PUBLISHED BY: Central Bank of Montenegro Bulevar Svetog Petra Cetinjskog 6 81000 Podgorica Telephone: +381 81 664 997, 664 269 Fax: +381 81 664 576

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CENTRAL BANK COUNCIL: Ljubiša Krgović, MS, president Milojica Dakić, MS Krunislav Vukčević Goran Knežević, MS Petar Drakić Radmila Savićević

TRANSLATED BY: Lidija Ćirović Popadić

DESIGNED BY: Andrijana Vujović

PRINTED BY: Grafo Crna Gora

The Report is published annually.

Users of this publication are requested to make reference to the source of information whenever they use data from the Report. LIST OF ABBREVIATIONS

BIS Bank for International Settlements BPK/BAK Banking and Payment Authority of Kosovo BS Bank of Slovenia BSCEE Group of Banking Supervisors from Central and Eastern Europe CBBiH Central Bank of Bosnia and Herzegovina CBM Central Bank of Montenegro CDA Central Depository Agency CEBIT Annual trade show of information and telecommunication technology EBRD European Bank for Reconstruction and Development ECB European Central Bank EIB European Investment Bank EMU European Monetary Union EU European Union EUR Euro EURIBOR Euro Interbank Offered Rate FDI Foreign Direct Investments FED Federal Reserve System HNB Croatian National Bank IBRD International Bank for Reconstruction and Development IDA International Development Association IDF Institutional Development Fund IFC International Finance Corporation IMF International Monetary Fund IMF International Monetary Fund IS-CB Information System of the Central Bank of Montenegro KFW Kreditanstait fur Wiederaufbau LIBOR London Interbank Offered Rate MFI Micro-credit Financial Institution MIGA Multilateral Investment Agency MONSTAT Statistical Office of Montenegro n/a not available NBM National Bank of Macedonia NBS National Bank of Serbia RIA Regulatory Impact Assessment RIR Register of account owners RM Republic of Montenegro SCG Serbia and Montenegro SDR Special Drawing Rights SITC Standard International Trade Classification UCD Unique Customs Declaration USD US Dollar VAT Value added tax WTO World Trade Organisation FOREWORD BY THE PRESIDENT OF THE CBM COUNCIL ...... vi ACTIVITIES OF THE CBM COUNCIL IN 2004 ...... ix 1. MACROECONOMIC ENVIRONMENT IN MONTENEGRO IN 2004 ...... 11 1.1. Review of Macroeconomic Developments ...... 13 1.2. Prices ...... 15 1.3. Monetary Developments ...... 20 1.4. Financial Markets ...... 26 1.5. Fiscal Policy ...... 29 1.6. Public Debt ...... 32 1.7. External Developments ...... 36 2. THE BANKING SYSTEM ...... 47 2.1. Structure of the Banking System in Montenegro ...... 49 2.2. Banks’ Performance in 2004 ...... 51 3. BANKING SECTOR SUPERVISION AND REGULATION ...... 67 3.1. Regulatory and Supervisory Developments ...... 69 3.2. Assessment of Compliance with Basel Core Principles ...... 71 3.3. Risk Exposure of Banking System ...... 74 CONTENTS

4. PAYMENT SYSTEM ...... 85 4.1. Payment System Reform ...... 87 5. BANKING AND FINANCIAL OPERATIONS ...... 91 5.1. Foreign Exchange Reserve Management ...... 93 5.2. International Payment Operations ...... 96 5.3. Fiscal Agent and Advisor ...... 97 6. MACROECONOMIC ANALYSES AND RESEARCH ...... 103 6.1. Improvements in Statistics ...... 105 6.2. Reporting on Macroeconomic Developments ...... 106 6.3. Projects ...... 106 6.4. Preparation of Laws and Enabling Regulations ...... 107 7. OTHER IMPORTANT ACTIVITIES OF THE CENTRAL BANK IN 2004 ...... 109 7.1. International Cooperation ...... 111 7.2. Vault ...... 114 7.3. Internal Audit ...... 114 7.4. Information Technology Support ...... 115 7.5. Human Resources Management ...... 116 7.6. Public Relations ...... 117 ANNEXES ...... 119 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

FOREWORD BY THE PRESIDENT OF THE COUNCIL OF THE CENTRAL BANK OF MONTENEGRO

The year 2004 can be categorized as a successful year in which macroeconomic stability was maintained, economic growth was accelerated, and the reform processes of the Montenegrin economy continued. The inflation downtrend continued, relatively high economic growth was achieved, the unemployment rate fell, the highest industrial growth in the region was achieved, the number of tourists significantly increased, and almost all monetary and financialaggregatesimproved.Thesuccessoftheimplementedreformsinthebanking system is definitely confirmed by the regained credibility of the system, something which had been lost during the 1990’s. A favourable credit rating assigned to Montenegro by the international rating agency Standard & Poor’s is also confirmation that the reforms are moving in the right direction, proving that Montenegro does not belong to the category of highly indebted countries. This rating improves Montenegro’s position in the international capital market, and shall bring about a higher inflow of foreign direct investments.

The reform process in the banking sector continued in the reporting year. With regard to the payment system, new regulations governing the domestic payment system were enacted, IT hardware and software requirements were met thus creating both normative and technical grounds for the successful transfer of payment operations to banks at the beginning of 2005. The bank supervision overall level of compliance with the Basel Core Principles was improved. Theregulationsgoverningthemanagingofoperativeriskandmarket risk in banks and country risk rounded off the legal requirements with regard to the risk management in banks. Operative activities on the closing of the Government’s deposit accounts with commercial banks and the transfer of those funds to the all-in-one account with the Central Bank were performed in cooperation with the Ministry of Finance.

Theresultoftheseisasoundandliquidbanking-financialsystemwhichcanbeconfirmedby theimprovement in almost all monetary indicators - loans granted, savings by private citizens, banks’ total assets, and deposits in which term deposits made up more than half. In addition, banks opened eighteen new branch offices.

The Central Bank established correspondent relations with eight foreign commercial banks where it held its foreign exchange funds and through which international payment operations were performed. According to reputable agencies, credit ratings of the aforementioned banks fall into the highest credit rating category.

vi FOREWORD BY THE PRESIDENT OF THE CBM COUNCIL

As the fiscalagentoftheGovernmenttheCentralBankofMontenegroorganisedthirty-eightT-Billsauctions, and the total amount of T-Bills sold was EUR 256.1 million, which is almost double the amount sold last year.

Regular macroeconomic analyses were performed in monetary, real sector, and the balance of payments areas, and numerous projects, studies, and analyses were also performed. In accordance with these, appropriate recommendations were prepared for the Government. The Central Bank started to report regularly to the Eurostat on macroeconomic developments in Montenegro, and preparations for regular reporting to the IMF were also made. A new methodology for the calculation of monetary aggregates was prepared by taking into account the situation in Montenegro and simultaneously being in line with the IMF international standards.

International cooperation was intensified, implying regular contacts with the International Monetary Fund, the World Bank, the European Bank for Reconstruction and Development, and the European Union. Closer cooperation was established with the Swiss National Bank, the National Bank of Poland, the Bank of Slovenia, the Bank of Austria, and the Bank of Albania. Additional links were made with the Bank for International Settlements (BIS) and the Development Bank of the Council of Europe.

The Central Bank of Montenegro received full membership of the Central Banks Governors’ Club of Central Asia, Black Sea Region, and Balkan Countries and the Association of Bank Supervisors of the Central and Eastern Europe.

Great attention was dedicated to the training of employees as the prerequisite of further improvement in working processes.

Through regular contacts with the public, publications, the participation in a number of conferences, and through our website we made our work public and transparent.

Ljubiša Krgović

vii CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

viii ACTIVITIES OF THE CBM COUNCIL IN 2004

ACTIVITIES OF THE COUNCIL OF THE CENTRAL BANK OF MONTENEGRO IN 2004

The Council of the Central Bank managed the Central Bank in accordance with the duties laid out in the Law on the Central Bank of Montenegro.

Twelve meetings were held and the Council did the following:

• established the Policy of the Central Bank, • monitored the activities of the Central Bank with regard to the strengthening of the banking sector and the transformation of the payment system, • passed regulations which regulate banking and payment operations, • reviewed macroeconomic and balance of payments analyses, and adopted recommendations for economic policy, • passed internal acts with a view to the more rational and efficient performance of the Central Bank.

When adopting the Policy of the Central Bank for 2004, the Council, among other things, set the following main objectives:

• the maintenance of high solvency in the banking system, the strengthening of financial discipline and confidence in the banking system through greater compliance with the Basic Basel Principles of efficient bank supervision; • the provisioning of an efficient payment system through further development of payment systems, in accordance with international standards and recommendations; • the monitoring of the position, and analysing the influence of the financial and the banking system on overall macroeconomic developments.

The Council reviewed the situation in the banking sector on a regular basis, and monitored the activities of the bankruptcy and liquidation managers during the bankruptcy proceedings over “Jugobank” ad Podgorica and the liquidation proceedings over “Ekos bank” ad Podgorica, respectively. By amending the Regulation on Banks’ Reporting to the Central Bank and the Regulation on the Method and the Procedure of Bank Supervision, and enacting the Regulation on Minimum Standards for Market Risk Management the Council of the Central Banks created normative assumptions for more efficientbanksupervision. At the same time, the level of compliance with the Basic Basel principles increased.

In accordance with the adopted Strategy for the Development of Payment Systems, the Council monitored activities on the implementation of the new payment system, which resulted in the enactment of 11 new regulations governing the performance of payment operations in the country. This also created the appropriate conditions for a modern and efficient performance of payment operations in 2005.

Whilst considering, during the adoption procedure, the law which directly or indirectly regulate the financial system and the market, as well as the laws in whose drafting the representatives of the Central Bank took part, the Council significantly contributed to the quality of these laws.

ix CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

The Council monitored the economic developments in the Republic through the Chief Economist’s monthly reports. On the basis of this data, analyses were made, and through quarterly reports recommendations were made for the activities which should be undertaken with a view to establishing macroeconomic stability and the objectives of economic policy. As a part of its legal obligations, the Council adopted the Recommendations for Economic Policy for 2005 which were then submitted to the Government of Montenegro to give greater insight of anticipated economic developments and the preparation of economic policy for next year.

The Council also passed the Decision on the Amendments of the Statute of the Central Bank of Montenegro which created the conditions for the establishment of the Audit Committee as a working body of the Council that would improve the Internal Audit function in the Central Bank. In addition, the Act on Systematisation and the Act on Employees’ Earnings that incorporates the methodologies for job evaluation and job performance. This was done with a view to matching the working of the Central Bank to the best international standards and practice.

In addition to the fact that the decisions, which have the character of general acts, were published in the “Official Gazette of the Republic of Montenegro”, the public was timely informed through the media and the Central Bank’s web page about the meetings of the Council and all other important decisions passed in the reporting period.

x 1. MACROECONOMIC ENVIRONMENT IN MONTENEGRO IN 2004

MACROECONOMIC ENVIRONMENT IN MONTENEGRO IN 2004

1.1. Review of Macroeconomic Developments

Macroeconomic situation in Montenegro improved in comparison with The money supply is also increasing. The broadest monetary aggregate, the previous year. It was characterized by an increase in production M21, amounted to EUR 547 million, showing an increase of more than output, a downfall in inflation, a reduction in the fiscal deficit, an EUR 50 million since last year. Bearing in mind that the movements in increase in savings and granted loans, and an increase in the current the balance of payments in euroised (dollarized) economies are the account deficit and a growth in foreign borrowing. sources of an increase and/or a decrease in the money supply, we can conclude that the real situation is much more favourable than recorded The inflation rate in 2004 was on a downtrend. Measured by the retail in the statistics, that is, there is a substantial amount of income which price index and the cost of living index it amounted to 4.3% and 1.5%, was not recorded. respectively. The facts that inflation is lower than the projected level of 4.5%, and that it has been on a downward trend for three years in a Interest rates are still high, thus making the economy’s business activities row are certainly encouraging. It has approached the EMU inflationrate harder. The main culprits for the high level of interest rates are: high (which is the goal to be reached in the long term), being at the same, country risk, client risk, inadequate working procedures of the judicial and even slightly below, the level of the aforementioned interest rate system, inflationstillhigherthanthatintheEMU,andsoon.Thesizeable until the fourth quarter of the year.1 If we analyse the factors which led differencebetweeninterestsreceivableandinterestspayableindicates to the increase in prices, we find that the main culprits are the prices that there is enough space for their further decrease. With regard to the of services whose growth can explain for 80% of this year’s inflation. stabilisation of economic and political situations, a gradual fall in interest Since these are solely the prices of non-tradable services by suppliers rates could be expected in 2005. enjoying monopoly or oligopoly position, the enactment of antimonopoly regulation is a sine qua non for restricting inflation in 2005. However, Net salaries grew by 11.7% in comparison with the previous year. In the we can conclude that a declining inflation rate is the price to be paid in last two year, salaries have grown much faster that the cost of living, the economic reform process. which has led to a real growth in the living standard. However, the continuation of a faster growth of salaries than productivity, i.e. the Positive trends were also present in the monetary sector. Banks’ potential GDP rate of increase, may bring about numerous negative trends, such rose by 27%, granted loans by 42%, savings by 79%, and total deposits as higher operating costs, a rising pressure on the budget, growth in by 30%. Observed as a whole, the banking sector was characterized inflation, a deterioration in the current account deficit, and so on. by a high liquidity level. To wit, the total liquid assets and discharged debts amounted to EUR 101 million and EUR 24 million, respectively. A Industrial production recorded an extremely high growth, 13.8%, which continuous increase in term deposits, which now make up more than is by far the highest in the region. It can be mostly explained by the half of the total deposits (55%), represents a very positive trend unlike privatisation and the reforms carried out in the last few years which are two years ago when they made up less than 30%. yielding positive results after a certain time delay. However, this year’s

1 Inflation was 2.5% until December, but an increase in the prices of telecommunication services of 100% led to inflation of 1.8% in the last month of the year, which represents the highest monthly inflation in the last three years, with the exception of April 2003 when VAT was introduced. Such an increase in prices raises doubts about the existence of an abuse of a monopoly position, which is prohibited in all developed market economies.

13 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

level of industrial output is just 70% of that achieved in 1990. The main to a growth in production). An uptrend in the import, as well as a contributors in the structure of industrial production are electricity and downtrend in the export of agricultural-consumer products gives some semi-finishedproducts.Withaviewtoachievinghighratesofeconomic reasons for concern if the existing natural conditions for the development growth it is necessary to continue with the restructuring of large systems, of this sector are taken into account. The main culprits for the deficit complete the privatisation process, upgrade the quality of production, are the following: uncompetitive domestic products, the expansion of and achieve international quality standards. domestic demand (through increases in salaries and consumer loans), a liberal foreign trade regime, the low employment of capacities, and Tourism is the branch that recorded the most dynamic development in the substantial amount of non-registered income as well. However, 2004. The number of tourists who visited Montenegro rose by 17.4%, we must be aware of the fact that almost all transitional economies whereby the number of overnight stays increased by 14.7%. The (including those who have become members of the EU) still face balance estimated revenues from tourism amounted to some EUR 180 million of payments current account deficits. (19% more than in 2003), which is very important from the aspect of the current account deficit. The number of foreign tourists is increasing The dynamics of the inflow of foreign investments is not as expected. steadily. The declining number of tourists who visited mountain resorts Almost half of them are in the service sector. However, what gives reason can be explained by the lack of modern well-equipped hotel enterprises. for concern is a drastic increase in loans. To wit, net loans amounted to Bearing in mind the extraordinary natural potential for the development EUR 122 million, which is three times the amount achieved last year. of mountain tourism, the restructuring of these enterprises is essential with a view to attracting foreign investors. What Montenegrin tourist Although the level of foreign indebtedness shows that Montenegro offerlacksmostarethenon-existenceofhigh-classhotelcapacitiesand belongs to the group of low-indebted countries, a certain concern the absence of renowned hotel chains. With regard to the great potential represents the fact that foreign borrowing is on the increase; its for greenfield investments it is important to strive towards attracting contribution to GDP is 34%, and it was 32% in 2003. Further foreign renowned investors. Although the number of registered overnight stays borrowing policy should be very restrictive, otherwise all future surpluses is 54.2% lower than that recorded in 1989, some indicators (the number will go to foreign debt repayments. ’ of roaming users, accommodation capacities, electricity consumption) suggest that the actual number of tourists was much larger. Montenegro was assigned a ’BB-’ credit rating by the international rating agency Standard&Poor’s. It is a very favourable rating, much Increases were also recorded in forestry and agriculture, and a fall in the higher than that assigned to most of the countries in the region. This construction industry. As for transportation, road transport of passengers, will certainly have a positive effect on Montenegro’s position in the air trafficandtransportationviarailwaysareontheincrease,whereasa international capital market, the movement of interest rates, and the downtrend was recorded with other forms of transportation. inflow of foreign investments. Of course, one should not expect the situation to improve radically, but to treat this credit rating as the The balance of payments current account deficitdeterioratedfromEUR confirmation that the reforms have been on the right track and that 114 million in 2003 to EUR 183 million in the reporting year. However, they should continue as planned. the dilemma remains whether this is the actual deterioration or a result of statistical omissions from the previous year which was, therefore, The grey economy is still widespread, so measures to suppress it must represented as falsely low. Some half of the increase in the current continue. On one hand, it acts as unfair competition, while on the other account deficit can be explained by the increased prices of oil and oil it reduces budgetary revenues. Bearing in mind the social dimension of derivatives. The balance of payments problems are mainly concentrated the grey economy, the accent should be put on its conversion into legal in the trade balance, as a result of the increased import of consumer flows by allowing tax relief wherever possible. goods and intermediate goods (this category can indirectly contribute

14 MACROECONOMIC ENVIRONMENT IN MONTENEGRO IN 2004

1.2. Prices

A downtrend in inflation continued in 2004, so measured by the retail high interest rates. Then, unbalanced growth in the prices of products price index and the cost of living index it amounted to 4.3% and 1.5%, and services causes price distortions (deterioration in price parity), respectively. The main causes of inflation in 2004 remain the prices of creating the stimulus for future inflation (an increase in the prices of tradable services, which indicate that urgent enactment of antimonopoly products that is above the average). The increase in prices induces a regulation is absolute necessity in the forthcoming period. fall in the living standard and employees’ demand for higher salaries, setting off the spiral of cost-push inflation. However, inflation could Although the inflation rate approached that existing in the EMU, it not have been avoided by any economy in transition, but its gradual is still higher. This affects the competitiveness of the Montenegrin declining represents a good signal. economy leading to numerous consequences. Firstly, inflation induces

Box 1.1. Inflation in Montenegro and the Euro zone

Graph 1. Inflation in 2004, %

Source: National statistics bureaus and Eurostat

The comparison of inflation in the above given Southeast European countries and countries which became members of the EU shows that inflation in Montenegro was at the average of inflation in these countries. Inflation in Montenegro was lower than that in Poland, Hungary, Slovakia, and new member countries of the EU.

In the long term, Montenegro should strive for the same inflation rate as that in the EMU. After the five-year euroisation this goal was achieved in most of 2004, as shown in the following graph:

15 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

Graph 2. Inflation in Montenegro and Euro zone since the introduction of EUR (annual rates of increase)

Source: Monstat and Eurostat

An upsurge in prices in December largely contributed to the higher annual retail price index from 2.5% (in November 2004 and compared to inflation rate. That is, the monthly increase in prices in this month was December 2003) to 4.3%. The overall growth in prices was due to an 1.8%, which, if we disregard April 2003 when VAT was introduced, was increase in the prices of telephone charges of 100%, which resulted in the highest monthly increase in the last three years. This price increase the increase in the prices of services of 9.5%. affected the movement of inflation for the whole year, increasing the

Graph.1.1. Retail prices in 2004 (monthly increase rates)

Source: Monstat

16 MACROECONOMIC ENVIRONMENT IN MONTENEGRO IN 2004

The monthly increase in inflation fluctuated throughout the year As for annual changes (month-on-month comparison of 2004 and (See Graph 1.8.), ranging between 0% (March and April) and 1.8% 2003), there was a substantial decrease in inflationfrom5.5%inMarch (December), with the average being 0.34%. Higher than the average to 2.3% in April 2004, which can be explained by the high comparison increase was recorded in four months (February, May, October, and base in the previous year. To wit, the prices of goods and services did December). The main generators of these jumps were mainly the prices not include VAT until April 2003, thus being much lower than the in state controlled, and the non-tradable goods and services. Thus in same prices in the corresponding months of the reporting year. The February, the largest contributor to inflation (64%) was the increase price difference disappeared in the latter month, so the price increase in monthly TV subscription of 52.17%. The main culprit for the May stabilised and ranged between 2% and 3% until November. Annual inflationwastheobligatoryvehicleinsurancewitha58%contribution. inflation in this period was 2.3%. The inflationinOctoberwasmainlygeneratedbyhigherpricesofrailway transport and intertown transport by bus, which contributed 68.6%, and The comparison of certain categories of goods and services shows that the reason for the December inflation has already been explained. The the prices of services were constantly higher than the prices of goods. prices of the aforementioned categories of goods and services represent This can be explained by the fact that within the category of goods, in unexpected and one-off causes of inflation. retail prices, most of the products were those which enjoy a developed market (tradable products) and whose prices are influencedbydomestic and international competition, the latter having more effect. On the other hand, most of the services are non-tradable and do not enjoy a developed market. Graph 1.2. Retail prices in 2004 (annual increase rates)

Source: Monstat

Box 1.2. Prices of services

The prices of services rose by 18%, mainly due to higher prices of transportation and PTT services by 22%, financial services by 16%, and educational and cultural services by 37.8%. The contribution of the aforementioned categories to total inflation was 74%. As has already been said, those were non-tradable services which largely determined this years inflation. If it had not been for those sudden price changes, inflation in 2004 would have been much lower.

17 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

Table 1. Contribution of certain categories (goods and services) to the annual inflation

Total Weight Contribution 10000 100,00 GOODS 8108 20.03% Agricultural products 514 -6.42% Industrial products 7594 26.38% Industrial food products 3246 10.52% Beverages 526 2.62% Tobacco 514 0.00% Industrial non-food products 3308 13.11% Liquid fuel and lubricants 141 1.28% SERVICES 1892 79.61% Professional 131 2.82% Public utility 248 2.99% Financial and other services 316 11.76% Educational 114 10.04% Public protection services 65 0.17% Transportation and PTT services 1018 52.04%

Source: Monstat and calculations by the Central Bank of Montenegro

The prices of goods grew by 1.1%, contributing 20% to overall inflation. the prices of footwear of 5.6%, contributing 5% to inflation. On the In the category of industrial food products, the highest increase was in other hand, a decline in the prices of agricultural products of 5.4% the prices of flour and the prices of fresh meat whose contributions to compensated for the increase in the aforementioned categories, which total inflation were 7% and 4%, respectively. The prices of industrial is the result of solid demand and a good harvest. non-food products rose by 1.7%, of which the highest growth was in

Table 1.1. Retail prices (per cent increase)

XII 2002 XII 2003 XII 2004 XII 2001 XII 2002 XII 2003 TOTAL INDEX 109.4 106.7 104.3 GOODS 108.7 105.1 101.1 - Agricultural products 119.6 97.1 94.6 - Industrial products 108.0 105.7 101.5 - Beverages 110.0 100.4 102.1 SERVICES 112.7 114.3 118.1

Source: Monstat

18 MACROECONOMIC ENVIRONMENT IN MONTENEGRO IN 2004

1.2.1. Cost Of Living

In spite of substantial increases in the price of oil and oil derivatives in The cost of living grew much slower than retail prices, so during mid-2004, the situation in the world market stabilized in November the twelve months they rose by 1.5%. The main reason for such a and December, so their growth was 3.4% at the end of 2004, but due slow growth is the difference in weight of some categories of goods to the low weight of this category in the total retail price index their and services used for the calculation of the retail price index and the contribution to total inflation was 1.3%. cost of living. To wit, the contribution of agricultural products to the retail price index calculation basket and the calculation of the cost of living was 5% and 11.40%, respectively, so the reduction in the prices of these products led to lower food expenses than that in 2003. This largely compensated for the increases in the expenses for clothes and footwear, housing, transportation, and PTT services.

Graph 1.3. Retail prices in 2004 (annual rate of increase)

Source: Monstat

Graph 1.4. Increase rates of net salaries and cost of living (per cent change)

19 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

1.2.2. Producers Prices of Manufactured Products

Graph 1.4. presents the analysis of the movement of net salaries and the Producers’ prices of manufactured products showed a strong growth in cost of living in the last two years.2 The undisputable conclusion is that the reporting year, growing much faster than retail prices. This was due salaries grew much faster than the cost of living, and that a continuous the higher prices of basic metals (aluminium) of 11.6% induced by the increase in the living standard was evident. increase on the world markets, resulting in higher prices of manufactured products and intermediate goods of 4.6% and 6.6%, respectively.

The increase in producers’ prices was not incorporated in the growth in retail prices since the prices of consumer goods, which are the main part of the consumer basket, fell by 1.4%. Graph 1.5. Retail prices and producers prices (annual per cent change)

1.3. Monetary Developments

The main objectives of the monetary policy for 2004, set up by the Policy banks, deposits by the corporate sector fell by 7.5%, whereby deposits of the Central Bank for 2004, were achieved: efficiency of the banking by private citizens increased by 79%. sector increased, the reform of the payment system was completed, and banks’ credit potential increased. The main loan beneficiarieswerethecorporatesectorandprivatecitizens. Regardless of the high annual increase rates, the level of these loans The main monetary indicators recorded positive rates of increase. Thus, was not great (11.95% of GDP and 5.04% of GDP, respectively). Loans compared to the previous year, the money supply (M21) grew by 10.5%, to private citizens showed more intensive growth during the year than banks’ potential by 27%, and total loans by 40% (of which loans to the those granted to the corporate sector. The average monthly increase corporate sector and loans to private citizens grew y 39% and 49%, rate of loans granted to private citizens amounted to 3.4%, the average respectively). In addition, total deposits grew by 29%, and the allocated annual increase was 26.3%, whereas the corresponding increase rates of reserve requirements by 22.5%. As a part of total deposits with domestic loans granted to the corporate sector were 2.9% and 22.1%, respectively.

2 The change of the methodology for the calculation of salaries does not allow for a longer series of analysis due to the lack of comparative data.

20 MACROECONOMIC ENVIRONMENT IN MONTENEGRO IN 2004

In spite of this, entrepreneurs consider that not enough loans, as a the Central Bank of Montenegro deposited EUR 53.5 million with foreign significant development factor, were granted throughout the year. banks. Additionally, the maturity structure of the loans, although somewhat better than in 2003, was not favourable since the main contributors The envisaged activities for 2005 are the privatisation of Podgoricka remained short-term loans (with a repayment period of up to one bank, initial preparations for the privatisation of Niksicka bank (the two year). remaining state-owned banks), and the commencement of operations of the Fund for Deposits Protection. The expectations for the next year Deposits by domestic banks with foreign banks fluctuated, amounting include a fall in interest rates and a greater transparency in the workings to EUR 44.2 million at the end of the reporting year. At the same time, of the insurance sector.

Box 1.3. The Structure of the Financial System

The financial system in Montenegro is characterized by the existence of almost all financial market institutions, appropriate laws and enabling regulations

The financial sector in Montenegro is dominated by commercial banks, but institutional investors (investment funds, pension funds, and insurance companies) remain without an appropriate role in the market. Their significance lies in the fact that they represent the basis for the long-term accumulation of capital, and contribute to the width and the depth of the equity and debt securities market. Private pension funds in Montenegro still do not exist, and investment funds and insurance companies do not play an active role in the capital market.

Financial institutions Montenegro Serbia Croatia Slovenia3 BiH Macedonia Kosovo 1. Central Bank CBCG NBS HNB BS CBBiH NBM BAK 2. Other depository corporations 10 42 45 33 35 36 7 Banks 10 42 39 20 35 21 7 3. Other financial corporations Insurance companies and pension funds 7 25 42 24 28 10 16 - Insurance companies 7 22 26 14 28 9 8 - Pension funds 0 3 164 10 0 1 8 Other financial intermediaries 9 0 35 28 40 8 14 - Micro-credit financial institutions 2 0 0 n/a 11 n/a 14 - Privatisation/investment funds 6 0 28 24 0 0 - Financial leasing companies 1 11 35 n/a 5 8 0 Other 9 67 27 17 28 9 0 Stock exchanges 2 2 2 n/a 2 1 0 Broker houses 6 65 25 17 26 8 0 Dealer houses 1 0 0 0

Source: Central banks of the listed countries

3 Data for 2003. 4 Obligatory pension funds – 4; Voluntary pension schemes – 4;Closed voluntary pension schemes – 8 (established by enterprises for their employees).

21 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

This review shows the dominant contribution of commercial banks in the structures of financial systems in Montenegro and countries in the region. The privatisation of state-owned banks together with the opening of banking institutions to foreign investors increased the presence of foreign ownership in the banks. However, the banking sectors in these countries are relatively small compared to the new EU Member States where banking sector assets equalled 64% of GDP in 20025 (25.5% in Montenegro). Montenegro recorded the lowest contribution of deposits in GDP in 2003 (15.3%) in comparison with other Western Balkan countries, and the average for the region amounted to 30% of GDP.6

Non-banking financialinstitutionsplayaverylimitedroleasasourceoffinancingfortheprivatesector.Althoughthesamestock exchanges operate in the aforementioned countries (except in Kosovo), they are still in their infancy in terms of stock market capitalisation.

1.3.1. Money supply

The money supply M21 fluctuated during the year, reaching the level of EUR 546.3 million at end-2004, which was 10.5% more than at the end of the previous year.

Table 1.2. Money supply M21 at end-months, EUR thousand

2003 2004 XII III VI IX XII M0 284,909 281,275 283,695 292,280 290,935 Banks’ deposits with CBM 34,909 31,275 33,695 42,280 40,935 Estimate of cash in circulation 250,000 250,000 250,000 250,000 250,000 M1 386,121 387,310 393,308 417,157 430,659 M0 284,909 281,275 283,695 292,280 290,935 Demand deposits in EUR 83,148 90,508 98,495 110,533 130,220 Demand deposits in other currencies 18,064 15,527 11,118 14,344 9,504 M11 402,586 394,775 399,198 424,993 436,876 M0 284,909 281,275 283,695 292,280 290,935 Demand deposits in EUR 98,776 97,531 103,921 117,472 136,064 Demand deposits in other currencies 18,901 15,969 11,582 15,241 9,877 M2 460,837 467,799 485,328 517,416 535,550 M1 386,121 387,310 393,308 417,157 430,659 Term deposits in EUR 71,229 75,681 85,872 97,414 98,128 Term deposits in other currencies 3,487 4,808 6,148 2,845 6,763 M21 494,290 485,177 497,293 533,682 546,287 M11 402,586 394,775 399,198 424,993 436,876 Term deposits in EUR 88,203 85,580 91,947 105,844 102,648 Term deposits in other currencies 3,501 4,822 6,148 2,845 6,763

5 Source: http://europa.eu.int, Enlargement papers: ‘’The Western Balkans in Transition’’, December 2004. 6 Source: ibid.

22 MACROECONOMIC ENVIRONMENT IN MONTENEGRO IN 2004

Monetary aggregate M11 was the dominant factor, 80% of the structure The money supply, monetary aggregate M11, amounted to EUR 436.9 of the M21 money supply at the end of the year. million at the end of 2004, which is 8.5% above the level achieved at the end of the previous year.

Graph 1.6. Money supply, EUR thousand

Box 1.4. Monetary Aggregates – Methodological Explanations

The assessment of money in circulation is a problem many economies without a local currency encounter, including the Euro zone countries. This assessment was used in Montenegro when the National bank of Montenegro did not issue money, and money in circulation was estimated on the basis of the contribution of Montenegro’s GDP to the GDP of Yugoslavia (5% at the time). The process of the conversion from the Deutsch Mark to the Euro was the most reliable indicator of the quantity of money in circulation. The Central Bank is aware that the main weakness of the methodology for calculating the money supply is the estimate of money in circulation itself, so it has initiated an assessment project.

Since there is no monetary aggregates definition common for all countries, but a country defines them on the basis of its characteristics (and can have more definitionsdependingontheobjectiveitistryingtoachieve),theCentralBankofMontenegro revised the definitionofthemoneysupplyin2004sothatmonetaryaggregatesencompassallthemoneyinthesystem.

The new methodology for monitoring the money in circulation in Montenegro takes into account all the specific characteristics of its economy, the main objective being the monitoring of the quantity of Euros, so monetary aggregates include deposits by all non-banking depositors with the banking sector in Montenegro. According to the methodology, monetary base (M0) is comprised of banks’ deposits with the CBM-payment Operations (banks’ giro accounts and allocated reserve requirements, excluding the part banks keep as treasury bills) and the estimated amount of money in circulation. Monetary aggregate M1 is comprised of M0, demand deposits by the non-banking sector with banks and the CBM-Payment Operations, in EUR and other currencies, excluding deposits by the central government. Monetary aggregate M11 comprises M1 plus the central government’s demand deposits in EUR and other currencies. Monetary aggregate M2 includes M1 and the non-banking sector’s term deposits with banks, in EUR and other currencies, excluding deposits by the central government. Monetary aggregate M21 comprises M11 plus the central government’s term deposits in EUR and other currencies.

