Chief Economist Annual Report 2006

CHIEF ECONOMIST ANNUAL REPORT 2006

Podgorica, 2007 PUBLISHED BY: Central Bank of Montenegro Bulevar Svetog Petra Cetinjskog 6 81000 Podgorica Telephone: +381 81 665 331 Fax: +381 81 665 336

WEBSITE: http://www.cb-cg.org

CENTRAL BANK COUNCIL: Ljubiša Krgović, MS, President Milojica Dakić, MS Goran Knežević, MS Petar Drakić Krunislav Vukčević Radmila Savićević Franjo Štiblar, PhD

PREPARED BY: Nikola Fabris, PhD, Chief Economist Research and Statistics Department

TRANSLATED BY: Translation Services Division

PRINTED BY: Grafo Crna Gora

PRINTED IN: 200 copies

Users of this publication are requested to make reference to the source of information whenever they use data from the Report. BASIC INFORMATION ABOUT MONTENEGRO

Surface: 13,812 km2 Population: 620.145 Length of borders : 614 km Podgorica (169,132 inhabitants) - Capital: administrative and economic centre

Royal Capital: Cetinje– historical and cultural centre Length of seacoast: 293 km Length of beaches: 73 km The longest beach: Velika plaza, Ulcinj - 13.000 m The highest peak: Bobotov kuk (mountain Durmitor) - 2,522 m The largest lake: Skadarsko lake - 391 km2 The deepest canyon: river Tara - 1,300 m The biggest bay: Boka Kotorska Time zone: GTM+1 Electric system: 220V/50Hz Climate: Mediterranean Average air temperature: in summer 27.4 C Maximum sea temperature 27.1 C Average number of sunny days in a year: 240 Swimming season: 180 days Sea: Adriatic Sea transparency: from 38 to 56 m

CONTENTS

MACROECONOMIC ENVIRONMENT IN MONTENEGRO 9 1. REAL SECTOR DEVELOPMENTS 13 1.1. Gross Domestic Product 15 1.2 Activities 21 1.3. Prices 31 1.4. Labour Market 39 1.5. Results of the Processing of Annual Financial Statements of Legal Entities in Montenegro 43 2. MONETARY DEVELOPMENTS 51 2.1. Money Supply 54 2.2. Banks’ Liquidity 55 2.3. Aggregated Balance Sheet of Banks 56 2.4. Banks’ Reserve Requirement 67 2.5. Micro Credit Financial Institutions 69 2.6. Lending Interest Rates 71 3. FINANCIAL MARKETS 75 3.1. Money Market 77 3.2. Capital Market 78 4. FISCAL SECTOR 85 4.1. Budget Review 87 4.2. Review of Budgetary Funds in 2006 94 5. PUBLIC DEBT 97 5.1. Foreign Public Debt 99 5.2. Domestic Public Debt 102 5.3. Public Debt Repayment 103 6. EXTERNAL DEVELOPMENTS 105 6.1. Balance of Payments Current Account 108 6.2. Capital and Financial Transactions Account 117 7. INTERNATIONAL ECONOMY 121 7.1. Economic Trends 124 7.2. Interest Rate Movements 126 7.3. Exchange Rate Movements 127 7.4. Montenegro and International Environment 128 8. IMPORTANT EVENTS IN 2006 131 9. ANNEX 139

Review of macroeconomic developments

Percentage 2005 2006 change REAL SECTOR DEVELOPMENTS GDP (in current prices in EUR million) 1,690.0 1,829.0 8.22 Industrial output index (compared to the same period the year before) -1.9% 1.0% --- Forestry (compared to the same period the year before) 14% 14.2%** --- Construction (compared to the same period the year before) 10.6% 47.8%** --- Employment Number of employed people (period-end) 145,261 155,566*** 7.0% Number of unemployed people (period-end) 48,825 38,876 -20% Inflation rate CPI (compared to December the year before) 2.4% 2.8% --- RPI (compared to December the year before) 1.8% 2.0% --- Average salary (EUR, without taxes and contributions) 213 245.95 15.5% MONETARY DEVELOPMENTS M11 (EUR million) 614.7 1.096.7 78.4 Total deposits (EUR million) 487.9 1.071.5 119.6 Deposits by economy 143.9 318.0 121.0 Government deposits 97.8 113.0 15.5 Central government 20.2 21.3 5.4 Institutions and agencies of central government 14.4 20.3 41.0 Funds and municipalities 63.2 71.4 13.0 Deposits by financial institutions 40.1 75.2 87.5 Deposits by households (savings) 175.8 498.6 183.6 Deposits - other 30.3 66.7 120.1 Total loans (EUR million) 375.9 844.4 124.6 Loans to economy 230.1 471.6 105.0 Loans to government 30.8 40.1 30.2 Central government 9.9 12.1 22.2 Institutions and agencies of central government 5.4 3.7 -31.5 Funds and municipalities 15.5 24.3 56.8 Loans to banks and financial institutions 0.1 6.5 6.400 Loans to private citizens 104.3 310.9 198.1 Other loans 10.6 15.3 44.3 Turnover in stock exchanges (EUR million) 198.45 377.01 90.0 NEX stock exchange 116.13 135.70 16.9 Montenegroberza stock exchange 82.31 241.31 193.2 Stock exchange indices NEX20 9,781.28 18,050.80 NEX PIF 7,992.50 17,763.63 MOSTE 465.60 918.88 Average interest rates on 28-day T-bills 4.65% Average interest rates on 56-day T-bills 1.64% Average interest rates on 91-day T-bills 0.98% 0.97% Average interest rates on 182-day T-bills 1.01% 0.50% FISCAL DEVELOPMENTS (EUR million) Origin revenues 428.1 567.2 32.5 Total expenditure and net borrowings 425.3 532.5 25.2 Surplus/deficit of the government 2.8 34.6 1,135.7 Financing 35.1 -32.1 -191.5 Grants 2.5 0.0 Privatisation revenues 136.3 6.3 -95.4 Net indebtedness -103.7 -38.5 -62.9 EXTERNAL DEVELOPMENTS Current account (EUREUR mmillion)illion) -154 -568.2 269.0 Trade balance -513.6 -905.6 76.3 Balance of services (tourism +transport+fin.services+other services) 195.5 216.4 10.7 % of trade deficit/other balances coverage 70 37.3 Capital and financial account Current account in % of GDP (EUR) -9.1 -31 240.7 Old FX savings (EUR million) 117 105.2 -10.1 External debt (EUR million) 513.4 504 -1.8

*Government projection for 2006 ** Data for January - November 2006 *** Data for November 2006

MACROECONOMIC ENVIRONMENT IN MONTENEGRO

The year 2006 may be viewed as a very successful year. It However, a somewhat higher inflation rate should was a transitional period from the phase of establishing be expected in 2007. Our forecast is that it will range stability to the phase of accelerated growth. The major between 2.5% and 4.5%. A similar estimate was trends that characterized this year were: a rapid growth obtained through the fan chart model that showed, in economic activity, a low inflation rate, the fiscal with a 90% probability rate, that inflation will vary surplus, the record inflow of foreign direct investments, between 1.9% and 4.2%. Inflation movement will and a remarkably dynamic development of the banking be greatly affected by the announced increase in the market. The only real imbalance is the high level of the prices of electricity. current account deficit. With a view to EU accession, 2006 was very important. According to preliminary estimates, GDP rose by 6.5%. The negotiations on the signing of the Stabilisation However, we believe that the actual growth is higher, and Association Agreement (SAA) were concluded, roughly estimated at being a minimum 8%. The GDP ratification being expected in the second quarter of increase was driven by growing demand, and the main 2007. Bearing in mind that Montenegro’s ultimate contributors to its growth were construction, tourism, objective is joining the European Monetary Union, an the banking system, and foreign direct investments. encouraging fact is that all the Maastricht Criteria were met both in 2005 and 2006 (except that with regard The inflation rate was only 2%, measured by the retail to the interest rate). It is not sufficient to fulfil these price index, thus continuing the five-year trend of one- criteria only one year but to keep doing so continuously. digit inflation. The achieved rate was much lower than Currently, most of the new EU member countries do the projected rate of 3%, thus being in line with the not fulfil these criteria. Maastricht Criteria. The somewhat higher rate than that recorded last year (by 2 percentage points) was The financial market developments were very primarily due to the amended methodology whereby encouraging. The amount of loans disbursed rose the oil derivatives weight was increased by almost five by 124%, placed deposits by 120%, and savings times in comparison with the previous year. The cost of by households by no less than 184%, while banks’ living index showed slightly higher growth, by 2.8%, assets increased by 105%. Banks have a high level of mainly as a result of the different weights of some food liquidity, showing that no part of the allocated reserve products. The inflation indicator that is going to be used requirements or loans for liquidity maintenance was as of 2007 is the cost of living index since the structure used during the reporting year. The privatisation of of the consumer basket has changed thus creating the the banking sector is nearing its completion and the conditions for the index change. This will provide a state, as a direct owner, has no bank shares. This data higher degree of comparability with the harmonized shows that the banking system reform process has consumer price index used by the European Monetary been successfully implemented. Union as the inflation indicator. MACROECONOMIC ENVIRONMENT IN MONTENEGRO

9 Interest rates have been on a downtrend, yet remain visited Montenegro in 2006 rose by 16.3% in comparison high. For the first time the average weighted effective with the previous year. A very encouraging fact is that lending rate was a one-digit figure. According to the number of foreign tourists is increasing, being preliminary data, it was 2.2 percentage points lower 38.9% higher than in 2005, and thus accounting for than in 2005, amounting to 9.94% at the reporting year- 40% of the total number of tourists. Regardless of the end.The comparative data show that interest rates in exceptional results, there is still room for improvement other countries of the region are at similar levels, and in this field. This is supported by the difference in the the reasons for this could be found in the continuing number of tourists who visited Montenegro in 2005 country risk, client risk, inefficient judiciary, a high and and 1989, discussed later on in this report. inelastic demand for loans, and the like. However, the encouraging fact is that banks expect that effective and A remarkably high growth in economic activity was nominal interest rates to be lower in 2007. achieved in construction (the number of effective working hours rose by 47.8%), and forestry (the The money supply is also increasing, and the broadest production of wood products increased by 14.2% in monetary aggregate M21 rose by 84.5% in comparison the first eleven months of the reporting year), but with end-2005, reaching the amount of EUR 1.6 the results in transportation differ to a great degree. billion. To wit, negative growth rates were achieved in public transport, freight transport via air and passenger After the last year’s fall, industrial output increased by transport via railways, whereas positive rates were 1%, yet remaining lower than that achieved in 2004. recorded in all other types of transport. The overall Observed by manufacturers, negative rates of increase results in transportation are greatly dependant on were recorded in companies whose privatisation and the condition of the transportation infrastructure, and restructuring have not ended, those working with this can be categorised as unsatisfactory in almost all obsolete technology, being highly illiquid and indebted, types of transport. dealing with redundancies, operating with losses, and the like. This clearly points out that any further The processing of annual financial statements1 delay in the privatisation and restructuring process provided information on sectors experiencing the would have counter-productive for the Montenegrin fastest growths, i.e. the sectors whose total assets economy. However, the fact should not be disregarded have been increasing most rapidly were identified as that the output decline was mainly due to problems banking, retail and wholesale trade, and tourism. The in several companies, primarily in the manufacturing sectors being mostly indebted, i.e. those having the of tobacco, chemical products, and rubber and plastic largest amount of outstanding liabilities, were the products. These add to the problems in Aluminium production of electricity, hotels and restaurants, and Plant Podgorica (KAP) with an output lower than manufacturing industry. Unlike tourism, wherein the • 2006 that actually possible. In small economies, such as high indebtedness occurred due to large investments, Montenegro, problems in a few companies may have industry is obviously in a very unfavourable financial a great impact on overall economic activity. situation. This is supported by the fact that the entire industry recorded a loss of some EUR 220 million. The Tourism is the branch that has experienced the most economic activity that recorded the largest profit dynamic growth in the last few years, recording two- was the retail and wholesale trade, some EUR 27.2 digit rates of increase. The number of tourists who million. CHIEF ECONOMIST ANNUAL REPORT

1 Data for 2005.

10 The higher increase in salaries than that in productivity the tax system reform through a decline in tax rates, jeopardizes the competitiveness of the Montenegrin restrictive budgetary expenditure, and a reduced economy. share of expenses for salaries in GDP via decreasing the number of employees in the government sector, The dominant employer in the labour market remains and reducing both external and domestic debt. A great the state, i.e. the public sector. The number of the threat may be the fact that the amount of liabilities unemployed fell remarkably, from some 85,000 in mid- arising from restitution is still unknown. 2000 to 38,876 at end-2006. Unemployment is still high in spite of its downward trend, but the activity rate The competitiveness of the Montenegrin economy and the employment rate are low. The main culprit for is extremely low, being one of the main culprits for such a high unemployment rate lies in the fact that a the relatively high current account deficit in 2006. relatively small number of new jobs were opened in the According to preliminary data, this deficit amounted new private sector. One of the features of the labour to EUR 568 million, being 268% higher than in the market is structural unemployment, i.e. a mismatch previous year. A deficit was recorded in only one of the between the labour force supply and demand that balance of payments sub-accounts, visible trade, but is reflected in the simultaneous existence of both the surpluses in all the other sub-accounts were not unemployed people and job vacancies that cannot be sufficient to compensate for this deficit. The share of matched due to an inadequate qualification structure. the current account deficit in GDP amounted to 31%, Also, numerous privatised companies had redundancies and it will probably be the highest in Europe. Due to thus being unable to absorb unemployment. The inadequate recording we cannot draw validconclusions limited opportunities for employment discouraged, on the structure of visible trade, but it is certainly and led to the withdrawal of, certain categories in unfavourable because the items mainly exported were the labour market, especially those belonging to the low-processing products, and those chiefly imported older age groups. What worries most is long-term were consumer goods. unemployment since it leads to outdated knowledge and skills and permanent withdrawal from the labour The existing level of the current account deficit does not market.With a view to encouraging new employment it represent a problem for the time being since it is entirely is necessary, inter alia, to remove a number of barriers covered by the inflow of foreign direct investments. in the current Law on Labour. However, it is unsustainable in the long-term as every country has limited absorbing capacities when the For the first time in a long while a fiscal surplus was attraction of FDI is concerned. The moment the FDI recorded in 2006. Budgetary surplus is an important inflow dries up the only possible way to cover a high requirement for system sustainability in any euroised deficit will be through borrowing from international economy. The achieved surplus was mainly due to creditors. Any such trend would lead to a country’s a large volume of activity, increased collection of increase in indebtedness and a "twin deficit".2 This public revenues, but also due to certain internal means a deterioration of macroeconomic stability rationalisations. A budgetary surplus is also planned and a fall in living standards. However, there is still to be achieved in 2007. In order to provide stable enough time to try toincrease the competitiveness of financing of budgetary expenditure it is necessary domestic producers, but this will primarily depend on to continue with fiscal reforms. The reforms involve the privatisation process and the current FDI inflow.

2 A simultaneous existance of a fiscal deficit and a current account deficit is called the twin deficit because frequently the existence of either MACROECONOMIC ENVIRONMENT IN MONTENEGRO of them induces the appearance of the other.

11 Foreign direct investments reached a record level, to the upper limit of low-indebtedness, necessary preliminary data showing the amount was EUR 644.3 precautions should be exercised in future borrowings. million, which is 22% more than in 2005. It is very The encouraging fact is that the Government has opted important to stress that FDI inflow in 2005 was mainly for the fiscal anchor policy which implies a small share due to privatisations, but the main contributors to FDI of the public debt in GDP. inflow in 2006 were greenfield investments (which are the best-quality source of growth) and investments The priorities of economic policy in the forthcoming related to the already carried out privatisations. et period should be: the completion of privatisation and FDI inflow amounted to EUR 466.7 million due to FDI restructuring processes in large enterprises, a further outflow of EUR 177.6 million. Foreign investors came improvement in the business environment and the from no less than 77 countries. According to preliminary freeing-up of administrative procedures, diminishing data, Montenegro was the first transitional country the existenceof the grey economy, the improvement of in Europe in regard to the share of FDI inflow in GDP judiciary efficiency, and the effective implementation of in 2006. antitrust legislation, and the like. All the administrative procedures regarding accession to the International According to the Ministry of Finance, the estimated Monetary Fund and the World Bank were completed in public debt of Montenegro at end-2006 amounted 2006, resulting in Montenegro’s membership in these to EUR 701.1 million, and its contribution to GDP institutions at the beginning of 2007. Therefore, one (preliminary data) was 38.3%. The Maastricht criterion of the major tasks in 2007 remains the harmonisation for public debt foresees an upper limit of 60%, thus of national regulations with those of the aforesaid the situation in Montenegro is more favourable than international institutions. in many EU member countries. This report is the end result of a joint effort by the Preliminary data on the external debt show the amount employees in the Research and Statistics Department. of EUR 5.1.1 million at end-2006. Its share in GDP was I hereby take the opportunity to thank them for their some 27%, which puts Montenegro in a group of low- conscientious and diligent work. indebted countries, as do all the other indebtedness indicators. Taking into account that the country is close Nikola Fabris, PhD, Chief Economist • 2006

CHIEF ECONOMIST ANNUAL REPORT

12 REAL SECTOR DEVELOPMENTS 1

1.1. Gross Domestic Product

Preliminary assessments show a GDP growth of 6.5% in 2006. Our supposition of an 8% growth is restrictive, and it is quite This is a very high rate, but it should be taken into account probable that the actual growth was much higher. that the average rate of GDP increase in transitional countries amounts to 6.2%.3 However, it is encouraging that this rate is Another indicator of a remarkably high growth rate is the very higher than the average. high rate of increase in VAT collection because this tax correlates with economic activity to a great extent. Revenues from VAT However, we believe that the actual GDP growth is higher than collection increased nominally by 41%. A part of these revenues’ that recorded. Rough estimates show a GDP growth of 8%. increase is certainly due to improved collection, but it is also an Taking into account the lack of a great deal of information we indicator of the remarkably high GDP growth. Furthermore, a reached this amount via numerous assumptions. The initial much higher GDP growth than that planned is the reason that surmise was that the economic structure remained the same as a fiscal surplus has been achieved instead of the projected in the previous year (we calculated the share of certain sectors in deficit. GDP on the basis of the structure of income in annual financial statements). For sectors where data was available, we applied Graph 1.1 – GDP growth rates in the sector growth rates. For trade, agriculture, and transportation transitional economies we used the eleven-month rate of increase (this is a restrictive assumption because, as a rule, the highest rate is achieved in December) because the data for all twelve months were not available. Taking into account that only data for certain types of transportation are available, we reached the synthetic indicator by calculating the number of transported passengers and tonnes of transported freight by certain branches, assuming that both freight and passengers transport have equal weights. As the activity indicator of agriculture we used the trade of agricultural products. The initial surmise for public and social services was that their rate of increase was 50% lower than the achieved GDP, and that of sectors experiencing the most dynamic growths – financial intermediation services and real estate activities Source: Economic indicators for Central and Eastern Europe, – 50% higher than the GDP increase (much higher in reality). BIS bank REAL SECTOR DEVELOPMENTS

3 Data refer to 17 transitional economies. All the former Soviet republics were excluded, except the Baltic republics.

15 GDP growth was demand-driven, but numerous factors that A large FDI inflow resulted in the creation of additional demand led to it will hardly reoccur next year. The reconstruction and since investments were in the modernisation of companies. The building of a large number of hotels resulted in a very high powerful development of the banking system and a large inflow increase rate of construction, and a large growth in tourism of foreign capital gave an additional boost to the development affected the development of many other sectors, primarily of the economy. The share of foreign capital inflow in GDP was transportation, trade, and the agricultural-food industry. very large, 37%.

Box 1.1 – Inﬂow of Foreign Capital in Transitional Economies

Preliminary data for 2006 show that the share of net foreign capital inﬂow in GDP in Montenegro was higher than in any transitional economy (Graph 1).

Graph 1 – Share of capital inﬂow in GDP

Source: Economic indicators for Central and Eastern Europe, BIS bank; source of data for Montenegro is the Central Bank of Montenegro

This indicator shows that foreign investors are very much interested in the Montenegrin market, i.e. that they • 2006

expect an accelerated economic growth.

In order for such a high GDP growth to be maintained in the forthcoming period, it will be important to increase productivity, undertake measures that will make Montenegro more appealing for further FDI, reform the educational system and adjust it to the needs of the economy, restructure industry and the energy CHIEF ECONOMIST ANNUAL REPORT sector, and implement administrative reforms by putting an emphasis on deregulation.

16 1.1.1. Gross Domestic Product Growth Forecast for 2007

Graph 1.2 shows a fan chart of the quarterly increases in value (Mode>Mean value), i.e. the probability distribution mass is Montenegrio’s GDP based on the seasonal autoregressive skewed to the left, making the values of distribution probabilities quarterly model for Montenegro (SARCG 2007)4.5 The fan chart concentrate around GDP values below the central projection value, gives a 90% probability that Montenegro’s GDP for 2007 will which points to the overestimated central projection. range between EUR 1.654,13 billion and EUR 2.095,4 billion. On the basis of the fan chart, and taking into consideration Values obtained by applying the SARCG model have been used the "ceteris paribus" of the current economic situation and the as the central GDP projection values for the four quarters of statistical method for monitoring GDP in Montenegro, as well as 2007; the central projection, which represents a cumulative the central bend values, it can be claimed with a 10% probability GDP distribution mode, amounts to EUR 2.038,97 billion for all that Montenegro’s GDP will range between EUR 2.009,57 billion four quarters.6 Since the value of skewed distribution is σ1>σ2 and EUR 2.043,28 billion, and with a 20% probability that it (3.8:0.56), the probability distribution is shifted below the mode will vary between EUR 1.979,7 billion and up to EUR 2.047,66

Graph 1.2 – Fan chart: Montenegro’s GDP projection for 2007

4 The forecast of Montenegro’s GDP movement, considering the limited time series and a distinct seasonal eﬀect on a quarterly basis, was made on the basis of a simple seasonal autoregressive model that is suitable only for short-term forecasts. More eﬃcient GDP forecasts can be expected in the forthcoming period with the improvements of the Macro Model for Montenegro. 5 Standard formulas for a continuous univariate distribution comprise of two parts, with the following relation:

F(x)={2/((1/(1/√1-γ + (1/√γ+1))*1/√2π*σ2* e[ -1/2σ2{ ((x-µ)2 + γ(x- µ/abs(v-µ) *(x-µ)2}],

where γ represents a kurtosis quotient, µ is the mean distribution value, and σ2 the variate distribution value. A detailed explanation of this type of a univariate distribution is given in the paper by Johnston, Kotz i Balakrishnan, "Continuous Univariate Distribution", Volume 1, pg 172.

6 This growth represents a nominal GDP increase whereby a base used is a still unrevised value of GDP for 2006 which amounts to EUR 1.829 REAL SECTOR DEVELOPMENTS billion. Namely, Monstat and the Ministry of Finance published in the Montenegro Economic and Fiscal Program 2006", November 2006, revised data on the value of GDP for 2004 and 2005, wherein , for example, the GDP value for 2005 was revised from EUR 1.644 billion to EUR 1.690 billion. It can be expected that the estimated GDP value for 2007 will also be adjusted. Thus, a new quarterly GDP estimate can be expected after the adjustment, based on a new, amended SARCG model.

17 billion, which approximates a nominal GDP growth of between The use of the Euro as the legal tender in Montenegro represents 8.2% and 11.9%. a particular convenience for both domestic and foreign investors since they do not face any exchange rate risk, i.e. a risk that Two things should be taken into account: the first is the fact that inadequate measures of economic policy may devaluate their the reliability of projections largely depend on the availability of profit through devaluation or depreciation. This is a great statistical data, their reliability, and the length of time series, all of comparative advantage of Montenegro in relation to other which can be considered acceptable in the case of Montenegro; countries of the region. the second thing is that the estimated GDP growth is possible and its fulfilment will be greatly dependent on economic policy A sound banking sector is an instigator of economic growth, measures and some external factors. Therefore, below is a SWOT7 confirmed by an intensive lending activity oriented towards the analysis that is supposed to present Montenegro’s strengths and corporate sectors, which is the basis for investments. opportunities, but also its weaknesses and threats. Low customs rates and a liberal foreign trade system also have 1. Strengths represent the factors that have positive effects on positive effects on investments not directed towards the domestic the acceleration of economic growth. Established macroeconomic market, which is very important considering the relatively limited stability reflected in low inflation, fiscal surplus, and low market potential of Montenegro, and simultaneously represent indebtedness represents the main prerequisite for dynamic elements of a stimulating business environment. development.

Table 1.1 – SWOT matrix

Strengths Weaknesses • Macroeconomic stability • Slow restructuring of big industrial companies • Euro as the legal tender • Ineﬃcient legal system in solving commercial disputes • Sound banking system • Uneven regional development • Low customs rates and a liberal system • Administrative barriers (especially at local levels) • Large potential for tourism development • Grey economy • High rate of growth • Lack of brands • Low tax rates Opportunities Threats

• Potential for FDI attraction • High foreign trade deﬁcit • Springs of drinking water • Overdependence on tourism and "aluminium" • Undetermined amount of liabilities for restitution • Good preservation from water, air, and • Corruption • 2006 land pollution • Redundancies • Membership of the CEFTA • Higher increase in salaries over productivity • Membership of the CEFTA • Hydro energy potential • Small market • Threats of price bubbles • Inadequate legislation with regard to labour relations • Incompatibility between educational system and economy needs • Depopulation of rural settlements • Poor transportation infrastructure CHIEF ECONOMIST ANNUAL REPORT

7 SWOT – Strengths, Weaknesses, Opportunities, Threats.

18 Tourism is a sector that has been recording two-digit growth rates The Grey economy represents a unfair competition for the part for several years in a row. However, as the number of tourists is of the economy that performs its business in accordance with still lower than that recorded in the late 1980’s, and considering regulations and services its tax obligations regularly. Estimates on the fact that a great deal of foreign investors are interested in the share of the grey economy in GDP vary extensively, ranging Montenegro, it is obvious that there are good chances for high between 15% and 30% of GDP. rates of growth to continue in the forthcoming period. Montenegro has not developed a single brand to launch on the The positive and increasing GDP growth rates are a good beacon international market. This points to the low competitiveness for both domestic and foreign investors of the expansion the of the Montenegrin economy, having an eﬀect on the greater Montenegrin economy is experiencing, a business-friendly variability of Montenegrin exports under the inﬂuence of business environment, and the right time for new investments. trends on the international market.

Value added tax (VAT) and capital gains tax are the lowest in 3. Opportunities represent chances for accelerating economic the region, thus representing significant factors in attracting growth. Whether these opportunities will be used or not will investments. However, with regard to budgetary potential, a very much depend on the efficacy of economic policy, and partly decrease of taxes and payroll contributions should be considered on certain factors that cannot be controlled. as they are among the highest in the region and discourage new employment. In the last two years, the level of GDP per capita has put Montenegro at the top of European transitional economies. 2. Weaknesses are factors that have negative effects on Considering the fact that some very attractive companies will economic growth which may already be felt in 2007. be privatised in the short-term, as well as the large potential for investments in tourism, it can be expected that a large inflow The restructuring of a number of large industrial companies of foreign direct investments will continue in the forthcoming has yet to be implemented. This means that their business period. activities may "put pressure" on the budget, whether through compensating for losses or allocating funds for social programs Many studies have shown that, in the decades to come, one to solve the problem of redundancies. of the main global problems will be the lack of drinking water. Montenegro is relatively rich in springs of drinking water, and Regardless of the obvious progress, commercial disputes are this is something that should be more economically valorised still not solved fast enough, so a number of companies calculate in the years to come. the so-called risk premium in the prices of their products and services. Montenegro is also ecologically well-preserved (except for few locations, e.g. near the Aluminium Plant Podgorica – KAP), A characteristic of Montenegro is also an uneven regional which represents a good basis for the development of tourism, development, which again may put pressure on the budget to agriculture, and the food industry. accelerate the development of underdeveloped areas, but also gives rise to migration from the north to the south of the country, Membership of the CEFTA means free access for all but sensitive thus creating numerous problems. products to all markets of the member countries of this group. This gives real opportunities to increase exports, but yet offers a Regardless of a relatively liberal system, certain administrative threat for the domestic market that will then be open to foreign barriers still exist, especially at local levels. They are reflected competition. in long and rarely transparent procedures for obtaining the REAL SECTOR DEVELOPMENTS licences necessary for the performing of any designated activity Montenegro still has unused hydro-energy potential, but the – a construction permit, the procedure for the change of use of valorisation of it should not be to the detriment of the country’s land, the lack of urban planning, and the like. natural beauties.

19 4. Threats represent the factors that may have negative effects Montenegro is a rather small market, so it is not attractive for on economic growth, but these could be eliminated or moderated companies that want to use the domestic market potential. by implementing adequate economic policy measures. The capital market embodies a great threat of the appearance of The high foreign trade deficit currently does not represent a price bubbles because inflated prices of some securities will have problem because it is being covered by the inflow of foreign direct to be corrected sooner or later. This could jeopardize operations investments. However, if the competitiveness of Montenegrin of all those who invested in these securities. Irresponsible producers does not increase in the long-term, this will lead to statements given by the institutions responsible for the capital the growing indebtedness of the country, a fiscal deficit, and market may only intensify this effect, and also have an impact the declining competitiveness of the economy. on Montenegro’s international image.

The great sensitiveness of the Montenegrin economy is due The educational system provides too much theoretical and not to the fact that it is largely dependent on the two strategic enough practical knowledge. It is not sufficiently adjusted to products: aluminium and tourism. Possible shocks that could the economy’s requirements, which often brings companies in have an impact on these products will have a negative effect the position of having to train the newly employed in order that on the entire economy, as well as on the deterioration of the they become productive. current account deficit. Inadequate labour regulations impose limits on employers and The amount of obligations for restitution remains unknown at the makes the signing of flexible service contracts more difficult, time being. Relatively high obligations could affect the budgetary thus having a negative effect on new employment. deficit and increase the country’s indebtedness. The depopulation of rural settlements leads to migration to urban A great number of international studies (EBRD - Transition areas. This reduces agricultural production, but also put pressure Report, EU Feasibility Study, World Bank study "Republic of on towns’ infrastructure and increases social differences. Montenegro: overview of public expenditure and institutions", OECD Investment Reform Index, and the like) point to the problem Poor transportation infrastructure, except air transportation, of corruption. Even if we assume that corruption does not exist, represents a limiting factor for the economic development, reports by international institutions have a negative effect on especially tourism. foreign investors. Entrepreneurs’ expectations may serve as the final argument to A certain number of companies still need redundancies. To lay support the hypothesis for high rates of growth in 2007. Namely, off too many people would mean the disturbance of the social half of the surveyed companies8 anticipate an improvement in peace or the provision of substantial funds for severance pay the business environment, while only 7% believe that it will be and resolving their status. worse than in 2006. • 2006

An ongoing trend in the last few years has been that salaries Furthermore, almost two thirds of the surveyed entrepreneurs have been growing faster than productivity. This was partly due expect an increase in the volume of activity, while only 7% to the legalisation that a part of salaries that were to be paid believe that it will reduce. out without paying taxes and contributions. Anyway, a faster growth of salaries than productivity could be a threat to the country’s competitiveness. CHIEF ECONOMIST ANNUAL REPORT

8 The sample covers companies quoted on the stock exchanges.

20 Graph 1.3 – Expected business recording rather low output at the second quarter-end and environment in 2007 the third quarter-beginning. However, at the annual level, the mining of coal was larger in 2006 which is partly due to the low comparative base as the output in 2005 was rather small. The mining of other ores and stone was lower than in 2005, primarily because of the lower production of salt caused by abundant rains during salt crystallisation, which caused much lower production than that planned, and also lower than that achieved in 2005.

The physical volume of manufacturing industry was a mere 0.1% larger than in 2005 due to the lower production in the ﬁrst quarter and August of the reporting year. Eleven industry sectors recorded output increases, accounting for 58.7% of Graph 1.4 – Expected volume of activity in total manufacturing industry. The most dynamic growth was 2007 recorded in the manufacturing of furniture and other products. This sector recorded remarkable increases over the entire year, recording a cumulative increase of 286% in comparison with the previous year, but its share in overall manufacturing industry was nothing more than 0.1%. A stable output growth was recorded in the production of food and beverages, 3.8%. The production of basic metals, which accounted for 40.7% of total industrial production, ﬂuctuated during the year because of occasional strikes in the Aluminium Plant Podgorica (KAP), but the cumulative production was 4.3% larger than in 2005. This was supported by the stabilisation and an increase in production of Željezara (Steelworks) Nikšić in comparison with the previous year.

1.2. Activities Lower outputs were recorded in six manufacturing sectors, with the largest falls recorded in the manufacturing of tobacco Industrial Production

Graph 1.5 – Industrial output, annual rates The physical volume of industrial production in 2006 was 1% of increase larger than in the previous year, and all three sectors recorded production increases. As for the annual rates of increase, industrial output in the reporting year was above the levels reached by August 2005, the following months recording falls, but picking up pace again in the last two months of the year.

Production in the mining and quarrying sector rose by

2.9% in comparison with 2005 due to the larger mining of coal, REAL SECTOR DEVELOPMENTS lignite and peat of 17.5%, while the mining of metal ores fell by 1.9% and that of other ores and stones by 13.7%. The month- Source: Monstat on-month mining of coal oscillated during the reporting year,

21 products (-59%) and chemical products and fibres (-34.9%), The production of electricity, gas, and water supply both accounting for 8.6% in overall industrial production. The was 3.1% higher than in the previous year. In spite of occasional manufacturing of wool and wood products slowed down its work interruptions, due to irregular supplies of coal during the pace after a stable increase in the first half of the year, which year, the thermal power plant Pljevlja fulfilled its annual plan resulted in a fall of 1% in comparison with the previous year. of production. The plant stopped work three times (in January, However, this lagging behind was due to a dynamic growth in March, and in mid-December), the total being 25 days, but it the second half of 2005, and consequently, a higher comparative increased production in the third quarter when hydroelectric base. Stable growth in manufacturing should be expected in the power plants worked to a lower capacity due to unfavourable forthcoming period, but it should be directed towards higher- weather conditions. processing products which would affect a lower import and a better utilisation of these products in the manufacturing of Most industrial sectors face similar problems, these being furniture that is very much in demand in the market. Namely, with illiquidity, obsolete technology, low level of investments, regard to the powerful growth of tourism and construction, as redundancies, unutilised capacities, non-competitiveness, and well as huge investments in the repair and modernisation of hotel the like. The restructuring of certain large systems is lagging capacities, there is an opportunity for domestic manufacturers behind the desired dynamics which could lead to a serious to increase their production and the sale of wood products and slowdown in this sector. furniture.

Graph 1.6 – Industrial output by sectors, Ø 2000 = 100 • 2006

Source: Monstat and Central Bank of Montenegro calculations CHIEF ECONOMIST ANNUAL REPORT

22 Box 1.2 – Industrial Output in Transitional Economies

Compared with industrial outputs in other countries of the region, Montenegro’s industry experienced a much slower growth in 2006. However, it should be taken into account that Montenegro is a service-oriented country.

Table 1 – Industrial production (annual rate of increase)

2000 2001 2002 2003 2004 2005 2006 Estonia 14.6 8.9 8.2 10.9 10.5 9.1 7.0 Hungary 18.1 3.6 2.8 6.4 7.4 7.3 10.1 Romania 7.1 8.3 4.3 3.1 5.3 2.0 7.1 Slovakia 8.4 7.6 6.7 5.3 4.2 3.6 9.9 Slovenia 6.2 2.9 2.4 1.4 4.8 3.3 7.0 Albania 1.3 6.1 -5.1 29.0 14.1 -20.7 NA Bosnia and Herzegovina 7.9 4.9 5.7 5.1 12.1 10.5 7.5 Croatia 1.7 6.0 5.4 4.1 3.7 5.1 4.4 FYR Macedonia 3.0 -2.9 -4.8 4.1 -2.2 7.0 NA Serbia 11.4 0.1 1.8 -3.0 7.1 0.8 4.7 Montenegro 4.2 -0.7 0.6 2.4 13.8 -1.9 1.0

Source: WIIW and statistical oﬃce of the selected countries

Tourism

Montenegrin tourism recorded growth in 2006 far above of the characteristics in the reporting year was an increase in the expected, with regard to tourist arrivals and overnights and frequency of tourist arrivals and the shortening of their stay. Also, received income. All the three parameters, which indicate the tourism revenues grew faster than the number of overnights, movement of tourism turnover, have been recording two-digit but the tourism oﬀer was richer, all of these resulting in the best ﬁgures of increase in Montenegro over the last four years. One tourist season in the last 15 years.

Table 1.2 – Comparison of expected and achieved tourist turnover in Montenegro in 2006

Expected Achieved Description Nominal Increase in % Nominal Increase in % Arrivals 904,000 10% 953,928 16.27% Domestic 540,000 0% 576,130 5.05% Foreign 364,000 30% 377,798 38.89%

Overnights 5,900,000 10% 5,936,270 13.90% REAL SECTOR DEVELOPMENTS Domestic 3,700,000 0% 3,740,179 6.00% Foreign 2,200,000 32% 2,196,091 38.69%

Source: Ministry of Tourism, Monstat and CBM calculations

23 The assessments of tourism turnover indicators (the number The estimates show that Montenegro’s income from tourism of tourists and their overnights) that had been prepared at the in the reporting year, which is 22.27% more than in 2005. Of beginning of 2006 were outstripped in the middle of the year, at this amount, EUR 271.08 million were from foreign tourists and the total level, thus observed by foreign and domestic tourists. EUR 36.65 million from domestic tourists, which is 25.93% and 61.68% more than in the previous year, respectively.

Box 1.3 – Assessments of International Experts

The World Travel and Tourism Organization (WTTO) estimated at the beginning of 2006 that Montenegro’s tourism growth would be 10.2% in the reporting year, and tourism growth in global terms would be 4.6%. With this rate of growth Montenegro would be on the list of the fastest growing economies in the world in 2006, but the recorded 16.27% certainly exceeded these estimates. Thus, according to the WTTO, Montenegro is in ﬁrst place among 174 assessed countries in the last three years, in front of India, China, Romania, Latvia, and Albania. The WTTO also estimated that in the case of a 10.2% growth, Montenegro could receive income from tourism and the related industries of EUR 521.3 million, cover 24,000 jobs, i.e. 16.8% of total employment, and account for 15.7% of GDP. Since tourism growth was higher than estimated, it can be considered that all the indicators estimated by the WTTO recorded higher levels. This organisation also foresees that tourism could generate up to 22.1% of GDP by 2016.

