THE CHIEF ECONOMIST'S ANNUAL REPORT FOR 2003

Transcription

1 THE CHIEF ECONOMIST'S ANNUAL REPORT FOR 2003 June, 2004 Podgorica

2 THE CHIEF ECONOMIST'S ANNUAL REPORT FOR 2003 PUBLISHED BY: WEBSITE: CENTRAL BANK COUNCIL: PREPARED BY: DESIGNED BY: TRANSLATED BY: PRINTED BY: Central Bank of Montenegro Bulevar Svetog Petra Cetinjskog Podgorica Switchboard: Telephone: Fax: Ljubisa Krgovic, MS, president Milojica Dakic, MS Krunislav Vukcevic, MS Goran Knezevic, MS Petar Drakic Research and Statistics Department Nikola Fabris, PhD, Chief Economist Marijana Mitrovic, coordinator Danijela Vukajlovic Grba, assistant director Vesna Saveljic, chief of Real Sector Developments Analysis and Research Division Milica Vlahovic, chief of Monetary Research and Statistics Division Svetlana Cerovic, chief of Fiscal Analysis Division Boris Kilibarda, chief of Balance of Payments Division Andrijana Vujovic Lidija Cirovic Popadic Stamparija Obod The Report is published annually. The users of this publication are requested to make reference to the source of information whenever they use data from the Report. II

3 LIST OF ABBREVIATIONS BoP Balance of Payments BTS- Electronic trade system used in the Nex berza stock exchange (a gift from Ljubljana stock exchange) CBM Central Bank of Montenegro DFI Direct Foreign Investments EBRD European Bank for Reconstruction and Development ECB European Central Bank EIB European Investment Bank EIT Economies in Transition EMU European Monetary Union EU European Union FED- Federal Reserve System (USA) FOMC Federal Open Market Committee GDP Gross Domestic Product IDA International Development Association IMF International Monetary Fund Index NEX 20- includes enterprises with the main share of the market capitalisation, the highest revenues and the largest number of transactions Index NEX PIF- includes six privatisation funds IOSCO- International Organisation of Securities Commissions IT Information Technology KM Convertible mark (standard monetary unit of Bosnia and Herzegovina) LIBOR - London Interbank Offered Rate MSCI - Morgan Stanley Capital International MVP - Mass Voucher Privatisation, form of privatisation applied in Montenegro in 2002 NAFTA North American Free Trade Agreement NBS - National Bank of Serbia NBY National Bank of Yugoslavia OPEC Organization of Petroleum Exporting Countries p.a. per annum RM - Republic of Montenegro RTGS Real Time Gross Settlement SITC-Standard International Trade Classification VAT Value Added Tax III

4 THE CHIEF ECONOMIST'S ANNUAL REPORT FOR 2003 Basic information about Montenegro Surface: 13,812 km2 Population: Length of borders : 614 km Major city: Capital: Length of seacoast: Length of beaches: The longest beach: The highest peak: Podgorica ( inhabitants)- administrative and economic center 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 IV

5 Overview of Macroeconomic Indicators Percentage Change REAL SECTOR GDP (in current prices, in mil. EUR ) ,00 Industrial output index (compared to the same period last year) 0.6% 2.4% Forestry (compared to the same period last year) -9.9% 0.6% Civil construction (compared to the same period last year) 12% -13.0% Earnings from tourism (mil. euros) Employment Number of the employed (average) 113, , Number of the unemployed (average) 80,600 68, Inflation Costs of living (compared to December last year) 9.2% 6.2% Retail prices (compared to December last year) 9.4% 6.7% Average wages and salaries MONETARY SECTOR M1 (in mil. EUR) Total deposits (in mil. EUR) Corporate deposits State deposits Central government Extrabudgetary funds and local governments Financial institution deposits Household deposits (savings) Total loans (in mil. EUR) Loans to companies Loans to the state Central government Extrabudgetary funds and local governments Loans to banks and financial institutions Loans to households Turnover on stock exchanges (in mil. EUR) 14,873 43, NEX stock exchange 6,153 17, Montenegro 8,719 26, Stock exchange indices (monthly change) NEX NEX PIF MOSTE Average interest rate on 28-day T-bills 8.14% 10.08% Average interest rate on 56-day T-bills 8.13% 10.13% FISCAL SECTOR* (in mil. EUR) Original revenues 229,8 337, Total expenditure and net lending 250,7 371, State surplus/deficit Financing Grants Proceeds from privatization Net indebtedness FOREIGN ECONOMIC RELATIONS* Current account balance (in mil. USD) Balance of trade Balance of services (tourism+transport+fin.serv.+other serv.) Current account balance as % of GDP (in EUR) Monetary reserve (in mil. EUR) Frozen foreign currency deposits (in mil. EUR) 127 External debt (in mil. EUR) 438,8 *Preliminary data V

