Medium Term Expenditure Framework

Transcription

1 Republika e Kosovës Republika Kosova- Republic of Kosovo Qeveria- Vlada- Government Ministria e Financave Ministarstvo za Finansije Ministry of Finance Medium Term Expenditure Framework April, 2015

2 List of abbreviations PAK KSA TAK GNIA EBRD PB GDP CBK ERS EPPD EU EULEX KAF FIFA IMF KSF CPI IFI FDI IPA IT MTEF KEK ODC LLGF LPFMA MEST MoF MLSW SAA SME UN RTK SDR USA UCHSK VAT UEFA USAID WEO Kosovo Privatisation Agency Kosovo Statistics Agency Tax Administration of Kosovo Gross National Income Available European Bank for Reconstruction and Development Payment Balance Gross Domestic Product Central Bank of Kosovo Energy Renewable Sources Economics and Public Policy Department European Union European Union Mission on Rule of Law Kosovo Armed Forces Fédération Internationale de Football Association International Monetary Fund Kosovo Security Force Consumer Price Index International Financial Institutions Foreign Direct Investments Instrument for Pre-Accession Assistance Information Technology Medium Term Expenditures Framework Kosovo Energy Corporation Other Depositing Corporations Law on Local Governance Finance Law on Public Finance Management and Accountability Ministry of Education, Science and Technology Ministry of Finance Ministry of Labour and Social Welfare Stabilisation and Association Agreement Small and Medium Enterprises United Nations Radio Television of Kosovo Special Drawing Rights United States of America University Clinical and Health Service of Kosovo Value Added Tax Union of European Football Associations United States Agency for International Development World Economic Outlook

3 Content FIRST PART GOVERNMENT DECLARATION FOR MEDIUM -TERM PRIORITIES Economic Development, Employment and Social Welfare Rule of Law European Agenda and Foreign Policy Education, Science, Culture, Youth and Sport Modern healthcare... 9 SECOND PART MACRO-FISCAL FRAMEWORK International Economic Environment Recent developments and macro-economic medium term scenario Real Sector Price fluctuation and projections for Developments and projections of the external sector Financial Sector Fiscal Sector Projections of budget revenues Revenues according to collection source Budget Spending Framework and Structure Budget deficit and its financing Borrowings during period Development Potentials and fiscal risks for the period Development Potentials Fiscal Risks THIRD PART BUDGET EXPENDITURE FRAMEWORK Framework And Structure Of Budget Expenditures Central Government Budget expenditures for for the Central Level MUNICIPAL MEDIUM TERM EXPENDITURE FRAMEWORK Municipal budget proposal for General Grant for Specific grant for pre-university education for Specific grant for primary healthcare covering Financing of secondary healthcare for Financing of residential services Municipality s Own Source Revenues for 2016 and forecasts Annexes

4 Introduction The Medium Term Expenditure Framework (MTEF) represents the main document based on which the draft annual budget is prepared. The main purpose of the MTEF is to provide an analysis based on the country s macroeconomic environment, thus establishing the basis for budget planning for coming years in line with the Government s strategic priorities. Sustainable economic development is the Government's key goal. It will enable the creation of new jobs and enhance people s welfare. Despite the advantages Kosovo has in terms of young population and vast natural resources, economic development and reduced unemployment rate remains a challenge that the Government will face. The Government of the Republic of Kosovo approved the Government Program in the beginning of 2015, setting forth the policy priorities for the medium term. The main pillar of the Government's Program is economic development, employment and enhanced welfare for the citizens followed by other non-less important priorities, such as Rule of Law, Education, Health, and European Integration. To this end, MTEF is an important tool for the Government in making the first steps towards achieving these objectives. MTEF is structured into three main parts. The first part provides offers a comprehensive overview of the Government s priorities in accordance with the Government Programme. Macrofiscal projections based on general parameters of economic development are discussed in the second part of this document. Fiscal estimations made in this part define the spending ceilings within which the central and municipal budgets are prepared. 1 Please note that in case of discrepancies, the Albanian version prevails