23 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

1.3.2. Instruments for Monetary Development During the reporting year, these deposits ranged from EUR 108 million Control to EUR 151 million, so the calculating base amounted to EUR 131 million, on average. From the firstreserverequirementaccountinJanuary2002 Pursuant to the Law, the Central Bank of Montenegro has a very limited until the end of 2004 this base ranged from EUR 61 million to EUR 151 number of instruments for monetary control at its disposal, primarily million, the average being some EUR 102 million. reserve requirements and loans for daily liquidity maintenance granted to banks. Deposits not included in the calculation base9 amounted to EUR 110 million, on average, with the highest level recorded at end-September, 1.3.2.1. Reserve requirements EUR 129 million.

The method of calculating reserve requirement was changed in mid- Applying the current reserve requirement rate, banks allocated EUR 33.2 August 2004 by the Regulation on Banks’ Reserve Requirements held million as at 31/12/04, which is EUR 6.1 million or 22.5% more than with the Central Bank of Montenegro7, so instead of the average two- at the end of 2003. (Annex B, Table 6) The annual daily average of the week balance of demand and term deposits with an agreed maturity of allocated reserve requirements with the Central Bank of Montenegro up to 30 days8, the base for calculating the required reserves makes up amounted to EUR 30.1 million, which is EUR 0.3 million more than the the average one-week state of the aforementioned deposits. In other daily average in 2003. words, the calculation and allocation of reserve requirements since August 2004 has been performed weekly. There were 37 accounting periods The structure of the allocated reserve requirement at the end of the during the year (17 two-week and 20 one-week). Other conditions year changed dramatically in comparison with the year-end 2002 and for calculation, allocation, and use of reserve requirements, as well 2003. Since the introduction of the reserve requirement instrument, as the level of interest rates which the Central Bank of Montenegro the allocation structure has changed in favour of reserve requirements charges to and collects from banks for their reserve requirements held in the CBM foreign accounts and the allocation in the form of T- were the same as at end-2003. Thus the basis for the calculation of bills, while the contribution of allocated reserve requirements in the the prescribed minimum amount of reserve requirements for two- country fell from 91% at end-2002 to 31% at end-2004. Observed week, i.e. one-week calculation period, made up the average balance from the aspect of annual daily average, 55.9% was allocated to the of demand deposits and term deposits with an agreed maturity of up reserve requirement account in the country, 20.7% to the Central Bank to 30 days. The reserve requirement rate was 23%, and the Central of Montenegro foreign account, whereas the average of blocked T-bills Bank of Montenegro paid 1% interest on 25% of reserve requirements of the Republic of Montenegro for reserve requirements made up 23.4%. allocated to banks’ reserve requirements account in the country, while The opportunity to keep 25% of the reserve requirements as T-bills was on the reserve requirement amount lower than prescribed the Central not used only by one of ten Montenegrin banks. Bank charged interest of 12%. On 25% of reserve requirement funds allocated to the CBM reserve Table 1.3. requirement account, the Central Bank calculated the annual interest Average balance of reserve requirement base, rate of 1% and paid EUR 73.2 thousand in 2004, which is EUR 16.3 in EUR million thousand less than in 2003.

Description/Year 2002 2003 2004 Banks did not use reserve requirement funds for their liquidity during Base average 71 108 131 the year because their liquidity was mainly satisfactory.

7 “Official Gazette of RM,” no 50/04 8 Except deposits by domestic banks (state owned and privately owned), both interest bearing and non-interest bearing 9 Deposits with an agreed maturity over 30 days and deposits by domestic banks are not included in the calculation of reserve requirements.

24 MACROECONOMIC ENVIRONMENT IN MONTENEGRO IN 2004

Graph 1.7. Reserve requirement at end-months in 2004, EUR thousand

Graph 1.8. Structure of allocated reserve requirements, 2002-2004

1.3.2.2. Intraday and overnight loans for liquidity maintenance

The reserve requirement level was lower than that prescribed only The liquidity of the banking sector in Montenegro was satisfactory for seven days (one or two days in certain months), so the Central during the year. Therefore, there was no reason for the banks to use Bank charged annual interest on the deficient amount of 12%. The loans from the Central Bank of Montenegro for liquidity maintenance deficient amounts of calculated reserve requirements were recorded (intraday and overnight loans). with five banks, to the amount of EUR 239.6 thousand. The interest on the deficient amount of reserve requirements which banks paid to the The importance of these loans with regard to the monetary regulating is Central Bank of Montenegro at the annual rate of 12% was insignificant, in determining the interest rate which the Central Bank of Montenegro only EUR 83.21. charges to banks for the use of intraday and overnight loans.

25 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

Pursuant to the applicable Regulation,10 the base for calculating this of borrowers, an inflation rate higher than in the EU, still high country interest is the average interest rate achieved at the last auction of T- risk, as well as banks’ high operating costs. bills. With a view to a further decrease in interest rates it is essential to The forming of interest rates on these financial instruments is based improve the efficiency in resolving commercial lawsuits, and complete on supply and demand, and there is no possibility of the Central Bank’s the privatisation of state owned banks, thus stimulating competition. control. It is also necessary to set up the Fund for Deposit Protection and a Credit Bureau.

1.3.3. Interest Rates A positive influence on the anticipated fall in interest rates in the forthcoming period will also be more intense competition in the treasury Interest rates did not change drastically during the year, but although bills market due to foreign banks’ increasing interest in this form of higher than the corresponding foreign interest rates, they were still investments, as well as a further fall in inflation. lower than at the end of 2003. (Annex 1, Table 7) The calculation of the weighted interest rate should also start next The reasons for such high interest rates in Montenegro are: the poor year, which would provide a more sensible review of interest rates performance of the institutions which guarantee the recovery of debts, in Montenegro and a better comparison of interest rates with other the non-functioning of the Fund for Deposit Protection, poor solvency countries.

1.4. Financial Markets

Financial markets in Montenegro are still developing in accordance with changes in the prices of certain companies yet to be privatised, and trade the achieved level of transition of the whole economy and the financial with frozen foreign currency deposit bonds started. system. Of all financial markets, the most developed is the banking market although loan securitization has not yet occurred. The capital market is more developed than the money market although the segment concerning the corporative bonds is still underdeveloped. The money market is not institutionalised, so of all the instruments of The only bonds traded in the capital market are frozen foreign currency this market the only ones traded are short-term T-bills, and only in the deposit bonds. primary market. Primary issues of these instruments are performed through the auction procedure which is carried out by the Central Bank With a view to improving the capital market in the forthcoming period of Montenegro in accordance with its legal authority. The real T-bills it is necessary to enact the Law on Capital and Financial Transactions, market actually does not exist due to the non-existence of secondary increase the transparency of regulations, regulate the trading with trading that would make these instruments potentially liquid. Other short-term T-bills, and standardize financial “products” (e.g. futures). money market instruments are not issued, and an organised interbank The following measures should be undertaken in order to improve market does not exist. The creation of prerequisites for the development the functioning of T-bills auctions: start with electronic collection of of the money market is expected in the forthcoming period. offers, consider the introduction of differentiation concept in retail with regard to large buyers, and consider the buying of a part of T-bills Developments in the financial markets in 2004 were characterized by with the revenues from privatisation since that would reduce budget an increase in transactions performed in the stock exchanges, dramatic expenses for interest.

10 Regulation on More Specific Terms and Conditions of Use of Banks’ Assets Approved by the Central Bank for the Purpose of Liquidity Maintenance, »Official Gazette of RM«, no. 02/02

26 MACROECONOMIC ENVIRONMENT IN MONTENEGRO IN 2004

1.4.1. Capital Market of investors regarding the trading of shares were also guided by the desire to profitfromchangesintheshareprice.Thisyearprovidedgreat Developments in the capital market in Montenegro were characterized by opportunities for that since the value of some of the investment material institutional, and other changes regarding investors’ preferences. The Law grew by over 600%. Great price changes and an increased volume of on Investment Funds enacted in 2004 permitted institutional investors trading were registered in investment units of privatisation funds, that to operate in the country. The two enacted subregulations related to the is, investment funds. In addition, such great variations were the result Law on the Settlement of Obligations and Liabilities Arising from Foreign of speculative transactions prompted by the announced privatisations Debt and Frozen Foreign Currency Savings enabled the conversion of of large enterprises with the majority state shareholding (Aluminium the frozen savings into bonds, which provided additional diversity of Plant Podgorica a.d.- KAP, Telecom Montenegro a.d., Bauxite Mines Niksic market material in the capital markets in Montenegro. Also, the newly a.d., hotel complexes, and so on). This situation in the capital market enacted Law on Enforcement Procedures should provide better protection is typical of all developing markets largely affected by the privatisation of creditors rights contributing to a further reduction in investment risk of state capital and the concentration of capital. Also, in such markets, in the Montenegrin market. Laws on insurance companies and financial some shareholders are not properly informed. However, the level of leasing have yet to be enacted, which is envisaged for 2005, and which knowledge of direct participants in exchange transactions has improved would induce more dynamic movements in the financial markets. over the years, and the completion of all institutional requirements is expected, so there is optimism regarding future developments in the In addition, the lowering of compensations for the Securities Commission, capital market in Montenegro. as well as the reduction in payment operation costs also influencedthe aforementioned developments. It is anticipated that these reductions, 1.4.1.1. Turnover in Stock Exchanges which happened in the second half of the year, will contribute to a somewhat intensified trading in Montenegrin stock exchanges in the The total turnover in Montenegrin stock exchanges amounted to EUR forthcoming period since its existing level has been estimated as being 42.9 million, of which EUR 18.9 was in the Nex Montenegro stock a cost barrier to more intensive investment. exchange, and EUR 24 million in the Montenegroberza stock exchange. This year’s turnover was EUR 600 thousand or 1.3% lower than last The year 2004 showed that investors were much more interested in the year’s (EUR 43.5 million). This was not a real fall but the result of the developments in the capital market. The sole reason for the purchase lack of large privatisations during the year, such as the privatisation of of shares previously was the concentration of ownership. This was also Montenegrobank whose shares were sold in the Montenegroberza stock the dominating motive during the reporting year, but the activities exchange (EUR 10.6 million) in July 2003.

Table 1.4. Transactions and turnover in 2003 and 2004

Turnover in 2003 Turnover in 2004 Change 2004/2003 No. Description in % of total in % of total Amount turnover Amount turnover Amount in % 1. Number of transactions 21,324 - 57,355 - 36,031 169 2. Primary trading (EUR million) 10,790,000 25 1,708,874 4 -9,081,126 15.84 3. Secondary trading (EUR million) 32,750,000 75 41,172,438 96 8,422,438 125.72 4. Total turnover in EUR million (2+3), 43,540,000 100 42,881,312 100 -658,688 98.49 5. Of which: 6. Shares (EUR million) 40.139 92.19 36.37 85.85 -3.77 90.61 7. FFCD bonds (EUR million) 2.57 5.90 2.88 6.65 0.31 112.06 8. Investment units (EUR million) 0.831 1.91 3.63 7.50 2.80 436.82

Source: Montenegroberza and Nex Montenegro stock exchanges

27 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

Graph 1.9. Number of transactions and total turnover in the period 2002-2004

Source: Montenegroberza and Nex Montenegro stock exchanges

If we disregarded this transaction in 2003, the picture of developments units. It can be expected that the year to come will bring a greater price in the capital market in Montenegro in 2004 would be much different range in the market material in Montenegrin stock exchanges in the - a 23% larger turnover than in 2003. light of the announced privatisations.

This is even more obvious if we compare the number of transactions With regard to further developments in the capital market, special performed and the turnovers achieved in the stock exchanges. To wit, emphasis should be placed on the creation of the necessary prerequisites the total number of transactions in the reporting year amounted to for the development of the securities market. To wit, firsttradingofFFCD 57,357, which is 169% (21,324) more than in the previous year. The bonds in 2004 represent the introduction of bonds to the domestic capital average monthly turnover was EUR 3,57 million which is some EUR 60 market. However, this cannot be considered as a sufficientincentivetothe thousand less than the year before. However, we get an even better necessary shift in external debt financing from bank loans to financing picture of the increase in turnover and number of transactions by giving securities. After two years of being successful in the timely fulfilmentof a comparative review of the last three years. its obligations regarding payments on maturity, the Government gained enough creditworthiness to issue longer maturity T-bills, which was also Of the total turnover (EUR 42.9 million), EUR 41.2 million or 93.6% was verified by the credit rating assigned to Montenegro by the Standard & achieved in the secondary, and only EUR 1.7 million or 6.4% in the primary Poor’s agency. Besides the state, a sector highly deficientinfundsisthe market. The largest primary market turnover was in the Montenegroberza corporate sector. The creation of any kind of condition for the introduction stock exchange, EUR 1,646,289 or 99.8%. The turnover in the primary of bonds as a means of debt financingrequirespreparationstoimprove market was much higher in the previous two years because banks issued the creditworthiness of the corporate sector. That is why it is important shares in order to comply with legally prescribed amount of share capital, to determine mutual debts, perform multilateral compensations where whereas there were no larger primary issues of shares which were traded possible, initiate and complete bankruptcy procedures, and finally,ensure in the stock exchanges in the reporting year. the effectiveness of the judicial system in Montenegro. Only then the bond market will have the chance to develop, becoming an alternative The structure of the material traded shows an increase in trading with to bank loans whose interest rates would then fall. Therefore, it can be bonds and investment units of privatisation funds, that is, investment said that all the aforementioned would significantlycontributetogreater funds. Regarding the latter, it should be emphasized that they increased dynamism in the overall economic developments in Montenegro and, their assets only last year thus increasing the price of their investment consequently, a growth in gross domestic product.

28 MACROECONOMIC ENVIRONMENT IN MONTENEGRO IN 2004

1.5. Fiscal Policy

1.5.1. Budgetary Review

Fiscal discipline represents the main prerequisite for macroeconomic The total budgetary revenues amounted to EUR 436.9 million or 97.3% of stability in euroised (dollarized) countries. Euroisation itself cannot planned assets for the reporting year. At the same time, this represents balance the budget, but an unbalanced budget is unsustainable. Thus an increase of 6.4% in comparison with the previous year. we can categorize the year-on-year downtrend in the budgetary deficit and its contribution to GDP as very promising. Montenegro fulfilledthe The inflow of funds to the Budget was lower in the first, and greater in criterion imposed by the EU for member countries of the EMU of having the second half of the year. The greatest inflow was in December (EUR a budgetary deficit below 3% of GDP. Table 1.8 shows the budgetary 58.8 million), which was provided by borrowings and loans, revenues deficit in Montenegro. from loan repayments, and donations. A great inflow recorded in July (EUR 43.9 million) was expected due to the tourist season. Budgetary expenditure in 2004 was in line with the aims of economic policy, and represents the continuation of the policy followed in 2003, The total budgetary expenditure (interim data) amounted to EUR 438.7 with the stress laid on financingthebudgetarydeficitfromrealsources. million (0.4% higher than budgetary revenues), which is 97.7% of The planned budget for this year was EUR 449.2 million, that is, the planned, and 3.3% higher than the year before. same as the revised budget in 2003, EUR 451 million, which represents a fall of 0.5%.

Table 1.5. Budgetary deficit movements

Description/Period 2002 2003 2004 2005 plan Budgetary deficit (EUR million) 25.16 45.29 32.21 34.32 % contribution in GDP 2.01 3.29 2.18 2.17

Graph 1.10. Structure of budgetary revenues in 2004

29 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

Graph 1.11. Structure of budgetary expenditure in 2004

As with the inflowoffundstothebudget,theoutflowoffundsdiffered for granted loans and borrowings and principal repayment, the budget from month to month. The highest amount spent was in December, of the Republic recorded a surplus of EUR 6.3 million. This surplus was EUR 64.1 million, due to debt repayments of EUR 8 million, and accrued actually the result of recorded budgetary expenditure for payments and interest of EUR 5.2 million, and in July when budgetary revenues reach not for assumed liabilities which are very high, and the recording of which the highest amounts. would require the allocation of substantial funds, with a budgetary deficit being the finalresult.Pursuanttothemethodologyforthesurplus/deficit Observing a surplus/deficit as the difference between total revenues calculation11, deficits existed only in two months of the year. reduced for taken loans and borrowings and total expenditure reduced

Box 1.5. Budgetary Deficit

The following Table shows the budgetary deficitsofsomeeconomiesintransitionwhichbecamethemembersoftheEU,andin some transitional economies in the region.

Table 1. Budgetary deficits

Bosnia and Czech FYR Zemlja Montenegro Croatia Hungary Slovenija Albania Herzegovina Republic Macedonia Budgetary deficit in % GDP -2.2 -0.4 -4.5 -5.7 -1.5 -5.0 -1.9 -6.5

Source: Transition Report, 2004.

It is obvious that Montenegro belongs to the group of countries with a low budgetary deficit, but there is an opportunity for its further decrease.

11 Official Gazette of RM, no. RCG 40/01

30 MACROECONOMIC ENVIRONMENT IN MONTENEGRO IN 2004

1.5.2. Review of Budgetary Funds

Despite the officiallystatedsurplus,theMontenegrinbudgetrana deficit The Health Care Fund received revenues of EUR 95 million (preliminary since outstanding liabilities were not included. Unfortunately, the exact data), of which EUR 39.8 million or 41.9% were contributions by the amount of these liabilities has not been revealed. corporate sector, and EUR 33.7 million or 35.4% were non-corporate contributions. The Pension Fund assets amounted to EUR 17 million With a view to creating a stimulating business environment in the long or 17.8% of the total revenues. Expenditure by this fund amounted to term, taxes must be reduced, especially those which are higher than EUR 94.7 million, of which expenses for regular activities and medicines that in the region (taxes and contributions on salaries, profittax,andso made up 91.7%. The fund ran a surplus in the reporting year of EUR on). Progressive tax rates are very discouraging and should be replaced 0.3 million. by proportional tax rates. Also, tax relief for large investors should be introduced since it is common in all the neighbouring countries, as well The Employment Bureau received revenues to the amount of EUR as tax relief on reinvested profit. 11.9 million, while expenditure by this fund were EUR 11.5 million, so the recorded surplus was EUR 0.4 million. At the same time, outstanding In order to diminish the tax burden and total expenditure it is crucial to liabilities were EUR 5.5 million. Of this amount, EUR 1.4 million were the follow a restrictive policy because any reduction in the tax burden which Bureau’s accounts payable, and EUR 4.1 million were the funds which is not followed by the rationalisation of expenditure can have adverse the Bureau received from the Budget for financingunemployedpeople, effects on the budget, leading to an increase in the budgetary deficit. and for financing trainees in accordance with the Government of the Also, it should be taken into account that the higher public expenditure, Republic of Montenegro program. the greater the part of GDP that is reallocated. This lowers the efficiency of the judicial system and diminishes the effectsofthemarket.Theright The Development Fund received revenues of EUR 419 thousand, track to follow would be overall rationalisation and a decrease in the and expenditure by this fund was EUR 335 thousand, so the recorded labour force financedfromthebudget.Sinceasubstantialincomefrom surplus was EUR 84 thousand. privatisation is expected in 2005, it would be very useful to use some these funds for a social program (solving the problem of the excess The Pension Fund received revenues to the amount of EUR 171.5 labour force), as it can bring long term budget savings. million. Of this amount, 50.2% or EUR 86.1 million were revenues from superannuation, EUR 67.5 million or 39.2% from budget transfers, EUR An additional source of increasing fiscalrevenuesshouldbesoughtinthe 4.9 million or 2.9% revenues from commission fees of the CBM-Payment legalisation of the grey economy. Also, in accordance with the practise of Operations, and EUR 0.6% were other revenues. The fund’s revenues from developed countries, consider the possibilities of entrusting the private share capital amounted to EUR 3.4 million, which represents 2% of the sector with part of the public functions if that would lead to a decrease total. In the reporting year, the fund withdrew funds from its deposits in public expenditure. Furthermore, the deadlines for VAT refund should with commercial banks to the amount of EUR 8.1 million. be shortened because these funds increase the liquidity of the corporate sector. Finally, with a view to stimulating employment it is important to Expenditure by this fund amounted to EUR 168.2 million, whereas continue granting tax relief for newly employed people. the main contribution was of expenditure for pensions of EUR 136.4 million or 81.1%.

By comparing only its revenues and expenditure, we come to a surplus of EUR 3.3 million. However, if outstanding liabilities of EUR 44.9 million were to be included in this analysis, then the fund would run a deficit of EUR 41.6 million. These outstanding liabilities include the amount of EUR 23.2 million which refers to unpaid pensions (one and a half pension per pensioner).

31 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

1.6. Public Debt

1.6.1. Foreign Public Debt

The total foreign debt of the Republic of Montenegro as at 31/12/04 The debt with the Paris Club amounted to EUR 145.6 million and amounted to EUR 502.4 million, thus representing some 34.1% of the the current debt is shown in the reduced amount of 51% which is the total GDP in 2004. The total foreign debt in 2003 amounted to EUR 438.8 first-stage write-off. Another 15% will be written-off after a three- million or 32% of the total GDP in that year. year arrangement with the IMF in May 2005 (from the agreed write-off of 66%), if the IMF gives a positive evaluation of the macroeconomic In the structure of public debt, the largest is with the World Bank to development of Montenegro. Montenegro redeemed the debt with the amount of EUR 293.3 million. This debt comprises of the debt with the London club in the early 1990’s. the International Bank for Reconstruction and Development (IBRD) and with the International Development Association (IDA). The main share Liabilities arising from new credits refer to the credits granted arose from accrued liabilities at original and default interest12. That is why by the European Investment Bank, the KFW, the Council of Europe interests payable exceed the liabilities arising from the principal. Development Bank (CEB), the European Union, the EBRD, the Anglo Yugoslav Bank, and the Bank Handlow from Poland to the total amount of EUR 52.5 million.

Table 1.6. Montenegro’s foreign debt as at 31.12.2004, EUR million

Foreign debt/ % of Foreign Creditor Debt GDP % debt International Bank for Reconstruction and Development (IBRD) 270.0 18.3 53.7 International Finance Corporation (IFC) 11.0 0.7 2.2 Member countries of the Paris Club of Creditors* 145.6 9.9 29.0 International Development Agency (IDA)** 23.3 1.6 4.6 European Investment Bank (EIB)*** 33.7 2.3 6.7 European Bank for Reconstruction and Development (EBRD) 3.0 0.2 0.6 Council of Europe Development Bank (CEB) 4.4 0.3 0.9 Bank Handlowy – Poland 1.1 0.1 0.2 European Community 4.0 0.3 0.8 Kreditanstait fűr Wiederaufbau (KFW) 4.9 0.3 1.0 Anglo Yugoslav bank 1.4 0.1 0.3 TOTAL 502.4 34.1 100.0%

Source: The Ministry of Finance of Montenegro *75% is original debt in EUR, and the remaining 25% in other currencies – mainly in USD; ** The amount is given in SDR (Special Drawing Rights); *** Old debt of EUR 1.2 million Note: The currencies were converted to the EUR at the exchange rate on 31 December 2004.

12 A debt rescheduling with the World Bank was made in 2001 (there is no debt write-off category in the World Bank’s policy), so the debt was transformed into a new credit with an agreed maturity of 22 years, with a grace period of three years and favourable interest rate – LIBOR and fixed spread. The opportunity to fix interests at the very low level was used when LIBOR was at this level due to the unfortunate events on 11 September 2001.

32 MACROECONOMIC ENVIRONMENT IN MONTENEGRO IN 2004

On the basis of data on the existing foreign debt the Ministry of Finance Since GDP projections were made only for the years 2005 and 2006 prepared the repayment projection as follows: (EUR 1.598 million and EUR 1.718 million, respectively), the estimate is that the foreign debt repayments plan in the respective years could be 1.3% of GDP and 1.5% of GDP.

Table 1.7. Foreign debt servicing until 2010

Year Principal Interest Total 2005 2,648,210.00 18,520,577.25 21,168,787.25 2006 6,978,083.13 19,112,384.35 26,090,467.48 2007 9,352,429.09 19,475,676.68 28,828,105.77 2008 11,703,163.25 19,318,481.35 31,021,644.60 2009. 14,169,850.47 18,970,235.50 33,140,085.97 2010 14,323,672.37 18,186,045.88 32,509,718.25

Source: The Ministry of Finance of Montenegro

Box 1.6. Indicators of foreign indebtedness

The contribution of foreign debt to gross domestic product shows the level of a country’s indebtedness. Countries whose contribution of foreign debt in gross domestic products exceeds 50% belong to the category of highly indebted countries, and those with the foreign debt contribution from 30% to 50% belong to the moderately indebted countries, and the ones with GDP contribution of below 30% belong to the low-indebted countries. According to this, Montenegro is on the boundary between the moderately- and low-indebted a country (32% of GDP in 2003; in 2004, GDP increased by EUR 100 million, and foreign debt by EUR 65 million). A further reduction in debt with the Paris Club, and more careful borrowing and stable GDP growth are the prerequisites that could lead to the decrease of the contribution of foreign debt to GDP in the future.

Table 1. Contribution of foreign debt in GDP of transitional economies in the period 1998 – 2004, in %

Country 1998 1999 2000 2001 2002 2003 2004* Bulgaria 80.6 78.7 88.9 78.3 72.3 65.6 57.6 Czech Republic 40.0 38.7 38.8 36.8 35.6 33.4 37.4 Croatia 44.8 50.1 60.0 57.0 67.7 81.8 79.9 Lithuania 34.2 41.9 43.0 43.6 44.1 40.6 43.2 Hungary 58.0 61.1 64.9 65.5 56.6 62.3 59.0 Romania 23.6 25.9 27.7 31.0 33.3 34.6 39.8 Slovenia 34.7 40.0 45.7 47.5 48.9 53.0 50.1

Source: Transition Report 2004 * Projections of the Deutsche Bank Research

33 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

Another indicator is the contribution of foreign debt in visible exports. Countries with foreign debt contribution in visible export exceeding 275% belong to the highly indebted countries. In moderately indebted countries this indicator is in the range of 165% to 275%, and with low-indebted countries it is below 165%. According to this indicator, Montenegro belongs to the category of low-indebted countries (with a 80.7% contribution).

The third indebtedness indicator is the level of a country’s indebtedness. It is obtained by putting in the ratio foreign debt repaid in the current year and visible exports. In highly indebted countries the value of this indicator is higher than 30%, in moderately indebted countries from 10% to 20%, and in low-indebted countries this indicator is below 10%. In 2004, this indicator for Montenegro was 3.7%, so that we can say that Montenegro is a low-indebted country.

Graph 1. Annual foreign debt repayment contribution in GDP for 2004

Source: The Deutsche Bank Research

1.6.2. Domestic Public Debt

The total amount of domestic public debt is not known. The main This debt also contains the state’s liabilities towards the corporate contributor to domestic public debt was frozen foreign currency deposits sector, and towards the Pension Fund as well. The total amount of these (FFCD), EUR 123 million The debt arising from FFCD fell by EUR 4.2 million liabilities is not known. in comparison with the previous year. With a view to determining the exact method of the repayment of foreign Beside FFCD, a substantial share of the domestic debt represent the debt and the so-called frozen foreign currency deposits (savings), in Government’s liabilities arising from the issued Treasury bills, EUR 37.4 2003, the Government of the Republic of Montenegro enacted, and at million or 21.8% and 5.6% of total domestic debt and the total public the beginning of 2004 amended, the Law on the Settlement of Liabilities debt, respectively. Arising from Frozen Foreign Currency Savings13. Pursuant to this Law the Republic of Montenegro assumed the responsibilities of the banks

13 “Official Gazette of RM”, no. 55/03 and 11/04

34 MACROECONOMIC ENVIRONMENT IN MONTENEGRO IN 2004

Table 1.8. Domestic public debt as at 31/12/2004

Creditor Debt in EUR % of GDP FFCD 123,000,000.00 8.3% Liabilities arising from bank loans 11,415,000.00 0.8% Liabilities arising from T-bills 37,380,000.00 2.5% TOTAL 171,795,000.00 11.6%

Source: Ministry of Finance of Montenegro 1.6.3. Public Debt Repayment in Montenegro related to FFCD, with the balance on 30 June 2003, with Liabilities arising from both domestic and foreign debt were paid to accrued annual interest of 2% as of 1 January 2003. The Law stipulates the amount of EUR 54,044,742.58. The contribution of public debt that all FFCD liabilities shall be paid by the year 2017, and enables the repayment to GDP was 3.66%. conversion of FFCD into bonds14. The value of bonds issued per one savings deposit book for 2004 is EUR 380, EUR 530 for 2005, and the The projected repayments of foreign debt and FFCD (without the planned amounts in the following years shall grow at the rate of 10% multiplying repayment of domestic taken loans and T-bills) served as the basis for the remaining amount by the quotients specified by the Law. the planned repayment of all liabilities arising from public debt in the forthcoming period. In accordance with GDP growth projection for The enabling regulation passed in accordance with the aforementioned the next two years, 2005 and 2006, it is estimated that the annual Law allows FFCD secondary trading in Montenegrin stock exchanges. Thus repayments’ contribution to GDPs would be 1.75% and 2.01%, the owners can make their FFCD liquid before the maturity specifiedby respectively. The inclusion of liabilities arising from domestic loans and the Law. The FFCD bond price is quoted in a stock exchange depending treasury bills will probably increase the foregoing by 1 percentage. on the supply/demand ratio. A number of these bonds were sold at EUR 0.11 for EUR 1, and the maximum selling price was some EUR 0.94 (the We can consider these to be acceptable, but we have to emphasize the average being EUR 0.6833). The lowest price, that is, the lowest discount, necessity in taking great caution with future borrowing, which, on the was of bonds with the longest maturity. To wit, the importance of bonds other hand, should be under more favourable conditions bearing in mind bought below their face value is that the Law and the corresponding the credit rating assigned to Montenegro. However, great care should enabling regulations allow the use of these bonds for: 1) the purchase of also be taken in reducing tax rates as much as possible and expanding shares of state owned enterprises, and that owned by the Development the tax base in Montenegro since these have predominantly effected Fund, the Pension Fund, and the Employment Bureau; 2) for purchasing the generation of income for public debt repayment. In addition, the apartments and other residential premises, business premises, land and ongoing privatisation process of profitablestateownedenterprisesleaves other state owned property the Government designates as available the state without an important source of income. Of course, reserves for purchase with FFCD bonds which are yet to mature, and 3) for tax for debt repayments can also be found by the reduction of budgetary payments. The greatest convenience of bonds bought at discount is expenditure. Thus, it is planned for the number of employees paid from that when used for the aforementioned purposes their value remains the Budget to be decreased. Also, one of the ways to diminish budgetary 1 EUR. This Law is also aimed at determining the plan for the fulfilment expenditure is the creation of the prerequisites for reducing interest of the Government’s liabilities with a view to a better Budget planning rates on T-bills, i.e. expenses arising from the payment of interest on in the future. these securities.

14 This is regulated by the Decree on the Conversion of Frozen Foreign Currency Deposits into Bonds, and the Decision on the Issue of Treasury Bills of the Republic of Montenegro for Frozen Foreign Currency Deposits by Private Citizens specifies the day of the issue, i.e. conversion shall be performed (»Official Gazette of RM«, no. 42/04)

35 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

Table 1.9. Structure of public debt repayment as at 31/12/2004, in EUR

Foreign debt Interest 20,287,364.34 Principal 1,761,289.27 Other costs 165,305.32 TOTAL: 22,213,958.93 Domestic debt Loan principal 24,115,212.13 Loan interest 1,143,397.28 T-bills principal 5,340,754.87 T-bills interest 1,231,419.37 TOTAL: 31,830,783.65 FOREIGN+DOMESTIC DEBT TOTAL: 54,044,742.58

Source: Ministry of Finance of Montenegro

Table 1.10. Public debt repayment plan for the period 2005 – 2010, in EUR

Basis* 2005 2006 2007 2008 2009 2010 Foreign debt repayment (principal + interest) 21,168,787 26,090,467 28,828,106 31,021,645 33,140,086 32,509,718 FFCD payments 6,785,605 8,487,072 8,218,942 8,195,342 8,362,347 8,700,677 TOTAL: 27,954,392 34,577,539 37,047,048 39,216,987 41,502,433 41,210,395

Source: Ministry of Finance of Montenegro * Without the planned repayment of liabilities related to domestic loans and T-bills

1.7. External Developments

The dilemma regarding the balance of payments current account deficit, but were registered in Montenegro due to the more favourable customs which was higher in 2004 than in the previous year, is whether this regime. Also, the effect of the increased prices of oil and oil derivatives represents an actual deterioration or is just a consequence of poor in the world market should not be disregarded. statistical record keeping in 2003. There is a reasonable doubt that a part of the transactions performed in December 2003 were registered in Foreign trade recorded a dynamic growth, contributing 81% to GDP, i.e. January 2004. Also, VAT was introduced in April 2003, and the Customs 104% if the service sector were added. However, the main problems are records were transferred from the Federal Customs OfficetotheRepublic still focused in the foreign trade element of the balance of payments. of Montenegro Customs Office.However,inthesefirstmonthsof trying (Annex 1, Table 12) to pick up pace with the records, a falsely low level of imports was registered. In addition, there is a doubt that within the category that The export/import ratio, although much improved, is still low, 47%, showed the highest increase, “Machines and transport equipment”, a which is by four index points more than in 2003. certain number of cars were actually imported by the citizens of Serbia,

36 MACROECONOMIC ENVIRONMENT IN MONTENEGRO IN 2004

Preliminary data on Montenegro’s international trade shows the encouraging is the unceasing growth in foreign direct investments, continuous dependence of the corporate sector on imports, that is, mostly in the service sector. a trade deficit, and an increase in the surplus in the sub-balance of services, and a moderate fall in surpluses achieved in the sub-balances Foreign direct investments (FDI) and the effortsmadeintourismresulted of factor income and transfers. The capital-financial element shows a in an increased number of overnight stays and, consequently, increased further growth in foreign borrowing and deposits by foreign banks revenues achieved in this field.However,therewerenotasmanyFDIsin with domestic banks as a supplement for insufficientdomesticsavings, this year as expected. The main culprit is the relatively high country risk that is, production, and as the source for financing the deficit. What is which makes Montenegro not too attractive for foreign investors.

