Gligor Bishev, Ph.D.
Deputy Governor, National Bank of the Republic of Macedonia
The Republic of Macedonia is located in the heart of the Balkan Peninsula, on the section of the main roads between the east and the west. In the past this was the main cause for hostile behaviour by neighbouring countries. Today, this is a big advantage, to be on the section of a market potentially involving almost 200 million citizens.
I would like to start by examining the strength and sustainability of price stability, as the main precondition for sound decision making by economic agents, efficient allocation of financial resources, and financial sector soundness. Ultimately, all of these lead to a rapid non-inflationary economic growth.
Maintaining low inflation has been the main priority of monetary policy since the independence of the Republic of Macedonia. From almost hyperinflation in 1992, created by the printing press of the national bank of the former Yugoslavia, inflation has now been reduced to industrial country level, at the following pace: 55.4 per cent in 1994, 9.2 per cent in 1995, 0.2 per cent in 1996 and 4.5 per cent in 1997. The inflation rate remained almost unchanged even after the devaluation of the exchange rate by 16.1 per cent in July 1997.
The stabilisation policy started as monetary based stabilisation, using the exchange rate as a key indicator of the monetary policy stance. In the last quarter of 1995, the stabilisation policy was transformed into exchange rate-based policy, as a consequence of the unstable money demand function and the strong link between price stability and the exchange rate stability.
The Central Bank started to implement rule-based monetary policy by accepting the denar exchange rate against the German mark as a key nominal anchor. This led to the sharp deceleration of the money supply growth. The growth rate of money supply M1 was reduced from 221.6 per cent at the beginning of 1994 to 9.2 per cent in 1995, and in 1996 it became negative (-3.1 per cent at the end of 1996, and -3,3 per cent in June 1997, before the devaluation of the exchange rate).
Negative money supply growth rates, together with the increased current account deficit in the balance of payments and decreased international reserves reduction, were clear signals that the real exchange rate is overvalued. After 42 months of exchange rate stability, the main nominal anchor was increased from 27.6 denars against one German mark to 31.0 denars against one German mark. The philosophy of rule-based monetary policy remained unchanged. It is expected that the new level of the exchange rate anchor will allow money supply growth rates to reach the German dynamic of 9.1 per cent in the middle of next year.
In the first months of the implementation of the stabilisation policy, the interest rates achieved high nominal and real levels of 331.4 per cent, ie, 63 per cent, respectively. As the credibility of the stabilisation policy increased, the interest rates started to fall. Nevertheless, they still remained high both in nominal and real terms (in November 1997, the nominal inter-bank interest rate was 21 per cent, while the real rate was 10.2 per cent). High interest rates are due to several factors:
Fiscal policy was highly coordinated with the monetary policy stabilisation oriented efforts. An extraordinary fiscal effort resulted in the reduction of the budget deficit from 11.1 per cent in 1993, to 2.0 per cent in 1996. This adjustment was based on the consolidation of budget expenditures through reduction of some generous expenditure items, including public sector wages, and by broadening the tax base through a reduction of most tax exemptions. However, although public consumption is reduced to the average level of government expenditures in the transition economies (45.4 per cent of GDP in 1996), it is still high and requires decisive action for its further reduction.
In addition, fiscal policy has been used for the sterilisation of the monetary effects of Central Bank interventions at the foreign exchange market. The sterilisation of these effects was executed through the creation of the stabilisation fund at the Central Bank, by transferring MKD 2,400 million (US$60 million) in 1995 and MKD 1,200 million ($30 million) in 1996 by the central government budget. In order to increase the level of domestic saving (in conditions when both, private and social sector saving is on an extremely low level), as well as to support credit and investment activity, assets from the budget continued to be transferred to the Central Bank in the first half of 1997, in the amount of MKD 1,040 million. According to the monetary projection for 1998, the budget is assumed to transfer to Central Bank funds in the amount of MKD 1,200 million.
The third main component of the stabilisation policy has been the credible wage control. In the first stage of the stabilisation programme, the key purpose of wage control was deindexation of wages, while in the current, second stage, the main purpose is to prevent possible cost push inflation. At the same time, reduction of the real wages should contribute towards lowering the unit labour costs, and therewith increase international competitiveness. The nominal wages have been frozen after devaluation in July 1997. This will allow the current level of average gross nominal wage of MKD 17,000 ($303) to remain unchanged until the end of 1997.
