Republika e Kosovës Republika Kosova - Republic of Kosovo Qeveria Vlada Government KOSOVO ECONOMIC REFORM PROGRAMME (ERP)

Transcription

1 Republika e Kosovës Republika Kosova - Republic of Kosovo Qeveria Vlada Government KOSOVO ECONOMIC REFORM PROGRAMME (ERP) 2016

2 TABLE OF CONTENTS 1. OVERALL POLICY FRAMEWORK AND OBJECTIVES MACROECONOMIC FRAMEWORK RECENT ECONOMIC DEVELOPMENTS MEDIUM-TERM MACROECONOMIC SCENARIO ALTERNATIVE SCENARIOS AND RISKS FISCAL FRAMEWORK POLICY STRATEGY AND MEDIUM-TERM OBJECTIVES BUDGET IMPLEMENTATION IN MEDIUM-TERM BUDGETARY OUTLOOK STRUCTURAL BALANCE (CYCLICAL COMPONENT OF THE DEFICIT, ONE-OFF AND TEMPORARY MEASURES, FISCAL STANCE) DEBT LEVELS AND DEVELOPMENTS, ANALYSIS OF BELOW-THE-LINE OPERATIONS AND STOCK-FLOW ADJUSTMENTS SENSITIVITY ANALYSIS AND COMPARISON WITH THE PREVIOUS PROGRAMME SUSTAINABILITY OF PUBLIC FINANCES INSTITUTIONAL FEATURES STRUCTURAL REFORM PRIORITIES IN IDENTIFICATION OF KEY OBSTACLES TO GROWTH AND COMPETITIVENESS (DIAGNOSTIC) STRUCTURAL REFORM PRIORITIES BY AREA PUBLIC FINANCE MANAGEMENT INFRASTRUCTURE SECTOR DEVELOPMENTS BUSINESS ENVIRONMENT, CORPORATE GOVERNANCE AND REDUCTION OF THE INFORMAL ECONOMY TECHNOLOGY ABSORPTION AND INNOVATION TRADE INTEGRATION EMPLOYMENT AND LABOUR MARKET FOSTERING SOCIAL INCLUSION, COMBATING POVERTY AND PROMOTING EQUAL OPPORTUNITIES SUMMARY OF REFORM PRIORITIES BUDGETARY IMPLICATION ON STRUCTURAL REFORMS INSTITUTIONAL ISSUES AND STAKEHOLDER INVOLVEMENT ANNEX 1. TABLES ANNEX 2. AN INVESTIGATION OF THE COMBINED EFFECT OF WAGES INCREASES AND WORLD COMMODITY PRICES ON KOSOVO S INFLATION ANNEX 3. ECONOMIC EFFECTS OF REFORM MEASURES ANNEX 4. THE FORECAST OF INDIVIDUAL REVENUE CATEGORIES

3 Abbreviations ARDP Agriculture and Rural Development Programme CBK Central Bank of Kosovo CEFTA Central European Free Trade Agreement CMIS Case Management and Information Systems CPI Consumer Price Index DEPP Department for Economic and Public Policy (MoF) DMU Debt Management Unit (MoF) EBRD European Bank for Reconstruction and Development EC European Commission EE Energy Efficiency EIB European Investment Bank EU European Union FDI Foreign Direct Investment GDP Gross Domestic Product GoK Government of Kosovo ICT Information and Communications Technology IIP International Investment Position IMF International Monetary Fund IPPR Immovable Property Rights Register KIESA Kosovo Investment and Enterprise Support Agency KCGF Kosovo Credit Guarantee Fund KPST Kosovo Pension Savings Trust KODE Kosovo Digital Economy KOSTT Kosovo Transmission System and Market Operator LFS Labour Force Survey LPFMA Law on Public Financial Management and Accountability MAFRD Ministry of Agriculture, Forestry and Rural Development MEST Ministry of Education, Science and Technology MoF Ministry of Finance MTEF Medium Term Expenditure Framework MTI Ministry of Trade and Industry NDS National Development Strategy NIC National Investment Committee NPL Non-Performing Loans NPSAA National Programme for Implementation of the SAA OECD Organisation for Economic Cooperation and Development OG Output Gap OSP Office for Strategic Planning PAK Privatisation Agency of Kosovo PPP Public Private Partnership PEFA Public Expenditure and Financial Accountability PFM Public Finance Management PFR Public Finance Review PTK Post and Telecommunication of Kosovo RE Renewable Energy RCC Regional Cooperation Council RDI Research, Development and Innovation SAA Stabilization-Association Agreement SAK Statistical Agency of Kosovo SEE South East Europe SEETO South East Europe Transport Observatory SME Small and Medium Businesses SPP Single Project Pipeline TAK Tax Administration of Kosovo TPP Thermo Power Plant USAID United States Agency for International Development VAT Value Added Tax VECM Vector Error Correction Model WB World Bank

4 List of Graphs and Tables Graph 1. Annual growth of GDP, in % 6 Graph 2. Inflation (average consumer prices), in % 7 Graph 3. The structure of GDP in 2015, 8 in millions of euro 8 Graph 4. Price levels in Kosovo 10 Graph 5. Gross average (monthly) wages, in Euro 12 Graph 6: Contribution to real GDP growth 14 Graph 7. Sectorial contributions to GDP growth in percentage points 15 Graph 8. Trade Openness Index, comparison to the region and Euro area 18 Graph 9. Foreign Direct Investment, in million euro 19 Graph 10. Structure of FDI by sectors in Graph 11. International Investment Position (IIP) end-of-period, in millions of euro 20 Graph 12. Development trend of the financial system and the financial sectors assets 21 Graph 13. The structure of deposits and annual growth, in % 22 Graph 14. Structure of loans and annual growth, in percentage 22 Graph 15. Alternative Scenarios, real GDP growth 25 Graph 16. The structure of tax revenue, as % to total 35 Graph 17. Trend of tax revenues and its relationship to economic indicators 36 Graph 18. The structure of expenditure by categories during , in million euro 39 Graph 19. Actual and potential GDP, annual and quarterly data 40 Graph 20. Cyclically adjusted budget balance and the output gap, annual and quarterly results 43 Graph 21. Composition of overall deficit and financing need 47 Graph 22. Indicators of public debt under baseline and investment clause scenarios 48 Graph 23. Scenario analysis: Decreasing the permanent GDP growth by 1 p.p. 49 Graph 24. Scenario analysis: Reducing permanently the bank balance to 3.0% of GDP 50 Graph 25. Scenario analysis: Temporary increase in the overall deficit in Table 1. The share of exported goods to total exports 16 Table 2. Geographical composition of exports, in 000 euro 17 Table 3. Financial Soundness Indicators 23 Table 4. Additional Investment Projects 27 Table 5. Alternative macro-fiscal scenarios 28 Table 6. General Government revenues and expenditures, in million euro 31 Table 7. The structure of budget revenue, in million euro 36 Table 8. Expenditure by economic categories during , in million euro 38 Table 9. The elasticity of tax revenues with respect to GDP 41 Table 10. The output Gap (OG), Cyclically adjusted budget balance, primary balance and the cyclical component of the balance 42 Table 11. Public Debt, in million euro (unless otherwise indicated) 44 Table 12. Alternative Macro-fiscal Scenarios 45

5 1. OVERALL POLICY FRAMEWORK AND OBJECTIVES The drafting of the ERP 2016 for Kosovo coincided with the development of the National Development Strategy (NDS), which is the first time Kosovo has introduced an all-encompassing planning document. NDS is to serve as an umbrella for all national strategies (including sectorial strategies) promoting economic development and is consistent with the Government Programme , a product of the coalition between the two parties which took office in January Thus, the ERP 2016 was drafted with the intention to be in line with what is laid out in the NDS and to serve as an opportunity for line ministries to harmonize all currently ongoing sectorial strategies under one common budgetary framework. While the NDS is a more general document, dealing with national policies on a wider level, the ERP attempts to focus on policies that fit into the agenda of enhancing competitiveness, which are to be integrated into a clearly set macro-fiscal framework. The two main objectives of the ERP 2016 are (i) to achieve the necessary fiscal consolidation required by excessive public finance deficit in 2014 and weak economic growth in 2015, and (ii) to focus structural reform on key areas for improving export competitiveness and reducing the identified binding constraints to economic growth. The fiscal strategy presented in Chapter 3 combines constraints on current expenditure with revenue enhancing measures and growth stimulating tax measures. The structural reforms presented in Chapter 4 have been prioritised in such a way that they: address the binding constraints of access to finance and contract enforcement (reform measures #10, #11 and #12 improving property rights system, judicial efficiency and SME financing), address the binding constraint of power supply (reform measures #3 and #4 to increase energy production capacity and energy efficiency) and the potentially binding constraint of transport infrastructure (reform measure #2), address the potentially binding constraint of the skills gap (reform measures #17, #18, #19 and #20 aimed at improving linkages between education and the labour market as well as improving skills and employability by active labour market policy), improve the production base for exports in traditional sectors (reform measures #7 and #16 for development of industrial clusters and promoting quality standards, reform measures #5 and #6 to facilitate competitive agricultural production, facilitate development of high-value added sectors (reform measures #8 and #15 promoting ICT infrastructure and business-academia cooperation) improve the investment environment and the quality of governance (reform measure #14 set to reduce informality, reform measures #1, #9 and #13 to improve the quality of regulation, SOE management and public procurement) 1

6 Last year, the (N)ERP 2015 was drafted during a very specific political environment, where government formation was delayed until late 2014 after the national elections held in June of the same year. In this sense, the inclusion of policies which often require approval by the political level was challenging. The coordinators of ERP have integrated the lessons learned from last year s submission, and combined it with the recommendations/policy guidance received from the Economic and Fiscal Dialogue, adopted in Joint Council Conclusions of May Working groups, including all relevant line ministries and/or other government agencies, have met regularly to discuss the content of the measures which are to be contained in the ERP 2016, as well as the harmonisation between the latter and the over-arching policies laid out in the NDS. The two documents have been discussed on a Ministerial level, approved by the Government before being submitted to the EC. It was of particular importance to both national co-coordinators of the ERP process (the Office for Strategic Planning within the Prime Minister s office and the Macroeconomics Unit within the Ministry of Finance) that a draft of the document be made available to relevant stakeholders for consultation in time, seeing that due to the specific political situation during 2014 this was not possible. This year, the document was made available to various institutional and NGO representatives through public consultations and presentations as well as having been published online through the website of the Prime Minister s office (more details in the part on Structural Reforms of this document), which was done in coordination with the (similar) consultation process of the National Development Strategy. Relevant stakeholders include representatives from the business sector, Chamber(s) for economic cooperation, civil society, as well as other stakeholders deemed pertinent to the agenda. Box 1. Response to the targeted policy guidance adopted by the Economic and Financial Dialogue in May 2015 The comments/recommendations were received for the two parts of the (N)ERP 2015 separately, and this section shall address them as such in the interest of keeping with the structure of last year s document as well as the Dialogue Conclusions. The recommendations were as follows: Concerning Part I: 1. Sustain the commitment to fiscal discipline and improve transparency of public finances by considering establishing an independent fiscal council, or fiscal agency, with a clear mandate to preserve sustainability of public finances, and reduce deficit bias, and by better coordination between government and parliamentary bodies responsible for budgetary processes. Improve the budget process by legislatively strengthening the role of the Medium Term Expenditure Framework and enshrine principles of cost-benefit analysis as the basis of the policy planning process. Take steps to increase government deposits to the threshold implied by the fiscal rule (4.5% of GDP) to provide additional financing buffer. As per the recommendation, there has been extensive, on-going debate regarding the establishment of a fiscal council/agency. Many forms of such a body have been put on the table, but the establishment of a fiscal council (in the sense of a consultative body of academics 2

7 which would evaluate forecasts and fiscal plans) was not considered to be the most effective remedy to help maintain good public finance management and reduce the deficit bias. There is reason to believe that such a body would not be in position to provide genuinely independent evaluations of forecasts and fiscal plans and could devolve into simply another layer of bureaucracy. A major objective of such a body is also to raise the public (media) debate on such issues, the result of which is highly dependent on the capacities of the academic community and media to engage in such debate, which in Kosovo is lacking (especially if this debate is to be substantially technical in content). Having this discussion now, allows Kosovo to assess the different ways countries have handled this issue in order to decide on the best option; wherein success varies on this measure being context specific. It is worthwhile to instead consider channelling efforts towards maintaining/improving the already existing infrastructure by providing independence to existing forecasting bodies within the government (similar to the Irish, Danish, or Slovene models). Such a body could help enhance the coordination between government and parliamentary bodies responsible for budgetary processes, as specified in the recommendation. The role of the MTEF is already clearly enshrined in the law, whereas including cost benefit analysis into the policy planning process is a considerable endeavour given that it encompasses all ministries, that is to say the whole Government. All new policy initiatives are required by law to be accompanied by a fiscal impact assessment when sent to the Ministry of Finance/Office of the Prime minister; however this is very rarely the case. During 2015, the MF has issued the administrative instruction which requires all budgetary organisations to submit the fiscal impact, accompanied with the underlying cost analysis, of any new initiative. Continuous efforts are being made to this end, associated mainly with the Budget Department within the Ministry of Finance; more details are provided in section 3.8. The National Investment Council was established last year and approved in December a list of 39 priority projects in transport, energy and environment based on costing and assessment of economic and development impact. In early 2015, the Government entered into a 22 month programme with the IMF. As the program is largely focused on the maintenance of the sustainable macro-fiscal framework, in coordination with the IMF, the Government is planning to gradually increase the useable cash buffers to around 4.5% of GDP by the end of This is also envisaged in the approved budget for Address immediate fiscal risks with necessary measures aimed at reducing unsustainably high current expenditures while preserving growth enhancing capital spending. Develop a legal framework for maintaining a sustainable public wage bill and strengthen targeting and means testing of transfers. Ensure planned increases in agricultural subsidies are directed exclusively at productivity increasing initiatives. Advance public administration reform with special attention on improving productivity and reducing costs. Take further steps in strengthening public finance management practices. This year marks the very first time Kosovo has revised its budget downwards. This was achieved, in part, also by cutting non-productive expenditure, with the intention of carefully monitoring further developments internally but also via recommendations/requirements by the 3

8 recent SBA with the IMF. Part of this SBA is also a wage-rule, which (in broad terms) anchors the increase of public wage expenditure to nominal GDP, in the interest of maintaining a sustainable public wage bill and aligning public sector wages to the productivity growth. Two major projects on which particular emphasis has been put during 2015 are the Reform on Public Administration Management and the Public Finance Management Reform, which have also been a recommendation from many other stakeholders (they are explained in more detail throughout the document). Reform measures #5 and #6 (agricultural infrastructure for agro-business; consolidation of agricultural land) will support the development of competitive agricultural production and improve the overall efficiency of public spending on agriculture. Reform measure #1 addresses an important element of sound public finance management by promoting centralised and electronic public procurement. Reform measure #9 will introduce strict RIA principles and procedures into the legislative process and improve the overall quality of public policies implying also a higher effectiveness of spending. Decisive efforts to assure fiscal stability were also made in preparation of the 2016 budget, which foresees an overall deficit of 1.6% of GDP, arrived at by reducing the current spending relative to the 2015 budget and preserving the capital spending at the 2015 budget levels 3. Modernize revenue collection to reduce reliance on customs receipts by improving property tax collection and strengthening the legal framework for collection of tax and municipal tax arrears. Revisit local government grant financing scheme to incentivize better collection of municipal revenues. Further broaden tax base by introducing the planned mandatory health sector contributions, and reassess planned tax exemptions Reform measure #14, following the Government Programme , has envisaged the establishment of a common revenue agency; in response to a number of issues which have been raised regarding the Tax Administration of Kosovo as well as the Kosovo Customs. Such a unified agency would improve services offered to taxpayers (standardize procedures and reduce costs), increase efficiency in tax collection, as well as increase the independence of such structures and contribute to the ongoing process of adapting to EU legislation and practices. Of particular interest would be the effect of such a reform on the reduction of the tax gap; it is estimated that the largest portion of this gap is from VAT, so tackling this issue within a common structure holds the potential to lead to a significant increase in VAT collection. It must be noted that the latter is more likely to begin after a certain period of time; after the two institutions settle into the new framework. Concerning local government grant financing schemes; a two-year EU funded project has analysed the system of municipal finances and worked with selected municipalities on increasing own-source revenues. The recommendations of the project were discussed by the interinstitutional working group on fiscal decentralisation and will be considered for adoption by the MF during the year. 4. Advance restructuring and restart the privatization of non-essential Publicly Owned 4

9 Enterprises (POEs). Take steps to improve the efficiency and corporate governance of strategic POEs. Address the lack of quorum of the board of Privatization Agency of Kosovo (PAK) and accelerate privatization of Socially Owned Enterprises still in PAK's portfolio. An important step has been taken with regard to the Privatization Agency, as the second half of 2015 finds Kosovo with an approved list of board members for this agency, such that all upcoming decisions and processes now are no longer on hold. The Government of Kosovo relies on the EC to understand the grave importance of such a body in regard to further developments to PAK s portfolio, which is why the process of finalizing a capable/ qualified list of potential board members was a particularly difficult task. This has been a key step in establishing a basis upon which the government can from hereon continue with the privatization of the remaining SOEs. Reform measure #13 is intended to improve the corporate governance and efficiency of SOEs in line with OECD principles. 5. Address the underlying causes for high costs of bank-based financing, reduce the duration and cost of insolvency procedures by adopting the new bankruptcy law and further improve contract enforcement with a view to increase overall financial intermediation in the economy. The banking sector in Kosovo has shown improvements in regard to this issue as interest rates on lending have fallen to 7.9% (in September 2015) compared to 10.7% (September of 2014); due to a combination of factors: the fall in interest rates on deposits, the improvement in the quality of the credit portfolio, as well as banks interest to increase lending as a result of inter-bank competition. Another factor with a direct impact in this regard is the reform within the justice system, particularly on the functionalization of Private Enforcement Agents, which are expected to continue to play a major role in one of the justice systems most prominent problems, that of contract enforcement 1. Reform measures #10 and #11 (strengthening the property rights system; increased judicial efficiency) will have a positive medium-term impact on efficiency of contract enforcement and bankruptcy procedure. In the short-run, reform measure #12 will improve access to finance for SMEs. 1 There has been a three-year USAID program directly involving in strengthening capacities linked to this issue in all levels of government. It builds on the progress achieved by the Systems for Enforcing Agreements and Decisions (SEAD) Program, more information available at: 5

10 2. MACROECONOMIC FRAMEWORK During 2014, the global economy 2 experienced moderate growth, accompanied by differences among regions. While in 2014 advanced economies continued with reforms targeted towards reducing private sector debt, improving the labour market and increasing competitiveness, all with the intention of ensuring sustainable economic growth; emerging economies continued to face structural problems accompanied by the tightening of the fiscal policy which impacted the economic growth perspective. On the other hand, geopolitical developments primarily related to the conflict between Ukraine and Russia and tensions in other major oil-producing countries continued during 2014, but their direct effects on global economic activity have been limited. According to WEO issued by the IMF, the global economy is projected to grow by 3.1% in 2015, and reach 3.6% in 2016, supported mainly by emerging markets and developing economies, as can be seen by the graph below. Graph 1. Annual growth of GDP, in % Following a two-year period of negative real growth rate resulting from the public debt crisis, the Euro zone economy started to recover gradually, with annual growth reaching 0.9% in 2014, as a result of increased domestic demand. The euro zone GDP growth is also attributed to balanced monetary policy by improving financing conditions and providing for more adaptive fiscal policy. Financial markets in the Euro zone gradually re-gained a positive outlook regarding the perception of risk by investors which contributed positively to business confidence, consequently increasing 2 Given that the timeline of the ERP 2016 extends to 2018, and the AMECO database of the European Commission only provides forecasts until 2017, the Kosovo ERP 2016 uses forecasts of economic indicators of the IMF WEO Database (Autumn 2015). In addition to this, the European Economic Forecast publication does not provide data on Kosovo. In the interest of consistency, the IMF WEO Database will be the main source of data on economic developments and forecasts throughout this document, with additional information from EC forecasts, where applicable 6

11 investment along with consumption. Furthermore, the decline in energy prices had a positive impact on increasing disposable income of households and businesses. Graph 2. Inflation (average consumer prices), in % Economic growth in the Euro zone during is expected to moderate, influenced mainly by the decline in oil prices, favourable monetary policy and the depreciation of the Euro. Projections indicate that economic growth in the Euro zone is expected to be 1.4% for 2015 and 1.6% in Economic growth in developing countries is expected to reach 4.5% in 2016, driven mainly by expectations of positive developments in some of these economies. In the short run, effects of the financial crisis are expected to weaken and growth in the Euro zone is expected to recover in the direction of long-term growth potential, where a special contribution is expected to be provided by the European Investment Plan adopted in This plan aims to eliminate barriers for investment, provide technical assistance for investment projects and more efficient use of funding sources 3. Positive economic developments globally and in the Euro zone are expected to have inflationary pressures globally. Thus, inflation in the Euro zone is foreseen to experience a slight increase at an average of 1.2% going towards the end of RECENT ECONOMIC DEVELOPMENTS Real GDP growth is estimated to reach 3.8% in 2015, a significant increase compared to the 1.2% of the previous year. The year 2015 saw this indicator become a subject of much debate among a wide range of stakeholders, given that it was the first time that the Statistical Agency of Kosovo published quarterly GDP. Nonetheless, the official annual growth rate of GDP for 2014 (1.2% compared to the initially published 0.9% from the quarterly data) 4, was published during late November. It is worthwhile to note that the year 2014 was characterized by uncertainties among agents due to the 3 Jobs, Growth, Investment Plan; ec.europa.eu/priorities/jobs-growth-investment/plan/index_en.htm 4 It is important to provide this explanation at this point given that the official Budget for 2015 uses 0.9% as the growth rate of real GDP because, as the Budget is prepared in October, that was the official rate made available by the SAK at the time. This also serves as an explanation to any large differences compared to forecasts in the previous submission 7

12 political situation; as there was a considerable delay in the formation of government after elections held in June 2014, hence contributing to the slowdown of the economy and the deviation from the expected growth rate in Graph 3. The structure of GDP in 2015, in millions of euro The beginning of 2015 however, brought about a recovery based on greater confidence of economic agents with regard to the environment, strengthened by a new government with a clearly articulated Government Programme upon entering into office. Graph 3 shows the components of GDP in millions of euro (in nominal terms) and illustrates their contributions to real GDP. Consumption and imports continue to be the largest contributor to GDP, while in 2014 a decline in public consumption and overall investment was particularly noticeable (where the latter is explained largely due to the stagnation of work on infrastructure projects as the main component of public investment). Going towards 2015, an increase in exports is observed, although the impact that this category has on GDP is limited given the low base, especially in comparison to imports which continue to maintain the trend of previous years. In order for the trade balance to begin contributing positively to GDP, a comprehensive set of policies to increase competitiveness is presented in Chapter 4 and their prioritisation logic was summarized in the introduction. Consequently, the influence of exports on GDP would increase, but more importantly the structure of this category would change (a much needed diversification of exports would come about, which would secure sustainability of this category). As a first step, tax incentives were introduced this year to stimulate domestic production and improve the business environment (see Box 2), but time is required for the already implemented policy changes to manifest their effects. It is estimated that the recovery which started in 2015 (more so beginning from the second quarter of the year) will be observed among all components of GDP more or less proportionally, as all sectors of the economy were affected by last year's slowdown in economic activity. Nonetheless, any development with an impact on the economy in Kosovo initially reflects through consumption, considering the share of this category in GDP, therefore we may notice a more significant increase of consumption (amounting to 6,025 million euro in nominal terms) compared to the previous year. The year 2015 was characterized by changes to the tax system, the ultimate goal of which is to stimulate domestic production. The first half of the year was dedicated to changes (or establishment, where needed) of the legal basis in order to enable a more convenient and transparent application of the changes for all stakeholders - a key element for the success of the initiated changes. 8

13 Box 2. Main tax policy changes The primary objective of changes to tax policy is to ease the tax burden on the private sector in order to stimulate domestic production while maintaining macro-fiscal stability. To this end, the Government initiated a range of tax policy changes to support domestic production on one hand and boost private activity through infrastructure improvement, on the other hand. Among the major reforms that the Government initiated were measures aimed at easing the process of formalising local businesses. This measure supports the conclusion of the fiscalisation process of all businesses which will promote a more competitive environment for all businesses operating in the Republic of Kosovo through: - Removing barriers for fiscalisation of all businesses by amending the Administrative instruction no.15/2010 for fiscal cashiers with the aim of liberalising the market for these devices. This measure will create prerequisites for entry into the market of a greater number of providers of these devices, which will have an impact on reducing the cost of devices as well as maintenance of these devices for businesses - Together with the liberalisation of the market for fiscal devices, the Ministry of Finance designed additional measures to stimulate consumers to collect fiscal receipts and raise awareness about the importance of formalising the business. More specifically, the incentive measures for collecting fiscal receipts foresee that consumers who collect - envelopes with more than 30 receipts from 250 to 500 will be refunded with 10; - envelopes with more than 40 receipts from 501 to 800 will be refunded with 15; - envelopes with more than 50 receipts over 800 will be refunded the value of 20 Amendments to the Law on Value Added Tax as a legislative part reflecting greater fiscal reform in relation to other tax legislation, contains: - Reducing the threshold for VAT registration from 50,000 euro to 30,000 euro. This measure is expected to affect the involvement of a significant number of businesses which already operate with a turnover between these intervals, with the intent of creating a more competitive market in the country, expansion of the VAT chain and providing opportunities for these businesses to reimburse VAT on their inputs - VAT differentiation was done by setting a reduced rate for basic products at 8%, intended for a more equal distribution of incomes, given the high rate of unemployment and the fact that most of the population spends around 45% of their income on food (bread and bread products, cereals and products consisting of grains, dairy, oil, eggs, water supply, electricity and other utilities, etc.). It is important to note that a 0% VAT rate is held on agricultural products in order to strengthen the sector and increase the share of agricultural products in the domestic market. The standard VAT rate is increased from 16% to 18%. Among the most significant steps reflected in the Law on VAT beside VAT differentiation is the exemption of input, production lines and machinery from VAT. This measure is expected to 9

14 improve the liquidity of local manufacturing businesses, which is of particular importance considering the difficulties to access financing and the accompanying high costs of finance. The Information Technology sector is considered as sector with particularly high potential in Kosovo. Amendments to fiscal policies include custom duty and border VAT exemptions of IT equipment in order to provide incentives to this sector and other sectors which use it intensively. Despite budget constraints (the impact of these measures on budget revenue) and as a result of a Government Programme heavily focused on economic development, undertaking these measures is considered vital to unlocking the economic potential of the private sector. The impact of changes such as the lowering of VAT threshold, the differentiation of VAT, exemptions for inputs and machinery which go into the production line as well as for IT equipment, etc., are expected to become more apparent starting from 2016 onwards. When it comes to 2015, a slight increase in investments is observed (1,557 million euro in nominal terms) driven mainly by private investment, which may reflect increased confidence of economic agents compared to last year. Similarly, exports also increase moderately (amounting to 1,179 million euro in nominal terms) because, this category also requires time to fully reflect the impact of the tax changes in the business climate. This also comes as a result of the low base and the fact that Kosovo s exports continue to be dominated by one product (metals). Imports continue to be a component with a high share in the GDP, amounting to 2,962 million euro in The measures taken to stimulate domestic production are expected to initially induce import substitution, more so on consumption goods (mainly agricultural goods, with particular attention on dairy products). In this regard, the subsidies provided to farmers during the past years and continued by this government are considered to have an impact, which the tax changes undertaken during 2015 are intended to complement. With regard to prices, the beginning of 2015 was characterized by a slight increase in food and (non-alcoholic) beverage prices; which hold the largest share of consumption in the country. Graph 4. Price levels in Kosovo Graph 4 illustrates how closely CPI follows food prices in Kosovo, given that the significant fall in oil prices in the beginning of 2015 did not affect the overall price level in the country. Prices of food 10

15 and beverages fluctuated around an average of 1.1% during the first half of the year, but as the second half of the year goes through food prices are shown to average at -0.4%. Developments in the level of oil prices in the beginning of this year imposed a review of this indicator on authorities globally; in Kosovo significant fluctuations in the first months of the year (up to 10 percentage points from January to June) make this a highly interesting indicator to follow closely going towards Employment 5, productivity, and wages According to the latest Labour Force Survey conducted by the SAK 6, in 2014 the working age population in Kosovo stands at 1,202,489 people, with an almost equal gender distribution. However, the active labour force (between the ages of 15 and 64) stands at 500,521 people, of which 128,975 are female. Consequently, the labour force participation rate for women is much lower than that of men, with the rate for the total population standing at 41.6%. According to the LFS 2014 there were 323,508 employed people in Kosovo (a 26.9% employment rate), a decrease of around 4% compared to As concerns the structure of employment, the top four economic activities (which employ around half of the total number of the employed) are production, closely followed by trade, construction, and education. Comparing LFS data of 2014 to 2013, there has been a fall in total productive hours on a national level, mainly because of the (aforementioned) lower level of employment in 2014 compared to Given the level of GDP for 2014, this has translated into a 8.5% increase in labour productivity 7 in 2014 compared to the previous year. On the other hand, concerning cost competitiveness, the ratio of ULC 8 in 2014 has decreased by 4.6% compared to the previous year 9. It is interesting to note that the level of total labour compensation of the country in 2014 remains similar to that of 2013 despite the fall in total hours worked, which implies that the increase in average wage in 2014 has made up for the fall in employment, from a national-level point of view. Unlike employment and productivity which are based on official SAK data, the discussion on wages shall be centred around KPST (administrative) data given the availability and more importantly, its frequency. In this sense, there are differences between main indicators when compared between the two sources, which are largely a result of differences in recording (for example, the KPST cannot record the self-employed or the informal sector so there is significant under-estimation, whereas the LFS does not offer detailed data on the public and private sector separately, which is central to our analysis of wages). 5 In 2015, changes were made in the methodology of jobseeker recording within the Ministry for Labour and Social Welfare, under which all persons recorded in the system should check-in at least once every 6 months, otherwise they are registered under 'passive'. These changes result from the transition to a more modern data management system, and are made to reflect current legal definitions for the terms 'active' and 'passive' in employment. 6 The latest LFS, that of 2014 was published in June Measured here as nominal output produced per hour of work, on national level. Productivity and ULC are calculated according to OECD methodology 8 Measured here as total labour compensation per nominal output, on national level 9 ERP 2015 reports an increase in ULC for the same period but this is because administrative KPST data was used in the calculation, whereas this year SAK data is used 11

16 As can be seen from the graph, after three years (2011 to 2014) of average wages in the public and private sector having moved almost in parallel to each other, a divergence is visible beginning from Q as a result of the decision to increase public sector wages by 25%. Public wages maintained this level until Q2 of 2015, at which point a slight increase (of around 30 euro) is visible, attributable to the implementation of the collective agreement. The average wage for 2015 is estimated to be 450 euro; 530 euro being the average wage in the public sector and 406 euro in the private sector. Graph 5. Gross average (monthly) wages, in Euro Source: KPST data, Macroeconomic Unit analysis 2.2. MEDIUM-TERM MACROECONOMIC SCENARIO Real sector In recent years, Kosovo recorded an average GDP growth among the highest in the region. Considering that the growth has been mainly driven by remittances and public investments, the structure of the economy is characterized by high levels of consumption and investment in nonproductive sectors (mainly construction), which has somewhat predetermined the import structure. Subdued growth in the Euro zone is forecasted to gradually strengthen hence, providing positive signs for growth in emerging economies, in particular for those that have strong trading relations with the EU countries. Major economic indicators which are well above the last year s levels, suggest that Kosovo s economy is gaining momentum, underpinned by improved crediting and enhanced investor confidence and strengthening of the Eurozone economy. While the pickup in investments is expected to support growth in the medium term, the economy will also benefit from slightly higher consumption and exports. The recent tax policy initiatives and the measures for improving access to finance (reform measures #10, #11 and #12) are expected to help address the existing problem of high cost of finance and hence, help boost domestic production. Consequently, based on the assumptions of the baseline scenario, the economic growth for the is expected to strengthen at an average 4.2%. 12

17 Overall consumption, which accounts for more than 80% of the disposable income, is expected to grow by an average real rate of 3.3%, thus contributing by 3.4 percentage points to the real GDP growth during While remittances and real growth of public sector wages 10 will continue to fuel the overall consumption, private consumption is also expected to benefit from the expected increase in consumer loans. Thus, the contribution of private consumption to the real GDP growth is expected to reach 4.0%, on average over the forecast horizon. On the other hand, the restrained growth of government spending is expected to somewhat repress the real growth of overall consumption. Indeed, the real government consumption is planned to fall by 0.6%, on average. Consequently, real consumption per capita is expected to grow by an average of 2.6% over the projected period, under the assumption that the population grows by 1.6% per year. During 2015 the government, in agreement with the IMF, introduced an investment clause which consents additional spending for growth-enhancing projects financed by IFIs. In addition, to steer the economy into more sustainable growth, the Government as part of the initiated fiscal reforms, exempted inputs and lines of production from the border VAT. Alongside these initiatives, the Government continued to carry forward the doing business reforms. Over the medium term, these initiatives are expected to support the private investment through improved business environment and better infrastructure (reform measures #2, #3 and #4). Consequently, starting from 2016, real investments are expected to increase by 8.9% on average, hence contributing by 2.5 p.p. to the GDP growth. While the effects of these measures on growth are expected to come as a direct injection into the economy in the medium term, they can only help achieve higher sustainable economic growth in a long run. The negative trade balance remains a challenge for Kosovo s economy. The high trade deficit is largely predetermined by the narrow export base and concentrated exports which largely determines the sustainability of the economic growth. On the other hand, the large representation of imports by consumption goods reflects the low production base as well as low competitiveness to produce substitutes of imports. Exports of goods will continue to be predetermined by the fluctuation in international metal prices and global demand for metals. Exports of goods are expected to grow at an average real rate of 6.1%, marking a slowdown in 2016 to reflect the subdued growth in China and hence the impact on the global demand for metals. The supportive investment environment, however, is expected to help increase the diversification of exports, hence enhancing sustainable export growth in the later years. Likewise, for the forecasted period, exports of services are expected to record an average real growth of 4.5% dominated by the export of travel services. Thus, total exports are projected to increase by 4.9% on average, more so after Given that international food prices are expected to decline further over the medium term, increasing of wages and pensions by 25% of 2014 has increased the level of real wages for civil servants. 13

18 Graph 6: Contribution to real GDP growth Source: Macro Unit forecasts Reflecting the projection for the growth of investment, exports of goods and consumption, imports of goods are projected to grow by an average of 5.1%. On the other hand, imports of services are dominated by transport and travelling. The trend of imports of transport services is largely affected by movements in the goods imports while the beginning of the highway 6 construction is expected to determine the rate of growth of import of construction services. Consequently, the import of services is foreseen to follow the average real growth of 5.7%. On the production side, the services sector remains the largest contributor to the economic growth, representing more than half of the GDP. Similar to its historical trends, services are projected to continue with increasing trend, marking on average 3.9% growth during the forecast horizon. While trade is expected to drive this sector during the forecast period, services are also expected to benefit from the transportation, IT and housing services. The second largest sector, the industry sector, is expected to recover gradually from the flagging growth in the manufacture sector last year. Although there is large potential to develop labor intensive manufacturing in Kosovo, this sector remains relatively small mainly because it has been hindered by a shortage of (costly) skilled labor, unreliable energy supply and the high cost of finance. However, over the forecast period, the growth of this sector is expected to mark 5.6% on average, reflecting the effect of the implementation of tax initiatives supportive to production sector and the reform measures aimed at improving labour supply (#17 to #20), energy supply (# 3 and #4) and access to finance (# 10 to #12). Construction is an important driver of growth although its growth reduced in recent years reflecting the completion of the construction of highway Merdare - Morine and the introduction of rather restrictive criteria for obtaining the construction permits by the municipality of Prishtina. The sector however, is projected to pick up speed through 2016 and onwards, supported by the continued housing investment and road/ highway infrastructure investment (reform measure #2). The agricultural sector comprises small share of GDP and it is projected to stage a faster resurgence underpinned by continuous government subsidies provided to this sector and measures to improve 14

19 the sector s competitiveness. Hence, during , agriculture is projected to increase by 2.6%, on average. Graph 7. Sectorial contributions to GDP growth in percentage points Source: SAK and DEPP/Macroeconomics Unit calculations Monetary and exchange rate policy and inflation Kosovo adopted euro unilaterally at the time it was launched and since then it uses it as its de facto currency. Consequently, the country does not have monetary policy instruments which it could use to address the weak trends in competitiveness and/or control inflation. Hence, movement of the overall price level in Kosovo is largely predetermined by the fluctuations in international commodity prices. Nevertheless, this correlation is rather stronger in times of upward inflationary pressures compared to the deflationary ones 11. Consequently, although IMF in their WEO report foresees a significant plunge in world food and oil prices, the price levels in Kosovo are expected to stabilize at an annual average of 0.4% over External sector and its medium-term sustainability During 2014, the current account deficit marked 7.9% of GDP and based on mid-year actual data and forecasted values thereafter, current account deficit is expected to improve slightly to 7.1% in In regard to the upcoming period, a deterioration of the current account balance is expected (averaging at 9%) driven to a large extent by the public infrastructure projects and repatriation of profits, thus mitigating the positive effect of gradually increasing exports. During the forecasted period, imports are expected to grow at an average of 5.2%, where the import of goods is expected to grow at 5.1% and that of services by 5.7%. Moreover, the structure of imported goods is expected to remain the same, the largest share of which is to remain mineral products, as well as prepared 11 See Annex 2 on the determinants of price levels in Kosovo. 15

