98768 MACRO MONITORING REPORT Q3 2015 \ MONTENEGRO Growth strengthened in the first quarter of 2015 boosted by rising domestic demand, as both consumption and investments surged. Although the second quarter brought a slight moderation of economic activity, for 2015 as a whole growth is expected to reach 3.4 percent as the Bar-Boljare highway section construction gets started in September. Activity and employment rates improved to historical highs for Montenegro, but unemployment at close to 18 percent remains a challenge, especially among the most vulnerable groups. External imbalances deepened in 2015, as highway-related imports surged while exports of aluminum and electricity fell. While the fiscal deficit declined to 1.5 percent of GDP in 2014, highway construction costs (about 23 percent of GDP over four years) will likely increase the deficit to close to 6 percent of GDP in 2015 despite continued consolidation measures. A concomitant rise in public debt is expected to raise financing costs and risks over the medium term. The economic activity accelerated in early 2015. Real GDP was generated in construction, retail and tourism. In the twelve rose by 3.2 percent from a year earlier in the first quarter of months to March 2015, the unemployment rate decreased to a 2015 supported by domestic demand after 2.6 percent in the still high 17.8 percent, while both activity rate and last quarter of 2014. Personal and government consumption employment rate increased to 52.7 percent and 43.4 percent, and investment grew by 4.5 percent, 3.6 percent and 6.8 respectively (both historical highs for Montenegro). percent y-o-y, respectively. At the same time, the contribution Improvement continued in the second quarter, as of net exports remained negative despite exports growing by administrative employment data suggest a further increase in 6.3 percent annually, driven mostly by tourism. April and May 2015 with the administrative unemployment rate declining to 15.4 percent in May. Real activity moderated slightly in the second quarter of 2015. Retail trade dropped for a third consecutive month in External imbalances deepened in 2014 and early 2015 on May leading to an average decline of 1.7 percent in April and the back of highway construction-related imports. A five- May (y-o-y). However, industrial production increase year positive trend in declining external imbalances was accelerated in the second quarter (growth of 12.8 percent y-o- stopped in 2014 with the current account deficit (CAD) y driven by manufacturing of pharmaceuticals, other non- reaching 15.4 percent of GDP and further increasing to metallic minerals, aluminum and machinery and equipment. 15.7 percent of GDP in the first quarter of 2015. While both At the same time, food production declined significantly. In services and income account surpluses increased by 0.7 contrast, on the external side, April and May marked percent and 15.8 percent, respectively, as tourism continues to continued annual growth of tourist arrivals and overnight stays remain strong and dividend withdrawals decline, trade deficit (15 percent and 9.7 percent, respectively). further deteriorated as exports disappointed (especially of electricity and aluminum) and initial highway-related imports’ Real GDP, annual growth rates started to mount. Cumulatively, in the first five months of (Percent) 2015, the trade deficit reached 41 percent of GDP. 8 5.9 Current account balance 6 4.9 3.6 4.1 (EUR billion and percent of GDP) 4 2.9 3.2 2.6 2.6 0.7 30 1.5 1.4 2 0.6 0.3 0.5 20 % 0 0.3 10 -2 -0.5 % of GDP EUR bn 0.1 0 -1.9-2.3 -4 -2.8 -3.4 -0.1 -10 -6 -0.3 -20 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 2011 2012 2013 2014 '15 -0.5 -30 II II II II II 2010 I III IV 2011 I III IV 2012 I III IV 2013 I III IV 2014 I III IV 2015 I Source: MONSTAT. Goods - lhs Services - lhs The labor market improved on the back of service sector Income - lhs Current transfers - lhs CAD - rhs employment. The survey data reports that unemployment dropped in the first quarter of 2015 by 4.7 percent y-o-y, while Source: CBCG, MONSTAT, WB staff calculations. the number of employed increased by 1.6 percent resulting in a slight increase in labor force. In particular, new