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Vol 3, No 15
30 April 2001
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Nikola Gruevski Surviving
the Uprising

A conversation with the Macedonian finance minister
Sam Vaknin

Macedonia is a small (25,000 km2), landlocked country in the Balkans. It serves as a natural bridge between Serbia, Bulgaria, Greece and Albania. As an inevitable result, its economy consists mainly of trading, services, low-tech, low value-added industries, such as textile and plastics, and agriculture. Countries such as Slovenia and Germany import wine from Macedonia, bottle it, label it and re-sell it at a much higher price. This pattern is repeated with tobacco and a host of other agricultural produce. Italian designers contract with family textile firms to seasonally manufacture for them. The banking sector is basic, though privately owned.

In recent years, and especially following the Kosovo crisis, the country benefited from increasing foreign direct investment (FDI), unilateral transfers of multilateral aid and credits and local spending by the likes of NATO and KFOR. Its biggest bank, Stopanska Banka, was sold to a Greek bank (National Bank). Many of the loss makers (Communist-era industrial dinosaurs) were either shut down or sold to foreigners.

The Macedonian Telecom firm was sold to a consortium led by MATAV. A host of critical economic laws passed Parliament, and long-postponed structural reforms were implemented. Value Added Tax (VAT) was introduced, the re-payment of Macedonia's internal debt has accelerated and bank lending, as well as money supply aggregates, increased dramatically. With GDP growth in excess of five percent (2000), Macedonia was poised for an economic take-off.

Conflict and economy

The current Albanian uprising (there has been a minor precedent in 1997 in Tetovo) is low-intensity warfare. It is unlikely to adversely affect the main monetary parameters (the stability of the Macedonian denar, a low to medium inflation rate and declining interest rates). With its budget in a surplus of close to four percent of the GDP, the government has no need to raise taxes. Tax receipts from the western part of Macedonia—now virtually non-existent—were never sizable.

Capital flight is bound to increase, but this is predicted to be more than fully offset by increased transfers of Macedonian and Albanian expatriates. Foreign exchange reserves are sound and cover about four months of imports. Moreover, past experience—of which, unfortunately, Macedonia has plenty—shows that both a possible (though improbable) devaluation of the currency and capital flight are reversed once the crisis is over (or becomes a way of life).

Following an initial panic during Operation Allied Force in Kosovo (1999), the Central Bank actually had to absorb excess foreign exchange in the markets as people sought to purchase denars. The same happened after the imposition of the Greek embargo and the sanctions on Yugoslavia (which used to be Macedonia's main trading partner).

An outside threat

The danger lies in the fickleness of international investors. Cancellations of commitments to invest in the local economy have started. If FDI dries up, Macedonia will be hard-pressed to cope with its current account deficit (circa 6.5 precent of GDP). This could be exacerbated if the international banking system were to wean Macedonian firms off trading and documentary credits. Foreign firms—especially American ones—tend, in such circumstances, to cancel orders for textile and light industrial products.

Macedonia has diversified its trade considerably and now does most of its business with the European Union, but its products—steel, textile, wine, tobacco, grain, lamb meat—are still subject to European protectionist measures. These were not relaxed even during the more parlous war in Kosovo. No special concessions are likely to be offered now.

One cannot expect international donors to cover the difference. Patience with the region and its endless squabbles has worn thin, and a potentially isolationist US administration is not likely to provide the leadership needed to revive it. Macedonia can be left high on insurgency and dry on cash.

But this is not a necessary scenario. It can be averted with goodwill and good planning. Foresight has often eluded the West's involvement in the Balkans. Here is an opportunity to make amends.

The Minister of Finance of the Republic of Macedonia is an unenviable position nowadays. It is one of the poorest countries in Europe (USD 1900 GDP per capita). Saddled by its Socialist past and an Albanian insurgency—largely imported from Kosovo, across its northern border—it still managed to grow by more than five precent last year, as well as reform its economy substantially.

The credit for most of this belongs to Macedonia's 30-year-old Minister of Finance, Nikola Gruevski.

To interview Mr Gruevski is refreshing. He is emblematic of a generation of humble and efficient technocrats, which sprang up across Central and Eastern Europe following the demise of Communism. He readily accepts the older generation, "whose personality was formed during Socialism. [They] talk the (Western-capitalist) talk but don't walk the walk."