20 foodstuffs, beverages and tobacco. Overall exports are expected to grow at an average rate of 4.9%, where the export of services is expected to grow at an average rate of 4.5% and that of goods by 6.1%. Hence, the trade balance for 2018 is expected to amount to around -35.8% of GDP. During the forecasted period, the positive balance in the trade of services is expected to continue, averaging at 5.1% of GDP. The main contributor to the export of services is the travel category. As can be seen from the table below, historically base metals has been the product with the largest share in the overall export of goods, however there are signs of gradual diversification of exports, albeit at a slow rate. The main contributors to this diversification are agricultural products (initially through import substitution) and to a lesser extent, textile products. Moreover, mineral products maintain their share as the second-largest export category, whereas the export of plastic and rubber goods is increasing steadily. Considering the current structure as well as the latest policy changes undertaken with the aim to stimulate domestic production, exports are expected to continue the trend of diversification, mainly in favour of agricultural and textile products, which hold the potential to be the categories that can contribute most towards a decline in the trade deficit. Export performance will be further supported in the medium-term by reform measures for improving the export base in agriculture (#5 and #6), industry (#7 and #16) and high value-added sectors (#8 and #15). Table 1. The share of exported goods to total exports Description Base metals and articles from base metal 49.0% 51.6% 49.7% Mineral products 16.5% 13.8% 12.1% Vegetable products 5.2% 5.7% 4.6% Plastic, rubber and articles thereof 6.2% 5.0% 7.1% Other 23.1% 23.9% 26.4% Source: Calculations based on SAK, External Trade Statistics Table 2 below represent the countries/country groups which (in each year) make up more than 90% of Kosovo s total exports. It seems that export has shifted from Italy and China to India which now receives more than 14% of total exports. Exports to Italy and China have fallen by 60% and 99% respectively between 2014 and 2015, export to which countries (put together) made up around 28% of total exports in Exports to EU and CEFTA countries on the other hand, remain at similar levels between 2014 and 2015, which leads one to believe that this switch in the export structure comes as a result of the change of the destination of metals. 16

21 Table 2. Geographical composition of exports, in 000 euro (data available until November) EU 118,422 98, ,385 of which Italy 74,363 49,660 19,391 CEFTA 104, , ,424 Switzerland 7,155 10,038 10,705 Turkey 7,393 10,365 8,207 Japan ,670 China 1,290 42, India 28,953 27,425 43,171 Total exports (in Euro) 293, , ,733 With regard to trade openness 12, Kosovo is a small, open economy and enjoys a liberal trade regime. As can be seen from the graph below, Kosovo does not hold a favourable position in this regard compared to neighbouring countries. A common note made on this index is that it should be viewed with caution since a low ratio does not necessarily imply high (tariff or non-tariff) barriers to foreign trade, but may be due to factors such as size of the economy and geographic remoteness from potential trading partners. Whilst these reasons are not particular to Kosovo s case (on the issue of size one can argue that the Kosovo and Montenegro are of similar size, whereas the difference to Montenegro s trade openness level is considerable), low levels of trade openness compared to the region have persisted throughout the years. Given the current standing, one is led to believe that Kosovo may have suffered from political challenges in regard to trade openness. As presented in graph 3, imports already represent a large share of the GDP, so the trade openness index is considered to suffer under the strain of a low export base. Utilizing free trade agreements (for example CEFTA, to which Kosovo is a signatory since 2007 as well as a number of other upcoming similar agreements) to their full potential is a challenge which the Government has been tackling through various channels, given that it requires establishing a reliant domestic production basis as well as creating and maintaining stable reciprocal political relations with trading partners (i.e. dependent on their political agendas in the context of the region). As discussed throughout this document, the Government is committed to implementing changes aimed at spurring domestic production which would contribute towards import substitution in the attempt to lay a basis for increasing exports in the medium-term. This, coupled with further institutional trade integration (expected from 2016 and onwards); such as the SAA with the EU and the free trade agreement with Turkey are seen as an opportunity for Kosovo to expand its market and improve in terms of trade openness in the future. 12 The trade-to-gdp ratio is calculated as the simple average (i.e. the mean) of total trade (i.e. the sum of exports and imports of goods and services) relative to GDP, and is interpreted as the higher the index, the more influence trade has in that country's domestic activity 17

22 Graph 8. Trade Openness Index, comparison to the region and Euro area Source: SAK and World Bank data The income account is expected to maintain a positive balance, to which the compensation of employees 13 is the largest contributor. During 2015, the income from compensation of employees dropped by some 19.5% compared to 2014 (amounting to 1.6% of GDP mainly driven by the 50% increase in the repatriation of profits from the FDI) and during the forecasted period the average growth rate is expected to amount to 0.2%. On the other hand, remittances, representing the largest category within the secondary income account, are increasingly contributing to the narrowing of the current account deficit. After a slowdown during the global financial crisis and the debt crisis in European countries, remittances increased significantly. In 2015 the annual increase in remittances (according to CBK data) marked 15%. However, as the general economic environment in the country gradually improves, growth rates of remittances are expected to moderate. Hence, in the years to follow, remittances are expected to grow by an annual average rate of 7.9%, however, still maintaining their share to GDP at an average of 14%. After a relatively stable real effective exchange rate (REER) 14 during (averaging around 0.1% y-o-y), a depreciation of 1.9% is registered by November The volume of FDI in 2014 decreased significantly, in large part due to the sale of shares of some foreign companies operating in Kosovo to residents and the distribution of the superdividend 15 of selected foreign companies operating in Kosovo. However, during 2015 direct investment has increased significantly and going towards the end of the year is expected to amount to 5.9% of GDP. 13 Revenues from the income of Kosovo employees abroad 14 REER is provided by the CBK (available until November 2015) 15 Superdividend implies the dividend which is higher than the profit of the company for the respective period. The distribution of the superdividend impacts the reduction of foreign share capital, which represents a reduction of FDI 18

23 As can be seen from the graph below, during the forecasted period 16, the average growth rate of FDI is expected to accelerate, mainly as a result of improved external conditions following the global financial and debt crisis as well as improved domestic conditions. Graph 9. Foreign Direct Investment, in million euro Source: CBK data and Macroeconomic Unit forecasts Graph 10. Structure of FDI by sectors in 2015 During 2015, real estate remains the largest absorber of foreign financing (more than 50% of total FDI in 2015) driven mainly by the investment of the diaspora in housing, followed by construction and financial intermediation. This structure of FDI is largely similar to previous years, with the exception of a slight fall in FDI towards the transport and telecommunications sector, most likely a result of higher investment of telecommunication providers during their years of establishment. It is important to note that a comparison to 2014 is not relevant given the political situation that followed the elections in June 2014, which brought about uncertainties among economic agents which in turn reflected on FDI resulting in a considerable fall in volume (151.2 million euro by end-year). In 2015 however FDI picked up, reaching million euro until October 2015, similar to 2013 levels (250.2 million euro by end-year). Looking towards the future, the structure of FDI is expected to gradually shift away from real estate due to the achievement of its growth potential and improvement of conditions and prospects in other sectors. In the long run, the expectation is that manufacturing and agriculture are to be the main players in 16 The forecasted value of FDI presented does not take into account the initiation of the new power plant given that the modalities of the implementation of this project were not know at the time in which the Budget for 2016 was prepared (the latest update of forecasts) 19

24 FDI absorption. From a medium term perspective, FDI in energy is expected to increase significantly as a result of the construction of the new power plant ( Kosova e Re ), which is scheduled to start by the end of 2016 (albeit not with significant financial impact in its initial year; see reform measure #3). From 2017 until 2021 (by which year the project is planned to be finalized), the energy sector is expected to be the leading sector in FDI absorption. With regard to the international investment position (IIP), net balance has been positive. Regarding assets, investments of the Central Bank, deposit-taking corporations and other investments represent the largest share, followed by portfolio investments (more specifically equity and investment fund representing around 24% of total assets). On the other hand, direct investments continue to be the largest category within liabilities amounting to around 74% of total liabilities by the end of second quarter of From an institutional sector point of view, it is observed that IIP is largely defined by the CBK and commercial banks investments abroad on the asset side, and the government external debt and other sectors debt on the liability side. Graph 11. International Investment Position (IIP) end-of-period, in millions of euro Source: Central Bank of Kosovo Financial sector Kosovo s financial system continued its positive growth trend during the first nine months of Total assets 17 of the financial system marked an annual growth of 7.1%, standing at 4.8 billion (83.1% of GDP) 18 as of September Banks represent 69.6% of the total assets of the financial system, followed by Pension Funds (24.4%), Insurance Companies (3.3%) and Microfinance Institutions (2.5%). Foreign-owned banks assets represented 90.0% of total banking sector assets by October The degree of market concentration, measured by the market share of the three largest banks (assets), decreased slightly. In October 2015, the three largest banks ratio stood at 64.4% 17 Excluding assets of Financial Auxiliaries and of the Central Bank of the Republic of Kosovo 18 Forecasted GDP for 2015 here; Central Bank of the Republic of Kosovo. 20

25 compared to 67.4% in October In addition, the degree of market concentration measured by Herfindahl - Hirschman Index (HHI) dropped to 1,757 points in October 2015, compared to 1,846 points in October Graph 12. Development trend of the financial system and the financial sectors assets Source: Central Bank of Kosovo (2015) In the last two years credit growth had accelerated, most notably during In October 2015, total loans reached 2.0 billion euros, marking the highest annual growth of 8.2% (3.1% in October 2014), in the last four years. Loans to enterprises grew annually by 5.9% and continued to dominate the loan portfolio with a share of 65.7% in October 2015 (67.1% in October 2014), whereas household loans marked an annual growth of 13.1% and represented 34.0% of total loans (32.5% in October 2014). Compared to previous year, financial service and real estate sector had the highest growth rate (68.5%) compared to a decline by 18.4% in October The manufacturing sector during this period, grew by 16.7% compared to 14.2% in the previous year. Agriculture registered a growth rate of 11.8% compared to a growth rate of 2.9% in October The trade sector, which represents the largest share of enterprise loans, grew by 4.3% compared to 3.0% in October

26 Graph 13. The structure of deposits and annual growth, in % % % % 16.0% 14.0% 12.0% , , , , , % 6.8% 5.8% 4.8% October 2011 October 2012 October 2013 October 2014 October % 8.0% 6.0% 4.0% 2.0% 0.0% Source: CBK (2015) Other Households Enterprises Annual Growth of Deposits The noticeable expansion of the lending activity until October of 2015 was mainly driven by the supply side. According to the Bank Lending Survey, conducted in August 2015 by the CBK, commercial banks have declared that they have eased somewhat the lending standards to enterprises and households, by lowering interest rates, expanding credit amounts and offering loans with longer maturities. Banks have also declared an increase in the demand for loans by enterprises and an increase in demand for consumption and mortgage loans by households. In the survey, banks declared that in the next six months credit standards and conditions will remain unchanged while they expect that the demand for loans will increase, noticeably for enterprises. The banking activity in Kosovo continues to be financed mainly by domestically collected deposits, which have shown to be a sustainable source of financing. In October 2015, deposits reached the value of 2.6 billion euros, representing an annual increase of 4.8%, the lowest annual growth of deposits until now. The increase of total deposits is mainly attributed to household deposits, which represent 73.1% of overall deposits in the banking sector. Graph 14. Structure of loans and annual growth, in percentage 2, % 2, , % % 16.0% 14.0% 12.0% 10.0% 1, % 8.0% 6.0% % 2.9% 3.1% 1, , , , ,317.6 October 2011 October 2012 October 2013 October 2014 October 2015 Other Households Enterprises Annual Growth of Gross Loans 4.0% 2.0% 0.0% Source: CBK (2015) 22

27 Financial intermediation in Kosovo in October 2015 has been characterised by declining interest rates on loans, whereas interest rates on deposits were characterized with a slight increase. The interest rate on loans decreased to 8.2% in October 2015 from 10.4% in October 2014, whereas the interest rate on deposits increased slightly from last year but compared to October 2013 decreased significantly. In October 2015 the interest rate on deposits stood at 0.9% from 0.8% in October 2014 (whereas in October 2013 was 3.5%). Therefore, because of the more pronounced decrease of interest rates on loans, the interest rate spread between loans and deposits decreased to 7.3 percentage points, compared to 9.6 p.p. in October Table 3. Financial Soundness Indicators Banking system Capital adequacy (%) Asset quality (%) Profitability (%) Liquidity (%) Core set October 2012 October 2013 October 2014 October 2015 Regulatory capital to risk-weighted assets Regulatory Tier I capital to riskweighted assets Nonperforming loans to total gross loans Return on assets (ROAA)* Return on equity (ROAE)* Interest margin to gross income Noninterest expenses to gross income Liquid assets (broad) to total assets Liquid assets (broad) to short-term liabilities * Net income before tax is considered. ** ROAA and ROAE are annualized Guide: Financial Soundness Indicators, Compilation Guide, IMF (2006) The profitability position of the banking sector increased significantly during 2015, reaching its historically highest levels. Until October 2015, profit increased by 26.0 million euros in annual terms, reaching 75.6 million euros from 49.6 million euros, where it stood in October The increase of profit during this period primarily reflects the decrease of banking sector expenditure on loan-loss provisions and interest payments, the latter mainly because of the decreased interest rates on deposits. The risks to the banking sector in Kosovo remain low. The liquidity position of the banking sector in 2015 is at satisfactory levels. The liquid assets to total assets ratio stood at 29.7% in October 2015, while liquid assets to short-term liabilities stood at 37.6%. As of October 2015, the loan to deposit ratio increased to 76.1% compared to 73.7% in October Liquidity stress-testing results for year 2015 show that the banking sector in Kosovo is resilient to adverse simulated liquidity shocks as a result of record profit growth. Credit risk exposure of the banking sector has recorded a decline in 2015 after three years of progressed growth. Non-performing loans in October 2015 stood at 6.8% from 8.7% in October 2014, which represents a decreasing trend compared to an increase of NPLs in 2014 (from 8.5% in October 2013). In addition, non-performing loans remain well-covered by loan-loss provisions. In 23

28 October 2015, NPL coverage with provisions stood at 115.5% compared to 113.2% in October Furthermore, the banking sector remains well-capitalized with a capital adequacy ratio of 18.6%, which is well above the minimum regulatory requirement of 12%. Credit risk stress testing results for 2015 suggest that the sector is capable to withstand severe shocks to its credit portfolio, along with simulated interest rate and exchange rate shocks. Based on the classification of loans by industry, as of September 2015, there is an improvement in the quality of loan portfolio in most sectors. Excluding the energy sector and financial services sector, which had an increase in NPL ratio, all other sectors where characterized with an improvement of the NPL ratio. The real estate sector experienced the highest improvement in the NPL ratio (from 12.6% in September 2014 to 7.7% in September 2015), followed by other services (tourism, hotels and restaurants) and trade, where the NPL ratio decreased from 9.7% to 7.5% respectively and from 11.7% to 9.5%. The manufacturing sector also showed an improvement of NPL ratio (decreased from 13.5% to 11.4%), followed by the agriculture sector (decreased from 8.7% to 6.6%). The sector with the highest NPL ratio was energy (20.4%), while the lowest levels were recorded in the communication sector (1.2%) and financial services sector (2.0%). The NPL ratio in the household sector loans remained low and improved compared to previous years (2.7% in September 2015 compared to 2.9% in September 2014) ALTERNATIVE SCENARIOS AND RISKS The baseline macroeconomic scenario that underpins the medium term budget projections - and the outlook presented on this update of the ERP - results from a careful consideration of both downside and upside risk factors associated with economic developments expected in the medium term. In line with the principles of prudent policymaking, many high-impact development projects - planned to commence implementation between 2016 and are excluded from the baseline scenario assumptions. On the other hand, only non-imminent downside risks, which originate from long standing structural constraints that define Kosovo s growth model (unstable electricity supply, low export competitiveness, reliance on high inflow of remittances), are excluded from the baseline scenario. The Government has duly acknowledged these risks in its Medium Term Expenditure Framework , and has taken necessary action, such as optimizing expenditure and maintaining adequate cash buffers, to safeguard a stable macro-fiscal environment and selecting NDS and ERP priorities that reduce key obstacles to economic growth. In the remainder of this section both upside and downside risks are examined, and then two alternative scenarios are presented - a high-growth scenario and a low-growth scenario - based on a selection of both types of risk factors. The high growth alternative scenario assumes the commencement of the implementation of a select number of high development impact projects. The low growth scenario assumes a combination of an external shock of reduced export demand and a domestic shock in energy supply that is accompanied with a shift in the composition of budget expenditure and an increase of imports. Graph 15 below summarizes projected real GDP growth for both alternative scenarios in comparison to the baseline. 24

29 Graph 15. Alternative Scenarios, real GDP growth Upside risks - Growth expectations relative to the baseline are amplified by the expected implementation of many investment projects in energy supply, tourism, transport infrastructure, water and waste treatment, irrigation, and other infrastructure projects. While the long term impact of these projects- through the removal of obstacles for private sector development takes precedence over the medium term effects, the initial implementation phase of these projects provides a positive shock to domestic absorption, thus giving a boost to growth and employment in the medium term as well. In addition, the Kosovo Parliament has recently amended LPFMA allowing the Government to surpass the legal deficit limitations in order to address more public investment needs by utilizing favourable IFI financing. This provides additional grounds for higher public investment relative to baseline medium term assumptions. The following is a list of projects expected to commence implementation in the medium term, which represent upside risks to the baseline scenario: Development of New Energy Production Capacities (reform measure #3): the Government has announced the winning private bidder for the construction and operation of new energy production capacities. With an estimated total investment of Eur. 1,000 million over 5 years, the construction of new generation capacities is expected to start in late 2016 or early In addition to new generation capacities, investment on the update of the transmission system is expected to accelerate beyond baseline scenario assumptions. Development of the Brezovica Tourist Resort: the Government has announced the winning private bidder for the development of the resort. The total investment associated with the project is Eur

30 million in the medium term (Eur. 400 million over the entire project), and investment is expected to commence in mid Additional Public Infrastructure Investment: in the medium term, investment the rehabilitation of the railway infrastructure (with a total investment of more than Eur. 160 million), as well as different segments of the road infrastructure, is expected to commence on top of baseline scenario investment assumptions. In addition, in line with the recent amendment of the LPFMA, the Government is expected to increase investment on water, waste management, and irrigation projects. Downside risks - Kosovo s structural constraints expose its economy to both external and domestic shocks. The two main external downside risks to the baseline scenario are: Dependence on Remittances/ Reduced Remittance Growth: Kosovo still receives a sizable inflow of migrants remittances, which mostly affects household consumption. A macroeconomic shock on the two main economies that employ the Kosovo s diaspora - Germany and Switzerland - can be transferred to Kosovo s economy through a reduction in the level of remittances, and thus a reduction in domestic consumption. Nevertheless, such a shock is unlikely, as the experience with the 2008 financial crisis has shown that such shocks have little to no effect on remittance flows to Kosovo. This is most likely due to the employment characteristics of the Kosovo migrants, namely their employment in low to medium skilled sectors which are not prone to direct business cycle effects. Another contributing factor to this relationship may be the use of migrants savings to smoothen out the flow of remittances sent to recipient households in Kosovo. Low export diversification/ Reduced Export Growth: Kosovo s economy is characterized with a low export base which constraints growth, but at the same time limits the effect of international shocks. Nevertheless, low diversification of exports exposes the domestic economy to the volatility of international metals prices (the main good exported from Kosovo), as well as from changes to the world demand for metals. Based on 2014 trade data, exports classified in two sections of the Harmonized System of the World Customs Organization, namely Base Metals and Articles of Base Metals and Mineral Products, constitute 72% of the volume of regular exports from Kosovo (65.7% of the value of regular exports). Moreover, over 40% of the value of goods is exported by three companies whose primary activity is the export of either raw metal commodities or mineral products. On the other hand, China - as one of the main consumers of commodity products - is always among the top ten destinations of Kosovo exports. The main domestic downside risk to the baseline scenario is: Fragile Domestic Energy Production Capacity/ Reduced Domestic Energy Production The baseline scenario assumes the current structure of domestic energy production will be maintained in the medium term. This implies there will be no need for additional Government subsidies for the 26

31 energy sector, and that the ratio between imported energy vs. domestically produced energy will remain in line with historical trends. Nevertheless, Kosovo s energy production capacities are depreciated and prone to malfunctions which may ultimately lead to financing needs for the energy sector and energy import patterns different from the assumptions of the baseline scenario. Alternative Scenarios - based on the qualitative examination of the upside risks and the downside risks to the baseline scenario, two alternative scenarios are presented in this section. High Growth Scenario Assumptions: incorporate into the baseline scenario a number of projects presented as upside risk factors above. The projects selected are those for which implementation preparations are finalized or are under finalization. The following are the assumptions on the implementation dynamics: Table 4. Additional Investment Projects Description Est. total Additional Investment (Eur. millions) % of total additional investment New Kosova Power Plant Project 0% 45% 59% Transmission Rehabilitation Project 1% 3% 2% Brezovica Tourist Resort Development 76% 26% 19% Railway Rehabilitation Project 17% 19% 18% Access Roads Project 5% 8% 3% All other estimated macroeconomic parameters are maintained as in the baseline scenario. Low Growth Scenario Assumptions: incorporate two risk factors: the external downside risk of reduced exports and the domestic downside risk of reduced energy production. The risk of reduced remittances is not addressed in this scenario as a shock of a proportion that would ultimately affect the inflow of remittances in Kosovo is not judged to be probable in the medium term. Thus, the key assumptions of the low growth scenario are: A 20% drop in the exports of goods throughout the medium term this is a reasonable assumption if the decline of metals prices is to be sustained and accelerated, and if the Chinese economy, as one of the main importers of metals, continues to slow down. In face of such events, Kosovo s metal exports which constitute almost ½ of total goods exports are likely to drop because of narrowing profit margins (due to falling prices) and because of lower export demand. A drop in energy production that forces the government to shift 20% of assumed baseline capital spending to subsidy spending, and increases imports relative to the baseline this assumption foresees that a malfunction constrains domestic energy production, and the Government intervenes to provide subsidies in order to maintain stable energy prices and energy consumption in face of higher energy import requirements. 27

32 Table 5. Alternative macro-fiscal scenarios *(L) Low growth scenario; (B) Baseline scenario; (H) High growth scenario Description (L)* (B) (H) (L) (B) (H) (L) (B) (H) Real growth rates (%) GDP GDP per capita Consumption Investment Exports Imports Price changes (%) CPI (annual monthly average) GDP deflator Import prices Savings/investment balances (% GDP) Net primary income from abroad Net secondary income from abroad of which: remittances Investment Current account balance Trade balance Memorandum items: (% GDP) Domestic demand (cons.+invest.) of which: Government demand Private consumption Private Investment Exports Imports High Growth Scenario Projections show that the implementation of the assumed additional investment projects increases average medium-term real GDP growth from 4.2% to 5.4%. While average ( ) baseline investment growth is projected at 8.9%, the same is projected to accelerate to 16% in the high growth scenario. In addition to the direct effect of increased investment, the implementation of the assumed projects also leads to higher disposable income, thus accelerating consumption growth from a medium term average of 3.3% (in the baseline scenario) to an average of 5% (in the high growth scenario). The assumptions on price movements in the baseline scenario and the high growth scenario are the same. The rationale for this judgement is that in face of high unemployment an increase in the level of investment, reflected in higher labour demand, cannot exert inflationary pressure on wages. At the same time, Kosovo s economy is characterized by a significant import share in the economy. Thus, a demand shock sparked by higher disposable income as a result of higher investment cannot produce inflationary pressure as imports are highly and quickly scalable. Due to the capital-intensive nature of the additional investment projects assumed, the High Growth Scenario does not assume an improvement of the trade balance relative to the baseline. While a significant improvement of the trade balance is one the long term objectives of these projects, their 28

33 implementation in the medium term will maintain and even deepen the projected trade deficit, and consequently the projected current account deficit. Low Growth Scenario Projections show that a combination of a negative shock to exports and energy production reduces expected medium term growth from a baseline average of 4.2% to an average of 2%. The incorporation of the assumptions of the low growth scenario, presented above, as part of the baseline budget scenario assumptions, reduces both consumption and investment growth almost to a half of the projected baseline trend. A negative exports shock leads to lower value added - and lower income -in the exports sector, adversely affecting overall private disposable income, and subsequently leading to both lower exports and consumption growth. On the other hand, a negative shock on energy production widens the gap between energy consumption and production. To close this gap, either energy prices need to reflect the additional cost of imported energy relative to domestically produced energy or such a difference in prices needs to be absorbed through public spending. The low growth scenario assumes the latter. Since fiscal space for public spending is constrained by the fiscal rule, an increase in subsidy spending can only be covered at the expense of the baseline investment spending projections. Thus, in addition to the effect of lower exports, lower energy production reduces investment, leads to further slowdown of consumption growth (due to lower disposable income), and further deteriorates the trade balance. While the baseline scenario results with an average medium term trade deficit of 37% of GDP, the low growth scenario estimates show a deterioration of the trade balance to an average of 39% (with a peak of 40% of GDP in 2018). Price fluctuations are assumed to be the same as the baseline scenario projections. 3. FISCAL FRAMEWORK 3.1. POLICY STRATEGY AND MEDIUM-TERM OBJECTIVES In the absence of monetary policy instruments available to boost private investment, fiscal policy remains the only means available to the Government of the Republic of Kosovo. Sound and prudent fiscal policy is, therefore, crucial for the maintenance of macroeconomic stability. The government program is a key document which determines the orientation and development of government policies and which provides the basis for setting policy priorities in the strategic planning documents. Government Program is a document of a political nature and involves plans and commitments of the Government in the medium term. The Government continues to have as its principal objective of fiscal policy the maintenance of the sustainable fiscal position and responsible public financial management, also being one of the 29

34 recommendations arising from the last Progress Report and ERP To preserve this commitment, the Government adopted the fiscal rule, which limits the overall deficit level to 2% of GDP. The aim of the adoption of such a mechanism has been to stabilize public debt level below the threshold set by law (40% of GDP). Considering the relationship that Kosovo has with the IMF as one of the main partners in terms of designing the macro-fiscal framework, Kosovo has considerably limited the space within which it can accommodate policies set forth in the government program. Earlier this year, the government has negotiated a 22-month IMF SBA program. Considering that Kosovo is not characterized by any considerable fiscal and balance of payments risks and has no monetary policy, this program has a particular focus on boosting the sustainable economic growth of the country. In October 2015, the Government approved the 2016 budget. The budget foresees an overall deficit of 1.6% of GDP, arrived at by reducing the current spending relative to the 2015 budget and preserving the capital spending at the 2015 budget levels. To this end, the Government has also introduced a rules-based mechanism which will anchor the growth of public sector wages to nominal GDP growth with the aim to better align the growth of public sector wages to the productivity. Considering the existing high structural bottlenecks facing the economy, the government has amended the LPFMA to adopt the investment clause which allows spending for large growthenhancing projects financed by IFIs. In this line, the government is committed to implement the structural reform agenda set forth in the government program. With the aim of increasing efficiency and transparency, the government in its reform agenda also envisages the implementation of the centralised procurement as well as the e-procurement (reform measure #1). To this end, during 2015 the list of six products that will be subject to the centralised procurement for all central level budget organisations has been approved by the government. Furthermore, the Government intends to gradually continue to further expand the list of goods and services that will be eligible for centralised procurement as well as cover all budgetary organisations, including municipalities and agencies. With regards to the e-procurement, the government drafted the legislation (which has been approved by the parliament) which makes the use of e-procurement mandatory for all central level budget organisations. The Government Programme has envisaged the establishment of a common revenue agency (reform measure #14); in response to a number of issues which have been raised regarding the Tax Administration of Kosovo as well as the Kosovo Customs. An integrated revenue agency is expected increase efficiency in tax collection, as well as increase the independence of such structures and contribute to the ongoing process of adapting to EU legislation and practices. Furthermore, during 2015, the government implemented tax policy changes as laid out in the Government program. In this context, the Government introduced a reduced rate VAT at 8% for a number of basic products, and increased the standard rate of VAT to 18%. In addition, to further promote the competition in the domestic market and reduce the tax evasion, the amendments were made to the VAT law to lower the threshold from euros to Aiming at indirectly reducing the need for finance and hence improving the liquidity of the domestic producers, lines of production and 30

35 inputs for producers were exempted from VAT at the border. Similarly, IT equipment is exempt from the VAT at the border whereas reduced rate VAT is introduced for pharmaceutical products 19. At the same time these goods were exempt from the customs tax, a measure that regulated the competition in this market (see box 2 for details on tax policy changes) BUDGET IMPLEMENTATION IN 2015 The new government was established in mid-december 2014, at the time when the 2015 budget was already approved by the Government. In order to continue with the daily operations of the government, the same budget, with only few changes, was sent to the newly established parliament and it has been approved as such. As it was also indicated in the ERP recommendations, the budget framework was based on the over-optimistic projection of revenues and as such needed significant adjustments. To this end, the Government reviewed the original budget and introduced cuts amounting to 53 million euros in the expenditure side while at the same time increasing the excise rate for some goods that were subject to this tax. Table 6. General Government revenues and expenditures, in million euro Description Revised Budget 2015 Execution 2016 Budget Total Revenue 1,333 1,524 1,452 1,590 Total Expenditure 1,463 1,635 1,552 1,671 Current 1,051 1,177 1,149 1,211 Capital Expenditure Primary balance Interest payments Overall balance (as per fiscal rule) Overall Balance GDP 5,581 5,705 5,705 5,958 Overall deficit as % of GDP -2.2% -2.1% -2.0% -1.6% Source: Treasury, Budget 2015 and DEPP/Macroeconomics Unit calculations Therefore, in this section the analysis on the execution of the budget is compared to the reviewed 2015 budget numbers (see table 6). The 2015 budget execution presented in this section is based on preliminary financial reports and might be subject to small changes. 19 Previously, pharmaceuticals were exempt from VAT and at the same time were subject to the customs tax. This promoted an unfair competition in favor of goods origination from countries with which Kosovo had free trade agreement. 31

36 a) Revenue performance during 2015 The performance of the key macroeconomic indicators for this period provide signs for the positive performance of the economic activity, in general. Improved economic performance was, to some extent, also reflected in the level of revenue collection although, tax changes made during the year contributed largely to revenues. By the end of the year, total budget revenues amounted to 1,452 million euros or 9.9% higher compared to the previous year s level. This increase was mainly driven by rapid increase in tax revenues although the growth was somewhat repressed by the poor performance of the non-tax and one off revenue categories. Tax revenues collected domestically registered an annual growth of 9.4% mainly resulting from the higher turnover declared by the ten largest companies 20. On the other hand, following the considerable increase in the quantity of imports which more than compensated the deflationary pressures on the value of imports stemming from falling international commodity prices, customs tax revenues increased by 9.1% and totalled at million euros by the end of The changes in excise rates 21 throughout 2015 combined with the VAT differentiation, contributed considerably to the increase in border tax revenues. With regard to the non-tax revenues, central level own source revenue (OSR) collection performed as it was foreseen in the budget, whereas local level own source revenues remained at 52.1 million euros which amounts to 70.2% of the forecast amount. The reason behind the lagging collection of local level OSR is the postponement of the property tax payments resulting from the early announcement and the delayed implementation of the law on debt amnesty. As it was foreseen with the reviewed budget, the Government collected 14.8 million euros for the 3G/4G license, whereas to allow for more investments to be made in the publicly owned post telecom company, the Government decided to withdraw a dividend of 15 million euros instead of 30 million euros as planned in the budget. Royalties collected surpassed the budgeted amount for this category by 3.4 million euros mainly as a result of higher royalties paid by exporting companies. On the other hand, due to the fall in the number of passengers traveling through the airport of Prishtina, concessionary tax, calculated as a percentage of the airport s turnover, has registered a shortfall of 2.5 million euros relative to the revised budget. 20 Including banks and Kosovo Energy Corporation (KEC) which account for the large part of the turnover declared at the Tax Administration. It is worth noting that commercial banks in Kosovo have lowered their deposit rates significantly while lowering the interest rates only moderately. Also, the increasing trend of e-banking allowed banks to perform their operations with lower number of employees which resulted in a large increase in the banks profits. In addition, during 2015, most of the banks introduced additional transaction fees. On the other hand, during 2015 KEC had significant damages in one of its production systems which led to the low production of energy compensated by the increase in imports of energy. This year, KEC operated in its full capacity and therefore reported higher profits. 21 During 2015, the Government increased the excise rates of tobacco, alcoholic products, beer, gambling and introduced this tax to the natural gas, heavy oil and fireworks. 32

37 b) Expenditure execution during 2015 General government expenditure has increased by 6.0% compared to This came mainly as a result of a higher public wage bill due to the full effect of the implementation of the wage increase via a government decision adopted in the spring of Although the wage increase is considered to be the main driver, another considerable contributor to this increase was the implementation of the collective agreement, as well as higher expenditure within the subsidies and transfers category due to the increase of pensions by the same government decision in Nevertheless, total expenditure has been executed at 94.9% in comparison to the reviewed budget for this year. Overall expenditure amounted to 1,552 million euro by the end of The aforementioned government decision on wages and pension increases (by 25%) of last year has shaped the current structure of general expenditure, in that around 60.8% of expenditure is wages and salaries and subsidies and transfers. Goods and services, on the other hand, make up around 13.2%, whereas capital expenditure amounts to 26% of total expenditure. Expenditure on wages and salaries amounted to million euro by the end of the year, realizing about 98.1% of the end-year plan for this category. Compared to 2014, expenditures on wages and salaries recorded an increase of 8.2% attributed mainly to the implementation of the experience related part of the collective agreement, whereas when comparing to the wage bill of 2013 the significant increase (of 25.9%) results from a combined effect of the collective agreement and the government decision to increase wages, which at that point was yet to happen. Expenditure on goods and services have followed the same trend of the year before, however the overall amount has decreased by about 0.2% compared to last year. This category amounted to million euro; a 96.3% execution of its end-year plan. Expenditure on service contracts, the purchase of goods and services as well as expenditure on fuel are the main areas to which the decrease in this category is attributed. Expenditure on subsidies and transfers include social transfers and subsidies, where a large part of the latter is comprised of subsidies to the agricultural sector. This category amounted to million euro, a 16% increase compared to last year. It is worth noting that besides the increased in wages and pensions in 2014, subsidies to the agriculture sector have also increased significantly compared to previous years. As a result, this category was executed by 98.3% compared to its planned end-year budget. This category is dominated by pension payments (basic pensions as well as contributors pensions) and the subsidies to the agriculture sector. Capital expenditure continued to be under-executed, where during 2015 this category amounted to 404 million euro, about 88.3% of its end-year plan. Compared to 2014 there is a 1.8% fall, reflecting low execution of this category when comparing the low execution in 2014 resulted from the political situation. Nonetheless, expenditure on this category also comprises advance payment of around 25 million euros made for the highway Pristina-Kaçanik, above the initially budgeted amount. 33

38 c) Deficit and financing during 2015 The level of deficit presented in the 2015 revised budget is slightly lower than the deficit level agreed with the IMF mainly due to the differences in the definition of deficit in the program relative to the LPFMA. Considering that revenues, in particular one off and non-tax OSR, turned out to be lower than projected and the lower than budgeted execution of expenditures led to the overall deficit amounting at 117 million euros or around 2% of GDP 22. In addition, following the commitments of the government to keep adequate levels of the bank balance, in 2015 the government increased the bank balance to 208 million euros financed through IFIs, issuance of the treasury bills and the withdrawal of the available balances of the privatisation fund which amounted to 61.3 million euros. Lower than projected deficit also contributed largely to the increase in the available Government bank balance MEDIUM-TERM BUDGETARY OUTLOOK Fiscal policy is projected to remain supportive to growth and macroeconomic stability over the medium term. The medium term outlook for the budget revenues and expenditures is the same to the one presented in the budget 2016 which was approved by the Parliament in early December. The fiscal plan for was prepared in agreement with the IMF, and intends to retain high capital spending levels while reducing the unproductive current spending. Thus, policies that were taken into account for preparing the baseline budgetary outlook are only the ones that are ongoing. As it was mentioned throughout the document, the Government has amended the LPFMA to allow for additional capital spending on growth enhancing projects. Thus, there is an open door in the budget that assures the implementation of some of the structural reforms while preserving a sustainable fiscal strategy. Medium term revenue projection The projection for revenues for the period is based on the forecast of economic activity according to the baseline scenario, and consequently the tax base which derives from the assumptions on underlying macroeconomic indicators. The projection for the revenue trend is based on revenue performance of 2015 and takes into account the effect of tax changes undertaken during The projections for 2017 and 2018 do not take into account any additional revenue measures with the exception of some excise increases, and are based mainly on the forecast of main economic indicators which underlie the revenue projection trend. For the upcoming medium term period, general revenues are expected to be dominated by regular tax revenues, which are to gradually substitute one-off revenues. Consequently, total tax revenues for 22 The GDP as estimated in the Budget During 2015 the excise on cigarettes was increased for 6 euro/conventional unit, the excise on gambling and games of chance has also been increased, and a new excise tax has been introduced on heavy oils, and the age limit on importing cars has been removed. 34