Box 1.7. Recommendations for the Improvement of Domestic Products Competitiveness

The main problems are concentrated in the foreign trade part of the balance of payments, which calls for a number of measures to be undertaken with a view to increasing the competitiveness of domestic products. The following were singled out as being the most important:

Freeing up of foreign trade procedures – Shorten time limits for performing certain foreign trade procedures, reduce their costs, and so on.

International standards – There is no access to the world market without prior fulfilment of international standards. An active role by the state is necessary in this field.Thiscouldbebypublishingandtranslatinginternationalstandards(firstofall,theISO Standards and EU Directives), organising seminars on the introduction of the aforementioned standards, and “on-site” assistance to certain enterprises – producers (construction, food products, equipment, and so on).

Subsidies – What needs to be considered, is the option of offeringsubsidieswhicharegivenbyotherdevelopedmarketeconomies, and which are in accordance with the WTO rules. These would be indirect measures, like: assistance in covering ecological costs, subsidies to export oriented enterprises in underdeveloped parts of the country, joint appearance in fairs, financial assistance to scientific-researchwork,andsoon.

The protection of the domestic market – in order to protect the domestic market and producers, it is necessary to take all the measures which have already been taken in developed market ecnomies, such as: antidumping procedures, precluding import of non-attested products, and so on.

Increased competitiveness of domestic products– Enterprises have to make a great effort to increase the quality of their products and reduce costs in order to be more competitive in the world market.

Admission to the World Trade Organisation - In order not to be discriminated against in the world market, admission to the WTO is necessary. The WTO rules give numerous rights, but also impose a number of obligations on its members. It is important to insist on the admittance of the State Union as a developing country because it will enable longer transitional deadlines for the preparation of certain agreements, technical assistance and other benefits. The possibility of dual track admission to the WTO entails rapid procedures of less then three years.

37 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

Admission to the EU and other international economic integrations – One of the most important objectives of the economic policy in the long run is acquiring full membership of the EU. One should not expect the admission process to the EU to be rapid, but we should work on the fulfilment of the conditions of admission. Primarily, this refers to the completion of the obligations stated in international agreements15, cooperation with countries in the region, harmonization of legal regulations, acceptance of the acquis commonautaire, and meeting the Copenhagen criteria.

1.7.1. Balance of Payments Current Account

If we observe the currency structure of transactions with abroad, it Preliminary data shows that the current account deficitamountedtoEUR can be seen that 80.6% of the entire inflows were in EUR, while 18.4% 143 million17, which represents an increase of 40% in comparison with was charged in USD. As for the outflow of money, 85.4% was in EUR, 2003. If foreign assistance were excluded, then the current account deficit and 14% in USD.16 would be 24% higher. This deficitwasmostlyinfluencedbytheincrease

Table 1.11. Balance of payments current account of Montenegro, EUR thousand

I-XII 2003 I-XII 2004 Index % GDP* A. CURRENT ACCOUNT (1+2+3+4) -101,986 -142,968 140.18 -9.7% 1. GOODS -359,330 -430,900 119.92 -29.2% 1.1. Exports 270,574 381,607 141.04 25.9% 1.2. Imports 629,904 812,507 128.99 55.1% 2. SERVICES 111,733 139,879 125.19 9.5% 2.1. Revenues 191,395 241,123 125.98 16.3% 2.2. Expenditures 79,662 101,244 127.09 6.9% 3. FACTOR INCOME 99,510 103,834 104.35 7.0% 3.1. Revenues 125,337 152,722 121.85 10.4% 3.2. Expenditures 25,827 48,888 189.29 3.3% 4. CURRENT TRANSFERS 46,101 44,219 95.92 3.0% 4.1. Transfers to Montenegro 55,225 54,946 99.49 3.7% 4.2. Transfers from Montenegro 9,124 10,727 117.57 0.7%

Source: Central Bank of Montenegro, preliminary data *Planned GDP for 2004

15 The fulfillment of the majority of international agreements depends on Serbia. First of all, this refers to honouring the Daton Agreement and the EU Security Council Resolution no. 1244, cooperation with the Hague Tribunal, and so on. 16 The source of data is the statistics of international payment operations, and the revenues do not include the estimated revenues from tourism (which are mainly in EUR). 17 With a view to the implementation of the IMF recommendation, and due to the fact that over 80% of all payments for international transactions are performed in the EUR, we started using this currency for the reporting about the balance of payments developments.

38 MACROECONOMIC ENVIRONMENT IN MONTENEGRO IN 2004

in the trade deficit of 20% which was mainly covered by balances in amounted to 9.7% of GDP (-7.4% of GDP in 2003), and represents 7.9% the sub-balances of services, factor income and current transfers, 67%. of total transactions with abroad (7.3% in 2003). This coverage was 72% in the previous year. The current account deficit

Box 1.8. The Balance of Payments Current Account Deficit in Transitional Economies

The balance of payments current account deficitisacommoncharacteristicofmosttransitionaleconomies.Thefollowinggraph shows the balances of current accounts as a percentage of gross domestic products of transitional economies.

Graph 1. Current account in 2004, in % of GDP

Source: Transition Report, 2004

The balance of payments current account deficitundoubtedlyaccompaniestransitionalprocesses,anditoccursasaconsequence of inherited structural discrepancies, bankruptcy and liquidation proceedings of industrial giants, and incomplete privatisation processes.

1.7.1.1. Visible Trade

The foreign trade turnover of Montenegro amounted to EUR 1.19 billion mainly to developed countries, whereas most of the imports were from in 2004, which is 32% more than the year before. Of this amount, EUR countries in transition. 382 million was visible exports, and EUR 812 million visible imports. The visible trade deficit was EUR 431 million or 20% more than in Preliminary data on visible exports shows an annual increase of 41%. 2003, which makes up 36% of total visible trade in the reporting year, The average monthly was EUR 32 million or EUR 10 million more than the or some 4% less than in the previous year. The encouraging fact is average in the previous year. The main characteristics of Montenegro’s that the annual increase in visible exports is 12% higher than imports. exports are the low level of diversity and the large export of raw materials Mainly imported goods were those for consumer spending, and the and semi-finishedproducts,ascounterpartstolowimportsoffinished highest increase in imports was of intermediate goods. Exports were products. Of the total value of exports, 41% or EUR 158 million were

39 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

of aluminium, and 27% other (cleared) products. In the reporting year, The main contributors to visible exports were manufactured products if observed in EUR, the export of aluminium grew by 44%, and 68% classified chiefly by materials, EUR 185 million or 71.3%, to which if observed in USD – the selling currency of aluminium. Such a high aluminium contributed a total of EUR 158 million or 85.4%. There was a growth in exports is the result of increased production, movements in noticeable fall in the export of alcoholic beverages and tobacco products the price of aluminium in the world stock exchanges, and of the statistical of 15%. The contribution of the aforementioned items to total exports recording itself. The average price of aluminium in 2004 amounted to in 2003 was 6.13% or EUR 11 million, whereas in 2004 it was 3.76% USD 1,698 or 20% more than in the previous year when it was USD 1,422. or EUR 9.7 million. This data is based on customs entries, excluding Income from exports to Serbia and Kosovo was EUR 122 million, which transactions with Serbia and Kosovo. is 31% greater. The source of data on trade with Serbia and Kosovo is international payment operations. Visible imports of EUR 813 million increased by 29%, with an average of EUR 68 million per month (EUR 52 million in 2003). In the structure Observed by regions, the biggest export partners of Montenegro were of total imports, 69% were consumer goods, 25% intermediate goods, developed countries, followed by countries in transition and developing and 5.4% was imported equipment. The highest increase recorded was countries. in intermediate goods, 52%.

According to the Unique Customs Declarations (JCD), the greatest Using the SITC nomenclature, imported products were mostly machines export product of Montenegro, aluminium, was the reason for the and transport equipment, EUR 161 million or 29.7%, of which motor increased exports to Italy, Greece, and Spain, and for the fall in exports vehicles (transportation vehicles and lorries) made up EUR 56 million to Switzerland as well. The contribution of aluminium to total export to or 35%. Italy was 78%, whereas this contribution in total exports to Switzerland fell from 38% to 6.6%.

Table 1.12. Visible exports and imports by SITC* in 2004, in EUR

ITEM Exports Imports 0 Food and live animals 4,116,809 87,990,083 1 Beverages and tobacco 9,763,717 11,055,274 2 Crude materials, except fuels 13,199,838 3,946,430 3 Mineral fuels, lubricants and related materials 632,160 87,180,543 4 Animal and vegetable oils, fats and waxes 56,605 665,829 5 Chemicals and related products 5,912,806 51,128,981 6 Manufactured goods clasified chiefly by materials 185,141,386 82,948,718 7 Machinery and transport equipment 37,293,314 161,237,685 8 Miscellaneous manufactured articles 3,388,682 57,196,958 9 Other products not mentioned 47,605 1,900 TOTAL 259,552,923 543,352,401

Source: Customs entries; *SITC – Standard International Trade Classification Data does not include transactions with Serbia and Kosovo

40 MACROECONOMIC ENVIRONMENT IN MONTENEGRO IN 2004

Box 1.9. Trade Relations

Bearing in mind the lack of data on the movement of average import and export prices, we can take the most important export product, aluminium, and the most important import product, oil, as their approximations (prices chain indices). The conclusion is that trade relations in 2003 were mainly stable, while in 2004 they generally deteriorated, although they improved in the last two months of the year.

Source: Prices in stock exchanges

However, there is one big limitation related to this analysis which should be taken into account, and that is the fact that the movement of oil prices was very dynamic during the year, unlike other import products.

The amount charged for visible imports from Serbia and Kosovo in Among the goods imported from Serbia and Kosovo the main contributors this year was EUR 246 million, which represents an increase of EUR 29 were consumer goods (EUR 182 million or 74%), intermediate goods million or 13% in comparison with the previous year. Greater discipline (EUR 54 million or 22%), and equipment (4%). in the financialandcommoditymarkets,aswellasthemorequalitative records of the visible flowsinfluencedtheincreasedimportsfromSerbia, in addition to the real increase of visible imports due to the increased tariff rates for other countries.

Table 1.13 Visible imports from Serbia and Kosovo, EUR thousand

Goods I-XII 2003 I-XII 2004 Contribution Index Intermediate goods 48,573 53,823 21.9% 110.8 Consumer goods 159,559 181,778 74.0% 113.9 Equipment 8,677 10,163 4.1% 117.1 Other 3 28 0.0% 933.3 Total 216,812 245,792 100,00 113.4

Source: Central Bank of Montenegro statistics of international payment operations

41 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

Box 1.10. Trade Statistics

The importance of accurate statistics on foreign trade is significant because of the importance of this activity to Montenegro’s economy. Statistics are of paramount importance for numerous institutions involved in the creation of economic policy. The data obtained is used as the basis for analysis and research, multilateral and bilateral negotiation, the credit rating of a country, and monitoring of the growth and/or fall in the country’s material resources. It is also the source for calculating gross domestic product, the compiling of the balance of payments, and for making various projections. In countries of the EU, statistical records of the aforementioned flowsaregivengreatattention.ForMontenegro,acountrywithoutitsowncurrencyandthereforehaving limited monetary instruments, high quality monitoring of these flows is very important, even more important than for other countries with local currencies.

The main sources of data on trade statistics are customs entries on exports and imports whose collection and accuracy checks are the responsibilities of the Customs Office. If the customs entries have not been completed correctly, the quality of data will be poor, as will the statistics prepared on the basis of such data.

Until 1 April 2003, there was a common customs office in Serbia and Montenegro which collected data on trade flows for the whole country (Union) and forwarded it to the Federal Statistics Bureau for further processing. The processed data was then sent to other users; in Montenegro that was the Central Bank of Montenegro where this data was checked on the basis of registration forms for export/import transactions. A new Law on Customs was enacted in April 2003 with a view to complying with European standards, leading to the setting up of two separate customs offices.Dataontradeflowsof Montenegrois collectedby theCustoms OfficeofMontenegroandthendistributedtootherusers.TherawdataisnolongersentforprocessingintheFederalStatistics Bureau, and the registration forms on foreign trade transactions have been abolished. The Central Bank of Montenegro is forced to take data directly from the Customs Office in order to monitor the developments in the balance of payments until another compatible institution becomes is able to properly handle the processing of this data. The processing of foreign trade data is one of the most complex methodological tasks carried out in statistics due to the fact that Unique Customs Declarations (UCD) are complex documents with 500 possible entries for all UCDs, of which some are important for statistics, and others for the customs procedure itself. The Central Bank of Montenegro has pointed out the gravity of this problem on numerous occasions, and has set up a number of meetings with the institutions directly involved in the preparation and the utilization of this data.

The quality of the current data, both entries (the instructions for the correct completion of UCDs, the Manual on the Form, Content, and Method of Submitting and Filling in Customs Declarations and Joint Registration Forms, which was enacted on 21 March, has already been corrected twice) and processed data, is unsatisfactory, which gives the wrong impression of developments in this field,makingtheanalysisofeconomicdevelopmentsamuchmoredifficulttask.

1.7.1.2. Services

The balance of services was positive and it totalled EUR 140 The balance of other services was negative, EUR 30 million, and EUR million, being EUR 28 million or 25% higher than the surplus achieved 11 million or 56% higher than the year before. in 2003. The balance of goods and services was negative and it amounted An increase in surplus was registered in transportation services and to EUR 291 million, which represents an increase of 17.5% in comparison tourism. with 2003.

42 MACROECONOMIC ENVIRONMENT IN MONTENEGRO IN 2004

1.7.1.3. Income 1.7.2. Capital and Financial Account

The third item in the balance of payments current account represents The capital-financial balance recorded increases in other investments, revenues and expenditure based on the ownership of production factors. and foreign and portfolio investments. Income earned from abroad in the reporting period amounted to EUR 152 million, which is an increase of EUR 27 million or 22%. Income The value of net direct investments was EUR 50 million, being 29% larger expenditure totalled EUR 49 million, showing an increase of EUR 23 than in the previous year. Most of the investments were in services and million or 89%. The balance of income was positive, EUR 104 million, the sale of property of 73% and 21%, respectively. The latter increased by which is 4% more than the surplus achieved in the previous year. 9% in comparison with 2003. The inflowofFDIwaslowerthanexpected, which shows that Montenegro is not yet a sufficiently attractive place for foreign investors. (Annex 1, Table 13) 1.7.1.4. Current Transfers As for other investments, loans grew by EUR 61 million, reaching the Current transfers are the fourth item in the current account and their amount of EUR 176 million. Repaid loans were at the level of EUR 78 main items are grants and gifts. Therefore, the recorded foreign grants million or EUR 10 million more than in 2003. in 2004 amounted to EUR 55 million, the same as the year before. The balance of current transfers was positive and amounted to EUR 44 The net foreign assets of banks at end-December 2004 were negative, million, which is EUR 1.9 million less than in 2003. amounting to EUR 19 million, which represents a fall of EUR 32 million

Table 1.14. Foreign direct investments in Montenegro, EUR thousand

Investment 2004 2003 Sale of property 10,626 5,306 Investments in production 2,274 2,157 Investments in services 37,671 24,235 Investments in financial organisations 1,239 12,091 TOTAL 51,810 43,789

Source: The Central Bank of Montenegro statistics on foreign payment operations

Table 1.15. Balance of payments, EUR thousand

Index I-XII 2003 I-XII 2004 Difference I-XII 2004/I-XII 2003 Current account -101,986 -142,968 140.2 -40,982 Capital and financial account 133,030 170,905 128.5 37,875 Net errors and omissions 31,044 27,937

Source: Central Bank of Montenegro

43 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

compared to the same month in 2003, while the Central Bank of Net errors and omissions amounted to EUR 28 million, which speaks Montenegro reserves in foreign exchange accounts grew by EUR 15 in favour of the improved balance of payments statistical recording in million. the reporting year.

Box 1.11. Methodological Explanations of the Balance of Payments

The balance of payments is prepared pursuant to the methodology prescribed by the International Monetary Fund (Balance of Payments Manual, 1993). The sources of data are: Republic of Montenegro Customs Office, MONSTAT, Electric Power Industry of Montenegro, the Ministry of Finance, commercial banks, and the Central Bank of Montenegro. The balance of payments is given in USD and EUR. Identical sources of data are used for both currencies, and thus the transactions included are the same. Recalculation of the transaction values from the original currency to the reporting currency is performed by: using the mean rate of exchange of the Central Bank of Montenegro on a transaction day, using monthly and annual mean rate of exchange of the Central Bank of Montenegro, and using a daily mean rate of exchange at the end of the period with evaluation of transactions whose change is monitored.

What influencestheaccuracyofdatausedforthecompilationofthebalanceofpaymentsisthestillsignificantshareofthegrey economy in all categories which are registered in the balance of payments, i.e. a great number of transactions are made in cash and they are not possible to record in the existing environment. It is expected that the enactment of the new Law on Current and Capital Transactions with Foreign Countries, i.e. the adoption of the enabling regulations, which should more qualitatively comprise cash flowrecords,bothinaccountsandincash,shallincreasethequalityandincorporationofthenecessarydata,thus reducing the net errors and omissions item.

Visible imports and exports are tracked on the basis of data from the Republic of Montenegro Customs Office, except for the trade with Serbia and Kosovo which is tracked on the basis of commercial banks’ reports. Until 1 April 2003, the source of data on Montenegro trade with foreign countries (except for Serbia and Kosovo) was the Federal Customs Office (through Federal Statistics Bureau and the National Bank of Yugoslavia) which was then processed in the Central Bank of Montenegro. From April 2003 data from the Montenegro Customs Office are directly used. Banks’ data on foreign payment operations are used for the recording of transportation services.

Data on revenues from tourism is obtained on the basis of the number of tourist nights (data from Monstat) and estimated average daily spending. We believe that the current method of data collection is not yet adequate and as such influences the accuracy of the balance of payments data.

Financial services (insurance and reinsurance, representative and mediation commission fees, and commission fees and expenses for banking operations) are tracked on the basis of the foreign payment operations statistics. Other services include investment work in foreign countries, PTT and communication services, forwarding services, expenses for the maintenance of representative offices, computer and information technology services, author’s fee, and fees for licence issuance, as well as other business services. The data is obtained from foreign payment operations statistics and banks’ reports.

Income statement comprises data from foreign payment operations statistics on compensations to employees, payments, and charged dividends. The source of data is banks’ reports. This statement also includes pensions, which are from the methodological point of view seen as transfers, but due to the inability of banks to record this item separately, we record them together with other income. The annual correction of both revenues and expenditure is consequently performed. To wit, it was noticed that pursuant to the Instructions for the method of performing foreign payment operations item 897 - withdrawn assets and issued

44 MACROECONOMIC ENVIRONMENT IN MONTENEGRO IN 2004

nostro cheques from foreign exchange accounts of resident private citizens was recorded as an outflowofforeigncurrenciesfrom the country, which was the case before the introduction of the EURO as the legal tender because all foreign payments could be made only in foreign currencies. However, with the introduction of the euro it was concluded that almost all the money is spent in the country. Furthermore, item 797 - deposited cash and cheques in foreign currency accounts by resident private citizens now represents depositing of assets by residents to their foreign currency accounts who manage them freely, which is not a part of the balance of payments statistics.

Current transfers include data from foreign payment operations statistics, the Ministry of Finance, and the estimate of the unregistered transfers.

Direct and portfolio investments are tracked on the basis of data from foreign payment operations statistics and conducted polls. Other investments include inflowsandoutflowsarisingfromcredits,andthebasicoftheirrecordingisthepaymentoperations statistics and the Central Bank of Montenegro statistics on credit relations with foreign countries.

The source of data for Other investments is the Central Bank of Montenegro foreign payment operations statistics. Both loans and deposits are included as parts of loans and loan repayments, but this will be the practise until the adoption of new Instructions for Monitoring Foreign Payment Operations when the aforementioned items will be recorded separately.

45

2. THE BANKING SYSTEM

THE BANKING SYSTEM

2.1. Structure of the Banking System in Montenegro

2.1.1. Banks’ Ownership Structure

Total capital of banks in Montenegro amounts to EUR 90.8 million as at State ownership in the capital of banks at 2004 year-end totalled 31/12/04. This increased by EUR 1.6 million or 1.76% in the one-year 25.76%, private capital amounted to 36.35% and foreign capital to period. The events influencing the increase in total capital were the 37.89%. In relation to year-end 2003, the ownership structure did not following: a new share issue by fivebanks(HipotekarnaBank,Pljevaljska significantlychange.Thestatehasmajorityownershipofthetotalcapital Bank, Niksicka Bank, Opportunity Bank and Komercijalna Bank Budva), in Podgoricka Bank and Niksicka Bank. and the achieved income at the end of 2004 by nine banks. If the negative impact of the capital decline of Hipotekarna Bank on the total capital in The ownership structure of total capital did not change significantly in the banking system were to be excluded, total capital of banks at the comparison with end-2003, as shown in Table 2.2. annual level would increase by EUR 8.8 million or 16.63%.

Table 2.1. Ownership structure of capital

Contribution of Contribution of State Contribution in Share Capital Private Parties in Foreign Parties in Share Total No. Bank Share Capital Share Capital Capital Capital Direct Indirect* Amount % Amount % Amount % 1 Hipotekarna Bank 3.88 22.25 3,514 26.13 9,577 71.21 358 2.66 13,449 7,869 2 Podgoricka Bank 55.32 20.31 5,880 75.63 1,895 24.37 - - 7,775 16,150 3 Montenegrobank - 3.42 139 3.42 205 5.06 3,713 91.52 4,057 12,556 Crnogorska 4 - 11.80 1,319 11.80 4,917 44.00 4,940 44.20 11,176 13,581 Komercijalna Bank 5 Euromarket Bank ------7,133 100.00 7,133 8,599 6 Pljevaljska Bank - 32.00 1,669 32.00 3,548 68.00 - - 5,217 5,922 7 Niksicka Bank 26.70 37.20 3,135 63.90 1,771 36.10 - - 4,906 5,379 8 Atlasmont Bank 19.18 6.22 1,304 25.40 3,831 74.60 - - 5,135 6,856 9 Opportunity Bank ------7,000 100.00 7,000 8,094 10 Komercijalna Bank - - - - 5,530 100.00 - - 5,530 5,760 TOTAL: 16,961 23.76 31,274 43.81 23,144 32.42 71,378 90,766

* Share through companies in which the state still has significant ownership.

49 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

Graph 2.1. Ownership structure of total capital

Graph 2.2. Ownership structure of share capital by banks

Table 2.2 Changes in banks’ ownership structure

State Contribution in Total Contribution of Private Contribution of Foreign Year Capital Parties in Share Capital Parties in Share Capital TOTAL Amount % Amount % Amount % 2001 19,838 43 18,620 41 7,411 16 45,869 2002 17,582 31 24,600 44 14,301 25 56,483 2003 14,869 23 29,143 44 21,771 33 65,783 2004 23,376 26 32,994 36 34,396 38 90,766 Index 2001/2004 118 60 177 88 464 238 198

Note: Information on state contribution in total capital for 2001 does not include Montenegrobank, which was, at that time, dominantly state owned bank.

50 THE BANKING SYSTEM

2.1.2. Market Share

The growth of concentration in the system is evident in 2004 in relation Information for 2001 on concentration is given at the year-end, and the to 2003. The three largest banks in the system make up 60% of total picture of concentration within the banking sector by each indicator was financialpotential.Thesebanksgranted58%oftotalgrantedloansand largely unfavourable prior to the introduction of interim administration accepted 64% of total deposits. The capital with these banks makes up in Montenegrobank during 2001. 45% of total capital of all banks. Merging in the banking sector is expected in the future, which may additionally intensify competition.

Table 2.3. Market share of banks

Market Share Assets Loans Deposits Capital in % 2001 2002 2003 2004 2001 2002 2003 2004 2001 2002 2003 2004 2001 2002 2003 2004 1 Bank 33 23 27 31 40 34 26 27 44 30 33 38 28 19 17 17 3 Banks 72 62 59 60 79 69 61 58 87 72 67 64 66 47 48 46 5 Banks 86 80 78 77 91 76 77 76 94 86 85 82 86 69 71 69 7 Banks 92 91 90 91 96 87 89 90 98 95 94 94 97 82 85 83

2.2. Banks’ Performance in 2004

2.2.1. Banks’ total assets 2.2.2. Assets of the Aggregated Balance Sheet of Banks in Montenegro The total assets of Montenegrin banks amounted to EUR 444,4 million as at 31/12/04 (Table 2.4). Crnogorska Komercijalna Bank has the largest In the structure of the aggregated balance sheet of the banking sector, total assets, which represents 30% of the total assets of all banks. The loans represent 63.24% of total assets and increased by EUR 80.86 market share of Montenegrobank, which is the second largest bank, million or at a rate of 40.30% in relation to the prior year-end, and in amounted to 16%. Four banks lost their market share in the year. relation to 2001 year-end they increased by 127.08%. If the banks that are under bankruptcy and liquidation proceedings, or that are liquidated All banks, except Hipotekarna Bank, increased total assets in the one- but were operating in 2001 are excluded, actual growth in the loan year period. The highest nominal growth was achieved by Crnogorska portfolio is 334%. Komercijalna Bank, by EUR 43 million or by 46%, then Montenegrobank by EUR 33 million or by 91%. Komercijalna Bank Budva, Opportunity Bank Cash is the most significantassetitemoftheaggregatedbalancesheet and Euromarket Bank also achieved significant growth in total assets. after loan and lease operations. Its contribution to total assets amounts to 24.21%. The level of cash funds in relation to 2003 year-end declined Total assets of the banking sector increased in 2004 by 27.05% in relation by 12.04%, which is substantially below the decrease of cash during to 2003 (Table 2.5). 2003 when it amounted to 31.49%. The decline of cash in the balance sheet of banks is due to the increased balance sheet and intensified lending activity.

51 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

Table 2.4. Banks` total assets

Total Assets % of Market Share No. Bank change 31/12/02 31/12/03 31/12/04 2003-2004 31/12/02 31/12/03 31/12/04 1 Hipotekarna Bank 79,007 60,232 31,827 -47.16 23.21 17.22 7.16 2 Podgoricka Bank 70,247 53,263 59,015 10.80 20.63 15.23 13.28 3 Montenegrobank 24,212 36,045 68,889 91.12 7.11 10.31 15.50 4 Crnogorska Komercijalna Bank 62,286 93,432 136,863 46.48 18.29 26.71 30.80 5 Euromarket Bank 21,795 29,015 43,158 48.74 6.40 8.30 9.71 6 Pljevaljska Bank 16,390 9,242 11,555 25.03 4.82 2.64 2.60 7 Niksicka Bank 10,915 13,681 13,753 0.53 3.21 3.91 3.09 8 Komercijalna Bank 0 11,363 17,985 58.28 0 3.25 4.05 9 Atlasmont Bank 35,816 26,410 35,531 34.54 10.52 7.55 8.00 10 Opportunity Bank 11,354 17,078 25,797 51.05 3.33 4.88 5.81 11 Ekos Bank 8,452 0 0 0 2.48 0 0 12 Beranska Bank 0 0 0 0 0 0 0 13 Jugobank 0 0 0 0 0 0 0 14 Bank for Development 0 0 0 0 0 0 0 TOTAL 340,474 349,761 444,373 27.05 100.00 100.00 100.00

Table 2.5. Aggregated balance sheet

Nominal Growth Structure No. Description 2001 2002 2003 2004 in % (2003/2004) in % 1 Cash Funds & Deposit Accounts with Depository Institutions 116,752 140,163 96,030 107,596 12.04 24.21 2 Trading Assets 2,098 138 23 0 -100.00 0.00 3 Placements with Other Banks 1,261 396 0 0 0.00 0.00 4 Loan and Lease Operations 123,957 124,845 200,626 281,482 40.30 63.34 5 Securities Held to Maturity 903 5,047 16,010 18,768 17.23 4.22 6 Business Premise and Other Fixed Assets 8,009 21,982 24,178 22,503 -6.93 5.06 7 Acquired Assets 1,934 14,268 6,447 5,071 -21.34 1.14 8 Equity Investments 4,311 5,852 5,685 5,441 -4.29 1.22 9 Other Assets 116,345 41,855 10,431 17,424 67.04 3.92 10 Less: Reserves for Losses 8,435 14,072 9,669 13,912 43.88 -3.13 11 TOTAL ASSETS 367,135 340,474 349,761 444,373 27.05 100.00 12 Deposits 148,185 205,536 211,004 273,195 29.47 61.48 13 Borrowings Taken From Other Banks 1,488 4,913 19,248 0 -100.00 0.00 14 Obligations on Taken Loans and Borrowings 54,192 9,274 17,390 54,213 211.75 12.20 15 Obligations to Government 1,342 2,768 5,170 5,328 3.06 1.20 16 Other Borrowings – Matured Obligations 99 0 0 0 0.00 0.00 17 Reserves 0 0 0 3,116 - 0.70 18 Other Obligations 107,408 40,035 7,751 17,755 129.07 4.00 19 Subordinated Debt 0 0 0 0 0.00 0.00 20 TOTAL LIABILITIES 312,714 262,526 260,563 353,607 35.71 79.57 21 Preferred Shares 0 3,195 3,000 3,000 0.00 0.68 22 Managing Shares 45,870 53,291 62,783 68,378 8.91 15.39 23 Issued Premiums 0 0 42 42 0.00 0.01 24 Retained Earnings/Loss and Capital Reserves 10,905 9,344 18,076 8,610 -52.37 1.94 25 Other Capital -2,354 12,118 5,297 10,736 102.68 2.42 26 TOTAL CAPITAL minus 23 and 24 if it is loss 54,421 77,948 89,198 90,766 1.76 20.43 27 TOTAL LIABILITIES AND CAPITAL (19+25) 367,135 340,474 349,761 444,373 27.05 100.00

52 THE BANKING SYSTEM

Graph 2.3. Asset structure of aggregated balance sheet

Of other asset items, securities held to maturity show constant growth 2.2.3. Loan Structure of 17.23% in relation to 2003 year-end. The same applies to the increase of reserves for losses on asset items. In comparison with 2003 year-end, Loans by the banks make up the most significant asset item. In 2004, these reserves increased by almost 44% in 2004, which is due to greater the total loans of the banks increased by EUR 81 million. The increase qualitative risk measurement regarding assets positions. of loans in the last quarter makes up more than half of the total loan growth in this period.

Graph 2.4. Total loans movements

53 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

Table 2.6 Loans, lease receivables and matured receivables

Matured Receivables and Short Term < 1 year Long Term > 1 year TOTAL No. Description Paid – Called OBL 2001 2002 2003 2004 2001 2002 2003 2004 2001 2002 2003 2004 2001 2002 2003 2004 Loans and Receivables 1 9,791 16,302 16,257 7,458 3,741 181 239 1,705 517 0 0 - 14,049 16,483 16,496 9,163 from Government of RoM 2 Government Agencies 1,691 2,008 3,042 7,594 0 0 1,597 9 0 0 0 0 1,691 2,008 4,639 7,603 3 Municipalities 0 2,595 2,451 4,720 0 174 144 4,715 0 130 0 0 0 2,899 2,595 9,435 4 State Owned Companies 2,156 9,234 9,596 7,975 7,088 1,952 2,465 2,571 0 77 253 0 9,244 11,263 12,314 10,546 5 Private Companies 37,373 51,768 75,855 100,868 11,528 12,741 26,040 59,416 15 1,328 2,715 0 48,916 65,837 104,610 160,284 6 Entrepreneurs 0 937 6,228 2,188 0 890 1,745 3,580 0 44 125 0 0 1,871 8,098 5,768 7 Banks 0 688 1,570 1,000 0 0 0 - 0 0 0 - 0 688 1,570 1,000 8 Financial Institutions 57 570 130 2,854 0 0 0 - 0 0 0 - 57 570 130 2,854 9 Non Profit Organizations 0 37 70 180 0 0 5 - 0 0 0 - 0 37 75 180 10 Natural Persons 4,793 12,725 32,292 34,347 1,500 9,303 16,939 39,150 24 166 637 0 6,317 22,194 49,868 73,497 11 Credit Cards 0 0 0 894 0 0 0 - 0 0 0 - 0 0 0 894 12 Other 2,225 204 78 182 1,725 791 153 76 0 27 0 0 3,950 1,022 231 258 TOTAL 58,086 97,068 147,569 170,260 25,582 26,032 49,327 111,222 556 1,772 3,730 0 84,224 124,872 200,626 281,482

Note: Due to the amendments to the Decision on Reports that the Banks Submit to CBM, this table does not show matured receivables for 2004.

Maturity Structure

Short-term loans represent 60.49% of total granted loans. A decline year. At 2003 year-end, short-term loans represented 73.55% of the in short-term and a growth in long-term loans is evident during the loan portfolio.