International experts believe that such, and even better, projections will be achieved with the lease of the island of Sveti Stefan (St. Stephen) to "Aman Resorts". With this contract, i.e. the publicity it will gain in the world, it is expected that Montenegro will enter the world’s elite tourism. Thus, it can be expected that some of the big hotel and tourism chains, such as the Hilton and the Hyatt, could be opened in Montenegro.

In the reporting year, the number of tourists amounted to 953,928 Graph 1.7 – Domestic and foreign tourist or 16.27% more than in 2005. The number of foreign and domestic arrivals, 2001 – 2006 tourists increased by 38.98% and 5.05%, respectively.

Foreign tourists accounted for 39.60% and domestic tourists for 60.40% of the total number of tourists, which is a change in comparison with the previous year when this ration was • 2006 33.2% to 66.8%.

Source: Monstat CHIEF ECONOMIST ANNUAL REPORT

24 Box 1.4 – Privatisations and Investments in Tourism

From 2001 until end-2006 a total of 24 hotels and 4 shareholding companies were privatised via the sale of blocks of shares. Although it was estimated at the beginning of privatisation that investments would amount to EUR 120 million, they exceeded EUR 200 million at end-2006. Investors interested in Montenegrin tourism during 2006 were from the USA, Russia, Great Britain, Malta, and other countries.

Although only a part of hotels and hotel companies of those planned for 2006 were actually privatised, and some tenders for sale fell through. Thus, those privatised were UTIP Crna Gora from Podgorica, the Hotel "Planinka" in Žabljak, the "Villa Oliva" in Petrovac, and "Jadran Perast" from Perast. Unlike with the aforesaid tenders, the re- announced tender for the sale of HTP Boka fell through although the offered price exceeded that in the previous year by EUR 3 million – EUR 7 million, and the amount offered for investments (from EUR 16 million - EUR 30 million) by some 10%. Regardless of its failure, it is believed that the state and other shareholders of this hotel company will not be at loss. Another tender that failed was that for the lease of Ada Bojana because there were no offers submitted. One of the reasons may be the inadequate electricity supply of this area, which is certainly not good for attracting potential investors. The bid for the sale of the ski centre "Bjelasica Rada" also fell through because the government funds decided to sell their shares at a public auction.

A Canadian company "PM Securities" bought the military repair service "Arsenal" in Tivat for EUR 3.26 million and provided another EUR 26 million for the social program. This company announced EUR 500 million investments in the project of the building of a marina within the "Arsenal" complex, with a capacity of 675 moorings (mainly for vessels 8-25 metres long, but also for those over 100 metres long), as well as the capacities for the maintenance of these vessels; new hotels, casinos, shops, restaurants, clinics, supermarkets, and other contents. HTP Budva Riviera signed in November a contract with the Austrian construction and real estate company "Soravia" which will invest EUR 24 million in the remodelling of the hotel "Slovenska plaza" in the coastal city Budva and turn it into a four-star hotel, and another EUR 40 million in the construction of a luxury hotel for the Hilton Group on Montenegro’s Adriatic coast.

The largest potential for greenﬁeld investments lies on the Montenegrin coast, in the areas of Ada Bojana, Valdanos, Velike plaže (Long Beach), Rt Kobila, Buljarice, and the Herceg Novi Riviera (Luštica peninsula). Foreign investors are also interested in the construction of sports facilities, i.e. the golf courses in the vicinity of the Skadar Lake. However, the greatest interest in greenﬁeld investments is the renowned tourist resorts of Budva and Bečići. Owners of great hotel chains, such as the Marriott, announced the construction of the hotel in Bečići at the beginning of 2007.

This year tourists also visited resorts other than those at the Also, there were more leases of hotel and other capacities at the seaside, which are certainly the most attractive and mostly visited. seaside by foreign tour operators in the period April – November, A slight increase was recorded in tourist visits to, and overnight which is very favourable with regard to extending the tourist stays in, mountain and other tourist resorts, as shown in Table season. A more than satisfactory ﬁlling of planned capacities 1.3. However, seaside resorts remain mostly visited (90.14% of was also achieved. total tourists) where the number of tourists rose by 15%. REAL SECTOR DEVELOPMENTS

25 Table 1.3 – Comparison of tourist arrivals and overnights by tourist resorts in Montenegro in 2005 and 2006

Total arrivals Total overnights Description % share in % increase in comparison % share in % increase in comparison total number with the previous year total number with the previous year Location/Period 2005 2006 2005/2004 2006/2005 2005 2006 2005/2004 2006/2005 Total 100.00 100.00 23.4 16.27 100.00 100.00 14.27 13.90 Middle part of the Republic 3.63 4.12 71.6 31.78 1.03 1.25 20.42 37.64 Seaside resorts 91.14 90.14 21.6 15.00 96.36 95.88 14.22 13.33 Mountain resorts 2.34 2.76 23.4 37.41 1.03 1.55 -1.84 27.71 Other tourist resorts 2.88 2.95 42.8 19.26 1.57 1.71 26.62 23.99 Other places 0.01 0.02 55.8 85.83 0.01 0.01 10.00 90.08

Source: Central Bank of Montenegro calculations

The number of tourist overnights recorded in the reporting year Graph 1.8 – Domestic and foreign tourist amounted to 5,936,270, which is 13.90% more than in 2005. overnights in period 2001 – 2006 However, this is still 22.94% less than in 1989 (which is considered to have been one of the most successful years in the history of Montenegrin tourism), which points to the fact that tourism still has a lot of potential for further growth.

Yet, the number of foreign tourists exceeded that recorded in 1989 by 17.81%, while the number of domestic tourists is still lower, by 22.93%, although this percentage fell considerably in relation to 2005 (36.3%)9.

In the structure of foreign tourists, the largest contributors were tourists from Bosnia and Herzegovina (17.2%), then Russia Source: Monstat (15.1%), the Czech Republic (8.6%), and Germany (6.7%).

Graph 1.9 – Structure of tourist by emitting countries, period 2002 – 2006 • 2006

9 It should be taken into account that in 1989 domestic tourists were considered all tourists from the former SFRY, which are now foreign CHIEF ECONOMIST ANNUAL REPORT tourists. However, even so, the number of domestic tourists in 2006 Source: Monstat cannot be considered a negative indicator.

26 Box 1.5 – Projects for the Infrastructure Improvements

The Montenegrin Government passed a decision in September 2006 on adopting a permanent solution for supplying the coastal area with water by selecting one of the two oﬀered projects which implies exploiting water from Skadar Lake. This project is supposed to solve the problem of water supply which, although improved, is still present during the summer tourist season and represents one of the main problems of Montenegrin tourism. The project is worth EUR 60 million, to be ﬁnanced as the credit arrangement with the World Bank and the EBRD.

In June the Government adopted a draft Strategy for Transportation Development which envisages the implementation of 25 projects in the following 10 years: 4 in each of the railway and maritime transportation, 16 in road transport, and 1 in air transportation. The implementation of these projects requires between EUR 1.44 billion and EUR 2.80 billion, which is a large amount for economies much bigger than the Montenegrin. It is envisaged that they will provide some 6,000 new jobs. The Government will be able to ﬁnance only a part of these projects from the budget funds, including funds from privatisation. However, the implementation of the projects in the near future is essential for the development of Montenegrin tourism since they are supposed to increase the security and safety of traﬃc. In addition, they will provide easier accessibility of remote areas of the Republic to both tourists and the domestic population. Priority is given to the construction of the road from Bar to the border with Serbia and the Adriatic-Ionic main road, as well as the reconstruction and modernisation of the railway line Bar – Belgrade for which a loan of EUR 60 million that will be provided from the EIB and the EBRD. Besides these, some other projects are of great importance for the development of tourism, such as the construction of roads Podgorica – Mateševo and Plužine –Šćepan Polje.

The IFC, a member of the WB, also showed interest in cooperation with the Montenegrin government in improving the business environment in Montenegro by financing the development of infrastructure, energy, and tourism. This can be carried out directly or through financing companies, domestic and/or foreign, that want to invest in Montenegro. The IFC prefers a government-private partnership as the main financing model, primarily through disbursing loans to domestic private companies and entrepreneurs.

Improvements in comparison with the previous year The Tourist economy offered in 2006 a large market for the and existing problems domestic food industry. Namely, as of 1 January 2006 (the time was subsequently prolonged to March 2007), in order to export There were some improvements in 2006 with regard to their products, domestic food producers have to have the HACCP the provision of tourist services, but some of the problems standard10, but only three domestic producers in Montenegro still remain. Positive changes were made in transportation met this standard (120 private companies in Montenegro have infrastructure, through the reconstruction of a part of the road introduced the HACCP standard). Having grown substantially network, the modernisation of airports, and the construction in the last two years owing to the encouragement of small and of border crossings. In addition, there were improvements in medium businesses but not having the HACCP in place, the the supplying of electricity, water, the disposal of solid and domestic food industry is willing to offer products of appropriate liquid waste, and public transportation, and beaches that are quality for the domestic tourist market. Thus, the growth in now tidier and safer. tourism turnover has also had a positive effect on the sales of

domestic food products even if they are unable to be exported. REAL SECTOR DEVELOPMENTS

10 HACCP (Hazard Analysis and Critical Control Point) is an internationally recognised standard that provides a systematic prevention approach to food safety.

27 Therefore, positive results are expected form the ratified Strategy municipalities and the government lose substantial income. It for the Development of Food Production and Rural Areas and is estimated that over 100,000 accommodation capacities are the Strategy for the Development of Fishing. off the record, and Monstat registers only 26,000, whereas some estimates show that there are between 275,000 and 400,000 However, both road and energy infrastructures can still be accommodation capacities in Montenegro. Tourists staying in considered underdeveloped, and the problem of pollution is unregistered accommodations use the infrastructure capacities also present. Although improved, a comprehensive solution in full, the same as the registered tourists, but they do not pay for the water supply has not yet been found, but the problem the visitors tax that is used for the renewal of the infrastructure. is expected to be overcome with the construction of regional Visitors tax costs EUR 0.75 bed/a day, so it is easy to calculate that waterworks. In some municipalities (Ulcinj), the electric power local authorities and the government are deprived of millions grid is in a critical situation, resulting in 16-hour power shortages of euros. Therefore, it is necessary to provide a better statistical during the summer season. This is a coastal area where the coverage of the tourism turnover as the existing data covers privatisation of hotel complexes is underway, and some of them only half of it. fell through, so it is necessary to solve this problem in order to provide a better valorisation of the existing capacities and create In addition to the aforesaid, another problem of the Montenegrin the conditions for investments, whether via privatisations or as tourism is the lack of qualified staff in hotels and restaurants, so greenfield investments. it is necessary to educate and train the domestic labour force in order to reduce employment through their employment in the An ongoing problem remains excessive construction in growing tourism industry. certain areas which threatens to jeopardize not only tourism development, but sustainable growth in these areas as well. Recommendations Added to this are the problems of illegal building and the lack of the required communicational and special planning, both at local Tourism is one of the most promising industries in Montenegro. and government levels, which hinder further development. Although having a large potential for investments, these should be restricted to some extent in order to preserve the conditions Another problem affecting tourism is construction work carried for the development of high level tourism. Currently, there are out during the summer season and the securing of construction some 35,000 hotel accommodations, and the building of an areas, regardless of some positive movements in this field, tourists additional 65,000 is planned in the next 15 years. These capacities still complain about noise and loud music, so it was obviously should be evenly distributed throughout Montenegro is order not enough just to enact the Law on Noise Protection, but to to provide sustainable development, i.e. the development of an implement it properly as well. elite tourism. It should be taken into consideration that during the summer high season beaches in the most attractive tourist Another issue unsolved is the location of the solid waste depot resorts are overcrowded, so one of the objectives should be the in Ubli, 33 km from Herceg Novi, which is one of the largest prolonging of the tourist season and the promotion of other • 2006 contaminators in the Boka Kotorska bay. An additional problem types of tourism. This means the diversification of the tourist in this area could be the announced construction of a cement silo. offer with some specific tourism types, such as rafting, nautical Since the conditions for cement loading already exist in the port tourism, spa and wellness, congress, eco-, and sports tourism. Bar, which is on the open sea and this makes it less attractive The development of sports tourism requires the construction in the tourism sense, it is unnecessary to create another source of sports facilities, such as golf and tennis courts, marinas, and of pollution in the middle of a bay which is suitable for further the like, which are suitable for greenfield investments, and are tourism development. the means for the extension of the tourist season and a better utilisation of hotel and other capacities. The problem still exists in the absence of a comprehensive CHIEF ECONOMIST ANNUAL REPORT statistical coverage of accommodation capacities, which makes Future efforts should be concentrated on the creation of the it harder not only to estimate tourism revenues, but makes conditions necessary for the envisaged tourism growth – train

28 staﬀ, introduce information technology in tourism, provide Graph 1.10 – Production of wood products easy and frequent transportation accessibility of Montenegro, (m3) and also connect agriculture, i.e. food industry and ﬁshing with hoteliers.

It is necessary to define target markets to focus marketing efforts and, inter alia, make the price more competitive. Therefore, important factors are transportation costs and low-cost companies, primarily airlines, which should be brought into the market and licensed. It is also important to increase the use of the Internet in tourism marketing, create a digital map, and increase Internet communication between institutions. Source: Monstat Montenegro has over 300 endemic species of plants and animals, as well as great caving opportunities, thus having great potential for the development of tracking tourism that is usually practised At the beginning of the second quarter, the Ministry of Agriculture, by highly solvent tourists. With a view to the valorisation of Forestry, and Water Management signed a Memorandum of the aforesaid, it is essential to create the conditions existing Understanding with the Netherlands Development Agency in other countries with developed mountain tourism: open (SNV) on the drafting of the National Forest Policy (NFP) to be mountain hostels, mark hiking tracks, establish professional the basis for the passing of the National Forestry Strategy aimed mountain rescue services, provide guides, helicopters, terrain at the development of forestry as a branch of the economy that vehicles, and the like. Tourists should be better informed at border could contribute to the overall development of Montenegro. crossings and be provided with maps and telephone numbers This is to be achieved through preserving and improving the of the emergency services. It is necessary to connect the tourist state of forests. product, local tourist places, and tour operators, as well as the seaside and mountain resorts tourism (offer tourists staying on Although some positive results were achieved in this field through the coast rafting, climbing, and hiking in the service package). the implementation of numerous projects, it is necessary to The building of small hotels in the mountains, i.e. cottages and establish a better control of illegal cutting, intensify afforestation boarding houses, should also be encouraged. of barren land, and perform a planned and controlled forest exploitation. In addition, the connection of the forestry and wood As for the off-accommodation expenditure, the rich historical industries is still unsatisfactory, so the export of logs should be and cultural heritage should be additionally promoted, the redirected to domestic manufacturing capacities in order to valorisation of which requires the restoration and protection encourage the development of the final processing of wood. of the cultural heritage. The funds for their financing could be provided through private-public partnerships. Construction12

Forestry11 The Construction sector recorded the most powerful growth in the reporting year, especially in the second and at the beginning The forestry sector has been recording positive rates of increase of the third quarter. The value of performed construction work since 2002. In the period January – November 2006, the in the period January – November 2006 amounted to EUR 180 production of wood products amounted to 304,000 m³, which million, which is a 161% nominal growth in comparison with is 14.2% more than in the same period of 2005. the same period last year. Measured through eﬀective hours this REAL SECTOR DEVELOPMENTS is an increase of 47.8% increase.

11 Only data for the period January – November were available at the moment this report was being prepared 12 Ibid

29 Graph 1.11 – Construction activity

Source: Monstat

The reason for such a high growth in this sector is large construction, and the inadequate legislative support which investments in the reconstruction of old, and the building of could have negative consequences where ecological and spatial new, facilities, these mainly being hotels and other tourist devastation is concerned. Also, another problem is the insufficient building, then apartments and investments in infrastructure. supply of domestic construction specialists in the general labour Construction is closely connected with investments which, force in this field. obviously effects the development of the entire economy. Taking into account the inflow of foreign direct investments Transportation13 and greenfield investments, it is reasonable to expect further positive developments in this field. However, problems associated According to Monstat data, different results were achieved in with construction are the still present grey market and illegal transportation. Thus, lower volume was recorded with passenger

Graph 1.12 – Road passenger and cargo transport • 2006

Source: Monstat CHIEF ECONOMIST ANNUAL REPORT

13 Only data for the period January – November were available at the moment this report was being prepared.

30 transport via railways (by 19.7%), public transportation (by 30%), and air cargo transport (by 23.9%), while all other types Graph 1.13 – Air passenger transport of transport recorded increases.

Month-on-month road passenger transport in the reporting year was higher than in that in 2005, which resulted in a cumulative growth of 38.7%. The largest increase was recorded in the third quarter of the year due to the summer tourist season. The reason for a larger volume of road transport is the low comparative base since the first quarter of 2005 saw frequent traffic delays on main roads due to the unfavourable weather conditions and heavy snows in that period. Additionally, the railway traffic interruptions at the beginning of the reporting year, as well as Source: Monstat the low service quality in railways resulted in the passengers’ opting for road and air transport. Road cargo transportation recorded a 24.2% increase. many years, so the accumulated problems in this field are a big Air passenger transport was 19.4% higher than in the comparative impediment to further development of all economic activities. period of 2005. However, air transport has a very distinct seasonal Also, the transport chain Port Bar – Railways of Montenegro character, with more passengers transported during the summer – Railways Belgrade is not used to its full extent and Port Bar tourist season. Thus, the largest number of transported passengers is not well-connected with countries in the region. Therefore, was in the period June – September 2006, being 18.5% higher it very important to pass and implement the Transportation than in the same months last year. The modernisation of airports Development Strategy that would define actions to be undertaken in Podgorica and Tivat and the introduction of more charter with a view to eliminating the existing bottlenecks. flights contributed to an increase in the turnover of air passenger transport. 1.3. Prices Maritime transport also recorded positive results, with cargo transport increasing by 64.5%. Also, the turnover in harbours Inflation in Montenegro in 2006, measured by the retail price rose by 16.8%, amounting to 2.3 million tonnes. Of the total index, amounted to 2%. Although the increase in prices was 0.2 turnover, 43% were exports and 57% imports. These results percentage points higher than n the previous year, price stability reflected in the increase in railway cargo transport of 44.2%. was maintained. The share of the prices of goods in inflation was The reconstruction and modernisation of the railway Podgorca 1.61 percentage points, and the prices of services accounted for – Nikšić started in the first quarter of the year. This project is of 0.39 percentage points. The average monthly rate of increase great importance for connecting the Aluminium Plant Podgorica was 0.16%, with the highest monthly growth was recorded in (KAP) and Steelworks (Željezara) in Nikšić, as well as a better April (0.6%), and a fall of 0.2% recorded in July. positioning of the Port Bar. The reconstruction is envisaged to be carried out in two to three years, so positive results can be Numerous factors affected the movement of prices in the reporting expected in the medium and long term. year, and these can be identified as structural (changes in tax policy), methodological (a weight change by Monstat), external Regardless of the positive results in transportation services (oil and sugar prices movements), and seasonal (agricultural in the reporting year, the transportation infrastructure is still products). REAL SECTOR DEVELOPMENTS underdeveloped and unadjusted to the needs of the economy, especially where railway and road transport is concerned. The The prices of goods increased by 2%. Until 2006, the main food railway infrastructure has not been maintained properly for products (bread, milk, eating oil, grease, and sugar) had been

31 explain some 25% of total inflation. Among these products, the Graph 1.14 – Retail prices, monthly rate of increase highest increase was in the price of sugar, 37.3%, but it can only partly be explained by the changed tax policy. The prices of sugar on the world market showed a very dynamic growth in mid-2006, and the supply in the Serbian market also changed significantly due to their producers’ reorientation to international markets, which subsequently affected the prices in Montenegro.

The seasonal character of agricultural products had a somewhat stronger impact than usual on the movement of prices in the reporting year. After price increases in the ﬁrst half-year, their seasonal fall occurred in June and July, and at the year-end they started rising again. Observed at an annual level, the prices of agricultural products were 6.7% higher than in the previous year, Source: Monstat and they accounted for 14.5% of total inﬂation (29% in 2005).

Changes in oil prices throughout the year had a stronger impact exempt from value added tax, but as of January 2006 they were on total inflation than in previous years because Monstat revised taxed at a 7% VAT rate, which was the main reason for their price the weights of certain categories of goods and services at the increases. Since these are products that have a large share in the beginning of 2006. Thus, the contribution of the item "liquid fuels total basket of goods and services used for the calculation of the and lubricants" rose from 1.41% to 6.9%, which means that the retail price index, the changes in their prices (although not big) same price increase had almost a fivefold greater effect on the

Table 1.4 – Share of certain groups of goods and services in inﬂation

Total weight growth rate share in total TOTALAL 10,000 2.0% 100% GOODS 8,040 2.0% 80.4% Agricultural products 445 6.54% 14.55% Manufacturing products 7,595 1.71% 64.9% Food products 2,518 3.64% 45.8% Beverages 552 0.47% 1.3% • 2006

Tobacco 493 0.0% 0% Non-food products 4,032 0.89% 17% Liquid fuels and lubricants 690 -0.95% -3.28% SERVICES 1,960 2.0% 19.6% Craftsman services 355 3.18% 5.6% Public utility services 303 6.29% 9.53% Financial services and other 118 5.21% 3.07% Education services 128 1.09% 0.7% Social security services 103 0.0% 0%

CHIEF ECONOMIST ANNUAL REPORT Transportation and postal service 953 0.1% 0.48%

Source: Monstat and CBM calculations

32 Graph 1.15 – Prices of agricultural products Graph 1.16 – Oil prices, monthly rates of increase

Source: Monstat Source: Monstat and ‘’Monthly oil market reports’’, OPEC

2006 inflation than on that in 2005. The first eight months of At the third quarter-end and the beginning of the fourth quarter, the reporting year was characterized by a powerful growth in oil there were significant changes in oil prices in the world market. prices, resulting in the average price of Brent crude oil increasing A relief of geopolitical tensions, the renewed production of some by 19% in comparison with end-2005. The volatility of the oil oil refineries in the Gulf of Mexico and Nigeria, as well as OPECs market was due to the growing political tensions in the Middle announced intention to maintain a high level oil production, East and political disturbances in Nigeria. The determination of increased oil supplies. In addition, the unusual warmth for that Iran, as the fourth largest oil exporter in the world, to start with a time of year and large oil supplies of the USA reduced market nuclear program brought about reactions by the USA that spoke demand. Thus, oil prices in the world market in September about a potential military intervention, and other countries to fell by 15.6% in comparison with the previous month, and indicate support for the introduction of sanctions. A fear of a the lowest monthly value of Brent crude oil was recorded in reduced oil supply on one hand, and increased global economic October, USD 58/barrel. After these developments, oil prices in activity and increased demand on the other, led to the oil prices Montenegro in December fell by 0.9% in comparison with the rises. The prices of the item "liquid fuels and lubricants" had risen same month in 2005. by 10.6% by August.

Table 1.5 – Retail prices (percentage change)

XII 2002 XII 2003 XII 2004 XII 2005 XII 2006 XII 2001 XII 2002 XII 2003 XII 2004 XII 2005 TOTAL,AL, iindexndex 9.4% 6.7% 4.3% 1.8% 2.0% GOODS 8.7% 5.1% 1.1% 1.8% 2.0% - Agricultural products 19.6% -2.9% -5.4% 10.1% 6.5% - Industrial products 8.0% 5.7% 1.5% 1.2% 1.7% - Beverages 10.0% 0.4% 2.1% 8.3% 0.5% REAL SECTOR DEVELOPMENTS SERVICES 12.7% 14.3% 18.1% 1.8% 2.0%

Source: Monstat

33 The prices of services were 2% higher than in 2005. Within this Graph 1.17 – Producer’s prices of category, the highest growths were recorded in the prices of manufactured products housing and public utility services (6.3%), craftsman services (3%), and ﬁnancial services (5%).

The cost of living grew faster than retail prices. The annual growth amounted to 2.8%, and the reason was a larger share of industrial food products and agricultural products in the total basket of goods and services used for the calculation of the cost of living index. A higher than average growth was recorded in expenses for food (4.4%) and housing (3.3%). The increase in other categories range between 0.1% (transportation and postal service expenses) and 1.5% (the expenses for clothes Source: Monstat and footwear).

Although the producers’ prices of manufactured products saw a more accelerated growth than retail prices and the cost of 1.3.1. Inflation Forecast living, they recorded a slowdown from 3.5% in 2005 to 2.9% in the reporting year. The average monthly rate of increase in Taking into account that the maintenance of macroeconomic these prices amounted to 0.24%. Observed by use, the prices of stability and an increase in gross domestic product (GDP) are the personal consumption goods rose by 5.5%, intermediate goods primary objectives of Montenegro’s economic policy, the Central by 1.6%, and the prices of capital goods remained the same as in Bank of Montenegro has dedicated particular attention to GDP the previous year. The increase in personal consumption goods and inflation forecasts as the main indicators of macroeconomic was affected by price increases in certain manufacturing sectors, stability. primarily the prices of textile and textile products (30.5%), the prices of wood and wood products (8.7%), and the prices of Therefore, the Central Bank regularly publishes Fan Chart Inflation food and beverages (5.9%). As for the prices of basic metals, Forecasts, starting form the Inflation Forecast for 2006. From they fell by 1.9%. January 2007 we started with fan chart inflation forecasts for one year ahead, on a monthly basis. In quarterly reports on inflation the Central Bank will also give assessments of the efficiency of inflation forecasting and measures for its quality improvements. • 2006

Box 1.6 – Use of Fan Chart

The very concept of a Fan Chart is based on quality improvement in presenting inflation movements, with the presentation focus of the fan chart being on forecasting inflation distribution rather than projecting inflation in exact numbers (targets). The fan chart helps to make it clear that monetary policy is about making decisions in an uncertain world and that the Central Bank cannot accept the responsibility or pretend to have instruments to forecast the exact rate of inflation.

The Fan Chart is primarily used to present a set of potential results arising from various scenarios wherein the CHIEF ECONOMIST ANNUAL REPORT central band of the fan chart is the rate of inﬂation with the least probability of error. The Fan Chart, besides

34 relying on econometric models, forces analysts to consider as many potential factors possible that may affect the inflation rate and place the necessary focus on potential shocks which are a part of the economic cycle of every country. This gives them a more precise estimate of the efficiency of the forecasted model by evaluating the risks and uncertainty that characterize the model.

In addition, the Fan Chart is an instrument for determining the quality of a model forecast, whether it can anticipate shocks and their relative impact on inflation movement, and the relative impact of inflation on real flows of an economy.

Montenegro’s inflation fan chart is a graphical view of a probability 3. Fan chart skewness – the level of distribution distribution forecast of inflation rate movement presented via skewness of inflation forecasts makes the fan chart the retail price index (RPICG14). Thus, instead of determining adjust to the forecast so as to determine whether the exact points, the fan chart probability distribution takes the central projection values have overestimated or into consideration both potential shocks and uncertainties that underestimated the rate of inflation movement. This could have an impact on inflation movement. The very purpose will also determine the position of the mean value of of the fan chart if to point to and consider uncertainties existing inflation distribution. in an economy’s real flows which, as a consequence, reflect in inflation movements (increases in the prices of energy, increases/ Fan Chart Central Projection - ARIMA model decreases in the foreign trade deficit). ARIMA (Autoregressive Integrated Moving Average) is the most The Fan Chart for Montenegro for 2007 is based on three general class of models for forecasting a time series. It consists of estimated parts: three elements: autoregressive, moving averages, and forecast 1. The central projection values – these have been errors. The autoregressive part examines the past values of calibrated from the ARIMA model presented in the the observed time series (AR), the moving averages to the Central Bank paper "Inflation Forecasting: Empirical drops of moving averages of the main series (MA), while ut research of the retail price index movement in is the forecasted error that is assumed to be independent and Montenegro for 2007 – the implementation of the follows the Gaussian distribution. The ARIMA model is generally ARIMA model". The obtained RPI values represent the referred to as an ARIMA (p,d,q) where p represents the number mode – the value with the highest frequency of the of autoregressive variables, d refers to the level of dependent probability distribution, variables that needs to be made stationary, and q is the number 2. The level of uncertainty – it determines the of variables, moving averages, in a certain model. fan chart width. Uncertainty coefficients have been obtained through analytical assessment and calculation The ARIMA (Autoregressive Integrated Model with Moving of the relative effect of potential internal (the expected Averages) model of inflation time series of Montenegro presented increase in the price of electricity) and external shocks through the retail price index15 was developed for the purpose (oil prices) on the Montenegrin economy in 2007, of creating the fan chart. and REAL SECTOR DEVELOPMENTS 14 Retail Price Index Montenegro 15 A detailed explanation of the ARIMA model of Montenegro is given in the Central Bank paper 11 Detaljno objašnjenje ARIMA modela Crne Gore predstavljeno je u radnoj studiji Centralne banke br.11 "Inflation Forecasting: Empirical research of the retail price index movement in Montenegro for 2007 – the implementation of the ARIMA model".

35 DLOGRPICG = α0 + α1 DLOGRPICGt-1 + α2 SDLOGRPICGt-8 + α3 DLOGRPICGt-12 + α4 DLOGRPICGt-20 +

β 1et-4 + β2 et-12 + ut ...... (ARIMA 1)

DLOGRPICG = -0.009 - 0.336 DLOGRPICGt-1 - 0.441 SDLOGRPICGt-8 - 0.296 DLOGRPICGt-12 -

0.6638 DLOGRPICGt-20 - 0.442 et-4- 0.663 et-12+ ut ...... (ARIMA 1)

DLOGRPICG = α0 + α1 DLOGRPICGt-1 + α2 SDLOGRPICGt-8+α3 DLOGRPICGt12 + α4 DLOGRPICG20 +

α5dummystrbreak1 + α6dummystrbreak2 + β1et-4 + β2et-12 + β1et-14 + ut ...... (ARIMA2)

DLOGRPICG = 0.0106 - 0.2715 DLOGRPICGt-1- 0.0195 SDLOGRPICGt-8 - 0.1867DLOGRPICGt-12 +

0.7282α4DLOGRPICGt-20 + 0.5931dummystrbreak1 + 0.0140dummystrbreak2 – 1.3032 β1et-4 -

0.4510et-12 + 0.2922et-14 + ut ...... (ARIMA2)

The ARIMA model has been used for short-term forecasts (12 below the mode, i.e. the central projection has overestimated months-year 2007) after testing many ARIMA models and ranking the future inﬂation value – the distribution is negatively skewed them with regard to their eﬃcacy and analysis quality. so that Avg

Creation of RPICG Fan Chart for 2007 In Montenegro’s inflation fan chart, monthly central projections represent the distribution modes, meaning that their mean values The selected ARIMA models ARIMA1 (4,1,2)16 and ARIMA2 are not equal to the mode value, which points to a positively (4,1,2)17 (two models with and without structural shocks) have curved, asymmetric distribution. probability levels sufficient for forecasting purposes. Therefore, these models have been used for inflation forecasting, i.e. their When speaking of the degree of uncertainty, which determines forecasts have been used as the central projection values of the fan chart width, it is approximated via the distribution variance the fan chart of rpi for 2007. The obtained values represent the calculated by the model so that the inflation rate distribution distribution mode, i.e. values with the highest frequency in the has a mean value and a variance as follows: distribution of this time series. E(RPICG)=µ+√2/π(σ2-σ1) The next step is to determine the mean distribution value, standard deviations (σ), and skewness. These determine the values of sigma VAR(E(RPICG)) = (1-2/π)(σ2-σ1)2 + σ2*σ1, 1 (σ1) and sigma 2 (σ2), which represent the parameters of the left part of the distribution N1 (central projection, σ1), and the where µ represent the distribution mode, σ2 and σ1 are right part of distribution N2 (central projection, σ2). If σ1<σ2, the standard deviations to the left, i.e. right, side of the asymmetric • 2006 distribution shifts towards the value over the mode, i.e. the given distribution, while γ represent the approximate distribution central projection has underestimated the future inflation – the skewness presented as the difference between the median and distribution is positively skewed to the left so that Avg>Me>Mo. the mode, as follows: On the other hand, if σ1>σ2, the distribution is concentrated

16 ARIMA model is generally referred to as an ARIMA (p,d,q) where p represents the number of autoregressive variables, d refers to the level

CHIEF ECONOMIST ANNUAL REPORT of dependent variable that needs to be made stationary, and q is the number of variables, moving averages, in the certain model. 17 ARIMA2 model, although having the same ARIMA (p,d,q) structure, also contains two dummy variables that refer to the structural breaks in the movement of the RPI, thus becoming more sensitive to potential shocks in the future.

36 f(RPICG)= RPICG exp(-( RPICG- µ)2(1+γ)/2σ2), equal number of bands (eight) on either side of the central band if RPICG< µ18 whereby every band is of the same colour, both above and below the central band, cumulatively takes the inflation projection to RPICG exp(-( RPICG- µ)2(1-γ)/2σ2), if RPICG>µ the next 10% of probability. As the degree of uncertainty grows over time, so the fan chart spreads. Based on the ARIMA1 optimistic model, the obtained central projection equals the mode, with the mean value of 2.48%, Montenegro’s inflation fan chart for 2007, based on the optimistic skewness coefficient that varies between 0.08 and 0.70, and ARIMA 1 model, shows with a 90% probability that inflation, standard deviation values on the left, i.e. the right, side of measured by the retail price index, will vary from 1.3% to 3.78%, the asymmetric distribution of σ2=0,210 and σ1=0,093, but based on the fan charts central projection, the same forecast, which indicates that the central band is in the lower part of the with a 10% probability, shows that inflation, measured by the distribution, i.e. that the degree of uncertainty, supported by retail price index, will range between 1.72% and 2.45%. inflationary expectations, spreads the fan chart towards higher inflation levels (Graph 1.18). The pessimistic ARIMA 2 model gives the central projection equal to the distribution mode, with a mean value of 3.11%, The fan chart presents a 90% probability of inflation distribution. the skewness coefficient varying between 0.048 and -1.27, The central projection is usually in the deepest shade of the fan and standard deviation values on the left and the right side chart, i.e. in the central 10% of probability.19 The fan chart has an of the asymmetric distribution of σ2=0,459 and σ1=0,145,

Graph 1.18 – Projection of Montenegro’s retail price index for 2007 based on the optimistic ARIMA 1 model without structural breaks

18 For detailed Fan Chart explanation see Britton, E, Fisher, P.G. and Whitley, J.D. (1998), "The Inﬂation Report projections: Understanding the REAL SECTOR DEVELOPMENTS Fan Chart ", Bank of England, Quarterly Bulletin, 38, pp. 30–37. 19 The mode value (central projection) is, by construction, always in the deepest band shade, but in case of a heavily unbalanced risk, the central projection may not cover either of these values ( Britton, E, Fisher, P.G. and Whitley, J.D. (1998), ‘The Inﬂation Report projections: Understanding the Fan Chart’, Bank of England, Quarterly Bulletin, 38, pp. 30–37.)

37 respectively, which indicate that the central band is in the lower Inflationary expectations part of the distribution, i.e. that the probability distribution is concentrated above the mode value (Graph 1.19). Inflationary expectations are in accordance with our model rates of inflation movement. Both entrepreneurs and banks Montenegro’s inflation fan chart for 2007, based on the pessimistic expect somewhat higher inflation in 2007, which is mainly ARIMA 2 model, shows with a 90% probability that inflation, due to the announced increase in the prices of electricity. measured by the retail price index, will vary from 1.4% to 4.2%, However, inflationary expectations are lower with the surveyed but based on the fan charts central projection, the same forecast, entrepreneurs than with banks. One third of banks believe that with a 10% probability, shows that inflation, measured by the inflation will be the same as in 2006, 22% expect it to fall, and retail price index, will range between 1.9% and 3.4%. 45% anticipate an inflation increase (Graph 1.20).

Graph 1.19 – Projection of Montenegro’s retail price index for 2007 based on the pessimistic ARIMA 2 model with structural breaks

Graph 1.20 – Inﬂationary expectations by Graph 1.21 – Inﬂationary expectations by

• 2006 surveyed entrepreneurs

surveyed banks CHIEF ECONOMIST ANNUAL REPORT

38 On the other hand, more than 80% of the surveyed entrepreneurs GraphGraﬁk br.1.22 1.22 – Trend – Konjukturni indicator indikator expect a higher rate of inﬂation than that recorded in 2006 (Graph 1.21).

Therefore, our trend indicator shows that an inﬂation increase can be expected in 2007, but expectations were lower at the beginning of 2007 than at end-2006 (Graph 1.22).

Note: The trend indicator (blue line) was calculated as the difference between those expecting inflation to increase (light red columns) and those expecting its decline (dark red columns). If the value of the trend indicator is above zero, then an inflation increase can be expected and vice versa.

1.4. Labour Market Graph 1.23 – Number of employees The growth in economic activity had a positive eﬀect on the labour market, resulting in increased employment and a reduced number of registered unemployed people.

Employment dynamics was more powerful than in 2005. According to Monstat data, the average number of employees in Montenegro in the period January – November 2006 amounted to 151,215 or 4.8% more than in the comparative period of 2005. The month-on-month increase was also higher in the reporting year, and the largest number of employees was recorded in July due to greater seasonal employments; in addition, the decline in employment was also reduced in the months that followed, and Izvor: Monstat even increasing again in the last quarter of the year. A decrease in the number of employees was recorded in the two sectors that showed the most dynamic output growth during the year 41%, while that of the production sector fell from 32% to 30% – construction (a fall of 8.6%) and hotels and restaurants (a (Graph 1.24). fall of 1%). According to Employment Bureau data and in line with the Regulation on the Employment of Non-resident Private As the number of employees rose, the number of the unemployed Citizens, the number of employed non-residents rose by 63% in on the Employment Bureau records declined, at an even faster rate. 2006, most of them in construction and tourism. The number The average number of unemployed throughout the reporting of employees declined in the agricultural sector (by 6.7%), year amounted to 43,190 or 20% less than in 2005, with the transportation (by 11.8%), and education (by 1%). The highest December 2006 records showing 38,876 registered unemployed increases in employment were in trade and repair (25%) and persons or 20.4% less than in the same month the year before. real estate (19%). The Bureau’s estimates indicate that of the total number of

unemployed persons, 70% are actually unemployed, and 30% are REAL SECTOR DEVELOPMENTS The structure of employees in the three main sectors: production, actively working in "the black market" and agriculture, yet being services, and the public sector, shows the largest share of on the records in order to receive medical-care insurance and employees was in the services sector that rose from 39% to other social beneﬁts. From March until October unemployment

39 gradually fell, primarily due to the successful tourist season and the Bureau’s activities in ﬁnding jobs for seasonal workers that Graph 1.24 – Employment structure resulted in 6,780 new positions or 23% more than planned for the reporting year. Increased economic activity resulted in a growing demand for the labour force, so there were 48,284 job announcements during the year, which is 38% more than in 2005. The number of employees and trainees hired via the Bureau during the reporting year amounted to 23,463 or 4% more than last year.