39 2016 are expected to amount to million euro, or 4.1% higher than the estimated end-year amount of tax revenues for Tax revenues are expected to represent 85.7% of total revenue, marking a 1.5 percentage point increase compared to This increase comes mainly as a result of the full effect of fiscal policies undertaken during 2015 and also takes into account the baseline expectations for main economic indicators, which define the tax base. Tax revenues are expected to continue to be mainly collected at the border, although with the latest changes to the Law on VAT, a gradual shift of tax collection is expected (from the border to domestic tax collection). The projected increase of tax revenue is expected to come mainly from indirect tax, i.e. VAT and excise, whereas a gradual decline in customs tax revenue is reasonable considering the implementation of the free trade agreements with the EU and Turkey. A gradual increase is expected also in direct taxes, even though the basis is to date relatively low, so that the impact cannot be as significant. Regarding non-tax revenue for , a modest increase is projected, which is to reflect the increased collection of own-source revenues, particularly those at the municipal level. More specifically, the year 2015 saw a delay in the implementation of the law on debt amnesty which has resulted in a slow-down in property tax collection 24, which is expected to reflect on the increase of revenue from this source in Moreover, an increase in royalties is expected in 2016, which represent 1.6% of total revenue in The government plans to collect 23 million euro under the dividend from PTK, as well as 10 million euro as concessionary tax from the Adem Jashari airport. Graph 16. The structure of tax revenue, as % to total Customs Duty Excise Property Tax VAT Direct tax revenues Tax revenues For , an increase in revenue is expected due to stronger economic growth as well as increased efficiency of relevant institutions measures taken by tax collection agencies are expected to contribute towards the narrowing of the tax gap. Total revenue is expected to increase by 2.5%, fuelled mainly by tax revenue. It is worthwhile to mention that the forecast of tax revenues accounts 24 Although property tax revenue are tax revenue, they are included in this section because they are part of municipalities ownsource revenues 35

40 for a 1.7% loss of customs revenue as a result of the exemption of production lines and input from VAT, as per the Law on VAT. The revenue trend has historically followed economic activity (see graph 17). Even though domestically collected revenues continue to be low, their performance in 2015 (largely based on structural reforms which the TAK has undertaken) has signalled a positive trend beyond the effect of increased economic activity. As can be seen from the graph, revenue collected domestically is expected to increase during 2016 and reach a level of around 6% of GDP, which it is expected to keep for the following two years. Graph 17. Trend of tax revenues and its relationship to economic indicators Import of goods Custom revenue (right axis) Linear (Customs revenue. right axis) Domestic revenue/gdp Linear (Domestic revenue/gdp Unlike domestic revenues, revenues collected at the border have historically followed the value and quantity of imports in cases where there were no changes in tax rates. The implementation of free trade agreements as well as VAT exemptions on imports for some products are expected to slightly offset the impact of projected economic activity on this source of revenue. Therefore, throughout slower growth of revenues collected at the border is expected, whilst the increase projected for 2016 takes into account the full impact of annual revenue measures undertaken during Table 7. The structure of budget revenue, in million euro Description Budget proposal 2017 Proj Proj. Total revenue 1,345 1,465 1,602 1,614 1,654 Tax revenue 1,141 1,247 1,370 1,396 1,436 Non-tax revenue Dividend Medium Term Budget Expenditure Planned budget expenditure for the year 2016, as well as projections for 2017 and 2018 are based on the existing fiscal space made available by revenue planning and is also limited within the required 36

41 level of budget deficit, as per the fiscal rule and obligations that arise from the Stand By Arrangement concluded with the IMF in This manner of budgeting serves as a guarantee of discipline which helps secure macro-fiscal stability even at the planning phase. In any case, macrofiscal stability is not a means within itself, but rather as a precondition to achieving the ultimate goal of supporting the general economic development of the country. Stemming from this main objective, the proposed budget is projected in three components: - Preserving the level of current expenditure which secure appropriate financing of public services and directly support the improvement of the business environment as well as citizens welfare - Offering a broad basis of financing of capital projects financing from tax sources, and based on this, - Creating the necessary space for the adoption of strategic capital projects, of a developmental nature, financed through agreements with international financial institutions (IFIs) The last component represents a new approach to strategic budgeting within the Government of Kosovo. Within the framework negotiated with the IMF (the SBA), the Government of Kosovo is strongly committed to attaining financing from IFIs in order to finance capital projects with direct impact on the development of the country, as an exception to the fiscal rule, without endangering the stability of public finances. This component becomes active once the amendment of the fiscal rule within the LPFMA has passed, and is operationalized through international financial agreements. For the year 2016, the budget proposal foresees total expenditure at 1,674 million euro (excluding Donor Designated Grants ), around 28% of the forecasted GDP for Due to the positive performance in tax revenue collection during 2015, which is expected to continue during 2016, general budget expenditure is expected to increase over 2% compared to planned expenditure with the budget review of 2015, and about 13% above the executed expenditure during The structure of expenditure in essence follows the principles laid out in the Government Programme, which clearly prioritize economic development, whilst continuing activities concerning the improvement of social welfare, as well as accommodating Kosovo s EU integration agenda. For these reasons, supplementary expenditure made possible through the increase of regular budget revenue is allocated in such a way that it maintains the ratio between current and capital expenditure. Moreover, considering the prioritization of economic development and increase of employment, the space for exceeding the deficit is reserved exclusively for strategic development projects financed by IFIs. Savings during 2015 on goods and services have made it possible to budget a 2.1% reduction in this category in 2016 compared to the reviewed budget of The rationalization of expenditure (mainly on per diems, transfers, etc.), as well as the performance of revenue collection, as well as improvements to the management of public finance, have translated into increased space for the accommodation of policies that are made possible through current expenditure, such as: - The increase by 25% of social assistance for families in need - The implementation of the law on state-financed pension schemes - The implementation of compensation of work experience of public servants 37

42 - Preserving the level of subsidies to the agricultural sector - The provision of pensions for veterans and other war categories - The accommodation of expenditure that derives from Kosovo s integration agenda - The increase of financial support to prosecution and judiciary The budget increase on capital expenditure also sustains the financing of the highway Prishtina- Skopje as well as other infrastructure projects. Among capital expenditure, there has been an increase in financing directed towards the purchase of equipment required for the restructuring of the Kosovo Security Force, as well as an increase in financial support to capital projects directed towards increasing productivity and employment in the agriculture sector. Budget expenditure by economic category The table below shows expenditure by economic categories for the year 2016 with projections for 2017 and 2018, as well as those realized for 2014 and the reviewed budget of General government expenditure in 2016 is expected to be higher for about 14% compared to the level of expenditures executed during 2014 and 2% higher compared to the 2015 budget review. Table 8. Expenditure by economic categories during , in million euro Description Budget proposal Proj. Proj. Total expenditure 1,475 1,565 1,684 1,704 1,749 of which: expenditure from PAK dedicated revenue Current expenditure 1,052 1,149 1,211 1,225 1,240 Wages and salaries Goods and services Subsidies and transfers Social transfers Subsidies to POEs Reserve Loans to POEs of which: loans to POEs of which: returns from POEs Capital expenditure Expenditure from donor designated grants Besides the increase in the overall budget expenditure, the structure of expenditure by economic categories has also exhibited shifts among categories, even though this is marginal between 2015 and the budget proposal for The graph below shows general budget expenditure by economic categories for 2015 and the planned amounts for As can be seen from the graph, the structure of budget expenditure during 2015 and 2016 is dominated by current expenditure, the share of which to total expenditure accounts for 72%. This expenditure is expected to represent 20% of GDP in 2016, compared to 21% of GDP in A similar ratio to GDP is to continue through 2017, falling to 19% in This is mainly due to the quicker rate of GDP growth compared to current expenditure. 38

43 Capital expenditure is planned to remain at relatively high levels, at around 28% of total budget expenditure, with an 8% share to GDP for the year It is important to mention that capital expenditure have increased by 1 percentage point as a share to GDP compared to 2014 and are expected to continue at this level going towards Moreover, these calculations do not include capital expenditure on strategic development projects, which are to be financed by IFIs through the exemption to the fiscal rule on deficit. According to the law in force and the agreement with the IMF, a level of expenditure of 90 million euro within one fiscal year is allocated for this modality (mean of financing). It is important to stress that the main criteria for utilizing this exemption is that the projects must exercise a direct impact on economic development. Graph 18. The structure of expenditure by categories during , in million euro Expenditure on wages and salaries for 2016 are planned to amount to million euro, a 2.4% increase compared to the plan for This category represents a 9.2% share in GDP for the year 2016 (compared to 9.4% of GDP in 2015) as a result of accelerated economic growth. The share of this category to GDP is expected to decrease gradually going towards 2017 and 2018, to 8.9% and 8.6% respectively. Subsidies and transfers, which includes social transfers and subsidies to POEs, during 2016 is expected to amount to million euro, an increase of 5.5% compared to the budgeted amount for In 2016 this category is expected to represent 7.5% of total expenditure, compared to 6.6% and 7.5% planned in 2014 and 2015 respectively. This increase in social transfers results from the implementation of policies such as: - The Law on War Veterans - The increase in social assistance and - The full implementation of the Law on state-financed pension schemes Subsidies for other categories in need of social assistance has been increased as per the increase in beneficiaries. 39

44 Goods and services; as a continuation of policies on savings policy which began in 2015, the budget for 2016 plans a lower level of expenditure for this category by 2.1% in comparison to 2015, amounting to million euro. The government will continue with activities aimed at increasing the efficiency in public spending including procurement (reform measure #1). Capital expenditure in 2016 is expected to amount to million euro, around 29% if the total budget, or 8% of GDP. Compared to the budgeted amount for the previous year, there is an increase of 1.2%, which for the following two years is expected to be around 5% on average. An important component of capital expenditure is the highway between Prishtina and Skopje (which is an ongoing project and is included in reform measure #2). This category also includes many other infrastructure projects, among others the M2 road to Mitrovica as well as the M9 road to Peja, improved infrastructure on roads, sports, and educational projects which compared to last year show a significant increase The budget deficit and fiscal rule As a result of increased funding for current expenditures, as well as maintaining of high share of capital expenditures, the overall budget deficit for 2016, in accordance with the fiscal rule (excluding PAK expenditures and spending financed through one-off financing), is expected to be 98 million, or 1.6% of GDP STRUCTURAL BALANCE (CYCLICAL COMPONENT OF THE DEFICIT, ONE-OFF AND TEMPORARY MEASURES, FISCAL STANCE) Considering the limited availability of GDP data, both of annual and quarterly frequency, the structural balance calculated in this section should be interpreted with a great degree of caution. For the purpose of this section, the structural balance is calculated in two steps. First, potential GDP is generated using the Hodrick-Prescott filter applying the smoothing parameter as suggested by ECB 25 at λ=480 for quarterly data and λ=30 for annual data. Hence, the structural balance is calculated in two ways by employing both quarterly and annual GDP data. Actual GDP, potential GDP and the resulting GDP gap (OG) are presented in the graphs below. Graph 19. Actual and potential GDP, annual and quarterly data 25 Bouthevillain et al. (ECB 2001), Cyclically adjusted budget balance: An alternative approach 40

45 When comparing the results from both exercises, the trend derived from applying annual GDP data gives slightly different results compared to the results generated from quarterly GDP data. This difference arises from the differences in the period observed in both exercises thus revealing the end-year problem of this filter 26. Given this fact, the analysis/interpretation is principally based on the estimations derived from the quarterly GDP data. Accordingly, the economy seems to have been growing above its potential during the period, and staged a considerable deterioration in 2014 which predominantly reflects uncertainties related to the establishment of governing institutions during the larger part of the year. In the second step, the elasticities of the fiscal variables are computed. To derive these, the methodology similar to that applied by the OECD and European Commission is employed. The elasticity for each individual budget tax revenue is estimated relative to GDP using simple OLS analysis 27. The elasticity of each revenue category is presented in the table below. On the expenditure side, however, the elasticity is kept at zero considering that there are no unemployment benefits provided by the Government and other budget expenditures are largely incompressible, thus independent from economic cycle fluctuations. As shown in the table, PIT is highly elastic to output changes which might result from its progressiveness and the response of employment to the business cycle, although its share to total revenues remains relatively low. Indirect taxes (which are the main source of revenue) and the CIT have elasticities close to 1 implying that they move in parallel with GDP. Table 9. The elasticity of tax revenues with respect to GDP Revenue categories CIT PIT Indirect taxes Other taxes Property tax Total revenue elasticity Elasticity Weighted average elasticity The cyclically adjusted primary balance capb as a share to potential GDP is then computed using the formula below: 26 The values of potential GDP are predominately determined by the values of the beginning or the end points of the sample. When applying the trend to the shorter sample of annual GDP, namely from 2011, the results were the same with those derived from the quarterly data. 27 Considering that the computation is made using quarterly data, the GDP and revenue series are first adjusted for the seasonality and then transformed into logs. The OLS is than employed in the transformed series. 41

46 Where gap denotes the output gap, the letters r and g are ratios of revenue and expenditures to potential GDP and ε is the elasticity of fiscal variables to GDP. In the interest of comparability, the same formula was employed to the annual data. The output gap and the computed cyclically-adjusted budget balance are presented in the graphs below. The graph on quarterly data shows that fiscal policy was countercyclical during the periods of negative output gap and managed well to offset the effects of the economic slowdown. On the other hand, the large temporary increases in the cyclicallyadjusted deficits in the second quarters of 2014 and 2012 were not justified by business cycle developments. Nevertheless, the deficit remained below 3% of GDP (on average) and until now was predominantly financed by accumulated bank balances from the previous years surpluses. For comparison, the respective graph also present results derived from the annual data which are less conclusive regarding the fiscal policy stance but also less reliable given the short time series and the fact that revenue elasticities were calculated using quarterly data. Table 10. The output Gap (OG), Cyclically adjusted budget balance, primary 28 balance and the cyclical component of the balance Period OG capb Primary balance Cyclical component In % of GDP 2011q1 6.5% 5.9% 7.9% 2.0% 2011q2-3.6% 0.6% -0.5% -1.1% 2011q3-2.6% 0.2% -0.5% -0.8% 2011q4-4.0% -7.9% -8.9% -1.0% 2012q1-3.6% -0.8% -2.1% -1.3% 2012q2 2.4% 1.0% 1.6% 0.6% 2012q3-0.1% 0.9% 0.7% -0.1% 2012q4 3.6% -9.1% -6.9% 2.2% 2013q1 1.8% 2.0% 2.9% 0.9% 2013q2 4.1% -2.7% -1.4% 1.3% 2013q3 0.8% 3.4% 3.2% -0.2% 2013q4-1.3% -6.8% -6.9% -0.1% 2014q1-1.2% 1.6% 1.6% 0.0% 2014q2-2.0% -2.4% -2.9% -0.5% 2014q3-0.2% 1.4% 1.2% -0.2% 2014q4 0.3% -9.3% -8.9% 0.4% 2015q1 1.1% -0.3% -0.1% 0.2% 2015q2-1.3% -0.8% -1.1% -0.3% 28 Considering that the debt interest payments are still low due to the low level of public debt, in this exercise only the primary budget balance is considered. 42

47 Graph 20. Cyclically adjusted budget balance and the output gap, annual and quarterly results 3.5. DEBT LEVELS AND DEVELOPMENTS, ANALYSIS OF BELOW-THE-LINE OPERATIONS AND STOCK-FLOW ADJUSTMENTS Kosovo has adopted very tight Constitutional and legal frameworks to prevent unsustainable debt policies. According to the Law on Public Debt, the Minister of Finance is the only authorized person to incur and negotiate the conditions of international debt on behalf of Kosovo. Under the Constitution, these agreements need to be ratified by a two-thirds majority in Parliament. A new regulation on issuing government debt has been approved and it requires that individual loans are negotiated by a team that consists of a member from the following departments: Debt Management Unit (DMU), Legal Department, Minister s cabinet, Fiscal Policies Department, Budget Department, and the respective Budget Organization. The Public Debt Law allows the central and municipal authorities to contract debt and issue guarantees; this was approved by Parliament in The law was endorsed by the IMF and includes several provisions that ensure fiscal stability, including a ceiling on public debt (40 percent of GDP) as well as tight limitations on municipal borrowing. The Public Debt Law mandates regular reporting to the Assembly (Article 15, Sections 2.4, 2.5, and 2.10, in particular) and the preparation of a State Debt Program, which includes the annual and medium term debt strategy to be submitted to Government for approval and to the Assembly for information. The debt management is in full compliance with these requirements. The State Debt Program has been drafted and needs to be approved by the government and published on the Ministry s website. A new medium term strategy has been drafted using the WB model and covers the period An amendment was added to the Law on Public Finance Management and Accountability (LPFMA) which limits the annual budget deficit to no more than 2 percent of forecasted GDP. Another amendment to the LPFMA was added in 2015 which allows the government to contract debt in excess of the 2 percent rule, given that the financing comes from international financial institutions and it is dedicated for capital projects. 43

48 The issuance of domestic government securities is sanctioned by the Law on Public Debt, and it is regulated by the regulation on Primary and Secondary Market for Government Securities. The DMU has initiated the amendment of said regulation in order to reflect the needs for trading in the secondary market. A regulation on issuing government debt and guarantees has been approved in 2013 and it sets the procedures for negotiating and contracting external debt as well as issuing domestic debt. The debt management is in full compliance with these requirements. Table 11. Public Debt, in million euro (unless otherwise indicated) Description est. International Debt Domestic Debt Public Debt State Guarantees Debt/GDP (includes State Guarantees) 6.4% 6.2% 5.5% 8.4% 9.1% 10.6% 12.9% Contingent liabilities So far, there has been only one issue of a State Guarantee to the amount of 10 million Euro. It is expected that another State Guarantee will be issued in 2016, which would bring the total amount of explicit guarantees to 20 million SENSITIVITY ANALYSIS AND COMPARISON WITH THE PREVIOUS PROGRAMME The sensitivity analysis of the baseline fiscal projections to alternative scenarios and risks shows that the Government s ability to maintain the deficit rule is conditional upon the robustness of the baseline assumptions on macroeconomic developments. The alternative scenarios developed in section 3.8 above identify the real sector, and hence economic growth, as the key factor that can impact the fiscal outlook. As Kosovo is a unilaterally euroized economy with the EU and CEFTA as its key trading partners, and most of its debt denominated in Euro, exchange rate fluctuations do not have any significant effect on the fiscal outlook. Also, with a relatively low share of debt to GDP, and stable trend of low interest rates on public debt (expected to prevail as such in the medium term as well), the key channel through which changes to interest rates affect the fiscal outlook is through the rate of economic growth, namely through the impact on private disposable income and investment. Thus, the main focus of this section is on the sensitivity of the baseline fiscal outlook to changes on economic growth, as per the assumptions of the alternative scenarios. Table 12 below summarizes the main differences in fiscal variable estimates of the two alternative scenarios relative to the baseline scenario. 44

49 A drop of real GDP growth from a medium term average of 4.2% to an average of 2% (as foreseen with the low growth scenario) disables the Government to maintain its legally binding fiscal rule (without any adjustment). The resulting reduction in growth expectations increases fiscal deficit from a medium term average of 1.7% of GDP to a medium term average of 2.6% of GDP. On the other hand, an increase in expected growth from a baseline average of 4.2% to an average of 5.4%, reduces the fiscal deficit to a medium term average of 1% of GDP over the medium term. The effect of the two alternative scenarios is channelled exclusively through changes in the revenue base. The sensitivity analysis under the low growth scenario implies that: An approximate 50% reduction of the projected rate of economic growth results in an average revenue shortfall of 3 percentage points relative to baseline revenue projections (or 49 million euro a year). Table 12. Alternative Macro-fiscal Scenarios Description (L)* (B) (H) (L) (B) (H) (L) (B) (H) General government budget (% GDP) Revenue of which: Tax revenue Non-tax revenue Expenditure of which: Recurrent spending Capital and net lending Interest payments Primary balance Overall balance Overall balance (fiscal rule definition) Government Revenue (in millions of euros) 1,556 1,590 1,596 1,550 1,602 1,643 1,570 1,642 1,712 off which Tax Revenue: 1,341 1,370 1,381 1,348 1,396 1,441 1,368 1,438 1,511 difference to baseline: 98% 100% 101% 97% 100% 103% 95% 100% 105% *(L) Low Growth Scenario; (B) Baseline Scenario; (H) High Growth Scenario 3.7. SUSTAINABILITY OF PUBLIC FINANCES Sustainability of public finances and sound fiscal policy has always been the overarching objective of the Government of Kosovo. With the aim to maintain the sustainability of public finances, Kosovo adopted a fiscal rule which limits the overall deficit at 2% of GDP aiming to predetermine the trajectory of state debt at the stabilizing levels below the threshold set by the law. Moreover, in 2010, the Government set the rule-based limit of debt at 40% of GDP and also recently adopted a wage rule which sets a cap on the level of public wages with the aim to limit the possibility of increasing public wages during the election years. 45

50 In addition, the debt sustainability analysis conducted in this section, assesses the effect of changes in the macroeconomic variables on the debt levels. Hence, the analysis reveals that there is no risk of future debt distress although this analysis is based only on the assumption that the deficit level will be contained at 2% of GDP regardless of the possible changes in the structure of the budget expenditures. According to the demographic forecasts conducted by the Statistical Agency of Kosovo, the structure of population is not foreseen to change considerably until Currently, the population in Kosovo is very young, with the median age averaging at 28.2 years in 2011 and the population between years old composing more than half of the population. The population projections reveal that in 2060 the structure of population will not change significantly with 58% being dominated by the population within the range of years old and the population over 65 years old representing 29%. The current pension system in Kosovo operates through two pillars: Pillar I or old age basic pension scheme which is financed by the state and is paid to every individual older than 65 years, and the Pillar II which is fully funded mandatory pension scheme which requires all employers and employees to contribute each 5% of the gross wage. This fund is managed by the Kosovo Pension Savings Trust (KPST) and assets are predominantly invested abroad by the European well-known asset managers. Considering that the pillar II is fully funded, the risk to the pension system sustainability is not foreseen to be large. The funds appropriated in the 2016 budget for financing the Pillar I pension scheme amount to around 211 million euros or around 3.5% of GDP. In 2014, the parliament approved the Pension Law which embeds several changes to the basic pension for beneficiaries that contributed in the ex pay as you go scheme. To this end, the MLSW issued an administrative instruction which outlines the educational and experience criteria as a basis on which the level of the pension benefit is to be determined. The additional cost to the budget for these changes amounts to around 23 million euros an amount that is already accounted for in the 2016 budget appropriations. Debt sustainability analysis The state debt level in Kosovo remains low relative to the maximum level allowed by law, hence the risk of debt distress remains moderate. However, the current low debt ratio is, in part, a result of the short history of debt issuance and does not necessarily result from appropriate debt policies adopted by the government. Nevertheless, for the first time, in 2014 the Government adopted the fiscal rule which limits the overall deficit at 2% of GDP with the intent to stabilize the debt levels below the threshold allowed by the law (i.e. 40% of GDP). Given the low level of debt to GDP and the existing infrastructural bottlenecks that the country is actually facing, during 2015 the Government adopted the investment clause which allows the Government to finance additional growth enhancing projects financed by IFIs. To this end, the DSA conducted in this section, scrutinizes two main scenarios, namely the baseline and the investment clause scenario. Further analysis intents to show the sensitivity analysis of debt to changes in the underlying macroeconomic indicators. 46

51 Kosovo DSA is conducted using the tool developed by the macro unit within the Ministry of Finance. To perform the analysis, several assumptions have been made on the baseline macroeconomic indicators as well as the debt indicators. The debt levels are examined using the risk indicators compiled by the World Bank-IMF for countries at the medium policy performer category 29. The debt indicators and debt burden thresholds compiled by the WB-IMF and the debt ratio limited by law are as follows: - Net Present Value (NPV) of Debt to GDP 40% - NPV of debt to exports of goods and services 150% - NPV of debt to budget revenues 250% - NPV of debt servicing to exports of goods and services 20% - NPV of debt servicing to budget revenues 30% The assumptions on the macroeconomic and debt indicators are as follows: - Nominal GDP growth of 6.0% - Exports share to GDP grows by 0.2 p.p. - Commercial loan interest rate at 5% - New concessional loan interest rate at 0.75% - Commercial loan matures in 5 years - Concessional loan matures in 10 years - Share of commercial loan to total new borrowing need increases from 50% in 2015 to 70% in the subsequent years - Bank balance to GDP at 4.5% - Overall deficit to GDP at 2% - Budget revenues at 24% of GDP Graph 21 presents the changes in the composition of deficit and the financing need over the forecast horizon under the baseline scenario. The share of interest expenditures relative to the share of primary deficit remains low in the early years. As the financing needs grow and the debt increases, interest expenditures capture an important fraction of the overall deficit. Likewise, the contribution of the deficit to the overall net financing need appears low relative to the contribution of debt servicing in total. Graph 21. Composition of overall deficit and financing need 29 World Bank s Country Policy and Institutional Assessment (CPIA) 47

52 The baseline scenario suggests that the country will not be in a debt distress for, at least, the forecast horizon. Specifically, both groups of indicators, namely solvency and liquidity, are below the debt burden indicators (see graph 22). In the baseline scenario, the debt-to-gdp ratio stabilizes at just below the 40% threshold while the debt to exports of goods and services reaches the threshold reflecting the narrow base and highly concentrated exports. Graph 22. Indicators of public debt under baseline and investment clause scenarios 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% a. NPV of debt/gdp 250% 230% 210% 190% 170% 150% 130% 110% 90% 70% 50% 30% 10% -10% b. NPV of debt/revenues c. NPV of debt/exports of G&S d. Debt servicing/revenues 160% 30% 140% 120% 100% 25% 20% 80% 15% 60% 40% 20% 10% 5% 0% 0% 20.0% 18.0% 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% e. Debt servicing/exports of G&S Baseline scenario Investment clause Source: MF, Economic and public policy department, macroeconomics unit calculations As it is presented in the graph 22, adopting the investment clause shifts the debt level towards the debt burden threshold, thus increasing the risk of debt distress. Noteworthy is the fact that the nominal GDP growth is set at a relatively high rates suggesting that lower GDP growth can increase the debt level above the threshold set by the law. 48

53 Results of the stress test analysis are presented in the graph 22. Considering that the debt servicing appears to be far below the revenue and exports indicators, the further analysis focuses only on the change in NPV of debt relative to GDP and exports. Lowering the GDP growth by 1 p.p. compared to the baseline - This scenario is built on the assumption of the permanent 1 p.p. change in the nominal GDP growth. As specified above, the fall in GDP by only one p.p. increases the debt levels above the specified boundaries, thus suggesting a breach of the GDP threshold in 2029 in the case of the scenario with investment clause and in 2042 in the baseline scenario, although the gap between the two scenario lines narrows by the end of the forecast horizon. Likewise, because of the narrow base of exports, the PV of debt to exports breaches the threshold in 2024 in the investment clause scenario and in 2033 in the baseline scenario. This indicator, however, shows that while in the baseline scenario it moves gradually downwards below the threshold, it returns faster beneath the threshold in the investment clause scenario. This situation arises because the investment clause scenario assumes additional concessionary debt at the annual amount of 90 million euros for only 10 years period. Graph 23. Scenario analysis: Decreasing the permanent GDP growth by 1 p.p. Lowering the bank balance from 4.5% to 3% of GDP: Considering that a significant amount of financing need stems from the necessity to retain adequate levels of bank balances, the analysis was conducted to see the movements in debt levels if the bank balance is reduced to 3% of GDP while retaining the nominal GDP growth at 5%. The graphs below, suggest that lowering the bank balance doesn t change the debt levels significantly, except that it slightly improves the NPV of the debt to export indicator. 49

54 Graph 24. Scenario analysis: Reducing permanently the bank balance to 3.0% of GDP Temporarily increasing the overall deficit to 5% of GDP: A simulation whereby the legally binding fiscal rule increases temporarily to 5% of GDP, and then reverses back gradually to the preceding levels in 2023, was also considered. This change will also permanently increase the debt ratio to GDP beyond the threshold by a large margin suggesting that any increase in the deficit to GDP ratio or any other shock to the economy should be accompanied by higher GDP growth and higher and sustainable export growth. Graph 25. Scenario analysis: Temporary increase in the overall deficit in INSTITUTIONAL FEATURES Wage rule Following the adoption of the deficit rule, the Law on Public Financial Management and Accountability was amended in 2015 to include a wage rule with the following key features: Starting from 2018, in each fiscal year the percentage increase in the public sector wage bill in comparison with the preceding fiscal year will not exceed the annual growth rate of nominal GDP (as published by the Statistical Agency of Kosovo); The wage bill comprises of all expenditures on wage and non-wage compensations; 50

55 The level and annual growth rate of nominal GDP should be used for the latest calendar year available by the time the consolidated budget of the central and municipal governments is being prepared; In cases when the annual growth rate of nominal GDP is less than or equal to 0.5%, the ceiling for the annual increase in the wage bill should be 0.5% or less. However, if in such circumstances the increase in the wage bill exceeds the annual growth rate of nominal GDP, then the ratio of the wage bill to nominal GDP must revert back to its pre-increase level within three years starting from the fiscal year in which nominal GDP growth exceeds 0.5%; With a view to ensure that the increase of the wage bill over time remains consistent with stable public finances and does not hinder the competitiveness of the economy, every fifth fiscal year, the Assembly can review and if needed it may adjust the indicator and formula that determine the ceiling of the annual wage bill growth; The increase in the wage bill cannot be cumulative within one year, meaning that if in one year the government decides not to increase the wage bill by the GDP growth, it cannot carry forward the growth in the subsequent years. Investment clause The amendments made to the LPFMA during 2015 also includes the adoption of the investment clause. The main features of this clause include: Capital projects that are financed from Supranational Financial Institutions, the European Union or its institutions, or foreign governments or their development agencies will not be taken into account in the calculation of the deficit, as defined by the fiscal rule; Any project that have been contracted and ratified before entry into force of this clause will not qualify to be treated with the investment clause; This clause will stay into force until the earliest of the time when the debt level reaches 30% of GDP or ten years from the date of entry into force of the investment clause. Public Finance Management Starting from the 2014 budget, the government adopted a fiscal rule which conditions the planning of public expenditures by limiting the budget deficit to 2% of GDP. This rule is planned to be applied in the medium term The projected budget deficit is expected to be funded through both domestic and external borrowing. In order to increase efficiency and effectiveness of the execution of the 2015 budget, savings, appropriations and internal adjustments of appropriations were made under Article 13.2 of the Law No. 05 / L-046 on Amending and Supplementing the Law no. 05 / L-001 on the Budget of the Republic of Kosovo in 2015, which must not exceed 5% of all appropriations. 51

56 With the purpose of monitoring the capital expenditures, the Budget Department at the MF has requested from budgetary organizations to report on the physical and financial plan/progress of capital projects worth more than 400,000 euros. Such reports are received on a quarterly basis from each budgetary organization. As far as the improvement in the management of public finance is concerned, the project of World Bank named Technical assistance to improve the capacity of the Public Financial Management in certain budgetary organizations has begun since The main objective of this project is to enhance the capacity of public finance management in the following budget organizations: the Ministry of Education, Science and Technology; Ministry of Agriculture and Rural Development and the Ministry of Finance. Compiling of draft strategy on Public Financial Management (third pillar for Public Administration Reform) is in process. This draft strategy outlines the challenges of Public Financial Management (PFM) and the activities to be undertaken to make the improvements. Public finance management will also be improved by introducing centralized and electronic procurement (reform measure #1) and RIA principles and procedures (reform measure #9). With the aim to improve the public finance management, the following activities were undertaken during 2015: - Implementation of Article 7 of the Law No.05 / L-001 on the Budget of the Republic of Kosovo for 2015, which pertains fulfilment of financial obligations remaining from the previous year for capital projects. - Document no. 28, issued by the MF on 09/01/2015 on Management of wages and salaries for 2015, which aims at improving the management of employment and the expenditures on wages and salaries. - Document no. 661 dated "Instruction on Preparation of Medium Term Expenditure Framework (MTEF) ". - Document no dated "Instruction on Budget Review 2015" to allow budget organizations to make budgetary adjustments under full justification with the purpose of efficient budget execution for the remaining period of the budget year. The draft law on amending and supplementing the Law No.05/L-001 on the Budget of the Republic of Kosovo for 2015 was approved by the Assembly of Kosovo on Document No.1627 dated , issued by the MF for Implementation of the Brussels Agreement, based on the Government Decision No.09 / 36 dated With the decision No.06 / 27 of the Government of the Republic of Kosovo dated was adopted the Administrative Instruction (GRK) No.03 / 2015 on the Budget Impact Assessment for the New Government Initiatives. - Amendment of the Law on Public Financial Management and Accountability was approved in principle by the Assembly of the Republic of Kosovo, which envisages changes in the organizational structure of the Budget Department. Public finance statistics 52

57 As of November 24th, the Ministry of Finance officially started to report data on the Government s financial operations in line with the IMF s Government Finance Statistics (GFS) reporting standard a standard which reflects best international practice for public sector reporting. With the adoption of this standard, the Government of Kosovo has taken a significant step to improve accountability and transparency by providing citizens with more accurate and comprehensive information: on taxes, fees, and other revenue it collects; on the way it spends public funds; and on the effect its operations have on the size of the public sector relative to the private sector. The data prepared in line with the GFS standard was also submitted, for the first time, for publication in the IMF s Government Finance Statistics Yearbook (GFSY) and for inclusion in the online GFS database, where 144 countries report their public finance data, in a manner which enables international comparability. As a precondition for the adoption of the GFS standard, the Ministry of Finance, together with the Central Bank of Kosovo and the Kosovo Statistical Agency, have for the first time published a comprehensive list of all institutions that make up the public sector that shall be jointly updated on a regular basis 30. In 2015, the Ministry of Finance also adopted the United Nations Classification of the Functions of Government (COFOG) as part of its standard budget classification. At end September, 2015, GoK approved a budget proposal for 2016 which not only informs citizens how much and on what inputs the Government plans to spend, but also shows for the first time - what policy areas the budget gives priority to. In addition, the Ministry of Finance MoF improved the presentation of budgeted revenue. The old presentation based on the institutions who receive the revenues has been replaced by a presentation of the types of revenue planned (income tax, fee, charge, etc.). This presentation establishes a direct link between budgeted revenue and economic projections. The Ministry of Finance has also significantly increased the comprehensiveness of information provided with quarterly budget report, and aligned its presentation to make it comparable with the budget documentation 4. STRUCTURAL REFORM PRIORITIES IN IDENTIFICATION OF KEY OBSTACLES TO GROWTH AND COMPETITIVENESS (DIAGNOSTIC) Two growth diagnostics studies were prepared to identify the binding constraints to growth and they have informed the selection of reform measures in ERP. 31 Both studies identified the difficulty of access to finance and the (related) weak contract enforcement as a binding constraint to growth. In order to reduce these obstacles, there are several priority actions planned. First, the aim is to improve 30 Both the list of institutions and the GFS data are now published on the MoF web-site, under a new section: 31 One study was prepared in 2014 by the EU technical assistance project as a background analysis for ERP 2015 and was briefly summarised therein. The other study was done in 2015 by the OECD team supporting ERP 2016 preparation. 53

58 the access to finance for Kosovo SMEs through expansion of credit guarantee schemes (reform measure #12). Second, the contract enforcement will be addressed through directly increasing judicial efficiency (reform measure #11) and strengthening the property rights system (reform measure #11). Related to the issues of contract enforcement and access to finance, the growth diagnostic studies identified burdensome regulations leading to economic informality as another binding constraint to growth. It was estimated that informal economy stands at 39% of GDP, creating unfair competition to formal businesses, with 41% of companies calling informal competition a very severe constraint to doing business. In comparison to regional economies, informality appears to be more important issue in Kosovo. Moreover, corruption perceptions among businesses represent a serious challenge for the doing business environment in Kosovo. On the broader issue of business environment, the growth diagnostics study identified coordination externalities as constraining to FDI and exports. Kosovo has one of the least diverse export baskets in the region, comprising almost solely of low value added goods. The scope for diversification particularly into export oriented higher value added products is high. One of the most notable, and persisting, weaknesses in competitiveness and capacity to export is the lack of compliance with EU quality standards. The inflow of FDI is comparable with the regional average, especially as a percentage of GDP, but the current levels are considered too low to have a meaningful development impact. These set of binding constraint will be addressed by a number of measures in different areas. Streamlining the evidenced based policy making and introducing RIA principles (reform measure #9), improving corporate governance of state owned assets (reform measure #13) and promoting centralised and electronic public procurement (reform measure #1) will all contribute to better business and investment environment. Informality and the ensuing tax gap will be reduced by establishing a single revenue collection agency (reform measure #14). Development of industrial clusters will be considered to reduce the coordination failure (reform measure #17). Businesses will be encouraged to improve the quality of products by developing the necessary quality infrastructure (reform measure #16). Development of high-value added product and sectors will be supported by fostering business academia cooperation through research grants and innovation vouchers (reform measure #15) and expansion of ICT infrastructure (reform measure #18). On the other hand, competitive and export oriented agricultural production will also be encouraged by investment in infrastructure for agro-business and agricultural land consolidation (reform measures #5 and #6). In infrastructure, access to uninterrupted power is a major obstacle to growth in Kosovo. Investing in new power generation capacity, upgrading the network transmission infrastructure and improving energy efficiency are thus key priorities for action (reform measures #3 and #4). Transport links are not considered a binding constraint for growth at present, but the road and rail infrastructure also require further development to facilitate cross-border trade, especially related to the mining sector (reform measure #2). Both growth diagnostics studies have also recognised the skills gap (in terms of vocational and graduate education) as a binding or potentially binding constraint on growth. This is mainly due to evidence of excess demand for high-skilled occupations, and evidence of a high-skill premium. Educational outcomes strongly influence the level of unemployment across age groups and levels of 54