6 VI THE CHIEF ECONOMIST'S ANNUAL REPORT FOR 2003

7 CONTENTS REVIEW OF MACROECONOMIC DEVELOPMENTS 9 REAL SECTOR DEVELOPMENTS 15 Liquidity 17 Activities 19 Industrial Output 19 Tourism 20 Construction Industry 21 Forestry 22 Transportation 22 Prices 23 Employment 28 MONETARY DEVELOPMENTS 33 Money supply 35 Aggregated balance sheet of banks 37 Monetary accounts 43 Deposits by private citizens 45 Reserve Requirements 46 Interest Rates in Montenegrin Banks and Interest Rate Risk 49 FINANCIAL MARKETS 51 Money Market 53 Capital Market 56 FISCAL DEVELOPMENTS 63 PUBLIC DEBT 71 THE BALANCE OF PAYMENTS 77 INTERNATIONAL ECONOMIC DEVELOPMENTS IN IMPORTANT EVENTS IN ANNEX 109 VII

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9 REVIEW OF MACROECONOMIC DEVELOPMENTS REVIEW OF MACROECONOMIC DEVELOPMENTS 9

10 10 THE CHIEF ECONOMIST'S ANNUAL REPORT FOR 2003

11 REVIEW OF MACROECONOMIC DEVELOPMENTS On the whole, the macroeconomic situation in 2003 improved in comparison to the previous year: positive growth rates of GDP and industrial production were recorded, the inflation rate decreased, the level of the foreign trade deficit was reduced, an increased turnover from tourism and the growth of savings and approved loans were recorded. In accordance with the planned dynamics, the payment operations reform concerning the movement of payment operations to the banking system was successfully completed. The privatisation of Montenegrobank was successfully completed, while the preparations for the privatisation of Podgoricka bank and the remaining state capital in the banking sector are under way. Ten banks that fulfilled the conditions prescribed by the Law on Banks and the new microfinancial institutions were licensed. The Agenda of Economic Reforms was adopted and a number of systematic laws were passed. In addition, a number of new reform laws and enabling regulations which regulate the micro credit financial sphere were enacted: the Regulation on Credit Unions, the Resolution on Micro-credit Financial Institutions, the Law on Deposit Protection, the Law on Settlement of Obligations and Claims Under Foreign Debt and Frozen Foreign Exchange Savings, the Law on the Prevention of Money Laundering, the Regulation on the Uniform Method of Calculation and Reporting of Effective Interest Rate on Loans and Deposits, the Regulation on the Chart of Accounts for Banks and Financial Institutions, as well as numerous enabling regulations in the bank supervision and payment systems. Value Added Tax was introduced with the common interest rate of 17%. The Republic Customs Law (and enabling regulations) was enacted. Pursuant to the constitutional Charter and the harmonization process for Serbia and Montenegro, higher customs rates were applied for 93% of products. The Regulation on Tax Relief for the Newly Employed stimulated registering of non-registered employees and employment of new ones. GDP in 2003 was estimated EUR million, which represents a growth rate of 2.53%, this does not represent an acceptable increase rate even though the growth rate was 1.5% higher than projected. This growth rate is lower than the overall international GDP increase rate (3.2%) and the increase rate of the economies in transition (4.9%). The achieved GDP represents 79.5% of the GDP level in The following table shows the most important macroeconomic indicators in 2002 and Table 1. Macroeconomic indicators Macroeconomic indicators GDP (EUR million) 1,221 1,375 GDP increase rate Population 672, 556 (616, 258) 1 GDP per capita (EUR) 1,981 2,231 Inflation Balance of payments current account (EUR million) Foreign direct investments (EUR million) Foreign assistance 2 (EUR million) Savings (EUR million) Approved) loans (EUR million) M1 (EUR million) According to the population census from 2003 the number of inhabitants is , but represents the number of inhabitants in the Republic. 2 Excluding the foreign assistance received through the nongovernmental and humanitarian organizations. 11

