The Montenegrin parliament passed the new VAT increase to 19% from the previous 17% during its June 19 session amid strong opposition, TV and radio broadcaster RTCG reported. Some 42 MP voted ‘yes’ for the hike and 34 voted ‘no’. One MP abstained in the 81- seat parliament.

The main opposition party – the Socialist People's Party (SNP), together with the Democratic Front, Pozitivna Crna Gora Party and the Liberal Party, reportedly voted against the raise of VAT, fearing the funds will go to finance the liabilities of the aluminium smelter KAP. The latter are estimated at over 11% of the GDP by the World Bank.

The VAT hike is part of the government’s efforts to stop further deterioration of the budget gap and curb rising public debt, finance minister, Radoje Zugic, said during the debate in parliament.

The move comes after both the IMF and the World Bank pointed out earlier this month that Montenegro should raise the tax, along with other measures, in order to meet its 2013 deficit target of 2.73% of GDP.  The country already increased the personal income tax from 9% to 15% on gross monthly salaries of over EUR 720 as of February 2013. The government is currently mulling introducing a new tax on payment transactions as an additional tool to boost budget income.

The mild VAT hike from 17% to 19% will be offset by maintaining the reduced VAT rate unchanged at 7% and won’t have a significant impact on the living standard of Montenegrins or on the country’s competitiveness, Zugic underscored.

The lower VAT rate applies to products accounting for around 50% of the consumer basket such as bread, flour, dairy products, meat, sugar, public transport, cultural and sport events.

By maintaining it unchanged, the government hopes to protect the most vulnerable social groups while the impact on the tourism sector will also be moderate as the lower VAT rate also applies to tourism related prices such as accommodation and food, Zugic added.

Earlier in June, the country’s central bank said the VAT rate hike from 17% to 19% will fuel inflation by 0.5-0.8%, adding that a more detailed analysis is needed to assess its full impact on the CPI. Montenegro’s CPI inflation eased to 3.0% y/y in May 2013, from 3.2% the month before.