III. FYR Macedonia’s Long-Term Vision, Medium-Term Plans, and Outlook

III. FYR Macedonia’s Long-Term Vision, Medium-Term Plans, and Outlook

1. FYR Macedonia’s Long-Term Vision and European Integration

18. 
    Prospects for faster growth have improved. Over the last four years, a number of important reforms have been implemented. Macroeconomic stability and predictability have steadily increased, inflation has remained under control, and barriers to market entry and exit have been reduced by simplifying and accelerating registration and bankruptcy procedures. The launch of a new “one-stop shop” business registration system in January 2006 significantly eased the time, cost and burden of registering new business. The new system provides a transparent registration for new businesses and has reduced registration time from 48 days to 5 days. A comprehensive judicial reform was launched in 2005 which, if vigorously implemented, will firmly establish the rule of law including creditor, contract and property rights. After engaging in a critical dialogue with social partners regarding an overhaul of the labor law and institutions to introduce more flexibility into fYR Macedonian labor markets, a new Labor Law was enacted in July 2005. In the banking sector, supervision, regulations as well as governance are being strengthened. Finally, the country has been successfully brought to candidacy status of the European Union. The latest Progress Report of the European Commission notes that fYR Macedonia is well advanced in establishing a functioning market economy, having maintained a broad consensus on the essentials of economic policies, though sustained efforts will remain critical to enable the country to cope with competitive pressure and market forces within the Union in the medium-term.
    

19. 
    But challenges remain. Enterprises in fYR Macedonia have not undergone the dynamics of restructuring witnessed in other countries in the region. This is in part due to the poor corporate governance which emerged following privatization (see paragraph 41 below). Unfair competition practices still occur and may discourage potential new firms from entering the market. In fact, fYR Macedonia has been much less successful than other countries in the region in attracting greenfield FDI and new domestic firms. In a number of transition countries, de novo small and medium enterprises have been a major source of new job creation. Unfortunately, fYR Macedonia lags far behind in this area. FYR Macedonia’s investment to GDP ratio also lags behind faster growing transition countries. Institutional weaknesses, such as cumbersome administrative procedures and corruption, as well as a low degree of legal certainty and predictability of economic and regulatory policies encumber the business climate and a proper functioning of the market economy. Labor and financial markets are still functioning unevenly, and the informal sector distorts the economy, resulting in unfair competition practices and weaker consumers’ protection. These flaws in the investment climate have been compounded by weak public sector governance which further undermines investor sentiment. Improvements in this area will be essential, also to deal with the complex EU accession requirements.
    

20. 
    A new government took office with great ambitions. A new coalition was elected to office in July 2006 on a very concrete election manifesto entitled "Rebirth in 100 Steps." These 100 steps focus predominantly on economic reforms aimed at accelerating economic growth from its current level of 3.5-4 percent to 6-8 percent in the next few years. The Manifesto was endorsed by all coalition partners, and, in July 2006, the government presented their new program for the period 2006-2010 to the Parliament. The main goals of the program are to improve the living standards of all citizens, increase employment, strengthen the fight against corruption, further develop democracy, and improve inter-ethnic relations and political stability.
    

21. 
    EU and NATO membership. The program says EU and NATO integration are of paramount priority for fYR Macedonia, and plans to finalize the remaining reforms, while promoting peace and stability in the country and in the region through respect of democratic principles.
    

22. 
    Spur dynamic economic development, reduce the grey economy and create jobs. To achieve the stretched goals of accelerated growth and job creation, the government’s strategy includes a wide ranging set of policies to spur economic activity and create jobs and increase living standards of the population. Some active labor market policies are envisaged as well. Within a disciplined, though slightly more relaxed fiscal policy framework, the government has started to reduce taxes and redirect public spending towards capital investments.
    

23. 
    Improve business climate. Structural reforms to improve the investment climate are central to the program, in particular by: (i) reducing the burden of superfluous business regulations by introducing a regulatory “guillotine” (for existing regulations) and requiring a regulatory impact assessment (for new regulations); (ii) reducing the business registration process time further from five to three days; (iii) completing the land cadastre and real estate registry; (iv) ensuring a more efficient and competitive financial system; (v) further increasing labor market flexibility; and (vi) protecting ownership rights, contract enforcement and shareholders rights.
    

