Chief Economist Annual Report 2009

Transcription

1 Chief Economist Annual Report 2009 Podgorica, 2010

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 Petar Drakić Velibor Milošević, MS Krunislav Vukčević Radmila Savićević Franjo Štiblar, PhD PREPARED BY: Nikola Fabris, PhD, Chief Economist Directorate for Monetary Policy and Fiscal Research Directorate for Balance of Payments and Real Sector A part of the Report was prepared by the Directorate for International Cooperation and European Integration. TRANSLATED BY: DESIGNED BY: PRINTED BY: PRINTED IN: Translation Services Division Andrijana Vujović OBOD 150 copies 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 : 614 km Capital: Podgorica (169,132 inhabitants) administrative and economic centre Royal Capital: Cetinje historical and cultural centre Length of seacoast: 293 km Length of beaches: 73 km The longest beach: Velika plaza, Ulcinj m The highest peak: 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 IN REAL SECTOR DEVELOPMENTS Gross Domestic Product Activities Prices Labour Market Results of the Processing of Annual Financial Statements of Legal Persons in Montenegro MONETARY DEVELOPMENTS Banks Liquidity Aggregated Balance Sheet of Banks Lending interest rates Deposit Interest Rates Banks Reserve Requirement Microcredit Financial Institutions MONEY AND CAPITAL MARKET Money Market Capital Market FISCAL DEVELOPMENTS Plan of Montenegrin Budget in Budget of Montenegro realization in Local administration State funds Plan of Public and Budget Spending for 2010 and Fiscal Risks PUBLIC DEBT Domestic public debt Foreign debt Projection and sustainability of public debt EXTERNAL SECTOR Current account Capital and financial transactions account INTERNATIONAL ECONOMY Market developments European Union (EU) Developing countries (Asia) Interest rates Foreign exchange rates IMPORTANT EVENTS ANNEXES 195

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7 7 Review of macroeconomic developments % REAL SECTOR DEVELOPMENTS GDP (in current prices in EUR million)* 3, ,003.0 Industrial output index (compared to the same period the year before) -2.0% Forestry (compared to the same period the year before) 6.6% Construction (compared to the same period the year before-measured by effective working hours)** 20.7% Employment Number of employed people (year-end) 169, Number of unemployed people (year-end) 28, Inflation rate (compared to December the year before) Cost-of-living index 7.2% CPI*** 6.9% 1.5% RPI 7.3% Average salary (EUR, without taxes and contributions) MONETARY DEVELOPMENTS (EUR million) M11 Total deposits 1, , Deposits by economy Government deposits Central government Institutions and agencies of central government Funds and municipalities Deposits by financial institutions Deposits by households (savings) Deposits - other Total loans 2, , Loans to economy 1, , Loans to government Central government Institutions and agencies of central government Funds and municipalities Loans to banks and financial institutions Loans to private citizens 1, Other loans MONEY AND CAPITAL MARKET Turnover in stock exchanges (EUR million)**** NEX stock exchange Montenegroberza stock exchange Stock exchange indices NEX20 10, , NEX PIF 5, , MOSTE Average interest rates on 28-day T-bills, last recorded Average interest rates on 56-day T-bills, last recorded Average interest rates on 91-day T-bills, last recorded Average interest rates on 182-day T-bills, last recorded 3.00% FISCAL DEVELOPMENTS (EUR million)**** Current incomes***** 1, Expenditures***** 1, Surplus/deficit Foreign debt without debt of public enterprises (in EUR million) Public debt without debt of public enterprises (in EUR million) EXTERNAL DEVELOPMENTS**** Current account balance (EUR million) -1, Trade balance -2, ,371.5 Balance of services % of trade deficit/other balances coverage Current account balance in % of GDP * Data for 2008 given by MONSTAT and 2009 data released by the Ministry of Finance. ** Monstat data *** The only inflation measurement as of January 2009 **** Data cover the periods I-XII 2008 and I-XII ***** Current revenues and expenditures of the budget, state funds and local self-governments.

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9 Macroeconomic Environment in Montenegro in MACROECONOMIC ENVIRONMENT IN MONTENEGRO IN 2009 Over the three-year pre-crisis period Montenegro saw a remarkably accelerated economic growth with the average rate amounting to around 8%. The crisis induced economic activity decline and deterioration of almost every macroeconomic indicator. The IMF estimates for 2009 show that Montenegro s GDP declined by 7%, stock market indicators lost over 70% of their values in relation to their record highs; after years of surplus, the budget and state funds recorded deficits of the respective 2.3% 1 and 3.5% 2 of total public sector, loans are on a downtrend, bank deposits also declined, and non-performing assets increased at an accelerating rate. The crisis adjustment became apparent as regards inflation which reached its record low from 2004 (1.5%) and the current account deficit which substantially declined. Positive trends were recorded in the inflow of net foreign direct investments that reached their record high of EUR million and thus prevented further economic downturn. The Ministry of Finance estimates show that GDP saw a 5.3% decline, whereas the IMF assessed that this fall amounted to 7%. Such a severe fall is the result of a sharp decline in both domestic and foreign demand. Furthermore, the fall was also due to high fixed costs burdening a number of enterprises and which could not be covered from regular operations under these circumstances. The annual CPI inflation amounted to 1.5%, being at the 2004 annual level of inflation measured by the cost of living index. The annual core inflation amounted to 0,04%. The global financial crisis induced a decrease in aggregate demand, both national and international, resulting in low rates of inflation worldwide. However, it should be taken into account that substantial monetary and fiscal stimuli used globally to combat recession will result in somewhat higher increases in post-crisis inflation. Such movements will inevitably affect Montenegro, so in the upcoming period we can expect the appearance of imported inflation. As for the Montenegrin banking system, 2009 brought first signs of stabilisation. The year-on-year increase in banks` capital amounted to 18.7%. Liquid assets of banks amounted to EUR million, being 26.4% higher than in This means that at end-december 2009 banks had EUR 11.9 million more funds at their disposal than in the pre-crisis period (September 2008). Nevertheless, banks recorded the annual decline in assets and total deposits, together with an increase in non-performing and overdue loans. Thus it is not surprising that banks reduced their lending activity. 1 Preliminary data 2 Ibid

10 10 Chief Economist Annual Report 2009 The weighed average effective interest rate at end-2009 was 9.38%, being 0.02 percentage points lower than a year ago. This stagnation is expected to continue in Deposit interest rates recorded a 0.24 percentage point decline, with the weighted average effective rate amounting to 3.87%. Such a movement of interest rate indicators is largely affected by the methodology which covers all loans and deposits, but not newly disbursed loans. Thus lending interest rates for new loans could be even higher. Industry is one of the branches which was most severely hit by the crisis. Its output decline in 2009 exceeded 30%. The crisis strongly hit the Montenegrin metal industry, as well as the related mining industry. In addition to the inherited problems, these branches have faced the problem of placement of their products in international markets. With a view to ensuring sustainable operations in the forthcoming period, it will be required to make additional efforts to restructure these systems and implement credit and social programs (the latter concerning redundancies) in order to ensure business continuity. Output increase was recorded only in two subsectors, the manufacturing of chemical products and fibres (42%) and the manufacturing of other machinery and equipment (9.1%). However, such a growth was due to the low base and not any significant increase in production. The number of tourist arrivals rose by 1.6%, yet tourist nights declined by 3.1%. Thus the 2009 tourist season may be characterized as better than expected. However, there still remains a dilemma regarding the exact tourism revenues and whether the global financial crisis has largely affected tourist spending. Almost all transportation categories recorded negative rates of growth in 2009, with the exception of road cargo transport which registered a 30.8% increase. Transportation is a very important branch of the Montenegrin economy as it is connected to tourism and geographical position in the transit of goods. The annual decline in forestry output in 2009 amounted to some 23%, whereas construction recorded a 19.2% fall, as measured in effective working hours. These branches have also been severely hit by the crisis and are now facing extremely complex business challenges. The global financial crisis induced a substantial decline in economic activity which, of course, reflected on public revenues and expenditures. That is why the 2009 fiscal policy addressed fiscal adjustments in the recession environment, both on the revenue and expenditure sides. The fiscal deficit was inevitable and it reached EUR million or 2.3% of GDP. Large fiscal deficits were also recorded by other countries, including those in the Euro area, of which some much higher than the level prescribed by the Maastricht criteria. Although expenditures for current public spending reduced owing to general austerity measures, 2010 will have to introduce even stricter fiscal measures that will be less popular and acceptable by the public administration employees. What is important in the fiscal domain is to ensure that public spending is adjusted to our real possibilities, meaning public revenues that our system can support. It is reasonable to expect that the budget spending will remain under strict control in 2010 to be based on reduced inflow of funds and the regular servicing of both foreign and domestic debt, together with the creation of a social program to protect the population which has been mostly affected by the consequences of the global financial crisis. The crisis also affected a substantial decrease in both visible exports (36.6%) and imports (34.6%). 3 A deficit was recorded in the visible trade sub-account, whereas the sub-accounts of services, income 3 As per special trade system

11 Macroeconomic Environment in Montenegro in and current transfers recorded surpluses. The current account deficit amounted to EUR million, thus being 42.7% lower than that recorded in Yet there are numerous doubts in the accuracy of visible trade data since the improvements in the balance of payments imbalances are not the result of better competitiveness of the Montenegrin economy, but rather the global crisis and reduced domestic demand. The issue of competitiveness of the Montenegrin products in international market, both regarding the prices and quality, remains the key problem our economy will have to face in the future and put additional efforts in that direction order to reduce the current account deficit. Net inflow of foreign direct investments amounted to EUR million in 2009, which is 65.1% more than in The structure of FDI improved, meaning that there was a substantial increase of investments in companies and banks, whereas investments in real estates declined. Although Montenegro did not use all its potential to attract FDI, a new model of growth will be required in the following period. This will involve the initiation of internal factors of growth and development to be based on performance and competitiveness growth, international presence, and further development of creativity and entrepreneurship. Employment growth averaged 4.8% in relation to the previous year. Unemployment was by an average 3.9% lower than in 2008, with an increase being recorded in the last quarter of It is obvious that this was due to the belated adjustments, as well as the fact that the first to have been hit was foreign labour force. Taking into account the lowering of economic activity and the necessity of restructuring of large economic systems, it should be expected that employment downtrend will continue in A particular problem is the lack of an economic development strategy which would undoubtedly provide answers to the question of objectives to be met in the upcoming period, their dynamics, the identification of strategic priorities and resources for their implementation. We have a number of non-interrelated sector strategies and that is why this calls for an economic development strategy that would encompass all individual strategies into one whole. That is why this gives an impression that the development in the previous period was somewhat spontaneous, without a clearly defined path to be followed. It is obvious that we need a new model of growth in the forthcoming period which will not rely on domestic consumption, but which will be instigated by exports and substantially improved international competitiveness. Nikola Fabris, PhD, Chief Economist

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13 1 REAL SECTOR DEVELOPMENTS

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15 Real Sector Developments Gross Domestic Product After the years of accelerated growth, GDP in 2009 saw a decline. At this point, the exact rate of decline is not certain, but rough estimates show that it probably ranges between 5.5% and 7.5%, primarily due to a decrease in overall industrial output, in particular in manufacturing and mining industries. Negative trends were also recorded in most of the other activities such as trade, construction, forestry, and almost all transportation sectors. Regardless of negative trends recorded in the last months of 2009 in the labour market, especially in manufacturing industry and the mining and quarrying sector, overall employment recorded an increase, whereas unemployment declined. This period was also characterized by a substantially lower inflation in comparison with rates recorded in the last two years. Low production and negative trends in the service sector, which accounts for the main share of the Montenegrin economy, resulted in the revision of the already estimated rates for both 2009 and Forecasts of various institutions on Montenegro s economic output in 2010 range between -2% and 0.5% (Table 1.1). The obvious decline in output is particularly apparent if observed through a severe decline in industrial production which restructuring and contributions of certain subsectors thereof will determine the overall output in Although the global crisis has spread to all countries in waves, its consequences and depth vary by the country and depend on internal (im)balance in every individual country. There are indications of the global economic recovery already in 2010, but for the Montenegrin economy this will be the year of facing the accumulated difficulties from the previous period. That is why there are numerous revisions of the forecasted rate of Montenegro s growth, as presented in Table 1.1. Table 1.1 Projected GDP growth rates for Montenegro in 2010 Institution EBRD IMF UNDESA Economist Intelligence Unit Global Insight Vienna Institute Business Monitor Online Forecasted rate of growth* 0,1-2,0 1,0 0,5-0,8 1,0 0,0 Revised forecasts** 0, ,5 *Source: Transition Report, EBRD ** Source: Websites of the respective institutions

16 16 Chief Economist Annual Report 2009 Graph 1.1 EBRD GDP growth forecasts for 2010, % Montenegro was the leading country among the former Yugoslav republics for its GDP growth in the past four years, which averaged 7.6%. The IMF projections presented in the World Economic Outlook (WEO) 2009 forecast GDP decline of 4% in However, after the IMF mission to Montenegro at end-january 2010, it was concluded that the fall is even higher (-7%), thus representing the highest negative GDP rate in comparison with the former Yugoslav republics. The IMF forecasts for 2010 of -2% GDP rate of growth and recovery not early before 2011 give rise to concern. The projections of Montenegro s real GDP movement provided by other institutions (see Table 1.1) are somewhat moderate. Source: EBRD The EBRD estimates of Montenegro s GDP in 2010 show moderate 0.1% and 0.4% increase, as presented by the respective October 2009 and January 2010 projections. Problems in the metal industry will affect the creation of a new weighting structure of this subsector to increase the share of electricity generation and the manufacturing of food products in total industry, which will consequently determine the overall industry output in The initiation of investment projects in energy and tourism, the commencement of the highway construction, and the exploitation of the agricultural sector capacity could indicate Montenegro s economic recovery in Structural economic reforms and improved business environment which moved Montenegro by 6 positions upward in the Doing Business 2010 report in a way open possibilities for the real sector to trend upward. Certain sectors could be the instigators of the Montenegrin economy, such as agriculture which has been recording positive results in recent years mostly owing to funds allocated by the Government in its agricultural budget, and tourism, which has diversified its offer in the past few years, and the development of agrotourism will bring benefits to both sectors. Increased agricultural production could encourage food industry, and investments in the energy sector will reflect in increased electricity generation, consequently affecting overall industrial output. The commencement of the highway construction could generate multiple effects through the engagement of the local construction companies (occasional or seasonal, depending on the scope and needs). Nevertheless, with modest recovery indications (in the second half of 2010), the Montenegrin economy will not be able to count on high rates of growth in the medium term such as those being recorded in the last three years prior to the crisis. Box Business environment in Montenegro and 2010 forecasts In spite of the challenges induced by the financial crisis, a number of undertaken reforms reached its record level, as indicated in the last World Bank report (Doing Business 2010). In the period June 2008 May 2009, 287 reforms were carried out in 131 countries, which is 20% more than in the previous reporting period. The reforms were focused on facilitation the starting of a business, strengthening

17 Real Sector Developments 17 of property rights, improvements in resolving commercial disputes and bankruptcy proceedings. It is obvious that the speeding up of reforms and the creation of as much stimulating environment as possible were the ways for numerous countries to encourage new investments and thus try to overcome the crisis. As for Montenegro s ranking, it was revised in relation to the previous report (same as for many countries), thus forecasting improvements in the ease of doing business in 2010 and ranking Montenegro 71st of total 183 countries. These improvements Montenegro achieved owing to its employment policy, that is, ensuring labour market flexibility, as defined in the Labour Law, and making it easier to deal with construction permits and other facilities set out in the Law on Spatial Planning and Construction, although it remains the worst ranked (moving up 6 positions in comparison with the previous ranking). Substantial improvements were achieved in the starting of a business, where Montenegro moved up 22 positions. As for the ease of doing business, of the former Yugoslav republics, FYR Macedonia made the greatest progress and is ranked 32 nd (moving up from 69 th place as of the previous report), Slovenia is ranked 53 rd (from 58 th place), Serbia is 88 th (from 90 th place), Croatia is 103 rd (from 110 th place), and Bosnia and Herzegovina is ranked 116 th (moving up from 119 th place) Observing the region with the total of 27 countries, FYR Macedonia is best ranked (5 th ), whereas Montenegro is ranked 15 th for the ease of doing business, thus coming before Serbia, Croatia, and Bosnia and Herzegovina. This clearly indicates that there is still plenty of room for the business environment improvement. Table 1 Montenegro s ranking in the main business indicators Change Ease of doing business Starting a business Dealing with construction permits Employing workers Registering property Getting credit Protecting investors Paying taxes Trading across borders Enforcing contracts Closing a business Source: Doing Business 2010, The World Bank Group Problems in economic activities will continue in 2010, as shown by the responses of entrepreneurs to the regular survey on doing business (carried out in January 2010), whereby most of them (59% or 2 percentage points more than a year ago) expect deterioration in business environment. Entrepreneurs indicated the same main business barriers as one year earlier, these being the general operational risk, low demand, and high lending interest rates.

18 18 Chief Economist Annual Report 2009 Graph 1.2 Expected business environment in 2010, % Graph 1.3 Expected business barriers in 2010, % The first half of 2010 will be under the express influence of the recession process with the belated crisis effects reflecting in increased unemployment, a decline in employment (particularly in the industry-related sectors), and lower wages which trended downward in the last quarter of These factors will affect a decrease in aggregate demand and hamper the recovery of the Montenegrin economy. The implementation of measures set out in the Economic policy for 2010 will make an attempt to instigate economic activity. Potential arrangements with the international financial institutions would represent a significant element of the overall macroeconomic framework in A strategic economic development framework in 2010 will be rounded off by the drafting of the document titled Montenegro in XXI century - the Competition Era and the National Development Plan, the latter being the enforcement document. This will create the conditions for defining a long-term development vision for Montenegro, the absence of which is a great disadvantage in the formulation of the current economic policy measures since it is not clear in which direction the Montenegrin economy should go. Box 1.2 Transitional indicators The year 2009 was one of the hardest years for economies in transition ever since the production collapse which had led to the crash of centralized planning in 1990`s. However, although the crisis slowed down the reforms, their subsequent changes were not as big as those undergone during the last big crisis that hit the region of economies in transition in In general, there were no pronounced changes in the indicators of these countries in relation to the previous comparison. Countries which recorded more than one positive change in individual indicators are Belarus, FYR Macedonia, and Montenegro. Montenegro improved its ratings for Competition policy and Overall infrastructure reforms. The higher Competition policy rating followed numerous activities on the establishment and registration of the Administration for Competition Protection (2007) and the adoption of the Competition Strategy, while the higher Overall infrastructure reforms rating was due to the Activities related to the Restructuring Strategy for the Railways of Montenegro whereby this company is to 4 Comments given in the text below refer only to the indicators (both positive and negative) which changed in relation to those published in the Chief Economist Report 2008.

19 Real Sector Developments 19 be legally unbundled to the Railway Infrastructure and Railway Transport, as well as the activities regarding the signing of the first public-private partnership in transportation. The Large-scale privatisations rating was lowered due to the state s repurchase of a substantial share in the largest country exporter. This is the Aluminium Plan Podgorica (KAP) which was sold in 2005, but due to the extreme financial difficulties the Government of Montenegro has endeavoured to support the company s restructuring process and cost-efficiency required to maintain production. As for other countries, Croatia received better rating for the Competition policy (3 ), Serbia improved its rating for Trade and foreign exchange system (4 ), Albania for Large-scale privatisations (4 ), and FYR Macedonia for Securities market and non-bank financial institutions (3- ) and Overall infrastructure reforms (3- ). Table 1 Transitional indicators for selected countries Country Montenegro Croatia Bosnia & Herzegovina FYR Macedonia Slovenia Serbia Albania Romania Bulgaria Large-scale privatisations Small scale privatisations Governance and enterprise Price liberalization Trade and foreign exchange system Competition policy Banking reform and interest rate liberalization Securities market and non-bank financial institutions Overall infrastructure reform Source: EBRD Transition Report 2009 (Transition indicator scores) Box 1.3 The Greek Crisis The Greek financial crisis, which emerged with the incoming new government in October 2009, has been in the centre of the global attention in the last few months. After many years of concealing, the actual condition of the Greek economy was revealed. The huge fiscal deficit and over-indebtedness have brought the country to the verge of bankruptcy. The main cause of the crisis is said to be the irresponsibility of the previous government that misreported to the EU institutions and thus concealed the actual indebtedness of the country. To wit, the previous Greek government succeeded in concealing the country s debt in cooperation with U.S. bank Goldman Sachs by presenting the loan taken from the bank as a currency trading, offering the bank the right to collect airport fees and future lottery revenues. The country overindebted by borrowing European funds and faced the problem of inability to repay its debts.

20 20 Chief Economist Annual Report 2009 Ever since joining the EU, Greece has faced deficit problems, which in the period averaged around 5.3% of GDP, which is much above the EU average of 2.2% (Graph 1 below). Graph 1 Greek deficit in comparison with the Euro area average, % of GDP In 2009, the Greek fiscal deficit reached 12.7% of GDP, being way too high than the EU prescribed 3%. The main problems of its economy are: a huge public sector, large public spending, unsustainable pension system, and budgetary allocations for military purposes which were all above the European average. All this, together with other problems, led to the total public debt of some EUR 300 billion or 113% of GDP in The new Greek government Source: European Commission, CA calculations has taken numerous measures aimed at overcoming the crisis, including taxation increase, reduction of public spending, issuing of bonds (planned to provide EUR 20 billion for refinancing debts maturing in April and May). It is planned to reduce the fiscal deficit to 8.7% by end-2010 and below 3% by The Greek government adopted the Stability and Growth Programme in which covers the following measures: Abolishing tax relieves Interim introduction of special property tax on high-value property and profitable companies, Temporary increase in taxes on certain products (tobacco, fuel, alcohol), Increase of off-shore company tax, Introduction of new property tax, Introduction of 40% income tax on earnings exceeding EUR 60,000 (previously being EUR 75,000), Reduction of public administration wages, Freezing of public administration employment, Reduction of spending on military and hospital equipment, Cancelling of social compensations during the crisis, Pension reform (increase of the retirement age for additional 2 years as of 2015), Increase of spending on education and investments, Reducing budget of ministries by 10% and the like. The Governor of the Greek National Bank, Mr. George Provopoulos, believes that the country s economy will see a higher fall than the one forecasted by the government (-0.3%) and that the government measures will result in a 2% decline in The Greek crisis has a substantial influence on the European Union s financial system. Therefore, the EU prepared the aid package that will exceed EUR 25 billion and which will be at the Greece s disposal should the government officials communicate the request for assistance. The plan for the upcoming period includes the strengthening of control and regulation measures to prevent similar developments 5 Source: Stability and Growth Programme, Greece, January 2010; CA

21 Real Sector Developments 21 in other Member States running a substantial fiscal deficit, primarily in Portugal (8% of GDP) and Spain (11.2% of GDP in 2009). The solving of the Greek problem is also important for the Balkan countries since Greece was one of the most important investors over the past years, especially in Bulgaria (where Greek banks account for 4 of 10 banks) and Serbia (3 of 10 largest banks) Activities Industrial Output The negative trend from 2008 continued in the reporting 2009, resulting in the industrial output decline of 32.2%. All three sectors recorded production decline, whereby the severest fall was in the mining and quarrying sector, 65.5%, followed by manufacturing industry that saw a 38.6% decline, and the production of electricity, gas and water supply with a 2.4% decrease. Graph 1.4 Industrial output Both mining and quarrying subsectors declined, whereby the mining of energy producing material fell by 43% and the mining and quarrying except energy producing material decreased by 77.6%. Manufacturing industry, which accounted for 69.2% of total industrial production, registered Source: Monstat the annual output decline of 38.6% in Of thirteen industrial subsectors, ten recorded production declines and only in the subsector of manufacturing of machines, devices and apparatus for households there was no production in the reporting year. Increases were recorded in the manufacturing of chemical products and fibres, 42%, and the manufacturing of other machinery and equipment, 9.1%, which together accounted for 5.8% of total industrial production. Although the subsector food products, beverages and tobacco recorded an 11.3% annual decline, some positive movements in this subsector could be expected in Namely, it is obvious that due to the all-year-round production in 2009 (eight months of recording positive monthly rates, with 0.3% in August and up to 33.2% in December) and investments from the Agrobudget for various support programs in food production, this industry will have a greater effect on the movement of total manufacturing industry in Production incentives to be provided from the Agrobudget in 2010 will be based on the National Programme for Food Production and Rural Development in the period , which represents a longstanding budget plan. Through the Law on Agriculture and Rural Development, the country s development policy will also address the issues of strengthening the competitiveness of food producers, a sustainable resources management, and the provision of an ongoing safe food supply, which will significantly affect positive movements in the manufacturing of food products.

22 22 Chief Economist Annual Report 2009 The severest fall recorded the manufacturing of textile and textile products, 86.4%, and the manufacturing of leather and leather products, 60.3%, both of which saw no production for most of the year. Textile industry has been experiencing obvious problems for many years, so its share reduced from a mere 2.4% in 2001 to even lower 1% in Production decline in the manufacturing of basic metals and metal products of 53.5% was due to the problems in the manufacturing of basic metals (-54%), which is in turn the result of the insufficient and unprofitable production of the Aluminium Plant Podgorica (KAP). Numerous factors which affected the situation in KAP (the global crisis, the global aluminium prices, redundancies, high productions costs) have imposed the need to restructure this enterprise with a view to preserving and maintaining production. The Montenegrin Government proposed a Social Programme for KAP Restructuring in April 2009 to cover 2,377 employees (including those employed in the Bauxite Mines Niksic (RBN)) in order to find a solution that would be satisfactory to employees and still financially viable for the company. The Government s commitment implies the saving of KAP and thus avoiding bankruptcy as the worst-case scenario for employees, provided that production is maintained with the optimum expenses and workers, and the latter who are not included in the proposed Social Program to be enabled to exercise their rights arising from redundancies. Other subsectors that also recorded declines are the manufacturing of other non-metal minerals (-42%) and the manufacturing of wood and wood products (-34.4%), which share of 7.8% significantly affected total production. The subsectors: manufacturing industry, n.e.c., the manufacturing of rubber products and plastic masses, the manufacturing of means of transport, and the manufacturing of paper, publishing and printing with their declines ranging between 7.2% and 48.5% nevertheless did not significantly affect either manufacturing or total industry output due to their 1.7% share in total industry (which recorded a 32.2% decline). Graph 1.5 Industrial output by sectors, Ø 2000 = 100 Source: Monstat and CBM calculation

23 Real Sector Developments 23 Box Aluminium industry trends Aluminium industry experienced a gradual recovery in After a substantial decline in the London Metal Exchange in 2008 and reaching the maximum of USD 1,250/tonne in February 2009, the aluminium prices were on an uptrend during most of the year. An average price of aluminium in 2009 amounted to USD 1,665/tonne. The prices of aluminium and all non-ferrous metals were mainly affected by large investments and hedge funds, some banks and larger companies which bought the metals at relatively low prices, expecting their increase in the years to come to make profit by their resale. Therefore, the prices increase in 2009 was mainly the result of speculative purchases. In addition, demand was positively affected by incentive measures taken by governments in order to help companies, but the demand remains lower than in the pre-crisis period (10%-20%, on average, depending on the region). European smelters (EU countries) which annually produce 4 million tonnes of primary aluminium reduced their production by 18% in At the beginning of 2010, demand for metals has begun increasing in the USA and Europe, in addition to China where it has reached its record high. Producers have increased their production due to increased demands for the second and third quarter, and it is expected to reach 38 million tonnes in 2010 (36 million tonnes in 2009). This increase affected the increase in premiums (surcharge to LME price which buyers pay to producers) which reached USD 135 to USD 145 in February and March 2010, respectively, above the LME cash price, with paid customs duties. Graph 1 LME aluminium prices and supply Source: LME, MBCNY Research Besides the aluminium prices, aluminium supplies also increased, which represents a certain paradox. Aluminium supplies amounted to some 4.6 million tonnes, which is a record high and even five times higher than in the precrisis period. The movement of prices and supplies at the LME is shown in Graph 1. This paradox of rising aluminium prices in parallel with the growing supplies over most of 2009 occurred due to the fact that almost 70% of the supplies were under forwardselling contracts. However, most of these supplies cannot be withdrawn by May Besides the registered supplies, there are also supplies in producers` warehouses, around 1.2 million tonnes, as well as the Chinese supplies of some 2 million tonnes that could be marketed at any time should the aluminium price upsurge. On top of this, some 5 million of closed capacities (12%-13% of the global production) have been waiting for the restarting of operations once the market is stabilized and the aluminium price increases further.

24 24 Chief Economist Annual Report 2009 As for the production of electricity, gas and water supply, which accounted for 23.3% of total production, registered a 2.4% annual decline in Production increase was recorded in January (39.1%), February (3.4%), November (48.6%), December (34.7%), and the ten-time higher monthly increase was recorded in October (1,025.8%). The reason for such an extremely high monthly production in October is the low September base and the restarted production of HPP Perucica after more than two months of break due to the regular annual repairs. Numerous projects were finished in 2009 such as the reconstruction and modernization of TPP Pljevlja, voluminous construction works in HPP Perucica, and initiated modernization of HPP Piva. After the reconstruction, TPP Pljevlja is expected to increase its production by some 40% in the upcoming period. The year 2009 was marked by the recapitalization of the Electric Power Company of Montenegro (EPCG), whereby its strategic partner (Italian A2A company), in order to purchase shares and recapitalize EPCG, invested EUR 430 million, of which EUR 96 million were in EPCG. The contract which allows A2A to manage the company also provides for activities on achieving certain operating and investment indicators (reliability and strength of production facilities, mounting of the eighth generating unit in HPP Perucica, GHG emission, and the like). The achievement of these would make EPCG a modern company, recognizable in the region. In December 2009, the project Year of Energy Efficiency was completed. It consisted of 17 concrete programs, which implementation represented one of the main objectives with regard to energy sector. Since energy efficiency is an important segment in all strategic energy documents in the country, further activities will be carried out in 2010 through the project Energy Efficiency in Montenegro to be funded from the World Bank loan (EUR 6.5 million in the following three years). The project envisages energy efficiency improvement in educational and health care institutions, as well as raising the public awareness of energy efficiency measures. As per the Energy Development Strategy of Montenegro by 2025 and the pertinent Action Plan, further energy-related activities will involve capital projects such as the construction of HPP on the Moraca river, HPP Komarnica, and the Project of small HPP construction. The Public Call for Prequalification for Granting Concession for the Exploitation of Watercourses and the Construction of Small Hydropower Plants was announced in September 2009 and qualified bidders may submit their offers with project designs by 25 March In addition, a public invitation was announced for the selection of investors for the construction of wind farms. Box 1.5 Global electricity generation and renewable energy sources According to the International Energy Outlook 2009, it is estimated that total global electricity generation will increase at an average rate of 2.4% in the period It is expected that the current recession would lower electricity demand in the near future, but the projection from the reference study does not envisage the continuation of the recession and already in 2010 it is expected that electricity demand will increase. The recession effects on electricity consumption was mostly felt in industry, due to the slowing down of production which in turn resulted from lower demand for industrial products. On the other hand, the household sector showed to be less prone to economic changes since, in general, it continues with electricity consumption even in such circumstances.

25 Real Sector Developments 25 Renewable energy sources are the fastest growing sources of electricity generation. According to the IEO 2009, total production from renewable energy sources has been growing at an average annual rate of 2.9% and its share in total global generation will rise from 19% in 2006 to 21% in The highest growth is expected in hydroelectricity and wind energy, as presented in Graph 1 below. Globally, society development directly depends on sufficient energy production, especially electricity, and country policies are, for the most part, the main instigators to advocate the construction of renewable energy producers. Observed in the long term, Montenegro also faces the lack of electric power, regardless of the sufficient production capacity. The encouraging fact is that the Energy Development Strategy of Montenegro by 2025 envisages the construction of small hydropower plants, in addition to big hydropower plants and thermal power plants, as well as the exploitation of wind energy, bioenergy, and solar energy. The five-year action plan for the Strategy implementation ( ) foresees the construction of wind farms in Montenegro, which is the first step in the implementation of the Program of renewable energy development wind energy exploitation. By accepting the EU Energy Policy, and as stated in the Strategy, one of the strategic commitments is the taking of decisive measures to sustain the use of RES of at least 20% of total primary energy consumption. Graph 1 World Renewable Electricity Generation by Source, (Trillion Kilowatt hours) Source: Energy Information Administration (EIA), Projections EIA, World Energy Projection Plus (2009)

26 26 Chief Economist Annual Report 2009 Graph 1.6 Industrial output linear trend The year 2009 proved to be extremely critical with regard to industrial production. Graph 1.6 shows that instead of a linear positive trend, which had been present as of the beginning of 2008, industrial output became non-linear and started trending downward (especially as of April 2009) Tourism Source: Monstat and CBM calculation Graph 1.7 Tourist arrivals A dynamic uptrend in tourism industry over the past years slowed down considerably in 2009, particularly in the first six months of the year, due to the negative global trends. Positive statistical indicators in July and August mitigated the negative trend existing in the first half of the year, resulting in 1,207.7 thousand tourist in 2009, which is 1.6% more than in the previous year. Foreign tourist arrivals rose by 1.2%, whereas domestic tourist arrivals increased by 4.3%. Tourist overnights declined by 3.1%. 6 Same as in the previous years, most tourist visits were to seaside resorts, 86.6% of total tourist arrivals, which is 0.5 percentage points more than in Tourist visits to mountain resorts increased by 0.2%, whereas visits to the main administrative centre and other tourist locations respectively declined by 0.2% and 0.5%. Source: Monstat Some 7.55 million tourist overnights were recorded in 2009, which is 3.1% less than in the previous year. Of this number, 95.9% refers to seaside resorts, 1.3% to mountain resorts, and 1.4% to each of the main administrative centre and other tourist locations. It is important to note that there was a 3.9% increase in the EU tourist overnights and they accounted for 21.3% of total tourist overnights in There was an increase in overnights by tourists coming from Italy (by 49.3%), Poland (44.6%), France (35.4%), Bulgaria (26.3%), Albania (24.6%), Russia (17.8%), Hungary (9.4%), Slovenia (7%), and the highest increase recorded tourists from Romania (141.5%), Luxembourg (eight times more), and Portugal (over twenty times more than in 2008). Less overnights recorded tourists who came from Austria (-43.7%), 6 However, the possibility that the fall was even higher than that statistically recorded cannot be excluded because those that were most severely hit were private accommodation services which are traditionally dominated by shadow economy, meaning that tourist stays are not reported to the relevant authority.