12 THE CHIEF ECONOMIST'S ANNUAL REPORT FOR 2003 The average number of unemployed people in the course of 2003 was and it was 11.1% lower than in Monstat data shows that 111,856 people on an average were employed in the reporting year, or 1.7% less than in This data clearly points to one of the greatest problems of the Montenegrin economy high unemployment. However, it is estimated that the real unemployment rate is much lower due to the great contribution of the grey economy to the labour market. Industrial production increased by 2.4%, mainly due to the increased production of electricity of 17.5%. A growth in production of 1.4% was recorded in the mining and quarrying sector, the level of production output in other sectors was below that reached the previous year. The level of industrial production in 2003 represents only 60% of the one achieved in With a view to the intensification of industrial production it is essential to continue with the privatisation process and the restructuring of large systems. An inflation rate of 6.7% recorded in Montenegro in 2003, measured by the retail prices increase (6.2% if measured by the cost of living index) when compared to the projected inflation rate was 1.3% lower. Despite the fact that this inflation rate is higher than the inflation rate in the European Union, which was 2.1%, it can be still considered acceptable. It should be noted that a continuous downtrend of the inflation rate is present (28% in 2001 and 9.4% in 2002), and the projected inflation rate for 2004 is even lower, 4.5%. This is the third time only in the last three decades that a single-digit inflation rate was recorded. A number of aggravating circumstances had the dominant influence on the level of the inflation rate in 2003: the increased customs duties of 93% for imported goods, the introduction of value added tax, and the continuation of the policy of price disparity elimination. Bearing in mind the great influence of the increased prices of some non-tradable services, it is necessary for the new anti-trust regulation to be adopted and implemented. A gradual decrease in the inflation rate is a price to be paid as a part of the overall economic reform processes. The long-term aim is to achieve the inflation level existing in the European Union. The grey economy is still widespread, but it is not higher than that in comparabe developing countries. In spite of the fact that the contribution of the grey economy to GDP in Montenegro was reduced by the introduction of VAT, the new law on customs, the introduction of cash registers, the stimulations for registering non-registered employees, and so on, it is necessary to continue with such measures to decrease it further. Some tourists visited Montenegro in 2003, which represents an increase of 10.7% in comparison to the previous year. The total estimated turnover from tourism is EUR 151 million, which is 5% more than in A sound banking sector was created and, as well as the mechanisms for its maintenance. Total assets of banks are on the increase. The value of approved loans grew by 61% in comparison to the previous year, and deposits by private citizens increased by 99%. Turnover in the stock exchanges is also on the increase, and compared to the previous year it almost tripled. These positive trends form a good basis for the further development of the financial market although satisfactory development of this market segment has not yet been achieved. The dominant contribution of short-term loans is still present, and it is a well-known fact that production cycles demand longterm loans. Interest rates, although somewhat lower than in 2002, are still extremely high and hinder the operation of the economy. The main culprits for the very high interest rates are the following: high business risk, low level of money supply, underdeveloped short-term securities market, inflation higher than in the EMU, non-efficient judicial system (slowness in economy dispute settlements), as well as the lack of some systematic laws. Too big a difference between interests receivable and interests payable speak in favour of further decreases in interest rates. Thus, monthly interests payable on demand deposits was in the range of 0.04% to 0.33%, and monthly interests payable on short-term loans went from 0.25% to 3.15%. It would probably be useful to establish some institutions which would enable the decrease of risk in the financial market; something like the Guarantee Fund institutions which proved to have been very successful in some economies in transition. Liabilities for frozen foreign currency deposits were removed from the balance sheets of four banks in December 2003, which the Government took over as public debt. According to interim data, the foreign debt amounts to EUR million, and the liabilities for frozen foreign exchange deposits amount to EUR 117 million. The main share of the debt dates back before the 1990`s and due to the reckless use of the borrowed assets it still encumbers the present and future generations. Although numerous indicators show that Montenegro belongs to the low-indebted countries, great precautions should 12

13 REVIEW OF MACROECONOMIC DEVELOPMENTS be taken with new borrowings to avoid entering the category of highly indebted countries and using the available accumulated assets for debt repayment instead of making investments. Special attention should be paid with borrowings in US dollars, bearing in mind that due to the current depreciation of this currency longterm loans might bear hidden interest yielding from any future appreciation of the same currency. Budgetary data shows a surplus of EUR 2.9 million, but this does not represent the actual state of affairs. The surplus was calculated on the basis of disbursements excluding the assumed liabilities which had not been paid. If these liabilities were included in the calculation, the actual state of affairs would be a budgetary deficit. Significant improvements in the balance of payments are present despite the deficit in the balance of payments current account. This deficit in 2003 amounted to EUR 102 million and compared to 2002 (EUR 175 million) it is 58.3% lower. As Montenegro is a member of the State Union, the political crisis in Serbia, which started at the beginning of 2003 and continued with the Parliamentary crisis, had an adverse influence on the perceived country risk of Montenegro. This will continue in The worsened international political environment and terrorist attack threats will influence changes in international tourist flows. It is reasonable to expect that visits to some traditional tourist destinations will decline presenting a chance for Montenegro to make a come-back on the international tourist market. All scenarios for the future development of Montenegro must be based on high investment rates, primarily on new ( green field ) investments. Bearing in mind the limited domestic resources for investments, the strategic aim must be that of attracting new investors and the creation of optimum conditions for their business operations in Montenegro. Therefore, it is a disturbing fact that foreign investments lessened in In order to attract direct foreign investments it is necessary to conduct a deregulation of business operations in the part that still represents the limiting factor of greater investment inflows. Tourism is a branch with a very big potential for the green field investments. Furthermore, it is essential to consider the possibility for the differentiation of tax treatment of this branch. Being a small country, Montenegro has to continue with the policy of a highly open economy. This means that a great part of domestic product has to be traded with foreign countries because all needs cannot be met from domestic production. Any selfsufficient policy would be an adverse solution for Montenegro, but this certainly does not mean that some strategic products should not be protected. Montenegro has to specialize in the production of those products and services which could achieve comparative advantages in the world market. These products are undoubtedly the tourist services, supporting activities to tourism, production of healthy food, alcoholic beverages and soft drinks, and so on. It would be worthwhile to enact a strategy of economic development that would identify sectors of the strategic importance and enable the allocation of insufficient resources in those sectors. At the same time, it is necessary to continue with the Montenegro admission policy to international integrations and institutions, primarily to the European Union and the World Trade Organization. Therefore, one of the main aims of the creators of economic policy in 2004 is the harmonization of national regulations with the regulations of these two international institutions. On the basis of the available data and estimates-basic developments in monetary, fiscal and external situation for Montenegro in 2003 have been presented in the report, as well as the review of the most important events in This report represents the end result of the joint effort of the employees in the Sector for Research and Statistics. I hereby take the opportunity to thank them on their conscientious and diligent work. Ph.D.Economics Nikola Fabris The Chief Economist 3 It should be emphasized that of the total inflow from foreign investments in 2002, 75% went on the sale of Jugopetrol. 13

