IMF: Kosovo could head towards fiscal crisis

Radio Free Europe: More than 350,000 Kosovo citizens receive money from social and pension schemes, this number could increase. The Kosovo government pays 370m euros for these schemes. Will this bring a budget into crisis?

Ruud Vermeulen: Sounds very alarming to talk about a crisis at this point. However, if we look at increasing trends and pressure to implement new classical social schemes -- whether for teachers, policemen, Trepca miners, and so on Kosovo could be on the path to creating a fiscal crisis. This is obviously something we would like to avoid.

Last year, Kosovo spent about 383m euros on social schemes, 30 percent more than in 2015. Two thirds of this increase has come only because of a scheme for war veterans' pensions, until 13,300 war veterans have started to receive pensions in the latter part of 2015 (more than 12,000 who were envisioned in the beginning) and that number then went to 36,000 at the end of last year.

This year, it is estimated that spending on social schemes will amount to over 400m euros - an increase of more than 10 percent compared to last year. About a third of this increase comes again because of a scheme for war veterans since over 2,000 new beneficiaries have been added this year.

If we look forward, Kosovo's budget cannot afford such a rapid increase in spending on social schemes. Not to mention the other pension schemes that are under consideration. If they were implemented, expenditures would increase to unstable rates.

Let me stress that this is not only disturbing because of fiscal costs and the change in taxpayers' money that would be available for more productive spending on education, health and infrastructure, but it is also disturbing because of the impact on the labour market.

Regenerative pension schemes and they can be compared to minimum and medium wages and require that beneficiaries be out of working relations can put out a huge number of Kosovars who are able to work and can also discourage earners from finding jobs (in this way in so-called book wages) . This hurts Kosovo's competitiveness and economic growth.

Rereading war veterans has had to happen long ago

Radio Free Europe: The Kosovo prosecution has launched investigations into all those registered as war veterans, but have never taken part in the war. You have criticised this process since the beginning that it has not been done properly. Are you satisfied with what the authorities are doing now?

Ruud Vermeulen: We have been involved and continue to assist with the verification and re-classification of war veterans, who had to happen long ago, in accordance with the amended war veterans law that went into effect in April last year.

This process of re-launching veterans according to their time of service and regulating pensions in accordance with this service, as by stopping and returning retirement payments from those who did not seek these benefits legitimately, it had to end now to ensure that total expenses did not exceed 0.7 percent of the local Bruto product, as legally envisioned.

Unfortunately, this process has not yet been initiated. As a result, this year the expenses for war veterans' pensions are expected to exceed 0.5 per cent of Bruto Product. This is equivalent to more than 30m euros, which could be used to invest in improving infrastructure, health and education.

IMF: Economic growth in 2018 is estimated at 4 percent

What are IMF forecasts for economic growth in 2018? What's driving this growth? Despite economic growth, poverty and unemployment are still high. What Kosovo must do in order to increase employment and reduce poverty.

Ruud Vermeulen: We expect economic growth to be about 4 percent this year, mainly in line with the growth rates we've seen in recent years, but we will review this issue in our next consultative mission on Article IV.

Economic activity is still dominated by private consumption, which is largely financed by remittances, then by investments. Compared to 2017, the contribution from exports to negative due to growth in imports and exports, which in part concerns the temporary ban on the production of Ferronikli, Kosovo's largest exporter.

While growth is high compared to countries in the region, it is not enough to narrow down the large gap in revenues with other countries in the region or the EU, or to generate jobs to reduce the unemployment rate.

To enhance Kosovo's economic growth, policymakers must design another model by switching from the current model of economic growth based on consumption financed by remittances and investments in non-commercial sectors towards a model that would be based on investments in trade sectors and exports.

Investments in human and physical capital are needed to boost development and private sector growth. This should go parallel to reforms that strengthen the business climate and include rule of law. The private sector, not the public sector, should be the engine of future economic growth and job creation.

Is there a plan for a new programme between Kosovo and the IMF?

Ruud Vermeulen: We are willing to discuss a new programme to back up funds at the request of authorities. So far we have not received such a request.

Fast credit growth in several segments can include large risks themselves

Is the financial sector stable?

Ruud Vermeulen: With high capital, high plastic cover and a low level of (NLP) credit with comprehensive provisions, Kosovo banks are well equipped to deal with major shocks. After the global financial crisis that did not affect Kosovo so much, their banks and overseers worldwide, but also in Kosovo, strengthened risk management, financial safety networks, and micro- and macro-redenial supervision. ]

This helped ensure and strengthen financial stability. The increase in credit reflects partly financial deepening, since more households and firms have access to bank financing. However, we draw attention from focusing on the increase in credit - raising statistics, considering that rapid growth in certain segments can include large rhythms themselves.

For example, the rapid increase in borrowing from unsanitized consumers used to finance property purchase can be disturbing if it goes into excessive supply. Therefore, it remains important for overseers to monitor such weaknesses. Outside the banking sector, it is encouraging to see that the Central Bank has also taken measures to improve conditions in the insurance sector.

Kosovo has already spent almost all of its emergency reserve fund mainly for folklore events. Is this the right way to spend this fund?

Ruud Vermeulen: According to us, a well-designed reserve for unpredictable should be a balance between budget flexibility and fiscal discipline. Many countries have such reserves in their budget to cover urgent, unprecedented and inevitable expenditures within the fiscal year without damaging budgetary plates, such as the costs resulting from natural disasters.

Kosovo's budget also contains a small reserve for such expenditures. In practice, there's a lot of pressure to use this reserve to finance new relief initiatives and, in this way, it loses meaning. Of course, some of the things this reserve has been used for were not in advance. In this context, to move forward, we think it is important to limit the use of this reserve and to be used only for urgent and unforeseen expenses.

Kosovo must strengthen fight against informal economy

Kosovo has accepted money from external donors with more than any state in the region. Why is it still the poorest country in the Balkans? Who should be blamed?

Ruud Vermeulen: Let me first say that comparison between states only partly reflects the whole picture. The challenges to Kosovo's development were and are still difficult. The 1998-1999 conflict has left Kosovo's equally low reserves virtually empty, while due to several-year-old neglect before the conflict it has also reflected on the underdeveloped production base, schools, roads and other vital infrastructure.

In view of this, the record of growth from independence is modest, but it could also be better considering the high unemployment rate and the degree of inactivity I mentioned earlier. Since independence, limited resources have become unproductive spending on public sector wages and social benefits, until public sector investments are dedicated to projects with the highest economic returns.

With tax collection lower than average in the region, Kosovo must strengthen the fight against informal economy, close large tax gaps, and expand tax bases, making sure taxpayers' money is spent properly.

Therefore, authorities need to focus on improving further budget composition and on the efficiency of spending to create more space for spending aimed at economic growth in areas mentioned earlier.

Acceleration of reforms to strengthen public procurement, public investment management, formation and supervision of public enterprises will be important not only to improve spending efficiency but also to increase transparency and accountability. Thus, to have significant economic growth such public finance reforms must be met by other reforms to strengthen the business climate.