27 Real Sector Developments 27 Germany (-19.9%), Norway (-27.7%), Ukraine and Belarus (some -50%), and the Baltic countries (-34.3% on average). Graph 1.8 EU - 25 tourist overnights The Ministry of Tourism and the National Tourism Organisation of Montenegro carried out numerous activities to implement priority tasks set out in the Tourism Development Strategy of Montenegro, which imply the carrying out of projects to contribute to the tourist offer diversification, extending tourist seasons and the valorisation of the existing potentials in line with the principles of sustainable development. Promotion activities in the region continued during the summer tourist season with the opening of two new representative offices in Belgrade and Sarajevo. However, the crisis directly reflected on restricted allocations for travel and thus resulted in fewer tourist arrivals from the neighbouring Serbia (-17.9%) and Croatia (-15.8), whereas tourist arrivals from Bosnia and Herzegovina increased by 3.2%. However, tourists from all three emitting markets recorded fewer overnights. Source: Monstat Graph 1.9 Structure of tourist arrivals by resorts in 2009, in % Same as in the previous years, representatives of the Ministry of Tourism and the National Tourist Organisation participated in all significant tourist bourses and manifestations aiming to promote tourism offers. The most important were the World Travel Market in London, whereat Montenegro tourism offer was presented with the emphasis on sustainable tourism and promotion of MICE and wellness hotel offers. In October Source: Monstat 2009, Montenegro had its first tourism offer presentation at the Adventure Travel World Summit (ATWS) in Quebec which was also attended by the leading North American tour operators for adventure travel and specialised researchers of sustainable, natural and cultural travel.

28 28 Chief Economist Annual Report 2009 Table 1.2 Montenegro tourist offer presentations in 2009 Event Ferien-Vienna Conventa - Ljubljana Holiday World- Prague Metubes-Budva BIT-Milan IFT-Belgrade Reisepavillon-Munich ITB-Berlin MITT-Moscow Cityscape Abu Dhabi Travel fair - Priština IMEX Frankfurt am Main RDA- Cologne, Germany Top Resa - Paris ATWS Quebec, Canada WTM - London EIBTM-Barcelona Date January January 5-8 February February February 26 February -1 March 26. February -2 March March March April 6-8 May May 4-6 August September October 9-12 November 1-3 December Source: Ministry of Tourism Box 1.6 Tourism achievements, global and regional trends, with the emphasis on European tourism (as compared with GDP movements) It seems that the Global economic crisis, accompanied by the uncertainties regarding the H1N1 pandemic, will be one of the severest crises to hit tourism. However, indicators in the last few months of 2009 show that although slow, the recovery of this industry was on the way. They showed recovery in GDP trends, whereas tourism industry recuperation is not expected before Positive tourism trend in 2010 is very important as this industry is seen by some analysts as the catalyst for economic recovery. Graph 1 Tourism and travel in global: growth of indicators in % for Source: IMF, Euromonitor International Note: arrivals physical indicator, other value indicator

29 Real Sector Developments 29 Positive indicators recorded in QIV 2009 point to the global tourism recovery, as stated in the latest UNWTO issue World Tourism Barometer". It is projected that tourist arrivals will rise in 2010 somewhere between 3% and 4%, whereas the estimated decline in 2009 is set at 4% at the global level. Indicators and experiences have shown that tourism revenues accompany tourist arrivals, so the available data for the first three quarters of 2009 indicate the annual decline of around 6%. As for tourist arrivals, the available UNWTO data for 2009 show that almost all regions recorded negative trends, except Africa, so it is estimated that: Europe ended 2009 with a 6% decline after a sharp fall in the first half of the year (-10%). Central, Eastern and Northern Europe were hit by the crisis to a somewhat greater extent, whereas Western and South Europe and the Mediterranean recorded better results; Asia and the Pacific with -2% showed a remarkable recovery after the negative trend in the first half of the year of -7%; America recorded a 5% fall, with the estimated growth in 2010 between 2% and 4%; The Middle East saw a 6% decline, although a positive trend was recorded in the second half of the year. Graph 2 International tourist arrivals and overnights in European destinations, year to date 2009* (% change on same periods in 2008) *Jan-Sep, Jan-Oct or Jan Nov measures used by the individual destinations vary Source: European Travel Commission European Tourism 2009 Trends & Prospects (Quarterly Report Q4/2009) The UNWTO assessments show that Europe recorded a fall in tourist arrivals in all four quarters, which makes it the region with the worst results to be achieved in The estimated decline of 1.1% in QIV is also its best result in 2009, especially when falls in the first three quarters amounted to 13.2%, 7.7% and 3.1%, respectively. Only few European countries recorded increases in tourist arrivals, while a decline registered in most European countries ranged between 5% and 12%, and Ireland, Lithuania, Latvia, Romania and Slovakia saw tourist arrival declines from 15% to 25%. Considering such negative trends Europewide, Montenegro s data do not seem to be of concern (a higher number of tourist arrivals and a decline in tourist overnights), especially since 2009 was the hardest year for tourism industry in general. Forecasts for 2010 tourism season are very moderate considering the global economic trends (with the recession in progress) which reflected on the entire Montenegrin economy. As tourism trends and economic, socio-demographic, climate and other changes have a great effect on tourism, this calls for ongoing adjustments in advertising and sales policies to address tourism market demands and turbulences. Montenegro can be

30 30 Chief Economist Annual Report 2009 rather satisfied with certain statistical indicators for the 2009 tourism season. Namely, the latest UNWTO estimates show that tourist arrivals declined at the global level by 4%, whereas Montenegro recorded an increase of 1.6%. With a view to raising the quality of services, in line with the Human Resources Development Strategy in the Tourism Sector, activities in 2009 involved the improvement of professional know-how, that is, the connection of the tourism industry and educational institutions. Projects were carried out in cooperation with various donors (USAID, ADA, GTZ, UNDP, SNV and others) to enable the creation of conditions for a further strengthening of Montenegro s tourism offer, such as the development of agrotourism, health and wellness, cultural tourism, better statistical data processing and the like. A significant cooperation was established with the Italian Government which supported the production of strategic documents and concrete projects for tourism development in the municipalities of Kolašin and Zabljak, and in Perast, then the construction of the first eco-building in Montenegro, and the like. In addition, the cooperation with the NGO sector resulted in 40 tourism projects, that is, the co-funding of these projects with EUR 44,500. The preparation for the tourist season also involved the improvement of public utility and road infrastructure. Substantial funds were invested, over EUR 27 million in road infrastructure and over EUR 6 million in airport infrastructure. The transmission and distribution systems were improved, being supported with over EUR 4 million. Border crossings infrastructure was also improved and delays thereat have reduced. However, the usual weaknesses were noticed during the tourist season such as the share of grey economy, sanitation remaining insufficient, the problem of noise in tourist places, and insufficient traffic safety. It is important to note that the liberated visa regime for the citizens of Montenegro, Serbia and FYR Macedonia represents a great challenge for the Montenegrin tourism industry. This accentuates the need for better quality of services to be provided to domestic tourists as they could look for cheaper foreign tourist destinations. Table 1.3 Rankings of selected countries in travel & tourism competitiveness index Country travel&tourism competitiveness rating changes 2009/2008 Cyprus Malta Croatia Slovenia Slovakia Bulgaria Montenegro Turkey Romania Serbia Albania Source: WEF (World Economic Forum) 2009 In addition to problems encountered in 2009, Montenegro s tourism managed to improve its competition index and move up seven places in the ranking covering 133 countries. The Travel & Tourism Competitiveness Index consists of three subindices with 14 pillars (regulatory framework, environmental regulation, health and hygiene, tourism infrastructure, air transport infrastructure, price competitiveness, human resources, safety and security, and the like) and it was introduced as the measure of factors and policies affecting travel and tourism developments in various countries. With the competition index 4.29 in 2009, Montenegro was ranked ahead of Turkey and Bulgaria, and the same as a year before, ahead of Serbia, Romania and Albania, as presented in Table 1.3.

31 Real Sector Developments Forestry Forestry output in 2009 amounted to 216,546 m³ of wood products, which is 23% less than in the previous year. Comprehensive preparations were made with a view to improving the condition in forestry, including the implementation of provisions harmonized with the EU legislation. Reforms were continued in the form of numerous projects aimed at enabling Montenegro to harmonize its legislation, economy and society with European standards. The carried out project of the National Forest Registry is significant as it provides the latest data on the national forest resources and better knowledge of habitats, biodiversity and their condition in the country. The FODEMO project activities include the support to the project Planning of forest management at the local level which is being carried out in the municipality of Mojkovac. The National Forestry Programme implementation resulted in the cooperation with the Dutch Development Organisation on the drafting of the new Forest law. A MoU was signed for the period March 2009 August 2010, and it proposes the Concept of Improved Forest Management Planning for private forests and a modern twinning project Integrated Forest Development Planning and Management in Graph 1.10 Production of forests assortments Source: Monstat Montenegro. The National action plan was adopted to combat unlawful activities in forestry as the response of the state institutions, civil society and other stakeholders to put an end or minimize negative effects representing a threat to the entire forestry sector reform. To that end, the project Green Phone for Green Forests was implemented, financially supported by the U.S. Embassy in Podgorica, which aims at raising the awareness and involvement of the citizens in reporting and solving the problem of illegal tree cutting and forest fires. Box 1.7 International forestry projects carried out in 2009 FODEMO project Forest Development in Montenegro - Lux Development Luxembourg Nature-based tourism, Norwegian Forest Group (NFG) - Norway Technical support provided by the Dutch Development Organisation (SNV) - the Netherlands Geographic information system (GIS) UNDP, Finland Project focusing on combating illegal tree cutting:

32 32 Chief Economist Annual Report Project to develop and implement the National Action Plans to improve forest management and control of illegal cutting in European and North Asian countries ECA, World Bank 2. Project Green Phone for Green Forests the US Embassy in Montenegro Construction Monstat records show that the total value of performed construction work in 2009 amounted to EUR million, being 21.5% lower than in the previous year, and if measured by effective working hours, it declined by 19.2%. The value of new building construction contracts amounted to EUR 46.8 million, which is 45% less than in 2008, and the value of other new construction contracts was EUR 94.4 million or 24.2% less than in the previous year. Lower economic activity and reduced investments reflected on construction activities which has begun in QIV 2008 and continued during the entire reporting year Drafting of the Construction Development Strategy of Montenegro by 2020 was initiated in 2008 to incorporate positive global, European and regional experiences based on sustainable development and sustainable construction principles. The Strategy itself is based on documentation cover the applicable laws and secondary legislation, the existing strategic documents, programs and plans, as well as the results of the conducted surveys on the construction-specific areas that have not been covered in the aforesaid documents. After consulting and incorporating all the relevant and professionally acceptable objections, comments and opinions, a new version of the draft document titled Proposed Construction Development Strategy of Montenegro by 2020 was prepared in November Graph 1.11 Construction Source: Monstat

33 Real Sector Developments 33 Box 1.8 Construction Development Strategy of Montenegro by 2020 Considering the importance of construction and its share in total GDP of 4.6% (the past four-year average) and its multiplication effects on other related activities, it became obvious that this sector required a strategic approach. Seven strategic commitments covered in the Strategy define the entire issue of construction activity in Montenegro, the analysis of which will serve for the development of action plans for the development of this activity by The main strategic commitments are: Montenegro s integration into the EU and sustainable development construction development is implied as an integral part of the EU integration process and sustainable development, Legal and institutional framework as the pillar of construction development starting point for other numerous actions to define the procedures, criteria and well-capacitated institutional framework, Technical regulations as the basis for the construction quality system ten Eurocodes to be implemented and enforced, as well as the transposition of other EU directives governing construction materials, energy efficiency, geotechnics and the like into the national legislation, Capital investments continuity - implementation of individual macroeconomic policy objectives is closely connected with the construction activity and the construction industry, Strengthening of competitiveness of the construction companies should seek to use the maximum human and material resources, with an ongoing monitoring and accepting of development achievements in science, practice and technology, Formation of the appropriate labour force structure in construction both number and quality deficits in the domestic construction labour force is evident, and Development of construction material industry to be based on the principles of sustainable development the main base of construction represents construction materials and their use should be subjected to sustainability treatment as soon as possible Transportation Monstat data show that road passenger transport recorded a 17.4% decline in 209, whereas road cargo transport increased by 30.8%. Representatives of the Montenegrin Government and the Croatian Consortium Konstruktor signed the concession award agreement in June for the construction of the highway Bar Boljare. However, since the consortium had failed to provide the necessary guarantees, preliminary negotiations were held with representatives of the Greek-Israeli Consortium Shikun&Binui Aktor Concessions. The aim of negotiations was to ensure the funding of the state of Montenegro to the least possible extent and ensure the scheduled milestones regardless of whether the highway would be constructed by the Croatian or the Greek-Israeli consortium. The construction of the first highway section Smokovac - Matesevo is planned in spring Passenger and cargo transport via railways respectively declined by 20.6% (measured in passenger kilometres) and 45.3% (measured in tonne-kilometres). Such a severe cargo transport decline was due to lower economic activity of big clients of the railways, such as KAP, Bauxite Mines, Steelworks Niksic and companies from Serbia (US Steel Serbia and MSK Kikinda).

34 34 Chief Economist Annual Report 2009 Graph 1.12 Road passenger transport Source: Monstat Graph 1.13 Air passenger transport The strategy for the restructuring of the Railways of Montenegro provided for the disintegration restructuring model which legally unbundled the company into Railway Infrastructure and Railway Transport. After the separation of the infrastructure from the operational activities, the two new shareholding companies continued as per individually established programmes. The EBRD provided a new EUR 15 million worth loan in December 2009 for the modernization of the railway network in Montenegro. The loan will be available to Railway Infrastructure to be used for the repair of the 57-kolometre long railroad track between Niksic and Podgorica. This should contribute to the increasing of the railway safety and the furthering of railway reforms. The loan will ensure the completion of the railroad track Podgorica-Niksic, which will contribute to the overall development of the country. Air passenger transport totalled 956 thousand passengers, which is 13.8% less than in This type of transport has a distinct seasonal component resulting in more flights during the summer tourist season, so the highest number of passengers transported was in the period June September (146,511 being a monthly average). Air freight transport decreased in the reporting year by 1.1%. Source: Monstat Montenegro Airlines fleet was supported with one more Embraer 195 airplane, the second of its kind in the company s fleet. At the beginning of the tourist season, the company introduced more flight connections with cities in the region and numerous European cities (Skopje, Pristine, Nis, Düsseldorf, and Copenhagen). The expanding of the general aviation platform at Tivat Airport substantially increased the airport s possibilities. The entire investment valued EUR 2.5 million. However, in order to achieve an accelerated tourism development, Montenegro should accept low-cost companies, primarily from destinations which are not covered by the domestic airliner.

35 Real Sector Developments 35 Maritime cargo transport (measured in tonne/miles) reduced by 22.7% in comparison with Total turnover in ports amounted to EUR 1,481.1 thousand tonnes, which is 24% less than a year ago. Of total turnover, 41.4% referred to exports (10.3% decline) and 56% to imports (32% decline) Prices After the high inflation rates recorded in two years preceding the reporting year, CPI inflation in 2009 amounted to 1.5%, and the year-on-year decrease was 5.4 percentage points. Lower inflation rate resulted from the decline in prices of the majority of food products, consumer goods, as well as the decrease in electricity prices in July Food prices, which in the period of over 30 years reached their peaks at international markets in mid-2008 (Food and Agriculture Organization Report - FAO), and recorded a decline in This decline caused lower inflation rates in most of the countries. For example, the annual inflation rate in the Euro area amounted to 0.9%, while food category recorded the largest decline (-1.3%), which together with categories housing (-0.3%) and communications (-0.8%) set off the increase in the prices of alcoholic beverages and tobacco by 4.8% and transport by 3.5%. From the beginning of the year, the annual inflation rate in Montenegro had a declining trend, with slight oscillations in August and November (Graph 15). In January, inflation amounted to 4.9%, in March it was 5.5% which represented at the same time the highest inter-annual growth in In June it was 2.8%, while at year-end it declined to 1.5%, which was the same inflation amount from 2004, but measured by the cost of living. The prices in category food and non-alcoholic beverages recorded zero (more precisely -0.05%) rate at the annual level. Within this category, the year-on-year oil and fats prices declined by 21.5%, vegetables by 5.5%, fruits by 3.8% and non-alcoholic beverages by 2.3%. The prices of meet increased by 3%, those of milk, cheese and eggs by 1.8%, while the prices of other food products did not change substantially over the same period. The prices of alcoholic beverages and tobacco grew by 7.8%, which resulted from the increase in excise duties on cigarettes and other tobacco products. Although category housing recorded an increase in prices of water supply and other services by 11.9%, the prices from this group recorded a decline of 0.3% mostly due to the decline in the electricity price by 2.8%,. The same decline of 0.3% was recorded by the prices under the category culture and entertainment. The lowest decrease was recorded in the category clothes and footwear (0.15), while home appliances recorded the highest decline (-6.8%). This decline resulted from the decline in the prices of furniture and appliances by 13.8% and housing devices by 5.9%. The prices under transportation category grew by 12.6%, mostly due to an increase in the prices of liquid fuels and lubricants by 16.3%. This increase, together with 15-day adjustment of prices, is the result of an increase in excise duties on mineral fuels (leaded and unleaded fuels and gas oils used as motor fuels). In addition, prices of communications increased by 5.2%, due to the growth in postal services prices (packages and telegrams). Growth in the prices under category restaurants and hotels (15.9%) is not realistic since it represents only an increase in the prices of accommodation in student dormitories.

36 36 Chief Economist Annual Report 2009 The annual core inflation rate in December amounted to 0.04% and it was 1.42 percentage points lower than the total annual inflation rate. Core inflation continuously declined over the year, with slight oscillations. It ranged from 5.69% (in January), over 4% (in June) to 0.04% (in December). Due to the cooling off of prices included in core inflation, and an increase in the prices of some of the excluded products (housing public utility services, tobacco, fuels and the like), core inflation significantly declined in relation to total inflation (Graph 1.14). Core inflation in 2008 was Graph 1.14 Rate of consumer prices and core inflation higher than total inflation by 0.76 percentage points. It must be taken into consideration that core inflation in 2008 was calculated based on the cost of living basket, since there was no detailed content of the of the consumer prices basket, except for the basic categories of products. Source: Monstat and CBM calculation Graph 1.15 Consumer prices Observed at the monthly level, consumer prices recorded the highest growth in February (0.7%), March (0.4%) and April (0.6%), while the highest decline was recorded in July (-0.6%), June and September (-0.3%). The lower prices of vegetables by 14% on average, contributed to lower monthly rate in June and July Observed at the annual level, these prices influenced lower inflation rate due to their negative share -21%. Due to the negative share of fruits and vegetables and oil and fats of -20.3%, food and non-alcoholic beverages recorded a negative share of 1.3%. Prices of transportation accounted for 1.2% in total inflation, which recorded a share of 78.5% due to an increase in the prices of fuel. A high share of the communications (21.4%) and alcoholic beverages and tobacco (23.5%) was set off by the negative share of categories which influenced total inflation with their weighting structure (71.83%). Certain categories in Table 1.4 recorded a share in total inflation but not the contribution as well, due to their small percentage changes (or small weights), thus the column contribution shows data only at the third decimal. Source: Monstat

37 Real Sector Developments 37 Table 1.4 Share of price movements of certain product categories in total inflation Weights XII 09/XII XII 08 Rate Contribution Share in total inflation TOTAL Food and non-alcoholic beverages Alcoholic beverages and tobacco Clothes and footwear Housing Home appliances and devices Health Transportation Communications Culture and entertainment Education Restaurants and hotels Other goods and services Source: Monstat and CBM calculations Box Inflation in Montenegro Important Components The prices of food products exerted a strong pressure on total inflation movement in the previous period. At the beginning of 2008, the core inflation, excluding agricultural products and administratively regulated products, contributed to 1.62% in total inflation, agricultural products contributed with 2.18%, while regulated and partially regulated products contributed to 4.08% in total inflation. At end-2008, this ratio significantly Graph 1 Contribution to annual inflation, % changed in favour of core inflation due to an increase in the prices of almost all food and other related products. Therefore, the contribution of the core inflation amounted to 5.15%, agricultural and other related products -0.12% and 2.2%, respectively. Contribution of these three components in total inflation changed along with the gradual decline in food prices. The core inflation with 3.59%, agricultural products (-0.2%) and other excluded products (1.51%) recorded the highest contribution to the January rate of 4.9%. In

38 38 Chief Economist Annual Report 2009 December 2009, core inflation contributed a mere 0.03% to total inflation. Regulated and partially regulated prices increased by 1.56%, due to the growth of tobacco product prices, fuels and housing and public utility prices in Due to its weight (63.2%) and the low annual rate (0.04%), as well as due to the decline in agricultural product prices (-2.07%), core inflation accounted for 1.92% of total annual inflation rate of 1.5%. It is worth mentioning that 2008 components were based on the basket of cost of living products, while 2009 components were based on consumer prices basket. The prices of liquid fuels and lubricants, which were mostly affected by the changes in the global oil prices, recorded the annual growth of 16.3%. A decline and/or growth in the liquid fuels and lubricant prices in Montenegro generally followed the movement of Graph 1.16 Oil prices, monthly growth rate Source: Monstat and Montly Oil Market Reports, OPEC oil prices in the world markets (Graph 1.16). Since the beginning of 2009, the global oil price, with slight oscillations, and in November the price of reference basket reached its highest level of USD/barrel. The average price of reference basket in 2009 was 61 USD/barrel, showing the yearon-year decline of 35.3%. The average price of the Brent in December 2009 amounted to USD/ barrel showing a year-on-year decline of 84.1%. The weak U.S. economy and the economies of leading industrial countries were some of the factors that influenced the decline in the oil price in 2009 which reflected on decreased demand for this product. The past year can be characterized as one of the worst regarding the world s demand for oil. Announcement of the economic recovery could positively affect oil demand. Box 1.10 Inflation: Comparison with regional countries, EMU and EU27 Year-on-year inflation had a significant declining trend in majority countries. Table 1 shows data only for some regional countries as well as data for EU 27 countries and Euro area countries. Generally speaking, the component food and non-alcoholic beverages significantly declined in relation to the previous year. The decline in prices of this category was 1.3% in Euro area, 1.2% in Slovenia, 1.8% in Croatia, 3.1% in Bosnia and Herzegovina, 3.4% in FYR Macedonia, (0.0%) in Montenegro, (-3.3%) in Bulgaria, while the increase in prices was reported in Serbia (0.8%), in Romania (0.4%) and in Albania even 6.8%. In 2009, the following three main categories affected the inflation: food and non-alcoholic beverages, alcoholic beverages and tobacco, and transport. Oil prices at global markets influenced mostly on the prices from the last category. Graph 1 shows category alcoholic beverages and tobacco that ranges from 3.3% in FRY Macedonia to 17.3 % in Bosnia and Herzegovina, while category transport was negative only in FYR Macedonia (-7.9%).A substantial growth of the selected components in relation to total inflation was reported in other selected countries.

39 Real Sector Developments 39 Table. 1 Annual inflation rate Countries XII 08/ XII 07 XII 09/XII 08 Bulgaria Serbia Montenegro Romania Albania Croatia FYR Macedonia Slovenia Bosnia and Herzegovina EU EMU- Euro area Source: Statistical Offices and Eurostat Graph 1 Annual change in selected components (December 2009) Source: Statistical Offices and Eurostat

40 40 Chief Economist Annual Report 2009 Graph 1.17 Producers price for industrial products Source: Monstat The producers` prices of manufactured products decreased 3.4% in Observed per months, a decline exceeding 1% was recorded in January (-1.2%), in March (-1.6%), in June (-1.1%) and in July (-1.4%). A decline in prices in January resulted from lower producers` prices in the mining and quarrying industry (-1.5%) and manufacturing industry (-1.6%). Lower prices in March and June were recorded due to a decline in prices in manufacturing industry, and a decline in prices in the mining and quarrying industry in June, while a decline in prices in all three sectors contributed to a decline in the prices in July. A decline in the producers prices at annual basis was influenced by prices of all three sectors, whereby producers prices in the mining and quarrying sector decreased by 1.6%, those in electricity, gas and water production decreased by 2.7% and the prices in manufacturing industry decreased by 3.8%. An average decline in producers prices of manufactured products in 2009 amounted to 3.9% Inflation forecast for 2010 Montenegro s inflation fan chart represents a graph of probability distribution of inflation rate presented by the retail price index (RPIMN 7 ). In that respect, instead of determining specific points, the fan chart also takes into account potential risks and uncertainties through probability distribution that might influence inflation movement in the following period. The fan chart is aimed at considering uncertainties in the real economy flows, which result in the inflation rate movement (increase in the prices of energy products, increase/ decrease in the foreign trade deficit). Montenegro s fan chart for 2010 was based on the following three evaluated components: 1. Central projection values were derived from ARIMA model and used Tramo/Seats simulation for the purpose of obtaining more efficient model. 2. Degree of uncertainty determines the fan chart width. The degree of uncertainty ratio is obtained through analytical assessment and calculation of a relative impact of potential internal (expected increase in prices of electric energy) and external shocks (movement in oil prices) which are possible in Montenegrin economy during Fan chart skewedness based on the level of skewedness of the distribution of inflation projection, the fan chart is adjusted to the forecast. In that way it shows whether the values of the central projections overestimated or underestimated inflation rates. This will also influence the position of the mean value of inflation distribution. 7 Consumer Price Index

41 Real Sector Developments 41 Fan Chart central projection - ARIMA model for 2010 With a view to developing a fan chart, an ARIMA (AutoRegressive Integrated Moving Average) model was developed of time series of inflation of Montenegro showed through the Consumer Price Index 8. ARIMA model was used for short term forecasts (10 months 2010), whereby iteration of 382 ARIMA models was made, which were ranked based on their efficiency and quality of diagnostics. The selected ARIMA model, ARIMA (5, 1, 5) 9 has sufficient confidence level for forecasts. Consumer price index time series was used for the first time for forecasts, which will represent the basis for inflation projections in the future. Based on Tramo/Seats 10 procedure, 4 bands (Chow Test was used for identification) have been identified so far, which correspond to a significant change in inflation structure from 2001 to 2009 and which are included in the ARIMA model through dummy variable. Result of the projection of ARIMA model was compared with the projected values of Tramo/Seats procedure that showed a significant compatibility level. The projection values on monthly basis were used for the values of Fan Chart central projections of CPI for Obtained values represented distribution mode, i.e., valued with the highest distribution frequency of this time series. Mean value of the obtained model was 3.1, while skewedness varied from 1.26 and 1.86, and standard deviation values were σ2=1.43 and/or σ1=0.29. This pointed out that central band in the last two years was placed in lower part of distribution, i.e. the corresponding degree of uncertainty was concentrated towards higher inflation levels, which is reflected in the graph through thicker band concentrated above central the deepest shade of blue band. 8 More detail explanation of ARIMA model of Montenegro was presented in the Central Bank Working Papers 11 Inflation forecasting: Empirical research of retail price index of Montenegro for 2007 implementation of ARIMA model, Moreover, although CBM follows as main indicators of prices the cost of living index, i.e. CPI (Consumer Price Index), the inflation projection is based on retail price index from two reasons. Firstly, the cost of living index in period prior to its upgrading in 2006, has a set of values with negative sign, which hinders the projection that is performed in dlog form due to non stationary of series. Secondly, CPI index has too short series for creation of model. 9 ARIMA Model s is generally referred to as an ARIMA (p,d,q) where p represents the number of autoregressive variables, d refers to the level of dependent variable that needs to be made stationary, and q is the number of variables, moving averages, in the certain model. 10 Tramo programme represents a programme for evaluation and projection of models (mostly ARIMA), which have problems with missing data, errors in data and the existence of large number of extreme data in time series. SEATS programme is used to extract time series elements that cannot be directly separated, separating elements such as trend, season, cycle, existence of Easter and Christmas effect, which enables better analysis and projection of ARIMA model. (For more details, see Handbook Tramo and Seats (Gómez and. Maravall, 1996).

42 42 Chief Economist Annual Report 2009 Graph 1.18 CPI projections of Montenegro for 2010 Source: Monstat Fan chart explained (presented) 90% of probability distribution of inflation. The central projection is usually placed in the deepest shade of Fan Chart, or central 10% of probability. 11 The fan chart has an equal number of bands (eight) on either side of the central band whereby every band has different colours, both above and below the central band, cumulatively takes the inflation projection to the next 10% of probability. As the degree of uncertainty grows over time, the fan chart spreads. Montenegro s inflation fan chart, based on the ARIMA model projection and Tramo/Seats simulation for 2010, shows, with a 90% probability that CPI inflation will vary from -0.1% to 2.3%, depending on months. To wit, as time horizon for making projections grows, uncertainty will also grow which will impact on the spread of the forecast span. The fan chart central projection that refers to its deepest shade, represents probability span of 10% and anticipates that the inflation in 2010, measured by the consumer price index, will vary from 0%-1.7% depending on the forecasting month. 11 Values of model (central projection) are usually found in the darkest shade of the band. However, if substantial risk exists, the central projection is not likely to encompass any of these values. (Britton, E, Fisher, P.G. and Whitley, J.D. (1998), The Inflation Report projections: Understanding the Fan Chart, Bank of England, Quarterly Bulletin, 38, pp ).

43 Real Sector Developments 43 In accordance with the model forecasts, a low level of inflation by the end of the current year is expected, particularly in the first six months. It is primarily due to decelerated economic growth, a fall in aggregate demand, unemployment growth, stagnation of real salaries and available income. External assumptions that have been taken into account when calculating the degree of uncertainty were based on the following statistical approach: 1. Oil and oil derivative prices do not exceed +15% of the prices as of December 2009; 2. Aluminium prices do not fall more than 10% below the price from June 2009; 3. Real estate prices do not fall more than 7% as compared to the last quarter of Real salaries growth is 2%; 5. Global economic growth in 2010 remains on the level projected by the IMF in October 2009; No significant corrections in taxes and excise duties will occur; 7. Income from tourism does not fall more than 10% in relation to 2009; The model forecast indicates, with probability of 90%, that the inflation rate will vary from -0.1% to 2.3% in this year. Our expert estimation is very similar to model assumption, but it gives a somewhat higher forecast of the inflation rate since the improvement of economic environment is expected in the second half of the current year. In that respect, inflation ranging between 1% and 4% may be expected. Table 1.5 Inflation rate estimation Optimistic estimation Realistic estimation Pessimistic estimation 1% 2.5% 4% 1.4. Labour Market In 2009, the number of employees amounted to , on average, and the year-on-year increase was 4.8%. The total number of employees amounted to at 2009 year-end, representing the year-on-year increase of 0.4%. The highest growth in the number of employees was recorded in the following sectors: real estate activities 30.6%, hotels and restaurants 13.9%, wholesale and retail trade and repair 13.4%, construction 13.2%, other utility, social and personal services 9.9%, transport and warehousing 8.3%, financial intermediation 7.8%, agriculture, forestry and water management 1.9%, state administration and social security 1.2% and education 0.8%. However, a delayed employment adjustment with the labour market requirements is noted in Montenegro, since the number of employees declined by 5.1% in December in relation to the maximum number of employees registered in August The Montenegrin Government adopted the savings programme at the beginning of 2009, which included the termination of employment in the public sector. Employment trend in the public administration, education and health sectors has been significantly decelerated but it has not been terminated, except in health sector that recorded a lower number of employees (1%) in relation to the average recorded in A decline in 12 IMF, World Macroeconomic Outlook, October 2009.

