8th January 2024, Skopje – At the beginning of the New Year, the accountants start preparing financial statements, presenting the companies’ performance, with the statisticians preparing annual national accounts. In a democratic setting, public officials reflect on what has been achieved, nurturing the principles of transparency and accountability. Such benefit of a democratic society and civilization, among other things, opens an opportunity for criticism, and provides for improved future performance. It is also a general rule for life – it is no coincidence that different cultures in our civilization in the course of history celebrate the holiday season when, following intense and turbulent times during the year, a break is taken in the form of a consensus to rest and reflect on what has been done and learnt, all to the end of better projecting the future. Hence, in this festive period, I would like to reflect in this column on what was going on throughout the years when we faced multiple global crises caused by the COVID-19 pandemic and the geo-strategic upheaval worldwide, as well as the war on the European continent posing serious security, energy and economic risks and ensuing consequences. We have witnessed many unprecedented events in most recent history as well, which there is so much to talk about and learn from. Despite my desire to depict what we have been through and done in times of crises, in particular about public finances, and given the limited space allotment for writing and respecting the readers’ time, I have decided to write only about what I believe would be a useful experience and an opportunity for criticism and sparking a debate how to better manage similar challenges in future.
SMART Finances
I have been advocating for SMART Finances, or smart public finance management system, from the very first day I have been appointed Minister of Finance. This system is based upon a clear strategy, maintainable and accountable, being reform-oriented and transparent (S-strategical, M-maintainable, A-accountable, R-reform-oriented, T-transparent). When a comprehensive reform process is implemented, setting up a new system as a cornerstone of the public sector, the economy and the society, it would be desirable to cast back a glance on the process, the starting point, what we have achieved and whether we are on the right track to meet the objectives. In fact, control is integral part of the management process.
Many systemic public finance reforms were implemented in the past three years – framework for strategical, maintainable, accountable, reform-oriented and transparent public finance management was put in place. Accelerated growth reform and reform aimed at boosting the competitiveness and the resilience of the domestic economy rest on this. New medium-term budget framework has been set up in a relatively short period of time, as have been the rules on prudent fiscal management, the measures for optimal allocation of resources in support of sustainability, as well as the mechanisms for improving the Budget execution. Systemic legal solutions have been laid down, aimed at fair minimum wage and harmonization of public sector wages, as well as pension indexation as per the costs of living and the average wage increase. Strategic framework for tax policy has been set up, geared towards more just, more efficient and more effective taxation, in support of the fiscal sustainability. Strategy, plan and measures for reducing informal economy have been adopted. Reforms aimed at strengthening the fiscal decentralization process have been implemented, coupled with increased accountability and encouraging good governance. New financial instruments have been introduced for diversifying the debt portfolio and mobilizing the capital in the country, in support of both growth and development. Mechanisms for encouraging green financing to tackle climate changes have been put in place. Many projects have been implemented, aimed at improving the public services by digitalizing the processes.
When this major public finance reform process was implemented, both the global and the domestic economy faced multiple overlapping crises. Ministry of Finance has taken an active role in tackling the crises by seamlessly financing all functions of the state, participating in the design and the implementation of the anti-crisis measures, as well as implementing policies aimed at maintaining macroeconomic stability. The reform agenda, side by side with the most severe turmoil the global economy has faced in the past half a century, are an enormous challenge to any institution, not only in our country, but worldwide, taking everything into account.
I will try to briefly explain the context of this major public finance reform process taking place in the past two decades.
Global and Domestic Economic Setting
The worst economic downturn global economy has faced in the past one hundred years, i.e. the crisis caused by the coronavirus pandemic or the Great Lockdown, began in Q1 2020. Throughout 2020, the crisis hit all economies worldwide, leading to a sharp decline of oil price and plunging many industrial branches into collapse, making them directly affected by the containment measures, such as, most part of the services industry. With the economic activity at certain branches being brought to a halt, unemployment rose rapidly, also impacting the consumption, with the world GDP declining by – 2.8% in 2020 overall.
As a result of the pandemic in 2020, our economy registered 4.7% GDP decline, as the average in South East Europe, in particular the economies which are relatable to us from geographical, institutional, cultural and structural perspective. If it wasn’t for the strong fiscal response in the form of six sets of anti-crisis measures (out of nine adopted sets of anti-crisis measures), the estimates of the international institutions were that economic activity would have contracted by almost twice as high. Government response has contributed to preserving jobs, companies’ liquidity, social safety and maintaining macroeconomic stability.
