CHIEF ECONOMIST ANNUAL REPORT 2005

Transcription

1 CHIEF ECONOMIST ANNUAL REPORT 2005 Podgorica, March 2005

2 PUBLISHED BY: WEBSITE: CENTRAL BANK COUNCIL: Central Bank of Montenegro Bulevar Svetog Petra Cetinjskog Podgorica Telephone: Fax: Ljubiša Krgović, MS, president Milojica Dakić, MS Goran Knežević, MS Petar Drakić Krunislav Vukčević Radmila Savićević Franjo Štiblar, PhD PREPARED BY: Nikola Fabris, PhD, Chief Economist Research and Statistics Department TRANSLATED BY: DESIGNED BY: PRINTED BY: Lidija Ćirović Popadić Andrijana Vujović Grafo Crna Gora The Report is published annually. Users of this publication are requested to make reference to the source of information whenever they use data from the Report.

3 BASIC INFORMATION ABOUT MONTENEGRO Surface: 13,812 km 2 Population: Length of borders : Major city: 614 km Podgorica ( inhabitants) - administrative and economic center Capital: Length of seacoast: Length of beaches: The longest beach: The highest peak: Cetinje historical and cultural center 293 km 73 km Velika plaza, Ulcinj m Bobotov kuk (mountain Durmitor) - 2,522 m The largest lake: Skadarsko lake km 2 The deepest canyon: river Tara - 1,300 m The biggest bay: Boka Kotorska Time zone: GTM+1 Electric system: 220V/50Hz Climate: Mediterranean Average air temperature: in summer 27.4 C Maximum sea temperature 27.1 C Average number of sunny days in a year: 240 Swimming season: 180 days Sea: Adriatic Sea transparency: from 38 to 56 m

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5 CONTENTS MACROECONOMIC ENVIRONMENT IN MONTENEGRO 9 1. REAL SECTOR DEVELOPMENTS Activities Prices Labour Market MONETARY DEVELOPMENTS Money Supply Banks` Liquidity Aggregated Balance Sheet of Banks Monetary Accounts Banks` Reserve Requirements Interest Rates Micro-Credit Financial Institutions (MFIs) FINANCIAL MARKET Money Market Capital Market Insurance in Montenegro The Pension System Reform in Montenegro FISCAL DEVELOPMENTS PUBLIC DEBT Foreign Public Debt Domestic Public Debt EXTERNAL DEVELOPMENTS Current Account Capital and Financial Transactions Account EU TOPICS INTERNATIONAL ECONOMY IMPORTANT EVENTS IN ANNEX 165

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7 Review of macroeconomic developments 2004 XII 2005 Change in % REAL SECTOR DEVELOPMENTS GDP (in current prices in EUR million) 1,535 1,642* Industrial output index 13.8% -1.9% Forestry 6.0% 14% Construction -5.7% 19.3% Employment Number of employed people Number of unemployed people Inflation rate CPI 1.5% 2.4% RPI 4.3% 1.8% Average salary (EUR, without taxes and contributions) MONETARY DEVELOPMENTS M11 (EUR million) Total deposits (EUR million) Deposits by corporate sector State deposits Central government Agencies and institutions of Central Government Funds and municipalities Deposits by financial institutions Deposits by households (savings) Other deposits Total loans (EUR million) Loans to corporate sector Loans to state Central Government Agencies and institutions of Central Government Funds and municipalities Loans to banks and financial institutions Retail loans Other loans Turnover in stock exchanges (EUR million) NEX Montenegro stock exchange Montenegroberza stock exchange Stock exchange indices NEX NEX PIF MOSTE Average interest rate on 28-day T-bills 8.83% 4.50% Average interest rate on 56-day T-bills 8.62% 1.64% Average interest rate on 91-day T-bills 9.70.% 0.98% Average interest rate on 182-day T-bills 10.15% 1.61% FISCAL DEVELOPMENTS (EUR million) Origin revenues Total expenditure and net borrowings Surplus/deficit of the state Financing Grants Privatization revenues Net borrowing EXTERNAL DEVELOPMENTS Balance of current account (EUR million) Trade balance Balance of services (tourism +transport+fin.services+other services) %trade deficit to other balance ratio Capital and financial balance Balance of current account -% of GDP (in EUR) Money reserves (EUR million) Frozen FX savings (EUR million) External debt (EUR million) * Data for period Januar - September 2005, ** Data referes to the last auction held in 2005