44 44 Chief Economist Annual Report 2009 the number of employees was recorded in other sectors, particularly in the mining and quarrying, 16.6%, manufacturing industry, 10.3%, electricity, gas and water production, 9.7%, fishing, 7.5%, and health and social care sector, 1%. A decline in industry was expected due to decline in total economy activity in three main industrial sectors, problems in their performance, the leading manufacturers (Aluminium Plant (KAP), Steel Plant, Bauxite Mines), as well as due to the resolution of the status of one part of employees through the social programme offered by the Government of Montenegro. Moreover, amendments to the legislation in 2009 (the new Law on Employment and Work of Foreigners entered into force on 1 January 2009) equalised the rights and obligations of non-residents with the local labour force. Since the beginning of 2009, approximately 17,000 working permits for non-residents have been issued which significantly influenced on the increase in employment in construction, tourism and retail sectors. Graph 1.19 Number of employees Observed by structure of employees through the main three sectors, the largest number of employees (77.150) was in services sector at 2009 year-end. This represented a yearon-year increase of 9.7% making up 45.4% of total number of employees. It was followed by public sector (31.2%) and finally manufacturing sector making up 23.4% of total number of employees. This also confirmed the fact that the Montenegrin economy is more directed to service than manufacturing industry, showing also that the number of employees in the public sector is too high. Source: Monstat Graph 1.20 Structure of employees by sector Employment Agency registered of unemployed persons at 2009 year-end, which represents the year-on-year increase of 6.3%. The number of unemployed persons in 2009 on average amounted to , or it decreased by 3.9% as compared to Source: Monstat Bearing in mind the global economic crisis that spilt over from the financial market to the labour market, its consequences are also felt in Montenegro, but with a delayed effect. To wit, the unemployment rate declined in the first nine months of 2009, and after that period it trended upward, indicating that the employment is not performed in the dynamics prescribed by the National Employment Strategy (rate below 10% as key success indicator). According to the Employment Agency, unemployment rate was 11.43% in December and increased by 0.69 percentage points in the one-year period. According to another methodology published by Monstat on quarterly basis, and based on the Labour Force Survey harmonised

45 Real Sector Developments 45 with Eurostat recommendations, unemployment rate increased in the first two quarters 2009 in relation to all four quarters of the previous year. This rate decreased in the third quarter by 1 percentage point as compared with the previous two quarters, but it is evident that rate from the Labour Force Survey will increase in the fourth quarter due to delayed labour market reaction on economic movements and operation of certain legal persons. Movement of these two rates was shown in Graph In 2009, the Employment Agency conducted a series of researches aimed at analysing the labour market trends. The Employment Agency conducted a Labour Force Survey, in cooperation with SNV, a Dutch development organisation, within the project Improvement of labour force in tourism in rural areas of Montenegro and the British Council within the project Skills in Practice. Survey included 488 owners, managers and workers from all Montenegrin municipalities and survey was conducted in July and August. The survey indicated that owners and managers in tourism were optimistic with respect to the employment in this sector anticipating high growth rate (three to six percent in the following three years). The Labour Force Survey showed that Montenegro has a substantial number of people holding a university degree being employed in the tourism sector, but a deficiency of employees in tourism holding a high school degree is also evident. Graph 1.21 Unemployment trends Source: Monstat and Employment Agency Graph 1.22 Number of unemployed persons In addition, a survey among employers on employment of high school graduates and Source: Employment Agency of Montenegro students for seasonal jobs was also conducted. The survey confirmed the well-known fact that the Montenegrin economy has extremely seasonal character. More than 56% of the surveyed employers hire seasonal employees, indicating that there is a competition among certain sectors (tourism, trade, construction and agriculture) for seasonal labour force, since the number of registered unemployed persons is not sufficient to meet the demand. Observed by region, the largest requirements were reported by coastal municipalities, such as Herceg Novi and Budva. The realisation of measures of employment policy continued in 2009, such as cooperation of public employment services with private employment agencies to resolve in a qualitative manner the problem of unemployment. In that respect, representatives of the Employment Agency of Montenegro and Dekra

46 46 Chief Economist Annual Report 2009 for Southeast Europe signed the Memorandum of Understanding. The subject matter of this MoU is the establishment of cooperation between the Agency and Decra in order to mediate in the employment of unemployed persons. Special attention is directed towards inclusion of poorly employed categories in the aforementioned programmes. Salaries According to the information from Monstat, an average salary in Montenegro was EUR 643 in 2009 and it increased by 5.6% in relation to the average salary in The average salary without taxes and contributions amounted to EUR 463 and it increased by 11.3% in relation to the prior year. The decline in personal income tax from 15% to 12%, as well as the decline in contribution rates for compulsory social and health insurance has lead to the increase in new salaries which was also evident from the data on average gross and net salaries. It is worth emphasising that in 2009, the average gross salaries declined only in mining and quarrying sector (-6.8%), manufacturing (-0.3%) and financial intermediation (-1.6%), Other sectors reported an increase in gross salaries that ranged from 0.6% in the public administration and compulsory social insurance sectors to 16.8% in agriculture, forestry and water management. The highest salaries without taxes and contributions were reported in financial intermediation (EUR 891), while the lowest salaries were still reported in fishing sector (EUR 159). Agriculture, forestry and water management (21.9%), as well as health and social care (19.7%) reported the highest increase in salaries without taxes and contributions. The increase in the health and social care sector resulted from the change in employees rate in January The increase was also evident in transport, warehousing and communications sector (18.3%). Table 1.6 Average salaries without taxes and contributions by sectors Salaries without taxes and contributions Nominal salaries index Real salaries index Ø 2008 Ø 2009 Ø 2009/Ø 2008 Ø 2009/Ø 2008 TOTAL Agriculture, forestry and water management Fishing Mining and quarrying Manufacturing Electricity, gas and water production Construction Wholesale and retail, repair Hotels and restaurants Transport, warehousing and communication Financial intermediation Real estate activities Public administration and social security Education Health and social care Other utilities, social and personal services Source: Monstat

47 Real Sector Developments 47 Box 1.11 Average salaries in the former Yugoslav Republics, November 2009 Information on average salaries in November clearly showed the difference in salaries in former Yugoslav Republics. According to the amount of salaries, Slovenia was in the first place. Croatia was in the second place on average and Montenegro was above Bosnia and Herzegovina, Serbia and FYR Macedonia. Gross and net salaries reported a nominal increase in all of the above mentioned countries, except in Croatia where a decrease in gross salaries by 0.3%, and/or net salaries by 0.2% was recorded. Although it is shown at the end of the table below, the highest increase in gross and net salaries was in FYR Macedonia (8.4% and 18.1% Table 1 Salaries in former Yugoslav republics, in EUR (classification by net amount) Country Net salaries Gross salaries Slovenia Croatia Montenegro Bosnia and Herzegovina Serbia FYR Macedonia Source: Statistical Offices and Central Banks of the abovementioned countries respectively), then in Serbia, where gross salaries increased by 5.2%, Bosnia and Herzegovina by 4.8%, Slovenia by 1.3% and Montenegro by 0.6%. Net salaries reported an increase as follows: 6.5% in Montenegro, 5.4% in Serbia, 1.9% in Bosnia and Herzegovina and 1.8% in Slovenia. It is worth mentioning that a slight deviation in absolute amounts of the salaries of the mentioned countries may occur due to translation of national currencies in euro, but it cannot change the order given in the table Results of the Processing of Annual Financial Statements of Legal Persons in Montenegro The Central Bank of Montenegro has also continued with the project of processing of annual financial statements (AFS) of legal persons in Montenegro in 2009, obligated to submit these reports to the Commercial Court in Podgorica in line with the Business Organisation Law and Accounting and Auditing Law. By 15 September 2009, legal entities submitted their AFS for 2008 to the Commercial Court, of which the Central Bank of Montenegro processed AFS. In that respect, only 43 AFS have not been processed due to incorrectly or inadequately completed forms, while 61 AFS of insurance and reinsurance undertakings, privatisation funds and trade union organisations have not been processed. The number of processed AFSs, in comparison to the number of submitted AFS, is significantly lower as compared to the previous years, which points out to more consistent observing of basic rules of completing the financial reports. Since the percentage of the processed AFS is lower in comparison with the total number of registered legal persons obliged to submit these statements, aggregate indicators obtained after the processing of the submitted, i.e. appropriately completed AFS can be taken with reservations to be representative for the Montenegrin economy.

48 48 Chief Economist Annual Report Methodological Remarks Legal persons in Montenegro compile their AFSs in accordance with the International Accounting Standards (IAS) and the International Financial Reporting Standards (IFRS). Annual financial statements of the legal persons are classified and aggregated in line with legal and international rules of financial and statistical reporting at the levels including areas, sectors, groups, and subgroups. In addition, all balance sheet macroaggregates are, besides aforementioned vertical level, classified at horizontal levels including economic level of Montenegro and economic level of its municipalities (21) The Processing Results General Remarks The processing of AFS gave numerous balance sheet aggregates which, with the aforesaid restrictions, can be considered representative macro-aggregates of the Montenegrin economy. Balance sheet macro-aggregates of legal persons in Montenegro were obtained from the basic, legally binding forms models prescribed by the Institute of Accountants and Auditors of Montenegro. Of processed AFS, referred to companies, 291 to non-government organisations, 164 to agencies and institutions, and 23 to stock exchanges and brokers. The processed AFS were used for the preparation of balance sheets, i.e. income statements by the respective groups individually and aggregately. In addition to the aforementioned macro-aggregates, the AFS processing gave more types of indicators of successful operations than did the balance sheets and the income statements Balance Sheets of Legal Persons Aggregate balance sheet of Montenegrin economy for 2008 was prepared using processed AFS that referred to legal persons (Table 1.7). Generally speaking, all asset positions increased except deferred taxes. Total assets of legal persons of Montenegro amounted to EUR ,17 million as at 31 December 2008, being by 25.71% higher than in 2007 (EUR ,15 million). Fixed assets in the amount of EUR 9.306,73 million made up 69.01% of total assets. It increased by 24.09% in one-year period. Working assets was EUR 4.178,43 million, reporting a year-on-year increase of 29.49%. Property, plant and equipment amounted to EUR 7.299,12 million or 54.12% (59.7% in the previous year) of total assets. This balance sheet position comprising of land, forests, permanent crops, breeding stock, construction premises, investments in process, equipment and other tangible assets increased by 26.22% in one-year period. Increase in this balance sheet position was recorded in all sectors including electric energy, gas and water production (10.2%), wholesale and retail trade (40.7%), real estate activities (39.6%), construction (67.6%), transport, warehousing and communications (21.2%), and hotels and restaurants (22.1%). Receivables from buyers amounted to EUR 1.689,2 million which grew by 32.5% in relation to the previous year. These receivables made up 12.5% of total assets and the largest (73.4%) portion included the following sectors: wholesale and retail (EUR 625,4 million or 37.0%), construction (EUR 218,1 million or 12.9%), real estate activities (EUR 216,7 million or 12.8%), manufacturing (EUR 180,4 or 10.7%).

49 Real Sector Developments 49 Table 1.7 Aggregated Balance Sheet of Montenegrin Legal as of 31 December 2008 in EUR No Position 31 December December 2007 Growth in % ASSETS I FIXED ASSETS 9,306,731,581 7,500,236,572 24,09 1 Unpaid subscribed capital 38,758,266 34,334,075 12,89 2 Intangible assets 635,377, ,596,375 18,41 3 Property, plant and equipment 7,299,116,604 5,782,982,684 26,22 4 Fixed assets held for sale 612,323, ,899,724 6,14 5 Long-term receivables 234,869, ,904,883 33,52 6 Long-term financial placements 475,274, ,806,084 27,14 7 Deferred taxes 11,011,536 19,712,747-44,14 II WORKING ASSETS 4,178,437,807 3,226,908,491 29,49 8 Supplies 1,234,659, ,147,461 34,18 9 Receivables from buyers 1,689,195,138 1,275,292,709 32,46 10 Short-term financial placements 350,387, ,326,367 27,73 11 Cash and cash equivalents 525,212, ,608,871 5,76 12 Prepaid expenses 184,327, ,481,608 44,59 13 Accrued unpaid income 121,592,646 69,645,800 74,59 14 Other working assets 73,063,687 63,405,675 15,23 III TOTAL ASSETS 13,485,169,388 10,727,145,063 25,71 LIABILITIES AND CAPITAL IV CAPITAL AND RESERVES 5,948,878,254 5,251,455,260 13,28 15 Subscribed capital 5,211,263,916 4,637,715,852 12,37 16 Issue premium 15,402,612 3,957, ,24 17 Revaluation reserves 760,519, ,848,837 3,49 18 Other reserves 99,384,992 60,137,662 65,26 19 Undistributed profit/loss -146,840, ,531,384-23,73 20 Minority interest 9,147,859 7,327,231 24,85 V LONG-TERM LIABILITIES 3,455,024,073 2,526,979,862 36,73 21 Long-term liabilities 2,809,179,147 2,114,265,394 32,87 22 Deferred taxes 46,980,869 56,403,493-16,71 23 Long-term provisions 105,031,749 98,563,793 6,56 24 Other long-term liabilities 291,483, ,705,969 89,64 25 Deferred income 202,348, ,041,213 94,49 VI SHORT-TERM LIABILITIES 4,081,267,060 2,948,709,941 38,41 26 Short term operating liabilities 2,531,589,117 1,743,936,360 45,17 27 Short term financial liabilities 1,014,479, ,836,780 19,23 28 Current portion of long term loans 168,316,972 91,805,325 83,34 29 Tax liabilities 176,241, ,700,183 10,36 30 Dividend liabilities 10,774,374 6,106,344 76,45 31 Short term provisions 19,992,817 12,353,241 61,84 32 Calculated reserves 159,872,248 83,971,708 90,39 VII TOTAL LIABILITIES AND CAPITAL 13,485,169,387 10,727,145,063 25,71

50 50 Chief Economist Annual Report 2009 Supplies (goods, material, raw materials, spare parts, small inventory, unfinished products, end products, fuel, packaging and the like) amounted to EUR 1.235,0 million at reporting period-end (9.2% of total funds), showing a year-one year increase 34.2%. Of total supplies, 75.8% referred to the following sectors: whole sale and retail (EUR million or 46.0%), construction (EUR million or 16.1%) and manufacturing (169.3 million or 13.7%). Montenegrin legal persons reported cash and cash equivalents in the amount of EUR million as at 31 December 2008 (demand deposits, cash in vault and accounts with banks and other financial institutions and other cash equivalents). This represented an increase of 5.8%. Total financial placements of Montenegrin legal persons amounted to EUR million representing a yearon-year increase of 27.4%. Long-term financial placements (total receivables of economy for bills of exchange, receivables for financial leasing, receivables based on long-term securities, equity participation with maturity over one year) amounted to EUR million or 57.6%, which grew by 27.1%. Short-term financial placements (total receivables based on executed placements with maturity up to 12 months) were EUR million and increased by 27.7%. Intangible assets (licenses, franchises, patents, goodwill and other intangible assets) were EUR million (4.7% of total assets), and they grew by 18.4% in comparison to the previous year. Unpaid subscribed capital, fixed assets held for sale, long-term receivables, deferred taxes, prepaid expenses, accrued unpaid income and other working assets amounted to EUR 1.276,0 million or 9.5% of total assets. The largest potion (44.1%) in the structure of total liabilities of Montenegrin legal persons as at 31 December 2008 referred to capital and reserves amounting to EUR 5.948,9. It represented a year-on-year increase of 13.3% (EUR 5.251,5 million). Total long-term liabilities were EUR 3.455,0 million representing a year-on-year increase of 36.7%, while total short term liabilities amounted to EUR 4.081,7 million representing an increase of 38.4%. Subscribed capital comprising of share capital, equity investments, stocks, state and other forms of capital represented the largest portion (38.6%) in the structure of total liabilities of Montenegrin legal persons in 2008 as well as in prior years. It amounted to EUR million as at 31 December 2008, which was by 12.4% higher than in the previous year. Approximately 64% of subscribed capital was reported in the following sectors: electric energy, gas and water production (EUR million or 20.7%), transport, warehousing and communications (EUR million or 18.5%), hotels and restaurants (EUR million or 13.7%) and manufacturing (EUR million or 11.7%). Revaluation reserves, including revaluation effects of individual assets of Montenegrin legal persons amounted to EUR million (3.5% more than in the previous year) and they made up 5.6% of their total liabilities. Long term liabilities of legal persons (long term liabilities to related legal persons, matured bills of exchange, liabilities based on financial lease, long term loans and other long term liabilities with maturity over 12 months as at balance sheet) increased by 32.9% in relation to the previous year. They amounted to EUR

51 Real Sector Developments million making up 20.8% of total liabilities (previous year 19.7%). Increase in long-term liabilities was reported in real estate activities (50.8%), wholesale and retail trade (70.7%) and hotels and restaurants (16.8%), construction (94.9%), transport, warehousing and communications (7.0%), financial intermediation (46.1%), and the like. Decrease in long term liabilities in one-year period was reported in manufacturing (11.8%) and utility, social and personal services sectors (10.5%). Short term operating liabilities such as liabilities to suppliers based on wages, fees and other personal income, to members of the board of directors for advance payments, membership fees and commission amounted to EUR 2.532,0 million or they grew by 45.2% in relation to 2008 making up 18.8% of total liabilities of the legal persons. Such movement largely resulted from the increase in these liabilities in wholesale and retail trade (32.0%), construction (43.8%), real estate activities (87.0%) and manufacturing (43.2%), making up 81.9% of total short term operating liabilities. Decrease in these liabilities was reported in fishing (21.5%). Short term financial liabilities based on loans received, interests, dividends, securities issued and other financial liabilities with maturity up to 12 months as at balance sheet were reported in the amount of EUR 1.014,5 million. They increased by 19.2% in one-year period. The largest portion (80.5%) of these liabilities were reported in wholesale and retail trade (EUR million), real estate activities (EUR million), construction (EUR million) and manufacturing (EUR million). Montenegrin legal persons reported tax liabilities of EUR million as of 31 December This showed year-on-year increase by 10.4%. The following sectors comprised 71% of these liabilities: wholesale and retail trade (EUR 36.1 million), manufacturing (EUR 48.0 million), electric energy, gas and water production (EUR 21,4 million) and mining and quarrying (EUR 18,9 million). Dividend liabilities were EUR 10.8 (previous year EUR 6.1 million) Profit and Loss Statement of Legal Persons of Montenegro for 2008 The profit and loss statement of Montenegrin legal persons for the period 1 January 31 December 2008 was prepared in accordance with the cost-based method (Table 1.8.). Total income of legal persons (realisation of products and services, other operating income, executed and capitalised work by companies for their own purposes) amounted to EUR 7.837,9 million in the observed period. It increased by 30.5% as compared to the previous year (EUR 6.008,2 million). The largest portion of this income in the amount of EUR million or 95.3% referred to total income from realised products and services at national and international market. This represented an increase by 30.51% as compared to the previous year (EUR million). Legal persons reported EUR million of total expenses in the observed period which increased by 34.8% in one-year period (EUR million). Operating expenses were EUR million.

52 52 Chief Economist Annual Report 2009 Table 1.8 Aggregated Profit and Loss Statement of Montenegrin Legal Persons as at 31 December 2008 in EUR No Position I-XII 2008 I-XII Income 7,470,379,743 5,723,854,981 2 Other operating gains 358,704, ,124,094 3 Executed and capitalised work by companies for their own purposes 8,825,967 8,260,238 4 Changes in supplies of end products and unfinished production -2,174,531-20,224,877 5 Raw materials used during period (for trade companies goods purchased and material used during period) -5,118,636,050-3,836,078,739 6 Employees expenses -834,088, ,965,411 7 Depreciation -312,219, ,428,211 8 Impaired value of property, plant and equipment -95,064,945-68,681,879 9 Other operating expenses -1,248,783, ,891,183 I OPERATING PROFIT/LOSS 226,942, ,969, Net financial expense -159,678,752-64,243, Share in income of associates -1,040,395-1,664, Profit tax -53,790,598-35,060, Net profit/loss from discounting operations -352, ,753 II II NET PROFIT/LOSS FOR THE PERIOD 12,079, ,559,990 In 2008, total income had an increasing trend (86.7% of total income) in the following sectors: wholesale and retail trade (23.4%), real estate activities (77.5%), construction (63.2%), manufacturing (21.3%) and transport, warehousing and communication (14.9%). Income from sale at national and international market was realised in the following sectors: wholesale and retail EUR 3.249,6 million or 43.5% of total income, manufacturing - EUR 963,1 million or 12.9%, transport, warehousing and communications - EUR million or 11.1%, real estate activities - EUR million or 9.7%, construction EUR million or 9.2%, electric energy, gas and water production - EUR 342,8 million or 4.6%, hotels and restaurants - EUR 208,6 million or 2.3%, mining and quarrying - EUR 61,9 million or 0.8%, agriculture, forestry and water management EUR 52,3 million or 0,7%, and the like. The largest portion (67.3%) of operating expenses comprised of raw materials used during period in the amount of EUR 5.118,6 million, showing a year-on-year increase by 33.4%. Wholesale and retail trade (goods purchased and material used) amounted to 51.9% of total raw materials used, while 14.2% of total raw materials used referred to manufacturing. Employees expenses amounted to EUR million or 11%, and depreciation amounted to EUR million or 4.1% of total operating expenses. Other operating expenses (incurred based on long term placements write off, loss based on sale of fixed assets, shortages, expenses for doubtful claims) were high amounting to EUR 1.248,8 million. These expenses increased by 38.8% in relation to the previous year making up 16.4% of total operating expenses.

53 Real Sector Developments 53 Legal persons in Montenegro reported negative financial result of EUR million with respect to net financial operations, profit tax, share in income of associate legal persons and discontinued operations. Almost entire amount of these financial expenses (99.3%) referred to net financial expense (EUR million or 74.3%) and current and deferred profit taxes (EUR 53.8 million or 25.0%). Finally, based on the obtained macro-aggregates, Montenegrin economy analysed in (non financial sector) reported positive result net profit of EUR million, which was significantly lower than the result reported in the previous year. Such result was due to high increase in total expenses of legal persons and substantial increase in net financial expenses of EUR million, which was almost 2.5 times higher than in the previous year. Based on the data on business result of the companies operating in Montenegro, it may be concluded that the first global financial crisis effects reflected in 2008 at the aggregate level Sectoral analysis of operating result of legal persons of Montenegro for 2008 Montenegrin legal persons, based on data from aggregate balance sheet for 2008, reported gross profit from operating activities of EUR million, which represented a decrease by 25.6%, while net profit for period was only EUR 12.1 million. Table 1.9 Net Profit by Sectors in 2008, in EUR 000,000 No Sectors Net Profit 2007 Net Profit 2006 Growth in % 1 Agriculture, forestry and water management 3,087 4,808 64,2 2 Fishery ,4 3 Mining and quarrying -4, ,7 4 Manufacturing -96,121-58, ,6 5 Electric energy, gas and water production -19,051-8, ,0 6 Construction 7,529 8,540 88,2 7 Wholesale and retail trade 87, ,347 62,6 8 Hotels and restaurants -36,978-13, ,2 9 Transport, warehousing and communications 74,549 99,634 74,8 10 Financial intermediaries 4,613 9,462 48,7 11 Real estate activities -13,134 24,327-54,0 The abovementioned data show that the largest portion of net profit was still reported by wholesale and retail trade (EUR 87,2 million) and transport, warehousing and communications (EUR 74,5 million) even besides the fact that these sectors reported year-on-year decrease by 37.4 and 25.2% respectively. Lower net profit but still positive result was reported by construction (11.8%), financial intermediaries (51.3%), agriculture, forestry and water management (35.8%) and education (31.3%). Sectoral analysis indicated substantial decrease in the financial result of Montenegrin legal persons, which was due to the increase in losses in manufacturing (64.6%), hotels and restaurants (over 2.7 times) and electric energy and gas production (over 2.2 times). In addition, this result affected losses in real estate activities (EUR 13.1 million) and mining and quarrying (EUR 4.4 million), which reported profit in the previous year.

54 54 Chief Economist Annual Report Operating result analysis of Montenegrin legal persons for 2008 Municipal level Observed by geographical area, legal persons reported the following balance sheet macro-aggregates in 2008 (profit/loss for the period): Table 1.10 Net profit by municipalities in 2008, in EUR 000 No Name Profit Loss 1 Podgorica 55,270 2 Herceg Novi 4,462 3 Danilovgrad 4,303 4 Bar 2,477 5 Ulcinj 1,012 6 Cetinje Bijelo Polje Rožaje Mojkovac Nikšić 24, Kotor 8, Berane 7, Pljevlja 6, Tivat 3, Plužine 2, Kolašin 2, Budva 1, Žabljak Šavnik Andrijevica Plav 68 TOTAL 70,292 58,212 Net profit for the period 12,080 The table 1.10 shows that the main revenue-earning business units were: Podgorica EUR million (which made up only one third of profit reported in 2007), Danilovgrad EUR 4.30 million, Bar (EUR 2.47 million) and Herceg Novi 4.46 million. Losses were mostly reported by legal persons having their registered offices in the following municipalities: Nikšić (EUR million or 41.46%), Kotor (EUR 8.6 million or 14.77%), Berane (EUR 7.68 million or 13.2%), and Pljevlja (EUR 6.84 million or 11.75%). Big companies such as Steel Plant and Bauxite Mines Nikšić AD are located in municipalities that reported loss in this year. On the other hand, two of three most profitable municipalities from 2007 reported loss in 2008: the municipalities of Kotor and Budva, which represents a concern Profitability and liquidity indicators of legal persons in Montenegro CBM has information on AFS of Montenegrin legal persons from 2006, 2007 and 2008, which represents a significant source of data for comparative review of performance indicators of legal persons in Montenegro. It is aimed at determining the efficiency and effectiveness of legal persons activities and their liquidity. Bearing in mind the financial crisis that transferred to real sector reflecting on overall illiquidity of the most developed economies, it is of general interest to determine to what extent Montenegrin economy efficiently handles its funds and whether it has substantial liquidity problems. Therefore, four indicators have been prepared: net profit margin, return on total assets, and overall liquidity ratio as liquidity ratio (so called Acid Test).

55 Real Sector Developments 55 Table 1.11 Net profit margin of Montenegrin economy Net profit Net profit/loss 12, ,560 60, Total income 7,837,912 6,008,241 4,637,608 Indicator (1:2) Net profit/loss of Montenegrin economy, as profit/loss indicator after taxes and total income was 0.15 in This indicator reported a significant decline in 2008 indicating that Montenegrin economy operated far more inefficiently in relation to Table 1.12 ROA of Montenegrin economy ROA Net profit/loss 12, ,560 60, Total assets 13,485,613 10,727,145 7,348,143 Indicator (1:2) Return on assets (ROA), as an indicator of efficiency of total assets of Montenegrin economy, had also a negative trend indicating that Montenegrin legal persons were significantly inefficient in using their assets in relation to the previous year. Liquidity of Montenegrin economy was calculated using overall liquidity ratio, i.e. working assets to short term liabilities ratio. This ratio is aimed at determining the extent of coverage of short term liabilities by working assets at the aggregate level. This ratio should exceed 1 (in sectors with high daily turnovers, such as trade, this ratio should exceed even 3). Therefore, deterioration in respect of 2007 is evident. Table 1.13 Liquidity ratio (overall liquidity ratio) Liquidity ratio (overall liquidity ratio) Working assets 4,178,880 3,226,908 2,183, Short term liabilities 4,081,708 2,948,710 2,065,985 Indicator (1:2) The second liquidity indicator, the so-called quick ratio, excludes from working assets inventories as the most illiquid form of working assets. This indicator should also exceed 1. Based on this criterion, significant deterioration of liquidity also occurred in 2008, which was unsatisfactory. It can be concluded that legal persons in Montenegro have a significant problem in financing short-term liabilities with short-term assets, which will reflect on deterioration of solvency indicator during 2009 and 2010.

56 56 Chief Economist Annual Report 2009 Table 1.14 Liquidity ratio of level II (short term liabilities to liquid assets and receivables) Liquidity ratio (short term liabilities to liquid assets and receivables) Working assets 4,178,880 3,226,908 2,183, Inventories 1,235, , , Short term liabilities 4,081,708 2,948,710 2,065,985 Indicator (1-2) : Observed by solvency, i.e. the indebtedness ratio, it can be concluded that Montenegrin economy was not able to provide financing of liabilities by own funds in 2008, which points to an increase in long term and short term indebtedness of economy. Table 1.15 Capital to total liabilities (indebtedness ratio, in EUR) Capital to total liabilities Capital and reserves 5,948,881 5,251,455 3,904, Lon term provisioning 105,032 98, , Long term liabilities 3,455,024 2,526,980 1,377, Short term liabilities 4,081,708 2,948,710 2,065,985 Indicator 1:(2 +3+4) The indebtedness ratio of Montenegrin economy (accounting approach) shows the structure of sources of financing divided by own and external sources. Generally speaking, higher value of this indicator indicates that Montenegrin economy finances its own property by higher amount of own funds and vice versa. It can be concluded that risks that were obvious in 2007 continued in 2008 as well. Indebtedness of economy significantly increased, which resulted in uncertainty of legal persons activities in period of global financial crisis. In addition, it may be concluded that Montenegrin economy is more directed to service sectors (telecommunications, real estate turnover, financial services). Significant increase in indebtedness of economy reflected on the level of financing expenses, which influences on deterioration of the financial result. Furthermore, a drastic decline in financial result of manufacturing, mining and quarrying, and real estate activities also represents a concern and it is also evident disproportion between financial results of legal persons at municipal level. Maintenance of solvency of economy in 2010 still remains as the challenge due to significant decline in lending activity of the banking sector and deterioration of the liquidity of economy Problems and Recommendations During 2009, a significant effort has been made in creating a quality legal and institutional framework for improving financial reporting in Montenegro. It reflected in the pursuing of the Strategy and Action Plan for improving the quality of the financial reporting and implementation the latest amendments to the Accounting and Auditing Law which were largely based on the adoption of recommendations for the improvement of

57 Real Sector Developments 57 accounting and auditing practice given by the World Bank to Montenegro in 2006 (Report on the Observance of Standards and Codes - ROSC). In the context of more efficient financial reporting, the new Law provided conditions for their improvement through the following: Introduction of compulsory electronic reporting 13, Shortening the deadline for submission of financial reports (instead by 30 June, the financial statements must be submitted by 28 February), Annual financial reports were amended by statistical annex, which represents additional assistance to MONSTAT in providing support for determining relevant macro-aggregates, Unification of calculation of expenses 14, Introduction of compulsory consolidated balance sheet of companies being holding or associated companies, More enhanced control of audit operations, Improvement of procedures of accountant certificates, licensing of auditors and audit firms. Other aspects of 2006, the ROSC recommendations included: activities of the competent authorities on developing supervisory mechanisms and strengthening their capacities 15, profession and ethics (development of generally accepted training for certified accountants), and update of translation of international accounting and auditing standards. Deadlines for the above mentioned recommendations were given within the Strategy and Action Plan for the improvement of quality of financial reporting. This created basis for substantial improvement of the quality of the annual financial statements (AFS) which will eliminate some of the basic problems arising during their preparation. Problems in filling out AFS forms in 2008 remained similar to those from the previous years, although in much smaller volume. Main deficiencies that occurred during filling out AFS were the following: 1. Inadequate structure of forms that does not require data input on type of ownership and organisational form of the legal persons, which disables comparison of successfulness of their performance by these features; 2. Legal persons does not often fill out prescribed items in the forms referring to the identification and registration number of legal person, which hindered processing and classification of legal persons by industries; 3. Failure to enter all items of the balance sheet and failure to submit correct data (e.g. discrepancy between assets and liabilities and capital amounts); 4. Certain number of joint stock companies and limited liability companies have not submitted all financial reports prescribed by the Law or they have not been signed by the authorised person; 5. Certain number of legal persons has not submitted obligatory audit reports. 13 However, in practice the submission of reports in electronic form included only submission of scanned documents, which does not facilitate processing of annual account, which was the main intention of this change. 14 Article of the old Law that prescribed division by cash or accrual accounting is deleted from the new Law. 15 Development of the capacities of National Council, establishment of inspection capacities for the implementation of the Law; development and expansion of internal audit concept within the Ministry of Finance, establishment of the body for overseeing auditors, and the like.

58 58 Chief Economist Annual Report 2009 Poor quality annual financial statements have significant negative effects on both macro and micro level. To wit, AFS are used for the GDP of Montenegro calculation so that incorrect financial reports showed not only incorrect evaluation of this macro aggregate, but also, which is much worse, incorrect analytical conclusions arising from poor quality statistical basis. The same applies to any form of analysis at the macro level, for example the movement of short term and long term indebtedness of individual sectors, their liquidity, and profitability. From the macroeconomic standpoint, poor quality financial reports distort the picture as viewed by the potential investors at the securities market influencing the liquidity of this market. Finally, poor quality AFS show inadequate information to banks on the financial standing of customers; asymmetric information between banks increases (both national and international) and customers legal persons, which influences risk growth, contributing to the interest rates growth, and an increase in non-performing assets within the banking sector, as was evident during As it has been stated, a significant effort has been made this year on creating qualitatively better institutional framework which reflected in adoption of the new Accounting and Auditing Law. Simultaneously, the Ministry of Finance has started since 2007 the process of analysing the quality of financial reporting. This institution required, through the inspections, the correction of irregularities and delivered a written warning to all legal persons where irregularities were noted. In addition, this year anticipated also execution of specific sanctions, which included criminal referrals against legal persons that has not preformed requested corrections and removed irregularities in their financial reports for the last year. The consistent implementation of this practise is recommended to improve the quality of financial reporting. Recommendations for this year may be based on the following: 1. Creation of conditions for monitoring and evaluating the Law amending the Accounting and Auditing Law, as well as on the progress of realisation of the Strategy and Action Plan for the improvement of the quality of financial reporting particularly in the part referring to the following: Strengthening the capacities of the financial sector and their supervisory mechanisms (CBM, Securities and Exchange Commission and Insurance Supervision Agency). Creation of capacities for the inspection oversight within the Ministry of Finance (with special stress on the analysis of compliance of the financial statements with the International Accounting Standards (IAS). Inspection oversight (Article 37 of the Law amending the Accounting and Auditing Law) includes supervision and analysis of all financial reports, strict observance of the latest Accounting and Auditing Law, as well as the process of initiating and monitoring effects of misdemeanours. These powers include extreme level of coordination for their qualitative performance. Creation of capacities within the Commercial Court of Montenegro for the submission of electronic financial statements that would be completely transparent. 2. In our opinion, independent and transparent monitoring and evaluation of the implementation of Law amending Accounting and Auditing Law, as well as evaluation of the progress of the realisation of the Strategy and Action Plan could be based on further close cooperation of the relevant institutions with the World Bank. All of the aforesaid should improve the accounting and auditing practices in 2010, and should bring more qualitative financial reporting.