Central Europe Review: Why a Minister? What's in it for you?

Nikola Gruevski: The challenge, the opportunity to make a difference. I was a critic of past economic policies. I cannot afford to miss the chance to implement my ideas.

These ideas span all the spheres of Macedonia's economy.

VAT was introduced and immediately generated a budget surplus that was used to pay off internal debt and to reduce other taxes. Macedonia has among the lowest personal income tax and corporate profit tax rates in the world (15 percent each). The windfall also enabled Macedonia to offer one of the most friendly investment and capital markets regimes in the world, with first-year tax exemptions for new and newly-listed businesses. VAT had an adverse effect on inflation. Still, even as energy prices surged, inflation increased, but tolerably so (by five percent).

Foreign banks are interested in opening branches here. This will greatly enhance the competition and revitalize the banking sector.

Even with the current crisis?

During the 1999 Kosovo crisis, Western investors and trading partners escaped. Greek investors, who know this region better, came in and picked up enterprises at bargain basement prices. I hope investors from other countries learned the lesson. Since the current crisis started, we have sold our biggest bakery—Zhito Lux—and our biggest fairgrounds—Skopski Saem—to Greek and Slovenian investors. The new owners of Macedonia's largest bank, Stopanska Banka (National Bank of Greece), are planning to increase the capital.

My work in this ministry is all about trust and transparency. We pay off the internal debt to citizens and banks ahead of schedule. We passed a law to compensate savers whose foreign exchange savings were frozen during the break-up of Yugoslavia—and [we've] already paid back some of it. We have restored property expropriated during Socialism to its rightful owners faster than any other country in transition (under a denationalization law enacted last year). We have revamped our property rights laws.

The result? Last year we had more than USD 150 million in FDI, the best year ever. And this is excluding more than USD 300 million paid by MATAV for 51 percent of the Macedonian Telecom.

Most of these investments are from Greece. Doesn't it look like a hostile takeover?

No way [he laughs]! What is more natural than for one neighbour to invest in another? The USA is the biggest investor in Canada. Greece is to us what Germany is to the Czech Republic. It would have been very worrying had they showed no interest to invest here.

On the whole, the 1999 Kosovo crisis was bad for us. What we need is peace and stability. Actually, following the war, Macedonia lost half of its market share in Kosovo to new entrants. Our industrial production has decreased by one-eighth. Inter-company debt shot up from DEM 600 million to one billion (and stayed there ever since). We received less than one-fifth of the aid we were promised. The Stability Pact—which encompasses the entire Balkans—is hardly an answer to our specific needs. We were left to pay the bill.

The current crisis is likely to shave a few percentage points off our GDP growth target (six percent). It depends on its length and intensity. We are afraid to again lose markets we have laboriously cultivated after the Kosovo war. Unemployment will again edge up. We have the support of the IMF and the World Bank, but we may have to divert resources to the war effort.

Has Macedonia been offered financial assistance by anyone?

I asked several foreign governments to help us with support for our budget, payment balance and the procurement of strategic goods, such as oil. I have received no response until now [he shrugs]. But the crisis did not breach the budget framework. It contains reserves, which we intended to use for structural reforms. We may have to re-allocate the money to the Defence and Interior Ministries.

Any other effects? On the foreign exchange rate? Capital flight?

Surprisingly little. In 1999, people bought foreign exchange in a frenzy, and, when the crisis abated, sold double the amount back to us at a loss. The National Bank of Macedonia (NBM) intervened then and is intervening now. But, we have hitherto spent only USD seven million on this (another 25 million were given to our refinery to purchase oil, to prevent pressure on our currency market).

We likely would have spent this amount anyhow, to absorb excess liquidity. Moreover, our reserves have doubled to about USD 700 million (or 3.5 months of imports) since 1999 (not counting the USD 300 million or so from the privatization of the Telecom). It is an entirely different situation.

You are talking about excess liquidity, on the one hand, and about a mountain of inter-company debt, on the other. Isn't this a contradiction?

Only on the face of it. In the last 12 months, the average interest rate charged to borrowers in Macedonia declined from 21 percent to 14 percent. Good borrowers pay less than ten percent per year. The implementation of a new, commercial bank-managed payment system will increase liquidity. The liquidity in the banking system is so high that the inter-bank lending rate is at seven percent, or half the market rate.