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9 MACROECONOMIC ENVIRONMENT IN MONTENEGRO

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11 MACROECONOMIC ENVIRONMENT IN MONTENEGRO The major trends that marked the year 2005 were an increase in economic activity, a downtrend in inflation to below 2%, extremely dynamic growth in the financial market, the beginning of negotiations with the European Union on the signing of the Stabilisation and Association Agreement, and also a lower volume of industrial output. The inflation rate, measured by the retail price index, amounted to a mere 1.8%, thus continuing a four-year trend of one-digit inflation. The achieved rate is much below the projected inflation rate of 3%, and even lower than that in the European Union. Also, it should be stressed that inflation in most of the countries in the region slightly increased in relation to the previous year. This is a very positive tendency achieving one of the long-term objectives. The cost of living index showed a somewhat higher growth, 2.4%, primarily due to the different weights of some food products. However, slightly higher inflation can be expected in 2006 due to certain administrative decisions. Inflation growth will be affected by the introduction of value added tax on some products that had not been levied before, as well as the announced increase in the prices of electricity. Therefore, it is not surprising that inflation forecasts are higher, but the envisaged inflation rate should not exceed 3%. With a view to appropriate inflation forecasting it would be very useful to develop the methodology for the calculation of core inflation. As for joining the EU, this year was very important. To wit, the EU Council of Ministers adopted the positive Feasibility Study in April, and negotiations for signing the Stabilisation and Association Agreement started in October. Bearing in mind that the Montenegro`s final objective is joining the EU, a very encouraging fact is that all the Maastricht Criteria have been fulfilled so far, except that regarding the interest rate, but most of the new EU members have not met this criterion. It is necessary to prepare well for the continuation of negotiations in 2006 because the obligations assumed in the Stabilisation and Association Agreement cannot be altered. Developments in the financial market were very encouraging. The amount of loans granted rose by 34%, deposits by 78%, savings by 118%, and banks` assets by 55.8%. Banks were highly liquid, and only rarely were the loans for liquidity maintenance used during the year. The privatisation of Podgoricka bank was completed successfully, and the preparations for the completion of the privatisation process in the banking sector are under way. This data points to a successful reform of the banking system, and its positive results. Interest rates are on a downtrend, but remain high. The reasons lie in the still high country risk, client risk, inefficient judiciary, the still large and inelastic demand for loans, and the like. Nevertheless, it is encouraging that banks` expectations for 2006 are that both nominal and effective interest rates will be lower. Almost half of the surveyed enterprises quoted on the stock exchange (47%) believe that the largest obstacles to their operations are high taxes. The money supply and the largest monetary aggregate M21 rose by 58.3% or almost EUR 320 million in relation to the previous year. Taking into account that this increase did not push inflation, it is obvious that the remonetization process is still under way. Data on GDP growth is still not available, so we can analyse only the available sectoral growth rates. The level of industrial production fell by 1.9%, which is a cause for some concern. To wit, observed by manufacturers, it can be seen that negative growth rates were recorded mainly in those branches where enterprises have not ended the privatisation and restructuring process, those facing obsolete technology, high illiquidity, redundancies, and the like. This definitely affirms that any further delay in the privatisation and restructuring 11

12 CHIEF ECONOMIST ANNUAL REPORT 2005 could have counter-productive effects on the Montenegrin economy. However, it should not be disregarded that the fall in industrial production is largely connected to problems in some enterprises, primarily in the electrical-energetic complex in Pljevlja and Željezara Niksic (Niksic Steelworks). In small economies, such as Montenegro, problems in few enterprises may have a large effect on the overall volume of economic activity. Tourism is the branch that is recording the most dynamic development, and in the last few years it has recorded a twodigit growth rates. The number of tourists rose by 16.6%, and especially encouraging is the increase in the number of foreign tourists of 44.6%, thus representing one third of the total number of tourists. Regardless of the exceptional results, there is still room for improvement in this field. This is supported by the difference in the number of tourists who visited Montenegro in 2005 and 1989, presented later on in the report. The main activities should be directed towards the improvements in infrastructure, accommodation capacities, the extension of the tourist season, further development of other types of tourism away from the coast, better quality of services, attracting renowned hotel chains, and the like. A remarkably high growth in economic activity was achieved in the construction industry (the number of effective working hours rose by 18%), and forestry (the production of wood products increased by 14%), but the results in transportation differ to a large extent. To wit, negative growth rates were achieved in road transport and passenger transport via railways, whereas positive rates were recorded in cargo transport via railways and air transport. The overall results in transportation are greatly dependant on the condition of the transportation infrastructure, and this can be categorised as unsatisfactory. The higher increase in salaries than that in productivity (measured by GDP per employee) jeopardizes the competitiveness of the Montenegrin economy. Especially worrying data is that, according to Monstat, the number of employees in state administration (state administration and social insurance excluding education and health care) rose by 2%, which is contrary to the officially declared objectives of the Government. The dominant employer in the labour market remains the state, i.e. the public sector. Unemployment is still high in spite of its downward trend. The main culprit for such a high unemployment rate lies in the fact that a relatively small number of new jobs were opened in the new private sector. The limited opportunities for employment have discouraged, and led to the withdrawal of, certain categories in the labour market, especially those belonging to the older age groups. What worries most is the long-term unemployment since it leads to the outdated knowledge and skills and permanent withdrawal from the labour market. With a view to encouraging new employments it is necessary, among other things, to remove a number of barriers in the current Law on Labour. The level of budgetary deficit is acceptable and in line with the Maastricht criteria. However, the level of public expenditure is too high, and has been increasing over the years. This has direct effects on the reduced competitiveness of the economy. Also, it is essential to alter the structure of expenditure since it is dominated by expenses for wages and salaries, subsidies, assistance to households, whereas the contribution of capital expenditure is too low. The competitiveness of the Montenegrin economy is extremely low, representing one of the main culprits for the relatively high current account deficit. According to preliminary data, this deficit amounted to EUR million, i.e. 8.6% of estimated GDP. A deficit was recorded in only one of the balance of payments sub-balances, visible trade, but the surpluses in all the other sub-balances were not sufficient to compensate for this deficit. The year-on-year comparison with 2004 shows that the current account deficit increased by EUR 21 million in It should not be disregarded that this increase was mainly due to the factors that are not directly connected to the competitiveness of the economy, these being the larger import of oil of EUR 25 million, reduced foreign assistance by EUR 13 million, and the increased import of electricity of EUR 4.9 million. Due to inadequate recording we cannot draw valid conclusions on the structure of visible trade, but it is certainly unfavourable because mainly exported were low-processing products, and those chiefly imported were consumer goods. 12