59 2 MONETARY DEVELOPMENTS

60

61 Monetary Developments 61 Trends in 2009 The global financial crisis, negative economic growth and problems in the real sector, supported by the earlier excessive borrowing by the corporate and household sectors, contributed to the banking system deterioration in The key balance-sheet positions: total assets, loans, deposits and borrowings recorded decline. A negative financial result was recorded at the system level, but the confidence crisis influenced by the deposits outflow seized. Credit to deposit ratio improved. Problems with the growth of non-performing loans moderated due to improvement of capital base of banks and growth of provisioning for loan losses. Borrowings decreased, and this fact might indicate lower need for financial support by the parent banks, as well as lower lending base. Operation indicators (liquidity and solvency, excluding profitability) of individual banks were satisfying, which indicates that the system stability was maintained. In 2009, the CBM, as the regulatory authority, had to take care also not to cause pro-cyclical environment, that is, not to influence banks to decrease their lending activity in the economic decline conditions more than reasonably justified to enable the creditworthiness of the borrower, thereat not harming realization of basic goal which is the financial stability. In order to improve liquidity and solvency of banks and provide higher operational and risk management standards, in 2009 the CBM twice revised reserve requirement policy 16 and amended several key regulations prescribing banks operations 17. With the aim of relaxing the banking liabilities and support the reviving of lending activity, the CBM passed a set of interim measures 18, which implementation enable more favourable conditions for the loan restructuring, asset classification and lower calculation of provisions for loan losses. Measures for the protection of the banking sector from the consequences of the global crisis passed in 2008 were in force by the end These measures were the following: Law on Measures for the Protection of the Banking System and related decisions passed by the CBM - The Decision on use of the reserve requirement to 16 Decision on Amendments to the Decision on reserve requirement of banks with CBM, Decision on amendments to the Decision on using reserve requirement of banks with CBM for the period longer than one day, OGM 15/09 17 Decision on minimum standards for credit risk management in banks, Decision on capital adequacy of banks, Decision on minimum standards for risk management in MFIs, and new Decision on reports to be submitted to the CBM, according to the Banking Law OGM, 41/ Decision on temporary measures for credit risk management, OGM, 64/09 and 87/09

62 62 Chief Economist Annual Report 2009 be held with the CBM for a period longer than one day and the Decision on granting short-term borrowings to banks. In 2009, market concentration in the banking sector decreased thus partly indicating strengthened competition in this segment of Montenegrin economy. Box 2.1 Measures regulating banking operations in 2009 (excluding the reserve requirement policy) Intensive adjustment of the legal framework to the banks operations in the condition of crisis continued also in Basic goal of the monetary policy was regaining confidence in the banking system, relaxing of banks liabilities regarding reserve requirement and loan loss provisioning, mitigation of the asset value loss, increase in capital of Montenegrin banks and improvement of their lending activity. Amendments to the Decision on minimum standards for credit risk management in banks passed in April 2009, relaxed the banks provisioning policy with regard to potential loan losses based on the past due criteria. A limit of 60 past due days, after which a liability is categorized as non-performing asset, is increased to 90 past due days. In addition, ultimate past due limit for the classification of asset items in the loss category is increased from 180 to 270 days. The aforementioned changes harmonized the Decision on reports to be submitted to the CBM in accordance with the Banking Law and the Decision on capital adequacy of banks, in a part of changing the past due limit from 60 to 90 days, after which expiry a borrower becomes irregular borrower. These changes provide favourable conditions for banks in calculating risk weighted assets for credit risk. In order to moderate the effects of the global financial crisis, the Council of the CBM passed a set of temporary measures in August 2009, which enable more favourable conditions for loan restructuring, asset classification and lower calculation of provisions for loan losses. The Decision on temporary measures for credit risk management in banks enabled banks as of 1 January 2009 to classify restructured loans in more favourable classification groups, under specific conditions, if that activity would not influence a bank s liquidity, while the restructuring provides duly debt servicing in future. In addition, this decision significantly facilitates position of borrowers, both legal and natural persons, who are past due owing to the global crisis. In accordance with this decision, banks are enabled, under specific conditions, to perform more favourable classification of loans collateralized by real estates. The purpose of passing these decisions was to cease or diminish a decline in assets quality, encourage lending activity and stimulate banks to work more actively on attracting new and returning withdrawn deposits. At end-december, the CBM passed the amendments of the Decision on temporary measures for the credit risk management in banks 19, which imply certain relaxations for banks, aiming to initiate lending activity. New measures decreased provisions for certain classification groups. In addition, it was stipulated that banks, when assessing a creditworthiness of the borrower, can exclude business indicators for Banks were also enabled to perform a classification of loans for investments in development projects by analysis of the project profitability, and not by the assessment of the creditworthiness of the borrower. A novelty is that reliefs for loan restructuring may be applied to loans which are past due to 180 days (instead current 90 days). 19 OGM, 87/09

63 Monetary Developments 63 Expectations in 2010 In 2010, banks will still be exposed to numerous external and internal risks. Figure 2.1 Major risks for Montenegrin banking system Despite the first signs of recovery, the global markets are still fragile. High indebtedness and endangered sustainability of fiscal positions of states are evident. In such conditions, sources of assets from foreign market will not be cheaper and will be restrictedly available in It is expected that reference rates (Euribor and Libor) will easily increase over 2010, due to two reasons: it is most probable that they reached their historical bottom, and slow recovery of the European economy. On the other hand, national economy is burdened with restructuring, redundancies, decrease of productivity, growth of mutual receivables, high level of indebtedness with banks, illiquidity. Creditworthiness of bank clients significantly decreased during the crisis, thus banks have to exercise caution in granting new loans to legal and natural persons. Besides detailed analysis of operations of every individual client, banks should analyse the situation in individual branches of the economy, taking into consideration medium-term business prospective, excluding business indicators from the previous year. New loans to natural persons of the bank will be granted with more caution: with the share of cash, collateral check and cash incomes. In order to be profitable, banks have to perform lending activities. Therefore, very moderate credit growth can be expected in Banks management and employees in banking analysis and risks management will have a specific responsibility. They will need sophisticated knowledge for the assessment of the client s creditworthiness, assessment of future macro and micro economic movements, risks management and

64 64 Chief Economist Annual Report 2009 liquidity, as well as stress testing. The highest challenge for the banks will be collection of doubtful receivables and improvement of credit portfolio. With a view of reducing operational losses, it is expected that the banks in the following year rationalize general and other costs. Therefore, competition between banks in 2010 will be evident, which will primarily be reflected through the differences in lending policy (interest rate policy, which will enable instant different levels of exposures of individual banks to risks and different level of available provisions and capital for their coverage). Significant decrease of lending interest rates will probably not occur, due to calculated risks and need to compensate losses. Deposit interest rates can expect slight decline, since the thrust crisis ended. Decrease of deposit interest rates could still influence slight decrease of lending interest rates. It is expected that in 2010, banks will perform additional recapitalization in accordance with international and national standards, as protective measures for existing and unexpected risks, in order to increase thrust in stability and development of the banking system. External credit lines of MFIs (such as EFSE, EIB and KFW) will most probably be more attractive for banks and they will use rather such credit lines in In addition, it is expected that parent banks will also provide credit support if required. In 2010, the new Central Banking Law, amendments to the Banking Law, the Bank Bankruptcy and Liquidation Law and amendments to the Deposit Protection Law will probably be enacted Banks Liquidity The Decision on minimum liquidity standards 20, entered into force as of January 2009, which prescribes banks obligation for maintaining minimum liquidity ratios 21 (0.9% - daily) and (1.0% - ten-day). Over 2009, daily and ten-day liquidity ratios for the banking system as a whole were above the prescribed minimum (Table 2.1). Observed by banks, over the first eight months of 2009 and in first two ten-day periods of September, one bank constantly had lower daily and ten-day liquidity ratios. As of the third ten-day period of September until end-2009, daily and ten-day liquidity ratios with all banks were above the prescribed minimum. Table 2.1 Aggregate liquidity indicator, end-month Period/Description Liquidity indicator (liquid assets of banks/matured liabilities for loans and borrowings 2009 I II III IV V VI VII VIII IX X XI XII Source: Daily banks reports 20 OGM, 60/08 21 Liquid assets of banks and matured liabilities for loans and borrowings

65 Monetary Developments 65 Structure of liquid assets at end-2009 indicate dominant share of liquid assets in the country (61.6%), while banks assets abroad made up remaining 38.4% of liquid assets. Graph 2.1 Liquid assets of banks, average by months Liquidity of the banking system at end-2009 was characterized by the improvement of certain basic liquidity indicators in relation to end Liquid assets of banks 22 at end-december 2009 amounted to EUR million or 26.4% more in relation to end-2008 (Graph 2.1). The share of liquid in total assets at end-2009 amounted to 15.3% and in relation to end of the previous year they increased by 4.2 percentage points. Loans to deposits ratio improved in relation to end-2008 (Table 2.2). Source: Daily banks reports Table 2.2 Selected banks liquidity indicators, period-end Period/Description III VI IX XII III VI IX XII Loans/Deposits 1,15 1,20 1,23 1,41 1,52 1,50 1,35 1,31 Liquid assets*/total assets 14,40 14,17 12,81 11,03 10,49 11,71 15,97 15,26 * Liquid assets for 2008, calculated with the aim of comparison, according to the new Decision on liquidity risk management. Over the first five months of 2009, three banks used allocated reserve requirement assets for the liquidity for the period longer than one day. Over the rest of the year, reserve requirement for liquidity was not used, but one bank had lower level of allocated reserve requirement than prescribed in the period June-September Aggregated Balance Sheet of Banks In 2009, total banks assets decreased by 8.6% (Table 2.3). Decrease of banks assets influenced the decline of loans by 14.3% (around EUR 400 million) and provisions for losses on other asset items (25.9%). All other asset items at the annual level recorded growth. Monetary 22 Pursuant to the Decision on liquidity risk management, liquid assets consisted of monetary assets and deposits with deposit institutions decreased by 50% of allocated reserve requirement.

66 66 Chief Economist Annual Report 2009 assets increased by 11.7%, other assets 32.9%, and provisions for loan losses by 34.2%. Securities were 3.6 times higher than at the end of the previous year. 23 Table 2.3 Banks assets, year-end Condition Change ASSETS /2008. million EUR EUR million % 1. Cash funds and deposits with depository institutions 473,3 528,7 55,4 11,7 2. Loans 2.797, ,8-399,8-14, Provisions for loan losses -111,9-150,2 38,3 34, Net loans 2.685, ,5-438,1-16,3 3. Securities 19,1 69,1 50,1 262,4 4. Other assets 139,9 185,9 46,0 32,9 5. Provisions for losses on other asset items -8,2-6,1-2,2-25,9 6. TOTAL ASSETS 3.309, ,2-284,4-8,6 LIABILITIES 1. Deposits 1.990, ,7-165,9-8,3 1.1 Demand deposits 726,9 667,8-59,1-8, Time deposits 1.263, ,9-106,7-8,4 2. Borrowings 908,2 734,8-173,3-19,1 3. Other liabilities 131,5 134,0 2,4 1,9 4. Total capital 279,4 331,7 52,4 18, Capital and reserves 299,1 353,3 54,2 18, Profit/loss (+,-) from the current year -19,7-21,6-1,9 9,6 5. TOTAL ASSETS 3.309, ,2-284,4-8,6 In the total liabilities of banks, deposits and borrowings significantly decreased (8.3% and 19.1%), while capital and other liabilities increased by 18.7 and 1.9, respectively. The financial result at the system level worsened by 9.6%, in relation to the previous year. Due to higher credit risks in 2009, higher provisions for loan and other asset item losses partially contributed to the worsening of the financial result. The loss of EUR 21.6 million was recorded. Observed by banks at end-2009, eight banks recorded increase of assets ranging from 1.58% to 33.9%, while three banks recorded decrease from 6.7% to 6.7%. ROA amounted to -0.70% at end-2009 (0.62% at end-2008), while ROE amounted to -0.78%. Earning assets made up 81.9% of total assets (88.2% at end-2008). 23 According to the Decision on amendments to the Decision on reserve requirement of banks with the CBM, enabled banks to keep a part of reserve requirement in T-bills, which were used in 2009 by the Government of Montenegro for the improvement of current liquidity

67 Monetary Developments 67 Pass assets (A) made up 48.4% (at end-2008 it made up 59.5%) while non-performing assets (C, D, E) accounted for 11.4% of total assets or 69.7% of the capital increased by loss provisions at end Box 2.2 Size and profitability of the banking system in the region The size of financial sectors in the region is expressed through the balance sheet of banks/gdp ratio. According to available data, the highest increase in total assets over GDP was recorded by Croatian banks, followed by those in Montenegro and Bosnia and Herzegovina. Graph 1 Graph 1 Assets, deposits and loans, % of GDP, end-2009 In 2009, the highest ROA was recorded in Croatia, then in Serbia, FYR Macedonia, Albania and Bosnia and Herzegovina, while ROA of the Montenegrin banking system was negative. The most profitable share capital was again recorded in the Croatian and Serbian banking system, followed by Macedonia, Bosnia and Herzegovina and Albania, while losses were recorded only in the Montenegrin banking system with a negative return on average equity (-8s%). Source: websites of the selected national banks Table 1 Profitability of the banking sector, end 2009 Countries Croatoa Serbia B&H Macedonia Albania Montenegro Assets,%GDP 112,2 79,3 84,6 77,3 77,3 100,7 ROA 1,4 1,1 0,2 0,7 0,2-0,7 ROE 8,1 4,8 2,1 6 1,8-8 Source: websites of the selected national banks Banks Balance Sheet Structure At end-2009, the structure of the balance sheet of banks changed in relation to Shares of loan loss provisions and provisions for other asset items losses increased (by 1.6 and 0.1 percentage points, respectively). The share of monetary assets increased by 3.2 percentage points, securities by 1.7 percentage points and other assets by 1.9 percentage points, while that of loans decreased by 5.2 percentage points.

68 68 Chief Economist Annual Report 2009 In liabilities, the share of borrowings decreased by 3.1 percentage points, whereas those of capital increased by 2.5 percentage points, other liabilities by 0.4 percentage points and deposits by 0.2 percentage points (Table 2.4). Table 2.4 Structure of balance sheet of banks, %, end-year Difference, percentage points ASSETS 1. Monetary assets and deposits with depository institutions Loans Securities Other assets Provisions TOTAL ASSETS LIABILITIES 1. Deposits Borrowings Other liabilities Total capital TOTAL ASSETS Concentration Indicators At end-2009, all concentration indicators of the Montenegrin banking system (measured by assets, deposits and loans) significantly decreased. The Hirshman-Herfindal index (HH index), measured by assets as at end-2009, amounted to points, which is 275 points less than at end-2008 (Table 2.5). Measured against loans and deposits, it was 260 and 523 points lower, respectively. Table 2.5 HH concentration index, end-period HH index Against assets 1,531 1,641 2,296 2,042 1,918 1,911 1,636 Against deposits 1,892 1,991 2,898 2,350 2,298 2,465 1,943 Against loans 1,526 1,699 2,336 2,126 1,917 1,959 1,699 The ratio measuring market share against assets of the four largest banks (C4), amounted to 73.7% at end- 2009, thus being lower than at end-2008 (77.7%). Measured against deposits and loans, C4 had the same value and amounted to 76.6%. Thus, C4 against loans was slightly above the previous year level, while against deposits it was significantly lower than at end-2008 when it amounted 83.1%.

69 Monetary Developments 69 The HH index at end-2009 points to the higher concentration of deposits than of assets and loans. Although the HH index values at end-2009 indicate significant concentration decline, the values of C4 ratio for assets, loans and deposits indicate still high concentration in the banking system, which is the characteristic of small economies such as Montenegrin economy. 24 The banking sector in Montenegro is highly concentrated in comparison to those in other countries in the region. According to the latest available data 25, the HH index against assets in Croatia and Serbia amounted to the respective 654 and 1,360 points, which is significantly above that in Montenegro. In FYR Macedonia, this index was slightly lower than in Montenegro and amounted to 1, Lending activity of banks Although demand for loans was high, it could not significantly influence the level of loans granted in Solvency of legal and natural persons declined, and therefore banks significantly decreased their offer of loans, thus managing their credit risk more carefully. Total loans granted at end-2009 were EUR 400 million or 14.3% lower than at end Total monthly decline of loans amounted to 1.3%. Insignificant loan growth was recorded only in March and November. However, observed at the system level, six banks recorded annual credit growth ranging from 1.4% to 39.7%. The key problem represented the absence of lending by the majority of systemically important banks. Loans to corporate sector and households made up 94.7% of loans granted at end In 2009, the corporate sector obtained 18.1% less and households 11.4% less loans (EUR million in total). Fewer loans were granted also to financial institutions (70.1%), while loans granted to the General Government doubled. This represents the usual trend followed by banks in crisis times with loan portfolios moving towards investments guaranteed by the state. Growth of loans was recorded also in the category other by 8.5% (Table 2.6). In the maturity structure of loans, long-term loans accounted for the main share of 74.8% at end 2009, which is a somewhat higher share of these loans than in the previous year (72.3%) (Table 2.7). Table 2.6 Increase in loans, % 2008/ /2008 Financial institutions Corporate sector Households General Government Other Total Table 2.7 Maturity structure of total loans, % XII 2008 XII 2009 To three months From 3 months to 1 year From 1 to 3 years Over 3 years Total The Hirschman Herfindahl Index (HHI) level index up to 1,000 shows there is no concentration; the level of index from 1,000 to 1,800 indicates moderate concentration; the level of index above 1,800 means the existence of significant concentration. The value of C4 index over 60% indicates significant concentration level. 25 September 2009

70 70 Chief Economist Annual Report 2009 Observed by activities, the biggest loan users were: household sector (38.3%), trade (22.8%), category other (9.1%), services, tourism and catering (7.5%), construction (7.8%) and real estate trade (4.4%). The remaining loans granted (10.1%) referred to: transport, warehousing, post and telecommunication, administration and other public services, finances, mining, energy, agriculture, hunting and fishing. The major share and maturity structure of loans granted to the service sector indicate the need of structural adjustments of the Montenegrin economy, aiming to ensure a sustainable development, both in medium- and long-term. Observed by the purpose, most of the loans were granted for: liquidity (19.0%), construction and adaptation of construction facilities, as well as for the purchase of fixed assets (16.9%), housing loans (14.6%), cash loans (14.4%) and category other (11.1%). Significantly less banks funds were used through overdrafts, credit cards, consumer loans, as well as for the preparation of tourist season, car purchases, refinancing of liabilities to other banks and the purchase of securities. Table 2.8 Key indicators of lending activity of banks, % Description/Period 2008 XII 2009 XII Non-performing loans (C,D,E) / Total loans 7,20 13,5 Past due loans/total loans 11,50 22,9 Loan loss provisions/total loans -4,0-6,3 Restructured loans /Total loans - 9,3 In the currency structure of total loans, 4.0% referred to foreign currency loans. Since FX deposits made up 3.4% of total deposits and FX borrowings accounted for 14.7% of total borrowings, FX risk of Montenegrin banks was irrelevant. The shares of non-performing and past due loans in total loans recorded growths in Nonperforming loans (C, D, E) made up 13.5% of total loans, the share of past due loans was 22.9%, while loan loss provisions made up 6.3% (Table 2.8). Box 2.3 Payment cards, ATMs, POS terminals, electronic banking Banking services referring to cards, ATMs, POS terminals and electronic banking were further improved in In 2009, insignificantly higher number of cards was issued than in 2008 (185), but the number of performed transfers and the value of recorded payment cards turnover significantly increased (by 64% and 25%, respectively), which is the consequence of decreased lending activities of banks and the lack of liquid funds of clients for servicing their current liabilities. The types of payment cards used in Montenegro are debit cards (with overdraft allowed) and credit cards. At end-2009, thousand payment cards were in circulation, of which thousand were debit and 56.9 thousand credit cards. Over the year, 5.3 million transactions were performed using payment cards, whereby the recorded value of transactions amounted to EUR million (Table 1).

71 Monetary Developments 71 Table 1 Basic data on payment cards Total number of payment cards 203, , , ,810 Debit cards 187, , , ,875 Credit cards 16,126 45,609 52,597 56,935 Number of transactions 1,029,976 2,067,578 3,252,972 5,326,505 Value of transactions 53,224, ,361, ,107, ,478,387 Source: CBM payment system Relative indicators of this kind of banking services indicates the following: In 2009, 14.2 transactions per card were realized, on average, as opposed to 8.5 transaction/card in 2008, 6.9 in 2007 and 5.1 in An average value of transactions per payment card in 2009 was higher than in previous years, amounting to EUR 807,53, whereas in 2008 it amounted to EUR 647,7 EUR 460,8 in 2007 and EUR 262,0 in In relation to comparative data from the previous two years, an average value of a transaction decreased. In 2009 it amounted to EUR 56.97, EUR 76.6 in 2008, EUR 66.9 in 2007 and EUR 51.7 in Table 2 Number of POS terminals and e-banking user Number of ATMs Number of POS locations 1,973 3,713 5,888 7,202 Number of e-banking beneficiaries 4,852 8,577 12,566 18,155 Source: Payment system of CBM Deposits Total deposits at the annual level recorded a decline of 8.3% or EUR million. An average monthly decline at the annual level amounted to 0.6%, while in the first four months it amounted to 3.5%. The beginning of the year was characterized by substantial pressure on aggregate demand, which was sett off by deposits withdrawal due to lower lending activity. Due to the psychological pressure induced by the global crisis, bad experiences in the past regarding the safety of deposits in banks, as well as liquidity problems in one bank, a significant lack of confidence occurred. Bank run from the beginning of the year seized due to the government s blanket guarantee for total deposits, higher interest rates on deposits, as well as the inflow of

72 72 Chief Economist Annual Report 2009 Graph 2.2 Deposits, in EUR million funds from the sale of Electric Company of Montenegro (EPCG) 26. At end-2009, deposits amounted to EUR 1.824,7 which was the same as in August 2007 (Graph 2.2). Box 2.4 Sale of share in EPCG capital to the Italian partner In 2009, EPCG got a strategic partner, an Italian company A2A which became the owner of 43.7% of stake in the company. In May, A2A purchased (through block transaction) 17.4 % of EPCG shares from privatization funds for EUR million. Then the Italian company paid EUR 96 million to the Government and 96 EUR to the EPCG for the respective million of Government shares and for the company recapitalization, and finally, it purchased 85% (12.02 million of shares) through block transaction of minority shareholders shares in the amount of EUR million. Thus, minority shareholders received EUR million, EPCG and Government EUR 96 million each, while the Montenegrin investment funds received EUR million from the sale. The inflow of funds from the sale of EPCG share was noticeable through significant monthly growth rates in deposits in Table 2.9 Deposits growth % 2008/ /2008 Financial institutions Corporate sector Households General Government Other Total In 2009, all sectors recorded deposits decrease, unlike in 2008 when three of the five sector deposits (corporate sector, households and General Government) recorded declines. The corporate sector deposits (Table 2.9) recorded the highest decline in absolute terms (EUR 79.4 million). The deposit structure per sectors/industries shows that the household sector accounted for the largest portion (46.2%) which is not favourable with regard to the banks exposure to individual sectors. This was followed by deposits by the finance sector (11.3%), category other (6.9%), administration and other public services (6.8%), transportation, warehousing and postal 26 First from deposits of the investment funds (sale of EPCG share from their portfolio, in May), and later from the sale of state share of the package of minor shareholders share of the EPCG (in September and November 2009)

73 Monetary Developments 73 and telecommunication services (6.7%), tourism (services, tourism, catering), (6.4%), trade (5.8%) and energy (5.7%) (Graph 2.3). Graph 2.3 Deposits by households, corporate sector and other, in EUR million At end-2009, the maturity structure of total deposits showed the main share of short-term deposits (with the maturity period of up to one year) of 87.7%, this being the same for the structure of time deposits. Short-term deposits with the maturity up to 3 months and from 3 months to one year, made up 80.5% of time deposits (Table 2.10). Table 2.10 Maturity structure of deposits, % Demand deposits Time deposits To 3 months From 3 months to 1 year From 1 to 3 years Over 3 years Box 2.5 Loans to deposits ratio in countries in the region at end-2009 Table below shows deposits/loans ratio for the household and corporate sectors in the regional countries. As it can be seen, loans exceeded deposits in Serbia, Bosnia and Herzegovina and Montenegro, in Albania and FYR Macedonia they were above the level of available deposits, while in Croatia, deposits and loans were at the same level. Households were net debtors in Bosnia and Herzegovina and Montenegro, while in other countries they were net depositors in the system. The corporate sector was a net debtor in the banking systems in all the selected countries, whereby net debt was the largest in Albania, Montenegro and Serbia. Table 1 Loans to deposits ratio in countries of the region, end-2009 Loans/Deposits Total Households Corporate Croatia 1 0,85 2,17 Serbia 1,29 0,68 2,33 Bosnia and Herzegovina 1,19 1,16 2,1 FYR Macedonia 0,95 0,58 2,02 Albania 0,66 0,26 3,01 Montenegro 1,31 1,09 2,66 Source: Websites of the selected national banks

74 74 Chief Economist Annual Report Foreign assets and liabilities of banks Foreign assets of banks 27 fluctuated over 2009 and at the year-end they reached the amount which was 31.1% higher in relation to 2008 (Table 2.11). In the structure of foreign assets, banks` deposits in banks abroad accounted for the main share (70.3%), followed by cash 28 (17.5%) and loans to non-residents (12.2%). At end-2009, foreign liabilities of banks 29 were 17.3% lower than a year ago (Table 2.12). In the structure of foreign liabilities of banks, the main share was recorded by loans of banks/financial institutions from abroad (66.9%) and deposits (32.6%), while a minor part of foreign liabilities of banks (0.4%) referred to liabilities for issued debt securities. Table 2.11 Foreign assets, period-end, EUR thousand Description/Period Foreign assets, total 61, , , , , ,802 Deposits 44, , , , , ,591 Cash (EUR and other currencies) 16,639 27,877 44,620 71,471 48,404 57,292 Loans 1,093 2,186 3,185 27,131 41,647 39,919 Securities, without shares - - 5, Table 2.12 Foreign liabilities, period-end, EUR thousand Description/Period Foreign liabilities, total 80, , , ,923 1,257,419 1,039,624 Loans (borrowings) 52,266 72, , , , ,603 Deposits 28,363 51, , , , ,422 Securities, without shares ,577 4,587 4,599 In 2009, borrowings from abroad amounted to EUR million, and in relation to end-2008 they decreased by 16.1%. This decline was obvious from April 2009, when they reached their maximum value of EUR million (Graph 2.4). If the CBM recommendation regarding the signing of the arrangement with the IMF had been implemented, Montenegro would have been a part of the Vienna initiative, and this credit support would not be lower and the level of lending activity would probably be higher. In 2009, ten banks used foreign borrowings, whereby the highest amounts were borrowed from Hypo Alpe Adria Bank AG, Societe Generale Bank, OTP Bank Hungary, EFSE and KFW. 27 Banks claims on non-residents 28 Cash in EUR and other foreign currencies 29 Banks` liabilities to non-residents.

75 Monetary Developments 75 The maturity structure of foreign borrowings shows the main share of long-term borrowings (96.7%). The currency structure of foreign borrowings indicates that banks mostly borrowed in euros (84.5%). Graph 2.4 Borrowings from abroad EUR million Net foreign assets amounted to EUR million at end-2009 (net foreign assets amounted to EUR -1,007.4 at end-2008). Such a level of net foreign assets resulted from an increase in deposits in foreign banks (44.2%) and cash in vaults (18.4%), as well as from a decline in deposits (19.8%) and banks foreign borrowings (16.1%). According to foreign liabilities to total assets ratio, it can be concluded that non-residents financed 34.4% of banks assets. On the other hand, 10.8% of banks assets referred to liabilities towards non-residents. The gap between foreign assets and liabilities declined at end-2009 to reach 23.5 percentage points (Graph 2.5). Graph 2.5 Share of foreign assets and liabilities in total assets, Montenegrin banking sector, % If compared with countries in the region, it can be concluded that the banking systems of most countries were net debtors to non-residents (Table 2.13). However, despite the evident decline in net debt to foreign countries, the Montenegrin banking system is still the biggest debtor among other countries in the region. Table 2.13 Net foreign assets as the balance sheet percentage, period-end Country Croatia Bosnia and Herzegovina Macedonia Serbia Albania Montenegro

76 76 Chief Economist Annual Report Household sector Loans to the household sector were on a downtrend over the entire An average monthly decline in loans amounted to 1%. Observed at the annual level, loans granted to households decreased by EUR million or 11.4%, and at end-2009 they amounted to EUR million. Since these were mostly long-term loans from the previous period (89.3%, were loans with the maturity over three years), earmarked loans accounted for the main share, especially housing loans and loans for the reconstruction of residential or business premises (83.7% of total earmarked loans). Mortgage loans also recorded a significant share in total loans of 17.3%. At the year-end, the number of indebted natural persons with domestic banks amounted to 117,045 (16.9 thousand clients less than in 2008). The average indebtedness per household, measured by the ratio of debt of this sector and the number of indebted citizens (banks clients) at the year-end amounted to EUR 7,854, while debt per capita amounted to EUR 1, Debt per client increased in relation to the previous year when it amounted to EUR 7,745, while at the same time debt per capita was EUR 200 lower. A certain number of clients were substantially indebted which points to a growth in households debt concentration. Although households net debt declined in 2009, 27.3% of total past due loans referred to loans granted to natural persons and current account and credit cards overdrafts. Since there was no traditional lending, households credit card borrowing was significant especially at the beginning of Box 2.6 Debt per capita in the region at end-2009 Graph 1 Per capita indebtedness in EUR in countries in the region, end-2009 According to the central banks data at end-2009, Croatia, Montenegro and Bosnia and Herzegovina recorded the highest indebtedness. Debt per capita in Croatia amounted to EUR 3,647. Every Montenegrin citizen had the average debt of EUR 1,459, while in Bosnia it amounted to EUR 1,397. The average per capita indebtedness in Serbia amounted to EUR 594, and in Macedonia EUR 574. The lowest debt to banks in the region was recorded in Albania, with the average debt per capita of only EUR 339. Source: Websites of the selected national banks 30 Number of Montenegrin residents in 2009 amounted to 630,095.

77 Monetary Developments 77 Graph 2 Savings per capita in EUR in countries in the region, end-2009 Savings per capita in the previous year were highest in Croatia (EUR 4,310), followed by Montenegro (EUR 1,339), Albania (EUR 1,279) and Bosnia and Herzegovina (EUR 1,201). The average per capita savings in FYR Macedonia amounted to EUR 994, and EUR 875 in Serbia. However, the nominal amount of savings per capita was higher than debt per capita in all of the countries, except in Bosnia and Herzegovina and Montenegro. Source: Websites of the selected national banks Deposits by households had been declining in the first five months of 2009, while since June they recorded ongoing gradual growth, which was especially significant for the regaining of trust in the banking system. The highest growth in household deposits was recorded in October (5.7%), when the largest part of households earnings from the sale of EPCG shares was transformed in savings. At end-2009, households deposits were 1.5% lower in comparison with end-2008 (Graph 2.6). Graph 2.6 Households deposits, monthly growth in EUR million (left) and growth in % (right) The maturity structure of households deposits at the year-end was not very favourable despite very stimulating deposit interest rates offered by banks. Some 87.2% of total households deposits referred to short-term deposits (up to one year), while the remaining 12.8% referred to long-term deposits, mainly deposits with the maturity from one to three years. Loans to deposits ratio for the household sector amounted to 1.09 at the end of the year and it was more favourable than at end-2008 when it amounted to Since May, loans to deposits ratio was improving, which influenced the decline in households net debt which reached EUR 75.4 million at end-2009 (Graph 2.7).

78 78 Chief Economist Annual Report 2009 Graph 2.7 Deposits, loans and households net debt, in EUR thousand Graph 2.8 Corporate sector deposits, loans and net debt, in EUR thousand Corporate sector In the period of the economic boom, banks` excessive appetite for risk without adequate provisioning and capital burdened the banking sector in The poor and in the meantime devaluated collateral security which could not be easily collected, matured past due loans, inadequate maturity match between liabilities and claims increased the banks precaution. Banks reduced their lending activities down to the minimum. The precaution was especially taken with regard to companies, since during the year it became obvious that the crisis transferred to the real sector causing great problems for the corporate sector liquidity. The number of good projects and solvent clients which banks were willing to finance was declining, thus some credit lines for the development of small and medium enterprises, obtained against the state s guarantee, remained unused. In 2009, loans to and deposits by the corporate sector substantially declined. An average monthly decline of loans amounted to 1.6% while that of deposits was 0.4%. The rate of decline in deposits would have been even higher if the deposits had not significantly increase in September due to the sale of EPCG shares. A much higher annual decline in loans (18.1%) than a decline in deposits (13.5%) resulted in a 20.6% decrease of the corporate sector s net debt to the banking system. Nevertheless, the corporate sector s net debt remained very high and at the end of 2009 it amounted to EUR million (Graph 2.8). Although the loans/deposits ratio of the corporate sector improved at end-2009 (2.66) in relation to end-2008 (2.81), loans granted to the corporate sector were above the level of their deposits over the entire year, thus the corporate sector represented the most significant net debtor in the system. The maturity structure of the corporate sector debt at the year-end shows that long-term loans accounted for the main share (67.3%), these being mostly loans maturing after three years (41.4%). The maturity structure of the corporate sector deposits, unlike the maturity structure of loans to this sector, points to the dominant share of short-term deposits (maturity up to one year) wherein demand deposits accounted for the main share. Regarding the corporate sector deposits with the maturity over one year, the main share was of deposits with the maturity from one to three years.

79 Monetary Developments 79 Box 2.7 Enforced collection In the Central registry of accounts there were 50,186 legal and natural persons performing corporate activity at end-2009, which is 10.4% or 4,740 persons less than at end Of the total number of legal and natural persons, 24.4% or 12,254 persons accounts were frozen. Total debt in the frozen accounts amounted to EUR million at end-2009 or EUR 84.5 million more than a year ago. Some 36.2% of total debt referred to 50 largest debtors, which points to its high concentration. In addition, accounts of 27 of 50 largest debtors, whose debt accounted for 18.2% of total debt, were continuously frozen in a period longer than one year. The rest of the debt of EUR 32.3 million referred to the remaining 23 largest debtors, whose accounts were frozen for less than a year Capital of banks In 2009, banks capital recorded a positive trend and at the year-end it was 18.7% higher than at end With a view to increasing their capital pursuant to the new CBM Decision on Capital Adequacy of Banks 31, banks issued shares to the amount of EUR 77.1 million 32 in This recapitalization was significant for the improvement of depositors confidence in the system as a whole. However, according to comparative data at end- 2009, despite the fact that the majority of banks substantially increased their capital over the year, their level of capitalization was lower than that of banks in the region. Recapitalization of banks was above the planned level of EUR 100 million for One of the reasons for undercapitalization of Montenegrin banks was the strict provisioning policy (until the adoption of a set of monetary policy measures aimed to relax and stimulate lending activity of banks at the year-end), as well growth in losses which simply ate new capital. Table 2.14 Total capital to assets ratio of banks, % Country/period XII 2007 XII 2008 XII 2009 Montenegro Serbia Croatia FYR Macedonia Bosnia and Herzegovina Albania Table 2.15 Total capital and loans ratio, % Country/period XII 2007 XII 2008 XII 2009 Montenegro Serbia Croatia FYR Macedonia Bosnia and Herzegovina Albania OGM 60/08 32 Including issue premiums

80 80 Chief Economist Annual Report 2009 The capitalization index against assets and loans was the lowest in the region. Thus, for example, the capitalization index against loans was almost two to three times lower in relation to other countries in the region (Tables 2.14 and 2.15). Therefore, it will be necessary to continue with the recapitalization process in 2010 in order to ensure safe banking operations Table 2.16 Capital adequacy ratio by countries, end-2009 and banks` ability to manage all operational, internal and external risks. Country Solvency ratio Croatia 15,9 Serbia 21,3 Bosnia and Herzegovina n.a. FYR Macedonia 16,5 Albania 16,7 Montenegro 15,8 The solvency ratio at the aggregate level amounted to 15.75% 33 and in relation to end-2008 it was 15.04% higher and above the prescribed level of 10% according to the Banking Law (Table 2.16). In the total capital structure, the state s share amounted to a mere 2.6%, that of domestic private capital was 16.08%, while the share of foreign capital amounted to 81.33%. Box 2.8 Rating and position of parent banks of Montenegrin banks In 2009, three leading rating agencies - Standard & Poors, Moody`s and Fitch decreased their rating for some parent banks of Montenegrin banks, and for some banks the rating remained the same. Table 1 Long-term rating of selected parent banks of Montenegrin banks NLB OTP Societe Generale Hypo Alpe Adria Erste Group Bank AG EBRD(25% of Commercial Bank ad Belgrade) Moody`s S&P`s Fitch Stable A1 (worsened from Aa3) No rating Stable A- Negative Baa1 BB+ (worsened from A3) (worsened from BBB) n.a. Negative Aa2 Stable A+ Stable A+ (unchanged) (worsened from AA-) (worsened form AA-) Negative Baa2 (worsened from Baa1) No rating No rating Negative Aa3 Negative A Stable A (unchanged) (unchanged) (unchanged) Stable Aaa Stable AAA Stable AAA (unchanged) (unchanged) (unchanged) Moody s agency assigned B1 rating to Atlasmont Bank in 2009 and confirmed a stable outlook. According to Moody s, the assessment reflects historical financial base of this bank, good solvency, liquidity and profitable income statements in the past six years. 33 The solvency ratio was calculated in accordance with the new Decision on Capital Adequacy of Banks, thus the data are not fully comparable with the previous year.