5 FIRST PART 1. GOVERNMENT DECLARATION FOR MEDIUM -TERM PRIORITIES The Mid-Term Expenditure Framework (MTEF) outlines Government priorities with a coherent, coordinated approach and is functionally harmonised with the key strategic documents and programme of the Government. MTEF enables budgeting of these priorities for the mid-term period. The Government of the Republic of Kosovo envisages the building of an effective, competent and accountable government as a primary goal towards achieving sustainable and inclusive growth and strengthening of social welfare. The mid-term priorities are based on the Government Programme , the National Economic Reform Programme and requirements from European integration process, in particular the Stabilization and Association Agreement. Statement of mid-term Government Priorities is oriented towards economic, social and institutional development of the country. Consequently, the Government of Kosovo, through this Statement, steers the budget development process for the period , which includes the funding of our key priorities through the available resources. In this context, MTEF is drafted in compliance with Government s commitments in relation to international institutions, within legal parameters of the Law on Public Financial Management and Accountability (LPFMA). In the context of priorities set as part of the government commitment to ensure economic growth and generation of new jobs. During the mid-term period , The Government will continue to implement legal reforms of fiscal policy and fight against the informal economy, by ensuring a favourable business environment. On the other hand, the Government intends to continue the implementation of the collective bargaining agreement - through payment of work experience for employees who receive salaries from the Kosovo budget, payment of health insurance, strengthening the public order and safety, supporting the agricultural sector, continuation of funding the social and pension schemes, including schemes for former political prisoners and war veterans. The Government will continue with investments in road infrastructure, including the construction of Route 6 (Prishtina - Hani i Elezit). Also, the fulfilment of the government s priorities includes necessary reforming of certain sectors, such as: structural reforms in education, and the reform of public administration. All the above policies will be implemented in order to ensure a sustainable mid-term budgetary framework. In this context, based on the Government Programme, the Government's medium term priorities are aggregated into five pillars as follows: 2

6 Economic Development, Employment and Social Welfare Rule of Law; Education, Science, Culture and Youth development; European agenda and foreign policy; Modern health. All the above mentioned priorities will be financed while maintaining the macro-fiscal sustainability. The Government will continue to develop a simple and modern tax system, which will be focused on expanding the tax base. In the view of achieving this goal, the Government of Kosovo remains committed to further advance the fight against the informal economy and money laundering, through the implementation of the Action Plan of the Strategy on prevention and fighting of informal economy, money laundering, financing of terrorism and financial crimes Successful prevention and fighting of informal economy will also ensure the maintenance of fiscal balance between the financing needs of public sector and the need for developing the private sector, by enabling equal conditions for private sector development Economic Development, Employment and Social Welfare The Government of the Republic of Kosovo, during the next mid-term period, will focus particularly on economic development, employment and social welfare. The implementation of these priorities will constitute the largest share of budgetary framework, which the government will undertake to ensure economic growth and create new jobs. In order to achieve the above, the government will focus on enabling a more favourable fiscal environment, improving the trade policy and integration into the global economy, including the improvement of the business environment, the continuation of existing projects to modernize infrastructure, as well as the government's policies in the energy sector and continuous support to agriculture and rural development. Appropriate tax system and business-friendly environment are the most important pillars for sustainable development of the private sector in the country. Therefore, the ongoing improvement of the tax system and tax compliance is the core priority of the Government. The Government hereby intends to achieve the expansion of the resource base in order to finance the economic development of Kosovo and social cohesion agenda, and same time to maintain competitiveness advantage of the country's business environment. In this regard, fiscal policy reforms include escalation of VAT, lowering the VAT threshold, VAT exemption for production lines and machinery, and functioning of industrial and technological parks for which it is foreseen provision of various tax incentives. Openness and the market and integration into the global and regional economies constitute a high priority for the Government, which should be addressed during this medium-term period. In addition to the continuous objective for Kosovo's membership in regional and global institutions and mechanisms, the Government will be focused on achieving strategic agreements on economic and trade cooperation with the region and beyond. In this context, an inalienable aspect regarding the trade policy of the Republic of Kosovo is the implementation of the Stabilisation and Association 3