13 MACROECONOMIC ENVIRONMENT IN MONTENEGRO Net foreign investments reached a record level, EUR 375 million, which was beyond expectations. The level of FDI per capita shows that Montenegro is third in the category of transitional economies, right behind the Czech Republic and Estonia, and the first in the group of transit economies that are not members of the EU. The main reasons for the increase in FDI are: attractive privatisations, macroeconomic stability, the liberal economic regime, a relatively cheap labour force, a low profit tax, the national treatment of foreigners, and the like. As a rule, the positive effects of foreign direct investments are not obvious in the year they occurred, but after a certain time period of one to two years. This means that powerful economic growth can be expected in the years to come. Some very positive tendencies were also present in the capital market. Turnover in the stock exchanges tripled, and the stock exchange indices recorded remarkably high rates of increase. Two trends marked the trading: intensified trading with a view to enlarging ownership, and increased trading with securities by shareholders. The adoption of the new Law on Securities is of great importance since it is essential for the creation of conditions for the future development of the financial market, especially the capital market, in the period following the completion of the privatisation process that will inevitably lead to a slowdown in stock exchange trading. The development of the securities market, shortterm and long-term securities, as well as the money market, is important due to the expansion of the capital market, i.e. securities that can be traded, with a view to preventing any possibility of domestic investors looking for opportunities to invest abroad in the lack of quality securities, and avoiding the creation of price bubbles which always represent a potential threat of a financial crisis. Interest rates on Treasury bills have been on a remarkable downtrend since March. At the beginning of 2004, they ranged between 10.73% and 10.22%, and at the end of the reporting year they varied between 1% and 2%. There are plenty of reasons for this fall, the main being the reduced financing needs of the budget due to a large inflow of privatisation funds, established macroeconomic stability, the large demand for Treasury bills (40% higher than the offer), the increased credibility of the state due to the timely payment of all budgetary liabilities arising from T-bills, and the like. A consideration in the forthcoming period should be the issuing of Treasury bills with a maturity period of ten years as this could be the way to obtain funds for financing large infrastructural projects, but it could also provide an accurate indicator of country risk on interest rates thus providing a comparable indicator for the Maastricht criterion for the rates of interest. According to the Ministry of Finance, the estimated public debt of Montenegro at end-2005 amounted to EUR million, and its contribution to GDP (preliminary data) was 42.7%. The Maastricht criterion for public debt foresees an upper limit of 60%, thus the situation in Montenegro is more favourable than in many EU member countries. Preliminary data on foreign public debt at end-2005 shows the amount of EUR million. According to the existing level of indebtedness, Montenegro is on the boundary between the moderately- and the low-indebted countries. Bearing in mind the successful implementation of the arrangement with the IMF, a write-off of an additional 15% of foreign debt with the Paris Club should be expected in After the write-off, Montenegro will find itself in the group of lowindebted countries, and since it will be on the upper limit of low-indebtedness, caution in future borrowing is crucial. Borrowing in the form of loans indexed in the Swiss Franc and the Chinese Yuan would be especially perilous because these currencies are expected to appreciate much faster than the EUR. Also, taking into account the future increase in interest rates, it would be useful when the loans taken had a fixed interest rate at the level currently prevailing in interest rates. Being a small country, Montenegro has to continue with the policy of a highly open economy, which means that a large portion of the domestic product must be traded abroad because domestic production cannot satisfy all needs. Any autarkic policy would be a bad solution for Montenegro, but this does not mean that some strategic products should not be protected, and that all protection instruments used by developed countries, such as antidumping procedures, should not be used, and that the import of non-attested products and products that do not meet the quality standards should not be forbidden, and so on. Montenegro has to specialize 13

14 CHIEF ECONOMIST ANNUAL REPORT 2005 in the production of those commodities and services that could provide it with competitive advantages in the world market. These products are definitely tourist services, additional activities supporting tourism (agriculture), the production of health foods, the manufacturing of alcoholic and soft beverages, and the like. An enactment of a strategy of economic development that would identify the sectors of strategic importance and enable the allocation of scarce resources in them would be very useful. The sectors that have been definitely underestimated, but could create a great additional value, are the so-called creative industries, such as software development, making craft souvenirs, and the like. The priorities in the forthcoming period regarding economic policy should be: the acceleration of the privatisation and restructuring process in large enterprises, a reduction in public expenditure, further improvement of the business environment and the freeing-up of administrative procedures, diminishing the existence of the grey economy, the improvement of judiciary efficiency, and the like. At the same time, it is essential to continue with the policy of Montenegro`s movement towards international organisations whose member it is yet to become, these primarily being the European Union and the World Trade Organisation. Therefore, one of the major tasks in 2006 remains the harmonisation of national regulations with those of the aforesaid international institutions. This report is the end result of a joint effort by the employees in the Research and Statistics Department. I hereby take the opportunity to thank them for their conscientious and diligent work. Ph.D. Economics Nikola Fabris, Chief Economist 14