24. 
    Increase fYR’s Macedonia competitiveness, and improve the performance of the agriculture sector. Investments in technology, knowledge and education will be increased to improve the competitiveness of the Macedonian economy, including its agricultural sector. Agriculture will also be supported, inter alia by the development of the agricultural land market, the international promotion of Macedonian agricultural products, increased access of farmers to credit and the development of certified organic foods.
    

25. 
    Attract new market entrants to boost competition. The government’s strategy places a great deal of emphasis on attracting new entrants to the market. The government is actively seeking to promote greenfield FDI and has appointed two ministers without portfolio and a number of consulting agencies to attract foreign investment. It is strengthening staffing, funding and international network for its investment promotion agency (MacInvest). The government has also started advertising heavily in major western business publications and is providing a package of incentives to potential investors.
    

26. 
    Governance and public service delivery. Under government plans, public service delivery would be improved through increased transparency and quality of public institutions to implement reforms. The program calls for improved governance, including implementation of the judicial reforms, and a decisive fight against corruption. Telecommunication costs will be reduced by increasing competition, and investments to expand road, electricity generation, and irrigation networks, including through concessions and public-private partnerships (PPPs), are envisaged. Railways will be modernized and internet penetration stimulated. The functioning of the energy market will be improved. Increased enrolment in (higher quality) education will be stimulated, as will enhanced quality in the health care sector through increased transparency and efficiency. Decentralization will continue, with adequate attention for a clearer definition of the competencies of local authorities. Finally, social policies will be more closely linked to the job market.
    

27. 
    Implementation of the program has started. A number of concrete steps of the Program have already been implemented. Within months of taking office, the government reduced the VAT for selected agriculture inputs and –effective January 2007– corporate and personal income tax rates were reduced and unified. At 12 percent, these rates are now among the lowest in the region. The zero taxation policy on reinvested profits has been introduced as well, with a 50 percent cap to limit loss of revenue. A third mobile telephone provider was licensed in February 2007, the regulatory “guillotine” system was launched in January 2007, and many other measures are under preparation.
    

2. The Medium-Term Economic Outlook

28. 
    FYR Macedonia could achieve faster growth in the medium-term. The projections presented here assume continuing improvements in regional stability, domestic political stability, prudent macroeconomic policies and strong and sustained reform implementation. Under these assumptions, the medium-term macroeconomic outlook is positive.
    

29. 
    Increasing investment to GDP. The government’s reform program builds on recently improving growth prospects by focusing on sustained improvements in the investment climate. Acceleration of economic growth to levels recently achieved in neighboring countries ultimately will depend on a positive private sector response to these emerging improvements in the investment climate. Attracting new entrants to the market, both greenfield FDI and de novo small and medium enterprises, gradually increasing the investment to GDP ratio, continuing the expansion of credit and reduction in real lending rates, will be essential ingredients for accelerating growth, exports, and job creation.
    

30. 
    Reduce perceived political risks. Sustained improvements in the investment climate would also require a reduction in perceived political and geopolitical risk. The continued implementation of the Ohrid Agreement, continued progress toward eventual EU membership, and the successful implementation of a final status arrangement in neighboring Kosovo ultimately could prove as important to the investment climate in fYR Macedonia as the envisaged economic reform program.
    

31. 
    The government’s medium-term fiscal strategy is ambitious. It aims at continuing the gradual decline in public debt ratios achieved in recent years and reducing the burden of distortionary taxation. The government has already announced plans to further reduce corporate and personal income tax rates to 10 percent in 2008. Its proposed reallocation of public expenditures towards public investment concurrent with a gradual reduction in the expenditure to GDP ratio and efficiency gains could better support growth.
    

32. 
    Moderate current account deficit. The current account deficit is projected to grow gradually to about 5 percent of GDP as aggregate demand increases. Prospects for export growth should slowly improve as structural reforms introduce greater competition and attract FDI which will gradually increase the competitiveness of Macedonian firms and their ability to produce higher-value added goods and services. Planned privatizations would finance the increased current account deficit in the next two years and a gradual increase in greenfield investment in the medium-term would help ensure that external debt remain modest at around 40 percent of GDP.
    

33. 
    Gross external financing requirements are expected to remain modest at about $1 billion per year over the medium-term. These would be required to finance a current account deficit of $350 to $400 million, amortization payments of a similar magnitude and a gradual increase in net foreign reserves. Net FDI flows could cover roughly 40 percent of total financing needs. Debt ratios would remain modest and stable. Debt sustainability is not likely to be a concern during this CPS period.