Money supply aggregates are high and growing. Still, many of the firms are not eligible to receive new credits. A lot of the outstanding inter-company debt is dead, belongs to long-defunct firms or to massive loss makers. As firms are privatized, it will either be privatized as well or deleted. A small part will be borne by the government. Illiquidity remained virtually unchanged since 1999.

In other words, most company debt is non-performing or bad? How does this reflect on the banking system?

No, these debts are not in the banking system at all. They were created by the previous management of state-owned firms in the previous regime. The IMF has officially confirmed that more than two-thirds of the loan portfolios of our banks in the year 2000 are in the least risky A and B categories. Stopanska Banka, which constitutes close to 50 percent of our entire banking system, has just finished cleaning up its portfolio, a major achievement of far-reaching structural importance.

This is the second time you mention the IMF. Some people accuse them of being socially insensitive. Unemployment, for instance, is blamed on the structural reforms that they imposed on Macedonia.

We sometimes disagree with the recipes of the IMF, and they do tend to administer the same advice to all their clients. But their contribution is positive and important. They provide credit and, thus, signal to investors that the right economic policies are implemented.

Politicians, dependent on voter satisfaction often need prodding to implement painful reforms. Some of the measures included in our arrangement have increased unemployment. We had to sell or shut down 12 large loss makers. Another 30 are to be sold or closed. We have pared more than 3000 workers off the state administration payroll. But this is a drop in the unemployment bucket.

Why is there persistent unemployment?

Many reasons [he sighs]. Unemployment is over-stated. Many workers in the informal economy go unreported (this, hopefully, will change with the lower taxes). Albanian women often refuse to work but register as unemployed to get the attendant benefits.

Still, unemployment is way too high. GDP needs to grow consistently over at least five years to make a dent. The private sector and its small and medium-size enterprises should be the engine of growth. But the private sector in Macedonia has stagnated. Previous governments sold firms to cronies. This was called "management buyout."

The old/new managers/owners had no vision, no new technology and no new products. Their firms created negative value added. Moreover, they crowded out newcomers by, for instance, absorbing the credits made available through the banking system. 81 percent of the credit aggregate in 1999 went to 16 loss makers. Less than 20 percent reached the private sector. It was an old boys network built on the residue of Socialism.

Additionally, there is a lack of good projects, deficient property rights legislation and enforcement and a dysfunctional and politicized banking system. The unstable region added to our problems.

Red Tape?

That too, although this was not a major obstacle, and the new company law makes it much easier to establish a firm and run it. But the governments pre-1998 seemed to be bent on repelling foreign investors rather than attracting them. They placed legal entry barriers. This is changed now. We crave foreign investors and welcome them.

Perhaps too much? Recent privatizations—notably of Okta and Skopski Saem—were criticized as lacking in transparency.

Skopski Saem was privatized through the stock exchange after a proper notice was published in the press. It was open to anyone. In the past (1996 and 1997), the World Bank recommended that we privatize also through direct negotiations.

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Okta—the refinery—was about to be shut down when a white knight appeared. We did not miss the opportunity to salvage this important asset. All three companies privatized through direct negotiations are now profitable. The new law allows us to privatize only through a stock exchange or a public tender. I hope this will put an end to the criticism.

Anything to conclude?

In the last year and a half we have gone through a compressed version of the structural reforms other, much richer, countries took a decade to implement. We passed numerous crucial laws. We liberalized the foreign exchange regime and rebuilt the tax administration, implemented a treasury system, restructured the customs and the payment system, reduced tariffs and excise on certain products and passed amendments to countless economic and financial laws (such as the insurance law).

We are preparing the ground for an Internet revolution in our country. We recently passed a digital signature law and are preparing other cyber-laws. We did all this—and endured unprecedented geopolitical turmoil—while keeping inflation low, forex reserves high and with record FDI. I have every reason in the world to be optimistic.

Interview conducted by Sam Vaknin

Also of interest:

Sam VakninThe author:

The author is General Manager of Capital Markets Institute Ltd, a consultancy firm with operations in Macedonia and Russia. He is an Economic Advisor to the Government of Macedonia.

DISCLAIMER: The views presented by the author in this article represent only the personal opinions and judgments of the author.

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After the Rain:
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