15 1. REAL SECTOR DEVELOPMENTS

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17 REAL SECTOR DEVELOPMENTS 1.1. Activities Industrial production The negative tendencies in the fourth quarter of 2005 resulted in a 1.9% lower physical volume of industrial production in relation to the previous year, which ended the upward trend of the previous three years. The main culprits for the fall in industrial output are associated with the problems that several enterprises encountered, especially the electricenergetic complex in Pljevlja and Željezara (Steelworks) in Nikšiću. According to rough estimates (it is not possible from the available statistical data to single out the production effects of individual enterprise), if these two enterprises had achieved the same production volumes as last year, industrial production would have been from 4% to 5% higher, and a moderate growth of between 2% and 3% would have been achieved. However, the fall in the physical volume of production may imply an increase in additional value. The mining and quarrying sector recorded a production increase of a mere 0.2%, primarily due to operating problems in the Rudnik uglja Pljevlja (Coal Mine Pljevlja). The mining of metal ores and other ores and stones was 8.6% higher. During the entire year, the coal mine operated under very difficult conditions due to the lack of financial assets necessary for carrying out repairs on machines and equipment, expropriation and investments, and for the provision of funds for daily liquidity as well. The situation was additionally aggravated by low temperatures and large snows in the first quarter of the year. These circumstances affected the lower production of coal, lignite and peat of 13.3%. The lower production of coal caused the lower production of electricity, gas and water supply of 13.4%. During the reporting year, the thermal power plant Pljevlja encountered six unexpected work interruptions due to insufficient amounts of coal, so, including the two interruptions for regular repairs, it was out of order for 131 days (more than four months). Although the hydro-electric power plants Piva and Perućica recorded productions higher than planned, this was not sufficient to cover the fall in production of TE Pljevlja which was 18% below the planned level. Graph Industrial output Source: Monstat 17

18 CHIEF ECONOMIST ANNUAL REPORT 2005 The production in manufacturing industry, which accounted for 67.6% of total industrial output, was 2.5% higher than in This was due to the larger production in eight branches that accounted for 11.6% of total production. The most powerful growth was recorded in the manufacturing of chemicals and chemical products, 195%, and it was the result of a rather low comparative base, the activation of plants that were out of order in 2004, and the incorporation of enterprises that were not statistically covered in the previous years. The growth in manufacturing industry was largely supported by a 10.6% increase in the manufacturing of food products and beverages because this branch accounted for 6.3% of total industrial production. Stable growth was also recorded in the manufacturing of wood and wood products from the beginning of the second quarter onwards. The first quarter production fell due to the lack of raw materials that were caused by unfavourable weather conditions. Movements in these branches can be assessed as positive since they are export-oriented and can be the substitutes for imports. On the other hand, Monstat data shows that falls were recorded in eight branches of manufacturing industry that accounted for 56% of total industrial production, and it ranged between -64.3% (the manufacturing of textile fibres) to -0.4% (the manufacturing of other non-metal minerals). High insolvency and obsolete technology characterised most of the enterprises dealing with the aforementioned manufacturing which, in addition to the existence of strong foreign competition on one hand, and poor purchasing power of the population on the other hand, significantly hindered the manufacturing of finished products (the manufacturing of textile and textile fibres, the manufacturing of rubber and plastic products, the manufacturing of tobacco products, and the like). Regardless of the higher production of aluminium, the production of basic metals and metal products (which includes aluminium and steel) was 6.7% lower than last year due to the very low production of Željezara Nikšić (steelworks Niksic) and frequent work interruptions in Graph Industrial production by sectors, Ø 2000 = 100 Source: Monstat and CBM calculations 18

