The fiscal deficit in Montenegro is expected to rise starting this year, accompanied by a gradual increase in debt due to substantial funding requirements, according to the International Monetary Fund (IMF).

The IMF cautions that the recent improvements in fiscal stability could be jeopardized if election pledges are enacted that would significantly raise net salaries and either partially or fully eliminate pension contributions.

In the conclusions of the IMF Executive Board following consultations with Montenegro, it was noted that the Montenegrin economy grew by six percent in 2023. This growth was bolstered by strong consumer spending, a resurgence in tourism revenues surpassing pre-pandemic levels, and an influx of relatively wealthy Russian and Ukrainian nationals fleeing the conflict in Ukraine.

“The unemployment rate has plummeted to its lowest level in history. Inflation has significantly decreased from its peaks in 2022, aided by lower international food prices,” the conclusions stated.

Under Article IV of the IMF Statute, the IMF conducts annual bilateral discussions with its member states, including Montenegro. During these discussions, IMF staff visit the country to gather economic and financial data and engage with officials regarding economic policies and development. After returning to IMF headquarters, the staff compiles a report which serves as the basis for discussions by the Executive Board.

The IMF mission visited Montenegro from late January to mid-February.

The economy is expected to slow to 3.7 percent this year

According to the IMF Executive Board’s conclusions, the growth of Montenegro’s economy is projected to decelerate to 3.7 percent in 2024, likely dropping to about three percent in the medium term.

“Barring any new shocks in the international market or substantial politically motivated increases in domestic salaries, the gap between inflation in Montenegro and that in the eurozone, currently at 1.7 percentage points, is expected to narrow further. The current account deficit is projected to return to historical average levels around 13.5 percent of gross domestic product (GDP),” the report published on May 3 states.

The IMF assesses that Montenegro’s fiscal position has improved significantly in recent years. Following a peak of 107 percent of GDP in 2020, public debt is estimated to have fallen to 61.5 percent of GDP in 2023, influenced by the aftermath of the pandemic and high inflation.

The report highlights that the state budget recorded a surplus in 2023 due to robust VAT revenues, one-time increases in non-tax income, and reduced planned expenses.

For the 2024 budget, the IMF projects a deterioration in fiscal position, primarily due to increased social benefits and the diminishing effect of one-time revenues.

“This rise in expenses will be partially offset by positive measures to enhance VAT and excise duty revenues, alongside gains from lottery and gambling activities. According to current policies, public debt is expected to gradually increase to about 66 percent of GDP by 2029, driven by rising social expenditures that are expected to outpace income growth, while interest costs will likely remain higher than in the past,” the IMF indicates.

Strong deposit growth has not been matched by an increase in private sector lending

The report also notes that the banking system has demonstrated resilience in face of recent shocks. The ratio of non-performing loans has continued to decline despite the cessation of COVID-related support measures, and the average capital adequacy ratio is almost double the regulatory minimum, resulting in record growth within the banking sector.

“Despite robust deposit growth in recent years, there has not been a corresponding rise in lending to the private sector, leading to a drop in the loan-to-deposit ratio. Bank profitability has reached unprecedented levels, attributed to the widening of net interest margins,” the IMF remarks.

The IMF Executive Directors concurred with the main findings of the IMF Mission, applauding the strong post-pandemic economic recovery that has significantly enhanced the fiscal position.

However, they emphasized the need for the authorities to work on effective fiscal policies, fortify the financial sector, and diversify the economy, with the IMF’s support when necessary, given the outlook for slower growth.

Maintaining a positive primary balance is deemed essential for keeping public debt below 60 percent of GDP. The directors welcomed the government’s commitment to fiscal prudence and plans to finalize their fiscal strategy and implement a new long-term management framework in 2024.

They underscored that structural fiscal reforms are critical for sustainable public finances, seeking to enhance revenue administration, optimize social spending, manage public administration growth efficiently, and improve government oversight.

The directors acknowledged the solid health indicators of the banking sector and stressed the importance of proactively addressing any potential vulnerabilities. They reiterated strong support for the operational independence of the Central Bank of Montenegro and urged the authorities to fully implement the recommended reforms.

Directors applauded the ongoing progress in aligning Montenegrin regulations and supervisory practices with international standards. They emphasized the necessity of continuously updating supervisory capabilities to address emerging risks, including those associated with the real estate market, foreign securities, cryptocurrencies, digitization, and other Fintech initiatives. They encouraged the authorities to enhance the framework for combating money laundering and terrorist financing, incorporating developments based on Moneyval recommendations from 2023.

The directors concurred that diversifying both within and beyond the tourism sector is a vital priority. They noted that Montenegro possesses significant potential in renewable energy, providing opportunities for diversification. Additionally, they stressed the importance of increasing women’s participation in the labor market as a means to yield significant economic benefits.