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15 REAL SECTOR DEVELOPMENTS REAL SECTOR DEVELOPMENTS 15

16 16 THE CHIEF ECONOMIST'S ANNUAL REPORT FOR 2003

17 REAL SECTOR DEVELOPMENTS On the basis of developments in production and services, and macroeconomic parameters, the Republic Secretariat for Development assessed that GDP for 2003 was about EUR million, which represents real growth of 2.53%. Growth was recorded in tourism, agriculture, and industry, while a fall was recorded in construction, transportation, and trade. The inflation rate (measured by the retail price index) in the reporting year was 6.7%, and it was 1.3 index points lower than the projected inflation rate. According to the official data, the unemployment rate in 2003 was 27.3%. However, the actual unemployment rate is much lower since many people are employed in the grey economy. The average number of unemployed people in the course of 2003 was 71,678 and it was 11.1% lower than in 2002 (the Employment Bureau data), while according to Monstat data the average number of employed people was 111,856 or 1.7% less than in It should be stressed that for some branches of the economy there is no, or there is very inadequate data on the actual value of production, which lessens the level of knowledge of the achievements and problems in the Montenegrin economy (e.g. in agriculture and trade). Therefore, it is necessary to solve the problem of the non-existence of this data trought institutional solutions, and by creating an electronic network for the production, distribution, and use of data at the Republic level. Liquidity Banks' liquidity during 2003 was satisfactory according to the level of available liquid assets in the country and abroad, which were always above accounts payable. 5 The following graph confirms this. The total liquidity assets of banks during 2003 were in the range of EUR 72 million to EUR million, the average being EUR 88.7 million. At end-december 2003 the total liquidity assets amounted to EUR 79.6 million. The total liabilities of banks during the year were much lower than the liquid assets, and the average amount was EUR 15 million. Graph 1.1. Total available assets and banks liabilities, at the end of the months, EUR million 4 This data is disputable because of the methodology for the calculation of the number of employed people. To wit, the number of the employed is determined on a sample basis, but small enterprises with up to 10 employees are not included in the calculation. 5 Source: Banks' daily liquidity reports 17

18 THE CHIEF ECONOMIST'S ANNUAL REPORT FOR 2003 Banks' liquid assets and liabilities for domestic and foreign payments recorded a surplus during the whole of 2003 with the average amount being EUR 73.9 million. The fact that the appropriated reserve requirements was used for liquidity only 10 days during the reporting year, speaks in favour of a high liquidity of the banking sector. During the year, the amount of liquid assets compared to banks' shortterm liabilities 6 was significantly below the prescribed minimum of 10%. According to data from the CBM Payment Operations Department on outstanding liabilities of legal persons for the period January - December 2003, 3,444 or 13% out of 26,326 legal persons (with 49,275 employees) were illiquid with EUR 46.5 million of outstanding liabilities as of 12/31/03; at the same time, this was the largest number of illiquid legal persons at end-month if compared to the other eleven months of the year. The largest amount of outstanding liabilities was in March, EUR million. The main share of the outstanding liabilities referred to 13 big enterprises (socially-owned and joint-stock enterprises). Graph 1.2. Total liquid assets and short-term liabilities of banks, 2003, EUR million Table 1.1. Recorded outstanding liabilities Date Number of legal persons with blocked accounts Number of employees Outstanding liabilities In EUR thousand ,810 36,734 32,852 Index (chain) ,558 32,020 32, ,790 36,606 62, ,507 30,677 42, ,696 34,778 47, ,776 32,130 57, ,719 34,276 54, ,742 28,881 43, ,782 26,496 45, ,017 46,153 48, ,998 38,335 46, ,444 49,275 46, Source: The Central Bank of Montenegro Payment Operations 6 Source: Decade reports on banks' liquidity 18