19 REAL SECTOR DEVELOPMENTS Tourism some of its plants. The situation additionally worsened in the last two months of the reporting year when the company Midland Resources, which bought 59% of the Steelworks` shares in 2004, left the company and breached the contractual obligations previously defined with the Montenegrin Government. All the steelworks` plants were out of order in November and December. The results achieved in the industry sector point to numerous unresolved problems: high illiquidity, obsolete technology, redundancies, the slow transformation of enterprises, and the like. With a view to achieving more favourable results in 2006, it is necessary to finish the privatisation of TE Pljevlja and the Coal Mine Pljevlja as they are two technologically connected and mutually dependent economic entities. This would provide a more reliable planning of the energetic balance and bring about a lower import of electricity. It is essential to continue with the restructuring of large systems and finish the initiated privatisation in order to renew the technology and raise capacity with fresh capital. The higher production of food products and beverages, wood and wood products, and furniture and chemical products is estimated as positive since these are mainly finished products that could bring about a lower domestic demand for their import. However, quality improvement in these products and the obtaining of international quality standards are necessary in order to succeed in demanding international markets. The number of tourists who visited Montenegro in this year is 820,457, or 16.6% more than last year. The number of foreign and domestic tourists rose by 44.6% and 6.4%, respectively. Foreign tourists represented 33.2%, and domestic 66.8%, of the total number of tourists. Most of the visits were to seaside resorts (91.1%) and here the number of tourists increased by 13.6%, while visits to mountain resorts rose by 3.5%. Graph Tourist arrivals (domestic and foreign) Source: Monstat The encouraging fact is that the number of foreign tourists increased substantially in all parts of Montenegro. However, compared with 1989, this number is 17.9% lower, and the number of domestic tourists less by 36.3%. Box Ongoing Activities on the Improvement of the Tourist Offer in 2006 A number of projects are planned with a view to making better preparations for the forthcoming tourist season in 2006 for which the Ministry of Tourism has planned ten percent more tourists than this year. Before the next season, the building and the reconstruction of some of the most critical locations on the road infrastructure is foreseen, among which the most important are the restoration of the tunnel Vrmac, and the construction of additional lanes on the roads Budva- Bar, Budva Cetinje, and Podgorica-Kolašin which are supposed to improve road traffic and solve the problems of traffic jams. Air traffic will be significantly improved by the construction of terminal buildings at the airports in Podgorica and Tivat, which, together with more efficient services at border crossings, will contribute to better quality transportation services. In addition to the transportation infrastructure, planned activities include the improvement in electricity and water supply, and the treatment of liquid waste. 19

20 CHIEF ECONOMIST ANNUAL REPORT 2005 The competitiveness in human resources is of vital importance for every branch of the economy. With a view to the improvement of the tourist product, the preparation of the Human Resources Strategy is planned, and together with other educational institutions in the field of tourism it is supposed to increase the competitiveness of human resources. The guidelines for the development of specific types of tourism have been established, such as nautical and wellness tourism, and the preparation of criteria for the development of golf courses is also planned. In 2006, more intensive activities will be performed on the categorisation of hotels, development of small and medium enterprises in tourism, and the creation of a favourable environment for tourism investments and the privatisation of tourist entities. The completion of the tender for the building of the hotel-tourist complex at Ada Bojana, and the overview of potential investments in the area of Boka Kotorska and Velika Plaza in Ulcinj are also envisaged. The number of tourist overnight stays amounted to 5,211,847 and it is 14.3% higher than last year, but 47.8% lower than in In the structure of foreign tourists, the largest contributors were tourists from Bosnia and Herzegovina (17.2%), then Russia (15.1%), the Czech Republic (8.6%), and Germany (6.7%). Graph Tourist overnight stays (domestic and foreign) Graph Structure of tourist overnight stays by countries 20

21 REAL SECTOR DEVELOPMENTS Box Brand Montenegro The efforts of the Montenegrin Tourist Organisation and the Ministry of Tourism in the creation of the Montenegro brand and the market positioning of the Montenegrin tourist industry have started yielding positive results. The World Travel and Tourism Council have declared Montenegro as the fastest growing tourism and travel economy in the world. In addition, the Montenegrin tourist product has been included in the offer of renowned tour operators under the slogan: One of the last concealed secrets of Europe. The image of Montenegro was greatly influenced by its reporting in many world reputable media such as CNN, BBC, The New York Times, The Los Angeles Times, and the Guardian which represented Montenegro as an uncut diamond of the Adriatic with intact, wide sandy beaches and medieval villages skirted by time. Montenegro is on the way to becoming one of the most popular European tourist destinations, such as those at the Azure coast, so it is one of the most interesting places that should be visited in All this contributed to the inclusion of property on the Montenegrin coast in the offers of international property sale agencies. Also, the eminent company Butterfield & Robinson has included Montenegro in its yacht travel arrangements. Although tourism in Montenegro has been experiencing a most accelerated growth, the tourist potential is far from being exploited, which is easily supported by the comparison of the number of tourists in 2005 and The Macroeconomic Model for the Montenegrin economy has pointed that the main restrictions for the further development of the tourism economy are on the offer side. The Montenegrin tourist offer is not sufficiently competitive in relation to some of the most important competitors, such as Bulgaria, Turkey, Egypt, Croatia, and others. The quality of accommodation capacities in Montenegro is lower, with the exception of Croatia, and the prices of services are higher. One of the reasons for higher prices is the short tourist season. To wit, the actual tourist season lasts some two months, plus the early season and the post season of one month each, which is an insufficient use of the capacities. This practically means that in 4 months the hotels are working they are supposed to cover operating expenses for the entire year, which inevitably leads to higher prices. A great paradox is that along the entire Montenegrin coast there are no five-star hotels, and the number of four-star hotels is very small. Also, not one of the hotels belongs to the world s largest hotel chains, and it is common knowledge that they attract the largest number of tourist. The improvement in the structure of the accommodation capacities is definitely the first to aim towards. Of course, it cannot be improved in the short term. There are many attractive locations at the Montenegrin coastline, such as Jaz, Buljarice, Kamenovo, and the like. The state should announce tenders for the construction of hotels at these locations, but priority should not be given to the price that could be obtained, but the repute of bidders (hotel chains) that could attract a large number of tourists, employ many domestic workers, and domestic construction industry. One of the priorities must also be the building of high-class hotels. The prerequisite for the announcement of such tenders must be resolving the ownership status of the land. The attraction of a large number of tourists requires appropriate travelling conditions. The standard of the existing two airports (this does not imply the security) is among the worst in Europe. However, owing to international loans, it is reasonable to expect that the situation regarding air transport will improve in a relatively short time. Therefore, the priority of the state must be the improvement of travel infrastructure. The longterm objectives should be the construction of the Adriatic-Ionian main road, and the motorway that would connect the north and the south of Montenegro. Bearing in mind the extremely unfavourable geographical realities for the construction of a motorway, which makes it highly expensive, it is obvious that the Government can build only small road sections using privatisation incomes and international loans. Therefore, the solution for the construction of the entire motorway must be sought in concessions. It is inconceivable for any serious tourism to develop without the resolution of problems regarding water supply, electricity supply, waste disposal, and the like. Unfortunately, the mind-set of tourists from the region regarding Montenegro is that it is a destination where one is most likely to encounter these problems rather than to expect that everything will 21