Table 2.7. Maturity structure of loans

Short Term Long Term No Description Total % < 1 year > 1 year 1 2 3 4 6 7 1 Loans to Government 7,458 1,705 9,163 3.26 2 Government Agencies 146 0 146 0.05 3 Funds 7,448 9 7,457 2.65 4 Municipalities (public organizations) 4,720 4,715 9,435 3.35 5 State Owned Companies 7,975 2,571 10,546 3.75 6 Private Companies 100,868 59,416 160,284 56.94 7 Entrepreneurs 2,188 3,580 5,768 2.05 8 Banks 1,000 - 1,000 0.36 9 Financial Institutions 2,854 - 2,854 1.01 10 Non Profit Organizations 180 - 180 0.06 11 Natural Persons 34,347 39,150 73,497 26.11 12 Credit Cards 894 - 894 0.32 13 Other 182 76 258 0.09 14 TOTAL: 170,260 111,222 281,482 100

54 THE BANKING SYSTEM

Graph 2.5. Maturity structure of loans

Graph 2.6. Short term and long term loans growth by industries

55 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

The graphs of the dynamics of lending by sectors clearly show that the banking sector does not have a sufficiently diversified portfolio.

Structure by Sectors

Privately owned companies and individuals were the most important total loans. The share of loans to state owned companies and to the borrowers in 2004 as in 2003. These two categories used 83% of total government in total loans decreased over the year. granted loans. As at 31/12/03, these two categories made up 77% of

Box 2.1. Dynamics of granted loans by sectors

In the period from 31/12/03 to 31/12/04, loans by borrowers showed oscillating dynamics. The largest nominal growth of EUR 55,674 thousand were loans to privately owned companies and their share of total granted loans increased by 4.8%. Loans to individuals increased by EUR 23,629 thousand or 47% in this period. Their share of total loans increased from 24.86% to 26.11%. Lending and collateral practices related to consumer lending in banks, considering their share of total loans, are satisfactory. As at 31/12/04, loans to state owned companies amount to EUR 10,546 thousand. They decreased over the one-year period by EUR 1,768 thousand or 14%. Their share of total loans also declined from 6.14% to 3.75%.

56 THE BANKING SYSTEM

Graph 1. Loan structure by sectors

Structure by Industries

Lending activity in 2004 was mainly directed to trade, administration, sector in relation to loans increased by EUR 5,467 thousand at 2004 year- services, and civil engineering. end) in the aggregated balance of banking sector, the trade sector is a net borrower of funds (loans to this sector in relation to deposits increased The most dynamic growth in the four-year period were loans to trade on average by EUR 37,021 thousand during 2004). and citizens. While citizens area is a net lender of funds (deposits of this

Table 2.8. Loan concentration by activities/industries

No. Activity/Industry 2001 % 2002 % 2003 % 2004 % Index 1. Agriculture, fishing, hunting, etc. 2,002 2.38 2,742 2.20 5,525 2.75 4,758 1.69 86.12 2. Mining 6,900 8.19 3,303 2.65 3,923 1.96 1,299 0.46 33.11 3. Energy 1,758 2.09 3,383 2.71 7,586 3.78 4,984 1.77 65.70 4. Civil engineering 5,005 5.94 7,532 6.03 10,471 5.22 14,240 5.06 135.99 5. Trade 26,672 31.67 31,966 25.60 73,025 36.40 116,861 41.52 160.03 6. Services, tourism, etc 4,317 5.13 7,619 6.10 12,304 6.13 16,933 6.02 137.62 7. Transport, storage, communication 1,860 2.21 3,389 2.71 7,972 3.97 5,982 2.13 75.06 8. Finance 7,968 9.46 8,369 6.70 15,825 7.89 9,520 3.38 60.16 9. Real estate trading 0 0.00 10 0.01 216 0.11 995 0.35 460.65 10. Administration, other public services 9,813 11.65 15,462 12.38 5,910 2.95 12,935 4.60 218.87 11. Citizens 6,317 7.50 22,194 17.77 49,868 24.86 73,815 26.22 148.02 12. Other 11,612 13.79 18,903 15.14 8,001 3.99 19,160 6.81 239.47 TOTAL 84,224 100% 124,872 100% 200,626 100% 281,482 100% 140.30

57 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

Graph 2.7. Loan structure by activities/industries

2.2.4. Liabilities of the Aggregated Balance sheet of Banks

The structure of sources of funds at the aggregated balance of banking Deposits are the most important contributor, which increased their sector consistently changed towards more permanent sources of contribution in sources of funds since 2001 by 52.32% (from 40.36% funds. to 61.48%). Deposits increased by 29.47% in relation to 2003 year- end, which represents a more impressive growth in relation to that achieved during 2003. Graph 2.8. Structure of sources of the aggregated balance

58 THE BANKING SYSTEM

The most significant decline in the four-year period in the structure of the books within this item. The capital of the banking sector increased by sources of the banking sector refers to the item “Other Liabilities” that EUR 36,345 thousand or at a rate 66.78% in the four-year period. Its share fell by 86.34%. Liabilities to “frozen foreign exchange deposits” were in the structure of the sources of funds increased by 37.8% if 2004 year- included in this item up to 2003 year-end, and then were assumed by end is compared to 2001 year-end. The increase of capital is even higher, the state and they were removed from the balances of five banks. from the standpoint of its size and its share in the sources’ structure, bearing in mind that capital was not adequately shown in 2001 in banks During 2004, liabilities on taken loans and borrowings significantly that were later under bankruptcy and liquidation proceedings. increased by 211.75% in the structure of sources of banks. The contribution of these sources to the aggregated balance sheet of banks amounted to 14.76% and 12.20% in 2001 and in 2004, respectively. However, in 2.2.5. Banks’ Deposit Structure 2001, the balance sheet of Montenegrobank, which was under interim administration at the time, recorded liabilities under various loans Total deposits of banks as at 31/12/04 amounted to EUR 273 million. In that were not clear from the legal point of view, which were removed comparison with 31/12/03, they increased by EUR 62,191 thousand or from the bank books during 2002 after the completion of the interim at a growth rate of 29.47%. Interest bearing deposits made up 77.29% administration and in the process of its privatisation. of total deposits. The share of interest bearing deposits to total deposits increased by 19.64% in relation to year-end 2003. The increase is due Total capital within the banking sector increased by 1.76% in relation to to intensified competition in the banking market. Almost all deposits 2003. The most significant increase was evident with the item “Other at year-end 2001were non-interest bearing. Capital”, which increased by 102.68%. Capital reserves were recorded in

Table 2.9. Deposits and their growth

Deposits % of Change Market Share No. Bank 31/12/02 31/12/03 31/12/04 2003-2004 31/12/02 31/12/03 31/12/04 1 Hipotekarna Bank 61,342 39,411 20,203 -48.74 29.07 18.68 7.40 2 Podgoricka Bank 40,974 31,134 37,426 20.21 19.42 14.76 13.70 3 Montenegrobank 6,996 10,725 27,796 159.17 3.32 5.08 10.17 4 Crnogorska Komercijalna Bank 44,770 70,086 101,976 45.50 21.22 33.22 37.33 5 Euromarket Bank 14,696 18,744 29,583 57.83 6.96 8.88 10.83 6 Pljevaljska Bank 4,150 3,000 4,195 39.83 1.97 1.42 1.54 7 Niksicka Bank 3,953 8,425 7,037 -16.47 1.87 3.99 2.58 8 Komercijalna Bank 0 5,954 10,751 80.57 0 3 3.94 9 Atlasmont Bank 23,297 19,808 28,003 41.37 11.04 9.39 10.25 10 Opportunity Bank 2,038 3,717 6,225 67.47 0.97 1.76 2.28 11 Ekos Bank 3,320 0 0 1.57 0.00 0.00 12 Beranska Bank 0 0 0 0 0 0 13 Jugobank 0 0 0 0 0 0 14 Development Bank 0 0 0 0 0 0 TOTAL 205,536 211,004 273,195 29.47 100.00 100.00 100.00

59 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

Maturity Structure Structure by Sectors

Observed by maturity, demand deposits made up 55%, deposits up to 3 In the deposits structure by bearers, the most significantpart(57.46%) months 11%, time deposits up to 1 year 29%, deposits up to 3 years 3%, refers to deposits of private companies and deposits by individuals. and time deposit over 3 years 1% of total deposits. In comparison with Deposits by private companies made up 28.44% of all deposits, and 31/12/03, the share of time deposits up to 3 months to total deposits deposits by individuals 29.02% of the total. These two categories of fell by 4%, while the share of time deposits up to 1 year grew by 3% deposits showed different trends over the one-year period. To wit, over the same period. All other deposit categories remained at almost deposits by private companies nominally decreased by EUR 7,206 the same level from the structure standpoint. thousand and their share to total deposits decreased by 11.79%. Deposits of individuals have nominally increased by EUR 34,729 thousand or 78% over the same period, while their share in total increased by 7.90%.

Table 2.10. Aggregated structure of deposits by maturity

No. Deposits 2001 % 2002 % 2003 % 2004 % 1. Demand 104,103 70% 137,318 67% 117,630 56% 151,503 55% 2. Up to 3 months 26,878 18% 7,085 3% 34,408 16% 31,154 11% 3. Up to 1 year 12,415 8% 39,654 19% 54,590 26% 79,748 29% 4. Up to 3 years 4,731 3% 18,731 9% 4,376 2% 8,058 3% 5. Over 3 years 58 0% 2,748 1% 0 0% 2,732 1% TOTAL 148,185 100% 205,536 100% 211,004 100% 273,195 100%

Graph 2.9. Deposit structure by maturity

60 THE BANKING SYSTEM

All deposit categories increased over the one-year comparative period, net position of the state sector as a lender of funds is evident. The net except deposits by the Government of RM, and deposits by private difference of the state as a lender (deposits and other obligations) and companies and entrepreneurs. The largest percentage share over the state as a borrower (loan and other receivables), in these three banks same period was achieved by banks’ deposits (437%) and financial is positive and amounts to EUR 18,980 thousand. The group of seven institutions (362%), but share of these deposits to total deposits was other banks is a net lender of funds to the state sector to the amount only 6.70%, or 4.50%. The largest percentage decline was by deposits of EUR 10,271 thousand. These banks granted placements to the state by the Government of RM by 53%, which was due to the transfer of sector of EUR 22,175 thousand, while liabilities of these seven banks these deposits to the account in the Central Bank of Montenegro. to the state sector amounted to 11, 904 thousand. Observed at the system level, the state sector was a net lender of funds to the amount Deposits from state sources (Government of RM, Government Agencies, of EUR 8,709 thousand. Funds, Municipalities (Public Organizations) and State Owned Companies) totalled EUR 58,896 thousand. The state sector was at the same time a Observed by activities/industries, a deposit concentration is evident net user of loans from the banking sector to the amount of EUR 36,747 with trade and finances, except for citizens. The share of deposits of thousand and this sector was a net lender of funds to the amount these two categories in relation to total deposits declined over the of EUR 22,149 thousand. The most significant amount (83.30%) of one-year period. deposits by the state sector was concentrated in three banks where the

Table 2.11. Deposit structure by depositors

Depositors 2001 % 2002 % 2003 % 2004 % Government of RM 23,263 15.70% 50,442 24.54% 22,732 10.77% 10,691 3.91% Government Agencies 0 0.00% 18,161 8.84% 16,541 7.84% 532 0.19% Funds 0.00% 20,817 7.62% Municipalities (Local Government) 0 0.00% 6,546 3.18% 9,127 4.33% 13,142 4.81% State Owned Companies 12,186 8.22% 20,983 10.21% 6,374 3.02% 13,714 5.02% Private Companies 80,776 54.51% 63,536 30.91% 84,897 40.23% 77,691 28.44% Entrepreneurs 0 0.00% 380 0.18% 1,241 0.59% 1,066 0.39% Banks 9,633 6.50% 9,212 4.48% 3,408 1.62% 18,295 6.70% Financial Institutions 2,242 1.51% 1,907 0.93% 2,658 1.26% 12,283 4.50% Non Profit Organizations 2,111 1.42% 9,521 4.63% 4,794 2.27% 5,260 1.93% Individuals 8,022 5.41% 16,682 8.12% 44,554 21.12% 79,283 29.02% Other 9,952 6.72% 8,166 3.97% 14,678 6.96% 20,421 7.47% TOTAL 148,185 100.00% 205,536 100.00% 211,004 100.00% 273,195 100.00%

Note: Due to the amendments to the Decision on Reports that Banks Submit to CBM, Banks reported separately deposits of Funds in 2004. Prior to these amendments, these deposits were part of the item Government Institutions.

61 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

Table 2.12. Deposit concentration by activities/industries

No Depositors 2003 % 2004 % 1 Agriculture, Hunting, Fishing, etc. 454 0.2% 902 0.3% 2 Mining 1,242 0.6% 1,874 0.7% 3 Energy 9,626 4.6% 3,464 1.3% 4 Civil Engineering 5,160 2.4% 5,187 1.9% 5 Trade 58,716 27.8% 57,594 21.1% 6 Service, Tourism 12,999 6.2% 21,211 7.8% 7 Transport, Warehousing, Communications 4,269 2.0% 9,927 3.6% 8 Finance 31,453 14.9% 35,041 12.8% 9 Real Estate Trading 2 0.0% 864 0.3% 10 Administration 17,106 8.1% 23,241 8.5% 11 Citizens 44,554 21.1% 79,282 29.0% 12 Other 25,423 12.0% 34,608 12.7% TOTAL 211,004 100.0% 273,195 100.0%

Box 2.2. Deposits by citizens in the period 2000 – 2004

In the last four years, with the introduction of a convertible currency as the legal tender (firsttheDeutschMark,andthentheEuro), and the implementation of far-reaching reforms in the banking, and the overall financialsystemoftheRepublicofMontenegro, the confidencelostintheMontenegrinbankingsystemwasregained,whichcanbebestverifiedbytheincreaseindepositsby private citizens, that is, a growth in savings with domestic banks

The firstresultswereobviousin2001whenthesedepositsgrewby196%incomparisonwith2000,amountingtoEUR11.2million. The growth continued the next year, 98%, and the annual increase rate reached the level of 104% in 2003.

The outcome in 2004 was an increase of no less than 606% in comparison with 2001.

On the basis of the market contribution related to the total assets of banks, the concentration of these deposits in banks was as follows:

Number of 31.12.2004 banks 1 44% 3 63% 5 81% 7 88%

At end-2004, 32.4% of total deposits by private citizens was with banks with majority private shareholding, and 14.7% with majority state shareholding.

62 THE BANKING SYSTEM

2.2.6. Aggregated Income statement of Banking Sector

Financial outcome at the aggregated level, at 2004 year-end is negative Net core income (net interest and fee income without reduction by amounting to EUR -1,116 thousand. All banks reported some income at provision for loan losses) amounted to EUR 43,338 thousand. It increased the end of the observed period, except Hipotekarna Bank that reported a by EUR 8,585 thousand or 24.70% in relation to 2003 year-end. Net loss of EUR 7,280 thousand at the year-end, which resulted in a negative core income made up 11.26% of average assets at 2004 year-end, aggregated financialoutcome.Allbanksreportedincomeat2003year- which represents an increase in relation to 31/12/03, when this ratio end, which amounted to EUR 5,336 thousand at the aggregated level. If amounted to 10.40%. the negative financial result of Hipotekarna Bank were to be excluded, reported income at the aggregated level would amount to EUR 6,164 Net interest income at the aggregated level amounted to EUR 23,504 thousand or be at a growth rate of 15.52%. thousand. In comparison with 2003 year-end, it increased by EUR 4,009 thousand or 20.56%. Net interest income in relation to average Due to negative financial outcome at the system level, aggregated assets represents 6.11%, showing an increase of 0.28% in relation to ROA (return on assets) was also negative amounting to -0.29%. This 31/12/03. compares to 1.60% at 2003 year-end. However, if the Hipotekarna Bank share were to be excluded, ROA at the system level would amount to Interest income amounted to EUR 33,098 thousand and represents 1.87% at 2004 year-end. 8.60% of average assets, which is more favourable than at 2003 year- end when this ratio amounted to 7.67%. Interest expenses represent Total earning assets of the banks amounted to EUR 341,536 thousand. only 2.49% of average assets, which is an increase of 0.66% in relation These assets increased by EUR 100,839 thousand in comparison with to the previous year-end. 31/12/03, which represent 41.89%. Earning assets growth is due to loans growth and partially securities growth. Earnings assets represent The interest rate spread in the one-year period shows a falling trend. 76.86% of total assets at 2004 year-end. As at 31/12/03, this indicator amounted to 9.62%, while it was 7.61% at 2004 year-end.

Table 2.13. Aggregated income statement

No. DESCRIPTION 2001 2002 2003 2004 1. Interest Income 11,599 16,216 25,694 33,098 2. Interest Expense 4,341 3,893 6,199 9,594 3. Net Interest Income / Expense 7,258 12,323 19,495 23,504 4. Provision for losses 8,184 13,907 6,234 14,450 5. Net Income / Expenses -926 -1,584 13,261 9,054 6. Fee Income 7,826 12,551 18,413 27,886 7. Fee Expenses 1,804 2,750 3,155 8,052 8. Net Fee Income / Expenses 6,022 9,801 15,258 19,834 9. Net Interest and Fee Income / Expenses 5,096 8,217 28,519 28,888 10. Other Operating Income 3,247 2,324 2,413 3,818 11. Operating Expenses 11,823 17,141 25,492 32,730 12. Income / Expense Before Extraordinary Items -3,480 -6,600 5,440 -24 14. Extraordinary Income 3,385 36,023 1,396 9 15. Extraordinary Expenses 556 14,412 727 85 16. Income / Expenses After Extraordinary Items -651 15,011 6,109 -100 17. Taxes 560 2,893 773 1,016 18. Net Profit / Loss -1,211 12,118 5,336 -1,116

63 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

Non-interest income (net fee income, income from FX dealings and of average assets and show an increase in relation year-end 2003 when other operating income) amounted to EUR 23,652 thousand. This income this ratio amounted to 1.87%. grew by EUR 5,981 thousand or 33.85% in relation to 2003 year-end. Non-interest income in relation to average assets makes up 6.15%, Overhead expenses at the aggregated level are high and amounted to which represents and increase in relation to year-end 2003 when it EUR 32,730 thousand. As at 31/12/03, overhead expenses amounted amounted to 5.29%. to EUR 25,492 thousand, or they increased by 28.39%.

Provision expenses on asset and off balance sheet items amounted to Overhead expenses to core earnings ratio (net interest and fee income) EUR 14,450 thousand. They increased by EUR 8,216 thousand or 131.79% amounts to 75.52%. This compares to 73.35% at 2003 year-end. in comparison with the previous year. These expenses represent 3.75%

Graph 2.10 Income structure

Table 2.14. Banks’ profitability and efficiency ratios

No. Ratios 2001 2002 2003 2004 1 Return of Average Assets -0.68% 3.97% 1.60% -0.29% 2 Return on Average Capital -4.44% 15.69% 6.50% -1.24% 3 Net Interest Income / Average Assets 4.06% 4.04% 5.83% 6.11% 4 Net Operating Income / Average Assets 5.18% 3.97% 5.29% 6.15% 5 Provision for Loan Losses / Average Assets 4.66% 4.56% 1.87% -3.75% 6 Operating Expenses / Average Assets 6.62% 5.62% 7.63% -8.51%

64 THE BANKING SYSTEM

Graph 2.11. Review of banks’ performances through ratios

65

3. BANKING SECTOR SUPERVISION AND REGULATION

BANKING SECTOR SUPERVISION AND REGULATION

3.1. Regulatory and Supervisory Developments

In 2004, the activities of the bank supervision department were focused on New techniques for a more thorough risk assessment were introduced the additional adoption of regulations, analyses of changes of regulation in on-site examination. Market risk examination was comprehensively and bank supervision globally, preparation of the amendments to the performed in all banks. In addition, examination of internal controls system Law on Banks, expansion of risk supervision of banks and intensification and audit were performed. The examination of the implementation of of international cooperation. regulations in the area of the prevention of money laundering started as well. The proposed amendments intensify the institutional strength of the Central Bank during the licensing process of new banks and during Significant activities performed in the off-site examination system, assessments of non solid operations that may expose the bank to besides regular analysis of individual banks and banking system analysis, excessive risks in operations. In addition, new solutions will enable the were improvements in software for bank analyses and preparation of preparations for implementing particular principles from Basel II in the establishing a regulatory credit bureau. The regulatory credit bureau forthcoming period, bearing in mind its approach of higher sensitivity will start to function at the beginning of 2005 and it will significantly to risks in the operations of banks. improve the quality of monitoring of the credit and market risks in banks. Besides, it may be used in the future for easier adoption of advanced Five enabling decisions were enacted: Decision on Minimal Standards for approaches within Basel II bearing in mind the specific nature of the Market Risk Management, Decision on Minimal Standards for Operational Montenegrin economy. Risk Management, Decision on Minimal Standards for Country Risk Management, Decision on Reports that Banks Submit to CBM and Decision on Manner and Procedures of and Fees for Bank Supervision.

Box 3.1. Regulatory Credit Bureau

The project of the introduction of the regulatory credit bureau has been brought to its implementation phase, so it will start to operate in the first quarter 2005. The main objectives are:

- Comprehensive, precise and dynamic evaluation and monitoring of credit risk in banks, individually and aggregately at the system level; - Obtaining all necessary information on borrowers to prepare better for on site bank examination; - Monitoring of possible transfers of credit risk among banks; - Creation of a wide information basis for stress testing at the banking system level; - Calculation and monitoring of movements of average weighted interest rate at the system level by individual credit lines or other desirable structures;

69 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

- Decrease of lending interest rates and other loan expenses, since the placement risk with banks will be decreased through the utilization of the report on creditworthiness in the following phases of the project (banks grant loans to better clients under more favourable conditions); - Better monitoring of credit risk concentrations and operations with related parties; - Creation of time buckets that enable better transition towards Basel II and its second pillar; - Credit risk management in banking sector is improved and enables implementation of so called “dynamic establishment of provisioning” and central rating approach; - Creation of database for better quality control of market and operational risk in banks; - Statistical information and analysis that the bureau may provide are useful indicators of movements in the credit industry and indicators that may be used for monetary statistics, analysis and macro economic modelling purposes; - Contributes to the improvement of the overall investment climate and sends a positive message to potential investors. Information whether there is recording of obligations and claims in a country is one of the main signals showing the level of security and the establishment of good relations in a national economy.

With a view to improving the system of internal controls Manuals were similar efficiency, from a human resources and a time standpoint, was prepared giving detailed job descriptions for each department. Activities achieved in 2003 and that during 2004 the scope of examination was taken during last years included the active implementation of the reform higher, from the size of controlled portfolio standpoint as well as from of the banking system, high compliance with the Core Principles for the volume of controlled risks standpoint, it may be concluded that the EffectiveBankSupervisionandactivemonitoringofinternationaltrends Bank Supervision Department achieved substantially higher efficiency in bank supervision. This resulted in the Central Bank of Montenegro in 2004. This was followed up by high quality, which can be seen from joining the Association of Bank Supervisors of the Central and East the fact that the banks established a higher level of reserves for potential European Countries (BSCEE), at the 19th meeting of the Association losses in 2004 than in 2003. held in Dubrovnik in May 2004. The Central Bank is planning to intensify cross border cooperation in the area of regulatory and control function Bearing in mind the significantincreaseinbanks’activities,particularly with a view to signing bilateral agreements with almost all the central the increase in lending activity, great attention was paid during the banks from the neighbouring countries in the near future. examinations to an evaluation of asset quality, financial analysis of borrowers and evaluation of their ability to repay the loans, and an evaluation of financial strength in the future. 3.1.1. Banking Supervision The expansion of consumer loans resulted in additional attention being During 2004, 20 on site examinations were performed18 - 10 full scope paid to this part of banks’ portfolios with special stress on procedures examinations and 10 target examinations. As compared to 2003, when and conditions of approval of loans. 33 on site examinations were performed (11 full scope and 22 target), this represents a decrease primarily due to the fact that the condition The level of market risk, techniques of measurement and identification of the banking system as a whole was stable and there were no need of these risks were controlled in all banks. During these examinations, to perform such a high number of targeted examinations. The average banks were given recommendations to improve management and number of engaged people/days in one examination is 5 x 15. Since a control of market risk.

18 Pursuant to the Memorandum of Understanding signed with the Bank of Slovenia, the supervisors from the Bank of Slovenia were a part of the team that performed the full-scope on site examination of Montenegrobank AD podgorica in mid-2004.

70 BANKING SECTOR SUPERVISION AND REGULATION

The adoption of the Law on Prevention of Money Laundering and Current experience in implementation of bankruptcy and liquidation establishment of Administration for Prevention of Money Laundering proceedings in banks shows that the Law on Bank Bankruptcy and intensifiedtheactivitiesofsupervisionofpreventionofmoneylaundering Liquidation should be amended to increase the efficiency of these during full scope banks examinations. proceedings.

Regular, quarterly analyses of individual banks and the system as a whole were improved to give the evaluations of future movements of 3.1.3. Issuing Bank Licenses, Approvals and key parameters and trends that serve as assessment of banks. Permissions

There were no requests for licensing new banks in the last year. Banks 3.1.2. Measures Against Banks continued to expand their business networks. 18 approvals for opening new branches were issued. In relation to the prior year, the number The measures that were taken during 2004 were primarily focused on of newly opened branches was significantly lower, which was to be the correction of weaknesses and deficienciesinoperationsofindividual expected since 44 approvals for were issued then. banks related to asset quality, funds management and improvement of risks management process. In one case, the request for issuing approval for acquiring qualified share in bank’s capital was denied. Three approvals were issued for the Orders were issued to two banks and an agreement on removing appointment of a general director in three banks. deficiencies in operations was signed with one bank. To further follow up measures taken over in particular cases, the employees from the Therefore, work in this area of the international plan is completed and division for monitoring and imposing measures against banks were it opens the further possibility of research, education and advanced directly engaged on follow up of the measures in banks against which training of supervisory activities, exchange experiences in conducting the measures were imposed. supervisory functions and know-how, through close cooperation and day-to-day communication with supervisory units of the countries Complicated proceedings, the inefficiency of the court system and members of the Association. The Bank representatives participated in weaknesses in legislation were the key factors in non-finalizingbankruptcy the 13th International Conference of Bank Supervisors in September proceedings in Jugobanka AD Podgorica. The same had happened with 2004 in Madrid. the liquidation proceedings in Ekos Bank AD Podgorica.

3.2. Assessment of Compliance with Basel Core Principles

An update of the assessment of compliance with the Basel Core Principles largely compliant; materially non-compliant; non-compliant; and for Effective Bank Supervision was performed in February 2005. It not applicable. To achieve a “compliant” assessment with a Principle, represents an update of the initial assessment that was conducted in all essential criteria generally must be met without any significant July 2003 by an assessment team consisting of James J. Hightower and deficiencies.Theremaybeinstanceswhereacountrycandemonstrate David Hawkins who have a lot of experience in banking supervision that the Principle has been achieved through differentmeans.Conversely, and international consulting in the assessment of efficiency of bank due to the specificconditionsinindividualcountries,theessentialcriteria supervision. An update of the assessment from 2003 was conducted may not always be sufficient to achieve the objective of the Principle, by James J. Hightower. and therefore one or more additional criteria and/or other measures may also be deemed necessary by the assessor to judge that compliance The assessment of compliance with each Principle is made on a is achieved. A “largely compliant” assessment is given if only minor qualitative basis. A five-part assessment system is used: compliant; shortcomings are observed, and these are not seen as sufficienttoraise

71 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

serious doubts about the authority’s ability to achieve the objective of compliance with the Basel Core Principles. The CBM is now in full that Principle. A “materially non-compliant assessment” is given when compliance or largely compliant with all but one of the core principles. the shortcomings are sufficient to raise doubts about the authority’s There are only two instances where efforts to achieve full compliance ability to achieve compliance, but substantive progress had been made. are not already underway. Achieving full compliance will be greatly A “non-compliant” assessment is given when no substantive progress dependent upon the government’s ability to maintain macroeconomic towards compliance has been achieved. stability, continued implementation of institutional and structural reforms, continued development of the banking culture and corporate Based on preliminary results the assessment may be summarized through governance, and improvement in the legal and judicial systems”. the following sentence from the report: Considering Principles 1(1) through 1(6) to be separate principles, and “Since the initial assessment, the CBM has further strengthened the further delineating the levels of non-compliance to indicate where efforts supervisory process, resulting in improvement in its overall level of to achieve compliance underway, the report reflects that the CBM has made substantial improvement in its overall level of compliance:

Table 3.1. Level of compliance with Basel Core Principles

Level of Compliance July-03 Feb-05 Non-compliant, and efforts to achieve compliance not underway None None Non-compliant, and efforts to achieve compliance underway 1 None Materially non-compliant, and efforts to achieve compliance not underway 2 None Materially non-compliant, and efforts to achieve compliance underway 2 1 Largely compliant, and efforts to achieve full compliance not underway 10 1 Largely compliant, and efforts to achieve full compliance underway 4 14 Compliant 9 12 Non-applicable 2 2

Box. 3.2. Compliance level with Basel Core Principles

Non-compliant, and efforts to achieve compliance not underway None Non-compliant and efforts to achieve compliance underway None Materially non-compliant, and efforts to achieve compliance not underway None Materially non-compliant, and efforts to achieve compliance underway CP 11 Identifying and managing country and transfer risks by banks Largely compliant, and efforts to achieve full compliance not underway CP 10 Lending to connected or related parties by banks

72 BANKING SECTOR SUPERVISION AND REGULATION

Largely compliant, and efforts to achieve full compliance underway CP 1(5) Legal protection for supervisors CP 1(6) Information sharing CP 3 Licensing criteria and licensing process CP 5 Bank criteria for reviewing major acquisitions and investments CP 7 Granting and managing of loans and investments by banks CP 9 Bank lending limits, concentration limits CP 12 Bank measures to measure, monitor and control market risks CP 13 Bank measures to measure, monitor and control all other material risks CP 14 Bank internal control systems CP 15 Bank rules for prevention of fraud and money laundering CP 16 Overall framework for on-site and off-site supervision CP 17 Ongoing communication with bank management and staff to fully understand bank operations CP 22 Remedial measures which supervisor can take against banks CP 25 Standards for local operations of foreign banks and information sharing with home country supervisors

Compliant CP 1(1) Responsibilities and objectives for the supervisory agency CP 1(2) Skills, resources, and independence of the supervisory agency CP 1(3) Legal framework CP 1(4) Enforcement powers CP 2 Permissible activities of banks CP 4 Authority to review/reject all significant transfers of ownership in banks CP 6 Minimum capital adequacy requirements CP 8 Requirements for evaluating asset quality, adequacy of loan loss provisions and reserves CP 18 Off-site supervision CP 19 Validation of supervisory information through on-site exams/external audit CP 20 Conduct of consolidated supervision CP 21 Maintenance of adequate records and publication of audited financial statements by banks

Not Applicable CP 23 Global consolidated supervision over internationally active banks CP 24 Contact and information exchange with other supervisors involved in international operations, e.g., host country authorities

Comparing the results of the current assessment with the average and capital adequacy standards given in Basel II, which will become level of compliance in developing countries and developed countries, obligatory in European Directives in the future. The basic condition for Montenegro shows considerable progress bearing in mind the period the transition to Basel II is a satisfactory level of compliance with the of four years in which this result was reached. This result is even better Core Principles for Effective Bank Supervision. from the standpoint of the possibility of transition to risk management

73 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

Graph 3.1. Comparison of compliance19

3.3. Risk Exposure of Banking System

3.3.1. Credit risk

The banks evaluate credit risk arising from credit activities of banks as Increase of criticized assets (B, C, D and E) is mostly due to the increase well as from other balance and offbalancesheetactivitiesbyestablishing of assets classified as special mention (B) by 152% over one-year reserves for losses pursuant to the performed classification. period. Assets classified as C, D and E in relation to total assets at 2004 year-end amounted to 5.53% and they increased in relation to year- During 2004, total poor quality assets (C, D and E) in balance and off end 2003 when they amounted to 4.79% and at year-end 2001, when balance sheet exposure increased in relation to total capital and reserves they amounted to 4.37%. at the system level in a one-year period. The level of this ratio was satisfactory as at 31/12/04 amounting to 22.80%. However, this ratio Past due loans at the system level amounted to 5.17% in the reporting is not favourable in relation to 31/12/03 when it amounted to 16.95%. year. In the past due loans structure, 51% refers to loans that are past The contribution of poor quality assets in total assets increased from due 30-89 days, 31% refers to loans that are past due over 90 days and 4.79% to 5.53% over the one-year period. still accruing, while 18% refers to non accrual loans.

19 Source: Basel II and Developing Countries Sailing through the Sea of Standards World Bank Policy Research Working Paper 3387, September 2004.

74 BANKING SECTOR SUPERVISION AND REGULATION

Table 3.2. Reserves for losses per bank, EUR thousand

2001 2002 2003 2004 No. Bank Minimal Minimal Minimal Minimal Established Established Established Established Required Required Required Required 1 Hipotekarna Bank 436 483 1,028 1,028 1,267 1,267 6,408 4,640 2 Podgoricka Bank 2,266 2,273 542 489 2,187 2,187 2,010 1,161 3 Montenegrobank 0 0 9,686 7,092 1,377 1,377 2,267 1,033 Crnogorska 4 409 186 724 400 1,377 882 2,473 1,216 Komercijalna Bank 5 Euromarket Bank 70 73 223 114 564 288 658 320 6 Pljevaljska Bank 422 349 535 535 665 665 483 304 7 Niksicka Bank 143 143 389 389 390 384 445 407 8 Komercijalna Bank 0 0 0 0 333 76 502 398 9 Atlasmont Bank 0 0 662 441 1,039 779 936 728 10 Opportunity Bank 0 0 200 74 470 180 844 365 11 Ekos Bank 153 89 82 79 0 0 0 0 12 Beranska Bank 81 75 0 0 0 0 0 0 13 Jugobank 4,273 4,273 0 0 0 0 0 0 14 Development Bank 187 4,840 0 0 0 0 0 0 TOTAL 8,440 12,784 14,071 10,641 9,669 8,085 17,026 10,572

Table 3.3. Percentage contribution of individual categories of classification in total classified assets

Classification 2001 2002 2003 2004 Pass (A) 74.40 81.71 78.02 64.93 Special Mention (B) 10.76 6.37 14.56 27.04 Substandard (C) 4.87 3.64 4.64 4.24 Doubtful (D) 0.15 7.82 2.72 2.79 Loss (E) 9.82 0.46 0.06 1.00

Established reserves for losses on assets and off balance sheet items at the banking system level. Reserves for loan losses to total loans amount amount to EUR 17,028 thousand and in relation to 31/12/03 they increased to 3.99% at 2004 year-end and this ratio is higher in relation to the by 78%. Reserves for loan losses make 82% of total established reserves comparable one-year period when it amounted to 3.27%.