19 REAL SECTOR DEVELOPMENTS Observed by activities, most of the legal persons with outstanding liabilities in the course of 2003 were in trade (about 1,437 on average), industry and mining (343), and in the field of transportation and communications (149). Of the total number of observed enterprises, 7.4% of the legal entities were state-owned, socially owned and joint stock companies (enterprises with partial social capital) which employ about 78% of the employees and account for 55% of the outstanding liabilities). This points to the existence of a large number of non-efficient enterprises, which have started with or are waiting for the ownership restructuring and thus creating liquidity problems to the rest of the economy due to their outstanding liabilities. Activities Industrial Output Compared to the previous year, the total level of industrial output in 2003 was 2.4% higher. This increase was the result of favourable weather conditions, and a greater production of electricity, gas, and water supply of 17.5%. A greater volume production of 1.4% was registered in the mining and quarrying sector due to an increased volume in other mining and quarrying of 172%, while industrial output in other branches of this sector was far below the level in Thus, the mining of coal, lignite, and peat fell by 14.6%, and the mining of metal ores (red bauxite) fell by 11.7%. Higher production of other ores and rocks was due to the successful production of salt. Unlike 2002, when the production of salt failed due to the abundant rains, some tons of salt was produced in 2003 due to the favourable weather conditions. Manufacturing, which accounts for the largest share of overall industrial production (71.2%), recorded a fall in production in 2003 of 2.1%. Production declined in twelve branches of this sector, and their contribution to total industrial output is 11.4%. A fall of production went from 14.2% (production of means of transport) to 87.5% (production of coke and oil derivatives which almost failed in 2003). Of the more important branches of manufacturing industry, a downturn in production was recorded in the manufacturing of wood and wood products (19.6%), the manufacturing of chemical products and fibres (21.5%), the manufacturing of textile and textile products (24.8%), and in the manufacturing of tobacco products (27%). Higher production of 2.1% was recorded in the main export oriented activity the manufacturing of basic metals (including aluminium and steel), which contributes 43.5% of overall production, then in the manufacturing of other non-metal minerals (0.3%) which contributes 7.4% of overall industrial production, while the manufacturing of food and beverages, which accounts for 6.4% in overall production, recorded an increase of 9.5%. Month-on-month industrial production in 2003 grew only in four months and at the average monthly rate of 16.6%. The largest monthly increase was recorded in December (17.7%), and the lowest in October (8.4%). A monthly fall of production was recorded in eight months of 2003, and it went from 0.3% in March to 26.8% in April. Graph 1.3. Industrial output, index (Ø 2002 = 100) Source: Monstat 19

20 THE CHIEF ECONOMIST'S ANNUAL REPORT FOR 2003 Despite the achieved positive increase rate in industrial production, there were no significant changes in this sector in the reporting year. Therefore, the main tasks for the following year are: to continue with the restructuring of large systems, completion of the privatisation process, and quality improvement of products. In this context, international grading of products is also very important. Tourism Some tourists visited Montenegro in 2003, which is 10.7% more than in The number of domestic tourists increased by 12.8%, while the number of foreign tourists increased by 4.1%. Most of the visits were to seaside resorts (90% of total tourist arrivals), which increased by 13.7%. Tourist arrivals increased mostly in the summer months, when a significant increase was recorded with domestic tourist arrivals, which increased 21.6% in the period June September 2003 compared to the same period the year before, while foreign tourist arrivals in this period increased by 3.5%. In the total structure of tourists, 76% were domestic tourists and 24% foreign tourists (Annex A, Table 7). Economic Policy for 2003 anticipated about 4.8 million tourist nights (3.6 million domestic tourist nights and 1.2 million foreign tourist nights). The total number of tourist nights in the period January Graph 1.4. Domestic tourist arrivals Source: Monstat Graph 1.5. Foreign tourist arrivals Source: Monstat 20

21 REAL SECTOR DEVELOPMENTS December 2003 was 4 million, which is 7.8% more than in 2002, whereas the number of domestic tourist nights increased by 10.2%, and foreign tourist nights increased by 0.4%. In the structure of foreign tourists, most of them were from Bosnia and Herzegovina (19%), then Germany (15%), Czech Republic (14%), Russia (10%), and Slovakia (8%). In this year, a great amount of effort and money were invested for the purpose of better advertising the tourist offer. Montenegro tourism was represented at fairs and stock exchanges all over Europe. More intensive advertising of Montenegrin tourism in Serbia was under a slogan»summer among friends«. These activities gave positive results but not to the expected extent (bearing in mind that the actual tourist nights were 16% below planned). In order to represent Montenegro as an attractive tourist destination it is necessary for tourists to keep coming for a few years to assure the quality of service. Categorisation of 117 hotels was performed during the year, of which 3 hotels were categorised as five-star hotels, and 15 hotels as four-star hotels. Total revenues from tourism in the period January December 2003 amounted to EUR 151 million and they were some 5% higher than in the same period in 2002, mainly due to the increased number of foreign tourists. Data on tourist visits in 2003 which is still only 47% of tourist arrivals in 1987, which is considered as one of the most successful tourist years in Montenegro, points to the fact that the results achieved in Montenegrin tourism are much below the actual capacities. However, in order for Montenegro to reappear in the world tourist market, i.e. to regain the position it had in the late 1980's, it is necessary to take a number of measures. First of all, it is necessary to continue with the modernization and improvement of the transport infrastructure. Thus, it is very encouraging that repair and modernisation of roads are under way, and that credit funds from abroad for the modernization of the airports in Tivat and Podgorica have already been provided. The next problem that needs to be solved is the improvement of public infrastructure - electricity, waste, and water supply. Therefore, the required quantity of electricity should be provided in time for increase demand in summer due to the increased use of air conditioning. 7 The problem of water supply has to be solved in the long term by exploiting new sources. Furthermore, the modernization of existing tourist capacities is also required since not enough was invested in the renovation and modernization of the biggest hotels. The Ministry of Tourism announced that they would grant loans for the development of small and medium-sized business in tourism in 2004 trought four credit lines (building of mini hotels, accomodation supporting services, quality improvement of present capacities, and rural tourism) worth EUR 4 million. In 2003, commercial banks approved EUR 12 million worth of loans to tourism and services, which is 60% more than in the previous year, and the contribution of these loans to the total approved loans to all activities was 6.1%. It is necessary to decide which hotels shall remain state-owned, and privatise the others. The only way the long-term positive effects could be achieved is for the main motive in the privatisation to be the goodwill of a tenderer, and not the selling price. It is also necessary to increase the number of hotels bearing in mind their small contribution to the overall tourist offer. Montenegro has a very large potential for new ( green field ) investments. Therefore, it important to attract the most famous hotel chains which, in addition to building hotels, would be motivated to bring foreign tourists to Montenegro. 8 However, building new hotels on a large number of construction sites is connected to solving the problem of land ownership. The worsened international political environment and terrorist attack threats will influence changes in international tourist flows. It is reasonable to expect that visits to some traditional tourist destinations will decline, which will be a chance for Montenegro to make a comeback on the international tourist market. Construction Industry Activities in the construction field during 2003 significantly fell below the already adverse results achieved in Therefore, the value of construction work in the period January December 2003 was 13% lower than in the same period the year before, while the physical volume of construction work measured by effective hours was 9% lower. Comparing each month in 2003 with the same month in 2002, it can be concluded that construction activities in 2003 were more intensive only in three months. The following table illustrates the construction output in the reporting year. 7 The consumption of electricity in the world during summer months is always much higher than in winter months. 8 The best example is Egypt, which has made a big boom in international tourist market in the last years by giving building concessions to big multinational hotel chains. 21