The most serious problem in the Montenegrin labour market is the existence of structural unemployment, i.e. the structural Source: Monstat discrepancy between supply and demand. Of the 972 different professions offered within the labour force during the year, 574 were not demanded at all, while on the other hand, some Graph 1.25 – Unemployment 328 professions were demanded but there were no suitable applicants. In addition, the unemployment structure shows that 58% is made up those waiting for employment for over a year, 29% over three years, and 12.5% longer than eight years. Longstanding unemployment leads to the loss of both working and professional abilities and, consequently, the quality of the labour force. Therefore, an active employment policy, through training programs, additional qualifications, and the retraining of those with obsolete skills, would play a great role in diminishing the aforesaid discrepancy. Structural unemployment also points to the need to improve education system, and also develop continual professional training. It is very important that programs Source: Employment Bureau of acquiring additional professional qualifications and retraining are made available to as many unemployed people as possible. Only professional education addressing the actual needs of the is that 84 persons registered as redundant were granted loans, market could have a positive effect on reducing unemployment. which enabled the opening of 144 jobs. During 2006, the Bureau organised training programs for 4,275 unemployed people, of which 654 programs were training course The activities of the authorized institutions concerned with for those who already had a prospective employer. promoting active and stimulating measures for employment • 2006 in the last few years have yielded positive results, especially An important factor in economic development should be the in self-employment, the acquiring of additional qualifications, development of small and medium enterprises, especially when professional retraining, the employment of trainees, public taken into account their great flexibility and quick adjustments works, and the like. Their continuation is essential with a view to market changes. Therefore, self-employment programs and to reducing longstanding unemployment, increasing the quality those for stimulating entrepreneurship are very fruitful with of the labour force, reducing the grey economy, and encouraging regard to future permanent employment. A continuation of the entrepreneurship. Encouraging the unemployed to actively look Program of Financing Self-Employment resulted in the granting for a work by providing them with counselling, the preparation of 2.038 requests for self-employment loans that will open 3,348 of individual plans for job seeking and additional training is of CHIEF ECONOMIST ANNUAL REPORT new jobs. Most of the loans were to agriculture, craftsmanship, great importance in the current situation of growing demand personal services, and trade. Another benefit from these loans for labour in Montenegro.

40 Box 1.7 – The Employment Rate and the Activity Rate

Monstat data obtained from the Survey on the Labour Force show that the activity rate (the share of the active population aged 15+ in the total population) amounted to 58% in 2006, and according to the Employment Bureau’s data, the employment rate was some 50%. These rates are very low when compared with countries in the region and some of the new EU member countries, lower being only in FYR Macedonia and Albania.

Table 1 – Structural labour market indicators

Employment rate, % Activity rate, % Czech Republic 64.8 70.4 Hungary 56.9 61.3 Poland 52.8 64.4 Slovakia 57.7 68.9 Slovenia 66 70.7 Estonia 64.4 70.1 Latvia 63.3 69.6 Lithuania 62.6 68.4 Bulgaria 55.8 62.1 Croatia 55.0 63.3 Romania 57.6 62.3 Albania 45.8 43.5 Macedonia 33.9 42.4 Montenegro 50 58

Source: Economic indicators for Central and Eastern Europe, BIS

However, it should be taken into account that the employment rate in Montenegro is higher due to the fact that there are many people working in the informal economy but yet being on the Employment Bureau’s records.

1.4.1. Wages and Salaries

The average salary in Montenegro in the reporting year amounted ﬁnancial intermediation (EUR 533), and the lowest in the ﬁshing to EUR 377, being 15.6% higher than in 2005, and the average sector (EUR 90). salary without taxes and contributions amounted to EUR 246 or 15.4% higher. Salaries grew much faster in 2006 than in Such a high nominal rate of increase in salaries (without taxes previous years, and they increased at the same rate as productivity and contributions), as well as a relatively small increase in the growth. cost of living, resulted in a real increase in salaries (without taxes

and contributions) of 12.03%. The transfer from progressive to REAL SECTOR DEVELOPMENTS According to Monstat data and classification, higher salaries proportional taxation, i.e. the implementation of the unique tax were recorded in six out of fifteen areas. The highest salary rate of 15%, together with an increase of the minimum wage from without taxes and contributions was recorded in the field of EUR 50 to EUR 52, will affect an increase in salaries in 2007.

41 Table 1.6 – Average salary (without taxes and contributions) by sectors

Salary without taxes and Nominal Real salary contributions salary index index 2005 2006 2006/2005 2006/2005 TOTALAL 213.14 245.95 115.39 112.03 Agriculture, forestry 171.57 196.15 114.33 111.0 Fishing sector 88.78 90.20 101.60 98.64 Mining and quarrying 295.92 380.79 128.68 124.93 Manufacturing 194.56 229.93 118.18 114.74 Electricity, gas and water supply 315.43 394.36 125.02 121.38 Construction industry 130.21 166.86 128.15 124.42 Trade, repairs 140.43 148.13 105.48 102.41 Hotels and restaurants 139.55 164.75 118.06 114.62 Transportation, warehousing, 263.21 310.84 118.10 114.66 communications Financial intermediation 467.15 552.79 118.33 114.88 Real estate, renting 210.79 227.46 107.91 104.77 Government and social insurance 243.90 282.68 115.90 112.52 Education 234.75 249.49 106.28 103.18 Healthcare and social care 218.62 243.56 111.41 108.17 Other public utility and personal services 159.06 204.67 128.67 124.92

Source: Monstat

Graph 1.26 – Real salaries (monthly increase) • 2006

Source: Monstat CHIEF ECONOMIST ANNUAL REPORT

42 1.5. Results of the Processing of Annual Financial Statements of Legal Entities in Montenegro

The Central Bank of Montenegro has initiated an experimental 1.5.1. Methodological Remarks processing of annual financial statements (AFS) of legal entities in Montenegro obligated to submit these reports to the Commercial Legal entities – economic subjects in Montenegro compile their Court in Podgorica20 in line with the Law on Accounting and AFS in accordance with the International Accounting Standards Auditing21. (IAS) and the International Financial Reporting Standards (IFRS) adopted and published by the authorized International Federation By 30 June 2006, 8,489 legal entities submitted their AFS to the of Accountants (IFA)24. Commercial Court, of which the Central Bank of Montenegro processed 8,214 AFS22, and the remaining 275 have not been For the purpose of processing, AFS were classified and processed processed due to incorrectly filled in forms23. in line with the definitions prescribed in the Law on Statistics and the Statistical System of Montenegro25 at the levels including Since the percentage of the processed AFS is lower in comparison areas, sectors, groups, and subgroups. The processing was also with the total number of registered legal entities obliged to submit in accordance with the definitions and forms specified in the Law these statements, the indicators obtained after the processing of on Accounting and26, the Company Law27, tthehe LLawaw oonn BusinessBusiness the submitted – appropriately filled in AFS can be taken with Classification, and the Registry of Classification Units28. some reservations to be representative of the Montenegrin economy. It should be stressed that of all the submitted AFSs, 1.5.2. Processing Results only 10% were filled in appropriately, and the remaining 90% had either a few or many mistakes in the completion of the The processing of AFS gave numerous balance sheet aggregates forms prescribed by the Institute of Accountants and Auditors which, with the aforesaid restrictions, can be considered of Montenegro and in line with the Law on Accounting. representative macro-aggregates of the Montenegrin economy. The sum of macro-aggregates of legal entities in Montenegro29

20 The Central Bank of Montenegro implemented this project in accordance with the Agreement of Cooperation with the Commercial Court in Podgorica in May 2006. 21 "Official Gazette of the Republic of Montenegro", no. 69/05 22 At end-2005, there were some 28,000 registered legal entities in the Commercial Court Central Registry. This includes some 14,000 legal entities whose registration was not extended, so they are considered inadequate (inadequate are those companies that perform no business activity, i.e. those pending or undergoing bankruptcy proceedings). 23 The processing did not include AFS of banks and banking institutions. 24 The legally binding financial statements of companies in Montenegro are the following: the balance sheet, the income statement, the cash flow statement, the change in net property (capital) statement, and notes to financial statements. 25 "Official Gazette of the Republic of Montenegro", no. 69/05 26 "Official Gazette of the Republic of Montenegro", no.69/05 27 "Official Gazette of the Republic of Montenegro", no. 6/02 28 "Official Gazette of the Republic of Montenegro", no. 31/96, 12/98, 59/98, 74/99 29 The macro-aggregates include the flowing balance sheet items: fixed assets, current assets, capital and reserves, long term financial liabilities, long term financial liabilities, net profit/loss for the accounting period, gross profit/loss (functional), technical account – non-life insurance REAL SECTOR DEVELOPMENTS operations, non-technical account, subscribed capital unpaid, intangible assets, tangible assets, net tangible assets, investments, deposits with companies investing, investments for the account and at the risk of life insurance policy beneficiary, technical provisions, technical provisions for life insurance policies, provisions for other risks, creditors, deferred tax, deferred income, and so on.

43 was obtained from the basic, legally binding forms – models 1.5.3. Balance Sheets and Income prescribed by the Institutes of Accountants and Auditors of Statements of Legal Entities Montenegro. Of 8,214 processed AFS, 7,872 referred to economic subjects. At Of 8,214 processed AFS, 7,872 referred to companies, 193 to non- the aggregated level, the value of the balance sheets of 8,214 governmental organisations, 121 to agencies and institutions, 9 AFS in 2005 amounted to EUR 5,579,291,460, which is 5.61% to insurance and reinsurance companies, 12 to stock exchanges, more than in 2004 (EUR 5,282,786,936). and 12 to brokers (authorised participants in the financial market), and 5 to privatisation-investment funds. The processed AFS were The table 1.8 shows that the value of real estate in the assets of used for the preparation of balance sheets, i.e. income statements economic subjects in the Republic increased by over EUR 100 by the aforesaid groups. million in 2005 in relation to 2004, i.e. by 3.10%. The amounts of long term financial investments, cash and cash equivalents In addition to the aforementioned macro-aggregates, the AFS are also substantial. processing gave more types of indicators of successful operations than did the balance sheets and the income statements.30 The aggregated liabilities show a remarkable increase in the subscribed capital and short term financial liabilities. The information from the processed income statements for all the aforesaid legal entities show the following net loss structure If the aggregated balance sheet of economic subjects is presented of 8,214 processed AFS: by types of activity (Table 11, Annex A), then the structure would be as shown in Graph 1.27. Of the total amount of the net loss of EUR 253,253,413 recorded in the economy, economic subjects from Podgorica account for EUR 128,746,337 or 50.84%.

Table 1.7 – Net proﬁt/loss of 8,214 processed AFS for 2005 and 2004

Number of legal Absolute Structure of legal entities entities which 2005 2004 change submitted AFS for 2005 NGO’s 193 1,583,256 1,058,724 524,532 Agencies and institutions 121 935,732 379,198 556,534 Insurance and reinsurance companies 9 -1,638,904 492,681 -2,131,585 Privatization-investment funds 5 0 0 0 • 2006 Stock exchanges and intermediaries 14 1,997,503 1,029,348 968,155 Total I 342 2,877,587 2,959,951 -82,364 Companies 7,872 -253,254,413 -83,418,207 -169,836,206 Total II 8,214 -250,376,826 -80,458,256 -169,918,570

Source: Central Bank of Montenegro CHIEF ECONOMIST ANNUAL REPORT 30 The indicators include: indicators of income/expenditure structure, indicators of cost-eﬃciency, indicators of current assets used/days, indicators of overall liquidity, and indicators of an accelerated and present liquidity.

44 Table 1.8 – Comparison of the selected balance sheet items for processed AFS for 2005 and 2005

As at As at Absolute Item Change in % 31.12.2005 31.12.2004 change ASSETS 5,579,261,460 5,282,786,936 296,474,524 5.61 Real estate 3,531,601,463 3,425,271,022 106,330,441 3.10 Long-term receivables 96,728,810 101,415,353 -4,686,543 -4.62 Long-term ﬁnancial investments 125,390,739 89,430,149 35,960,590 40.21 Cash and cash equivalents 116,604,365 76,276,459 40,327,906 52.87 LIABILITIES AND CAPITAL 5,579,261,460 5,282,786,936 296,474,524 5.61 Subscribed capital 3,048,573,814 2,847,416,754 201,157,060 7.06 Long-term liabilities 546,684,151 603,862,622 -57,178,471 -9.47 Short-term ﬁnancial liabilities 335,359,525 197,156,787 138,202,738 70.10 Long-term loans 29,184,598 13,514,632 15,669,966 115.95 Dividends 395,644 295,187 100,457 34.03

Graph 1.27 – Share structure of activities in million or 427.73%), public utility, social, and personal services the balance sum (EUR 14.1 million or 13.1%), and agriculture, forestry and water management (EUR 11.4 million or 33%). The largest fall in total assets were recorded in economic entities in manufacturing industry (of EUR 103.8 million or 10.60%), then transportation, warehousing, and communications (EUR 78.4 million or 9.29%), and the mining and quarrying (EUR 11.4 million or 6.61%).

Observed by the selected assets items, the largest value of real estate owning economic subjects were from the production of electricity sector (31.94%), then transportation, warehousing and communications (16.67%), manufacturing industry (16.25%), Source: Central Bank of Montenegro wholesale and retail trade (11.73%), and hotels and restaurants (8.38%). Economic subjects in wholesale and retail trade, hotels and restaurants, and real estate recorded the aggregated largest Other activities, including public utility, social, and personal increases (15.35%, 34.45% and 29.16%). services, health care and social work, education and financial intermediation, agriculture, forestry and water management, The most long term receivables in the aggregated balance sheet and fishing accounted for the remaining 5.37%. Remarkable were recorded in economic subjects in the wholesale and retail increases in total assets in relation to 2004 were recorded in trade (EUR 42.7 million or 44.16%), but they is still a lower the following activities: wholesale and retail trade (EUR 215.9 proportional increase than in 2004, when in the production of million or 21.68%), hotels and restaurants (EUR 91.9 million or electricity (EUR 20.3 million or 20.95%) of total receivables, they 22.1%), real estate (EUR 79.5 million or 40.83%), construction recorded an increase of 9.65%. (EUR 42.2 million or 22.1%), financial intermediation (EUR 21.4 REAL SECTOR DEVELOPMENTS

45 Economic subjects in the wholesale and retail trade also had the The largest amounts of short term liabilities35 were recorded largest amount of long term ﬁnancial investments31 in 2005 (EUR in manufacturing industry (EUR 108.4 million or 32.34%) and 57.8 million or 46.1%), which rose by 23.70% in comparison with wholesale and retain trade (EUR 108.4 million or 32.31%). These the previous year, as did those in manufacturing industry (EUR activities also recorded the highest increase in these liabilities 24.9 million investments and an increase of 180.93%). (by 186.46% and 32.31%, respectively).

The largest amount of cash and cash equivalents32 was also The largest amounts of long term loans36 were recorded in in wholesale and retail trade companies (EUR 40.6 million health and social (EUR 14.6 million or 49.89%), wholesale and or 45.65%), then those in transportation, warehousing and retail trade (EUR 5.8 million or 20.03%), and manufacturing communications (EUR 15.8 million or 13.51%), real estate (EUR industry (19.67%). 9.6 million or 8.26%), and construction (5.71%). The total amount of liabilities for dividends37 was relatively low The largest amount of subscribed capital33 on the balance sheet in 2005, a mere EUR 395.6 thousand, of which wholesale trade liabilities side was recorded in the production of electricity accounted for the largest share, EUR 273.4 million or 69.11%. (EUR 684.1 million), then transportation warehousing, and communications (EUR 664.7 million), manufacturing industry The income statement of Montenegrin economic subjects for (EUR 525.2 million), and wholesale and retail trade (EUR 403.5 the period 1 January – 31 December 2005 was prepared in million), hotels and restaurants (EUR 351.3 million), and real accordance with the cost-based method38 (in line with the IAS, estate activities (EUR 114 million). i.e. paragraph 80), because only a few legal entities submitted their income statements in accordance with the functional The largest amount and share of long term liabilities34 were in method. This is because the cost-based method is suitable for the activity of producing electricity (EUR 141.2 million or 25.83%) small and medium companies which accounted for the largest and hotels and restaurants (EUR 121.5 million or 22.23%), share of the processed AFS. The functional method is more the latter recording the largest increase in this item (98.54%). suitable for large companies which accounted for a small share High amounts of long term liabilities were also recorded in the of the AFS submitted. wholesale and retail trade companies (EUR 79.5 million) and those in manufacturing industry (EUR 66.3 million), which Although legal entities received EUR 500 million more income recorded remarkable decreases in long term loans of 15.68% in 2005 than in the previous year, employees costs also rose, and 49.49%, respectively. as did other operating expenses, but the highest increase was in the loss for the accounting period of nearly EUR 170 million. • 2006 31 Long term financial investments include bills receivable, receivables for financial lease, long term securities, investments in capital of legal entities, and other. 32 The item cash and cash equivalents cover demand deposits, cash with banks and other financial institutions, cash in hand (domestic and foreign currency), and other cash equivalents. 33 Subscribed capital covers share capital, shares of other legal entities, stakes, and other capital. 34 Long term liabilities include liabilities due after 12 months: long term liabilities to associated entities, bills due, financial lease, long term loans, and other. 35 Short term financial liabilities include liabilities for loans, interest, dividends, issued securities, and other financial liabilities due up to one year. 36 This item covers a part of long term liabilities for loans sue up to one year. 37 Liabilities for dividends include liabilities to pay a part of the allocated profit to shareholders, as decided at shareholders meetings. CHIEF ECONOMIST ANNUAL REPORT 38 This refers to the costs breakdown (depreciation, salaries, costs of material, transportation costs, and other) allocate to different functions with legal entities. This brings costs down to costs of products sold.

46 Table 1.9 – Comparison of certain income statement items of legal entities whose AFS for 2005 and 2005 were processed

I – XII I – XII Absolute Item Change in % 2005 2004 change Income 3,107,023,663 2,602,086,164 504,937,499 19.41 Employees costs -416,291,058 -361,519,467 -54,771,591 15.15 Other operating expenses -587,903,685 -450,639,496 -137,264,189 30.46 Net proﬁt/loss for the accounting period -253,254,413 -83,418,207 -169,836,206 203.60

Source: Central Bank of Montenegro

However, this begs the question of whether this loss is genuine Graph 1.28 – Structure of income in the or was presented as such in order to avoid tax payment. aggregated income statement for 2005

Observed by economic activities,39 the largest income was received in the wholesale and retail trade (EUR 1.6 billion or 50.16% of the aggregated income), manufacturing industry (EUR 537.8 million or 17.31%), and transportation, warehousing and communications (EUR 258.3 million or 8.31%). These activities also recorded the highest income increases (20.48%, 9.84%, and 17.66%, respectively).

The highest employees costs were in manufacturing industry (EUR 115.6 million or 27.78%), wholesale and retail trade (EUR 92.9 million or 22.15%), and transportation, warehousing and communications (EUR 57.5 million or 13.81%).

Looking from the proﬁt/loss aspect, the largest net proﬁt was recorded in the wholesale and retail trade (EUR 27.2 million), and Source: Central Bank of Montenegro the largest loss in manufacturing industry (-EUR 190.3 million), being 424.63% higher than in 2004. REAL SECTOR DEVELOPMENTS

39 Income includes income from the sale of merchandize, material, and services to both domestic and foreign markets, and which are recorded and presented by the principle of invoiced realisation (excluding value added tax).

47 Table 1.10 – Net proﬁt and loss by activity, 2005/2004

Economic activity 2005 2004 Wholesale and retail trade 27,161,524 10,204,852 Construction 3,633,677 306,832 Agriculture, forestry, water management 758,668 259,811 Public utility, social, personal services 491,730 -5,412,754 Financial intermediation 199,653 907,412 Manufacturing industry -190,300,081 -36,273,037 Transportation, warehousing, communications -39,185,759 5,351,558 Electricity production -29,680,553 -11,647,054 Hotels and restaurants -17,496,568 -36,027,191 Mining and quarrying -7,585,368 -2,728,190 Real estate -762,186 -7,991,155 Health and social services -373,852 -570,573 Education -62,219 142,868 Fishing -53,079 58,414

Source: Central Bank of Montenegro

1.5.4. Problems and Recommendations

Problems related to the filling in of the AFS form are associated a few AFS have been audited, so it can also be considered that with the very structure of the form that does not require the the reliability of the presented AFS data is problematic. entry of information on the type of property and organisation of an economic subject, which prevents any comparison of Monstat calculates Montenegro’s GDP on the basis of such operating successfulness. In addition, legal entities often do not inadequately presented balance sheets and income statements fill in the mandatory items in the form referring to the identity which the Central Bank of Montenegro processed experimentally and registry numbers, which make it difficult to process, i.e. in order to get an insight in the quality of potential macroeconomic classify legal entities. The Commercial Court in Podgorica should aggregates and indicators that it tried to calculate. Moreover, the return any incorrectly filled in AFS forms and insist on their same AFS forms are used to calculate tax, which also begs the correct completion. An alternative to submitting these form question whether a quality tax calculation could be performed on to the Commercial Court in Podgorica, which has no interest in the basis of such annual financial statements. Also, it is debatable • 2006 analysing information, could be entrusted to another institution whether the income statements were compiled improperly in that would deal with this more attentively. order that a lower tax rate could be calculated or because their quality is not regulated by anyone. However, information on the identity and registry numbers in the AFS form are far less of a problem than are the inadequately It should also be stressed that banks doe not ask from their completed balance sheets and income statements. The poor clients-legal entities to present their balance sheets and income quality of these sheets is reflected in the omission to fill in all statements when granting them loans. These reports give a basic the items, as well as in some illogical information (e.g. total description of a legal entity’s operations. After reviewing no less income spent entirely on salaries without showing other costs, than 90% of poor quality AFS, it can be easily understood why CHIEF ECONOMIST ANNUAL REPORT and many others, including an overall inconsistency between there is so great a demand for loans from Montenegrin banks, assets and liabilities). Another adverse characteristic is that only and they, being concerned with diminishing their operational

48 risk, primarily credit risk, refuse to grant loans to legal entities The obligation of taking care of AFS quality by legal entities having no quality information contained in their balance sheets cannot be considered a business-barrier, but on the contrary, and income statements. Therefore, it would be good to give a the restriction to business development in Montenegro is the mandate to the Commercial Court in Podgorica or some other non-existence of quality information on the business operations competent institution to control the quality of AFS and return of legal entities. If the information were of better quality and those improperly competed to the bookkeepers who have available, banks would have a better insight into the operations compiled them, similarly to what had been done by the Bureau of prospective clients and would gladly grant them loans. This for Clearing and Settlements (the former ZOP). When looking at would increase business activity, and eventually, reduce the all the negative effects of such poor quality financial statements interest rates of domestic banks. on tax revenues, interest rates, contractual risk, and the very legal entities, it would be cost-effective to hire a number of high A certain encouragement is the larger number of submitted AFS quality professionals that would work on the improvement of in 2005 than a year earlier. Since there has been an increasing financial statements in Montenegro. awareness of the necessity to prepare accurate and quality AFS, as well as of their availability to the public, a further increase in legal entities obliged to submit AFS can be expected. REAL SECTOR DEVELOPMENTS

MONETARY DEVELOPMENTS PRELIMINARY DATA FOR DECEMBER 2006 2

Trend in 2006

Preliminary data point to accelerated developments in the the previous year. The share of state capital in total banks’ banking system during 2006. capital signiﬁcantly decreased. At the end of November 2006, foreign capital made up 80% of total banks’ capital. In addition, The increase in banks’ loans was intensiﬁed during 2006, and at the bankruptcy proceedings imposed against Jugobanka ad year-end, they reached an amount that was two times higher than Podgorica that commenced in 2002, were completed in 2006. the amount recorded a year before. The largest portion (55.8%) A new bank, Hypo Alpe Adria Bank ad Podgorica started with referred to loans to the corporate sector, while the households operations, and Pljevaljska Bank started to work as Invest Bank sector made up 36.8% of total loans at year-end. The corporate Montenegro after being purchased by Atlasmont Bank. sector still had position of net debtor in relation to the banks, and households sectors during the whole year and represented a net creditor of the banks. Expectations in 2007

Besides loan growth, significant deposit growth was recorded in Further growth and the development of the banking sector in 2006, which rose by 6.8% on an average monthly basis being at the following period can be expected based on the monetary year-end two times higher than at 2005 year-end. Total deposits indicators (banks’ assets, deposits, loans, savings, and capital) exceeded EUR 1 billion, and were above the amount of loans at and GDP, so that it can meet the requirements of the corporate year-end, so that the loans to deposits ratio amounted to 0.79% and households sector among other things. These sectors will at year-end or an average of 0.83% during the reporting year. also influence the accelerated development of the banking sector, since the economic growth that is expected as a result The continued process of consolidation and the completion of of the completed reforms, privatizations performed, inflows of the privatization process in the banking sector characterized FDI, and the like.

Table 2.1 – Selected monetary indicators

Change Change 2006 2006 2002 2003 2004 2005 2006 Description/Period 2006-2002 2006-2005 2002 2005 In EUR million In % Money supply M21 n/a 494.3 546.5 867.3 1,600.6 - 733.3 - 84.5 Banks’ assets 340.5 349.8 444.4 695.8 1,425.1 1.084.6 729.4 318.5 104.8 Total loans 124.7 200.6 281.5 375.9 844.4 719.7 468.5 577.1 124.6 Corporate loans 78.7 126.6 175.6 230.1 471.6 392.9 241.5 499.2 105.0 Households loans 22.3 49.9 74.4 104.3 310.9 288.6 206.6 1.294.2 198.1 MONETARY DEVELOPMENTS Total deposits 205.5 211.0 273.2 487.9 1.071.5 866.0 583.6 421.4 119.6 Corporate deposits 72.7 91.0 85.5 143.9 318.0 245.3 174.1 337.4 121.0 Households deposits 22.2 45.1 79.3 175.7 498.6 476.4 322.8 2.145.9 183.7 Allocated reserve requirement 35.6 27.1 33.2 61.7 172.8 137.2 111.1 385.4 180.1

53 Further growth in domestic sources for loans, primarily termed 2.1. Money Supply ones, and a slowing down of the growth in external sources for lending activity are expected in the following period. The During 2006, all monetary aggregates increased. The largest entrance of new foreign banks is expected in the Montenegrin monetary aggregate – money supply M21 reached the amount market, which has been announced for 2007. It will intensify the of EUR 1,6 billion at 2006 year-end, with an annual growth rate competition between banks since new banks would want to of 84,5%. increase their market share by attracting new clients. Therefore, the increase in interest rates on savings, as one of the ways to Note: Monetary base (M0) is comprised of banks’ deposits attract deposits should be expected, as well as the continuance with the CBM (banks’ settlement accounts and allocated reserve of the decreasing trend in lending interest rates. requirements, excluding the part banks keep as treasury bills) and the estimated amount of cash in circulation. Monetary Since external factors had a significant impact on the development aggregate M1 is comprised of M0, demand deposits by the of monetary indicators in 2006 (FDI inflow, revenues from non-banking sector with banks and the CBM, in EUR and other tourism, and the like), special attention in the following period currencies, excluding deposits by the central government. should be paid to operating risks, particularly to those that come Monetary aggregate M11 comprises M1 plus the central from the neighbouring countries. This includes the expected government’s demand deposits in EUR and other currencies. growth in spending, foreign trade deficit, increase in foreign Monetary aggregate M2 includes M1 and the non-banking borrowings of corporate sector, etc. With a view to the additional sector’s term deposits with banks and the CBM, in EUR and promotion of management of all risks in the banking sector other currencies, excluding deposits by the central government. and the further development of market discipline, as well as Monetary aggregate M21 comprises M11 plus the non- providing legal prerequisites for the expansion of the banking banking sector’s term deposits including the central government’s market, the Central Bank of Montenegro will work in 2007, in deposits in EUR and other currencies. accordance with the CBM Policy for 2007, on the harmonization of the current and the adoption of a new regulatory framework, The amount of M21 reached at 2006 year-end is the highest which will be in compliance with the best international practices amount since the current records begun, and the annual increase and it will continuously monitor and review risks to which the also represented the highest growth rate. (Graph 2.1) banks are exposed.

Table 2.2 – Money supply, period end, in EUR thousand

Description/Period 2003 2004 2005 2006 M0 284,909 290,935 351,276 483,889 • 2006

M1 386,121 430,657 596,267 1,076,694 M0 284,909 290,935 351,276 483,889 Demand deposits 101,212 139,722 244,991 592,805 M11 402,586 437,114 614,721 1,096,713 M0 284,909 290,935 351,276 483,889 Demand deposits 117,677 146,179 263,445 612,824 M2 460,837 535,548 802,256 1,502,569 M1 386,121 430,657 596,267 1,076,694 Term (time) deposits 74,716 104,891 205,989 425,875 M21 494,290 546,525 867,294 1,600,585

CHIEF ECONOMIST ANNUAL REPORT M11 402,586 437,114 614,721 1,096,713 Term (time) deposits 91,704 109,411 252,573 503,872

54 Graph 2.1 – The money supply M21, in share was noted in relation to 2005 year-end when it amounted EUR million and annual growth rate, in % to 70.9%. Simultaneously, the share in term deposits increased from 29% at 2005 year-end, to 31.5% in the reporting year.

The high liquidity of banks and the implementation of the new Decision on reserve requirement inﬂuenced the increase in aggregate M0 so that it amounted to 37.8% at year-end, which was higher than at end 2005. Banks’ deposits with CBM within this aggregate were two times higher than the amount recorded last year.

2.2. Banks’ Liquidity

The M21 grew monthly at an average rate of 5.3%. This compared The banking sector maintained liquidity at a satisfactory level to 4.1% at 2005 year-end. The increase in monetary aggregates in 2006, as can be seen from the level of banks’ available liquid was due to GDP increase, the high inflow of funds based on assets in the country and abroad which were much higher than FDI, transfers from abroad, inflow of funds based on tourism, their executed payments. foreign borrowings of economy, etc. The changes in the reserve requirement instrument did not slow down the loan growth Banks’ total assets available for payments ranged between EUR or the growth in money supply M21. The increase in demand 151 million and EUR 505 million, averaging EUR 267.7 million, for money and the increase in monetary assets did not impact which was greatly above the level achieved in previous years on inflation. Movements of money supply in 2006 were under (Table 2.3). Month-on-month, the highest level was recorded the great influence of the tourist season and the inflow periods in December (EUR 416.6 million), and the lowest in February of FDI. (EUR 184.3 million).

Although the largest portion of the money supply M21 still At the year-end, assets available for payments amounted to EUR referred to the monetary aggregate M11 (68.5%), a decrease in 394.8 million, which was 64.5% more than a year ago. Of this amount, 52% referred to domestic payments.

Table 2.3 – Average of banks’ available liquid funds and executed payments, in EUR thousand

Description/Period 2004 2005 2006 Banks’ available liquid funds 87,899 137,166 267,724 Executed payments 15,084 17,935 27,337 Surplus 72,815 119,231 240,387

Table 2.4 – Banks’ available funds and executed payments, last day in month, in EUR thousand

2003. 2004. 2005. 2006. MONETARY DEVELOPMENTS Description /Period XII XII XII III VI IX XII Available funds 79,578 100,727 239,903 209,902 232,589 275,690 394,757 Executed payments 22,746 24,380 6,605 29,046 45,156 3,406 9,191 Surplus 56,832 76,347 233,298 180,856 187,433 272,284 385,566

55 Banks’ executed payments were continuously below the Graph 2.2 – Banks’ available funds and available assets, averaging EUR 27.3 million. Movements of the executed payments, last day in month, aforementioned resulted in surpluses over the year, the average in EUR thousand amounting to EUR 240.4 million.40

In addition to banks’ satisfactory liquidity lies the fact that the reserve requirement was not used for liquidity in 2006. In addition, banks’ liquid assets (cash and deposits with depository institutions) amounted to EUR 511 million as of 12/31/06, and they increased by EUR 244 million or 91% in relation to December 2005. The share of liquid assets in total assets amounted to 36%.

Besides the aforementioned indicators, the loans to deposits ratio (0.79% at year end) showed a satisfactory level of liquidity. (Annex B, Table 13). Graph 2.3 – Banks’ liquid assets and short- term liabilities (in EUR thousand) and their Ten-day liquidity reports showed that during 2006, the cash to ratio (in %) short-term sources ratio41, for the entire banking system, was constantly above the ten-day minimum (20%) prescribed for banks that have higher amount of loans than total deposits, and/or a high share of non performing loans in the total loan portfolio. (Graph 2.3)

2.3. Aggregated Balance Sheet of Banks

The aggregated balance sheet of banks included the balance sheets of ten banks at year end. Although the total number of banks remained unchanged in 2006, changes occured in the owernship structure. Hypo Alpe Adria Bank started its operations, Table 2.5 – Selected monetary indicators and and Atlasmont Bank acquired Pljevaljska Bank, which currently GDP, in % operates under the title Invest Bank Montenegro. • 2006

2002 2003 2004 2005 2006* The relation between assets, deposits, loans and GDP, although Assets/GDP 26.2 26.5 28.4 41.2 77.9 signiﬁcantly improved since the beginning of the banking sector Deposits/GDP 15.8 16.0 17.5 28.9 58.6 reform, still showed that there is room for the further development Loans/GDP 9.6 15.2 18.0 22.2 46.2 of the banking system (Table 2.5). * Projected GDP for 2006 CHIEF ECONOMIST ANNUAL REPORT 40 Source: Banks’ Daily liquidity reports 41 Source: Banks’ Ten-day liquidity reports

56 The process of consolidation and privatization of banks, and Banks’ assets amounted to EUR 1.4 billion at the end of the the coming of reputable foreign banks/financial institutions reporting year, and it was two times higher than it was in 2005. influenced a decrease in concentration in the banking sector. The All banks contributed to this increase since all of them reported a market concentration to assets ratio (CRa) showed a decrease higher level of assets in relation to the previous year: the lowest in market share of one bank in the one year period, from 43% increase amounted to 8%, while one bank reported as much as to 38%, while approximately 80% of assets of all banks were four times higher assets than at end 2005. restricted to five banks. The Market concentration to deposits ratio (CRd) also showed a decrease in the market share of one All asset items recorded an increase in relation to the previous bank by 7%. (Table 2.6). year. The assets structure changed, so that loans increased and had the highest share in assets (Table 2.8). Additionally, The Herfindahl-Hirschman index (HHI) of concentration for assets, it is worth mentioning that all banks began to place funds in deposits and loans decreased at end 2006. (Table 2.7) foreign securities: one bank purchased bonds from the French and Belgium governments in December, which was positive from 2.3.1. Banks’ Balance Sheet Structure the risk management/diversification standpoint.

The banks’ balance sheet structure showed that deposits were the All liabilities items recorded increases in relation to the previous main sources for banks’ placements in which loans were dominant year. The largest share in total liabilities was of deposits - 75,2% in 2006. Investments in securities, although increased, still had at end 2006. (Table 2.9) a low share of placements, which was justiﬁed considering the high demand for loans, high interest rates and the banks’ income on that basis, as well as a high level of uncertainity in the capital market.

Table 2.6 – Concentration at Montenegrin banking sector to CR

CRa to assets CRk to capital CRd to deposits 1 bank 3 banks 5 banks 1 bank 3 banks 5 banks 1 bank 3 banks 5 banks 2002 0.22 0.59 0.75 0.19 0.53 0.71 0.30 0.72 0.90 2003 0.27 0.59 0.78 0.18 0.50 0.74 0.33 0.67 0.85 2004 0.31 0.60 0.77 0.18 0.47 0.65 0.37 0.62 0.82 2005 0.43 0.66 0.81 0.21 0.51 0.69 0.50 0.69 0.85 2006 0.38 0.64 0.80 0.20 0.50 0.71 0.43 0.68 0.83

Table 2.7 – HH index, Montenegrin banking sector

2002 2003 2004 2005 2006 HHI assets 1.552 1.531 1.641 2.296 2.034 HHI deposits 1.965 1.892 1.991 2.898 2.346

HHI loans 1.950 1.526 1.699 2.336 2.116 MONETARY DEVELOPMENTS

57 Table 2.8 – Banks’ assets, period end

2002 2003 2004 2005 2006 Description € million % € million % € million % € million % € million % Cash and Deposits with 140.2 41.2 96.0 27.5 107.6 24.2 267.0 38.4 511.2 35.9 Depository Institutions Loans 124.7 36.6 200.6 57.4 281.5 63.3 375.9 54.0 844.4 59.3 Securities 5.6 1.6 16.0 4.6 23.9 5.4 16.9 2.4 25.8 1.8 Other Assets 84.1 24.7 46.5 13.3 45.3 10.2 51.1 7.3 63.7 4.5 Total Reserves -14.1 -4.1 -9.4 -2.7 -13.9 -3.1 -15.3 -2.2 -20.1 -1.4 Total 340.5 100.0 349.8 100.0 444.4 100.0 695.8 100.0 1,425.1 100.0

Table 2.9 – Banks’ liabilities, period end

2002 2003 2004 2005 2006 Description € million % € million % € million % € million % € million % Deposits 205.5 60.4 211.0 60.3 273.2 61.5 487.9 70.1 1,071.5 75.2 Borrowings 12.0 3.5 26.6 7.6 59.5 13.4 80.3 11.5 173.3 12.2 Other Liabilities 45.0 13.2 23.0 6.6 20.9 4.7 21.1 3.0 30.6 2.2 Total Capital 77.9 22.9 89.2 25.5 90.8 20.4 106.5 15.3 149.7 10.5 Total 340.5 100.0 349.8 100.0 444.4 100.0 695.8 100.0 1,425.1 100.0

2.3.2. Banks’ Lending Activity

Changes in reserve requirements, which resulted in the increase amount recorded a year ago. To wit, loan growth was more in the amount of funds allocated to accounts with CBM on this intensive in 2006 than in 2005. The average monthly growth basis, did not influence the slowing down of banks’ lending amounted to 7% in 2006, which was significantly higher than activity, so that loan growth was kept at a high level, following the average monthly growth recorded in 2005 (2.5%), and in the increasing demand for this type of funding. After continious 2004. (2.9%), as well as in relation to 2002 (4,7%) and 2003 growth during the entire year, banks’ loans reached the amount (4,1%) when banks’ lending activity started, which influenced of EUR 844,4 million, which was two times higher than the the high growth rates in that period. • 2006

Box 2.1 – Share of Loans to Private Sector in GDP

The share of loans to the private sector in GDP in Montenegro amounted to 42.2% at end 2006. The value of this indicator is similar to those for economies in transition, which are EU members. Bearing in mind the value of this indicator in the EU and the Baltic Republics, it is obvious that there is still space for further loan growth in Montenegro. CHIEF ECONOMIST ANNUAL REPORT

58 The majority of economies in transition are Graph 1 – Share of loans to private sector in characterized by the extremely high growth in GDP loans granted, and the reasons for such rapid loan growth were similar to those of the lending expansion in Montenegro. It was the combination of micro and macro economic factors: the growth in available profit, the growth in consumer confidence, the decreasing inflation rates, and stable rates of national currencies, improvements in investment opportunities, and the like. Simultaneously, the supply of banking loans increased as a result of financial deregulation, the intensifying of the financial market and the coming of foreign highly credible banks to the markets of the countries in transition. The intensified competition between banks led to a Source: Economic indicators for Central and Eastern Europe, decline in interest rate spread and easier access to BIS loans. The prevailing opinion is that rapid lending expansion does not represent a serious threat.