75 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

Table 3.4. Banks’ assets classification as at 31/12/04

C L A S S I F I C A T I O N No. Assets and Off Balance Sheet Items Collateral Total A B C D E 1 Loans 30,812 161,937 71,158 7,649 2,106 1,066 273,662 2 Matured Claims 40 1,258 2,001 3,245 1,277 638 7,821 3 Interest 6 1,148 514 234 64 26 1,966 4 Other Claims 0 8,599 368 1,250 3,785 9 14,002 5 Total (1+2+3+4) 30,858 172,942 74,041 12,378 7,232 1,739 297,451 6 Assets Not Requiring Reserves For Loan Losses 86,248 74,586 0 0 0 0 160,834 7 Total Assets Items (5+6) 117,106 247,528 74,041 12,378 7,232 1,739 458,285 8 Guarantees 732 24,026 8,622 518 1,277 117 35,175 9 Letters of Credit 0 1,422 96 55 45 0 1,618 10 Other Off Balance Sheet Commitments 0 355 0 0 0 1,219 355 11 Total Off Balance Items (8+9+10) 732 25,803 8,718 573 1,322 1,336 37,148 12 Off Balance Sheet Not Requiring Reserves 36,596 13,354 0 0 0 0 49,950 13 TOTAL OFF BALANCE SHEET ITEMS (11+12) 37,328 39,157 8,718 573 1,322 1,336 87,098 14 Total Balance and Off Balance Sheet Items (7+13) 154,434 286,685 82,759 12,951 8,554 3,075 545,383 Total Balance and Off Balance Sheet (5+11) 15 198,745 82,759 12,951 8,554 3,075 303,009 Requiring Reserves for Losses 16 Established Reserves 4,156 3,623 2,812 5,100 1,157 15,691 17 Coverage (16/15)% 2.09 4.38 21.71 59.62 37.63 5.18

3.3.2. Solvency Risk

All banks meet the prescribed legal requirement of solvency ratio of 8%. lending activity. The largest decline of solvency ratio in one-year period The solvency ratio decreased in 7 banks during this period. It is due to was evident in Montenegrobank, while the largest increase was achieved the increase in risk-weighted assets, which resulted from intensified by Pljevaljska Bank.

Table 3.5. Solvency ratio per bank

No. Bank 2001 2002 2003 2004 1. Hipotekarna Bank 34 30 26 17 2. Podgoricka Bank 43 56 47 36 3. Montenegrobank 0 46 55 29 4. Crnogorska Komercijalna Bank 30 24 25 16 5. Euromarket Bank 99 74 49 46 6. Pljevaljska Bank 73 27 59 90 7. Niksicka Bank 41 52 52 56 8. Komercijalna Bank 0 0 96 76 9. Atlasmont Bank 0 59 37 41 10. Opportunity Bank 0 76 45 37

76 BANKING SECTOR SUPERVISION AND REGULATION

Solvency ratio at the aggregated level amounted to 31% at 2004 year- in one year is due to the decline of risk-based capital of Hipotekarna end and it decreased in relation to 2003 when it amounted to 39%. Bank. If this is excluded from total risk based capital movements, the total risk based capital increased by EUR 8,4 million or 12% in one-year Total risk-based capital of the banks as at 31/12/04 amounted to EUR period. Other banks showed risk-based capital growth. In relation to the 85,4 million. In the one-year period, it increased by EUR 950 thousand previous quarter, risk-based capital decreased by 2.43%. At year-end or at a growth rate of 1.13%. The minimal growth of risk-based capital 2004, all banks met the prescribed minimum of EUR 5 million.

Graph 3.2. Solvency ratio in 2004

Tabela 3.6. Risk based capital and total risk weighted assets

2001 2002 2003 2004 No. Bank Risk Total Risk Risk Total Risk Risk Total Risk Risk Total Risk Based Weighted Based Weighted Based Weighted Based Weighted Capital Assets Capital Assets Capital Assets Capital Assets 1 Hipotekarna Bank 11,267 32,781 12,127 41,090 12,651 48,489 5,219 30,231 2 Podgoricka Bank 12,848 29,833 13,262 23,642 13,714 29,380 14,730 41,071 3 Montenegrobank 0 0 12,407 27,138 12,576 22,994 12,992 45,659 4 Crnogorska Komercijalna Bank 4,566 15,105 7,762 32,933 11,318 45,082 11,546 73,530 5 Euromarket Bank 5,893 5,945 6,078 8,266 8,000 16,474 8,550 18,744 6 Pljevaljska Bank 2,948 4,040 3,988 14,583 4,600 7,808 5,955 7,400 7 Niksicka Bank 2,644 6,491 3,286 6,262 4,514 8,654 5,471 9,716 8 Komercijalna Bank 0 0 0 0 4,569 4,797 5,804 7,683 9 Atlasmont Bank 0 0 4,489 7,478 6,113 16,707 6,906 16,652 10 Opportunity Bank 0 0 6,090 7,977 6,370 14,276 8,202 22,404 11 Ekos Bank 4,416 5,640 4,802 7,390 0 0 0 0 12 Beranska Bank 2,066 2,443 0 0 0 0 0 0 13 Jugobank -920 10,010 0 0 0 0 0 0 14 Development Bank 532 7,706 0 0 0 0 0 0 Total 46,260 119,994 74,291 176,759 84,425 214,661 85,375 273,090

77 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

Total risk-weighted assets in the banks amounted to EUR 273 million. Banks’ liquid assets (cash funds and deposit accounts with depository In comparison with 31/12/03, they increased by EUR 58.7 million or at institutions) amount to EUR 107,596 thousand as at 31/12/04. They a growth rate of 27.4%. This increase is mainly due to the intensified increased by EUR 11,566 thousand or 12.04% in relation to 2003 year- lending activity by banks. end.

Liquid assets to total assets indicator at the aggregated level amounted 3.3.3. Liquidity Risk to 24.21% as at 31/12/04. This ratio declined over the previous one –year period when it amounted to 27.46% at the aggregated level. Banks’ liquidity is satisfactory, although key ratios during 2004 showed negative movements. The decline of liquid assets to total assets, high level Total liabilities of the banks amounted to EUR 353,606 thousand. They and growth of loans to deposits ratio, decrease of cash funds in relation to increased by EUR 93,043 thousand or 35.71%, compared to 31/12/03. All total deposits and total liabilities, and an increase of maturity mismatch categories of liabilities increased in the one-year period. In the liabilities of financialassetsandliabilitiesinsomebanksareduetothecontinuous structure, 77% refers to deposits, 15% refers to obligations based on increase of lending activity. An increase of loans by 40% was followed taken loans and borrowings, 5% refers to other liabilities, and 2% refers up by an increase in deposits by 30% in this year. Dynamic growth of to obligations to the Government, while 1% refers to reserves for losses lending activity was achieved by banks through the utilization of loans on off balance sheet commitments. and borrowings and significant deposit increase as well.

Table 3.7. Movement of aggregated level of liquid assets to short-term and total libilities of banks in 2004

31/12/03 31/03/04 30/06/04 30/09/04 31/12/04 Liquid Assets 96,053 88,192 83,203 118,316 107,596 Short Term Liabilities 228,981 229,529 232,479 259,658 262,404 Total Liabilities 260,563 268,411 289,063 322,577 273,195 Liquid Assets/Short Liabilities 42% 38% 36% 46% 41% Liquid Asset /Total Liabilities 37% 33% 29% 37% 39%

Table 3.8. Loan to deposit ratio per bank

No. Bank 2001 2002 2003 2004 1 Hipotekarna Bank 44 70 98 102 2 Podgoricka Bank 49 45 102 104 3 Montenegrobank - 4 109 178 4 Crnogorska Komercijalna Bank 31 57 73 86 5 Euromarket Bank 58 45 74 55 6 Pljevaljska Bank 214 199 254 217 7 Niksicka Bank 95 108 110 131 8 Komercijalna Bank - - 86 81 9 Atlasmont Bank - 36 90 73 10 Opportunity Bank - 357 360 335 11 TOTAL 47 61 95 103

78 BANKING SECTOR SUPERVISION AND REGULATION

Table 3.9. Short term and long term loans and deposits ratio in 2004

31/12/03 31/03/04 30/06/04 30/09/04 31/12/04 Short Term Loans 151,307 156,586 171,602 174,149 170,260 Short Term Deposits 220,396 229,529 217,947 246,605 262,404 Coverage % 68.65 68.22 78.74 70.62 64.88 Long Term Loans 49,327 59,677 66,428 65,762 111,222 Long Term Deposits 4,376 4,721 8,533 8,828 10,790 Coverage % 1.127.21 1.264.08 778.48 744.93 1.030.78

The loans to deposits ratio is very high, at 103.03%, which represents − Decision on Minimal Standards for Market Risks Management an increase compared to the 95.08% as at 31/12/03. in Banks was drafted − Supervision of risk became a part of full scope examination Maturity match of short-term and long-term loans with short-term and − Amendments to current Chart of Accounts including accounts long-term deposits shows that long-term loans growth has not been related to derivatives and hedging were proposed matched by long-term deposits growth. According to the visits to banks and bank market risk profilesperformed During 2004, banks regularly serviced their current liabilities and individually for each bank, market risk is currently at a low level mostly maintained liquidity above the prescribed minimum. due to the limited market. The main sources of market risk are FX positions and interest rate risk. Market risks management requires improvement, but it does not represent a concern for the level of assumed risk. However, 3.3.4. Market Risk experiences of neighbouring countries shows that the following years will bring an expansion of assumed market risk and its complexity. Market risk is the potential loss resulting from adverse changes in interest rates in the market, foreign exchange rates, prices, indices and/or other Insufficientknowledgeinthisareawasnotedduringthesupervisionvisits factor that influence the value of financial instruments. to banks. Most of the banks do not have adequate limits for placements or limits for interest rate and FX risk exposures. These observations were In 2004, the activities of the Bank Supervision Department were directed addressed in the reports and during the discussions with management, towards more intensifiedsupervisionofmarketriskthebanksareexposed so it is expected that in 2005 risks management will be improved. to and supervision of the risk management system. The intention was to use a preventive approach to bank supervision rather than to wait until Interest rate risk is the risk to earnings and/or capital occurring due the problem occurs and then to take actions for which can be too late. from changes in interest rates and arising from: repricing risk (maturity Market risk activities taken by the Department refer to the following: mismatch), basis risk, yield curve risk and option risk.

− Identification of market risk as a future point of bank Sensitivity to interest rate in Montenegrin banks is mostly evaluated by supervision applying the gap method, which is appropriate with regard to the size − Establishment of market risk team for identification, and complexity of the balance and off balance sheets of Montenegrin quantification and monitoring of market risk in banks banks. This method determines cumulative difference between rate − Continuity of basic training of team through visits to banks sensitive assets and rate sensitive liabilities. The higher cumulative − Market risk profiles for all banks in Montenegro were difference, the higher potential risk to bank’s earnings due to adverse performed change in interest rate. − Products profiles and services related to market risk profiles were performed

79 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

Aggregate assessment of interest rate risk cannot be precisely determined. Aggregated balance in all foreign currencies at 2004 year-end amounted During the supervision visits to banks, the gap report on sensitivity to to EUR 11,003 thousand or 12.03% of the first class capital. interest rate risk has not correctly reflectedbanks’exposurestointerest rate risk. When filling out gap reports, most banks used maturity of The decrease of exposure to USD has continued. First class capital assets and liabilities instead of repricing criteria. These deficiencieswere exposure to USD of 2.02% at the banking system level decreased in communicated to banks during the examination and in the reports as well relation to 2003 year-end when it amounted to 3.77%. and will be subject to additional attention by examiners during 2005. Other risk bearing balance positions are minimal and do not represent As at 31/12/04, aggregated interest rate spread amounts to 7.61% and a concern. As at 31/12/04, equity investments represented only 1.22% decreased in comparison with 31/12/03 when it amounted to 9.62%. of assets of the banking system with a declining trend. Investment in Although it was decreased, it is still too high to provide security to banks T-Bills represented 4.22% of assets at the aggregate level, but banks due to adverse movements in interest rates. should improve their accounting practices related to the recording of T-bills and equity investments. Although the secondary market has Foreign exchange risk is the probability of incurring losses in balance not developed, banks in Montenegro record T-bills at accounts “held sheet and off-balance sheet positions due to changes in currency rates to maturity”, while, pursuant to sound banking practices, they should and/or a mismatch in the volume of assets, liabilities and off-balance be recorded at account “available for sale” since their purpose was sheet items within the same currency mostly to support the liquidity management. To show operating results more correctly, some banks are recommended to perform monthly The level of FX risk is low. USD was the most represented currency in 2004. reconciliation of the discount of T-Bills. Although 2004 can be considered as a year marked by the depreciation of USD, the banking system had more liabilities in USD than assets as at In respect to the accounting of equity investments, the banks were 31/12/04. Exposure to other currencies is minimal. recommended to determine what the purpose of investments was and to perform bookkeeping. It is due to the IAS 39 requirement to show In respect to the conversion of USD to EUR, banks protected themselves equity investments at trading or available for sale accounts. Some banks by calculating high fees that even reached 5%. keep equity investments at accounts “held to maturity”.

Graf. 3.3. Interest rate spread

80 BANKING SECTOR SUPERVISION AND REGULATION

Graph 3.4. Aggregated exposure to FX risk

Table 3.10. Sensitivity to FX risk as at 31/12/04

Description DIN USD GBP CHF Other Net Long (Short) Positions 1 -1,849 -168 416 -2,931 % of First Class Capital 0 2.02 -0.18 0.45 3.21

Graph 3.5. First class capital exposure to USD

81 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

3.3.5. Operational Risk

Operational risk is the risk of incurring losses in the bank’s operation, as a The examinations performed in 2004 (eight banks) disclosed that overall result of inadequate internal processes, controls and systems, weaknesses conditions are satisfactory. IT in one bank is unsatisfactory, in two banks and errors in performance, illegal actions and external events that may it needs improvement, while in other banks it was relatively good. expose a bank to loss. Weaknesses disclosed during 2004 mostly referred to development Operational risk was evaluated through the examination of the quality of a disaster recovery plan, removal of a back-up server to an external of the internal controls system during the examinations in 2004. location and strengthening of management in the IT area. Most of the banks installed new software in 2004 for performing payment Internal Controls system operations and it contributed to the efficiency of performed operations. During on-site examinations in 2004, the examiners disclosed that overall, internal control system is satisfactory. Improvement is needed External Audit in one bank, and in seven banks, the functioning of internal controls system is satisfactory, while in two banks the internal controls system The external audit of financial reports for 2003 was performed for was unsatisfactory. all banks in Montenegro. Auditor Delloite &Touche was the external auditor for Euromarket Bank and KPMG was the auditor for five banks: Deficiencies disclosed during the examinations mostly referred to the Niksicka Bank, Opportunity Bank, Podgoricka Bank, Pljevaljska Bank following: and Hipotekarna Bank, PriceWaterHouseCoopers D.O.O. Beograd for Montenegrobank, PriceWaterHouseCoopers Paris for Crnogorska - Deficiencies in filling out the reports submitted to the Central Komercijalna Bank, while Ernest & Young performed audit for Atlasmont Bank, as incorrect accounting of particular transactions, Bank and Komercijalna Bank Budva. - Internal controls system is not designed so as to efficiently identify, monitor and control all operating risks, However, as in the prior year, the CBM examination disclosed deficiencies - It was disclosed in three banks that the Supervisory Committee in auditors’ reports, so the improvement of auditors is needed. does not perform detailed insight over the functioning of the internal controls system as required by Article 4 of the Decision These were the following deficiencies: of Basics of Internal Controls System in Banks. - Risk assessments and amount of funds established against Information Technology earnings to cover losses on assets items. - Analysis of collateral including qualitative and market IT supervision is performed once in two years. The examination included instruments of security, the following: - Description of condition in IT department (with most of the banks) without suggestions for the improvement of how the - IT Audit department functions. - IT Management - Systems and Programming Decision on Operational Risk was adopted at 2004 year-end, which - Computer Operations created the grounds for more comprehensive assessment of this risk in banks in 2005.

82 BANKING SECTOR SUPERVISION AND REGULATION

3.3.6. Country Risk

Country risk represent the possibility of incurring losses by a bank, Banking sector exposure based on deposits pledged with foreign banks due to an inability to collect receivables from the entities outside of according to the information as at 31/12/04 is the following: the Republic of Montenegro, which results from political, social and economical environment of the country in which a debtor has its head a) Total amount of deposits and funds at correspondent account of office or residence. Montenegrin banks with foreign banks amount to EUR 43,561 thousand or 48.74% of total firstclasscapitalofthebanksinthe The Decision on Country Risk was adopted at 2004 year-end and defined Republic that amounts to EUR 91,434 thousand, of which EUR that the bank has the obligation to establish specificreservesthatshould 28,960 thousand refers to deposits and EUR 15,601 thousand not be lower then: refers to funds at correspondent accounts; b) Banking system exposure is the largest to Commerz Bank Minimal Reserves Long Term Rating Frankfurt amounting to EUR 18,716 thousand or 20.47% of or Its Equivalent total firstclasscapitalofthebanksintheRepublic,thentoLHB Bank (EUR 11,580.000 or 12.67% of the first class capital, -no reserves required BBB or better c) Five banks have an exposure over 20% of their firstclasscapital -2% BBB minus to one foreign bank. -5% BB plus and BB -10% BB minus, B plus and B -20% B minus -30% CCC plus -50% CCC to CCC minus -50% CC plus to CC minus -75% C plus to C minus -100% DDD to D -10% No applicable

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4. PAYMENT SYSTEM

PAYMENT SYSTEM

In the course of 2004, the activities of the Central Bank concerning The aims that the Central Bank had set in its Policy for 2004 were achieved payment operations were directed towards system reform, as well as - payment system reform in the country was intensifiedandcompleted towards the more efficient implementation of payment operations in which created the foundations for the new payment system to become the Republic on a regular basis. operative at the beginning of 2005.

4.1. Payment System Reform

4.1.1. Development of the New Payment System

After the firstphaseofthereformin2003,whichresultedinthemigration The most important characteristics of the new payment system in the of cashless and cash payment operation services to banks, activities on country are as follows: the development of a new payment system were intensifiedduringthe reporting year. − it enables the processing of payments by the real time gross settlement principle and the deferred time net settlement The main objective of the payment system reform was its complete principle; demonopolization. The reform was twofold: the first phase implied − the processing of payments between the participants in banks’ takeover of payment operation activities on behalf of their clients. the interbank payment system is electronic and completely The second phase, in legal, technological, and functional terms implied automatic; the development of a completely new payment system in line with the − the account structure was changed, which created the latest practical innovations in developed payment systems, and generally prerequisites for the implementation of the international IBAN accepted international recommendations, primarily “Core Principles for standard; Systematically Important Payment Systems”, CPSS by the Committee on − the communication between the participants in the new MPS Payment and Settlement Systems – Bank for International Settlements, is based on the exchange of electronic payment messages in Basel, Switzerland. the SWIFT format, which enables the processing of payment transaction without any additional changes, by the so-called The aforementioned aims were carried out through the preparation of "Straight through processing" principle; new regulatory framework, the implementation of a new interbank − the adoption of the SWIFT standard enabled easier and payment system, the development of intrabank payment systems in more efficient connections with payment systems of other commercial banks (for the processing of their own, and payments countries. for their clients), the establishment of the appropriate organisational structure in the Central Bank with regard to the organisational units responsible for the organisation and functioning of payment operations in the country, and an active participation of the Central Bank in the reform of public finances through the implementation of the so-called “revenue model”.

87 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

4.1.2. Implementation of New Interbank Payment System

The function of the Central Bank in the new interbank payment system of the existing payment operation information system; comes down to the role of the accounting agent for the processing of − during this transitional period, there were frequent changes in interbank payments, i.e. payments between clients of differentbanks.At organisation and roles and, consequently, the reallocation of the same time, pursuant to the Law on the Central Bank of Montenegro, people to new jobs and duties so it took time for the people the Central Bank performs cashless payment operations for its clients to achieve optimum job performance levels; – commercial banks, government bodies and other organisations. − the new information system had to provide additional technical support for the implementation of the new model of the public The activities with regard to the implementation of the new interbank revenues pay-in accounts; payment system, as the finalstageinthereformofthepaymentsystem − simultaneously, social programs for solving the problem of in the country, were directed towards the introduction of concrete redundancies were also carried out. operative procedures. The new payment system provided the prerequisites for a quality The selection of the best bidder in the tender for the acquisition of the improvement in two segments: a better quality and more efficient IT solution for the new interbank payment system in the Republic, services to all participants in the payment operations, and enabled banks announced at end-2003, was performed in the first quarter of 2004. to continuously monitor their liquidity and manage their assets better. The contract with the system supplier was concluded at the beginning Additionally, this new system created the space for the introduction of of July, which created the conditions for intensifying the implementation new payment services in accordance with modern trends in this area, and development of the new interbank payment system. primarily those related to e-banking.

During the implementation period of six months, all the normative, 4.1.2.1. Payment System Regulations technical, and personnel conditions were created for the transfer to the new payment system at the beginning of 2005. During the reporting year, four regulations governing the payment operation system were amended, and 77 instructions, opinions, and During the aforementioned period, the Central Bank carried out intensive interpretations were prepared, providing the reliability of the payment consultations with, and offeredthenecessaryassistanceto,allrelevant system regulatory framework. In addition, as a part of the normative- organisations and institutions directly or indirectly involved in the regulatory framework, ten new regulations were prepared with a view payment system reform. to providing complete, quality, and up-to-date transfer of payment operations to banks. The new payment system saw a successful start on 6 January 2005. At the same time, all potential problem areas recorded during the same reforms in neighbouring countries were avoided. 4.1.3. Regular Payment Operation Activities

The importance of such a successful start is even greater bearing in Regular payment operation activities were performed during the year mind the environment in which these very complex and intensive in accordance with the legally prescribed obligations of the Central activities were carried out, and which was characterized by the following Bank of Montenegro. These included payment operation activities for circumstances: the clients of the central Bank, and the offering of technological and technical support to banks in the performance of payment operations, − relatively modest human resources who were simultaneously and so a relatively high safety in the functioning of payment system engaged in performing regular payment operations and all the was achieved. activities with regard to the development of the new payment system; The technical aspects of the payment operation information system − continuous presence of the operating risk in the functioning were continuously improved.

88 PAYMENT SYSTEM

4.1.3.1. Licensing the Bearers of the Payment 4.1.4. Enforced Payment Operations The enactment of the Law on Enforcement Procedure in 2004 specified Upon the request of six banks, 14 new organizational units of these the role of the Central Bank of Montenegro as the institution responsible banks were licensed to perform payment operations (Annex 1, Table 14). for the organisation and implementation of enforced payments from Additionally, 25 interbank contracts were implemented, whereas four debtors’ account, which represents its non-payment functions in the of 105 contracts signed during the year were terminated. (Annex 1, payment system. Table 15) Therefore, the Central Bank had to reorganise the enforced payment 3.1.3.2. Control of the Bearers of the Payment process in accordance with the new Law and within the existing payment Operations system,. These activities were also successful, so the new system of enforced payment started simultaneously with the functioning of the Fifty (of 52 planned) comprehensive controls in ten banks were carried new payment system. The enforced payment is automatic, observing out during the year. (Annex 1, Table 16). On the basis of records and all standards on which this new payment system is based. reports on detected irregularities, orders for the elimination of these irregularities were issued. The usual inconsistencies related to the irregularities in the conclusion of contracts on the opening and managing accounts (inappropriate contract forms, unsigned contracts), non- submitting requests for opening of an account, or non-submitting of adequate documentation, anomalies in the fulfilling of payment operation forms (stamp, signature), improper fulfillingofRIR,receiving and executing formally-logically incorrect orders, unidentifiedpersonsin cash payments, irregularities in informing clients about rejected requests, inconsistencies in entering data in the operation system, faults in keeping records on the order of receiving enforcement orders.

89

5. BANKING AND FINANCIAL OPERATIONS

BANKING AND FINANCIAL OPERATIONS

In the domain of financial and banking operations, the Central Bank One of the priority tasks was also the efficient performance of the of of Montenegro defined its prime objectives in 2004. The most the banking, advisory and fiscal agent services on behalf of and for the important were the following: the improvement in monetary reserve account of bodies and organizations of the Republic, with the emphasis management, the strengthening of the existing and the establishment being on quality improvement in the banking services, the efficient of new correspondent relations with highly rated international banks performance of domestic and international payment operations on and banking institutions, regular provision of the domestic financial behalf of the clients of the Central Bank of Montenegro, the monitoring institutions with euro banknotes and coins, and the following of an of inflows and the use of financial assets disbursed for the Republic active reserve requirement policy. in the form of credits and donations, as well as the inflow of other foreign funds and the closing of deposit accounts of the Government in commercial banks, and the transfer of these funds to the all-in-one account in the Central Bank of Montenegro (in cooperation with the Ministry of Finance).

5.1. Foreign Exchange Reserve Management

Investment of foreign exchange reserves in 2004 was carried out The level of available foreign exchange assets in the accounts of the in compliance with the Regulation on Foreign Exchange Reserves Central Bank of Montenegro abroad recorded huge fluctuations and Management and Guidelines, as well as with the established framework varied between EUR 35 million and EUR 65 million. The Euro was the definedbytheInformationontheManagementofFundsintheCentral dominating currency in the structure of the country’s foreign exchange Bank of Montenegro’s Foreign Accounts During 2004 with the Proposed reserves, 95.04%, followed by the US Dollar, 3.70%, the Swiss Franc, Strategy in the Forthcoming Period previously adopted by the Council of 1.08%, and the British Pound, 0.18%. the Central Bank of Montenegro. This means that the foreign exchange funds were invested with first-classforeignbanksandtothepreviously The funds in the foreign accounts were formed from the following specified limits. To wit, the Decision and the Guidelines prescribe that sources: (1) share capital of the Central Bank of Montenegro, (2) “at most 25% of foreign exchange reserves held abroad may be kept earmarked deposit by the Ministry of Finance, (3) allocated commercial in one foreign commercial bank.” banks’ reserve requirements in the Central Bank`s foreign accounts, (4) allocated commercial banks’ reserve requirements in the Central Bank’s The Risk Management function in the Central Bank of Montenegro domestic accounts (taken abroad), (5) interest on funds deposited in continued, including the continuous monitoring of the rating of both foreign banks in 2004, and (6) a part of the funds in the item “non- corresponding banks and those the Central Bank of Montenegro may allocated profit and other reserves”. cooperate with in the future. The ratings by Standard & Poor’s and Moody’s agencies for the categories of long-term and short-term deposits are used as the criteria for the selection of the aforementioned banks.

93 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

Graph 5.1. FX funds in foreign accounts, EUR, in 2004

Graph 5.2. 7-day Euribor and USD Libor in 2004

An increase in interest rates on the USD was recorded, whereas those so-called automatic investment program was established with the on the EUR and other currencies remained the same during the whole Federal Reserve Bank of New York, which means the Central Bank of year, but they were still lower than in 2003. Foreign exchange funds Montenegro authorizes the Federal Reserve Bank of New York to invest were invested at the average rate of 1.75% for the USD (1.12% in 2003), in repo agreements and purchase Treasury bills of the American Treasury and about 2% for the EUR (2.25% in 2003). with any surpluses of funds (above the prescribed minimum) in the Central Bank’s account. The Participation Agreement was concluded Cooperation with several foreign central banks and commercial banks with the Deutsche Bundesbank at end-2004, defining the terms and commenced during the year. In addition to the investment aspect, conditions for the investments of assets with this bank. This agreement this cooperation included the exchange of information, the training was the result of the decision by the ECB on the harmonizaton of terms of staff in risk management, dealing with securities, gold, and so on. and conditions under which all European central banks (members of Cooperation also started with the National Bank of Switzerland, and the ESCB) may offer new services to their correspondent banks. To wit, it continued with the FED, the Deutsche Bundesbank and the Bank pursuant to the provisions set forth in this Agreement, the funds may of England, as well as with some of the most reputable commercial be invested with the Deutsche Bundesbank, or with “selected” banks banks in London, Frankfurt, and Zurich. At the beginning of April, the through the Deutsche Bundesbank as the agent.

94 BANKING AND FINANCIAL OPERATIONS

Box 5.1. Monetary Reserves

Being a euroised country, it is very difficult to define the term foreign exchange reserves in Montenegro since these reserves do not have the same function as in the countries with a local currency, so monetary reserves is the most appropriate term to be used here.

The basic meaning of monetary reserves in Montenegro can be definedasdepositsbytheCentralBankabroad.Inawidersense, they also include commercial banks’ deposits with foreign banks. However, as a rule, foreign exchange reserves are under effective control of a monetary authority, but this is not the case with deposits by commercial banks with foreign banks, so we think that the narrower definitionofmonetaryreservesismoreappropriate.Frombasiccomponentsofforeignexchangereserves(bydefinition), the Central Bank’s foreign account is the only one that can be monitored since the Republic of Montenegro does not have gold reserves, or a reserve position with the IMF, Special Drawing Rights, and the Central Bank’s other claims on non-residents.

Deposits by the Central Bank with foreign banks amounted to EUR 53.5 million, which is 39% more than at end-2003. Most of the deposits were term deposits in EUR (94%), followed by term deposits in other currencies of 4.4%, and the remaining 1.6% was demand deposits.

Graph 1. Central Bank of Montenegro’s deposits with foreign banks, EUR thousand

If commercial banks’ deposits with foreign banks were included, monetary reserves would amount to EUR 98.2 million.

Graph 2. Central Bank of Montenegro’s and banks’ deposits with foreign banks, EUR thousand

95 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

5.2. International Payment Operations

The Central Bank of Montenegro established corresponding relations All international claims due were paid on time, and foreign exchange with eight foreign commercial banks where foreign exchange funds inflows were forwarded to end users in a relatively short time, and were kept and through which international payment operations were available assets were fully invested. Payments from the international performed. According to the most reputable rating agencies, the ratings account were effected to the total amount of EUR 99.7 million, as of the aforementioned banks belong to the highest category. follows:

At the beginning of April, an account with the Federal Reserve Bank of 1) payment of liabilities for loans taken by the Republic of New York was opened. In addition, an Agreement was signed between the Montenegro, EUR 17.5 million; Bank for Foreign Economic AffairsoftheUSSR(Vnesheconombank)from 2) transfer of funds in favour of the Ministry of Finance (SAC1 and Moscow and the Central Bank of Montenegro on the technical procedure SAC2), EUR 14.1 million; of accounting on the settlement of mutual financialclaimsbetweenthe 3) transfer of funds to domestic banks for the sold cash holdings Russian Federation and the Successor States to the Former SFRY related and refund of reserve requirement, EUR 48.5 million; to the settlement of accounts under the commodity exchange between 4) buying of cash holdings for domestic payment operation the former USSR and the former SFRY. The Agreement was signed by purposes, EUR 15.9 million; the representatives of the central banks emerging from the former SFRY, 5) transfers in favour of foreign banks by the order by the Ministry and it imposes the obligation of signing concrete bilateral agreements of Finance, EUR 2.4 million; between the Vnesheconombank and each of the central bank separately. 6) payments on behalf of and for the account of the Central Bank These agreements shall closely regulate the terms and the method of of Montenegro, EUR 1.3 million. technical procedure of accounting and managing of interbank accounts related to the settlement of clearing claims. EUR 1.16 million or 91% of total payments on behalf of and for the account of the Central Bank was for the purchase of interbank payment The buying and selling of cash holdings Montenegrin banks performed system software from the Hewlett Packard company. on their own or through the Central Bank of Montenegro. The total cash holdings transactions amounted to EUR 147.4 million, of which EUR 50 million was for the banks’ purposes, and EUR 97.4 million for the purposes of domestic payment operations (EUR 81.5 million for selling and EUR 15.9 for buying the cash holdings). The transactions with the cash holdings were performed in accordance with the special agreement with the foreign bank. This agreement specifies that the transport of money is provided in line with international banking standards in the way that the correspondent bank undertakes all risks with regard to the transportation of money (“door-to-door” cargo insurance).

96 BANKING AND FINANCIAL OPERATIONS

5.3. Fiscal Agent and Advisor

Pursuant to the Contract with the Ministry of Finance, the Central Bank of The quantitative change in T-bills market represented a significant Montenegro provided banking and advisory services on behalf of and for increase in the total amount of issued and sold T-bills in comparison the account of bodies and organizations of the Republic of Montenegro with the same period in 2003. Thus, 117.8 million or 85.2% more T-bills as their fiscal agent. Those services were: were sold than in the previous year (EUR 256.1 million in 2004 and EUR 138.2 million in 2003). The sold amount of T-bills on the last day of the - the opening of new and the termination of old accounts with reporting year was EUR 37.4 million, which is EUR 17.6 million more the Payment Operations Department; than the balance on 31 December 2003, which had been definedbythe - giving advice and recommendations concerning financingthe Decision on the Issue of Treasury Bills and the subsequent amendment budgetary deficit; to this Decision. - conducting international payment operations and the regular servicing of credit liabilities with foreign creditors; The buyers of these T-bills received income for interest to the amount - organization of auctions of treasury bills. of EUR 3,058,832.00.