7 Agreement, which will have an impact on a large part of government policy. Consequently, as part of competitive trade policy and for improving the business environment, the Government will work on reaching agreements with various countries for the elimination of double taxation, promotion of services trade, modernization of customs services, development of cadastral system and further improvement of the public procurement system In order to support small and medium enterprises, as well as to attract investments, the Government will work on eliminating the legal barriers and reducing bureaucracy, subsidizing enterprises with potential for export, operationalizing the free trade zones, and fight against informal economy. The aim here is to develop policies that enable the growth of business investments, especially in manufacturing and value-added services. In order to strengthen the small and medium enterprises, the Government, in addition to current schemes, as grant program and Voucher scheme, with the support from development partners, will establish a Credit Guarantee Mechanism. Establishment of an Employment and Development Fund is a priority of the Government of Kosovo, which, as other policies, aims at contributing to the economic growth, creating new jobs, improving access to finance with favourable conditions for young and women entrepreneurs, small and medium enterprises, and corporations. The Government will work on developing the energy and mining sector, applying international standards for environmental protection, as the basis for sustainable economic development of the country, and foreign investments. Quality power supply is one of the priorities of the Government. Development and exploitation of existing mines and the opening of new mines should be in line with country s development objectives, where during the next medium-term period, the Government will establish a strategic approach for the exploitation of mineral resources of Kosovo which will reflect economic and state interests of Kosovo, resulting in increase of investments and the creation of new jobs. The development of energy infrastructure for ensuring a stable power supply will be treated with high priority within the Government Policy for this sector. In particular, the Government policies will be focused on building new capacities for energy production. Also, in context of aims to create a functioning energy market in Southeast Europe, regulatory and administrative measures will be undertaken, as well as it will be worked in finalizing ongoing projects for strengthening the transmission network infrastructure. By constructing the high interconnection line between Kosovo and Albania, may commence the development of a common energy market, which represents complementarities in terms of energy resources. Another option to ensure sufficient capacities to generate electricity is to enhance the use of renewable, solar, wind, hydro and biomass energy. In this regard is drafted the legal framework related to Renewable Energy Sources (RES) Targets 2020, which are in accordance with the requirements of the Energy Community. The implementation of measures and achievement of targets for energy efficiency also constitutes an important Government policy, which continues to obtain the development partners support. Aiming the continuation of reforms and support to the agricultural sector, the Government of Kosovo, in cooperation with various development partners, will be strongly committed to promote 4

8 the production chain, from primary agricultural production to the processing, storage and marketing of agricultural products, as well as credit and subsidies incentive measures and improving public infrastructure. The Government will continue to support the agricultural sector, with priority in sectors with comparative and competitive advantages. In addition to other policies, the Government will also work on the implementation of Agriculture and Rural Development Plan , which foresees a gradual increase of the fund for subsidies and grants for 5% each year; cooperation with development partners for the development of the agricultural sector (benefit through IPA II which envisaged 79.7 million euros financial assistance to the sector, as well as the implementation of the AGRO-USAID funded project 12 million US dollars). The Government of Kosovo will continue the modernization of road and railway infrastructure to facilitate the regional trade and attract foreign direct investments. In particular, the Government will work on finalizing the highway Prishtina - Hani Elezit (Route 6) and policies to improve the Kosovo railway network. In addition to this, it will be worked also on finalizing the modernization of existing projects, including: expansion of the road N2 Prishtina - Mitrovica; expansion of the road N9 Prishtina - Peja, and other national roads. The Government will promote tourism as a sector with high development potential. The development of tourism will have a direct impact in several areas, such as: production, income growth, development of economic activities, tourism, transport, trade, cultural institutions, etc., in increasing the employment, raising the living standard level, increasing investments, improving the balance of payments, the development of underdeveloped areas, etc. In this regard, the Government will work on the implementation of the Project for the Development of Tourist Centre Brezovica, which has already begun, and was classified as a project of national significance. As regards to environmental policies and water management, in cooperation with donors currently supporting this sector, we will continue to build capacities for rehabilitation and expansion of potable water capacities, collection and treatment of wastewater, improving waste management, etc. With this, the Government aims to capitalize Kosovo water sector resources, through improvement of planning and usage of water as economic and social resource. Within social policies, social welfare and cross-social solidarity, the Government is committed to strengthen the market economy and economic development as the main tool for reducing poverty and unemployment, also providing an cross-social solidarity through income redistributive economic policies. Social policies will ensure financial stability and sustainability of the mandatory pension contributions scheme and will promote voluntary savings schemes. In support to employment policies, we will continue to reform and modernize the public employment services, focusing on building capacities of state mechanisms, increasing active measures of the labour market, promoting the employment of young people, people with disabilities, long-term unemployed women and communities. The Government will also be committed in the decentralization of social services, as well as creating opportunities for social entrepreneurship development concept. 5

