TRANSITION REPORT 2014 Innovation in Transition

http://2014.tr-ebrd.com/wp-content/uploads/2014/10/FYR-Macedonia.jpg) top left;" title="FYR Macedonia">

Highlights

  • Economic performance has strengthened, helped by significant FDI inflows. Sustained efforts over the years to attract foreign direct investment (FDI) are paying off in terms of strong export growth and a significant economic recovery from the 2012 recession.
  • Further improvements have been made to the business environment. Efforts have been stepped up to oversee the inspection process in order to reduce the potential for inefficiencies and corruption.
  • Key infrastructure is being upgraded. Important advances have been made with regard to the building of new roads and strengthening of electricity interconnections with regional economies.

Key priorities for 2015

  • The size of the informal sector needs to be reduced. Businesses have identified unfair competition from the informal sector as the main obstacle to doing business. Tackling this problem is required to ensure a level playing field for enterprises.
  • Regional linkages should be further enhanced. Given the country’s small, land-locked status, improved transport and energy links with neighbouring countries are vital for economic recovery.
  • A more prudent fiscal policy is needed. FYR Macedonia has a good track record of fiscal prudence, as shown by the relatively moderate level of public debt, but the past couple of years have seen a significant rise in government deficits and debt levels, which could lead to problems if not checked promptly.

ECONOMIC PERFORMANCE HAS STRENGTHENED, HELPED BY SIGNIFICANT FDI INFLOWS

FURTHER IMPROVEMENTS HAVE BEEN MADE TO THE BUSINESS ENVIRONMENT

KEY INFRASTRUCTURE IS BEING UPGRADED

2014 sector transition indicators
Corporate Energy Infrastructure FI

Source: EBRD.
Note: FI – Financial institution; ICT – Information and communication technology; Water – Water and wastewater; IAOFS – Insurance and other financial services; PE – Private equity.


Main macroeconomic indicators %

  2010 2011 2012 2013 2014
          proj.
GDP growth 2.9 2.8 -0.4 2.9 3.0
Inflation (average) 1.5 3.9 3.3 2.8 1.5
Government balance/GDP -2.4 -2.5 -3.9 -4.1 -3.5
Current account balance/GDP -2.0 -2.5 -3.0 -1.9 -4.6
Net FDI/GDP 2.2 4.5 1.0 3.3 3.8
External debt/GDP 58.0 65.1 70.8 75.4 n.a.
Gross reserves/GDP 24.3 27.7 29.4 25.9 n.a.
Credit to private sector/GDP 44.5 45.3 47.7 49.1 n.a.

Macroeconomic performance

The economy has recovered well after the 2012 recession. In contrast to 2012, when GDP contracted by 0.4 per cent on the back of weak export growth and reduced private consumption, growth in 2013 was relatively strong. GDP rose by about 3 per cent, owing primarily to public investment, along with the recovery of exports and private consumption. However, the more vibrant economy has not been reflected on the labour market and in price dynamics. The level of unemployment remained high (nearly 30 per cent) and the decline in inflation accelerated in the second half of 2013. So far, these trends have continued into 2014, with growth of almost 4 per cent year-on-year in the first half of the year, along with low inflation, which turned negative in April and has remained so since, apart from in July.

Fiscal policy has loosened considerably over the past few years. The budget deficit rose from 2.5 per cent in 2011 to nearly 4 per cent of GDP in 2012 and about 4.1 per cent in 2013. It is expected to remain elevated in the coming years on account of the government’s continued high capital expenditures. Public debt (including guaranteed debt of public enterprises and state-owned companies), however, still remains relatively moderate by regional standards at an estimated 46.8 per cent of GDP as of August 2014. However, this is more than double the level in 2008, which was 23 per cent of GDP. The government has started the process of imposing a constitutional ceiling on the budget deficit and public debt at 3 per cent and 60 per cent of GDP, respectively. In doing so, the government is signalling its determination to adhere to fiscal discipline and stability.