81 Monetary Developments 81 In 2009, parent banks provided significant support to their daughter banks/subsidiaries in Montenegro. Through lending 34 and recapitalization, they contributed to the stability of the Montenegrin banking system and the protection and safety of depositors, thus providing growth in liquidity and solvency of their subsidiaries in Montenegro. Table 2 Recapitalization of banks in 2009, EUR million 1. Hypo Alpe Adria OTP CKB Societe General Podgoricka Bank, 10,1 4. NLB Montenegro Bank 5,0 TOTAL 77,1 Box 2.9 Acquisition and nationalization Erste&Steirmarkishe Bank d.d. Rijeka - Acquisition of Opportunity Bank Montenegro In January 2009, the Council of the Central Bank of Montenegro granted a permission to Erste & Steirmarkishe Bank d.d. Rijeka, a member of the Erste Group Bank AG from Vienna, for the purchase of 100% of capital of Opportunity Bank AD Podgorica. Data on its operations in 2009 point to the following: ROA amounted to 1.3%; ROE amounted to 11.4%. Increase of assets in 2009 amounted to 7.4%, that in deposits 7%, and growth in loans was 7.5%. Only net earnings were 22.9% lower due to higher loss provisions. Nationalization of Hypo Alpe Adria Group from Austria Due to bad investments and accumulated problems caused by risk mismanagement, Hypo Alpe Adria Group (HAAG) faced problems in 2009 threatening the bank bankruptcy. Despite the fact that it is the sixth bank according to the market share in Austria, it was proclaimed as systemic bank whose collapse would have long-term negative consequences on the banking system of Austria, as well as other European countries. Therefore, in December 2009, Austria nationalized Hypo Alpe Adria, thus financially insuring its depositors. The sale of the bank to the state of Austria cost the previous owners (Bavarian Regional Bank Bayern LB 67%, Grawe insurance agency from Gratz 20.5% and Austrian region Koruska 12.5%) too much. They had to allocate EUR 1.5 billion to save the bank: the largest owner Bayern LB had to pay EUR 825 million, Koruska EUR 200 million, Grawe EUR 30 million, while the state of Austria paid EUR 450 million. Thus, Hypo Alpe Adria Bank received additional capital to the amount of EUR 1.5 billion, which increased its solvency by 8%. The previous owners will inject liquidity in HAAG to the amount of EUR 3.4 billion. According to the bank s management, the bank will end 2009 with a loss of EUR 1.45 billion. 34 Out of total borrowings (EUR 734 million at end-2009) foreign borrowings accounted for 94.8%, where 85% referred to borrowings from parent banks.

82 82 Chief Economist Annual Report 2009 Taking over of Hypo Alpe Adria by the state of Austria will provide for bank recapitalization, stabilization and successful business continuity which could also be useful to foreign daughter banks subsidiaries, including the bank operating in Montenegro as an independent legal person. Loss at the banking system level amounted to EUR 21.6 million at end This negative result would have been even higher if the CBM had not relaxed assets classification for provisioning for contingent losses by amending its Decision on minimum standards for credit risk management in banks at end In addition, two banks in the system displaced EUR 180 million of claims from loans through their sale to the parent banks. This decreased loan and systemic risks, moderated loss at the system level and improved capital adequacy. Box 2.10 Procyclicity challenge for (monetary) policy makers Macroeconomy grows or declines over time in series of repeated expansions and contractions. One business cycle begins with the expansion period and continues with the contraction. Business cycles repeats periodically in regular time intervals. Each business cycle is unique regarding the time of duration, bottom and peak it reaches. Procyclicity 35 represents a manner of exaggerated improvement or worsening of the cyclical aggregate economic trends. It is undesirable because it creates uncertainty. This is particularly obvious in the financial system. Economic policy makers have to aim to moderate peaks and gaps of usual business cycles through prudential regulations, accounting standards, risk measurement practices and monetary policy. The aim is to create a less pro-cyclical system to render the financial system less sensitive to strong shocks (booms, negative shocks, expansion or contraction). Careful monitoring of the pro-cyclical effects has to be overseen in order to prevent excessive credit contractions during a declining phase or credit relaxing during a growth phase. Banks should be stimulated to grant profitable loans based on realistic lending conditions and proper assessment of borrowers` creditworthiness. The issue of present procyclicity, however, is not simple and its consideration requires a careful balancing of important public policy interests. First of all, policy makers should revise the existing rules, measures and standards in order to determine which of these rules should be modified to diminish the possibility of pro-cyclical effects and enable the attainment of desired objectives. 35 Some economic categories (GDP, industrial output, earnings, loans ) are positively correlated, and move in the same direction as the economy (growth-decline). For such economic categories we say they are pro-cyclical. For the economic size which is negatively correlated with movement of aggregate economy we say it is countercyclical. There are also categories which are independent from the total economic condition and they are not cyclical

83 Monetary Developments Lending interest rates At end-2009, lending interest rates were almost at the same levels as in December Many factors affected the movement of lending interest rates. Growth in global liquidity, owing to enormous injections of monetary assets by central banks, was used to cover costs and losses of own systems, and thus less foreign borrowings were available to Montenegrin banks 2009 (EUR million less than at end-2008). In addition, risk premium increased, due to lower quality of credit portfolios of domestic banks. Observed at the internal level, risk premium growth was influenced by the lack of liquidity and problems with the collection of claims from companies and natural persons. Recorded asset losses and growth of uncollected claims worsened the financial result which induced additional resistance to a decrease in lending interest rates. 36 Table 2.17 Expected influence on interest rates in 2010 Expected growth in reference rates (Euribor, Libor) High risk premium (global level) => Growth (high level) in loan prices => Increase of loss due to uncollectable placements Growth in risk premium (internal) Growth in prices of foreign financing sources Decline in ROE => Growth (high level) in loan prices In 2009, weighted average lending effective interest rates (WALEIR) recorded a gradual moderate growth (except the noticeable decline in January), almost reaching the level as at end In December, WALEIR amounted to 9.38%, being a mere 0.02 percentage points lower in relation to the previous year-end (Graph 2.9). Graph 2.9 Lending interest rates at the system level, annual level, % Observed by sectors (private, government, foreign), a slight growth was recorded in interest rate on loans granted to the private sector that amounted 9.45% at end-2009, which is 0.05 percentage points more than at the end of 2008 (9.40%). Interest rates on loans to the state declined by 1.30 percentage points and that on loans to the foreign sector by 1.33 percentage points (Graph 2.10), reaching the respective 8.72% and 7.18% at end-december Such movements on interest rates indicators is largely influenced by the weighting methodology and share of loans granted in the previous period which account for a substantial share in the structure of total loans granted, thus a growth in lending interest rate, particularly on new loans, may be more significant in practice than as shown in the methodology.

84 84 Chief Economist Annual Report 2009 Graph 2.10 WALEIR by sectors, annual level, % The interest rates on loans to natural persons declined, while those on loans to legal persons increased at the annual level. The WALEIR on loans to natural persons amounted to 10.53%, recording a minor decline of 0.23 percentage points, while the WALEIR on loans to legal entities amounted to 8.66% with the growth of 0.08 percentage points (Graph 2.11). Graph 2.11 WALEIR on loans to natural and legal persons, annual level, % Graph 2.12 WALEIR by maturity, annual level, % Observed by industries, the WALEIR recorded the annual growth on loans granted to the mining and energy sectors, construction and trade, while that on other industries recorded decline (Table 2.18). Observed by maturity (Graph 2.12), short-term interest rates continued their upward trend as of the third quarter of 2008, yet starting to decline from mid-2009 until the year-end. Such a movement is due to large demand and insufficient supply of short-term loans (interest rate uptrend phase), as well as due to the repayment of a substantial part of short-term loans in the second half of the year (interest rate downtrend phase). A decline in the number of bank clients (16.9 thousand fewer clients) is also an indicator of repayment of short-term loans at the annual level. At year-end, however, interest rates on short-term loans were significantly above those on longterm loans (by 1.01 percentage points). Interest rates on short-term loans at end-2009 amounted to 10.30%, while those on long-term loans amounted to 9.29%.

85 Monetary Developments 85 Table 2.18 WALEIR on loans to legal persons by industries, annual level, % Industry 1. Agriculture, hunting, fishing 2. mining 3. Production 4. Energy 5. Construction 6. Trade 7. Services, tourism, catering 8. Transport, warehousing, postal and telecommunication services 9. Finances 10. Real estate trade 11. Administration and other public services 12. Other Rate XII XII III VI IX XII Nom Eff Nom Eff Nom Eff Nom Eff Nom Eff Nom Eff Nom Eff Nom Eff Nom Eff Nom Eff Nom Eff Nom Eff Box 2.11 Interest rates An expansive lending policy of the majority important central banks over 2009 was followed by declines in the reference interest rates, but also by declines in interest rates at which the leading (European) banks were willing to borrow funds to each other at the interbank (European and London) market. Our banks use some of these rates in their calculation of variable interest rates. They mostly use 3-month and 6-month EURIBOR, while one bank uses also 3-month LIBOR (CHF).

86 86 Chief Economist Annual Report 2009 Graph 1 Movement of 3-month LIBOR (CHF) Source: British Bankers Association Graph 2 Movement of 6-month and 3-month EURIBOR, All three rates reached their record lows at end That is why it is occasionally heard that during strong market turbulences these rates lose their quality as indicators which should properly reflect the situation in the debt market, financial markets in general and the real economy. Leading banks are ready to borrow to each other at these rates, but not to anyone else. However, from the aspect of commercial banks, as being obvious for long-term loans, variable rates (with the EURIBOR and the LIBOR and the fixed margin), are more resistant to interest rate risk, especially if we take in consideration their currently the lowest level and potential future growth. The following graphs show the movement of average lending interest rates on some type of loans in the banking sectors of Bosnia and Herzegovina, Croatia, FYR Macedonia and Serbia in the period Interest rates on loans in domestic currency were significantly above those on loans granted in domestic currency containing the currency clause, as well as on foreign currency loans Source: Reuters (European Banking Federation) (Bosnia and Herzegovina, Croatia and FYR Macedonia). Debt monetization caused by the crisis created a pressure on national currency devaluation, increasing the risk of borrowing in domestic currencies which, consequently, reflected on the level of interest rates. The presented movements of interest rates on loans were predominantly stable, without any significant fluctuations in In 2010, stagnation of the lending interest rates is the maximum that could be expected, while it is unreasonable to expect their significant decline. 37 The graphs show only the interest rate trends because since it is impossible to compare interest rates among countries due to methodology differences.

87 Monetary Developments 87 Graph 3 Selected interest rates in Bosnia and Herzegovina, Source: Central Bank of Bosnia and Herzegovina Graph 4 Selected interest rates in Croatia, Source: National Bank of Croatia

88 88 Chief Economist Annual Report 2009 Graph 5 Selected interest rates in FYR Macedonia, Source: National Bank of the Republic of Macedonia Serbia recorded a declining trend in long-term and short-term interest rates on loans in dinars, as well as higher interest rates on long-term loans, which were above the level of interest rates on short-loans in 2009 (with the exception of May and June). Graph 6 Selected interest rates in Serbia, Source: National Bank of Serbia

89 Monetary Developments Deposit Interest Rates Deposit interest rates had been declining until September 2009, when they reached the lowest level (3.64%). After that, they gradually increased and at end-december WADEIR reached 3.87%. In relation to December 2008, WADEIR at the system level declined by 0.24 percentage points (Graph 2.13). As of July 2009, positive developments related to the ending of bank run and constant monthly growth in household deposits improved the liquidity of banks and opened a window for a decline in deposit interest rates. Graph 2.13 WADEIR, end-month, % At end-2009, the interest rate spread (difference between lending and deposit interest) amounted to 5.51 percentage points, while at end-2008 it amounted to 5.30 percentage points (Graph 2.14). Compared to countries in the region, the interest margin of Montenegrin banks was lower than that of Serbian and Croatian banks, while it was higher in relation to Albania and FYR Macedonia. The spread will remain considerably high in the next year due to reduced solvency of bank clients. WADEIR on deposits by natural persons amounted to 4.50% (a 0.20 percentage points increase in relation to December 2008), while on deposits by legal persons it was 3.32% (a 0.63 percentage points decrease in relation to December 2008). The interest rate spread on loans granted to natural persons amounted to 6.03 percentage points (6.46 percentage points in December 2008), while on loans granted to legal persons it was 5.34 points (4.63 percentage points in December 2008). Graph 2.14 Spread* of region countries, end-month, %** Observed by maturity, the WADEIR amounted to 0.89% on demand deposits; 4.97% on deposits with maturity up to three months; 5.86% on deposits with maturity from three months to one year; 5.85% on deposits with maturity form one to three years; 5.80% on deposits with maturity from three to five years and 5.83% on deposits with maturity over five years. In relation to the * Difference between effective, weighted average, lending and deposit interest rates on total loans and deposits in the system ** Latest available data end of the previous year, the WADEIR on total deposits, deposits with maturity up to three months and deposits with maturity up to three years declined, while that on other deposits increased.

90 90 Chief Economist Annual Report Banks Reserve Requirement In 2009, the CBM significantly changed the reserve requirement policy. The regulations 38 prescribing the implementation of reserve requirement instruments were amended in February and June The result of the amended reserve requirement policy and deposits movements, the allocated reserve requirement as at 31 December 2009 amounted to EUR million which represents a decrease of EUR 43.8 million or 20.2% in relation to end-2008 (Table 2.19). Table 2.19 Allocated reserve requirement, deposits, borrowings, in EUR million III VI IX XII III VI IX XII Allocated reserve requirement 278,8 283,2 287,6 216,6 202,2 180,4 168,2 172,8 Total deposits 2.140, , , , , , , ,7 Total borrowings 618,7 742,2 777,8 908,2 990,5 971,3 874,4 734,8 The share of allocated reserve requirements in total bank deposits decreased from 10.9% as at the end of 2008 to 9.5% as at end Table 2.20 Allocated reserve requirements to total bank deposits and borrowings ratios, % Description/Period III VI IX XII III VI IX XII RR/total deposits RR /total deposits + borrowings Table 2.21 shows that the allocated reserve requirement/total deposits ratio, that is, bank assets in Montenegro was among the lowest in the region. Table 2.21 Reserve retirement/total banks deposits and assets ratio, end-2009,% Reserve requirements/deposits Reserve requirements/assets Bosnia and Herzegovina 24.4% 14.3% Montenegro 9.5% 5.7% Croatia 11.2 % 7.6 % FYR Macedonia 13.9% 8.5% Serbia 10.1% 4.8% 38 Decision on bank reserve requirement to be held with the CBM (OGM 9/07, 05/08, 15/09, 41/09) and Decision on using bank reserve requirement held with CBM for a period longer than one day (OGM 65//08, 15/09, 41/09)

91 Monetary Developments 91 The structure of reserve requirements significantly changed in relation to 2008, since in 2009 eight banks used the possibility of allocating a part of their reserve requirement in the form of T-bills. At end-2009, banks allocated EUR 38.4 million in T-bills or 22.2% of the total allocated reserve requirements. Some 65.9% was allocated to the reserve requirement account in the country, while 11.9% was allocated to the CBM accounts held abroad (Table 2.22). Table 2.22 Structure of allocated reserve requirements, % Description/Period III VI IX XII III VI IX XII Reserve requirement account in the country T-Bills Reserve requirement in CBM accounts abroad During the first five months of 2009, three banks used their reserve requirement for liquidity maintenance in line with the Decision on bank reserve requirements to be held with the Central Bank of Montenegro for a period longer than one day. In the period June-December 2009, reserve requirement was not used for liquidity maintenance purpose, but one bank recorded a lower level of the reserve requirement than that prescribed in the period June-September At end-2009, all banks maintained the prescribed level of reserve requirements Amendments to the Reserve Requirement Policy in 2009 At end-february 2009, the CBM changed regulations governing the application of reserve requirement instruments. The amendments enabled banks to keep a part of their reserve requirements (up to 20%) in the form of T-bills, issued by the state of Montenegro. The replacing of differential reserve requirement rates (19% and 2%) with the unique rate of 11% on all deposits with banks represents a novelty. In addition, period of the reserve requirement used for liquidity maintenance was prolonged from seven to ten working days. In addition to the aforementioned changes, the interest rate charged for the use of reserve requirement for liquidity was decreased from 5% to 4%, while the default interest rate charged for a delay in returning the used reserve requirement funds to meet the minimum reserve requirements to be held with the CBM was reduced from 11% to 9%. The interest rate paid by the CBM on 30% of the total allocated banks reserve requirements amounted to 1% at the annual level. At end-june 2009, the CBM again changed the reserve requirement policy. This released banks from allocating reserve requirements on the deposits growth recorded in relation to the first accounting period from June 2009, and they were enabled to keep up to 25% of the reserve requirement in T-bills. The reserve requirement rate declined from 11% to 10%, and the interest rate on the use of reserve requirement for liquidity for a period longer than one day is determined according to the annual ECB s interest rate for the principal refinancing operations increased by 0.5 percentage points. The default interest rate charged for a delay in returning used reserve requirement funds for liquidity is set at the level of 7%. The CBM interest paid on 25% of total bank allocated reserve requirement funds still amounts to 1% at the annual level.

92 92 Chief Economist Annual Report Microcredit Financial Institutions At end-2009, total assets of microcredit financial institutions (MFIs) amounted to EUR 75.4 million or EUR 3.7 million (4.7%) less than at end-2008 (Table 2.23). Table 2.23 Total assets of MFIs, three-month period, EUR thousand Description/Period III VI IX XII III VI IX XII MFI assets 62,034 69,432 69,974 79,124 77,312 77,667 75,549 75,430 Concentration in the MFI sector is strong as 69.2% of total assets, 71.8% of total loans and 73% of total borrowings are held by one MFI. At end-2009, gross loans accounted for the main share MFIs` assets, 87.3%, whereas borrowings made up the main share of liabilities, 71.1%. At end-2009, total loans amounted to EUR 65.8 million or EUR 10 million (13.2%) less than at end-2008 (Table 2.24). Loan loss provisions made up 5.5% of total loans. Table 2.24 MFIs` total loans, three-month period, in EUR thousand Description/Period III VI IX XII III VI IX XII MFI loans 58,163 65,782 68,990 75,823 74,630 72,320 68,661 65,834 Graph 2.15 MFI loans by industries, end-2009, % Some 99% of loans were granted to natural persons. In the structure of MFIs` loan portfolios by industries, loans to agriculture made up the main share of 60.1%, and together with services, catering and tourism they made up 83.3% of total loans (Graph 2.15). In the maturity structure of loans, long-term loans accounted for the main share (95.5%). Past due loans made up 10.57% of total loans at end

93 Monetary Developments 93 Some 73.4% of liabilities referred to total MFIs` liabilities. 39 The largest MFIs` financing source came from borrowings, 94.9% of which came from non-residents. Total capital of MFIs amounted to EUR 20.1 million or 26.6% of total liabilities at the end of Of this amount, 70.2% referred to capital from donations and 28.9% from undistributed profit. At the aggregate level, MFIs ended the year with EUR 0.6 million profit. MFIs Interest Rates At end-2009, the weighted average nominal interest rate (WALNIR) on total loans amounted to 17.71% while the corresponding effective interest rate (WALEIR) amounted to 27.47%. The WANIR and WAEIR were by 3.7 percentage points and 0.66 percentage points higher in relation to end-2008, respectively (Graph 2.16). At end-2009, the WALEIR on total short-term loans amounted to 34,94%, while on long-term loans it was 27.14% (Table 2.25). The WALNIR on loans granted to legal persons amounted to 16.23% while the WALEIR was 26.80%. The WALEIR on short-term loans to legal persons amounted to 33.62%, while that on long-term loans was 26.33%. Graph 2.16 WALIR on total MFI loans, % WALNIR WALEIR XII XII III VI IX XII The WALNIR on loans granted to natural persons amounted to 17.73%, while the WALEIR amounted to 27.47%. The WALEIR on short-term loans amounted to 34.96%, while that on long-term loans was 27.15%. Interest rates at which banks and MFIs granted loans were significantly different. Namely, the WALNIR with banks amounted to 8.85% and the WALEIR amounted to 9.38%. The respective rates with MFIs amounted to 17.71% and 27.47%. Banks granted short-term loans at the of 10.30% while MFIs granted the same loans at the WALEIR of 34.94%. The WALEIR on long-term loans with banks amounted to 9.29%, while with MFIs it amounted to 27.14% (Table 2.25 and Graph 2.17). 39 Liabilities for loans and borrowings, conditional grants, subordinated debt and other liabilities

94 94 Chief Economist Annual Report 2009 Table 2.25 Interest rates of banks and MFIs at end-2009 Short-term Long-term Total Natural persons Legal persons Total loans banks MFI banks MFI banks MFI WALNIR WALEIR WALNIR WALEIR WALNIR WALEIR Graph 2.17 Interest rates of banks and MFIs, %

95 3 MONEY AND CAPITAL MARKET

96

97 Money and Capital Market Money Market Seven auctions of 182-day T-bills were held in 2009, with the total issue amounting to EUR 106 million. Graph 3.1 Sold amounts and interest rates on 182-day T-bills in 2009 Of total 182-day T-bills issued in 2009, EUR 84.2 million or 79.5% were sold. Total demand was EUR million and it exceeded the supply by 0.21%. The buyers at all T-bill auctions were Montenegrin banks, whereas the Deposit Protection Fund appeared as a buyer at one auction. The average recorded interest rate to T-bills with maturity of 182 days was 3.85%. The interest rates at T-bill auctions in 2009 are shown in Graph 3.1. For the purpose of financing short-term budget spending, 155 auctions of four T-bill types (with maturity of 28, 56, 91 and 182 days) have been held since The amounts of issued and sold T-bills had been on an uptrend until 2005, when their downward trend started. Through more rational budget spending and higher budget revenues, the implementation of the Public Debt Management Strategy resulted in a first-time budget surplus in Part of the strategy referred to decreasing budget indebtedness by issuing T-bills. The value of total T-bills sold in 2006 was EUR 96.4 million lower than in Decreasing budget indebtedness by issuing T-bills continued in Two auctions of T-bills were held in 2007, with the total EUR 1.8 million worth of T-bills sold. There were no T-bill auctions in In 2009, the Government decided to issue T-bills in order to mitigate the effects of the global economic crisis on the realization of the Source: CBM Graph 3.2 Offered and sold T-bills at auctions Source: CBM

98 98 Chief Economist Annual Report 2009 planned budget. Some EUR 84.2 million or 79.5% of T-bills were sold in 2009, speaking of substantial budget indebtedness through the issuing of T-bills in relation to the previous year. Namely, there was no organized sale of T-bills since February 2007, because the state budget has been recording surpluses Capital Market Although the global financial crisis had a significant influence on the capital market in 2008, the signs of recovery became visible in However, it should be noted that the recapitalization and sale of the minority share in EPCG were the key improvement factors in this area. Table 3.1 Comparison of turnover at Montenegrin stock exchanges (relative changes) Period Total turnover at Montenegrin stock exchanges Calculation: CBM I-XII`09 I-XII`06 I-XII `09 I-XII `07 Graph 3.3 Total turnover (in EUR million) and number of transactions at Montenegrin stock exchanges in 2009 and 2008 I-XII `09 I-XII `08 7.6% -44.2% 153.1% The capital market was characterized by cyclical trends in Turnover recorded in May and September made up 61% of total annual turnover at the Montenegrin stock exchanges, and it was 54% higher than the turnover in the entire The sale of EPCG shares accounted for 62% of turnover structure, which recapitalization mostly guided the expectations and events at the stock exchange in The turnover at the Montenegrin stock exchanges in 2009 amounted to EUR million, and it was achieved through 58.8 thousand transactions. In relation to 2008, the turnover increased by 153.1% or EUR million, whereas the number of transactions was 29.5% lower. The average monthly turnover amounted to EUR 33.8 million being much higher than in 2008, when it amounted to EUR 13.4 million. However, if the transactions including EPCG were to be excluded, the average monthly turnover would amount to EUR 15.2 million, and it would be slightly higher than the one recorded in Most of the turnover was through secondary trade, whereas primary trade accounted for only 0.6% of turnover. Source: Nex Montenegro and Montenegro stock exchanges Most of the turnover and transactions were realized through the Montenegro stock exchange (60.0% of total turnover and 68.1% of total transactions), and the rest through Nex Montenegro stock exchange (40.0% of total turnover and 31.9% of transactions).

99 Money and Capital Market 99 Nominal amounts of total turnover and the number of transactions presented in the table below show the growth and decline rate of the investors interest. After a substantial decline in turnover in 2008, a slight recovery appeared in However, such a significant growth was due to the recapitalization of EPCG, we should be cautions while making conclusions on the recovery of this part of the financial market. Graph 3.4 Turnover at Montenegrin stock exchanges in 2006, 2007, 2008 and 2009, in EUR million Table 3.2 Historical overview of the turnover and the number of realized transactions at Montenegrin stock exchanges Year Turnover in EUR Number of million transactions , , , , , , , ,778 Source: Nex Montenegro and Montenegro stock exchanges Graph 3.5 Turnover at Montenegrin stock exchanges in 2009 Source: Nex Montenegro and Montenegro stock exchanges Turnover Structure In the total turnover structure, company shares turnover accounted for the major share (93.6%), followed by various bonds (4.0%), and units of joint investment funds (2.4%). Source: Nex Montenegro and Montenegro stock exchanges Compared to previous years, the turnover structure significantly changed, showing an increase in total turnover of company shares of 21.1 percentage points. Joint investments funds` turnover decreased by 14.9 percentage points, while that of bonds recorded a significant decline of 6.2 percentage points. A significant growth in company shares turnover was the result of trade in EPCG and Coal Mines shares.

100 100 Chief Economist Annual Report 2009 Table 3.3 Total turnover and turnover structure in 2006, 2007, 2008 and 2009 Turnover structure Absolute amount I-XII 2006 I-XII 2007 I-XII 2008 I-XII 2009 % of total turnover Absolute amount % of total turnover Absolute amount % of total turnover Absolute amount % of total turnover Shares ,04% ,4% ,4% ,6% Joint Investment ,87% ,2% ,3% ,3% Fund units Bonds ,09% ,4% ,3% ,0% TOTAL ,0% ,0% ,0% ,0% Source: Nex Montenegro and Montenegro stock exchanges Graph 3.6 Turnover (in EUR million) and number of company shares transactions in 2008 and 2009 Total turnover of Montenegrin companies shares amounting to EUR million in the previous year was recorded through 29.4 thousand transactions or 50.0% of totally transactions. The recorded turnover of shares was 3.4 times higher than in the previous year. The number of realized transactions in the comparative year was 5.9 thousand transactions lower. Source: Nex Montenegro and Montenegro stock exchanges Turnover of investment funds shares in 2009 was 93.2% or EUR million lower than in 2008, and it amounted to EUR 9.5 million, whereby 53.1% of total turnover of investment funds units was recorded at the Nex Montenegro stock exchange. Joint investment funds increased their value in relation to 2008, which points to substantial increase of the prices of shares in their portfolios, but the value of their assets is below that at end-2007 (Graph 3.8). The HLT joint investment fund was the only fund which assets recorded a decline in relation to 2008 yearend. Although the value increased when compared to the year of recession, the decline speaks of the fund s portfolio mismanagement relying only on capital gain and not on investments, thus increasing the mistrust of individual investors.

101 Money and Capital Market 101 The bigger part of the total bonds turnover in 2009, amounting to EUR 16.3 million, referred to restitution bonds (55.9%) 40, followed by the Pension and Disability Insurance beneficiary bonds (32.1%) 41, frozen foreign currency deposit bonds (7.8%), whereas the remaining 4.3% of turnover were municipality bonds. In 2009, there was no trading with bonds for road reconstruction. The high share of restitution and frozen foreign currency deposit bonds was influenced by the decision of the Ministry of Finance 42, which enabled debtors (natural and legal persons) to settle their liabilities to the state (paying taxes, repaying debts) with the restitution and frozen foreign currency savings bonds. The increase in the turnover of bonds was primarily due to the turnover of the Pension-disability insurance beneficiaries bonds (P09P, P09D, P10P, P10D, P11P). The bigger part of pension insurance beneficiaries, due to the low living standard, decided to sell them immediately upon acquiring this right in order to meet their basic living needs. Graph 3.7 Trends of turnover (in EUR thousand) and number of transactions of joint investment funds units at Montenegrin stock exchanges in 2009 Source: Nex Montenegro and Montenegro stock exchanges Graph 3.8 Value of joint investment funds Source: Nex Montenegro and Montenegro stock exchanges 40 The Law on Budget of Montenegro, OGM 12/07, has planned EUR 10 million for the purchase of restitution bonds in The nominal value of the bond is EUR 1. The broker house that was the best bidder committed to pay EUR 0.35 per bond, while their market value is slightly below this amount. 41 The Ministry of Finance issued Pension and Disability Insurance bonds to the total amount of EUR 105 million. The bonds have been maturing at 6 different series starting from 20 October The Law on Compensation to the Holders of Pension and Disability Insurance Rights (OGM 40/08) foresees that the pensioners may exercise their right to restitution for paying the electricity bills, taxes, the purchase of state company shares and companies owned by the Development Fund of Montenegro, which are in the process of privatization, as well as for the purchase residential premises, land and other state property. The nominal value of the bond is EUR Decision on the conditions and procedure of the debt buyback of Montenegro using frozen savings bonds and restitution bonds, OGM 17/08 as of 11 March 2008

102 102 Chief Economist Annual Report 2009 Graph 3.9 Trends of turnover (in EUR thousand) and number of transactions of bonds in Montenegrin stock exchanges in 2008 Source: Nex Montenegro and Montenegro stock exchanges Graph 3.10 Turnover of various bonds on Montenegrin stock exchanges in 2009 Source: Nex Montenegro and Montenegro stock exchanges Stock exchange indices In 2009, the Montenegro stock exchange index MOSTE recorded a growth of index points in relation to end 2008, i.e. 36.1% in relative terms. The maximum value was recorded in September, when it amounted to index points, which is 39.7% less than its maximum value reached at the beginning of This index recorded the maximum value in March, when it amounted to index points. Therefore, the index

103 Money and Capital Market 103 spread in 2009 was index points, being 2.2 times less than in 2008, which points that the variations of this index were much lower than in Graph 3.11 Movements of indices at the Nex Montenegro and the Montenegro stock exchanges (NEX20 and NEX PIF- left scale and MOSTE- right scale) The NEX20 index recorded a 45.9% increase in 2009, and its absolute change amounted to 4, index points. The maximum value of 19, index points was reached in October, while the minimum value of 8,685.9 index points was recorded in March. In absolute terms, the NEXPIF recorded a 20.1% or 1, index points increase in The maximum value of 12, index points was registered in May, while the minimum value of 4.305,79 was recorded in April. At the end of December 2009, the respective indices (MOSTE, NEX PIF and NEX20) declined by 74.0%, 86.2% and 70.0% in relation to their historical maximum values (recorded in 2007). Source: Nex Montenegro and Montenegro stock exchanges Table 3.4 General data on indices MOSTE NEX 20 NEXPIF As of 31 December , , ,66 Absolute change of index in , , ,02 Starting index value 100,0 March ,00 March ,00 March 2003 Maximum value in , , , Maximum historical value 2.455, , , Minimum historical value 94, , , Annual growth (decline) in ,1% 45,9% 20,1% Source: Nex Montenegro and Montenegro stock exchanges Block trade In 2009, 36 block transactions were realized to the amount of EUR million, which makes up 68.4% of total turnover. The biggest turnover in block transactions was recorded in the sale of EPCG shares (81.5%).

104 104 Chief Economist Annual Report 2009 Table 3.5 Turnover value and number of block trade transactions in 2009 Turnover value Number of block transactions EPCG a.d. Nikšić ,90 10 Rudnik uglja a.d. Pljevlja ,50 8 Erste Bank a.d. Podgorica ,51 1 Hipotekarna banka a.d. Podgorica ,00 6 Montepranzo-Bokaprodukt a.d. Tivat ,76 1 Štampa a.d. Podgorica ,00 1 Plus comerce a.d. Nikšić ,34 2 Atlas Mont banka a.d. Podgorica ,00 2 Izbor a.d. Bar ,00 2 Lutrija Crne Gore a.d. Podgorica ,20 1 HTP Mimoza a.d. Tivat ,29 1 Progas a.d. Podgorica ,99 1 TOTAL ,49 36 Source: Nex Montenegro and Montenegro stock exchanges Graph 3.12 Capitalization on Montenegrin stock exchanges Capitalization At 2009 year-end, capitalization on the Nex Montenegro stock exchange amounted to EUR 2.04 billion, and it was 44.0% higher than in December It was 53.5% lower in relation to the maximum market capitalization recorded in August Capitalization on the Montenegro stock exchange amounted to EUR 2.95 billion, thus increasing by 30.7%. It was 29.6% lower in relation to the maximum market capitalization recorded in August Source: Nex Montenegro and Montenegro stock exchanges Total capitalization on Montenegrin stock exchanges at end-2009 amounted to EUR 2.87 billion, making up 95.4% of the estimated GDP.

105 Money and Capital Market 105 The year-to-year liquidity at end-2009, measured through the turnover ratio, was 50.7% lower at the Nex Montenegro stock exchange, whereas it significantly rose at the Montenegro stock exchange. Graph 3.13 Market capitalization on both stock exchanges in 2009 Conclusion 2009 was characterized by an increase in the indices of the Montenegrin stock exchanges. After a longer period of investors pessimism, optimism prevailed at the Montenegrin capital market in Such market conditions were mostly the result of sale of the EPCG packet of shares, as well as of positive signals from the international capital market where the financial conditions gradually stabilized. There were many events influencing the capital market in the previous year. The most important was the sale of the investment funds` and minority shareholders` shares in EPCG (Trend, Moneta, Eurofond and Atlasmont fund), which primarily led to the recovery of the capital market, after a longer period of negative trends. Besides this sale, some enterprises and insurance companies recapitalized, and the bonds of the Podgorica Municipality were issued. Four broker firms ceased their operations in Source: Securities and Exchange Commission of Montenegro Graph 3.14 Turnover ratio Four banks operating in Montenegro were recapitalized by issuing new shares, thus increasing the equity capital by EUR 77.1 million. Source: Nex Montenegro and Montenegro stock exchanges A new measure of the Securities and Exchange Commission of Montenegro, regulating the hiding of symbols of the broker companies in the trade systems, came into force in April The measure aims at preventing the realization of the originally agreed deals between broker houses. Within the new directive, the Securities and Exchange Commission passed the Rules on the Contents, Deadlines and Manner of Publishing the Financial Reports of the Securities Issuers (OGM, No 20/09) in 2009, which is important for improving the transparency of company operations. Montenegro needs a unified securities market, which would meet the criteria for the improvements of the exchange supervision, operational and informational efficiency, increasing the market liquidity, as well as easier integration into the regional and European capital market.