employment Montenegro continued attracting robust foreign percent annually on the back of improved contribution investments in real estate. Russian citizens hold the largest collection and excises. share of real estate among foreigners. Net FDI reached 10 As the deficit widened, so did the public debt. Public debt percent of GDP in the twelve months to March 2015. increased in the first quarter by 18 percent in nominal terms However, debt-creating inflows remained high leading to a compared to end-2014 on the back of external borrowing further rise in external debt to GDP ratio estimated at 121 (EUR500 million in Eurobonds) to cover the July bond percent. redemption. In relative terms, it reached 68.3 percent of GDP After deflation throughout 2014, inflation was positive in (or 79.8 percent of GDP including guarantees). Public debt is 2015 supported by domestic demand pick-up. Consumer expected to reach 72 percent of GDP by 2018. Financing prices increased on an annual basis reaching 1.9 percent in needs will double in 2015 and 2016 to close to 16 percent of June, after 2.3 percent in May which was the highest rate since GDP, with large Eurobond repayments coming due. July 2013. In January-June, price were up 1.5 percent y-o-y, S&P affirmed the sovereign credit rating on Montenegro boosted by food and clothes prices, while oil prices fell. at B+/B with stable outlook. It reflects a balance of risks from After months of declining, lending growth turned positive worsening external, fiscal, and general government debt in May. Total loans in May grew by 1.1 percent annually metrics against the country's growth potential over the coming boosted by recovery of corporate sector loans (0.4 percent) 12 months. The rating could be lowered if: (i) the country's and continued increase of loans to households (2.5 percent). fiscal metrics deteriorate further than currently envisaged In contrast, government reduced its borrowing from the (cost overruns related to the highway construction, further banking sector. At the same time, domestic deposits costs incurred in relation with legal proceedings and accelerated annual growth to 12.4 percent in May reducing the restructuring of KAP, or expenditure overruns from lower loan-to-deposit ratio to 101.3 percent. The share of non- levels of government); (ii) the country finds it harder to roll performing loans (NPLs) in total loans reached 16.3 percent over its external debt; (iii) large-scale FDI projects stall or do in April, compared to 15.9 percent at the end of 2014. In not materialize as this would depress Montenegro's growth parallel, the newly enacted Law on Consensual Financial prospects. On the other side, the ratings would be raised if Restructuring of Debts to Financial Institutions (so-called Montenegro’s economic growth will pick up faster than Podgorica approach) will hopefully lead to voluntary anticipated in conjunction with a decline in the government resolution of bad assets to unlock further access to capital to and external debt. corporates. In July 2015, the Government adopted the Montenegro Fiscal consolidation efforts moderated vulnerabilities in Development Directions for 2015-2018. This development 2014. The fiscal deficit was reduced to 1.4 percent of GDP in strategy proposes ways for a long-term increase of living 2014, led by an equal revenue and expenditure consolidation standards through alignment with the Europe 2020 strategy. effort. Public debt growth slowed down, although debt Recognizing the available potential, tourism, energy, reached 60.5 percent of GDP at the end of 2014. agriculture, rural development, and processing industry are emphasized as priority sectors of Montenegro’s development. However, highway construction costs will widen the fiscal Total estimated value of planned public and private sector deficits in 2015-2018. The 2015 deficit was planned at investments during the three-year period amounts to EUR2.9 6 percent of GDP, in spite of the government reform billion or close to 81 percent of current GDP. program’s aim for large non-highway fiscal surpluses. This is proposed to be done through additional revenue measures Growth is expected to pick up to 3.4 percent in 2015 driven (retaining