The International Monetary Fund (IMF) said on September 18 it expects the Macedonian economy to slow down to moderate growth of 1.9% in 2017 due to the prolonged political uncertainty. The fund also warns that the ruling coalition, which enjoys only a slim majority in the parliament, will be tested by the upcoming local elections in October. 

Macedonian GDP was flat in the first quarter and contracted by 1.8% in the second quarter of 2017, according to statistics office data. The 2017 state budget is based on GDP growth projection of 2.2%.

An IMF team led by the head of the Fund’s mission to Macedonia Jesmin Rahman visited Skopje from September 6 to 18.

“The prolonged political uncertainty resulted in a slowdown of real GDP growth to 2.4% in 2016, the lowest since 2012. Data for the first half of 2017 point to economic contraction driven by a sharp drop in investment,” the IMF said in a statement. 

Real GDP growth is expected to rebound in 2018 and gradually rise to 3.75% over the medium term, buoyed by improved investor sentiment, expanded export capacities, and continued labour market improvement.

Export growth has remained robust, and private consumption has been resilient, helped by employment growth and rising wages and pensions. Inflation is expected to reach 1.2% in 2017, ending three years of deflation, the IMF said.

The risks to the outlook are mostly on the downside. A slim-majority governing coalition led by Social Democrats may be tested, in the upcoming local elections, and renewed political uncertainty could undermine fragile confidence, the IMF underlined.

The IMF warned that there are also external risks from weaker growth in Macedonia's trading partners, and global policy uncertainty which could reduce exports and FDI inflows. On the upside, the strengthening of political stability may lead to a decisive push for structural reforms and enhance EU accession prospects and growth potential.

With public debt above 45% of GDP at end-2016, a near doubling since 2008, fiscal consolidation is urgently needed to safeguard sustainability, rebuild buffers to tackle future shocks and make space for pressing social development and infrastructure needs.

Monetary policy should remain accommodative given low inflation and stability of the exchange rate peg. Finally, structural reforms are critical to support higher growth, with the labor market, governance, and the judiciary being priority areas.

In the absence of durable consolidation measures, Macedonia's fiscal deficit is expected to widen and public debt to rise. Despite slower growth, under-execution of capital and goods and services spending is likely to keep the fiscal deficit at around 3% of GDP in 2017.

In the medium term, the deficit is projected to rise above 3.5% of GDP, reflecting clearance of unpaid claims, wage subsidies, and additional social protection support.

As a result, public debt is expected to exceed 53% of GDP by 2022, with gross fiscal financing needs estimated to reach around 15.5% of GDP.

The IMF said that with the aim of creating policy space and maintaining sustainability, gradual fiscal consolidation should start without delay. 

The mission welcomes the government’s intention to support employment and social inclusion, but the plan to achieve this mostly through subsidised higher wages and tax incentives risks fiscal sustainability.

To ensure durable results, these objectives should be pursued through a set of policies that enhance incentives for participation in the labour market, reduce inefficiencies in social spending, and create additional space for public investment in human capital and infrastructure, the IMF suggested.

In this regard, the mission recommends specific measures such as reducing the labour tax wedge at low-income levels as well as decreasing the minimum income base for social security contributions.

The IMF said that the VAT collection has been deteriorating and remains significantly lower than in Macedonia's Western Balkan peers and suggested that further revenue gains can be achieved from higher tax rates on gasoline, which are among the lowest in the region, and higher taxes on property.

Fiscal space in recent years has largely been used to increase subsidies and pensions. Untargeted subsidies should be reduced and large and widening pension deficits should be reined in through raising the statutory retirement age to the EU average, tightening options for early retirement, indexing pension to CPI inflation only, and refraining from ad-hoc increases, the IMF recommended.

On the other hand, the mission welcomed the government’s intention to strengthen management of public finances and increase fiscal transparency. 

Monetary policy should remain accommodative in the near term, the IMF suggested. 

The IMF said that Macedonia's banking system is currently well capitalised, liquid, and profitable, with limited exposure to parent bank financing. However, there are balance sheet risks from a high degree of financial euroisation and moderate deleveraging risks from the large presence of EU parent banks.

Improving Macedonia’s medium-term growth potential hinges on decisively tackling weaknesses in the judicial system and overall governance frameworks.

Limited progress in implementing reforms, especially in the areas of governance and competition policy, has held back FDI inflows and hindered deeper integration with the European Union, the IMF said.

However it noted that the new government’s focus on reforming the judiciary, and improving the efficiency and transparency of public institutions is encouraging as is the intention to provide a level playing field for all investors.

“Any direct support to enterprises in the form of subsidies or tax breaks should be carefully assessed to not jeopardize fiscal sustainability,” the IMF warned.

Macedonia currently has no arrangement with the IMF.