106 106 Chief Economist Annual Report 2009 It is obvious that the recovery of the Montenegrin market will depend on the global financial market recovery. However, it will also depend on the inflow of assets from the real estate market, as well as on the volume of investments by big international funds and individual portfolio investors. It is worth noting that the forecasts regarding the global events are optimistic, and many international institutions deem that the following year will be the year of a minor and gradual global economic recovery. Box 3.1 Regional stock exchanges, selected operation indicators The majority of stock exchanges in the region were facing the loss of turnover and capitalization due to drawbacks of the global financial flows. On the other hand, indices of the regional stock exchanges show signs of recovery, being higher than at 2008 year-end. Tables below show some of the indicators of operations of stock exchanges in the region. Table 1 Turnover and realized transactions at regional stock exchanges Stock exchange Relative turnover ratio I-XII 09/ I-XII 08 Relative transactions ratio I-XII 09/I-XII 08 Belgrade stock exchange Zagreb stock exchange Sarajevo stock exchange Macedonian stock exchange Ljubljana stock exchange Nex Montenegro stock exchange Montenegro stock exchange Source: Reports of the national stock exchanges Data from table above show that total turnover in 2009 at all stock exchanges was considerably below the turnover realized in the reference period of The severest turnover decline was recorded by Zagreb stock exchange (64.9%), Sarajevo stock exchange (54.1%) and Macedonian Stock Exchange (45.6%). The turnover at the Montenegro Stock exchange in 2009 increased by 214.4%, whereas the turnover that the Montenegro stock exchange increased by 95.9%, mostly due to the trade of shares of EPCG. The number of transactions recorded negative trends on all stock exchanges at the region. Stock exchange indicators in 2009 showed better performance in relation to 2008 year-end. Observing indices at the annual level, indices of all regional stock exchanges recorded increases, except the reference index of the Sarajevo stock exchange which fell by 14.6%.

107 Money and Capital Market 107 Table 2 Changes in the selected regional stock exchange indices Stock exchange Index Index value % of change 31 XII XII 2008 XII 09/XII 08 Belgrade stock exchange BELEX15 663,77 565,18 17,44 Zagreb stock exchange CROBEX 2.004, ,25 16,36 Sarajevo stock exchange SASX , ,65-14,64 Macedonian stock exchange MBI , ,16 31,28 Ljubljana stock exchange SBI , ,72 10,36 Nex Montenegro stock exchange NEX , ,93 45,93 Montenegro stock exchange MOSTE 638,99 469,53 36,09 Source: Reports of national stock exchanges Market capitalization, in relation to end 2008, increased at all stock exchanges in the region, except in Zagreb and Sarajevo stock exchanges, which recorded the respective decline in capitalization of 3.1% and 8.3%. The highest capitalization increases was recorded at the Nex Montenegro stock exchange (44.0%) and at Montenegro Stock exchange (30.7%), whereas the capitalization at the Ljubljana stock exchange recorded a 25.9% increase. Table 3 Comparison of market capitalizations at the regional stock exchanges Stock exchange Market capitalization (% of change) Market capitalization / GDP 31. XII 09 /31. XII 08 Belgrade stock exchange % Zagreb stock exchange % Sarajevo stock exchange % Macedonian stock exchange % Ljubljana stock exchange % Nex Montenegro stock exchange % Montenegro stock exchange % Sources: Websites of the regional stock exchanges

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109 4 FISCAL DEVELOPMENTS

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111 Fiscal Developments 111 The fiscal policy in 2009 was mostly directed towards mitigating the effects of the global financial crisis that spread to the Montenegrin Economic System in The negative influence of the global financial and economic crisis from the banking and real sector was transferred to the public finance system. In the last quarter of 2008, as well as in 2009, the public finances significantly deteriorated, primarily because of a decline in the current public and budget revenues, as well as a further increase in expenditures, thus resulting in the budget deficit. The decline in public revenues was mostly influenced by the decline in economic activities, i.e. substantial decline in imports and exports, a decline in foreign direct investments, as well as lower demand and the sale of real estates. Table 4.1 The budget trends Description/Period Plan for 2010 Public sector deficit/surplus (EUR million) 63,21 178,25-12,11-106,45-140,62 % of share in GDP 2,94 6,65-0,39-3,54-4,51 Deficit/surplus of the Budget of Montenegro with the state funds (EUR million) 71,50 176,14 15,12-69,1-133,19 % of share in GDP 3,33 6,57 0,49-2,30-4,27 Source: Ministry of Finance Besides the negative impact of the crisis on running the fiscal policy in 2009, the Ministry of Finance managed to regularly finance all budget users, regularly settling even the liabilities for loan repayments and interest to domestic and international financial institutions. In 2009, the Government decided to follow the restrictive fiscal policy by reducing expenditures and introducing austerity measures in the current budget. 43 The Government continued the taxation reforms by reducing the tax on income and contributions for obligatory social insurance, and introducing the subsidies for electricity bills for deprived citizens, as well as for small and medium enterprises. 43 Suspending employment and reducing gross salaries in the public sector, as well as the restriction in all material expenditures (using of official vehicles, rationalisation of expenses for representation and business trips, amending the dynamics of expenditures for material and services, and the like).

112 112 Chief Economist Annual Report 2009 After a further decline in source income (primarily VAT and customs duties) in relation to the plan, the revised budget was adopted to include additional austerity measures. Additional rationalization measures led to a decline in the consolidated expenditures (expenditures for gross salaries, expenditures for materials and services and capital expenditures). However, capital expenditures were reduced only for positions that would not have any significant influence on the budget. The growing problems in the economy called for an increase in social security transfers primarily the severance pay for redundancies in the privatized companies or in those which are in the process of privatization. On the revenues side, the excise duties on mineral fuels increased, which should contribute to the increase of budget revenues, and thus not burden the citizens` living standard. After the budget revision and for the purpose of further rationalization of budgetary expenditures, additional austerity measures were introduced to affect current consumption: reducing funds for salaries and other earnings through the rationalization of the public administration and other material expenditures and expenditures for services. In order to improve the budget administration and to ensure greater transparency and rationalization of the public finances in 2009, the Pension and Disability Fund and the Employment Agency were integrated into a single consolidated account of the State Treasury, while the implementation of the Programme and the Capital Budget was continued as well as the implementation of the Budget consumption medium-term framework. Box 4.1 Long-term feasibility of the EU public finances Important fiscal stimuli contributed to the easier recovery of the European economies from the crisis, therefore significantly deteriorating public finances. The EU state deficit increased (from the lowest level in 2007 of 0.8%) to 7% in 2009, and the 2010 forecast points to its possible increase to 7.5% of GDP. Most probably, the debt will simultaneously increase by 20 percentage points. In the long run, the current levels of deficit and debt are not sustainable. The problem of fiscal consolidation has become the burning issue of EU economies. Besides financing the costs of the financial crisis, deterioration of the EU fiscal policy was significantly contributed by the problem of aging population. As the population ages, the economic activity declines, and the costs of pensions, health insurance, longterm care, education and unemployment grow. Taking into account the productivity growth scenarios, the public debt in many countries is inflating as a balloon. Without an efficient fiscal consolidation, the ratio of gross debt to GDP for the whole EU may reach 100% in 2014 and 130% in However, an increase in the debt ratio may be avoided. Successful fiscal strategies for deficit and debt reduction have to be followed by the structural reforms and labour market reforms, as well as the social security system, especially of the pension and the health care regime. % of GDP Gross Debt ratio Changes in debt ratio Growth of projected costs in relation to aging population EU EU Source: European Commission, Directorate General for Economic and Financial Affairs

113 Fiscal Developments 113 The long-term sustainability of the public finances is measured by establishing the sustainability gaps 44. The sustainability gaps measure the necessity of adjusting taxes or consumption at the present or in the future, so that the debt ratio would remain within the desired framework as time goes by. It should be noted that there are many differences in risks and sources of risk that the Member States are exposed to with respect to fiscal sustainability. Bulgaria, Denmark, Estonia, Finland and Sweden have relatively high budget positions, and they have taken comprehensive fiscal reforms in the past years. Although the crisis leads to deterioration in their budget balance and an increase in indebtedness, their structural fiscal policies remain healthier than in many EU countries and they present a low risk in the long-term. The long-term sustainability of Belgium, German, France, Italy, Hungary, Luxembourg, Austria and Portugal is medium. Austria and Germany have higher costs of aging population, but the initial budget position is solid. The high debt ratio in Belgium and Italy represents a burden and the specific risk. The long term costs of aging population in France, Hungary and Poland have not been projected to be considerably high, but their fiscal policy is bad, even without an increase in population aging costs. The highest projected costs of aging population in the EU are present in Luxembourg, but the risk is mitigated by low indebtedness. The sustainability gaps in the Czech Republic, Cyprus, Lithuania, Latvia, Malta, the Netherlands, Romania and Slovakia are all above 6% of GDP, and they are even twice as high in Ireland, Greece, Spain, Slovenia and the Great Britain. These countries are exposed to very high long-term risk. The coverage of these gaps requires not only a decrease of deficit and debt, but also further reforms of the social security system. Fiscal stimuli used for the European economies` exiting the crisis would be undermined if the market saw them as a threat to the public finances in a long run. Fiscal measures to increase confidence and support demand are successful only if the market and the public see them as short-term and consistent with long-term sustainability. Successful fiscal expansion against the recession backdrop and a longterm fiscal sustainability are not incompatible Plan of Montenegrin Budget in 2009 Starting from the low realization of the source budget revenues in relation to the plan in the first half of 2009, as well as the estimate that the negative trend in payment of current revenues would continue until the yearend, the Parliament of Montenegro passed the Law on Amendments to the Law on Budget for (OGM 51/09) at end-july The passing of the Law was conditioned by the change in the structure and reduced amount of the current budget assets, the change in the structure and reduced amount of the capital budget assets, the change in the structure and reduced amount of the state funds` budget, the implementation of the Decree on State Administration Organization and Operations and the increase of transfers to the Employment Agency pursuant to the Law on Amendments to the Law on Employment. 44 The sustainability refers to the ability of the government to take care of the current revenues and expenditures without enormous debt accumulation. 45 OGM, 51/09

114 114 Chief Economist Annual Report 2009 With the amended budget 46, the current Budget and state funds revenues 47, were planned to the amount being lower by 14.5%, and the consolidated budget expenditures 48 being 7.9% lower in relation to the assets planned by the Law on Budget for 2009, so that the planned budget deficit amounted to 2.8% of GDP, which almost meets the Maastricht Criteria on the maximum fiscal deficit of 3% of GDP. In addition, the amending budget envisages the indebtedness in 2009 to finance the deficit and repay debts, prescribing the signing of a loan agreement and issuing T-bills to the maximum amount of EUR 240 million, issuing the state guarantees for loans to the amount of EUR 376 million, as well as the signing of a loan agreement with multilateral institutions and as a part of bilateral arrangements to the total amount of EUR 125 million Budget of Montenegro realization in 2009 The negative impact of the global crisis on the Montenegrin economy in 2009, led to a slowdown in economic activity, primarily in construction, trade, tourism and transport, which conditioned lower realization of the budget and public revenues in relation to the plan Consolidated public revenues and expenditures Total current public revenues 49 in 2009, according to the estimate of the Ministry of Finance, amounted to EUR 1,366.5 million, i.e. 45.5% of the estimated GDP for Compared to 2008, public revenues were 12% lower, and after the amended budget, they were 7.3% lower in relation to the plan. The decline in the current revenues was the result of the evident decrease in all tax revenues, contributions, fees and other revenues. The main share in the structure of public revenues was of taxes, 58.2%, followed by contributions with 22.5%, whereas other revenues accounted for 19.3%. Consolidated public expenditures in 2009 amounted to EUR 1,472.9 million, making up 49% of the estimated GDP. In relation to 2008, public spending was 5.4% lower, whereas in relation to the amended plan, it declined by 7.2%. The decline of expenditures in relation to 2008 was affected by lower current and capital expenditures, transfers to institutions, individuals and the public sector, reserves and granted borrowings and loans, while the social security transfers increased. Current public spending 50 amounted to EUR 1,220.1 million or 40.6% of GDP and it was by 7% lower in relation to the plan, i.e. by 2% in relation to The biggest share in the structure of public expenditures was in transfers with the share of 42%, followed by current expenditures (38.2%), capital expenditures (17.2%), whereas the remaining expenditures accounted for 2.8%. 46 For more information, see the Chief Economist Report January - September Excluding privatization revenues, donations and credits and loans 48 Total planned expenditures minus repayment of debts. 49 Total current public revenues include revenues of the budget, state funds and local administration. 50 Consolidated public expenditures minus total capital expenditures

115 Fiscal Developments 115 The level of public revenues in 2009 was lower than the realized consolidated public spending, so that the public sector deficit amounted to EUR million or 3.5% of the estimated GDP. (Annex D, table 12). Table 4.2 Consolidated public consumption, % of GDP Description 2006 EUR million % of GDP 2007 EUR million % of GDP 2008 EUR million % of GDP 2009 EUR million % of GDP Plan for 2010 EUR million Current public revenues 980,26 45, ,02 49, ,44 50, ,48 45, ,02 43,02 Consolidated expenditures 917,05 42, ,77 43, ,55 50, ,93 49, ,64 47,53 Capital expenditures 97,05 4,52 187,26 6,99 310,89 10,08 252,80 8,42 225,20 7,22 Current public consumption 820,00 38,16 974,51 36, ,66 40, ,13 40, ,44 40,31 Surplus/Deficit 63,21 2,94 178,25 6,65-12,11-0,39-106,45-3,54-140,62-4,51 % of GDP Source: Ministry of Finance Budget of Montenegro and the state funds According to preliminary data of the Ministry of Finance, total budgetary and the state funds` revenues amounted to EUR 1.479,4 million in 2009, which is 49.3% of the estimated GDP. In relation to the previous year, they increased by 12%, as the result of increased revenues from privatization, and foreign and domestic borrowing. The main share in the structure of budget revenues was of current transfers, 80%, whereas revenues from privatization and sold properties, donations and borrowing and loans from foreign sources accounted for 20%. Revenues from privatization amounted to EUR 100 million and they increased four times in relation to 2008, and almost three times in relation to the plan. The majority of these assets, EUR 96 million, came from the sale of the state shares in EPCG. In addition, in order to maintain the budget liquidity, a considerable increase was recorded in borrowings from foreign sources (by fifty times), as well as borrowings from domestic sources (by six times) and they totalled to EUR 193 million. In parallel, foreign donations increased by 73% in relation to 2008, but in relation to the planned amount they were 66% lower. (Table 4.4) Current revenues of the budget in 2009 amounted to EUR 1,182.8 million, which makes up 39.4% of the estimated GDP. A downward trend in the payment of current revenues continued in 2009, so that in relation to the plan, after the amended budget, these revenues declined by 6%, whereas they were 8% lower in relation to The decline in current revenues was primarily the result of lower tax, contributions and other budget revenues. The main share in the current revenues was of tax revenues, accounting for 60.2%. Tax revenues recorded a 7% decline in relation to the plan and 14% decrease in relation to the previous year. Reduced economic activity and declines in imports, sale of real estates, and foreign capital inflow influenced a considerable decline in almost all new taxation categories, while an increase was recorded in other taxes and revenues from excise duties. The amended Law on Excise Duties (OGM 76/08, 50/09), which increased excise duties on tobacco products and mineral oils, made additional impact on the budget revenues increase.

116 116 Chief Economist Annual Report 2009 However, in relation to previous years, the structure of source revenues in 2009 changed to the benefit of direct taxes (income tax, profit tax and property tax). An increase in employment and wages and a decline in shadow economy in 2009, as well as favourable taxation environment (decline in tax rates on natural and legal persons` income and contributions), led to an increase in direct taxes` share in total revenues, whereas a decline in exports by almost 40% led to a decline in indirect taxes (VAT and customs duties). In addition, the structure of the paid import VAT in relation to VAT from internal turnover changed in 2009, so that instead of the earlier ratio of 75:25, the ratio changed to 63:37 due to the lower payment of VAT on imported goods. Table 4.3 Realization of revenues from taxes (VAT, customs and excise duties) in the Budget of Montenegro in the period , and the Plan for 2010 DESCRIPTION 2004 EUR mill. % of share in revenues 2005 EUR mill. % of share in revenues 2006 EUR mill. % of share in revenues 2007 EUR mill. % of share in revenues 2008 EUR mill. % of share in revenues 2009 EUR mill. % of share in revenues Plan for 2010 EUR mill. % of share in revenues VAT Excise duties Customs duties Source: Ministry of Finance Table 4.4 Current revenues of the Budget of Montenegro and state funds Type of revenue Plan for 2009 EUR million Realization Jan Dec 2009 EUR million % of share in revenues in the period Jan Dec 2009 % of share in revenues % of realization in relation to the Plan Realization Jan Dec 2008 EUR million % of realization Jan Dec 2008 TAXES Personal income tax Corporate tax Property tax VAT tax Excise duties Tax on international trade and transactions Other Republic taxes Contributions FEES DUTIES OTHER REVENUES Receipts from credit repayments CURRENT REVENUES 1, , Privatization revenues Donations Borrowings and loans from foreign sources Borrowings and loans from domestic sources TOTAL REVENUES IN THE BUDGET OF MONTENEGRO AND FUNDS 1, , Source: Ministry of Finance

117 Fiscal Developments 117 The share of contributions in current revenues was 26% and they recorded a 9% decline both in relation to 2008 and in relation to the plan, with the obvious negative trend in all categories. The remaining part of the current revenues (13.8%) referred to taxes, fees, other revenues and revenues from loan repayment. In relation to the previous year, the revenues from taxes and fees decreased, whereas other revenues and revenues from loan repayment increased. Revenues from loan repayment increased by seven times, and they amounted to EUR 61.7 million, of which EUR 44 million referred to the repayment of the loan granted to Prva Banka Crne Gore. According to preliminary data of the Ministry of Finance, total budgetary expenditures in 2009 amounted to EUR million which makes up 46.4% of the estimated GDP. Compared to 2008, the budget spending was recorded at the same level, whereas in relation to the plan for 2009, it was by 6.8% lower. Lower realization in expenditures was the result of a decrease in all budget expenditures (current, capital, transfers and other expenditures). The budget spending was realized through regular settling of liabilities towards international and domestic financial institutions, as well as through regular servicing of all users and budget units. Consolidated Budget expenditures 51 in 2009 amounted to EUR 1,251.8 million, making up the 41.7% of the estimated GDP. In relation to 2008, realized expenditures declined by 2%, whereas they were 7% lower than planned. The decline in expenditures was the result of the taken austerity measures and the commitment of the Montenegrin Government to rationalized spending of all budgetary assets at all levels, which is in compliance with the adopted plan and the additional austerity measures after amending the budget for 2009, as well as the amended dynamics of the execution of expenditures according to priorities, covering all budget users. The biggest share in the structure of budget expenditures was of the current expenditures 38.9%, which were at their level recorded in 2008, but being 3.5% lower in relation to the plan. These expenditures recorded a decline in all expenditures categories. However, besides lower budget expenditures and following the austerity measures for the budget beneficiaries, there are some categories of budgetary expenditures having the priority in payment, such as salaries, pensions and social benefits, the repayment of debt and interests to international and domestic financial institutions. However, the main part of assets (53%) was allocated to gross salaries, whereas other current expenditures (rent, interest, expenditures for material and services, subsidies, current maintenance) made up 47%. It is evident that, in relation to 2008, the expenditures for subsidies, interests and other expenditures increased, while a decline was recorded in expenditures for gross salaries, material and services, current maintenance and other receivables. Social security transfers and transfers to institutions, individuals, NGOs and the public sector accounted for 47% of total expenditures, and these assets were directed to the Pension and Disability Fund, for redundancies and for the social and health insurance. The allocation for capital expenditures accounted for 11.2% of assets, whereas the remaining 2.9% referred to granted borrowings and loans by the Government and from the budget reserves. The expenditures for debt repayment amounted to EUR million, of which the residents were paid EUR 29.2 million, while non-residents were paid EUR 27 million, and the repayment of earlier debts (frozen foreign currency deposits, restitution and other liabilities) amounted to EUR 84 million (Table 4.5). 51 Total expenditures minus debt repayments

118 118 Chief Economist Annual Report 2009 Box 4.2 Public finance trends in the period The favourable macroeconomic and fiscal environment in the period was followed by a significant increase in the budget expenditures. The source revenues increase was about 50% lower than the increase in budget expenditures. For example, the biggest realization of revenues in 2008 amounted to EUR million, while the budget expenditures were planned in the amount of EUR million before the amended budget. In the period , consolidated expenditures of the budget and the state funds (without debt repayment) increased from EUR 788 million to EUR million, which is a 71% increase. Therefore, significant adjustments had to be made in order to reduce the expenditures. The increase in consumption was caused by the increase in expenses for wages and pensions. In the period , due to the increase in the minimum official wage and the wage classes coefficients, gross salaries increased about 63%, so that the total fund of wages in the public sector (without local administration) amounted to about EUR 210 million in 2006, whereas after the amended budget, it was planned to about EUR 340 million in Including the part of wages paid via the budget transfers (health institutions, University of Montenegro, Montenegrin Academy of Science, and the like), they amounted to about EUR 371 million planned in the amended budget. According to the Ministry of Finance data, the number of employees in public administration, health and education amounted to about 42.5 thousands, including trainees and employees hired as per service contracts. The current number of pension and disability insurance beneficiaries is about 110 thousand which, with regular and extraordinary adjustments, increased the expenditures for pensions from EUR 199 million in 2006 to EUR 321 million in 2009, or by 61%. Besides the increase in consumption in the earlier period, the increase of state mandatory or fixed expenditures was also present. In the period , the level of fixed consumption ranged to 70-80%. According to the amending budget for 2009, over 75% of consolidated budget expenditures were defined in advance by the legislation (general and branch collective agreements, laws and agreed liabilities) - wages and other personal receivables, social security transfers, transfers to the University of Montenegro, transfers to political parties, interests, subsidies, and the like. Discretionary consumption was limited to a part of expenditures for material and services, capital expenditures and reserves. Table 1 Budget consumption for the period DESCRIPTION Recorded in 2006 Recorded in 2007 Recorded in 2008 EUR million % of share EUR million % of share EUR million % of share Amending budget in 2009 EUR million % of share CONSOLIDATED EXPENDITURES FIXED CONSUMPTION DISCRETIONARY CONSUMPTION Current expenditures Transfers for social security Transfers to institutions, individuals and NGO Capital expenditures Loans and credits Reserves Source: Ministry of Finance

119 Fiscal Developments 119 Table 4.5 Consolidated expenditures of the Budget of Montenegro and State Funds - 1 January 31 December 2009 DESCRIPTION Plan for 2009 EUR million Recorded in Jan Dec 2009 EUR million % of share in expenditures % of share in GDP % recorded in relation to the Plan Recorded in Jan Dec 2008 EUR million % recorded in relation to Jan Dec 2008 Current expenditures 504,56 487,16 38,92 16,22 96,55 488,25 99,78 Gross salaries and contributions paid by 262,52 259,21 20,71 8,63 98,74 274,70 94,36 employer Other personal income 24,51 21,53 1,72 0,72 87,84 21,75 98,99 Material and service expenses 118,81 112,05 8,95 3,73 94,31 114,43 97,92 Current maintenance 5,99 5,09 0,41 0,17 84,97 22,15 22,98 Interests 25,17 24,42 1,95 0,81 97,02 22,53 108,39 Rent 9,67 8,33 0,67 0,28 86,14 8,36 99,64 Subsidies 51,07 49,82 3,98 1,66 97,55 18,59 267,99 Other expenditures 6,82 6,71 0,54 0,22 98,39 5,74 116,90 Transfers for social security 419,75 387,80 30,98 12,91 92,39 346,54 111,91 Transfers to individuals, NGOs and public 213,02 199,62 15,95 6,65 93,71 213,71 93,41 sector Total capital expenditures 167,84 140,45 11,22 4,68 83,68 148,54 94,55 Loans and credits 28,75 24,89 1,99 0,83 86,57 62,54 39,80 Reserves 14,07 11,91 0,95 0,40 84,65 12,44 95,74 CONSOLIDATED EXPENDITURES 1.347, ,83 100,00 41,69 92, ,02 98,41 Repayment of debts to residents 42,47 29,16 2,09 0,97 68,66 48,38 60,27 Repayment of earlier debts 81,44 84,00 6,03 2,80 103,14 57,76 145,43 Repayment of debts to non-residents 22,46 27,09 1,95 0,90 120,61 16,76 161,63 TOTAL EXPENDITURES 1.494, ,08 46,36 93, ,92 99,80 Source: Ministry of Finance The Budget of Montenegro recorded a deficit 52 in 2009 of EUR 69.1 million or 2.3% of GDP. If we take into consideration the unsettled budget liabilities in 2009, the budget deficit would be much higher. The budget deficit was financed by the increased revenues from privatization, T-bills sold, loans taken from foreign commercial loans. According to the Ministry of Finance, lower realization of budget expenditures and a lower deficit were the result of additional savings on the current expenditures and the capital budget. 52 Methodology for calculating surplus/deficit, OGM 53/09

120 120 Chief Economist Annual Report 2009 Box 4.3 Budget surplus/deficit as a percentage of GDP According to the IMF forecast, the fiscal deficit in the EU countries would amount to 6.9% of GDP. The table below shows the budget deficit of countries in the region. Table 1 Budget surplus/deficit as a % of GDP Country/Period Forecast 2009* 2010* Montenegro Bulgaria Bosnia and Herzegovina Macedonia Serbia Croatia Albania Hungary Romania Source: IMF, World Economic Outlook, October 2009 * Data for Montenegro for 2009 and 2010 were estimated by the Ministry of Finance 4.3. Local administration Total current public revenues of local administration in 2009, according to the estimate of the Ministry of Finance, amounted to EUR million, i.e. 6.1% of the estimated GDP for Compared to 2008, the recorded amount was 29% lower, whereas in relation to the plan it declined by 17%. The biggest share in the recorded revenues was of revenues from taxes (45%) and fees (42%), whereas other revenues (duties and other local revenues) accounted for 13%. The negative trend in 2009 was recorded in all categories of local revenues (property turnover tax, income tax, local taxes, local fees, as well as other duties). Consolidated local administration expenditures amounted to EUR million, or 7.4% of the estimated GDP. Compared to 2008, they declined by 22%, as well as by 8% in relation to the plan. The most significant item in local administration expenditures was capital expenditures, with the share of 50%, followed by capital expenditures (34%), transfers to institutions, individuals and NGOs and public sector (13.6%), while the remaining 2.4% were reserves, loans and credits and social security transfers. (Table 4.6)

121 Fiscal Developments 121 Table 4.6 Current revenues and consolidated expenditures of local administration Type of revenue Plan for 2009 EUR million Recorded in Jan Dec 2009 EUR million % of share in revenues % recorded in relation to the Plan Recorded in Jan Dec 2008 EUR million % recorded in Jan Dec 2008 CURRENT REVENUES Taxes Fees Duties OTHER REVENUES Receipts from credit repayments CONSOLIDATED EXPENDITURES CURRENT CONSUMPTION Current expenditures Gross salaries and contributions paid by employer Other personal income Material and service expenses Current maintenance Interests Rent Subsidies Other expenditures Transfers for social security Transfers to institutions, individuals, nongovernmental and public sector Capital expenditures Loans and credits Reserves SURPLUS/DEFICIT Transfers from the Budget of Montenegro Privatization revenues Donations Borrowings and loans from foreign sources Borrowings and loans from domestic sources Debt repayment Source: Ministry of Finance In 2009, local administration used loans and credits from domestic sources to the amount of EUR 17.5 million, recording the revenues from privatization and donations of the respective EUR 22.7 million and EUR 5.5 million, but at the same time it repaid debts to the amount of EUR 36.5 million. In 2009, local administration recorded a EUR 37.4 million deficit, or 1.3% of GDP.

122 122 Chief Economist Annual Report State funds In 2009, the Pension and Disability Insurance Fund of Montenegro 53 recorded total revenues of EUR million. Current revenues of the Fund amounted to 95% of total revenues, and they were 14% higher in relation to 2008, but 3% less in relation to the planned amount. The share of contributions, the primary source of Pension and Disability Fund financing in current revenues, amounted to 61%, recording a 7% decline in relation to 2008, whereas it decreased by 8% in relation to the plan. Lower collection of revenues was recorded from contributions from agriculture, which declined by 6%. Besides lower compulsory pension insurance contributions in 2009, a decrease in contributions was influenced by lower liquidity of economy and delays or defaulting in settling liabilities by some companies, against the backdrop of the financial crisis. In relation to 2008, revenues from non-economy contributions increased by 11%. Other revenues (revenues from capital and collection of disputable receivables from the previous period) made up 2.8% of the current revenues and they recorded an increase of 47% in relation to the previous year. At the same time, transfers from the budget increased significantly, by 78%, and their share in the current revenues amounted to 37.3%, while the Fund used the loan amounting to EUR 15.1 million or 4.4% of total revenues in Overall expenditures of the Pension and Disability Insurance Fund in 2009 were recorded in the amount of EUR million, which is 6% less in relation to Consolidated expenditures (total expenditures minus debt repayment) amounted to EUR million. Expenditures for pensions accounted for the main share in total expenditures with 82.3%, whereas the remaining 17.7% of expenditures were for fees, allowances, payment of foreign pensions, military pensions, and contributions for health insurance of pensioners, operational expenditures, earlier obligations and the repayment of loans. Compared to 2008, expenditures for pensions increased by 19% due to adjusting pension increases in semi-annual intervals, regular pension payouts (1 January and 1 July), as well as the payout of second extraordinary pension to users of the pension and disability insurance. Comparing the recorded current and consolidated expenditures, the Fund recorded a deficit of EUR 8.2 million in Box 4.4 Average pensions and the burden of pension and disability insurance funds According to the data of the Pension and Disability Insurance Fund of Montenegro, the total number of pension and disability beneficiaries amounted to 111,053 in December 2009, of which total number of pensioners in Montenegro was 97,088, the number of beneficiaries outside Montenegro totalled 4,361, whereas there were 9,604 beneficiaries of other rights. An average pension amounted to EUR 257. Table 1 shows the data on average pensions, the number of pensioners in relation to the number of employees in 2009 and the burden of pension and disability funds in the observed countries in the region. Slovenia is at the top of the list regarding the pension amount, followed by Croatia, while Montenegro is ahead of Bosnia and Herzegovina, Serbia, the Republic of Srpska and FYR Macedonia. The most burdened funds are those in Serbia and the Republic of Srpska, followed by Croatia and Slovenia, whereas the burden of the Montenegrin Pension and Disability Insurance Fund is higher only than those in Bosnia and Herzegovina and FYR Macedonia. 53 Source: Republic Pension and Disability Fund (preliminary data).

123 Fiscal Developments 123 Table 1 Number of pension and disability beneficiaries in the neighbouring countries Country Population Pensioners Population/ Pension beneficiaries Labour force* Labour force / Pensioners Employed population Employed population / pensioners Average pension in EUR Slovenia 2,053, , , , Croatia 4,436,000 1,172, ,758, ,485, Montenegro 642, , , , Serbia 7,334,935 1,603, ,350, ,860, Bosnia and Herzegovina 3,129, , ,594, , FYR Macedonia* 2,048, , , , Republic of Srpska 1,437, , , , Source: Pension and Disability Funds and Statistical Offices of the selected countries, * October Data According to preliminary estimates for 2009, the Republic Health Insurance Fund recorded total revenues (current revenues and transfers) to the amount of EUR million or 10% less than in The decline in recorded revenues was due to a decrease of contributions by all categories, as well as lower budget transfers. Total expenditures of the Health Insurance Fund, without loan repayment, amounted to EUR million in 2009, and they were 3.2% higher than in the previous year. The highest share in total expenditures, 91.6%, was for the current expenditures, including transfers to the public health institutions and social security transfers, the regular activity of the Fund, whereas the remaining 8.6% of assets were spent for capital expenditures and other expenditures. Comparing the total revenues and recorded expenditures in 2009, the Fund recorded a deficit of EUR 16.5 million. The Employment Agency of Montenegro recorded total revenues of EUR 31.6 million in Current revenues (contributions, fees, other revenues and receivables from loan repayment) made up 48% of revenues, and they were 20% lower in relation to 2008, whereas their decline in relation to the plan was 14%. Lower collection recorded the revenues from fees for non-resident employments (68%) and receivables from loan repayment (36%), whereas other revenues recorded a minor increase of 2%. Revenues from contributions increased by 11% in relation to 2008, while in relation to the plan they recorded a 2% decline. Budget transfers increased by 34% and they made up 50% of total revenues, while the remaining 2% referred to revenues from privatization. Expenditures of the Agency amounted to EUR 31.9 million, and they were 5% higher than in 2008, yet 14% lower in relation to the plan. Current expenditures accounted for 18.7% of total expenditures, whereas transfers to individuals, institutions and public sector accounted for 26%, social protection transfers 39.5%, loans and credits 14.8% and capital expenditures 1%.