22 CHIEF ECONOMIST ANNUAL REPORT 2005 run smoothly. The problem of water supply must be solved by exploiting new springs as Montenegro is abundant with water. As for electricity, the world trend in a larger consumption of electricity during summer due to air conditioning should be accepted, so more attention should be paid to the exploitation of alternative energy sources: solar energy, wind power, wave power, biomass, and the like. Of course, these issues cannot be solved by the municipalities themselves, but it is necessary to engage the entire state. Most likely, the most rational solution would be to invest all revenues from the privatisation of tourist enterprises and objects in the improvement of tourist infrastructure. It is necessary to continue granting loans to the tourism economy at a beneficiary interest rate. In the last few years, the Ministry of Tourism has led a very successful campaign of promoting Montenegro, and it should be continued in the following years. Finally, the combination of various types of tourism is necessary with a view to improving the tourist offer. The prevailing form of tourism in Montenegro, seaside tourism, should be combined with culturalhistorical sights off the coast, rural tourism, rafting, mountain tourism, the exploitation of the potential of the Skadar Lake, and the like. Forestry Regardless of bad weather and heavy snows in the first quarter, the production of wood products amounted to 279,000 m 3, being 14% higher than in Production growth was the most evident in September and October when it was two times higher than in the previous year. Also, the sale of wood products rose by 3%. Graph Production of wood products (m 3 ) Source: Monstat The forestry sector has been recording positive results in the last three years, which is even more significant if taken into account that the afforested areas are mainly in the poorer north part of the Republic, and this can be a solid basis for its accelerated economic growth. This additionally improves raw material supplying to the wood industry. The results of the Reconstruction-Development Program of Forestry and Wood Industry adopted by the Montenegrin Government in mid has yielded positive results. Better quality planning, protection, and exploitation of forests should be enabled in the forthcoming period. Renewal and rehabilitation of eroded land should be continued because for more than ten years the forestry in Montenegro has been characterized by unplanned and illegal wood cutting. International projects should be carried out with a view to obtaining a certificate on sustainable forestry and develop a competitive wood-cutting industry. Construction Industry The activities in the construction industry also recorded positive movements. The value of performed construction work in the reporting year amounted to EUR 80 million, being 40% nominally higher than the year before. Observed through effective working hours, this is an increase of 19%. The average number of employees for the performance of this work was 2.4 thousand. Data on loans granted by banks for construction activity also indicate a higher activity in this sector, and they recorded an annual rate of increase of 56%. Transportation The development of every country implies the existence and a continuous development of the transportation infrastructure that would enable the reduction of costs and a more efficient transport of freight and passengers. However, Montenegro belongs to a group of countries whose transportation, from the technical-technological aspect, lags behind Western European standards. A smaller volume of transportation services was achieved this year. In road transport, passenger transport fell by 15.6%. A fall was especially notable in the first half of 2005, and positive growth rates were achieved afterwards, but they were cumulatively insufficient to result in an increase in relation to the previous year. The transport of freight was 5.3% lower. The smaller volume of transport was due to the poor road infrastructure that caused frequent interruptions in traffic, bad weather conditions at the beginning of the year, more intensive repair work on certain road sections before the beginning of the summer season, and also due to 22

23 REAL SECTOR DEVELOPMENTS Graph Construction activity Source: Monstat Graph Transportation turnover Ø 2000 = 100 Source: Monstat illegal activities of certain carriers that were not registered. Monstat data on the transportation turnover of passengers and freight via railways shows that 13.8% less passengers were transported as a direct consequence of the extremely poor condition of transport capacities and railway infrastructure. The lack of investments in the railway infrastructure causes interruptions and a reduction in speed, and thus longer journey. The reconstruction of certain railway sections in Serbia resulted in the cancellation of some trains and additionally reduced the number of transported passengers. A larger volume of transport 23

