Tuesday, October 23, 2007

Kosovo’s Economy: From Consolidation to Sustainability

Kosovo's Economy: From Consolidation to Sustainability

Prishtinë, October 22, 2007 - The extensive economic reforms undertaken since 1999 are finally having an impact on the private sector performance. For the first time since 1999, clear signs of sustainable economic growth are visible, and the private sector carries that growth. In addition, as a result of successful privatisation and industrial restructuring, Kosovo again is starting to export the products of its traditional industries where potential for further growth is large. The agricultural sector is also showing signs of growth and improved competitiveness.

In the past several years, many observers stated an ironic disparity between the strong success in the conduct of economic reforms in Kosovo and the weak performance of Kosovo's private sector. While UNMIK and the local institutions of Kosovo, assisted by bilateral and multilateral donors, have managed to create the foundations of a modern economic system, the performance of Kosovo's economy remained weak. Thus, it was obvious that even with extensive reforms, results would not occur overnight.

Now notwithstanding a significant reduction in foreign assistance and public expenditures, Kosovo's GDP is estimated to have grown by about 3% in 2006. Clearly, this time growth was not driven by increased public expenditure or donor spending, but by a better performance of the private sector. Several economic indicators also signalled improved economic performance. After a fall in 2005, Kosovo's exports grew remarkably in 2006 by 54%, with a modest growth of imports by 5%. Furthermore, the rate of non-housing private investment grew impressively by 61% and lending to the private sector also increased. If the momentum of economic reforms is sustained, GDP should continue to grow, probably at an accelerated rate.

Macroeconomic stability was maintained in 2006, albeit challenged by a number of fiscal initiatives that could have jeopardized it. The rate of inflation stood near zero, in spite of accelerating economic activity. Government spending was kept within the prescribed and sustainable levels, in line with a Letter of Intent, which the Government of Kosovo signed with the International Monetary Fund (IMF) in 2005. However, maintaining reasonable spending has not been easy, partly due to pressures to increase social benefits for war invalids and families of deceased soldiers. The importance of maintaining a sustainable and pro-growth expenditure structure can hardly be overestimated. This norm is especially important in the light of the expected status resolution, which will bring new fiscal liabilities: Kosovo is likely to assume a portion of the old Yugoslav debt and will have to incur additional spending to finance the new public bodies that will be established following the transfer of further competencies from UNMIK and progress in the decentralization process. On the other hand, some of the existing sources of public revenue, such as those derived from the presence of UNMIK and its staff, cannot be sustained in the long run.

The privatisation process continued at the remarkably fast pace that was set already in 2005. Privatisation brought significant cash and investment commitments. The process of liquidation of insolvent enterprises gathered speed and is now well under way. Importantly, the privatisation process has been both very fast and highly transparent, probably more so than any privatisation in the whole region. At the same time, the Kosovo Trust Agency made significant progress in incorporating the Publicly Owned Enterprises (POEs), a crucial task for improving their corporate governance.

In 2006, Kosovo marked new milestones on its regional integration agenda; most notably it became a member of the enlarged Central Europe Free Trade Area (CEFTA). Finally, the Government has made noteworthy progress in facilitating the project to develop Kosovo C power plant, which would be the largest investment in the history of Kosovo whose contribution to GDP and public budget will be massive.

Kosovo's economic development hinges on maintaining and building upon the economic foundations, which have so far been put in place. Kosovo's economic development is still most severely constrained by interruptions in the electricity supply, weak capacity of public institutions, and the lack of adequate skills in the labour market. While there are a number of other obstacles to Kosovo's economic growth, the ones above underpin the factors that create the most binding constraints to economic growth. Devising a well-informed, prioritised, sequenced, and achievable strategy to remove those constraints and committing resources to its implementation will be essential for Kosovo's economic future. The government will not only have to maintain the fiscal stability and progress achieved on other reform fronts, but will have to undertake bold steps ahead by staying in the same path. In particular, efforts to secure uninterrupted power supply and to further improve the financial viability of Kosovo Energy Cooperation (KEK) should remain on top of the agenda as this is an immediate and serious obstacle to foreign and domestic investment alike.

In the fiscal realm, public investment has to be given the top priority, expenditures on public salaries have to be contained, and social expenditures should carefully target poverty reduction. Tax structure has to remain simple, but strong efforts have to be made to improve internal revenue collection. Furthermore, if the capacity of public institutions is to be improved, a new salary scheme should be considered to allow higher pay for key staff while keeping the overall amount of spending on public salaries within reasonable limits. At the same time, the Government has to ensure merit-based hiring and promotion policies within the public sector.

Source: Economic Policy Office of the EU/UNMIK Pillar IV

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