The Central Bank of Montenegro organised thirty-eight auctions of T- 5.3.1. Auctions of Treasury Bills bills of 28 days, 56 days, 91 days, and 182 days of maturity, of which two were unsuccessful because there were no buyers. In the thirty-six The auction sale of short-term T-bills was performed pursuant to the successful auctions, the issued amount of EUR 269.8 million (the average Decision on the Issue of Treasury Bills20 which foresaw the sale of T- per auction being EUR 7.5 million) was 5.3% higher than the sold amount bills to the net amount of EUR 15 million in 2004. This decision enabled (EUR 256.1 million), but it was 1.3% lower than the demand amount. the issuing of T-bills of 91 and 182 days maturity. The Decision on the Total demand was 6.3% higher than the sold amount. The main share, Extraordinary Issue of Treasury Bills21 anticipated the additional issue EUR 174.6 million or 68.2%, was 28-day T-bills (13 issues and 66.7% of of T-bills of EUR 4 million, but only EUR 2 million worth T-bills were total T-bills sold), EUR 53.8 million or 1% to 56-day T-bills (13 issues and sold at the auction. 23% of total T-bills sold), EUR 20.1 million or 7.8% to 91-day T-bills (8 issues and 7.5% of total T-bills sold), while only EUR 7.5 million or 2.9% Besides the qualitative changes, the movements in the primary market referred to 182-day T-bills (4 issues and 2.8% of total T-bills sold). of T-bills were also characterized by quantitative changes. The quality changes implied the aforementioned issue of longer maturity T-bills The percentage contribution of 28-day T-bills sold to the total amount (91 and 182 days), and the appearance of foreign legal entities and of T-bills sold recorded a slight decrease from 72.9% in 2003 to 68.2% resident private citizens as buyers of T-bills. Their appearance in the in 2004, which is rather strange since the value of 28-day T-bills sold primary market of T-bills resulted in a reduction in interest rates on these more than doubled. This indicates that confidence in longer-term securities. However, without the secondary trading option, treasury bills investments is growing.s are deemed illiquid, which is one of the motives for the high interest rates still demanded by buyers.

20 “Official Gazette of RM”, no. 24/04 21 »Official Gazette of RM«, no. 81/04

97 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

Graph 5.3. Nominal amount of T-bills sold in 2003 and 2004, EUR thousand

Source: Central Bank of Montenegro

Graph 5.4. Nominal amount of T-bills sold in 2004

Source: Central Bank of Montenegro Note: The year-on-year comparison shows that two auctions of 56-day T-bills were held both in April 2003 and April 2004, and two 28- day T-bills auctions in September 2004, which is the reason for the increase in the total amount of T-bills sold in these months.

98 BANKING AND FINANCIAL OPERATIONS

5.3.1.1. Auctions of 28-day T-bills

Thirteen auctions of 28-day T-bills were held in the reporting period extremely poor, that is, there is no secondary market for these securities, (32. - 44.), to a total value of EUR 174.6 million (the average per auction nor the opportunity to transfer them into cash before the maturity date. being EUR 13.4 million). Participants in the auctions were mainly banks, This great demand was also sustained by the lack of quality alternative then enterprises, one Montenegrin stock exchange (at the May auction), destinations for the investment of free financial assets which caused and one insurance company which participated in the June auction for the matured amounts from prior issues to be reinvested, that is, it led the first time. A significant increase in demand, which resulted in the to the capitalisation of interest. increased amount of T-bills sold, was evident during the second and the third quarters of the year, followed by a notable fall in the last quarter, If we observe the annual movement of interest rates on 28-day T-bills, but the average demand was EUR 5.8 million higher than the year before. we notice that the level of the average weighted interest rate per auction As for interests payable, the Government owed the buyers of these bills was 0.06% higher than in 2003. However, interest rates on these T-bills a total of EUR 1,362,839.00. (Annex 1, Table 8) recorded a slight fall since April, which was mainly caused by the change in the structure of buyers, that is, the appearance of domestic private Banks’ demand for T-bills was still great due to relatively high interest citizens and foreign legal entities, demanding lower interest rates than rates and a low default risk although the liquidity of these securities was other buyers, especially the banks from Montenegro.

Graph 5.5. Sold amounts and interest rates on 28-day T-bills in 2004

Source: Central Bank of Montenegro

99 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

5.3.1.2. Auctions of 56-day T-bills

The level of issued, that is, 56-day T-bills sold in thirteen auctions The buyers of these bills were mainly banks, insurance companies, one increased in comparison with 2003. Thus, EUR 53.8 million worth of Montenegrin stock exchange (in the September auction), and foreign these bills were sold in 2004, whereas this amount in the comparative banks, since October. The banks redeemed from 65% to 100% of the year was EUR 37.5 million. (Annex 1, Table 9) issued 56-day T-bills. The reason for such a great demand by domestic banks was the high liquidity. However, demand for these bills was also Buyers of 56-day T-bills received income for interest of EUR 816,138. characterized by continuous growth which no longer shows cyclical movements. This was also due to the appearance of other investors, An increase in demand for these bills was noticeable from May, while except domestic banks. (Annex C, Table 14) the average demand per auction in the reporting period was some EUR 1.7 million greater than in the previous year. The reason for such a Observed from the firstissueof56-dayT-billsuntilthelastauctionheld relatively moderate increase in demand for these bills lies in the fact that in December the annual weighted interest rate on these T-bills grew by due to the previous purchases of these T-bills in smaller amounts, the 1.12%. However, after the growth in the first four months, the interest amounts reinvested are also smaller in comparison with the reinvested rate recorded a fall, the same as that of 28-day T-bills. It should also be amounts of 28-day T-bills. taken into account that the new Decision on the Issue of Treasury Bills enabled the issuing of longer maturity T-bills (91days and 182 days), which provided alternatives to 56-day T-bills.

Graph 5.6. Sold amounts and interest rates on 56-day T-bills in 2004

Source: Central Bank of Montenegro

100 BANKING AND FINANCIAL OPERATIONS

5.3.1.3. Auctions of 91-day T-bills 5.3.1.4. Auctions of 182-day T-bills

There were eight auctions of 91-day T-bills in the reporting year (two in Pursuant to the new Decision on the Issue of Treasury Bills enacted in June, two in September, and four in December) of a total value of EUR April 2004, the Government of the Republic of Montenegro issued the 20.1 million. The last auction of these bills issued on 31 December was first T-bills with an agreed maturity of 182 days. Four auctions of these unsuccessful because there were no buyers. (Annex 1, Table 10) T-bills followed, but the second (held on 17 November and with an issue of EUR 2 million worth of bills) was unsuccessful for the same reason as The participants were mainly banks, both domestic and foreign, and in the case of the last auction of 91-day T-bills – no interested clients. the total demand was EUR 24.4 million. The buyers were one enterprise in the first auction, domestic banks in the third and fourth auction, and one international financial institution The increased demand for these T-bills affected the movement of their in the last auction. (Annex 1, Table 11) interest rates. Observed from the first until the seventh auction, the level of the average annual weighted interest rate per auction fell by Although relatively low, the contribution of 182-day T-bills sold to the some 1.2%. total amount of T-bills sold recorded a slight growth, amounting to EUR 7.5 million. The same as with the introduction of 28-day T-bills and 56-day T-bills, the demand for these bills was also characterized by a cyclic movement As for the average annual weighted interest rates on these bills, it fell of the amounts issued and sold. by 1.82% from the first until the last issue of these T-bills.

The Government of the Republic of Montenegro owed the buyers of The interest that the Government paid, and is yet to pay, on the maturity these T-bills total interest of EUR 514,064. date of these T-bills is EUR 365,792.

Graph 5.7. Sold amounts and interest rates on 91-day T-bills in 2004

Source: Central Bank of Montenegro

101 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

Graph 5.8. Sold amounts and interest rates on 182-day T-bills in 2004

Source: Central Bank of Montenegro

102 6. MACROECONOMIC ANALYSES AND RESEARCH

MACROECONOMIC ANALYSES AND RESEARCH

In addition to the regular monthly, quarterly, and annual reporting IMF international standards. A comprehensive revision of the statistical on macroeconomic developments, the Central Bank of Montenegro monitoring of external flowsstarted,andbothMonstatandtheCustoms prepared numerous pilot projects, studies, and analyses. Statistical Office of Montenegro, as the institutions also authorized for this area, monitoring of monetary aggregates was improved significantly,which were included in this process following the proposal by the Central Bank was also confirmed in the report by the International Monetary Fund. of Montenegro. There were regular contacts and negotiations with the The Central Bank also started with regular reporting on macroeconomic IMF with regard to the three-year arrangement, as well as with the developments in Montenegro to the Eurostat, and preparations were representatives of the World Bank, the European Commission, the Council made for the beginning of regular monthly reporting to the IMF. A new of Europe Bank, and other international institutions. Great attention was methodology of monetary aggregate account was prepared, which is also dedicated to the training of employees, as a prerequisite for future more appropriate for the environment in Montenegro and is in line with improvement in analysing and statistical monitoring.

6.1. Improvements in Statistics

Statistical data from the monetary and the balance of payments After the adjustment to the standards of Eurostat, the Statistical Office fields that fall within the direct authority of the Central Bank were of the European Union, regular reporting to this institution started. systematically collected, as well as data from the field of economy, The result of the aforementioned cooperation was the inclusion of budget and budgetary funds. Montenegro in the publication “Statistics in focus: Exchange rate in Western Balkan countries”, and subsequently in the “Review of the Monetary statistics was significantly improved and almost entirely International Role of the Euro”. harmonized with IMF standards, which was stated in the aforementioned IMF report (a complete harmonization requires amendments to enabling With a view to improving the balance of payments statistics, and regulations). following the proposal by the Central Bank of Montenegro, a technical mission of the IMF and a mission of the Center of Excellence in Finance A new methodology of monetary aggregate account was prepared in from Ljubljana visited the Central Bank. After analysing the situation in accordance with the recommendations of the IMF, allowing the existence this field,recommendationsweregiventobecarriedoutinseveralphases of more than one national definition of monetary aggregates. One and in cooperation with other institutions in the Republic of Montenegro: definition (the narrow concept) is in accordance with IMF standards, Monstat, the Customs OfficeofMontenegro,theMinistryofTourism,and and the other (the broad concept) is more appropriate for the situation the Agency for Foreign Investments. In addition, for most of the year, in Montenegro, the conditions in the euroised economy. the improvements in the balance of payments statistics were made in cooperation with a foreign consultant from Bearing Point.

105 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

6.2. Reporting on Macroeconomic Developments

Reports that were prepared during the year were the Chief Economist’s On the basis of constant monitoring and research of macroeconomic monthly and quarterly reports, the Chief Economist’s Annual Report for developments, the Central Bank of Montenegro prepared the 2003, the Central Bank of Montenegro Annual Report for 2003 containing “Recommendations to the Government for the Economic Policy for statistical review and analysis, as well as recommendations with regard 2005” submitted to the Government in November, and “The Policy of to the macroeconomic movements in the Republic. The reports were the Central Bank of Montenegro for 2005” containing the main objectives published and released on the website of the Central Bank of Montenegro of the Central Bank of Montenegro in the following year, as well as the both in Serbian and English. In addition to being accessible to the public tasks and activities for their implementation. and contributing to the transparency of economic developments in the Republic, the reports were a useful source of information for many In addition, through public announcements, interviews, participation international organisations that used these reports as the basis for in the gatherings both in the country and abroad, and lectures given their assessments of macroeconomic developments in Montenegro. at the University of Montenegro, the Central Bank of Montenegro Thus, the Central Bank of Montenegro provided important information informed the professional and the general public about macroeconomic for the preparation of the credit rating of Montenegro by the Standard developments in Montenegro. & Poor’s rating agency, but also to the IMF, the World Bank, the EBRD, and the European Commission for their macroeconomic assessments The analysis of the Budget of the Republic of Montenegro for 2005 was needed for the evaluation of credit arrangements of Montenegro with prepared, containing concrete recommendations, and the representatives the aforementioned institutions. The same support was provided for of the Central Bank participated in the preparation of the Agenda of the Commission for the coordination of the accession of the Republic Economic Reform. of Montenegro to the European Union for the purposes of further dialogue.

6.3. Projects

Numerous projects were completed throughout the year, among which Additionally, in the domain of monetary statistics, corrections in the was the project “Weighted Interest Rate” whose purpose was to test methodology for the calculation of the money supply in the Republic the model for the calculation of the wighted interest rate at the level of were made, which resulted in the amended methodology represented the banking system in Montenegro. The implementation of the model in the Chief Economist’s Report for the period January – May 2004. is expected in 2005. Within the regular reports, certain topics of importance for Montenegro The analysis of reserve requirement as an instrument of monetary policy, were also reviewed proposing concrete measures to be undertaken containing alternative scenarios, was also prepared. In the domain of with a view to the improvement of the current situation. These were monetary and macroeconomic research, a working paper “Economic research dedicated to the grey economy, inflation, a reduction in the Policy in Dollarized Economies with a Special Review of Montenegro” was current account deficit, and so on. prepared and released on the website of the Central Bank of Montenegro.

106 MACROECONOMIC ANALYSES AND RESEARCH

6.4. Preparation of Laws and Enabling Regulations

With regard to the part of the macroeconomic statistics which fall within The Central Bank also gave evaluations, i.e. recommendations for the authority of the Central Bank, the following enabling regulations numerous laws and enabling regulations governing financialtransactions were prepared: Decision on Amendments to the Decision on Payment out of the jurisdiction of the Central Bank, such as the Law on Foreign Operations with the Republic of Serbia and Kosovo and Metohija, and Trade and the Law on Capital and Current International Transactions the Instructions on Amendments to the Instructions on the Method of Abroad. With regard to the latter, the Central Bank insisted on the Performing Payment Operations with the Republic of Serbia and Kosovo issues of potential future insurance of residents of Montenegro abroad, and Metohija. The Central Bank took an active part in the preparation limiting domestic banks in keeping their funds in the accounts of foreign of the Law on Statistics of the Republic of Montenegro. non-financiallegalentities,aswellasthelimitingdomesticcompanies when opening international accounts. The Central Bank also accentuated the need to establish adequate statistical forms for the monitoring and reporting on all financial and capital transactions with a view to the prepration of better quality reports on the balance of payments of Montenegro.

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7. OTHER IMPORTANT ACTIVITIES OF THE CENTRAL BANK IN 2004

OTHER IMPORTANT ACTIVITIES OF THE CENTRAL BANK IN 2004

7.1. International Cooperation

In accordance with the adopted policy for 2004, the Central Bank carried 7.1.1.1. The World Bank out the activities with a view to the improvement of cooperation with international financial organisations, the initiation of the membership The Central Bank of Montenegro achieved direct cooperation with the of regional organisations, and the establishment of closer cooperation World Bank (WB) as the functioning fiscal agent of the state Union of with other central banks and foreign financial institutions. Serbia and Montenegro, and through WB projects in the Republic of Montenegro.

7.1.1. Cooperation with International Financial As the fiscalagent,theCentralBankcommunicatedwiththeauthorized Organisations departments of the World Bank with regard to: the maintenance of the capital value of SCG in the WB, settlement of financial liabilities of the The Central Bank mainly cooperated with the World Bank, the International State Union with the WB, preparation and implementation of strategic Monetary Fund, and the European Union. The World Bank carried out documents and policies, and so on. In addition, the Central Bank regularly eleven missions in the Central Bank with regard to the coordination of the communicated with the authorized bodies in Serbia and Montenegro with “Fiduciary Safeguard Assessment Mission”, preparation and granting the regard to obtaining the approval for guarantees and reinsurance by the credit for structural adjustment SAC2, the preparation of the economic Multilateral Investment Agency - MIGA and the International Financial Memorandum for Montenegro, and other programs. Corporation - IFC for the projects on the territory of the State Union SCG whose implementation requires approval by the State Union. The cooperation with the International Monetary Fund was achieved through direct contacts during the IMF missions in Montenegro, and by The fiduciaryassessmentbytheWorldBankwascarriedoutfromApril sending periodic reports in the form prescribed by this institution. until November. This was to issue the Central Bank of Montenegro a certificatetoperformfinancialtransactionswithregardtothewithdrawal As for the cooperation with the European Union, the Central Bank of funds and repayment of loans of the Republic of Montenegro, and debt provided information within its authority and for the purpose of restructuring with the World Bank. The result of the recommendations preparing the Feasibility Study necessary for the future signing of the given in the Final Fiduciary Assessment Report was the initial activities Agreement on Stabilisation and Association to the European Union, the for the implementation of the technical assistance to the Central Bank for implementation of recommendations given by the European Partnership the institutional strengthening of the internal audit and internal controls for the State Union of Serbia and Montenegro, and the preparation of functions. This technical assistance was financedfromtheInstitutional reports concerning the third tranche of the second macroeconomic Development Fund (IDF). assistance by the European Union to the State Union.

111 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

Shortly before the Spring Meeting and the Annual Meeting of the World year arrangement for extended financing. Furthermore, the missions Bank and the IMF, a delegation of the Central Bank of Montenegro led were aimed at obtaining a full insight into current macroeconomic by the President of the Council participated in meetings of the Swiss developments, as the basis for giving recommendations on the measures constituency where the most important policies and activities of the to be undertaken with a view to the implementation of the economic WB and the IMF group were presented, as well as overall cooperation policy for 2004. between the member countries, including the Republic of Montenegro’s cooperation with these financial institutions. At the Annual Meeting of the Board of Governors of the World Bank and the International Monetary Fund, held in Washington DC in October 2004, The President of the Council of the Central Bank of Montenegro, acting a delegation from the Central Bank discussed with the representative as the Deputy Governor of the State Union of SCG in the IMF, together of the IMF the opportunities for obtaining technical assistance in the with the other members of the Central Bank delegation, participated in fields of risk management, research, and monetary policy. Therefore, the Spring Meeting (Washington DC, 24 and 25 April) and the Annual a “diagnostic” ission of the IMF stayed in the Central Bank from 15 to Meeting (Washington DC, 1 – 4 October). The issues discussed with 19 November, whereupon a report was prepared stating the need for the representatives of the World Bank related to the conditions for the offering technical assistance for the aforementioned sectors, as well as Second credit for structural adjustment - SAC222, and the amount and the models for their implementation. the structure of the World Bank’s three-year assistance for Serbia and Montenegro (CAS)23. 7.1.1.3. The European Union

In the Client Connection Project, under the patronage of the World During the preparation of the Feasibility Study and initiating negotiation Bank, whose objective is to enable its member countries more efficient for signing the Agreement on Stabilisation and Association to the electronic access to the loan and donation portfolio, simultaneously European Union, the Central Bank participated in the preparation of a improving their implementation and utilization monitoring, the Central report on the progress of the reform activities in areas within its authority. Bank of Montenegro is registered as a regular client. This position provides The representatives of the Central Bank were directly involved in the the Central Bank an insight into all loans and donations provided on the work of the Enhanced Permanent Dialogue, the forum in which the territory of Serbia and Montenegro. representatives of the authorized bodies maintain permanent dialogues with the representatives of the European Union. Two Enhanced Permanent 7.1.1.2. The International Monetary Fund Dialogue meetings were held in the reporting year, the first on 27-28 January in Belgrade, and the second on 16 July in Podgorica. The cooperation with the IMF was mainly conducted through direct discussions during the IMF missions in Montenegro with regard to the With a view to implementing short-term and mid-term recommendations auditing of the current Extended Arrangemet. In addition, cooperation by the European Partnership for Serbia and Montenegro, the was maintained through the submission of periodic reports on current representatives of the Central Bank took an active part in the work of activities, monetary accounts, as well as in defining the conditions and the Commission for the Coordination of the Association Process to the mechanisms for the implementation of reforms in the banking system of EU. With the participation at the meetings of the Commission and timely Montenegro. The IMF missions stayed in Montenegro from 22 to 24 March submission of data and information within its authority, the Central Bank (third audit) and from 2 to 5 October (fourth audit). The aim of these contributed to the preparation of the Action Plan for the implementation missions was the evaluation of the activities carried out in accordance of the aforementioned recommendations. with the determined criteria for the implementation of the three-

22 The Executive Board of the World Bank granted the Republic of Montenegro on 17 December 2004 the second credit for structural adjustment to the amount of USD 18 million as the support for further implementation of reforms. 23 On 17 December 2004, the Executive Board of the World Bank granted to the State Union SCG the three-year assistance for the period 2004 – 2007 - CAS, to the maximum loan amount of USD 550 (of which USD 225 million would be under IDA terms and conditions).

112 OTHER IMPORTANT ACTIVITIES OF THE CENTRAL BANK IN 2004

In addition, the Central Bank regularly submitted information within Bank of Polans and the Swiss National Bank. Thus, a study visit to the its authority for the preparation of the report on the achieved level of National Bank of Poland was organised from 23 to 26 August when the reforms with regard to the third tranche of the second macroeconomic functioning and the current activities of the Internal audit department of assistance to the State Union SCG granted by the European Union to the the bank were presented. A work visit by the President of the Council of amount of EUR 25 million. The European Commission performed the the Central Bank of Montenegro in December marked the beginning of Opearational Assessment of the financial flows and procedures in the cooperation with the Swiss National Bank, and represents the basis for Central Bank of Montenegro in July 2004 with a view to evaluating the future planning of activities with regard to the training of employees flows and the distribution of funds of the macroeconomic assistance of the central Bank, as well as the exchange of information between granted by the European Union to SCG in July 2004. these two institutions.

The Central Bank also established closer cooperation with the Banking 7.1.2. Cooperation with Regional and Other and Payment Authority of Kosovo-BPK, the Bank of Austria, and the Bank Organisations of Albania with which the adjustment of the text of the Agreement on Cooperation in Bank Supervision is under way. Recognizing the need for further international affirmation, the Central Bank of Montenegro initiated membership of two regional organisations Communication was also maintained with the Bank of International at the beginning of the year: the Group of Banking Supervisors from Settlements (BIS), Basel, and the Development Bank of the Council of Central and Eastern Europe - BSCEE Group and the Central Bank Governors’ Europe, which mainly related to the exchange of information with regard Club in the region of Black Sea, Balkans and Central Asia. to the membership of the Central Bank in the aforementioned financial institutions, that is, showing the willingness for further development The aim of the Group of Banking Supervisors from Central and Eastern of cooperation. Europe is to establish closer cooperation among supervisors in Central and Eastern European countries through communication and the exchange The Memorandum of Understanding with the Bank of Slovenia signed of experiences. After the procedure, the Central Bank of Montenegro in 2003 with regard to bank supervision is being implemented in all officially received membership of the BSCEE at the 17th Annual BSCEE its segments as expected, and the cooperation with this bank was Conference held in Dubrovnik from 26 to 29 May 2004. significantly improved with regard to the fields in which the Bank of Slovenia is more experienced, operative risk and market risk. The membership of the Central Bank Governors’ Club in the region of Black Sea, Balkans and Central Asia the Central Bank was initiated with a Unfortunately, the cooperation concerning the Memorandum of view to establishing closer relations with central banks from the region, Understanding with the National Bank of Serbia with regard to bank especially in monetary, financial and banking fields. The Central Bank supervision showed no progress. The Central Bank of Montenegro is still was notified of being granted membership at the end of the year, but ready, as it has been before, to make the necessary effortswithaviewto formal acceptance is expected at the next Governors’ Club meeting fulfilling the obligations specified in the agreement, and hopefully the which will be held in Sankt Petersburg on 27-28 May 2005. Agreement will be implemented during 2005 to mutual satisfaction.

Cooperation with the European Bank for Reconstruction and Development 7.1.3. Cooperation with Other Central Banks and (EBRD) was performed through direct dialogues with its representatives International Financial Institutions during their visits to the Central Bank of Montenegro, and through the exchange of information and data necessary for the preparation of the With a view to being more present in the international scene, the Central Country Strategy as the basis for planning further activities of EBRD in Bank of Montenegro established close relations with the National Montenegro.

113 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

7.2. Vault

Pursuant to the Law on the Central Bank of Montenegro and the Policy At end-June, the Regulation on the Method of Using Montenegrin of the Central Bank of Montenegro for 2004 the Central Bank undertook Commemorative Coins Issued on the Occasions of the Anniversary of a number of activities in the field of vault operations. the Establishing of the Central Bank of Montenegro was amended, in accordance with which activities were undertaken on the sale of Most of the activities referred to the supplying with cash and taking Montenegrin Commemorative coins through legal entities (the so- over money surpluses from the regional centres, organising a regular called contractual sale). money “processing” process, and detecting counterfeits by performing validity assessments with a view to preventing the introduction of With a view to enriching its numismatic collection, the Central Bank counterfeits in payment operation channels, as well as to the creation of Montenegro took over from the Austrian mint certain specimens of of the necessary conditions for organising the operations with precious the original Montenegrin Perper coins minted in Vienna (1906 – 1914). metals in accordance with legal requirements. Therefore, a public invitation was announced to bids for the original Montenegrin coins and other money from the territory of Montenegro. Money in circulation (both undamaged and worn) and other means of In addition, the ceremonies marking the 100th anniversary of the payment were sold to correspondent foreign banks, and the money in first minting of money in circulation in Montenegro started with the circulation was also bought due to the increased payments in certain preparation of designs for minting the commemorative Montenegrin periods, and the inadequate denomination infrastructure of the available coins – the Perper marked “the year 2006”, as well as appropriate coins money. with the symbol of the Central Bank of Montenegro to be issued on the same occasion. Special attention was paid to detecting counterfeits and the prevention of their entering in circulation. The representatives of the Central Bank As a part of payment system reform, a reorganisation of the vault of Montenegro attended the “Currency Conference 2004” in Rome and operations and the supply of the bearers of payment operations with the seminar “Fight against Counterfeiting” in Paris organised by the cash were performed at the end of the year. The process also implied Banque de France (the International Banking and Finance Institute). The the enactment of the Regulation on Providing Banks with Bank Notes attendance at these conferences contributed to acquiring new skills and and Coins. New software was designed for the implementation of the knowledge with regard to the fight against counterfeiting. aforementioned changes in the vault operations, especially with a view to providing the interaction of the Vault with regional centres, RTGS, With a view to improving vault operations, employees were trained and the General Ledger. to work with the equipment for precious metals, which is the basic prerequisite for starting precious metals redemption by the Central In order to improve the conditions under which the vault operations Bank of Montenegro. were performed, certain activities were undertaken to modernize the technical security of the vault premises.

7.3. Internal Audit

The activities of the Internal Audit were intensified during the year • Foreign Exchange Reserve Management Division, since it is a department of great importance whose task is to take • Finance Division, preventive actions with regard to the removal of potential internal • Payment Operation Regulation Division, operation problems. Five internal audits in the following departments • Interbank Payment Operation Division and were performed in 2004: • Information Technology Centre.

114 OTHER IMPORTANT ACTIVITIES OF THE CENTRAL BANK IN 2004

The audit of the Foreign Exchange Reserve Management Division was The audit of the Interbank Payment Operation Division was completed completed in June, and its conclusion was that the foreign exchange reserve at the beginning of December, and the opinion of the Internal Audit was management is performed in a manner which provides a reasonable that the interbank payment operations function requires improvements, security level. The audit report contained thirteen recommendations, which were stated in five recommendations. of which eight have been implemented, one was not accepted, and the implementation of the remaining four is under way. The audit of the Information Technology Centre was completed during January 2005. The Internal Audit is of the opinion that the audited The audit of the Finance Division was completed in September, and operations are performed in the manner providing an acceptable security the Internal Audit estimated that the operations in this division are level. The audit report contained nineteen recommendations. performed in the manner which provides reasonable security level. The audit report contained fifteen recommendations, of which six During the World Bank visit to the Central Bank of Montenegro it was have been implemented, and the implementation of the remaining determined that the Internal Audit should be given assistance by a nine is under way. World Bank consultant in a form of technical support whereby the foreign consultant would be engaged for the period of one year (200 The audit of the Payment Operation Regulation Division was completed working days). Therefore, the Central Bank shall announce a tender to in October, and the Internal Audit concluded that the operations in this bids for consultant services. During the firsthalfof2005,theconsultant division are performed in the manner which provides reasonable security shall start working on the strengthening of the Internal Audit activities level. The audit report contained eight recommendations which were which, among other things, implies the preparation of a constructive agreed with the manager of the audited division. framework for Risk Management in the Central Bank, the assistance in the preparation and implementation of the Internal Audit annual operating plan, the development of the essential audit skills and training program, and the development of the necessary procedures and instructions for the implementation of the aforementioned plan.

7.4. Information Technology Support

Realizing the role and the importance of the implementation of modern availability must not be compromised, the Information Technology Centre information technologies for the improvement of the quality of operations, of the Central Bank prepared the Basic Document on the Information the Central Bank of Montenegro defined as one of the aims in its Policy System Security Policy in the Central Bank of Montenegro which defines for 2004 the upgrade of technical efficiency. the security policy of the IS-CB establishment and maintenance.

The study “Further development directions of the Central Bank of The Central Bank reorganized the communication network infrastructure Montenegro Information System” was prepared, whose aim is to define with a view to providing better solution for the connection of the further development of the Information System of the bank which should interested subjects. Thus, the network security system was defined efficientlysupporttheCentralBank’soperationsinatleastthenextfive and implemented, implying the protection of transmission paths, years, being at the same time set on the basis that would enable its communication equipment, and network traffic control, that is, the continuous development in many years to come. control of the network access in shared servers. This new network infrastructure was designed so as to be easily managed, controlled, and Taking into account that the information contained in the Information supervised by authorized persons in the Central Bank. System of the Central Bank of Montenegro (IS-CB) are very valuable and has to be protected from any unauthorized access, modification, Starting from the fact that the role of the information system is to utilization and destruction, and that their integrity, confidentiality and provide timely, relevant, and complete information to the management

115 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

and all employees, the Centre worked on the automatization of a part subsystems of the Central Bank of Montenegro Information System. This of the working processes which had not been covered by the existing primarily referred to those subsystems required by the implementation information system, and on the change of a part of the application of the new interbank payment system.

7.5. Human Resources Management

In accordance with the Policy of the Central Bank for 2004, special • The methodology on positions complexity, which was attention was dedicated to Human Resources Development. Stafftraining implemented on all systematized positions and job was performed in the country and abroad, and the priority was given descriptions to using the technical assistance of international and other institutions, • The Code of Conduct of the Central Bank employees that is, the attendance of those programmes for which the participation fees need not be paid by the Central Bank. The training on the introduction of the performance management system was carried out in cooperation with Bearing Point, and was attended by The previously established strategic decision, that the employees should 55 managers and 227 employees. All organizational units implemented be trained in accordance with the needs of their positions, was respected the performance appraisal «pilot project» for various periods in 2004. in the course of 2004. Special attention was dedicated to young staff This was the way to promote the job description forms, the performance with good qualifications,butotheremployeeswerenotneglected.Staff objectives, the performance appraisal according to the already defined requiring better English language or IT skills to carry out their daily tasks criteria; and what is most important - employees know that their work were also trained. The development of the language skills and IT training is measured, and when it is exceptional, it is specially rewarded. was carried out in cooperation with the University of Montenegro. This year the transfer of the payment operations from the Payment The most significantpartnersforcooperationinthefieldofstafftraining Operations Department to commercial banks was finished, and, in of the Central Bank during 2004 were central banks: The Deutsche accordance with the new Law on Foreign Trade the work on export Bundesbank, The Nederlandsche bank, The Czech National Bank, The registering stopped, which led to redundancies and rationalization. Bank of England, Banque de France, as well as the Federal Reserves Bank The number of employees was reduced by 135, and the Central Bank of the USA; the fellowships of the international financialinstitutionswere of Montenegro fulfilled its obligations to them according to the Law used for stafftrainingattheJointViennaInstituteandtheIMFInstitute on Labour. in Washington. Regional cooperation was particularly developed in cooperation with the Center of Excellence in Finance from Ljubljana, as The Central Bank of Montenegro started the process of creating the staff well as with other central banks in the region. electronic database, and to manage the database in a more efficientway special software will be developed during 2005. During 2004 a number of documents concerning Human Resources Management were adopted and implemented, such as: The participation of the employees in the operations and presentations of the Central Bank of Montenegro, on the domestic and international • The regulations on the systematisations of all positions within financial and IT forums, fairs and other events significantly contributed the Central Bank, with an appropriate job description for each to the strengthening of professionalism in the institution and its overall position, which were used as the basis for the preparation and reputation. We should particularly stress the participations of our signing of work contracts, economists to the Economic Assembly in Budva, the Banking Forum in • The regulations on earnings, other personal incomes and London, the Banking Conference in Vienna, the Lawyers Assembly in compensations in the Central Bank of Montenegro, Salzburg, and the IT specialists attendance in the fair of IT technology in Budva, and CEBIT in Hanover.

116 OTHER IMPORTANT ACTIVITIES OF THE CENTRAL BANK IN 2004

The Central Bank continues to invest in its staff according to its development, making its staffabletorespondtotheneedsanddemands of modern central banking.