With the immunization process and the re-opening of the economy, global economic activity registered a solid recovery in 2021. Our economy registered 4.5% growth in 2021. The Government continued its financial support to both the citizens and the businesses, all to the end of maintaining social and economic stability and recovery.
Still, road to economic recovery was obstructed by lot of hurdles, mainly stemming from the disrupted market equilibrium as a result of the sharp decline of supply and demand globally and in the domestic economy. As a result of the market distortion caused by the COVID-19 induced crisis, energy crisis emerged at the end of 2021. Quarantine measures introduced in the course of 2020 and the travel restrictions had a big say in the decline of both the supply of fuel, as well as its price, reaching its lowest level in the last several decades. Following the abolishment of the restrictions, energy demand was restored and, while it was rising, the supply continued to lag behind, which affected the prices. Altogether, energy crisis was a result of the global shortage of energy, bringing about high increase of prices. At the beginning of 2022, with the onset of the Russia’s invasion of Ukraine, state of play with the supply of energy products deteriorated. Taking into account that prices of energy products are critical input into almost every good, their increase translated into higher inflation. Increase in food prices as a result of the war in Ukraine, as one of the leading grain exporter worldwide, further aggravated the price crisis.
Government’s response through the anti-crisis measures continued all this while. The respective measures were focused on electricity subsidies and cushioning the consequences of high food prices, by freezing the prices of commodities, increasing the minimum wage, as well as the pensions and the public sector wages, coupled by the one-off financial allowances for the most vulnerable categories.
Economy continued recovering in 2022 and 2023 as well, although not with the desired economic growth rates, mostly due to the external environment, which, as a small and open economy (trade openness of 140% of GDP), we are susceptible to.
Fight against Multiple Crisis Caused Fiscal Implications Worth EUR 2.7 billion
Our so-far efficient response to the multiple crises has been highlighted on several occasions, covering plenty of measures and policies, such as the designed nine set of anti-crisis measures. The fiscal implications therefor amounted to around EUR 2.7 billion. They contained various measures, depending on the external shocks and the categories of citizens and businesses needing this support the most. Set of measures in response to the pandemic, was worth around EUR 1.2 billion, mostly aimed at safeguarding the life and health of citizens, preserving the jobs, and keeping the economy alive. The second group of measures, i.e. the set of measures in response to the energy and price crisis, amounted to approximately EUR 760 million, being primarily aimed at cushioning the blow of the crisis on the socially vulnerable categories of citizens and businesses. Latest set of measures reached EUR 662 million, which main purpose was tackling the protracted price crisis, comprising measures geared towards safeguarding the living standard of citizens, while also providing support for the most vulnerable categories of citizens, as well as the businesses, by extending favorable loans against a backdrop of high interest rates, crucial for boosting the liquidity thereof, as well as supporting the investments in the economy in support of sustainable growth, green transition and digital transformation. The multiple crises intertwined with diverse implications in several areas were unpredictable, whereby the fiscal space was narrowing. Hence, the strategy of designing anti-crisis measures covered taking general and rapid actions, followed by selective, targeted and more cautious actions in order not to disrupt the market principles, while also preserving the fiscal space, thus, being ready to respond to any unpredictable crisis situations in future. Hence, the investments and the structural reforms will also be supported, all to the end of attaining sustainable and accelerated economic growth in the medium and long term.
Strategic Approach to Fiscal Consolidation
Let me get back to the main topic – implemented public finance reforms and the effects therefrom. Crises posed plenty of economic challenges, some out of which entailed swifter implementation of the reform process. Due to the pandemic and the vigorous response to sustain the economic activity and preserve the jobs, the majority of developing economies experienced ballooned public debt. As of the onset of the energy crisis and inflation, the governments’ race turned into a marathon, with the fiscal space becoming increasingly narrow.
By putting a consistent fiscal consolidation plan in place, incorporated in the fiscal strategies, the public debt management strategies, as well as the fiscal sustainability plan (with precise measures on the revenue and the expenditure side), we managed to maintain stability throughout the crisis period, while also gradually reducing the fiscal deficit and the public debt. In fact, starting 2021, public and general government debt have been declining on continuous basis, whereby, as per the most recent data on the third quarter of 2023, they were reduced to 55.3%, i.e. 47.8% of GDP, being by 4.4 p.p. i.e. 3 percentage points lower compared to the year of the pandemic. At the same time, budget deficit was reduced from 8% in 2020 to 4.6% in 2023.