9 1.2. Rule of Law Strengthening of public order and safety, and functioning of the rule of law is vital for Kosovo. Good governance and the rule of law will be the main pillars to economic growth, through efficient justice, improving the public administration, implementation of anti-corruption policies, fight against organized crime, terrorism and activities related to the phenomenon of terrorism, economic crime, human trafficking and other types of crime. The Government of Kosovo will be committed in supporting the independent judicial institutions in handling the large number of backlog cases, improving and processing the data and case management. Also, a special dedication will be given to the rule of law in relation to the implementation of contracts, mainly since commercial disputes resolution in courts is very difficult. In order to improve the situation in the justice system in general, the Government is committed to implement reforms necessary for the development of a judicial system that will be transparent, providing full functionality of judicial reform in accordance with applicable laws, create and improve the physical infrastructure of courts in order to meet the needs arising from the reform process. The Government of Kosovo is committed to support the independent judicial institutions in handling the large number of backlog cases, improving and processing the data and case management. The Government will cooperate with international institutions, in particular with the European Union Rule of Law mission in Kosovo, EULEX, and will also work on the adoption of legislation towards the international obligations for the establishment of the Special Court. In the context of the full functioning of the justice system in the entire territory of the Republic of Kosovo, an important priority is the implementation of the Justice agreement, for achieving a complete integration of northern municipalities in the justice system and the functioning of the justice institutions in north. Fight against corruption constitutes an area of strategic importance for the Government of Kosovo, hence, the focus will be on improving and strengthening the legislative and institutional framework for fight against corruption. Aiming at addressing the challenges in this regard, the Government will increase efforts to investigate, prosecute and punish corruption-related cases, placing emphasis in strengthening of institutional cooperation. Regarding the defence and security, the Government will implement the recommendations of the strategic review of the Security Sector, aiming at the establishment of Armed Forces of Kosovo and support in capacity building of security institutions. In this regard, it will be worked on the development and completion of legal basis and strategic policy framework for Armed Forces of Kosovo, as well as on establishing new training programs for further development of this institution. During the medium-term period and further, there will be efforts on recruiting the members and building of units of AFK, with the aim of achieving initial operational capacity, as well as addressing infrastructure needs. In the context of fiscal framework, the Government will address the needs for capacity building of the institutions of public order and safety, including the advancement of the conditions of the Kosovo Police, and other law enforcement agencies. The government will work on its capacity 6

10 building to prevent radicalization, including the development of appropriate measures to address the phenomenon of fighters joining conflict outside the country. In this context, the Government will continue its commitment in the fight against terrorism through cooperation with strategic partners, as well as to improve national policies and legislation. The Government will also work towards enhancing bilateral cooperation with and integration in relevant regional and international organizations in the field of border issues and Integrated Border Management, the field of migration, protection of personal data, fight against organized crime, etc. Also, within the Brussels Dialogue, the Government will work on the implementation of agreements on Integrated Border Management and freedom of movement. Modernization and Reform of Public Administration, built on European principles, as a key factor for the provision of services to citizens and increase of efficiency, is the main objective of the Government. In this regard, the Government will prepare a strategic framework to address the challenges in the development and coordination of policies, public finance management, and management of human resource and civil service development, administrative procedures, provision of administrative services, as well as the system accountability in the civil service. In order to address the challenges in this regard, the Government will work to implement legislation for providing a structured and standard-based public service, a non-political service based on fair and transparent recruitment, promotion based on merit and professional advancement. Also, the Government aims at building a unified system of wages in public administration and digitalization of the human resource management process. The Government will work to increase transparency and participation of citizens in decision-making and strengthening cooperation with the private sector and civil society organizations. For continuous advancement of local governance, as well as for a quality service delivery, the Government will continue to implement strategic and legislative framework in the field of local governance. The mid-term period will consist of an increased commitment of the government in relation to the unification of local self-governance system in the country, namely the creation of political, administrative and institutional conditions for the integration of the northern municipalities in the local self-governance system of the Republic of Kosovo European Agenda and Foreign Policy The achievement of Kosovo's European agenda is a priority to the Kosovo institutions. In this regard, as special priority during the mid-term period will be the SAA implementation, by coordinating the dialogue with all involved parties. In particular, efforts will be intensified in relation to visa liberalisation process, in particular in increasing administrative capacities to face the obligations arising from Stabilisation and Association Agreement, respectively approximation and harmonisation of legal framework with EU, as well as capacity building on implementation of the legal framework. Due to limited financial recourses and human capacities, the government aims at prioritisation of its objectives for the medium term period by harmonising them with the requirements of European agenda and at same time ensuring an integrated planning approach which ensures that financial and human resources of the government are oriented towards meeting the obligations under the 7