7.6. Public Relations

The aim of the Central Bank of Montenegro in the fieldofpublicrelations The participation in international conferences was very important for was to inform the public about the institution’s activities, results and the the creation of the image of the Central Bank of Montenegro among further improvement of its image. The approach to the public, especially the international public. The Central Bank was the co-organiser of the the general public, was open and active. Seminar on Investments and Business in Montenegro, which was held in Dubrovnik in October, as a part of the Summit on Investments organized Through a great number of interviews, public announcements, press by the Euromoney. The Deputy General Director for Bank Supervision conferences, specially prepared materials and reports, especially the presented the Montenegrin banking system both at the summit and Central Bank of Montenegro Annual Report and Chief Economist’s the seminar. The participation of our representatives in the European Reports, guest appearance by the Central Bank’s executive officers and Central Bank Conference, the 60 Years of Breton Woods Conference other representatives in the electronic media, the participation in round- in Vienna, the Conference on Corporative Management in Banks in table discussions, conferences and other gatherings, information about London, the European Banking Congress in Frankfurt, the Summit of the activities of the Central Bank was available both to the professional Serbia and Montenegro in Belgrade, the Challenges and Perspectives and the general public alike. (Annex 1, Table 19) By regular updating of for Southeast Europe Conference in Vienna, the International Forum on the web page of the Central Bank, the publication of reports, statistical Investments in Montenegro in Budva, the Convention of Economists of data, advertisements, tenders, interviews and other material, more SCG in Budva, as well as the papers they presented on the aforementioned detailed information and analyses found their way to all interested occasions, contributed to spreading a positive image of the Central Bank parties both domestic and foreign. of Montenegro both at home and abroad.

The overall activities of the Central Bank regarding the creation of The President of the Council made a guest appearance in the show enabling and other regulations governing monetary developments, “Voice of America”, gave interviews to the Financial Times, Reuters and banks’ operations, and payment systems were the subjects of continuous a French magazine Newzy. The information about the Central Bank of interest of the media of Montenegro. The topics mainly discussed in all Montenegro published in the “Central Banking”, “Bank Almanac” and media were the transfer of payment operations to commercial banks other publications increased international recognition of the Central Bank. and the payment of frozen foreign currency deposits. Frequent headlines The presence was boosted by inserting the Central Bank of Montenegro of newspaper articles and the major topics of specialized TV programs web address in web sites of equally important institutions. The Central were the privatisation of banks, with a special review of Podgoricka Bank of Montenegro Annual Reports, the Chief Economist’s Reports, bank, foreign debt, the liquidity of legal entities in Montenegro, and the Bank Supervision reports were submitted to interested central macroeconomic indicators and inflation,cooperationwithinternational banks and other financial institutions. financial institutions and new borrowing, the effect of the illiquidity of the corporate sector on the liquidity of banks, and the depreciation of By comprehensive information to the domestic and foreign public, the USD and its effects on the Montenegrin economy. professional and general public, as well as its employees, the Central Bank of Montenegro shows its openness to the public and creates a positive image of its independence and trustworthiness.

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ANNEXES

ANNEXES

Annex 1. Statistics

Table 1. Preview of macroeconomic developments

2003 2004 (chain index) DESCRIPTION XII/XI I II III IV V VI VII VIII IX X XI XII Industrial output (index) 82.6 109.4 102.3 107.0 97.8 99.7 90.7 93.8 110.6 101.4 110.1 126.6 Cost of living (index) 100.1 100.2 100.1 100.0. 100.4 99.4 99.3 100.1 100.0 100.3 100.1 101.6 Retail prices (index) 100.1 100.5 100.1 100.1 100.6 100.0 100.0 100.1 100.2 100.5 100.1 101.8

Table 2. Retail prices

I II III IV V VI VII VIII IX X XI XII Chain index 100.1 100.5 100.1 100.1 100.6 100.0 100.0 100.1 100.2 100.5 100.1 101.8 ø 2003 = 100 101.7 102.3 102.6 102.7 103.4 103.5 103.4 103.5 103.7 104.2 104.3 106.2 Same month in the preceding year 105.2 105.7 105.5 102.3 100.6 102.4 102.1 102.1 102.0 102.4 102.5 104.3 The same period in the preceding year 105.6 106 105 104.6 104.2 103.9 103.7 103.5 103.4 103.3 103.4 December 2003 = 100 100.1 100.7 100.8 100.9 101.6 101.6 101.6 101.7 101.9 102.4 102.5 104.3

Table 3. Cost of living

I II III IV V VI VII VIII IX X XI XII Chain index 100.1 100.2 100.1 100.0 100.4 99.4 99.3 100.1 100.0 100.3 100.1 101.6 ø 2003 = 100 102.3 102.5 102.8 102.8 103.2 102.6 101.9 101.9 101.9 102.2 102.3 103.9 Same month in the preceding year 105.2 105.4 105.8 102.6 102.8 100.9 100.9 100.8 100.3 100.3 100.3 101.5 The same period in the preceding year 105.3 105.8 105.0 104.6 103.8 103.6 103.2 102.8 102.6 102.4 102.4 December 2003 = 100 100.1 100.3 100.4 100.4 100.8 100.2 99.5 99.6 99.5 99.8 99.9 101.5

Table 4. Producers’ prices of manufactured products

I II III IV V VI VII VIII IX X XI XII Chain index 99.8 100.5 103.3 100.6 100.3 99.6 100.2 100.3 99.4 99.9 100.0 99.6 ø 2003 = 100 102 102.6 106 106.6 107.0 106.6 106.8 107.1 106.4 106.3 106.3 105.9 Same month in the preceding year 106.3 106.9 108.7 106.3 106.7 105.5 105.7 106.0 104.9 104.6 104.6 103.6 The same period in the preceding year 106.6 107.3 107.0 107.0 106.7 106.6 106.5 106.3 106.1 106.0 105.8 December 2003 = 100 99.8 100.4 103.7 104.4 104.7 104.3 104.5 104.8 104.1 104.0 104.0 103.6 Source: Monstat

121 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

Table 5. Prices

Producers prices of Retail prices Costs of living manuf. products Total Goods Servicies Total Total annual monthly annual monthly annual monthly annual monthly annual monthly growth growth growth growth growth growth growth growth growth growth rate rate rate rate rate rate rate rate rate rate Jan 20.5 3.7 21.7 4.5 15.1 0.3 20.1 4.8 12.4 1.1 Feb 21.4 1.6 22.4 1.5 16.5 2.4 20.5 1.7 12.4 5.3 Mar 20.3 0.7 20.7 0.3 18.3 2.3 19.7 0.7 10.9 -0.5 Apr 19.2 0.8 19.4 0.8 18.4 0.6 17.5 0.8 10.8 0.6 May 18.8 1.0 19.0 1.2 18.3 0.0 17.9 1.8 13.2 1.3 Jun 21.9 3.2 19.3 0.9 34.4 14.1 22.1 3.0 13.1 0.3 2001 Jul 23.4 2.4 18.6 0.5 45.3 10.4 21.5 0.4 15.5 1.1 Aug 24.8 2.7 20.5 3.2 44.9 1.1 23.3 2.7 19.7 1.6 Sep 25.6 2.0 21.4 2.0 45.3 1.8 23.5 1.3 18.6 -1.2 Oct 25.1 0.5 20.9 0.6 44.8 0.1 22.8 0.5 19.4 -0.5 Nov 25.0 2.8 21.5 3.5 41.5 0.0 24.3 3.7 12.7 1.2 Dec 28.0 3.5 25.6 4.0 39.5 1.7 26.5 2.5 15.1 4.1 Jan 20.3 1.7 19.0 0.6 26.5 6.9 18.3 1.3 7.3 0.6 Feb 19.7 0.9 18.7 1.1 24.5 0.3 18.0 1.3 6.0 1.1 Mar 19.8 0.6 19.2 0.8 22.3 0.0 18.2 0.9 7.9 1.0 Apr 20.8 1.6 20.6 2.0 21.6 0.1 19.7 2.0 7.1 -0.2 May 21.3 1.4 21.1 1.6 21.9 0.3 19.4 1.7 6.6 0.4 Jun 20.7 0.8 21.2 0.9 18.2 0.2 19.1 0.8 3.8 -2.4 2002 Jul 19.4 0.1 20.7 0.1 13.5 0.2 17.6 -1.0 2.4 -0.3 Aug 17.3 0.3 18.2 0.3 13.0 0.8 15.8 0.4 0.9 -0.6 Sep 16.1 0.9 16.9 0.8 12.6 1.4 15.5 0.9 3.8 1.4 Oct 15.7 0.3 16.4 0.3 12.7 0.2 15.1 0.2 4.2 -0.1 Nov 12.8 0.3 12.4 0.0 14.7 1.9 11.0 0.1 3.9 0.1 Dec 9.4 0.1 8.7 0.1 12.7 0.0 9.2 0.5 0.7 -0.3 Jan 8.4 0.8 8.4 0.3 8.4 2.8 8.4 0.5 -0.7 -0.1 Feb 8.0 0.5 7.5 0.2 10.3 2.1 7.2 0.1 -1.5 0.0 Mar 8.0 0.6 6.8 0.1 13.8 3.2 6.5 0.2 -0.7 1.8 Apr 9.7 3.2 8.1 3.2 17.3 3.2 7.7 3.1 3.8 3.8 May 8.5 0.2 6.6 0.2 17.4 0.4 6.1 0.2 2.9 0.0 Jun 8.0 0.3 6.0 0.4 17.1 0.0 6.6 1.3 6.7 0.9 2003 Jul 8.3 0.3 5.8 -0.2 19.8 2.4 6.9 -0.8 7.2 0.2 Aug 8.0 0.1 5.7 0.1 18.9 0.0 6.7 0.2 7.9 0.0 Sep 7.4 0.3 5.2 0.4 17.4 0.2 6.3 0.5 6.7 0.4 Oct 7.1 0.1 5.0 0.1 17.2 0.0 6.3 0.2 7.0 0.1 Nov 6.8 0.0 5.0 0.0 15.1 0.0 6.4 0.1 7.3 0.2 Dec 6.7 0.0 5.1 0.2 14.3 -0.7 6.2 0.3 8.2 0.6 Jan 5.2 0.1 4.2 0.1 10.3 0.2 5.2 0.1 6.3 -0.2 Feb 5.7 0.5 4.5 0.2 11.1 2.3 5.4 0.2 6.9 0.5 Mar 5.5 0.1 4.9 0.1 8.4 0.2 5.8 0.1 8.7 3.3 Apr 2.3 0.1 1.7 0.2 5.0 0.0 2.6 0.0 6.3 0.6 May 2.7 0.6 1.7 0.2 7.4 2.6 2.8 0.4 6.7 0.3 Jun 2.4 0.0 1.3 0.0 7.5 0.1 0.9 -0.6 5.5 -0.4 2004 Jul 2.1 0.0 1.5 -0.1 5.0 0.1 0.9 -0.7 5.7 0.2 Aug 2.1 0.1 1.4 0.1 5.0 0.0 0.8 0.1 6.0 0.3 Sep 2.0 0.2 1.2 0.1 5.2 0.3 0.3. 0.0 4.9 -0.6 Oct 2.4 0.5 1.3 0.2 7.1 1.8 0.3 0.3 4.6 -0.1 Nov 2.5 0.1 1.2 0.1 7.8 0.0 -0.1 0.1 4.0 0.0 Dec 4.3 1.8 1.1 -0.1 18.1 9.5 1.5 1.6 3.6 -0.4 Source: Monstat

122 ANNEXES

Table 6. Review of calculated and appropriated reserve requirements, EUR thousand

Licensed banks 1 2 3 4 5 6 7 8 9 10 11 Komerc. Hipotekarna Podgoricka Crnog. kom. Euromarket Niksicka Pljevaljska Atlas Mont Montenegro- Opportunity TOTAL bank - bank bank bank bank bank bank bank bank bank (1-10) Budva 5,469 4,715 8,624 2,995 498 208 1,774 1,545 352 1,362 27,542 2003 December 5,207 4,915 8,636 2,987 607 225 1,735 1,405 374 1,296 27,387 4,831 5,024 8,545 2,733 681 194 1,881 1,547 369 1,278 27,083 5,536 4,851 7,986 2,579 658 221 1,650 1,455 293 1,225 26,454 January 4,625 5,083 8,119 2,483 562 183 1,657 1,470 287 1,216 25,685 5441 4,870 8,169 2,637 483 212 1,746 1,647 295 1,193 26,693 February 5,095 4,789 8,008 2,620 390 201 1,662 1,518 337 1,387 26,007 4,785 4,671 7,587 2,218 445 258 1,471 1,520 411 1,472 24,838 March 5,138 4,660 7,862 2,486 348 231 1,424 1,657 428 1,391 25,625 4,767 4,647 7,963 2,251 369 233 1,640 1,816 380 1,196 25,262 April 4,599 4,717 8,314 2,317 397 211 1,755 1,927 380 1,287 25,904 4,065 4,822 8,035 2,368 361 190 1,843 2,102 369 1,336 25,491 May 3,843 4,971 8,181 2,318 415 203 2,034 2,060 409 1,329 25,763 3,806 5,102 8,674 2,364 373 168 2,217 2,305 402 1,265 26,676 June 3,636 4,996 8,952 2,235 400 183 2,121 2,300 414 1,354 26,591 3,402 4,991 7,991 2,274 375 167 1,903 2,021 451 1,309 24,886 3,173 4,853 8,626 2,396 461 306 1,852 2,082 439 1,364 25,552 July 3,122 5,182 9,608 2,588 546 284 2,241 2,532 489 1,482 28,074 3,209 5,450 11,848 2,772 687 285 2,416 2,508 501 1,556 31,232 August 3,076 5,678 12,137 3,001 725 260 2,358 2,607 523 1,642 32,007 3,361 5,929 13,374 3,214 698 260 2,670 2,617 530 1,725 34,378 2004 3,381 6,160 13,222 3,316 796 261 2,836 2,634 532 1,707 34,845 3,190 6,094 12,705 3,391 755 335 2,760 2,605 478 1,706 34,019 September 3,300 6,207 12,330 3,576 667 268 2,770 2,485 483 1,715 33,801 3,022 6,167 12,039 3,421 634 268 2,924 2,510 522 1,830 33,337 2,160 6,371 12,012 3,364 646 307 2,887 2,715 500 1,738 33,700 3,131 6,191 11,775 2,679 685 278 2,679 2,813 482 1,729 32,460 2,954 6,667 12,071 4,810 593 283 2,632 2,515 603 1,678 34,806 October 2,793 6,627 12,299 4,266 617 236 2,640 2,377 547 1,828 34,230 2,803 5,985 11,824 4,199 582 251 2,604 2,478 584 1,903 33,213 2,704 5,885 12,182 4,305 658 278 2,640 2,357 595 1,910 33,514 2,799 5,776 13,058 3,568 710 239 2,839 2,394 601 2,163 34,147 November 2,760 5,608 12,047 3,559 730 247 2,732 2,487 601 2,176 32,947 2,744 5,985 12,026 3,706 727 282 2,861 3,615 608 2,151 34,705 2,767 5,752 11,382 3,146 839 354 2,856 2,484 699 1,984 32,263 2,596 5,750 10,973 3,070 804 346 2,625 2,522 694 1,940 31,320 December 2,557 5,799 11,080 3,081 758 315 2,498 2,677 695 1,989 31,449 2,651 5,794 11,442 4,612 654 298 2,605 2,361 669 2,022 33,108 2,570 6,048 10,361 5,059 580 404 3,010 2,401 716 2,017 33,166

Source: Central Bank of Montenegro

123 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004 4.00 8.00 11.00 11.00 36.00 36.00 2004 4.02 8.03 11.81 10.83 32.29 38.39 2003 Maximal interest rates (%) 8.00 39.17 13.04 43.20 16.00 30.00 2002 1.50 1.00 0.50 3.00 0.80 8.00 2004 1.95 7.06 0.97 2.07 0.49 3.04 2003 1.37 7.00 1.30 2.00 2.00 0.80 Minimal interest rates (%) 2002 Table 7. 7. Table Minimal and maximal interest rates of banks in Montenegro, annually BanksSource: in Montenegro On term deposits in other currencies Interests receivable On short-term loans On term deposits in EUR On securities held maturity to Interests payable On demand deposits On long-term loans

124 ANNEXES

Table 8. Auctions of 28-day T-bills

2003 2004 Interest Interest Demand Issued Sold T-bills Demand Issued Sold T-bills rate rate sold (%) sold (%) (EUR thousand) (annual %) (EUR thousand) (annual %) January 5.912.00 7.000.00 5.912.00 84.46 7.99 12.162.00 12.000.00 12.000.00 100.00 10.10 February 5,762.00 6,500.00 5,762.00 88.65 8.49 11,225.00 12,500.00 11,225.00 89.80 10.71 March 6,065.00 7,000.00 6,065.00 86.64 8.94 11,647.00 12,000.00 11,647.00 97.06 10.72 April 7,028.00 7,500.00 7,028.00 93.71 10.17 15,027.00 17,000.00 15,027.00 88.39 10.73 May 6,949.50 8,000.00 6,949.50 86.87 10.45 15,840.50 16,000.00 15,840.50 99.00 10.49 June 6,674.00 7,500.00 6,674.00 88.99 10.75 15,555.50 15,000.00 15,000.00 100.00 10.45 July 6,682.00 7,000.00 6,682.00 95.46 10.71 15,132.00 15,500.00 15,132.00 97.63 10.48 August 8,285.00 7,000.00 7,000.00 100.00 10.83 16,559.00 16,000.00 16,000.00 100.00 10.45 September 8,832.00 8,000.00 8,000.00 100.00 10.76 18,812.00 16,100.00 16,100.00 100.00 9.92 September 0.00 0.00 0.00 0.00 0.00 12,962.00 13,500.00 12,962.00 96.01 9.59 October 8,847.00 8,500.00 8,500.00 100.00 10.57 12,600.00 13,000.00 12,600.00 96.92 9.38 October 10,760.00 9,500.00 9,500.00 100.00 10.25 0,00 0.00 0.00 0.00 0.00 November 10,629.00 12,000.00 10,629.00 88.58 10.01 11,100.00 10,500.00 10,500.00 100.00 8.92 December 12,008.00 13,000.00 12,008.00 92.37 10.08 10,600.00 10,700.00 10,600.00 99.07 8.83 Total 104,433.50 108,500.00 100,709.50 92.82 10.00 179,222.00 179,800.00 174,633.50 97.13 10.06

Source: Central Bank of Montenegro

Table 9. Auctions of 56-day T-bills

2003 2004 Interest Interest Demand Issued Sold T-bills Demand Issued Sold T-bills rate rate sold (%) sold (%) (EUR thousand) (annual %) (EUR thousand) (annual %) January 1,670.00 3,000.00 1,670.00 55.67 8.13 3,788.00 5,500.00 3,788.00 68.87 10.22 February 2,250.00 3,000.00 2,250.00 75.00 8.38 3,403.50 4,500.00 3,403.50 75.63 10.48 March 1,320.00 4,500.00 1,320.00 29.33 9.13 2,568.00 4,500.00 2,568.00 57.07 10.80 April 2,866.00 4,000.00 2,866.00 71.65 10.05 3,095.00 4,000.00 3,095.00 77.38 10.63 April 2,100.00 3,000.00 2,100.00 70.00 10.06 2,873.50 3,000.00 2,873.50 95.78 10.82 May 2,876.00 3,000.00 2,876.00 95.87 10.76 4,197.50 4,000.00 4,000.00 100.00 10.57 June 2,143.50 2,500.00 2,143.50 85.74 11.51 4,000.00 4,000.00 4,000.00 100.00 10.19 July 3,826.00 4,500.00 3,826.00 85.02 11.24 4,499.00 4,500.00 4,499.00 99.98 10.41 August 3,443.50 3,000.00 3,000.00 100.00 11.12 7,152.00 5,000.00 5,000.00 100.00 9.98 September 5,340.00 4,500.00 4,500.00 100.00 10.63 5,524.00 5,500.00 5,500.00 100.00 9.78 October 3,235.50 4,000.00 3,235.50 80.89 10.45 7,700.00 5,000.00 5,000.00 100.00 8.94 November 4,982.00 5,500.00 4,982.00 90.58 10.03 7,400.00 5,500.00 5,500.00 100.00 8.78 December 2,743.50 4,000.00 2,743.50 68.59 10.13 4,600.00 5,200.00 4,600.00 88.46 8.62 Total 38,796.00 48,500.00 37,512.50 77.35 10.12 60,800.50 60,200.00 53,827.00 89.41 10.02

Source: Central Bank of Montenegro

125 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

Table 10. Auctions of 91-day T-bills

Issue Demand Issued Sold Interest rate Interest paid Auction date (EUR thousand) (annual percent) (EUR) 1 24.06.04. 2,000.00 2,000.00 2,000.00 10.90 53.627.96 2 30.06.04. 2,000.00 2,000.00 2,000.00 10.97 53.960.49 3 23.09.04. 2,000.00 21,000.00 2,000.00 10.90 53.627.96 4 29.09.04 9,128.00 5,000.00 5,000.00 9.80 130.619.53 5 22.12.04. 2,200.00 2,000.00 2,000.00 10.66 52.473.36 6 28.12.04. 2,000.00 4,000.00 2,000.00 9.50 47.745.13 7 29.12.04. 5,100.00 5,100.00 5,100.00 9.70 122.009.75 8 31.12.04. 0.00 2,000.00 0.00 0.00 0.00

Source: Central Bank of Montenegro

Table 11. Auctions of 182-day T-bills

Issue Demand Issued Sold Interest rate Interest paid Auction date (EUR thousand) (annual percent) (EUR) 1 15.07.04. 3,500.00 3,500.00 3,500.00 10.82 181.206,14 2 17.11.04. - 2,000.00 - - - 3 24.11.04. 2,500.00 2,000.00 2,000.00 10.15 97.590,85 4 01.12.04. 2,500.00 2,000.00 2,000.00 9.00 86.994,96

Source: Central Bank of Montenegro

126 ANNEXES

Table 12. Balance of payments of Montenegro, EUR thousand

January-December Index Difference 2003 2004 1 2 3 GOODS Total exports 270,574 381,607 141.0 111,033 Export of goods excluding aluminum and trade with Serbia and Kosovo 67,849 101,484 149.6 33,635 Export of aluminum 109,726 158,069 144.1 48,343 Export to Serbia and Kosovo 92,999 122,054 131.2 29,055 Total Imports 629,904 812,507 129.0 182,603 Import of goods excluding electricity and trade with Serbia and Kosovo 316,441 456,559 144.3 140,118 Import of oil and gas 50,124 61,380 122.5 11,256 Import of electricity 46,526 48,777 104.8 2,251 Import from Serbia and Kosovo 216,813 245,791 113.4 28,978 Goods trade balance -359,330 -430,900 119.9 -71,570 SERVICES Total Transportation Revenues 35,009 45,341 129.5 10,332 Transport official data about revenues 29,634 39,756 134.2 10,122 Transport revenues from Serbia 5,375 5,585 103.9 210 Total transportation Expenditures 25,904 29,378 113.4 3,474 Transport official data about expenditures 19,801 19,262 97.3 -539 Transport expenditures to Serbia 6,103 10,116 165.8 4,013 Transportation services balance 9,105 15,963 175.3 6,858 Total Revenues from Tourism 136,046 163,495 120.2 27,449 Revenues from tourists abroad (estimate) 61,753 82,204 133.1 20,451 Tourists from Serbia (estimate) 74,293 81,291 109.4 6,998 Total Expenditures to Tourism 10,096 6,951 68.8 -3,145 Expenditures for tourism abroad 8,043 5,214 64.8 -2,829 Montenegrin tourists in Serbia 2,053 1,737 84.6 -316 Tourism balance 125,950 156,544 124.3 30,594 Revenues from Financial Services 2,848 4,035 141.7 1,187 Commision fee 1,567 3,308 211.1 1,741 Commision fee on serbian import/export 1,281 727 56.8 -554 Others Expenditures to financial services 6,761 6,462 95.6 -299 Commision fee 5,517 5,290 95.9 -227 Commision fee on serbian import/export 1,244 1,172 94.2 -72 Financial services balance -3,913 -2,427 1,486 Revenues from other Services 17,492 28,252 161.5 10,760 Expenditures to other services 36,901 58,453 158.4 21,552 Balance of other services -19,409 -30,201 155.6 -10,792 Revenues from services 191,395 241,123 126.0 49,728 Expenditures to services 79,662 101,244 127.1 21,582 Balance of services 111,733 139,879 125.2 28,146 Total balance of goods and services -247,597 -291,021 117.5 -43,424 Income Income revenues 125,337 152,722 121.8 27,385 Compensation of employees 85,496 129,822 151.8 44,326 Revenues from Serbia for individuals 39,261 22,314 56.8 -16,947 Interest income 577 541 93.8 -36 Received dividends 3 45 1500.0 42 Investments abroad Income Expenditures 25,827 48,888 189.3 23,061 Compensation of employees 3,362 6,289 187.1 2,927 Expenditures for Serbia for individuals 1,083 2,782 256.9 1,699 Interest expenses 12,568 24,524 195.1 11,956 Paid dividends 8,814 15,293 173.5 6,479 Investments abroad (estimate) Balance of income 99,510 103,834 104.3 4,324 Current transfers Revenues 55,225 54,946 99.5 -279 Transfers to Montenegro from abroad 3,188 8,568 268.8 5,380 Foreign assistance 21,807 20,078 92.1 -1,729 Foreign assistance, over NGO and humanitarian organization 30,230 26,300 87.0 -3,930 Expenditures 9,124 10,727 117.6 1,603 Transfers from Montenegro to abroad 9,124 10,727 117.6 1,603 Balance of current transfers 46,101 44,219 95.9 -1,882 Total revenues 642,531 830,398 129.2 187,867 Total expenses 744,517 973,366 130.7 228,849 TOTAL BALANCE OF CURRENT ACCOUNT -101,986 -142,968 140.2 -40,982 CAPITAL AND FINANCIAL ACCOUNT 133,030 170,905 128.5 37,875 Capital account Capital transfers Financial account 133,030 170,905 128.5 37,875 Direct investment 38,725 50,015 129.2 11,290 Equity capital 38,725 50,015 129.2 11,290 Reinvested earnings and undistributed branch profits Portfolio investment-net 942 5,524 586.4 4,582 Other investments 47,047 98,170 208.7 51,123 Loans 114,597 176,103 153.7 61,506 Repaid loans 67,550 77,933 115.4 10,383 Change in Net Foreign Assets 45,759 32,237 Change in CBM foreign reserve assets 557 -15,041 Net errors and omissions 31,044 27,937 Source: Central Bank of Montenegro

127 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

Table 13. Foreign direct investment in Montenegro, by country 01.01 - 31.12.2004, EUR

Financ. Total Production Services Real estate Organiz. 1=2+3+4+5 2 3 4 5 Austria 2,259,000.00 2,259,000.00 Bosnia and Herzegovina 178,795.00 125,000.00 53,795.00 Estonia 1,810,184.99 196,910.00 1,613,274.99 France 215,598.62 77,000.00 138,598.62 Greece 174,791.00 25,000.00 149,791.00 Croatia 57,490.00 57,490.00 Irska 164,950.00 164,950.00 Israel 486,630.00 486,630.00 Italy 268,999.90 268,999.90 Japan 1,120,000.00 1,120,000.00 Canada 143,798.00 143,798.00 Cyprus 2,015,283.86 720,532.26 1,294,751.60 Hong Kong 90,757.50 90,757.50 Letonia 3,730,673.00 3,730,673.00 Hungary 2,402,985.00 2,095,000.00 307,985.00 Germany 7,774,509.88 3,235,916.88 4,538,593.00 Panama 1,299,973.00 1,199,973.00 100,000.00 Russian Federation 669,760.00 649,780.00 19,980.00 USA 822,236.12 227,941.40 63,137.90 360,354.24 170,802.58 Slovakia 100,000.00 100,000.00 Slovenia 14,068,572.23 534,125.40 12,466,501.00 0.00 1,067,945.83 Serbia 1,825,000.00 392,000.00 925,000.00 508,000.00 Switzerland 6,603,229.59 6,079,385.79 523,843.80 Sweden 11,795.00 11,795.00 United Kingdom 449,845.13 124,858.33 324,986.80 Lithuania 299,825.00 299,825.00 Lesoto 15,000.00 15,000.00 Danemark 78,987.40 78,987.40 Luxembourg 13,966.02 13,966.02 Norway 6,100.91 6,100.91 Virgin Islands (British) 700,000.00 700,000.00 Lichtenstein 200,925.00 200,925.00 Bulgaria 1,750,000.00 1,750,000.00 TOTAL 51,809,662.15 2,274,066.80 37,670,997.49 10,625,849.45 1,238,748.41

Source: Central Bank of Montenegro

128 ANNEXES 1 7 3 5 6 2 1 2 6 2 6 2 1 2 3 4 5 6 3 1 14 82 TOTAL 7 bank Affiliate Affiliate Affiliate Affiliate Affiliate Affiliate Head office Opportunity 2 bank Pljevaljska Branch office Branch office 6 bank Affiliate Branch office Branch office Branch office Branch office Branch office Komercijalna ce 5 bank Affiliate Affiliate Window Window Hipotekarna Branch offi 3 bank Org.unit Nikšićka Org. unit Org. unit

ička 8 bank Affiliate Affiliate Window Window Window Head office Podgor Branch office Branch office 20 Bank Affiliate Affiliate Affiliate Affiliate Affiliate Affiliate Affiliate Affiliate Window Window Window Window Org. unit Crnogorska Branch office Branch office Branch office Branch office Branch office Branch office Branch office Komercijalna 10 Affiliate Affiliate Affiliate Affiliate Affiliate Affiliate Window Window Branch office Branch office Montengrobank 9 bank Org.unit Org.unit Org.unit Org.unit Org.unit Org.unit Org.unit Org.unit Window Head office Euromarket 12 Affiliate Affiliate Affiliate Affiliate Affiliate Affiliate Window Branch office Branch office Branch office Branch office Branch office Atlasmont bank : Table 14. 14. Table arrangementTerritorial of organizational units of banks licensed perform to payment operations in 2004 licenses for performing 14 paymentNOTE: operations were the organizational issued to units of six banks and are they presented in the table in bold. Andrijevica Location Bar Berane Bijelo Polje Budva Danilovgrad Žabljak Kolašin Kotor Mojkovac Nikšić Plav Plužine Pljevlja Podgorica Tivat Ulcinj HercegNovi Cetinje Šavnik TOTAL Rožaje

129 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004 1 3 2 5 4 7 7 9 3 6 5 2 7 7 3 4 5 5 5 8 7 105 TOTAL bank Opportunity 7 7 14 bank Pljevaljska 2 2 bank Komercijalna 2 2 2 5 11 bank Hipotekarna 4 7 7 18 bank Nikšićka

čka i 1 6 7 1 1 2 18 bank Podgor 1 2 1 4 Bank Crnogorska Komercijalna 1 5 6 Montenegrobank 3 1 1 4 5 3 17 bank Euromarket 1 2 2 1 5 2 2 15 Atlasmont bank Table 15. 15. Table Review of interbank contracts for performing payment operations in the Republic of Montenegro Note: Nine banks contracts, signed of which four 109 were terminated, more interbank but 25 contracts were signed in the reporting year than in 2003. Andrijevica LOCATION Bar Berane Bijelo Polje Budva Danilovgrad Žabljak Kolašin Kotor Mojkovac Nikšić Plav Plužine Pljevlja Podgorica Rožaje Tivat Ulcinj Herceg Novi Cetinje Šavnik TOTAL

130 ANNEXES 1 1 2 otal t artial p SUPERVISIONS UNEPERFORMED 1 1 2 ull f otal t artial p SUPERVISIONS EXTRAORDINARY ull f 6 3 8 1 1 8 2 2 1 1 1 1 1 1 1 1 11 50 otal t artial p 6 3 8 1 1 8 2 2 1 1 1 1 1 1 1 1 11 50 full PERFORMED SUPERVISIONS 6 3 9 1 1 8 2 2 1 1 1 1 1 1 1 1 12 52 otal t IONS S artial p PLANNED SUPERVI 6 3 9 1 1 8 2 2 1 1 1 1 1 1 1 1 ull 12 52 f PERVISED SUBJECTPERVISED SU : šićka bank AD Nikšić Hipotekarna bank AD Podgorica CBCG-Regional centre Bijelo Polje Montenegrobank AD Podgorica CBCG-Regional centre Podgorica Pljevaljska bank AD Pljevlja Crnogorska komercijalna bank AD PG CBCG-Regional centre Nikšić CBCG-Regional centre Berane CBCG-Regional centre Kotor Opportunity bank AD Podgorica CBCG-Regional centre Bar TOTAL Euromarket bank AD Podgorica Komercijalna bank AD Budva Atlasmont bank AD Podgorica Podgorička bank AD Podgorica Nik CBCG-Regional centre Pljevlja . 7. 1. 9. 5. 2. 3. 4. 6. 8. Table 16. 16. Table Report on supervisions of the bearers of payment operations in 2004 17. 11. 15. 12. 13. 14. 10. 16. No

131 CENTRAL BANK OF MONTENEGRO ANNUAL REPORT 2004

Table 17. Statistics of the completed training of the CBM employees in the country

Qualification structure of participants Number of Two-year post Institution Course/Seminar/Training Duration Secondary participants secondary University school school