59 education. Secondary vocational education is found to be more labour market relevant, especially in comparison to those in general education. The skills gap will addressed by improving linkages between education and labour market (reform measure #17), modernising the employment services and active labour market policies (reform measure #18 and #18) as well as improving the education system through enhancing teachers' competences (reform measure #20). The growth diagnostic studies, being horizontal in nature, did not identify growth constraints at the sectorial level. Considering the significant share of agriculture in the overall economic activity, improvements to productivity and export competitiveness would contribute to growth over time. Key priorities for action in the agriculture (reform measures # 5 and #6) aim to ensure planned increases in agricultural incentives that are directed exclusively at productivity increasing initiatives, such as upgrade of agriculture infrastructure for agro-business and agricultural land consolidation. In terms of the industry sector development, there are numerous weaknesses in the private sector environment, such as low value-added, undifferentiated, and low-complexity products and a focus on overly saturated tertiary activities. The key industrial priorities for action are the development of SMEs through cluster developments in priority sectors (reform measure #7). Within the services sector, ICT sector is considered to hold a significant potential for growth. The key services sector priorities for action are the deployment of the network infrastructure for ICT and the development of digital economy subsequently (reform measure #8). Research, development and innovation (RDI) are together key drivers of economic competitiveness. They are extremely important for emerging and middle-income economies which can use the benefits of innovation in diversifying their economies and improving competitiveness. However, various reports have recently identified the several obstacles for promotion of technology and innovation. In particular, insufficient human capital for R&D and technology transfer hampers the innovation absorption capacity and pushes for low technology transfer (World Bank s analysis, 2013) and there is a lack of incentives for both private companies and academia to get involved with research, development and innovation (addressed by reform measure #15). Universities primarily engage in teaching and their research capacity is limited. The number of graduates in science and technology (S&T) is low and there are very few researchers working in key priority areas of industrial development STRUCTURAL REFORM PRIORITIES BY AREA The following section provides 20 priority structural reform measures identified for the Economic Reform Programme, covering the period Selected measures represent existing and new strategic priorities that Kosovo has identified as most important in order to address key obstacles to growth and competitiveness as outlined in the section 4.1. The measures presented have been elaborated within a comprehensive policy dialogue across government central and local structures, private sector and civil society. In general, they derive from the Government Programme and the National Development Strategy , which addresses country specific policy guidance from May

60 PUBLIC FINANCE MANAGEMENT 1. State of play and key obstacles to competitiveness Public Finance Management has not been identified as a major obstacle to growth in Kosovo. However, based on PEFA and OECD/SIGMA assessments, improvements in PFM area are needed in order to enhance Government s ability to budget policy priorities as well as ensure transparent and efficient execution of budget allocations especially in areas pertaining to economic growth and competitiveness. In relation to economic growth and competitiveness public procurement is the focus, as it directly intertwines with competition, which is a catalyst for innovation and firm competitiveness. Lack of transparent and competitive public procurement market which in the case of Kosovo accounts for a particularly significant proportion of both public expenditure and demand for goods and services in the economy - can negatively affect economic growth. The main challenges in the public procurement system are related to the need to improve the relevant legal framework, enhance the development of e-procurement, undertake improvement of administrative capacity and procurement skills, and strengthen monitoring of procurement procedures. For instance, actions are required to strengthen the public procurement system, improve the legal framework to simplify administrative procurement procedures, and reduce the usage of negotiated procedures without publication of a contract notice. EC Progress Report 2015 stresses that Kosovo is at an early stage of alignment with European standards, including in the areas of public procurement, Legislative alignment in some areas is high but implementation is weak. Some progress was made in the area of public procurement, especially as regards the enforcement of a centralised public procurement system, but concerns about corruption persist. 2. Measures taken to fulfil the country specific policy guidance since May 2015 The Joint conclusions of the Economic and Financial Dialogue between the EU and the Western Balkans and Turkey from 12 May 2015 (hereinafter: Joint Conclusions), identified three recommendations related to PFM. An overview of implementation of these recommendations has been provided under section 1 of ERP. Moreover, there are two specific policy recommendations which directly address the challenges identified under diagnostics: - Recommendation #2: Advance public administration reform with special attention on improving productivity and reducing costs. Take further steps in strengthening public finance management practices - Recommendation #8: Step up the fight against corruption and efforts to improve public procurement, by enhancing administrative capacity, increasing efficiency and effectiveness of the Public Review Board, and implementing central procurement. In order to implement these recommendations, the Government of Kosovo has undertaken concrete measures in terms of putting in place respective policy framework. Coordination mechanisms are established in order to further strengthen country s efforts on public administration reform. In addition to this, Kosovo will further increase its efforts on Public Administration Reform to achieve 56

61 necessary indicators for forthcoming Sector Budget Support. These developments include the following: - Putting in place coordination mechanisms for Public Administration Reform; - Adoption and initiating drafting of strategic framework under three PAR related pillars: Strategy on Modernization of Public Administration (adopted Sept 2015) Strategy on improvement of Policy Planning and Coordination (adopted June 2015) Public Finance Management Reform Program (drafting initiated, adoption expected by June 2016). Strategy on Public Internal Finance Control (adopted May 2015); Adoption of the National Strategy on Public Procurement System (January 2016) With the aim of increasing efficiency and transparency, the government in its reform agenda also embeds the implementation of the centralised procurement as well as the e-procurement. Regarding centralised procurement, during 2015 the list of six products that will be subject to the centralised procurement for all central level budget organisations has been approved by the government. Furthermore, the Government intends to gradually continue to further expand the list of goods and services that will be eligible for centralised procurement as well as cover all budgetary organisations, including municipalities and agencies. In addition, amended Law on Public Procurement has been approved by the Assembly, which introduces e-procurement and makes its use mandatory for all central level budget organisations. 3. Reforms planned to fully fulfil the outstanding policy guidance. As outlined in the previous section, there direct steps were undertaken to fully fulfil the policy guidance. As a continuation of reforms from ERP 2015, the main focus will be on implementation of strategic and legal framework recently adopted. In particular, launching and application of specific e- procurement modules will be one of main priorities for the medium term period. Reform measure #1: Improving public procurement through electronic procurement application Description of measure: In line with the planned reforms Kosovo adopted amendments to the Law on Public Procurement, which among other amendments through introduction of electronic procurement aims to increase efficiency and transparency of the public procurement procedures, to ensure a better usage of public funds and to reduce the procedural costs, and to encourage economic operators to participate in the public procurement procedures. It also strives to promote a fair competition between the economic operators, while guaranteeing an equal treatment and nondiscriminatory principle for all economic operators participating in the public procurement procedures, guarantees integrity, public trust and transparency in public procurement procedures. The main objective of reform measure is to develop and promote a wide use of electronic public procurement through a well-developed information and communication technology system. Timeline 57

62 In the coming three years the following activities are planned: 2016: 2017: 2018: - Launching and application of e-tendering and e-complaints modules of e-procurement - Increase awareness on public procurement among contracting authorities, economic operators and public procurement institutions. - Issuing operational guidance for e-procurement; - Training of all procurement officials on e-procurement; - Increase of administrative capacities, basic and advanced training; - Launching and application of e-contracting and e-contract management system modules - Specific and advanced training, including training for trainers, training on e-procurement - Maintenance and assessment of electronic procurement system - Specific and advanced training, including training for trainers, training on e-procurement Impact to the budget: Implementation of electronic procurement will not imply additional cost for the coming midterm period, as necessary funding has been allocated for Additional cost will involve only on the maintenance of the system in the amount of Euro, budgeted for the next three years. Initial capacity building activities will be covered through the existing World Bank Project, the following training activities will not imply additional cost. Implementation of this measure will have positive impact to the budget, as the increase of transparency through e- procurement will attract foreign contractors and investments. Impact on competitiveness: Application of electronic procurement will have direct effects to transparency and efficiency of public spending; therefore it will enable a more competitive system. Annual savings on government procurement contracts will be increased from the total value of procurement, which then would enable investment of public funds in other priorities. Decreasing the tolerance to corruption so that it is no longer the major obstacle to business requires a big push in order to increase fair competition, limit discretionary decision-making of state authorities, and improve accountability of institutions. In specific, the expected impact is to increase transparency of the public procurement process, to have greater accountability of the contracting authorities, to increase professional independence of the procurement officers, to improve control of corruption and to enable a larger number of companies, including SMEs, to compete for public contracts on a fair basis. Relevance for SEE2020 and any impact on the national and regional targets The measure is relevant to the SEE 2020 strategy under the Governance for Growth pillar. This measure will contribute to the achievement of the pillar objective: Improve government s effectiveness as measured by the World Bank Governance Index from 2.33 to 2.9 by Specifically related to the Dimension O: Anti-Corruption. Relations with national strategic documents and sector strategies 58

63 This measure is in line with the National Development Strategy, under Pillar II Governance and Rule of Law, Measure 5: Closing loopholes in the public procurement system. In addition the measure is in line with the National Programme for Implementation of SAA (NPSAA), under Objective 3.6, Chapter 5 on Public procurement INFRASTRUCTURE 1. State of play and key obstacles to competitiveness Access to uninterrupted power is a major obstacle to growth in Kosovo. Investing in new power generation capacity, upgrading the network transmission infrastructure and improving energy efficiency are thus key priorities for action. Transport links are not a binding constraint for growth at present, but the road and rail infrastructure also require further development to facilitate cross-border trade, especially related to the mining sector. Road and railway infrastructure - Since the declaration of independence, public investment in physical infrastructure has increased considerably. Investments in transport have mainly focused on the construction of new roads. The scale and composition of transport investment marked a significant shift: it rose from 0.4% of GDP on 2007 to 6% in 2012 (WB, PFR, 2014). However, most of this increase resulted from the construction of Route 7 with Albania. But, while the road maintenance expenditures increased significantly until 2009, they were scaled back to 0.5% of GDP in light of the construction of Route 7. Roads represent more than 90% of transport infrastructure by length, while 98% by service delivery (WB, PFR, 2014). Road infrastructure is comparable to the Eastern European average i.e. Kosovo has a high road transport density (average road length per square kilometre, per dollar of GDP and per capita), but when measured as the average road length per thousand of population, Kosovo s road density is average (WB, PFR, 2014). Related to the railway sector, Kosovo s needs should be defined in relation to the potential of the mining sector, by directing public investment, and soliciting private sector participation from mining operators and companies, toward freight transport, rather than passenger railway transport. The investment in transport infrastructure, especially railways, should specifically target trade corridors that enhance export links. Statistically, Kosovo has a very low railway density. Energy Globally, Kosovo stands at 124 in the ranking of 189 economies on the ease of getting electricity. In terms of reliability of supply and transparency of tariffs Kosovo is ranked with the score of 2.0, standing at the same level with Albania, but other countries of the region have higher values indicating greater reliability of electricity supply and greater transparency of tariffs (WB, Doing Business 2016). Based on an analytical simulation by the World Bank, Kosovo will face a power gap of around 3,000 gigawatts per hour in 10 years: this is due to an increasing power demand, and a planned decommissioning of the Kosova A power plant (PFR, World Bank, 2014). According to EC Progress Report (2015) investment and maintenance continue to improve the reliability of the power transmission system and reduce transmission losses. Whilst distribution 59

64 losses dropped, combined commercial and technical losses are high at %. One of the major constrains in terms of commercial and technical losses is bill collection in the North of Kosovo. Kosovo also faces the challenge of connecting to the SEE energy market. On the area of renewable energy, Kosovo lags significantly behind. The existing renewable energy policy framework, authorising and licensing procedures have yet to produce results or even remotely approach Kosovo s renewable energy target of 25 % by (EC Progress Report 2015) A strategy on energy efficiency has also been adopted for the period which includes a 3% savings target. The directive on energy performance of buildings is not being implemented. Kosovo still has not set up its own energy efficiency fund. The combined heat and power project at the Kosovo B power plant started operating in November, resulting in lower costs to households, reduced environmental pollution and a more secure supply for Pristina residents. 2. Measures taken to fulfil the country specific policy guidance since May The joint conclusions from May 2015 include one recommendation related to the infrastructure: Recommendation #6: Strengthen government oversight and consider setting up an advisory body to contribute to the assessment of future major infrastructure projects, including their fiscal impact and make sure they align with the regional agenda on connectivity (core network). Advance towards securing a reliable energy supply while ensuring the compliance with the EU environmental standards in the production of energy. In the view of Berlin process requirements, on 8 July 2015 the Government established the National Investment Committee (NIC). NIC serves as a mechanism through which priority investment projects are prepared and financing plans for each of the steps related to the specific projects from the Single Project Pipeline are discussed and agreed. The NIC framework introduces a Methodology for Selection and Prioritisation of Infrastructure Projects. In this regard, SPP methodology will serve as the main policy planning instrument for coordination of infrastructural investments in transport, energy and environment. This development enables Kosovo to fully adhere within the regional agenda on connectivity, thus benefiting from EU and other development partners support. Notably, as part of connectivity agenda SEETO Comprehensive Network was defined as TEN-T comprehensive network in the South East Europe. Moreover, existing and future planned investments in infrastructure directly target connectivity with the regional and European market, through improving access with main road and railway infrastructure. On energy, Kosovo has finalised its part of construction of the high voltage interconnectivity line between Kosovo and Albania. Based on this interconnection Kosovo can start developing a joint energy market with Albania, being complementary to each other. A joint market would significantly increase security and reliability of electro energetic systems of both countries as well as contribute to energy security of the region. 3. Reforms planned to fully fulfil the outstanding policy guidance. In order to fully address challenges identified under diagnostics and country specific recommendations, the Government will continue its existing investment projects on road 60

65 infrastructure, upgrade and modernisation of railway network, and energy generation and efficiency. The aim is to further develop road and railway infrastructure in order to facilitate regional trade and attract FDI, in line with Western Balkans connectivity agenda. Furthermore, in order to address challenges regarding generation capacities and ensure stable supply of electricity in the medium-term the focus will be on construction of new generation capacities as well as implement energy efficiency measures. Reform Measure #2: Construction of new highway to Skopje and upgrade and rehabilitation of railway line 10 The measure is a continuation of respective flagship measure and under ERP 2015, thus it represents a strategic priority for the Government of Kosovo. While in the road infrastructure there have been major advances in quality through building an extensive network of motorways and segments of highways network, in the railway sector further investments are necessary to bring Kosovo railroads to EU quality standards. Specifically the government will continue to implement its projects on construction and modernisation of road infrastructure, in addition to upgrade and/or rehabilitation of railway infrastructure. These infrastructure projects are of interlinks determined by the TEN-T Comprehensive Network in the SEE.Main investment projects for development of road and railway transport involve: 1. Roads: new construction - Construction of priority segments of Route 6 Prishtina Han i Elezit (R6) which connects the Corridor VIII to South-East Europe 2. Railway: upgrade and/or rehabilitation - Preparation of detailed project design for southern and northern part of the railway line 10 - General rehabilitation of railway line 10 (border with Serbia Leshak Fushë Kosovë Hani i Elezit border with Macedonia) Construction of Route 6 Prishtina Hani i Elezit started in 2014 and currently one segment has been finalised. The project will continue during the next three years when it is expected to be completed. Regarding general rehabilitation of Railway Route 10 (Border with Serbia Leshak Fushe Kosove Hani i Elezit Border with Macedonia), in 2010 a feasibility study financed by WBIF and implemented by IPF Technical Assistance was conducted during The most beneficial option for railway route 10 in Kosovo was proved to be general rehabilitation and electrification of the line. The next steps towards implementation include preparation of detailed project design for the entire line. Currently there is an ongoing procedure for implementation of the Project Design for the Southern Part of the Railway Route 10. There is a need to follow with project design for the northern part of the line in order to start with the general rehabilitation. Timeline In the coming three years the following activities are planned: 61

66 2016: - Construction of priority segments according to dynamics of implementation - Preparation of detailed project design for southern and northern part of the railway line : - Construction of priority segments of Route 6 according to the dynamics of implementation 2018: - Construction of priority segments of Route 6 according to the dynamics of implementation - Start of investments for general rehabilitation of Railway Route 10 Cost per activity: Annual cost for construction of Route 6 will be following: ,000,000; ,000,000; ,000,000 The cost for implementation of the project for Railway Route 10 will be following: million for preparation of detailed of project design for northern part of railway route ,875,000 as part of investments on general rehabilitation of Railway Route 10 (note that this cost will involve overall project implementation which will last until 2021) Budgetary impact: The total budgetary impact for construction of highway Prishtina Skopje (R6) will be 408,000,000 Euro financed entirely from the Kosovo budget. Whereas the total budgetary impact for general rehabilitation of Railway route 10 will be 50,075,000 Euro, from external finances. More than 80 million euro has been made available by the European Investment Bank (EIB) and the European Commission (EC) for the start of modernisation of 148 kilometres of railways in Kosovo, connecting it to the European network. A 42 million euro loan agreement for the modernisation of the Kosovo part of the European Route 10 Rail network was signed by EIB and Government of Kosovo. The EU will initially support the project with a 40 million euro grant for project preparation and implementation. An additional 40 million euro in EU grant is potentially envisaged for later stages of the project. Impact on competitiveness: Infrastructure is not a means in itself but a means to an end. The upper mentioned investments in infrastructure will generate short-term economic growth, but the purpose of the proposed measures is to make those capital investments play a support function for industrial development. The impact of the measures will therefore be a decrease in the cost of transport for exporting agricultural goods and minerals, a decreased cost of moving goods and people within the country, more efficient operations of public institutions and businesses, better market access for product placement and business deals. All of this could lead to increased output and more profitability in several business sectors, thus enabling higher economic growth for Kosovo. Relevance for SEE2020 and any impact on the national and regional targets The measure is relevant to the SEE 2020 strategy under the Sustainable Growth pillar. This measure will contribute to the achievement of the pillar objective: Increase exports of goods and services per capita from the region from EUR 1,780 to EUR 4, 250 under the Dimension I: Transport. 62

67 Relations with national strategic documents and sector strategies This measure is in line with NDS Pillar IV Infrastructure, Measure 29: Further Development of Road and Railway Infrastructure. It also corresponds with NPSAA, Priority measures under Economic Criteria and Objective 3.15 Transport. Reform Measure #3: Further development of energy production capacities Description of measure: In order to address challenges regarding electricity generation capacities and ensure stable supply of electricity in the medium-term, a new power plant will be constructed. The TPP Kosova e RE is expected to have generation capacities of around 500MW. Another dimension of interventions is the rehabilitation of TPP Kosova B, as a follow up of respective feasibility study. Further development of the energy capacities strives to ensure the security of supply for a more competitive market with as minimal environment effects as possible. Main milestones for implementation of this measure include: development of new generation capacities from lignite, TP Kosova e Re, with the most up to date agreed capacity of around 500 MW, and feasibility study for rehabilitation of TPP Kosovo B; as well as determining the decommissioning process of TC Kosova A. Timeline: 2016: 2017: 2018: - Signing contract with the investor, Contour Global - Publication of international competition process for construction of TPP Kosova e Re - Signing contract for the feasibility study on rehabilitation of TC Kosova B - Arrangement of EC Technical Assistance under IPA II on decommissioning of TC Kosova A - Carrying out Environmental Impact Assessment, and finalise detailed dismantling plan and necessary documents to commence physical dismantling - Selection of the company and commence construction works for the TPP Kosova e Re - Finalise feasibility study for rehabilitation of TC Kosova B - Finalise EIA and detailed dismantling plan - Continue construction works for the TPP Kosova e Re Budgetary impact: Construction of new generation capacities will be carried out by a private investor, therefore there will not be any direct impact to the budget for given period of time. The Government as per terms of contracts will guarantee the investor. For activities related to feasibility study for TC Kosova B, overall cost will be 1.5 million euro from IPA II and 3.1 million Euro from Kosovo Budget. 63

68 Decommissioning of TPP Kosova A is expected to be supported through IPA II. Studies for decommissioning will be supported through IPA 2014 which will cost 1.5 million euro. Whereas dismantling of facilities will cost 23 million Euro, to be supported through IPA II (starting from 2018). Impact on competitiveness: By increasing the energy generation, and simultaneously reducing the domestic consumption through efficiency measures and diversifying sources of imports, Kosovo could turn into a net exporter of electricity while also reducing the cost of imports and thus the cost to end-use consumers. Energy could thus play not only a supportive function to development by providing stable supply to other sectors of the economy, but could also become a source of development by generating revenues for the state. At the moment, there is a lack of competitiveness and openness in regional energy markets. The implementation of these measures would ensure an optimal mix of generation sources and take into account social aspect and environmental concerns. Relevance for SEE2020 and any impact on the national and regional targets The measure is relevant to the SEE 2020 strategy under the Sustainable Growth pillar. This measure will contribute to the achievement of the pillar objective: Increase net enterprise creation (new businesses per year) from 30,107 to 33, 760 and Increase exports of goods and services per capita from the region, from EUR 1,780 to EUR 4, 250. Specifically related to the Dimension H: Energy. Relations with national strategic documents and sector strategies This measure is in line with NDS, Pillar IV, and Measure: Construction of new energy generation capacities. It s also in line with NPSAA, respectively the Chapter on Economic Criteria and Objective 3.16 Energy. 4. Other reforms to help remove the obstacles identified in point 1 Reform Measure #4: Decrease energy consumption through energy efficiency measures Description of measure: The measure involves strategic priorities of the government on implementation of energy efficiency measures. In order to fulfil, its commitments towards Energy Community Treaty, Kosovo s priorities remain the implementation of legislation for buildings and adoption of missing secondary legislation and Energy Efficiency Law. Implementation of Energy efficiency fund will be focused on the following milestones: - EE and RE Investments in Central Government Buildings Financing eligible EE and RE subprojects in central government buildings about 140 buildings; - Pilot EE Investment Program for Municipalities Competitive callas for municipal proposals for grants to support building and street lighting improvements with some cofinancing requirement, or possibly a budgetary mechanism to recover part of the funds. - Technical Studies and Supervision. This includes consultancies to support the investment component, including conducting of building energy audits, development of detailed designs and bidding documents, and construction supervision. 64

69 - Training of Firms - support targeted training to design firms, construction companies and other EE/RE service providers to ensure adequate technical competencies and learning lessons from early projects, such as reasons for variations from energy audits and commissioning, typical technical design and construction weaknesses, etc. Budgetary impact: Improving the energy efficiency state in the period is expected to have a cost of million EUR, of which 0.45 million EUR from the Kosovo budget while 44.3 million EUR from WB and KfW. Energy Efficiency Measures in Public Institution Buildings. The approximate cost for the activity is 30.2 million EUR. Impact on competitiveness: Implementation of the measure on energy efficiency will contribute to decreasing of domestic consumption. Decreasing energy consumption will serve to lowering the cost of energy and as the result will help businesses and increase investments in private sector. Energy efficiency can help address issues related to energy security (current deficits and reduced imports), while reducing public expenditures on energy and environmental impacts of energy use. Efficiency measures enable substantial budgetary savings estimates indicate that the Government of Kosovo (GOK) spends some 41 million per year for energy in its buildings and could save as much as million annually through cost-effective EE measures. Relevance for SEE2020 and any impact on the national and regional targets The measure is relevant to the SEE 2020 strategy under the Sustainable Growth pillar. This measure will contribute to the achievement of the pillar objective: Increase net enterprise creation (new businesses per year) from 30,107 to 33, 760 and Increase exports of goods and services per capita from the region from EUR 1,780 to EUR 4, 250. Specifically related to the Dimension H: Energy. Relations with national strategic documents and sector strategies This measure is in line with the National Development Strategy, respectively measure 27 within Pillar IV Infrastructure. In addition to this, the measure is in line with the NPSAA, respectively with Economic Criteria Block II and Objective SECTOR DEVELOPMENTS Agriculture sector development 1. Diagnostics Agriculture is not identified as one of the binding constraints for economic growth in Kosovo at present. However, given its sizable share in the overall economic activity, improvements to productivity and export competitiveness would contribute to growth over time. This is why the National Development Strategy has prioritized agricultural infrastructure investments facilitating development of agri-business, as well as improvements to agricultural land regulation. Also irrigation systems and cold storage facilities require significant attention, as this is an area where high-value added fruit and vegetable production can be especially profitably exploited. 65

70 Agriculture plays a significant role in Kosovo s economy. It is a major contributor to national GDP, accounting for about 11.9 per cent of GDP in Approximately 60 per cent of the country s poor live in rural areas and depend, directly or indirectly, on the agricultural sector for their livelihood. The sector is the largest private employer, accounting for about one-fifth of total employment, although primarily on an informal basis. About 90 per cent of the population have land for cultivation and 55 per cent own livestock. Beyond economic considerations, Kosovo s reliance on agriculture has a crucial social dimension being pervasive as a safety net for much of its population. Despite a steady growth in the sector since independence, the overall balance of trade in agricultural products is substantially negative. Imports of agricultural products remain relatively high, accounting for about 10 per cent of all imports. Of this amount, 30 per cent comprise food and food products. On a per capita basis, Kosovo is one of the largest importers of food in Europe. This is largely due to the fact that the sector has remained predominantly subsistent/semi-subsistent in nature and faces several diverse and inter-related challenges that are reducing competitiveness and preventing it from meeting its production potential. A key sector of Kosovo s economy, agriculture is fraught with systemic and structural challenges that will need to be addressed to harness its competitive and growth potentials. At present, agriculture is characterised by (still) poor overall productivity, primarily due to the following: fragmented land holdings averaging about 2 hectares (often spread across an average of seven smaller plots, further exacerbating economies of scale); outdated farm technologies and lack of modern agricultural knowledge/skills among farmers and agro-processors; lack of diversification of agricultural products; lack of investments in irrigation and the absence of a participatory system of irrigation management; limited access to, and especially high costs of, credit and investment capital, partly reflecting high informality and the inability to realise the value of collateral (e.g., because of the weaknesses in property rights regarding the availability and reliability of land title documents and maps); limited processing facilities, including lack of storage, packaging, and transport facilities; limited implementation of food safety and hygiene standards; 2. Measures taken to fulfil the country specific policy guidance since May The Joint Conclusion of the Economic and Financial Dialogue between the EU and the Western Balkans and Turkey from 12 May 2015 include one recommendation related to the agricultural sector: - Ensure planned increases in agricultural subsidies are directed exclusively at productivity increasing initiatives. This recommendation addresses key challenges Kosovo has in terms of productivity, diversification of agricultural products, and lack of investments in irrigation and absence of a participatory system of irrigation management. 66

71 To address these challenges, the Government of Kosovo has continued its support for agricultural sector through implementation of its Agriculture and Rural Development Strategy. The overall objectives of the agricultural and rural development strategy for Kosovo have been set for the period, based on the Europe 2020 strategy and its long term strategic objectives of contributing to i) viable food production ii) the sustainable management of natural resources and climate actions and iii) the balanced territorial development of rural areas. The support schemes will directly contribute to: - Increase productivity through implementation of measures under Agricultural and Rural Development Programme, the Government aims to contribute to increasing productivity, increase efficiency and effectively, usage of new technologies and replacement of old ones. Increase quality and safety standards through investments in agro-processing; - Reorientation of existing policies through promotion of new crops with priority and competitive advantage and organic farming; - Diversification activities development of rural tourism and other activities, in addition to the collection and cultivation of medicinal and aromatic plants, and non-wood forest products; - Transfer of innovation and knowledge in agriculture, forestry and rural areas and strengthening public administration capacity in implementing rural development programs; Budget allocation for measures of the first pillar of ARDP for 2016 is 50%, from the total budget on subsidies and grants. Implementation of these measures is in line with the Common Agricultural Policy, as within the EU, budget allocation for direct payments is split into 73% for direct payments and 27% for other activities. Implementation of these foreseen activities for ERP 2016 will have a direct impact in increasing agricultural production and processing, creation of new jobs and supporting of existing ones. Also, this measure will have a direct impact on improving livelihoods in rural areas, by way of implementation of rural diversification projects and involvement of Local Action Groups. Overall, the implementation of these measures will have a direct impact in the economic development of the country. 3. Reforms planned to fully fulfil the outstanding policy guidance. As outlined in previous sections the Government through implementation of support initiatives for agriculture sector has contributed to improvement of productivity and export competitiveness. In order to address existing challenges in the sector, the Government will focus its priorities on investments in agricultural infrastructure for agribusiness and land consolidation related activities. Reform measure #5: Agricultural infrastructure for agro-business The measure aims to address challenges related to agricultural infrastructure, including soft and physical infrastructure. This entails extending the coverage of irrigation system throughout the regions with high production potential, improvement of wholesale markets, decreasing transaction costs, quality assurance. This reform measure is in line with the National Development Strategy, and it includes the following: 1. Increase irrigation system coverage to at least 40% of arable land by 2020 (from the current ~15%); 67

72 2. Develop the agricultural wholesale market infrastructure, respectively increase warehouse and storage facilities in key Kosovo regions, including through PPP; 3. Expand the number of laboratory testing units for verifying the quality of private seed production and to improve phyto-sanitary measures, which are key to expanding agricultural exports; 4. Establishing Integrated Agricultural Information System in order to increase competitiveness in the sector (integration of existing agricultural information systems FADN, EFR, LPIS, and IACS); Budgetary impact: MAFRD has allocated 2,100,000 for irrigation projects in the public sector in In addition, another 1,000,000 is planned as part of the 2016 rural development program targeting private farms. It is expected that donors will also be involved in irrigation projects and IT infrastructure related projects. Impact on competitiveness: Implementation of these measures will directly impact the growth of agricultural productivity, through better and additional irrigation possibilities; improvement of agricultural production and trade through better market infrastructure, including wholesale markets and improvement of IT systems related to more efficient implementation and monitoring of MAFRD support measures and a more functional system of registration of farms. Increasing agricultural productivity, facilitating trade and advancing innovation will translate into cost savings for agroprocessing industry and its growth, and will help provide higher rates of return and overall economic growth. Relevance for SEE2020 and any impact on the national and regional targets The measure is relevant to the SEE 2020 strategy under the Sustainable Growth pillar. This measure will contribute to the achievement of the pillar objective: Increase net enterprise creation (new businesses per year) from 30,107 to 33, 760 and Increase exports of goods and services per capita from the region from EUR 1,780 to EUR 4, 250 under the Dimension J: Environment. Relations with national strategic documents and sector strategies This measure is in line with the NDS and NPSAA. Both addressing the need for investments in agricultural infrastructure (NDS Measure 31, and NPSAA Objective 11, Agriculture and rural development. Reform measure #6: Consolidation of agricultural land Description measure: Through this measure, the Government aims to address fragmentation of agricultural land, by grouping and creation of larger and consolidated parcels, with the purpose of increasing their sizes, which will lead to an increase in the average size of farms. This will have a direct impact in increasing the agricultural productivity and competitiveness in the market. Dispute resolution of legal participants in the unfinished land consolidation and registration of property owners in the Immovable Property Rights Register (IPPR) in Municipal Cadastral Office. Increasing the size of the farm, in order to be more competitive in the market. The completion and registration of owners in IPPR will enable the creation and development of the land market as very important precondition of a free market economy. 68

73 Increasing opportunities for long-term investments in lands that have the status of unfinished land in the process of land consolidation. Facilitating land reform through the development of the land market (trade, the creation of standard rental contracts), stopping the further fragmentation of plots. Improved control of unplanned construction in areas covered by land consolidation, thus decreasing the loss of agricultural land. Timeline: The project on land regulation on voluntary basis currently is carrying out public consultation and information with owners and users of agricultural land in the village of Pozharan, Municipality of Vitia and it is expected to continue with project implementation in an area of 30 ha. This project will also continue in other municipalities according to the Law No. 04/L-040 on land consolidation. Budgetary impact: According to the Action Plan of the Strategy on Land Consolidation, completion of unfinished land consolidation projects will be carried out during , for which activities around Euro for each year are allocated from the national budget. This entails some cadastral zones in these municipalities: Vushtrri, Gjakove, Mitrovice, Viti, Obiliq, and Prishtina. Impact on competitiveness: Projects of voluntary consolidation of agricultural land will continue to increase farm sizes, improve access to property, resolution of property disputes, support income generation for farmers, reduce unit costs, increase productivity of agricultural crops and improve competition of agricultural products on the market. Also, land consolidation will contribute to the sustainable development of agriculture and rural areas. Land consolidation as an integral part of rural development and an important policy reform of agricultural land can have an impact on several different levels: lower level (with farmers as direct beneficiaries, social and gender equality because it will help in clarifying property rights), medium level (indirect beneficiaries, improved infrastructure opening of new jobs) and high level (national economy, institutions and the environment). Relevance for SEE2020 and any impact on the national and regional targets The measure is relatively relevant to the SEE 2020 strategy under the Sustainable Growth pillar. This measure will contribute to the achievement of the pillar objective: Increase net enterprise creation (new businesses per year) from 30,107 to 33, 760 and Increase exports of goods and services per capita from the region from EUR 1,780 to EUR 4, 250 under the Dimension J: Environment. Relations with national strategic documents and sector strategies This measure is in line with the NDS and NPSAA addressing legal and other interventions needed to be undertaken in order to increase agricultural productivity through addressing significant land fragmentation (NDS Measure 20, NPSAA Objective 11, Agriculture and rural development. Industry sector development 1. State of play and key obstacles to competitiveness Industry-level factors are not identified as a binding obstacle to growth in Kosovo. The share of industry to GDP is comparable to some of its regional peers, but given development needs, including 69

74 the need to create jobs, this may be considered as low. Weaknesses in the private sector environment are pervasive, including engagement in low value-added, undifferentiated, and low-complexity products and a focus on overly saturated tertiary activities. Kosovo has yet to exploit the potential of industrial clusters as a means toward greater employment generation, but this, too, is hindered by a host of factors, including weak inter-firm cooperation via underperforming industry association. The relative size of industry, measured by its value added, to GDP, for the period stands at an average of 20%. This is comparable to some of its neighbours: Albania s industry to GDP share for the same period is 14%; 26% in Bosnia and Croatia, 27% in Macedonia and Serbia; and 19% in Montenegro. The regional average across these countries, including Kosovo, stands at 25%. Kosovo s private sector is stuck in a low equilibrium trap: it is small-scale, scattered, engaging unspecialized labour, operating in overly-saturated low value-added tertiary activities, characterized by lack of knowledge and innovation, inadequate corporate financial reporting standards and a systemic failure to adopt EU quality management and safety standards. This, in turn, translates in undifferentiated and low product complexity that is not competitive in international markets and yields low incomes that do not place Kosovo on a sustainable income convergence path to the EU. In general, Kosovo also faces challenges related to the emergence of industrial clusters, because of weak inter-firm cooperation and coordination via underperforming industry associations; weak educational and research institutions who would have supplied the SME sector with businessrelevant knowledge; even with those institutions that do exist, there are weak links between them and the SME sector; lack of competitive edges (due to lack of high-skilled labour or lack of innovation) to integrate local clusters as part of regional or global value chains; lack of strong business advisory services to improve value proposition by businesses, including advice on deal-making to enhance joint strategic partnerships both within and outside of Kosovo; efforts to integrate local clusters and the SME sector in general as part of regional and continental value chains are hampered by lack of production certification. Cooperating between firms to pool production capacities together for largescale orders is hard to achieve if there is variance in firms complying with product certification standards. 2. Measures taken to fulfil the country specific policy guidance since May The Joint Conclusions of the Economic and Financial Dialogue between the EU and Western Balkans and Turkey from 12 May 2015 does not provide specific recommendations related to industry sector. 3. Reforms planned to fully fulfil the outstanding policy guidance. In order to address challenges identified under section 1 of this area the Government has initiated specific studies on industry sector development. The study identified priority sectors with potential for cluster development, to follow further with development of policy framework. Reform measure #7: Determining the potential for industrial cluster development Description of measure: The main objective of the reform measure is to establish conditions for development of SMEs in Kosovo through cluster development in priority sectors of Kosovo s 70

75 industrial policy. The rationale behind this reform measure is that Kosovo s internal competitiveness is weak because of domestic policy failures and external competitive pressures. This would enhance domestic competitiveness and includes policy and institutional framework; supporting cluster development; and facilitating establishment of supplier and sub-contractor cluster networks. This priority is a continuation of measures from ERP Timeline: 2016: Through Regional Cooperation Council component on competitiveness Kosovo will implement the following activities: 1. Strengthening industrial base through: Regional Industrial Policy Harmonization and Sectorial Dialogue; Industrial policy analysis and establishment of the regional observatory on the state of industrial policy in the region and Development of regional industrial development Instruments : Increase competition and export promotion through: - Analysis of the value chain within domestic markets - Development and implementation of Competitiveness Programme. Budgetary impact: Within the RCC component on competitiveness Kosovo during 2016 will benefit euro. IPA project Increase of competitiveness and export promotion for the next period will be 2 million euro. Impact on competitiveness cluster development will enhance competitiveness of private sector, enable links to and for the value chain to development. Implementation of the measure will also increase exports with higher value added, and exports in general in relation to GDP and increase financial capital turnover while increasing domestic industrial production (mining) and its exports, and finally increase the level of strategic cooperation between businesses. Relevance for SEE2020 and any impact on the national and regional targets The measure is relatively relevant to the SEE 2020 strategy under the Smart Growth pillar. This measure will contribute to the achievement of the pillar objectives: Increase GDP per person employed by 32% & Add highly qualified people to the workforce. Specifically related to the Dimension D: Education and Competencies; and Dimension E: R & D Innovation. Relations with national strategic documents and sector strategies This measure is one of core policy intervention within the NDS, in particular development of a industrial policy (Measure 17) is considered and linkage throughout other area fields is crucial for Kosovo s growth and competitiveness Services sector development 1. State of play and key obstacles to competitiveness The service sector itself is not considered to be a binding obstacle to growth in Kosovo.., However economic activity has been concentrated mostly in the services sector, which has grown through large remittance inflows and the large international presence in Kosovo. Substantial productive investment in the tradable goods sector has not taken place yet. Kosovo s services sector is characterized by large differentials in earnings and concentrated in terms of location only in a few 71