24 CHIEF ECONOMIST ANNUAL REPORT 2005 than the average achieved in 2004 was registered during the summer months of the current year, due to the tourist season, but compared to the same months of last year, a fall is noticeable. The transport of freight was 39% larger due to the increased turnover in ports of 16%, which is the result of better utilization of the logistic chain Luka Bar (Port Bar) Železnica Crne Gore (Railways of Montenegro) ŽTP Beograd (Railway Transport Enterprise Belgrade), and the signing of the Protocol on Cooperation between the aforesaid enterprises and the U.S. Steel Serbia enterprise. Of total turnover in ports, 57% referred to exports, and 43% to imports. However, urgent renovation of the infrastructure and transport capacities in this sector is crucial because the opposite could lead to a remarkable fall in 2006, especially in road transport. Air traffic recorded better results this year, bringing a 5% and a 59% increase in the transportation of passengers and freight, respectively. A larger volume of transported passengers was rather obvious from June to August, resulting in 10% more passengers transported in these months than in the same months last year due to a successful tourist season. If it had not been for an unusual slowdown in the first quarter (the closing of the airport in Podgorica due to bad weather, and the strike in the Serbian airline JAT), the turnover in air traffic would have recorded a much higher rate of increase. Intensive activities on the implementation of the project Modernisation of Airports in Podgorica and Tivat also contributed to air traffic being restricted to certain times in the day. The general conclusion is that, regardless of the activities undertaken by the authorized institutions and financial investments, the transportation infrastructure in Montenegro is still at a relatively low level, and that it may represent a serious impediment to future economic development. With a view to its modernisation and connecting to European transportation flows it is essential to prepare a detailed strategy for a long-term development of transportation in Montenegro that will take into account structural changes in the economy Prices The process of disinflation that has started in 2001 continued in the reporting year. This year`s inflation was 1.8%, measured by the retail price index (i.e. 2.4% when measured by the cost of living index). Price movements in 2005 were largely affected by the changes on the side of supply which were induced by domestic and foreign factors. Thus, the main bearers of inflation were agricultural products, the change of excise duties on alcoholic beverage, oil price increases in the world markets (this directly affected the prices of liquid fuels and lubricants in Montenegro), and the higher prices of obligatory vehicle insurance and technical vehicle inspection. The prices of goods rose by 1.8%, contributing 81% to total inflation. The largest contributors were the prices of agricultural products that increased by 10% in the reporting year, accounting for 0.52% to inflation. Bad weather conditions in the first quarter of the year, extremely heavy snows that brought about damages to agricultural producers, especially producers of greenhouse agricultural products that resulted in a smaller domestic supply. On the other hand, the poorer domestic demand was compensated by a larger import of the aforementioned products, which was calculated in final retail prices. Agricultural products are classified in a group of products whose prices show the largest fluctuations since they are determined by climate and seasonal factors, and their annual movements are very hard to affect or forecast. Graph Retail prices, monthly increase rates Source: Monstat In the category of industrial products, the prices of food products rose by 14%. The main contributors to total inflation were the prices of fresh meat that were 1.9% higher than last year, but which contributed 9% to inflation due to their large weighting. The changes in fiscal policy affected the increase in the prices of beverages of 8.3%. To wit, in accordance with the Law on Excise Duties ( Official Gazette of RoM, no. 65/01 and 12/02), and a gradual adjustment 24

25 REAL SECTOR DEVELOPMENTS Graph Prices of agricultural products Graph 1.11 Prices of beverages, monthly increase rates Source: Monstat of the amount of excise duties with the minimum amounts in the European Union, new excise duties on alcoholic beverages became effective as of 1 January. Thus, the excise on beer increased from EUR 1.55 per alcohol volume per hectolitre to EUR 1.90, and the excise on the manufacturing of brandy increased from EUR 100 to EUR 550 per hectolitre of pure alcohol. These changes did not have a one-off effect on the retail prices of beverages, but induced increases in these prices from month to month. To wit, some retailers adjusted their prices with some time delay due to the existence of supplies of these goods. Besides the aforementioned changes in excise duties, the price increases in the summer months were also affected by greater demand which is usual in June and July. The increase in the prices of beverages stabilised in September (i.e. changes in excise duties were completely incorporated in retail prices), and a much more stable movement of these prices can be expected in The contribution of the beverages price increase to total inflation was 24%. Source: Monstat The higher prices of industrial non-consumer products were entirely the result of a very volatile oil market. The average price of Brent crude oil in the world markets was 42% higher than in The first quarter of the reporting year was characterised by very cold weather in the United States and most of Europe, so the worry that such cold weather could have lasted longer affected the larger demand and a decrease in oil supplies. A continuation of economic growth in China exerted additional pressure on demand. The situation additionally worsened in summer months due to the holiday season in the USA, so OPEC could not entirely support the growing demand in spite of increased production. In August and September, the average value of the OPEC reference basket and Brent crude oil reached record levels. The reasons for this were political tension in Saudi Arabia after the death of its king, the nuclear program of Iran, and the hurricane season in the Gulf of Mexico. Hurricane Katrina hit the Gulf of Mexico at end-august causing great damage to the oil infrastructure, so a large number of oil refineries were out of order, and the average price of the OPEC reference basket to amount to USD per barrel, which is 8.8% more than in July and 62% more than at end Table Oil prices (USD/barrel) - monthly average 2005 I II III IV V VI VII VIII IX X XI XII OPEC 40,24 41,68 49,07 49,63 46,96 52,04 53,13 57,82 57,88 54,63 51,29 52,65 Brent 44,01 44,87 52,60 51,87 48,90 54,73 57,47 64,06 62,75 58,75 55,41 57,02 WTI 46,64 47,69 54,09 53,09 50,25 56,60 58,66 64,96 65,28 62,67 58,42 59,36 Source: Monthly oil market reports, OPEC 25

