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In brief, but worth mentioning

2nd April 2022, Skopje – 30 years ago today, the first Budget was adopted following the proclamation of independence of our country. This was all the more significant for laying the foundations of the country. Ever since, each year, upon proposal by the Ministry of Finance, the Government submits draft Budget to the Parliament, a financial plan which projects the funds for economic development, capital projects, health, education, security, ecology, science and culture. In a nutshell, it is a plan for growth and development during good times, and a response to overcoming the challenges in times of crisis. It is therefore quite logical to talk about the Budget on this day, its financing and the direction we are headed with the fiscal policy within the context of the ongoing situation.

Recovery of our economy is a priority. We as a Government put all our efforts thereto. GDP growth of 4% and unemployment rate reduced to historic low 15.2% last year marked the start of the recovery of the national economy from the most severe economic crisis the world witnessed in the last 100 years.

 

Fresh Response to the New Economic Challenges

Still, we face new challenges ahead of us. Most of the economies worldwide have not been immune to the price pressures on the global commodities markets. They occurred last year as a result of the disrupted post-pandemic supply chains, the geopolitical tensions and the climate changes, culminating with Russia launching an invasion of Ukraine at the beginning of this year. At this time, Brent oil price has gone over US$ 130 per barrel, for the first time since 2008 onwards. Gas price on European stock markets set new price records of US$ 2,000 per 1,000 cubic meters, while price of megawatthour exceeded EUR 400 (for comparison purposes, in 2021, it was by four times lower). Double-digit annual growth on the global stock markets was also registered at prices of cereals and other commodities.

Since the beginning of the year, inflation in many countries hit its highest level in the past years. For instance, March inflation rate of the largest economy in the Eurozone – Germany hit 30-year high at 7.3% (which might lead the European Central Bank to revisit the current monetary policy). As per the announced data so far, inflation rate in the Eurozone is around 5.5% in average since the beginning of the year, while the average of the 27 EU Members States is around 6%. Some countries register high increase of consumer prices, Lithuania for instance registered double-digit growth of 13.1% in the first two months. Acceleration in the inflation has been recorded in the region since the beginning of this year, with an average rate of around 6.5% Highest increase of consumer prices is registered in Serbia – 8.5%, Bosnia and Herzegovina – 7.5% and Kosovo – 7.3%. As for our country, rise in consumer prices stood at 7.1% in the first two month this year.

Price pressures, coupled with considerable economic uncertainty stemming from the beginning of the war in Ukraine, required response from the policy makers. Stagflation fear – high inflation rates, accompanied by low or negative growth rates and high unemployment – has encouraged the governments and part of the monetary authorities to undertake respective measures to prevent this phenomenon.

Almost all governments in Europe, even globally, adopted anti-crisis measures geared towards supporting the standard of their citizens and the economy. Our Government started responding even last year, when the first pressures of the so-called energy crisis started to be felt. In order to cushion the market trends of electricity price, we have introduced tax relief by reducing VAT rate for the end consumers. Budget subsidies were also introduced to finance the high difference between the market price of electricity and the price paid by the consumers on the regulated market. We have acted promptly following the conflict in Ukraine, by adopting a new set of 26 anti-crisis measures totaling EUR 400 million. The set comprises tax deductions and tax relief, direct financial support and interest-free loans for the companies. The objective is to support the standard of the citizens, protect the vulnerable categories, as well as the companies and the economy. Effects from these policies and anti-crisis measures are already visible, considering their scope and promptness. If compared to the other countries in the region, prices of commodities are the lowest in our country, hence is the consumer basket, as well as the prices of fuel and energy products (not excluding the importance of the ratio between prices and average wage).

The economic crisis caused by COVID-19 has taught us that effective and prompt response by the policy makers has contributed for cushioning the impact on the economy. However, fiscal measures have caused higher budget deficit and public debt surging by several percentage points at almost all economies. Ongoing developments, although different from the ones during the coronavirus crisis (when entire economic sectors were locked down), require actions. As regards our country, the fiscal response is estimated at around EUR 615 million so far. Additional measures are planned in the agriculture sector, in particular food crops, as well as all those affected by the price shock. Quantities and prices of commodities on the market are closely monitored as well, so as to undertake timely actions. In the meantime, ways are sought for to support the municipalities and share the burden of the energy crisis. The Government has already undertaken measures for additional savings in the public sector by reducing the costs for goods and services by 10%, as well as minimizing the non-productive expenditures for furniture, vehicles and optimizing the official travel.

Next activities include the Supplementary Budget (with revised macroeconomic and fiscal projections), as well as the way of financing the measures for cushioning the effects from the existing crisis, thereby maintaining the economic growth, the fiscal consolidation in the medium term amid price surge and interest rate increase.

We are now placed between the hammer and the anvil – stimulus and fiscal consolidation, to which extent and for how long.

 

Which debt threshold does not jeopardize the growth?