As in the other transition countries, the desinflationary costs were very high. They were strengthened by the supply shocks that hit the economy in the process of dissolution of the former Yugoslavia. Thus, the real GDP fell by 24.5 per cent in the period 1990-1995 and in 1995 it was reduced to 57.8 per cent of its 1989 level. The positive effects of the price stability and real sector reform started to dominate in 1996, when the Macedonian economy finally came out of the long-standing recession and the positive growth rate of real GDP was achieved (0.7 per cent). The positive growth rate is considered to be an indicator for coming out of the recession and for positive change in the economic cycle, which the Macedonian economy is currently undergoing. Production activities in the period January - November 1997 have followed the positive trend, and in unfavourable circumstances (such as tight monetary policy in order to maintain exchange rate stability and financial turmoil in some neighbouring countries - Albania and Bulgaria, which are significant trade partners of Macedonia) industrial production grew by 1.5 per cent. Increased international competitiveness is expected to increase net export, which, together with relaxed monetary policy, will lead to further long-run acceleration of economic activity.
Since 1992, investment, as a main generator of long-run development, has permanently increased. The share of gross investment in GDP increased from 15.5 per cent in 1992 to 18.6 per cent in 1996. In the first eleven months of 1997, the Republic of Macedonia faced a fall in investment activity of over 25.2 per cent, which appears to be a serious threat for economic activity during the course of this year and the next. Yet, improved liquidity and dynamics of the banks credit activity after the devaluation of the Macedonian national currency is expected to recover the investment activity of the Republic. Thus, in the period after devaluation, the amount of credits extended to both the private and social sector increased by MKD 1,6 million, which is 1.8 times higher than the total growth accomplished in the first half of 1997. At the same time, direct positive effects on investment and economic activity are expected from the several agreed credit lines with the World Bank Group. The most important is the credit line in the amount of $18 million for support of private sector development, as well as the credit line of $6.8 million from the International Fund for Agriculture Development (IFAD) planned for the less developed agricultural areas. In addition, at the end of October 1997, the World Bank Board approved a new credit line in the amount of $40 million for private sector development.
High gross investment on one hand and low domestic saving on the other (except for 1997) created a high and unsustainable deficit in the current account of the balance of payments. Thus, in 1996, the deficit amounted to $288 million or 7.8 per cent of the GDP. Negative tendencies in the external trade exchange continued in the first ten months of 1997, leading to a deficit of $335 million in the trade balance. This was the main reason for devaluation of the exchange rate in July 1997. The initial results and effects from the devaluation regarding the foreign exchange reserves are more favourable than those expected. Thus, in the first four months after devaluation, the National Bank of the Republic of Macedonia purchased foreign exchange in the amount of $30 million, which is $10 million above the anticipated purchase for the second half of 1997. It meant issuing reserve money in the amount of MKD 1,6 billion, which is 70 per cent more than the lack of liquidity in the first half of 1997, caused by the unfavourable circumstances in the foreign exchange market. It opened a process of normalisation of the monetary growth rates. Thus in November 1997 the money supply M2 denar, which has the closest correlation with inflationary movements, accomplished a positive annual growth rate of 5.3 per cent. At the same time, the negative growth rate of the money supply M1 from 3.3 per cent in June was transformed into a positive rate of growth of 6.7 per cent in November 1997.
If foreign exchange market movements follow approximately the same dynamics as in the first months after devaluation, by the end of the year it would be normal to expect monetary and credit aggregates to accomplish anticipated growth rates as in the monetary projection, which means providing an optimal non-inflationary quantity of money supply for support of the economic activity. Besides, the implemented devaluation is expected to improve the unfavourable financial results achieved by the economic agents in the first half of 1997 through increased profitability.
Price stability is perceived by the Central Bank, not as an ultimate goal, but as a means for creating sustainable non-inflationary economic growth. Price stability is the best environment for efficient structural reforms. The main components of the Macedonian structural reform programme are:
After slow progress in 1994, the privatisation process was significantly accelerated in 1995 and 1996. As of June 30 1997, out of 1.217 enterprises which entered the process of privatisation, 1.012 enterprises have been privatised, with about 174.000 employees. By August 31 1997, 101.069 enterprises were registered, out of which 88.2 per cent were private. From the end of 1996, the process of privatisation covered agricultural enterprises as well.
The bank rehabilitation operation covered measures on two levels:
The third component of the structural reforms programme is the restructuring of 23 of the largest loss making enterprises. During their restructuring process their access to the banks' credits was not allowed. Then a detailed cost cutting programme, including labour shedding and spinning off non core businesses, was implemented for these enterprises. All 23 enterprises have been downsized and dismantled into 123 business units, and only sound units have been allowed to compete with other economic units for banks' credits on market-based terms.