11 agreement and stated reforms under the government programme and in line with the expected national development strategic framework. The Government also recognizes the need for an integrated approach in the European agenda implementation for achieving these priorities. With such an approach, the Government will ensure the continued implementation of the reforms in different areas, which will enable proper implementation of SAA, whose implementation will be strongly supported by the Government. In the context of implementation of European integration requirements, the Government will maximise the use of EU funds as part of Instrument for Preaccession Assistance and Western Balkan Investment Framework, as well as other development partners. The Government of Kosovo will undertake necessary reforms to ensure Kosovo s access to EU funds in the form of direct budget support. In regards to foreign policy, the Government of the Republic of Kosovo, during this period, will increase efforts towards Kosovo's membership in international organizations, targeting specialized agencies within UN. In addition to this, the Government of the Republic of Kosovo, aiming at establishing contacts with countries that have not recognized Kosovo, will continue to strengthen and expand its presence in multilateral systems. Also, the Government will see opportunities to strengthen its presence in different regions of the world in order to be closer to states that have not recognized Kosovo. For achieving this, a rapid development of capacities of the diplomatic and consular service in the diplomatic missions of the Republic of Kosovo is needed Education, Science, Culture, Youth and Sport Education is considered as one of the main determinants of long-term economic and social development and stability in Kosovo. In this regard, the Government, during the next period, will work on developing a new vision for education, whereby in 2016 will draft the next Education Strategy. At the same time we will work on improving the quality of education, such as: infrastructure improvement, with particular emphasis on areas with overcrowded schools, the intensification of activities for the further teachers development, as well as the e-education system will be functionalised, which will greatly affect the more efficient management of this sector in order to increase the quality. The Government of Kosovo is committed to promote the increase and expand of scientific and research activities. In this regard, the Government, during the mid-term, will work on improving the funding for this sub-sector and also the consolidation of mechanisms for effective management of the sector. During the mid-term period we will be work on completing the legal infrastructure in culture, where as a priority will be the drafting of a Strategy for Culture and the Law on Sponsorship and Donations. Also, the existing laws will be reviewed, as well as the Law on Cinematography will be drafted, in order to be more applicable and to serve to the benefit of the development of cultural life in the country. Attention will be paid to the finding funding opportunities for expanding the presence of the Republic of Kosovo in important cultural events in the world. Also, it is important to work on the implementation of the Common Calendar of Cultural Activities with the Republic of Albania. A 8

12 special attention will be paid also to the preservation of cultural heritage, through the support of specialized institutions in this field. Regarding Youth, the Government will continue the activities to strengthen and increase its participation in decision-making. Support to the youth organizations and creation of a special fund for entrepreneurship among young people will be the main priority. Also, the Government will work on creating a proper infrastructure for cultural activities. Also, the Government will continue to intensify its work for supporting the sport in Kosovo in order to develop it, starting from the young ages, by promoting and expanding sports in schools and educational institutions. At the same time we will be work on the drafting and adoption of new laws on sport, then the law against hooliganism during sport events. Regarding the internationalization, the membership in International Olympic Committee has been essential to pave the way towards membership in various federations, where the most complex is the membership in the Federations such as UEFA and FIFA, which would finalize the long internationalization process. At the same time, the Government will continue to improve the sports infrastructure in Kosovo and to bring the sports halls in compliance with the requirements for holding international matches Modern healthcare Reform of the health system represents a significant challenge for Kosovo. In addition to the creation of conditions for implementation of the law on health, and functioning of the health insurance fund, this reform aims at ensuring the universal access to quality health services for all citizens and residents of Kosovo. Increasing the quality of services has become a necessity; therefore, the primary goal of this reform will be the increase of the sector performance in the provision of services. This will be achieved through the establishment of a sustainable financing system for the health sector, which will result in a Public Health Insurance Fund. The supply with medicines is the most urgent priority, and in this regard the Government will work on compiling a list that is in line with relevant international standards, based on the real needs of Kosovo, and within available resources. A specific priority will be also the capacity building through programs for specialization, and citizens awareness-raising in order to prevent various diseases. However, for achieving a modern health system are needed strong institutions, which are able to cope with challenges, and to resolve issues that may arise. Therefore, reform of the Ministry of Health, in terms of strengthening the policy-making, regulatory, evaluator and monitoring role, as well as the establishment of a sector-wide approach in policy-making, including other institutions such as the Chambers of Professionals, Health Insurance Fund and HUCSK, will be issues that will have special attention during the next period. 9