76 large cities, increasing further the interregional differences in growth rates and development levels (UNDP, Human Development Report, 2012). In fact, the ICT sector is considered to hold significant potential for growth. ICT promotional policies and support schemes in Kosovo are rather modest compared to other regional countries. Human resources, mainly educated in local universities need to be provided with additional trainings for specific sectors dealing with ICT as well as new methods of management and marketing. It is necessary to overcome the existing gaps through education and employment, increase the number of local talents and expand opportunities for the creation of digital jobs, with a special focus on youth, women and people with disabilities. In terms of infrastructure, fixed telecommunication networks are widespread in urban areas due to the liberalization of the sector in 2003 and considerable private investments since then. However, despite some success stories from Kosovo companies adopting state-of-the-art ICT through imports and foreign direct investment (FDI), the overall use of ICT in the industry is still limited and its competitive benefits are not adequately understood by many firms, especially MSMEs (Micro, Small & Medium Enterprises). More must be done especially in broadband connections, with a focus on areas without coverage with such infrastructure, in order to improve Kosovo s position in comparison to countries in the region (in 2014, the penetration rate of broadband lines at the national level was 10.97% of the population, mainly concentrated in cities). Regarding the policy framework the Government in April 2013 approved the Strategic document Digital Agenda for Kosovo , whereas recently a National IT Strategy has been adopted by the Government. Main interventions under these two documents provide for introduction of new policies to ensure a business environment conducive of ICT sector growth, in terms of infrastructure with a focus on rural areas, schools, libraries, healthcare institutions, and also adopt new educational policies to create a new adequate workforce/ict workforce. Better coordination between the parties involved in ICT activities, application of international standards for ICT, facilitating access to finance for ICT business sector and for businesses which seek to enhance the efficiency and competitiveness of their business through ICT, would have a significant impact on improving the ecosystem of doing business in Kosovo, focusing on the future digital economy of Kosovo. 2. Measures taken to fulfil the country specific policy guidance since May The Joint Conclusions of the Economic and Financial Dialogue between the EU and Western Balkans and Turkey from 12 May 2015 does not provide specific recommendations related to services sector. 3. Other reforms to help remove the obstacles identified in point 1 In order to address existing challenges in the ICT services sector and enabling an environment for development of the potential of ICT services the Government will focus on accelerating the access to, and use of ICT through the rollout of infrastructure broadband, strengthening its human capital to ensure full involvement, and maximizing the benefits of the digital economy in the global market. 72

77 Reform measure #8: Expansion of the relevant infrastructure for ICT networks and services for socio-economic development Description of measure: Ministry of Economic Development in cooperation with the World Bank, is developing the program for Kosovo Digital Economy KODE. KODE components are based on projects that will develop broadband infrastructure in rural areas with no coverage, as well as human capital and digital businesses, in order to bring Kosovo into the digital economy of the future. The implementation of the Kosovo Digital Economy Development KODE includes: - High-speed broadband infrastructure Deployment; - ICT skills development for Digital Economy and supply and support to digital businesses. The capacity building phase will consist of training on technical and soft skills that are mostly demanded skills for jobs in international online marketplaces. The pilot will be implemented during January and June 2016 and is fully funded by the Korean Green Growth Trust Fund. Timeline: Expanding ICT infrastructure through leasing % of Dark Fiber Infrastructure of Energy Company-KOSTT which is currently not in use. During Implementation of pilot project Women in online work in two municipalities (100 women); and Training of 90 youngsters in a 12 month period on ICT, followed up with internship programmes within 1 year at STIKK member companies through the internship pool/student placement service of STIKK, which will help them put to practice the newly acquired skills and showcase their skills to potential employers. Cost per activity 1. Deployment of high-speed broadband infrastructure; costs necessary for the implementation of the activity are 31 million Euros, distributed linearly (World Bank loan) 2. ICT skills development for the Digital Economy and supply and support to digital businesses). Cost required for implementation 6 million Euros, distributed linearly (IPA 2 or from World Bank loans). Budgetary impact: Budgetary impact for two components of the programme will be 37 million Euro for the period Impact on Competitiveness: Information and Communication Technology as a general purpose technology and broadband as infrastructure, necessary to facilitate access to ICT services, can radically change how and where an economic activity is organized. High-speed broadband infrastructure deployment creates a suitable environment for the development of innovation, new business models, new and improved products and services thus increasing competitiveness and flexibility in economy. Enabling broadband services will lead to an increased productivity of business activities, access to new markets and development of business models improving the competitiveness. Offering a highly skilled labour force will help boost the ICT sector, increase competition and increase revenues in our country s economy. Building the capacities of businesses to export services 73

78 to countries in need of software and applications will also be the focus of this program. Management of processes, quality, reporting and compliance with international safety standards are of particular importance for ICT businesses in Kosovo. Offering a highly skilled labour force will help boost the ICT sector, increase competition and increase revenues for our country s economy. Relevance for SEE2020 and any impact on the national and regional targets The measure is relevant to the SEE 2020 strategy under the Smart Growth pillar. This measure will contribute to the achievement of the pillar objectives: Increase GDP per person employed by 32% & Add highly qualified people to the workforce. Specifically related to the Dimension F: Digital society. Relations with national strategic documents and sector strategies This measure is in line with the National Development Strategy, respectively with measure 29, under Pillar IV Infrastructure BUSINESS ENVIRONMENT, CORPORATE GOVERNANCE AND REDUCTION OF THE INFORMAL ECONOMY 1. State of play and key obstacles to competitiveness Cost of finance is considered to be a major obstacle to growth, given the low loans to GDP ratio, high interest rate spread, uncompetitive behaviour in the banking sector and a high level of contract enforcement risk. Contract enforcement is also considered a binding constraint to growth due to the cumbersome commercial court resolution process. Practices of the informal economy, too, are considered by Kosovo firms to be a major constraint to business growth. Perceptions among Kosovo firms on the level of corruption practices in Kosovo are considered to be highest in the region, and this presents serious challenges to doing business in the country. Business Environment: The World Bank Doing Business report of 2016 specifies a number of areas where Kosovo has made progress. The regulatory framework in Kosovo receives mixed marks, but in general it can be considered a binding constraint to growth. Labour regulations are considered adequate, but customs and trade regulations are perceived to be a major constraint to enterprise growth (World Bank Doing Business 2016). Starting a business requires 5.00 procedures, takes days, costs 1.10% of income per capita and requires paid-in minimum capital of 0.00% of income per capita. Kosovo stands at 47 in the ranking of 189 economies on the ease of starting a business. Registering property there requires 6.00 procedures, takes days and costs 0.30% of the property value. Kosovo stands at 32 in the ranking of 189 economies on the ease of registering property. According to OECD growth diagnostics study cost of finance is considered to be a major obstacle to growth, given the low loans to GDP ratio, collateral requirements are the highest in the region (300% of the loan amount). Most small firms use their retained earnings or own capital to finance investments and capital markets generally under-developed; venture capital or other start-up financing is almost non-existent. 74

79 The study points out the perception that judicial system is considered one of the most corrupt out of the public institutions. As a results the study concludes that companies face poor protection of property rights and weak contract enforcement. According to 2016 World Bank Doing Business report, contract enforcement takes days and costs 34.40% of the value of the claim. The report stresses that Kosovo stands 48 in the ranking of 189 economies on the ease of enforcing contracts. There are constraints in relation to regulatory system, as its frequent changes in regulation, limited consultation and weak implementation capacity at local level presents a considerable problem in Kosovo. Administrative and finance burden on businesses remain high: Kosovo ranks 75th out of 189 countries and below most regional peers. Doing Business 2016 reports that dealing with construction permits requires procedures, takes days and costs nearly four times more than OECD countries. Insolvency resolution is also difficult in Kosovo, the financial and administrative burden on insolvency resolution is also limiting, and costs are particularly high both in terms of share of estate value and in terms of the recovery rate. Resolving insolvency takes 2.00 years on average and costs 15.00% of the debtor s estate, with the most likely outcome being that the company will be sold as piecemeal sale. The average recovery rate is cents on the dollar. Kosovo stands at 163 in the ranking of 189 economies on the ease of resolving insolvency. Corporate governance and privatisation process: EC Progress Report 2015 emphasise the challenges related to privatisation and liquidation process. Over 2015, the Privatisation Agency remained dysfunctional and its credibility was further tarnished amid political controversy and corruption allegations. The unresolved status of property rights and lengthy legal proceedings in dealing with financial claims on privatised assets hinder the privatisation process and delay disbursement of privatisation revenue held at the central bank. Among centrally-managed enterprises, only two, the Kosovo Energy Corporation and Post and Telecommunications Kosovo, continued to generate a profit in Informal Economy: According to OECD Growth Diagnostics study, businesses in Kosovo bypass burdensome regulations by staying in the grey economy. Hence, it is estimated that informal economy stands at 39% of GDP, creating unfair competition to formal businesses, with 41% of companies calling informal competition a very severe constraint to doing business. In comparison to regional economies, informality appears to be more important issue in Kosovo. 2. Measures taken to fulfil the country specific policy guidance since May 2015 The Joint Conclusions of the Economic and Financial Dialogue between the EU and Western Balkans and Turkey from 12 May 2015 identified several recommendations for Kosovo respective for this area: Continue to improve the business environment and continue with the clearing of court backlogs, strengthening capacities of judicial system, and developing cadastre databases. Advance measures to tackle informality in line with the strategy for the prevention and fight against informal economy, including incentives to reduce undeclared work. 75

80 Reduce the administrative burden for business by implementing the Better Regulation Strategy and the Law on Permits and Licences. Develop measures to provide targeted support for SMEs and to widen their access to finance. Step up the fight against corruption and efforts to improve public procurement, by enhancing administrative capacity, increasing efficiency and effectiveness of the Public Review Board, and implementing central procurement. Advance restructuring and restart the privatization of non-essential Publicly Owned Enterprises (POEs). Take steps to improve the efficiency and corporate governance of strategic POEs. Address the lack of quorum of the board of Privatization Agency of Kosovo (PAK) and accelerate privatization of Socially Owned Enterprises still in PAK's portfolio. Address the underlying causes for high costs of bank-based financing, reduce the duration and cost of insolvency procedures by adopting the new bankruptcy law and further improve contract enforcement with a view to increase overall financial intermediation in the economy. The recommendations stemming from Joint Conclusions of May 2015 address most of challenges identified under section one above. In order to address these challenges the Government of Kosovo has been focused on implementing specific recommendations particularly in terms of improving the business environment. These efforts have been recognised by the World Bank Doing Business Report Some of main achievements and plans are outlined below: In order to improve contract enforcement and increase judicial capacities, Kosovo has initiated regulation of property rights system which entails development of strategic and legislative framework. The strategic plan for Kosovo s judiciary, the communication strategy and the national strategy for reducing the backlog of cases are being implemented, addressing substantial shortcomings in the judiciary. The Government has also adopted the Law on Strategic Investments. The purpose of the Law is to facilitate promoting, attracting and realization of strategic investments. This Law also aims to establish administrative procedures and criteria for evaluation, selection, implementation and monitoring of strategic projects, as well as determining the procedures for granting the use of the property of the Republic of Kosovo, for the purpose of implementing strategic investments projects. The banking sector in Kosovo has shown improvements in regard to this issue as interest rates on land have fallen to 7.9% (in September 2015) compared to 10.7% (September of 2014); due to a combination of factors: the fall in interest rates on deposits, the improvement in the quality of the credit portfolio, as well as banks interest to increase lending as a result of inter-bank competition. Another factor with a direct impact in this regard is the reform within the justice system, particularly on the functionalization of Private Enforcement Agents, which are expected to continue to play a major role in one of the justice systems most prominent problems, that of contract enforcement. The Government has adopted the strategy for Modernisation of Public Administration, which among other deals with service delivery focusing on improving the quality and accessibility of administrative services to citizens and businesses, based on reasonable administrative procedures and using client-oriented delivery methods based on inter-operability of government s ICT systems and 76

81 databases. In order to improve regulatory framework, implementation of Better Regulation Strategy has been followed up with concrete interventions. Law on Normative Acts has been adopted by the Government, and proceeded for approval by the parliament. The latter foresees introduction of Regulatory Impact Assessment, and establishment of a Unit within the Office of Prime Minister. An important step has been taken with regard to the Privatization Agency, as the second half of 2015 finds Kosovo with an approved list of board members for this agency, such that all up-coming decisions and processes now are no longer on hold. The Government of Kosovo relies on the EC to understand the grave importance of such a body in regard to further developments to PAK s portfolio, which is why the process of finalizing a capable/ qualified list of potential board members was a particularly difficult task. This has been a key step in establishing a basis upon which the government can from hereon continue with the privatization of the remaining SOEs. Government has paid particular attention to implementation of the Strategy against Informality. In particular reforms on tax policy were aimed at easing the tax burden and process of formalising local businesses. This measure aims the conclusion of the fiscalisation process of all businesses which will promote a more competitive environment for all businesses operating in the Republic of Kosovo. Together with the liberalisation of the market for fiscal devices, the Ministry of Finance designed additional measures to stimulate consumers to collect fiscal receipts and raise awareness about the importance of formalising the business. 3. Reforms planned to fully fulfil the outstanding policy guidance. As outlined in the previous section there are a number of outstanding policy guidance that need to be addressed in order to improve the current situation on business environment, corporate governance and fight against informal economy. Therefore, this ERP will focus more on improving evidenced based policy development, address efficiency of courts, improve property rights system, and facilitate access to finance and contract enforcement, and boost government efforts to reduce informal economy. Reform measure #9: Streamline evidenced policy making Description of measure: Better regulation strategy aims at creating a smart regulatory system that balances gains and economic, environmental and social costs. The goal calls for strict adherence to RIA principles and procedures to ensure that all legislation meets this standard. In line with this, establishment of a Regulatory Quality Unit would also be helpful in gathering and analysing data trends that will inform the process of designing smarter policies in the future. By encouraging RIA in the process of policymaking, unnecessary legislation is avoided, and policies enacted are clear, consistent, and problem oriented. Given Kosovo s constrained resources, undertaking RIA should help the government achieve greater results per euro spent. Finally, the government should involve business community representatives as social partners throughout the policy-cycle; the maxim Nothing About Them, Without Them should underpin the complete policymaking cycle. Timeline: 2016: 77

82 - 25 RIA trainers from line ministries will finalise training - Establishing Unit for Quality Assessment within the Office of Prime Minister - Adoption of the Law on Normative Acts, and putting in place procedures for compulsory implementation of RIA through the system of concept papers and explanatory memorandums of draft legal acts. - Review and improve the legal framework regulating RIA process and methodology : - Piloting and regulatory impact assessments (3 in 2017 and 5 in 2018). - Design a training course on good governance principles and RIA. Annually conduct trainings for the Better Regulation Unit, representatives of regulatory authorities, NGOs and private sector - Provide assistance to KIPA in order to include the course on good governance principles and RIA in their curricula - Set clear and effective reporting criteria for regulatory framework reform for regulatory authorities, including on meeting principles of good governance and RIA. Budgetary impact: 1.98 million for a capacity building project to support the central public administration carry on good quality RIA. The project costs are for 6 full time local experts with a salary of 500 hired for 2 years (including 20% contingency costs) and 300 thousand software cost for RIA database and 10% for its subsequent annual maintenance. Impact on competitiveness: Policy formulation and law-making is more effective and efficient as well as unnecessary legislation is avoided and policies are clear and consistent and problem-oriented. Systematic implementation of RIA will enable the government to achieve greater results for each euro spent. Their implementation will lead well thought policies and increase of overall efficiency of work in the public and private sector. Decreasing administrative cost and business cost from avoiding unnecessary regulation will enable reduction of government spending and lower cost for doing business, which will directly have impact to economic growth. Relevance for SEE2020 and any impact on the national and regional targets The measure is relevant to the SEE 2020 strategy under the Governance for Growth pillar. This measure will contribute to the achievement of the pillar objective: Improve government s effectiveness as measured by the World Bank Governance Index from 2.33 to 2.9 by Specifically related to the Dimension N: Effective Public Services. Relations with national strategic documents and sector strategies This measure is in line with the National Development Strategy measure 11 under Pillar II Rule of Law and Governance. The Measure is also the core intervention of the Strategy for Better Regulation. 78

83 Reform measure #10: Strengthening the property rights system Description of the measure: The main objective under this measure is to strengthen the property rights system through particular focus on strengthening the legal framework, promotion of marketable land, strengthening judicial capacities for dealing with property rights as well as activities that would ensure better protection of property rights for marginalised groups, minorities as well as women. Property rights system improvement will require the following milestones: - Development of implementation-oriented legislation to clearly define property rights and improve tenure security for women and members of minority communities - Development of improved court procedures to more efficiently resolve property claims and disputes - Increased capacity of courts to decide and enforce property rights - Increased capacity of Civil Society Organizations to raise public awareness, change societal attitudes and behaviours, and advocate for women s rights to property - Increased number of women inheriting property and securing access to credit Timeline: In 2016 the Ministry of Justice will focus on drafting and adoption of the Strategy on Property rights, as well as Adoption of the concept paper on public property. This undertaking will be supported by USAID Property Rights Programme which will last until Budgetary impact: the overall cost of the measure will be 7.7 million Euro which will be funded by USAID Property Rights Programme. Impact on competitiveness: Creation of an effective system of property rights creates legal certainty to investors and consequently increases investment opportunities, while it creates citizens more opportunities to use property as collateral and therefore improves access to finance. Implementation of this measure will have impact on increased private investments that are much needed to enable economic growth. The focus on property rights for marginalised groups also will enable greater social cohesion. Relevance for SEE2020 and any impact on the national and regional targets The measure is relevant to the SEE 2020 strategy under the Integrated Growth pillar. This measure will contribute to the achievement of the pillar objective: Increase SEE intra-regional trade in goods by more than 140% and Increase overall annual FDI inflow to the Region by at least 160%. Specifically related to the Dimension B: Competitive Economic Environment and Dimension C: Integration into Global Economy. Relations with national strategic documents and sector strategies This measure is in line with the National Development Strategy measure 13 under Pillar II Governance and Rule of Law. 79

84 Reform measure #11: Increased judicial efficiency Description of measure: The efficiency of the judiciary is commonly measured as the speed and quality with which justice is made. However, the Kosovo s judicial system is slow in the disposition of the cases (large number of received minor offence cases, large historical backlog, and low clearance case lead to accumulation of backlog), subsequently causing high transaction costs. The focus in improving the efficiency of judiciary should be on decreasing the caseload for minor offences through incentives and speedy court settlements, temporary increase in hiring additional manpower to sort out cases, and introducing a Case Management and Information System (CMIS) in all courts by Improving the performance of the judicial system in terms of increase of the clearance rates, reduction of disposition time and elimination of backlogged cases is the top priority for Kosovo. In this context, the following challenges need to be addressed: 1. Amending the legal framework so that the judicial system deals only with the minor offences if the fines were appealed by the parties. 2. Decreased caseload for minor offences: Introduction of incentives for early payment of fines so that: (1) a 50% discount is applied for fines paid within 72 hours and (2) a 50% increase of the fine is applied if the 7 days payment period is breached and the settlement is transferred to a court. 3. Targeting zero backlog: Achieve Zero Backlog in 2020 for civil and criminal cases by hiring additional manpower: Hiring a task force of 80 associates for a period of 4 years with the specific job to dispose of 90 thousands civil and criminal cases 4. Improve the clearance rates by optimizing the Case Management System: Automation of Kosovo Judiciary through the deployment and maintenance of CMIS system, including software, hardware and communication lines; training of end users (judges and prosecutors) Timeline: During 2016 it is expected amendment of legal framework, as well as initiating start of implementation of the project for Case Management System. Cost per activity: Subject to the law on minor offences whereby it is stipulated that courts will be dealing with cases only after they have been reviewed by institutions (i.e. police inspectorate and municipal authorities) and a second instance decision of these institutions was made. As such this requires increase of resources within these institutions with an approximate cost of 200,000 Euros. In relation to activity on amending the legal framework if the law is regulated as described above then the actual minor offence judges (close to 70) will be redistributed to work on civil and criminal backlog cases. As such this has no cost however the overall number of judges are still in need of professional associates (legal advisers) to assist them in day to day work and assist them in tackling the backlog of cases. These 80 additional professional associates will approximately cost 500,000 Euros per year. Second, the activity on targeting zero backlog costs around 4,800,000. It is accounted towards the salary wage for 50 judge advisers earning a monthly salary of 4,000 to support disposition of 90 thousand back-logged civil and criminal cases within 2 years. 80

85 Third, the cost for the fourth activity is 6,700,000. It comprises the software and implementation costs for the introduction of an Integrated Case Management System which enables case distribution and tracking from the registration to execution. Budgetary impact: The total cost for the measure is 11,700,000 EUR. Impact on competitiveness: The impact of the reforms on the judicial efficiency is indirect on the economic growth, competitiveness, FDI, while the policy measure itself does not have an impact on budget revenues or saving, nor in the job creation. Time savings from decreased disposition time is tremendous. Besides quicker access to justice and, henceforth, improved rule of law, that can attract new investment, the direct impacts of the decreased disposition time is the value saved by those that seek justice in courts. To determine the monetary value of the time savings, the shadow prices from arbitration were analysed. As we know, arbitration is more costly but it provides a swifter settlement of disputes. The break-even value of one day saved is 8.1 determined as the marginal cost of trials/arbitration divided by the marginal time savings. Using this parameter, we have that faster disposal of one case saves 2.5 thousand EUR and, multiplying this to the total number of incoming cases the overall value saved for the society is 140 million Euros. Subsequently, this amount is used as a proxy for the increase in gross fixed capital formation, which is forecasted to have an economic growth increase at a marginal rate of 0.1%. Relevance for SEE2020 and any impact on the national and regional targets The measure is relevant to the SEE 2020 strategy under the Governance for Growth pillar. This measure will contribute to the achievement of the pillar objective: Improve government s effectiveness as measured by the World Bank Governance Index from 2.33 to 2.9 by 2020 Specifically related to the Dimension P: Justice. Relations with national strategic documents and sector strategies This measure is in line with the National Development Strategy. Reform measure #12: Improve access to finances for Kosovo SMEs Description of measure: One of the main barriers for private sector investments in Kosovo is access to finance. Around 40% of firms identify access to finance as a major constraint. A large number of SMEs cannot meet collateral requirement to obtain bank loans. Expansion of credit guarantees and improved information on business and individual lending history would enable many more businesses to get access to finance and at lower interest rates. Timeline: During 2016, fully functioning Credit Guarantee Scheme and newly resourced based on the current design scheme (while ensuring transparent management) and taking into consideration the sectorial priorities deriving from existing studies on industrial policy. Arrangement of organisational structures, including board of directors will be carried out in the first half of : Evaluating the functioning of the scheme and reviewing the options for further expansion and optimisation. Finding other sources of funding in order to increase the sum of the capital invested. 81

86 Budgetary impact: 22 million is the capital contribution to the KCGF out of which the GoK will contribute an initial investment of 2 million by the end of 2016 and an additional 2 million by the end of International donors have promised support of 18 million euros. Impact on competitiveness: It is anticipated that FKGK will support over 4,150 new loans to SMEs, with the cumulative value over 360 million, creating over 20,000 new jobs in the first 6 years of its operation. Relevance for SEE2020 and any impact on the national and regional targets The measure is relevant to the SEE 2020 strategy under the both Smart Growth & Sustainable Growth pillars. This measure will contribute to the achievement of the pillars objectives: Increase GDP per person employed by 32% & Add highly qualified people to the workforce and Increase net enterprise creation (new businesses per year) from 30,107 to 33, 760 and Increase exports of goods and services per capita from the region from EUR 1,780 to EUR 4,250. Specifically related to the Dimension D: Education and competences and Dimension K: Competitiveness. Relations with national strategic documents and sector strategies This measure is in line with the National Development Strategy. Reform measure #13: Improve corporate governance with state owned assets Description of measure: Through this measure the Government aims to improve the efficiency of public enterprises in line with OECD corporate governance principles. Within this the Government will consider options for sectorial approach of monitoring and management of corporates with public ownership. In addition to this, the lack of a proper process for risk analysis of state enterprises to the budget and economy, results with a weak development of enterprises. An important intervention for improvement of corporate management includes training of officials in respective sectors on corporate governance and review possibilities for elimination of bureaucracies and influence to the commercial enterprises operating in competitive markets. Timeline: 2016: 2017: 2018: - Concept Document for new Law on Publicly Owned Enterprises approved - New Law on POE Adopted - Secondary Legislation approved containing reporting forms - Improvement of Monitoring and Supervision Capacities. - New POE Sup. & Mon. MIS developed - Capacities for Supervision and Monitoring Improved - POEPMU transferred to the Centre of Government, POE to Relevant Sectors 82

87 - Consolidated Report for 2017 in line with new requirements - Quarterly Monitoring in line with new requirements - Quarterly Monitoring in Line with New Requirements. Budgetary impact: 1 million for the period (1 year within the budget, second and third year additional 0.5 mil) Impact on competitiveness: implementation of this measure will lead to improvement of performance of enterprises with state assets; therefore it will result to increasing their contribution to economic growth, increase of the value of enterprises and increased incomes for the state budget through dividend. Better management will ensure that loss-making enterprises would cost less to the government, hence improving the fiscal risk. Relations with national strategic documents and sector strategies This measure is in line with the National Development Strategy. Reform measure #14: Merging customs and tax administration, establishing a single revenue collection agency Description of measure: One of the main aspects of reforms in order to tackle informal economy is the activity on merging the two revenue collection agencies, respectively Customs and Tax Administration. Establishing a single revenue collection agency is based on the need for improvement of services towards taxpayers, reduction of tax gap through simplified and effective structures of revenue collection. As the result this will increase the efficiency of revenue collection and reduction of cost during this process, will increase the autonomy of institutional structures dealing with revenue collection. Last but not least, with the new revenue collection agency the aim is to put in place more efficient institutional structures for implementation of tax and custom policies, as well as fulfilling EU integration requirements. The Government of Kosovo adopted an initial plan for establishment of Revenue Agency. According to this decision, the Minister of Finance established a coordination group to lead this process. Timeline: 2016: Coordination Group and its sub groups focus on drafting the legal foundation and the action plane; the Government proceeds to the Assembly the Law on Revenue Collection Agency. Following the approval of the law, commences formal merger of Customs and Tax Administration. 2017: complete functioning of the Agency and necessary intervention in legislation and the organisational structures of the agency, if necessary. 2018: ongoing merger process towards full integration (classical integration). Budgetary impact: preliminary analysis indicated that that the cost for implementation of the measure will be ,00 Impact on competitiveness In the case of Kosovo, the main motivation behind merging two key institutions is the increased potential for raising further domestic revenues, in a light of expected 83

88 further decline of border revenues due to preferential agreements with CEFTA and the SAA with the EU. Restructuring of labour inspectorate will enable a new dynamics in the implementation of the legal mandate of the institution, focusing on the protection and guarantee of the rights of the parties in labour market and reduce non-formal employment. Relations with national strategic documents and sector strategies This measure is in line with the National Development Strategy TECHNOLOGY ABSORPTION AND INNOVATION 1. State of play and key obstacles to competitiveness Research, development and innovation (RDI) are together key drivers of economic competitiveness. They are extremely important for emerging and middle-income economies which can use the benefits of innovation in diversifying their economies and improving competitiveness. The Government has frameworks in place to support Kosovo s largely low value-added private sector enterprises increase their access to research and innovation activities. The Law on Scientific Research Activity (2004) has enabled the establishment of the National Research Council - the body responsible for setting national research priorities and administration. The law states that up to 0.7% of Kosovo GDP should be spent on research and innovation, however public expenditures on R&D were estimated to be at around 0.1% of GDP in 2011 (OECD, 2013), which is marginal. The adoption of the National Research Program has marked the first comprehensive approach to identify national research priorities and to establish a system and infrastructure for research. The program has identified five research priorities: national resources, energy and environment, agricultural production and food safety, medical research, social and economic studies, and cultural and historic studies. The key objectives of the research program are the development of human capacities for research, development of research infrastructure, internationalization of research activity, strengthening the links between research and economy and promoting excellence in research activity. The National Research Programme is currently the main document for guiding legislation and policy design in the area of innovation. The Ministry of Education, Science and Technology (MEST) and the Ministry of Trade and Industry (MTI) are the main institutions responsible for developing a policy framework. MEST worked closely with the OECD in 2012 to develop a draft national strategy for innovation, however the document is still yet to be approved. Kosovo also drafted the Innovation Strategy developed in 2012 for the approval of the government. Various reports have recently identified the following major obstacles for promotion of technology and innovation: Insufficient human capital for R&D and technology transfer hampers the innovation absorption capacity and pushes for low technology transfer (World Bank s analysis, 2013). 84

89 Lack of incentives for both private companies and academia to get involved with research, development and innovation. Universities primarily engage in teaching and their research capacity is limited. The number of graduates in science and technology (S&T) is low and there are very few researchers working in key priority areas of industrial development. There is an inadequate and out dated infrastructure at research centres and universities. Given that micro-enterprises comprise the majority of the private sector in Kosovo, the financial capacity to plough back investment toward R&D and innovation remains very weak (World Bank, 2013) The weak capacity of business support organizations and business associations also hampers knowledge links with abroad and hurts the capacity to foster innovation in the SME sector. Lack of innovation promotion and awareness activities at a national level promoting innovation and helping youth engage with the areas relevant to science, technology and innovation. Insufficiently developed linkages with global networks of research and innovation, including linkages with the scientific diaspora. Development of the Policy Framework for industry academia- public sector cooperation with the support of the OECD. The draft document was presented in Pristina in May to get a feedback from the relevant stakeholders. The document is currently being finalised. Triple Helix Competition which was co-organised by the Kosovo Investment and Enterprise Support Agency (KIESA) at MTI in partnership with the OECD. Ten applicants were received under the current call and eight have received capacity building support with the development of their ideas. 2. Measures taken to fulfil the country specific policy since May 2015 The Joint conclusions of the Economic and Financial Dialogue between the EU and the Western Balkans and Turkey from 12 May 2015 do not specifically address technology and innovation. 3. Other reforms to help remove the obstacles identified in point 1 As outlined in the previous section, the Innovation Strategy is still being finalised and updated prior to be adopted by the Kosovar Government. Once adopted, the document would provide a clearer framework to be able to tackle the major obstacles for promotion of technology and innovation mentioned earlier. Therefore, this ERP will focus more on the issue of adoption of the Innovation Strategy as well as implementation of the other measures to foster business-academia cooperation and support promotion of technology and innovation with the aim to increase the competitiveness of the companies in Kosovo. Reform measure #15: Fostering business academia cooperation through research grants and innovation vouchers Description of measure: Under this measure the Government of Kosovo will focus on creating the policy framework for accelerating creation of research and innovation capacity with a focus on 85

90 priority sectors of industrial policy and based on improved partnerships between public research institutions, such as universities, the private sector firms, and the Government. As to the later, a coordinated approach between various institutions will be sought. It is expected the measure will establish the basis for increased public and private spending on research and development, which requires a clear policy framework, coordination and appropriate incentives. Over the following period of three years the following milestones are expected to be achieved: Timeline Adoption of the Law on Innovation and Technology Transfer (much needed especially when defining the royalties split between the research institution and researchers) Adoption of the Innovation Strategy. The strategy would define the key areas which need to be affected in order to create an enabling ecosystem to promote innovation in Kosovo. Including governance structures, necessary incentives, necessary skills and human capital as well as the necessary infrastructure needed to promote technology and innovation. Establishment of the Council for Innovation under the supervision of the Prime Minister Practical initiatives focused on creation of capacity building to promote technology transfer and innovation which for 2016 would involve: o Innovation vouchers 20 innovation vouchers for 2016 o Research project grants some 20 grants for 2016 o Innovation competition and awareness raising campaign In the coming three years the following activities are planned: 2016: 2017: Adoption of the Innovation Strategy. Establishment of the Council for Innovation. Distribution of the innovation vouchers. Distribution of the research project grants. Awareness raising activities. 2018: Law on Innovation and Technology Transfer. Distribution of the innovation vouchers. Capacity building and awareness raining activities Planning of financial instruments to promote innovation. - Further implementation of the strategy and operation of the fund. Cost per activity 120,000 for implementation of capacity building activities in ,000,000 for implementation of the Fund for Smart Specialisation. 86

91 Budgetary impact: National funding within the MEST has been foreseen to cover the innovation vouchers (20,000) and research project grants (100,000) for Additional funding has been foreseen under IPA II funding through the fund for implementation of SMART specialization and advanced link with the industry will be available from in the amount of 2,000,000 EUR. Impact on competitiveness: Improved quality of research and access to innovation leads to a better understanding of business needs for new technological solutions and, in turn, the research and innovation concepts applied in business activities result in higher quality and more competitive products and services with higher export potential and added value. From a social point of view, the implementation of this measure will contribute to the creation of a more employable workforce. Social and economic effects will be long term and will be accompanied by growing income for workers and enterprises. Creating a more agile workforce will help attract foreign direct investment. Implementation challenges: Implementation challenges relate to the limited national budget for this specific area and the need for inter-ministerial coordination. Relevance for SEE 2020 and any impact on the national and regional targets The measure is relevant to the SEE 2020 strategy under the Smart Growth pillar. This measure will contribute to the achievement of the pillar objective: Increase GDP per person employed by 32% & Add highly qualified people to the workforce. Specifically related to the Dimension: R & D innovations and Dimension D: Education and Competencies. Relations with national strategic documents and sector strategies: This measure is in line with the National Development Strategy TRADE INTEGRATION 1. State of play and key obstacles to competitiveness The growth diagnostics study identified coordination externalities as constraining to FDI and exports. On the other hand the Growth diagnostics study stresses that information externalities are important but not binding at the moment. Kosovo has one of the least diverse export baskets in the region, comprising almost solely of low value added goods. The scope for diversification particularly into export oriented higher value added products is high. One of the most notable, and persisting, weaknesses in competitiveness and capacity to export is the lack of compliance with EU quality standards. The inflow of FDI is comparable with the regional average, especially as a percentage of GDP, but the current levels are considered too low to have a meaningful development impact. Kosovo has a precarious current account (CA) balance, even though this is similar across the Western Balkan region. During 2014, the current account deficit marked 7.8% of GDP and based on mid-year actual data and forecasted values thereafter, current account deficit is expected to improve by 0.7% percentage points during The volume of FDI in 2014 decreased significantly, in large part due to the sale of shares of some foreign companies operating in Kosovo to residents and the 87

92 distribution of the superdividend of selected foreign companies operating in Kosovo. However, during 2015 direct investment has increased significantly and going towards the end of the year is expected to amount to 5.2% of GDP. EC Progress 2015 report stresses that Kosovo is at an early stage of preparation in the free movement of persons, services and the right of establishment. Thorough and transparent auditing and accounting are crucial for the development of a sound financial services market and the economy at large, especially small and medium-sized enterprises (SMEs). Yet Kosovo has to improve inter-institutional coordination to ensure that legislation is enforced; and further improve quality infrastructure, strengthen market surveillance capacity and increase consumers awareness of their rights. Modernization of quality infrastructure (standardization, metrology, accreditation and conformity assessment) is mandatory in order to reduce trade barriers and increase trade integration. Approximation of legislation with EU Directives for different groups of products remains satisfactory; however, it still needs further alignment and implementation. Furthermore, the Progress Report underlines that Kosovo is moderately prepared in the area of customs and at an early stage in taxation, with some progress made in both areas. It took some initial steps towards merging the customs and tax administrations and upgrading internal controls. Customs legislation is largely compliant with the EU s customs code. 2. Measures taken to fulfil the country specific policy guidance since May The Joint conclusions of the Economic and Financial Dialogue between the EU and the Western Balkans and Turkey from 12 May 2015 identified the following recommendations related to the area of trade integration: Facilitate trade by amending the Customs Code and adopting new legislation on customs enforcement of IPR. Adopt holistic approach to FDI with supportive policies and focus on removing existing obstacles in a strategic framework. Increase investor protection by developing after-care program and investor grievance mechanism. Strengthen regulatory institutions and ensure their independence Ministry of Trade and Industry in cooperation with Kosovo Customs and relevant institutions, including the private sector and with the support of USAID carried out a trade facilitation selfassessment to identify gaps and specific actions that shall be taken by the respective institutions, based on the aforementioned self-assessment; MTI has prepared an action plan on trade assessment. Trade Facilitation Action Plan involve: implementation of activities on trade facilitation, which include coordination of activities at the national and the regional level with the CEFTA with a view to negotiate and implement the Trade Facilitation Agreement; Amendment of the Customs Code in line with the acquis; Drafting and adapting the implementing provisions of the amended Customs Code; Increase human capacities and improve customs performance on providing the relevant customs procedures for businesses; Law on customs measures for protection of IPR; Drafting and adopting secondary legislation on protection of IPR; Full functionalization of the INES system for online application for protection of IPRQ Improve customs controls (including ex-officio) on 88