The banks encouraged an increase in production and spending an increase in the civil engineering sector, which influenced the through the intensified lending activity: the largest debtors growth in real estate prices. were the corporate and households sectors, but they did not influence any instability in the market of goods (the prices of The intensification of the financial sector, the privatization of goods increased by 2% in 2006). Production increased only by the banking sector, the increase in competition amongst banks 1% in the reporting year, but the overall economy, based on contributed to the increase in loan supply, as well as economic estimates by the Secretariat for Development, would increase growth and the arrival of qualitative clients (foreign investors). by 6.5%. Stable conditions in which the banks operated enabled the increase in core sources for lending activity, deposits and foreign With respect to the banks’ lending activity, residential loans borrowings. Relatively high interest rates, interest margin and showed an increase in 2006. The increase in long-term loans the like also contributed to the increase in loan supply. The is a positive trend since it involved the increase in investments increase in supply corresponded to the increase in demand for as well. But besides the positive impact on economic activity, it loans, which was very high in 2006, which contributed to both showed that the increase in this type of banking supply impacted trancation (increase in available profit, optimistic expectations of the price growth on the real estates market. However, although profit), and specuulative motives (speculative earnings, primarily there is inter-connectivity between these two developments, at capital market). In addition, the increase in demand for loans; a such a connection was not a characteristic of the Montenegrin decrease in lending interest rates (in the case of effective interest market in the previous year, since the inflow of FDI or funds rate: by 2.17% in a year); better opportunities for investments; based on the sale of real estates influenced the increase in the the development of the capital market and the like influenced MONETARY DEVELOPMENTS real estate market. The inflow of funds on this basis still led to the stabilization of inflation. an increase in demand for apartments and business premises,

59 Box 2.2 – Sectoral Loan Structure

The sectoral loans structure of the banking loans in Montenegro was favourable: the largest portion of loans was granted to non-ﬁnancial institutions, of which the largest portion was to the corporate sector (Table 1).

Table 1 – Sectoral loan structure in Montenegro, as at year end, in %

Financial Non ﬁnancial Households Government* Non residents institutions institutions 2002. 17.9 0.6 16.5 0.0 65.0 2003. 24.9 0.8 10.3 0.0 64.0 2004. 26.4 1.4 6.7 0.4 65.2 2005. 27.7 0.0 8.2 0.6 63.5 2006. 36.8 0.3 4.7 0.8 57.3

*"Government" sector includes: central Government, agencies and institutions of the central Government, municipalities and government Funds

The share of loans in the government sector has signiﬁcantly decreased since the beginning of the banking sector reform, from 16.5% as of 2002 year-end to 4.7% as of 2006 year-end. The decrease in government sector borrowings, primarily central Government, was due to the increase in the inﬂow of funds from privatization and the Strategy for the management of public debt of Montenegro for 2005-2007, which set forth the guidelines for the reduction of borrowings through banking loans and treasury bills as "the riskiest categories of domestic debt".

Since the liquidity of banks was good, inter bank lending was rare and small, so that the largest portion of loans granted to ﬁnancial institutions referred to loans granted to non banking institutions. Loans to ﬁnancial institutions made up only 0.3% of total loans at end 2006.

The largest portion of banking loans was granted to non ﬁnancial institutions (57.3% at year-end 2006). The Corporate sector made up 97% of the loans granted to non ﬁnancial institutions. Based on the share in total loans, 55% of all loans were granted to the corporate sector. A positive change was the change in the maturity Graph 1 – Sectoral loan structure, in % structure of these loans, which led to the increases in long-term loans used for investment activities

• 2006 (55.3% 2006 year-end; 45.7% 2005 year-end).

Loans granted to households have shown a constant increase since the beginning of the banking system reform, so that their share in total loans increased from 17.9% in 2002, to 36.8% at 2006 year-end. In 2006, the maturity structure of these loans changed so that long-term loans made up 89.9% of loans granted to this sector. CHIEF ECONOMIST ANNUAL REPORT

60 The structure of banking loans in Montenegro is similar to the loans structure in both EU countries and countries in transition (Graph 1).

Observed by countries, the largest portion of loans was granted to non ﬁnancial institutions (Slovakia, Latvia, Lithuania, Slovenia, Romania and Montenegro) and to households (Hungary, Estonia, and Poland), while the decrease in loans granted to government sector was evident and this sector had the lowest share in total loans in the majority of the observed countries.

Loans to Households

Loans to households grew constantly during the entire year Graph 2.4 – Monthly increase in loans to amounting to EUR 310,9 million at 2006 year-end, which was households, in % almost three times higher than at end 2005. The growth in loans to this sector was more intensive in 2006 than in the previous period: the average monthly increase amounted to 9.6%, while it amounted to 2.9% in 2005 and 3.4% in 2004. Observed in an absolute amount, loans to households grew monthly by EUR 17.2 million on average, which was signiﬁcantly above the amount reached in 2005 (EUR 2.5 million) and 2004 (EUR 2.0 million). The largest monthly increase was recorded in December 2006 – EUR 32.6 million, while the largest monthly increase in the previous two years amounted to EUR 6.6 million. At year-end, the indebtedness of citizens per capita to banks amounted to EUR 501.4, which was higher by EUR 333.1 in relation to the per capita indebtedness at end 2005. The maturity structure of loans to households signiﬁcanlty Loans to households had a seasonal character, as do the majority changed in 2006: long-term loans made up 89.9% of total loans of monetary aggregates of the Montenegrin economy. Graph 2.4 granted to this sector (73% at end 2005). Long-term loans to shows the largest monthly increase in loans in March, and rates households increased by EUR 203.7 million in a year or three that were lower during the main tourist season. and a half times.

Box 2.3 – Overdrafts

Overdrafts are a form of short-term lending, i.e. loans based on so called negative balance at citizens’ accounts. In 2006, three banks did not provide this service to their depositors, while other banks provided this service under diﬀerent conditions. Depositors of two banks could have negative balance up to 100% of their net salaries, three banks allowed borrowings up to 50% of the last salary i.e. an average of the last three net salarise, while two banks

provided overdrafts up to 30% of the last net salary. Interest rates on monthly basis for this type of loans were the MONETARY DEVELOPMENTS following: 1% (one bank), 1.33% (one bank), 1.5% (three banks) and 2% (two banks). Interest was accrued on the number of days of the use of negative balance or until the inﬂow of the following net salary, which represented a day when the bank’s claims were liquidated.

61 This type of lending was used more frequently by citizens. However, only small number of users of this services considered it as bank loan. Namely, citizens tend to believe that in this way they do not borrow from bank, but they "borrow from themselves", i.e. their following salary. The majority of clients are not familiar with the interest that is paid for this service, since their salaries are mostly regular, so that the interest is calculated for a month or less then a month. But the interest rate is not low, which is shown by its annual level (Table 1)

Table 1 – Annual eﬀective interest rate on overdrafts

Annual interest rate Monthly interest rate Month having 30 days Month having 31 day Month having 28 days 1,00% 12.17% 11.78% 13.04% 1,33% 16.19% 15.67% 17.35% 1,50% 18.27% 17.68% 19.57% 2,00% 24.36% 23.57% 26.10%

If we know that the average weighted eﬀective interest rate on short-term loans up to three months that were granted to resident citizens amounted to 18.55%, or total to households sector to 15.79% at the annual level, it may be concluded that the use of overdrafts is expensive.

Loans to Corporate Sector

The following inﬂuenced the increase in demand for loans to Lending to the corporate sector was also more intensive in 2006 households: than it used to be. Of total banks’ claims on this basis, 55.8% referred to claims from the corporate sector. - High proceeds from the Montenegrin capital market – in the observed period a number of citizens borrowed Loans to the corporate sector have constantly increased over the from banks, using these funds to invest on the capital year and at the end of December they amounted to EUR 471.6 market, which showed an increase in turnover of 90% million. This represented an increase which was two times higher over a year; than at end 2005. The average monthly increase amounted to - The decrease in interest rates on loans to households EUR 20.1 million, or 6.2%, which was higher if compared to the (by 2.07% for a year, eﬀective interest rates); last two years (in 2005 - EUR 4.5 million or 2.3%; in 2004 - EUR • 2006 - The increase in demand for long-term loans, primarily 4.1 million or 2.8%). The corporate sector borrowed an additional residential loans under favorable conditions: in 2006, EUR 241.5 million in 2006. the project of the Government of Montenegro "1.000 residential loans" started in cooperation with the Although corporate sector lending had a seasonal character, the commercial banks.42 decline in growth, even in the negative growth rate was evident during the main tourist season, while the increase in demand for loans was evident in the months before the summer and winter tourist seasons.

CHIEF ECONOMIST ANNUAL REPORT 42 Annual interest rate is 6.4%, repayment period up to 5, 10 or 20 A positive change in 2006 was the increase in the share of long- years, in the amount of EUR 5, 15 or 30 thousand. term loans in total loans from 45.7% (2005) to 55.3% (2006).

62 Graph 2.5 – Monthly growth in loans to The increase in total deposits was a positive characteristic of the corporate sector, in % banking sector in 2006. However, it should be borne in mind that a portion of deposits, primarily corporate deposits came from foreign borrowings. Based on the preliminary information, the corporate sector borrowed approximately EUR 180 million from foreign banks/ﬁnancial institutions in 2006, of which, the largest portion (98.7%) was for long-term borrowings. These borrowings were two times higher than in 2005. In addition, the turnover of real estate had a signiﬁcant impact on the total deposits growth in 2006.

Citizens’ DepositsDeposits

Citizens’ deposits amounted to EUR 498.6 million representing 2.3.3. Deposits 46.5% of total deposits. They grew constantly during 2006, at a monthly average of 9.2%. This growth was more intensive in Deposits with banks constantly grew during 2006 at an average relation to the previous year, when the average monthly growth monthly rate of 6.8%, while the average growth in an absolute rate was 7%. The amount reached at the end of the reporting year amount was EUR 48.6 million. Extremely high growth was was almost three times higher than at end 2005, which was, at recorded in the fourth quarter: the monthly increase in December the same time, the highest annual increase ever recorded. was 15.4%, which resulted from the inﬂow based on sale of shares of Crnogorska Komercijalna Bank to OTP Bank. Observed in an absolute amount, citizens’ deposits grew by EUR 322.8 million in a year, where the average monthly increase Demand deposits growth (monthly average by 7.5%, or EUR 351.5 amounted to EUR 26.9 million (the average monthly increase million in 2006) and term deposits growth (average monthly by in 2005 amounted to EUR 8 million, and in 2004 – EUR 2.9 6.1%, or EUR 232.1 million in 2006) contributed to the growth million). The largest monthly increase in 2006 even amounted in total deposits. to 74.2 million. Demand deposits also grew on a monthly basis by EUR 42.1 million and time deposits grew by EUR 32.1 million. Although time deposits were two times higher in 2006 than The increase in demand deposits by citizens amounted to EUR in 2005, their share was still lower than the share in demand 200.8 million in a year, while the increase in time deposits deposits that made up 57.1% of total deposits. amounted to EUR 122 million.

Graph 2.6 – Deposits in 2006, Graph 2.7 – Citizens’ deposits (left scale in EUR million, as at period end in EUR million, right scale in %) MONETARY DEVELOPMENTS

63 The question what has happened to the economy over the year Graph 2.8 – Citizens’ deposits, and resulted in, among other things, the extremely high increase in EUR million in citizens’ deposits is posed looking at Graph 2.8. Employees’ salaries could not influence on such an increase in savings. However, 2006 was characterized by the high inflow of foreign direct investments, of which 53% were inflow based on the sale of real estates, which represented a significant source for increase in citizens’ deposits. Besides, the inflow from tourism was also significant (revenues from tourism increased by 29.7% in 2006 in relation to the same period 2005), as well as the current transfers of citizens, which amounted to 108.5 million based on preliminary information for 2006. Also, factor income increased in 2006 amounting to EUR 65.3 million. The Montenegrin capital market was a significant source of funds in 2006 with turnover being by 90% higher than in the previous year. Graph 2.9 – Corporate deposits, in EUR million, year-end Demand deposits were still high in the maturity structure of total citizens’ deposits (59% at 2006 year-end). The largest share were time deposit from three months to one year (77.5%), time deposits up to three months (12.6%), and those from one to three years (9.5%), while the share of time deposits over three years in time deposits was still insignificant (0,4%), although their share increase by EUR 422,000 of twice that of end 2005.

Although time deposits from citizens showed an increase, the maturity structure of this sector was not favourable. It was due to the low level of current salaries, and a fear of a number of citizens towards the long-term depositing of funds, which resulted from the problems the banking sector confronted during the 90s of the last century, high proceeds in the capital market The possibility of foreign borrowings was created through the in Montenegro and the like. liberalization of the current and capital accounts. Therefore, the inﬂow of EUR 180 million during 2006 went to the accounts of Corporate Deposits companies, of which the largest portion (77%) referred to debt of companies from the tourism sector (hotel management) and • 2006 Corporate deposits experienced a dynamic growth during 2006. civil engineering. They reached the amount of EUR 318 million at the end of the reporting year through average monthly growth of 7.1%, which 2.3.4. Banks’ Borrowings is the highest amount since the banking sector reform started. The amount reached at 2006 year-end was two times above the Banks’ borrowings amounted to EUR 173.2 million at 2006 level recorded at 2005 year-end. Observed in an absolute amount, year-end representing an amount that was two times higher corporate deposits increased by EUR 174.1 million in 2006. than the one at 2005 year-end. The average monthly increase in borrowings amounted to EUR 7.7 million or 6.9%. The increase in deposits by the corporate sector is an indicator of CHIEF ECONOMIST ANNUAL REPORT positive movements in this sector. However, it should be borne Borrowings mostly referred to long-term banks’ borrowings from in mind that the majority of these funds represent foreign debt. their parent foreign banks. In doing so, the banks found more

64 easily long-term sources of funds under favourable conditions. 2.3.6. Banks’ Capital Parent banks were interested in providing funds, particularly taking into account the high demand for loans, the potential Total banks’ capital amounted to EUR 149.7 million at end 2006, for economy growth, and the still high lending interest rates which represented an increase in EUR 43.2 million or 40.6% in and the like. relation to the same period 2005. The annual increase in total capital was due to the increase in both share capital (by 30.7%) Such sources of lending do not represent a basis, but only an and reserves (by 68.7%), and current year income growth. additional source for meeting the demand and making profit. The banks do not borrow, for instance, due to slow growth in Banks’ share capital increased by EUR 26.9 million in the year, of domestic sources or deposits, since their increase is dynamic which EUR 15.0 million referred to share capital of a bank that and significant. However, since the growth in time deposits is started its operations in 2006, and EUR 11.9 million the net evident but insufficient to meet demand for long-term loans, increase in share capital of the existing banks. Trade with banks’ primarily residential loans, this type of external financing by shares totalling EUR 129 million was conducted on Montenegrin banks enables the adjustment of the maturity structure of supply stock exchanges, of which EUR 6,3 million referred to the issue with demand for loans. of shares by one bank. Through block trading with banks’ shares it traded EUR 104.9 million in 2006. Of the total increase in borrowings of EUR 92.9 million, EUR 38.9 million referred to newly founded banks, and borrowings of the Banks’ ownership structure significantly changed in 2006, existing banks rose by EUR 54 million. increasing foreign capital and capital from domestic private sources. Foreign capital made up 80% of total capital, while The following banks appeared as creditors: KfW, OTP Bank, Nova private capital made up 15.4%, and state capital made up 4.6% Ljubljanska Bank, Hypo Alpe-Adria Bank, IFC, DEG, EBRD, etc. of total capital at November end 2006.

2.3.5. Banks’ Loans and Deposits with Banks Banks’ earnings amounted to EUR 108.5 million. They increased (and Banks’ Borrowings) by 39.4% in relation to 2005. Banks’ expenses amounted to EUR 97.5 million, representing an increase of 33.7% in relation to the Banks’ foreign borrowings increased by EUR 92.9 million over the previous year. Banks paid taxes and contributions were EUR 0.6 year, deposits with banks increased by EUR 583.6 million, while million based on the achieved result. Interest income (59.5%) loans recorded an annual increase of EUR 468,5 million. dominated within income and it grew by 54.7%, which was expected since the largest share within this position was interest The total loans to deposits ratio was favourable during the income on loans and lease operations (92.7%). They increased entire year, ranging from 0.79% to 0.90%, and it amounted to and were characterized by good collection. Fee income was also 0.83% on average for 2006. Total loans to deposits and banks’ significant, representing 33.5% of total income. It increased by borrowings averaged 0.73%. 32.6% in relation to the previous year. Banks’ expenses also increased by 33.7%, and the largest portion referred to overhead The loans to deposit ratio by sectors showed that the households expenses (salaries and contribution expenses, business premise sector was a net depositor with a ratio of 0.6%, while the and fixed assets expenses, and other expenses). At year-end, corporate sector in relation to banks was a net debtor with this banks reported positive financial results to the amount of EUR ratio at 1.5% at year-end. Deposits from the household sector 10.4 million. Only one bank reported a negative financial result, rose by EUR 187.7 million in relation to their debt to banks based while the profits of other banks ranged between EUR 0.2 and on loans, while, on the other hand, the debt of the corporate 4.0 million. sector to banks was EUR 153.6 above the level of their deposits MONETARY DEVELOPMENTS with banks.

65 Box 2.4 – Reputable International Banks/ Financial Institutions – A part of the Banking System of Montenegro

Although the overall number of banks remained unchanged from 2002 until end 2006, banks’ capital signiﬁcantly increased, and the ownership structure of capital changed, and there were cases of mergers and acquisitions of banks and the opening of new banks.

Banks’ capital at end 2006 increased by EUR 71,7 million, or it increased nearly two times more than it was at end 2002.

Since 2002 until end 2006, the ownership structure of banks’ capital signiﬁcantly changed. It was performed through the privatization process, i.e. through the sale of state capital at international public tenders or at stock exchanges. The share of state capital in total banks’ capital declined from 31% as of end 2002 to 4.6% as of November end 2006. Simultaneously, the share of foreign capital increased from 25% to 80%, while the share of private capital decreased from 44% to 15.4% (Graph 1). The largest contribution to foreign share capital Graph 1 – Ownership structure of banks’ was achieved by Societe Generale, Hypo alpe- capital, period-end, in % adria bank Group, Komercijalna bank Belgrade, Opportunity Transformation Inv. INC USA, OTP Bank and FMO. Besides aforementioned, DEG, Nova Ljubljanska Bank dd Ljubljana, Koroska Bank dd Slovenj Gradec, Cerera S.R.L. Italy, EBRD, Hemago Limited London, Bucom KFT Budapest, East capitalholding aktiebolag Stockholm, A Bank Ljubljana, Podravska Bank Croatia and Hrvatska poštanska Bank had also share in capital in local banks.

Table 1 shows that highly reputable banks/ Source: CBM – Bank Supervision Department ﬁnancial institutions entered the Montenegrin market.

Table 1 – Credit rating of foreign banks that have ownership in Montenegrin banks • 2006 Standard & Poor’s Moody’s Fitch Ratings Societe Generale AA/Stable/A-1+ Aa2 AA Hypo alpe-adria bank Group Not rated Aa2/P-1 Not rated FMO AAA/ Stable/ A-1+ n/a n/a KfW Bankengruppe AAA/ Stable/ A-1+ Aaa/P-1/Stable AAA/F1+/Stable Nova Ljubljanska bank dd Ljubljana Not rated A2/Prime-1/Stable A-/F2/Stable OTP bank Budapest BBBpi A2 n/a A bank Ljubljana Not rated BBB/F-3/Stable Not rated EBRD AAA/Stable/A-1+ Aaa AAA/F1+/Stable CHIEF ECONOMIST ANNUAL REPORT Source: Standard & Poor’s and web pages of the observed banks/ﬁnancial institutions

66 The following were the reasons for foreign banks to enter the Montenegrin market, through the share capital of local banks: achieved macro economic stability; expected fast growth in GDP; attractiveness of market, i.e. availability of new clients/operations; announcement of membership of Montenegro in EU, which practically expands participation in the EU market; high demand for loans, primarily corporate and household sectors; poor competition; risk diversification; prerequisite for increase in profitability; high interest margins; increase in market share. In addition, foreign banks relied on easy access to cheap funds, primarily from their parent banks, which is a significant advantage, since, contrary to local banks, they do not rely on domestic financial potential, but mostly to long-term financial strength outside the country. Except in two cases, foreign banks entrance, i.e. foreign capital was not a spontaneous process. Banks and their owners made their own decisions on the sale of capital to foreign banks. In the case of Montenegro, the entrance of foreign capital resulted from the privatization process in which the government as majority owner chose new majority owners.

The coming of foreign, reputable banks to Montenegro influenced the strengthening of confidence in the banking system, the increase in competition, which further influenced the decline of lending interest rates, further inflow of foreign capital, access to long-term sources of financing, etc.

2.4. Banks’ Reserve Requirement

Central Bank of Montenegro enacted a new Decision of Reserve requirement may be used by banks for maintenance of daily Requirement of Banks to be held with CBM in January 2006, liquidity up to 50% without interest, if they return used amount introducing significant changes in reserve requirements policy. of the reserve requirement the same day, where this is not a case, The new decision came into force in April 2006 and it prescribed interest is accrued at a rate of 11% (previous 12%). lower rates with an expansion of the base for calculation of the reserve requirement. The possibility of allocation of a portion of During 2006, deposits that were included the base for calculation reserve requirement in treasury bills was also reduced. of reserve requirement ranged between EUR 252 to EUR 1.024 million, so the base for calculation averaged EUR 580 million. The new policy of the reserve requirement introduced a Besides total deposits growth, a significanly higher level of the differentiated rate of reserve requirement, instead of the existing base for calculation of reserve requirement in 2006 in relation rate – uniform rate. It amounts to 19% for demand deposits43 to 2005 (2.9 times), was was the result of the expansion of the and deposits with maturity shorter than 90 days, and for deposits base for calculation of the reserve requirement. Month-on- longer than three months and shorter than a year it amounts to month, the largest level of deposits included in the base for 5%. Time deposits over one year are not included in the base calculation of the reserve requirement in 2006 was recorded for the calculation of the reserve requirement. The possibility of in December (EUR 942 million on average). Simultaneously, allocation of a portion of reserve requirement in treasury bills deposits not included in the base for calcualtion averaged EUR is reduced from 25% to 10%, and the rate by which CBM pays 85 million, and at December end, they were EUR 40 million, interest on 40% of total allocated funds of the banks’ reserve which was due to the aforementioned changes in the reserve requirement is 1% at annual level. Allocated funds of the reserve requirement policy. MONETARY DEVELOPMENTS

43 Deposits of local banks are not included in the base for calculation of the reserve requirement.

67 Table 2.10 – Average base for calculation of the reserve requirement, in EUR million

Description/Year 2002 2003 2004 2005 2006 Average base 71 108 131 199 580

Table 2.11 – Average base for calculation of the reserve requirement by months, in EUR million

2005 2006 Description/Year XII I II III IV V VI VII VIII IX X XI XII Average base 264 257 260 264 390 524 571 622 712 773 803 845 942

Due to the aforementioned developments, the banks allocated Graph 2.10 – Reserve requirement, period a total amount of EUR 172.8 million of reserve requirement as end in EUR thousand of 27/12/06, which represented an increase of EUR 111 million or 2.8 times in respect to 2005. These changes in the reserve requirement policy resulted in an increase of the share of allocated reserve requirement in total banks’ deposits, which rose from 12,6% as of December 2005 to 16,1% as of December 2006. (Attachment B, Table 14)

The structure of allocated reserve requirement in 2006 signiﬁcantly changed in relation to end 2005 so that 9% was allocated at the reserve requirement account in the country, 89% was allocated at the CBM account abroad, and 2% of the calculated reserve requirement was in treasury bills. Signiﬁcnat changes in the structure of the reserve requirement were due to the decision CBM calculated interest at a rate of 1% annually on allocated of the majority of banks to allocate most of the funds at CBM reserve requirement held at the account of the reserve requirement accounts abroad, and reduce the possiblity for banks to allocate a with CBM and paid EUR 375.839,08 in 2006. The banks did not portion of the reserve requirement in treasury bills of the Republic use reserve requirement for liquidity in the observed period, of Montenegro. (Table2.12). while a lower level of reserve requirement than the prescribed one was recorded with four banks only for four days. • 2006

Table 2.12 – The structure of allocated reserve requirement, year-end, in %

Description/Year 2002 2003 2004 2005 2006 Reserve Requirement Account in the Country 91 50 31 43 9 T-Bills 9 24 23 12 2 Reserve Requirement at CBM account abroad 0 26 46 45 89 CHIEF ECONOMIST ANNUAL REPORT

68 Graph 2.11 – The structure of reserve Observed in an absolute amount, MFIs assets increased by EUR requirement allocation, 2002-2006 15.4 million in the one-year period (Table 2.13).

Receivables based on loans granted dominated in MFI assets that made up 95.4% of total assets.

During 2006, MFIs receivables based on loans granted grew at an average monthly at rate of 5.5% and amounted to EUR 32.5 million at year-end. This represented and increase of 82% in relation to end 2005. Of the total amount of receivables on this basis 69% referred to Agronivest receivables and 31% referred to receivables of other MFIs.

In the structure of MFIs loan portfolio by sectors, loans granted for agriculture were dominant (69,5% at end 2006).

2.5. Micro Credit Financial Long-term loans went up from 67% to 85% of total loans Institutions granted by MFIs. The loan portfolio mostly showed the low level of past due loans that represented less than 1% in the A high growth in activities of the micro financial sector was observed period. recorded in 2006, which was contributed to by new micro credit financial institutions on the financial market of Montenegro44. Net loans of EUR 32.2 million represented 99% of total MFIs receivables based on granted loans, and the remaining portion The total assets of micro credit financial institutions (MFIs) in referred to loan loss reserves. Montenegro amounted to EUR 34 million at end 2006, which was 83% above the level achieved in 2005, or three times higher Cash amounted to EUR 1.1 million at end 2006 (3.1% of total than in 2003 when records began. The total assets of Agroinvest assets), while fixed assets and other assets amounted to EUR went up from 66% to 70% of total assets of MFIs. 0.8 million (2.4% of total assets).

Table 2.13 – MFIs total assets, as of month-end, in EUR thousand

2003 2004 2005 2006 Description/Period XII XII XII III VI IX XII Alter modus 2,800 4,262 5,999 7,009 7,873 7,854 9,064 Agroinvest 8,452 9,728 12,612 14,949 14,981 16,990 23,248 Montenegro Investment credit 596 981 1,017 Ozmont 342 411 705 Kino 11,252 13,990 18,611 21,958 23,792 26,236 34,034 MONETARY DEVELOPMENTS

44 At beginning of March, CBM granted a license to two new micro credit ﬁnancial institutions: "OZMONT" doo Podgorica and "MONTENEGRO INVESTMENT CREDIT" doo Podgorica.

69 Table 2.14 – MFIs total loans, as of month-end, in EUR thousand

2003 2004 2005 2006 Description/Period XII XII XII III VI IX XII Alter modus 2,728 4,237 5,885 6,859 7,841 7,586 8,658 Agroinvest 7,668 9,431 11,946 12,352 14,040 16,582 22,285 Montenegro Investment credit 564 837 906 Ozmont 300 403 624 Total 10,396 13,668 17,831 19,211 22,745 25,408 32,473

Table 2.15 – MFIs total loans, by sectors, as of month-end, in EUR thousand

2005 2006 Description /period XII III VI IX XII Trade 2,222 2,434 2,864 3,050 3,565 Services 2,570 3,175 3,935 3,932 4,693 Production 838 901 862 905 838 Agriculture 12,201 12,701 14,630 16,781 22,570 Other 454 740 807 Total 17,831 19,211 22,745 25,408 32,473

Total liabilities (liabilities on loans taken and borrowings, capital from donations, EUR 0.6 million or 4,6% to donations, conditional grants, subordinated debts and other liabilities) while undistributed profit amounted to EUR 3,2 million or 24% amounted to EUR 20,7 million or 60,9% of total liabilities. Sources of total capital. At end 2006, MFIs reported positive financial of funds of MFIs were and remained mostly foreign capital, which results totalling EUR 2.4 million. was directed through micro credti lines to agrucluture producers, entrepreneurs from the services sector, small production, trade, However, besides the significant growth in lending activities and the like. in the observed period, and the increased significance of this sector as additional source of funds primarily for clients that have Total MFIs capital amounted to EUR 13.3 million or 39.1% of total limited access to banking loans, MFIs still have relatively small liabilities. Of that amount, EUR 9.5 million or 71.4% referred to importance in the financial system of Montenegro. • 2006

Table 2.16 – GDP, loans of banks and MFIs in Montenegro, in EUR million

Description/Period 2003 2004 2005 2006 GDP 1,392.0 1.565.0 1,690.0 1,829.0* MFIs Loans 10.4 13.7 17.8 32.5 Banks’ Loans 200.6 281.5 375.9 844.4 MFIs Loans/GDP (%) 0.7 0.9 1.1 1.8

CHIEF ECONOMIST ANNUAL REPORT MFIs Loans/Banks’ Loans (%) 5.2 4.9 4.7 3.8

* Projected GDP

70 2.6. Lending Interest Rates

During 2006, lending interest rates were on a downward trend. Graph 2.12 – Annual average weighted At end 2006 they decreased by 1.7% (nominal) and 2.17% lending interest rates, in % (eﬀective) in relation to year end 2005 when they amounted to 9.06% (nominal) and 9.94% (eﬀective). This compared to 10.76%, and 12.11% respectively45 at 2004 year end.

The decrease in interest rates on both short-term and long-term loans was evident in 2006, wherein the decrease in interest rates on short-term loans was higher. Interest rates on short-term loans constantly were above the interest rates on long-term loans. The nearing of these rates was noted so that the range between these two rates declined from 2.42% as of the third quarter end 2005 to 0.21% at end 2006. (Graph 2.13). Source: CBM Regulatory Credit Bureau With respect to other trends that occurred in 2006, the following should be mentioned: Graph 2.13 – Annual average weighted 1. Interest rates on loans granted to natural persons were eﬀective interest rates, in % constantly higher than the interest rates granted to legal persons. AWELIR46 for natural persons amounted to 4.23% at December end 2005, while it was 12.16% at end 2006. AWELIR for legal persons amounted to 11.67% at December end 2005, while it was 9.01% at end 2006. 2. Interest rates on loans to the private sector were constantly higher than on loans to the government sector. AWELIR for the private sector amounted to 12.46% at December end 2005, while it was 10.23% at end 2006. AWELIR for the government sector amounted to 10.41% at December end 2005, while it was 7.56% Source: CBM Regulatory Credit Bureau at end 2006.

The aforementioned was more or less present in other countries as well. The explanation lies in the fact that the legal persons and government sector are less risky debtors than natural persons and the private sector. MONETARY DEVELOPMENTS

45 Data does not refer only to newly granted loans in the reporting month, but to all loans (cumulative) granted in the reporting month. 46 Average weighted eﬀective lending interest rate.

71 Table 2.17 – Annual average weighted lending interest rates, by sectors, in %

2005 2006 Description/Period IX XII III VI IX XII Agriculture, Hunting, Fishing AWIR – nominal 8.76 7.49 7.36 6.72 6.72 6.52 AWIR – effective 9.54 7.62 7.54 7.05 7.07 6.88 Mining AWIR – nominal 12.78 11.71 10.58 10.85 8.68 7.81 AWIR – effective 17.38 12.81 10.94 11.12 10.19 7.29 Production AWIR – nominal 11.15 10.68 10.53 9.70 9.03 8.25 AWIR – effective 12.13 11.70 11.41 10.54 9.94 8.89 Energy AWIR – nominal 9.65 10.45 10.49 9.33 10.10 8.27 AWIR – effective 14.82 14.17 13.30 11.41 13.86 8.90 Civil Engineering AWIR – nominal 12.49 11.97 10.40 9.73 8.84 8.33 AWIR – effective 13.10 12.72 11.60 10.35 9.49 9.06 Trade AWIR – nominal 11.69 11.04 10.61 9.94 9.44 8.57 AWIR – effective 12.21 12.24 11.52 10.64 11.40 9.53 Services, Tourism, Hotel Management AWIR – nominal 9.85 9.78 9.86 9.49 8.40 7.57 AWIR – effective 15.31 11.06 10.42 9.65 8.30 8.55 Transport, Warehousing, PTT Communications AWIR – nominal 10.25 9.78 9.73 9.33 8.74 8.52 AWIR – effective 11.94 10.81 10.19 10.09 9.39 9.37 Finance AWIR – nominal 7.12 5.85 10.15 9.65 7.23 7.12 AWIR – effective 4.91 6.11 11.14 10.46 7.55 7.85 Real Estates Trade AWIR – nominal 11.55 11.74 11.39 10.14 8.98 8.42 • 2006

AWIR – effective 12.95 13.04 12.05 11.09 9.96 9.51 Administration and Other Public Services AWIR – nominal 10.16 9.28 9.77 9.43 8.83 7.97 AWIR – effective 10.17 11.05 12.23 10.53 9.65 8.51 Other AWIR – nominal 6.99 10.24 6.44 6.74 6.78 7.27 AWIR – effective 7.80 10.81 3.66 3.76 3.45 4.78

Source: CBM Regulatory Credit Bureau CHIEF ECONOMIST ANNUAL REPORT

72 The following developments contributed to the decline in Although the intensified competition in the Montenegrin interest rates during 2006: an increase in the deposit potential market contributed to the decrease in lending interest rates, it of banks; legal liberalization of current and capital flows with is still insufficient: new banks accept current interest rates with aboard, which enabled all corporate entities (including local downward corrections, taking into account the high needs of banks) to borrow abroad under lower interest rates than those households and the corporate sectors to borrow. Insight of banks offered by the Montenegrin banking sector; the strengthening of in debtors’ history, an improvement of the creditworthiness of competition and efficiency (including better risk management) companies, and the like would better contribute to a further in the banking/financial market (primarily through the entrance decline in interest rates. of foreign banks i.e. famous world brands in the area of the provision of financial services); decline in country risk (political Besides the difference between nominal and effective interest risk); stabilization of inflation. rates, the difference between effective interest rates on loans granted to different sectors ( up to 4,81%) and those to legal The following can be mentioned with respect to the developments persons for different activities (up to 4,75%) points to the fact still influencing the relatively high level of interest rates: that there is space for further reductions in interest rates.

1. High demand for cash (loans). As long as there is high demand, the banks will give interest rates at a higher level, ceteris paribus. 2. Reference interest rates in countries of the European Monetary Union (European Union): Banking sector is foreign owned and foreign banks place funds using higher interest rates through to Montenegrin banks, which they obtain with a lower interest rate at EMU (EU) market. Since interest rates have increased lately on the EMU (EU) market, interest rates at Montenegrin market are maintained at a relatively high level. For instance, referent interest rates47 of the European Central Bank through which the Euro system48 placed funds for liquidity to the banking sector amounted to 2%, or 3% respectively, as of June 6, 2003. At December end 2006, these rates amounted to 3.5%, or 4.5% respectively. The same occurred with EURIBOR49, rate by which banks on EU market lend funds to each other. For instance, a six-month EURIBOR amounted to 1.923% as of March 24, 2004, while it was 3.853% as at end 2006. MONETARY DEVELOPMENTS

47 First refers to loan with a maturity of 7 days, and the second on overnight loans. 48 It is comprised of the Eurpean Central Bank and central banks of members of the European Monetary Union. 49 Six-month EURIBOR is taken as an expmle, althouth rates are with diﬀerent maturities: from one week to one year.

FINANCIAL MARKETS 3

3.1. Money Market

Fifteen auctions of treasury bills (T-bills) were held in 2006. The Graph 3.1 – Sold bills and achieved amount of EUR 12.6 million was issued and sold, with demand weighted rates on 91-day T-bills in 2006 that exceeded the bid by 82.3%. The .number of auctions as well as amounts of issued T-bill decreased in relation to 2005. Auctions of 28-days and 56-days T-bills did not occur in 2006.

3.1.1. 91-Day Treasury Bills Auctions

Seven auctions of T-bills with a maturity period of 91 days were held in 2006, which makes six auctions less than in 2005. The total amount of issue was EUR 4.9 million. The total issue was sold, while demand for bills exceeded supply by 86.7% and amounted to EUR 9.1 million. In relation to the previous year, there were issued 79% and sold 78% less bills of this type. The Source: Central Bank of Montenegro average weighted interest rates ranged between 0,49% and 2.52%, so that the average interest rate on this type of bills amounted to 1,18%. In relation to 2005 (when the average Graph 3.2 – Sold bills and achieved interest rate for T-bills was 5.76%), a fall in interest rates of weighted rates on 182-days T-bills in 2006 4.58% was recorded.

3.1.2. 182-Days Treasury Bills Auctions

At eight T-bills auctions with a maturity period of 182 days held in the reporting year (one less in relation to the previous year), EUR 7.6 million was issued and sold, which was 79.5% less than the demand for these bills. In relation to the previous year, this percentage was lower by 54%. The weighted interest rate FINANCIAL MARKETS ranged between 0.45% and 2.96%. The average interest rate on this type of bills in 2006 amounted to 1.18% and was lower Source: Central Bank of Montenegro in relation to average interest rate in 2005 by 5.3%.

77 Since 2001, when the Central Bank of Montenegro as the fiscal Graph 3.3 – Offered and Sold Bills since the agent of the Government of Montenegro started T-bills auctions, auctions has started 146 auctions of four types of T-bills (with maturity periods of 28, 56, 91 and 182 days) were performed for financing short- term budget spending. The amounts of issued and sold bills grew from year to year until 2005 when their sale declined in relation to 2004 by 57.5%. A budget surplus was created for the first time in 2006 by applying the Strategy for the reduction of public debt, through better budget spending and higher budget revenues. A portion of this strategy was a reduction of budget borrowings through issues of T-bills. In 2006, the value of bills sold declined by EUR 96.4 million.