26 CHIEF ECONOMIST ANNUAL REPORT 2005 Oil prices rises in the international market affected prices in Montenegro since this an import-oriented economy. The prices of the category liquid fuels and lubricants were 15.6% higher than at end-2004, contributing 12% to total inflation. However, it should be taken into account that the contribution of this category in the calculation of retail prices is unreasonably low, making up only 1.4% of the total basket of goods and services included in the calculation of inflation, and that oil shocks affected the living standards of Montenegrin citizens more than Monstat data show. Also, oil products participate in the prices of many finished products, thus having an indirect effect on higher retail prices. Moderating oil shocks in Montenegro can be achieved through a decline in the tax burden since import taxes and duties that represent Budget revenues (harbourage, turnover tax, excise duties, ecological fee, highway fee, special revenue) account for about 50% of retail prices. The prices of services in the reporting year showed much slower growth than in the previous year, 1.8%. Their contribution to total inflation was 19%. The largest contributors to the increase in the prices of services were the prices of obligatory vehicle insurance and technical vehicle inspection that rose by 5.5% and 43.6%, respectively. These are the prices of non-tradable services, and their level is affected by monopoly Graph Oil prices, monthly increase rates Source: Monstat and Monthly oil market reports, OPEC structures, while demand for these services is of low elasticity, so it will not react to lower demand for the higher prices. Observing the annual growth rate of the prices of services shows an abrupt fall in December due to the comparative basis. To wit, until Table Share of certain categories (goods and services) in inflation Total Weight Increase rate Share Total ,8% 100% 1 GOODS ,8% 81% 11 Agricultural products ,13% 29% 12 Industrial products ,21% 52% 121 Industrial food products ,77% 14% 122 Beverages 526 8,31% 25% 123 Tobacco 514 0,0% 0% 124 Industrial non-food products ,7% 13% Liquid fuel and lubricants ,64% 12% 2 SERVICES ,8% 19% 21 Professional 131 8,0% 5% 22 Public utility 248-0,09% -0,13% 23 Financial and other services 316 7,7% 14% 24 Educational 114 2,4% 1% 25 Public protection services 65 0,0% 0% 26 Transportation and PTT services ,06% -0,3% Source: Monstat and CBM calculations 26

27 REAL SECTOR DEVELOPMENTS December, the comparative base was low and exclusive of the increase of the prices of telephone charges of 100% from December This price differential was not lost before December, so the annual increase in the prices of services dropped from 11.4% in November to 1.8% in December. Graph Retail prices, annual increase rate Source: Monstat Price stability is a prerequisite for the optimum stability of development and employment. It is also a necessary prerequisite for the maximum allocation of resources since only the prices not altered by inflation can help a rational allocation of scarce resources. In addition, stable prices are the condition for efficient accumulation of savings, and accordingly, the acceleration of investment and economic growth. That is why the lack of price stability is a danger every economy is prone to. The inflation rate achieved in 2005 is satisfactorily low. However, the attainment of price stability implies the maintenance of a low inflation rate in the middleterm. Therefore, Montenegro should strive to achieve this objective in the forthcoming period, despite structural changes in the economy. This means a gradual adjustment of the remaining share of state controlled prices to market conditions, primarily those of electric energy. The Electric Power Industry did not change its prices, so that is another reason for the moderate prices growth in the reporting year. The Montenegrin Energy Law foresees the prices and tariffs of electricity to be proposed by an energy body (EPCG Electric Power Industry of Montenegro) and approved by the Energy Regulatory Agency. The EPCG submitted a request to the Agency for the approval of the permitted revenues and tariffs in mid-november, but since new prices and tariffs can be applied not sooner than four months after the request submission, this means that the current prices will remain the same until mid-march The price of electricity paid by Montenegrin households is much below the market price, which makes its increase justifiable, but it should be introduced gradually so as to avoid deterioration in citizens` still low living standards and endangering price stability. Also, the restrictive fiscal policy with a reduction in tax burdens should be continued with, which may diminish the influence of external price shocks. It is also necessary to enact the missing laws and enabling regulations prescribing the protection of competition with a view to prevent any misuse by monopoly structures. Table Retail prices (per cent increase) XII 2002 XII 2001 XII 2003 XII 2002 XII 2004 XII 2003 XII 2005 XII 2004 TOTAL INDEX 9,4% 6,7% 4,3% 1,8% GOODS 8,7% 5,1% 1,1% 1,8% - Agricultural products 19,6% -2,9% -5,4% 10,1% - Industrial products 8,0% 5,7% 1,5% 1,2% - Beverages 10,0% 0,4% 2,1% 8,3% SERVICES 12,7% 14,3% 18,1% 1,8% Source: Monstat 27