13 SECOND PART 2. MACRO-FISCAL FRAMEWORK International Economic Environment During 2014, the global economy was characterised by slow recovery, particularly in advanced economies which continue to suffer high levels of private and public debt. Although financial markets have been optimistic, investments, particularly in advanced economies, have not reached the expected levels. Economic projections and expectations were based on the assumption that global growth would be driven by advanced economies as a result of measures taken for fiscal consolidation and appropriate monetary policy. Despite the weakened activity, capital flows to emerging markets continues to be stable, where exchange rates have played a stabilising role in some cases. Amongst advanced economies, EU States and Japan expect slower growth compared to USA, whilst among emerging economies slower growth is expected in China and Brazil. Moreover, geopolitical tensions (the situation between Russia and Ukraine and the conflict in the Middle East), although still active in the respective regions, are expected settle down this period. However they continue to be increasingly threatening the overall security and particularly leading to economic uncertainty. Economic developments in the end of 2014 and the first half of 2015 made the economic agents to change their expectations on the global economy by reviewing their official projections on economic growth rates. The decline in oil prices (driven by supply) is expected to foster global growth over the next two years by increasing the purchasing power and private demand in oil importing countries. This is expected to be strongly manifested in advanced economies due to faster transmission of these lower prices effect to the customers / end-users, whilst in emerging economies positive effects on economic growth is expected to be mainly manifested through public investments 2. On the other hand, coping with lower rates of economic growth compared to expectations is, in many countries (except the USA), thought to be expected to fit the behaviour of economic agents, which will be manifested through the decline in investment. Such behaviour would counteract to the effect of lower oil prices. This would result in the fall in oil prices not being utilized in its full potential; therefore economic growth in many countries for the coming years is revised downwards in January 2015, except in the case of the US. The following table presents the re-written growth rates according to the International Monetary Fund. This table shows review of the global growth rate of 3.5% (from3.8%) for 2015 and 3.8% (from 4%) in Consumption and production in developing countries are considered to be more dependent on use of energy. IMF highlights that the decline in oil prices in developing countries results in more windfall revenues (e.g. less subsidies for energy) creating thus the possibility to support public finances. Thus, the impact reaches the end user indirectly. 10

14 Table 2.1 Economic growth projections (in %) Description Projections October 2014 Reviewed World GDP Advanced economies Euro zone Germany Developing economies European developing economies The Balkan Region Albania Macedonia Montenegro Serbia Source: IMF WEO, published on 14 April 2015 In regard to Eurozone 3, the estimates of the Directorate for Economic and Financial Affairs (DGECFIN) show a slow European growth, but the potential to growth in the next two years as a result of recent global developments. The fall in oil prices and other products represents the best chance for recovery of economic growth in fuel importing countries, such as the EU states. According to European Commission estimates, the EU growth was mainly supported by private consumption, whilst investment levels remained weak throughout In addition to the decline in oil prices, the Euro has depreciated and the European Central Bank plans to expand its asset purchase. The EU's GDP is estimated to grow by 1.7% this year and 2.1% next year. In the Eurozone, GDP is estimated (unlike the IMF) to grow at the rate of 1.3% in 2015 and 1.9% in Inflation in the euro area is estimated to be -0.1% this year and 1.3% next year. In general, countries like Germany, whose export is more oriented towards commodity exporting countries (compared with exports of services), will face a decline in external demand (in the case of Germany, net exports are forecasted to reach negative values in 2016). The Balkan region was characterised by slower recovery, where Albania gives the impression of the state with the most potential for growth over the next two years, whilst Serbia has much work ahead to restore growth to positive values. Albania's economy was characterised by lower inflation than expected, which strengthened private consumption as a result of the fall in international oil price. In general, there are signs of recovery followed by improved fiscal balance. Large investments in infrastructure projects in 2014 were the largest contributor to GDP growth in Macedonia. However, growth for the years 2015 and 2016 is expected to mainly occur from the increase in FDI reflected through increased domestic demand. The external balance continues to 3 Table 1 contains the most recent IMF information on all countries (for consistency). The discussion on economic projections for Europe and the Balkans is based on European Economic Forecast 2015, an EC publication, because it provides more detailed information on Europe developments. 11

15 adversely affect the growth in Macedonia because, despite significant improvement in export of goods, the slow decrease of import remains a challenge. Montenegro marked a slow growth during 2014 as a result of the decline in industrial production and export. Year 2015 will mark the start of the construction of a large motorway, which is expected to affect economic growth in the coming years. This initiative comes after a period of several years of budget cuts in capital investments. Serbia had a difficult year, when economic growth decreased marginally by falling to around -2% in 2014 as a result of major floods during 2014 and weak external environment. The recovery is expected to be slow, where investments in particular, which have been performing poorly, are expected to reach their lowest level in Recent developments and macro-economic medium term scenario Year 2014 was particularly challenging for Kosovo as it was characterised by considerable lack of activity as a result of Government s delay in establishing government institutions after the elections of June It was understandable that such a situation would affect the behaviour of economic agents, who seemed to be waiting for the establishment of governmental institutions in order to avoid uncertainties. Retaining macro-fiscal stability is a challenge at the time of an urgent need for economic development. There isn t too much room for cutting the expenditures, and for a transition country like Kosovo, the need for investment remains considerable. Kosovo's economy continues to show resistance to turmoil in the European countries economy. However, developments in the region should be carefully followed. This consistency is mainly due to the low rate of Kosovo's integration into global capital markets. Financial market in Kosovo reflects very few European or global financial developments (fluctuations). Other reasons are the high levels of capital expenditures, a characteristic of transition countries which usually suffer from lack of infrastructure. The impact of infrastructure investments on economic growth is intended to be replaced by increased private investment and growth in export. In this regard, competitiveness (particularly the regional one) continues to be a priority for Kosovo, emphasised through on-going Government s efforts towards continuous capital investments, improvement of the business environment and support to local production in various forms Real Sector Consumption and private investments as well as exports, to a lower extent, are the categories expected to boost economic growth in Kosovo during the medium term period. According to the Government Programme (recently adopted), changes 4 have been made Kosovo's tax 4 See box 1 for more details regarding the last changes to the tax system. 12