Source: Central Bank of Montenegro

Box 3.1 – Government Borrowings on the Money Market

Total budget borrowings based on T-bills at December end 2006 amounted to EUR 3,3 Graph 1 – Unpaid T-Bills million, and showed a decline in borrowings of 57.8% in relation to December last year, while that decline was even higher in relation to 2004 representing 91.2%. According to the Strategy for public debt management, the alternative sources of ﬁnancing the budget illiquidity can be issues of medium-term bonds on the international capital market (at a rate of 6%), or obtaining loans from European development banks at Euribor. Source: Ministry of Finance • 2006

3.2. Capital Market Montenegrin exchanges. Such developments were mainly due to the political uncertainty with respect to the status of the 3.2.1. Assessment of Development country. Since June and up to the end 2006, if the purchase of Crnogorska Komercijalna Bank is excluded (EUR 104.0 million), CHIEF ECONOMIST ANNUAL REPORT The capital market oscillated in the last year. At May end 2006, a turnover of EUR 217.2 million has been made, representing turnover made up only 14.8% of the total annual turnover at higher turnover that in all of 2005. However, the second half of

78 the year showed high oscillations in turnover and capitalization Graph 3.4 – Total turnover and number of transactions at Montenegrin exchanges in on the stock exchanges. After the extremely high turnover that 2006 and 2005 occurred in August and September, an overhearing of the market and the overrating of some securities occurred. Therefore, the following three months showed inevitable corrections in the prices of a large number of shares. There is still a concern that shares of a number of companies are still inﬂated and that in the following period we can expect their reduction.

During 2006, a new type of bonds appeared for the ﬁrst time on the market: bonds of the Restitution Fund, bonds for roads reconstruction, and municipality bonds.

Source: Montenegroberza and Nex Montenegro 3.2.2. Turnover

The total turnover on Montenegrin exchanges amounted to EUR 377 million in 2006 representing an increase in 90% or EUR Graph 3.5 – Turnover structure at Montenegrin Exchanges in 2006 178.6 million in relation to 2005. The largest turnover occurred in December amounting to EUR 146.1 million, and was primarily due to the turnover of shares of Crnogorska Komercijalna Bank (a purchase made by Hungarian OTP Bank) to the amount of EUR 104 million. Turnover in August amounted to EUR 45.9 million, and was primarily due to the participation of small investors and Funds. The lowest turnover (EUR 9.4 million) occurred in April, just before the referendum. The turnover for 249 trading days was made through 114.073 transactions and, compared to the volume of turnover that was almost double, represented an increase of only 2.7% in relation to the number of transactions Source: Montenegroberza and Nex Montenegro made in 2005.

The average monthly turnover amounted to EUR 31.4 million, in 2006 and 82.4% in 2005), but the trade with investment and was higher than the average monthly turnover in 2005 (by units of investment funds increased (13.9% in 2006 and 9.5% EUR 16.5 million) by 89.9%. An average of 458 transactions in 2005), while trading with bonds decreased (5.1% in 2006 was made on a daily basis, while daily turnover amounted to and 8.6% in 2005). EUR 1.5 million.

3.2.3. Turnover Structure 3.2.4. Shares

Companies’ shares (81% of total turnover) made up the largest In 2006, the turnover of companies’ shares increased by EUR 141.9 contribution to the turnover structure. The shares of investment million or by 86.7%, in relation to 2005. In the total structure funds made up 13.9%, while 5.1% of total turnover referred to of the turnover of companies’ shares, trading with shares at FINANCIAL MARKETS trade with various types of bonds. Montenegroberza (64%) was signiﬁcantly higher. The turnover of this type of securities on Montenegroberza increased by In relation to 2005, the turnover structure remained almost the 231.2% in relation to 2005, while the same type of turnover at same in 2006 with respect to the companies’ shares (81.0% Nex Montenegro declined by 5.2%.

79 If the number of issuers (444) at Montenegroberza is taken into Graph 3.6 – Turnover of shares of account, and the number of companies at (435) Nex Montenegro investment funds and number of is also taken into account, regardless of the high growth in transactions made turnover and capitalization of individual companies, the fact is that of the total turnover made in 2006, 74% of the total turnover referred to some 30 of the most liquid securities (all were companies’ shares, except bonds of the Compensation Fund) on both exchanges remains a concern. There is a signiﬁcant number of illiquid securities that were rarely or not traded. These are companies that have in their assets a certain value of real estate and land that might be of interest for potential investors in the future.

For instance, 62% of the total annual turnover at Montenegroberza was made through trading with the five most liquid securities (5 Source: Montenegroberza and Nex Montenegro companies), and 39,2% of annual turnover at Nex Montenegro exchange was made through trading with five of the most liquid securities (four companies and bonds of the Restitution Fund). Graph 3.7 – Turnover of different type of bonds at Montenegrin exchanges in 2006 3.2.5. Investment Funds

The turnover of shares of investment funds increased by EUR 33,4 million or by 177,6% in 2006, and amounted to EUR 52,3 million, where 63,8% of the total turnover of shares of investment funds was made at Nex Montenegro exchange, (due to the investors’ sensibility to changes in the NEXPIF index).

3.2.6. Bonds

Of the total turnover made on Montenegrin exchanges 5.1% referred to trading with bonds. The review of trading with bonds showed that bonds of frozen foreign exchange savings were Source: Montenegroberza and Nex Montenegro traded during all of 2006 and their turnover made up 39,5% of the total turnover of bonds. Since May, trading with the bonds of • 2006 the Compensation Fund has begun and their turnover made up 39.5% of the total turnover of bonds. Besides the fact that they made a signiﬁcant contribution to turnover, these bonds were 3.2.7. Stock Exchange Indexes liquid throughout 2006. In September, trading with bonds for roads reconstruction began (19.4% of the total turnover of bonds), The Montenegroberza index MOSTE recorded growth in 2006 and in October it started trading with the bonds of Montenegrin of 455.8 index points or it increased by 98.4%. It reached its municipalities (6.2% of total turnover of bonds). maximum in September amounting to 1124.9 index points, which is also the historical high of the index. This index was at its lowest in January amounting to 465.6 index points. The index CHIEF ECONOMIST ANNUAL REPORT spread in 2006 amounted to 659.3 index points.

80 Table 3.1 – General information on indexes

MOSTE NEX 20 NEXPIF As of December 31/2006 918.9 18,050.89 17,763.63 Absolute change in 2006 +455.8 +8,269.61 +9,668.06 Initial value of index 100.0 1,000.00 1,000.00 Maximum in 2006 1,124.9 12.09.2006 23,113.16 01.10.2006 25,038.54 12.09.2006 Minimum in 2006 465.6 09.01.2006 9,825.72 09.01.2006 7,992.5 09.01.2006 Maximum historical value 1,124.9 12.09.2006 23,113.16 01.10.2006 25,038.54 12.09.2006 Minimum historical value 94.8 23.06.2004 918.57 14.04.2003 959.53 02.04.2003 Growth from Dec 31, 2004 to Dec 31, 2005 302.20% 287.66% 404.86% Growth from Dec 31, 2005 to Dec 31, 2006 98.44% 84.54% 119.42%

Source: Montenegroberza and Nex Montenegro

Graph 3.8 – Index MOSTE in 2006 Graph 3.9 – Indexes NEX20 and NEX PIF in 2006

Source: Montenegroberza Source: Nex Montenegro

The index NEX20 recorded a growth in 2006 of 84.5%, and its 3.2.8. Capitalization absolute change amounted to 8269.6 index points. It reached its peak in September amounting to 23.133,1 index points, As of 12/31/06, the capitalization of Nex Montenegro exchange and it reached its lowest point of 9825.7 index points at the amounted to EUR 1.94 billion, and it increased by 32.5% in relation beginning of the year. to 2005. In relation to 2004, it grew by 63.6%. The turnover ratio amounted to 0.010019. NEXPIF grew by 119.4% in the last year, which represented the highest growth of all indexes on Montenegrin exchanges. The capitalization on the Montenegroberza exchange amounted FINANCIAL MARKETS The maximum value of this index was recorded in September to EUR 1.66 billion as of 12/31/06 and showed an increase of (25.038.5 index points), and its minimum in January (7992.5 88% in relation to 2005, and 539.6% in relation to 2004. The index points). turnover ratio amounted to 0.076221.

81 3.2.9. Block trade

Both stock exchanges had 22 block trades amounting to EUR companies. Of the total amount of block trade, 89% referred to 117.5 million, which represented 31.2% of total turnover. It also only one transaction, the sale of CKB to OTP Bank. represented an indicator of mergers of ownership in Montenegrin

Table 3.2 – Turnover and number of transactions in block trades in 2006

Jan Feb March April May June July Aug Sep Oct. Nov Dec Total Block trades in 559,123 3,770,256 1,797,414 2,313,766 0 0 0 0 0 0 3,213,533 105,883,528 117,537,620 2006 1 5 2 2 0 0 0 0 0 0 3 8 21

Source: Montenegroberza and Nex Montenegro

Box 3.2 – What was the Most Interesting Item for Investors to Invest in our Country and in the Region in 2006?

It is interesting to see what industries were the most interesting for investments, through the stock exchanges, in Montenegro and other countries in the region. It can be noted that the situation differs from country to country. Yet, it should be borne in mind that the level of different interest is largely due to the different level of development of individual industries.

For instance, on the stock exchange in Ljubljana, investors were mostly interested in the pharmaceutical industry, the oil industry, ﬁnancial services, freight forwarding and harbour services, the food industry and household furnishers’ production.

The largest turnover in Croatia in 2006 was in pharmaceutical companies, the food industry, the oil industry, sugar refineries, maritime traffic, and financial services.

The largest turnover in Serbia in 2006 was in companies from the ﬁnancial sector, civil engineering and infrastructure, • 2006 the oil industry, electrical energy, and very attractive food industries.

The stock exchange in Sarajevo recorded the largest turnover in companies from the food industry partly due to the protective measures that exist in this industry.

In Montenegro, judging by the 20 most liquid securities, the most attractive were the energy sector and mining, telecommunications, the banking sector and the tourist sector, and lately, companies involved in the construction of infrastructure. CHIEF ECONOMIST ANNUAL REPORT

82 Conclusion

Although a significant growth in turnover on the capital market Misinformation of the financial results of Montenegrin companies was achieved in 2006, low capitalization, low liquidity, the poor is extremely high. The low level of general knowledge comes transparency of companies’ performances and potential danger from the inadequate legal treatment of the obligatory submission of "price bubbles" still remains as the main characteristics of of financial reports. The practices of other countries in transition the market. show that a more frequent disclosure of financial reports and the existence of an institution that deals with the preparation Trading on Montenegrin exchanges is characterized by the narrow of credible analyses and reports, increases not only the prices spectrum of tradable securities, their limitation in trading with of shares on stock exchanges, but influences the reduction of ordinary shares, investment units of investment funds and only risky investments and risks in general that come from obligatory four types of government or quasi-government bonds. There were relations in the economy. These positive practices should also be also a small number of initial public offers for securities, which are applied in Montenegro. If not, the completion of the privatization mostly placed with financial institutions. The following period process may lead to a drastic fall in trading on Montenegrin should create conditions for the greater reliance of companies exchanges. on gathering external funding on the capital market though additional issues of shares and issues of corporate bonds. More attention should be paid in future to fair values of the companies, their operating history and balance sheets must For the purpose of providing conditions for expanding the types be available to all interested parties. Therefore, it would be of securities for trading on Montenegrin exchanges, as well as for desirable to establish a reputable institution that would deal more intensive trading with the existing securities, the efficiency with the analysis of the creditworthiness of the operations of of the protection of creditors’ rights should be increased, as well Montenegrin companies. as the level of transparency of local companies’ operations. The consequences for the exchanges and for investors from a possible fall in turnover on the Montenegrin exchanges could be prevented through timely operations with, and connections with, other exchanges in the region. FINANCIAL MARKETS

FISCAL SECTOR 4

4.1. Budget Review

Fiscal discipline is the main prerequisite of macroeconomic This law was enacted because of the changed structure of stability in euroised economies. That is why it is of great revenues (the increase of the original budget revenues) the importance that the results achieved in fiscal policy in 2006 application of the Law on earnings and other income of deputies are in accordance with the objectives of the Economic Policy and and high officials, the application of the Law on financing political the Agenda of Economic Reforms, as the continuation of the policy parties, as well as the application of the Collective Contracts in followed in the previous year. The consistent implementation the field of culture and health and social security. of the reformed tax system, greater financial discipline, a more efficient tax collection, and a reduced participation of the grey With the revision, current budgetary revenues were estimated economy in the reporting year had a direct impact on the growth to the amount of EUR 492.7 million, being EUR 12.5 million of source budgetary revenues, creating the conditions for more higher in relation to the level planned by the Law on Budget financing of budgetary expenses from real sources, eliminating for 2006 (because of the better collection of VAT by EUR 10.7 long-term deficits, and a future budget surplus. million and the tax on international trade and transactions by EUR 1.8 million). Table 4.1 shows the movements of the budget deficit in the period 2002-2006, and the planned surplus for 2007. On the side of expenses, by the new plan the expenses on the basis of the rights in the field of social protection are increased The Montenegrin Parliament adopted the Amended Law on by EUR 4.3 million, because of the increased number of users of Budget of the Republic of Montenegro for 2006 (Official Gazette these rights, and the funds for current budgetary reserves are of the Republic of Montenegro 70/06) at end-November 2005, increased by EUR 8.3 million after the application of the Law on by which the revision is performed, and by which the planned earnings and other income of the deputies and high officials and budget receipts and expenses increase by EUR 12.5 million and other non-planned expenses in 2006. amounted EUR 531.5 million. The Budget for 2006, after its revision, was planned to the amount of EUR 531.5 million, which is an increase in 6% in relation to the budget from 2005.

Table 4.1 – Budget surplus/deﬁcit

Description/Period 2002 2003 2004 2005 2006 Plan for 2007 FISCAL SECTOR Deﬁcit/Surplus of the Budget RM (million euros) -25.2 -45.9 -32.8 -30.1 34.6 10.6 % Participation in GDP -2.02 -3.30 -2.22 -1.92 1.89 0.53

Source: Ministry of Finance

87 The total budgetary receipts (preliminary data of the Ministry Graph 4.1 – Review of the budget in the of Finance) in 2006 amounted to EUR 582.3 million and are period 2003-2006 by months, EUR million higher by 9.6% in relation to the planned funds for 2006 after the revision.

Looking at the budgetary revenues achieved in 2005, without the privatisation income from the sale of Telecom Montenegro, the growth in budgetary revenues is noticeable in the observed period in relation to the comparative period last year, by 24%. That is positive, and is in accordance with the established policy in the ﬁscal sphere.

During the year, the realization of the budgetary receipts was uneven month by month, but with a tendency of growth. The largest inﬂow of funds was in the second part of the year, which Graph 4.2 – Structure of budgetary is, inter alia, the result of the successful tourist season and an receipts in the period 2003-2006 and increase in the current revenues (revenues on tax on VAT, customs plan for 2007 duties and excise on imported goods) as well as receipts from loan repayments.

The structure of budgetary receipts shows a very dynamic growth in the current revenue with a participation of EUR 567.1 million or 97.4 including receipts from loan repayments. In relation to the plan for 2006, these revenues increased by 15%, while compared to 2005 they were higher by 32%, as a result of the growth in revenues from taxes and compensations.

Box 4.1- Structure of Budgetary Revenues

The income from the sold goods (financial and non-financial) amounted EUR 6.3 million or 1% of the total receipts • 2006 and are lower in relation to the plan for 10%, but considerably lower in relation to 2005, when the privatization of Telecom of Montenegro carried out, which influenced the high growth of income arising from this. On the basis of loans repayment used by public enterprises, individuals and other institutions EUR 9 million collected or almost four times more than in the previous year, while the income from donations and transfers were insignificant and amounted to EUR 44 thousand (planned funds arising from this amounted to EUR 5 million). Borrowings and loans from foreign sources amounted to EUR 9 million, and have a declining trend in relation to 2005, as well as in relation to previous years, which is positive and in accordance with the IMF recommendations that the Government should be indebted as little as possible and avoid the use of expensive sources of borrowing.

Current revenues of the budget are mostly formed from the tax revenues with a participation of 88% amounting CHIEF ECONOMIST ANNUAL REPORT to EUR 499 million, and represents an increase of 14 % of the plan after the revision, and 24% in relation to 2005.

88 A strong inﬂow of revenues from value added tax and excise contributed to this increase in the total amount of EUR 345 million, what is an increase of 33% in relation to the previous year. Comparing to the previous year, the revenues from VAT is higher by 41% and participates with 55% of tax revenues, or 48% of current revenues. From the excise, as the second largest revenue category, EUR 72 million or 10% more in relation to 2005 was collected, but 7% less than planned. In 2006, an increase is evident in the structure of tax in all categories in relation to the plan, except income tax in which the result was lower by 21%, as a result of the application of the reduced rate of 9% from 1 January 2006. In relation to 2005 these incomes recorded a fall of 40%. However, the growth of the payment of revenues on this basis should be expected, according to data from the Tax Administration, the number of tax payers increased in relation to previous years. The revenues from the income tax of physical persons recorded a growth of 8% in relation to the previous year, and amounted to EUR 73 million, which suggests the increased economic activity of the current year. In 2006, high growth of 300% in relation to the plan was achieved in income from the tax on property to the amount of EUR 7.4 million, as a result of the increased sale of real estate for diﬀerent reasons especially in the seaside area. In relation to 2005, these revenues increased by 200%. From the tax on international trade and transactions (customs duty) EUR 57 million was revenued or 38% more than in 2005, which due to the increased imports during the summer months, as well as the strong expansion of construction. Other taxes recorded an increase of 22% in relation to 2005, and amounted to four and a half million euros.

Graph 1 – Structure of taxes in the period The tax income in 2006, were EUR 14 million, 2003-2006 and plan for 2007 or 103% more in relation to the previous year. In these revenues a considerable share of 97% were administrative and court fees, while the participation of revenues of residence tax was 3%. Payment of the residence tax in relation to the plan was higher by 83%, and these funds are redirected in accordance to the Law on residence taxes -80% to the local, and 20% to the National tourist organization. The revenues from these taxes in the original budgetary revenues was just 3%.

A very dynamic growth was recorded in other revenues which accounted for 2.3%, and increased by 160% in comparison with the previous year, particularly payments of tolls and gambling revenues. A negative trend was achieved by the other republic revenues, being 22% lower compared to those in the previous year, as a result of an unrealized plan and the poor collection of other revenues. In the current receipts these revenues make up 5% of the total.

The growth of budgetary revenues during the twelve months and enterprises, better charging of the public revenues, as well records the continuity, that is, among other reasons, the result as the implementation of a number of laws in the ﬁeld of ﬁscal

of the successful tourist season, the positive eﬀects of the tax policy from January 2006 (Law on Amendments of the Law on FISCAL SECTOR relief that the Government of the Republic of Montenegro enacted Excise, Law on Amendments of VAT50, Law on customs tariﬀ as during 2004, the reduction of the income tax rate of the citizens well as Law on the unique registration and reporting system

50 By amendmends to this Law VAT payment was introduced on products for which VAT had not been paid until 1 January 2006 (food, books and teaching aids, press, medicines, various services and others)

89 on accounting and the charge of taxes and contributions). A Graph 4.3 – Receipts and expenses in the considerable increase in the revenues from VAT for 2006, in period 2003-2006 relation to the previous year, shows an increase in economic and business activities, financial discipline, reduction of the grey economy and more efficient involvement of the tax and customs offices, and confirms the fact that the VAT revenue is a significant source of budgetary liquidity and stability. Also, it is expected that the continuing growth of revenues from VAT will continue, and that together with the revenues on taxes on other bases provide compensation for the reduction of budgetary revenues because of the reductions in income tax of physical persons. Namely, by adhering to the Law on Amendments to the Law on the income tax for physical persons from 1 January 2007, the tax rate is being reduced from the progressive 15,19 and 23% bands, to a unique one of 9%. A gradual reduction is proposed, Graph 4.4 – Expenditures by months, in the next two years the tax rate would amount to 15%, in period 2003-2006 2009 12%, and in 2010 9%. The introduction of the proportional taxation on earnings of employees would have positive effects with the goal of creating favourable conditions for business development, providing an incentive for entrepreneurship, the engagement of new employees, all being listed in the Agenda on Economic Reforms.

The total budgetary expenditures, according to the preliminary data of the Ministry of Finance, in 2006 amounted to EUR 579.8 million, and the actual receipts are lower by 0.4% or EUR 2.5 million. The performance of expenditures in relation to the plan for 2006, after revision, was increased by 9%, as a result of the increased expenditures debt repayments, borrowings and loans and current budgetary reserves. Compared to last year Graph 4.5 – Structure of total expenditures in the period 2003-2006 and plan for 2007 they are 5% higher.

During the year, the spending of budgetary funds according to individual months was uneven, the same as with the funds inﬂow. • 2006 A high level of loan repayments, unsettled obligations from the previous years and interest, determined high expenditure of the budgetary funds especially in the second part of the year, when the receipts were at the highest level.

The structure of the total expenditures during the year shows the continuity of the high share of current expenditures of EUR 262 million or 45%, which is in relation to the projected amount after the revision for 2006 lower by 2%, but more than the same CHIEF ECONOMIST ANNUAL REPORT percentage in relation to 2005.

90 Box 4.2- Structure of the Budgetary Expenditures

In 2006 the State singled out EUR 94 million or 16.2% of the total expenditures, which is higher by 144% in relation to the plan, and has positive eﬀects on the reduction of the state public debt, through the regular servicing of obligations from foreign and other loans, as well as obligations from previous years. Borrowings and loans the government allocated (to non-ﬁnancial institutions, individuals and other borrowings) amounted to EUR 6.8 million or 1.2 %, and were lower than the previous year by 8%. In the same period, receipts from repayments of the approved loans amounted to EUR 9.3 million, and the budget surplus was EUR 2.5 million. For budgetary reserves (permanent and current) the amount was EUR 27.3 million, or 60% more in relation to 2005.

Transfers to institutions, individuals, non-governmental and the public sector and transfers for social protection cumulatively amounted to EUR 158.2 million or 27.3 of the total expenditures, which provides a high level of social, health protection, as well as regular settlement of obligations from pensions and disability insurance. Compared to the previous year, these expenditures increased by 38%.

For capital expenditures in 2006 (investments in infrastructure at the general and local level, construction, as well as investment maintenance) EUR 32 million was allocated, or 6% of the total expenditures. In 2005, these funds were higher and amounted to EUR 52 million, including project loans. However, lower levels of capital expenditures were balanced by the return of loans and unsettled obligations from the previous year.

On the basis of gross earnings and contributions, as the largest expenditure item, EUR 159 million was allocated, that makes up 29.8% of the total expenditures, respectively 61% of the current budget expenditure. In relation to the plan, expenditures for gross earnings were lower by 3%, while in relation to 2005, were higher by 1%. Funds for gross earnings make up 8.7% of GDP.

Graph 1 – Expenditures in the period 2003-2006 and plan for 2007

Other categories on the side of expenditures (expenditures for material and services, current maintenance, other personal earnings, rents subventions and other expenditures), in relation to the planned expenditures for 2006, record a declining trend, but individual expenditures grew in relation to the previous year. These expenditures FISCAL SECTOR cumulatively amounted to EUR 81 million, with a participation of 15%, with the highest share of expenditures for material, services and current maintenance. In relation to the previous year, rent expenditures increased by 35%, other expenditures by 56%, while subventions were lower by 5%. On behalf of the obligation on the basis of interest, in 2006 EUR 22.3 million were planned, some 44% more than planned, but 8% more compared to the

91 previous year. The high growth of current budgetary revenues, as well as the budgetary surplus, made possible the ﬁnancing of budgetary expenditure in 2006 from real sources and the regular servicing of obligations to international ﬁnancial institutions.

Looking at the amount of the surplus/deficit as the difference December 2006, the budget of the Republic achieved a surplus between receipts and expenditures, while the receipts are reduced of EUR 34.6 million51. (Annex D, Table 17). for loans, accepted transfers, donations and receipts from sold property, while expenditures for repayments of capital in the If we consider a surplus to be the difference between receipts country and abroad on the basis of debt arising from borrowing and expenditures then it amounted to EUR 2.5 million. and the issuance of securities, in the period of 1 January to 31

Box 4.3- Fiscal deﬁcit/surplus

In most economies in transition budget deﬁcit was Graph 1– Participation of the budgetary deﬁcit/ in accordance with the Maastricht criteria. Only in surplus in GDP the case of Hungary it was extremely high.

Montenegro belongs to a smaller number of economies in transition that recorded budget surpluses. • 2006

In December, the Parliament adopted the proposal of the Budget accordance with the Amendments to the Law on the Budget for 2007. The Budget for the next year amounts to EUR 616.9 adopted in November 2005. Namely, the Law prescribes that million, and is higher by EUR 85.4 million or 16% in relation to the budget, besides the current one, contains also the capital that planned last year (Budget after revision in 2006 amounted budget with the aim of advancing the process of budget planning to EUR 531.5 million), and EUR 34 million higher than receipts and performance, and the precise deﬁnition of works that will from last year. The reason for the increase of the Budget is, be ﬁnanced through the current budget as well as works and among others, the implementation of the capital budget, in projects that will be presented in the capital budget. According CHIEF ECONOMIST ANNUAL REPORT

51 Methodology of calculating surplus/deﬁcit "Oﬃcial Gazette of the Republic of Montenegro", 71/05

92 to this, the current budget is planned to the amount of EUR expenses have priority with a participation of 56.7%, or EUR 330.7 582.9 million, and the capital one in the amount of EUR 33.9 million, and are higher by 24.2% in relation to those from the million. The planning of the budget is performed on the basis previous year, in which the dominant factor was expenditures of the revenues in previous years, the estimated growth in GDP, from gross earnings, with 54%. In GDP, the share of gross earnings as well as the fiscal influence of the new regulations that will amounts to 8.9%. In relation to 2006, planned expenditures be implemented in 2007, with the goal of increasing budgetary from the transfer for social protection are increased by 12%, revenues, the rationalization of expenditures and an increase with the increase of funds for technological surplus, while the in the capital expenditures. All of this is in accordance with the transfer to individuals, institutions and public sector is lower by objectives of the economic policy for 2007. Bearing in mind the 2%. However, the transfers in total expenditures make up 28% expected nominal growth of GDP, we can say that the budget was that provides a high level of social, health protection as well planned realistically and that it is very probable that srevenues as regular settlement of obligations on the basis of pension- will be higher than planned. disability insurance. Capital expenditures of the current budget are planned to a higher level in relation to 2006, and relates On the side of revenues, the planned current budgetary revenues to smaller projects that do not fulfil the criteria of the capital for 2007 amount to EUR 589 million, including receipts of loan budget, and in total planned funds make up 5.9%. By projecting repayments, and are higher by 15% in relation to 2006, after the budget for 2007, the funds from the borrowings and loans revision and are based on the positive trends of VAT payments, are reduced by 13% with a participation of 0.9% in the totally the tax on international trade and transactions, compensations planned expenditure, while the funds for budgetary reserves and revenues that consumers provide through their own activities. (current and permanent) in relation to 2006 are lower by 37%, Also, a positive effect on the increase of budgetary revenues is making up just 0.9%. From debt repayment, planned funds also expected through the implementation of a number of laws in amounts to EUR 41 million and are higher by 6% in relation to the area of fiscal policy in 2006 and 2007. Privatization revenues 2006, and are intended for credit repayment to residents, non- are planned to the amount of EUR 11.4 million, and are higher by residents, obligations from previous years and given guarantees 4.4 million in relation to those from last year, and will be used in the country and abroad. for financing the capital budget, while the planned donations of EUR 0.6 million, and are significantly lower compared to 2006 The capital budget for 2007 is planned to the amount of EUR 33.9 (planned donations in 2006 amounted to EUR 5.5 million). Loans million, and is related to capital projects that will be carried out and credits (foreign sources of financing) are higher by EUR 11 by the Directorate for Public Works and Directorate for Transport, million, and are planned to be EUR 15.9 million, including project and include the construction of new and the maintenance of loans. These funds relate to the loans for the reform of the Pension existing objects and equipment, as well as buying the land, fund, health reform, capital budget and the construction of the the duration of which is longer than five years. Because the Adriatic Highway. capital projects are large expenditures and require longstanding financing, it is necessary to define the priorities and plan the Budget expenditures for 2007 are projected at 16% more in height of indebtedness through the loans or long-term credits. relation to that planned for 2006, and their growth was influenced However, capital projects may be financed by means of funds by: the change of the status of the Republic of Montenegro, and from donations. It is also important to understand the linkage of taking over the international and other obligations from the level the current and capital budget, because the procurement of the of the ex State Union, the implementation of the Law on earnings capital funds (construction and purchase) must have the support of high officials, deputies and state officials and employees by of the current budget, so that the funds can be maintained.

which gross earnings and other receipts are increased, as well FISCAL SECTOR as an increase in capital expenditures by the implementation In 2007, the net amount of budget available for expenditure of the capital budget. amounts to EUR 578 million, which is 29% of the estimated GDP, while the budget surplus amounts to EUR 10.7 million making The current budget is planned for 2007 to the amount of EUR up 0.5% of GDP. The implementation of the stable ﬁnancing 582.9 million. In the structure of these expenditures the current of the budgetary expenditure in the following years, and the

93 continuation of fiscal reforms is necessary. The reforms relate to insurance and payments of foreign pensions, the Fund spent the tax system through the reduction of the tax rate, restricted EUR 32.5 million or 16% of the total expenditures. Operational budgetary expenditure and a reduction in the participation of expenses which include: current and capital expenditures, expenditures for earnings in GDP, through a reduction in the borrowings and loans and transfers to individuals, institutions, number of employees in the state sector, as well as the reduction public and non-governmental sector amounted to EUR 7 million of the total foreign and domestic debt. The highest potential risk or 3% of total expenditure. For obligations from the previous year relates to the fact that the amount of obligations on the basis the Fund allocated EUR 1.5 million and additional EUR 11 million of restitution is still unknown. A large burden of the budget as time deposits with commercial banks in order to provide better on this basis would have a negative impact on the long-term borrowing so as to provide liquidity maintenance. budgetary balance. Comparing revenues and expenditures, the Pension and Disability Insurance Fund achieved a deficit to the amount of EUR 0.7 4.2. Review of Budgetary Funds million in 2006. in 2006 The Republic Health Care Fund (according to preliminary data of the Fund) in 2006 realized revenues in the amount of EUR The Republic Pension and Disability Insurance Fund 118 million, what is in relation to 2005 an increase of 11% , as a (preliminary data of the Fund) during 2006 received total result of better collection of contributions. In total revenues, 72% revenues to the amount of EUR 206.1 million, and that is 17% or EUR 85.3 million were revenues from contributions, while other more than in the previous year. From the contributions, as the revenues, revenues from agriculture and the Employment Bureau most important source of financing of the Pension and Disability amounted to EUR 1.2 million. The participation of the revenues Insurance Fund that provides the liquidity of the Fund and the from the Pension and Disability Insurance Fund amounted to regular servicing of obligations, the amount of EUR 138.5 million 21%, while the revenues from the budget transfers accounted was revenued, which is an increase of 17% in relation to 2005. for 6% in total receipts. Expenditures of the Health Care Fund Contributions participated in the total revenues with 67%, amounted to EUR 119 million, and in relation to the previous year what suggests their trend of growth, as the consequence of the were higher by 9%. The largest part in total expenses were the higher rate of employment, the reduction of the grey economy, expenses for regular activities, as well as the supply of medicines as well as a higher level of the fiscal discipline. Except for the to the amount of EUR 111 million, or 95%. The Fund ended its growth of revenues from contributions, a positive influence on operations in 2006 with a deficit of EUR 1 million (modified the financial stability of the Fund were revenues from sale of calculating models), but also with outstanding liabilities to the shares from the Fund portfolio, transfers from the budget, as amount of EUR 13.6 million. well as the internal economy, and internal rationalization of Fund operations. Transfers from the budget amounted to EUR The Employment Bureauof the Republic of Montenegro, 54 million or 26%, revenues from equity capital EUR 10 million in 2006, received revenues to the amount of EUR 19.2 million • 2006 or 5%, while other receipts amounted to EUR 2 million, and by (including transfers and receipts from loans repayments). Current 24% higher in relation to the previous year. According to the data receipts (contributions, fees and other revenues) amounted to of the Fund, in the current period of this year, the Fund withdraw EUR 10.5 million, what is 57% more in relation to the same EUR 1.3 million from the deposits, and did not use funds from period of the previous year. From the transfers from the budget loans at commercial banks. EUR 6 million was revenued, a donation of EUR 0.1 million, while receipts from the loan repayment amounted to EUR 3 million. The total expenditures of the Pension and Disability Insurance From the sale of equity capital, in the observed period, the Bureau Fund in the observed period amounted to EUR 206.8 million, and received EUR 4 million. in relation to 2005 were higher by 2%. The most significant share CHIEF ECONOMIST ANNUAL REPORT was pension expenditures, amounting to EUR 155 million or 75%. The Bureau’s expenditures amounted to EUR 29.2 million in From the compensations, allowances, contributions for health 2006, of which EUR 7 million related to current expenditures,

94 while transfers for social security and transfers to individuals, The Development Fund received revenues to the amount of institutions and public sector amounted to EUR 13.3 million. EUR 1.5 million in 2006, that is compared to the previous year Some EUR 0.4 million was allocated for capital expenditures, two and a half times more, as a result of the increased revenues while net borrowings amounted to EUR 5.5 million, because the (interest from approved loans, capital market transactions and approved borrowings and loans amounted to EUR 8.5 million, dividends), while expenses amounted to EUR 0.8 million, so the and the receipts from loan repayments EUR 3 million . Comparing surplus was EUR 0.7 million. receipts and expenditures in 2006, the Bureau operated with a deﬁcit of EUR 10 million. According to the Bureau’s data, (Annex D, table 18) outstanding liabilities as at 31 December 2006 amounted to EUR 4.4 million. FISCAL SECTOR

PUBLIC DEBT 5

5.1. Foreign Public Debt

The public debt of the Republic of Montenegro in 2006 amounted The total foreign debt of Montenegro as at 31 December 2006 to EUR 701.1 million, and its share in estimated GDP for 2006 amounted to EUR 504 million, which makes about 27.6% of the was about 38.3%. From the total amount of public debt, EUR estimated GDP for 2006 and is presented in Graph 5.1. 197.1 million or 28.1% relates to domestic debt, while the foreign debt amounts to EUR 504 million or 71.9%. Debt to the Paris Club amounts to EUR 137.8 million and is expressed in the total reduced amount of debt. This debt is The amount of the public debt of Montenegro, compared to other reduced for the rest of the 15% in 2006 (from an agreed writing- countries in transition, including the average in the European off of debt of 66%) to the amount of $26 million, according Union and the Maastricht criteria, is relatively favourable, to successfully concluded arrangement with the IMF. In the so Montenegro continues to be classified as a low-indebted structure of the foreign debt relating to the Paris club of creditors, country. except writing-off, there is also a change arising as a result of an increase of this obligation of about EUR 12.5 million by adding The structure of the public debt in Montenegro suggests the capitalized interest on the amount of debt, as is anticipated by situation in which the inherited indebtedness from the previous the provisions of bilateral agreements. In the state of debt the system is still dominating, respectively, about 84% of obligations obligations on the first withdrawal of loans of the governments relate to the obligations assumed by the Law on regulation of of Poland and Hungary are included, as well as new withdrawals obligations and receivables on the basis of the foreign debt and from the arrangement with KfW. In the process of regulating the frozen foreign currency deposits of citizens. obligations to creditors of the Paris club the signing of a bilateral agreement with Japan still remained, i.e. the Japanese Bank for International Cooperation JBIC (debt to the amount of about Graph 5.1 – Share of Montenegro’s public ¥123 million is not included in the data), while with Italy and debt in GDP in the period 2002-2006 Serbia was signed a trilateral agreement on debt rescheduling. The Secretariat of the Paris Club announced the intention of the creditor countries that after gaining independence, they would sign bilateral agreements with Montenegro. The state of debt according to the Paris Club will not significantly change, after the signing of the bilateral agreements, because the obligations of the Republic of Montenegro had been defined by the principles

of end-user in the existing bilateral agreements with the Federal PUBLIC DEBT Republic of Yugoslavia, respectively Serbia and Montenegro. From September 2007, Montenegro will begin the repayment of 60% of the capitalized interest in 14 semi-annual instalments, Source: Montenegrin Ministry of Finance which will increase the debt according to the Paris Club by EUR 12.5 million.

99 Table 5.1 – Montenegro’s foreign debt as at 31 December 2006, EUR million

State of Foreign % foreign % public Creditor GDP debt debt /GDP debt debt (2/3) 1 2 3 5 6 4 International Bank for Reconstruction and 261.8 1,829.0 14.3% 52.2% 37.5% Development (IBRD) International Financial Organization (IFC) 9.2 1,829.0 0.5% 1.8% 1.3% Member countries of the Paris club of creditors* 137.8 1,829.0 7.5% 27.5% 19.7% International Development Association (IDA)** 34.9 1,829.0 1.9% 7.0% 5.0% European Investment Bank (EIB)*** 37.2 1,829.0 2.0% 7.4% 5.3% EBRD 1.4 1,829.0 0.1% 0.3% 0.2% Development Bank of the Council of Europe 2.6 1,829.0 0.1% 0.5% 0.4% European Union 5.5 1,829.0 0.3% 1.1% 0.8% Creditor Bank for Reconstruction - Germany (KFW) 5.9 1,829.0 0.3% 1.2% 0.8% Austrian Credit 4.1 1,829.0 0.2% 0.8% 0.6% Anglo Yugoslav Bank 0.7 1,829.0 0.0% 0.1% 0.1% Hungary Credit 1.5 1,829.0 0.1% 0.3% 0.2% Polish credit 1.4 1,829.0 0.1% 0.3% 0.2% TOTALAL 504 1,829.0 27.6% 100.0% 71.9%

* Amount of the original debt in EUR is 71%, 26% in USD, and 3% in other currencies; Conversion was performed on 30 September 2006 **Original amount is in the special drawing rights (SDR) ***Old debt EUR 1.2 million

Obligations arising from new loans increased in 2006 by The indicators of external indebtedness suggest that, in spite some 20%, of which the largest share, about EUR 7.1 million, of high inherited indebtedness, Montenegro is in the group relates to the withdrawal of loans on the basis of SAC II loans of countries with low indebtedness. The external debt to GDP (loans for structural adaptation) granted by the World Bank. ratio (27.2%), participation of the external debt in the estimated export of goods and services (about 55%), as well as debt per According to data on the state of the existing external debt, the capita confirm such a conclusion. After writing off the remaining Ministry of Finance worked out the projection of its repayment debt according to the Paris Club, Montenegro is classified among given in Table 5.2. low indebted countries (level of debt is below 30% of the gross domestic product) as is positively estimated by the IMF. • 2006

Table 5.2 – Projection of servicing the Montenegro external debt until 2010

Year Capital Interest Total 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

CHIEF ECONOMIST ANNUAL REPORT 2010 14,323,672.37 18,186,045.88 32,509,718.25

Source: Montenegrin Ministry of Finance

100 Table 5.3 – Criteria of indebtedness and position of Montenegro

Highly Low Montenegro Indicator Medium indebted indebted indebted 31 Dec. 2005 31 Dec. 2006 State of debt/GDP Ratio>50% 30%220% 132%

The presented percentages may be considered acceptable, 1. Implementation of the model for public debt i.e. the public debt is sustainable, but it is still necessary to management. In this way the possibilities for the emphasize the necessity that future indebtedness should be repayment of the existing debt would be considered, undertaken cautiously. The barrier on the side of sources available as well as the levels of potential future borrowing. in the previous two decades resulted with a low level of new 2. When making new debts it is necessary to perform indebtedness and reduced investments of the state through continuous analysis of the «cheapest» sources so that this kind of financing. By stabilizing the political and economic efficient financing can be provided. situation in Montenegro this type of barriers has been reduced 3. With the goal of the rationalization of expenses in the or has disappeared, allowing Montenegro free access to the public sector the process of the tender procedure should international capital market. With such a high quality position be applied while making the choice of the sources of at the very beginning of the process, permanent improvement financing for the public sector. of the strategy of public debt management is necessary so that a 4. Strict control of all forms of additional obligations of good environment could be created for future generations. Public the public sector (on the state level, as well as at local debt management (both internal and external), as a prerequisite levels). Manage a quality records of obligations based for creating a sustainable economic system, should be provided on indebtedness by the issuance of debt instruments through the following activities: and planned expenses on this basis, so that the potential risk of over-indebtedness could be reduced.