the crisis PIT tax and increase in the rate of health by investment in public infrastructure and stronger insurance contribution by 0.5 percentage points) as well as tourism. The outlook has notable downside risks, external and pension indexation freeze in 2015 and abolishment of the domestic. The crisis in a country in Southeast Europe and privileged retirement schemes. According to the geopolitical tensions have minimal direct impact on Macroeconomic and Fiscal Policy Guidelines for 2015-2018 Montenegro, but carry financial and growth risks via second- adopted in April, public spending in the next three years will round effects. Financial volatility caused by persistent be relatively high due to the highway construction, reaching strengthening of the U.S. dollar against the euro could put 49 percent in 2015 in order to decline to 43 percent of GDP in pressure on balance sheets due to the highway loan 2018, with capital budget amounting to about 9 percent of denominated in US$ (EUR809 million). Any rise in the cost GDP. Excluding highway costs, spending is expected to of financing, in particular for vulnerable emerging markets, remain flat in nominal terms. would also lead to excessive cost of debt service. There are also additional risks on the fiscal side that include the rollover The general government cash deficit already widened this of the 5-year Eurobond issue equivalent to 10 percent of GDP year. The deficit grew to 3.3 percent of GDP in the first half maturing in 2016. The main domestic risks refer to slow of 2015 due to expenditure growth of 8.1 percent y-o-y. The recovery of credit supply, and delays in planned structural latter reflected a rise in capital expenditures, transfers to local reforms, which are expected to raise potential growth once the governments to help clear subnational arrears and larger highway construction ends. interest payments. The repayment of arrears (of pension debt, court case resolutions, and utilities) amounted to 1.1 percent of GDP. In the same period, revenues went up by only 2.3 High frequency data, trend-cycle adjusted series External trade (index) (Percent) 140 30 130 Total Industry_tc Annual growth rates Exports Retail trade_tc 20 (%, 3-month moving average) 120 Tourism_tc index, 2011=100 110 10 Imports 100 0 90 % -10 80 -20 70 60 -30 last obs.: 5/15 last obs.: 5/15 50 -40 Apr-09 Apr-10 Jan-09 Oct-09 Jan-10 Oct-10 Jan-11 Apr-11 Apr-12 Apr-13 Apr-14 Jul-09 Jul-10 Oct-11 Oct-12 Oct-13 Oct-14 Apr-15 Jan-12 Jan-13 Jan-14 Jan-15 Jul-11 Jul-12 Jul-13 Jul-14 Apr-14 Apr-12 Apr-13 Apr-15 Oct-13 Jan-12 Oct-12 Jan-13 Jan-14 Oct-14 Jan-15 Jul-12 Jul-13 Jul-14 Source: MONSTAT, WB staff calculations. Source: MONSTAT, WB staff calculations. Labor market, administrative data General government deficit (Thousands) (Percent of GDP) 200 40 1800 1 195 38 1600 0 190 36 1400 -1 185 34 1200 -2 % of GDP 180 32 1000 EUR mn '000 -3 '000 175 30 800 170 28 600 -4 165 26 400 -5 160 24 200 -6 155 last obs.: 5/15 22 0 -7 150 20 2008 2009 2010 2011 2012 2013 2014 Jan-Jun Apr-12 Apr-13 Jan-10 Jan-11 Apr-10 Oct-10 Apr-11 Oct-11 Oct-12 Oct-13 Apr-14 Oct-14 Apr-15 Jan-12 Jan-13 Jan-14 Jul-14 Jan-15 Jul-10 Jul-11 Jul-12 Jul-13 2015 Total Revenues and Grants Total Expenditure and Net Lending Employment (lhs) Employment_tc (lhs) Cash deficit (% of GDP) - rhs Unemployment (rhs) Unemployment_tc (rhs) Accrual deficit (% of GDP) - rhs Source: MONSTAT, WB staff calculations. Source: MoF, MONSTAT, WB staff calculations. Labor market, survey-based data General government debt (Percent) (EUR billion and percent of GDP) Participation rate Employment rate Foreign public debt (EUR bn) Unemployment rate - rhs 3.0 Domestic public debt (EUR bn) 80 60 25 Public debt (% of GDP) 70 2.5 50 20 60 2.0 % of GDP EUR bn 40 50 15 % 30 % 1.5 40 10 30 20 1.0 20 10 5 0.5 10 0 0 0.0 0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 2007 2008 2009 2010 2011 2012 2013 2014 2015f 2016f 2017f 2012 2013 2014 '15 Source: MONSTAT. Source: MoF, MONSTAT, WB staff calculations. Loans and deposits, annual growth CPI and PPI, annual growth rates (Percent) (Percent) 8 15 Total deposits 6 10 Total bank loans 4 5 2 % 0 % 0 -2 -5 -4 CPI PPI -10 -6 last obs.: 5/15 last obs.: 6/15 -15 -8 Apr-13 