External financial support
After the initial problems caused by the dispute with the Republic of Greece, the Republic of Macedonia succeeded in reintegrating itself into the international financial community, normalising its relations with all external creditors. The stabilisation process and the structural reforms have been supported by external financial resources in the amount of $507 million in the period 1993 - 1996, of which $70.6 million was financial support from the IMF (STF arrangement in 1994 and Stand by arrangement in 1995), $228.8 million was financial support from the World Bank and IDA (Enterprise Restructuring Loan, Financial and Enterprise Sector Adjustment Credit, Credit for Social and Health Reforms), $173.4 million was financial support from the European Bank for Reconstruction and Development (credits for investments in infrastructure and private enterprise investments) and $34.1 million was financial support by bilateral creditors. Simultaneously, external relations with other multilateral creditors have been normalised. Thus, an agreement for rescheduling the debt with the Paris Club of creditors (governments and government institutions) was signed in 1995, and another one with the Zurich Club of creditors (commercial banks) was signed in 1996. In this way, at the end of 1996, the total medium and long-term external debt of the Republic of Macedonia amounted to $1.17 billion, ie, 31.7 per cent of GDP, which means that according to international standards, the Republic of Macedonia is considered to be a low-indebted country.
The current economic policy is supported by a 3 year ESAF arrangement with IMF, which started at the beginning of 1997. Until the end of 1997, external credits in the amount of $88.5 million were received, of which $27.8 million was from the European Union for repaying debt to EIB, $35.7 million was from the World Bank (Social Adjustment Loan), and $25.0 million was from the first two tranches of the ESAF arrangement with the IMF. Simultaneously, external credit obligations in the amount of $101.9 million were regulated, out of which $36.1 million was to EIB, $46.6 million was to the Paris Club, $10.4 million was to IBRD, etc.
With the inflation rate being very low and there being no need for its further reduction, the period of bearing disinflationary costs is behind the Macedonian economy. Bearing in mind the rapid restructuring of enterprises, the dynamic development of the real sector, and the country's economic position (the Republic of Macedonia is a low income country far from using its potential capacity). Thus, a strong economic growth is expected in the forthcoming years. However, high growth rates will be postponed if measures are not undertaken for resolving some problems that still exist in the Macedonian economy, such as high public consumption relative to GDP, poor corporate governance, and high indebtedness of the largest net exporters.
Economic growth will be mainly led by increasing net export, bearing in mind that the Republic of Macedonia is a small market economy with limited domestic consumption. In conditions when the exchange rate is used as an anchor for maintaining price stability (which means it can't be used as a means of balance of payments adjustment), international competitiveness will be mainly maintained through high productivity growth and reduced unit labour costs.
From the perspective of the Republic of Macedonia, great importance is placed upon the successful restructuring of the 20 enterprises which are the largest debtors to the banking system, but on the other hand, the largest net exporters in the Republic. The problem with these enterprises was raised 2/3 years ago, and therefore they were not included in the programme for the restructuring of the largest loss making enterprises, nor in the programme for bank rehabilitation. Due to the long-standing real appreciation of the denar exchange rate, these enterprises accumulated high real interest rate expense, which is much higher than that of the economic enterprises which are not net exporters. Therefore, the restructuring of these enterprises should provide for the decrease of real operational costs, as a precondition for their international competitiveness. As a matter of fact, the successful restructuring of these enterprises will significantly determine the final effects of the conducted devaluation. If those enterprises are not successfully restructured, it will be difficult to accomplish the expected growth of the Macedonian economy, in which export should be the basic generator of growth.
In order to increase the level of domestic savings and to intensify investments, additional efforts should be made to increase governmental savings and to gain surplus in the budgetary account. Banks are also expected to contribute to the mobilisation of the domestic financial resources, which in market conditions will provide optimum allocation of assets according to the principle of maximum efficiency.
The lack of domestic capital, which despite all efforts the Republic of Macedonia will have to face again in several years, should be compensated through more intensive inflow of foreign capital, especially in the form of direct investments. The relaxation of political tensions in the region, expansion of the domestic market through offered and signed agreements for free trade with several countries in the region, as well as the sale of the Macedonian Telecom, is expected to contribute towards a significant increase of foreign direct investments in the Republic of Macedonia during the following year.
Although young by its establishment, its lucrative experience from hyperinflation to inflation at the level of developed countries, the National Bank of the Republic of Macedonia may be rendered among the central banks with the experience of a couple centuries. We learned the lesson that once achieved, price stability is fragile and requires permanent stability oriented monetary policy. By pursuing rule-based monetary policy, the Central Bank has succeeded in increasing its credibility and giving the country a stable currency. The Macedonian people who are intelligent, hardworking and patient, will, I am sure, make the most use of the transparency and predictability that is bearing the stable currency. I also hope that international investors and the international community will benefit from this situation. That will be their best contribution for speeding up the economic growth in Macedonia. These include, Makedonija Tabak, Jugohrom, Zito Luks, Tipo, Godel, Skopje Brewery, Tobacco Combine Prilep, Jugotutun Bitola, Jugotutun Strumica, Tobacco Combine Skopje, Makedonka Stip, Jaka etc.