124 124 Chief Economist Annual Report 2009 Comparing the revenues (current revenues with transfers) and recorded expenditures in 2009, the Agency ran a deficit of EUR 1 million in The Employment Agency s outstanding liabilities amounted to EUR 2.6 million. In 2009, the Development Fund of Montenegro recorded total revenues (from interest on investment loans, time deposits, dividends and other revenues) of EUR 2.9 million, while its expenditures amounted to EUR 4.7 million, thus recording a deficit of EUR 1.2 million. The Restitution Fund of Montenegro recorded total revenues arising from general revenues of EUR 2 million, being 76% less than planned. The Fund s expenditures amounted to EUR 2 million, of which EUR 1.9 million were cash debt repayment arising from restitution and EUR 0.1 million referred to current and capital expenditures. At the same time, following the Decision on the Second Issue of Restitution Bonds, EUR 71.9 million of FO02 bond series were registered, and their sale was performed through the stock exchange Plan of Public and Budget Spending for 2010 and Fiscal Risks Public spending in 2010 was planned following the objectives set out in the Economic Policy of Montenegro for 2010, which foresees the maintaining of economic stability by creating the conditions for reducing public consumption, improving business environment, attracting new foreign direct investments, especially in the energy and tourism sectors, further incentives for entrepreneurship development with the emphasis on small and medium enterprises, as well as the development of underdeveloped regions and rural areas. On the other hand, primary objectives of public consumption were focused to limiting the levels of current public consumption and decreasing its share in GDP through the rationalization of spending public funds, potential increase in the current revenues of the state budget and local administration budgets, by applying new legislation in the taxation system in 2010, maintaining the planned level of capital expenditures, as well as continued reforms in health, education and public administration. Current public revenues for 2010 were planned in the amount of EUR 1,341.0 million, or 43% of the estimated GDP for 2010, while consolidated public expenditures were planned in the amount of EUR 1,481.6 million, or 47.5% of the estimated GDP. The planned public consumption deficit amounted to EUR million, making up 4.5% of the estimated GDP. The public consumption deficit, as well as liabilities towards debt repayment to residents and non-residents, payment of outstanding liabilities, frozen foreign currency deposits and restitution liabilities will be financed from privatization revenues, donations, as well as foreign loans and credits. The funds for debt repayment were planned to the amount of EUR million. The Parliament of Montenegro passed the 2010 Budget Law at end-december OGM, 87/09

125 Fiscal Developments 125 Table 4.7 Consolidated plan of the Budget of Montenegro and State Funds for 2010 DESCRIPTION Plan 2010 EUR million % of GDP Amending budget 2009 EUR million % of GDP Difference EUR million CURRENT REVENUES 1, , Taxes Personal income tax Tax on Profit Real Estate Turnover Tax Value Added Tax Excise Duties Tax on International trade and Transactions Other Republic Taxes Contributions Contributions for pension and disability insurance Contributions for health insurance Contributions for unemployment insurance Fees Duties Other revenues Revenues from loan repayment CONSOLIDATED EXPENDITURES 1, , Current budget consumption 1, , Current expenditures Gross salaries and contributions paid by employer Other personal income Expenditures for material and services Current maintenance Interests Rent Subsidies Other expenditures Transfers for social security Transfers to institutions, individuals, NGO and public sector Capital expenditures Capital expenditures of the current budget and State funds Capital budget of Montenegro Borrowings and loans Reserves SURPLUS / DEFICIT Repayment of debts to residents Repayment of unsettled liabilities Foreign financing 0.00 Borrowings and loans from foreign sources Repayment of debts to non-residents Donations Revenues from privatization and sale of property bias % Source: Ministry of Finance

126 126 Chief Economist Annual Report 2009 The 2010 Budget of Montenegro envisages the borrowing from international financial institutions to the amount of EUR 78.5 million, issuing EUR 202 million worth guarantees for loans as the continuation of support to the corporate and banking sector, as well as the financing of the budget deficit, debt servicing and additional support to the banking sector to the amount of EUR 200 million. Data from Table 4.7 show that the highest inflow of revenues in the 2010 Budget (92%) was planned from taxes (especially VAT and excise duties), whereas the largest portion of expenditures (43.8%) were planned for current expenditures, followed by social security transfers (31.3%), transfers to institutions, individuals, NGOs and the public sector (13.4%), capital expenditures (10.3%) and other expenditures (1.2%). According to the Ministry of Finance, the 2010 Budget was planned with the objective to provide regular functioning of all budget users and the implementation of priority activities to take into account the decline in economic activity, which is reflected in the planned budget deficit. A EUR million deficit planned in the 2010 Budget makes up 4.3% of the projected GDP, and it is above the Maastricht Criteria, but it is lower in relation to the estimated budget deficit of 7% in the EU. The Budget deficit is at the level of the capital budget and it is primarily related to the implementation of capital projects, which shows that current consumption will be financed from current budget revenues, while the deficit will be financed from revenues from privatization, donations and loans. However, in order to maintain the viability of the budget and public finances in 2010, it is necessary to continue further adjustments aimed at reducing the public and budget consumption, with the simultaneous increase in current revenues by reducing the wages fund and the number of public administration employees, expenditures for material and services, and maintaining the level of capital expenditures in the current budget and the state funds` budget. It should be noted that, according to the IMF opinion, the key risk is the high structural fiscal deficit of 6% of GDP recorded in The structural deficit came as the result of a high increase in public spending and a reduction of taxes during the expansion period. On the other hand, the Ministry of Finance have found that this deficit is significantly lower. The IMF also saw as the problem the fact that there the misbalance between the high level of public consumption and lower taxes: VAT and income tax, with the respective rates of 17% and 9%, are low according to international standards, while the share of public consumption in GDP of 48%, on the other hand, is higher than the average in countries in transition 55. Box Employment in the public sector Fiscal consolidation in the following years should address a decline in the number of public administration employees, as well as the share of wages in the budget. According to the both observed indicators, Montenegro is in a more unfavourable position than many of the observed countries (Graphs 1 and 2) 55 The report on IMF consultations regarding Article IV

127 Fiscal Developments 127 Graph 1 Percentage of labour force in the public administration Source: IMF, Staff report for 2010 Article IV Consultation, 2010 Graph 2 Share of public sector salaries in GDP Source: IMF, Staff report for 2010 Article IV Consultation, 2010 Fiscal risks to which an ongoing financing of the budget consumption may be exposed in 2010 and later on include the following: Exposure to external shocks. Small open economies, such as Montenegro, are subject to transposing foreign shocks. Euroized economies therefore have less protection instruments at their disposal (limited monetary policy instruments and the absence of exchange rates as the means of protection). The most frequent channels of external shocks are trade and banking flows. These two flows should be improved in order to avoid external influences, because we cannot claim with certainty that the global crisis is completely over.

128 128 Chief Economist Annual Report 2009 Figure 4.1 Most prominent risks Tourism (Seasonal character and external dependence). Trends in tourism are of special importance for the development of the Montenegrin economy, and they are affected by the seasonally character of the activity and great dependence on economic situation of countries from which the majority of tourists come from. The risk is increased by the visa liberation regime for the neighbouring countries, so now many tourists from Serbia, Macedonia and Montenegro may now travel abroad without any obstacles. Increase of deficit and the external debt. Public finances of almost all countries deteriorated due to the increased costs of financing the recovery from the crisis, as was the case with Montenegro. That would, therefore, limit the liquid assets available at international markets in the next year and the access to these funds by many small economies which credit rating is not on the level of the developed Western countries. Reduced public consumption. The reduction of public spending will have a negative impact on aggregate demand, which will result in economic slowdown.

129 Fiscal Developments 129 Guarantees and other implicit liabilities of the state. In the upcoming year, the issued state guarantees for credit lines for the real (and banking) sector, influenced by further deterioration in companies` operations, may be activated, thus increasing the costs of debt repayment and reducing otherwise limited available assets for budget consumption. Increase of unemployment and a decline in wages. The increase in unemployment and lower salaries (at least in the public sector, and mostly in many other), may influence not only an increase in expenditures for transfers, but also some revenues from taxation as the most significant type of budget revenues. Uncertainty of privatizations within the specified timeframes. A delay in carrying out planned privatizations of some state-owned companies would disturb the dynamics of planned inflows into the budget and slow down the economic recovery. High mandatory and optional transfers. High and growing transfers deteriorate the fiscal position of the state. Besides, suspension of the pension reform additionally worsens the financial position of the budget in a long run. Recovery of the heavy industry sector. The lack or a delay of restructuring of the heavy industry companies and the absence of agreements with strategic partners regarding the development of these companies would undermine the growth potential of the Montenegrin economy. Overindebtedness of the economy and households. Corporate and household overindebtedness narrows the possibilities of using new loans for development projects that would encourage growth, and it also suppresses the aggregate demand which is a new main trigger of growth. Banking sector consolidation. Trust into the banking sector was regained, as viewed in ongoing increase in household deposits in the last six months, but there are still some problems with past due loans, high credit risk and insufficient capitalization of banks. This exposure indirectly renders the recovery of the real economy and the fiscal position more difficult. Box 4.6 Medium-term budget framework and the crisis scenario Taking into account the fiscal risks and the fact that a high level of public and budgetary consumption would lead to a longer and slower industrial and economic recovery, the Government of Montenegro passed the medium-term framework of the budget consumption for , based on: Reducing the personal income tax rate to 9% in 2010; Reducing the contributions for health insurance to 9% and contributions for pension insurance to 20% in 2010; Reducing the contributions paid by employer to 10% and increasing the contributions paid by employee to 24% in 2010; Limiting the level of current public consumption by reducing its share in GDP to less than 34.2% in 2012; Increasing current consumption only for development projects, simultaneously cancelling irrational public consumption programmes; Continuing the payout of liabilities for frozen foreign currency deposits and restitution, limiting the annual repayment of restitution to 0.5% of GDP; Using the EU IPA funds to the amount of EUR 33 million in the period ; Implementation of the medium-term budget framework Continuing the implementation of the capital budget of Montenegro, at the annual level of 3.5% of GDP;

130 130 Chief Economist Annual Report 2009 Full implementation of the programme budget and Establishing sustainable health and pension systems. Unlike the budget scenario, the Government of Montenegro prepared the fiscal crisis scenario for the period , based on the respective real GDP growth of -2.0%, 3.0% and 4.5% in 2010, 2011 and The fiscal crisis scenario means the consolidated public spending at the approximately same nominal level in the period , so that in 2010, albeit the continuing economic crisis, there will be no further decline in expenditures which would, in parallel with a decline in public revenues over the same period, result in a higher deficit at the level of 5.8% of GDP in 2010 to decline in the following two years to 3.2% of GDP in 2011 and to 1.7% of GDP in The deficit would be financed from foreign sources and the state deposits, which would lead to the public debt increase. If the crisis scenario would happen, the following measures should be taken in order to provide sustainable functioning of the public finance system: Implementation of additional austerity measures regarding the current spending to the amount of EUR 20 million; Further reduction of wages through the rationalization of the public administration or reducing gross wages; there is room for reductions in this area, but they are limited by the General Collective Agreement, that would be the subject of negotiations with all participants in the social dialogue in Montenegro; Reducing expenditures in the capital budget by EUR 30 million; and Revising the taxation policy by increasing tax rates in order to increase source revenues of the budget of Montenegro and the local administration. An increase of VAT rate by 1 percentage point would additionally increase revenues by EUR 20 million and an increase in excise duties on mineral oils of EUR 0.05/litre would increase revenues from excise duties by some EUR 15 million.

131 5 PUBLIC DEBT

132

133 Public Debt 133 The public debt of Montenegro was EUR 1,140.2 million or 38.0% of estimated GDP for 2009 based on the Ministry of Finance data. A yearon-year increase was 27.4%. Graph 5.1 Pubic debt, % GDP Table 5.1 Structure of public debt, in EUR million Total public debt Domestic public debt Foreign public debt Government debt with the debt of public companies 1.140,2 38,0% GDP 440,3 14.7% GDP 699,9 23.3% GDP 1296,9 43,2% GDP Source: Ministry of Finance Guarantees of Montenegro were about EUR million or 3.5% of GDP, or 9.3% of the public debt. Public debt accounted for 75.3 % of total registered budget revenues in 2008 (without revenues from privatization, loans and donations). Public debt, along with the debt of public companies amounted to EUR 1,296.9 million or 43.2% of the estimated GDP (Table 5.1). Currency structure of the foreign debt is favourable. The total domestic debt was in euro currency. Some 82% of the foreign debt was also in shown in euro currency, whereas a part of obligations to the Paris Club of creditors, as well as those from IDA loans and the debt to EUROFIMA was shown in other currencies. Graph 5.2 Currency structure of foreign debt Source: Ministry of Finance of Montenegro

134 134 Chief Economist Annual Report Domestic public debt Domestic public debt amounted to EUR million showing a year-on-year increase of EUR 27.3 million, or 6.6%. An increase in the domestic public debt in 2009 was due to the implementation of the Directorate for Transport project aimed at resolving the transport bottlenecks of EUR 47.2 million 56. This is done through the issue of T-bills of EUR 49.6 million, and growth in indebtedness of municipalities. On the other hand, domestic public debt was reduced by regular repayment of debt instalments from old frozen foreign currency deposits of EUR 8.3 million, instalment of debt from restitution of EUR 2.2 million, repayment of loans with commercial banks and non-financial institutions, repayment of assumed debt of Railway Transport of Montenegro and Railway Infrastructure of Montenegro to commercial banks and suppliers. It was also reduced based on the Bioce accident of EUR 6.8 million, repayment of assumed debt of Radio and Television Company of Montenegro of EUR 4.1 million, as well as repayment of regular instalments from the implementation of the projects of the Directorate for Transport to the amount of EUR 14.6 million. As regards the structure of domestic public debt, debt from old frozen foreign currency deposits of 24.5% represented the largest share, followed by obligations from restitution (22.8%), and debt of local municipalities (14.0%). Debt from T-bills made up 11.3% of domestic debt, 11.0% referred to debt from unpaid pensions, 9.0% referred to loans of commercial banks, while 7.4% referred to loans of non-financial institutions (Table 5.2, Graph 5.3). Table 5.2 Domestic public debt, as at 31 December 2009 Creditor Debt in EUR million Domestic debt share in estimated GDP, % % domestic debt % public debt Old frozen foreign currency deposits Debt of local self-governments Obligations* from restitution Loans with commercial banks Loans with non-financial institutions Unpaid pensions Treasury bills TOTAL * Bonds acquired based on the Law on indemnity to pension and disability insurance beneficiaries were issued on 15 September 2008 in total amount of EUR million. Source: Ministry of Finance Total obligations from restitution amounted to EUR million, representing a year-on-year decline of EUR 16.6 million. The reduction of debt from restitution resulted from the repayment of cash obligations and repurchase of bonds FO01 and FO02 57 by the Government on the stock exchange. With a view to reducing 56 Construction loans of the Directorate for Transport local construction company performs works within the agreed deadline (financed from their own resources), and the Directorate for Transport (i.e. Government of Montenegro) repays the loan according to agreed amortization plan. 57 FO01 and FO02 Obligations of the Restitution Fund

135 Public Debt 135 the domestic public debt, the Government of Montenegro repurchased bonds from restitution before the maturity date in January this year, based on the restitution of the previous owners. Some EUR 17.0 million of bonds was purchased, for which some EUR 5.5 million was paid. Graph 5.3 Structure of domestic public debt, in EUR million Debt from T-Bills amounted to EUR 49.6 million due to the issue of T-Bills during 2009 through seven auctions. No T-Bills auctions occurred in With a view to reducing domestic public debt, the Government adopted the Decision on purchasing frozen foreign currency deposit bonds for 2016 and 2017 in Total of EUR 1.2 million bonds have been purchased so far, of which EUR 0.5 million was purchased in The debt of municipalities amounted to EUR 61.7 million, according to data delivered by municipalities, which represented a decline by 19.3 million at end During 2009, principal of EUR 53 million and interest of EUR 3.1 million of interest of the debt to residents was paid Foreign debt Foreign debt amounted to EUR million or 23.3% of GDP at end It was a year-on-year increase by EUR million or 45.3%. This increase resulted from the debt assumption of Railway Infrastructure of Montenegro to the Czech Export Bank of EUR 48.1 million, to the European Investment Bank of EUR 7.0 (funds have not been withdrawn yet), to the European Bank for Reconstruction and Development of EUR 11 million (some EUR 8.9 million has been withdrawn so far), and assumption of debt of Railway Transport of Montenegro to EUROFIMA of CHF 34.5 million. Moreover, foreign debt increased due to the loan withdrawals from Erste Bank to the amount of EUR 30 million, from Credit Suisse Bank of EUR 90.3 million, and IBRD loans for projects Cadastre, Agriculture and Energy Efficiency to the amount of EUR 1.9 million. It also increased due to loan from Hungary of EUR 1.1 million, EBRD road rehabilitation loan of EUR 0.8 million, IDA loans of EUR 0.7 million, loans for project financing Purchase of special fire fighting and rescue vehicles from Austrian Steiermarkisiche Bank und Sparkassen AG of EUR 9.1 million, EIB loan for road rehabilitation project to the amount of EUR 27 million, commodity loan from the Government of Spain for recycling centre in Podgorica to the amount of EUR 0.9 million, and loans from France for the Electric Company to the amount of EUR 0.5 million. This debt was reduced based on regular repayment of principal to non-residents to the amount of EUR 26.9 million. In addition, EUR 20.1 million was repaid based on interest repayment to non-residents.

136 136 Chief Economist Annual Report 2009 Table 5.3 Structure of foreign debt in period January-December 2009 Creditor Debt EUR mill. Foreign debt/ GDP Share in foreign debt % Share in public debt International Bank for Reconstruction and Development (EBRD) % International Financial Corporation (IFC) % Members of the Paris Club of Creditors % International Development Association 2 (IDA) % European Investment Bank 3 (EIB) % European Bank for Reconstruction and Development (EBRD) % Development Bank of the Council of Europe % European Community % Kreditanstalt für Wiederaufbau - Germany (KFW) % Loan from Austria % Loan from Hungary % Loan from Poland % Societe Generale - Education IT % Loan from France % EUROFIMA debt of Railway Company % Czech EXIM debt of Railway Company % Steiermarkische Bank und Sparkassen AG % Erste Bank % Credit Suisse Bank % Loan from Spain for the construction of landfill % TOTAL % Original debt is 71% in EUR, 26% in USD and 3% in other currencies. 2 Original amount is in special drawing rights (SDR). The exchange rate XDR/EUR = was used. 3 EIB loans of EUR 47 million serviced by public companies (Monteput, Montenegro Aerports and Electric Company of Montenegro) are excluded from the amount of foreign debt, and they are treated as guarantees. 4 Loans from German KfW Bank for water supply are used by municipalities, but it is shown in the aggregate table of foreign debt. 5 Commodity loan Electric Company of Montenegro 6 Debt to EUROFIM was CHF 34.5 million, the exchange rate was used. 7 Loan for purchase of fire fighting vehicle for the Ministry of Interior Affairs Source: Ministry of Finance The amount of foreign debt excludes obligations from unsettled debts with Libya, Kuwait, Czech Republic, Slovakia and UBS Bank based on bonds issued within the London Club. The debt to governments of these four countries was assigned to Montenegro based on the distribution of non-allocated debt (5.88% out of 38% for Serbia and Montenegro). According to the Agreement on Succession Issues signed in Vienna on 29 June 2001, this issue is resolved by mutual opinion within the Committee for the Distribution of the Financial Assets and Liabilities of the former SFRY. As regards API bonds, the negotiations will be held at the beginning of 2010 with the representatives of the UBS Bank to find possibilities for bilateral resolution of these issues. The

137 Public Debt 137 total amount of obligations from unsettled debts will probably amount about 1% of GDP and it is included in projections of debt movement in period Negotiations on clearing debt of the Republic of Albania towards former SFRY were held in September 2009 between the representatives of the Ministry of Finance of Albania and representatives of all successors countries of former SFRY. The amount of debt of the Republic Albania to Montenegro was determined, and the manner of its settlement will be agreed by bilateral agreement which signing is expected at the beginning of Some 9.5 million of special drawing rights remained undrawn of total available funds from IDA loans, EUR 27.8 million of KfW loans (water supply phases II and III), EUR 0.6 million of EBRD loans for the road rehabilitation project. The following special drawing rights remained also undrawn: EUR 0.3 million of the loan from Poland, EUR 2.1 million of the loan from Hungary, EUR 7.0 million of the assumed loans of the Railway Company granted by EIB, and EUR 2.1 million of EBRD loan, as well as EUR 4.1 million of the commodity loan of the Government of Spain for the recycling centre in Podgorica. This also applies to EUR 6.0 million of the commodity loan of Erste Bank from Austria, EUR 10.6 million of the loans of International Bank for Reconstruction and Development for cadastre, EUR 6.1 million for energy efficiency, EUR 10 million for Agriculture, EUR 5.1 million for health care, as well as EUR 5 million for waste water management from the loan of the European Investment Bank, EUR 27 million for solid waste from the European Investment Bank, funds from the European Investment Bank for the road rehabilitation to the amount of EUR 7 million, EUR 12.9 million for the purchase of special fire fighting and rescue vehicles from the Austrian Steiermarkisiche Bank und Sparkassen AG. The total amount of available and undrawn funds was about EUR million. The following loan agreements were signed during 2009: with the Austrian Steiermarkisiche Bank und Sparkassen AG for purchase of special fire fighting and rescue vehicles (EUR 22 million), with the IBRD for the institutional development and strengthening of agriculture (EUR 11 million), with EBRD for the improvement of the health care in Montenegro (EUR 5.1 million), for with the Credit Suisse budget spending (EUR 90 million), with Erste Bank Austria for budget spending (EUR 30 million), with the EIB for disposal of solid waste (EUR 27 million), and for roads and bridges A3 (EUR 30 million). The following guarantee agreements were signed as well: for with the EIB granting loans to SMEs through commercial banks (EUR 91 million), with KfW for loans to Opportunity Bank (Erste Bank) (EUR 15 million) and NLB Montenegrobank (EUR 16 million), with the EBRD for the loan for the 3rd phase of the Railway Company project (EUR 4 million), and with the OTP Bank for loan support to Aluminium Plant Podgorica (EUR million) Projection and sustainability of public debt The following table shows the Ministry of Finance projection on the public debt movement in the period with a view to assessing debt s sustainability. The assessment was made based on the assumed legal and contractual obligations of the Government.

138 138 Chief Economist Annual Report 2009 Table 5.4 Amount and structure of government debt of Montenegro, period 2010 projection 2011 projection 2012 projection 2013 projection Foreign debt (EUR million) 856,2 964,2 970,0 968,0 Foreign debt (in % GDP*) 26,7% 28,3% 26,4% 24,4% Domestic debt (EUR million) 408,3 354,8 284,7 243,2 Domestic debt (in % GDP) 12,8% 10,4% 7,8% 6,1% Total debt (EUR million) 1.264, , , ,2 Total debt (in % GDP) 39,5% 38,7% 34,2% 30,5% * Estimated GDP in 2010 was EUR million, in 2011, EUR million, in 2012, EUR 3,671.6 million, and in 2013, EUR 3,965.4 million Source: Ministry of Finance The following assumptions for the domestic public debt projection are used: Repayment of obligations from restitution will amount to 0.5% of GDP per year, The amount of repayment of the obligation from unpaid pensions will be EUR 34 million per year and they will be completely paid by the end of 2011, Borrowings to finance the Directorate for Transport projects and resolve bottlenecks in transport will amount to EUR 53.3 million in 2010 and EUR 20.7 million in 2011, Debt of local municipalities will remain at the same level, Repayment of obligation from old frozen foreign currency deposits will amount to EUR 14 million per year, Repurchase of old frozen foreign currency deposit bonds OB16 and OB17 58 and DO16 and DO7 59 is not taken into account. No debts of the companies shall be taken into consideration. With respect to the foreign debt projection, new borrowings and transfer loans are projected in accordance with the agreed cooperation framework with international and bilateral creditors. Those funds will be used for the projects from the following areas: waste water management, regional water supply, road and railway infrastructure and energy. The foreign debt movement was projected considering the average four-year loan withdrawals. In 2010, additional borrowings were taken in the amount of EUR 150 million for budgetary deficit financing. In 2011, some EUR 100 million of borrowings were taken to the loan repayment. The Ministry of Finance is expected to provide funds from foreign sources. Box 5.1 Projected Government indebtedness in 2010 The Budget Law for 2010 prescribed the Government indebtedness of EUR 3.5 million with the IBRD for the protection of sensitive tourist areas, and of EUR 10 million with the Council of Europe Development Bank (CEB) for the Apartments of solidarity and resolving of residential needs of households and 58 Frozen foreign currency deposit bonds maturing 2016 and Government bonds maturing 2016 and 2017

139 Public Debt 139 mitigating the economic crisis effects on the construction sector. This law also prescribed the Government indebtedness with the EBRD for Deposit Protection Fund to the amount of EUR 30 million, and with EIB for wastewater management to the amount of EUR 25 million and for resolving bottlenecks in transportation in the amount of EUR 5.0 million. The bilateral and multilateral loan agreements for the protection the cultural monuments in Cetinje will be signed to the amount of EUR 5.0 million. Besides, the budget for 2010 anticipated borrowings to provide funds for budget financing, debt repayment and support to banking sector to the amount of EUR 200 million. With respect to the guarantees of the State, guarantees to the total amount of EUR 202 million will be issued, of which EUR 140 million refers to guarantees for loans to economy, EUR 15 million for loan for the Railway Company obtained from the EBRD, EUR 7 million for the loan for Railway Company obtained from the EIB, as well as EUR 40 million for the loan for the purchase of new ships obtained from the Export-Import Bank of China, which beneficiary is Crnogorska plovidba AD Kotor. With respect to debt sustainability, the debtor is able to service the debt obligations without any major adjustments to his income and expenses. The sustainability is mostly tested according to the GDP movements, inflation, interest rates, exchange rate and budgetary revenues of the primary balance. According to the IMF research on debt crises of medium-level developed countries in the last 30 years, the probability that the country with debt/gdp ratio of 40% will face debt crisis is below 20%, whereas, for example, this probability amount to 50% using debt/gdp ratio of 80%. The share of debt in GDP that deems to be safe for the mediumlevel developed countries ranges from 15 to 20% of GDP, while the average debt to GDP ratio was 62% for eight countries that either faced debt crisis or had to refinance their debt in the last ten years. However, it should be born in mind that the amount of indebtedness has increased in majority countries during global financial crisis. Government of Montenegro issued guarantees of EUR million in If they were taken into consideration, total government debt with guarantees would amount to EUR 48.1% of GDP, which is still below Maastricht criteria. However, special attention should be paid to the borrowings in future. As guarantees refer to loans granted by international financial organizations, foreign debt with guarantees amounted to 33.4% of the estimated 2009 GDP. Graph 5.4 Guarantees issued in 2009, in EUR million Debt repayment (principal and interest) to residents and non-residents in 2009 including repayment of obligations from the previous years amounted to EUR million. The budget for 2010 anticipates debt repayment to residents and non-residents, including obligations from the previous period of EUR million. Source: Ministry of Finance

140 140 Chief Economist Annual Report 2009 Graph 5.5 Debt repayment in 2009 and repayment plan in 2010, in EUR million The average fixed interest rate on loans granted by international financial institutions was 3.21%, while the variable rate is mostly pegged to EURIBOR and LIBOR movements. Source: Ministry of Finance Box 5.2 Comparison of indebtedness indicators According to the World Bank methodology (Debt Reporting System) the share of foreign debt in gross domestic product below 30% indicates to the low indebted country, from 30% to 50% indicated to medium indebted country, and the share of over 50% to highly indebted country. Montenegro belongs to low indebted countries with 23.3% of share of foreign debt in GDP. Graph 1 Public debt of countries in the region*, % GDP * 2009 estimate Source: CIA, The World Factbook At end-2009, public debt of Montenegro 60 amounted to 38% as compared to gross domestic product estimated for This is significantly lower than the defined fiscal criterion, i.e. maximum allowed public debt of the European Union. In that respect, Montenegro meets one of the Maastricht criteria, which prescribes that total debt must not exceed 60% of GDP. This indicator is considered to be the most important indicator of debt sustainability. The share of public debt in GDP below 48% points to a low indebted country, of 48% to 80% to a medium indebted country, and the share of over 80% to highly indebted country. 60 World Bank calculates public debt as Government debt (Government with funds and local self-governments) and guarantees for companies

141 Public Debt 141 Graph 2 Public debt of countries members of the Euro area and Montenegro, % GDP Source: CIA, The World Factbook Montenegro belongs to low indebted countries with 38% of share of public debt in GDP. The following graphs show the share of public debt in GDP of Montenegro, countries of the region and of countries of the Euro area. Public debt amounted to 126.2% as compared to exports of goods and services indicating that Montenegro belongs to low indebted countries and having sustainable debt position. Based on the World Bank methodology, the share of public debt in exports of goods and services below 132% shows low indebted country, from 132% to 220% shows medium indebted country, and the share of over 220% shows highly indebted country. According to the methodology of the World Bank, the share of foreign debt in exports of goods and services below 165% points to low indebted country. Montenegro s share of 70.9% of external debt in exports of goods and services indicates to low indebted countries. Table 1 Criteria of indebtedness and the position of Montenegro Indicator Highly indebted Medium indebted Low indebted Montenegro I-XII 2009 Public debt/gdp Ratio>48% 48%<Ratio 80% 80% Ratio 38.0% Foreign debt/gdp Ratio>50% 30%<Ratio 50% 50% Ratio 23.3% Public debt/export* Ratio>220% 132%<Ratio 220% 132% Ratio 126.2% Foreign debt/import* Ratio>275% 165%<Ratio 275% 165% Ratio 70.9% * Exports of goods and services

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143 6 EXTERNAL SECTOR

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145 External Sector 145 Against the backdrop of global recession, reduced local and foreign demand and negative economic trends in 2009, the current account deficit recorded a decline. The balance of payments trends were characterized by a decline in the foreign trade deficit, as well as surpluses on the sub-accounts of services, income and current transfers, a record net FDI inflow, and net outflows in the portfolio and other investments accounts. As a result of the economic crisis the current account deficit was 42.7% lower than in the previous year and amounted to EUR million. The share of the deficit in GDP was still high and it amounted to 29.9%. The lower current account deficit was primarily due to the reduced foreign trade deficit which amounted to EUR 1,371.5 million or 34.1% less than in A declining trend in visible exports and imports as of end-2008 continued in This decline was conditioned by a fall in production and import demand, as well as the reduced availability of foreign capital (loans), which resulted in a decline in the visible foreign trade of 35%. The coverage of imports by exports was 17.8%. The coverage of the foreign trade deficit with the surpluses registered in other current account sub-accounts was 34.7%, which is 9.8 percentage points more than in the previous year. The current account deficit was completely financed by net FDI inflow which amounted to 30.3% of GDP. The volume of services exchange in 2009 amounted to EUR million which was by 11.4% less than that registered in The surplus was EUR million, which was 3.7% less than in the previous year. The deficit in the sub-accounts of goods and services (direct GDP components) amounted to 32.9% of the estimated GDP for 2009 and its share was lower than in 2008 (54.5%). The factor income sub-account registered a surplus of EUR 5.3 million, being by 88.3% lower than in The positive trend was registered in the sub-account of current transfers where a EUR 85.4 million surplus was recorded, which is 16.9% more than that achieved in The growing trend of net FDI inflow continued in 2009, which was mainly the result of a substantial inflow of funds from privatization and recapitalization of the Electric Company of Montenegro (EPCG). According to preliminary data, net FDI inflow in 2009 was EUR million or 65.1% more than in The total FDI inflow amounted to EUR 1,068.4 million or 30.8% more than in High FDI inflow in the last several years financed the current account deficit, but the problem was its structure. The largest FDI in the previous years was registered from privatization and real estates sale, and these resources are limited and thus result in reduced inflows in the future. The only way to maintain (increase) FDI inflows is possible by increasing greenfield investments, especially in the production sector, as this would allow for the establishment of new companies and an increase in exports, thus contributing to the improvement of the current account balance.

146 146 Chief Economist Annual Report 2009 The sub-account of portfolio investments recorded a net outflow of EUR 41.9 million in 2009, while a net outflow in the sub-account of other investments amounted to EUR million, which was the consequence of reduced foreign borrowing. Table 6.1 Balance of payments of Montenegro, EUR thousand Change in % % GDP* A. CURRENT ACCOUNT -1,564, , GOODS -2,082,340-1,371, Export 467, , Exports in foreign trade statistics 433, , Volume adjustment 34,226 19, Import 2,549,724 1,667, Import in foreign trade statistics 2,527,151 1,654, Volume adjustment 22,573 13, SERVICES 399, , Revenues 750, , Expenditures 351, , INCOME 45,613 5, Revenues 168, , Expenditures 123, , CURRENT TRANSFERS 73,060 85, Transfers to Montenegro 109, , Transfers from Montenegro 36,248 32, B. CAPITAL AND FINANCIAL ACCOUNT 1,329, , CAPITAL ACCOUNT , FINANCIAL ACCOUNT 1,330, , Direct investment-net 551, , In abroad -73,704-32, In Montenegro 625, , Portfolio investment-net -15,528-41, Assets -11,642-38, Liabilities -3,886-3, Other investments-net 638, , Assets -179, , Liabilities 817,827 36, Change in CBM reserves 155,301-56, C. NET ERRORS AND OMISSIONS (-A-B) 234, ,454 Source: CBM

147 External Sector 147 Box General and special trade system differences in registration of goods in customs warehouse Monstat used two systems for data representation in the foreign trade statistics: the general and the special trade system. The difference between these two systems is in registering the entry and exit of goods in the customs warehouse. The comparative analysis of data on Montenegrin exports and imports (obtained from the customs declaration,) represented as per both systems, showed that the value of visible imports according to the general trade system, was significantly lower than the value of imports according to the special trade system, which is shown in the following table. Table 1 Visible trade of Montenegro according to the general and special trade system in period , EUR thousand 2007 Export Import Balance 1. General trade system 514,715 1,685,218-1,170, Special system of trade 487,119 2,072,481-1,585,361 Difference (1-2) 27, , , General trade system 484,686 1,986,641-1,501, Special trade system 433,158 2,527,151-2,093,993 Difference (1-2) 51, , , * 1. General trade system 312,914 1,314,622-1,001, Special system of trades 287,877 1,652,170-1,364,293 Difference (1-2) 25, , ,586 * Preliminary data according to the general and special trade systems for 2009, since the final data are available only according to the special trade system Source: Monstat The value of exports and imports represented as per the general trade system should be approximately the same or insignificantly higher than their respective values shown as per the special trade system. However, significant differences between the values of visible imports represented per these systems point to serious flaws in data quality. According to the general system, visible import in 2009 was EUR million lower than the import represented as per the special trade system, in 2008 it was EUR million lower, and in 2007 it was EUR million lower. Table below shows a significant difference between registering the entry of imported goods into the customs warehouse (as per the general trade system) and their putting into free trade after the customs warehousing (as per the special trade system). As the table 2 shows, there was a significant difference between registering the entrance of goods into the customs warehouse and putting them into free circulation after warehousing. According to Monstat data obtained from customs declarations for 2009, the value of imported goods entering the customs warehouse was EUR 82.4 million, whereas the value of goods put into free circulation was EUR million, five times more than the registered entrance. The differences were significantly greater in 2007 and 2008, when the visible imports were higher than in 2009.

148 148 Chief Economist Annual Report 2009 Table 2 Registering of goods in the customs warehouse, EUR million Customs procedures Procedure of customs warehousing without the previous proceeding (involved in the general trade system) 68,32 86,93 82, Putting goods into free circulation after the customs warehousing (included in the special trade system) 472,49 627,92 420,40 Difference ( ) -404, Source: Monstat 6.1. Current account As in the previous years, movements in the current account mostly depended on movements in the subaccount of goods. A decline in the foreign trade deficit reflected on the reduction of the current account deficit. This decline was also due to positive results recorded in other sub-accounts of the current account. Table 6.2 Current account, in EUR thousand Change in % (2009/2008) A. CURRENT ACCOUNT ( ) ,70 1. GOODS , Exports , Imports ,59 2. SERVICES , Revenues , Expenditures ,73 3. INCOME , Revenues , Expenditures ,93 4. CURRENT TRANSFERS , Transfers to Montenegro , Transfers from Montenegro ,88 Source: CBM

149 External Sector 149 Box 6.2 Comparative (mirror) analysis of foreign trade With a view to obtaining reliable statistical data and their verification, the statisticians very often use the so-called mirror analysis. This comparative analysis aims to prove whether there are any differences in amounts of one and the same item registered in various countries. Monstat data on Montenegro s foreign visible exchange contain certain discrepancies when compared to the same data presented by the national statistic agencies of the partner countries. The data analysis was focused on countries which were the main foreign trade partners of Montenegro in 2008 and Monstat data show that Montenegro s export to Serbia amounted to EUR million in 2008, while the value of Serbia s import from Montenegro, according to the Statistical Office of the Republic of Serbia, was EUR million (a difference of EUR 29.5 million). After Serbia, there was a large discrepancy in the exchange data with Greece, of EUR 11.7 million. As for the imports in 2009, the largest difference in absolute terms was in data regarding the exchange with Serbia of EUR 45.7 million, then Croatia and Italy with differences of EUR 28.8 million and EUR 11.9 million, which is represented in the following table. Table 1 Comparative analysis of Montenegrin exports and/or imports of partner countries from Montenegro in 2008 and 2009, EUR million Country Difference Difference Exports Statistics of Exports Statistics of (Monstat) countries In absolute (Monstat) countries In absolute in % in % terms terms Serbia 107,81 137,30 29,49-21,5 77,27 123,00 45,73-37,2 Greece 53,23 64,90 11,67-18,0 47,80 37,54 10,25 27,3 Italy 130,56 124,21 6,35 5,1 32,95 44,87 11,93-26,6 Hungary 9,25 5,71 3,53 61,9 11,66 13,00 1,34-10,3 Slovenia 37,35 39,97 2,62-6,5 24,28 17,63 6,65 37,7 Croatia 6,62 4,71 1,91 40,7 9,12 37,93 28,80-75,9 BiH 22,09 20,24 1,85 9,1 17,82 19,82 2,01-10,1 Kosovo 15,45 14,07 1,38 9,8 16,26 12,35 3,91 31,7 Source: Monstat and the national statistical offices Large discrepancies are obvious in Montenegro s import, as shown in the following table.