Apr-11 Oct-11 Apr-12 Oct-12 Oct-13 Apr-14 Oct-14 Apr-15 Jan-11 Jul-11 Jan-12 Jan-13 Jan-14 Jan-15 Jul-12 Jul-13 Jul-14 Oct-10 Oct-11 Oct-12 Oct-13 Oct-14 Jan-10 Apr-10 Jan-11 Apr-11 Jan-12 Apr-12 Apr-13 Apr-14 Apr-15 Jul-10 Jul-11 Jan-13 Jan-14 Jan-15 Jul-12 Jul-13 Jul-14 Source: CBCG. Source: MONSTAT. Montenegro Selected Indicators* Avg. '00-14 2011 2012 2013 2014E 2015 E 2016 F Income and economic growth GDP growth (annual %) 3.0 3.2 -2.5 3.3 1.5 3.4 2.9 GDP per capita growth (annual %) 2.8 3.1 -2.6 3.2 1.4 3.3 2.8 GDP per capita (US$) 4978 7250 6519 7111 7318 7649 8094 GDP per capita, PPP (current international $) 10902 14082 13589 14136 14323 14624 14931 Private Consumption growth (annual %) 4.7 1.9 -3.2 1.1 1.3 1.2 2.5 Gross Investment ( % of GDP) 20.9 18.4 18.5 19.2 19.9 24.6 23.6 1 Gross Investment - Public ( % of GDP) 4.6 5.2 4.4 4.1 5.5 9.4 9.2 Gross Investment - Private ( % of GDP)1 16.3 13.2 14.2 15.1 14.4 15.2 14.4 Money and Prices 2 Inflation, consumer prices (annual %, end of period) 5.3 2.8 5.1 0.3 -0.3 2.0 2.2 Inflation, consumer prices (annual %, period average)2 5.6 3.1 4.1 2.2 -0.7 1.0 1.9 M2 ( % of GDP) 39.3 46.0 51.3 51.0 55.7 54.9 58.6 Domestic Credit to the Private Sector ( % of GDP) 49.8 59.4 58.9 56.7 56.0 53.6 55.4 Nominal Exchange Rate (local currency per USD) 0.8 0.7 0.8 0.8 0.8 0.8 0.7 Real Exchange Rate Index (2010=100) .. 96.8 100.0 98.9 .. .. .. Fiscal Revenue (% of GDP) 41.8 39.8 41.4 42.8 44.9 42.9 41.9 Expenditure (% of GDP) 44.4 44.1 47.2 47.6 46.2 48.8 47.3 Interest Payments (% of GDP) 1.2 1.5 1.9 2.1 2.3 2.2 2.1 Non-Interest Expenditure (% of GDP) 43.2 42.6 45.4 45.5 43.9 46.5 45.2 Overall Fiscal Balance (% of GDP) -2.6 -4.3 -5.9 -4.8 -1.4 -5.9 -5.5 Primary Fiscal Balance (% of GDP) -1.4 -2.8 -4.0 -2.7 0.9 -3.6 -3.3 General Government Debt (% of GDP) 42.3 46.0 54.0 58.1 60.5 65.7 68.5 External Public Debt (% of GDP)1 30.4 32.9 41.1 43.1 48.3 56.0 61.3 External Accounts Export growth, f.o.b (nominal US$, % yoy) 14.2 25.4 -7.1 3.4 -0.1 1.0 3.0 Import growth, c.i.f (nominal US$, % yoy) 15.8 12.4 -4.6 -1.5 0.5 3.7 4.3 Merchandise exports (% of GDP) 17.5 14.7 12.4 11.9 10.4 10.1 9.7 Merchandise imports (% of GDP) 56.8 55.1 56.6 51.8 50.6 50.3 49.7 Services, net (% of GDP) 12.8 18.2 19.4 19.6 20.2 19.4 19.0 Current account balance (current US$ millions) -698 -797 -755 -646 -699 -761 -828 Current account balance (% of GDP) -19.5 -17.7 -18.7 -14.6 -15.4 -16.0 -16.4 Foreign Direct Investment, net inflows (% of GDP)1 13.4 12.0 14.7 9.7 10.3 10.7 10.8 External debt, total (% of GDP)1 100.4 108.0 115.1 115.4 120.7 128.5 139.1 1 Multilateral debt (% of total external debt) 18.3 14.5 19.7 20.6 20.3 19.3 17.7 Debt service ratio (% of exports goods and non-factor services)1 28.1 43.7 26.7 38.1 36.0 41.2 40.0 Population, Employment and Poverty Population, total (millions) 0.6 0.6 0.6 0.6 0.6 0.6 0.6 Population Growth (annual %) 0.2 0.1 0.1 0.1 0.1 0.1 0.1 Unemployment Rate1 22.2 19.7 20.0 19.5 18.0 17.7 17.5 Poverty headcount ratio at national poverty line (% of population)1 8.4 9.3 11.3 8.6 .. .. .. Poverty headcount ratio at US$1.25 a day (PPP) (% of population)1 0.2 0.2 .. .. .. .. .. Poverty headcount ratio at US$2.00 a day (PPP) (% of population)1 0.5 0.7 .. .. .. .. .. Inequality - Gini Coefficient1 26.7 25.9 26.5 26.2 .. .. .. 1 Life Expectancy 74.7 76.1 76.4 76.6 .. .. .. Other GDP (current LCU, billions) 2.4 3.2 3.1 3.3 3.4 3.6 3.8 GDP (current US$, billions) 3.1 4.5 4.0 4.4 4.6 4.8 5.0 GDP per capita LCU (real) 2210 2530 2464 2544 2580 2664 2738 Doing Business Rank3 39.0 .. .. 42.0 36.0 .. .. Human Development Index Ranking4 .. .. 52 51 .. .. .. CPIA (overallrating)1 .. .. 3.7 3.7 .. .. .. Notes: ".." indicates not available. E = estimate, F = forecast. Data from MFMOD unless otherwise noted 1/ World Development Indicators Database 2/ World Bank GEM database 3/ This indicator is ranked out of 175 countries in 2007, 178 in 2008, 181 in 2009, and 183 in 2010 and 2011. 4/ The HDI ranking in 2001 is in relation to 175 countries and in 2010 in relation to 169 countries. Methodological enhancements in HDI calculations have resulted in notable improvements in the countries' rankings. Sources: MFMOD Database, World Bank WDI and GEM databases, IMF.