16 system which are expected to foster the increase in investments (particularly in manufacturing) and private consumption. Although being in the short term, these measures may not have a major impact. In the longer run, they are expected to contribute to the substitution of imported goods with domestic products and to increased and diversified exports. Therefore, these tax changes (which are expected to be effective as of July 2015) present an opportunity to improve the foreign trade balance, which continues to be a challenge for Kosovo's economy. This is because Kosovo exports are dominated by exports in services, whilst when it comes to goods, export of metal products plays a dominant role. Therefore, there is considerable room for improvement regarding further diversification of exports. The need for the latter has prompted the Kosovo Government to take measures aimed at supporting domestic manufacturers so that Kosovo products would replace a significant portion of imports be launched to regional and global markets in the future. Economy was estimated to grow at 3.3% in 2014, whilst considering the global economic developments, in particular those in the Eurozone, economic growth for 2015 is projected to be 3.8%, to be then stabilised at 4.4% on average over the medium term period (chart 1) The chart shows that during 2014 Graph 2.1. Real GDP growth and its components consumption was the largest 8% contributor to economic growth. 6% Although the full effect of the increase 4% in public sector wages and pensions will be manifested after spring 2015 (since it began to be implemented from April 2014), this change is estimated to boost the real disposable incomes of a considerable portion citizens, thus 2% 0% -2% -4% -6% contributing to the growth of private consumption. It should be emphasized that a large part of the consumption Source: SAK and Macro Unit calculations originates from imports, which explains the considerable share of this category in the 2014 economic growth. 2.8% 3.4% 3.3% 3.8% 4.1% 4.5% 4.5% Consumption Investment Export Import Real GDP In 2014, exports contribution to economic growth has increased compared with 2012 and This is mainly attributed to the fact that Kosovo's exports have begun to signal for diversification. Such a phenomenon has been observed over the past years, where, despite the increase in the goods exports value, exports of metals have decreased being replaced with wooden, plastic and food products. However, the exports contribution to economic growth is less negligible due to the low base total exports continue to have. As a result of the country s political situation in 2014, the economy slowed down and many expectations did not materialise, which largely explains the general lack of investments during most of The forecasts scenario estimates that the economy will start recovering from the challenges faced in Year 2015 will be a period of stabilisation to precede a medium-term period of more stable macroeconomic environment and more favourable environment for doing 13

17 business. Effective tax changes are also expected to contribute to this. The Government s Program is based on the past and current challenges and has put particular emphasis on economic development by stimulating local production. These fiscal changes include the production line in different sectors, including the agricultural one, which is being subsidised by government from some time now. Regardless of the fact that consumption is expected to decline in relation to GDP, graph 2.1 indicates that consumption growth will continue to be largest contributor to the Kosovo GDP growth in the medium-term, supported by remittances among others. It also indicates that this period is expected to be characterised by significant improvement in investments. Although the European recovery remains slow (uncertainty in the Eurozone was diminished less than expected), the overall perspective is positive. Therefore no drastic decline in migrants transfers, whether remittances or real estate investments, are expected. Although there are signs of improvement in the exports category, the level of Kosovo exports remains low. As a result, Kosovo Government has considered exports to have the potential to contribute to the growth in GDP. Therefore, considering the challenges faced by producers, Kosovo Government has made tax changes that facilitate the existing burden of Kosovo businesses in manufacturing. Thus, Kosovo's products will begin to gradually replace imported ones and will have easier access to international markets. Application of these changes as of July of this year will allow the effects of these changes to be manifested in early medium term. This is also reflected in the increased share of exports in GDP over this period (see Chart 2.1). Moreover, the Government s Programme is focused on different sectors aiming to support Kosovo s exports diversification. This enhances the stability of this category contribution to the growth of GDP. In general, the period will not bring any drastic changes in the structure of the contributors in Kosovo GDP growth. Expectations mostly lean towards the gradual improvement of each category. It should be noted that the beginning of the period will consist in the overall economic recovery and stabilisation after the stagnation in Price fluctuation and projections for The trend of slow growth in the price level, measured by the annual change in consumer price index (CPI), has continued in 2014 as well. Graph 2.2: Price forecast Similar to last year, food and transport 5% prices have fall slightly, thus reflecting the fall in global prices of food and oil, 0% whilst other components such as -5% tobacco, alcohol and services have increased. As predicted the increase of -10% salaries in the public sector seems to -15% have had an impact on the increase in prices. -20% CPI GDP deflator World food prices 14