In 2020, we observed the largest one-year debt surge since World War II. The world was hit by a global health crisis and a deep recession. As a result of revenue collapse and increased expenditures, global debt rose to US$ 226 trillion or, according to IMF data, it picked up by 28 percentage points to 256% of GDP, in 2020. Public debt accounted for most of the increase, as the global public debt jumped to a record 99% of GDP. Public debt increase is particularly striking in the advanced economies, where it rose from around 70% of GDP in 2007 to 124% of GDP in 2020. Fiscal deficits soared as a result of revenues collapse due to the recession and the expenditures increase due to the sweeping fiscal measures put in place to manage the health and the economic crisis. Global public debt rose by 19% p.p. of GDP in 2020, an increase like the one seen during the global financial crisis, over two years: 2008 and 2009. Developing economies, although contributing less to overall debt growth during the pandemic, are also facing elevated debt driven by the large fall in nominal GDP.

Private debt jumped by 14 percentage points of GDP in 2020, almost twice as much as during the global financial crisis, reflecting the different nature of the two crises. During the pandemic, governments and central banks supported further borrowing by the private sector to help protect lives and the standard of living, whereas during the global financial crisis, the challenge was to contain the damage from excessively leveraged private sector. Hence, it is very important to emphasize the coordination between the fiscal and the monetary authorities during crisis geared towards supporting the economy, as well as preserving financial stability.

The increase in debt during COVID-19 pandemic was justified by the need to protect people’s lives, preserve jobs and avoid a wave of bankruptcies. If governments had not taken action amid coronavirus crisis, the social and the economic consequences would have been devastating. Still, the debt surge amplifies vulnerabilities, especially as financing conditions tighten.

There are many papers and plenty of research by economists examining the relationship between public debt and economic growth. One of the most quoted papers is “Growth in a Time of Debt” by Carmen Reinhart and Kenneth Rogoff. They, by analyzing data from 44 countries spanning about 200 years, pertaining to the public debt as a percentage of GDP and the economic growth, concluded that public debt rates of over 90% of GDP, slow down the economic growth. While politicians in Europe and the United States have applied these data in the light of fiscal consolidation, other researchers using the same data and other research methods yielded conflicting results, with no evidence of any negative impact from the higher public debt level on the economic growth. This still remains open issue for a scientific debate among the economists, but also a political one as regards the economic policy makers, as well as in light of the political economics about the intergenerational income distribution.

According to the estimates of the International Monetary Fund, as well as the experts, 70% threshold for countries from Central, Eastern and Southeastern Europe, will no adversely affect the economic growth of these economies.

 

Public debt in our country: reduction by several percentage points compared to 2020

Public debt in our country is far below these thresholds. According to the latest data on the general government and the public debt in our country, they accounted for 48.7% and 57%, respectively at the end of January this year. Guaranteed debt accounted for 7.95%. Compared to the end of 2020, public debt reduced by 4 percentage points, while general government debt declined by 3.2 percentage points. Anyway, the fiscal rules defined as Maastricht Criteria, which are already an integral part of the draft organic Budget Law, being in parliamentary procedure, forecast a 60% threshold for the general government debt and 15% threshold for the guaranteed debt as a percentage of GDP, according to which, public debt may reach 75% of GDP, in cumulative terms. However, the new draft Organic Budget Law, stipulates for the budget deficit not to exceed 3% of GDP.

In line with the revised 2022-2024 Public Debt Strategy (with prospects until 2026), it was expected for 2021 to end with a public debt of 61.2% and a general government debt of 52%. However, the performance was somewhat lower than these projections. As for this year, in line with the Strategy, public and general government debt are expected to account for 63.5% and 53.4%, respectively, however, the lower starting point, as well as the newly occurred developments in Ukraine should also be taken into account.

This year, in line with the 2022 Budget, EUR 894.9 million are needed to finance the budget deficit, as well as the liabilities falling due to be repaid on the foreign and domestic market (EUR 545.2 million out of which for covering the budget deficit, EUR 186 million for repayment of external and domestic debt and EUR 164 million for interest repayment). Sources, wherefrom these needs will be financed are the government securities on the domestic market in the amount of EUR 350 million, Eurobond initially projected in the amount of EUR 250 million, loans from international institutions for financing projects in the amount of around EUR 95 million and around EUR 203 million as deposits. Thereby, as elaborated below, in order to support the business sector and avoid any potential stagflation, it is advisable to focus on external sources of financing.

Budget deficit is projected at 4.3% in 2022. In line with the 2022-2024 Fiscal Strategy (with prospects until 2026), budget deficit is projected to be reduced to 3.5% in 2023, 2.9% in 2024, 2.5% in 2025 and 2.2% in 2026. In line therewith, public and general government debts are expected to be reduced to 56.5% and 50%, respectively until 2026.

As I pointed out, fiscal consolidation is incorporated in our Fiscal Strategy. We strive for maximum expenditure rationalization, while expanding the development component of the Budget. At the same time, more systemic activities have been undertaken for the purpose of increasing the revenues – such as the measures and the activities aimed at combating the grey economy and enhancing the institutions’ capacities for the revenue collection.