93 fighting counterfeit goods at the borders; Simplifying procedures during the all stages, Harmonization of procedures between the implementing agencies at national level. 3. Reforms planned to fully fulfil the outstanding policy guidance. As outlined in the previous section the quality infrastructure is one of the main challenges for Kosovo market to be integrated into globally economy. The Government will continue its efforts for modernisation of quality infrastructure (standardisation, metrology, accreditation and conformity assessment) in order to reduce trade barriers and increase trade integration. Reform Measure #16: Encouraging businesses to improve quality of products Description of measure: In order to address the challenges this reform measure will focus on further completion of the framework legislation of quality infrastructure, implementation of this legislation and direct support to businesses to improve quality of products (through certification). Main milestone for implementation of this measure include: - Further completion of the framework legislation on quality infrastructure in line with the EU acquis check the National Programme for Implementation of SAA - Adoption of new European and international standards (1400 new standards 2016) - Completing existing laboratories and establishing new laboratories - Increase the number of conformity assessment bodies - Increase awareness of businesses on quality infrastructure and support businesses on implementation of standards. Timeline: Many of the activities foreseen in this measure are a continuation of the processes that are ongoing within the MTI. This excludes the financial support to businesses to certify their products, which is planned to start in the late 2016 through the support of an IPA project. All the activities of this measure will continue up to Budgetary impact: For the implementation of this measure, from the Government of Kosovo Budget is foreseen a rough amount of (which includes the accounts- goods and services and capital investments for all the QI pillars QID, AKS, AMK, DAK). Moreover, development of quality infrastructure is supported also by different donors: - IPA project on Free Movement of Goods Million - A regional SIDA project Million - A potential IPA project on Free Movement of Goods Million - A potential IPA project for financial support to businesses to certify their products Million approved by Austrian Development Cooperation Impact on competitiveness: Establishment / Strengthening of Quality Infrastructure is a durable boost to the competitiveness of businesses. All activities and operations of the Quality Infrastructure, including harmonization of legislation, raising awareness among stakeholders, and other technical capacity building, have a direct and indirect impact on trade integration. Relevance for SEE2020 and any impact on the national and regional targets 89

94 The measure is relevant to the SEE 2020 strategy under the Sustainable Growth pillar. This measure will contribute to the achievement of the pillar objective: Increase net enterprise creation (new businesses per year) from 30,107 to 33, 760 and Increase exports of goods and services per capita from the region from EUR 1,780 to EUR 4, 250. Specifically related to the Dimension J: Environment. Relations with national strategic documents and sector strategies This measure is in line with the National Development Strategy EMPLOYMENT AND LABOUR MARKET 1. State of play and key obstacles to competitiveness According to growth diagnostic study, human capital was not identified as one of the top constraints by enterprises in the 2013 BEEPs survey. However, the lack of high-skilled labour in both graduate and vocational education is considered to be a binding constraint to growth. This is mainly due to evidence of excess demand for high-skilled occupations, and evidence of a high-skill premium. Educational outcomes strongly influence the level of unemployment across age groups and levels of education. Secondary vocational education is found to be more labour market relevant, especially in comparison to those in general education. Unemployment is a major problem in Kosovo, it remains the highest in the region. The data from the Labour Force Survey for 2014 notes that unemployment increased to 35.5 % from 30.0 % in 2013, whereas in 2014 the level of youth unemployment reached 61%. Funding for employment services as well as training and re-training remains insufficient and fragmented in some subjects. In the other hand, informality in the labour market is very high, a significant proportion of economically inactive persons are in fact discouraged workers and the public employment services have an evident need for reform and modernization and better linkage with the labour market. Lack of skilled labour is considered to be a binding constraint to growth. There is fragmentary evidence of a high wage premium i.e. scarcity of supply of the high-skilled labour. Discrepancy between labour market needs with the knowledge and skills gained in higher education and vocational education are identified as huge gap of more than 2/3 of existing and potential investors in Kosovo - about 25% of firms in Kosovo still complain that the workforce has inadequate skills; low level of expenditure for students in VET and at least a quarter of VET schools do not offer practical work either in school or outside school; no system for predicting the skills required in the marketplace. European Commission Progress Report underlines that no progress was made in improving the quality of education. Increases in public spending on education (up to 4.4 % of GDP in 2014 with 4.6 % planned for 2015) have so far been used almost entirely to cover salary increases. More funding should be directed to other aspects of education reform. Kosovo operates a Public Employment Service (PES). In 2014, PS helped find 4,729 jobs for jobseekers, while the number of people trained by it was 2,093. Public expenditure for PES in Kosovo amounts to around 0.16% of the GDP, but there is an extensive donor support for the active labour market measures, which is estimated at up to of 0.30% of GDP in Besides the PES, 90

95 there are 8 Vocational Training Centers and 6 Mobile Centers (under the MLSP) providing shortterm modular trainings to unemployed. There are also numerous private sector providers of training services; however, the licensing is not fully developed. Informality in employment remains high. Preparations in education and research are at an early stage. There has been no progress in this area over the last year. The quality of education needs to be considerably improved. In the coming year, Kosovo should in particular: Improve quality of education at all levels and improve access to quality education for marginalised groups, especially children with disabilities, Roma, Ashkali and Egyptian children; ensure the autonomy and independent operation of higher education institutions and adopt a new law for higher education based on international standards; rationalise VET school network as well as review of VET provision implementation of process of validation of qualifications, accreditations of VET institutions, and the process of development of occupational standards Implementation of institutional network optimization, which includes a master plan for the VET schools, institutions of lifelong learning and employment services, in line with demographic change, urbanization trends and related policies for the educational staff. Lack of skills forecasting system and professional qualification standard. 2. Measures taken to fulfil the country specific policy guidance since May The recommendations from the Ministerial Council meeting between the EU and Western Balkan countries, in regard to area of employment and labour market for Kosovo were: higher effectiveness of the Public Employment Service; education system to respond better to labour market requirements; modernization of vocational education; and provision of incentives to reduce the level of undeclared labour. The achieved progress so far of the above recommendations is the following: the regulatory framework for the Public Employment Service is on finalizing stage; the package that refers to licensing non Public Employment Service providers has been prepared; the draft Law on social enterprises is in the process of opening to the public discussion; the Strategic Development Plan for the Labour Inspectorate is prepared; and the review of five vocational training programs is under completion. The Government will continue education reform towards increasing quality in pre-university education through improving access to education, continues teacher development, and performance assessment of teachers. Reforms in education sector will build on recent evaluation of the Kosovo Education Strategic Plan which has identified key achievements and needs for further interventions. Based on this evaluation and measure under the National Development Strategy, the Government will develop a new KSAP for the period Furthermore, the Government of Kosovo signed with the Bank credit for the Kosovo Education System Improvement Project that aims at 91

96 strengthening selected systems that contribute to quality, accountability, and efficiency improvements in education in the Republic of Kosovo. The Education System Improvement Project will support the Government s education sector reform strategy and agenda. More specifically, the project aims at strengthening planning, financial management, and evaluation capacities at different levels of the education sector, including the national, the municipal and the school and university level, as well as to enhance and modernize the systems and practices of data management and analysis in the education sector. It also aims at supporting and institutionalizing the teacher career system, facilitating the use of international best practices in student assessment and evaluation, and enhancing the capacities and responsiveness of tertiary education institutions to the labour market. 3. Reforms planned to fully fulfil the outstanding policy guidance. As outlined in the previous section, ERP 2016 aims to strengthen the links between educational programs and labour market needs through the establishment of professional standards and priority areas, and implementation of the core curriculum and teacher training. In addition to this, Kosovo will continue efforts to promote active labour market measures as well as reform the public employment services. Reform measure #17: Better linkage between education and labour market Description of measure: The objective under this measure is to strengthen the links between educational programs and labour market needs through the establishment of professional standards and priority areas, and implementation of the core curriculum and teacher training, which will be achieved through: Ensuring the quality of trainings, the review of the curriculum and accreditation of new ACA Qualification; Expansion of a new curriculum for all remaining schools, while at the same time undertaking the evaluation of efficiency in pilot schools (10 %), and systemic corrections where necessary; Review of existing textbooks to better fit the student s needs, including the development of new textbooks according to the learning outcomes. While, because of the specifics that VET has, there will be basic texts developed for the respective profiles and other educational materials; Implement pilot VET system s mixed with elements of dual learning (combination of learning in schools and enterprises) starting with priority areas and continuing VET according to Core Curriculum. Coordination with wage subsidy system in those areas, in order to achieve better integration of VET graduates to the labour market; 92

97 Budgetary impact Ensuring the quality of trainings, the review of the curriculum and accreditation of new ACA Qualification: 30,000 for 2016 form the budget of Kosovo, also for 2017 and ,000 euros per ach year. In the VET sector, for the training and professional development of teachers, according to the budget plan for the 2016 and budget estimates for are planned 66, euros per each budget year. According to the budget planning for 2016 and budget estimation for for each budget year for the curricula are planned around 50, euros. Impact on competitiveness: Implementation of this measure will contribute to the creation of more employable workforce and help enterprises become more efficient and productive. Social and economic effects will be long term and will be accompanied by growing income for workers and enterprises. Creating a more agile workforce will help attract foreign direct investment. Investing in smart specialization and R & I will make the most innovative enterprises and thus will enable the growth of industries. Social impact: Provision of additional training, the adaptation of curricula and similar actions will influence the improvement of vocational training resulting in greater harmonization of supply and demand in the labour market, and therefore contributing to higher employment and citizens welfare. Relevance for SEE2020 and any impact on the national and regional targets The measure is relevant to the SEE 2020 strategy under the Smart Growth & Inclusive Growth pillars. This measure will contribute to the achievement of the pillar objective: Increase GDP per person employed by 32% & Add 300,000 highly qualified people to the workforce and Increase overall employment rate of the 15+ population from 39.5% to 44.4%. Specifically related to the Dimension D: Education and Competencies ; Dimension F: Digital Society ; and Dimension L: Employment Relations with national strategic documents and sector strategies The measure is in line with the National Development Strategy, respectively Pillar I Human Capital. It is also in line with education sector and sub-sector strategic framework Reform measure 18: Further strengthen public employment services through operationalization of the Employment Agency Description of measure: Building on ERP 2015 reform measure on improvement of public employment services, the aim under this measure is implementation of policies leading to further improvement and increase of the efficiency of public employment services. Hence, the reform measure will focus on reform and modernization of Public Employment Services and Improving the capacities of Employment Agency to support Active Labour Market Measures (ALMM) based on accurate Labour Market Information and Capacity development for VTCs. Main interventions will 93

98 include capacity building of PES services, including non-public services; focused on increasing human resources and professional capacities of the bodies for inspection of economic operators in order to effectively implement legal provisions regulating the labour area. Timeline: Implementation of this measure include continues interventions on functioning of the Employment Agency of Kosovo, capacity building, licencing of non-public employment services; developing the system of internal training of the Agency and VTCs. Cost per activity: - Functionality and strengthening the capacity of the Employment Agency of the Republic of Kosovo; 80,000; - Licensing of non-public employment providers; - Development of on-job training system for EARK staff and providing Training of Trainers modules to the VTCs; 30,000 - Providing equipment to new and existing workshops, as well as the recruitment of a number of coaches for new workshops; 580,000 - Developing the sublegal act to regulate the procedures for placement of products and services into the market; 2,000 Budgetary impact: Functionality and strengthening of the capacities of the Employment Agency of the Republic of Kosovo; 80,000 for 2016 (from Budget of Kosovo) and continuing for the years 2017 to 2018 with the same amount planned per each year. From IPA 2016 funding 1, euro are provided for the years 2016 to Impact on competitiveness: Reforming and modernization of the Public Employment Services will have positive effects in increasing competitiveness and improving the quality of market demand and the needs of jobseekers. In particular, licensing of the non-public employment service providers will help reduce the cost of this service, the expansion of its service and in the medium term will lead to an achievement of larger targets to alleviate unemployment. And finally, the promotion of employment services by providing greater access to job seekers and employers in the public and private employment, will affect growth increased competition and institutional and public accountability in this regard. Reform measure #19: Providing opportunities for training and employment through active labour market measures Description of measure: The main purpose of this reform measure is to provide opportunities for training and employment through on job-training, wage subsidies, institution and enterprise based training, internships and apprenticeships programmes, self-employment programmes, etc. In particular, the aim is to utilise existing and forthcoming wage subsidy initiatives towards increasing job creation through new hiring and enhanced employability. The primary purpose of the WSF is to 94

99 mobilize government and donor funds towards increasing the employability of vulnerable groups, especially youth, women and long-term unemployed. Budgetary impact: Wage Subsidy Programme is supported through the project the Active Labour Market Programme 2 project, funded by the Ministry for Foreign Affairs of Finland and the Kosovo Government, builds on long-standing UNDP achievements in supporting Kosovo citizens, with particular focus on vulnerable young men and women, to find a job or establish a new venture through supporting Kosovo institutions in designing strategic, evidence-based policies and programmes, and providing on-the-job training, as well as grants and consultancy to foster selfemployment opportunities. The total cost of the Project is 1,507,500, with participation from UNDP 187,500, Kosovo Government 1,200,000 and Government of Finland 1,200,000 Impact on competitiveness: Implementation of this measure will enable provision of opportunities for beneficiaries of different categories, especially youth and women that will receive continuous support and training to find a job and develop their career, or to establish their own enterprise. Through this around 500 young unemployed are offered skills development opportunities as well as around 40 new businesses are established and supported to become successful. Furthermore, it will provide for enhancing knowledge base on the labour market and will lead to evidence-based decision making by institutions that regulate the labour market. With the capacity development of Employment Agency implementation of the measure will lead to expanding opportunities for beneficiaries of different categories, especially for younger age groups that will benefit through training on entrepreneurship and more importantly will benefit from projects related to labour market active measures and projects that support the creation of new jobs through small grants by respective ministries. Reform Measure #20: Implementation and Improvements to the Teacher Career System Description of measure: The objective of this measure is twofold. It will focus on: (i) implementation of the career system for teachers professional development (PD); performance assessment (PA) and promotion; and (ii) provide policy support to further strengthen, complement and systematize the teacher career system and licensing scheme. This will continue the implementation of the conceptual framework which links teachers career advancement with professional development and performance assessment. Main interventions of this measure will include: - development and implementation of a plan for teacher performance assessment aligned with local capacities; - development of competency-based teacher licensing and promotion scheme that defines key competencies for each type of license in the existing scheme and links these with financial incentives; and - Setting up of an induction program for new teachers, and other activities aimed at improving and institutionalizing teacher performance assessment and professional development. Timeline: 95

100 2016: : - Teacher professional development/career development in line with the preparation of teachers for implementation of new Curricula. This stage will include teachers. - Teacher licensing process based on levels of licenses and promotion according to Administrative Instruction 25/ Developing and adopting the legislative framework for teacher licensing, professional development and performance assessment - Establishment of the State Council for Teacher Licensing; - Development, piloting and adoption of teacher performance assessment instruments. - Revised teacher salary structure to match it with pre-service qualifications; - Rolling out licensing for teachers at the Career Teacher license; - Development of teacher licensing database; Budgetary impact: The measure is part of a comprehensive education reform programme that the Government of Kosovo has recently signed with the World Bank which has three components. Project is to be implemented over a period of four years, between 2015 and It would be fully financed by an IDA credit in the amount of US$11 million equivalent. Overall cost of Component 2 Strengthening management capacity and accountability to enhance quality of education will cost 5,000,000. Impact on competitiveness: This measure aims at directly targeting governance and indirectly targeting quality of education, two of the keys for successful learning outcomes. A potential expected benefit would be the attraction and coordination of large investments from other international donors, as a result of increased capacity of systems, institutions, and management. By supporting the implementation of several levers that are closely aligned with improved teacher performance, the measure should indirectly impact student performance. Implementation challenges: the main challenge would be linking salary system with the licensing and promotion system FOSTERING SOCIAL INCLUSION, COMBATING POVERTY AND PROMOTING EQUAL OPPORTUNITIES Kosovo has put in place respective institutional and legal framework to provide social protection. Kosovo s current demographic trends imply that aging does not present a risk for the pension system sustainability in the foreseeable future. In relation to the health sector, Kosovo is unable to provide meaningful universal health care access, and available health services are of weak quality. At country level, there is a large there is a large number of vulnerable groups endangered from poverty and social exclusion. The social protection system continues to face various challenges due to budgetary constraints and other limitations affecting effective implementation of legislation and policies. In this regard, maintenance and upgrade of a social protection and health care system that addresses problems and provides support for all those citizens in need remains a challenge. The 96

101 number of people and families in need of social protection, health care and other such services remains high. Social welfare policies are not sufficiently synchronized active measures on the labour market. A portion of social security remains the responsibility of informal networks, namely the families and friends of people with needs, while the implementation of the health insurance scheme has not yet started. Research and strategic evaluation reports have shown that there are other important actors and provider of resources in providing social welfare services, which are organizations of civil society and family members of the beneficiaries. Currently there is a final map of the providers of these services, as there is an advanced estimate of the range and quality of services. Provision of social services requires additional resources for municipalities. On social protection, the first round of licensing of individual social and family service providers has been completed and the second phase of licensing legal entities/organisations has started. In 2014, four new minimum standards for social and family services were adopted, increasing the number to 16. However the decentralisation of social services has still not been implemented by municipalities and allocation of funding from the central budget is still needed to ensure effective decentralisation. The key obstacle to address issues of social exclusion and inclusion of all marginalized groups is the lack of a specific grant to fund social services. Unlike other countries in Kosovo has a special component for the financing of social services in this formula despite the fact that municipalities are responsible for the management of social services. Services provided by the Centre for Social Work are of particular importance to social stability, to promote social responsibility, protection of risk and subjected to violations and improving the involvement that is essential for economic growth. Also social defence system, in combination with other policies at the Ministry and Government should improve better targeting of women and girls in need, as well as persons with disabilities. On human and fundamental rights EC Country Report provides for that the existing legal framework broadly guarantees the protection of human and fundamental rights in line with European standards. However, implementation of human rights is hindered by a lack of resources and political commitment, including at local level. The adoption of the package of human rights laws strengthened the institutional set-up and clarified the roles of various institutions. On equal opportunities, the law on gender equality has been adopted but implementation and enforcement of legislation needs to be improved to address high unemployment among women and under-representation of women at all levels of decision-making. Insufficient maternity leave provisions undermine efforts to tackle discrimination against women in the workplace, especially in the private sector. The Agency for Gender Equality has not assessed the implementation of the programme for gender equality ( ). Kosovo is currently unable to provide meaningful universal access to health services, while the quality of such services is low. Kosovo has an under-financed public health system, in which total public spending from the national budget, and as a percentage of GDP, are low based on the regional and EU average. This relates both to total health expenditure and to the health share of the government budget. Spending on health in 2012 stood at 2.6% of GDP, while health accounted for 97

102 9% of total government spending in that same year. The EU average in 2011 stood at around 13% of the general government spending and 5% of GDP. On public health policy, the first phase of the Health Information System (HIS) has been completed and continued to be implemented. However, public health spending remains among the lowest in the region. This hinders implementation and enforcement of sector reforms and policies. For example, the action plan to implement the health sector strategy still needs to be adopted, the law on health insurance needs to be implemented, implementation of the HIS needs to be completed to allow reliable collection of health data, the health insurance fund needs to be set up and the rare diseases action plan needs to be implemented. The Government of Kosovo during this period has been focused on fulfilling the secondary legislation and operational infrastructure, regarding the provision of services that are directly influenced from the measure. Activities that have been implemented in the course of second half of this year include: approval of secondary legislation for implementation of state funded pension schemes, and secondary legislation for implementation of the law on war categories; verification of the status of veterans and starting implementation of pension schemes for war veterans; approval of the increase of social assistance, approval of the regulation on internal organisation of Health Financing Agency; drafting secondary legislation for commencing implementation of premiums for health insurance; developing software for the Health Information System; addressing gender equality through capacity building for an inclusive decision-making as well as rational distribution of human and financial resources SUMMARY OF REFORM PRIORITIES This section provides an overview of reform measures planned by the Government of Kosovo for the period in order to address key obstacles to growth and competitiveness, and which are basically addressing recommendations from the Joint conclusions of the Economic and Financial Dialogue between the EU and the Western Balkans and Turkey from 12 May Priority Area Name of measure Summary of the measure Public Finance Management Reform measure #1: Launching and application of electronic procurement Infrastructure Reform Measure #2: Construction of new highway to Skopje and upgrade and rehabilitation of railway line 10 Reform Measure #3: It addresses promotion of the public procurement system, e-procurement training to procurement professionals, and information management improvement of the electronic and centralized procurement processes. It represents a continuation of infrastructure reforms, in this case it connects the Corridor VIII to South-East Europe. This measures tackles the development of new 98

103 Agriculture Sector Development Industrial Sector Development Services Sector Development Further development of energy production capacities Reform Measure #4: Decrease energy consumption through energy efficiency measures Reform measure #5: Agricultural infrastructure for agro-business Reform measure #6: Consolidation of agricultural land Reform measure #7: Determining the potential for industrial cluster development Reform measure #8: Expansion of the relevant infrastructure for ICT networks and services for socio-economic development Reform measure #9: Streamline evidenced policy making Reform measure #10: Strengthening the property rights system generation capacities from lignite, TP "Kosova e Re", and enhancing the operational efficiency in central district heating in Pristina and Gjakova. The measure strives the implementation of energy efficiency measures. Towards commitments of Energy Community Treaty, Kosovo s priorities remain the implementation of legislation for buildings and adoption of missing secondary legislation and Energy Efficiency Law. It addresses challenges related to agricultural infrastructure, including soft and physical infrastructure, including the upgrade of irrigation system coverage throughout the regions with high production potential. The objective of this measure is to address fragmentation of agricultural land, by grouping and creation of larger and consolidated parcels, with the purpose of increasing their sizes, which will lead to an increase in the average size of farms. This reform tackles the development of SMEs in Kosovo through cluster development in priority sectors of Kosovo s industrial policy while directly striking the weak Kosovo s internal competitiveness due to its failures in domestic policy and external competitive pressures. This digital agenda reform s objective is to deploy broadband infrastructure in rural areas with no infrastructure coverage, as well as develop human capital and digital economy. Streamline evidenced policy making addresses the creation of a strict adherence to RIA principles and procedures for all legislation at place and a smart regulatory quality system that balances gains and economic, environmental and social costs. The main objective is to strengthen the property rights system: strengthen the legal framework, promote marketable land, strengthen judicial capacities for dealing with property rights and 99

104 Technological absorption and innovation Trade integration Employment and labour market Reform measure #11: Increased judicial efficiency Reform measure #12: Improve access to finances for Kosovo SMEs Reform measure #13: Improve corporate governance with state owned assets Reform measure #14: Merging customs and tax administration, establishing a single revenue collection agency Reform measure #15: Fostering business academia cooperation through research grants and innovation vouchers Reform measure #16: Encouraging businesses to improve quality of products Reform measure #17: Better linkage between education and labour market Reform measure 18: Further strengthen public ensure property rights for marginalised groups, minorities and women. This measure s objective is to improve the efficiency of judiciary by decreasing the caseload for minor offences through incentives and speedy court settlements and other legal framework amendments, temporary increase in hiring additional manpower to sort out cases, and introducing a Case Management and Information System (CMIS) in all courts. This measure strives to expand the credit guarantees and to improve information on business and individual lending history which would enable many more businesses to get access to finance and at lower interest rates. This measure aims to improve the efficiency of public enterprises in line with OECD corporate governance principles such as review the options for sectorial approach of monitoring and management of corporates with public ownership. This measure tackles informal economy through reduction of tax gap through simplified and effective institutional structures of revenue collection. This measure attempts to establish the policy framework for accelerating creation of research and innovation capacity with a focus on priority sectors of industrial policy and based on improved partnerships between public research institutions and the Government. It addresses directly the quality infrastructure modernization for businesses, such as: legal infrastructure standardization, metrology, accreditation and conformity assessment bodies. The objective under this measure is to strengthen the links between educational programs and labour market needs through the establishment of professional standards and priority areas, and implementation of the core curriculum and teacher training, The reform measure will focus on reform and modernization of Public Employment Services 100

105 employment services through operationalization of the Employment Agency Reform measure #19: Providing opportunities for training and employment through active labour market measures Reform Measure #20: Implementation and Improvements to the Teacher Career System and Improving the capacities of Employment Agency to support Active Labour Market Measures (ALMM) based on accurate Labour Market Information and Capacity development for VTCs. The main purpose of this reform measure is to provide opportunities for training and employment through on job-training, wage subsidies, institution and enterprise based training, internships and apprenticeships programmes, self-employment programmes. The objective of this measure is twofold. It will focus on: (i) implementation of the career system for teachers professional development (PD); performance assessment (PA) and promotion; and (ii) provide policy support to further strengthen, complement and systematize the teacher career system and licensing scheme. 5. BUDGETARY IMPLICATION ON STRUCTURAL REFORMS The reforms identified in the previous section entail existing and new policies of the Government in order to address key obstacles to growth, competitiveness and job creation, These reforms are mainly funded through Kosovo budget, but also external funding from financial institutions, grants and technical assistance from development partners. On the expenditure part, the budgetary impact of reforms is approximately 1,229,479,053 EUR for the period These are mainly existing policies which have received respective funding from Kosovo budget and commitments from the development partners. Of all the priority areas, Infrastructure policy reforms comprise the weightiest direct impact on the budget. On revenue side, the impact of the structural reform measures is significant on upgrading and/or rehabilitating both physical and energy infrastructure, improving the procurement system, assisting agriculture in the function of competitiveness, increasing competition and revenues through proper industrial policy making, improving business environment through tackling contract enforcement and judicial reforms, labour market reforms as well as improving the access to finance for Kosovar SMEs. 6. INSTITUTIONAL ISSUES AND STAKEHOLDER INVOLVEMENT This section presents the institutional process for the preparation and approval of Economic Reform Programme as well as the consultation of national actors (national parliament, regional and local authorities, social partners and civil society) during the preparation process. As a result of the 101

106 Kosovo Government endeavours to involve a wide range of actors in the process, a very satisfactory involvement and participation of all actors from all sectors was achieved in order to ensure ownership and facilitate their later involvement on the implementation of the programme. To coordinate the process, the Government of the Republic of Kosovo has adopted the decision No. 07/56, to initiate drafting the Economic Reform Programme as part of the dialogue between the EU and Republic of Kosovo within economic governance area. According to this decision, the Minister of Finance was appointed as the National Coordinator of ERP 2016, whose work was supported by the Strategic Planning Office (SPO) within the Office of Prime Minister; the Department of Economic, Public Policies and International Financial Cooperation (DEPPIFC) in the Ministry of Finance; and coordinators of respective fields in the line Ministries: Ministry of Finance, Ministry of Economic Development, Ministry of Trade and Industry, Ministry of Agriculture, Forestry and Rural Development, Ministry of Education, Science and Technology, Ministry of Labour and Social Welfare, Ministry of Public Administration, Ministry of Environment and Spatial Planning, Ministry of Justice, Ministry of Infrastructure, and Ministry of European Integration and other supporting bodies and agencies. The SPO has been responsible for developing the part of the structural reform, including the identification of priority measures to be included in ERP 2016, while the DEPPIC was responsible for the macro-economic framework and fiscal policies, which presents the analysis of the current state of the economy of the country and expectations for the future, based on which the structural reforms are oriented. Government of Kosovo was also trying to involve social partners and civil society by consulting them during the preparation of the program and ensure that their input is taken into account, in order to have the program reach the widest possible consensus. The public consultation as such involved two public meetings with different stakeholders. The first meeting was organized under the framework of the National Economic Development Council a mechanism chaired by the Prime Minister, with members from key ministries and private sector representatives (business associations and chambers of commerce). The second public consultation involved civil society organizations and social partners. In this meeting more than 30 representatives from different NGOs and academia participated. The discussions in the consultation events were very productive. The public consultations also involved the participation of local authorities, through the Association of Kosovo Municipalities. The draft of ERP 2016 has been presented also to representatives of National Committee on Economic Development - permanent members of the NCED, on the meeting organized with the National Council for Economic Development (NCED). After the approval of the final version by the Government of Kosovo, ERP 2016 will be presented to the National Parliament for information. 102

107 ANNEX 1. TABLES Table 1a: Macroeconomic prospects Percentages unless otherwise indicated ESA Code Level (mil. ) Rate of change 1. Real GDP at market prices B1*g 5, Current GDP at market prices B1*g 5, Components of real GDP 3. Private consumption expenditure P3 4, Government consumption expenditure P Gross fixed capital formation P51 1, Changes in inventories and net acquisition of valuables (% of GDP) P52+P Exports of goods and services P Imports of goods and services P7 2, Contribution to real GDP growth 9. Final domestic demand 6, Change in inventories and net acquisition of valuables P52+P External balance of goods/services B11-1, Table 1b: Price developments Percentage changes, annual averages ESA Code GDP deflator Private consumption deflator HICP : : : : : 4. National CPI change Public consumption deflator Investment deflator Export price deflator (goods & services) Import price deflator (goods & services)

108 Table 1c: Labour market developments ESA Code Level Level/Rate of change 1. Population (thousands)/1 1,837 1, , , , , Population (growth rate in %) Working-age population (persons) 1, , , , , Participation rate Employment, persons Employment, hours worked/2 685,513 : : : : 7. Employment (growth rate in %) Public sector employment (persons) : : 9. Public sector employment (growth in %) : : 10. Unemployment rate 35.3 : : : : 11. Labour productivity, persons 16, Labour productivity, hours worked 8.5 : : : : 13. Compensation of employees D1 1, /The Statistical Agency of Kosovo has developed 3 demographic trend scenarios, of which the middle scenario is recommended for planning and analysis 2/Total hours worked within the year on national level Table 1d: Sectoral balances Percentages of GDP ESA code Net lending/borrowing vis-à-vis the rest of the world B of which: - Balance of goods and services Balance of primary incomes and transfers Capital account Net lending/borrowing of the private sector B.9/ EDP B Net lending/borrowing of general government Statistical discrepancy Table 1e: GDP, investment and gross value added ESA Code GDP and investment GDP level at current market prices (in domestic currency) B1g 5,568 5,800 6,060 6,361 6,692 Investment ratio (% of GDP) Growth of Gross Value Added, percentage changes at constant prices 1. Agriculture Industry (excluding construction) Construction Services

109 Table 1f: External sector developments Million Euro unless otherwise indicated Current account balance (% of GDP) % of GDP Export of goods Million EUR Import of goods Million EUR 2, , , , , Trade balance Million EUR -2, , , , , Export of services Million EUR Import of services Million EUR Service balance Million EUR Net interest payments from abroad Million EUR Other net factor income from abroad Million EUR Current transfers Million EUR 1, , , , , Of which from EU Million EUR : : : : : 12. Current account balance Million EUR Capital and financial account Million EUR Foreign direct investment Million EUR Foreign reserves Million EUR Foreign debt Million EUR 1, ,813.1 : : : 17. Of which: public Million EUR O/w: foreign currency denominated Million EUR : : : : : 19.O/w: repayments due Million EUR Exchange rate vis-à-vis EUR (endyear) NCU/EUR Exchange rate vis-à-vis EUR (annual average) NCU/EUR Net foreign saving % of GDP : : : : : 23. Domestic private saving % of GDP Domestic private investment % of GDP Domestic public saving % of GDP Domestic public investment % of GDP Table 1g: Sustainability indicators Dimension Current Account Balance % of GDP Net International Investment Position % of GDP Export market shares %, yoy : 4. Real Effective Exchange Rate %, yoy Nominal Unit Labour Costs %, yoy : : : -4.6 : 6. Private sector credit flow % of GDP Private sector debt % of GDP General Government Debt % of GDP

110 Table 2a: General government budgetary prospects ESA code Level (mil. ) % of GDP Net lending (B9) by sub-sectors 1. General government /1 S Central government S1311 : : : : : : 3. State government S1312 : : : : : : 4. Local government S1313 : : : : : : 5. Social security funds S1314 : : : : : : General government (S13) 6. Total revenue TR 1, Total expenditure TE 1, Net borrowing/lending EDP.B Interest expenditure EDP.D41 incl FISIM 10. Primary balance One-off and other temporary measures : : : : : : Components of revenues 12. Total taxes (12 = 12a+12b+12c) 1, a. Taxes on production and imports D2 1, b. Current taxes on income and wealth D c. Capital taxes D : : : : : 13. Social contributions D : : : : : 14. Property income D Other (15 = 16-( )) = 6. Total revenue TR 1, p.m.: Tax burden (D2+D5+D61+D91-D995) 1, Selected components of expenditures 16. Collective consumption P Total social transfers D62 + D a. Social transfers in kind P31 = D63 : : : : : : 17b. Social transfers other than in kind D = 9. Interest expenditure (incl. FISIM) EDP.D41 + FISIM Subsidies D Gross fixed capital formation P Other (21 = 22-( ) : : : Total expenditures TE [1] 1, p.m. compensation of employees D / The deficit presented here is not calculated in accordance with the fiscal rule definition as per LPFMA 106

111 Table 2b: General government budgetary prospects ESA code Millions of euros Net lending (B9) by sub-sectors 1. General government /1 S Central government S1311 : : : : : 3. State government S1312 : : : : : 4. Local government S1313 : : : : : 5. Social security funds S1314 : : : : : General government (S13) 6. Total revenue TR , , , , Total expenditure TE 1, , , , , Net borrowing/lending EDP.B Interest expenditure EDP.D41 incl. FISIM Primary balance One-off and other temporary measures : : : : : Components of revenues 12. Total taxes (12 = 12a+12b+12c) 1, , , , , a. Taxes on production and imports D2 1, , , , , b. Current taxes on income and D wealth 12c. Capital taxes D91 : : : : : 13. Social contributions D61 : : : : : 14. Property income D Other (15 = 16-( )) = 6. Total revenue TR 1, , , , ,641.5 p.m.: Tax burden (D2+D5+D61+D91-D995) 1, , , , ,438.0 Selected components of expenditures 16. Collective consumption P Total social transfers D62 + D a. Social transfers in kind P31 = D63 : : : : : 17b. Social transfers other than in kind D = 9. Interest expenditure (incl. EDP.D41 + FISIM) FISIM Subsidies D Gross fixed capital formation P Other (21 = 22- ( ) : Total expenditures TE [1] 1, , , , ,782.4 p.m. compensation of employees D / The deficit presented here is not calculated in accordance with the fiscal rule definition as per the LPFMA 107

112 Table 3: General government expenditure by function Percentage of GDP /1 COFOG Code General public services : : 2. Defence : : 3. Public order and safety : : 4. Economic affairs : : 5. Environmental protection : : 6. Housing and community amenities : : 7. Health : : 8. Recreation, culture and religion : : 9. Education : : 10. Social protection : : 11. Total expenditure (item 7 = 23 in Table 2) TE : : 1/ Given that this was the first time our budget was compiled using functional classification codes, it was not possible to provide reliable numbers for 2017 and Budget figures are not comparable to historical execution data as the adoption of functional classification in the budget has corrected previous misclassification. A backward revision has not been carried yet. Table 4: General government debt developments % of GDP ESA code Gross debt Change in gross debt ratio Contributions to change in gross debt 3. Primary balance Interest expenditure EDP D Stock-flow adjustment of which: - Differences between cash and accruals : : : : : - Net accumulation of financial assets : : : : : of which: - Privatisation proceeds : : : : : - Valuation effects and other : : : : : p.m. implicit interest rate on debt Other relevant variables 6. Liquid financial assets Net financial debt (7 = 1-6) Table 5: Cyclical developments % of GDP ESA Code Real GDP growth (%, yoy) B1g Net lending of general government EDP.B Interest expenditure EDP.D One-off and other temporary measures : : : : : 5. Potential GDP growth (%, yoy) : : : : : Contributions: - labour : : : : : - capital : : : : : - total factor productivity : : : : : 6. Output gap : : : : : 7. Cyclical budgetary component : : : : : 8. Cyclically-adjusted balance (2-7) : : : : : 9. Cyclically-adjusted primary balance (8+3) : : : : : 10. Structural balance (8-4) : : : : : 108

113 Table 6: Divergence from previous programme GDP growth (%, yoy) Previous programme Latest update Difference (percentage points) General government net lending (% of GDP) Previous programme Latest update Difference General government gross debt (% of GDP) Previous programme Latest update Difference Table 7: N/A Table 7a: Contingent liabilities % of GDP Public guarantees Of which: linked to the financial sector Table 8: Basic assumptions on the external economic environment underlying the programme framework (Purely) technical assumptions Dimension Short-term interest rate, Euro-area19 /1 Annual average : Long-term interest rate, Euro-area19 /1 Annual average : USD/EUR exchange Annual average : : Nominal effective exchange rate /2 Annual average : : : Exchange rate vis-à-vis the EUR Annual average Global GDP growth, excluding EU /3 Annual average : EU GDP growth/3 Annual average : Growth of relevant foreign markets /3 Annual average Germany Annual average : Switzerland Annual average : World import volumes, excluding EU /4 Annual average : Oil prices /5 Annual average /OECD, Financial Data 2/ CBK, for 2015 data available until November 3/ World GDP, volume (percentage change on preceding year), EEF Autumn / World imports of goods and services, volume (percentage change on preceding year), EEF Autumn / IMF, Financial Data, 2015 onwards are projections, petroleum price is average of spot prices for U.K. Brent, Dubai and West Texas Intermediate 109

