On May 20, 2015, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation¹ with Kosovo.

Growth in Kosovo has proven relatively resilient and stronger than in its Western Balkan neighbors, averaging slightly more than 3 percent over the last five years. Steady remittances from the Diaspora living in Advanced Europe continue to be a key driver of growth, supporting as they have private consumption and investment. Nonetheless, medium-term growth prospects of some 3½ percent per year, while reasonable, are not strong enough to steadily lift incomes towards regional standards, or to create enough jobs in a country with very high unemployment.

Kosovo continues to enjoy a low public debt, and last year’s deficit complied with the fiscal rule’s limit. However, promises made in the run up to the general elections could push this year’s deficit above the limit. Moreover, the composition of the budget has worsened considerably, with unproductive current spending crowding out spending on infrastructure, education, and health.

Kosovo’s banks remain liquid, well capitalized, and profitable. NPL ratios are slightly elevated at 8.4 percent, but are stable and fully provisioned. The central bank has made commendable progress in strengthening bank supervision as well as the framework for emergency liquidity assistance. However, there are obstacles to the provision of credit, despite high levels of liquidity in the banks. In particular, inefficient court proceedings on bank cases contribute to high interest margins and high collateral requirements. High levels of informality also deter credit provision via the concomitant lack of reliable financial statements.

Kosovo’s productive and export capacity is low at present owing to the country’s significant wage and non-wage competitiveness gap. The former is related to unsustainable wage pressures in the public sector, which make it difficult for the private sector to attract talent. The latter involves a looming energy deficit, limited access to and quality of education and vocational training, and remaining issues in the business environment, including perceptions of corruption.

Executive Board Assessment²

Executive Directors welcomed the resilient performance of Kosovo’s economy, driven by private consumption and investment on the back of strong remittances. Meanwhile, low energy prices and developments in the euro area have kept inflation low. Directors noted, however, that the growing fiscal deficit and competitiveness gap weigh on medium-term prospects for growth, employment, and income convergence with neighboring countries. They stressed that strong policy action, including fiscal adjustment and broad based structural reforms, is critical to address these challenges in the period ahead.

Directors called on the authorities to preserve fiscal credibility and gradually strengthen buffers. Following last year’s large wage and benefit increases, they welcomed the initial steps taken this year to contain fiscal overruns. Directors agreed that additional measures would be needed to bring the 2015 deficit closer to the ceiling under the fiscal rule. They saw scope for further mobilizing revenues, particularly the value added tax. Directors also recommended improving the composition of the budget by containing increases in unproductive current spending, so as to create space for spending in priority areas such as infrastructure, education, and health care. They welcomed the authorities’ plan to develop a rules based mechanism for public wage setting consistent with productivity gains, and pointed to the benefits of a broader reform of the civil service. Directors also saw merit in revisiting the investment clause in the fiscal rule to allow for externally financed development projects, while preserving Kosovo’s good debt position.

Directors noted that Kosovo’s banking sector is generally healthy and well capitalized. They commended the authorities for the progress in strengthening the supervisory and regulatory framework, especially the adoption of risk based supervision. Continued efforts are necessary to further enhance the frameworks for emergency liquidity assistance, macroprudential policies, and crisis management. Directors also saw a need to improve access to credit and facilitate financial intermediation, supported by a more efficient judicial system.

Directors underscored that raising potential growth and improving labor participation and productivity remain key priorities for the country. They called on the authorities to expedite structural reforms in several areas to boost competitiveness and help spur private sector development and job creation. Specifically, Directors encouraged further steps to modernize energy infrastructure, address high labor costs, and improve education. Enhanced efforts are also needed to strengthen governance and the business environment more broadly. Directors welcomed the authorities’ intention to remain closely engaged with the Fund, including through a possible new arrangement to help anchor their ambitious policy and reform agenda.