Institute for Foreign Languages in English language courses 3 months 47 7 36 Podgorica Institute for Foreign Languages in English language courses 3 months 27 6 19 Podgorica Association of Lawyers of SCG Days of law on Kopaonik 5 days 2 2 Association of Lawyers of SCG Days of law in Budva 4 days 4 4 Disbursement of the EU funds for Centre for the European Education 2 days 6 6 economic development and integration SWIFT Educational Centre, Belgrade SWIFTcourse 2 days 3 3 SWIFT Educational Centre, Belgrade Credit Transfer and Cash Management 1 days 2 2 SWIFT Educational Centre, Belgrade Credit Transfer and Cash Management 2 days 1 1 Anti-Money Laundering Prevention of Money Laundering 2 days 2 2 Administration, Podgorica Provision of receivables in Law and TAZ - Belgrade 2 days 3 3 Practice and New Legal Regulations Friedrich Ebert Stiftung and Centre European Integration- Different 3 days 2 2 for Civil Education Aspects and our way Bearing Point - Podgorica Performance Management Workshop 5 days 40 Bearing Point - Podgorica Seminar- Performance Management 1 day 215 IMF - Belgrade Financial Programming and Policies 12 days 2 2 Belgrade Fair Book Fair 6 days 2 2 Republic Secretariat for Festival of IT Achievements 8 days 4 4 Development of Montenegro United SCG IT Association IX JISA Congress 5 days 1 1 Montora - Podgorica Introduction in Oracle 9i:SQL 4 days 1 1 BS and British Standards Institution System of the information protection 1 day 1 1 Belgrade and security (ISO 17799) Manage - Beograd Human Resources Management 2 days 3 3 PWH Beograd IAS /IFRS Expert modul 2 days 2 2 Agency for Reconstruction and the Public Relations in Democratic Societes 3 days 1 1 Council of Europe Fridrich Nauman Foundation - EU and Communication Strategy 2 days 1 1 Podgorica Training as the form of the Human Srma Consulting - Belgrade 1 day 1 1 Resources Development

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Table 18. Statistics of the completed training of the CBM employees abroad

Qualification structure of participants Number of Two-year post Institution Course/Seminar/Training Duration Secondary participants secondary University school school Risk Management 5 days 1 1 Foreign Exchange Management 5 days 1 1 Payment System 5 days 1 1 Deutsche Bundesbank Internal Audit 5 days 2 2 Public Relations 5 days 1 1 Human Resources Management 5 days 1 1 Foreign Exchange Management 5 days 1 1 Bank of England Back Office 5 days 1 1 Public Debt Management 5 days 1 1 Monetary Policy 4 days 2 2 Crisis and Security Management in Central Banks 3 days 2 2 Czech National Bank Securities Payments and Settlements Systems 2 days 1 1 The Role of the Internal Audit 3 days 2 2 Monetary Policy 5 days 2 2 Credit Risk Transfer 3 days 2 2 National Bank of Poland Control on a Consolidated Base 5 days 2 2 Study Visit 3 days 3 3 Management and Operations 5 days 1 1 Preparatory Workshop 2 days 1 1 Central Banking 9 days 1 1 Federal Reserve System of New York Portfolio Management and Market Analysis 5 days 1 1 Banking Supervision I 5 days 1 1 Implementation of US Monetary Policy 5 days 1 1 Practical training 15 days 4 4 Study Visit 5 days 4 4 The Constitution for the Enlarged Europe: the Oesterreichische nationalbank institutional and economic implications on the 1 day 1 1 economic and monetary union Foreign Exchange Management 3 days 1 1 De Nederlandsche Bank Securities Payments and Settlements Systems 4 days 1 1 Banque de France Fight Against Counterfeiting 3 days 1 1 IMF Financial Programming and Policies 53 days 1 1 Basic Control Issues 4 days 1 1 Challenges on the road to EU and EMU 4 days 3 3 Monetary and Financial Statistics 18 days 2 2 Joint Vienna Institute Macroeconomic Analysis and Policy 25 days 1 1 Direct Foreign Investment Policies 5 days 1 1 Accounting in Central Banks 5 days 1 1 Development of the Mortgage Market 2 days 1 1 Tax opennes: issues and practices 3 days 1 1 Holland experience in transfer from indirect to direct 2 days 1 1 reporting Balance of Payments: data sources and recording Center of Excellence in Finance 3 days 1 1 services in the balance of payments statistics Macroeconomic Management and Financial Sector 10 days 1 1 Issues Internal Audit 2 days 3 3 Project Management 5 days 3 3 Monetary theories and policies 12 days 1 1 Study Center Gerzensee Monetary economy 12 days 1 1 Salzburg Seminar - Austria The Fifth Lawyers Assembly 5 days 3 3 National Bank of Croatia Regional Symposium on Balance Statistics 4 days 2 2 Dubrovnik Investment Conference 8 8 Practical Training – Training Program on International Lloyd TSB Bank PC 5 days 1 1 Banking Operations SWIFT Conference, Vienna Regional Conference 3 days 1 1 Commercial Bank Frankfurt International Banking Seminar 16 days 1 1 Fortis Commercial Banking and the Bank of Seminar on Developing Markets 1 day 2 2 Belgium, Geneva The Currency Conference, Rim Currency Issues 4 days 2 1 1 Eurostat, Luksemburg Financial Accounting 2 days 1 1 HP Minhen Technology Fair 4 days 1 1 Association of Chartered Certified Accountants, International Accounting Standards 2 days 2 2 Prague Croatian Economic Chamber and EDUCA plus Human Resources Management 3 days 2 2

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Table 19. Public appearances of the Central Bank of Montenegro employees in media

Media No. of appearances Organisational level Others 11 22 33 In the Country Newspapers 26 8 6 7 5 Magazines 12 8 1 3 TV shows 19 14 5 Informational 12 Thematic 7 Radio shows 23 2 21 Agencies 16 9 7 Total: 108 32 22 8 8 Press conferences 5 CBCG website– announcements and similar 22 Professional conferences 8 6 2 1 International media Newspapers 1 1 Magazines 4 4 Agencies 12 Total: 17

1 Top management – Executives and the Chief Economist 2 Medium management – Directors of departments, their deputies and assistants 3 Chiefs of divisions within the departments

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Annex 2: Enabling Regulations

Regulations governing the Bank Supervision

Regulation of Reports that Banks Submit to the Central Bank of Montenegro (“Official Gazette of RM”, no. 9/04) Regulation on the Manner and Procedures of and Fees for the Bank Supervision (“Official Gazette of RM”, no. 70/04) Regulation on Minimal Standards for Market Risk Management in Banks (“Official Gazette of RM”, no.81/04)

Regulations and Instructions governing the Financial and Banking Operations Regulation on Amendments to the Regulation on the Performing of Payment Operations with the Republic of Serbia and Kosovo and Metohija (“Official Gazette of RM”, no.14/04) Instruction on Amending the Instruction on the Methods of Performing Payment Operations with the Republic of Serbia and Kosovo and Metohija, and contribution to the preparation of the respective Law (“Official Gazette of RM”, no.14/04) Decision on the Issue of Treasury Bills (“Official Gazette of RM”, no. 24/04) Regulation on Amending the Regulation on Reserve Requirements of Banks with the Central Bank of Montenegro (“Official Gazette of RM”, no. 50/04) Regulation on the Conditions and Manner of Performing Exchange Operations (“Official Gazette of RM”, no. 70/04)

Regulations governing the Payment System Regulation on Amending the Regulation on Compensation for Services of the Central Bank of Montenegro for Performing Payment Operations in the Interbank Payment System and the Giro System (“Official Gazette of RM”, no.63/04) Regulation on the Conditions and Method of Performing Domestic Payment Operations by the Authorized Agent (“Official Gazette of RM”, no. 78/04) Regulation on Performing Domestic Payment Operations Electronically (“Official Gazette of RM”, no. 78/04) Regulation on Performing the Enforcement Collection from the Account of the Named Debtor (“Official Gazette of RM”, no. 78/04) Regulation on the Form, Contents, and Use of the Unique Payment System Instruments for Domestic Payment Operations (“Official Gazette of RM”, no. 78/04) Regulation on Performing Interbank Payments from Settlement Accounts of Participants in the Interbank Payment System (“Official Gazette of RM”, no. 78/04) Regulation on Compensation of Services of the Central Bank of Montenegro for Performing Domestic Payment Operations (“Official Gazette of RM”, no. 78/04) Regulation on the Unique Structure for the Identification and Classification of the Accounts for Performing Domestic Payment Operations (“Official Gazette of RM”, no. 78/04) Regulation on Domestic Payment Operations (“Official Gazette of RM”, no. 78/04) Regulation on Amending the Regulation on Domestic Payment Operations (“Official Gazette of RM”, no. 46/04,57/04) Regulation on the Sort of Data that Banks Submit to the Central Bank of Montenegro and the Method and Terms of the Submission of that Data (“Official Gazette of RM”, no. 78/04) Regulation on Opening, Maintaining, and Closing of the Accounts for Performing Domestic Payment Operations (“Official Gazette of RM”, no. 78/04)

Currency regulations - the Euro Regulation on Providing Banks with Bank Notes and Coins (“Official Gazette of RM”, no. 82/04)

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Annex 3: The Policy of the Central Bank for 2005

Pursuant to Article 17, Paragraph 1, Item 1 of the Law on the Central Bank of Montenegro (“Official Gazette of the Republic of Montenegro”, No. 52/00 and 47/01), the Council of the Central Bank of Montenegro at its meeting held on 17 December 2004 adopted:

THE POLICY OF THE CENTRAL BANK FOR 2005

Relying upon the results of the policies in previous years, especially in the domain of the credibility of the banking system and financial stability, the Central Bank of Montenegro set the following aims for 2005:

1. Monitoring and analysing the state of the economy, and especially the financial system of the Republic with a view to determining and undertaking effective measures of monetary policy, and giving recommendations for improvement in economic policy as a prerequisite for accelerated economic growth; 2. The maintenance of the safety and stability of the banking system and financial discipline through comprehensive assessment of risks in banks’ operations, and improvement in bank supervision concerning a broader division of risk and expanding to those fields defined in other legal acts; 3. Further improvement in monitoring and controlling liquidity in the banking system and the managing of the monetary reserves of the Republic of Montenegro; 4. Maintenance of the efficiency and further development in the payment system in the country supported by new technology; 5. Further improvement in the efficient performance of the functions of banker, advisor, and fiscal agent on behalf of the agencies and organisations of the Republic of Montenegro; 6. Improve the cooperation with international financial institutions and organisations, and other central banks; 7. Upgrade the personnel and technical efficiency of the Central Bank; 8. Analyse the viewpoints and expectations of the public and keep the public better informed about the activities of the Central Bank.

1. In order to monitor and analyse the state of the economy, and especially the financial system of the Republic with a view to determining and undertaking effective measures of monetary policy, and giving recommendations for improvement of economic policy as a prerequisite for accelerated economic growth, the Central Bank shall: a) Monitor macroeconomic developments in the Republic by collecting data from relevant institutions, and preparing regular reports and other analyses of monetary, business, and fiscal developments, and developments in the field of international relations; b) Analyse the effects of the existing instruments of monetary and economic policy, as well as potential development, and the implementation of new instruments under euroisation conditions by using a macroeconomic model for Montenegro and preparing a feasibility study; c) Put a special emphasis on analysing the possibilities of maintaining macroeconomic stability, improving economic development, eliminating the balance of payments current account deficit, reducing interest rates, eliminating all risks, and maintaining a low budgetary deficit in the existing monetary regime with no exit options; d) Follow the policy of optimising the money supply under the condition of limited monetary instruments and the limited opportunities to estimate cash in circulation; e) Monitor and analyse international experiences, especially of the countries with dollarized economies, with a view to perceiving the opportunities for using the previously successful measures of monetary and economic policy in dollarization conditions; f) Observe and point out the weaknesses in the existing statistical, methodological, and institutional basis of economic policy, and give recommendations for their elimination;

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g) Take part in the preparation of new and the amendment of current regulations with a view to improving the business environment and increasing the efficiency of the Central Bank and state institutions; h) Work on the improvement of the reporting framework in order to increase the efficiency of the aforementioned measures.

2. With a view to maintaining the stability and safety of the banking system and financial stability, the Central Bank shall work on the following: a) Continue to improve the compliance of banks following the Basic principles of efficient bank supervision, emphasising the sensitivity to risks in banks operations and respecting the individual approach to the treatment of risk profiles by each bank; b) Development of the current, and the introduction of new techniques, of off-site and on-site bank supervision with a view to more comprehensive risk assessment, and training employees of banks with a view to better quality and more comprehensive risk management; c) Performing analyses for stress testing the system in order to correct certain segments of the bank supervision policy; d) Expanding bank supervision to the implementation of other legal acts and enabling regulations that influence banks’ operations, especially in the field of the prevention of money laundering and fight against terrorism; e) Enforcement of relevant measures against banks, ensure their implementation, and sanction non-compliant banks in order to prevent the transfer of adverse effects to the whole banking system; f) Licensing of banks and giving other approvals in order to protect depositors, strengthen competition, and spread a professional corporative culture in the banking system; g) Supporting all policies, measures, and activities that contribute to the protection of creditors, the strengthening of financial discipline, and diminishing risks in banks’ operations which are not directly regulated and controlled by the Central Bank; h) Establishing and further improvement of cooperation with other bank supervision regulation institutions in the country and abroad.

3. With a view to the further improvement in monitoring and controlling the liquidity of the banking system and the managing of the monetary reserves of the Republic of Montenegro, the Central Bank shall: a) Follow active reserve requirement policy; b) Influence the creation of mechanisms for eliminating unfettered interest rates; c) Help banks to overcome the problem of short-term illiquidity by using legal instruments – the opportunity to use their reserve requirements and loans for daily and overnight liquidity maintenance; d) In accordance with available instruments and needs, undertake measures in order to prevent destabilising effects of the short-term movement of capital; e) Create institutional and other prerequisites for improved quality management of liquidity surpluses in the Republic by encouraging the development of the interbank market, the money market, and open market operations; f) Manage the monetary reserves of the Republic, both in country and other countries, by respecting the minimizing risk and maximizing profit principle; g) Work on the improvement and development of the payment system with abroad by creating additional institutional prerequisites; h) Provide the required amounts and denomination structure of euros, and ensure the adequate distribution of banknotes and coins to be used in financial transactions.

4. The Central Bank shall maintain the efficiency and the further development of the payment system in the country by: a) Finishing the regulatory framework for the new payment system by enacting the Law on Domestic Payment Operations and amending enabling regulations in accordance with practical experiences; b) Improving the functioning of the new interbank payment system;

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c) Developing and implementing the information system for enforced collection, by developing the central registry of accounts in accordance with the Law on Enforcement Procedures; d) Ensure the high quality performance of domestic payment operations for the clients of the Central Bank.

5. With a view to improving the efficient performance of the functions of banker, advisor, and fiscal agent on behalf of the agencies and organisations of the Republic of Montenegro, the Central Bank shall: a) Develop new, and improve the quality of the current services offered to the agencies and organisations of the Republic; b) Manage all deposit accounts of the Government after their closure with commercial banks, transfer the funds to the all-in-one account with the Central Bank, and perform domestic and foreign payment operations on behalf of the agencies and organisations of the Republic; c) Once a year, and more often if necessary, make recommendation to the Government regarding the financing of the fiscal deficit, limits to domestic and foreign borrowing and public debt, increase in the inflow of foreign direct investments as a prerequisite for accelerated economic development and overall economic policy; d) Monitor the inflow and use of financial assets given to the Republic as credits and donations, as well as the inflow and use of other funds from abroad; e) Perform auctions of treasury bills of the Republic of Montenegro.

6. The Central Bank shall improve cooperation with international financial institutions and organisations, and other central banks by: a) Improving the cooperation with the World Bank by performing the function of fiscal agent of the State Union of Serbia and Montenegro, especially in performing financial transactions for the servicing of debts of the Republic of Montenegro with the World Bank, and the fulfilment of obligations regarding the implementation of necessary reforms and conditions for obtaining financial assistance from this institution; b) Taking an active part in the process of joining the European Union in accordance with its legal competence; c) Intensifying the cooperation with international financial and other institutions through direct contacts, information collection, and monitoring the activities of these organisations; d) Monitoring and improving the implementation of signed agreements, and initiating cooperation with other central banks; e) Finishing negotiations with the National Bank of Serbia regarding the division of property and liabilities, the division of public debt, and defining the model for establishing the payment system between the two Republics; f) Undertaking other activities regarding the international promotion of the Central Bank.

7. The Central Bank shall work on the upgrade of its personnel and technical efficiency by: a) Training its employees, primarily in modern business communications, correspondence, and protocol; b) Improving the technical equipping, developing and improving the level of information system security of the Central Bank; c) Developing software applications with modern tools and migration of the existing applications to the WEB environment.

8. The analyses of the viewpoints and expectations of the public and keeping them better informed about its activities, the Central Bank shall achieve through: a) Further improvement in communication, both within the Central Bank and with the public – partners, citizens, domestic and international media and interested groups; b) Informing the public via the media about its regular activities, and educating the public on the functions of the Central Bank, as well as increasing the public’s awareness of the importance of financial stability and fiscal discipline.

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Annex 4: Recommendations for Economic Policy for 2005

INTRODUCTORY NOTES

Montenegro, which was a part of the former SFRY that used to belong to the group of the most developed countries of Eastern Europe, now belongs to the group of less developed countries. With the decisive implementation of economic reforms and a market oriented policy it is possible to bring Montenegro back on the road of accelerated economic growth and to the group of developed Eastern European countries.

Every scenario for the future development of Montenegro must be based on a high rate of investments, primarily “greenfield”investments.Bearing in mind the limited domestic resources for investment, a strategic aim has to be the enticement of foreign investors by creating optimum conditions for their business operations in Montenegro.

Being a small country, Montenegro has to continue following a policy of a highly open economy. This means that a great share of domestic products have to be traded abroad because domestic production alone cannot satisfy all needs of the Montenegrin population.

The state should withdraw from the production processes, and its main task should be to create a stimulating business environment similar to that in developed market economies. The role of the state should be the protection of the legal system, the country’s defence, and the preservation of public peace and order, and the economy should be left to market forces but with the state retaining a corrective function in case of major market disturbances.

At the same time, it is necessary to continue with the policy of admission to international organisations and institutions, primarily to the European Union and the World Trade Organization. Therefore, one of the main aims of the creators of economic policy in 2005 is the harmonization of national regulations with those of these two international institutions.

The following should be the aims of economic policy:

• GDP growth rate of at least 4%, • The inflation rate not higher than 3%, • Fiscal deficit not more than 3% of GDP, • The reduction of unemployment, and, • An increase in foreign direct investments.

In order to achieve these aims it is necessary to undertake a number of reform measures alongside appropriate economic policy. Pursuant to legal authorization the Central Bank of Montenegro is under the obligation to make recommendations to the Government of the Republic of Montenegro regarding economic policy, systemized in five segments:

• Recommendations regarding the real economy, • Recommendations regarding fiscal policy, • Recommendations regarding the financial system, • Recommendations regarding international economic relations, and • Recommendations regarding other areas.

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RECOMMENDATIONS REGARDING THE REAL ECONOMY

The aim of economic policy has to be the creation of a business environment that would boost new investments, both domestic and foreign. Therefore, a number of measures should be undertaken, of which the following should be singled out as being the most important:

1. Create a strategy of economic development that would indentify the sectors of strategic importance and enable the allocation of the current meagre resources to those sectors. 2. Conduct overall deregulation of business activities; shorten deadlines and reduce the costs of all administrative procedures, as well as to increase the transparency of regulations. 3. Implement RIA (Regulatory Impact Assesment) methodology in the enactment of new regulations, in accordance with the OECD recommendations. 4. Enable the registration of undertakings to be performed in one place, simplify the procedures thereof, and reduce the costs of closing enterprises. 5. Create a stimulating tax system (reduce taxes and contributions on income, reduce profit tax, give tax relief for the newly employed, relieve large investors from profit tax, and so on). 6. Improve the infrastructure that greatly affects the development of tourism (water supply, sewage, waste water, electricity supply, main roads, airports, and so on). Set up tourist markers in accordance with the recommendations by the World Tourist Organization. 7. Consider the option of the differentiation of tax treatment for the tourism sector. 8. Announce an international public tender for building hotels in appealing locations in order to attract quality investors who would bring a great number of tourists and employ a great number of people. 9. Intensify marketing activities on the promotion of Montenegro tourism in targeted markets, primarily in countries of the EU, Serbia, Kosovo, FYR Macedonia, Bosnia and Herzegovina, Russia, the Czech Republic, and others. 10. Accelerate the privatisation process and the restructuring of large systems, and ensure shareholders are better informed about their rights and opportunities. 11. Intensify the efforts on making the EPCG a commercially sustainable enterprise. Initiate activities on separating the production and the distribution of electricity. Intensify activities on reducing losses in the transmission of electricity, eliminating privileged users, reducing illegal connectors, and increasing the collection of revenues. 12. Grant funds for the subvention of agricultural production in accordance with available budget and the rules of the World Trade Organization, with a view to increase agricultural production by providing favourable loans. Resolve the placement of agricultural surpluses systematically by providing the instruments for their repurchasing and funds for their financing. 13. Encourage the development of organic farming and the establishment of a certified agency. Implement the program “Made in Montenegro”. 14. Enact antitrust regulations in line with the EU in order to prevent the high pricing and low quality of certain products and services, thus preventing anz decrease in the living standard of consumers and the prosperity of a part of the economy. 15. Transfer the informal economy (as unfair competition to enterprises who are in legal business, and as the culprit for the reduction in fiscal revenues) to legal flows and allowing certain tax relief. 16. Increase the efficiency of the legal system in settling commercial disputes, primarily by reducing their duration. 17. Re-examine legal solutions and propose alterations with a view to a more efficient execution of bankruptcy proceedings introduced in enterprises that fulfilled the necessary conditions (forming accredited institutions to be in charge of monitoring bankruptcy proceedings, limiting the maximum duration of the proceedings, accelerating the termination of earlier proceedings, reduce the costs of the proceedings, and so on). 18. Solve the question of denationalisation, and the status of confiscated property.

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19. Consider the possibility of creating conditions to provide a more favourable position for domestic bidders in local tenders within a reasonable time frame. 20. Form a special agency with a view to promoting investment opportunities for foreign investors that would operate on a “one-stop- shop” principle. 21. Carry out programs of training, retraining and additional training for unemployed people and encourage the system of informal education. 22. Form business “incubators” in order to stimulate the development of small and medium-sized enterprises. 23. Provide credit lines for the establishment of new undertakings and the development of prosperous small and medium-sized enterprises through the Development Fund, in cooperation with international organisations. 24. Follow a restrictive policy of environment protection and implement ISO 14000 standard series. 25. Find alternative solutions to moderate the energy deficit instead of carrying out the “Buk-Bijela” project that would damage the unique natural environment of the river Tara upstream. 26. Gradual withdrawal of the state from all monopoly-holding activities, as well as considering the options of performing certain public functions by the private sector, with subventions and grants. 27. Enact appropriate regulations in order to protect the intellectual property and ensure its full implementation with a view to attracting new investors and easier admission to international institutions.

RECOMMENDATIONS REGARDING FISCAL POLICY

Bearing in mind that one of the main prerequisites for the accelerated economic growth of Montenegro is the attraction of foreign and an increase in domestic investments, fiscal policy should create a stimulating business environment. This means that tax rates should be lower than those in the region, and at the same time, the state should reallocate as small a share of GDP as possible thus restricting state interference in primary allocations, which would improve the efficiency of the private sector. Taking into account that Montenegro’s economy is in transition, one of the ultimate aims of the fiscal reform, a balanced budget, cannot be achieved in 2005. Therefore, pursuant to the “Maastricht Convergence Criteria”, the fiscal deficit must not be higher than 3%, and preferably lower than that.

Therefore, we believe that the following measures should be undertaken:

1. Continuous comparative analysis of tax systems in the region, the revision of tax policies (at least once a year), undertaking corrective measures and adopting the most suitable tax rates, all that with a view to creating a stimulating business environment. 2. Gradual abolishing of progressive and implementing proportional tax rates in order to create a stimulating business environment by eliminating additional taxation of those who are ready to work harder and achieve better results. 3. Reduce various forms of hidden taxes, both republic and local. 4. Reduce profit tax to the maximum of 10% (5% would be most desirable). No significant repercussions for the budget are expected considering the very small contribution of this tax to the total budget revenues. 5. Relieve both domestic and foreign “big investors” from profit tax for a limited time frame (five to ten years) in order to make Montenegro more attractive to foreign investors. We propose that the “big investors” treatment should be allowed to all investors who invest over EUR 1 million. 6. Tax relief on reinvested profit in order to motivate foreign investors to make new investments rather than repatriating the profit. 7. Reduce taxes and contributions on earnings (since they are among the highest in the region) in accordance with the quality action plan that would include the positive effects of this measure since there could be some disapproval by international institutions. 8. Implement overall measures of savings and rationalisation that would lead to a reduction in public expenditure (that is, a continuous fall in the contribution of public expenditure in GDP), in order to prevent the possible growth of the fiscal deficit resulting from the proposed reduction in tax rates.

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9. Reduce the number of employees in the state administration simultaneously increasing its efficiency. 10. Continuous analysing “the cheapest” sources for covering the fiscal deficit (domestic bank loans, bonds, international loans), and following a restrictive policy of new borrowing to prevent Montenegro becoming one of the highly indebted countries. 11. Implement the Law on Borrowing and Public Sector Debt Management with a view to recognizing the possible options for the repayment of the existing debt and the possibilities for new borrowing. Therefore, the Ministry of Finance should take over the complete records and registration of foreign debts. 12. Intensify inspections (in order to increase fiscal revenues) to prevent the existence of privileged enterprises; intensify efforts in the collection of outstanding tax liabilities, and undertake all legal instruments, in accordance with available regulations, against enterprises that avoid paying taxes. 13. Continue following the policy of tax relief for newly employed people with a view to stimulating new employment. 14. Open a common account for all budgetary users (treasury) in order to improve the efficiency of the use of budgetary funds, and transfer all state accounts from banks in Montenegro to the account with the Central Bank of Montenegro in accordance with the planned dynamics. 15. Harmonize and consolidate mutual accounts payable to budgetary users, and the state’s accounts payable to other users. 16. Continuously re-examine the collection mechanisms and VAT refund deadlines, primarily to shorten the detention of imported goods at customs.

RECOMMENDATIONS REGARDING THE FINANCIAL SYSTEM

In accordance with the Central Bank of Montenegro recommendations and the Economic Policy for 2004, the Government of Montenegro undertook significant activities in 2004 in order to encourage the development of financial markets, and these were mainly concerned with their institutional regulating. Accordingly, the following laws were enacted: the Law on Mortgage, the Law on Investment Funds, the Law on Enforcement, the Law on the Restoration of Revoked Property Rights and Indemnification, the Amended Law on Settlement of Foreign Currency Deposits, and the Law on Gaming.

Bearing in mind legal limitations, the document Economic Policy should not contain as obligations for the Government the activities that are, pursuant to the Law, exclusively the obligation of the Central Bank of Montenegro and the Securities Commission of the Republic of Montenegro.

In cooperation with independent regulatory bodies in the Republic and with a view to improving the money market and the capital market, the Government should undertake numerous measures:

1. Continue with activities on finishing off the institutional framework by introducing laws still unenacted and adequate enabling and other regulations that would allow the creation of an efficient money market in the Republic (the Law on Insurance, the Law on Current and Capital Transactions with Abroad, the Law on the Promissory Notes, and the Amended Law on Securities). 2. Carry out the activities on forming appropriate registers, the preparation of adequate forms and instructions, the training of employees in newly formed institutions, and educating the users of their services. 3. Create the conditions for the comprehensive implementation of the laws concerning the protection of creditors’ rights, which should provide the safety and legal protection of creditors, which further implies the improvement of the material status of the judicial system as the main prerequisite for its independence. 4. Reduce the CDA’s (Central Depository Agency) commission fees as part of costs that the owners of securities pay, and which are one of the main obstacles for the development of the securities market. 5. Carry out the activities on further decreasing tax rates in investment income and profit. 6. Alter the existing Law on Securities to enable the distinguishing of long-term and short-term securities, separate the authorities for regulating the money market and the capital market, and provide the necessary solutions regarding registration, clearing and

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balancing of transactions in the money market in the CDA. 7. Enact the Law on Promissory Notes and provide its full implementation in order to overcome the problems of short-term illiquidity and refinancing, which would consequently lead to a reduction in prices of financial assets in the Republic. 8. Enact the Law on Insurance with a view to quality institutionalising in this area and clearly define the institution that would control insurance companies. However, it should be taken into account that the most suitable policy regarding the aforementioned would be the forming of this regulatory body within the existing regulatory institutions in the Republic that already have a tradition and reputation in the quality performance of this. 9. Continue commenced activities on the privatisation of Podgoricka bank with a view to bringing in a strategic partner, and intensify the activities regarding the sale of the remaining majority state owned capital in banks. 10. Implement a new income model, that is, a new model for the collection of public income, and consider the possibilities of reducing the part of payment operations costs used for the financing of a part of pensions disbursed by the Republic Pension Fund. 11. In accordance with EU recommendations, continue negotiations with the NBS about finding a solution for establishing a direct payment system between Montenegro and Serbia in order to reduce the current costs of payment operations between these two Republics. 12. Improve cooperation with the World Bank and other financial institutions with a view to obtaining financial assistance and continue with reform activities.

RECOMMENDATIONS REGARDING INTERNATIONAL ECONOMIC RELATIONS

Regardless of numerous economic reforms and the positive results achieved in international economic relations, the main problems are still focused on the foreign trade part of the balance of payments. Therefore, it is essential to undertake a number of measures in order to make domestic products more competitive and create a stimulating business environment. The following measures could be designated as priorities:

1. Deregulate foreign trade procedures in order to reduce deadlines for certain foreign trade procedures, reduce the costs of these procedures, avoid the double customs clearance of products, shorten deadlines for VAT refund, and so on. 2. The implementation of international standards with a view to gaining entrance to the world market, wherein the active role of the state is essential, meaning publishing and translating international standards (primarily the ISO standards and EU directives), organizing seminars on the introduction of the aforementioned standards, and field assistance to specific enterprises. 3. Form a credit potential in commercial banks with the state participating in it, which would be used for financing exports under more favourable conditions than those currently existing, and, in the long term, form a Fund for the Crediting and Insurance of Foreign Trade Transactions. 4. Implement measures of protection of the domestic market and domestic producers (the antidumping procedure, prevent the import of non-certified and products that do not satisfy quality standards, lower the level of illegal imports, and so on). 5. In accordance with the WTO rules, provide subventions, such as: financial assistance for scientific research, joint appearance at fairs, assistance in covering ecological expenses, subventions to agriculture (to the level existing in the period 1986 – 1988), subventions to export-oriented enterprises in underdeveloped regions of Montenegro, and so on. 6. Enact the Law on Capital and Current Transactions with Abroad. 7. Improve the efficiency of the Customs Office with a view to accelerating the process of registering imported goods and preventing illegal imports. 8. Implement signed agreements on free trade, that is, finish the process ofamending annexes that has already started. 9. Implement the Copenhagen criteria, observe obligations from international agreements1, regional cooperation with neighbouring

1 The implementation of most international agreements primarily depends on Serbia and especially on adhering to the Dayton Agreement, cooperation with the Hague Tribunal, the UN Security Council Resolution No. 1244, and so on.

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countries, harmonization of legal regulations, and accept acquis commonautaire with a view to accession tothe EU and other international economic integrations. 10. Create the conditions for becoming a member of the OECD, which is significant since it obliges its members to do some restructuring by providing various forms of support, which would intensify the process of convergence of economic performance and legal regulations with the performance of member countries of the EU. 11. Harmonise the foreign trade regime with WTO regulations with a view to non-discrimination appearance in the world market, which implies membership of the WTO. It is crucial to insist on accepting the State Union of Serbia and Montenegro (or Montenegro on its own) as a developing country because it will provide longer transitional periods for the implementation of certain agreements, technical assistance, and other benefits. 12. Adopt numerous strategic documents such as: the Strategy for Joining the EU, the Strategy for Joining the WTO, the Analysis of Costs and Benefits from Joining the EU, the Communication Strategy for Joining the EU, and so on. 13. Intensify cooperation with the diaspora with a view to creating suitable conditions for their investing in Montenegro.

RECOMMENDATIONS REGARDING OTHER AREAS

1. Improve the IT equipping of the public administration, as well as the IT education of the employees, wherein the final result should be the creation of an “e-Government”. 2. Develop a static system with the appropriate segregation of duties as follows: • Monstat – national accounts, real sector, price movements, employment, • Customs Administration – foreign trade statistics, • The Ministry of Finance – statistics of public finances and foreign debt, • The Ministry of Tourism – tourism statistics, • The Agency for Foreign Investments – statistics of foreign direct investments, • The Central Bank of Montenegro – the balance of payments and monetary statistics. 3. Increase the level of ability of Monstat to perform basic statistics research through the better equipping of staff with software and hardware, and more training programs for employees (offered by international institutions), as well as to adopt a statistics research plan and perform the review of the methodology that is currently applied. 4. Define the institution in charge of processing annual financial statements of enterprises. 5. Improve the existing Law on the Conflict of Interest. 6. Prepare adequate social programs for the anticipated redundancies in the process of restructuring the economy, by using possible donations for these purposes and a part of privatisation revenues (these revenues should also be used to create the prerequisites for self-employment). The social programs should be restricted only to those categories that cannot economically survive without it. The state’s paternalism diminishes the initiatives for independently resolving this problem. 7. Undertake activities to prevent the employment of more people than needed in certain enterprises, as this will reduce operating expenses and improve competitiveness in the world market. 8. Continue with retraining, additional training, and training of unemployed people, as well as encourage the work of nongovernmental institutions that are engaged in informal education. 9. Enact the Law on the Prevention of Corruption and undertake active measures to suppress corruption. 10. Continue monitoring the implementation of economic reforms set out in the “Agenda of Economic Reforms for Montenegro”.

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