22 THE CHIEF ECONOMIST'S ANNUAL REPORT FOR 2003 Table 1.2. Construction output Index Value of construction work in EUR thousand Index Effective hours in thousands 2002 ø Jan.-Dec , ø Jan.-Dec. 87 4, January , February , March , April , May , June , July , August , September , October , November , December 116 5, Source: Monstat A fall in this industry can be partly explained by the reduction of foreign assistance in 2003, resulting in a fewer number of projects of the public and transportation infrastructure financed by international organisations, and by a lower demand for apartments due to their high prices and still unattractive housing loans offered by banks. Forestry The volume of production in forestry in the period January December 2003 was m 3 which is only 0.6% less than in the same period the year before when the adverse results were achieved in this industry (the fall in production in 2002 in comparison with 2001 was 10%). The main reason for such a fall in production was the unfavourable weather conditions in the first quarter of After this period, monthly production surpassed average production in the range of 21% to 78%, which was enough to compensate for the fall of production in the first quarter. During the reporting year, m 3 of wood products were sold, which is 6% less than in the same period in Table 1.3 shows the output in forestry. Poor results in the field of forestry are due to long lasting problems of unplanned and illegal woodcutting, and bad management of forest resources, as well as the obsolete technology which is used by wood processing enterprises. The problems deepen through the slow collection of concession fees. All the above mentioned point out the necessity of undertaking activities on improving forest resources management in order for Montenegro to obtain a certificate for maintainable forestry needed to gain access to international markets. The first steps have already been taken, so the implementation of the EUR 3.1 million project The Development of Forestry in Montenegro financed by the government of Luxemburg has started. In addition, it is necessary to undertake the restructuring and integration of wood processing enterprises. Transportation According to data from Monstat, the downtrend in transportation in 2002 continued in However, if we observe the structure of transport of people and goods by transportation branches, it can be concluded that the situation is not critical. The greatest fall was recorded in public transportation, and the increase of turnover was recorded in sea and air transport. 22

23 REAL SECTOR DEVELOPMENTS Table 1.3. Forestry output Index Production of assortments m 3 Index Sale of assortments m ø Jan.-Dec , , ø Jan.-Dec , , Jan , ,262 February , ,652 March 9.9 1, ,483 April , ,239 May , ,688 Jun , ,202 Jul , ,870 August , ,055 September , ,208 October , ,771 November , ,210 December , ,982 Source: Monstat The very low quality of the road infrastructure and frequent traffic interruptions in certain road sections influenced the fall in road transportation, so that compared to 2002, 18.2% less passengers and 8.1% less goods were transported in Work on the project Fast Rehabilitation of the Roads in Montenegro in the road section Podgorica Kolasin, funded by the loan from the European Investment Bank has started at end of A fall was also recorded in transportation via railways 2% less passengers and 16.5% less goods were transported in the reporting year. The greatest fall behind the results achieved in 2002 was in public transportation not less than 43.3%. Positive results were achieved in air traffic where 602,942 passengers or 2.1% more than in 2002 were transported in 2003, while transport of goods was 14.1% lower. The increased number of transported passengers in air traffic was primarily due to the better tourist season since 5% more passengers were transported in the period May September 2003 than in the same period the year before. Some 378 million tons of goods were transported in sea transport (in ton miles), which is 4.1% more than in the comparative period. The total turnover in ports in the reporting year was 1.9 million tons and it increased by 41% in comparison with Some 51% of transhipped cargoes referred to exports, with an increase of 99.4%, while 47.7% referred to imports, with an increase of 6.6%. Prices Data calculated by Monstat represents the basis for monitoring and analysing price changes in Montenegro. Price changes in Montenegro are monitored through three indicators: the retail price index, the cost of living index, and the producers' prices of manufactured products index. Retail prices are used as the inflation indicator. An inflation rate of 6.7% 9 was recorded in Montenegro in 2003, measured by the retail prices increase (i.e. 6.2% if measured by the cost of living index) and compared to the projected inflation rate it was 1.3% lower. Despite the fact that this inflation rate is higher than the inflation rate in the European Union, which was 2%, it can be still 9 The so-called end year inflation methodology was used, that is, the year-on-year comparison of December 2002 and December