114 Table 9. Selected employment and social indicators Data source Labour market participation rate (%) 36.9 LFS (SAK) total (15-64) n/a n/a - male LFS (SAK) n/a n/a - female LFS (SAK) n/a n/a 2. Employment rate (%) total LFS (SAK) 25.5 (15-64) n/a n/a - male LFS (SAK) n/a n/a - female LFS (SAK) n/a n/a 3. Unemployment rate (%) total LFS (SAK) n/a n/a - male LFS (SAK) n/a n/a - female LFS (SAK) n/a n/a 4. Long-term unemployment rate (%) total n/a n/a n/a n/a n/a - male e n/a n/a n/a n/a n/a - female e n/a n/a n/a n/a n/a 5. Youth unemployment (15-24 yrs) rate (%) total LFS (SAK) n/a n/a - male LFS (SAK) n/a n/a - female LFS (SAK) n/a n/a 6. Young people (please indicate the age bracket of the available figures) not in employment, education or training (NEET), in % LFS (SAK) 35.1 (15-24) n/a n/a 7. Early school leavers, in % (Eurostat definition) e n/a n/a n/a n/a n/a 8. Participation rate in early childhood education and care / n/a n/a 9. GINI coefficient n/a n/a n/a n/a n/a 10. Inequality of income distribution S80/S20 e n/a n/a n/a n/a n/a 11. Social protection expenditure in % of Treasury GDP Dept Health expenditure in % of GDP At-risk-of-poverty before social transfers, % of the population e n/a n/a n/a n/a n/a 14. Poverty rate n/a n/a n/a n/a n/a 15. Poverty gap n/a n/a n/a n/a n/a 1/ Calculated as the ratio between the enrolment of children at the age of 0-5 and the total number of population at this age. 110

115 Table 10: Matrix of policy commitments Description of policy Launching and application of electronic procurement A. Duration of the reform* X X X B. Net direct budgetary impact (if any) (in ) B.1 Direct impact on budgetary revenue (in ) B.2 Direct impact on budgetary expenditure (in ) 50,000 50,000 50,000 B.3 Possible non-budgetary financing (in ) - B.3.1 Of which committed IPA funding including WBIF funding (in ) 2. Construction of new highway to Skopje and upgrade and rehabilitation of railway line 10 A. Duration of the reform* X X X X B. Net direct budgetary impact (if any) (in ) B.1 Direct impact on budgetary revenue (in ) B.2 Direct impact on budgetary expenditure (in ) 110,200, ,000, ,968,750 B.3 Possible non-budgetary financing (in ) - B.3.1 Of which committed IPA funding including WBIF funding (in ) 3. Further development of energy production capacities A. Duration of the reform* X X X X B. Net direct budgetary impact (if any) (in ) B.1 Direct impact on budgetary revenue (in ) B.2 Direct impact on budgetary expenditure (in ) 189,745, ,745, ,745,000 B.3 Possible non-budgetary financing (in ) 1,500,000 23,000,000 - B.3.1 Of which committed IPA funding including WBIF funding (in ) 4. Decrease energy consumption through energy efficiency measures A. Duration of the reform* X X X B. Net direct budgetary impact (if any) (in ) (28,000,000) 9,550,000 9,550,000 B.1 Direct impact on budgetary revenue (in ) 18,850,000 18,850,000 18,850,000 B.2 Direct impact on budgetary expenditure (in ) 450, B.3 Possible non-budgetary financing (in ) 46,400,000 9,300,000 9,300,000 - B.3.1 Of which committed IPA funding including WBIF funding (in ) 2,100,000 9,300,000 9,300, Agricultural infrastructure for agro-business A. Duration of the reform* X X X B. Net direct budgetary impact (if any) (in ) B.1 Direct impact on budgetary revenue (in ) B.2 Direct impact on budgetary expenditure (in ) 3,100,000 B.3 Possible non-budgetary financing (in ) - B.3.1 Of which committed IPA funding including WBIF funding (in ) 6. Consolidation of agricultural land A. Duration of the reform* X X X B. Net direct budgetary impact (if any) (in ) B.1 Direct impact on budgetary revenue (in ) 111

116 B.2 Direct impact on budgetary expenditure (in ) 166, , ,667 B.3 Possible non-budgetary financing (in ) - B.3.1 Of which committed IPA funding including WBIF funding (in ) 7. Determining the potential for industrial cluster development A. Duration of the reform* X X X X B. Net direct budgetary impact (if any) (in ) B.1 Direct impact on budgetary revenue (in ) B.2 Direct impact on budgetary expenditure (in ) 2,017,280 B.3 Possible non-budgetary financing (in ) 2,017,280 - B.3.1 Of which committed IPA funding including WBIF funding (in ) 8. Expansion of the relevant infrastructure for ICT networks and services for socio-economic development A. Duration of the reform* X X X B. Net direct budgetary impact (if any) (in ) B.1 Direct impact on budgetary revenue (in ) B.2 Direct impact on budgetary expenditure (in ) 12,333,333 12,333,333 12,333,333 B.3 Possible non-budgetary financing (in ) 12,333,333 12,333,333 12,333,333 - B.3.1 Of which committed IPA funding including WBIF funding (in ) 9. Streamline evidenced policy making A. Duration of the reform* X X X B. Net direct budgetary impact (if any) (in ) B.1 Direct impact on budgetary revenue (in ) B.2 Direct impact on budgetary expenditure (in ) 990, ,000 B.3 Possible non-budgetary financing (in ) - B.3.1 Of which committed IPA funding including WBIF funding (in ) 10. Strengthening the property rights system A. Duration of the reform* X X X B. Net direct budgetary impact (if any) (in ) B.1 Direct impact on budgetary revenue (in ) B.2 Direct impact on budgetary expenditure (in ) 2,571,051 2,571,051 2,571,051 B.3 Possible non-budgetary financing (in ) - B.3.1 Of which committed IPA funding including WBIF funding (in ) 11. Increased judicial efficiency A. Duration of the reform* X X X B. Net direct budgetary impact (if any) (in ) B.1 Direct impact on budgetary revenue (in ) B.2 Direct impact on budgetary expenditure (in ) 3,900,000 3,900,000 3,900,000 B.3 Possible non-budgetary financing (in ) - B.3.1 Of which committed IPA funding including WBIF funding (in ) 12. Improve access to finances for Kosovo SMEs A. Duration of the reform* X X X B. Net direct budgetary impact (if any) (in ) 52,000,000 53,000,000 53,000,000 B.1 Direct impact on budgetary revenue (in ) 60,000,000 60,000,000 60,000,000 B.2 Direct impact on budgetary expenditure (in ) 2,000,000 1,000,000 1,000,

117 B.3 Possible non-budgetary financing (in ) 6,000,000 6,000,000 6,000,000 - B.3.1 Of which committed IPA funding including WBIF funding (in ) 13. Improve corporate governance with state owned assets A. Duration of the reform* X X X B. Net direct budgetary impact (if any) (in ) B.1 Direct impact on budgetary revenue (in ) B.2 Direct impact on budgetary expenditure (in ) - 500, ,000 B.3 Possible non-budgetary financing (in ) - B.3.1 Of which committed IPA funding including WBIF funding (in ) 14. Merging customs and tax administration, establishing a single revenue collection agency A. Duration of the reform* X X X B. Net direct budgetary impact (if any) (in ) 4,000,000 7,000,000 9,000,000 B.1 Direct impact on budgetary revenue (in ) 5,000,000 8,000,000 10,000,000 B.2 Direct impact on budgetary expenditure (in ) 1,000,000 1,000,000 1,000,000 B.3 Possible non-budgetary financing (in ) - B.3.1 Of which committed IPA funding including WBIF funding (in ) 15. Fostering business academia cooperation through research grants and innovation vouchers A. Duration of the reform* X X X B. Net direct budgetary impact (if any) (in ) B.1 Direct impact on budgetary revenue (in ) B.2 Direct impact on budgetary expenditure (in ) 120,000 B.3 Possible non-budgetary financing (in ) 666, , ,667 - B.3.1 Of which committed IPA funding including WBIF funding (in ) 666, , , Encouraging businesses to improve quality of products A. Duration of the reform* X X X B. Net direct budgetary impact (if any) (in ) B.1 Direct impact on budgetary revenue (in ) B.2 Direct impact on budgetary expenditure (in ) 800,000 B.3 Possible non-budgetary financing (in ) 4,516,667 3,683,333 3,683,333 - B.3.1 Of which committed IPA funding including WBIF funding (in ) 6,350,000 5,516,667 5,516, Better linkage between education and labour market A. Duration of the reform* X X X B. Net direct budgetary impact (if any) (in ) B.1 Direct impact on budgetary revenue (in ) B.2 Direct impact on budgetary expenditure (in ) 146, , ,000 B.3 Possible non-budgetary financing (in ) - B.3.1 Of which committed IPA funding including WBIF funding (in ) 18. Further strengthen public employment services through operationalisation of the Employment Agency A. Duration of the reform* X X X B. Net direct budgetary impact (if any) (in ) B.1 Direct impact on budgetary revenue (in ) B.2 Direct impact on budgetary expenditure (in ) 80,000 80,000 80,000 B.3 Possible non-budgetary financing (in ) 416, , ,

118 - B.3.1 Of which committed IPA funding including WBIF funding (in ) 416, , , Providing opportunities for training and employment through active labour market measures A. Duration of the reform* X X X B. Net direct budgetary impact (if any) (in ) B.1 Direct impact on budgetary revenue (in ) B.2 Direct impact on budgetary expenditure (in ) 1,500,000 1,500,000 1,500,000 B.3 Possible non-budgetary financing (in ) 4,416,667 4,416,667 4,416,667 - B.3.1 Of which committed IPA funding including WBIF funding (in ) 4,416,667 4,416,667 4,416, Implementation and Improvements to the Teacher Career System A. Duration of the reform* X X X B. Net direct budgetary impact (if any) (in ) B.1 Direct impact on budgetary revenue (in ) B.2 Direct impact on budgetary expenditure (in ) 2,033,401 2,033,401 2,033,401 B.3 Possible non-budgetary financing (in ) - B.3.1 Of which committed IPA funding including WBIF funding (in ) Total net budgetary impact Total impact on budgetary revenue Total impact on budgetary expenditure 403,469, ,015, ,994,

119 Table 11. TIMETABLE OF STRUCTURAL REFORM MEASURES Reform measure #1: Launching and application of electronic procurement Q Q Q Q Launching and application of e-tendering and e-complaints modules of e- procurement; Increase awareness on public procurement among contracting authorities, economic operators and public procurement institutions. Launching and application of e-tendering and e-complaints modules of e- procurement. Increase awareness on public procurement among contracting authorities, economic operators and public procurement institutions. Issuing operational guidance for e- procurement; Training of all procurement officials on e- procurement; Increase of administrative capacities, basic and advanced training; Issuing operational guidance for e- procurement; Training of all procurement officials on e- procurement; Increase of administrative capacities, basic and advanced training; Q Q Q Q Launching and application of e- contracting and e-contract management system modules. Launching and application of e- contracting and e-contract management system modules. Specific and advanced training, including training for trainers, training on e- procurement. Specific and advanced training, including training for trainers, training on e- procurement. Q Q Q Q Maintenance and assessment of electronic procurement system Specific and advanced training, including training for trainers, training on e- procurement Maintenance and assessment of electronic procurement system Specific and advanced training, including training for trainers, training on e- procurement Maintenance and assessment of electronic procurement system Specific and advanced training, including training for trainers, training on e- procurement Maintenance and assessment of electronic procurement system Specific and advanced training, including training for trainers, training on e- procurement Reform measure #2: Construction of new highway to Skopje and upgrade and rehabilitation of railway line 10 Q Q Q Q Construction of priority segments according to dynamics of implementation Construction of priority segments according to dynamics of implementation Construction of priority segments according to dynamics of implementation Construction of priority segments according to dynamics of implementation Preparation of detailed project design for southern and northern part of the railway line 10 Preparation of detailed project design for southern and northern part of the railway line 10 Preparation of detailed project design for southern and northern part of the railway line 10 Preparation of detailed project design for southern and northern part of the railway line 10 Q Q Q Q

120 Construction of priority segments of Route 6 according to the dynamics of implementation Construction of priority segments of Route 6 according to the dynamics of implementation Construction of priority segments of Route 6 according to the dynamics of implementation Construction of priority segments of Route 6 according to the dynamics of implementation Q Q Q Q Construction of priority segments of Route 6 according to the dynamics of implementation Construction of priority segments of Route 6 according to the dynamics of implementation Construction of priority segments of Route 6 according to the dynamics of implementation Construction of priority segments of Route 6 according to the dynamics of implementation Start of investments for general rehabilitation of Railway Route 10 Start of investments for general rehabilitation of Railway Route 10 Start of investments for general rehabilitation of Railway Route 10 Start of investments for general rehabilitation of Railway Route 10 Reform measure #3: Further development of energy production capacities Q Q Q Q Finalise financing agreement for construction of New Power Plant. Finalise financing agreement for construction of New Power Plant. Finalise financing agreement for construction of New Power Plant. Finalise financing agreement for construction of New Power Plant. Q Q Q Q Commence construction works for the TPP Kosova e Re. Commence construction works for the TPP Kosova e Re. Commence construction works for the TPP Kosova e Re. Commence construction works for the TPP Kosova e Re. Q Q Q Q Ongoing construction works for the TPP Kosova e Re. Ongoing construction works for the TPP Kosova e Re. Ongoing construction works for the TPP Kosova e Re. Ongoing construction works for the TPP Kosova e Re. Reform measure #4: Decrease energy consumption through energy efficiency measures Q Q Q Q EE and RE Investments in Central Government Buildings; Pilot EE Investment Program for Municipalities; Technical Studies and Supervision; EE and RE Investments in Central Government Buildings; Pilot EE Investment Program for Municipalities; Technical Studies and Supervision; EE and RE Investments in Central Government Buildings; Pilot EE Investment Program for Municipalities; Technical Studies and Supervision; EE and RE Investments in Central Government Buildings; Pilot EE Investment Program for Municipalities; Technical Studies and Supervision; 116

121 Training of Firms; Training of Firms; Training of Firms; Training of Firms; Q Q Q Q EE and RE Investments in Central Government Buildings; Pilot EE Investment Program for Municipalities; Technical Studies and Supervision; Training of Firms; EE and RE Investments in Central Government Buildings; Pilot EE Investment Program for Municipalities; Technical Studies and Supervision; Training of Firms; EE and RE Investments in Central Government Buildings; Pilot EE Investment Program for Municipalities; Technical Studies and Supervision; Training of Firms; EE and RE Investments in Central Government Buildings; Pilot EE Investment Program for Municipalities; Technical Studies and Supervision; Training of Firms; Q Q Q Q EE and RE Investments in Central Government Buildings; Pilot EE Investment Program for Municipalities; Technical Studies and Supervision; Training of Firms; EE and RE Investments in Central Government Buildings; Pilot EE Investment Program for Municipalities; Technical Studies and Supervision; Training of Firms; EE and RE Investments in Central Government Buildings; Pilot EE Investment Program for Municipalities; Technical Studies and Supervision; Training of Firms; EE and RE Investments in Central Government Buildings; Pilot EE Investment Program for Municipalities; Technical Studies and Supervision; Training of Firms; Reform measure #5: Agricultural infrastructure for agro-business Q Q Q Q Increase irrigation system coverage; Develop the agricultural wholesale market infrastructure; Expand the number of laboratory testing units. Increase irrigation system coverage; Develop the agricultural wholesale market infrastructure; Expand the number of laboratory testing units. Increase irrigation system coverage; Develop the agricultural wholesale market infrastructure; Expand the number of laboratory testing units for verifying the quality of private seed production and to improve phyto-sanitary measures; Increase irrigation system coverage; Develop the agricultural wholesale market infrastructure; Expand the number of laboratory testing units for verifying the quality of private seed production and to improve phyto-sanitary measures; Q Q Q Q Increase irrigation system coverage; Develop the agricultural wholesale market infrastructure; Expand the number of laboratory testing units; Establishing Integrated Agricultural Information System Increase irrigation system coverage; Develop the agricultural wholesale market infrastructure; Expand the number of laboratory testing units; Establishing Integrated Agricultural Information System Increase irrigation system coverage; Develop the agricultural wholesale market infrastructure; Expand the number of laboratory testing units; Establishing Integrated Agricultural Information System Increase irrigation system coverage; Develop the agricultural wholesale market infrastructure; Expand the number of laboratory testing units; Establishing Integrated Agricultural Information System 117

122 Q Q Q Q Increase irrigation system coverage; Develop the agricultural wholesale market infrastructure; Expand the number of laboratory testing units; Establishing Integrated Agricultural Information System Increase irrigation system coverage; Develop the agricultural wholesale market infrastructure; Expand the number of laboratory testing units; Establishing Integrated Agricultural Information System Increase irrigation system coverage; Develop the agricultural wholesale market infrastructure; Expand the number of laboratory testing units; Establishing Integrated Agricultural Information System Increase irrigation system coverage; Develop the agricultural wholesale market infrastructure; Expand the number of laboratory testing units; Establishing Integrated Agricultural Information System Reform measure #6: Consolidation of agricultural land Q Q Q Q Completion of unfinished land consolidation projects will be carried during Completion of unfinished land consolidation projects will be carried during Completion of unfinished land consolidation projects will be carried during Completion of unfinished land consolidation projects will be carried during Q Q Q Q Completion of unfinished land consolidation projects will be carried during Completion of unfinished land consolidation projects will be carried during Completion of unfinished land consolidation projects will be carried during Completion of unfinished land consolidation projects will be carried during Q Q Q Q Completion of unfinished land consolidation projects will be carried during Completion of unfinished land consolidation projects will be carried during Completion of unfinished land consolidation projects will be carried during Completion of unfinished land consolidation projects will be carried during Reform measure #7: Determining the potential for industrial cluster development Q Q Q Q Analysis of the value chain within domestic markets Development and implementation of Competitiveness Programme. Analysis of the value chain within domestic markets Development and implementation of Competitiveness Programme. Analysis of the value chain within domestic markets Development and implementation of Competitiveness Programme. Analysis of the value chain within domestic markets Development and implementation of Competitiveness Programme. Q Q Q Q Development and implementation of Competitiveness Programme. Development and implementation of Competitiveness Programme. Development and implementation of Competitiveness Programme. Development and implementation of Competitiveness Programme. 118

123 Q Q Q Q Development and implementation of Competitiveness Programme. Development and implementation of Competitiveness Programme. Development and implementation of Competitiveness Programme. Development and implementation of Competitiveness Programme. Reform measure #8: Expansion of the relevant infrastructure for ICT networks and services for socio-economic development Q Q Q Q Deployment of high-speed broadband infrastructure Deployment of high-speed broadband infrastructure Deployment of high-speed broadband infrastructure Deployment of high-speed broadband infrastructure ICT skills development for the Digital Economy and supply and support to digital businesses ICT skills development for the Digital Economy and supply and support to digital businesses ICT skills development for the Digital Economy and supply and support to digital businesses ICT skills development for the Digital Economy and supply and support to digital businesses Q Q Q Q Deployment of high-speed broadband infrastructure Deployment of high-speed broadband infrastructure Deployment of high-speed broadband infrastructure Deployment of high-speed broadband infrastructure ICT skills development for the Digital Economy and supply and support to digital businesses ICT skills development for the Digital Economy and supply and support to digital businesses ICT skills development for the Digital Economy and supply and support to digital businesses ICT skills development for the Digital Economy and supply and support to digital businesses Q Q Q Q Deployment of high-speed broadband infrastructure Deployment of high-speed broadband infrastructure Deployment of high-speed broadband infrastructure Deployment of high-speed broadband infrastructure ICT skills development for the Digital Economy and supply and support to digital businesses ICT skills development for the Digital Economy and supply and support to digital businesses ICT skills development for the Digital Economy and supply and support to digital businesses ICT skills development for the Digital Economy and supply and support to digital businesses 119

124 Reform measure #9: Streamline evidenced policy making Q Q Q Q Establishing the Regulatory Quality Unit and complete capacity building within the administration. Establishing the Regulatory Quality Unit and complete capacity building within the administration. Establishing the Regulatory Quality Unit and complete capacity building within the administration. Establishing the Regulatory Quality Unit and complete capacity building within the administration. 25 RIA trainers from line Ministries trained and certified 25 RIA trainers from line Ministries trained and certified Q Q Q Q Establishing the Regulatory Quality Unit and complete capacity building within the administration. Establishing the Regulatory Quality Unit and complete capacity building within the administration. Establishing the Regulatory Quality Unit and complete capacity building within the administration. Establishing the Regulatory Quality Unit and complete capacity building within the administration. 3 RIA trainers for piloting and regulatory impact assessments 3 RIA trainers for piloting and regulatory impact assessments 3 RIA trainers for piloting and regulatory impact assessments 3 RIA trainers for piloting and regulatory impact assessments Q Q Q Q Establishing the Regulatory Quality Unit and complete capacity building within the administration. Establishing the Regulatory Quality Unit and complete capacity building within the administration. Establishing the Regulatory Quality Unit and complete capacity building within the administration. Establishing the Regulatory Quality Unit and complete capacity building within the administration. 5 RIA trainers for piloting and regulatory impact assessments 5 RIA trainers for piloting and regulatory impact assessments 5 RIA trainers for piloting and regulatory impact assessments 5 RIA trainers for piloting and regulatory impact assessments Reform measure #10: Strengthening the property rights system Q Q Q Q Drafting and adoption of the Strategy on Property rights Drafting and adoption of the Strategy on Property rights Drafting and adoption of the Strategy on Property rights Drafting and adoption of the Strategy on Property rights Adoption of the concept paper on public property Adoption of the concept paper on public property Adoption of the concept paper on public property Adoption of the concept paper on public property 120

125 Q Q Q Q Drafting and adoption of the Strategy on Property rights Drafting and adoption of the Strategy on Property rights Drafting and adoption of the Strategy on Property rights Drafting and adoption of the Strategy on Property rights Adoption of the concept paper on public property Adoption of the concept paper on public property Adoption of the concept paper on public property Adoption of the concept paper on public property Q Q Q Q Drafting and adoption of the Strategy on Property rights Drafting and adoption of the Strategy on Property rights Drafting and adoption of the Strategy on Property rights Drafting and adoption of the Strategy on Property rights Adoption of the concept paper on public property Adoption of the concept paper on public property Adoption of the concept paper on public property Adoption of the concept paper on public property Reform measure #11: Increased judicial efficiency Q Q Q Q Amending the legal framework; Decreased caseload for minor offences; Targeting zero backlog: Improve the clearance rates by optimizing the Case Management System; Fiscal departments within the basic court in Prishtina; Amending the legal framework; Decreased caseload for minor offences; Targeting zero backlog: Improve the clearance rates by optimizing the Case Management System; Fiscal departments within the basic court in Prishtina; Amending the legal framework; Decreased caseload for minor offences; Targeting zero backlog: Improve the clearance rates by optimizing the Case Management System; Fiscal departments within the basic court in Prishtina; Amending the legal framework; Decreased caseload for minor offences; Targeting zero backlog: Improve the clearance rates by optimizing the Case Management System; Fiscal departments within the basic court in Prishtina; Q Q Q Q Amending the legal framework; Decreased caseload for minor offences; Targeting zero backlog: Improve the clearance rates by optimizing the Case Management System; Fiscal departments within the basic court in Prishtina; Amending the legal framework; Decreased caseload for minor offences; Targeting zero backlog: Improve the clearance rates by optimizing the Case Management System; Fiscal departments within the basic court in Prishtina; Amending the legal framework; Decreased caseload for minor offences; Targeting zero backlog: Improve the clearance rates by optimizing the Case Management System; Fiscal departments within the basic court in Prishtina; Amending the legal framework; Decreased caseload for minor offences; Targeting zero backlog: Improve the clearance rates by optimizing the Case Management System; Fiscal departments within the basic court in Prishtina; Q Q Q Q

126 Amending the legal framework; Decreased caseload for minor offences; Targeting zero backlog: Improve the clearance rates by optimizing the Case Management System; Fiscal departments within the basic court in Prishtina; Amending the legal framework; Decreased caseload for minor offences; Targeting zero backlog: Improve the clearance rates by optimizing the Case Management System; Fiscal departments within the basic court in Prishtina; Amending the legal framework; Decreased caseload for minor offences; Targeting zero backlog: Improve the clearance rates by optimizing the Case Management System; Fiscal departments within the basic court in Prishtina; Amending the legal framework; Decreased caseload for minor offences; Targeting zero backlog: Improve the clearance rates by optimizing the Case Management System; Fiscal departments within the basic court in Prishtina; Reform measure #12: Improve access to finances for Kosovo SMEs Q Q Q Q Fully functioning Credit Guarantee Scheme and newly resourced based on the current design scheme taking into consideration the sectorial priorities from the Industrial Policy paper. Fully functioning Credit Guarantee Scheme and newly resourced based on the current design scheme taking into consideration the sectorial priorities from the Industrial Policy paper. Fully functioning Credit Guarantee Scheme and newly resourced based on the current design scheme taking into consideration the sectorial priorities from the Industrial Policy paper. Q Q Q Q Fully functioning Credit Guarantee Scheme and newly resourced based on the current design scheme taking into consideration the sectorial priorities from the Industrial Policy paper. Fully functioning Credit Guarantee Scheme and newly resourced based on the current design scheme taking into consideration the sectorial priorities from the Industrial Policy paper. Fully functioning Credit Guarantee Scheme and newly resourced based on the current design scheme taking into consideration the sectorial priorities from the Industrial Policy paper. Q Q Q Q Fully functioning Credit Guarantee Scheme and newly resourced based on the current design scheme taking into consideration the sectorial priorities from the Industrial Policy paper. Fully functioning Credit Guarantee Scheme and newly resourced based on the current design scheme taking into consideration the sectorial priorities from the Industrial Policy paper. Fully functioning Credit Guarantee Scheme; Evaluating the functioning of the scheme and reviewing the options for the further expansion and optimisation. Fully functioning Credit Guarantee Scheme; Evaluating the functioning of the scheme and reviewing the options for the further expansion and optimisation. Fully functioning Credit Guarantee Scheme; Evaluating the functioning of the scheme and reviewing the options for the further expansion and optimisation. Fully functioning Credit Guarantee Scheme; Evaluating the functioning of the scheme and reviewing the options for the further expansion and optimisation. Reform measure #13: Improve corporate governance with state owned assets Q Q Q Q Approval of the Concept Document for Law on POE. Approval of the Concept Document for Law on POE.. Approval of the Concept Document for Law on POE. Approval of the Concept Document for Law on POE. 122

127 Q Q Q Q New Law on POE Adopted; Secondary Legislation approved containing reporting forms; Improvement of Monitoring and Supervision Capacities; New POE Sup. & Mon. MIS developed; Improving capacities for Supervision and Monitoring. New Law on POE Adopted; Secondary Legislation approved containing reporting forms; Improvement of Monitoring and Supervision Capacities; New POE Sup. & Mon. MIS developed; Improving capacities for Supervision and Monitoring. New Law on POE Adopted; Secondary Legislation approved containing reporting forms; Improvement of Monitoring and Supervision Capacities; New POE Sup. & Mon. MIS developed; Improving capacities for Supervision and Monitoring. New Law on POE Adopted; Secondary Legislation approved containing reporting forms; Improvement of Monitoring and Supervision Capacities; New POE Sup. & Mon. MIS developed; Improving capacities for Supervision and Monitoring. Q Q Q Q POEPMU transferred to the Centre of Government, POE to Relevant Sectors; Consolidated Report for 2017 in line with new requirements; Quarterly Monitoring in line with new requirements. POEPMU transferred to the Centre of Government, POE to Relevant Sectors; Quarterly Monitoring in line with new requirements. POEPMU transferred to the Centre of Government, POE to Relevant Sectors; Quarterly Monitoring in line with new requirements. POEPMU transferred to the Centre of Government, POE to Relevant Sectors; Quarterly Monitoring in line with new requirements Reform measure #14: Merging customs and tax administration, establishing a single revenue collection agency Q Q Q Q Drafting the legal foundation and the action plan. Drafting the legal foundation and the action plan. Drafting the legal foundation and the action plan; the Government proceeds to the Assembly the Law on Revenue Collection Agency. Q Q Q Q Complete functioning of the Agency and necessary intervention in legislation and the organisational structures of the agency, as necessary. Complete functioning of the Agency and necessary intervention in legislation and the organisational structures of the agency, as necessary. Complete functioning of the Agency and necessary intervention in legislation and the organisational structures of the agency, as necessary. Q Q Q Q Drafting the legal foundation and the action plan; the Government proceeds to the Assembly the Law on Revenue Collection Agency. Following the approval of the law, commences formal merger of Customs and Tax Administration. Complete functioning of the Agency and necessary intervention in legislation and the organisational structures of the agency, as necessary. 123

128 Ongoing merger process towards full integration (classical integration) of customs and tax administration. Ongoing merger process towards full integration (classical integration) of customs and tax administration. Ongoing merger process towards full integration (classical integration) of customs and tax administration. Ongoing merger process towards full integration (classical integration) of customs and tax administration. Reform measure #15: Fostering business academia cooperation through research grants and innovation vouchers Q Q Q Q Adoption of the Innovation Strategy; Establishment of the Council for Innovation; Distribution of the innovation vouchers; Distribution of the research project grants; Awareness raising activities. Adoption of the Innovation Strategy; Establishment of the Council for Innovation; Distribution of the innovation vouchers; Distribution of the research project grants; Awareness raising activities. Adoption of the Innovation Strategy; Establishment of the Council for Innovation; Distribution of the innovation vouchers; Distribution of the research project grants; Awareness raising activities. Adoption of the Innovation Strategy; Establishment of the Council for Innovation; Distribution of the innovation vouchers; Distribution of the research project grants; Awareness raising activities. Q Q Q Q Law on Innovation and Technology Transfer; Distribution of the innovation vouchers; Capacity building and awareness raising activities; Planning of financial instruments to promote innovation. Law on Innovation and Technology Transfer; Distribution of the innovation vouchers; Capacity building and awareness raising activities; Planning of financial instruments to promote innovation. Law on Innovation and Technology Transfer; Distribution of the innovation vouchers; Capacity building and awareness raising activities; Planning of financial instruments to promote innovation. Law on Innovation and Technology Transfer; Distribution of the innovation vouchers; Capacity building and awareness raising activities; Planning of financial instruments to promote innovation. Q Q Q Q NA. NA NA. NA. Measure #16: Encouraging businesses to improve quality of products Q Q Q Q Further completion of the framework legislation on quality infrastructure; Adoption of new European and international standards; Completing existing laboratories and establishing new laboratories; Increase the number of conformity assessment bodies; Further completion of the framework legislation on quality infrastructure; Adoption of new European and international standards; Completing existing laboratories and establishing new laboratories; Increase the number of conformity assessment bodies; Further completion of the framework legislation on quality infrastructure; Adoption of new European and international standards; Completing existing laboratories and establishing new laboratories; Increase the number of conformity assessment bodies; Increase awareness of businesses on quality infrastructure and support businesses on Further completion of the framework legislation on quality infrastructure; Adoption of new European and international standards; Completing existing laboratories and establishing new laboratories; Increase the number of conformity assessment bodies; Increase awareness of businesses on quality infrastructure and support businesses on 124

129 implementation of standards. Q Q Q Q Further completion of the framework legislation on quality infrastructure; Adoption of new European and international standards; Completing existing laboratories and establishing new laboratories; Increase the number of conformity assessment bodies; Increase awareness of businesses on quality infrastructure and support businesses on implementation of standards. Financial support to businesses to certify their products Further completion of the framework legislation on quality infrastructure; Adoption of new European and international standards; Completing existing laboratories and establishing new laboratories; Increase the number of conformity assessment bodies; Increase awareness of businesses on quality infrastructure and support businesses on implementation of standards. Financial support to businesses to certify their products Further completion of the framework legislation on quality infrastructure; Adoption of new European and international standards; Completing existing laboratories and establishing new laboratories; Increase the number of conformity assessment bodies; Increase awareness of businesses on quality infrastructure and support businesses on implementation of standards. Financial support to businesses to certify their products Q Q Q Q Further completion of the framework legislation on quality infrastructure; Adoption of new European and international standards; Completing existing laboratories and establishing new laboratories; Increase the number of conformity assessment bodies; Increase awareness of businesses on quality infrastructure and support businesses on implementation of standards. Financial support to businesses to certify their products. Further completion of the framework legislation on quality infrastructure; Adoption of new European and international standards; Completing existing laboratories and establishing new laboratories; Increase the number of conformity assessment bodies; Increase awareness of businesses on quality infrastructure and support businesses on implementation of standards. Financial support to businesses to certify their products. Further completion of the framework legislation on quality infrastructure; Adoption of new European and international standards; Completing existing laboratories and establishing new laboratories; Increase the number of conformity assessment bodies; Increase awareness of businesses on quality infrastructure and support businesses on implementation of standards. Financial support to businesses to certify their products. implementation of standards. Financial support to businesses to certify their products Further completion of the framework legislation on quality infrastructure; Adoption of new European and international standards; Completing existing laboratories and establishing new laboratories; Increase the number of conformity assessment bodies; Increase awareness of businesses on quality infrastructure and support businesses on implementation of standards. Financial support to businesses to certify their products Further completion of the framework legislation on quality infrastructure; Adoption of new European and international standards; Completing existing laboratories and establishing new laboratories; Increase the number of conformity assessment bodies; Increase awareness of businesses on quality infrastructure and support businesses on implementation of standards. Financial support to businesses to certify their products. 125

130 Reform measure #17: Better linkage between education and labour market Q Q Q Q Ensuring the quality of trainings, the review of the curriculum and accreditation of new ACA Qualification; Expansion of a new curriculum for all remaining schools; Review of existing textbooks; Implement pilot VET system s mixed with elements of dual learning & wage subsidy system. Ensuring the quality of trainings, the review of the curriculum and accreditation of new ACA Qualification; Expansion of a new curriculum for all remaining schools; Review of existing textbooks; Implement pilot VET system s mixed with elements of dual learning & wage subsidy system. Ensuring the quality of trainings, the review of the curriculum and accreditation of new ACA Qualification; Expansion of a new curriculum for all remaining schools; Review of existing textbooks; Implement pilot VET system s mixed with elements of dual learning & wage subsidy system. Ensuring the quality of trainings, the review of the curriculum and accreditation of new ACA Qualification; Expansion of a new curriculum for all remaining schools; Review of existing textbooks; Implement pilot VET system s mixed with elements of dual learning & wage subsidy system. Q Q Q Q Ensuring the quality of trainings, the review of the curriculum and accreditation of new ACA Qualification; Expansion of a new curriculum for all remaining schools; Review of existing textbooks; Implement pilot VET system s mixed with elements of dual learning & wage subsidy system. Ensuring the quality of trainings, the review of the curriculum and accreditation of new ACA Qualification; Expansion of a new curriculum for all remaining schools; Review of existing textbooks; Implement pilot VET system s mixed with elements of dual learning & wage subsidy system. Ensuring the quality of trainings, the review of the curriculum and accreditation of new ACA Qualification; Expansion of a new curriculum for all remaining schools; Review of existing textbooks; Implement pilot VET system s mixed with elements of dual learning & wage subsidy system. Ensuring the quality of trainings, the review of the curriculum and accreditation of new ACA Qualification; Expansion of a new curriculum for all remaining schools; Review of existing textbooks; Implement pilot VET system s mixed with elements of dual learning & wage subsidy system. Q Q Q Q Ensuring the quality of trainings, the review of the curriculum and accreditation of new ACA Qualification; Expansion of a new curriculum for all remaining schools; Review of existing textbooks; Implement pilot VET system s mixed with elements of dual learning & wage subsidy system. Ensuring the quality of trainings, the review of the curriculum and accreditation of new ACA Qualification; Expansion of a new curriculum for all remaining schools; Review of existing textbooks; Implement pilot VET system s mixed with elements of dual learning & wage subsidy system. Ensuring the quality of trainings, the review of the curriculum and accreditation of new ACA Qualification; Expansion of a new curriculum for all remaining schools; Review of existing textbooks; Implement pilot VET system s mixed with elements of dual learning & wage subsidy system. Ensuring the quality of trainings, the review of the curriculum and accreditation of new ACA Qualification; Expansion of a new curriculum for all remaining schools; Review of existing textbooks; Implement pilot VET system s mixed with elements of dual learning & wage subsidy system. 126

131 Reform measure 18: Further strengthen public employment services through operationalisation of the Employment Agency Q Q Q Q Continuous interventions on functioning of the EA, capacity building, licencing of non-public employment services; developing the system of internal training of the Agency and VTCs. Continuous interventions on functioning of the EA, capacity building, licencing of non-public employment services; developing the system of internal training of the Agency and VTCs. Continuous interventions on functioning of the EA, capacity building, licencing of non-public employment services; developing the system of internal training of the Agency and VTCs. Continuous interventions on functioning of the EA, capacity building, licencing of non-public employment services; developing the system of internal training of the Agency and VTCs. Q Q Q Q Continuous interventions on functioning of the EA, capacity building, licencing of non-public employment services; developing the system of internal training of the Agency and VTCs. Continuous interventions on functioning of the EA, capacity building, licencing of non-public employment services; developing the system of internal training of the Agency and VTCs. Continuous interventions on functioning of the EA, capacity building, licencing of non-public employment services; developing the system of internal training of the Agency and VTCs. Continuous interventions on functioning of the EA, capacity building, licencing of non-public employment services; developing the system of internal training of the Agency and VTCs. Q Q Q Q Continuous interventions on functioning of the EA, capacity building, licencing of non-public employment services; developing the system of internal training of the Agency and VTCs. Continuous interventions on functioning of the EA, capacity building, licencing of non-public employment services; developing the system of internal training of the Agency and VTCs. Continuous interventions on functioning of the EA, capacity building, licencing of non-public employment services; developing the system of internal training of the Agency and VTCs. Continues interventions on functioning of the EA, capacity building, licencing of non-public employment services; developing the system of internal training of the Agency and VTCs. Reform measure #19: Providing opportunities for training and employment through active labour market measures Q Q Q Q Provision of training and employment opportunities, through the Wage Subsidy Fund Provision of training and employment opportunities, through the Wage Subsidy Fund Provision of training and employment opportunities, through the Wage Subsidy Fund Provision of training and employment opportunities, through the Wage Subsidy Fund Q Q Q Q Provision of training and employment opportunities, through the Wage Subsidy Fund Provision of training and employment opportunities, through the Wage Subsidy Fund Provision of training and employment opportunities, through the Wage Subsidy Fund Provision of training and employment opportunities, through the Wage Subsidy Fund Q Q Q Q