150 150 Chief Economist Annual Report 2009 Table 2 Imports of Montenegro and/or exports of partner countries to Montenegro in 2008 and 2009, in EUR million Country Difference Difference Import Statistics by Import Statistics by (Monstat) countries In absolute (Monstat) countries In absolute in % in % amounts amounts Greece Bosnia and Herzegovina Croatia Slovenia Serbia Germany Italy Source: Monstat and national statistic agencies All this creates a serious doubt in the accuracy of these data, and the latest IMF document on Montenegro expresses a doubt that data on exports were underestimated. Graph 6.1 Structure of the current account by quarters, EUR thousand International visible exchange in 2009 was characterized by a continued decline in visible exports from previous several years, but also a significant decline in imports. Visible exports fell by 36.6%, while imports declined by 34.6%. The share of foreign trade deficit in GDP was remained high, 45.7%. In the observed period, the account of services recorded a surplus of EUR million. The surpluses in the accounts of income and current transfers amounted to EUR 90.7 million. Source: CBM

151 External Sector 151 Box 6.3 Impact of the financial crisis on the current account deficit in South-East European countries The current economic and financial crisis stabilized the balance of payments and reduced the current account deficit in most countries. As for the South-East European countries, a decline in the current account deficit was 6.5%, on average, while in most countries the deficit reduced by half for example in Turkey to a mere 2% of GDP. In Central European countries there was a larger decline in deficit than expected from almost 6% of Table 1 Current account deficit in the selected countries, % GDP Current account (% GDP) * 2010* Slovenia Estonia Latvia Lithuania Bulgaria Croatia Romania Turkey Albania Bosnia and Herzegovina FYR Macedonia Serbia * Estimates for 2009 and 2010 Source: IMF, World Economy Outlook, October 2009; IMF- Balance of Payments Statistics GDP in 2008 to average 2% of GDP in Several factors in connection with the crisis influenced this situation. A large decline in local demand (especially for vehicles and other durables) was caused by halts in investments and construction influenced a decline in imports. As a result of the aforementioned, total imports significantly declined in Reduced local demand was additionally affected by limited and more expensive sources of capital in financial markets. The Baltic countries, which were particularly hit by the crisis, passed from two-digit deficits in 2008 to surpluses of 1.5% -6% of GDP in 2009, which was a change of about 15 percentage points, on average Visible exchange 61 Visible exchange recorded a decline due to reduced capital inflows in 2009, primarily caused by a decreased inflow of monetary assets (through loans) which households and corporate sector used to finance imports in the previous period. According to Monstat data, the foreign trade deficit of Montenegro in 2009 was EUR 1,377.1 million, being 34.2% lower than in Total foreign trade was EUR 1,931 million, which was significantly less than in 2008 when it was EUR 2,960.3 million. The share of imports in total exchange was significantly higher and it was 86%, whereas the share of exports was only 14%, indicating low competitiveness of the national economy. 61 Methodological remarks: Data on foreign trade of Montenegro were represented according to the special trade system. The CBM made adjustments of data obtained from Monstat for the purpose of creating the balance of payments in accordance with the IMF methodology (Balance of Payments Manual, Fifth edition, IMF, 1993).

152 152 Chief Economist Annual Report 2009 Graph 6.2 Exports and imports by quarters in period , EUR thousand Source: CBM and Monstat Graph 6.3 Coverage of visible imports by exports in period Although the foreign trade deficit was significantly lower, its share in GDP remained very high in The global economic crisis significantly influenced the reduction in personal consumption, which caused a decline in visible imports. Also, the giving up of some companies from capital investments and the reduction in demand influenced a decline in imports of capital and intermediary products. A decline of the national industrial production, as well as reduced volume of banking loans additionally reduced the demand for products from abroad. Although the reduction of imports can be observed as a positive event, it was simultaneously an indicator of negative trends in the economy and a decline in investment activity. Observed by quarters, the largest coverage of imports by exports was in the first quarter (20.3%), while the lowest was in the second (12.5%) quarter of Source: Monstat Box 6.4 Visible exchange of countries in the region in 2009 The economic crisis severely hit all countries in the region, which reflected on their visible exchange. A decline in overall economic activity was best reflected through the decline in visible trade. Most countries in the region recorded two-digit percentage declines in visible exchange in After Montenegro, the highest percentage decline of foreign visible trade was with Serbia (25.3%) and Croatia

153 External Sector 153 Graph 1 Visible exchange of countries in the region in 2008 and 2009, EUR million Source: National statistical offices (25.2%), then FYR Macedonia (24.4%), Slovenia (23%), Bosnia and Herzegovina (22.3%) and Albania (10.1%). The largest absolute decline in visible exchange was with Slovenia of EUR 9.9 billion. Such a substantial decline in visible exchange was influenced by both imports and exports. Observed cumulatively, exports of all the selected countries in 2009 was 20.2% lower than in 2008, while imports registered a larger decline (25.8%). All countries saw their foreign trade deficits decline in relation to A declining trend in the value of import from previous years continued in According to Monstat, the total value of visible exports was EUR 277 million, which represents a decline of 36.1% in comparison with This decline was due to a decline in the prices of metals and reduced production. A fall in the export of intermediary products, i.e. low-processed products, shows that importers or industries which use them face a severe decline in demand. In the structure of exports, same as in previous years, the largest share was of aluminium and its derivatives (41.1%), followed by iron and steel (11.5%), beverages, alcohol and vinegar (7.6%), reactors, boilers, mechanical devices and their parts (7%), and timber and related products (4.9%). The aforementioned five products accounted for 72% of total exports. Poor differentiation is the key problem of the Montenegrin exports. The largest absolute decline in exports was of aluminium and related products (of EUR 66.7 million or 36.9%), iron and steel (EUR 53.3 million, or 62.6%) and their derivatives (EUR 11.4 million or 59.9%). The highest absolute growth in the value of exports in 2009 was registered in the following group of products: reactors, boilers, machines, mechanical devices and their parts (of EUR 4.4 million or 29.4%), products of meat, fish and other water invertebrates (of EUR 1.3 million or 55.2%) and windmill industry products (of EUR thousand). Table 6.3 Structure of visible exports in 2009, EUR thousand Product Value Share in % Aluminium and related products ,9 41,1 Iron and steel ,7 11,5 Beverages, alcohol and vinegar ,8 7,6 Reactors, boilers, machines and mechanical equipment and their components ,0 Wood and related products; wood coal ,2 4,9 Pharmaceutical products 8.971,3 3,2 Mineral fuels, mineral oils and products of their distillation; bitumen material; mineral 8.383,8 3,0 waxes Products of iron and steel 7.629,1 2,8 Vegetables and potatoes 3.706,0 1,3 Products of meat, fish and other water invertebrates 3.564,6 1,3 Source: Monstat

154 154 Chief Economist Annual Report 2009 Graph 6.4 Exports of aluminium and total exports, EUR thousand Source: CBM and Monstat Graph 6.5 Global metal prices in 2008 and 2009 The export of aluminium and related products registered the lowest value in the last few years of EUR million, which was 36.9% and 55.3% lower than in 2008 and 2007, respectively. A significant reduction in the aluminium export was the consequence of the global economic crisis and low prices of aluminium in the world market, as well as a reduced production of the Aluminium Plant Podgorica (KAP). Due to the lower demand and a fall in the prices of iron and steel in the global market, the export of products from the iron and steel group fell by 62.6% compared to An average price of steel in 2009 was significantly below that in the previous year, which pointed to a very difficult position of producers directly hit by the crisis. The exports of products from the group reactors, boilers, machines and mechanical devices and their components rose by 29.4%. Although the price of aluminium increased in 2009, it was significantly lower than the average from the previous year when it reached the value exceeding USD 3,000 per tonne (Graph 6.5). Source: Reuters Observed in absolute amounts, the economic crisis generated more significant decline of visible imports than exports, which affected a decline in the foreign trade deficit. According to Monstat data, visible imports in 2009 amounted to EUR 1,654 million or 34.5% less than in the previous year. The decline in the value of imports was significantly influenced by the reduced personal and investment consumption, as well as a drop in the prices of imported raw materials. Also, one of the factors which influenced the decline in imports was the impossibility of borrowing by local and foreign companies to finance imports. In the structure of imports, a significant share was of raw materials and equipment. In the reporting year, the mainly imported products were those under the categories mineral fuels, oils and products of their distillation, reactors, boilers, machines and mechanical devices and electric machines and equipment and their components.

155 External Sector 155 The import of products from the category mineral fuels, mineral oils and products of their distillation amounted to EUR million or 42.4% less than in 2008, which was the result of the drop in oil prices and its derivatives, as well as the lower import of electricity. Within this group of products, mostly imported were oil derivatives and bitumen minerals, EUR million or 47.4% less than in 2008, and electricity EUR 68 million (40.4% less). Although the global prices of oil and electricity trended upward in 2009, they were significantly lower than in the previous year (Graph 6.6). The import of products from the category reactors, boilers, machines and mechanical equipment was EUR 120 million and it recorded the year-on-year decline of 54.1%. The decline in imports of these products was the result of reduced construction activities in which they are mostly utilised (these were mainly construction machines). The import of electrical machines and their equipment and components totalled EUR 117 million, which is 34.1% less than in The largest absolute decline in imports was of vehicles (EUR million), mineral fuels, oils and products of their distillation (by EUR million), reactors, boilers, machines and mechanical devices (by EUR million). In spite of a large decline in imports, the imports of the following products increased: pharmaceutical products (by EUR 5.8 million), coffee, tea and spices (by EUR 5.3 million) and nonorganic chemical products (by EUR 5.2 million). Table 6.4 Structure of visible imports in 2009, EUR thousand Product Value Share in % Mineral fuels, mineral oils and products of their distillation; bitumen materials; mineral ,1 12,6 waxes Reactors, boilers, machine and mechanical devices and their components imehanički ,9 7,3 uređaji i njihovi djelovi Electrical machines and equipment and their components ,1 7,1 Vehicles, excluding rail and tram vehicles and theirs components and equipment ,0 5,4 Meat and related products ,9 3,6 Iron and steel products ,7 3,6 Furniture, linen, mattresses, pillows and related products; lamps and other fluorescent ,7 3,3 items etc., mounting buildings Pharmaceutical products ,6 3,0 Plastic masses and products of plastic masses ,7 3,0 Beverages, alcohol and vinegar ,3 2,8 Source: Monstat Graph 6.6 Global prices of energy products, A downtrend in the global economy strongly influenced the most important economic partners of Montenegro, the EU and CEFTA countries, which reflected on the changes in the regional structure of visible exports and imports in comparison with 2008, as well as on the fall Source: Reuters in total visible exchange with most of these countries. The export to the EU countries made up 48.3% of total exports in 2009 and it was 12.9 percentage points lower than in The import from the EU countries accounted for 39.5% of total imports, which is 1.6 percentage points less than in Of the

156 156 Chief Economist Annual Report 2009 Graph 6.7 Products which primarily affected a decline in visible export/ imports, EUR million Source: Monstat EU countries, most of the visible exports was to Greece, EUR 47.8 million (17.3%), Italy, EUR 32.9 million (11.9%) and Slovenia, EUR 24.3 million, (8.8%), whereas most of the visible imports was from Italy, EUR 115 million (7%), Germany, EUR 104 million (6.3%), Slovenia, EUR 89.2 million (5.4%), and Greece, EUR 85.9 million (5.2%). Visible exports to CEFTA countries made up 46.2% of total exports, which is 9.5 percentage points more than in Most visible exports was to Serbia, EUR 77.3 million (27.9%), Bosnia and Herzegovina, EUR 17.8 million (6.4%) and Kosovo, EUR 16.3 million (5.9%). The import from the CEFTA countries made up 44.5% of total imports, which was 4 percentage points less than in Most of the visible imports was from Serbia, EUR million (30.6%), Bosnia and Herzegovina, EUR million (6.1%) and Croatia, EUR 99.5 million (6%). Table 6.5 Visible exchange by countries in 2008 and 2009, EUR thousand EXPORTS IMPORTS BALANCE EU (27) 265, ,827 1,039, , , ,168 Austria 1,538 1, ,053 63, ,515-61,651 Greece 53,225 47, ,455 85, ,230-38,065 Italy 130,563 32, , ,996-62,632-82,051 Hungary 9,248 11,660 54,710 22,456-45,462-10,797 Germany 16,218 2, , , , ,437 Slovenia 37,355 24, ,297 89, ,942-64,894 CEFTA 158, ,920 1,227, ,799-1,068, ,879 Albania 5,907 6,080 20,324 8,804-14,417-2,724 Bosnia and 22,089 17, , , ,721-83,066 Herzegovina Croatia 6,620 9, ,665 99, ,046-90,401 Serbia 107,811 77, , , , ,222 FYR Macedonia 902 1,364 29,878 20,755-28,976-19,391 Moldavia Kosovo 15,450 16,262 3,321 1,302 12,129 14,960 CEFTA 1, ,606 60, ,796-59,929 Other countries 7,259 14, , , , ,086 USA 889 7,407 31,964 13,104 31,075-5,697 Russia 1,041 1,513 3,042 38,039 2,001-36,526 TOTAL: 433, ,982 2,527,151 1,654,044-2,093,993-1,377,062 Source: Monstat

157 External Sector 157 Total visible exchange of Montenegro was reduced by 34.8%, but the decline was uneven. With the EFTA 62 countries the agreed foreign trade was 51.4% less, which was not so significant considering a low volume of exchange. Foreign trade with the EU and CEFTA countries reduced by 39.6% and 37.6%, respectively. Observed by individual countries, Montenegro has the largest deficit in the exchange with Serbia (EUR million), then Germany (EUR million), Croatia (EUR 90.4 million) and Bosnia and Herzegovina (EUR 83.1 million). Graph 6.8 Total visible exchange of Montenegro, by groups of countries Source: CBM and Monstat Box 6.5 Global competitiveness index and the position of Montenegro The global competitiveness index was created by the World Economic Forum and it was one of the most famous competitiveness indices in the world. It was based on examinations which included a wide spectrum of parameters influencing a country s competitiveness. Factors which influence the competitiveness were grouped into 12 pillars of competitiveness classified into three groups: main requirements (institutions, infrastructure, macroeconomic stability, health care and primary education), factors of increased efficiency (university education and training, efficiency of the merchandize market, efficiency of the labour market, sophistication of financial markets, technological readiness and the market size) and innovation and sophistication factors (sophistication of business processes and innovation). The significance of the pillars of individual competitiveness of a country depends on its development. For the least developed countries the Graph 1 Index of the global competitiveness of Montenegro as per competitiveness pillars (ratings from 1 to 7) Source: World Economic Forum 62 Norway, Island, Lichtenstein and Switzerland

158 158 Chief Economist Annual Report 2009 most important was the first group of pillars main requirements, for middle developed countries in addition to main requirements of large significance were factors of increased efficiency, whereas for the developed countries the most important were increased efficiency, innovation and sophistication factors. For Montenegro, as a middle-income developing country, in addition to main requirements, the factors of increased efficiency are also important. According to the latest report on the global competitiveness published in September 2009, Montenegro was 62nd of 133 counties covered in the research. The value of the competitiveness index was 4.1 of the maximum 7 points. The first place in the latest report of the World Economic Forum takes Switzerland, which replaced the USA which was ranked first in the past two years, and the deteriorated ranking was the consequence of the aggravation of macroeconomic stability and lower rating of financial markets. Compared to 2008, Montenegro improved its position to move three places up. Of 12 pillars of competitiveness, decline was registered only in macroeconomic stability where the rating was 4.6 (in 2008 it was 5.5). Montenegro was ranked worst for the market size, 2.2 points, then infrastructure, 3, and innovation, 3.3 points. The best rating for the pillars of competitiveness was for health care and primary education, 5.8, and sophistication of the financial market, 5. A positive fact is that Montenegro was rated 5.6 within the pillar efficiency of the market of goods as per the criteria of the attractiveness of the FDI environment for and it occupied 18 position on the list of 133 countries of the world. Within the pillar sophistication of financial market, according to the limitation of financial flows criteria, Montenegro was ranked 17th (5.4 rating), whereas for the protection of rights of foreign investors it was rated 6.3 (24th). According to the global competitiveness index for 2009, and compared to countries of the region, Montenegro was ranked best. Only Montenegro, FYR Macedonia and Albania progressed compared to 2008, whereas Serbia, Croatia and Bosnia and Herzegovina received worse ratings. The worst ranked countries in the region were Bosnia and Herzegovina, 109th, and Albania, 96th. Croatia received the worst rating in the last eight years as long as it has been included in the research (72nd) and it declined by 11 positions compared to Graph 2 Rating of countries in the region according to the global competitiveness index (positions 1-133) Source: World Economic Forum Services The account of services registered the year-on-year decline of surplus, which was the consequence of reduced revenues. As for the international exchange of services in 2009, Montenegro had a surplus of EUR million, which is 3.7% less than in The total volume of exchange of services was EUR million and it was 11.4% less than in 2008.

159 External Sector 159 Revenues from services amounted to EUR million and they were 9.3% lower than in the previous year. Most revenues were from travel tourism, EUR million, then transport, EUR 99 million, other business services, EUR 29.1 million, and construction services, EUR 27.7 million. Expenditures for services amounted to EUR 296 million, which was a 15.7% year-on-year decline. A significant reduction of investments, especially in construction, influenced the reduced requirement for services of non-residents. In the structure of expenditures, the largest share was of other business services, EUR 73.6 million, of which the most significant expenditures were those for various business services, EUR 60.1 million. In the aforementioned category, the largest expenditures were for legal, accounting and consulting services, EUR 21.6 million, then architectural, engineering and other technical services, EUR 14.7 million, and research and development services EUR 11.3 million. Expenditures for transport were EUR 66.8 million. As for construction, expenditures amounted to EUR 41.4 million and they were 36.3% lower than in 2008, whereas those for travel amounted to EUR 35.3 million. Graph 6.9 Structure of revenues from services in 2009 Source: CBM Graph 6.10 Structure of expenditures for services in 2009 The account of transport services recorded a surplus of EUR 32.3 million. Transport revenues were EUR 99 million, which is 7.7% less than in The largest revenues were from air transport, EUR 36.9 million (37.3%) and maritime transport EUR 35.8 million (36.1% of total transport revenues). Maritime transport recorded revenues to the amount of EUR 35.8 million, which is 1.9% less than in 2008, and it was owing to the increased revenues from services provided in ports, as well as larger reloading of certain types of cargo. Revenues from air transport were EUR 36.9 million, which was approximately at the same level as in Observing the structure of revenues in air transport, the increase of revenues from the air passenger transport was 12%, whereas the revenues from air Source: CBM Graph 6.11 Transport revenues in 2008/2009, EUR thousand Source: CBM

160 160 Chief Economist Annual Report 2009 cargo transport reduced by 73.6%. The increase of revenues from the air passenger transport was the result of introducing the new flights and the liberated visa regime for countries signatories to the Schenghen Agreement. The road transport recorded revenues of EUR 10.3 million, which is 20% more than in 2008, and it was the result of increased revenues from the road cargo transport by 29.4%. Table 6.6 Structure of transport revenues in 2008 and 2009, EUR thousand Type of transport 2008 % share 2009 % share Changes in % ( 2009/2008) Maritime 35, , Railway 4, , Air 37, , Road 8, , Other 5, , TOTAL 92,000 99, Source: CBM Graph 6.12 Transport expenditures in 2008 and 2009, EUR thousand Total transport expenditures amounted to EUR 66.8 million and they were 19.4% lower than in The largest revenues were from air and road transport. The expenditures in air transport amounted to EUR 30.5 million, which is 22.1% less than in Source: CBM Road transport expenditures amounted to EUR 23 million or 25% less than in 2008, which was the consequence of the reduced visible exchange. The share of expenditures for cargo transport was 37.6% of total transport expenditures, whereas the share of passenger transport expenditures amounted to 29.2%. Table 6.7 Structure of expenditures for transport in 2008 and 2009, EUR thousand Type of transport 2008 Share in % 2009 Share in % Changes in % (2009/2008) Maritime 8, , Railway 1, , Air 39, , Road 30, , Other 2, , TOTAL 82, , Source: CBM

161 External Sector 161 Revenues from travel were calculated by estimating revenues from tourism, completed with data on the provided health and recreational services and spending for education. These revenues are an important item in the balance of payments of Montenegro considering their significant role in financing the foreign trade deficit. In 2009, the estimated revenues from travel were EUR million, which is 7.9% less than in the previous year, as the consequence of reduced tourist overnights and spending. The number of foreign tourist overnights, according to Monstat data, was 3.9 percentage points lower than in The travel surplus in 2009 totalled EUR million, which is 9.5% less than in As for the communication services, revenues amounted to EUR 26.5 million. The largest portion of these revenues came from telecommunications. The expenditures for communication services amounted to EUR 17.3 million. The account of communication services recorded a surplus of EUR 9.1 million, whereas in 2008 this surplus was EUR 22.5 million. Revenues from other business services were EUR 29.1 million, 27.2% less than in Most revenues were from different business, professional and technical services (legal and accounting services, consulting, engineering services and the like) to the amount of EUR 25.6 million. The expenditures for other business services were EUR 73.6 million. Some EUR 21.6 million was paid for legal, accounting and consulting services. The costs of promotion of domestic products and services at international fairs, the purchase of advertising material, market research and other types of media advertising amounted to EUR 20.6 million. The other business services accounted registered a deficit of EUR 44.5 million, which is 17.7% less than in A decline of investment activity in construction influenced a reduction in revenues from and expenditures for construction services. The inflow of funds from the work on construction projects and installations by local companies outside and in Montenegro amounted to EUR 27.7 million, which is 45.3% less than in The expenditures for the employment of non-residents in construction were EUR 41.4 million or 36.3% less than in As for the construction services, the deficit was 5.1% lower than in the previous year and it amounted to EUR 13.7 million. In 2009, Montenegrin residents allocated EUR 13.4 million for international insurance services, whereas revenues on this basis amounted to EUR 3.8 million. Insurance services recorded a deficit of EUR 9.7 million, which is 5.4% less than in Factor income The account of factor income registered a surplus of EUR 5.3 million in 2009, being significantly lower than the surplus registered in the previous year (EUR 45.6 million). Revenues from factor income amounted to EUR million, which is 3.5% less than in The largest portion of these revenues was compensations of employees of EUR million. Expenditures for income on international investments were EUR 7 million. Expenditures for factor income amounted to EUR million, which is 27.9% less than in The increase in expenditures is the result of the increased outflow arising from interest repayment and dividends payout. Of total expenditures, EUR million related to income from international investments (investments in the form of loans, foreign direct and portfolio investments), and EUR 6 million to salaries to

162 162 Chief Economist Annual Report 2009 Graph 6.13 Structure of factor income revenues in 2009 Source: CBM non-residents employed in Montenegro. Of total expenditures from international investments, EUR 86.3 related to interest payment, which is 2.1% less than in The outflow arising from paid dividends was EUR 65 million, which was much more than in 2008 (EUR 29.2 million) and it showed that foreign investors were less keen to reinvest their share in profit and that they transferred more funds to their accounts held abroad Current transfers The account of current transfers recorded the year-on-year increase of surplus due to a mild growth of inflow from transfers and a reduced outflow. The balance of current transfers in 2009 was EUR 85.4 million, which was 16.9% less than in Total revenues from current transfers in the observed period amounted to EUR million, being 7.7% lower than in the previous year. In the structure of revenues, EUR million referred to other sectors and EUR 14.8 million to the government sector. Transfers to other sectors were 7.4% higher than in Of total inflow of transfers of other sectors, EUR 61.6 million referred to remittances, whereas the inflow from other transfers (inheritance, maintenance, gifts and assistance) was EUR 41.2 million. In the same period, the expenditures for current transfers amounted to EUR 32.3 million, which is 10.9% less than in the previous year. In the structure of expenditures, the government sector accounted for EUR 9.5 million, and EUR 22.8 million referred to other sectors. Within the transfers of other sectors, the outflow arising from remittances was EUR 12.4 million, while the outflow arising from inheritance, gifts and different types of assistance was EUR 10.4 million, which is 44.6% less than in It is interesting to note that the inflow of assets in the form of transfers and factor income accounted for 94.6% of total funds which Montenegro earned by exporting goods abroad Capital and financial transactions account Movements in the capital and financial account in 2009 were characterized by the record FDI inflow as well as a net outflow in the accounts of portfolio and other investments. Montenegro registered an exceptionally high FDI inflow in the reporting year. Net FDI inflow (inflow minus outflow), according to preliminary data, was EUR million or 65.1% more than in the previous year, whereas the total inflow was EUR 1,068.4 million. The increase in net inflow was due to the privatisation and recapitalisation of the Electric Company of Montenegro (EPCG) by the Italian company A2A. The sale of shares to the Italian company was the confirmation of the fact that for good companies and projects, in spite of the crisis, it is not difficult to

163 External Sector 163 Graph 6.14 Net FDI inflow in 2008 and 2009, EUR thousand find investors and it was a good signal to foreign investors to participate in investment projects significant for the development of Montenegro. In the reporting year, most assets were invested in the energy and banking sectors. The largest FDI inflow was from privatisation and recapitalisation of EPCG (41%), as well as recapitalisation of and investments in the banking sector (10%). Total investments in local companies and banks amounted to EUR million or 181.3% more than in the previous year, while real estate investments were EUR million or 46.7% less than in Some EUR million was in the form of intercompany debts, which is 28.8% less than in The inflow of monetary assets from reduced capital in foreign banks and companies and the real estate sale abroad amounted to EUR 571 thousand. Observing the regional FDI structure, the largest inflow of funds was from Italy (43%), then Austria (7.6%) and the Russian Federation (6.2%). Source: CBM Graph 6.15 Structure of total FDI inflow in period , EUR thousand Source: CBM Box 6.6 FDI trends in the world in According to the UNCTAD report, FDIs recorded sharp declines in At the global level, the decline in FDI inflow was almost 39%, from USD 1,700 billion in 2008 to somewhat above USD 1,000 billion in The decline was registered in all three groups of countries: developed, underdeveloped and transitional countries. There was a substantial decline in FDI inflow in 2008 in developed countries and it continued in 2009 (about 41%). The largest fall was registered in the USA, Great Britain, Spain, France and Sweden. FDI inflow to countries of the European Union was 29% lower than in Developing 63 Source: UNCTAD - Global Investment Trends Monitor No. 2, January 2010

164 164 Chief Economist Annual Report 2009 countries saw FDI decline of 35%, which was very large considering that in the last six years the FDI inflow to these countries has been on an ongoing upward trend. The region of the Western Asia saw the largest fall (43%). FDI flows to Eastern European countries and those of the CIS also declined substantially (by 39%). In Eastern European countries this fall was significantly contributed by structural weakness of these economies, as well as privatisation processes that are nearing their completion. Graph 1 FDI inflow by groups of countries, USD billion Observed by the structure, all three FDI components - ownership capital, reinvested profit and other capital declined in The largest decline was in ownership investment, which was directly related to long-term investment strategies of transnational companies which were severely hit by the crisis. A large drop was evident in greenfield investments, 23% in comparison with The estimated sharp decline in FDI inflow can be best seen if observed per quarters of The sharpest fall was in the first quarter, to be followed by a significant recovery in the second quarter and almost the same FDI value in the third quarter. All these inflows were significantly lower than in the same period in The UNCTAD predicted a minor FDI increase in the fourth quarter compared to the third quarter of The UNCTAD forecasts modest FDI recovery in The improvement of macroeconomic environment for international investment is expected. The recovery of the global economy and an increase in profit of the transnational companies as of the second quarter of 2009 have been encouraging investors to revise their investment plans and thereby contribute to a higher FDI inflow in Potentials for the inflow of foreign investments have not still been exploited. The energy sector and tourism industry in Montenegro have large potentials for attracting foreign investments. As for the energy sector, the available natural potentials have not been efficiently utilised and Montenegro currently uses a little more than 17% of its energy potentials. In addition to its hydro-potential, Montenegro has many unused potentials of renewable energy sources (wind, solar energy, biomasses and vegetable waste) which can be valorised together with investments. It is necessary to change the FDI structure with a view to attracting those which will contribute to the future development and exports. It should be strived to increase the share of greenfield investments in total FDIs and redirect foreign investments to export-oriented sectors. To that end, it should be strived to intensify the promotion of investments prospects of Montenegro, and particularly emphasize the advantages of the CEFTA, thus enabling a partial overcoming of the problem of a small local market. As branches having large unused potentials to be promoted are the energy sector, wood processing industry, food industry and the like.

165 External Sector 165 Total FDI outflow in 2009 was EUR million, which is 40.5% less than in In the structure of the outflow, EUR 34.7 million related to reduced obligations of local companies for loans taken from parent companies. The outflow from real estates was EUR 24.9 million. Investments of Montenegrin residents in foreign banks and companies amounted to EUR 29.1 million, whereas the outflow from the withdrawal of a part of foreign capital in local banks and companies was EUR 68.8 million. Box 6.7 Country measures aimed at attracting FDI In 2009, FDI flows at the global level were strongly hit by the global economic crisis. Recognizing the significance of these investments for the recovery of national economy, many countries took appropriate measures in order to attract more foreign investments to get them near to the levels existing in previous years. Only in the second half of 2009, 51 countries worldwide implemented numerous amendments and adjustment of their economic policies with a view to improving FDI inflows. A large part of these amendments both in G20 countries and in others addressed the liberalization, promotion and facilitation of FDI inflows. Many of the countries facilitated the entry of foreign investors to their markets. Also, large economies continued with government assistance through different stimulating packages. Tailor-made measures for companies, sectors, and intersectoral measures were also adopted. With a view to increasing FDI, numerous international investment and bilateral agreements were concluded. However, some countries adopted economic measures which are not in favour of FDI: nationalisation, expropriation, new limitations to foreign capital and other unpopular measures. Measures which were common for a large number of countries related to different international and bilateral investment agreements, as well as government aid packages to the economy. Table 1 Measures of selected European countries with a view to increasing FDI inflow MEASURES SPECIAL MEASURES GENERAL MEASURES COUNTRY Taxation Promotion of direct General Taxation International Liberalization Government Promotion (special investments in legal (general agreements of entrance aid measures) countries framework measures) Bulgaria x x Greece x x x Czech Rep. x x Cyprus x x x x Hungary x x x Romania x Russia x x Estonia x x Latvia x Poland x x Slovakia x x Slovenia x x B&H x FYR Macedonia x x Serbia x Great Britain x x x Source: UNCTAD - Investment Policy Monitor, December 2009

166 166 Chief Economist Annual Report 2009 With a view to attracting FDI, the Government of Montenegro adopted the Foreign Direct Investment Incentives Strategy of Montenegro in The strategy focuses on the key investment policies through the implementation of fiscal, financial and institutional incentive measures, as well as the key promotional activities and creating the image of Montenegro as an attractive investment destination. The strategy targets foreign investors. The implementation of the strategy is a very complex process. A number of measures shall be implemented over a long period and their effects can be estimated only in a long-term. The measures defined in the strategy are divided into three groups: general strategic measures, focused strategic measures and promotional strategic measures. Since the starting of the strategy implementation and until the end of 2009, many measures were implemented, and the application of numerous started. In the field of general strategic measures, as the widest framework of the strategy, much has been done: labour legislation have been improved, several bilateral investment agreements have been confirmed or signed, and much has been done on the pension system reform, the labour market reform, regulations in the area of intellectual property rights and alike. Focused strategic measures were implemented to a great extent: the financial system has been improved for foreign investors, personal income tax has been reduced, as well as tax rates on dividends and share in profit, municipal taxes have been reduced, the spatial plan of Montenegro was adopted as well as local spatial plans, development strategies for tourism, transport and energy sector etc have been adopted. The goals of the promotional strategic measures are the creation of a positive international image of Montenegro and the attraction of foreign investors. Many presentations and forums were organised and contacts have been established with strategic investors, and various international organizations and institutions. Considering the fact that investment environment is more or less the same in most economies in transition and that there is a strong competition in attracting FDI, macroeconomic stability will be very important in the future, as well as the functioning of the market, legal system and institutions. Taking into account that FDIs are the main source of financing the high current account deficit and one of the bearers of economic growth of Montenegro, it is necessary to intensify the activities on the promotion of foreign investments with a view to attracting strategic investors for the priority development projects in tourism, energy sector and other fields. Unlike FDI, which capital inflow is more stable, portfolio investments tend to be quickly withdrawn in the condition of aggravating financial markets, which has been proven by the current crisis. The account of portfolio investment recorded a net outflow of EUR 41.9 million, which is more than in 2008 (when it was EUR 15.5 million). Net FDI inflow from portfolio investment was EUR 47.2 million, whereas the outflow was EUR 89.1 million. The indebtedness of foreign companies in abroad reduced, which was the consequence of expensive and limited sources of financing. The net outflow in the account of other investments (which included loans, trade loans, cash and deposits) amounted to EUR million, different from the previous year when the net inflow registered was EUR million. The inflow from loans taken from abroad amounted to EUR million, which is much less than in 2008 (EUR million). At end- December 2009, monetary assets of the Central Bank in foreign accounts and in the vault were EUR 56.6 million higher that as at 31 December 2008.

167 External Sector 167 Box 6.8 Methodological changes in the current account Foreign visible exchange Data on foreign visible exchange in the balance of payments of Montenegro for 2009 were shown according to the special trade system. The CBM revised its balance of payments for 2007 and 2008 and in the future it will use data on visible exports and imports represented according to the special trade system. The data were revised with a view to improving the accuracy of data on exports and imports produced by Monstat. These changes led to a higher current account deficit, according to new data for foreign trade represented in line with the special trade system. The revised data for other components of the balance of payments were based on more detailed and comprehensive data and recommendations of the IMF. However, there is a serious doubt that exports were underestimated and, consequently, that the current account deficit is higher than the one recorded.

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