24 THE CHIEF ECONOMIST'S ANNUAL REPORT FOR 2003 considered acceptable. One should bear in mind that the decreasing trend of the inflation rate had started in 2001 (28%), continued in 2002 (9%), while the projected inflation rate for 2004 is even lower 4.5%. With the exception of the previous year, a single-digit inflation in Montenegro was recorded in late The average inflation rate in economies in transition was 8.3% in 2003 and it was 1.6% higher than the one in Montenegro; the average inflation rate in the EMU was 2%. In the harmonization process of customs rates those ones in Serbia there was an increase in the customs rate, which directly influenced the upsurge in prices of certain categories of products (the average weighted customs rate increased from 2.7% to nearly 6%). Since some 50% of Montenegrin imports are in goods and unfinished products the increase in customs tax was also incorporated in the prices of finished products that were processed domestically. The introduction of value added tax also influenced the price increase. Prices of a certain number of products, which traders had sold earlier at lower prices because they had not incorporated turnover tax, increased because the VAT calculation methodology hinders tax evasion. Therefore, the largest monthly price increase in the reporting year was recorded in April (3.2%), the month when VAT was introduced. Besides, almost none of the economies in transition have recorded a one-digit inflation in the year of the VAT introduction. In an underdeveloped economy it is necessary to conduct the policy of gradual elimination of price disparities, which has an effect of delayed inflation. The increase in prices of electricity (24%), public utility services (13%), PTT services (5.4%), bread (15.4%), and so on, had a direct influence on the increase of inflation. These prices could have grown in one of the previous years, so the inflation rate in the reporting year would be significantly lower. However, bearing in mind the achieved level of living standard, such a policy would have been irresponsible and socially unacceptable. If the price growth was observed by the structure of products, it can be concluded that the prices of agricultural products fell by 2.9%, the prices of industrial products and beverages increased by 5.7% and 0.4%, respectively, and the main culprit for the price growth was the increased price of services of 14.3%. The biggest contribution to the price increase in the category of services had the increase in cost of obligatory vehicle insurance and passenger transport of 65.3% and 8.5%, respectively. Increase in prices of only two of these categories explains the 74.6% of the overall price growth. Bearing in mind that these two services are dominant in the category of non-tradable services, it is obvious that there is a risk that the prices of non-tradable products and services may affect the macroeconomic stability in the forthcoming period. Furthermore, if we observe the last three years, it can be concluded that the prices of services have grown above average in comparison with prices of other products. In order to prevent further price increase in the sector of non-tradable services and other sectors, enactment and consistent implementation of new anti-trust regulations is required. Box 1.1. Methodology for the calculation of inflation Retail prices are prices at which individual producers and suppliers of services sell their products and services to end consumers. Retail prices in the Republic are monitored in four chosen towns: Podgorica, Niksic, Kotor and Pljevlja. A list used for determining the retail price index consists of 382 items of which 320 are products and 62 are services. Correction of weight is made at the beginning of every year only on the basis of prices increase during the previous year, and not on the basis of altered needs and tastes of consumers. Therefore, these corrections are insignificant. It should be taken into account that numerous methodological problems in the calculation of the inflation rate do not show the real state of affairs of inflation rate movements. Some products and services are not included in this calculation, such as travel costs, cell phone expenses, the Internet, computers, and so on, which represent important parts of a consumer s basket. Moreover, only domestic products are included in this calculation, which is unthinkable for a highly open economy such as Montenegro. The last time the correction of the contribution weight of certain products in a consumer s basket was done was seven years ago, and the annual weight corrections made only on the basis of price changes do not show the real state of affairs. Furthermore, this opens the question of what constitutes an adequate sample selection on which inflation should be monitored since this sample includes only four towns. 24

