiency in this institution.

CENTRAL BANK OF MONTENEGRO
Podgorica, 27 March 2017

Celebration of the Global Money Week (GMW) started

Celebration of the GMW under the motto "Learn, save, earn" began today by the visit of students of the high school "Slobodan Škerović" to the Central Bank of Montenegro.

Governor of the Central Bank of Montenegro, Radoje Žugić, in his welcome speech to high school students, said that this institution has developed a number of activities within the framework of the GMW and the same included a large number of children and young people, with the aim of financial education, which is especially important in terms of the increasing sophistication of financial market, which, day after day, is offering new products and services. Through the initiation and implementation of these educational and socially responsible activities, Central Bank supports financial education, and strengthens financial literacy, which is a prerequisite for responsible money management.

"Money is a valuable resource which is not easy to get, and therefore must not be understood and perceived easily. Our goal is to provide you, through this and other similar activities, with this fact and motivate you to develop habits of saving and responsibly and skilfully manage personal budgets, which today represents an allowance or, perhaps, scholarship, and already tomorrow honestly earned wage and other income"- said the governor Žugić.

After the welcoming speech of the Governor, students of high school "Slobodan Škerović" attended lectures on financial products and recognition of counterfeit money, in which the main financial products and services offered in the domestic market were presented as well as the ways in which we can recognize false i.e. counterfeit money.

GMW is a global event, organized at the initiative of the Child and Youth Finance International (CYFI) aiming to strengthen financial literacy, as well as the spreading of financial knowledge and skills of children and young people.

CENTRAL BANK OF MONTENEGRO
Podgorica, 24 March 2017

ANNOUNCEMENT: CBCG celebrates Global Money Week for the fifth consecutive year

Next week, the Central Bank of Montenegro will celebrate the Global Money Week (GMW) under the motto "Learn, save, earn". This event, which is organized at the initiative of the Child and Youth Finance International (CYFI), aims to strengthen financial literacy, as well as to spread financial knowledge and skills, particularly with these categories.

As in previous years, the Central Bank of Montenegro, with a view to marking this event, implemented number of activities which will include a large number of children and young people through visits to kindergartens and schools and the organization of lectures, discussions, creative workshops, and the like.

On Monday, 27 March 2017, students of the high school "Slobodan Škerović" will visit the Central Bank of Montenegro, where will attend the lectures on financial products and to recognition of counterfeit money. On 28 March 2017, students from two primary schools in Podgorica "Maksim Gorki" and "Vlado Milic" will visit the Central Bank of Montenegro, with the aim of familiarizing children with basic financial concepts and categories.

On Wednesday, 29 March 2017, students from Cetinje high school as well as students from two primary schools from Cetinje ("Njegoš" and "Lovćenski partizanski odred") will visit Money Museum.

On Thursday, 30 March 2017, representatives of the Central Bank of Montenegro will visit the Naval high school and PI Resource centre for education and rehabilitation of persons with hearing and speech disorders in Kotor, where high school students will have the opportunity to hear lectures on the theme: "How to identify counterfeit money" and "Introduction to the world of money."

On Friday, 31 March 2017, children from two kindergartens from Podgorica, ''Suncokrili'' - PI "Ljubica Popovic" and "Vrela ribnička" – PI ''Đina Vrbica'', will be visited by the representatives of the CBCG who will be organize creative workshops for children through play and socializing, introducing them with the world of finances ".

Through the initiation and implementation of these educational and socially responsible activities, the Central Bank of Montenegro supports financial education, and strengthening financial literacy, which is a prerequisite for responsible money management.

CENTRAL BANK OF MONTENEGRO
Podgorica, 08 March 2017

Ambassador of Romania in Montenegro visited the Central Bank of Montenegro

Governor of the Central Bank of Montenegro, Radoje Žugić, met his Excellency, the Ambassador of Romania in Montenegro, Ferdinand Nagi.

During the meeting, Governor Žugić informed the Ambassador of Romania about the current economic situation in the country, with special emphasis on the situation in the financial and banking sector and stressed the readiness of the CBCG to, within its competences; contribute to the overall process of fiscal consolidation.

The governor pointed to the CBCG activities intensively conducted in the framework of the obligations in the process of European integration, in order to ensure full compliance of the regulatory framework with European standards.

The Ambassador stressed the importance of the CBCG in the financial system and supported its current and future activities.

During the discussion it was stated that the bilateral relations are developing, as well as contribution of cooperation between the National Bank of Romania and the CBCG to the improvement of overall bilateral cooperation between the two countries.