Box 5.1- Comparison of Indebtedness Indicators

When looking at the indi- Graph 1 – Share of the external debt in GDP in selected countries in the period 2002 – 2006 cators of indebtedness by countries in the region, in the period 2002-2006, it may be concluded that Montenegro belongs to low-indebted countries, as well as that these indicators show a tendency of improvement. PUBLIC DEBT

Source: Handbook of Statistics 2006 Central, East and Southeast Europe, Source for 2006: IMF, Publication notices, IMF Executive Board Concludes 2006 Article IV Consultation with countries

101 Graph 2 – Share of external debt in total export of goods and services, in selected countries, 2002 – 2006

Source: Handbook of Statistics 2006 Central, East and Southeast Europe

5.2. Domestic Public Debt

Domestic public debt at the end of 2006 amounted to EUR 197.1 The government debt arising from the issuance of short-term million or 10.8% of the gross domestic product. The largest share treasury bills in 2006 amounted to EUR 3.3 million, and is reduced in domestic public debt is still old foreign exchange savings, by 59% in relation to the previous year. This positive tendency which on 31 December 2006 amounted to EUR 105.2 million or began last year by a decision of the government to use cheaper 53.3% of domestic debt. Debt on this base is reduced in relation sources of financing in the case of the necessity to overcome to the state at the end of the previous year by EUR 11.8 million short-term liquidity problems through the debt management. or by about 10% of the debt. It should also be noted that the reduced need for these funds occurred as a result of the reduced need of the Ministry of Finance Besides old foreign exchange savings, a significant part of for further borrowing because of the high privatization revenues the domestic public debt (26.5%) relates to newly formed in the budget that had been received in the previous two years. obligations arising from the compensation or restitution52 of As a consequence of the reduced offer of treasury bills, the interest ownership that is included by the methodology of statement rate on these securities recorded a remarkable fall. • 2006 of account and expressed in 2006, while the total obligations are reduced for obligations on treasury bills by EUR 4.7 million and for the remaining state budgetary obligations by almost EUR 10.6 million.

52 The Restitution Fund issued these bonds in March 2006, in a total value of EUR 150 million. These can be sold on the market or used for buying stocks or shares and other property of the Republic of Montenegro and state funds. The initial value of one bond is one euro, but unlike FFCD bonds and municipal bonds, these are non-interest bearing and they do not have maturity periods. However, they have the

CHIEF ECONOMIST ANNUAL REPORT term of validity, 8 April 2007, and all those who buy the restitution bonds at a stock exchange, after this term expires, gain the right to be compensated for in six-month installments planned in accordance with the Law on Return of Deprived Property and Compensation. These bonds can be traded on the free exchange market.

102 Table 5.4 – State of domestic debt in Montenegro on 31 December, 2006

State of Domestic % domestic % public Creditor GDP debt debt/GDP debt debt 1 2 3 (2/3) 4 5 6 Old foreign exchange savings 105.2 1,829.0 5.8% 53.4% 15.1% Obligations on banking credits 0.0 1,829.0 0.0% 0.0% 0.0% Obligations on treasury bills 3.3 1,829.0 0.2% 1.7% 0.5% Remaining budgetary obligations 15.4 1,829.0 0.8% 7.8% 2.2% Debt of the local self-government 20.9 1,829.0 1.1% 10.6% 3.0% Obligations on compensations 52.3 1,829.0 2.9% 26.5% 7.5% TOTALAL 197.1 1,829.0 10.8% 100.0% 28.2%

5.3. Public Debt Repayment

In 2006, the total public debt serviced amounted to EUR 74.31 whom Montenegro has issued guarantee or counter-guarantee, million, which is a 4% share in the estimated GDP in 2006. are Monteput, Airports of Montenegro, Electric Power Industry The servicing of liabilities is in accordance with the envisaged of Montenegro and The Agency for Flight Control, which are repayment dynamics of due debts. enterprises with autonomous revenues, and there is a justiﬁed assumption that they will service their debts regularly, so in Montenegro’s public debt, including public companies, amounted accordance with the ESA-95 accounting method, these liabilities to some EUR 775 million or 42.4 % of GDP on 31 January 2006. have not been included in the public debt, but have been treated Public companies, as the beneﬁciaries of foreign loans and to as the public sector debt.

Table 5.5 – Structure of public debt repayment in 2006, EUR million

External debt Repayment of interests on loans and guarantees 19,003 Repayment of capital loans and guarantees 14,544 Repayment of other expenses 0,267 TOTALAL 33,814 Domestic debt Repayment of capital on loans and guarantees 17,136 Repayment of interests on loans and guarantees 2,018 Repayment of capital on short-term treasury bills 4,663 Repayment of interest on short-term treasury bills 0,102 Repayment on taken over debts 2,717

Repayment of the remaining obligations on the conclusion of the government 13,105 PUBLIC DEBT Given loans 0,755 Decisions of the Cabinet of Government 0,675 TOTAL:AL: 41,171 TOTAL FOREIGN AND DOMESTIC DEBT: 74,985

Source: Ministry of Finance

103

EXTERNAL DEVELOPMENTS 6

Preliminary data on the balance of payments of the Republic The improvement in economic living conditions and less migration of Montenegro show that the current account deficit in 2006 influenced the downtrend in surplus of factor incomes and amounted to EUR 568.2 million or 268.8% more than in 2005. transfers. In 2006, the surplus was EUR 121 million or 26.2% Observed as a GDP percentage, the deficit increased from 9.1% less than in 2005. in 2005 to 31.1% of GDP in 2006. A remarkably large inflow of foreign direct investments and an increase in loans mostly The inflow of foreign direct investments to Montenegro in 2006 affected a high increase in visible imports. The coverage of foreign was EUR 644.3 million, while their outflow amounted to EUR trade deficit by surpluses in other current account sub-balances 177.6 million. was 37.3%, some 32.8 percentage points less than in 2005. With portfolio investments during 2006, the inflow was recorded The accelerated economic growth of Montenegro in the reporting to the amount of EUR 43.8 million, and their outflow of EUR year was due to an increase in the volume of current account 48.3 million. transactions of 28.6% in comparison with 2005. Overall volume of exchange in the commodity account in 2006 was 34.8% The inflow of other investments in 2006 was EUR 427.5 million larger in comparison to 2005. The import/export coverage was while their outflow was EUR 288.7 million. In the overall amount 36.2%, which is some 11 percentage points less than in the of loans taken, a significant share made up funds invested in same period in 2005. tourism.

The volume of services trade was EUR 650.7 million or 40.2% more than in 2005. At the same time, the net export of services increased, which is mostly determined by income movements from tourism services. The surplus was EUR 216.4 million, which is an increase of 10.7% compared to the surplus achieved in 2005. EXTERNAL DEVELOPMENTS

107 Table 6.1 – Balance of payments, EUR thousand and GDP percentage

2005 2006 Change % GDP*

A. CURRENT ACCOUNT (1+2+3+4) -154,045 -568,162 368.83 -31.06 1. GOODS -513,653 -905,596 176.30 -49.51 1.1. Export 460,648 514,466 111.68 28.13 1.2. Import 974,301 1,420,062 145.75 77.64 2. SERVICES 195,540 216,415 110.68 11.83 2.1. Revenues 329,765 433,548 131.47 23.70 2.2. Expenditures 134,225 217,134 161.77 11.87 3. INCOME 17,512 30,800 175.88 1.68 3.1. Revenues 62,291 65,334 104.88 3.57 3.2. Expenditures 44,779 34,534 77.12 1.89 4. CURRENT TRANSFERS 146,556 90,220 61.56 4.93 4.1. Transfers to Montenegro 163,455 108,555 66.41 5.94 4.2. Transfers from Montenegro 16,899 18,336 108.50 1.00 B. CAPITAL AND FINANCIAL ACCOUNT 191,881 523,438 272.79 28.62 1. CAPITAL ACCOUNT 0 -14,028 -0.77 2. FINANCIAL ACCOUNT (1+2+3+4+5) 191,881 537,466 280.10 29.39 2.1. Direct investment-net 381,213 466,701 122.43 25.52 2.2. Portfolio investment-net 4,815 -4,444 -92.30 -0.24 2.3. Other investment-net -20,390 138,879 -681.11 7.59 2.4. Change in Net Foreign Assets of commercial banks -60,900 73,379 -120.49 4.01 2.5. Change in CBM foreign reserve assets -112,857 -137,048 121.44 -7.49 C. NET ERRORS AND OMISSIONS (A+B) 37,836 -44,724

* GDP for 2006 Source: CBM

6.1. Balance of Payments Current Account

According to preliminary data, the current account deficit in 2006 The financing of the current account deficit was mostly through • 2006 amounted to EUR 568.2 million, which is 31.1% of GDP. Balance foreign direct investments. of payment data show that foreign trade deficit amounted to 49.5% of the estimated GDP. There was a surplus of EUR 216.4 million or 11.8% of GDP with services in 2006. On the factor income sub-account, there was an increase in net income, while on the current transfers sub-account, a fall in net income was recorded in comparison to 2005. The coverage of foreign trade deficit by the surplus which was made on other current account sub-accounts amounted to 37.3%. CHIEF ECONOMIST ANNUAL REPORT

108 Table 6.2 – Current account, EUR thousand

Change 2004 2005 2006 2005/2004 2006/2005 A. CURRENT ACCOUNT (1+2+3+4) -119,642 -154,045 -568,162 128.76 368.83 1. GOODS -416,436 -513,653 -905,596 123.35 176.30 1.1. Revenues 452,148 460,648 514,466 101.88 111.68 1.2. Expenditures 868,584 974,301 1,420,062 112.17 145.75 2. SERVICES 148,176 195,540 216,415 131.96 110.68 2.1. Revenues 249,529 329,765 433,548 132.15 131.47 2.2. Expenditures 101,353 134,225 217,134 132.43 161.77 3. INCOME 86,242 17,512 30,800 20.31 175.88 3.1. Revenues 135,455 62,291 65,334 45.99 104.88 3.2. Expenditures 49,213 44,779 34,534 90.99 77.12 4. CURRENT TRANSFERS 62,376 146,556 90,220 234.96 61.56 4.1. Transfers to Montenegro 73,493 163,455 108,555 222.41 66.41 4.2. Transfers from Montenegro 11,117 16,899 18,336 152.01 108.50

Source: CBM

Graph 6.1 – Current account per quarters Graph 6.2 – Current account and inﬂow of in 2005 and 2006 foreign direct investments of GDP%

Source: CBM Source: CBM

Box 6.1 – The Highest Deﬁcit in Europe

In spite of signiﬁcant reforms, most new EU member countries and South East Europe countries still experience

high current account deficits. Also, counties which achieve strong economic growths, due to increases in domestic EXTERNAL DEVELOPMENTS demand and a higher need for investments with the current level of national savings, use foreign capital, which generates current account deficit. According to preliminary data, Montenegro recorded the current account deficit in 2006 of 31% of GDP, which is the highest deficit in Europe.

109 The main reason for the high deficit is the Graph 1 – Current account deficit in GDP percentage, in 2006 extremely high foreign trade deficit – 49.5% of GDP. A record inflow level of foreign direct investment, a substantial inflow of loans and a high level of investment activities, all had an influence on the increased import of goods which cannot be covered by the surpluses made on other sub-accounts. It is expected, as a consequence of the accelerated economic growth and large investments that the domestic economy’s competitiveness will increase, which will additionally decrease imports and increase exports, and consequently, reduce the foreign trade imbalance.

Source: Economic indicators for Central and Eastern Europe, the BIS, CBM

6.1.1. Visible Trade53

The visible trade of Montenegro with other countries in 2006 Graph 6.3 – Export and import of goods in was much more dynamic when compared to 2005. In 2006, Montenegro, 2004-2006, EUR million EUR 514.2 million54 was exported as goods, while the import of goods amounted to EUR 1,420.1 million. A faster annual growth of imports over exports led to a decrease in the export/import ratio of 11 percentage points (amounting to 36.2%) and increased the trade deficit. Total visible trade in 2006 amounted to EUR 1,934.5 million, which is 34.8% more than in 2005. It is obvious that the accelerated economic growth, a high inflow of foreign direct investments and loans used for investment purposes, affected a significant increase in the import of goods which are not produced in Montenegro or are produced in insufficient • 2006 quantities. Also, when comparing data for 2006 with those from earlier years, one should also bear in mind that the data for 2006 are preliminary. Source: CBM and Monstat

53 It is not possible to monitor the structure of visible trade, as Monstat data were not available. 54 METHODOLOGY REMARKS: Data on export/import of goods are compiled in accordance with the Methodology BPM5 (Balance of Payments CHIEF ECONOMIST ANNUAL REPORT Manual, Fifth edition, IMF, 1993). Methodology diﬀerences imposed the obligation of adjusting data obtained from foreign trade statistics for the balance of payments needs, due to which the data on imports and exports of goods in the balance of payments do not match data on visible trade provided by Monstat.

110 The share of the foreign trade deﬁcit in overall visible trade Unalloyed aluminium was mostly exported to Italy – 58.6%, amounted to 46.8%, which is 11 index points more than in the Greece – 19.1% and Hungary – 17.6%. Countries to which same period in 2005. Montenegro mostly exports are Serbia – EUR 168.2 million, Italy – EUR 142.2 million and Hungary – EUR 43.9 million. Data on visible exports show that exports rose by 11.7% in relation to the same period last year. The most important In 2006, Montenegro mostly imported from Serbia – EUR 400.4 export product remains aluminium and aluminium products million, Germany – EUR 155.4 million and Italy – EUR 138.7 which account for 41.8% of total exports (EUR 215.3 million). million.

Graph 6.4 – Export and import of goods in Graph 6.5 – Export concentration, 2006, Montenegro, 2004-2006, EUR million EUR thousand

Source: CBM and MONSTAT Source: CBM and MONSTAT

Box 6.2 – Alternative Energy Sources

The shortage of electricity in Montenegro has Graph 1 – Import of electricity per quarters, become more of a problem over the years, 2004-2006, EUR thousand threatening to become a hampering factor for the further economic growth. In 2006, more electricity was produced, spent and imported in Montenegro than originally planned. A more complicated situation is expected in 2007 in regard to electricity provision (a shortage of electricity in the region due to the anticipated closing of two reactors in Bulgarian power plants). In 2005, the EPCG imported EUR 31.2 million, and in 2006 – EUR 43.1 million (data EXTERNAL DEVELOPMENTS on the imports of KAP and the Steelworks Nikšić were not included). Source: Electric Power Industry of Montenegro (EPCG)

111 The Energy Development Strategy of Montenegro by 2025 envisages, inter alia, the construction of a number of electrical energy sources, the construction of smaller power plants, the establishment of generators farms which would use the wind power (Niksic and Ulcinj regions), the development of solar power plants which could operate by using the biomass energy (a power plant of three-four megawatts using industrial wood scraps).

Montenegro has a great potential for using renewable energy sources in the future. Some thirty kilometres from Niksic, a factory producing ecological fuel from wood scraps and sawdust was opened. Daily production in this factory is up to six tones of products, which will gradually increase in order to achieve a capacity of 30 tones of eco-fuel in the short term. The final product is made of sawdust in the shape of small cylinders and has enormous caloricity power (2-3 kilograms of sawdust is equivalent to one litre of petrol, and steam-heating that uses eco-fuel is 30% cheaper than with other conventional types). The production of alternative types of energy, in this case eco-fuel has multiple benefits and importance for Montenegro, primarily in the ecological sense (removing waste areas in which wood scraps stored for years), reducing consumption of expensive energy, growth and development of certain regions, export potential and the possibility of opening new jobs through greenfield investments (construction of micro- and mini-power plants).

6.1.2. Services

On the services sub-account there was a great growth in the Revenues from services in 2006 amounted to EUR 433.5 overall volume of services trade, of which tourism, construction, million and they increased by 31.5% in comparison with the communication, and various business and technical services previous year. The largest revenues were from travel – 67%, can be singled out. The overall volume of services trade transport – 13%, other business services – 7% and construction in 2006 amounted to EUR 650.7 million, which is 40.2% more services – 6%. than in 2005.

Graph 6.6 – Movement in volume of Graph 6.7 – Structure of revenues by services trade in %, 2003-2006 services in 2006 • 2006

Source: CBM Source: CBM CHIEF ECONOMIST ANNUAL REPORT

112 Expenditure on services in 2006 was EUR 217.1 million Graph 6.8 – Structure of expenditures on and it increased by 61.8% in comparison with 2006. The main services in 2006 reason for the increase in expenditures is a significant increase in expenditures on construction services, which accounted for 35% of total expenditures on services. Significant investments in infrastructure, tourism and other fields of construction required the hiring of foreign experts and foreign labour force due to an insufficiently skilled local workforce, which contributed to the increase in expenditure on services to a great extent.

The balance of services amounted to EUR 216.4 million. When compared to 2005, a 10.7% higher surplus was made on the services account. Observed by types of services, the highest Source: CBM surplus was made in travel and tourism (EUR 268 million), while the highest deﬁcit was recorded in construction services (EUR 49.8 million). Graph 6.9 – Balance of services in 2006 Transportation revenues in 2006 amounted to EUR 56.8 million, which is a decrease of 10.7% when compared to 2005. The largest income was from maritime transport – EUR 28.7 million or 50.4% of total transportation revenues, followed by air traﬃc – EUR 17.8 million or 31.3%.

Revenues from transportation via railways were 47% higher when compared to 2005, which is a consequence of increased transportation of goods intended for export and goods in transit. An increase in revenues was also recorded in road transport to the extent of 160% when compared to 2005. As of 2006, a portion of revenues in maritime transport was recorded as goods Source: CBM for the purpose of the harmonization with the international methodology,

Table 6.3 – Transport revenues during 2005/2006, EUR thousand

Type of transport 2005 share in % 2006 share in % 2006/2005. Diﬀerence Maritime 40,664 63.87 28,660 50.43 70.48 -12,004 Railway 2,204 3.46 3,240 5.70 147.01 1,036 Air 16,821 26.42 17,809 31.34 105.87 988 Road 1,248 1.96 3,253 5.72 260.66 2,005 EXTERNAL DEVELOPMENTS Other 2,733 4.29 3,867 6.80 141.49 1,134 TOTAL 63,670 100.00 56,829 100.00 89.26 -6,841

Source: CBM

113 Table 6.4 – Structure of transport revenues in 2006, EUR thousand

Type of transport services Share Type of transport Total Passenger transport Freight transport Other in % Maritime 2,701 1,651 24,308 28,660 50.43 Railway 2 3,172 66 3,240 5.70 Air 13,232 5 4,572 17,809 31.34 Road 544 2,628 82 3,253 5.72 Other 0 0 3,867 3,867 6.80 TOTAL 16,479 7,456 32,895 56,829 100.00 Share in % 29 13 58 100

Source: CBM

Total transportation expenditure in 2006 amounted to of foreign transportation enterprises importing construction EUR 48.9 million, being 36.8% higher than in 2005. material. Expenditures in the ﬁeld of air traﬃc in the reporting period amounted to EUR 21.5 million, which is EUR 4.7 million The highest increase in expenditures was in road transport, or 27.7% more than in 2005. 68% more compared to 2005, due to the increased engagement

Table 6.5 – Transport expenditures in 2005/2006, EUR thousand

Type of transport 2005 Share in % 2006 Share in % 2006/2005 Diﬀerence Maritime 5.397 15.07 7.128 14.55 132.07 1,731 Railway 2,670 7.46 1,999 4.08 74.87 -671 Air 16,862 47.09 21,538 43.96 127.73 4,676 Road 9,770 27.29 16,489 33.66 168.77 6,719 Other 1,108 3.09 1,838 3.75 165.88 730 TOTAL 35,807 100.00 48,992 100.00 136.82 13.185

Source: CBM

Table 6.6 – The structure of transport expenditures in 2006, EUR thousand • 2006

Type of transport services Share Type of transport Total Passenger transport Freight transport Other in % Maritime 148 2,331 4,650 7,128 14.55 Railway 43 1,648 308 1,999 4.08 Air 9,375 235 11,927 21,538 43.96 Road 314 15,817 359 16,489 33.66 Other 0 10 1,828 1,838 3.75 TOTAL 9,880 20,041 19,071 48,992 100.00 CHIEF ECONOMIST ANNUAL REPORT Share in % 20 41 39 100

Source: CBM

114 The share of expenditures on the transport of goods in overall research and other types of domestic investments amounted transport was 40.9% and that of expenditures on the passengers to EUR 6.4 million. transport was 20.2%. Work on construction projects and the installation of machines by The balance of transportation services in 2006 was positive local companies outside Montenegro, as well as in Montenegro (in and amounted to EUR 7.8 million, which is EUR 20 million or 72% cases of foreign companies’ hiring residents) during 2006 resulted less than the surplus recorded in 2005. in an inflow of funds to residents’ accounts of EUR 27.1 million. Expenditures on engaging non-residents in the construction field The revenues from travel are calculated by estimating tourism in the observed period amounted to EUR 76.9 million, which led revenues, which are supplemented with data on provided health- to a deficit in this field to the amount of EUR 49.8 million. The recreation services and expenses for education. In 2006, the airport reconstruction and roads construction accounted for the estimated tourism revenues amounted to EUR 288.3 million, largest share in overall expenditures in this field. 29.7% more than in 2005. Better-quality of tourism services, the successful promotion of Montenegro by the Ministry of Tourism, For international insurance services Montenegrin residents paid the construction of infrastructure, etc, all had as a consequence EUR 8.9 million in 2006, which resulted in a deficit of EUR 7.4 the prolonging of the tourist season, the arrival of a large number million. of organized tours from abroad, and consequently, an increase in revenues. The surplus made in the travel and tourism during the 6.1.3. Factor Income reporting year amounted to EUR 267.9 million and was 26.4% higher than in 2005. The third item in the balance of payments current account is revenues and expenditure based on the ownership of the As for communication services in 2006, revenues were production factors. It includes compensation to employees received to the amount of EUR 22.9 million or 49.2% more than (salaries, wages), and revenues and expenditures from interests, in 2005, of which revenues from telecommunication services investments, i.e. dividends. The new Law on current and capital amounted to EUR 22.5 million. New services and an increased transactions prescribes the period of 6 months for one to be number of tourists who use telecommunication services are some considered a "resident private citizen", which led to changes in of the reasons for the increase in revenues. Concerning the fact classifying most of the inflows by our workers abroad. Namely, that expenditures on these services amounted to EUR 7.2 million, a great number people working on temporary work abroad the surplus was recorded to the amount of EUR 15.7 million. spend less than a year abroad, but more than six months (as in the case of seafarers). Earnings of those workers sent to their Revenues from, and expenditures on, other business services families are now treated as transfers instead of factor incomes, during 2006 reached the level of EUR 28.4 million and EUR 38.4 as classified up to January 2006. million, respectively. Most of the revenues were from various business, professional and technical services (legal and accounting Factor income revenues in 2006 amounted to EUR 65.3 services, consulting, engineer services and services in the field of million, out of which EUR 61.4 million was for compensations to architecture) – EUR 22.3 million, and in the field of trade – EUR employees. Income from international investments amounted 5.8 million. The number of companies in the re-export business to EUR 3.9 million. Factor income expenditure in the reporting and the games of chance also increased. year was EUR 34.5 million, of which EUR 4.4 million related to non-resident salaries, other being interests earned on short- On the expenditure side for hiring foreign experts from the legal, term and long-term loans (EUR 29.7 million) and income from accounting and consulting field, EUR 13.1 million was paid in direct and portfolio investments (EUR 405.9 thousand). The 2006. The cost for promoting domestic products and services balance of income in 2006 was positive and amounted to EXTERNAL DEVELOPMENTS at international fairs, for buying advertising material, market EUR 30.8 million.

115 6.1.4. Current transfers The inflow from other transfers amounted to EUR 12.9 million. The total inflow from current transfers in 2006 amounted to EUR In the same period, the current account outflow was EUR 18.3 108.5 million, out of which EUR 8.1 million related to the government million, of which other sectors made up EUR 16.9 million, and sector and EUR 100.4 million to other sectors. Within other the government sector EUR 1.3 million. The balance of current sectors, the inflow from workers earnings was EUR 87.5 million. transfers in 2006 amounted to EUR 90.2 million.

Box 6.3 – Remittances

According to the latest data of the World Bank, in 2004, a total number of USD 232 billion cash remittances were recorded in the world, of which 8% related to Europe and Middle Asia. The largest number of remittances as GDP percent was recorded in Togo and Moldavia, 50% and 28%, respectively. From the neighbouring countries, the remittance share in GDP was 25% in Bosnia and Herzegovina, 16% in Albania, and 8% in Croatia. Remittance share in GDP is used as one of the poverty indicators. Montenegro belongs to the group of countries Graph 1 – Share of incomes and transfers in with relatively high income inﬂow from earnings total revenues in the CBM current account, of residents who work abroad and from transfers 2000-2006, in % made by emigrants. In 2006, the percentage of remittances as a share of GDP was 9.5%, being 13.3% the year before.

Factor income revenues and transfer inflows in Montenegro in 2006 made up 15.5% of total current account revenues, while in 2005 they were 22.2%. These are income revenues registered through the banking channels. This means, if the income revenues that come through informal channels would be included, especially Source: CBM during the summer when emigrants come for a visit, this amount would be higher. It is very hard to show precisely these flows at the global level due to the use of these informal channels, therefore, there are significant discrepancies in comparing inflows to outflows. According to the World Bank annual report (Global Economic Prospects 2006), cash remittances sent through informal channels, if registered, would increase official • 2006 estimates of cash remittances by some 50%, if not more, becoming one of the main capital sources in developing countries.

Table 1 – Employees compensations and workers earnings in the world, from 1999 to 2005, in USD millions

1999 2000 2001 2002 2003 2004 2005 Employees compensations Inﬂow 40,850 39,986 42,119 48,048 58,081 66,370 71,770 Outﬂow 46,889 47,000 50,054 56,495 66,465 75,522 82,217 CHIEF ECONOMIST ANNUAL REPORT Global deviation -6,039 -7,014 -7935 -8,447 -8,384 -9,152 -10,447

116 Table 1 – Employees compensations and workers earnings in the world, from 1999 to 2005, in USD millions - continued

1999 2000 2001 2002 2003 2004 2005 Workers earnings Inflow 67,308 73,301 82,570 94,739 114,869 130,653 151,390 Outflow 8,114 11,290 15,200 17,268 33,741 39,935 53,975 Global deviation 59,194 62,011 67,370 77,471 81,128 90,718 97,415 Sum of amounts from empolyees compenastions and workers earnings Inflow 108,158 113,287 124,689 142,787 172,950 197,023 223,160 Outflow 55,003 58,290 65,254 73,763 100,206 115,457 136,192 Global deviation 53,155 54,997 59,435 69,024 72,744 81,566 86,968

Source: Balance of Payments Statistics Yearbook 2006, Part 2, IMF

6.2. Capital and Financial Transactions Account

Within the capital-financial balance, a significant inflow of Graph 6.10 – Inflow of foreign direct foreign direct investments continued. The value of net direct investments per quarters in 2005 and 2006 investments in 2006 amounted to EUR 466.7 million. The total inflow of foreign direct investments in 2006 amounted to EUR 644.3 million, out of which EUR 641.2 million related to non- residents investments in Montenegro, and EUR 3.1 million to the withdrawal of funds directly invested abroad. Investments in equity capital by non-residents amounted to EUR 596 million in 2006, which is by 51.7% more than in 2005, while some EUR 45.1 million of investments were in the form of intercompany debts, loans, deposits, and other claims.

Source: CBM

Box 6.4 – Investment climate in Montenegro EXTERNAL DEVELOPMENTS The OECD and the Stability Pact, in the recently published study "Progress in Policy Reform – to improve the investment climate in South East Europe" have rated the investment climate in Montenegro. The good and bad sides are given in the following table:

117 Table 1 – Bad and goods sides of investment climate in Montenegro

Good sides of the investment climate Bad sides of the investment climate Investment policy Fight against corruption policy Taxation policy Investments promotion Human capital Trade policy Regulatory framework Anti-monopoly policy

Source: "Progress in Policy Reform – to improve the investment Climate in South East Europe", OECD and Stability Pact, 2006.

The reasons for bad ratings in certain ﬁelds are given in the following text and they can be good guidelines for improvements necessary in the upcoming period.

Fight against corruption in Montenegro is the worst-rated field in the whole region. The reasons for this lie in inadequate regulations, non-ratified international conventions in this field and unsatisfactory results in restraining corruption.

Investments promotion was badly rated due to the poor on-the-ground services and sector-speciﬁc barriers for potential and existing investors.

Trade policy, asas a partpart ofof tthehe iinvestmentnvestment climateclimate waswas badlybadly ratedrated becausebecause MontenegroMontenegro isis notnot a membermember countrycountry ofof the WTO and still has not signed the Stabilisation and Association Agreement with the EU.

Competition policy was badly rated because all the necessary regulations have not yet been adopted, due to the lack of an independent institution and undeﬁned priorities in this area.

Of total FDI inﬂow, EUR 337.9 million or 53% related to real estates purchase while the investment of foreign capital in local Graph 6.11 – Structure of FDI inﬂow in 2006 enterprises and banks amounted to EUR 252 million or 39%.

The FDI outﬂow in the reporting year amounted to EUR 177.6 • 2006 million, of which EUR 81 million referred to real estates, EUR 64.4 million to the withdrawal of the foreign capital share in local banks and companies, while EUR 29.3 million related to domestic companies’ investments abroad. By observing the outﬂow structure, 45.6% was the sale of real estate, while 36.3% the withdrawal of the foreign capital share in local banks and companies.

Source: CBCG CHIEF ECONOMIST ANNUAL REPORT

118 Box 6.5 – Real Estate Market in Montenegro

The real estate market in Montenegro experienced a great expansion in 2006. This is conﬁrmed by data on foreign direct investments, where investments in real estate amounted to EUR 337.9 million, which represents 53% of the total of foreign direct investments. A greater demand for real estate is present with foreign investors as well as with the local population. The largest investments in real estates were in coastal towns, with growing investments in other places as well.

The main reasons for the increasing interest of foreign investors in investing in real estates in Montenegro are favourable investment conditions – simple legislation, a strong potential for further growth of the real estate market and earning proﬁt from the real estates sale, as well as the growth of the tourism industry. According to the World Travel and Tourism Council (WTTC), Montenegro will achieve the highest tourism growth in the world in the upcoming period, the assessments reaching 10.2%55 in the period 2007 - 2012. The growth of tourism will additionally have an eﬀect on medium-term and long-term market growths and an increase in real estates demand (for lease, sale, and the like). This is an additional incentive for foreign investors to purchase real estate in Montenegro, as the increasing demand will lead to the real estate prices growth.

Besides the increased FDI inflow in real estates, Graph 1 – Foreign direct investments in real there was also an outflow arising from the sale estates of real estates owned by non-residents to the amount of EUR 81 million, which accounted for 45.6% of total outflows and it was EUR 68.6 million higher than in 2005. The situation that foreign investors purchase real estates in order to sell them later and earn on the price differences is more present. This is a situation of the so-called passive foreign direct investments, with the primary aim of earning from the real estates prices growth.

Source: CBM

The inflow and outflow of portfolio investments in 2006 loans taken by local enterprises and banks from abroad, while EUR amounted to EUR 43.8 million and EUR 48.3 million, respectively. 4.2 million related to a reduction in the debts of local enterprises On the Other investments account, covering loans, trade loans, on the basis of the funds given. The outflow of Other investments cash and deposits, the inflow of funds amounted to EUR 427.5 was EUR 288.7 million, so the net Other investments inflow was million, which is EUR 332.6 million more than in 2005. Observing EUR 138.9 million. the structure of other investments, EUR 423.3 million related to EXTERNAL DEVELOPMENTS

55 World Travel and Tourism Council, Tourism Satellite Accounting Report

119 Box 6.6 – International Loans

A strong growth of liabilities to abroad was recorded in 2006, mainly due to the growing obligations of banks and other sectors arising from loans taken from foreign banks and financial institutions. Total obligations to abroad in 2006 amounted to EUR 351.7 million or 119.5% more than in 2005. The inflow from loans in 2006 was EUR 423.3 million which is by 125.5% more than in 2005, while the outflow (principal repayment) was EUR 67.6 million or 38.3% more. The inflow structure shows that of the total inflow of funds received as loans, some 47% referred to financial institutions (commercial banks, micro-credit institutions, leasing companies) while some 36% related to legal entities who were granted loans in order to perform construction work mainly in tourism Graph 5.14 – Structure of loans inflow in (the construction of new, and the reconstruction Montenegro of old, hotels) and investments in real estate. Other loans were for other economic subjects, the Government, and so on.

As for financial institutions, these were mainly the borrowing between the associated companies ("parent-daughter company relationship"), with the possibility in the case of hotels and real estate to transform loans to proprietary investment. Therefore, the high inflow of loans should be regarded as the cause-and-effect relation with Source: CBM the associated accelerated economic growth in Montenegro.

Commercial banks’ net foreign assets in 2006 fell by EUR 73.4 million when compared to 31 December 2005. At the same time, the CBM funds in the accounts abroad and in the Vault as at 31 December 2006 were EUR 137 million higher when compared to same date a year ago. • 2006

CHIEF ECONOMIST ANNUAL REPORT

120 INTERNATIONAL ECONOMY 7

Preliminary data show that the global economic growth in The price of oil per barrel at end-December 2006 amounted 2006 was 4.9%, which represents an increase of 0.1 percentage to USD 61, being higher during the year (USD 75 in June). The points in comparison to 2005. The main driving forces of such factors which mostly contributed to the decrease in oil prices a growth were the United States, China and Russia. Predictions in the second half of the year were: a more favourable geo- for the following period indicate that the global growth will be political environment and a review by certain international lower, as a consequence of slowdowns in the economies of the institutions on the level of demand for these energy products United States, Japan and in the Euro zone. in the upcoming period.

Global trends were incited by a growth in international trade According to the estimates of the American Energy Agency and and low import prices of products from the South East Asian International Energy Agency, oil prices will remain within the countries. The main global policies were sound, financial markets same range in the next two years, since none of the causes of were flexible and absorbed more restrictive monetary policies high prices will disappear. The estimate is based on the analysis of of the leading central banks with success. However, there are the existing energy markets and the fact that the oil companies, risks which can slow down the global economic trends in the due to low energy product prices in the last 20 years, have not upcoming period, the main being the balance of payments invested enough in production. Only three years ago, the price of imbalance in the USA, high levels of oil prices, geo-political oil per barrel circulated around USD 20, but now, when the price risks, and the like. has tripled, oil companies are investing, but the effects of those investments will show results only in a few years. The global imbalance manifested in the high US trade deficit (7% of GDP or some USD 900 billion in 2006) and on the other Graph 7.1 – Movement of oil prices during side, in an increasing surplus and foreign exchange reserves in 2006 developing markets in Asia and oil exporters. The risk of foreign investors’, who financed the US trade deficit, changing their mind, would cause a fall in the USD value and a growth in short-term interest rates. Besides the global imbalance, high levels of oil prices and other raw materials, which in the long-term lead to an increase in core inflation, impact economic growth. However, it is estimated that there is a high flexibility in financial markets and that the global financial system is stable and capable of absorbing the existing risks, which includes further increases in central banks’ interest rates. INTERNATIONAL ECONOMY

Source: Bloomberg 2007

123 7.1. Economic Trends

7.1.1. Developed Countries the most successful transition country, the central bank interest rate was only 2%. The USA – The US economy saw a moderate growth of 3.5% in 2006, which is 0.3 percentage points more when compared to In EU 25, the unemployment rate was 7.7%, and preliminary data 2005 (3.2% in 2005, 3.9% in 2004). The effects of the tightening on the annual inflation rate (HICP) was around 2.2%. of the FED’s monetary policy as of June 2004 has started to influence the US economic growth since, as a rule, its effects The European Commission predicts that the growth in the are delayed from 12 to 18 months. Besides monetary policy Euro area, i.e. the Eurozone will slow down to 2.4% and 2.1%, measures, oil prices and a slowdown in the real estate market, respectively, in 2007 due to an expected decrease in demand which recorded high growth rates in the previous period, also in Germany which raised VAT from 16% to 19% as of 1 January affected such a moderate economic growth. The long-standing 2007, and due to the slowdown in the US economy. increase in the prices of real estates had created the feeling of greater wealth with consumers and stimulated personal JAPAN- The estimated GDP growth rate in 2006 was 2.7%, consumption, but their fall reduced consumption and overall being 0.1 percentage points higher than in 2005. An increase economic activities at the year-end. The estimated annual in prices was also recorded in 2006, which points to the fact inflation rate in 2006 amounted to 2%. that the long-term deflationary trend in Japan has ceased, one of the reasons being the increase in energy prices in the global Analysts predict that the US economy growth rate in 2007 will market. Preliminary data show that the inflation rate in 2006 was be around 2.2%. 0.6%. The Bank of Japan warned about the possible risks for the Japanese market in the following period, stating that the highest The EU - Positive market trends were recorded in the European risk may be a possible slowdown in the US economy as the main Monetary Union member countries and the estimated economic export market for Japanese products, as well as further oil prices growth rate was 2.7%. An increase in the ECB reference interest growth as Japan covers all its oil needs via imports. rate and the strengthening of the EUR against the USD did not lead to a slowdown in economic activity. Preliminary data show It is expected that a slower economic growth of some 1.8% will that the annual inflation rate in 2006 was 1.9%. Oil prices and be recorded in Japan in 2007, as the consequence of a global high indirect taxes mostly influenced the inflation rate. The same slowdown and an increase in imports. level of inflation is expected in the forthcoming period. The unemployment rate in the Eurozone was 7.6% in December, which Graph 7.2 – Annual inflation rate is the lowest level since the monitoring of this data series has movement in the chosen started (since 1993). Unemployment in the Eurozone, with one new member country – Slovenia – that joined on 1 January, was • 2006 reducing slowly but steadily. Quarter-on-quarter employment in the Eurozone during 2006 rose at the rate of 0.4%, while the highest employment rate was in the financial sector and construction.