18 Consumer prices are expected to remain low in the medium term period, 0.2% in 2015, averaging 0.5% in the period. Low inflation rates are expected as a result of stabilisation/lower prices of the two components - food and transportation - with greater weight in the CPI as a result of further decrease of food and oil prices in global markets, whilst other groups of products and services are projected to continue to offset some of this decline. The GDP deflator, as a measure of the level of prices of all new, domestically produced, final goods and services in an economy, is estimated to be 1.4%, and is projected to remain above the CPI; on an average of 0.9% in the coming years Developments and projections of the external sector External position of Kosovo's economy continues to be determined by developments in the global economy and European Union in particular. This is because the bulk of Kosovo exports are oriented towards the EU countries, whilst Germany and Switzerland are the main source of remittances and foreign direct investment in Kosovo. The fall in international prices of food and oil products is expected to be reflected in the decline of imports value, whilst the projected increase in international prices of metals associated with new measures taken by the Government to stimulate the production is expected to stimulate the export of goods. The current account deficit is expected to improve slightly over the forecasted period, reaching 7.4% of GDP at the end of the period out of 7.9% as projected in The trade balance during 2014 resulted in an increase (improvement) of 0.7 percentage points in relation to GDP compared to 2013, thus reaching -36.8%. This improvement was mainly driven by the rapid growth of exports of goods and the slowdown of imports growth due to the pressure of falling international prices. Graph 2.3: The structure of the current account, as % of GDP Trade Balance Services balance This trend is expected to continue Net income Net transfers Current account balance during the forecasted period, with imports expected to continue to grow at a slow pace (average 4.7% in nominal terms), partially influenced by falling prices and to a greater extent by the substitution of imported goods with local products. Export of goods (projected to grow at an average of 9.6% per year) are expected to mainly contribute to the improvement of the trade balance, which is driven Kosovo Government s measures taken to stimulate production and investment in the private sector. Therefore, the trade balance, mainly supported by government initiatives to promote production, is expected to improve by about 2 percentage points reaching -34.6% of GDP at the end of the forecasted period. 15

19 The services account was closed with a positive balance of about 6% of GDP in Based on the background of growth of this item, the services account is expected to continue providing a positive contribution to the current account. Consequently, the share of services balance is expected to grow by 0.3 percentage points over the forecasted period, reaching 6.3% of GDP (see Chart 2.3). This growth is expected to continue to be supported by travel services, although an accelerated growth is envisaged in transport services as well as information technology and communication services. Net income account is expected to worsen from 1.9% of GDP in 2004 to 2.4% of GDP in Despite expectations for a significant increase in revenues from the remuneration of employees, increased outflow in the form dividends and return on foreign investments in Kosovo is expected to slow down the growth in revenues account. This will be highly contributed by the envisaged decline in revenues from the interest of local financial institutions investments abroad as a result of low and near-zero interest rates and reduction of these investments. Notwithstanding expectations for an increase in remittances, transfers account is expected to worsen to 2.3 percentage points during period, therefore reaching 18.6% of GDP. This decline is expected to be affected by the projected decline in official transfers. At the end of the forecasted period, the capital and financial account is expected to represent approximately 6.4% of GDP. This growth is expected to occur by increasing the flow of foreign direct investments, which are expected to account for about 3.1% of GDP from 2.8% in The portfolio investment outflow are expected to decline over years under the assumption that local financial institutions will reduce investments and that these investments will be channelled in the country's economy through lending and investment in Government securities. Errors and mistakes are expected to fall in relation to GDP although their value remains high and positive. It is assumed that this item of the balance of payments (BOP) consists of revenues not recorded as remittances, foreign direct investments or unregistered export of goods or services. In 2014, this category of BOP has represented 5% of GDP (corresponding to million euros) from the 3% of GDP it was in The Central Bank of the Republic of Kosovo, as the designer of these statistics, makes constant changes in the reporting of revenues and expenditures in order to identify unrecorded revenues. Changes are reflected in the annual review of all items of the balance of payments which are then reflected in the national accounts and the GDP nominal value Financial Sector Kosovo's financial sector remains well-capitalized, liquid and profitable and characterised by positive trends of growth in deposits and crediting. The banking sector continues to retain its dominant role in the financial system in terms of both lending and the payments system. The banking sector has continued to be stable and profitable despite the inconsistencies that covered the international financial markets in recent years, where limited integration with international 16