CENTRAL BANK OF MONTENEGRO
Podgorica, 06 March 2017

Sixth CBCG Council Session Held

The Central Bank of Montenegro Council held its sixth session today.

The Council passed the Decision on Amendments to the Decision on Bank Reserve Requirement to be Held with the Central Bank of Montenegro, decreasing the reserve requirement ratio by two percentage points, from 9.5% to 7.5%, i.e. from 8.5% to 6.5%, depending on the defined reserve requirement calculation base. Both calculation period and maintenance period with the CBCG were changed from weekly to monthly term, which is in line with regional and global practice, as well as with those of ECB, all having this period longer than 42 days. In doing so, as well as by decreasing the reserve requirement ratio, this monetary policy instrument is becoming gradually harmonised with the EBC legislation in this area. Releasing the portion of banks` funds used for appropriation, i.e. maintenance of reserve requirement, liquid funds of banks, which can stimulate credit activity, will increase.

The Council also discussed other current issues from its competence.

INTERNATIONAL MONETARY FUND
Podgorica, 01 March 2017

Staff Concluding Statement of the 2017 Article IV Mission

An International Monetary Fund mission visited Podgorica from February 15 to March 1 to conduct the 2017 Article IV consultations.

Adverse fiscal developments in 2016 have worsened the fiscal outlook and reduced the authorities’ future investment capacity. This will impact growth adversely, despite some positive effects from the highway. The authorities recognize the need for strong fiscal adjustment to limit the projected increase in public debt and put the public finances on a sustainable footing. The 2017 budget was an important first step in addressing fiscal challenges and will reduce the non-highway budget deficit. The authorities have already identified some medium-term measures, and additional measures will be announced as part of a fiscal strategy in the second quarter of 2017. The financial sector appears to be improving, but the planned fiscal adjustment process could affect bank profitability, and the supervisory authorities should continue to monitor any emerging risks. Further efforts in reducing the grey economy and improving competitiveness could support the authorities’ adjustment efforts.

Recent Developments and Outlook

1. Real economic growth in 2016 is estimated at a lower-than-expected 2.4 percent, partly due to a delay in the highway project. Tourism enjoyed another strong season, while energy and mining grew. Construction strengthened as tourism, infrastructure, and energy projects were implemented. Private sector credit expanded by 6.4 percent after a few years of subdued lending activity. End-year inflation was low at 1 percent on account of declining food, household, and transport prices. The external current account deficit increased to 19 percent, partly reflecting machinery imports for the highway, tourism and energy projects.

2. The estimated fiscal deficit of 5¼ percent of GDP was substantially smaller than expected, but the underlying fiscal position deteriorated. Capital spending was 5 percent of GDP instead of a previously projected 12 percent because of the highway delay. However, current spending grew by more than 3 percentage points of GDP on account of lifetime benefits to mothers of three or more children, public sector wage increases, and one-off transfers. The decision to grant benefits to mothers had unfortunate side effects, notably its high fiscal cost (2 percent of GDP), its poor targeting in terms of social protection, and the negative impact on female labor participation. On the positive side, the tax-to-GDP ratio increased by 1½ percentage points on account of strong performance with the personal income tax and VAT. Also, nontax revenues increased due to a one-time communications fee of 1½ percent of GDP. General government debt increased to 71 percent of GDP, (79 percent of GDP including guarantees).   

3. The economy is projected to expand by 3¼ percent in 2017, which reflects the positive demand effect from the highway and other private investments, but also some negative impulse from the adjustment in the non-highway budget. Growth would be driven by investment and to a smaller extent by private consumption, with an expected negative contribution from the external sector. The current account deficit is projected to increase due to the import needs related to capital investments. Credit to the private sector is expected to increase by 5 percent. Inflation is projected to increase by slightly less than 2 percent on average.

4. Economic growth over the medium term is affected by the highway project through immediate demand and subsequent supply effects. With an estimated cost of €1.0 billion (higher than initially expected due to exchange rate effects), it is projected to increase 2023 GDP by about €150 million. Economic growth is expected to average 3 percent over the next five years. Other large, foreign-financed capital investment projects are also projected to contribute to growth, but also to an elevated current account deficit. Following the banking system’s efforts to reduce non-performing loans, banks should be in a position to support the economy through increased private sector lending. Low inflation in the euro area is expected to help restrain price pressures.