We remain committed to further fiscal consolidation as foreseen under the 2024 Budget as well. This year’s budget deficit is projected at 3.4% of GDP, being reduced by almost one third compared to last year. It is important to note that half of the deficit is used for paying the interests on the debts accumulated from the previous years. In line with the medium-term projections sеt under the 2024-2028 Fiscal Strategy, budget deficit is forecasted to drop to 3% of GDP in 2025 and 2026, as per the Maastricht Criteria, which is to be reduced to even below 3%, i.e. to 2.8% and 2.5% of GDP, respectively in 2027 and 2028.
I would like to hereby highlight that the fiscal consolidation implementation is not only aimed at streamlining the budget expenditures, but also at improving the revenue collection. I will hereto mention the tax reform focused on expanding the basis, thus contributing to improved revenue collection without thereby increasing any tax. Budget revenue collection is also underpinned by the fight against eradication of informal economy, being strategically and systematically planned, carried out via series of measures, including process digitalization, as well as boosting the tax morale.
Reduced Interest-Related Costs Despite Tightened Conditions on Financial Markets
One of the key reforms implemented in the field of public finance in support of fiscal sustainability, is the introduction of fiscal rules and the establishment of the Fiscal Council, which will supervise their implementation. Adoption of the reform 2022 Organic Budget Law provides for setting numerical rules on the amount of the public debt and the budget deficit as per the Maastricht Criteria. Anyhow, the Parliament selected the members of Fiscal Council as an independent body, supervising the fiscal rule implementation, being fully operational at present.
Fiscal Council’s opinion about the 2024 Budget speaks in favor of the effects from the public debt management. In fact, its members pointed out that “all analyzes related to the cost of financing the deficits, as well as the payment of accrued debts and interest, demonstrate that an improvement has been observed over the last 2-3 years, despite the worsened developments and the crisis situation on the capital markets, which is a promising sign in view of a prudent fiscal policy and accountable public finance management”. This accountable management provides for reducing the interest-related costs paid by the state. Our debt sustainability strategy is aimed at continuous reduction of the gap between the revenues and expenditures, all to the end of financing the budget needs, while also optimizing the cost of borrowing and the maturity. Historic low 1.65% interest rate on the Eurobond issued in 2021, as well as the budget support portfolio with the arrangements concluded with the international financial institutions, such as the International Monetary Fund, the World Bank, the German Development Bank, OPEC, Bank of the Council of Europe, as well as the EC Macro-Financial Assistance and the funding of infrastructure projects with favorable loans from EBRD, EIB, World Bank and other institutions, play a significant part thereto.
Budget Structure Change: Sustainability and Development
How citizens’ money is spent is the third aspect as regards ensuring fiscal sustainability. Enhanced investment Budget component, i.e. the change of its structure is of exceptional significance for economic development. In fact, the latest two Budgets were designed as per the golden rule of government spending – making borrowing solely for investments, thus producing value added to the economy. The funds intended for capital investments have increased significantly, i.e. being twice as high compared to the past three-year period. Last year, capital expenditures exceeded the budget deficit amount, which execution amounted to EUR 707 million, being all-time high execution, both in nominal and relative terms, accounting for 97% of the projections. For comparison purposes, over the years, capital expenditure execution ranged around 70% (for instance 69% in 2005, 76% in 2016). Compared to 2022, capital expenditures were higher by 52%, accounting for 4.9% of GDP, unlike the prior average of 3% of GDP.
Improved capital expenditure execution, as a Budget development component, is due to the numerous mechanisms introduced in the last three years. One of those mechanisms is “punishing and awarding” of institutions, as per the capital expenditure execution, better known under the name “CAPEF”. This mechanism will provide for overcoming the longstanding budgeting issue i.e. capital expenditures as “just numbers committed to paper”. This issue is additionally resolved through the medium-term budgeting introduced by adopting the new Organic Budget Law. This Law provides for strengthening the process of planning as per the performance indicators, being particularly significant for major capital projects, has been implemented over several fiscal years. Improved capital expenditure execution is also due to the introduction public investment planning and control units, i.e. the Public Investment Management Department and the Government Committee for Public Investments, which will be in charge of identifying the priority projects.