Economic growth in EU countries was mainly incited by the growth in domestic demand. In the Central and Eastern Europe countries the highest economic growth was in the Czech Republic – 7% where, along with Poland and Romania, economic growth CHIEF ECONOMIST ANNUAL REPORT was stimulated by the growth in domestic demand, while in Hungary by an increase in net exports. In the Czech Republic, Source: Bloomberg

124 7.1.2. Developing Countries in Brazil as well. In October 2006, the annual growth rate of industrial production in this country was 4.9%, while the annual CHINA - Preliminary data show that the Chinese economy inflation rate was 3% (in November 2006). In Argentina, the recorded a growth rate of 10.4% in 2006, so the country is now annual economic growth of 8.7% was recorded mainly under the facing the challenge of restraining sudden expansion. According influence of external demand growth and real estate prices. to preliminary estimates of the Chinese state agency for planning, the GDP value was over USD 2,600 billion. In the last five years, China has almost doubled the national production due to strong 7.1.3. Economies in Transition industrialization, urbanization and foreign investments. China is facing challenges in managing economic growth in spite of During 2006, economic growth was stable in economies in restrictive monetary policy measures (increases in the central transition. Croatia recorded the economic growth rate of 4.8%, bank interest rate and reserve requirement rate, and decreases in which is 0.5 percentage points more than in 2005, while the loans) which are directed toward the prevention of demand-pull average annual inflation rate was 3.2%. Economic growth in inflation and which should reduce the high level of investments Croatia was mostly incited by an increase in investments and and therefore remove the threat from inflation, i.e. debt crisis. private consumption. The HRK/EUR exchange rate at the end of 2006 was 0.4% nominally higher than at end-2005 when it China attracted a record level of FDI inflow of USD 63 billion was 7.38 HRK/EUR. in 2006, or 5% more than in 2005. These data did not include investments from abroad in the Chinese financial sector. With In Serbia, the annual economic growth rate in the third quarter a view to stimulating the export of capital in order to reduce the of 2006 was 4.6%, while the annual inflation rate was 6.6%. In pressure by its leading trade partners, primarily the United States, the last quarter of 2006 there was a reduction in inflation due to to help the appreciation of the Yuan (CNY), China encourages an increase in the level of restrictive monetary policy measures, domestic companies to invest abroad in order to secure their which led to a slowdown in the growth rate of monetary resources, create brand names and acquire larger market share. aggregates and credit activity. During 2006, the variability of Foreign investments by Chinese companies in 2006 were 32% the RSD/EUR exchange rate, measured by the change of daily (USD 16.1 billion) higher than in 2005. Chinese foreign exchange exchange rate against the euro, was very remarkable and was reserves rose by 30% in comparison with end-2005, which 0.15% in relation to 0.04% in 2005. The nominal effective and represents an additional pressure on the CNY appreciation. The the real effective exchange rate were lower than in the previous Chinese trade surplus in 2006 increased by 74% reaching a months (EUR 1 = RSD 79.00)54. record level of USD 177.5 billion mostly due to exports growth. In comparison with 2001, when China joined the World Trade In Bosnia and Herzegovina the annual inflation rate was 7.6% in Organisation (WTO), surplus of that country has risen almost eight September 2006, with the introduction of VAT having the main times. In 2007, economic growth in China is expected at around influence on the growth. 9.5% mostly due to the Chinese government decision to take measures for moderating growth of investment consumption. The improvement of business conditions in the transition countries remains one of the key prerequisites for intensifying economic LATIN AMERICA growth. Table 7.1 shows an overview of the results of transition measured by the EBRD transition index. Economic activity continuously grows in the Latin American countries. The annual growth rate of industrial output of Mexico According to our forecasts, the South East Europe region will be was 4.6% (October 2006), and the annual inflation rate was 4.1% booming in the following period. Our forecast on GDP growth in November. Economic indicators point to economic growth rates up to 2020 is given in the following table: INTERNATIONAL ECONOMY

56 Source: National Bank of Serbia

125 Table 7.1 – Forecast for GDP growth rates from 2006 to 2020

Growth rate GDPp* GDPr** GDPo*** PREB BDPpc-p BDPpc-r BDPpc-o Albania 4 6 7 0.7 3.3 5.3 6.3 Bosnia and Herzegovina 5 6 7 0.1 4.9 5.9 6.9 Croatia 3.5 4 5.5 -0.2 3.7 4.2 5.7 Macedonia 2.5 4 5 0.4 2.1 3.6 4.6 FYR Montenegro 4 6 7 -0.1 4.1 6.1 7.1 Serbia 4 5 7 -0.25 4.25 5.25 7.25 Western Balkans 3.8 4.9 6.3 0.1 3.7 4.8 6.2 Slovenia 0.05 2.95 3.95 4.95 EU 27 1.5 2.2 3.0 0.5 1.0 1.7 2.5

Source: CBM * p – pesimistic scenario; ** r – real scenario; *** o – optimistic scenario

Graph 7.3 – The results of transition for 7.2. Interest Rate Movements certain countries The ECB – In 2006, the ECB increased the reference interest rate, which reached the level of 3.50% in December and it is estimated that it will be 3.75% in 2007. The ECB representatives argue that an increase in interest rate was necessary for repressing the inﬂationary pressure in the Eurozone. The estimates show that, even at the current level of the reference interest rate, monetary policy in the euro zone was expanding, for which we can ﬁnd evidence in data related to the growth of loans to the private sector. The analysis shows that the neutral interest rate ranged between 3.5% and 4%.

Source: EBRD • 2006 Table 7.2 – ECB interest rates during 2006 (annual percentage)

Deposit Main reﬁnancing operations Marginal credit Date facilities Minimum variable rates arrangments 13 Dec 2.50 3.50 4.50 11 Oct 2.25 3.25 4.25 2006 9 Aug 2.00 3.00 4.00 15 Jun 1.75 2.75 3.75 8 Mar 1.50 2.50 3.50

CHIEF ECONOMIST ANNUAL REPORT 2005 6 Dec 1.25 2.25 3.25

Source: ECB

126 The FED - At the end of 2006, the FED reference interest rate Among other central banks, we single out the Bank of England reached its highest level since March 2001 and was 5.25%. The which joined the trend of increasing interest rates by 0.5 financial markets expected that the FED would stop at the level percentage points and it now amounts to 5%. of 5% which would be near the neutral interest rate and almost three percentage points above the core inflation, but investors’ expectations did not come true. The FED estimate was that the 7.3. Exchange Rate Movements risk of economic growth slowdown, due to a potential overdraft of the neutral interest rate level, was smaller than the risk of creating The movements in foreign exchange markets during 2006 inflationary expectations with consumers and the business sector. were marked by the USD depreciation against the EUR and the The FED gave priority to repressing inflatory expectations even JPY. The reasons for the decrease in value are expectations of at the cost of sacrificing a part of economic growth. investors in the foreign exchange market that the FED would stop increasing interest rates and that the decrease in value The BoJ - The reference interest rate of the Bank of Japan at of the dollar was inevitable due to a decline in the imbalance end-2006 was 0.25%, and was 0.15 percentage points higher of the US trade balance. At the same time, the ECB started to than in 2005, fulfilling expectations of the analysts that the Bank implement measures for repressing inflation and contributed would abandon its zero interest rate policy. Since March 2001, to an increase in attractiveness of euro investments. Unlike in the Bank of Japan has conducted a monetary policy of the so- the earlier period, when the strengthening of the Euro against called "quantitative easing" which kept the reference interest the US dollar caused concern with monetary authorities and practically at the zero rate and inserted fresh money into the businessmen, such a scenario was not present in this period. system. The reason for pursuing such a monetary policy was The reason for this lies in the fact that the USD depreciated a danger of possible deflation. However, since end-2005 and against numerous European and Asian currencies during the during 2006 Japan experienced a remarkable economic recovery year. Therefore, the EUR was not the single currency which had through the increase in personal consumption and companies’ to bear the brunt of the decreasing value of the US dollar. At the profit, and the unemployment fall, which diminished the danger end of 2004, when the EUR rapidly appreciated against the USD from deflation the Monetary Committee members feared. The and other currencies, particularly the JPY, remained relatively Bank of Japan responded to the first inflationary signals by stable, it all meant that solely European exporters had to pay increasing the reference interest rate. the price of the decreased value of the US currency. In December 2006, the value of the EUR was 1.33 against the 1 USD, which is The continuation of such a monetary policy is expected in 2007, 2.6% more than at the end of September, i.e. 3.4% more than i.e. the abandonment of a brisk expanding monetary policy. the annual average.

Table 7.3 – FED interest rates movement during 2006

Change (basis points) Date Growth Reduction Amount (%) 8 August - - 5.25 29 June 25 - 5.25 10 May 25 - 5.00 28 March 25 - 4.75 INTERNATIONAL ECONOMY 31 January 25 - 4.50

Izvor: FED

127 Graph 7.4 – The USD/EUR exchange rate Graph 7.5 – The JPY/EUR and the JPY/USD movement during 2006 exchange rate movement during 2006

Source: ECB Min= 1.1852 (27 Feb 2006) Source: ECB Min= 137.77 (27, Feb 2006) Max= 1.3331 (5 Dec 2006) Max= 155.31 (29, Dec 2006)

An increase in the value of the US dollar against the Euro is 7.4. Montenegro and International expected in 2007, and estimates show that it will move in the span from 1.33 to 1.40 USD/1 EUR. A gradual increase in the euro Environment value is expected, so the highest amount should be reached at the end of 2007. At the international level, 2006 was a very successful year for Montenegro. Preliminary negotiations with the EU on the signing The JPY/EUR exchange rate was fluctuating during 2006. It was of the Stabilisation and Association Agreement (SAA) were stable during the first part of the year, while in the second half, completed, as did the activities related to Montenegro’s admission the JPY depreciated. In June and December 2006, the average to the IMF and the World Bank. value of the EUR was 145.105 JPY and 157.89 JPY, respectively. These fluctuations were mostly incited by expectations of the The global economic market conditions had a positive effect on participants in the financial market of the Bank of Japan’s future Montenegro’s economic growth, the FDI inflow, and movements monetary policy, as well as by short-term speculative transactions in the monetary sphere. in the money market. • 2006 Table 7.4 – Exchange rates of EUR against the selected European currencies

Month Czech koruna British pound Hungarian forints Polish zloty December 2006 27.485 0.67290 251.77 3.8310 November 2006 27.972 0.67425 256.27 3.8113 October 2006 28.219 0.66850 260.22 3.8731 September 2006 28.383 0.67511 274.42 3.9649 August 2006 28.194 0.67669 274.41 3.9046 July 2006 28.448 0.68782 277.49 3.9962 CHIEF ECONOMIST ANNUAL REPORT

Source: ECB

128 Oil prices rises in the world market in the first half of 2006, led The global forecasts for 2007 are positive, which will create to an increase in production costs which had an effect on retail favourable external conditions for economic activity in prices and the cost of living in Monetengro. At the same time, Montenegro, except for the announced interest rate movements the oil share in overall inflation was as much as 42%, while in which may have an adverse effect. the second half of the year it fell (due to the fall in oil prices in the world market). Besides oil, the movement of the prices The signing of the SAA is expected in 2007, which will represent of metals (bauxite and aluminium) had a great influence on an important step forward for Montenegro on its road to European economic development of Montenegro, because their share in integration and create conditions for the beginning of a new overall exports was significant. The growth of interest rates in phase of relations with the EU. the world had negative effect on movements in Montenegro, as a net debtor with abroad. INTERNATIONAL ECONOMY

129

IMPORTANT EVENTS IN 2006 8

January February

The implementation of the Law on the implementation of The Government of Montenegro adopted the Draft Law on local regulations prescribing the protection of intellectual property communal taxes and the Privatisation plan for the reporting year. rights started as of this month, and it would enable a sustained Also, the Government adopted the Annual program, wherein implementation of these regulations. the priorities are joining the European Union as well as creating the conditions for the improved functioning of government Three important events were recorded in the banking sector: institutions after gaining independence. Societe Generale bank took over Podgorička bank, which rounded off the process of selling the majority ownership of this bank Financial arrangements that the International Monetary Fund that was initiated at the end of the previous year. Euromarket granted to the State Union almost four years ago were successfully bank officially merged with NLB Montenegrobanka Podgorica. ended and, in accordance with the achieved agreements with the Atlasmont bank from Podgorica is the first bank from Montenegro IMF representatives, the debt with the Paris Club was reduced by to open a branch in the Russian Federation, after getting the additional 15% (from the agreed 66% write-off). approval from the Central Bank of Russia. Members of the Committee for the Division of Financial Assets The contract was signed on the sale of the hotel "Galeb", in the and Liabilities of the former SFRY signed the Resolution on the ownership of the Ulcinjska Riviera (in bankruptcy), to the Croatian division of 27% shares in the authorized capital of Yugoslav bank company"PGM Ragusa" for EUR 5.3 million. for international economic cooperation (JUBMES).

The Government of Montenegro invited investors to apply for The Central Bank of Montenegro licensed the Austrian Hypo Alpe winning concessions for the use of water from nine springs for Adria Bank, whose management announced that it will oﬀer commercial purposes. clients in Montenegro more competitive banking products.

The Montenegrin Ministry of Finance published the Draft Law March on the local communal taxes, according to which municipalities will be able to charge taxes for using signiﬁcant infrastructural The 15th International Fair of Tourism "Metubes", that gathered telecommunication and electricity facilities for another two 114 exhibitors from the country and abroad. Montenegrin years. companies, whose representatives visited the Employment Bureau’s display at this fair, showed interest in engaging over 700 The Montenegrin Central Depositary Agency became a member of unemployed persons on the Employment Bureau’s records. of the European Association of Central Securities Depositaries. IMPORTANT EVENTS IN 2006

133 The Securities Commission of the Republic of Montenegro allowed Representatives of the Montenegrin government and the Nex Montenegro Exchange to announce a public oﬀer for taking Government of Poland signed in Warsaw a loan contract on over Montenegroberza. Nex Montenegroberza announced the USD 15 million that will be used for the reconstruction of the prospectus for taking over of all (about 1.3 thousand) voting railway and agricultural development. shares of Montenegroberza for which it intended to pay EUR 130 per share. The Government of Montenegro adopted the proposal of the Law on Public Procurement, harmonised with the corresponding EU The Agency for Tobacco assigned the ﬁrst wholesale tobacco legislation, which will not give domestic bidders the required products trading licences to companies in Podgorica "Rokšped" temporary privileged status over foreign bidders. and "Bar-Kod". The Employment Bureau, the Directorate for development of small The Montenegrin Government agreed to participate in the project and medium enterprises and the Development Fund delivered "A thousand residential loans", by which it will be made possible 530 decisions on disbursing loans to entrepreneurs, small and for citizens to get a loan under more favourable conditions than medium enterprises to the total value of about EUR 5 million. existing, in monthly instalments of EUR 90 to EUR 180. Members of the Montenegrin Parliament adopted the Law on Representatives of the Norwegian company "Stakraft" and Taxation of Gambling, the Law on communal taxes, the Law on Montenegrin electric power company "Elektroprivreda CG" signed Voluntary Proceedings, as well as Amendments to the Law on the Memorandum of Cooperation, with a view to strengthening Labour and Expropriation. the role of Montenegro in the energy market of South-East Europe. May

April On 21 May the Referendum on the state status of Montenegro was held. Montenegrin independence was supported by 55.4% The Montenegrin Government adopted the Decree on tax relief of voters, by which Montenegro officially became an independent for employers hiring disabled persons, redundancies and workers state. The Government of Montenegro, immediately after the aged 50 old, invalids, unemployed persons who are more than declaration of independence by the Parliament, started the five years on the employment records, seasonal workers, as well procedures for the membership of Montenegro in international as workers employed in the public sector. financial organizations.

The Montenegrin Directorate for Development of small and A celebration was held in Cetinje on the occasion of the centenary medium enterprises invited emigrants from Montenegro to apply of the issuing of Montenegro’s first money. Representatives of for a total of EUR 500 thousand worth loans that will be disbursed a great number of other central banks and the highest state in cooperation with Crnogorska Komercijalna Bank (CKB). officials attended the celebration that was organised by the • 2006 Central Bank of Montenegro. Representatives of Serbia and Montenegro, the Montenegrin government and the European Investment Bank signed a financial The Austrian Mint gifted the Central Bank of Montenegro the protocol on a loan resolving the problem of waste waters and only remaining machine on which the first Montenegrin money, water supply in Montenegro. the Perper, was minted a 100 years ago.

Hypo Alpe Adria bank, by signing a contract with the Government A new Free Trade Agreement between Serbia and Montenegro of Montenegro, became a part of the project "A thousand and FRY Macedonia entered into force, after seven phases of residential loans". negotiations harmonized at the end of May 2005. CHIEF ECONOMIST ANNUAL REPORT

134 "Cijevna Commerce" from Podgorica was proclaimed the most The Parliament of Montenegro adopted a new Law on Public successful Montenegrin company for 2005, according to the first Procurement, which envisages new and simpler methods and open competition announced by the Directorate for development procedures of public procurement, like the introduction of of small and medium enterprises. an electronic system that will enable the procedure of public procurement to be more efficient, effective and transparent. June The Montenegrin government prepared the proposal of the Law The Ministries of Finance and Governors of the central banks of on the ratification of the agreement between Montenegro and Serbia and Montenegro, generally agreed that the membership of the European Union on the establishment of the common energy the former State Union (SCG) in international financial institutions market of South-East Europe and adopted the Strategy for the will be continued by Serbia, with the existing membership share, development of food production and rural areas. from which Montenegro will be refunded the agreed amount. The Government also adopted the Strategy for encouraging At the Ministerial Conference in Vienna, the Declaration on creating foreign direct investments, the document that puts an emphasis a unique regional investments framework that is expected to on the key mechanisms of investment policy and the attraction bring about more investments in South-East Europe. of investors by application of fiscal, financial and institutional supporting measures and promotional activities. The proposal of The Montenegrin Ministry of Finance prepared the Draft the Law on obligatory insurance in transport, that the Government Amendments to the Law on the Regulation of Obligations also adopted, will make possible better protection and the and Receivables Arising from Foreign Debt and Frozen Foreign insurance of damaged parties. Currency Deposits that will enable depositors from Montenegro to return their deposits held with banks whose head offices The Government terminated the contract signed with the Greek are in Serbia. Hellenik petroleum on the construction of the first oil well on the Montenegrin coast, because Hellenik petroleum failed twice After the signing of the sale contract for the controlling interest in respecting the terms of the contract. of Pljevaljska Bank, Montenegro became the first state in the Balkans approaching a completely private banking sector and Montenegro became a full member of the International the capital market. Labour Organization, as well as a member of the International Telecommunication Union (ITU), whose headquarters is in The Montenegrin Agency for telecommunications and postal Geneva. services prepared a Draft Regulation on the conditions and the ways of giving greater public internet access based on the Internet The authorised municipal commissions delivered to the Restitution protocol, with the aim of giving incentives to competitiveness, Fund 53 valid judgements and orders on restitution of property liberalization and the follow-up of new technologies in that that had been taken away from the rightful owners after WWII, area. whose total value amounts to EUR 9.5 million.

July August

Representatives of governments and central banks of Montenegro The Government of Montenegro accepted the proposal of the and Serbia signed the interstate Agreement on regulating the International standardization organization for the basic national membership of international financial organizations and the code of Montenegro to be the sign ME and the three-letter division of financial rights and obligations of the State Union, one MNE. IMPORTANT EVENTS IN 2006 after which the Montenegrin Parliament adopted the Law on the ratification of this agreement.

135 The Hungarian OTP Bank signed a contract on buying all shares October of Crnogorska Komercijalna Bank (CKB) from Podgorica for EUR 105 million. That amount, almost seven times larger than the The Chamber of Commerce of Montenegro oﬃcially became nominal value of the equity capital of this bank OTP will pay by a member of the Association of the European Trade-Industrial the end of the year. Chambers (Eurochambers).

The Board of Directors of Electric Power Industry of Montenegro Montenegro became the 36th member of the European (EPCG) initiated the procedure for the sale of ﬁve small hydro- Commission for Tourism at the general meeting of that power plants, and the ﬁnal decision about their sale will be organization. adopted by the shareholder assembly. Representatives of the Serbian and Montenegrin governments September harmonized the language of the Agreement on social insurance between the two countries, but were unable to agree on the The Government of Montenegro adopted the Draft Law on proposal of Montenegro that until its coming into force, all the consumer protection, prescribing a full protection of rights and current rights of users with residence on either territory shall interests of the consumers. be respected.

Montenegro, via its Chamber of Commerce, joined the World The fourth phase of negotiations on the unique agreement on free Trade Net of 66 countries that exchange information on trade, trade of South-Eastern European countries started in Brussels. systems and problems as well as methods of their solution. The European Fund for South-East Europe was promoted in The International organization for standardization approved for Podgorica, and the plan for the following five years envisages the two-letter abbreviation for Montenegro to be ME, and the the refinancing of about 150 thousand loans and the opening three-letter MNE, while the International Telecommunication of about 30,000 new jobs in the region. Union (ITU) assigned Montenegro a new international code for the telephone net +382. The Montenegrin Ministry of Maritime Affairs and Transportation did not allow the Belgrade low-cost air company "Centavia" to The American organization CHF, in the first year of the fly to Podgorica. implementation of the program of local economic development (CRDA-E), approved 163 projects valued at over EUR 6.3 November million. Montenegro became a member of the European Bank for Representatives of a Slovenian company "Petrol" and the Reconstruction and Development. Montenegrin "Montenegrobonus" signed a letter of intention • 2006 in Cetinje, defining joint projects to the total value of EUR 1.5 The Montenegrin Government adopted a new proposal of the billion. Law on Budget, by which the planned surplus in consolidated public expenditure is 0.54 % of GDP. The Government also The Montenegrin capital market, instead of the continuation agreed with the proposal of the Committee for IMF membership of the prices growth that happened in the post-referendum that the quote of Montenegro in that institution would be 27.5 and the period after the national parliament elections were million of SDR. held, recorded a negative trend, which analysts explain as a decrease in demand. Members of the Montenegrin Parliament adopted the Law on the ratification of the Agreement on economic and trade cooperation CHIEF ECONOMIST ANNUAL REPORT between the Governments of Montenegro and China.

136 The Montenegrin Agency for Telecommunications announced Members of the Montenegrin Parliament adopted the Insurance an international public tender for assigning the licenses for the Law and accepted the report on the work of the Regulatory Energy second and third generations of mobile telephony. Agency and that of the Central Bank of Montenegro, as well as their financial reports for 2005. They also adopted Amendments Representatives of the British MN Specialty Steels, the Montenegrin to the Law of the State Auditing Institution (SAI) and the Law Government and government funds signed a sale contract on of on personal income tax. The Law on voluntary pension funds, 66.7% shares of "Zeljezara" in Niksic. as well as the proposal of the Budget for 2007 were adopted regardless of the request on the part of members to return them "Crnagoraput", an enterprise of which 30.9% shares were sold to be additionally drafted and amended. to Strabag with the obligation of additional capitalization, shall perform road constructions in Montenegro. The Government of Italy wrote-off a part of the debt of Montenegro with the Paris Club of creditors to the amount of The implementation of the new rules on block trade on the EUR 2.5 million and USD 2 million. Montenegrin capital market started, allowing the prices of shares to differ not more than one fifth from the market price. Montenegro was accepted into membership of the World Customs Organization. Representatives of the Montenegrin and German governments signed a protocol on cooperation for 2006, worth about EUR 63 The Government delegation talked to the representatives of the million, including access to regional funds, thus showing Germany Microsoft about the possibilities of establishing a technological support to Montenegro on its way to the European Union. centre of that company in Montenegro that would recruit new experts from Montenegro and be a motivation for those already The European Conference of Ministers of Transport (ECMT), which qualified abroad to come back to Montenegro. assists in the creation of an integrated, economically efficient and safe transport system, accepted Montenegro as its member. Officials of Montenegro, Croatia, Albania, Bosnia and Herzegovina, Serbia, Bulgaria, Moldavia, Romania and FYR Macedonia, as December well as the special representative of the UN in Kosovo signed in Bucharest the Central-European Free-Trade Agreement Negotiations on the Stabilisation and Association Agreement (CEFTA). to the European Union were completed, and it shall be signed when the Government of Montenegro fulfils its obligations in The Hungarian OTP Bank officially became the owner of the areas of customs and competition. Crnogorska Komercijalna Bank (CKB) with the purchase of all of its shares at the Montenegroberza stock exchange. The Government of Montenegro adopted proposals of agreements on regulating obligations of the Russian Federation to Montenegro, The minimum wage, the base for calculating income in the incurred at the time of the former SSSR and SFRY. The Government public sector, will gradually increase in 2007, reaching EUR 55 also adopted the proposal of the Law on government control in July, as set out in the Agreement signed by the Government that forbids the government to disturb market competition, have representatives, the representatives of the Labour Union and the any influence on the fulfilment of international obligations, or Union of Employers of Montenegro. perform any action that may cause such an effect. IMPORTANT EVENTS IN 2006

137

ANNEX 9 140 Annex A: Real sector developments

Table 1 – Preview of macroeconomic developments

2005 2006 (chain index) DESCRIPTION XII/XI I II III IV V VI VII VIII IX X XI XII Industrial output (index) 102.2 97.9 90.5 111.3 86.3 109 101.6 99.8 93.8 105.5 91.5 115.5 104 Cost of living (index) 100.2 100.3 100.3 100.2 100.7 100.7 100.1 98.9 100.3 100.3 100.4 100.3 100.3 Retail prices (index) 100.1 100.2 100.1 100.1 100.6 100.3 100.2 99.8 100.2 100.1 100.0 100.1 100.2

Source: Monstat

Table 2 – Industrial output

ø 2005 = 100 LEVEL INDEX Contribution 2005 2006 XII 2006 XII 2006 I-XII 2006 in 2005 XI XII I -XII XI XII I -XII XI 2005 XII 2005 I-XII 2005 Industry-total 100.0 106.1 108.4 100.0 106.6 110.9 101.0 104.0 102.3 101.0 Mining and quarrying 6.1 81.0 125.9 100.0 96.4 108.8 102.9 112.9 86.4 102.9 Mining and quarrying of en. producting mat. 2.0 119.6 113.9 100.0 127.2 123.1 117.5 96.8 108.1 117.5 Mining of pit coal, lignite and peat 2.0 119.6 113.9 100.0 127.2 123.1 117.5 96.8 108.1 117.5 Mining and quarrying exept energy produc. mat. 4.1 61.7 131.9 100.0 81.0 101.6 95.6 125.4 77.0 95.6 Mining of metal ores 3.2 60.7 148.8 100.0 83.9 112.5 98.1 134.1 75.6 98.1 Other mining and quarrying 0.9 65.4 69.2 100.0 70.2 61.2 86.3 87.2 88.4 86.3 Manufacturing 70.6 99.8 103.1 100.0 108.8 108.0 100.1 99.3 104.8 100.1 Manufacture of food products, beverages, and tobaco 9.0 94.3 105.3 100.0 85.5 112.2 90.6 131.2 106.6 90.6 Manufacture of food products baverages 7.1 117.0 121.4 100.0 102.3 137.6 103.8 134.5 113.3 103.8 Manufacture of tobaco products 1.9 8.6 44.8 100.0 22.4 16.4 41.0 73.2 36.6 41.0 Manufacture of textiles and textiles products 1.2 67.6 80.9 100.0 133.3 154.0 116.6 115.5 190.4 116.6 Manufacture of textile fabrics 0.1 105.0 278.2 100.0 328.5 184.0 148.6 56.0 66.1 148.6 Manufacture of wearing apparel and fur 1.1 65.6 70.1 100.0 122.7 152.3 114.9 124.1 217.3 114.9 Manufacture of leather and leather products 0.1 339.8 100.0 159.2 339.8 139.8 213.4 139.8 Manufacture of wood and wood products 2.2 151.7 268.9 100.0 111.2 131.2 99.0 118.0 48.8 99.0 Manufacture of paper, publishing, and printing 1.0 87.9 107.6 100.0 71.6 69.2 95.9 96.6 64.3 95.9 Manufacture of celulose paper and paper products 0.4 86.8 104.0 100.0 67.6 87.4 86.8 129.3 84.0 86.8 Publishing, printing and reproduction 0.6 88.5 109.8 100.0 74.0 58.3 101.4 78.8 53.1 101.4 Manufacture of chemical products and ﬁbres 6.7 132.2 139.8 100.0 92.8 84.9 65.1 91.5 60.7 65.1 Manufacture of rubber and plastic products 0.1 109.5 124.8 100.0 87.2 136.6 69.6 156.7 109.5 69.5 Manufacture of other non-metal minerals 6.1 101.0 98.3 100.0 100.3 100.4 100.9 100.1 102.1 100.9 Manufacture of metal and metal products 42.6 93.4 90.2 100.0 113.8 107.9 104.8 94.8 119.6 104.8 Manufacture of basic metals 40.7 93.6 87.2 100.0 111.5 106.3 104.3 95.3 121.9 104.3 Manufacture of metals products, exept machinery 1.9 90.6 153.5 100.0 162.8 140.9 114.7 86.5 91.8 114.7 Manufacture of other machinery and equipment 0.8 115.0 100.1 100.0 300.3 256.5 225.7 85.4 256.2 225.7 Manufacture of other machinery and household appliances 0.1 120.9 103.6 100.0 120.9 120.9 114.4 100.0 116.7 114.4 Manufacture of transport equipment 0.6 119.1 58.0 100.0 119.1 64.1 98.5 53.8 110.5 98.5 Manufacturing N.E.C. 0.1 135.9 169.4 100.0 361.9 389.9 386.7 107.7 230.2 386.7 Electricity, gas, water supply 23.3 132.0 120.0 100.0 102.5 120.4 103.1 117.5 100.3 103.1

Source: Monstat

141 Table 3 – Industrial production

Total Mining and quarrying Manufacturing Electricity, gas, water supply Annual Monthly Annual Monthly Annual Monthly Annual Monthly 2000=100 growth growth 2000=100 growth growth 2000=100 growth growth 2000=100 growth growth rate rate rate rate rate rate rate rate 2001 99.3 -0.7 88.5 -11.5 101.6 1.6 93.9 -6.1 2002 99.9 0.6 95.1 7.5 103.9 2.3 87.7 -6.6 2003 102.3 2.4 96.5 1.4 101.8 -2.1 103.1 17.5 2004 116.4 13.8 91.5 -5.1 115.1 13.1 124.7 21.0 Jan 78.2 -16.0 -33.8 74.9 52.9 -39.3 76.2 -5.6 -31.2 87.3 -38.0 -39.6 Feb 87.4 -17.2 14.0 90.0 51.8 20.1 99.5 -1.4 30.7 56.7 -57.2 -28.8 Mar 99.6 -12.8 11.8 72.7 -8.4 -19.2 107.1 1.3 7.6 87.8 -40.8 45.0 Apr 94.1 3.2 -5.6 49.6 57.1 -32.8 114.4 14.4 6.8 51.9 -39.2 -40.8 May 80.6 -21.6 -14.3 71.9 -18.4 44.8 104.5 -4.0 -8.6 17.2 -81.0 -66.9 June 95.5 2.2 18.3 100.4 10.6 39.6 108.2 2.8 3.5 58.5 -4.6 240.4 2002 July 105.5 24.5 10.5 113.0 61.9 12.5 111.4 9.6 2.8 86.9 103.1 148.6 Aug 93.5 5.2 -11.2 133.0 23.4 17.7 95.6 -11.6 -14.1 75.7 150.6 -12.9 Sep 107.6 18.2 15.0 126.1 -18.6 -5.1 110.5 11.1 15.6 93.7 95.7 23.7 Oct 117.8 17.4 9.5 120.8 2.7 -4.3 111.3 4.0 0.6 134.9 75.7 44.0 Nov 116.3 10.0 -1.4 122.2 35.6 1.1 108.4 7.8 -2.6 135.8 9.1 0.6 Dec 120.1 1.6 3.3 66.0 -46.5 -45.9 99.7 -0.6 1.6 164.0 19.7 20.7 Jan 100.9 29.0 -16.0 46.3 -38.2 -29.9 86.2 13.1 -21.8 124.2 42.3 -26.3 Feb 111.7 27.9 13.3 66.8 -25.8 44.1 97.2 -2.3 13.1 163.9 189.3 10.7 Mar 113.8 14.3 -0.3 77.0 5.9 15.2 107.3 0.2 10.1 144.1 64.1 -17.8 Apr 83.5 -11.3 -26.8 56.4 13.6 -26.8 95.6 -16.4 -11.0 58.8 13.2 -59.1 May 80.9 0.4 -3.1 56.1 -22.0 -0.5 98.4 -5.9 3.1 40.2 134.2 -31.6 June 102.6 7.5 26.9 98.1 -2.3 74.2 111.7 3.2 13.5 79.2 35.4 96.7 2003 July 107.0 1.5 -1.3 100.7 -10.9 3.0 105.6 -5.2 -5.4 89.7 3.2 13.4 Aug 100.0 6.9 -1.3 210.7 58.4 109.3 97.8 2.3 -7.3 71.9 -5.0 -19.7 Sep 106.4 -1.1 -3.3 177.3 40.6 15.8 98.8 -10.6 1.0 66.4 -29.2 -7.9 Oct 104.7 -11.1 8.4 103.9 -14.0 -41.4 113.2 1.7 14.6 166.8 23.6 10.1 Nov 103.7 -10.8 -1.0 88.6 -27.5 -14.8 104.5 -3.6 -7.7 105.9 -22.0 29.2 Dec 122.0 1.6 17.7 75.1 13.8 -15.3 101.9 2.2 6.9 164.8 0.5 55.7 Jan 100.8 -0.1 -17.4 56.3 21.5 -25.2 85.0 -1.4 -23.9 124.2 0.0 -4.1 Feb 107.8 -3.5 9.4 71.7 7.4 27.6 95.4 -1.8 12.7 151.5 -7.6 2.3 Mar 112.6 -1.1 2.3 46.1 -40.1 -35.6 123.3 14.9 28.9 103.9 -27.9 -35.9 Apr 120.8 44.7 7.0 58.3 3.4 26.3 117.2 22.5 -5.3 150.3 155.7 45.1 May 118.1 46.0 -2.2 53.8 -4.1 -7.8 113.3 15.2 -3.0 190.8 374.2 0.2 June 119.5 16.5 -0.3 101.4 3.3 87.6 117.6 5.3 1.6 129.6 63.7 -13.9 2004 July 113.6 6.1 -9.3 100.0 -0.7 -1 119.3 13.0 2.8 77.0 -14.2 -40.6 Aug 100.2 0.2 -6.2 90.4 -57.1 -9.6 114.0 16.5 -3.8 65.2 -9.3 -15.1 Sep 121.9 14.6 10.6 164.3 -7.3 82.1 118.2 19.6 3.6 74.5 12.3 13.9 Oct 112.3 7.3 1.4 102.1 -1.7 -37.9 123.4 9.0 4.5 173.3 3.9 14.4 Nov 123.8 19.4 10.1 88.3 -0.3 -3.7 121.6 16.3 -1.5 140.4 32.5 64.7 Dec 156.5 28.3 26.6 166.9 122.1 88.2 128.1 25.7 15.4 198.4 20.4 41.5 Jan 114.2 13.3 -27 61.5 9.3 -63 101.1 19 -27.8 130.6 5.1 -16.3 Feb 101.9 -5.5 -8.7 42.8 -40.4 -30.4 104.2 9.2 3.4 114.1 -24.7 -26.7 Mar 117.6 4.5 13.1 83.8 81.7 96.1 117.6 -4.6 12.6 129.2 24.4 5.8 Apr 105.8 -12.4 -10.3 61.6 5.7 -26.5 114.6 -2.2 -2.9 95.3 -36.6 -26.1 May 111.4 -5.7 5.4 70.3 30.8 14.3 119.2 5.2 4.3 129.5 -32.1 7.5 June 115.7 -3.2 2.3 108.4 7 53.4 122.0 3.7 0.2 100.3 -22.6 -1.9 2005 July 125.0 10.1 4.1 106.0 6.0 -1.9 137.1 14.9 13.9 79.0 2.7 -21.1 Aug 116.7 16.5 -1.5 129.4 43.1 22 133.0 16.7 10.1 67.8 4.0 11.7 Sep 133.2 9.3 3.8 146.1 -11.1 13.1 129.1 9.2 -3.1 92.1 23.6 35.3 Oct 110.2 -1.9 -9 101.2 -0.9 -30.7 120.1 -2.7 -6.9 175.4 1.2 -11.5 Nov 120.9 -2.4 9.3 74.3 -15.9 -26.7 118.1 -2.9 -6.9 142.3 1.4 65.0 Dec 123.4 -21.2 2.2 116.1 -30.4 55.5 111.4 -13 3.3 129.4 -34.8 -9.0 Jan 120.7 5.7 -2.1 93.0 51.3 -19.5 100.5 -0.6 -17.6 144.9 11 42.5 Feb 106.7 4.7 -9.5 91.8 114.8 -1.3 96.0 -7.9 -4.1 139.8 22.6 -19.0 Mar 121.2 3.0 11.3 90.5 8.0 -1.4 118.8 1.0 23.3 138.7 7.3 -7.4 Apr 105.0 -0.8 -13.7 70.8 14.9 -21.8 114.2 -0.3 -4.1 89.8 -5.8 -35.1 May 114.3 2.6 9.0 90.0 27.9 27.1 118.7 -0.4 4.1 138.3 6.8 21.8 June 117.9 1.9 1.6 96.3 -11.2 6.6 124.4 2.0 2.6 106.2 5.9 -2.9 2006 July 138.0 10.4 -0.2 96.8 -8.7 0.8 140.3 2.4 1.7 129.2 63.5 -6.3 Aug 112.2 -3.9 -6.2 108.0 -16.5 11.7 120.8 -9.2 -2.5 75.3 11.1 -24.2 Sep 126.2 -5.3 5.5 124.3 -14.9 15.3 129.2 0.1 6.9 72.1 -21.7 -4.4 Oct 104.9 -4.8 -8.5 82.8 -18.2 -33.3 120.6 0.5 -6.5 139.1 -20.7 -5.2 Nov 121.5 0.5 15.5 88.4 19.0 6.5 128.7 9.0 6.7 110.6 -22.3 61.7 Dec 126.2 2.3 4.0 100.3 -13.6 12.9 116.8 4.8 -0.7 129.8 0.3 17.5