The Need for Fiscal Adjustment

5. While the highway will bring with it some economic benefits, its very high costs will limit the government’s ability to undertake other important investments and expose the economy to risks. General government debt is projected to increase to 82 percent of GDP by 2019 (89 percent of GDP including guarantees). However, non-highway capital spending over the next five years may only amount to some €125 150 million (around 3½ percent of GDP) per year. This compares to estimated investment needs in the environmental area alone (water sanitation, air pollution, and global warming) of possibly almost €1½ billion in order to meet EU standards. Moreover, funding for other high-return investments in public infrastructure, health, education, and social protection will also be very limited. The country’s capacity to respond to temporary external or domestic economic shocks has likewise been diminished because of the high level of debt. Finally, large projected government refinancing needs for maturing debt will require some recourse to external markets and will expose Montenegro to more volatile international financial markets.

6. The authorities recognize the challenges related to increasing debt and have already taken significant steps in the context of the 2017 budget. In the mission’s view, the budget contains more than 2 percent of GDP in fiscal measures. On the revenue side, the new measures include an extension of the 11 percent rate for the personal income tax, an increase in gasoline excises, improvements in tax administration, and collections from a tax debt restructuring program. The tax debt program, while allowing viable companies to pay their overdue tax obligations in a more growth-supporting manner, does contain elements of a tax amnesty, because it forgives interest, with possible moral hazard effects. On the expenditure side, the authorities limited the financial impact of the mothers’ law and reduced wages for senior public officials, but also limited the non-highway capital budget, which is already low. The overall budget deficit in 2017 is projected to increase to 7½ percent of GDP, mainly on account of highway spending, which is expected to more than double to 6 percent of GDP. General government debt will likely end this year at 75 percent of GDP (82 percent of GDP including guarantees).    

7. The authorities are committed to a medium-term fiscal consolidation plan that would put debt firmly on a downward path after the highway is finished in 2019. The authorities’ consolidation plan already targeted a primary fiscal surplus of 3 percent of GDP for 2020. The authorities have already identified measures that focus on reducing expenditures, including the public sector wage bill and mothers’ benefits, with some gains related to improvements in tax administration, collection of tax arrears, and regularization of buildings without permits.

8. The mission recommends a primary surplus target of 4½ percent of GDP for 2020. The authorities agree with the mission that this very high primary balance is needed to reduce the large financing requirement that would otherwise materialize in 2019 and 2020. As part of the fiscal adjustment strategy, the mission recommends creating room for increased capital spending of ½ percent of GDP and well-targeted social spending of ¼ percent of GDP to support growth and soften the impact of adjustment on the most vulnerable parts of the population. The mission estimates that fiscal adjustment measures of 2¾ percent of GDP would be needed to reach the target. This is in addition to the 1½ percent of GDP in measures already identified by the authorities, who intend to work with Fund and World Bank staff to identify the remaining measures in a fiscal strategy document planned for the second quarter of 2017. Starting in 2021, the primary surplus could be reduced gradually, while keeping debt on a downward trend. This would allow for an increase in priority spending, and debt could be lowered to 66 percent of GDP by 2022 (72 percent of GDP including guarantees).

Possible Measures for Fiscal Adjustment   

9. The mission believes that the major adjustment effort should be on the expenditure side. The public sector wage bill and pension spending are high by international comparisons and should be reduced over the medium term.

• The mission is encouraged by the fact that the authorities are working with the EU on a public administration reform focusing on right-sizing government employment and shifting towards merit-based pay. Public wage increases should be constrained until a comprehensive public administration reform can be adopted.
• The mothers’ benefit should be changed such that mothers who left their jobs are compensated in a way that encourages them to rejoin the work force. Mothers who were previously unemployed or retired should be returned to the social protection system (and be subject to means-testing) or the pension system, although they could be given an additional year of service for the pension calculation.
• At the same time, the social protection system should be changed to better target the vulnerable parts of the population. Social protection spending is significant, but it is currently not well-targeted and it provides disincentives for joining the labor market.
• The pension system is not inherently generous, but past ad-hoc decisions created early retirement opportunities that the system could not afford. The mission believes that pension costs could be reduced in a fair manner in the short term by including pensions in the taxable base for the personal income tax, which would only affect high earners. Also, pensioners could pay a health insurance contribution to be assessed against the amount that their pensions exceed the average pension, which would also primarily affect better-off pensioners. The mission concurs with the World Bank’s recommendation to increase the early retirement decrement (penalty), abolish eligibility for retirement with 40 years of service, reduce the early retirement period to 2 years, and make accelerated pensions contributions actuarially fair.    

10. The authorities want to maintain a competitive tax system with low rates. Given the need to reduce the deficit relatively quickly, the mission recommends a number of revenue measures that will reduce negative externalities related to pollution or chronic diseases, broaden the tax base, and contribute to social fairness.