25 REAL SECTOR DEVELOPMENTS The first four months of 2003 were characterised by a substantial increase in prices, so the average retail prices increase rate in this period was 1.28%. Compared to December 2002, the retail price index in April 2003 was 5.2%. After April, price changes stabilised considerably, so that inflation in the period May December 2003 was 1.3%, i.e. the average retail prices increase rate in this period was 0.16%. The largest monthly retail prices increase was in April (3.2%) due to the implementation of Value Added Tax (VAT) and the increased state controlled prices of electricity of 23.7%. The summer tourist season had no significant effect on the price increase since the prices in June and July increased at the rate of 0.3%, and the increase rate in August was only 0.1%. Prices stabilised completely at the end of the year, so that the level of prices in November and December 2003 remained the same as in October. In addition, there was a constant tendency of growth of credits to natural persons during the year, which actually represented an increase of solvent demand that exerted pressure on commodity stocks, which may also have led to inflation. During 2003 the prices of services grew much faster than the prices of goods. The biggest contribution to the increased prices of services (50%) was of the cost of obligatory vehicle insurance, which increased three times during the year (22.7% in January, 14.7% in February, and 17.34% in April), so this price was 65.13% higher at the end of 2003 compared to the year-end Prices of passenger transport, with an increase of 8.5%, made up 24.6% of total increase of prices of services during the reporting year. Another price increase was of public services of 13%, and with a contribution of 12.4%, and price increase of 5.4% with a contribution of 5.6% of the total price increase of services. In the category of goods, the only prices at end-2003 that was lower than at end-2002 were the general prices of agricultural products (by 2.9%) due to the lower prices of fruit of 8.2%, while the prices of vegetable were 19.7% higher. The prices of manufactured food products were 4.2% higher, of which the price of bread was 15.4% higher and contributed 14.6% of total inflation, while the prices of fresh and processed milk increased by 8.2%, thus contributing 4.5% to total inflation. The prices of manufactured non-food products recorded an increase of 8%, mainly because of the increased prices of electricity of 23.7%. The contribution of the increased prices of electricity to the total price increase during 2003 was 23.9%. The fluctuation of prices of oil and oil derivatives reflected on their price movements in Montenegro. The reason for this was the Regulation on Forming the Maximum Retail Prices of Oil Derivatives enacted by the Government of Montenegro at end-september 2002, which prescribed automatic pricing of these derivatives on the basis of their price movements in the world markets, starting from January Therefore, the Government does not fix the prices of fuel in Montenegro, for it only approves the calculations submitted by Jugopetrol and other suppliers every other Monday. The maximum retail price can be recalculated and applied as such if a price of any of the elements used for setting the retail price of oil derivatives changes for +/- 5% (prices of oil derivatives published in Platt's European Marketscan, EUR/USD exchange rate, fees, taxes, spread, and so on). As a consequence, the highest monthly price increase of oil and oil derivatives was in March (7.07%), and the lowest fall of these prices was registered in May (6.02%). The Monstat data shows that the prices of the main categories, which make up the retail price index, grew a little slower in 2003 than in Graph 1.6. Retail prices (chain index) Source: Monstat 25

26 THE CHIEF ECONOMIST'S ANNUAL REPORT FOR 2003 Graph 1.7. Prices of oil and oil derivatives in 2003 (chain index) Source: Monstat Graph 1.8 Retail prices in 2003 (December 2002 =100) Source: Monstat Table 1.4. Retail price index in Montenegro Source: Monstat XII 2001 XII 2000 XII 2002 XII 2001 XII 2003 XII 2002 TOTAL GOODS Agricultural products Industrial products Beverage SERVICES

27 REAL SECTOR DEVELOPMENTS The cost of living at end-2003 was 6.2% higher than at end Expenses that grew far more than average are fuel and light expenses (20.2%), cultural and leisure (15.5%), household (14.6%), services (8.4%), and clothes and footwear (7.3%). Compared to end-2002, food increased by 4.7%, and the only expenses that decreased in 2003 were tobacco and beverages (0.1%). The cost of living index is often seen as equal to the retail price index. However, it should be taken into account that these two indicators differ significantly both in the volume and the list of weight of certain articles and services in the lists. The grouping of items and services in these two indices is also different, so direct comparison with similarly named groups is often impossible (e.g. the group services in the retail price index has an item rent, while in the cost of living index rent is shown as a separate group named apartment. The cost of living index represents a special type of the retail prices of consumer goods and services index. The cost of living list contains 303 products and 62 services (a total of 365 items). The value of sold quantities is used as weight in calculating the retail price index (used as a basis for tracking the prices at which the largest quantities of selected products are sold, the so called usual prices). Therefore, weights are determined on the contribution of certain items and groups of items to total retail trade turnover. The structure of values of personal consumption articles and services purchased by the polled households serves as weight for calculating the cost of living index. This structure is obtained by conducting special polls. Producers' prices of manufactured products are the prices at which producers sell the largest quantities of their products in the domestic market, or those are the prices at which producers settle an account with other producers or merchants in the case of a joint venture. The producers' prices of manufactured products fluctuated during 2003 and grew much faster than in 2002 (Graph 1.9.). Observed on a monthly level, these prices fell only in February (0.1%); in May and August these prices did not change, while in the other seven months, prices rose. The highest monthly increase of 3.8% was recorded in April as a consequence of the increased prices of electricity of 24%. Prices of capital goods grew by 33.1% during 2003; consumer goods grew by 13.2%, while the prices of intermediate goods increased by 4.7%. Observed by sectors, the highest increase in prices was recorded in electricity, gas, and water supply of 24%. The total price increase in the manufacturing sector was 6.1%; only the prices of tobacco products and clothing stayed the same as in The prices in other branches of manufacturing industry grew in the range of 0.5% (chemicals and chemical products) to 23% (food products and beverages). The prices of basic metals grew by 0.9% during the reporting year. The prices in the mining and quarrying sector fell by 1.7% due to the lower prices of other ores and rocks of 12.1%, while in other branches of the sector there were no price changes. Graph 1.9. Producers' prices of manufactured products (chain index) Source: Monstat 27