Source: Monstat and CBM calculations 142 Table 4 – Industrial output

I II III IV V VI VII VIII IX X XI XII Chain index 97.9 90.5 111.3 86.3 109.0 101.6 99.8 93.8 105.5 91.5 115.5 104.0 ø 2005 = 100 106.1 96.0 106.8 92.2 100.5 102.1 101.9 95.6 100.9 92.3 106.6 110.9 Same month in the preceding year 105.7 104.7 103.0 99.2 102.6 101.9 110.4 93.1 94.7 95.2 100.5 102.3 The same period in the preceding year 105.2 104.4 103.2 103.1 102.9 103.9 102.5 101.5 100.9 100.9 101.0

Table 5 – Retail prices

I II III IV V VI VII VIII IX X XI XII Chain index 100.2 100.1 100.1 100.6 100.3 100.2 99.8 100.2 100.1 100.0 100.1 100.2 ø 2005 = 100 101.2 101.3 101.4 102.0 102.4 102.5 102.4 102.6 102.7 102.7 102.8 103.0 Same month in the preceding year 102.6 102.3 102 102.1 102.2 102.3 102.3 102.3 101.7 101.7 101.9 102.0 The same period in the preceding year 102.5 102.3 102.3 102.2 102.1 102.2 102.2 102.2 102.1 102.1 102.1 December 2005 = 100 100.1 100.4 100.5 101.1 101.4 101.6 101.4 101.6 101.7 101.7 101.8 102.0

Table 6 – Cost of living

I II III IV V VI VII VIII IX X XI XII Chain index 100.3 100.3 100.2 100.7 100.7 100.1 98.9 100.3 100.3 100.4 100.3 100.3 ø 2005 = 100 102.1 102.4 102.6 103.3 104.0 104.1 103.0 103.3 103.6 104 104.3 104.6 Same month in the preceding year 102.9 102.9 102.8 103.1 103.3 103.1 103.3 103.3 102.7 102.8 102.7 102.8 The same period in the preceding year 102.9 102.9 102.9 102.9 102.7 102.9 103 103 103 103 103.0 December 2005 = 100 100.3 100.6 100.8 101.5 102.2 102.3 101.2 101.5 101.7 102.2 102.5 102.8

Table 7 – Producers’ prices of manufactured products

I II III IV V VI VII VIII IX X XI XII Chain index 100.1 100.4 101.0 100.4 100.2 100.5 100.0 100.2 100.7 99.6 100.2 99.6 ø 2005 = 100 101.3 101.7 102.8 103.2 103.4 103.9 103.9 104.2 104.9 104.4 104.6 104.2 Same month in the preceding year 103.1 97.2 102.3 103.8 103.9 103.6 103.6 103.8 104.3 104.1 104.1 102.9 The same period in the preceding year 97.1 102.8 103.1 103.3 103.3 103.4 103.4 103.5 103.6 103.6 103.5 December 2005 = 100 100.1 100.4 101.5 101.9 102.1 102.6 102.6 102.8 103.5 103.1 103.3 102.9

Source: Monstat

143 Table 8 – Prices

Producer’s 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 June 21.9 3.2 19.3 0.9 34.4 14.1 22.1 3.0 13.1 0.3 July 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 2001 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 June 20.7 0.8 21.2 0.9 18.2 0.2 19.1 0.8 3.8 -2.4 2002 July 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 June 8.0 0.3 6.0 0.4 17.1 0.0 6.6 1.3 6.7 0.9 2003 July 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 June 2.4 0.0 1.3 0.0 7.5 0.1 0.9 -0.6 5.5 -0.4 2004 July 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 Jan 3.7 0.1 0.9 0.1 16.5 0.0 1.2 0.1 3.6 0.1 Feb 3.5 0.1 0.9 0.1 15.0 0.0 1.2 0.1 3.3 0.2 Mar 3.6 0.2 1.0 0.2 15.2 0.2 1.3 0.2 2.5 2.2 Apr 3.9 0.4 1.3 0.4 15.6 0.3 1.8 0.5 0.4 -1.5 May 3.6 0.2 1.4 0.3 12.8 0.1 2.0 0.6 0.5 0.5 June 3.8 0.2 1.6 0.2 13.2 0.4 2.9 0.3 1.7 0.8 2005 July 3.5 -0.2 1.3 -0.3 13.1 0.0 2.7 -1.0 1.5 0.0 Aug 3.5 0.1 1.3 0.1 13.1 0.0 2.7 0.2 1.3 0.1 Sep 3.7 0.3 1.4 0.3 13.2 0.3 3.2 0.4 2.1 0.2 Oct 3.3 0.2 1.4 0.2 11.4 0.3 3.2 0.3 2.1 -0.1 Nov 3.4 0.1 1.5 0.1 11.4 0.0 3.8 0.6 2.2 0.1 Dec 1.8 0.1 1.8 0.1 1.8 0.0 2.4 0.2 3.5 0.8 Jan 2.6 0.2 2.8 0.3 1.6 0.0 2.9 0.3 3.1 0.1 Feb 2.3 0.1 2.5 0.2 1.6 0.0 2.9 0.3 -2.8 0.4 Mar 2.0 0.1 2.2 0.1 1.5 0.1 2.8 0.2 2.3 1.0 Apr 2.1 0.6 2.3 0.7 1.0 0.1 3.1 0.7 3.8 0.4 May 2.2 0.3 2.5 0.4 0.9 0.0 3.3 0.7 3.9 0.2 June 2.3 0.2 2.6 0.2 0.8 0.1 3.1 0.1 3.6 0.5 2006 July 2.3 -0.2 2.6 -0.2 0.9 0.0 3.3 -1.1 3.6 0.0 Aug 2.3 0.2 2.4 0.1 1.6 0.7 3.3 0.3 3.8 0.2 Sep 1.7 0.1 1.7 0.0 1.8 0.3 2.7 0.3 4.3 0.7 Oct 1.7 0.0 1.6 -0.1 2.0 0.5 2.8 0.4 4.1 -0.4 Nov 1.9 0.1 1.9 0.1 2.0 0.0 2.7 0.3 4.1 0.2 Dec 2.0 0.2 2.0 0.2 2.0 0.0 2.8 0.3 2.9 -0.4

Source: Monstat 144 Table 9 – Tourism

2005 2006 Index I - XII ‘06 Structure XII I - XII XII I - XII I - XII ‘05 Total 9,880 820,457 17,681 953,928 116.3 100.0 Arrivals domestic 5,905 548,452 9,317 576,130 105.0 60.4 foreign 3,975 272,005 8,364 377,798 138.9 39.6 Total 27,569 5,211,847 48,475 5,936,270 113.9 100.0 Nights domestic 17,207 3,628,337 25,541 3,740,179 103.1 63.0 foreign 10,362 1,583,510 22,934 2,196,091 138.7 37.0

Source: Monstat

Table 10 – Number of employed and unemployed people

I II III IV V VI VII VIII IX X XI XII Employed* 2001 114,536 113,500 113,542 113,663 113,943 114,137 114,106 114,024 115,077 114,755 114,170 113,744 2002 113,594 113,597 113,953 113,663 113,943 114,137 114,422 113,684 113,526 113,676 113,679 113,425 2003 112,637 112,846 112,317 112,132 111,738 112,648 112,905 112,647 111,461 110,911 110,387 109,639 2004 108,562 107,359 108,634 109,623 109,642 109,863 110,886 111,158 110,049 109,696 110,055 108,228 2004*** 142,081 142,834 142,361 143,224 143,845 146,696 145,160 142,634 143,447 143,113 143,992 142,438 2005*** 142,145 142,072 141,298 140,959 142,248 145,852 148,528 146,744 145,739 145,923 145,528 145,261 2006*** 145,388 146,163 146,964 147,927 149,731 152,088 155,133 154,699 154,646 155,062 155,566 Unemployed** 2001 81,238 82,158 82,453 83,091 82,629 82,140 81,823 80,686 80,952 80,668 80,440 81,069 2002 80,385 81,360 81,510 81,961 81,602 81,041 81,116 80,830 80,809 80,183 79,894 76,293 2003 76,584 76,077 76,165 74,976 73,520 69,735 66,951 66,277 67,664 71,023 72,544 68,625 2004 69,573 71,419 72,378 72,202 68,993 64,572 60,993 60,771 60,447 59,930 59,387 58,950 2005 59,115 58,774 58,075 57,557 56,772 55,199 53,683 52,494 51,843 51,266 49,886 48,825 2006 48,639 48,656 49,388 48,651 45,640 42,560 40,220 39,093 38,919 38,747 38,892 38,876

*Source: Monstat ** Source: Employment Bureau *** New methodology applied

145 Table 11 – Selected items of aggregated balance sheet for 2005 and 2004

Long term Long term Cash and cash ASSETS Real estate ﬁnancial receivables equivalents investments 2005 1,211,577,757 414,288,755 42,718,340 57,774,562 40,619,038 Wholesale and retail trade 2004 995,696,832 294,150,248 56,953,433 46,704,777 27,887,808 2005 875,981,365 573,773,537 1,294,167 24,964,398 15,756,387 Manufacturing industry 2004 979,802,606 627,711,690 2,207,770 8,886,250 7,667,891 Transportation, warehousing, 2005 765,617,465 592,922,803 16,935,950 9,898,881 17,428,444 communications 2004 844,004,941 696,004,892 16,937,703 9,912,399 12,937,702 2005 233,206,495 81,273,347 552,515 3,593,415 6,661,625 Construction 2004 191,016,292 70,460,476 378,843 2,281,329 5,199,210 2005 1,259,409,680 1,127,942,254 20,264,615 5,026,174 1,769,506 Electricity production 2004 1,245,493,069 1,128,222,421 18,496,648 3,824,031 1,566,157 2005 274,094,633 167,425,961 616,035 7,873,413 9,635,563 Real estate 2004 194,629,664 129,625,060 928,377 2,107,062 4,595,306 2005 160,842,894 84,228,245 5,688,485 4,387,160 584,099 Mining and quarrying 2004 172,221,251 101,149,381 4,733,629 6,655,797 275,810 Agriculture, forestry, water 2005 45,838,257 20,050,308 4,432 1,260,407 908,275 management 2004 34,454,505 17,192,544 4,624 638,313 553,261 2005 3,573,627 1,159,056 0 288,921 94,351 Fishing 2004 3,933,850 1,309,133 0 262,292 47,091 2005 508,617,071 295,952,774 335,160 7,491,089 16,628,394 Hotels and restaurants 2004 416,713,478 220,114,679 536,544 7,180,245 12,853,038 2005 26,443,075 8,373,485 8,034,658 1,421,786 1,605,593 Financial intermediation 2004 5,010,678 274,642 0 94,927 272,391 2005 4,048,810 1,166,317 0 39,873 294,110 Education 2004 3,371,789 933,443 0 39,873 155,388 2005 88,356,082 84,039,131 50,061 428,779 350,172 Health and social service 2004 88,833,879 85,011,430 66,033 552,531 241,063 Public utilty, social, personal 2005 121,684,249 79,005,490 234,392 941,881 4,268,808 services 2004 107,604,102 53,110,983 171,749 290,323 2,024,343 2005 5,579,291,460 3,531,601,463 96,728,810 125,390,739 116,604,365 ECONOMIC SUBJECTS - TOTAL 2004 5,282,786,936 3,425,271,022 101,415,353 89,430,149 76,276,459

Source: Central Bank of Montenegro

146 Table 11 – Selected items of aggregated balance sheet for 2005 and 2004 - Continued

Long term Subscribed Long term Share of long LIABILITIES ﬁnancial Dividends capital liabilities term loans liabilities 1,211,577,757 403,549,273 79,517,812 108,352,386 5,845,327 273,447 2005 Wholesale and retail trade 995,696,832 336,303,380 94,310,345 64,324,114 1,583,726 262,504 2004 875,981,365 525,210,455 66,342,940 108,443,840 5,741,954 33,900 2005 Manufacturing industry 979,802,606 494,780,904 131,338,461 37,856,995 2,321,819 0 2004 765,617,465 664,717,067 53,576,244 18,125,922 1,079,085 41,244 2005 Transportation, warehousing, 844,004,941 627,705,516 113,585,902 12,472,850 576,401 24,866 2004 communications 233,206,495 53,378,178 8,379,120 17,088,540 266,250 1,661 2005 Construction 191,016,292 46,071,384 11,409,605 8,912,405 191,625 4,320 2004 1,259,409,680 684,113,549 141,228,676 8,683,818 568,556 0 2005 Electricity production 1,245,493,069 683,183,377 135,433,107 5,203,715 852,835 0 2004 274,094,633 114,461,887 14,450,803 26,542,737 188,924 2,555 2005 Real estate 194,629,664 92,026,291 8,324,560 12,469,408 128,539 3,497 2004 160,842,894 81,693,688 32,897,398 6,837,637 40,482 0 2005 Mining and quarrying 172,221,251 105,115,413 32,881,677 6,959,374 7,407,461 0 2004 45,838,257 28,885,011 2,157,573 2,242,972 71,085 0 2005 Agriculture, forestry, water 34,454,505 23,079,644 1,801,686 1,518,705 45,940 0 2004 management 3,573,627 1,643,202 0 695,652 22,917 0 2005 Fishing 3,933,850 1,569,589 37,793 590,136 0 0 2004 508,617,071 351,313,043 121,503,108 23,948,762 540,132 534 2005 Hotels and restaurants 416,713,478 311,563,273 61,196,836 19,708,868 300,812 0 2004 26,443,075 1,716,759 16,432,089 2,926,043 2,660 0 2005 Financial intermediation 5,010,678 983,127 0 584,032 0 0 2004 4,048,810 1,455,464 170,650 329,586 205,959 42,303 2005 Education 3,371,789 1,148,217 366,343 93,714 85,813 0 2004 88,356,082 61,649,567 551,803 5,848,663 14,560,376 0 2005 Health and social service 88,833,879 61,391,357 3,636,898 21,330,121 0 0 2004 121,684,249 74,786,671 9,475,935 5,292,967 50,891 0 2005 Public utilty, social, 107,604,102 62,495,282 9,539,409 5,132,350 19,661 0 2004 personal services 5,579,291,460 3,048,573,814 546,684,151 335,359,525 29,184,598 395,644 2005 ECONOMIC SUBJECTS - 5,282,786,936 2,847,416,754 603,862,622 197,156,787 13,514,632 295,187 2004 TOTAL

Source: Central Bank of Montenegro

147 Table 12 – Selected items of aggregated income statement for 2005 and 2004

Other operating Net proﬁt/loss for the Income Employees costs expenses accounting period 2005 1,558,542,611 -92,202,896 -148,832,547 27,161,524 Wholesale and retail trade 2004 1,293,661,275 -81,847,459 -136,870,367 10,204,852 2005 537,833,833 -115,648,890 -116,015,964 -190,300,081 Manufacturing industry 2004 489,669,448 -103,018,159 -64,544,981 -36,273,037

Transportation, warehousing, 2005 258,327,796 -57,471,580 -153,089,893 -39,185,759 communications 2004 219,548,315 -55,003,841 -79,877,359 5,351,558 2005 195,393,274 -21,732,860 -25,429,882 3,633,677 Construction 2004 129,224,296 -19,901,899 -21,418,083 306,832 2005 180,743,575 -10,844,962 -30,230,167 -29,680,553 Electricity production 2004 173,965,390 -10,326,831 -32,275,244 -11,647,054 2005 138,877,156 -30,940,738 -40,404,315 -762,186 Real estate 2004 92,714,305 -17,110,396 -29,275,574 -7,991,155 2005 64,192,456 -29,472,231 -16,129,910 -7,585,368 Mining and quarrying 2004 64,744,674 -25,705,115 -17,376,177 -2,728,190

Agriculture, forestry, water 2005 29,461,154 -3,132,782 -4,378,907 758,668 management 2004 21,607,928 -2,125,740 -3,051,578 259,811 2005 3,023,461 -398,619 -448,781 -53,079 Fishing 2004 3,147,159 -427,048 -790,416 58,414 2005 64,443,022 -22,514,204 -24,924,427 -17,496,568 Hotels and restaurants 2004 52,355,053 -19,132,819 -40,482,986 -36,027,191 2005 6,194,787 -646,177 -1,734,621 199,653 Financial intermediation 2004 4,960,512 -246,881 -3,199,513 907,412 2005 4,856,370 -1,839,245 -1,021,090 -62,219 Education 2004 4,009,983 -1,256,350 -597,433 142,868 2005 5,578,054 -2,321,470 -1,452,059 -373,852 Health and social service 2004 4,313,644 -1,697,696 -1,130,752 -570,573

Public utilty, social, personal 2005 59,556,114 -27,124,404 -23,811,122 491,730 services 2004 48,164,182 -23,719,233 -19,749,033 -5,412,754 2005 3,107,023,663 -416,291,058 -587,903,685 -253,254,413 ECONOMIC SUBJECTS - TOTAL 2004 2,602,086,164 -361,519,467 -450,639,496 -83,418,207

Source: Central Bank of Montenegro

148 1,8 0,7 9,8 4,5 0,5 2,2 -1,3 -0,1 57,9 11,6 35,9 43,0 32,2 59,3 10,5 75,2 100,0 100,0 1.12. %, 3 Structure 62 88 141 191 153 145 136 125 202 141 232 235 248 228 205 205 220 225 14:2 Index 98 111 115 115 115 121 191 126 120 115 114 114 110 108 106 100 104 107 14:13 Index 7,822 -1,085 10,377 25,837 14 63,696 30,640 511,180 -18,998 139,314 612,246 165,429 459,250 825,450 149,691 31.12. 844,448 1,071,496 1,425,078 1,425,078 4,090 8,548 -1,103 61,403 26,726 13 20,468 -19,087 131,413 152,876 530,616 424,692 398,061 746,869 139,961 765,956 928,676 30.11. 1,252,329 1,252,329 722 7,639 -1,016 39,138 59,667 12 22,096 -18,164 474,979 124,575 422,619 379,980 146,240 669,908 132,214 854,959 31.10. 688,071 Table 13 – Balance sheet of banks, 13 Table thousand EUR 1,173,273 1,173,273 876 6,400 -1,069 24,159 27,543 -17,174 59,879 11 132,436 125,635 635,886 383,408 448,727 360,646 132,035 809,373 653,060 30.09. 1,102,263 1,102,263 838 -987 5,882 61,577 28,410 25,010 10 -15,905 103,196 330,967 126,089 599,383 443,249 131,971 353,648 774,216 615,288 31.08 1,038,631 1,038,631 2006 832 9 4,279 -1,011 57,075 24,831 25,375 94,546 -14,971 31.07. 305,169 296,317 125,709 566,799 406,893 581,770 703,210 129,988 953,407 953,407 -868 8 1,841 1,996 82,819 54,591 22,724 25,766 -15,148 544,174 274,650 30.06. 360,924 122,864 250,239 635,574 559,322 124,860 870,860 870,860 7 3,010 2,071 -1,793 17,816 55,376 20,716 76,784 -14,247 327,531 119,030 512,597 31.05. 121,101 258,550 223,696 807,692 807,692 586,081 526,844 1,319 6 2,010 -1,772 57,059 77,565 26,016 16,023 -13,704 117,225 291,391 253,318 30.04. 224,891 472,843 118,544 544,709 486,347 768,844 768,844 91 5 7,508 -1,777 21,043 71,240 50,759 16,056 -13,550 117,466 31.03. 117,557 273,659 240,278 513,937 442,898 223,348 731,285 731,285 456,449 7,737 4 1,407 -1,797 19,010 15,979 70,931 52,756 -13,724 231,122 242,103 28.02. 274,994 402,527 106,368 107,775 506,116 711,569 711,569 416,252 275 3 8,123 -1,775 15,681 16,673 52,549 70,895 -13,659 31.01. 272,120 219,298 374,336 106,457 491,417 253,049 387,996 106,732 693,840 693,840 4,183 2 8,921 -1,762 51,128 71,373 16,941 21,082 -13,511 267,019 2005 227,188 31.12. 102,280 362,430 260,729 487,917 375,941 695,756 695,756 106,463 1 ﬁnancial institut. ASSETS Financial resources and1. deposits 2. Credits Credit loss reservations 2.1. 2.2. Net credits 3. Securities 4. Other assets Reserves5. ASSETS6. TOTAL LIABILITIES Deposits1. Demand deposits 1.1. Time 1.2. deposits 2. Short term borrowings from 3. Other borrowings 4. Other liabilities capital Total 5. Capital and reserves 5.1. current 5.2. Proﬁt / Loss (+,-) year LIABILITIES6. TOTAL Annex B Source: Bookkeeping of banks

149 61,690 95,932 59,867 59,906 61,344 60,025 90,022 60,272 90,723 58,988 64,022 90,205 60,505 157,952 128,918 172,762 149,758 123,833 128,780 146,579 125,488 (1-11) TOTAL 878 600 906 646 2,519 1,793 1,787 1,736 2,677 1,894 2,549 3,667 11 Hipo Alpe - Adrija Bank 3,411 4,158 7,059 7,602 3,951 7,645 3,321 6,732 4,073 4,207 4,367 8,055 3,607 4,383 8,336 3,447 4,085 6,462 6,946 4,344 4,440 10 Budva Kom. bank 7,303 7,586 4,393 3,956 9,828 4,020 4,672 6,778 4,545 4,454 3,839 3,996 4,638 6,777 17,145 10,158 11,042 18,190 16,774 10,522 16,054 9 bank Opportunity 7,207 7,299 7,868 8,079 8 bank* Euromarket 5,115 5,126 9,219 7,677 9,936 8,753 5,550 5,770 6,378 9,396 9,647 5,239 6,730 8,652 4,345 4,823 8,828 9,060 6,642 5,084 4,464 7 bank Atlasmont 511 715 716 476 774 971 291 329 293 538 542 779 997 729 869 999 300 990 804 464 1,025 6 bank Licensed banks Pljevaljska 913 915 970 877 998 904 904 ka 1,134 2,182 2,418 2,219 1,675 1,661 3,721 1,790 1,002 4,570 3,291 1,649 2,293 8,284 c i 5 s bank Nik 4,193 4,152 9,810 9,720 4,265 4,239 11,913 17,971 12,152 13,103 10,703 24,435 19,289 14,039 17,844 21,867 13,303 12,908 19,486 23,630 25,668 4 NLB Montenegrobank 47,816 29,192 27,472 61,947 27,224 62,317 26,811 74,453 68,317 68,974 60,219 81,948 45,573 45,282 23,527 24,909 26,773 24,096 26,443 44,965 60,466 kom. . 3 g bank o Crn ka c 6,176 6,139 5,916 9,749 6,122 9,639 9,303 9,268 8,387 6,722 5,822 8,240 11,818 13,164 13,979 13,661 13,329 12,354 12,509 14,257 10,404 2 bank Podgori 3,115 1,511 1,524 1,379 1,332 1,381 1,578 1,481 1,622 3,352 1,560 1,508 1,566 2,562 3,272 2,330 2,265 3,999 1,406 2,490 1,644 1 bank Hipotekarna June March December December September 2005 2006 Table 14 – Review of calculated 14 and appropriatedTable reserve requirements, thousand EUR * As of 1 January 2006 Euromarket bank and Montenegrobank operate (merger) under the name NLB Montenegrobank Source: Central Bank of Montenegro

150 Annex C: Auctiones held in 2006

Table 15 – Auctions of 91-day T-bills

Lowest Highest Auction Issue date Issued Sold Demand Weighted rate rate rate XXII AUCTION 18.01.2006 700,000.00 700,000.00 2,220,000.00 0.49 0.49 0.49 XXIII AUCTION 22.03.2006 1,000,000.00 1,000,000.00 1,190,000.00 0.80 1.00 0.97 XXIV AUCTIONAUCTION 19.04.2006 700,000.0 700,000.00 700,000.00 0.95 5.00 2.52 XXV AUCTION 21.06.2006 1,000,000.00 1,000,000.00 1,750,000.00 1.25 5.00 1.48 XXVI AUCTION 19.07.2006 500,000.00 500,000.00 1,686,000.00 0.90 4.99 0.90 XXVII AUCTION 20.09.2006 500,000.00 500,000.00 800,000.00 0.85 0.99 0.92 XXVIII AUCTION 20.12.2006 500,000.00 500,000.00 800,000.00 0.95 0.99 0.92 January - TOTAL December 4.900.000,00 4.900.000,00 9.146.000,00 2006

Table 16 – Auctions of 182-day T-bills

Lowest Highest Auction Issue date Issued Sold Demand Weighted rate rate rate XIV AUCTION 09.01.2006 1,500,000.00 1,500,000.00 3,161,000.00 0.69 0.69 0.69 XV AUCTION 22.02.2006 1,300,000.00 1,300,000.00 2,715,000.00 0.45 0.49 0.46 XVI AUCTION 06.04.2006 1,000,000.00 1,000,000.00 1,900,000.00 0.75 1.00 0.91 XVII AUCTION 23.05.2006 1,000,000.00 1,000,000.00 1,013,000.00 0.90 5.50 2.96 XVIII AUCTION 10.07.2006 1,300,000.00 1,300,000.00 1,450,000.00 2.50 3.00 2.96 XIX AUCTION 23.08.2006 500,000,00 500,000.00 1,300,000.00 0.45 2.99 0.45 XX AUCTION 05.10.2006 200,000.00 200,000.00 500,000.00 0.40 0.69 0.53 XXI AUCTION 21.11.2006 800,000.00 800,000.00 1,600,000.00 0.49 0.50 0.50 January - TOTAL December 7,600,000,00 7,600,000,00 13,639,000,00 Izvor: CBCG 2006

Source: Central Bank of Montenegro

151 0.80 97.10 97.82 89.51 52.55 99.01 92.67 43.94 99.96 89.83 98.47 79.04 98.37 88.78 98.20 98.60 131.77 114.24 128.16 113.22 113.88 135.81 103.01 172.63 185.98 136.73 392.98 109.56 109.09 299.81 144.02 108.52 108.94 realization % umulative 0.00 C 01.01. - 31.12.2006 01.01. 44,155.27 6,287,921.72 8,164,967.57 2,429,650.17 2,419,239.24 7,371,892.86 9,312,788.53 6,407,999.53 8,818,136.40 1,050,939.44 4,535,766.87 6,072,666.83 6,884,832.28 Amounth 47,287,647.97 20,933,511.78 31,398,176.75 22,319,637.85 13,900,279.19 34,615,592.98 44,513,257.68 12,681,282.08 18,844,737.58 72,493,703.82 43,270,224.90 45,510,364.29 56,766,223.62 158,195,972.51 579,780,128.90 499,381,748.51 557,795,285.38 262,110,684.35 345,532,879.26 158,589,560.21 582,258,287.30 0.00 279.76 2,301.66 35,875.42 613,929.14 382,189.65 199,435.22 252,751.64 288,675.61 418,068.45 520,449.01 300,076.90 1,567,165.59 8,611,085.41 9,045,144.61 Amounth 1,109,806.01 1,460,122.85 5,727,604.53 5,566,482.15 5,552,333.58 6,467,768.22 5,883,202.31 5,648,955.79 1,662,706.38 2,398,729.23 4,230,876.04 December 16,184,231.68 13,639,818.29 61,532,244.09 58,931,498.22 66,960,678.12 30,975,608.72 30,630,355.25 48,860,289.96 0.00 9,678.47 37,219.36 53,813.13 99,785.71 96,720.93 818,815.55 227,942.37 752,697.96 489,347.94 209,293.94 636,302.04 405,665.06 262,000.00 4,631,113.11 5,755,459.17 2,518,673.31 Amounth 1,262,100.40 8,287,595.64 2,887,658.70 1,590,184.80 1,577,008.29 8,377,863.20 6,647,404.69 2,900,466.10 3,892,004.34 November 51,651,132.92 42,011,169.32 49,156,215.81 52,613,567.23 28,937,986.46 12,446,071.50 22,332,073.90 14,246,506.51 0.00 300.00 7,602.65 291,919.75 247,876.93 212,547.68 250,337.67 541,370.35 751,028.89 436,532.07 442,909.47 893,784.89 October 7,537,762.65 3,427,407.75 1,441,122.01 1,318,526.14 1,279,913.32 6,527,227.06 1,530,698.17 Amounth 1,908,821.33 2,852,183.09 5,165,304.40 6,340,109.62 1,255,880.75 3,825,881.48 32,211,453.14 50,117,426.86 59,571,913.49 13,545,556.87 45,985,330.45 15,445,582.22 57,364,223.69 13,586,606.45 22,256,638.09 0.00 5,416.47 413,017.59 274,519.71 -36,036.43 615,125.00 122,811.87 581,271.98 832,198.47 786,150.85 130,758.72 173,544.31 608,695.51 295,000.00 3,428,557.14 3,771,726.51 Amounth 4,351,263.26 4,374,489.90 1,291,854.20 3,730,553.32 1,684,970.98 5,908,515.86 2,406,395.74 4,536,543.63 2,330,643.37 2,068,442.43 29,110,552.61 55,120,450.19 September 53,547,856.17 15,014,877.66 17,725,292.49 48,402,507.13 31,205,669.39 43,682,095.79 0.00 0.00 378.07 35,000.00 296,187.16 837,828.71 494,481.01 218,796.85 216,963.84 342,430.07 672,296.41 607,564.84 404,333.26 273,606.33 August 3,957,132.47 1,859,116.33 1,185,818.66 1,713,676.80 6,923,787.64 Amounth 5,667,948.43 3,722,599.79 1,942,088.89 2,452,302.64 5,235,896.78 3,893,048.21 8,590,683.34 13,194,981.11 51,315,927.72 17,375,753.39 56,711,220.76 45,933,164.22 14,290,685.18 36,809,733.27 56,458,878.85 0.00 0.00 5,447.48 Jul y 327,311.35 363,172.74 387,891.07 551,362.49 262,501.24 389,007.32 242,964.92 753,363.28 614,000.00 405,596.56 662,224.88 264,369.68 Table 17 – Budgetary 17 revenues and budgetaryTable expenditures in 2006, EUR 2,177,717.56 Amounth 3,243,431.53 9,315,965.56 5,749,354.51 1,120,362.23 6,027,729.04 1,206,033.38 3,436,536.56 5,873,942.80 4,543,423.44 2,050,884.09 19,729,610.35 47,273,740.57 46,109,004.65 32,783,953.94 50,472,798.41 51,536,942.98 11,005,368.07 14,362,733.39 0.00 11,899.32 June 119,350.11 573,165.15 327,712.54 786,173.75 347,420.02 139,259.63 475,939.46 371,462.32 226,213.60 473,282.38 173,483.22 1,112,035.70 1,193,280.18 1,169,276.98 4,324,721.49 1,654,877.92 Amounth 2,790,164.45 1,267,860.40 5,244,332.67 2,360,874.73 3,209,754.94 5,409,728.98 2,389,795.84 6,362,225.87 26,574,978.17 30,603,517.47 43,793,382.17 50,015,461.79 13,952,073.99 47,752,823.60 15,202,038.01 49,866,663.49 0.00 32.34 May 95,149.34 53,345.36 83,708.60 423,940.74 169,573.00 395,905.57 472,854.01 293,206.61 160,940.27 628,689.05 995,808.41 844,379.80 Amounth 2,479,301.37 5,100,916.20 2,502,156.69 1,289,420.02 5,270,952.24 1,399,525.67 5,691,073.38 3,936,710.22 1,395,678.69 2,552,400.69 3,203,900.86 1,240,000.00 12,767,082.13 45,376,874.13 32,522,245.35 49,324,953.51 49,643,053.55 21,685,834.06 14,568,209.12 48,391,895.49 0.00 0.00 55,576.11 April 543,141.03 573,152.41 103,018.91 321,725.33 579,075.70 139,452.89 943,715.87 833,936.75 361,756.84 230,539.55 191,666.66 -744,703.24 4,253,310.61 Amounth 3,781,356.85 1,534,492.62 6,007,280.01 2,728,373.49 1,299,230.07 2,857,220.00 2,852,682.71 1,086,370.23 2,466,270.01 2,048,574.26 21,111,544.85 11,668,817.61 14,497,361.62 43,719,189.54 41,597,408.52 37,658,355.58 24,248,012.78 42,486,921.38 0.00 0.00 3,798.78 80,591.07 March 989,112.80 137,692.28 414,212.20 421,901.64 173,621.64 986,425.19 954,154.63 148,718.69 338,106.05 645,969.80 862,540.37 444,426.77 5,807,139.92 Amounth 3,447,281.59 1,095,178.48 2,580,737.02 1,265,949.66 4,134,088.62 1,998,236.92 8,698,046.13 3,700,909.89 10,997,091.24 37,621,690.91 41,297,606.41 42,269,715.32 52,596,162.37 -9,858,984.66 28,705,382.72 24,899,692.63 19,640,253.68 0.00 0.00 0.00 92,342.51 87,344.86 94,323.06 557,103.99 613,916.29 923,129.67 181,813.44 817,254.54 315,564.47 739,414.68 331,025.54 332,004.19 191,666.66 1,193,807.13 1,129,716.45 February 5,170,583.92 1,479,715.86 6,124,878.07 3,183,479.64 Amounth 4,497,608.58 1,545,580.03 2,221,565.86 3,496,094.40 2,344,540.22 11,902,310.45 35,136,819.79 20,897,712.43 31,340,697.21 32,598,431.77 34,485,392.74 12,356,544.71 0.00 0.00 ,070.43 2,302.61 3,400.00 54,597.06 96,930.91 83,205.04 32,808.23 787,499.16 124,759.23 242,851.63 479 659,789.32 266,732.51 351,900.00 191,666.66 -211,518.43 630,473.48 643,605.36 466,244.04 January 1,045,454.11 7,160,282.39 2,382,707.76 1,907,869.24 3,132,738.70 2,795,712.96 Amounth 3,658,496.93 11,353,492.95 19,437,293.68 27,341,369.05 27,302,858.21 10,695,650.51 30,650,515.34 25,626,930.62 2,621,787.12 revised 3,339,746.81 2,459,262.00 2,458,847.06 8,346,715.29 5,108,234.00 5,503,625.00 19,111,918.36 6,075,000.00 7,000,000.00 6,320,000.00 5,000,000.00 2,000,000.00 15,497,739.59 41,518,056.18 Amounth 70,376,155.20 21,195,445.82 35,078,625.15 24,471,042.98 12,033,100.00 16,043,415.68 19,290,332.57 10,548,639.97 44,958,549.60 48,738,673.66 437,147,690.87 161,091,029.07 303,411,469.94 531,462,185.26 531,462,185.26 163,326,959.47 266,178,055.49 Plen for 2006 492,654,880.44 curity e fers s ax s Annex D t n salaries enditures e a tax r p e t income m c o m and c l trade and o rves e s bli a n e i nt ex REVENUES e inc DESCRIPTION t res EXPENDITURES enanc nt income nt budget reserves e L t year liabilities payment Surplus / Deﬁcit as the diﬀerence between total revenues (reduced for borrowings, donations, transfers revenues and from sale property) of expenditures and for principal securities repaymentand loans of taken issued the in country abroad and e e

152 r payment Prior year funds Taxes Personal Corporate Property tax Value added tax and excise duties Internation transactions tax Other taxes Dues Other Repu Curr Real estate sale Loan repayment Donations and Loans and borrowings REVENUESTOTAL EXPENDITURES currTotal Gross wage Other earnings and compensation of employees Expenditures for material and services Interest rates Annuity Subventions Other expenditures Main Capital expenditures EXPENDITURESTOTAL Transfers and social Loans and borrowings Frozen FX and debt re Guarantees repayment Prio Budg Curr TOTA Surplus/ (deﬁcit) 29.2 23.3 -4.41 119.0 -0.70 -0.99 118.0 0.715 1.485 206.1 0.770 206.8 umulative C 1.9 1.9 0.0 -3.0 -0.2 22.7 19.70 0.165 0.168 22.27 22.05 0.003 XII 0.1 3.7 0.3 3.8 -0.1 10.4 0.137 0.169 10.67 0.032 20.53 XI 20.40 1.3 2.2 -0.9 -0.4 -0.3 9.95 10.3 18.18 0.149 X 18.53 0.053 0.097 9.0 2.0 2.5 0.5 0.2 0.49 9.23 17.83 0.128 0.033 18.38 0.095 IX 1.4 2.5 2.2 8.3 -0.1 -1.08 0.152 0.101 10.51 0.051 20.31 20.22 VIII 0.1 3.6 0.6 2.2 8.6 2006 9.23 0.139 14.98 14.90 0.071 0.068 VII 2.1 0.9 9.2 0.0 0.3 -1.2 9.49 0.142 18.91 18.93 0.091 0.052 VI 1.9 1.5 2.4 0.0 8.8 -0.4 0.103 V 16.01 10.38 16.00 0.054 0.049 1.7 1.3 0.0 8.2 -0.1 -0.4 8.15 14.56 0.075 14.54 0.026 IV 0.049 9.1 1.8 0.0 2.2 -1.6 -0.4 7.43 14.24 14.26 III 0.054 0.094 0.040 8.1 2.9 2.5 0.0 -0.1 -0.4 7.95 II 14.61 14.62 0.078 0.020 0.058 1.9 1.8 6.3 -1.0 -0.1 -0.8 5.33 I 14.19 13.37 0.059 0.030 0.089 99.9 18.8 0.05 2.36 23.6 5.00 0.319 0.212 201.6 201.6 0.531 102.2 2005 01.01-31.12. DESCRIPTION/month INCOME Fund Pension Health Fund Care Employment Bureau Development Fund EXPENDITURE Fund Pension Health Fund Care Employment Bureau Development Fund SURPLUS/DEFICIT Fund Pension Health Fund Care Employment Bureau Development Fund Table – Revenues and expendituresTable of funds, million EUR Source: Republic Funds in Montenegro 153 CIP - Katalogizacija u publikaciji Centralna narodna biblioteka Crne Gore, Cetiwe

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CHIEF economist annual report 2006 / central bank council Ljubiša Krgović ... et al. - (2003) - . - Podgorica (Bulevar Svetog Petra Cetinjskog br. 6) : Central bank of Montenegro, 2003 (Podgorica : Grafo Crna Gora). - 28 cm

Godišnje ISSN 1800-6507 = Chief economist annual report (Podgorica) COBISS.CG-ID 11466768