Over Billion Euros Budget Support for Companies
When speaking about budget structure, from development component perspective, I would like to highlight the substantial direct budget support also extended in this past three-year period in the amount of EUR 550 million to both the private sector and the private investments. This incorporates the measures and the activities of the Development Bank, the Innovation and Technological Development Fund, the Directorate for Technological Industrial Development Zones, as well as the support under the Law on Financial Support of Investments. In the past three years, 11,491 companies, employing 119,000 persons, were supported, thus stimulating the companies to invest EUR 2.1 billion in our economy. By also putting projected 2024 Budget funds and the most recent set of anti-crisis measures into the mix, budget support to the companies and favorable loans exceed EUR 1 billion. With the issuance of new financial instruments on the capital market, additional resources from different funds (such as Green Investment Fund and so forth) are being mobilized, intended for support of private sector’s investment activities. Moreover, support to the private sector was continuously extended through other government programs as well, coupled with labor market active measures by the Employment Service Agency.
Sustainable Wage and Pension Systems
In support of sustainable public finances, in the last three years, plenty of significant, systemic reforms were carried out, pertaining to setting the minimum wage, pension indexation and public sector wage harmonization. These systems are set on solid grounds, all to the end of ensuring sustainability, as well fairness and protection of the citizens’ living standard. As a result thereof, we observe a steady increase of minimum wage and pensions, as well as public sector wages, on several occasions. As for the future, supporting structural reforms is of key importance, since they contribute to increased productivity and boosted competitiveness of our economy, all to the end of the policies aimed at providing higher and sustainable living standard of the citizens to be sustainable in the medium and the long run.
Strengthening the Fiscal Decentralization
I would like to refer to one of the major reforms – the strengthening of fiscal decentralization, given the significant role it plays for economic development. The reform comprises three pillars: enhanced fiscal capacity and increased revenues of municipalities; strengthened fiscal discipline and increased transparency and accountability throughout municipalities’ operations. It also covers the increase of funds allocated to municipalities from the taxes collected in the Central Budget, as well as increase of municipalities’ own revenues, and establishment of funds supporting the solid performance, i.e. Performance Fund and Equalization Fund. Municipalities showing positive results and higher own revenue performance will be awarded funds from the Performance Fund, while municipalities with lower revenue performance, but also showing fiscal effort and good results in collecting their own revenues, will be awarded funds from the Equalization Fund.
Under this year’s Budget, as well as the previous two Budgets, based on the projected percentage increase of VAT revenues for the municipalities, the percentage is increased from 4.5% to 6% of the amount of the VAT collected in the previous year. The same approach for municipal revenues’ increase was applied for the personal income tax, with the percentage transferred to municipalities increased from 3 to 6% in the last three years. In addition, structural bonds for municipalities facilitate liquidity management and municipal debts.
To encapsulate all public finance reforms implemented in the course of these last three years in a wide frame, more space is needed to extoll thereon. However, the objective of this column is not to summarize everything that was done, but rather to give an overview of the current reform impact results, which are to contribute to the economic development and the fiscal sustainability over the long run.
Neither 2024 Suggests that We Are to Have “Smooth Sailing”
We are living in unpredictable times in view of global economy, which, as the UN World Economic Situation and Prospects 2024 states, “this veneer of resilience, however, masks both short-term risks and structural vulnerabilities”. The Report warns us of the risks of the long-term tighter financial conditions, investment shortfall and geopolitical fragmentation as opposed to globalization, due to which international trade is losing steam as a growth driver. The fiscal space in most countries is quite shrunken, thus making them vulnerable to possible shocks. Economists pinpoint risks in the continuation of the war in Ukraine and Middle East conflict, the crisis that emerged from the real estate market in China, the German industry, the cautiousness of the central banks, advancement in artificial intelligence, nuclear energy and other challenges, including elections in many countries, particularly those in the EU and the USA. All this indicates we are not to expect “smooth sailing” nor in 2024, globally speaking, since we are to have parliamentary and presidential elections in May, which will leave its mark on the dynamic of economic activities.
We keep mentioning the economic growth rates of 5% in order for our economy to achieve faster convergence with the European economy and citizens to reap the benefits of this growth much sooner. These rates are not unreachable, on the contrary, I believe that in the event of a different global context and no unprecedented crises on our front, as may be seen once every century, these rates, in all likelihood, would have been attained. In this column, I touched upon the fundamentals, whereas in the following one, I would reiterate on building an economy which delivers accelerated, inclusive and sustainable development needed for providing prosperity to the citizens. Evaluation, sound strategy, solid plan, inclusive approach, thoroughly constructed measures and performance – that is the path to economic growth.
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