Newly occurred situation as regards the price surge of energy products must be absolutely taken into account. As the case with COVID-19 crisis, if no action is taken promptly, there will be substantial social and economic consequences. So-far response implies less tax revenues and additional fiscal expenditures aimed at supporting both the citizens and the companies. Moreover, it must be taken into consideration that although the epidemiological picture has improved significantly and the health crisis has been brought under control, more time is sill needed so as to fully restore the confidence of consumers and investors. Certain sectors are nevertheless vulnerable and many companies are still exhausted in terms of liquidity and solvency. Another issue is the economic uncertainty stemming from the Russia-Ukraine crisis and the rise in inflation, thus leading to more prudent consumption. Hence, what is most important is to continue to support the recovery of the economy, as the slow and lengthy economic recovery may also contribute to the increase in public debt as a percentage of GDP.

I would like to hereby point out that the Government stands ready to also undertake new measures geared towards protecting the living standard of the citizens, as well as supporting the economic recovery. Providing fresh foreign capital so as not to “crowd out” the real sector

As for the manner of financing the budget deficit, I will explain why it is advisable to rely more on external sources. Providing fresh foreign capital replenishes the foreign exchange reserves, thus providing conditions for pursuing eased monetary policy. Inflow of external financing offsets part of the decline in remittances and foreign direct investments, thus, helping finance the trade deficit and the current account deficit. This will prevent the financial “crowding out” of the real sector as regards the access to financial resources on the domestic financial market, with the government borrowing not affecting the monetary policy stance and the interest rates on the domestic financial markets.

However, globally, monetary policy shifts the focus to rising inflation and inflationary expectations. The US FED and the Bank of England have already raised the policy interest rate, while the ECB announces that their decisions will depend solely on the macroeconomic indicators and the expectations. Interest rate increase aimed at preventing the inflation growth provides for higher borrowing costs for both the private sector and the Governments. Thus, approaching the international capital market is extremely important in providing funds from foreign sources. Since the beginning of the year, we have been ready to approach the international capital market, by issuing Eurobond thereon. However, we are monitoring the developments on the market so as to issue Eurobond at the right moment as was the case last year.

 

“Golden Rule” of borrowing and the budget deficit

“Golden Rule” of borrowing should be applied over the business cycle. This means that when the economy stands at the through of the business “cycle curve, higher budget deficit (as percentage of GDP) is advisable for financing investment projects, as well as liquidity support therefor. During the expansionary phases, the budget deficit needs to be lower so as to generate reserves (so-called buffers) and broader fiscal space for any future interventions.

Fiscal consolidation in the medium run is an important factor in providing sustainable growth. Simply put, if we want to financially support growth, in case there are no sufficient own savings in place, we can attain such growth by borrowing, however, it should be economically justified so as to provide for sustainable growth. If we borrow today, it means that the borrowed funds should be repaid tomorrow, which, on the other hand, means that if we make an investment today, we should reap the benefits therefrom tomorrow, or if a generation borrows and the next one should repay this debt, it is understandable that the later should reap the fruits of such decision.

 

Fiscal prudence and intergenerational solidarity

The budgetary support is always needed regardless of the revenue side of the Budget. Many of these requests are completely justified, as they pertain to the financial support for vulnerable categories of citizens or companies. During a heated political debate, amounts of budgetary support are often proposed, which would be too high amid usual circumstances or unacceptable even for those proposing them, in case they are in power to make such decisions.

Therefore, fiscal prudence is necessary, as well as taking care of the financial position of the Budget being on a sustainable path. Such public finance path is based on consistent adherence to the intergenerational solidarity principle, i.e. avoiding the temptation to make borrowing too easily and by putting a significant burden on the present and the future generations.

In other words, as regards the fresh borrowing, particular attention is paid on the purpose or the absorption of these funds. At present, budget funds are borrowed solely for financing the capital expenditures, i.e. investment projects of public significance. Even with assumed lower fiscal multipliers in the short run, budget capital expenditures have a positive impact on the medium- term and long-term growth. Increasing the economic growth and supporting the economic recovery will provide for reduction of public debt as a percentage of GDP, which is to be reduced below 60% of GDP in the medium-term. This goal will also be attained via stronger fiscal consolidation in the next period by reducing the budget deficit and creating broader fiscal space in case of future interventions and upcoming challenges.

 

Financing costs of policies in overcoming the crisis and underpinning the growth

During this period, main points of discussion with economists, businessmen, journalists, as well as citizens are “How do we cope with the crisis? Are there sufficient funds in the Budget? Where to find money? “The prevailing opinion is that in times of crisis, the most important matter is to find solutions for its overcoming, as well as provide sufficient funds, while the financing costs are secondary. However, I would add that, when it comes to growth and development, the financing costs thereof also matter, i.e. they should be lower than the growth rates being generated therefrom.

 

Fatmir Besimi, Minister of Finance

Also available in: Macedonian Albanian

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