Further growth is likely this year. GDP is expected to grow by about 3 per cent in 2014, similar to last year. The country continues to strive to attract much-needed FDI. In the baseline, these efforts should maintain positive growth prospects in the coming years and enable FYR Macedonia to reap the benefits of sustained macroeconomic stability and business environment reforms that have been pursued in recent years. Unblocking political obstacles to European Union (EU) accession would provide a further boost to investor confidence and economic growth.


Major structural reform developments

High-level accession dialogue with the European Union continues but formal EU accession negotiations remain stalled. In October 2014 the European Commission issued a recommendation to open accession talks with FYR Macedonia for the sixth year in a row. However, thus far the European Council has not upheld this recommendation. The high-level accession dialogue between the EU and FYR Macedonia, initiated in 2012 and aimed at maintaining the country’s reform momentum in five key areas (rule of law, public administration, freedoms, electoral reform and the economy), is ongoing.

Privatisation agreement was reached on major tobacco company, but other sales remain stalled. In May 2014 a strategic partnership was signed between state-owned tobacco company, Tutunski Kombinat AD Prilep (TKP), and the multinational company Philip Morris. Under the joint venture, 51 per cent will be owned by Philip Morris and 49 per cent by TKP. Philip Morris has committed to investing in technology upgrades and productivity enhancements of the currently loss-making company. Other potential large-scale privatisations, including chemicals company, Ohis, electrical engineering company, EMO Ohrid, and weapons manufacturer, 11 Oktomvri Eurokompozit, remain stalled due to lack of investor interest.

Further enhancements to the business environment have been made over the past year. In recent years, FYR Macedonia has consistently out-performed other countries in the region for its ease of doing business. The country currently ranks 30th (out of 189 countries) in the World Bank Doing Business 2015 report. Further measures taken in the past year to ease the burden on enterprises include a new Law on Financial Discipline, effective May 2014, which aims to improve liquidity in the private sector. In addition, the authorities have established a new inspection council to oversee other inspection bodies, which is meant to reduce corruption and promote a more professional approach to inspection. The main challenges are to ensure effective enforcement of these new laws and to address more deep-rooted constraints to doing business.

Reform efforts to attract foreign direct investment are paying off. FDI jumped more than threefold in 2013 relative to the previous year, and was followed by a 43 per cent year-on-year increase in the first four months of 2014. This reflects the strong pro-FDI policies of the previous years. The source of FDI is quite diverse, covering both EU countries as well as partners from the Middle East, the United States and Turkey, among others. FYR Macedonia has also become a producer of car components and there are several investments in this growing sector. In addition, the government has been moving forward on a new initiative to establish an international financial zone. Under this plan, the regulations of those economies that are the most attractive for investors will be replicated, and those companies willing to move their branch offices into the zone will be offered additional benefits.

Transport infrastructure upgrades continue. Two key road projects have been approved in FYR Macedonia: the Skopje-Stip highway and the highway from Kicevo to Ohrid. Under an agreement signed in 2013, China Exim Bank will finance the project and the Chinese company Sinohydro Corporation Limited will carry out the construction work. The value of the two projects is estimated to be above €0.5 billion. Under the agreement, Sinohydro is required to hire at least 49 per cent of subcontractors and 51 per cent of the workforce from the local economy. This should help alleviate the country’s high level of unemployment and further strengthen the economic recovery.

Electricity interconnection with Albania is helping to advance the creation of a regional electricity market. FYR Macedonia’s state-owned electricity transmission system operator, MEPSO, is planning to design a 400 kV interconnection line between FYR Macedonia and Albania. The planned interconnection is part of an initiative to create a major electricity transmission corridor in south-eastern Europe and between this region and Italy. This will be accomplished via a cable under the Adriatic Sea. In addition, the country has continued to expand its electricity generation capacities, which includes the construction of FYR Macedonia’s first wind power plant in Bogdanci.

Financial sector stability has been preserved. The market is dominated by foreign banks, which account for over 90 per cent of total banking assets. However, banks have relied primarily on domestic deposits to fund lending and less on parent bank capital (the loan-to-deposit ratio of the private sector is about 93 per cent), so they were not as affected by deleveraging pressures during the crisis as their regional peers. The non-performing loan ratio has been declining somewhat since mid-2013 (when it was at its post-crisis maximum of 11.8 per cent) to 10.6 per cent as of March 2014.