Montenegro will start calculating the higher VAT rate at 19%, up from current 17%, as of July 1 after the changes made in the respective law enter into force on June 30, TV and radio broadcaster RTCG reported on June 25, quoting finance ministry information. The lower rate remains unchanged at 7%.

The ministry reminds the parliament approved the hike on June 19 – and it enters into force on the eighth day after being published in the state gazette.

The VAT increase was carried out amid a huge public and political debate on whether the fresh revenue is intended to actually finance the liabilities of aluminium smelter KAP, which will likely enter into bankruptcy next month. Opposition parties and NGOs accused the government that via the move it is trying to once again burden the taxpayer with KAP’s debts, estimated at some EUR 360mn.

The government has already issued state guarantees worth over EUR 100mn for KAP. Therefore the company’s bankruptcy might eventually result in a revision of this year’s state budget if some of the guarantees are activated.

In its defense, the governing DPS party has said the VAT hike is a temporary measure, via which Montenegro hopes to curb its worsening state finances. The higher VAT rate could be corrected downwards at the end of 2014, or the start of 2015.

Furthermore, both the IMF and the World Bank have pointed out 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. It also introduced in July 2012 a temporary special EUR 1 monthly tax per SIM card, tariff metering set, cable network connection and tobacco products consumption, which will remain valid until January 2014.

The government is currently mulling introducing a new tax on payment transactions as an additional tool to boost budget income.

Finance minister Radoje Zugic has said the VAT hike to 19% will be offset by maintaining the lower VAT rate unchanged at 7% and the impact on the living standard of Montenegrins or on the country’s competitiveness will be insignificant. 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.

In early June, the central bank said the VAT rate hike 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.