• The burning of coal contributes significantly to local pollution and global warming. The mission estimates preliminarily that the local pollution cost of using coal is a multiple of its current price and its global warming cost is about half of its current price. An introduction of an excise on coal would internalize these costs and lead to the reduction of health-related costs, while generating revenues for the budget and stimulating investment in cleaner energy sources. The excise should be introduced gradually and eventually raised to the full level of associated externalities. The increased cost of coal should be fully reflected in electricity prices, and transitional arrangements for affected industries should be considered.
• Excises for cigarettes, alcohol, fuel products, and sugary drinks could be increased, bringing them in line with EU standards where applicable, while ensuring that they do not significantly exceed similar excises in neighboring countries.
• At the local level, tariffs for water and waste disposal should be raised to full cost recovery level including, over time, future costs of capital improvements. Currently, tariffs do not even cover current maintenance costs and contribute to the poor fiscal performance of local governments and environmental degradation. Working with multi-lateral and bilateral donors in this area could also help mobilize further resources. Consideration should also be given to increasing collections for the value-based real estate tax by improving the legal and administrative framework (including better databases and valuation), and potentially by raising rates.  
• The lower VAT rate could be moved to half of the regular rate, and the VAT for hotel services and marina services could be moved to the regular rate.
• The mission recommends raising the higher rate on personal income tax to 13 percent and extending it through 2022 to ensure a fair contribution to the adjustment by those with higher incomes, as during the financial crisis.

11. Regarding fiscal financing, the mission encourages the authorities to accelerate their privatization program and improve the debt repayment profile. The privatization of Montenegro Airlines and other public enterprises without a public policy function would add to financing resources and reduce the future drain on budgets. The authorities should also continue their efforts at developing the local T-bill and longer-term bond market.

Financial Sector

12. Financial conditions have improved during 2016. Banks are highly liquid and average capital ratios exceed regulatory minimums, albeit with some variation across institutions. Profitability for most banks has increased, but remains weak despite noticeably declining nonperforming loans (NPLs) and high interest margins, which are partly explained by a high cost structure and country risk premia. Credit to the private sector has increased, after shrinking for a sustained period, although not as fast as might be expected given high liquidity. This reflects problems with collateral execution, weak enterprise accounting practices, particularly in the SME sector, and relatively high lending standards in the aftermath of high NPLs.

13. The authorities consider strong credit growth to be essential to support the government’s growth strategy. To that end, the voluntary debt resolution framework (Podgorica approach) is expected to be extended until 2018 and enhanced by including more classes of NPLs and providing greater incentives for participation. Notwithstanding the authorities’ desire to see stronger credit growth, banks should be allowed to respond to market conditions without administrative interference. The mission supports the authorities’ intention of moving away from interest rate caps as such measures could have unintended consequences.

14. The authorities are continuing to implement recommendations from the Financial Sector Assessment Program (FSAP) to mitigate risks to the financial system. These include improving the management of nonperforming assets and liquidity risk, reducing operational risks, and limiting risks related to funding and credit concentration. The authorities are closely monitoring weaker banks and are preparing resolution plans in the context of contingency planning. They are drafting a new banking law and intend to introduce International Financial Reporting Standard (IFSR) 9 regulations in 2018, which should result in more stringent provisioning practices, and they have requested Fund TA to help with this process. They plan to roll out asset quality reviews in 2018/19. Given the high fixed costs of complying with accounting and reporting requirements, an increase of the minimum required capital might be considered as it would help banks realize economies of scale and could lead to greater competition.

15. The authorities need to be especially vigilant in monitoring threats to financial stability in the absence of monetary policy tools and limited fiscal space. In the process of fiscal retrenchment, banks’ profitability may suffer and the central bank should monitor closely the potential impact on individual banks and the system. Banks with no access to emergency funding should receive particular attention. The authorities are drafting a bank resolution law, where recourse to public financial support would be considered only after shareholder equity, hybrid capital, and subordinated debt are written off. The authorities are also drafting a new financial institutions law, which should lead to the elimination of supervisory gaps. 

Structural Reforms

16. The authorities plan to revise the labor law to increase labor market participation and encourage the formalization of the informal economy. Given the absence of monetary policy tools and severely limited fiscal space, they should focus on increasing the flexibility of labor markets, reducing labor market informality, and continuing to improve the business climate (e.g., contract enforcement). In particular, the approval process for permits and licenses could be accelerated. More active labor market policies could also be considered to diminish the high level of long-term unemployment. It will also be important to improve the practical skills of university graduates to facilitate their faster integration in the labor market. Finally, public outreach to explain the benefits that come from government spending could boost revenue and reduce the grey economy.

The mission would like to thank the authorities for their generous hospitality and their and other counterparts’ very open and constructive discussions.