Montenegro country assessment

• The fate of the main industrial enterprise needs to be resolved. The future viability of the aluminium company KAP is highly uncertain. The government needs to come up with a clear action plan for either major restructuring or closure of this company, which still employs a significant portion of the labour force and accounts for a large share of exports.
• Further strengthening of the financial system and maintaining adequate access to financing for the private sector, especially small and medium-sized enterprises (SMEs), is vital for economic recovery. The state’s involvement in this sector should be designed to ensure a level playing field and transparent regulation, rather than focused on support for selected troubled banks.
• Moving ahead with the restructuring of the power sector is a priority to improving electricity supply and efficiency. The government has adopted an ambitious Energy Development Strategy, but concrete programmes and implementation instruments to promote renewable energy and energy efficiency have yet to be established.

Economic performance has weakened substantially. After the severe economic contraction in 2009, Montenegro was on its way to a modest but steady recovery, growing at 2.5 per cent in 2010 and 3.2 per cent in 2011. Exports and tourism were the main drivers of growth in 2011, countering the drop in FDI inflows and an ongoing credit crunch. However, external demand has weakened substantially this year as a result of the impact of the eurozone crisis and, combined with weak domestic demand, this has resulted in a slight fall in GDP in the first half of the year. The weak external environment affected the aluminium producer KAP, Montenegro’s largest enterprise and exporter, which was reflected in very volatile industrial production figures. In December 2011 industrial production marked the largest fall in two years, plunging 37.5 per cent year-on-year. In January 2012 it was down 24.5 per cent year-on-year. The current account deficit, which narrowed to 19.4 per cent of GDP in 2011, remains the highest in the region. Inflation has been on a generally upward trend this year. It stood at 4.4 per cent year-on-year in July 2012.

The fiscal position has been weakened by KAP nationalisation and weaker than expected growth. On the fiscal side, policies have become more prudent in the past couple of years, but the deteriorating economic situation and the activation of state loan guarantees related to KAP have prompted revisions of the 2012 budget. Public debt was close to 50 per cent of GDP as of August 2012. Following its country mission in February 2012, the IMF has expressed readiness to start negotiations for a credit arrangement with Montenegro.

Negligible growth is expected in the short term. The eurozone crisis will continue to negatively impact Montenegro’s economy and growth is forecast at negligible levels in 2012, with only a small rise in this figure expected in 2013. Diversification of the economy remains a challenge for building sustainable growth in the medium term, but the visible progress in the EU approximation process should help to attract further FDI and ultimately boost the country’s growth prospects.

Montengero’s EU membership aspirations have received a significant boost. In June 2012 Montenegro received official approval from the European Council to proceed to the next stage of the EU accession process. The Council endorsed the European Commission’s assessment that Montenegro was sufficiently compliant with the membership criteria to be able to start accession negotiations. The Council also highlighted that the government needs to make further efforts in addressing important remaining challenges, particularly the strengthening of judicial independence, tackling corruption and fighting against organised crime.

Montenegro has become a member of the World Trade Organization. Accession to the WTO finally took place in December 2011. Montenegro had started WTO membership negotiations in December 2004, but its accession was delayed due to disagreements on the bilateral treaty with a member of the WTO. When an agreement was finally reached and the bilateral treaty was signed in November 2011, the path was clear for Montenegro’s accession in December. WTO accession may help boost trade and economic growth in the medium to long term.

The state has repaid a major loan of KAP, for which it had provided a sovereign guarantee. In April 2012 the government paid from the budget €23.4 million (€22 million principal and €1.4 million interest and other expenses) to Deutsche Bank. Substantial payments to the Hungarian bank, OTP, are also overdue and are being negotiated. Although there have been some disagreements with the other major shareholder of KAP, that is, Russian EN+ Group, over how to manage the company’s debt, the government has decided not to cancel the privatisation contract with EN+. KAP’s financial situation is difficult and the company made a net loss of €21 million in the first half of 2012. Meanwhile, the government had a success in April 2012 when it managed to sell the steel company, Zeljezara Niksic, to a Turkish investor for €15 million. Two previous tenders for the sale of the company had failed to attract any bids.

Electricity tariffs are rising towards more cost-reflective levels. In December 2011 the energy regulatory agency of Montenegro approved an increase in electricity prices to compensate the electricity generation company, EPCG, for its rising production and import costs. The regulator approved an average increase in tariffs of 6.13 per cent. The highest increases of on average 6.7 per cent were applied to households. This represents a partial reversal of moves by the energy regulator last year to lower consumer tariffs.

Plans are advancing for a major underwater cable with Italy. The construction of the Italy-Montenegro interconnection cable is expected to start by the end of 2015. The agreement on the establishment of a submarine interconnection between Montenegro and Italy was signed in November 2010. The interconnection cable will be 415 km long (of which 390 km will be under the sea). The Italian company, Terna, will begin the construction of the electricity transmission infrastructure. The company announced completion of the authorisation process on its side but this process is still ongoing on the Montenegrin side as the expropriation and public land (including maritime property) rights acquisition processes have not yet been completed. The detailed spatial plan has been approved by the Montenegrin government.

Deleveraging continued in the financial sector in the past year. Prior to the crisis between 2006 and early 2008, Montenegro reported annual credit growth rates of over 100 per cent. Since the crisis, however, significant deleveraging has taken place and this trend has continued at a vigorous pace over the past year. Private sector credit as a percentage of GDP fell from 69 per cent at the end of 2010 to 55 per cent of GDP at the end of 2011. The banking sector is also characterised by a high level of non-performing loans (NPLs). NPLs declined from about 21 per cent of total loans in 2010 to 15.5 per cent in mid-2012, but this figure is still at the higher end of the spectrum in the SEE region as well as the transition region more broadly.