132 Provision of training and employment opportunities, through the Wage Subsidy Fund Provision of training and employment opportunities, through the Wage Subsidy Fund Provision of training and employment opportunities, through the Wage Subsidy Fund Provision of training and employment opportunities, through the Wage Subsidy Fund Reform Measure #20: Implementation and Improvements to the Teacher Career System Q Q Q Q Teacher professional development/career development in line with the preparation of teachers for implementation of new Curricula; Teacher licensing process; Developing and adopting the legislative framework for teacher licensing, professional development and performance assessment. Teacher professional development/career development in line with the preparation of teachers for implementation of new Curricula; Teacher licensing process; Developing and adopting the legislative framework for teacher licensing, professional development and performance assessment. Teacher professional development/career development in line with the preparation of teachers for implementation of new Curricula; Teacher licensing process; Developing and adopting the legislative framework for teacher licensing, professional development and performance assessment. Teacher professional development/career development in line with the preparation of teachers for implementation of new Curricula; Teacher licensing process; Developing and adopting the legislative framework for teacher licensing, professional development and performance assessment. Q Q Q Q Establishment of the State Council for Teacher Licensing; Development, piloting and adoption of teacher performance assessment instruments; Revised teacher salary structure to match it with preservice qualifications. Establishment of the State Council for Teacher Licensing; Development, piloting and adoption of teacher performance assessment instruments; Revised teacher salary structure to match it with preservice qualifications. Establishment of the State Council for Teacher Licensing; Development, piloting and adoption of teacher performance assessment instruments; Revised teacher salary structure to match it with preservice qualifications. Q Q Q Q Establishment of the State Council for Teacher Licensing; Development, piloting and adoption of teacher performance assessment instruments; Revised teacher salary structure to match it with preservice qualifications. Rolling out licensing for teachers at the Career Teacher license; Development of teacher licensing database. Rolling out licensing for teachers at the Career Teacher license; Development of teacher licensing database. Rolling out licensing for teachers at the Career Teacher license; Development of teacher licensing database. Rolling out licensing for teachers at the Career Teacher license; Development of teacher licensing database. 128

133 Table 12. SUMMARY OF STRUCTURAL REFORM MEASURES Reform measure #1: Launching and application of electronic procurement Short description Summary of implementation timeline Cost of implementation Expected impact on competitiveness This measure aims the introduction of electronic procurement, increase efficiency and transparency of the public procurement procedures, to ensure a better usage of public funds and to reduce the procedural costs, and to encourage economic operators to participate in the public procurement procedures. It also strives to promote a fair competition between the economic operators, while guaranteeing an equal treatment and non-discriminatory principle for all economic operators participating in the public procurement procedures, guarantees integrity, public trust and transparency in public procurement procedures. The main objective of reform measure is to develop and promote a wide use of electronic public procurement through a well-developed information and communication technology system. Under this measure, in the coming three years the following activities are planned to be undertaken: 2016: Launching and application of e-tendering and e-complaints modules of e-procurement; Increase awareness on public procurement among contracting authorities, economic operators and public procurement institutions. Issuing operational guidance for e-procurement; Training of all procurement officials on e-procurement; Increase of administrative capacities, basic and advanced training; 2017: Launching and application of e-contracting and e-contract management system modules; Specific and advanced training, including training for trainers, training on e-procurement 2018: Maintenance and assessment of electronic procurement system; Specific and advanced training, including training for trainers, training on e-procurement 150,000 EUR Application of electronic procurement will have direct effects to transparency and efficiency of public spending; therefore it will enable a more competitive system. Annual savings on government procurement contracts will be increased from the total value of procurement, which then would enable investment of public fund in other priorities. It will increase fair competition, limit discretionary decision-making of state authorities, and improve accountability of institutions. Short description Summary of implementation timeline Reform Measure #2: Construction of new highway to Skopje and upgrade and rehabilitation of railway line 10 This measure represents a continuation of infrastructure reforms, in this case it connects the Corridor VIII to South-East Europe.While in the road infrastructure there have been major advances in quality through building an extensive network of highways, in the railway sector further investments are necessary to bring Kosovo railroads to EU quality standards. Main investment projects for development of road and railway transport involve: a) new construction of roads (construction of priority segments in highway Prishtina Han i Elezit (R6) which connects the Corridor VIII to South-East Europe) and b) upgrade and/or rehabilitation of railway (preparation of detailed project design for southern and northern part of the railway line 10; General rehabilitation of railway route 10 (border with Serbia Leshak Fushë Kosovë Hani i Elezit border with Macedonia)). Under this measure, in the coming three years , the following activities are planned to be undertaken: 2016: Construction of priority segments according to dynamics of implementation; Preparation of detailed project design for southern and northern part of the railway line : Construction of priority segments of Route 6 according to the dynamics of implementation 2018: Construction of priority segments of Route 6 according to the dynamics of implementation; Start of investments for general rehabilitation of Railway Route

134 Cost of implementation Expected impact on competitiveness Short description Summary of implementation timeline Cost of implementation Expected impact on competitiveness Short description Summary of implementation timeline Cost of implementation Expected impact on competitiveness 422,168,750 EUR The impact of the measures will therefore be a decrease in the cost of transport for exporting agricultural goods and minerals, a decreased cost of moving goods and people within the country, more efficient operations of public institutions and businesses, better market information for product placement and business deals. All of this could lead to increased output and more profitability in several business sectors, thus enabling higher economic growth. Reform Measure #3: Further development of energy production capacities Further development of the energy capacities strives to ensure the security of supply for a more competitive market with as minimal environment effects as possible. This measures tackles the development of new generation capacities from lignite, TP "Kosova e Re", and enhancing the operational efficiency in central district heating in Pristina and Gjakova. In order to implement these measure, the following activities are planned to be undertaken: development of new generation capacities from lignite, TP Kosova e Re, with the most up to date agreed capacity of around 500 MW, and feasibility study for rehabilitation of TPP Kosovo B; increasing the possibilities for thermal energy supply and enhancing the operational efficiency in central district heating in Pristina and Gjakova. Under this measure, in the coming three years , the following activities are planned to be undertaken: 2016: Finalise financing agreement for construction of New Power Plant 2017: Commence construction works for the TPP Kosova e Re 593,735,000 EUR Energy could thus play not only a supportive function to development by providing stable supply to other sectors of the economy, but could also become a source of development by generating revenues for the state. At the moment, there is a lack of competitiveness and openness in regional energy markets. The implementation of these measures would ensure an optimal mix of generation sources and take into account social aspect and environmental concerns. Reform Measure #4: Decrease energy consumption through energy efficiency measures The measure involves strategic priorities of the government on implementation of energy efficiency measures. In order to fulfil, its commitments towards Energy Community Treaty, Kosovo s priorities remain the implementation of legislation for buildings and adoption of missing secondary legislation and Energy Efficiency Law. Implementation of Energy efficiency fund will be focused on the following milestones: EE and RE Investments in Central Government Buildings; pilot EE Investment Program for Municipalities; Technical Studies and Supervision; and, Training of Firms. In the coming three years it is planned a continuous implementation of the following activities: EE and RE Investments in Central Government Buildings; Pilot EE Investment Program for Municipalities; Technical Studies and Supervision; and Training of Firms. 65,450,000 EUR Implementation of the measure on energy efficiency will contribute to decreasing of domestic consumption, which will serve to lowering the cost of energy and as the result will help businesses and increase investments in private sector. 130

135 Short description Summary of implementation timeline Cost of implementation Expected impact on competitiveness Short description Summary of implementation timeline Cost of implementation Expected impact on competitiveness Reform measure #5: Agricultural infrastructure for agro-business The measure addresses challenges related to agricultural infrastructure, including soft and physical infrastructure. This includes the coverage of irrigation system throughout the regions with high production potential, improvement of wholesale markets, decreasing transaction costs, etc. This reform measure is in line with the National Development Strategy, and it includes the following: increase irrigation system coverage; develop the agricultural wholesale market infrastructure; expand the number of laboratory testing units for verifying the quality of private seed production and to improve phyto-sanitary measures; and, establishing Integrated Agricultural Information System in order to increase competitiveness in the sector. In the coming three years it is planned a continuous implementation of the following activities: Increase irrigation system coverage; Develop the agricultural wholesale market infrastructure; Expand the number of laboratory testing units; and Establishing Integrated Agricultural Information System. 3,100,000 EUR Implementation of these measures will directly impact the growth of agricultural productivity, through better and additional irrigation possibilities; improvement of agricultural production and trade through better market infrastructure, including wholesale markets and improvement of IT systems related to more efficient implementation and monitoring of MAFRD support measures and a more functional system of registration of farms. All of this will lead to cost savings for agro-processing industry and its growth, and will help provide higher rates of return and overall economic growth. Reform measure #6: Consolidation of agricultural land The objective of this measure is to address fragmentation of agricultural land, by grouping and creation of larger and consolidated parcels, with the purpose of increasing their sizes, which will lead to an increase in the average size of farms. Under this measure, in the coming three years , also according to the Action Plan of the Strategy on Land Consolidation, it is planned a continuous completion of unfinished land consolidation projects which will be carried out during ,000 EUR Projects of voluntary consolidation of agricultural land will continue to increase farm sizes, improve access to property, resolution of property disputes, support income generation for farmers, reduce unit costs, increase productivity of agricultural crops and improve competition of agricultural products on the market. Also, land consolidation will contribute to the sustainable development of agriculture and rural areas. Land consolidation as an integral part of rural development and an important policy reform of agricultural land can have an impact on several different levels: lower level (with farmers as direct beneficiaries, social and gender equality because it will help in clarifying property rights), medium level (indirect beneficiaries, improved infrastructure opening of new jobs) and high level (national economy, institutions and the environment). 131

136 Short description Summary of implementation timeline Cost of implementation Expected impact on competitiveness Short description Summary of implementation timeline Cost of implementation Expected impact on competitiveness Reform measure #7: Determining the potential for industrial cluster development The main objective of the reform measure is to establish conditions for development of SMEs in Kosovo through cluster development in priority sectors of Kosovo s industrial policy. This would enhance domestic competitiveness and includes adoption of a National Competitiveness Strategy; supporting cluster development; and facilitating establishment of supplier and subcontractor cluster networks. In order to enhance industrial sector development, the Government will focus on putting in place strategic and policy framework on industrial policy. This involves also identification of investment opportunities for the development of clusters, identification of competitive products in Kosovo through value added chain. Other activities will include awareness raising of businesses for economic benefits from cooperation in clusters as well as provision of grants for start-ups in the framework of clusters. Under this measure, in the coming three years it is planned a continuous implementation of the following activities in order to increase competition and export promotion: Analysis of the value chain within domestic markets; and Development and implementation of Competitiveness Programme. 2,017,280 EUR Cluster development will enhance competitiveness of private sector, enable links to and for the value chain to development. Implementation of the measure will also increase exports with higher value added, and exports in general in relation to GDP and increase financial capital turnover while increasing domestic industrial production (mining) and its exports, and finally increase the level of strategic cooperation between businesses. Reform measure #8: Expansion of the relevant infrastructure for ICT networks and services for socio-economic development This digital agenda reform s objective is to deploy broadband infrastructure in rural areas with no infrastructure coverage, as well as develop human capital and digital economy. Ministry of Economic Development in cooperation with the World Bank, is developing the program for Kosovo Digital Economy KODE. KODE components are based on projects that will develop broadband infrastructure in rural areas with no coverage, as well as human capital and digital businesses, in order to bring Kosovo into the digital economy of the future. The implementation of the Kosovo Digital Economy Development KODE includes: High-speed broadband infrastructure Deployment; ICT skills development for Digital Economy and supply and support to digital businesses. Under this measure, in the coming three years it is planned a continuous implementation of the following activities: Deployment of high-speed broadband infrastructure; and, ICT skills development for the Digital Economy and supply and support to digital businesses. 37,000,000 EUR High-speed broadband infrastructure deployment will contribute to a suitable environment for the development of innovation, new business models, new and improved products and services thus increasing competitiveness and flexibility in economy. Enabling broadband services will lead to an increased productivity of business activities, access to new markets and development of business models improving the competitiveness.whereas, offering a highly skilled labor force will help boost the ICT sector, increase competition and increase revenues in our country s economy. Building the capacities of businesses to export services to countries in need of software and applications will also be the focus of this program. Management of processes, quality, reporting and compliance with international safety standards are of particular importance for ICT businesses in Kosovo. Offering a highly skilled labor force will help boost the ICT sector, increase competition and increase revenues for our country s economy. 132

137 Short description Summary of implementation timeline Cost of implementation Expected impact on competitiveness Short description Summary of implementation timeline Cost of implementation Expected impact on competitiveness Reform measure #9: Streamline evidenced policy making This measure aims to ensure a streamline evidenced policy making which addresses the creation of a strict adherence to RIA principles and procedures for all legislation at place and a smart regulatory quality system that balances gains and economic, environmental and social costs. By encouraging RIA in the process of policymaking, unnecessary legislation is avoided, and policies enacted are clear, consistent, and problem oriented. During the period the Government will focus on implementation of these activities: establish the unit for quality assessment of legislation and capacity building of line ministries on RIA; putting in place procedures for compulsory implementation of RIA through the system of concept papers and explanatory memorandums of draft legal acts; establishing a mechanism for systematic collection and maintenance (database) necessary quantitative data for preparation of Regulatory Impact Assessment; using the mechanism of National Economic Development Council and its ad-hoc committees for detailed analysis of policies and legislation. Implementation of this measure throughout will include establishing the Regulatory Quality Unit and complete capacity building within the administration. On the latter, in the first half of 2016, 25 RIA trainers from line Ministries trained and certified. Next steps will include piloting and regulatory impact assessments (3 in 2017 and 5 in 2018). 1,980,000 EUR Policy formulation and law-making is more effective and efficient as well as unnecessary legislation is avoided and policies are clear and consistent and problem-oriented. Systematic implementation of RIA will enable the government to achieve greater results for each euro spent. Their implementation will lead well thought policies and increase of overall efficiency of work in the public and private sector. Decreasing administrative cost and business cost from avoiding unnecessary regulation will enable reduction of government spending and lower cost for doing business, which will directly have impact to economic growth. Reform measure #10: Strengthening the property rights system The main objective under this measure is to strengthen the property rights system through particular focus on strengthening the legal framework, promotion of marketable land, strengthening judicial capacities for dealing with property rights as well as activities that would ensure better protection of property rights for marginalised groups, minorities as well as women. Property rights system improvement will require the following milestone: development of implementation-oriented legislation to clearly define property rights and improve tenure security for women and members of minority communities; development of improved court procedures to more efficiently resolve property claims and disputes; increased capacity of courts to decide and enforce property rights; increased capacity of Civil Society Organizations to raise public awareness, change societal attitudes and behaviours, and advocate for women s rights to property; Increased number of women inheriting property and securing access to credit; etc. These milestones will be achieved mainly through: drafting and adoption of the Strategy on Property rights and Adoption of the concept paper on public property. Under this measure, in 2016 the Ministry of Justice will focus on drafting and adoption of the Strategy on Property rights, as well as Adoption of the concept paper on public property, which will last until ,713,152 EUR Creation of an effective system of property rights creates legal certainty to investors and consequently increases investment opportunities, while it creates citizens more opportunities to use property as collateral and therefore improves access to finance. Implementation of this measure will have impact on increased private investments that are much needed to enable growth. 133

138 Short description Summary of implementation timeline Cost of implementation Expected impact on competitiveness Short description Summary of implementation timeline Cost of implementation Expected impact on competitiveness Reform measure #11: Increased judicial efficiency This measure s objective is to improve the efficiency of judicial system which at the moment is slow in the disposition of the cases (large number of received minor offence cases, large historical backlog, and low clearance case lead to accumulation of backlog), subsequently that causing high transaction costs. The focus in improving the efficiency of judiciary is on decreasing the caseload for minor offences through incentives and speedy court settlements, temporary increase in hiring additional manpower to sort out cases, and introducing a Case Management and Information System (CMIS) in all courts by Improving the performance of the judicial system in terms of increase of the clearance rates, reduction of disposition time and elimination of backlogged cases is the top priority for Kosovo. In this context, the following challenges will be addressed: amending the legal framework; decreased caseload for minor offences; targeting zero backlog; improve the clearance rates by optimizing the Case Management System; and, establishing fiscal departments within the basic court in Prishtina. Under this measure, in the coming three years it is planned a continuous implementation of the following activities: amending the legal framework; decreased caseload for minor offences; targeting zero backlog: improve the clearance rates by optimizing the Case Management System; and, fiscal departments within the basic court in Prishtina. 11,700,000 EUR The impact of the reforms on the judicial efficiency is indirect on the economic growth, competitiveness, impact on FDI, while the policy measure itself does not have an impact on budget revenues or saving, nor in the job creation. Reform measure #12: Improve access to finances for Kosovo SMEs This measure tackles one of the main barriers for private sector investments in Kosovo which is access to finance. Around 40% of firms identify access to finance as a major constraint. A large number of SMEs cannot meet collateral requirement to obtain bank loans. Expansion of credit guarantees and improved information on business and individual lending history would enable many more businesses to get access to finance and at lower interest rates. The following are the main activities of the measure on access to finance improvements for Kosovo SMEs: fully functioning Credit Guarantee Scheme and newly resourced based on the current design scheme (while ensuring transparent management) and taking into consideration the sectorial priorities from the Industrial Policy paper; and, evaluating the functioning of the scheme and reviewing the options for the further expansion and optimisation. Finding other sources of funding in order to increase the sum of the capital invested. Under this measure, in the coming three years it is planned a continuous implementation of the Kosovo Credit Guarantee Fund (KCGF) which will be carried out till the end of ,000,000 EUR It is anticipated that KCGF will support over 4,150 new loans to SMEs, with the cumulative value over 360 million, creating over 20,000 new jobs in the first 6 years of its operation. 134

139 Short description Summary of implementation timeline Cost of implementation Expected impact on competitiveness Short description Summary of implementation timeline Cost of implementation Reform measure #13: Improve corporate governance with state owned assets Through this measure the Government aims to improve the efficiency of public enterprises in line with OECD corporate governance principles. Within this, the Government will consider options for sectorial approach of monitoring and management of corporates with public ownership. GoK intends to improve corporate governance with state owned assets through the following activities: approval of the Concept Document for Law on POE; new Law on POE adopted; secondary legislation approved containing reporting forms; improvement of Monitoring and Supervision Capacities; new POE Sup. & Mon. MIS developed; improving capacities for Supervision and Monitoring; POEPMU transferred to the Centre of Government, POE to Relevant Sectors; consolidated Report for 2017 in line with new requirements; and, Quarterly Monitoring in line with new requirements. Under this measure, in the coming three years , are planned the following activities: 2016: Approval of the Concept Document for Law on POE; 2017: New Law on POE Adopted; Secondary Legislation approved containing reporting forms; Improvement of Monitoring and Supervision Capacities; New POE Sup. & Mon. MIS developed; Improving capacities for Supervision and Monitoring; 2018: POEPMU transferred to the Centre of Government, POE to Relevant Sectors; Consolidated Report for 2017 in line with new requirements; Quarterly Monitoring in line with new requirements. 1,000,000 EUR Implementation of this measure will lead to improvement of performance of enterprises with state assets; therefore it will result to increasing their contribution to economic growth, increase of the value of enterprises and increased incomes for the state budget through dividend. Reform measure #14: Merging customs and tax administration, establishing a single revenue collection agency This measure aims merging the two revenue collection agencies, respectively Customs and Tax Administration and establishing a Single Revenue Collection Agency. It is based on the need for improvement of services towards taxpayers, reduction of tax gap through simplified and effective structures of revenue collection. As the result this will increase the efficiency of revenue collection and reduction of cost during this process, will increase the autonomy of institutional structures dealing with revenue collection. Also, with the new revenue collection agency the aim is to put in place more efficient institutional structures for implementation of tax and custom policies, as well as fulfilling EU integration requirements. Under this measure the following activities will take place: Adoption of the Innovation Strategy; Establishment of the Council for Innovation; Distribution of the innovation vouchers; Distribution of the research project grants; Awareness raising activities; Law on Innovation and Technology Transfer; Distribution of the innovation vouchers; Capacity building and awareness raising activities; Planning of financial instruments to promote innovation. Under this measure, in the coming three years , are planned the following activities: 2016: Drafting the legal foundation and the action plan. 2017: Complete functioning of the Agency and necessary intervention in legislation and the organizational structures of the agency, as necessary. 2018: Ongoing merger process towards full integration (classical integration) of customs and tax administration. 3,000,000 EUR 135

140 Expected impact on competitiveness Short description Summary of implementation timeline Cost of implementation Expected impact on competitiveness Short description Summary of implementation timeline The main motivation behind merging customs and tax administration is the increased potential for higher domestic revenues, in a light of expected further decline of border revenues due to preferential agreements with CEFTA and the SAA with the EU. Restructuring of labour inspectorate will enable a new dynamics in the implementation of the legal mandate of the institution, focusing on the protection and guarantee of the rights of the parties in labor market and reduce non-formal employment. Reform measure #15: Fostering business academia cooperation through research grants and innovation vouchers This measure attempts to establish the policy framework for accelerating creation of research and innovation capacity with a focus on priority sectors of industrial policy and based on improved partnerships between public research institutions and the Government.It is expected the measure will establish the basis for increased public and private spending on research and development, which requires a clear policy framework, coordination and appropriate incentives. Over the following period of three years the following milestones are expected to be achieved: adoption of the Law on Innovation and Technology Transfer (much needed especially when defining the royalties split between the research institution and researchers); and adoption of the Innovation Strategy. It includes also, governance structures, necessary incentives, necessary skills and human capital as well as the necessary infrastructure needed to promote technology and innovation; Establishment of the Council for Innovation under the supervision of the Prime Minister; and, practical initiatives focused on creation of capacity building to promote technology transfer and innovation. Under this measure, in the coming two years , are planned the following activities: 2016: Adoption of the Innovation Strategy; Establishment of the Council for Innovation; Distribution of the innovation vouchers; Distribution of the research project grants; Awareness raising activities. 2017: Law on Innovation and Technology Transfer; Distribution of the innovation vouchers; Capacity building and awareness raining activities; Planning of financial instruments to promote innovation. 2,120,000 EUR Improved quality of research and innovation access leads to better understanding business needs for new technological solutions and in turn, applied research and innovation concepts in business activities ultimately leading to higher quality and more competitive products and services with higher export potential and added value. Reform measure #16: Encouraging businesses to improve quality of products This measure addresses directly the quality infrastructure modernization for businesses, such as: legal infrastructure standardization, metrology, accreditation and conformity assessment bodies. Modernization of quality infrastructure (standardization, metrology, accreditation and conformity assessment) is mandatory in order to reduce trade barriers and increase trade integration. In order to address the existing challenges this reform measure will focus on further completion of the framework legislation of quality infrastructure, implementation of this legislation and direct support to businesses to improve quality of products (through certification): further completion of the framework legislation on quality infrastructure in line with the EU acquis check the National Programme for Implementation of SAA; adoption of new European and international standards (1400 new standards 2016); completing existing laboratories and establishing new laboratories; increase the number of conformity assessment bodies; increase awareness of businesses on quality infrastructure and support businesses on implementation of standards. Many of the activities foreseen in this measure are a continuation of the processes that are ongoing within the Ministry of Trade and Industry (MTI). This excludes the financial support to businesses to certify their products, which is planned to start in the late 2016 through the support of an IPA project. All the activities of this measure will continue up to

141 Cost of implementation Expected impact on competitiveness Short description Summary of implementation timeline Cost of implementation Expected impact on competitiveness Short description Summary of implementation timeline Cost of implementation 12,683,333 EUR Establishment/Strengthening of Quality Infrastructure is the means and the most durable boost of the competitiveness of businesses. All activities and operations of the Quality Infrastructure, including harmonization of legislation, raising awareness among stakeholders, and other technical capacity building, have a direct and indirect impact on trade integration. Reform measure #17: Better linkage between education and labour market The objective under this measure is to strengthen the links between educational programs and labor market needs through the establishment of professional standards and priority areas, and implementation of the core curriculum and teacher training, which will be achieved through: Ensuring the quality of trainings, the review of the curriculum and accreditation of new ACA Qualification; Expansion of a new curriculum for all remaining schools, while at the same time undertaking the evaluation of efficiency in pilot schools (10 %), and systemic corrections where necessary; Review of existing textbooks to better fit the student s needs, including the development of new textbooks according to the learning outcomes. While, because of the specifics that VET has, there will be basic texts developed for the respective profiles and other educational materials; Implement pilot VET system s mixed with elements of dual learning (combination of learning in schools and enterprises) starting with priority areas and continuing VET according to Core Curriculum. Coordination with wage subsidy system in those areas, in order to achieve better integration of VET graduates to the labor market; Under this measure, in the coming three years , are planned the following activities: Ensuring the quality of trainings, the review of the curriculum and accreditation of new ACA Qualification; Expansion of a new curriculum for all remaining schools; Review of existing textbooks; Implement pilot VET system s mixed with elements of dual learning & wage subsidy system. 438,000 EUR Implementation of this measure will contribute to the creation of more employable workers and more efficient and productive enterprises. Social and economic effects will be long term and will be accompanied by growing income for workers and enterprises. Creating a more agile workforce will help attract foreign direct investment. Investing in smart specialization and R & I will make the most innovative enterprises and thus will enable the growth of industries. Reform measure #18: Further strengthen public employment services through operationalisation of the Employment Agency The reform measure will focus on reform and modernization of Public Employment Services and Improving the capacities of Employment Agency to support Active Labour Market Measures (ALMM) based on accurate Labour Market Information and Capacity development for VTCs. The aim under this measure is implementation of policies leading to further improvement and increase of the efficiency of public employment services. Main interventions will include capacity building of PES services, including non-public services; focused on increasing human resources and professional capacities of the bodies for inspection of economic operators in order to effectively implement legal provisions regulating the labour area. In the coming three years , the implementation of this measure include continues interventions on functioning of the Employment Agency of Kosovo, capacity building, licencing of non-public employment services; and, developing the system of internal training of the Agency and VTCs. 1,489,998 EUR 137

142 Expected impact on competitiveness Short description Summary of implementation timeline Cost of implementation Expected impact on competitiveness Short description Summary of implementation timeline Reforming and modernization of the Public Employment Services will have positive effects in increasing competitiveness and improving the quality of market demand and the needs of jobseekers. In particular, licensing of the non-public employment service providers will help reduce the cost of this service, the expansion of its service and in the medium term will lead to an achievement of larger targets to alleviate unemployment. Implementation of this measure will also contribute to the creation of more employable workers and more efficient and productive enterprises. Developing a more agile workforce will help attract foreign direct investment. Investing in smart specialization and R&I will make innovative enterprises and thus will enable industry growth. Reform measure #19: Providing opportunities for training and employment through active labour market measures The main purpose of this reform measure is to provide opportunities for training and employment through on job-training, wage subsidies, institution and enterprise based training, internships/apprentiships programmes, and self-employment programmes. In particular, the aim is to utilise existing and forthcoming wage subsidy initiatives towards increasing job creation through new hiring and enhanced employability. The primary purpose of the WSF is to mobilize government and donor funds towards increasing the employability of vulnerable groups, especially youth, women and long-term unemployed. The Wage Subsidy Fund (WSF) aims to become an integrated instrument to support the placement of jobseekers into Kosovo private sector firms by temporarily sharing the hiring cost. Provision of training and employment opportunities (including Wage Subsidy Programme), under this measure, will be implemented during the years ,750,000 EUR Implementation of this measure will enable provision of opportunities for beneficiaries of different categories, especially youth and women that will receive continuous support and training to find a job and develop their career, or to establish their own enterprise. Furthermore, it will provide oppurtunities for enhancing knowledge based on the labour market and will lead to evidence-based decision making by institutions that regulate the labour market. Reform Measure #20: Implementation and Improvements to the Teacher Career System This measure will focus on: (i) implementation of the career system for teachers professional development (PD); performance assessment (PA) and promotion; and (ii) provide policy support to further strengthen, complement and systematize the teacher career system and licensing scheme. This will continue the implementation of the conceptual framework which links teachers career advancement with professional development and performance assessment. Main interventions of this measure will include: development and implementation of a plan for teacher performance assessment aligned with local capacities; development of competency-based teacher licensing and promotion scheme that defines key competencies for each type of license in the existing scheme and links these with financial incentives; and setting up of an induction program for new teachers, aimed at improving and institutionalizing teacher performance assessment and professional development. Under this measure, in the coming three years , are planned the following activities: 2016 Teacher professional development/career development in line with the preparation of teachers for implementation of new Curricula; Teacher licensing process based on levels of licenses; Developing and adopting the legislative framework for teacher licensing, professional development and performance assessment : Establishment of the State Council for Teacher Licensing; Development, piloting and adoption of teacher performance assessment instruments; Revised teacher salary structure; Rolling out licensing for teachers at the Career Teacher license; 138

143 Cost of implementation Expected impact on competitiveness Development of teacher licensing database. 6,100,202 EUR This measure aims at directly targeting governance and indirectly targeting quality of education, two of the keys for successful learning outcomes. A potential expected benefit will be increased capacity of systems, institutions, and management. By supporting the implementation of several levers that are closely aligned with improved teacher performance, the measure will indirectly impact student performance and consequently result in higher competitive labour skills. 139

144 ANNEX 2. AN INVESTIGATION OF THE COMBINED EFFECT OF WAGES INCREASES AND WORLD COMMODITY PRICES ON KOSOVO S INFLATION 32 In 2011, the Government increased public sector wages by 50%. Although the country was experiencing steady growth of revenues, to preserve the level of capital spending, the wage increase was somewhat compensated by increasing excise taxes on tobacco and introducing excise tax on a number of other goods 33. These measures generated enough revenues to retain the expenditure structure at that time, although one-off revenues 34 contributed considerably to the maintenance of low deficit levels. Three years later, in 2014, the year in which the fiscal rule was adopted, the Government took a decision to increase public sector wages and pensions by 25%. This increase resulted in a shift in the expenditure structure, lowering capital spending from 11% of GDP in 2011 to 7.4% in 2014 (see graph 1). This change in expenditure structure, coupled with limited space to further cut spending in order to preserve the deficit, pressured the Government to undertake additional revenue measures, such as increasing existing excise taxes. Graph 1: Government Expenditures on wages and capital, in millions of euros The wage increase of 2014 coincided with downward inflationary pressures stemming from falling international commodity prices. Considering the large share of imports in the economy, prices are predominantly influenced by international price movements. Hence, falling international prices were expected to affect the overall price level in Kosovo, although in the previous forecasts it was assumed that there is a strong asymmetric price stickiness to the impact of international prices (i.e. large in response to increases in world commodity prices as firms raise domestic prices to protect mark-ups; but small in response to decreases in world commodity prices as firms maintain domestic prices in the interest of preserving said mark-ups). In addition, demand push inflation 32 This investigation of the combined effect of wages increases and world commodity prices on Kosovo s inflation represents a condensed version of the analysis that has been conducted with the help of Professor Geoffrey Pugh, through the EU funded Project Support to the Ministry of Finance managed by the EUO in Kosovo 33 Cars, bulbs, used tires, and plastic bags 34 In 2012 a dividend of 60 million euros was received from the PTK and additional 19 million euros in the form of budget support was provided by the World Bank. One off income from the license paid by PTK for the use of the telecom frequencies was also received in

145 was assumed to be very small, as in a small-open economy with very low production base demand pressures are more likely to increase imports rather than exert upward pressure on price levels. Given that the determinants of the price levels in Kosovo have never been tested, the increase in wages triggered strong debate among the general public on the impact they had on overall price levels. In the interest of providing relevant, thorough analysis on which to base this debate in the future, this section analyses the combined effect of the wage increase and world commodity price changes as exogenous variables in relation to the overall price level in Kosovo. This exercise has been tackled using two approaches: firstly, single-equation modelling; and secondly, via estimating a small system in the form of a vector-error correction model (VECM). Graph 2. Plot of Kosovo CPI, average wage and world commodity prices Graph 2.a. Plot of the first differences of Kosovo CPI, average wage and world commodity prices 141

146 To perform this analysis we used the quarterly data on Kosovo CPI (kcpi), average wage (total_wages) and world commodity prices (worldcomm), the plots of which are provided in graphs 2 and 2a, for the period from Q to Q The data is seasonally adjusted and, to enhance comparability, are re-indexed and world commodity prices were transformed into Euro. The unit root testing suggested that all three variables in first differences are generated by a stationary process (therefore they are I(1) in levels) and the results generated from the diagnostic testing suggest a model with one lag, which is deemed reasonable also considering the short time series available for these indicators. Moreover, the diagnostic tests suggest that there is a break in the Kosovo CPI series in 2007Q2, probably representing the beginning of the global financial crisis 35. For this reason, an impulse dummy for 2007Q2 was included in the model. To test for the asymmetry of prices in Kosovo in relation to international prices, the model also includes an interaction dummy (where the dummy variable DLncommDV, which takes a value of 1 for negative changes in world commodity price inflation and 0 for no change and/or increases, is multiplied by the world commodity price inflation variable DLnCDVbyDlnC ). The hypotheses that are tested are as follows: 1. the suggestion that there is a political economy effect, whereby arbitrary wage increases are financed by tax increases that depress demand and prices in the short-run; and 2. a strategic reaction is played out by firms (especially large retailers) with respect to larger wage increases, whereby anticipated increased demand leads to temporary price reductions in order to capture the largest possible market share Initially, the specification of the VAR model which forms the basis of the systems-cointegration test was conducted. Therefore, using the information criteria and a series of diagnostic tests, the lag length of our VAR specification is determined, including a constant and the shift dummy for the structural break in 2007Q2. As shown in table 3, the diagnostic tests recommend VAR (2) although the information suggests problems with normality. Table 3. Diagnostic tests for VAR (p) specifications Lags Q (16) Q* (16) FLM (5) LJB (4) MARCH (5) p = [0.94] [0.65] [0.10] [0.00] [0.38] p = [0.96] [0.70] [0.43] [0.00] [0.42] p = [0.30] [0.08] [0.02] [0.08] [0.12] Source: Macro Unit calculations, JMulti Time Series Analysis Software Package, Lütkepohl & Krätzig World commodity prices and the interaction dummy were included as exogenous variables in the model considering that price levels in Kosovo are affected by movements in international prices but not vice versa. As a result, the test for the existence of the cointegrating vector was conducted only for the two variables, namely Kosovo prices and wage levels. The results of the cointegration test are shown in the table below. 35 The structural breaks in each variable do not have a common source and thus do not line up ; whilst world commodity prices and Kosovo s CPI display a break associated with the global financial crisis, aggregate wages are more influenced by domestic political decisions to raise public-sector wages. Nevertheless, the breaks on these two variables did not result significant therefore the model was constructed with only one break, namely 2007Q2. 142

147 Table 4. Cointegrating tests (allowing for a constant restricted to the cointegrating vector, allowing for a single structural break 2007Q2) Johansen Trace Test (re-specified according to final VECM) r0 LR P-val 90% 95% 99% Saikkonen & Lütkepohl Test (in the presence of a user-specified structural break) r0 LR P-val 90% 95% 99% Source: Macro Unit calculations, JMulti Time Series Analysis Software Package, Lütkepohl & Krätzig The evidence reported in table 4 overwhelmingly suggests that there is a cointegrating relationship between price and wage inflation. Hence we estimated VECM based on the VAR (2) specification and cointegrating rank of 1. The likelihood ratio (LR) test conducted for the purpose of comparing the restricted model against the unrestricted one recommended the use of the restricted model, namely the model with only the constant and the intercept shift deterministic terms in the cointegrating vector. The formula below shows the Johansen ML estimate of the cointegration relation β, where we have normalized the coefficient of kcpi to one, the loading coefficient for kcpi and the deterministic terms and the exogenous variables. (1) where t-values are shown in parenthesis Kcpi denotes natural logarithm of Kosovo CPI as reported by the statistical Agency in Kosovo, total wages represent natural logarithm of the average total wages in Kosovo, shift07q2 denotes the shift dummy for the structural break in 2007q2, DLnCDVbyDLnC represents the interaction dummy and DLncommDV is the dummy variable for world commodity prices as explained above. The negative sign and the small size of the loading coefficient reveals an equilibrating reaction of current price inflation to previous disequilibrium in the long-run relationship between price and wage levels. The estimated adjustment coefficient suggests that price inflation adjusts to remove 16.6% of past disequilibrium per quarter. On the other hand, the loading coefficient of the current wage inflation was not statistically different from zero suggesting that price inflation does not adjust to restore previous disequilibrium, a finding which suggests considerable nominal wage stickiness. The equation (2) below represents the re-written error correction term derived from equation (1). 143