Concluding Statement of IMF Mission in Kosovo, October 2018

An IMF mission, led by Stephanie Eble, visited Pristina during October 17-October 30 to conduct the 2018 Article IV consultation discussions.

According to the conclusion after the visit of this mission, Kosovo has continued to experience robust growth over the last year, maintaining fiscal discipline and strengthening financial sector resilience. However, fiscal risks have increased and should be carefully managed. Reforms to improve competitiveness and strengthen governance to achieve stronger and more inclusive growth, reduce unemployment and the large income gap with the rest of the Europe should continue to be on the forefront of the policy agenda.

Growth is expected to be around 4.0 percent in 2018 , among the highest in the region, led by investment, consumption, and service exports, which in turn are underpinned by strong bank lending and remittance inflows. In 2019, growth is projected at 4.2 percent, supported largely by a temporary acceleration in public investment.

While growth could surprise to the upside if reform implementation accelerates, risks are tilted to the downside. Spending pressures, predominantly for higher, untargeted social benefit spending, if realized, would crowd out productive spending and likely increase the fiscal deficit. The proposed new power plant would provide an impulse to growth and reduce energy bottlenecks, but would also widen the current account deficit during the construction period and could—depending on its implementation—significantly increase public debt. Other domestic risks include political uncertainty that could undermine confidence and halt reforms. On the external side, a normalization of EU monetary policy or tighter global financial conditions could increase government financing risks in the domestic debt market. Weaker than expected growth in the EU could result in lower remittance inflows and decelerate growth.

Headline inflation remains subdued but has started to pick up because of higher food and energy prices and is expected to average 0.9 percent this and 1.4 percent next year.

In particular, higher growth is needed to accelerate job creation and reduce the still large income gap with the rest of Europe. In this context, while there has been some progress, much needed structural reforms to tackle weak external competitiveness, low labor force participation and high unemployment, particularly among young workers, still lie ahead.

The 2018 budget deficit (under the fiscal rule definition) is expected to be around 1½ percent of GDP, well within the fiscal rule ceiling of 2 percent with lower revenue (including from local governments) and higher social spending offset by lower budget-financed investment. Importantly, the draft 2019 budget targets a deficit of 1.9 percent of GDP, keeps the wage bill constant as a share of GDP, and the bank balance at 4.5 percent of GDP, all in line with the fiscal rule. It accommodates increased allocations to priority sectors such as health, education, and the judiciary, but also higher (permanent) spending on pension benefits, relying on ambitious gains from revenue administration reforms (totaling about 1 percent of GDP, including ⅔ percent of GDP from additional tax debt collection and enforced compliance and ⅓ percent from local governments), as well as ¼ percent of GDP in savings from war veteran benefit reform. At the same time, the budget projects an acceleration in investment financed by donors and privatization receipts under the investment clause, which—if realized—would add an additional 4 percent of GDP in capital spending.

The mission advised to:

  • Accelerate tax administration reforms to reduce informality, tax gaps, and tax debts . To meet the targets for tax debt collection and compliance gains foreseen in the 2019 budget, collections should be reinforced by setting quantitative and strategic performance targets, widening the tax filing requirements and late filing penalties, and improving the productivity of audits. Moreover, collection should be centralized in one office, the process systematized, and enforcement actions taken on a timely basis. Any changes to the import VAT collection system should retain collection with Customs and include proper safeguards (e.g., strict eligibility criteria, deferred payments secured by guarantee, rollout conditional on a successful pilot, etc.) to minimize any revenue risks. The granting of tax holidays or new exemptions that erode the tax base should be avoided.
  • Move ahead with measures to contain spending pressures. This includes the long overdue reforms of war veteran and war disability benefits; and the restructuring of the publicly-owned enterprise sector, including by rationalizing employment and aligning wages with productivity. In this context, the mission advised against introducing unbudgeted non-contributory early retirement schemes for special groups (such as police), special benefits for teachers that worked during the 1990s, and universal child allowances as these would undermine the fairness and financial soundness of the social benefit system. 
  • Improve spending efficiency and outcomes. With increased budget allocations for priority sectors such as health, education and active labor market policies, efficiency-enhancing reforms in these sectors should move ahead in earnest to also improve outcomes. Despite some progress, the public investment framework requires further strengthening through better cost-benefit analysis and ex-post audits to maximize its growth impact.

Further efforts to deepen financial intermediation should be carefully considered . While credit penetration at around 40 percent of GDP is low relative to other CESEE and Western Balkan countries, it has continued to increase, facilitated by low interest rates, KCGF guarantees of loans to SMEs, and strengthened contract enforcement. The CBK is working on regulation allowing for the creation of investment funds, while legislation regulating and widening the range of activities of micro-finance institutions (MFIs) is currently before parliament. However, these changes should be designed to ensure fair competition between MFIs and banks, while safeguarding prudential and consumer protection standards. The authorities should also continue to further reduce structural impediments to credit growth, including by fully implementing the law on enforcement procedures, accelerating the resolution of commercial cases (for example, by having more specialized judges and/or creating a commercial court), and strengthening property rights.